Ladies and gentlemen, thank you for standing by, and welcome to the Parker Hannifin Fiscal 2021 Third Quarter Earnings Conference Call and Presentation. The opening speaker for today's call is Parker's Chief Financial Officer, Mr. Todd Lambrunno. Please go ahead, sir.
Thank you, Elaine, and good morning, everyone. Thanks for joining our FY 2021 Q3 earnings release webcast. As Elaine said, this is Todd Leanbrunno, Chief Financial Officer speaking. Here with me today are Chairman and Chief Executive Officer, Tom Williams and President and Chief Operating Officer, Lee Banks. On Slide 2, you'll find the company's Safe Harbor disclosure statement addressing forward looking statements as well as non GAAP financial measures.
Reconciliations for all non GAAP measures are included in today's materials. These reconciliations and our presentation are accessible under the Investors section
atparker.com
and will remain available for 1 year. We'll start the call today with Tom providing some quarter highlights and some strategic commentary. I will provide a summary of the quarter financial results and review the increased guidance that we announced this morning. Tom will then close with key messages and then Tom Lee and I will take any questions the group may have. With that, I'll direct you to Slide 3 and I'll hand it off to Tom.
Thank you, Todd, and good morning, everybody. Before I jump into Slide 3 in the quarter, I want to say thank you to all the Parker team members around the world for an outstanding quarter. It's really more than just this quarter. It's really been the whole year and the performance through the pandemic and also transformation of the company into a top quartile diversified industrial company. These results are all because of your efforts.
So let's look at the quarter on top of Slide 3. Starting with safety as we always do, we had a 33% reduction in We're still in the top quartile. The combination of safety, lean, our high performance team structure and kaizen All driving high engagement and high performance and you see that show up in our results. Sales grew about 1%. The organic decline was minus 1%.
But in particular, if you take out Aerospace and look at the Industrial only, Industrial segment grew organically almost 4%, so that was significant. We had 5 all time quarterly records. You can see the net income, EPS and the segment marks for Parker North American International. EBITDA margin was very strong at 21.6 percent as reported, 21.8 percent adjusted, a huge increase versus prior 2 50 basis points. Year to date cash flow was an all time record of $1,900,000,000 and 18 a little over 18% of sales.
If you go to the very last row of this page, you see segment operating margin on adjusted basis, 21.4%, again a significant improvement versus prior Plus 2.40 basis points. So a terrific quarter and really tough conditions. If you go to the next slide, I want to talk about the transformation of the company. The old adage that a picture is worth a 1,000 words. And so I want to take you to Slide 5 and this is really the picture that speaks to the transformation of the company.
Let me explain the chart here for a minute. So you've got in gold bars the adjusted EPS. The blue line is global PMI plotted on a quarterly basis. If you look at the last 6 years Look at that dotted green line and compare that to the blue global PMI line, you see they are much less correlated. In fact, they are diverging.
And there's been a step change in performance. EPS over this time period has more than doubled from $7 to our guidance of $14.80 so approaching $15 And what's propelled that over that time period is an EBITDA margin that's grown 600 basis points. So you might ask how that happened. It's really in that blue takeaway at the bottom of the page. It's our people that focus the alignment, the engagement that comes when you have People think and act like an owner.
The portfolio, which is a combination of our interconnected technologies and the value they bring And the capital deployment we've done by some great companies that have added to the strength of the company. Then our performance, which really sits with the strategy of the company, Win Strategy 2.0 at the beginning of this journey and then Win Strategy 3.0 most recently in FY 2020. So this combination has really transformed the company. You see that as evidenced in this slide and we're very proud of it. But if you go to slide 6, So that's what's kind of in the rearview mirror.
But going forward, we're equally excited about where the company is going to go. And I've called this a convergence of positive inflection points. So on the left hand side is kind of those external inflection points. You're familiar with a lot of these, but the macro environment industrial momentum, you see that in our positive orders and positive organic growth industrial we showed in this quarter. Aerospace is going to recover.
The question is just what the trajectory will be and the timing. Vaccines are making progress around the world. There's going to be a significant amount of climate investment. If you put all that on top of it, I didn't write all these down, but low interest rates, pent up CapEx demand and fiscal spending, You have a very attractive environment for industrials for the next several years. On the right hand side is really the internal things we've been doing, Win Strategy 3.0 in particular, but that last slide that I just went through spoke to all those internal actions because that's what's been propelling us.
Remember that last period, Last 6 years really had very little help from a macro standpoint. So you look at the 3 major things I highlight here: performance, becoming top quartile, strategy to grow fast in the market. You've seen our margin expansion, great cash flow generation consistently over the cycle. Portfolio. We've added 3 great companies, all accretive on growth cash margins.
And with the rapid debt pay down that we've done, We're positioned to do future capital deployment, which is very exciting. The technology, I'll get into in the next slide, but the interconnected technology is really distinctive for us. And then with the climate investment, we are very well positioned with our suite of clean technologies to take advantage of that. So I would tell you that My view and the team's view is this is about as good an environment as we've seen in a number of years. Let's go to Slide 7.
