parker hannifin annual 06


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parker hannifin annual 06

  1. 1. The Premier Diversified Motion & Control Company Annual Report 2006
  2. 2. Parker is the world leader in motion and control technologies, serving hundreds of markets. We are a diversified investment in our industry space, generating strong returns for our shareholders year after year. 9 Billion in Sales 118 Divisions 292 Manufacturing Plants 1,200 Markets 8,400 Distributors 57,000 Employees 417,000 Customers 900,000 Products 2006 IN REVIEW 2 LETTER TO SHAREHOLDERS 3 GROWTH 6 MARKETS 7 SERVICE 8 PEOPLE 9 TECHNOLOGY 10 PERFORMANCE 11 FINANCIAL REPORT 12
  3. 3. parker technologies are essential to a world in motion.
  4. 4. NET SALES NET INCOME CASH FLOWS FROM AVERAGE SALES/EMPLOYEE OPERATING ACTIVITIES Millions of Dollars Millions of Dollars Thousands of Dollars Millions of Dollars 1,000 900 9,000 630 180 800 8,000 560 160 700 7,000 490 140 600 6,000 420 120 500 5,000 350 100 400 4,000 280 80 300 3,000 210 60 200 2,000 140 40 100 1,000 70 20 0 0 0 0 02 03 04 05 06 05 02 03 04 05 06 05 02 03 04 05 06 05 02 03 04 05 06 THE YEAR IN REVIEW FOR THE YEARS ENDED JUNE 30, 2006 2005 2004 (in thousands, except per share data) OPERATING DATA $ 9,385,888 Net sales $ 8,068,805 $ 6,887,596 2,018,270 Gross profit 1,677,328 1,309,708 673,167 Net income 604,692 345,783 954,639 Net cash provided by operating activities 853,506 662,398 (921,243) Net cash (used in) investing activities (565,383) (270,472) (194,192) Net cash (used in) financing activities (137,538) (448,491) PER SHARE DATA $ 5.57 Diluted earnings per share $ 5.02 $ 2.91 .92 Dividends .78 .76 35.46 Book value 28.14 25.24 RATIOS 7.2% Return on sales 7.5% 5.0% 9.0 Return on average assets 9.3 5.7 17.8 Return on average equity 19.1 12.6 21.1 Debt to debt-equity 22.5 24.9 OTHER 57,986 Number of shareholders 54,632 54,683 57,073 Number of employees 50,019 47,433
  5. 5. Don Washkewicz, Chairman of the Board and Chief Executive Officer, and Nick Vande Steeg, President and Chief Operating Officer. LETTER TO SHAREHOLDERS In 2006, we delivered record for growth. We believe investors • Sales climbed to $9.4 billion, an results to our shareholders by will find few companies better increase of 16.3 percent over 2005, executing the three pillars of our with organic growth driving positioned for consistent long-term Win Strategy: Premier customer performance. nearly half of the increase. service, financial performance • Income from continuing and profitable growth. And while we are diverse, we are operations increased 19.7 percent also united by a single common to a record $638.3 million, or platform: The Parker Win The cover of this year’s annual $5.28 per diluted share, compared Strategy. Now in its sixth year, report illustrates the many with $533.2 million or $4.43 per dimensions that have enabled Parker’s Win Strategy continues to diluted share a year ago. Parker to become the premier be deployed across the globe in every • Cash flow from operations diversified motion and control part of our business. This simple reached a record $954.6 million company. Indeed, diversification framework provides each of our or 10.2 percent of sales, surpassing is one of our greatest strengths. decentralized and entrepreneurial last year’s record of $853.5 We are diverse in our global scope, business units with operational million. the products we manufacture, the clarity, the tools to execute, and the • We increased our annual dividend for the 50th consecutive year, one markets we reach, the customers we metrics to determine success. For serve, and the talented people we shareholders, the result is a focused, of the longest records of dividend employ. Our motion and control yet diverse, company much greater increases among the Standard technologies are virtually everywhere than the sum of its parts. Poor’s 500. – saving energy, speeding processes, • We achieved near top quartile Winning Results building infrastructure, ensuring return on invested capital among Everywhere safety and improving lives. This our peers. focused breadth of capabilities Our employees’ continued embrace • We were ranked in the top 10 helps us to mitigate market risk, of the Parker Win Strategy drove percent among Barron’s magazine’s counter business cyclicality, and record results across the company in 500 best performing companies. create ongoing opportunities 2006.
