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EX-32 - EXHIBIT 32 - PARKER HANNIFIN CORPph3312017ex32.htm
EX-31.B - EXHIBIT 31.B - PARKER HANNIFIN CORPph3312017ex31b.htm
EX-31.A - EXHIBIT 31.A - PARKER HANNIFIN CORPph3312017ex31a.htm
EX-12 - EXHIBIT 12 - PARKER HANNIFIN CORPph3312017ex12.htm
EX-10.A - EXHIBIT 10.A - PARKER HANNIFIN CORPph3312017ex10a.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
OR 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File number 1-4982
 PARKER-HANNIFIN CORPORATION
(Exact name of registrant as specified in its charter)
 
OHIO
 
34-0451060
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
 
 
6035 Parkland Blvd., Cleveland, Ohio
 
44124-4141
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (216) 896-3000
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  ý    No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act (check one): 
Large accelerated filer
 
ý
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
Number of Common Shares outstanding at March 31, 2017 133,183,359




PART I - FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS

PARKER-HANNIFIN CORPORATION
CONSOLIDATED STATEMENT OF INCOME
(Dollars in thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
March 31,
 
March 31,
 
2017
 
2016
 
2017
 
2016
Net sales
$
3,119,139

 
$
2,828,665

 
$
8,533,074

 
$
8,403,603

Cost of sales
2,383,790

 
2,209,401

 
6,534,280

 
6,550,929

Gross profit
735,349

 
619,264

 
1,998,794

 
1,852,674

Selling, general and administrative expenses
392,036

 
335,908

 
1,051,583

 
1,020,788

Interest expense
42,057

 
33,745

 
109,649

 
103,802

Other (income), net
(13,807
)
 
(23,382
)
 
(90,468
)
 
(50,438
)
Income before income taxes
315,063

 
272,993

 
928,030

 
778,522

Income taxes
76,216

 
85,851

 
237,545

 
213,217

Net income
238,847

 
187,142

 
690,485

 
565,305

Less: Noncontrolling interest in subsidiaries' earnings
174

 
58

 
378

 
261

Net income attributable to common shareholders
$
238,673

 
$
187,084

 
$
690,107

 
$
565,044

 
 
 
 
 
 
 
 
Earnings per share attributable to common shareholders:
 
 
 
 
 
 
 
Basic
$
1.79

 
$
1.39

 
$
5.17

 
$
4.16

Diluted
$
1.75

 
$
1.37

 
$
5.09

 
$
4.12

 
 
 
 
 
 
 
 
Cash dividends per common share
$
0.66

 
$
0.63

 
$
1.92

 
$
1.89

See accompanying notes to consolidated financial statements.














- 2 -



PARKER-HANNIFIN CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Dollars in thousands)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
March 31,
 
March 31,
 
2017
 
2016
 
2017
 
2016
Net income
$
238,847

 
$
187,142

 
$
690,485

 
$
565,305

Less: Noncontrolling interests in subsidiaries' earnings
174

 
58

 
378

 
261

Net income attributable to common shareholders
238,673

 
187,084

 
690,107

 
565,044

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
  Foreign currency translation adjustment and other
83,100

 
130,766

 
(170,634
)
 
(72,592
)
  Retirement benefits plan activity
35,512

 
28,422

 
105,847

 
85,539

    Other comprehensive income (loss)
118,612

 
159,188

 
(64,787
)
 
12,947

Less: Other comprehensive income (loss) for noncontrolling interests
301

 
(2
)
 
281

 
(133
)
Other comprehensive income (loss) attributable to common shareholders
118,311

 
159,190

 
(65,068
)
 
13,080

Total comprehensive income attributable to common shareholders
$
356,984

 
$
346,274

 
$
625,039

 
$
578,124

See accompanying notes to consolidated financial statements.





- 3 -



PARKER-HANNIFIN CORPORATION
CONSOLIDATED BALANCE SHEET
(Dollars in thousands)
 
(Unaudited)
 
 
 
March 31,
2017
 
June 30,
2016
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
819,563

 
$
1,221,653

Marketable securities and other investments
36,758

 
882,342

Trade accounts receivable, net
1,869,303

 
1,593,920

Non-trade and notes receivable
235,924

 
232,183

Inventories
1,538,644

 
1,173,329

Prepaid expenses
118,962

 
104,360

Total current assets
4,619,154

 
5,207,787

Plant and equipment
5,130,954

 
4,737,141

Less: Accumulated depreciation
3,185,215

 
3,169,041

 
1,945,739

 
1,568,100

Deferred income taxes
65,152

 
605,155

Other assets
848,212

 
827,492

Intangible assets, net
2,338,364

 
922,571

Goodwill
5,508,712

 
2,903,037

Total assets
$
15,325,333

 
$
12,034,142

LIABILITIES
 
 
 
Current liabilities:
 
 
 
Notes payable and long-term debt payable within one year
$
776,159

 
$
361,787

Accounts payable, trade
1,209,351

 
1,034,589

Accrued payrolls and other compensation
376,177

 
382,945

Accrued domestic and foreign taxes
158,634

 
127,597

Other accrued liabilities
528,120

 
458,970

Total current liabilities
3,048,441

 
2,365,888

Long-term debt
5,255,156

 
2,652,457

Pensions and other postretirement benefits
1,787,311

 
2,076,143

Deferred income taxes
159,666

 
54,395

Other liabilities
327,033

 
306,581

Total liabilities
10,577,607

 
7,455,464

EQUITY
 
 
 
Shareholders’ equity:
 
 
 
Serial preferred stock, $.50 par value; authorized 3,000,000 shares; none issued

 

Common stock, $.50 par value; authorized 600,000,000 shares; issued 181,046,128 shares at March 31 and June 30
90,523

 
90,523

Additional capital
577,562

 
628,451

Retained earnings
10,725,262

 
10,302,866

Accumulated other comprehensive (loss)
(2,292,833
)
 
(2,227,765
)
Treasury shares, at cost; 47,862,769 shares at March 31 and 47,033,896 shares at June 30
(4,358,375
)
 
(4,218,820
)
Total shareholders’ equity
4,742,139

 
4,575,255

Noncontrolling interests
5,587

 
3,423

Total equity
4,747,726

 
4,578,678

Total liabilities and equity
$
15,325,333

 
$
12,034,142

See accompanying notes to consolidated financial statements.

- 4 -



PARKER-HANNIFIN CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
 
Nine Months Ended
 
March 31,
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net income
$
690,485

 
$
565,305

Adjustments to reconcile net income to net cash provided by operations:
 
 
 
Depreciation
142,959

 
143,663

Amortization
93,584

 
88,114

Share incentive plan compensation
60,916

 
53,735

Deferred income taxes
43,530

 
(25,925
)
Foreign currency transaction loss
6,204

 
25,663

Loss on sale of plant and equipment
513

 
76

       Gain on sale of businesses
(42,994
)
 
(10,668
)
       Gain on sale of marketable securities
(1,032
)
 
(535
)
Changes in assets and liabilities, net of effect of acquisitions:
 
 
 
Accounts receivable, net
(45,442
)
 
21,167

Inventories
(91,170
)
 
53,120

Prepaid expenses
(1,329
)
 
117,203

Other assets
1,384

 
(19,246
)
Accounts payable, trade
101,143

 
(93,948
)
Accrued payrolls and other compensation
(46,755
)
 
(69,179
)
Accrued domestic and foreign taxes
28,823

 
(10,759
)
Other accrued liabilities
(21,686
)
 
(25,209
)
Pensions and other postretirement benefits
(140,154
)
 
(75,540
)
Other liabilities
10,314

 
(32,471
)
Net cash provided by operating activities
789,293

 
704,566

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Acquisitions (net of cash acquired of $157,426 in 2017 and $3,814 in 2016)
(4,067,755
)
 
(67,552
)
Capital expenditures
(145,236
)
 
(110,804
)
Proceeds from sale of plant and equipment
8,452

 
14,112

Proceeds from sale of businesses
85,610

 
24,325

Purchases of marketable securities and other investments
(451,561
)
 
(1,188,594
)
Maturities of marketable securities and other investments
1,264,721

 
974,417

Other
(2,590
)
 
(40,364
)
Net cash used in investing activities
(3,308,359
)
 
(394,460
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Proceeds from exercise of stock options
2,095

 
89

Payments for common shares
(264,343
)
 
(464,456
)
Proceeds from notes payable, net
447,799

 
523,336

Proceeds from long-term borrowings
2,614,756

 
2,287

Payments for long-term borrowings
(374,794
)
 
(220,068
)
Dividends
(257,161
)
 
(256,890
)
Net cash provided by (used in) financing activities
2,168,352

 
(415,702
)
Effect of exchange rate changes on cash
(51,376
)
 
(40,017
)
Net decrease in cash and cash equivalents
(402,090
)
 
(145,613
)
Cash and cash equivalents at beginning of year
1,221,653

 
1,180,584

Cash and cash equivalents at end of period
$
819,563

 
$
1,034,971

See accompanying notes to consolidated financial statements.

