Meggitt PLC (PH) Earnings Call Transcript & Summary

Good day and thank you for standing by. Welcome to the Parker-Hannifin Conference Call and webcast to discuss the completed acquisition of Meggitt PLC. [Operator Instructions] I'd now like to hand the conference over to your speaker for today, CFO, Todd Leombruno. You may begin.

Thank you, Towanda. Good morning, everyone, and thanks for joining our webcast today. We are so excited to be able to update everyone on the closing of Parker's acquisition of Meggitt PLC. As Towanda said, this is Todd Leombruno, Chief Financial Officer speaking, and I'm joined today by Tom Williams, our Chairman and Chief Executive Officer. Our discussion today will address forward projections for the Meggitt acquisition and the Parker Aircraft Wheel and Brake divestiture only. We will refer to non-GAAP financial measures. Slide 2 provides details to our disclosure statement in these areas. Actual results may differ from our projections due to uncertainties listed in these forward-looking statements and detailed in our SEC filings. Reconciliations for all the non-GAAP measures, along with this presentation have been made available under the Investors section at parker.com and will remain available for 1 year. Today, our agenda begins with Tom, welcoming the Meggitt team to Parker, detailing the secular growth opportunities we see in Aerospace, and describing how Meggitt complements our overall portfolio. We will also touch on our proven track record of achieving synergies, highlight the commitments we've made to the U.K. and talk about our path to expanding EBITDA margins. I will give an overview of the transaction details and provide color to the additions and subtractions to our forecast for the remaining 9 months of our fiscal year 2023. It is important to note today, since we are so close to the end of our quarter, we are not commenting on our initial FY '23 guidance for the legacy company that we just issued in August. We're simply highlighting the addition of Meggitt and the divestiture of Parker Aircraft Wheel and Brake from the date of close through the remainder of our fiscal year 2023. Tom is going to close the presentation today, just explaining the compelling value this acquisition creates for shareholders. And then Tom and I will take any questions that anyone has on the materials we cover today. So with that, Tom, I'll turn it over to you and ask everyone to refer to Slide 3.

