Earnings Call: Q3 2027

Apr 27, 2017

Summary

Q3 sales rose 10% YoY, adjusted EPS increased 40%, and orders strengthened across industrial markets. FY2017 guidance was raised, with CLARCOR integration and debt reduction central to the outlook.

Good day, gentlemen, and welcome to the Parker-Hannifin Corporation third quarter 2017 earnings conference call. At this time, all participants are in a listen-only mode. Later, there will be a question-and-answer session, and instructions will follow at that time. If you require any assistance during today's call, you may press star and then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Kathy Suver, Chief Financial Officer. Ma'am, you may begin. Thank you, Shannon. Good morning. Welcome to Parker-Hannifin's third quarter fiscal 2017 earnings release teleconference. Joining me today is Chairman and Chief Executive Officer, Tom Williams, and President and Chief Operating Officer, Lee Banks. Today's presentation slides, together with the audio webcast replay, will be accessible on the company's investor information website at phstock.com for one year following today's call. On slide number 2, you'll find the company's safe harbor disclosure statement addressing forward-looking statements as well as non-GAAP financial measures. Reconciliations for any reference to non-GAAP financial measures are included in this morning's press release and are posted on Parker's website at phstock.com. Today's call agenda appears on slide number 3. To begin, our Chairman and Chief Executive Officer, Tom Williams, will provide highlights for the third quarter of fiscal year 2017. Following Tom's comments, I'll provide a review of the company's third quarter fiscal year 2017 performance, together with the guidance for full fiscal year 2017. Tom will provide a few summary comments, and then we'll open the call for a Q&A session. This time, I'll turn it over to Tom and ask that you refer to slide number 4. Thanks, Kathy, and welcome to everyone on the call. We appreciate your participation this morning. I'd like to take a moment to congratulate Kathy on her new role as Chief Financial Officer, which we announced earlier this month. We will certainly miss Jon Marten, who announced his retirement. We thank John for his great leadership and service during his 30 years with the company. We are very fortunate to have someone of Kathy's leadership and experience to step into this important role. Kathy has 30 years of experience in operational and financial roles at Parker and has been acting CFO since November of last year. This seamless transition is an indicator of the effectiveness of our leadership succession planning at Parker. Now, moving on to the results, I would like to share highlights of our third quarter results, which were strong across many measures, give you an update on the CLARCOR integration, and comment on our changes to the fiscal year 2017 guidance. Before I get into the financials, I would like to first report on our safety performance since keeping our people safe is our highest priority and our most important measure. During the third quarter of 2017, we were able to reduce our recordable injuries by 28% compared to the prior year. Importantly, we reduced our lost time due to injuries by 39% compared with the prior year period. This builds on a significant year-over-year improvement the last several years. That is even more impressive considering the increase in volume we have experienced this quarter. This improvement is being driven by strong leadership, training, and engagement of our team members globally through high-performance teams that are focused on achieving a goal of zero accidents. Now on to the financial highlights for our third quarter results. This was another strong quarter for Parker across many measures. Third quarter sales were $3.12 billion, a 10% increase compared with the same quarter a year ago. Organic sales increased 6% and acquisitions contributed 5%, while currency was a negative 1%. We are particularly pleased with the strong organic growth driven by improving conditions across many of our end markets. This is noteworthy as it is the first quarter of organic growth since December 2014 quarter. As you know, we closed the CLARCOR acquisition in late February and had one month results included in the quarter, which drove the 5% increase from acquisitions. Order rates, which do not include the impact of acquisitions, also continued to move in a positive direction for the third consecutive quarter. Total orders increased 8% compared with the same quarter last year. Industrial North America orders increased 9%. Industrial International orders were up double digits at 13%, and in our Aerospace Systems segment, orders were flat. Again, we see encouraging signs of recovery and demand levels. We will provide more color on the markets in our Q&A portion of the call. Net income for the third quarter increased 28% to $238.8 million as reported compared with the same period last year. Earnings per share were $1.75 as reported, or $2.11 on an adjusted basis, a 40% increase in adjusted earnings per share compared with adjusted earnings in the same quarter last year. Our overall segment operating margin performance this quarter was very strong at 14.8% as reported, or 16.1% on an adjusted basis. Adjusted segment operating margins increased 140 basis points compared with the third quarter of fiscal 2016, an excellent year-over-year improvement. Year-to-date cash from operations, excluding a discretionary pension contribution, was 11.8% of sales, demonstrating our ability to be a strong generator of cash on a consistent basis. Now, just a few highlights, updates on capital allocation. As we announced at the end of February, we closed the transaction to acquire CLARCOR. Since the transaction closed, we have welcomed the global CLARCOR team to Parker and have begun the process of integrating our businesses. Filtration Group President Rob Malone has formed a leadership team for the newly combined business. We have also formed a dedicated integration team staffed with some of our most experienced and talented operational and functional leaders. I feel very good about the progress we have made with the integration, and I'm confident we can generate the $140 million in cost synergies we initially expected from our combined filtration businesses. We've incurred the expected amount of one-time acquisition-related expenses, which Kathy will highlight in her slides, and we will provide the FY 2018 CLARCOR costs and EPS projections when we provide full-year guidance in August. Also, during the quarter, we completed the acquisition of Helac Corporation to add specialty rotary actuators and attachments to our hydraulics portfolio. During the quarter, we announced a 5% increase in the quarterly dividend. We have now increased our annual dividends paid for 61 consecutive fiscal years. This is among the top five longest-running