Parker-Hannifin Corporation

Greetings and welcome to the Parker Hannafin Fiscal 2024 Second Quarter Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Todd Liam Bruno, Chief Financial Officer. Thank you. You may begin.

Well, thank you, Diego, and good morning, everyone. Welcome to Parker Hannafin's Fiscal Year 2024 Second Quarter Earnings Release Webcast. As Diego said, this is Todd Liam Bruno, Chief Financial Officer speaking, and I'm here today with our Chairman and Chief Executive Officer, Jenny Parmentier. We know that this is an extremely busy day for everyone, and we appreciate you joining us, and we appreciate your interest in Parker. On slide two, you'll see our disclosures addressing forward-looking projections and non-GAAP financial measures. Actual results could vary from our forecast based on the items listed here. Our press release, this presentation, and reconciliations for all non-GAAP financial measures were released this morning and are available under the investor section at parker.com. The agenda for today has Jenny starting with the highlights of our record second quarter. She's also going to reinforce how our portfolio, our team members, and the wind strategy, our business system, are driving margin expansion and position partner for a very bright future. I'm going to add some color on the financial results and a few details on the increase to our guidance that we released this morning. And after that, we're going to open up the lines, and Jenny and I will take any questions from those in the queue. I now ask you to move to slide three, and Jenny, I'll turn it over to you.

Thank you, Ted. Good morning to everyone, and thank you for joining our call today. Q2 was a quarter of exceptional results. Excellent operating performance driven by all of our team members executing the win strategy. Starting with safety, a 16% reduction in recordable incidents over prior Q2. Safety has been and will remain our top priority. Record sales of $4.8 billion in the quarter, a 3% increase over prior year with organic growth of 3%. Record adjusted segment operating margin of 24.5%, a 300 basis point increase over prior year with all segments expanding margins. And adjusted EPS growth of 29% along with 11.9% year-to-date free cash flow margin. Aerospace strength was a significant driver of our performance in the quarter. We now expect to achieve $200 million in cumulative synergies in fiscal year 24. a $50 million increase to our original guide for this fiscal year. We remain committed to achieving $300 million in synergies by fiscal year 26. And our backlog remains resilient at $10.8 billion. We had a strong finish to the first half, and as a result, our increasing fiscal year 24 guidance. Tal will go over this later in the slide deck. Next slide, please. I'd like to spend a few minutes highlighting the power of the entire Parker portfolio. We have a technology powerhouse of interconnected solutions that delivers value for customers in both aerospace and industrial markets. Today, two-thirds of our revenue comes from customers who buy four or more of the technologies you see across the top of this page. And two-thirds of our portfolio product solutions that we have today enables clean technologies. Next slide, please. Parker has significant content on leading aerospace programs. We have a comprehensive product offering with proprietary design on premier programs. On the upper left-hand side of this page is our first half sales mix by application. You see a nice balance of commercial and military, as well as business jets, regional transport, and helicopters. This diverse aerospace and defense exposure allows us to have multiple products and technologies on every major aircraft program globally, many of them seen along the bottom of this page. All of this adds up to be a compelling value proposition for all of our aerospace customers. Next slide, please. And equally compelling is our global distribution network, a competitive differentiator for Parker. 50% of our diversified industrial revenue is through distribution, a high-margin channel serving aftermarket and small-to-medium-sized OEMs. Our distribution partners integrate Parker technologies that solve customer problems. They are truly an extension of Parker's sales and engineering teams. Building on the success of the North American distribution channel, we continue to drive an increasing revenue mix of 100 basis points per year in international markets. This past December, we held our North America National Sales Meeting for the first time since the pandemic. Nearly 100 distribution partners attended the meeting, along with Parker divisions and sales teams. It was great to have everyone together again, and despite the destocking we've been talking about for several quarters, the overall sentiment and tone was very positive for the future. Next slide, please. We continue to be very proud of our margin expansion progress. Our people, our business system, the wind strategy, and our portfolio have truly transformed Parker's performance. The progress can be seen in every segment on this page. In addition to our core strategies on lean pricing and procurement, wind 3.0 initiatives like Simple by Design, our focus on demand forecasting, zero defects, and productivity and automation will take us to 25% adjusted operating margins, and beyond. Every strategy and tool in the WIN strategy expands margins. I'll turn it back to Todd.