Thank you, Todd, and welcome, everybody, to the call. Really glad that you can join us today. It's an exciting time as we welcome the Meggitt team joining the Parker, 2 great companies being put together. Given that the acquisition announcement was in August of last year, we thought it would be good to have a dedicated investor call to update everybody on the acquisition. And as you can see from the illustration, we've got on Slide 3, we're ready for takeoff. And we have taken off and acquisition closed September 12, and we've had day 1 celebrations at Meggitt facilities around the world, which you could see on Slide 4. Just some sample pictures on the day 1 celebrations. We had partner executives at every site to welcome the Meggitt team and really myself, and the entire leadership team, a warm welcome to all the Meggitt team members around the world. We are so happy to have you part of the team. So great pictures, and I was at one of them and very exciting times, very energizing for everybody. If you go to Slide 5, I kind of want to take you back to what we talked about at Investor Day in March, the 4 secular trends, and how they're going to positively impact Parker going forward. You see them in a picture there: Aerospace, Digital, Electrification and Clean Technology. Obviously, Meggitt further strengthens our aerospace position but these secular trends in combination with the portfolio transformation the company has done over the last years and the 1 strategy changes are really the key enablers to that new goal we put on growth of 4% to 6% organic growth over the cycle. On Slide 6, I wanted to give you a little bit more insights into why we like the long-term growth dynamics of Aerospace. It's really the first 2 circles on the left to 19,000 and 77% are all indicators of statistics that support long-term commercial OEM growth over the next 10 to 20 years. The 3.8% is the revenue passenger kilometer growth over the next 20 years. So that's an indicator of commercial MRO activity being strong over this period of time. And then, we've got the F-35 in service, and so it's early days of spares and repair activity, and we're projecting repair activity to increase by a factor of 4 over the next decade. So a lot of really good statistics to back up the positive trends we feel about aerospace, put that in combination with Meggitt, and you really got a strong aerospace business going forward. On Slide 7, looking to illustrate the transformation of the portfolio. Over the last year, if you start with FY '15, we have strategically reshaped the portfolio to double the size of Aerospace, Filtration and Engineered Materials. You can see there as we bracketed them from $5 billion to $10 billion of the portfolio. This will further enhance our resilience over the cycle and increase organic growth. And with Meggitt, there's a portion of that business, composites and seals, that is really better aligned with our Engineered Materials business. In our Engineered Materials business, they are the best owner in home for these type of technologies. They have the expertise in material sciences and the process to go into producing these products. They serve today a variety of end markets, including Aerospace, the rest of Meggitt will go into the Aerospace reporting segment. And Todd will give you the split between as far as where Meggitt goes x percent of the aerospace, North America and international later in the presentation. We just call your attention down to the FY '23 guide pie, you see Filtration and Engineered Materials $5.6 billion. And just -- we haven't really disclosed this in the past, but just to get a feel of that $5.6 billion, about $850 million of that predominantly Engineered Materials goes into supporting aerospace applications. So we've got Aerospace as a segment we report separately, but there's other technologies that we have, predominantly filtration and engineered materials that support that industry as well. If you go to Slide 8, it's really the combination of the portfolio changes that are on the prior slide, those secular trends that I started with, it's going to create a profound shift in our sales mix. So if you look at it from an illustrator standpoint, at FY '27, we'll have approximately 85% of the company that will either be long cycle or will be tied to industrial aftermarket. That's a significant mix shift and it gives us additional confidence as to why we're going to grow differently in the future. So if we go to Slide 9. Just to refresh everybody, so why Meggitt? Why did we want to acquire Meggitt? Well, first of all, it's a company we've admired for a long time, and it really creates a powerful combination. The very first bull is kind of the sweet spot of acquisitions where you understand the customers, you understand the end markets. In this case, in aerospace, you're on premier programs, but you're on there with complementary technologies to your existing portfolio. Second bull, I have a pie chart to illustrate this. We're going to be increasing the aftermarket mix by 500 basis points, obviously, more resilient top line and margin enhancement. As we've gotten to know the team through due diligence and integration planning, of course, today with about 2 weeks of ownership, this is a very good cultural fit. Similar heritage and values and great people, highly engaged. We're poised to benefit on the commercial aerospace recovery, but also the military business will do well, as I think we all recognize we live in a more dangerous world and military investments are going to happen in the future, probably at a quicker pace than they had in the past. Both companies, equally focused on sustainable aviation, and that's a good thing. We'll be able to create incremental value from our customer's technologies. And then we're going to have a very compelling value proposition for customers, a stronger bill of material, the ability to solve more problems with customers and create additional customer value. And if you add all these up, we're going to drive significant shareholder value as well, which we'll get into when I show the synergies momentarily. Go to Slide 10. This is Meggitt sales profile. On the left-hand side is a pie chart of sales by application. I'm not going to go through all of these because I'm going to cover some of the products and technologies in more detail in subsequent slides. But on the left-hand side, the 1 comment I did want to make because I'm not going to cover later is on that energy and power generation. In power gen, they do sensors, pressure and temperature sensors for the turbine. And then on the energy side, is to be heat exchangers, primarily in LNG and regasification, which is obviously an attractive space given the world's needs for LNG, especially in areas that lack stable natural gas flow. On the right-hand side is sales by customer geography, you can see significant sales in North America, but makes our aerospace business more global than it has been in the past, but a very well balanced, very well balanced across the various platforms and applications. Go to Slide 11. I mentioned earlier a lot about that aftermarket mix going up 500 basis points. On the left-hand side is legacy Parker Aerospace, 36% aftermarket. Meggitt is 46% aftermarket, so 1,000 basis points higher. And then when you do the combination, it will be at approximately 41%. Again, this aftermarket mix shift is going to drive a more resilient top line and better margins as well. If you go to Slide 12. I have 2 slides where I'm going to walk through both on the airframe and the engine side, little bit about Meggitt's products and technologies. And I'm going to provide a little bit of color, not to make people aerospace engineers, but to help, I think, illustrate what they do. So just to orientate you to this slide, Parker is in blue, I'm not going to cover that because that's currently what you should already know. And then Meggitt is in green. So we're starting kind of in the upper left top of the page, fire protection and safety. So that will be smoke and fire detection sensors, and then fire suppression primarily for the engine, the APU and the cargo compartment. Avionics and sensors would be for secondary flight controls, and then sensors to provide applications on pressure, ice detection, aircraft position as examples. Door seals would be pretty much what you might think it is. It is in the main door and the landing gear door. Fuel tanks and bladders, self-explanatory. Braking systems, obviously, a very important part of the company, both at the component level as well as the system levels that they make those and main wheels. They have carbon steel and electric rigs, and on the systems side, they do the control system, they do brake control valves and anti-skid valves as well as brake temperature monitoring. In the electric power, a couple of examples, they have electric-driven generators. Think of that as for power for avionics, lighting and actuation. We've got AC/DC converters as most of the equipment on board uses DC. If you go to Slide 13, same process on the engine side. Again, Parker in Blue, Meggitt in Green. Start kind of in the middle of the page, upper right on sensors. This will be primarily by patient monitoring just to make sure the engine is in balance. Fire protection, this would be for detection and suppression, similar to the airframe side. The composite you see there, this is engine inlet anti-icing. So these are electrically heated composites to help prevent icing. The sealing applications are primarily the interface between the heat exchanger and the duct work that would be in the core. Thermal management with the heat exchangers to cool the engine oil. And then on the valve side, there's to be bleed air anti-icing and then engine control valves as part of the portfolio. I think another way to illustrate it is on Slide 14, and you've seen us do this before. Now we didn't list all of Parker's existing capabilities. We really started with what Meggitt brings and just to illustrate whether there's any overlap there. And again, this comes back to the highly complementary