Parker-Hannifin Corporation — Q2 FY2014 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2013. The company manufactures motion- and control-technology products and reports two segments: Diversified Industrial and Aerospace Systems. Unless indicated otherwise, amounts below are in U.S. dollars.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $3,106.0 million, up 1.3% year over year | $6,332.2 million, up 0.8% |
| Gross profit / margin | $686.0 million / 22.1% (21.0% prior year) | $1,435.8 million / 22.7% (22.0% prior year) |
| Net income attributable to common shareholders | $253.3 million; diluted EPS $1.66 | $497.6 million; diluted EPS $3.28 |
| Operating cash flow | Not separately reported for the quarter in the supplied filing text | $540.1 million, versus $347.3 million |
Reported earnings include unusual, material items: a $412.6 million pre-tax gain from deconsolidating a subsidiary and a $188.9 million goodwill and intangible-asset impairment charge. The gain included about $186 million from remeasuring the retained investment. The impairment related to the Worldwide Energy Products Division. The effective tax rate was 48.8% for the quarter and 39.3% for the six months, elevated mainly by discrete tax costs related to the impairment and GE Aviation joint venture. Accordingly, reported net income should not be read as an unadjusted measure of underlying performance.
Gross margin improved year over year, supported by higher Diversified Industrial International volume and lower pension costs, partly offset by Aerospace product mix and support costs. SG&A rose to 12.8% of sales for the quarter from 12.4% a year earlier, reflecting higher incentive compensation and research and development spending.
Segments and material changes
- Diversified Industrial: Quarterly sales were $2,602.3 million, up 2.6%; six-month sales were $5,260.9 million, up 1.0%. International growth drove the increase; North American sales were weaker over the six-month period. Quarterly operating margins were 15.1% in North America and 10.5% internationally, both higher year over year.
- Aerospace Systems: Quarterly sales declined to $503.8 million from $528.7 million, while six-month sales were nearly unchanged at $1,071.2 million. Quarterly operating margin fell to 8.9% from 9.9%; six-month margin was 9.6% versus 10.7%. The filing cites the GE Aviation joint venture, unfavorable mix and higher product-support costs among the factors affecting margins.
- The company reorganized its reporting structure effective July 1, 2013, combining Climate & Industrial Controls activities into existing groups. Prior segment results were revised for comparability.
- Quarterly and six-month results include business realignment charges of $13.2 million and $24.5 million, respectively. The company expected about $75 million of additional realignment charges in the remainder of fiscal 2014.
Cash flow, balance sheet and liquidity
- Six-month operating cash flow was $540.1 million, up from $347.3 million. Management attributed the improvement largely to working-capital cash flows; pension contributions were $75 million, versus $226 million in the prior-year period.
- Investing activities provided $99.4 million, compared with $687.0 million used a year earlier. The current period included proceeds from the GE Aviation joint venture transaction and less acquisition spending. Financing activities used $333.3 million, including $134.7 million of dividends and $103.7 million of share repurchases.
- Cash and equivalents were $2,139.5 million at December 31, 2013. Working capital was $2,441.8 million and the current ratio was 1.74, compared with 1.57 at June 30, 2013. About $1,863 million of cash was held by foreign subsidiaries and generally was not readily available for U.S. use without adverse tax consequences.
- Total debt was approximately $2,724 million; debt to debt-plus-shareholders’ equity was 30.2%, down from 33.0% at June 30. The company reported a net-of-cash ratio of 8.5%. Commercial paper outstanding was $1,216 million; $784 million of its $2 billion revolving credit facility was available. The company stated it was in compliance with debt covenants.
- Inventory increased to $1,448.6 million from $1,377.4 million at June 30; days’ supply rose to 72 from 62. Trade receivable days sales outstanding remained 49 days.
Outlook, risks and contingencies
- Management expected fiscal 2014 sales to increase about 2% in both Diversified Industrial North America and International, with operating margins of approximately 16.5% and 11.7%, respectively. Aerospace Systems sales were expected to decline about 2%, with an operating margin of approximately 11.6%. Management forecast a fiscal 2014 effective tax rate of about 34%.
- Management cited improving PMI readings in the United States, eurozone and China, higher global aircraft miles flown and passenger miles, and higher U.S. housing starts. It expected U.S. defense spending to be about 1% lower than fiscal 2013.
- Key risks include changing demand and product mix in industrial and aerospace markets, customer and supplier disruptions, pricing and raw-material pressures, execution and savings from realignment, acquisition or divestiture outcomes, currency and economic conditions, and estimates used in goodwill valuations. The company warned that adverse changes in assumptions could require further impairment testing.
- Marine-hose cartel-related proceedings remained relevant: Brazilian authorities formally closed their investigation in January 2014 after a settlement payment; the European Commission appealed a court ruling that had reduced the fine and limited the company’s joint liability. The filing also describes other legal-proceeding risks.
Important facts for investors to verify
- Separate recurring operating trends from the $412.6 million deconsolidation gain and $188.9 million impairment when assessing earnings and EPS.
- Review the GE Aviation joint venture’s effect on reported Aerospace sales, margins, backlog and the value of the retained investment.
- Compare actual results with the fiscal 2014 segment sales, margin and tax-rate outlook, and track the expected additional realignment charges and savings.
- Monitor inventory growth, foreign-held cash availability, commercial-paper reliance and remaining revolving-credit capacity.
- Track resolution of the European Commission appeal and the company’s other stated legal and impairment-related risks.