Parker-Hannifin Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 4, 2023

There are 15 speakers on the call.

Operator

Good day, and thank you for standing by. Welcome to Parker Hannifin's Fiscal 2023 Third Quarter Earnings Conference Call and Webcast. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the conference over to Todd Liam Bruno, Chief Financial Officer.

Operator

Please go ahead.

Speaker 1

Thank you, Chris, and good morning, everyone. You for joining Parker's fiscal year 2023 Q3 earnings release webcast. As Chris said, this is Todd Lea Bruno, Chief Financial Officer speaking. And joining me today is Jenny Parmatier, our Chief Executive Officer and Lee Banks, our Vice Chairman and President. Our Q3 results were released this morning.

Speaker 1

And just a reminder, today we will be addressing forward projections and non GAAP financial measures. On Slide 2 of this presentation, you will find further details to our disclosures in these areas. Actual results may vary from our projections based on some of the details

Speaker 2

that are listed on this slide.

Speaker 1

Our press release, this presentation and all reconciliations of non GAAP financial measures are available under our Investors section atparker.com and they will remain available for 1 year. We're going to begin the call today with Jenny addressing highlights of 3rd quarter and really touching on how Parker is so well positioned for the future. I will follow with a brief financial summary and then review the increase to our guidance that we released this morning. Jenny will then wrap up with summary comments and then Jenny, Lee and myself will address any questions from the queue. I will ask you now to address yourself to Slide 3.

Speaker 1

Jenny, I'll hand over to you.

Speaker 3

Thank you, Ted. Good morning to everyone and thank you for joining our call today. Q3 was a quarter of outstanding performance across all of Parker. Starting with safety, we remain in the top quartile with a 17% reduction in recordable Safety has been and will continue to be our top priority. We had record sales of $5,100,000,000 in the quarter, A 24% increase over prior year with organic growth of 12%.

Speaker 3

The Win Strategy and portfolio changes have clearly delivered record performance driving a full year guidance increase. We are increasing the quarterly dividend 11% over last year And we are happy to report today that the Meggitt integration and synergies are ahead of schedule for fiscal year 2023. Moving to Slide 4, please. We couldn't be more pleased with the enthusiasm and dedication of the talented Meggitt team, further evidence to the shared heritage culture identified early in the acquisition process. From the start of the integration, safety and engagement have been top priority.

Speaker 3

We have the key leaders and structure in place to ensure performance into the future and the wind strategy deployment is well underway. The team picture on the right of this page is from a recent Kaizen event held in the Ansey Park, UK location. And at the end of March, we held a wind strategy training session here in Cleveland with over 50 leaders from various Meggitt locations. There are multiple examples of where the Win Strategy has already taken root and is being used to improve the business. We are confident in our assumptions around working capital opportunities and are already starting to see some of them materialize.

Speaker 3

We are increasing our FY 'twenty three synergies from $60,000,000 to $75,000,000 and we remain committed to achieving $300,000,000 in synergies by FY 'twenty six. Slide 5, please. With the addition of MEGA to our portfolio, we are well positioned for long aerospace cycle growth. We have significant content on premier commercial and military programs, all the right ones with a growing bill of material. These are long lifecycle programs with a growing aftermarket well into the future.

Speaker 3

As a reminder, with the addition of Meggitt, Our aerospace aftermarket has increased 500 basis points. We are greatly benefiting from the recovery of the aerospace market. Commercial MRO and OEM is very strong and military is positioned to do well in the upcoming years. With the addition of Meggitt's complementary technologies, we provide a comprehensive offering and a stronger bill of materials that allows us to add value And help solve our customers' problems. We have key technologies such as advanced sensors for more efficient engine control, Thermal management systems for higher heat loads and lightweight materials for reduced fuel consumption, all of these enabling sustainable aviation.

Speaker 3

Aerospace and Defense markets are now 30% of our sales. All of this adds up to significantly increased shareholder value. Slide 6, please. Many of you have seen the slide before as we introduced it last year at our Investor Relations Day. Over the last 8 years, we have strategically reshaped the portfolio to double the size of aerospace, filtration and engineered materials.

Speaker 3

The combination of the portfolio changes and secular trends is all ready and will continue to create a profound shift in our sales mix. By FY 'twenty seven, we will have approximately 85% of the company in long cycle end markets or industrial aftermarket. This mix shift is further reason why we will grow differently in the future, and it is why we are committed to our FY 'twenty seven target of 4% to 6% organic growth Slide 7, please. A lot of discussion, questions and inquiries lately on backlog. And as you can see by the chart on the left of this page, our backlog is at a record level.

Speaker 3

What is encouraging is that in Q3, we saw our backlog dollars increase 3% sequentially. Since FY 2016, we've seen a 3x increase in backlog dollars and a 2x increase in backlog coverage. Very important to note here that we are constantly analyzing the backlog at the division and group level and staying close to our customers on the health of the backlog. We know from the past that it isn't bulletproof. But having said that, this consistent growth over time is an indicator that the portfolio changes are changing the company.

Speaker 3

Slide 8, please. As demonstrated by the strong performance in the quarter and the increasing power of our transformed portfolio, I want to share a few slides with you on why Parker is built for the present and the future. Slide 9, please. Parker has a proven business system, the Win Strategy 3.0. Whenever I talk to anyone about the Win Strategy, whether it's a new Parker team member or someone externally, I'd say the same thing.

