Parker-Hannifin Corporation (PH) Q2 2020 Earnings Report, Transcript and Summary

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. [Operator Instructions] Please be advised that today's conference may be recorded. [Operator Instructions] 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 all-time highs, relative to previous downturns. I think the best way to compare this -- the best way to do it apples-to-apples is look at the base business without lowering side and compare 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, and that Q2 adjusted operating margins were 13.5%. Both of these recessions had about similar organic sales declines and this represents a 260 basis point improvement comparing that to our best previous recession performance. Really, a remarkable performance and really my thanks to 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. Strong FY 2020 margin performance and cash flow generation so far are really a reflection of the improvements driven by The Win Strategy and the strengthening of our portfolio by buying companies that are accretive to growth into margins. So we are excited about where we are and we're excited about where we're going to go in the future. Shifting to safety. We had a 25% reduction in recordable incidents in Q2. Really making great progress here and my thanks again to everybody for their effort on this and their dedication to safety. Our recordable incident rate and what that is to people that aren't familiar with that, that is the number of safety incidents we have per 102 members that is now top quartile versus our project peers. And there's a very strong linkage. You've heard me talk about is between safety and business performance. If you were to apply our safety metrics and our financial metrics you'll see them moving in tandem in a positive direction. So 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 guide. The 737 Max issues impacted our aerospace business as Q2 airframe and engineers were slowed in advance of the production pause. Strong adjusted EBITDA margins were significantly higher than they were during the last recession. We came in at Q2 adjusted EBITDA margin of 18.5% again really strong performance. Earnings in the quarter were excellent and adjusted EPS exceeded expectations. Order rates in the quarter continued to be negative impacting organic growth. And the portfolio additions that we have 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're well positioned for excellent performance in the second half of FY 2020 and beyond that. I want to move now to year-to-date cash flow. You've heard me talk about how this is such a strategic priority for us. We want to be great generation deployers of cash to drive excellent returns for our shareholders. We've achieved the best-ever cash flow from operations of any first half in our history. And given current market conditions that's really commendable. Free cash flow to sales is about 10% and we're expecting to achieve our 19th consecutive year of cash from operating activities as a percent of sales in excess of 10% for FY 2020. The year-to-date free cash flow conversion was excellent at 130%. Moving now to the outlook, we're increasing EPS guidance for FY 2020 on roughly flat sales 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 we're well positioned for growth with excellent margins and cash flow as the macro conditions improve. Some of the factors that are driving this feeling of confidence will be first launching, The Win Strategy 3.0 which is going to drive a further step-change in the performance of the company really building on the momentum from the previous updates that we've made to The Win Strategy. Second would be the portfolio strengthening that we've done through the strategic acquisitions that have come on board. We're very happy with how LORD and Exotic integrations are progressing and we can comment more about that in the Q&A. And we recently had the leadership teams for both businesses here at headquarters talked about the -- incorporating The Win Strategy 3.0 their integration plans. It was a great session; a lot of good teamwork there. And then third would be the launch of 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. And we recognize that it takes being a top-quartile performing company to live up to the higher purpose. Parker is transforming as evidenced by the higher level of performance that we're doing in a very difficult part of the business cycle with lots of opportunities to drive earnings growth beyond FY 2020. Switching to the next slide, you'll see a reminder of our winning formula what we have characterized as our competitive differentiators. And I've talked about these before, so I'm not going to say highlight each one specific. I would just tell you this is -- this listing in aggregate is what makes us special. This is why customers come to us and this is why shareholders should think about investing in Parker. If I had to reference one in particular these competitive differentiators, I would point out Win Strategy 3.0 and what we're -- the momentum and the performance enhancements that's going to create over time. And a lot more discussions will happen on that as we forward. So my thanks to all the global team members for their continued and dedicated effort in creating a top-quartile company. And with that I'll 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 to achieve 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 adjusted earnings per share of $2.51 to the second quarter of fiscal -- 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 $0.34 reduction in operating income. The Legacy Parker teams did a good job of 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 the 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 $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 before 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're showing the impact LORD and Exotic had on the second quarter 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 the hard work of 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 is made up 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 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 of 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, 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 to the as reported forecast made in this guidance 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. In addition, 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%, second half 52% -- sorry 48% first half, 52% second half. Adjusted segment operating income is split 49% first half, 51% second half. Adjusted EPS second half is -- first half second half is divided 50%, 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 to a $0.32 EPS beat in the quarter. Updates to the second half guide result 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'll 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're well on our way to delivering top-quartile financial performance as a company. I just want to remind people where we're trying to drive to as far as we're laser focused on our FY 2023 targets and those are sales growth at 150 basis points greater than global industrial production growth, segment operating margins at 19%, EBITDA margins at 20%, free cash flow conversion greater than 100%. And those would all culminate in driving an EPS CAGR of 10% plus. So thanks again to the global team everybody around the world for all your hard work. And with that, I'll hand it over to Liz to start the Q&A portion of the call.

