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Parker-Hannifin Corp
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Good day, and thank you for standing by. Welcome to the Parker-Hannifin’s Fiscal 2023 Third Quarter Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded.
I would now like to hand the conference over to Todd Leombruno, Chief Financial Officer. Please go ahead.
Thank you, Chris. And good morning, everyone, and thank you for joining Parker’s fiscal year 2023 Q3 earnings release webcast. As Chris said, this is Todd Leombruno, Chief Financial Officer, speaking. And joining me today is Jennifer Parmentier, our Chief Executive Officer; and Lee Banks, our Vice Chairman and President.
Our third quarter results were released this morning. And just a reminder, today we will be addressing forward projections and non-GAAP financial measures. On Slide 2 of this presentation you will find further details to our disclosure in these areas. Actual results may vary from our projections based on some of the details that are listed on this slide. Our press release, this presentation and all reconciliations of non-GAAP financial measures are available under our Investors section at parker.com, and they will remain available for one year.
We're going to begin the call today with Jenny addressing highlights of the third quarter and really touching on how Parker is so well positioned for the future. I will follow with a brief financial summary and then review the increase to our guidance that we released this morning. Jenny will then wrap up with summary comments, and then Jenny, Lee and myself will address any questions from the queue.
I will all ask you now to address yourself to Slide 3. And Jenny, I'll hand over to you.
Thank you, Todd. Good morning to everyone and thank you for joining our call today. Q3 was a quarter of outstanding performance across all of Parker. Starting with safety. We remain in the top quartile with a 17% reduction in recordable incidents. Safety has been and will continue to be our top priority.
We had record sales of $5.1 billion in the quarter, a 24% increase over prior year with organic growth of 12%. The Win Strategy and portfolio changes have clearly delivered record performance, driving a full year guidance increase. We are increasing the quarterly dividend 11% over last year, and we are happy to report today that the Meggitt integration and synergies are ahead of schedule for fiscal year 2023.
Moving to Slide 4, please. We couldn't be more pleased with the enthusiasm and dedication of the talented Meggitt team, further evidence to the shared heritage and culture identified early in the acquisition process. From the start of the integration, safety and engagement has been top priority. We have the key leaders and structure in place to ensure performance into the future and the Win Strategy deployment is well underway.
The team picture on the right of this page is from a recent Kaizen event held in the Ansty Park UK location. And at the end of March, we held a Win Strategy training session here in Cleveland with over 50 leaders from various Meggitt locations. There are multiple examples of where the Win Strategy has already taken root and is being used to improve the business.
We are confident in our assumptions around working capital opportunities and are already starting to see some of them materialized. We are increasing our FY 2023 synergies from $60 million to $75 million, and we remain committed to achieving $300 million in synergies by FY 2026.
Slide 5, please. With the addition of Meggitt to our portfolio, we are well positioned for long aerospace cycle growth. We have significant content on premier commercial and military programs, all the right ones with a growing bill of material. These are long life cycle programs with a growing aftermarket well into the future.
As a reminder, with the addition of Meggitt, our aerospace aftermarket has increased 500 basis points. We are greatly benefiting from the recovery of the aerospace market. Commercial MRO and OEM is very strong and military is positioned to do well in the upcoming years.
With the addition of Meggitt complementary technologies, we provide a comprehensive offering and a stronger bill of material that allows us to add value and help solve our customers' problems. We have key technologies such as advanced sensors for more efficient engine control, thermal management systems for higher heat loads and lightweight materials for reduced fuel consumption, all of these enabling sustainable aviation. Aerospace and defense markets are now 30% of our sales. All of this adds up to significantly increased shareholder value.
Slide 6, please. Many of you have seen this slide before as we introduced it last year at our Investor Relations Day. Over the last eight years, we have strategically reshaped the portfolio to double the size of aerospace, filtration and engineered materials. The combination of the portfolio changes and secular trends is already and will continue to create a profound shift in our sales mix.
By FY 2027, we will have approximately 85% of the company in long cycle end markets or industrial aftermarket. This mix shift is further reason while we will grow differently in the future, and it is why we are committed to our FY 2027 target of 4% to 6% organic growth over the cycle.
Slide 7, please. A lot of discussion, questions and inquiries lately on backlog. And as you can see by the chart on the left of this page, our backlog is at a record level. What is encouraging is that in Q3, we saw our backlog dollars increased 3% sequentially.
Since FY 2016, we've seen a 3x increase in backlog dollars and a 2x increase in backlog coverage. Very important to note here that we are constantly analyzing the backlog at the division and group level and staying close to our customers on the health of the backlog. We know from the past that it isn't bulletproof. But having said that, this consistent growth over time is an indicator that the portfolio changes are changing the company.
Slide 8, please. As demonstrated by the strong performance in the quarter, and the increasing power of our transformed portfolio, I want to share a few slides with you on why Parker is built for the present and the future.
