Earnings Call: Q1 2015

Oct 28, 2014

Summary

Q1 sales reached a record $3.3B, adjusted EPS rose 13% to $1.89, and segment margins improved on restructuring and volume. FY adjusted EPS guidance rose to $7.45–$8.05, with currency headwinds partly offsetting stronger results.

Good day, ladies and gentlemen, and welcome to the first quarter 2015 Parker-Hannifin Corporation earnings conference call. My name is Janeda, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. If at any time you require operator assistance, please press star followed by zero, and we will be happy to assist you. As a reminder, this conference is being recorded. I will now turn the conference over to Ms. Pam Huggins, Vice President and Treasurer. Please proceed. Thanks, Janeda. Good morning, everyone. It's Pam speaking, just as Janeda mentioned. I would like to welcome you to Parker-Hannifin's fiscal year 2015 first quarter earnings release teleconference. Joining me today is Chairman, Chief Executive Officer, and President, Don Washkewicz, and Executive Vice President and Chief Financial Officer, Jon Marten. For those of you who wish to do so, you can follow today's presentation with PowerPoint slides that have been presented on Parker's website at phstock.com. For those of you not online, the slides will remain posted on the company's investor information website one year after today's call. At this time, if you will reference slide number 2 in the slide deck, which is the safe harbor disclosure statement addressing forward-looking statements, and I ask that you please take note of this statement in its entirety if you haven't already done so. This slide also indicates, as required, that in cases where non-GAAP numbers have been used, they have been reconciled to the appropriate GAAP numbers and are posted on Parker's website, again, at phstock.com. Slide number 3. This is the agenda for today. It consists of four parts. First, Don, Chairman, Chief Executive Officer, and President, will provide highlights for the first quarter. Second, I'll provide a review, including key performance measures for the first quarter, and then, of course, conclude with the revised guidance for fiscal year 2015. The third part of the call will consist of our standard Q&A session. The fourth part of the call, Don will close with some final comments. At this time, I'll turn it over to Don and ask that you refer to slide number 4, titled, "Highlights First Quarter Fiscal Year 2015. Thanks, Pam, and welcome to everyone on the call. We certainly appreciate your participation today. I'll make a few brief comments, and then Pam's going to return for a more detailed review of the quarter. I'll address capital structure in a moment, but first, I want to review a very strong first quarter for the company. I am pleased we're off to such a solid start to the year as we executed well, delivered strong results, and reinforced our view that this will be another record year for the company. The first quarter highlights, we had a record first quarter sales at $3.3 billion, up slightly from last year's first quarter. Organic growth, adjusted for the GE Aviation joint venture, increased almost 4%, so we're very pleased with that. Orders increased 5%, and were positive across all segments, but especially strong in Aerospace. Total segment operating margins reached 15.9%, and we are certainly very pleased with those numbers. That is a 150 basis point increase from last year's first quarter, and on an adjusted basis, reached 16.1%. This is a result of the successful restructuring completed last fiscal year. Our performance was led by an all-time record for segment operating margins in our Industrial North American businesses at 18%. Both Aerospace Systems and Diversified Industrial International had meaningful increases in margin this quarter compared with a year ago. Notably, Diversified Industrial International margins reached 15%, and that is a great number considering Europe and Latin America are still pretty weak for us. Hitting 15% was a great accomplishment. Operating cash flows was again strong at $261 million, and we anticipate that fiscal year 2015 will be our 14th consecutive year of cash flows greater than 10%. We have generated greater than 10% ever since we launched the Win Strategy back in 2001. Now I will make a few comments on our capital allocation strategy as a follow-on to our announcement last week. We are very pleased to announce that the board increased the quarterly dividend 31%, from $0.48 to $0.63, and authorized a repurchase of up to 35 million shares. Our capital allocation priorities remain pretty much the same as they have in the past. As we have consistently communicated, our first priority is to maintain our dividend increase record. The significant increase last week brings us into alignment with our goal of a 30% payout ratio, calculated as a percentage of net income. We have been saying pretty much for the last year or so that we wanted to hit that 30% payout within three years, by 2016, and we are pretty much on target for that. Second, we are committed to reinvesting in our business through capital spending that drives organic growth. We have been running less than 2% CapEx, and we think that we can manage this business by continuing to execute lean and keep the CapEx around 2%, give or take a little bit. Third, we have a target to grow through acquisitions, and we will continue to pursue acquisitions that fit with the company strategically. Lastly, we are committed to providing returns to our shareholders. The new authorization of 35 million shares approved by the board last week allows us more flexibility for share repurchases. This authorization more than doubles the number of shares available to purchase compared to our previous authorization. Our goal is to repurchase $2 billion-$3 billion in the next 24 months. For planning purposes and for your spreadsheets, you can assume a straight-line repurchase over the next two years. Of course, it will probably be a little lumpy, but I think that will be pretty much the best advice we can give you. Assume straight line, and you will be pretty close. Guidance has been increased based on our strong first quarter results, partially offset by significant currency headwinds. Adjusted guidance has been increased to a range of $7.45-$8.05 in diluted earnings per share, and that excludes $0.25 of restructuring expenses. The savings from the timely execution of our restructuring activities gives us confidence that we will deliver another record year in fiscal 2015. So now I'm going to turn the call back over to Pam, who will get in a little bit more detail review of the quarter. Thanks, Don. At this time, I'll ask that you reference slide number 5, and I'll begin by addressing earnings per share. If you go to the far