Q4 2021 Parker-Hannifin Corp Earnings Call
[music].
Yeah.
Good day, and thank you for standing by welcome to the Parker Hannifin fiscal 2021 fourth quarter and full year earnings conference call and webcast. At this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session to ask a question during the session you on.
Need to press Star 1 on your telephone please be advised that today's conference is being recorded if you require any further assistance. Please press star zero I would now like to hand, the conference over to your Speaker today, Parkers, Chief Financial Officer, Todd Lamb Bruno.
Thank you Jon and good morning, everyone. Thanks for joining our FY 'twenty 1 Q4 earnings release webcast as Dan said this is Todd Williams, Chief Financial Officer speaking I am here today with Tom Williams, Our chairman and Chief Executive Officer, and Lee Banks, our President and Chief operating Officer.
If you could focus on slide 2 this is the company's safe Harbor disclosure statement addressing forward looking statements and non-GAAP financial measures reconciliations for any non-GAAP measures are included in today's materials.
Those reconciliations and our presentation are accessible under the investors section at Parker Dot Com and will remain available for 1 year.
As usual, we will start today with Tom providing some highlights for the quarter on a record fiscal year.
As well as some color on Parker's transformation following Tom's comments I'll provide a brief financial summary, and provide some details on our FY 'twenty 2 guidance that we just released this morning on.
Then hand, it back to Tom for closing comments, and then Tom Lee and I will open the lines for Q&A.
And just 1 reminder, in respect to the announcement, we made Monday.
Turning to the Mega acquisition, we are still bound by the requirements of the U K takeover code.
With that I'll ask you to move to slide 3 and I'll hand, it off the top thank you Todd and good morning, everybody. Thanks for joining us today.
This marks the end of FY 'twenty, 1 for us and it was a typical here personally and professionally for everybody due to COVID-19, but it was a year, where the Parker team really shine, we delivered outstanding results and lived up to our focus on enabling a better tomorrow.
Thanks goes out to the global team for just a great year, great quarter. So let's start with the quarter. It was dynamite top quartile safety performance, 29% reduction in reportable incidence.
Sales growth on the quarter was 25% approximately organic was almost 22 and the industrial portion of the company grew at almost 27% in the quarter.
We have 6 all time quarterly records sales net income EPS segment margin for total Parker as well as North America and International EBITDA margins were very strong at 21, 8% as reported or 22, 1% adjusted <unk> was 190 basis points improvement versus prior on.
Segment operating margin on an adjusted basis. If you go to that last row, 22, 2% or 230 basis point improvement versus prior just a great quarter and a really great team effort by everybody around the world.
Go to slide 4 we'll move to the full year.
It was a year of records and I won't read all of these to you, but you can see 8 all time fiscal year records from just that's in the history of the company. So Thats, a 104 years to put up a record for us. So it speaks to how well the team performed in this last fiscal year.
Those growth came in almost 5% year over year organic was flat, but clear momentum building on orders and organic growth in the second half of the year as you see from our order rates FY 'twenty 3 margin targets.
We hit them on to full 2 years early.
And we will be announcing new targets. Once we have investor day March next year, and we're going to go out for a new 5 year targets will be going out to FY 2006, we look forward to discussion at that time.
Operating cash flow was $2.6 billion.
A record it was almost 18% of sales.
Cash flow conversion rate was 135%.
And we were very pleased to be able to announce the offer to acquire Mega plc, which greatly enhances our aerospace portfolio and I'll touch on that briefly here a few minutes.
So if you go to slide 5 I want to talk about the transformation of the company.
To give you a little bit of color behind what's driving it and the progress we're making on the results on slide 6 speaks to those 3 drivers living up to our purpose.
Great generators, and deploy that cash and being a top quartile performer I'm going to touch on each 1 of these over the next several slides.
When it comes to purpose, enabling engineering breakthroughs that lead to a better tomorrow. This is something that really resonates with our people. It represents a higher calling to your work and it acts as our North star.
And the next few slides I'm going to talk about and highlight our purpose in action, specifically, our technologies and how they are helping health care.
How they are helping the climate and create a more clean technology growth for everybody.
So on slide 8.
I'm talking about vaccine production in particular is something that's on.
It's a very pertinent for today COVID-19 production.
On the left hand side speaks to the challenges that drove it drug manufacturers have today.
This is a batch process typically with extensive inventory has long lead times to produce these products.
Take huge space requirements large footprint from storage large footprints with the manufacturing processes.
Very typical changeovers of cleaning cycles between the best processes is very complicated.
So the idea here is a simple concept that most of us can relate to all of those have been some kind of a restaurant with a soda fountain.
Good picture your beverage of choice and of course, the technology behind that is it concentrated syrup.
Carbonated water and you get to pick the soft drink of your choice. So the idea here is instead of soft drinks could we deliver sterile vaccine ingredients with a similar type of process on slide 9 is that process. So it's our in line solution system. That's a proprietary point of views process for combining the purified vaccine ingredients.
So if you look at that piece of equipment, you can see it's on wheels, which modular.
Easy to move around and easy to deploy as.
As mixing and sensing combined it is 2 way communications via Iot enabled.
It can talk to the manufacturers enterprise system to enable scheduling adjusted time.
It uses very importantly, intellectual property protected single use consumables so on.
So these massive batch processes huge cleaning events for changeovers. This is a giant productivity improvement for the drug manufacturers on the speed of the changeover, but also just reducing contamination titled the changeover.
Then our software.
Automation helps control the amount and the flow of these various ingredients. So this applies obviously to COVID-19 by to other vaccines that are being developed and we can use it for other drugs as well. So this is a really attractive business opportunity for us, but more importantly, it's a great help to customers and the societies are great examples of our purpose.