Okay, thanks, Jenny. I'm going to start on slide nine, and I'm just going to really quickly go through the FY24 Q2 financial summary. As Jenny mentioned, the second quarter was an extremely strong quarter for us. It was a great finish to the first half of our fiscal year. And once again, the team set an unbelievable amount of records for the quarter. If you look at this slide, every number in that gold column is a second quarter record. We set new highs for sales, segment operating margin, EBITDA margin, net income, and earnings per share. Total sales growth was plus three in the quarter. All of that 3% was organic. Just a reminder, this is the first full quarter that we have MEGIT in both the current and prior year period. The net impact of divestitures and currency basically offset each other. Divestitures was slightly unfavorable at 0.3. Currency was slightly favorable at 0.5. When you look at the margins, Jenny already mentioned this, but 24.5 was an increase of 300 basis points for his prior year. An adjusted EBITDA margin reached 25.7. That was an increase of 330 basis points for his prior year. If you take a look at net income, we did 802. Million dollars on an adjusted basis, that is a 16.6% return on sales. That was a 30% increase versus prior year. And lastly, adjusted earnings per share, a record for the quarter, $6.15. That was up 29% from prior. Just an exceptional second quarter, and again, unbelievable margin expansion. And what I really like about it, it was very consistent across all of our businesses, as Jenny just shared on that last slide. If you go to slide 10, this is the earnings per share bridge, and this chart really shows what a high-quality quarter it was for the company. The 29% in adjusted earnings per share, that amounted to an additional $1.39 of earnings per share in the quarter. Main driver of this continues to be excellent operating performance. If you look at segment operating income dollars, that increased by $173 million in the quarter. That accounted for just a little over a dollar of that EPS growth, And that equated to 74% of the increased earnings per share in the quarter. Clearly, aerospace systems was a major driver of improvement, but what is really impressive is both industrial businesses also contributed to the increase in segment operating income dollars. If you look at tax, that was 18 cents favorable versus prior year. Again, just driven by some discrete items. Other expense was favorable, 12 cents versus prior year. That was mainly the result of currency changes and some favorable pension expense. Interest expense was 10 cents favorable versus prior. That really is a result of our successful efforts to reduce outstanding debt over the last 12 months. I'll talk about that in a little bit later in the deck. Corporate G&A and share count were just both slightly higher than prior year, just a net 3 cents. And those are the components of the increase in adjusted earnings per share. Really, it's just strong margin performance. across the company continue with some great outstanding performance from the mega business. If you go to the next slide, oh excuse me, if you go to slide 11, we'll talk about the segment performance. That's detailed on slide 11. Couldn't be prouder of the broad-based margin expansion, really driven by the wind strategy. Jenny mentioned this, but our synergies are ahead of schedule. We did increase that synergy number. Aerospace demand really remains very, very high. So just a nice, consistent execution across our businesses, across all of our global team members. You can see that segment operating margin, 24.5 at the bottom of the page, up 300 basis points. Incrementals were stellar at over 100%. And orders remain positive at plus 2 versus prior year. And backlog really remains resilient. Total backlog. Blocked dollars did increase slightly sequentially as well. And Jenny mentioned this, but total backlog remains at near record levels. And aerospace activity remains especially robust. If you look at the North American businesses, sales volume reached $2.1 billion in the quarter. Organic growth was down 1.5% versus prior year. That was driven by continued destocking, some channel rebalancing, and really some softness in off-highway markets. However, what is impressive out of the North American team is that adjusted operating margins did increase 240 basis points to a second quarter record of 24.2%. That was just really driven by excellent execution, some great efficiency improvements, and really some tight cost controls. Orders in North America also remained consistent the prior quarter. They remained at down minus 4. If you look at the international businesses, sales were $1.4 billion. slightly positive versus prior year. Organic growth was essentially flat, which was better than we were forecasting. Organic growth in EMEA was positive at 0.7. Latin America was positive at 9.2. And Asia-Pac did improve. It did come in at negative 2.5, really just being pulled down