Parker-Hannifin Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Parker Hannifin Fiscal 2020 Second Quarter Earnings Conference Call and Webcast. At this time, all participant lines are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during this session, you will need to press star, then 1 on your telephone keypad. Please be advised that today's conference may be recorded. If you require any further assistance, please press star, then 0 to reach an operator. I'd now like to hand the conference over to your speaker today, Ms. Kathy Siever, Chief Financial Officer. Please go ahead, ma'am.

Thank you, Liz. Good morning, and welcome to Parker Hannafin's second quarter fiscal year 2020 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 second quarter. Following Tom's comments, I'll provide a review of the company's second 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. Good morning, everybody, and welcome to the call, and thanks for your interest in Parker. Let me start with some strategic highlights, first of all, and we are very pleased to report that despite challenging macroeconomic conditions, our margins and our cash flow are at all-time highs relative to previous downturns. I think the best way to compare this, the best way to do it apples to apples, is look at the base business without lowering ZOIC, and compared to prior downtrends. When you look at our second quarter FY20 adjusted operating margin without acquisitions, that came in at 16.1%. This compares to our previous best recession performance, which was in FY16, and that Q2 adjusted operating margins were 13.5%. Both of these recessions had about similar organic sales declines, and this represents a 260 basis point improvement, comparing that to our best previous recession performance. Really remarkable performance and really my thanks to everybody around the world for doing such a great job. In addition to the margin improvement, cash flow from marketing activities was an all-time year-to-date Q2 record. This performance demonstrates that we are building a more resilient business that is poised for accelerated earnings growth as the market returns. Strong FY20 margin performance and cash flow generation so far are really a reflection of the improvements driven by the WIN strategy and the strengthening of our portfolio by buying companies that are creative to growth and to margins. So we are excited about where we are, and we're excited about where we're going to go in the future. Shifting to safety, we had a 25% reduction in recordable incidents in Q2, really making great progress there. My thanks again to everybody for their effort on this and their dedication to safety. Our recordable incident rate, and what that is, for people that aren't familiar with it, that is the number of safety incidents we have for 100 team members. That is now top quartile versus our proxy peers. And there's a very strong linkage, you've heard me talk about this, between safety and business performance. If you were to plot our safety metrics and our financial metrics, you'll see them moving in tandem in a positive direction. So some summary comments on Q2. Sales were our second quarter record as acquisition revenue offset soft organic sales. Organic sales declined as we expected with improvement in international organic sales versus our guide. The 737 MAX issues impacted our aerospace business. as Q2 airframe and engine orders were slowed in advance of the production pause. Strong adjusted EBITDA margins were significantly higher than they were during the last recession. We came in at Q2 adjusted EBITDA margin of 18.5%, again, really strong performance. Earnings in the quarter were excellent, and adjusted EPS exceeded expectations. Order rates in the quarter continued to be negative, impacting organic growth, and the portfolio additions that we have made are certainly going to help our organic growth over time, We've acquired businesses that are more resilient with higher organic growth rates than Legacy Parker. We're well positioned for excellent performance in the second half of FY 2020 and beyond that. I want to move now to year-to-date cash flow. You've heard me talk about how this is such a strategic priority for us. We want to be great generators and employers of cash to drive excellent returns for our shareholders. We've achieved the best ever cash flow from operations of any first half in our history. And given the current market conditions, that's really commendable. Free cash flow to sales is above 10%, and we're expecting to achieve our 19th consecutive year of cash from operating activities as a percent of sales in excess of 10% for FY20. The year-to-date free cash flow conversion was excellent at 130%. Moving now to the outlook, we're increasing EPS guidance for FY20 on roughly flat sales to the prior year. This reflects strong Q2 performance, which is being offset by the 737 MAX. and slightly weaker organic sales in the second half versus our prior guide. Our guidance assumes no additional 737 max sales for the balance of FY20. We are very excited about the future. We feel we're well positioned for growth with excellent margins and cash flow as the macro conditions improve. Some of the factors that are driving this feeling of confidence would be, first, launching of the one strategy 3.0, which is going to drive a further step change in the performance of the company. really building on the momentum from the previous updates that we've made to the One Strategy. Second would be the portfolio strengthening that we've done through the strategic acquisitions that have come on board. We're very happy with how Lord and Exac integrations are progressing, and we can comment more about that in the Q&A. And we recently had the leadership teams from both businesses here at headquarters talk about incorporating the One Strategy 3.0, their integration plans. It was a great session, a lot of good teamwork there. And then third would be the launch of the purpose statement, which is enabling engineering breakthroughs that lead to a better tomorrow. This statement is a real source of pride for organization, and we recognize that it takes being a top quartile performing company to live up to that higher purpose. Parker is transforming as evidenced by the higher level performance that we're doing in a very difficult part of the business cycle with lots of opportunities to drive earnings growth beyond FY20. Switching to the next slide, you'll see a reminder of our winning formula, what we've characterized as our competitive differentiators. And I've talked about these before, so I'm not going to say highlight each one specific. I would just tell you this listing in aggregate is what makes us special. This is why customers come to us, and this is why shareholders should think about investing in Parker. If I had to reference one in particular of these competitive differentiators, I would point out one strategy 3.0 and what we're the momentum and the performance enhancements that it's going to create over time, and a lot more discussions will happen on that as we move forward. So my thanks to all the global team members for their continued and dedicated effort in creating a top quartile company. With that, I'll hand it back to Kathy for more details on the quarter and the guidance.