  6. 6. Multiple Paths to early stages, it is already yielding Parker Continues Its Disciplined New Business advancements such as intelligent Approach To Strategic Acquisitions hydraulic cylinders, regenerative While our 2006 results were filtration products, leak-sensing tremendous, our growth prospects DENQUIP, Hydraulics, South Africa solenoid valves and conductive are even more exciting. The good DOMNICK HUNTER, Filtration, UK thermoplastics. news for shareholders is that we are FILTRAN, Seal, US not dependent on any single avenue HERL REFRIGERATION, Climate Industrial Controls, Germany The marriage of acquired and to generate that growth. KENMORE INTERNATIONAL, Climate Industrial Controls, UK internally developed products also KURODA PNEUMATICS, Automation, Japan increases our ability to grow through Consider strategic acquisitions. PORTER INSTRUMENT, Instrumentation, US system solutions. Recent system Few companies in our space have RESISTOFLEX AEROSPACE, Aerospace, US wins include: our record of success. During the SSD DRIVES, Automation, UK past year, we acquired thirteen STERLING HYDRAULICS, Hydraulics, UK • Fuel, flight control and hydraulic motion and control businesses, TAIYO, Hydraulics, Japan systems for the new ARJ21 aircraft adding nearly $1 billion in TEXLOC PAGE, Fluid Connectors, US which will support the rapidly annualized revenues and thousands TTXE, Seal, US expanding civil aviation market in of talented employees. Of particular China. Market potential: Up to note: $300 million. • Domnick Hunter dramatically Through it all, we have strategically • A vehicle energy recovery system adds to one of our strongest maintained our roughly 50-50 using hydraulic technology to performing and fastest growing balance between OEM and MRO improve fuel efficiency by up businesses: Filtration. business. This gives us the ability to 50 percent. Initial market • SSD Drives’ footprint in the to grow profitably throughout potential: Up to $150 million. U.S., Europe and China gives us a business cycles, supplying new • A high-throughput autosampler very strong position in the global products to original equipment system using motion, fluidic and electromechanical and drives makers when the economy is sealing technologies to eliminate market. strong, and maintenance, repair and bottlenecks in bioanalytical • Alliances with Taiyo and Kuroda overhaul of parts when the cycle sample processing. Market Pneumatics evolved into majority cools. potential: Up to $10 million positions, giving us additional annually. growth platforms for Japan and What’s more, our lean enterprise the entire Asia Pacific region. efforts are amplifying the effect of We also grow through our cross all of our growth platforms through sales leads program. Cross leads arise We continue to be our industry’s continuous cost reduction and when one business unit of Parker acquirer of choice. As we identify operating efficiencies. finds an opportunity for a sister additional opportunities in 2007, we unit. This year, approximately 1,000 will continue to invest in a focused Many Ways to cross leads worldwide generated and disciplined way. Serve the Customer millions of dollars in new business We believe in creating value for that might not otherwise have been Internally, we’ve ramped up our our customers and shareholders captured. efforts to develop breakthrough through premier customer service. innovative products. Though our Everything begins with meeting Winovation program is still in its the customer’s delivery request date. Delivering when others can’t is often HY MARKETS Y RAP OG OL G HN GEO Parker is diversified in its core components, all of which combine to create UTION TEC E ISTRIB PEOPL a focused company resistant to cyclicality, volatility, and risk. Our unique D business model emphasizes decentralized divisions empowered to act CUSTO OPERA M TIONS ERS quickly to meet customer needs. SE ACQ PRODUCTS RVI CES UIS ITIO NS
  7. 7. a strategic advantage for Parker. our operational, sales and service So, as we close 2006, we thank our customers for giving us the Our current on-time delivery rate capabilities in numerous countries, of approximately 95 percent is including strategic growth regions opportunity to earn and maintain rewarding us in the marketplace such as India, China and Turkey. their business. We thank our distributors and business partners with strong orders. Using lean We will continue to follow our techniques and other elements of the many customers wherever they may who continue to help us grow. We thank our 57,000 talented Win Strategy, we’re usually able to need us. and hard-working employees bring the businesses we acquire to Investors can take comfort in this same high level of performance who continue to execute our Win Strategy. And we thank you, our relatively quickly. this combination of market and shareholders, for entrusting us geographic diversification. Clearly, with the management of your Another service differentiator is our fortunes are not tied to any investment in Parker, the premier our global network of 12,000 single market or business. We are diversified motion and control independent distributor, wholesale positioning ourselves to weather company. and retail locations. Through this volatility and for continued global distinctive resource, Parker products growth. and services are almost never out Sincerely, Greater than the of reach. Examples abound, from Sum of Our Parts helping bring gas and oil producers Diversification within our industry back online in the aftermath of Donald E. Washkewicz is good. Our record performance Hurricane Katrina to repairing Chairman and Chief Executive Officer heavy equipment at China’s Three in 2006 is proof of that. In 2007 Gorges Dam, the world’s largest and beyond, we will continue to construction project. capitalize on Parker’s many facets for Nickolas W. Vande Steeg the benefit of all our stakeholders. President and Chief Operating Officer Other value-added services, Among our continuing goals: including custom manufacturing, inventory management, kitting, • Compound growth rate of greater Hose Doctor service vans, online than 10 percent. ordering and technical training, plus • Top quartile return on invested the long service and low turnover capital among our peers. of our workforce, continue to make • Operating cash flow of greater Parker a preferred supplier for new than 10 percent. and existing customers alike. • Continued dividend growth. World of Market Opportunities Parker technologies are essential to a world in motion. Hundreds of industries rely on our engineering. Our hydraulics let us move massive loads. We automate factory assembly lines, and we shield the delicate electronics in hand-held devices. Our cooling expertise lets us chill everything from ice cream to computer chips. We filter drinking water and diesel fuel. We harvest crops, we generate power, and we fly. And emerging areas such as life PHconnect sciences and fuel cells demonstrate our ability to apply our core expertise in new ways. Global customer needs in these markets drive our geographic The Win Strategy gives clarity to our people and operations around the world. Our vision of being the #1 motion and control company rests on the relentless execution of the strategy’s expansion. This year we added to pillars of premier customer service, financial performance and profitable growth.
