Q3 2020 Earnings Call
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I'd now like how the conference over to your host Chief Financial Officer Kathy.
[music] speculative.
Good morning, welcome to Parker Hannifin third quarter fiscal year 20 earnings release teleconference.
Joining me today, our chairman and Chief Executive Officer, Tom Williams.
President and Chief operating Officer Leap banks.
Today's presentation slides together with the audio webcast replay will be accessible on the company's investor information website at <unk> P. H stock dotcom for one year following todays call.
On slide number two you'll find the company 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 parkers website at <unk> Dot Dot com.
[music] today's agenda appears on slide number three.
Well 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 question and answer session.
Well do our best to take all the questions we can't today.
Please refer now to slide number four and time will get a started.
Thank you can't think good morning, everybody. Thanks for your participation today, probably get into slide four just want to first extend our thoughts to all those have been affected by the crisis and our deepest sympathies go out to those sort of lost loved ones as result of the virus.
Hey, special Thank you to all the health care professionals for their courageous efforts around the world.
I'd also like to thank all the Parker team members for their dedication of their support.
And what we have done unrelated and our own small way to help societies through this crisis.
Elaborate more about that later on the presentation.
So this is unprecedented times and that's a word is probably overused, but very appropriate given the unique despite having a combined health and economic crisis. So on slide four our performance and our strength.
For both of these crisis really comes from the one strategy.
She is a proven operating system and we're now under a third.
Very powerful revision of that.
<unk> products and technologies that are needed.
And this has never been more evident an important than today's climate, we make things at the world absolutely needs, our culture, and our values, which is why people join and stay Parker.
And our purpose, which has been our north star and I'll talk more about the connect condition or purpose.
Actions later on and we have and engage team of people.
At the top Cortile engagement scores of you couple that with our do centralized divisional structure that is what does it has enabled us to move with the speed and agility that you've seen a turn this crisis.
So on slide five our crisis management strategy.
It's really threefold first is the safety of our team members and their families seconds, how do we hope society through this crisis, we are essential.
And I'll talk more about why we are central and that we want to emerge stronger than ever before after the crisis over.
We have utilized a crisis response management team that structure, we have in every country, we have it for corporate as well and their focus has really been on health and safety side of things. We've had a daily cadence will 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 see the top 20 exact isn't a company have still been coming to the office and we maintain physical distancing.
And do some conferencing all those type of thing, but it's very advantageous to have as co located Tory very quickly can see each other make decision that's been a key and able to our speed and decisive decisiveness as well.
On slide six we'll talk about the health and see health and safety actions.
They have been earlier than they've been decisive they've been patterned off of the CDC and the WH, though as well as lessons that we've learned from China.
And this is a list that you probably are familiar with as you listen to other companies I wonder so they go through each one of these beverages point too we were early on what travel restrictions and we were early with cancellation of in person meetings and I would highlight two examples first con Expo, we're probably going to first companies to withdraw from Con Expo, which is a very important.
So that sends a.
A very strong message I think to.
Everybody in our space as well as our people does importance of what we wanted to do your protecting our people and that we weren't early adopter the virtual investor day.
Which all people are part of them. We thought that was very successful not as good as a person, but it was very successful in them. So smart move to do that so the takeaway on this page.
The governing message to all of our people has been this takeaways we wanted to to say if this places for people to be at work and at home and we're going to do everything humanly possible to make sure that happen.
So I mentioned that we were essential.
On slide seven just one of the highlight some examples of our purpose an action.
And you I'm going to go through these just real quickly, but our products that help us decided to 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 its emerged transportation on a helicopter are on hospital beds and we are essential manufacturer, but we're also helping other people that are essential manufacturers a little picture that you see an upper right hand corner. There is a picture of a typical manufacturing plant.
With the roof off of it.
And I would I would tell you that where we are in almost every manufacturing plant around the world helping people make their products. So those eight motion control technology has seen a lower right are being put to use to help society.
And if you go to the next page on slide eight.
Couple of more examples transportation well, that's heavy duty truck or air freight to get products to customers power generation for electricity were on traditional as well as renewables.
And I would.
I think the Best example, the poster child. This crisis is really the ventilator.
We do a fair amount in health care, but the ventilator particular, we have almost doubled our sales in this calendar year 2020, and we have six of our eight technologies on the ventilator and we've been supporting new and existing customers as well as countries from around the World and Division has been doing this is just on a herculean job.
Staying up with customers and just a fantastic job my complements total.
So on slide the next slide is our purpose statement.
Enabling engineering breakthroughs that lead to a better tomorrow.
Releases last September and I can tell you, we probably never envisioned how positive impact its head on our people and there's really is becoming a rallying cry.
For our organization through this crisis and it illuminates I think the purpose and what we bring to society. It gives a great deal meeting for our people and what they do Dana.
Moving to slide 10.
A quick snapshot of facility in supply chain status.
And you go to the Middle column, just at the major reasons or total Parker. So this is percent capacity versus pre fibers using pre virus is 100% as an example, where virtually back to normal.
Nine some per sub Theres, obviously a lot of.
Things that one on through the quarter and in April with.
Stay at home orders and all that.
At the move this up quite a bit our supply and trading supply chain strategy on the right hand side has done great very effective during the crisis.
Let me talk about this in the past, but we may find so in the region for the region. We've also got a very robust supply chain risk mitigation strategy that we've been doing for years well before this started so were very good shape on that this is a non issue for us.
Moving to 11 want to talk about a quarter.
And I would just if I had to summarize.
Would tell you is probably one of the best quarters that we've ever done.