Slide 9, please. Parker has a proven business system, the Win Strategy 3.0. Whenever I talk to anyone about the Win Strategy, whether it's a new Parker team member or someone externally, I'd say the same thing. Trust me. I've used it and it works. It is a system focused on the fundamentals. We trust the process, and we know that making the safety and engagement of our team members, our top priority consistently delivers results. Our Lean tools, Kaizen culture, supply chain and simplification initiatives have driven margin expansion and will continue to do so well into the future.
Our increased aerospace exposure is delivering results today as well as our 800 basis points expansion of international distribution, which still has room for growth. Our innovation sales are two times the previous decade. And we have a new annual incentive plan that incentivizes the right behaviors and driving intensity around profitable growth throughout the whole company. Nearly all of our 65,000 team members are on this plan as of this fiscal year. Now more than ever, we have better top line resilience.
Slide 10, please. And the good news is we have significant opportunities ahead. As I mentioned earlier, approximately 85% of our portfolio will be longer cycle and more resilient. There are strong Meggitt growth opportunities well into the future, and we are confident in achieving the $300 million in synergies by FY 2026. The Win Strategy 3.0 performance acceleration will further drive margin expansion and ensure we hit our FY 2027 goals.
As I mentioned in our February call, the pandemic and subsequent increase in volume exposed some areas that we can further improve upon to become supply chain leaders. We will utilize new tools and strategies to respond to changing demand while increasing productivity and achieving best-in-class lead times.
Simplify design has become a business fundamental and will continue to drive us to design excellence by reducing complexity and overall product costs, thus helping to further expand our margins.
We're very excited about zero defects. It's still early days. It exposes the hidden factory, improves quality, reduces cost, expands margins and most importantly, provides a better overall customer experience. And with all of the announced and already initiated Meggitt capital projects in addition to the secular trends, we will grow differently in the future.
I'll now hand it over to Todd.
Thank you, Jenny. Just for reference, everyone, I'm going to start on slide 12 with just the Q3 financial summary. It was a stellar quarter for the company. Every number on this page highlighted in the gold box is a record for Q3, every single number. And Jenny did mention this, but we did surpass $5 billion in sales for the first time for a quarter in the history of the company.
Reported sales were up 24% versus prior year. Organic sales were very robust at approximately 12% in the quarter, and that did extend our string of double-digit organic growth quarters. The net of acquisitions and divestitures did have a favorable impact on sales. That was approximately 15%. And currency still remains negative, but it's basically exactly as we forecast. It's minus 2.4% impact for the quarter and that is obviously unfavorable to prior year.
When you look at adjusted segment operating margins, we did exceed our forecast. We finished at 23.2% for the quarter. That's an increase of 50 basis points versus prior year. It's the first time in history of the company that we surpassed 23% for a full quarter. So impressive results really across the board.
When you look at dollars on segment operating margin, we generated nearly $1.2 billion in segment operating margin dollars. That itself is a 27% increase from prior year. And it happens to be the second quarter in a row that the company has generated over $1 billion in adjusted segment operating dollars.
When you look at EBITDA, another record here, we surpassed 24% for the first time. In the history of the company, we finished at 24.2% and adjusted net income of $772 or 15.2% ROS, was an improvement of 22% versus prior year. And finally, when you look at EPS, adjusted EPS nearly $6, $5.93 for the quarter. That was an increase of $1.10 or 23% compared to prior year, just outstanding execution for the company for the quarter. When you look at sales, segment operating margin dollars, net income and earnings per share, every single one of those was an increase of greater than 20%.
I can tell you, I'm just immensely proud of our team for the record performance. Meggitt is really truly adding value to the company, and the company is just executing soundly across the board.
If you go to slide 13, this is just a walk on that $1.10 improvement of EPS year-over-year. And I mentioned on the last slide, the biggest driver of that is our increase in segment operating income dollars. We did basically an additional $250 million in segment operating income. That 27% increase. That added $1.50 to EPS year-over-year. When you look at the corporate G&A and other that was a $0.23 favorable EPS impact that was primarily driven by lower salary and other benefit costs. Interest, as you all know, is a headwind. That was a $0.54 headwind, but 100% of that is attributed to the Meggitt acquisition and of course, what's going on in our rates.
You look at income tax that was $0.09 unfavorable. Really, it's driven by some prior year favorable items that were discrete that aren't repeating this year. And really, that's the walk to the $5.93. It's really a stellar number, record 23% increase.
If you go to slide 14 across the segments, you can see, as I mentioned, it's really just across the board solid performance. Organic growth was a double-digit positive in every segment. We exceeded our margin expectations across the board and our legacy businesses really perform soundly with incremental margins above 30% in every single segment.
Beginning this quarter on orders, we finalized the Meggitt structure. We felt good about that. And going forward, we are including Meggitt orders in both the prior and current period for comparison purposes. And we really feel that, that better reflects the transformed portfolio that Jenny mentioned earlier.
So all in, orders remain positive despite really some tough comps versus prior year and finished at plus 2%. Demand remains really broad-based across most of our markets. And Jenny also mentioned this, but I just want to reiterate, the dollar value of orders in the quarter was certainly the highest that we've had in FY 2023, and it did grow 9% sequentially from Q2. And of course, the backlog obviously is up 3% sequentially as well. So our team members are really just executing well to meet our customer expectations and really focus on delivering top quartile results.
