Earnings Call Transcript
Parker-Hannifin Corp (PH)
Earnings Call Transcript - PH Q2 2022
Operator, Operator
Thank you for standing by and welcome to the Parker-Hannifin Corporation Fiscal Year 2022 Second Quarter Conference Call and Webcast. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. As a reminder, this call may be recorded. I would now like to introduce your host for today's program, Todd Leombruno, Chief Financial Officer. Please go ahead, sir.
Todd Leombruno, CFO
Thank you, Jonathan and good morning everyone. Welcome to Parker's fiscal year 2022 Q2 earnings release. As Jonathan said, this is Todd Leombruno, Chief Financial Officer speaking. Tom Williams, our Chairman and Chief Executive Officer; and Lee Banks, our Vice Chairman and President, are both with me here today for the webcast. I'd like to direct you to slide number two, which details our disclosure statement addressing forward-looking statements and non-GAAP financial measures. Reconciliations for all non-GAAP financial measures are included in today's materials. Those materials, those reconciliations, along with this presentation, are accessible under the Investors section at parker.com and will be available for one year. As usual, today, Tom is going to begin with highlights of the quarter and a few comments on the company's transformation. I'll follow-up with a brief financial summary and review the increase to our full-year guidance that we announced this morning. Tom is going to handle closing comments, and then we'll open up the lines for your questions. Two comments before we begin today. First, as a reminder, regarding the pending Meggitt acquisition, we are still bound by the requirements of the UK Takeover Code in respect to discussing certain transaction details. And secondly, we are announcing a date and time change to our upcoming virtual Investor Day due to a scheduling conflict with another company's Investor Day. Our meeting will now be held on Tuesday, March 8th, from 9:00 A.M. to 12:00 P.M. Eastern. It will be a virtual event, and among the topics that we'll cover will be the release of our new long-term financial targets. So, with that, I'll ask you to move to slide three, and I'll turn it over to you, Tom.
Tom Williams, CEO
Thank you, Todd, and welcome everyone. I appreciate your participation today. I want to begin with the title of this slide, which emphasizes exceptional execution in a challenging environment. Looking at the company's overall performance in terms of safety, sales growth, margin expansion, and earnings per share, it was a notably strong quarter. This performance comes in the face of what has arguably been one of the most challenging operational environments we’ve encountered in our careers, considering the cumulative effects of inflation, supply chain issues, and the Omicron virus. I want to thank the global team for their remarkable execution this quarter and their consistent performance over many quarters as we proceed through this presentation. Let's start with the first point. Our focus on safety remains unchanged and is our top priority. We are utilizing our high-performance teams, which include the natural work teams in our plants and warehouses, alongside the Star Point teams and kaizen efforts. This combination of team structure and kaizen is fostering an ownership culture within the company, encompassing not just safety but also quality, cost, delivery, and engagement. We experienced a 12% year-over-year sales growth, with organic growth at 13%. This positive trend was evident across all external reporting segments and in every region. Total sales for the quarter set a new record, alongside total segment operating margins. The EBITDA margin was reported at 18.2%, or 22.7% when adjusted, marking an increase of 180 basis points compared to the previous year. Demand remains robust, with over 90% of our end markets in the growth phase, which we find very encouraging. This performance is a direct result of the cumulative impact of One Strategy 2.0 and 3.0. When you combine strategy improvements with our portfolio changes and the beneficial acquisitions we've made in recent years, alongside the favorable long-term trends I will discuss shortly, we anticipate a longer, more resilient, and faster-growing cycle ahead. Moving to the next slide, I've mentioned this previously, but it illustrates our strategic focus around three key drivers: fulfilling our purpose, being exceptional generators and deployers of cash, and achieving top quartile performance compared to our peers. Now, on slide 5, which expresses the idea that a picture is worth a thousand words, it summarizes how the company has evolved over the past few years. We’ve updated this slide with FY 2022 financials. On the left, you will see adjusted EPS and on the right, we have the adjusted EBITDA margin. Looking at the left for FY 2016, our company worked diligently for 100 years to reach an EPS of $6.99. In the past six years, we've grown it by 2.5 times to just over $18 in our current outlook. Notably, just from FY 2020 to FY 2022, we’ve seen an increase of almost $6, which seems significant given it coincided with the launch of Win Strategy 3.0, evidencing its impact on our performance. On the right side, we do not provide guidance on EBITDA margin, but it currently stands at 22.4% year-to-date, reflecting a 770 basis point improvement since FY 2016, which is an impressive achievement. The results stem from our dedicated people, our portfolio changes, and the cumulative effect of Win Strategy 2.0 and 3.0. Looking ahead to the next slide, I want to give you a quick update on the Meggitt transaction. We are making good progress with four main workstreams ongoing. The first two involve the economic and national security reviews we are conducting with the UK government, which are progressing positively and remain on track. The antitrust and foreign direct investment filings are also proceeding as expected. We still anticipate concluding this transaction in the third quarter of calendar 2022, and we are very excited about it. This represents a compelling combination that will double the size of our aerospace business, integrating highly complementary technologies at a time when commercial aerospace is entering a recovery phase, yielding excellent synergies. Additionally, on slide 7, alongside the strategic acquisitions, we are well-positioned with our eight motion control technologies to capitalize on the four significant secular trends presented on this slide. I previously mentioned aerospace recovery and the synergy between Meggitt and Parker. However, we are also focused on electrification, ESG initiatives, and digitization, which are long-term growth catalysts for us, both in terms of onboard applications and infrastructure. We are eager to discuss these trends further during Investor Day on March 8th. With that, I will turn it over to Todd for details on the quarter.
