Exhibit (13) to Report
On Form 10-K for Fiscal
Year Ended June 30, 2013
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 and similar transactions, including the anticipated closing of the previously announced joint venture with GE Aviation;
the determination to undertake business realignment activities and the expected costs thereof and, if undertaken, the ability to complete such activities and realize the anticipated cost savings from such activities;
ability to realize anticipated benefits of the consolidation of the Climate & Industrial Controls Group;
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, 2013, 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. Recent PMI levels for some regions around the world were as follows:
 
June 30, 2013

 
March 31, 2013

 
June 30, 2012

United States
50.9

 
51.3

 
49.7

Eurozone countries
48.8

 
46.8

 
45.1

China
48.2

 
51.6

 
48.2

 
Global aircraft miles flown increased one percent from the comparable 2012 level and global revenue passenger miles increased two percent from the comparable 2012 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 2014 will decrease by one percent from the comparable fiscal 2013 level.
 
Housing starts in June 2013 were approximately 10 percent higher than housing starts in June 2012 and were approximately 19 percent lower than housing starts in March 2013.

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 33.0 percent at June 30, 2013 compared to 35.9 percent at March 31, 2013 and 26.1 percent at June 30, 2012. Net of cash and cash equivalents, the debt to debt-shareholders' equity ratio was 15.4 percent at June 30, 2013 compared to 19.9 percent at March 31, 2013 and 15.4 percent at June 30, 2012.

The Company believes many opportunities for 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.











13-2



The Company believes it can meet its strategic objectives by:
Serving the customer;
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 an 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;
Driving efficiency by implementing lean enterprise principles; and
Creating a culture of empowerment through its values, inclusion and diversity, accountability and teamwork.
During fiscal 2013, the Company completed eight acquisitions whose aggregate sales for their most recent fiscal year prior to acquisition were $484 million. 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. During fiscal 2013, the Company divested the automotive businesses of the Mobile Climate Systems division and the Turkey refrigeration components business. Both of the divested businesses were part of the Climate & Industrial Controls Segment. The Company recognized a net pre-tax gain of approximately $18 million related to these divestitures. 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.

The discussion below is structured to separately discuss each of the financial statements presented on pages 13-13 to 13-18. 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)
 
2013
 
2012
 
2011
Net sales
 
$
13,016

 
$
13,146

 
$
12,346

Gross profit margin
 
22.5
%
 
24.2
%
 
24.0
 %
Selling, general and administrative expenses
 
$
1,555

 
$
1,519

 
$
1,468

Selling, general and administrative expenses, as a percent of sales
 
11.9
%
 
11.6
%
 
11.9
 %
Interest expense
 
$
92

 
$
93

 
$
100

Other (income) expense, net
 
(18
)
 
1

 
(15
)
(Gain) on disposal of assets
 
(10
)
 
(2
)
 
(8
)
Effective tax rate
 
27.6
%
 
26.7
%
 
25.2
 %
Net income attributable to common shareholders
 
$
948

 
$
1,152

 
$
1,049


Net sales in 2013 were 1.0 percent lower than 2012. Acquisitions made in the last 12 months contributed approximately $448 million in sales in 2013 and the effect of currency rate changes decreased net sales in 2013 by approximately $140 million. Excluding the effect of acquisitions and currency rate changes, net sales in 2013 were 3.3 percent lower than 2012. The decrease in sales in 2013 is primarily due to lower volume experienced in the Industrial Segment.

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 contributed approximately $72 million in sales in 2012. The effect of currency rate changes decreased net sales in 2012 by approximately $102 million.


13-3



Gross profit margin decreased in 2013 primarily due to higher defined benefit costs in all segments, operating inefficiencies in the Industrial Segment and higher engineering development costs in the Aerospace Segment. Gross profit margin was higher in 2012 primarily due to the higher sales volume in the Industrial North American businesses and the Aerospace Segment. Included in gross profit in 2013, 2012 and 2011 were business realignment charges of $8.4 million, $12.7 million and $15.3 million, respectively.

Selling, general and administrative expenses increased 2.3 percent in 2013 and increased 3.5 percent in 2012. The increase in 2013 was primarily due to higher amortization expense and charitable contributions, partially offset by lower net expenses associated with the Company's incentive and deferred compensation programs. 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.

Interest expense in 2013 decreased primarily due to a lower average interest rate in the debt portfolio during the latter part of 2013 than the debt portfolio during the latter half of 2012 more than offsetting the effect of higher weighted-average borrowings and interest rates on commercial paper borrowings. Interest expense in 2012 decreased primarily due to lower average debt outstanding as well as lower weighted-average interest rates on commercial paper borrowings.

Other (income) expense, net in 2012 included $8.3 million of expense related to historical tax credits. Other (income) expense, net in 2011 included $10.9 million of income related to insurance recoveries.

(Gain) on disposal of assets in 2013 includes a net gain of $14.7 million resulting from business divestiture activity. (Gain) on disposal of assets in 2012 included $3.7 million of gains from asset sales. (Gain) 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.

Effective tax rate in 2013 and 2012 was higher primarily due to an unfavorable geographical mix of earnings. Effective tax rate in 2013 was favorably impacted by the enactment of the American Taxpayer Relief Act on January 2, 2013. Effective tax rate in 2012 was favorably impacted by the settlement of tax audits.

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 and a discussion of the recent consolidation of the Company's reportable business segments, effective for fiscal periods after June 30, 2013.