Operator Instructions] 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 is segment level for organic growth, especially in your industrial business?

Mig, it's Tom. So what we assumed for – I'm just going to give you for the second half with the new guide was North America at minus seven, international at minus 12, aerospace at minus 0.5 gets to the second half at a minus 7.5. And that compares to the prior guide was minus six. Big difference there being a little bit of weakness in North America but the big difference was 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 – in the first half there is some deceleration there? And obviously your orders are looking a little bit different in that regard being less bad if you would. So can you help us understand kind of how you're seeing it and what's going on there?

Yes. So our thinking on – again Mig. it's Tom. Our thinking on the orders and the sales for international, first of all, you're right. So orders came in at minus six. They did improve in Q2 but that was driven mainly by Asia. And from what we can tell, a lot of that was influenced by some pull-ins in advance of Chinese New Year. So we feel these order rates may be a little bit overstated or maybe not entirely reflective of underlying market conditions. And then given the uncertainties of the Coronavirus and the fact the Chinese government has extended Chinese, New Year by one week, we actually had our Asia team just within the last 48 hours redo the second half forecast on what they thought. And their latest thinking which is obviously very fluid given what's going on there is now reflected in this new guide. And ironically it came in about the same as what we had before. We were minus 11.5 before, we were minus 12 million. But that was our thinking is that combination of the orders are a little bit over-enhanced from the pull-ins and our current intelligence-based on what's going on is reflected in this guide.

I appreciate that. Not to put too fine a point but as we're sort of thinking about the 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.

Yes. So I'm not going to split it out necessarily by region but we have international for Q3 at about minus 16. So the worst of it hitting in Q3, you got the Chinese, New Year, the extension of that. There's some obvious reasons why Q3 might be impacted worse.

Great. Thank you, Tom.

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. I mean you were kind of 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 kind of 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? And do you think you can maintain it for the rest of the year?

Yes. Nathan, it's Lee. To answer your question is yes. As you know, our goal always is to be price/cost-neutral, margin-neutral. And I think why we're so resilient in doing that are the processes that we have? We follow the input costs through our purchase price index and we have our selling price index that we track at all the different locations. But in our forecast and what we're expecting is to be price/cost-neutral, margin-neutral.

Okay. You guys have also -- I mean, you've taken the margin expectation in aerospace down, which I think is fairly straightforward, right? You've got less volume from the MAX, so you're not going to say the leverage on that. 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, its Tom. I think what we're experiencing, what we said, and you saw a lot of that in the first half; I'd take North America as an example. We had some benefits from lower synergies pulling in from what we had originally expected, The Win Strategy and everything we're doing there. We've seen a lot of help from Kaizen activities at all of our plants. On international, we had a very strong Q2, driven somewhat with higher volume burst of our guide. But the same thing for international, Kaizen activities, The Win Strategy, we had the benefit of prior restructuring that is playing through for us there. And I think it just gave us confidence that when we looked at our second half that we could continue that in the second half. The organic growth is slightly different, slightly worse than the prior guide. But we didn't think it was enough to -- we felt we had enough other positives to offset that and to improve the margins.

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 that you made. I think you said that it impacted 2Q. And so, if it did, like, what kind of impact did it have on 2Q? And then secondly, as you think about the zero for the second half of the year, is it just fair to assume that airframers have inventory on hand and that's why the MAX is going to zero in 2H?

