Parker-Hannifin Corp

NYSE:PH

Greetings and welcome to the Parker-Hannifin Corporation Fiscal 2025 Second 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.

Thank you, [ Shelomy. ] We appreciate it so much. Welcome to Parker's Fiscal Year 2025 Second Quarter Earnings Release Webcast. This is Todd Leombruno, Chief Financial Officer speaking. And with me today is Jenny Parmentier, our Chairman and Chief Executive Officer. We appreciate your interest in Parker, and thank you for joining us today.

On Slide 2, we will address our disclosures on forward-looking projections and all non-GAAP financial measures. Items listed here could cause actual results to vary from our forecast. Our press release, this presentation, and all reconciliations for any non-GAAP measures were released this morning and are available under the Investors section on parker.com. The agenda for the call today has Jenny starting with the highlights to our record second-quarter performance. She will also highlight how our business system, the Win Strategy drives operational excellence in Parker. And then she will give an update to our market vertical outlook for the rest of our fiscal year FY '25.

I will follow Jenny with more details on our strong second-quarter financial results and provide additional color to our updated guidance. We'll then conclude, as usual, with the question-and-answer portion of the call, and we will do our best to address as many questions as possible within the hour.

Now I'd like to draw your attention to Slide #3. And Jenny, I will turn it over to you.

Thank you, Todd, and thank you to everyone for attending the call today. Our performance this quarter reflects our focus on operational excellence and the strength of our balanced portfolio. We produced top-quartile safety performance, aligned with our goal to be the safest industrial company in the world, and saw continued strength from our aerospace aftermarket. Consistent execution of the Win Strategy delivered 110 basis points of margin expansion, resulting in a Q2 record of 25.6% adjusted segment operating margin. In addition, our teams delivered record-adjusted segment operating margins across all businesses as well as record earnings per share.

Record year-to-date cash flow from operations, coupled with proceeds from previously announced divestitures allowed us to substantially reduce debt by $1.1 billion this quarter. And finally, we are encouraged to see industrial orders turn positive in our longer-cycle businesses. Next slide, please. With our Win Strategy, I'm often asked, how do we continue to expand margins and more importantly, can we continue to do so. I've talked about this several times in the past. It is our business system, the Win Strategy that drives operational excellence. We trust the process. It is a proven strategy and it works. The next few slides will show you how our teams use the Win Strategy to drive performance over the cycle.

Next slide, please. Embedded in the Win Strategy is the Parker Lean System. It is fundamental to our culture and drives continuous improvement at all 85 divisions. Within the same pillars of the Win Strategy are the critical tools used by all of our general managers and their teams to expand margins and drive organic growth. Disciplined execution of the Parker Lean System reduces variation and eliminates waste from the business. This system allows us to keep taking performance to the next level. And important to point out here is that we are never done improving our business. Next slide, please. On this slide, we have an example of how the Win Strategy drives performance through the cycle in one of our North American divisions. This is a division in our Filtration Group that has diverse exposure across industrial market verticals and a balanced OEM aftermarket mix.

This is an engaged team that has utilized our high-performance team structure to execute the Win Strategy. Looking at the results on the far right-hand side of the page. They have achieved first quartile safety by bringing attention and ownership to concerns, tracking them to closure and scheduling audit follow-ups to ensure sustained results. They are utilizing the Parker Lean system, specifically Kaizen, to expand margins and achieve the FY '25 profitability goals for their division, even in a negative growth environment. In addition, they have utilized the Simplify design tools to reduce complexity and cost as well as increased dual sourcing to strengthen their supply chain. And finally, use of our zero defect tools has resulted in a 52% reduction in rejected parts per million, thus providing their customers a better experience.

Next slide, please. Parker is a transformed company today. The chart on the left side of this page shows the strength of our portfolio over the last 2.5 years. Order rates increased across all reported business in Q2, coming in at 5% for the quarter. Aerospace order strength continued in both aftermarket and OEM. And although we are seeing a continued delay in the expected industrial recovery, we are encouraged to see industrial orders turn positive in our longer-cycle businesses. Next slide, please. Taking a look at our updated FY '25 sales forecast by market vertical. We are raising aerospace and defense to 11% on the strength of the aftermarket and gradual OEM rate increases.