You've heard me talk about this page, the power that this interconnectedness of technology brings the value increase for customers. What I want to do today in light of the clean technology discussion is give you four examples of how this suite of technologies helps with a more clean environment, clean technology world. So the first would be electrification. And we've got a full portfolio of technologies here, hydraulic, electrohydraulic, pneumatic, electromechanical, no competitors got that breadth of technologies. And we formed about 4 years ago the Motion Technology Center, which put the best and brightest of engineers doing motion technologies and things that fly As well as things with wheels underneath it.
So we put the motion and the aerospace teams together. And this team has come up with a great Listing of products around motors, inverters and controllers, but there's also in addition to the typical motion opportunities, There's other challenges around electrification like light weighting, thermal management, shielding, structural adhesives and noise vibration. All these With the combination of Kevin's legacy Engineered Materials and with the Lord acquisition, we're well positioned to take advantage of those. 2nd area is batteries and fuel cells. They utilize most of the technology you see on this page.
3rd would be clean power sources and that kind of falls into 2 buckets. Renewables, which we do a lot and always have done a lot on wind and solar. Then the hydrogen, we just recently joined the Hydrogen Council. And there's going to be both onboard as well as infrastructure opportunities as you go out over the next many years. It's really building on our high pressure and our cryogenic applications that we have today.
And then we've been a more sustainable company for a long time and really The clean technology example for us that started a lot of things is filtration. And our filtration business protects and purifies assets and equipment for people for a more sustainable environment. So we feel very good about this portfolio as there's more climate investment in the future. Going to Slide 8, Just wanted to remind you of our purpose statement enabling engineering breakthroughs that lead to a better tomorrow. It's been very inspirational for our team.
I think it comes more to light when we give you examples of the purpose and action, which is on Slide 9. And again, kind of following with a clean technology discussion, When I'd highlight electrification, I'm going to highlight in particular, electric vehicles. On the left hand side, You see applications that have changed because of an HEV or an EV versus a combustion engine. On the right hand side, you see the various technologies that Parker has that addresses those applications. I won't read all those underneath it, but you see the major categories: safety, related technologies, things that save weight, Thermal management and a variety of things we do for critical protection.
The big opportunity for us, so we obviously are in the factories helping to make these vehicles. We'll always do that, but the big opportunity for us is the onboard content around Engineered Materials. Our bill of material for an EV or an HEV It's 10x what it was in a combustion engine, and it's one of the key reasons why our lowered business has grown so nicely Even despite the pandemic, so we grew 11% organically in Q3 for Lorde. So we're very happy with the progress so far and our purpose and action around electrification as an example. So with that, I'm going to turn it over to Todd with more details on the quarter.
Okay. Thanks, Tom. I'll just orientate everyone to Slide 11, and I'll do a quick review of the financial results for the quarter. Tom mentioned some of these, so I'll try to move Sales for the quarter were $3,746,000,000 that is an increase of 1.2% versus prior year. We are proud of the fact that the Diversified Industrial segment did turn positive organically.
Industrial segment organic growth was 3.7. Obviously, that was offset by the Aerospace Systems segment. Their organic decline was 19.7%. So all in, That drove total organic sales to minus 1.0. Currency was a favorable impact this quarter of 2.2%.
And just a note in respect to acquisitions, this is the 1st full quarter that we report both LORD and Exotic in our organic growth numbers. So therefore, the acquisition impact was 0. Moving to segment operating margins, you saw the number 21.4 percent. That's an improvement of 240 basis points from prior year. It's also an improvement of 130 basis points sequentially, strong margin performance there.
And that really was a result of just broad based execution of the Win Strategy. We continue to manage our cost in a disciplined manner. The portfolio additions in CLARCOR, LORD and Exotic are all performing soundly. And you've all been With the restructuring activities that we've done in FY 2020 and in FY 2021, those are on track and on planned and generating the savings that we expected. Adjusted EBITDA margins did expand 2 50 basis points from prior year, finished the quarter at 21.8 percent And net income is $540,000,000 which is a 14.4% ROS that's increased by 22% from prior year.
Adjusted EPS is $4.11 That is a $0.72 or 21% increase compared to prior year's results of $3.39 And as Tom said, it's just really outstanding performance. And I'd also too like to commend our global team members for generating these results. 12. This is really a bridge of that $0.72 increase in adjusted EPS versus prior year. And the story here across the board is just strong execution from all of our businesses.
This produced robust incrementals in our diversified industrial segment and really commendable decrementals in the Aerospace Systems segment. Adjusted segment operating income did increase by $98,000,000 or 14% versus prior year. That equates to $0.58 of EPS and really is the primary driver of the increase in our adjusted EPS number. Interest expense was favorable to prior by $0.12 as we posted yet another quarter of sizable repayment of our serviceable debt and that is really benefiting from our strong cash flow generation. Other expense, income tax and shares netted to a $0.02 favorable impact compared to prior year.
Moving to Slide 13, this is just an update on our discretionary and permanent cost out actions. And this is just a reminder, these represent Both savings recognized in the current fiscal year from our discretionary actions in response to the pandemic and our permanent realignment actions that were taken at the end of FY 2020 and throughout FY 2021. Discretionary savings came in exactly as we guided at $25,000,000 for Q3 and now total $215,000,000 year to date. There is no change to our discretionary savings forecast for Q4. That remains $10,000,000 and we continue to forecast the total year to be $225,000,000 in full year savings.