If you look at the North American businesses, sales really strong at $2.3 billion. Organic growth was just under 12%. Adjusted segment operating margins nearly 23%. And if you remember, there is a dilutive impact on some of the Meggitt businesses that are in the Industrial North American businesses, but like I said before, the legacy business has really outperformed and strong sales growth in supply chains, improving gradually and really just great incrementals across those base businesses and really strong backlog and that demand is very solid across all of our North American businesses.
International really outperformed in the quarter. Sales were $1.5 billion. Organic growth exceeded our expectations and finished at just about 10% organic growth versus prior year. Organic growth in the International segment was positive in all regions. EMEA was plus 11%, Asia Pac 8.5%, Latin America 8%. So all positive in every single region in the International segment. Adjusted operating margins were up 70 basis points, finished at 23.4%, really benefiting from that volume, that strong organic growth, but really some focus on cost control and productivity improvements really helped leverage result in the International segment this quarter.
Overall, this really strong performance across every region. And then finally, aerospace, secular trend we've talked a lot about. Sales were $1.2 billion. That's almost 90% increase from prior year. That is obviously clearly driven by the Meggitt acquisition. But organic growth led the company in aerospace at 14.5% versus prior year. And really just strong across the board, OEM and MRO commercial businesses, sales and orders are very strong, both being mid-20s positive. And interesting, this quarter, military OEM returned to flat versus down from prior quarter.
Operating margin is extremely sound, 23.5%. That's 160 basis point improvement year-over-year. Jenny mentioned it, that the Meggitt integration is going extremely well. Synergies are ahead of schedule. We did raise our synergy estimate for the quarter, $15 million and performance in those businesses continue to impress.
Order rates in aerospace, obviously very strong. You look at that order number of plus 25%, but both strong in commercial and military end markets. Just really sound operational performance across the company, no weak spots at all.
Moving to slide 15, just talking about our year-to-date cash flow performance. Cash flow from operations was 12.8% of sales. $1.8 billion of cash generated so far this fiscal year, that's 16% over what we did last year. Free cash flow is 10.9%. Our CapEx remains right at 2% like we have been forecasting.
There are some one-time transactions that were the result of the Meggitt transaction. That impacts our cash flow by 1.5 points. So without those transactions, those numbers I just gave you would be 1.5% better. And free cash flow continues to be greater than 100%. We're at 111% year-to-date.
And just I want to reiterate, for the full year, we continue to forecast cash flow from operations and free cash flow conversion of over $100 million and that free cash flow would be mid-teens for the year.
If we go to the next slide, just touching on capital deployment and some leverage. We did increase our quarterly dividend. Our Board approved this last week to an 11% increase. The dividend payout is now $1.48. That is in line with our stated target of being in the range of 30% to 35% of our trailing five-year net income. And the increase this quarter does increase our annual record of increasing annual dividend paid from 66 years to 67 years. So long-standing record that we intend to keep.
On leverage, we did make some significant progress reducing leverage this quarter. We paid down approximately $650 million in debt in the quarter. If you look at our gross debt to adjusted EBITDA, it was 3.2, that's down from 3.6 last quarter, so 0.4 turns from Q2. And if you look at the net debt to adjusted EBITDA, finished the quarter at 3.1, that's down 0.3 turns from Q2.
So we are pleased with the deleveraging progress. We are on track and we continue to target our leverage commitment of 2.0 times, and we are committed to delivering on our commitments there.
Looking at slide 17 and guidance. Obviously, we increased our guidance this morning. We have incorporated obviously the strong performance from Q3, but we've also increased our expectations for Q4.
Full year sales growth at the mid point increases to 19% versus prior year, with organic moving up to 10%. That's up from 7% last quarter. When you look at the net impact of acquisitions and divestitures, we expect that to be about 12%. That's just up slightly from 11.5% last quarter and currency remains a headwind, no change to our prior guidance, but the full year, we expect it to be a minus 3.
When you look at adjusted segment operating margins, we've increased our full year guide by 40 basis points. We now are forecasting 22.5% for the full year. And the midpoint of adjusted EPS is raised to $20.75 for the full year with a range of plus or minus $0.15. Just some specific details for Q4. We expect organic growth to be approximately 4% in the quarter and segment operating margins to be approximately 22.6%. And finally, EPS for the quarter, we are forecasting $5.32 and at the midpoint, same range wrapped around that. And we've also included guidance by segment and several other details that could be useful for your models in the appendix. So with that, just a really solid quarter. Glad to increase our guide.
And with that, Jenny, I'll hand it back to you and ask everyone to reference Slide 18.
Thank you, Todd. As discussed today, Parker has a very promising future. Our highly engaged team is living up to our purpose as evidenced in the results. We will continue to accelerate our performance using the Win Strategy 3.0. And as mentioned several times, our portfolio transformation is making us longer cycle and more resilient. This will allow us to achieve our FY 2027 targets and continue to be great generators and deployers of cash. We remain committed to top quartile performance. . Next slide, please. A quick look at our upcoming events for the rest of the calendar year.
And with that, Chris, we are ready for questions.
