Parker-Hannifin Corporation — Form 10-Q Summary
Business context and period: The filing covers the first quarter of fiscal 2018, the three months ended September 30, 2017, compared with the three months ended September 30, 2016. Parker-Hannifin manufactures motion and control technologies and systems. Its reportable segments are Diversified Industrial and Aerospace Systems. Financial statements are unaudited.
Key financial results
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Net sales | $3,364.7 million | $2,743.1 million |
| Gross profit margin | 24.7% | 23.2% |
| SG&A as a percentage of sales | 11.9% | 11.8% |
| Income before income taxes | $374.3 million | $292.2 million |
| Net income | $285.5 million | $210.2 million |
| Net income as a percentage of sales | 8.5% | 7.7% |
| Diluted EPS | $2.10 | $1.55 |
| Cash dividends per share | $0.66 | $0.63 |
| Operating cash flow | $239.0 million | $113.9 million |
Sales increased approximately 22.7% year over year, and net income increased approximately 35.8%. The company attributed higher gross margin primarily to higher sales volume, lower operating expenses from simplification and prior-year restructuring actions, and improved Aerospace Systems margins. Interest expense rose to $53.6 million from $34.1 million, mainly due to higher average borrowings. The effective tax rate was 23.7%, down from 28.1%, primarily because of discrete tax benefits, including benefits related to stock-based awards; management expected approximately 28% for fiscal 2018.
Segments
| Segment | Sales | Operating income | Operating margin |
|---|---|---|---|
| Diversified Industrial—North America | $1,594.7 million; +36.7% reported | $256.0 million | 16.1%, versus 17.2% |
| Diversified Industrial—International | $1,238.8 million; +22.0% reported | $191.8 million | 15.5%, versus 13.5% |
| Aerospace Systems | $531.2 million; down from $561.2 million | $77.4 million | 14.6%, versus 13.1% |
Diversified Industrial sales growth reflected both acquisitions and organic demand. Excluding acquisitions and currency, North American and International sales increased 9.7% and 11.7%, respectively. Acquisitions, including CLARCOR, contributed approximately $382 million to company sales in the quarter. Aerospace sales declined mainly because of lower commercial aftermarket and OEM volume and lower military OEM volume; improved aftermarket profitability helped lift its margin.
Liquidity, debt, and cash flow
- At September 30, 2017, cash and cash equivalents were $874.8 million; marketable securities and other investments were $99.8 million. Management reported combined cash and investments of $974.6 million, including $892 million held by foreign subsidiaries, generally not readily available for U.S. use without adverse tax consequences.
- Working capital was $1,537.5 million and the current ratio was 1.44. Inventory rose $157.5 million from June 30, 2017; days of inventory supply increased to 77 from 67 at June 30.
- Current notes payable and long-term debt payable within one year were $1,144.1 million; long-term debt was $4,788.1 million. The filing reports long-term debt carrying value of $5,408.7 million in its financial-instrument note.
- Operating cash flow was $239.0 million; capital expenditures were $79.3 million. Investing activities used $118.3 million, while financing activities used $135.4 million. Cash and cash equivalents declined $10.1 million during the quarter.
- Commercial paper outstanding was $569 million. Of a $2.0 billion revolving credit facility, $1.431 billion was available. The company reported a 0.52-to-1.0 debt-to-debt-and-shareholders’ equity ratio, below its 0.60-to-1.0 covenant limit, and compliance with covenants.
Operating cash flow increased year over year, but the comparison is affected by a $220 million voluntary contribution to the domestic qualified pension plan in the prior-year quarter. Current-quarter cash use also reflected higher inventory and other working-capital needs. The company repurchased 306,037 shares for approximately $50 million and paid $88.1 million in dividends.
Outlook, notable items, and risks
- For fiscal 2018, management forecast Diversified Industrial North American sales growth of 19%–23% and International growth of 15%–19% from fiscal 2017, with operating margins of 16.2%–16.6% and 14.1%–14.5%, respectively. Acquisitions were expected to be the primary sales-growth driver.
- For Aerospace Systems, management forecast fiscal 2018 sales flat to 2% higher than fiscal 2017 and operating margins of 15.4%–15.8%. A greater commercial OEM mix or higher-than-expected product-development costs could pressure margins.
- The company expected approximately $95 million of additional business realignment charges and acquisition integration costs during the remainder of fiscal 2018. Current-quarter charges and integration costs totaled $14.0 million. Management said realignment actions were expected to benefit future results; estimated savings from current-quarter workforce reductions were expected to lift fiscal 2019 operating income by approximately 2% in North America and 1% internationally.
- Other unusual items included a $13.8 million loss on the sale of an investment. The quarter also included substantial foreign-currency translation gains in other comprehensive income.
- Principal disclosed risks include changes in demand and economic conditions, customer or supplier disruptions, raw-material cost increases, acquisition integration (including CLARCOR), realignment execution, competitive pricing, currency and interest-rate exposure, labor and cybersecurity risks, and legal proceedings.
- Gross unrecognized tax benefits were $150.7 million, with $16.7 million of related accrued interest. The company said up to approximately $110 million of gross unrecognized tax benefits could be reduced within 12 months, depending on tax examinations and statute closures.
Important facts for investors to verify
- How much of reported sales growth and future guidance depends on acquired businesses, particularly CLARCOR, versus continuing organic demand.
- Whether inventory growth and higher days of supply convert into shipments and cash, and whether working-capital performance improves.
- Progress on CLARCOR integration, the expected $95 million of further realignment and integration costs, and delivery of projected savings.
- Whether Aerospace Systems sales and margins meet guidance given the stated mix and development-cost risks.
- Debt maturities, borrowing costs, credit ratings, and covenant headroom; the filing notes ratings below management’s stated “A” goal following capital deployment.
- Potential changes in tax contingencies and the expected approximately 28% fiscal 2018 effective tax rate.