Q4 2019 Earnings Call
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Later, we will conduct a question and answer session and instructions will follow at that time.
As a reminder, today's conference maybe recorded.
I'd now like to introduce your host for today's conference Ms., Cathy Fever, Executive Vice President Finance and administration and Chief Financial Officer. Please go ahead.
Thanks Liz.
Good morning, welcome to Parker Hannifin Sports order 2019 earnings release teleconference.
Joining me today are chairman and Chief Executive Officer, Tom Williams.
And President and Chief operating Officer Lee banks.
Today's presentation slides together with the audio webcast replay will be accessible on the company's investor information website at P.H. stock Dot com for one year following today's call.
On slide number two and three you'll find the company's safe Harbor disclosure statement addressing forward looking statements as well as non-GAAP financial measures.
Reconciliations for any reference to non-GAAP financial measures are included in this mornings press release and are also posted on Parker's website at P.H. stocks Dot com.
Today's agenda appears on slide number four.
Well begin with our chairman and Chief Executive Officer, Tom Williams, providing comments and highlights from the fourth quarter and full fiscal year 2019.
Following Tom's comments I'll provide a review of the company's fourth quarter and full fiscal year 2019 performance together with guidance for fiscal year 2020.
Tom will then provide a few summary comments and we'll open the call for a question and answer session.
Please refer now to slide number five and Tom will get us started.
Thanks, Katherine good morning, everybody. Thanks for your participation.
Looking at slide five we had a strong fourth quarter and completed brokers best year ever in our history, but before I jump into all the results I wanted to just pause for a minute and reflect on the remarkable transformation of our company.
Parkers are very different company now delivering record performance and better able to perform through market cycles. We have a stronger portfolio of business has fallen to three transformational acquisitions, we've done the last three years.
If you look at performance and go back the last five years adjusted operating margin percentage improved 200 basis, and 280 basis points.
And adjusted EBITDA margins improved over 300 basis points.
We are a better performer over a cycle, we've always been good on cash flow or cycle, but we're now we're much better on EPS in margins over the cycle.
A particular note our margin performers from a 15 and 16 industrial recession.
And our margin performance just in last quarter Q4 on negative order growth. They all point to the improved performance that I was referring to.
On the three acquisitions, they're going to lift the company up on two levels portfolio and performance on a pro forma portfolio side, we've wanted to add to filtration engineered materials and aerospace. These are parts that we've talked about wanting to add too because in their resilience over the cycle.
On the performance side, we're adding three great businesses that are accretive to growth.
And the margins our goal here through the win strategy in our capital deployment strategy is to build a better business generates higher gross margins and cash flow through the business cycle and you're seeing evidence of that already.
Alternately this is going to result in Parker being a best in class company. So my thanks to all the Parker team members that are listening in for all their hard work last year, but really over the last several years to get us to this point.
If you turn to slide six.
Part of what is transforming a company is our business model and the competitive differentiators that makes us special.
I want to just talk through these bullets on this page briefly the win strategy. So our business system. It is the engine behind our results our decentralized divisional structure really drives an entrepreneurial spirit and the company.
The motion and control technologies that we have really creates the breadth of our portfolio and this strategically positions us to have a big advantage versus our competition.
And recognizing the fact that I've talked about before 60% of our revenue comes from customers that buy from four more of those technologies. That's a good evidence that our customers value that breadth of technologies, our strong intellectual property, 85% of our portfolio and typically what we ship has some element intellectual property tied to it.
We have long product lifecycles decades long.
As a go balanced OEM and aftermarket and we have arguably the best distribution channel and the motion control space, we have low capex requirements, our lean transformation.
It's really driven a low capex to drive our business and that enables us to have a very robust capital deployment process.
And were great generators and applies a cash and you've seen us an action over last five years in that regard. So if you turn to slide seven.
Some highlights from the fourth quarter safety continues to be our top priority our recordable incidents for the quarter were down 24%. Our high performance teams are helping to drive. These results. Our goal is zero incidence that's not an aspiration goal is really an expectation or we're going to run the company.
And the ownership culture, that's created Tonight foreseen processes, starting with safety is going to be applied also to quality cost and delivery and that will naturally lift on the performance of the company.
All time quarterly records for the fourth quarter total segment operating margin total industrial segment operating margin net income and EPS couple of notes on a quarter sales were negative 3.5% that was composed of a negative 2% on organic and a negative one a half percent currency orders declined 3% against some tough comparables and we had a fourth quarter record on industrial International segment margins as well my thanks to international team for a great job in the quarter.
So now want to turn to full year results reflect 19.
We had a number of all time records of course, we only do records on a reported basis. They are sales total segment operating margins net income EPS and operating cash flow.
A couple of the highlights for the full year, we came in on organic growth of 2.6% organic sales.
Outpacing global industrial production, we had excellent improvement in segment operating margin and EBITDA margins versus the prior year.
Adjusted EBITDA margins, if you go back to when we acquired CLARCOR, we were 14.7%.
We're now at 18.2%.
From an EBITDA dollar standpoint, we were 1.7 billion and now we're at 2.6 billion that growth and margins that growth in EBITDA dollars. It's really helped enable us to do both the board and exotic acquisitions that we recently announced we achieved 17% segment operating margins from here ahead of our original target and the first time in our history.
17%, a number that we're extremely proud of and obviously, we're not stopping there, but it was a huge milestone for us to reach.
Tremendous cash flow generation, resulting in $1.7 billion and operating cash when you do it on a percent basis, we came in at 12.1% CFO away and excluding the pension contribution that would be 13.5%.
Switching to cash and capital deployment.
The goal and you've heard me talk about this is to be great generator supporters of cash.
