Q2 2021 Parker-Hannifin Corp Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Parker Hannifin Corporation fiscal 2021 second quarter earnings Conference call and webcast. At this time all participant lines are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question during the session.

I need to press star one on your telephone.

Please be advised to today's conference is being recorded.

Do you require any further assistance. Please press star zero I would now like to hand, the conference over to your Speaker today, Todd Ma'am Bruno Chief Financial Officer. Thank you. Please go ahead Sir.

Thank you Gigi and welcome everyone to our earnings release webcast.

This is totally and Bruno Chief Financial Officer, and joining me today are chairman and Chief Executive Officer, Tom Williams, and President and Chief Operating Officer Lee banks today.

Today's commentary and the slide presentation will be accessible is on on demand webcast on our investor information website located at th stock Dot com and will remain available for one year.

If you move to slide two you'll see the company's safe Harbor disclosure statement addressing forward looking statements as well as non-GAAP financial measures.

Reconciliations for any reference to any non-GAAP financial measure is included in today's material and are also posted on our website at ph Doc on Dot com.

If you move to slide three you'll.

You'll see our agenda will begin with chairman and Chief Executive Officer, Tom Williams, providing some strategic comments and highlights from our second quarter. Following Tom's comments I'll provide a more detailed review of our second quarter performance and review the components of our increase to guidance for the major of our fiscal year FY 'twenty one.

I will then provide a few summary comments and we'll open the call to questions from Thomas Lee or myself with that Tom I'll hand, it off to you. Thank.

Thank you Todd and good morning, everybody. Thanks for your participation today.

Before I move to slide four I wanted to make a few opening comments calendar 2020 was an extremely difficult year to say the least for all of us both professionally and personally.

I hope all of you are staying safe our global team has come together like no. Other time in our history has responded to this combination of on health and economic crisis, we've rallied around our purpose and the win strategy really showed their parkers an exceptional performer.

Even on the most difficult of environments.

Like to take this opportunity beginning here to thank our global team for just create performance you're going to see evidence of that over the next couple of slides.

Go to slide for <unk>.

One of our key competitive advantages our breath for motion control technologies.

For now up to two thirds of our revenue.

Talked about this historically it was 60% now for two thirds of our revenue comes from customers that buy from for more of these technologies.

These interconnected technologies that enable us to create even more value for our customers. He created a distinct competitive advantage versus our competitors.

Moving to slide five we.

We just had outstanding performance for the quarter were running through some of the highlights top quartile safety performance. We had a 23 per cent reduction from a Carnival instance, this now makes 75 per cent reduction for the last five years, which is a phenomenal sales.

Sales decline was two five per cent year for here you can see it was a little over 6% from an organic standpoint, this was significantly better than our guidance.

About 50% plus improvement from where we were on Q1.

Q2 was a record net income at $447 million.

EBITDA margin was a little over 23% as reported or 28% adjusted you can see the significant improvement versus prior to on a 30 basis points.

Year to date cash flow from operations was a record at 24 per cent of sales.

On the table to bottom there has got to segment operating margin, both as reported and adjusted basis I'd call your attention to the adjusted ROE.

<unk>, 4%.

Sue on operating margin as adjusted.

In a giant increase versus prior of plus 250 basis points. So there's a lot on numbers on this page.

A lot of companies to track so the easy way to remember this is the quarter, we put up 300, Twenty's and <unk>.

Happened to highlight and gold so greater than 20% EBITDA margin <unk> margin and say when our providers. So we're pretty proud of that and those are all create results during a pandemic.

Fantastic job on whole team.

If you go to slide six where I will talk about cash flow.

Big cash flow quarter paid down $767 million of debt quarter. If you look at the last 14 months is $2 $8 billion of debt. This is a little over half of the acquisition. We took on a sort of exercise which is great progress. There you see the ratios in the middle of the page there of significance. If we go back.

A year ago, we were for point zero.

And now we're at two seven on a gross debt to EBITDA basis.

We've now reinstated effective in this quarter Q3.

Three are.

<unk> one share repurchase program.

So I'll move to the next slide which is our transformation of the company and hopefully just the last two slides or are indicative of how the company has transformed but I'd like to give a little more color or context as to what we're doing so we can move to slide eight.

This is our strategy summary on a page and it's flanked on the left side with why we win which you've heard me talk about this in the past.

This is a list of our competitive advantages.

Highlights for them, so I'm not going to talk about them necessarily today, but their historical success factors that will continue on into the future on our focus most of the time for my next couple of slides on where we're going and I've got a slide on each one of these bullets and the output or fully this historical successfactors on where we're going.

We want to be a top quartile company, we want to stand out on the crowd and we think we're doing that so if you go to slide nine.

One strategy. This is three point, though this is our business system with pound for pound.

This has been the most impactful change we've made to date for the win strategy, it's going to be when three point.

And our purpose statement theyre going to be the powerhouse behind our future performance.

Good at 10.

You've seen our purpose statement, enabling engineering breakthroughs that lead to a better tomorrow.

This is a statement that everybody has really rallied around the foundry exploration within the company.

As enabled everyone to connect their efforts to this higher call on this higher purpose in life and it really helps to answer the question on how can we help through our customers create a better tomorrow.

Given what's going on with the coronavirus and the vaccine slide 11.

Probably create highlight of our purpose in action and just how essential we heard for the vaccine value chain the way to read this slide to.

To go left or right and go in a clockwise fashion was turned on the upper left hand corner. So we're on a development of production phase.

These vaccines mixing purification and filtration on dispensing.

Then you've got to get the product.

