Exhibit (13) to Report
On Form 10-K for Fiscal
Year Ended June 30, 2012
By Parker-Hannifin Corporation
Forward-Looking Statements
Forward-looking statements contained in this and other written and oral reports are made based on known events and circumstances at the time of release, and as such, are subject in the future to unforeseen uncertainties and risks. All statements regarding future performance, earnings projections, events or developments are forward-looking statements. It is possible that the future performance and earnings projections of the Company, including its individual segments, may differ materially from current expectations, depending on economic conditions within its mobile, industrial and aerospace markets, and the Company's ability to maintain and achieve anticipated benefits associated with announced realignment activities, strategic initiatives to improve operating margins, actions taken to combat the effects of the current economic environment, and growth, innovation and global diversification initiatives. A change in the economic conditions in individual markets may have a particularly volatile effect on segment performance.
Among other factors which may affect future performance are:
changes in business relationships with and purchases by or from major customers, suppliers or distributors, including delays or cancellations in shipments, disputes regarding contract terms or significant changes in financial condition, changes in contract cost and revenue estimates for new development programs, and changes in product mix,
ability to identify acceptable strategic acquisition targets,
uncertainties surrounding timing, successful completion or integration of acquisitions,
ability to realize anticipated cost savings from business realignment activities,
threats associated with and efforts to combat terrorism,
uncertainties surrounding the ultimate resolution of outstanding legal proceedings, including the outcome of any appeals,
competitive market conditions and resulting effects on sales and pricing,
increases in raw material costs that cannot be recovered in product pricing,
the Company's ability to manage costs related to insurance and employee retirement and health care benefits, and
global economic factors, including manufacturing activity, air travel trends, currency exchange rates, difficulties entering new markets and general economic conditions such as inflation, deflation, interest rates and credit availability.
The Company makes these statements as of the date of the filing of its Annual Report on Form 10-K for the year ended June 30, 2012, and undertakes no obligation to update them unless otherwise required by law.


13-1



MANAGEMENT'S DISCUSSION AND ANALYSIS

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 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. The PMI at the end of fiscal 2012 for the United States, the Eurozone countries and China was 49.7, 45.1 and 48.2, respectively. The PMI for the United States, the Eurozone countries and China all sequentially decreased during fiscal 2012.
 
Global aircraft miles flown increased three percent from the comparable 2011 level and global revenue passenger miles increased four percent from the comparable 2011 level. The Company anticipates that U.S. Department of Defense spending with regards to appropriations, and operations and maintenance for the U.S. Government's fiscal year 2012 will be up slightly from the comparable fiscal 2011 level.
 
Housing starts in June 2012 were approximately 24 percent higher than housing starts in June 2011 and were approximately 16 percent higher than housing starts in March 2012.

The Company has remained focused on maintaining its financial strength by adjusting its cost structure to reflect changing demand levels, maintaining a strong balance sheet and managing its cash. The Company continues to generate substantial cash flows from operations, has controlled capital spending and has proactively managed working capital. The Company has been able to borrow needed funds at affordable interest rates and had a debt to debt-shareholders' equity ratio of 26.1 percent at June 30, 2012 compared to 24.3 percent at March 31, 2012 and 24.7 percent at June 30, 2011.

The Company believes many opportunities for growth are available. The Company intends to focus primarily on business opportunities in the areas of energy, water, agriculture, environment, defense, life sciences, infrastructure and transportation.

The Company believes it can meet its strategic objectives by:
Serving the customer;
Empowering its employees to become successful in its lean enterprise and fostering an entrepreneurial culture;
Successfully executing its Win Strategy initiatives relating to premier customer service, financial performance and profitable growth;
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;
Maintaining its decentralized division and sales company structure;
Acquiring strategic businesses;
Organizing around targeted regions, technologies and markets; and

13-2



Advancing business practices to achieve corporate sustainability goals.
During fiscal 2012, the Company completed four acquisitions and purchased the outstanding shares not previously owned by the Company in two majority-owned subsidiaries. Acquisitions will continue to 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. The Company will also continue to assess the strategic fit of its existing businesses and initiate efforts to divest businesses that are not considered to be a good long-term fit for the Company. Future business divestitures could have a negative effect on the Company's results of operations.

The discussion below is structured to separately discuss each of the financial statements presented on pages 13-12 to 13-16. All year references are to fiscal years.

Discussion of Consolidated Statement of Income

The Consolidated Statement of Income summarizes the Company's operating performance over the last three fiscal years.

(dollars in millions)
 
2012
 
2011
 
2010
Net sales
 
$
13,146

 
$
12,346

 
$
9,993

Gross profit margin
 
24.2
%
 
24.0
 %
 
21.5
%
Selling, general and administrative expenses
 
$
1,519

 
$
1,468

 
$
1,277

Selling, general and administrative expenses, as a percent of sales
 
11.6
%
 
11.9
 %
 
12.8
%
Interest expense
 
$
93

 
$
100

 
$
104

Other expense (income), net
 
1

 
(15
)
 

(Gain) loss on disposal of assets
 
(2
)
 
(8
)
 
10

Effective tax rate
 
26.7
%
 
25.2
 %
 
26.3
%
Net income attributable to common shareholders
 
$
1,152

 
$
1,049

 
$
554


Net sales in 2012 were 6.5 percent higher than 2011. The increase in sales in 2012 primarily reflects higher volume in the Industrial and Aerospace Segments. Acquisitions made in the last 12 months contributed approximately $72 million in sales in 2012. The effect of currency rate changes decreased net sales in 2012 by approximately $102 million.

Net sales in 2011 were 23.5 percent higher than 2010. The increase in sales in 2011 primarily reflects higher volume in all segments with the largest increase occurring in the Industrial Segment. Acquisitions contributed approximately $54 million in sales in 2011. The effect of currency rate changes increased net sales in 2011 by approximately $205 million.

Gross profit margin increased in 2012 primarily due to the higher sales volume in the Industrial North American businesses and the Aerospace Segment. Gross profit margin was higher in 2011 primarily due to a combination of higher sales volume, resulting in manufacturing efficiencies, as well as lower business realignment expenses recorded in 2011 as compared to 2010. Included in gross profit in 2012, 2011 and 2010 were business realignment charges of $12.7 million, $15.3 million and $43.0 million, respectively.

Selling, general and administrative expenses increased 3.5 percent in 2012 and increased 14.9 percent in 2011. The increase in 2012 was primarily due to the higher sales volume as well as higher expenses associated with the Company's incentive and deferred compensation programs. The increase in 2011 was primarily due to the higher sales volume as well as higher incentive compensation as compared to 2010.

Interest expense in 2012 decreased primarily due to lower average debt outstanding as well as lower weighted-average interest rates on commercial paper borrowings. Interest expense in 2011 decreased primarily due to lower average debt outstanding as well as the debt portfolio in 2011 having a lower average interest rate than the debt portfolio in 2010.

Other expense (income), net in 2011 included $10.9 million of income related to insurance recoveries.

(Gain) loss on disposal of assets in 2012 includes $3.7 million of gains from asset sales. (Gain) loss on disposal of assets in 2011 included income of $3.8 million related to insurance recoveries for expenses incurred related to a previously divested business, $3.8 million of expense related to asset writedowns and $7.5 million of gains from asset sales. (Gain) loss on disposal of assets in 2010 included a loss of $4.8 million resulting from the divestiture of a business.

13-3




Effective tax rate in 2012 was higher primarily due to higher taxable income in jurisdictions with higher tax rates. Effective tax rate in 2011 was lower primarily due to favorable foreign tax rate differences as well as higher research and development tax credits.

Discussion of Business Segment Information
The Business Segment information presents sales, operating income and assets on a basis that is consistent with the manner in which the Company's various businesses are managed for internal review and decision-making. See Note 1 to the Consolidated Financial Statements for a description of the Company's reportable business segments.

Industrial Segment (dollars in millions)
 
2012
 
2011
 
2010
Sales
 
 
 
 
 
North America
$
5,041

 
$
4,517

 
$
3,624

International
5,034

 
4,917

 
3,811

Operating income
 
 
 
 
 
North America
895

 
746

 
487

International
733

 
754

 
394

Operating income as a percent of sales
 
 
 
 
 
North America
17.8
%
 
16.5
%
 
13.4
%
International
14.6
%
 
15.3
%
 
10.3
%
Backlog
$
1,814

 
$
1,907

 
$
1,505

Assets
7,991

 
8,414

 
7,310

Return on average assets
19.8
%
 
19.1
%
 
11.9
%

Sales in 2012 for the Industrial North American operations increased 11.6 percent compared to an increase of 24.6 percent from 2010 to 2011. The increase in sales in 2012 and 2011 reflects higher demand from distributors and higher end-user demand in a number of markets, particularly in the heavy-duty truck, construction equipment, farm and agriculture equipment, and machine tools markets. Sales in 2012 also benefited from higher end-user demand in the oil and gas market and sales in 2011 also benefited from higher end-user demand in the mining market. Acquisitions completed within the last 12 months contributed approximately $45 million in net sales in 2012.

