Parker-Hannifin Corporation — Q2 FY2019 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2018. Unaudited results; fiscal year ends June 30. Parker-Hannifin manufactures motion-control and fluid systems and reports Diversified Industrial and Aerospace Systems segments.
Financial performance
| Metric | Quarter | Six months |
|---|---|---|
| Net sales | $3.472 billion, up 3.0% year over year | $6.951 billion, up 3.2% |
| Gross margin | 25.0%, versus 23.9% | 25.2%, versus 24.5% |
| Net income | $311.9 million, versus $56.3 million | $687.8 million, versus $341.9 million |
| Diluted EPS | $2.36, versus $0.41 | $5.15, versus $2.51 |
| Operating cash flow | $541.0 million for six months, versus $456.8 million | |
| Capital expenditures | $94.4 million for six months, versus $144.8 million; operating cash flow less capex was approximately $446.6 million |
Quarterly SG&A was $397.3 million, or 11.4% of sales, versus $408.3 million, or 12.1%. Interest expense was $47.5 million, down from $53.1 million, primarily reflecting lower average debt. The effective tax rate was 27.7% for the quarter and 22.8% for six months; the prior-year rates were unusually high at 84.4% and 53.5%, respectively, mainly due to discrete Tax Cuts and Jobs Act-related tax costs recorded in those periods.
Segments: Diversified Industrial sales rose 1.2% for the quarter as reported (4.4% excluding currency and divestitures); North America grew 4.3%, while International declined 2.5%. Aerospace Systems sales rose 12.1% to $616.3 million. Quarterly operating margins were 15.8% for Diversified Industrial North America, 15.5% for International, and 19.7% for Aerospace Systems. Aerospace margin growth reflected higher volume and profitability, joint-venture earnings, and lower costs.
Balance sheet, liquidity and capital allocation
At December 31, 2018, cash and cash equivalents were $1.047 billion; cash, marketable securities and other investments totaled approximately $1.078 billion. Working capital was $1.826 billion and the current ratio was 1.52, versus 1.59 at June 30. Inventories increased $183 million to $1.805 billion; inventory days supply rose to 77 from 64 at fiscal year-end.
Notes payable and debt due within one year were $1.144 billion, and long-term debt was $4.303 billion. Commercial paper outstanding was $1.141 billion. A $2.0 billion revolving facility had $859 million available. The company reported a debt-to-debt-and-shareholders’-equity ratio of 0.49 against a maximum covenant level of 0.60 and stated it was in compliance. Senior-debt ratings were Fitch A-, Moody’s Baa1 and S&P A.
Six-month financing included $606 million of net commercial-paper borrowing, $100 million of long-term debt repayments, $550 million of share repurchases and $200 million of dividends. The company repurchased 3.3 million shares at an average $166.54 per share. Shareholders’ equity was $5.815 billion, down from $5.860 billion at June 30.
Changes, outlook and risks
- Sales growth came primarily from Diversified Industrial North America and Aerospace; currency reduced sales by approximately $73 million in the quarter and $130 million for six months. International Diversified Industrial sales were particularly affected.
- Management forecast a fiscal 2019 effective tax rate of approximately 23.5%. Fiscal 2019 sales guidance: Diversified Industrial North America up 1.4%–3.9%, International down 4.9%–2.5%, and Aerospace Systems up 4.5%–6.6%. Expected segment operating margins were 16.6%–17.2% for North America, 15.7%–16.1% for International, and 18.9%–19.3% for Aerospace.
- Total backlog was $4.209 billion; approximately 92% was expected to convert to revenue within 12 months. Aerospace backlog was $2.048 billion, up from $1.821 billion a year earlier.
- Management expected approximately $19 million of additional business realignment and acquisition-integration costs during the rest of fiscal 2019. Current and prior actions had approximately $18 million of remaining severance payments; additional charges may occur, with timing and amount uncertain.
- The quarter included a $14.5 million additional tax expense related to the estimated transition tax under the Tax Cuts and Jobs Act. Gross unrecognized tax benefits were $146.6 million, plus $23.4 million accrued interest; up to approximately $110 million could be reduced within 12 months as tax matters progress.
- Management cited economic and market uncertainty, including manufacturing activity, currency, trade-policy responses, customer orders, raw-material costs, competition, acquisition integration, restructuring execution, cybersecurity, labor and legal matters. China’s PMI was below 50 at period-end. Aerospace margins could be pressured by a greater commercial OEM mix or higher-than-expected new-product development costs.
- Other notable items: a $200 million discretionary pension contribution in September; adoption of revenue-recognition guidance increased retained earnings by approximately $5 million and had an immaterial current-period operating impact. Interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether order rates, backlog conversion and regional demand support the segment sales and margin forecasts, particularly in International Diversified Industrial.
- How much reported earnings growth reflects operating performance versus the unusually high prior-year tax expense and other period-specific items.
- Inventory growth, working-capital trends, and the extent to which operating cash flow continues to fund repurchases and dividends.
- Commercial-paper reliance, debt ratings and available revolving-credit capacity, especially following substantial share repurchases.
- Potential tax adjustments, remaining restructuring costs and the realization and timing of expected savings.