Parker-Hannifin Corporation (NYSE:PH) Q1 2024 Earnings Call Transcript

Parker-Hannifin Corporation (NYSE:PH) Q1 2024 Earnings Call Transcript November 2, 2023

Parker-Hannifin Corporation beats earnings expectations. Reported EPS is $5.96, expectations were $5.33.

Operator: Greetings, and welcome to the Parker Hannifin Fiscal 2024 First Quarter Earnings Conference Call and Webcast. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Todd Leombruno, Chief Financial Officer. Thank you. You may begin.

Todd Leombruno: Thank you, Diego. Welcome to Parker’s Fiscal Year 2024 First Quarter Earnings Release Webcast. As Diego said, this is Todd Leombruno, Chief Financial Officer, speaking. Thank you to everyone for joining us this morning. With me today is Jenny Parmentier, our Chief Executive Officer; and Lee Banks, our Vice Chairman and President. Our comments today will be addressing forward projections and non-GAAP financial measures. Slide 2 of this presentation provide specific details to our disclosures in respect to these areas. Actual results could vary from our projections based on the items listed here. Our press release, this presentation and reconciliations for all non-GAAP measures were released this morning and are available under the Investors section at parker.com.

And they will remain available there for 1 year. Today, Jenny is going to start with some highlights of our outstanding first quarter. She will also reiterate how our portfolio transformation, along with strong aerospace secular trends, position Parker for a promising future. I will then provide some financial details on the quarter and detail our increase to our fiscal year ’24 guidance. Jenny is going to wrap up. And then Jenny, Lee and I will take as many questions as we could fit in the hour. And with that, I would ask you to move to Slide 3. And Jenny, I’ll hand it over to you.

Jennifer Parmentier: Thank you, Todd. Good morning to everyone, and thank you for joining our call today. Q1 was a standout quarter, driven by a strong portfolio and our teams executing The Win Strategy. Starting with safety, a 16% reduction in recordable incidents. Safety has been and will remain our top priority. Record sales of $4.8 billion in the quarter, a 15% increase over prior year with organic growth of 2.3%. Record adjusted segment operating margin of 24.9%, a 220 basis point increase over prior year with all segments coming in above 24% and 26% adjusted EPS growth along with 11.4% free cash flow margin. The combination of Parker and Meggitt delivered an outstanding quarter for aerospace and a strong start to the year.

As a result of this performance, we are increasing our FY ’24 guidance, and Todd will go over this later in the slide deck. Next slide, please. Many of you have seen this slide before. The transformation of our portfolio over the last 8 years has doubled the size of aerospace, filtration and engineered materials. As a result of this, from FY ’15 to FY ’24 guidance, you can see the obvious shift to a longer cycle and secular revenue mix. We have high confidence that by fiscal year ’27, we’ll have approximately 85% of the company in long cycle end markets and industrial aftermarket. Next slide, please. The mix shift that I just spoke of is evident in our strong backlog. For total Parker, backlog remains resilient. Coverage has doubled from 27% in fiscal year ’16 to 54% today, and this has been consistent for the last several quarters.

Aerospace backlog is extremely robust. This coverage will support high single-digit growth well into the future. Industrial backlog coverage continues to be 2x what it was in the past, from mid-teens to low 30s. We now have longer-term visibility from the portfolio changing acquisitions with secular and longer-cycle exposure. Next slide, please. We have transformed the portfolio, and we have strong backlog. Let me remind you of the future sales growth drivers. The Win Strategy is our business system that delivers growth and financial performance. It is a proven strategy, and every tool in this system expands margins. Macro CapEx reinvestment is addressing the last decade of underinvestment as well as investments to strengthen and develop the supply chain.

This will result in increased equipment spend and higher levels of automation. Under innovation, our new product blueprinting tools and Simple by Design principles have increased our product vitality index, that is the percent of sales from new products, enabling faster growth and support of the secular trends. And as mentioned on the previous slide, the acquisitions we have made are great companies with higher growth rates, aftermarket and accretive margins. We continue to benefit from the growth related to the secular trends. As previously stated, we expect multiple years of solid growth in aerospace, driven by both commercial and defense. And no matter what the energy source is, from diesel to electric to hybrid, the primary Parker content that we have today increases 1.5 to 2x with electrification.

With 2/3 of our portfolio supporting clean technologies, we are well positioned today, even better for tomorrow, and we are truly energy-agnostic. Again, all of this is giving us high confidence to grow differently than we have in the past and achieve our 4% to 6% organic growth over the cycle. Next slide, please. Now 30% of our business, aerospace is a growth differentiator for Parker. And Parker and Meggitt are a powerful combination. This team has embraced The Win Strategy and is exceeding our expectations. We couldn’t be happier with this acquisition. Next slide, please. From nose to tail, we have a comprehensive portfolio of products and services. Parker has a broad product offering for both airframe and engine applications. Meggitt brought new product and system areas, including braking, fire detection and suppression, thermal management, avionics and sensors and electric power.

This breadth of technologies is enabling a more strategic relationship and discussions with our customers, both OEM and aftermarket. Next slide, please. This slide highlights the favorable aerospace secular trend we are experiencing now and will into the future. Taking a look at the sales mix at the top of the page, we are now 45% aftermarket, an 800 basis point increase with the acquisition of Meggitt. And we have a balanced portfolio with strong growth drivers in each of these 4 areas. At the bottom of the page are the macro growth drivers. On the commercial side, we are expecting double-digit growth in aircraft deliveries and air traffic. On the military side, the Department of Defense budget increases. And our military aftermarket partnerships will drive mid- and long-term growth, a very promising future for aerospace.

