Earnings Call Transcript
Parker-Hannifin Corp (PH)
Earnings Call Transcript - PH Q3 2020
Operator, Operator
Ladies and gentlemen, thank you for joining us for the Parker Hannifin Fiscal 2020 Third Quarter Conference Call and Webcast. I would now like to turn the call over to our Chief Financial Officer, Cathy Suever. Please, go ahead.
Cathy Suever, CFO
Thank you, Latif. Good morning and welcome to Parker Hannifin's third quarter fiscal year 2020 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 phstock.com for one year following today's call. On slide number 2, 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 morning's materials and are also posted on Parker's website at phstock.com. Today's agenda appears on slide number 3. We'll begin with our Chairman and Chief Executive Officer, Tom Williams, providing comments on the current environment and related actions we've been taking. Tom will then discuss highlights from the third quarter. Following Tom's comments, I'll provide a more detailed review of our third quarter financial performance. Tom will then provide a few summary comments and we'll open the call for a question-and-answer session. We'll do our best to take all the questions we can today. Please refer now to slide number 4 and Tom will get us started.
Tom Williams, CEO
Thank you, Cathy. Good morning, everybody. Thanks for your participation today. Before I get into Slide 4, I just want to first extend our thoughts to all those that have been affected by the crisis and our deepest sympathies go out to those that have lost loved ones as a result of the virus. A special thank you to all the health care professionals for their courageous efforts around the world and I'd also like to thank all the Parker team members for their dedication and their support and what we have done in really, in our own small way to help society through this crisis. I'll elaborate more about that later on in the presentation. So these are unprecedented times, and that's probably a word that's overused but very appropriate given the uniqueness of having a combined health and economic crisis. So on Slide 4, our performance and our strength for both of these crises really comes from The Win Strategy, which is a proven operating system and we're now in our third and very powerful revision of that. A portfolio of products and technologies that are needed, and this has never been more evident and important in today's climate. We make things that the world absolutely needs. Our culture and our values are why people join and stay at Parker and our purpose has been our North Star, and I'll talk more about the connectedness of our purpose to our actions later on. We have an engaged team of people. We have top quartile engagement scores and when you couple that with our decentralized divisional structure, that is what has enabled us to move at the speed and agility that you've seen during this crisis. So on Slide 5, our crisis management strategy is threefold. First is the safety of our team members and their families; second is how do we help society through this crisis, we are essential, and I'll talk to you more about why we are essential. We want to emerge stronger than ever before after the crisis is over. We have utilized the crisis response management team and that's a structure we have in every key country and we have it for corporate as well, and their focus has really been on the health and safety side of things. We've had a daily cadence with that team, seven days a week, really, since this all started in January. I wanted to make a comment about how the executive team has been functioning. The executive team, say the top 20 executives in the company, have still been coming to the office, and we maintain physical distancing and do Zoom conferencing, all those types of things, but it's very advantageous to have us co-located to where we can very quickly see each other and make decisions. That's been a key enabler to our speed and to decisiveness as well. On Slide 6, we'll talk about the health and safety actions. They've been early, and they've been decisive. They've been patterned off of the CDC and the WHO as well as lessons that we've learned from China. This is a list that you probably are familiar with as you've listened to other companies. I won't necessarily go through each one of these, but I would just point to, we were early on with travel restrictions and we were early with the cancellation of in-person meetings. I'll highlight two examples. First, ConExpo. We're probably one of the first companies to withdraw from ConExpo, which is a very important show. That sends a very strong message to everybody in our space as well as our people about the importance of protecting our employees. We were also an early adopter of the virtual Investor Day, which all of you were part of, and we thought that was very successful. Not as good as in person, but it was very successful. And the takeaway on this page, the governing message to all of our people has been this takeaway. We wanted the two safest places for our people to be at work and at home, and we're going to do everything humanly possible to ensure that happens. I mentioned that we were essential. On Slide 7, I just wanted to highlight some examples of our purpose in action. Our products have helped society through this entire crisis. If you look at food supply, we have products from the farm all the way to the point-of-use in retail, helping patients, whether it's emergency transportation on a helicopter or on hospital beds. We are a central manufacturer but we're also helping other people that are central manufacturers. That little picture that you see in the upper right-hand corner is a typical manufacturing plant with the roof off of it. I would tell you, we are in almost every manufacturing plant around the world, helping people make their products. Those eight motion control technologies, seen in the lower right, are being put to use to help society. As we go to the next page on Slide 8, a couple more examples, transportation, whether it's heavy-duty trucks or air freight to get products to customers, power generation for electricity. We're on traditional as well as renewable energy. I think the best example and the poster child of this crisis is really the ventilator. We do a fair amount in health care but the ventilator in particular, we have almost doubled our sales in this calendar year 2020, and we have six of our eight technologies on the ventilator. We've been supporting new and existing customers as well as countries from around the world. The divisions that have been doing this have just done a herculean job staying up with customers. It's just a fantastic job, and my compliments to all of them. Moving to Slide 10, a quick snapshot of the facility and supply chain status. You go to that middle