Thank you. At this time we will conduct a question-and-answer session. [Operator Instructions] Our first question comes from Joe Ritchie of Goldman Sachs. Your line is open.
Thanks. Good morning, everyone.
Good morning.
So let's just -- let's start on the backlog as a percentage of next 12-month sales is super interesting, how that's progressed over time. I guess -- my question is really, as you're kind of thinking about the 2024 framework, I know you'll give us guidance in August. How is this going to inform that framework, whether that's a like more narrow sales range? And any color you can give us around that would be helpful.
Well, you're right. We'll come back to you in August with the full year guidance. So we really believe that this backlog as we've shown the consistent increase over time will remain. I always use the term demand sense. And I think that with the transformation of the portfolio, we're going to have more backlog because we have a longer cycle business. So we'll look at it for the new fiscal year, the same way in which we've been looking at it most recently. So that will help us with the future year guidance.
Okay. Thank you. That's helpful. And I guess maybe since things seemingly are still going very well. If you take a look at the organic growth you put up this quarter, there's certainly some pricing that's coming through that as well. Just maybe talk through the orders in industrial a little bit. And I'd love to hear whether there are certain areas, particularly in industrial distribution, how that's holding up today, whether there's any destocking that's happening. Just any color around that would be helpful.
So I'll start off and give you a little bit of color on industrial, and then I'll let Lee chime in on distribution. So in North America, orders to go negative, as Todd mentioned, a negative 4%.
Just a reminder, real tough comp as North America last Q3 was plus 23%. So, customer demand remains strong. We have seen some destocking happening, and we believe that's very steady overall, positive outlook, and we continue to believe there will be broad-based growth.
International also at minus 4%. That decrease was mainly driven by Asia-Pacific, which was down the mid-teens. China Mobile construction remaining very soft. A lot of, I think, automotive awaiting for the government stimulus. Semicon soft, but that's pretty much what drove the international negative.
And EMEA, there's really no signs right now of the market weakening, strong mobile construction and automotive. still some tough comps related to COVID vaccine business last year and some supply chain challenges. But that's primarily around electronics chips and sensors. So, it looks to be good in EMEA.
Joe, I'll just add on, just a quick -- this is Lee, just a little bit about distribution. I would tell you, in general, the sentiment is still very strong, very positive, and the backlogs have stayed very consistent. There's obviously here and there some balancing of inventory, but it's truly negligible on the total backlog for distribution and it's really true for all the regions.
North America, the most. Asia, I continue to see some strength in China on our distribution level. And EMEA has been fairly resilient, which if you would have asked me a quarter ago, I thought we'd have a little more headwinds, but it's been much more resilient than I planned on.
Got it. Thank you both.
Thank you. This question comes from Andrew Obin of Bank of America. Your line is open.
Good morning.
Good morning Andrew.
Good morning Andrew.
So, I love your slide that shows the company's transition to longer cycle business over time and how it's just fundamentally different. But I guess it's a question for Jenny and Lee. As you -- as the company has transitioned the portfolio, clearly, it's happening outside of aerospace as well, right?
How are you adjusting the sales organization and you go to market to deal with the fact that you now have to deal with longer horizons, perhaps you do need to carry more inventory to service these kinds of customers. Maybe give us a 30,000-foot view. Thank you.
Yes. That's a great question, Andrew. So, I think I could probably spend a half hour on this conversation. But the sales organizations continue to morph around the globe. I would say at a high level, we've got very focused teams that deal in the aerospace sector, deal with the big OEMs and in a separate organization on the MRO side.
And then with key market segments, if I could take electrification initiatives around automotive, we've got whole sales organizations and application engineers that deal specifically with that. So, we are constantly adapting. We've got a team right now that's dealing nothing, but hydrogen generation, even though it's early days. So, we kind of organized based on some of these secular trends and based on what we see the opportunity in the field.
Excellent. Thank you. And I guess I want to resist asking this question, giving Jenny's background. But I think a lot of debate on HVAC. And I know that this is one of your largest businesses. Can you just give us more insight if you're willing to go that granular what's happening at the Portland? And I guess if you can, that's great. And if you can, just would love to hear your view on the U.S. construction cycle? Thank you.
So yes, obviously, very, very fond of the Portland division and a lot of history there. It is one of our markets that is single-digit negative right now. But I would tell you this is a very strong business and historically has done very well. So we don't expect that this is going to be any time -- any long-term impact to the division. And I think they're in a good position, Andrew. .
Thank you.
Thank you. One moment for the next question. This question comes from Scott Davis of Melius Research. Your line is open.
Great. Good morning, Jenny, Lee and Todd. Congrats on another good quarter here. Great quarter. Jenny, you mentioned in your prepared remarks about a new annual incentive plan. What -- can you share a little bit of color around what you changed or what you're emphasizing in the plan?
Yes. Thanks for asking, Scott. So we used to be on a plan that was driven off of return on net assets. And it was very difficult for all of our team members from -- inside of our factories even up into our offices to understand exactly where all those numbers came from and how they fit into that calculation. And now with our annual incentive plan, the operators on the shop floor, all of the people who support the manufacturing environment, everyone can clearly see because it is based off of sales and profit and cash.
