Good day, and thank you for standing by. Welcome to the Parker-Hannifin Fiscal 2021 Fourth Quarter and Full Year 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. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Parker's Chief Financial Officer, Todd Leombruno.

Thank you, Dawn. And good morning, everyone. Thanks for joining our FY '21 Q4 earnings release webcast. As Dawn said, this is Todd Leombruno, Chief Financial Officer speaking. I'm here today with Tom Williams, our Chairman and Chief Executive Officer; and Lee Banks, our President and Chief Operating Officer. If you could focus on slide two, this is the company's safe harbor disclosure statement addressing forward-looking statements and non-GAAP financial measures. Reconciliations for any non-GAAP measures are included in today's materials. Those reconciliations and our presentation are accessible under the Investors section at parker.com and will remain available for one year. As usual, we'll start today with Tom providing some highlights for the quarter and our record fiscal year, as well as some color on Parker's transformation. Following Tom's comments, I'll provide a brief financial summary and some details on our FY '22 guidance that we just released this morning. I'll then hand it back to Tom for closing comments. And then Tom, Lee, and I will open the lines for Q&A. And just one reminder, in respect to the announcement we made Monday concerning the Meggitt acquisition, we are still down by the requirement of the UK takeover code. With that, I'll ask you to move to slide three, and I'll hand it off to Tom.

Thank you, Todd. Good morning, everybody. Thanks for joining us today. This marks the end of FY '21 for us, and it was a difficult year personally and professionally for everybody due to COVID, but it was a year where the Parker team really shined. We delivered outstanding results and lived up to our purpose in enabling a better tomorrow, and my thanks goes out to the global team for just a great year, great quarter. So let's start with the quarter. It was dynamite. Top quartile safety performance, 29% reduction in reportable incidents. The sales growth in the quarter was approximately 25%. Organic was almost 22% and the industrial portion of the company grew at almost 27% in the quarter. We have six all-time quarterly records, sales, net income, EPS, segment margins for total Parker, as well as North America and international. The EBITDA margins were very strong at 21.8% as reported or 22.1% adjusted, that was a 190 basis points improvement versus prior. On the segment operating margin, on an adjusted basis, if you go to that last row, 22.2% or a 230 basis point improvement versus prior. Just a great quarter and a really great team effort by everybody around the world. Go to slide four, we'll move to the full year. It was a year of records, and I won't read all of these to you, but you can see eight all-time fiscal year records. And just - that's in the history of the company, so that's 104 years to put up a record. So it speaks to how well the team performed in this last fiscal year. Sales growth came in almost 5% year-over-year. Organic was flat, but clear momentum building on orders and organic growth in the second half of the year, as you see from our order rates. FY '23 margin targets, we hit them at full two years early, and we'll be announcing new targets once we have Investor Day, March of next year, and we're going to go out for a new five-year target, so we'll be going out to FY '26. We look forward to a discussion at that time. Operating cash flow was $2.6 billion, a record, that was almost 18% of sales. Free cash flow conversion rate was 135%. And we were very pleased to be able to announce the offer to acquire Meggitt Plc, which greatly enhances our aerospace portfolio, and I'll touch on that briefly here in a few minutes. So if you go to slide five, I want to talk about the transformation of the company, give you a little bit of color behind what's driving it and the progress we're making on the results. And slide six speaks to those three drivers, living up to our purpose, being great generators and deployers of cash; and being a top quartile performer. I'm going to touch on each one of these over the next several slides. When it comes to purpose, enabling engineering breakthroughs that lead to a better tomorrow. This is something that really resonates with our people. It represents a higher calling to your work, and it acts as our North Star. In the next few slides, I'm going to talk about and highlight our purpose in action, specifically our technologies and how they're helping health care and how they're helping the climate and create a more clean technology world for everybody. So on slide eight, we're going to talk about vaccine production, in particular, something that's obviously very pertinent for today, COVID-19 production. On the left-hand side speaks to the challenges that drug manufacturers have today. This is a batch process typically with extensive inventories, long lead times to produce these products. They take huge space requirements, large footprints for storage, large footprints with the manufacturing processes, and very difficult changeovers. The cleaning cycles between the batch processes is very complicated. So the idea here is a simple concept that most of us can relate to. All those have been in some kind of a restaurant with a soda fountain, where you can pick your beverage of choice. And of course, the technology behind that is a concentrated syrup and carbonated water, and you get to pick the soft drink of your choice. So the idea here, instead of soft drinks, could we deliver sterile vaccine ingredients with a similar type of process? And slide nine is that process. So that's our inline dilution system. It's a proprietary point-of-use process for combining the purified vaccine ingredients. So if you look at that piece of equipment, you can see it's on wheels, so it's modular, easy to move around, easy to deploy. As mixing and sensing combined, it has two-way communications via the IoT-enabled, so it can talk to the manufacturer's enterprise system to enable scheduling just in time. It uses, very importantly, intellectual property-protected single-use consumables. So instead of these massive batch processes and huge cleaning events for changeovers, this is a significant productivity improvement for the drug manufacturers on the speed of the change, but also just reduces contamination tied to the changeover. Then our software and automation helps control the amount and the flow of these various ingredients. So this applies obviously to COVID-19 and applies to other vaccines being developed, and we can use this for other drugs as well. So this is a really attractive business opportunity for us. But more importantly, it's a great help to customers and society—a great example of our purpose in action. Move to slide 10, move to the climate and the clean technology portion of our purpose. We just recently announced last month new sustainability targets. You see on the right side of this page is our new sustainability report, which you can reach electronically, where we announced a 50% reduction in emissions by 2030. So that would be Scope 1 and 2 emissions, direct and indirect. And by 2040, same things go pointing to be carbon neutral. So enabling a more sustainable future with what we do with our plants, our operations, our supply chain. But in addition, if you go to slide 11, and actually, more importantly, how can we help our customers? Like how can we help society with the sustainability journey? And so on this page, you see the eight motion control technologies across the top, and this portfolio, approximately two thirds of this portfolio is very much part of the enabling of clean technologies for our customers. The exciting part is an expanding bill of material on automobiles, construction equipment, on forestry and mining, basically almost every piece of equipment on airplanes, engines, everything is feeling this impact for more electric applications. So there's onboard opportunities, but there's also infrastructure opportunities as the world has to build in infrastructure to support that growth. Our technologies can help with that infrastructure move. And then I want to move to slide 12, which illustrates the top quartile performance portion of those three drivers. And you can see we're using two metrics to illustrate this, adjusted EPS on the left and adjusted EBITDA margin on the right. It's really been our people, the strategic portfolio changes we made, the capital deployment decisions that we made over the last seven years and The Win Strategy that's transformative of this performance. And when you step back and look at this, this is just a remarkable improvement. On the left is a more than doubling of our EPS. And that's hard to do. I can assure you that's really hard to do. This is fantastic progress, a little less than $7 in FY '16 and over $15 as we closed last year. And the EBITDA margin, which has clearly been propelling that from 14.7% to 21.3%, so a 660 basis point improvement there. And then the last part on transformation and the drivers is cash generation and deployment. We touched on the cash generation piece in my opening comments, but clearly, in the deployment is how to deploy capital and buying effective companies. And we're very excited to put two high-quality companies together, an aerospace combination that we announced Monday, Parker with Meggitt nearly doubles the size of our Aerospace Systems segment with highly complementary technologies, 70% sole source, strong recurring revenue, excellent growth potential combination of commercial aerospace recovery, as well as the synergies, and this will be accretive to our organic sales growth margins, EPS and cash flow.