Yes. So let me just -- Joe, this is Tom. Glad you asked, because I wanted to give a little bit of color as to why we did what we did on the MAX. First, given Boeing's public comments about the ungrounding occurring sometime in the middle of the year, we felt that, hey, there's a lot of uncertainty there. Even Boeing doesn't fully know exactly what's going to happen with that, once suppliers will turn back on. And that we really wanted to derisk the guidance for the rest of the fiscal year by taking the MAX out. I also felt that it wasn't fair to our shareholders to have it in and then be guessing on what it's going to be and what kind of ramps it could be. I thought it was a disservice to our shareholders and that it would be much better perceived stronger by taking it completely out and showing that we could demonstrate the guidance that we're going to -- that we have here, even without the MAX. So what we did is -- so the production pause officially started January 15. However, when you look at what hit us in Q2, there was some minor slowing of orders, both on the airframe and the engine side. It was approximately $5 million in Q2. The total amount for us for the full year, including Q2 and the second half, is $150 million impact for the MAX and $50 million of earnings. Obviously, lower volume and the lack of absorption associated with that. But obviously Boeing and as well as all of our customers are really important to us. We're going to be there to support them whenever the production returns. If it happens to return sooner what we have in this guidance we'll be there for them. And in the meantime, we're reallocating our team members to other programs as much as possible to help with backlog and potentially accelerating schedules of our customers permit that. So that's really the strategy and the thinking behind the MAX.

That's super helpful Tom. And then maybe if you can just, kind of, talk about the North America weakness in a little bit more detail, just parsing out like 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?

Okay. So Joe what I'll do is I'll go through North America, but I'll just maybe run through the whole company on markets, because it's typically a question people want. But our thinking on North America, we're guiding 100 bps lower than what the prior guide. So it was minus six. Now it's minus seven. I'm just talking about the second half because, obviously, that's what's left. Orders were down from -- 100 basis points from Q1 to Q2. So that's probably the most direct linkage there. We had distribution weaker. We have the December ISM at 47.2. And all those factors plus, obviously, every time we do this we do a bottoms-up. We really look at what our thinking was there. I went through international, but I wanted to make a comment about distribution when I think about North America. So distribution and the whole for the whole company was down mid-single digits about 400 basis points worse than Q1. And this declined pretty much sequentially through the quarter and really was broad-based from an end-market standpoint. International distribution was worse in North America, but about all the regions went down equally approximately going Q1 to Q2. In North America in particular, we think the holiday timing hurt. There's two Wednesdays involved there for Christmas and New Year's Day. And really what we saw with end customers is that drove extended plant shutdowns. And our distributors as a result of this broad market based decline and the extended shutdowns took the opportunity to resize their inventory. So if you think about down mid-single digits on distribution, our best intelligence and again this is an estimate it was about half of that was destocking. Half of it was tied in markets. Maybe if I go back to just total end markets, I'm just going to list all of the positives and the negatives and I'll give maybe a little more color on the specific end markets. But on the positive side for the quarter Q2 total Parker, aerospace, mining, semiconductor, lawn and turf and marine. And then minus was distribution, which was -- I was just talking about. It's not a market but an important channel to us. Mills and foundries, refrigeration, machine tools, tire and rubber, power generation, telecom, life sciences, oil and gas, automotive, heavy-duty truck, construction, ag, forestry and rail this is too long a list on the negative side. So -- but let me give you some color if I was to, kind of, lift it up to the major segments. So I talked about distribution. So now I'd just characterize industrial end markets. For those maybe not familiar, all of our industrial markets are basically things without wheels things that don't move equipment that doesn't move. That was -- that improved. So, industrial markets went from minus nine to minus 6.5, again total company. The positive side of there was low single-digit improvements in mining and semiconductor. Semiconductor is starting to come back. On the negative side, low single digits. I'm just going to give you buckets. Low single digits was mills, oil and gas. Mid-single digits was refrigeration, power gen and general industrial. And things greater than 10% declines were machine tools, rubber and tire, telecom and life science. Then on the mobile side, again equipment with wheels saw us go from minus 6.5 in Q1 to minus 14. So that was the big shift. A lot of that was driven in North America. And the positives there was mid-single-digit improvements in lawn and turf. And then on the negatives, kind of, two buckets here, high single-digit decline in forestry. But then almost all the end markets with mobile were kind of in that 10% to 20% decline range: automotive construction, heavy truck, ag, rail and material handling. And then Cathy alluded to in her comments about aerospace. I'm rounding to the nearest half. Up plus 1.5. We had commercial OE minus 3; military OE plus 2; commercial MRO plus 15; and military MRO down 5. Netted out to 1.5. So that's kind of the spend through the end markets, Joe, I hope you have a follow-up to that.

