Parker-Hannifin Corporation

Good day, and thank you for standing by. Welcome to the Parker Hennepin Corporation's Fiscal 2023 Second Quarter Conference Call and Webcast. At this time, all participants are now listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during that session, you will need to press star 1 1 on your phone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. And I would now like to hand the conference over to your speaker today, Mr. Todd Liam Bruno, Chief Financial Officer. Sir, please go ahead.

Thank you, Chris. Good morning, everyone, and thank you for joining Parker's Fiscal Year 2023 Q2 Earnings Release Webcast. As Chris said, this is Todd Liam Bruno, Chief Financial Officer, speaking. And joining me today is Jenny Parmentier, our Chief Executive Officer, and Lee Banks, our Vice Chairman and President. Our second quarter results were released this morning, and before we get started, I just want to remind everyone, we will be addressing forward projections and non-GAAP financial measures. Slide two of this presentation details our disclosure statement to issues in these areas. These forward-looking statements detail issues that could make actual results vary from our projections. Our press release, this presentation, and all reconciliations for non-GAAP measures are now available under the investor section at Parker.com and will remain available for one year. We're going to start the call today with Jenny addressing some focus areas for the company as she takes on the role of CEO. She will then address some highlights for the quarter, which we just released this morning, and then I'll follow up with a brief financial summary and then review the increase to our FY23 guidance that we issued this morning. Jenny's going to wrap up with a few summary comments, and then Jenny, Lee, and I will take as many of your questions as possible. I now ask you to reference slide three, and Jenny, I will hand it over to you.

Thank you, Todd. Good morning to everyone, and thank you for joining the call today. As Todd said, before we get into the quarter results, I'd like to remind everyone what drives Parker and give you some insight on where we'll be focusing. Moving to slide two. New CEO, same three drivers. Living up to our purpose, continuing to be great generators and deployers of cash, and achieving top quartile performance versus our proxy peers. Slide three, please. Safety, purpose, and engagement are the foundation of top quartile performance. As I mentioned to all of you in the December call, we are committed to delivering the MEGIT cost synergies of $300 million and we're very pleased with the progress to date. We've said before it's still early innings for Wind Strategy 3.0, and we will continue to utilize it to accelerate our performance. Our culture is one of continuous improvement, as evidenced by past performance and results we will deliver well into the future. And we are fully committed to achieving our FY27 targets that we rolled out at Investor Day last March. All of this will allow us to continue with the transformation and ensure a very promising future for Parker. Moving to slide four, please. You've seen this before. Parker has a proven strategy. The wind strategy is and will remain our business system. It is a system focused on the fundamentals. We trust the process and will continue to get results from it as we have in the past. Slide five, please. So where will Wind Strategy 3.0 accelerate our performance? Well, it always starts with our people. Safety is number one, and it always will be. Our goal is zero incidents, and we believe it is possible. We've brought a lot of new people into the business over the last couple years, and we have the opportunity to double down on the training and chartering of high-performance teams and leaders. This will further strengthen our culture of continuous improvement and our brand of Kaizen well into the future. Moving over to customer experience, we have an opportunity to do even better with the digital customer experience. Anywhere from how we interact with our customers on quotes and orders to the availability of digital products and the use of artificial intelligence for demand forecasting with both our customers and our suppliers. It's early days for our zero defect initiative as well. This obviously drives better quality and overall customer satisfaction. This is the exact same approach that we took with zero safety incidents. Zero defects is possible. It starts with engaging our people around robust products and capable processes. Doing this right exposes the hidden factory, improves quality, reduces cost, and thus expands margin. Best-in-class lead times have been part of our wind strategy for many years. And coming out of the pandemic and subsequent increase in volume, we see even more opportunities to improve lead times and become supply chain leaders. Our customers deserve this level of service, and all of these are strong enablers of growth. Profitable growth is a combination of performance and portfolio changes, which we have demonstrated. Strategic positioning is a tool used by our general managers to segment their business and position them best in their markets and with their customers. This process and cadence will continue to drive the critical thinking about growth in the division and closest to the customer. We are obviously seeing the benefits of a transformed portfolio and we will continue to seek out those opportunities that will enhance the transformation. The most significant CapEx spending in decades will bring growth to Parker with all the technologies we have supporting the secular trends today and for many years to come. We have an annual cash incentive plan which incentivizes the right behaviors and drives a real intensity around growth. Moving over to financial performance, we have a proven set of simplification tools which will continue to help us reduce complexity and cost. Housed in this area is our simplified design process which you've heard us talk about a lot. This has become a fundamental, a business fundamental across the corporation. We have a robust process around value pricing and will continue to strive for margin neutrality in these inflationary times. We will also double down on training the principles of lean. This is the foundation of our continuous improvement culture and it drives safety and productivity in all of our operations. You've heard us say many times over the past few years that while not immune, To the chaos of the supply chain, we fared better than others due to our dual sourcing initiative and our local for local strategy. The pandemic and subsequent increase in volume exposed some areas that we can further improve upon to ensure that we become supply chain leaders. Our teams are looking to further enhance the visibility of the changing demand picture and utilize some new scheduling tools that will drive efficiency in the operations and those best in class lead times that I just mentioned. Focusing on these areas in Wind Strategy 3.0 will help us to achieve top quartile performance. Slide six, please. Our capital deployment priorities remain unchanged. We will maintain our record on dividend payouts and target a five-year average payout of 30% to 35% net income. We will target 2% of sales on CapEx to fund organic growth and productivity. The 10b51 share repurchase program will remain in place and our near-term and top priority is to de-lever post the MEGIT acquisition. We will keep our acquisition pipeline healthy, and we'll continue to build relationships for future acquisitions. Slide 7, please. The Q2 was another quarter of excellent operating performance. We saw a 16% reduction in safety incidents versus prior year, further supporting our ability to reach zero incidents. Sales came in at $4.7 billion, a 22% increase to prior, with organic growth coming in at 10%. Strong segment operating margin across all segments has led us to a full-year guidance increase, and we are very happy with the progress of the MEGIT integration. All activities and synergies are on schedule. Moving to slide eight, we'd like to share some recent highlights on the integration. Key leaders from both Parker and Meggitt are leading over 20 teams that are creating a lot of value and integrating the functions. Engagement with the team members and the customers is high. Widespread activity in all locations. And wind strategy training and implementation is well underway. Just a note here, we have a proven track record of delivering synergy targets, and this acquisition will be the same. The teams are following the integration playbook that has been developed over the last several acquisitions, and I am sure they will add some new best practices to it as well. Slide number nine. So we are on track to achieve the $60 million in synergies by the end of this fiscal year, and the graph on the left illustrates our path to $300 million in synergies and adjusted EBITDA margins of 30% by FY26. Synergies are represented in blue, and the cumulative costs to achieve are in gold. On the right side of this page, this quadrant depicts the use of the overall wind strategy to achieve the synergies and ensure operational excellence into the future. Starting with the top left, safety, lean, Kaizen, high-performance teams all make up our brand of Kaizen and will drive the engagement and continuous improvement well into the future. Simplification is a major area of focus for the integration teams. This is where we look at structure and org design. We use our 80-20 complexity reduction tool, and we implement simple by design principles. All of this drives real ownership and decision-making at the division level, further empowering the team to drive results. Moving over to SG&A, we've had the realization that there is a lot of opportunity moving MEGA from a centralized structure to Parker's decentralized structure, driving that overall decision-making to the local level and improving overall speed. With this acquisition, footprint optimization is very minor. Remember, we have complementary technologies with this acquisition and not a lot of overlap at the plant level. And with supply chain, we'll optimize pricing, terms and conditions, direct and indirect material spend, as well as logistics. Again, off to a great start, very pleased with the performance one quarter in. And now I'll turn it back to Todd for a summary of our Q2 results.