Just to note, with the increased demand levels that we're seeing from our positive order entry, our teams have really pivoted to growth. And really now these discretionary actions that we knew would diminish across the calendar year have now really been based in reduced travel expenses. If you move to permanent savings, we realized $65,000,000 in Q3. Our total year to date is $190,000,000 The full year forecast again here remains as previously communicated at $250,000,000 One item to note, we did guide that the cost of the FY 2021 restructuring would come in around $60,000,000 It's now expected to be $10,000,000 less or $50,000,000 but there is no change to the expected savings that we are forecasting. Total incremental impact for the year from both permanent and Specialty savings is $260,000,000 And just one other thing to note, this will probably be the last quarter that we detail these items as we anniversary The pandemic induced volume declines and really focus our attention on growth.
So the takeaway is savings are on track, no changes other than the If you go to Slide 14, this is just highlighting some items from our segment performance for the Q3. In our Diversified North America business sales were $1,760,000,000 That is an improvement in organic sales sequentially from Q2. It still is down 1.2% from prior year. But if you look at the adjusted operating margins, we did increase those operating margins by 190 basis points versus prior year and reached 21.9% for the quarter. We were able to increase these margins despite that sales decline Due to our disciplined cost management, those portfolio improvements we've talked about and really margins in this segment are at a record level.
If you slide over to order rates, another positive here, they improved significantly from plus 1 last quarter and they're now ending the quarter at +11. Looking at the Diversified Industrial International sales, robust organic growth here of 11.1%. Total sales came in at $1,390,000,000 And another great story here, adjusted operating margins have expanded substantially and reached 21.6 percent, an improvement of 400 basis points versus prior year. Clearly, the double digit organic growth coupled with Cost containment and the effort from our global team really generated this level of record margin performance as well. And again, another plus here is order rates Accelerated in this segment and are now plus 14% for the quarter.
If you look at Aerospace Systems, they continue to really perform soundly In the current environment, sales were $599,000,000 for the quarter. Organic sales showed a slight sequential improvement from Q2, but are still down Basically 20% from prior year. Commercial end markets are still under pressure. However, there is strength in our military end markets. What's nice here is operating margins were 19.4%, 30 basis points better than prior year despite that 20% client in volume.
And if you look at our fiscal year, that performance of 19.4% is the highest they've done all year. So we're really proud about that. Decremental margins are also impressive here in this segment. This quarter they're 18% decremental margins. Order rates appear to have bottomed and finished at minus 19 for this quarter.
And just a reminder, that is on a rolling 12 month basis. So overall, we're pleased about a number of things this quarter. That Diversified Industrial segment organic growth of 3.7% is a positive. Total segment margins improved 2 40 basis points from prior year and at record levels. Orders have turned positive and are plus 6, and our teams really continue to leverage the win strategy to drive significant improvements in our business And increased productivity and generate strong cash flow.
So with that, I'll ask you to go to Slide 15. This is just some details on our cash flow. Year to date cash flow from operations is now $1,900,000,000 that's 18.1 percent of sales. That's up 0.45 percent from prior year and it is a year to date record. Improved net income margin is We've talked about before is really a key driver in this.
It's created a step change in our cash flow generation. But I'd also like to commend our team members' intense focus on our work capital metrics. Each of our working capital metrics is improving and showing positive results and I'm really proud about that. Moving to free cash flow at 16.8 percent of sales, that's an increase of 6.30 basis points over prior year And our free cash flow conversion is now 141%, which compares to 122% in the prior year. So great cash flow generation there.
Moving to Slide 16, I just want to mention some things we've done on our capital deployment. We did pay down $426,000,000 of debt this quarter. That brings our total debt reduction to a little over $3,200,000,000 in the last 17 months since the LORD acquisition closed. This reduced our gross debt to EBITDA to 2.4%. It was 3.8% in the prior year and net debt to EBITDA is now 2% and that's down from 3.5% in the prior year.
Looking at dividends, last week, you saw our Board of Directors approved a quarterly dividend Increase of $0.15 or 17%. This raises our quarterly dividend from $0.88 to $1.03 per share and extends our record of increasing the annual dividends paid per share to 65 consecutive years. And finally, as we mentioned at the Q2 earnings release, we reinstated our 10b5 program and repurchased $50,000,000 of shares in the quarter.
All right.
So if you go to Slide 17, I'll just provide some color to the increase in guidance that we gave this morning. Really the strong year to date performance and these order trends have positioned us to increase our full year outlook for sales to a year over year increase of 4.5% at the midpoint. And the breakdown of that sales change is this. Organic sales are now expected to be flat year over year, acquisitions will add 3% and the full year currency impact is expected to be 1.5%. We've calculated the impact of currency to spot rates as of the quarter ended March 31, And we held those rates constant to estimate the Q4 2021 impact.
Moving to second operating margins. Our guidance for the full year has raised So 20.8 percent and that would equate to an increase of 190 basis points versus prior year. And just some additional color, some things to note. Corporate G and A interest in other is expected to be $381,000,000 on an as reported basis $479,000,000 on an adjusted basis. The main difference between those two numbers is that $101,000,000 pretax or $76,000,000 after tax gain on real estate that we recognized and adjusted and the other income line in Q2.
That's the main item. If you look at our tax rates down just a little bit, we're now expecting the full year tax rate to be 22.5%. And moving to EPS on a full year basis, our as reported EPS guidance range is increased from $12.96 to $13.26 that's $13.11 at the midpoint. And on an adjusted basis, we're increasing the range $14.65 to $14.95 that's $14.80 at the midpoint. For Q4, adjusted EPS is projected to be $4.18 per share.