Around so we are on sterile transport containers, especially designed and then all of our motion control technologies are in both air and ground transportation for that move the product from around the world.

You need to be able to store locally that requires low temperature refrigeration. So our refrigeration technologies are at play there and when he administered to the patient again you need on <unk>.

Premise refrigeration.

Stoppers and strength sales as part of our engineered materials.

Offering so we're very proud to be part of this value chain and through our customers, hoping to create a better tomorrow that all of US as I started this call are striving for as we tried to exit the pandemic and deliver billions of vaccines for people around the world over the next.

Orders of gears.

If you move to slide 12 on my last slide from my opening comments.

On a focus on our strategy to grow fast in the market.

And our proxy for the market as global industrial production growth, which is skippy that acronym. So on the left hand side. It's a series of portfolio of things that you've seen us make transformative portfolio company buying three great companies $3 billion of acquired revenue.

For all accretive on growth cash markets.

Matter of fact, as an example.

Lower grew mid single digits last quarter, while the rest of the company total company growth minus six on the right hand side, because the list of organic growth strategies and what's interesting about the splits with the exception of international distribution. These are all new with one share jets, we point out so going on.

A quick comment on each one for strategic positioning it.

Really our effort to focus on stronger divisional strategies, and we have a cadence with every division with 2383, a month and these are extremely productive conversations with our general managers, how theyre going to position your division to wind versus the competition second bolt on on innovation. We've made two big changes one is a metric.

PPI, which is product vitality index to measure of new products as a percent of sales looking at a five year period for new products.

New product blueprinting, which is that NPV acronym there has really changed for ideation process to create better ideas coming into the innovation funnel.

What we're trying to do here is that we want our PVA context, the percent of sales to grow by 600 basis points over the next five years and more innovative portfolio.

Petr chances to growth better margins et cetera.

And then simplify design I've talked a lot about that.

Speed initiative, it's a cost initiative, it's a customer experience initiatives.

As for recognition at 70% of your costs are tied up on how you design a product and simple by design is all about focusing on design excellence. So when you put together design excellence with operational excellence. It's a day on my parent international distribution is going to continue on.

The success, we've had with two point out.

Digital leadership is really a four pronged attack digital customer experience digital products digital operations and digital productivity and does your productivity is where we have a.

Concerted effort on artificial intelligence and data analytics, and then lastly, a new incentive plan our annual cash incentive plan.

And thats going to focus our divisions and the whole company on driving growth cash and earnings. So it's this combination.

This combination that has helped us perform better on the top line.

Organically in particular on the current downturn and it will be our catapult to growing fashion on the market as we go forward, so with that I'm going to hand, it back to Todd for more details for the quarter.

Thanks, Tom.

I'd like to direct everyone to slide 14, and I'll just begin summarizing our strong second quarter results. This slide displays as reported and adjusted earnings per share for the second quarter and I'll focus on adjusted earnings per share.

We generated $3 40 for this.

This quarter and that compares to $2 98.

Last year, if you look at the breakdown on the adjustments for the FY 'twenty, two or excuse me FY 'twenty one as reported.

It netted to <unk> this quarter on that is made up in the following buckets business realignment expenses of 14.

Integration costs to achieve of <unk> acquisition related amortization expense of 62.

And as we communicated last quarter, we are adjusting out the gain on the sale of land that amounted to 77.

And all in the net tax impact of all of those adjustments is too.

Last year, our second quarter earnings per share were adjusted by $1 41. The details of which are included in the reconciliation tables for non-GAAP financial measures.

If you move to slide 15. This is just a walk from the $2 98 to $3 44.

For the quarter and despite organic sales declining 6% and total sales declining two 5% adjusted segment operating income increased by $70 million for 11.

That equated to <unk> 42 per share so very strong operating beat for the quarter.

Incremental margins on a year over basis, our favorable demonstrating the excellent operational execution robust cost containment by our team members really in every segment and every region.

If you can tell you on the slide we had a slight headwind from higher corporate G&A. Just <unk> that was a result of market based adjustments to investment tied to deferred comp and as Tom mentioned, our strong cash flow allowed us to pay off a significant portion of that on a year over year basis that reduced our interest expense that equated to <unk> 12.

For the quarter and then if you look at the remaining items. Other expense was just one slightly higher.

We had a higher effective tax rate that impacted us by <unk> and finally slightly higher diluted shares resulted in a 270.

Impact for that is how we get to the $3 40 for us.

If you move to slide 16.

Savings from our cost out actions on I know theres been a lot of questions. On this just from some of the early reports just to reminder, these represent savings recognized in the year as a result of our discretionary actions in response to the pandemic and volume declines plus the savings we realized from our permanent realignment actions taken.

In FY 'twenty and also on FY 'twenty one so if you look at this our second quarter discretionary savings exceeded our forecast and now amount to $190 million on a year to date basis. We are now forecasting for the full year that discretionary total will increase to 225 million for an increase of 50 million.

The majority of that increase was recognized in the second quarter and roughly amounts to $35 million above our.

<unk> forecast.

Just a reminder, as demand continues to increase and our teams pivot to support growth. We expect these discretionary savings to be lower in the second half per.

Permanent actions remain on track there is no changes to what we have communicated previously our full year forecast will generate savings of $250 million and that will be $210 million incremental and.

And we believe that this will help us generate strong incremental margins that we have in our guide for the second half.

If we move to slide 17. This is just the work of the total results for the company sales and segment operating margin and as Tom mentioned organic sales did decline by six 1% this year.

The decline was partially offset by the contributions from acquisitions that was two 6% and currency impact of 1%.