Industrial Segment (dollars in millions)
 
2013
 
2012
 
2011
Sales
 
 
 
 
 
North America
$
5,051

 
$
5,041

 
$
4,517

International
4,868

 
5,034

 
4,917

Operating income
 
 
 
 
 
North America
845

 
895

 
746

International
584

 
733

 
754

Operating income as a percent of sales
 
 
 
 
 
North America
16.7
%
 
17.8
%
 
16.5
%
International
12.0
%
 
14.6
%
 
15.3
%
Backlog
$
1,693

 
$
1,814

 
$
1,907

Assets
8,780

 
7,991

 
8,414

Return on average assets
17.0
%
 
19.8
%
 
19.1
%

Sales in 2013 for the Industrial North American operations increased slightly from 2012 compared to an increase of 11.6 percent from 2011 to 2012. Acquisitions completed within the last 12 months contributed approximately $217 million in net sales in 2013. Excluding acquisitions, sales in 2013 decreased 4.1 percent from 2012 reflecting lower demand from distributors as well as from end-users in most markets with the largest decline occurring in the construction equipment, oil and gas, mining, heavy-duty truck and machine tool markets.

13-4



The increase in sales in 2012 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, oil and gas and machine tools markets.

Sales in the Industrial International operations decreased 3.3 percent in 2013 following an increase of 2.4 percent from 2011 to 2012. Acquisitions completed within the last 12 months contributed approximately $231 million in net sales in 2013, most of which related to Europe. The effect of currency rate fluctuations decreased 2013 net sales by approximately $137 million, half of which related to Europe, a quarter of which related to the Asia Pacific region and a quarter of which related to Latin America. Excluding acquisitions and the effect of currency rate changes, sales in the Industrial International operations decreased 5.2 percent from 2012, primarily due to lower volume across most markets in all regions with the largest decrease equally distributed between Europe and the Asia Pacific region. The sales increase in 2012 is primarily due to higher volume experienced in Europe.

The decrease in operating margins in 2013 in the Industrial North American operations is primarily due to an unfavorable product mix and operating inefficiencies resulting from the decrease in sales volume, partially offset by the favorable effect of lower raw material prices. The decrease in operating margins in 2013 in the Industrial International operations is primarily due to the lower sales volume, resulting in operating inefficiencies, as well as the impact of integration costs related to 2013 acquisitions. Operating 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 operating 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.
 
The following business realignment expenses are included in Industrial North America and Industrial International operating income:
   
(dollars in thousands)
 
2013
 
2012
 
2011
Industrial North America
 
$
2,342

 
$
3,355

 
$
4,223

Industrial International
 
8,973

 
9,711

 
11,204


The business realignment charges consist primarily of severance costs resulting from plant closures as well as general reductions in work force. The Industrial North America business realignment charges for 2012 also include expenses associated with enhanced retirement benefits. The Company does not anticipate that cost savings realized from the work force reductions taken during 2013 will have a material impact on future operating margins. In 2014, the Company expects to take actions necessary to structure appropriately the operations of the Industrial Segment. Such actions are expected to result in approximately $95 million in business realignment charges in 2014.

The Company anticipates Industrial North American sales for 2014 will range between being flat to increasing 5.0 percent from the 2013 level and Industrial International sales for 2014 will range between being flat to increasing 4.8 percent from the 2013 level. Industrial North American operating margins in 2014 are expected to range from 16.5 percent to 17.1 percent and Industrial International margins are expected to range from 10.3 percent to 10.7 percent. The change in sales and operating margins between 2013 and 2014 include the businesses of the Climate & Industrial Controls Segment, which has been consolidated into the Industrial Segment effective July 1, 2013.

The decline in total Industrial Segment backlog in 2013 is primarily due to lower order rates in both the Industrial North American and Industrial International businesses partially offset by an increase in backlog from acquisitions. 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 assets in 2013 was primarily due to acquisitions as well as increases in plant and equipment, net and cash and cash equivalents, partially offset by the effect of currency fluctuations as well as decreases in inventory and intangible assets, net. 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.





13-5







Aerospace Segment (dollars in millions)
    
 
2013
 
2012
 
2011
Sales
$
2,268

 
$
2,103

 
$
1,922

Operating income
280

 
290

 
247

Operating income as a percent of sales
12.4
%
 
13.8
%
 
12.9
%
Backlog
$
1,936

 
$
1,862

 
$
1,702

Assets
1,140

 
1,033

 
995

Return on average assets
25.8
%
 
28.6
%
 
25.9
%

Sales in 2013 increased 7.8 percent compared to an increase of 9.4 percent from 2011 to 2012. The increase in net sales in 2013 is primarily due to higher volume in all businesses with the largest increase being experienced in the commercial and military original equipment manufacturer (OEM) businesses. The increase in net sales in 2012 is primarily due to higher volume in both the commercial and military OEM and aftermarket businesses.

The lower margin in 2013 is primarily due to higher engineering development costs, including fuel cell development, more than offsetting the benefit of the higher sales volume. The higher margin in 2012 is primarily due to the higher sales volume, particularly in the higher margin commercial aftermarket business, partially offset by higher engineering development costs.

The increase in backlog in 2013 is primarily due to higher commercial and military OEM orders and commercial aftermarket orders partially offset by lower military aftermarket orders. The increase in backlog in 2012 is primarily due to higher order rates in the military OEM businesses.