Given the environment that were end it was really just remarkable performance by the team starting with safety, we had a 27% reduction to recordable incidents and that yields when you look at recordable incident rate. So that's number of safety and since per hundred people were a top quartile company, which is fantastic progress sales were flat year over year Act.
Positions offset the decline we had an organic.
Currency, but the margins really were still are they really stood out. So we got two categories here without acquisitions and I would call your attention to the adjusted segment operating Roe.
We we came in at 17.3% for the quarter versus 17.2% 19 same quarter, So 10 basis point improvement.
16% decremental remember this is on about a 7% to 10% 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.
Look at EBITDA margin on an adjusted basis that last ROE you can see that came in at 19.3%. So 60 basis point improvement versus the prior period and this speaks to two things one the base business keeps getting better is performing better and we acquired companies that have accretive EBITDA margins to legacy.
Occur, which is helping fuel that margin expansion.
One more page and 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 casual so records means record in the history the company.
Point 3 billion, which was was create the CFO away margin was 12.3% and free cash flow conversion rate was 122%.
We're very pleased with our debt reduction of $611 million that was a very nice reduction.
Help reduced our leverage.
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 and a very strong financial position.
So on slide 13, we've got the order rates and this is traditionally and Kathy section one of the pull it up earlier to allow me to talk about April. This reminder, on this page.
Industrial orders or a three month year over year comparison, and aerospace as a 12 month year over year, Rolling 12 month year over year comparison.
And excludes acquisitions and currency.
I think the next so you can see what happened there little bit better driven primarily by international that's probably a little more illustrator. If you go to slide 14, where we talk about.
April in particular.
But I just want to emphasize that well Q3 get a little better there was a distinct drop and we felt.
In March and the middle of the month, so on a daily rate basis could remember that prior side is three months rolling when you look at a daily basis, we were clearly feel in us in March.
Already and so that was impacting those dependent it was declared March 11.
And we had IR day on March 12.
I think just as soon as the cameras stuff rolling the stay at home orders started up pretty much around every country around the world China restarted that.
And so what you're looking at this page is a 112 not a 312. So this is April month to date versus April month to date is prior period again 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 the next.
So with customer plant shutdowns as happened through the month of April.
And started in March for that matter as well.
The one positive note here is that orders have stabilized the last two weeks so thats a very good size.
So as result of that in slide 15.
We've taken decisive cost reduction actions and in the fourth quarter and I would give you a hockey analogy, we are skating to where the PUC was going.
We saw this decline happening we felt it in middle of March and we started these actions in March and so we started a rate beginning of April these were effective April onest.
Now these actions are really in two distinct buckets. The first is discretionary which will vary based on order entry and that will flex to the amount of orders and business that we have so thats the first category.
Second as permanent structural cost actions that are predominantly SGN eight and that will be across the company, but in particular, focusing on aerospace and oil and gas end markets that are low for longer that needs structural actions. So let me just take one at a time here so on and discretionary side, we have separate base.
Wage reductions and you can see the various elements here all of our Sarah team members around the world and our directors took a 10% base salary reduction our offers officers are in the 20% to 30% range and myself at 50%.
Now this is effective April onest since effective for 90 days and we'll evaluate whether we need to extended when we get to Q1 that valuation will be dependent on how order or order entry is doing and how the business is progressing.
Next category you see there is reduced work schedules and that could range anywhere from a reduced work schedule, a 10% to 100% and we could take a plant one day a week. It could go down for several weeks at a time it depends on reduced activity in a plant and were very much matching work hours to order entry we've had terrific.
Terrific collaboration around the world from all of our colleagues works councils exit or to use this as a very effective tool to adjust business to order entry.
Before going annual Merit increases.
We are reducing travel and basically reducing everything that's not moving we're not spending so that you add up all that the comes to a 250 to 300 million dollar cost reduction in Q4, and then as I referred to on a structural side those are as she in a related reductions in force if I was to highlight aerospace.
We're going to do an approximate 20% reduction in force in the number of people that we haven't aerospace group.
And that yields a 25% to 30% 30 million dollar cost reduction for the quarter add that up its to $75 million to $330 million. So we're targeting an approximate 30% decremental margin. We're planning for an l. type of recovery here, where the Els going ahead, the bottom of the LD horizontal side is going.
I have some variation and the variation that is not known at this point, we're planning conservatively on a cost and cash side for and Hello, but have you noticed very distinctly with the way we've done in discretionary we absolutely have the flexibility that ill turn into a modified TV or to you that we could respond at a moment's notice any kind of growth.
Because we are 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 for the company you go through all of our past recessions. This is a legacy that we've always done extremely well and.
Were temporarily suspended a tenbfive one share repurchase program and we will maintain the dividend payout and annual record of increasing dividends paid to us as a footnote our annual dividends paid enough. When 19 was $3 in 16 cents network 20 was $3.52 to record we're proud of answer.
A record thats going to continue.
We are confident you look at all these actions on the cost side, and the cash side and generating greater than 10% CFO away going into the future. So I want to close out my opening section with the transformation of the company.
And it starts with the win strategy well there was the original one strategy almost 20 years ago. When showed a 2.0 in 2015 today. Once rigid 3.0. This is the the engine behind our success and that's going to create a very powerful future for us with this is the highlights of Investor day, So I won't go back through the.
As we just did last month on slide 19.
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 portfolios is very much needed in society.
And the fact is 60% of our revenue comes from customers that buy from for more of these eight technologies is recognition that our customers feel the same way.
On slide 20.
We've been very strategic and upgrading the portfolio. This is a list of three transformational acquisitions, adding to filtration engineered materials aerospace.