- 5 -



PARKER-HANNIFIN CORPORATION
BUSINESS SEGMENT INFORMATION
(Dollars in thousands)
(Unaudited)
The Company operates in two reportable business segments: Diversified Industrial and Aerospace Systems.
Diversified Industrial - This segment produces a broad range of motion-control and fluid systems and components used in all kinds of manufacturing, packaging, processing, transportation, mobile construction, refrigeration and air conditioning, agricultural and military machinery and equipment and has a significant portion of international operations. Sales are made directly to major original equipment manufacturers (OEMs) and through a broad distribution network to smaller OEMs and the aftermarket.
Aerospace Systems - This segment designs and manufactures products and provides aftermarket support for commercial, business jet, military and general aviation aircraft, missile and spacecraft markets. The Aerospace Systems Segment provides a full range of systems and components for hydraulic, pneumatic and fuel applications.
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 31,
 
March 31,
 
 
2017
 
2016
 
2017
 
2016
Net sales
 
 
 
 
 
 
 
 
Diversified Industrial:
 
 
 
 
 
 
 
 
North America
 
$
1,413,302

 
$
1,247,904

 
$
3,701,326

 
$
3,695,008

International
 
1,128,886

 
1,019,776

 
3,149,777

 
3,050,687

Aerospace Systems
 
576,951

 
560,985

 
1,681,971

 
1,657,908

Total net sales
 
$
3,119,139

 
$
2,828,665

 
$
8,533,074

 
$
8,403,603

Segment operating income
 
 
 
 
 
 
 
 
Diversified Industrial:
 
 
 
 
 
 
 
 
North America
 
$
227,419

 
$
202,180

 
$
612,043

 
$
568,509

International
 
152,995

 
105,161

 
417,708

 
329,823

Aerospace Systems
 
79,967

 
84,238

 
225,764

 
240,005

Total segment operating income
 
460,381

 
391,579

 
1,255,515

 
1,138,337

Corporate general and administrative expenses
 
45,747

 
42,322

 
120,707

 
126,583

Income before interest expense and other expense
 
414,634

 
349,257

 
1,134,808

 
1,011,754

Interest expense
 
42,057

 
33,745

 
109,649

 
103,802

Other expense
 
57,514

 
42,519

 
97,129

 
129,430

Income before income taxes
 
$
315,063

 
$
272,993

 
$
928,030

 
$
778,522




- 6 -



PARKER-HANNIFIN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Dollars in thousands, except per share amounts

1. Management representation
In the opinion of the management of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the Company's financial position as of March 31, 2017, the results of operations for the three and nine months ended March 31, 2017 and 2016 and cash flows for the nine months then ended. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s 2016 Annual Report on Form 10-K. Interim period results are not necessarily indicative of the results to be expected for the full fiscal year.
The Company has evaluated subsequent events that have occurred through the date these financial statements were issued. No subsequent events have occurred that required adjustment to these financial statements.

2. New Accounting Pronouncements
In March 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-07, "Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost." ASU 2017-07 requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. ASU 2017-07 also provides that only the service cost component is eligible for capitalization, when applicable. ASU 2017-07 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued. ASU 2017-07 should be applied retrospectively for the income statement presentation of net periodic pension cost and net periodic postretirement benefit cost and prospectively, on or after the effective date, for the capitalization of the service cost component of net periodic pension cost and net periodic postretirement benefit cost. The Company has not yet determined the effect that ASU 2017-07 will have on its financial statements.
In January 2017, the FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment." ASU 2017-04 eliminates Step 2 from the goodwill impairment test. Under the amendments in this Update, an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 also eliminates the requirement for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. ASU 2017-04 is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not believe the adoption of ASU 2017-04 will have a material effect on its financial statements.
In October 2016, the FASB issued ASU 2016-16, "Intra-Entity Transfers of Assets Other Than Inventory." ASU 2016-16 provides that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Consequently, the amendments in ASU 2016-16 eliminate the exception for an intra-entity transfer of an asset other than inventory. ASU 2016-16 is effective for fiscal years, and interim periods within those years, beginning after December 31, 2017. Early adoption is permitted. The Company has not yet determined the effect that ASU 2016-16 will have on its financial statements.
In August 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 provides specific guidance on several cash flow classification issues to reduce diversity in practice in how certain transactions are classified within the statement of cash flows. ASU 2016-15 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted. The Company has not yet determined the effect that ASU 2016-15 will have on its financial statements.


- 7 -




2. New Accounting Pronouncements, cont'd
In June 2016, the FASB issued ASU 2016-13, "Measurement of Credit Losses on Financial Instruments." ASU 2016-13 requires a financial asset (or a group of financial assets) measured at amortized cost to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. ASU 2016-13 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption is permitted. The Company has not yet determined the effect that ASU 2016-13 will have on its financial statements.
In March 2016, the FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting." Under ASU 2016-09, all excess tax benefits and deficiencies arising from employee share-based payment awards, and dividends on those awards, will be recognized in the income statement during the period in which they occur. ASU 2016-09 allows companies to make an accounting policy election to estimate forfeitures, as required today, or record them when they occur and allows companies to withhold an amount up to the maximum statutory tax rate without causing the award to be classified as a liability. Within the statement of cash flows, ASU 2016-09 requires excess tax benefits to be classified as an operating activity and cash payments to tax authorities in connection with shares withheld to be classified as a financing activity. The Company adopted ASU 2016-09 in the first quarter of fiscal 2017. In fiscal 2017, the Company applied the recognition of the excess tax benefits and deficiencies requirement on a prospective basis and recognized a discrete income tax benefit, which was recorded as a reduction to income tax expense, of $13,664 and $30,763 for the three and nine months ended March 31, 2017, respectively. Prior to the adoption of ASU 2016-09, this excess tax benefit was recorded as an increase to additional capital. The cash flow classification requirements of ASU 2016-09 were applied retrospectively. As a result, for the nine months ended March 31, 2016 cash flows from operating activities was increased by $23,067 and cash flows from financing activities was decreased by $23,067. The Company elected to continue to estimate forfeitures expected to occur rather than electing to account for forfeitures as they occur. The other provisions of ASU 2016-09 related to accounting for income taxes and minimum statutory share withholding tax requirements had no impact on the Company's financial statements.
In February 2016, the FASB issued ASU 2016-02, "Leases." ASU 2016-02 requires lessees to put most leases on their balance sheet by recognizing a liability to make lease payments and an asset representing their right to use the asset during the lease term. Lessee recognition, measurement, and presentation of expenses and cash flows will not change significantly from existing guidance. Lessor accounting is also largely unchanged from existing guidance. ASU 2016-02 requires qualitative and quantitative disclosures that provide information about the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. The Company has not yet determined the effect that ASU 2016-02 will have on its financial statements.
In January 2016, the FASB issued ASU 2016-01, "Recognition and Measurement of Financial Assets and Liabilities." ASU 2016-01 requires equity investments (excluding equity method investments and investments that are consolidated) to be measured at fair value with changes in fair value recognized in net income. Equity investments that do not have a readily determinable fair value may be measured at cost, adjusted for impairment and observable price changes. The ASU also simplifies the impairment assessment of equity investments, eliminates the disclosure of the assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at cost on the balance sheet and requires the exit price to be used when measuring fair value of financial instruments for disclosure purposes. Under ASU 2016-01, changes in fair value (resulting from instrument-specific credit risk) will be presented separately in other comprehensive income for liabilities measured using the fair value option and financial assets and liabilities will be presented separately by measurement category and type either on the balance sheet or in the financial statement disclosures. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company has not yet determined the effect that ASU 2016-01 will have on its financial statements.









