All right. Good morning, everyone. Thank you for joining us. My name is Mig Dobre. I cover Machinery for Robert W. Baird. It is my pleasure to introduce to you today, Parker-Hannifin, as you probably know, Parker is a global leader in industrial and aerospace motion process control and Materials Technologies.
Joining us today, we have Chief Financial Officer, Todd Leombruno. Todd I'm going to turn it to you, and then we'll do some Q&A.
Mig, it's a pleasure to be here. It's great to see you. I know it's been a while since we've seen you not in a Zoom screen, but it's really a pleasure to see so many people in the audience, and I'm blessed to be able to talk about Parker-Hannifin and what we're doing.
Mig said this, but we are the global leader in motion control. We have been around for over 100 years, really focusing our technologies on solving complex application issues for our customers. There's a few things that are very important for Parker-Hannifin. Number one, we have the broadest breadth of technologies in the space. We have the greatest distribution network from an industrial product standpoint on the planet. We have a fiercely decentralized operating structure. We believe the more people that can be part of a P&L and own the results, the better the results have been.
Our operating system, we call it The Win Strategy, who doesn't like winning. And we're on version 3 of that now, and it's been extremely successful. And really, there's 3 things that the company is focused on.
One, it is living up to our purpose, enabling engineering breakthroughs that lead to a better tomorrow, generating top quartile performance against our proxy peers and being great generators and great deployers of cash. And if you've seen what the company has done over the last 10 years, I think we've filled the bill on a lot of those things.
One of the things that we've been focused on is really changing the portfolio within the company, and we've done this really through a series of really transformational acquisitions. But also where we focused our organic growth and our resources across all of our businesses within the portfolio.
You can see what we have laid out here is the transformation from FY '15 all the way through what we hope to be when we get to FY '27. And it really is moving the company into a more of a longer cycle position. We've done that with the acquisitions of CLARCOR, LORD, Exotic, and most recently, Meggitt. But also, we're poised to benefit from really some secular trends that we think over the long term are great tailwinds for growth, and this will help us grow differently as a company. These are things around aerospace, CapEx demand, digitization, clean tech and electrification. So the portfolio is very balanced and very poised to benefit from growth in these areas.
I couldn't be more proud of this slide. This is really the results of all of our team members around the globe working extremely hard for a long period of time. You can see from FY '16, we've grown at an 8% CAGR over time. Our goal organically, we've lifted that organic goal to be 4% to 6% over the cycle. The EBITDA margin expansion has been tremendous, right, almost 900 basis points of EBITDA margin expansion. And I'm proud to say that, that has been experienced really across all aspects of our business. It hasn't been 1 or 2 things. It's really been across the whole portfolio.
You look at EPS, we've grown EPS at a CAGR of 17%. And of course, free cash flow, there's been a step change in the amount of cash we've generated as a company.
And we think that has served our shareholders well. This is a TSR chart. You could see over the last 10 years, we've beat all of our proxy peers, all of the S&P 500 Industrials, and we've generated over 300% return for our shareholders. That's something that's very meaningful for us and we're very proud of.
And lastly, looking towards the future, we're not done yet. We have set FY '27 targets for the company. We have that 4% to 6% growth target. EBITDA and segment operating margins of 25%. We expect free cash flow to be in the mid-teens. And what I like here is, is this EPS growth, we feel like we can get to a $30 earnings per share by FY '27.
All the items listed here are the main elements that are going to drive us in that direction. And I can tell you, the company has never been more aligned, and we've never been more proud of our results, but we've never been more focused on what our promising future holds.
So Mig, with that, I'll turn it over to you and anyone else in the crowd, and we'll take some questions.
That's great. Speaking of that, if you'd like to contribute to the discussion, you can e-mail session2@rwbaird.com.
That was a great intro. I appreciate that, Todd. I think where I want to start is with a question that I've been getting more and more from investors of late. There is a generational change going on within Parker as we have seen with a number of leadership retirements and folks stepping up to fill those roles.
So talk a little bit about that and where there is change to be noted? Where there's continuity? And how the company is evolving in that regard?
Yes, Mig, that's a great question. So obviously, I think everyone is probably aware, Tom Williams, who was our CEO last year, retired from that position last year. Jenny Parmentier has been our CEO for now coming on a one full year. Tom, and this was already announced in the plan, he was chair for 1 year, and that was his plan. He is retiring from Chairman of the Board as of December 31, and Jenny will take the role of Chairman and also CEO. So that has been going unbelievably smooth.