And even in these trying times, we see the power. These deals they are top lines. All three of those have been far more resilient and legacy Parker and the EBITDA margins have been nicely accretive.
Because slide 21.
This is the chart we showed at Investor day.
And we've got to stair steps and here to the black is as reported operating margin.
The Orange is adjusted operating margin in this is how we've done the last five manufacturer recessions and this is remarkable progress more everywhere on division one stretch it was launched.
Fiber sessions in these stair steps they really speaks 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 as we've been changed in 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% environments. We are performing ever remarkably high levels in a tough environment. That's an almost 900 basis point improvement from one of which.
Stretches first launched.
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 a prior recession.
On 22, as a look at cash flow.
And I would just call your attention to the Blue line, which is a CFO away margin line and you can see we've been extremely resilient over many cycles. Good times and Bedtimes is this company generates 10% or greater Seattle weight, and 100% greater free cash flow conversion, we did it before going to do it again.
The scrap hopefully speaks to the resiliency of the cash flow for the company.
And on 23.
Outlook for.
Terrific 20 into the current environment is highly uncertain result hold as you can certainly understand and appreciate making it very difficult for us to guide with any kind of the accuracy of reliability hence.
Thrown if what 20 guidance the portfolio in the cost structure has been transformed the last five years. It's why would they are performing as well as we have been in the proof is really in those slides I just show to we've come out very rapidly and assertively to adjust cost to current environment.
As I just spoke to our cash flow is very resilient and we have a bright future lineage at 3.0, and our purpose are going to propel us as soon as we get through this crisis and were pulls through this crisis as well so within them and effective Kathy for details on the quarter. Okay. Thanks, Tom I'd like you to now refer to slide number 24, and I'll summarize the.
Quarter.
This slide present as reported an adjusted earnings per share for the third quarter adjusted earnings per share for the quarter $2, a 92 cents compared to $3 in 17 cents last year.
Adjustments from the current fiscal year as reported results netted to nine cents, including before tax amounts of business realignment charges of 10 cents.
Acquisition cost to achieve of six cents.
And acquisition transaction expenses up 14 cents.
These were offset by the tax effect of these adjustments of seven cents and the result of a favorable tax settlement of 14 cents.
Prior year third quarter earnings per share has been adjusted three cents. The details of which are included in the reconciliation tables for non-GAAP financial measures.
On slide 25, you'll find the significant component of the walk from adjusted earnings per share of $3 in 17 cents for the third quarter last year to $2, a 92 cents for the third quarter. This year.
Starting with the net decrease of seven cents in segment operating income.
For legacy Parker Athree hundred $29 million decline in sales resulted in only at 54 million dollar reduction in operating income or 31 cents.
The Parker teams did an excellent job of controlling costs on the lower volume, resulting in a legacy Parker decremental margin of 16% for the quarter.
The Lord and exotic acquisitions contributed 24 cents in operating income.
Lower net corporate DNA. Another expense contributed three cents this quarter as a result of currency gains on forward hedge contracts.
We incurred incremental interest expense of 19 cents year over year.
After adjusting out the benefit of a favorable tax settlement, a higher tax rate from continuing operations and less favorable discrete adjustments resulted in a four cents reduction from income taxes.
On slide 26, you'll find the significant components of the walk from the previous third quarter adjusted earnings per share guidance at the midpoint of $2.36 to $2. A 92 cents for the third quarter fiscal year 20 actual results.
Segment operating income contributed 43 cents more to the quarter than anticipated.
Our guidance was developed at the start of the Covet 19 scare in Asia, and we anticipated to 16% drop in international organic sales, but actually achieved only a 10% organic decline.
The aerospace segment on the other hand experienced more impact in the quarter than was anticipated.
Our quick reaction to controlling costs and the resulting higher margins also contributed to the higher than expected operating income.
Lower net corporate DNA and other expense contributed 10 cents due to the previously noted currency gains in the quarter.
Lower interest expense due to reductions in debt and lower variable interest rates in the quarter resulted in a two cents per share improvement.
Slide 27 shows total market Parker sales and segment operating margin for the third quarter.
Organic sales decreased year over year by 7.4% and currency had a negative impact of 1.5%.
These declines were more than offset by the positive impact of 9.3% from acquisitions.
Total adjusted segment operating margins were 16.9% compared to 17.2% last year.
This 30 basis point decline is net of the company's ability to absorb 100 basis points of incremental amortization expense from the acquisitions.
On slide 28, we're showing the impact Lord and exotic had on the third quarter fiscal year 20 on both an as reported and adjusted basis.
Sales from the acquisitions were 343 million and operating income on an adjusted basis was 42 million.
The operating income for Lord and exotic includes 35 million in amortization expense.
No the improvement of 10 basis points in legacy Parker operating income despite the $329 million drop in sales.
The great work the teams did on controlling costs resulted in a 16.4% decremental margin for the quarter.
Moving to slide number 29, I'll discuss the business segments, starting with diversified industrial North America.
For the third quarter, North American organic sales were down 7.1%, while acquisitions contributed 8.9%.
Operating margin for the third quarter on an adjusted basis, but 17.1% of sales versus 16.5% in the prior year.
The 60 basis point improvement is after absorbing 100 basis points of incremental amortization.
North America as legacy businesses generated an impressive decremental margin of 4%, reflecting the hard work of diligent cost containment and productivity improvements together with the impact of our win strategy initiatives.
Moving to the diversified industrial International segment on slide number 30.
