Ladies and gentlemen, thank you for standing by and welcome to the Parker-Hannifin Fiscal 2020 Second Quarter Earnings Conference call and Webcast. At this time, all participant lines are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference may be recorded. I'd now like to hand the conference over to your speaker today, Ms. Cathy Suever, Chief Financial Officer. Please, go ahead, ma'am.

Thank you, Liz. Good morning and welcome to Parker Hannifin's second quarter fiscal year 2020 earnings release teleconference. Joining me today are Chairman and Chief Executive Officer, Tom Williams; and President and Chief Operating Officer, Lee Banks. Today's presentation slides, together with the audio webcast replay, will be accessible on the company's investor information website at phstock.com for one year following today's call. On slide number two, you'll find the company's Safe Harbor disclosure statement, addressing forward-looking statements as well as non-GAAP financial measures. Reconciliations for any reference to non-GAAP financial measures are included in this morning's materials and are also posted on Parker's website at phstock.com. Today's agenda appears on slide number three. We'll begin with our Chairman and Chief Executive Officer, Tom Williams, providing highlights from the second quarter. Following Tom's comments, I'll provide a review of the company's second quarter performance, together with the revised guidance for the full year fiscal 2020. Tom will then provide a few summary comments and we'll open the call for a question-and-answer session. Please refer now to slide number four and Tom will get us started.

Thank you, Cathy. Good morning, everybody, and welcome to the call and thanks for your interest in Parker. Let me start with some strategic highlights. First of all, we are very pleased to report that despite challenging macroeconomic conditions, our margins and our cash flow are at all-time highs, relative to previous downturns. The best way to do an apples-to-apples comparison is to look at the base business without acquisitions and compare it to prior downturns. When you look at our second quarter FY 2020 adjusted operating margin without acquisitions, that came in at 16.1%. This compares to our previous best recession performance, which was in FY 2016, where the Q2 adjusted operating margin was 13.5%. Both of these recessions had similar organic sales declines, which represents a 260 basis point improvement compared to our best previous recession performance. This is really a remarkable performance, and I want to thank everybody around the world for doing such a great job. In addition to the margin improvement, cash flow from operating activities was an all-time year-to-date Q2 record. This performance demonstrates that we are building a more resilient business that is poised for accelerated earnings growth as the market turns. Our strong FY 2020 margin performance and cash flow generation so far are really indicative of the improvements driven by The Win Strategy and the strengthening of our portfolio by acquiring companies that are accretive to growth into margins. So we are excited about where we are and where we are headed in the future. Moving on to safety, we achieved a 25% reduction in recordable incidents in Q2, making great progress here, and I thank everyone for their effort on this and their dedication to safety. Our recordable incident rate, for those unfamiliar, is the number of safety incidents we have per 102 members; that is now top quartile compared to our project peers. There's a very strong linkage between safety and business performance. If you apply our safety metrics and our financial metrics, you will see them moving in tandem positively. Some summary comments on Q2: sales were our second-quarter record, as acquisition revenue offset soft organic sales. Organic sales declined as we expected, with improvement in international organic sales versus our guidance. The 737 Max issues impacted our aerospace business, as Q2 airframe and engineering were slowed in anticipation of the production pause. Our adjusted EBITDA margins were significantly higher than they were during the last recession, recording a Q2 adjusted EBITDA margin of 18.5%, which is a strong performance. Earnings in the quarter were excellent, with adjusted EPS exceeding expectations. Order rates in the quarter continued to be negative, impacting organic growth. However, the portfolio additions we've made are certainly going to help our organic growth over time. We've acquired businesses that are more resilient with higher organic growth rates than legacy Parker. We are well positioned for excellent performance in the second half of FY 2020 and for years to come. I want to move now to year-to-date cash flow. I've mentioned before how strategic this is for us. We aim to be great generation deployers of cash to drive excellent returns for our shareholders. We achieved the best-ever cash flow from operations for any first half in our history. Given current market conditions, this is commendable. Free cash flow to sales is about 10%, and we expect to achieve our 19th consecutive year of cash from operating activities as a percentage of sales in excess of 10% for FY 2020. The year-to-date free cash flow conversion was excellent at 130%. Moving to the outlook, we're increasing EPS guidance for FY 2020 on roughly flat sales compared to the prior year. This reflects strong Q2 performance, which is being offset by the 737 Max and slightly weaker organic sales in the second half versus our prior guide. Our guidance assumes no additional 737 Max sales for the balance of FY 2020. We are very excited about the future. We feel well positioned for growth, with excellent margins and cash flow, as macro conditions improve. Some factors driving this confidence include first, the launch of The Win Strategy 3.0, which is going to drive a further step-change in the company's performance, building on the momentum from previous updates to The Win Strategy. Second, the portfolio strengthening we've done through strategic acquisitions is notable. We're very satisfied with how the integrations of LORD and Exotic are progressing, and we can comment further about that during the Q&A. Recently, we had the leadership teams for both businesses here at headquarters to discuss incorporating The Win Strategy 3.0 into their integration plans, and it was a great session, showcasing a lot of good teamwork. Third, we launched the purpose statement, which is 'enabling engineering breakthroughs that lead to a better tomorrow.' This statement is a real source of pride for our organization. We recognize that achieving top-quartile performance requires us to live up to these higher standards. Parker is transforming, as evidenced by our higher level of performance during a difficult phase of the business cycle, with many opportunities to drive earnings growth beyond FY 2020. On the next slide, you'll see a reminder of our winning formula, which I’ve characterized as our competitive differentiators. I won’t highlight each one specifically, but together they make us special. This is why customers come to us, and why shareholders should consider investing in Parker. If I had to reference one competitive differentiator, it would be Win Strategy 3.0, which will enhance momentum and performance over time. I want to thank all global team members for their continued and dedicated effort in creating a top-quartile company, and with that, I will hand it back to Cathy for more details on the quarter and the guidance.

