Parker-Hannifin Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Parker Hannifin Corporation Fiscal 2021 First Quarter Earnings 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 may be recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Kathy Seaver, Chief Financial Officer. Please go ahead, ma'am.

Thank you, Sonia. 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 a 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 three. We'll begin with our Chairman and Chief Executive Officer, Tom Williams, providing a few comments and some highlights from the first quarter. Following Tom's comments, I'll provide a more detailed review of our first quarter performance together with the revised guidance for the full year fiscal 2021. Tom will then provide a few summary comments and we'll open the call for a question and answer session. We plan to end the call at the top of the hour. Please refer now to slide four and Tom will get us started.

Thank you, Kathy, and good morning, everybody. Thanks for your participation today. I hope that you, your family, and your friends are all safe and healthy. So before I go through the quarterly results, I wanted to highlight slide four, which is really our strategic positioning slide on one page. It's how we create value for our customers, our shareholders, and our people. And I'm going to highlight some of these through the course of my remarks in the opening slides here. But really, the output of all these differentiators is really that last bullet. It enables us to be great generators and deployers of cash over the cycle, which is a proven strength of ours that has only gotten better over the years. This list is what sets us apart, is what enables us to be a top quartile company, hopefully a company that you'll want to be a shareholder of. So go to slide five. This is one of those competitive differentiators, which is the breadth of our technologies. This is a portfolio of eight motion control technologies that are all interconnected and complementary to each other. It's how we bring value to customers. It's how we solve problems for our customers. Our customers see the value in it, too, because 60% of our revenue comes from customers who buy from four or more of these technologies. So if you go to slide six, we'll talk about the quarter. It was an outstanding quarter. Great results in the face of unprecedented times, and a big thank you goes out to our entire global team for all their hard work, dedication, and the great results here. So starting with the first bullet, something that we take great pride in, we are a top-quartile safety-performing company. In addition to that, we continue to reduce recoverable injuries and incidents by 31%. Sales declined 3%. Organic decline was 13% year-over-year, but that showed nice improvement versus the prior quarter, which was a 21% decline, so we were pleased to see the progress there. EBITDA margin was 19.5% as reported, or 20.1% adjusted, That makes two quarters in a row that we've been greater than 20% EBITDA margins we're excited about. And it was 100 basis point improvement versus the prior year. We did a great job on debt reduction. We paid down debt in a quarter of $557 million. And our cash flow from operations was just an outstanding level at 22.8%. So if I call your attention to the little table at the bottom of the page and go to that last row, the total segment operating margin adjusted row, See, we came in at 19.9% for the quarter. That was 110 basis point improvement versus the prior year. Our decrementals were just terrific. If you look at our decrementals on an adjusted basis with acquisitions, they were favorable. Meaning that we had less sales and we had more income versus the prior year. On a legacy basis, so Parker without acquisitions, again, on an adjusted basis, was a 14% decremental. Just great results by the operating team. So if you go to slide seven, The deleveraging progress has been just dynamite. You can see we paid down $2 billion worth of debt in the last 11 months. We've now paid off 37% of the Lord and Exide transaction debt. And you can see the multiples, whether it's on a gross basis or on a net basis, continue to make nice progress reducing those leverage multiples. So very proud of that. Move to slide eight. These outstanding results are really underpinned by a couple of factors. First is the prior period of restructuring that we've done, the wind strategy and the performance enhancements that it's driving, and the speed and agility of our pandemic response. And just for clarification, when you look at these numbers, these are cost-out actions that represent the savings that are recognized in the year as a result of our pandemic response. The incremental amount is footnoted at the bottom of this page, and that was $210 million year-over-year incremental. But the big thing that I want to make a point on this page is the shift to more permanent reductions. And while we didn't put it on here, we didn't put Q4, but if you go back and look at your Q4 notes, we were 90% discretionary, 10% permanent. This quarter, Q1, we are now 30% permanent, moving to a full year of 60% permanent. If you just go to that full year section of the page and look under FY21, see $175 million discretionary, It's a little bit less than what we showed you last quarter, primarily because our volume is better and we didn't need to enact as many of those discretionary type of actions. Most of our wage reductions have been restored to normal effective October 1st, with some minor exceptions in countries where those governments support supplementary income for short work weeks, which we've continued. Permanent actions stayed the same at $250 million or right on track to deliver that And really, I think this bodes well when you look at this shift to more permanent actions for the remainder of FY21 and sets us up very nicely for FY22. So if you go to the next slide, we're talking about our transformation. And clearly, I'm going to show you a couple of numbers here. Hopefully, you're going to believe the company is definitely transforming. We'll talk about how, and we'll talk about more importantly where we're going to go in the future. Next page is on the how portion of it. It's been a combination of portfolio things we've done as well as just sheer performance improvements. On the performance side, it all starts with the Parker Business System, which is the win strategy, and two major updates that we've made that you're familiar with, which is really propelling our performance. We simplified the organization from a structure standpoint, and we acquired three outstanding companies that were accretive on growth, margins, and cash flow, and they're performing very well during the pandemic. And I think the best evidence, which is the slide you've seen before, is on slide 11, which is the transformation across the last five manufacturing sessions on how we've been raising the floor operating margin. We wanted to put this slide in again because we've updated it based on the latest adjustments where we include deal-related advertising in our adjustments. And we did that through all the prior periods. So the reported in shades, that's in gray. In gold is the adjusted. And you can see that the improvement now is even more pronounced. 