No. I think I'm all good. Thanks. Thanks, Tom.

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 bit about what happened in international. But what's your view on whether or not order activity has bottomed and maybe thinking about how January has trended as a way to characterize that?

Nicole, its Tom. So if I was to kind of do what I did, I won't go into that same kind of detail for North America. But if you look at North America industrial, it went Q1 to Q2 basically about to say minus 5.5, minus 6. So basically the same quarter-over-quarter. The mobile is what declined the most. It went from minus 5 to minus 16. And all the same end markets that I just described for the total company, is what we saw there. And then on distribution, that went from minus 2 to about -- I mean, it was flat in North America to about minus 4 or so -- in Q2. So that was 400 bps in North America alone that we went down. So that was kind of how we look at North America. I think, in general, when we think about organic growth for the year, we're really -- in our guidance, we're reflecting really Q3 is kind of our bottom from what we see at this point.

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

Yes. We saw a little bit of the synergies for LORD pull into the second quarter. The timing moves ahead for us, so we got them sooner than we anticipated. And so, we're then factoring that through the rest of the year as well. So, a small amount in Q2 with $18 million for the full year effect.

Got it. Thanks. I'll hop it on.

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.

Good morning. Tom, would you just comment on the notion on that, while you've taken the downturn in aerospace because of the 737 MAX? Couldn't 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, its Tom. We did factor that in. Because people who don't realize that we'd have a fair amount of work that goes that's aerospace-related and engineered materials and filtration that goes into that. So the $150 million includes the industrial piece in that. And just in round numbers about 10% of that is industrial; and the other 90% as you might imagine, the bulk of it is in the Aerospace segment. But we did factor in the amount of onboard type of work we did. And then the -- I think what data part you're referring to is the things that might be in the factories of our suppliers. That's factored into the guide we have for the rest of the business.

Okay. That's -- I appreciate that. And then just circling back on the same topic, can you give us a breakdown, the $150 million? How much of that is Legacy Parker? And how much is Exotic Metals?

So Exotic is $16 million of the $50 million.

$150 million.

Of the $150 million, sorry. Yeah, $60 million of the $150 million.

$60 million of the $150 million?

Yes.

Okay. And that includes both direct shipments content on the aircraft as well as shipments to the engine?

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 and when is there -- should we be thinking about incrementals any differently? And I'm wondering if there's a difference on how to think about things Industrial versus Aerospace I guess? And then just my second question just relates to your portfolio given some of the announcements recently. One, do you see any change in the competitive landscape? Or could that be a positive for you with Eaton selling their hydraulics business? And just your view of -- is there any change in your view I guess of your portfolio in terms of potential divestitures? Thank you.

