Parker-Hannifin Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Parker-Hannifin Fiscal 2020 Fourth Quarter and Full Year Earnings Release Conference Call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you will need to press star, then one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, Please press star, then zero. I would now like to hand the conference over to your speaker today, Kathy Seaver, Chief Financial Officer. Please go ahead.

Thank you, Sarah. Good morning, everyone. Welcome to our teleconference this morning. 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. In 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. We'll begin with our chairman and chief executive officer, Tom Williams, providing an update on Parker's response to COVID-19. Tom will then discuss highlights from the fourth quarter and full year. Following Tom's comments, I'll provide a review of our fourth quarter performance together with guidance for fiscal year 2021. 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 calls we can today. Please refer now to slide four, and Tom will get us started.

Thank you, Kathy, and good morning, everybody. A couple comments from me before we start slide four. First, I hope that everybody listening in that you and your families are safe and healthy, and I'd like to extend our thoughts to those affected by this crisis. and our deepest sympathies go out to those that have lost loved ones as a result of the virus. I have a special thank you for all the Parker team members that are listening in for their hard work and their dedication in really delivering two high-level accomplishments. First, we delivered outstanding performance during unprecedented times, as you saw by the quarter and by the four-year results, and we're living up to our purpose. We're providing products and technologies that are helping society through the crisis, and we're helping to do our part to create a better tomorrow for people. So on slide four, we talk about our response to the pandemic. It starts with safety. That's the first goal in my strategy, and really when we made that change in 2015, it provided a great foundation for us to respond to this pandemic. We're helping society through the crisis. Our technologies are essential. What was interesting with all the government orders that came out, almost every one of those deemed us as an essential manufacturer. Our purpose and action is more clear than ever, and I'll give you a few examples of that. and our manufacturing capacity has stayed near normal levels throughout the pandemic. The governing principle has really been the takeaway on this page, which is our two safest places that we want for our people is to be at work and at home, and we're doing everything we can to live up to that. So in slide five, the performance during this health and economic crisis, and the confidence in the results that you saw in Q4 really come from this list that you see. I want to just touch on the very last bullet, the engaged people, This is a big change that we made in one strategy 2.0, 2015, and we recognized the strong correlation between safety, engagement, and business performance. We are now top quartile in safety, top quartile in engagement, and you can see the significant progress we're making towards being top quartile on our financial performance based on the results that we just turned in. If you go to the next page, I'm going to talk about the strength of our portfolio and our purpose in action, and on slide seven, is the unmatched breadth of technologies that we have, those eight motion control technologies. They are our competitive differentiator. It's how we bring value to customers. And our customers see it. Sixty percent of our revenue comes from customers who buy or perform more of these technologies. Go to slide eight. Our capital deployment strategy has been thoughtful, and we've been transforming this already great portfolio through these strategic acquisitions. by acquiring Clarkor, Lord & Exotic. This is $3 billion of acquired sales. We bought three great companies, the three largest in our history, and they've increased our resilience because of their technologies and because of their aftermarket content. And you've seen in the results, they are accretive to growth, margins in cash, and this was especially evident during the crisis. And we've been able to equal or beat our synergy goals despite the macro conditions. Slide 9 is our purpose statement, enabling engineering breakthroughs that lead to a better tomorrow, which has really acted as our compass and our guiding light and provided a lot of inspiration to our team. On slide 10, just some examples of that purpose and action. On the left-hand side is the food supply. We're basically from the farm all the way to your kitchen table. Transportation, whether it's truck, air, or rail, we're helping the world move products and goods around the various customers. In the middle section there, on life sciences, we're helping patients, whether it's in the hospital or in the ambulance. And probably the poster child for us and the one that's probably the signature of the purpose and action for the last quarter was the work we did on the ventilator. So six of those eight technologies that I showed on the prior page or two are in ventilators. And we saw dramatic, as you might expect, ramp up in production needs based on what was happening in society. with existing customers, and we took on a lot of new customers. I could not find suppliers that could keep up with this production demand. And in some cases, we went from zero to full production