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
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. 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. 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
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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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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
