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Parker-Hannifin Corp  (NYSE:PH)
Q2 2019 Earnings Conference Call
Jan. 31, 2019, 11:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Parker Hannifin Fiscal 2019 Second Quarter Earnings Conference Call. (Operator Instructions) I'd now like to turn the conference over to the Chief Financial Officer, Cathy Suever. Please go ahead.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Thanks, James. Good morning. Welcome to Parker Hannifin's second quarter fiscal year 2019 earnings release teleconference. Joining me today are 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 also posted on Parker's website at phstock.com.

Today's agenda appears on Slide 3. To begin, our Chairman and Chief Executive Officer, Tom Williams will provide comments and highlights from the second quarter. Following Tom's comments, I'll provide a review of the Company's second quarter performance together with the guidance for the full year fiscal 2019. Tom will then provide a few summary comments and we'll open the call for a question-and-answer session.

Please refer now to Slide number 4. Tom will get us started.

Thomas L. Williams -- Chairman and Chief Executive Officer

Thank you, Cathy, and good morning, everybody. Thanks for your interest in Parker and your participation today. So I'm going to start by first highlighting Parker's business model, which Cathy mentions on Slide 4 specifically those competitive differentiators that really help us stand out versus other companies and versus our competition.

So first on the list and first and foremost is the Win Strategy. It's our business system, it's a proven strategy that has a long track record of success. The second be our decentralized divisional structure. We like that structure because it's close to the action. We want our people close to the customers and close to the P&L so that we know whether we're making money or not.

The breadth integration of Parker's technology portfolio really creates this combination technologies that creates a unique customer value proposition. I think this is best demonstrated by the fact that 60% of our revenue comes from customers that buy more and more of those technologies. We make engineered products, about 85% of our products had some kind of intellectual property wrapped around them.

Our products have long product life cycles, which is a great thing. We're balanced between OEM and aftermarket and support this business model only requires low operating CapEx requirements, which is pretty positive. We've got a great track record on cash generation and deployment and we want to continue that over the cycle going forward. So some key takeaways for the quarter.

Safety is always our top priority. We had really strong performance, 23% reduction in recordable incidents. This is building on great progress from prior quarters and thanks to everyone for their efforts on owning safety the leaders and all the team members within Company. And I would just remind shareholders, there is a very close linkage between safety performance and financial and customer performance. And you can see that linkage as we improved safety seeing the performance in our customer and our financial metrics.

We put up a number of second quarter records. This was on sales, segment operating margins, net income and EPS. We reached 16.4% as reported on operating margins in the quarter. This is an unprecedented level of performance for the second quarter. If you were to go back years ago, it would normally be a Q4 type of performance to get what we did in Q2, a really significant job for everybody around the world.

Our organic growth came in positive at almost 6% partially offset by currency and we had strong cash flow and free cash flow conversion for the quarter driven by operating income growth and good working capital management. As a result of all this, we're increasing earnings guidance for the fiscal year and we remain confident in our ability to reach our new guidance for FY '19 as well as FY '23 5-year financial targets. So my thanks to the team members for Parker around the world, great progress, great results, thank you so much.

So a couple of more comments about the quarter. A strong quarter, nice earnings improvement year-over-year as I mentioned a number of records. From a net standpoint, our sales came in at 3%, again with almost 6% organic, which is very close to our guidance spot on. Order rates moderated with the combination of tougher comparables as well as growth moderating. We'll talk more about that during the Q&A.

Net income was a Q2 record, which included income tax expense related to US Tax Reform of $14 million. And segment operating margins again was a record 16.4% as reported. This compares we look, what was the previous Q2 record, was 14.4%. So if I could just comment for a second, most of the time when you beat a margin record, you beat it by 10 basis points to 15 basis points, some nominal type of beat. Effectively beat us by 200 basis points is very significant. We've almost never did something like that, that was remarkable. And of note, is that this includes the CLARCOR intangibles as well as the cost achieved. Again a really outstanding result.

If I would switch now on an adjusted basis, adjusted segment operating margins for total Company were 16.6%, which was up year-over-year 170 basis points versus Q2 of FY '18. Aerospace had another great quarter, making three straight quarters with margins over 19%. A great job by aerospace team demonstrating really nice returns on the significant amount of investments that we made there over the last decade or so. And what we have done is, we built a long cycle high-performing business that we're excited about now and we're excited about what the future is going to bring for the aerospace business.

On an as reported EBITDA standpoint, EBITDA margins were up 120 basis points to 17% or 17.2% on an adjusted basis. So I spent a fair amount of time talking about margins. There's three big factors that drove margin expansion for us. Again it starts with the Win Strategy and execution the team is doing on that. The productivity what we demonstrated in the plants and the plant closures including there and supply chain optimization.

Cash flows within the cash was strong. We expect to exceed a 100% free cash flow conversion and operating cash greater than 10% of sales for the fiscal year. This will be excluding discretionary pension contribution. And then on share repurchase we bought a total of $500 million in Q2. This was made up of a discretionary repurchase of $450 million and our 10b5-1 program repurchasing $50 million.

So now switching to the outlook, we're increasing EPS guidance by $0.09 at the midpoint to $11.29. This is on an as reported basis and we're increasing $0.20 at the midpoint to $11.60 on an adjusted EPS basis. This reflects the strong first half that we had and the outlook for the remainder of the fiscal year. We're forecasting moderating sales growth based on our current order entry and currency impact and this has a forecasted organic growth range of 2% to 4% for the full fiscal year.

