Parker-Hannifin Corporation

Good day and thank you for standing by. Welcome to the Parker Hannafin Corporation's Fiscal Year 2022 Third Quarter Earnings Webcast and Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. And now it is my pleasure to hand the conference over to your first speaker today, Todd Leon Bruno, Chief Financial Officer. Thank you. Please go ahead.

Thank you, Paul. Good morning, and thanks to everyone for joining. This is our fiscal year 2022 Q3 earnings release webcast. As Paul said, this is Todd Leon Bruno. I am Chief Financial Officer. And as usual, with me today are Tom Williams. our Chairman and Chief Executive Officer, and Lee Banks, our Vice Chairman and President. Today, we are going to discuss forward-looking projections, and also we will discuss some non-GAAP financial measures. Slide 2 in our deck details our disclosure statement on these areas. Actual results may differ from our projections due to uncertainties listed in these forward-looking statements, and those are detailed in all of our SEC filings. Reconciliations for all the non-GAAP measures, along with this presentation, have been made available under the investor section on Parker.com, and those will remain available for one year. I'd like to remind everyone before we begin that we are still bound by the requirements of the UK Takeover Code in respect to discussing certain details of the pending MEGIT transaction. As for the call today, as usual, we'll start with Tom discussing some key items for the quarter. I'll follow up with some additional color on our Q3 results and detail the increase to our guide that we issued this morning with all of our press releases. We'll finish the call with any questions you have for Tom, Lee, or myself. And with that, we are now on slide three, and Tom, I'll hand it over to you. Thank you, Todd, and welcome, everybody, to the call today.

Appreciate your participation. It was a record quarter, record quarter for the quarter and record quarter for all-time and a lot of key metrics and was delivered against very difficult circumstances that required exceptional agility and performance by our global team. I know we all lived through it, but just as a refresher, what happened in Q3, we had the Omicron spikes, which drove absenteeism. We had supply chain challenges, inflation, China COVID shutdowns, and the Ukraine war. So just your basic average quarter, obviously I'm being sarcastic, but obviously not ideal conditions. And what was remarkable against that backdrop, we turned in a number of all-time records, as I mentioned, and my thanks to the entire team for just great performance and resilience in these times. So a couple comments about the quarter on slide three. Safety is our top priority. We continue to be top quartile when you look at our performance on safety incidents versus our peers. We're doing that through our high-performance teams, which is how we run the factories and the warehouses, and a culture of Kaizen. And as I've mentioned before to shareholders, There's a very strong linkage between safety, engagement, and business performance. If you look at those three metrics for us for the last seven years, they're all going in the same direction. Our sales growth was 9% versus the prior year. Organic was a positive 11%, so that was very nice. We eclipsed $4 billion in sales for the first time in the history of the company. First time over $4 billion and a quarter, so it was a great milestone. We had strong demand against virtually all of our end markets. Segment operating margin was 20.3% as reported, or 22.7% adjusted. That was 130 basis points, better than prior years. So expanded margins, 130 basis points, and the kind of conditions that I started to call was just remarkable performance. We increased the quarterly dividend 29%. That is the largest increase in our history and clearly signals the confidence that we have about Parker for the future. We have some temporary things which we highlighted in future slides here that Todd will go over about the Q4 impact related to China COVID shutdowns. The comment here I just want to make is that that's a temporary thing. How long it goes, it's hard to predict, but we expect to come up to full production sometime in Q1 and that we'll make up this delta that we're experiencing in Q4 during the course of the rest of FY23. And maybe to clarify, if you're looking at our what we're talking about China versus what some of our peers are, we only have 60 days left in our fiscal year. So it's very hard for us to make that up in the rest of the fiscal year, but we clearly feel confident that we'll make it up in FY23. If you look at these results, it's the win strategy, it's the portfolio changes, it's the fact that the company is now a much longer cycle and a better performing company. On slide four, what drives us is really three things. Living up to our purpose, which is enabling engineering breakthroughs, that lead to a better tomorrow, being great generators and employers of cash, and being a top quartile performer. And I want to give you one example on slide five, really our purpose and action related to clean technologies. As the world migrates to a more carbon-friendly environment and applications, we're going to be there to help. One very topical and current area, given the inflation pressures in the Russia-Ukraine is the topic of energy and the availability of energy and inflation of energy prices around the world. And as the world moves from brown sources of energy to greener sources of energy, it's pretty clear that we're going to need to use all shades of color between brown to green as we walk to that cleaner tomorrow. And clearly a big part of that bridge to that cleaner tomorrow is going to be natural gas. And we wanted to talk about really natural gas, where we play in it, and just how we're going to be able to help society, our purpose and action here. So upstream, there's four main components here, upstream, midstream, liquefaction, storage and regasification, and power generation. On the bottom of this slide, you see the six Parker technologies that we utilize to go into there. A couple anecdotal comments for each one. So in upstream, we've got fluid power controls for the rig equipment. We have instrumentation valves and controls in there as well. In midstream, it's primarily gas filtration. On the liquefaction, storage, and regasification, that would be our pumps, our valves, sealing technologies, fluid conveyance, and this is all under cryogenic conditions, so ultra-low temperatures. Then power gen I'm going to cover on the next slide. So a lot of what we do for society on compressed natural gas and liquid natural gas is going to be directly applicable as the world moves to hydrogen, which is on slide six. So that last value chain as part of natural gas that I think cover is the power generation piece. And clearly, what's obvious here and what's really helpful for us, and I think our customers, is all the technologies we have on CNG and LNG are directly applicable in the hydrogen. You can see in the middle of the page the applications, those five bullets we have in the middle. On the right-hand side are our various technologies, and there's similar technologies for both fuel sources, with the exception of our same technology, will need to be even more sophisticated, which we're working on as we speak, to be able to seal hydrogen, which is a smaller molecule and more difficult to seal. But we'll be a big part of this bridge with natural gas, and we'll be there to help when society is ready for hydrogen as well. You go to slide seven, which happens to be one of my favorite slides. And while you may be tired of me showing this slide, I think it's the simplest way for shareholders and people that maybe aren't familiar with us to understand how different the company is over the last seven years. It's been our people, which is really their engagement, their ownership, those top quartile results that we see from our people driving top quartile performance. So in the portfolio, and I would just summarize it, when we close MEGIT, we will deploy $20 billion of money into acquisitions, reshaping the portfolio. We will have doubled engineering materials, doubled aerospace, and doubled our filtration businesses over this period of time. dramatically reshaping the company and the future of the company. Then on the strategy side, you have the wind strategy 2.0 and 3.0 now over this period of time, and you've seen what it's done to margins. EPSCs are just phenomenal. This is high into the right type of metrics on this page, which is hard to do, I can assure you of that. So hopefully you see from this progress, in addition to the alignment we have with the positive secular trends in aerospace, digital, electrification, and clean tech that our business is poised for a very promising future over the next five years. I wanted to close my opening comments with giving you an update on slide eight with where we stand with the regulatory clearances regarding to the MEGIT transaction. So on the antitrust side, we've already cleared without any conditions from the following countries, Australia, China, Saudi Arabia, Singapore, and Turkey. Brazil has given us unconditional approval subject to their usual 15-day waiting period, so that's in good shape. We've received conditional antitrust clearance from the European Commission, subject to our commitment to divest of our aircraft wheel and brake business, which is in process. And then on the foreign investment side of things, the transaction's been cleared by Australia, Denmark, Germany, and Italy. So probably the simplest way for me to describe it, what remains and what's left, our antitrust clearances for the U.S. and the U.K., and then national security clearances for the U.K. and France. So we're making good progress, and we continue to expect the transaction will close sometime during Q3 of this calendar year, and we're very excited. We're going to put two great companies together. We're going to double the size of aerospace, and we're going to have great synergies as we work together, and we're going to do all this at the beginning of an aerospace recovery, so the timing is perfect. With that, I'll turn it over to Todd to give you more details on the quarter.