dividend increase records in the S&P 500. We have also continued our 10b5-1 program and bought $50 million worth of shares in the third quarter. These actions reinforce our commitment to being a great deployer of cash in ways that generate increased long-term returns for our shareholders. Just one other strategic update to comment on. This week, we launched our Voice of the Machine Internet of Things offering at the world's largest trade fair for industrial technologies in Hanover, Germany. The Voice of the Machine IoT platform is an open, interoperable, and scalable system of connected products and services. We are excited about the launch of this new capability that offers benefits to our customers, such as improved safety, reduced maintenance costs, and downtime, while simultaneously uncovering opportunities to improve operational performance. Moving to our revised FY 2017 guidance. We are increasing our full-year sales growth forecast from a negative 0.5% to an increase of a positive 5.9% at the midpoint in our new guidance to reflect higher organic growth and the impact of acquisitions. Full fiscal year 2017, we are updating guidance for as-reported earnings in the range of $6.90 to $7.20 per share, or $7.05 at the midpoint. On an adjusted basis, we expect EPS in the range of $7.70 to $8 for a midpoint of $7.85. Earnings are adjusted for anticipated business realignment expenses of approximately $0.25 forecasted for fiscal 2017, and for acquisition-related expenses of $0.55. To be clear, our revised guidance does include the benefits and costs from the CLARCOR and Helac acquisitions. For now, I'm going to hand things back to Kathy to review more details on the quarter and the fiscal 2017 guidance. Thanks, Tom. Please refer to slide number 5. I'll begin by addressing earnings per share for the quarter. Adjusted earnings per share for the third quarter were $2.11 versus $1.51 for the same quarter a year ago. This equates to an increase of 40%. Third quarter earnings have been adjusted to exclude CLARCOR acquisition-related expenses of $0.27 per share incurred during the quarter and business realignment expenses of $0.09 per share, which compares to business realignment expenses of $0.14 per share for the same quarter last year. On slide number 6, you'll find the significant components of the walk from adjusted earnings per share of $1.51 for the third quarter fiscal 2016 to $2.11 for the third quarter of this year. Increases included higher adjusted segment operating income of $0.44 per share, of which legacy Parker was $0.37 and CLARCOR contributed $0.07. Lower income taxes as compared to the prior year equated to an increase of $0.18, due largely to the stock option expense tax credit, while lower other expense and the impact of fewer shares outstanding equated to an increase of $0.03. Adjusted per share income was reduced by $0.05 due to higher interest expense and corporate G&A. Moving to slide number seven, we review total Parker sales and segment operating margins for the third quarter. Total company organic sales for the third quarter increased by 5.7% compared to the same quarter last year. There was a 5.6% contribution to sales in the quarter from acquisitions, while currency negatively impacted the quarter by 1%. Total segment operating margins, adjusted for realignment costs, as well as CLARCOR acquisition-related expenses, was 16.1% versus 14.7% for the same quarter last year. Business realignment costs incurred in the quarter were $16 million versus $25 million last year. CLARCOR acquisition-related costs included in segment operating income totaled $26 million in the quarter. The increased adjusted segment operating income this quarter of $503 million versus $417 million last year reflects the impact of organic growth, combined with the benefits yielded from our simplification initiatives. Moving to slide number eight, I'll discuss the business segments, starting with Diversified Industrial North America. For the third quarter, North American organic sales increased by 3.8% compared to the same quarter last year. Acquisitions contributed 9.7% impact to sales, while currency negatively impacted the quarter by 0.2%. Operating margin for the third quarter, adjusted for realignment and CLARCOR acquisition-related costs, was 18.2% of sales versus 16.9% in the prior year. Business realignment expenses incurred totaled $4 million as compared to $9 million in the prior year. CLARCOR acquisition-related costs included in operating income totaled $26 million during the quarter. Adjusted operating income was $258 million as compared to $211 million, driven by strong incremental margins on increased revenues and lower fixed costs. I'll continue with the Diversified Industrial International segment on slide number nine. Organic sales for the third quarter in the Industrial International segment increased to 9.5%. Acquisitions positively impacted sales by 3.7%, while currency negatively impacted the quarter by 2.5%. Operating margin for the third quarter, adjusted for business realignment costs, was 14.5% of sales, versus 11.9% in the prior year. Realignment expenses incurred in the quarter totaled $11 million, as compared to $16 million in the prior year. Adjusted operating income was $164 million, as compared to $121 million, which again reflects strong incremental margins on increased revenues and lower fixed costs. I'll now move to slide number 10 to review the Aerospace Systems segment. Organic revenues increased 2.9% for the third quarter. With flat growth in OEM sales, aftermarket demand helped drive growth in both commercial and military businesses during the quarter. Operating margin for the third quarter, adjusted for realignment costs, was 14.2% of sales versus 15.1% in the prior year. Business realignment expenses incurred in the quarter totaled $2 million, compared to $1 million in the prior year. Adjusted operating income was $82 million, as compared to $85 million, reflecting the impact of higher development costs during the current quarter. Moving to slide number 11, with the detail of order rates by segment. As a reminder, Parker orders represent a trailing average and are reported as a percentage increase of absolute dollars year-over-year, excluding acquisitions, divestitures, and currency. The Diversified Industrial segments report on a three-month rolling average, while Aerospace Systems are based on a 12-month rolling average. Total orders improved to a positive 8% for the quarter end. Diversified Industrial North America orders increased to a year-over-year 9% change. Diversified Industrial International orders increased year over year to a positive 13% for the quarter, and Aerospace Systems orders were flat year over year. On slide number 12, we report cash flow from operating activities. Year to date, cash flow from operating activities was $789 million, or 9.2% of sales. This compares to 8.4% of sales for the same period