Okay. Thanks, Tom. I'd like you to now refer to slide number 6. This slide presents as reported and adjusted earnings per share for the second quarter. Adjusted earnings per share for the second quarter were $2.54, compared to $2.51 for the same quarter a year ago. Adjustments from the fiscal year 2020 as reported results totaled $0.97, including before-tax amounts of business realignment charges of $0.08, acquisition costs of $0.05, and acquisition transaction expenses of $1.14. These were offset by the tax effect of these adjustments of $0.30. Prior year second quarter earnings per share had been adjusted by $0.15, the details of which are included in the reconciliation tables for non-GAAP financial measures. On slide number 7, you'll find the significant components of the walk from the adjusted earnings per share of $2.51 for the second quarter of fiscal 2019 to $2.54 for the second quarter of this year. Starting with the net decrease of $0.13 in segment operating income. For Legacy Parker, a $260 million decline in sales contributed to a reduction of $0.34 in operating income. The Legacy Parker teams did a good job controlling costs on this lower volume by sustaining a decremental margin of 23% for the quarter. The acquisitions contributed $0.21, partially offsetting this reduction. Lower corporate G&A contributed $0.16 due to gains this year compared to losses last year on market-adjusted investments tied to deferred compensation. Incremental interest expense on the debt borrowed for the acquisitions resulted in a $0.20 year-over-year decline in current earnings per share. Lower other expense of $0.07 benefited from interest income earned on the bond proceeds prior to the closing of the LORD acquisition. We gained $0.10 from a lower tax rate, primarily due to favorable discrete tax benefits, and a lower share count benefited the current quarter by $0.03. Slide number 8 shows total Parker sales and segment operating margin for the second quarter. Organic sales decreased year-over-year by 7.1%, and currency had a negative impact of 0.4%. These declines were more than offset by the positive impact of 8.2% from the acquisitions. Total adjusted segment operating margins were 15.8%, compared to 16.6% last year. This 80 basis point decline is primarily due to the incremental amortization expense from the acquisitions. With the help of the Win Strategy tools, the Legacy Parker businesses managed to achieve good decremental margins of 23% on their lower sales volume. On slide 9, we are showing the impact LORD and Exotic had on the second quarter of fiscal year 2020. These results reflect a partial quarter of contribution from LORD since the acquisition closed on October 28; and a full quarter of Exotic, which closed on September 16. Sales from the acquisitions during the quarter were $286 million, and operating income on an adjusted basis was $36 million during this stub period. Moving to slide number 10, I'll discuss the business segments, starting with Diversified Industrial North America. For the second quarter, North American organic sales were down 8.5%, while acquisitions contributed 7.3% to the segment. Operating margin for the second quarter on an adjusted basis was 15.4% of sales, versus 16% in the prior year. Incremental amortization of 75 basis points in the quarter more than accounted for the change in margins. North America's legacy businesses generated a good decremental margin of 24%, reflecting diligent cost containment and productivity improvements together with the impact of our Win Strategy initiatives. Moving to the Diversified Industrial International segment on slide number 11, organic sales for the second quarter in the Industrial International segment decreased by 9.4%. Acquisitions contributed 4.5% to the segment, and currency had a negative impact of 1.4%. Operating margin for the second quarter on an adjusted basis was 14.6% of sales, versus 15.7% in the prior year. Incremental amortization was 30 basis points in the quarter. The legacy businesses generated a very good decremental margin of 23%, which was partially offset by contributions from the acquisitions. I'll now move to slide number 12 to review the Aerospace Systems segment. Aerospace Systems sales increased $111 million, or 18% from acquisitions, and 1.3% from organic sales. Growth in military OEM and commercial aftermarket sales were largely offset by lower commercial OEM sales and military aftermarket sales. Operating margin for the second quarter was 18.5% of sales, versus 19.7% last year. Incremental amortization expense of 160 basis points more than accounted for the change in margins. Good margin performance from Exotic and hard work by the teams on productivity improvements helped contribute to the strong performance in the quarter. On slide number 13, we report cash flow from operating activities. Year-to-date cash flow from operating activities was $826 million, or 12.1% of sales. This compares to 10.7% of sales for the same period last year after last year's number is adjusted for a $200 million discretionary pension contribution. That's a year-over-year increase of 11%. Free cash flow for the current quarter was 10.4% of sales, and the conversion rate to net income was 130%. Moving to slide number 14, we show the details of order rates by segment. As a reminder, these orders results exclude acquisitions, divestitures, and currency. The Diversified Industrial segments report on a 3-month rolling average, while Aerospace