And again, despite these lower sales total adjusted segment operating margins improved to 24% versus 17, 9% last year. This 250 basis point improvement reflects all the positive impacts from.

Our win strategy initiatives, the hard work and dedication to cost containment and productivity improvements as well as savings from those realignment activities I just spoke of and really performance of the recent acquisitions. So strong execution really across the entire company to get these results.

If we jump into the segments. If you go to slide 18, looking at diversified industrial North America sales there declined by five 9% acquisitions were up plus a three 1%.

Currency only slightly negatively impacted sales, but again, even with these lower sales our operating margin for the second quarter on an adjusted basis increased <unk> to 21, 3% last year. It was 18, 2%. So again another impressive 310 basis point improvement focused on our long term.

Initiatives around the win strategy.

Along with the productivity improvements.

Diligent cost containment actions and really some increased synergies, we're seeing out of the Lord acquisition.

So if we go to the next slide slide 19 for diversified industrial International.

Organic sales for the quarter.

Increased by three 1% acquisitions added three 2% and currency accounted for three 5% again strong operating performance here for the quarter, we reached 23% of sales versus 16% in the prior year and again same story win strategy initiatives strong synergy.

Growth and really our teams around the world rallied together in light of the spend.

Hello.

If we go to slide 20, I will talk about aerospace systems segment and again.

What we'll see here is a decline of 29% for the quarter acquisitions helped us by <unk>, 4% and again.

Small currency impact of <unk>, one really declines on the commercial businesses, both in the OEM and aftermarket and markets, where the main impact. These were partially offset by higher sales in both military OEM and military aftermarket sales.

Operating margins for the second quarter was 18% versus last year's 22%. This resulted in a decremental margin of 28, 8%, which is in line with our expectations and really the result of all.

All the previous actions, we've taken to realign the aerospace business to current market conditions, along with strong cost controls and really helping to offset the pandemic and post mix that we're seeing from the commercial and military.

Yes.

Slide 21 is just some highlights on cash flow Tom already mentioned this but our operating cash flow activities increased 64% year over year to a record of $1 three $5 billion of cash. This is an impressive 24% of sales. Our global teams are really focused on this very disciplined.

Managing our working capital across the World and we're really focused on delivering strong cash flow generation.

If you look at free cash flow year to date, we now move to 19%, that's an increase of 78% versus prior year and our cash flow conversion is now 164 versus 130% last year. So just strong cash flow performance from from the team very impressive results.

If we wanted to just focus on orders real quick moving to slide 22, our orders came in at flat this year or this quarter I should say and that was really driven by plus one in our industrial North American businesses.

Plus 10 and our.

Diversified industrial businesses and minus 18 on a 12 month basis and aerospace.

So all in we came in flat and Thats. The first time in seven quarters I believe.

Ben.

Negative.

If we move to slide 23 on the guidance, obviously, we have a pretty large guidance.

<unk>, we are now providing this on an as reported and adjusted basis and based on the strong performance. We just spoke of in the first half all the current indicators that we see right now we've increased our total outlet for sales.

Two a year over year increase of one 7% at the midpoint.

This includes a forecasted organic decline of three 4% offset by increases from acquisitions of two 9% in currency of two 2%.

Just a reminder, we've calculated the impact of currency to spot rates based on the quarter ending December 30th and we've held those rates steady as we look through the second half of our fiscal year.

In respect to margins.

For adjusted operating margins by segment on at the midpoint. We are now forecasting to increase margins 150 basis points year over year and that range is expected to be 22% to 24% for the full year.

And if you note for items below segment operating income there is a fairly significant difference between the as reported estimate of $3 88, and the adjusted for.

Forecast of 487, the differences that land sale that we spoke about that for $101 million pretax $76 million. After tax that was recognized as other income in Q2.

And since that's an unusual one time items, we are going to adjust that from we have adjusted that from our results full year effective tax rate no change, we still expect that to be 23% and for the full year the guidance range for earnings per share.

On an as reported basis is now $11 90 to $240 or $12 15 at the midpoint and on an adjusted per share basis. The guidance range is now $13 65 to 14 15 or $13 90 at the midpoint.

Adjustments to the as reported forecast made in this guidance at a pretax level include business realignment expenses of approximately $60 million for the year associated with the savings projected from those actions to be $50 million in the current year.

Acquisition integration costs to achieve.

$50 million of expense <unk>.

Synergy savings for the Lord acquisition are now projected to reach 100 billion that is an increase of $20 million from our prior.

Stated numbers of $80 million and that is included in our guidance exotic synergies remain on expected to be $2 million for the full year.

Just to reminder, acquisition related intangible asset amortization expense is forecasted to be $322 million for the year and some assumptions that we have baked into the guidance here.

At the midpoint are sales are divided 48% first half, 52% second half and both adjusted segment operating income and adjusted EPS is split 47% first half 53% second half for.

For the third quarter of FY 'twenty, one we are forecasting adjusted earnings per share to be $3 50 for at the midpoint and that excludes 57 or <unk> $97 million of acquisition related amortization expense the business realignment expense and integration costs to achieve for the quarter.

So if you look at move to Slide 24. This is really just a walk from our previous guide to our revised guidance, we had guided at $12 per share last quarter based on the strong second quarter performance, we exceeded our estimates by $1 six.

And we've mentioned this but the improving demand environment, along with the strong operational performance.

Some additional extended discretionary savings the permanent restructuring savings and increased Lord synergies, we feel confident in raising our forecasted margins, which at 85% of segment operating income over the next two quarters for the remainder of the fiscal year. So.

