Parker-Hannifin Corporation

Good day, and thank you for standing by. Welcome to the Parker Hennepin Fiscal 2022 Fourth Quarter and Four-Year Earnings Conference Call and Webcast. 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 the session, you will need to press star 11 on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Todd Leonbruno, Chief Financial Officer. Please go ahead.

Thank you, Carmen. Good morning, everyone, and thank you for joining Parker's fiscal year 2022 Q4 earnings release webcast. As Carmen said, this is Todd Leonbruno, Chief Financial Officer speaking. And as usual, with me today are Tom Williams, Chairman and Chief Executive Officer, and Lee Banks, Vice Chairman and President. Today our discussion will address forward projections and non-GAAP financial measures. Slide 2 of the presentation provides details to our disclosure statement in these areas. Actual results may differ from our projections due to uncertainties listed in these forward looking statements and detailed in our SEC filings. Reconciliations for all non-GAAP measures along with this presentation have been made available under the investor section at Parker.com and will remain available for one year. In respect to the mega transaction, while we expect this transaction to close in Q1 of fiscal year 2023, that's our current quarter, we are still bound by the requirements of the UK Takeover Code in respect to discussing certain details. We do plan to hold an investor call shortly after the close to provide expanded color on the transaction once regulations allow. For the call today, we'll start with Tom discussing the fourth quarter and our fiscal year 2022 full year results. And I'll follow with a brief financial summary and review some of the assumptions around our initial fiscal 2023 guidance that we issued this morning. After that, we'll finish the call with the Q&A section for any questions you have for Tom, Lee, or myself. So with that, Tom, I'll turn it over to you and ask everyone to refer to slide number three.

Thank you, Todd, and good morning, everybody, and let me welcome everybody as well to the call. Starting with slide three, we had a great quarter. It was absolutely dynamite, record performance, great execution by the team around the world. The first two bullets really is what drove our success. You know, safety has always been our top priority. We're leveraging high-performance teams. Think of that as how we are organized around the world and how we engage and involve our people. Lean is how we run the factories, and Kaizen is our culture of continuous improvement and how we go about making things better. We also just conducted our 2022 engagement survey. We were able to capture over 90% participation of our people around the world, ask them questions around empowerment and engagement, and we got great results. We got results that put us in the top 8% of industrial companies. It's really these first two bullets that's driving an ownership culture within the company, driving an ownership for results and our business performance. Going down to the third bullet, sales were 4.2 billion. so an increase of 6% versus the prior year. Organic growth was 10% versus the prior year, so an excellent quarter organically. Segment operating margins was 20.9% as reported, or 22.9% adjusted, so that's a 70 base points better than prior year. This is really excellent margin expansion in the face of all the challenges that you're fully aware of, supply chain inefficiencies, inflation, and, of course, the China COVID lockdowns. So just really outstanding performance in a very difficult environment. Lots of records, and my thanks to the global team for all their hard work. Moving to slide four, talking about the full year, came in at $15.9 billion of sales, 12% organic growth versus the prior year. So a really big year for us organically. Record segment operating margin, 20.1% as reported, or 22.3% adjusted. That was 120 basis points. better than the prior year, really speaks to the robustness and the agility of our business model. Operating cash flow was $2.4 billion, and that represented 15.4% of sales. So a mid-teen CFOA with growing sales, which was very commendable. And then, of course, all of you hopefully are aware we announced our FY27 targets in the March Investor Day. And I'll just summarize. It was bigger growth. bigger margins, bigger cash flow targets, and we're confident in our ability to get there in the future. So a transformed company with a promising future. What drives us is on slide five. It's what's been driving us in the past, present, and will drive us in the future versus living up to our purpose, enabling engineering breakthroughs that lead to a better tomorrow. Being great generators of cash, as evidenced by the mid-teens, see it the way that you saw, and great deplorers of cash by our pending Megadac acquisition. And then being a top quartile company and how we perform versus our peers, which really goes to slide six, which I'd like to show this slide. It's updated now for FY22 numbers. And really, the reason for showing it is objective evidence that our company is significantly different, significantly better than it's been in the past. On the left-hand side is adjusted EPS, and on the right-hand side is adjusted EBITDA And I think the pace of improvement speaks for itself. You can look at this chart. Everything's moving high and to the right, and it's really great progress. In particular, if you look at 21 versus 22 on EPS, going from $15.04 to $18.72, at the gain of $3.68, it's the largest year-over-year dollar gain we've had on EPS in the history of the company. So that was a 24% improvement. On the right-hand side, almost 800 bps of EBITDA margin improvement, which is fantastic. And if you look at these two improvement trends side by side, arguably the most improved industrial company out there over this time period. And I'm hoping for the shareholders, a great company to invest in as well. Going to slide seven, I like the picture here. We're trying to symbolize that we're coming in for a landing here on Megan. We're close to the end. We expect to close sometime in Q1, our current quarter, FY23. The only remaining regulatory approval is the U.S. Department of Justice, which we expect to complete sometime in a quarter. And following the USDOJ, it's customary to go to court in the UK to get final approval, which we expect also in the current quarter. The timing here is perfect. We're adding a transformational acquisition, doubling aerospace at the beginning of a commercial aerospace recovery, and with the synergies in front of us to help us grow the top line and the bottom line. And as Todd mentioned, we'll host a call after this closes to bring you up to date on MEGIT and to update our guidance. Moving to slide eight, we're going to talk a lot in the Q&A about FY23 sales guidance, I'm sure, but I wanted to highlight the future growth drivers that we talked about in the March Investor Day. These growth drivers remain intact. I'm just going to walk you briefly through the five columns that you see here. The first is our business system, the wind strategy. It's about the things we can do ourselves to grow differently organically. It's about innovation, strategic positioning, distribution growth, incentive plan changes that we're making, and simple by design. Go to the next column, the CapEx changes that we expect over this time period. We think this will be a very constructive time for industrials. There's going to be a need to invest in supply chain development, dual sourcing, automation, all things that are going to be very helpful and need to mark our products. Regarding channel restocking, in particular here I'm referring to the distribution channel, it's improving, but there's still ways to go. And I think our partners will probably be somewhat cautious as they add inventory. But as we go out the next several years, they're clearly not at the inventory levels they'd like to be, so that's additional tailwind. The acquisitions are transformational. reshape the portfolio, doubling filtration, doubling engineered materials, doubling our aerospace business once mega closes, and really reshaping the portfolio to be much more longer cycle, accretive, more resilient. And then our linkage to the secular trends around the world, aerospace, digital, electrifications, and clean technologies are all going to help us grow differently. So there's targeted organic growth by FY27, 46%. We think industrials and Parker in particular is going to be a very attractive space over the upcoming years. And with that, I'll turn it back to Todd to talk more about the quarter.