I’ll now turn it over to Todd to go through the summary of our Q1 results.

Todd Leombruno: Thank you, Jenny. I’m going to begin here on Slide 11 and just touch on some of the financial results. Jenny mentioned this, our FY ’24 is off to a very strong start, really speaks to the alignment across our global team. We broke several records this quarter. We set records for sales and on an adjusted basis, segment operating margin, EBITDA margin, net income and earnings per share. If you look at the sales growth, it’s up 15% versus prior year, obviously, strongly impacted by the net of acquisitions and divestitures. You look at that impact, that was a little over 11% positive to our growth. Organic growth remained positive at 2.3%, and currency was actually a slight favorable 1% impact in the quarter. When you look at adjusted segment operating margin, it was 24.9%.

That is an increase of 220 basis points versus prior year. And if you look at adjusted EBITDA margin, that was 24.8%, an increase of 150 basis points versus prior year. If you look at adjusted net income, we generated $776 million in net income. And adjusted EPS was a record at $5.96. If you look at both of those items, it’s a 26% improvement versus prior year. And we can’t say this enough, it’s our portfolio transformation and really consistent execution across the global team, just great work delivering a standout quarter here. And I’m really pleased to say that these results are consistent across all of our businesses. If you can move to Slide 12, this just kind of details the 26% increase in earnings per share, that’s $1.22 of improvement.

What I really like about this chart, the main driver continues to be standout operating performance. We increased segment operating margin dollars by nearly $250 million. That was $1.46 of our EPS growth. And while all segments contributed to growth, really the strength in our aerospace business was a major driver this quarter. If you look at income tax, that was $0.17 favorable this year. Really, that is solely based off of a few discrete items that settled in the quarter. We did have some headwinds on the other expense line of $0.27 and also the interest expense line of $0.10. But I will tell you, both of those items are simply related to timing with last year’s funding of the Meggitt transaction. We do not expect those to repeat going forward.

And finally, corporate G&A and share count were just slightly [indiscernible] at $0.02 each, and that is — really that is in line with what we guided to. So nothing of concern there. So that’s the walk to the record $5.96 in EPS, and it really is just driven off a broad-based offering improvements. Obviously, the Meggitt results are in there. The synergies are in there. And as you can see, strong record margins across all of the businesses, just great job by the team. On Slide 13, we’ll just talk a little bit about segment performance. Every segment delivered adjusted operating margins over 24%. That’s the first time in the history of the company that, that has happened. And it was really, again, just driven by strong performance, good volumes.

Obviously, Meggitt synergies helped quite a bit, and really just the global team is very aligned. If you look at incrementals, we did 40% incrementals versus prior year, really proud of that number. And orders are positive at plus 2 versus prior year. And backlog coverage, as Jenny mentioned, really remains elevated. And again, aerospace activity remains especially robust on the order line. So just great work there. And then lastly, I would just say as we celebrate that 1-year anniversary with Meggitt, we’re really very pleased that those businesses continue to outperform. It’s been a great addition to the company. If you look at North America specifically, sales volume is up 4.5%. We generated $2.2 billion of sales. Organic growth was slightly positive, just 0.5% there.

And that was impacted by some destocking and channel rebalancing that we’ve kind of mentioned throughout the quarter. If you look at adjusted operating margins, we did increase operating margins 150 basis points to 24.9%. And that was really just great execution and obviously cost controls. So great work there. And if you look at orders in North America, they did improve versus last quarter. They are minus 4. They did improve from minus 8. And backlog coverage in North America obviously remains strong as well. So great work to our North America team. In the international businesses, sales were $1.4 billion. That is an increase of about 2.5% versus prior year. Organic growth in the segment was about negative 2. So that was down. Organic growth in EMEA was positive 2, right?

So that was a plus. Latin America, also very positive at plus 8. The impact of the segment was really driven by Asia Pacific, and that was about a negative 8 organic growth. And that’s really just a result of mostly China softness that I think is well documented and also some tough comps that we had in the prior year. However, if you look at operating margins, even with that negative 2 organic growth, we expanded operating margins by 100 basis points. And the segment finished at 24.1%. So our team members there are focused on productivity, cost controls. The team really expanded margins in a very, very tough environment. So just great, resilient performance across the segment there, very nice work. Order rates do continue to be choppy. They did decline to minus 8.

Really, that is conditions driven really out of Europe and China. The standout for the quarter is our aerospace business, right? Just a stellar quarter from aerospace. Sales were $1.2 billion. That was an increase of 65% versus prior year. Organic growth, very robust at about 16%. And that was really broad-based, double-digit growth in all of the aerospace market platforms. So business is very strong there. Operating margins, unbelievable, a new record, increasing 610 basis points to 26%. Really, that was driven by healthy margins, rate increases at the airlines, strong aftermarket growth, really all those things contributing to great margin performance. I will note, we did benefit from a few small favorable onetime contractual settlements in the quarter.

