Parker-Hannifin - Q4 2023

Transcript

Operator (participant)

Hello, welcome to the Parker Hannifin Corporation's Fiscal 2023 Fourth Quarter and Full Year Earnings Conference Call and Webcast. At this time, all participants are on a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Todd Leombruno, Chief Financial Officer. Thank you. Please go ahead.

Todd Leombruno (EVP and CFO)

Thank you so much, Donna, good morning, everyone, and thank you for joining Parker Hannifin's Fiscal Year 2023 Fourth Quarter and Full Year Earnings Release Webcast. As Donna said, this is Todd Leombruno, Chief Financial Officer speaking, and with me today, for the webcast is Jennifer Parmentier, our Chief Executive Officer, and Lee Banks, our Vice Chairman and President. I think everyone knows we've released our results and all of these slide materials this morning. Our comments today will address forward projections and non-GAAP financial measures.

On slide 2 of this presentation, you will find specific details to the disclosures that we are making in respect to both non-GAAP financial measures and the forward projections. Just as a reminder, actual results could vary from what we speak about today in this presentation, based on all of the items listed here in these disclosures. Our press release, this presentation and all reconciliations are available under the Investor sections at parker.com, and those will remain available for one year. Today, we're gonna start with Jenny addressing some of the highlights of our strong fourth quarter and really what was a transformational fiscal year for Parker.

She is also gonna reiterate some reasons that show why Parker is so well positioned for the future. I'm gonna follow up with just some color on how the quarter wrapped up and provide some details around our initial FY '24 guidance that we released this morning. Jenny will wrap up the call with some key messages, and then we're gonna open up the lines for Q&A for Jenny, Lee, or, or myself. Now, I'll ask you all to move to slide three, and Jenny, I'll hand it over to you.

Jennifer Parmentier (CEO)

Thank you, Todd. Good morning to everyone, thank you for joining our call today. Q4 was a quarter of outstanding performance across all of Parker. Starting with safety, we remain in the top quartile with a 20% reduction in recordable incidents. Safety has been and will remain our top priority. We had record sales of $5.1 billion in the quarter, a 22% increase over prior year, with organic growth of 6%. This is our second quarter above $5 billion in sales. We achieved record adjusted segment operating margin of 24%, a 110 basis point increase over prior year.

As we discussed last quarter, our backlog coverage remains resilient at 55% and has increased 1% sequentially. The Win Strategy and portfolio changes have delivered a strong finish to a great year. Next slide, please. A great and transformational year. On the right side of the page, you can see highlights from fiscal year 2023. It all starts with our team. Top quartile safety and engagement delivers these results. We now have approximately 30% of the portfolio in Aerospace and Defense, and we couldn't be happier with the progress of the Meggitt integration. The team is exceeding our expectations.

A record $3 billion operating cash flow, 22% higher than prior year, allowing us to make great progress in paying down debt. Todd will give you a few more details on this in his upcoming slides. Next slide, please. Many of you have seen this slide before. As you know, over the past eight years, we have strategically reshaped the portfolio to double the size of Aerospace, Filtration, and Engineered Materials. I'd like to draw your attention to the middle of the page for the FY '23 update.

The dotted line represents where we originally forecasted our longer cycle and secular trends revenue to be at the end of the year. The arrow and new solid line represent that we have realized a bigger shift to longer cycle revenue. The combination of the portfolio changes and secular trends is already and will continue to create a profound shift in our revenue mix. We have high confidence that by FY '27, we will have approximately 85% of the company in long cycle end markets and industrial aftermarket. This mix shift is further reason why we will grow differently in the future. Next slide, please.

Diving a little deeper into our future sales growth drivers, the 5 buckets on this slide will allow us to achieve our FY '27 target of 4%-6% organic growth over the cycle. The Win Strategy is our business system. It delivers growth and financial performance. Every tool in this system expands margins. CapEx reinvestment is addressing the last decade of underinvestment, as well as investment to strengthen and develop the supply chain. This will result in increased equipment spend and higher levels of automation. Under innovation, our New Product Blueprinting tools and Simple by Design principles have increased our Product Vitality Index.

That is the percentage of sales from new products. This enables faster growth in support of the secular trends. The acquisitions we have made are great companies with higher growth rates, aftermarket, and accretive margins. We continue to benefit from the growth related to secular trends. We expect multiple years of solid growth in Aerospace, driven by both Commercials and Defense. We are enjoying an increased bill of material on all electric passenger vehicles and continue to partner with our mobile customers on electrifying their equipment and helping them to achieve their carbon neutral goals.

Today, 2/3 of our portfolio enables these clean technologies. Again, all of this giving us high confidence to grow differently than we have in the past and achieve our 4%-6% organic growth over the cycle. Next slide, please. As a reminder, living up to our purpose, top quartile performance, and being great generators and deployers of cash is what drives Parker. This slide provides an update on living up to our purpose, enabling engineering breakthroughs that lead to a better tomorrow. We are committed and on track to be carbon neutral by 2040, achieved a 20% carbon reduction in fiscal year 2023.

We are proud to be in the first quartile of the Carbon Disclosure Project on climate change. Post-pandemic, our teams were anxious to get back into the communities where we work and volunteered over 10,000 hours in fiscal year 2023 to help serve others. Again, our clean technologies are critical in helping our customers achieve their carbon neutral goals. Next slide, please. The combination of our growth drivers and living up to our purpose points to a very promising future for Parker. We are committed to our FY '27 targets of growing EPS from $21.55 to $30 and achieving 25% adjusted segment operating margin.