right of this slide, you can see that the first quarter came in at $1.89 versus $1.67 for the same quarter a year ago, an increase of $0.22 or 13%. Restructuring, while originally planned at $0.07, was $0.04 in the quarter, and this compares to $0.06 for the same quarter a year ago. Moving to slide number 6. This chart lays out the significant components of the walk from adjusted earnings per share of $1.67 for the first quarter last year to the $1.89 for the first quarter of this year. As you can see by looking at this slide, the significant contributors to the increase was segment operating income of $0.24. And this was due to better performance across all segments with a little offset due to higher below-the-line expenses, $0.02. This is a result of less stock compensation expense offset by a higher tax rate due to the elimination of the R&D credit and favorable discrete items last year. I think that's not news to you. Moving to the next slide, number 7. On the far right in the blue box, if you go to the fourth line down, you can see that adjusted organic sales in the first quarter increased almost 4%. So we're real happy with that 4% increase. This takes into account, just as a reminder, the joint venture that commenced October 1 of last year. There was minimal impact to sales in the quarter from acquisitions. Currency or FX, originally planned to be positive, reduced reported sales by $23 million or 0.7% in the quarter. If you move to the bottom of this slide, you can see segment operating margins adjusted for restructuring costs in the quarter. The margins were 16.1%, and this compares to 15% for the same quarter last year. Restructuring costs in the quarter affecting segment operating margin, it was $6 million this quarter versus $11 million last year. Please note that total restructuring costs were really $8 million in the quarter and $12 million for the same period last year. This difference of $2 million and $1 million is really included in below-the-line items in other. The higher adjusted segment operating income this quarter, $525 million versus $476 million last year, which is a 10% improvement, is due to higher volume in North America and Aerospace, less support costs in Aerospace, and leverage as a result of restructuring in Europe. Moving to slide number 8. Focusing on the business segments, commencing with North America. You can see that reported and organic revenues increased 6% to $1.47 billion from $1.3 billion last year, and there was little impact from currency and acquisitions in the quarter. Going down to the bottom, looking at the adjusted operating income for the first quarter, you can see that it increased to $264 million from $236 million a year ago, again, mainly the result of higher volume in the quarter. Moving to the next slide, Diversified Industrial International. Here you can see that organic revenues for the quarter in this segment increased almost 1%. Currency, however, was a deduction to sales with an impact of -1%. Acquisitions, again, minimal impact, so reported revenues were down just a little less than 1%. Adjusting for realignment costs, operating margin for the first quarter increased 110 basis points to 15.5% from 14.4%, and this obviously is a result of less restructuring costs and savings associated with the restructuring activities completed last year. Restructuring costs in this segment, $6 million in the quarter, and this compares to $9 million in the same quarter a year ago. Moving to slide number 10, Aerospace. Reported and organic revenues adjusted for the previously announced joint venture increased slightly more than 3% for the quarter. Again, the impact of acquisitions and currency on this segment was negligible. The increase in revenues was mainly due to higher commercial OEM business. Operating margins for the quarter increased 100 basis points from 11.2% to 12.2%, and this is due to higher margin OEM business and less support costs. Now moving to order rates. Just as a reminder, these numbers represent a trailing average and are reported as a percentage increase of absolute dollars year-over-year, excluding acquisitions, divestitures, and currency. Diversified Industrial uses a 3-month average, while Aerospace Systems uses a 12-month average. As you can see from this slide, total orders were positive 5% for the September quarter just ended. North America orders were up 6%. Industrial International orders up 2% for the quarter, and Aerospace Systems increased 12%. Now if we can move to slide number 12, the balance sheet. Parker's balance sheet remains strong. Cash and short-term investments on the balance sheet at quarter end was $2 billion, partially offset by outstanding commercial paper of a little more than $700 million. DSI, or days sales in inventory, came in at 69 days, flat with a year ago. Inventory levels at 10.9% of sales are an improvement versus first quarter last year, where inventory as a percent of sales was 11.2%. Accounts receivable in terms of DSO closed at 49, a 1-day improvement from the first quarter last year, and weighted average days payable outstanding at the end of September was 60, a 2-day improvement sequentially from the June quarter end. Moving to slide 13. Don talked about cash flow. It was $261 million, or 8% of sales. The major uses of cash in the quarter, $122 million returned to shareholders by share repurchases and dividends, $113 million utilized in the reduction of commercial paper outstanding, and $55 million utilized in connection with capital expenditures. As a result of this and more, the cash on hand declined by close to $100 million in the quarter. Moving to slide number 14, addressing the guidance. Please remember that as requested, we are providing adjusted guidance in line with last quarter. Sales growth is adjusted for the GE joint venture that commenced the 1st of October last year, and segment operating margins and earnings per share exclude restructuring charges. On this slide, we have detailed guidance for adjusted sales growth, adjusted segment operating margins, below the line items, the tax rate, the shares outstanding, and then we have provided the range for reported and adjusted earnings per share at the bottom. Beginning at the top, looking at the fourth line down and addressing sales, total adjusted sales are expected to increase from 0%-3% for the year. This is lower than the previous guidance provided at the end of last quarter due to negative headwinds from currency, mainly the strengthening of the dollar versus the EUR throughout the quarter. Adjusted organic growth at the midpoint is 3.3%, and there is minimal impact from acquisition carryover. Currency in the guidance is now a deduction to sales of 1.9%, almost all related to the Diversified Industrial International. For total Parker adjusted segment