Todd Leombruno, CFO
Thank you, Tom. I'll now direct everyone to slide 9 to discuss our FY '22 Q2 results. As Tom noted, this was a remarkable quarter. Our operations leaders are significantly enhancing our performance. Sales rose by 12% compared to last year, reaching a record $3.8 billion. Organic sales were strong at 13%, although currency fluctuations impacted sales by about 1 point. Demand remains strong, and our backlogs are healthy. We are experiencing broad-based growth across all our industrial sectors. In the Aerospace sector, commercial demand is still trending positively, and our acquisitions of CLARCOR, LORD, and Exotic have exceeded our expectations. Segment operating margins reached a record for Q2 on an adjusted basis, achieving 21.6%, which is a 120 basis points increase from last year. Our teams are effectively managing well-known supply chain challenges and inflation. I want to commend them for their swift actions in managing these costs while still achieving record sales this quarter. Adjusted EBITDA margins were 22.7%, an improvement of 180 basis points from last year. Both adjusted net income and adjusted EPS increased by 29% compared to the prior year. Net income reached $582 million, corresponding to a 15.2% return on sales, and adjusted EPS was $4.46, up $1.01 from last year's $3.45, indicating a strong quarter. Now, looking at Slide 10, I want to highlight the components that contributed to the $1.01 increase in adjusted EPS. Operating execution was the primary driver, with adjusted segment operating income rising by $132 million, which is a 19% increase over the prior year and accounted for 80% of the EPS increase. There were favorable items totaling $0.19, including some currency gains and the sale of restructured facilities, along with reduced pension expenses compared to last year. Other items provided a net of $0.04 in favor. Overall, it was a remarkably strong operational quarter. Moving on to Slide 11, I'd like to comment on our segment performance. As Tom mentioned, we are experiencing growth from prevailing secular trends across all segments. Every segment recorded a new high in adjusted segment operating margin this quarter, maintaining a cost/price neutral stance, which we are proud of. Incrementals rose by 32% compared to the previous year. Excluding last year's discretionary savings of $65 million, incrementals would have increased by 48%. This showcases the effectiveness of our One Strategy and our capability to navigate the current environment successfully. For orders, we saw a 12% increase, indicating robust demand across our businesses. In Diversified Industrial North America, sales hit $1.8 billion, with organic growth of 15% year-on-year. We are pleased with this region's performance, especially considering ongoing supply chain issues and the Omicron impact. Nonetheless, operating margins in this segment remained high at 21.3%, with order rates showing a 17% uptick, and a strong backlog. Notably, 91% of our markets are currently in growth mode. In the Industrial International segment, sales reached $1.4 billion with organic growth at 14%. Growth was consistently strong across regions in the International segment, with adjusted operating margins improving to 22.4%, a rise of 210 basis points year-over-year. Our team has done an excellent job managing costs while the order rates were up 14%, indicating solid international performance. Regarding Aerospace Systems, we have seen continued recovery with sales of $618 million and organic sales growing almost 6%. Demand in our commercial OEM and MRO markets was notably strong, leading to an impressive operating margin increase of 270 basis points, finishing the quarter at 20.7%. It's important to note that this performance is at pre-COVID volume levels. Although our 12-month rolling Aerospace orders fell by 7%, this was largely due to a few large multi-year military orders from the prior period. Excluding those, Aerospace orders would show positive mid-teens growth, suggesting encouraging momentum. On Slide 12, I'll discuss cash flow. We generated over $1 billion in operational cash flow, which represents 13.3% of sales. Free cash flow was $900 million, almost 12% of sales, with a year-to-date conversion of 107%. We continue to effectively manage working capital in response to heightened demand. This quarter saw a 1.9% use of cash compared to a 4.1% source of cash last year. For the full year, we project mid-teens cash flow from operations and free cash flow exceeding 100%. Now, turning to Slide 13, I want to touch on our capital deployment activities. Last week, our Board