Systems are based on a 12-month rolling average. Continued declines in the industrial markets resulted in total orders dropping 3%. This year-over-year decline consists of a 7% decline from Diversified Industrial North American orders, and a 6% decline from Diversified Industrial International orders, offset by a positive 12% increase from Aerospace Systems orders. Moving to slide number 15. The full year earnings guidance for fiscal year 2020 is outlined. This guidance has been revised to align to current macro conditions and includes the impact of the LORD and Exotic acquisitions. Guidance is being provided on both an as reported and an adjusted basis. Total sales for the year, with the help from acquisitions, are now expected to be flat compared to the prior year. Anticipated full year organic change at the midpoint is a decline of 6.4%. Currency is expected to have a negative 0.5% impact on sales, and acquisitions will add 6.9% to the current year. We have calculated the impact of currency to spot rates as of the quarter ended December 31, 2019, and we have held those rates steady as we estimate the resulting year-over-year impact for the remaining quarters of fiscal year 2020. Considering the uncertainty around the regulatory clearance of the 737 MAX, we have now excluded all 737 MAX sales for the balance of the fiscal year 2020. For total Parker, as reported segment operating margins are forecasted to be between 15.1% and 15.5%, while adjusted segment operating margins are forecasted to be between 16.0% and 16.4%. We have not adjusted the incremental amortization expense of approximately $100 million that we will incur in fiscal year 2020 as a result of the two acquisitions. The full year effective tax rate is projected to be 22.5%. The second quarter tax rate was favorably impacted by discrete items which we don't forecast for the balance of the year. We continue to anticipate a tax rate from continuing operations of 23.3% for the remainder of the year. For the full year, the guidance range for earnings per share on an as reported basis is now $8.78 to $9.38, or $9.08 at the midpoint. On an adjusted earnings per share basis, the guidance range is now $10.25 to $10.85, or $10.55 at the midpoint. The adjustments made in this guidance to the as-reported forecast include business realignment expenses of approximately $40 million for the full year fiscal 2020, with the associated savings projected to be $15 million this year. Synergy savings from CLARCOR are still estimated to achieve a run rate of $160 million by the end of fiscal year 2020, which represents an incremental $35 million of year-end savings. Additionally, guidance on an adjusted basis excludes $27 million of integration costs to achieve for LORD and Exotic, and $185 million of one-time acquisition-related expenses. LORD and Exotic are expected to achieve synergy savings of $18 million this fiscal year. A reconciliation and further details of these adjustments can be found in the appendix to this morning's slides. Savings from all business realignment and acquisition costs to achieve are fully reflected in both the as reported and the adjusted operating margin guidance ranges. We ask that you continue to publish your estimates using adjusted guidance for purposes of representing a more consistent year-over-year comparison. Some additional key assumptions for full year 2020 guidance at midpoint are sales are divided 48% first half, 52% second half; adjusted segment operating income is split 49% first half, 51% second half; adjusted EPS second half is divided 50% first half, 50%. Third quarter fiscal 2020 adjusted earnings per share is projected to be $2.36 per share at the midpoint and this excludes $18 million of projected business realignment expenses, $7 million of integration costs to achieve, and $19 million of one-time acquisition-related expenses. On slide 16, you'll find a reconciliation of the major components of revised fiscal year 2020 adjusted EPS guidance of $10.55 per share at the midpoint, compared to the prior guidance of $10.50 per share. During the second quarter, stronger than guided sales together with meaningfully higher segment operating margins from the industrial segment generated a net $0.17 operating income beat. Strong gains in market-adjusted investments tied to deferred compensation and lower-than-guided interest expense contributed a benefit of $0.08, and favorable discrete tax benefits during the quarter helped to contribute $0.07, totaling a $0.32 EPS beat in the quarter. Updates to the second half guidance resulted in a $0.04 increase in operating income, offset by a $0.30 negative impact to operating income from the elimination of 737 MAX shipments in the second half. Updates to the below-the-line items resulted in a net $0.01 decline. This results in a net $0.05 increase to the fiscal 2020 full year guided earnings per share at the midpoint. On slide 17, we show the impact the acquisitions will have on both an as reported and adjusted basis for the full year. On an adjusted basis, the acquisitions lower operating margin to 16.2% for total Parker from 16.6% for Legacy Parker, impacted by the $100 million or 70 basis points of full year FY 2020 incremental amortization expense. For the adjusted EBITDA margins, the acquisitions provide 50 basis points of improvement, moving from 18.1% for Legacy Parker to 18.6% for total Parker. If you'll now go to slide 18, I will turn it back to Tom for summary comments.

