Parker-Hannifin Corporation — Form 10-Q Summary
Reporting period: Fiscal second quarter and first six months ended December 31, 2016; comparisons are with the periods ended December 31, 2015. Financial statements are unaudited. Parker-Hannifin makes motion-control and fluid-system products through its Diversified Industrial and Aerospace Systems segments.
Financial performance
| Metric | Three months ended Dec. 31, 2016 | Year-over-year change | Six months ended Dec. 31, 2016 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $2.671 billion | Down 1.3% | $5.414 billion | Down 2.9% |
| Gross profit / margin | $626.3 million / 23.5% | Margin up from 20.9% | $1.263 billion / 23.3% | Margin up from 22.1% |
| Net income | $241.4 million | Up from $183.1 million | $451.6 million | Up from $378.2 million |
| Diluted EPS | $1.78 | Up from $1.33 | $3.33 | Up from $2.74 |
| Net income margin | 9.0% | Up from 6.8% | 8.3% | Up from 6.8% |
For the quarter, lower North American Diversified Industrial and Aerospace sales were partly offset by higher International Diversified Industrial sales. Year-to-date sales were lower mainly because of North American Diversified Industrial weakness. Management attributed improved gross margin primarily to cost reductions from its Simplification initiative and prior restructuring, partly offset by lower Aerospace margins. Currency reduced sales by about $31 million in the quarter and $35 million year to date.
Segments and operating trends
- Diversified Industrial: Quarterly sales were $2.127 billion, down 1.2%; operating income was $311.5 million. North American sales fell 3.4% while International sales rose 1.4% as reported. Six-month segment sales were down 3.8%. Cost savings supported higher operating margins in both regions, despite weaker North American demand and unfavorable International product mix. Segment backlog was $1.507 billion, versus $1.448 billion a year earlier.
- Aerospace Systems: Quarterly sales were $543.8 million, down 1.6%, and operating income was $72.5 million; operating margin fell to 13.3% from 14.8%. Six-month sales increased 0.7%, but operating income declined. Lower quarterly volume and prior-year favorable contract settlements weighed on margins; higher warranty costs affected the six-month comparison. Backlog was $1.665 billion, down from $1.721 billion a year earlier.
Cash flow, balance sheet and liquidity
- Six-month operating cash flow was $404.2 million, versus $362.6 million. Management cited higher net income, partly offset by greater cash use for working capital. The company contributed $220 million to its domestic qualified pension plan, compared with $200 million in the prior-year period.
- Investing activities provided $102.3 million, including $85.6 million of proceeds from the Autoline product-line sale. Financing activities used $140.7 million, including $169.0 million of dividends and $196.0 million of share repurchases and option-related share activity. Cash and cash equivalents rose $299.1 million to $1.521 billion.
- At December 31, cash plus marketable securities and other investments totaled $2.205 billion; $2.156 billion was held by foreign subsidiaries and generally was not readily available for U.S. use without adverse tax consequences. Working capital was $2.822 billion and the current ratio was 2.16.
- Current debt due within one year was $581.5 million and long-term debt was $2.654 billion. The company reported a debt-to-debt-and-shareholders’-equity ratio of 41.8%, up from 39.9% at June 30, 2016, above its stated 37% financial goal. It had $1.470 billion available under its $2.0 billion revolving credit facility and $530 million of commercial paper outstanding. Management said it was in compliance with debt covenants.
- Shareholders’ equity was $4.528 billion, down from $4.575 billion at June 30, 2016. Foreign currency translation reduced equity by approximately $254 million during the six months.
Outlook, notable items and risks
- Fiscal 2017 outlook: Diversified Industrial North American sales expected to decline 5% to 1%, with operating margins of 17.2%–17.6%; International sales expected to range from a 1% decline to 3% growth, with margins of 12.8%–13.2%. Aerospace sales expected to grow 1%–3%, with margins of 14.9%–15.1%. Management expected a full-year effective tax rate of approximately 27.5%.
- The company agreed to acquire CLARCOR for approximately $4.3 billion in cash, including assumed net debt, subject to closing conditions and CLARCOR shareholder approval. Parker-Hannifin intended to fund the transaction with cash and new debt; the parties expected closing on or about February 28, 2017.
- The Autoline product-line divestiture generated an approximately $45 million pretax gain, materially contributing to the increase in other income. The related business was described as immaterial to consolidated operations and financial position.
- Fiscal 2017 share-based-payment accounting changes produced discrete tax benefits of $7.6 million for the quarter and $17.1 million year to date. A change in pension-cost estimation methodology reduced pension cost by approximately $8 million for the quarter and $17 million year to date versus the comparable periods.
- Business realignment charges were $18.6 million year to date. Management expected about $28 million of additional charges in the remainder of fiscal 2017 and estimated current-year workforce reductions would increase annual operating income by 1% in each of fiscal 2017 and 2018. About $30 million of remaining severance payments from current- and prior-year actions was accrued.
- Risks include cyclical and regional demand, foreign exchange, customer and supplier changes, Aerospace contract costs and warranty exposure, execution and financing of the CLARCOR acquisition, realization of restructuring savings, and legal, regulatory, commodity, labor and cybersecurity uncertainties. Management cautioned that interim results may not indicate full-year performance.
Important facts for investors to verify
- Whether the CLARCOR acquisition closed on expected terms and how its cash-and-debt funding affected leverage, interest expense and liquidity.
- Whether segment sales and margins tracked the fiscal 2017 ranges, particularly the Aerospace margin outlook and North American industrial demand.
- How much reported earnings growth reflected recurring operations versus the $45 million Autoline gain and discrete tax benefits.
- Whether working capital, pension contributions and further realignment charges affected cash generation, and whether leverage moved toward the company’s 37% goal.
- Developments in uncertain tax positions: gross unrecognized tax benefits were $133.1 million, and the company said up to approximately $100 million could be reduced within 12 months.