For 2014, sales are expected to range from being flat to increasing 4.0 percent from the 2013 level and operating margins are expected to range from 12.4 percent to 13.4 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 change in sales and operating margins between 2013 and 2014 include the impact of the anticipated formation of the previously announced joint venture with GE Aviation.

The increase in assets in 2013 and 2012 was primarily due to increases in accounts receivable, net, inventory and intangible assets, net.


Climate & Industrial Controls Segment
(dollars in millions)
 
2013
 
2012
 
2011
Sales
$
830

 
$
968

 
$
990

Operating income
82

 
84

 
76

Operating income as a percent of sales
9.9
%
 
8.7
%
 
7.7
%
Backlog
$
110

 
$
160

 
$
171

Assets
608

 
705

 
725

Return on average assets
12.5
%
 
11.8
%
 
10.7
%

Sales in 2013 decreased 14.3 percent compared to a decrease of 2.3 percent from 2011 to 2012. The decrease in sales in 2013 is primarily due to the absence of sales from businesses divested in 2013 as well as lower volume in the commercial refrigeration and air conditioning markets. 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. Operating margins in 2013 and 2012 were higher primarily due to spending control efforts and lower material costs more than offsetting the impact of the lower sales volume and an unfavorable product mix.


13-6





The decrease in assets in 2013 was primarily due to the absence of assets from businesses divested in 2013. 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.

Corporate assets increased 39.7 percent in 2013 compared to an increase of 91.3 percent from 2011 to 2012. The change in Corporate assets in 2013 and 2012 was primarily due to 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)
 
2013

 
2012

Cash and cash equivalents
 
$
1,781

 
$
838

Accounts receivable, net
 
2,063

 
1,992

Inventories
 
1,377

 
1,401

Notes payable and long-term debt payable within one year
 
1,334

 
226

Pensions and postretirement benefits
 
1,372

 
1,910

Shareholders' equity
 
5,738

 
4,897

Working capital
 
$
2,011

 
$
2,012

Current ratio
 
1.6

 
1.8

Cash and cash equivalents include $1,655 million and $629 million held by the Company's foreign subsidiaries at June 30, 2013 and June 30, 2012, respectively. Generally, cash and cash equivalents held by foreign subsidiaries are not readily available for use in the United States without adverse tax consequences. The Company's principal sources of liquidity are its cash flows provided by operating activities, commercial paper borrowings or borrowings directly from its line of credit. The Company does not believe the level of its non-U.S. cash position will have an adverse effect on working capital needs, planned growth, repayment of maturing debt, benefit plan funding, dividend payments or share repurchases.

Accounts receivable, net are primarily receivables due from customers for sales of product ($1,841 million at June 30, 2013 and $1,782 million at June 30, 2012). Days sales outstanding relating to trade receivables for the Company was 49 days in 2013 and 48 days in 2012. The Company believes that its receivables are collectible and appropriate allowances for doubtful accounts have been recorded.

Inventories decreased $24 million (which includes a decrease of $7 million from the effect of foreign currency translation) primarily due to a decrease in inventory levels in the Industrial Segment partially offset by acquisitions and an increase in inventory levels in the Aerospace Segment. Days supply of inventory on hand was 62 days in 2013 and 63 days in 2012. Days supply of inventory amount at June 30, 2012 has been revised from the amount previously presented to conform to the current calculation methodology.
Notes payable and long-term debt payable within one year increased primarily due to a higher amount of commercial paper borrowings outstanding at the end of 2013. The Company from time to time will utilize short-term intercompany loans to repay commercial paper borrowings. At times, the short-term intercompany loans are outstanding at the end of a fiscal quarter.

Pensions and postretirement benefits decreased primarily due to an increase in the 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 2013 included a decrease of $257 million related to share repurchases, an increase of $325 million related to pensions and postretirement benefits, and a decrease of $17 million related to foreign currency translation adjustments.






13-7





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)
 
2013

 
2012

 
2011

Cash provided by (used in):
 
 
 
 
 
 
Operating activities
 
$
1,191

 
$
1,530

 
$
1,167

Investing activities
 
(810
)
 
(376
)
 
(245
)
Financing activities
 
576

 
(823
)
 
(916
)
Effect of exchange rates
 
(14
)
 
(150
)
 
76

Net increase in cash and cash equivalents
 
$
943

 
$
181

 
$
82


Cash Flows From Operating Activities decreased from 2012 primarily due to a decrease in net income as well as $226 million of voluntary cash contributions made to the Company's domestic qualified defined benefit pension plan in 2013. 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 cash contributions to the Company's domestic qualified defined benefit plan in 2011.

Cash Flows Used In Investing Activities increased from 2012 and 2011 primarily due to an increase in acquisition activity and capital expenditures. Cash flows used in investing activities in 2013 was favorably impacted by net proceeds from business divestitures.

Cash Flows Used In Financing Activities in 2013 included the repurchase of approximately 3.0 million common shares for $257 million as compared to the repurchase of 6.4 million common shares for $455 million in 2012. In both 2013 and 2012, the Company purchased the outstanding shares not previously owned by the Company in majority-owned subsidiaries. Cash flows used in financing activities in 2013 include a higher level of commercial paper borrowings due to the increase in acquisition activity. Cash flows used in financing 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 flows used in financing 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.

Dividends have been paid for 252 consecutive quarters, including a yearly increase in dividends for the last 57 fiscal years. The current annual dividend rate is $1.80.

