Earnings Call Transcript - PH Q4 2025

Operator, Operator

Good morning, everyone. Welcome to the Parker Hannifin Corporation's Fiscal 2025 Fourth Quarter and Full Year Earnings Conference Call and Webcast. Please be advised that today's conference is being recorded. I would now like to turn the call over to Mr. Todd Leombruno, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Todd M. Leombruno, CFO

Thank you so much. I'd like to welcome everyone to Parker's fiscal year 2025 Fourth Quarter and Full Year Earnings Release Webcast. As mentioned, this is Todd Leombruno, Chief Financial Officer speaking, and with me today, as usual, is Jenny Parmentier, our Chairman and Chief Executive Officer. We appreciate your interest in Parker and thank everyone for joining us today. On Slide 2, we address our disclosures on forward-looking projections and non-GAAP financial measures. Items listed here could cause actual results to vary from our forecast. Our press release, this presentation and reconciliations for all non-GAAP measures were released this morning and are available under the Investors section on our website. The agenda for today has Jenny starting out with the highlights of our record fiscal year 2025 performance. She will then reiterate the strength of our transformed portfolio, the power of The Win Strategy, which drives performance in all economic climates, and she will provide some color on our recently announced acquisition of Curtis Instruments. I'm going to follow with a few details on our strong fourth quarter financial results. We did release our initial FY '26 guidance this morning and will discuss the assumptions, and provide some color on what we expect to be another record year for Parker. We'll conclude the call with a normal question-and-answer session, and we will do our best to take as many questions as possible. Now I would ask everyone to call your attention to Slide 3, and Jenny, the floor is yours.

Jennifer A. Parmentier, CEO

Thank you, Todd, and thank you to everyone for joining the call today. The Win Strategy and our culture of high performance delivered another record year. We had a 17% reduction in recordable incident rate, once again achieving top quartile safety performance and record engagement survey results. Top line sales finished at $19.9 billion, and this team achieved record adjusted segment operating margin of 26.1%, an increase of 120 basis points from the prior year, and record adjusted EBITDA margin of 26.4%, an increase of 80 basis points from the prior year. We generated record cash flow from operations of $3.8 billion and delivered 7% adjusted EPS growth. We finished the year with a record $11 billion in backlog and remain committed to a disciplined, active, and balanced capital deployment strategy. Next slide, please. Another year of outstanding performance from Aerospace with record sales of $6.2 billion. That's 13% organic growth and 190 basis points of adjusted segment operating margin expansion. Orders continued to outpace sales growth as we finished the year at a record backlog of $7.4 billion. Today, we enjoy a balanced and diverse Aerospace portfolio. We finished FY '25 with 51% of our sales from serving the aftermarket and 49% from serving our OEM customers. Looking back to FY '19. I'd like to recognize our Aerospace team for navigating and managing through numerous industry challenges, successfully integrating the Parker and Meggitt Aerospace businesses together, and staying focused every day on the safety of our team members and improving the experience for all of our customers. The performance is impressive. Sales are approximately 2.5x higher, and we are on track to expand adjusted segment operating margin by 940 basis points from fiscal year '19 through our fiscal year '26 guidance, and we're not done yet. Our comprehensive offering of proprietary designs on premier programs and our global footprint that supports a diverse customer base well positions us for sustained growth and operating performance. Next slide, please. The Industrial segment of our business has been a large part of our transformation and margin expansion story. Fiscal year '25 delivered record adjusted segment operating margin of 25.1%, a 90 basis point increase from the prior year. Using The Win Strategy, our teams are on track to deliver 700 basis points margin expansion from fiscal year '19 through our FY '26 guidance. This is a testament to our ability to expand margins through the cycle, even in periods of negative organic growth. Our powerhouse of interconnected technologies, global distribution network, and global manufacturing footprint are competitive advantages that will drive growth from secular trends across the market verticals. Our portfolio today is well balanced. Two-thirds is now longer cycle, secular trends and aftermarket. We are poised for a return to growth. Next slide, please. Once again, the transformation of our portfolio further expanded longer cycle and secular revenue mix in fiscal year '25. Acquisitions in both Aerospace and Industrial, along with international distribution growth, have greatly contributed to this transformation. We see this transformation continuing and expect 85% of our portfolio to be longer cycle, secular, and aftermarket by fiscal year '29. Next slide, please. On June 30, we announced our intent to acquire Curtis Instruments, further expanding our electrification offering and secular revenue mix. Curtis is the leader in low-voltage motor control solutions for zero-emission and hybrid mobile equipment. This acquisition will add a complementary suite of control solutions to pair with Parker's electric motor and motion control portfolio. This will further enhance our capabilities for in-plant and off-highway applications. Curtis has a strong market position across diverse and growing end markets. These are markets that we know, with customers we have relationships with, and products that will be a great addition to our portfolio. We expect to close by the end of the calendar year and look forward to welcoming the Curtis team to Parker. Next slide, please. A reminder on why we win. First, The Win Strategy is our business system. We have a decentralized operating structure, 85 divisions run by general managers with full P&L responsibility, acting like owners, close to their customers and executing the Win strategy every day. We have innovative products that solve customer problems, with 85% covered by intellectual property. Our application engineers provide the expertise that allows us to have a competitive advantage with our technologies to provide efficient solutions for our customers. Finally, our distribution network is the envy of the competition and the best in the world. It took us over 60 years to build it, and it is truly an extension of our engineering teams, providing solutions to small and mid-sized OEMs. These partners are experts at applying our interconnected technologies. I'll now turn it back over to Todd to go through our fiscal year 2025 highlights.