last year. When adjusted for the $220 million discretionary pension contribution made in the first quarter, cash from operating activities was very strong at 11.8% of sales. This compares to 10.8% of sales for the same period last year, adjusted for the $200 million discretionary pension contribution made in the prior year. In addition to the discretionary pension contribution, the significant uses of cash year to date have been $4.1 billion for acquisition, $262 million for the company's repurchase of common shares, $257 million for the payment of shareholder dividends, and $145 million, or 1.7% of sales, for capital expenditures. The full year earnings guide for fiscal year 2017 is outlined on slide number 13. Guidance is being provided on both an as-reported and an adjusted basis. Adjusted segment operating margins and earnings per share exclude expected business realignment charges of $48 million for the full year. Adjusted segment operating margins, below the line items, and earnings per share exclude expected CLARCOR acquisition related expenses of $103 million for total fiscal year 2017. Total sales are expected to be in the range of positive 4.9% to positive 6.9%, as compared to the prior year. Full year organic growth at the midpoint is up 1.9%. Acquisitions in the guidance are expected to positively impact sales by 5.1%. Currency in the guidance is expected to have a negative 1% impact on sales. We have calculated the impact of currency to spot rates as of the quarter ended March 31, and we have held those rates steady as we estimate the resulting year-over-year impact for the final quarter of fiscal year 2017. For total Parker, as reported segment operating margins are forecasted to be between 14.7% and 14.9%, while adjusted segment operating margins are forecasted to be between 15.6% and 15.8%. The full year guidance at the midpoint for below the line items, which includes corporate G&A, interest, and other expense, is $470 million on an as reported basis and $425 million on an adjusted basis. The full year tax rate is now projected at 27%. The average number of fully diluted shares outstanding used in the full year guidance is 136 million shares. For the full year, the guidance range on an as reported earnings per share basis is $6.90 to $7.20, or $7.05 at the midpoint. On an adjusted earnings per share basis, the guidance range is $7.70, or $8, or $7.85 at the midpoint. This adjusted earnings per share guidance excludes business realignment expenses of approximately $48 million for the full fiscal year 2017. The effect of this restructuring on earnings per share is approximately $0.25. Savings from these business realignment initiatives are projected to be $30 million and are fully reflected in both the as-reported and the adjusted operating margin guidance ranges. In addition, adjusted guidance excludes $103 million of CLARCOR acquisition-related expenses for fiscal 2017, equating to $0.55 earnings per share. Our revised guidance now includes the benefits and the costs from the CLARCOR and Helac acquisitions completed during the third quarter. We would ask that you continue to publish your estimates using adjusted guidance for purposes of representing a more consistent year-over-year comparison. Some additional key assumptions for full year 2017 guidance at the midpoint are: sales are divided 45% first half, 55% second half. Adjusted segment operating income is divided 43% first half, 57% second half. Adjusted earnings per share, first half, second half is divided 45%, 55%. Fourth quarter of 2017 adjusted earnings per share is projected to be $2.22 per share at the midpoint, and this excludes $0.07 of projected business realignment expenses and $0.19 of projected CLARCOR acquisition-related expenses. On slide number 14, you'll find a breakout of CLARCOR's impact on our fiscal 2017. CLARCOR sales contributed $136 million in the third quarter and are forecasted to be $369 million for Q4, resulting in a full 2017 sales impact of $505 million. CLARCOR acquisition-related expenses were $16 million in Q2, $51 million in Q3, and are expected to be $36 million during Q4. CLARCOR earnings per share impact on an as-reported basis was a negative $0.09 in Q2, negative $0.24 in Q3, and is expected to be a negative $0.14 in Q4. The earnings per share impact of CLARCOR, adjusted for acquisition-related expenses, was an accretive $0.04 in Q3 and is expected to be $0.04 in Q4. These earnings per share amounts include CLARCOR-related amortization, which is presently estimated to be $130 million per year, additional depreciation estimated to be $13 million per year, and incremental interest expense of $73 million per year. Please note that Q3 included only the month of March, and this year, March had a high number of shipping days, which helped with absorption of fixed costs. The estimates for Q4 represent a more normal level of quarterly sales and earnings per share accretion for making assumptions going forward. On slide number 15, you'll find a reconciliation of the major components of fiscal year 2017 adjusted earnings per share guidance of $7.85 per share at the midpoint compared to the prior guidance of $7.30 per share. Increases include $0.62 from stronger segment operating income, of which CLARCOR is forecasted to contribute $0.21. Additionally, a lower tax rate, other expenses, and corporate G&A resulted in a $0.07 per share increase. The decreases include a $0.12 per share reduction from higher interest expense and $0.02 from a modestly higher share count. Please remember that the forecast excludes any acquisitions or divestitures that might close during the remainder of fiscal 2017. This concludes my prepared comments. Tom, I'll turn the call back to you for your summary. Thanks, Kathy. We have continued to make progress through fiscal 2017, and our third quarter continued this momentum. I would like to thank our team members around the world for their dedicated efforts. We are making meaningful progress with the new Win Strategy, which is designed to drive top quartile performance versus our proxy peers and generate long-term shareholder value. All signs point to a strong close to the fiscal year. More importantly, we continue to see opportunities that allow us to achieve our key financial objectives by the end of fiscal 2020, which includes organic sales growth of 150 basis points higher than the rate of global industrial production, 17% segment operating margins, and a compound annual growth rate in earnings per share of 8% over this five-year period. This is a special year for us at Parker as we celebrate our 100-year anniversary. We are very proud of our history and confident in the bright future that we see in front of us. With that, at this time, we are ready to take questions. Shannon, if you could go ahead and get it started. Thank you. Ladies and gentlemen, if you wish to ask a question at this time, please press star