approved a dividend of $1.03 per share, reflecting our commitment to our 65-year history of increasing dividends. Regarding the Meggitt financing, we are making good progress with our flexible and efficient financing plan to mitigate risk. On the last call, I mentioned our secured deal contingent forward hedge contract worth £6.4 billion. According to accounting rules, we had to report a non-cash charge of $149 million this quarter, reflected under other expenses, as we treat it as an adjusted item. We currently have $2.5 billion in cash reserved in escrow for the Meggitt transaction, recorded as restricted cash, funded through commercial paper and available cash. Consequently, our gross debt-to-EBITDA ratio stands at 2.7 times, with net debt at 2.5 times. If we factor in the restricted cash, our net debt-to-EBITDA drops to 1.8. As we move to Slide 14, I want to share details about the guidance increase we announced today, presented on both an as-reported and adjusted basis. We are raising the full-year adjusted EPS by $0.75, revising our midpoint from $17.30 to $18.05, while also narrowing the range to plus or minus $0.25. Our sales guidance midpoint is now set at a 10% growth range, with 9% to 11%. Organic growth at midpoint stands at 10.5%, with an unfavorable impact from currency expected to be about 1 point. We do not anticipate any impact from acquisitions for this period. Moreover, we are raising the full-year adjusted segment operating margin by 20 basis points, now expecting it to reach 22.1% at the midpoint, with a 20 basis points variance on either side. Corporate G&A and other costs are projected to be at 6.56 on an as-reported basis but adjusted to 4.35. There are several standard adjustments related to acquisition-related intangible assets, realignment expenses, and lowered acquisition costs, along with transaction-related expenses for Meggitt. Year-to-date, we've incurred $71 million in transaction costs, plus the earlier mentioned $149 million non-cash loss. We will keep adjusting for these expenses as they are incurred. The tax rate is now forecasted to be slightly lower at 22% based on first-half performance. Lastly, our full-year guidance assumes that sales, adjusted operating income, and EPS will split 48% in the first half and 52% in the second half. For Q3, the adjusted EPS guide is set at $4.54. Now, Tom, I’ll pass it back to you for your closing comments, and let's move to slide 15.
Tom Williams, CEO
Thank you, Todd. We've got a highly engaged team around the world living up to our purpose, which is enabling engineering breakthroughs that lead to a better tomorrow. You've seen what 3.0 has done as I referenced in that EPS that's driving our current performance what's going to drive our future performance. It's early days of Win Strategy 3.0, and I would characterize it as having long legs, lots of potential ahead with Win Strategy 3.0. The portfolio transformation continues. We've acquired three great companies, are in the process of a fourth that will make us longer cycle, more resilient. And if you put that on top of the secular trends that I highlighted, we feel very, very positive about the future. So it's been our portfolio changes. It's been the strategy changes, but it really starts with our people, 55,000 team members that are thinking and acting like an owner, so 55,000 owners that are driving this transformation. So my thanks to all of them for what we did in the quarter, but really for what we've done in the last number of years. And then I'm going to hand it back to Todd for a quick comment just to set up the Q&A before we get started.
Todd Leombruno, CFO
Yeah. Jonathan, I just wanted to ask the participants on the call, just as a reminder to ask one question, a follow-up, if needed, and then jump back in the queue. Just so we can try to get everyone on the call to have a shot at answering the question. We do appreciate your cooperation. So Jonathan, I'll turn it over to you for Q&A.
Operator, Operator
Certainly. Our first question comes from the line of Joe Ritchie from Goldman Sachs. Your question please.
Joe Ritchie, Analyst
Hi. Good morning everybody. Nice quarter.
Tom Williams, CEO
Thanks, Joe.
Joe Ritchie, Analyst
So Tom, you mentioned in your prepared comments that 90% of your end markets are growing. I think that there's still some concern just around like this hyper growth that we're seeing this year, and that we’re kind of closer to peak. Can you maybe just tell us a little bit more about, kind of, like the sustainability of growth even beyond this year and maybe some commentary around inventory balances as well?