column, just at the major regions and total Parker. This is percent capacity versus pre-virus. Using pre-virus as 100%, as an example, we're virtually back to normal at 97%, but there's obviously a lot of things that happened through the quarter and in April, with stay-at-home orders and all that, that moved us up quite a bit. Our supply chain strategy on the right-hand side has been great and very effective during the crisis. You've heard me talk about this in the past, but we buy and sell in the region for the region. We've also got a very robust supply chain risk mitigation strategy that we've been doing for years, well before this started. So we're in very good shape on that; this is a nonissue for us. Moving to Slide 11, I want to talk about the quarter, and I would just summarize, I'd tell you it's probably one of the best quarters that we've ever done, given the environment. It was remarkable performance by the team. Starting with safety, we had a 27% reduction in recordable incidents, and when you look at reportable incident rates, we’re a top quartile company, which is fantastic progress. Sales were flat year-over-year. Acquisitions offset the decline we had in organic and currency. But the margins were stellar; they really stood out. So we have two categories here without acquisitions, and I would call your attention to the adjusted segment operating growth, and you see we came in at 17.3% for the quarter versus 17.2% in FY 2019, the same quarter. So a 10 basis point improvement, 16% decremental and remember, this is on about a 7.5% organic decline. Just fantastic progress by the teams to pull that off. When you put acquisitions, it's easier to look at EBITDA to make it apples-to-apples. If you look at EBITDA margin on an adjusted basis, that last row, you can see that came in at 19.3%, so a 60 basis point improvement versus the prior period, and this speaks to two things: one, the base business keeps getting better and is performing better, and we acquired companies that have accretive EBITDA margins to legacy Parker, which helps fuel that margin expansion. One more page on the highlights for the quarter on Slide 12. Our EPS performance, as you saw, was very strong, exceeding expectations. We had a record Q3 year-to-date casual. Records meaning a record in the company history of $1.3 billion, which was great. The CFOA margin was 12.3%, and the free cash flow conversion rate was 122%. We are very pleased with our debt reduction of $611 million. That was a very nice reduction. That helped reduce our leverage from 4.0 to 3.8 when you look at it from gross debt to EBITDA. So you can see from these two slides and how the quarter went, we performed extremely strongly. We're going into this pandemic in a very strong financial position. On Slide 13, we had the order rates. This was traditionally in Cathy's section, but I wanted to pull it up earlier to allow me to talk about April. Just a reminder, on this page, industrial orders are a three-month year-over-year, and aerospace is a 12-month year-over-year, rolling 12-month year-over-year comparison and excludes acquisitions and currency. I think the next – so you can see what happened here a little bit better, driven primarily by international, but it's probably a little more illustrative if you go to Slide 14, where we talk about April in particular. I just want to emphasize that while Q3 got a little better, there was a distinct drop and that we felt it in March in the middle of the month. So on a daily rate basis, you got to remember that the prior slide is three months rolling. When you look at the daily basis, we were clearly feeling this in March already, and so that was impacting us. The pandemic was declared on March 11, and we had IR day on March 12. Just as the cameras stopped rolling, the stay-at-home orders started up pretty much around every country and around the world. China had already started that. What you're looking at this page is a 112, not a 312, so this is April, month-to-date, versus April month-to-date of the prior period. Again, it excludes acquisitions and currency. The month hasn't closed, hence why we have ranges on here. Orders were clearly influenced by the stay-at-home orders that I referred to and extensive customer plant shutdowns that happened throughout April and started in March, for that matter as well. One positive note here is that our orders have stabilized in the last two weeks, so that's a very good sign. As a result of that, on Slide 15, we've taken decisive cost reduction actions in the fourth quarter and I would give you a hockey analogy that we are skating to where the puck was going. We saw this decline happening; we felt it in the middle of March and we started these actions in March. We started rate at the beginning of April; these were effective April 1. Now these actions are in two distinct buckets. The first is discretionary, which will vary based on order entry and flex to the amount of orders and business we have. So that's the first category. The second is permanent structural cost actions that are predominantly SG&A and will be across the company, but in particular focusing on aerospace and oil and gas end markets that are low for longer and need structural actions. Let me take one at a time here. On the discretionary side, we have salary-based wage reductions, and you can see the various elements here. All of our salary team members around the world and our directors took a 10% base salary reduction. Our officers are in the 20% to 30% range and myself at 50%. Now this is effective April 1 and it's effective for 90 days, and we'll evaluate whether we need to extend it when we get to Q1, and that valuation will depend on how order entry is doing and how the business is progressing. The next category you see there is reduced work schedules. That could range anywhere from a reduced work schedule of 10% to 100%. We could take a plant down for one day a week, it could go down for several weeks at a time. It depends on really the activity in that plant, and we've had terrific collaboration around the world from all of our colleagues, works councils, etc., to use this as a very effective tool to adjust business to order entry. We're foregoing annual merit increases, reducing travel, and essentially producing everything that's not moving; we're not spending. You add that up, and that comes to a $250 million to $300 million cost reduction in Q4. As I referred to on the structural side, those are SG&A-related reductions in force. If I was to highlight aerospace, we are going to do an approximate 20% reduction in force in the number of people we have in the aerospace group. That yields a $25 million to $30 million cost reduction for the quarter. Add that up, that's $275 million to $350 million. So we're targeting an approximate 30% decremental margin. We're planning