Okay, thanks, Tom. I'm going to start on slide 10. This is just a year-over-year comparison of our Q3 financial results. And Tom mentioned this. Really, all the credit goes to our team members, really demonstrating stellar execution to generate a number of record results in a quarter that, as Tom mentioned, had a lot of disruptions. Sales increased 9 percent. We did eclipse $4 billion for the first time in our history. Organic growth was 11. Currency was a drag at two points. So, that's how we get to the 9 percent growth. I just want to make a comment. Our backlog levels are unbelievably strong. They're up 25 percent from this time last year, and over 90 percent of our end markets are in a growing state. We continue to see all regions perform extremely well. Commercial aerospace and really all of the North American markets are really the most robust. But it is broad-based across the company. Tom mentioned this, but we did expand segment operating margins, 130 basis points in the quarter. We finished at 22.7 on an adjusted basis. And I'll go through the segments in a couple slides, but really every segment, every region contributed to this performance. The inflationary and supply chain issues, they are persistent. They remain, yet our team members are really showing their resiliency as we leverage the wind strategy to really achieve our goal, which is top quartile performance. When you look at EBITDA, our EBITDA margins expanded 70 basis points. We finished at 22.6 for the quarter, and net income, adjusted net income, grew by 16%. in the quarter and we finished at $630 million or 15.4% return on sales. That income grew 16% versus prior year. Very, very impressive. I think we've mentioned this multiple times before, but Tom was talking about MEGIT. The currency deal contingent hedge we have on the pound to dollar requires mark-to-market accounting treatment. Due to what's going on with currency rates and really the strengthening of the dollar versus the pound, we did record a pre-tax non-cash charge in the quarter of $247 million. And that really accounts for the major difference between the as reported in the adjusted numbers this quarter. When you look at EPS, we did $4.83. That is 71 cents greater than prior year. That's up 17 percent from the 412 we did last year. So, just really solid performance across the board. And again, I can't thank our team enough. If you go to slide 11, what we did here is we just put a graph together that displays really the elements of that 71 cent or 17 percent increase in EPS. And again, once again this quarter, we continue to outperform. It's really driven by volume. Of course, the margin expansion that Tom and I talked about. But really what I like about this is it really displays our solid operating performance. The majority of the change, all of it, is showing up in segment operating income. Seventy-five cents of the 71 cent increase is all segment operating income. If you look at everything else, that's the four cents of a drag, but really proud that we were able to not only improve EPS but do it at the operating line. If we jump into slide 12, this is our segment performance. Growth continues to be broad-based across every segment and every region. Demand continues to be robust. Our orders are up 14%. The team has taken prudent actions to manage the inflationary environment, and that really has positioned us to continue to maintain margin neutral on all of these price-cost issues that are fairly well-documented across the world. That and the operating execution that I talked about really allowed us to improve margins in every segment. If you look at our incrementals, they're 37%. You know, we've talked about this a couple times, but we still are going up against pandemic-level comps. We had $25 million of discretionary savings in Q3. If you account for that, incrementals would have been 44% for the quarter. So just Really solid incremental performance. It really highlights the power of the wind strategy, and it demonstrates the transformation that we spoke about at our investor day just March 8th. If you jump into the segments, North America surpassed sales of $2 billion. Organic growth was almost 15% versus prior year, and adjusted operating margins expanded by 100 basis points and reached 22.9% for the quarter. That led the company this quarter, right, which is really impressive. North America has certainly had challenges across the supply chain. It's great to see them rebound and lead the company again. Their incrementals improved in the quarter, and they're the best incrementals they generated all fiscal year. And even more importantly, order rates accelerated to 23%, and backlog, of course, grew even stronger. Just very impressive. a great execution, broad-based demand in the North American segment. If we move to international, sales were about $1.4 billion. Organic growth there is almost 9% from prior year. EMEA and Latin America combined was mid-teens positive, and Asia Pacific was low single-digit, but all regions are positive in the international segment. Again here, Operating margins expanded 110 basis points in international and finished really at a high level of 22.7. Really satisfied to see the consistent performance. Our international teams continue to post, and we've talked about this. It's been a long-term effort for a long time, and I'm really happy that we're seeing the results out of our international segment. Order rates international are plus 9. If we look at aerospace, aerospace continues to rebound. Sales were 632 million. Organic growth was almost 6%. Very strong demand in our commercial markets, both OEM and MRO. And operating margins, a great expansion here. 250 basis points of improvement. Came in at 21.9%. And I just want to remind everyone, with this great margin performance, we are still – operating at below pre-COVID baseline when it comes to sales. Orders in aerospace are minus four, but if you remember, we talked about this last quarter, there were a few large military orders in the prior period that