And we do not expect those to repeat throughout the rest of our fiscal year. Aerospace orders, I already mentioned this, but plus 24 are very robust. Great future for the aerospace business. If you move to Slide 14, just a quick look at cash flow. Our cash flow from operations increased 42% versus prior year. Cash flow from operations was $650 million. That’s 13.4% of sales. Our free cash flow increased even more, 48% increase versus prior year, finished at $552 million for the quarter. That’s 11.4% of sales, and free cash flow was 85%. For the full year, we are committed to our strong cash flow generation profile. We are forecasting mid-teens cash flow from operations. And of course, we will extend our record free cash flow conversion of over 100% [indiscernible].

So great start to the year on cash flow. Moving to Slide 15. I just want to touch real quick on our leverage reduction. I think everybody knows we are focused on our leverage reduction commitment. We reduced debt in the quarter by $370 million. And just since the Meggitt close, we’ve reduced that by over $1.8 billion and improved our leverage by 1.2 turns. Both of those numbers are ahead of what we originally scheduled. If you look at gross debt to EBITDA, it’s now 2.6 and net debt to adjusted EBITDA is now 2.5. And of course, we are still committed to forecast over 10 — over $2 billion of debt paydown in FY ’24. So great work there that [indiscernible]. Looking forward on Slide 16, just some details on guidance. Basically, we are reaffirming our full year organic growth midpoint.

We did incorporate September 30 currency rates. And we are increasing our margin and EPS expectations for the year. Reported sales growth for the year is now forecasted to be in the range of 2.5% to 5.5% or roughly 4% at the midpoint. That split will be just as it always is, 49% in the first half, 51% in the second half. We are raising our aerospace organic growth guidance 200 basis points from 8% in our prior guide, now 10%. So that’s great to see that business performing so well. Full year organic growth is tweaked just a little bit. The company will remain at 1.5%. Currency is a small offset, which is now expected to be just a slight headwind to our prior guide. Margins, if you look at margins, we’re raising our margin expectation to 23.6. At the midpoint, there’s a range of 20 basis points on either side of that.

And if you look at what we’re forecasting on a year-over-year change, we’re increasing that expectation to 70 basis points of margin expansion versus prior year. It was 30 basis points in our prior guide. Incremental margins really just based off of the strong Q1 performance, we expect those to be around 40% for the full year. And if you look at the other items, corporate G&A, interest and other are relatively unchanged to what we guided to last quarter. Tax rate for Q2 through Q4 we expect to be 23.5. So if you look at the full year, that will equate to about 23% on the tax line. And EPS on an as-reported basis is now $19.13 at the midpoint, and adjusted EPS is $23. And the range on both of those items is $0.40 plus or minus. Split remains the same, 48% first half, 52% second half.

And specifically for Q2, adjusted EPS is now expected to be $5.17 at the midpoint. And as usual, if needed, we have more guidance specifics that are included in the appendix, and that’s all I had. Jenny, I’ll turn it back to you, Slide 17.

Jennifer Parmentier: Thank you, Todd. And now I would like to recognize our colleague and friend, Lee Banks, during his last quarter earnings call. Lee will be retiring as Vice Chairman and President effective December 31, 2023. He joined Parker in 1991, has been an officer of the company since 2006 and a director since 2015. During Lee’s tenure, sales grew at a 7% CAGR to nearly $20 billion. EPS grew from $0.36 per share in fiscal year ’91 to $21.55 adjusted per share in fiscal year ’23. Since 2015, total shareholder return was 292% versus S&P 500 industrial sector of 80%. As if all of this isn’t enough, I’d like to repeat a few of my comments from last week’s shareholder meeting when we announced Lee’s retirement. It’s obviously not possible to overstate the tremendous positive impact Lee has had on our company, our businesses and our team members around the world.

His legacy and track record is nothing short of extraordinary. From leading our largest businesses to growing our global distribution network to championing and driving operational excellence to co-creating the recent versions of The Win Strategy and probably most importantly and what he’s proud of is to recruiting, leading and developing many of our most talented leaders and beyond, Lee’s set the bar for us for what good looks like and was a key leader in the transformation of Parker’s performance and portfolio. Lee, on behalf of all of us, we can’t thank you enough. We will miss you. And we wish you and your family nothing but great health and happiness in your retirement.

Lee Banks: Thank you, Jenny. Thank you, Todd.

Todd Leombruno: Lee, we know you’re going to crush retirement just like you crushed [indiscernible].

Lee Banks: I’ve got a plan.

Jennifer Parmentier: All right. Next slide, please. A few key messages to close this out before Q&A. Q1 was a great start to fiscal year ’24. Our focus on safety and engagement will continue to drive positive results in our business. We have a proven track record, and we’re going to continue to accelerate our performance with The Win Strategy 3.0. It’s been a successful first year with Meggitt. And the transformation of the portfolio is delivering a longer cycle and more resilient revenue mix, allowing us to achieve our FY ’27 goals and continue to be great generators and deployers of cash. We have a very promising future ahead of us. Back to you, Todd.

Todd Leombruno: Diego, we’re going to open the call for Q&A. So we’ll take whoever’s first in the queue. Thank you.

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Q&A Session

Operator: [Operator Instructions]. And our first question, we have Andrew Obin with Bank of America.