Okay, thanks, Tom. I'm going to start on slide 10. This is just a year-over-year comparison of our Q4 financial results. And as Tom said, really proud of our team members for just delivering across-the-board record results against the backdrop of several continued global challenges. So Tom mentioned that sales was up 6%. We did hit a record sales number of $4.2 billion in the quarter. Organic growth was double digit at 10%. I think everyone's following these currency rates. The strong dollar drove currency headwinds for us. It was a minus four impact to sales. Our backlog remains healthy. It did increase 21% versus the prior year. And over 90% of our markets are in growth phases. So we're very happy with that. Two markets to note, commercial aerospace and North American industrial markets are two that really remain very robust. Adjusted segment operating margin was 22.9% for the quarter. That's a 70 basis point increase versus the prior year. And our adjusted EBITDA margin was 23.1. That's 100 basis point increase from prior year in the quarter. Both these margin numbers, segment operating and EBITDA margins, exited the year at the highest levels of our fiscal year. So really happy with the strong finish that the team put forth in Q4. When you move down to net income, adjusted net income was $671 million. That's a 16% ROS. It just also happens to be a 16% improvement from prior year. And again, I'll just note, due to the continued strengthening of the dollar, specifically versus the pound, we did record a pre-tax non-cash charge in the quarter for $619 million. That is related to the MEGIT deal contingent currency contracts. And I just want to remind everyone that these contracts, we entered into these contracts really to eliminate currency exchange rate risk associated with the purchase price of the MEGIT acquisition. And the total expected U.S. dollar outlay related to the transaction included in these contracts is neutral to the transaction consideration we announced last year. So moving on to EPS, EPS is great, $5.16 on an adjusted basis. That is a record. It's an increase of 78 cents or 18 cents or 18% versus prior year. Really strong results there. And I really just commend our team for the strong finish for the fiscal year. If you move to slide 11, this is just the bridge. This details some of those elements of the 78 cents improvement. We did generate 35% incremental margins. That was really aided by our margin expansion, but more significantly, just very solid execution across every one of our businesses. Adjusted segment operating income increased by $80 million, or 9%, versus the same quarter last year. That accounts for over 60%, or 47 cents, of the EPS improvement that we had in Q4. If you net corporate G&A, interest expense, and other, all that amounts to just one cent favorable, And we did have a few discrete tax settlements in the quarter that drove a lower income tax expense. That did calculate to a 24 cent positive impact to EPS. And that was specifically in our fourth quarter. And then finally, just a slight reduction in the number of shares outstanding accounted for a favorable 6 cents to EPS. So all in, that's the 18% increase in adjusted EPS, or our $5.16. If you move to slide 12, I'll talk a little bit about the segments. Across the board, very strong performance here, 35% incremental margins. We increased segment operating income really across the board, and it's really just nice to see positive organic growth in every segment. That growth continues to be very broad-based. Orders for the total company ended up positive three. and that really is against a backdrop of increasingly more challenging comps. And the team really remains agile in this current supply chain and inflationary environment. We're happy with our actions. It is materializing and results in the financial statements and just really proud of all the effort that's going on here. All of this gives us performance or confidence in our performance that we will achieve our FY27 targets that Tom mentioned we just announced. just back in March. So if I jump into the businesses in North America, very strong organic growth, 15% versus prior year. Sales reached 2.1 billion. Adjusted operating margins, increased 40 basis points. Our North American team achieved 22.9% ROS. And really, you know, we've talked about this all year. They continue to manage well through a more difficult regional supply chain environment. So just kudos to them. Incrementals in this segment was about 25%, so we're happy with that, with all the headwinds. And really, orders continue to impress at plus 10%. In the North American segment, our backlog is up 50% versus prior year, and it did grow 5% sequentially from Q3. Moving on to international, international sales, $1.4 billion. Organic growth just above 5% for that segment. Organic growth in EMEA in Latin America was mid-teens positive, with Asia-Pacific mid-single digits negative. Obviously, that was driven by the shutdowns in China based on the COVID outbreak. But margins, if you look at margins, margins were 22.4% and still increased 30 basis points from prior year despite all those challenges. And really just tremendous effort from our Asia-Pacific team. We forecasted a $100 million increase negative sales impact based on the shutdowns at the time we talked last quarter. The team really out achieved and that ended up being only a $50 million impact for the quarter and it was really a strong month in June. So much appreciation to our super dedicated Asia Pacific team. They really went above and beyond to serve our customers. International order rates did inflect to a minus four, which did reflect some short-term impact from those shutdowns in China. But great overall performance by the international team. Looking at aerospace, another strong quarter from aerospace. This is the best organic growth and margin performance that that segment has had all year. Sales were $676 million. Organic growth is about 8%. Commercial businesses in both the OEM and MRO markets are very, very strong. And the operational margins increased 260 basis points. and finish it in impressive 24.2. Those Q4 margins did benefit from a favorable mix, aftermarket mix, and lower than expected NRE expenses that were really just due to some program timing. So this is really a record margin performance for that segment, and I still note that we are still below pre-COVID sales levels. So we're very happy with the cost controls and the execution in our aerospace business. A note on orders. Aerospace orders are showing flat, but if you remember, we've talked about this. We did have some very significant military orders that we booked in Q2 of our