then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Nathan Jones with Stifel. You may begin. Good morning, everyone. Morning, Nathan. If you have the numbers handy, could you talk about what the incremental margins were excluding the acquisitions? Yeah. Why don't I talk about excluding CLARCOR? We've done it multiple ways here to analyze our core business results, but looking at just excluding CLARCOR, the incremental margins in the third quarter were in the range of the high 40s. I think you had fairly considerably higher incremental margins in the last quarter, and probably, even at the high 40s, which is very good, was maybe a little lower than expected. Was there anything in there that dragged those down in the quarter, or how should we be thinking about those incremental margins going forward? Well, I think it's normal for us to be in the high 40s as we're coming, we're growing, and markets are improving. We've seen some also benefit from the simplification efforts we've been making, and I'm giving you a broad, total Parker number. On the industrial side, it was higher. It was in the 50s. So it depends on which of the segment of the business you're looking at. Okay, that- Nathan, this is Tom. Because Aerospace was a little challenged with some extra development costs in the quarter, that kind of deflated the marginal return on sales a little bit. If you back that out, just look at industrial, and then also take all the acquisitions out, we're in the mid-50s. Now, I would not project a mid-50 MROS for us going forward. We tend to have the first quarter or two up about that level, and then glide back down to a more steady state of, plus 30. But, these margins are really, really stellar, that we put up in this quarter. Are those Aerospace development costs projected to increase or to continue at that level? Nathan, in this quarter, we pulled in some development work to help some of our customers to get their development cost programs finished. It was more costs that had been planned for FY 2018 that we pulled into this third quarter. Okay. It should glide down then. Correct. Just a question on industrial. Clearly, Parker usually is a beneficiary early in the cycle of inventory restocking in the channels. Can you talk about what you think is maybe the growth that you're seeing there that's due to inventory restocking? Yeah, Nathan, it's Lee. I think the exciting part for us industrially in North America is we saw a lot of our distributor partners see a substantial increase in their backlog, throughout the quarter. That's had a knock-on effect of order entry and shipments. I'm sure there's some marginal inventory restocking, but I wouldn't call that a significant driver of what's happening. I would characterize it more as real demand. That's helpful. Thanks. I'll get back in the queue. Thank you. Our next question comes from Jamie Cook with Credit Suisse. You may begin. Hi. Good morning. One question and then, I guess a follow-up. Tom, just to be clear on the last question with the incremental margins, I guess, more broadly, we shouldn't assume that CLARCOR dampens incremental margins, assuming things continue to recover, so we should think about Parker's historical incremental margins and assume that's how we think about things going forward. I just want to make sure there's no short-term issues with the integration of CLARCOR. Then second, obviously the orders inflected higher broadly if we think about North America, although easier comps and on the international side. So Lee, perhaps you could provide some color on which markets inflected more positively versus last quarter or last year. Thanks. Okay, Jamie, I'll start, then I'll hand it over to Lee for the markets. On the MROS, I think with CLARCOR all in, you should see us do what we've historically done, if that, plus a little bit more, because of everything we've done as a company with the new Win Strategy, the fixed costs that we've taken out, simplification. So I think you could model historical plus a little bit better. On the integration, it's going terrific. I'm very pleased with the integration so far. The teamwork between both companies basically becoming one. They're the talent, the cultural fit, all the synergies, very interesting. The synergies we thought when we were kind of looking at it more isolated, now that we're looking at it jointly, there's a lot of harmony between both teams looking at it and saying, "We agree that this is a dynamite list." We're very encouraged. As we go forward, when we update you in August, we'll give you better clarity as to the cost to achieve and the savings for that fiscal year. We're off to a good start with that. Okay. On the markets, I would just tell you that it's really nice having sat in this room now for 10 quarters to have a quarter where we have an exciting organic growth story to tell you. It's across pretty much the board, and I'll let Lee give you the color on that. Sorry, Tom, just to follow up on the incremental, though. Obviously, it's very encouraging that you think you can do a little better than where we were historically, and you don't see price cost is an issue as well. That's not- No going to be short-term. Okay. All right. Great. Sorry, Lee. Go ahead. No, that is fine. I think, just to highlight here, which was kind of nice, this is the strongest quarter's growth we have had since Q1 of FY 2012. It has been some time that we have had that kind of inflection. Just talking about the industrial markets, as we look through all our end markets, and we track these kind of on a giant heat map, it is hard to find any significant market that did not show positive year-over-year order entry growth during the quarter. Really, Jamie, to highlight some of the key markets, I think if you bucket all the natural resource end markets, those continued to grow during the quarter. We kind of saw some of it last quarter that I highlighted. This would include agriculture, construction equipment, mining, oil and gas. The number in oil and gas rigs, North America have nearly doubled from a year ago, and we have just seen an appreciable pickup in quotes and order entry activity, for a lot of rigs that have been stored where parts have been cannibalized. It is really not new rig activity, it is just a lot of MRO, which is great business for our guys. We also saw a really nice rebound in activity from our distributor partners around the world. For the first time, we are up worldwide with all their distributor partners for some time. I would say other notable markets that grew during the quarter, microelectronics was strong, HVAC&R refrigeration, very strong. Telecom, Class 8 truck, were all really strong markets. If I can, as long as I am going here, Jamie, I will just cover the regions real quick. I am not going to walk through the markets, but just give you some color Okay on the regions. North America, as I just talked, was very strong. Really encouraged by the increasing