Yeah. Thanks, Tom. I guess I would like to direct everyone's attention to slide 15. And I'll just, real quickly, walk through the FY '21 Q4 results. As Tom mentioned earlier, we have some outstanding results to share here. Sales increased over 25% in Q4 versus prior year and finished at $3.9 billion. As we said, that's an all-time record for the company. And we're really particularly proud of this due to the fact that our aerospace markets are still challenged. It really demonstrates the strength of the portfolio additions that we've spoken about, CLARCOR, LORD & Exotic, and really is driven by strong broad-based demand across all of our industrial businesses. Organic sales are up 22% in the quarter. So basically, the majority of that 25% change is all organic. This is the first time organic sales have been positive for the company in over two years. Currency also was favorable with a 3.5% impact to total sales. Moving to adjusted segment margins. That 22.2% is an improvement, like Tom said, a 230 basis points from prior year, and it's also 80 basis points improved sequentially from Q3. Just another strong quarter of margin performance, as really our teams around the world pivoted to the increased demand levels and managed through a number of challenges, very proud of our team for that margin performance. Incrementals are also commendable at 31% year-over-year, really impressive considering last year with the depth of the pandemic. And our decrementals last year were fantastic at minus 13%. And if you remember, that included approximately $175 million of temporary savings in that FY '20 Q4. So we're really happy with the 31% incrementals. EBITDA margins also expanded 190 basis points from prior year, finishing the quarter at 22.1%. If you look at that net income number, $577 million, that's an ROS of 14.6%, and that's an increase of nearly 50% from prior year. All of those great results translated to an adjusted EPS of $4.38. That's an increase of $1.39 per share or 46% compared to the prior year number on this slide of $2.99. Just one point I want to reference to the prior year numbers, and I'm really speaking to net income and the EPS numbers only. We have been planning for some time to convert our remaining US locations that used to use LIFO for inventory evaluation to standardize that across the company and move to FIFO inventory valuation purposes. We made that voluntary change in FY '21 Q4, and we've retrospectively applied that change to prior years, and we've attached the impact of those prior years to this press release in the table section. So the impact to the previously reported quarter last year was minimal. It was only $0.04 last year. So the $2.99 on this page, if you're looking back to prior year, that would have been $3.03. So just one other note I want to make, LIFO, we've always booked this at the corporate level. This has no impact to our segment operating margins or the incrementals that I just mentioned to and now 100% of the company's inventory is valued using the FIFO method. So just one last comment on the quarter. Really proud of our team globally. It's just a tremendous effort the team put forth to put up just such a solid quarter to finish really, as Tom said, a record year. So if we can move to slide 16, this is just a bridge of that $1.39 increase to adjusted EPS that I just mentioned, and what I love here is the largest bar on the page, signals the strong operating performance that the teams put together. Our segment operating income on an adjusted basis increased $250 million or 40% from prior year Q4. That accounts to $1.50 of the increase in EPS that we just put up for the quarter of $1.39, so it's really strong execution really everywhere across the company. All the other items you see on the slide, if you net it, it's $0.11 unfavorable. Corporate G&A, income tax and shares were slightly unfavorable, but lower interest and lower other expense partially offset the impact there. So again, most of this is really fantastic due to comparing back to our COVID-impacted quarter of the prior year. If you go to slide 17, just some color on our segment performance. Really, the message here is our industrial businesses delivered outstanding results across the board. We've spoken in the past about the impact of these portfolio changes have had on the company, and you can see it here in these margin numbers. Diversified North America sales were $1.8 billion in the quarter. Organic sales improved again in this segment sequentially up and are up 26% versus prior year. Operating margins improved an impressive 300 basis points versus prior year and really finished at 22.5% for the quarter. Obviously, volume helped us a little bit there, but really the disciplined operating performance and cost control really continue to drive the sizable increase to margins. Margins in this segment are a record, all-time record. And incrementals were also were very healthy at 34%. And again, I keep referencing the comparables back to last year, which is just a very tough comparison. If you look at order rates, order rates are robust at plus 56%. This is up sequentially from last quarter where we reported plus 11% and really just strong across the board. If I move to the International, Diversified International segment, really same story here, a little bit higher organic growth of 20.5% And sales just reached $1.5 billion in that segment. And again, another story here, adjusted segment operating margins expanded 300 basis points versus prior year and finished at 22.1% in the International segment. Just really, again, strong organic growth in that volume, coupled with that cost containment and productivity initiatives