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)
 
2013
 
2012
  Debt
 
$
2,830

 
$
1,730

  Debt & Shareholders' Equity
 
8,568

 
6,626

  Ratio
 
33.0
%
 
26.1
%

As of June 30, 2013, the Company had a line of credit totaling $2,000 million through a multi-currency revolving credit agreement with a group of banks, of which $669 million was available at June 30, 2013. The credit agreement expires in October 2017; 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. Advances from the credit agreement can be used for general corporate purposes, including acquisitions, and for the refinancing of existing indebtedness. 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

13-8



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 $1,850 million of short-term commercial paper notes. As of June 30, 2013, $1,331 million of commercial paper notes were outstanding and the largest amount of commercial paper notes outstanding during the last quarter of 2013 was $1,525 million.

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. Based on the Company's rating level at June 30, 2013, 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.

Contractual Obligations - The total amount of gross unrecognized tax benefits, including interest, for uncertain tax positions was $112.6 million at June 30, 2013. 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.

(dollars in millions)
 
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)
 
$
1,498

 
$
2

 
$
260

 
$
511

 
$
725

Interest on long-term debt
 
803

 
73

 
140

 
123

 
467

Operating leases (Note 9)
 
281

 
86

 
96

 
38

 
61

Retirement benefits (Note 10)
 
200

 
150

 
12

 
12

 
26

Total
 
$
2,782

 
$
311

 
$
508

 
$
684

 
$
1,279


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 existing at June 30, 2013 by approximately $12.3 million.









13-9





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 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 2013 annual goodwill impairment test performed as of December 31, 2012 indicated that no goodwill impairment existed. The results of the Company's annual goodwill impairment test and rollforward procedures performed as of June 30, 2013 indicated that the following reporting units had an estimated fair value that the Company determined was not significantly in excess of its carrying value (dollars in millions).
Reporting Unit
 
Goodwill Balance
 
Fair Value In Excess of Carrying Value
Worldwide Energy Products
 
$
176.0

 
114.2
%
Hiross/Zander
 
102.3

 
107.2
%
SSD Drives
 
45.0

 
104.8
%
All of these reporting units are part of the Industrial Segment and the sales growth assumption had the most significant influence on the estimation of fair value.
The sales growth assumption for Worldwide Energy Products was based on future business already secured or highly likely to be secured with existing customers based on current quoting activity and forecasted demand for the oil and gas industry as well as sales initiatives to expand the use of the reporting unit's products in the oil and gas industry.
The sales growth assumption for Hiross/Zander was based on forecasted market data specific to the products this reporting unit currently manufactures as well as new product introductions and sales initiatives to expand market share.

13-10



The sales growth assumption for SSD Drives was based on market data research, historical sales trends and new product introductions.
The key uncertainty in the sales growth assumption used in the estimation of the fair value for all these reporting units is actual market demand versus forecasted demand as well as the ability to successfully introduce new products in the marketplace and expand market share.

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 2013, 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 50 basis point change in the assumed long-term rate of return on plan assets is estimated to have an $11 million effect on pension expense and a 50 basis point decrease in the discount rate is estimated to increase pension expense by $27 million. As of June 30, 2013, $1,157 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 eight 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.





13-11









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 February 2013, the Financial Accounting Standards Board (FASB) issued new accounting guidance requiring an entity to provide information about the amounts reclassified out of accumulated other comprehensive income (AOCI) by component. For items reclassified out of AOCI in their entirety, the disclosure of the income statement line where those items are reflected is also required. Cross-reference to disclosures providing additional information is required for other items not reclassified in their entirety. The guidance does not change the current requirements for reporting net income or other comprehensive income. The guidance, which must be presented prospectively, is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012.



13-12



Consolidated Statement of Income


 
For the years ended June 30,
(Dollars in thousands, except per share amounts)
 
2013

 
2012

 
2011

Net Sales
 
$
13,015,704

 
$
13,145,942

 
$
12,345,870

Cost of sales
 
10,086,675

 
9,958,337

 
9,387,457

Gross profit
 
2,929,029

 
3,187,605

 
2,958,413

Selling, general and administrative expenses
 
1,554,973

 
1,519,316

 
1,467,773

Interest expense
 
91,552

 
92,790

 
99,704

Other (income) expense, net
 
(18,198
)
 
1,295

 
(15,075
)
(Gain) on disposal of assets
 
(10,299
)
 
(2,494
)
 
(7,710
)
Income before income taxes
 
1,311,001

 
1,576,698

 
1,413,721

Income taxes (Note 4)
 
362,217

 
421,206

 
356,571

Net Income
 
948,784

 
1,155,492

 
1,057,150

Less: Noncontrolling interest in subsidiaries' earnings
 
357

 
3,669

 
8,020

Net Income Attributable to Common Shareholders
 
$
948,427

 
$
1,151,823

 
$
1,049,130

 
 
 
 
 
 
 
Earnings per Share Attributable to Common Shareholders (Note 5)
 
 
 
 
 
 
Basic earnings per share
 
$
6.36

 
$
7.62

 
$
6.51

Diluted earnings per share
 
$
6.26

 
$
7.45

 
$
6.37


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

13-13



Consolidated Statement of Comprehensive Income

 
 
For the years ended June 30,
(Dollars in thousands)
 