really just kind of make a tough comp in aerospace. If you exclude those items, aerospace orders were positive 20. And again, aerospace dollars in the quarter are the largest dollar level. that we've had in the last four quarters. So it just really gives us confidence in aerospace recovery. Really proud to be able to share these results across all of our segments. And, you know, like Tom says, it really demonstrates the power of the performance and portfolio change that a lot of all of our team members have been working on for some time. So if I go to slide 13, cash flow generation, right? Tom talked about being great generators and great employers of cash. Year-to-date, we've exceeded $1.5 billion in cash flow from operations. That's 13.3% of sales. Our free cash flow is about $1.4 billion. That's almost 12% of sales. And our year-to-date conversion is 117%. We continue to still manage this diligently in a growth environment, which is not the easiest thing to do. If you look at year-to-date, working capital is a use of cash of about 3% versus last year it was a source of cash of about 1.2%. Q4 is our strongest quarter for cash. If you've followed us for a long time, you know that. We still continue to forecast mid-teens CFOA and obviously greater than 100% conversion when it comes to cash flow conversion. Tom called out the 29% dividend increase that we announced. This really reflects the confidence we have in our ability to generate cash, not just in the short term, but in the long term as we look out to achieving those FY27 goals. Just a few notes on leverage. Our gross debt to EBITDA was 2.8. Our net debt was 2.6. But if you remember, we have about $2.5 billion of cash in escrow to pay to For the mega-transaction, we are classifying that as restricted cash. If you exclude that $2.5 billion, our net debt to EBITDA would be 1.8. Now, let's look at the guidance. If I go to slide 14 on the guidance, we obviously announced an increase to our guidance this morning. I'm going to give it to you on an as-reported and adjusted basis. We're raising full-year EPS by 10 cents. Last quarter, we were projecting $18.05 per share. We are now at $18.15 per share at the midpoint. We've also narrowed the range to $0.15 on either side. Sales growth for the full year is forecasted to be about 10%. We did increase the organic guide 50 basis points from 10.5% to 11%, so 11% full-year organic growth. And while currency remains a headwind in the quarter for the full year, we think it will be about a 1% drag to the top line. Just a reminder on currency, for our guide, we are using March 31st rates to calculate our estimate. If you look at segment operating margins, full year guidance is 22.1%. I just want to call out, if you look at that versus last year's actual, that's 100 basis point increase. in segment operating margins. So I'm glad to be able to speak to that. The corporate G&A interest and other is really expected to be $947 million on an as-reported basis and $459 million on an adjusted basis. And the adjustments we've detailed out for everybody, the acquired intangible asset amortization is $315 million. Business realignment charges are $20 million. Load cost achieved is $5 million. And of course, we closed our Russian operations. That is a charge of $20 million. If you're curious, that was $13 million in the segment line and $7 million below the segment operating income line. MEGIT acquisition-related expenses that we've incurred to date is $84 million. And finally, that deal contingent hedge that I mentioned, on a full-year basis, it's $396 million. We will continue to adjust transaction-related expenses. as they are incurred all the way up until we get to close. And a note on tax, our full year tax rate is down a little bit. We expect that to be about 21.5% for the full year. And when you do all the math, for us that equates to an EPS, adjusted EPS guide for Q4 of $4.60. This quarter we actually put another slide in here. It's a bridge on our guidance reconciliation. The Q3 performance that we had, we really outperformed our guide significantly. We beat our guide by 29 cents. We've rolled that into our full year guide here. And based on really strong backlog and order rates in North America specifically, we have increased our Q4 North American organic growth guide by 300 basis points. versus what we thought last quarter. And that really is generating about $0.08 of segment operating income in Q4. Tom has mentioned this, but the COVID related shutdowns in China are a near term temporary headwind for us in Q4. Obviously, Q4 is the end of our fiscal year here. We are estimating that to impact Q4 sales by $100 million. We're using a 40% decremental on this $100 million which is greater than what we normally operate at simply because a number of our facilities are fully shut down. So we are confident that the facilities that are operating in China and those others in the international segment are going to be able to perform, but we're using a 40% decremental on just that $100 million of near-term headwind. That equates to a 24-cent EPS headwind going into Q4. All the other items net to a slight EPS reduction of three cents, and that really is the walk on how we get to our new guide of 1815. So before I turn it back over to Tom, I just want to make sure everyone saw the press release that we issued on Tuesday with Robin announcing her retirement plans after what will be almost two decades with Parker Hannifin. And Robin has really been a driving force within the company, really helping us to transform our M&A processes, our long-range planning, and of course, serving as our voice and our biggest fan with the investment community. She has put forth timeless effort to champion PeerW, which is our first business resource group that is focusing on developing women leaders, and that will leave a lasting imprint on partners. Robin, all of us here, we couldn't be happier for you, for your husband, Scott, as you transition into the best phase, the next phase of your life, and we thank you very much.