That excludes $0.54 or $93,000,000 of acquisition related amortization expense, for finishing of our business realignment expenses and integration cost If you look at Slide 18, this is just a bridge of our increase to our adjusted EPS guidance. No, these results that we just reviewed, you could see the outperformance that we had in Q3. That increases our previous guide by $0.57 The order strength that we just reviewed and really the exceptional operation and execution by our teams have allowed us to increase Q4 guide by an additional $0.33 and that is exclusively based on increased segment operating income. This raises our full year EPS guide by about 6.5% from prior guide. And with that, I'll turn it over to Tom for Some summary comments and ask you to move to Slide 19.
Thanks, Todd. So we've got a highly engaged team. You see that this was driving our results, The ownership culture that we're building, record performance in difficult times. These numbers are historical All time highs for us and not the best of times. The convergence of positive inflection points, we feel it points to a very bright future.
And the cash generation and deployment is evidenced by the rapid debt pay down, the acquisition performance And our dividend increase, which I would just highlight the first time we've ever been over $1 at $1.03 on a quarterly dividend, which we're very proud of. So the Win Strategy 3.0 in our purpose statement is well positioned in addition to those inflection points for a very strong future. I'll turn it back to Elaine for to start the
Q and A. And your first question comes from the line of Jamie Cook from Credit Suisse.
Hi, good morning and nice quarter. I guess just two questions. 1, understanding you don't want to talk about 2022, but I'm trying to understand the setup for incrementals And to what degree of volumes are still there? Can we have above average sort of incrementals and how the discretionary costs sort of factor back in and impact incremental margins. And then I guess my second question is regards to your longer term margin targets, Which you're already starting to beat those targets.
So in particular, with volumes not really showing up in your numbers, I'm
Jamie, it's Tom. So I'll start with the incrementals. The one thing that I would point out is our guidance for Q4 It's incremental of about 30%. And if you were to do like for like and take out the discretionary savings we had in Q4 prior period, they'd be about a 50% incremental. So they'd be at the incrementals that we feel based on The cost structure and all things we've done with Win 2.0, Win 3.0 that we would generate at this point in the cycle.
So that's we would continue to do 30 percent, I think, as we go into 2022. Obviously, we're not guiding to that yet, but I think that's a good round number to use for us. But I highlight Q4 because it is impacted by the prior period discretionary, which we don't have now or not as much. And that difference is pretty significant. We go from a 30 to a +50, I think, a metal.
So it speaks to the underlying power of the business is there. And then on your question on long term margin targets, yes, this is a good problem that we have that we basically beat our targets by about 2 years. Our guide to 20.8 at the midpoint on op margin is within spitting distance of the 21. And then on EBITDA, what we don't guide on EBITDA margins will be at the 21% for a full year on EBITDA. So we're actively working on what this new set of targets will be.
And I'm sure this is a question everybody had. So we're going to Disclosed them at IR Day, which will be March of next year. And we think that's the appropriate form to do that. But rest assured, we're working on it. And we're not going to settle or be happy with stopping where we're at.
We're going to continue to march forward and we'll give you that vision When we have Investor Day.
Okay. Congrats. Thank you.
Thanks, Jamie.
And your next question comes from the line of Andrew Obin from Bank of America.
Hello, Andrew. Yes, I
guess I'll follow Jamie's lead. I'll ask one question, but it will have 2 parts. It seems you guys are getting ready for Some of the best growth you've seen in a long, long time. And the 2 part question that I have for you is, How do you think about your supply chain and manufacturing footprint to meet demand and meet growth over the next 3, 4, 5 years in North America. So that's part 1.
And part 2, For the past decade at least, we didn't really have a lot of growth in North America structurally. And in terms of your distribution channel, do you need what do you need to do to optimize your distributors for This new growth environment, do they need to be better capitalized? There's been some consolidation. Do you need to continue consolidating your dealers? So part 1, manufacturing getting ready for this multiyear upturn and part 2, what do you need to do on the distribution side?
Thank you.
Okay, Andrew, it's Tom. I'll start, maybe Lee can pile on with the manufacturing structure of the company. But We feel that we're well positioned to take advantage of this growth. I mean, one of our strengths historically is when there is a spike in demand, Our supply chain and the fact that we make, buy and sell local for local in our manufacturing footprint, which is diversified around the world, Has typically been more responsive than our competitors. And then what we've done with 3.0 and added Kaizen And when so I start with my opening comments.
When you link the safety performance, lean, Kaizen and the high performance teams, I think the high performance teams is a structure how we run The various sales and value streams, you've got a very powerful combination. And as we do Kaizen, we keep finding ways to free up capacity, Free of floor space, free of capacity in our equipment. We're able to do what we call more simple automation Katakuri, which is uses the only free thing in life, which is gravity. And if you saw these, these are gravity induced material handling things and Simple automation in the factories has allowed us to be responsive to this demand. So I think we're well positioned.
Obviously, we're going to have to continue to invest, Which we will, but we just found ways to do it more efficiently. And Kaizen has been kind of the great liberator for us to be able On the channel, the channel has been, to your point, has been consolidating over the last number of years. I think it's in Better position than it's ever been to respond. We did see nice growth in distribution sequentially, and our distributors are investing in And some inventory for the future, and I think they'll be in a position to respond. Obviously, we take share through them as well as through our OEMs going direct.