Thanks, Cathy. We're pleased with the continued progress. We are performing well for this downturn, as demonstrated by our cash flow performance and our ability to raise the floor on margins. We are well on our way to delivering top-quartile financial performance as a company. I just want to remind everyone where we're trying to drive to in terms of our FY 2023 targets: sales growth at 150 basis points greater than global industrial production growth, segment operating margins at 19%, EBITDA margins at 20%, and free cash flow conversion greater than 100%. All of these would culminate in driving an EPS CAGR of over 10%. So thanks again to the global team and everybody around the world for all your hard work. With that, I'll hand it over to Liz to start the Q&A portion of the call.

Our first question comes from the line of Mig Dobre with Baird. Your line is now open.

Yes. Good morning, everyone.

Yes. Good morning, Mig.

Maybe just very quickly some clarification on what's embedded in segment level for organic growth, especially in your industrial business?

Mig, it's Tom. For the second half with the new guidance, we assumed North America at minus seven, international at minus 12, aerospace at minus 0.5, which gets to the second half at a minus 7.5. This compares to the prior guidance, which was minus six. The big difference there being some weakness in North America and a shift in the mix.

Understood. Then, if I may, on international, I think you said negative 12 for the second half?

Yes. Yes.

So if I'm comparing that with what you've done in the first half, there is some deceleration there? Obviously, your orders are looking a little bit different in that regard, being less bad if you would. So can you help us understand how you're seeing it and what's going on there?

Our thinking on the orders and sales internationally has been typically affected by fluctuations. The orders came in at minus six and did improve in Q2, driven mainly by Asia, influenced by some pull-ins in advance of Chinese New Year. We feel these order rates may be slightly overstated or are not entirely reflective of underlying market conditions due to uncertainties around the Coronavirus. Our Asia team just re-evaluated the second half forecast based on current intelligence, which resulted in a slight adjustment reflected in the new guidance.

