Parker-Hannifin Corporation (PH) Earnings Call Transcript & Summary

All right. I think we're ready for the next session. Happens to be my final session as well. We're really happy to have Parker-Hannifin here with us today. We've got the Chairman and CEO, Tom Williams. Tom, thanks so much for joining us today virtually.

Thank you, Joe. Great to be here.

So let's -- why don't we get right into the Q&A. So one of the questions I've actually gotten a lot from investors today, so may as well ask it at the forefront is it's just recession planning. It's hard to believe that we're talking about recession scenarios, to some degree because the order rates are so good, but obviously, there's a lot happening in the backdrop here. And Tom, I would just love to get your view, you're a different company today than you were the last time we went through this. But how does Parker look in a recession scenario?

Well, I think, hopefully, people can look at how we performed the last 7 years as an example, 2 recessions in a pandemic. If you want an indicator of how we're going to do, I think you just look at that. And in that past 7 years, it's pretty hard to find a downturn for us as far as EPS accretion and margin accretion. But to your point, Joe, the company is dramatically different. The portfolio cap is positioned significantly shifted to more engineered materials, filtration, aerospace, longer cycle, secular trends that we outlined in IR Day around clean tech, digitization, electrification and aerospace are all going to create different growth dynamics as we go forward. And really, the recession planning starts with what you've done in the last number of years. Yes, you can do the immediate things where you make sizing type of decisions immediately. But you plan for the next recession years in advance. So all the restructuring we've done, the structure of the company is different simplification and all those things have put us into a position where we can weather the recession. And after what we've gone through, not that I'm ready for more, I'd like to not add more, but I think the team is pretty prepared for whatever comes our way.

That's good to hear. And I know that you've operated incredibly well, especially in recent history. I'm curious like Tom, is there a way to think about like what levers you still have to potentially pull in a recessionary type scenario or a way to think about margin preservation? Clearly, it's hard to determine like what type of recession we could have, that would all just be kind of conjecture at this point. But the margin piece and the levers, I'm hoping that you can maybe provide a little bit more color there.

Yes. So if I think about some of the composition of the company, so the percent international sales that's tied to distribution has grown quite a bit. So higher margin, more resilient. The portion of the company that's innovative, the percent that comes from new products has doubled over this period of time. Again, typically easier to sell, more resilient, about 10 to 15 points higher margin than the rest of it. And then all the activities we've been doing on Kaizen, part of why we've been so successful is our Kaizen activity has driven a lot of productivity, our engagement of our people. And the fact that we just did a recent engagement survey, Joe, the feedback we've got from our team members was really good. But then the third party administers that I have for us said our scores were in the top 8% of industrial companies around the world. So that level of ownership and the ability to be nimble and care and be passionate by what you do is another part of why we're so successful. If you look at the acquisitions we acquired, they all were accretive on margins and they were definitely more resilient on the top line. So they're going to help us as we go through this as well. So it will be a combination of what the normal things you do, the initiatives we've been doing as well as the structural things. I would remind people take a look at what happened with aerospace. So aerospace went through one of those generational downturns with the pandemic. Well, basically nobody is flying and go look at our Aerospace margins. We very quickly resized that business. And so we're not predicting that kind of recession. I would tend to think it will be nowhere near that. But we have the ability to do what we got to do and keep plowing forward.

That's helpful color, Tom. And I guess maybe just talking about some of the more near-term things that are impacting performance this year, and we'll see into next year. China has been top of mind for everybody. You guys now have kind of called out a near-term headwind of, call it, roughly $100 million. The decremental high, right? 40% decremental, it's greater than what you normally operate in. And so as it stands today, just maybe just talk us through where China stands and then also it seems to us like there's maybe some conservatism in that number, especially the margin number, but maybe just help contextualize the -- both the revenue and the margin figure.