Tom Williams, CEO
I would describe it as some recovery from the lowest point, Joe, and there are many positive factors to consider. The long-term trends I mentioned earlier, such as aerospace recovery, ESG electrification, and digitization, are all part of what I see as longer cycles. The trend towards electrification is expected to take years, even decades. This includes developments in ESG and digitization. The changes in content we’re witnessing and the necessary infrastructure to support this will be significant and will allow us to grow in ways that differ from the past. There are also other factors that will support a more favorable industrial business cycle going forward. Firstly, there will be a need for capital expenditure, especially to reinvest in areas that have seen little investment over the past decade. This underinvestment was common among my industrial peers, particularly during the last eight years which included two industrial recessions and the pandemic. Many will need to catch up on this. Additionally, there is a demand for stronger supply chain systems with multiple sources, which will require infrastructure and more equipment. Therefore, there will be two significant areas of capital expenditure that will arise. We also need to return to normal inventory levels, as current inventory is almost nonexistent outside of suppliers like us. Larger distributors among our customers will require an inventory replenishment cycle. Thus, many factors indicate a more promising future. Moreover, we have been acquiring companies that are aligned with longer cycles and have better growth rates than we’ve pursued historically. The improvements we've made to the balance sheet and capital deployment have also benefitted us. I believe this time is distinct. While there are always uncertainties, like geopolitical issues and viruses, I think if we look ahead, the next seven or eight years will be better for industrials than the last seven or eight.
Joe Ritchie, Analyst
Yeah. That's super helpful. Thank you, Tom. Maybe my follow-on there is again, stand out from a margin standpoint, this quarter was Aero, and it seems like we're still so far off the bottom in that business. I'm just – I'm just curious, maybe just kind of peel back the onion a little bit on what's really kind of driving the strong margins and then sustainability of those margins moving higher from here?
Tom Williams, CEO
The big help with Aerospace is twofold. One, we were very aggressive in establishing, again, Joe, it's Tom. Establishing a fixed cost structure that was going to be designed to withstand current conditions and flexible enough to withstand the commercial recovery. So we've done that. And we were – probably, I'd say, one of the more aggressive and quick to do that of our other peers are in the aerospace industry. So we have a fixed cost structure that is in a great position to leverage this additional volume. And then in the near-term, you're seeing significantly higher volume from commercial MRO. And that piece is obviously more higher margins. I mean, commercial MRO in the last quarter grew 47%. So those would be the two big things. We had moderate R&D in that low 3% type of level. So you get additional volume over a great cost structure and additional volume being the higher-margin piece of the portfolio is driving the margins. Just for people, I mentioned this in the last quarter, but it's even more pronounced now. We're guiding to 21.4 for the full year and that's against an all-time peak pre-COVID of 20.5. So that's fantastic. It's 90 bps higher than our previous high, and we're nowhere near previous high on revenue for Aerospace. You've got – so what's going to help, Joe, going forward, you've got ASKs, they're going to recover. You got departures, they're going to recover. Omicron is probably the silver lining to helping all of us get out of this pandemic. And the Aerospace industry will be the first to recover and you can look at – there's a lot of different people forecasting in the future. When we get back to pre-COVID, I think you can say anywhere from 2023 to 2025 calendar year. If you kind of look at the median – middle of that, what most forecasts were saying that puts you kind of in 2024. But there's a – you're going to have a lot of positives going forward. You've got the recovery, we've got Meggitt, and the continued good things we're doing in aerospace as a whole, so we're very positive. If we weren't so positive, we obviously wouldn't have bought Meggitt. We think there's a great space to invest in.
Joe Ritchie, Analyst
Makes a lot of sense. Thanks, Tom.
Tom Williams, CEO
Yeah. I appreciate the questions, Joe.
Nigel Coe, Analyst
Thanks. Good morning. Hi, guys. Just wanted to maybe just pick up on your investment comments, Tom. You talked about CapEx, but I'm just wondering about OpEx investments. And so just wondering if there's a need to catch up on engineering spending, R&D within aerospace, any comments there would be helpful.
Tom Williams, CEO
Yes, Nigel, it's Tom. On the operational expenses, I believe we are in a solid position. Our experience shows that innovation isn't solely about financial investment. While it's important to allocate resources, the key factors are the organizational structure, talent, and processes that support innovation. We feel we are at a good level. In our R&D efforts, particularly in aerospace, we are concentrating on future component technologies and additive manufacturing to be prepared for our customers when requests for proposals arise. If we wait until RFPs are released to begin our R&D, we miss the opportunity. It’s crucial to anticipate market trends. Our simplified design process enhances our innovation efficiency, and every new product undergoes this process, which will benefit us as well. Regarding capital expenditures, we anticipate a minor increase that will likely bring us to the upper 1s or nearer to 2.0 for productivity and organic growth. A relevant example of our progress is the introduction of a new metric called the product vitality index, which reflects the percentage of our sales from new products developed in the last five years. This percentage has doubled over the past five years, indicating that the portion of our portfolio that is innovative has increased significantly. This improvement will contribute to sustainable growth and positively impact our margins, as new products are designed to have a more appealing value proposition and higher margins. Thus, as long as we invest wisely, substantial rewards can follow.