FY22. That continues to make our 12-year comparisons difficult. If we exclude those items, aerospace orders were positive 24% for the quarter, and our aerospace dollars in respect to orders continues to remain really strong. So overall segment performance very, very strong and I'm proud of our teams. It's really a testament to our strategy and our purpose. So if we jump to slide 13, cash, we had an unbelievable cash flow generation quarter in Q4. It was really stellar. We did exceed the forecast that we gave in Investor Day for both cash flow from operations and free cash flow by about $100 million for the full fiscal year. Tom mentioned this, but we generated $2.4 billion in cash flow from ops. That was 15.4% of sales. Pre-cash flow is $2.2 billion, or 13.9% of sales, and obviously the conversion is 168%. We really have been managing working capital very diligently throughout the year. As our year progressed, that use of working capital began to normalize across the company. If you look at this year, the change in working capital was a 1.6% of sales use of cash. If you're comparing that to prior year last year, that was a 1.0 source of cash. So we are very disciplined. Our teams are focused on generating top quartile cash flow performance. And again, we're really confident that we can achieve that FY27 target of 16%. Just a few comments on leverage at the end of the quarter. Gross debt to EBITDA was 4.7. Net debt to EBITDA was 4.5. That increase from last quarter is really a result of our issuance of $3.6 billion of bonds that we will use to fund the MEGIT transaction. That cash is sitting in escrow. It is on our balance sheet listed as restricted cash. If we exclude that restricted cash, our net debt to EBITDA at the end of June was 2.0 times. So happy with the reduction there. The spike is just really preparing for the mega transaction. And just one final note on our strong cash flow performance. We've already used $1.5 billion of cash that we've generated this year to fund the mega transaction. So we are really happy with our position on that, and we're looking forward to getting to close and welcoming all the mega team members into Parker-Hannifin. Okay, if we go to slide 14, guidance, this is just some detail on the guidance we released this morning. As usual, we're providing this on an as reported and an adjusted basis. And I think everyone caught this, but just to be very clear, while we expect that mega transaction to close in this quarter, we have not included any sales or earnings in our guidance number. However, we have given you color on the interest expense that is already committed for Q1. And I'll give you some more color on that in a second. So no sales and earnings, just the Q1 interest that we have already committed to in our Q1. So if you look at sales, reported sales growth for the year is forecasted to be flat to 3% or 1.5% positive at the midpoint. Organic growth is obviously better than that. It's expected to be 3.5% at the midpoint with a range of 2% to 5% on that. As usual, we're using currency rates as of June 30th. We do forecast currency to be a headwind this year. It will be about a 2% headwind to sales versus the prior year. And as usual, if you look at the split, our sales are 48% first half, 52% second half. Moving on to segment operating margins, our as reported segment operating margin guidance is 20.4%. On an adjusted basis, that's 22.5%. That's at the midpoint. We have a range of 20 basis points on either side of that. And the split of segment operating income is 47% first half, 53% second half. We are forecasting incremental margins to be 30% for the full year. And just to give a little bit more clarity on a few additional items, corporate G&A, we expect to be $204 million in FY23. The interest related to the legacy company, so this is excluding MEGIT interest, is expected to be $228 million, and that MEGIT-related interest that will cover Q1 only is $42 million, or roughly 25 cents of EPS. We will give you an updated interest expense number once we schedule that update call that we have post-close on MEGIT. Other income expenses expected to be $14 million. And as usual, any acquisition related expenses that are associated with the mega transaction, we'll continue to book those as incurred. We're not going to guide for those. We will just adjust those out as they incurred. We do expect the tax rate from continuing ops to be 23% next year. That is essentially what our continuing ops rate was this year. That does not include any discrete items that may be favorable or unfavorable. And finally, we expect full year EPS on an as reported basis to be $16.53 at the midpoint or $18.50 adjusted. And the range on both of those figures is plus or minus 40 cents. EPS is split 46% first half, 54% second half. And just a little color on Q1, we foresee Q1 adjusted EPS to be $4.13, and that's right at the midpoint. And then just a little color on those adjustments. It's really just the acquired intangible asset amortization, which is now $300 million, and expected business realignment charges of $35 million. So we try to give a lot of color there. We hope that that was helpful. Slide 15 might give a little bit more color. This is just the bridge and really the highlights here. It's really just continued strength and demand across the board. Obviously, our productivity initiatives and our expectations across all of our operations increases segment operating income on a year-over-year basis. The total is $0.49 EPS of increase. And I just want to note that that does include an estimated headwind of approximately $0.40 based on currency. So in a constant currency, obviously, that $0.49 would be $0.89. But we're incorporating that 40 cent currency headwind so we get a 49 cent increase in segment operating margin. When you look at corporate G&A, that legacy interest and any other items, those are all forecast to be favorable to prior. Those actually help us by nine cents. And then again, that forecasted tax rate of 23 cents creates a 55 cent headwind compared to that lower tax rate that our actual rate was in FY22. I just would note there on that, our FY22, we always have discreets. We don't try to forecast them because they move around so much, but our FY22 did have a higher than normal amount of discrete items. That's just a little color on there. As I mentioned earlier, we've included that interest expense. You can see the bridge there. It's 25 cents. It's $42 million. That is the Q1 amount only. And that's how we walk from our FY22 finish to legacy 1875 or including that 25 cents of mega 1850. So with that, that's my color on guidance. Tom, I'll hand it back to you and ask everyone to move to slide 16.