I'm glad you asked it because it gives me a chance at least to in a public forum to talk more about it. So with China, we have roughly 18 facilities. And what we see now is we have about half of them that are running about normal and the other half are virtually shut down. And so that's what -- looking at that and not necessarily seeing a lot of change, maybe a little bit of gradual improvement with that mix of normal versus shutdown improves to the quarter. But that's what we're experiencing now, and we're not expecting that to get much better. I mean as you follow things and you all know about what we know as far as what the government is going to do there. It's hard to predict what they're going to do and what provinces will come up. But I wanted to talk about the decremental just to help maybe educate people. You can hold a 30% decremental when you have some volume going through your facility. When your plant is down completely, I don't care how good you are. There's nothing to cover fixed cost. So those 50%, those half the plants are contributing nothing to help you. And that's why the decremental is a little bit higher. We'll do the thing we've got to do with the normal plants. The plants aren't running. It's -- you just doesn't -- you're stuck. In this way, if you compare our decrementals like in other times when you just have a recession or volume drop, yes, you can manage it because you typically maybe you're going down 10%, you're going down 20% supply debt. You're not going down 100%. So people look at that 40%, that's why.

Makes sense. And no, I appreciate that color. Can we talk -- shifting gears over to the supply chain and explicitly where you're seeing it. All our companies are seeing it slightly differently. Some are just seeing it in chips components, some are seeing it in electronic circuit boards, Others are seeing it also from a labor installation standpoint. How is it affecting your business explicitly?

Yes. So I would characterize chips to be the worst, as everybody has expected. And chips for us got worse through the quarter. So we're not anticipating any kind of help there anytime soon. And then on, say, everything else, started to stabilize, but I would say, stabilized at a non-normal level. What not normal kind of lead times, normal deliveries. All that is still putting efficiency pressures in the factories, inefficiencies in the factory because of the supply chain. We're not forecasting that to get up. But obviously, we're only forecasting the next 60 days. So it's not like it's a big leap here. But we're not anticipating any help in that regard. Now part of why we've done a little better than most. And as you're probably familiar, Joe, was our local-for-local strategy, and that's helped us. That's been our operating model for couple of decades, mainly because of the service and the ability to close and respond to customers. But we spent a lot of time this year in particular, looking at dual sourcing. So we have a target for every division, every group as well as redeploying engineers to help qualify alternative materials, alternative ships. So the other part that was -- has gotten a little better, but it's still a pressure point is raw materials, chemicals, resins, those things that go into our material science portion of the company. That's where a lot of alternative material qualifications going in then on the chip side as well. And that's a lot of work with your customers to go through that requalification process. But I'd like to be able to tell shareholders. I see light at the end of the tunnel. I guess that you can take some comfort that it didn't get worse on the non-chip stuff. So you got to kind of find bottom first, and I think we've found bottom, the chips are still trying to find bottom.

And Tom, I know that you don't necessarily look at every other company that we look at and compare yourselves to those companies. But it seems to me, I guess, that maybe you have less chip content than some of the other companies that we would cover. Because partly what makes me say that is as you take a look at your performance in your North America business and the performance has been good. I mean, good growth, good margin expansion. And so is that a fair comment that you are feeling some supply chain issues, but maybe not as much as some others because of the products that you sell.

Well, probably depend who you compare us to. If you take our aerospace business, there's a fair amount of chip content there, and that grew 6% and the margins. So I think that would be a good microcosm if you were to compare us to maybe more chip-dependent businesses. When you get to the industrial piece, our motion systems, all those motion related technologies have electronics tied to them. But we don't call that out separately, it would be hard for investors and analysts to kind of get a gleam of that. But I think if you're going to compare maybe like-for-like compare our aerospace business to all other people did not. Sure, Joe. You're talking to an OEM. They have a bigger pressure point. If you're like us, a Tier 1 or Tier 2 supplier, it would be lower pressure point than the OEMs. But I think you got to do like-for-like compare us to other Tier 1s or Tier 2s.

Helpful. And then just touching on EMEA for a second. Clearly, you're still growing double digits in that region. I think the expectation is that maybe moderates a little bit in the fourth quarter. Just maybe some color on what you're seeing on the ground there. What kind of impact are you seeing from the Russia-Ukraine conflict?

