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Edited Transcript of OSK earnings conference call or presentation 31-Jul-18 1:00pm GMT

Q3 2018 Oshkosh Corp Earnings Call

OshKosh Jul 31, 2018 (Thomson StreetEvents) -- Edited Transcript of Oshkosh Corp earnings conference call or presentation Tuesday, July 31, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David M. Sagehorn

Oshkosh Corporation - Executive VP & CFO

* Patrick N. Davidson

Oshkosh Corporation - SVP of IR

* Wilson R. Jones

Oshkosh Corporation - President, CEO & Director

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Conference Call Participants

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* Charles Damien Brady

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Courtney Yakavonis

Morgan Stanley, Research Division - Research Associate

* Jamie Lyn Cook

Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst

* Jerry David Revich

Goldman Sachs Group Inc., Research Division - VP

* Michael Shlisky

Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst

* Mircea Dobre

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Robert Stephen Barger

KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst

* Ross Paul Gilardi

BofA Merrill Lynch, Research Division - Director

* Seth Robert Weber

RBC Capital Markets, LLC, Research Division - Analyst

* Stanley Stoker Elliott

Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst

* Stephen Edward Volkmann

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Oshkosh Corporation Reports Fiscal 2018 Third Quarter Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Pat Davidson, Senior VP of Investor Relations for Oshkosh Corporation. Thank you, Mr. Davidson, you may begin.

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Patrick N. Davidson, Oshkosh Corporation - SVP of IR [2]

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Good morning, and thanks for joining us today. Earlier, we published our third quarter 2018 results. A copy of the release is available on our website at oshkoshcorporation.com. Today's call is being webcast and is accompanied by a slide presentation, which includes a reconciliation of GAAP to non-GAAP financial measures that we will use during this call and is also available on our website. The audio replay and slide presentation will be available on our website for approximately 12 months.

Please refer now to Slide 2 of that presentation.

Our remarks that follow, including answers to your questions, contain statements that we believe to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks that could cause actual results to be materially different from those expressed or implied by such forward-looking statements. These risks include, among others, matters that we have described in our Form 8-K, filed with the SEC this morning, and other filings we make with the SEC. We disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly earnings conference call, if at all.

All references on this call to a quarter or a year are to our fiscal quarter or fiscal year, unless stated otherwise.

Our presenters today include Wilson Jones, President and Chief Executive Officer; and Dave Sagehorn, Executive Vice President and Chief Financial Officer.

Please turn to Slide 3. And I'll turn it over to you, Wilson.

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [3]

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Thank you, Pat. Good morning, everyone. We're pleased to announce another quarter of solid results with $2.20 of adjusted earnings per share as we head into the home stretch of 2018. Our team members continue to executive our move strategy against the backdrop of uncertain trade policies and other challenges that we've previously discussed. Our performance for the first 3 quarters has been strong. We are executing well and maintaining discipline. Despite the challenges we are facing, we're increasing our full year financial outlook. I'm pleased to announce that we are raising our expectations for full year adjusting earnings per share to a range of $6 to $6.10. We have many reasons to be optimistic, for example, our defense team is on track to achieve full rate production for the JLTV program before the end of the calendar year, which will allow more and more men and women of our armed forces an opportunity to use the world's best military tactical vehicle. Our access equipment business just delivered a record quarter for revenues in its own track for strong double digit sales growth in the year. The fire & emergency team is raising their profit expectations, again, and continues to lead the industry with new innovations that has kept us in front of the competition.

And finally, our commercial group delivered significantly improved operating income margins in the quarter. This segment is also executing cultural and operational changes as they institutionalize simplification and realize the many benefits from reducing complexity in their business.

When we look at macroeconomics and industry-specific indicators of activity for our markets, we remain encouraged. We have strong backlog across all 4 segments. In fact, backlogs in all 4 segments on June 30 were higher than the prior year.

As we mentioned on our last call, we implement surcharges in our nondefense segments due to the extraordinary nature of raw materials inflation that's been occurring.

While no customers want to pay higher prices, the reality is that input costs have increased substantially and have continued to increase as new tariffs have been announced. We cannot absorb those significant cost increases alone.

Please turn to Slide 4 to begin the discussion for each of our business segments. I'll start it off, as I typically do, with our access equipment segment.

The access equipment team recorded sales of more than $1 billion in the quarter for the second time in their history, achieving a new record for quarterly sales of $1.16 billion. As we expected, orders in the quarter moderated from their elevated levels in the first half of the year when they grew 63%. This segment exit the quarter with a strong backlog of $1.2 billion that puts us in a position to finish the year on a high note. Our customers continue to benefit from a strong oil market for access equipment in North America and most regions around the globe. As we've talked about earlier, fleet metrics, such as utilization and rental rates have been solid and used values continued to be strong, leading to a strong demand environment.

Last quarter, we discussed challenges we were facing, and I'm pleased to say that our team has made progress addressing these challenges. Like many companies, we're experiencing a tight labor market, but we have a solid crew, and we're seeing progress as new team members move up the learning curve.

Our efficiency numbers still aren't where they need to be, but they did improve during the quarter. We continued to experience supply change challenges in the third quarter leading to production disruptions. This remains a big focus area for us, and we expect to continue to see improved operational execution by the end of the year.

Finally, we're spending considerable time and effort analyzing our cost as we prepared to update our pricing for calendar 2019. This involves looking at more than just higher commodity cost, other material cost and freight rates have also risen. We commented previously that we expect to announce a larger than typical price increase for the segment and that expectation remains the case today.