for an L-type recovery here, where the L is going to have the bottom of the L, the horizontal side is going to have some variation, and a variation that is not known at this point. But we’re planning conservatively on the cost and cash side for an L. Notably, with the way we've done discretionary, we absolutely have the flexibility that L could turn into a modified V or U shape, and we could respond at a moment's notice to any kind of growth. If you go to Slide 16 on the cash side, we're conserving capital spending, as you might imagine, we're optimizing working capital, which is a traditional strength for the company. You go through all of our past recessions; this is a legacy that we've always done extremely well in. We're temporarily suspending the 10b5-1 share repurchase program, and we will maintain the dividend payout and the annual record of increasing dividends paid. Just as a footnote, our annual dividends paid in FY 2019 was $3.16 and FY 2020 was $3.52. It's a record we're proud of, and it’s a record that's going to continue. We're confident looking at all these actions on the cost side and the cash side, and generating more than a 10% CFOA going into the future. I want to close out my opening section with the transformation of the company. It starts with the Win Strategy. While it was the original Win Strategy almost 20 years ago, Win Strategy 2.0 in 2015 to today, Win Strategy 3.0, this is the engine behind our success. It's going to create a very powerful future for us, but this is the highlight of Investor Day, so I won't go back through that as we just did that last month. On Slide 19, this unmatched breadth of technologies is even more clear today because it's a portfolio that is unmatched and gives us a competitive advantage, but it's also a portfolio that is very much needed in society. The fact that 60% of our revenue comes from customers that buy from four or more of these eight technologies is recognition that our customers feel the same way. On Slide 20, we've been very strategic in upgrading the portfolio. This is a list of three transformational acquisitions, adding to filtration, engineered materials, and aerospace. Even in these trying times, we see the power of these deals; their top lines, all three have been far more resilient than legacy Parker, and the EBITDA margins have been nicely accretive. If you go to Slide 21, this is the chart we showed at Investor Day, and we've got two stair steps in here that the black represents reported operating margin and the orange represents adjusted operating margin. This shows how we've done the last five manufacturing recessions, and this remarkable progress signals our performance when the original Win Strategy was launched five recessions ago, and our ability to prepare for your current recession many years before. The reason why we're performing as well as we are now is we've been changing the cost structure for the last five years and have been working on this for the last 20. Our Q3 year-to-date adjusted operating margin at 16.7% was already in a tough environment. Year-to-date, if I add organic and currency together, it's about a minus 7% environment. We are performing at remarkably high levels in a tough environment; that's an almost 900 basis point improvement from when The Win Strategy was first launched. Q4 is going to put downward pressure on that number, but we will still end the year significantly better than we've been in any prior recession. On Slide 22, as I look at cash flow, I would just call your attention to the blue line, which is the CFOA margin line. You can see we've been extremely resilient over many cycles. Good times and bad times, this company generates 10% or greater CFOA and greater than 100% free cash flow conversion. We did it before, and we're going to do it again. This graph hopefully speaks to the resiliency of the cash flow for the company. On Slide 23, the outlook for FY 2020. The current environment is highly uncertain as all of you can understand, making it very difficult for us to guide with any accuracy or reliability; hence, we're withdrawing FY 2020 guidance. The portfolio and the cost structure has been transformed over the last five years; it's why we've been performing as well as we have been, and the proof is in those slides I just showed you. We've come out very rapidly and assertively to adjust costs to the current environment. Our cash flow is very resilient, and we have a bright future. The Win Strategy 3.0 and our purpose are going to propel us as soon as we get through this crisis and will propel us through this crisis as well. With that, I'm going to hand it back to Cathy for details on the quarter.
Cathy Suever, CFO
Thanks, Tom. I'd like you to now refer to Slide number 24, and I'll summarize the quarter. This slide presents as reported and adjusted earnings per share for the third quarter. Adjusted earnings per share for the quarter were $2.92 compared to $3.17 last year. Adjustments from the current fiscal year as-reported results netted to $0.09, including before-tax amounts of business realignment charges of $0.10, acquisition costs to achieve of $0.06, and acquisition transaction expenses of $0.14. These were offset by the tax effect of these adjustments of $0.07 and the result of a favorable tax settlement of $0.14. Prior year third quarter earnings per share has been adjusted $0.03, the details of which are included in the reconciliation tables for non-GAAP financial measures. On Slide 25, you'll find the significant components of the walk from adjusted earnings per share of $0.17 for the third quarter last year to $2.92 for the third quarter of this year. Starting with the net decrease of $0.07 in segment operating income. For legacy Parker, a $329 million decline in sales resulted in only a $54 million reduction in operating income or $0.31. The Parker teams did an excellent job of controlling costs on the lower volume, resulting in a legacy Parker decremental margin of 16% for the quarter. The LORD and Exotic acquisitions contributed $0.24 in operating income. Lower net corporate G&A and other expenses contributed $0.03 this quarter as a result of currency gains on forward hedge contracts. We incurred incremental interest expense of $0.19 year-over-year. After adjusting out the benefit of a favorable tax settlement, a higher tax rate from continuing operations and less favorable discrete adjustments resulted in a $0.04 reduction from income taxes. On Slide 26, you'll find the significant components of the walk from the previous third quarter adjusted earnings per share guidance at the midpoint of $2.36 to $2.92 for the third quarter fiscal year 2020 actual results. Segment operating income contributed $0.43 more to the quarter than anticipated. Our guidance was developed at the start of the COVID-19 scare in Asia, and we