On the industrial side of the business, although orders have turned positive, there continues to be pressure in many of these markets. We are expecting in-plant and industrial equipment growth to be slightly lower within our low single-digit framework. We are continuing to see delays in recovery, while distribution sentiment does remain positive. We are changing our forecast on transportation from low single-digit to neutral, primarily driven by weakness in automotive and higher dealer inventories. The bright spot here is that work truck demand does remain strong. Off-highway steps down to negative mid-teens as OEM destocking and production cuts continue and the weakness in ag persists.

We expect energy markets to remain neutral as projects and CapEx delays continue. And finally, we are increasing HVAC from low single-digit to mid-single-digit growth, driven by refrigerant changes in the industry. All of this adds up to an organic growth forecast of approximately 2% for fiscal year '25.

I will now turn it over to Todd to summarize our Q2 results.

Thanks, Jenny. Okay, everyone. I'm going to begin with results on Slide 10, and then we'll get to some more details on the outlook that Jenny just touched on. As Jenny mentioned, the second quarter was a strong quarter, lots of records. It was another quarter of strong margin expansion and EPS growth despite some real top line pressures. Sales were down 1.6% versus prior. Most of that decline is the result of the divestitures that we announced. The divestiture impact in the quarter was an unfavorable 1.4%. Currency also flipped on us this quarter. While we were forecasting a slight positive 90 days ago, it turned out to be unfavorable at 0.9%. And on a good note, organic growth was positive at almost 1%. If you look at segment operating margins, 25.6% is a Q2 record. That's an increase of 110 basis points versus prior year. And adjusted EBITDA margin was also a record at 26.8%, happens to also been an increase of 110 basis points from prior year. Adjusted net income of $853 million or 18% return on sales, both of those are also records. And lastly, adjusted earnings per share were up 6% to a Q2 record of $6.5.

Jenny mentioned this also, but the strong second quarter performance was consistent across all of our businesses and really just a nice solid finish to the first half of our fiscal year. If we could move to Slide 11, this shows the walk for that $0.38 or 6% increase in adjusted EPS. And again, it was just a nice high-quality quarter from an operating standpoint. Segment operating income dollars did increase by $33 million or $0.20 despite the 1.6% lower top line. And while strong Aerospace performance was the primary driver, the industrial businesses delivered record segment operating margins despite negative organic growth pressure and FX pressures as well. In total, interest expense was $0.17 favorable. That was driven by our continued focus on debt reduction.

Income tax and other both contributed $0.03 which was mostly offset by slightly higher corporate admin and share count. So the adjusted EPS of $6.53, I already said it, it's a record. And I really commend our team members around the world for strong operating performance, really diligent cost actions where necessary and really a focus on cash flow that helped us achieve these results. If we move into the segments, if I look on Slide 12, it really is a testament to the Win Strategy that our team members were able to deliver such broad-based margin expansion. We're so proud of the hard work and all of their efforts. Every business delivered record segment operating margins, whether they had a positive 14% organic growth or whether they were negative 5%.

Margin expansion for the entire company was 110 basis points. And another positive sign was that orders moved to plus 5% versus prior year, mainly off of a longer cycle end market strength. If you look at the Diversified Industrial North America businesses, sales were $1.9 billion. That equated to an organic growth of negative 5% versus prior. That was lower than our expectations going into the quarter. We continue to see delays in the industrial recovery, specifically in transportation and off-highway markets. A recovery has also yet to materialize in the distribution channel. But if you look at adjusted segment operating margins, we were able to increase those by 40 basis points to a record 24.6%, driven by just unbelievable operating execution. A nice positive sign in North America where orders did turn positive after a few quarters of negative. So we are happy to see that. And again, it's specifically driven by some of our longer cycle verticals.

If we move to the Industrial International businesses, sales were $1.3 billion. Organic growth in International came in at negative 3%. Asia Pac was a positive 3%. That's similar to what we had last quarter. Latin America, positive at plus 10%, while EMEA remains challenged with organic growth at negative 8%. But if you look at adjusted segment operating margins, the international team achieved a record high of 24.1% and expanded margins by 110 basis points. As Jenny mentioned, it's really just the power of the Win Strategy in action. Our international team continues to focus on productivity, cost controls, all things in the Win Strategy to expand margins and really are operating with unbelievable resiliency in a very tough growth environment. Order rates here also moved further positive from plus 1% last quarter to plus 4%, and that was mainly driven by improvement out of Asia Pacific.