We are in a great position, the best position we've ever been to outperform regardless of the market environment. Several factors underpin our confidence and ability to perform here. New Win Strategy is demonstrating a distinct step change in performance. I think the best example is if you were to look at our margin expansion over the last four years, that's a great indicator that there's clearly a step change of performance and the underpinning of that is the Win Strategy. What really gives us a lot of confidence is that, we're still in early days at the Win Strategy performance. And I'll just highlight a few opportunities there. The first is our high-performance team process, which is all about creating an ownership culture of the company as you have owners evolve and continue to care more and drive more engagement, you're going to see performance improve with it.

Simplification initiatives are still early days. The innovation pipeline is growing. And the combination of lean and kaizen opportunities and our supply chain strategies are going to continue to yield margin expansion as we go forward. We are stronger as a Company now than we've ever been. Our cost structure is in the best shape that it's been and we're well positioned to managing the kind of market dynamics and softening. The combination of our earnings growth, cash flow and our strong balance sheet gives us a number of capital deployment opportunities as we continue to drive increased shareholder value.

We continue to have confidence in our ability to reach the financial targets in FY '23, 2023 that we communicated in last year's Investor Day. And just as a reminder, what those are, to grow organically 100 basis points faster in market, this will be over this cycle. Segment operating margins of 19%, EBITDA margins of 20%, free cash flow conversion greater than 100% and EPS CAGR over this time period of 10% plus. In sum, we anticipate another record year for FY '19 and we're making good progress toward our new 5-year targets.

And with that, I'll hand it back to Cathy for a more detailed review on the quarter.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Thanks, Tom. I'd like you to now refer to Slide number 6, and I'll begin by addressing earnings per share for the quarter. Adjusted earnings per share for the second quarter were $2.51, which is a 17% increase compared to $2.15 for the same quarter a year ago.

The differences between the as-reported results and the adjusted results are as follows. Fiscal year 2019 second quarter operating income adjustments include business realignment expenses of $0.01 and CLARCOR cost to achieve of $0.03. This compares to prior year adjustments of $0.07 per business realignment expenses and $0.07 per CLARCOR costs to achieve.

In fiscal year '18, we also adjusted other expense to exclude a net gain of $0.05 from the sale of assets and the writedown of an investment. Income tax expense in the current year second quarter has been adjusted by $0.11 for a tax expense related to US Tax Reform. This updates the initial net one-time tax reform adjustment of $1.65 adjusted for in the second quarter of fiscal year '18.

On Slide number 7, you'll find the significant components of the walk from adjusted earnings per share of $2.15 for the second quarter of fiscal 2018 to $2.51 for the second quarter of this year. The most significant increase came from higher adjusted segment operating income of $0.41 attributable to earnings on meaningful organic growth, synergy savings from acquisitions and increased margins as a result of Win Strategy initiatives.

Lower average shares resulted in an increase of $0.07 and lower interest expense contributed $0.03. Adjusted earnings per share was reduced by $0.06 due to higher income tax expense in fiscal year '19 driven by higher earnings and higher year-over-year corporate G&A expense primarily as a result of losses in market adjusted investments tied to deferred compensation resulted in a $0.09 per share reduction.

Moving to Slide 8, you'll find total Parker sales and segment operating margin for the second quarter. Total Company organic sales in the second quarter increased year-over-year by 5.7%. There was a 0.5% negative impact to sales in the quarter from prior year divestiture while currency negatively impacted the quarter by 2.2%.

Total segment operating margin on an adjusted basis improved to 16.6% versus 14.9% for the same quarter last year. This 170 basis point improvement reflects the benefits of higher volume, productivity improvements, and the benefits of synergies from acquisitions combined with the positive impact from our Win Strategy initiatives.

Moving to Slide number 9, I'll discuss the business segments starting with Diversified Industrial North America. For the second quarter, North America organic sales increased by 5% as compared to the same quarter last year. Our prior year divestiture accounted for a 0.4% loss of sales while currency also negatively impacted the quarter by 0.3%.

Operating margin for the second quarter on an adjusted basis was 16% of sales versus 15.1% in the prior year. This 90 basis point improvement for North America reflects the hard work dedicated to productivity improvements as well as the benefits from additional volume, synergies from acquisitions and the impact of our Win Strategy initiatives.

I'll continue with the Diversified Industrial International segment on Slide number 10. Organic sales for the second quarter in the Industrial International segment increased by 3.6%. Negative impact from a prior year divestiture accounted for 0.8% of sales while currency negatively impacted the quarter by 5.3%. Operating margin for the second quarter on an adjusted basis was 15.7% of sales versus 14.2% in the prior year reflecting increased volume, improved operating cost efficiencies from realignment initiatives and the benefits of the Win Strategy.

I'll now move to Slide number 11 to review the Aerospace Systems segment. Organic revenues increased an impressive 12.2% for the second quarter due to strength in the military and commercial OEM businesses as well as the aftermarket businesses. Operating margin for the second quarter was 19.7% of sales versus 16% in the prior year reflecting the benefits of higher volume and cost efficiencies, the impact of a favorable sales mix, the deferral of some development costs and good progress on the Win Strategy initiatives.

Moving to Slide 12, we show the details 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 3-month rolling average, while the Aerospace Systems segment reports on a 12-month rolling average. Total orders increased by 1% as of the quarter end. This year-over-year growth is made up of flat order growth from Diversified Industrial North America, a decline of 2% from Diversified Industrial International orders and a 10% growth from Aerospace Systems orders.

On Slide 13, we report cash flow from operating activities. Year-to-date cash flow from operating activities was $541 million when adjusted for a $200 million discretionary pension contribution made during the first quarter, cash flow from operations was $741 million or 10.7% of sales. This compares to 6.8% of sales for the same period last year. The significant capital allocations year-to-date have been $200 million for the payment of shareholder dividends, $550 million for share repurchases of common shares made up of $100 million through our 10b5-1 plan and $450 million of discretionary share repurchases completed in the second quarter and $200 million for the previously mentioned discretionary pension contribution.