nature of the acquisition. Again, to me, this is a sweet spot when you add technologies that are complementary on top of customers and markets you know well, it creates a very compelling value proposition for your customers. Now on braking, familiar that we sold our braking business. So we're a hollow dot there. So we're excited to have Meggitt's braking system join the company. Strong sensor portfolio that I illustrated some of that in the prior slides, the safety systems. On the Engine Valves, you see dots for both Parker and Meggitt, but there's different actuation technologies utilized for. So Parker's primarily fuel drop actuators are using high-pressure fuel to actuate the valves. And for the most part, on Meggitt's technologies is primarily pneumatic. Electric Power were some of the electric capabilities I mentioned on the airframe and then a bigger thermal management offering, primarily heat exchangers, that helps us and, obviously, in more electric hotter applications, just having thermal management is a strong offering. So a much broader offering, in addition you add the legacy Parker technologies to help solve problems for our customers. Go to Slide 15, a little bit about the approach and how we're going to capture synergies. And it's going to be a very similar approach and structure, that's been so effective in the last 3 acquisitions. This is where we take leaders from Meggitt and leaders from Parker, put them on either value creation and synergy teams or the functional integration teams, think of the typical functions, finance, IT, supply chain, et cetera, and the value creation teams around those areas, we think that are the most energetic, approximately 20-plus teams that are engaged. And we've got a very robust -- we've done a lot of these. We have a very robust program management and operating cadence around us, and we've got a great track record. You've seen our track record on either beating the synergy targets or hitting them sooner. Obviously, either one of those would be a great outcome for the business, but a very structured and deliberate process to drive value. And speaking of the synergies on Slide 16 -- no, sorry, that's the next slide after that. Slide 16, I wanted to try to give you a little bit more comfort and understanding about the regulatory commitments that we've made to the United Kingdom. And maybe just to step back for a second for many people that aren't familiar with why we had engaged in that process. U.K. government, probably about a year before we actually started approaching Meggitt, put into law an approval process that had a factor in economic and national security considerations, in addition to the normal antitrust reviews, whenever you had a foreign company buy the U.K. asset. I want to characterize this list, which I'll go through here momentarily, but first, this is a very natural logical list of commitments that we make that we would have done regardless of whether it was government involvement or not. And then second, this is in no way limits our ability to generate synergies. So let me just walk through a couple of these and give you some illustration. So first one, maintaining Meggitt's Ansty Park Center of Excellence. This is a center of excellence where the Meggitt team consolidated some facilities and kind of created a center of excellence around brakes, not the only place to do brakes, but a center of excellence for brakes in the U.K. MRO services for the EMEA region and then heat exchangers. So we'll continue that. It's a great facility. Retaining existing U.K. technical capabilities, which we would have, things like brakes, heat exchangers, additive composite sensing and avionics. On the people count, that third bullet down, maintain approximately 1,400 U.K. technical jobs, and increase apprenticeship by 20%. Let me start with the technical jobs. Without getting real detail, just think of that as manufacturing people count labor there and R&D engineers. And to help give you some backdrop that 1,400 represents about 60% of the U.K. people count. So we have ample room to do the things we think might be appropriate for how we structure Meggitt in the U.K. And the apprentices is just good -- smart to do. This is what we're doing around the world. As you look at succession planning for our talented team members in the factories, we need to have a stronger apprentice program. So we're happy to invest in that and increase that over this period of time. Now we're going to increase the U.K. R&D spend. That's about GBP 6 million over the next 5 years. So that's a relatively nominal amount and we're happy to do that. And continue to invest about 2/3 of that sustainable initiatives. When you look at our portfolio of innovation as well as Meggitt's, they're all geared to these kind of things, light weighting, more efficient applications, reducing emissions, improving fuel efficiencies. They're all doing sustainable activities. So this is an easy lift because it's a natural part of what we do. Next bullet down, uphold existing U.K. government contracts. Of course, we would do that. We always do that. We honor the contracts we have with the governments. On the climate side is very much similar to what we do today. They're a little bit earlier on their 50% target. We're at 2030, they're at 2025, but they're aligned to hitting that number. And our net zero for the company was 2040, they were 2050. So a very similar approach to trying to show incremental improvements and a long-term vision of getting to carbon neutral. So really, this list of commitments is going to drive and help us in tandem drive long-term value creation. So we're very comfortable with this list and we should be comfortable with it as well. So again, what I was referring to now on the synergies, Slide 17. Take the left-hand side first, just to orientate you to the page. Synergies are in blue by fiscal year between FY '23 and FY '26. The cumulative cost to achieve is in gold. As you can see, they're going out over the same time period. We're starting off at approximately 20% EBITDA margin. This is our projection, our estimate for this year. Think of it as base business plus that $60 million of synergies you see in the blue bar. And the synergies we're going to do in this period of time taking us to about 30% EBITDA margin. So now on the right-hand side, let me give you a little bit of color on to how we're going to achieve it. Think of it as really as, it's the Win Strategy overall is the overarching business system, driving synergies and operational excellence. And the Meggitt business system is very similar to the Win Strategy. I would just characterize it as earlier days and probably closer to the original Win Strategy as far as where it was. And so really, the upside is the transformation that you saw with Parker as we went from the original Win Strategy to Win 2.0 and Win 3.0. And you saw the margin enhancement and the EPS enhancement that I've showed you over the years, we expect the same kind of leverage as we introduce the Meggitt team, and they evolved to Win Strategy 3.0. Now if I just take you through some of these boxes that you see on the right-hand side, safety, lean Kaizen, High-Performance Teams, that HPT acronym and simplification. Let me start with simplification. Simplification will be a big driver. And you're familiar with our simplification approach, it's structure, organizational design, it's 80-20, so that revenue complexity and simplify design. Those are the 4 key elements. They will be a big driver of synergies. Our branded Kaizen is really those first 4 words, it's safety, lean, performance teams with Kaizen, and that's how we create step changes in quality, productivity and safety for our team members. The other part I would say before leaving this quadrant is that if I compare the 2 companies, legacy Parker is more decentralized. And I think we're going to obviously do that across the entire company. We believe in that. We like to drive ownership to the lowest levels we can in the company. We like intimacy with the P&L, that intimacy with customers. But the one thing I think you're going to -- we're going to see is that we're going to be creating the ability that ownership mentality to unleash lots of ideas that the Meggitt team has, by giving them the authority and empowering them to drive the things that they see and make decisions faster. And so we're going to encourage that. We're looking forward to that. If you move to the right, SG&A, the way I just summarize it to help you get to the impact here. Meggitt is in the low 20s. When you think of a SG&A as a percent of sales and Parkers in the mid-teens. So you've got lots of opportunity to improve the SG&A structure. Think of this as being very lowered like and comparing to our prior acquisition of Ford, where this is more a SG&A versus a footprint. And that takes me to the footprint optimization. There'll be a relatively minor footprint opportunities here. Remember, these are complementary technologies, not a lot of overlap at the plant sites. Obviously, we'll look at potential to co-locate sales offices, if that's obvious, and there might be some minor footprint optimization, that's relatively small. Remember, CLARCOR was a large footprint optimization. And again, when you look at the degree of risk, it's a lot easier to do Win Strategy, SG&A, supply chain things versus footprint. And that's what we have with this acquisition, a lower risk profile, the type of synergies. And then lastly, supply chain. We'll be looking to optimize the supply chain, comparing pricing, terms and conditions, looking at direct, indirect materials as well as logistics. And if I just would summarize the whole approach, any time we look at an acquisition, it's taken the best of Meggitt and the best of Parker, so that 1 plus 1 equals 3, and bringing everybody because if you think about the Win Strategy, it's suite of best practices, both inside and outside the company, and we're open to create ideas wherever they happen to originate. So we feel good about this road map. And with that, I'll turn it over to Todd to give you more details.