by the slower than expected recovery in China. But also what's impressive there is adjusted operating margins did expand 110 basis points in these businesses, and also finished at a second quarter record of 23%. That international team continues to be focused on productivity improvements, expanding margins, and being very resilient across the segment, even in a low-growth environment. Very impressive results. Borders and the international segment did improve. If you remember last quarter, they were minus 8. They did improve to minus 5. And finally, on aerospace systems, they delivered another standout quarter. Sales reached $1.3 billion, a 15% increase from prior year. All of that 15% is organic growth. And volume just continues to be driven by commercial aftermarket growth that was in the quarter up 25%. Operating margins reached a new record, increasing by 590 basis points to reach 26.5%. Really, the healthy volumes, the favorable aftermarket mix, outstanding performance from the mega business really all contributed to drive these record margins. We are increasing the synergies. Jenny went over that just briefly. Cumulative synergies, we're increasing from $150 million to $200 million, and order rates in aerospace continue to remain plus 21, which is very robust. On the next slide, we'll talk about cash flow. Let's take a look at what we've done there. Our year-to-date cash flow from operations is $1.4 billion. That's 14% of sales. That is an increase of 26% versus prior year. Just fantastic cash flow performance. If you look at pre-cash flow, that was $1.1 billion. That's up 11.9%, also increasing significantly, 29% increase from prior. Our cash flow conversion is year-to-date 86%. We really have the team remaining focused on being great generators and great deployers of cash. You've heard us say that many times. Last week, our board approved a quarterly dividend of $1.48 per share. That is our 295th consecutive quarterly dividend. Just a nice, solid testament to our belief that we can be great generators and great deployers of cash. When you look at the full year, we are increasing our expectations for free cash flow. We've increased that range to $2.8 billion to $3.1 billion. That's moving the midpoint up $150 million to approximately $3 billion. And of course, free cash flow conversion will be over 100% for the full year. On the next slide, let's take a look at our progress on deleveraging. We did reduce debt another $400 million in the quarter. And just a reminder, since we closed MEGA just five quarters ago, We have reduced debt by over $2.2 billion now, and we've improved our leverage by 1.4 turns. Both of those figures are ahead of what we've originally committed to. If you look at the metrics, gross debt to adjusted EBITDA is now 2.4. Net debt to adjusted EBITDA is 2.3. And we continue to forecast just approximately $2 billion of debt paid out in the fiscal year. And now, based on the performance we've got year-to-date, we expect to achieve net leverage of 2.0 times by June of 2024. Just great performance across the board. Okay, on guidance, just a few details on guidance. You saw the increase to guidance. We are reaffirming our full-year organic growth midpoint and increasing our margin and earnings-for-share expectations for the year. Our reported sales growth for the year is forecasted to be in the range of 3 to 5, or at the midpoint, and they are modeled 49% first half, 51% second half. In respect to organic growth, we are raising the aerospace organic growth midpoint by 200 basis points to 12% for the full year. We are also raising the international organic growth midpoint by 100 basis points to minus 2. That's slightly better than what we gave you last quarter. Those increases are offset by a decrease in the North American organic growth midpoint by 200 basis points to minus 1.5. Full year organic growth for the entire company remains the same as last quarter at plus 1.5. Moving on to margins, adjusted segment operating margin guidance is being raised to 24.3 at the midpoint. That's up 70 basis points from prior guidance. And if you look at it on a year-over-year basis, that would be 140 basis points of margin expansion versus prior year. Mega synergies, we talked a lot about that. We're moving that to $200 million. Corporate G&A, interest and other are relatively unchanged from our prior guide. Tax rate has tweaked just a little bit. We expect the full year to be $22.5. That's really based on the performance in the first half. We expect the second half to be $23.7 from a tax rate perspective. Full year, as reported, earnings per share increased to $20.30, and full year adjusted earnings per share has increased to $24.20. Both of those are And finally, for FY24 Q3 adjusted earnings per share, we expect that to be $6 even at the midpoint. And as usual, we've included some more specifics in the appendix. So that's it on the increase to guide. Jenny, I will hand it back to you and ask everyone to move to slide 15.