The majority of this increase is based on operational performance.

This calculates to an estimated incremental margin of 41% for the second half.

And then some other minor minor adjustments to the below segment operating income lines.

Or a negative impact of <unk>.

And Thats, a net of interest expense and income tax. So that's how we get to the $30 90 that is approximately a 16% increase from our prior guidance.

So if I can.

And direct you to slide 25, I'll turn it back over to Tom for some comments. Thank.

Thank you Todd.

I want to wrap things up with these great results don't happen by accident or driven.

Really engaged global team.

Our focus on safety high performance teams lean and Kaizen is driving an ownership culture within the company and its resulting a top quartile engagement as well as top quartile results.

We've talked about the portfolio, it's a big competitive advantage of us and our connectivity.

Transformation on the three acquisitions and the fact that Theyre outgrowing engineering more cash and margins on the legacy Parker our performance over the cycle, but I would just reflect on the last five years and just use round numbers. Our margins are up 500 basis points and a five year period of time that was not just for the easiest five year period of time for north.

For companies.

Then our win strategy three point on a particular purpose statement are going to be the powerhouse behind <unk>.

<unk> for the future. So again my thanks to everybody for all their hard work on the credit results.

And JJ, we'll hand, it back to you for.

Start the Q&A.

As a reminder to ask a question you will need to press star one on your telephone.

Withdraw your question press the pound key please standby, while we compile the Q&A roster.

Our first question comes from the line of Joe Ritchie from Goldman Sachs. Your line is now open.

Thanks, Good morning, everybody and congratulations on a fantastic quarter.

Joe.

Maybe just kind of just starting off.

Obviously.

It seems like being very thanks for kind of coming off the bottom here, you're starting to see some improvement on the order trend.

In your industrial businesses both domestically.

And internationally can you maybe just walk us through exactly like what you saw what your per.

Really seeing on what you saw kind of transpired as the quarter went on.

Sure.

On the orders too.

We saw if you look at.

Total Parker from minus 12 to zero in North America are a modest 11 plus one.

Nashville from plus or minus.

Minus for plus 10.

Aerospace get a proof of minus two quantified them on as <unk> pretty.

Pretty much North America international improve throughout the whole quarter and from our view it looks like aerospace is finding part on the international piece in particular.

If you look at that plus 10 that was EMEA plus seven Asia plus 13 on Latin America Post 2000 service are pretty strong.

Rebound across all of the particular regions internationally.

When I look at some of the higher level subs sub segments. So the major buckets outside of aerospace distribution get better.

Minus <unk> 14 per quarter minus six.

This quarter industrial.

Thanks for stationary went from <unk>.

Minus 7% plus one five.

On mobile saw the biggest approval from minus 13 to plus two and a half. So we saw all the sub segments improved nicely.

With the largest recover being on mobile.

Look at our end markets for the four phases of growth.

Roughly 30% of our end markets are accelerating growth.

Two thirds of R&D silver and declines so we continue to move on.

All of the various end markets into either bottoming out and you saw a decline is starting to turn for accelerated growth.

And maybe I'll pause to I don't know if you want me to go through all the end markets, but that's that's the color we saw on distribution.

And entities talking which was encouraging.

Servers.

I would say cautiously optimistic there.

We're being careful there is some uncertainty obviously the next six months.

We are seeing from distribution is.

Selective restocking.

In particular, focusing on those longer lead time type of products that they can get ahead of demand and position themselves to take share, which we're happy to help them with that and in general we're seeing from distribution in some cases with some of the Oems is placing a little larger stock orders, which.

With scheduled releases over the next several quarters, which are all indicators that people I think trying to plan is a few things returning as George and get it get ahead of things.

Yes, that's true.

For helpful and great to hear Tom if I could I just ask one follow up question and really just focusing on sustainability.

Margin improvement going forward clearly you have got a lot of long term action within the win strategy that theyre going to help but I really want to focus on the temporary cost actions that are benefiting FY 'twenty, one the roughly $225 million.

Should we think about that beyond 2021 are you is that is that going to be a headwind beyond this year or are there. Other actions you can take to mitigate some of those expenses coming back.

Yes, Joe This is Todd I'll take that one I mean, some of these things are volume related so as volume continues to come back we expect some of those costs to come back into the business, but really what we what we saw on the second quarter was.

A lot of productivity improvements. This has been based on our focused on chi's on for a long time.

Elements of our win strategy initiatives have helped drive that but theres been strict cost containment containment by our teams are really around the globe.

What did surprise us a little bit was lower travel and lower discretionary expenses.

That's why we increased the discretionary expenses for the remainder of the year just based on the current situation that we see in the world right now, but we do see that.

Returning nowhere will it go back to the levels that we've seen in the past, but we do see it going on from where we're at.

Got it thank you both.

Thank you. Our next question comes from the line of Nicole <unk> from Deutsche Bank. Your line is now open.

Yes, thanks, good morning, guys.

Morning, Nicole.

Can we start with just looking at.

<unk> outlook whats baked in at the mid point with respect to organic growth and if there is any big.

Alright, divergence and the incremental margins, you're expecting in <unk> relative to <unk>.

Yeah, Nicole this is Tom so if I take the top line and maybe to help with.

The guide for the full year. So we reduce the guide on decline on an organic from minus seven five to minus three and a half, but I think what's probably of most interest to analysts and shareholders is what do we think the second half is going to be so the second half our assumptions is that God is North America and international.

And that kind of that 6% to 7% positive organic growth.

And aerospace.

At around minus 11 for the <unk>.

Second half when we look at Q3 I want to focus on a tough on I'll come back to us.