So on the cash generation. So we ended up 2019 at 115% free cash flow conversion that makes 18 consecutive years of free cash flow conversion create a 100%.
An unemployment side it was a big year.
Dividends are our stated target is to pay out 30% to 35% of net income and as a result of our growth and an income we increased annual dividends paid out by 13%.
We had our 60 threerd consecutive year of annual increases to dividends paid out a record were very proud of as well and one that we intend to keep.
We announced two transformational acquisitions and on the share repurchase side, we've done we did $200 million.
Tenbfive one program, we purchased $600 million on a discretionary basis.
Debt reduction is going to be a higher priority going forward, our targeted within three years to get 2.0.
Multiple from a gross debt to EBITDA multiple and we will pause in M&A activity until we get there.
Just a few comments on the acquisitions are really going to generate create value for our shareholders.
We announced in the last 90 days the acquisition of the lower Corporation, an exact metals transformational to our portfolio, adding to our engineered materials business and our aerospace group was high growth and high margin businesses. When you look at the pro forma EBITDA margin.
Take legacy Parker with Lord and exotic and your forecast that out five years, we're going to improve EBITDA margins by more than 400 basis points over that five year period of time.
That's really going to help propel us being the top quartile company that we desire and both of these companies are referred to Florida and exotic are both great cultural fits and we expect a seamless integration.
Now turning to the outlook.
We're issuing guidance for a flight 2020.
We've got monitoring market conditions were forecasting sales of negative three to flat, so minus 100% that midpoint and I'll talk more about that during the Q and a.
I think the effectiveness of the win strategy is really being observed when you look at our 20 guide historically on negative organic growth, we'd be reducing margins, but what does guidance. We're expanding segment operating margins and we're posting a record EPS. Adjusted EPS is at $11.50 to told US 30 cents or 11 $11.90 at the midpoint.
Business realignment of $20 million.
And we did not include more or exotic and thus avoid 20 guidance. We will of course update guidance after the close.
So going forward really if you look at deploying 19 results. Therefore, 20 guide coupled with the momentum that we have with the win strategy and our recent acquisitions, we're well on our way to achieving or about 23 targets and just to remind people those targets for 23, our sales growth of 150 basis points greater than global industrial production growth over the cycle.
Segment operating margins of 19%.
EBITDA margins for the 20%.
Free cash flow conversion greater than 100% EPS CAGR over that time period of 10% plus.
The actions were taking the dedication of our global team members are really helping to generate strong returns for our shareholders.
And with that I'll hand, it back to Cathy for a more detailed review on the quarter.
Thanks, Tom.
I would like you to now refer to slide number eight.
This slide presents as reported and adjusted earnings per share for the fourth quarter and full year fiscal 2019 compared to 2018.
Adjusted earnings per share for the fourth quarter increased 3% compared to the prior year, reaching $3.31.
Adjustments from 2019 as reported results total 14 cents, including business realignment expenses of four cents.
And lowered acquisition and integration expenses of 10 cents.
This compares to fiscal 2018 adjustments of 60 cents for business realignment expenses CLARCOR costs to achieve a net loss on sale and write down of assets and the U.S. tax reform adjustment.
For the full year adjusted earnings per share for fiscal 2019 was $11.85 an increase of 14% compared to fiscal 2018.
Adjustments from the 2019 as reported results totaled 37 cents.
This compares to fiscal 2018 adjustments of $2.59.
The details of all of these adjustments are included in the reconciliation tables for non-GAAP financial measures.
Moving to slide number nine.
You'll find the significant components of the nine cents walk from prior year fourth quarter adjusted earnings per share to $3.31 for the fourth quarter of this year.
We gained four cents from lower corporate DNA interest expense and other expense.
Lower income tax expense accounted for six cents.
And lower average share count contributed 11 cents.
Offsetting these gains segment operating income decreased by 12 cents as a result of lower volume with sales down 3.6% versus the prior year quarter.
And also as a result of higher development costs incurred in our aerospace segment.
Moving to slide 10, you'll find the significant components of the dollar 43 cents walk from adjusted earnings per share of $10.42 for fiscal 2018 to $11.85 for this year.
The largest improvement came from segment operating income.
This accounted for an increase of 79 cents with total segment margins, improving by 100 basis points year over year.
14 cents came from lower interest expense.
Lower income tax expense accounted for 19 cents and reduced average shares contributed 31 cents.
Slide 11 shows total Parker sales and segment operating margin for the fourth quarter and full year 2019.
For the fourth quarter organic sales decreased year over year by 1.9% and currency had a negative impact of 1.7%.
Despite a decline in sales the fourth quarter total segment operating margin on an adjusted basis improved to 17.6% versus 17.5% last year.
This improvement reflects productivity improvements and the benefits of synergies from acquisitions combined with the positive impacts from our win strategy initiatives.
For the full year organic sales increased by 2.6% and total segment operating margins increased 100 basis points to 17.2%.
Moving to slide 12, I will discuss the business segments, starting with diversified industrial North America.
For the fourth quarter, North America organic sales were down 3.2%.
Even with lower sales operating margin improved nicely for the fourth quarter to 18.4% on an adjusted basis.
North America continued to deliver improved margins, which reflects the hard work dedicated to productivity improvements as well as synergies from acquisitions and the impact of our win strategy initiatives.
For the full year, North America organic sales increased 1.8% and adjusted margins increased 30 basis points to 16.9%.
I'll continue with the diversified industrial International segment on Slide 13.
Organic sales for the fourth quarter in the industrial International segment decreased by 4.1%.
Currency also negatively impacted the quarter by 4.5%.
Despite the lower sales operating margin for the fourth quarter 2019 on an adjusted basis improved 30 basis points to 16.4% of sales.