Thank you, Todd. A few key messages to close us out. Q2, as we've stated many times, was an exceptional quarter that closed a strong first half. We'll continue to drive positive results and accelerate our performance using the win strategy. Our portfolio and strengthened customer value proposition, along with growth from secular trends, will deliver organic growth of 4% to 6% over the cycle. We remain committed to our FY27 targets of approximately $30 earnings per share and greater than $3.5 billion free cash flow. We expect another year of record performance, and we have a very promising future ahead of us. We look forward to talking to you about our promising future at our investor meeting on May 16th of this year.

Back to you, Todd. Okay, Diego, we are ready to open the lines for Q&A, and we'll take whoever is first in the queue.

Thank you. And to remind everyone, to ask a question, press star 1 on your telephone keypad. A confirmation tone will indicate you're in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from Joe Ritchie with Goldman Sachs. Please state your question.

Hi. Good morning, everyone, and great quarter.

Good morning, Joe. Thanks, Joe.

The first place I'd like to start is just around North America. So clearly, good color, Todd, and what the guidance now implies. But it looks like your order rates are at least stabilizing there, even though you took down the growth guidance for the year. So maybe just talk a little bit about what you're seeing across those end markets and whether you're seeing any stabilization or green shoots on your North America industrial business.

Sure, Joe, this is Jenny. So, yeah, we did see, as Todd said, you know, a negative 1.5% of organic decline in Q2. We've had four consecutive quarters with negative orders now, but as Todd stated, the orders did remain the same as last quarter at minus four. You know, what I would say is that destocking in the channel continued. We saw weakness in off-highway, primarily construction in Q2, some weakness in transportation and automotive and in heavy duty. We did talk last quarter about this inventory rebalancing and destocking, not only through distribution but also at the OAM level with customers, dealerships, dealers, and that we did anticipate this to go into calendar year 24. So I would say overall, D-stocking is in line with our expectation for Q2, but North America was just a little worse. It's been a year since it started, and it's going to continue into the second half here, and that's what we have in the guide. But backlog remains strong. We have this longer horizon of backlog strength, and I would say that, as I mentioned earlier, distribution sentiment is very positive. We haven't seen any major cancellations or push-outs out there right now. So, you know, we lowered the guide to 2.5% on this continued destocking, and the softer off-highway we think is going to continue. We see it'll be construction again and ag too this quarter. But, you know, we're feeling good about this guide right now.

Hey, Joe, this is Todd. I would just add, you know, if you look at the total industrial business, right, in total it kind of came in exactly as we were expecting. You're exactly right. There was a little bit of a shift from North America into the international markets. But when you look at the total reported sales, at least what we're guiding to, you know, these are really very, very close to all-time highs when it comes to volume. So we feel really good about that. We think we can continue to expand margins despite inflation.

what's going on with the choppiness in the order market so we feel really good about that yeah that's great color uh from both of you i guess my quick follow-on there is look the margin performance uh despite the you know kind of weaker growth expectations you know in north america and really across your industrial businesses have been incredible last couple quarter you're above 24 percent So I guess the question is, is 24% kind of the new baseline for the industrial businesses going forward?

Joe, it's a great question. Like I said in the comments, couldn't be prouder of the team. We talk about this all the time, the win strategy. Every single item on that win strategy is a margin-enhancing set of tools. And it really is rewarding to see the team put up numbers like that. You know, we have a target set out there. We want the company to be at 25% segment operating margin. We have not achieved that yet. We will achieve that. There is no doubt. But, you know, we're just keeping an eye on what's happening with the top line, and obviously we're doing everything we can within the four walls of our facilities to make sure that we keep pushing that number higher.

Joe, I would just add, I mean, you know, our culture is one of continuous improvement, and we're just We're never waiting for a downturn. We're using all the tools in the wind strategy to expand margins. And, again, I have to echo Todd's comments. We couldn't be prouder of the team. They're just really doing a really nice job in a slower growth environment. We expect that to continue.

Great. Thank you both.

Thanks, Joe.

Our next question comes from Julian Mitchell with Barclays. Please state your question.

Hi, good morning. Maybe just wanted to understand on the international business, in industrial, orders have been down I think for five quarters now. You slightly took up the sales guide. What's your impression of where we are in that orders downturn? Maybe help us understand what on the revenue side changed a little bit Are we thinking it's sort of a very gradual, maybe we find a flaw in the next couple of quarters and then a very gradual recovery thereafter across those main regions in international?