Okay. Jamie, it's Tom. So I'm going to work backwards on the questions. I'll start with -- I think what you're referring to is the Danfoss Eaton announcement. I would first say we weren't surprised, given I think the portfolio that Eaton has. And I think some of our inclination as to what they might do with it. We have a lot of respect for both Danfoss and Eaton. And in our view, strong competitors make you a better business. So we welcome the challenge. We like our chances. We believe that the breadth of our technologies, the growth that we have with the motion and control technology and the Win Strategy is going to allow us to compete effectively with any company in our space. And we're confident going forward. Obviously when you have these, kind of, transitions, having done a lot of these type of acquisitions ourselves, we recognize that there's stress in the system when that happens. And there's maybe a potential opportunity to look at share gain. And so we will, obviously, be doing everything we can to optimize that and take advantage of that and good competitive tension in the system. So if I move back to maybe your other two comments from incremental MROSs, kind of, looking forward. I still think plus 30 in general is a good number if you're doing it over multiple years. But clearly coming out of a downturn as we have talked about in the past, you would expect to see that be north of a plus 30, because you're going to get some help as that volume comes up. And you're going to be only adding incremental variable cost and doing it very efficiently as you do that. So I think the first couple of quarters coming out, tends to be stronger than what I would say you'd see over a whole cycle. And then the whole goal of these acquisitions and they will but maybe I could just comment in general about them. I'm extremely pleased with the progress. We've acquired great products and technology but the best thing that we've done is the talent that's come into the organization from these two businesses. It was on full display when we had the leadership meaning we have about 80 people from both businesses and together. And if I look at LORD, LORD is ahead of what we had hoped for, low single-digit growth and that compares to a minus 6.5% for total Parker. So it's doing what we wanted. It's more resilient. And what we're seeing from the aerospace thermal management. The structural adhesives part of LORD is really doing quite nicely. We were very confident on the $125 million of cost synergies and we pulled in the synergies into this year. Now with Exotic, the team is doing a great job. The 737 MAX is out of everybody's hands. That's something we can't control. But that team there is effectively redeployed everybody that was on the MAX and we've redeployed them to the F135. And we got to do some minor CapEx to help facilitate that. But we have them on F135. We also have the repair depot starting up on the F135. And then we've got one of the big synergies which we didn't really disclose on our revenue side is the fact that we have this well-established aftermarket organization customer support operation as part of legacy Parker aerospace that can help with the commercial efforts of Exotic to go capture those legacy engines and to look for spares and repairs for all the type of products that Exotic does. And we're going to do that and we're going to try to pull them in. And everything I just described in that is not going to really help so much Exotic in FY 2020 but it's really positioned for FY 2021. And the MAX will come back. And so I think we have the benefit there. There's potentially a one-two punch with Exotic MAX goes back. And then we've also got additional people trained. Now some of the F135 will depend on our customer allowing us to accelerate the schedule. I think they have signaled that they would. But obviously, if some other supply becomes a constraint for them they might slow us down. But that's an opportunity to accelerate the F135. So that's kind of a long-winded answer on acquisitions. But if you think about them in aggregate they're coming in they're going to grow faster than the legacy Parker. And that was the whole reason why we acquired them. You see the incremental EBITDA, what it's doing for us in one of the slides that Cathy had. So we're still very positive. The MAX is a short-term blip on the path to a pretty strong future for them.

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 kind of in the automotive markets? And you had pointed to kind of the ability to outgrow through thick and thin. We've heard a lot of the kind of negative automotive comments out of the 3Ms and DuPonts here this earnings season. Just wondering how things are really progressing for that slice of the business?

Yes. So – and without getting into specific numbers, if I just take the three major buckets. Aerospace is a pretty strong growth for us. And then the industrial piece would be slightly negative and automotive would be neutral to slightly positive. And what's really happening there is the technologies we have there that are more electrification type of technologies which would be thermal management. And structural adhesives are offsetting the weaknesses that we have. And the traditional adhesives and coatings they might be more supplied into the internal combustion engine. So I'm really happy with what they're doing, coming in at low single digits. And that's even factoring in some weakness in Asia tied to the Coronavirus. So those -- that's, obviously, a new element and that's an unknown still as -- and yet to be determined. But I'm really happy with what they're doing out of the gate.

And I was curious back to the MAX situation. You provided a little detail on the redirect to the F135 et cetera. But 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 make sure you are ready to go if you get the signal?

Well, obviously, that's a balancing act. So we redeployed the people. So we haven't lost that skill set for the most part. There's some we could not retain unfortunately, but we've retained most of them. So we have the skill set people wise. Obviously we'll make sure we maintain any of the equipment that needs to be maintained. So we're ready to go. And with our supply chain, we're making sure that they're ready and able to supply to us when we need to. So if we need to carry a little extra inventory to be ready we'll do that. And our suppliers will be ready too. But I thought it was prudent for us and for our shareholders to not be trying to chase and guessing when the MAX is going to start back up. So we didn't build it in the guidance. But, obviously, internally we're going to make sure we built a supply chain that can respond. And, obviously, Boeing needs to give us some lead time and they recognize that they will. But we will be there to respond when Boeing gives us a signal.

Right. Thank you.

Thanks, Jeff.

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

Hey guys, how it’s going?

Good morning, Joel.

We've gotten a lot of good information here. So just a couple of like whatever clarification I guess. Are you guys giving any updates on your debt-to-EBITDA? Like where do you expect to be by when? Or is that more for the Analyst Day?

I can talk about that for you Joel. 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 as is four times. And our net debt is 3.6 times. We expect by the end of the year we'll have the gross debt down to 3.7 and the net debt down to 3.3. Again that's not -- that only has a sub period of EBITDA for the acquisitions in there. So it's actually -- next year will look -- quickly look a little better once we get 12 months of EBITDA.