And we've got a great distribution team. Our partners are strong. We've got a great distribution sales force. Distributors have been investing in application engineers And they're relying on us to be better at supply chain. And in their eyes, we can continue to do better, but we have made quite a bit of stride on that.
So I think both of those will be well positioned to take advantage of this upturn.
Thank you, Tom.
Thanks, Andrew.
And your next question comes from Scott Davis from Melius Research.
Hi, good morning, everybody. Thanks for including me. Kind of fascinated by Slide 9. I know you've shown it before, but I don't think you guys have disclosed kind of the opportunity difference between the electric vehicle and potential content versus ICE. Is there any way that you can quantify the opportunity for us?
Scott, it's Tom. So For competitive reasons and for sensitivities with customers, I won't get into the dollar content, which is why you heard me describe it In terms of just size versus ICE, 10x our build material, our build material on board It's primarily almost exclusively all engineered materials. So everything when you go down that list on the right hand side of Slide 9, these are all engineered materials and this would be a combination Pretty strong portfolio we had before we did LORD, but then LORD added quite a bit to that. And really the combination we've got there It's really given us a very attractive offering for customers. And the debate is How fast it's going to grow and what percentage of the total fleet will take over.
But for us, every time there's a new EV, It's an upside opportunity. Recognize, as I mentioned, the LORD growing 11% in the quarter, LORD's at 3rd Aerospace. So LORD's Aerospace business It's doing a little better than legacy Parker's because they have pretty big military exposure, but it's feeling pressure just like legacy Parker is And for LORD as a whole to show a +11 percent to show you the growth we've got on the EV and HEV side.
Okay, fair enough. And what just again looking at Slide 13 and the discretionary cost versus the permanent. How do you think about this going forward and kind of past the middle of the year? Will expenses kind of go back to pre COVID levels? Is that something that you guys are starting to model in?
Or is there some sort of a improvement to discretionary that's even that almost becomes permanent, if you will, like people will travel a little bit less or there's You find that you don't need to send 30 people to a trade show, you can send 20. I mean it or is that in the numbers already? And Open end question, I guess, Tom.
Scott, this is Todd. I'll take that question. You're right on all accounts there. When we talked about this last year, Because the decline in volume came so quickly, we pulled a number of levers on discretionary expenses. A lot of this was in response to the volume declines, right.
And we talked about our permanent actions and that eventually our permanent actions would right size the business. We feel like we're there now, but we have found a new way to do business, right? I don't think we will go back to the way we did things. Travel, trade shows, those are all great examples. But there will be some, right?
We're still trying to figure out what that is, But it will not be like it was before. So that will be essentially a change that will be structural going forward.
Okay, perfect. Good luck and congrats guys. Thank you.
Thanks, Scott.
And you have a question from Joel Tiss from BMO.
I'm glad you started off with the safety talk, Tom. I've got my mask and my safety glasses on and I got all Shots and everything, I'm ready for it. I'm proud of you, Joel. Stay safe, Joel. Stay safe.
Can you talk a little bit about the inventories in The channel in aerospace and just sort of maybe more generically how the industry is setting up for 2022 and 2023, like what are you hearing From your customers and your distributors and things like that?
Joel, it's Tom. So on distribution, We saw really nice improvement versus Q2. So distribution came in at +2 overall for the quarter versus a minus 6 in the 15% to 20% range. EMEA was flat and North America was just slightly negative, low single digits. Pretty much across all our distributors, we saw a combination of actual activity driving demand and then investing in inventory So I think the channel has turned from last quarter, I talked about selective restocking.
I think it's pretty much across the board, people planning for the future. And then in Aerospace, we still need time. I think we're bouncing along the bottom there. And we sized the company To put a great margins in the quarter right now, we have the advantage of being very diversified in our segments between engines, Military, commercial, helicopters, etcetera, going down the line. That's helped us quite a bit.
We're about fifty-fifty military and OE. So we're well positioned, but the question mark there is just what will the trajectory be and how long do we bounce along bottom. Clearly, I think the military side will continue to be strong for us. It was strong this quarter and will continue to be strong going forward. Both OE and MRO, we're on the right programs there.
And the commercial side will be all based on MROE, will be based on line rates from the OEMs, And then on the MRO side for commercial, it's all about air traffic, shop visits and New seat positives with airlines hiring pilots back and departure rates are improving And that will speak well to shop visits down the road.
All right.
That's
great. Thank you.
Thanks, Joel.
And you have a question from Joe Ritchie from Goldman Sachs.
Good morning, Joe.
Thanks. Hey, good morning, guys. So I'll ask a multipart one question, but really around free cash flow because that's been a great story for you guys as well. And so as we think about next year and the inflection that you're going to see in growth, how do we think about you having to build working capital within your own distribution and the impact that that could have on 2022 for cash flow margins. And then beyond that, like longer term, what's kind of like the right entitlement?
If margins are going to be going up longer term, What can free cash flow margins look like longer term for the company?
Hey, Joe, this is Todd. I'll take that question. And thanks for Noting our superb free cash flow, we are really proud about that. As you know, we don't guide on free cash flow. We're really happy with our results.
