Parker-Hannifin Corporation

Ladies and gentlemen, thank you for standing by, and welcome to Parker Hennepin's Fiscal 2020 Third Quarter Conference Call and Webcast. 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 over to your host, Chief Financial Officer Kathy Peer. Madam, please go ahead.

Thank you, Lateef. Good morning. Welcome to Parker Hannafin's third 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 material's 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 comments on the current environment and related actions we've been taking. Tom will then discuss highlights from the third quarter. Following Tom's comments, I'll provide a more detailed review of our third quarter financial performance. Tom will then provide a few summary comments, and we'll open the call for a question and answer session. We'll do our best to take all the questions we can today. Please refer now to slide number four, and Tom will get us started.

Thank you, Kathy, and good morning, everybody. Thanks for your participation today. Before I get into slide four, I just want to first extend our thoughts to all those who have been affected by the crisis, and our deepest sympathies go out to those that have lost loved ones as a result of the virus. A special thank you to all the health care professionals for their courageous efforts around the world. And I'd also like to thank all the Parker team members for their dedication and their support and what we have done in our own small way to help society through this crisis. I'll elaborate more about that later on in the presentation. So this is unprecedented times, and that's a word that's probably overused, but very appropriate given the uniqueness of having a combined health and economic crisis. So on slide four, our performance and our strength for both of these crises really comes from the wind strategy, which is a proven operating system, and we're now in our third and very powerful revision of that, a portfolio of products and technologies that are needed. And this has never been more evident and important in today's climate. We make things that the world absolutely needs. Our culture and our values, which is why people join and stay at Parker, And our purpose, which has been our North Star, and I'll talk more about the connectedness of our purpose to our actions later on. And we have an engaged team of people. We have top quartile engagement scores, and if you couple that with our decentralized divisional structure, that is what has enabled us to move at the speed and agility that you've seen during this crisis. So on slide five, our crisis management strategy is really threefold. First is the safety of our team members and their families. Second is how do we help society through this crisis? We are essential, and I'll talk to you more about why we are essential, and that we want to emerge stronger than ever before after the crisis is over. We have utilized a crisis response management team, and that structure we have in every key country, and we have it for corporate as well, and their focus has really been on the health and safety side of things. We've had a daily cadence with that team seven days a week, really since this all started in January. I wanted to make a comment about how the executive team has been functioning. So the executive team, say the top 20 executives in the company, have still been coming to the office, and we maintain physical distancing and do Zoom conferencing and all those type of things, but it's very advantageous to have us co-located so we very quickly can see each other, make decisions. That's been a key enabler to our speed and decisiveness as well. On slide six, we'll talk about the health and safety actions. They've been early and they've been decisive. They've been patterned off of the CDC and the WHO, as well as lessons that we've learned from China. And this is a list that you probably are familiar with as you've listened to other companies. I won't necessarily go through each one of these, but I would just point to we were early on with travel restrictions and we were early with cancellation of in-person meetings. And I would highlight two examples. First, ConExpo. We were probably one of the first companies to withdraw from ConExpo, which is a very important show. So that sent... a very strong message, I think, to everybody in our space as well as our people, the importance of what we wanted to do here, protecting our people. And then we were an early adopter of the Virtual Investor Day, which all of you were a part of, and we thought that was very successful. Not as good as in person, but it was very successful, and it was a smart move to do that. So the takeaway on this page, the governing message to all of our people has been this takeaway, that we wanted the two safest places for our people to be at work and at home And we're going to do everything humanly possible to make sure that that happens. So I mentioned that we were essential. And on slide seven, I just wanted to highlight some examples of our purpose and action. And I'm going to go through these just real quickly. But our products have helped society through this entire crisis. If you look at food supply, we have products from the farm all the way to the point of use in retail, helping patients, whether it's emergency transportation on a helicopter or on hospital beds. And we are an essential manufacturer, but we're also helping other people that are essential manufacturers. That little picture that you see in the upper right-hand corner there is a picture of a typical manufacturing plant with the roof off of it. And I would tell you that we are in almost every manufacturing plant around the world helping people make their products. So those eight motion control technologies you see in the lower right are being put to use to help society. And if you go to the next page on slide eight, A couple more examples, transportation, whether it's heavy-duty truck or air freight to give products to customers, power generation for electricity. We're on traditional as well as renewables. And I think the best example and the poster child of this crisis is really the ventilator. We do a fair amount in health care, but the ventilator in particular, we have almost doubled our sales in this calendar year of 2020, and we have six of our eight technologies on the ventilator. And we've been supporting new technologies. and existing customers as well as countries from around