  8. 8. GROWTH Multiple Paths to New Business STR ATEGY EXECUTION RESULTS Diversification begins at Parker with As customer needs become more Parker increased revenues the way we grow. By mixing organic complex, our industry-leading product by $1.3 billion this fiscal year. Organic growth accounted growth with strategic acquisitions, breadth and systems capabilities drive our organic growth. for approximately half of the we can expand profitably while increase, as customers continued to avoiding reliance on any single Additional growth comes from our product line, business, or geographic Winovation methodology, which rely on our combination of technical area. directs our resources to innovative expertise, product availability and product ideas with the highest market premier customer service. This balanced formula delivers potential. reliable growth year after year. We also completed a record Acquisitions result from staying thirteen acquisitions this year, all close to potential partners. As such complementary to one or more of our businesses become available, our core motion and control technologies. superior cash flow enables us to act These businesses continue to add decisively. Our goal is to remain the new and growing revenue streams. motion and control industry’s acquirer of choice.
  9. 9. MARKETS A World of Opportunities STR ATEGY EXECUTION RESULTS Parker serves thousands The essential nature of Parker’s Parker has diversified into 1,200 markets. No single market of customers in many end technologies enables us to apply dominates our business. markets. As a result, we are them just about anywhere. not overly dependent on any one For example, our filtration know- We have maintained leadership in industry for revenues and profits. how reduces engine emissions and our growing traditional markets, purifies semiconductor fabrication. and we are penetrating new high- This diversification strategy means Sealing proficiency reduces hazard- margin, counter-cyclical markets overall business cycles tend to ous leaks and shields electronic such as fuel cells, life sciences, be less volatile for us, competi- devices. Cooling expertise chills electronics, and pharmaceuticals. tors find it difficult to match us, vaccines and refrigerates food and risk is reduced for those who The payoff: A 9.3 percent warehouses. invest in us. compound annual growth rate over the last twenty years and Solving these and other motion 9.4 percent over the last five. and control challenges transcends geographic boundaries. Our people, products and operations respond to customer needs wherever they may be.
  10. 10. SERVICE Adding Value Throughout the Chain STR ATEGY EXECUTION RESULTS Parker’s excellence in service is Despite ever-shortening customer All of our operating divisions are at or nearing our 95 percent based on the foundation of deliv- lead times, our lean operations or above on-time delivery ering quality products on time. are providing on-time deliveries when competitors cannot. goal. The year also saw our North We extend our basic service prom- America 1-800-C-PARKER call ise through our global network Together with our distributors, we center process nearly 200,000 cus- of more than 12,000 indepen- are meeting customer requests tomer inquiries. dent distributor locations. This for just-in-time replenishment competitive differentiator ensures programs, customized kits, and on- Our channel partners continue to replacement products and techni- site engineering. find new ways to serve Parker’s cal expertise are readily available. end customers. Sales to our top Service innovations, such as retail 100 global distributors grew Finally, we elevate the service ParkerStores, Hose Doctor emer- nearly 17 percent. experience by partnering with gency repair vans, mobile Tech our customers, improving their Tours, and our PHconnect Web These and other examples are designs, removing waste from portal, continue to make us among the many steps in our con- their processes, and increasing a supplier of choice. tinuing customer service journey. their profits.
  11. 11. PEOPLE Diverse Talents to Grow Diverse Markets STR ATEGY EXECUTION RESULTS Parker is continually deepening We’ve built our entire Win Strat- Our diverse workforce is making its talent pool. We recruit from egy on the concept of empowered us stronger and more competitive. employees. The local knowl- dozens of colleges each year, edge and expertise of Parker’s By embracing lean concepts, seeking outstanding functional Parker employees have steadily 57,000-member team lets us skills balanced with diverse life increased their productivity, as understand and meet customer experiences. needs in dozens of countries. measured by sales per employee. Local empowerment has also en- Current employees, new recruits, Employees know that their skills, abled them to decrease inventory and people joining Parker via ac- more than any other factor, are and improve customer service. quisition grow their skills through what make them valuable. They more than 100 core courses, 800 recognize that Parker’s continued At Parker, what we know and how online courses, and company- success depends on their diverse diligently we apply our knowl- sponsored academic study. talents, cultures and points of view. edge in concert with others will always be of greatest importance. Succession planning is also Diverse talent is a strength we addressed continuously, placing the best talent in the most celebrate. critical jobs.