Thank you, Jenny. That was great. Okay, so I'm going to begin on slide 12 with the financial results. I can't tell you how excited the team is. This is the first full quarter that includes MEGIT in our results. It also is the first full quarter that we do not have aircraft wheel and brake in our results. So the year-over-year comparisons are a little bit more complicated than usual. But you see the top line sales increased 22% versus prior year. That clearly is a record for us at $4.7 billion. Organic growth continues to be extremely healthy and was just over 10% in the quarter. That does extend our string of double-digit organic growth quarters. Although better than forecasted, the currency headwinds do continue. The currency impact to sales was unfavorable by 4% in the quarter versus prior year. And when you look at the net of the MEGIT acquisition and the aircraft wheel and brake divestiture, that was a positive 16% to our sales in the quarter. Looking at adjusted segment operating margin, we exceeded our forecast and we finished at 21.5%. And if you look at adjusted EBITDA margins, that was even stronger at 22.4%. And just as a reminder, we mentioned this last quarter, we do expect MEGIT to be just slightly dilutive to overall margins in this first 12 years. as we generate those synergies that Jenny just spoke to. Looking at adjusted net income, we did $619 million or 13.2% ROS. That is an improvement of 6% versus prior year. And adjusted earnings per share were $4.76. That's a Q2 record and an increase of 30 cents or 7% compared to the prior year. Overall for Q3, we are extremely happy to have that first quarter of MEGIT in the books. to see that sales increase by 22% and obviously see the positive net income in the EPS growth. So just really happy with the results of the quarter. If we jump to slide 13, this is just going to be the visual elements of that 30 cent EPS improvement. And again, I'm really happy to say the driver of this is the additional segment operating income. We generated 180 million or 22% additional segment operating income versus the prior year. If you look at that, that added $1.08 the EPS for the quarter. Interest expense, as expected, is a headwind. It's a $0.51 headwind. That was a little bit higher than we were expecting, just with the movement in rates. 100% of that entire $0.51 is related to the mega transaction and what's going on in the rate environment. Other expense was $0.12 unfavorable. That was primarily driven by year-over-year changes in currency rates. And income tax is a drag of $0.14 really because last year benefited from a number of discrete items that were favorable and of course this year we have some of these transaction costs in the in the quarter that are non-deductible everything else nets to just a penny and if you look at all those items that makes up our 30 cent increase to that record four dollars and 76 earnings per share and we're really happy with that if you jump to slide 14 and just looking at the segments once again every segment is was positive organic growth in the quarter. We exceeded our margins across the board. Every segment exceeded our expectations on margins. Orders remained positive despite some pretty tough comps in the prior year and for the total company finished at plus three. And really demand does remain robust across all the markets we serve. Our team members really are working hard to meet customer expectations. And the result is that record sales that we just generated in the second quarter. If you look specifically at the North American businesses, sales are extremely strong at 2.1 billion. Organic growth in that segment is 13.5%. Adjusted operating margins did increase 50 basis points in North America. They finished at 21.8%. That is a record. And just really healthy volumes and a gradually improving supply chain really helped drive performance in those North American businesses. Order rates are positive at plus two, and that really matches our strong backlog and really that broad-based demand that is consistent across North America. So special thanks to our team members in North America for their record performance. Looking at the international businesses, sales were 1.4 billion. Organic growth there almost 9% from prior year. And across all of our regions in the international segment, we were positive from an organic growth standpoint. Margins remained high at 21.9%. This is slightly down from prior year, really due to currency, a little bit of product mix, and some China COVID-related headwinds, just specifically in China. Order rates are minus four. They were positive last quarter, but that did have a bit of a rebound, if you remember, from the COVID-related shutdowns in China. So we're watching that very closely. Aerospace systems, obviously huge sales, up 84%. They did exceed $1 billion for the first time, and that obviously is clearly driven by the addition of the mega businesses in our aerospace systems segment. Organic growth in aerospace was almost 5%. Really strong OEM and MRO commercial activity in that segment, both from sales and orders, being mid-teen positive on the OEM side of it. And military OEM remains negative as we expected. Operating margins are 20.6% in that segment. That is up 70 basis points from last quarter and better than we forecasted. And really the mega integration, the performance of the