So I'm going to just pile on while we have Robin blushing and embarrass her no more. She's just done a great job. I've had a chance to work with her for 20 years. If I think about her deal-making skills and what she did once she led M&A and her ability to finance all these transactions, which isn't the easiest thing, and like Todd said, the investor relations, and you've all experienced it, her ability to be the top spokesperson for the company, just an outstanding leader. We're going to miss her, but thankfully, she's given us lots of lead time here, and she's not leaving until the end of the year, and we'll get every ounce out of her that we possibly can over these next several months. She's nodding her head in agreement. So the last slide, slide 16, You know, we have a highly engaged team. They're the people behind these results. Their ownership, their engagement is driving our success. You saw the EPS and the margin expansion just phenomenal. It speaks to the wind strategy. It speaks to the portfolio changes. We are a longer cycle, more resilient company. And we've got great alignment to the secular trends that I referred to earlier. And we're going to help the world as it moves to the clean technologies to be more sustainable. We gave you a new guide. feedback on where we're headed for FY27 with continued improvement across the board and really a transformed company with a bright, promising future. Again, my thanks to everybody on the global team. Just a fantastic quarter, fantastic year to date. And I'm going to turn it back to Paul to start the Q&A.

Thank you, sir. We will now begin the question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad Again, please press star followed by the number one on your telephone keypad. Please stand by while we compile the Q&A roster. Your first question is from Scott Davis with Milius Research.

Please go ahead. Good morning, everybody, and congrats, Robyn. I did not see the announcement. You will be missed. We appreciate your help over the years. I wanted to talk a little bit about your results. I mean, it doesn't seem like supply chains hurt you guys really at all. I mean, you had 11% core growth in a zero GDP world. So was there a tangible impact to supply chains on being able to get stuff out the door in the quarter? It sure didn't seem like it could have been much.

Scott, as Tom, supply chain is still a challenge. I would characterize it, if I take chips out, I'll come back to chips in a second. that is stabilized, but stabilized still at a fairly inefficient level. It really hasn't shown much improvement over the last several quarters, nor are we forecasting that. Obviously, we're not forecasting very far out here for the rest of our fiscal year, but I think it's going to be a challenge as we go into the rest of the calendar year. What we did see worsen was chips, and that continues to be a challenge. But I think why you've seen us perform maybe better than most has been our ability to work local for local Our supply chain has been built around that for years. And while we continue to want to localize even more, we kind of had a running start against a lot of this. We've been active on trying to increase tool sourcing. And our engineers, we spent a fair amount of time with our engineers working to develop alternative materials that would be qualified with our customers, materials that are even more readily available, especially on the chip side. We're qualifying alternative chips. And some of our... engineering materials products where some of the chemicals, et cetera, were difficult to get. We've been qualifying alternative materials there. So I would put, say, in doing all of the above and just an awful lot of elbow grease and work in the factories and the warehouses to make this work. This is not the easiest environment, but the team did a great job with it.

Yeah, it certainly seems so. The example you gave on natural gas to hydrogen was kind of interesting, and I It begs the question of does the competitive landscape change as you go to the more complex hydrogen applications? I mean, my understanding is that the specs have to be pretty darn tight in hydrogen. It's a highly volatile material. But does the competitive landscape change at all, or do you think the competitors will be there, the similar competitors will be there?