Action.
Moving to slide 10.
To the climate and the clean technology portion of our purpose.
We just recently announced last month, new sustainability targets you see in the right hand side of this page is our new sustainability report, which you can reach electronically, but were announced a 50% reduction in emissions by 2030, so that'd be scope, 1 and 2 emissions direct and indirect.
And then by 2040 same thing scope on the tubes to be carbon neutral. So the neighborhood on sustainable more sustainable future with what we do with our plants our operations our supply chain, but in addition, if you go to slide 11.
Actually more importantly, how can we help our customers.
How can we help society with our sustainability journey.
And so on this page you see the 8 motion control technologies across the top.
And that this portfolio approximately 2 thirds of this portfolio is a very much part of the enabling of clean technologies for our customers.
So any part is expanding bill of material.
On automobiles on construction equipment on forestry on mining basically almost every piece of equipment on airplanes engines everything's feeling this impact of a more electric applications.
So theres onboard opportunities, but also infrastructure opportunities as the world has to build an infrastructure to support that growth our technologies can help to debt.
Net infrastructure move.
And then I want to move to slide 12.
Which illustrates the top quartile performance portion of those 3 drivers.
And you can see we're using 2 metrics to illustrate this adjusted EPS on the left and adjusted EPS EBITDA margin on a rate that's really been our people the strategic.
Portfolio changes, we've made the capital deployment decisions that we've made over the last 7 years and the win strategy. That's transformative performance when you step back and look at this this is just remarkable improvement on the left is a more than doubling of our EPS.
And that's hard to do I can assure you that's really hard to do some fantastic progress.
Less than $7 in FY 16 over $15 as we closed last year.
EBITDA margin, which has clearly been propelling the head from $14.7 to 21, 3 so a 660 basis point improvement there.
And then the last part.
On the transformation and the drivers as cash generation on deployment, we touched on the cash generation piece my opening comments, but clearly on the deployment is how do you deploy capital on buying effective companies and were very excited to put 2 high quality companies together and aerospace combination that we announced on Monday.
Parker and Mega nearly doubles the size of our aerospace systems segment with highly complementary technologies.
70% sole source a strong recurring revenue.
Excellent growth potential combination of commercial aerospace recovery as well as the synergies and this will be accretive to our organic sales growth margins EPS and cash flow.
This deal makes sense for all stakeholders to shareholders of Parker and Megan the team members of both of our companies their parishioners pensioners and of course, both of our customers.
On the announcement on Monday, we've introduced ourselves to the key stakeholders in the UK.
Unfortunately, why we are the best home from Megan.
Our long great track record in the UK, the clear strategic rationale for the deal, including the premium we are offering to the <unk> shareholders.
Our shared interest to continue to innovate and invest.
Net we are committed to being on responsible steward of $1 million and that is why we have agreed with mega to offer the U K come on a number of legally binding commitments, but how we were operating going forward. These.
These type of transactions take time, but we're pleased with the reception so far and we look forward a constructive discussions with the key people in the U K Cup.
And we will keep you updated as the process unfolds.
Go to the planned completion of this approximately 12 months.
And with that I'll hand, it back to Todd for more details on the quarter.
Yes, Thanks, Tom I.
I guess I would like to direct everyone's attention to slide 15, and I'll just real quickly walk through the FY 'twenty, 1 Q4 results.
As Tom mentioned earlier, we have some outstanding results to share here sales increased over 25% in Q4 versus prior year and finished at $3.9 billion.
As he said Thats, an all time record for the company.
And we're really particularly proud of this due to the fact that our aerospace markets are still challenged on.
It really demonstrates the strength of the portfolio additions that we've spoken about CLARCOR, Lord and exotic and really is driven by strong broad based demand across all of our industrial businesses.
Organic sales are up 22% in the quarter. So basically the majority of that 25% change is all organic. This is the first time organic sales have been positive for the company in over 2 years.
Currency also was favorable with a 3.5% impact to total sales.
Moving to adjusted segment margins at 22, 2% is an improvement like Tom said of 230 basis points from prior year, and it's also 80 basis points.
Sequentially from Q3, just another strong quarter of margin performance as really our teams around the world pivoted to the increased demand levels and manage through a number of challenges I'm very proud of our team for that margin performance. Incrementals are also commendable at 31% year over year really impressive considering last year was the day.
<unk> of the pandemic and our Decrementals last year were fantastic at plus or -13%.
And if you remember that included approximately $175 million of temporary savings.
On that FY 'twenty Q4, so we're really happy with the 31% Incrementals.
EBITDA margins also expanded 190 basis points from prior year, finishing the quarter at 22, 1% and if you look at that net income number of $577 million. That's on Ross, a 14, 6% and Thats an increase of nearly 50% from prior year.
All of those great results translated to on adjusted EPS of $4 at 38.
Increase of $1.39 per share or <unk>, 46% compared to the prior year number on this slide on 299.
1 point I want to reference to the prior year numbers.
I'm really speaking to net income and the EPS numbers only.
We have been planning for some time to convert our remaining U S locations that.
Used to use LIFO inventory valuation.
To standardize that across the company and moving to a FIFO inventory valuation purposes, we made that voluntary change in FY 'twenty on Q4, and we have retrospectively applied that change to prior years and we've attached the impact of those prior years to this press release and the tables section so impact of the previously reported.
Quarter last year was minimal it was only 4 <unk> last year. So the 299 on this page if youre looking back to prior year that would've been 303 in FY 'twenty.
So 1 other note I want to make LIFO, we've always booked at the corporate level debt.