businesses, the synergies like Jenny had mentioned, totally on track and we're really happy with that. When you look at aerospace orders, they are plus 22. We talked for the last couple quarters about that bad comp we had with the military orders. We've now passed that comp, so you can see the orders are 22%. We're really happy with that. Great performance across all of the businesses this quarter. Great job, everyone. If you go to slide 15, this is just cash flow. This is our performance on a year-to-date basis. The mega transaction, we've talked about this last quarter. There's a drag to cash flow just based on some of those transactions costs. They did impact CFOA and free cash flow by roughly 2%, but even excluding that, if you look at the numbers as reported, cash flow from operations is 12.1% of sales. We did surpass $1 billion in cash flow from operations on a year-to-date basis, and our free cash flow is 10% of sales. Our CapEx, as we have communicated, just slightly over 2% for the year. and free cash flow conversion is 114%. I think everyone knows us pretty well. Our cash flow is always second half weighted, and we continue to forecast mid-teens cash flow from operations and certainly free cash flow conversion over 100% for the full year. If we jump to slide 16, just a few comments on capital deployment. I think everyone saw that last week our board approved a quarterly dividend payout of $1.33. per share. That is our 291st consecutive quarterly dividend, and it is certainly in line with those targets that Jenny mentioned earlier. On leverage, we did make progress on reducing our leverage. If you look at gross debt to adjusted EBITDA, that was 3.6. Net debt to adjusted EBITDA was 3.4. Both of those metrics improved 0.2 turns from Q1. So that EBITDA is on a trailing 12-month basis, and just a reminder, that only includes mega EBITDA from the date of close, so roughly three and a half months of mega EBITDA. And I'm proud to say we've now applied over $2.2 billion of cash towards that mega transaction, and we're really fully committed to our deleveraging plan, and that plan remains on track. So good progress there. Okay, so moving to guidance on slide 17, you saw we did increase our guidance this morning. We are providing this as usual on an as reported and on an adjusted basis. And if you look at the sales range, we are increasing that. We're increasing the range from 14 and a half to 16 and a half or from, excuse me, 14 and a half to 16 and a half or 15.5% at the midpoint. More importantly, organic growth. If you look at our organic growth for the full year, we are increasing that to 7%. That is up 1% from 6% last quarter. The impact of acquisitions and divestitures, we're moving that up just slightly to 11.5%. That was 11% last quarter. And while currency is still a headwind, we expect that to be less bad. We now forecast that to be a 3% impact to sales negative That's down from what we were forecasting last quarter at negative 4.5. And that is using spot rates as of December 31st like we normally do. When you look at adjusted segment operating margins for the full year, we are increasing that full year guide by 20 basis points to 22.1%. And that is at the midpoint. There's a range of 20 basis points on either side of that. And just a few additional items to note. If you look at the interest expense, That is now up to $555 million. That was $510 last quarter. That does include the changes in the interest rates that just were announced yesterday and really what we forecast them to do in the upcoming months. Corporate G&A is $204 million and other income is really an income of $18 million. Both of those numbers are virtually unchanged from our prior guide. If you look at our tax rate just based on where we're at now halfway through the year, We believe that will be 23.5% for the full year and adjusted EPS is now raised to $19.45. That's a 50 cent increase from our prior guide and there is a range around that or plus or minus 25 cents. Specifically for Q3, organic growth is expected to be nearly 4%. We raised that from our prior guide and adjusted EPS is expected to be $4.86 at the midpoint. And finally, adjustments in the forecast at a pre-tax level are listed here on this table for the reign of the year together with acquisition expenses incurred to date. So that's the details on guidance. If you go to slide 18, this is again just a little bridge on that. You can see where we start. Our prior guidance was 1895, that strong performance in Q2. We're rolling in that 45-cent beat. We are increasing segment operating income by 35 cents for the remainder. of the second half and I just wanted to note that 25 cents of that is due to the less bad currency rates. If you remember last quarter, we knocked that down a little bit based on what rates were at the end of September. We've now moved that back a little bit and there's a little bit more based on the organic growth increases and that is 35 cents. Interest and tax still continue to be a bit of a headwind. You can see the interest expense is 20 cent headwind and income tax for the second half of the year is just 10 cents. Add it all together, we get to $19.45 at the midpoint, and that is the changes to our guidance. So that slide, I will ask you to focus on slide 19. Jenny, I will hand it back over to you for summary comments before we go to Q&A.