Yes.

Decrementals on Incrementals.

Q3, we're going to see a slight improvement on the industrial force of the company of about 100 basis points as there is still some uncertainty in those orders I referred to earlier on.

Scheduled releases are calling out multiple quarters.

<unk> aerospace are about the same.

As we had in Q2.

When we get to Q4, we've got North America and that.

Upper teens.

International around plus 10 in aerospace getting to flat.

And that puts total Parker in Q4.

The low teens for Q4, so again industrials.

For the second half net plus 6% to 7% range in aerospace at minus minus 11, so when we think about.

The margin side of things.

Q3 margins are going to be slightly less in Q2 and is mainly from the reasons that Thomas described.

We're going to have less discretionary savings in Q2 that we had in Q3.

Q3 should be around $25 million Q2 was 65 million.

<unk> got $40 million less discretionary savings going into Q3.

We will still have a favorable MLS and that people aren't familiar with what the term is that's basically have less sales and you've got more earnings.

Really calculated.

On incremental but it's favorable.

We get to Q4.

We've got approximately 30% from or less I would just make the comment for Q4 really for the first half of FY 'twenty two that the incremental MRO losses are going to be a tough comp for us so the plus 30.

This is against remember Q for prior period, we had the gargantuan discretionary.

Cost households wage reductions at that time, if you were to make it like for like take out discretionary actions for both periods. This will be a greater than 60% incremental.

So.

Business is performing at a very high level, you'll see margins get a little better into Q for the appear our highest margin quarter.

If you just look at for the second half.

We go from.

21% as the first half total company for 27 in the second half so.

Continued improvement.

We're not going to stop there obviously, we our goal is to keep driving this as we go into FY 'twenty two.

Got it thanks, Tom that's Super helpful.

And then maybe just for the follow up can you just talk about any impact you're seeing too.

Reduction supply chain with respect to Covid and what level of confidence you have as a result and ramping as this recovery does take place.

Nicole It's Tom again, when we look at Covid and its impact.

We're mirroring case rates and the local communities that we're at we've done a great job of it.

I would say almost exclusively our cases originated from outside of work and we've tried to take the position we want people to be safe at home, let's say for work, but we'd like them to be the safest possible that could be one day or at work.

Not immune to.

Absenteeism type of things as it relates to this but it's not been material impact for us we've been able to keep up with demand.

Keep up with our lead times and if you look at US historically, obviously as the pandemic is a unique phenomenon.

Periods of increased demand.

We out service our competitors.

Something we've proven time and time out.

Look for us to have the opportunity to take share because our lead times on our customer experience will be better than our competitors. So I feel very good and on the supply chain side.

We purposely laid out a strategy years ago to be local for local so we make by its still in the region for the region so that.

That supply chain strategy net operational strategy allows us to be very flexible based on what's happening to not have all our eggs in one basket on one particular region to be overly exposed on trade.

Tariffs on those type of things so we feel pretty good about where we are on supply chain.

Thanks, Tom I'll pass it on.

Thanks Nicole.

Thank you. Our next question comes from the line of Scott Davis from Melius Research. Your line is now open.

Hi, good morning, guys.

Scott.

And.

And I don't say this very often but congrats on a great.

Not just a couple of quarters, but man Greg class two or three years has been just phenomenal.

Impressive but.

Anyways.

I wanted to talk a little bit about M&A, because you've been so successful in that front, which is not perhaps not something folks would have expected out of Parker in the old days.

Going to be down to two five turns of debt as you said this year and.

Are you ready to reload on on the M&A front do you have an interesting.

Backlog at all that you want to talk about.

Yes, Scott first of all Tom. Thank you for your comment on the recognition of the progress.

Simcoe on notice and we do appreciate it.

On the M&A side, what's been interesting, we're really happy about.

The cash flow and the ability to pay down debt is clearly ahead of schedule and we're going to be a physician come into this fiscal year, where all of our service level to term loans on the CP that we took out for these acquisitions will be all paid off.

And our next corporate bond is not due to the September 'twenty two.

The nominal amount of $300 million, so we were going to be.

<unk> with a much stronger balance sheet to look at capital deployment.

All of the day and snow.

And particularly you talked about M&A so.

Lesson learned for us historically is to never stop working on the M&A pipeline.

And so we're continuing to build those relationships we are building those relationships.

A couple of themes, we want to be the consolidator of choice within our space.

Thank you.

A leader in this space, we think for the best home, which means we'd like to be looking at anything within our space in particular, though if we only had a certain amount of money in all eight of the technology that I referred to earlier on overall on the table, we'd like to focus on.

Filtration engineered materials instrumentation in aerospace, we think those you've seen us focus on those to date, but I would tell you we like the entire portfolio.

<unk>.

What we've been working on is what you saw us do with the last three deals by a company's debt within very quickly or within a reasonable period of time with synergies can outgrow can outpace margins can outpace cash flow for the base business and Thats, what we did and thats going to be the flavor you're going to see as we go forward if we don't find.

The right properties.

We think we're a great investment and we're going to.

It does from Parker.

And buy our shares.

Makes sense, Tom can you talk a little bit about how when you do a deal how do you integrate it I mean, how do you bring.

Or how do you how do you bring win into an asset do you come in with all the tools you come in with lean first or is there some sort of a.

Is it case by case is there a playbook I don't think I've ever heard you guys talk about that.

Curious.

It's a good question Theres, obviously theres lessons learned what we've learned over the years on how to organize.

Project Management office.