- 8 -



2. New Accounting Pronouncements, cont'd
In April 2015, the FASB issued ASU 2015-03, "Interest - Imputation of Interest." ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in the ASU. ASU 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. During the first quarter of fiscal 2017, the Company retrospectively adopted ASU 2015-03 and has revised the following captions within the Consolidated Balance Sheet at June 30, 2016:
 
As Previously
Reported
 
Revised
Other assets
$
850,088

 
$
827,492

Notes payable and long-term debt payable within one year
361,840

 
361,787

Long-term debt
2,675,000

 
2,652,457


In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers." ASU 2014-09 requires revenue recognition to depict the transfer of goods or services to customers in an amount that reflects the consideration that a company expects to be entitled to in exchange for the goods or services. To achieve this principle, a company must apply five steps including identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations, and recognizing revenue when (or as) the company satisfies the performance obligations. Additional quantitative and qualitative disclosure to enhance the understanding about the nature, amount, timing, and uncertainty of revenue and cash flows is also required. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. In April 2016, the FASB issued ASU 2016-10, "Identifying Performance Obligations and Licensing." ASU 2016-10 clarifies the following two aspects of ASU 2014-09: identifying performance obligations and licensing implementation guidance. The effective date of ASU 2016-10 is the same as the effective date of ASU 2014-09. The Company has not yet determined the effect that ASU 2014-09 and ASU 2016-10 will have on its financial statements.


3. Acquisitions and divestiture

Acquisitions - During the first nine months of fiscal 2017, the Company completed three acquisitions, including the acquisition of a 100 percent equity interest in CLARCOR Inc ("Clarcor") for approximately $4,110 million in cash, including the assumption of debt. The remaining disclosures in Note 3 pertain only to Clarcor as the other two acquisitions completed during the first nine months of fiscal 2017 were deemed immaterial for further disclosure.

Clarcor is a major manufacturer of filtration products under more than a dozen respected brands including CLARCOR, Baldwin, Fuel Manager, PECOFacet, Airguard, Altair, BHA, Clearcurrent, Clark Filter, Hastings, United Air Specialists, Keddeg and Purolator. Clarcor had annual sales of approximately $1,400 million for its fiscal 2016. For segment reporting purposes, Clarcor will be part of the Diversified Industrial Segment.

The Company believes that Clarcor is a highly complementary acquisition that provides the Company with additional proprietary media, industrial and process filtration products and technologies, as well as a broad portfolio of replacement filters. The acquisition of Clarcor also offers significant expected operating synergies.

The Clarcor assets acquired and liabilities assumed will be recognized at their respective fair values as of the acquisition date. The process of estimating the fair values of certain tangible assets, identifiable intangible assets and assumed liabilities requires the use of judgment in determining the appropriate assumptions and estimates. The following presents the preliminary estimated fair values of Clarcor's assets acquired and liabilities assumed on the acquisition date. These preliminary estimates are based on available information and will be revised during the measurement period, not to exceed 12 months, as third-party valuations are finalized, additional information becomes available and as additional analysis is performed. Such revisions may have a material impact on the Company's results of operations and financial position.






- 9 -






3. Acquisitions and divestiture, cont'd

 
February 28, 2017

Assets:
 
Cash and cash equivalents
$
145,491

Accounts receivable
249,045

Inventories
278,060

Prepaid expenses
13,903

Plant and equipment
373,698

Deferred income taxes
4,558

Other assets
8,367

Intangible assets
1,497,280

Goodwill
2,649,456

 
5,219,858

Liabilities:
 
Notes payable
20,162

Accounts payable, trade
82,436

Accrued payrolls and other compensation
42,653

Accrued domestic and foreign taxes
4,379

Other accrued liabilities
79,066

Long-term debt
288,336

Pensions and other postretirement benefits
33,928

Deferred income taxes
542,698

Other liabilities
13,878

Noncontrolling interests
1,843

 
1,109,379

Net assets acquired
$
4,110,479


Goodwill is calculated as the excess of the purchase price over the net assets acquired and is not deductible for tax purposes. With respect to the Clarcor acquisition, goodwill represents cost synergies and enhancements to the Company's existing filtration technologies. See Note 11 for additional information about intangible assets.

The Company's results of operations for the first nine months of fiscal 2017 include Clarcor's results of operations from the date of acquisition, February 28, 2017, through March 31, 2017. Net sales and segment operating (loss) attributable to Clarcor during this period was $135,986 and $(13,582), respectively.

The following unaudited pro forma information gives effect to the Company's acquisition of Clarcor as if the acquisition had occurred on July 1, 2015 and Clarcor had been included in the Company's results of operations for the first nine months of fiscal 2017 and the twelve months ended June 30, 2016.

 
Nine months ended

 
Twelve months ended

 
March 31, 2017

 
June 30, 2016

 
 
 
 
Net sales
$
9,562,307

 
$
12,772,097

Net income attributable to common shareholders
754,323

 
780,421

Diluted earnings per share
5.57

 
5.70


- 10 -







3. Acquisitions and divestiture, cont'd

The unaudited pro forma financial information in the table above includes adjustments related to amortization expense, depreciation, interest expense and transaction costs incurred as well as adjustments to cost of sales for the step-up in inventory to estimated acquisition-date fair value and related income tax effects and is based on a preliminary purchase price allocation using currently available information. Transaction costs incurred and the adjustment to cost of sales for the step-up in inventory to estimated acquisition-date fair value are considered to be non-recurring. Adjustments for non-recurring items increased pro forma net income attributable to common shareholders by $72,006 for the nine months ended March 31, 2017 and decreased pro forma net income attributable to common shareholders by $29,106 for the twelve months ended June 30, 2016. The unaudited pro forma financial information does not give effect to any synergies, operating efficiencies or cost savings that may result from the Clarcor acquisition.

Divestiture - During the second quarter of fiscal 2017, the Company divested its Autoline product line, which was part of the Diversified Industrial Segment. The operating results and net assets of the Autoline product line were immaterial to the Company's consolidated results of operations and financial position. The Company recorded a net pre-tax gain in the second quarter of fiscal 2017 of approximately $45 million related to the divestiture. The gain is reflected in the other (income), net caption in the Consolidated Statement of Income and the other expense caption in the Business Segment Information for the nine months ended March 31, 2017.



4. Earnings per share
The following table presents a reconciliation of the numerator and denominator of basic and diluted earnings per share for the three and nine months ended March 31, 2017 and 2016.
 
 
Three Months Ended
 
Nine Months Ended
 
March 31,
 
March 31,
 
2017
 
2016
 
2017
 
2016
Numerator:
 
 
 
 
 
 
 
Net income attributable to common shareholders
$
238,673

 
$
187,084

 
$
690,107

 
$
565,044

Denominator:
 
 
 
 
 
 
 
Basic - weighted average common shares
133,232,378

 
134,809,610

 
133,410,622

 
135,675,823

Increase in weighted average common shares from dilutive effect of equity-based awards
2,870,596

 
1,743,159

 
2,116,573

 
1,636,025

Diluted - weighted average common shares, assuming exercise of equity-based awards
136,102,974

 
136,552,769

 
135,527,195

 
137,311,848

Basic earnings per share
$
1.79

 
$
1.39

 
$
5.17

 
$
4.16

Diluted earnings per share
$
1.75

 
$
1.37

 
$
5.09

 
$
4.12

For the three months ended March 31, 2017 and 2016, 717 and 3,087,061 common shares subject to equity-based awards, respectively, were excluded from the computation of diluted earnings per share because the effect of their exercise would be anti-dilutive. For the nine months ended March 31, 2017 and 2016, 1,608,245 and 3,062,752 common shares subject to equity-based awards, respectively, were excluded from the computation of diluted earning per share because the effect of their exercise would be anti-dilutive.




- 11 -




5. Share repurchase program
The Company has a program to repurchase its common shares. On October 22, 2014, the Board of Directors of the Company approved an increase in the overall number of shares authorized for repurchase under the program so that, beginning on such date, the aggregate number of shares authorized for repurchase was 35 million. There is no limitation on the number of shares that can be repurchased in a fiscal year. Repurchases may be funded primarily from operating cash flows and commercial paper borrowings and the shares are initially held as treasury stock. During the three-month period ended March 31, 2017, the Company repurchased 332,113 shares at an average price, including commissions, of $150.55 per share. During the nine-month period ended March 31, 2017, the Company repurchased 1,661,459 shares at an average price, including commissions, of $129.22 per share.