So just to wrap things up before we open up Q&A, it was a record, FY22. Probably easier to say, well, it was not a record. There were so many records to speak of. A challenging environment, but just my congratulations to the entire global team for just a job well done. It's been our people, the portfolio changes, and the second bullet there, the changes we made to the wind strategy, specifically wind strategy 3.0, that have driven over this period of time 800 base points, almost 800 base points of EBITDA margin expansion. We're positioned to pour well in FY23, and it's really because of the remaining items you see on this page, the last three bullets. The portfolio is dramatically different, reshaped from where it was in the past, with mega closing in this quarter. Very few companies are going to be in a position to add a great company tied to future growth and synergies like we will be able to do. And then we're positioned for growth with the secular trends, aero, digital, clean tech, and electrification. So hopefully you feel, as you see in our numbers, a transformed company with a promising future. And with that, I'll turn it over to Carmen. to open up the Q&A.

Thank you, sir. And as a reminder, to ask a question, simply press star 11 on your telephone. One moment for our first question. Our first question comes from Jeff Sprague with Vertical Research Partners. Please go ahead.

Thank you. Good morning, everyone. Not sure if I'm going to cross any lines with this mega question, but I'll just give it a try. You know, they reported today, as I'm sure you well know, and they put up a 17% EBITDA margin. Just thinking about the trajectory, you know, from your slides last year, right, you had them at 19% in 2019, dipping to 14 in 2020. Clearly on the upswing now. Are you able to in any way address whether kind of the aggregate results there are, in fact, in line with your original deal case?

Jeff, it's Tom. Yeah, thank you for the question. Yes, we feel very good about MECA's results. They're growing faster actually than we had expected and faster than Parker Aerospace. They grew at 11% for the last six months. Their EBITDA held in there at 17, as you mentioned. And, you know, we projected, you know, as we looked at this, as they get back to pre-COVID levels, that would put them at the 19% and hopefully maybe better. And then with the 300 million of synergies, so they're still on a trajectory when we put the two companies together to get that back to that 30% EBITDA for mega. So we feel very good about what the job that they're doing. And frankly, we can't wait to officially welcome them to the team.

And just then on, I guess for Todd, on this interest expense, just to be totally clear, this 25 cents or 42 million just ties to the permanent financing you did, right? So on... On close, obviously, there's going to be additional interest expense in the equation. It sounds like you're going to, you know, kind of fine-tune that for us when you do close, but just want to be kind of clear on that and any other color you could provide there.

Yeah, it's a good question. You're right. The majority of that $0.25 is related to the longer-term debt that we issued. There is a slice of some CP in there, but the vast majority of that is the bonds that we issued in prep for that. And you're right, we will give you a full look at the financing and the interest layout post-close, and we'll fill in the rest of the quarters for the year on that.