If we look at Aerospace, Aerospace continues to outperform. Sales were a record $1.5 billion in Aerospace. That is up 14% versus prior year. That did exceed our expectations for the quarter. All of that growth was organic, 14% organic growth, and that was really driven by 20% plus growth in the aftermarket area and mid-single-digit positive growth in the OEM markets. Adjusted segment operating margin, same story here, a record 28.2%. That is an increase of an incredible 170 basis points versus prior. Just really robust top line, favorable aftermarket mix continues to drive this great margin performance and aerospace orders continue at a positive clip of plus 9%. So just great job across all of our businesses in the quarter.

On Slide 13, just to touch on our year-to-date cash flow performance. Year-to-date cash flow from operations was 17.4% of sales. That equates to about $1.7 billion in CFOA. That is a record, and it's also an increase of 24% versus prior year. Year-to-date free cash flow increased 17% from prior year. We finished at $1.5 billion or 15.2% of sales for free cash flow. Jenny mentioned some of that divestiture activity. Divestiture activity in the quarter generated cash proceeds of approximately $620 million and an as-reported post-tax gain of $223 million. We have excluded that gain from our adjusted results in the quarter. And 100% of the proceeds from those transactions were used to further reduce debt. Jenny mentioned in the quarter, we paid down $1.1 billion. That moves our year-to-date debt reduction to $1.5 billion, and our gross debt to adjusted EBITDA is now 1.7. So good work on cash flow across all elements of the business.

Okay. Moving to Slide 14 and guidance. Let me give you some more details on this. Reported sales growth for the year is now forecasted to be in the range of minus 2% to positive 1% with 0.5% negative at the midpoint. Keep in mind, divestitures are 1.5% of that unfavorable impact and 100% of that divestiture activity is from the Industrial North America businesses. Currency headwinds are now expected to be a 1% negative headwind. That is based on December 31 exchange rates as we always do. That did flip from what we were expecting 90 days ago. Just currency rates continue to show significant volatility. In respect to organic growth, we have raised the Aerospace organic growth midpoint by 100 basis points to now 11% for the full year. But the offset is on Industrial segment.

The midpoint has been decreased as followed. In Industrial North America, organic growth is now forecasted to be negative 2.5% at the midpoint for the year, and the midpoint of the Industrial International organic growth is now forecasted to be flat. For the full year, we expect Parker's organic growth to be a positive 2% at the midpoint. Despite all of that, we are raising our adjusted segment operating margin guidance by an additional 10 basis points for the full year and moving our expectations to 25.8% for the year. That is now a forecasted margin expansion of 90 basis points versus our FY fiscal year finish of last year. Tax rate is now slightly down to approximately 22%. We are modeling 22.5% for the second half of the year. And that -- there's more details of that in the appendix, along with assumptions we're using for corporate G&A, interest and other as we usually provide those.

Despite the currency headwinds and the delayed industrial recovery that Jenny talked about, we are maintaining our full year adjusted EPS midpoint at $26.70. Full year as-reported EPS is now expected to be $24.76. And like I just said, adjusted EPS midpoint is expected to be $26.70. Both of those have a range of plus or minus $0.30 on either side. We also remain committed to our free cash flow forecast in the range of $3 billion to $3.3 billion for the full year. If we look specifically at the third quarter for FY '25, reported sales are expected to be approximately $4.9 billion, with organic growth of positive 1.5%. Adjusted segment operating margin is 25.6% and adjusted EPS for the quarter is expected to be $6.65.

So Jenny, that's all I have. I will hand it back to you, and I'll draw everyone's attention to Slide 15.

Thank you, Todd. And a reminder on what drives Parker, safety, engagement and ownership are the foundation of our culture. It's our people and living up to our purpose that drives top quartile performance. And we remain committed to being great generators and deployers of cash. Todd just showed you our cash generation year-to-date, and we talked about all the great performance across all of the divisions. We are actively focused in extending our track record of deploying capital to deliver the best shareholder value possible.