anticipated a 16% drop in international organic sales but actually achieved only a 10% organic decline. The aerospace segment, on the other hand, experienced more impact in the quarter than was anticipated. Our quick reactions to controlling costs and the resulting higher margins also contributed to the higher than expected operating income. Lower net corporate G&A and other expenses contributed $0.10 due to the previously noted currency gains in the quarter. Lower interest expense due to reductions in debt and lower variable interest rates in the quarter, resulted in a $0.02 per share improvement. Slide 27 shows total Parker sales and segment operating margin for the third quarter. Organic sales decreased year-over-year by 7.4%, and currency had a negative impact of 1.5%. These declines were more than offset by the positive impact of 9.3% from acquisitions. Total adjusted segment operating margins were 16.9% compared to 17.2% last year. This 30 basis point decline is net of the company's ability to absorb 100 basis points of incremental amortization expense from the acquisitions. On Slide 28, we're showing the impact LORD and Exotic had on the third quarter of fiscal year 2020 on both an as-reported and adjusted basis. Sales from the acquisitions were $343 million and operating income on an adjusted basis was $42 million. The operating income for LORD and Exotic includes $35 million in amortization expense. Note the improvement of 10 basis points in legacy Parker operating income despite the $329 million drop in sales. The great work the teams did on controlling costs resulted in a 16.4% decremental margin for the quarter. Moving to Slide number 29, I'll discuss the business segments, starting with diversified industrial North America. For the third quarter, North American organic sales were down 7.1%, while acquisitions contributed 8.9%. Operating margin for the third quarter on an adjusted basis was 17.1% of sales versus 16.5% in the prior year. This 60 basis point improvement is after absorbing 100 basis points of incremental amortization. North America's legacy businesses generated an impressive decremental margin of 4%, reflecting the hard work of diligent cost containment and productivity improvements together with the impact of our Win Strategy initiatives. Moving to the Diversified Industrial International segment on Slide number 30, organic sales for the third quarter in the Industrial International segment decreased by 10.2%. Acquisitions contributed 6.2%, and currency had a negative impact of 4%. Operating margin for the third quarter was 16.2% of sales versus 16.5% in the prior year. Without the incremental amortization expense, margins would have improved 10 basis points on an overall 8% reduction in sales. The legacy businesses generated a very good decremental margin of 19%, reflecting diligent cost containment and the impact of The Win Strategy. I'll now move to Slide number 31 to review the Aerospace Systems segment. Aerospace Systems sales increased 16.7% from acquisitions, while organic sales declined 2.4%. Declines in OEM volumes, primarily commercial, were partially offset by higher commercial and military aftermarket sales. Operating margin for the third quarter was 17.4% of sales versus 20.7% in the prior year. Incremental amortization expense impacted the change in margins by 160 basis points. Lower earnings were driven by the OEM volume declines, higher engineering development costs, and a less favorable aftermarket mix. Good margin performance from Exotic and hard work by the teams on cost containment and productivity improvements helped contribute to the solid performance in the quarter. On Slide 32, we’re showing the impact Lord and Exotic has had year-to-date fiscal year 2020 on both an as reported and adjusted basis. Sales from the acquisitions total $651 million and operating income on an adjusted basis contributed $82 million. This operating income includes $65 million of amortization expense. Adjusted EBITDA from Lord and Exotic is 26.3%. With this meaningful contribution from acquisitions, total Parker adjusted EBITDA has increased to 19% year-to-date compared to 18% for the same year-to-date period in fiscal year 2019. On Slide 33 we report cash flow from operating activities. Year-to-date cash flow from operating activities was a record $1.3 billion or 12.3% of sales. This compares to 12.1% of sales for the same period last year after last year’s number was adjusted for a $200 million discretionary pension contribution. Free cash flow for the current year-to-date is 10.5% of sales and the conversion rate to net income is 122%. Moving to Slide 34. I’d like to discuss our current liquidity and credit positions. Our cash as of the end of the quarter was $0.7 billion. The majority of this cash is overseas allowing the international operations to be self-financed. Our long history of free cash flow exceeding net income during growth periods as well as recessionary periods gives us strong confidence in our cash flow outlook. With additional emphasis on our well-established cash management practices, we are optimizing working capital, taking advantage of government tax payment deferrals, and reducing our capital expenditure investments. We have temporarily suspended our 10b5-1 share repurchase program, but as Tom described, we remain committed to paying our shareholders a dividend, and we’re confident we have the cash available to do so. We have a $2.5 billion revolving credit facility readily available should we need it, and we have no major debt repayments due until fiscal year 2023. We remain active in the commercial paper market and as of the quarter end, we held $0.9 billion in commercial paper debt. The only active financial covenant in place is to maintain a gross debt to total cap ratio below 65%. We are currently at 59.4% and have $2.5 billion of headroom if we need additional debt. Our gross debt to EBITDA leverage metric at the end of the quarter was 3.8 times, down from 4.0 times at December 31. We were able to pay down $611 million of debt during the quarter, and as we build a full 12 months of EBITDA from the acquisitions, the metric will become more meaningful. As Tom mentioned, we are withdrawing our fiscal year 2020 guidance due to the uncertainties we are still facing through this quarter. We ask that you continue to publish your estimates using adjusted results for a more consistent year-over-year comparison. As a reminder, we will be revising our method of reporting adjusted results to include adjusting out the acquisition-related amortization expense, but we do not intend to make that change until fiscal year 2021. We ask that you do not adjust for amortization expense in your estimates until we all consistently make that change. If you’ll now go to Slide number 35, I’ll turn it back to Tom for summary comments.