end market activity. It was really nice just to see a significant increase in backlog with some of our distributor partners that had really been hit hard by the oil and gas natural resource end market collapse. In EMEA, we saw strong order entry growth during the quarter, and it kind of built as the quarter went on. In fact, this will be the first year we expect year-over-year organic growth in three years in EMEA. We are hoping that is going to continue as we go forward. Asia is really strong. China continues to lead with strong industrial and natural resource end markets. The strength in China really has been led by a significant infrastructure investment and strong housing market. We also see emerging markets in Southeast Asia continuing to show great growth. We are really happy with what is happening. There is clearly a positive global sentiment to growth right now anywhere you go. I think we will be happier if we see a couple more quarters of this kind of order entry growth going forward. Okay, great. That was very helpful. I will get back in queue. Thank you. Thanks, Jamie. Thank you. Our next question comes from Joe Ritchie with Goldman Sachs. You may begin. Thank you, and congratulations, Kathy. John, if you're listening, you'll certainly be missed, and we definitely wish you well. First question, maybe just staying with the discussion on organic growth. Did trends improve as we progressed through the quarter? How have trends started out in April? Any commentary you can have on that'd be helpful. Yeah. Joe, this is Tom. The trends through the quarter, North America and Europe showed steady progress through the quarter, and Asia Pacific and Latin America were pretty much consistent, stayed at a high level for the quarter. April is consistent with what we saw and is reflected in the guide. In general, I think Lee kind of hit it. We're encouraged, but a couple more quarters would just solidify that for us. Got it. No, that's helpful. Maybe when I kind of take a look at your organic growth guidance for the year, I recognize the commentary around March being a healthier quarter from a shipment perspective for CLARCOR. I'm just trying to break up your total organic growth guidance in the North America business. It seems like you were expecting at least high single digit, maybe even low double-digit organic growth in that business for 4Q, and I just want to make sure that I'm calculating things right for CLARCOR. Any other detail you can give on the components, it would be helpful. Sure, Joe. We're expecting for North America, high single digits organic growth in the fourth quarter. CLARCOR right now is running more mid-single digit, but total Parker North America, high single digit. Okay. All right. That's helpful. Then maybe if I could ask one more on CLARCOR. The $103 million in costs this year, how much integration costs, I think you guys had highlighted about $90 million in integration costs that you expected to take on CLARCOR to get the synergy benefits. How much of any of those integration costs are going through this year? Maybe if there's some cadence for FY 2018 as well, that'd be helpful. Yeah. It's very small so far this year and expected in the fourth quarter as we're just getting started. We do have the full-time team on board, so we're including the cost for that team. I would say you can think of it in terms of a couple million dollars for FY 2017. Then for FY 2018, we're expecting, I think initially we told you the $90 million would be split. About 75% of it would be in the first and second years, and we can continue to think in those terms for FY 2018. Okay, great. I'll get back in queue. Thanks, guys. Okay. Thank you. Our next question comes from John Inch with Deutsche Bank. You may begin. Thanks. Good morning, everyone. Morning, John. Morning. Kathy, CLARCOR was what, mid-single digit organic growth in this quarter? I realize you only owned it for a month, but if you just look at their quarter, is that about the number? Because it was only the month of March with the high sales compared to a normal quarterly month sales, it was higher than mid-single digit for just the month of March. You think it- It was actually double digit. Okay. So it was double. All right, that makes more sense. You think it reverts to more of a mid-single because why again? Just because they had such a big March? Yes. March had 23 shipping days, and that's a bit unusual. When you look at shipping days per month on a quarterly average, it's closer to 21. CLARCOR tends to have a heavy burden of fixed costs, and if you think about the amortization being layered in there, you get quite a bit of absorption improvement when you have higher volume. They saw that in March, but that isn't a normal trend. Okay. I want to ask about the tax rate. Obviously, I'm assuming the stock option expense issue is driving this lower quarterly. Is there not a better way to forecast this? Your tax rate for the year, do you assume that no options get exercised as part of the derivation of this? Because it did add a significant amount to EPS versus the forecast last quarter. Is this something we just got to live with, or what? Yeah. John, we look at that, and we do not forecast any because there's so many variables involved. We don't know how many people will be exercising their options. We don't know what options they're going to exercise at what grant value, and we'd have to also know what we've already incurred as expense, because it's only the differential of where they exercised versus what we had already recognized as expense. There are so many variables that we choose to not try to forecast that. It's an upside. No, that's fine. I just want to make sure I'm not missing something. There's a lot of interest expense running through for CLARCOR. Maybe Tom or Lee or Kathy, can you remind us, what's your plan to deleverage, and when do you start paying that debt back so we get even higher accretion? Because I guess accretion's running 15-20 cents, but could be an awful lot more if you could pay this debt down. Yeah, John, I will start at the high level, and I will let Kathy fill in if you need more details. Our goal is, we are about 3.2x debt to EBITDA. Yeah. Over the next 24 to 36 months, we want to drive it down to a 2.0 debt to EBITDA. That cash flow, we are very proud of it, almost 12% CFOA. We are going to be using that to help pay down the debt, and we are encouraged by what we have seen so far as far as synergies and our ability to put these businesses together. We think cash will continue to be a very strong component of it. That is the focus, is driving that down. Well, people are already building out your 2018. I guess the question is are you still going to make a big pension contribution next year, or do you channel that into debt? How much debt can we reduce in 2018 to kind of help us with the accretion? Yeah. A little too early to tell with having only CLARCOR for one