Scott, it's Tom again. I think it does change a little bit. I think it thins out. because I think there's fewer people that can do the kind of things that we can do in that area. The fact that we've already developed a lot of these cryogenic solutions puts us in a running start with that. Yes, we had to look at hydrogen embrittlement and make sure that there's material compatibility, which we're doing. And then the advancement we've had in engine materials and the fact that we have that technology in addition to all the other technologies, because, like I mentioned, the big challenge with hydrogen is sealing a molecule that is much smaller than and prone to leaking and then two-point volatile. And so we're doing investments as we speak. We just looked at that early this week. We had a clean tech review with all of our groups, and we're investing in that right now so we can be ready for one that does come to market.

Okay. Sounds good. I'll pass it on. Thank you. Appreciate it, and good luck, guys. Thanks, Scott.

Your next question is from Meg Dober with Bayer. Please go ahead.

All right. Thank you. And Robin, all the best. Congrats. Tom, I want to go back to your comments on North America. You really kind of highlighted this geography as accelerating maybe relative to the others. And I'm wondering, what are you seeing that's differentiated or special here? And let's leave the China COVID lockdown to the side, because that part is pretty obvious. And I'm curious, when we're looking at the sequential acceleration in order intake, are you actually seeing better volumes, or is this just a function of higher pricing given, you know, everything that's happening on a commodity fund?

Well, I think in North America, as Tom, I think North America has gotten on top of the horse, so to speak. You know, the supply chain challenges we had were the most pronounced in North America. They had more work to do. or work to do on logistics, on dual sourcing, on qualifying alternative materials versus the other regions. And I think you see the benefit of some time and good work by all the teams, which was evidenced in their MROSs improving, you know, as you go through the course of the year and them having their best ROS quarter to date and leading really all the segments. So North America clearly has gotten on top of it and made a lot of progress. to that vantage point. There is good volume improvement really across the world. Obviously, I think most of that volume improvement has been in North America and in aerospace because aerospace with their long-term contracts were somewhat shielded from the inflation pressures there. So they've benefited from the volume as well.

Okay. Okay. And then my follow-up, I'm curious, as you're looking at your international business, maybe Europe specifically, are you sort of seeing any change in the pace of business, customer confidence, whatever you want to call it, as a result of this situation in Russia and Ukraine? How did April progress for you maybe relative to March, if you can comment on that? Thanks.

Well, on EMEA, I would say, again, it's Tom. It's probably too soon to know for sure how the whole Russia-Ukraine process is going to play through. Obviously, Russia and our hearts go out to the Ukrainian people, and we've done a lot of our philanthropic work has been to help all the people that were involved there. But it's small sales for us. It's immaterial. Obviously, the human toll is huge. The sales toll is immaterial. But our orders for... you know, if I look at Q3 versus Q2, we're roughly the same. They were in the low teens. I'm talking about EMEA. We do forecast sales. You know, sales, you break out the international piece, and EMEA was 13% for Q3. We are forecasting it to soften in Q4 to 5%. So we do anticipate some moderation there. Some of it is comp. Some of it is based on what we're seeing with the orders, and that's all baked into our guide. But I think to fully understand... what the second derivative is of all the Ukrainian war, I think we're going to need more time to see how that plays through.

Understood. Thank you.

Your next question is from Jeff Sprague with Vertical Research. Please go ahead.

Thank you. Good morning, everyone. Congrats, Robin. Hey, just a couple of maggot-related questions, if I could. First, Todd, on the FX hedge, are you completely economically neutral at close on this? Obviously, the dollar has strengthened a lot against the pound, which impacts the ultimate out-of-pocket. If you could just clarify that, and also, Any color on whether or not your funding costs to ultimately consummate the deal have moved materially here?

Yeah, Jeff, thanks for that question. On the deal contingent hedge, what we did is we locked in a pound-dollar rate. I think we did that in September time period. Obviously, a lot has changed across the world in the economic landscape since then. We still are confident that that was the right thing to do. It has made our certain fund process, as we go through the transaction, certainly much clearer and much easier. Most recently, and you've seen the pound to the dollar, really the pound weak and the dollar strengthen, that has created these accounting transactions that we have to record each quarter. So from an economic value standpoint, we're working through that right now. Obviously, there's a lot of moving pieces with the valuation and the purchase price accounting of all that stuff, but we're confident that we're going to like the result that we have. As far as the financing goes, you know, we've done a lot of work on this with our team, with our advisors on this, and really what we found is the – increasing interest rate environment is pretty much priced into the market. So, you know, just on a high level, the way we are attaching that is really based on our strong cash flows. We are just leaning towards more of a mix of serviceable debt on the transaction. So when you look at this compared to the last large deal that we've done, The financing plan is basically using the same methodology, and they're about the same costs in total. So more to come on that, Jeff, but we feel good with where we're at in respect to financing and the pending transaction.

Great. And then thanks for the color on the approvals and what remains. Would the U.K. national security be the longest pole in the tent here, or – Should we think about the remaining items as roughly equivalent and on the same timeline?

Jeff, it's Tom. It's hard to predict that, but we've had a lot of discussions with the U.K. government. There's a couple tracks. There's the economic considerations, which are really the things we had in 2.7, the national security considerations. There were a number of discussions with them. And then you have their antitrust process as well. I can't predict who will go first, just that the list of who's in the outbox is increasing, and it all bodes well that we're getting closer to the end. And I think you'll see them probably all kind of go roughly in about the same time frame would be my guess.

