Parker-Hannifin Corporation — Form 10-Q Summary
Business context and period: The filing covers the fiscal first quarter ended September 30, 2019, compared with the quarter ended September 30, 2018. Parker manufactures motion-control and fluid-system products for industrial, mobile and aerospace markets. Its reportable segments are Diversified Industrial and Aerospace Systems. Amounts below are U.S. dollars.
Financial performance
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $3.335 billion | $3.479 billion | Down 4.2% |
| Gross margin | 25.6% | 25.4% | Up 0.2 percentage points |
| Income before taxes | $433 million | $460 million | Down 5.8% |
| Net income attributable to common shareholders | $339 million | $376 million | Down 9.8% |
| Diluted EPS | $2.60 | $2.79 | Down 6.8% |
| Operating cash flow | $449 million | $159 million | Up $290 million |
SG&A was $399 million, or 12.0% of sales, versus $394 million, or 11.3%, a year earlier. Interest expense rose to $70 million from $44 million, primarily reflecting higher average debt. The effective tax rate increased to 21.7% from 18.2%, mainly because of fewer discrete tax benefits. Other income was $48 million, versus $14 million, including higher interest income and gains on asset disposals.
Segments
- Diversified Industrial: Sales declined 7.3% reported (5.5% excluding currency) to $2.703 billion. North America sales fell 3.4%; International sales fell 12.6% reported, including a 3.9% adverse currency effect. North American operating margin improved to 16.9% from 16.4%; International margin declined to 15.6% from 16.7%. Management cited weaker demand across many industrial and mobile markets.
- Aerospace Systems: Sales increased 11.8% to $631 million, and operating income rose to $123 million from $110 million. Operating margin was unchanged at 19.5%. Higher commercial and military aftermarket and OEM volume contributed; acquisition-related costs offset some benefits.
Cash flow, balance sheet and liquidity
Operating cash flow increased mainly because of working-capital movements. Investing cash outflow was $1.853 billion, primarily reflecting the $1.696 billion Exotic acquisition. Financing cash inflow was $1.838 billion, including $1.104 billion of net commercial-paper borrowings and a $925 million term loan; dividends paid were $113 million. Cash and cash equivalents were $3.627 billion at quarter-end; cash plus marketable securities and other investments totaled $3.909 billion.
Total debt payable within one year was $1.737 billion and long-term debt was $7.367 billion. Working capital was $3.981 billion, down from $4.521 billion at June 30, and the current ratio declined to 2.0 from 2.4. The debt-to-debt-plus-shareholders’ equity ratio was 0.60, below the 0.65 covenant limit; the company reported compliance with its covenants. The amended credit facility had $809 million available at September 30, and commercial paper outstanding was $1.691 billion.
Material changes, outlook and risks
- Parker completed its approximately $1.706 billion cash acquisition of Exotic on September 16. The acquisition added $21 million of quarterly sales and increased aerospace goodwill and intangible assets. Purchase accounting estimates were preliminary and could be revised.
- On October 29, after quarter-end, Parker completed the approximately $3.453 billion acquisition of Lord, including assumed debt. Parker also fully drew an $800 million term loan to finance part of the purchase. Lord’s pro forma combined sales were disclosed, but pro forma earnings were not available because acquisition accounting was incomplete.
- Fitch downgraded Parker’s rating to BBB+ on October 29, citing debt used to fund acquisitions. The company identified leverage and debt service, acquisition integration, economic and market conditions, currency, trade policy, raw-material costs, cybersecurity, taxes, product liability and regulatory matters among risks that could affect results.
- Management expected fiscal 2020’s effective tax rate to be approximately 23%. It anticipated approximately $65 million of additional business realignment and acquisition integration charges in the remainder of fiscal 2020. The filing did not provide specific full-year revenue or earnings guidance.
- Total backlog was $5.022 billion at September 30, with approximately 87% expected to be recognized as revenue within 12 months. Diversified Industrial backlog declined year over year as shipments exceeded orders; Aerospace backlog increased, partly from Exotic and orders exceeding shipments.
- Management cited global aircraft miles flown up approximately 4% and available revenue passenger miles up approximately 5% year over year, while September U.S. housing starts were approximately 2% higher year over year. Regional manufacturing indicators were mixed, including a Eurozone PMI below 50.
The company adopted the new lease standard on July 1, 2019, recording approximately $126 million of right-of-use assets and lease liabilities; management said the adoption did not materially affect income or cash flows. It reported effective disclosure controls and procedures; integration of Exotic’s processes and internal controls was ongoing.
Important facts for investors to verify
- Whether weaker Diversified Industrial demand and declining backlog persist, and how order rates develop across regions and end markets.
- Exotic and Lord integration progress, final purchase-accounting values, realized synergies and the effect of acquisition-related costs.
- Post-acquisition leverage, refinancing needs, credit ratings, covenant headroom and liquidity, including the impact of the Lord financing.
- Progress against the approximately $65 million of expected remaining FY2020 realignment and integration charges, and the stated tax-rate outlook.
- Whether working-capital-driven operating cash flow is sustainable and how inventory levels and cash conversion evolve.