This margin performance reflects our team's improved operating cost efficiencies from realignment initiatives and the benefits of the win strategy.
For the full year organic sales for industrial international increased 1.1% and adjusted operating margins increased by 110 basis points to finish the year at 16.4%.
I will now move to slide 14 to review the aerospace systems segment.
Organic sales increased 6.5% during the fourth quarter, primarily due to commercial and military OE growth.
Along with growth in commercial aftermarket.
Operating margin for the fourth quarter decreased by 200 basis points due to higher development costs in the quarter.
And a lower mix of military aftermarket sales as compared to the prior year.
For the full year, our aerospace systems segment delivered great organic sales growth of 8.5% and an impressive 210 basis point improvement in adjusted segment margin, finishing the year at 19.4%.
On slide 15, you'll find the differences in fiscal year 2019 earnings per share between our full year guidance going into the quarter compared to the actual results from the outperformance in the fourth quarter.
Final full year earnings per share on an adjusted basis was 25 cents higher than previously guided.
At the operations level segment operating income finished one cents higher than expected driven by productivity improvements despite the lower than expected sales.
Lower corporate DNA interest and other expense resulted in an additional six cents.
We benefited 16 cents from lower income tax expense due to discrete tax adjustments and additional benefits, resulting from new regulations related to us tax reform recognized in the quarter.
And lastly, we benefited two cents from lower average shares.
On Slide 16, we report cash flow from operating activities.
We had strong cash flow this whole year full year 2019 cash flow from operating activities was a record $1.73 billion.
When adjusted for a $200 million discretionary pension contribution made during the first quarter cash flow from operations was 13.5% of sales.
This compares to 11.2% of sales for the same period last year.
On Slide 17, we show a history of Parker's free cash flow conversion rate.
For the 18th consecutive year Parker generated free cash flow conversion of greater than 100%, finishing fiscal year 2019 at 115%.
Parker is great at cash generation, even during growth periods.
We're very proud of our team for their good management of working capital.
Moving to slide 18, we show the details of order rates by segment.
Total orders decreased by 3% as of the quarter ending June .
This year over year decline is a consolidation of minus 4% within diversified industrial North America.
Minus 8% within diversified industrial international and a positive 10% within aerospace systems orders.
The full year earnings guidance for fiscal year 2000, 2020 is outlined on slide 19.
Guidance is being provided on both an as reported and an adjusted basis.
Total sales for the year are now expected to decrease 1.5% compared to the prior year within a range of minus 3% to zero percent.
Anticipated organic growth for the full year is forecasted in approximately the same range at a midpoint of minus 1.5%.
Theres no prior year acquisition or divestiture impact and the currency impact is expected to be minimal.
We have calculated the impact of currency to spot rates as of the quarter ended June 32019, we've held those rates steady as we estimate the resulting year over year impact for fiscal year 2020.
You can see the forecasted as reported and adjusted operating margins by segment at the midpoint total Parker adjusted margins are forecasted to increase approximately 20 basis points from prior year.
For guidance, we are estimating an adjusted range of 17.2% to 17.6% for the full fiscal year.
The full year effective tax rate is projected to be 23%.
For the full year the guidance range on an as reported earnings per share basis is $11.38 to $12, an 18 cents or $11.78 at the midpoint.
On an adjusted earnings per share basis, the guidance range is $11.50 to $12.30 or $11, a 90 cents at the midpoint.
The adjustments to the as reported forecast made in this guidance include business realignment expenses of approximately $20 million or 12 cents per share for the full year fiscal 2020, but the associated savings projected to be $10 million.
Some additional key assumptions for full year 2020 guidance at the midpoint are sales are divided 47% first half 53% second half.
Adjusted segment operating income is divided 46% first half 54% second half.
Adjusted earnings per share first half second half is divided 45% 55%.
First quarter fiscal 2020 adjusted earnings per share is projected to be $2.66 per share at the midpoint.
And this excludes four cents of projected business realignment expenses.
On slide 20, you'll find a reconciliation of the major components of fiscal year 2020, adjusted earnings per share guidance of $11, a 90 cents per share at the midpoint.
Compared to the prior year of $11.85 per share.
Increases include seven cents from corporate DNA.
55 cents from other expense.
And 13 cents from lower average shares.
Other expense includes 35 cents of interest income from the proceeds of the bonds that we issued in June 2019, which are being held for the lower transaction.
The remainder in other is primarily related to numerous unusual charges incurred in fiscal 2019 that are not expected to repeat in 2020.
Offsetting these increases is a four cents per share decrease from segment operating income.
The operating income impact from the drop in sales volume will be partially offset by margin improvement throughout the year.
The remaining decreases our 30 cents from higher income tax expense and 36 cents per share from higher interest expense.
The decrease due to higher income tax expense is from discrete tax items in 2019 that we do not forecast in fiscal 2020.
The change in interest expense includes an additional 47 cents in interest cost from the bonds issued in June .
Partially offset by anticipated lower commercial paper outstanding as compared to fiscal year 2019.
This forecast does not include any results from our announced acquisitions of Lord Corporation or exotic metals forming company.
We ask that you continue to publish your estimates using adjusted guidance for purposes of representing a more consistent year over year comparison and that you do not include the pending acquisitions until we are able to close the transaction.
This concludes my prepared comments, please turn to slide number 21, I will turn it over to Tom to provide summary comments. Thanks, Ken. So just a couple of quick comments were very pleased with our continued progress.
The projected record year of earnings and up 20.
And we're well on our way to delivering a being a top quartile company and being the best in class company that we are aspiring to be.
Thanks to the global team all their hard work their dedication that results from a point 19.
And we're looking forward to our bright future together and will that lives were happy to start the Q and a portion of the call.