No impact to our segment operating margins or the Incrementals that I just mentioned 2 and now 100% of the company's inventory is valued using the FIFO method.
So just 1 last comment on the quarter really proud of our team globally.
It's just a tremendous effort the team put forth to put up just such a solid quarter to finish really as top set a record year.
So if we can move to slide 16. This is just the branch of that $1.39 increase to adjusted EPS that I just mentioned.
But I love here at both largest bar on the page.
Signals the strong operating performance that the team has put together on.
Our segment operating income on an adjusted basis increased $250 million or 40% from prior year Q4.
That accounts to $1.50 of the increase in EPS that we just put up for the quarter of $1.39, So it's really strong execution really everywhere across the company.
All the other items you see on the slide if you net it it's 11.
On favorable corporate G&A income tax on shares were slightly unfavorable but lower interest and lower other expense partially offset.
There. So again most of this is really.
Fantastic due to comparing back to.
Our COVID-19 impacted quarter on the prior year.
If you go to slide 17, just some color on our segment performance really the message here is our industrial businesses delivered outstanding results across the board.
We've spoken in the past about the impact these portfolio changes have had on the company and you can see it here in these margin numbers.
Diversified North America sales were $1.8 billion in the quarter.
Organic sales improved again in this segment sequentially up and are up 26% versus prior year on.
Operating margins improved an impressive 300 basis points versus prior year and really finished at 22, 5% for the quarter, obviously volume helped us a little bit there, but really the disciplined.
Operating performance and cost control really continue to drive the sizeable increase the margins.
Margins in this segment on a record all time record and Incrementals will also were very healthy at 34% and again I keep referencing the comparable is back to last year, which is just a very tough comparison.
If you look at order rates order rates on a robust at plus 56%. This is up sequentially from last quarter, we reported plus 11% and really just strong across the board.
If I move to the international diversified International segment really same story here.
Little bit higher organic growth of 28, 5% sales just reached 1.5 billion net segment and again another story here.
Adjusted segment operating margins expanded 300 basis points versus prior year and finished at 22, 1% in the international segment.
Just really again strong organic growth in that volume coupled with debt cost containment and productivity initiatives really generated this record margin performance in this segment as well order rates again here tremendous up a little bit higher than North America, plus 58% versus 14% positive in the last quarter. So really just a great performer.
It's out of our industrial businesses.
I'll just touch on aerospace systems really slightly very sound performance in.
In the current market sales here were at $630 million for the quarter and Im happy to report organic sales have turned positive in the segment. They are up 1% we.
We saw strength in commercial and military aftermarkets.
Strong sequential growth again in Q4, and we're happy to start seeing rate increases from Oems, particularly in the narrow body and business jet platforms.
Aerospace orders also.
Got less negative and improved to -7 this quarter on a rolling 12 basis versus -19 last quarter and further proof that we are seeing signs of recovery area operating margins also very strong 21, 6 that improved sequentially from Q3, and really finished the year at the highest level they've had in the entire fiscal year.
Very proud of our aerospace team there.
So just looking at the company at all we're really pleased with these results as a solid finish to the fiscal year. Our total incrementals were 31% really proud about that and really just a comment if I. If I look at just our industrial businesses. If I go back to pre pandemic FY 19.
On a like for like basis, if I include Lord and those FY 19 numbers.
In the industrial businesses, our sales volume has surpassed pre COVID-19 levels.
So we're really proud about that order as you can see in total are plus 43% and as Tom mentioned.
Not only did we achieve our FY 'twenty 3 margin targets, what we surpassed them and we did that 2 years.
So if I got on the next slide Slide 18 cash flow. We're obviously very proud of this Tom mentioned this earlier full year cash flow from operations was $2.6 billion. That's an all time record for the company.
17, 9% of sales just outstanding top quartile performance.
If you look at that compared to prior year, we generated over $500 million more cash at 24% more cash than we did prior year and like I said that CFO at $2.6 billion is a record.
<unk> capital really solid performance here and I want to just really thank our teams everywhere around the world for focusing on this we asked them to.
Focus on this through the pandemic and they delivered to us not only so I want to thank you all for your focus on that free cash flow also fantastic 16, 5%, that's up 310 basis points versus prior year and the free cash flow conversion for the year of 135%.
So with that this now marks the 20th year in free cash flow conversion has been greater than 100% at cash flow from operations with greater than 10% 20 years running.
All of this allowed us to significantly pay down our serviceable debt, we've been vocal about that for the last couple of months.
If you look at the last 20 months, we've paid down $3.4 billion of debt.
And our gross debt to EBITDA finished the year at 2.1% net debt is 1.9%.
So again, it's a similar story here we achieved these leverage levels are.
A full 1 year sooner than we had originally forecast and it's just an outstanding cash position.
Its top quartile execution and really impressive considering the backdrop global head on.
Yeah.
So 19, I will ask you to focus on 19, just flipping to FY 'twenty 2 and our guidance you saw that we released this morning.
As usual, we're going to provide this on an as reported and on adjusted basis and I'll just start at the top sales we're forecasting sales to increase.
In the range of 5% to 9% really 7% at the midpoint and really on the breakdown of that sales growth is essentially all organic we do not expect the mega transaction to close in FY 'twenty 2.
Both Lord and exotic anniversary. So those are no longer considered acquisition sales. Therefore, we are forecasting no impact.
To sales from acquisitions and currency is just a minimal drag at 0.2 percentage of sales and just like we always do.
We have calculated the impact of currency to spot rates at the end of June 30, and we've held those rates steady as we forecast that 2022, 1 thing I'll note. The sales split for the guide is 48% first half 52% second half.
The next item I'll talk about is our segment operating margin on an as reported basis the guidance for the full year is 19, 3% at the midpoint.