Organic sales for the third quarter in the industrial International segment decreased by 10.2% acquisitions contributed 6.2% and currency had a negative impact of 4%.
Operating margin for the third quarter on an adjusted basis was 16.2% of sales versus 16.5 in the prior year.
Without the incremental amortization expense margins would have improved 10 basis points on an overall, 8% reduction in sales.
The legacy businesses generated a very good decremental margin of 19% again, reflecting diligent cost containment and the impact of the win strategy.
Ill now move to slide number 31 to review the aerospace systems segment.
Aerospace systems sales increased 16.7% from acquisitions organic sales declined 2.4%.
Decline in OEM volumes, primarily commercial were partially offset by higher commercial and military aftermarket sales.
Operating margin for the third quarter was 17.4% of sales versus 20.7% in the prior year.
Incremental amortization expense impacted the change in margins 160 basis points.
Lower earnings were driven by the OEM volume declines higher engineering development costs, and a less favorable aftermarket mix.
Good margin performance from exotic and hard work by the teams on cost containment and productivity improvements helped contribute to this solid performance in the quarter.
On slide 32 were showing the impact lowered and exotic has had year to date. This figure 20 on both an as reported and adjusted basis.
Sales from the acquisitions totaled 651 million and operating income on an adjusted basis contributed 82 million.
This operating income includes 65 million of amortization expense.
Adjusted EBITDA from Lord and exotic is 26.3% with this meaningful contribution from acquisitions total Parker adjusted EBITDA has increased to 19% year to date compared to 18% for the same year to date period in fiscal year 2019.
On Slide 33, we report cash flow from operating activities year to date cash flow from operating activities was a record $1.3 billion or 12.3% of sales.
This compares to 12.1% of sales for the same period last year. After last year's number is adjusted for a 200 million dollar discretionary pension contribution.
Free cash flow for the current year to date is 10.5% of sales and the conversion rate to net income is 122%.
Moving to slide 34, I'd like to discuss our current liquidity and credit positions.
Our cash as of the ended the quarter was point $7 billion. The majority of this cash is overseas, allowing the international operations to be self finance.
Our long history of free cash flow exceeding net income during growth periods as well as recessionary periods.
The strong confidence in our cash flow outlook.
With additional emphasis on are well established cash management practices, we are optimizing working capital taking advantage of the government tax payment deferrals and reducing our capital expenditure investments.
We have temporarily suspended our tenbfive one share repurchase program, but as Tom described we remain committed to paying our shareholders a dividend and we're confident we have the cash available to do so.
We have a two and a half billion dollar revolving credit facility readily available should we needed and we have no major debt repayments and due until fiscal year 23.
We remain active in the commercial paper market and as of the quarter end, we held point $9 billion in commercial paper debt.
The only active financial covenant in place is to maintain a gross debt to total cap ratio below 65%.
We're currently at 59.4% and we have two and a half billion dollars of headroom, where we in need of additional debt.
Our gross debt to EBITDA leverage metric at the ended the quarter was 3.8 times down from 4.0 times at December 31.
We were able to pay down $611 million of debt during the quarter and as we build a full 12 months of EBITDA from the acquisitions the metric will become more meaningful.
As Tom mentioned, we are withdrawing our fiscal year 2000 guidance due to the uncertainties, we are still facing through this quarter.
We ask that you continue to publisher estimates using adjusted results for a more consistent year over year comparison.
As a reminder, we will be revising our method of reporting adjusted results to include adjusting out the amortization related and the acquisition related amortization expense, but we do not intend to make that change until fiscal year 21.
We ask that you do not adjust for amortization expense in your estimates until we all consistently make that change.
If you will now go to slide number 35, I'll turn it back to Tom for summary comments and thank you Kathy we are confident in our ability to emerge stronger than we've ever been before.
And that confidence in that hope really comes from a couple of factors to win strategy. The portfolio, we have of Nida products and technologies, our culture and our purpose and probably most importantly is the last page.
Our team of people fantastic team of people, which we try to show as many as we could here on this page from all around the world and what this crisis is clearly exposed in shown it's just how was an important role everybody plays within the company I would just like against thank the global team for an extraordinary job.
Thank him what they've done to date and thank him for what we're going to do in the future and with that I'll turn it over to Latif to start the kuna.
Thank you Sir as a reminder to ask your question you will need to press star one when your telephone.
Draw your question first account.
Star one of your telephone to ask your question. Please stand by what we compile.
Yes.
First question comes on the line of Nigel Coe of Wolfe Research. Your line is open.
Thanks, Good morning can you hear me.
Good morning, I Hope, we can hear you well yes.
Great.
Okay, great. So.
So let me mention that Youll timing on analysis, you recovery and Im just wondering what that means in terms of balance sheet liquidation inventory.
Suggest that you going to be very aggressive in terms of liquid balance sheet. So my real question is.
We will keep Dodge something bigger drawn but.
Compensate you for will generate 1.8 vendor the free cash flow the 1.3 year to date.
Nigel yes, because we typically our fourth quarter, even in tough times.
Is always very strong quarter for us and we will have the advantage of working capital.
Generating a lot of cash for us in Q4, and that should help us quite a bit and so we still see that that 10% or greater CFO away as person sales is going to continue and we'll do good job in Q4, I think what I want to emphasize is we're planning for an l.
To be conservative, but we had the flexibility with whatever shape letter it turns out to be in and of course nobody knows at this point, but we have the supply chain flexibility, we have that people flexibility.
Spano whatever direction it works.
Great. Thanks.
And then my second question a on the decremental margins.
Good job, especially on the legacy talk anything.