I think with Ukraine is too soon to tell. But if I look at the most near-term order entry from a dollar volume standpoint, it was consistent with where we were in the first 3 months of this calendar. So if you look at kind of January, February and March, April looked like that from a raw dollar standpoint. But when you look at the comp into prior period, it's a tougher comp, which is why we went in with a forecast of 5% growth in Q4 for EMEA. But it's not because the overall numbers are dropping off. It's more of a comp there. And we'll have to see how Ukraine plays through. I think it's too soon to tell yet what happens there.

Okay. That's fair. Yes, you have a really difficult comp in the fourth quarter that makes it on the sense. Just on the inventory side, there's a lot of concern in the market around double ordering and inventory levels being -- starting to elevate. What are you guys seeing from your -- and hearing from your distributors as it relates to inventories. And to the extent that you have regional color, that would be helpful.

Yes. So the distributors in general, I would say this is true across all the regions, would like to see more inventory. They can't keep up with what they want. They are not in the stocking positions that they'd like to be in, so they'd like to add inventory. And when they're able to get into that position, it won't be this fiscal year because it's a very short time left, but certainly they would hope to try to get into that sometime in the first half of '23. But I think it will all depend on supply chain and really how maybe other suppliers that go into them as well can come up to speak. Because they're not going to necessarily bring on Parker content if there aren't other things that they want to put together with it. But usually, our distributors, one of their big advantages is relying on us for the A items, some of the B and having stocking positions on B and C items and they're concerned that they're not in those stocking positions. Now the double ordering, I think most of what we're seeing is real end market demand. Not to say there isn't some of that going on because that's always hard to police. But it doesn't feel like there's a lot of -- I want to make sure I got my place in line type of thing.

Okay. That makes sense. And when I think about your -- the ability to navigate this environment, it's been really good, particularly from a price cost standpoint. It seems like your distributors have been -- and OEMs have been receptive to price increases. I guess from here on out, is it getting any more difficult to pull -- to put price through? I know you've been kind of basically managing to like price cost neutral. Is that still the expectation going forward?

Yes. The expectation will be margin neutral because cost neutral means margin dilution. But I would say the -- I forget the word you used at the beginning. They're not necessarily comfortable with it. I mean there isn't 1 customer or 1 distributor likes a price increase. So I would characterize the conversations as very lively, very engaged. And -- but they understand the situation. Part of what I think has changed, Joe, and in our approach, maybe why we've been so successful about it. Some of it is our process, that whole sell price index and purchase price index division by division is 20 years of mechanics that are in place there, but is looking at inflation from a more holistic standpoint. Because historically, if you look over the last 20 years, it's been material inflation. Let's cover that and then use productivity to everything else because everything else was within your productivity, strikes on it to offset it, is no longer true. You add up logistics, energy, wages and now immaterial, you have to be looking at inflation for a more holistic standpoint. So we made that change over the last 18 months as we start to look at inflation division by division. And we've had to have those kind of discussions with our customers. Our customers get it as well. They're having the same discussions with their customers, and they're looking at it the same way. I do think going forward, I would characterize it's going to still be as difficult. The advantage that we -- as far as doing the pricing actions, but it will still maintain that margin neutrality. It helps to have a business that has a value proposition. If you're a business that doesn't have a distinguishing value proposition, any pricing discussion with the customers fraught with all kinds of difficulty and risk for your company. But we need to keep bringing that value proposition to our customers, and we'll keep doing that.

Appreciate the margin neutral clarification because honestly, you're one of the few that we cover that have been able to do that. So kudos to you guys for being front footed there. Particularly, the order rates that you put up in your industrial business last year, I mean, north of 50% orders in both of your businesses, it's hard to imagine a scenario where orders are positive in the fourth quarter. I guess maybe just provide some color to the investment community. There's been a fixation on order deceleration across the coverage. And so how do you think investors should be thinking or looking at your demand levels in light of what's going to be some really, really tough comps in the fourth quarter?