And there's a range of 20 basis points on either side of that but more importantly on an adjusted basis segment operating margin guidance for the full year is 21, 6% at the midpoint same range of 20 basis points on either side of that.
This adjusted segment operating margin guide is 50 basis points higher than what we just finished a record FY 'twenty 1 app.
Just some color on adjustments at a pretax level business realignment charges are expected to be $35 million.
For FY 'twenty 2.
<unk> costs to achieve are only $7 million for the forecasted year and acquisition related intangible amortization is $320 million.
Just a note on a split adjusted segment operating margins, 46% first half 52% second half.
If you look at the corporate G&A interest and other $480 million as our forecast that is the same on an adjusted and an.
And as reported basis.
Tax rate, we are forecasting full year to be 23%.
And finally on EPS on an as reported basis, our guidance is $14.48 at the midpoint. There is a <unk> 40 range on either side of that and our adjusted EPS guidance is $16.16 at the midpoint same 40 range on either side of that adjusted EPS split first half is 45.
Percent.
Second half is 55% on a little color on Q1, we are forecasting adjusted EPS to be $3.60.
At the midpoint.
Slide 20 is the branch and again this is very similar to Q4 main driver of the $1.56, or 10% increase to adjusted earnings per share. It is just our continued strong execution across the enterprise.
Segment operating margin is accounting for $1.76.
That change and on again, just slightly higher corporate G&A Pax and average shares outstanding are a little bit of a drag but all in $1.56 increase in earnings per share.
Increasing earnings per share by 10%.
Lastly, I will just talk about capital deployment for FY 'twenty 2.
We are committed to our capital deployment strategies.
A strong 65 year of.
Our record of consistently consecutively, increasing the annual dividends paid were going to continue with that record.
Our payout target has not changed it remains 30% to 35% of the 5 year average of net income and of course, we're going to continue to fund organic growth and productivity across our global locations, we expect capital expenditures to be 2% for the year.
Our <unk> 1 share repurchase program.
Reinstated debt. This year, we are committed to continuing that in FY 'twenty, 2 and as I mentioned when I was talking about cash flow we have.
Extinguished all of our serviceable debt and we are now on a cash building position. So our focus for FY 'twenty 2 will be to continue our record of strong cash flow generation and accumulation in preparation for the closing of the Mega transaction.
So with that Tom I'll turn it back to you and I'll ask the audience growth focus on slide 22. Thank you Todd just closing messages.
We will drive these results the engine behind the company is our people highly engaged team create culture higher levels of ownership driving this performance period inspiring results as you've seen living.
Moving up to our purpose of the vaccine production is a classic example of that.
Quartile performance, the more than doubling of EPS and 660 basis points improvement in EBITDA margin from the last 6 years.
Within our margin targets that we laid out for you 2 years early on obviously, we're going to keep improving upon that.
On the strategic deployment of capital and change in the portfolio CLARCOR.
Lord and exotic and now Megan you put that together with the win strategy 2 <unk> and now 3 point on it really spills for a bright future and will continue to accelerate to performance.
With that I'll turn it over to Don to open up to Q&A.
<unk>.
Thank you Richard.
Ask a question. Please press star 1 on your telephone to withdraw your question press the pound key.
The standby, while we compile the Q&A roster.
Yeah.
And your first question comes from the line of Scott Davis with Melius research.
Hi, Good morning, guys and congrats on a great year. Thanks Scott.
I don't always say that but I mean it.
Guys you've had a few days for this to marinate the Mega deal at least what's been the what's been the customer response.
And feedback to to the announcement.
Scott It's Tom we're early days on the Unreached out to customers.
General view as very positive day like the fact that this is a.
A stronger build material opportunity to create more value the highly complementary technologies and really the track record of both companies. Both companies have a great reputation great innovators create engineering lift companies. So the response so far is very positive.
Good to hear and what.
Not to get too Nitty gritty here, but.
You Didnt really talk much about some of the challenges out there on the cost side supply chain disruptions logistics all of that.
Clearly we're at 31%.
Incrementals it couldn't have been too big of a deal for you guys, but perhaps you could help us understand how you've.
Manage through that and how are you thinking about that as it relates to guidance over the next 12 months as well.
Scott It's Lee.
I'll take a shot at answering this I think the.
The first thing on the supply chain side is just the kind of step back and recognize our structure which is growth.
Huge benefit for the company. So as you know we make solid source in the region for the region. So it allows us to be closer to the customers and get away from a lot of international shipments having.
Having said that we're not immune to what's going on in any of the regions, but I would characterize it internally as being manageable.
But not without hard work.
Now I would say the biggest challenges were dealing with is just our customers. So I think <unk>.
Automotive is very public on what's happening, but I probably don't have.
A large OEM that hasn't had some kind of disruption where landsman down people been sent home.
Et cetera, So we're working with our customers to work through that it's just creating a lot of chatter in the channel.
And it's just.
I would say versus a lot of choppy production.
Yeah makes sense, okay. Thanks Lee.
Net.
Perfect guys.
I'm sorry. Your next question comes from the line of Jamie Cook with Credit Suisse.
Hi, good morning, and nice net.
This quarter I guess, just a couple of questions can you help us understand what you're assuming for organic growth in the first half versus the second half and what youre assuming sort of.
Price.
Versus volume and then I guess the.
The aerospace like debt debt.
Top line guide to me seemed like with whats going on understanding we have the delta varian, but there could be some level of conservatism there as we think about sort of the top line. So if you can just help me understand what your assumptions are on the Aerospace guide. Thank you.