Thanks, Tom. I share your excitement. This is really a transformational transaction for us. I'm looking forward to getting into it. I'm going to start on Slide 18 and just really, I want to reiterate the commitment we have to our fiscal policy. We have a gross debt-to-EBITDA target of 2x. There is no change to that fiscal policy. Obviously, we've used our capacity now on the last 3 transactions, Meggitt will be the fourth. These have been transformational transactions for the company. They have helped us grow. They've increased our margins that generated cash for us. And we've used our discipline in our cash flow generation to quickly delever after these transactions. And if you look at our strong cash flow profile today, we have basically achieved a 2x reduction in the leverage post close in about a 2-year period after each of these last 3 transactions. So with the performance of the company, we're very confident that we can do that again with the Meggitt transaction. We're not speaking to gross debt to EBITDA at close, simply because we don't want to mention EBITDA for the quarter. We will give you more color on that, obviously, when we close Q1 in November, but very confident in our ability to delever quickly. If you look at Slide 19, I'm just going to give some details on the transaction. Obviously, everyone knows we announced this last August. The total consideration has not changed. It's $8.9 billion. That essentially is the transaction price. Since last August, and this is something that we're extremely proud of, we have already allocated $1.8 billion of cash from our cash flow generation towards the purchase price. So new financing for the transaction is $7.1 billion. So that's the new finance debt of $7.1 billion, about 50% of that, half of that is serviceable and it allows us for easy, flexible repayment and we're very focused on doing that right now. I think everyone knows the $2 billion term loan that we announced a while ago, we did draw on that in September. That is essentially the only incremental debt that we've had since the June report. And we will have about $1.5 billion of commercial paper that will also be flexible. So that makes up the $3.5 billion flexible amount. The $3.6 billion of bonds, those are the bonds that we issued in June. So those are not new bonds. Those were bonds that we issued in advance of payment. Those are split into 3 tranches, a 2-year bond, a 5-year bond and a 7-year bond. Again, those were already issued in June for the Meggitt transaction. So looking today, obviously, rates have changed significantly. Our all-in weighted average interest rate for all of this financing is still only 3.9%. That is very similar to what we've done in prior deals, and we feel comfortable with that. And that is the current rate as of today. And about -- like I said, half of that is serviceable, flexible payment and the rest is longer term, what you can see in the longest term we have set out is 7 years. We've also assumed approximately $1 billion of Meggitt debt. We've talked about that before. That's about $900 million in debt that Meggitt had. And then the remaining difference is just the recognition of some capital leases from a GAAP standpoint. And then lastly, on this slide, I just want to reiterate that our current debt ratings have been maintained at Baa1/BBB+ and of course, A2/P2 for our commercial papers. So company is in strong financial shape and ready to continue to focus on paying down debt. If you go to Slide 20. Slide 20 is what we're providing for a preliminary forecast. This is for the Meggitt acquisition and the Aircraft Wheel and Brake divestiture. If you remember, our initial guide that we just issued in August, we did include what we defined as the committed interest expense for Meggitt in Q1. That was really the bonds that we issued and the commercial paper that was outstanding. That did not include the $2 billion term loan that was drawn later in the month of September. And we did include a full year of Aircraft Wheel and Brake because that was contingent on closing Meggitt. So all of these numbers presented on this slide are really incremental to what we just announced in August. So first, if you look at the yellow shaded column, this is the forecast we have for Meggitt. That's from the date of close through the end of our FY '23. So that's basically a little over 9 months of activity. We see sales to be about $1.8 billion, adjusted segment operating income is forecasted to be $300 million, and that incremental interest expense, that is for the term loan and for Q2, 3 and 4 of our fiscal year, that is expected to be $225 million. That's for the 9-month period. So if you're looking for a full year of interest, you would add that $42 million that we guided to originally to the $225 million that's listed on this slide. What is powerful here is on an adjusted basis, EPS in the stub year, the 9 months that we will own Meggitt, it will add $0.45 to our earnings per share. Very happy with that. We have had a number of questions throughout this entire period on what the first 12 months of Meggitt would look like. So we are providing that information. That's the blue shaded columns on this page. That is the first 12 months. So that obviously reaches into Q1 of our FY '24. It's really just there for informational purposes. So you could see in the first 12 months, we expect $0.80 of EPS accretion for adding Meggitt. We are guiding and forecasting $0.45 for our fiscal year FY '23. And Tom mentioned earlier, but I just want to clarify, the majority of this Meggitt activity will be reported in our Aerospace Systems segment. You can see on the slide here, 82% will be reported in Aerospace, 14% will be reported in Industrial North America and 4% will be reported in the diversified international industrial segment. So one last thing on this slide. In respect to aircraft wheel and brake. I mentioned before, we did include this in our FY '23 guidance. Now that, that divestiture is closed, we are removing that from our forecast. And what we've done here is, we've laid out the 9 months looking forward that we would have guided for in FY '23 that we were moving from our forecast. Sales are approximately $55 million, adjusted segment operating income was expected to be about $21 million, and EPS was expected to be $0.12. So all of that was reported in the Aerospace Systems segment. And I just want to summarize the 9 months of Meggitt, that $0.45 needs to be netted against the $0.12 of Wheel and Brake, and that's really what we're adding to our FY '23 forecast. So that's what I had on just financial transaction details and guidance. And with that, I'll ask you to move to Slide 21, and I'll turn it back to Tom.

