Okay, thanks everyone. We're moving right along here. I think we're the last stop before lunch, so thanks everyone for coming out today. I'm Tim Fine , this is my first conference here. This guy has been with me a number of years. This is the first time for this conference, so hopefully a start of a new tradition. So thank you, Todd, for coming out. Todd Leombruno , CFO of Parker Hannifin. We're going to kick it over to you for maybe a couple slides, and then we'll keep this interactive. So if anyone has questions along the way, just raise your hand and we'll get to you. And with that, over to you, Todd. Thanks again.
Yeah, absolutely. Tim, thanks for having us. It's a pleasure to be here. As Tim said, I'm Todd Leombruno with Parker Hannifin. I just have a few slides to give you an overview of the company. It's great to see so many faces in the room, some very familiar, some brand new, so I'll go really quick here. You know, the company has been a leader in the motion control space for over a hundred years, and if you followed us for any period of time, you could see the company is much different than we've been compared to our history. This year, we will do nearly $20 billion in annual sales, and that will be equally dispersed across our businesses. We now have roughly 31% of our sales exposed to our aerospace end markets in our aerospace segment.
And then if you look at the diversified industrial segment, we break that out into international and North America. You could see roughly 28% outside of North America and 41% within North America. What's been really unique, if you've followed the company over any period of time, is this technology platform mix. Historically, we were probably known more for motion systems and flow and process control. You could see today that's 40% of the company. But 60% of the company today is levered towards aerospace end markets and filtration and engineering materials end markets. Those are things like sealing, shielding, thermal management, vibration control. And all of these things at the bottom of the slide kind of tie what makes us special. And I have another slide on that, so I'll talk about that in a second.
When you look at what our end markets are, the aerospace and defense markets are a little bit bigger than our aerospace segment. We have anywhere from 3% to 5% of aerospace exposure in our industrial businesses. Those would be technologies like engineering materials and filtration across that. But the next biggest end market we have is 20%. That's in plant and industrial equipment. And then you can see it rounds out 15% transportation, 15% off-highway, energy, HVAC make up the tail end of it. What is really unique about the company is the fact that the technologies that are within the company really spread across all of these end markets. So we are not an aerospace company and an industrial company. We are a motion control company that has technologies. This would be hydraulics, pneumatics, electromechanical, filtration, sealing, shielding, fluid conveyance, instrumentation, thermal management.
Those apply across all of these end markets that we have exposure to. We think it's really important for our customers. Two-thirds of our revenue, two-thirds of our sales comes from customers that buy four or more of those technologies that I just listed out, and what's really special now is our growth is very much levered towards aerospace growth and towards some other secular trends like electrification, clean tech, digitization, and really kind of all tied together by this massive investment in mega-capex projects , so we feel really good about our growth profile looking to the future. What really differentiates us and makes us win, first of all, it's our strategy. We call it the Win Strategy. It was simply based on the fact that every day when you get up and go to work, you'd like to know whether you're winning or losing.
And that's kind of how we name the strategy to make it the Win Strategy. It overrides all of our businesses. It is really focused on our people. It's focused on safety. It's focused on engagement and really serving our customer. We are fiercely decentralized in nature. We have 85 businesses within the company. We have a leader for each one of those businesses, a full P&L for each one of those businesses. They have segmentations underneath those 85 P&Ls. But the thought is that we want as many of our 60,000 people as possible every day to know how their actions are impacting a financial statement. And that's been really special for us. Our products are all engineered products. They're not commodity products. There's engineering or IP wrapped around every one of these products.
We have focused on making sure we develop products that our customers are looking for, right? We don't develop products and then try to go sell them. We really try to apply our technologies to applications that make our customers' end products better. Application engineering is one of the big technical expertises across the company. It bleeds into our distribution network, which is second to none in our space. 50% of our sales goes through this independent distribution network. We love that channel because it gets our reach further out than what our operations and team members can cover, and it's also a higher profitability margin channel, and I already said this before, but what makes it special is the fact that we have the entire breadth of technologies that's required to be a full motion control company, and that's meaningful for the way the business operates.