Jamie It's Tom I'm going to take the guide and I'll take a few minutes to describe that I'll go through the aerospace piece and I'll, Let me touch on the price cost aspect.
So this is probably the question that they will put us on everybody's mind on how do we come up with the guidance on some of the context behind it. So first of all there's a number of tailwind.
I'll highlight some of the headwinds, but on the tailwind side clearly the order trends the macro environment I think there is a capex on.
<unk> spend that happened for a number of years. So I think there is some capex demand is coming back from manufacturing companies clearly.
Governments be more prone to put in stimulus is.
On the rebound from the great shutdown and of course.
The rebound of activity the commercial aerospace recover which I'll touch on to answer your question here in a minute Jamie low interest rates and on the climate investment, which with our clean technology portfolio is a very attractive positive for the future on that.
On the headwind side is the Delta variant and Covid it hasn't gone away and is creating uncertainty throughout the world and supply chain.
Supply chain disruptions in particular, our customers and how that might impact demand patterns, which lead touched on on inflation, both on the material side and on wages, but we've built a pretty sophisticated AI model over the last 18 months, it's not perfect from nothing is when it comes to forecasting but.
But in my time at the company surpassed tool we've had to date and we are.
Factored in all of these inputs and came up with.
This forecast is and I'll give you a little more detail behind it the first half that we're looking at.
It is up a little over 9%.
Organically in the second half up mid single digits, that's how you get to the 7% overall and important part, though if you look at the industrial piece, both North American industrial approximately the same up 11% in the first half and up mid single digits the second half.
When you think about aerospace on you and several.
Several of the pre reports that came out.
Didn't have the insight on what has shared with you right now so we have aerospace.
With a gradual recovery up 3% in the first half up 5% for the second half is where you get the 4% at the midpoint.
But what's underneath that and will help give you some context as to why that number is what it is on the commercial side, both OEM and MRO, that's going to grow low single low teens. So nice recovery. There military MRO is growing mid single digits, what is down as military OEM, it's down mid single digits.
On the reason for that and thankfully our customers thought of as our customers accelerated deliveries last year.
Were up 19% as an example, they did this to protect the supply chain to support.
<unk> supplier health, because a lot of suppliers have commercial exposure as well as military exposure and they accelerated in the military exposure to help everybody. So this year that we're in now 20 twos, a reset of the inventory through that supply chain.
We will be down and of course, then we'll go back to more normal levels in FY 'twenty 3 if you take out that acceleration in.
In the prior period <unk> 'twenty, 2 military OEM would be about a plus 3.
So then when you add when you would factor that in aerospace growth will be more like 8%. So that 4% is being weighted down by the military OEM segment that reset of inventory. So that hopefully that helps everybody with white aerospace number it is what it is.
Comparing debt growth rate to 7%.
To give me global industrial production index.
That's going to be within our fiscal year 'twenty 2 that's a 4.8% forecast and you've heard us talk externally, we want to grow on a 50 basis points faster than that so that our number 7 percentage to them than.
And then maybe while I've got.
Talking about guidance I wanted to touch for a second on operating margin and then ill, let becoming about price cost. So our operating margin guidance at 21, 6% at the midpoint with an approximate 30% number was from the full year.
If you were to take out the discretionary prior period made us an apples to apples the underlying MRO Wes as a positive 50%.
And are good indicators of what we did in Q4, we did over 50% in Q4, so that was actual results by region.
The reason why I mentioned that is that underlying MRO west as being hidden because of the year over year comparisons being awkward and it really speaks to the operational excellence from the team just because it's hard to do an underlying 50% from or was I think everybody can appreciate that so Lee if you want to comment on the price Jamie I'll just.
And on maybe finish up here with price cost so.
Last earnings call. The question came up and I talked about how we track all the commodities on quarterly trends on an year over year trends.
I've said back then it was a sea of Red in other words everything was up and I would tell you here a quarter later, it's still a sea of red.
But having said that we are able to see this coming very well because of the processes. We have internally by measuring what we call our purchase price index and.
Then also maintaining margin neutrality by our selling price index. So we're on top of it on our goal as we've always said is to be margin neutral.
We're actively working on price.
Both with direct customers and distribution.
But it is a.
There is a lot of inflation on the commodity side right now no doubt about it.
Okay. Thank you I appreciate the color.
Thanks, Jamie.
Your next question comes from the line of Mr. Brian <unk> with Baird.
Good morning Mig.
Good morning, everyone and thank you for taking the question.
Tom I guess on I'm looking for a little more context from U B industrial order strength, both North America and international I don't know what your expectations were for the quarter, but I'll tell you versus ours.
Orders were much stronger.
And I'm also looking to understand what backlog look like at this point because obviously your order intake was higher than organic growth and are there any challenges with regards to converting this backlog to actual revenue either on your side or maybe potentially on your customers.
But let's start with that maybe.
So Megan let me.
Talk about orders as Tom I.
And I think just maybe help clarify things where people people who are doing 2 year stacks you might say.
It seems like the organic growth might be light compared to the 2 years. The 1 thing is you have to look at is.
And current period, we have acquisitions in prior periods, we do not have Lord and exactly go way back to 19, when you do apples to apples on quarters $19 to 21 and excludes the acquisitions.
Our industrial orders were up low teens.
And I just mentioned as I was answering jamie's question, our forecast for the first half on the industrial is.
Low teens with 11% organic growth. So there's clear correlation between what we are seeing versus 19 again apples to apples on order entry.
And that's how we.
In addition to the AI model, how we laid out the year.
Backlogs are increasing again youre going to remember that the prior periods is uniquely low comps is probably <unk>.
<unk> number that you can't get too excited about on our on time delivery is holding up nicely.
My customers would like to see us do better on that.