Back to you, Todd.

[ Shelomy, ] we are ready to begin the Q&A session. So we'll take whoever you got first in the queue.

[Operator Instructions] Our first question comes from the line of Jeff Sprague with Vertical Research Partners.

Jenny, maybe to start, just more complexion on what you're seeing in the industrial long cycle. I guess when you're kind of addressed this pointing to the strength in industrial long cycle, is this the aero stuff that sits inside industrial? Or maybe you could elaborate on what verticals specifically are looking better on the long-cycle side?

Yes, Jeff, primarily, it is the long cycle strength of the aerospace and defense is sitting in those industrial businesses. But it's also positive in HVAC and in semicon. So that's really what's helping those orders in Asia Pacific increase this last quarter.

And so the kind of sales conversion cycle on that stuff is -- we're talking more 6, 9, 12 months in your view?

Right, right. Beyond our fiscal year and more into fiscal year '26.

Okay. Great. And then I was just hoping, Todd could give a little bit more color on just the pattern -- organic pattern of industrial revenues Q3 and Q4 to close out the year. What's embedded in the [ $665 million, ] for example, for the industrial?

Yes. Absolutely, Jeff. So we did pull down Q3 slightly. When you look at what we're looking at full year -- Jenny, I may ask you to grab that, if you've got it handy...

Yes. So we have -- for our Q4 guidance, the industrial organic sales guidance is 2.5% for North America and 5% for international. And it does assume a recovery, right? So basically, what we've done here is push things out a quarter. This guide is in line with prior growth periods when you look at sequentially Q3 to Q4. So that's an assumption that we're making in there. Aerospace, we've raised the growth outlook, as Todd mentioned earlier, to 11% for the full year. And if you look at Q4 for Aerospace last year, we were at a positive 19%. So it's a tough comp for Aerospace, but that's what we're showing for the rest of this year.

Our next question comes from the line of Joe Ritchie with Goldman Sachs.

So I know that 1 month doesn't necessarily make a trend, but I'm just curious, as we've started 2025, have you seen like any discernible differences or changes in trends based on how you exited calendar year 2024?

What we have right now is the best look that we have for this quarter and for the second half. So nothing notable that I would comment on at this point, just the best look we have today.

Okay. Fair enough. And then I guess the follow-on question to that, Jenny, is like, look, you guys have done an amazing job, and you described it a little bit earlier in your prepared remarks regarding your ability to expand margins in the industrial businesses despite this like very weak environment. If the current like trends hold through the remainder of your fiscal year, I mean, do you still expect to see some margin expansion coming out of both North America and international? Or has it become a lot harder?

I think we're still going to expand margins. I feel very strongly about the power of The Win Strategy and the tool set that's available to our general managers. I mean, obviously, everybody likes me, right? That's something that is a positive. But I don't pull back on my margin expansion story. We have the tools and our teams are doing a great job.

Yes. Joe, I would just add. We do have margin expansion in the guide here for the second half. It is more muted just because there's some currency headwinds, and obviously, the top line headwinds. But to Jenny's point, if you look at across all 3 businesses, we're still showing strong margin expansion across all 3 of those businesses.

Our next question comes from the line of Scott Davis with Melius Research.

There's not much to pick on. There hasn't been for some time for you guys. So I'll kind of ask some nuances around M&A. We keep hearing about kind of some of the enthusiasm of stuff coming out of PE, but historically, you guys have had kind of probably tilted a little bit more towards carve-outs. But what do you see out there in the M&A environment? And is your enthusiasm or I should say, confidence in getting deals done in '25 higher than it was in -- you think in '24 or comparable?

So it is an exciting time, and we do have a robust pipeline. We put a lot of stock in the fact that many of the assets in the pipeline are relationships that we've built over many years. And obviously, we've worked really hard, and we've done a good job paying down debt. So we're in a position to do that. So I don't know if I would comment that it's easier, but it's definitely a focus for us, and we're going to make sure that we continue to keep a close eye on everything.

Targets of all sizes in the pipeline, you've heard me say that a couple of times. We still have the same criteria. We want to acquire companies where we're the clear best owner, accretive to growth, resiliency, margins, cash flow, EPS, all with synergies. So we're really, really committed to deploying our capital in a way that's going to deliver the shareholder value that we've shown we can deliver in the past.