If you look at our performance over the last three years, this is just the last three years. This reaches into our FY25, which we're halfway through. So this does have two months of guidance that we have on here. We've been able to grow sales at an 8% CAGR, and our margin expansion story continues. So this is just over the last three years, 350 basis points of adjusted segment operating margin expansion. And what I really love about this is the earnings per share and the free cash flow CAGR, 13%, far greater than our growth in sales. And it's really just using every tool in that Win Strategy to continuously improve our business every day, every week, every month, every quarter. And that's given us a nice track record that the company is very proud of.
But I would tell you that we're not complacent, and we know that we have the ability to make this continue, and that's really where we're focused on. So this is the future. This is our near-term targets here. This is out to FY25. We just announced this last May. We're off to a great start. The toughest one on this page is clearly the 4% to 6% organic growth, right? That is one of the targets that we still, we've set a high bar for ourselves, and we still have to prove it to you. There's a number of initiatives and tools within the company, along with some of those secular trends that I mentioned, that will help us get there. But what we did was we increased all of our margin targets, our segment operating margin targets, our EBITDA margin targets, and our free cash flow conversion targets.
Of course, we're going to continue to grow earnings per share at a 10% plus clip into the future. I will say this as my last slide. The company's never been bigger. We've never been more profitable. We've never been more aligned. We're looking forward to the future. Tim, I'll leave it to you or anyone else in the room that's got questions, and we could talk about Parker more in depth.
That the margin discussion shortchanges the journey the company has been on. I can remember
Yeah.
Picking up Parker back in the Stone Ages, and I think your expectation or the target was, I think, 12%, and now you're talking 27%.
Correct. Yeah, we've definitely had a step change when it comes to margin expansion, and I think it's, you know, we've talked about this a lot. A lot of people ask questions about that. It has really been a structural change, but also a cultural change within the company. We used to have more aspirational margin targets, and now we've raised the margin target, I think, four times in the last seven years, so it's been a great journey to be a part of, and it's been really rewarding to watch it happen across the company.
You touched on one of the enablers to the margin improvement or the margin profile that the company has is distribution.
Yes.
But I think from the outside, people hear distribution and they, I don't know, sometimes I think that's kind of overlooked in terms of, walk us through what does a typical Parker distributor look like?
That's great.
What are the dynamics? We can go from there.
It's a great question. It's been a very important element of our success. When I'm talking about our distribution network, I'm really talking about the industrial side of the business. That's roughly 70% of the company today, as you saw. 50% of our sales in the industrial segment goes through the independent distribution network. So these are not just outlets that are holding our product. This is really an extension of our engineering expertise. So what we love about these distributors is they're entrepreneurial. We do not own them. Because we have such a broad offering in the motion control space, we make up a tremendous amount of their bill of material. So there is little to no competitive pressure from our technologies within our distribution network. They are very independent. They don't have to have multiple providers of product.
They are basically selling Parker Hannifin product and then some other ancillary things that are needed in the various end markets that are not in our portfolio. We love that channel because it's 10-15 gross margin points higher than our direct OEM business. It is very diverse, and it is global in nature. We've been at this for decades, you know, over 70 years we've started with the distribution network. We've been really expanding it internationally. We set a pretty aggressive target to expand 100 basis points a year, distribution versus OEM mix outside of North America, and we're now in our ninth year of doing that. It still is not to the weighting that we see in North America. North America is greater than 50%. International is left, and it bounces together, becomes 50%.
But it really is a key competitive advantage for us, something that sets us apart from the competition.
And the typical distributor sale, is a lot of it should investors think about like kind of break-fix activity? Is it?
It's a combination, yeah, it's a combination of repair work across all of our end markets. Many of these distributors focus on end markets that are important to them in their regions. A lot of these mega-capex projects are being supported by the distribution network. But they also cater to small regional OEMs, maybe OEMs that need more attention than what we can give them from a size and scale standpoint. And I would tell you, we work hand in hand. We have a team that supports the distribution network. The distribution network has their own team of application engineers and account managers, and it just works out to be a really nice partnership.
Yeah. Where are we in terms of from a stocking levels, if you think about distributor network overall, are they, is that kind of, how do you think about that kind of complementing or working against the cycle?
