Parker-Hannifin Corp quarterly report, Q1 FY2015

Parker-Hannifin Corporation — Form 10-Q Summary

Business context and reporting period. Parker-Hannifin manufactures motion-control and fluid systems and components. This unaudited filing covers the first quarter of fiscal 2015, the three months ended September 30, 2014, compared with the three months ended September 30, 2013. The company reports Diversified Industrial and Aerospace Systems segments.

Financial performance

Net sales rose about 1.4% and net income about 14.7%. Gross margin improved 1.6 percentage points; SG&A was 12.3% of sales versus 12.6%. The effective tax rate increased to 29.4% from 24.6%, reflecting expired U.S. tax provisions and credits and fewer discrete tax benefits. Management expects an approximately 29% effective tax rate for fiscal 2015.

Segments: Diversified Industrial sales increased 2.9% as reported (3.6% excluding acquisitions and currency); North America grew 6.0% and International declined 0.6%. Operating income was $264.2 million in North America and $189.8 million International, with margins of 18.0% and 15.0%, respectively. Aerospace Systems sales declined to $534.6 million from $567.5 million, while operating income increased to $65.3 million and margin to 12.2% from 10.1%. Aerospace sales were affected by a deconsolidated subsidiary and lower military volume; improved mix and lower support and engineering costs helped margins.

Financial position, cash flow, and material changes

At September 30, 2014, cash and cash equivalents were $1,092.1 million and marketable securities $945.4 million, for combined cash and securities of $2,037.6 million. Total debt was approximately $2,184.5 million, including $702.0 million payable within one year and $1,482.5 million long term. Debt-to-debt-and-equity was 24.9%, down from 25.9% at June 30; net of cash and securities, the ratio was 2.2% versus 2.0%. Working capital was $2,988.1 million and the current ratio 2.03.

Operating cash flow decreased to $260.9 million, primarily because increased cash use by working capital more than offset higher net income. Investing activities used $480.9 million, including $446.7 million net purchases of marketable securities and other investments; financing activities used $229.7 million. Cash and cash equivalents fell $521.4 million during the quarter, also reflecting a $71.7 million adverse exchange-rate effect. Foreign subsidiaries held $2,019 million of the combined cash and securities balance, generally not readily available for U.S. use without adverse tax consequences.

Foreign currency translation reduced other comprehensive income by $302.1 million; total comprehensive income attributable to common shareholders was $5.0 million, compared with $429.2 million a year earlier. Inventories increased $69.8 million from June 30, 2014. The company repurchased 422,615 shares during the quarter at an average $118.31 per share. On October 22, 2014, after quarter-end, the board increased the aggregate repurchase authorization to 35 million shares.

Outlook, risks, and contingencies

• For fiscal 2015, management expects Diversified Industrial North American sales growth of 3%–7% and International sales to decline 4%–1% versus fiscal 2014. Expected segment margins are 16.6%–17.0% and 14.6%–15.0%, respectively.
• For fiscal 2015, Aerospace Systems sales are expected to grow 2%–3% (excluding $49.5 million of fiscal 2014 sales from the deconsolidated subsidiary), with operating margins of 13.2%–13.7%. Higher commercial OEM mix or development costs could reduce margins.
• The company expects approximately $36 million in additional business realignment charges in the remainder of fiscal 2015, primarily associated with operational restructuring. Management says the actions are expected to benefit future results; additional charges may arise.
• Management anticipated issuing long-term debt in fiscal 2015’s second quarter for general corporate purposes, dividends, and share repurchases. A $2.0 billion revolving credit facility had $1.298 billion available at quarter-end; the company reported covenant compliance.
• Key uncertainties include economic and market demand, customer and distributor changes, pricing and raw material costs, currency movements, acquisition and divestiture execution, restructuring savings, retirement and health-care costs, and legal proceedings.
• A European Commission appeal remains pending in the Parker ITR marine-hose matter. A prior court ruling reduced the fine to €6.40 million and set joint and several liability for the company and subsidiary at up to €6.30 million; the Commission appealed.
• Gross unrecognized tax benefits were $155.1 million, including $73.3 million that would affect the effective tax rate if recognized. Management did not expect a significant change over the next 12 months. The company also disclosed ongoing tax examinations and foreign-exchange and interest-rate exposures, managed in part through financial instruments.

Important facts for investors to verify

• Whether sales and margin trends continue, particularly the divergent performance of North American, International, and Aerospace businesses.
• Whether working capital and inventory growth convert to cash, and the effect of foreign-held cash on U.S. liquidity.
• Actual restructuring costs and savings compared with the expected $36 million of additional fiscal 2015 charges.
• Execution and cost of planned borrowing, dividends, and the expanded share-repurchase program.
• Developments in the marine-hose appeal, tax examinations, and the recognition or settlement of uncertain tax positions.