month, John. We are optimistic in the performance we are seeing and what they will provide for us in cash. We did purposely keep some of the new debt short-term so that we can be paying it down as we have the cash available. Too soon to tell how much will happen in FY 2018. Okay. Then just last, I think, Lee, you were in China recently. Is China getting better? It seems China's a source of strength for a lot of industrials this quarter versus last quarter. You guys had strong Asia PAC results before because of, I guess, the build-out of your distribution network and so forth. If you were to try and pro forma for that, what's going on in China? Did it strengthen for you, or is it sort of status quo strong? Anything you could say about it would be helpful. Thanks. Well, it's been strong the last couple of quarters. I talked about this infrastructure build. If I look at all the Chinese national manufacturers' construction equipment, their production's more than doubled than what it was a year ago. So it's just really strong. There's been strength over the last year in rail. There's been a lot of strength in life science industries that we serve. So it's been positive across many different fronts. In fact, when you look at all the end markets in China, it's hard to find anything that's red. No. I know. Do your folks on the ground, though, think it can be sustained, I guess, is where I'm going. Or is this a little bit- Well, I- due to stimulus and all that other stuff? I think the consensus is going to be sustained, but you know how that works. Yeah. There's definitely a lot of things driving it right now. Yeah. Growth Chinese style. Okay. Thanks, guys. Appreciate it. Yeah. There you go. Thank you. Our next question comes from Andy Casey with Wells Fargo Securities. You may begin. Thank you. Good morning. Morning, Andy. A couple questions. You mentioned earlier that you really didn't see any meaningful restocking in the North America distribution channel. Did you notice any occurring in the North American-based OEMs? I'm just wondering if they may be staging for further production increases. Andy, I think order entry up is across many different markets. So, those customers are placing orders. To what extent they're trying to create a buffer of inventory is really hard for me to see, per se. But I would characterize most of the demand that we're seeing as real demand based on what I see on production rates with our customers as just being passed through. Okay. Thanks, Lee. Then I'm wondering if you could elaborate a little bit more on the revised outlook for the industrial North American margin. You shaved 20 basis points, not a lot, but 20 basis points off the top end. Was that all CLARCOR, or was there anything else that you were considering in that guidance revision? For North America, Andy, we've actually bumped it up if you consider pulling CLARCOR out. So what you see as the little bit of deterioration is CLARCOR-related. Okay. Thank you very much. Thank you. Our next question comes from David Raso with Evercore ISI. You may begin. Hi. Just one question. I was curious. I know you're speaking encouragingly about some of your end customers' end demand, not just stocking. Just so we can kind of baseline where do you feel we're launching into FY 2018 guide. If the order rates stayed where they are, the comps do get a little bit harder. But I'm just trying to understand, where are the orders exiting FY 2017 on a year-over-year basis if we just run it sequentially flat for the quarter? David, it's Tom. We can't predict it at this point. I know everybody would like me to start talking about FY 2018 in April, but FY 2018 is hard enough to talk about in August. We'll give you the color on that. We just started our process internally, so I'm going to just ask you to wait till we get to August. Well, that's why I asked it the way I did. I wasn't asking for a prediction. I was asking current levels, run straight out flat sequentially, where would we exit the year? Really, I'd have to go do that math. Probably be doing that math, but also be talking to our customers, looking at economic forecasts. It's not just trying to take current quarter and projecting it out and comparing it to prior periods. It's actually looking and understanding end demand and what's going on. We will do that, but that's not the only factor that will influence it. Well, again, just mathematically, right? The comp gets a little harder, right? Negative 6 a year ago for this quarter. It's negative 1 comp next quarter, and you can double stack it, however you want to look at it. But I'm just trying to get a feel. We're up 8, or especially the industrial business is up 9 and 13. If I can just maintain this level, comp actually gets a little easier in North America, a little harder internationally. I'm just trying to make sure we manage expectations, but also understand the launch for 2018, CLARCOR aside, the core business. Again, it's hard. You have the exact numbers, but it would seem like industrial, the orders would still be running up, call it high single digit at a minimum on the two industrial businesses. Aero, obviously, it's over 12 months, a little harder comp analysis there. But is that a fair assessment? Again, it is just the math. If you want to talk offline, that's fine. I'm just trying to understand for modeling 2018, should at least talking the industrial businesses, the orders just being flat sequentially should launch into 2018 up high single digit. Yeah, David, I think the best approach would be take it offline. You and Robin and Ryan can talk about it in a follow-up call. All right. I appreciate that. Okay. Thank you so much. Thank you. Our next question comes from Ann Duignan with J.P. Morgan. You may begin. Hi, guys. Hi, Anne. Can we go back to CLARCOR again? Just talking about the synergies. I know you're just working through everything, but when we did our bottom-up analysis, the one assessment we made was that there probably wasn't that much opportunity on the purchasing or strategic sourcing side. Could you maybe describe to us where we could be wrong on that? Or where do you think the opportunities will be? I know you don't want to break into buckets some of the other synergy opportunities, but at least on the strategic sourcing side, just give us a little bit more color there, and at least where you think there's some overlap that you can achieve savings. Yeah, sure. Anne, this is Tom. We actually think the supply chain side has a tremendous amount of synergies because CLARCOR was a very decentralized company, similar to us. However, they ran a very decentralized buying organization, so they didn't leverage any of their spend or very little of the spend across their various businesses. You got leverage there first just by itself, but then combining it with our spend as well, you have that aggregation. We see big upside. I think all of you know we've been careful on breaking the