in weeks, and it was really a remarkable job by the divisions involved. On the right-hand side and the upper right, we are an essential manufacturer, as I mentioned earlier. And basically, if you look at any plant in the world, you can probably find a Parker Park somewhere in that plant. So we're an essential manufacturer because we're needed by everybody else. Then in power generation, whether it's traditional renewables, we're there to help customers with their energy source. Moving and shifting to really the summary of the quarter and the full year, on slide 12, it was outstanding. It was, you know, a difficult time, probably the most difficult in the history of the company. The organic growth came in at a 21% decline, so we felt that impact, but we paid down debt by $687 million. That was on top of what we did in Q3. And when you look at margin on the two different categories we're going to look at here, it was just terrific performance. On operating margin, it's better to look at it without acquisitions, given the acquisitions we've got and don't have in prior periods. But if you look at the adjusted growth there, 18.1% versus 17.6%. So a 50 pips increase in Q4 is a 16% detrimental, which is fantastic, actually. on the company. And then without acquisitions, EBITDA is a good way to look at this, apples to apples. If you go down to the last row, 20.4%, 160 base point improvement. Probably the first time, at least in recent memory, that we've elipsed 20% EBITDA margin. So this is really a combination of the base business performing well, the wind strategy, the prior period restructuring, and bringing on acquisitions that are accretive on the margins. If you go to slide 13, quick summary of the full year, we made continued progress. I would just remind people that we were already in an industrial recession before the pandemic hit. So these accomplishments really are up against a pretty stiff headwind. And on safety, 35% reduction in recordable incidents. This puts us in the top quartile. And I would just contrast five years ago, we were in the fourth quartile on safety, and we're now in the first quarter. So remarkable progress there. Cash flow from operations from a dollar standpoint is an all-time record. So that's an all-time record in the history of the company, $2.1 billion. If you've got to hit a record, cash is a good place to hit a record on. You can see the CFOA margins at 15.1%, pre-cash flow conversion on a 52%, and then just some debt metrics, leverage metrics there. You can see that we improved on a gross debt down to 3.6, 3.8 times, then on a net debt standpoint, this is a 3.3 from 3. And FY20 was $1.3 billion, approximately 25% of the transaction debt. So in just a little over eight months of acquisition ownership, we paid off a quarter of the debt that we took on to acquire the company. So just a great job by the teams here. Then moving on 14 to the full year, again, just great margin performance for that. So the full year organic was down about 10%. And, again, same methodology without acquisitions. Look at the operating. which is very hard to do on a volume drop, and came in at a 17% decramental, which is a best-in-class performance. With acquisitions, looking at EBITDA adjusted, we raised it to 19.3%, again, showing the combination of the wind strategy and acquiring companies that are creative on margins to help out the total business. So if you move to the transition here, so the Parker transformation, it's happening. Those numbers that you saw in the prior pages don't happen just by accident or by luck. So what have we been doing to drive that? So if you go to page 16, all roads lead to the wind strategy. And I would say it's the combination of our decentralized divisional structure with the wind strategy that drives this unique ownership culture that is really putting up these kind of results. If you go to page 17, just elaborate a little bit more on what's different. You know, we started off this time period with the major restructuring activities really starting at like 14. And if you look at the cumulative restructuring we did for those three years, it was approximately $270 million of restructuring. So that really set us on a path of putting the right kind of cost structure in place. We built upon that with on simplification in 2015. And remember simplification on a broad standpoint is structure and organization design, on 80-20, and on simplified design. But just from a structures third of the divisions of the company. And we made two major updates to the Parker business system, which is the one strategy. Building on the success of the original one strategy, we did 2.0 in 2015 and, of course, 3.0 just recently. And we're very excited about that because we have a ton of potential. We just launched it and has a lot of runway in front of it. We talked about the power of the companies that we acquired. And you see that resilience coming through in the business cycle. And I'm going to give you two slides coming up that will show you that resilience. looking at both margins and growth. But don't underestimate the takeaway. The purpose statement has really provided creative alignment and inspiration. And there's a big difference between being at work and being inspired by your work. And purpose does that for you. And that's what our people feel about that. So on slide 18, talk about the margin side. And I showed you this last quarter. And this is looking at the last five manufacturer sessions. And I would argue FY20 It's actually got two separate recessions in it. The industrial recession we were already in and the pandemic