Can I just take one more? Are we still looking at kind of a $70 million gap, so to speak, between GAAP accounting and IFRS accounting as it relates to R&D and other items?

Yeah, Jeff, I don't know if we can answer that, Jeff. We're still kind of looking at that. Obviously, post-close, that will be part of what we get color on.

Great. Thank you. Good luck.

Thank you.

One moment for our next question, please. Our next question is from Joe Ritchie with Goldman Sachs. Your line is open.

Thanks. Good morning, everyone, and congrats on the night here.

Thanks, Jeff.

Maybe I'll just kind of start to maybe parse out a little bit more of the guidance that you just gave for 1Q. The 413 number, obviously, you know, adjusted for the interest expense would have been, you know, kind of more like 438. Can you maybe just give us a little bit of details on the trends that you saw exiting the quarter and what the expectation is, either from growth or from margins for the core business in 1Q?

Joe, it's Tom. So I'll talk about the first quarter, but I'd like to lift it up and maybe talk about the whole year as well, because it kind of goes hand in hand with our thinking there. And maybe if I could start with it. We always relish, and I'm being a little bit sarcastic, being one of the first companies to talk about calendar 23. It's a difficult spot to be put in. And this forecast period is probably a little more complex than others, as we have a lot of unprecedented actions that have somewhat unknown consequences things that you're all familiar with, quantitative tightening, rising interest rates, inflation, the dollar strengthening, energy costs and availability in the Ukraine war. So it's a list that we really haven't faced and forecasted into. But we've got strong backlogs. We've got resilient order entry. We're very pleased with the order entry that we showed for the quarter. And actually we saw, even though international was minus for the quarter, and that was really influenced by EMEA and Asia in the month of June, in particular Asia with the COVID shutdowns. We saw international orders come back quite nicely in July, kind of in that mid to upper single digits. So our guidance really includes our AI model, the inputs from the divisions, customers, and distributors, and we still see broad-based growth. across almost all of our end markets. We've got almost all the end markets positive. If I could maybe go deeper into some of the secular areas, aerospace, which you saw at the midpoint at 6.5%, we've got greater than 10% for commercial OEM and military MRO, high single digits for commercial MRO. We're soft on military OEM. versus some of the initial provisionings of the pull forward that happened on the F-35 and the 135. That'll turn around in FY24. So aerospace in general, really, really positive for the whole year. That whole digital thread through the company is going to grow in that mid-single to high-single digits. And what I'm referring to is in markets like semiconductor, heavy-duty truck, which is obviously needed to transport all these digital goods. lift trucks with 5G type of things, data centers, telecom. And then if I look at clean tech electrification kind of an aggregate, and if I look at automotive, ag, mining, construction, and you just cut the sliver of electrification that cuts through those, that's all growing at greater than 10%. I'm going to get to your Q1, Joe, hang in there with me. PowerGen is going to grow mid-single digits. That's a combination of renewables and conventional. And oil and gas, which has been soft the last couple of years, is going to turn positive, greater than 10%. So we've got LNG, CNG, and really kind of a return to investment here with, I think, the world recognizing as we journey from brown to green, we're going to need all shades of colors in between, and we're going to need oil and gas for many, many years. The other part I would remind people is not only are the growth rates of these secular trends faster, the bill of material content is higher. So our bill of material tends to be one and a half to two times traditional ice application. So now if I get closer to your question now, the first half, second half splits, first half, I'm talking about total company, five and a half percent organic, second half, two percent organic. And we've got Q1 at a little higher organic growth rate, kind of a high single digits, seven percent give or take. for that Q1. And that's what's coming off of the current orders that we've got. The fact that we saw international get better in the month of July is what really kind of framed our thinking for Q1.

Hey, Joe, I'll just add a little bit of color on Q1. Obviously, you called out the additional interest expense that we tried to highlight there. But tax rate is a big issue. If you look at our Q4 tax rate, it had those discrete items in there. We are guiding to 23%. And then you know this is a normal thing, but we do recognize a higher amount of equity-based comp in Q1. So if you're doing a Q4 to Q1 walk, that other line is higher than what we normally have in Q4.

Guys, I'll just keep it to that one question. Thanks for the detailed answer.

Thanks, Joe.

One moment for our next question, please. comes from the line of Scott Davis with Emilius Research. Please go ahead.

Hey, good morning, guys. Good morning, Scott. You're one of the few companies we cover that's generated real cash flow this quarter, and you didn't seem to have a whole lot of supply chain problems. I mean, is there anything that supply chain or that you would call out as an issue?