operating margins are forecasted to be between 15.7% and 16.1%, and this compares to 14.4% for FY 2014, and that is on an adjusted basis. The guidance for below the line items, which include corporate admin, interest, and other, it is forecasted to be $470 million. Again, this is lower than the previous guidance given, and this is due to the first quarter favorable results. The full-year tax rate is projected at 29%, and the number of shares used in the guidance is 151.1 million. Please note that shares outstanding have not been reduced for the share repurchases that will take place in connection with the new authorization of 35 million shares and the plan to purchase $2 billion-$3 billion in shares over the next 24 months. Also, please note that the restriction on annual share repurchases has been lifted. This restriction was equal to the greater of 7.5 million shares, or 5% of the shares outstanding as of the end of the prior fiscal year, and is no longer in effect. For the full year, revised guidance on an adjusted earnings per share basis is $7.45-$8.05 and $7.75 at the midpoint, just as Don said. This guidance excludes restructuring expenses of approximately $50 million to be incurred in FY 2015. This is consistent with the previous guidance. The effect of this restructuring on EPS is approximately $0.25, and the $0.25 will be incurred about 50% in the first half, 50% in the second half. Just a couple of salient points with respect to guidance. Sales are divided 48%, or $6.43 billion first half, 52%, or $6.93 billion in the second half. This is obviously at the midpoint. Segment operating income, first half, second half is divided 45% in the first half and 55% in the second half. Earnings per share, first half, second half is 43%, 57%, or $2.98 in the first half and $3.95 the second half, and again, that is at midpoint. Second quarter adjusted earnings per share is projected to be $1.47 at the midpoint, and this number has been adjusted for $0.08 of restructuring costs expected to be incurred in the second quarter. So in summary, the major difference between the full guidance this quarter versus last is the higher than previously guided first quarter results, partially offset by the negative impact of currency as a result of the strengthening of the dollar throughout the first quarter. Please remember that the forecast excludes any acquisitions or divestitures that may be made in fiscal year 2015. For published estimates, as requested, please exclude restructuring expenses. So at this time, we will now commence with the standard Q&A session. As a reminder, the call will be limited to one hour, so please honor the request of one question at a time and a follow-up only when clarification is needed. By adhering to this courtesy, everyone will have a chance to participate. Thank you so much. Ladies and gentlemen, if you have a question, please press star followed by one on your phone. If your question has been answered or you would like to withdraw your question, press star followed by two. Please press star one to begin. Your first question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Please proceed. Good morning. Good morning, Jeff. Pam, congrats on the retirement, and best of luck. Thank you so much. It's been a pleasure, Jeff. Okay. Just to be clear on the buyback, are you guys doing a 10b5-1 where you'll be in it every day, or will you be more opportunistic and have your normal blackouts? And maybe just to follow on, what kind of gets you to the high or low end of that $2 billion-$3 billion? Okay, Jeff. John here. I will start out. I think we are going to continue with our 10b5-1, just as we have right now. As Don said, for planning purposes, best to use a straight line method for yourself. The actual results are likely to be lumpy. We are going to be reviewing matters as the ensuing quarters go on, and it is going to be something that we are going to be focused on every day. Okay. What takes you to the high or low end? I think that we are going to just take it one quarter. Our best advice right now, Jeff, is that we are just going to take it one quarter at a time. We are going to update you every quarter as to what the results are. We will be able to tell you more about the high or the low end as we get into the program and time goes on. I do not want to say anything to lead you to believe that it is going to be closer to the low end or the high end on this call. Okay, great. Just a quick follow-up. Can you just talk about what trends you are seeing in Europe, just on an underlying basis, what you saw coming out of the summer shutdowns into September, October, and we are hearing certainly mixed things and just wanted to get your sense of Europe. I think to just start out on that, Jeff, in Europe, things came in exactly as we had put our guidance together. We had a good July, not a great August, again, accounting for the normal shutdowns that we see in August. And then we had exactly what we expected in the month of September. Things are not ramping up. Things are not ramping down. Things are relatively flat in Europe when we take a look at the orders, and that's what we're seeing right now. Of course, the major change in our guidance going forward is just the impact of the strong dollar vis-à-vis the EUR. But that's how we're seeing it, and that's how Europe is looking to us right now today. Thanks. Your next question comes from the line of Mig Dobre with R.W. Baird. Please proceed. Hi. Good morning, everyone. This is Joe Grabowski for Mig. Really nice recovery in the international operating margins. Just wanted to maybe find out if some of the restructuring disruptions you had last quarter, it seems like perhaps those were worked out this quarter. Yeah, that's a fair assumption. We were really quite worried about that in Q4. We talked about it a lot in our Q4 conference call. Those kind of disruptions, the restructuring-related costs that we were experiencing in Q4 of last year have all but been eliminated here. Our plans are being executed very well by our teammates, and we're very pleased with our results internationally here this past quarter. Great. Okay, thanks. Then maybe just a quick follow-up. You kind of gave sort of the cadence of business in Europe. Could you maybe talk about how the quarter progressed for North American Industrial and maybe what you are seeing so far in October? Well, right now in terms of the orders in North America, first, your last question first. For October, it fits right into where our guidance is coming out, so nothing remarkable there to report out on to you. Follows along with our orders, follows along with our guidance. In North America, in the quarter, the results as we saw them in July, August, and September, again, sequentially, August is always lower than July, which is