Growth from secular trends, continued transformation of the portfolio with Meggitt, continuing to accelerate our performance with Win Strategy 3.0, will drive top quartile performance and organic growth of 4%-6% over the cycle. We have entered fiscal year 2024 on a solid foundation. The guidance that we are sharing with you today reflects continued progress to these FY '27 goals. Todd will go through the quarter and the guide. Then I will be back with more comments on our guide assumptions and why we are still very bullish about the future and the 4%-6% organic growth over the cycle. Over to you, Todd.

Todd Leombruno (EVP and CFO)

Well, thank you, Jenny. If everyone's following, I'm going to start on slide 10, I'm really proud to say once again, every Q4 number highlighted in this gold box is a record for the company. It was really just an unbelievably strong finish to the fiscal year. I'm going to try to move quickly because Jenny already spoke to the 22% sales growth and the 24% segment operating margin. In respect to sales, organic growth was 6%. When you take a look at the Meggitt acquisitions and the divestitures that we did in FY '23, the net addition for the quarter was 16%.

The good news here is on currency. The headwinds have moderated. It now was just a slight headwind of 0.4% in the quarter. One thing I do want to note is Adjusted EBITDA margins, 24.4%. That's an increase of 130 basis points versus prior year. If you continue down the page, both net income and adjusted EPS did increase by 18% versus the prior year. Our adjusted net income was $791 million, or a 15.5% return on sales, and adjusted EPS was $6.08 in the quarter. That is an increase of $0.92, or 18%, versus prior year.

You know, internally, we always stress how important it is to finish strong, and really, these results are just really a testament to the resilience of our global team. Thank you to everyone for a great Q4 and a great fiscal year 2023. If you move to slide 11, this is just a bridge on how we have generated that $6.08. This is a $0.92 walk. And I'm proud to say again, you can see the biggest bar on this page is increased segment operating income. If you look at that, we increased segment operating dollars by $264 million.

That's nearly 28% increase year-over-year. That added $1.63 of EPS to our total for the quarter. There were a few headwinds below the segment that are really no surprise. Obviously, that interest is 100% related to Meggitt. That's consistent with what we've seen in past quarters. Income tax was favorable this year in the quarter. Even though we did finish favorable, it was a headwind of $0.19 compared to what we did last quarter. If you think about that, last quarter, we did have a few one-time items that were related with the acquisition that were favorable and some higher discretes last year.

Those were obviously non-repeating issues this year. The story on the walk is just really strong operating execution, and it's really across the board. If you move to slide 12, just some details on the segment performance. Every segment delivered positive organic growth this quarter, but they also delivered positive margin expansion. You can see across the board here. Incrementals were very strong, and all of these margins are records. I'm also proud to say, even with the challenging comparisons, orders did increase from last quarter to a +3 versus prior year, our backlog did increase 1% sequentially and did reach a record $11 billion.

This is really the result of a robust Aerospace activity, but also the changes to the portfolio that we spoke to throughout the year. Just jumping into the North American businesses, sales were very strong, $2.3 billion. That was 5% organic. That's really right in line with our guide. Adjusted operating margins did increase 60 basis points to 23.5%, really just driven by excellent execution across those North American businesses. Incrementals also did improve sequentially, that helped drive our margin expansion.

You know, one thing to note, orders did turn negative to 8%, that really still is against tough comps. We still strong backlog coverage that we believe will continue to support growth. Customer sentiment overall remains positive in North America. All in all, a great quarter and a great finish by our North American team members. You look at the international businesses, sales are $1.5 billion, organic growth, nearly 4%. Organic growth did remain positive in all of our international regions, really led by Asia Pacific, 8.5%, almost 8.6. Excuse me, Latin America was +2.5%, even EMEA, which we've seen some softness in, did post a +1% organic growth.

Even with all that said, margins did increase 90 basis points, finished at 23.3% versus prior year, and really still continue to reflect consistent performance, productivity improvement, good cost controls, and that increase in distribution mix that we've talked about periodically. Orders in the international business did improve from last quarter. They are still -1, but it is a nice improvement from last quarter. And again, from our international team members, great, consistent performance, and glad to see these results.

If you move to Aerospace, this is really the story of the quarter, really a standout. Just fantastic results all around. Sales are $1.3 billion, 16% organic. Total sales are a 90% increase versus prior year. That's really obviously benefiting from the Meggitt acquisition. If you look at the business, Commercial OEM and MRO continue to be very strong. Both of those businesses are growing at +20% versus prior in the quarter. The Military OEM business did return to growth this quarter with high single-digits organic performance. That was really nice to see.

Operating margins, a new record high, really increasing on an impressive 160 basis points to 25.8%. Those strong margins reflect that growth in the Commercial aftermarket businesses and really, notably, a nice, favorable mix of spares versus repairs. You can also see the addition of Meggitt has also increased our aftermarket exposure. That was one of the compelling aspects of that acquisition. We're glad to see that materialize in the results. The Aerospace team is really doing a phenomenal job, obviously dealing with growth. The integration is ahead of schedule and on track. These results are really fantastic to see.

It's really true that Parker and Meggitt are really better together. If you look at Aerospace order rates, +28 continues to be robust, and obviously it's helping our backlog. Great performance across the segments. If I jump to slide 13, I just wanna highlight our cash flow performance. We finished the year with extremely strong cash flow. It was a record in FY '23. We increased cash flow from operations, 22%. We reached a record $3 billion of cash flow from operations. That's 15.6% of sales. Free cash flow, also very strong, $2.6 billion, or 13.6% of sales. Our CapEx came in right where we were forecasting, 2%.