Yes. Well, the comps are going to be hard for in fourth quarter, particularly gets a little bit ill in the next quarter, after that's pretty bad. I'm looking at the numbers as we speak. But I think what you're going to see is a company -- the big change we made at Investor Day describing our organic growth as 4% to 6% versus some element greater than the market and the market being global industrial production growth. And I got a lot of feedback from customers -- from shareholders that they really view that as a very constructive change. And a lot of what's driving that change is there's a lot of different levers for growth for us. So in the near term, it's harder for me to predict the next quarter or 2, there will be a lot of volatility, and we've got tough comps. But if you go beyond that, our company is going to still grow much differently than we have in the past. You've got the portfolio changes we did. You got the secular trends. You got the need to reinvest industrial companies on CapEx, reinvest to strengthen supply chain and then some of the channel restocking that we've talked about. So there's a lot of levers if you get through however long we define this churn period of time. There's a lot of levers that are distinguished definitely different for us as a company that will make us stand out in the crowd. In near term, I do think we'll continue to weather it better than we have in the past because we bought companies that are more resilient that are tied to these secular trends. So I still think even in the near term, we'll do better. And that's what I'm hoping. When we show near-term results, and we compare them to maybe other soft parts in prior cycles. I think you're going to see a company that weathers it -- we've always weathered it really well on margins. I think you'll see the top line do better.

Yes. And Tom, that's a great point because as part of your transformation, the business is now in -- it's -- you've transformed the business over the last few years. And I think that there's still a lot of emphasis on you guys being short cycle, PMI levered. I'll give you a moment here to just maybe discuss some of those secular drivers across your business. And what you think could help offset maybe some weakness in the more cyclical pieces of your business if we were to go into a downturn?