Ladies and gentlemen, if youd like to ask a question at this time. Please press. The Star then the number one key on your Touchtone telephone.
If your question has been answered all your wish to remove yourself from the queue. You may do so by pressing the pound key.
It is now open.
Hi, good morning.
Nice quarter.
I guess just first question Tom if you could just provide some context around how you're thinking about the organic growth cried for 2020, what's implied for sort of first half versus second half and then.
What you're seeing in terms of you mentioned channel inventory before how long that continues to weigh on results versus clearance versus clear the channel.
So I guess start there and then.
Yeah, I guess why don't we start there that's fine.
Okay, Jamie its Tom happy to do that because that's obviously probably top of mind for everybody. So let me take you through our assumptions and obviously this process that we do is we are one of the first company to start talking about calendar 20.
We take a lot of input from customers distributors or divisions of course, and our own economic models. So the organic growth that we talked about at the midpoint of minus one and a half that turns into a first half of minus four.
What's really mirrors, our current order entry in the second half of plus one so on the second half we have slightly better volume a little bit easier comps. If you look at minus one and a half organically on a regional basis is North America at minus one and a half international and minus four and a half and aerospace at a plus for November kind of rounding to half's here as I go through it.
Well, it's not a predictor of our future is another important data points that we have looked at and that's our pressure curve history.
If you look at the last 10 years anytime to 312 curve has gone less than one.
It tends to go down less than one per a 12 to 18 month duration, depending on where.
A particular business cycle is our current pressure curves have been less than one for about seven months.
So this guidance assumes that the 312 per.
Crosses one.
Approximately 15 months from when it started so not too different from what we've seen in other cycles.
Of course, and that's our best estimate at this time.
Let me take you through the markets that we see for F Y 20, not give a little color as to what we think striving to second half.
I'm going to make just a clarifying comment like I usually do.
Our list markets and positive neutral negative. This is our forecast for the market will take my comments as I'm speaking about the entire market is just how partners going to perform in the market. So on a positive side as aerospace forestry and life Sciences.
Neutral, which is a pretty big section agriculture, construction distribution lawn and turf material handling.
Oil and gas power Gen.
Refrigeration Semicon telecom and ground military and defense on the negative side is automotive engines heavy duty truck machine tools marine.
Mills, and foundries mining wheel and tire and rubber so what's driving the markets on an ARPU in the second half. Besides some help on compare easier comparables will be the one one part which is what youre alluding to earlier.
Jamie on distribution the Destocking that we were seeing early in Q3, and Q4 will continue for the first half, but at a diminishing rate.
And then we'll we'll be pretty much an equilibrium and our view on the distribution channel come into this calendar year and that turns to a slight positive for the second half.
Life Sciences will be positive for us in the second half as well as power Gen. Turning from negative to positive in the second half so thats, one category or things that we see moving to positive in the second half Theres. Another big category of markets that are currently negative.
We see its going to neutral in the second half. So I don't know that provided a tailwind but to become less of a headwind. Obviously, so the negative to neutral ones first half to second half from skin listings.
Our construction oil and gas semicon automotive machine tools mining.
Rail mills and foundries again tires.
So I'm pretty optimistic.
When you look at the 312 curves they are less than one.
But they're flattening so that's that's a positive indicator.
When you look at our four phases of the business cycle, we have about two thirds of our markets. They are in phase three phase III being the accelerating decline phase of a four phase business cycle and what that signals to us is that we are moving our way through the soft patch because the next phase after accelerated decline.
As decelerating decline, which means you are starting to to move out of that and then the next phase after that is growth. So in our view there was lots of self help here.
The markets are are going to turn.
And are going to start to help us, albeit a little bit later and deployed 20, but we'll start to provide some small.
Organic sales environment.
We've got the two transformational acquisitions and board and exotic it Brian .
Higher growth and margins.
And just about the time that we close these deals and really get the integration.
Really up and running.
Is also to be by the time these market start to come back and start to give us. Some some slight tailwind. So I think that all is going to line very nicely. So I feel good about 20.
And I think you know it all comes back to the most as I started the call was that we're positioned well for the cycle and.
We're going to continue to be try to be the best in class company.
So you don't do a follow up Jamie or not.
No I mean, I think I guess, just if I can have a follow up.
The implied margin.
You know resilience that we're going to see in the North American markets in 2020, even with the sales decline just any color in particular on that and then I'll get back in queue.
Yes, So we have North America going up about 20 basis points versus 19.
It's really going to be the continued one strategy efforts the productivity that we've got the kaizen activity that we have is all creating the capacity for us to be more resilient on the margin side.
And north Americas volume being down not as bad as international.
They are able to hold up the margins in fact expand margins because of that.
Okay. Thanks, I'll hop back in queue.
Thanks, Jamie.
Your line is now open.
Good morning, everyone.
So Tom.
I want to go back to your comments.
Early on when you talked about the transformation of the business.
This is something that we spend some time speak when investors about and one of the questions that I think we often get maybe you can help us with.
When you when you're looking at your at your business mix and you look at what traditionally have been perceived as your key customers in key drivers.
Heavy machinery OEM Bill.
How is your business looking today, especially when you when you count in Lord and Youre counting CLARCOR as well as exotic versus say the way and look in fiscal 15 in the last cycle or even the cycle prior to that because there is a business mix aspect here that I think.
Perhaps underappreciated even by by me.
Yes, I think you're right I mean that was.
As you know Mig and everybody else that's been listening on the call.
Almost all of my Investor presentations, when I've talked about capital deployment.
On our connectors on our motion technologies and AD.
Filtration, which is not one of our largest groups and.
And with Lord engineered materials will be one of our larger groups.