Sales in the Industrial International operations increased 2.4 percent in 2012 following an increase of 29.0 percent from 2010 to 2011. The increase in sales in 2012 is primarily due to higher volume experienced in most markets in Europe. Acquisitions completed within the last 12 months contributed approximately $26 million in net sales in 2012. The effect of currency rate fluctuations reduced 2012 net sales in Europe and Latin America by approximately $87 million and $24 million, respectively, and increased 2012 net sales in the Asia Pacific region by approximately $32 million. The sales increase in 2011 is primarily attributable to higher volume across most markets in all regions with the largest increase in volume experienced in Europe and Asia Pacific.

Margins in 2012 in the Industrial North American operations were higher than the prior year primarily due to the higher sales volume, resulting in manufacturing efficiencies. Industrial International margins in 2012 were lower than the prior year primarily due to operating inefficiencies resulting from the decline in the rate of sales growth between 2011 and 2012, especially in Europe and the Asia Pacific region, as well as an unfavorable product mix. Margins in the Industrial North American and Industrial International businesses were higher in 2011 primarily due to the higher sales volume resulting in manufacturing efficiencies, and a lower fixed cost structure resulting from past business realignment actions, including the incurrence of severance costs related to plant closures and general reductions in the work force.
    
Included in Industrial North American operating income in 2012, 2011 and 2010 are business realignment charges of $3.4 million, $4.2 million and $11.6 million, respectively. Included in Industrial International operating income in 2012, 2011 and 2010 are business realignment charges of $9.7 million, $11.3 million and $32.4 million, respectively. The business realignment charges consist primarily of severance costs resulting from plant closures as well as general reductions in the work force. The Company does not anticipate that cost savings realized from the work force reductions taken in the Industrial Segment during 2012 will have a material impact on future operating margins. The Company expects to continue to take actions necessary to

13-4



structure appropriately the operations of the Industrial Segment. Such actions may include the necessity to record business realignment charges in 2013.

The Company anticipates Industrial North American sales for 2013 will increase between 5.1 percent and 9.1 percent from the 2012 level and Industrial International sales for 2013 will range from a decrease of 2.0 percent to an increase of 2.0 percent from the 2012 level. Industrial North American operating margins in 2013 are expected to range from 17.5 percent to 18.1 percent and Industrial International margins are expected to range from 14.1 percent to 14.7 percent.

The decline in total Industrial Segment backlog in 2012 is primarily due to lower order rates in the Industrial International businesses, especially in Europe and the Asia Pacific region, more than offsetting higher order rates in the Industrial North American businesses. The increase in total Industrial Segment backlog in 2011 is primarily due to higher order rates in most markets in both the Industrial North American and Industrial International businesses with almost three-fourths of the increase occurring in the Industrial International businesses.

The decrease in assets in 2012 was primarily due to the effect of currency fluctuations as well as decreases in cash and cash equivalents, inventory, intangible assets, net and deferred taxes partially offset by an increase in accounts receivable, net. The increase in assets in 2011 was primarily due to the effect of currency fluctuations as well as increases in accounts receivable, net, inventory and cash and cash equivalents, partially offset by decreases in plant and equipment, net and intangible assets, net.

Aerospace Segment (dollars in millions)
    
 
2012
 
2011
 
2010
Sales
$
2,103

 
$
1,922

 
$
1,744

Operating income
290

 
247

 
208

Operating income as a percent of sales
13.8
%
 
12.9
%
 
11.9
%
Backlog
$
1,862

 
$
1,702

 
$
1,474

Assets
1,033

 
995

 
911

Return on average assets
28.6
%
 
25.9
%
 
22.8
%

Sales in 2012 increased 9.4 percent compared to an increase of 10.2 percent from 2010 to 2011. The increase in net sales in 2012 is primarily due to higher volume in both the commercial and military original equipment manufacturer (OEM) and aftermarket businesses. The increase in net sales in 2011 is primarily due to higher volume in both the commercial OEM and aftermarket businesses partially offset by lower volume in the military OEM business.

The higher margins in 2012 and 2011 were primarily due to the higher sales volume particularly in the higher margin commercial aftermarket business, partially offset by higher engineering development costs. In 2011, margins were favorably impacted by the effect of retroactive billings and contract reserve adjustments resulting from the finalization of contract price negotiations related to certain programs.

The increase in backlog in 2012 is primarily due to higher order rates in the military OEM businesses. The increase in backlog in 2011 is primarily due to higher order rates in both the commercial OEM and aftermarket businesses as well as the military OEM business.

For 2013, sales are expected to increase between 4.4 percent and 7.4 percent from the 2012 level and operating margins are expected to range from 13.8 percent to 14.1 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.

The increase in assets in 2012 was primarily due to increases in accounts receivable, net, inventory and intangible assets, net. The increase in assets in 2011 was primarily due to an increase in accounts receivable, net and inventory.



13-5




Climate & Industrial Controls Segment
(dollars in millions)
 
2012
 
2011
 
2010
Sales
$
968

 
$
990

 
$
814

Operating income
84

 
76

 
53

Operating income as a percent of sales
8.7
%
 
7.7
%
 
6.6
%
Backlog
$
160

 
$
171

 
$
162

Assets
705

 
725

 
693

Return on average assets
11.8
%
 
10.7
%
 
7.7
%

Sales in 2012 decreased 2.3 percent compared to an increase of 21.7 percent from 2010 to 2011. The decrease in sales in 2012 is primarily due to lower end-user demand in the commercial refrigeration and residential air conditioning markets, partially offset by an increase in volume in the automotive and heavy-duty truck markets. The increase in sales in 2011 is primarily due to higher end-user demand in the heavy-duty truck, automotive and commercial refrigeration markets. Margins in 2012 were higher primarily due to the impact of spending control efforts and lower material costs more than offsetting the impact of the lower sales volume and an unfavorable product mix. Margins in 2011 were higher primarily due to the higher sales volume, favorable product mix and benefits from past business realignment actions, including plant closures, but were adversely affected by higher material costs as well as operating inefficiencies, which primarily included overtime and premium freight.

Included in operating income are business realignment charges in 2012 and 2010 of $1.3 million and $3.9 million, respectively. The Company expects to continue to take actions necessary to structure appropriately the operations of the Climate & Industrial Controls Segment. Such actions may include the necessity to record business realignment charges in 2013.

The Company anticipates sales in 2013 will increase between 2.1 percent and 6.2 percent from the 2012 level and operating margins are expected to range from 10.0 percent to 10.6 percent.

The decrease in assets in 2012 was primarily due to the effect of currency fluctuations as well as decreases in inventory, plant and equipment, net, and intangible assets, net. The increase in assets in 2011 was primarily due to the effect of currency fluctuations.

Corporate assets increased 91.3 percent in 2012 compared to a decrease of 24.5 percent from 2010 to 2011. The change in Corporate assets in 2012 and 2011 was primarily due to the effect of currency fluctuations as well as fluctuations in the amount of cash and cash equivalents and deferred taxes.

Discussion of Consolidated Balance Sheet
The Consolidated Balance Sheet shows the Company's financial position at year-end, compared with the previous year-end. This discussion provides information to assist in assessing factors such as the Company's liquidity and financial resources.

(dollars in millions)
 
2012

 
2011

Accounts receivable, net
 
$
1,992

 
$
1,978

Inventories
 
1,401

 
1,412

Investments and other assets
 
931

 
598

Accounts payable, trade
 
1,195

 
1,174

Long-term debt
 
1,504

 
1,691

Pensions and postretirement benefits
 
1,910

 
863

Shareholders' equity
 
4,897

 
5,384

Working capital
 
$
2,012

 
$
1,914

Current ratio
 
1.8

 
1.8


Accounts receivable, net are primarily receivables due from customers for sales of product ($1,782 million at June 30, 2012 and $1,770 million at June 30, 2011). Days sales outstanding relating to trade receivables for the Company was 48 days in 2012 and 2011. The Company believes that its receivables are collectible and appropriate allowances for doubtful accounts have been recorded.

13-6




Inventories decreased slightly primarily due to a reduction in inventory levels in the Industrial International businesses more than offsetting increases in inventory levels in the Industrial North American businesses and the Aerospace Segment. The effect of currency fluctuations reduced inventories in 2012 by approximately $69 million. Days' supply of inventory on hand was 55 days in 2012 and 2011.

Investments and other assets increased primarily due to an increase in non-current deferred taxes related to pensions and postretirement benefits.

