Parker-Hannifin Corp quarterly report, Q2 FY2011

Parker-Hannifin Corporation — Q2 FY2011 Form 10-Q

Reporting period: Three and six months ended December 31, 2010. The company manufactures motion- and control-technology products and reports Industrial, Aerospace, and Climate & Industrial Controls segments. Comparisons are with the corresponding periods ended December 31, 2009. Amounts below are U.S. dollars; financial statement amounts are rounded to millions unless otherwise noted.

Financial performance

MetricThree monthsSix months
Net sales$2,866.7 million, up 21.7%$5,695.9 million, up 24.0%
Gross profit / margin$670.9 million / 23.4% (20.6% prior year)$1,362.3 million / 23.9% (20.1% prior year)
Net income$231.8 million ($230.2 million attributable to common shareholders)$480.8 million ($477.4 million attributable to common shareholders)
Diluted EPS$1.39, versus $0.64$2.90, versus $1.10
Cash dividends per share$0.29, versus $0.25$0.56, versus $0.50
  • For the six months, operating cash flow was $408.2 million, compared with $606.3 million; investing cash outflow was $145.3 million, and financing cash outflow was $66.4 million. Cash increased $233.2 million to $808.7 million.
  • Management attributed lower operating cash flow mainly to a $200 million voluntary pension contribution and increased working-capital use, particularly from inventory and receivables. The notes report $219 million of qualified-plan contributions during the half-year.
  • At December 31, cash was $808.7 million; current assets were $4,043.9 million and current liabilities $1,940.9 million. Working capital was $2,103.1 million and the current ratio 2.08, versus 1.63 at June 30, 2010.
  • Notes payable were $101.3 million and long-term debt $1,742.5 million. The reported debt-to-debt-plus-shareholders’ equity ratio was 26.5%, down from 28.9% at June 30. The $1.5 billion revolving credit facility was fully available; no commercial paper was outstanding at quarter-end.

Changes and segment results

Revenue increased across all segments, with the largest contribution from Industrial. Higher volume and manufacturing efficiencies, together with lower realignment charges, lifted gross margin. SG&A rose in dollars with sales and incentive compensation but declined as a share of sales. The effective tax rate fell to 24.3% for the quarter and 25.2% for the half-year, partly reflecting tax legislation and a roughly $5 million discrete research-credit benefit in the quarter.

SegmentQ2 sales and operating marginSix-month sales and operating incomeFiscal 2011 outlook
Industrial$2,192.7 million combined North America and International sales; margins 15.2% and 14.6%, respectively$4,350.6 million sales; $700.4 million operating incomeNorth America sales growth 19.8%–21.8%, margin 16.2%–16.8%; International sales growth 18.6%–20.6%, margin 15.1%–15.7%
Aerospace$459.6 million sales; 13.8% margin$896.3 million sales; $107.4 million operating incomeSales growth 6.7%–8.7%; margin 13.6%–13.9%
Climate & Industrial Controls$214.3 million sales; 4.4% margin$449.0 million sales; $31.1 million operating incomeSales growth 14.6%–15.6%; margin 8.3%–8.8%

Backlog rose year over year in all three segments: Industrial $1,703.2 million, Aerospace $1,702.7 million, and Climate & Industrial Controls $174.1 million. Management expected fiscal 2011 effective tax rate of approximately 27%. No overall consolidated sales or earnings guidance is stated in the provided filing text.

Outlook, risks, and unusual items

  • Management cited improving manufacturing activity: December PMI readings were 57.0 in the United States, 57.1 in the Eurozone, and 54.4 in China. Aircraft miles flown and passenger miles were each up about 8% from comparable prior-year levels; U.S. housing starts were down about 8% year over year.
  • Industrial demand improved broadly, while Aerospace growth reflected commercial OEM and aftermarket activity, partly offset by weaker military aftermarket volume. Climate & Industrial Controls benefited from heavy-duty truck, automotive, and commercial refrigeration demand, but faced higher material costs and operating inefficiencies.
  • Management said further realignment actions may be taken and additional fiscal 2011 charges are possible; timing and amounts were not finalized. Current-period realignment charges were $1.7 million for the quarter and $4.8 million for the half-year.
  • Other income included gains from intellectual-property and real-estate sales. Prior-year other expense included asset writedowns. Aerospace margins benefited in the quarter from retroactive billings and contract reserve adjustments; management flagged product mix and development costs as potential margin pressures.
  • The company cited risks including economic and market changes, customer or supplier disruptions, pricing and raw-material costs, acquisition integration, realization of restructuring savings, pension and health-care costs, currency and interest-rate movements, and legal proceedings.
  • Marine-hose antitrust matters remain unresolved in Brazil and on appeal in Europe. The European Commission imposed a €25.61 million fine, with the company jointly and severally responsible for €8.32 million; the appeal was pending. A U.S. False Claims Act case was dismissed with prejudice as to the company but remained pending against its subsidiary Parker ITR. The filing states that the ultimate outcomes are uncertain.
  • The fiscal 2011 annual goodwill impairment test was in process and expected to be completed by the end of the third quarter. Management reported no then-current impairment indicators for long-lived assets. Warranty accrual changes were described as immaterial.

Important facts for investors to verify

  • Whether strong sales growth, segment margins, and rising backlogs continued after December 31, 2010, and whether management’s segment guidance was achieved.
  • How much of reported earnings growth reflects higher volumes and operating efficiency versus tax benefits, asset-sale gains, and contract adjustments.
  • Working-capital and pension-funding trends, particularly inventory growth and the difference between reported pension contributions and the voluntary contribution cited in MD&A.
  • Debt levels, credit-facility availability, and compliance with covenants, alongside the company’s stated 37% maximum debt-to-debt-plus-equity goal.
  • Developments in the marine-hose proceedings, the goodwill impairment test, and any additional restructuring charges.