And add to aerospace, which balances out the short cycle nature of the company with a higher margin business. That's got a great growth trajectory. So clearly that portfolio as we've added $3 billion of revenue.
And roughly three years.
That goes into those targeted parts of the portfolio that will make us clearly more resilient.
It's.
It's you can't ever be.
Not have any reaction to the business cycle everybody feels good.
But can you density.
Steve the lows versus what you had in the past and I think you see evidence of that.
We hold margins almost virtually flat during the industrial recession of 15 to 16 margin performance in Q4.
Those are pretty phenomenal results and that was even before of course Q4 had CLARCOR on it.
But its before any lower than exotic so the mix is going to go into continue to help us and the win strategy is going to continues to help us too because we're not we're not stopping at 17% operating margin.
I see okay, and then if I may ask a question on industrial International.
Obviously, your full year guidance implies organic growth decline I'm presuming, you're sort of thinking that.
Orders kind of.
In line with.
With your organic guidance.
Two years in a row now of contraction in international So from your perspective, what sort of environment are you really baking into into your outlook in.
I am to some degree surprised that youre not announcing some kind of restructuring of storage.
Addressing basically the second year of volume decline here.
Maybe you can comment on that and how.
Your cost structure has changed and international whatever we can to you've done. Thank you.
Yes, so on the restructuring side, we have been restructuring international since.
Slide 14, and we've been on our very aggressive restructuring.
Getting international margins.
Almost to the levels of North America. If you look at last year 16.4 versus the 16.9 and a lot of you that followed us for a long time never thought we could ever do that so international has been moving because of the restructuring that we've been doing that we've been creating a much more agile organization and the mix improving distribution versus OEM. So that's that's been helping international so we don't feel the same need at least at these levels.
Sales decline could trigger some new level restructuring, we've got the organization, where it needs to be obviously, we'll do the normal.
Variable cost reductions and temps and overtime.
Voluntary pica works those type of things, but we think we've got we've really done a great job internationally and hence that's why you see the margins.
I'm not sure I hit everything you wanted to cover moved.
No I mean, you kind of did I'm I'm.
I guess I'm wondering if in some ways it a little bit unusual to see two years in a row of say orders or volume decline here that that's actually worse than what happened in 2015, right. So you know trying to understand kind of that dynamic in.
Also trying to understand if your cost structure is become more variable than it's been in the past thats kind of where I was going.
Yes, so maybe there was a part of your question on those international did grow at least minus 1% last year.
But it was the first to start to go down.
And so which it felt a little bit sooner. So international didn't decline organically last year of course had had a lot of currency.
Minus five different currency, but we do I think we've been realistic with international we've got international.
Down about eight and have percent the first half.
And then starting to work its way to buy the pipe piling time, we exit.
Q4.
You know to almost a.
A neutral type of positioning in Q4.
So it was first to.
To go win.
And.
I think it will be fine.
And I think the guidance pretty realistic in what we have entered the international.
All right. Thank you.
Thanks Mick.
Our next question comes from Joe Ritchie with Goldman Sachs.
Your line is now open.
Thanks, Good morning.
Good morning, Joe.
So I guess my first question is just going back to the.
Inventory comments from earlier I guess.
As you think about the next couple of quarters. It sounds like you're expecting destock to continue I guess in that context have you have you heard or have you experienced any distributor.
Price adjustment how are those conversations with your distributors occurring on the pricing side, just given the backdrop.
So let me I'll start with the inventory I'll, let Lee chime in on the pricing side of things.
So with at least North America, we do have good visibility into the sales out in sales in that I referred to in the last call and so we look at North America, we see about a flat growth organically was about 200 basis points of Destocking. So North America came in at about a minus two on distribution growth that was about minus 300 bips of de stocking in Q3. So we saw a little bit of improvement of 100 basis points of improvement and that's really was our thinking as we go into the first half.
Of of 20, we'll have about another 100, bips every quarter, hence six months to get through the de stocking and that's obviously through conversations that we have other servers and then we were plotting like I've referred to last quarter. We're plotting that sales out of sales and so we can get a little better visibility to trend slightly comment on the pricing side.
Yes.
Just commenting on distribution speaking about North America I would it's kind of said it was mixed during the quarter. It really depends on the region and Destocking continued actually on the pricing side.
If you're asking if there's still pricing power in the channel I'm not quite sure exactly.
We're asking a real we're still in a slightly inflationary environment I would say that you're still pricing taking place.
And which still promising theres still a lot of capex.
Activity still taking place at this point in time, which is a good indicator that.
And I'm speaking, mostly in North America that are still a lot of positive momentum going on.
Yes, we my comment was more around like whether your distributors.
Looking back on price at all in this backdrop and and really kind of trying to understand whether that has any implications on the leverage in your in your North American business.
No there's really none of that taking place right now.
Okay got it and then maybe just my follow on.
And just thinking about the trajectory of the Aero business Aereo obviously.
Continues to do well from an order perspective, you take a look at the.
The growth expectation for 2020, and they seemed a little light based on the trends that we've been seeing and so maybe some commentary around that.
As we head into 2020.
Okay, Joe it's Tom so.
On orders remember orders are long cycle, or 12 months and they tend to be lumpy and you don't always can't always translate the due dates directly out into the next fiscal year, but.
We were plus 10 like like you've seen that composition was minus five.
On commercially.
Plus 42% of military OE, plus 13 on commercial MRO and plus 24, a military MRO. So some of the things that really drove some of the big spikes for.
35 on the military OE on the commercial side it was.
Some 37, and 787 and really kind of a mixture of a 220, a couple of pretty nice broad base fixture on the MRO side and the military MRO a lot of the fighters.
18 or 19.