Accounts payable, trade increased primarily due to the timing of purchases and payments. Days payable outstanding increased to 42 days in 2012 from 41 days in 2011.

Long-term debt decreased primarily due to the classification of $225 million Senior Notes due in 2013 as a current liability.

Pensions and postretirement benefits increased primarily due to an increase in the under funded status of the Company's defined benefit pension plans. The change in this amount is further explained in Note 10 to the Consolidated Financial Statements.

Shareholders' equity activity during 2012 included a decrease of $455 million related to share repurchases, a decrease of $598 million related to pensions and postretirement benefits, a decrease of $74 million related to the acquisition of the remaining ownership interest in two majority-owned subsidiaries, and a decrease of $367 million related to foreign currency translation adjustments.

Discussion of Consolidated Statement of Cash Flows
The Consolidated Statement of Cash Flows reflects cash inflows and outflows from the Company's operating, investing and financing activities.

A summary of cash flows follows:
 
(dollars in millions)
 
2012

 
2011

 
2010

Cash provided by (used in):
 
 
 
 
 
 
Operating activities
 
$
1,530

 
$
1,167

 
$
1,219

Investing activities
 
(376
)
 
(245
)
 
(146
)
Financing activities
 
(823
)
 
(916
)
 
(650
)
Effect of exchange rates
 
(150
)
 
76

 
(35
)
Net increase in cash and cash equivalents
 
$
181

 
$
82

 
$
388


Cash Flows From Operating Activities increased from 2011 primarily due to an increase in net income as well as the absence of voluntary contributions made to the Company's qualified defined benefit plans in 2012. The Company made $400 million in voluntary contributions to the Company's domestic qualified defined benefit plans in 2011.

Cash Flows Used In Investing Activities increased from 2011 primarily due to an increase in acquisition activity. Refer to Note 2 of the Consolidated Financial Statements for a summary of net assets of acquired companies. Capital expenditures, as a percent of sales, was 1.7 percent in 2012 and 2011.

Cash Flows Used In Financing Activities in 2012 included the repurchase of approximately 6.4 million common shares for $455 million as compared to the repurchase of 8.0 million common shares for $693 million in 2011. During 2012, the Company purchased the outstanding shares not previously owned by the Company in two majority-owned subsidiaries. Cash flow activities in 2012 included a borrowing and a repayment, each for Japanese Yen (JPY) 6 billion (approximately $73 million), under the terms of separate credit facilities. Cash flow activities in 2011 included the issuance of $300 million aggregate principal amount of medium-term notes and a payment of approximately $257 million related to Euro bonds, which matured in November 2010.

13-7




Dividends have been paid for 248 consecutive quarters, including a yearly increase in dividends for the last 56 fiscal years. The current annual dividend rate is $1.64.

The Company's goal is to maintain no less than an "A" rating on senior debt to ensure availability and reasonable cost of external funds. As one means of achieving this objective, the Company has established a financial goal of maintaining a ratio of debt to debt-shareholders' equity of no more than 37 percent.

Debt to Debt-Shareholders' Equity Ratio (dollars in millions)
 
2012
 
2011
  Debt
 
$
1,730

 
$
1,766

  Debt & Shareholders' Equity
 
6,626

 
7,150

  Ratio
 
26.1
%
 
24.7
%

As of June 30, 2012, the Company had a line of credit totaling $1,500 million through a multi-currency revolving credit agreement with a group of banks, all of which was available at June 30, 2012. The credit agreement expires in March 2016; however, the Company has the right to request a one-year extension of the expiration date on an annual basis, which request may result in changes to the current terms and conditions of the credit agreement. A portion of the credit agreement supports the Company's commercial paper note program, which is rated A-1 by Standard & Poor's, P-1 by Moody's and F-1 by Fitch Ratings. These ratings are considered investment grade. The revolving credit agreement requires the payment of an annual facility fee, the amount of which would increase in the event the Company's credit ratings are lowered. Although a lowering of the Company's credit ratings would likely increase the cost of future debt, it would not limit the Company's ability to use the credit agreement nor would it accelerate the repayment of any outstanding borrowings.

The Company is currently authorized to sell up to $1,350 million of short-term commercial paper notes. No commercial paper notes were outstanding as of June 30, 2012 and the largest amount of commercial paper notes outstanding during the last quarter of 2012 was $815 million.

During 2012, the Company entered into a five-year JPY 6 billion credit facility. Based on the Company's rating level at June 30, 2012, the credit facility bears interest of JPY LIBOR (reset semi-annually) plus 55 basis points. Interest is paid semi-annually and any principal borrowings are due to be repaid in March 2017. The Company borrowed the full JPY 6 billion during 2012, equivalent to $73 million at the time of borrowing, and used the funds to repay the balance due on the Company's previous JPY credit facility.

The Company's credit agreements and indentures governing certain debt agreements contain various covenants, the violation of which would limit or preclude the use of the applicable agreements for future borrowings, or might accelerate the maturity of the related outstanding borrowings covered by the applicable agreements. At the Company's present rating level, the most restrictive financial covenant contained in the credit agreements and the indentures provides that the ratio of secured debt to net tangible assets be less than 10 percent. However, the Company currently does not have secured debt in its debt portfolio. The Company is in compliance with all covenants and expects to remain in compliance during the term of the credit agreements and indentures.

The Company's principal sources of liquidity are its cash flows provided from operating activities and borrowings, either from or directly supported by its line of credit. The Company's ability to borrow has not been affected by a lack of general credit availability and the Company does not foresee any impediments to borrow funds at favorable interest rates in the near future. The Company expects that its ability to generate cash from its operations and ability to borrow directly from its line of credit or sources directly supported by its line of credit should be sufficient to support working capital needs, planned growth, repayment of maturing debt, benefit plan funding, dividend payments and share repurchases in the near term.

Contractual Obligations -The total amount of gross unrecognized tax benefits, including interest, for uncertain tax positions was $113.4 million at June 30, 2012. Payment of these obligations would result from settlements with worldwide taxing authorities. Due to the difficulty in determining the timing of the settlements, these obligations are not included in the following summary of the Company's fixed contractual obligations. References to Notes are to the Notes to the Consolidated Financial Statements.


13-8



(Dollars in thousands)
 
Payments due by period
Contractual obligations
 
Total

 
Less than 1 year

 
1-3 years

 
3-5 years

 
More than 5 years

Long-term debt (Note 9)
 
$
1,729,535

 
$
225,589

 
$
552

 
$
328,394

 
$
1,175,000

Interest on long-term debt
 
866,635

 
80,604

 
146,510

 
129,743

 
509,778

Operating leases (Note 9)
 
268,710

 
82,652

 
90,893

 
37,895

 
57,270

Retirement benefits (Note 10)
 
331,897

 
285,587

 
10,308

 
10,564

 
25,438

Total
 
$
3,196,777

 
$
674,432

 
$
248,263

 
$
506,596

 
$
1,767,486


Quantitative and Qualitative Disclosures About Market Risk
The Company manages foreign currency transaction and translation risk by utilizing 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. 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.
Derivative financial instruments are recognized on the Consolidated Balance Sheet as either assets or liabilities and are measured at fair value. Further information on the fair value of these contracts is provided in Note 15 to the Consolidated Financial Statements. Gains or losses on derivatives that are not hedges are adjusted to fair value through the Consolidated Statement of Income. Gains or losses on derivatives that are hedges are adjusted to fair value through accumulated other comprehensive income (loss) in the Consolidated Balance Sheet until the hedged item is recognized in earnings. The translation of the foreign denominated debt that has been designated as a net investment hedge is recorded in accumulated other comprehensive income (loss) and remains there until the underlying net investment is sold or substantially liquidated.
The Company's debt portfolio contains variable rate debt, inherently exposing the Company to interest rate risk. The Company's objective is to maintain a 60/40 mix between fixed rate and variable rate debt thereby limiting its exposure to changes in near-term interest rates. A 100 basis point increase in near-term interest rates would increase annual interest expense on variable rate debt by approximately $6.2 million.

Off-Balance Sheet Arrangements

The Company does not have off-balance sheet arrangements.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The policies discussed below are considered by management to be more critical than other policies because their application places the most significant demands on management's judgment.

Revenue Recognition - Substantially all of the Industrial Segment and Climate & Industrial Controls Segment revenues are recognized when persuasive evidence of an arrangement exists, product has shipped and the risks and rewards of ownership have transferred or services have been rendered, the price to the customer is fixed and determinable and collectibility is reasonably assured, which is generally at the time the product is shipped. The Aerospace Segment recognizes revenues primarily using the percentage of completion method and the extent of progress toward completion is primarily measured using the units-of-delivery method. The Company estimates costs to complete long-term contracts for purposes of evaluating and establishing contract reserves. The estimation of these costs requires substantial judgment on the part of management due to the duration of the contractual agreements as well as the technical nature of the products involved. Adjustments to cost estimates are made on a consistent basis and a contract reserve is established when the estimated costs to complete a contract exceed the expected contract revenues.