The revised full year earnings guidance for our fiscal year 2019 is outlined on Slide number 14. Guidance is being provided on both an as reported and an adjusted basis. We have adjusted our sales outlook for the second half to reflect current order trends and current currency rates. Total sales increases for the year are now expected to be in the range of minus 0.4% to plus 2% as compared to the prior year.

Anticipated organic growth for the full year is forecasted in the range of 2% to 4% or 3% at the midpoint. The prior year divestiture negatively impact sales by 0.4% and currency is expected to have a negative 1.9% impact on sales for the year. We've calculated the impact of currency to spot rates as of the quarter ended December 31 and we have held those rates steady as we estimate the resulting year-over-year impact for the remaining quarters of fiscal 2019.

For total Parker, as reported segment operating margins are forecasted to be between 16.7% and 17.2% while adjusted segment operating margins are forecasted to be between 17% and 17.4%. The full year effective tax rate is projected to be 23%. This anticipates a tax expense run rate of 24% for the third and fourth quarters.

For the full year the guidance range on an as reported earnings per share basis is now $11.04 to $11.54 or $11.29 at the midpoint. On an adjusted earnings per share basis, the guidance range is now $11.35 to $11.85 or $11.60 at the midpoint. This updated guidance on an adjusted basis excludes business realignment expenses of approximately $19 million or $0.11 per share for the full year fiscal '19 with the associated savings projected to be $10 million.

The guidance on an adjusted basis also excludes $15 million or $0.09 per share of CLARCOR cost to achieve expenses. CLARCOR synergy savings are estimated to ramp to a run rate of $125 million by the end of fiscal '19, which represents an incremental $75 million of run rate savings as we exit fiscal '19. We remain on track to realize the forecasted $160 million run rate synergy savings and $100 million revenue synergies by fiscal year '20.

And finally, guidance on an adjusted basis also excludes $0.11 per share for the second quarter tax expense related to US Tax Reform. Savings from business realignment and CLARCOR cost to achieve are fully reflected in both the as reported and the adjusted operating margin guidance ranges. We 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 2019 guidance at the midpoint are sales are divided 48% first half 52% second half. Adjusted segment operating income is divided 47% first half, 53% second half. Adjusted earnings per share first half, second half is divided 46%, 54%. Third quarter fiscal 2019 adjusted earnings per share is projected to be $2.99 per share at the midpoint and this excludes $0.05 of projected business realignment expenses and $0.01 of projected CLARCOR cost to achieve.

On Slide 15, you'll find a reconciliation of the major components of fiscal year 2019 adjusted earnings per share guidance of $11.60 at the midpoint compared to the prior guidance of $11.40 per share. Increases include $0.11 from stronger segment operating income, $0.03 from lower full year tax expense and $0.20 from reduced average shares. Offsetting these increases is an $0.11 per share decrease from higher corporate G&A than previously forecasted due to market adjusted investments tied to deferred compensation and higher other expense attributed to mark-to-market accounting of equity investments in the second quarter as well as $0.03 from higher interest expense for the year. Please remember that the forecast excludes any acquisitions or divestitures that might close during the remainder of fiscal 2019.

On Slide 16, you'll find the components of our updated full year increased guidance relative to the outperformance in the second quarter versus our initial guidance going into the quarter. Actual second quarter earnings per share on an adjusted basis were $0.12 stronger than previously guided due to excellent operating performance partially offset by higher corporate G&A and other expense attributable to the market investment losses previously mentioned.

For the balance of the year, we expect net incremental per share benefits of $0.08. Lower tax expense will provide $0.03 and $0.16 will occur due to the lower average shares. Offsetting these favorable items will be the impact that moderating growth will have on operating income in the second half of $0.10 per share as well as an expected net $0.01 unfavorable impact from below the line items of corporate G&A interest and other expense. All of this equates to a net increase to adjusted earnings per share for the full year of $0.20. This concludes my prepared comments.

Tom, I'll turn the call back to you.

Thomas L. Williams -- Chairman and Chief Executive Officer

Thank you, Cathy. We're very pleased with our continued progress with the execution that once scheduled projecting another earnings record for fiscal 2019. I just want to conclude by saying thank you to the global team for all the hard work, their dedication and I thank our shareholders for their continued confidence in us.

And with that, James, I'll hand it over to you to start the Q&A portion of the call.

Questions and Answers:

Operator

Excellent. Thank you sir. (Operator Instructions) Our first question comes from Ann Duignan with JP Morgan. Your line is now open.

Ann Duignan -- JP Morgan -- Analyst

Hi, good morning.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Good morning Ann.

Ann Duignan -- JP Morgan -- Analyst

I think maybe perhaps you could give us some color on the regions what you're seeing in the various regions and then the various end markets. We used to do the 312 and the 1212 are the trends around the end markets and the regions. Perhaps we could start with that Tom.

Thomas L. Williams -- Chairman and Chief Executive Officer

Okay. Ann, this is Tom. I'll start. I'm going to give you maybe an overall framework and then I'll hand it to Lee with more details. Let me start with the new guide and I am going to focus on organic guide. So we guided now to 2% to 4% as far as our range. And I'm going to put the regions in Aerospace into that range and give you where they sit. So on 2% to 4% Latin America would be above that range. Aerospace is above it. North America would be right at the midpoint. Asia Pacific would be at the low end of that range. And EMEA would be flat. So that's our view on organic growth for the full year.