  12. 12. TECHNOLOGY A Portfolio of Essential Engineering STR ATEGY EXECUTION RESULTS Our Winovation process is Parker technology is solving Market diversification comes from spurring advancements in the increasingly complex customer our related core technologies: next generation of motion and problems. We are purifying air Hydraulics, pneumatics, electro- control technologies, such as mechanical, filtration, sealing and water, reducing pollution, in- shielding, process control, fluid hollow fiber membrane gas sepa- creasing energy efficiency, building gas handling, aerospace and ration, laser optic particle detec- infrastructure, aiding the disabled, climate control. tion, alternative refrigerants, smart and facilitating communication. materials, and intelligent devices. We are experts in applying and Our repeated ability to apply our We provide systems. We’ve developing each technology. We technologies is resulting in greater have assembled the widest product married hydraulic, fluid handling demand and profitable growth. Our breadth available from any single and filtration technologies for reputation for innovation continues manufacturer in our industry. off-road vehicles. In aerospace, to expand. we deliver fuel, hydraulic, flight We leverage our capabilities into control, pneumatic and inerting In every case, the goal is the same: A differentiated product integrated systems that often com- systems. We’ve even combined bine multiple technologies. We or system with a clear com- motion, sealing and fluidics to strive to meet the entire range petitive advantage. simplify medical sample analysis. of customer needs. 0
  13. 13. PERFORMANCE Greater Than the Sum of Our Parts STR ATEGY EXECUTION RESULTS t PHconnec Parker’s Win Strategy is raising Strategic procurement agree- Our reduced supplier base is ments are providing flows of raw providing cost-saving ideas worth the performance of the com- materials, even when competitors millions. Lean has improved pro- pany for the benefit of all Parker experience shortages. Pricing spe- ductivity as measured by sales per stakeholders. We are serving the cialists are finding and capturing employee. Inventory is down and customer, growing profitably, and the true value of our products. All service levels are up. performing financially. employees are solving problems Our Win Strategy relies on a set by using standard lean tools and In 2006, we generated returns metrics. above our cost of capital, and we of center-led initiatives designed remained near the top quartile to capture value across the entire in return on invested capital These initiatives are being chain. implemented daily at our 118 among our peers. Cash flow, sales and earnings are at re- divisions. Our lean journey con- Our commitment to strategic cord levels. tinues ever forward, as we seek procurement, strategic pricing and to increase efficiency in every lean enterprise has not and will 2006 also marked our 50th functional area. not change. We are focused on consecutive fiscal year of sustained operational increased dividends. excellence.
  14. 14. Cash Flow from Operations Our North By Northwest Goal Millions of Dollars 16% GOAL 14 Net Cash 12 % of Sales 10 8 12% $1,000 % of Return on Sales 6 10 800 4 8 2 600 6 0 .30 .40 .50 60 .70 .80 400 Net Assets/Sales 01 02 03 04 05 06 4 Record Dollars in 2006 – In 2006, cash flow from operations reached a Above-the-Line Performance in 2006 – This chart contains two important record $954.6 million or 10.2% of sales. This strong position allows us the financial measures: Operating margin and net assets/sales. The corporate flexibility to invest in strategic acquisitions, develop innovative products, goal, represented by the line, helps divisions focus on controlling costs and develop our employees, repurchase shares and provide dividends. assets while growing sales. The quickest way to meet the target is to move “north by northwest.” Since the launch of the Win Strategy, Parker has steadily moved toward the goal, reaching the line in 2005 and eclipsing it in 2006. FINANCIAL STRENGTH Over the last five years, Parker’s Win Strategy has driven the company’s financial performance to a higher level. As our employees continue to execute our Win Strategy, we will continue to operate from a position of financial strength, enabling us to invest in strategic new opportunities, grow our business, and provide strong returns to our shareholders. Parker ROIC Versus Peers’ ROIC* 32.5% 32.1% 28.0% 25.9% 21.2% PARKER 20.9% 20.7% 18.7% 18.1% 16.7% Peers Parker 16.6% 15.8% Strong ROIC Performance in 2006 – Our ROIC continues 15.4% to outpace our weighted average cost of capital, creat- 14.9% ing value for our shareholders. 12.6% 12.6% 9.5% 8.0% 6.9% 30% 35% 0% 5% 10% 15% 20% 25% Return on Invested Capital % *Return on Invested Capital (ROIC) is defined as: Earnings before interest and taxes (EBIT) divided by average capital (average of debt and equity at the beginning and end of the fiscal year). Parker’s ROIC peers include CAT, CBE, CMI, DE, DHR, DOV, EMR, ETN, FLS, GR, HON, IR, ITT, ITW, PLL, ROK, SPW, and TXT. The information for Parker and its peers is based on the last completed fiscal year of each company.