1100 basis points over this period of time, just dramatic improvement. And obviously we intend to keep moving in this direction. Go to slide 12. We're gonna talk more about the future now and where we're going. And it's gonna be all around one strategy 3.0, which we just recently changed in our purpose statement, which is in that blue box down at the bottom. Both of these changes have created excitement within the company. and an inspiration from our people on that higher purpose that we're all trying to live up to. Slide 13, where I'm gonna spend a little bit of time going through 3.0 to give you a little more context and color as to why we think our future performance is gonna continue to accelerate. I'm gonna make a comment on each one of these. So, start with simplification. You've seen what we've done on structural things and organization design work continues. Simplification's gonna expand into more 80-20 and simple by design. And of course, you're all familiar with 80-20, but for us it's still early days with lots of upsides. A simple by design is the realization that 70% of your cost is tied up in how you design the product. And what we want for our company is design excellence and operating excellence. We want both of those things. And the way you get design excellence is through simple by design. It's going to have three major buckets. It's going to be complexity assessment, of our existing and new designs. We're going to use four guiding principles on how we design products. We're going to design with forward thinking. We're going to design to reduce how we use material. We're going to design to reuse things that we use across the company. We're going to design the flow. We're going to enable all this with the use of AI, which is going to allow our engineers to be able to do these things in a much faster and knowledgeable fashion. Second bullet is innovation. In our stage gate process, we call internally winnovation. So that's taking an idea to launch for a new product. And we're making three changes there. One's in metrics, and that's called PVI, Product Vitality Index. Not a new metric for most of you who are familiar with this. It's the percent of revenue that comes from new products and things that we've launched and commercialized over the last five years. So we're holding people accountable to that, and we're seeing nice progress. We've also included Two key processes, one is new product blueprinting, which is an outside-in orientation for engineers, so spending more time with customers and end users to understand their pain points and their needs so that we design and develop better products to solve those. And, of course, simplified design is embedded into the new innovation as well. Third goal is digital leadership. Now, we put this on there before the pandemic, but, of course, with the pandemic, this is even more important. We've got four big areas that when we say digital leadership, we mean four things. Digital customer experience, digital products, which would be IoT, digital operations, and then digital productivity. And digital productivity is what we would do, include our data analytics and artificial intelligence. The next bullet is growing distribution. We just want to continue the great progress we've been making, especially growing international distribution. The next one is Kaizen. Our brand at Kaizen is unique, and it's really combining Kaizen, our high-performance team structure, which is how we build the company, our natural work teams, and that ownership that it creates in our plants, warehouses, and the offices, and the use of lean. And I would just tell you that COVID has not slowed us down one second on the use of Kaizen. We continue to have the same activity and the same results, and we're very pleased with that progress. On the acquisition front, we want to be the consolidator of choice and continue to buy great companies like you've seen us do the last several years. And then underpinning all this and supporting this is going to be a new incentive program, which is called the Annual Cash Incentive Program, so ACIP for short. And we're going to roll this out over the next two years, FY22 and 23. We've been piloting it over the last two years, 20 and 21. and it's going to replace return on net assets as our annual incentive, and it's going to have three simple components, earnings, revenue, and cash. So it'll be easy to explain, easy for our people to understand. Those three metrics are highly aligned to total shareholder return, and this will provide better linkage to our annual performance. So we feel very excited to continue the performance changes we've been making, and the performance lift we're going to get with 3.0 that the transformation that you've seen is going to continue in the future. Moving to slide 14, you probably saw on Monday this week we made some important organization announcements. And the first one, the lady that's sitting right next to me is strategically positioned six feet away from me, though. Kathy Seavers, retiring January 1st. This is part of Kathy's long-term plan. And she has 33 years with the company and 33 great years. And everything she's done, she's excelled in, and she's basically helped us a tremendous amount. Whether it was bad times in recessions or good times with expansions, it's been a big part of the win strategy. And her team, her and her team, the work we did in those acquisitions is a huge lift by the finance team and really made a big difference for us. A great example of values and results and a great example for the rest of our leadership team. So this is Kathy's last earnings call. And I can see she's pretty tore up about that. But she's going out in style because these are fantastic results to do as your last earnings call. Now, succeeding Kathy on slide 15 is Todd Lambruno. And Todd will be our CFO on January 1st of next year. I think a lot of you know Todd. Todd was in investor relations and knows the company extremely well, 27 years with the company. He's been a division controller, a group controller, now a corporate controller. And he'll be joining Lee and myself and the office's chief executive as CFO. So, Todd, if you want to just make a few introductory comments to everybody. Yeah, good morning, everyone.