buckets up because obviously some of those buckets are sensitive to how we would disclose these things. But you can rest assured we have a very finite detail by major cost bucket and supply chain being one of the largest, actually. It's the natural things you would think of, the Win Strategy initiatives, corporate SG&A, supply chain, leveraging the manufacturing capabilities for both of our companies. The advantage here is not just looking at one isolated, it's the combination. So looking at both of our manufacturing capabilities and leveraging that. Just part of how we did this with our own insight, and what's really been great is now with the CLARCOR team's viewpoint, and we've been spot on as far as in agreement as what we think we need to do, which has been very encouraging. Okay. Is there a point in time where you will at least break out the buckets, at least on the strategic sourcing side? I know you said it's a major part of the $140 million. Will you break that out for us at any point? I think what we'll certainly do is every quarter, starting in August, we'll give you the projection of what we think we'll do for that fiscal year as far as cost to achieve, then the synergies that we're going to get. Then we'll update how we're doing every quarter against that. The supply chain savings, I'm not worried about disclosing that, so if that's something in particular that you'd like to see, we can provide more detail. I also don't want to scatter the herd on my suppliers either, so I'll have to think about how much of that we actually do. But the team on the phone, you have to be very confident that we have this down to a very finite detail by my major bucket. There's various sensitivities as you disclose that we'll just have to consider. But certainly, we're going to give you the total and how we're tracking against it. Okay. I appreciate that, and I appreciate you not wanting to tip your hand to your suppliers. That's certainly understandable. Can you just talk then a little bit finally about the one month, you're one month in. You were probably talking to the CLARCOR team well before that. Has there been any upside surprise, anything that you've learned in the short time that you've owned CLARCOR that maybe you hadn't anticipated prior to the acquisition? And it's Tom again. I guess the encouraging thing is there's been no negative surprises. It's all been positive reinforcement and affirmation of the assumptions we made. And I am very pleased with the leadership talent and the strength of the organization. I'm pleased with the cultural fit. I'm pleased with the fact that both teams are working as one when they look at these synergies, and there's been a lot of buy-in as to what we have to do to make both of our filtration businesses the best filtration business in the world. So, I'm knocking on wood. I couldn't be happier with the start. Okay. I'll leave it there and get back in line. Thank you. I appreciate it. Thanks, Anne. Thank you. Our next question comes from Mig Dobre with Baird. You may begin. Yes, thank you for taking my question. I want to go back to this tax issue just to clarify something. Can you confirm that your adjusted tax rate in a quarter was just under 25%, first and foremost? Then, I guess related to this, I am trying to figure out why the step-up sequentially in the fourth quarter in the tax rate and whether or not we should be really thinking about this number to migrating actually quite a bit lower than 27% for the year as a whole going forward. Sure, Mig. Yes, you are correct in that our effective rate for the third quarter was 24.7%, and we are forecasting a higher rate in Q4, and that is really driven by, we have a fair amount of the acquisition-related expenses that we are incurring are not tax-deductible. So we are expecting to have to finish the year at an overall effective rate higher than what you saw come through in Q3, reflecting those non-deductible expenses and also a little bit of shift in mix between U.S. and foreign. You are right in that there will be upside to the rate if we have a heavy amount of stock option exercises. At the current stock price, it is likely going to be a nice credit for us, but we just have no way of forecasting how much that might be. All right. That is helpful. Thank you. Maybe to ask a demand question, when I am looking at your various technology platforms that you are reporting, I am looking at motion systems, for instance. That platform is down, call it 20%, versus the peak from a couple of years ago. How do you think about demand progression over the next few years? Really what I am trying to get at is, in order to get to prior peaks, what do we need to see in terms of volumes from OEMs versus maybe some of the things that are internal initiatives for you, such as market share gains, new products, things of the sort? So Mig, it is Lee. I think when you think about motion systems, some of the big drivers in there are really around those natural resource end markets. So think about construction equipment, mining, even land-based oil and gas. I think what is encouraging is globally we are seeing a significant rebound on those. So, it is been a big driver of what is happening in China. So it is trending in the way of getting us back to where we have been. Thank you. Our next question comes from Millie Pasquale with Morgan Stanley. You may begin. Thanks. I just wanted to ask a question about the longer-term segment margin target. You have expressed confidence about this in the past. Obviously, this was before CLARCOR. I guess, are you willing to comment on potential areas for upside to this goal? Or perhaps if you do not want to comment at this time, is this something we should be looking for, I do not know, in the coming months as we think about FY 2018 guidance? Yeah, Millie, it is Tom. Well, first of all, remember when we set those targets, they were top quartile, performance threshold for our peer group, and that continues to be a good number. I am very happy to re-look at that number once we have achieved it. I do not want to demotivate the team by moving it before we have actually achieved it. So we are going to achieve it first. We are going to obviously continue to drive continuous improvement, and we will also look at what top quartile is running at that time. Because we see our ability to continue to get more profitable all the time, but we are not going to move the 17% target till we actually achieve it. Okay, understood. I guess just as a quick follow-up, more of a clarification, I think you mentioned price cost a little bit earlier in the Q&A session. I just want to clarify. You said you do not think that that is going to be a challenge as the year goes on? Is that Millie, it's Lee. Price cost absolutely is a challenge, but I don't think it's going to be a challenge for us in terms of affecting margins. We've seen escalation in some key commodities. But we've also been able to