Thank you, Todd. So we have a very promising future. We have a highly engaged team that's living up to its purpose. We'll continue to accelerate our performance with Wind Strategy 3.0. We are seeing the benefit of our strategic portfolio transformation, and we will continue to be great generators and deployers of cash. And with that, Chris, I think we're ready for questions.

Thank you. As a reminder, to ask a question, please press star 1 1 on your phone and wait for your name to be announced. To withdraw your question, please press star 1 1 again. Stand by as we compile the Q&A roster.

And one moment for our first question.

Our first question will come from Jamie Cook of Credit Suisse. Your line is open.

Hi, good morning. Nice quarter. I guess two questions. One, can you give a little more color on the negative order growth in international and then the acceleration that you saw orders in the aerospace segment that would be helpful and then Jenny I guess just a bigger question for for you today obviously Parker's been on a journey to you know move their through acquisitions move their their portfolio into higher value-add services higher organic growth businesses but it's been more really about acquisitions versus you know divestitures I guess as you look at the portfolio today do you still see Parker going down the path of looking at acquisitions or is an opportunity to look at potential businesses that might not make sense for Parker over the longer term? Thank you.

Thanks, Jamie. Good morning. I'll try to answer your second question, then I'm going to let Lee give some color on your first question. So, you know, we always want to be the best owner of any business, right? So we have a regular process where we look at that every year. So, That's something that's well in place and we'll continue to do that. As we look to future acquisitions, again, we're going to be looking for the type of acquisition that is margin accretive, has that resilience of a longer cycle business, and something that fits well with Parker. Obviously, short term, we need to pay down some debt for MEGIT, but that's why it's important for us to keep those relationships strong for the future. Jamie, it's Lee.

Just commenting on international borders, the biggest story here is really Asia Pacific, and it's really around China. If you think about where we've been, I mean, we've had consistent COVID lockdowns, start-stop, and then really tight monetary and fiscal restraint by the government trying to get some of the real estate markets under control, etc., And we saw really that really play out specifically later in the quarter Things contracting and slowing down the other thing, you know quite frankly the Chinese New Year It's the first time in almost three years that Chinese New Year has really been fully open So the amount of people traveling and gone is a lot different than it's been in the past having said that you know, we're we're Conservatively optimistic going on the second second half of the year, you know, I'm seeing a low single flat low single digit positive growth in asia pacific really led by china the um i think it's still going to be a little troublesome in china as they get their supply chains up and running etc but i i'd like to believe that with the stimulus going in and everything else that we're going to see some positive momentum there okay thank you and then color on the com on aerospace is it just all commercial i presume yeah the big thing on um aerospace was really the military OEM orders lapping. So we had some big pull-forwards orders and then we've lapped that on a 12-12 basis. So you're seeing the positive order entry rate in commercial OEM and commercial MRO right now.

Thank you.

Thanks, Jamie.

Thank you. One moment, please, for our next question. Our next question will come from Andrew Obin of Bank of America. Your line is open. Oh, yes.

Hi. Hi. How are you?

Andrew, how are you? Thanks for joining.

Yeah, I know. It's a pleasure not to be restricted. Yeah, just more of a longer-term question. So a couple of companies are sort of talking about, you know, managing the operations, managing the backlog differently in this environment. maybe sort of accepting that lead times are going to be extended for a while, right, given that at the tail there is still a lot of disruption in the supply chain. Are you guys thinking about sort of structurally adjusting your view on lead times, you know, how much backlog Parker carries into the future? Just any insight would be super helpful.