really generated this record margin performance in this segment as well. Order rates again here, tremendous, up a little bit higher than North America at plus 58% versus 14% positive in the last quarter. So really just a great performance out of our industrial businesses. I'll just touch on Aerospace Systems, really slightly. Very sound performance in the current market. Sales here were $630 million for the quarter. And I'm happy to report organic sales have turned positive in this segment; they are up 1%. We saw strength in commercial and military aftermarkets with strong sequential growth again in Q4 and we're happy to start seeing rate increases from OEMs, particularly in the narrow body and business jet platforms. Aerospace orders also got less negative and improved to minus 7% this quarter on a rolling 12 basis versus minus 19% last quarter and further proof that we are seeing signs of recovery in this area. Operating margins also very strong, 21.6% that improved sequentially from Q3 and really finished the year at the highest level they've had in the entire fiscal year. So very proud of our aerospace team there. So just looking at the company as a whole, we're really pleased with these results. It's a solid finish to the fiscal year. Our total incrementals were 31%. I'm really proud about that. And really just a comment, if I look at just our industrial businesses, if I go back to pre-pandemic FY '19 and on a like-for-like basis, if I include LORD in those FY '19 numbers, in the industrial businesses, our sales volume has surpassed pre-COVID levels. So we're really proud about that. Orders, you can see in total are plus 43%. And as Tom mentioned, not only did we achieve our FY '23 margin targets, but we surpassed them, and we did that two years earlier. So if I go to the next slide, slide 18, cash flow. We're obviously very proud of this. Tom mentioned this earlier, full year cash flow from operations was $2.6 billion, that's an all-time record for the company. 17.9% of sales, just outstanding top quartile performance. If you look at that compared to prior year, we generated over $500 million more cash. That's 24% more cash than we did prior year. And like I said, that CFOA at $2.6 billion is a record. Working capital, really solid performance here. And I want to just really thank our teams everywhere around the world for focusing on this. We asked them to focus on this through the pandemic, and they delivered soundly. So I want to thank you all for your focus on that. Free cash flow, also fantastic, at 16.5%. That's up 310 basis points versus prior year, and the free cash flow conversion for the year, 135%. So with that, this now marks the 20th year that free cash flow conversion has been greater than 100% and cash flow from operations has been greater than 10%, 20 years running. All of these allowed us to significantly pay down our serviceable debt. We've been vocal about that for the last couple of months. If you look at the last 20 months, we've paid down $3.4 billion of debt, and our gross debt-to-EBITDA finished the year at 2.1%, net debt is 1.9%. So again, the similar story here, we achieved these leverage levels a full one year sooner than we have originally forecast, and it's just an outstanding cash position. It's top quartile execution and really impressive considering the backdrop of the global pandemic. So 19, I will ask you to focus on 19, just flipping to FY '22 and our guidance. You saw that we released this morning. As usual, we're going to provide this on an as-reported and adjusted basis. And I'll just start at the top. Sales. We're forecasting sales to increase in the range of 5% to 9%, really 7% at the mid-point. And really the breakdown of that sales growth is essentially all organic. We do not expect the Meggitt transaction to close in FY '22. Both LORD and Exotic have anniversary, so those are no longer considered acquisition sales. Therefore, we are forecasting no impact sales from acquisitions. And currency is just a minimal drag at 0.2% of sales. And just like we always do, we have calculated the impact of currency to spot rates at the end of June 30, and we've held those rates steady as we forecast FY '22. One thing I'll note, the sales split for the guide is 48% first half, 52% second half. The next item I'll talk about is segment operating margin. On an as-reported basis, the guidance for the full year is 19.3% at the mid-point, and there's a range of 20 basis points on either side of that. But more importantly, on an adjusted basis, segment operating margin guidance for the full year is 21.6% at the mid-point, same range of 20 basis points on either side of that. This adjusted segment operating margin guide is 50 basis points higher than what we just finished our record FY '21 app. Just some color on adjustments. At a pretax level, business realignment charges are expected to be $35 million for FY '22. LORD cost to achieve are only $7 million for the forecasted year, and acquisition related intangible amortization is $320 million. Just a note on the split, adjusted segment operating margins, 46% first half, 52%, second half. If you look at the corporate G&A interest and other, $480 million is our forecast. That is the same on an adjusted and an as-reported basis. Tax rate, we are forecasting full year to be 23%. And finally, EPS on an as-reported basis, our guidance is $14.48 at the midpoint. There's a $0.40 range on either side of that. And our adjusted EPS guidance is $16.60 at the mid-point, same $0.40 range on either side of that. Adjusted EPS split: first half is 45%, second half is 55%. And a little color on Q1, we are forecasting adjusted EPS to be $3.60 at the mid-point.