Yes. That makes sense. And I have to ask a question just because orders are a little better than I would have thought they'd be. Any kind of weird stuff out there as it relates to either buying ahead of tariffs or buying ahead of price increases or anything else that you can kind of point to -- that would have impacted orders a little bit? Or was it just pretty much things are getting better, and that's the story?

Yes. No, I wouldn't say nothing at all under that -- under those couple of items that you just said. I mean we're seeing the strength of aerospace and defense in our industrial businesses and HVAC and semicon. So longer cycle, nothing strange.

Okay. Congrats and best of luck this year.

Thank you.

Thanks, Scott.

Our next question comes from the line of Mig Dobre with Baird.

Just to follow up on that tariff discussion. I'm wondering sort of how your own thinking has evolved around this issue. What are you hearing from customers in terms of how they're preparing to deal with tariffs, especially Canada and Mexico is involved? And again, what Parker's strategy would be around this, whether with your production or anything else that you're planning to do with your business?

Yes. Well, I mean, obviously, there will be an impact depending on what actually happens. But we've dealt with tariffs before. We have the visibility, we have the tools, and we have the agility to act when something does happen, if and when something happens. So I would also say that over the past decade, we've built a local-for-local model because we want to be close to our customers. So if it happens, there will be impact, but that definitely helps us. And we've been focused on supply chain leadership now for a couple of years. A lot of new tools and strategies have been put into place to enforce that local for local and reduce lead times. So we don't see a big need for a supply chain realignment. We don't foresee any of that. And because we've dealt with this before and our customers know how we've handled this before, the teams will get to work when they need to.

Understood. My follow-up, looking at Slide 8, where you kind of talk about your growth forecast by end market verticals, I'm wondering a little bit about mix. Maybe you can comment on that. I know we talk about it in aerospace and defense, but within your industrial businesses, we're seeing some verticals like off-highway, for instance, more pressure relative to others. Is there anything to call out here in terms of some of these end markets carrying maybe higher margins versus the segment average?

I don't think there's anything to call out here, anything that would be of a concern or change the way that we're looking at the forecast or how we can expand margins. So nothing -- within some of these verticals, you've heard us talk, for instance, within off-highway, ag is weaker than construction. But there's nothing there that I would say we would point to a mix concern.

Yes, the only thing I would tell you, as you know, this -- our distribution channel has a more positive margin profile than the OEM channel, but it's not anything out of line than what we've seen in normal periods at this time. So the margin expansion is really coming from the team working really hard on productivity, working really hard on cost and managing what they can control.

Our next question comes from the line of David Raso with Evercore ISI.

Jenny, earlier you were mentioning, I believe you said fourth quarter organic growth rates. And I won't bore you with the math right now, but I'm just trying to make sure I understand the cadence seems to have a very light organic growth for Aero in the third quarter to foot to the full company third quarter organic, but then a big bounce in the fourth quarter. I'm just trying to make sure I'm reading that correctly the way you laid out the industrial growth.

So Aerospace in the third quarter is projected to be 9.5%. Fourth quarter is 5%. And what I mentioned earlier was fourth quarter last year was 19% -- so still strong aerospace growth, but pretty tough comps there. Total year at 11% for aerospace.

David, I really do think it's just the comps. If we look at the sheer dollars, Q4 would be the highest aerospace shipments we've ever had as a company, and it would be obviously the highest we shipped all year.

Okay. Helpful. And then when you noted you expect some improvement in the fourth quarter, can you highlight where are you seeing that? Are there already conversations, some restocking levels maybe on some of the short cycle? Just where do you expect to see that improvement?

Well, we just -- we expect to see some gradual industrial recovery based off of the fact that, as Todd just mentioned, our distributor sentiment is very positive. And we've been here at that average time of impact. We're here at 5 quarters of negative growth and the average is 6, and that's in North America International, we're at 6 quarters of negative growth and the average is 6. So we're just expecting that this turn is coming, but it's been pushed out another quarter from what we see right now.