Tom Williams, CEO
Thank you, Cathy. We are confident in our ability to emerge stronger than we’ve ever been before. That confidence and that hope really comes from a couple of factors: The Win Strategy, the portfolio we have of needed products and technologies, our culture and our purpose, and probably most importantly, is the last page - our team of fantastic people, from all around the world. What this crisis has clearly exposed is just how important everyone plays within the company. I'd like to again thank the global team for an extraordinary job, thanking what they’ve done to date and thank them for what we’re going to do in the future. With that, I’ll turn it over to Latif to start the Q&A.
Operator, Operator
Thank you, sir. Our first question comes from Nigel Coe of Wolfe Research. Your line is open.
Nigel Coe, Analyst
Thanks. Good morning. Can you hear me?
Cathy Suever, CFO
Good morning, Nigel. We can hear you well. Yes.
Nigel Coe, Analyst
Okay. Great. So Tom, you mentioned that you’re planning on analysis recovery. I’m just wondering what that means in terms of balance sheet liquidation inventories and it suggests that you’re going to be very aggressive in terms of liquidating the balance sheet. So my real question is, 4Q guidance obviously being withdrawn, but do you have confidence that you could still generate $1.8 billion of free cash flow versus the $1.3 billion year-to-date?
Tom Williams, CEO
Nigel, yes. Typically, our fourth quarter, even in tough times is always a strong quarter for us, and we will have the advantage of working capital generating a lot of cash for us in Q4, and that should help us quite a bit. We still see that 10% or greater CFOA as a percent of sales continuing, and we’ll do a good job in Q4. I think what I want to emphasize is we’re planning for an L shape to be conservative, but we have the flexibility with whatever shape it turns out to be. Nobody knows at this point, but we do have the supply chain flexibility and people flexibility to respond in whatever direction it works.
Nigel Coe, Analyst
Great. Thanks, Tom. And then my second question is on the decremental margins. You’ve obviously done a fantastic job, especially on the legacy Parker businesses. Your comments on the 4Q seem to suggest that there’s going to be some deterioration in the run rate given the volume drop-off that you’re expecting. But given the cost countermeasures you’ve put in place, I’m a little bit surprised that maybe decrementals can’t be managed below 30%. I’m just wondering what you’re expecting in terms of decremental margins based on your scenario planning?
Tom Williams, CEO
Well, like I have on that slide where I outlined all the cost reductions, we’re targeting a 30% decremental. A 30% decremental is still best-in-class if you benchmark other companies. Doing a 30% decremental approximately in this kind of climate is really outstanding performance. Who knows what the quarter is going to turn out to be? I would suggest to the folks listening that April is probably our low point and that we would see May start to improve a little bit and then improve a little bit after that with June. If you can do decrementals like this in this kind of environment, that’s really outstanding performance.
Nigel Coe, Analyst
Great. Thanks, Tom. Good luck.
Cathy Suever, CFO
Thanks, Nigel.
Operator, Operator
Thank you. The next question comes from the line of Mig Dobre of Baird. Your line is open.
Mig Dobre, Analyst
Thank you. Good morning, everyone. I’m glad to hear you doing well. I’d like to ask a question on aerospace. The color that you’ve given us on April is quite different from the orders prior to COVID-19 becoming an issue. I guess I’m wondering how should we be thinking about this softness in orders playing through to fundamentals next quarter and over the next couple of quarters? How does it flow to revenues and how should we think about decremental margins in this segment specifically?
Tom Williams, CEO
Mig, it’s Tom. Obviously, we haven’t disclosed aerospace until now because it's lumpy, with a lot of multimonth, multiquarter orders. So it can sometimes be misleading, either positive or negative. In aerospace, what we’re planning for is a significant change. The commercial side is going to come down very strongly, but we have a really great military business. So we’re basically two-thirds commercial and one-third military, and that military business is growing very nicely. So our 20% reduction in force will be in addition to those discretionary actions for aerospace. We will continue the reduced work schedules, the salary reductions from the discretionary page I outlined, so that aerospace can flex as well. We feel good about aerospace being able to do well in this new environment. The Exotic team that’s come on is performing well. They are performing better than legacy Parker and have over 60% military business. So aerospace long-term is still a great business, but it’s going to have a couple of years here of challenges, and we’re reshaping the portfolio to win in this new reality, and we’re doing it very quickly.
Mig Dobre, Analyst
Understood, Tom. But is there a way to maybe talk about this business sequentially from a revenue standpoint? Just trying to make sure we have our expectations properly gauged.
Tom Williams, CEO
Well, we're not guiding, so I’m not going to start spouting off about what I think Q4 is going to be. I think you can look at order entry, and you can also recognize that we do have very strong backlogs in this business. The backlogs have held up fairly well. When I look at backlogs going from March to April to date, commercial OEM is at about an 11-month backlog, military OEM is almost a two-year backlog, commercial MRO was at 2.5 months, it’s still about 2.5 months, and military MRO is about a 16-month backlog. The backlogs are holding up. Our customers are rescheduling quantities. We’re reshaping our supply chain demand and our people to that new reality.
Mig Dobre, Analyst
Appreciate the color. Thank you.
