Parker-Hannifin Corp (PH) — Q1 2015 Earnings Call Transcript

Thanks, Genaida. Good morning, everyone. It’s Pam speaking, just as Genaida mentioned. I’d like to welcome you to Parker Hannifin’s fiscal year 2015 first quarter earnings release teleconference. Joining me today is Chairman, Chief Executive Officer and President, Don Washkewicz; and Executive Vice President and Chief Financial Officer, Jon Marten. For those of you who wish to do so, you can follow today’s presentation with the PowerPoint slides that have been presented on Parker’s website at www.phstock.com. For those of you not online, the slides will remain posted on the company’s investor information website one year after today’s call. At this time, if you will reference Slide #2 in the slide deck, which is the Safe Harbor Disclosure Statement addressing forward-looking statements. I ask that you please take note of this statement in its entirety if you haven’t already done so. This slide also indicates, as required, that in cases where non-GAAP numbers have been used, they have been reconciled to the appropriate GAAP numbers, and are posted on Parker’s website again at phstock.com. Slide #3. This is the agenda for today. It consists of four parts. First, Don, our Chairman, Chief Executive Officer and President, will provide highlights for the first quarter. Second, I’ll provide a review, including key performance measures for the first quarter, and then, of course, conclude with revised guidance for fiscal year 2015. The third part of the call will consist of our standard Q&A session. And in the fourth part, Don will close with some final comments. So, at this time, I’ll turn it over to Don and ask that you refer to Slide #4 titled Highlights, First Quarter Fiscal Year 2015.

Thanks Pam and welcome to everyone on the call. We certainly appreciate your participation today. I’ll make a few brief comments and then Pam is going to return for a more detailed review of the quarter. I’ll address capital structure in a moment, but first I want to review a very strong first quarter for the company. I’m pleased that we’ve had such a solid start to the year, as we executed well, delivered strong results and reinforced our view that this will be another record year for the company. The first-quarter highlights include record first-quarter sales at $3.3 billion, up slightly from last year’s first quarter. Organic growth, adjusted for the GE Aviation joint venture, increased almost 4%. We’re very pleased with that. Orders increased by 5%, and we’re positive across all segments, but it was especially strong in Aerospace. Total segment operating margins reached 15.9%, and we’re certainly very pleased with those numbers, reflecting a 150 basis point increase from last year’s first quarter; on an adjusted basis, it reached 16.1%. This is a result of the successful restructuring completed in fiscal year 2014. Our performance in Industrial North America was particularly notable with an all-time record for segment operating margins at 18%. Both Aerospace Systems and Industrial International had meaningful increases in margin this quarter compared to a year ago. Notably, the Industrial International margins reached 15%. That’s a great number considering Europe and Latin America are still pretty weak for us. Achieving 15% was a significant accomplishment. Operating cash flows were again strong at $261 million, and we anticipate that fiscal year 2015 will be our 14th consecutive year of cash flows greater than 10%, having generated over 10% ever since we launched the win strategy back in 2001. Now, I’ll discuss our capital allocation strategy as a follow-up to our announcement last week. We are very pleased to announce that the Board increased the quarterly dividend by 31% from $0.48 to $0.63 and authorized the repurchase of up to 35 million shares. Our capital allocation priorities remain consistent, as we have communicated; our first priority is to maintain our dividend increase record. This significant increase last week aligns with our goal of a 30% payout ratio calculated as a percentage of net income. We have consistently indicated that we wanted to hit that 30% payout by 2016, and we’re pretty much on target for that. Secondly, we are committed to reinvesting in our business through capital spending that drives organic growth, running at less than 2% CapEx while managing the business by executing lean initiatives. Thirdly, we have a target to grow through acquisitions and will continue to pursue acquisitions that fit strategically. Lastly, we are committed to providing returns to shareholders. The new authorization of 35 million shares approved by the Board last week allows us more flexibility for share repurchases; this authorization more than doubles the number of shares available to purchase compared to our previous authorization. Our target is to repurchase $2 billion to $3 billion in the next 24 months. For planning purposes, you can assume a straight-line repurchase over the next two years, but it may appear a bit lumpy. Guidance has been increased based on our strong first-quarter results, partially offset by significant currency headwinds. Adjusted guidance has been increased to a range of $7.45 to $8.05 for diluted earnings per share, which excludes about $0.25 of restructuring expenses. The savings from the execution timing of our restructuring activities give us confidence that we will deliver another record year in fiscal 2015. Now I’ll turn the call back over to Pam for a more detailed review of the quarter.