Speaker 3

Trust me, I've used it and it works. It is a system focused on the fundamentals. We trust the process And we know that making the safety and engagement of our team members our top priority consistently delivers results. Our lean tools, Kaizen culture, supply chain and simplification initiatives have driven margin expansion and will continue to do so well into the future. Our increased aerospace exposure is delivering results today as well as our 800 basis points expansion of international distribution, which still has room for growth.

Speaker 3

Our innovation sales are 2x the previous decade and we have a new annual incentive plan that incentivizes the right behaviors and drives an intensity around profitable growth throughout the whole company. Nearly all of our 65,000 team members are on this plan as of this fiscal year. Now more than ever, we have better top line resilience. Slide 10, please. And the good news is, we have significant opportunities ahead.

Speaker 3

As I mentioned earlier, approximately 85 percent of our portfolio will be longer cycle and more resilient. There are strong well into the future, and we are confident in achieving the $300,000,000 in synergies by FY 'twenty six. The Win Strategy 3.0 performance acceleration will further drive margin expansion and ensure we hit our FY 'twenty seven goals. As I mentioned in our February call, the pandemic and subsequent increase in volume exposed some areas that we can further improve upon to become supply chain leaders. We will utilize new tools and strategies to respond to changing demand while increasing productivity and achieving best in class lead times.

Speaker 3

Simplify Design has become a business fundamental and will continue to drive us to design excellence by reducing complexity and overall product costs, thus helping to further expand our margins. We're very excited about 0 Defects. It's still early days. It exposes the Hidden Factory, improves quality, reduces cost, expands margins and most importantly, provides a better overall Customer experience. And with all of the announced and already initiated mega capital projects in addition to the secular trends, We will grow differently in the future.

Speaker 3

I'll now hand it over to Todd.

Speaker 1

Thank you, Jenny. Just for reference everyone, I'm going to start on Slide 12, With just the Q3 financial summary, it was a stellar quarter for the company. Every number on this page highlighted in the gold Is a record for Q3, every single number. And Jenny did mention this, but we did surpass $5,000,000,000 in sales for the first time for a quarter in the history of the company. Reported sales were up 24% versus prior year.

Speaker 1

Organic sales were very robust at approximately 12% In the quarter and that did extend our string of double digit organic growth quarters. The net of acquisitions and divestitures did have a favorable impact on sales That was approximately 15% and currency still remains negative, but it's basically exactly as we forecast. It's minus 2.4% impact for the quarter And that is obviously unfavorable to prior year. When you look at adjusted segment operating margins, we did exceed our forecast. We finished at 23.2 percent for the quarter.

Speaker 1

That's an increase of 50 basis points versus prior year. It's the first time in the history of the company that we Past 23% for a full quarter. So impressive results really across the board. When you look at dollars on segment operating margin, We generated nearly $1,200,000,000 in segment operating margin dollars. That itself is a 27% increase from prior year And it happens to be the 2nd quarter in a row that the company has generated over $1,000,000,000 in adjusted segment operating dollars.

Speaker 1

When you look at EBITDA, another record here. We surpassed 24% for the first time in the history of the company. We finished at 24.2% And adjusted net income of $7.72 or 15.2 percent ROS was an improvement of 22% versus prior year. And finally, when you look at EPS, just EPS, nearly $6.5.93 for the quarter, that was an increase of 1 $0.10 or 23 Compared to prior year. Just outstanding execution for the company for the quarter.

Speaker 1

When you look at sales, segment operating margin dollars, net income and earnings per share, Every single one of those was an increase of greater than 20%. I can tell you I'm just immensely proud of our team for the record performance. Meggitt is really truly adding value to the company and the company is just executing soundly across the board. If you go to slide 13, this is just a walk on that $1.10 improvement Of EPS year over year and I mentioned on the last slide, the biggest driver of that is our increase in segment operating income dollars. We did basically an additional $250,000,000 in segment operating income.

Speaker 1

That's that 27% increase. That added $1.50 to EPS year over year. When you look at the corporate G and A and other that was a $0.23 favorable EPS impact that was primarily driven by lower Salary and other benefit costs. Interest as you all know is a headwind that was a $0.54 headwind, but 100% of that is attributed to the Meggitt acquisition And of course, what's going on in our rates. If you look at income tax that was $0.09 unfavorable, really it's driven by some prior year favorable items that were discrete that aren't repeating this year.

Speaker 1

And really that's the walk to the $5.93 It's really a Stellar number, record 23% increase. If you go to slide 14 across the segments, you can see as I mentioned it's really Across the board solid performance, organic growth was a double digit positive in every segment. We exceeded our margin expectations Across the board and our legacy businesses really performed soundly with incremental margins above 30% in every single segment. Beginning this quarter on orders, we finalized the Meggitt structure. We felt good about that.

Speaker 1

And going forward, we are including Meggitt orders in both the prior and current period for comparison purposes. And we really feel that that better reflects the transformed portfolio that Jenny mentioned earlier. So all in orders remain positive despite really some tough comps versus prior year and finished at plus 2. Demand remains really broad based across most of our markets. And Jenny also mentioned this, but I just want to reiterate the dollar value of orders in the quarter Well, certainly the highest that we've had in FY2023 and it did grow 9% sequentially from Q2.

Speaker 1

And of course, the backlog obviously is up 3% sequentially as well. So our team members are really just executing well to meet our customer expectations and really focused on delivering top quartile results. If you look at the North American businesses, sales really strong at 2,300,000,000 Organic growth was just under 12%. Adjusted segment operating margin is nearly 23%. And if you remember, there is a dilutive impact on And then, I'll turn it over to Mike to

Speaker 2

discuss some of the mega businesses that are

Speaker 1

in the Industrial North American businesses. But like I said before, legacy businesses really outperformed And strong sales growth, supply chains improving gradually and really just great incrementals across those base businesses. And really strong backlog and that demand is very solid

Speaker 2

across all of our North American businesses.