What youre going to do on day, one and Theres really two big kind of themes that youre looking at you are looking at all of the integration task those basic task with putting the business together and then your synergy test we've learned to make sure you've got a dedicated integration team and you put the best and brightest people in those various leadership positions put a great integration manager.

But the key thing to remember is <unk>.

On and create companies and they are bringing good things to us and we're trying to bring good things to them as we become one one team and it is true.

Concept of one plus one equals three so we're going to take the best day acquisition for the best for Parker and obviously.

We worked to win strategy, but we do give some latitude within their respective acquisitions to how they wanted to win share. It is there's no. It's not an option that you're going to implement it but we give them the latitude as to how they want to phase it in.

Obviously certain parts might be more applicable faster for their respective acquisitions, we have a real robust cadence as far as the review.

<unk>.

Frankly, I think we've gotten pretty good at this.

We want to keep doing it.

Helpful. I'll pass it on thank you and good luck for the rest of the year guys. Thanks, Scott I appreciate the comments.

Thank you. Our next question comes from the line of Andrew <unk> from Bank of America. Your line is now open.

Yes.

Can you hear me.

Yes, we can hear you Andrew how are you yeah, great quarter, great free cash flow conversion as well.

Thank you.

Just a quick question for me.

The first one you sort of talked about your dealers still being cautious.

If you look at our channel checks, if youll look what other publicly traded hydraulics companies or.

Go on centers.

Still hydraulics companies.

Sort of talk about what they are seeing on the channel, but it just sound a bit more optimistic.

Relative to what you guys are saying on sort of our channel checks I think a bit more optimistic on <unk>.

Look as well just trying to understand is that market based conservatism or are your dealers are more conservative Youre channel just know some things that we just don't see across the industry.

Well, you're probably referring to one of our neighbors.

They would be much more heavy mobile.

On stationary and distribution.

We're not on Hydraulics company, we're a diversified industrial company. So that's a big big difference, but I'm also talking about a smaller competitor down on Florida I guess.

Okay.

Still feel good but part of what Theyre doing is placing orders making.

Making scheduled releases over the next couple of quarters now we still think.

If I look at going into Q3 that we're going to go from a minus six to getting to probably.

Flat on North America and EMEA.

We'll be probably net upper teens, when you look at Asia Pacific.

You get to Q4 will be very strong on North America and EMEA.

Early on around that plus 10.

I know China is a tough comp in Q4, because if you remember that's when they rebounded from the pandemic. So they are they are probably going to be flat on distributions, but our distributors still feel very good.

When we look at distribution for the whole second half it'll end up being on a nice positive.

Gotcha.

Second question would you sort of talked about China, and I think we've been sort of talking about hydraulics competition emerging out of China for the past 20 years, but it does seem that we finally are at a point, where you are sort of seeing.

Chinese competitors on particularly the fact that China is leading.

Recovery this time around.

How do you see competition in China from the local competitors.

Time around in this op from how different is that and then also Tom on them I'm talking about getting into industrial applications now, even though probably you have a bigger moat there, but just how do you think about Chinese competition coming out of this downturn and in the next cycle. Thank you.

Andrew is telling me on it.

A question really for for a while now and I really don't see it much different coming out of this and that was when we went into it.

Just as a reflection on China for Us grew.

<unk> grew about 10% last quarter. So we did quite well on China Asia Pacific Overall grew about 7% and the way we win in China as were in China, with the same or better cost structure, because we have.

Nice density of plants.

In China.

Very robust supply chain in China.

Sure.

And we have the breadth of our technologies. So we go to compete and again, that's a distinguishing characteristics that we have around the world.

To just competing as a Chinese fitting company or a Chinese host company, we can put the whole portfolio technology together.

A discussion with the customer.

They can't beat us, having a discussion around cost of ownership for the weight of the product reliability ease of assembly. All those type of things that you can do when you're a multi technology and obviously these multi technologies or on a connected or not.

Spirit.

Colleges are interconnected technologies that create a big value proposition for customers. So that's been we could beat them on a cost because we are there for the same cost structure better and we have a better basket to sell more problems for customers.

Thank you very much.

Thanks, Andrew take care.

Thank you. Our next question comes from the line of David Raso from Evercore. Your line is now open.

Hi, My question's on aerospace, but if you could clarify first.

So on the fourth quarter of the fiscal fourth quarter aerospace organic sales flat.

It's going to make sure that correctly.

Yes, David this is Thomas.

Flat to prior year.

And then I'm not asking for 'twenty, one guidance, but can you take us through your thoughts on how you see the cadence of the aerospace recovery on.

So that May color also how you think about M&A in this space as well so I'm trying to tie those two together.

Give us a little laid on land if you're already at flat.

In calendar <unk> fiscal <unk>, how are you thinking about the slope from there.

Yes, David It's Tom again, so we like this space. This is all of our motion control technologies going into things that Florida with one of the things that apply to things that are stationary and things that have wheels under them.

And the way, we look at aerospace as.

We haven't sized to win in the current climate.

The current climate is finding bottom.

And it's going to be a slow turn coming back up but my view over the next several years is going to congratulation on improvement now what does the pace of improvement I think it is going to mirror the pace of vaccine deliveries in the comfort of travel.

Travelers feel and I think youll see resident personal travel.

Come back much more aggressively for business travel will come back that will will probably plateau at a certain level based on just the efficiencies of digital tools where per.

Positioned to win right now with the kind of op margins in this current climate is only going to get better growth.

For it so.

With respect to M&A.

Actually I think this is a good time to look at M&A in the aerospace arena, depending on the rate property and the right pricing obviously, but.

But I think the future is bright and now it's going to be it's a long cycle business. So it will turn.