So just 1 last slide to wrap things up before we open it up to Q&A. A compelling value creation for our shareholders. EPS accretion in FY '23, Todd illustrated that, $300 million of synergies by FY '26, high single-digit ROIC, I am referring to the deal ROIC in year 5 with continued expansion. Our goal as a total company is to drive ROIC to 15%. Overall, think of this as the base business plus Meggitt, that's a top quartile ROIC number. This is a strategic capital deployment, reshaping the portfolio, aligning us to separate trends to drive long-term shareholder value. Our dividend policy is not changing. We're going to continue to break those records of annual dividend increases as well as keep it in that strike zone of 30% to 35% of net income in our 5-year average payout, and we're committed to a strong balance sheet. We're committed to investment-grade credit. We're going to rapidly deleverage with our strong cash flows in the same way that you've seen us do in the past. And with that, I'm going to turn it back to Towanda to open things up for Q&A.

[Operator Instructions] Our first question comes from the line of Jamie Cook with Credit Suisse.

Congratulations. I guess my first question, Tom, now that we're sitting over a year from when you announced the deals, can you talk about the conversations you're having with your customers and the potential for revenue synergies if you're feeling any more optimistic there. And then my second question, can you just talk to understanding you laid out the cost to achieve and the cost synergy targets, assuming the macro were to weaken, how do you think of the earnings resilience of Meggitt and/or could you accelerate some of the cost opportunities that you have, if the macro were to weaken?