Sure. Yeah, it's a great question. Being half of the industrial business, it's clearly meaningful for the business. Our orders in our industrial business have been negative for six quarters. Just last quarter was the first quarter that they turned positive. So a lot of destocking did occur throughout that channel. We believe that that destocking has run its course. We don't expect any more destocking in the distribution network. But we haven't seen restocking occur. So that is yet to come. We think we're very, very close to that. The sentiment across that channel is extremely positive right now. It just has not materialized into order activity. The orders that we did report just last quarter were positive.
A lot of that was in what we would consider our longer cycle business, some of those aerospace end markets that are in our industrial business, some HVAC business, and some semiconductor business is what really drove the majority of those orders turning positive. But we're feeling like the destocking is done, and we're just waiting for a few more signs to have that turn positive across the distribution network.
Maybe we can talk about pricing, and you hit on the Win Strategy earlier, but strategic pricing has been, I think, kind of an element of going back to the first Win Strategy.
Yeah, it really has. It really has. You know, what we learned decades ago is that because of the value that our products are bringing our customer, instead of basing price based on cost and putting some kind of markup on top of that, we really develop tools to say, what value are we bringing to the customer? And quite honestly, what's the next best alternative, right? If it's not a Parker Hannifin solution, what is the customer's next best option to that? And we basically build price based on what we're saving the customer. And all of these products are making the customer's end product perform better, whether that's more efficiently, whether that's less emissions, whether that's lighter weight, whether that's higher power density, you name it. Whatever the challenge is that the customer needs, our engineers apply the product to those demands. And that brings value to the customer.
And that's really how we base price. I mentioned on that one slide that we're fiercely decentralized. So we have as many people as possible looking at P&Ls every day. So they know what the input costs are. They know what the output costs are. We do owe it to ourselves to generate productivity every year, right? So that is part of our lean system. That's part of our productivity metrics. That's part of our automation processes. But when something abnormal occurs, whether it's inflationary periods, whether it's tariffs, our feeling is that we owe it to our shareholders to make sure that we remain margin neutral when it comes to those things that are abnormal and outside of the company's control. So pricing is a function within Parker. It sits at the table at our executive leadership meetings.
We have an organization that we've built over decades, and I would put that as world-class when it comes to data analysis, tools, and bringing value to the organization.
You hit on one word that I'm sure no one has asked you today, but.
Tariffs.
On the eve of Tariff Tuesday, what's the latest there?
Well, listen, it is certainly creating a lot of noise across the organization. It's a lot of work. It's not a surprise to us. We, like everyone here, has been following the elections. We knew that this was coming. We've been through it before. And I don't think you've ever heard us say, if you go back to any transcript, we never would have used any inflationary pressures or tariffs to be a reason why we did not perform as we had committed to. So the team is working hard on this. There's a lot of analysis going on to it. We do not expect this to be material at all for the corporation. One of the things that is also important about us is we've grown internationally over time as our customers became more global.
We've always felt that it's important to serve and service those products in a local way. So in the local region, in the local customs, in the local language, in the local currencies. So we never really, labor is a small piece of our cost of goods. So we never really chased low-cost labor around the world as certain regions became in vogue. That's a lot of words there, but we're really in the region for the region. So I will tell you, in China, we're in China for China. We're not making product in China, putting it on planes, boats, and trains, and getting that anywhere around the world where the end demand is. We actually make it in the region for the region. So it makes tariffs a smaller piece for us. It also helps with currency hedges with all the volatility of currencies. But if there is an impact to us, we will make sure that does not have a drag on margins.
I'll pause to see if anyone has any questions. Okay, maybe shift just to the demand outlook and just what your conversations with customers and distributors. Maybe start with your largest market, aerospace.
Aerospace is, you know, all things are positive in aerospace. We are now two and a half years of double-digit organic growth in aerospace. We expect the growth trend to continue. We do not expect it to continue at double digits just because we're lapping some really tough comparisons, but we do expect aerospace for the rest of our fiscal year and really for the foreseeable future to grow at high single digits from an organic growth standpoint. The aftermarket is extremely strong in aerospace. You know, mid-teens is what we're forecasting for both OEM and, or I should say, commercial and military aftermarket business. We are forecasting a gradual recovery in the OEM commercial markets and defense. We expect to continue based on demand around the world.