the world. And the divisions that have been doing this have just done a herculean job staying up with customers and just a fantastic job. My compliments to all of them. So the next slide is our purpose statement, enabling engineering breakthroughs that lead to a better tomorrow. We released this last September, and I can tell you we probably never envisioned how positive an impact it's had on our people, and it really has become a rallying cry. for our organization through this crisis. And it illuminates, I think, the purpose and what we bring to society and gives a great deal of meaning for our people and what they do day in and day out. Moving to slide 10, a quick snapshot of facility and supply chain status. And you go to that middle column, just did the major regions and total parker. So this is percent capacity versus pre-virus, using pre-virus as 100% as an example. We're virtually back to normal at 97%. There was obviously a lot of things that went on through the quarter and in April with stay-at-home orders and all that that moved this up quite a bit. Our supply chain strategy on the right-hand side has done great and very effective during a crisis. You've heard me talk about this in the past, but we make, buy, and sell in the region for the region. We've also got a very robust supply supply chain risk mitigation strategy that we've been doing for years, well before this started. So we're in very good shape on that. This is a non-issue for us. Moving to 11, I want to talk about the quarter. And I would just, if I had to summarize, I would tell you this is probably one of the best quarters that we've ever done, given the environment that we're in. It was really just remarkable performance by the team. Starting with safety, we had a 27% reduction in recordable incidents, And that yields, when you look at reportable incident rates, so that's the number of safety incidents per 100 people, we're a top quartile company, which is fantastic progress. Sales were flat year over year. Acquisitions all set to decline. We had an organic end currency. But the margins really were stellar. They really stood out. So we've got two categories here. Without acquisitions, and I would call your attention to the adjusted segment operating row, and you see we came in at 17.3% for the quarter last year. versus 17.2% in FY19, same quarter. So 10 basis point improvement, 16% decremental. And remember, this is on about a 7.5% organic decline. So just fantastic progress by the teams to pull that off. And then when you put acquisitions, it's easier to look at EBITDA to make it apples to apples. If you look at EBITDA margin on an adjusted basis, that last row, you can see we came in at 19.3%. so a 60 basis point improvement versus the prior period. And this speaks to two things. One, the base business keeps getting better and is performing better, and we acquired companies that have accretive EBITDA margins to Legacy Parker, which is helping fuel that margin expansion. One more page on highlights for the quarter on slide 12. Our EPS performance, as you saw, was very strong, exceeded expectations. We had a record Q3 year-to-date cash flow, so records mean a record in the history of the company of $1.3 billion, which was great. The CFOA margin was 12.3%, and the free cash flow conversion rate was 122%. We were very pleased with our debt reduction of $611 million. That was a very nice reduction. That helped reduce our leverage from 4.0 to 3.8 when you look at it from a gross debt to EBITDA. So you can see from these two slides and how the quarter went, we performed extremely strong. So we're going into this pandemic in a very strong financial position. So on slide 13, we have the order rates. And this is traditionally in Kathy's section, but we wanted to pull it up earlier to allow me to talk about April. Just a reminder on this page, industrial orders are a three-month year-over-year comparison, and aerospace is a 12-month year-over-year, rolling 12-month year-over-year comparison. and excludes acquisitions and currency. But I think the next, so you can see what happened there a little bit better, driven primarily by international, but it's probably a little more illustrative if you go to slide 14, where we talk about April in particular. But I just want to emphasize that while Q3 got a little better, there was a distinct drop, and we felt it in March, in the middle of the month. So on a daily rate basis, you've got to remember that the prior site is three months rolling up, When you look at a daily basis, we were clearly feeling this in March already. And so that was impacting us. The pandemic was declared March 11th, and we had IR Day on March 12th. And I think just as soon as the cameras stopped rolling, the stay-at-home orders started up pretty much around every country around the world. China had already started that. And so what you're looking at this page is a 112, not a 312. So this is April, month of date 12. versus April month-to-date of the prior period. Again, it excludes acquisitions and currency. The month hasn't closed, hence why we have ranges on here. And orders were clearly influenced by those stay-at-home orders that I referred to and extensive customer plan shutdowns that happened through the month of April and started in March, for that matter, as well. But the one positive note here is that our orders have stabilized the last two weeks. So that's a very good sign. So as a result of that, in slide 15, we've taken decisive cost reduction actions in the fourth quarter. And I would give you a hockey analogy. We are skating to where the puck was going. We saw this decline happening. We felt it in the middle of March. And we started these actions in March. And so we started right at the beginning of April. These were effective April 1st. Now, these actions are really in two distinct buckets. The first is discretionary. which will vary based on order entry, and it will flex to the amount of orders and business that we have. So that's the first category. The second is permanent structural cost actions that are predominantly SG&A, and that will be across the company, but in particular focusing on aerospace and oil and gas and markets that are low for longer that need structural actions to them. So let me just take one at a time here. So on the discretionary side, we have salary-based wage reductions, and you can see the various elements here. All of our salary team members around the world and our directors took