Andrew Obin: Lee, congratulations. We’ll definitely miss you. But these EPS numbers are staggering when you started where you are right now. Yes, just a question in terms of guidance. If I take the midpoint of your EPS guidance and you gave us the first half, second half split, and then just subtract what you’ve printed in the first quarter, there seems to be a sort of sequential decline in EPS that would be quite a bit more than what the history would suggest. And I’m just trying to understand, is that — given that you do have Meggitt now, is that just a different seasonal pattern that Parker is going to have? Or are there onetime items in the second quarter versus the first quarter that’s sort of this — that the implied numbers are driving?

Todd Leombruno: Andrew, I’ll take a stab at that and then if Jenny or Lee’s got some color, I’ll let them add. Q2 for us has obviously got some seasonality in it. It is our lowest volume quarter of the year. But really, I would call out just a stellar performance in Q1. Every number that we talked about was a record. It’s kind of hard to keep that going into your lowest volume quarter. You’re right, we do anniversary Meggitt. So that from a year-over-year standpoint, it’s now in the base or will be in the base for Q2. So that is it. But there’s no other onetime items that are abnormal that we would expect to see in Q2. It’s really just volume and seasonality around the business.

Andrew Obin: No, that’s a good answer. I’ll take it. And the other question, just North American orders. Could you just provide a little bit more visibility by key verticals? I think they’re holding in a bit better than I would have expected. What’s coming in better than expected, what’s weaker and maybe a lot of focus on orders this quarter. Maybe just talk a little bit about the cadence of orders throughout the quarter.

Lee Banks: Andrew, it’s Lee. I’ll take this. So maybe I’ll just take a step back. I think all the reports that I’ve read, I think the narrative is right. If you look at it globally, and I’ll get into North America here in a second, but underlying demand in North America is still fairly positive. There is definitely some inventory balancing taking place, not only through the distribution channel, but I would also argue at OEM levels, too, with their customers, dealership, dealers, et cetera. And I think that’s going to continue to play out through the second half of this — into calendar 2024. But there’s a lot of — I mean, you just look at all the infrastructure spending taking place, there’s been a lot of money flooded in the economy in North America.

And I would still say it’s good. When you look at the rest of the world, really, the story is China. China, not only tough comps, but it just hasn’t rebounded like I thought it would have rebounded maybe 3 or 4 quarters ago. And it’s got — it’s probably got a bigger impact on what’s happening in Europe right now, especially in Germany would be a key market. So that’s soft. If I look at the rest of Asia, the rest of Asia, Southeast Asia, India are still strong. But if you look at Japan and Korea, they’re pretty soft, too, I think, tied to China. When I think about the North American markets, and I’ll lump aerospace in there, I mean, you can’t find any weakness. What’s going on in aerospace, commercial, military, OEM, MRO, all really strong.

And I don’t see that stopping for some time. If you look at those 3 indicators that Jenny talked about, you’re hard-pressed to find a time in history where you’ve had all those 3 indicators, available seat kilometers, DoD spend and then aircraft coming into service where they’ve all lined up that well. Land-based oil and gas in North America is still really strong. There’s less rig count, but there’s a lot of MRO activity taking place that’s keeping people busy. And again, our distribution, if you look at all the end markets, yes, they [indiscernible] on inventory, but things are not falling off a cliff. It’s still real good. So the short way telling you, I feel pretty positive about North America end markets. We just got a little bit of a balancing taking place right now.

Operator: Our next question comes from Joe Ritchie with Goldman Sachs.

Joseph Ritchie: Congrats on a great start to the year. And then, Lee, trips to Cleveland won’t be as fun. We’ll miss you. [indiscernible] retirement.

Lee Banks: Great.

Joseph Ritchie: So maybe following up on Andrew’s question, if you had to think — if you had to look across your industrial end markets today, what portion of those end market do you think are continuing to decelerate? And then as you kind of think about the destocking commentary, any color on like how long you think certain end markets will continue to destock for you guys?

Lee Banks: I’ll take a stab at this, and maybe I’ll let Jenny and Todd pile on. But I think in North America, you’ve got things like automotive are somewhat flat; heavy-duty trucks, flat; agriculture is flat. Construction in North America is really kind of flat for the most part. Again, I think there’s some dealer inventory that people are working through. But it’s still good overall demand there. I think things that were tied to COVID production, life sciences, there’s still some big overhang from the ramp-up we had during that period of time. So that’s just tough comps, and the demand is down a little bit. Yes, I’ll leave it — material handling is still really strong.

Joseph Ritchie: Got it. Go ahead, Jenny.

Jennifer Parmentier: Just to echo Lee’s comments to Andrew’s question and yours, I think with this backlog as strong as it is, although that we see this destocking continuing, we see a bit of supply chain normalizing, and that’s helping things. And as that heals, we’ll start to see, I think, a bit of a better environment. But just echo all Lee’s comments.

Lee Banks: One other thing I meant to say when I was talking, Joe, is I think what everybody forgets about, everybody is focused on aerospace and Meggitt, which have been huge positives. But don’t forget about that we bought LORD and we bought CLARCOR. And we bought those to kind of — we knew they would not be as cyclical as the core legacy Parker business. And I think you’re seeing that in the numbers. It’s panning out that way to be true.

Joseph Ritchie: Okay. Great. That’s helpful. And then look, big focus this quarter on mega projects, timing of orders. Just, Jenny, maybe just talk a little bit about how you see things kind of playing out with all the investment that’s happening in the U.S. Do you think Parker is well positioned to see an inflection in orders when you start to see a lot more equipment and the stuff that’s going inside of factory come through?