Probably what's more important and interesting for everybody in the call is, what are we seeing for the second half. So our first six months of the calendar year 2019. So our organic guide, I'm going to kind of round here is approximately a little bit less than 1% for the second half. And the way that splits out is North America a little bit, north of 1%, international about a minus 0.5%, Aerospace at 2.5%. So now, if I split out international, that minus 0.5% is around Latin America plus 5%, Asia Pacific flat, and EMEA about negative 1.5%. Again these are all second half numbers for us.

So maybe a little bit of thoughts for me on what's behind the second half guide. Well, it starts first with the most recent order entry and you all saw the numbers from the press release, North America at 0, international minus 2, Aerospace at plus 10, total company at 1. So if I could step back for a second and go back to where we were two years ago, we were clearly in an accelerating growth environment. That very naturally moves into a moderating growth as most business cycles do from accelerating into a moderating growth. And that's fully based on last guide, what we had projected for the second half.

However, if I was to give you an analogy going from moderating to really what we guided to a slow growth, I'd have you visualize a metal spring, not spring the season, but a spring, a metal spring. And I think that spring is our organic growth. And it's still I think very capable of a moderate growth environment. I don't think the dynamics have changed. However, there's been some weights put on top of the spring and these weights would be some macroeconomic and geopolitical issues that we have all been talking about and reading about and listening to and trade-related things, Brexit, monetary policy, the oil and gas price softening and the government shutdown.

I am very optimistic, we are very optimistic that those weights, those macro issues will resolve themselves, maybe not all of them, but several are going to resolve themselves. And that spring, our organic growth guide for the second half that is currently now on slow growth environment could spring back to the moderate growth environment. Big question is when. And I don't think anybody really knows the answer to that. However, our guide assumes that those macro issues are not going to get resolved in enough time to really have much support or change to what our current second half guide is. So that's a backdrop, and I'm going to hand it over to Lee to give you more details on the markets.

Lee C. Banks -- President and Chief Operating Officer

Okay, Ann. What I thought I would do, if you don't mind is, first just some color on Aerospace. I mean, we were absolutely pleased with the performance in Aerospace, strong organic growth. And I just thought I'd give you some color by the segments in Aerospace. So commercial OEM for us was up 11% in Q2 and we're guiding at the midpoint for 5% for the full year. Military OEM, up 24% in Q2 and a guide to 14% for the full year. Commercial MRO up 8% a guide to 4% for the full year and military MRO was a strong 9% in Q2 and a 3% guide for the full year. So these full year guides, obviously some of the stuff is very lumpy and then there's tougher comps, but that's our latest thinking right now. So we're guiding to 5.7% organic growth at the midpoint for Aerospace.

On the Industrial side of the business, what we did is, just kind of look at this, we took all our markets in Q2, how we saw them. And this is pretty consistent with Tom's comments how we're projecting them going forward. But we kind of put these markets in three buckets, growing and still stable, growing but moderating from Q1 and then soft to negative that we saw in Q2. And really was a carryover from Q1.

Just reading through some of these markets that are still positive, refrigeration is doing well, telecom, life sciences, construction markets, heavy-duty truck in North America and Europe fantastic, build rate still. The one area that it's down significantly is in Asia, China specifically. And I'll comment on that later. Agriculture, lawn and turf, forestry, material handling and then I just talked about Aerospace. Moderating from Q1 and Q2 was distribution mostly North America.

Oil and gas, mostly land-based oil and gas. And then general industrial and mining. And then what we would consider soft or you could say negative and there's four of these that we would kind of put in the trade-related bucket, mills and foundries, which is -- impacts China significantly. Automotive, machine tools, tires and rubber, and then there's four key markets that have been flat since Q1. Power gen, it hasn't gotten worse, it's stable, so I think we're bouncing along the bottom there.

Semiconductor, microelectronics, if you will, has gotten worse in Q2. Rail is stable and marine is stable at a low level. I'll just comment quickly on the regions. I think in North America we're still pretty bullish, our distributor base is bullish. I'd say the only moderation we saw was really distribution that serves kind of the microelectronics markets and land-based oil and gas. It definitely took a step back. And I would say, clearly there was some rebalancing of inventory from some of our channel partners in North America in Q2.

On EMEA, you've got Turkey, Brexit, tariffs, and yellow jackets and put a lot of pressure on a lot of different areas. We're expecting slightly negative growth for the second half, although we did see some rebounding in offshore North Sea oil and gas which was nice. And with continued headwinds in the machinery markets mostly around Germany.

And in Asia, two great years, strong comps, as we talked about, I'd say overall, Asia -- as Tom mentioned, we're forecasting to be flat in the second half. So by and large we're very encouraged. As Tom mentioned, there are some pressure on some markets, but I don't get a sense everywhere that there is going to be some precipitous pull back. I just think we're in a kind of a pause or a slow growth area right now. So I'm going to stop. I just gave you a lot and go from there.

Ann Duignan -- JP Morgan -- Analyst

You did indeed. And I don't want to hog the call, but I just -- could I just clarify without putting words in your mouth, would North America distribution has been the one kind of that inflected the most in the quarter and I'll leave it there. Thank you.

Lee C. Banks -- President and Chief Operating Officer

It definitely pulled back North America. I would not say overall. I would say those areas a little bit of rebalancing across the channel and those areas are around land-based oil and gas pull back. But that's just off the hip right? I don't think so. I don't think the most would be a wrong way to characterize it.

Ann Duignan -- JP Morgan -- Analyst

Okay, I'll leave it there in the interest of time. I appreciate the color.

Lee C. Banks -- President and Chief Operating Officer

Thanks.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Thanks Ann.

Operator

Thank you. Our next question comes from Andy Casey with Wells Fargo Securities. Your line is now open.

Andrew Casey -- Wells Fargo Securities -- Analyst

Thanks. Good morning everybody.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Good morning Andy.