Thank you, Todd. Just closing there. So just, you know, what drive these results, the engine on company’s are people, our engage team, great culture, higher levels of ownership driving this performance very strong results as you’ve seen. Living up to our purpose, the vaccine production is a class of chain puller, top quartile performance the more than doubling of EPS, the 660 basis points improvement in EBITDA margin for the last six years, getting the margin targets that we laid out for you two years early. And obviously, we're going to keep improving upon that. And the strategic deployment of capital and change in the portfolio, CLARCOR, LORD, Exotic, and now Meggitt. You put that together with The Win Strategy 2.0 and now 3.0, and it really spells for a bright future, and we'll continue to accelerate this performance. And with that, I'll turn it over to Dawn to open up to Q&A.

Thank you. And your first question comes from the line of Scott Davis with Melius Research.

Hi. Good morning, guys. And congrats on a great year.

Thank you, Scott.

I don't always say that, but I mean it. Guys, you've had a few days for this to marinate the Meggitt deal at least. What's been the customer response and feedback to the announcement?

Scott, it's Tom. We're early days on reaching out to customers. General view is very positive. They like the fact that this is a stronger bill of material opportunity to create more value, the highly complementary technologies and really the track record of both companies. Both companies have a great reputation, great innovators, great engineering-led companies. So the response so far is very positive.

Good to hear. And not to get too nitty-gritty here, but you didn't really talk much about some of the challenges out there on the cost side, supply chain disruptions, logistics, all of that. I mean clearly, with 31% incrementals, it couldn't have been too big of a deal for you guys. But perhaps you could help us understand how you've managed through that? And how are you thinking about that as it relates to guidance over the next 12 months as well?

Hey, Scott. It's Lee. I'll take a shot at answering this. I think the first thing on the supply chain side is just to kind of step back, I recognize how we're structured, which is a huge benefit for the company. So as you know, we make, sell and source in the region for the region. So it allows us to be close to the customers and get away from a lot of international shipments. Having said that, we're not immune to what's going on in any of the regions. But I would characterize it internally as being manageable but not without hard work. Now I would say the biggest challenges we're dealing with is just our customers. So I mean, I think automotive is very public on what's happening. But I probably don't have a large OEM that hasn't had some kind of disruption where lands have been down, people have been sent home, et cetera. So we're working with our customers to work through that. It's just creating a lot of chatter in the channel and it's just, I would say, best is a lot of choppy production.

Yeah. Makes sense. Okay. Thanks, Lee.

I am sorry. Your next question comes from the line of Jamie Cook with Credit Suisse.

Hi, good morning. And nice quarter. I guess just a couple of questions. Can you help us understand the - what you're assuming for organic growth in the first half versus the second half? And what you're assuming sort of price versus volume? And then I guess the aerospace, like the top line guide to me seemed like you know, with what's going on, understanding we have the Delta variant, but there could be some level of conservatism there, as we think about sort of the top line. So if you can just help me understand what your assumptions are on the aerospace guide?