Speaker 1

National really outperformed in the quarter. Sales were $1,500,000,000 Organic growth exceeded our expectations and finished At just about 10% organic growth versus prior year, organic growth in the international segment was positive in all regions. EMEA was +11%, Asia Pac 8.5%, Latin America 8%. So all positive in every single region in the international segment. Adjusted operating margins were up 70 basis points finished at 23.4%, really benefiting from that volume, that strong organic growth, But really some focus on cost control and productivity improvements really helped leverage results in the international segment this quarter.

Speaker 1

Overall, just really strong performance across Every region. And then finally, Aerospace, secular trend we've talked a lot about. Sales were $1,200,000,000 that's almost 90% from prior year. That is obviously clearly driven by the Meggitt acquisition, but organic growth led the company in Aerospace at 14.5% versus prior year. And really just strong across the board OEM and MRO commercial businesses, sales and orders are very strong both being mid-20s positive.

Speaker 1

And interesting this quarter military OEM returned to flat versus down from prior quarter. Operating margin is extremely sound 23.5 percent, that's 160 basis point improvement year over year. Jenny mentioned it, but the Meggitt integration is going extremely well. Synergies are ahead of schedule. We did raise our synergy estimate for the quarter, $15,000,000 and performance in those businesses continue to impress.

Speaker 1

Order rates in aerospace, obviously very strong. You look at that Order number of +25, but both strong in commercial and military end markets. Just really sound operational performance across the company. No weak spots at all. Moving to slide 15 and just talking about our year to date cash flow performance.

Speaker 1

Cash flow from operations was 12 0.8 percent of sales, dollars 1,800,000,000 of cash generated so far this fiscal year. That's 16% over what we did last year. Free cash flow is 10.9%. Our CapEx remains right at 2% like we have been forecasting. There are some one time transactions that were the result of the Meggitt Transaction, that impacts our cash flow by 1.5 points.

Speaker 1

So without those transactions, those numbers I just gave you would be 1.5% better and free cash flow continues to be greater than 100%. We're at 111% year to date. And just I want to reiterate for the full year, we continue to forecast cash flow from operations And free cash flow conversion of over $100,000,000 and that free cash flow would be mid teens for the year. If we go to the next slide just touching on capital deployment and some leverage, we did increase our quarterly dividend. Our Board approved this last week So 11% increase, the dividend payout is now $1.48 That is in line with our stated target of being in the range of 30% to 35% of our trailing 5 year net income.

Speaker 1

And the increase this quarter does increase our annual record of Increasing annual dividend paid from 66 years to 67 years. So long standing record that we intend to keep. On leverage, we did make some significant progress reducing leverage this quarter. We paid down approximately $650,000,000 in debt In the quarter, if you look at our gross debt to adjusted EBITDA, it was 3.2, that's down from 3.6 last quarter. So, 0.4 turns from Q2 and if you look at the net debt to adjusted EBITDA finished the quarter at 3.1, that's down Point 3 turns from Q2.

Speaker 1

So we are pleased with the deleveraging progress. We are on track and we continue to target our leverage commitment of 2.0 times. We are committed to delivering on our commitments there. Looking at Slide 17 and guidance, obviously, we increased our guidance this morning. We have incorporated obviously the strong performance from Q3, but we've also increased our expectations for Q4.

Speaker 1

Full year sales growth at the mid Point increases to 19% versus prior year with organic moving up to 10%. That's up from 7% last quarter. When you look at the net of impact of acquisitions and divestitures, we expect that to be about 12%, that's just up slightly from 11.5 Last quarter and currency remains a headwind. No change to our prior guidance, but the full year we expect it to be a minus 3. When you look at adjusted segment operating margins, we've increased our full year guide by 40 basis points.

Speaker 1

We now are forecasting 22.5% for the full year And the midpoint of adjusted EPS is raised to $20.75 for the full year with a range of plus or minus $0.15 Just some specific details for Q4. We expect organic growth to be approximately 4% in the quarter And segment operating margins to be approximately 22.6%. And finally, EPS for the quarter, We are forecasting $5.32 at the midpoint, same range wrapped around that. And we've also included guidance by segment and several Other details that could be useful for your models in the appendix. So with that, just a really solid quarter, glad to increase our guide.

Speaker 1

And with that, Jenny, I'll hand it back to you and ask everyone to reference Slide 18.

Speaker 3

Thank you, Todd. As discussed today, Parker has a very promising future. Our highly engaged team is living up to our purpose as evidenced in the results. We will continue to accelerate our performance using the Win Strategy 3.0. And as mentioned several times, our portfolio transformation is making us longer cycle and more resilient.

Speaker 3

This will allow us to achieve our FY 'twenty seven targets And continue to be great generators and deployers of cash. We remain committed to top quartile performance. Next slide, please. A quick look at our upcoming events for the rest of the calendar year. And with that, Chris, we are ready for questions.

Operator

Thank you. At this time, we'll conduct a question and answer session. Please standby while we compile the Q and A roster. Our first question comes from Joe Ritchie of Goldman Sachs. Your line is open.

Speaker 4

Thanks. Good morning, everyone.

Speaker 1

Good morning, Joe.