Slower industrial turn would be but again, if you're positioned to win now and youre going to have a gradual upturn.

It speaks to the nice incrementals in a nice positive year over year changes from here over the next several years.

Yes, I'm just trying to balance the dance that doesn't go on go on with the stock right. The traditional crowd that looks at the ASM and says Hey, This is fantastic right now.

How much better can it get while the compounded crowd and looks at your cash flow the deleveraging and say look we can definitely move the ball forward here. This is not just on old ISN play.

And the timing of the M&A I think it's.

It's important.

To balance that those two crowds.

And not to.

Inside your M&A Department here, but when you listed those four categories.

Can you just give us some sense of you know.

If you had your druthers identical kind of assets when you think of where your position your size the competitive landscape and then obviously, how you beat the cycle playing out on.

I mean would you prioritize them at all between filtration and engineered materials filtration and aerospace.

I, probably won't prioritize not to disappoint you on being vague on the answer but we like all of those properties that will come back to the very first thing and this is on what I always remind laborde.

Mind shareholders, we want to be the consolidator of choice within our space. So those eight motion control technologies of I believe it was on slide four.

As the space, we plan on it and we have a big advantage.

We're not disparate pieces of businesses.

With now two thirds of this revenue come from people to apply for these all of these technologies for for war.

We like all of those technologies I think the thing Youre going to see US look for is a theme that you've seen over the last three deals.

Within a period of time, depending on synergies theyre going to be growth accretive margin accretive and cash accretive and that's a different strategy a thing for the company, our Tennessee, we would prefer to buy things that are not ultra small.

But if you just look at the histogram of targets.

It's more in the mid size.

<unk> just because of the lay of the land. There is fewer of these really super large targets that you can look at we will look at them obviously.

When I say mid size, what's changed for us versus the past is our mid size is no bigger.

The mid sized target for us would be envision an exotic like deal, which historically would have been the largest deal the history of the company.

For Laura and CLARCOR. So our appetite is there if I could go back David to comment you made about the ism, which I thought was.

Thoughtful comment.

Power of this portfolio.

Besides being interconnected.

That the cycle is somewhat.

Balance each other so yes, we will see some near term.

We'll see how long near term turns out to be on the industrial portion of the company that's going to have much more robust macro conditions, but then following that the aerospace business is going to start to be healing.

Sequentially.

Time periods are going to be complementary to each other.

It apart.

Is that this five year period that I envision going forward is going to be I think much easier for industrial companies in the last five year period, because we went through two industrial recession for the pandemic I'm knocking on wood here I guess, it's possible to have that happen again, but the odds are.

Low that it would repeat so I think it's a much better time.

We have enough self help.

All of those people that are likely to encourage we are no longer short cycle, but we are a bit over the cycle.

And we have all kinds of room when churches, we've just started.

And those FY 'twenty three targets are not on endpoint.

They are a mile market, we're going on we're going to blow past.

I appreciate the comments thank you Tom Thanks, David.

Thank you. Our next question comes from the line of Mig <unk> from Baird. Your line is now open.

Thank you good morning, and maybe just to kind of pick up on this.

The topic here.

Tom.

You've spent the better part of <unk>.

Last year, it sort of showcasing how the business is performing different than it has in prior downturns right or entering an upturn and I am curious.

To give you a perspective as to how this next upturn might be different than what we've seen historically.

Well I think it's always hard to predict.

One cycle versus.

I think you will continuous continue to see us perform very well on converting.

On the incremental side, but just I would caution people incrementals.

For Q4, this year and for the first half of next year are going to be tough comps, we're going to try to flatten the field. When we gave you the results so youll be able to see the real incrementals as a company.

But I think you would expect to see us north of 40 in the first couple of quarters in them and we glide down into <unk>, but we're going to be at a much.

Stair step slide that I've showed for the last couple of quarters, our intention is to keep raising the ceiling.

The raise on the floor. So this next ceiling. This next cycle.

Expectations could it be higher than loans in the last CLEC, we're doing it right now this isn't either related initially a good period right now for <unk>.

Breaking records on margins, so im bullish because there's a lot of positive factors.

Just look at interest rates, what's happening with global industrial production forecast.

In my view, a pent up need for Capex.

Given that theres been two industrial recession over the last number of years.

Aerospace cycle that will follow.

Industrial cycles that you got the benefit of those I think we had on top of each other and just a tremendous amount of self help a lot of what you've seen is propelled these margins to date as prior period restructuring and win strategy to point out.

At three point O and I mentioned, not just being biased because I'm a part author of it is better than two point on hands down and you've only seen about a year of that in play and so three point on is kind of got us tremendous legs. So.

So we have still a portfolio is self help and the big thing is that we're back into capital deployment.

So it will be.

Steady diet of dividends.

Share repurchase and acquisitions, obviously that that formula we're going to we're going to raise I can assure all the shareholders listening there will be a queue for increased the dividend, we're not going to break our track record.

And then we'll continue to do what we've always done is look at the acquisitions versus share repurchases try to make the best decision on behalf of shareholders.

That's the best long term return for them.

I appreciate that.

I guess.

Perhaps youre going to want to punt on this but you are pretty close to your stated fiscal 'twenty three targets.

At what point do we expect an update to this and I'm also curious as to how you're thinking about free cash flow margin here I mean, even taking out the working capital benefit that you've had year to date free cash flow margin is quite impressive.

Stable do you think this is especially as.

Perhaps we need to see a little more working capital coming back into the business. Thank you.

So maybe I'll start on the 'twenty three targets, so I'm going to let Todd take the free cash flow on.