Thanks, Julian. This is Jenny. Listen, we've been saying it's just been choppy in international now for several quarters, but call it flat organic growth in Q2. As Todd said, orders did improve from minus 8 in Q1 to minus 5 in Q2. Europe, EMEA had positive organic growth of 0.7%. It was better than our forecast, as you said, really due to some resilience in our filtration business and favorable project business timing. We did see destocking continue. We see some softness in off-highway and industrial markets. In Asia Pacific, Todd mentioned a 2.5% organic decline. China recovery is still slow. I mean, we did see some low single-digit positive growth for China in Q2, but again, it was against a much easier comp from the COVID shutdown last year. So off-highway construction remains soft in Asia Pacific. Transportation, truck, I would say that India does remain a bright spot in Asia Pacific. When we look forward, That full year organic growth improved 100 basis points really due to the strength we saw in Q2 and an improvement in orders in Asia Pacific. We do expect that Europe destocking will continue and that softness that I mentioned in Q2 off highway and industrial markets will continue. Again, China recovery is still slow. The team is doing a great job controlling the cost and giving margin performance in the region. I would say that when you look at the rest of Asia, Japan and Korea are still pretty soft in Semicon, but again, Southeast Asia and India look good right now.

That's helpful. Thank you. Then just my follow-up on aerospace systems. you know, maybe help us understand sort of, you know, is it more volume or price perhaps in commercial that drove the revenue guide uplift for Aero? And, you know, on the synergies point, you know, it came in with a much stronger margin than I think people were expecting for the second quarter in aerospace. Maybe help us understand kind of any bucket of those synergies that's coming in ahead of plan.

Yeah, Julian, this is Todd. I'll start. On the increase to the top line, obviously you can see demand across all verticals in the aerospace business is extremely strong. If you look at what we did in the quarter, 15% organic growth in the quarter. That gave us the confidence to raise the second half. That has been a big plus. If you look at within the business, the mix, it's 47% aftermarket. that was higher than we were forecasting. So that was a part of driving that margin expansion. And we've talked about this now for a year on MEGIT and our base aerospace business. It really is, the volume is certainly a help to that, but it's really the team working through the efficiency. The supply chain is still a little noisy on the aerospace side of the business, but it's really the team is starting to perform in a normalized environment when it comes to that. That's what gave us comfort in aerospace.

We've obviously, with pulling the synergies ahead, we've had some great performance by the team. We've done a really nice job de-layering the organization and getting it into the Parker division structure. Now we're really starting to see the benefits of implementing the wind strategy. The team's really doing a nice job, and as Todd said, we expect this to continue. Volume always helps.

Great. Thank you.

Thank you. Our next question comes from Scott Davis with Mellius Research. Please state your question.

Hey, good morning, everybody. Good morning, Jenny and Todd. Good morning. This is kind of a nuanced question, and excuse if I think it's weird, but your gross margin has just gone up a ton, right? Pre-COVID, kind of 25%. Today, 35 plus percent. Op margins have gone up five, you know, call it 500 basis points or so that same time frame. But is a future margin improvement that you guys see, do you think it'll come more from gross margin than kind of SG&A leverage? Or would we expect a balance there? I guess it's It's a nuanced question, but I'm kind of fascinated. It feels like there could be some upside to operating margins, perhaps beyond even what you've shown today.

Yes, Scott, it's a great question. It's something we look at intensely across the organization. I think there's upside on both areas, to be totally honest with you. But you're right. If you look at what we've done, and it depends on You know, if you're looking at the as reported gross margin number, there is a lot of noise in there from the purchase accounting transactions over the last year. But, you know, this quarter was fairly clean. So I expect it to stay at the high levels that it was at this quarter and obviously improve from there. We are constantly looking at SG&A and reinventing ourselves everywhere that we do business. So I really do think that there is potential in both areas.