Speaker 4

Hey, so let's just let's start on the backlog As a percentage of next 12 months sales, it's super interesting how that's progressed over time. I guess My question is really as you're kind of thinking about the 2024 framework, I know you'll give us guidance in August. How is this going to inform that framework, Whether that's a like more narrow sales range and any color you can give us around that would be helpful.

Speaker 3

Well, you're right. We'll come back to you in August with the full year guidance. So we really believe that this backlog, as we've Shown the consistent increase over time, will remain. I always use the term demand sense and I think that With the transformation of the portfolio, we're going to have more backlog because we have a longer cycle business. So We'll look at it for the new fiscal year, the same way in which we've been looking at it most recently.

Speaker 3

So that will help us with the future year guidance.

Speaker 4

Okay. Thank you. That's helpful. And I guess Maybe since things seemingly are still going very well, if you take a look at the organic growth you put up this quarter, There's clearly some pricing that's coming through that as well. Just maybe talk through the orders in industrial a little bit.

Speaker 4

And I'd love to hear whether there are certain areas, particularly in industrial distribution, how that's holding up today, whether there Any destocking that's happening, just any color around that would be helpful.

Speaker 3

So I'll start off and give you a little bit of color on industrial, then I'll let Lee Chime in on distribution. So in North America, orders did go negative, as Todd mentioned, a negative 4%. Just a reminder, real tough comp As North America, last Q3 was +23. So customer demand remains strong. We have seen some destocking happening We believe that's very steady overall positive outlook and we continue to believe there'll be broad based growth.

Speaker 3

International also at a minus 4%. That decrease was mainly driven by Asia Pacific, which was down the mid teens. China Mobile Construction remaining very soft. A lot of, I think, automotive awaiting further government stimulus. Semiconductor soft, but that's pretty much what drove the international negative.

Speaker 3

In EMEA, there's really no signs right now of the market weakening. Strong mobile construction and automotive, Still some tough comps related to COVID vaccine business last year and some supply chain challenges, But that's primarily around electronics, chips and sensors. So it looks to be good in EMEA.

Speaker 5

Joe, I'll just add on just a quick this is Lee. Just a little bit about distribution. I would tell you in general, The sentiment is still very strong, very positive and the backlogs have stayed very consistent. There's obviously here and there Some balancing of inventory, but it's truly negligible on the total backlog for distribution.

Speaker 1

And that's really true For all the regions, North America the

Speaker 5

most, Asia, I continue to see some strength in China On our distribution level and EMEA has been fairly resilient, which if you would ask me a quarter ago, I thought it would have a little more headwinds, but it's been Much more resilient than I planned on.

Speaker 4

Got it. Thank you, both.

Operator

This question comes from Andrew Obin of Bank of America. Your line is open.

Speaker 6

Hi, good morning.

Speaker 4

Good morning, Andrew. Good morning, Andrew.

Speaker 6

So I love your slide that shows the company's transition to longer cycle business over I was just fundamentally different. But I guess it's a question for Jenny and Lee. As you as the company has transitioned the portfolio, clearly it's happening outside of aerospace as well, right? How are you adjusting the sales organization and you go to market to deal with the fact that you now have to deal with Longer horizons, perhaps you do need to carry more inventory to service these kinds of customers. Maybe give us a 30,000 foot view.

Speaker 6

Thank you.

Speaker 5

Yes, that's a great question, Andrew. So I think I could probably spend a half hour on this conversation, But the sales organizations continue to morph around the globe. I would say at high level, we've got very focused teams that deal in the aerospace sector, Deal with the big OEMs and in a separate organization on the MRO side. And then with key market segments, if I could take electrification We've got a whole sales organizations and application engineers that deal specifically with that. So We are constantly adapting.

Speaker 5

We've got a team right now that's dealing nothing but hydrogen Generation, even though it's early days. So we kind of organize based on some of these secular trends and based on what we see

Speaker 6

Excellent. Thank you. And I guess I won't resist asking this question Giving Janet's background, but I think lots of debate on HVAC and I know that this is one of your largest businesses. Can you just give us more insights if you're willing to go that granular, what's happening at Portland? And I guess if you can, that's great.

Speaker 6

And if you can, Just would love to hear your view on U. S. Construction cycle. Thank you.

Speaker 3

So, yes, obviously, very fond Of the Portland division and a lot of history there. It is one of our markets that is single digit negative right now. But I would tell you, this is a very strong business and historically has done very well. So We don't expect that this is going to be any time any long term impact to the division and think they're in a good position, Andrew.

Speaker 6

Thank you.

Operator

Thank you. One moment for the next question. This question comes from Scott Davis of Melius Research. Your line is

Speaker 7

open. Good morning, Jenny and Lee and Todd. Congrats on another Good quarter here. Great quarter. Jenny, you mentioned in your prepared remarks about a new annual incentive plan.

Speaker 7

What Can you share a little bit of color around what you changed or what you're emphasizing in the plan?

Speaker 3

Yes. Thanks for asking, Scott. So, we used to be on a plan that was driven off of return on net assets. And, it was very difficult For all of our team members from inside of our factories, even up into our offices to understand You know exactly where all those numbers came from and how they fit into that calculation. And now with, our annual In our incentive plan, the operators on the shop floor, all of the people who support the manufacturing environment, Everyone can clearly see because it is based off of sales and profit and cash.