Andrew Casey -- Wells Fargo Securities -- Analyst

I'm wondering how to view the Industrial International guidance for the second half. You're guiding the top line down a little bit. The margins are pretty resilient. And I'm just wondering, is the resilience more a function of the structural cost work that you've done for that region. Is it mainly comps or is it something else?

Thomas L. Williams -- Chairman and Chief Executive Officer

Andy, it's Tom. I think what you're seeing is a combination of things. You pointed to one of them. The restructuring that we've done and I would characterize this for really all the regions. Obviously International we did probably more over the last several years that we had in North America. But it's a combination of that prior period restructuring, so that fixed costs in a lot better position than we've been. The new Win Strategy changes and that focus on simplification and the costs SG&A costs have come down. Our variable costs have gotten better.

The productivity of the plants we saw continue to improve through the quarter and our -- we continue to feel that they'll improve in the second half, which is why our margins are so resilient with a little bit of softness there. And we've done a really nice job on supply chain and started just optimizing all the dynamics that are going on from a material inflation, freight et cetera. So I think the team is doing a great job of executing, but there's still a lot more opportunities there, which is why we've guided to pretty good margins in the second half even with some softness in the top line.

Andrew Casey -- Wells Fargo Securities -- Analyst

Okay. Thanks Tom. And then I think you said it, but if -- investors seem to be worried about a downturn across several markets, and I'm just wondering what you would expect from Parker in terms of return performance if the markets actually did go into a downturn, are we looking at, not only raised, you know, increased margin performance that you've already demonstrated with this record in the second quarter, but also decreased return sensitivity to the changes in end market demand swings.

Thomas L. Williams -- Chairman and Chief Executive Officer

Well, honestly and it depends on the severity of a market swing. But I would tell you, we have this continuous view on being cost leaders. Everything we're doing around the Win Strategy, the execution there is making us the most nimble, agile business that we possibly can be. And I think the best evidence of that is just plot our margins over the last four years and what's happened. You've seen significant margin improvement. And of course, in the second half, we're guiding to a little less sales and margins equal to or better than what we originally said in the last guide.

Now typically over a cycle, we would expect sales would drop that same 30% decremental, I think is still good rule of thumb. But what we've demonstrated over the last several cycles, go back to '02, I'm going to take a history lesson for those that haven't tracked the Company a long time. 2002 we had a 60% drop in earnings, '08 to '09 was a 40% drop. The '15 to '16 industrial recession contraction is a 20% drop. And so, we continue to get better.

Our whole goal is to raise the floor, raise the ceiling of margin performance. And while we're very proud of what we did in Q2 and very proud of -- and we're guiding for the first time in history of the Company to do a 17% operating margin, we clearly have a lot more opportunity in the future. So I'm not worried at all about any kind of softness. We've been practicing for this every day, so we're ready for it.

Andrew Casey -- Wells Fargo Securities -- Analyst

Thank you very much.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Thanks Andy.

Operator

Thank you. Our next question comes from the line of Nathan Jones with Stifel. Your line is now open.

Nathan Jones -- Stifel Nicolaus -- Analyst

Good morning everyone.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Good morning Nathan.

Nathan Jones -- Stifel Nicolaus -- Analyst

Just like to dig a little bit further into the margin in North America. I think incrementals are in the mid to upper 30s in the second quarter North America versus kind of that 10 to 20 that you'd guided to for the first half. So clearly better there. And I think this is probably around the productivity improvement post-closing the CLARCOR and Parker facilities. Maybe Tom you could -- Tom or Lee you could talk a bit about the improvement in productivity there if those businesses are now running at the levels that you expect them to run, if there's further improvement we're going to see in the third quarter, any -- just any color you can give us around that?

Thomas L. Williams -- Chairman and Chief Executive Officer

Yes, Nathan, this is Tom. I would say first, you have a good ground rooted improvement in productivity regardless of the plants that were involved plant closures because you've got all the other plants that are improving as well when strategy execution and all the things that I talked about earlier in my opening comments. So you got a good ground-based improvement in productivity specifically around the plants that, and all the lines that we moved, we saw steady progress and productivity, but we have more to do.

So we were pleased, as you pointed out, 37% and more or less in North America for the quarter and beat what we had guided to and what we communicated. But we expect that to continue to get better and we're guiding to an even stronger second half. So our belief that we told you last quarter about the second half being stronger than what we feel the first half would be, that still holds true. We may have gotten a little better faster, but what we've seen is, there's still lots of opportunities who are not yet at the complete rates that we need to be. So I think that bodes well to what our second half is going to be. And really I think signals -- I am not talking about FY '20 yet, but signals that we have momentum at FY '20 as well.

Nathan Jones -- Stifel Nicolaus -- Analyst

And maybe then just on the order, the flat orders in North America in the quarter. Lee talked about maybe channel rebalancing on the distribution side. Have you seen that abate into the third quarter here? Are you seeing any channel rebalancing or any OEM channel rebalancing their inventory there, maybe with your OEMs anticipating a little slower growth, they tend to maybe take some inventory off the shelves? Or what your expectations are in both channels for inventory over say the next six months?

Lee C. Banks -- President and Chief Operating Officer

Yes, Nathan, it's really hard for me to have a gauge to the OEM channel, but my feeling to the distribution channel is the rebalancing that took place is by and large done. I think there is real pull on demand that's taking place. And so, I don't feel like there is more pull back coming given current market conditions right now.

Nathan Jones -- Stifel Nicolaus -- Analyst

Okay, thanks very much. I'll pass it on.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Thanks Nathan.

Operator

Thank you. Our next question comes from Julian Mitchell with Barclays. Your line is now open.