Scott, it's Tom. Part of why we've done this maybe better than most has been that strategy we've been utilizing for years, local for local. We've been focused on dual sourcing before dual sourcing became popular. And so that has clearly helped us weather this. But we're not immune. We felt it. Our team has done a great job, I think, scheduling the shops, working with our suppliers. I think the use of our lean techniques in Kaizen are all things that have maybe helped us perform better than others. If I was to characterize supply chain going forward, let's take chips out of it for a second. It has stabilized, and in our forecast period coming up, FY23, we're going to see slow, gradual improvement. I wouldn't characterize that we're going to be back to normal by the end of FY23, but making slow improvement, which will be good. As in this year, it was more of a struggle for the whole year. But chips is a different story. We're fortunate. We're maybe not quite as chip-dependent, obviously, as our OEM customers are. But certainly, our aerospace business, motion systems, in particular, those two businesses have a fair amount of electronic content. And that one, we're not forecasting really any improvement. We've done an awful lot of work. with our engineering team qualifying alternative suppliers, alternative materials across the board. And a lot of credit goes to them. We've been able to be very nimble and agile with expanding our available materials and supplies to satisfy demand. And we did that on chips, but chips is still a struggle. And for FY23, we're not forecasting any help on chips. I think it'll take beyond that time period to get better.

Yeah, Tom, I would just add, you know, working capital is a focus. We talk about it every week. Our teams are very dedicated to it and really did a fantastic job in Q4.

Clearly, you must have confidence in your supply chain to be able to have working capital improve like that. But, yes, I just wanted to clarify on guidance, the 2% to 5% organic guidance. I would imagine that Just based on pricing you did this year alone, you'd probably have a few points of price in there. But can you clarify on that, please?

Scott, you broke up about midway there, but I think you were asking about the guidance. You're probably asking volume versus price. Is that your question?

That's correct, Tom. Sorry if I break up.

Okay. All right. So as you know, we don't get into segmenting price for all the commercial reasons. suffice it to say as we go from that five and a half in the first half to two in the second half you know the volume is going to mimic that and probably when we look at a volume standpoint you know aerospace is going to be fine all year good organic or their organic growth actually expands in their second half versus the first half but on the industrial side second half will be weaker for all the things that you see out in the world and so somewhere in our q3 and q4 we will probably get to flat volume, slightly negative, somewhere in that time period. So that is in our forecast period.

All right. Good luck. Well done, guys. Thank you. Appreciate it, Scott. Thanks.

Thank you. One moment for our next question, please. Comes from the line of Stephen Volkman with Jefferies. Please go ahead.

Hi. Good morning, guys. Thanks for taking the question. I'm wondering, maybe somewhat on the same topic here, presumably despite the fact that you've really done a great job with margins and incrementals, I'm guessing there's still been some sort of productivity headwinds from these supplier kind of issues. And I'm wondering if that's true and if maybe you can ballpark what sort of headwind you've seen.

Yes, Steve, it's Tom. It's really hard to do that, to give that kind of detail. You're right. It's in there. We had to overcome it. We overcame it with all the things we were doing, the supply chain, wind strategy, pricing, et cetera. But it's really hard to quantify. It will be something that will gradually help us as we go into this year. But as I mentioned, we're projecting gradual improvement, not some big step change in the supply chain improvement.

Got it. Okay. I guess where I'm trying to think about this is that if supply chain were to normalize, and it doesn't sound like that's really totally your view, but if it were, my guess is that the incremental margins would be kind of higher than what you've laid out.

Well, certainly it would help us. I mean, the incrementals in the guide are pretty respectable. North America is at around numbers 30. International is at a decremental upper 20s. And aerospace is in the mid-20s. Recognize that aerospace has a unique challenge this year as we compare it to the prior. Our mix shift is going to be much more commercial. We've got commercial E growing 2X commercial MRO, which is what the exact inverse we had in FY22. We had commercial MRO growing twice what commercial E. And I think everybody understands the difference in margins on MRO versus OE on that. So that's probably the... The exact inverse we had in FY22, we had commercial MRO growing twice what commercial OE. And I think everybody understands the difference in margins on MRO versus OE on that. So that's probably the biggest headwind there, but still putting up mid-20s incrementals. But to your point, Steve, if we were to end up having even quicker supply chain improvements, yes, that's a potential upside for us. Potential upside for us.

Super. And then just a final one on supply chain is just we do hear hydraulics as a bottleneck for a lot of the customers that we speak with still. And I don't know whether they're just using the wrong supplier or whether that's kind of an area of issue. But are there opportunities for kind of share gains here if you're able to manage this more effectively?

Again, Steve is tough. Absolutely. And I would not want to be pretend that we are lily white in that because we have opportunities because I know our customers listen to this and that's one of the top things that they talk to me about but we do have a distinct advantage that we're typically much better than our competitors when you look at lead times and our ability to deliver so we always look at these times where it's kind of a struggle that we can become the go-to supplier of choice and have an opportunity and once you know a customer makes that kind of commitment making the effort to switch to us. So, again, that's a potential upside.

Cool. Thank you, guys.

Appreciate it, Steve.

One moment for our next question, please. It comes from Jamie Cook with Credit Suisse. Please proceed.

Hi. Good morning. A nice quarter. I guess my first question, you know, Tom, can you just talk to your assumptions within North America and industrial organic growth first half versus second half? And then just sort of, you know, your organic growth is below your your your targeted range of of the of the four to six percent. So just your view on the macro, you know, I mean, like how does Europe and China come out of this and why is North America sort of more resilient? Thank you.