So they know exactly how they fit into it at the division level. So if you can kind of imagine a production planner, thinking about the inventory they need to bring in and the scheduling of the shop floor, they are in tune to that fact that, that is cash, and that is a metric that drives their incentive plans. So that's just one example of how we've been able to take that plan and the metrics that support it and deploy it to where everyone can understand it and buy into it. First full year this year, all groups, and like I said, nearly all of our team members are on this and has been very positive thus far.
That makes sense. And just conceptually to back up a little bit. I mean, it's -- I've been studying companies for 30 years. It's very hard for capital spending to stay at levels around 2% of sales with growth above GDP and less productivity is just exceptional. And so I guess my question, which is a little bit of a tough question here. But productivity is something you measure in kind of the 3% to 4% level. I would guess it would have to be something like that to be able to sustain something down towards the 2%. How do you guys think about it, I guess, is the question?
Yes. Great question. So we think about it a little bit higher than that. We're very challenging when it comes to continuous improvement. It's why the Win Strategy has been so successful. Our lean tools and Kaizen constantly drive cost out of the business and make that productivity possible. That goes again to every member of the business being part of using those lean tools being part of Kaizen.
So it's ingrained in our culture to consistently be more productive quarter-over-quarter, year-over-year. And in many cases, that's part of people's annual goals, depending on the role they're in. So we pride ourselves. We we're the hardest on ourselves. We still think we have plenty of room to improve, but we do pride ourselves on constantly looking for ways to increase efficiency and drive output.
So even above the 3% to 4% level that I mentioned, is that what you said, Jenny?
In some cases, targets that divisions will be there, yes.
All right, okay. Impressive. Thank you. Best of luck.
Thank you.
Thank you. One moment for the next question. This question comes from the line of Mig Dobre of Baird. Your line is open.
Thank you and good morning, everyone. I wanted to go back to backlog as well. I'm curious how much of this backlog is deliverable in the next 12 months? Do you have multiyear orders that are in here? And as you look at the backlog build here, is there a sense from you as to how much of this build is just a function of supply chains and lead times and folks securing production slots as opposed to just a pure structural change in your business model?
Well, Mig, I think that, obviously, we know that the supply chain has been very chaotic over the last several years. But -- that's why we wanted to talk about this consistent growth over time, because this is not just related to what's happened in the supply chain. I mean, you can look at the slide, you can think about where floored and Exotic and now Meggitt has come into play. And those are all longer cycle businesses that put orders out there for a further period of time. So when you look at this, we think that this is something that is going to be consistently out there into the future. We don't expect that we're going to see this drop very much.
And how much of this is deliverable in the next 12 months? Is it all of it or just portions?
About 85% of it.
Okay. Then my follow-up on industrial and international, and maybe this kind of relates to the backlog discussion, too. If we're looking at the last couple of quarters, we've seen order intake declines. Your organic growth has stayed positive. You're guiding for the fourth quarter, implying still positive organic growth. So there is this disconnect, I guess, between orders and organic growth. And I'm wondering how you would frame it for us to think on a go-forward basis? Thank you.
Well, I think the big thing there is that the backlog remains strong, right? So the orders did go negative. But as I mentioned earlier, we constantly check the health of that backlog, and we see the shippable orders to that backlog.
Thank you.
Thank you. One moment for next question. [Operator Instructions] This next question comes from the line of Julian Mitchell of Barclays. Your line is open.
Hi. Good morning. Just wanted to switch back maybe to the aerospace business. Some of your peers have been very, very upbeat as they're thinking about the defense or military exposure into next year. I think your orders are starting to reflect that the last couple of quarters after some tough comp's prior to that. So maybe help us understand kind of how you're thinking about that military piece within aerospace over the next kind of 12, 18 months. Any update around Meggitt's organic performance?
Sure. So first of all, you're right about military. Military OEM, we're starting to see orders return on the F-35, F-135 and the Black Hawk. So we're happy to see that. That's looking good.
On military MRO, it is increasing as well with some new partnerships on stocking. And when you look at the growth compared to last year, military OEM will still be negative mid-single digits. But as Todd pointed out, it went flat to prior year for the first time in the last quarter and MRO will be high single digits. So I feel really good about that. . The second part of your question again, please?
It was really around the sort of the growth outlook into fiscal 2024. Aero is a particularly sort of backlog-centric business, especially the OE side. So is it realistic that we could see kind of high single-digit growth again for the segment overall next year just because you've got very good commercial growth and now sort of military helping.
Yeah, absolutely. We see that as a possibility. And just as a note, last quarter, I mentioned that the outlook for this fiscal year for Meggitt was $1.9 billion at 17% and we increased that to $2 billion at 19%. So strong outlook.
Yeah, Julian, I would just add. If you look at our organic growth in our aerospace business, nearly 15%. The Meggitt business is performing better than that. If you remember, they dipped down lower than we did in the airline COVID times, but orders are strong. And if you see the total orders that we reported, it's a plus 25%. So we feel really good going forward about aerospace.