It's holding up very well compared to comparable times and I would say the impact that we've seen has been more on customer push outs of schedules.
On automotive we're on.
Immobile.
Mmm are having trouble with chips as everybody knows and they are taking really targeted shutdowns and that will push out our various orders net that impact in North America.
A little bit in Q4, but.
As Todd mentioned, our Q4 sales.
We're up about 10% of industrial late versus.
Q4, 2019, so everything's kind of coalescing between orders and sales compared to 19 around that low teens type of growth rate.
Okay.
And then.
I guess I wanted to follow up on Jamie's question on on pricing and trying to see if we can get maybe a more specific answer.
When I'm looking at various PPI that some of the product categories that you guys are involved with.
Pretty common debt Im CND CPI somewhere in the flow.
4.4 and a half.
Yes.
Year over year, and I'm, just sort of wondering if you're seeing a similar level of price increases in your industrial business.
There are differences at all in terms of.
OE versus your distributor partners. Thank you.
So I would say, it's arrange some lower in some higher on whether it averages out to that or not I can't really say.
But.
With our OEM customers.
Customers.
We've got direct contracts with many of them and we're benefiting from is a lot of them have material clauses in them. So it allows us to capture that debt pricing as we go forward on the distribution side. That's typically just on list price increase but what youre seeing is kind of our best guess on is all on the guide right now.
Thank you.
Thanks Meg.
Your next question comes from the line of Nicole <unk> with Deutsche Bank.
Good morning, Nicole Catherine.
Thanks, Good morning, guys.
Can we do.
Maybe I know you went through the 1 half.
Dynamics, Tom but can you just narrow that youre, a little bit to what's baked in to <unk>, both with respect to organic growth.
And.
Incremental margin.
<unk>, it's Tom So first quarter will be up kind of <unk>.
Low to mid teens for industrials aerospace low single digits.
Really our first half.
From an MRO is going to be in that upper twenty's.
And again I would just point to again the comparison, if you did apples to apples would still be in that 50% range. So it's really outstanding performance by the operating team being masked by the.
Prior period on the discretionary cost savings that we had.
Got it okay. Thanks, Tom and then can you clarify on the change to FIFO accounting in the U S. I guess what was the impetus to do that now and is there any benefit to the 2022 guidance related to the change.
Yes, I'll take that this is this is todd.
We've been talking about this internally for quite some time and it really started with.
The recent acquisitions CLARCOR, Lord and exotic those companies always use the FIFO valuation.
Method.
We did not use it in our aerospace business, we really only used it in our traditional U S locations all of our international locations.
By rule have had to use the FIFO valuation method. So we took a look at it and said Hey, maybe this year is an opportunity to convert and that's that's essentially what we did.
We converted early in the quarter we worked.
Tirelessly across our teams and with our internal or excuse me, our external auditors and we felt it was the best time to do it there really is no impact to the quarter. Since we converted we essentially reported the quarter in the FIFO method. We did go back and restate prior years just to show you what the impact was.
<unk>.
And I just want to make sure everybody realizes debt. If you look at this historically, it's a penny or 2 per quarter. It's a very immaterial impact we always booked at corporate so it had no impact to our segment margins are anywhere incrementals and it really just now standardizes our inventory valuation across the entire company. So we're happy.
With the results.
In respect to FY 'twenty 2 there is no there is nothing in the guidance for GAAP.
Benefit for converting to FIFO.
Okay. Thanks for clarifying on Todd I'll pass it on.
Okay. Thank you.
Your next question comes from the line of Nathan Jones.
Okay.
Hi, and good morning, everyone. Good morning.
I wanted to follow up on the MRO MRO.
Comment Tom.
EBIT debt, if you normalize both years for all of the discrete costs and charges and benefits.
Which I think is.
You would normally see a high NRO.
Real year for recovery here.
Which would then glide back down to something more normalized can you talk but I think the <unk> was probably higher than you would normally get into <unk> can you talk about what you think that MRO kind of progression would be over time, and what a normalized average kind of <unk>.
Incremental margin MRO, but basically you guys.
Yes, Nathan this is Tom and Youre right I think this underlying them relative to 2%.
For a whole year and it would be also counting Q4, probably Q3 of last.
Last year, or so 18 months will be higher and longer than we would normally expect I think which speaks to the changes from the win strategy.
And the fixed cost changes, we've made and maybe the efficiencies on top of those changes that came out of the pandemic just as more efficiently at work, but I think going forward, especially when we get to FY 'twenty 3.
Had these anniversaries to worry about the discretionary 1 year not in the next year I think and I would just use for people modeling, 30% as we've looked at and benchmark business that continues to be a best in class number and I think with all the changes we've made.
I think thats, a good number to use over a cycle to use 30%.
Okay.
Thanks for that.
I think what to ask a question on net ESG report that you guys put out the other day is clearly.
Very significant reductions debt park has made over the last decade or so.
Good aggressive targets that would be the next 10 to 20 years can you talk just a little bit about it's probably a very long answer.
Some of the mechanism.
Some of the main initiatives that youre going to use to achieve those goals.
This is going to be a combination so we've been working on this already.
We've had since 2010, 44% reduction I've got the report actually from an ethical applying various we use different time periods with 50% of the sport.
On.
Since 2010, so we've been on this for a while and it's.
Energy things that we do within the plants renewables different lighting some.
Some of this will happen from indirect emissions.
The utility.
Utility companies changeover to consume renewables, we automatically get credit for that as well, we're going to be working with our suppliers on what they can do to reduce it.
All the Kaizen work, we do we just.
Utilize the equipment better.
Smaller footprints.
Better flow less.