There has been a step change if you look back over time. I kind of alluded to that in the slides there. It's really driven by our increased margin performance. But not only that, I mentioned our working capital. Our teams really have put intense focus on this.
And that's one of the areas that we really have improved with these recent acquisitions, kind of bringing them into Parker type terms and Parker type policies. So we're not done with that. We still have room to go on that on every single one of those metrics. So we do see that improving. Will there be some pressure as growth comes?
Absolutely, but it will not adversely affect those numbers. We
see a
positive future here for cash flow.
Got it. Okay. Thank you very much.
And you have a question from Nathan Jones from Stifel.
Nathan. Good morning, everyone.
Good morning.
I'd like to follow-up on the aerospace side. Tom, specifically on commercial aerospace and even more specifically on the aftermarket side, that's where you guys are going to see the pick On the commercial side first, have you seen sequentially that get any better as we're really seeing the front end of air traffic start to pick up? And if not, what's the typical kind of lag you see from when that recovery in air traffic starts to when you actually see the recovery in your aftermarket orders?
Yes, Nathan. Nathan, it's Tom. So sequentially on sales for commercial and rural, we saw a 13% improvement Going from Q2 to Q3. And the lag is sometimes hard to predict, but the sequence would be Increase in available sea kilometers and increase in departure rates drive shop visits to go up At some period of time after that. And that's always the hard part because it depends on what the routes are and the cycles and particular engine, etcetera.
But those will start to improve. And then once the shop visits go up, then our flow through The commercial MRO is going to happen. So I can't give you an exact lag because if I did it, I would probably be wrong. But clearly, these are all positive signs. Pilot's being hired, departure rates going up, available sea kilometers starting To at least stabilize and starting to improve.
Those are all speak to shop visits going up and they'll drive higher content of MRO for us. Okay.
And then one on use of cash here. I think you guys had said once we get to about mid this year, mid calendar year, You're going to be out of debt to pay off and obviously producing a lot of cash flow here.
Can you talk about your approach to
the M and A market now, when we might Expect to see you back into it and what the maturity of the pipeline looks like right now?
Dene, this is Tom again. So you're right. Our serviceable debt will be paid off this quarter. So we'll enter FY 2022 with no serviceable debt and our next payment Corporate bond not due to September of calendar 2022. So we have opportunities.
And We have always described it and the lessons learned from the financial crisis is to continuously work the financial pipeline. Lee, Todd and myself, just did reviews. We do this all the time. Lee does it monthly with his presidents. And so this is something we stay on top of Building those relationships, so the pipeline is active, but it's always a matter of finding a willing seller and a willing buyer.
And so it's definitely activity just doesn't always translate into actual properties being acquired. But We're looking and certainly we're going to continue to buy companies with the same kind of themes that you've seen before That either are immediately accretive or accretive within our synergy time period to where they can help the growth rates of the company, help margins, help cash flow. And you'll continue to see us be the consolidated choice. We think we're still the best home, these motion control properties. But we'll also look at the other areas that you've seen us build on in the last several years.
And hopefully, by now, people feel good about our track record. We've the last 3 got a lot of fanfare. We've been good at this for a long time. We've done 80 deals in the last 20 years. And I think you'll see us 1st and foremost for us is dividend.
We were very excited to clip that dollar mark on a quarterly basis. And you'll see us stay on top of that. Our net income is going to grow, and we're going to stay on top of those dividends to match That net income growth, we'll continue to invest in the company organically and productivity. And if we don't find the right properties, which our preference We do deals because it drives cash and EBITDA growth. We think we're a great investment and we'll buy shares on a discretionary basis On top of the 10b5-1, but the pipeline is active and more to come on that.
Great. Thanks for taking my questions.
And you have a question from Julian Mitchell from Barclays.
Hello, Julian.
Maybe, first question around the sort of linked topics of cost inflation and component shortages and the sort of unifying factor of tight supply chains.
I mean, I guess 2 parts. One is, do
you think there's much evidence of sort of excess stocking up or accelerated stocking up by your customers or channel partners, given all the headlines around supply chain shortages? And then secondly, when you look at Parker itself,
how comfortable do
you feel on that pricing outlook, to offset cost inflation pressures.
Julien, it's Lee. I was waiting for somebody to ask a question regarding Material costs and pricing. I'm looking at a commodity chart right now, which has got trends year over year, quarter over quarter going back to the last big inflation period, it's a sea of rent. But the thing I would say about our team is we saw this coming early on as we did this. And as you know, We've got really 2 great internal processes inside the company.
It's how we track our PPI, which are input cost and how we track our selling price index to make sure that we always maintain this margin neutral kind of role. We've been active with price through the distribution channel, and we'll continue to do that. We're fortunate to have great Contracts in place with many OEMs that have raw material cost escalators in them. But our goal on the whole pricing side is to be margin neutral. We've done that We'll continue to do that.
On the supply chain side, I would say, just echo what Tom said earlier, the biggest benefit is our business model. So we design, source, make, sell in the region for the region. Everything you read about In the paper, we're not immune to that. I mean, there's still things that happen on a day to day basis. But I would just Tell you from a company standpoint, it's not material.
I mean, we manage it day in and day out. So on pricing, I think we're active in a good place on the supply chain side. We're managing it. The model is set up, so I don't think we'll get hurt and it's really not going to be material.