Yeah, thanks for the question, Andrew. So, you know, the beauty of the wind strategy and the lean tools that are inside of the wind strategy is really all about constantly looking at optimizing our lead time. So as far as restructuring the way we look at it, I wouldn't say we're going to do that, but I would say we're going to continue to look to have those best-in-class lead times. You know, the supply chain, I would characterize it as it's healing and You know, we are seeing some improvement. You know, the one thing that we will really continue to do is, you know, increase our dual sourcing and our local for local model. That has really, you know, helped us out. It also helps us that our teams are, you know, in a decentralized structure and they're able to work closely with the customers. So I think that, you know, those are some of the keys that help us work closer with our suppliers and really help us have a good look into the future so we can best utilize our resources and our capacity.

Just a follow-up question on CapEx when you talk about your capital deployment priority. You said CapEx target 2%. I may be wrong, but I recall having conversations where you thought maybe you needed on the margin to have capacity in places like Mexico, etc., and maybe take it up a bit to deal with what's coming in terms of the cycle. A, have you changed your view? Is it a function of MEGIT? And just generally, maybe how do you think about capacity additions given, you know, what you're seeing over the next couple of years in terms of broader CAPEX cycle trends? Thank you.

No, we have not changed our position. We're doing exactly what we said we were going to do. You know, we have a need to increase capacity in a couple of our operating groups. Obviously, we'll invest in MEGIT in the future as well. That position remains the same.

Andrew, I would just add, if you look at historically over the last couple of years, our CapEx has been about 1.4% of sales. You look at it today, it's at 2.1. That's a pretty significant increase for us. Of course, as the sales of the company increase, that's more CapEx dollars that we've got to spend there. We think that 2% number is right, including maggot, including all the supply chain additions that we're looking for as well. And it might be a little bit bumpy, but you're not going to see it too far above that, too.

No, that makes a lot of sense. Thanks so much.

Thank you. And one moment for our next question. Our next question will come from Scott Davis of Milius Research.

Your line is open.

Good morning, everybody. Good morning, Scott. I was hoping to dig into supply chain a little bit and not necessarily what's going on this quarter, but the longer term fixes and priorities and such. And so when you think about supply chains, there's a notion of kind of localization and dual sourcing. Some of that in some ways feels almost inflationary, but then there's the other component of kind of streamlining supply chains and driving more productivity and it becomes a kind of a cost tailwind. How do you guys think about the priorities that you're trying to, now that kind of COVID is less of a problem around the globe, how do you think about those priorities and the puts and the takes behind kind of it, costing you more, but maybe saving you more Um, yeah, I'll just stop there and leave it open ended.

Yeah, no, no. Thanks for the question, Scott. You know, listen, it, it, it really is, um, all about driving efficiency in the operations and we've, we've had, um, you know, a long-term strategy of being local for local, right. Being, being close to our customers, having our suppliers close and being able to, you know, give that good lead time and, and really provide a good customer experience. So, um, you know, we'll, we'll continue with that. And then with dual sourcing, I mean, I think. Some of it in the past has had to do with different things going on in whatever environment we're in, but it really is a good practice through different cycles in the business. It's really something that we want to increase in all regions and make sure that we can be flexible and agile as demand goes up and down. That's the big key is being able to go to one source or the other. and really respond to your customers' demands. So that is really the way that we look at it. I think going forward, we've learned a lot through the pandemic. That's the beauty of having a continuous improvement culture. Our teams are trained to recognize where there's opportunities, and we think we have opportunities to make sure we're more efficient, and that comes through visibility and analysis of demand, as well as, you know, really optimizing the schedule that goes to the production floor. So that's where we're focused.

Okay. Makes sense. And then back up a little bit, you know, when you have a big CEO change, you know, oftentimes, you know, any issues or problems or complaints or gripes kind of come up, you know, or, you know, kind of rise to the top of your desk pile. But What are the big internal complaints or fixes or gripes that perhaps we don't see as investors, but things that you want to try to tackle and fix internally that maybe perhaps wasn't really something that Parker was good at in the past?

Well, first of all, I'd like to say that I've had no big complaints or gripes or no surprises. Somebody asked me last week if I had any surprises, and no, there's been none of those. I've I've been on this team for several years now and very aware of how we run the business. What I talked about with my slides, that's where the focus is. There's an opportunity to become supply chain leaders here. There's an opportunity to really make sure that we capitalize on the portfolio transformation and we continue to expand margins. What you saw in those slides is exactly what we're going to work on.

Scott, it's Lee. I would say the only gripe is the one I have. She's working me harder than Tom ever would.

Yeah, well, my gripe is I don't own enough of your stock. But otherwise, I'll pass it on. Thank you. Take care. Good luck this year.

Thank you. Appreciate it, Scott.

Thank you.

One moment, please, for our next question. And our next question will come from Julian Mitchell of Barclays.

Your line is open.

Hi, good morning. Maybe just the first question on the industrial businesses. So I guess several other industrial companies who are more sort of short cycle in nature have talked about maybe some destocking early in the year in the U.S. and also Europe. It doesn't sound like you're seeing any of that yourself, but maybe just talk a little bit about how you see customer behavior or distributor behavior, if it's different on that front, and what you assume Europe does in terms of organic sales in the international business, the balance of the fiscal year.