  15. 15. Financial Review Consolidated Statements of Income and Comprehensive Income page 20 Consolidated Statement of Cash Flows page 23 Business Segment Information page 21 Notes to Consolidated Financial Statements page 24 Consolidated Balance Sheet page 22 Eleven-Year Financial Summary page 36 RETURN ON AVERAGE FIVE-YEAR AVERAGE RETURN DIVIDEND ASSETS/ COMPOUND EQUITY ON SALES PAYOUT RATIO SALES SALES GROWTH Goal: 15.0% Goal: 6.5% Goal: 25.0% Goal: $.80 Goal: 10% 15.0% 9.0% $1.20 24.0% 75.0% 10.0% 6.0% $.80 16.0% 50.0% 5.0% 3.0% $.40 8.0% 25.0% 02 03 04 05 06 02 03 04 05 06 02 03 04 05 06 02 03 04 05 06 02 03 04 05 06 ManageMent’s Discussion anD analysis overview eight times during fiscal 2006. Additional increases in interest rates could have a negative impact on industrial production thereby lowering future order rates. The Company is a leading worldwide diversified manufacturer of motion control technologies and systems, providing precision engineered solutions for a wide variety The Company’s major opportunities for growth are as follows: of commercial, mobile, industrial and aerospace markets. Leverage the Company’s broad product line with customers desiring • The Company’s order rates provide a near-term perspective of the Company’s future to consolidate their vendor base and outsource engineering, revenues particularly when viewed in the context of prior and future order rates. Marketing systems solutions for customer applications, • The Company publishes its order rates on a monthly basis. The lead time between Expand the Company’s business presence outside of North America, • the time an order is received and revenue is realized can range from one day to 12 New product introductions, including those resulting from the Company’s • weeks for commercial, mobile and industrial orders and from one day to 18 months innovation initiatives, and for aerospace orders. The Company believes the leading economic indicators of these Strategic acquisitions in a consolidating industry. • markets that have a strong correlation to the Company’s future order rates are the The financial condition of the Company remains strong as evidenced by the continued Institute of Supply Management (ISM) index of manufacturing activity with respect generation of substantial cash flows from operations, a debt to debt-equity ratio to commercial, mobile and industrial markets and aircraft miles flown, revenue of 21.1 percent, ample borrowing capabilities and strong short-term credit ratings. passenger miles and Department of Defense spending for aerospace markets. Cash flows from operations in 2006 were $955 million, or 10.2 percent of sales. An ISM index above 50 indicates that the manufacturing economy is expanding Many acquisition opportunities remain available to the Company within its target resulting in the expectation that the Company’s order rates in the commercial, mobile markets. During fiscal 2006, the Company completed 13 acquisitions whose and industrial markets should be positive year-over-year. The ISM index at the end of aggregate annual revenues were approximately $983 million. The Company believes fiscal 2006 was 53.8 compared to 54.0 at the end of June 2005. With respect to that future financial results will reflect the benefit of a fast and efficient integration the aerospace market, aircraft miles flown and revenue passenger miles in 2006 of the companies recently acquired. Acquisitions will continue to be considered from have shown moderate improvement over comparable fiscal 2005 levels and the time to time to the extent there is a strong strategic fit, while at the same time, Company expects continued improvement in 2007. The Company anticipates that maintaining the Company’s strong financial position. The Company will also continue Department of Defense spending in fiscal 2007 will remain at the fiscal 2006 levels. to assess the strategic fit of its existing businesses and initiate efforts to divest The Company also believes that there is a high correlation between interest rates and businesses that are not considered to be a good long-term fit for the Company, Industrial manufacturing activity. The Federal Reserve raised the federal funds rate as evidenced by the divestitures completed in fiscal 2006 and 2005. Parker Hannifin Corporation annual report 2006
  16. 16. MANAgEMENT’S DISCuSSIoN ANALYSIS Current challenges facing the Company include maintaining premier customer service are expected to increase approximately 18 percent with operating margins expected levels while benefiting from strong customer demand, successfully matching price to remain at or be slightly higher than their 2006 level. Aerospace operations sales increases to raw material cost increases and managing rising expenses related to are expected to increase in the mid-single digit range with operating margins employee retirement and health care benefits. The Company is also challenged with remaining near their 2006 level. Climate Industrial Controls sales are expected trying to minimize the potential adverse impact of the weakening financial condition to increase in the mid-single digit range with an operating margin improvement of of its automotive market customers. The Company has implemented a number of about 25 percent over their 2006 level. strategic financial performance initiatives relating to growth and margin improvement was higher in 2006 primarily due to a