Please turn to Slide 5 for a discussion of the defense segment. The defense team delivered another quarter of strong results with operating income margins in excess of 10%. Much like last quarter, the ramp-up of JLTV production along with higher FMTV sales helped to partially offset the M-ATV sales decline. The JLTV program is in great shape as we approach the planned timing to achieve the full rate production milestone.

To further illustrate the strength and finally commitment for this program, in late June, we received an order for an additional 1,574 JLTVs, extending our production backlog for this program well into 2019.

I'd like to congratulate the defense team for their outstanding testing and reliability results as JLTV program has taken shape over the last couple of years. Our team is delivering JLTVs that were evaluated to deliver more than twice the reliability called for by the program requirements. This is a great example of our team going the extra mile and delivering for our customers.

We're also proud to have sold the first 2 JLTVs to our a non-U. S. customer. The United Kingdom, Ministry of Defense has purchased these units for testing and evaluation as they formulate their specific JLTV requirements. We remain firmly committed to our international customers and expect that they will become a significant part of our defense business over the next several years.

While the JLTV is approaching the full rate production milestone, we are still in the very early stages of development for the next-generation FMTV, or A2 program. As we said on our last earnings call, we've been shipping the FMTV A1 units since winning the contract in 2009. Our team is executing the engineering phase of the A2 contract, and we expect 2021 to be the transition year for delivery of FMTV A1 units to A2 units.

At the Congress Conference on the fiscal 2019 National Defense Authorization Act, the house approved the NDAA on July 26. We were pleased with the funding for Oshkosh programs in the NDAA, and it will be taken up by the Senate this week. We included a summary schedule on this slide for our primary domestic programs of record along with the expected delivery periods for each. We're well positioned for multiple years for all 3 programs. We have FHTV through 2022, JLTV through 2024 and FMTV through 2026. Now, of course, our intentions are to keep all 3 programs with Oshkosh for many years beyond these dates.

Let's turn to Slide 6 to discuss the fire & emergency segment. Fire & emergency team delivered yet another strong quarter with significantly higher year-over-year operating income margins. We've talked about the benefits of simplifying processes and practices at this segment, and these actions, along with improved pricing, continued to be a recipe for success for our team. We've made improvements to our operations as well as our order management processes to deliver strong results.

We've also invested in new products and technologies that have allowed us to stay up in front of the competition. Last quarter, our earnings call overlapped with the largest fire industry of North America, the FDIC trade show, and we were not able to discuss the launch of our mid-mount Ascendant aerial, but we can talk about it now.

It was a big success and was really the talk of the show in Indianapolis. Traffic in Pierce booth and interest in the new mid-mount Ascendant was beyond our most optimistic expectations. Since the show, we've taken the Ascendant mid-mount units out on the road, creating strong interest and excitement on demo tours in cities across the U.S. and Canada.

These aerials offer best-in-class features, including superior movability, drivability, operator functionality and serviceability. Together, this package addresses firefighters essential mid-mount aerial apparatus needs.

Our airport business recently scored several big victories. We were awarded multiple orders from the U.S. Air Force for a total of 91 airports snow removal units. And we were ordered an order for 10 airport rescue firefighting units for the new airport being built to serve Beijing, China. These orders call for shipments to begin in 2019.

Our view of the domestic fire apparatus market in 2018 continues to be positive but measured. We don't expect to see the market grow by a significant amount in the near future, but we believe the positive tailwinds of municipal tax receipts growth in age fleet dynamics will continue to benefit domestic demand.

Please turn to Slide 7, and we'll talk about our commercial segment. The commercial segment delivered solid results with a meaningful improvement in operating income margin compared to the prior year. We have experienced growth in refuse collection vehicle demand this year, and our team is working hard to respond to the opportunities.

We also saw an increase in concrete mixer unit orders this quarter compared to the prior year quarter. Fire & emergency isn't the only segment that is undergoing a transformation through simplification actions. Our commercial team continue to execute on its simplification journey during the quarter. They've delivered a few recent wins in the areas of concrete mix for configurations and different product options. We believe there is a lot more to be gained as the simplification culture takes root.

We're excited about their progress so far and look forward to seeing the transformation continue in 2019 and beyond.

Most of you know that both residential and nonresidential construction are important drivers to our commercial business. We remain encouraged and believe that these key industries will continue to grow as evidenced by the many forecasts and investment indicators that point toward additional construction activity.

That wraps it up for our 4 business segments, I'm going to turn it over to Dave to discuss our financials and updated outlook for 2018 in greater detail.

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [4]

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Thanks, Wilson, and good morning, everyone. Please turn to Slide 8. Consolidated results for the quarter were better than the expectations we summarized on the last earnings call.

Consolidated net sales for the quarter were $2.18 billion, up 6.8% from the prior year quarter. As we expected, access equipment segment sales were up double-digit percent versus the prior year, continuing the strong sales pattern exhibited over the past several quarters. Access equipment orders in the quarter were lower than the prior year as Wilson noted, but that wasn't a surprise and shouldn't be taken in -- and should be taken in context given the exceptionally strong order rates in prior quarters.

Defense segment sales were down 8% compared to the prior year, in line with our expectations as the prior year quarter included a large quantity of international M-ATVs. And while JLTV and FMTV volumes were both up year-over-year, they weren't up enough to offset the lower M-ATV sales. Fire & emergency and commercial segment sales were roughly unchanged from the prior year.