Julian, it's Lee. I'm going to just take a step back a little bit and talk to what you're asking to, but a little bit commercial for the company. You know, sitting in front of me is a heat map from every country around the world and region of what the PMIs are doing. And it's a sea of red, and it's really turned into a sea of red since, you know, August or September. And the success we're having today I think really has to do with the portfolio changes that we've made inside the company and then really focusing on these key secular trends. So that's made a big difference as we navigate through what is forecasted around the world is a slowdown in different areas. On inventory, I would say if I just break this down by region, I was out with some of our large distributors here in North America. There's definitely some inventory balancing taking place. We were at a frantic pace there for probably 18 months. These things came out of COVID. There's people taking their breaths, balancing things out. But I would tell you their order book is still very strong, and they're still very positive about what's happening. And the other thing, the test for me in some of the regions on distribution is what kind of CapEx projects they have going on with customers. And the CapEx dollars and customers are still flowing. On the OEM side, I would say, broadly speaking, order books are still good, especially on the mobile side. um you know and that that inventory level they they try to get as true to adjusting time as as they can a little bit of disruption with microprocessors etc but really not a great deal so that's still positive um i think i'll stop there if if i don't know if i hit your your question or not no that's that's good color thank you lee and maybe just to follow up on um

aerospace, give us some insights as to how the Megit top line is trending at present. And I guess when you think of overall Parker Aerospace, a couple of large sort of aero peers, GE and Honeywell, for example, have talked about the headwinds, whether it's cash or P&L margin from the OE ramp at the air framers. Maybe help us understand if that's a big pressure point for Parker Arrow on margins or cash the next year or two?

I'll start with your last comment first. We don't see that as a big pressure point for us. I mean, we're pleased with the performance. We expect their full year sales to be $1.9 billion at about approximately 17% adjusted segment operating margin. As I mentioned earlier, we're on track to achieve the $60 million in synergies by the end of this fiscal year. We expect this to grow at or a bit faster than legacy aerospace, so we're real positive on this.

Great. Thank you.

Thanks, Julian.

Thank you.

One moment, please, for our next question. Next question will come from Jeffrey Spraud of Vertical Research. Your line is open.

Hey, thank you. Good day, everyone. Kenny, just back to where you left off on MEGIT and synergies, probably very early to talk about changing those forecasts or anything. I'm actually a little bit more curious about costs to achieve and opportunities to sort of outperform there. You know, given that it's not a real heavy lift on factories and the like you know there's some people costs associated with getting this right but um is that a potential lever here as you get into this and lean the company out um you know to do this maybe even more cost effectively than you were originally thinking so so jeff you're right it is it is too early to say that um you know

that there's some upside to that number. We feel good about this year's synergies at 60 million. We feel good about the path to 300. But obviously, you know, as I spoke about, you know, with the synergies and the operational excellence driven by the wind strategy implementation, you know, we expect to get, you know, this to a higher level of performance, and we'll, you know, we'll update you along the way.

You know, HF, this is Todd. I would just add, you know, this is a big question. complex acquisitions. The biggest one we've done to date, we've talked about the integration team. It's the largest team that we've had to date. Jenny had a comment. There's over 20 teams, both Parker and MEGIT team members working together across the board. A big chunk of this is SG&A cost, right? There's clearly associated with that. So I would say in the near term here, I'm pretty confident on those costs to achieve. If there is maybe some upside, I think it's too early to tell, but maybe in the out years, 25, 26, maybe there might be some upside there. But again, I think we're going to have to talk about that when we get further into the process.

And then maybe a follow-up for Lee. Lee, when you were addressing the international question, you mostly talked about what's going on in China, which is understandable. But can you give us a little bit of an update on China? you know, what you're seeing in Europe and, you know, how you're expecting the balance of the year to play out there?

Yeah, so I think the balance of the year and kind of what's implicit in our guide is, you know, kind of flat to very low single digits negative. There's definitely, you know, saw a big slowdown in December. I mean, you've got rate hikes everywhere. You've got the war going on. You've got the industrial business being affected by that. So that's kind of how I would see it. Distribution is still hanging in there. Some inventory rebalancing taking place. And there's some incredibly tough comps from previous year. I mean, Europe was one area where we were the benefit of some big COVID production type products that have kind of lapped and they're not coming back. So that's how I would characterize it. Flats are slightly negative.

Great. Thanks for the color. I'll leave it there.

Thank you. One moment for our next question. And our next question will come from . Your line is open.

Good morning, everyone. Lee, maybe. Sticking with you here, you provided color on order trends by geography, but I'm kind of curious if you can comment by the various end markets within your industrial business, if there's any variance there that we should be aware of.