Cathy Suever, CFO
Thanks, Mig.
Operator, Operator
Thank you. Our next question comes from Andrew Obin of Bank of America. Your line is open.
Andrew Obin, Analyst
Can you hear me? I apologize.
Cathy Suever, CFO
Yes. Good morning.
Andrew Obin, Analyst
Good morning. Just a question. Can you just talk about region-specific trends on orders? You provided great granularity on orders by segment in April. But maybe just compare and contrast how Asia, Europe, and U.S. are faring? How is the pace of recovery in Asia, and what do you see at the end of the tunnel in terms of your China experience?
Tom Williams, CEO
Andrew, it’s Tom. Let me start with Q3. I recognize a lot of you won’t need Q3, but I’ll give it to you for context. The orders on Q3, the improvement we saw before middle of March was international, both EMEA and Asia. You saw aerospace orders stay level because we had very strong military OEM orders. When you look at it by subsegment, this is organic; total Parker was minus 7.5%, aerospace minus 2.5%. Distribution was down about mid-single digits pretty much steady versus the prior quarter. This is a Q3 market summary. Industrial was down mid-single digits, a slight improvement of about 200 bps versus Q2, and mobile was down low teens, a slight improvement versus Q2. The markets that were positive with greater than 10% were power generation and semiconductor. Two markets that were positive with low single digits were marine and mining. On the declining markets, low single-digit decline was mills and foundries; mid-single-digit declines, refrigeration, oil and gas, with tariff impacting distribution; and high single-digit declines in life science and automotive. That 20% to 10% declines were tires, telecom, construction, heavy-duty truck, agriculture, and rail. In April, I think it's important to note orders were down about 25% to 30%. But Asia Pacific was down about minus 5% to minus 10%, while EMEA and Latin America were down minus 35% to 40%. We did have some strong end markets in April, life sciences, the ventilator work we were doing, power generation, semiconductor, along with aerospace military OEM and aerospace military MRO. The positive, as I mentioned earlier, is that our orders stabilized in the last two weeks. We expect May to be slightly better than April and June to build slightly better on that.
Andrew Obin, Analyst
That is incredibly helpful. Just a follow-up question: How do you gauge the financial health of your distributors, the ability to access capital, and where do you think financial health for your distribution stands right now? Thank you.
Lee Banks, President & COO
Yes, Andrew, this is Lee. As you know, we’ve got incredibly close relationships with all our distribution. We have constant health checks with them, very current on receivables, just very frank conversations on credit, and we don’t have any issues looking through the channel right now to speak of.
Andrew Obin, Analyst
That was helpful. Congratulations and thank you. Congratulations on a great quarter.
Operator, Operator
Thank you. Our next question comes from David Raso of Evercore ISI. Your line is open.
David Raso, Analyst
Hi, good morning. I’m trying to think of a setup exiting this calendar Q2. It looks like the way the revenues are playing out with your decrementals, it seems like you’re sort of wide range EPS for the quarter is like $1 to $1.50 or so. But typically, the next quarter, you have sales down mid-single digits. I would think just given what’s happening here, it should be the opposite. They should be improving from calendar Q2 to 3Q? But I’m trying to understand the setup. When you’re saying stabilization, are you getting any indication, is this – distributor inventories low enough that they’re restocking? OEMs were not stocking up before their shutdown, so they have a catch-up? I’m just trying to get a better sense of how comfortable we can be that the first quarter of fiscal 2021 can really leverage off that range? I think people are just trying to get a sense of what’s the earnings power after what could be obviously difficult calendar Q2?
Tom Williams, CEO
David, it’s Tom. I probably won’t surprise you. I’m not going to comment on Q1, but I’ll give you maybe some thoughts on the other parts of your question. When I make comments about being more stable, it’s the daily rate stabilizing for the last two weeks. Our distributors are smart business people and they’re conserving cash just like everybody else. They’re being very careful about what they’re going to do on inventory. I think our Q1 is going to have an advantage because our cost structure is going to be extremely lean going into Q1. What I can’t predict is what’s going to happen on the top line. I do think we’ll progressively improve April to May, May to June. But I can’t necessarily guess what the year-over-year is going to be because we have to cycle the pandemic before we start to show really positive gains. But I think sequentially, you’re going to start to see improvement. The big question is just the rate of improvement; is this an L? An L where the bottom of the L starts to move up more aggressively than a traditional L? Is it a U? We don’t know. That’s why we’ve designed our ability to flex to that demand if it happens, but have a cost structure that can be there, if it doesn’t happen as well.
David Raso, Analyst
That was sort of the genesis of the question. So if there’s any reopening that can be stabilized at all, you would think your revenue sequentially would go against the historical norm. It won’t decline mid-single, it should improve. But from your answer, it sounds like it’s more OEM right now than it is distributor. And to your point, I’m just trying to figure out the incrementals coming out because if it’s OEM over a distributor, you’d argue you’d rather have distributor. But to your point, you’re going to have cost outs that should not automatically come back. Right? You should have some leaned out costs. But again, it’s more OE improving from here, stabilizing let’s say, than I should think distribution. It’s more OE. Right?