Total loans, a bomber, but some pretty good product pretty good progress on orders are for.
Sales are forecast about 4% composition as commercial plus three military OE applause to.
Commercial tomorrow at plus four.
Military Emerald plus 10.
And.
That's our best view at this moment.
I appreciate the color.
Thanks, Joe.
Our next question comes from David Raso with Evercore ISI. Your line is now open.
Hi, good morning.
My question focuses on the sensitivity of your margin guidance the volume.
What's striking me is in the first half of the year.
You have total company sales down 4% to 5%.
The implied margins up 10 depth.
The second half year revenues up.
And the margins are up 30, bips not terribly differently. It doesn't seem like there's much volume sensitivity.
To the to the margin improvement.
Now I do appreciate the year ago comp.
Mix currency could mess with the analysis a bit I'm just trying to understand.
Is that accurate, that's where you see your margin improvement coming from really isnt that volume sensitive.
Well, if I take total Parker.
I'm just doing total MRO us.
So we're in that minus 15 to minus 20 range for the first half.
And if I look at the second half a slight plus over 70%, though Ken as long as Paul numbers, you've got relatively modest sales increase so youre seeing some pretty nice lift in that second half.
As far as them or less ASCO.
One last thing the opposite Tom saying, you would think the second half of the year has got a really carry the load on the margin improvement because your distributors aren't destocking in the same way you have volume overhead absorption, that's improving because you have revenues up not down.
But I think Thats what strikes me is interesting that.
You're almost saying I can grow margins nothing regardless of volumes, but.
I'll use the word impressive, but yes, if you can do it it's impressive that you can have down volumes.
Op margin and up volumes up margins I mean, it's interesting.
Thats, a say because obviously if you really can do without them and volume sensitivity. It makes to the credibility that guide.
Improves I am just trying to understand.
Am I reading it right am I know I'm doing the math right, but I'm just trying to figure out.
Are there clear things on the margin improvement this year that you would say, yes, it's really not tied to volume at all.
I have confidence that we can grow margin even when volumes are down does that that's what you're implying in the first half yes. No you are absolutely reading it right and that's part of the transformation that I spoke to at the beginning of the call.
The combination of all the things we've been doing on lean kaizen active or really started heavy for us.
In the fall of last year.
The win strategy simplification, all those type of things.
The inefficiencies that we've.
We have worked through the CLARCOR synergies that are really kicking in all those things and of course, the portfolio shift as far as things were adding to the portfolio are enabling us to be better our margins. When we have softness on sales. So yes, we feel good about the.
Yeah, I wasn't sure maybe the part of the reason that the price cost is particularly helpful. The next couple of quarters, because you sell some lag benefit from prior price increases.
But now you get to benefit from a lower cost than that kind of goes more neutral in the second half.
Doesn't seem like in the channel you put much of a price increase if any through July one.
I'm not sure how much benefit maybe in your fiscal second half you'll have on price, but the carry over from the prior price increases should still be there. The next six months.
And then maybe benefit from lower costs. So.
Yes.
Not blessing it here, but just it's impressive that you can do that where you're not that volume sensitive im just trying to get a handle on.
It seems like you've you believe it just whether a couple of buckets to make us feel good about.
That's not volume sensitive we know what the price cost is are we now we have some inefficiencies that were still lingering at CLARCOR that aren't there in the fiscal first half a 20, that's all I was driving at yeah. No I think you're right you hit on all the buckets of inefficiencies that we have the CLARCOR clearly more pronounced in the first half of <unk>.
Eight to 19, and so that helps us as we look at a 20.
Some of the carryover on pricing is a little bit better in the first half.
In general if I was to to the total pricing for the year it'd be margin neutral, but we do get a little bit of help more than first half. So I think you're right.
Okay, all right I appreciate the color. Thank you.
Thanks, David.
Our next question comes from Nicole Deblase with Deutsche Bank. Your line is now open.
Yeah. Thanks, good morning.
Running nickel.
So I just want to start with the first quarter, so that color between the first half in the second half was really helpful. But if you guys. He gave us a sense of what's baked in from an organic and a margin perspective in that to 66 midpoint guidance. Prior one Q that would be helpful.
Sure Nicole I'll help you here, we're anticipating organic decline of about 3.5% for the first quarter.
With just a minimal impact from currencies say half 0.1%.
Currency, but as you look at the margins, we're expecting year over year to North America to see improving margins year over year again that relates to some of the inefficiencies. We saw at the first half of last year that are improving.
International with the decline will have lower margins than last year.
A nice decremental, though there.
And aerospace, we'll see improving margins.
Okay got it that's helpful. Thank you and then.
Secondly on aerospace margins it looks to me like you've embedded about 50% Incrementals and 2020 guidance.
I'm just curious how much are in the maybe contributes to that the factors driving the pretty substantial year on year increase in margins to about 20%.
Yes, a lot of that or a good portion of that has to do with the development costs and what we incurred in fiscal 19 compared to what we anticipate in fiscal 2000, and especially what we incurred in the fourth quarter. So in the fourth quarter of this year. Our development costs were 7.5% of sales that was pretty high our overall average for the year was 5.6%.
In fiscal year 20, we expect development costs to be less than that and were forecasting in the range of 4.5% to 5%.
So lower development costs are driving some of that incremental along with other.
Continuous improvement the teams are making to implement.
Productivity and win strategy initiatives, and just improving the processes in the shops and.
And getting more productive.
Okay got it thanks I'll pass it on.
Thanks Nicole.
Our next question comes from Andrew Obin with Bank of America. Your line is now open.
Yes, good morning.
Good morning, Andrew.
Can we just touch just going back to the strategy question can we talk.
About internal capital deployment, and it's really a two part question.
Hey, how do you think.