Yeah, I'll give you kind of what our outlook is that's implicit in our guide. You know, and I think that the key thing to think about is really 90% of our markets are still positive as we look forward, but I'll kind of look at the greater than 10% positive. Commercial aerospace is still really strong. Commercial military MRO is really strong. Electric vehicle passenger cars, that's one of those secular trends where we've applied product through our portfolio change that we're participating in. And then oil and gas, especially here in the U.S., land base and even some offshore now has really come back with a vengeance. I would call high single-digit positives agriculture, heavy-duty trucks, passenger cars, and telecommunications. And then mid-single digits, the neutral, construction markets, distribution, forestry, marine, material handling, mining, power gen, rail, et cetera. And semiconductor is still strong. There's a lot of infrastructure build on the semiconductor side that's still taking place. The big negative markets that kind of stand out, a little bit of what we would categorize as life science, and that's really comps around COVID equipment and drug dispensing stuff that we were supplying. And then really military OEM. It's really a timing thing, I think, long term, but that would be negative for the outlook. So at a kind of high level, not breaking it down by region, that's kind of how we see it.

I appreciate that. then I guess my follow-up would be, you know, you talked about the fact that there's a divergence between the demand that you're seeing and PMIs in the industrial business. That's obviously obvious to everyone at this point. But I'm curious, as you're kind of analyzing your order intake, how much of that do you think can be attributed specifically to these higher growth verticals rather than customers that have significant backlogs that are just now trying to increase production after normalizing the supply chain?

I would be – that's not something I could answer here on the call. I would just tell you anecdotally some of the customers that we're participating with today are at a different level than we've participated with them before, and that's due to the portfolio changes. But I can't answer that right off the cuff.

I appreciate that. Thank you.

Thank you.

And one moment for the next question. The next question will come from the line of Stephen Volkman of Jefferies.

The line is open.

Hi. Thanks for taking my question. Maybe I'll stick with you, Lee, here, because as I hear you lay all that out, it sounds like the Maybe you even said, I mean, it was quite tilted to the positive, and yet I look at kind of what's embedded in your organic guide for the second half, and I guess it looks like the exit rate is going to be sort of close to zero on organic growth. Maybe you disagree with that, but I'm just curious, would you sort of characterize this as a little bit conservative or careful given the economic outlook, or is this really kind of a bottomed-up kind of forecast that you have for the second half?

Hey Steve, this is Todd. I'll give Lee a chance here to catch his breath a bit. You know, there is a lot of positives. We see demand broad-based across the business. Obviously, we talked about North America. We did increase the North America organic guide. Basically, we doubled it. It was two and a half. This is for the third quarter, I'm speaking. It was two and a half. We moved that to almost five. You know, for the third quarter, I think I was clear on the guidance. We think it's going to be about four organic growth. Q4, a little bit of comps come into play there. Your rough math is pretty close. You know, we think maybe 1% organic growth in Q4. Second half really is 2.5 when you look at the total. So, you know, there are some headwinds out there. I think we're being a little cautious in what we're seeing here. And, you know, at this point, it's the best look that we got. So the international piece, I think Lee gave some color on that. Currency is still not as bad, but still pretty hurtful. You look at the second half, it's about 1.5% drag for the total company, but almost a little over 4% for the international segment. So that's kind of how we rolled up the numbers, and that's the way we feel right now.

Okay, fair enough. Just to follow on to that, though, I mean, It would seem, Todd, that you could get that level organic just from kind of pricing rolling its way through. Any comment on that?

Well, you know, we don't get a lot of color on pricing there, but you could tell it's in the organic number. So that's totally in the guide that we just laid out.

All right. Fair enough. Thank you.

Thanks, Steve.

Thank you.

And one moment for our next question.

And our next question will come from Josh Porzywinski of Morgan Stanley. Your line is open.

Hi, good morning, all. Good morning, Josh. Hi, Josh. Hi there. We've covered supply chain and some of this like inventory phenomenon for a while now in orders, but maybe just to put a bow on it a little bit. As your own lead times have improved, have you seen customers adjust The way they order to match that, so I'm assuming there was a point in time in which everyone was sort of scrambling a little bit more to get everything that they can, and maybe it was a little bit more normalcy that's changed. Anything that you guys have seen on that end?

Yeah, I think that's a really good question. We really haven't seen that yet, but we know that that's what happens, right? We know that when the lien time either reduce or just get back to normal, the order patterns usually follow that. You know, we have really close relationships from the divisions to the customers, so we really work closely with the customers in looking at the backlog and, you know, making sure that it's healthy. But I would also say at the same time, you know, we've seen a few push outs. You know, nothing that I would characterize as being significant, but I do think it's a little bit of a leveling of demand. as the supply chain heals, but really nothing that has drastically changed in the order patterns yet.

Got it. That's helpful. And then just as a follow-up in terms of what lessons, I guess, the last two or three years have taught you guys, how are you thinking about different ways you would pull levers in a downturn, knowing the types of scarcity and tightness that might await on the other side? As well as, you know, what you guys are doing today, even without a downturn.

Yeah, you know, I think we, you know, as we've talked about before, we're well positioned for changes. You know, we have a recession playbook, right? We start pulling those levers way in advance at the first signal. So I think we do a really good job of that. Thinking about levers into the future, it really goes back to that increasing the dual sourcing and the local for local. It's what helps us reduce those lead times and ensure that we can give our customers the delivery that they're looking for. That's why that's an area of focus for us going into the future.