Tom Williams, CEO
Okay. I get your question more, David. You’ll see improvement – marked improvement across both channels, OE and distribution, because those order rates I showed you on that slide for April are pretty equally representative distribution and OEM, maybe slightly better in distribution, but they’re pretty much the same. You’ll get both coming back. It won’t be like, hey, we’re just going to rebound in OEM, and distribution stays the same. You’ll get both of them coming back.
David Raso, Analyst
Okay. That’s helpful. I appreciate it. And lastly, anything about how you’re viewing the world now, that changes how you feel about what leverage you want to come down to before? I know it never was imminent anyway, but we used to talk kind of 12, 18 months. Have you rethought at all what you’re comfortable with on leverage before you would lean back forward, be it M&A or repurchase?
Tom Williams, CEO
David, it’s Tom again. We still feel strongly we want to get back down to that approximate 2.0 level on gross debt to EBITDA. That was our feeling before the crisis, and it’s still our feeling.
David Raso, Analyst
Okay. Thank you very much.
Operator, Operator
The next question comes from Nathan Jones of Stifel. Your line is open.
Nathan Jones, Analyst
Good morning, everyone. Just a question on the decrementals first. You guys have some noise going on in the decremental margins with the acquisitions folding in. Is that 30% decremental that you’re targeting, including the acquisitions, excluding the acquisitions? How should we think about that?
Tom Williams, CEO
Nathan, it’s Tom. That would be excluding the acquisitions, the legacy business. But I would just tell you, the two acquisitions are doing extremely well. The improvement in North America is due to accelerating synergies on LORD. We’ve gone from what we told you last quarter at $18 million in FY2020 to $30 million. We’ve been able to accelerate our SG&A on LORD. We look for the decrementals on legacy, while the two acquisitions are coming in at a really nice – LORD is significantly beating where we thought they’d be on EBITDA at approximately 27% for Q3, and Exotic was in the mid-20s. Both of those businesses are executing the same kind of cost reductions and cash actions that the rest of the business is doing, continuing to be helpful. Their top line is holding up better than legacy Parker, and our margins are better. So that decremental-like quote is on the legacy business.
Nathan Jones, Analyst
Okay. And then on the cost-out numbers, the $250 million to $300 million, it sounded like that was in place on April 1. Are you already at the run rate there? And then the $25 million to $30 million that’s structurally coming out of the aerospace business, how long does that take before that falls into your cost structure?
Tom Williams, CEO
The numbers on that page are what we will feel in Q4 as that’s for a full quarter you’ll feel it. It’s more than just aerospace; there are structural changes in oil and gas sectors and things across every group that we’re doing. But clearly, a lot of it is aerospace-driven.
Nathan Jones, Analyst
And then just one quick one on the Exotic synergies. You talked about the LORD synergies there. Does the large drop in the expectation for aerospace reduce the expectation of the amount of synergies that you can get out of Exotic over the next year or two?
Tom Williams, CEO
For Exotic, we’ve had a very minimal amount of synergy with material savings for Exotic with long supply agreements not starting to kick in until year 2022 and 2023. Most of Exotic’s synergies were productivity and The Win Strategy, which we feel good about. The $50 million in synergies is not changing. I would highlight again for Exotic, their top line in Q3 was still significantly better than legacy Parker. Luckily, over 60% of that business is military. We were able to pull forward and our customers approved this; the F135 work is fortunate for us, positioning the company on what’s happening on the commercial side. Exotic delivering mid-20 EBITDAs is fantastic performance given the ongoing challenges.
Nathan Jones, Analyst
Okay. Thanks for taking my questions.
Operator, Operator
Thank you. Your next question comes from Jamie Cook of Credit Suisse. Your line is open.
Jamie Cook, Analyst
Good morning and nice quarter. I guess, two questions. Tom, you kept talking about the resilience of Exotic and LORD through the third quarter. Can you sort of talk about trends that you’re seeing in April for those businesses? My second question was with regards to the 30% decremental, I assume that’s specific to the fourth quarter. If we’re in a prolonged sort of downturn, how confident are you with decremental margins, given that some of the actions you’re taking seem like more short-term versus salary cuts and stuff that are long term?
Tom Williams, CEO
On the second part, the 30% decremental in Q4 will continue going forward. We’ll continue to do the things we have to do to flex the business to deliver that. I believe this will start to turn, so you need to be careful that you don’t do too many permanent structural actions to prevent your ability to respond. We’ll look at that quarter-to-quarter and make those decisions as a team. But you can expect the decremental to remain resilient due to the structure we built over the last 20 years. As for the trends on in April for LORD and Exotic, LORD would be probably half of what you saw for legacy Parker, at least half better – that’s a way to say that. Exotic is doing better, able to hang in there at a high single-digit decline because of their strong military business. Our customers and our fortunate position have allowed us to triple output, especially in the ventilator market; it’s critically important.
Jamie Cook, Analyst
Okay. Thank you. I appreciate it.
Tom Williams, CEO
Thanks, Jamie.
Operator, Operator
Thank you. Your next question comes from Nicole DeBlase of Deutsche Bank. Your line is open.
Nicole DeBlase, Analyst
Yes, thank you. Good morning, guys. I just wanted to talk a bit more about distributor inventory levels. If you could just comment on whether you think distributor inventories have rightsized for the current level of demand? Just trying to gauge how much restocking would be required as we come out of this and end-user demand increases?
Lee Banks, President & COO
Nicole, this is Lee. My sense is that inventories are in line with demand. They're not buying anything; they're conserving cash. You would see a pull-through in real demand through the channel back to Parker-Hannifin.