Deploying capital in terms of sort of capital and labor and specifically on capital.
If you could talk about sort of implementing robotics.
Three the manufacturing how much money are you spending how much impact because it making.
The second question is given all the trade tensions how are you guys thinking about deploying capital by geography, North America. The rest of the world and what are you seeing in your supply chain I know, it's sort of an expansive question. So that would be one from me.
Andrew its Tom So let me start with the Capex side. So I think a good round number for to think about us on Capex and this will be for the fund organic growth as well as productivity is around 2% and we are very active on robotics and additive I would just tell you that our strategy on automation robotics is to do kaizen first.
We believe that was not automate waste that we're going to do kind of are going to streamline the processes and optimize what we have and that will automate the remaining processes.
And so theres, a little bit of a learning curve on learning all the automation. We've got a lot of great partners that were working with and we've had a number of us somewhat sessions with all of our manufacturing engineers and I would say the organization is really jazzed up about it but were and I think this is a good strategy. We're putting kaizen first then automation and that's part of why I think you've seen the margins do as well as it has the kaizen activities are just starting to gain traction so more robotics coming forward, but we will invest in that that will be in that 2%.
And because of our lean transformation, we don't need as much dollars. We can divert some of that will what we've traditionally done into more capex towards robotics on the additive side work Thats a big deal to US. We've got three centers of excellence that we've decided strategically that we're not going to have this is not the kind of process you're going to have.
80 of them like one for every division.
So we have two centers of excellence.
For aerospace and we've got one for the entire company and that one for the entire company really acts as an incubator for all the industrial.
Divisions as well as also for aerospace and we're working on proprietary material powder blending and processes. So there's a lot of good work that we're very close to having our first production parts, both industrial and aerospace to make it into the field utilizing additive.
I'd tell you the other thing on additive is it designing for Adam So we have a proven working on designing for ahead of world because it's very important to design. The next generation of products thinking about an additive manufacturing process versus designing in the subtraction world.
You talk you are asking about supply chain.
We've always been a view on supply chain is that we like to make and buy and sell in the region for the region. So maybe you're asking about China, we feel still good about China.
We really do I mean, we have not over positioned ourselves in China, where we think we'll over extended.
We still have low cost.
Centers, there that were very very happy with China is still a huge country for us.
And we need to be there to service that.
And so I don't I don't think you're going to see us doing much.
Big Capex shifts like building a bunch of plants in Indonesia, we have the footprint, we need and the B, maybe just some minor tweaking of lines, but it will be immaterial.
And I'll just sneak in one more follow up on collaborative robotics I know that you had a big.
Rollout.
Program I believe you did.
Where are you in that Toms sort of ties on versus actual physical rolling out of.
Our capacity.
Heavy heavy on the kaizen activity.
Early days still in the cloud of robots, we we have several lots of them and all of our factories, but we have particular strategically of emphasize cousins first you talk to most sense size that are experts in this kind of transformation. They will encourage you to do the same thing.
And it's a lot faster dollars to the bottom line and a lot more capex friendly and the collaborative robotics is really capex friendly as well, it's going to be a light touch on Capex I don't see that as an issue, but the process has been let's do the guys and let's get the processes right first.
Really appreciate it thank you very much.
Thanks, Andrew.
Our next question comes from the line of anti gun with JP Morgan. Your line is now open.
Yes, Hi, most of my specific questions have been answered, but Tom maybe I'll throw this one at you if you look at.
For your end markets are today versus where we were when we went into the industrial recession in 15 and 16 it strikes me that.
As we look at the number of end markets that are.
Down or negative right now it's much more broad based.
Do you worry at all but heading into calendar year 2020 , we're facing much broader decline. When you include automotive heavy duty truck you take the impact of the Boeing 737 Max.
Production schedule declines it looks to me like we've got a pretty broad based set of end market decline.
Okay, and it's Tom I'll make a comment let me touch on the Max real cooking for a second so the Max for us.
We in our guidance, we put in 42.
Month.
And.
Because his first fit.
And most of our content there.
Very low margins, it's immaterial to us.
Pretty much what the schedule is to change, but I just want you to know we put it in a 42. So I think we're in good shape on that but I think your characterization characterization is pretty accurate. This is much more broad based but not as deep type of softness.
The 15, and 16 industrial recession was a sharp contraction and natural resources. So you had all the natural resource related end markets as we all remember went down significantly and so that was.
More isolated this is little more broader base my comment earlier on that we have two thirds of our markets an accelerating decline.
As an indicator that we have some pockets that are usually down things like semiconductor in power Gen.
But we're we're hopeful on power agenda, that's starting to find a bottom.
And we're also hopeful actuant semiconductors is starting to find a bottom as well.
And yes, I just wanted to follow up on the Boeing.
Im going to be some let me isn't there a risk that again, but that becomes more broad based it's not just about how much you supply onto the airplane, but there are a lot of kind of.
Second derivative impacts that could impact your business.
I'm not exactly sure what you're referring to because it would just be reflecting our building materials or you just don't but in term of the general supply chain. It supports bowling.
Yeah, and just thinking about the impact of pulling down the schedule at the one large manufacturing facility and how that might impact some of your industrial distribution business Oh, Okay, I see what you're saying.
I think that would be very minor based you wouldn't be able to find it so they shut down the plant.
At Redmond for 20 days or whatever.
Temporary basis, it would be immaterial to us as far as the implant things, we do on the industrial side.
Okay I'll leave it there I appreciate that thank you.
Thank you Anne.
Our next question comes from Nigel Coe with Wolfe Research. Your line is now open.
Thanks, Good morning, guys.
Yes, So just wanted touch on international orders.
We still.
The year over year.