Great. Thanks for the caller. Good luck with that.

Your next question is from Jamie Cook with Credit Suisse. Please go ahead.

Hi. Good morning and congrats on a nice quarter. I guess, you know, first just a, you know, modeling question that looks like the aerospace margins, you know, get a nice bump in the next quarter. So is there anything unusual, you know, driving that or I'm just trying to understand what that could potentially mean for the trajectory. into 2023 as aerospace starts to improve? So that's my first question. And then I guess my second question, again, very good organic growth, Tom. The market's very concerned about a slowdown and people are using the R word. Just wondering if you could talk to how you think your portfolio could perform in a slowdown, you know, are some of the market share gains, are you getting market share, and could that, and the pricing dynamics, could that help, you know, make your sales more resilient, assuming we're going into, you know, a downturn over the next, you know, six to 12 months? Thanks.

Jamie, it's Tom. So I'll start with the first one, the aero margins. You know, Q4 is naturally our highest margin in aerospace, typically based on shop visits and the exposure with the summer, et cetera, for aircraft and engines. And then also, it's been driven by the commercial MRO activity increasing as it's growing at the fastest rate. That happens to be our highest margins, which is why you see them performing like they do. Now, coming back to, you know, this question happens all the time as far as, well, how will Parker do during the next recession? And I'm hoping that You go to that slide that I mentioned in my prepared remarks. It's my favorite slide that shows the margin in EPS expansion. That has two industrial recessions, a pandemic, and, of course, everything we're experiencing today all in it, and you've seen us move pretty much at a 45-degree angle. So I think you could rest assured this team has proven its resilience to weather any recession, and if it happens, we'll weather it the same way we have in the past. But I would argue to your point that, that the company is significantly different. You know, in Investor Day, we went through the longer view of the company between the wind strategy and how the portfolio has dramatically changed. Now we've doubled the size of engineering materials, filtration, and aerospace, and that's going to allow us to grow differently. And when we showed you that five-year vision, those who maybe didn't see it, there was a mix of short, long, and aftermarket. And when we get out to FY27, If I add up the long and after markets, roughly 85% of our sales mix. So that's going to have us operate much differently. Now, if you go to say, well, Tom, I don't care about five years. I'm worried about what's happened in the next 12 months or so. I think I would come back to our ability to perform is proven in good times and bad times. And we have the benefit of the beginning of our commercial aerospace recovery, which is going to help us. We have that linkage to the secular trends, much more so than we have in the past, which, okay, they could get impacted. I'm talking electrification, digital, aerospace, and clean tech, but they're probably not going to get impacted the same as any of the traditional end markets. We have mega coming on board, so we get a lift from the acquisition just from an incremental revenue there. We're going to have the synergies, et cetera. And we have a company that is dramatically leaner, more agile, proven by what we've done the last seven years. So we're ready, you know, The last quarter, I was being sarcastic when I was referring to it as a normal quarter. I think, if anything, we've proven to be a very resilient team and the ability to be flexible and nimble, and I think you'll see that going forward.

Okay, thanks, and congratulations, Robin. Thanks for all the help. You've been fantastic.

Thanks, Jamie.

The question is from David Rosu with Evercore ISI. Please go ahead.

Hi, thank you, and best of luck, Robin. A quick question on the China getting back to full production in July. Can you just give us a little more color on your confidence in that? And then also, I mean, historically, you've sort of gone through 312 pressure curves through the key markets. Obviously, the North American orders were strong, but I'm just curious, are there any areas that you're seeing the book to build or the 312 pressure curves that you track that are starting to show, you know, those are some of the short cycle businesses that maybe are showing a little bit of cracks or we're just not seeing any cracks anywhere in the North American market at this stage. Thank you.

David, it's Tom. So I'll start with a full production comment in China. If you notice, we put Q1. We didn't say July. We said Q1. And the first thing I'll say, it's an educated guess. Obviously, I'm no smarter than anybody else, and only President Xi knows when those lockdowns are going to turn around. However, a couple of things, just, you know, part of what we have to do when we forecast is use some pragmatic thinking and a little bit of history. So we go back to when China went through its, you know, the beginning of COVID, it had a pretty rapid rebound compared to the other regions. So some of that was factoring into our equation. And then just thinking about the practicality, how long can you practically keep people locked up in their apartments and their homes? And it started, you know, middle of March. And so there's a point of diminishing returns here where the people are going to have to come back, the factories are going to have to come back. And so our best guess is sometime in Q1 of FY20. I'm not saying it's July, it could be August, it could be September, and I could be wrong in that too, but we had to pick. The whole point I was making about that comment is that it's temporary. This is not a permanent situation in China. And if we look at FY23 and if we look at China, we would make up whatever happens here in the next several months because we have another 12 months ahead of us to make up with that. Now, in your comment related to end markets, we have over 90% of the end markets positive and virtually with the exception, you know, everything is positive with the exception of aerospace, military, and PowerGen, and that's our outlook for Q4. It feels the same, and the pressure curves look good. We still feel very good about what's going on. Broad-based, I would describe it.