And when it comes to the mix of what is picking up versus what you expect to pick up, I'm just trying to get a sense of how much should we think about, is it an accelerator in the margin expansion, all else equal, with what's supposed to pick up in a couple of quarters? I mean usually, you think of, for example, distribution is some of your highest margin business, and that sounds like that maybe hasn't necessarily accelerated yet. Is that still on the come? Or maybe you can explain a little bit how to think about the mix of what's starting to recover and what's on the come?

Yes. Distribution, it's still on the come, right? I mean they're positive. They're expecting it to happen. They're ready for a recovery, but it hasn't come yet. So yes, obviously, distribution is a higher margin for us. But again, our margin expansion is going to come from the teams continuing to do all the great work that they do on productivity and driving out costs in our plants as well.

Yes. The spirit of the question is everybody after the next quarter or even after this call, start thinking about how do you guide in July or early August. And just trying to think about if distribution starts to be a little more of a lead horse on the earnings recovery into fiscal '26, relatively speaking, that should be a positive margin mix. So that was the spirit of it.

We were really happy to see the orders turn positive. I think another quarter would be another great data point to make us feel good about '26.

Our next question comes from the line of Jamie Cook with Truist Securities.

Congrats on a nice quarter. I guess just 2 questions. One, can you give more color on the LatAm orders up 10% and then EMEA, I guess, down 8%, what you're seeing there? And then I guess, Jenny or Todd, in the spirit of the margin question again and your outperformance given organic growth is disappointed this year. To what degree can we expect when the markets turn, is there a reason to believe that incremental margins coming out of this downturn should be better than average because of structural improvements in the Win Strategy that you would point to above-average incremental margins this cycle?

Yes, Jamie, maybe let me touch on that margin question first. The incremental margins are a little bit difficult with a muted top line, right? The calculations get a little strange. But the team has unbelievably performed on that. We have clear margin expansion targets out to our longer-term targets. We don't expect FY '26 to be any different. That will be another leg in moving those margins to what we have committed to. But I think if you're looking at -- in general, we really still believe 30% incremental margins are best-in-class. And if you're doing that, you're doing all the right things like investing in the business and obviously generating higher organic growth. So that's what we're kind of pushing the teams to.

In respect to Latin America, yes, they have been fantastic. It is a small piece of the company, but the team down there has been really stellar in growth and margin performance and really just doing a fantastic job. We tell them all the time when we're in our meetings that we're so impressed with what they've been able to do. It's pretty much been broad-based performance across the Latin America businesses. There's a lot of filtration business in Latin America, a lot of Motion Systems business in Latin America, but they do touch really all of the verticals that we play in. So I'd say broad-based.

Sorry, on EMEA, down 8%?

I'm sorry, what was that, Jamie?

Sorry, the EMEA order is down 8%, EMEA?

EMEA has just been a really challenging environment. It's across the board there. It's been in a negative environment for a while. I think it's a plus that international orders have turned positive. We have yet to see that in our EMEA region. But I will tell you, the team, again, is doing everything they can to be ready for a recovery and to do that in the most cost-efficient managed possible. They continue to be able to eke out margin improvement despite the top line pressure.

Yes. Jamie, I would just add on to that, that I would consider a broad-based, implant transportation, off-highway, just really a challenging demand environment there.

Our next question comes from the line of Andrew Obin with Bank of America.

Just a sort of follow-up on Dave's question, I think, a little bit. Industrial businesses are getting more long cycle within your portfolio. So if you look at history, does it take longer versus history now for positive orders to translate to positive sales growth? Should we just thinking different growth algorithm?

Well, it's been 7 quarters and the average was 6. So it's 1 quarter longer than the past, so...

No, no, no. I'm asking historically, you are a longer-cycle business, right? So if you get an order, right, should we dial in growth later than we would like looking at Parker 5, 10 years ago?

Yes.

Yes. I think on the longer cycle businesses, Andrew, that's for sure. I think the real challenge is some of those shorter-cycle businesses are the ones that are under the most pressure right now. So when we see that come back, I wouldn't expect any change in that cadence. But if you look at the mix of the whole company, leaning more longer cycle for us, that means a little bit longer translation into organic growth.

And I guess, I'll ask 2 questions as a follow-up because I think one of you simply can't answer. Any sense when this off-highway OEM destock will end? And then second question, just granularity maybe on aftermarket for aero military versus commercial because that has been a very nice story?