You are right I am going to punt, but.

Hopefully you recognize we have not hesitated to changes so we've gone from I'm just going to use segment operating margins have gone from 15% to 17% to 19% to now 21 for success.

We have not hesitated to updated we just want to prove for several quarters that were.

Closer at it and once we do that we'll be prepared to give you a better vision for that and I'll, let Todd talk about free cash flow.

Yes, Youre right our cash flow has been really impressive and like I said, it's really the work of our global team really focusing on.

Very quickly on working capital management.

No theres going to be some pressure on working capital as growth returns for the business.

Well aware of that but as Tom said, we've basically had a step change here our margins are a different profile than they used to be and that obviously feeds.

Free cash flow so.

We think historically, we're going to be better than we've been historically and we're positive on that going forward.

Great. Thank you next day.

Yes.

Thank you. Our next question comes from the line of Nigel Coe from Wolfe. Your line is now open.

Thanks, Good morning, everyone on the.

Great great job, you're making it look easy, but I know, it's not all done.

So we are pretty deep into the Q&A, Jim Im not the end market roll down for I'd be remiss not to do that but just for clarification. The the lag on distribution distributed.

Okay.

This is joey.

<unk> been surprised with that is that normal at this point on the cycle.

Turning back up.

A quick on this pandemic.

Joe It's Tom it's very normal.

Mobile tends to lead which is doing now and then industrial and then followed by distribution remember that distribution well service from smaller to medium sized Oems is primarily the aftermarket.

It tends to lag here.

After you see a sharp return, which is what youre seeing with some of the other end markets and I will spin you through the end markets quickly.

And I'm going to break it into the buckets like have historically done I'm, starting with a positive end markets the greater than 10%. This is for the total company was semiconductor life science power generation agriculture.

Refrigeration aerospace military OEM and aerospace military tomorrow on.

On the positive high single digits with automotive.

Positive low single digits was construction and heavy duty truck.

Then on a declining market. So I've got four buckets low single digit decline was telecom and tires.

On a single to decline was lawn and turf material handling mining.

Foundries distribution.

She has done a market for let's put it in there.

On the 10 to 20 range as rail marine and forestry and the greater than 20 was machine tools oil and gas aerospace commercial OEM and aerospace commercial MRO.

Alright, Thanks Thomas.

And then just on the margins between International and North America, We now have very good conversion.

Is that really a function of the recovery profile mixed.

For the situation now.

Margins going forward and we are very comparable.

Yes.

We've worked for this for many many many years to get those margins comparable and I really give credit to our international team they've made great great progress so.

We're not where we want to be we still have plans to moving forward but.

We see those margins.

No reasons, why those margins can't be similar.

Alright. Thanks.

Gigi I think we have time for maybe one more question.

Thank you. Our next question comes from the line of Josh.

Lynskey from Morgan Stanley. Your line is now open.

Hi, Good morning, guys good morning, Josh.

Just following up on.

Hey, Brian.

<unk> from earlier, just on PMI peaks I guess is there anything in the business today, Tom that Youre seeing that would say that yes.

PMI has maybe not indicative of where the business and your recovery your customers are and in recovery like maybe things don't feel quite as far along as they normally would with like a 60 PMI, whether it's inventory levels, which we sort of talked about or just.

On the types of end market leadership anything that would make you feel like maybe this has kind of some longer legs to it than you.

You would normally see at this point.

Josh It's Tom <unk>.

I think that Youll see relatively similar correlation to applaud our orders historically against PMI is anywhere from a three to six month lag I think the pandemic has the potential to maybe influence that a little bit we will just have to see as it plays through.

I would just characterize I feel better about this next several years.

I do about what happened in the last six years of Liza My time on leading the company.

I just think about we went through.

Natural resource recession.

We went through the most current recession that we had the pandemic and so I think there is there is a need for industrial and infrastructure type of activities I think aerospace will return longer term.

So I just think there is there is a bidder.

Potentially more stable macro environment for the next couple of years.

Got it that's helpful and I agree with that and I guess, just kind of related to that all the while bringing up.

Segment operating margins within striking distance.

On your target, even with arrow still on its back.

At what point this gross margin become a limiter on unique defined yourself mixing higher on that front.

On the distance between the two is narrower than we see in most of our coverage.

So at what point does that mean more differentiated growth or M&A mix like what you had with exotic.

Just any any observation you would make on what it takes to get to the steps beyond.

Yeah, Josh again as Tom one clarification on gross margin might look different on you compared to other companies because we we.

We embed a fair amount of SG&A into our cost of goods sold so our gross part of has some of that in there versus other people might be bookings for SG&A in different categories, but your question is.

Stepping higher levels really can margins continue to grow higher and absolutely. They can if you look at what I was referring to earlier on about early days when share to $3.

And all of the initiatives we have underneath there.

I feel very good about our potential there and just for a strong legs and will for future can hold you put that in place maybe at a little better macro environment, because you can have a little more.

<unk> induced leverage.

And then we're coming into a period of time, where we have a stronger balance sheet. So we can put that to work as well.

So what I've told people before me who will close on this.

If you like what's happened in the last six years and the environment, we had with <unk>.

<unk> no macro help.

The next several years are going to be fantastic.

That's great I appreciate it.

Thanks, Josh Thanks, Tom Alright.

Alright, everyone. This concludes the Q&A portion of our earnings call. We appreciate all your comments and as always thank you for your interest in Parker.

Robin and Jeff we're going to be available throughout the day, if anyone needs any follow ups.

Thank you again on everyone stay safe thanks.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.

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