Impairment of Goodwill and Long-lived Assets - Goodwill is tested for impairment, at the reporting unit level, on an annual basis and between annual tests whenever events or circumstances indicate that the carrying value of a reporting unit may exceed its fair value. For the Company, a reporting unit is one level below the operating segment level. Determining whether an impairment has occurred requires the valuation of the respective reporting unit, which the Company has consistently estimated using primarily a discounted cash flow model. The Company believes that the use of a discounted cash flow model results in the most accurate calculation of a reporting unit's fair value since the market value for a reporting unit is not readily available. The discounted cash flow analysis requires several assumptions including future sales growth and operating margin

13-9



levels as well as assumptions regarding future industry specific market conditions. Each reporting unit regularly prepares discrete operating forecasts and uses these forecasts as the basis for the assumptions used in the discounted cash flow analysis. The Company has consistently used a discount rate commensurate with its cost of capital, adjusted for inherent business risks, and has consistently used a terminal growth factor of 2.5 percent. The Company also reconciles the estimated aggregate fair value of its reporting units as derived from the discounted cash flow analysis to the Company's overall market capitalization.

The results of the Company's fiscal 2012 annual goodwill impairment test performed as of December 31, 2011 indicated that no goodwill impairment existed and all reporting units had an estimated fair value that the Company determined, from a quantitative and qualitative perspective, was significantly in excess of its carrying value.

The Company continually monitors its reporting units for impairment indicators and updates assumptions used in the most recent calculation of the fair value of a reporting unit as appropriate. The Company is unaware of any current market trends that are contrary to the assumptions made in the estimation of the fair value of any of its reporting units. If actual experience is not consistent with the assumptions made in the estimation of the fair value of the reporting units, especially assumptions regarding penetration into new markets and the recovery of the current economic environment, it is possible that the estimated fair value of certain reporting units could fall below their carrying value resulting in the necessity to conduct additional goodwill impairment tests.

Long-lived assets held for use, which primarily includes finite-lived intangible assets and property, plant and equipment, 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 are less than their carrying value. The long-term nature of these assets requires the estimation of their cash inflows and outflows several years into the future and only takes into consideration technological advances known at the time of the impairment test. During 2012, there were no events or circumstances that indicated that the carrying value of the Company's long-lived assets held for use were not recoverable.

Inventories - Inventories are valued at the lower of cost or market. Cost is determined on the last-in, first-out basis for a majority of domestic inventories and on the first-in, first-out basis for the balance of the Company's inventories. Inventories have been reduced by an allowance for obsolete inventories. The estimated allowance is based on management's review of inventories on hand compared to estimated future usage and sales. Changes in the allowance have not had a material effect on the Company's results of operations, financial position or cash flows.

Pensions and Postretirement Benefits Other Than Pensions - The annual net periodic expense and benefit obligations related to the Company's defined benefit plans are determined on an actuarial basis. This determination requires critical assumptions regarding the discount rate, long-term rate of return on plan assets, increases in compensation levels, amortization periods for actuarial gains and losses and health care cost trends.

Assumptions are determined based on Company data and appropriate market indicators, and are evaluated each year as of the plans' measurement date. Changes in the assumptions to reflect actual experience as well as the amortization of actuarial gains and losses could result in a material change in the annual net periodic expense and benefit obligations reported in the financial statements. For the Company's domestic defined benefit plans, a 25 basis point change in the assumed long-term rate of return on plan assets is estimated to have a $5 million effect on pension expense and a 25 basis point decrease in the discount rate is estimated to increase pension expense by $11 million. As of June 30, 2012, $1,622 million of past years' net actuarial losses related to the Company's domestic qualified defined benefit plans are subject to amortization in the future. These losses will generally be amortized over approximately 9 years and will negatively affect earnings in the future. Actuarial gains experienced in future years will help reduce the effect of the actuarial loss amortization.

Further information on pensions and postretirement benefits other than pensions is provided in Note 10 to the Consolidated Financial Statements.

Stock-Based Compensation - The computation of the expense associated with stock-based compensation requires the use of a valuation model. The Company currently uses a Black-Scholes option pricing model to calculate the fair value of its stock options and stock appreciation rights. The Black-Scholes model requires assumptions regarding the volatility of the Company's stock, the expected life of the stock award and the Company's dividend ratio. The Company primarily uses historical data to determine the assumptions to be used in the Black-Scholes model and has no reason to believe that future data is likely to differ materially from historical data. However, changes in the assumptions to reflect future stock price volatility, future dividend payments and future stock award exercise experience could result in a change in the assumptions used to value awards in the future and may result in a material change to the fair value calculation of stock-based awards. Further information on stock-based compensation is provided in Note 12 to the Consolidated Financial Statements.


13-10



Income Taxes - Significant judgment is required in determining the Company's income tax expense and in evaluating tax positions. Deferred income tax assets and liabilities have been recorded for the differences between the financial accounting and income tax basis of assets and liabilities. Factors considered by the Company in determining the probability of realizing deferred income tax assets include forecasted operating earnings, available tax planning strategies and the time period over which the temporary differences will reverse. The Company reviews its tax positions on a regular basis and adjusts the balances as new information becomes available. Further information on income taxes is provided in Note 4 to the Consolidated Financial Statements.

Other Loss Reserves - The Company has a number of loss exposures incurred in the ordinary course of business such as environmental claims, product liability, litigation and accounts receivable reserves. Establishing loss reserves for these matters requires management's estimate and judgment with regards to risk exposure and ultimate liability or realization. These loss reserves are reviewed periodically and adjustments are made to reflect the most recent facts and circumstances.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2011, the Financial Accounting Standards Board (FASB) issued new accounting guidance requiring an entity to present net income and other comprehensive income (OCI) in either a single continuous statement or in separate consecutive statements. The guidance does not change the items reported in OCI or when an item of OCI must be reclassified to net income. The guidance, which must be presented retrospectively, is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.
In September 2011, the FASB issued new accounting guidance related to testing goodwill for impairment. The new guidance allows an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether the entity should calculate the fair value of a reporting unit. It also expands the events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. This guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 31, 2011. The Company has not determined the effect, if any, that this new guidance will have on its goodwill impairment tests.


13-11



Consolidated Statement of Income

 
 
For the years ended June 30,
(Dollars in thousands, except per share amounts)
 
2012

 
2011

 
2010

Net Sales
 
$
13,145,942

 
$
12,345,870

 
$
9,993,166

Cost of sales
 
9,958,337

 
9,387,457

 
7,847,067

Gross profit
 
3,187,605

 
2,958,413

 
2,146,099

Selling, general and administrative expenses
 
1,519,316

 
1,467,773

 
1,277,080

Interest expense
 
92,790

 
99,704

 
103,599

Other expense (income), net
 
1,295

 
(15,075
)
 
311

(Gain) loss on disposal of assets
 
(2,494
)
 
(7,710
)
 
10,292

Income before income taxes
 
1,576,698

 
1,413,721

 
754,817

Income taxes (Note 4)
 
421,206

 
356,571

 
198,452

Net Income
 
1,155,492

 
1,057,150

 
556,365

Less: Noncontrolling interest in subsidiaries' earnings
 
3,669

 
8,020

 
2,300

Net Income Attributable to Common Shareholders
 
$
1,151,823

 
$
1,049,130

 
$
554,065

Earnings per Share Attributable to Common Shareholders (Note 5)
 
 
 
 
 
 
Basic earnings per share
 
$
7.62

 
$
6.51

 
$
3.44

Diluted earnings per share
 
$
7.45

 
$
6.37

 
$
3.40


The accompanying notes are an integral part of the financial statements.