6. Trade accounts receivable, net
Trade accounts receivable are initially recorded at their net collectible amount and are generally recorded at the time the revenue from the sales transaction is recorded. Receivables are written off to bad debt primarily when, in the judgment of the Company, the receivable is deemed to be uncollectible due to the insolvency of the debtor. Allowance for doubtful accounts was $15,719 and $8,010 at March 31, 2017 and June 30, 2016, respectively.


7. Non-trade and notes receivable
The non-trade and notes receivable caption in the Consolidated Balance Sheet is comprised of the following components:
 
 
March 31,
2017
 
June 30,
2016
Notes receivable
 
$
105,865

 
$
102,400

Accounts receivable, other
 
130,059

 
129,783

Total
 
$
235,924

 
$
232,183




8. Inventories

The inventories caption in the Consolidated Balance Sheet is comprised of the following components:
 
 
March 31,
2017
 
June 30,
2016
Finished products
 
$
616,363

 
$
458,657

Work in process
 
736,697

 
639,907

Raw materials
 
185,584

 
74,765

Total
 
$
1,538,644

 
$
1,173,329









- 12 -




9. Business realignment charges
The Company incurred business realignment charges in fiscal 2017 and fiscal 2016.
Business realignment charges presented in the Business Segment Information are as follows: 
 
Three Months Ended
 
Nine Months Ended
 
March 31,
 
March 31,
 
2017
 
2016
 
2017
 
2016
Diversified Industrial
$
14,605

 
$
24,406

 
$
32,164

 
$
67,405

Aerospace Systems
1,713

 
624

 
2,796

 
2,604

Corporate general and administrative expenses

 
2,049

 

 
2,129

Other expense

 

 

 
116

Work force reductions in connection with such business realignment charges in the Business Segment Information are as follows: 
 
Three Months Ended
 
Nine Months Ended
 
March 31,
 
March 31,
 
2017
 
2016
 
2017
 
2016
Diversified Industrial
312

 
875

 
642

 
2,929

Aerospace Systems
52

 
15

 
89

 
81

Corporate general and administrative expenses

 
50

 

 
52

The charges primarily consist of severance costs related to actions taken under the Company's Simplification initiative aimed at reducing organizational and process complexity, as well as plant closures, with the majority of the charges incurred in Europe and North America. The Company believes the realignment actions will positively impact future results of operations but will not have a material effect on liquidity and sources and uses of capital.
The business realignment charges are presented in the Consolidated Statement of Income as follows:
 
Three Months Ended
 
Nine Months Ended
 
March 31,
 
March 31,
 
2017
 
2016
 
2017
 
2016
Cost of sales
$
10,342

 
$
21,628

 
$
24,968

 
$
54,559

Selling, general and administrative expenses
5,976

 
5,451

 
9,992

 
17,579

Other (income), net

 

 

 
116

As of March 31, 2017, approximately $12 million in severance payments had been made relating to charges incurred during fiscal 2017, the remainder of which are expected to be paid by March 31, 2018. Severance payments relating to prior-year actions are being made as required. Remaining severance payments related to current-year and prior-year actions of approximately $28 million are primarily reflected within the other accrued liabilities caption in the Consolidated Balance Sheet. Additional charges may be recognized in future periods related to the realignment actions described above, the timing and amount of which are not known at this time.













- 13 -




10. Equity

Changes in equity for the three months ended March 31, 2017 and 2016 are as follows:

 
Shareholders’
Equity
 
Noncontrolling
Interests
 
Total Equity
Balance at December 31, 2016
$
4,527,709

 
$
3,269

 
$
4,530,978

Net income
238,673

 
174

 
238,847

Other comprehensive income
118,311

 
301

 
118,612

Dividends paid
(88,171
)
 

 
(88,171
)
Stock incentive plan activity
(4,383
)
 

 
(4,383
)
Acquisition activity

 
1,843

 
1,843

Shares purchased at cost
(50,000
)
 

 
(50,000
)
Balance at March 31, 2017
$
4,742,139

 
$
5,587

 
$
4,747,726

 
 
 
 
 
 
 
Shareholders’
Equity
 
Noncontrolling
Interests
 
Total Equity
Balance at December 31, 2015
$
4,799,406

 
$
3,315

 
$
4,802,721

Net income
187,084

 
58

 
187,142

Other comprehensive income (loss)
159,190

 
(2
)
 
159,188

Dividends paid
(85,182
)
 

 
(85,182
)
Stock incentive plan activity
13,114

 

 
13,114

Shares purchased at cost
(50,000
)
 

 
(50,000
)
Balance at March 31, 2016
$
5,023,612

 
$
3,371

 
$
5,026,983

 
 
 
 
 
 

- 14 -




10. Equity, cont'd

Changes in equity for the nine months ended March 31, 2017 and 2016 are as follows:
 
Shareholders’
Equity
 
Noncontrolling
Interests
 
Total Equity
Balance at June 30, 2016
$
4,575,255

 
$
3,423

 
$
4,578,678

Net income
690,107

 
378

 
690,485

Other comprehensive income (loss)
(65,068
)
 
281

 
(64,787
)
Dividends paid
(256,823
)
 
(338
)
 
(257,161
)
Stock incentive plan activity
13,360

 

 
13,360

Acquisition activity

 
1,843

 
1,843

Shares purchased at cost
(214,692
)
 

 
(214,692
)
Balance at March 31, 2017
$
4,742,139

 
$
5,587

 
$
4,747,726

 
 
 
 
 
 
 
Shareholders’
Equity
 
Noncontrolling
Interests
 
Total Equity
Balance at June 30, 2015
$
5,104,287

 
$
3,282

 
$
5,107,569

Net income
565,044

 
261

 
565,305

Other comprehensive income (loss)
13,080

 
(133
)
 
12,947

Dividends paid
(256,851
)
 
(39
)
 
(256,890
)
Stock incentive plan activity
48,052

 

 
48,052

Shares purchased at cost
(450,000
)
 

 
(450,000
)
Balance at March 31, 2016
$
5,023,612

 
$
3,371

 
$
5,026,983


Changes in accumulated other comprehensive (loss) in shareholders' equity by component for the nine months ended March 31, 2017 and 2016 are as follows:

 
Foreign Currency Translation Adjustment and Other
 
Retirement Benefit Plans
 
Total
Balance at June 30, 2016
$
(844,121
)
 
$
(1,383,644
)
 
$
(2,227,765
)
Other comprehensive (loss) before reclassifications
(169,883
)
 

 
(169,883
)
Amounts reclassified from accumulated other comprehensive (loss)
(1,032
)
 
105,847

 
104,815

Balance at March 31, 2017
$
(1,015,036
)
 
$
(1,277,797
)
 
$
(2,292,833
)

 
Foreign Currency Translation Adjustment and Other
 
Retirement Benefit Plans
 
Total
Balance at June 30, 2015
$
(641,018
)
 
$
(1,097,600
)
 
$
(1,738,618
)
Other comprehensive (loss) before reclassifications
(71,989
)
 

 
(71,989
)
Amounts reclassified from accumulated other comprehensive (loss)
(470
)
 
85,539

 
85,069

Balance at March 31, 2016
$
(713,477
)
 
$
(1,012,061
)
 
$
(1,725,538
)

- 15 -





10. Equity, cont'd

Significant reclassifications out of accumulated other comprehensive (loss) in shareholders' equity for the three and nine months ended March 31, 2017 and 2016 are as follows:
Details about Accumulated Other Comprehensive (Loss) Components
 
Income (Expense) Reclassified from Accumulated Other Comprehensive (Loss)
 
Consolidated Statement of Income Classification
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
March 31, 2017
 
March 31, 2017
 
 
Retirement benefit plans
 
 
 
 
 
 
Amortization of prior service cost and initial net obligation
 
$
(1,735
)
 
$
(5,202
)
 
See Note 12
Recognized actuarial loss
 
(53,727
)
 
(159,946
)
 
See Note 12
Total before tax
 
(55,462
)
 
(165,148
)
 

Tax benefit
 
19,950

 
59,301

 
Income taxes
Net of tax
 
$
(35,512
)
 
$
(105,847
)
 



Details about Accumulated Other Comprehensive (Loss) Components
 
Income (Expense) Reclassified from Accumulated Other Comprehensive (Loss)
 