New coming from the full cues can suggest the best let me some deterioration that run rates given the volume drop off and you are expecting but given the cost Panamaxes and then place a little bit surprised that may be detrimental Tom be managed nothing to sense I'm just wondering.
You are expecting some background of margins based telling us in our filings.
Well like I have on that slide that I outlined all the cost productions were targeting a 30% decremental a 30% Decrementals still best in class as you. If you benchmark other companies and doing a 30% decremental approximately and this kind of climate is really really good performance.
So who knows what the quarters going to turn out to be I would suggest as a folks listening.
That april's probably are low point.
We should see.
May start to improve a little bit.
Prove a little bit of to that with June.
But if you can do decrementals like this and this kind of environment, that's really outstanding performance.
Great. Thanks.
Thanks Nigel.
Thank you our next question.
Some from the lie.
Okay Fair your line.
Thank you good morning, everyone.
Glad to hear you're doing well.
I'd like to ask a question on aerospace.
The color then you've given us on April is quite different than the order.
Prior to Corona buyer is becoming an issue.
I guess I'm wondering how should we be thinking about this.
Softness in orders playing through to fundamentals next quarter and over the next couple of quarters, how does the float revenues.
And how should we think about decremental margins in this segment specifically.
Make its Tom So I think obviously, we never disclose that haven't disclosed and told US. This time aerospace on a 112, because it is lumpy and there's a lot of multi month multi quarter, a multi year type orders that get in there. So it can sometimes be misleading either on the positive for the negative side.
You look at it but aerospace what we're planning for is a significant change to aerospace it's going to go through a tough time and you've got the commercial side, that's going to come down very strongly but we have a really great military business or basically two thirds commercial one third military and that military business is growing very nicely.
So our 20% reduction in force will be in addition to those discretionary and things for aerospace. So we'll do the 20%.
And of course, that's a permanent as two new challenge to kind of reshape aerospace for this new new normal, but we will continue the reduced work schedules the salary reduction of things I have on the discretionary page that I outlined so that aerospace can flex as well.
And we feel very good at aerospace, we'll be able to do well in this new environment.
Zonnic team Thats come on is performing well they are performing.
Better the legacy Parker and it has an over 60% military business. So the aerospace long term long long term is still a great business, it's going to have a couple of years here of challenges and we are reshaping the portfolio to win in this new reality and we're doing a very quickly.
Understood, Tom but is there a way to maybe talk about this business sequentially.
From a revenue standpoint.
Just trying to make sure that we have our expectations proper the game.
Well, we're not guiding so im not going to start spouting off what I think Q4 is going to be but I think you can look at order entry there and you can also recognize that we do have very strong backlogs in this business.
So we had the ability to continue to work backlog and actually the backlogs that held up fairly well when I look at backlogs going from.
March to April to date.
Commercial OEM is at about 11 month backlog and military OEM as at almost two year backlog commercial and MRO. If you remember IR day, we talked about a two and half month, it's still about two and a half months and military emrose at about a 16 month backlog. So the backlogs are holding up I would tell you what customers are doing.
There are more rescheduling.
Quantities.
And that's what we're what we're doing is we are reshaping our supply chain demand and our people to that new reality.
Appreciate the color. Thanks.
Thanks, Mike.
Thank you. Our next question comes from Andrew Obin Bank of America.
Your line is.
I'm sorry, you hear me I apologize.
Good morning, good morning.
Just a question can you just talked maybe about a region specific trends.
Orders you provided greater granularity on orders by segment in April, but maybe just compare and contrast, how Asia Europe and US while you ask you happen how the pace of recovery in Asia, and what do you see at the end of the title in terms of your China experience.
Andrew as Tom So I'll address that.
Let me start with ill give you the Q3 I reckon as maybe a lot of you won't need to Q3, but I'll just I'll give it to you for context, and then I'll go into April and China. Your specific question. So you saw the orders on Q3 and the improvement that we saw before middle of March was really international was both EMEA and Asia.
And you saw aerospace orders state level and that was because we had very strong military OEM.
Orders when you look at it by kind of sub segment.
And this is organic.
In use already seeing total Parker minus seven of the have aerospace and let us to and have the distribution was down mid single digits pretty much steady versus other per quarter of again. This is a Q threes market summary.
Industrial was down mid single digits.
Slight improvement about 200 puts improvement versus Q2, and the mobile was down low teens.
Had a slight improvement versus Q2.
The markets that were positive we had some very strong and Mercer positive in Q3 greater than 10% was powergen semiconductor we had two markets that were positive low single digits marine and mining.
And then another declining market. So just give you and various buckets low single digit decline was mills and founders.
Mid single digit declines refrigeration will give us lawn and turf and distribution high single digit declines life science, and automotive and then that 20 to and that 10% to 20% decline was tires telecom construction heavy duty truck agriculture in rail.
Now to April.
Andrew So what we saw in April so, Florida. So you saw the segments. Let me give you color on international.
So in a page slide 14, the deck, it's 25 30 down but Asia Pacific was down.
Minus five to minus 10.
And then EMEA and Latin America down minus 35 to 40, we did have some positive end markets in April life Sciences, I mentioned, the metal ventilator work that we were doing power generation semiconductor as well as aerospace military and aerospace military MRO, all the other ones or negative.
The positive as I mentioned earlier on was that orders.
Stabilized the last two weeks it at these levels. So that did not continue to decline which is going in the first on an appealing.
In May and this was a guess on our part is that this would be somewhat similar but slightly better as most of our customer shutdowns start backup in may but there's been a lot of variations as part of why we're not giving guidance is theres start dates have moved very much almost everyday we get a new letter from a customer moving you start date.