13-12



Business Segment Information
By Industry

(Dollars in thousands)
 
2012

 
2011

 
2010

Net Sales:
 
 
 
 
 
 
Industrial:
 
 
 
 
 
 
North America
 
$
5,041,106

 
$
4,516,510

 
$
3,623,460

International
 
5,034,249

 
4,917,007

 
3,811,464

Aerospace
 
2,102,747

 
1,921,984

 
1,744,283

Climate & Industrial Controls
 
967,840

 
990,369

 
813,959

 
 
$
13,145,942

 
$
12,345,870

 
$
9,993,166

Segment Operating Income:
 
 
 
 
 
 
Industrial:
 
 
 
 
 
 
North America
 
$
895,010

 
$
745,544

 
$
487,137

International
 
733,123

 
754,222

 
394,089

Aerospace
 
290,135

 
247,126

 
208,002

Climate & Industrial Controls
 
84,274

 
76,134

 
53,452

Total segment operating income
 
2,002,542

 
1,823,026

 
1,142,680

Corporate administration
 
193,367

 
163,868

 
153,965

Income before interest expense and other
 
1,809,175

 
1,659,158

 
988,715

Interest expense
 
92,790

 
99,704

 
103,599

Other expense
 
139,687

 
145,733

 
130,299

Income before income taxes
 
$
1,576,698

 
$
1,413,721

 
$
754,817

 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
Industrial
 
$
7,991,498

 
$
8,413,552

 
$
7,309,735

Aerospace
 
1,033,449

 
995,026

 
910,740

Climate & Industrial Controls
 
704,596

 
724,966

 
692,532

Corporate (a)
 
1,440,739

 
753,261

 
997,375

 
 
$
11,170,282

 
$
10,886,805

 
$
9,910,382

 
 
 
 
 
 
 
Property Additions (b):
 
 
 
 
 
 
Industrial
 
$
211,778

 
$
147,929

 
$
95,838

Aerospace
 
19,651

 
18,012

 
21,619

Climate & Industrial Controls
 
8,094

 
8,234

 
6,040

Corporate
 
8,223

 
38,495

 
6,133

 
 
$
247,746

 
$
212,670

 
$
129,630

 
 
 
 
 
 
 
Depreciation:
 
 
 
 
 
 
Industrial
 
$
171,131

 
$
186,057

 
$
200,617

Aerospace
 
19,395

 
20,035

 
20,501

Climate & Industrial Controls
 
11,722

 
12,895

 
14,117

Corporate
 
8,260

 
10,251

 
10,060

 
 
$
210,508

 
$
229,238

 
$
245,295


13-13



(Dollars in thousands)
 
2012

 
2011

 
2010

By Geographic Area (c)
 
 
 
 
 
 
Net Sales:
 
 
 
 
 
 
North America
 
$
7,830,517

 
$
7,151,390

 
$
5,913,770

International
 
5,315,425

 
5,194,480

 
4,079,396

 
 
$
13,145,942

 
$
12,345,870

 
$
9,993,166

Long-Lived Assets:
 
 
 
 
 
 
North America
 
$
867,159

 
$
864,287

 
$
856,782

International
 
852,809

 
932,892

 
841,099

 
 
$
1,719,968

 
$
1,797,179

 
$
1,697,881


The accounting policies of the business segments are the same as those described in the Significant Accounting Policies footnote except that the business segment results are prepared on a basis that is consistent with the manner in which the Company’s management disaggregates financial information for internal review and decision-making.
(a)
Corporate assets are principally cash and cash equivalents, domestic deferred income taxes, investments, benefit plan assets, headquarters facilities and the major portion of the Company’s domestic data processing equipment.
(b)
Includes the value of net plant and equipment at the date of acquisition of acquired companies (2012 - $28,929; 2011 - $5,376; 2010 - $408)
(c)
Net sales are attributed to countries based on the location of the selling unit. North America includes the United States, Canada and Mexico. No country other than the United States represents greater than 10 percent of consolidated sales. Long-lived assets are comprised of plant and equipment based on physical location.


13-14



Consolidated Balance Sheet
(Dollars in thousands)
 
 
June 30,
 
2012

 
2011

Assets
 
 
 
 
Current Assets
 
 
 
 
Cash and cash equivalents
 
$
838,317

 
$
657,466

Accounts receivable, net (Note 1)
 
1,992,284

 
1,977,856

Inventories (Notes 1 and 6):
 
 
 
 
Finished products
 
576,291

 
584,683

Work in process
 
692,042

 
670,588

Raw materials
 
132,399

 
156,882

 
 
1,400,732

 
1,412,153

Prepaid expenses
 
137,429

 
111,934

Deferred income taxes (Notes 1 and 4)
 
129,352

 
145,847

Total Current Assets
 
4,498,114

 
4,305,256

Plant and equipment (Note 1):
 
 
 
 
Land and land improvements
 
300,852

 
308,052

Buildings and building equipment
 
1,401,234

 
1,460,333

Machinery and equipment
 
3,051,684

 
3,112,810

Construction in progress
 
95,459

 
63,540

 
 
4,849,229

 
4,944,735

Less accumulated depreciation
 
3,129,261

 
3,147,556

 
 
1,719,968

 
1,797,179

Investments and other assets (Note 1)
 
931,126

 
597,532

Intangible assets, net (Notes 1 and 7)
 
1,095,218

 
1,177,722

Goodwill (Notes 1 and 7)
 
2,925,856

 
3,009,116

Total Assets
 
$
11,170,282

 
$
10,886,805

 
 
 
 
 
Liabilities and Equity
 
 
 
 
Current Liabilities
 
 
 
 
Notes payable and long-term debt payable within one year (Notes 8 and 9)
 
$
225,589

 
$
75,271

Accounts payable, trade
 
1,194,684

 
1,173,851

Accrued payrolls and other compensation
 
463,889

 
467,043

Accrued domestic and foreign taxes
 
153,809

 
232,774

Other accrued liabilities
 
448,042

 
442,104

Total Current Liabilities
 
2,486,013

 
2,391,043

Long-term debt (Note 9)
 
1,503,946

 
1,691,086

Pensions and other postretirement benefits (Note 10)
 
1,909,755

 
862,938

Deferred income taxes (Notes 1 and 4)
 
88,091

 
160,035

Other liabilities
 
276,747

 
293,367

Total Liabilities
 
6,264,552

 
5,398,469

Equity (Note 11)
 
 
 
 
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 in 2012 and 2011
 
90,523

 
90,523

Additional capital
 
640,249

 
668,332

Retained earnings
 
7,787,175

 
6,891,407

Accumulated other comprehensive (loss)
 
(1,415,900
)
 
(450,990
)
Treasury shares at cost: 31,415,530 in 2012 and 25,955,619 in 2011
 
(2,205,532
)
 
(1,815,418
)
Total Shareholders' Equity
 
4,896,515

 
5,383,854

Noncontrolling interests
 
9,215

 
104,482

Total Equity
 
4,905,730

 
5,488,336

Total Liabilities and Equity
 
$
11,170,282

 
$
10,886,805

The accompanying notes are an integral part of the financial statements.

13-15



Consolidated Statement of Cash Flows

 
 
For the years ended June 30,
(Dollars in thousands)
 
2012

 
2011

 
2010

Cash Flows From Operating Activities
 
 
 
 
 
 
Net income
 
$
1,155,492

 
$
1,057,150

 
$
556,365

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
Depreciation
 
210,508

 
229,238

 
245,295

Amortization
 
111,421

 
110,562

 
117,214

Stock incentive plan compensation
 
80,935

 
73,238

 
59,318

Deferred income taxes
 
(56,452
)
 
20,715

 
(17,353
)
Foreign currency transaction loss (gain)
 
4,300

 
10,470

 
(1,249
)
(Gain) loss on disposal of assets
 
(2,494
)
 
(7,710
)
 
10,292

Changes in assets and liabilities, net of effects from acquisitions:
 
 
 
 
 
 
Accounts receivable
 
(91,091
)
 
(259,752
)
 
(220,349
)
Inventories
 
(28,333
)
 
(139,062
)
 
53,862

Prepaid expenses
 
(26,981
)
 
6,477

 
29,581

Other assets
 
(6,578
)
 
(39,118
)
 
42,031

Accounts payable, trade
 
59,692

 
228,164

 
259,436

Accrued payrolls and other compensation
 
16,003

 
75,405

 
26,014

Accrued domestic and foreign taxes
 
(70,302
)
 
53,424

 
63,119

Other accrued liabilities
 
33,512

 
(27,726
)
 
36,137

Pensions and other postretirement benefits
 
123,944

 
(281,285
)
 
(9,879
)
Other liabilities
 
16,809

 
56,743

 
(31,012
)
Net cash provided by operating activities
 
1,530,385

 
1,166,933

 
1,218,822

Cash Flows From Investing Activities
 
 
 
 
 
 
Acquisitions (less cash acquired of $19,161 in 2012 and $385 in 2011)
 
(156,256
)
 
(60,227
)
 
(5,451
)
Capital expenditures
 
(218,817
)
 
(207,294
)
 
(129,222
)
Proceeds from disposal of assets
 
20,404

 
32,289

 
11,929

Other
 
(21,099
)
 
(9,706
)
 
(23,429
)
Net cash (used in) investing activities
 
(375,768
)
 
(244,938
)
 
(146,173
)
Cash Flows From Financing Activities
 
 
 
 
 
 
Proceeds from exercise of stock options
 
10,599

 
25,862

 
10,307

Payments for common shares
 
(456,969
)
 