You know, just as a note, because this was the closing of Meggitt, we did have some transaction-related expenses that were a drag to cash flow. That was about 1% of sales, so those obviously aren't gonna repeat next year. We have set ourselves up extremely well to be great generators of cash. If you look at conversion, free cash flow conversion for the year, 125%. You know, I just really wanna thank our teams for the great work on working capital.

We strive to be great generators, great deployers of cash, and reaching this $3 billion milestone is really the result of significant effort from our team across the globe. If you go to slide 14, you can see what we did with all that cash. We reduced debt by $850 million in the quarter. Since we closed Meggitt just this fiscal year in September, we have reduced our debt by $1.4 billion. Since announcing Meggitt, way back in August of 2021, we have already paid down approximately 35% of the total consideration of nearly $10 billion.

Very impressive work across the board by our team. If you look at leverage, Gross Debt to Adjusted EBITDA finished the year at 2.8%, and Net Debt to Adjusted EBITDA finished the year at 2.7, excuse me, 2.7x. We've spoken about our great track record of how we are so dedicated to quickly deleveraging after the deals, and since closing the transaction in September, we have already reduced leverage by one full turn, so we're proud of that. Looking forward to next year, we expect to generate significant cash flow. We think we can reduce debt by an additional $2 billion in FY '24, and we are targeting leverage of 2x in early FY '25.

Moving to guidance, and putting FY '23 to bed, you can see what we are looking at here is slide 15. I'll start with the top line. Reported sales growth for the year is forecasted to be in the range of 3%-6% or 4.5% at the midpoint. That equates to approximately $19.9 billion in total sales. If you look at the split, the first half is 49%, and the second half is 51%. Speaking specifically to organic growth for the full year, we expect it to be 1.5% at the midpoint.

In respect to Aerospace, we're expecting high single-digit growth in Aerospace, a little over 8%. North America organic, we expect that to still be positive at +1%. International, we are forecasting slightly negative at 2.5%. Those are all full year numbers. The backlog that I just spoke of earlier does support our growth, we feel confident in these numbers. If you look at the breakdown, the guidance does assume acquisition sales, roughly $500 million from Meggitt, offset by $400 million of the divestitures that we did complete in FY '23. The net impact is $460 million, or about 2.5% of our total sales.

I mentioned currency earlier. Based on spot rates as of June 30th, we do expect currency to be a slight tailwind of 0.5% or roughly $100 million. That is based on currency rates as of June 30th. We still see margin expansion this year. 30 basis points is what we're forecasting for FY '24. That is all based on continuing to accelerate our performance across all of our businesses using the Win Strategy and, of course, delivering on Meggitt synergies that we have communicated.

If you look at adjusted segment operating margin, our guidance is 23.2% at the midpoint, and there is a range of 20 basis points on either side of that midpoint. If you look at operating income dollars, segment operating income dollars, the split is 47% first half, 53% second half. For the full year, we are forecasting incremental margins of 30%. A few other items in respect to guidance. Corporate G&A is $240 million. That's a full year number. Interest expense is $525. That is a $40 million reduction from where we finished in FY '23, really just based on our strong debt paydown.

Other expense is $25 million. Full tax rate, we're guiding at 23.5%. That is without any discrete items. That is really our continuing rate from operations, 23.5%. Finally, we expect full year as reported EPS of $18.55, or on an adjusted basis, $22.40. The range, those are both midpoint numbers. The range on either side of those is $0.50, ±. The splits, 46% first half, 54% second half. Just specifically for Q1 of FY '24, we are forecasting adjusted EPS to be $5.10 at the midpoint.

Looking at cash flow, full year free cash flow is expected to be between $2.6 billion and $3 billion, we'll be mid-teens free cash flow, our conversion will be over 100%. Also included in the appendix is some segment guidance details and some other specifics that you might find helpful. If I move to slide 16, this is just the bridge, really highlights as follow. Again, very similar to what's happened throughout this fiscal year, that organic growth, the acquisition sales, margin expansion, and the $75 million of incremental Meggitt synergies for the year translate to an increase in segment operating income of $1.47.

We will have less interest expense next year based on that debt reduction that we've done- that will add $0.23 to EPS. Our forecasted tax rate of 23.5% is a headwind of $0.26. You remember, we had a lot of favorable items in FY '23. We're not forecasting those to continue. We also had lower interest income. If you remember, we pre-funded those, the Meggitt transaction in June of last year, so we had interest income in the Q1 of last year. That was about $35 million.

Just to note, that is reported in the other expense slash income line on the business segment statement. That was a one-off benefit that obviously will not repeat in FY '23. That's a $0.21 headwind. The rest is just a forecasted $0.20 unfavorable to, to EPS, and there's just some, really some non-repeating items in there. Obviously, share count is also a $0.10 headwind that we hope to make up. That's the walk from FY '23 to FY '24. EPS at the midpoint is forecasted to be $22.40. With that, Jenny, I'll hand it back to you and ask everyone to move to slide 17.

Jennifer Parmentier (CEO)

Thank you, Todd. Just a few key messages to close us out. FY '23 was a tremendous year with record performance. We have top quartile safety and engagement, and that continues to drive results in our business. We, we truly have a great team. We have a proven track record, and we're going to continue to accelerate our performance with the Win Strategy 3.0. The transformation of the portfolio is clearly delivering a longer cycle and more resilient portfolio, and this will allow us to achieve our FY '27 targets and continue to be great generators and deployers of cash.

Before we go into Q&A, I'd like to give you a few of our assumptions and comments on the guide. Obviously, Aero is a real growth differentiator for Parker in fiscal year '24. We are projecting total Aerospace growth at 17%, with the acquisition sales from Meggitt, and organic growth of 8%. We see strong mid-teens growth in Commercial and mid-single digit in Military. Good story all the way around. We have now had 2 years in a row of double-digit growth for industrial, but having said that, as Todd mentioned, industrial orders have been negative for the past 2 quarters.