Jamie, it's Tom. So from a customer standpoint, customers have been very positive. I think one of the things that they like is the opportunity for hopefully, they know our operational excellence. They know our track record on quality and delivery. And then I think they're looking for us to be able to help things as we look at the total company. And so we're going to obviously try to do that, working together as a joint team. On the revenue synergies, we did not put any in. As you probably are aware, these are all cost synergies only. But clearly, we will take a look at by account, what is the best way to approach an account to how we create the most value. We've not quantified those, but there's always synergies on the top line, whether it's an aftermarket servicing headquarter or on the OEM side. They will just be longer term, and we don't count on them because we want to hurdle this on the cost side only. On the cost to achieve, I think the advantage here, we're buying a property that's recovering from a COVID decline and obviously, COVID impacted aerospace industry harder than the industrial portion of the company. And I think while this macro could weaken, I think that the -- we're in good shape to see -- there's no really debate on whether Aerospace is going to improve. It's a question just related on the trajectory. And so I feel very good about that. I think that synergy walk will be very resilient to whatever happens on a macro standpoint. So I'm confident we could deliver that, whatever happens in the macro. As far as pulling in costs to achieve, it will really be not so much driven by the macro, be more driven by our knowledge of the business and getting really at that simplification initiative, creating the right structure, right talent, right organization to sign, all those kind of things. And as soon as we're comfortable jointly, both the Meggitt and the Parker team as to what that looks like, we'll do that regardless of what happens with the macro environment.

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

I just -- I guess I'll have 2 questions. So the first one, if you look at Meggitt inventory turns, they've been a bit below Parker quite consistently. So the question is just generally between just structurally low inventory turns and supply-chain issues specific to aerospace, what's the near-term ability to release working capital from Meggitt? And longer term, what's the opportunity to bring Meggitt inventory turns more in line with Parker's average?

So Andrew, it's Tom. So yes, so over time we would like to do that. And I think that's -- we feel very comfortable to having their working capital match our working capital. What I would say first is that I try to have it match Parker Aerospace's working capital and then we'll try to get the whole thing to the total Parker average. But doing lean, Kaizen, supply chain, I think their supply chain, they've experienced about the same kind of challenges that we have. So I wouldn't necessarily say that they're better or worse than that. But what we've seen typically, as we do in the Parker Lean system, is we see improvements in inventory, we see improvements in on-time delivery, we'll free up working capital. We do pretty good on receivables. As you know, that's the strength of the company, will look at their terms and conditions for all their payables. So yes, from a cash flow standpoint, we're looking to move the working capital closer to Parker. And this -- when we gave you the guidance on cash flow for FY '27, that's 16% free cash flow target, that included Meggitt. So we -- that's our goal, and that's a top quartile goal with including Meggitt. Welcome back to the calls.

It's good to be back. Just a follow-up question on your payout ratio. Just looking at the basic accretion over the next several years, I think you've grown dividends low teens over the past several years. But if you look at the accretion, your dividend can easily grow quite a bit above that for a number of years, just thinking about Meggitt accretion. Is that the right way to think about the basic math?

Andrew, it's Tom again. Yes. Without me committing to a number, it's going to keep pace. And as you can see between this, what we'll do with the base business and you can look at our FY '27 targets, and we're pretty good on our say-do ratio when we lay out a 5-year target about delivering them, that you would expect our dividend growth rate to be at a faster clip than what it's been, it will keep pace, and as net income grows, so will the dividends. So I think our shareholders can -- that's one thing they can rest assured.

Andrew, I would just add to what Tom said there. If you go back to our Investor Day, we did -- all of those targets did include Meggitt. And if you remember that dividend slice, we did account for that staying within that 30% to 35% of 5-year net income.

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

Congrats. I -- first I wanted to ask about the first 9 months and the first 12 months. It looks like it kind of implies think around $0.35 in fiscal 1Q '24. And so just looking for I guess, a little bit of color on that step-up in the run rate from what we see in the first 9 months to what would be a pretty good starting point when you go to now.

Exactly right. That's the math that we see there. Obviously, volume is a big piece of that. We're just 11 days into ownership. So there's a lot of -- obviously, a lot of good work being done, a lot of moving pieces on getting all that information in there, but a big piece of its volume. The other piece of it is synergies start to kind of roll in as we get out into that period. And that's really the -- yes, the big pieces of it interest will probably be a little bit less based on rates today, just as we continue to pay down that. So we see a little bit of upside there as well. But it's basically volume, it's efficiency improvements and then real synergies as well.

And is that volume just as you sort of fully ramp the stuff that's in backlog? Or is it more tied to kind of anticipation of recovery trajectory?

Well, the aerospace business, one of the reasons we like it is a very long cycle, so not as much movement in the industrial side of the business, and this is the best look that we have working with our Meggitt team members and our Aerospace team members. So that's what I would speak to, on the volume.

Okay. And then just a clarification question, Tom. I think you said that -- or Todd, I think you said that you would have -- the rates were set -- the interest rates were set as of today, basically. And then I just wanted to confirm exchange rates as well, just given a lot of the movement we're seeing in the rate environment as well.

Yes. Obviously, the rates have been extremely volatile. So yes, I would say we've used the current rate. I wouldn't say the rate today. I think we were using about a 1.8% rate, but obviously, much more current than 0.08%, much more current than what we did when we gave initial guidance.

And same thing for the exchange, I guess it's like 20% GDP, the same thing there?

I'm sorry, what was that, Joe?

I was just talking exchange rates as well. I think the appendix shows like 20% exposure to GBP. And so I just wanted to confirm...