Nigel Coe, Analyst
It seems there won't be a significant investment cycle in operating expenses. Additionally, I'm curious about the margins in the Industrial segment compared to North America and international markets. Historically, the Industrial sector has underperformed in North America. The guidance shows that international margins are 50 basis points higher than North America's. Looking ahead, do we expect the structural margins for international and North America to be similar?
Tom Williams, CEO
Yes, Nigel, it's Tom again. Yes. Yes. I mean they're there now, and we think they basically should run the same. And they're great positive about this and for all my international colleagues that are listening, this has been years in the making, a fantastic run rate really from all the regions outside of North America have contributed to this. We're seeing margin expansion across all three regions. And the short answer, Nigel, is yes, North America and international, should basically be about the same as we go forward.
Nigel Coe, Analyst
Great. Thanks Tom.
Joel Tiss, Analyst
Thanks. Well, you see, after I ask my question, you might not feel that way. No, just kidding. So, I have one short-term, one about net pricing for 2022? Do you think that's going to be positive, or you think it's going to continue to be neutral?
Lee Banks, CFO
Yes. Joel, it's Lee, also congratulations. Maybe just taking a step back for everybody on the call. I think the one thing that we've established inside this company is a great culture of value-based pricing. So always pricing products for kind of the – how we make or save money for our customers. When we have times of inflation, we've got great processes internally to gauge pricing, but also what's happening with material costs. And as you know and I've said in the past, our goal is always to be margin-neutral, and we've been able to accomplish that for a long period of time. I will tell you what's happening now is just looking at material cost is not enough. Inflation is incredibly broad-based. And we've just had to take a very comprehensive look to maintain that margin neutrality. And we're very active in this last quarter. I mean, we saw things ramp up quickly. But to answer your question, I expect to maintain that margin neutrality going forward.
Joel Tiss, Analyst
And then a longer-term question, probably maybe beyond Tom's scope or whatever, one we're on Wind 5.0. Do you think by 2030, we could see 30% EBITDA margin potential? And the reason, I'm asking the question is maybe just a little bit of thought process about some of the some of the big strides, you have in front of you to get the margins higher than where they are now?
Tom Williams, CEO
Joel, it's Tom. I want to extend my congratulations as well and take a moment to elaborate. We have always valued your honesty, intelligence, and sense of humor, just as you demonstrated with your questions. That’s refreshing, and it's not something we encounter often. On behalf of all of us, we thank you and congratulate you on a remarkable career. Regarding the long-term outlook for 2023, you are correct that it will extend beyond my tenure. However, we are not a company that believes there are limits to what we can achieve. I won’t claim that achieving that number is impossible. We are going to provide a first look at our five-year plan when we meet on March 8, which I believe will give you insight into our vision for the company's future. As you noted in the chart at the beginning of my comments, our EBITDA margin has been steadily improving. As long as we continue to develop technologies and products that deliver the distinct value mentioned by Lee, we can reach that level of margin achievement. While I understand you’re not implying immediate results by 2030, I believe that as we progress along the path of continuous improvement, there are no limits. We will keep moving forward, striving to become the best industrial company we can be.
Joel Tiss, Analyst
Thank you very much.
Todd Leombruno, CFO
Joel, we greatly appreciate it. You have a wonderful retirement.
Operator, Operator
Our next question comes from the line of Jamie Cook from Credit Suisse. Your question please.
Jamie Cook, Analyst
Hi good morning and congrats on a nice quarter. Tom, I guess, my question, again, relates to the margin performance in the first half of the year and what's implied in the back half of the year. I'm just sort of wondering, while you're putting up better margins than everyone expects, can you sort of talk through the supply chain, the labor inefficiencies, some of the headwinds that you're seeing in the margins, because it just makes me think, obviously, the underlying margins could be much stronger as some of these short-term issues go away. And I guess, as I think about that, does that set up Parker to put up above-average incrementals as we think about 2023, assuming sort of the world goes back to normal? Thanks.