Consolidated Statement of Income Classification
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
March 31, 2016
 
March 31, 2016
 
 
Retirement benefit plans
 
 
 
 
 
 
Amortization of prior service cost and initial net obligation
 
$
(1,842
)
 
$
(5,528
)
 
See Note 12
Recognized actuarial loss
 
(42,714
)
 
(128,538
)
 
See Note 12
Total before tax
 
(44,556
)
 
(134,066
)
 
 
Tax benefit
 
16,134

 
48,527

 
Income taxes
Net of tax
 
$
(28,422
)
 
$
(85,539
)
 
 

11. Goodwill and intangible assets
The changes in the carrying amount of goodwill for the nine months ended March 31, 2017 are as follows:
 
 
Diversified Industrial
Segment
 
Aerospace
Systems
Segment
 
Total
Balance at June 30, 2016
$
2,804,403

 
$
98,634

 
$
2,903,037

Acquisitions
2,677,271

 

 
2,677,271

Divestitures
(22,618
)
 

 
(22,618
)
Foreign currency translation and other
(48,966
)
 
(12
)
 
(48,978
)
Balance at March 31, 2017
$
5,410,090

 
$
98,622

 
$
5,508,712

Acquisitions represent the original goodwill allocation and final adjustments to purchase price allocations during the measurement period subsequent to the applicable acquisition dates (see Note 3 for further discussion).
Divestitures primarily represent goodwill associated with the sale of a product line during the first nine months of fiscal 2017 (see Note 3 for further discussion).


- 16 -




11. Goodwill and intangible assets, cont'd
Intangible assets are amortized on the straight-line method over their legal or estimated useful lives. The following summarizes the gross carrying value and accumulated amortization for each major category of intangible assets:
 
 
March 31, 2017
 
June 30, 2016
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Gross Carrying
Amount
 
Accumulated
Amortization
Patents
$
258,979

 
$
94,826

 
$
150,914

 
$
95,961

Trademarks
588,978

 
188,117

 
340,805

 
179,156

Customer lists and other
2,477,945

 
704,595

 
1,362,521

 
656,552

Total
$
3,325,902

 
$
987,538

 
$
1,854,240

 
$
931,669

Total intangible amortization expense for the nine months ended March 31, 2017 was $87,724. The estimated amortization expense for the five years ending June 30, 2017 through 2021 is $138,099, $220,921, $214,725, $207,500 and $199,525, respectively.
The following is a summary of the identifiable intangible assets acquired as part of the Clarcor acquisition, the fair values of which were determined using an income valuation approach. The weighted-average life is based on the Company's historical experience. The fair value of the identifiable intangible assets is subject to change upon completion of the final valuation, some of which may be material.

 
Fair value
 
Weighted-Average Life
Patents
$
113,760

 
18 years
Trademarks
251,600

 
12 years
Customer lists and other
1,131,920

 
11 years
Total
$
1,497,280

 
12 years
Intangible assets are evaluated for impairment whenever events or circumstances indicate that the undiscounted net cash flows to be generated by their use over their expected useful lives and eventual disposition may be less than their net carrying value. No such events or circumstances occurred during the nine months ended March 31, 2017.


12. Retirement benefits
Net pension benefit cost recognized included the following components:
 
 
Three Months Ended
 
Nine Months Ended
 
March 31,
 
March 31,
 
2017
 
2016
 
2017
 
2016
Service cost
$
23,632

 
$
23,680

 
$
70,971

 
$
71,199

Interest cost
31,734

 
45,138

 
93,202

 
136,872

Special termination cost

 

 

 
7,088

Expected return on plan assets
(59,480
)
 
(55,418
)
 
(177,277
)
 
(166,633
)
Amortization of prior service cost
1,702

 
1,868

 
5,101

 
5,606

Amortization of net actuarial loss
52,805

 
42,573

 
158,557

 
127,841

Amortization of initial net obligation
4

 
4

 
14

 
12

Net pension benefit cost
$
50,397

 
$
57,845

 
$
150,568

 
$
181,985

During the three months ended March 31, 2017 and 2016, the Company recognized $1,034 and $1,001, respectively, in expense related to other postretirement benefits. During the nine months ended March 31, 2017 and 2016, the Company recognized $3,266 and $7,696, respectively, in expense related to other postretirement benefits.


- 17 -




12. Retirement benefits, cont'd
During the nine months ended March 31, 2016, the Company provided enhanced retirement benefits in connection with a plant closure, which resulted in an increase in net pension benefit cost of $7,088 and an increase in expense related to other postretirement benefits of $4,521.
Beginning in fiscal 2017, the Company changed the method used to estimate the service and interest cost components of net periodic pension and other postretirement benefit costs. The new method uses the spot yield curve approach to estimate the service and interest costs by applying the specific spot rates along the yield curve used to determine the benefit obligations to relevant cash outflows. Previously, these costs were determined using a single-weighted average discount rate. The change does not affect the measurement of the Company's benefit obligations. The new method provides a more precise measure of service and interest costs by improving the correlation between projected benefit cash flows and the discrete spot yield curve rates and is accounted for as a change in estimate prospectively beginning the first quarter of fiscal 2017. As a result of the method change, net pension benefit cost for the current-year quarter and first nine months of fiscal 2017 is lower than the prior-year quarter and first nine months of fiscal 2016 by approximately $8 million and $25 million, respectively,


13. Debt

During the current-year quarter, the Company issued the following long-term debt:
 
 
Notional Amount

Senior notes 3.25%, due 2027
 
$
700,000

Senior notes 4.10%, due 2047
 
$
600,000

Term loan Libor plus 100 bps, due 2020
 
$
500,000

Senior notes 1.125%, due 2025
 
700,000

Term loan Libor plus 150 bps, due 2022
 
100,000


Interest payments are paid semi-annually for the Senior notes due 2027 and 2047, paid annually for the Senior notes due 2025 and are generally paid quarterly for the term loans. Total debt issuance costs were approximately $27,515 and will be amortized over the respective debt terms. The Company primarily used the net proceeds from all debt issuances for the Clarcor acquisition (see Note 3 for further discussion).

14. Income taxes
The Company and its subsidiaries file income tax returns in the United States and in various foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities throughout the world. The Company is open to assessment of its federal income tax returns by the U.S. Internal Revenue Service for fiscal years after 2011, and its state and local returns for fiscal years after 2011. The Company is also open to assessment for foreign jurisdictions for fiscal years after 2007. Unrecognized tax benefits reflect the difference between positions taken or expected to be taken on income tax returns and the amounts reflected in the financial statements.
As of March 31, 2017, the Company had gross unrecognized tax benefits of $141,931. The total amount of gross unrecognized tax benefits that, if recognized, would affect the effective tax rate was $85,293. If recognized, a significant portion of the gross unrecognized tax benefits would be offset against an asset currently recorded in the Consolidated Balance Sheet. The accrued interest related to the gross unrecognized tax benefits, excluded from the amounts above, is $14,770. It is reasonably possible that within the next 12 months the amount of gross unrecognized tax benefits could be reduced by up to approximately $100,000 as a result of the revaluation of existing uncertain tax positions arising from developments in the examination process or the closure of tax statutes. Any increase in the amount of gross unrecognized tax benefits within the next 12 months is expected to be insignificant.