what we saw, and September was sequentially better than August, and September was slightly better than the month of July. Okay, great. Thanks for taking my questions. Sure. Your next question comes from the line of Nathan Jones with Stifel. Please proceed. Good morning, Don, Jon, Pam. Hi, Nathan. If we could just go back to the beat in the quarter. It seemed to me when you gave the guidance for this quarter that you had some wiggle room built in there for possible cost overruns from the restructuring in Europe. How much of that improvement in Europe or the beat relative to your guidance was not incurring those costs, good execution on the restructuring versus fundamental improvement in the business? I think, Nathan, there certainly was some hesitation on our part in the month as we were putting the guidance together in terms of would it happen in Q4 for Europe. But a significant part of the beat that you're looking at above the segment line is coming from a tremendous performance in North America, our North America industrial business, with an all-time record 18% return on sales as we're reporting externally. And that was even bigger than the slight beat that we saw in the month of Europe and the worry that we had in terms of what had transpired in Q4 last year. On those margins in North America, which were obviously extremely strong, was there anything that positively impacted that, like mix or price, et cetera? This is normally your second lowest revenue quarter. Are these sustainable kind of margin levels, do you think? Well, first of all, to answer your first question, it was across the board, excellent performance, every product grouping across the company in North America. So there's no one mix issue that crops out here. Are these margins sustainable? Well, we have for the year, our guidance in Diversified Industrial North America at very good margins for us. We're not showing that it can be sustained in Q2 or Q3. Q2 is always sequentially a little bit lower in terms of the top line. In Q3, we start to catch up, and around Q4, we'll be very close to that same number in terms of our return on sales. So for the whole year, we'll be slightly below the 18%. That's what's indicated in our guidance. But we will be, in our guidance, showing, and we are showing all-time high North America industrial margins. One follow-up just on the balance sheet, Don, you can't get rid of me without one on the balance sheet. I know you guys would've liked to be able to get deals done over the past 12 months or so before getting to this point. Can you talk about what got in your way from getting those deals done, whether it was discipline on price or what led you to not be able to get those done? Nathan, Don, just so that everybody on the call recalls what we had said in the past, it's been about three or four quarters that, of course, everybody was asking how we're going to deploy capital and so forth as we're building up cash balances on the balance sheet. Just so that I can let you know now what was going on. We had been in very serious discussions with a couple major acquisition opportunities, in which case, I would've needed all of the capital, all the cash that we had on the balance sheet, and then some. They were very significant. We were in confidentiality agreements with them. I really couldn't disclose or say anything, or didn't want to say anything at all at the time. We kept putting you off, and I know that was frustrating for all of our shareholders out there that we weren't taking any positive action. I think they were thinking that we're dragging our feet for one reason or the other. But we were very, very seriously involved in a couple major ones. We just couldn't bridge the gap at the end of the day. We're pretty disciplined. These being strategic acquisitions, we felt that we had an advantage over other potential parties that would be interested from the standpoint that we would have more synergies. Even using a synergistic model, with building in all the synergies, we still came up significantly short from what the expectation of the sellers were. We agreed to part ways, and at some point in the future, maybe we'll come back together. I think we kept everything friendly, and I think there was just a difference in expectation or valuation expectation that was the main reason why we parted. Like I said, we're very disciplined on this. We know the businesses very well. We know what the capability is of all of these companies that we're looking at because we're in similar businesses. I don't think we missed anything from a valuation or a fair valuation standpoint. It was just that we were not going to come together at this point in time on either one of these. Plan B, Nathan, was always share repurchase, and we had been talking about the dividend increase. We moved that up a quarter because once we broke the confidentiality agreement with these, we were then free to go ahead and take some actions with regard to the dividend increase, which we did. Of course, we announced the share repurchase as well. That was always plan B. I think, obviously the investment community saw that as a real positive. That's not to say that going forward, we do have some smaller ones now, more typical of what we've done in the past, that are in the funnel. We probably will have a couple coming out, hopefully. Again, we don't predict anything, but I would just say that my guess is right now we have a couple smaller ones coming through the pipeline in the next few months. You'll still see us active in this area, but very disciplined. Hopefully, that answers your question. I think, obviously, at some point in the future, we could revisit any of these and/or all of these. But right now, that's off the table. We're pursuing the actions that we presented to you this past week. That's a great explanation. Thanks, Don, and good luck, Pam. Thank you, Nathan. Your next question comes from the line of Eli Lustgarten with Longbow Research. Please proceed. Good morning, everyone, and allow me to also wish you the best, Pam. Thank you, Eli. The pleasure has been mine. Can we talk about what you are seeing in the marketplace and demand across the board? Don, you have gone through plus or minus in the segments, and the orders in North America were quite respectable for the quarter. Can you give us some idea what we are seeing across business at this point as we go into the end of the year? Yeah, I think I can do what I have done in the past. It seems like people would like to hear a little bit about. First, I would give you a little color on the PMI, and then I will give you a little overview on the regions, and then maybe go into some specific market segments, kind of wrap it up. Just starting off on the PMI, and this would be comparing PMI of June to PMI of