combination of the Gross profit marGiN in order to meet these challenges, including strategic procurement, strategic pricing, increase in sales as well as the effects of the Company’s financial performance lean manufacturing and business realignments. initiatives, especially in the areas of lean manufacturing and strategic procurement. The discussion below is structured to separately discuss each of the financial Included in 2006 gross profit is $10.3 million of expense related to stock-based statements presented on pages 20 to 23. All year references are to fiscal years. compensation awards. The higher margins in 2005 reflect the effects of the Company’s financial performance initiatives, resulting in better manufacturing Discussion of consolidated statement of income utilization levels. Current-year acquisitions, not yet fully integrated, negatively affected the current-year gross margin. The Consolidated Statement of Income summarizes the Company’s operating increased 20.5 percent in performance over the last three fiscal years. selliNG, GeNeral aNd admiNistrative expeNses 2006 primarily due to the higher sales volume, $23.1 million of expense related to (millions) 2005 2004 2006 stock-based compensation awards, higher amortization expense related to intangible Net sales $ 8,069 $ 6,888 $ 9,386 assets and higher incentive compensation. Gross profit margin 20.8% 19.0% 21.5% in 2004 resulted from the Company’s goodwill Selling, general and Goodwill impairmeNt loss administrative expenses $ 860 $ 766 $ 1,037 impairment test required to be performed under the provisions of SFAS No. 142. Goodwill impairment loss 1 No impairment loss was required to be recognized in 2006 or 2005. Interest expense 67 73 76 increased in 2006 primarily due to higher average debt iNterest expeNse Other (income) expense, net 8 (1) (9) outstanding resulting from an increase in borrowings used to fund acquisition activity Loss (gain) on disposal of assets 4 (2) 15 in 2006. Interest expense declined in 2005 as a result of lower average debt Effective tax rate from continuing operations 27.8% 29.8% 29.1% outstanding. Income from includes, plant and equipment disposals, loss (GaiN) oN disposal of assets continuing operations $ 533 $ 332 $ 638 divestitures of businesses and asset impairments and other miscellaneous asset Income from adjustments. continuing operations, as a percent of sales 6.6% 4.8% 6.8% (millions) 2005 2004 2006 Discontinued operations $ 72 $ 14 $ 35 Plant and Net income $ 605 $ 346 $ 673 equipment disposals $3 $2 $ (1) in 2006 were 16.3 percent higher than 2005. The increase in sales Net sales Divestitures (11) 10 in 2006 primarily reflects higher volume experienced across all Segments. Asset adjustments 1 7 6 Acquisitions completed within the last 12 months contributed about one-half of See Note 2 on page 26 for a discussion of divestitures. See Note 3 on page 27 for the net sales increase. The effect of currency rate changes reduced net sales by a discussion of asset adjustments. approximately $38 million. in 2006 was higher primarily effective tax rate from coNtiNuiNG operatioNs Net sales in 2005 were 17.1 percent higher than 2004. The increase in sales in due to a lower level of research and development tax credits as compared to 2005, 2005 primarily reflects higher volume experienced throughout all of the Company’s partially offset by the effect of tax planning initiatives. The effective tax rate in Segments, especially in the Industrial North American and Industrial International 2005 was lower primarily due to a favorable ruling obtained from the Internal operations. Acquisitions completed within the last 12 months contributed about Revenue Service regarding research and development tax credits as well as the one-third of the sales increase and the effect of currency rate changes increased effect of tax planning initiatives related to recent acquisitions. net sales by approximately $165 million. iNcome from coNtiNuiNG operatioNs – In addition to the individual income During 2006, the Company experienced strong business conditions in most of statement items discussed above, net income in 2006 and 2005 was adversely the markets that the Industrial North American businesses serve. The Company affected by an additional expense of approximately $15 million and $11 million, anticipates that favorable business conditions will prevail for most of 2007 respectively, related to domestic qualified defined benefit plans. The increase in translating into sales growth in the mid-single digit range and operating margins expense associated with the Company’s domestic qualified defined benefit plans remaining close to their 2006 level. Sales in the Industrial International operations resulted primarily from changes in actuarial assumptions for 2006 and higher Parker Hannifin Corporation annual report 2006