Jamie, it's Tom. I'm going to take the guide, and I'll take a few minutes to describe that. I'll go through the aerospace piece. I'll let Lee touch on the price-cost aspect. So this is probably the question that everybody is on everybody's mind, and how do we come up with the guidance and some of the context behind it. So first of all, there are a number of tailwinds, and I'll highlight some of the headwinds. But on the tailwind side, clearly, the order trends, the macro environment, I think there's a CapEx under-spend that happened for a number of years. So I think there's some CapEx demand that's coming back for manufacturing companies. Clearly, governments being more prone to put in stimuluses, the rebound from the great shutdown and, of course, rebound of activity. The commercial aerospace recovery, which I'll touch on, to answer your question here in a minute, Jamie. Low interest rates and then a climate investment, which with our clean technology portfolio is a very attractive positive for us in the future. On the headwind side is the Delta variant and COVID hasn't gone away and is creating uncertainties throughout the world. The supply chain disruptions in particular, our customers and how that might impact demand patterns, which Lee touched on than inflation, both on the material side and wages. But we've built a pretty sophisticated AI model over the last 18 months. It's not perfect, nothing is when it comes to forecasting. But in my time at the company, it's the best tool we've had to date, and we factored in all this inputs and came up with what the best forecast is. And I’ll give a little more detail behind it. The first half, that we're looking is up a little over 9% organically, and the second half up mid single digit, that’s why you get to 7% overall. And an important part, so if you look at the industrial piece, both North America and industrial approximately the same, up 11% in the first half and up mid single digits in the second half. When you think about aerospace and several of the pre-reports that came out, didn't have the insight that I'm going to share with you right now. So we have aerospace with a gradual recovery, up 3% in the first half, up 5% in the second half, that's where you get the 4% at the mid-point. But what's underneath that and will help give you some context is as to why that number is what it is. On the commercial side, both OEM and MRO, that's going to grow low teens, so nice recovery there. Military MRO is growing mid single digits. What is down is military OEM, it's down mid single digits. And the reason for that, and thankfully, our customers thought as our customers accelerated deliveries last year, we were up 19%, as an example. They did this to protect the supply chain to protect supplier health because a lot of suppliers have commercial exposure, as well as military exposure, and they accelerated the military exposure to help everybody. So this year that we're in now, '22 is a reset of the inventory through that supply chain. So we will be down. And of course, then we'll go back to more normal levels in FY '23. If you would take out that acceleration in the prior period, our FY '22 military OEM would be about a plus three. So then when you add - when you would factor that in, aerospace growth would be more like 8%. So that 4% is being weighted down by the military OEM segment, that reset of inventory. So hopefully, that helps everybody with why the aerospace number is what it is. Just comparing that growth rate to 7% to GIPI, Global Industrial Production Index, that's going to be within our fiscal year '22, that's a 4.8% forecast. And you've heard us talk externally, we want to grow 150 basis points faster than that, so that our number of 7% would do that. Then maybe while I've got kind of talking about guidance, I want to just touch for a second on operating margin, and I'll let Lee comment about price cost.

Yeah. Jamie, I'll just add on, maybe finish up here with price, cost. So at the last earnings call, the question came up, and I talked about how we track all the commodities on quarterly trends and the year-over-year trends. And I said back then, it was a sea of red. In other words, everything was up. And I would tell you here a quarter later, it's still a sea of red. But having said that, we're able to see this coming very well because of the processes we have internally, by measuring what we call our purchase price index and then also maintaining margin neutrality by our selling price index. So we're on top of it. And our goal, as we've always said, is to be margin neutral. We're actively working price both with direct customers and distribution. But there is a lot of inflation in the commodity side right now, no doubt about it.

Okay. Thank you. I appreciate the color.

Thanks, Jamie.

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

Good morning, everyone. Thank you for taking the question. Tom, I guess I'm looking for a little more context from you vis-à-vis industrial order strength, both North America and International. I don't know what your expectations were for the quarter, but I'll tell you, versus ours, these orders were much stronger. And I'm also looking to understand what backlog must look like at this point? Because obviously, your order intake was higher than organic growth. And are there any challenges with regards to converting this backlog to actual revenues either on your side or maybe potentially your customers? So let's start with that, maybe.

So Mig, let me talk about orders. This is Tom. I think just to maybe help clarify things for people. People, you're doing two year stacks, you might say, hey, geez, it seems like the organic growth might be like compared to the two year stack. The one thing that you have to look at is in the current period, we have acquisitions in prior period. We do not have LORD exactly go the way back to '19. When you do apples-to-apples on orders, '19 to '21 and exclude the acquisitions, our industrial orders are up low teens. And I just mentioned, as I was answering to Jamie's question, our forecast for the first half on industrial is low teens at 11% organic growth. So there's a clear correlation between what we're seeing versus '19, again, apples-to-apples on order entry. And that's how we - in addition to AIMO how we laid out the year. The backlogs are increasing. Again, you got to remember that the prior periods has uniquely low comps. It's probably an inflated number that you can't get too excited about. Our on-time delivery is holding up nicely. Obviously, my customs would like to see us do better on that, but it's holding up very well compared to comparable times. And I'd say the impact that we've seen has been more on customer push-outs of schedules, particularly in automotive, where the automobile OEMs are having trouble with chips as everybody knows, and they're taking really targeted shutdowns, and that will push-out our various orders and that impacted North America a little bit in Q4. But as Todd had mentioned, our Q4 sales were up about 10% industrial versus Q4 FY '19. So everything is kind of coalescing between orders and sales when you compare to '19 around that low teens type of growth rate.