But also, we have Lee Banks, who's been our Vice Chair and President for many, many years, I think, over 32 years. He is retiring effective December 31. And Andy Ross will take the role of COO and President for the company.
And I would tell you, this has been a long thought-out plan. Tom will tell the story that when he became CEO almost 9 years ago -- that not the very first thing, but probably the second thing that he started doing was thinking about who could be his successor.
And I would tell you, Lee and Tom spent a significant amount of time over those last 9 years, trying to figure out what would be best for the company. And Jenny Parmentier became CEO. And I would tell you, she has excelled in every opportunity that she's had within the company. She is an unbelievably inclusive leader. People love to work for Jenny. And I would tell you, she is aggressive and she runs fast.
She is an operator at heart, so one of the things that we're very proud of in the company is our attention to operating excellence. We feel really important. That is a very important driver for us to generate consistent, resilient results no matter what's going on with the top line, and Jenny is a firm believer of that.
Andy has been with the company for a tremendous amount of time as well. He has run multiple businesses within our company. And he's been the President of 2 of our operating groups.
So I would tell you, they're big shoes to fill with Tom and Lee, but they couldn't be better filled with Jenny and Andy. So we're really excited to see what they do for the company. I think Lee said this best on the earnings call. We've had the pleasure of having great leadership within the company. We take talent development as one of the most serious things we can do. And every CEO that has taken the job has taken the baton and run a little bit faster than the person before that.
And that's what we're really focused on doing is continuing the transformation of the company, not only achieving but surpassing those FY '27 targets and making sure that we do Tom and Lee proud in everything that we do.
You set me up for my follow-up pretty well in that. Given everything that you talked about in this change, does it sort of makes sense to revisit and revamp this fiscal '27 strategy? Under the guide of the new folks.
Well, I would tell you, both Andy and Jenny and Lee and Tom and really the entire senior leadership team. They have had their fingerprints on the strategy changes that we've made on the portfolio changes, that we've made on the agreement on the targets? And are they reasonable targets and are they meaningful targets?
So you're not going to see us change strategy. You're not going to see us change direction. You're not going to see us change target until we achieve those numbers, and then we'll set a new set of targets, but you're not going to see us do any kind of pivot far into the right with any of these leadership changes.
All right. That's helpful. That's good. Maybe let's pivot a little bit and talk about demand and business conditions. You reported recently. I think one of the things that stood out to folks was industrial right that's behaving a little bit different than it has in prior cycles. So give us a little bit of insight there. And I think industrial in North America, in particular, has been kind of the area of focus. So let's dig into that.
Well, it goes back to that slide that I had about changing our portfolio and making sure that we remain resilient and that we can really grow differently. We're very proud of all the results that we've been able to post. One of the challenges that we still have yet to conquer is, can we grow differently. So before I get to industrial, I'll talk a little bit about aerospace.
Aerospace, unbelievable stellar quarter, right, 16% organic growth, record margins really across the board. Really strength in every vertical that we have in the aerospace business, and that has really been fantastic.
One year after the Meggitt acquisition, integration, it's really 1 year in. Couldn't be going any better than it's been. We've been very proud with all of those businesses. We've been proud with the growth that's come from those. We've been proud with the margin performance. And of course, we are committed to that synergy plan that we've talked about.
Specifically, you mentioned industrial business. Now the Industrial business, you're right, it did perform better than a lot of people expected. Orders did continue to decline. They were minus 4, but they got better, they were minus 8 the quarter before. So a little bit of that has been our focus within the industrial portfolio on things that are longer cycle, more margin accretive. And you've seen that in a little bit of our acquisition performance, but also where we focused our organic investment and our focus within our businesses.
We were talking about this on the way here. We focus on things that are hard. We focus on things that add value to our customers. We focus on things that bring value and those things are sticky, right? So those are the things that have really happened on that.
North America, in general, the demand still remains robust. There has been some softness in what I'll call some consumer-facing verticals, construction, HVAC, semicon, believe it or not, we've called out as a softness. But overall, we've been very proud with the performance of North America.
Yes. I think people have been trying to sort of parse out if North America is somehow reaccelerating versus what has happened in the prior quarter.
Yes. Well, I mean, I'll cite the orders, right? The orders were minus safe, they improved to minus 4. So that's a little bit of improvement, and we're happy to see that. Orders have been declining over the last couple of quarters. I don't know if I'm ready to call a bottom on that or not yet, but we were positive with the results that we saw there.
One of the things that I've personally wondered about within your North America, the mobile component of your business, when I'm thinking of motion control for specifically.