September, basically. I am going to run you through the regions. Globally, off just a little bit, about four-tenths, still tracking north of 50 at 52.2. So globally, we are still in positive territory there. The U.S. was a very nice pickup since June. June was 55.3. We are at 56.6, so it was a pickup of 1.3, which was good. The Eurozone was just the opposite. It went down to 50.3 from 51.8, was off 1.5. Germany was a big negative within the Eurozone. Of course, Germany makes up a big part of the Eurozone. Germany came in just about 50, was running more around 52 in June, and now tracking around 50, so just off about two points. China off about a half, tracking at about 50.2 right now in September. Brazil was under 50 at 49.3. Just some general comments about the PMI. All the PMIs are 50 or greater, which bodes well with one exception, and that is Brazil, and they are very close. They are at 49.3. But I think when you look at just the PMI, keep in mind, my understanding of the way it works is that even when you are down as low as 44, you can still be growing, but at a much subdued or a much lower rate. So all of these being around 50 or north of 50 is still pretty good news overall. The largest increase in the PMI from June was with North America, with the United States up 1.3. The largest reduction from June was Eurozone down 1.5, and that was led again by Germany. Then the largest absolute PMI was the United States, which is 56.6, which is definitely the strongest region of all of them. Now I will just kind of comment a little bit more detail on the regions, more so than what you got from our order trends that we announced publicly. North America, as you saw, I am going to give you the three 12 and 12 12s. North America, you saw three 12 run at about 107, and the 12 12 run at around 107. So those are both very strong numbers. Europe was pretty flat. Three 12 and 12 12 running at about 100. So the last three months orders over the previous year to same three, and the last 12 or the prior year to same 12, running at about 100%. So pretty flat in Europe. A strong trend in Asia overall, three 12 running about 107, 12 12 running about 108. So Asia and North America are our two strongest regions. Latin America, again, very similar to Europe being flat, three 12 and 12 12 running pretty flat at 100. So these order trends pretty much match up well with the PMI indices that I just reviewed for you. Talking about some market segments now, market trends. What I will try to do is give you a little comparison. This would be comparing the fourth quarter, which tends to be a stronger quarter for us, to the first quarter, which is weaker. So we would expect some more sequential lower numbers or lower activity numbers in some of these markets. I will give you a little color as to how the year-over-year looks in these segments as well, because it will make a difference because of the two quarters are different with respect to strength, fourth quarter being stronger than the first quarter. Some positive market segments for us is Aerospace Systems on the commercial side, the OEM, and aftermarket. Those are strong segments. Something that turned strong for us that was running kind of negative was Aerospace Systems defense MRO, okay? With all the activity going on, that did not surprise us too much. The other strong segments for the quarter were distribution. I will mention here in a little bit just how strong that was. It is one of our strongest segments. Cars and light trucks, telecom, and heavy-duty trucks. Both distribution and heavy-duty trucks were very strong. Now, on a negative standpoint, which segments are trending negative sequentially would be Aerospace Systems defense OEM. It does not surprise us. It has been there for quite a while now. Farm and ag, machine tools, general industrial, life sciences, oil and gas, mining, marine, forestry, power gen, commercial refrigeration, and commercial air conditioning. So that is a pretty long list. Then kind of flat, slightly positive to flat, would be construction, process, and semiconductors. Now, coming back to all the negatives, because that was a long list of negatives, I want to just read off now the ones that are tracking positive year-over-year. Keep in mind what I said earlier, the fourth quarter tends to be stronger than the first, so maybe this is a better indicator of where these segments really are headed. The ones that are tracking positive year-over-year yet are machine tools, general industrial, oil and gas, marine, forestry, power gen, and commercial refrigeration and commercial air conditioning. You can see, on a year-over-year basis, we still see positive trends in all of those segments as well. Just coming back for a second on the three 12 and the 12 12s, I mentioned distribution being strong and heavy-duty truck being strong. Those are the two strongest segments for us on the positive side. The distribution on a three 12 basis is running 108, and on an order trend basis and on a 12 12, it's running 108. So it continues to run extremely strong for us, and keep in mind, distribution's half of our industrial business, so that bodes very well. Strong, likewise, is heavy-duty truck. Of course, last year, this was running quite the opposite, quite negative, but now it's running positive, three 12 at 110, 12 12 at 109, so those are very strong. I mentioned ag is weakening. The three 12 on ag is 73. That shouldn't surprise anybody, and the 12 12's at 90, so that continues to weaken. Construction and semicon are pretty flat. Process, slight increase. Three 12's running at 100, 12 12's at 97. There's a slight increase in process industries. And Aerospace Systems is very strong. Three 12 bounces between 100 and 120, and the 12 12 at 110. Those would be, hopefully, that isn't overly confusing. You'll probably have to go back and re-read some of those, but that's how we see it here. I think it's important to kind of compare the year-over-year numbers because of the difference in the quarters, fourth quarter being stronger than the first. Yeah. Did that help? Thank you very much. One quick follow-up. Can we talk about pricing? Is there any movement in pricing at all in the industry? Pricing and raw materials. First of all, let me just touch on raw materials because it's tied in with pricing. We're seeing quite a few of the inputs there as far as raw materials going up. Steel and aluminum both are going up. Aluminum is actually up 20%. This is comparing trends from October last year to October this year. Copper's down just slightly. Steel's up. What we're doing is, as we have done in the past, our time for reviewing pricing on the distribution channel is January and July. We're going to be approaching that here in the next month or two. I anticipate we'll be making some adjustments depending on