Parker-Hannifin Corporation — Form 10-Q Summary
Business context and reporting period
The filing covers the first quarter of fiscal 2016, the three months ended September 30, 2015, compared with the three months ended September 30, 2014. Parker-Hannifin manufactures motion-control and fluid systems and operates two reportable segments: Diversified Industrial and Aerospace Systems. The company cautions that interim results are not necessarily indicative of full-year results.
Financial performance
| Metric | Quarter ended Sep. 30, 2015 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $2,869.3 million | $3,269.9 million | Down 12.2% |
| Gross profit / margin | $668.4 million / 23.3% | $810.1 million / 24.8% | Margin down 1.5 points |
| Income before taxes | $275.6 million | $396.6 million | Down 30.5% |
| Net income attributable to common shareholders | $195.0 million | $280.1 million | Down 30.4% |
| Diluted earnings per share | $1.41 | $1.85 | Down 23.8% |
| Operating cash flow | $5.0 million | $260.9 million | Down $255.9 million |
| Cash dividends per common share | $0.63 | $0.48 | Up 31.3% |
SG&A was $370.2 million, or 12.9% of sales, versus $400.8 million, or 12.3%. Interest expense rose to $35.8 million from $21.0 million, primarily due to higher average borrowings and interest rates. The effective tax rate was 29.2%, compared with 29.4%.
Segments: Diversified Industrial sales fell 15.0% as reported (8.7% excluding acquisitions and currency); North America sales declined 12.6% and International sales declined 17.8%. Their operating margins fell to 16.5% and 12.5%, respectively. Aerospace Systems sales increased 1.9% to $544.6 million, and operating margin improved to 13.6% from 12.2%.
Balance sheet, liquidity and cash flow
- At September 30, 2015, cash and cash equivalents were $974.3 million; marketable securities and other investments were $815.5 million. Management’s combined cash measure was $1,789.8 million.
- Total debt was approximately $3.356 billion, including $630.7 million payable within one year and $2.725 billion of long-term debt. Debt-to-debt-plus-shareholders’ equity was 40.9%, above the company’s stated maximum goal of 37%; net of cash and investments, the ratio was 24.4%.
- Working capital was $2.778 billion and the current ratio was 2.09, down from $3.233 billion and 2.38 at June 30, 2015. The company had a $2.0 billion revolving credit facility, with $1.593 billion available, and $407 million of commercial paper outstanding.
- Operating cash flow was only $5.0 million, primarily reflecting lower earnings and a $200 million voluntary contribution to the domestic defined-benefit pension plan. Capital expenditures were $38.7 million; operating cash flow less capital expenditures was negative $33.7 million. Cash and cash equivalents declined $206.3 million during the quarter.
- Financing included $407 million of net commercial-paper borrowings, $310 million of share repurchases and $86.0 million of dividends. The company repurchased 2.77 million shares at an average price of $111.89.
Material changes and management commentary
- Lower sales in both Diversified Industrial businesses drove the overall revenue decline. Currency reduced sales by approximately $186 million; acquisitions contributed approximately $12 million.
- Management attributed weaker Diversified Industrial demand to lower distributor and end-user demand, particularly in oil and gas, agriculture and construction equipment, and to declines across international regions. Segment backlog also decreased as shipments exceeded orders.
- Aerospace Systems benefited from higher commercial and military aftermarket volume, lower engineering development costs and favorable contract settlements. Management cited higher commercial OEM mix and higher-than-expected development costs as potential margin pressures.
- Business realignment charges were $21.8 million, primarily severance and plant-closure costs under the Simplification initiative. Management expects approximately $80 million of additional charges during the remainder of fiscal 2016 and anticipates cost savings from the actions.
- Foreign currency translation and other items reduced comprehensive income; the quarter recorded an $83.2 million other comprehensive loss attributable to common shareholders.
Guidance, risks and contingencies
- For fiscal 2016, management expects Diversified Industrial North American and International sales each to decline 10%–14% from fiscal 2015. Expected operating margins are 15.3%–15.7% for North America and 11.5%–11.9% for International.
- Fiscal 2016 Aerospace Systems sales are expected to increase 1%–3%, with operating margins of 14.3%–14.7%. Management expects a fiscal 2016 effective tax rate of approximately 29%.
- Management discussed mixed indicators: September 2015 manufacturing PMI was 50.2 in the U.S., 52.0 in the Eurozone, 47.2 in China and 47.0 in Brazil. Global aircraft miles flown and revenue passenger miles were up approximately 6% and 7%, respectively, versus comparable fiscal 2015 levels. These indicators are not company-specific guidance.
- Risks include changing economic and market demand, currency movements, customer and supplier changes, pricing and product mix, acquisition and divestiture execution, realization of restructuring savings, raw-material costs, benefit costs, cybersecurity and legal proceedings.
- The company disclosed ongoing European Commission proceedings concerning alleged marine-hose cartel activity involving Parker ITR. The European Court of Justice had reversed an earlier General Court ruling and referred the case back; the ultimate outcome remained unresolved.
- Gross unrecognized tax benefits were $138.3 million, plus $10.3 million of accrued interest. The company said up to approximately $100 million of gross unrecognized tax benefits could be reduced within 12 months, depending on tax examinations or statute closures.
- The company reported compliance with debt covenants. It uses derivatives and foreign-currency debt to manage currency exposure and has variable-rate debt exposure. Disclosure controls were judged effective, with no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether demand and backlog stabilize in Diversified Industrial, especially in oil and gas, agriculture, construction and international markets.
- Whether the company restores operating cash generation after the pension contribution and manages working capital and inventory levels.
- Whether leverage moves back toward the stated 37% debt-to-debt-plus-equity goal, given increased commercial-paper borrowing and substantial share repurchases.
- Whether the announced realignment savings materialize and whether further charges remain within management’s expectations.
- How aerospace segment sales, margins and backlog develop relative to guidance, and the outcomes of the marine-hose proceedings and uncertain tax positions.