2013

 
2012

 
2011

Net Income
 
$
948,784

 
$
1,155,492

 
$
1,057,150

Less: Noncontrolling interests in subsidiaries' earnings
 
357

 
3,669

 
8,020

Net income attributable to common shareholders
 
948,427

 
1,151,823

 
1,049,130

 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 Foreign currency translation adjustment (net of tax of $1,239, $(11,530) and $12,675 in 2013, 2012 and 2011)
 
(18,974
)
 
(392,742
)
 
512,081

  Retirement benefits plan activity (net of tax of $(195,884), $330,984 and $(144,108) in 2013, 2012 and 2011)
 
325,066

 
(597,979
)
 
253,603

  Realized loss (net of tax of $(101), $(102), and $(119) in 2013, 2012 and 2011)
 
204

 
204

 
212

    Other comprehensive income (loss)
 
306,296

 
(990,517
)
 
765,896

Less: Other comprehensive (loss) income for noncontrolling interests
 
(1,771
)
 
(25,607
)
 
8,325

Other comprehensive income (loss) attributable to common shareholders
 
308,067

 
(964,910
)
 
757,571

Total Comprehensive Income Attributable to Common Shareholders
 
$
1,256,494

 
$
186,913

 
$
1,806,701


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


13-14



Business Segment Information
By Industry

(Dollars in thousands)
 
2013

 
2012

 
2011

Net Sales:
 
 
 
 
 
 
Industrial:
 
 
 
 
 
 
North America
 
$
5,050,604

 
$
5,041,106

 
$
4,516,510

International
 
4,867,758

 
5,034,249

 
4,917,007

Aerospace
 
2,267,715

 
2,102,747

 
1,921,984

Climate & Industrial Controls
 
829,627

 
967,840

 
990,369

 
 
$
13,015,704

 
$
13,145,942

 
$
12,345,870

Segment Operating Income:
 
 
 
 
 
 
Industrial:
 
 
 
 
 
 
North America
 
$
845,225

 
$
895,010

 
$
745,544

International
 
583,747

 
733,123

 
754,222

Aerospace
 
280,286

 
290,135

 
247,126

Climate & Industrial Controls
 
82,227

 
84,274

 
76,134

Total segment operating income
 
1,791,485

 
2,002,542

 
1,823,026

Corporate administration
 
185,767

 
193,367

 
163,868

Income before interest expense and other
 
1,605,718

 
1,809,175

 
1,659,158

Interest expense
 
91,552

 
92,790

 
99,704

Other expense
 
203,165

 
139,687

 
145,733

Income before income taxes
 
$
1,311,001

 
$
1,576,698

 
$
1,413,721

 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
Industrial
 
$
8,779,858

 
$
7,991,498

 
$
8,413,552

Aerospace
 
1,139,967

 
1,033,449

 
995,026

Climate & Industrial Controls
 
608,169

 
704,596

 
724,966

Corporate (a)
 
2,012,904

 
1,440,739

 
753,261

 
 
$
12,540,898

 
$
11,170,282

 
$
10,886,805

 
 
 
 
 
 
 
Property Additions (b):
 
 
 
 
 
 
Industrial
 
$
306,060

 
$
211,778

 
$
147,929

Aerospace
 
20,838

 
19,651

 
18,012

Climate & Industrial Controls
 
6,332

 
8,094

 
8,234

Corporate
 
7,105

 
8,223

 
38,495

 
 
$
340,335

 
$
247,746

 
$
212,670

 
 
 
 
 
 
 
Depreciation:
 
 
 
 
 
 
Industrial
 
$
177,296

 
$
171,131

 
$
186,057

Aerospace
 
19,498

 
19,395

 
20,035

Climate & Industrial Controls
 
9,718

 
11,722

 
12,895

Corporate
 
7,210

 
8,260

 
10,251

 
 
$
213,722

 
$
210,508

 
$
229,238


13-15



(Dollars in thousands)
 
2013

 
2012

 
2011

By Geographic Area (c)
 
 
 
 
 
 
Net Sales:
 
 
 
 
 
 
North America
 
$
7,844,552

 
$
7,830,517

 
$
7,151,390

International
 
5,171,152

 
5,315,425

 
5,194,480

 
 
$
13,015,704

 
$
13,145,942

 
$
12,345,870

Long-Lived Assets:
 
 
 
 
 
 
North America
 
$
871,958

 
$
867,159

 
$
864,287

International
 
936,282

 
852,809

 
932,892

 
 
$
1,808,240

 
$
1,719,968

 
$
1,797,179


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 (2013 - $74,439; 2012 - $28,929; 2011 - $5,376).
(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.


13-16



Consolidated Balance Sheet
(Dollars in thousands)
 
 
June 30,
 
2013

 
2012

Assets
 
 
 
 
Current Assets
 
 
 
 
Cash and cash equivalents
 
$
1,781,412

 
$
838,317

Accounts receivable, net (Note 1)
 
2,062,745

 
1,992,284

Inventories (Notes 1 and 6):
 
 
 
 
Finished products
 
531,897

 
576,291

Work in process
 
733,025

 
692,042

Raw materials
 
112,483

 
132,399

 
 
1,377,405

 
1,400,732

Prepaid expenses
 
182,669

 
137,429

Deferred income taxes (Notes 1 and 4)
 
126,955

 
129,352

Total Current Assets
 
5,531,186

 
4,498,114

Plant and equipment (Note 1):
 
 
 