Yes. I think off-highway is going to be challenged for the rest of the calendar year, especially. So that would be my best estimate right now. And you want some color on aero mix? Was that what you asked, Andrew?

Yes, just aftermarket, military versus commercial.

So aftermarket -- well, let me just -- let me go through the sales with you and then just remind you of our guidance. So total aerospace was 14% growth. Commercial OEM was 5%. Defense OEM was 8%. Commercial aftermarket, 21%; defense aftermarket, 25%. So we're continuing to see that strength there as we're waiting for those rate increases to go up. And then also, we just have a really strong defense depot partnerships, which is helping the defense aftermarket.

And then if you look at the outlook, we are raising commercial OEM to mid-single-digit growth. It was previously low single digit. We're raising commercial MRO to high teens growth. It was previously mid-teens. And we're raising defense MRO to high teens growth, previously low double digits. So really just overall great strength here in aerospace continues.

How about that, Andrew, we've got both of them for you.

Our next question comes from the line of Julian Mitchell with Barclays.

Maybe just my first question around trying to understand in the industrial businesses, the sort of difference between North America and international. So if we look at the guidance, you've got worse trends in North America organic sales for the year than international. I think the sort of comps are pretty similar in terms of the 2024 performance. And I think in general, people would say there's been a better tone or customer sentiment or what have you among U.S.-based distributors at least in the last month or 2. So just trying to understand why there is that worse outlook in North America. Is it -- because you talked about the HVAC and A&D strength on Slide 8, which I think would help North America at least as much as international. So is it just perhaps the greater weighting of North America to off-highway and transport that's really hurting it, and that's offsetting whatever better domestic distributor sentiment there is?

I think you nailed it. Yes, I think that's exactly it. It's the greater weighting of the industrial business in North America.

Yes. The other thing, Julian, you got to go back a couple of quarters here, but international decline started before the North America decline. So a little bit of this is year-over-year comparisons. It feels like international started a quarter or 2 before...

A quarter before...

North America got negative. So I think a little bit of that is just comps.

Understood. And then just a quick follow-up on the aerospace outlook. I think you mentioned that because of that very difficult comp that the fourth quarter Aerospace organic sales are up around mid-single digits. I guess when we're thinking about the modeling of that, is it really that military side of things where you may be flattish exiting the year and then you have another sort of quarter of very tough comps and then you kind of pull out of that at the end of the calendar year on the military side.

I don't think it's just military. It's just an overall tough comp because of how strong Q4 was last year. I wouldn't call out anything specific in military.

Yes. I think we are expecting just a gradual recovery on commercial OEM. That might be some of it, if you're modeling, Julian.

Our next question comes from the line of Nigel Coe with Wolfe Research.

I'm going to portray my [ picture ] here, a little bit. Just curious, why would HVAC and semi be considered long-cycle orders? Because I think most of us would consider those to be pretty short-cycle book and ship types of end markets. So just curious why they're long cycle. And then maybe, Jenny, you talked about the recovery pushing to the right, and I think we've all seen that. Obviously, now we've got ISM getting to 50, orders have turned positive. So it seems like the recovery is forming. But just curious what you're hearing from some of your customers, major customers, distribution partners, et cetera. How is the tone in the field right now?

The tone with distribution is very positive. They're ready for the recovery, and they're expecting the recovery. So they've been bullish for several quarters now. So no change there. If anything, I think as more time goes by, they know it's coming and they're making sure that they're ready for it. And the first part of your question again?

Yes...

Why are we considering those? Julian, first of all, we get the visibility from an order standpoint from -- in those areas. We get that long demand horizon. But these both follow the secular trends that you hear us talk about. And we consider that longer cycle.

Got it. Okay. And then just a quick one on SG&A. I mean, outstanding SG&A management. I think on an online basis, SG&A fell from $678 million down to $651 million, so call it 4%, 5% decline there. I know the aero mix is helping there to a degree. But as we recover, just the confidence levels on -- you said [indiscernible] margin, so that's very clear. Just how much of that SG&A reduction is structural versus some temporary cost management and that comes back in on the recovery?