Yeah, I just pile on a little bit there. You know, the wind strategy tools apply to the entire business, right? So I agree with Todd. It would be in both places. And I mentioned earlier some of the wind strategy initiatives, you know, that came with 3.0. And, you know, you look at Simple by Design just yielding benefits, you know, everywhere, up and down. And then some of the initiatives that we have around wind Demand forecasting, you know, allowing us to better analyze demand, better staff our factories, really be able to serve the customer better, really reduce our overall cost of service to the customer. So that's really a plus. And then, you know, our zero defect initiative. You know, a lot of activity around, you know, producing a product 100% quality the first time, and that's, you know, a lot of cost reduction there. So just A lot of tools in our toolbox to continue to expand margins and a lot of nice work done across the board by all the teams. The high performance team structure really lends itself to improvements throughout the whole organization. It's not going to be in just one area. It will be across the board.

That's super helpful. You know, I'm going to leave it at that. You guys are doing a great job, and best of luck in 2024. Thank you. We appreciate it. Thank you, Scott.

Our next question comes from Nicole DeBlaze with Deutsche Bank. Please state your question.

Yeah, thanks. Good morning, Jenny. Good morning, Todd. Good morning. Just maybe starting with the cadence of EPS through the year, I think just looking back at normal seasonality, you do typically see like a step up. In the second half from either the first half or 2Q, however you want to look at it, I guess what are the key puts and takes that you're embedding more of like a step down at the midpoint this year?

Nicole, that's a great question. We looked at that a lot as we put this guidance together. What I like about the guide is the EPS is evenly split now, first half, second half. It's 50-50, so there's no big ramp in the second half that should be concerning. I would call out the Q1 and Q2. Obviously, those were both record numbers when it comes to EPS. So I think that's a little bit of the driver there. You know, aerospace business remains strong. We have no concerns about that business whatsoever. But, you know, we did see some softness in the North American businesses, and obviously international got a little bit better, but it's still a little choppiness out there. So that's really the elements that went into our guide. If you look at both of those and really the second half of the year, I mean, we really are still guiding at record levels of earnings per share.

Totally understood. Thanks, Todd. And then just going back to some of the order trends, you guys gave really good color around the international revenues that you saw, but what actually improved sequentially in the orders going from the down eight to the down five in 2Q? Thank you.

Asia Pacific orders improved in the quarter. Got it.

Thanks, Jenny. I'll pass it on.

Our next question comes from Nathan Jones with Stiefel. Please state your question.

Good morning, everyone. Morning, Nathan. I'm going to start off on capital allocation now that the balance sheet is in much better order post paying down a lot of the debt off Megit. Being back to maybe around two turns in that leverage at the end of 2024, can you talk you know, about your willingness to get back into the M&A market. We're in a bit of a different interest rate environment than we were when you bought Maggot. You went up to a little over three and a half tons of leverage to buy that. What your appetite is for, you know, potentially levering up given the different interest rate environment and priorities for debt versus M&A?

Thank you, Nathan. This is Jenny. Well, you know, first of all, as we've said, debt... pay down is our number one priority. But as Todd mentioned, we are ahead of schedule for achieving around that 2.0 number by the end of this fiscal year. One thing I would say is that we never let the pipeline go dry. We're always working the pipeline. We've built a lot of relationships over the years. That's how we've wound up with these great companies in our portfolio, and we continue to do that. We have to have the right deal. It has to be the right property out there. We still want to be the consolidator of choice. We like all of our eight technologies. We do see an opportunity to build on the entire portfolio. We want that to be driven by secular trends and longer cycle, faster growing, more resilient businesses. And, you know, we want it to, you know, be accretive to margins, to EPS, to cash flow. So, you know, we'll keep this pipeline going and, you know, we'll be looking for that right deal.

I mean, would you be willing to do something like three and a half tons of leverage and then delever after that? Again, given the change in the interest rate environment, is a lower number kind of your ceiling? these days, given the interest rate environment?

Hey, Nathan, this is Tom. I'll take a stab at that. So listen, we're not trying to do anything bigger than what we've done. Jenny said it, I think, very well. We're trying to make sure we do the right deal for the company, for the shareholders. What we have proven is we have proven that we can deliver quickly. We generate cash like we've never done before. And, you know, I think what we've been is we've been creative with the way we've structured those deals that allows us some flexibility on that. So, you know, I don't think we wouldn't be afraid to do something like what we did before, but we don't necessarily have to do that if it doesn't present itself.