However, in North America, backlog coverage is still above 30%, which is roughly double what it has been in the past, and it will support the growth we have in the first half. We do expect some destocking to continue, but overall sentiment from our customers is positive about steady demand and future growth. Obviously, there's more macroeconomic uncertainty for the second half, and we'll update you on that in future calls.

While we did see an improvement in international orders from Q3 to Q4, this does include a benefit coming from some of those multi-period longer cycle orders and an easier comp from last year's China COVID shutdown. The backlog coverage remains above 30%, but as Todd said, we are forecasting negative growth for the first half and full year. Since the last time we talked, we've seen some signs of Europe slowing. Customers are returning to those seasonal shutdowns, where they do maintenance in their facilities, and we're starting to see some softness in some of the end and geographic markets, as well as some weakening macroeconomic indicators.

Although China had stronger growth in Q4 than Q3, recovery is slower than anticipated, and then we will face a tough comp in Q1 against prior year China COVID rebound. In summary, this is our thinking right now- strong Aerospace growth, strong backlog on the industrial side, some near-term uncertainties and tough comps, but the future growth drivers that I went through on the earlier slide remain intact, and activity is at a high level. We are still very bullish about the future and our 4%-6% organic growth target over the cycle. Now I'll hand it back to Donna for Q&A.

Operator (participant)

Thank you. The floor is now open for questions. If you would like to ask a question, please press star one on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. In order to allow as many individuals as possible, the opportunity to ask a question, we do ask you to please limit yourself to one question and one follow-up. Again, that is star one to register a question at this time. Today's first question is coming from Julian Mitchell of Barclays. Please go ahead.

Julian Mitchell (Equity Research Analyst)

Thanks, and good morning. Maybe just wanted to start off with the industrial businesses. Maybe give us a bit more color on the assumptions for international. It sounds like you've got a down first half organic sales and also down second half organic sales in the guide. Are you sort of assuming, you know, heavy negative orders pressure there for the coming 6 months or so? Just wanted to check that. Broadly on destocking, any regions or markets to call out in particular, where that's most severe?

Jennifer Parmentier (CEO)

Good morning, Julian. First of all, to your question on international, like I was talking about earlier, you know, obviously the backlog is still strong, it's above 30%. Those customer shutdowns that I mentioned, you know, that takes weeks out of the schedule that we hadn't seen previously. A return to that is one of the reasons. Obviously, since the last time we talked, we've seen a slowing in Europe. We've seen the demand not be as strong in certain regions. The China recovery is, you know, we haven't seen the rebound from the stimulus that had been previously anticipated, so that is all weighing in there as well.

Julian Mitchell (Equity Research Analyst)

I see. Maybe just following up on the sort of the, the destocking, comments you'd made, any more color on, you know, markets or geographies, most affected?

Jennifer Parmentier (CEO)

Well, we, we did see destocking happen in Q4, and we just expect that to continue through the first half. I'll let Lee comment a little bit on the specifics of some regions and markets.

Lee C. Banks (Vice Chairman and President)

Yeah, Julian, it's Lee. Good morning. I think, a destocking, mostly at the distribution level, there's, you know, it's been going on for 2 quarters. They were holding more inventory than usual. I would tell you the sentiment is still strong. We've seen destocking across our European distributors and, and in North America. Maybe too, just a little more color on Europe, as Jenny was talking about. The, the biggest softness really is around the DACH region, so that'd be Germany, Austria, Switzerland. I think it's a couple of things.

The China export market's a big deal for them, and China has not rebounded like we all expected it would. I think when you pivot to Asia, with China, the property woes continue to weigh heavily on the business community there. All the stimulus we read about really hasn't trickled down to any significant economic activity. I'm still expecting that to change going forward, you know, those are the those are the plus sides as we move forward.

Todd Leombruno (EVP and CFO)

Hey- hey, Julian, this is Todd. I would just add, we don't have this really first half, second half weighted. We are forecasting international and total to be about 2.5% for the full year, and if I look across the year, there's no real weighting there. It's about an even split.

Julian Mitchell (Equity Research Analyst)

That's great. Thank you.

Operator (participant)

Thank you. The next question is coming from Joe Ritchie of Goldman Sachs. Please go ahead.

Joe Ritchie (Managing Director)

Thanks. Good morning, guys. Nice, nice end to your year.

Jennifer Parmentier (CEO)

Thanks. Good morning.

Joe Ritchie (Managing Director)

Hey, just wanted to maybe talk a little bit more about North America. You know, obviously, you know, you've got this little order deceleration, the destocking commentary. Just maybe, maybe talk a little bit more about what your expectation is for orders, you know, going forward, or, or any, any comments you can make about how this fiscal Q1 is trending, that, that would be helpful.

Jennifer Parmentier (CEO)

Yep, thanks you. Thank you, Joe. Obviously, we've, we've already talked a bit about what we expect to see, a continuing destocking and, and just kind of a- a softening in orders, despite a very positive sentiment from the customer. In the, in the first half, in North America, you know, we're projecting 2% growth, and, and overall for the year, 1%.

We think that, there's some macroeconomic uncertainty in the second half, but in the first half, we, we fully believe that this strong backlog is going to, to support what we have in the guide. The backlog, again, above 30%, a little bit down, about 2% down, from last quarter, but very strong. You know, in talking with our customers, you know, we continue to constantly pressure test this and, and analyze it, and we're not really seeing any, any major pushouts or cancellations. We feel good about the guide we have out there.