Todd M. Leombruno, CFO

Thank you, Jenny. FY '25 was really a strong year. I'm going to try and quickly wrap up FY '25 with the Q4 results, and I'm on Slide 10. The fourth quarter was another record-setting quarter. In fact, every number on this page is once again a record. It was another quarter of continued margin expansion and a quarter of double-digit EPS growth. Really impressive considering that sales were up just 1% versus the prior year. Organic growth was positive at 2%. That's the highest we've been all fiscal year. Currency did turn favorable at 1%, and the divestitures that we previously announced throughout the year were 2% unfavorable to total sales. Adjusted segment operating margin was 26.9%. That's up 160 basis points from the prior year, and adjusted EBITDA margin was 26.8%. That's an increase of 50 basis points from the prior year. Adjusted net income was almost $1 billion, was $992 million in the quarter. That was an 18.9% return on sales. Adjusted earnings per share were up 14%, and they reached $7.69 per share. Just a fantastic quarter, really from all the businesses, resulting in the best performance that we've had this fiscal year for sales, for organic growth, for adjusted segment margins, and for adjusted EPS. We'd really like to thank our global team for a strong finish to the fiscal year. We talk about this a lot internally, finishing strong, and everyone certainly delivered. If you could move to Slide 11. This just highlights the components in the year-over-year improvements in adjusted EPS. What I'm proud to say here is 60% of the improvement in EPS in the quarter came from strong operating execution. Segment operating income dollars are up $96 million, or 7%. That was $0.56 of our improvement. Income tax was a bit favorable in the quarter. That's $0.47 favorable. That was really a result of a few discrete tax benefits that were resolved in the quarter. Also, I'd just like to call attention that Q4 last year was our highest tax rate of the year. So comps off a little bit there. Interest expense continues to be favorable. That was $0.12 favorable. That's really just based on our efforts to pay down debt throughout the year, and discretionary share repurchases drove a $0.09 favorable impact. You can see that share count there. Corporate G&A and other were unfavorable, really combined $0.32. That's a combination of less favorable pension expense versus the prior year, but really a result of foreign currency exchange volatility year-over-year. The EPS growth story has been really consistent throughout the year, just strong operating execution, very tight cost controls, driving margin expansion, and as Jenny mentioned, disciplined capital allocation. So just a great way to finish the year. If we can go to Slide 12, this just details the performance across our businesses. First, I'll start with orders. Orders continue to be positive. It's plus 5% versus the prior year. Aerospace strength continues to drive backlog higher. Jenny mentioned that's a record. We did see gradual improvement in sales growth across our major market verticals. Once again, this quarter, every business delivered record segment operating margins. Very nice to see that. I already mentioned it, but in total, we were up 160 basis points from the prior year. Looking specifically at the North America businesses, sales were $2.1 billion. Organic growth was just down 1% versus prior, but we did continue to see a sequential improvement in organic growth. Quite honestly, that was better than our expectations coming into the quarter. We did see improvement across the market verticals in North America. So that was a positive, and distribution sentiment continues to be positive across the channel. Adjusted operating margins did increase 170 basis points to a record 26.7%, and that was driven by excellent operating execution, cost controls, and a little bit of favorable mix. Gradual improvement in distribution kept orders in North America positive at plus 2% versus the prior year. I want to note that this is the third consecutive quarter of positive order growth for North America. Moving to the Diversified Industrial International businesses, sales were up to $1.5 billion. That's up 4%. Organic growth was positive at 1%. It was nice to see that turn positive. In Asia Pacific, organic growth was plus 6%. In Latin America, it was plus 4%, while EMEA did improve, it remained negative at 3% from an organic growth standpoint. Our international teams are committed to using the tools of The Win Strategy to reduce costs, improve efficiency, and drive margin expansion, no matter what's happening with the top line. That resulted in adjusted operating margins achieving a record of 24.7%, which is an 80 basis point expansion from the prior year. On the order front, international orders were flat versus the prior year, really against some tough comps. Just a reminder that orders in Q3 did benefit from a number of significant long-cycle orders that remain in the backlog. Lastly, if I look at Aerospace Systems, the momentum continues in Aerospace. Sales were a record $1.7 billion. That's up 10% versus the prior year. That exceeded our expectations for the quarter. Organic growth was mostly that, 9% of that growth is organic, driven by strong strength in the aftermarket channels. Adjusted segment operating margins up huge by 190 basis points versus the prior, and reached a record 29%. Aerospace orders continue to be positive at plus 12%. I really want to commend our aerospace team members for another outstanding quarter and a strong finish to a stellar year. On Slide 13, this is my last slide for the year. This is cash flow. We finished FY '25 by achieving record cash flow generation. Cash flow from operations was a record at $3.8 billion, that's 19% of sales. Free cash flow was also a record at $3.3 billion, or 16.8% of sales, with conversion at 109% after adjusting for some non-operating items. Both CFOA and free cash flow increased by 12% versus the prior year. Additionally, we repurchased an additional $850 million in shares during the quarter, bringing our year-to-date share repurchases to $1.6 billion. And that is a wrap on our record FY '25 performance. I know everyone is interested in guidance. We'll move on to FY '26 guidance. Jenny, I'm going to hand it back to you on Slide 15.