Thanks, Don. At this time, I ask that you reference Slide #5, and I’ll begin by addressing earnings per share. The first quarter came in at $1.89 versus $1.67 for the same quarter a year ago, reflecting an increase of $0.22 or 13%. Restructuring costs were originally planned at $0.07, with $0.04 in the quarter, and this compares to $0.06 for the same quarter a year ago. Moving to Slide #6, this chart lays out the significant components of the lock from adjusted earnings per share of $1.67 for the first quarter of last year to the $1.89 for this quarter. The significant contributors to the increase included segment operating income of $0.24, which was due to better performance across all segments, offset slightly by higher below-the-line expenses of $0.02. This resulted from less stock compensation expense, offset by a higher tax rate due to the elimination of the R&D credit and favorable discrete items last year. Moving to Slide #7, on the far right in the blue box, you can see that adjusted organic sales in the first quarter increased almost 4% after accounting for the joint venture that commenced on October 1st of last year. There was minimal impact to sales from acquisitions, and currency or FX originally planned to be positive reduced reported sales by $23 million, or 0.7%, in the quarter. Adjusted segment operating margins for the quarter were 16.1%, compared to 15% for the same quarter last year. Restructuring costs affecting segment operating margin were $6 million this quarter compared to $11 million last year. Total restructuring costs were $8 million in the quarter and $12 million for the same period last year. The higher adjusted segment operating income this quarter of $525 million versus $476 million last year, a 10% improvement, is due to higher volume in North America and aerospace, less support costs in aerospace, and leveraged order restructuring in Europe. Moving to Slide #8, focusing on the business segments, North America's reported and organic revenues increased 6% to $1.47 billion from $1.3 billion last year. There was little impact from currency and acquisitions in the quarter. The adjusted operating income for the first quarter increased to $264 million from $236 million a year ago, again mainly the result of higher volume in the quarter. In the Diversified Industrial International segment, organic revenues for the quarter increased almost 1%, while currency had a negative impact of 1%, leading to reported revenues being down slightly less than 1%. After adjusting for realignment costs, the operating margin for the first quarter increased by 110 basis points to 15.5% from 14.4%, a result of reduced restructuring costs and savings associated with restructuring activities completed last year. Restructuring costs in this segment were $6 million in the quarter, down from $9 million in the same quarter a year ago. Moving to Slide #10, aerospace reported and organic revenues adjusted for the previously announced joint venture increased slightly more than 3% for the quarter. Acquisition and currency impacts on this segment were negligible. The increase in revenue was mainly due to higher commercial OEM business, with operating margins for the quarter increasing by 100 basis points, from 11.2% to 12.2%, due to higher margin OEM business and lower support costs. The order rate represents a trailing average and is reported as a percentage increase in absolute dollars, year-over-year, excluding acquisitions, divestitures, and currency effects. Diversified industrial uses a three-month average while aerospace systems use a twelve-month average. Orders were positive, increasing by 5% for the September quarter just ended, with North American orders up 6%, Industrial International orders up 2% for the quarter, and aerospace systems increased by 12%. Moving to Slide #12, Parker’s balance sheet remains strong, with cash and short-term investments at quarter-end at $2 billion, partially offset by approximately $700 million in outstanding commercial paper. Day Sales in Inventory (DSI) came in at 69 days, flat with a year ago; inventory levels at 10.9% of sales improved from the previous year's first quarter, when it was 11.2%. Accounts receivable in terms of Days Sales Outstanding (DSO) closed at 49, a 1-day improvement from the first quarter of last year; the weighted average days payable outstanding at the end of September was 60, a 2-day improvement sequentially from the end of June quarter. Moving to Slide #13 to talk about cash flow, it was $261 million or 8% of sales. The major uses of cash in the quarter included $122 million returned to shareholders through share repurchases and dividends, $113 million utilized in the reduction of commercial paper outstanding, and $55 million for capital expenditures. As a result, cash on hand declined by close to $100 million in the quarter. Moving to Slide #14 addressing the guidance, we’re providing adjusted guidance in line with last quarter. Sales growth is adjusted for the GE joint venture that commenced in the first of October last year, with segment operating margins and earnings per share excluding restructuring charges. On this slide, we have detailed guidance for adjusted sales growth and segment operating margins as well as below-the-line items, the tax rate, shares outstanding, and the range for reported and adjusted earnings per share. Total adjusted sales are expected to increase from 0% to 3% for the year, which is lower than the previous guidance provided at the end of last quarter, due to negative headwinds from currency, mainly the strengthening of the dollar versus the euro since last quarter. Adjusted organic growth at the midpoint is 3.3% with minimal impact from acquisition carryover. Currency is now expected to deduct 1.9% from sales, primarily related to Industrial International. Total Parker adjusted segment operating margins are forecasted to be between 15.7% and 16.1%, compared to 14.4% for fiscal year 2014, and the guidance for below-the-line items, corporate administration, interest, and other expenses, is projected at $470 million, lower than previous guidance due to favorable first-quarter results. The full-year tax rate is projected at 29%, with shares used in guidance set at 151.1 million. Please note that shares outstanding have not been reduced for share repurchases taking place in connection with the new authorization of 35 million shares, and the plan to purchase $2 billion to $3 billion in shares over the next 24 months. The restriction on annual share repurchases has been lifted. The full-year revised guidance on an adjusted earnings per share basis is $7.45 to $8.05, with $7.75 at the midpoint as Don mentioned. This guidance excludes restructuring expenses expected to incur approximately $50 million in fiscal year 2015, and is consistent with previous guidance. The effect of this restructuring on EPS is approximately $0.25, with $0.25 expected to be incurred approximately 50% in the first half and 50% in the second half. Sales are divided 48% or $6.43 billion for the first half, and 52% or $6.93 billion for the second half, based on the midpoint. Segment operating income is split 45% in the first half and 55% in the second half, while earnings per share is split 43% to 57% at $2.98 in the first half and $3.95 in the second half, also at the midpoint. Second-quarter adjusted earnings per share is projected to be $1.47 at the midpoint, adjusted for $0.08 in expected second-quarter restructuring costs. In summary, the major difference between the full-year guidance this quarter versus last is higher than previously guided first-quarter results, partially offset by negative currency impact due to the strengthening of the dollar during the first quarter. Please remember that the forecast excludes any acquisitions or divestitures that may occur in fiscal year 2015; for published estimates, please exclude restructuring expenses. Now we will commence the standard Q&A session. Please remember that the call will be limited to one hour, so please honor the request of one question at a time and a follow-up only when clarification is needed. Thank you so much.