Yes. So if you take Arrow, which is that's the easiest one to start with. We've got the commercial aftermarket and OEM recovery that -- okay, even if there's a soft spot here, we're balancing off really low comps there, and you're going to see some recover there. In the military, once we cycle here a couple more quarters, we'll go from being a drag to kind of a low single-digit live for us. And with the military, we've got a great platform there between all the legacy platforms as well as on the marquee platform, the F-135 and the F-35. And so that will be fairly flat with some slight growth. And then you got military MRO kicking in. The whole F-135 and F-35 MRO stream and all those depots getting set up is going to kick in. So the military side will be kind of low single digits with the commercial being very strong. So that's the kind of the aftermarket. That's really the aero story. When you think about electrification and clean technologies, I'll kind of maybe group them together as a clean tech being maybe the 9 -- the ICE to electric is electrification, like clean tech is all the renewables and hydrogen and LNG and all those kind of things. But our bill of material grows in each one of those applications where you go from an ICE application to a bill of material that's more electric anywhere from 1.5 to 2x. So even if you have a reduction in total applications that you're going after, your content per application is going up. So we're going to get a lift there. If I just look at growth rates today on automotive, EV versus ICE, it's a no-brainer how -- growing. Obviously, it's a smaller number to compare it to, but it's growing dramatically. There's not a person here that disagrees that the transformation to EVs isn't going to be a long-time secular trend, and we have some nice content there that came with us with LORD as well as our legacy business. The clean tech part of things and you look at our portfolio. When I've had discussions with my counterparts at our OEMs, one of the first things they want to talk about is can you help me with my sustainability journey? Can you help me reduce carbon -- my carbon footprint, my weight, my emissions, et cetera. And the technologies that we have are really energy agnostic. So whether that construction equipment, that [indiscernible] equipment, that mining equipment goes from a diesel engine to some kind of hybrid to a fuel cell or to a battery, all the work functions after that or the functions that we do are the same or get bigger. Because we've got a provide more thermal management content as things got hotter on the application. So we're very excited about that journey. And that's why when I showed the long cycle is easy to pick out. You can go just find everything aerospace and put it in that bucket. The aftermarket is easy. That's that. So that's 2/3 of the company, roughly almost 70% of the company. But then you start taking the stuff that was traditionally short cycle and portions of that are going to start acting longer cycle, like parts of automotive, it's electrification, parts of construction, mining [indiscernible]. Again, the change out in equipment has to happen as we move to a more carbon-neutral world. Semiconductor which was notoriously a highly cyclical white knuckle ride either going up and loving every minute of it, going down and hating it, is now one of the longest secular trends that you can have. And we're participating in all those things, whether it's the fab which is the construction of the equipment, all the infrastructure, getting you to the tool and a number with the tool OEMs. Take utility lift trucks, which didn't normally get people excited. Well, all the stuff that's happening in the digital world, 5G and all the telecommunications, you need these lift trucks. We have a huge content on these lift trucks. And guess what, they're going to digital as well. So a lot of these markets that I think a lot of us -- and I'm not naming names in the crowd that are watching me that all viewed us as being short cycle because of your alignment to that. We're now like 85% going to be long or secular and 15% short. Now here in the near term, you don't wave a wand and it happens automatically, but we're feeling it now. And I think we'll prove to all of you that you'll see a more resilient top line as we go out in the future years, you're going to see a company that grows differently. And then the other part I would tell people about and probably they don't appreciate is our incentive change we made. So our short-term incentive, which has been around for 30 years, was return on net assets, was effective, but unfortunately, return on net assets acts very much like a long-term incentive. And I want people to know what the temperature is outside. I want them to feel it. And so we have ROIC, and we have other long-term metrics, that's fine. But the short-term incentive, we're moving to cash, earnings and revenue. And if you go talk to our commercial people, they will say that's probably the single biggest change, positive change to change how we look at growth in the company, even putting aside the secular stuff and the portfolio changes, they like the fact that the divisions now have equal skin in the game with them. The reason why I say it is if you're a division that runs a very low asset to sales ratio, you're less sensitive to revenue changes and you can have a good incentive payout. And so we took that away. Now half the company changed already. The other half starts in FY '23. I just want to calibrate people. 98% of our team members, myself with the exception of just a handful of sites are on this short-term incentive. This is a huge change management discussion with works councils, one-on-one discussions with everybody. I think that's underappreciated that you're changing behaviors, how people align themselves to I think things are much more aligned to shareholder interest and performance interest. And that's on top of all the good performance we've had. So I'm pretty -- obviously, I'm optimistic in general, but I think I'm pretty bullish about how we'll weather whatever comes our way. At this point, Joe, I'm pretty numb. I've been through so many things. I think you could throw hailstorms at me. And I think we'd be fine, but I think we're in pretty good shape.

That makes 2 of us. No, I appreciate that commentary around incentives, super important. And I do think that, that's an area that the market probably doesn't pay as much attention to. It's -- you mentioned the semi fab cycle. And as Ronnie who works for me is a millennial, he would say like double-click into that and let's get a little bit more detail on specifically how you will play in a semi fab investment cycle in the U.S.

So most of our content will be on the tools, but we do have things in the fab, the bigger, larger valves, et cetera, on the kind of the infrastructure of the building, those type of things. And any of the general Parker industrial things that would go into the construction of a new site. All the construction type of content. But specifically making the chips. We have a lot of content around valves, regulators and manifolds. If you think about that all around control and gas flow, there's a lot of different sequences in making a chip as far as different tools to do different things, add stations and different stations that they do. And we make -- we have all those technologies controlling the flow of those gases and you might appreciate the purity of those is really a big deal. So there's filtration technologies. There's conveyance technologies for the equipment. And then sealing is really important, sealing off those gases and getting the right kind of content on. So it's a relatively small portion of the company. It's about 2% of sales, but it's got great rate growth dynamics and it's going to be a long cycle. And we are participating with -- these are big, long investments that various companies are doing. And I've been around this -- because when I started with the company, it was one of my first assignments was in this area. This is the best it's been. And the team there is very excited about the future. It's -- by now, we have -- in this short period of time, we've gone -- we would have probably gone through 2 cycles, good and bad with semi, and we're still on a good and I think it's a long-term good.