  17. 17. Sales in 2006 for the Industrial North American operations were 13.6 percent higher amortization of prior years’ actuarial losses. Net income in 2007 is expected to than 2005 following a 16.6 percent increase from 2004 to 2005. The increase in be positively affected by a decrease in pension expense related to the Company’s sales in 2006 was primarily due to acquisitions, which accounted for about one-half domestic qualified defined benefit plans of approximately $19 million. The decrease of the sales increase, as well as higher end-user demand experienced in virtually in pension expense in 2007 is primarily due to an increase in the discount rate from all markets, with the largest increases in heavy-duty truck, construction, mobile 5.25 percent to 6.0 percent and lower expense from the amortization of prior equipment and oil and gas. The sales increase from 2004 to 2005 was primarily years’ actuarial losses. due to higher end-user demand experienced in the heavy-duty truck, construction represents the operating results and related gain on the discoNtiNued operatioNs and agriculture and mobile equipment markets. sale, net of tax, of the Astron Buildings business which was divested in August 2005 Sales in the Industrial International operations increased 21.0 percent in 2006 and the Wynn’s Specialty Chemical business which was divested in December 2004. following an increase of 21.8 percent from 2004 to 2005. The sales increase in other compreheNsive iNcome (loss) – Items included in other comprehensive 2006 was primarily due to acquisitions, which accounted for about 70 percent of income (loss) are gains and losses that under generally accepted accounting the sales increase, as well as higher volume in Europe and the Asia Pacific region, principles are recorded directly into stockholders’ equity. The following are the partially offset by lower volume in Latin America. Foreign currency rate changes Company’s items of other comprehensive income (loss): reduced net sales in 2006 by $54 million. The increase in sales from 2004 to 2005 was primarily due to higher volume across most markets in Europe, Latin America (millions) 2005 2004 2006 and the Asia Pacific region. Acquisitions completed in 2005 and the effect of foreign Foreign currency translation $ 13 $ 34 $ 104 currency rate changes each contributed about 30 percent of the sales increase. Net unrealized (loss) gain The higher Industrial North American operating margins in 2006 and 2005 were on marketable primarily due to the increased sales volume as well as operating efficiencies. The equity securities (11) 5 operating efficiencies reflect the execution of the Company’s financial performance Minimum pension liability (154) 95 167 Net unrealized gain (loss) initiatives, especially in the area of lean manufacturing and strategic procurement. on cash flow hedges (7) 5 Acquisitions, not yet fully integrated, negatively impacted margins in both 2006 and 2005. Included in Industrial North American operating income in 2006, 2005 The change in foreign currency translation in 2006 primarily resulted from the and 2004 are business realignment charges of $5.4 million, $3.7 million and $9.1 weakening of the u.S. dollar against most other currencies. The minimum pension million, respectively. The business realignment charges resulted from actions the liability was recorded in comprehensive income in accordance with the requirements Company took to structure the Industrial North American operations to operate of SFAS No. 87 (see Note 10 on page 30 for further discussion). in their then current economic environment and primarily consisted of severance costs and costs relating to the consolidation of manufacturing operations. Discussion of Business segment information The Industrial International operating margin improvement in 2006 and 2005 The Business Segment information presents sales, operating income and assets on a was primarily due to the higher sales volume, especially throughout all businesses basis that is consistent with the manner in which the Company’s various businesses in Europe, as well as the effects of the Company’s financial performance initiatives. are managed for internal review and decision-making. See Note 1 on page 24 for Acquisitions, not fully integrated, negatively impacted margins in 2006 and 2005. a description of the Company’s reportable business segments. operating income in 2006, 2005 and 2004 included $10.3 million, $9.9 million IndustrIal segment and $4.5 million, respectively, of business realignment charges that were taken to appropriately structure primarily the European operations. (millions) 2005 2004 2006 Sales Industrial Segment order rates were higher throughout 2006 as virtually all markets North America $ 3,517 $ 3,017 $ 3,993 experienced continued strength in end-user demand. The Company expects order International 2,398 1,970 2,903 entry levels in 2007 in most markets of the Industrial North American operations Operating income to be relatively flat or decline slightly as compared to their 2006 levels. The North America 468 291 597 Company expects sales in the Industrial International operations to increase about International 267 160 354 18 percent over 2006 reflecting strong end-user demand and the sales contribution Operating income as a percent of sales from acquisitions completed in 2006. operating margins in both the Industrial North America 13.3% 9.6% 15.0% North American and Industrial International operations are expected to remain at International 11.1% 8.1% 12.2% or be slightly higher than their 2006 level. Industrial International operating margin Backlog $ 944 $ 840 $ 1,178 in 2007 is expected to be adversely affected by recent acquisitions that will not Assets 4,714 4,277 6,154 be completely integrated for the entire year. As part of the Company’s financial Return on average assets 10.4% 7.1% 11.0% performance initiatives, the recognition of additional business realignment charges may be required in 2007.