Speaker 3

So they know exactly how they fit into it at the division level. So if you can kind of imagine a production planner, Thinking about the inventory they need to bring in and the scheduling of the shop floor, they are in tune to that fact that that is cash And that is a metric that drives their incentive plan. So that's just one example of how we've been able to take that plan And the metrics that support it and deploy it to where everyone can understand it and buy into it. 1st full year This year, all groups and like I said, nearly all of our team members are on this and has been very positive thus far.

Speaker 7

That makes sense. And just conceptually to back up a little bit, I mean, it's I've been studying Companies for 30 years, it's very hard for capital spending to stay at levels around 2% of sales with growth above GDP, unless productivity is just exceptional. And so I guess my question, which is a little bit of a puff question here, but Productivity is something you measure in kind of the 3% to 4% level. I would guess it would have to be something like that to be able to Sustain something down towards the 2%. How do you guys think about it, I guess, is the question?

Speaker 3

Yes, great question. So, we think about it a little bit higher than that. We're very challenging when it comes to continuous improvement. It's why The Win Strategy has been so successful. Our lean tools and Kaizen constantly drive cost out of the business And make that productivity possible.

Speaker 3

That goes again to every member of the business being part of using those lean tools, being part Of Kaizen. So it's ingrained in our culture to consistently be more productive quarter over quarter, year over year. And in many cases, that's part of people's annual goals depending on the role they're in. So We pride ourselves. We're the hardest on ourselves.

Speaker 3

We still think we have plenty of room to improve, but we do pride ourselves On constantly looking for ways to increase efficiency and drive output.

Speaker 7

So even above the 3% to 4% Level that I mentioned, is that what you said, Jenny?

Speaker 3

In some cases, targets at divisions will be there, yes.

Speaker 1

Wow!

Speaker 7

Okay, impressive. Thank you. Best of luck.

Speaker 3

Thank you.

Operator

And thank you. One moment for the next question. This question comes from the line of Mig Dobre of Baird. Your line is open.

Speaker 8

Thank you and good morning everyone. Wanted to go back to backlog as well. I'm curious how much of this backlog is deliverable in the next 12 months? Do you have sort of multiyear orders that are And as you kind of look at the backlog build here, is there a sense from you as to how much of this build is Just kind of a function of supply chains and lead times and folks kind of securing production slots as opposed to just Pure structural change in your business model.

Speaker 3

Well, Mig, I think that Obviously, we know that the supply chain has been very chaotic over the last several years. But that's why we wanted to talk about this Consistent growth over time because this is not just related to what's happened in the supply chain. I mean, you can look at the slide, you can think about where Floor and Exotics and now Meggitt have come into play. And those are all longer cycle businesses that Put orders out there for a further period of time. So when you look at this, We think that this is something that is going to be consistently out there into the future.

Speaker 3

We don't expect that We're going to see this drop very much.

Speaker 8

And how much of this is deliverable in the next 12 months? Is it all

Speaker 2

of it or This portion?

Speaker 3

About 85% of it.

Speaker 8

Okay. Then my follow-up, on Industrial and International, Maybe this kind of relates to the backlog discussion too. If we're looking at the last couple of quarters, we've seen order intake declines, Your organic growth has stayed positive. You're guiding for the 4th quarter implying still positive organic growth. So there's this Disconnect, I guess, between orders and organic growth.

Speaker 8

And I'm wondering how you would frame it for us to think on a go forward basis. Thank you.

Speaker 3

Well, I think that the big thing there is that the backlog remains strong, right? So the orders did go negative. But as I mentioned earlier, We constantly check the health of that backlog and we see the shippable orders to that backlog.

Speaker 8

Thank you.

Operator

Thank you. One moment for the next question. This next question comes from the line of Julian Mitchell of Barclays. Your line is open.

Speaker 9

Hi, good morning. Just wanted to switch tack maybe to the aerospace Business, some of your peers have been very, very upbeat as they're thinking about the defense or military Exposure into next year. I think your orders are starting to reflect that the last couple of quarters after some tough Comps prior to that. So maybe help us understand kind of how you're thinking about that military piece Within aerospace over the next kind of 12, 18 months, any update around Meggitt's organic performance?

Speaker 3

Sure. So, first of all, you're right about military. Military OEM, we're Starting to see orders return on the F-thirty five, F-one hundred and thirty five and the Black Hawk. So we're happy to see that. That's looking good.

Speaker 3

On military MRO, it is increasing as well with some new partnerships on stocking. And when you look at the growth compared to last year, military OEM will still be negative mid Single digits, but as Todd pointed out, it went flat to prior year for the first time in the last quarter. And MRO will be High single digits. So, feel really good about that. The second part of your question again, please?

Speaker 9

It was really around the sort of the growth outlook into fiscal 2024. Aero is a particularly sort of backlog centric Business, especially the OE side. So is it realistic that we could see kind of high single digit growth again For the segment overall next year, just because you've got very good commercial growth and now sort of military helping?

Speaker 3

Yes, absolutely. We see that as a possibility. And just as a note, last quarter, I mentioned that The outlook for this fiscal year for Meggitt was $1,900,000,000 at 17%, and we've increased that to $2,000,000,000 at 19%. So, strong outlook.

Speaker 1

Yes, Jenny, Julian, I would just add, if you look at our Organic growth in our aerospace business nearly 15%. The Meggitt business is performing at better than that. If you remember, they dipped down lower than we did In the airline COVID times, but orders are strong. And if you see the total orders that we reported, it's a +25. So we feel really good going forward about aerospace.