Jennifer Parmentier: Absolutely. I mean, when you think about, as I mentioned earlier, the underinvestment that’s happened in the last decade and what will happen a decade, I mean, we are in a great position to participate. We’ve said a couple of times, it’s still early days. But in speaking with some of our channel partners, where there’s some factories going in for semicon and some of these other big projects, they’re starting to participate in that. We’ve said we’re there when the land is prepped, when the walls go up and when the equipment goes inside the factory. And some of our distributors have been able to talk to us about how they’re already enjoying that business. So we’re in a really good position with those as well as the secular trends that I mentioned earlier.

Operator: Our next question comes from Mig Dobre with Baird.

Mircea Dobre: Congratulations, Lee, and all the best to you going forward. My question, going back to the industrial backlog discussion, I’m sort of curious as to how you think about this elevated level of backlog. Is this sort of a function of a change in the way your customers are ordering? Or is this more of a function of really what we’ve been going through over the past couple of years with supply chains and so on and so forth and safety stock being built up?

Jennifer Parmentier: Mig, this is Jenny. I think it’s all the things you mentioned. But as Lee just stated, with the acquisitions that we’ve made, we’re getting longer cycle business here. So we see a longer demand sense, a longer demand horizon than we’ve seen in the past. So the transformation of the portfolio is definitely impacting the backlog. And I do think that what we’ve been through the last couple of years, of course, you’re going to see some people just kind of sharpening their pencils on how they order and making sure that they have the right lead times out there. So I think that’s part of it. But more of it is really about the shift of our portfolio. I’ve said many times, we know from the past that backlog isn’t bulletproof.

But we’ve seen this now for the last several quarters in a declining order environment. In North America, orders have been negative for quarters, but this backlog has remained resilient. And we believe that while it might go down a little bit, our portfolio is going to drive us to have this kind of backlog going forward.

Mircea Dobre: Right. Understood. My follow-up is on aero. Can you be a little more specific on that contractual settlement and the benefit in the quarter? And then in terms of the guidance raise, talk a little bit maybe about that as well, the organic as well as the market. I mean, is this a function of aftermarket really driving that guidance raise? Or is there something else in there?

Todd Leombruno: Mig, this is Todd. On the guidance raise, you obviously can see the orders. Activity across all of those platforms has been extremely strong. Aftermarket was a big standout in the quarter. That was a big driver of the growth, and it was a big driver of the margin performance. So we just feel a little bit more confident with another quarter in there that we feel that we’re able to raise that. So we moved to 200 basis points from 8 to 10 for the full year, and we feel pretty confident about that. I don’t want to make a big deal about those things. I said they were small and minor, those onetime items. I just wanted to call it out so that it would make a little bit more sense if you look at our margin guide going forward for the rest of the year. So it’s little of that.

Jennifer Parmentier: And just a little more color on aerospace. Like Todd said, very strong aftermarket, commercial and military. And if we look forward in this guidance, we’ve said it a couple of times already, but just to look at each 4 of these — each of these areas, commercial OEM is in the mid-teens. And those narrow-body rate increases, they’ve happened, and we see that they’re going to continue to do so. Commercial MRO is in the mid-teens. The narrow-body aircraft are almost at pre-pandemic levels. There’s a lot of engine repair and component restocking going on. So very positive there. And then military OEM, mid-single-digit as demand for legacy programs continue. And then military MRO, mid- to high single digit. Near term, we have tailwind with some of our Department of Defense repair depots.

We continue to really enjoy public-private partnerships. They’re growing. And there’s fleet [indiscernible] and service extension. So just all in all, just a great environment across all 4 of these areas.

Operator: And our next question comes from David Raso with Evercore ISI.

David Raso: Obviously, congratulations, Lee. Best of luck. When it comes to the North American orders, just given 2 quarters ago, right, down 8, now some second derivative improvement we just saw. Given the comps are starting to ease, I’m just curious if you’d be willing to say, do you think we’ve seen the bottom in the year-over-year orders in North America? And then I have a question about the organic sales cadence. Can you just update us on how we get from here to the full year 1.5? And I’m particularly interested also what do you have for organic in Europe in the guide.

Jennifer Parmentier: David, this is Jenny. I don’t think any of us really have that good of a crystal ball. But I will restate that the backlog is strong. And as you said, orders were at negative 8, and they went to negative 4. So we feel good about that. There’s some uncertainty out there. And all in all, if you look at North America, we have the first half slightly lower at about 1%, but full year, mostly unchanged, it’s slightly positive. So I can’t give you an exact answer on that, but we feel good about where we’re at right now.

David Raso: Can you help with the organic cadence a little bit though maybe for the whole company just to get a sense of the 1.5, if you can take us through that a little bit detail? And again, maybe a little color on Europe, in particular, what’s in the guide. I thought the first quarter was a little stronger than expected. So just trying to get a sense.

Todd Leombruno: Yes, David, I agree with you. Europe did outperform in the first quarter. I think we called that derivative plus 2. The total company did plus 2. Obviously, aerospace was fantastic at 16. If you look at the cadence, it’s really not that much different than what we guided to initially, is not second half-weighted. We expect comps to kind of moderate a little bit. But if you look at Europe specifically, they did 2 in Q1. We’re expecting about 1 in Q2, and then it goes — turns a little bit negative just again based on comps in the second half. I would say for the second half, it’s probably about minus 3.

