Parker-Hannifin Corporation

Good day, ladies and gentlemen, and welcome to the Parker Hannafin Fiscal 2019 Second Quarter Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be provided at that time. Should anyone require operator assistance during today's call, please press star then zero on your touchtone telephone. I'd now like to turn the conference over to the Chief Financial Officer, Kathy Siever. Please go ahead.

Thanks, James. Good morning. Welcome to Parker Hannafin'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 two, 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 three. 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 of fiscal 2019. Tom will then provide a few summary comments and will open the call for a question and answer session. Please refer now to slide number four. Tom will get us started.

Thank you, Kathy, and good morning, everybody. Thanks for your interest in Parker and your participation today. So I want to start by first highlighting Parker's business model, which Kathy mentions on slide four, 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 would 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 of 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 four or more of those technologies. We make engineered products. About 85% of our products have some kind of elemental property wrapped around them. Our products have long product life cycles, which is a great thing. We're balanced between OEM and aftermarket. And to support this business model only requires low operating CapEx requirements, which is very 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. My thanks to everyone for their efforts on owning safety, the leaders and all the team members of the company. And I would just remind shareholders there's a very close linkage between safety performance and financial and customer performance, and you can see that linkage as we improve 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 FY19, as well as the FY23 five-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 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 was very close to our guidance, spot on. Order rates moderated. It was a 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 U.S. tax reform of $14 million. In segment operating margins, again, was a record 16.4% as reported. This compares, if you 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 to 50 basis points, some nominal type of beat. The fact that we beat this by 200 basis points is very significant. We almost never do something like that. That was remarkable. And of note is that this includes the Clarkor 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 the total company were 16.6%, which was up year over year 170 basis points versus Q2 of FY18. Aerospace had another great quarter. making three straight quarters with margins over 19%. A great job by the 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've done is we've built a long-cycle, high-performing business that we're excited about now, and we're excited about where the future is going to bring for the aerospace business. On an as-reported EBITDA standpoint, EBITDA margins were up 120 basis points to 17.0%. or 17.2% on an adjusted basis. So I've 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 wind strategy and the execution the team's doing on that, the productivity that we demonstrated in the plants and the plant closures improving there, and supply chain optimization. Cash flow, switching to cash, was strong. We expect to exceed 100%. Free cash flow conversion and operating cash greater than 10 percent of sales for the fiscal year. This would be excluding discretionary pension contribution. And then on share repurchases, we bought a total of $500 million in Q2. This was made up of a discretionary repurchase of $450 million and our 10 program repurchasing $50 million. So now switching to the outlook, we're increasing EPS guidance by 9 cents at the midpoint to $11.29. This is on an as reported basis. And we're increasing at $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 wind 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 in performance, and the underpinning of that is the wind strategy. What really gives us a lot of confidence is that we're still in early days of the wind strategy performance, and I'll just highlight a few opportunities there The first is our whole high-performance team process, which is all about creating an ownership culture of the companies. As you have owners evolve and continue to care more and drive more engagement, you're going to see performance improve right 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 manage any 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 FY23, 2023, that we communicated in last year's Investor Day, And just as a reminder, what those are, to grow organically 150 basis points faster than the market, this would be over the 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 FY19, and we're making good progress towards our new five-year targets. And with that, I'll hand it back to Kathy for a more detailed review on the quarter.