That's very good to hear. Thank you. And just one quick sort of fiddly follow-up, apologies for this, but just sort of the nature of the guide. If I look at the North America industrial, it looks like you're assuming sort of margins are down a bit year-on-year in the current fourth fiscal quarter. Just wondered, if that's correct. And is that more just around the kind of seasonal you've got a sequential decline in sales and that's bringing the margins down with it, anything else going on there?
Yeah. I mean I would just say, Julian, Q3 was fantastic. I mean, stellar far exceeded our expectations. We were forecasting a slight decline in margin for Q3. We outperformed, and we did better than that. We did increase our Q4 margin expectations. You're right though, it is slightly below prior year. It's just a combination of mix and of course, Meggitt being in there, and obviously, organic growth moderating. So we're going to try to do the best we can there, but we are forecasting just a slight dilutive year-over-year just for Q4.
That’s great. Thank you.
Thank you. One moment for the next question. This question comes from the line of Jamie Cook with Credit Suisse. Your line is open.
Hi, good morning. Nice quarter. I guess two questions. One, the international margins have surprised on the upside, in particular this quarter in your guidance. So can you speak to the color of what's going on there? How much of that's price cost versus some structural stuff?
And then I guess my second question, back to Parker's change business model with later-cycle businesses and Meggitt and integrator backlog going into a potential recession. How does Parker manage the business differently going into recession versus the old Parker that was much shorter cycle in terms of levers that you pull, maybe you're less aggressive to take cost out quickly. I'm just trying to understand how you approach the new Parker in a pending recession. Thanks.
Yeah. Hey, Jamie, this is Todd. Thanks for the good comments there. I'll start with the international margins, and then maybe I'll hand it over to Jenny to talk about how we're going to manage through whatever the future holds for the macroeconomic trends.
You're absolutely right. International margins, international volumes far surpassed our forecast. And it really was across the board. It was -- Europe is way better than feared. Asia has been extremely resilient with the start-ups and shutdowns and the back and forth with certain end markets. And Latin America has really been very solid for us. So across the board, it was a combination this specifically this quarter. Lots of volume leverage, great cost control, really integrating the Meggitt businesses that are in the international area. And it was just solid execution across the board, so easiest that.
I wouldn't call out price cost as any different than any other region. They're doing exactly the same thing that we're doing everywhere across the board, it was really just really solid execution.
Jenny, you want to take that?
Thanks, Todd. So Jamie, probably the biggest thing to say is we don't wait for the recession to hit. We have a playbook for this. And quite honestly, we're always planning for the next recession. So when you look inside of the wind strategy and you look at our tool box, some of the things I was talking about earlier, constantly using our lean tools and our Kaizen events to make sure that we drive out cost. Those are the things that are always ongoing that help us expand margins.
When we get to the point where there are some changes in volume, we have several different levers that we pull around -- over time around the temporary workforce before we make any permanent reductions. We also make sure that we are constantly keeping an eye on the customer demand. Like right now, we've seen no significant push-outs or cancellations, but we continue to work closely with them. So we can stay ahead of that from the standpoint of bringing in inventory and staffing the shop floor. So we have a lot of levers we pull on an ongoing basis, and we performed well in the last couple of downturns. And as I mentioned before, we're very well-positioned for what's going on today and into the future.
Thank you. Great job.
Thanks Jamie.
Thank you.
Thank you. One moment for the next caller. The next question comes from the line of Nathan Jones of Stifel. Your line is open.
Good morning, everyone.
Good morning, Nathan.
Good morning, Nathan.
Just a question on the corporate G&A. I think, Jenny, you said lowest salary and other benefits. I'm here if anybody talking about labor costs going down. Can you give us a little more color around what's going on there?
Nathan, yes, that was me. It's really true. So lower salary costs across the board. I did mention other benefit costs, a little bit of that is pension. Other things is just a market-based benefit. So it's really a combination of really just minding our SG&A, like we always do and then some favorable headwinds from pension and other market-based benefits.
Are you talking about salary costs going down per capita or the number of heads going down?
Yes, it would be the number of people.
Number of people. Okay. And then maybe if you could just give us an outlook on working capital going forward here. You obviously got growth to support, but it's probably carrying extra inventory or supply chain issues and themselves out. So just any expectations, I guess, more for going into 2024 than for just the end of the fiscal year?
Yes, for sure. Obviously, working capital with what's been going on in supply chain and obviously dealing with the growth and making sure we've got continuity for our customers. It has been a headwind to cash flow. I think we've turned the corner on that. Our teams are really focused on reducing inventory.
We are tightly managing CapEx, right? Our plan has been 2%. We've kind of stated that throughout the year. There is opportunities certainly across the Meggitt businesses as we continue to integrate those. So we feel positive about that being a tailwind for next year. And I would tell you across a number of the legacy businesses, we think there's opportunity as well. So I expect that to be a plus for us going forward, Nathan.
Great. Thanks for taking the questions.
Thank you. One moment for the next question. The next question comes from the line of Nigel Coe with Wolfe Research. Your line is open.