I appreciate that. Not to put too fine a point but as we're sort of thinking about Q3, specifically, in Asia, in China, how do we think about that in terms of the negative 12 for the back half of the year? Thank you.

I'm not going to break it down necessarily by region, but we are guiding international for Q3 at about minus 16, which accounts for these factors and the effects of the extended Chinese New Year shutdown.

Thanks, Mig.

Our next question comes from Nathan Jones with Stifel. Your line is now open.

Good morning, everyone.

Good morning, Nathan.

Maybe I'll just start with a question on pricing. You were getting to the peak of the negative comps in this part of the down cycle. Are you guys seeing any pressure coming from customers? Any aggressive or irrational behavior from competitors in the market out there? I know you guys are always targeting being price/cost neutral. Are you still able to maintain that at the moment? Do you think you can maintain it for the rest of the year?

Yes, Nathan, it's Lee. The answer is yes. Our goal is always to be price/cost-neutral, margin-neutral. We're resilient in doing that because we follow the input costs through our purchase price index and have our selling price index that we track at all locations. Based on our forecast, we expect to maintain price/cost neutrality, margin neutrality.

You guys have also taken the margin expectation in aerospace down, which is straightforward given less volume from the MAX. However, you did take the margin expectations in both North America and international up. Can you talk about what's going on there, whether it's internal productivity or what else has led to an expectation of better margins for the full year than you had previously baked into guidance?

Nathan, it's Tom. What we're experiencing is those margin improvements, especially in North America, were supported by lower synergies and positive findings from The Win Strategy initiatives. We've also seen benefits from Kaizen activities enhancing productivity at our plants. Internationally, we had strong Q2 driven above our guidance, and we feel confident we can continue these improvements during the second half.

Okay. Thanks very much for taking my questions. I'll pass it on.

Thanks, Nathan.

Our next question comes from Joe Ritchie with Goldman Sachs. Your line is now open.

Thanks. Good morning, everyone.

Good morning, Joe.

Tom, I just want to clarify the MAX comment you made. I think you said that it impacted Q2. If it did, what kind of impact did it have on Q2? Secondly, as you think about the zero for the second half of the year, is it fair to assume that airframers have inventory on hand and that's why the MAX is going to zero in 2H?

Joe, this is Tom. I wanted to give you a little color on the MAX. First, given Boeing's public comments about the ungrounding occurring sometime in the middle of the year, we felt there's a lot of uncertainty there, and it was prudent for us to remove the MAX from guidance for the rest of FY. Regarding Q2, there was minor slowing of orders, both on the airframe and engine side, approximately a $5 million impact. Overall, the total for the year, including Q2, is around $150 million impact on the MAX, and we're prepared to support our customers once production returns. We'll allocate our team members to other programs in the meantime.

That's super helpful, Tom. Maybe if you can just talk about the North America weakness in a little more detail, just parsing out what you're seeing from a distributor perspective versus what you're seeing on the heavy industry side and how you expect that to play out in your fiscal second half?

In North America, for the second half guidance, we adjusted from minus six to minus seven. Orders were down in Q1 and Q2. Distribution decline was mid-single digits, around 400 basis points worse than Q1. This decline was widespread across end markets. In North America, holiday timing affected the extended plant shutdowns, and distributors used this opportunity to resize their inventory. Distribution was flat in North America, down to minus 4 in Q2, resulting in a decrease in order volume.

Thank you, Joe.

Our next question comes from Nicole DeBlase with Deutsche Bank. Your line is now open.

Yes. Thanks. Good morning, guys.

Good morning, Nicole.

So, I guess, maybe focusing on the North America orders, we already talked a little about what happened in international. But what's your view on whether order activity has bottomed? Can you comment on how January has trended as a way to characterize that?

If we consider North America industrial orders, in Q1 to Q2, basically we're in the same range overall, slightly weaker. The mobile side worsened significantly. We reported lows in order performance, and we projected Q3 to be a bottom based on our current views.

