Parker-Hannifin Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Parker Hannafin Corporation first quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference to your speaker today, Kathy Seaver, Chief Financial Officer. Please go ahead, Madam.

Thank you, Joelle. Good morning, everyone. Welcome to Parker Hannafin's first quarter fiscal year 20 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 materials and are also posted on Parker's website at phstock.com. Today's agenda appears on slide number three. We'll begin with our Chairman and Chief Executive Officer, Tom Williams, providing highlights from the first quarter. Following Tom's comments, I'll provide a review of the company's first quarter performance together with the revised guidance for the full year fiscal 2020. 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 four and Tom will get us started.

Thank you Kathy and good morning everybody and welcome to the call. We appreciate your interest in Parker. So let me start with the first quarter highlights and I'm going to start like I normally do on safety. We had a 25% reduction in recordable safety incidents year over year, which is a great start to the year. When you look at it from a safety incident rate, so for those who aren't familiar with this, this is the number of safety incidents per 100 people. We came in at 0.46, which is a top quartile number. Top quartile happens to be 0.5, so this is the first time in the history of our company that we came in at a top quartile for an incident rate, so we're very proud of that. Safety for us is a core value, and zero accidents is not an aspirational goal. It's really an expectation that we're going to operate the business and lead the business in such a way that we're going to drive a zero-accident culture. And as you've seen, there's a very strong linkage between safety and business performance. And you can see that if you look at our numbers over the last several years and plotted safety and our financial improvement, you'll see that they went hand in hand. So switching to financial results, Q1 was a strong quarter on margins and on cash against a challenging macro environment on sales. Sales declined 4%, and that composition was a minus 3 organic, minus 1.5 on currency, and a plus 0.5 on acquisitions. Total segment operating margin remained level at 17.0% reported. Adjusted segment operating margins increased 10 basis points to 17.3. On a reported basis, EBITDA margin increased 70 basis points to 18.4, and adjusted EBITDA margin increased 110 basis points and reached 19.1%. So really when you look at it, operating margin or EBITDA margin, really excellent performance at this part of the cycle. EPS reported was $2.60. On an adjusted basis, it was $2.76. We had a very strong quarter on cash flow. Cash flow from operations came in at 13.5% of sales. We had a record as far as cash flow from operations in terms of dollars at $449 million. And free cash flow was 12.0%. And when you look at free cash flow conversion, that was 118%. So really, really strong quarter on cash. We had a number of exciting announcements in the quarter. We launched Wind Strategy 3.0. So that's the third revision of the Wind Strategy. This follows the second revision we did in 2015. And we launched a new purpose statement for the company. And we closed the Lord & Exotic acquisitions. So we've been busy in the quarter. And we're really excited to welcome the Lord & Exotic team members to the Parker team. The joint integration teams have been working hard in preparation for the closings, and they're hitting the ground running as we speak. As you heard me talk about, the acquisitions are transformational to Parker's portfolio, really strengthening engineering materials and aerospace with high growth, high margin businesses that will definitely be more resilient over the business cycle. Our global Parker teams are very energized by all these announcements between the wind strategy, purpose, and these acquisitions, so we're excited about the future. Now switching to the outlook. Revised guidance for FY20. We've seen a market shift within the last 90 days. It's reflected in weekend order entry. Primarily driven from macro conditions and trade uncertainties. So when you look at total sales for Parker and FY20, they're expected to be flat year over year at the midpoint. With guidance now, these are all midpoint numbers at minus six organic, minus one for currency, and plus seven on acquisitions. Segment operating margin guidance is now at 15.2% as reported. at the midpoint, and the adjusted midpoint is now 16.3%. I would just call to your attention there's two important impacts on there. When you look at it from a partial year is the amortization of the two deals. From a partial year standpoint for FY20, that impacts us by 70 basis points. When you look at it in a full 12 months, there's 100 basis points of deal amortization as a headwind on margins. Business realignment expenses are expected to increase to $40 million. This is reflective of the current macro conditions. This was $20 million in the prior guide. And, of course, our guidance now includes lord and exotic metals forming for the balance of the year. And we'll go through discussing markets and the guidance assumptions in more detail during the Q&A. So let's switch to cash flow and margin resilience. So hopefully you saw on the cash flow numbers in my comments just a moment ago, cash flow was very strong, record numbers. And then when you look at the operating and EBITDA margin performance, and I'm going to compare it to 2015 and 16. So the last downturn we experienced, I'm going to look at this legacy partner without acquisitions that allows us to do apples to apples comparison. So FY16, which would have been the worst year in that downturn on a adjusted operating margin was 14.8%. And then FY20 guidance is 16.6% at the midpoint. So when you look at that delta, That's an improvement of 180 basis points. On adjusted EBITDA and FY16, it was 14.7%. Our current guide at the midpoint is 18.2%. So that's a 350 basis point improvement. So clearly, raising the floor on margins when you compare the 15, 16 downturn to what we're experiencing now. We fully anticipate to do double digit cash flow from operations for the full fiscal year, like we've been doing for the last 18 years. And really this performance is driven by a combination of factors. The new wind strategy which we introduced in 2015 is propelling our performance. All the previous restructuring activities we've done which has positioned us to be a more agile and lean operating company. So let's move to slide five and talk about the future. We're very positive about the future. And I think we are absolutely poised to generate nice earnings growth after we clear these near term macro conditions. A couple things influencing our confidence on the earnings potential. Wind strategy 3.0 and the purpose statement represent some important changes for the company. Plus, we've added two great businesses via these acquisitions. And actually, in my view, the timing of these acquisitions couldn't be any better during the soft part of the cycle. There's clear advantages here. We have the capacity to digest these much easier than when we were digesting Clarkor as we were trying to ramp up the base business as well as digest Clarkor. And when you look at the timing, when you look at the integration teams hitting their stride, it's about the same time the markets will start to turn for us, you know, approximately nine months. And both of those factors will drive earnings growth as we look into the future. We're going to be hosting an Investor Day, March 12th of 2020 in New York City. And during that Investor Day, we're going to showcase One Schedule 3.0 and the purpose statements to give you a lot more color on the key strategic changes for the future. We're going to highlight all six operating groups. In the past, we've highlighted one group. Last time, we highlighted three groups. For the first time ever, we're going to give you insights of all six groups. You'll see the entire company. We'll go through the three last acquisitions, Clark, Orr, Lord, and Exxon. Just a quick reminder, which is on this page, that you see the winning formula for Parker, our competitive differentiators. The win strategy, now 3.0, the third revision of that, which is Our business system, you couple that with our decentralized divisional structure. In my view, that's the best of both worlds. You get a centrally-led business system that's deployed locally with that closeness to the P&L. The breadth of our portfolio technology is very interconnected. Strong intellectual property, long product life cycles, very balanced between OEM and aftermarket with the best distribution channel in the motion control space. Low CapEx requirements to actually generate growth and productivity. And all this ends up culminating in being able to generate a lot of cash and being able to deploy it on the best behalf we can for our shareholders. So we have a lot of confidence in our ability to achieve the FY23 financial targets. I just want to thank all the global team that's listening in for their hard work, their continued and dedicated effort, and I'll hand it back to Kathy for more details on the quarter and the guidance.