Josh, the other thing I would add to that too is we've got an incredibly strong operating cadence around here. We are looking at orders. We're looking at businesses weekly, both at the division level and enrolled up to myself and Andy Ross. And as a team, we get together once a month, look at the trend, making sure we are ahead of the curve on whatever's happening. And it's no different. It's the way we've operated in the past, and that's the reason we've been able to act so quickly.

Got it. That's helpful. Best of luck. Thanks, John.

Thank you.

And one moment for our next question. Our next question will come from Joe Ritchie of Goldman Sachs.

Your line is open.

Thanks. Good morning.

Good morning.

Haley, just one quick clarification on your sea of red comment from earlier. Uh, you're basically implying that, you know, the outlook is that your end markets are decelerating, but not, not necessarily negative. Cause it sounds like you still, you guys found still pretty constructive on, on most of your end markets. Is that, is that correct?

Yeah, I think that's exactly what I'm trying to tell you. I, when I'm looking at this, uh, this, this heat map, um, You know, we've been in a contraction from a PMI standpoint almost around the world since August. And I think what's really holding us well are the portfolio changes that we've done inside the business and the secular trends that are taking place that we're able to tap into inside our business today. So we're not immune from what's happening around the world. None of us are. But it's a different portfolio today when I started 32 years ago.

Yeah, okay, great. That that makes a lot of sense. And one to ask also on cash flow, Todd, obviously, I saw you guys, you know, you reduce your debt by about a couple 100 million this quarter, know that there's a lot more cash flow expected in the second half of the year. What can we anticipate from a either a net leverage or debt reduction perspective as you progress through the year?

Yeah, we're really focused on that, Joe. It's a great question. I kind of mentioned it earlier. Our cash flow is certainly more weighted to the second half. We just made the dividend increase. Jenny talked about the capex. 100% of the cash flow that we generate in that second half will be dedicated to that debt pay down. And like I said, we've got a nice plan for it. We're on track. And the team is already focused on that. So we're pretty positive on that.

Okay, great. Thank you both.

Thanks, Joe. Thank you. Hey, Chris. Chris, this is Todd. I think we have time for one more question. So we'll take whoever's next on the list.

Thank you. One moment for the next question. Our last question will come from Nathan Jones of Stifel. Your line is open.

Good morning, everyone. Morning, Nathan. I've got a bit of a follow-up on the kind of orders, backlog, cadence as we see supply chains normalize here. Can you give us maybe a little bit more color on how elevated your backlog is relative to where it normally was? I guess we haven't had normal for three or four years now. And as supply chains improve and lead times shorten, if you would expect to see backlog get worked down, the order cadence drop down a bit, And we could get into a scenario where we see lower orders without that actually signaling any lower demand as we normalize order cadence and backlog.

Okay, Nathan, this is Jenny. You know, just to kind of talk a little bit about the backlog. So right now our backlog without MEGIT is 12% over prior year. It's roughly coming in at the same dollars as last quarter. When we answer this question, it's around $8 billion. If you put MEGIT on top of that, it's another $2 billion plus, so a little bit over $10 billion total. So when we look at the backlog and at the orders, I think the first thing to point out is that with the portfolio changes, it's different than it used to be. So we have longer cycle business. We're going to see what I like to call a demand fence, a longer demand fence, and we're going to see more orders out there. There's been a lot of noise the last couple years because of the supply chain, but we have seen, with the transformation of the portfolio, that this has gradually increased. So even with supply chain normalizing in the future, order patterns changing, I don't think we're going to get this down to where it used to be, pre-portfolio transformation. I think we're going to see a higher backlog.

Thanks for that. And I have one on price cost. Parker has a tremendous long-term record for being mutual on price cost at the margin level and did a tremendous job through the inflationary period we've seen over the last couple of years. Do you expect that if we get to a deflationary period to remain price-cost neutral, or do you think that you could actually hold on to some of that pricing and have that be a tailwind to margins?

Well, Nathan, it's Lee. I think, you know, the first thing is – A lot of our pricing isn't always price-cost neutral. We're introducing a lot of new products every year based on the value delivered to the customers. These are margin accretive, so there's a big mix about what's happening. We've been through moderate deflationary periods in the past, and we've weathered it just fine. And when I talk about one of those operating cadences, when it comes to price-cost, that's just kind of ingrained in all of us here and how we do that. I think we'll be okay on the margin front.

Okay, thanks very much for squeezing me in.

Thanks, Nathan. All right, everyone, this concludes our FY23 Q2 webcast. We do appreciate your time, your questions, and, of course, your interest in Parker. If anyone needs any clarifications or follow-ups on anything we've covered today, Jeff Miller, our Vice President of Investor Relations, and Yen Wah, our Director of Investor Relations, will be available today. So that's all we have today. Thank you for joining and have a great day. Thank you.

This concludes today's conference call. Thank you all for participating. You may now disconnect and have a pleasant day.