Tom Williams, CEO
Yes, Jamie, it's Tom. I'll begin, and Lee can join in as he's leaving us now. I mentioned earlier that this is arguably the toughest environment in my career, and I've been around a long time. It's truly a challenging landscape. For general managers and operations managers, the supply chain issues, inflation, and COVID disruptions are making it really hard to schedule everything from suppliers to team members. Omicron has been a double-edged sword; while it’s been difficult, I believe it might ultimately help us move past these issues. It peaked in January and is expected to decline as we head into February, but it has significantly impacted absenteeism rates. We experienced some of this in the second quarter and are noticing even higher absenteeism at the start of Q3. That's why I want to emphasize how impressive our numbers are. Running a factory while trying to hire and train new employees amidst high absenteeism and having to redeploy and retrain staff puts a strain on operations. On any given day, uncertain material availability adds to the difficulty. These numbers are remarkable, and as we transition to more normal times, it will be beneficial, which we will clarify on IR day. The implied guidance for our second half is significantly better than the first half, forecasting a total operating margin of 22.3%. In comparison, we achieved 21.8% in the second half of 2021, which is a 50 basis points increase from last year and the same increment over the first half. As a reminder, you cover many companies. When the pandemic started, we aggressively cut costs, which put us in a strong position initially, but now we must compare against those years. In the last quarter, our incremental margin was 48%. The second half guidance shows around 40% for Q3, and we expect about 35% for Q4 after accounting for discretionary costs. Over the entire year, excluding those, it came to 30%, which I believe is a strong result. Achieving a 30% incremental in this environment demonstrates exceptional work. I also want to thank Lee, Jenny, and everyone involved for doing an excellent job managing our factories. We'll provide more insights, Jamie, on what we can achieve in a more normalized environment and share our targets on IR day.
Jamie Cook, Analyst
Okay. Thank you. I appreciate it.
Tom Williams, CEO
Thanks, Jamie.
Mig Dobre, Analyst
Thank you. Good morning, everyone. Tom, I remember on the last earnings call, you were talking about supply chain disruptions, maybe not so much impacting you, but impacting your customers and their ability to frankly produce and thus, purchase or get deliveries of components from you. I'm wondering if you can maybe give us an update here in terms of how things have evolved. And as you're looking at the back half of your fiscal year, how you think your own customers’ output/throughput is going to progress?
Tom Williams, CEO
Yes, that is still true. When considering the entire value chain, including our customers, us, our suppliers, and their suppliers, everyone is experiencing challenges. Our customers, particularly the OEMs, are facing the toughest situation due to their more complex build materials and greater shipping dependencies. This makes their situation more challenging. While we are also affected, the biggest issue remains our customers and their capacity to handle the intricate build materials they need. This complexity makes it hard for us to forecast sales accurately since we have to consider our inputs, our AI model, and feedback from various sources. Our customers are cautious about not taking in more than they can use. We're maintaining that same cautious approach with our suppliers. The situation has not changed significantly since our last discussion. Many of the chip shortages affecting our industry remain a problem, and it may have worsened as we entered the third quarter. We’re not expecting any relief in the near term. As a company with a different fiscal year, we have only five months left to address this issue, and we don’t anticipate improvements in our fiscal year. Any potential relief is likely to arrive closer to the end of this calendar year.
Mig Dobre, Analyst
Understood. You talked earlier about the robustness of this industrial cycle. But, I guess, one of the concerns out there is that, the robust orders that you've seen thus far could potentially be a factor of customers trying to make sure that they do have available components in an environment in which there are shortages out there. So what is your science as to whether or not this resulted in some unnatural boost to demand or double ordering, however you want to characterize it?
Tom Williams, CEO
Yes, it's Tom. From what we understand, the demand we're seeing is primarily driven by underlying factors rather than customers trying to get ahead by ordering multiple times. While I can't rule out that some double ordering may be occurring, it's likely happening in limited cases. Overall, my earlier comments about the industrial cycle suggest that it has a strong foundation because of recovery dynamics, capital expenditures, and our connections to broader trends. Most customers are now being practical; they are placing orders over longer time frames than usual, which is beneficial for the entire supply chain.
Mig Dobre, Analyst
Thanks for the call.
Tom Williams, CEO
Appreciated it, Mig.
David Raso, Analyst
Thanks for the time. One question a little longer-term and one more near-term. With the meeting coming up, last meeting, the margin expansion was really focused on simplification and then a better mix as distribution grows. And within simplification, obviously, we had org structure, operational complexity and particularly simple by design. I was just curious, can you give us at least a little insight on how to think about approaching this meeting? Is this the ability to drive those initiatives further, get a further update on those? Are there other things that we should consider? And then I'll follow up with my near-term question.