The impact of improved pricing was offset by the timing of international sales at fire & emergency. Timing of commercial segment sales in the prior year was more heavily weighted to the second half of the year, which is atypical for that segment. Sales in the current year reflect the more normal seasonal pattern.

Adjusted consolidated operating income for the third quarter was $229.3 million or 10.5% of sales compared to $222.5 million or 10.9% of sales in the prior year quarter.

Higher operating income margins in the fire & emergency and commercial segments were offset by lower margins in the access equipment and defense segments.

The access equipment segment delivered higher operating income compared to the prior year quarter as a result of the higher sales volume and improved pricing, but operating income margin was lower. Wilson talked about the issues that this segment continues to work through, and they were the primary drivers of lower operating income margin. In addition, this segment was negatively impacted by higher freight costs, along with adverse customer and product mix and foreign exchange headwinds.

Defense operating income margin was lower than the prior year due to a mixed shift. International vehicle sales were down more than 90% compared to the prior year, which included a high percentage of M-ATVs, and JLTV sales were up more than 80%. While margins were down compared to the prior year quarter, defense did experience better operational efficiencies than we expected coming into the quarter, continuing a pattern of improved execution.

Fire & emergency and commercial segment results were both meaningfully stronger than the prior year. Fire & emergency operating income margin was up 190 basis points, and commercial operating income margin was up 120 basis points. Focus on simplification along with a more favorable pricing environment drove the higher fire & emergency segment margin. The commercial segment benefited from a favorable mix and lower SG&A costs. These items were partially offset by higher material costs. There's still more work to do, especially in the commercial segment, but we're pleased with the progress they have made this year and are encouraged by the momentum and enthusiasm.

Due to the timing of when the higher input costs began to roll through the income statement, we didn't see a lot of impact this quarter from increased steel and other commodity costs. We expect to see more of an impact in the fourth quarter and an even higher impact in the first quarter of 2019, although we also expect to realize higher surcharges in both the fourth quarter and first quarter of 2019.

Expectations for fourth quarter impact of both of these items are incorporated in our revised outlook for the year. Corporate costs increased approximately $3 million compared to the prior year, driven by higher consulting and share-based compensation costs.

Further information on segment third quarter results, including information on segment backlog, can be found in the appendix to the slide deck.

The adjusted tax rate for the quarter was 23.7%. This rate reflected the impact of tax reform in the U.S. Adjusted earnings per share for the quarter was $2.20 compared to $1.84 in the third quarter of 2017. The lower tax rate was the largest driver of the higher earnings, followed by higher non-defense segment operating income. We repurchased 523,300 shares of our common stock in the quarter, and subsequent to the end of the quarter, we repurchased an additional 309,500 shares under a 10b5-1 plan. That brings year-to-date repurchases to more than 2.4 million shares.

Adjusted earnings per share compared to the prior year quarter benefited $0.04 per share from repurchases completed during the previous 12 months. We also refinanced our credit agreement in the quarter, replacing up with a new 5-year unsecured credit facility. In addition, we issued $300 million of 10-year notes and used a significant portion of the proceeds to call our 2022 notes.

Both the new credit facility and the 10-year notes include lower interest rates or interest rate spreads than the credit they replaced.

Please turn to Slide 9 for a review of our updated expectations. We are raising our expectations for 2018. At the consolidated level, we are increasing our estimated sales to a range of $7.6 billion to $7.65 billion, compared to our previous estimate range of $7.4 billion to $7.6 billion. We are raising our consolidated adjusted operating income estimate range to approximately $630 million to $640 million compared to the previous estimate range of $575 million to $625 million. And we're increasing our adjusted earnings per share estimate range to $6 to $6.10 compared to our previous estimate range of $5.40 to $5.85 per share. We're leaving the adjusted full year tax rate unchanged at 23% and reducing the average diluted share count from $75.5 million to $75.1 million to reflect the impact of third quarter share repurchases and repurchases completed to date in the fourth quarter.

At the segment level, we're making the following changes: we're adjusting the access equipment sales estimate to $3.7 billion, the high-end of the previous $3.6 billion to $3.7 billion estimate range. And we now expect the segment's adjusted operating income margin will be 10.5%, the high-end of the previous range. We're leaving the defense sales estimate unchanged at $1.825 billion and increasing its operating income margin estimate to approximately 11.25%, reflecting the continued improvement in operational efficiencies in this segment. We're also leaving the fire & emergency sales estimate unchanged at $1.1 billion and increasing its operating income margin estimate to approximately 12.25% to reflect additional improved operational efficiencies. And in the commercial segment, we're raising the full year sales estimate to $1.025 billion compared to the previous estimate of $975 million, mostly reflecting higher RCV demand. We're raising the adjusted operating income margin estimate for this segment to approximately 6.25%, the high-end of the previous range of 5.75% to 6.25%.

We're also increasing estimated corporate expenses to $160 million from $155 million. And we are reducing our free cash flow estimate from $400 million to $200 million, almost totally to adjust the estimated timing of receipt of payment on an international contract, which we now expect to receive in the next fiscal year. At a high level, we expect flattish sales in the fourth quarter compared to the prior year with higher access equipment in fire & emergency segment sales, offset by lower defense and commercial segment sales. And we expect modestly higher adjusted earnings per share compared to the prior year quarter.

