Earnings Call Transcript - PH Q1 2023

Operator, Operator

Thank you for holding. Welcome to the Parker-Hannifin Fiscal 2023 First Quarter Earnings Conference Call and Webcast. Today's program is being recorded. I would like to introduce your host, Mr. Todd Leombruno, Chief Financial Officer. Please proceed.

Todd Leombruno, Chief Financial Officer

Thank you, Jonathan. Good morning, everyone, and thank you for joining Parker's fiscal year 2023 Q1 earnings release webcast. As Jonathan said, this is Todd Leombruno, Chief Financial Officer speaking. And joining me today is our Chairman and Chief Executive Officer, Tom Williams; our Vice Chairman and President, Lee Banks; and our current Chief Operating Officer and Chief Executive Officer elect, Jenny Parmentier. We will be addressing forward projections and non-GAAP financial measures today. Slide 2 provides details on our disclosure statement in these areas. Actual results could vary from our projections for the items listed in these forward-looking statements and also detailed in our SEC filings. The presentation today will address non-GAAP measures, and reconciliations for those non-GAAP measures are available in this presentation, which is all available in the Investors section at parker.com and will remain available for one year. Tom is going to begin the call today with a couple of highlights on the quarter and also provide an update on the Meggitt integration. I'll follow with a brief summary of the financials and review the increase to our guidance that we issued this morning. Then we'll touch on the leadership transition that we announced last week, and we'll finish the call with Q&A. So if I could ask you to reference Slide 3, and I'll hand it over to Tom to begin.

Thomas Williams, Chairman and Chief Executive Officer

Thank you, Todd, and good morning, everybody. Thanks for joining the call today. We had impressive first quarter record sales, net income, EPS, and several margin records. We closed the Meggitt acquisition, which was a big accomplishment. Looking at this slide, the first bullet is safety is our top priority. We leverage high-performance teams, Lean, and Kaizen. We had a 17% reduction in incidents versus the prior year. Looking at the safety incident rates, the number of incidents per 100 team members puts us in the top quartile versus our proxy peer group. Fantastic results. Sales were $4.2 billion, an increase of 12% versus the prior year. Organic growth was very strong at plus 14% versus the prior, with strength across all regions and segments. Segment operating margin was 19.8% as reported or 22.7% adjusted. We had a 70-basis point improvement versus the prior year, again, excellent improvement in pretty tough conditions. As I mentioned, we completed the Meggitt acquisition integration, which is well underway. We're off to a good start. If you look at the quarter and the last several years, the takeaway that you see in this slide is that The Win Strategy, along with portfolio changes, is working together to deliver record performance. Moving to Slide 4, we showed you some pictures from day 1 of the Meggitt integration. Parker executives visited every Meggitt site globally, 34 sites around the world. Very positive meetings, and we're off to a good start putting the two companies together. On Slide 5, I want to orient you on the left-hand side. The blue bars indicate the synergies, while the gold indicates the cost achieved. This is by fiscal year, and it shows the path to $300 million worth of synergies by FY '26, aiming for an approximate 30% adjusted EBITDA margin over time, which marks a significant improvement in profitability. On the right side, I went into detail on how we'll achieve these $300 million synergies. We're now 7 weeks into the integration, and I feel very good about our ability to deliver these synergies.

Todd Leombruno, Chief Financial Officer

Thanks, Tom. I'm going to start on Slide 9. Obviously, this was an impressive quarter. Tom mentioned that, and it's a really strong start to our fiscal year. Our global team members continue to execute and deploy The Win Strategy, and we're very proud of the results. Tom mentioned that sales are up 12.5% versus the prior year. That was a record of $4.2 billion. The organic growth in Q1 was extremely strong, at 14%. As everyone is seeing, the strengthening of the dollar has created a currency headwind for us, about 5.5% of sales. We're very pleased that we closed Meggitt and also the Aircraft Wheel and Brake divestiture. All in, net of that, it added 4% to our sales for the quarter. Adjusted segment operating margins were at 22.7%, an increase of 70 basis points from the prior year. Adjusted EBITDA margins came in at 23.3%, a bigger increase at 120 basis points up from the prior year, demonstrating the power of Win Strategy 3.0. Adjusted net income was $616 million, which represents a 14.5% ROS. Adjusted earnings per share is $4.74, which is also a Q1 record, up $0.48 from the prior year, despite currency headwinds. Both adjusted net income and earnings per share have increased 11% versus the prior year. I do want to note that there were several one-time items incurred this quarter as a result of the Meggitt acquisition and the Wheel and Brake divestiture. We've included a reconciliation to those items in the appendix. Most of these one-time items have concluded, but I want to thank our global finance and accounting teams for their exemplary work during this transition.

