Parker-Hannifin Corporation — Form 10-Q Summary
Period clarification: The filing covers the quarter ended March 31, 2016, and the nine months then ended (fiscal 2016 third quarter), not calendar 2015 Q3. Amounts below are in U.S. dollars; financial-statement figures are rounded to millions where shown.
Business context and results
Parker-Hannifin manufactures motion and control technologies through two reportable segments: Diversified Industrial and Aerospace Systems. The unaudited interim statements include management’s normal recurring adjustments; management cautions that interim results are not necessarily indicative of full-year results.
| Metric | Three months ended Mar. 31, 2016 | Three months ended Mar. 31, 2015 | Nine months ended Mar. 31, 2016 | Nine months ended Mar. 31, 2015 |
|---|---|---|---|---|
| Net sales | $2,828.7m | $3,162.3m | $8,403.6m | $9,567.2m |
| Gross profit margin | 21.9% | 25.0% | 22.0% | 24.4% |
| Net income | $187.1m | $285.5m | $565.3m | $833.0m |
| Diluted EPS | $1.37 | $2.02 | $4.12 | $5.68 |
| Net income as % of sales | 6.6% | 9.0% | 6.7% | 8.7% |
Sales fell about 10.6% in the quarter and 12.2% year to date versus the comparable periods. Foreign exchange reduced sales by approximately $47m in the quarter and $372m year to date; acquisitions added approximately $9m and $31m, respectively. The filing attributes lower sales chiefly to Diversified Industrial demand weakness. Gross margins declined primarily from lower industrial volumes and manufacturing inefficiencies, unfavorable product mix in Diversified Industrial International, and higher realignment costs, partly offset by simplification savings and favorable Aerospace mix.
Segments and outlook
- Diversified Industrial: Quarter sales declined 12.4% as reported and 11.0% excluding acquisitions and currency; nine-month sales declined 14.6% as reported and 10.4% excluding those effects. North American and International operating margins were 16.2% and 10.3% for the quarter, respectively, versus 16.3% and 12.1% a year earlier. Weakness included oil and gas, construction equipment, farm and agriculture, and marine markets. Backlog was $1,518.6m, down from $1,662.9m a year earlier.
- Aerospace Systems: Quarter sales were $561.0m, down from $572.4m; operating income rose to $84.2m from $73.3m and margin improved to 15.0% from 12.8%. Year-to-date sales were nearly flat at $1,657.9m, while operating margin increased to 14.5% from 12.3%. Higher commercial aftermarket volume was partly offset by weaker OEM and military aftermarket sales. Backlog was $1,794.9m.
- Fiscal 2016 outlook: Management expects Diversified Industrial North American sales to decline 14.5%–12.5% and International sales to decline 14.2%–12.2% from fiscal 2015; respective operating margins are expected at 15.7%–15.9% and 10.7%–10.8%. Aerospace sales are expected to range from a 0.4% decline to 1.2% growth, with margins of 14.7%–14.9%. Management expects an approximately 28% full-year effective tax rate.
Management cited improving U.S. PMI to 51.8 at March 31, while China (49.7) and Brazil (46.0) remained below 50. Global aircraft miles flown and passenger miles increased approximately 8% and 7%, respectively, from comparable fiscal 2015 levels. Housing starts were 14% above March 2015 but 7% below June 2015.
Cash flow, liquidity, and capital
- Nine-month operating cash flow was $681.5m, down from $791.1m. Management cited lower net income and a $200m voluntary contribution to the domestic qualified pension plan; working-capital cash use was lower than in the prior-year period.
- Investing cash use was $394.5m, compared with $797.4m; financing cash use was $392.6m, compared with $461.9m. Cash and cash equivalents decreased $145.6m to $1,035.0m.
- At March 31, cash, cash equivalents, marketable securities, and other investments totaled $2,104.6m; $2,079m was held by foreign subsidiaries and generally was not readily available for U.S. use without adverse tax consequences. Working capital was $2,956.2m and the current ratio was 2.18, versus 2.38 at June 30, 2015.
- Debt was $3,252m; the debt-to-debt-and-shareholders’ equity ratio was 39.3%, above the company’s 37% goal and up from 36.6% at June 30, 2015. Net of cash and investments, the ratio was 18.6%. The company had $1,526m available under its $2,000m revolving credit facility and $474m of commercial paper outstanding; it reported compliance with debt covenants.
- Share repurchases totaled $450m for 4.17m shares during the nine months; dividends were $256.9m. The quarterly dividend was $0.63 per share, unchanged year over year.
Notable changes, charges, and risks
- Business realignment charges were $24.7m in the quarter and $72.3m year to date, compared with $8.3m and $25.1m in the prior-year periods. They primarily related to severance and plant closures under the Simplification initiative. Management expected approximately $35m of additional charges in the remainder of fiscal 2016; remaining current-year severance payments were expected by March 31, 2017. Management estimated workforce reductions would raise annual operating income by approximately 4% in fiscal 2016 and 8% in fiscal 2017 in each Diversified Industrial business.
- Quarter other income included a $10.0m gain on business sales; foreign-currency transaction results swung from a $56.4m gain in the prior-year quarter to a $17.5m loss in the current quarter. The effective tax rate was 31.4% for the quarter versus 26.5% a year earlier, primarily due to a lower estimated share of foreign earnings in lower-tax jurisdictions, partly offset by the U.S. R&D tax credit.
- Gross unrecognized tax benefits were $134.0m, including $76.6m that would affect the effective tax rate if recognized; related accrued interest was $11.1m. The company said up to approximately $100m could be reduced within 12 months as examinations or statutes progress.
- A European Commission marine-hose antitrust matter remained pending after the European Court of Justice reversed a lower-court ruling and referred the case back to the General Court. The filing describes potential joint and several liability of up to €6.30m under the lower court’s prior decision; the ultimate resolution was uncertain.
- Risks identified include market and customer demand, competitive pricing and product mix, currency and interest rates, raw-material costs, execution and savings from restructuring, acquisition integration and divestitures, retirement and health-care costs, cybersecurity, and legal proceedings. Aerospace margins could be pressured by a higher commercial OEM mix or higher new-product development costs.
Important facts for investors to verify
- Confirm the filing period: fiscal Q3 ended March 31, 2016, despite the request metadata’s “2015 Q3” label.
- Track order rates and backlog conversion, especially the industrial downturn and the reported decline in Diversified Industrial backlog.
- Assess whether segment sales and margin guidance, restructuring savings, and the expected $35m of additional realignment charges were achieved.
- Monitor cash generation, the elevated 39.3% debt ratio, near-term debt maturities, commercial paper usage, and the availability and geographic location of cash.
- Review developments in the tax examinations and the pending marine-hose antitrust proceeding, including any resulting cash or earnings effects.