 
Land and land improvements
 
316,360

 
300,852

Buildings and building equipment
 
1,431,358

 
1,401,234

Machinery and equipment
 
3,131,077

 
3,051,684

Construction in progress
 
120,506

 
95,459

 
 
4,999,301

 
4,849,229

Less accumulated depreciation
 
3,191,061

 
3,129,261

 
 
1,808,240

 
1,719,968

Investments and other assets (Note 1)
 
687,458

 
931,126

Intangible assets, net (Notes 1 and 7)
 
1,290,499

 
1,095,218

Goodwill (Notes 1 and 7)
 
3,223,515

 
2,925,856

Total Assets
 
$
12,540,898

 
$
11,170,282

 
 
 
 
 
Liabilities and Equity
 
 
 
 
Current Liabilities
 
 
 
 
Notes payable and long-term debt payable within one year (Notes 8 and 9)
 
$
1,333,826

 
$
225,589

Accounts payable, trade
 
1,156,002

 
1,194,684

Accrued payrolls and other compensation
 
426,996

 
463,889

Accrued domestic and foreign taxes
 
136,079

 
153,809

Other accrued liabilities
 
467,300

 
448,042

Total Current Liabilities
 
3,520,203

 
2,486,013

Long-term debt (Note 9)
 
1,495,960

 
1,503,946

Pensions and other postretirement benefits (Note 10)
 
1,372,437

 
1,909,755

Deferred income taxes (Notes 1 and 4)
 
102,920

 
88,091

Other liabilities
 
307,897

 
276,747

Total Liabilities
 
6,799,417

 
6,264,552

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 2013 and 2012
 
90,523

 
90,523

Additional capital
 
608,752

 
640,249

Retained earnings
 
8,421,270

 
7,787,175

Accumulated other comprehensive (loss)
 
(1,107,833
)
 
(1,415,900
)
Treasury shares at cost: 31,757,604 in 2013 and 31,415,530 in 2012
 
(2,274,286
)
 
(2,205,532
)
Total Shareholders' Equity
 
5,738,426

 
4,896,515

Noncontrolling interests
 
3,055

 
9,215

Total Equity
 
5,741,481

 
4,905,730

Total Liabilities and Equity
 
$
12,540,898

 
$
11,170,282

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

13-17



Consolidated Statement of Cash Flows
 
 
For the years ended June 30,
(Dollars in thousands)
 
2013

 
2012

 
2011

Cash Flows From Operating Activities
 
 
 
 
 
 
Net income
 
$
948,784

 
$
1,155,492

 
$
1,057,150

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
Depreciation
 
213,722

 
210,508

 
229,238

Amortization
 
121,902

 
111,421

 
110,562

Stock incentive plan compensation
 
84,996

 
80,935

 
73,238

Deferred income taxes
 
(1,368
)
 
(56,452
)
 
20,715

Foreign currency transaction loss
 
19,497

 
4,300

 
10,470

Loss (gain) on disposal of assets
 
2,746

 
(2,494
)
 
(7,710
)
Gain on sale of businesses
 
(14,637
)
 

 

Changes in assets and liabilities, net of effects from acquisitions:
 
 
 
 
 
 
Accounts receivable
 
(21,206
)
 
(91,091
)
 
(259,752
)
Inventories
 
98,518

 
(28,333
)
 
(139,062
)
Prepaid expenses
 
(47,451
)
 
(26,981
)
 
6,477

Other assets
 
(16,007
)
 
(6,578
)
 
(39,118
)
Accounts payable, trade
 
(66,082
)
 
59,692

 
228,164

Accrued payrolls and other compensation
 
(45,771
)
 
16,003

 
75,405

Accrued domestic and foreign taxes
 
(17,054
)
 
(70,302
)
 
53,424

Other accrued liabilities
 
(62,728
)
 
33,512

 
(27,726
)
Pensions and other postretirement benefits
 
(16,691
)
 
123,944

 
(281,285
)
Other liabilities
 
9,765

 
16,809

 
56,743

Net cash provided by operating activities
 
1,190,935

 
1,530,385

 
1,166,933

Cash Flows From Investing Activities
 
 
 
 
 
 
Acquisitions (less cash acquired of $33,932 in 2013, $19,161 in 2012 and $385 in 2011)
 
(621,144
)
 
(156,256
)
 
(60,227
)
Capital expenditures
 
(265,896
)
 
(218,817
)
 
(207,294
)
Proceeds from disposal of assets
 
25,047

 
20,404

 
32,289

Proceeds from sale of businesses
 
73,515

 

 

Other
 
(21,367
)
 
(21,099
)
 
(9,706
)
Net cash used in investing activities
 
(809,845
)
 
(375,768
)
 
(244,938
)
Cash Flows From Financing Activities
 
 
 
 
 
 
Proceeds from exercise of stock options
 
32,204

 
10,599

 
25,862

Payments for common shares
 
(258,007
)
 
(456,969
)
 
(693,096
)
Tax benefit from stock incentive plan compensation
 
66,030

 
16,107

 
42,823

Acquisition of noncontrolling interests
 
(1,091
)
 
(147,441
)
 

Proceeds from (payments for) notes payable, net
 
1,319,524

 
(1,961
)
 
(18,908
)
Proceeds from long-term borrowings
 
3,768

 
73,556

 
291,683

Payments for long-term borrowings
 
(331,245
)
 
(76,757
)
 
(358,058
)
Dividends paid
 
(255,009
)
 
(240,654
)
 