Speaker 7

That's very good

Speaker 9

to hear. Thank you. And just one quick sort of fiddly follow-up, apologies for this, but just sort of the nature The guide, if I look at the North America Industrial, it looks like you're assuming sort of margins are down a bit Year on year in the current 4th fiscal quarter. Just wondered if that's correct and is that more just around the kind of Seasonal, you've got a sequential decline in sales and that's bringing the margins down with anything else going on there?

Speaker 1

Yes. I mean, I would just say, Julien, Q3 was fantastic. I mean, stellar far exceeded our expectations. We were forecasting in margin for Q3. We outperformed and we did better than that.

Speaker 1

We did increase Our Q4 margin expectations, you're right though, it is slightly below prior year. It's just a combination of mix and of course, Meggitt being in there and obviously organic growth moderating. So we're going to try to do the best we can there, but we are forecasting A slight dilutive year over year just for Q4.

Speaker 7

That's great. Thank you.

Speaker 1

Yes. Thank you.

Operator

Thank you. One moment for the next question. This question comes from the line of Jamie Cook with Credit Suisse. Your line is open.

Speaker 10

Hi, good morning and nice quarter. I guess two questions. 1, the international margins have surprised on the upside, in particular, This quarter in your guidance. So can you speak to color of what's going on there? How much of that's price cost versus some structural stuff?

Speaker 10

And then I guess my second question back to Parker's changed business model with later cycle businesses and Meggitt and greater backlog Going into a potential recession, how does Parker manage the business differently going into recession versus the old Parker that Much shorter cycle in terms of levers that you pull, maybe you're less aggressive to take up costs out quickly. I'm just trying to understand how you approach The New Parker and a Pending Recession. Thanks.

Speaker 1

Yes. Hey, Jamie, this is Todd. Thanks for the good comments there. I'll start with the international margins and maybe I'll hand it over to Jenny to talk about how we're going to manage through whatever the future holds for the macroeconomic trends. You're absolutely right.

Speaker 1

International margins, international volumes far surpassed our forecast and it really was across the board. It was Europe is way better than feared. Asia has been extremely resilient with the startups and start The shutdowns and the back and forth with certain end markets and Latin America has really been very solid for us. So across the board, It's been it was a combination this specifically this quarter, lots of volume leverage, great cost control, Really integrating the Meggitt businesses that are in the international area and it was just solid execution across the board. It's easy as that.

Speaker 1

I wouldn't call out price cost as any different than any other region. They're doing exactly the same thing that we're doing everywhere across the board. It was really just Really solid execution. Jenny, you want to take Yes.

Speaker 3

Thanks, Todd. So Jamie, probably the biggest thing to say is We don't wait for the recession to hit. We have a playbook for this. And quite honestly, we're always planning for the next recession. So when you look inside of the Win Strategy and you look at our toolbox, some of those things I was talking about earlier, constantly using our lean tools and, our Kaizen events to make sure that we Drive out cost, those are the things that are always ongoing that help us expand margins.

Speaker 3

When we get to the point where, there are some Changes in volume. We have several different levers that we pull, around overtime, around the temporary workforce, Before we make any permanent reductions, we also make sure that We are constantly keeping an eye on the customer demand. Like right now, we've seen no significant push outs or Cancellations, but we continue to work closely with them. So we can stay ahead of that from the standpoint of bringing inventory And staffing the shop floor. So we have a lot of levers we pull on an ongoing basis and we've performed well in the last Couple of downturns.

Speaker 3

And as I mentioned before, we're very well positioned for what's going on today and into the future.

Speaker 10

Thank you. Great job.

Speaker 1

Thanks, Jamie.

Speaker 3

Thank you.

Operator

Thank you. One moment for the next caller. The next question comes from the line of Nathan Jones of Stifel. Your line is open.

Speaker 4

Good morning, everyone.

Speaker 3

Good morning, Nathan.

Speaker 4

Just question on the corporate G and A. I think, Jenny, you said lower salary and other benefits. I'm yet to hear of anybody talking about Labor costs going down. Can you give us a little more color around what's going on there?

Speaker 1

Nathan, yes, that was me. It's really true. It's lower salary costs across the board. I did mention other benefit costs, a little bit of that is pension. Other things is just a market based benefit.

Speaker 1

So, it's really a combination of really just binding our SG and A like we always do and then some favorable headwinds from pension and

Speaker 4

Are you talking about salary costs going down per capita or the number of heads going down?

Speaker 1

Yes, it would be the number of people.

Speaker 4

Number of people. Okay. And then maybe if you could just give us an outlook on working capital going forward here. You obviously got growth to support, but it's probably carrying extra inventory as supply chain issues iron themselves out. So just any expectations, I guess, more for going into 2024 than for just the end of the fiscal year?

Speaker 1

Yes, for sure. Obviously, working capital with what's been going on in supply chain and obviously dealing with the growth and making sure We've got continuity for our customers. It has been a headwind to cash flow. I think we've turned the Corner on that, our teams are really focused on reducing inventory. We are tightly managing CapEx, right.

Speaker 1

Our plan has been 2%. We've kind of stated that Throughout the year, there is opportunities certainly across the Meggitt businesses as we continue to integrate those. So we feel positive about that That being a tailwind for next year. And I would tell you across a number of the Legacy businesses, we think there's opportunity there as well. So, I expect that to be a

Speaker 2

plus for us going forward, Nathan.

Speaker 4

Great. Thanks for taking the questions.

Operator

The next question comes from the line of Nigel Coe with Wolfe Research. Your line is open.

Speaker 11

Thanks. Good morning, everyone, and great quarter. We have very strong execution, obviously.