The distances traveled all those kind of things helped on this reduction. So we have every group signed up with <unk>.
With respect to bringing on.
<unk> targets that they are working on and they know exactly where they are and that gets cascaded down plant by plant.
And then we've also helps.
Every group, having a list of greenhouse gas emissions reductions what are the things theyre doing recycling things theyre doing thats been the way we know how to do we drive it down to the respective divisions and then at the group level, we have each group under ticked down roadmap developing their technology portfolio.
And how it needs to change for or Evs.
<unk> fuel cell, evs or hydrogen et cetera, and.
The groups have been actively doing is the good thing about.
As we formed the motion Technology Center.
About 3 years ago and from <unk>.
People aren't familiar with it this is taking the best and brightest.
Could between aerospace our motion systems group, so taking all the motion related technology, the company, having et cetera center of excellence for that.
And in particular, focusing on electrification and a lot of the technologies that we developed in the nineties on the F 30 fives.
Flight surfaces on the F 35 fighter, our electro hydraulically actuated and we've taken a lot on those learnings and applied it into.
Into the industrial portion of the company.
Developed a suite of motors and motor controllers and software that we're offering on the industrial companies.
Oems in particular with our platform changes as I look at more electric and when you add in.
Acquisitions like Lord on top of the engineered materials applications that we have from legacy Parker, we have a really strong materials science portfolio to help with that transformation as well. So our sustainability message is twofold things, we're going to do internally, which we have good line of sight too.
And we put out 2 major targets 2030 in 2040, but we're looking for year over year things to get there and then what we're doing to help our customers because our customers that scope 3 that's helping.
Customers will be all overdoing it.
Great. Thanks for taking my questions.
Thanks, David.
Your next question comes from the line of Joe Ritchie with Goldman Sachs.
Thanks, Good morning, everyone. Good morning, Joe.
Todd maybe first question on free cash flow clearly.
Really nice job this year at 16, 5% of sales I guess, you think about the free cash flow margin going forward.
Should we be thinking that theres going to be a little bit more of a working capital drain going forward just given that growth is impacting here on the industrial side.
Well.
Yes, absolutely Joe theirs.
There's been a step change in our cash flow performance and I think everyone has seen that over the last couple of years.
It's always a little bit tougher in a growth environment.
So we will be ready for that I still think theres some opportunity across our enterprise. Some of the recent acquisitions I think we've got some upside on inventory.
And really.
On receivables.
Payables throughout.
The last 20 months, so I still think we've got room to grow here.
So we're not expecting much of a much of an impact.
Okay, Great Great day here and then my follow up Tom Obviously, clearly big announcement this week.
I'm curious maybe on the flip side of things are you thinking.
Maybe a little bit more aggressively around like portfolio divestiture side.
To help with the potential deleveraging from this large acquisition and how youre thinking about divestitures in Holistically that'd be helpful.
Chose time, we look at that all the time not just when we have a large acquisition, but this is something we have standard work around that we look at it.
At the opposite Chief executives to lead Todd on myself as well as we do it annually with the board and I would characterize that I've used this visual for people I think the portfolio of the company. It's been very thoughtfully put together to think of it as a tree trunk with the various branches too.
2 thirds of our revenue.
Comes from customers that buy from 4 or more of the technology. We have so my.
Sensors and everybody that built this company did a very thoughtful job of putting together.
Our connected pieces that makes sense, so when we do that portfolio analysis.
There's very little that we see that we would want to divest something we look at all the time.
We will divest of anything but if you use the tree analogy would be a small branch there's going to be no major trucks that gets slapped on if we look at it all the time.
But I wouldn't I wouldn't see any big announcements from us regarding divestitures.
Okay. Thanks for taking my questions.
I appreciate it Joe.
Yeah.
Your next question comes from the line of Joel <unk> with BMO.
Hey, guys.
Yes.
Just a different angle on the on that last question are there any internal actions you guys can can take or or that would really help you to get ready for the Mega acquisition.
That's not how you work.
Well I would characterize as Tom those internal actions have been happen every day since I joined the company on every day to day everybody else at work here.
We're all about continuous improvement and I think the slide we showed earlier on 660 basis points improvement in EBITDA margin as.
This would position us to be able to do a deal of this size if you think about.
A couple of a couple of things regarding Megan and just using that as an example, the <unk>.
Multiples that we're going to do.
Very similar or less than what we did with CLARCOR.
The synergies well the dollars or percent synergies.
Are very similar to what we did with <unk>.
CLARCOR Lord and.
And what's interesting is we're going to do a deal that has over 2 <unk> the purchase price of.
Our largest transaction, but our starting leverage will be about the same point.
We're weighted Lord and exotic so the question might be well.
The reason for that is because EBITDA has grown dramatically.
The cash flow generation of the company the EBITDA margins have grown so dramatically that we can take this size and it looks very similar to what we did in the past.
Get ready every day and as we keep getting rate will probably be ready to do something.
Even better as we go into the future.
When we update you on our FY 'twenty 6 targets, they're going to be higher than where we are today.
When should I G. III, just started and it has tremendous.
Firepower behind it to continue to propel the company so.
We're preparing for the future every day and I think what we did really the last 10 years has positioned us to do.
Hey, good acquisition.
Does that take away youre kind of potential as we get to Investor day to have some kind of bigger levers that really drive margin forward is it is it really just a series of small things and can you give us a couple of examples of some of the things you're working on that could really.
We continue to transform this company and then on finished thank you.
Well, there's a couple of things I would talk about on the top line.
It would be the portfolio changes, we've made but there's also things organically, we're doing differently the whole strategic positioning, which I'll try to give more color on that on IR day, and how our divisions are taking.