Joe Ritchie (Managing Director)

Okay, great. And then maybe just focusing to Aero. I guess it's funny, like, y- y- you're expecting 8% growth, good growth, but, you know, why is 8% the right number? It feels like it could be better than that. Particularly with Military inflecting. Also would love to get any color around where the integration is going better than expected with Meggitt.

Jennifer Parmentier (CEO)

Sure, sure. The first half for Aero is, is 12%. Obviously, we're, we're gonna see some nice growth here in the first half. In the second half, we have 5%, and, you know, the, the comps get pretty tough in the second half. We feel good about that 8% organic number right now. Obviously, we're seeing, you know, really nice, really nice growth in Commercial OEM. We see those narrow body rates increasing. Wide bodies are starting to recover, but, really, it's a story about narrow body rate increases.

Then MRO, as Todd mentioned earlier, the Meggitt acquisition has really increased our aftermarket exposure, and it's been really strong with the air traffic recovery, especially with those, those narrow bodies. And, and we're pleased to see Military OEM return. Obviously, the Military budget increase is gonna drive mid- and long-term growth. F-35 is, nearing peak delivery, so all good news there. Then, you know, same thing with Military MRO.

I mean, there's a, there's a focus on retrofits and upgrades as the fleet ages. Really, really good outlook for all of Aerospace going forward. You questioned about Meggitt integration. You know, I mentioned in the slides, we couldn't be happier with the progress of that integration. We're forecasting another $75 million in synergies in FY '24. Team did a great job in FY '23 of pulling some actions ahead and allowing us to increase those synergies by $15 million. Really, just a positive outlook for Aerospace.

Joe Ritchie (Managing Director)

Sounds good. Thank you.

Todd Leombruno (EVP and CFO)

Yeah. Hey- hey, Joe, this is Todd. Just one thing I would add. If you remember a year ago when we did the Meggitt post-close call, we said that we felt Meggitt could add $0.80 of EPS on a full year basis. We are ahead of that schedule, so that should give you some comfort, too, that it is adding EPS to the bottom line as well.

Joe Ritchie (Managing Director)

Good.

Operator (participant)

Thank you. The next question is coming from Andrew Obin of Bank of America. Please go ahead.

Andrew Obin (Managing Director of Equity Research)

Hi, guys. Good morning.

Jennifer Parmentier (CEO)

Good morning, Andrew.

Andrew Obin (Managing Director of Equity Research)

Morning, Jenny, Todd, Lee. Good to hear from you guys. Yeah, just a question on price and cost. Companies are starting to talk about disinflation, maybe some deflation. What's the view on the company's pricing power into next year, and also ability to actually extract price concessions from, you know, supply chain?

Lee C. Banks (Vice Chairman and President)

You know, we've- Andrew, you've covered us a long time. I mean, the one thing I think we've got a good handle on inside the company is kind of price, cost, and the ability to push cost in the price. Every one of our facilities, and it's embedded in our Win Strategy, we look at cost constantly, and we look at price. I would say pricing has become much more normal now. We're not in that rapid in- inflationary period. You know, our goal is always to keep things margin neutral, and we're working that. We're working the cost side on the supply chain side, too. I'm comfortable that kind of the price cost scenario we have is baked into our margin forecast and [audio distortion]

Andrew Obin (Managing Director of Equity Research)

Excellent. Then the other question, you know, you sort of talked about seeing Europe slow down, specifically Germany and the DACH region. You know, if you read the newspapers- The Economist, POLITICO- a lot of articles about sort of structural slowdown in Germany, right? Because exports to China, cheap energy from Russia. Could you use this slowdown as an opportunity to sort of reconfigure your manufacturing footprint and supply chains in Central, I would call it Central Europe or just Western Europe in general? What are your thoughts? You know, is it too early to say?

Lee C. Banks (Vice Chairman and President)

Well, I- first off, we've been reconfiguring our supply chains and our manufacturing footprint in Europe for the last 8 or 10 years. I mean, you remember when Tom and I took our roles, we had a big initiative.

Andrew Obin (Managing Director of Equity Research)

I absolutely do. Absolutely do.

Lee C. Banks (Vice Chairman and President)

You know, and, and I would just tell you that that is always ongoing. We never stop with that, and we take every opportunity we can to just continue to be better. And we're doing that today.

Jennifer Parmentier (CEO)

Yeah, we don't wait for an event, Andrew. You know, it's something we're always working on.

Todd Leombruno (EVP and CFO)

You know, Andrew, this is Todd as well.

Lee C. Banks (Vice Chairman and President)

Yep.

Todd Leombruno (EVP and CFO)

I, I think, you know, Lee Banks brings up a good point. We've been working that initiative for a long time, and if you look at the margins that I just ran through for Q4 and really what we're guiding for FY '24, you'll see that those international margins are similar to every other piece of our business. That has been a great success.

Lee C. Banks (Vice Chairman and President)

Great European team with great leadership, doing great things. They really are.

Andrew Obin (Managing Director of Equity Research)

No, I, I appreciate you. Certainly been doing something right. Thanks a lot.

Lee C. Banks (Vice Chairman and President)

Thank you.

Jennifer Parmentier (CEO)

Thanks, Andrew.

Operator (participant)

Thank you. The next question is coming from Nathan Jones of Stifel. Please go ahead.

Nathan Jones (Managing Director)

Good morning, everyone. Question on the margin guidance in Aerospace. Jenny, you just mentioned $75 million of additional synergies for Meggitt in 2024, which I think is about 150 basis points, and the margin guidance is up about 60 basis points. Maybe just some commentary on on the core, I guess, margin decline in 2024. Is that really just a function of increasing Commercial OEM as part of the mix or something else in there?