Nicole DeBlase, Analyst
Okay. Got it. Thanks, Lee. That's helpful. And then on the leverage, is the expectation that you guys have more opportunity to continue paying down debt in the fourth quarter? Or is the next tranche likely to come in 2021?
Cathy Suever, CFO
Yes, Nicole, this is Cathy. We'll watch how things are going through the fourth quarter, but if you look at our expectation for cash flow, we will have some flexibility, I believe, to pay down additional debt during the quarter. If we're comfortable going into next year in the position that we are, then I think we will definitely do that.
Nicole DeBlase, Analyst
Got it. Thanks, Cathy. I'll pass it on.
Cathy Suever, CFO
Thanks, Nicole.
Operator, Operator
Thank you. Our next question comes from Ann Duignan of JP Morgan. Your line is open.
Bill McMullan, Analyst
Hi, thanks. This is Bill McMullan on behalf of Ann. Her question is, can you provide a little bit more of an update on the lower discount rate environment and weaker equity returns on your pension plan funding?
Cathy Suever, CFO
Sure. This is Cathy. The discount rate that we're currently booking expense was set last June, and we set it once a year at our June 30 timing, and we're at a discount rate of 3.28%. As we disclose in our queues, if the rate drops 50 basis points, that'll impact about $15 million to our expense. We're watching it. As of the June rating last year, we had no required pension contribution due until fiscal year 2023. The rate will likely drop and will have some impact on the need to fund; we don't anticipate it being any sooner than fiscal year 2022. We have a good year plus before any repayment, which we think would be minimal. So no funding requirements for the rest of this year and fiscal 2021.
Bill McMullan, Analyst
Great. Thank you. That's all I have. I’ll pass it on.
Cathy Suever, CFO
Thank you.
Operator, Operator
Thank you. Our next question comes from Steve Volkmann of Jefferies. Your line is open.
Steve Volkmann, Analyst
Great. Maybe I could do a couple of longer-term questions here, and I'll just sort of take them together. I'm wondering, it's probably too early to answer a lot of it, but I'm wondering if there's any change in your long-term margin expectations as you have laid out recently? Second, does that potentially free up some businesses that might be candidates for divestiture going forward?
Tom Williams, CEO
Steve, it’s Tom. The margin targets we gave you at Investor Day are still the targets, and we're not moving off of those. We’re still striving to hit those for FY 2023, and we still think we can do that. As for divestitures, oil and gas and aerospace are still great businesses, performing well in those end markets. We use all eight technologies in those markets, so they meet all criteria to stay part of the team. We will get through these near-term challenges and reshape those businesses to win in this new market. They are strong businesses with great returns.
Steve Volkmann, Analyst
Thank you. Good luck.
Cathy Suever, CFO
Thanks, Steve.
Operator, Operator
Thank you. Our next question comes from Julian Mitchell of Barclays. Your line is open.
Julian Mitchell, Analyst
Hi. Good afternoon. Maybe just a quick question around aerospace again. You’ve taken some fixed costs measures in that business, and the assumption is understandably for a prolonged downturn. Maybe just help us understand what you're thinking about aerospace aftermarket within the commercial side specifically? And is it fair to assume similar to peers that decremental margins on that aftermarket decline will be very, very severe?
Tom Williams, CEO
Julian, its Tom. On the F-35, no, we've not seen any choppiness, we are accelerating our deliveries. Everything has been fine on that side. The commercial MRO is feeling a very sharp decline, probably more than 50%, and that will take a while to heal. You’ll need the public to want to get back to air travel, but they will come back over time - leisure travel wants comfort and safety. The business traveler will return, but probably not to the same levels seen previously due to digital productivity. Our expectation is that once we get through this reshaping of aerospace, it will start to follow GDP growth, which is robust, due to demographics before.
Julian Mitchell, Analyst
Great. Thank you.
Cathy Suever, CFO
Okay. Thanks, Julian. Latif, we have time for one more question.
Operator, Operator
Yes, ma'am. Next question comes from Andy Casey with Wells Fargo Securities. Your line is open.
Andy Casey, Analyst
Thanks so much, and hope everybody is well.
Cathy Suever, CFO
Hey, Andy.
Andy Casey, Analyst
I just was looking for a little bit more color on the – what you may be seeing on the distribution inventory actions. Going into the quarter, it looked like those were stabilizing a little bit. Clearly, in April, they probably fell off. Is the pattern kind of stabilization and then reacceleration?
Lee Banks, President & COO
Andy, I think the way I would characterize it is that they were declining to stabilizing in March. In the second half of March, the channel saw what was coming and there was a conservation of cash, really not buying anything. We saw a direct impact through our divisions from distribution. I would tell you in April, as Tom characterized, they’re down about as much as the OEMs are down right now. Any rebound we get in demand will facilitate a rebound in demand directly to our divisions.
Andy Casey, Analyst
Thanks so much.
Cathy Suever, CFO
Okay. Thanks, Andy. This concludes our Q&A session and the earnings call. Robin and Jeff will be happy to take your calls should you have any further questions. Thank you for joining us today. Stay safe and enjoy the rest of your day.
Operator, Operator
Ladies and gentlemen, that concludes today's conference call. Thank you for participating. You may now disconnect.