One, I'd love to hear you talk about that directly. But I do wonder when we're actually looking at the production schedules of those customers despite what the PMIs or whatever else would indicate, they've been pretty strong. In fact, they've been trying to increase production rather than decrease production. So do you have any inkling for them as to what calendar '24 might look like and how that might flow through your orders?
Yes. I mean, obviously, we just gave a full year guide, right? So our guide uniquely goes out into June 2024. So you look at the comparables, the comparables get a little bit more difficult as you look out into next year. But we feel pretty confident on the guide that we gave, right? It's not a huge growth year, but it's kind of staying positive, right? For the whole company, I think we guided to 1.5%, 2% organic growth.
Aerospace is helping that. But on the mobile side, we talked about some rebalancing, some inventory control. But to be honest with you, I would say we're more positive than negative when it comes to that side of the business.
And as far as your North American distributors, can you comment on that?
Yes. North American distribution is a huge part of the North American business. If you look at the weighting of that, it's probably a 60-40 mix distribution to OEM in North America. Sentiment is positive. There has been some channel destock, which is, I think, pretty documented and pretty common across the business. But overall, like I said, the demand has been fairly positive, so we feel good about that.
Do you have a sense or your commercial teams that is, when talking to distributors as to what they view as normal stocking level? Do they go back to pre-COVID?
Yes. I don't think we're going to see back to pre-COVID levels. I think that one of the things that I've heard our distribution state as a result of [indiscernible]. We kind of got caught on a lack of supply. We don't want to go back to that area. The other thing I would tell you about North America is that, Mig, you mentioned the fluid power, the motion system side of the business. That portfolio has changed tremendously, right? With the CLARCOR acquisition, we've got a huge amount of filtration aftermarket with the Lord business. We expanded our Engineered Materials business. So that mix of that business isn't as levered towards just fluid power as it might have been 5, 10 years ago. So I think that's also helping drive the performance in that business a little differently than it has in the past.
Yes. That's -- to some degree, what I was trying to tease out with the prior question because if -- I do wonder if the fluid power business is behaving more consistent with what you've seen in the prior cycles, but there are these other verticals that are product...
I would say we are seeing that. But then also, the themes that have come up has been these mega cap projects, this capital investment, this reshoring, this near shoring that coupled with the secular trends of clean tech electrification and really the digital supply chain. Those have also been things that have, I think, kept us a little bit more growth-focused than maybe previous cycles.
And it's really early days on a lot of those things. Obviously, aerospace is a secular trend is clearly booming, and we expect that to stay that way for some period of time. But I would tell you, we're pretty bullish on those things and what they mean for our industrial business.
Understood. Maybe moving on to international. Yes. Let's start with just some commentary as to what you see by geographies.
Well, we said this on the call last week, all the data that you're reading out of Europe is, are they in a recession isn't negative? To be honest with you, Europe performed better than we expected in the quarter. That was a nice positive surprise for us. And it wasn't a surprise from September, it really continued throughout July, August and September for us.
China is certainly weak, right? And the comparables are tough with some life science, tough comparables. But China, we thought would be probably a higher performer than it is today, and we expect that to be soft for the foreseeable future.
It really depends on what happens in Germany and do we get any kind of lift out of Europe. If you saw, we kind of tweaked our international guide just slightly down. But overall, what we're really proud about the international business is their ability to expand margins.
So I think that's something that's different about Parker-Hannifin today than maybe what you would have seen 5 or 10 years ago is. The tools of The Win Strategy are real and they work. And no longer do we need significant growth to grow margins. We think that there is efficiencies to be gained on our shop floors, in our supply chain. That add to our margin expansion story. So we feel really good about that no matter what the macro sends us.
I defer talking about margins for a bit, but I've got 5 different questions from the audience topics. So clearly is of interest...
We like talking about margins. We're really proud of what we've done, and we're really confident in where we're going. So we'll take all those questions.
Well, this question is quite pointed talking about the fact that Q1 has been so strong from a margin perspective. Yet the guidance obviously implies deceleration going forward so unpack that.
Yes. So Q1 really was a stellar quarter. Obviously, it was significantly better than our prior year. It was significantly better than our guide. It was really a perfect volume quarter. Everything went perfectly when it comes to volume. And really, I would tell you, our teams are focused on doing everything we can to make sure that we're doing the best thing we can for our customers, but also for our shareholders and our bottom line.
When you look at aerospace, aerospace was clearly the standout 26% margins within aerospace. We had unbelievable volume. We had great performance out of our legacy business and our Meggitt business. We had an unbelievable mix of aftermarket OEM or commercial OEM -- or excuse me, commercial aftermarket business. Obviously, the margin profile of that business is the best. So that was really a plus in the quarter.