Good morning.

Good morning, Jeff.

Pam, congrats on the retirement and best of luck.

Thank you so much, it’s been a pleasure, Jeff.

Okay, just to be clear on the buyback, are you guys doing a 10b5, or will you be in the market every day, or will you be more opportunistic and have your normal blackouts? And maybe just to follow on, what drives you to the higher or lower end of that $2 billion to $3 billion?

Okay, Jeff, Jon here. I’ll start out. We are going to continue with our 10b5 just as we have right now. As Don said, for planning purposes, the best approach is to use a straight line method. The actual results are likely to be lumpy. We will be reviewing matters as the ensuing quarters progress, and it’s going to be something we’re focused on every day.

Okay, and what takes you to the higher or lower end?

We’re going to just take it one quarter at a time. We will update you every quarter as to what the results are. We would be able to tell you more about the high or low end as we get further into the program; I don’t want to give any indication that it is going to be closer to the low end or at the high end on this call.

Okay, great. And just a quick follow-up, can you talk about the trends you’re seeing in Europe just on an underlying basis? We’re hearing some mixed things and just want to get your sense of Europe?

To start out, Jeff, in Europe, things came in exactly as we had put our guidance together. We had a good July, not a great August, again accounting for the normal shutdowns that we see in August. We had exactly what we expected in September, and things are not ramping up or down; they are relatively flat in Europe when looking at the orders. That’s how we’re seeing it right now. The major change to our guidance going forward is the impact of the strong dollar against the euro.

Thanks.

Hi, good morning everyone, this is Joe Grabowski for Mig. It's a really nice recovery in the international operating margins. I just wanted to find out if some of the restructuring disruptions you had last quarter seem to have worked themselves out this quarter?

Yeah, that’s a fair assumption. We were quite worried about Q4. We discussed it a lot during our Q4 conference call. Those disruptions and restructuring-related costs we experienced in Q4 last year have all been eliminated this quarter. Our plans are being executed very well by our teammates, and we are very pleased with the results internationally this past quarter.

Great, okay thanks. Just a quick follow-up, you mentioned the cadence of business in Europe; could you talk about how the quarter progressed for North American industrial and what you’re seeing so far in October?

As for October, it’s aligning with our guidance, so nothing remarkable to report. In North America, during the quarter, the results corresponded with July, August, and September. August is always lower than July, and September showed sequential improvement over August, slightly better than July.

Okay, great, thanks for taking my questions.

Sure.

Good morning, Don, Jon, and Pam.

Hey Nathan.

If we could revisit the quarter's beat, it seemed to me when you gave the guidance, you had some vigor built in there for possible cost overruns from the restructuring in Europe. How much of the improvement in Europe, or the beat relative to your guidance, was due to a lack of those costs and good execution on the restructuring versus fundamental improvement in the business?