Jennifer Parmentier (CEO)

You, you just answered the question, right? We, we expect those, narrow body rates to go up, and it's, it's definitely a matter of mix.

Nathan Jones (Managing Director)

Okay, fair enough. That's helpful. And then I guess just on the M&A outlook now, you guys have obviously done a sensational job paying down debt post-Meggitt. You know, back toward 2x by the end of the fiscal year, early in 2025. What are kind of your criteria for getting more materially back into the M&A market? And you know, the, the shape of the pipeline, I know you guys continue to cultivate that even when you're out of the market. Just commentary on plans there.

Jennifer Parmentier (CEO)

Yeah. You know, we're, we're committed first to pay down our debt. That is our number 1 priority and our focus. We're always working the pipeline. You know, we have long-standing relationships with, you know, people we talk to now as we have in the past. That's not something that we ever let go stale or dry. It's, it's a continuous pipeline. For, for now, we're focused on paying down debt and, you know, we expect to get in the range of about 2x by fiscal year 2025, and, and I'm sure we'll, we'll talk about it in the future.

Nathan Jones (Managing Director)

Fair enough. Thanks for taking my questions.

Lee C. Banks (Vice Chairman and President)

Thank you, Nathan.

Operator (participant)

Thank you. The next question is coming from Jeff Sprague of Vertical Research Partners. Please go ahead.

Jeffrey T. Sprague (Founder and Managing Partner)

Hey, thank you. Good morning, everyone.

Jennifer Parmentier (CEO)

Good morning, Jeff.

Jeffrey T. Sprague (Founder and Managing Partner)

Just- hey, good morning. Good to touch base with all of you. Just wanted to follow up on Lee, your comments on price, cost, margin neutral. I believe you got yourself to price, cost, margin accretive through this period. You know, kind of correct me if I'm wrong on that, but should we kind of expect that trend back to neutral, you know, to occur here in 2024? Or can you actually maintain some kind of positive spread?

Lee C. Banks (Vice Chairman and President)

Well, I, I think- you know, Jeff, again, you followed us. We've always maintained some kind of positive spread. We're, we're always looking at the portfolio. We're sunsetting products. We've got, you know, different strategic pricing initiatives. I would tell you, you know, we deal with a lot of, we deal with a lot of, core, tough customers, and, and pricing is very competitive. It's really what we do with the balance of the portfolio that, that helps us out. As we've talked about in the past, one of the great strengths of this company is the distribution base we have, which gives us a great opportunity to kind of price into that market.

Jeffrey T. Sprague (Founder and Managing Partner)

Understood. Jenny, just back to Aero. Can you be a little bit more explicit about what your Aero-Commercial aftermarket assumption is inside the guide? You know, is the growth similar at Legacy Parker Aero and Meggitt, you know, on those metrics?

Jennifer Parmentier (CEO)

I guess I would say, first of all, that it, it is very similar. Obviously the Meggitt acquisition, as we've mentioned, has meaningfully increased our aftermarket exposure. It's mid-teens is what we're projecting right now. Again, that air traffic recovery, especially with the narrow bodies, with this high domestic traffic, is that really what's gonna help that into the fiscal year.

Jeffrey T. Sprague (Founder and Managing Partner)

Great. Thank you very much.

Jennifer Parmentier (CEO)

You're welcome.

Operator (participant)

Thank you. The next question is coming from David Raso of Evercore ISI. Please go ahead.

David Raso (Senior Managing Director)

Hi. Thank you for the time. On the margins industrially, that you have them up despite in aggregate, your industrial organic sales are down. Just want to make sure I understand, the destocking that you're referring to- I, you know, I think that probably is distribution, which would be a, a challenging mix if that's your destock. Are you also referencing, though, maybe a more balanced destock it's at OEs as well? I'm just trying to get a sense of the ability to have margins up when you're destocking distribution's a, a heavy lift.

I'm just curious if you could color on that. And maybe what's in the backlog. It sounds like the backlog will, you know, help carry the first part of the fiscal year. Are the margins particularly positive, will be coming out of the backlog? Just trying to get a sense of the margin progression and how to have margins up if organic's down industrially for top line.

Jennifer Parmentier (CEO)

Yeah.

David Raso (Senior Managing Director)

Thanks.

Jennifer Parmentier (CEO)

You know, David, primarily when we talk about destocking, we are talking about distribution. You know, we're just seeing a kind of a moderation of, of growth across all of our customers. Don't worry about margin degradation. We, you know, we're, we're not going to allow that. We have all the, all the right things in place to make sure that we hit our margin targets. Really, you know, it's, it's about, you know, we're, we're just continuing to see the benefit of this transformed portfolio, right? We're continuing to see, the, the power of the acquisitions that we've done over the last several years.

Todd Leombruno (EVP and CFO)

Hey, David, this is Todd. I, I would just add to that. Jenny's absolutely right. We, we do believe that we can expand margins, both in the North American businesses and the international businesses. It really is a testament to the power of the Win Strategy. If I'm looking at the numbers here, it really is a smooth glide path, very similar to what we've done historically with our normal seasonality. So it's not weighted in any, you know, one way or the other. I gave a little color on the splits of seven operating income, but the margin expansion is a nice glide throughout the year.

David Raso (Senior Managing Director)

Maybe I missed it. Just clarification. The Q1 in North America, particularly, has a hard comp. Are we saying margins could be up every quarter in North America, or is it just for the full year and the Q1's down, and then it's up from there?

Todd Leombruno (EVP and CFO)

No, we see margin expansion in every quarter of the fiscal year.