Operator: Our next question comes from Scott Davis with Melius Research.

Scott Davis: Also, congrats, Lee. Great run. It’s been nothing but a pleasure indeed, but good luck in the future. I have a tough time picturing you retired, but…

Todd Leombruno: Scott. You’ve got a plan. He’s got a plan.

Scott Davis: Yes. I’m guessing we’ll see you around on Boards and such even more so. But anyways, a lot of the questions about inventories and stuff have been asked. So I just wanted to go back to a big picture one on Slide 4. Jenny, you kind of showed the — where you want to be in ’27. Can you get there with — I mean, is the plan kind of further tweaking around with the portfolio and a longer cycle M&A? Or do you get there just on the growth rates, the outsized growth rates and aero and some of your longer-cycle businesses?

Jennifer Parmentier: Yes, it’s the latter. We — these illustrations are with the portfolio that we have today and the tailwind that we see not just from aerospace but from the macro CapEx investment and the secular trends.

Scott Davis: Okay. Fair enough. And then the — just looking through my notes here, the distribution levels and like Parker stores, you guys have great visibility. But are they — is there a new normal above COVID levels? I know this has been asked in a different way, and I’m trying to really narrow down whether in this new world, everybody holds a little bit more inventory or whether supply chains are so healed up and people are so comfortable that they’re back down to kind of what was more of the long-term averages pre-COVID. And obviously, the cost of carrying inventory has risen, too, with higher rates. We haven’t had that in quite some time. So any comments there and how that plays into it would be interesting, too.

Lee Banks: Yes, Scott, it’s Lee. I would think it’s the latter. The cost of carrying inventory is way up from what it’s been. I think the insanity of supply chains has started to quiet down. So I don’t expect there to be a huge difference as we go forward about how some of those core industrial products are inventory versus what they were before pre-COVID.

Operator: Our next question comes from Jeffrey Sprague with Vertical Research.

Jeffrey Sprague: Lee, congrats, and thanks for all the help over the years. Could we just maybe kind of come back to the margins, which really stood out here. I think it’s probably pretty clear from just other companies we follow that price/cost spreads were pretty favorable this quarter. I know you don’t want to talk about price in isolation, but can you give us some sense of kind of where you’re tracking on a price/cost basis, how that might differ from what you saw in fiscal ’23 and how it’s progressing through the year embedded in your guide?

Jennifer Parmentier: So if you recall, we went out early and often with price. And we are now back to more of a what we would call a normal pricing environment where we are going out in July and January. So we don’t disclose the specifics, obviously, but price/cost management is a core element of The Win Strategy. And what we did do is we expanded from just material inflation to total cost of inflation. So we feel good about what we have covered, and we’re back to more of a normal environment.

Jeffrey Sprague: But you are getting some cost relief. Is that fair or not so much? You’ve got some metals relief, but other inflation, maybe just a little perspective on the cost side of the equation.

Jennifer Parmentier: Where we have some of those commodities index, which is very few, there’s adjustments. And where we have agreements with customers, there’s adjustments, but that’s already built in.

Jeffrey Sprague: And then just back to Meggitt and aero. When I saw the margins this morning, I thought okay, you’re going to be talking up the synergies or you’ve accelerated them into 2024. Really no comment about that. So I’m sure you’re capturing synergies, but it sounds like the margins are little one-offs that Todd mentioned but mostly aftermarket mix. But maybe just a little bit of color on the synergy pace, and is there scope for that to go up? And is any of that actually embedded in these results here in the quarter?

Jennifer Parmentier: So if you recall, in fiscal year ’23, we increased the synergies from $60 million to $75 million. And then we committed to another $75 million in fiscal year ’24. So as Todd mentioned, the synergies are in there. The team is doing a great job. We’re committed to the $300 million, and we’re just confident we’re going to get there. A lot of — as Todd mentioned, too, strong aftermarket, right? That is just a very favorable mix, really helped boost the margin in the quarter.

Jeffrey Sprague: Great. Yes. Felt like you’re getting after that additional 75 faster, but I’ll leave it there.

Todd Leombruno: No, Jeff, it really is a combination of — obviously, the volumes have helped on the efficiency side, but Jenny has mentioned supply chain has eased. I think that has taken a lot of noise out of a lot of our operations. It’s not totally gone yet, but if you look back to a year or 1.5 years ago, it is a lot more efficiencies that we’re seeing across all businesses.

Jennifer Parmentier: Yes.

Operator: Our next question comes from Julian Mitchell with Barclays.

Julian Mitchell: I wish Lee all the best. Just wanted to circle back to my first question on the international sort of demand picture. So I guess, if you look at the last 6 quarters, you’ve had orders down in 5 of those 6. When you think about inventory levels, and it’s an extremely disparate set of countries and markets, that down 8 on orders you saw in the most [indiscernible] quarter and when you think about the duration of these orders downturn, I just wondered any perspectives on when you think we start to sort of pull out of that order slump. And if you think that down 8 marks the kind of low point of what we should see this down cycle in international orders.