Jennifer A. Parmentier, CEO

Thanks, Todd. This slide shows our fiscal year '26 organic sales growth forecast by key market verticals. So in Aerospace, we are forecasting high single-digit growth, with higher growth in commercial OEM than in the commercial aftermarket. We are forecasting low single-digit growth in in-plant and industrial, assuming a gradual industrial recovery. Transportation, our most challenged market this year, we are forecasting a mid-single-digit organic decline. In off-highway, we are forecasting a low single-digit decline. The ag market has moved past the trough but needs a little more time before returning to positive. Construction is stronger than ag with recovery underway, and we expect positive low single-digit growth in energy, as well as HVAC and refrigeration. At the midpoint, this results in 8% organic growth for Aerospace, approximately 1% organic growth for both Industrial North America and Industrial International, and approximately 3% total Parker organic growth. I'll give it back to Todd to go through more details of the guidance.

Todd M. Leombruno, CFO

Okay. Thank you, Jenny. I'm on Slide 16. We'll just go over a few items. Reported sales growth for the year is expected to be in the range of 2% to 5%. That's 3.5% at the midpoint, approximately $20.6 billion in annual sales. We have modeled those sales 48% in the first half, 52% in the second half. Consistent with our practice, this guidance does not include any impact from the Curtis Instruments acquisition. We will add Curtis to our guide once it closes. If you look at organic growth, Jenny mentioned this, but the forecast is in the range of 1.5% to 4.5%, or 3% at the midpoint. Aerospace is again 8% at the midpoint and both North America and International we expect 1%. Organic growth is modeled 2% in the first half and 4% in the second half. Currency, as usual, is based on the June 30 spot rates, and based on our math here, it shows that that's expected to be favorable by 1.5%, or roughly $260 million. On margins, adjusted segment operating margin guidance is 26.5% at the midpoint. That is an increase of 40 basis points versus the FY '25 finish. In respect to incrementals, we have modeled roughly 35% for the full year on incrementals. A few things to note: below segment operating income, corporate G&A is approximately $200 million. Interest expense, approximately $390 million. Other expenses, approximately $80 million. All of those are at the midpoint. Tax rate, we are modeling a 22.5% tax rate. As usual, we are not including any unknown discretes in that number. 22.5% is what we have modeled. EPS for the full year is expected to be $28.90 on an adjusted basis at the midpoint. That is an increase of 6% versus the prior year. We have a range of $0.50 on both sides of that $28.90. The split on EPS is 46% for the first half, 54% for the second half. Lastly, with respect to cash flow, full-year free cash flow is expected to be in the range of $3 billion to $4 billion, with conversion at approximately 100%. Lastly, on the far right column here, you could see what we have highlighted for Q1, FY '26. All of these numbers are at the midpoint. Reported sales are roughly 0.5% positive. Organic growth is 2% positive, and we are forecasting 26.1% for adjusted segment margins and an adjusted EPS of $6.51. As usual, we have some further details in the appendix, if those are helpful for your model. Lastly on Slide 17, this is just a bridge, and I'll just highlight as we walk through this. We are forecasting a 5% increase in adjusted segment operating income dollars, which translates to $1.68 in additional EPS. Share count, based on that year-to-date repurchase amount, is roughly $0.37 of improvement in EPS for FY '26. Corporate G&A is forecasted to be $0.18 favorable. Interest rates will give a little bit of a tailwind, $0.11 for the year. The forecasted tax rate of 22% is a headwind of $0.77 compared to our effective tax rate that we realized in FY '25. That does not include any discrete items. In summary, we are guiding FY '26 at $28.90 in adjusted EPS, that is up 6%. With that, I'm going to ask you to move to Slide 18, and Jenny, I will hand it back to you.