David Raso (Senior Managing Director)

Okay. All right. Thank you so much.

Todd Leombruno (EVP and CFO)

Yep. Thanks, David.

Jennifer Parmentier (CEO)

Thanks, David.

Operator (participant)

Thank you. The next question is coming from Josh Pokrzywinski of Morgan Stanley. Please go ahead.

Josh Pokrzywinski (Executive Director)

Hi, good morning, y'all.

Jennifer Parmentier (CEO)

Good morning.

Josh Pokrzywinski (Executive Director)

Jenny, you've referenced the backlog here a few times. I, I think for most folks, they don't really think about backlog when they think about the industrial pieces of Parker. Clearly, that's changing, but maybe some more, you know, kind of breakdown of how long does that backlog extend out? Is there a particular set of end markets or, you know, channel mix? Like I would assume more OEM, maybe more project activity. Just any kind of color you can give us on the nature of that backlog and really the duration over which it ships. Is it, you know, kind of one to two quarters, three, four, or something like that?

Jennifer Parmentier (CEO)

You know, the backlog, as I've said, is, you know, at 55% right now, and it went up 1% sequentially. We talk about that backlog being so strong, and especially, obviously, Aerospace is in there, but in industrial being above 30% is roughly double what it was in the past. You know, we were sitting around 15%-17% coverage in the past, and now we have 30. That's really, you know, coming from the acquisitions we've done, the higher aftermarket, the longer cycle. We're seeing a more resilient and longer, I call it the demand horizon, a longer horizon on that backlog. We feel very strongly about it.

You know, we know from the past that backlog isn't bulletproof, but we are constantly pressure testing it, analyzing it, talking to our customers, which is really a, a great benefit of us being so decentralized because our divisions can have, you know, real-time conversations to make sure that that backlog is strong. I wouldn't, you know, be able to break out all the detail that you were just asking about between the channel and the OEM, but I would, I would tell you that, over 30% coverage in industrial is, is a good place to be right now. That's why we feel good about it covering the growth we have in the first q- the first half.

Josh Pokrzywinski (Executive Director)

Got it. That's helpful. Oh, yeah, please go ahead.

Todd Leombruno (EVP and CFO)

Josh, this is Todd. I was just going to add to that. You know, the other thing to keep in mind is, when we talk about the company having 30% Aerospace exposure, 5% of that exposure does come from our industrial businesses. That is also a plus there as well.

Josh Pokrzywinski (Executive Director)

Appreciate. That's helpful. Just pivoting to something I've heard a lot of your peers talk about, you know, particularly this quarter on U.S. mega projects, or I guess North American mega projects and nearshoring. Obviously, you folks play in, you know, all stages of that, I guess, you know, new products that are being developed here, as well as the construction of maybe the, some of these facilities themselves. Open-ended question, is that something that in, you know, Parker's, I guess, more kind of component and subsystem-type business that you're actually seeing yet, or is it just a little too early, and maybe we see that more, you know, kind of later in 2024?

Jennifer Parmentier (CEO)

You know, we, we are seeing some of it, you know, through our, through our customers and our distributor partners. You're right, there's just been a massive amount of announced CapEx. I mean, some, some industry sources are citing over $500 billion. You know, some, some key examples of that, where, you know, we will get, you know, into the game is the semifabs and the electric vehicle battery plants that are, that are now breaking ground. We win, Parker wins when the job site is prepped, when the factory is built, and when the machines go into the factory. It's early days, Parker is, is winning and will continue to win in the future.

Josh Pokrzywinski (Executive Director)

Great. Appreciate it. Best of luck rest of the year.

Todd Leombruno (EVP and CFO)

Thanks, Josh.

Operator (participant)

Thank you. The next question is coming from Joe O'Dea of Wells Fargo. Please go ahead.

Joseph O'Dea (Managing Director)

Hi, good morning. Thanks for taking my questions.

Jennifer Parmentier (CEO)

Good morning, Joe.

Joseph O'Dea (Managing Director)

Morning. Todd, wanted to circle back. You talked about Meggitt trending ahead of that $0.80 that you had given about a year ago. Just any sort of color on, you know, what you think the all-in Meggitt contribution is this year?

Todd Leombruno (EVP and CFO)

Yeah, I would say it's, it's slightly above that $0.80 that we really forecasted for the first full 12 months. You know, we've only owned them, 9.5 months, but it has been, it's been a fantastic 9.5 months. You know, we've talked about the synergies being ahead of schedule, but the other thing is, you know, they're benefiting from this secular trend in Aerospace. Their growth has exceeded expectations every quarter since the close. You know, we feel really good about that, and I'm really happy we got the deal done.

Jeffrey Hammond (Managing Director)

Got it. Then, Jenny, I wanted to circle back the, the macro CapEx investment sort of drivers that you talked about, kind of the three main buckets with under-investment, supply chain, mega projects. Can you just talk about sort of within those buckets, sort of if you can rank order, you know, what, what you're seeing as sort of, like, the biggest growth drivers for you, but also just what you're seeing in terms of kind of the evolution of them, maybe where things are accelerating, where things have played out a little bit more?

Jennifer Parmentier (CEO)

Well, I don't know that I can rank them right now, but I would tell you that, you know, I see activity in obviously all three of them. You know, if you start off just thinking about the CapEx investment because of the reinvestment over the last 10 years, you know, we're seeing some, you know, just some upgrading, upgrading of factories, a lot of, a lot of work being done to really develop the supply chain and increase capacity. You know, that, that ties into the investment.