(206,084
)
Net cash provided by (used in) financing activities
 
576,174

 
(823,520
)
 
(915,778
)
Effect of exchange rate changes on cash
 
(14,169
)
 
(150,246
)
 
75,723

Net increase in cash and cash equivalents
 
943,095

 
180,851

 
81,940

Cash and cash equivalents at beginning of year
 
838,317

 
657,466

 
575,526

Cash and cash equivalents at end of year
 
$
1,781,412

 
$
838,317

 
$
657,466

Supplemental Data:
 
 
 
 
 
 
Cash paid during the year for:
 
 
 
 
 
 
Interest
 
$
88,084

 
$
91,677

 
$
99,227

Income taxes
 
311,988

 
494,378

 
203,539


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


13-18



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, 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
 

 

 

 
757,571

 

 
8,325

 
765,896

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
 

 

 

 
(964,910
)
 

 
(25,607
)
 
(990,517
)
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

Net income
 

 

 
948,427

 

 

 
357

 
948,784

Other comprehensive income (loss)
 

 

 


 
308,067

 

 
(1,771
)
 
306,296

Dividends paid
 

 

 
(254,283
)
 

 

 
(726
)
 
(255,009
)
Stock incentive plan activity
 

 
(34,678
)
 
(60,049
)
 

 
188,423

 


 
93,696

Acquisition activity
 

 
3,181

 


 

 

 
(4,020
)
 
(839
)
Shares purchased at cost
 

 

 


 

 
(257,177
)
 


 
(257,177
)
Balance June 30, 2013
 
$
90,523

 
$
608,752

 
$
8,421,270

 
$
(1,107,833
)
 
$
(2,274,286
)
 
$
3,055

 
$
5,741,481


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

13-19



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.
As of June 30, 2013, the Company operated 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 46 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. Effective July 1, 2013, the businesses of the Climate & Industrial Controls Segment will be consolidated into various business units of the Industrial Segment. As a result of this consolidation and resulting change in management structure, beginning in fiscal 2014, the Company will have two reporting segments: Diversified Industrial and Aerospace Systems.
See the table of Business Segment Information “By Industry” and “By Geographic Area” on pages 13-15 and 13-16 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.




13-20



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.
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,
 
2013

 
2012

Accounts receivable, trade
 
$
1,855,644

 
$
1,792,961

Allowance for doubtful accounts
 
(14,824
)
 
(10,518
)
Non-trade accounts receivable
 
110,394

 
84,872

Notes receivable
 
111,531

 
124,969

Total
 
$
2,062,745

 
$
1,992,284

                      
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 $319,586 and $571,039 at June 30, 2013 and June 30, 2012, 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.


13-21



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, 2013 and 2012 is immaterial to the financial position of the Company and the change in the accrual during 2013, 2012 and 2011 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 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, 2013. No subsequent events occurred that required adjustment to these financial statements. In July 2013, final regulatory approval was received for a previously announced agreement to form a joint venture between the Company and GE Aviation. The joint venture is expected to be formed in fiscal 2014.
Recent Accounting Pronouncements - In February 2013, the Financial Accounting Standards Board (FASB) issued new accounting guidance requiring an entity to provide information about the amounts reclassified out of accumulated other comprehensive income (AOCI) by component. For items reclassified out of AOCI in their entirety, the disclosure of the income statement line where those items are reflected is also required. Cross-reference to disclosures providing additional information is required for other items not reclassified in their entirety. The guidance does not change the current requirements for reporting net income or other comprehensive income. The guidance, which must be presented prospectively, is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012.


2.
Acquisitions and Divestitures
Acquisitions - During 2013, the Company completed eight acquisitions whose aggregate sales for their most recent fiscal year prior to acquisition were $484 million. Total purchase price for the eight acquisitions was approximately $621 million in cash and $114 million in assumed debt.
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 in 2012 was approximately $156 million in cash. 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 acquisition whose aggregate sales for their most recent fiscal year prior to acquisition were $65 million. Total purchase price for the three acquisitions was approximately $61 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 2013, 2012 and 2011 are presented below. Some of the 2013 acquisitions are still subject to purchase price adjustments.



13-22



 
2013

 
2012

 
2011

Assets:
 
 
 
 
 
Accounts receivable
$
91,668

 
$
24,833

 
$
9,332

Inventories
93,915

 
29,102

 
7,908

Prepaid expenses
4,672

 
1,541

 
69

Deferred income taxes
(1,713
)
 
5,679

 
468

Plant and equipment
74,439

 
28,929

 
5,376

Intangible and other assets
280,001

 
59,576

 
35,094

Goodwill
317,879

 
68,144

 
8,715

 
860,861

 
217,804

 
66,962

Liabilities and equity:
 
 
 
 
 
Notes payable
11,920

 
1,887

 

Accounts payable, trade
46,596

 
7,189

 
2,440

Accrued payrolls and other compensation
12,099

 
3,672

 
765

Accrued domestic and foreign taxes
7,073

 
2,882

 
215

Other accrued liabilities
16,805

 
5,984

 
1,500

Long-term debt
102,122

 
4,365

 

Pensions and other postretirement benefits
2,125

 
11,396

 

Deferred income taxes
39,214

 
24,062

 
1,815

Other liabilities
689

 
111

 

Noncontrolling interests
1,074

 

 

 
239,717

 
61,548

 
6,735

Net assets acquired
$
621,144

 
$
156,256

 
$
60,227


Divestitures - During 2013, the Company completed several divestitures, the primary ones being the automotive businesses of its Mobile Climate Systems division and its Turkey refrigeration components business. Both of these businesses were part of the Climate & Industrial Control Segment and had combined revenues of approximately $158 million for their most recent fiscal year. The Company recorded a net pre-tax gain during 2013 of approximately $18 million related to these divestitures. The gain is reflected in the (gain) on disposal of assets caption in the Consolidated Statement of Income.