Speaker 1

So just looking at

Speaker 11

the 4th quarter guidance, unless my math is wonky, you're guiding for sales to be down Roughly 4%, 5%. Again, if I'm wrong there, please let me know. But that's something we only normally see during recessions, I think it's 2,009 and 2020, doesn't sound like you're planning for a recession. So just curious what caused you to be so conservative With that 4Q guide and what are you hearing from customers as you go into 2024? Are you hearing more caution as we Kind of coming to that planning session.

Speaker 11

I mean any thoughts there would be helpful.

Speaker 1

Yes Nigel, hey, this is Todd. I think your number might be a little bit high. I think If you look at it, we might be close to 2 down from Q3. And when you look at this, Q4 really starts to kind of anniversary some of these growth periods that we had prior year. If you remember, Jenny said last year, I think North America was +23.

Speaker 1

We significantly increased our guide. If you look at organic growth for the quarter, I think we were almost flat Was our forecast coming into Q4. We're now roughly 4% to 4.5% organic growth. There's still some uncertainty out there. We are monitoring it closely.

Speaker 1

And

Speaker 8

like I

Speaker 1

said, we're just giving you the best look that we have Right now, we feel really good about aerospace and we're watching North America and international. You've seen the orders. The orders did Turn negative, still robust. We're just giving the

Speaker 5

best look we got at this point.

Speaker 11

No, I appreciate that. That's helpful. And just on the orders, Todd, you're down 4% for both North America and international. I noticed that you've made a slight tweak to the policy with acquisitions. So does those numbers include the contribution From the Meggitt industrial businesses in both segments or is that a change to the like for like?

Speaker 11

So you've also just the prior year, so we still have a call, But including Meggitt, so do we have 4 or 5 points in North America for Meggitt?

Speaker 1

No, yes, we did. You're absolutely right. What we started to do this quarter, we finalized the Formal structure of where those Meggitt businesses now sit within legacy Parker Hannifin, and we felt good about that. And as we've talked about the change in our portfolio And when we looked at what we were guiding going forward, we felt at this point in time it was prudent enough to include those both in the prior and in the current year period. So that is those comparison rates that you're seeing, those are apples to apples comparison rates.

Speaker 1

And if you remember Okay. That's helpful. Yes. 80% of Meggitt sits in the Aerospace Systems segment, roughly 20% of that does sit in the International segment, Roughly 15% of that is North America, 5% of that is in international. And I would tell you just got to keep in mind, obviously, Aerospace segment Got the biggest chunk of that.

Speaker 1

You could see the plus 25 on the orders in the Aerospace segment. It is a smaller slice of Meggitt that is in the North American and International Industrial segments. And when you look at the size of those businesses, it really is a small Impact to what we would have historically reported.

Speaker 11

That's very helpful. Thanks, Tim.

Operator

Thank you. One moment for the next question. Our next question comes from the line of Jeffrey Sprague with Vertical Research Partners. Your line is

Speaker 2

open. Thank you. Good morning, everyone. I was on late, so I'm just going to ask one and I apologize if it's Been addressed, but just again looking at kind of the backlog, it is interesting, right, the backlog to forward sales has moved up pretty nicely. Certainly, aero plays a big role in it.

Speaker 2

But looking at even industrial, backlog to forward sales by my math is Sort of double what it used to be, high teens to maybe into the 30s now sort of thing. I just wonder if you could maybe address how much of that Is reflective of the longer cycle business mix shift that's going on within industrial versus Just kind of legacy supply chain and other issues and just kind of the raw ability to get stuff out the door as you deal with Supply chain both on the back end of the process through your plants and then out to the customer level. Thanks.

Speaker 3

Yes. Thanks, Jeff. Yes, we believe that the majority of it is due to longer cycle business and, the way that It's going to look going forward. So if you think about the addition of, the Lord business And you think about how that's impacted the Industrial segment, that's definitely longer cycle and in here, along with all of The aerospace that you already mentioned. So we feel like this is the new way that the backlog is going to look and feel that it's A little bit of supply chain impact probably, but seeing this growth over time is an indicator to us that The portfolio changes are really changing the company and changing what the backlog looks like going forward.

Speaker 2

And maybe then just a second part of that. So the margins obviously look very solid. Are there any residual just inefficiencies that you're dealing with In the system because of supply chain or other dynamics or is that pretty much ironed itself out at this point? Thank you. Yes.

Speaker 3

I would say, overall, we've seen some supply chain healing, but we definitely are still in the thick of it when it comes To electronic sensors and chips and our Motion Systems group on the mobile side is impacted by that. And I would say that Aerospace Not only impacted by chips and sensors, but still a little bit of a bumpy road in supply chain yet in aerospace. So we're not completely through it.

Speaker 1

Great. Thanks for the color.

Operator

Thank you. One moment for the next question. This question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Your line is open.

Speaker 12

Hey, good morning, everyone.

Speaker 1

Good morning, Jeff. How are you?

Speaker 12

Hey, just to follow on supply chain. I guess, 1, if you look in the industrial business, as supply chains kind of heal, are you seeing Changes in order patterns, less blanket orders and maybe how does that impact the order rate? And then also just as the supply chain friction comes out, How do you see that playing out in the margins going ahead?