What we were trying to show in the appendix, Joe, was just looking at the revenue profile of the Meggitt business, 70% of their sales are invoiced in U.S. dollars and the 20% that is in the pound.

Our next question comes from the line of Jeffrey Sprague with Vertical Research Partners.

Congrats. Tom, thanks for walking through kind of the synergies the way you did. I just wonder if we could kind of drill down on that a little bit, given until you own these things, you really can't get into them that deeply. It sounds like based on what you said on SG&A and probably some educated guesses you could make on supply chain and a little bit on footprint that maybe you have like very, very clear visibility on maybe half the synergies and kind of the other half comes into applying lean and simplification and the like. Is that the way to think about it? I know your confidence level in those actions is high, but is that the way to think about it? And how does that stack up relative to kind of bringing other deals into the fold and trying to capture synergies?

Yes, Jeff, it's Tom. I don't know if I -- I don't want to necessarily get into what percent of it is given the walk to the $300 million. I would just say the 3 areas: SG&A; the Win Strategy elements, simplification, safety thing, et cetera; supply chain. Those would be the 3 big elements. But it's the Win Strategy in general. And if you just -- I would take you back to my characterization of Meggitt around their businesses to being similar, more similar to the original Win Strategy and you saw the lift in margins we got as we did 2.0 and 3.0. And obviously, that kind of combines all 3 of these things. That's why we've got confidence. And some of it requires more work. You could do the math on the SG&A low 20s into the mid-teens and figure out what that number is and the rest of the report a little bit more action. But I feel very good about the synergy profile. It's not -- I wouldn't characterize it as easy, but it has a lot less risk associated with it and I don't think we had to close factories and move products and do all those kind of things, you add your risk complications dramatically. And I think just as we move to a more decentralized structure, I think the Meggitt team kind of characterizes as we're going to unleash a lot of the ideas that they have. And that's things that will be baked into this plan as well.

And maybe for Todd, just on your interest expense guide, just trying to understand how much deleveraging is in the guide, right? If I -- $285 million of interest expense at 3.9% would imply kind of $7.3 billion of debt, right? You're starting at $8.1 billion. So it kind of implies you're maybe paying down $800 million in this forecast. You can kind of get halfway there on wheels and brakes. Is that directionally the way to think about it? Or what is really kind of the deleveraging plan out of the gate?

Yes, Jeff, obviously, we're committed to the dividend. We're committed to CapEx. We're committed to our 10b5-1 program, 100% of the remaining cash flow generated will be used to pay down the debt. So that's what we've got in our plan, and that's what we're committing to.

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

Two quick questions. First, further on the deleveraging. When I look at LORD, right, being more of a SG&A cost save, with CLARCOR a little slower with the footprint decisions. But of course, the macro environment also we can dictate how you allocate your funds. But is it fair to say when we look at the historical deleveraging time frame for those 2 acquisitions, this should be a little bit closer to the LORD time frame than CLARCOR, especially given the cost savings are more SG&A like LORD? Is that a fair generalization?

Yes, David, this is Todd. I agree with you, LORD and both Exotic, we did a little faster than what we did with CLARCOR, but it's really because the company is bigger, our EBITDA margins have expanded. Our cash flow generation dollars have expanded. So there's just more capacity that we have to allocate to that. So I would agree with your comments more like the latter than CLARCOR.

And then on Meggitt with the R&D spend that they've had to maybe a little bit below industry average. In your forecast, do you have a step-up in the R&D for Meggitt, just to kind of win and take advantage of the platform for more content wins?

David, it's Tom. I would not characterize them as being below. Remember, what I've got is 4.7% of sales is what they had in our R&D. And we've been in that 3% to 3.5%. And it depends on what you decide to go bid on it. It's all -- in Aerospace, it's all about portfolio management. What technology you want to develop, what programs you want to go after? I think when I look at it longer term, and obviously, we'll support whatever is there in near term. The combined business, total aerospace business is probably in that 3% to 4% range, longer term. And if they have opportunities that are exciting, we'll clearly go above that. You've seen historically we were as high as in the low teens. So we've never hesitated to go after the right things, and we won't hesitate if the right target was presented here. But I think over the next period of time, I think it's going to kind of evolve to the 3% to 4% range.

Okay. That's interesting. I remember there's moments where you have aggressively gone after platforms. And as you said, your R&D and aerospace has been a lot higher than 3% to 4%, high single digit, even higher. Where is your R&D run rate right now, legacy Parker?

That's in the 3% to 3.5% range.

So this is 3.5% right now.

Part of the difference, David, is that there's a lot -- if you think about the super cycle in Aerospace has really started probably about 15 years or so, there was development at almost every airframe and development at almost every engine platform. There's a lot less with that development. So it's much more targeted. But we're working on as kind of component technologies. We're trying to anticipate where the puck is being shot to. And so that's where our investment is going. Obviously, we'll invest in like the new helicopter programs and those type of things as they come up, but just a lot less aero frame and engine development that's happened over the last decade or so.