In addition, we called that on the earnings call, we had a few onetime settlements. That was about 100 to 150 basis points size-wise. So that is what we don't expect to repeat going on in Q2, Q3 or Q4. When you look at our Q2, there's some seasonality in Q2. It is the lowest volume quarter that we have in the year. It's the lowest number of workdays. That's just part of the natural cycle of the business. So that's why we guided the way we did in Q2.
And if you look at that, if you take out those onetime items in that favorable mix, you'll see that we have progression in that aerospace business as we go into the second half.
On the international side, obviously, the orders, the concerns about China, the concerns about Europe drove what we guided to on the margin side. And then North America, we're still going to remain positive, but you can see that we're not expecting the record levels that we had in Q1, but still pretty much margin expansion for the year.
For the full year, we did increase our margin guidance. We are now guiding at 23.6% for the full year that 70 basis points improvement from prior year. And that's pretty good with a 1.5% organic growth top line number. So we feel good about that.
I have follow-ups for each segment.
Oh my God, that's great.
So on Industrial North America so on this notion of margin progression, and this is not just a question for today, but one that I've been giving for a while. Is it -- is there something within your cost structure, whether it's price cost or however you want to identify it that has created sort of a temporary lift, maybe in like Q4 and Q1 that actually starts to normalize as you go forward? And I'm asking about North America specifically.
Yes. When it comes to price cost, obviously, we've been through as everyone that's in the space has gone through over the last 2 years. It has been an unbelievably difficult inflationary environment, logistics, energy, freight, labor. Those have all been challenges for everyone to overcome.
I think we fared better than most when it comes to that, and it's really a testament to our team, really all around the world. What we try to do from a pricing standpoint is we try to remain margin neutral. We didn't try to leverage that. We didn't try to drive anything extra to the bottom line. We really try to cover our cost in that manner. And that's really what the focus has been. So I don't see price/cost being a margin negative going forward. And if we have to continue with price, if we continue in this inflationary environment, we'll continue to do the same.
I guess the way I was thinking it's not so much that it's a negative, but it's less of a positive, if that makes sense.
Well, yes, we're not going to go to -- pricing over the last 2 years has been really significant. I'd say once in a lifetime, type pricing environment. We would expect pricing to be more of a normal environment going forward, and that's kind of what we're forecasting.
Understood. International, as you mentioned a few minutes ago, it's been just -- quite a margin story.
It has. I really over a longer period of time, it has been growing.
But the mix here is still adverse relative to North America, meaning you have less -- more sales to OEM rather than distribution. So what have you done -- what's been the method through which you've narrowed the margin?
Well, one of the things we have worked on, Mig, over many years is expanding that mix of distribution versus OEM in the international business. We've had a goal of 100 basis points a year improvement in that mix. We've done that for the last 7 years, 7 or 8 years. And we see that, that certainly can't continue. That's been part of the margin story. If you followed us for a long time, international margins were always lower than North American market.
We actually closed that gap significantly. It hasn't just been that mix of business. It really has been a really focused attempt at the cost structure. And really trying to leverage synergies across the region. And the team has really done an unbelievable job doing that. So that has been great.
In Asia Pac, it's also been wonderful to see the team in China perform. And really, all of those countries outside of China have helped improve margins as well. So that's kind of been the international margin expansion story. It's really been The Win strategy, just good, solid execution of The Win Strategy.
Maybe asking the question differently, is this mostly a cost effort? Or is it better pricing or strategic pricing things that you've done on that side.
Mig, it's all of the above, right? There isn't a 1, 2 or 3 items that have made that margin change. It's really been over a long period of time. It's been changing the portfolio, right, those acquisitions that we've done both CLARCOR and LORD. Obviously have a presence in the international business as well. It's been changing that mix. It's been working the cost structure, and it's been focusing our organic investments and our organic growth in markets that grow better, that have better margin profiles and that appreciate the expertise of the Parker applications.
So it's been a combination of all of those things.
And that's sustainable.
That is certainly sustainable and we think we can improve on it.
Is there a world in which international is more profitable for whatever reason, in North America?
Well, we did have a couple of quarters where international margins did surpass North American margins. I think that was more driven on certain regional supply chain challenges within the North American region. But we've always said this. There's no reason why these businesses can have similar margin profiles. It's the same technologies. They're very similar customers. They are different applications. And you know when you go to Europe, everything costs a little bit differently than it does in here at home. And we've tried to make sure that we get value in a similar manner.