Jennifer Parmentier: Well, Julian, orders, like you said, it’s been choppy for a while. In international, Q1 organic growth was in line with our prior forecast at segment level. As Lee mentioned, in Europe, destocking continues, softness in some broad-based end markets. Low recovery in China is impacting that region. And there’s Eurozone macroeconomic indicators that remain in contraction territory. So I would say, hard to tell there. But two, again, China, if you look at Asia Pacific, China recovery remains slow. There’s continued softness in construction in semicon and automotive. As we mentioned earlier, there is a bit of a tough comp for last year Q1 because they were rebounding from the Q4 shutdown. So in the guide, no big change for the first half, and the full year is largely in line with previous guidance, so at about negative 3%. This is the best view we have today.

Julian Mitchell: And then on the North America business, I think a lot of investors still get concerned when they see some of those big sort of mobile OEM customers talk about backlog down, and what does that mean for their inventories for suppliers such as yourselves and others. So maybe just remind us of the scale of that kind mobile piece within North America. And how do you gauge or what’s your assessment of that inventory level at some of those big machine or mobile customers?

Jennifer Parmentier: So as Lee mentioned, there’s a certain amount of rebalancing going on there as well as dealers are starting to get some inventory. But it kind of goes in line with the constant analysis we do on the backlog to make sure that there are no pushouts, there are no cancellations. And in discussion with some of our big OE mobile customers, they are adamant that the orders, the backlog are real. And some have even commented that if they happen to get a cancellation from one customer, they have another customer who will take that slot right away. So we still feel pretty positive about that. But again, as — if the supply chain is improving, it’s helping us. So I think we’re in a pretty good position there.

Todd Leombruno: Yes, Julian, I would just add. Lee brought this up earlier, but you think about the North America portfolio, that does include LORD. That does include the CLARCOR businesses. There’s a significant amount of aftermarket that we benefit from in the North America business, and I think that’s helped offsetting some of these larger OEM callouts.

Jennifer Parmentier: Longer cycle.

Operator: Our next question comes from Joe O’Dea with Wells Fargo.

Joseph O’Dea: First question is just related to field inventory. I think some of the corrections have been going on for several quarters now. And so what your views are, both at an OEM level and a distributor level and maybe even if you take it by region. But just how far along that process is? Are those headwinds actually starting to abate a bit?

Jennifer Parmentier: Yes. Well, I think as we’ve gone through the regions, what we’ve talked about here is that first, again, backlog coverage remains strong. Destocking is continuing. We probably saw a little more of that in North America in Q1 than we had anticipated, and it’s continuing. But as Lee pointed out, the overall channel sentiment is very positive. As I was just mentioning before, international, too, I mean, the backlog is strong, too, there. But the orders have been choppy. So to try and say where that’s going to wind up in the next quarter or 2, we’ll have a better update for you in February. But as Lee mentioned, this is — and international is really a story about China recovery remaining slow and the impact that it has on — and on Europe. So continued softness there in industrial markets, and destocking is continuing.

Joseph O’Dea: And then, Jenny, I wanted to ask on investment spend and just strategic focus as you think about opportunities over the next 1 to 2 years and really, in particular, on the industrial side of the business. But across the regions, across technologies, where you’re trying to direct the most emphasis right now because of the biggest opportunities that you see for returns on some of that spend?

Jennifer Parmentier: Well, our CapEx goal has increased from 1.5% to 2%. We were at 2%, a little bit above in fiscal year ’23. And we’re forecasting 2% for fiscal year ’24. It’s a pretty big increase from our 10-year average. And our focus is on safety, automation, robotics, some AI tools on AI-driven inspection, so things that are really going to help us increase our efficiency and our productivity. We’re investing in the supply chain. And then we’re investing in specific divisions where we have — we need to support secular growth. So, for instance, electrification projects with our customers. So when we look at this, the investing in the supply chain is something that we think will help us well into the future and make sure that we have not only those local-for-local strategy is intact, but dual sourcing strategies. And so that investment, we expect that to pay dividends well into the future.

Operator: Our next question comes from Brett Linzey with Mizuho.

Brett Linzey: Congrats to Lee. Appreciate all the insight over the years. Wanted to come back to some of the market choppiness and the destock. I guess what is Parker doing from a cost-containment standpoint? In the quarter, international volumes down, margins up. Is this just simply throttling back on discretionary? Are you taking more structural simplification actions and how that positions you?

Jennifer Parmentier: Yes. So we always say that we’re planning for the next recession, right? So what is evident with our Q1 performance is that executing The Win Strategy in a slower-growth environment works, right? So every tool, and I say this because I’ve used The Win Strategy to run Parker divisions and Parker groups. Every tool in that Win Strategy helps to expand margins. So it can be anywhere from adjusting your discretionary spending, changing the way you staff the operation to how you order material for your production. So there’s a lot of levers that our general managers can pull. And they become very agile and flexible. And they have learned how to look around corners and see demand changes coming. So we’re very proud of what they do on the downside as well as the upside to make sure that we get the best return.

Brett Linzey: Yes. That’s great. And then just one more on orders. Just curious how the sequential evolution of orders played out through the quarter into October. Any discernible pattern that might give you confidence that we could be some [indiscernible] to the bottom here?

Jennifer Parmentier: We’ll give you an update on that in February.

Todd Leombruno: Brett, I wanted to just touch on that restructuring comment. There’s been no change to our restructuring plans for the fiscal year. We do this all the time. This is not something that we wait for. I think we have $70 million of restructuring costs in the guide for the year. And that’s the beauty of the decentralization of all the markets. Our businesses are doing what they need to do depending on what’s happening in their businesses all around the world. So we’re not waiting for any kind of high sign to do restructuring. We constantly do that. To Jenny’s point, it’s part of The Win Strategy, and it’s part of what we do every day.