To the extent that aftermarket is the airframe customers, if you've struggled with driving rate increases, it's obviously benefiting companies like Parker. How should investors think about if and when we do get to that more normalized mix between OEM and aftermarket?
Yeah, I mean, Meggitt brought a significant amount of aftermarket to the company. I think it was over 900 basis points of aftermarket mix. So it's been a meaningful addition to the company. Today, it's over 50 in aerospace. That is at really all-time highs. We do not expect it to continue at that level, and mainly because as the OEM ramps continue to increase, there will be an offset. But there's still such a backlog of planes that need to be delivered. The air traffic demand still really continues. We expect it to be robust for the foreseeable future, to be honest.
Can you talk about, on the military side, some of the work you've done from these public?
Well, absolutely. Military is about 35% of the aerospace business. So of the 31% of the company, aerospace is about a third of that. So again, we're on basically every platform that's important. There is a nice mix between OEM and aftermarket businesses. But these public-private partnerships have been a nice growth vehicle for the company. One of the things we're doing with the Meggitt integration now is combining our aftermarket facing our unit that faces customers, combining that with the Parker unit going to market as Parker Aerospace as one. And that is an unbelievable organization. When you look at that, it's 50% of our aerospace business. So it's 50% of a $6 billion-plus business within the company that now is operating around the clock, serving customers around the globe. So there's lots of opportunity that we see in that space as well.
From a, you mentioned Meggitt, obviously the largest deal in Parker history. Where are we in terms of it operated quite a bit differently and just in terms of how that company grew up and was formed relative to how Parker runs?
Yeah.
Where are you in terms of?
It's been a great addition to the company. We couldn't be happier with the performance that we're seeing out of those teams. I would tell you today, you know, it's now coming up on the third year of having Meggitt in the portfolio. They are performing better than they ever have. Part of that has been using the Win Strategy to improve their businesses. But we have made those businesses look and act like a Parker division. So there are weekly cadences. There's no longer a biannual update and a year-end, right? They are reporting out their results every week, just like we do across all of our businesses. And it's really rewarding to see that. I will tell you today, to this day, there is still the people running those Meggitt businesses are Meggitt team members. We didn't put some Parker Hannifin person in there to run those businesses.
We integrated them with a cross-functional team of Parker teammates and Meggitt teammates. They are part of our aerospace group. They operate under that umbrella, and they're really doing an unbelievable job. The majority of the heavy lifting is done on an integration standpoint. I had mentioned earlier, we're working through the customer-facing aftermarket piece of that, and that has been rewarding and continuous. We couldn't be happier that we got the Meggitt transaction done.
Maybe just from the standpoint of the broader kind of industrial economy, you guys are as much of a bellwether as any in terms of just touching so many different verticals. In the many years of you doing this and seeing how markets kind of develop, how does this one look? And how do you see, as you look across your key verticals, you know, that your traditional mobile customers obviously in some not great spot?
Correct, yeah. Well, it's a great point. The company has got a much different portfolio than we did years ago. On the industrial side of the business, some of those same customers are still very important to us. The end markets like construction equipment and ag, we're calling them off-highway, are still very much depressed. We do believe that the majority of the destocking has worked its way through those channels, not done totally yet. The sentiment has been very positive, both from the OEMs and I already mentioned the distribution network. We were really happy to see the orders turn positive. I think we need another quarter or two before we feel really more bullish on the recovery. The one thing I'll note is we've looked at this for decades.
Usually when our orders turn negative, in the worst times, they stay negative for six to seven quarters, averages six quarters. So we've gone through that six-quarter period. The one difference this time is that the downturn has been much less steep. So historically, when we would go that long, there would be a big bottoming out. And part of that is the portfolio. Part of that are the secular trends that we've talked about. And then part of that is just the demands of what's going on across the businesses right now. So I think we're through it. We are being very prudent when it comes to monitoring that. But sitting here today, I think we're closer to the beginning of the recovery than even the middle of the downturn. So it feels good.
Got it. In terms of capital deployment, obviously M&A has become a bigger and bigger part of the Parker story. What are you seeing just in terms of post-election? Are you starting to see maybe signs that more properties coming up?