  18. 18. MANAgEMENT’S DISCuSSIoN ANALYSIS The increase in total Industrial Segment backlog in 2006 and 2005 is primarily due Sales in 2006 increased 24.0 percent compared to an 18.3 percent increase in sales to acquisitions, which contributed about one-half of the increase in both 2006 and from 2004 to 2005. The increase in sales in 2006 was primarily due to acquisitions, 2005, as well as higher order rates in both the Industrial North American and which accounted for about one-half of the sales increase, as well as higher end-user Industrial International businesses. demand in the residential air conditioning market, which is being driven by energy efficiency legislation. The increase in sales in 2005 was the result of current-year The increase in assets in 2006 and 2005 was primarily due to current-year acquisitions partially offset by lower end-user demand experienced in the automotive acquisitions and the effect of currency fluctuations partially offset by a decrease in market. The lower margins in 2006 are primarily due to manufacturing inefficiencies plant and equipment. related to recent plant relocations and integration costs related to recent acquisitions. The lower margins in 2005 are primarily due to unfavorable overhead absorption aerospace segment levels and higher automotive platform set-up costs as compared to 2004. operating (millions) 2005 2004 2006 income in 2006 included $3.6 million of business realignment charges. Sales $1,359 $1,216 $1,505 Operating income 199 158 221 During 2006, the Climate Industrial Controls Segment experienced strong business Operating income conditions in the residential air conditioning market and soft business conditions as a percent of sales 14.7% 13.0% 14.7% in the automotive market. For 2007, business conditions in the residential air Backlog $1,229 $1,203 $1,328 conditioning market are anticipated to be strong while business conditions in Assets 658 635 748 the automotive market are not expected to improve significantly. Sales in 2007 are Return on average assets 30.8% 24.3% 31.4% anticipated to increase in the mid-single digit range with a corresponding 25 percent increase in operating margin. operating margins in 2007 are expected to benefit Sales in 2006 increased 10.7 percent compared to an increase of 11.8 percent from the completion of recent plant relocations and margin contributions from from 2004 to 2005. The increase in sales in both 2006 and 2005 primarily reflects recent acquisitions which have now been completely integrated. the continued recovery of the commercial airline industry, in both the original equipment manufacturer (oEM) and aftermarket markets as well as continued The increase in assets in 2006 was primarily due to acquisitions and an increase in strong demand in the military market. accounts receivable and inventory partially offset by a decline in plant and equipment. The increase in assets in 2005 was primarily due to acquisitions. Despite the higher sales volume in 2006, operating margin remained at the 2005 amount of 14.7 percent primarily due to a higher concentration of 2006 assets decreased 42.2 percent in 2006 and 13.7 percent in 2005. corporate sales occurring in the commercial and military oEM businesses as well as higher The fluctuation in 2006 is primarily due to a decrease in cash partially offset by engineering costs incurred in 2006 for new programs. The higher margins in 2005 an increase in investments and a decrease in inventory reserves. The fluctuation in were primarily due to the higher sales volume as well as product mix partially offset 2005 was primarily due to a decrease in accounts receivable, investments and net by higher aircraft product liability insurance premiums. The continued implementation assets of discontinued operations and an increase in inventory reserves. of the Company’s financial performance initiatives also positively affected margins in 2006 and 2005. Discussion of consolidated Balance sheet The increase in backlog in 2006 was primarily due to higher order rates experienced The Consolidated Balance Sheet shows the Company’s financial position at year-end, in both the commercial and military businesses. The slight increase in backlog in compared with the previous year-end. This statement provides information to assist in 2005 was primarily due to higher order rates in the commercial businesses being assessing factors such as the Company’s liquidity and financial resources. partially offset by lower order rates in the military business. The upward trend in commercial order rates experienced in 2006 is expected to continue in 2007. (millions) 2005 2006 Military order rates are expected to be slightly lower in 2007. Heavier commercial Accounts receivable $ 1,225 $ 1,592 Inventories 1,017 1,183 oEM volume in future product mix could result in lower margins. Plant and equipment, net 1,581 1,694 The increase in assets in 2006 and 2005 was primarily due to increases in Investments and other assets 832 859 accounts receivable and inventory partially offset by a decline in plant and Goodwill 1,371 2,010 equipment. A portion of the increase in assets in 2006 was also attributable Intangible assets, net 240 471 to an acquisition. Accounts payable, trade 569 771 Shareholders’ equity 3,340 4,241 clImate IndustrIal controls segment Working capital $ 1,455 $ 1,458 (millions) 2005 2004 2006 Current ratio 2.12 1.87 Sales $ 794 $ 671 $ 985 are primarily receivables due from customers for sales of accouNts receivable Operating income 75 72 83 product ($1,475.9 million at June 30, 2006 and $1,111.1 million at June 30, 2005). Operating income The current-year increase in accounts receivable is primarily due to acquisitions as as a percent of sales 9.4% 10.7% 8.5% well as a higher level of sales experienced in the latter part of the current fiscal year Backlog $ 131 $ 122 $ 190 as compared to fiscal 2005. Days sales outstanding relating to trade receivables for Assets 696 361 812 Return on average assets 14.2% 19.5% 11.0% Parker Hannifin Corporation annual report 2006