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

Joel, it's Tom. I think as – 2.0 is what we'd like to get to. But, obviously, as we start to glide closer to that we're -- obviously our interest is going to get more keen. The key thing on what we've learned and it's not a new lesson over the years is you have to continually work that business development pipeline. We are working it now today as we speak, building those relationships, understanding the strategic fits to our company. And so we'll continue to do that. Even though we're not ready to action a thing, we'll continue to work that pipeline. But yes we need to get closer to two before we get back in the game.

Okay. And just one last quick one. You -- Jamie asked about PLS and you didn't really -- you missed that part of the question. I just wondered are there any, kind of, bigger chunks that you guys are seeing that could accelerate the restructuring. Or everything is pretty much as you expected and we just keep the incremental improvement?

Joel help me with PLS?

Product line simplification, so looking at individual product lines and having them off or finding a better owner for them?

Okay. Good. So yes, that's going to be a big but we will talk a lot about that at IR day. But the cliff notes is that still a really big part of our strategy going forward. And we've added to it was Simple by Design. So it's still looking at what I'll call organization or structural change, a number of divisions and cruise. But that has played through for the most part but we continue to look at that. But the other part of that that we'll look at is just within the divisions do we have the right staffing elements, what we call competitive staffing analysis looking at debt versus best-in-class examples. So that's item one. Item three is I think what you were using – what we would call 80-20. And that's still early days. We have lots of opportunities and that's a big part of how we're trying to simplify things, revenue complexity and the processes and structure that services that. And the third element is Simple by Design, which gets at that approximately 70% of the product cost is tied up in how we design things in the first place. So you can have the most fantastic lean system in Kaizen and doing all these other simplification things I just talked about, but a lot of your cost and your speed within your factories and your speed of service customers is stuck in concrete based on how you design the product. So we'll go through that in a lot more detail at IR Day. And we think we're one of the first people thinking differently on how we want to do that and it'll be a combination of process and software things that we'll elaborate in more detail. And that's – obviously, that's a little bit longer term because you've got to do that as you design new things. There are some things we can do going backwards with existing designs. But that will set us up nicely for margin expansion and really I think speed in the future.

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. So I just wondered what your guidance implies for that destock aspect in the second half please?

That one is really hard to predict exactly how destocking goes and doesn't go. To be honest I would not have expected given what we were trending before the quarter does to have it stepped down about 200 bps. We're in round numbers we're about minus 100 destocking in Q1. It's now around minus 300 in Q2. That has to eventually find equilibrium. And I would – based on probably the Q3 being our bottom, our hope is that the destocking when to hit bottom in Q3. And then everything else from our distribution channel would be end market-related as we go into Q4.

That's helpful. Thank you. And then my second question just on the international industrial segment. You gave a lot of good color on the top line pieces moving around there. I just wanted to ask on the margins because it looks as if – in terms of the margin rate your full year guide for margins in international implies a step-down sequentially in the second half in the first half or second half versus Q2, even though the revenues just in dollar terms should be going up. So I just wondered if there's something around mix or something with the Asian production impact that you were talking about earlier that dragged down the margin sequentially even with that higher revenue?

Yes. You hit the nail on the head. So percentage-wise organic goes down 11.5 to minus 12 for international. But I think in particular, what you're seeing there, is we've got a little -- our assumption is a little weaker decremental, go from a decremental in the low 20s in the first half to kind of the low 30s in the second half for Asia, really influenced by how we looked at what the risks associated and the uncertainties around, in particular, Asia, the Coronavirus and just the unknowns there. Recognizing that as you extend Chinese New Year shutdown, nothing's happening there. And then when you start back up, it's going to be much more inefficient. Our belief on the start-up than in previous times coming off of the Chinese New Year. So that's really the difference, Julian.

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 different than you expected, but are you seeing -- we're seeing some improving macro stuff. Are you seeing anything on the ground that would follow that?

Hey, Andy, it's Tom. We saw some slight improvement in Europe. If I look at EMEA as a total region, industrial went from minus 13 to minus 11 in Q2. So still soft, but got a little bit better. There was no particular end market that kind of lifted up sand. That was what drove it, just was kind of really a whole breadth of it getting a little bit better. Mobile was basically the same, minus 13, slight improvement minus 12.5. I'm rounding to the nearest half. So I would say, fairly consistent with some minor improvement.