I'll turn it back over to Wilson now for some closing remarks.

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [5]

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Thanks, Dave. Just a brief comment about our team before we go to Q&A. Our people-first culture continues to develop and supports our positive outlook in all 4 segments. Our team is motivated to finish strong in 2018 and is preparing a disciplined approach for 2019. I'm proud of this team and their performance, and I'm confident in our ability to navigate through the coming years.

I'll turn it back to Pat to get our Q&A started.

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Patrick N. Davidson, Oshkosh Corporation - SVP of IR [6]

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Thanks, Wilson. (Operator Instructions)

Operator, please begin the question-and-answer period of this call.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Charlie Brady, SunTrust Robinson Humphrey.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [2]

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Just on particularly on access on pricing and the surcharges you guys have put through and will continue to put through. Are you guys in Q3, where you -- are you even on cost price or will you be that way in Q4? And when you talk about '19, do you expect what you're going to have to do there will put you even? Or is it still going to be a slight headwind against the margin on the pricing and surcharges?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [3]

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I'll take that, Charlie, a lot of -- I guess, a lot of components there. So as you can imagine, when you think about trade policy, tariffs, a lot of moving pieces there. We're still in the process of developing our budget for fiscal '19. But in terms of Q4, largely what we're dealing with is just the strength of the backlog that we had coming into the time when we announced the tariffs. And it's not only in access we have that -- I'm sorry, the surcharges makes that. And it's not only in access it's the same dynamic really in fire & emergency and to a lesser extent, commercial. But as we look at Q4, overall, we think absurd, excluding the backlog that is not subject to the surcharges, we think we've covered. Dialing ahead to fiscal '19 as we think about that, again, we do have some backlog that was in place for Q1 that was not subject to the surcharges when we implemented those. And -- but we do believe that's largely a Q1 situation. So we think it will be largely compartmentalized to that based on what we currently see. And with that, as we look across the -- all the non-defense segments, in total, we think that will be a headwind somewhere in the range of $15 million to $25 million. Again that's all associated, we're just working through that backlog that was in place for Q1 at the time we implemented the surcharges. Look -- certainly take a look at -- as we go through the remainder of the year here in terms of what the landscape is in the way of tariffs and trade policy as to whether we need to make adjustments, but as Wilson commented on the -- in his prepared remarks, as we're thinking about the price increases as we get into the calendar year '19, we are likely looking at larger-than-normal price increases just as we see in the inflation in the input costs. We're certainly still dealing with higher freight costs, et cetera. So -- but it's still a little bit of a moving picture, and we'll continue to update it as we go.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [4]

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And that $15 million to $25 million you referenced, that's Q4?

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [5]

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No, that's Q1 of fiscal '19.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [6]

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Okay. And then as a follow-up on the defense business, the U.K. MoD order for the 2 units to test, is there any sense on timings as to how long that test phase goes through and when they might be able to put through a larger regular order?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [7]

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No, Charlie. That's going to up to the -- from a timing standpoint. We know they wanted to do some testing. I think they're going to look at and may be adding some variance and things like that. So not really a scheduled test time with us. As we've said before, most of the international activity, we expect those orders to start after the full rate production decisions made, which we -- this calendar year into the first part of the new calendar year.

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Operator [8]

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Our next question comes from Jamie Cook, Crédit Suisse.

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [9]

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A clarification first. That you've said the $15 million to $25 million impact from steel in the first quarter. Is that the same number in the fourth quarter? And then my second question the free cash flow cut from $400 million to $200 million. I'm assuming that was defense, and you said you would get it back in '19. But any clarity? Is it early '19 or later '19? And then my last question, you talked about implementing price increases for 2019. To what degree, do you think that, that could potentially, I mean, create a pre-buy? And how you, sort of, thinking about order trends for access and as we progress throughout the calendar year '18?

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [10]

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Good morning, Jamie, it's Dave. I'll take the first 2 and let Wilson address the second one. In terms of the surcharge and the impact from what we're seeing as we said on the call, really, really didn't see much in the third quarter. We think we will see more in the fourth quarter, somewhere, I would say, in that probably $6 million to $8 million range of impact based on how we're currently looking at it, and then it will step up to that $15 million to $25 million into the first quarter of '19. And largely, why you're seeing that is, with the lag effect of the timing of the steel increases coming through, we'll feel kind of the, what I'd call, the full brunt of that in our first fiscal quarter. And then in terms of the change in the free cash flow. Yes, it's a large international defense contract. This is a customer that we've dealt with on a number of contracts. And we have seen them in the past delay or stretch our payments, as we executed this most recent, large contract, they've been performing very well in terms of adherence to the contract terms. But as we got near the end of it, we saw them start to stretch things out, and that's what it appears are doing. From our standpoint, it's just a push from this fiscal year into next fiscal year, regarding is it first quarter? We're working with them on that. We would like to believe that it can be first quarter, but as we've seen them delay here, it's something that we're going to need to stay in close contact with them and encourage them, I guess, I would call it to, get that payment in as soon as they can. But we certainly don't believe it's any issue around if we're going to collect it. It's just a matter of when we're going to collect it.