Jennifer A. Parmentier, CEO

Thank you, Todd. So I'll close with a reminder on what drives Parker. Again, thank you to all of Parker's team members for a fantastic fiscal year '25 and a very, very promising FY '26. Safety, engagement, and ownership are the foundation of our culture. It's our people and our purpose that drives top quartile performance, and we remain committed to being great generators and deployers of cash.

Todd M. Leombruno, CFO

Okay. We are ready to start the Q&A session.

Operator, Operator

We'll go first today to Joe Ritchie of Goldman Sachs.

Joseph Alfred Ritchie, Analyst

Congrats on another great year. Can we just maybe talk about the Q1 guide? Take a look at that relative to the last few years, it's a pretty meaningful sequential step down in EPS relative to what you've seen even just in the last 3 years. So can you guys maybe just talk about the bridge between Q4 and Q1 and what's really changing on the margin embedded in your guide?

Jennifer A. Parmentier, CEO

I'll begin, Joe, and then Todd can add any additional comments. Firstly, we experienced minimal sales growth in the first quarter, and our EPS guidance for that period reflects a 5% year-over-year increase. The margin stands at 26.1%, showing a 40 basis points expansion and marking a record for the first quarter. I believe this sets a positive foundation for us as we head into the year.

Todd M. Leombruno, CFO

Yes, Joe, I would add that transitioning from Q4 to Q1 can be challenging. Q1 marks the beginning of our fiscal year, and we need to account for some of the stock compensation that significantly impacts Q1. Compared to the previous year, we are forecasting 80 basis points of margin expansion for Q1 '26 versus '25, and earnings per share is expected to increase by just over 4%.

Joseph Alfred Ritchie, Analyst

It seems a bit conservative, but that's fine. I have a broader question. It sounds like you are noticing some positive developments across your businesses. Could you discuss what you’re observing in the Industrial short cycle business? Additionally, could you touch on the self-help opportunity for this year? You clearly did an excellent job from a margin perspective, so addressing those two points would be helpful.

Jennifer A. Parmentier, CEO

Sure. In terms of our guidance for In-plant & Industrial Equipment, we are anticipating a positive low single-digit growth for the year. This assumes a slow recovery in the industrial sector. Distributor sentiment remains optimistic, and we are well-positioned to take advantage of various customer supply chain initiatives. We expect to see a boost from increased maintenance, repair, and operations activity, as well as any factory updates or spending that occurs, with our distributors actively involved in that process. During a recent visit with a distributor, I noticed they are actively quoting, and there is activity happening, although we still need to address some of the delays we've been discussing over the last few quarters.

Todd M. Leombruno, CFO

No, Joe, I would just add, your question on self-help. Everything we have on The Win Strategy is a self-help margin-enhancing process of tools. We are forecasting slightly higher restructuring this year versus what we did last year, just in some of those regions or some of those end markets that may need attention.

Jennifer A. Parmentier, CEO

Yes. As you've heard me say before, we're very confident in our ability to expand margins with these tools. It has obviously shown in what we've done in all of the business in this past fiscal year and the ones before. But we have great teams that are using these tools regularly, delivering great results. It will continue.

Operator, Operator

We go next now to Jeff Sprague of Vertical Research Partners.

Jeffrey Todd Sprague, Analyst

Jenny or Todd, maybe you could just speak a little bit more to Curtis, kind of where the margin profile is on a Parker comparable basis, what kind of improvement you can get in the business from a synergy standpoint relative to the deal plan that you must have internally? And what's the growth been like in that business recently? How is it performing in 2025?

Jennifer A. Parmentier, CEO

Yes, sure, Jeff. We're really excited about bringing Curtis into the Parker team. We chose not to disclose their margins, more about the size of this deal. Initially, the margins will be dilutive, but we see a clear path to accretion with The Win Strategy. The tools we were just talking about and with synergies. We expect, like you've seen with our past deals, full synergies within 3 years, and relative size would be similar to the LORD and Meggitt deals. Historically, Curtis sales have grown mid-single digits to high single digits over the past 5 to 10 years, so really nice growth profile with them.

Todd M. Leombruno, CFO

Yes, Jeff, the only thing I would add is if you look at what we were forecasting for '26, the segment operating income dollars are roughly $5.5 billion, and that does not include Curtis. To Jenny's point, this will be slightly dilutive, but it's small in scale compared to where it fits in the total company.

Jeffrey Todd Sprague, Analyst

Right. It would be margin dilutive. I know you don't want to give an EPS number yet, but it looks like it's EPS accretive, right? Margin dilutive EPS accretive?

Todd M. Leombruno, CFO

Correct.

Jennifer A. Parmentier, CEO

Yes, we expect EPS accretion in the first year.