(693,096
)
 
(24,999
)
Tax benefit from stock incentive plan compensation
 
16,107

 
42,823

 
13,698

Acquisition of noncontrolling interests
 
(147,441
)
 

 

Payments for notes payable, net
 
(1,961
)
 
(18,908
)
 
(421,974
)
Proceeds from long-term borrowings
 
73,556

 
291,683

 
3,293

Payments for long-term borrowings
 
(76,757
)
 
(358,058
)
 
(67,582
)
Dividends paid
 
(240,654
)
 
(206,084
)
 
(162,739
)
Net cash (used in) financing activities
 
(823,520
)
 
(915,778
)
 
(649,996
)
Effect of exchange rate changes on cash
 
(150,246
)
 
75,723

 
(34,738
)
Net increase in cash and cash equivalents
 
180,851

 
81,940

 
387,915

Cash and cash equivalents at beginning of year
 
657,466

 
575,526

 
187,611

Cash and cash equivalents at end of year
 
$
838,317

 
$
657,466

 
$
575,526

Supplemental Data:
 
 
 
 
 
 
Cash paid during the year for:
 
 
 
 
 
 
Interest
 
$
91,677

 
$
99,227

 
$
104,812

Income taxes
 
494,378

 
203,539

 
127,320


The accompanying notes are an integral part of the financial statements.


13-16



Consolidated Statement of Equity
(Dollars in thousands)
 
 Common Stock
 
Additional Capital
 
Retained Earnings
 
Accumulated Other Comprehensive (Loss)
 
Treasury Shares
 
Noncontrolling Interests
 
 Total
Balance June 30, 2009
 
$
90,523

 
$
588,201

 
$
5,722,038

 
$
(843,019
)
 
$
(1,289,544
)
 
$
82,241

 
$
4,350,440

Net income
 
 
 
 
 
554,065

 
 
 
 
 
2,300

 
556,365

Other comprehensive (loss) income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation, net of tax of $(8,274)
 
 
 
 
 
 
 
(186,925
)
 
 
 
7,093

 
(179,832
)
Retirement benefits plan activity, net of tax of $106,065
 
 
 
 
 
 
 
(183,364
)
 
 
 
 
 
(183,364
)
Net realized loss, net of tax of $(2,937)
 
 
 
 
 
 
 
4,747

 
 
 
 
 
4,747

Total comprehensive (loss) income
 
 
 
 
 
 
 
 
 
 
 
9,393

 
197,916

Dividends paid
 
 
 
 
 
(162,540
)
 
 
 
 
 
(199
)
 
(162,739
)
Stock incentive plan activity
 
 
 
49,241

 
(23,131
)
 
 
 
44,564

 
 
 
70,674

Shares purchased at cost
 
 
 
 
 
 
 
 
 
(24,999
)
 
 
 
(24,999
)
Retirement benefits plan activity
 
 
 
 
 
(3,887
)
 
 
 
31,995

 
 
 
28,108

Balance June 30, 2010
 
$
90,523

 
$
637,442

 
$
6,086,545

 
$
(1,208,561
)
 
$
(1,237,984
)
 
$
91,435

 
$
4,459,400

Net income
 
 
 
 
 
1,049,130

 
 
 
 
 
8,020

 
1,057,150

Other comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation, net of tax of $12,675
 
 
 
 
 
 
 
503,756

 
 
 
8,325

 
512,081

Retirement benefits plan activity, net of tax of $(144,108)
 
 
 
 
 
 
 
253,603

 
 
 
 
 
253,603

Realized loss, net of tax of $(119)
 
 
 
 
 
 
 
212

 
 
 
 
 
212

Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
16,345

 
1,823,046

Dividends paid
 
 
 
 
 
(202,786
)
 
 
 
 
 
(3,298
)
 
(206,084
)
Stock incentive plan activity
 
 
 
30,890

 
(41,482
)
 
 
 
115,662

 
 
 
105,070

Shares purchased at cost
 
 
 
 
 
 
 
 
 
(693,096
)
 
 
 
(693,096
)
Balance June 30, 2011
 
$
90,523

 
$
668,332

 
$
6,891,407

 
$
(450,990
)
 
$
(1,815,418
)
 
$
104,482

 
$
5,488,336

Net income
 
 
 
 
 
1,151,823

 
 
 
 
 
3,669

 
1,155,492

Other comprehensive (loss) income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation, net of tax of $(11,530)
 
 
 
 
 
 
 
(367,135
)
 
 
 
(25,607
)
 
(392,742
)
Retirement benefits plan activity, net of tax of $330,984
 
 
 
 
 
 
 
(597,979
)
 
 
 
 
 
(597,979
)
Realized loss, net of tax of $(102)
 
 
 
 
 
 
 
204

 
 
 
 
 
204

Total comprehensive (loss) income
 
 
 
 
 
 
 
 
 
 
 
(21,938
)
 
164,975

Dividends paid
 
 
 
 
 
(233,168
)
 
 
 
 
 
(7,486
)
 
(240,654
)
Stock incentive plan activity
 
 
 
45,532

 
(22,887
)
 
 
 
65,266

 
 
 
87,911

Acquisition activity
 
 
 
(73,615
)
 
 
 
 
 
 
 
(65,843
)
 
(139,458
)
Shares purchased at cost
 
 
 
 
 
 
 
 
 
(455,380
)
 
 
 
(455,380
)
Balance June 30, 2012
 
$
90,523

 
$
640,249

 
$
7,787,175

 
$
(1,415,900
)
 
$
(2,205,532
)
 
$
9,215

 
$
4,905,730


The accompanying notes are an integral part of the financial statements.

13-17



Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)

1.
Significant Accounting Policies
The significant accounting policies followed in the preparation of the accompanying consolidated financial statements are summarized below.
Nature of Operations - 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 evaluates performance based on segment operating income before corporate and administrative expenses, interest expense and income taxes.
The Company operates in three business segments: Industrial, Aerospace and Climate & Industrial Controls. The Industrial Segment is an aggregation of several business units, which manufacture motion-control and fluid power system components for builders and users of various types of manufacturing, packaging, processing, transportation, agricultural, construction, and military vehicles and equipment. Industrial Segment products are marketed primarily through field sales employees and independent distributors. The Industrial North American operations have manufacturing plants and distribution networks throughout the United States, Canada and Mexico and primarily service North America. The Industrial International operations provide Parker products and services to 45 countries throughout Europe, Asia Pacific, Latin America, the Middle East and Africa.
The Aerospace Segment produces hydraulic, fuel, pneumatic and electro-mechanical systems and components, which are utilized on virtually every domestic commercial, military and general aviation aircraft and also performs a vital role in naval vessels and land-based weapons systems. This Segment serves original equipment and maintenance, repair and overhaul customers worldwide. Aerospace Segment products are marketed by field sales employees and are sold directly to manufacturers and end users.
The Climate & Industrial Controls Segment manufactures motion-control systems and components for use primarily in the refrigeration and air conditioning and transportation industries. The products in the Climate & Industrial Controls Segment are marketed primarily through field sales employees and independent distributors.
See the table of Business Segment Information “By Industry” and “By Geographic Area” on pages 13-13 and 13-14 for further disclosure of business segment information.
There are no individual customers to whom sales are more than three percent of the Company's consolidated sales. Due to the diverse group of customers throughout the world the Company does not consider itself exposed to any concentration of credit risks.
The Company manufactures and markets its products throughout the world. Although certain risks and uncertainties exist, the diversity and breadth of the Company's products and geographic operations mitigate the risk that adverse changes with respect to any particular product and geographic operation would materially affect the Company's operating results.
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Basis of Consolidation - The consolidated financial statements include the accounts of all majority-owned domestic and foreign subsidiaries. All intercompany transactions and profits have been eliminated in the consolidated financial statements. The Company does not have off-balance sheet arrangements. Within the Business Segment Information, intersegment and interarea sales have been eliminated.
Revenue Recognition - Revenue is recognized when persuasive evidence of an arrangement exists, product has shipped and the risks and rewards of ownership have transferred or services have been rendered, the price to the customer is fixed and determinable and collectibility is reasonably assured, which is generally at the time the product is shipped. Shipping and handling costs billed to customers are included in net sales and the related costs in cost of sales.
Long-term Contracts - The Company enters into long-term contracts primarily for the production of aerospace products. For financial statement purposes, revenues are primarily recognized using the percentage-of-completion method. The extent of progress toward completion is primarily measured using the units-of-delivery method. Unbilled costs on these contracts are included in inventory. Progress payments are netted against the inventory balances. The Company estimates costs to complete long-term contracts for purposes of evaluating and establishing contract reserves. Adjustments to cost estimates are made on a consistent basis and a contract reserve is established when the estimated costs to complete a contract exceed the expected contract revenues.