Julian Mitchell -- Barclays -- Analyst

Hi, good morning. Maybe just following up in the industrial businesses on the cadence of the order changes that you saw in the last few months. Was it in general when you look globally a big step down very late in fiscal Q2? Or was it a steady deceleration since sort of early October? And related to that perhaps, how should we think about the organic growth guide in the current quarter versus the fourth fiscal quarter? Is there any particular cadence on the industrial side that you would emphasize?

Thomas L. Williams -- Chairman and Chief Executive Officer

Julian, it's Tom. Let me -- I'll start first with the order trends and I'll maybe take region by region. So North America pretty well declined equally equal parts through the quarter and really mirrored the -- if you go back to the prior year the increases we had. So kind of a mirror image there. I would say, EMEA and Latin America was -- I'd say really all the regions were pretty sequentially equal drops. EMEA and Latin America exited flat to prior, so remember our international was at minus 2. That composition was EMEA and Latin America exiting flat and Asia Pacific exiting slightly negative on that end.

As far as the first half, second half in third quarter and Q4, on organic, we have a little bit better organic in Q3 and that's mainly because of the comps with Aerospace in Q4. We had a huge Q4 in Aerospace with some big MRO activity that is unlikely to repeat. And so, that's probably what's weighting it down. But I would say in general, how I articulate and what Lee articulated as far as organic growth, is not really too much different between Q3 and Q4.

Julian Mitchell -- Barclays -- Analyst

Thank you. And then my second question would be around maybe switching to the balance sheet. You talked about the buyback step up, the $500 million or so in Q2. Does the demand slowdown at all affect your appetite to undertake acquisitions and therefore buybacks are a more logical use of cash? Or are you still equally interested in M&A as you look out over the rest of this year?

Thomas L. Williams -- Chairman and Chief Executive Officer

Julian maybe start with -- I'd like to cover the capital deployment from a comprehensive standpoint. So first is dividends, we're going to keep that consecutive increase record. And we like to target 30% to 35% of net income on a rolling 5-year average. And our dividends are going to grow because we're going to grow net income over this time period. CapEx as my opening comments about, one of the things that make us unique, we are pretty efficient on CapEx. We will use CapEx to fund organic growth and strategic productivity. So, now to the heart of your question, is share purchase versus strategic acquisitions, and we like both. We will do what the best use of this for our shareholders for the long run.

I think in general, acquisitions generate incremental cash, generate incremental EBITDA that would be the preference, provided that they meet our stringent and our disciplined view of acquisitions. Over the cycle, it's important as far as where we are, but what's more important is it's a strategic fit, will it hit our return criterias? We would model where we were organically into the DCF, so we'll fact that in. So I would just say the M&A pipeline is active. We're going to continue to look at properties really along two big things. We want to be the consolidated choice in our space if the property is a good fit. And then all things being equal, we're going to invest in engineering materials, aerospace, instrumentation, filtration, of course you've seen are the big investment we did in filtration.

What you saw on the last quarter, we bought shares. We didn't see a property that we could execute on, that made sense, that would click, remember the acquisition pipeline is not a 100% first pass yield, it requires two people to get married. And we think we're of great value. And we know where the Company is going and we thought it was a great investment. Great time to buy Parker. And for that matter, it's never a bad time to buy Parker. So we'll continue to look at all those. I think in general, like you've heard me talk before, we want to have a balance sheet that is put to work. We have a great earnings profile. We have great cash flow and we want to be great deployers and we're going to deploy it the best possible way recognizing that, our goal is to drive shareholder value over the long term. And every quarter might be a little different how we tweak that. But I think you'll see us continue to be active.

Julian Mitchell -- Barclays -- Analyst

Great. Thank you.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Thanks Julian.

Operator

Thank you. Our next question comes from the line of Andrew Obin with Bank of America Merrill Lynch. Your line is now open.

Andrew Obin -- Bank of America Merrill Lynch -- Analyst

Yes, good morning. I guess it's still morning. How are you guys?

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Good morning Andrew.

Andrew Obin -- Bank of America Merrill Lynch -- Analyst

Just a question I guess for Tom and Lee. I remember maybe, well, last year you guys were sort of stressing the fact that, we're still in very early innings of the industrial cycle. And I looked at your growth and you guys have been spot on, I get it, but your peer Eaton just provided sort of 5%, 6% organic growth for hydraulics for '19, 8%, 9% for Aerospace, Rockwell is guiding for 7% for 2019. So I'm just wondering, what has happened to the cycle and why are you so different from other short cycle industrials that I'm looking at -- looking at '19. And have you changed your view about the long run? Sorry for a long-winded question, but just the difference in guidance is so stark between you and everybody else. Thanks.

Thomas L. Williams -- Chairman and Chief Executive Officer

Andrew, it's Tom. I can't comment about everybody else. I can just comment about what we see. We can -- if I take Aerospace, we continue to see Aerospace very strong. And we have robust orders, you saw the order entry there. We had a robust first half. Our second half will still be very strong sequentially. It's a 7% growth sequentially. We have some pretty tough comparables in the second half, which make it not look quite a strong. But I put up our Aerospace numbers against anybody in that space. On the Industrial side, we do tend to probably see things maybe a tad quicker than other people, but we're giving you what we see right now and that's all we can do.

The order entry in the prior quarter given the fact that our backlog is four weeks to six weeks typically and the Industrial piece is what you're going to yield out in the next quarter. I still believe and as you heard me talk about before that I still think this is a great industrial environment. I do think though that some of the uncertainties weighed on order demand. And I do think they were resolved, but since our fiscal year end June 30th, I'm not sure they're going to resolve of time to influence our second half. Remember we're guiding only for our second half, or our full year which ends June 30th, whereas everybody else is guiding to a full year, calendar year 2019. So that's how I would describe it.