Jeffrey Todd Sprague, Analyst

Yes, absolutely. Okay. And then just on international orders. I guess, Todd, your comment alluded to the fact that maybe the softness here in Q4 was because you got some chunky orders in Q3. Maybe you could just elaborate a little bit more on that and what's going on sort of in the international order pipeline?

Jennifer A. Parmentier, CEO

Sure. Yes, Todd did mention that we had a very strong long-cycle orders in International in Q3. We saw that in HVAC refrigeration, power gen, Aerospace, and Defense. They didn't repeat in Q4, but we did see EMEA slightly positive with energy remaining really strong. In Asia, orders were slightly negative, and that was really more about a challenging comp to the prior year. But if you look at the order dollars, they were flat sequentially to Q3. So that really explains the difference between Q3 and Q4 and that drop that we saw.

Operator, Operator

We'll go next now to Scott Davis with Melius Research.

Scott Reed Davis, Analyst

Jenny and Todd, congrats on a good year. Just want to follow-on just on Curtis and then combine that with the big buyback, or the $1.6 billion that you've done. Is that an indication that you expect M&A to continue to be more of kind of the smaller bolt-on type stuff? Or am I reading too much into that?

Jennifer A. Parmentier, CEO

Well, like you've heard me say many times in the past, Scott, we have deals of all sizes in our pipeline. It can be small and bolt-on or there could be something larger out there. Timing is hard to predict. Our strategy remains the same. We want to acquire companies. We're the clear best owner. Fits in with our interconnected technologies and follows the secular trends that we've talked about here for a while. It doesn't mean that they'll all be this size, but we're going to continue to work that pipeline. It's building those strong relationships and making sure that we're ready when they're ready.

Todd M. Leombruno, CFO

Yes, Scott, I would just add, we've talked. We want to operate with net gross debt to adjusted EBITDA around 2. We finished the year at roughly 1.7. We do have capacity to do something even below 2. The cash flow generation profile that the company has really gives us lots of optionality. You saw us be active with the share repurchase this year. We will constantly balance what the best use of our capital is, and that's what we expect to do throughout FY '26.

Scott Reed Davis, Analyst

Yes, makes sense. I don't think you mentioned tariffs. I know it wasn't a big deal even last quarter. But just curious, is the lack of mention of tariffs an indication that you've just been able to capture price to offset any impacts? I'm trying to picture how 85 different P&Ls manage something that's such a big, complex global issue, but maybe you can address both of those in some way in your answer, if you can.

Jennifer A. Parmentier, CEO

Sure. First, I would just say our teams are doing a fantastic job managing tariffs and making sure that there's no impact to earnings per share. You probably heard us say pricing is something that is a strong muscle for us. This is a function within Parker-Hannifin. These divisions have pricing leaders. There's a lot of coordination within the groups and across the enterprise. Obviously, because a lot of our businesses share the same customers. So it's a lot of work. I'm not going to say it’s not. It's been a whole lot of work for them. But they had this down path. They've done really a great job with it, and we have the analytics. We have these robust processes, and we've been able to navigate and act very quickly. We didn't talk about it because we feel like we have it covered and it is going to continue to evolve and change, but we are going to make sure that it doesn't impact EPS.

Todd M. Leombruno, CFO

I would just add, pricing is one of the levers we're able to flex, but it's also our global footprint. It’s our local-for-local model that we've had for years. It's really our supply chain team being creative with dual sourcing and the ability to ship from multiple regions. Pricing is a big piece of it, but it's not the only tool.

Jennifer A. Parmentier, CEO

Yes. Our global capacity has been really a good thing for us.

Operator, Operator

We go next now to Amit Mehrotra of UBS.

Amit Singh Mehrotra, Analyst

Just a follow-up to that earlier comment. I just wondered if you can help us sort of bifurcate the exceptional margin performance and resilience between price and lower costs. I know each of the 85 divisions has its own pricing managers. So obviously, pricing is a focus. But one thing I noticed is the absolute cost base of the company also went down in fiscal '25, which was pretty amazing, just given inflation has been a little bit higher. So can you help us think about those two things? And is there an opportunity for the OpEx space, or the cost base, to actually move down on an absolute basis after the huge performance in '25? Or are we just entering a more normalized period where the cost base will mirror normal inflation?

Jennifer A. Parmentier, CEO

Thank you for the question. It gives me a chance to discuss the effectiveness of The Win Strategy. Our teams are dedicated to cutting costs and increasing margins, even in a challenging organic growth environment. This reflects our culture of continuous improvement, or Kaizen. We actively manage our operations rather than waiting for changes to occur. There is definitely room to further reduce costs, and our teams are consistently working towards that goal. We have an excellent lean system and a comprehensive set of tools that enable our general managers to effectively manage their businesses, which are all unique. The strength of The Win Strategy lies in the ability to utilize this toolbox to enhance various aspects of each business. Our teams are performing exceptionally well in this regard.