Tom Williams, CEO
Yes, David, this is Tom. We will provide an update on the latest developments regarding Win Strategy 3.0, which will include ongoing changes. It's challenging during earnings calls or even in a typical roadshow to cover all aspects of Win Strategy 3.0, so we aim to give a more thorough overview of how it contributes to growth and margin expansion. We'll also discuss some incentive changes designed to enhance our team's motivation and behavior. We will update you on unique secular trends. When Lee and I began our roles, the ESG phenomena, electrification, and digitization were present, but not to the same degree of momentum and capital investment we see now. We want to clarify how these trends will transform our portfolio and content. There will be ample time devoted to this, leading to a forecast of our five-year goals. This will outline the high-level timeline for our meeting agenda.
David Raso, Analyst
That's helpful. Thank you. And just real quick, I know the guide, we can debate conservative or not on the revenue. But in particular, the international revenues for the back half of the year implied only growing 1% despite the order it just came in 2014. And I suspect some of it's currency weighing on it. But anything we should be thoughtful about on why if you look at where the guide in the back half seems a little, at least raises an eyebrow, why would international slow that much?
Tom Williams, CEO
Okay, David, it's Tom and Todd, tag on if I missed something here. So I'll give you what I have. I don't know where you're getting to 1%, but I'll give you what we're seeing for the second half. I'm going to give you the organic numbers. So we are raising the guide, it was 6% for the second half, all-in total company to 7%. And just to kind of provide context, that 7% is against the 10% that we did in the prior second half. So again, it's kind of the two-year stack, it's 7% on top of 10%. But if I split out the segments for you to get to the 7% North America second half is around 8.5%, International is 5%, so it's not 1%, it's 5% organic. And then Aerospace is approaching 7%, and that's how you get to the total number of 7%. I don't know, Todd, do you have to...
Todd Leombruno, CFO
Yes, Dave, I would just add, you're right. You mentioned currency. We're forecasting between 3.5 and 4 points of negative impact in the International segment just from where the currency rates are today. We're not trying to forecast those going forward. It's just a year-over-year comparison. To kind of put that in perspective, we had less than one in the first half. So that's probably a little bit of a –
David Raso, Analyst
So that's the gap between the five and one essentially?
Tom Williams, CEO
Correct. Yeah.
David Raso, Analyst
Okay. I appreciate it. Thank you so much.
Tom Williams, CEO
Thanks, David.
Jeff Sprague, Analyst
Thank you. Good morning.
Tom Williams, CEO
Good morning, Jeff.
Jeff Sprague, Analyst
Hey, Todd, you laid out how your FX hedge on financing for Meggitt. Could you just update us on what, if any, interest rate risk you have just on the actual financing cost itself?
Todd Leombruno, CFO
Yeah. We've got a very flexible plan here. We've talked a little bit about that. It's going to be a mix of commercial paper, a mix of cash. We did take out a deferred throughout term loan, and then the remaining of that is yet to be determined. We've looked at it. We feel good with the rates that we're seeing. So I guess, we could give you more info that as we get a little bit closer to taking action on that. But we've got the team looking at it, and we feel really good with the total cost of debt for this transaction.
Jeff Sprague, Analyst
You're not proactively locking anything else in front of the transaction?
Todd Leombruno, CFO
No, we've looked at that, because the close timing is uncertain, the breakeven on that just becomes a little bit challenging.
Lee Banks, CFO
Yeah, I'm not sure I can be that specific for you. But I think the one thing I was thinking about when Tom was talking, the one reason we've been able to come through this two years of pandemic is really the culture around our high-performance teams driving all these processes that are embedded inside the company around lean, talent, supply chain, and the way there is just this culture of ownership. And what's been rewarding for me to see is we have had a spike in absenteeism rate, but our teams figure it out. They prioritize what needs to get done. Our local teams figure it out. There's certainly an increase in cost in different markets, inflation – to sum it up in one number, I can't do that for you. But I can tell you, costs are going up and all the support costs that go with it. But bottom line is it's really our team that keeps working all the way through this to help us achieve these results.
Joe O'Dea, Analyst
Hi. Good morning, everyone. I wanted to start on supply chain and experience over the past few months, and your confidence in kind of stabilization of peak pain, if you think we see that kind of this past quarter and the quarter we're in right now? Anything you have in terms of visibility on things getting better? And then within that, any characterization of differences you see on the North America side versus the international side on supply chain?