Andrew Obin -- Bank of America Merrill Lynch -- Analyst

Now, that's very fair. And just a follow-up question. I think our channel check work is picking up very, very strong pricing, even though we are seeing the slowdown you guys are talking about. Is there anything different about the industry pricing strategy in this cycle? It is just, you know, I've been doing it for a while and pricing seems to be as sticky as I've ever seen. Thanks a lot.

Lee C. Banks -- President and Chief Operating Officer

Andrew, it's Lee. As you know, I mean, we're constantly measuring our input costs using our PPI metric and using our -- and seeing what's happening with inflation. There's certainly been a lot of inflation in this cycle, some driven just by pure commodity pricing, some driven by extra things like tariffs et cetera. So I think what you're seeing is just the ability to probably cover some of those input costs that are maybe a little different than past cycles.

Andrew Obin -- Bank of America Merrill Lynch -- Analyst

Right. But what's driving this fundamental ability? That's a big deal.

Lee C. Banks -- President and Chief Operating Officer

You mean for it to stick? Andrew, I think I lost you there. But I would just finish by saying that, we were in a very rapid growth environment. I think supply was paramount for everybody. And I think there is just strong brand recognition with Parker's brand throughout the channel. So not sure I can...

Andrew Obin -- Bank of America Merrill Lynch -- Analyst

No, you guys certainly doing great job in the channel. I'll follow up off-line. Thanks a lot.

Lee C. Banks -- President and Chief Operating Officer

Okay. Thanks.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Thanks Andrew.

Operator

Thank you. Our next question comes from Jamie Cook with Credit Suisse. Your line is now open.

Jamie Cook -- Credit Suisse -- Analyst

Hi, good morning. I guess first question on Aerospace margins have been very strong in particular over the past three quarters. I know you are guiding for margins to deteriorate in the back half. But can you talk about mix or whether there is upside to Aerospace margins over the next couple of years and what would be driving that I guess, is my first question. And then my second question, just based on sort of what you see and certainly in the macro environment are -- and some of the slowdown in the markets you talked about, are you considering potentially additional restructuring actions at all and how we should sort of think about that or what actions you're taking to prepare if there is a downturn? Thanks.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Jamie, this is Cathy. I'll start on the Aerospace margin. We're very pleased with the margins that they achieved in the quarter. And we do see a lot of improvement that they've worked hard at getting -- gaining in their infrastructure and their cost control. If you notice we did raise the guidance for their margins for the year a fair amount. In the second half, you'll see maybe not as high as you would have expected and that's going to be driven by higher development costs in the second half than what we experienced in the first half.

We're anticipating development costs for the year to finish somewhere between 5.75% of their sales to 6.25%. They did 5.5% in the first half and we're expecting closer to 6.5% in the second half just because of the timing of some of those development activities.

Thomas L. Williams -- Chairman and Chief Executive Officer

And then Jamie, this is Tom. I'll take the market question there. Again I will just go back to, we're constantly preparing for any softness by just having the best cost structure we positively can, but we will make market adjustments. We're not seeing anything yet that would warrant a change in our restructuring profile. We have a lot of levers you can pull that don't trigger that like a reduction of temporary workforce, overtime reduction, those type of things, recognizing that we have probably around 8% of our workforce total company that is temporary people. So there is a number of levers we can move that won't trigger a restructuring change.

Jamie Cook -- Credit Suisse -- Analyst

Okay. Thank you. I'll get back in queue.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Okay. Thanks Jamie.

Operator

Thank you. Our next question comes from David Raso with Evercore ISI. Your line is now open.

David Raso -- ISI Group -- Analyst

Hi, good morning. Obviously an important time for the stock and the company here in the sense of trying to show the evolution, how does Parker handle a slowdown differently than in the past. And I mean, this quarter obviously you're able to show weaker orders, weaker organics still able to raise the guide, do a good job in the quarter. But just can you help frame a little bit thinking about really not that far away from six months from now fiscal '20 guide, we can all make our top line assumptions. But can you help us with -- you look at the order patterns, what you're seeing right now, as you know, North America, if you look at the comparisons and you double stack them, right, the actual North American comp gets a little harder and then it begins to ease. The international order comps start to ease from here.

Can you help us level set -- again, I know you're not going to give us fiscal '20 guide right now, but should we be thinking the order rates in North America and International are both negative in the current calendar 1Q? And then I'd like to follow up with a question on, kind of, cost side items or below the line items as well to think about puts and takes '20 versus '19.

Thomas L. Williams -- Chairman and Chief Executive Officer

David, it's Tom. As you might expect and I won't get into FY '20, but I think orders are going to be reflective of what I imagine that organic guide that I gave you for the second half meaning that, a little less than 1% total company North America plus 1 International, about minus 0.5, and Aerospace the 2.5. So I think orders will mimic that. Obviously Aerospace orders are longer cycle lumpier, so they may not look exactly like that. But I think the industrial pieces will mirror that organic guide that I gave you. And as far as below the line, why don't you follow-up with that question.

David Raso -- ISI Group -- Analyst

Sure. And just to be clear on your answers. So it doesn't sound like you see the North American orders -- I'm not going to try to hold you to 100, 200 bps here, but doesn't sound like you see North American orders going maybe negative at all let alone any materiality. And then international orders sounds like you also don't think those get any worse from here. Is that a fair characterization of your answer? Just seeing what you're saying out there and knowing the comps.

Thomas L. Williams -- Chairman and Chief Executive Officer

Yes, again, I would frac it with a little bit of a range. It's really hard to pinpoint this stuff. But I mean, the numbers I gave you is our best estimate at this point based on the current order entry.