Todd M. Leombruno, CFO

It is a testament to the decentralization of the organization. Those 85 P&Ls have business leaders that are making decisions constantly. We've been taking costs out of the business for over a decade. We've talked about this a lot. We've changed our compensation structure to reward and be flexible with the flexes of business. I think that's been a nice plus to the profile and cost as well.

Amit Singh Mehrotra, Analyst

If that's the case, why is a 35% incremental growth projection the right figure for '26? You're seeing over 40% in Aero and International, while in North America, the decremental margins are around 2%. It seems like there could be an opportunity to exceed expectations when volumes increase, considering the pricing base and the cost factors you mentioned. Is this simply a conservative estimate, a reasonable placeholder, or is there something else that justifies the incrementals?

Todd M. Leombruno, CFO

Well, it is a gradual movement to positive. It's a 1% organic growth in the Industrial side of the business that is 70% of the company. I don't look at this as being conservative. Normally, we say model 30. We're at 35%. I think we just need to see how it plays out.

Operator, Operator

We'll go next to now to Andy Kaplowitz of Citi.

Andrew Alec Kaplowitz, Analyst

Jenny or Todd, could you give us a little more color on how you're thinking about Aerospace and Defense for '26? Was it obviously strong in Q4? Were they stronger on the defense side versus commercial? When you look at that 8% growth for '26, is the growth pretty balanced between defense and commercial and aftermarket and OE? How are you thinking about that?

Jennifer A. Parmentier, CEO

Yes. I'll take that. Full year organic growth at 8%, and we see that on continued MRO strength and gradual OEM recovery. We have commercial OEM expected to be low double-digit growth, commercial MRO at high single-digit growth, defense OEM at mid-single-digit growth, and defense MRO also at mid-single-digit growth. It's going to be another great year for Aerospace. We're coming off of 3 years of double-digit organic growth. We ended Q4 at about 9%, and we have Q1 at 8%. As I said, we have the year modeled at about 8%. So it's going to be another good year.

Andrew Alec Kaplowitz, Analyst

Very helpful. And then, Todd, you're guiding to a call at mid-single-digit plus EPS growth at the midpoint for '26, but free cash flow at the midpoint is slightly lower. I would have thought you get a little bit of cash tax help from The Big Beautiful Bill. So maybe just reconcile the forecast?

Todd M. Leombruno, CFO

Yes, we are digesting The One Big Beautiful Bill, for sure, and that will be a benefit. To be honest with you, that's more of an FY '27 benefit for us versus an FY '26 benefit. But on cash flow, there's a few things. When you're looking at net income, we had a few one-time items. We had some divestitures. We had some discrete tax items. We had some facility sales that helped build up the as-reported net income. This year, we do expect Industrial to grow. In previous years, we were getting a benefit from working capital. We do think there will be some investment there to support growth. You saw we called out 2.5% CapEx. That's higher than what we've historically done. This is all making sure we have capacity in the businesses that need it, and that we are investing appropriately in automation and robotics and productivity. I did mention, we do have a little bit more restructuring that we expect to do in FY '26 versus '25. Lastly, Jenny mentioned Curtis; we're going to have some one-time costs associated with the acquisition and the integration, and the cost to achieve the synergies that we've laid out there. We still feel really good about the number. We still think it's very much top quartile from a cash flow standpoint, and we're going to obviously try to outshoot that number.

Operator, Operator

We go next now to Andrew Obin of Bank of America.

Andrew Burris Obin, Analyst

Just a question on Aerospace. You had a re-acceleration in Aerospace orders in the past couple of quarters. I think, from high single digits to 14% in the third quarter, 12% in the fourth quarter. Can you just talk about this re-acceleration and what's driving this?

Jennifer A. Parmentier, CEO

I think, for the most part, what we've seen here is that the commercial transport rate is increasing and wide-body rates are growing to meet international traffic. I think that's been some of it. As air traffic growth overall continues, the aftermarket is continuing to grow. We have everything that's going on in defense as well. There's been a continued demand for all of the legacy programs and continued growth in the Department of Defense budget. We've seen some nice orders come in, and as you know, those are all longer cycle orders.

Andrew Burris Obin, Analyst

And I appreciate you gave some detail here. But last year, you had 7% organic Aerospace orders, and you delivered 13% organic growth. This year, you had 12% organic aero orders and guiding to 8% at the midpoint. Can you just help us understand the dynamic between orders and forecast a little bit better versus last year?

Jennifer A. Parmentier, CEO

As I mentioned earlier, these orders tend to be longer cycle. Currently, we have backlog coverage exceeding 100% in Aerospace, along with a record backlog. The incoming orders are higher, but there’s a limit to how much can be produced simultaneously. As production rates increase, we expect to benefit from that. We maintain close relationships with all our customers, particularly in Aerospace, where we have a clear understanding of their build plans and production rates, giving us strong visibility into both demand and capacity. Therefore, we believe that Aerospace's growth rate of 8% in Q1, compared to 9% in Q4, is quite in line with expectations.