And I would imagine that there's downstream investment that you're going to participate in as well.

Certainly, certainly.

This might be a question is a question that's coming from the audience. I'm not entirely sure how much of this you can answer as it relates to Meggitt. And it's a recession-related question. And so this person wants to know if Meggitt once it closes, could potentially offset any headwinds associated with a recession if it were to happen over the next year in your ability to at least maintain earnings over the next year?

Well, certainly, it's going to be very helpful on the top line. So you're going to bring in all that revenue. And obviously, it had to be a pretty severe recession to not have us still net out reported sales as growth with that kind of accretion. The fact that it's almost 100% aerospace. If they're going to benefit from the commercial recovery, the same military softness that we're seeing that they've been seeing. And by the time when they come in, we're probably a quarter or 2 away from cycling through that. And so you should at least not have military be a drag anymore. And then we've got all the synergies that we're going to be able to go after with Meggitt. And we've been public about the $300 million. I can't necessarily go into the color behind how in detail we get to those $300 million. But that's -- you'll have accretion coming from the commercial recovery, but the accretion coming from the synergies. And we have a pretty good track record of that. And the way we approach these things is we want 1 plus 1 equals 3. I mean, we're going to take the best of Meggitt, the best of Parker and make it a stronger company. But those things that we did, you can compare our margins. It is part of the cycle, the Meggitt's margins, our aerospace to their business, and we're at a better starting point. And there's things that we are on as far as our journey related to the Win Strategy, their version of the Win Strategy is the Parker and Meggitt business system. There are a lot of similarities. I think we're just a little deeper in our learning curve on that, and so that will be a big part of our focus.

Is there any other update? I mean, you just reported not too long ago and you guys have been pretty explicit around like the regulatory process around Meggitt. Just is there any other update that you can give us at this point regarding how that's proceeding?

No, nothing new than what I said on the earnings call, Joe.

Okay. Shifting gears a little bit. I want to talk about industrial international margins. That's just been levering up at a really, really good rate. And it's been a great story for you guys over the last several years. And so maybe just talk about like how you've been able to improve margins in that business structurally and maybe why it's like in the near term, it might just be supply chain is levering up at a better rate than the North America business.

Yes. I'll talk about how we've got to. But to answer your last part, that is the answer. The supply chain, primarily the logistics complications and lead times, et cetera, are much more pronounced in North America than they are anywhere else. But this has been a long time coming with what we've been doing with international. It's been restructuring for, I'd say, clearly, the last decade, some pretty aggressive restructuring on footprint. And dramatically simplifying the region and simplifying as far as a number of sales companies we have, back office, warehouses, you name it, a lot of simplification on structure or design. The movement we've done on adding more distributors was very pronounced in international in general. But in Europe, so that helped their margins as well. And they've been very good about the Win Strategy. So it's -- you have -- when you look at that region, you've got Asia Pacific tended to run higher than the company average already. So they were already pulling. Latin America is very small for us, but Latin America has had a dramatic turnaround. We've had a huge restructuring program in Latin America to -- and so now they're actually north of the company average. And it was where it was -- it was Europe. That was a challenge for us in Europe has now come along very nicely. So much -- so, Joe, I don't know if you probably don't remember, but the original Win Strategy we had in the words was in our European initiatives, which was code for fix Europe. And we fixed Europe so much so that the Europeans are so happy. We no longer have that on the Win Strategy, which is significant because it says we brought Europe to the same as everybody else.

That's super helpful. I guess just when you think about the outlook for this business and the margin opportunity in this business, where do you see kind of potential white space to continue to improve from here? I mean, it's been real drastic improvement over the last several years.