Thank you. And then how about on your own sort of customers or channel partners? Do you see them kind of across the board Doing any kind of accelerated stocking up because of the supply chain issues being so well publicized? Or do you think that the activity is kind of normal What one would expect, as you see a macro inflection positive?
Listen, everybody is very, very busy right now. I would say Supply chain issues aside, North America labor is very tight. I mean, you read about that, that is a fact. So a lot of our customers are doing what we're doing, just really using Kaizen automation where appropriate, etcetera. But I don't Look, every time there's a ramp, there's a little bit of a bullwhip effect, but this is no different than anything I've seen in the past.
It's just people trying to manage the increase in demand.
Great. Thank you. Thank you. Thanks, Julien.
And you have a question from John Inch from Gordon Haskett.
Thank you. Good morning, everyone. Hey, Lee, maybe to pick up on some of the themes here. What are you seeing in terms of competitive behavior, Particularly given the inflationary backdrop, how are competitors jockeying, jostling and how is that maybe modifying your own behavior in this period of post pandemic or emerging from post pandemic?
I think there really the narrative right now, John, is around I think everybody's we're structured much differently than many of our competitors. So the issues that you read about every day maybe are not as Comparative to us. But I think the narrative right now is around supply. People are looking for Annuity of supply, if they can get it. Everybody understands what's happening with commodity prices.
So I don't really see any Negative customer actions taking place. I will tell you is and we've talked about this for years, This is always an inflection point for us where we tend to do better than the market as we come out of this. It's a combination of 2 things. We've done a lot of work with OE customers on design during the downturn because they're looking to simplify their designs, take cost out. We do that through our application centers.
We see the benefit of that as we ramp up. And then second, our internal distribution systems are really poised to take advantage of disruptions with competitors.
Well, I was wondering, like as Prices go up and everybody is trying to raise in various aspects of their operations. Our competitors one of the ways a competitor might instigate a price cut To position themselves by not raising commensurately, say, compared with other people or other companies or players. Are You're seeing any of that kind of that behavior? Or is it still a little bit too soon to tell?
I haven't seen that kind of behavior, and I typically really don't see that during this kind of cycle. You see more of that John when you're at the bottom of the cycle and people are trying to fill up factories.
Yes, that makes sense. And then Tom, simple by design, as it becomes more ingrained as let's call it an operating competitive advantage for Parker, do You think it could be used to perhaps offensively target companies for M and A picking up on the M and A theme. I was thinking you could maybe provide a bit of an opportunity for, say, Parker to be able to go in and maybe even bid more knowing you can drive more synergies than other bidders that don't have simplified design as part of their arsenal?
Yes, John, it's Tom. So clearly simple by design. I would just say everything that's in Win 3.0 It's part of our basket of goods that go into evaluating an acquisition. So we look at what the Best practices are for the acquisition, what best practices do we bring, that combination of 1 +1 equals 3 generates the synergy plan. And that's The bigger the synergies, which you're alluding to with Simple by Design, the opportunity you have to pay.
And what we really look for It's what's the synergized EBITDA multiple when we're done. And is that something that makes sense given that where we're trading? The other part aside from acquisitions to get at what Lee was talking about with competitive dynamics, Civil by Design is an opportunity for share gain. As we come up with products that are simpler to make easier supply chains, more reliable, etcetera, And maybe in some areas where we won't don't currently have share, it allows us to penetrate an account. Overall, we've got 11%, 12% market share of this one $35,000,000,000 space.
We've got lots of room to grow. SimplifiedSign is just one of many share gain opportunities.
Yes, makes sense. Great. Thank you very much.
Thanks, John.
And you have a question from Jeff Sprague from Vertical Research.
Good morning, Jeff.
Hey, good morning. Thanks, everyone. Hey, I guess 2 from me. Just thinking about this idea, Tom, of trying to break the gravitational pull of the PMI, Actually, two questions. One just kind of maybe fundamental in the business and maybe a second kind of philosophical.
First, obviously, the PMI is a broad industrial benchmark, right? Have you considered that calling your segments The diversified industrial just suggests you are an industrial proxy. Perhaps Some kind of different earnings presentation would make sense. You give us this global technology platforms, but we don't know anything about the profitability of those sub segments. So That's more of a philosophical question.
I wonder if you've thought about that. And then secondly, although most of your business Is short cycle, right? I would argue it's really a broad mix of early, mid and late. And I think to some degree people confuse short with early. I just wonder if you could kind of give us some rough buckets, what percent of your business You would actually characterize this early cycle versus mid cycle versus late cycle.
Okay, Jeff, it's Tom. So those are that's a good question, hard one. First of all, that whole PMI gravitational pull, that's one of the reasons besides I think it's Great way to describe the company why we did Slide 5. And that's the for those of you who are not looking at your slides, that's the whole PMI versus our EPS trend. And I hope you I hope people got the point there.
This company is dramatically, and I would underline, dramatically different. And yes, We'll never be completely detached from PMIs because obviously that represents total manufacturing activity and we will benefit But we didn't get much help from that over the last 6 years, and you've seen us double EPS and add 600 basis points to EBITDA margins. We'll continue that and hopefully people recognize that we don't need the macros to help us. We have enough self help Well, 2.03.0 to keep last year's for many, many years. The current environment is going to get better, so we are going to get some help with that.