A real step change in ownership of how they position themselves versus the competitors innovation changes, we've made on PVA and new product blueprinting simple by design, which is a growth propellant disclose on margin.
Engine International distribution growth digital leadership, and the new incentive plan changes that replacement Rona all of those things are going to help on the top line with several of those on the on.
The margin side as well so as the portfolio becomes more innovative than it has over the last number of years those carry higher margins simple by design as some of you maybe heard <unk> talk about will be the single largest margin enhancement the company has ever done.
It's just starting.
International distribution as we move that mix, that's a margin enhancement.
Non with digital leadership that we continue to get more efficient with the use of AI.
And then probably the last day.
The most important things we've done around engagement I had to pick 1 single thing that propelled the company. It's been the engagement of our team members' engagement scores on the.
The ownership and it's hard to put a.
And number 2 that we should know when you have people, who think and act like an owner that used lean and kaizen. It's just part of their normal thinking that spirit of continuous improvement is a big part of what's driven our success to date you can plot of our ties on activity and our engagement scores and they're working hand in hand to look on a parallel path.
Driving success, so it's not 1 single thing Joel.
It's a number of things and I guess that 1 slide that we showed you earlier showed the compounding effect of improvement year over year compounding on EPS doubling at the compounding on margins.
That's going to keep going on I'm not going to stop.
That's great. Thank you.
Thanks, Joe Hey, Jon I think we have time for 1 more question. So whoever is next in queue, we'll take 1 more question.
Okay. We have a question from the line of David Raso with Evercore ISI.
Hi, Thank you very much and I apologize I didn't follow the order commentary.
You said that the current quarter orders were running I think you said, 17% first clarify that.
Is that industrial was at the whole company I'm, just trying to understand that comment.
David This is Tom so the comment I mentioned on orders was contrasting 19% to 21, where we were if you've made it apples for apples.
Because we didn't have acquisitions less acquisitions in 19 and that has orders growing versus 19.
Low teens.
And I was just making that correlation between order entry coming in low teens versus 19.
Got.
Sales growth in Q4 was right around 10% versus 19, and our forecast for organic growth. The first half for the industrial piece of the company was around 11%. So they all kind of coalescing around that 10% to 11% low teen type of level.
I appreciate that but we're not there right on when it really comparing versus 19. Your guide is 22 versus <unk> 21 and.
And if the orders were over 50% industrial even last quarter.
If you look at the more challenging comps.
Single stack, maybe it's you know 17% so the orders would be up like 40, or you want to double stack and its even less of a degradation. So I'm just trying to understand what are the actual order trends right now versus a year ago. Just so we understand are you seeing a slowdown or are we just confusing the 2.
Commentary about versus 19, just to be clear because the the first half industrial growth.
Is the correlations breaking significantly versus orders, leading sales and how you're guiding right. Just 1 what are you trying to industrial orders I was trying to give you back to something that's more normalized activity because the year over year is what we've announced it was.
<unk> plus percent for international and -7 for aerospace at plus 43, but you can extrapolate debt against normal conditions, because that was against a quarter ago, which is 1 of the great shutdown happened. So you can't take that number extrapolated into organic growth you're going to come back to kind of some other benchmark.
So we went back to when activity was more normalized.
<unk> debt.
They came up with.
This is what I appreciate it's pretty safe bet on the various inputs.
That we've put into that so there's a lot of science that went into this number and I'm just trying to contrast, why you can't take up 43% order entry and so you're going to have a 43% organic growth what would you be able to help us with how the orders are trending currently versus a year ago.
Orders continue to grow through the quarter I mean no.
If I take North America was 11%.
301% to 56% on it sequentially got better every month.
Through the quarter same thing happened in international So we saw we saw momentum building through the quarter things are definitely not slowing down David I don't want anybody to take that that thought process things built through the quarter. That's all I want to be clear on time and if you've got 50 in this past quarter that usually is.
Some of it of a correlation for the next quarter, but the comps.
Not exactly a normal comp.
But the fact is if you look at the constant.
Current quarter the industrial orders.
It should still be up north of 30 or so.
And then when you have 2 quarters running 50 than 30, it doesn't make a lot of sense to be thinking that first half industrial is kind of low teens.
I'm just I know, it's a little tricky on the conversion maybe some things have taken a little longer to ship I'm, just making sure we don't walk away thinking.
A pretty dramatic slowdown so youre on.
You're saying you're not seeing a slowdown end of the day.
I'm going to be very clear there is absolutely no slowdown from as you can't take that 50% of our order entry rate.
Draw linear curve, there and so it's a 50% organic growth.
I hear you on that works for them.
I hear Ya lastly for the March meeting.
When we think about the comment about simple by design. So you feel pretty early in the journey.
Any way you can frame for us how you perceive.
Margin improvement from from here versus kind of the journey, we've been on the last 5 years, just to kind of frame it a little bit for us given similar debt.
They wanted to do that in full context.
Through all of the strategies and how we're going to do it and giving you a fully.
Right.
Explanation.
But I would just say that we're going to continue to get better.
If the future is.
On the past is an indicator.
You can draw that into the future.
No I appreciate that okay. Thank you very much appreciate it David.
Alright.
Just wanted to say thank you to everyone for joining US today. This does conclude our FY 'twenty 1 on Q4 earnings webcast.
And again, just consistent with the comments made on Monday regarding.
The requirements of the UK takeover code and our pending.
Mega transaction.
Representative of Citibank will continue to participate on all of our analysts and investor calls for the foreseeable future.
Robin and Jeff are obviously available here all day, if you have further questions or need any further clarification and always thank you for your interest in Parker and I Hope everyone has a great day on a great weekend.
Care.
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