David Raso -- ISI Group -- Analyst

All right, thank you. And then on the year-over-year benefits, I know you're not going to quantify them. Just if you can help us a little bit. You are obviously going to have the share count help. The full year benefit of the plant closures and some of the approved -- improved efficiencies and I would suspect and we can debate the cost structure materials. But do you think for price cost maybe even gets better as we look into the moment, you have to give a guide on '20.

Can you help us a little bit maybe even prioritize for us, is the biggest benefit of the plant closure efficiencies having that for a full year. Obviously, repo versus M&A the next six months being debated, but sounds like you have a nice share count health. Can you just kind of frame the puts and takes for us on those cost items and below the line items and obviously any other help you have on tax or anything would be great, just things that you see as of today.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

David, I'll start out here. We're forecasting from the realignment activities that we're doing this year that we'll see $10 million of savings in the year and then that'll carry through. In terms of the integration and the synergy savings we're seeing with continuing to work on integrating CLARCOR, we've increased the run rate to up to $125 million through this, the end of this year and that's a $75 million incremental. And we still then think that by the end of fiscal '20 we'll be up to $160 million. So yes, we'll continue to see savings from those activities. In terms of price cost, we don't really talk about in that detail, Lee, you want to touch on that?

Lee C. Banks -- President and Chief Operating Officer

No, I would just say on price cost David, you know, the way we track this and our goal is just to be margin neutral as we go through these.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

And in terms of tax expense, we are forecasting an effective rate of 23% this year. I would expect that to be our continuing long-term rate for the next year or two unless things change significantly.

David Raso -- ISI Group -- Analyst

Right. That's helpful.

Thomas L. Williams -- Chairman and Chief Executive Officer

But David, it sounds like (inaudible) to a higher point here. I think what you're getting at is, we got more room to go. We're going to end at 17%, we're on a mission to get to 19%. We're not stopping there, that's just a test. We're just going to stop for a minute and congratulate ourselves and keep moving. We are very pleased with what we're seeing and I won't get into FY '20 because we haven't done that. But we are going to continue to grow earnings and grow margins.

David Raso -- ISI Group -- Analyst

All right. I appreciate that. Thank you.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Okay. Thank you, David. I think we have time for one more question.

Operator

Excellent. Our final question will come from the line of Joel Tiss with BMO Capital Markets. Your line is now open.

Joel Tiss -- BMO Capital Markets -- Analyst

All right. Thank you. Just two things...

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Good morning Joel.

Joel Tiss -- BMO Capital Markets -- Analyst

Good morning. I wonder, again just more of a characterization, but are the pieces largely in place for the 19% longer-term operating margins? Or are there more levers that have to be pulled or it just depends on what the volume profile looks like? And just help us get a sense of where you are there?

Thomas L. Williams -- Chairman and Chief Executive Officer

Well, it would be -- all the things -- Joel, this is Tom. All the things that we have had in the Win Strategy, all along in that infamous walk we've got that shows you from where we were in FY '18 at the IR Day to the 19% (ph). And if I would just tell you the major ingredients without going to the numbers, the CLARCOR's synergy is a big part of it. All simplification program, which we didn't talk about is still early days, the whole 80-20 look at our revenue complexity is a big deal.

We're down to 80 divisions now, 122 to 80 divisions. So 80, eight-zero, we continue to work that. But I would tell you that the revenue complexity side is a bigger deal. Productivity, we have a lot of things we're doing on kaizen. We're combining lean and kaizen and some strategic CapEx investments we're making around automation, those will continue to yield. We've done a great job in supply chain and we've been able to optimize supply chain in a much more efficient way than I think maybe historically, which we're pretty pleased with that. And we'll continue to leverage a fair amount of our spend I think has not had as much visibility, all indirect cost side of things.

And then we're going to continue to have margin enhancements around change in the mix and distribution, the innovation pipeline, those type of things. So I think you all know us well enough. We won't put out a number. Even if it was five years ago, we didn't think we had a road map to get there. So we believe in our road map. But I would just again emphasize that is not the final destination and we got to 17% early. I'm not saying we'll get to 19% early, but our confidence is there.

Joel Tiss -- BMO Capital Markets -- Analyst

And then just the last one in Aerospace, is there any unusual mix that could put a little pressure on the margin progression over the next say 12 months to 18 months?

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Yes, good question, Joel. We will see an increased volume of OEM activity of entry into service as some of the newer platforms are now ramping up and that does start out at very low margins. So that will have some pressure on our Aerospace margins. But we are confident, I mean, we're forecasting a midpoint margin for this year of 19%, 19.1% and the cost efficiencies that they've been working hard on, I think will help balance against that mix pressure that they're going to feel in the next few years.

Joel Tiss -- BMO Capital Markets -- Analyst

Okay. Thank you so much.

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Okay, thanks Joel. All right, this concludes our Q&A session and our earnings call for today. Thank you everyone for joining us. Robin will be available to take your calls should you have further questions. Thanks everybody. Have a great day.

Operator

Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may all disconnect.

Duration: 62 minutes

Call participants:

Catherine A. Suever -- Executive Vice President-Finance, Administration and Chief Financial Officer

Thomas L. Williams -- Chairman and Chief Executive Officer

Ann Duignan -- JP Morgan -- Analyst

Lee C. Banks -- President and Chief Operating Officer

Andrew Casey -- Wells Fargo Securities -- Analyst

Nathan Jones -- Stifel Nicolaus -- Analyst

Julian Mitchell -- Barclays -- Analyst

Andrew Obin -- Bank of America Merrill Lynch -- Analyst

Jamie Cook -- Credit Suisse -- Analyst

David Raso -- ISI Group -- Analyst

Joel Tiss -- BMO Capital Markets -- Analyst

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