Yeah, you know, so I'll just broadly talk about capital allocation. We have an unbelievable dividend record. We have a goal that goes back decades of paying out more dividends, dollars every year. We're going to continue that record. All the things that we've done in the Win Strategy from a lean and simplification process has allowed us to invest both maintenance and growth in the company from a CapEx standpoint to be around 2% of sales. We have a little bit of a share buyback that we're just using to offset dilution from equity programs. And then we have a whole bunch of options left with our excess free cash flow. The company today is going to burn off, generate over $3 billion of free cash flow a year. After we did the Meggitt transaction, we made some big commitments to deliver.
We say that we'd like to operate in a 2.0 net debt to adjusted EBITDA space. Today, we are below that. We're at 1.7. We spiked all the way up to 3.6 when we did the Meggitt deal, but we reduced that to below 2 in seven quarters. So it was really impressive to get to that point. Our preference is 100% of what's left would go towards M&A. But I would tell you that we're not under any pressure to do a deal just because the balance sheet says we can do one. What has made these transactions successful has been the fact that there's a technology that fits within the company that helps us broaden our offering to our end customers. It's got to be in end markets that we're familiar with. We don't want to stretch into something that is not a Parker Hannifin end market.
Quite honestly, it's got to help us grow differently. It's got to help us expand margins. It's got to help us generate those track records of earnings per share and free cash flow, CAGR growth. And that's all important to us. And it's got to fit within our financial model to be accretive to EPS and also generate ROIC that's attractive to us. So that relationship never stops. Some of these relationships last for years. Meggitt was a company that we've partnered with and monitored for 10 years. And we finally got to yes. So I would tell you that's every person that's running a business within the company, it is their job to know who they're competing with, who they are partnering with, who has a portfolio that leverages one of those secular trends that I mentioned, and making sure that there's a relationship there.
We know that this is a competitive process. We know that usually the highest bidder wins when it gets to a competitive process. But if we have a relationship that goes back for years, we find that more often than not, we become the best home for those businesses. And that's what the company continues to do, continues to work on that. So the strategy has not changed. It's the same as it's always been. And we're ready to do a deal or a series of deals if we can get to yes. That's the toughest thing to do is predict timing on those things. What we have said is we're going to be active when it comes to capital deployment. We have an unbelievably strong balance sheet. We are uber confident in our ability to generate cash in good times and bad.
All of those numbers that I flashed up on the screen were done under the backdrop of fairly soft industrial demand. The company's never been more aligned and more focused on that. We feel good about that.
Within the aerospace vertical itself, do you think are there holes in the portfolio still?
There's always things to add, right? We have sized the market that we play in at $145 billion market size. We're $20 billion today. So there's $125 billion of opportunity out there. Not all of those are actionable, of course, and some of those take years to get to a yes. But we have not run out of opportunity within that space. Another example would be Lord brought a nice adjacency to the company with structural adhesives that expanded our addressable market. And that's been a nice addition to us. But it's been with customers and applications that we're very familiar with.
Got it. Maybe just from a high level, there was a lot of kind of post-election optimism in North America. You saw it in some of the business surveys, and time has gone on, and it seems like a lot of that's kind of sputtered. So I'm just curious from your lens as a CFO, as you think about kind of the regulatory and the environment that we're in and all the uncertainties, is it giving you more pause to say, you know, maybe we wait to see what happens with tariffs or taxes?
You know, I think we are very confident in our strategy. We're very confident in the portfolio of the company. I think we've proven over a long period of time that we do best managing on things that we can control. We ask our, you know, we're a global company, 60,000 team members all around the world. We often ask people to rise up over the political noise and focus on the customer, focus on our team members, keeping ourselves and our team members safe. And that has really worked for us. So that's really what we're continuing to do. I can't say that we're pausing anything based on anything that's come out of the election. We do feel positive that there's positive sentiment out there. I know that hasn't converted yet into a shippable backlog for orders, even though our backlogs are at all-time highs.
But we feel pretty good about what the future holds for us. So that's what we tell our team, focus on what you can do. We've got those FY29 targets. Those are cascaded across every one of our businesses. And what's nice about that is those targets are not volume-driven. So we believe that our team should be able to achieve those no matter what happens on the top line. Any more questions for the room? Thanks for your attention.
Great stuff. Thank you, everyone.