Yes. I mean the reason it's all important is if you have $0.65 of accretion in the first 12 months, right, the 80 minus, say, 50 for the air brake, just the incremental synergies from, say, $75 million at first year to get up to $300 million. The accretion is well over $2 just from sort of the synergy story in near term. So whatever growth you look at for aerospace in the next couple of years, which I think generally people are kind of constructive on how aerospace is going to grow, you don't see it as a heavy spend to serve that cycle, right? That was the genesis of the question.

So I think you've characterized it perfectly, this is exactly, I would say.

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

Congrats. Tom, I wanted to go back to your comments on synergies again. You talked about SG&A -- bringing SG&A down at Meggitt somewhere in the mid-teens. But looking at Parker, you guys are right around 10% of sales. So is, frankly, 10% an achievable target longer term? And related to this, when I'm looking at the aircraft wheel and brake divestiture, the margins here were quite impressive, right? I mean 38% by my math. So I'm curious beyond the synergies that you've outlined here, as you think about Meggitt longer term, can Meggitt get anywhere close to where Aircraft Wheel and Brake margins currently are?

Mig, it's Tom. Good question. So on the SG&A, I'm quoting you more of an internal SG&A because what you see publicly is how we characterize this, externally factoring in the SG&A really kind of sits in the divisions. And that's how we look at it as just the total SG&A of the business. So that's where we're at. We're at mid-teens. So that's the number that's really a more reflective number. And on Wheel and Brake, what you can't do is take our Wheel and Brake business because they don't -- they're not 100% Wheel and Brake. They have a lot of other technologies that they do. But the Wheel and Brake business is highly profitable. We would certainly be comparing notes to make sure our memory of our old Wheel and Brake business and their Wheel and Brake business, getting into comparable margins. But you can't extrapolate the 2 because they're making a lot of other technologies as the size is growing.

Yes. That's what I was getting at. If there was a difference between this portion of the business and everything else that Meggitt was doing. Then my follow-up, maybe this one is for Todd. I appreciate the breakdown here of revenue by currency. But I'm wondering if there's a way to think about the transactional exposure that Meggitt might have, how much manufacturing is happening maybe in the U.K., Europe. And is there a benefit to margin given some of the changes in FX that we take?

Mig, we're still learning. It's just been 11 days since we've had ownership. So we're going through that. It's pretty reflective of the way the sales is listed. If you look at where their facility is at, it will all be reported in local currency. So I might push that one to maybe a November until I feel a little bit more comfortable with it, but we think it matches up pretty closely to what we're showing here on Slide 24.

Yes. Mig, it's Tom. Just in general, about 60% of our plants are in U.S.

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

Maybe just the first question around that sort of revenue assumption. So you've got the $2.4 billion of first 12-month sales at Meggitt, hasn't really been any discussion, I think, yet on the sort of assumptions of organic growth within that, what's going on commercial versus military? What's assumed around pace of supply-chain constraint easing within that number? So maybe starting off with any color there, please.

Julian, this is Tom. So in general, our organic growth assumption is low to mid-teens or if I took Meggitt by itself. And really the makeup of that would be -- now contrast a little bit to legacy aerospace, very similar on the commercial OE mid-teens. The military OEM, they did not do the same level of pull-ins that we did in our whole supply chain and the customers we were supporting did a bunch of pool-in. So we are negative on military OEM. They're positive around that 10% range. The big difference is their commercial MRO is around double legacy Parker, so we were kind of mid-single digits to high single digits, and they're in that mid-teens. And that really is kind of the recovery, 2 things of recovery on brakes and just more exposure to having A320. And in the military MRO, they're a little bit lighter than ours. We have a little stronger connection to the depots. And obviously, we're going to try to do that for the combined business as well. So that will be a walk-through the 4 segments.

That's very helpful. And then just my follow-up around that adjusted sort of segment profit on Slide 20. You've got that $300 million number for the 9 months. Historically, Meggitt always had kind of higher operating margins in the calendar second half of the year than the first, and then it would sort of step down and then go back up the following second half. Is that roughly how we should think about the cadence of that $300 million for Parker? Or is there something different going on just post acquisition and that type of thing? Just trying to understand how much of the $300 million is the second half of your fiscal year versus the first.

Yes, Julian, this is Todd. We work with the Meggitt team members to build this forecast. So it's been done in the very similar methodologies to what they've done before. I don't -- have not seen any differences in the way those numbers would be generated just because now it's reporting under Parker. So probably have more to come on that soon.

I'll now turn the call back over to Todd for closing remarks.

Okay. Thanks, Towanda, and thanks to everyone for joining us today. Like I said at the beginning of the call, we're very excited to get to this point. We're excited to share more with you as we learn more. A special welcome to all of the new Meggitt team members. We're really excited to have you on board. This is really all we had today. This concludes our webcast. Thanks for your support. Thanks for your interest in Parker. As usual, Robin and Jeff will be here today if you need any further clarifications on anything that we cover. Have a great afternoon. Thanks, all. Thanks.

And this concludes today's conference call. Thank you for your participation. You may now disconnect.