the raw material involved and the product involved. Keep in mind that our goal here is for the, we have what we call a PPI index, that purchasing price index. The goal is to keep that less than one, and we've been running less than one, so we've been recouping any increases in our input costs effectively. The other thing we track very closely worldwide is our sell price index, and that's been tracking greater than one. It has been running greater than one for a considerable period of time. We're recovering. Basically, what that tells you is recovering our cost plus the margin. There will be some adjustments in January, and if these increases continue, we'll have to adjust them again mid-year. The other thing we do is for the OEMs. We look at the pricing at the anniversary of the contracts that we have with the OEMs and make the appropriate adjustments, and negotiate those adjustments at that time. Thank you very much. Your next question comes from the line of Jamie Cook with Credit Suisse. Please proceed. Hi. Good morning. Can you hear me? Hi, Jamie. Oh, and Pam, congratulations. Thank you, Jamie. Just a couple questions, and I apologize because there's like four different calls going on at the same time. Can you just give us an update on the Aerospace Systems side, your confidence level with the margin projections that you guys have, given where we are in the first quarter and the headwinds that we've experienced over the past couple of years? My follow-up question is just back, sorry again, on the share repurchase again. You talked through your assumptions of the timeline, but can you just talk to how you plan to finance that? Would you take on debt? Should we expect you'll just use your free cash flow? Will you repatriate cash from overseas? If you could just walk through that. Thanks. Okay. Jamie, Jon here. First on the Aerospace Systems margins, we're expecting them to come in right around guidance. We had a slight beat here in Q1. We are concerned, as always, about the trends that we see in the development expenses. That might be a little bit higher than we were talking about for the year, maybe $5 million-$10 million. But still, we're expecting R&D as a percent of sales around 9% for the year, and we're expecting the results to come in right at the 13.5 range. In terms of the share buyback, we're going to just use cash that we have on hand in the U.S., as well as our Commercial paper line that we have, that we use, that you'll see that in our notes payable portion of our balance sheet. It's just the cash that we generate, the cash that we have here in the U.S., and our Commercial paper line. That's how we plan to fund the share repurchases. The money that is overseas have been permanently reinvested overseas. Alrighty. Thank you. Okay. Your next question comes from the line of David Raso with ISI Group. Please proceed. Yeah. Hi. Just a quick question on the sales guidance for international. It appears you lowered it solely on currency. Can you take us through the moving parts geographically? Did you raise your outlook on Asia to offset a weaker outlook on Europe, or has everything generally been maintained? Well, David, just big picture, you are correct. Asia is trending better than we expected, and so the trends in Asia are offsetting the weakness that we're seeing in Europe without regard to the currency. As it turns out, the currency offsets the impact overall internationally. But when you break it down a little bit further, we are seeing some pretty good growth, and better than we expected in Asia in some of our key end markets. Can you flesh that out a little bit? Where is Asia providing you the upside? Well, this would go along with some of our rail businesses, our marine businesses, our oil and gas businesses. This would be centered around some of our Engineered Materials Group, some of our filtration groups, some of our life sciences businesses that are cut across all of our groups. So it's no one end market, David. But it's good. The mobile construction, which of course has been a problem, is flattening out there. And again, we're seeing in other end markets, other key end markets in Asia, some signs of mid-single digit to a little bit higher growth there in some of those markets that I just mentioned. The net ex currency is international, still expected to be up a little bit. Can you help us a little bit with how much is Europe down in that total international up slightly ex currency? Yeah, I don't want to give you an impression that Europe is down very big. It's not. It's just down slightly. It's relatively flat. It's just the currency that we're seeing, that we're calling out here on the call. And Asia is up slightly. But I don't want to give you the impression that in our guidance, Europe is coming in extremely weak. It is not. It's coming in right as we had kind of put our guidance together, just slightly down, but not significant at all. David, just kind of regrouping back at the order trends, that is evidenced by the order trends, 3 12 being running at about 100 and 12 12s at 100. So it is pretty flat. I appreciate the color. Thank you. Your next question comes from the line of Joel Tiss with BMO. Please proceed. Hey, guys. How is it going? Good. How are you? That's good. All right. This other expense line, I do not know if you talked about that or not. It is down $26 million in the quarter. I just wondered what was in there. Well, on the other expense, it is really a reduction in our stock option expense. It is just less stock option expense. We do that once a year in the company, and it came in significantly lower for that line than we had planned, Joel. So that is what we called out in our opening comments. Okay. Is there any reason why, well, sort of going to glue two weird questions together. Is there any reason why you are not updating your long-term operating margin targets? You always talked about 15%. It seems like you are pretty much there now. I just wondered if there is another level. Is there any reason why you are not including share repurchase in your forward guidance? Well, in terms of the share repurchase in the forward guidance, because it is likely to be lumpy as time goes on, we thought the best thing to do for everybody, understanding the models that we're working with, is to just give the advice that it would be just straight lined over the next 24 months. In terms of updating our long-term operating margins, of course, we don't see a limit to the increasing in margins that we're seeing right now. We feel like that 15% has always been the number that has been over the cycle. That is something that we've been really keyed on. In areas of the world like we are right now in North America, we're able to do 18. It is something that we are very proud of here, but we don't want to set a