Yeah, Jamie. So the four to six, remember, is over the cycle with an FY27 target. And actually being two to five in the current climate with all the things I said at the beginning, quantitative tightening, high inflation, high interest rates, the dollar strong, I mean, I actually think it's pretty remarkable that we're putting in that kind of a number given all the conditions we're facing. So I'll make that comment on the four to six. But specifically in North America, you know, first half is more like seven and a half. Second half goes to one and a half. and international is first half, two and a half, versus kind of a flat second half. As far as in markets, I gave color around the secular ones, but if I just was to bucket, I don't want to read this giant list and bore everybody to tears, but we have a couple in the greater than 10%, and I would say this is pretty indicative, as I describe these across the world, obviously some of the regions have a little bit more softness. In particular, I think maybe to get, before I go to that, and some of your question around maybe the difference between regions, you know, we see EMEA having probably, and given everything that's going on there between the war and energy challenges, you know, being the regions that in the second half is probably going to go negative, so that's in our guide. Asia Pacific, we've got not weaker than North America, obviously. It's going to be in that low single digits throughout the whole year. But in the first half, we've got China somewhat flat, the rest of Asia mid-single digits. In the second half, both China and the rest of Asia gets in that low to mid-single digits. Recognizing that Asia gets a chance to compare to the current quarter, the last Q4, which was really a tough quarter given all the shutdowns, So North America, more resilient on order entry. We've seen that the last quarter or two, that we've been rejecting that trend for the whole year. And maybe I'll just stop there, see if you have any follow-up to that.

No, I mean, that's good color. I guess my only other question is, I know you don't want to comment specifically on pricing and what your assumptions are, but to what degree should we think you know, your pricing is fairly sticky so that if we do get into, you know, a deflationary market, you know, that potentially is a positive for you. And I guess sort of what's embedded on price cost in the 2023 guide. Thanks.

Jamie, it's Lee. I would say, you know, as we, as you look at pricing across the enterprise, it's fairly sticky. I mean, There are material contracts on the OEM level that flex based on what's happening with commodities, but that's a small part of what's going on. So I'm not really concerned about a price rollback inside the company.

Okay, thank you.

Thanks, Jamie.

One moment for our next question, please. comes from David Russell with Evercore ISI. Please go ahead.

Hi, thank you. Looking at the splits, it looks like despite you have higher organic in the first half than the second half, the margin improvement in the first half and second half year over year is about the same. It's about 20 bps in the first half year over year and 10 bps in the second half. So I'm just making sure we understand despite the slower organic growth in the second half of the year, the margin performance year over year will be similar. And again, is that a price cost is inherently better in calendar first half of 23 than back half?

David, stop. Yes, that's part of it. Yeah, definitely pricing was better in the second half of 22, which will help us as we go into 23. But I think we've proven you know, in slowing top-line areas to do pretty good at margin control. So I look for us to continue to do that.

And then lastly, the comment about July, I think you said all of international orders went back to up, I think you said mid to upper single digit. Was that a year-over-year order comment for July for all of international? And if you can give us a little more color on that, it would be great.

Yeah, David, thank you for this time again. Thank you for asking it because it allows me to So it's just a one month, so it's a 1-12, it'd be July versus July. So it's not our typical 3-12, which is why I don't typically quote that number, but given coming off the negative 3-12 international. And of course, when you get to forecast into a new calendar year, we look for every single piece of data we can get our hands on. And that was a nice indicator for us, because we saw really all three regions. Latin America held up well in Q4, but Latin America continued to do well in July. But we had both EMEA and Asia turn back positive in July. You know, it's one month, so it's not a long data trend, but it was a good indicator.

I think China getting better in July from June with a little bit of reopening I don't think would surprise people. But that Europe reaccelerated in July, I'll leave it at this. Any color on that? Is that distribution? Is it OEM? I think that's a pleasant surprise that Europe re-accelerated last month.

Yeah, one month I don't have, you know, my typical segmented market type of comparison, but I would just say it would be across both distribution and OEM. Okay.

Thank you very much.

Hey, David, I would just add on the margin walk throughout the year, you know, currency does come into effect that, A little bit, right? So we have a little bit more headwind in the first half, and it kind of normalizes as we get to the second half, just because the comps become a little bit easier on those currency changes. I'm just looking at the margin walk. It's a very similar progression, Q1 to Q4, versus what we did this year as well.

All right. Thank you very much. Yep.

Thanks, Dave.

One moment for our next session, please. comes from the line of Nigel Cole with Wolf Research. Please go ahead.

Thanks. Good morning, everyone. So it does feel like July was a bit stronger than June, or certainly in the second quarter. Second quarter calendar, of course. I mean, you're very broad and you touch pretty much every single part of the industrial economy. I'd just be curious if you could give your perspective on what's going on outside of China, obviously, which is a bit more of its own beat. But... So maybe, Tom, you might want to take that. But just in terms of the financing for Megits, it looks like we've got about $6 billion already financed on the balance sheet. I'm just wondering, you know, just based on whatever cash we've got on collateral with the derivative contract, et cetera, how much more has to be raised to get to that $9.9 billion?