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [11]

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Okay, Jamie, I'll jump in on the price increase pre-buy question. We have signaled this, you've heard us on the last 2 calls, that we're currently debating, what will our pricing be starting in calendar year 2019. This is our normal process that we go through. I would say that we're taking a real disciplined approach here to better understand where costs are going. And it's not just steel, as you know, there is other material costs, there is freight. There's other things that we have to consider going forward. And, as you know, trade policies is changing on a weekly basis. So we're trying to be real thoughtful on our debate there. We'll start talking to our customers in the next month to 2 months that's, again, the normal process. In terms of will that drive our pre-buy? As Dave mentioned, we feel like through our analysis, we know about what our exposure is on the backlog that's already in Q1. The current surcharges that are in place that are going into Q1, we believe, cover our costs for that quarter. Now we do know our costs are going to go -- increased based on what we're getting from supplier information coming in that would be an effect to us in the -- sorry, the calendar year. So if it drives a little bit of a pre-buy, we'll believe we covered in Q1. Anything now becomes in to access in the form of delivery after January 1, there's a notation on the order receipt that those are -- those orders are subject to our price increase that will be announced this fall. So we believe we're covering that backlog as it does go in to the calendar year. So I think we're in a good shape as we can be in terms of any kind of pre-buy around our upcoming price increase.

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Operator [12]

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Our next question comes from Steve Volkmann, Jeffries.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [13]

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Sorry to keep beating on this, but do you have any backlog in the next fiscal year that goes beyond the first quarter that would, sort of, have this extra surcharge with it?

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [14]

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Yes, Steve. We do have some. And I know there is -- through the planning cycle now that the JLG team is currently talking to some customers just again to plan out their purchasing for the next calendar year, very preliminary in discussions, but we have seen some orders come in. I wouldn't say that it's a significant number, but we do have some.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [15]

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Okay. And then just back to defense for a second. You have, sort of, touched on this, but if we go to full rate production soon. First question may be for Dave, does that trigger any accounting change? Does anything with the program in terms of what we're going to see with numbers change relative to that? Or is that just kind of volume? And then the second question, we keep kind of talking about the potential for foreign orders waiting for that full rate production, but given that that's pretty darn and close, it sounds like we're getting a lot closer to some potential foreign orders there. And I guess, the question is do you expect those to follow on fairly quickly with that full rate production signpost to having get past?

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [16]

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Yes. So, Steve, there -- the full rate production, it's more of a contractual milestone than it is in terms of the actual volumes that are running through our factories. We'll continue to ramp up here, really over the next year to 2 years from a production standpoint. So -- but that is something that we still believe that milestones will be achieved late calendar year. In terms of the international opportunities, there certainly our defense team has been talking with a lot of foreign militaries. There's a lot of interest out there in the vehicle. We've demoed it to a quite a few countries. We are still, I would say, guided by the U.S. government's giving us the green light to accept production orders for the vehicle, the U.K. was kind of a little bit of a one-offs they could do some testing. But we're certainly in a position where we've been more than happy to take those orders, we think there are some that are fairly close in terms of countries making their final decisions. But they're all going to have to wait until we get the green light from the U.S. government.

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [17]

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I think what I would just add there, Steve, is, as you saw the U.K., they came to -- it's a process. They go to the state department to get approval. So that's where you will start to hear when those internationals were getting close to coming to where we actually received them is when the actual state department approvals start to become public. That's were -- that's probably the kind of the box to check that you'll be hearing about.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [18]

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So FRP doesn't automatically trigger that?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [19]

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It does not, no.

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [20]

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Approval.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [21]

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And sorry, Dave, there is no program review or anything that might move the margin once we get the FRP either?

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [22]

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No, we will go through our typical process of looking at the program estimate of completion at the end of every quarter. And then we'll make our decision as to whether we are needing to make an adjustment to the profitability outlook for the program.

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [23]

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I just wanted to make my comment. I can't help myself. I liked your headlines, stronger for longer. And I think that's really kind of where we are. We know there's lot of questions about '19 and we're working through those. But when you look at our defense segment over the next several years, solid foundation and you've got fire & [rescue] in municipal markets, you've got the eventual replacement demand, the cycle that should drive there in access. We're certainly with you on thinking in the long-term. So appreciate that headline.

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Operator [24]

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Our next question comes from Jerry Revich, Goldman Sachs.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [25]

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In access equipment, where your guidance implies year-over-year margin expansion in the fourth quarter. So nice to see that progression. I'm wondering if you could talk about, is it mix that's improving? Is it the production transition gaining traction? Can you just give us some more -- your context? Because as you mentioned price costs still a headwind. So nice to see the improvement. Any color on the drivers would be helpful?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [26]

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Sure, Jerry. The biggest thing that will be a difference, I would say, versus Q3 incrementals is better product mix. When we scrub the backlog to see what the mix in the quarter look like, it is ending up being a more favorable mix. The other thing I would say is, when you look at the price increase that we put in place at the beginning of the calendar year little more traction there vis-à-vis what we were seeing for input costs last year. So that's another year-over-year benefit that we didn't necessarily see in the third quarter. But you're right. And as Wilson pointed out, we're still experiencing a number of the headwinds associated with the ramp-up in production. From the workflow standpoint, the team members that we brought on, that we talked about last quarter, we did see good improvement there. The biggest thing that we're still, I would say, encountering are supply chain constraints, as the supply chain continues to ramp up their production to meet our demands. And we did see a number of situations in the quarter, where they actually -- those constraints shutdown the lines. We think we'll probably continue to see some of that in the fourth quarter, although we do expect some progression. But overall, as you pointed out, we are expecting better incremental margins year-over-year in the fourth quarter.