Operator: Our next question comes from Nathan Jones with Stifel.

Nathan Jones: I add my congratulations on retirement to Lee and [indiscernible]. I’m going to ask David and Julian’s question a little bit of a different way. Parker has been through many order downturns over the years. And while every downturn is different, the math always tends to be the same. You see 3 to 5, maybe 6 quarters of negative order rates. The magnitude of those declines are either a mid-cycle pause or a recession. We’ve got to the point where we’re now 3 to 5 quarters of negative order rates. Is this starting to feel more like a mid-cycle pause in the recession we’ve been trying to talk ourselves into for the last 18 months? And maybe just any comments around the feelings you guys have about this downturn relative to the downturns that you’ve seen previously.

Jennifer Parmentier: Well, I’ll start off just by saying that I think as evidenced by past performance, we’re able to handle these downturns, and we just weather them better each time, right? So with the transformation of the portfolio, again, I think we’re going to continue to see a longer cycle view of the backlog, and we’re going to be less susceptible to the dips. So I think we’re just in a really good position going forward to be able to achieve our organic growth targets and really perform at a higher level. We’re going to keep expanding margins in a slower-growth environment and be very well positioned for when some of this returns on the industrial side.

Todd Leombruno: Nathan, too, we’ve said this a couple of times, but we’ve never had as high a percentage of aerospace exposure across the whole portfolio. So it’s over 30% of the portfolio, and that part of the business is extremely strong right now. So we’re benefiting from that as well.

Nathan Jones: Yes. I was just talking about the industrial businesses that understand that there [indiscernible] dynamic. And then just one on Meggitt. You guys have talked about that outperforming. I think it’s clearly seeing better growth, the market seeing better growth likely leading to some [indiscernible] margins here. You had targeted year 5 high single-digit ROI. Is the double-digit ROI on this business with the outperformance now within reach in year 5?

Todd Leombruno: Nathan, we couldn’t be more happy with the way that business is performing. It still is early days. We just had the 1-year anniversary. Growth is robust. The margin performance has been good. And if you remember, we had a 3-year plan here on synergies and our focus is executing that. It’s kind of performing better than our expectations. So we’re happy with it.

Nathan Jones: Okay. We’ll wait till the upgrade of that target.

Todd Leombruno: Yes. Thanks, Nathan. Diego, I think we got time for one more question.

Operator: Okay, and that question comes from Nigel Coe with Wolfe Research.

Nigel Coe: Lee, you’ve had a lot of callouts, but we will like dream of walking off on a high, and that’s certainly what you’re doing. So congrats and enjoy. Enjoy the rest of the year before you retire. So backlog, I’ve got to say I’m surprised you didn’t consume more backlog based on what we’re hearing elsewhere. Maybe you could confirm, Todd. I’m calculating maybe $100 million of sequential backlog consumption in industrial in that kind of range. I was wondering, are you seeing more like longer cycle, lumpier orders coming through the backlog here? I mean, just any color there would be helpful.

Todd Leombruno: Nigel, you’re saying specifically on aerospace?

Nigel Coe: Industrial, industrial.

Todd Leombruno: Excuse me, industrial. I think you’re about right on the number that you’re talking about. And again, Jenny and Lee have talked about this. We think it’s really just kind of more rebalancing, nothing overly concerning at this point in the cycle yet. I can’t say that we’re seeing anything more lumpiness from the industrial orders. There are some project-based things in there, but it’s nothing significant in comparison to the total.

Nigel Coe: Okay. Great. And as the last question, I guess, is the cleanup questions here. But I’m getting — when I bridge the current guide to the previous guide for FY ’24, I’m getting $0.40 from the margin uplift, about $0.10 in taxes [indiscernible] taxes, about $0.10 of interest. Is that right? That gets me to $0.60 or thereabouts, which is the increase. And there’s nothing [indiscernible] for FX. Is that right?

Todd Leombruno: The only thing we did for FX was updated the currency rates to September 30. So there’s a little bit of a headwind on the sales line. That translates throughout the P&L, but it’s really just an update, [indiscernible] major.

Nigel Coe: Okay. Great. Well, sorry for the low-level questions there.

Todd Leombruno: No. No worries. No worries. Yes, and we can follow up with you more.

Lee Banks: I think we’re almost at the end. I’m going to pass it back to Todd. This is Lee. I just want to say thank you for all the nice callouts from everybody. It’s 32 years. It’s been a long run. During that 32 years, I’ve worked for 4 CEOs, 3 of them directly. Every CEO has taken the baton from their predecessor and run the race faster. And I’ve got no doubt in my mind that Jenny and this team is going to do the same thing. So thank you, and hopefully, we’ll see you around.

Todd Leombruno: Lee, you’re definitely going to see us around. Congratulations to you and Elizabeth and your whole family. I know they’re going to enjoy more Lee time. And we are going to miss you. So congratulations again. Thank you to everyone for joining us today. This does conclude our FY ’24 Q1 webcast. As usual, Jeff Miller, our VP of Investor Relations; and Yan Huo, our Director of Investor Relations, will be available if anyone needs any kind of follow-ups. Thank you all for joining, and everyone, have a great day. Thanks.

Operator: Thank you, and that concludes today’s call. All parties may disconnect. Have a good day.