And our levels production of moved and where they won't be finalized the startup and will start at low levels. We expect me to be slightly better than June should build slightly better on that but your point.
Well, what we're looking at release, which you are getting too is Asia. So Asia was the first to go in and the first to come out of those so Asia, well, maybe not necessarily.
Thing foreshadowing with the rest of what's going to do is illustrated to understand what happened in Asia. So in particular.
If I look at China.
Because that's really the bulk is half of Asia at least.
In Q3, the trend there I'm using round numbers on sales was a minus 30 in January minus 40 in February and then flat and March.
So we had a very sharp rebound and China orders in March this was restocking due to the pent up demand from the from January and February.
And so our thoughts about the only reason I'm going to give you thoughts on Q4 is Asia.
And so I'll give you what weve, our initial estimates or might be for Asia.
Again as indicative of might happen as you think about the rest of world subsequent months down the road.
Is that we have North Asia, China, Japan, and Korea kind of an at minus by the minus 10 for the quarter Q4.
Southeast Asia is slightly positive and then India being down probably in a high teens most of India's taking a very hard line under manufacturing capacity shutdowns that puts total Asia.
And that minus five to minus 10% range for Q4.
I would just commented that visibility as cloudy.
Totally dependent on.
Global trade doesn't probably mostly dependent on China's economy. The same challenges that we have seen the rest of world on small to medium sized companies.
China is the same issue those companies to cash.
And then the rest of Asia is still operating with partial shutdowns. If you look at New Zealand, Singapore, Malaysia, Indonesia, and India in particular.
So Asia, the first to start to heels and Thats the indicator that we see at this moment Andrew.
Yes.
Very helpful. Just a follow up question, how do you gauge the financial health a few at distributor stay ability to access capital.
Related to access this environment.
What do you think national health for your distribution stands right now.
Thank you.
Yes, Andrew this is Lee.
So I mean, it's you know we've got incredibly closer relationships with all our distribution.
And we have cash and health trucks with them.
Very current on receivables.
Right.
Just very Frank conversations on credit and we don't have any issues.
Through the channel right now to speak of.
Okay. That's helpful.
Thank you and congratulations great quarter.
Thanks, Thanks, Andrew.
Thank you. Our next question comes from David Raso of Evercore ISI. Your line is open.
Hi, good morning, I'm trying to think of the setup exiting this calendar to Q.
I mean, it looks like whether you revenues are playing out the orders we your decrementals.
It seems like your sort a wide range EPS for the quarters like a dollar to dollar 50, or so but typically the next quarter you have sales down mid single digits.
Thanks, just given what's happening here it should be the opposite they should be improving from calendar twoq to Threeq you.
I'm trying to understand the setup when you're seeing stabilization.
Getting any indication is this distributor inventories low enough that they are restocking.
OEM yet.
We're not stocking up before their shutdown. So they have a catch up im just trying to get a better sense of how comps will ultimately be that the first quarter fiscal 21.
Can really leverage off that say dollar to dollar 50 range I think we would just trying to get a sense of what's the earnings power after what could be obviously difficult calendar twoq.
So David it's Tom So I, probably won't surprise, you im not going to comment on Q1, but I'll give you that maybe some thoughts on the other parts of your question. So when I make comments about being more stable, it's the daily rate stabilizing.
For the last two weeks and our distributors are smart business people and their conserving cash just like everybody else. So they are pretty much.
Being very careful with what kind of things are going to do on inventory and we're managing inventory.
Very appropriately.
I think our Q1 is going to have an advantage because our cost structure is going to be extremely lean going into Q1, what I can't predict is what's going to happen on the topline.
I do think that we will progressively improve.
April to May may to June.
But I can't guess honestly, what the year over year is going to be because the pandemic you have to cycled a pandemic before you start to show really positive gains of it I think sequentially, you're going to start to see improvement. The big question is just the rate of improvement.
It was as Intel is that an l. will.
With the bottom Neal starts to move up or grossly the nutritional visited you. We don't know Thats why weve designed our ability to flex to that demand if it happens, but have a cost structure there could be there if it doesn't happen as well.
That was sort of Genesis of the question so.
If there's any reopening that can be stabilized at all you would think you'd revenue sequentially would go against the historical norm and one it declined mid single should improve but from your answer it sounds like it's more OEM right now.
And is it distributor and to your point I'm, just trying to figure out the incrementals coming out because if it's OEM over distributor you'd rather have distributor, but to your point, you're going to have cost outs that should not automatically come back.
All right you should have some leaned out costs, but again, it's more oh, we improving from here are stabilizing lets say then and I should think it's the distributions more OE. Okay. So I get I get your question more data. So I think you will see improvement marked improvement across both channels OE and distribution because.
Those order rates today that we showed you on that slide for April.
Our pretty equally representative distribution and OEM might be slightly better distribution, which are pretty much the same.
So you're going to see both them come back it won't be located we just get a rebound in OEM and distribution stays the same you'll get both come of that.
Thats helpful. I appreciate it and lastly, anything about how you're viewing the world now that changes how you feel about what leverage you want to come down to.
For and I know never was imminent anyway, but we used to talk kind of 12 18 months.
How do we thought it all what you are comfortable with on leverage.
For you would lean back for via M&A or repo.
Dave It's Tom again, so we still feel strongly we want to get back down to the approximate 2.0.
Level on a growth gross debt to EBITDA that was our feeling before the crisis is still are feeling.
Okay. Thank you very much.
Thanks, David.
Thank you next question comes from making Jones.