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [27]

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I think I would just add there, Jerry, too, that JLG, Our whole global procurement team has done a nice job of mobilizing into our supply base and helping there from supplier -- quality supplier development standpoint. We did ramp up quick, and they brought on people fast like we did, too. So we're working closely with our supply chain to get them up to speed.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [28]

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Okay. And then in terms of the order cadence that you expect to play out with the remainder of this calendar year. Any difference versus normal seasonality that we should think about in actual equipment since -- it's unclearly yet, what the industry price increases will be for '19? How do you expect that to impact or the order trends that we're going to see over the next few quarters?

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [29]

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I'll start, Jerry, and Wilson, if you want anything you want to add, please do. But as we said at the end of June 30, the backlog that we had for fiscal first quarter -- excuse me, the first quarter of fiscal 2019 was actually several hundred million dollars better than we were looking at entering into the first quarter of fiscal '18 a year ago. So from that standpoint, we're ahead of the game. You've seen the strong orders earlier in the year. In the first half, orders were up 63%. And when you look at year-to-date through June, there were up 37%. So there's probably going to be a little bit of a moderation. We saw some of that in the third quarter that might continue, but that's just one piece. And then as you look at the normal negotiations, I think we'll kick those off with the large national (inaudible) companies here in the next couple of months. So I don't know if there's we're expecting anything meaningfully different other than the fact that we're -- stronger backlog already for the first quarter, the next fiscal year than we were a year ago.

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Operator [30]

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Our next question comes from Mig Dobre, Robert W. Baird & Company.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31]

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It could be that I'm stating the obvious year, but when I'm looking at order patterns for fiscal '18 and access equipment it looks to me that the pre-buy has already occurred. And now we're talking about meaningfully higher prices that are going to be implemented into fiscal '19. And we've already seen some sequential softening in orders. So I guess, my question is this, based on all your discussions with customers, how confident are you that the market at this point can support these price increases and that demand can remain stable in '19 and maybe even into '20?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [32]

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Well, Mig, you're a little early with that question because, as I said earlier, we're just -- we haven't really started our negotiations because we haven't finalized our pricing for next year. What we know today is -- and I know you follow these metrics very close, but utilization, rental rates, used values, they are all very positive. If you look, there is a good construction outlook. We still see replacement demand as a tailwind. We're seeing broader application of use of access products. So all the key indicators around the market, and I think you've heard the public comments from some of the bigger oil companies their outlook is positive going forward. So we'll know more through these next few months at our next call when we do come out with our '19 guidance. But today we do know there is demand for new machines with the activity that's in front of us. So we're not calling that yet. We have to get through the next several months. And like I said, we'll be talking about that on the next conference call.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [33]

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Well, fair enough. Then in defense maybe there's -- the margin question there a little different. It clearly looks like next year you're going to have higher revenues, your backlog is up, you got orders. Is there any reasons at this point to think that margins should look different next year versus this year on a revenue increase?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [34]

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Mig, what I would point you to is, what we've pointing people to for some time now when we go back really to the Analyst Day and what we said there a couple of years ago is -- and we were talking about top end or sales of $1.7 billion to $2 billion. We do think we'll be at the high end of that range, probably into the next fiscal year. We also talked about margins in high single digits. What you're going to see next year is a continued transition to a higher percentage of JLTVs. And with that, I think you're going to see based on how we're thinking about things today, those margins tend or trend back towards that high single-digit range that we laid out at the Analyst Day at the end of '16. So that all seems to still be squaring up, certainly we'll continue to look at the margin on the JLTV. And if we come to a decision that the margin there needs to change that certainly could impact that, but it's based on what we know now. I would still guide you toward that high single-digit range.

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Operator [35]

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Our next question comes from Mike Shlisky, Seaport Global Securities.

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Michael Shlisky, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [36]

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I have a defense question as well. At this time last year, you gave a number you said to us what was the backlog sign for fiscal '18 as of July of -- I guess, was early August of 2017. Do you have that current number today? So what's been signed? What you have in your backlog in defense that's planned for delivery in 2019 at...

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [37]

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Sure. As we exited June, Mike, that was about $1.550 billion -- $1.55 billion.

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Michael Shlisky, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [38]

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Okay. Perfect. And then secondly on commercial, from a margin standpoint this was your best quarter, I think in like 5 or 10 years, 8.6%. Can you give us a sense as to -- is the range of margin in this segment now permanently gotten better? Do you feel like what you've done to restructure has been successful? You haven't really gotten much about on an annual basis 7%, the last 5 or 10 years. But at this point, are you back above that kind of 7% annualized run rate going forward?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [39]

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Well, as much as I would like to say 1 quarter makes a year that's isn't necessarily the case. We're certainly pleased with the performance in the commercial segment this quarter, Mike. I thank a lot of this is -- it's still a work-in-process there. When you look at what we're doing in terms of simplifications, the product platform teams that have been established earlier this year. And we're starting to see some traction from that. We did benefit from a more favorable mix in the quarter than we had seen there was also some timing of spend that benefited us a little bit there. But Overall, our expectation is we're going to see improved margins in the commercial segment. We've talked in the past, and we've talked for a long time about double-digit margins at least for that segment, and that's our goal. We are executing some of the same playbook that we executed in the fire & emergency segment. You've seen how it's been successful there. We believe it can be successful in the commercial segment as well. So I think we would be disappointed if we didn't see continued margin improvement out of that segment. But I don't think I'm ready to call that we're going to see 8.5% margins quarter upon quarter at this time.