Yeah, Nigel, this is Todd. We are complete with the financing program for that. The one element of that is that $2 billion delayed draw term loan that we will pull once we get more clarity on the close date. So that's really the last piece that's already set. We just have to wait till we get some clarity on close.

So the $42 million in one queue, so we can analyze that, add on the $2 billion for the delayed draw, and that gets us in the ballpark of the current interest rates or interest expense for Megat.

Yeah, it's a good question. You know, what our plan on that is to, you know, come back to you once we close and we've got some clarity on what the rates happen to be. We will lay that all out for you in very good detail. Okay, thank you. Yep.

One moment for our next question. comes from Joseph O'Day with Wells Fargo. Please go ahead.

Hi, good morning, everyone. Good morning, Joe. I wanted to start on backlog. I imagine it was flat up a little bit sequentially, I think running at something like 2x what would be normal levels relative to demand. And so as you're thinking about the upcoming year, What do you expect in terms of backlog trends? Do you think this is something that sort of normalizes relative to demand over the course of the year or based on what you're hearing from customers that they still want to order kind of well in advance? Just generally how you're preparing for that.

So backlog is up significantly year over year, about 21%. Backlog was $7.8 billion in June 30. But sequentially it was pretty flat. And so I think this is kind of the peak in the backlog. I would expect it to moderate through the years, slowly declining, probably not getting back to what I would call normal backlogs through the course of the whole year, but starting to moderate. And this backlog, in addition to our order entry patterns, the secular trends, the portfolio changes, these are all part of why we felt good about the 2% to 5% organic growth guide.

Got it. And then related to market share gains, do you have any perspective on what you think you achieved in terms of share gains last fiscal year? I imagine North America was a bigger opportunity with presumably some of the tougher supply chain dynamic in that region. So I don't know specifically if you could comment on that as well, really all of this related to the industrial businesses.

Joe, it's Tom again. So I would characterize it, yes, we did gain some share. Calculating market share by region and all that is really difficult. You don't get the degree of accuracy. We track share by account, and obviously I'm not going to quote any accounts here, but that's where you can actually get good accuracy because you know what potential is for an account and you know what your sales is into it. You have good gauge R&R and repeatability to that. So we've seen where we've been able to make some improvements, not on every single account, but on some accounts. And so I would use that as an indicator that we had made some progress, but obviously more to come.

Very good. Thank you. Thank you.

Carmen? Yes, sir. Carmen, I think we maybe have time for one more question.

Excellent. One moment for our last question, please. comes from the line of Julian Mitchell with Barclays. Please proceed.

Hi, thanks for squeezing me in. Maybe just a first quick one around, you know, the free cash flow margin assumption. And, you know, you had a very strong sort of 14% margin in the year just finished. You know, as you look at the sort of the current business ex-megat, you know, how should we think about that free cash flow margin assumption? in the upcoming fiscal year? Should that sort of move up slightly with operating margins or do you get a big sort of hit still from working cap in the first half or something?

Julian, hey, this is Todd. This is a great question. You know, we obviously are very proud of our cash flow performance that we just finished in FY22. We do see a little upside of that in FY23. Obviously, the growth isn't as great as the growth period that we just came through. Teams continue to manage working capital, so I think you'll see a slight increase in that. We'll give you a little bit more color once we get some of the mega details on what it does for the whole company. Obviously, on the integration year, the stub year, there will be some pressure on the total company free cash flow just as we get through the acquisition, but core company will be very similar to what we did last year with a little upside.

That's good to hear. And then a quick follow-up, aerospace guidance. I think, Tom, you had said that the organic sales growth assumption for aerospace is higher growth in the second half, I think, year on year than the first half. Any color around that, is it to do with sort of easing supply chain constraints in commercial OE? you know, lumpiness in military, and then commercial MRO, I think you said up high single, which may look low versus what some other companies have talked about for the next year or two.

Yeah, so maybe I'll just give you the splits on, not the splits, but the segments. So our guide assumes a mid-teens commercial OEM, a high single-digit decline in military OEM. That's, again, the pull forward and the provisioning on the F-135 and and the 135 engine. Highest single digits on commercial MRO. Remember, that's comparing against what we just did last year, which was a plus 36%. So that's, you get this really big, difficult comp on the commercial MRO, but it continues to grow. And the military MRO, positive mid-teens. Do that math of those four segments, gets you to six and a half. These first half, second half, it's just kind of the normal pattern Aerospace tends to be stronger growth in the second half. You'll have some of the military MRO probably hitting stronger in the second half as well.

Great. Thank you.

Thank you, Julian. All right. This concludes our FY22 Q4 earnings webcast. We really do appreciate all your support, all your interest in Parker. Like we said, we will do another one of these shortly. Once we get through close, Robin and Jeff are obviously here all day. If you have any further questions, once again, I thank everyone for joining. Once again, I thank everyone for joining, and we will talk to you soon.

With that, ladies and gentlemen, we conclude today's conference. Thank you for your participation, and you may now disconnect.