Todd M. Leombruno, CFO

Andrew, we're expecting that to be pretty consistent throughout the year. There's no real ramp on what we're forecasting here. Every one of those numbers will be a quarterly record for Aerospace. So the momentum continues.

Operator, Operator

We'll go next now to Julian Mitchell of Barclays.

Julian C.H. Mitchell, Analyst

Maybe just wanted to start with the industrial growth outlook. It sounds like Aerospace is sort of pegged at 8% growth in the first quarter and through the balance of the year. Maybe help us understand within Industrial, what's dialed in for sort of the first quarter, and then the slope of that acceleration on organic sales? And anything you've seen around the pull forward of demand by distributors, or OEM customers because of tariffs?

Jennifer A. Parmentier, CEO

Yes. I would first just start off saying, Julian, that we're not seeing any evidence of a pull forward. There's nothing that I could point to that would show that. For industrial, for Q1 in North America, we're forecasting negative 1.5% organic growth and positive 0.5% for International. So total Industrial, we're still showing it slightly negative here at approximately 1%. When we look at North America, in particular, I'm seeing gradual in-plant industrial recovery, and as I mentioned, positive sentiment from the distribution channel, a lot of increased quoting activity. Transportation remains challenged in auto and trucks, but construction is getting better. Ag is still weak; power generation is strong in our energy vertical, oil and gas remains a little weak. In HVAC, it's really coming off a strong fiscal year '25 with a lot of refrigerant changes. We expect it to be low single-digit growth in fiscal year '26, and that will be more around commercial and refrigeration than it was residential in fiscal year '25. When we look at International, Industrial International, again, we have that full year expected to be at about 1%. Q1 again is about 0.5%. Again, same assumptions on a gradual industrial recovery. EMEA, flat to slightly positive organic growth for the fiscal year. Uncertainty remains, but we expect continued strength in energy, both oil and gas and power generation.

Julian C.H. Mitchell, Analyst

That's very helpful. And just my follow-up, maybe circling back to the operating margin expansion guide. It's up, I think, 40 bps in the first quarter, and up 40 for the year as a whole. As you said, that's sort of despite volume leverage accelerating through the year. I just wondered maybe on that point, maybe is there some sort of mix effect in Aerospace, perhaps, that weighs later in the year, maybe due to Meggitt synergies being front half-loaded, or the outgrowth of commercial aero OE versus commercial aero aftermarket? Anything like that sort of moving around in aero, or it's just pretty steady through the year?

Jennifer A. Parmentier, CEO

That's just steady through the year. We are expecting commercial OEM to be low double-digit growth and MRO of high single-digit growth. They are kind of changing this year, but we see it pretty much the same throughout the whole year.

Operator, Operator

We'll go next now to Jamie Cook with Truist.

Jamie Lyn Cook, Analyst

Nice quarter and nice year. The first question. Just the North American margins in the quarter struck me like the strength of the margins. I think it's one of your highest margin quarters despite a decline in sales and in organic growth. Was there anything unusual in that mix, pricing or something, which drove the margins high with organic sales down? My second question, just on the guide, Todd or Jenny. If we think about the past couple of years, the story of Parker has been while Industrial has been weaker, Aerospace is making up for any delay in the recovery in Industrial. I guess as you think about 2026, do you think there's greater risk that if Industrial doesn't inflect that Aero can't make up for it? Or perhaps you're just more bullish on Industrial just given at least we're seeing some resurgence in orders?

Jennifer A. Parmentier, CEO

Okay. So first question, yes. Q4 North America was just great, expanded margins, 170 basis points year-over-year. We really had a favorable sales mix, specifically in our engineered materials group and our filtration group. Exceptional performance with those two groups, and with strategy execution across the other groups as well. Not to take anything away from them, but we had a nice favorable mix in those two areas. As far as a risk in the future with industrial, I would say we have 1% organic growth in Industrial. I think our guide reflects what we see in orders, what we see in backlog, and what we know about what's going on in these market verticals. All in all, I would say that all of us want to be bullish on Industrial. It's time, right? As I said, we're poised for growth here. I'm not concerned that we won't be able to continue to expand margins and deliver this guide.

Operator, Operator

We'll go next now to Mig Dobre of Baird.

Mircea Dobre, Analyst

I only have one question, and it's about the guide, too. I don't know, maybe just for you Todd. If I look at the exit rate here, $7.69, really a good fourth quarter. If we annualize that, we end up with something just under $31 of EPS. What's interesting in my observation here is that going back over the past decade, you're able to do that or better. So you're able to do better than your annualized exit run rate on every single year with the exception of fiscal '21, when you had to deal with COVID. I guess my question to you is, why this year, fiscal '26, be any different than the norm?