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Operator [40]

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Our next question comes from Courtney Yakavonis, Morgan Stanley.

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Courtney Yakavonis, Morgan Stanley, Research Division - Research Associate [41]

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Just a quick clarification on the price increase you guys are contemplating. How should we think about that either replacing the surcharge for fuel or the fuel surcharge kind of rolling off over the next year? But I think we had commented that a lot of this is due to other additional costs like freight, et cetera?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [42]

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Courtney, that's a good question. We're -- that's part of our debate now. In the past, we've had surcharges that we kept in place, in that way when things did moderated, go back to a more normal level, we could pull the surcharge back. So that's part of our debate now is determining what would that level of surcharge be, and then what is the additional price increase needed to cover the other material costs, the freight, the other issues that we've talked about. So I think today the way we're dealing is to keep a surcharge in place, so we can eliminate that for our customers when and if that raw materials come back in line. But I guess, I want to keep ourselves open a little bit because, again, we're still doing a lot of analysis around that we're still waiting for some of our other supplier partners to come in and talk with us about '19. So I guess, today, I would say we're leaning that way, but we'll be telling you a lot more about that in the next call.

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Courtney Yakavonis, Morgan Stanley, Research Division - Research Associate [43]

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Okay. Great. And then just another clarification on the access margin rate, I think last quarter you have lowered it through a combination of some of the labor inefficiencies and then also customer mix and material costs. When you think about the race back to the high-end of that range now, was it mostly customer mix that's causing that, I think, you kind of answered that in response to Jerry's question or was it something else?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [44]

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No, I think, well, Courtney, we're at the high-end. I would tell you just tightened the guidance to the prior high-end. Overall, like, performance in the access equipment segment in Q3 was largely in line with what we're thinking and the full year outlook there other than getting to the high-end of that range really hasn't changed much.

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Operator [45]

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(Operator Instructions) Our next question comes from Seth Weber, RBC Capital Markets.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [46]

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Just going back to the defense margin dynamic, again, for a second. Dave, you may have addressed this to an earlier question. But so the implied margin for the defense business for the fourth quarter is lower, again, sequentially even though revenue is higher. Is that a function of more JLTV or is there something in the mix over the last couple of quarters that kind of goes away here in the fourth quarter?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [47]

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I -- Seth, I would say there's a couple of things there. One, we have our annual shut down over the 4th of July in that segment so that from a -- from just a production and an absorption that's a little bit of a drag sequentially versus Q3. Also there is some spend timing on discretionary spend that is more heavily weighted this quarter or into the fourth quarter than in the third quarter. And then the last thing I would say is, we are starting up another facility, which -- there is some cost associated with that, that we'll be incurring in the fourth quarter.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [48]

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That's helpful. And then going back to your full rate or your -- sort of your production ramp commentary earlier. Is 3,000-ish units still a good way to think about FY '19 for the JLTV? Or could you -- do you think you can get back to be above that at this point, given your prior comment about year-end full rate levels?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [49]

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It is -- I'm thinking in terms of dollars not units. And I'm kind of looking at we must have had here. See if he's got the units, but certainly...

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [50]

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It's been 3,000 kind of approximate rate that -- approximately 3,000 from '18 has been our guidance.

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [51]

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So with that -- so that would be a meaningful jump over fiscal '18 levels?

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [52]

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Right. But you still -- that's where you're at, but still you're not moving off that number at this point?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [53]

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Not at this point.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [54]

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Okay. And then maybe just on the access side, you called out some relatively good trends in international markets, is there any color why you would anything you would call out there regions or product, in particular?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [55]

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Yes, Seth. I think we've seen more stabilization in Europe, which has been good. The big jumps have really been Asia Pacific, primarily China. We're seeing further adoption of our products there. We've got some -- what I would call sophisticated real companies that have gone in and serviced themselves in that market. So those are probably the 2 that stand out the most.

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Operator [56]

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Our next question comes from Stanley Elliott, Stifel.

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Stanley Stoker Elliott, Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst [57]

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A quick question on the fire & emergency business. Certainly, the margin profile and progression continues to be very good. When we think about '19, or would you guys care to update the margin kind of targets within that business? And then maybe kind of frame that on the context of some of the longer -- or some of the international orders that you have, what that does to the margin profile into next year?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [58]

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Stanley, we'll give you a big A for effort there on trying to get us to call '19, doing a good job. But we're not going to -- about '19 as far as margins and things like that. I will complement our fire & emergency team because they continue to really work through this transformation and simplify their business. They are reducing complexity, doing a good things inside the business. But now you're starting to see transfer and working on commercial segment. We've said at the start of this year, they had a couple of 100 basis point jump year-over-year last year. And we signaled that although we'd love to see that every year, we don't expect that every year. So they're going to stay the course here and continue to work and improve margins as they can. International orders to your question, does that offer some upside. In some cases, those situations are highly competitive. Others, they are products that we have good intellectual property and patterns around and it provides us some margin enhancement opportunities. So tough to dial-in on exactly which international orders will have in the mix for '19 and the margin profile there. But something that we'll definitely be talking about through '19 with you.

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Stanley Stoker Elliott, Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst [59]

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Perfect. Now that has been a fantastic part of the story. And then secondly kind of switching gears to the defense business, a lot of the news flow around NATO allies and then kind of their allocation to defense spending, have you all seen. I know that the JLTV has been very successful from in terms of demoing an interest, has that interest picked up post that -- post those headlines, just more curious directionally.