Your line is open.
Good morning, everyone.
Running Nathan.
Hi.
Question on the Decrementals.
You guys have done noise going in the decremental margins with the acquisitions follow the gain is that 30% decremental that you're targeting.
Including the acquisition, excluding the acquisitions, how should we think about that.
Nathan as Tom that would be excluding acquisitions.
Legacy business, but I would just telling the two acquisitions are doing extremely well.
And I would just.
Want to make one quick common in cases people at more might a more questions and acquisitions.
Part of what you see the improvement in North America is our synergies on board have accelerated we've gone from what we told you last quarter at 18 million and that's why $20 million to $30 million.
And we've been able to accelerate our question a onboard and so we look for Thats decrementals on legacy.
What we looked at the two acquisitions both acquisitions as you saw are coming in.
Really nice lowered has significantly beating where we thought they'd be an EBITDA. There are approximately 27% EBITDA for Q3 and exotic was in the mid Twentys and both of those businesses are executing the same kind of cost reductions and cash actions that the rest of the business is doing.
So they will continue to be helpful. Do their topline is holding up better than legacy Parker and our margins are better. So do they will continue to hold but that decremental I quoted was on the legacy business.
Okay and on the.
On the cost that number is.
The 250 to 300 million it sounded like.
That was in place on April one have you already at the run rate that and then the 25 to 30 that structurally coming out of the aerospace business, how long does that take before that fall did your cost structure.
The numbers around a page or what we will feel in Q4.
So the.
The full full quarter, you'll feel it and it's more than just aerospace infrastructural result, and gas things, we're doing and are things really across every group that we're doing as well, but clearly a lot of it as aerospace driven.
And then just one quick one on the exotic synergies you talked about them what's energy there.
The large drop in the expectation for aerospace the.
Reduce the expectation of the amount of synergy that you can get out of exotic over the next year.
Yes for exotic.
We had a pretty minimal amount of the synergy if you remember is $30 million and we recognize that with material savings for exotic you've got long supply agreements and they really weren't going to start to kick until you are 22 and 23.
And most of exotics synergies were productivity and the one strategy, which we feel pretty good vessel to $13 million short answers, we feel good about that does not changing.
I would just highlight again for exotic.
There are top line in Q3 was still significantly better than legacy Parker upward.
Clearly fortunate over 60 person that business is military and we've been able to pull in and accelerate our F. 135 work to kind of help cushion what's happening on the commercial side and so for exotic to deliver mid 20, EBITDA us given what's going on it's just really fantastic performance for them.
Hi, Thanks for taking my questions.
Thanks Anthony.
Thank you. Your next question comes from Jamie Cook of Credit Suisse Your lines.
Hi, good morning, and nice quarter.
Thanks, Jamie I guess my question.
He kept talking about the resilience of exotic anymore through the third quarter can you start to talk about trends that youre seeing in April.
Businesses and then my second question with regards to that 30% decremental I assume that's specific to the fourth quarter and my question is if foreign a prolonged downturn. How confident are you with decremental margin because some of the actions you're taking.
More short term versus like salary cuts and stuff like that person's long term. Thanks.
Okay, Let me start with the second parts of the third as a percent decremental in Q4.
That will continue going forward, we'll continue to do the things we have to do to two flux the business to deliver that and again I'm, saying approximately 30%.
Regardless of what's happening with the topline.
I believe that this will eventually start to terms you had to be careful that you don't do too many permanent structural actions.
And prevent your ability to respond. So we we will watch set we obviously won't let the temperate things go on forever because that would be unfair to people. We would then have to turn them into permanent but we'll look at that quarter to quarter and make those decisions as a team, but I think you can expect the decrementals in the resilience remember results you're seeing now is.
Five years into making work we've been doing on and I would say, even before that that stair steps on those margins happen because of all the actions we've done over the last 20 years, we've been building a more resilient business model for 20 years no. So this is why we're able to perform here, but specifically you've seen the margins significantly increased the last.
Five years and that you could point directly to win share to 2.0 or for that the trends on the in April.
For lower and exotic so I don't really want to go into too much detail owns over to say that lowered.
Would be probably.
Half as better and better than what you saw for legacy Parker at least half better I mean, I mean was half less bad so that's a way to say that an English.
And I would say the same thing.
For an even better for exotic because exotic is probably going to be able to hang in there at a high single digit type of decline because those are very strong military business.
And Thats whats really really opened that we've been able to pull forward and our customers have approved this the F 135 work.
We just happen to be very fortune. Thank you to the exotic team.
We are having such a big bill of material on one of the Premier military programs really in our history.
Okay. Thank you I appreciate.
Thanks, Jamie.
Thank you. Your next question comes from Nicole Deblase of Deutsche Bank. Your line is over.
Yes.
Okay.
Turning the call. So I just wanted to talk a little bit more about distributor inventory levels.
You could just comment on how do you think distributor inventories have right.
That level of demand I'm, just trying to gauge how much restocking would be required.
Come out of that.
And increase.
Nicole This is Lee.
You don't my sense is that inventories are in line with demand, they're not buying anything there conserving cash. So what I think you would see is a pull through on real demand through the channel back back to Parker Hannifin.
Okay got it thanks Thats helpful and then on.
It is the expectation that you guys have more opportunity to continue paying down debt in the fourth quarter or is the next tranche of not likely to be coming in 2021.
Nicole This is Kathy will watch how things are going through the fourth quarter, but if you look at our expectation for cash flow. We will have some flexibility I believe to pay down additional debt during the quarter and if we're comfortable going into next year in the position that we are.