Speaker 3

First of all, we're not seeing any significant Changes in order patterns or lead times overall, I would say. The thing I would Say about that is that, when we have supply chain issues in any of our businesses, it does somewhat drive inefficiency, right? We're doing whatever we can to get the material in and get it out the door. So as the supply chain continues to heal in different parts of our business, We'll look for those opportunities to be more productive. It's one of the things that I mentioned that we were focused on in the last call and again in this call Is that some of the chaos that we went through really highlighted some areas where we could improve and we could look to use new Tools and new strategies to analyze that demand in a faster way, be more reactive, thus increasing productivity And shortening the lead time.

Speaker 3

So definitely still opportunities out there to become supply chain leaders. And we're working closely with our suppliers on this. And It's one of the things that we've come out and said that we're using capital for to invest in the supply chain.

Speaker 12

Okay. And then just on Maggot, do you have an accretion number for the quarter to give us? And then just on The up synergy, should we think of that as more of a pull ahead, getting things done faster or some upside to that 300 number?

Speaker 1

Yes, Jeff. This is Todd. I'll take that. We're not going to give an EPS accretion number. I would tell you we're just extremely happy with the way that's It is doing exactly what we hoped it would do.

Speaker 1

When you look at the synergies, we did up the synergy number go to that detail, the cost to achieve were slightly higher. That's just a result of doing things faster than we originally had planned. So we still are committed to the 300,000,000 In the full 3rd year of acquisition, we just are pulling those a little bit forward. Okay, thanks. Thanks, Jeff.

Operator

Thank you. One moment for the next question. This question comes from Josh Pokrzywinski with Morgan Stanley. Your line is open.

Speaker 13

Hi. This is Toby on for Josh. Congrats on a great

Speaker 8

On that. Thanks.

Speaker 13

A follow-up The order trend question, Jenny, you mentioned some of the mega projects that have been going on. Where are you seeing this in the business and how would you think about the potential uplift given Parker historically is focused more on components and assemblies.

Speaker 3

Yes. So it's Difficult to directly tie it to a specific project, but we are definitely benefiting, from some of these projects and the secular trends. So if you think about a lot of the new battery plants that are being built to support electrification, we're there when they're prepping the land, We're there when they're building the factory and we're there when they're putting all the equipment in the factory. So definite benefits there. Also, Although it's a little bit longer term for these to be online, but we'll directly benefit from a lot of the chip and sensor production That is coming to the U.

Speaker 3

S. And today, if you look at the secular trends, obviously, aerospace, we've been talking about that a lot today. So We're definitely benefiting from that secular trend in that market recovery. And beyond the battery production, we Currently have a lot of content on electric vehicles. And when we transitioned from an internal combustion to an electric, it's 1.5 to 2 times the bill of material for us.

Speaker 3

In addition, we're starting to see, from an electrification standpoint, a big pulse on our mobile business. So between mega CapEx projects and secular trends, again, It's the reason we feel so confident about those targets in the future, 4% to 6% organically and really why we believe we're going to grow differently with this portfolio.

Speaker 6

That's very helpful. Thank you.

Speaker 1

Hey, Chris, this is Todd. I think we've got time to maybe squeeze in one more question. Let's

Operator

Our final question comes from the line of Joe O'Dea of Wells Fargo. Your line is open.

Speaker 14

Hi, thanks for taking my questions. One, just on the quarter in the North America margins, Flat year over year on 12% organic growth. And so can you elaborate a little bit on mix? I think with Meggitt in there, maybe Some drag, but also just anything else that you could be ramping up on the investment spend side, where you could see opportunities there?

Speaker 1

Yes. Let me take this. This is Todd. When you look at the Meggitt business, we're extremely happy with the way the Meggitt business is Performing, if you remember what we did was we put some of those businesses in the technologies where we thought they fit fast. That would be Engineered Materials and a little bit Filtration.

Speaker 1

Those just happen to be some businesses, some parts of Meggitt that are lower performance compared to the total. So when you take that out, if you could look at just the legacy portion of North America, it would be very similar to what you're seeing across the rest of the company. Record performance, record volumes, record incrementals and or strong incrementals, I should say, And really sound performance across those legacy businesses. So if I had to call one thing out, it would be the main driver why North America was flat. It would be simply the inclusion of those mega businesses in that total.

Speaker 14

That's helpful. And then just in terms

Speaker 8

of, I mean, what's kind

Speaker 14

of changed over the past 3 months? I think, Jenny, 3 months ago, you were talking about Maybe seeing a little bit of push outs, I'm sure a little bit of destock as supply chain improves here. But given the strength of the revenue in the quarter, No real evidence of much in terms of push outs. And so I'm just curious with credit conditions out there, obviously the macro uncertainty, but sort of day to day what you're seeing, Anything notable in terms of shifts either more constructive or more cautious?

Speaker 3

Yes, really, I think it goes back to the strength of the backlog and We've seen no notable shifts. We were cautious last quarter and I think we obviously are very pleased with the performance. March is always a really strong month for us. So we were able to ship a lot of that backlog. And Again, that backlog is still healthy and really has what has led us to the guide for Q4.

Speaker 14

Appreciate it. Thank you.

Speaker 7

Thank you.

Operator

Andy, thank you for your participation in today's conference. Sorry, please go ahead.

Speaker 1

Yes. Thank you, Chris. This concludes our FY 2023 Q3 webcast. If anyone needs any kind of clarification or has further questions or needs follow-up, Both Jeff and Yan will be here for today and through tomorrow. We obviously appreciate everyone's time.

Speaker 1

We appreciate your recognition of the strong quarter And we obviously appreciate your interest in Partner. So thank you all for joining us today.

Operator

That does conclude our program. You may now disconnect.

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Earnings Conference Call
Parker-Hannifin Q3 2023
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