Fair enough. Thanks for taking the questions.

Thanks, Nathan.

Thank you, Nathan.

Our next question comes from Meg Dobre with Bayard. Please state your question.

All right. Good morning. Thank you for the question. Just to follow up on that discussion with Nathan, when you're approaching M&A at this point, first, are you sort of just looking at the eight technologies that you currently have in your portfolio, or are you willing to look more broadly beyond that? And also, how do you sort of think about your specific vertical or in-market exposure You've done some sizable things, obviously, in aerospace. Is that still an area that you're looking at, or are you, frankly, willing to look to further diversify your portfolio beyond the end markets that you currently have exposure to?

We like the eight core technologies. We think that that is where we do really well. We don't have a specific aerospace area. mixed number that we target. Right now we have a nice balance between the segments, but we're going to continue to keep growing the industrial business as well. We're going to be looking at the markets that we know, customers that we know, and technologies that we're familiar with. That's our current focus.

I would just add, you're right, we have expanded the aerospace exposure pretty significantly, but Those are the same technologies that we have throughout the entire company. They just happen to be in aerospace and markets. The applications are part of those eight technologies. That's why we like those eight technologies so much.

Understood. Then I know a lot of people asked about margins. I guess I'll ask one as well. The performance in industrial really kind of stood out to me given everything that's going on in those end markets. And I'm sort of curious as to what are you effectively doing there? Is this margin expansion that we're seeing more of a cost mitigation in an environment in which the volumes are frankly not that great? Or is there something more structural in nature If we see re-acceleration, for instance, in fiscal 25, should we assume normal incremental margins at that point on this base? Or will some of these costs that you've taken out eventually come back with volume?

Thank you. I think we can say that you would see normal incremental margins with an acceleration. It's a lot of what we've talked about this morning. The wind strategy is very effective across all the businesses. And Our teams are doing an excellent job with, you know, some of our legacy tools around lean and supply chain, as well as some of those newer initiatives that are driving costs out. And we'll continue to see that in the industrial business. We've said a couple times, you know, wind strategy 3.0 still has room in it, and we'll continue to expand margins.

Appreciate it. Thank you.

Thank you. Our next question comes from Andrew Obin with Bank of America. Please state your question. Hi, Andrew Obin. Your line is open. Please go ahead. All right. We'll move on to the next question. Please press star 1 to recue. Our next question comes from Jeff Sprague with Vertical Research Partners. Please state your question.

Yeah, Diego, it's a busy day out there. I know people might be stacked up on multiple calls.

Thank you. We'll move to the next question. We have Joe O'Day with Wells Fargo. Please state your question.

Hi, good morning. Thanks for taking my questions. Jenny, I wanted to circle back. You talked about sort of recent meetings with distributors and a broadly sort of positive tone. Can you just expand on that a little bit in terms of how maybe that tone has changed over the last several months, what they're pointing to, trying to understand bigger picture thematic elements versus a little bit more near term kind of on the ground and what folks are talking about seeing out there?

I would have to tell you that visiting distributors and talking with distributors over the last several quarters, I've never felt a negative tone. They've all felt positive. rather positive and bullish on the future. A slowdown in orders, but never an overall concern about what was in front of us. What I would say about the meeting in December is that there was just a lot of talk about a return to acceleration. Not seeing it yet, but very positive that it would come. And, you know, commentary on, you know, it's been almost four quarters now. Now it has been four quarters, and, you know, we usually see that turn coming in front of us. So just a very overall, you know, positive sentiment. Some of them are participating in some of these, you know, what we would call mega CapEx projects. You know, they've commented on how they're working with some local and national contractors on, you know, new plants that are being built, site prep, and some of the walls going up. So, Some feel really positive about that. So again, really good sentiment, good tone about the future.

I appreciate the color. And then also wanted to ask on international margins. I think you commented about ongoing progress in terms of the distribution side of the margin profile improving on the international segment. But those international margins are pretty close to North America margins too. So just if we think specifically about the distribution side, what does the margin gap look like sort of international versus North America? How much more upside should we think about in terms of navigating higher on international distribution margins?