new level of expectations at this point, Don. But you want to add on to that? Yeah, I'd just say that, if you look at where we're headed, we're at 15% here. We're going to close the year at 15%, and what I would consider kind of a mediocre year, with two of our regions doing reasonably well, North American and Asia, and two pretty much flat on their back being Europe and Latin America. I think you can see that any tailwind that we get, going forward, is just going to be accretive to our margins. I think it's going to obviously be accretive to the MROs that we'll be generating. I think when you look at Aerospace is still well below where we think it will ultimately be. I think, as we bleed off some of the R&D, the NRE expense, the R&D that we've been experiencing because of the new programs, I think you're going to see margin improvement certainly across that platform. I think the other thing is, you've heard now about our self-help program. Everybody was very positive on that this last year, and we appreciate the fact that you hung in there with us through that process. But we're not done. There's some more restructuring going on right now. Some of that's baked, obviously, into the numbers that you see. But as we fully appreciate the full impact of all of this restructuring, that's going to help margins as well. The other thing going on in the company that we don't talk about a whole lot, certainly on these calls, is the innovation. As we drive more and more innovation, new product, new to the world, new to the industry type products out there, our margins are going to increase. Lastly, I would say, and we already talked a little bit about this, was our distribution channel. We continue to add distributions somewhere in the world every day. We are adding distribution, whether it be a ParkerStore, a HOSE DOCTOR, a distributor, a principal location or something. Somewhere in the world, something is going on every day. We want to continue building on that. I think when you talk about margins in the company, we do not know how high this can go. Frankly, we are taking it one year at a time, and of course, everything is fluid, so things change every year. We are just going to take it one year at a time. I think, though, the trend, you can see when we were at 13%, we were getting questions, "Don, do you think you are peaked out at 13%?" I said, "No, we are going for 15." When we got to 14%, I was getting the same questions, "Do you think that is about it?" I said, "No, I think we can go higher." 15. I think we are going to see. I think the good news is we have a lot of great things happening in the company, and we are going to be moving the needle as far as we possibly can. Better days are ahead. Let me just leave it at that. All right. Thank you very much. Thanks, Joel. Your next question comes from the line of Alex Blanton with Clear Harbor Asset Management. Please proceed. Hi. Thank you. Good morning, Alex. Good morning, and congratulations, Pam. Thank you. Best of luck. A quick question on the payout ratio that you indicated. If you take the new quarterly dividend rate, it is $2.52 a year, and divide that by the midpoint of your guidance, it is a 32.5% payout. To be a 30% payout, you would have to earn $8.40 this year. Could you just clarify that? Well, Alex, Jon here. My math comes up a little bit differently here. I am showing at around 31, but of course, you are not far off. We are, of course, going to always grow. We have not talked about our FY16 and what we expect in FY16 in terms of the top-line growth, as well as EPS. But our goal that we had set a few years ago, that was to get to a 30% payout ratio, and I do not think that there is anything wrong with the calculation that you just did. But I am not sure. You might want to just check your calculations on the share buybacks and what the straight line of the share buybacks would give you in terms of the 31. I think it might move from 31 to maybe- around 28 or 29. Oh, so your 31% takes into account a reduction number of shares. The 31% as it exists right now today, uses the current shares. Oh, current shares. Yeah. But I think that if you just assumed in your calculation the advice that- Well- we gave at the outset, I think it'll go below 30. Yeah, I just did a simple calculation. Right. The dividend rate per share divided by earnings per share. Right. Okay, I see what you're saying. All right. The second question sort of relates to Joel's previous question. You had an incremental margin overall of 111% in the quarter, with profit up $49 million on $44 million increase in sales. That was composed of 33% incremental margin North America, and then in the rest of the world and Aerospace Systems, you had higher profit on lower sales. So that was the result of your restructuring program, which I assume will continue to show some results this year. But going forward after that and relating to the possibility of even higher operating margins, what do you think you can generate normally as an incremental operating margin without any further restructuring? Normally? Well, normally. Going forward after the restructuring is all in, what would you continue to expect leverage? Our cost structure right now normally will give us about a 30% marginal return on sales as the business unfolds over time. That's what our cost structure gives us across the board for all of the segments. 30%. Well, of course, if you carry that out forever, you would raise the operating margin 30% ultimately. Right. Thanks, Alex. Yeah. We try to make people understand that. Yeah. Thank you. You just helped us. My point is that there is an upper limit, but it can be well above where you are now. Right. Yes, sir. Okay. Thank you. Thank you. Your next question comes from the line of Josh Pokrzywinski with Buckingham. Please proceed. Hi, good morning, guys. Good morning, Josh. So just a couple clarifications. First, on the pacing of the buyback. I guess, first, why not try to front-load that to the extent that the free cash flow enables it? Then, I guess secondly, just looking out into the coming years, especially with the CEO transition coming up, how should we think about any discretion on the low end of that range to the extent deals come up? I would imagine that whoever takes the reins from Don here wouldn't want to feel handcuffed by a program. Should we think of that $2 billion as being a line in the sand, and if something comes along, you're still able to do that? How should that transpire? This is Don. We think that, first of all, there's no big acquisition that we're looking at right now, as I had talked about earlier. So the smaller ones that we anticipate coming through, we'll be able to handle those in a normal course, okay? We're not using every last bit of capacity that we have. So there'll be enough