realize price in certain parts of our channel. We track our cost input, that's our PPI index, and we track our sales number, which is our selling price index, and we've got a positive gap between the two, and we expect that to continue going forward. Okay, understood. Thanks. Thank you. Our next question comes from Joe Giordano with Cowen and Company. You may begin. Hey, guys. Thanks for taking my question. I just kind of wanted to get a sense, as you look at the simplification, outside of anything in CLARCOR, just where do you think you are in that and how far along that spectrum have you progressed, and is 2018 like a bigger year potentially than 2017 in terms of the cost you can take out? Just how are you looking at that broader transition that you're doing? Joe, it's Tom. Again, I would characterize it as early days still. There's some things that we moved out more on, division consolidations and those type of things. We'll continue to look at that, and we'll certainly update you on what plans we might have there in the future. But the bigger area that has, I think, the most upside is that whole revenue complexity, that looking at the product line simplification, that last couple percent of revenue and the complexity associated with that, one, to service our customer and to make it faster and a better experience for them, but also to redesign our organization and the processes and the SG&A cost that supports that. So I'm very encouraged because every time we look at that, I still see tremendous upside. That part that I just described, the product line complexity, is hard work. I've described it as hand-to-hand combat. You got to go part number by part number to go through that. So that's why I characterize it that it's still very early days, because the companies of our size with the number of part numbers, there's still a lot of work we're doing, and we're very active on that. And I think you'll see that be a contributor for margin expansion for multiple years. Then on the, I think you mentioned earlier today, $30 million you're planning on savings that are in guidance from the $48 million that you're spending this year. Is that like a realized $30 million for this year? What's the exit rate and how much of that spills over? Yeah, that's a real number. We are benefiting $30 million this year, and certainly, that carries over, and we'll see some rollover full-year impact from the initiatives we've done this year. Of that $330 million, how much have you done through three quarters? Maybe that will kind of frame into next year. Yeah. The majority of that is tail end of the year because some of the initiatives that we have done, it takes time to see the benefit of it, so heavily weighted towards the second half of the year. Perfect. Thanks, guys. Thank you. Our next question comes from Jeff Hammond with KeyBanc. You may begin. Hey, just a couple housekeeping items on CLARCOR as you get it closed. I think you said $163 million in amortization. Is that still a good number? As you kind of put together your debt, how did the debt cost come out relative to your initial assumption? Yeah, Jeff, the $163 million was our initial estimate, but actually we're seeing that much lower. It's $130 million a year as we have preliminarily estimated the beginning balance sheet. Now we're still fine-tuning that, and it may tweak slightly as we finish the fourth quarter, but right now we're estimating $130 million a year. The debt costs also came in lower. We were estimating additional interest expense of about $100 million, and that's now solidly in the books at $73 million incremental per year as we were able to get better rates on the bonds that we sold. Okay, great. Just within the 13% order growth in international, is there a way to get kind of place where Asia, Europe, and LATAM were either exactly or directionally? Sure, Jeff. We're seeing, for Europe, mid-single digits. Asia Pacific is mid-teens, and Latin America also in the mid-teen range. Okay, perfect. Thanks a lot. Okay. Thank you. Once again, ladies and gentlemen, if you wish to ask a question at this time, please press star then one. Our next question comes from Stephen Volkmann with Jefferies. You may begin. Hi, good morning, all. Thank you for taking the question. Just a couple of quick fill-ins. Kathy, is there any type of shorter-term step-up amortization that we should be thinking about that rolls off quickly versus the longer-term stuff that will be with us for a while? Yeah, good question, Steve. I am glad you asked. So in the number of one-off acquisition related expenses is the gross-up of the value of the inventory that we bought from CLARCOR. That is about $39 million, and that will roll through cost of sales over a 3-month period. So we incurred one-third of that in March, and we will incur the rest of it in April and May, and then that rolls off. Okay, just sort of thinking about that, if you're sort of at a $0.04 accretion for the fourth quarter, the number in 2018 would be higher than that because you wouldn't have the step-up accretion. Yeah, but keep in mind that we have adjusted that out. So the accretion that we're telling you has taken the impact of that out. So the $0.04 takes that out already. The $0.04 is a run rate, correct. Got it. Okay, that's helpful. I appreciate that. Totally unrelated, but I'm just curious, I think you guys probably have a reasonable amount of visibility in your Aerospace business, and we sort of ticked down to zero, and I know it's very chunky on a quarter-to-quarter basis with respect to orders. Does that business grow next year? As you see the programs come down the pike, how do we think about that in sort of the next couple of years? Yeah, we still anticipate growth in Aerospace. What you see in the zero order rate for the 12-month rolling now as of March 31, we had a pretty significant military OEM order come through in January of 2016. It was a multi-year order. That has now dropped from the numerator into the denominator, causing tough comparables. So it's a little bit of a misnomer. It's a little bit deceiving to see that flat. We do anticipate continued growth. We're seeing nice improvement these days in the MRO, especially the military MRO business. Commercial OEM is a little down year-over-year, but commercial MRO is strong. So military good, commercial struggling a little bit in the OE side, but strong in the aftermarket side. Great. I appreciate that. Thanks. Thank you. I'm showing no further questions at this time. I would like to turn the call back over to Kathy Safeer for closing remarks. Okay. Thanks, Shannon. This concludes our Q&A and our earnings call. Thanks everybody for joining us today. Robin and Ryan will be available throughout the day to take your calls should you have any further questions. Thank you, everyone. Have a great day. Ladies and gentlemen, this concludes today's conference. Thanks for your participation and have a wonderful day.