- 18 -




15. Financial instruments
The Company’s financial instruments consist primarily of cash and cash equivalents, marketable securities and other investments, accounts receivable and long-term investments as well as obligations under accounts payable, trade, notes payable and long-term debt. Due to their short-term nature, the carrying values for cash and cash equivalents, accounts receivable, accounts payable, trade and notes payable approximate fair value.
Marketable securities and other investments include deposits, which are recorded at cost, and investments classified as available-for-sale, which are recorded at fair value with unrealized gains and losses recorded in accumulated other comprehensive (loss). Gross unrealized gains and losses were not material as of March 31, 2017 and June 30, 2016. All of the available-for-sale investments in an unrealized loss position have been in that position for less than 12 months. There were no facts or circumstances that indicated the unrealized losses were other than temporary.
The contractual maturities of available-for-sale investments at March 31, 2017 and June 30, 2016 are as follows:
 
March 31, 2017
 
June 30, 2016
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Less than one year
$
325

 
$
327

 
$
29,960

 
$
29,990

One to three years
7,870

 
7,917

 
144,100

 
144,625

Above three years
2,018

 
2,024

 
34,276

 
34,275

Actual maturities of available-for-sale investments may differ from their contractual maturities as the Company has the ability to liquidate the available-for-sale investments after giving appropriate notice to the issuer.
The carrying value of long-term debt and estimated fair value of long-term debt are as follows:
 
 
March 31,
2017
 
June 30,
2016
Carrying value of long-term debt
 
$
5,327,952

 
$
2,733,140

Estimated fair value of long-term debt
 
5,517,317

 
3,133,989

The fair value of long-term debt was determined based on observable market prices in the active market in which the security is traded and is classified within level 2 of the fair value hierarchy.
The Company utilizes derivative and non-derivative financial instruments, including forward exchange contracts, costless collar contracts, cross-currency swap contracts and certain foreign denominated debt designated as net investment hedges, to manage foreign currency transaction and translation risk. The derivative financial instrument contracts are with major investment grade financial institutions and the Company does not anticipate any material non-performance by any of the counterparties. The Company does not hold or issue derivative financial instruments for trading purposes.
The Company’s Senior Notes due 2025, Euro bonds, which matured in November 2015, and Japanese Yen credit facility, which matured in March 2017, have each been designated as a hedge of the Company’s net investment in certain foreign subsidiaries. The translation of the Senior Notes due 2025, Euro bonds and Japanese Yen credit facility into U.S. dollars is recorded in accumulated other comprehensive (loss) and remains there until the underlying net investment is sold or substantially liquidated.
Derivative financial instruments are recognized on the Consolidated Balance Sheet as either assets or liabilities and are measured at fair value.


- 19 -




15. Financial instruments, cont'd
The following summarizes the location and fair value of significant derivative financial instruments reported in the Consolidated Balance Sheet as of March 31, 2017 and June 30, 2016:

 
 
Balance Sheet Caption
 
March 31,
2017
 
June 30,
2016
Net investment hedges
 
 
 
 
 
 
Cross-currency swap contracts
 
Other assets
 
$
30,775

 
$
24,771

Cash flow hedges
 
 
 
 
 
 
Costless collar contracts
 
Non-trade and notes receivable
 
670

 

Costless collar contracts
 
Other accrued liabilities
 
5,786

 
8,368


The cross-currency swap and costless collar contracts are reflected on a gross basis in the Consolidated Balance Sheet. The Company has not entered into any master netting arrangements.
Gains or losses on derivatives that are not hedges are adjusted to fair value through the cost of sales caption in the Consolidated Statement of Income. Gains or losses on derivatives that are hedges are adjusted to fair value through accumulated other comprehensive (loss) in the Consolidated Balance Sheet until the hedged item is recognized in earnings.
Cross-currency swap contracts have been designated as hedging instruments. Costless collar contracts have not been designated as hedging instruments and are considered to be economic hedges of forecasted transactions.
Gains (losses) on derivative financial instruments that were recorded in the Consolidated Statement of Income for the three and nine months ended March 31, 2017 and 2016 were not material.

Gains (losses) on derivative and non-derivative financial instruments that were recorded in accumulated other comprehensive (loss) in the Consolidated Balance Sheet are as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
March 31,
 
March 31,
 
2017
 
2016
 
2017
 
2016
Cross-currency swap contracts
$
(1,278
)
 
$
10,934

 
$
3,741

 
$
3,140

Foreign denominated debt
(11,009
)
 
(2,131
)
 
(11,005
)
 
2,202

There was no ineffectiveness of the cross-currency swap contracts or foreign denominated debt, nor was any portion of these financial instruments excluded from the effectiveness testing, during the nine months ended March 31, 2017 and 2016.


- 20 -




15. Financial instruments, cont'd
A summary of financial assets and liabilities that were measured at fair value on a recurring basis at March 31, 2017 and June 30, 2016 are as follows:
 
 
 
 
Quoted Prices

 
Significant Other

 
Significant

 
 
Fair

 
In Active

 
Observable

 
Unobservable

 
 
Value at

 
Markets

 
Inputs

 
Inputs

 
 
March 31, 2017

 
(Level 1)

 
(Level 2)

 
(Level 3)

Assets:
 
 
 
 
 
 
 
 
Equity securities
 
$
2,302

 
$
2,302

 
$

 
$

Corporate bonds
 
5,587

 
5,587

 

 

Asset-backed and mortgage-backed securities
 
4,680

 

 
4,680

 

Derivatives
 
34,799

 

 
34,799

 

Investments measured at net asset value
 
6,599

 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Derivatives
 
9,600

 

 
9,600

 


 
 
 
 
Quoted Prices

 
Significant Other

 
Significant

 
 
Fair

 
In Active

 
Observable

 
Unobservable

 
 
Value at

 
Markets

 
Inputs

 
Inputs

 
 
June 30, 2016

 
(Level 1)

 
(Level 2)

 
(Level 3)

Assets:
 
 
 
 
 
 
 
 
Equity securities
 
$
1,296

 
$
1,296

 
$

 
$

Government bonds
 
15,764

 
15,764

 

 

Corporate bonds
 
184,380

 
184,380

 

 

Asset-backed and mortgage-backed securities
 
8,746

 

 
8,746

 

Derivatives
 
25,303

 

 
25,303

 

Investments measured at net asset value
 
361,770

 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Derivatives
 
13,028

 

 
13,028

 

The fair values of the equity securities, government bonds, corporate bonds and asset-backed and mortgage-backed securities are determined using the closing market price reported in the active market in which the fund is traded or the market price for similar assets that are traded in an active market.
Derivatives consist of forward exchange, costless collar and cross-currency swap contracts, the fair values of which are calculated using market observable inputs including both spot and forward prices for the same underlying currencies. The calculation of fair value of the cross-currency swap contracts also utilizes a present value cash flow model that has been adjusted to reflect the credit risk of either the Company or the counterparty.
Investments measured at net asset value primarily consist of investments in fixed income mutual funds, which are measured at fair value using the net asset value per share practical expedient. These investments have not been categorized in the fair value hierarchy. The Company has the ability to liquidate these investments after giving appropriate notice to the issuer.
The primary investment objective for all investments is the preservation of principal and liquidity while earning income.

There are no other financial assets or financial liabilities that are marked to market on a recurring basis. Fair values are transferred between levels of the fair value hierarchy when facts and circumstances indicate that a change in the method of estimating the fair value of a financial asset or financial liability is warranted.




- 21 -



PARKER-HANNIFIN CORPORATION
FORM 10-Q
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2017
AND COMPARABLE PERIODS ENDED MARCH 31, 2016
OVERVIEW
The Company is a leading worldwide diversified manufacturer of motion and control technologies and systems, providing precision engineered solutions for a wide variety of mobile, industrial and aerospace markets.
The Company’s order rates provide a near-term perspective of the Company’s outlook particularly when viewed in the context of prior and future order rates. The Company publishes its order rates on a quarterly basis. The lead time between the time an order is received and revenue is realized generally ranges from one day to 12 weeks for mobile and industrial orders and from one day to 18 months for aerospace orders. The Company believes the leading economic indicators of these markets that have a strong correlation to the Company’s future order rates are as follows:

Purchasing Managers Index (PMI) on manufacturing activity specific to regions around the world with respect to most mobile and industrial markets;
Global aircraft miles flown and global revenue passenger miles for commercial aerospace markets and Department of Defense spending for military aerospace markets; and
Housing starts with respect to the North American residential air conditioning market and certain mobile construction markets.
A PMI above 50 indicates that the manufacturing activity specific to a region of the world in the mobile and industrial markets is expanding. A PMI below 50 indicates the opposite. Recent PMI levels for some regions around the world were as follows:
 
March 31, 2017

 
December 31, 2016

 
June 30, 2016

United States
57.2

 
54.5

 
52.8

Eurozone countries
56.2

 
54.9

 
52.8

China
51.2

 
51.9

 
48.6

Brazil
49.6

 
45.2

 
43.2

Global aircraft miles flown increased by approximately five percent and revenue passenger miles increased approximately seven percent from their comparable fiscal 2016 levels. The Company anticipates that U.S. Department of Defense spending with regard to appropriations and operations and maintenance for the U.S. Government’s fiscal year 2017 will be approximately seven percent higher than the comparable fiscal 2016 level.
Housing starts in March 2017 were approximately nine percent higher than housing starts in March 2016 and approximately two percent higher than housing starts in June 2016.
The Company believes many opportunities for profitable growth are available. The Company intends to focus primarily on business opportunities in the areas of energy, water, food, environment, defense, life sciences, infrastructure and transportation. The Company believes it can meet its strategic objectives by:

Serving the customer and continuously enhancing its experience with the Company;
Successfully executing its Win Strategy initiatives relating to premier customer service, financial performance and profitable growth;
Maintaining its decentralized division and sales company structure;
Fostering a safety first and entrepreneurial culture;
Engineering innovative systems and products to provide superior customer value through improved service, efficiency and productivity;
Delivering products, systems and services that have demonstrable savings to customers and are priced by the value they deliver;
Acquiring strategic businesses;
Organizing around targeted regions, technologies and markets;

- 22 -



Driving efficiency by implementing lean enterprise principles; and
Creating a culture of empowerment through its values, inclusion and diversity, accountability and teamwork.
Acquisitions will be considered from time to time to the extent there is a strong strategic fit, while at the same time, maintaining the Company’s strong financial position. In addition, the Company will continue to assess its existing businesses and initiate efforts to divest businesses that are not considered to be a good long-term strategic fit for the Company. Future business divestitures could have a negative effect on the Company’s results of operations. See Note 3 to the Consolidated Financial Statements for further discussion of acquisitions and divestitures.
The discussion below is structured to separately discuss the Consolidated Statement of Income, Results by Business Segment, Consolidated Balance Sheet and Consolidated Statement of Cash Flows.
CONSOLIDATED STATEMENT OF INCOME
 
 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
(dollars in millions)
 
2017
 
2016
 
2017
 
2016
Net sales
 
$
3,119.1

 
$
2,828.7

 
$
8,533.1

 
$
8,403.6

Gross profit
 
$
735.3

 
$
619.3

 
$
1,998.8

 
$
1,852.7

Gross profit margin
 
23.6
%
 
21.9
%
 
23.4
%
 
22.0
%
Selling, general and administrative expenses
 
$
392.0

 
$
335.9

 
$
1,051.6

 
$
1,020.8

Selling, general and administrative expenses, as a percent of sales
 
12.6
%
 
11.9
%
 
12.3
%
 
12.1
%
Interest expense
 
$
42.1

 
$
33.7

 
$
109.6

 
$
103.8

Other (income), net
 
$
(13.8
)
 
$
(23.4
)
 
$
(90.5
)
 
$
(50.4
)
Effective tax rate
 
24.2
%
 
31.4
%
 
25.6
%
 
27.4
%
Net income
 
$
238.8

 
$
187.1

 
$
690.5

 
$
565.3

Net income, as a percent of sales
 
7.7
%
 
6.6
%
 
8.1
%
 
6.7
%

Net sales for the current-year quarter increased from the prior-year quarter primarily due to higher sales in both the Diversified Industrial and Aerospace Systems Segments. Net sales for the first nine months of fiscal 2017 increased primarily due to higher sales in the Diversified Industrial International businesses and the Aerospace Systems Segment. The effect of currency rate changes decreased net sales by approximately $29 million in the current-year quarter ($25 million of which was attributable to the Diversified Industrial International businesses) and $64 million for the first nine months of fiscal 2017 ($50 million of which was attributable to the Diversified Industrial International businesses). Acquisitions made in the last 12 months contributed approximately $159 million and $176 million in sales in the current-year quarter and first nine months of fiscal 2017, respectively.
Gross profit margin increased in the current-year quarter and first nine months of fiscal 2017 primarily due to lower operating expenses resulting from the Company's Simplification initiative and prior-year restructuring activities, primarily experienced in the Diversified Industrial Segment, partially offset by lower margins in the Aerospace Systems Segment. Foreign currency transaction (loss) (primarily relating to cash, marketable securities and other investments and intercompany transactions) included in cost of sales for the current-year quarter and prior-year quarter were $(7.1) million and $(17.5) million, respectively, and $(6.2) million and $(25.7) million for the first nine months of fiscal 2017 and 2016, respectively. Pension cost included in cost of sales for the current-year quarter and prior-year quarter were $34.6 million and $40.3 million, respectively, and $101.8 million and $128.1 million for the first nine months of fiscal 2017 and 2016, respectively. Cost of sales for the current-year quarter and prior-year quarter also included business realignment charges of $10.3 million and $21.6 million, respectively, and $25.0 million and $54.6 million for the first nine months of fiscal 2017 and 2016, respectively.
Selling, general and administrative expenses increased for the current-year quarter and first nine months of fiscal 2017 primarily due to higher amortization expense resulting from current-year acquisitions and higher acquisition expenses partially offset by lower expenses resulting from the Company's Simplification initiative, lower professional services expenses and lower expenses associated with the Company's deferred compensation program. Pension cost included in selling, general and administrative expenses for the current-year quarter and prior-year quarter were $16.4 million and $18.2 million, respectively, and $48.6 million and $55.8 million for the first nine months of fiscal 2017 and 2016, respectively. Business realignment charges included in selling, general and administrative expenses were $6.0 million and $5.5 million for the current-year quarter and prior-year quarter, respectively, and $10.0 million and $17.6 million for the first nine months of fiscal 2017 and 2016, respectively.

- 23 -



Interest expense for the current-year quarter increased primarily due to higher weighted-average borrowings partially offset by lower weighted-average interest rates. Interest expense increased for the first nine months of fiscal 2017 primarily due to higher weighted-average borrowings and higher weighted-average interest rates.
Other (income), net in the current-year quarter and first nine months of fiscal 2017 includes income of $10.9 million and $30.0 million, respectively, related to equity method investments compared to $6.1 million and $16.7 million for the prior-year quarter and first nine months of fiscal 2016, respectively. Other (income), net includes a gain related to the sale of a product line of approximately $45 million in first nine months of fiscal 2017 and $11.5 million in the prior-year quarter and first nine months of fiscal 2016.
Effective tax rate for the current-year quarter and first nine months of fiscal 2017 was lower than the comparable prior-year periods primarily due to a net decrease in estimated tax related to international activities and a net increase in discrete tax benefits. The Company expects the effective tax rate for fiscal 2017 will be approximately 27.0 percent.
RESULTS BY BUSINESS SEGMENT
Diversified Industrial Segment
 
 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
(dollars in millions)
 
2017
 
2016
 
2017
 
2016
Net sales
 
 
 
 
 
 
 
 
North America
 
$
1,413.3

 
$
1,247.9

 
$
3,701.3

 
$
3,695.0

International
 
1,128.9

 
1,019.8

 
3,149.8

 
3,050.7

Operating income
 
 
 
 
 
 
 
 
North America
 
227.4

 
202.2

 
612.0

 
568.5

International
 
$
153.0

 
$
105.2

 
$
417.7

 
$
329.8

Operating margin
 
 
 
 
 
 
 
 
North America
 
16.1
%
 
16.2
%
 
16.5
%
 
15.4
%
International
 
13.6
%
 
10.3
%
 
13.3
%
 
10.8
%
Backlog
 
$
1,969.1

 
$
1,518.6

 
$
1,969.1

 
$
1,518.6























- 24 -



The Diversified Industrial Segment operations experienced the following percentage changes in net sales in the current-year period versus the comparable prior-year period:
 
 
 
Period Ending March 31,
 
 
Three Months
 
Nine Months
Diversified Industrial North America – as reported
 
13.3
 %
 
0.2
 %
Acquisitions
 
9.7
 %
 
3.3
 %
Currency
 
(0.2
)%
 
(0.4
)%
Diversified Industrial North America – without acquisitions and currency
 
3.8
 %
 
(2.7
)%
 
 
 
 
 
Diversified Industrial International – as reported
 
10.7
 %
 
3.2
 %
Acquisitions
 
3.7
 %
 
1.8
 %
Currency
 
(2.5
)%
 
(1.6
)%
Diversified Industrial International – without acquisitions and currency
 
9.5
 %
 
3.0
 %
 
 
 
 
 