Thanks, good morning, everyone and great quarter. Very strong execution, obviously. So just looking at the fourth quarter guidance. And as my math is 1Q, you're guiding for sales to be down roughly 4%, 5%. Again, if I'm wrong there, please let me know. But that's something we only normally see during the sessions, I think it was 2009 and 2020. It doesn't sound like you're planning for recession. So just curious what course need to be so conservative with that 4Q guide? And what are you hearing from customers as you go into 2024? Are you hearing more caution as we kind of come into that planning session? I mean any thoughts there would be helpful.
Yes. Nigel, this is Todd. I think your number might be a little bit high. I think if you look at it, we might be close to 2%, down from Q3. And when you look at this, Q4 really starts to kind of anniversary some of these growth periods that we had prior year. If you remember, Jenny said last year, I think North America was plus 23%. We significantly increased our guide. If you look at organic growth for the quarter. I think we were almost flat with our forecast coming into Q4, we're now roughly 4%, 4.5% organic growth.
There's still some uncertainty out there. We are monitoring it closely. And like I said, we're just giving you the best look that we have right now. We feel really good about aerospace, and we're watching North America and international. You've seen the orders, the orders did turn negative, still robust. We're just giving you the best look we got at this point.
No, I appreciate that. That's helpful. And just on the orders cuts, down 4% for both North America and International. I noticed that you've made a slight tweak to the policy with acquisitions. So do those numbers include the contribution from the Meggitt industrial businesses in both segments, or is that a change to the like-for-like? So you've also just the prior year. So we still have a core but including Meggitt, so do we have 4, 5 points in North America for Meggitt there?
No. Yes, we did. You're absolutely right. What we started to do this quarter, we finalized the formal structure of where those Meggitt businesses now sit within legacy Parker-Hannifin. And we felt good about that.
As we've talked about the change in our portfolio and when we looked at what we were guiding going forward, we felt at this point in time, it was prudent enough to include those both in the prior and in the current year period. So that is -- those comparison rates that you're seeing, those are apples-to-apples comparison rates. And if you remember…
Okay. That’s helpful. Yes.
Yes. 80% of Meggitt sits in the Aerospace Systems segment, roughly 20% of that does sit in the International segment, roughly 15% of that is North America, 5% of that is in international. And I would tell you, just got to keep in mind, obviously, Aerospace segments got the biggest chunk of that.
You can see the plus 25% on the orders in the aerospace segment. It is a smaller slice of Meggitt that is in the North American and International Industrial segments. And when you look at the size of those businesses, it really is a small impact to what it was historically reported.
That’s very helpful. Thanks, Todd.
Yes.
Thank you. One moment for the next question. Our next question comes from the line of Jeffrey Sprague with Vertical Research Partners. Your line is open.
Thank you. Good morning, everyone. I was on late, so I'm just going to ask one, and I apologize if it's been addressed. But just, again, looking at kind of the backlog. It is interesting, right, the backlog of forward sales has moved up pretty nicely. Certainly, Aero plays a big role in it. But looking at even industrial backlog to forward sales by my math is sort of double what it used to be, high teens to maybe into the 30s now sort of thing.
I just wonder if you could maybe address how much of that is reflective of the longer-cycle business mix shift that's going on within Industrial, versus just kind of legacy supply chain and other issues and just kind of the raw ability that gets to out the door as you deal with supply chain, both on the back end of the process through your plants and then out to the customer level. Thanks.
Yes. Thanks, Jeff. Yes, we believe that the majority of it is due to longer cycle business and the way that it's going to look going forward. So if you think about the addition of the LORD business and you think about how that's impacted the industrial segment, that's definitely longer cycle and in here along with all of the aerospace that you already mentioned. So we feel like this is the new way that the backlog is going to look and feel that it's a little bit of supply chain impact probably, but seeing this growth over time is an indicator to us that the portfolio changes are really changing the company and changing what the backlog looks like going forward.
And maybe then just a second part of that. So the margins obviously look very solid. Are there any residual just inefficiencies that you're dealing with in the system because of supply chain or other dynamics, or is that pretty much ironed itself out at this point? Thank you.
Yes, I would say, overall, we've seen some supply chain healing, but we definitely are still in the thick of it when it comes to electronic sensors and chips. And our Motion Systems group on the mobile side is impacted by that. And I would say that aerospace not only impacted by chips and sensors, but still a little bit of a bumpy road in supply chain yet in aerospace. So, we're not completely through it.
Great. Thanks for the color.
Thank you. [Operator Instructions] This question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Your line is open.
Hey good morning everyone.
Good morning Jeff. How are you?
Hey just a follow-on on supply chain. I guess, one, if you look in the industrial business, as supply chains kind of heal, are you seeing changes in order patterns, less blanket orders and maybe how does that impact the order rate? And then also, just as the supply chain friction comes out, how do you see that playing out in the margins going ahead?
Well, first of all, we're not seeing any significant changes in order patterns or lead times overall, I would say. The thing I would say about that is that when we have supply chain issues in any of our businesses, it does somewhat drive inefficiency, right? We're doing whatever we can to get the material in and get it out the door.