capacity to handle a number of smaller ones, tuck-in type acquisitions like you've seen us do in the past pretty effectively. So I don't think we'll be tying anyone's hands going forward as far as the ability to continue down that path. And we do want to continue down that path because we do want to grow via acquisitions as well as internal growth. What was the other question? You kind of tied them both together, so no, that was helpful. I guess just as a follow-up, Don, you mentioned a couple of whale-sized properties that you were looking at in the space. Anything from an end market perspective that you could share color on where you guys were focused? Maybe I- No, I don't think we want to do that because of the sensitivity, of course, of the companies that we're looking at and the people there. We did have a confidentiality agreement, and we're going to honor that even going forward. We won't be disclosing any specifics. Suffice it to say, though, that these properties, as everything we do, makes perfect sense, and I would assure you that you would agree with us, would make perfect sense for the company. It's focused on motion and control. It's accretive. They're synergistic. Everything that we would do is not going to be off in left field somewhere. It would be good for the company if we were able to do that. I'm still optimistic that down the road that we'll have another shot at a couple of these, potentially. We won't go into specifics as far as segment or name or anything for obvious reasons. Understood. Thank you very much. Thank you, Josh. Your next question comes from the line of John Inch with Deutsche Bank. Please proceed. Oh, thanks. Good morning, everyone. Good morning, John. Welcome. Morning, Pam. Thank you and congratulations. Thank you. I just want to ask about the financing again of the share repurchase. I think based on the previous quarter or Q, almost all of your cash, Jon, was overseas. If you are stepping this up, your dividend is up and all your cash is overseas. Does that imply that the repurchase, if it is going to be linear, mostly has to be financed with commercial paper? I am trying to understand the mechanics of how you afford this if, in fact, you did not really have any cash in the U.S. to begin with and you have just jacked up your dividend commendably in the U.S., which has to be paid with U.S. dollars. Right. Well, your facts are absolutely correct. All of the cash on our balance sheet that you were looking at June 30 was overseas, and we used the cash that we generate here in the U.S., I think in order to pay down CP or take care of ongoing U.S. needs. We would do the same for our share repurchase program. We would use the U.S. cash that we generate, which is a significant portion of our free cash flow, of course. And we would use our credit line that we have established as it is right now in CP in order to fund the program going forward. As we model the straight line guidance that we gave to you, because of the cash-generating ability of the company, we feel that we can fund the share repurchase quite nicely. Maybe another way to ask this was if you, prior to the dividend increase and share repurchase authorization, you were generating healthy profit in the U.S. and you did not have the cash on balance sheet. Where was the cash going that now allows you to use that cash to, in turn, fund these actions? That is maybe the better question. I don't have the exact numbers in front of me, John. But in round numbers, I think we took our notes payable line, if you look on our balance sheet, down approximately in the last 12 months as we were going through this review of these very big opportunities, as Don Washkewicz was talking to you about, by a total, just for those, just for a total of about $900 million in the last 12 months. I could be wrong on that exactly, but that's, if you looked at the notes payable line and the reduction there, that's where you'll see that. Okay, that's probably the filler. Then just big picture, you beat commendably by $0.25. It seems like maybe half of that was below the, or I'm sorry, $0.05 of that was below the line. $0.19 now from currency. You add the moving parts, and it doesn't seem like you're really, given that you raised the guidance by $0.10 at the midpoint, giving yourself much credit for the opportunity based on improving orders. How much of the $0.10, if you will, comes from an expectation that these improved orders in North America and overseas actually roll through to the rest of the quarters? Well, I think all of the $0.10 is really tied into the increased confidence that we have in our guidance that we set out for the year that we are maintaining in terms of the top line, but for the translational impact of the strong dollar. As we look at that in our guidance, we wanted to take the guidance up by $0.10, and as we added up all the numbers from all around the world, that's the way that our calculations came together. I think that our order rates support that. Our order rates support our guidance. Keep in mind, the strongest order rates are in North America, and our guidance is over 5% increase in volume in North America. I think it ties together quite nicely looking at the trends in the orders, and we feel very confident in our guidance going forward. Hopefully that helps you, John. It does. Thank you. Thank you, John. We are now five minutes past the hour, so I am going to turn it over to Don, who has some closing comments. I would just like to thank all of you, and it has really been a pleasure working with all of you, and hope to talk to you soon. Just a few closing comments. I want to once again thank everybody on the call for joining us this morning. To recap, our current performance expectations for fiscal 2015 continue positive, thanks to the restructuring we completed in FY 2014. Our confidence is reflected in the announcements we just made, increasing our dividend 31% and the $2 billion to $3 billion share repurchase program, along with a strong quarter to start our fiscal year. As always, I will take this opportunity to thank our employees for their continued commitment and success. Our global team has done just an outstanding job executing the Win Strategy and delivering positive results for the company. I also want to say thanks to all of you on the call for congratulating Pam on her retirement. I know that she is going to miss working with all of you, and I will add a special thanks to Pam Huggins for her 30-plus years of service, loyal service to the company, and her passion for helping our company and our shareholders. If you have any additional questions, Pam and Todd, Lee, and Bruno will be around the balance of the day. I want to thank you once again, and have a great day. Bye-bye. Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.