Yes. Nigel, we've always been very focused and frugal when it comes to SG&A. If I had to make a guess, I'd say almost all of it is structural. There will be an increase in aerospace R&D -- but that's going to be a ways off, and that's going to depend on new programs coming. So we don't see that in the near term. That's not in our guide for the rest of this fiscal year. But I don't think you'll see us have a step-up in SG&A costs.

Our next question comes from the line of Joe O'Dea with Wells Fargo.

Along similar lines to some of the other questions, just trying to think through kind of typical cycle relationships and looking at the order chart on Slide 7. And I think over the past couple of quarters, you've expressed confidence that the destock headwinds are really done, and that's played out. And so now we start thinking about restock. But when you start to see orders get a little bit better and you think about the distributor tone that's been better, what is that typical lag time between some signs of end market demand are getting better and then that starts to translate to a channel inventory reaction?

I don't know that I have a specific time frame that I can call out for you. I think there's just a lot of our distributors that have gotten really good at controlling their cash and keeping a close eye on their inventory levels. So they're waiting for the orders to hit them. They've all commented that there's been a lot of quoting activity, right? So they're -- that's why I think they're very bullish on the future and expecting the recovery. But we'll just have to wait and see what happens here. As we've already talked about, we're nearing that point where we're going to cross over the average of when this should recover. So we're all going to be ready.

And then last quarter in the deck, you put some details on mega projects in our tracking of that data, we did see some delays from '24 into '25. Right now, it would have a pipeline with some pretty strong activity in 2025 across a number of the verticals that you called out last quarter. But just curious in terms of what you see in conversations you're having, I think general concerns that maybe there's enough nervousness, the stuff continues to push to the right. Anything you're seeing that's starting to sort of pulse that now things are going to start hitting construction and demand tied to that?

No major changes. I mean this is still a growth driver for implant and industrial market, especially. And as you know, there's just been a massive amount out there that's been announced -- we're going to benefit at every stage. In some cases, some examples I've given in the past about where our distributors are quoting business with local and national contractors. There's still some of that going on. But I would say that some of those projects are being delayed. But whenever we might hear about a delay or a cancellation, the number goes up again. So it's still coming. It just hasn't hit yet.

Our next question comes from the line of Nicole DeBlase with Deutsche Bank.

So maybe just one on the 3Q outlook. And again, like I have to commend you guys for continued really strong margin performance. But you are modeling segment margins kind of flattish from 2Q to 3Q. And typically, we do see like a bit of a sequential step-up. So just curious if maybe that's some conservatism baked in. Maybe there's something going on from a mix perspective with aerospace. Anything on that?

You're right. Your math is right, Nicole. I would tell you, 28.2% in Q2 for Aerospace was an all-time record. Obviously, the aftermarket mix was very, very favorable. We do not have that sort of mix in the guide, so that's a little bit of the flattishness is aerospace not expected to be as high. And then the currency impact really is impacting the international side of the business. So we've got slightly lower than Q2 margins forecasted for the international businesses, but that is really volume and currency related. If you look at North America, we're actually expanding margins in Q3 from Q2.

Got it. That's really helpful. And then just -- Understand the commentary around the long-cycle end markets picking up within orders. Did you guys actually see short cycle kind of stabilize? Did it get worse? Just curious about the short-cycle order trend during the quarter.

I would say, it's the same as it has been. So no real change there, Nicole.

Okay. I can't believe this, but we've gotten through the entire queue. I think that might be the first time ever. So this is the conclusion of our FY '25 Q2 earnings release webcast. Jeff Miller, our VP of Investor Relations; and Yan Huo, our Director of Investor Relations, will be available for any follow-ups needed today and tomorrow. And just one last note for everyone on the call. This will be the last time that Yan will be available for follow-ups. We need to congratulate Yan on taking a new role within the company as Group Vice President and Controller for our Motion Systems Group.

So Yan, we thank you for all your great work you've done for the company. We will miss you in the Investor Relations space, but we know you're going to be a wonderful addition to the Motion Systems team. So congrats, Yan.

Great.

Okay. For everyone else on the call, we appreciate your time and your attention. Thank you for joining us today. I hope everyone has a wonderful afternoon. Thank you.

Thank you. This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.