Okay. Got it. That's helpful. Thanks, Tom. A quick one on the deals. I think you guys said that you're expecting $18 million of synergies, up a little from your prior guidance. Can you just clarify what you've realized in synergies in the second quarter? What's remaining for the second half?

Yes. We saw some of the synergies for LORD pull into the second quarter. The timing moved ahead, so we received them sooner than anticipated. We are factoring that throughput for the rest of the year as well - a small amount in Q2 equating to the full-year $18 million total.

Got it. Thanks. I'll hop off.

Thanks, Nicole.

Our next question comes from the line of Ann Duignan with JPMorgan. Your line is now open.

Hi. Good morning, everybody.

Good morning.

Tom, could you comment on the notion that while you've taken the downturn in aerospace because of the 737 MAX, could that also spill over into your industrial business more broadly, just from the supply chain and the supply base as they have to shut down production?

Yes. Ann, it's Tom. We factored that in. A fair amount of work tied to aerospace-related engineered materials and filtration feeds our industrial segment. The $150 million impact includes industrial components, with $60 million specifically from industrial. We considered the operational headwinds that may arise from our suppliers during this transition.

I appreciate that. A quick follow-up on the MAX situation. Can you provide a breakdown of the $150 million? How much of that is from Legacy Parker? How much is from Exotic Metals?

For the $150 million, Exotic contributes $16 million of the total.

$60 million of the $150 million?

Yes.

Okay. I appreciate that. I just wanted to get back color, and I think you’d given us most of everything I’m assuming. So, I appreciate it.

Okay. Thank you.

Thanks, Ann.

Our next question comes from Jamie Cook with Credit Suisse. Your line is now open.

Hi, good morning. A nice quarter. I guess two questions, Tom. Just in terms of as we exit 2020, potentially comps get better when we start to see organic growth reignite again. Based on what you've done with the acquisitions, when should we think about incrementals any differently? Is there a difference on how to think about things Industrial versus Aerospace?

For the way we look at it, Jamie, I think you should look at incrementals higher as we come out of downturns, especially with these acquisitions providing a boost. We tend to have stronger than expected increments for a couple of quarters post-downturn when volume comes back sharply. So the expectation is there will be good efficiency gains from variable costs as those volumes rise.

Thanks, Tom. And then my second question relates to your portfolio, given some of the announcements recently. One, do you see any change in the competitive landscape? Could that be a positive for you with Eaton selling their hydraulics business? What's your view on potential divestitures?

Regarding the Danfoss Eaton announcement, we weren't surprised, but we respect both Danfoss and Eaton. Strong competitors make you a better business. We see potential for growth in our motion and control technology regardless. The new competitive tension can provide opportunities for us. As for the larger context of potential divestitures, we don't see any major changes necessary in our portfolio, though we'll continue to tweak as needed.

Thank you. I appreciate the color.

Thanks, Jamie.

Our next question comes from Jeff Sprague with Vertical Research. Your line is now open.

Yes. Thank you. Good day, everyone. Just a couple of things for me. First, just back to LORD. Tom, can you address how it's performing in the automotive markets? We've heard negative automotive comments out of 3M and DuPont here this earnings season. Just wondering how things are really progressing for that slice of the business.

LORD is progressing well. The performance differs across our three major buckets. Aerospace is performing strongly, industrial slightly negatively, and automotive neutral to slightly positive. Our technologies in thermal management and structural adhesives are offsetting some weaknesses stemming from traditional adhesives tied to internal combustion engines. Overall, I'm pleased with LORD's performance given the challenges in the sector.

I was curious back to the MAX situation. You provided detail on the redirect to the F135, et cetera. Have you actually shut down MAX-related production or are you continuing at some low rate to keep the line warm? How do you manage that operationally to ensure readiness?

That's a balancing act. We have redeployed most of our team members and thus retained the skill set for the most part. We ensure that the equipment needing maintenance is kept in optimal condition. We will build a supply chain ready to respond to signals from Boeing when they give us the go-ahead to resume production.

Right. Thank you.

Thanks, Jeff.

Our next question comes from Joel Tiss with BMO Capital Markets. Your line is now open.

Hey guys, how’s it going?

Good morning, Joel.

We've received a lot of good information here, so just a couple of clarifications. Are you guys providing any updates on your debt-to-EBITDA? Where do you expect to be by when?