So, as the supply chain continues to heal in different parts of our business, we'll look for those opportunities to be more productive. It's one of the things that I mentioned that we were focused on in the last call and again in this call, is that some of the chaos that we went through really highlighted some areas where we could improve, and we could look to use new tools and new strategies to analyze that demand in a faster way, be more reactive, thus increasing productivity and shortening the lead-time.
So, definitely still opportunities out there to become supply chain leaders in. We're working closely with our suppliers on this. And it's one of the things that we've come out and said that we're using capital for to invest in the supply chain.
Okay. And then just on Meggitt, do you have an accretion number for the quarter to give us? And then just on the up-synergy should we think of that as more of a pull ahead, getting things done faster or some upside to that $300 million number?
Hey Jeff, this is Todd. I'll take that. We're not going to give an EPS accretion number. I would tell you, we're just extremely happy with the way that's performing. It is doing exactly what we hoped it would do.
When you look at the synergies, we did up the synergy numbers for FY 2023 from $60 million to $75 million. That's basically just doing things faster. So, if you look at the cost to achieve, if you go to that detail, the cost to achieve are slightly higher. That is just a result of doing things faster than we originally had planned. So we still are committed to the $300 million in the full third year of acquisition. We just are pulling those a little bit forward. .
Okay. Thanks.
Thanks, Jeff.
Thank you. One moment for next question. This question comes from Josh Pokrzywinski with Morgan Stanley. Your line is open.
Hi. This is Toby [ph] on for Josh. Congrats on great -- a follow-up on the order trend question. Jenny, you mentioned some of the mega projects that have been going on. Where are you seeing this in the business? And how would you think about the potential uplift given Parker historically is focused more on components and assemblies?
Yes. So it's -- it's difficult to directly tie it to a specific project, but we are definitely benefiting from some of these projects in the secular trends. So if you think about a lot of the new battery plants that are being built to support electrification, we're there when they're prepping the land, we're there when they're building the factory and we're there when they're putting all the equipment in the factory.
So definite benefits there. Also although it's a little bit longer-term for these to be online, but we'll directly benefit from a lot of the chip and sensor production that is coming to the U.S. And today, if you look at the secular trends, obviously, aerospace, we've been talking about that a lot definitely benefiting from that secular trend in that market recovery. And beyond the battery production, we currently have a lot of content on electric vehicles. And when we transition from an internal combustion to an electric, it's 1.5 times to two times the bill of material for us.
In addition, we're starting to see from an electrification standpoint, a big pull on our mobile business. So between mega CapEx projects and secular trends, again, it's the reason we feel so confident about those targets in the future, 4% to 6% organically and really why we believe we're going to grow differently with this portfolio.
That's very helpful. Thank you.
Hey, Chris, this is Todd. I think we've got time to maybe squeeze in one more question. Let's take one more and then we'll wrap up after that.
Thank you. Todd. Standby for our next question. Our final question comes from the line of Joe O'Dea of Wells Fargo. Your line is open.
Hi. Thanks for taking my question. One, just on the quarter in the North America margins flat year-over-year on 12% organic growth. And so can you elaborate a little bit on mix? I also just anything else that you could be ramping up on the investment spend side where you could see opportunities there?
Yes. Let me take this. This is Todd. When you look at the Meggitt business, we're extremely happy with the way the Meggitt business is performing. If you remember, what we did was we put some of those businesses in the technologies where we thought they fit best. That would be engineered materials and a little bit into filtration. Those just happen to be some businesses, some parts of Meggitt that are lower performers compared to the total.
So when you take that out, if you could look at just the legacy portion of North America, it would be very similar to what you're seeing across the rest of the company, record performance, record volumes, record incrementals and -- or strong incrementals, I should say and really sound performance across those legacy businesses. So if I had to call one thing out, it would be the main driver of why North America was flat, it would be simply the inclusion of those mega businesses in that total.
That's helpful. And then just in terms of -- I mean, what's kind of changed over the past three months? I think, Jenny, three months ago, you were talking about maybe seeing a little bit of pushouts. I'm sure a little bit of destock as supply chain improves here. But given the strength of the revenue in the quarter, real evidence of much in terms of pushouts. And so I'm just curious with credit conditions out there, obviously, the macro uncertainty, but sort of day-to-day, what you're seeing anything notable in terms of shifts, either more constructive or more cautious?
Yeah. Really, I think it goes back to the strength of the backlog, and we've seen no notable shifts. We were cautious last quarter, and I think we obviously are very pleased with the performance. March really, really strong month for us. So we were able to ship a lot of that. And again, that backlog is still healthy and really has what has led us to the guide for Q4.
Appreciate it. Thank you.
Thank you.
And thank you for your participation in today's conference. Sorry, please go ahead.
Yes. Thank you, Chris. This concludes our FY 2023 Q3 webcast. If anyone needs any kind of clarification or have further questions or need to follow-up, both Jeff and Yan we'll be here for today and through tomorrow. We obviously appreciate everyone's time. We appreciate your recognition of a strong quarter, and we obviously appreciate your interest in Parker. So thank you all for joining us today. .
That does conclude our program. You may now disconnect.