Okay. Thanks, Tom. And then, I think, last quarter you called out phase three, phase one -- sorry, phase three, phase four being 28% and 48% respectively. It sounds like North American distribution had a little bit of a lag down. Could you kind of help us with how phase three and phase four trended in Q2 and how that may change if you exclude the North American distribution piece?

Yes. Andy, so that distribution -- as distribution goes, it really influences these four phases. I think what we've seen now and looking at these phases, things can move kind of jock you back and forth between phase three and phase four, depending on what's going on. And that's what we saw in this last quarter. Distribution went from phase four in the prior quarter to phase three. And distribution, being like 37 points of our -- excluding aerospace, it influences it quite a bit. So, if I just contrast for you phase one that's accelerating growth was plus 3. I'm talking about the current quarter. Decelerating growth, phase two, was plus 17% -- or 17% of our sales. Accelerating decline in phase three was 72% and that main reason why that moved higher, was because distribution moved into there and automotive moved in there. Automotive was in phase four. The balance being 8% of our sales was in phase four decel and decline. So the big shift predominantly was distribution and automotive moving from four to three.

Okay. Thank you. And then, one last one and this isn't an attempt, because irrespective of what, just, I'll be at the Investor Day. But should we expect any significant changes in the longer-term goals that you previously outlined outside of potentially EBITDA margins, which are -- look on track to maybe exceed it? Given a big slug of amortization that you're carrying now, the EBIT margin seems like it might be more of a challenge. But anyway should -- your lineup looks great. It looks like you're going to be providing a lot of detail. But at the end of it, should we expect significant changes in the longer term trajectory?

This is Tom. You're very perceptive. Obviously the amortization headwinds Cathy gave numbers by segment. If you look at that on a steady state round numbers, it's about 100 bps of headwind that we now have with amortization before -- that we didn't have before we set those goals. But I would -- the short answer to your question is, no, you should not see any big changes. But, obviously, EBITDA needs to be looked at given what's happened. And we will look at that. And we're looking forward to seeing everybody, because I think you're going to see an excited team with an exciting lineup with I think more information than we've ever shared with you. And we're going to get a chance to talk about the Win Strategy 3.0 and a lot of things that I think are going to be very compelling to people want to be excited about our current shareholders and then hopefully future shareholders to want to own Parker-Hannifin.

Great. Thank you very much.

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

Our last question comes from the line of 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 talking about earlier when I think Joel was asking you about product line simplification. And you talked about 80/20. From a lot of other companies who have instituted this, a big part of the process was having off a fairly chunky size of revenues that might be underperforming or might just not have the potential to perform over time that you might have thought. You've made lots and lots of acquisitions. So I guess I was just trying to get a little more clarity there. Can you picture Parker going through a process of divesting a significant chunk of revenue to, kind of, prepare the ship for higher returns and higher growth going forward? Or is the portfolio where you want it and there might be some tweaking but nothing major?

Yes. Steve, it's Tom. So that's a good question. And actually that's probably what Joel was getting at and I didn't completely answer him. I think the short answer is, no, you're not going to see any major chunks come off. You might see some minor tweaks. The big difference between say how we're deploying 80/20. We're deploying it the same way that people that you've seen to it before like ITW et cetera. The difference is in our portfolio. Our portfolio is built with a lot of complementary interconnectivity there. And with 60% of our revenue coming from customers that buy from four or more of our technologies, our revenue in the tail is very much linked to other revenue throughout the company. So it requires a little more thoughtful approach. We can't just lop off those tails saying hey that's the end of it because the tail for one division might be an A item for a different division. So we're doing that for a very thoughtful standpoint. We will still get the same kind of speed and margin improvements. We're just -- you're not going to see really any, kind of, revenue changes on that. We don't see it as a headwind to revenue. It will be neutral on the revenue side. You might see some minor things that we do on that, but most of it is going to be just helping customers through different ways to deliver it. Different pricing things are different things we can do on alternative part numbers to satisfy their demand. We want to still take care of our customers and create a great experience for them. We're just going to find more efficient ways to do it.

Great. Good color. I appreciate it. Thanks.

Okay. Thanks, Stephen. Okay. 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. Enjoy the rest of your day.

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