Thomas Williams, Chairman and Chief Executive Officer

Thank you, Todd. Moving to Slide 16, we have the leadership transition. As announced last week, several leadership changes have been made. I have been planning my transition for many years, and with my upcoming birthday, I believe this is the right time to step down from the CEO position effective at the end of this calendar year. It has been an honor to lead this great company, and I'd like to express my gratitude to our shareholders, the Parker Board of Directors, our dedicated team members, and especially to my fellow executives who have helped me lead the company. It is a distinct privilege to work with such an exceptional leadership team who always strive for excellence. I will continue as Executive Chairman until the end of 2023 to facilitate a smooth transition.

Jennifer Parmentier, Chief Operating Officer and CEO Elect

Thank you, Tom. I am honored and proud to be appointed the next CEO of Parker Hannifin and am very excited about our future. I'm grateful to both Tom and Lee for their support and mentorship, as well as to our Board of Directors for their confidence in my leadership. Effective January 1, this is the office of the Chief Executive. Lee, Todd, and I have been part of this team for some time, and we welcome Andy to the role of Chief Operating Officer. This seasoned leadership team has been instrumental in the company's transformation and will continue to drive record results into the future. Looking ahead, my priority is to build upon the success of Parker's transformation, integrating Meggitt into our operations and achieving committed synergies.

Lee Banks, Vice Chairman and President

I know everybody is anxious to get to Q&A, but I have one more thank you to express here. Tom, on behalf of our 60,000-plus teammates around the world, I want to thank you for your exceptional leadership as our Chief Executive Officer over the past 8 years. Your vision has transformed our company, creating a safer, more engaged workforce, and driving us to top quartile financial performance. You've left us with a company structured for future success, which is a significant achievement. Thank you.

Todd Leombruno, Chief Financial Officer

Thank you, Lee. Jonathan, we're ready for Q&A. I want to clarify an earlier incorrect number regarding our Q2 EPS forecast. The accurate number for FY '23 Q2 is $4.31 at the midpoint.

Scott Davis, Analyst

Congrats, everybody. Tom, your integrity over these 8 years has been exceptional. Jenny, what does the Board want you to do differently, if anything?

Jennifer Parmentier, Chief Operating Officer and CEO Elect

Thank you, Scott. My priority is to build upon the success of Parker's transformation and efficiently integrate Meggitt while achieving committed synergies. I anticipate that there will be continuity in day-to-day operations.

Andrew Obin, Analyst

I want to extend my gratitude to Tom and congratulations to Jenny. I'm looking for your insights on order activity, lead times, and inventory dynamics. How do you think these factors interplay with your guidance?

Thomas Williams, Chairman and Chief Executive Officer

Inventory in the distributor channel increased slightly, but nothing materially significant. Our order entry was positive despite tough comparisons. We saw solid growth across regions, and overall demand remains strong. That said, we're still cautiously optimistic as we proceed through the fiscal year.

Todd Leombruno, Chief Financial Officer

We are focused on achieving strong cash flow conversions despite rising interest expenses. Our cash flow generation profile remains robust with efforts to optimize inventory management, especially through the integration of Meggitt.

Jeffrey Sprague, Analyst

I want to commend Tom for his exceptional leadership. I'm curious about the pricing pressures and efficiencies in your operations related to ongoing supply chain challenges. What are you observing?

Lee Banks, Vice Chairman and President

While we've seen a moderation in pricing vs. costs, it's still a significant issue. Different costs are still elevated in comparison to historical levels. However, our operational strategies and lean systems help us address these challenges.

Thomas Williams, Chairman and Chief Executive Officer

We have a substantial backlog that indicates ongoing demand. While we are cautious about the macro environment, we still see a lot of potential for growth in many of our end markets.

David Raso, Analyst

Can you provide insights into the split of orders between distributors and OEMs and any expectations of cancellations in your backlog?

Thomas Williams, Chairman and Chief Executive Officer

We have experienced a healthy backlog and have not seen cancellations. Should customers wish to adjust, they typically push out delivery dates. We are monitoring these customer signals closely.

Stephen Volkmann, Analyst

Congratulations to all, and Tom, happy birthday. I'm interested in your views on recurring revenue opportunities and divestitures.

Thomas Williams, Chairman and Chief Executive Officer

Parker has a strong recurring revenue model through our distribution supply chains, especially within aftermarket services. We are reviewing our portfolio thoughtfully, but we expect any divestitures to be small in scale.

Jamie Cook, Analyst

Tom, congrats and thanks for your excellent service. Jenny, congratulations as well. I'm interested in your perspectives on trends in Europe and China, as well as how macroeconomic conditions might impact your guidance.

Thomas Williams, Chairman and Chief Executive Officer

In Q1, we had positive organic growth in both China and Asia, around 10%. Moving forward, we are prepared for potential macroeconomic fluctuations but are maintaining a positive outlook overall.

Todd Leombruno, Chief Financial Officer

Thank you all for your participation today. A special mention to Robin, who is retiring and has greatly contributed to our investment story during Tom’s tenure. Jeff will be taking over Investor Relations in January. We appreciate your interest in Parker and look forward to seeing you on our next call.

Operator, Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program.