Okay. And then I guess I want to follow up on Jamie's question on pricing and trying to see if we can get maybe a more specific answer. When I'm looking at various PPIs of some of the product categories that you guys are involved with, it's pretty common seeing these PPIs somewhere in plus 4%, 4.5% year-over-year. And I'm just sort of wondering if you're seeing a similar level of price increases in your industrial business. And if there are differences at all in terms of OE versus your distributor partners? Thank you.

So I would say it's a range, some lower and some higher. Whether it averages out to that or not, I can't really say. But with our OEM customers, we've got direct contracts with many of them, and what we're benefiting from is a lot of them have material clauses in them. So it allows us to capture that pricing as we go forward. On the distribution side, that's typically just a list price increase. But what you're seeing is kind of our best guess and it's all in the guide right now.

Thank you.

Thanks, Mig.

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

Thanks. Good morning, guys. Can we just - maybe, I know you went through the one-half dynamics, Tom, but can you just narrow that view a little bit to what's baked in to Q1, both with respect to organic growth and incremental margin? Thanks.

Yeah. So Nicole, it's Tom. So first quarter would be up kind of low to mid-teens for Industrials, Aerospace, low single digits; and really our first half from an MROS is going to be in the upper 20s. Again, I would just point to, again, the comparison, if you did apples-to-apples, would still be in that 50% range. So it's really outstanding performance by the operating team being masked by the prior period, all the discretionary cost savings that we had.

Got it. Okay. Thanks, Tom. And then can we just clarify on the change to FIFO accounting in the US? I guess, what was the impetus to do this now? And is there any benefit to the 2022 guidance related to the FIFO change?

Nicole, I'll take that. This is Todd. We've been talking about this internally for quite some time, and it really started with the recent acquisitions, CLARCOR, LORD, and Exotic, those companies always use the FIFO valuation method. We do not use it in our Aerospace business. We really only used it in our traditional US locations. All of our international locations by rule had to use the FIFO valuation method. So we took a look at it and said, hey, maybe this year is an opportunity to convert, and that's essentially what we did. We converted early in the quarter. We worked tirelessly across our teams and with our internal - or excuse me, our external auditors and we felt it was the best time to do it. There really is no impact to the quarter since we converted. We essentially reported the quarter in the FIFO method. We did go back and restate prior years just to show you what the impact was. And I just want to make sure everybody realizes that. If you look at this historically, it's $0.01 or $0.02 per quarter. It's a very immaterial impact. We always book that at corporate, so it had no impact on our segment margins or anywhere incrementals, and it really just now standardizes our inventory valuation across the entire company. So we're happy with the results. In respect to FY '22, there's nothing in the guidance for a benefit for converting to FIFO.

Okay. Thanks for clarifying Todd. I’ll pass it on.

Okay. Thank you.

Your next question comes from the line of Nathan Jones from Stifel.

Good morning, everyone.

Morning.

I wanted to follow up on the MROS comment, Tom. 50% if you'd normalize both years for all of the discrete costs and charges and benefits, which I think is you would normally see a high MROS in the first real year of recovery here, which would then glide back down to something more normalized. Can you talk - but I think the 50 was probably higher than you would normally get in the first year. Can you talk about what you think that MROS kind of progression would be over time? And what a normalized average kind of incremental margin (MROS) would be for you guys?

Yeah. Nathan, it's Tom. And you're right. I think this underlying MROs of 50% for a whole year, and it would be also counting Q4 and probably Q3 of last year, so 18 months will be higher and longer than we normally expect. I think what speaks to the changes from The Win Strategy and the fixed cost changes we made and maybe the efficiencies on top of those changes that came out of the pandemic is just a more efficient way of working. But I think, going forward, especially when we get to FY '23, you won't have these anniversaries to worry about with the discretionary on - you're not in the next year. I think - and I would just use for people modeling, 30%. As we've looked at it in benchmark, that continues to be a best-in-class number. And I think with all the changes we've made, I think that's a good number of you over a cycle to use 30%.

All right. Thanks for that. I want to ask a question on the ESG report that you guys put out the other day. There are clearly some very significant reductions that Parker has made over the last decade or so and some good aggressive targets over the next 10 to 20 years. Can you talk just a little bit about - it's probably a very long answer. Is some of the mechanism that you guys used, some domain initiatives that you're going to use to achieve those goals?