Your comment philosophically on reporting segments, yes, that's been a raging internal debate for many, many years. There's pros and cons to it, probably longer discussion than I can do on an earnings call. But we continue To think that representing the way we do today is the best way because if you go back to those 8 technologies and the fact that 2 thirds of our revenue comes That's exactly how we go to market. We don't go to market specifically with 1 off technologies all the time. We go to market if you look at our commercial teams, leveraging that breadth of technology.
So that's how we're presenting the company to shareholders. It's exactly how we go to market. The whole early versus mid versus late, I'm not even going to try to do that other than I'm going to reinforce your point that yes, we are a mixture. And obviously, you can look at aerospace and characterize that as long. But where do you want to put EV?
I mean, EV, we're feeling that now, but EV is a long term change. It's going to happen. Where do you want to put all the clean technology? I could add up all the things I talked about on that one slide related to clean technology, and you get a pretty percentage of the company. Obviously, hydrogens long very long cycle what's happening there.
Electrification is a little more near term. So it's I think unfairly, we've been characterized as early, and maybe because of just historically how we Report orders on a monthly basis and people could see those things sooner. I think we're a good mix. And I think hopefully over the last 6 years, people recognize we're a good bet. We're you want to bet your money, they're betting on this team.
Great. Thanks for that perspective.
Thanks, Jeff.
And you have a question from David Raso from Evercore ISI.
Good morning, David. Curious, It seemed like the January price increases you put through, were relatively modest. I think kind of where we were in the cost escalation moment, it made sense. But as the quarter has gone on and we look out to fiscal 2022, I'm assuming the Fluid Connector Group Put out an increase, but you don't usually do a lot of increases for July 1. The setup here feels though more accommodative to you putting price increases through.
So two questions. Is it fair to say we should see a lot more mid year price increases than we've in the past? And second, is the lead time issue significant enough where distributors who would normally want to get ahead of that increase Are not able to given the lead times? I'm just trying to get a sense of how much of the price increase we could think about for 2022 and sales that kind of Sure. It first is maybe a little bit of a natural pre buy that you see sometimes when you announce an increase.
Yes, David, it's Lee. I'll take that question. So I think it's fair to say you'd see mid year price increases going after the distribution channels, not only in North America, but globally, given where we are with input costs, etcetera. And I would say by and large, you're probably pretty correct lead times that a lot of pre buying While there's some, it's not what you would expect if the level of activity wasn't so strong as it is right now.
All right, terrific. Thank you very much.
Thanks, David. I know everyone's got a pretty packed schedule today. So, Elaine, we'll take one more question before we wrap up.
Okay. The last question comes from Josh Pokrzywinski from Morgan Stanley.
Good morning, Josh. How are you?
We may have lost Josh. We may have lost Josh.
Okay, do you want to take
another question? You'll go
to the next
one.
Next question comes from the line from Nigel Coe from Wolfe Research.
Thanks. I'm guessing Josh is speechless by the results. So thanks for fitting me in here. So look, I think that I think Jeff hit a pretty good point on the sort of early cycle points. The fact that You're still negative in 2 of your 3 segments, I think is sort of proof that you're not classically cycled.
So I think that's an important point. I did want to go back to your comments about incremental margins for 2022. And I know that that wasn't guidance necessarily. But If you could do 3% incremental margins with the temporary costs coming back and perhaps, obviously, inflation pretty rampant in the back half of the calendar year, I guess what I'm trying to ask is, do you think that there's a line of sight based on weighted today to hit net fixed incremental margin for FY 2022?
Yes, Nigel, it's Tom. So you're right. We are not this is not a guidance discussion for 2022. 2022 is hard enough to do when we do it in August. But I think philosophically, our goal and what is best in class is to do a 30% incremental.
And I think the evidence that we're going to do about 30% in Q4 even with the tough comps that we have with High discretionary cost as we did in Q4 prior period are evidence that we can do that going into 2022. We'll see when we pull the numbers together Because this Q4 is probably one of our tougher comparisons, and it will get Q1 will probably another tough comparison, But it will get progressively easier as we go through 2022, those comparisons. But I think a 30% is still on our radar and Q4 is good evidence. We can do it in Q4. We can do it going forward.
And that's kind of that raises the question then. If you can do it In an environment like this, presumably FY 'twenty two, mix isn't going to be that helpful, I don't think, in FY 'twenty two. But Once aerospace starts kicking back into gear, do you think 35% maybe plus could be a good run rate beyond FY 2022?
I missed the word. What was before FY 2022 there?
I mean, do you think that better than 3% could be a good number to use beyond FY 2022?
Yes, over the business cycle, what we've always told people is if you're modeling us over multi years, use 30. Now clearly in inflections, we've done better than that on the 40 to 50 range. But this is while we're in inflection now Is a little bit masked because of the prior period, big huge discretionary savings. That's why I gave the number. If you took that out, it'd be 50.
So typically, we glide pretty high up at the beginning, 30 over the cycle, 10 to later in the cycle, you're down into the 20s. But if you're modeling multiyear, I would use 30.
Okay, that's great. Thanks.
Thanks, Michael. All right, Elaine. That concludes our call today. I'd just like to thank everyone for joining us. As always, we appreciate your interest in Parker.
Robin and Jeff will be here all day if you have further questions or if you need clarification. I hope everyone has a great afternoon and stay safe everyone.
Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. You may now disconnect.