And last quick clarification. The aerospace, it's rolling 12 months. I appreciate that. When does that large order that's making for the difficult comps roll off in that calc?

Yeah, David, I could take that one. This is Todd. We probably still have another two quarters to get through that. If you remember, we just started calling that out last quarter. This is the second quarter we've called it out. So we've got two more quarters to go.

All right. Thank you.

Your next question is from Joe Ritchie with Goldman Sachs. Please go ahead.

Thanks. Good morning, everyone. And I would echo all the comments about Robin. Really, really great working with you and wish you the best. First question on industrial, on the global business. So just looking through the guidance, it looks like you're kind of forecasting a mid-single-digit decline. And you had a pretty high decremental. I'll call it high 30s decremental. I know that the comps are tough. in 4Q, but is there anything else that you want to call out for the 4Q number?

Joe, are some of you referring to sales or margins?

Yeah, so if my math is right, it looks like sales are expected to be down year over year, margins also down, call it more than 100 basis points. I'm just trying to parse it out and see whether there's some conservatism in there or You know, you guys are seeing something specific to 4Q for the international business.

Okay. So, well, margins total for the company, 22.2 is what the effective Q4 guide is. We did 22.2 last year, last Q4. And we see expansion in North America. North America margins expand. Aerospace margin expands. And then Asia, international margins decline. A little bit is still coming in. Our implied guide is right around 21%, and that's because of the China shutdown. So, you know, really good margin expansion in the areas outside of the China shutdown. And on the top line, you know, Todd referred to this, that we bumped up North America organic guide by 300 bps. I'm going prior guide to new guide. Bumped up aerospace by 50. And, of course, you know, we took down international. So maybe to calibrate people, the effect of the China shutdowns we would increase total guide for Q4 by 250 pips if that was running normal, and the total international would go up 650 pips. So it's a pretty big impact, which is weighting down international.

Got it. Okay, that makes a lot of sense. And then also I kind of wanted to ask about Aero also, more from a near-term perspective. I recognize you guys are – kind of calling for some good growth year-over-year on the margins as well. Sequentially, though, it doesn't really seem like the margins are expected to pick up in the fourth quarter just based on the full-year guide. Is this anything that, like, you would call out from a mixed standpoint in the fourth quarter versus the third quarter or, you know, still seeing good mix coming through in 4Q as well?

Hey, Joe, this is Todd. I could take that one. You know, what we've got in the fourth quarter guide, you're talking specifically for aerospace, right? Yes, that's right. Yeah, we actually are improving margins, you know, from Q3 to Q4. We did 21.9 in Q3, and, you know, we're right at 22.2 for Q4. So there is expansion there.

Okay. All right, great. Thanks, guys. I'll get back to you. Okay.

Thanks, Jeff.

Your next question is from Stephen Volkman with Jefferies. Please go ahead.

Great. Thanks for taking the question, and congrats, Robin. For me, I'm very impressed with the sort of incremental margin performance accelerating here, and I'm wondering just kind of directionally how we should be thinking about that for 23. Is there some reason that it would revert to kind of a long-term average, or Do we get to enjoy a longer period of a little bit higher incrementals?

Steve, this is Tom. I'm going to probably not make any specific comments about 23. I think you can appreciate there's a lot of things that change. We're one of the first companies that has the good fortune to talk about 23, and so I won't talk about it a month sooner than I need to. However, in general, when I've articulated incrementals, they tend to reflect at your highest point at the beginning of an upturn, they start to moderate, and then you use 30%, you know, kind of an over-the-cycle type of number, and that means you're deeper in the cycle, it would go below 30. So we'll see as the numbers roll up and as we forecast, but I continue to, you know, we gave you our five-year look. I think we had incrementals in that low 30s over the course of the next five years to get to those five-year targets, and so that's, you know, we need to do that consistently somewhere over the next five years to hit those five-year targets, and You've seen our track record on doing that. We are pretty good about our say-do ratio on the five-year targets. So we'll see what happens, but the company is clearly in better shape and better condition to generate those incrementals.

Okay, yes, agreed. Well, it's worth a try. Maybe I'll shift to ask you about distribution, and I'm curious – you know, if there's any interesting trends you're seeing in distribution that are worth calling out as we try to think about the direction of everything here. And maybe you can add a comment on kind of distributor inventory when you do that.

Steve, it's Lee. So distribution as a whole, I would say, is going very well. I'll break it down a little bit. North America, all markets are very positive. You know, there's For those distributors that are covering the natural resource industries, that business is coming back quickly and specifically. Internationally, we continue to grow distribution, despite all the turmoil, about 100 basis points a year. So we've been making great progress on that. And I would say on inventory, everybody could use more. I mean, there's a great poll taking place. We're able to satisfy customers, but as a whole, distribution. If they could build more inventory, I think they would.

And are you seeing more price in the distributor channel relative to the rest?

Well, as you know, we've been very proactive on making sure we cover material costs and do the pricing that's necessary with that. And those distributors have been passing those price increases along.

Okay. Appreciate it, guys.

Thanks, Steve.

Your next question is from Nigel Coe with Wolf Research. Please go ahead.