Moving on to Aerospace. Maybe we can talk a little bit about the Meggitt integration. It sounds like it's going quite well. The cost to achieve are coming down in this fiscal year. So talk a little bit about what was done last year, what's going to get done this year and the type of synergies that you're expecting?
Well, obviously, we committed to $300 million of synergies by the full third year of ownership. That was about 10% of pre-COVID sales. We are on track to achieve that $300 million of synergies. We couldn't be happier with the way this is going. It has really been -- timing has been perfect.
A lot of times we buy an acquisition and something turns and all of a sudden, the economy goes through some kind of cycle. We knew this when we were doing the due diligence that there was this pent-up demand in aerospace, and we knew that COVID was going to be a temporary thing and that travel would get back to some normal semblance of what we've seen there. So all of that has been wonderful.
What we've done with Meggitt, we've done a lot, it's only been 12 months. We've done quite a bit. We have obviously taken out all the public company costs. We have divisionalized that business into division structures that we see across Parker-Hannifin. We have made those businesses look like Parker-Hannifin divisions. We have obviously worked on the cost structure as far as indirect spend, leveraging the power that is Parker-Hannifin. We have introduced the Win Strategy to the Meggitt operations, and it's early days as that starts to transpire.
So we're happy where we're at. We still have a lot of work to do. There's no doubt. Last year, I think we committed to $60 million in synergies. We did raise that. Some stuff got pulled ahead and got done quicker. So we achieved $75 million. We're expecting another incremental $75 million of synergies this year. And we're only 3 months into the year, but we are on track for that as well.
So maybe to push you a little bit on the $75 million of incremental synergies, I'm looking at your margin guide in that kind of accounts for the lion's share of the margin expansion...
I mean, it's all in there. It's all in there and it's real. And like I said, we couldn't be happier with the way those teams are performing, the way those businesses are performing. We're benefiting from a lot of volume, right? There's a lot of growth in aerospace. We moved our guidance from 8% full year to 10% organic growth for Aerospace, and we feel very confident about that. So we're just doing the right things for that business, and we're taking advantage of the volume levels that we have, and we're benefiting from a lot of good hard work.
Excluding the Meggitt synergies, what are sort of the normal core incremental margins on that volume growth?
Well, I mean, obviously, we hold our teams at 30%. We guided to 40% for the full year here. A good chunk of that came from the Q1 performance. But we've benchmarked this, and we think 30%. This is not easy. This has come up in a couple of questions earlier today. This doesn't happen automatically. This happens from a lot of hard work, from a lot of our team members around the world, and it doesn't happen without a lot of effort.
So if you're modeling us, we ask you to model us at 30%. That's what we expect out of that business. Obviously, the synergies and Meggitt would be a plus to that.
In a world in which for whatever reasons, volumes get weaker. And I'm not talking about your guidance here, I'm just sort of hypothetically speaking, I'm curious as to what the Parker playbook looks like now. And I'll be pointing -- in the past, call it, 2-plus decades you and others have used things on the labor side to sort of adjust for lower volume. Do you still have the ability to do that in a tight labor market?
We absolutely do. I think obviously, the labor market has gone through a number of challenges. I'm hearing less and less of that as a challenge than I did maybe 6 months to a year to 1.5 years ago within our businesses. And it's a big plus. We have businesses, some of those mobile markets that you mentioned that are contracting.
We are making adjustments in our business where it needs to be done, right? Obviously, in spaces like aerospace, we are not, right? We are doing -- going the opposite direction. So I think one of the things that we do the best is we react to whatever the top line is telling us. And that we have refined that toolbox over many years. You've seen our charts where we try to raise the floor and raise the ceiling on margin performance. You will see that again from Parker-Hannifin. We will do that again no matter what happens with the top line.
The other thing I would tell you is if you think about our guide, we're going to grow margins 70 basis points this year with really a relatively small growth number, right? And most of that is coming out of aerospace. So you'll see those tools at work.
The last thing I would tell you is that what would be totally different from last time is our incentive compensation program has really been levered towards performance on a sales, earnings and cash flow standpoint. So for some reason, the top line drives those numbers lower, we're going to have an automatic relief when it comes to incentive comp.
That sounds great. It sounds like the playbook still works.
It certainly still works and The Win Strategy still works. The company has never been more aligned. We've never been stronger. We've never been bigger. We're very proud of what we've done with the portfolio. And we're committed not just to the FY '24 guide, but to the FY '27 targets.
Absolutely. Congrats on all that. This is a great place to spot.