Yeah. So we've been at this already and we've had since 2010 a 44% reduction, I’ve got the report actually – these different time periods 30% since 2010. So we’ve been on this for a while. And it's energy things that we do within the plants, renewables, different lighting, some of this will happen from indirect emissions, as the various utility companies change over to using renewables. We automatically get credit for that as well. We're going to be working with our suppliers on what they can do to reduce it. All the Kaizen work we do or we just utilize the equipment better, smaller footprints, better flow, less distances traveled—all those kind of things helps in this reduction. So we have every group signed up for their - have their prospective greenhouse targets that they're working on. They know exactly where they are, and that gets cascaded down plant by plant. And then we've also envisioned every group having a list of greenhouse gas emissions reductions, all the things they're doing, recycling things they're doing, that's in the way we know how to do. We drive it down in the respective divisions. And then at the group level, we have each group on their technology roadmap, developing their clean technology portfolio and how it needs to change for more EVs or fuel cell EVs or hydrogen, et cetera, and the groups have been actively doing it. The good thing about this is we formed the Motion Technology Center about three years ago, and for people who aren't familiar with it, this was taking the best and brightest that we could between aerospace and our Motion Systems Group. So taking all the motion-related technology of the company, having a center of excellence spread. And in particular, focusing on electrification. And a lot of the technologies that we developed in the '90s on the F-35, so the flight surfaces on the F-35 fighter are electro-hydraulically actuated, and we've taken a lot of those learnings and applied them into the industrial portion of the company and have developed a suite of motors and motor controllers and software that we're offering to the industrial companies, OEMs in particular, where their platform changes as they look more electric. And when you add in acquisitions like LORD on top of the engineered materials applications that we have from legacy Parker, we have a really strong material science portfolio to help with that transformation as well. So our sustainability message is twofold, things we're going to do internally, which we have good line of sight to, and we put out two major targets 2030, 2040, but we're looking for year-over-year things to get there; and then what we're doing to help our customers because our customers at Scope 3, that's us helping our customers, and we'll be all over doing that.

Great. Thanks for taking my questions.

Thanks, Nathan.

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

Thanks. Good morning, everyone.

Good morning, Joe.

Todd, maybe a first question on free cash flow. Clearly, really nice job this year at 16.5% of sales. I guess as you think about the free cash flow margin going forward, should we be thinking that there's going to be a little bit more like a working capital drain going forward, just given that growth is inflecting here on the industrial side?

Well, yeah, absolutely, Joe. There's been a step change in our cash flow performance. And I think everyone has seen that over the last couple of years. It's always a little bit tougher in a growth environment. So we'll be ready for that. I still think there's some opportunity across our enterprise. Some of the recent acquisitions, I think we've got some upside on inventory, and really I think on receivables and payables throughout the last 20 months. So I still think we've got room to grow here. So we're not expecting much of an impact.

Okay, great. Great to hear. And then my one follow up, Tom, obviously, clearly big announcement this week, I am curious, you know, maybe on the flip side of things, are you thinking maybe a little bit more aggressively around like portfolio divesture side, can help with the potential deleveraging from this large acquisition and how you're thinking about divestitures and holistically, that would be helpful.

Yeah, Joe, it's Tom. We look at it all the time, not just when we have a large acquisition, but this is something we have standard workaround that we look at the office of the Chief Executive. So Lee, Todd, and myself, as well as we do it annually with the Board. And I would characterize that I've used this visual for people. I think the portfolio of the company has been very thoughtfully put together. Think of it as a tree trunk with the various branches. Two-thirds of our revenue comes from customers that buy from four or more of the eight technologies we have. So my predecessors and everybody that built this company did a very thoughtful job of putting together interconnected pieces that make sense. So when we do that portfolio analysis, there's very little we see that we'd want to divest. It's something we look at all the time. It doesn’t mean that we wouldn't divest anything. But if you use the tree analogy, it would be a small branch. There's going to be no major trunks that get lopped off. But we look at it all the time, but I wouldn't see any big announcements from those regarding divestitures.

Okay. Thanks for taking my questions.

Appreciate it, Joe.

Your next question comes from the line of Joel Tiss with BMO.

Hey, guys.

Good morning, Joe.

Just a different angle on that last question. Are there any internal actions you guys can take? Or that would really help you to get ready for the Meggitt acquisition? Or that's not how you work?

Well, I would characterize it as - Joel, it's Tom. Those internal actions have been happening every day since I joined the company and every day that everybody else that works here. I mean, we're all about continuous improvement. And I think the slide we showed earlier on the 660 basis points improvement in EBITDA margin is what's positioned us to be able to do a deal of this size. If you think about a couple of things regarding Meggitt, and just using that as an example. The multiples that we're going to do are very similar or less than what we have at CLARCOR. The synergies, while the dollars are big, the percent synergies are very similar to what we did with CLARCOR and LORD. And what's interesting is we're going to do a deal that has over 2x the purchase price of our largest transaction, but our starting leverage will be about the same point that we were when we did LORD and Exotic, so that's what might be how. The reason for that is because EBITDA has grown dramatically, the cash flow generation of the company, the EBITDA margins have grown so dramatically that we can take this size and it looks very similar to what we did in the past. And so we will get ready every day, and as we keep it be ready to do something even better as we go into the future. When we had reached our FY ’26 targets, we're going to be higher than what we are today and when Win Strategy 3.0 just started and it has tremendous firepower behind it to continue to propel the company. So we're preparing for the future every day. And I think what we did really the last 10 years is what's positioned us to do the Meggitt acquisition.

Does that take away your kind of potential as we get to Investor Day to have some kind of bigger levers that really drive margin forward? Is it really just a series of small things? And can you give us a couple of examples of some of the things you're working on that could really continue to transform this company? And then I'm finished. Thank you.