Yeah, sure. This is Todd. We've been very public, but the sales that go through the distribution network are anywhere from 10 to 15 margin points better than our direct shipments, and that's just – It's part of the structure of the channel. It's part of the value they add. Jenny had a nice slide that kind of went through why that is supportive of that margin mix. What we've been trying to do for many years now is increase that mix in the international businesses. That was on the slide as well. We think we're not done with that yet. We think we have more room to grow on that. So we feel like that still has room to grow and that that will also be a margin driver out into the future.

Got it. Thank you.

Our next question comes from Jeff Hammond with KeyBank Capital Markets. Please state your question.

Hey, good morning, everyone.

Morning, Jeff.

Hey, just on second half arrow margins, I think you're guiding maybe flat to a little bit down. It seems like synergies are building. Just wondering, you know, I think historically your margins are kind of built through the year. Just how are you thinking about you know, maybe any headwinds within second half versus first half arrow margins?

Yeah, I would just start with, and I can let, you know, Todd add on. We had a really nice aftermarket mix, you know, in Q2 and in the first half. We were really driven by favorable spares. So, you know, we didn't feel comfortable forecasting that into the second half, so that is some of it.

Yeah, we did call out some one-timers in Q1 that were margin positive. Q2 obviously was another great margin quarter. Jenny is absolutely right. That mix at 47%, we hope it remains there, but we didn't feel prudent to guide that way. And again, I just go back to if you look at the second half there, those are record numbers when you look at what we're guiding to. So we feel like we can achieve them. I'd like to see a few more quarters at that level before we get overly confident.

Okay, that's great. Just the backlog, I think you've said it's stable at a high level. I think you've given some stats around 30% for industrial and 55% for overall, and that was kind of 2x. Are those kind of running at those same levels? Are we seeing any backlog drawdowns?

No, I mean, they're just exactly what you said. They're holding steady at those levels. And it is about twice of what we've seen in the past. So we feel really good about the quality of the backlog. I would tell you that we constantly analyze it, and we do a lot of checks with our customers. But, again, not seeing any major cancellations or push-outs at this time, so we think it's of good quality.

Okay, great to hear. Thanks.

Thanks, Jeff.

Our next question comes from Andrew Obin with Bank of America. Please state your question.

I guess still good morning. Still good morning. Good morning. Yeah, and I apologize for the confusion earlier. No problem. Just a question on pricing and inflation. I guess our channel work suggests that just generally fluid power pricing is running higher, I think, than we would have expected. In the new calendar year, what are your expectations, how your expectations about pricing are evolving, any change to your framework, and what does it say about sort of just general inflationary environment for the industrials?

So, Andrew, this is Jenny. You know, just kind of a reminder with pricing, we went out early and often, you know, some of these really historical inflationary times over the last couple of years. We are now back at our regular pricing cadence of January and July. And I would just say that the increase that we just did was very modest. I wouldn't consider it a higher increase for fluid power. And that's what we, barring any major changes, that's what we expect to see going into the future. So we still are in inflationary times. You know, and there's some of those inflationary cost drivers that aren't going to reverse. So, you know, looking forward, this is what we see right now, but, you know, we'll continue to use the pricing tools that we've always used in the past.

Gotcha. And just to follow up, I think, on mega synergies, you know, I guess just to clarify, you know, you've raised the synergies from 150 to 200 million cumulative. So should we think about it as a pull forward, or is the $300 million target going higher? Because clearly, Megan, it has been a big success for you, but just to understand what the formal framework is.

Consider it a pull forward. We originally said $75 million for this fiscal year. Now it's going to be that $50 million higher. So we're in a good position here. We remain committed to the $300 million. by FY26. We're just realizing some of that sooner.

Well, sounds like good news. Thanks so much.

Thank you, Andrew.

Thanks, Andrew. Diego, I'm being told that that was the last question in the queue, so unless you see anything different, we will wrap up just a little bit early. I know it's a busy day out there for everyone. If you do need any follow-ups, Jeff Miller, our VP of Investor Relations, and Hien Hoa, our Director of Investor Relations. Certainly we will be available if you need any follow-ups. As always, we appreciate your attention. Thank you for your support of Parker, and I hope everyone has a great day. Thanks.

Thank you. And that concludes today's conference. All parties may now disconnect. Have a great day.