Thanks. Good morning. And Robin, congratulations. Thanks for all the help. Going back to maggots and some of these currency moves, I'm guessing that the bulk of the functional currency for maggots is U.S. dollar. I'm guessing that the bulk of the cost base is sterling. Is that correct and correct? Because that implies that if we do have a structurally weaker sterling going forward, that should be helpful to margins. So just wondering if you could maybe comment on that.

Yeah, Nigel, this is Todd. You know, I don't think I could comment on that. You know, we are bound by the code. You know, we did, you know, mention, I believe, on the call, there's a significant mix of the mega business that is in the U.S. that obviously is dollar-based. So I think I'll leave it at that. Okay.

Yeah, the move is significant, so it's worth exploring. And then just things about international. So it looks like ex-China, so the kind of the ex-China business is low single digits in 4Q. So I'm just wondering if maybe you could just talk about, you know, what you're seeing geographically, you know, in international markets. And then, you know, would you encourage us to model the recovery of that $100 million of lost sales through FY23 at this point?

Yes, 100 million. We will recover some time in FY23, and obviously we'll embed that when we give you the guide here in August. But when I think about markets across the regions, in Q3, I'll just give you the regions. This is all organic numbers I'm giving you. You have both North America and EMEA, and mid-teens, Latin America, upper teens, aerospace, 6%, and then Asia Pacific was in the low single digits, and Asia Pacific was impacted because of China. China was down mid-single digits. The rest of Asia was up high single digits, and that's how you got to the Asian number. But when you look at end markets, it's pretty much across the board. As I mentioned on David's question, we have strength in 90% of our end markets. The only market that declined was aerospace, military, and power jets. So it's very broad-based. If I lift it up even higher, you know, distribution and industrial both going about the same rate and mobile a little bit slower, but it's been across all the segments.

Great. Well, thanks, Tom. Good luck.

Thanks, Nigel. Hey, Paul, I think we've got time for one more question.

Thank you, sir. For our final question, it's from Julian Mitchell with Barclays. Please go ahead.

Thanks very much. Good morning, and appreciate all the help, Robin. So, yeah, I guess my final question really just on the aerospace business, I guess two aspects. One is I think you toned down the sales guide a little bit for the year, so just trying to understand what drove that and whether you think on the revenue side the military headwinds abate entering fiscal 23. And then the margin performance for the year as a whole in aerospace is kind of exceptional on the operating leverage this year. Is there any way you could parse out drivers within that around maybe synergies or lower R&D, just so we can sort of use our own math to get to the sort of forward incrementals next year?

So, Julius, Tom, you know, what's driving aerospace, if I just give you the two key components, is performance. the commercial recovery. Our growth in Q3, commercial MRO was plus 31% and commercial OEM was plus 21%. So those two, and when I get to the full year, plus 27 for commercial MRO, plus 17 for commercial OEM. And I think actually when I look at my numbers, we bumped aerospace up 50 pips in Q4 versus the prior guide. So we see aerospace as positive, the order entry Again, once we cycle over the multi-year military order, which we've been trying to give you visibility of that, that was plus 20. I mean, the orders that we had, you know, commercial OEM was over 100%. Commercial MRO was 60%. So, you know, gigantic orders. And what you've got right now offsetting that is the military piece, which everybody tracks lots of companies. The military piece for supplier health, a lot of the OEMs pulled in, military business into FY21, which makes the comparable in 22 difficult. But we'll cycle through that, and we'll, you know, military will eventually get back to kind of a low single-digit type of growth. So I'm very bullish on aerospace. You know, we don't have any of the megacenturies and that kind of stuff into it now. But I, you know, we have the same goal for aerospace as we do for everybody else, trying to get to 25% ROS over the next five years and a We've got a great acquisition in which we've shown what that synergies brings that the mega business up to a 30% EBITDA once we get to the end of those synergies. So we have a lot of things that will help us with aerospace.

And thanks, Norman. Is there any kind of outsized mix or R&D tailwind you'd call out for the margin performance in fiscal 22, you know, just overall in aerospace?

Well, in the current quarter, it was light, mainly due to timing, nothing unique there. I would say in general, it's a tad light, but it's going to be 2.5% to 3% for this fiscal year. It's going to probably be more in that 3 to 4 range if I go over that five-year period of time. But you won't see that hit in any material way, like a specific quarter or a specific year. It's going to, over that period of time, will grow the And still the R&D, but still by historical standards, that's a pretty efficient R&D spend versus what we were at the beginning of the super cycle for aerospace.

Hey, Julian, I would just add to that. If you remember at the pandemic when we made our adjustments, aerospace made the most aggressive adjustments from a cost basis. So we have obviously benefited from that throughout this year. Those costs are not coming back, so that would be another change from this year versus pre-pandemic levels.

That's great. Thank you.

Okay. That concludes our Q3 earnings call. I'd like to thank everyone for joining us today. Robin and Jeff are going to be here today if you have any further questions or if you'd like to congratulate Robin personally. I would just like to make sure everyone knows Robin is will be here through December 31st of this calendar year. So you definitely have time to congratulate her, hopefully in person, as we go throughout the year. And she'll be here for the next couple calls as well. So that is it. I'd like to thank everyone for their interest in Parker, and thanks again for joining us today. Thank you.

Ladies and gentlemen, that concludes today's conference call. Thank you for joining. You may now disconnect. Stay safe and well. Have a good day.