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [60]

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No, Stan, I would just say interest has been good. We continue to have some of our allies that are coming in and taking a look or doing some trials. So I think our outlook for international is similar today as it was 3, 6 months ago. It's very positive. Something that's going to be as you said, a good story that we believe that's going to be a really good story in the next several years.

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Operator [61]

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Our next question comes from Gilardi Ross, Bank of America Merrill Lynch.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [62]

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So I just want to understand and for -- and the first free cash flow ended fiscal '19. So what's the chance of an outsized free cash flow year, next year. I mean, any big puts and takes to consider. Is there an earnings or EBITDA conversion to free cash rate that you point us to help us think about next quarter. Could you gotten additional $200 million that's getting pushed into -- in the next year and your business are still growing, obviously?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [63]

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Ross, that's the biggest outsized driver that I -- immediately comes to mind is just the push of that large payment on the international defense contract. I would think about the other businesses. It's still early as Wilson said. So we'll be putting the model together for that. But I don't really see any significant changes in terms of the dynamics around or thinking on DSO or inventory turns or anything like that in the rest of the business.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [64]

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Okay. Thanks, Dave. And then just on the production challenges in access, can you just talk about that a little bit more I mean, is it a -- are these component issues or you've got any trouble getting engines, is it a headcount issue or kind of all the above?

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [65]

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Yes, Ross, the production challenges started with that big first half we had. And -- Q1, we got that. We thought (inaudible) would moderate a little bit Q2, they didn't. That caused us additional hiring ramp. At the same time, with this time of demand, we're driving that demand into our supply chain. So they are ramping up. I think we were probably 2 may be 3 months ahead of some of them and our ramp-up of people. So our people challenges are certainly starting to subside and get in our internal efficiencies back and where they need to be. Some of the different components, it's not been anything one specific big item I would -- I could share with you, there's been a lot of smaller component issues that even it's a small component, it can cause some major product disruptions on your lines. So that's where we've deployed our supplier quality and supplier development folks and to help some of the smaller suppliers really get up to speed and help their people get up to speed a little quicker. That's nothing that I would say it's just 1, 2 or 3 things, it's been a multiple of things, but I will say that our team at access is handling very well.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [66]

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Unemployment is still low in Wisconsin, I mean, how are -- even obviously, it sounds like you have been able to hire people, but are you seeing wage inflation pick up pretty materially or are you able to contain that somehow?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [67]

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Well, so we expect some wage inflation over our whole business area. In terms of what's constant, you're right. Unemployment is very low here. We'd talked before about access to skilled labor is going to be one of our big issues going forward. I'll see this to our team. I'll call it up Ramsays kitchen sink because we're throwing everything at it in terms of working with the technical schools, we're doing quiz programs with the high school. We have a school-to-work program in our facilities now, where they actually teach 4 hours of high school classroom and then they work 4 hours in our business. A lot of military recruiting for us. So -- and then you couple that, which is the up skilling opportunities we've had. We've been successful in getting some grands to help us on the similar learn the skill of well-being or learning the skill of the coming electrician. So there is a lot of that going on. I think it's a case where we got to keep working at that because most of the areas where our facilities are is -- that unemployment is very low and then when you look at what is available, there is not a lot of skills -- right skills available. So you have to take those into your own hands and train for those.

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Operator [68]

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Our last question comes from Steve Barger, KeyBanc Capital Markets.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [69]

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Just a quick follow-up on the production. You said some supply chain constraints shutdown the AWP lines. Here you still put up a record quarter. How many days did you miss? And did you make that production up with over time or did those deliveries push them to 4Q?

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [70]

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It was -- it wasn't a significant number overall. Steve, so I don't want to leave you at that impression. But it was a handful of times during the quarter when lines were down. In terms of dealing with that, you touched on it, it was really increased over time. We tried to make up for that. So just if you look at the whole full year revenue guidance, we just ended up at the top end of the range. So it wasn't necessarily a push out of the year or anything. So I think we're able to effectively manage it from the top line, but it does cause some challenges when you have those constraints pop up from a production standpoint.

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David M. Sagehorn, Oshkosh Corporation - Executive VP & CFO [71]

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I think where we really want to get to, Steve, is the cadence now of supply chain hitting their teams up to speed like our team is up to speed. So the next year all these issues are behind us in terms of manpower, trained labor that can build and deliver these products.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [72]

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Yes. As those constraint sees and you think about the price and mix in your backlog? And what you see for FY '19, any thought on what the upper limit of capacity could be on a dollar basis for an AWP quarter?

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [73]

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Upper limit for a quarter. In fact, we probably haven't gotten that, that granular on it. What we have is, we certainly could support additional demand without significant investment in brick-and-mortar in that segment. We are running at 2 shifts in most areas. But if you think about the efficiency picking up, that should free up some excess capacity in the future.

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Operator [74]

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Ladies and gentlemen, we have reached the end of the question-and-answer session. And now I would like to turn the call back to management for closing remarks.

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Wilson R. Jones, Oshkosh Corporation - President, CEO & Director [75]

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Thanks, operator. Thanks all for joining us today. We look forward to speaking with you at the conference on our next earnings call. We appreciate your interest in the Oshkosh Corporation. Thank you.

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Operator [76]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.