A lot of, you know, a lot of machinery and a lot to, to help really that supply chain development. You know, a lot of folks that got burned during, you know, the pandemic are, are going to dual sources, so that drives a lot of, a lot of investment. As I mentioned, just a few minutes ago, you know, the mega projects, we're starting to see some of that. We're hearing about involvement in that from some of our distribution partners. It's still early days, but there's a lot out there for us to go win.

Jeffrey Hammond (Managing Director)

Thank you.

Operator (participant)

The next question is coming from Jamie Cook of Credit Suisse. Please go ahead.

Jamie Cook (Managing Director of Equity Research)

Hi, good morning. Congrats on a nice quarter. I guess most of my questions have been asked, but I guess just to- you wouldn't know this from looking at your results, but in 2023 or 2022, is there any way you can handicap the inefficiencies, you know, running through your earnings, whether it's related to, you know, supply chain, you know, employees not being back, et cetera? I'm just wondering for if any of this is an opportunity for 2024 potential tailwind that's not implied in your guide.

My second question- Lee, I don't think you, you said this yet. I know you walked through some end market color, but last quarter, you told us, like, the percent of the portfolio that was growing versus not growing. I think last quarter, 90% of the portfolio was still in growth mode. Can you give us an update, just on your portfolio, % flat versus growing versus negative? Thank you.

Lee C. Banks (Vice Chairman and President)

Jamie, it's Lee. I guess I'll start on a couple things. One, in terms of, you know, we're always striving for productivity and continuous improvement, certainly things coming out of COVID were chaotic. Some of that chaos is settling down, so those are opportunities for us. You know, productivity is increasing. You see it in our numbers, and kind of the inefficiencies that were going on are getting better. It's not perfect. There still are supply chain issues out there, but it's a far cry from what it was before.

I would say when we look at our markets from the backlog we have, you know, all our markets, are s- are still growing at different, different levels. I mean, it, it, it's kind of interesting. Nobody talks about Oil and Gas anymore, but that's been incredibly strong. Land-based Oil and Gas here, and even offshore here and, and in Europe. Everything in Aerospace is great, and forestry and automotive is still great. North America, anything around electric vehicles is doing really well, and, and we share a lot of content in those areas.

Construction equipment's still steady throughout all that, and as is, as is ag. I think some of the areas that have softened, and you've seen it with public announcements, is the whole area of HVAC, is, is down. I think that's short term. That, that will come back. Semicon is, is soft, and life sciences, really just tough comps coming out of COVID. Things were really, were really going there. The, the sentiment is, it's just tough comps, so it's getting better as we kind of cycle through the comps.

Todd Leombruno (EVP and CFO)

Hey, Jamie, this is Todd. I would just add to that, on your 90% question, you know, if you, if you look at our total orders, last quarter, they were +2%. They did move to +3%, so there really hasn't been a material change in that percentage of end markets that continue to grow.

Jamie Cook (Managing Director of Equity Research)

Thank you.

Operator (participant)

Thank you. The next question-

Todd Leombruno (EVP and CFO)

Hey, Donna, this is- sorry to interrupt you, this is Todd. I think we have time for one more question, so whoever you have next in the queue, that'll be our last call.

Operator (participant)

Okay. The next question is coming from Jeffrey Hammond of KeyBanc Capital Markets. Please go ahead.

Jeffrey Hammond (Managing Director)

Hey, good morning, everyone.

Todd Leombruno (EVP and CFO)

Morning, Jeff.

Jennifer Parmentier (CEO)

Good morning, Jeff.

Jeffrey Hammond (Managing Director)

Just a couple quick questions. Supply chain and Aero is, is kind of been a problem point. Just wondering what you're seeing there and how that kind of informs, kind of the growth rate and, and, and how much it's maybe holding, holding the growth back?

Jennifer Parmentier (CEO)

Yeah. You know, it's, it's interesting. I've been talking to a lot of people about supply chain, as always. You know, the Aerospace supply chain is really experiencing what the industrial side of the business did 18-24 months ago. You know, just, it's, it's a little bit tough. There's constraints responding to the, you know, to the high rate increases in demand. I, I would tell you that outside of chips and electronics, you know, we're starting to see some lead times moderating.

Overall, I would say it's, it's still a constraint for Aerospace. Again, we work closely with our suppliers. We're investing in, in developing suppliers, especially in Aerospace, because obviously, with it being a third of our portfolio, it's very important to us that we can deliver these orders.

Jeffrey Hammond (Managing Director)

Okay, great. I think as was the case with, with LORD, Exotic, you know, the deleveraging process is, is pretty swift here and, and seems maybe a little bit ahead. Just level set us on when we start to shift, you know, away from debt, debt paydown.

Todd Leombruno (EVP and CFO)

Hey, Jeff Miller, this is Todd. Obviously, Jenny mentioned it earlier: we are fully committed to debt paydown. If you look at what I mentioned earlier, we expect to pay down another $2 billion of debt in this fiscal year of FY '24. We don't expect to get to 2.0x till early FY '25. You know, we've talked about the portfolio. We never stop looking at it, both from an addition and a subtraction standpoint, but our main focus really is still, for FY '23, is to continue that debt paydown trajectory.

Jeffrey Hammond (Managing Director)

Okay, thanks so much.

Jennifer Parmentier (CEO)

Thank you.

Todd Leombruno (EVP and CFO)

Okay, this concludes our FY '23 Q4 Webcast. As always, we fully appreciate everyone's interest in Parker. Jeff Miller, our VP of Investor Relations, and Yan Huo, our Director of Investor Relations, are available if anyone needs any further clarifications or has any questions on any of the materials we covered this morning. I want to really thank everyone for joining. We appreciate your support. Thanks.