13-18



Cash - Cash equivalents consist of short-term highly liquid investments, with a three-month or less maturity, carried at cost plus accrued interest, which are readily convertible into cash.
Accounts Receivable - The accounts receivable, net caption in the Consolidated Balance Sheet is comprised of the following components:

June 30,
 
2012

 
2011

Accounts receivable, trade
 
$
1,792,961

 
$
1,780,137

Allowance for doubtful accounts
 
(10,518
)
 
(10,472
)
Non-trade accounts receivable
 
84,872

 
75,550

Notes receivable
 
124,969

 
132,641

Total
 
$
1,992,284

 
$
1,977,856

                      
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.
Inventories - Inventories are stated at the lower of cost or market. The majority of domestic inventories are valued by the last-in, first-out method and the balance of the Company's inventories are valued by the first-in, first-out method.
 
Plant, Equipment and Depreciation - Plant and equipment are recorded at cost and are depreciated principally using the straight-line method for financial reporting purposes. Depreciation rates are based on estimated useful lives of the assets, generally 40 years for buildings, 15 years for land improvements and building equipment, seven to 10 years for machinery and equipment, and three to eight years for vehicles and office equipment. Improvements, which extend the useful life of property, are capitalized, and maintenance and repairs are expensed. The Company reviews plant and equipment for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. When plant and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the appropriate accounts and any gain or loss is included in current income.
Investments and Other Assets - Investments in joint-venture companies in which ownership is 50 percent or less and in which the Company does not have operating control are stated at cost plus the Company's equity in undistributed earnings. These investments and the related earnings are not material to the consolidated financial statements. Also included in this balance sheet caption is non-current deferred income taxes of $571,039 and $214,546 at June 30, 2012 and June 30, 2011, respectively.
Goodwill - The Company conducts a formal impairment test of goodwill on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.
Intangible Assets - Intangible assets primarily include patents, trademarks and customer lists and are recorded at cost and amortized on a straight-line method. Patents are amortized over the shorter of their remaining useful or legal life. Trademarks are amortized over the estimated time period over which an economic benefit is expected to be received. Customer lists are amortized over a period based on anticipated customer attrition rates. The Company reviews intangible assets for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable.
Income Taxes - Income taxes are provided based upon income for financial reporting purposes. Deferred income taxes arise from temporary differences in the recognition of income and expense for tax purposes. Tax credits and similar tax incentives are applied to reduce the provision for income taxes in the year in which the credits arise. The Company recognizes accrued interest related to unrecognized tax benefits in income tax expense. Penalties, if incurred, are recognized in income tax expense.
Product Warranty - In the ordinary course of business the Company warrants its products against defect in design, materials and workmanship over various time periods. The warranty accrual at June 30, 2012 and 2011 is immaterial to the financial position of the Company and the change in the accrual during 2012, 2011 and 2010 was immaterial to the Company's results of operations and cash flows.
Foreign Currency Translation - Assets and liabilities of most foreign subsidiaries are translated at current exchange rates, and income and expenses are translated using weighted-average exchange rates. The effects of these translation adjustments, as well as gains and losses from certain intercompany transactions, are reported in the accumulated other comprehensive (loss) component of shareholders' equity. Such adjustments will affect net income only upon sale or liquidation

13-19



of the underlying foreign investments, which is not contemplated at this time. Exchange gains and losses from transactions in a currency other than the local currency of the entity involved, and translation adjustments in countries with highly inflationary economies, are included in net income.
Subsequent Events - The Company has evaluated subsequent events that have occurred through the date of filing of the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2012. On August 13, 2012, the Company entered into an agreement to divest the automotive businesses of the Mobile Climate Systems division (MCS). MCS is part of the Climate & Industrial Controls Segment. The divestiture is expected to close in October 2012 and is expected to result in a pre-tax gain of approximately $30 million. The results of operations and net assets of the divested businesses are immaterial to the consolidated results of operations and financial position of the Company. No subsequent events occurred that required adjustment to these financial statements.
Recent Accounting Pronouncements - In June 2011, the Financial Accounting Standards Board (FASB) issued new accounting guidance requiring an entity to present net income and other comprehensive income (OCI) in either a single continuous statement or in separate consecutive statements. The guidance does not change the items reported in OCI or when an item of OCI must be reclassified to net income. The guidance, which must be presented retrospectively, is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.
In September 2011, the FASB issued new accounting guidance related to testing goodwill for impairment. The new guidance allows an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether the entity should calculate the fair value of a reporting unit. It also expands the events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. This guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 31, 2011. The Company has not determined the effect, if any, that this new guidance will have on its goodwill impairment tests.


2.
Acquisitions
During 2012, the Company completed four acquisitions whose aggregate sales for their most recent fiscal year prior to acquisition were $141 million. Total purchase price for the four acquisitions was approximately $156 million in cash and $6 million in assumed debt. Also during 2012, the Company purchased the outstanding shares not previously owned by the Company in two majority-owned subsidiaries. Total purchase price for the two majority-owned subsidiaries was $147 million in cash.
During 2011, the Company completed three acquisitions whose aggregate sales for their most recent fiscal year prior to acquisition were $65 million. Total purchase price for the three acquisitions in 2011 was approximately $61 million in cash.
During 2010, the Company completed one acquisition whose aggregate sales for its most recent fiscal year prior to acquisition were $11 million. Total purchase price for this business was approximately $5 million in cash.
The results of operations for all acquisitions are included as of the respective dates of acquisition. The initial purchase price allocation and subsequent purchase price adjustments for acquisitions in 2012, 2011 and 2010 are presented below. Some of the 2012 purchase price allocations are preliminary and may require subsequent adjustment primarily to the values currently assigned to plant and equipment and intangible assets.


13-20



 
2012

 
2011

 
2010

Assets acquired:
 
 
 
 
 
Accounts receivable
$
24,833

 
$
9,332

 
$
908

Inventories
29,102

 
7,908

 
447

Prepaid expenses
1,541

 
69

 
(575
)
Deferred income taxes
5,679

 
468

 

Plant and equipment
28,929

 
5,376

 
408

Intangible and other assets
59,576

 
35,094

 
4,198

Goodwill
68,144

 
8,715

 
2,891

 
217,804

 
66,962

 
8,277

Liabilities assumed:
 
 
 
 
 
Notes payable
1,887

 

 

Accounts payable, trade
7,189

 
2,440

 
531

Accrued payrolls and other compensation
3,672

 
765

 
219

Accrued domestic and foreign taxes
2,882

 
215

 
(91
)
Other accrued liabilities
5,984

 
1,500

 
2,587

Long-term debt
4,365

 

 

Pensions and other postretirement benefits
11,396

 

 

Deferred income taxes
24,062

 
1,815

 
(420
)
Other liabilities
111

 

 

 
61,548

 
6,735

 
2,826

Net assets acquired
$
156,256

 
$
60,227

 
$
5,451



13-21



3.
Charges Related to Business Realignment
To structure its businesses in light of current and anticipated customer demand, the Company incurred business realignment charges in 2012, 2011 and 2010.
Business realignment charges by business segment are as follows:
 
2012

 
2011

 
2010

Industrial
$
13,066

 
$
15,427

 
$
44,058

Aerospace

 
1,024

 
575

Climate & Industrial Controls
1,255

 

 
3,868

Work force reductions by business segment are as follows:
 
2012

 
2011

 
2010

Industrial
496

 
466

 
1,454

Aerospace

 
49

 
47

Climate & Industrial Controls
25

 

 
254

The charges primarily consist of severance costs related to plant closures as well as general work force reductions implemented by various operating units throughout the world. The business realignment charges in 2012 also included charges related to enhanced retirement benefits. The Company believes the realignment actions taken will positively impact future results of operations, but will have no material effect on liquidity and sources and uses of capital.
The business realignment charges are presented in the Consolidated Statement of Income as follows:
 
2012

 
2011

 
2010

Cost of sales
$
12,669

 
$
15,276

 
$
42,995

Selling, general and administrative expenses
1,020

 
1,175

 
5,506

Other expense (income), net
632

 

 

As of June 30, 2012, approximately $8 million in severance payments had been made relating to charges incurred during 2012, with the majority of the remaining payments expected to be made by March 31, 2013. All required severance payments have been made relating to charges incurred in 2011 and 2010. Additional charges to be recognized in future periods related to the realignment actions described above are not expected to be material.