As we finished the quarter, considering that we don't have a full 12 months of EBITDA from the acquisitions in there, we're currently at a gross debt-to-EBITDA of four times. Our net debt is 3.6 times. We expect to reduce our gross debt to 3.7 by the end of the year and our net debt to 3.3. These projections do not include the full 12 months of EBITDA for the acquisitions.

Is there a target before you'd look at acquisitions again? Do you need to be closer to two, or is it more like 2.5?

Aiming for 2.0 is preferred, and as we approach that target, our interest in acquisitions will increase. We'll continue to work that business development pipeline as we identify potential strategic fits.

Okay. Just one last quick question. Jamie asked about PLS, and I wanted to make sure to address that part of the question. Are you observing any larger segments that might speed up restructuring? Or is everything largely as you anticipated?

PLS is going to play a big role, and we will outline this at our Investor Day. We're focusing heavily on simplifying our processes and organizational structure. We continue to look at the right staffing levels in our divisions. We anticipate significant opportunities, especially with new designs given the relationship of design costs to overall product costs. We’ll share more detail at the Investor Day, but our long-term goals on simplifying revenue complexity and process optimization remain unchanged.

Okay, great. Thank you very much.

Thanks, Joel.

Our next question comes from Julian Mitchell with Barclays. Your line is now open.

Hi, good morning. I think Tom you had said that destocking was about a 2.5 point drag on sales in the fiscal second quarter. I just wondered what your guidance implies for that destock aspect in the second half please?

Predicting destocking precisely is challenging. We saw about minus 100 in Q1 and it has stepped down to around minus 300 in Q2. We hope Q3 marks the bottom for destocking, with Q4 reflecting end-market conditions.

That's helpful. Thank you. On the international industrial segment, your full year guide for margins in international implies a sequential step-down in the second half versus Q2 despite higher revenues in dollar terms. I just wondered if there's something around mix or the impact of production in Asia that dragged down the margin sequentially even with that higher revenue?

The percentage-wise organic decline from minus 11.5 to minus 12 in international reflects a lower decremental performance moving from low 20s to low 30s. This change is primarily influenced by the uncertainties tied to the Coronavirus and extension of the Chinese New Year shutdown, leading to anticipated operational inefficiencies on restart.

That’s great. Thank you.

Thanks, Julian.

Our next question comes from Andy Casey with Wells Fargo Securities. Your line is now open.

Thanks a lot. First question on Europe. It doesn't seem like that's trending any differently than you expected, but are you seeing any signs of improving macro conditions? Are you seeing anything on the ground that would follow that?

We observed some minor improvement in Europe. EMEA industrial went from minus 13 to minus 11 in Q2. Overall, it isn't attributed to any particular end market, just a broad slight improvement.

Okay. Thanks, Tom. Last question, I think last quarter you called out the percentages of phase three and phase four, so phase three and phase four being 28% and 48% respectively. It sounds like North American distribution had a bit of a lag down. How did phase three and phase four trend in Q2, especially excluding the North American distribution piece?

Phase two was at plus 17%. Phase three represented a drop to 72%. The shift came primarily from the distribution decline from phase four into phase three due to weaker automotive performance.

Okay. Thank you very much.

Thanks Andy. Liz, I think we have time for one more question.

Our last question comes from Stephen Volkmann with Jefferies. Your line is now open.

Well, just slid it in. Thank you.

Good morning.

Can I just ask Tom to go back to something you were discussing earlier concerning product line simplification? For many companies, a big part of the process was divesting some products that may be underperforming. You've made lots of acquisitions. Can you envision Parker going through a process of divesting significant chunks of revenue to prepare for higher returns in the future? Or is the portfolio where you want it, with only minor tweaks needed?

The answer is no, you're not going to see any major chunks come off. Our portfolio is constructed with a lot of complementary interconnectivity. We can't simply cut off tails, as they might be vital for another division. We aim for margin improvements through a structured approach. No major changes are anticipated, just minor adjustments to refine efficiency.

Okay. Thanks, Stephen. This concludes our question-and-answer session and the earnings call. Thank you everyone for joining us today. Robin and Jeff will be available throughout the day to take your calls should you have further questions. Thank you and enjoy the rest of your day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.