that came in in March. But you can see whether you look at it on an as reported basis or adjusted, you can see the significant step change in performance over these manufacturing recessions. Something we're very proud of and something that we intend to keep doing. And if you go to 19, this is a look at top line resilience. And go to 19. Okay. So I recognize that the Great Recession and COVID-19 is not the same, but these are two examples of significant shocks to the system. My view of COVID-19 is worse. You look at the GDP reduction across the world in the last quarter, it dwarfs any kind of GDP reduction that happened in the Great Recession. Well, let's just say for the sake of argument that the organic, that the environment was the same. happened to be Q4 as well, and FY09 was down 32%. And then what did we do last quarter? We did minus 21. Now, hopefully, that'll be our worst quarter. Time will tell, but we think it's going to be the worst quarter. So why is it better? There's some distinct structural reasons why it's better. First, the clarifier acquisition is now part of our organic performance, and it has 80% aftermarket, so that's more resilient. The percent revenue that we get from innovative products And the way we calculate that is percent of revenue that's new to the world, new to the market, divided by our total revenue. That, over the last five years, that has more than doubled over this period of time. Innovative production, more resilient, they grow faster, better margins. And then you've heard us talk about how we've changed the mix in international distribution by raising that by 500 pips over this period of time. And we've had better customer experience. We're not there. We have lots more to do on customer experience, but that's been another contributor. So the top line, we're not immune to the cycle. We felt it, obviously, but it is better than we were before. And there's distinct reasons why it's better. And it's only going to get better in the future because Lord and Exotic are not yet in our organic numbers. And you can see by the results we showed so far, they are performing better than Legacy Parker. Moving to slide 20, something we're very proud of, our cash generation history. I mentioned the CFOA record at $2.1 billion. And then we've just been very, very consistent. Good times and bad times, you see 19 consecutive years of double-digit CFOA and greater than 100% pre-cash flow conversion. So I want to move to FY21 and the outlook. And we decided to reinstate guidance. And you can make good arguments as to why not to give guidance with the uncertainty. And we're not trying to pretend that we're any smarter than anybody else because we're not. However, we're four months smarter than we were at the last earnings call. And we've proven that we can operate safely and with strong results. And while the future is uncertain, we felt we are in the best position to communicate to shareholders and provide them the insight as to where we're going. And hence, that's why we decided to do guidance. Of course, it's an opportunity we'll have every quarter, and we'll certainly get smarter as order entry comes in, and we'll update your thoughts as we go through, and certainly we'll go through this in more detail in the Q&A portion of the call. But I wanted to give you that context as to why we decided to guide before Kathy executes some specific numbers. So then if you go to 22, a big part of our success in Q4 was our actions on costs. This is a combination, as I've mentioned, of prior period restructuring, the wind strategy, and all the things we've been doing for years, and then the speed and agility of our pandemic response. But what you see here in contrasting between what we did in Q4 and what we're going to do in FY21 is a strategic shift in the cost to a more permanent cost-action basis. So you can see the little donut chart in Q4 of FY20, 12% permanent, and that's going to move to 55% permanent in FY21. If you look underneath the donut for Q4, you see permanent actions. These are all savings with $25 million. That was spot on what we told you last quarter. And you see the $175 million of savings that was less than what we told you. We told you the range of $250 to $300. And it was lower because our volume was better, which was a good thing. You know, we didn't necessarily give you specific guidance last quarter, but we had our own internal planning. We were projecting a 30% decline in volume. And hence, that's why we gave it a range in discretionary. It came in at minus 21, which we were grateful for, and we didn't need to do as many discretionary actions. We needed people to work more hours, which was a good thing. Then when you move to 21, you see discretionary at $200 million. That'll be mostly in the first half, and we'll gradually wean off of that as we go to the first and predict predominantly in how the balancing plant powers the demand. But then you see the permanent action rising to $259. And if you look at when COVID hit, and you take the second half of FY20, and add to all of FY21, and look at our restructuring costs. So we did $65 million. We're proposing $65 million of restructuring in FY21. We did $60 million in the second half of COVID-related restructuring that's going to generate just $250 million of savings. So that might seem a little more efficient than normal, and the reason for that is it's going to be an asset-light restructuring plan. We will have very few plant closures as a result. That's why it's a lot more efficient than normal. So with that, I'm going to hand it back to Kathy for more details on the quarter.