The thing that I'm really excited about because everybody wants to know it. To your point, Joe, I mean, our margins round numbers up 800 bps, if you look at EBITDA and the EPS up 2.5x. Can you keep this 45-degree angle trajectory? And when I think about on Strategy 3.0, and what it's done so far. It's really -- it's early days. And the content of 3.0 versus 2.0 in the original is pretty significant. Maybe a tad biased because I'm a part editor and author of all that stuff. But 3.0 has a lot more strategic content and has longer legs, I think. So if you think about Kaizen and engagement, engagement was there before, but Kaizen was new. And Kaizen has been an absolute catapult for us. We haven't talked a lot about 0 defects externally. I had one slide an IR Day. But I would put 0 defects in that whole process second to Simple by design is probably the biggest margin accretion going forward. And think of it as an iceberg, the tip of the iceberg in a factory are things you can see like scrap and warranty costs when you think of poor quality. It's all the things underneath there around poor first pass yields, the rework, the extra time an assembler has to spend because the stack up wasn't perfect, et cetera. As we get processes that are 0 defect, more stable processes, our lead times tend to go down and our cost of simple, et cetera. So 0 defects is a big part of the margin enhancement. And we are -- I just spent last week. I had 3 or 4 hours I spent with a number of the groups on that. I'm really pleased with their progress on that. We've got digital leadership which is the use of AI, et cetera, and digital productivity. This is an example of this digital productivity that it's really changed the game for us, that will continue. I've talked about some of these other ones, the percent innovation, the percent of distribution, the structural changes. And then simplification, we're going to go back to the very beginning of simplification, clean sheet of paper. Are we happy with the structure again. Are we are happy with the hard design within that. And then 80-20, even though we've been at it for a while, it's like a well that never runs dry. We keep finding ways to get better at it. And then Simple by Design is our largest margin enhancement. And you're seeing early days of that. I mean part of why the margins have improved year-over-year is there's a little bit of Simple by Design in there now, but that's a multiyear journey for us, and that will be there for a long time.

And Tom, final question for me. I guess, maybe a little bit of a multi-part question. But as you think about your capital deployment. You've outlined, I think it was $30 billion over 6 years. Meggitt is a big part of that as our dividends and CapEx. But assuming Meggitt does close in calendar 3Q, how are you thinking about your leverage and your capital deployment? And then the second part of that question, is really -- you guys haven't really done much in terms of large divestitures in your portfolio. Are you looking at your portfolio closer? And are there opportunities potentially to divest maybe pieces of your portfolio that don't fit strategically over the long term?

Yes. Let me just start with that. So we have a real rigorous process around that. And there are some divestitures that we're looking at. They're all small, trimming. I've always used this tree and outage. There's no major trunks or branches getting trimmed up, but there are certain parts of the trees that we'll take a look at. Obviously, it's a wheel and brake part as part of the mega transaction, we'll be looking. But there's ones we're looking at right now as we speak that obviously can't be public about it, but they'd be small, Joe. They're not going to move the needle as far as in any material way. But that's -- there's a process that we do formally with myself and informed with the Board, so that's active. We're going to want to -- on capital deployment, we're going to want to pay down debt, and that will be just like we've done before. We're going to be about the same starting point on EBITDA leverage that we were with CLARCOR, with LORD and [indiscernible] as we are with Meggitt. Even though this deal is significantly larger and larger purchase price. Because the EBITDA dollars of the company are so much bigger, we started about the same leverage point. So you're going to see the same kind of interest. The dividends, that big increase we did, 29% increase is because our net income has grown so -- and net income will continue to grow. We have to keep at a pretty high pace on dividends staying at 30% to 35% of net income payout. We'll keep doing the CapEx for productivity and growth and the share repurchase. And what we have left over is going to go into paying down debt. And then I look to pay it down just as rapid as we had the previous deals and they get in a position where we could -- the balance sheet was ready to book again. Now we don't necessary need to look at another giant deal again once we get to that point. It will be whatever makes sense at that point in the cycle.

Makes a lot of sense. Tom, thanks so much for spending time with us this afternoon. It's always great to see you.

Good to see you, Joe, and thank you everybody for listening again.

Take care.