Total Diversified Industrial Segment – as reported
 
12.1
 %
 
1.6
 %
Acquisitions
 
7.0
 %
 
2.6
 %
Currency
 
(1.3
)%
 
(0.9
)%
Total Diversified Industrial Segment – without acquisitions and currency
 
6.4
 %
 
(0.1
)%
The above presentation reconciles the percentage changes in net sales of the Diversified Industrial Segment reported in accordance with U.S. GAAP to percentage changes in net sales adjusted to remove the effects of acquisitions made within the prior four fiscal quarters as well as the effects of currency exchange rates (a non-GAAP measure). The effects of acquisitions and currency exchange rates are removed to allow investors and the Company to meaningfully evaluate the percentage changes in net sales on a comparable basis from period to period.
Excluding the effects of acquisitions and changes in currency exchange rates, Diversified Industrial North American sales increased for the current-year quarter primarily due to higher demand from distributors and end-users in the oil and gas and construction equipment markets, partially offset by lower demand from end-users in the car and light truck, heavy-duty truck and life sciences markets. Sales decreased for the first nine months of fiscal 2017 primarily due to lower demand from end-users in most markets, partially offset by higher demand from distributors. The markets that experienced the largest decline in end-user demand for the first nine months of 2017 were the heavy-duty truck, car and light truck, oil and gas, life sciences, construction equipment and general industrial machinery markets.
Excluding the effects of acquisitions and changes in currency exchange rates, Diversified Industrial International sales for the current-year quarter increased from the prior-year quarter primarily due to higher volume in all regions. For the first nine months of fiscal 2017, Diversified Industrial International sales increased compared to the first nine months of fiscal 2016 primarily due to higher volume in the Asia Pacific and Latin America regions, partially offset by lower volume in Europe. Within the Asia Pacific and Latin America regions, higher demand was experienced from distributors and end-users in the construction equipment and semiconductor markets during the current-year quarter and first nine months of fiscal 2017. The increase in current-year quarter sales within Europe reflects higher demand from distributors and end-users in the construction equipment market, partially offset by a decrease in demand in the industrial machinery and marine markets. Sales for the first nine months of fiscal 2017 within Europe were lower primarily due to lower demand from distributors and end-users in the industrial machinery, oil and gas and marine markets, partially offset by higher demand in the construction equipment market.
Operating margins in the Diversified Industrial North American businesses for the current-year quarter were relatively unchanged from the prior-year quarter as the impact of the higher sales volume and lower operating expenses resulting from prior-year restructuring activities and the Company's Simplification initiative were offset by acquisition-related expenses and higher amortization expense. Operating margins in the Diversified Industrial North American businesses for the first nine months of fiscal 2017 were higher than the comparable prior-year period primarily as a result of a favorable product mix and lower operating expenses resulting from prior-year restructuring activities and the Company's Simplification initiative more than offsetting the impact of the lower sales volume and acquisition-related expenses and higher amortization expense.


- 25 -



The increase in operating margins in the Diversified Industrial International businesses for the current-year quarter and first nine months of fiscal 2017 was primarily due to the higher sales volume, lower operating expenses resulting from prior-year restructuring activities and the Company's Simplification initiative, resulting in manufacturing efficiencies.

The following business realignment expenses are included in Diversified Industrial North American and Diversified Industrial International operating income:
 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
(dollars in millions)
 
2017
 
2016
 
2017
 
2016
Diversified Industrial North America
 
$
4.0

 
$
8.5

 
$
10.0

 
$
25.5

Diversified Industrial International
 
10.6

 
15.9

 
22.1

 
41.9


The business realignment charges primarily consist of severance costs related to actions taken under the Company's Simplification initiative implemented by operating units throughout the world as well as plant closures. The majority of the Diversified Industrial International business realignment charges were incurred in Europe. The Company anticipates that cost savings realized from the work force reduction measures taken during the first nine months of fiscal 2017 will increase annual operating income in the Diversified Industrial North American businesses by one percent in fiscal 2017 and two percent in fiscal 2018 and will increase operating income in the Diversified Industrial International businesses by one percent in fiscal 2017 and three percent in fiscal 2018. The Company expects to continue to take the actions necessary to structure appropriately the operations of the Diversified Industrial Segment. Such actions are expected to result in approximately $12 million of additional business realignment charges in the remainder of fiscal 2017.
Diversified Industrial Segment backlog increased from the prior-year quarter and the June 30, 2016 amount of $1,455.3 million as orders exceeded shipments in both the North American and International businesses. Backlog from current-year acquisitions also contributed to the increase in backlog, the majority of which is in the North American businesses. Within the International businesses, backlog in Europe represented approximately 21 percent and 22 percent of the increase from the prior-year quarter and the June 30, 2016 amount, respectively, and the Asia Pacific region represented approximately 16 percent and 13 percent of the increase from the prior-year quarter and the June 30, 2016 amount, respectively. Backlog consists of written firm orders from a customer to deliver products and, in the case of blanket purchase orders, only includes the portion of the order for which a schedule or release date has been agreed to with the customer. The dollar value of backlog is equal to the amount that is expected to be billed to the customer and reported as a sale. The Company anticipates Diversified Industrial North American sales for fiscal 2017 will increase between seven percent and nine percent from their fiscal 2016 level and Diversified Industrial International sales for fiscal 2017 will increase between five percent and seven percent from their fiscal 2016 level. Diversified Industrial North American operating margins in fiscal 2017 are expected to range from 16.1 percent to 16.3 percent and Diversified Industrial International operating margins in fiscal 2017 are expected to range from 13.2 percent to 13.4 percent. These sales and operating margin amounts include the contribution from current-year acquisitions.
Aerospace Systems Segment 
 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
(dollars in millions)
 
2017
 
2016
 
2017
 
2016
Net sales
 
$
577.0

 
$
561.0

 
$
1,682.0

 
$
1,657.9

Operating income
 
$
80.0

 
$
84.2

 
$
225.8

 
$
240.0

Operating margin
 
13.9
%
 
15.0
%
 
13.4
%
 
14.5
%
Backlog
 
$
1,695.2

 
$
1,794.9

 
$
1,695.2

 
$
1,794.9

The increase in net sales in the Aerospace Systems Segment for the current-year quarter and first nine months of fiscal 2017 was primarily due to higher volume in the commercial and military aftermarket businesses and the military original equipment manufacturer (OEM) business, partially offset by lower volume in the commercial OEM business. The lower operating margin for the current-year quarter and first nine months of fiscal 2017 was primarily due to higher development, warranty and business realignment expenses, partially offset by higher aftermarket profitability and lower operating expenses. The absence of favorable contract settlements that occurred in the prior-year quarter and first nine of fiscal 2016 also contributed to the decline in operating margin.



- 26 -




The decrease in backlog from the prior-year quarter is due to shipments exceeding orders in the commercial and military OEM businesses, partially offset by orders exceeding shipments in the commercial and military aftermarket businesses. The decrease in backlog from the June 30, 2016 amount of $1,761.7 million was primarily due to shipments exceeding orders in the commercial and military OEM businesses, partially offset by orders exceeding shipments in the commercial and military aftermarket businesses. Backlog consists of written firm orders from a customer to deliver products and, in the case of blanket purchase orders, only includes the portion of the order for which a schedule or release date has been agreed to with the customer. The dollar value of backlog is equal to the amount that is expected to be billed to the customer and reported as a sale. For fiscal 2017, sales are expected to range from being flat to increasing two percent from the fiscal 2016 level and operating margins are expected to range from 14.4 percent to 14.6 percent. A higher concentration of commercial OEM volume in future product mix and higher than expected new product development costs could result in lower margins.
Corporate general and administrative expenses
Corporate general and administrative expenses were $45.7 million in the current-year quarter compared to $42.3 million in the comparable prior-year quarter and were $120.7 million for the first nine months of fiscal 2017 compared to $126.6 million for the first nine months of fiscal 2016. As a percent of sales, corporate general and administrative expenses were 1.5 percent in both the current-year quarter and prior-year quarter and decreased to 1.4 percent in the first nine months of fiscal 2017 from 1.5 percent in the first nine months of fiscal 2016. The primary drivers for the change in corporate general and administrative expenses between the current-year quarter and first nine months of fiscal 2017 as compared to the respective prior-year periods were higher expense associated with environmental remediation and research and development and lower net expenses associated with the Company's incentive and deferred compensation programs.

Other expense (in the Results By Business Segment) included the following:
 
(dollars in millions)
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
Expense (income)
 
2017
 
2016
 
2017
 
2016
Foreign currency transaction
 
$
7.0

 
$
17.5

 
$
6.2

 
$
25.7

Stock-based compensation
 
8.4

 
8.5

 
43.6

 
41.2