Our then I think we will definitely do that.
Got it thanks.
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Okay. Thanks, Michael.
Thank you our next question comes from.
Of JP Morgan your line is.
Hi, Thanks, this is going to calling on behalf and.
Provide more of an update.
Lower discount rate environment and weaker equity returns on your planned funding.
Sure this as Kathy.
The pension the discount rate that were currently booking expense to was set last June and we said at once a year at our June 30 timing and we're at a discount rate of 3.28%.
As we disclosed in our Q if the rate dropped 50 basis points that will have an impact of about 15 million to our expense. We're watching it we in as of the June rating last year, we had no required pension contribution due until.
Fiscal year 23.
As the rate will likely drop and we'll have some impact on the need to fund, we don't anticipate it being any sooner than fiscal year 2002.
And so we have again.
Year, plus before we'd have any and that payment, we think would be pretty minimal amount required.
So no funding requirement, we don't think where the for the rest of this year end fiscal 21.
Great. Thanks.
Okay. Thank you.
Thank you. Our next question comes from Stephen Volkmann of Jefferies. Your line so.
Great.
We expect could do a couple of longer term questions here and I'll, just sort of keep them together I'm wondering probably too early to answer a lot, but I'm wondering if there's any change in your long term margin expectations.
Laid out recently and second to that.
Given that things will look like they could be a little bit differently or for some of the end markets White you've mentioned in the aerospace in oil and gas does that potentially for renewal.
This is that might candidate.
Sure.
Forward. Thanks.
Steve as Tom So the margin targets that we gave you an investor day.
Our still the targets, we're not moving off of those are still what were what we're striving to get to free up by 23.
And we still think we can do that.
From the Divesture side oil and gas and aerospace are still great businesses, and we are able to performed well in those end markets.
And we use all eight of the technologies into those end markets.
So they meet all the performance criteria to stay part of the team and we'll get through this near term challenges and we're going to reshape those businesses to win in this new market.
But these are really strong business for us have all the right kind of returns. So yes, they will stay part of the portfolio.
Thank you good luck.
Thanks, David.
Thank you. Our next question comes from Julian Mitchell of Barclays. Your line is open.
Hi, good afternoon.
Maybe just a quick question around.
Aerospace again.
You've taken some fixed cost measures in that business. So the assumption understandably is is for a prolonged downturn, maybe just help us understand what you're thinking about aerospace aftermarket within the commercial side specifically.
And is it fair to assume similar to pay is the decremental margins on that off the market decline will be very very severe.
And then sticking to aerospace one of the knowledge defense contractors talked about.
Production.
Choppiness for the F 35 program.
Just one that is.
You'd seen any of that or expecting any type of slow down or disruption on that program on the military side. Thank you.
Agility as Tom I'll start with that one.
No not seen in each other's it's perfect. We are accelerating our delivers so everything has been fine on that and then the commercial MRO you're right as you might expect that's appealing a very sharp decline is probably in the greater than 50% type of decline area.
And.
That will take a while to heal you'll need to the public to want to get back and.
Airplanes.
But they will have you think about it over time here I think the leisure traveler once the right kind of safeguards and comfort or there will come back.
Who knows how long that takes what they will come back in the business traveler will come back we're probably not levels that you've seen because we've all learned that theres a lot of digital productivity that you could do.
That's why we're designing a structured aerospace to be able to win.
As it might take a little while for this to heal.
Nobody fully knows but I think you'll see the leisure side hills faster the business travel will come back, but probably not come back 100%, but then you'll have the demographics of over there before is that aerospace.
Tends to follow GDP historically.
Intends to apology to appear to X GDP. So once you get through this kind of reshaping of aerospace. It will start to then follow that kind of growth rate, which is a nice growth rate and we will continue to have this business performed well we will do the things to make aerospace as creative businesses is now be great.
In a tough environment.
Great. Thank you.
Thanks, Julien, let Keith we have time for one more question.
Yes, Ma'am Nextquestion comes from Andy Casey of Wells Fargo Securities. Your line is so.
Thanks, a lot help everybody as well.
Thanks, Andy.
I just was looking for a little bit more color on the what you may be saying on the distribution inventory actions.
Going into the quarter it looked like those might be stabilizing a little bit clearly April they probably felt loss, but as the pattern kind of stabilization and then reacceleration.
Yes, Andy.
I think the way I would characterize that you're right.
They were declining to stabilizing in March I think the second half from March.
You know there was.
The channel saw what was coming there was a conservation of cash really not buying anything we saw a direct impact.
Through our through our divisions from distribution I would tell you in April as time characterize they are down about as much as the Oems are down right now so.
I think any kind of rebound we get in demand.
We will facilitate a rebound of demand directly to our divisions.
Thanks, Lee and then.
Should we kind of look at the distribution as in terms of regions as similar to what.
Tom and laid out in terms of.
China, getting a little bit better.
Down less maybe getting better.
And then the other regions still down.
Yes, I think the way to think about distribution is really the the.
The reemergence of the manufacturing base. So you know a lot of our distribution.
Is dealing with our MRO activities inside the manufacturing space and when they're close they're not buying anything so we've seen a rebound in distribution in.
In Asia, China, specifically Europe's been incredibly soft.
Along with North America in Latin America.
Okay. Thank you very much.
Okay. Thanks, Andy This concludes our Q and a session and the earnings call Provident, Jeff will be happy to take your costs should you have any further questions.
Thank you for joining us today stay safe and enjoy the rest of your day.
Ladies and gentlemen that concludes today's conference call. Thank you for participating you may now disconnect.
Yeah.
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