Todd M. Leombruno, CFO

Mig, this is Todd. Yes, we would love to take Q4 and annualize that. The math on that looks great. The reality is that's not the way the business operates. If you look back over decades, our sales mix is 48% first half, 52% second half. Obviously, that 52% is fully weighted by that strong Q4 result. We also have to recognize some of the stock comp that is a big hit in Q1 versus the prior year. Jenny mentioned this, but we're forecasting 40 basis points of margin expansion Q1 '26 versus '25, and EPS is just a little over 4% of an increase.

Operator, Operator

We'll go next now to Joe O'Dea of Wells Fargo.

Joseph John O'Dea, Analyst

Can you talk about the complexion of 8% organic aero growth over the course of the year? How does that shift between commercial OE and aftermarket? And really getting at the margin mix considerations within that? I think for a while now that's been a focus topic clearly, with Aero margins up again this year. Maybe I'll weave into the question just any color on Meggitt synergy contributions for the year?

Jennifer A. Parmentier, CEO

We don't go into that much detail and disclose all that mix within the year. I would tell you, as I said with my slides earlier, we ended the year at 51% aftermarket, 49% OEM. We're showing OEM to be low double digits this year and aftermarket to be high single digits. We continue to be confident in expanding our margins. The Aerospace guide at 8% for the whole year is appropriate for what we see now.

Todd M. Leombruno, CFO

In respect to the synergies, you had a question about synergies for Meggitt. We still believe there's $50 million of synergies left to achieve on Meggitt. We expect that to ramp throughout the year, just like we've seen it for the last 3 years. So all is going unbelievably well with Meggitt, and that's in the mix as well.

Joseph John O'Dea, Analyst

I think the sentiment among our North American distributor partners has improved over the last few quarters. Are you noticing any developments in areas that are showing improvement? What do you believe is holding back the acceleration of quoting into orders, and to what extent are tariffs or other factors influencing this?

Jennifer A. Parmentier, CEO

I mentioned that I had been on some distributor visits recently, and again, it's a common theme. Quoting activity is high; no project cancellations or delays. There are pockets where some of them are participating in retooling in the automotive space and just some refurbishments that are happening. You hear about those pockets of where they're really having wins. Overall, I think they were very bullish on the future; that's what we continue to hear. The second part of your question, I think one of the things coming back might be uncertainty, right, on tariffs and interest rates. I think those two things may be holding up projects or purchasing decisions. But as I said before, distribution is bullish, we're ready, and it's time for an industrial return.

Todd M. Leombruno, CFO

Bo, I think we've got time for one more. Can we take one more question?

Operator, Operator

We’ll take that final question today from Nigel Coe of Wolfe Research.

Nigel Edward Coe, Analyst

Jenny, I agree, it is time for this recovery. Bring it on. I just want to dig into the free cash flow. Todd, you mentioned CapEx 2.5%. That's about $0.5 billion of CapEx, so that's about $100 million higher – not a big deal, but I'm just wondering, do you think that's sort of a medium-term shift in CapEx? The reason I am asking is because we've heard this from some others. I'm curious if you're sort of reinvesting in the U.S. and if that's what's driving it. Maybe just put a finer point as well on the cash restructuring you expect for FY '26?

Todd M. Leombruno, CFO

Yes. I think the CapEx, I can't say that that's going to be a go-forward rate. We do have a few projects this year that we're investing in. Most of those are in North America, in the North American region. I think that's more of a one-off type of thing versus a run rate going forward. On restructuring, we did about $50 million in '25. Right now, we're forecasting about $70 million in '26. So it's $20 million more. But again, I don't want you to read too much into this. This is just working capital investments for growth, integrating Curtis according to our schedule, and paying all those fees with it. Making sure that we continue our multi-decade plan of free cash flow conversion.

Andrew Burris Obin, Analyst

Great. And then just a quick one on the profile of the industrial recovery you're seeing in FY '26. It seems like you've down and flat to maybe slightly down in the first half of the year and obviously 2% to 3% in the back half. Would that be directionally consistent?

Todd M. Leombruno, CFO

That is exactly what we have, roughly flat first half to the second half. That's total Industrial.

Operator, Operator

That concludes our FY '25 earnings release webcast. We appreciate your time and attention, and thanks again for joining us today. Our IR team will be available. That's Jeff Miller, Jenna Stuckey, and Chantelle O'Kelly, if there's any need for any follow-ups or clarifications. Thank you all again. Have a fantastic day.

Todd M. Leombruno, CFO

Thank you, Mr. Leombruno, and thank you, Ms. Parmentier. Again, ladies and gentlemen, thank you for joining Parker Hannifin's Corporation's Fiscal 2025 Fourth Quarter and Full Year Earnings Conference Call and webcast. Again, that will conclude our call. Thank you all so much for joining us, and we wish you all a great day. Goodbye.