Parker-Hannifin Corporation — Form 10-Q
Period clarification: The supplied filing is for the fiscal third quarter and nine months ended March 31, 2020, not 2019 Q3. Amounts below are U.S. dollars; financial statement figures are in millions unless otherwise noted.
Business context and reporting period
Parker-Hannifin manufactures motion-control and fluid systems and operates through Diversified Industrial and Aerospace Systems segments. The quarter ended March 31, 2020; the nine-month comparison is against the period ended March 31, 2019. Results include LORD Corporation and Exotic Metals Forming Company from their respective acquisition dates.
Financial performance and position
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net sales | $3,702; prior year $3,688 (+0.4%) | $10,535; prior year $10,639 (-1.0%) |
| Gross profit margin | 25.3%; prior year 25.0% | 24.7%; prior year 25.1% |
| Net income | $367; prior year $411 (-10.7%) | $911; prior year $1,099 (-17.1%) |
| Diluted EPS | $2.83; prior year $3.14 | $7.01; prior year $8.29 |
| Operating cash flow | Not provided separately for the quarter | $1,291; prior year $1,093 |
Quarterly SG&A was $413 million (11.2% of sales, versus 9.8%); nine-month SG&A was $1,304 million (12.4%, versus 10.8%). Interest expense rose to $81 million for the quarter and $234 million for nine months, primarily due to higher average debt. Effective tax rates were 19.1% and 20.2%, respectively, below prior-year rates of 22.3% and 22.6%.
Quarterly segment sales were $1,776 million in Diversified Industrial North America, $1,182 million in Diversified Industrial International, and $745 million in Aerospace Systems. Aerospace sales increased, but operating margin fell to 17.1% from 20.7%. Diversified Industrial sales excluding acquisitions and currency declined 8.5% for the quarter; both North American and International operating margins were lower year over year.
At March 31, 2020, cash and cash equivalents were $698 million and marketable securities and other investments were $93 million, totaling approximately $790 million, versus $3,371 million at June 30, 2019. Current assets were $5,481 million and current liabilities $3,674 million; working capital was $1,808 million and the current ratio 1.5, down from 2.4 at fiscal year-end. Total debt was approximately $9,133 million, including $1,035 million payable within one year and $8,098 million long-term. Shareholders’ equity was $6,296 million. The company reported $1,551 million available under its $2,500 million credit facility and was in compliance with debt covenants.
Nine-month investing cash outflow was $5,045 million, including $5,076 million for acquisitions; financing cash inflow was $1,273 million. Cash and cash equivalents declined by $2,522 million during the nine months.
Material changes versus comparable periods
- Reported sales were nearly flat for the quarter and down 1.0% for nine months; acquisitions partly offset weaker underlying Diversified Industrial demand and unfavorable currency effects.
- Acquisitions contributed $343 million of quarterly sales and $651 million for nine months. LORD and Exotic were purchased for approximately $3,455 million and $1,706 million, respectively. Acquisition-related transaction costs were $115 million for the nine-month period.
- Quarterly gross margin improved slightly, but nine-month gross margin declined. Net income and diluted EPS fell in both comparisons, with higher SG&A and interest expense among the factors.
- Debt, goodwill and intangible assets rose substantially following the acquisitions. Goodwill increased to $7,830 million from $5,454 million at June 30, 2019.
- Operating cash flow increased year over year, while cash fell sharply due mainly to acquisition spending. The company also paid $340 million in dividends and repurchased $147 million of shares during the nine months.
Outlook, risks and unusual items
- Management said COVID-19 had not materially affected reported third-quarter results but expected it to negatively affect fiscal fourth-quarter and later results. April 2020 orders were expected to be significantly lower year over year; management said the ultimate impact could not be reasonably estimated and could be material.
- The company cited potential facility closures, weaker customer demand, supply-chain disruption, and particularly severe aerospace-market disruption. It responded with salary reductions, shorter work schedules, reduced discretionary spending and capital expenditures, and targeted restructuring.
- Management expected approximately $25 million of additional Diversified Industrial realignment and integration charges and $27 million of Aerospace Systems realignment charges during the remainder of fiscal 2020; changing conditions could alter these amounts. Further charges may also arise from other realignment actions.
- The share repurchase program was suspended in March 2020. Capital spending was limited to safety-related needs and strategic investments.
- The company warned that a prolonged downturn could require interim goodwill impairment testing; no interim test was required in the quarter, and the December 2019 annual test found no impairment. Other stated risks include Boeing 737 MAX uncertainty, acquisition integration, leverage, currency and interest-rate exposure, and cyber risk.
- A foreign tax examination settlement reduced unrecognized tax benefits by $74 million during the quarter. Gross unrecognized tax benefits were $82 million at March 31, 2020; up to approximately $40 million could be reduced within the next 12 months, according to the filing.
- Backlog was $5,543 million, with approximately 87% expected to be recognized as revenue within 12 months. Backlog includes acquisition-related additions and should not be treated as a guarantee of future sales.
Important facts for investors to verify
- Confirm the reporting period: this filing covers fiscal Q3 2020, not 2019 Q3.
- Track order trends and the realized COVID-19 effects on sales, margins, cash flow and aerospace demand, including April orders cited by management.
- Assess liquidity and refinancing needs against cash balances, commercial paper outstanding, committed credit availability and covenant limits.
- Monitor integration performance and final purchase accounting for LORD and Exotic, including acquisition-related costs, goodwill and intangible amortization.
- Compare actual restructuring charges and savings with management’s remaining-fiscal-2020 estimates, and assess potential impairment indicators.