4.
Income Taxes
Income before income taxes was derived from the following sources:

 
2012

 
2011

 
2010

United States
$
810,150

 
$
681,910

 
$
354,675

Foreign
766,548

 
731,811

 
400,142

 
$
1,576,698

 
$
1,413,721

 
$
754,817



13-22



Income taxes include the following:

 
2012

 
2011

 
2010

Federal
 
 
 
 
 
  Current
$
255,991

 
$
121,292

 
$
84,878

  Deferred
(48,252
)
 
34,136

 
6,104

Foreign
 
 
 
 
 
  Current
191,167

 
193,064

 
105,927

  Deferred
(29
)
 
(24,229
)
 
(22,788
)
State and local
 
 
 
 
 
  Current
30,500

 
21,500

 
25,000

  Deferred
(8,171
)
 
10,808

 
(669
)
 
$
421,206

 
$
356,571

 
$
198,452


A reconciliation of the Company's effective income tax rate to the statutory Federal rate follows:

 
2012

 
2011

 
2010

Statutory Federal income tax rate
35.0
 %
 
35.0
 %
 
35.0
 %
State and local income taxes
0.9

 
1.8

 
2.1

Foreign tax rate difference
(5.8
)
 
(8.7
)
 
(7.4
)
Cash surrender of life insurance
0.1

 
(0.9
)
 
(1.0
)
Federal manufacturing deduction
(1.6
)
 
(0.9
)
 
(0.6
)
Research tax credit
(0.4
)
 
(1.1
)
 
(0.7
)
Other
(1.5
)
 

 
(1.1
)
Effective income tax rate
26.7
 %
 
25.2
 %
 
26.3
 %

Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of assets and liabilities. The differences comprising the net deferred taxes shown on the Consolidated Balance Sheet at June 30 were as follows:

 
2012

 
2011

Retirement benefits
$
751,676

 
$
374,005

Other liabilities and reserves
134,358

 
161,954

Long-term contracts
27,726

 
7,355

Stock-based incentive compensation
70,129

 
63,590

Loss carryforwards
175,571

 
186,613

Unrealized currency exchange gains and losses
9,057

 
43,484

Inventory
18,535

 
24,623

Foreign tax credit carryforward
19,079

 

Depreciation and amortization
(480,791
)
 
(479,103
)
Valuation allowance
(176,079
)
 
(192,904
)
Net deferred tax asset
$
549,261

 
$
189,617

Change in net deferred tax asset:
 
 
 
Provision for deferred tax
$
56,452

 
$
(20,715
)
Items of other comprehensive (loss)
319,352

 
(131,552
)
Acquisitions and other
(16,160
)
 
(1,519
)
Total change in net deferred tax
$
359,644

 
$
(153,786
)


13-23



At June 30, 2012, the Company had recorded deferred tax assets of $175,571 resulting from $701,310 in loss carryforwards. A valuation allowance of $165,907 related to the loss carryforwards has been established due to the uncertainty of realizing certain deferred tax assets. Of this valuation allowance, $147,755 resulting from $516,808 in loss carryforwards, relates to a non-operating entity whose utilization of its loss carryforward is considered to be remote. An additional valuation allowance of $10,172 relates to a foreign capital loss carryforward and certain deferred tax assets associated with other liabilities and reserves. The foreign capital loss carryforward and some of the loss carryforwards can be carried forward indefinitely; others can be carried forward from three to 20 years.
Provision has not been made for additional U.S. or foreign taxes on undistributed earnings of certain international operations as those earnings will continue to be reinvested. It is not practicable to estimate the additional taxes, including applicable foreign withholding taxes, that might be payable on the eventual remittance of such earnings.
Accumulated undistributed earnings of foreign operations reinvested in their operations amounted to $669,000, $983,950 and $1,102,978, at June 30, 2012, 2011 and 2010, respectively.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

 
2012

 
2011

 
2010

Balance July 1
$
81,156

 
$
82,089

 
$
132,954

Additions for tax positions related to current year
66,500

 
8,398

 
10,815

Additions for tax positions of prior years
11,047

 
10,015

 
23,408

Additions for acquisitions

 

 
294

Reductions for tax positions of prior years
(23,456
)
 
(15,060
)
 
(64,821
)
Reductions for settlements
(23,434
)
 
(7,133
)
 
(21,770
)
Reductions for expiration of statute of limitations
(1,636
)
 

 
(37
)
Effect of foreign currency translation
(442
)
 
2,847

 
1,246

Balance June 30
$
109,735

 
$
81,156

 
$
82,089


The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $61,601, $78,754 and $81,927 as of June 30, 2012, 2011 and 2010, respectively. If recognized, a significant portion of the gross unrecognized tax benefits as of June 30, 2012 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, was $3,676, $11,331 and $8,200 as of June 30, 2012, 2011 and 2010, respectively.
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's tax returns are subject to examination by taxing authorities throughout the world. The Company is no longer subject to examinations of its federal income tax returns by the United States Internal Revenue Service for fiscal years through 2010. All significant state, local and foreign tax returns have been examined for fiscal years through 2003. The Company does not anticipate that, within the next twelve months, the total amount of unrecognized tax benefits will significantly change due to the settlement of examinations and the expiration of statute of limitations.


13-24





5.
Earnings Per Share
Basic earnings per share are computed using the weighted-average number of common shares outstanding during the year. Diluted earnings per share are computed using the weighted-average number of common shares and common share equivalents outstanding during the year. Common share equivalents represent the dilutive effect of outstanding stock-based awards. The computation of net income per share was as follows:

 
2012

 
2011

 
2010

Numerator:
 
 
 
 
 
Net income attributable to common shareholders
$
1,151,823

 
$
1,049,130

 
$
554,065

Denominator:
 
 
 
 
 
Basic - weighted-average common shares
151,222,033

 
161,125,869

 
160,909,655

Increase in weighted-average common shares from dilutive effect of stock-based awards
3,442,477

 
3,672,352

 
1,992,062

Diluted - weighted-average common shares, assuming exercise of stock-based awards
154,664,510

 
164,798,221

 
162,901,717

Basic earnings per share
$
7.62

 
$
6.51

 
$
3.44

Diluted earnings per share
$
7.45

 
$
6.37

 
$
3.40


For 2012, 2011 and 2010, 0.7 million, 1.6 million, and 9.0 million common shares, respectively, subject to stock-based awards were excluded from the computation of diluted earnings per share because the effect of their exercise would be anti-dilutive.



6.
Inventories
Inventories valued on the last-in, first-out (LIFO) cost method were approximately 31 percent of total inventories in 2012 and 28 percent of total inventories in 2011. The current cost of these inventories exceeds their valuation determined on the LIFO basis by $212,033 in 2012 and $205,739 in 2011. Progress payments of $36,087 in 2012 and $33,489 in 2011 are netted against inventories.

7.
Goodwill and Intangible Assets
The Company's annual impairment tests performed in 2012, 2011, and 2010 resulted in no impairment loss being recognized.
The changes in the carrying amount of goodwill for the years ended June 30, 2012 and June 30, 2011 are as follows:
 
Industrial Segment
 
Aerospace Segment
 
Climate & Industrial Controls Segment
 
Total
Balance June 30, 2010
$
2,380,640

 
$
98,856

 
$
306,838

 
$
2,786,334

Acquisitions
7,424

 

 
1,291

 
8,715

Foreign currency translation
208,261

 
58

 
6,059

 
214,378

Goodwill adjustments
(336
)
 

 
25

 
(311
)
Balance June 30, 2011
$
2,595,989

 
$
98,914

 
$
314,213

 
$
3,009,116

Acquisitions
68,337

 
(193
)
 

 
68,144

Foreign currency translation
(143,348
)
 
(47
)
 
(5,152
)
 
(148,547
)
Goodwill adjustments
(2,857
)
 

 

 
(2,857
)
Balance June 30, 2012
$
2,518,121

 
$
98,674

 
$
309,061

 
$
2,925,856


Acquisitions represent the original goodwill allocation and any changes in the purchase price for the acquisitions during the measurement period subsequent to the applicable acquisition dates.

13-25




Goodwill adjustments primarily represent final adjustments to the purchase price allocation for acquisitions during the measurement period subsequent to the applicable acquisition dates. The Company's previously reported results of operations and financial position would not be materially different had the goodwill adjustments recorded during 2012 and 2011 been reflected in the same reporting period that the initial purchase price allocations for those acquisitions were made.
Intangible assets are amortized on a straight-line method over their legal or estimated useful life. The following summarizes the gross carrying value and accumulated amortization for each major category of intangible asset as of June 30, 2012 and June 30, 2011:

 
2012
 
2011
 
Gross Carrying Amount
 
Accumulated Amortization
 
Gross Carrying Amount
 
Accumulated Amortization
Patents
$
118,034

 
$
66,303

 
$
124,015

 
$
61,061

Trademarks
321,019

 
129,081

 
319,158

 
116,995

Customer lists and other
1,247,820

 
396,271

 
1,251,271

 
338,666

Total
$
1,686,873