Tom Williams, CEO
Yeah, Joe, it's Tom. I don't expect things to improve during this fiscal year. Currently, this quarter is likely the toughest we'll face, at least I hope so. We've managed the situation fairly well, and a key indicator of our resilience has been our margin conversion and expansion. The pressing questions are whether we can handle inflation, supply chain disruptions, and absenteeism, and the important measure is how we're performing on margins. We’ve successfully maintained margin growth and converted incremental revenue at a favorable rate. Historically, our success with supply chain management stems from our strategy of making, buying, and selling locally. While we have global supply chains, we prioritize local sourcing to enhance service and customer experience, which have contributed to our effectiveness, particularly since many challenges are logistics-related. We also have a strong risk mitigation strategy that includes dual sourcing, and we plan to increase this approach in the future. Additionally, we're going to implement simplified designs at our suppliers to make it easier for them to produce at a better cost. North America faces more significant challenges due to logistics and labor issues. In contrast, Europe has managed to retain a stable workforce during the pandemic due to various programs that varied by country. As a result, labor availability and logistics are functioning better in Europe compared to North America, which underscores the existing disparities.
Joe O'Dea, Analyst
Got it. And then a related one on the incrementals when you talk about adjusted incrementals and a stronger first half of the year than the back half of the year, what within that change is operational versus how much of that is more a function of comps and mix and factors like that, that we would consider more non-operational elements of a step-down in the incremental in the back half?
Tom Williams, CEO
Incrementals are based on operating margins, so they are all operating. The difference, as I mentioned in response to one of the questions, is that we had some impressive incrementals during the initial reset of the pandemic. If you look back at benchmarks, we were clearly in the top quartile, possibly not the best incrementals among any industrial company, which makes the comparison challenging. We have worked to provide a more straightforward comparison. There were one-time factors, like employee pay cuts at the beginning of the pandemic, that are not repeating. Comparatively, our first half of this year is in the upper 40s. When you consider apples-to-apples incrementals, this is outstanding. That's impressive during normal times and doing so under current circumstances is truly remarkable.
Todd Leombruno, CFO
Yes, Joe, I would just add that the discretionary savings decreased as we returned to normal operations. The adjustment becomes lower in the second half. The comparison is $25 million in Q3 and drops to $10 million in Q4. So Q1 was $125 million and Q2 was $65 million. You can see that decline beginning to take shape.
Joe O'Dea, Analyst
But you're not saying that there's something about supply chain that's getting tougher or that labor is driving some meaningful change within those incrementals in the back half?
Tom Williams, CEO
No.
Operator, Operator
Thank you. Our next question comes from the line of Scott Davis from Melius Research. Your question please.
Scott Davis, Analyst
Good morning. Congratulations on achieving another impressive result here.
Todd Leombruno, CFO
We appreciate that.
Scott Davis, Analyst
I have a couple of points. First, hearing all these questions raises your inquiry about whether working capital needs to be almost permanently higher over the next 2 to 5 years due to various disruptions. This could complicate some of your traditional lean practices.
Todd Leombruno, CFO
No, Scott, we don't believe it is. We believe that this is a short-term response to the spike in demand. If you look at us over the longer period of time, you can see that we have done a wonderful job managing working capital. It still is early days on some of the recent acquisitions. So, I do think we have some upside there as well. But the other thing I would say is, if you look at our second half, historically, the second half is really where we've started to get a little bit more leverage from the working capital side of the fence, and that's exactly what expect to see in the second half of '22. It's always a little bit tougher in a growth environment, but that's a good problem to have. And I'm really happy with the way the teams are managing this across the entire company.
Tom Williams, CEO
Scott, it's Tom, if I would add on, our inventory levels right now we have lots of opportunity. And as we go forward, that will be a source of cash for us once we get through the more normal supply chain conditions.
Scott Davis, Analyst
That's helpful. Looking at your original deal models for CLARCOR, LORD, and Exotic, can you share where you've found the most satisfaction with the potential upsides? I understand that each has a different timeframe, making it a bit challenging to compare them directly. However, when you consider how to normalize their progress, what stands out to you? Is there anything specific about those three major deals that you would highlight?
Tom Williams, CEO
So Scott, I’ll do my best to keep this brief. We couldn’t be happier with all three. It’s similar to choosing a favorite among your three children; you appreciate them all. Each has met the margin targets we set and has shown resilience in growth. In particular, LORD introduced some unique best practices in our commercial strategies that we are implementing company-wide. They have all contributed positively to our growth, margins, and earnings per share. The design intent we had at the start has been fulfilled, which is often not the case. We are very pleased with this outcome.
Todd Leombruno, CFO
Yes. Jonathan, just to be respectful of everyone's time, I don't think we have time for another question, so I apologize to those that didn't get on the call. This really concludes our FY '22, Q2 earnings webcast. As always, Robin and Jeff are going to be available for the rest of the day. if you need any clarifications or questions. And I just ask everyone that try to stay warm, stay safe, and have a great afternoon. Thanks for your interest in Parker and thanks for joining us today.
Operator, Operator
Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.