Well, there is a couple of things I'd talk about on the top line. It would be the portfolio changes we've made, but there's also things organically, we're doing differently the whole strategic positioning, which I'll try to give more color on that on IR Day and how our divisions are taking a real step change in ownership of how they position themselves versus their competitors. The innovation changes we've made on PVI and new product printing, simplify design, which is a growth propellant as well as a margin engine, international distribution growth, the digital leadership and the new incentive plan change, ACIP replacing RONA. All those things are going to help on the top line with several of those help on the margin side as well. So as the portfolio becomes more innovative, and it has over the last number of years, those carry higher margins. Simplified design, as some of you may be heard me talk about will be the single largest margin enhancement the company has ever done, and it's just starting. International distribution as we move that mix, that's a margin enhancement. We found what digital leadership that we continue to get more efficient with the use of AI. And then probably last but not least the most important, the things we've done around engagement. If I had to pick one single thing that propelled the company, it's been the engagement of our team members, the engagement scores, the ownership. And it's hard to put a number to that, which you know when you have people that think and act like an owner that use Lean and Kaizen, which is part of their normal thinking, that spirit of continuous improvement is a big part of what's driven our success to date. You can plot our Kaizen activity and our engagement scores and they're working hand in hand. They're locked on a parallel path driving success. So - it's not one single thing, Joel. It's a number of things. And I guess that one slide that we showed you earlier showed the compounding effect of improvement year-over-year. The compounding on EPS, doubling at the compound of margins, and that's going to keep going. We're not going to stop.

That’s great. Thank you.

Thanks, Joel. Hey, Dawn, I think we have time for one more question. So whoever is next in queue, we'll take one more question.

Okay. We have a question from the line of David Raso with Evercore ISI.

Thank you very much. I apologize. I didn't follow the order commentary. You said that the current quarter orders were running, I think, you said 17%. Can you first clarify that? Was that industrial? Was it the whole company? I'm just trying to understand that comment.

David, this is Tom. So the comment I mentioned on orders was contrasting '19 to '21, where we were, if you made it apples-for-apples. And because we didn't have acquisitions, two last acquisitions in '19. And that has orders growing versus '19 at around low teens. And I was just making that correlation because we got order entry coming in low teens versus '19. And we've got sales growth in Q4 was right around 10% versus '19. And our forecast for organic growth the first half for the industrial piece of the company was around 11%. So they all kind of coalesce around that 10% to 11% low teen type of level.

I appreciate that. But we're not - right, we're not really comparing it versus '19. Your guide is '22 versus '21. And if the orders were over 50% industrial in last quarter, if you look at the more challenging comps, single stack, maybe its you know, 17%, so the orders will be like 40 or you want to double stack it, and see less of degradation. So I am just trying to understand, what are the actual order trends right now versus a year ago, just so we understand, are you saying a slowdown? Or are we just confusing the commentary about versus '19? Just to be clear, because the first half industrial growth is the correlations breaking significantly versus orders leading sales and how you're guiding.

Right. I was trying to give you back to something that was more normalized activity because the year-over-year is what we've announced. It was over 50-plus percent for international and minus 7 for Aerospace, plus 43. Because you can't extrapolate that against normal conditions because that was against a quarter ago, which is on when the great shutdown happened. So you can't take that number and extrapolate it into organic growth. You got to come back to kind of some other benchmark so we went back to when activity was more normalized, and that's the data that came up with. This is what I - all the various inputs that we put into that. So there's a lot of science that went into this number. And I'm just trying to contrast why you can't take a 43% order entry and so you're going to have a 43% organic growth.

But would you be able to help us with how the orders are trending currently versus a year ago?

Well, orders continued to grow through the quarter. I mean, if I take North America, it was 11% at Q3 and it went to 56%, and it sequentially got better every month through the quarter, same thing happened in international. So we saw momentum building through the quarter. Things are definitely not slowing down, David. I don't want anybody to take that thought process, things built through the quarter.

That's what I want to be clear, I mean, Tom, if you've got 50 in this past quarter, that usually is right, somewhat have a correlation for the next quarter, but the comps not exactly a normal comp. But the fact is if you look at the comps, this current quarter, the industrial orders should still be up north of 30 or so. And then when you have two quarters running 50, then 30, it doesn't make a lot of sense to be thinking the first half industrial is kind of low teens. And I'm just - I know it's a little tricky on the conversion, maybe some things were taking a little longer to ship. I'm just making sure we don't walk away thinking that's a pretty dramatic slowdown. So you're saying you're not seeing a slowdown at the end of the day?

I'm going to be very clear, there's absolutely no slowdown. You can't take a 50% order entry rate and draw a linear curve there and say it's a 50% organic growth.

I hear you. Lastly, to the March meeting, when we think about the comment about Simple by Design, still you feel pretty early in the journey. Any way you can frame for us how you perceive margin improvement from here versus kind of the journey we've been on in the last five years? Just to kind of frame it a little bit for us, given Simple by Design.

I want to do that in full context of going through all the strategies and how we're going to do it, and giving you a fully baked explanation. But I would just say that we're going to continue to get better. And if the future is - if the past is an indicator, you can draw that into the future.

Thank you very much.

Thanks to everyone for joining the call and for your interest in Parker-Hannifin. We appreciate your time.