I think there was hesitation on our part when putting the guidance together in terms of what would happen in Q4 for Europe. However, a significant part of the beat is coming from a strong performance in North America, particularly in our Industrial business, which recorded an all-time high of 18% return on sales. While Europe also improved slightly, the considerable strength is attributed to North America.

And were there any positive impacts on those margins in North America? Are these margins sustainable moving forward?

Yes, the excellent performance was across the board, with no mix issues impacting margin. We expect slightly lower margins in Q2, but we will maintain high margins throughout the year; for the overall year, we will be slightly below 18% as indicated in our guidance, which shows that we expect to maintain our record high North American Industrial margins.

And on the balance sheet, we know you’ve been waiting for the right deals. Can you talk about what held you back from making those deals, whether it was discipline on price or other reasons?

Just to recall what we have said in the past, over the last three or four quarters there were many inquiries about our capital deployment and the accumulation of cash on the balance sheet. We were seriously discussing a couple of major acquisition opportunities that required all cash on the balance sheet. We had confidentiality agreements that limited our communication. We acknowledge the frustration of our shareholders, but we were in serious discussions regarding significant opportunities. Ultimately, we could not bridge the valuation expectations, as we are quite disciplined regarding strategic acquisitions.

That’s a great explanation. Thanks, Don, and good luck, Pam.

Thank you, Nathan.

Good morning, everyone, and I also wish you the best, Pam.

Thank you, Eli, it’s been a pleasure.

Can we discuss market demand across the board? The North American orders were quite respectable this quarter. What are your expectations as we approach the end of the year?

I’ll provide some color on the PMI and regional performance. Globally, the PMI is tracking positive territory at 52.2. The U.S. saw a pickup since June, now at 56.6. The Eurozone declined to 50.3, influenced by Germany. In Asia, we see positive growth, while Brazil remains just under 50. The overall picture shows North America and Asia as the two strongest regions. Positive segments include Aerospace, distribution, and heavy-duty trucks, while we’re seeing negatives in several other segments.

Can we talk about pricing and movement in the industry?

We’re seeing many inputs for raw materials going up, with steel and aluminum both increasing. Steel is up by about 20% year-over-year. We will examine pricing adjustments based on these inputs in January and July, maintaining margins while managing price expectations over time.

Good morning, can you hear me?

Hi Jamie, yes, we can hear you.

Pam, congratulations.

Thank you, Jamie.

Can you give us an update on Aerospace margins confidence, considering the headwinds you’ve faced over the past couple of years?

Regarding Aerospace margins, we expect to achieve guidance. We note that R&D expenses may be slightly higher than projected, around $5 million to $10 million. However, overall, we are confident in our guidance of approximately 13.5%.

Could you discuss how you plan to finance the share repurchase?

We plan to use cash generated here in the U.S. and our commercial paper line for the share repurchase program. We will not repatriate cash from oversees, as it has been permanently reinvested there.

Hi, just a quick question on the sales guidance for International. I was curious, you lowered it solely on currency. Can you take us through the moving parts geographically? Did you raise your outlook for Asia to offset a weaker outlook for Europe?

You are correct; Asia is trending better than we expected, offsetting weakness in Europe. Europe is expected to remain flat with slight declines against strong performance in Asia, which includes growth in several key end markets.

Hey guys, how's it going?

Good, how are you?

This other expense line is down $26 million in the quarter; what was included in there?

The reduction in that line is primarily due to lower stock option expenses, which are reviewed once a year, coming in significantly lower than anticipated.

Any reason why you're not updating your long-term operating margin targets? It seems you're at 15% now.

We feel that 15% is a good target over the cycle. With North America and Asia performing well while Europe and Latin America remain mostly flat, any possible tailwinds going forward will be positive for margins. However, we prefer not to set additional targets at this point.

Thanks.

Hi, good morning, everyone.

Good morning, Josh.

Just a quick clarification on the pacing of the buyback. Why not frontload that to the extent the free cash flow enables it?

For now, we are transitioning to smaller tuck-in acquisitions, which we believe will maintain balance and allow us to remain active in pursuing growth avenues. We don’t foresee handcuffing anyone regarding future acquisitions.

Understood, thank you very much.

I appreciate your insights today, thank you.

Thank you for joining us today to recap our current performance expectations for fiscal 2015. We have strong confidence based on our restructuring success, which is reflected in our announcements regarding the dividend increase and share repurchase program. I also want to thank our employees for their commitment and success in executing the win strategy. If you have additional questions, Pam and Todd Leombruno will be available for the remainder of the day. Thank you once again and have a great day.