Parker-Hannifin Corporation — Form 10-Q summary
Period clarification: The filing covers the quarter ended March 31, 2018 (the third quarter of fiscal 2018) and the nine months ended that date. This does not match the request metadata’s “2017 Q3.” Financial amounts below are in U.S. dollars; “million” is used for readability.
Business context and reporting period
Parker-Hannifin manufactures motion and control technologies and systems. Its reportable segments are Diversified Industrial (North America and International) and Aerospace Systems. The unaudited interim statements cover the three- and nine-month periods ended March 31, 2018, compared with the corresponding 2017 periods.
Financial performance and position
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Net sales | $3,749.6m | $3,119.1m | $10,484.9m | $8,533.1m |
| Net income | $366.1m | $238.8m | $708.0m | $690.5m |
| Diluted EPS | $2.70 | $1.75 | $5.22 | $5.09 |
| Gross margin | 24.7% | 23.6% | 24.4% | 23.4% |
| Net margin | 9.8% | 7.7% | 6.8% | 8.1% |
Quarterly sales rose about 20% and net income about 53% year over year. For the first nine months, sales rose about 23%, while net income increased about 3%. Nine-month results include a substantial one-time tax charge related to the Tax Cuts and Jobs Act (TCJ Act), which makes the reported effective tax rate of 41.2% unusually high; the comparable prior-year rate was 25.6%. The quarterly effective tax rate was 22.1%, versus 24.2%.
Nine-month operating cash flow was $904.8m, compared with $789.3m. Capital expenditures were $194.3m; cash and cash equivalents at period-end were $1,089.5m, with marketable securities and other investments of $101.2m. Current assets were $5,563.1m and current liabilities $3,508.5m; the current ratio was 1.59, compared with 1.41 at June 30, 2017. Working capital was $2,054.6m.
Debt payable within one year was $1,055.5m and long-term debt was $4,818.6m. The company had $474m of commercial paper outstanding and $1,526m available under its $2,000m revolving credit facility. Its debt-to-debt-and-shareholders’ equity ratio was 0.502, below the 0.60 covenant limit; the company reported compliance with its covenants. Senior debt ratings were Fitch A-, Moody’s Baa1, and S&P A.
Nine-month dividends were $1.98 per share, versus $1.92 in the prior-year period. The company repurchased 839,717 shares for $150m during the nine months.
Material changes and segment results
- Diversified Industrial: Sales increased 24.0% in the quarter and 28.5% for the nine months as reported. Excluding acquisitions and currency, sales grew 9.5% and 10.5%, respectively. Higher demand was broad-based across regions and several end markets. North American margins eased (quarter: 15.9% versus 16.1%; nine months: 15.5% versus 16.5%), while International margins improved (14.8% versus 13.6%; nine months: 14.5% versus 13.3%). Higher amortization, raw-material costs, product mix, and incomplete Clarcor integration affected results.
- Aerospace Systems: Quarterly sales grew about 4%, while nine-month sales were slightly lower. Margins improved to 17.8% for the quarter from 13.9%, and to 16.2% for the nine months from 13.4%, supported by aftermarket performance, mix, lower expenses and engineering costs, and favorable contract settlements.
- Backlog increased year over year to $2,285.8m in Diversified Industrial and $1,981.7m in Aerospace Systems, primarily as orders exceeded shipments in several businesses.
- Currency increased consolidated sales by approximately $136m in the quarter and $264m in the nine months; acquisitions contributed approximately $233m and $970m, respectively.
Outlook, commentary, risks and unusual items
- Fiscal 2018 guidance: Diversified Industrial North American sales growth of 24%–26% and margins of 15.9%–16.1%; International sales growth of 19%–21% and margins of 14.2%–14.4%. Aerospace sales are expected to be flat to up 2%, with margins of 16.4%–16.6%. Management expected a full-year effective tax rate of about 37%, including an estimated 13-percentage-point impact from TCJ Act one-time adjustments.
- Management expected approximately $40m of additional business realignment and acquisition integration costs in the remainder of fiscal 2018. Savings from workforce actions taken in the first nine months were expected to increase fiscal 2019 operating income by about 3% in each Diversified Industrial region.
- In April 2018, after quarter-end, the company completed the divestiture of certain aerospace filtration businesses. The businesses were immaterial to consolidated results and position; the company expected an approximately $48m after-tax loss in fiscal Q4, substantially related to tax expense on a transaction tax gain.
- The TCJ Act produced a provisional $225m discrete tax cost: a $287m transition-tax expense on previously unremitted foreign earnings, partly offset by a $62m benefit from revaluing tax-related assets and liabilities. Estimates remained subject to completion. Management was also evaluating the future effects of other TCJ Act provisions.
- Other nine-month unusual items included an approximately $20m investment writedown, $13.8m loss on an investment sale, and $28.4m real-estate sale gain. The prior-year period included an approximately $45m gain on a product-line sale.
- Key risks identified include changes in market conditions and customer orders, raw-material costs, acquisition integration (including Clarcor), realization of restructuring savings, aerospace product mix and development costs, currency and interest-rate exposure, tax-law interpretation, trade conditions, litigation, labor, environmental compliance, and cybersecurity. Management cautioned that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Confirm the fiscal-period labeling: this is Q3 FY2018, not Q3 2017.
- Assess earnings excluding the TCJ Act tax adjustments and other unusual gains or charges; the filing does not provide a single normalized earnings measure.
- Track working-capital use: receivables and inventory rose, while management attributed part of the operating cash-flow improvement to the absence of a prior-year $220m pension contribution.
- Monitor delivery against segment sales and margin guidance, restructuring costs and savings, and Clarcor integration progress.
- Verify the final accounting and fiscal Q4 impact of the aerospace filtration divestiture and the eventual TCJ Act tax calculations.
- Monitor debt ratings, commercial-paper funding, covenant headroom, and the availability of the revolving credit facility.