Parker-Hannifin Corporation — Q2 FY2016 Form 10-Q
Reporting period: Three and six months ended December 31, 2015; comparative periods ended December 31, 2014. Unaudited interim results. Unless noted otherwise, amounts are in millions of dollars.
Business context and results
Parker-Hannifin manufactures motion and control technologies and reports two segments: Diversified Industrial and Aerospace Systems. The quarter’s results reflect a substantial decline in Diversified Industrial demand, while Aerospace Systems operating income and margins improved.
| Metric | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Net sales | $2,705.6 | $3,135.0 | $5,574.9 | $6,404.9 |
| Gross profit | $565.0 | $733.4 | $1,233.4 | $1,543.5 |
| Gross margin | 20.9% | 23.4% | 22.1% | 24.1% |
| Net income attributable to common shareholders | $183.0 | $267.3 | $378.0 | $547.3 |
| Diluted EPS | $1.33 | $1.80 | $2.74 | $3.66 |
| Operating cash flow | Not separately reported for the quarter | $346.6 | $538.5 |
Quarterly sales fell about 13.7% year over year and six-month sales fell about 13.0%. Six-month diluted EPS declined about 25%. Lower Diversified Industrial volume reduced factory utilization and margins; unfavorable mix also weighed on international industrial results. Savings from simplification and restructuring, and a more favorable Aerospace mix, partly offset the pressure.
Segments and material changes
- Diversified Industrial: Q2 sales were $1,160.8 in North America and $992.5 internationally, down 16.4% in each region as reported. Excluding acquisitions and currency, North American sales fell 15.2% and international sales fell 7.1%. Operating margins were 13.2% in North America and 9.6% internationally, versus 16.3% and 11.5% a year earlier. Weakness was concentrated in oil and gas, construction equipment, and farm and agriculture markets.
- Aerospace Systems: Q2 sales were $552.4, down slightly from $558.4; operating income rose to $81.8 from $66.8 and margin increased to 14.8% from 12.0%. Higher commercial aftermarket volume, lower operating expense, and lower engineering development costs supported the improvement.
- Foreign exchange reduced sales by approximately $139 in Q2 and $325 in the first six months. Currency transaction effects were also unfavorable in the current-year periods.
- Business realignment charges were $23.2 in Q2 and $45.0 for the first six months, primarily severance and plant closures. The company reported 2,120 workforce reductions across the two segments during the first half. Q2 pension cost included $7.1 of special termination cost; enhanced retirement benefits related to a plant closure added $11.6 of expense.
Financial position, cash flow and liquidity
- At December 31, cash and cash equivalents were $1,047.5 and marketable securities and other investments were $820.7. Total assets were $11,754.1 and shareholders’ equity was $4,799.4.
- Current liabilities were $2,368.1; working capital was $2,782.9 and the current ratio was 2.18, compared with 2.38 at June 30, 2015.
- Debt was approximately $3,299, including $574.3 due within one year and $2,724.9 of long-term debt. Debt-to-debt-and-equity was 40.7%, above the company’s stated goal of no more than 37%; net of cash and investments, the ratio was 23.0%. The company said temporary excess over its goal would not, in its view, impair affordable borrowing.
- Six-month operating cash flow was $346.6, down from $538.5. Management attributed the decline primarily to lower net income and a voluntary $200 pension contribution, partly offset by lower cash use from working capital. Investing outflow was $223.3 and financing outflow was $209.1. Cash and equivalents declined $133.1 during the period.
- The company had a $2.0 billion revolving credit facility, with $1.426 billion available, and $574 million of commercial paper outstanding. It reported compliance with debt covenants. Cash held by foreign subsidiaries was $1.829 billion and generally was not readily available for U.S. use without adverse tax consequences.
- Share repurchases totaled $400 million for 3.7 million shares in the first half; dividends paid were $171.7 million. The quarterly dividend was $0.63 per share.
Outlook, management commentary and risks
- Management expected FY2016 Diversified Industrial North American sales to decline 16%–12% and international sales to decline 15%–12% from FY2015. Expected operating margins were 15.2%–15.4% in North America and 11.1%–11.3% internationally.
- FY2016 Aerospace sales were expected to be flat to up 2%, with operating margins of 14.5%–14.7%. Management cautioned that higher commercial OEM mix or greater-than-expected product-development costs could reduce margins.
- The company expected an FY2016 effective tax rate of approximately 28%. Actual rates were 20.3% for Q2 and 25.2% for the first half, with the lower current-period rates reflecting tax-credit reinstatement and discrete tax benefits.
- Management anticipated approximately $40 of additional business realignment charges in the remainder of FY2016. It estimated workforce reductions taken in the first half would increase annual operating income by approximately 3% in FY2016 and 5% in FY2017 in both Diversified Industrial regions. Additional future charges may occur; timing and amount were not known.
- Backlog declined year over year in both segments as shipments exceeded orders in several businesses. Economic indicators were mixed: U.S. manufacturing PMI was 48.2, while Eurozone PMI was 53.2. Management cited economic and market demand, currency movements, customer and supplier relationships, acquisitions and divestitures, cost savings execution, input costs, pension and health costs, cybersecurity, competition, and legal matters as risks to future performance.
- A European Commission marine-hose cartel proceeding remained pending after an appeal and referral back to the General Court of the European Union. The filing does not provide a clear estimate of any ultimate financial exposure.
Most important facts for investors to verify
- Whether steep Diversified Industrial declines, weaker backlog, and pressure in oil and gas, construction, and agriculture continued after the reporting period.
- Whether the segment sales and margin outlooks, approximately 28% tax-rate estimate, and projected $40 of additional realignment charges were achieved.
- Operating cash generation and liquidity, including the pension contribution, commercial paper balance, and debt ratio relative to the company’s 37% goal.
- Progress and realized savings from restructuring, and any additional severance or plant-closure costs.
- Developments in the marine-hose legal proceeding and any change in the company’s assessment of exposure.