a 10% base salary reduction. Our officers are in the 20% to 30% range, and myself at 50%. Now, this is effective April 1st, and it's effective for 90 days, and we'll evaluate whether we need to extend it when we get to Q1, and that evaluation will be dependent on how order entry is doing and how the business is progressing. The next category you see there is reduced work schedules. And that could range anywhere from a reduced work schedule of 10% to 100%. And we could take a plant down one day a week. It could go down for several weeks at a time. And it depends on really the activity in that plant. And we're very much matching work hours to order entry. And we've had terrific, terrific collaboration around the world from all of our colleagues, works councils, et cetera, too, use this as a very effective tool to adjust business to order entry. We're foregoing annual merit increases, and we're reducing travel and basically reducing everything that's not moving we're not spending. So you add up all that, that comes to a $250 to $300 million cost reduction in Q4. And then as I referred to on the structural side, those are SG&A-related reductions in force. And if I was to highlight aerospace costs, we are going to do an approximate 20% reduction of force in the number of people that we have in the aerospace group. And that yields a $25 to $30 million cost reduction for the quarter. Add that up, that's $275 to $330 million. So we're targeting an approximate 30% decremental margin. We're planning for an L type of recovery here, where the L is going to have the bottom of the L, the horizontal side is going to have some variation here. and a variation that is not known at this point. We're planning conservatively on the cost and cash side for an L, but you notice very distinctly with the way we've done in discretionary, we absolutely had the flexibility that L turned into a modified V or to a U that we could respond at a moment's notice to any kind of growth because our discretionary side is very flexible. If you go to 16 on the cash side, we're conserving capital spending, as you might imagine, We're optimizing working capital, which is a traditional strength of the company. You go through all of our past recessions. This is a legacy that we've always done extremely well in. We're temporarily suspended a 10B51 share repurchase program, and we will maintain the dividend payout and the annual record of increasing dividends paid. Just as a footnote, our annual dividends paid in FY19 was $3.16, and FY20 was $3.52. It's a record we're proud of, and it's a record that's going to continue. We're confident. You look at all these actions on the cost side and the cash side and generating a greater than 10% CFOA going into the future. So I want to close out my opening section with the transformation of the company, and it starts with the wind strategy. Whether it was the original wind strategy almost 20 years ago, wind strategy 2.0 in 2015, to today, wind strategy 3.0, this is the engine behind our success. and it's going to create a very powerful future for us. This is the highlight of Investor Day, so I won't go back through that as we just did that last month. On slide 19, this unmatched breadth of technologies is even more clear today because it's a portfolio that is unmatched and gives us a competitive advantage, but it's also a portfolio that is very much needed in society. And the fact that 60% of our revenue comes from customers that buy from four or more of these eight technologies is is recognition that our customers feel the same way. On slide 20, we've been very strategic in upgrading the portfolio. This is a list of three transformational acquisitions, adding to filtration, engineering materials, and aerospace. And even in these trying times, we see the power of these deals. Their top lines, all three of them, have been far more resilient than Legacy Parker, and the EBITDA margins have been nicely accretive. If you go to slide 21, This is the chart we showed at Investor Day, and we've got two stair steps in here. The black is as reported operating margin, and the orange is adjusted operating margin. And this is how we've done the last five manufacturing recessions, and this is remarkable progress from where we were when the original wind strategy was launched. Five recessions, and these stair steps, they really speak to the improvement that we've done over many recessions. And you get ready for your current recession. many years before. So the reason why we're performing as well as we are now is we've been changing the cost structure for the last five years, and we've been working at this for the last 20. Our Q3 year-to-date adjusted operating margin at 16.7% was already in a tough environment. I would remind you that year-to-date, if I add organic and currency together, it's about a minus 7% environment. So we are performing at remarkably high levels in a tough environment. That's an almost 900 basis point improvement from when the wind strategy was first launched. Now, obviously, Q4 is going to put downward pressure on that number, but we will still end the year significantly better than we've been in any prior recession. On 22, there's a look at cash flow, and I would just call your attention to the blue line, which is the CFOA margin line. And you can see we've been extremely resilient over many cycles, Good times and bad times, this company generates 10% or greater CFOA and 100% or greater free cash flow conversion. We've did it before. We're going to do it again. This graph hopefully speaks to the resiliency of the cash flow for the company. And on 23, the outlook for FY20, you know, the current environment is highly uncertain, as all of you, I think, can certainly understand and appreciate, making it very difficult for us to guide with any kind of accuracy or reliability, hence the or we're throwing the FY20 guidance. The portfolio and the cost structure has been transformed in the last five years. That's why we've been performing as well as we have been, and the proof is really in those slides I just showed you. We have come out very rapidly and assertively to adjust costs to the current environment, and as I just spoke to, our cash flow is very resilient. And we have a bright future. The one strategy 3.0 and our purpose are going to propel us as soon as we get through this crisis and propel us through this crisis as well. So with that, I'm going to hand it back to Kathy for details on the quarter.