Deteriorate and from last quarter on an easier comp. So I'm just curious if you maybe just talk about geographically, where you still have the incremental weakness and then I've got a follow up.
Yes, Nigel it's Tom so on international.
The composition of that minus eight.
We had both EMEA and Asia Pacific at about the same that high single digit declines.
And we had Latin America low single positive remember Latin America's fall, so, it's not really enough to move the needle.
And the way the trended.
In the quarter as that Asia Pacific weakened in May.
Lets stayed stable in June so may.
Stepped down from April to May, but may and June were were pretty well flat.
And then Europe was pretty consistent it was in that high single digit level the entire quarter. So no no real variation going April to June and in Latin America, we saw some variation, but in general slight slight growth.
And then in Europe have you seen any signs of a bottom though is it still.
You bet.
I think my description of the markets earlier on that I went through.
As a pretty good indicator for your for Europe as well.
So that's that's how I would characterize your if you only difference.
In Europe would be maybe a little weaker distribution channel than we have in North America.
But that would be the key difference.
And then my follow up is really maybe just touching on what and with digging into and going back to the 15 16, we saw north American negative 12%.
And third in doing them with don't support that kind of that kind of deterioration, but maybe just take a step back and characterize what you're seeing today. What are you hearing from the field.
From your channel partners and characterize what you hear today to what you saw in 15 and 16.
Yes, Nigel so this feels very different I mean distinctly different petunias 16 was a commodity driven production.
Remember the commodity prices, we can dramatically the whole equipment that went in there the demand dried up we had oil and gas prices dropped dramatically. So it was a very different type of downturn disposal is like I mentioned earlier on is broader based.
We I think our forecast was realistic part of why we started those pressure curves.
Was it just look at what history has shown us going back we will have data back 10 years and the financial crisis today in that 12 to 18 month interval.
It was fairly consistent over the years cycles, but this the big difference for me is sharp spike down and natural resource before.
This one a little more broader based across a broader base of end markets, but not as severe.
Okay fair enough. Thanks.
Thanks, Nigel lives I think we have time for one more question.
Our last question will come from the line of Nathan Jones with Stifel. Your line is now open.
Good morning, everyone.
Morning, Nathan.
Thanks for fitting me in.
First question I, just want to follow up on the on this conversation about.
The shallowness of this pull back and perhaps its duration.
Tom It sounds like.
A lot of your outlook for for when we recover from this is based on historical correlations and historical.
Outlooks for the businesses.
You did say this is different to 15 and 16 do you need some kind of trade resolution here in order to see that recovery do you need to avoid a hard Brexit other geopolitical things here.
Maybe they didn't make this decline at any day, but then then it is that you're projecting but maybe it makes it longer than than you're projecting and just how you're thinking about those kinds of things in it. This time, so I want to clarify because simply took my comments are away, we're not using a pressure curve history as to how we predict future sales. This is one data point.
On top of our customers our distributors our divisions.
Cetera, Okay. So it's just one of many in addition to the regression models, we have but it's just another element that I wanted to share.
I think that.
As far as this forecast does not assume any kind of trade resolution.
So if we had some kind of trade resolution and there was a.
No it really positive on that that would be upside to us.
Obviously this doesn't us and.
Resolution of Brexit or whatever that happens that will be immaterial to us is not big enough to.
To move the needle.
And.
We're always subject to if there was something geopolitical event out of our control.
But on those.
Can't forecast those type of things and does not assume any kind of upside on trade.
It's really mirroring the current order ensure we have.
For the full first half and then we get some help on comps and then as we went to the market. So it was all those markets that we think are going to go for you from negative to neutral.
Or from neutral to positive and then we track all these end markets and where they are in those four phases and when you have two thirds of them and phase three that's an indicator that you're you're going to start to turn you're going to next phase is going to be diesel are in decline and thats. What we put in the forecast. So there was a whole bunch of different angles. We looked at it as you know is a forecast is only as good as the most current data.
And we will update you.
Every quarter and hopefully better information.
Good my follow up question, a little more longer time on aerospace and the margins are you guys said, 5.6% and engineering expenses in 2019, four and a half to five in 2020 does that continue to decline going forward and then maybe you can comment on the mix as we go out a few years I'd think you're fairly heavily on commercial OE at the moment and that should switch as we go forward to a little more commercial aftermarket.
Clearly those are at opposite ends of the margin scale. So just any any qualitative commentary you could give on how you think margins should progression aerospace over the next few years.
Yeah, Nathan its Tom again, so we we feel very good about margins aerospace in the future. The current mix of OE to aftermarket for aerospace is 64%, we 36% aftermarket.
And you're right you mean that that won't necessarily change much see over the next.
Three to five years, but once you start going beyond that and we started having shop visits.
You're looking at the engine content on the airframe content that its going to gradually start to move.
A point or two movement on that as a big deal to us from a margin standpoint, the NRG that 4.5% to 5% that we're guiding for roughly 20.
I think is a pretty good.
Future number to use as well and so the other advantage that the aerospace has besides the mix you referred to is that it's still have ample opportunity just like the rest of the company on the win strategy. It's got opportunities on kaizen. It has.
Additional opportunities and that all the entry into service part of what they're doing today.
Which you know your first pump versus your 100 of pump versus your 500 pump.
We're going to work down that learning curve and we will have some cost advantages not in this next 12 months, but as you work through that we're going to have cost advantages on the entry into service learning. So it's a business we're very bullish on from a from a margin expansion.
Very helpful. Thanks for fitting me in.
Okay. Thank you Nathan Alright. This concludes our Q and eight and our earnings call. Thank you everyone for joining us today.
Robin and Jeff will be available to take your calls should you have any further questions.
Everybody have a great day. Thank you.