13-23



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 2013, 2012 and 2011.
Business realignment charges by business segment are as follows:
 
2013

 
2012

 
2011

Industrial
$
11,315

 
$
13,066

 
$
15,427

Aerospace

 

 
1,024

Climate & Industrial Controls
919

 
1,255

 

Work force reductions by business segment are as follows:
 
2013

 
2012

 
2011

Industrial
644

 
496

 
466

Aerospace

 

 
49

Climate & Industrial Controls
81

 
25

 

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. In addition, $1,918 of severance costs for 98 people have been recognized in connection with the Company's divestiture of its Turkey refrigeration components business and is reflected in the other expense caption in the Business Segment Information for 2013. 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:
 
2013

 
2012

 
2011

Cost of sales
$
8,354

 
$
12,669

 
$
15,276

Selling, general and administrative expenses
3,880

 
1,020

 
1,175

Other (income) expense, net
1,918

 
632

 

As of June 30, 2013, approximately $10 million in severance payments had been made relating to charges incurred during 2013, with the majority of the remaining payments expected to be made by March 31, 2014. All required severance payments have been made relating to charges incurred in 2012 and 2011. 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:

 
2013

 
2012

 
2011

United States
$
653,622

 
$
810,150

 
$
681,910

Foreign
657,379

 
766,548

 
731,811

 
$
1,311,001

 
$
1,576,698

 
$
1,413,721




13-24



Income taxes include the following:

 
2013

 
2012

 
2011

Federal
 
 
 
 
 
  Current
$
167,350

 
$
255,991

 
$
121,292

  Deferred
26,523

 
(48,252
)
 
34,136

Foreign
 
 
 
 
 
  Current
176,739

 
191,167

 
193,064

  Deferred
(28,472
)
 
(29
)
 
(24,229
)
State and local
 
 
 
 
 
  Current
19,496

 
30,500

 
21,500

  Deferred
581

 
(8,171
)
 
10,808

 
$
362,217

 
$
421,206

 
$
356,571


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

 
2013

 
2012

 
2011

Statutory Federal income tax rate
35.0
 %
 
35.0
 %
 
35.0
 %
State and local income taxes
1.0

 
0.9

 
1.8

Foreign tax rate difference
(5.8
)
 
(5.8
)
 
(8.7
)
Cash surrender value of life insurance
(0.7
)
 
0.1

 
(0.9
)
Federal manufacturing deduction
(1.0
)
 
(1.6
)
 
(0.9
)
Research tax credit
(1.1
)
 
(0.4
)
 
(1.1
)
Other
0.2

 
(1.5
)
 

Effective income tax rate
27.6
 %
 
26.7
 %
 
25.2
 %

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:

 
2013

 
2012

Retirement benefits
$
535,260

 
$
751,676

Other liabilities and reserves
113,257

 
134,358

Long-term contracts
26,714

 
27,726

Stock-based incentive compensation
59,274

 
70,129

Loss carryforwards
286,180

 
175,571

Unrealized currency exchange gains and losses
14,639

 
9,057

Inventory
15,570

 
18,535

Foreign tax credit carryforward
25,195

 
19,079

Depreciation and amortization
(527,860
)
 
(480,791
)
Valuation allowance
(273,413
)
 
(176,079
)
Net deferred tax asset
$
274,816

 
$
549,261

Change in net deferred tax asset:
 
 
 
Provision for deferred tax
$
1,368

 
$
56,452

Items of other comprehensive (loss)
(194,746
)
 
319,352

Acquisitions and other
(81,067
)
 
(16,160
)
Total change in net deferred tax
$
(274,445
)
 
$
359,644



13-25



At June 30, 2013, the Company had recorded deferred tax assets of $286,180 resulting from $1,012,448 in loss carryforwards. A valuation allowance of $256,124 related to the loss carryforwards has been established due to the uncertainty of realizing certain deferred tax assets. Of this valuation allowance, $244,484, relates to non-operating entities whose loss carryforward utilization is considered to be remote. 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 approximately $2,700,000 at June 30, 2013.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

 
2013

 
2012

 
2011

Balance July 1
$
109,735

 
$
81,156

 
$
82,089

Additions for tax positions related to current year
10,285

 
66,500

 
8,398

Additions for tax positions of prior years
10,719

 
11,047

 
10,015

Reductions for tax positions of prior years
(20,683
)
 
(23,456
)
 
(15,060
)
Reductions for settlements
(4,266
)
 
(23,434
)
 
(7,133
)
Reductions for expiration of statute of limitations
(437
)
 
(1,636
)
 

Effect of foreign currency translation
2,087

 
(442
)
 
2,847

Balance June 30
$
107,440

 
$
109,735

 
$
81,156


The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $60,876, $61,601 and $78,754 as of June 30, 2013, 2012 and 2011, respectively. If recognized, a significant portion of the gross unrecognized tax benefits as of June 30, 2013 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 $5,184, $3,676 and $11,331 as of June 30, 2013, 2012 and 2011, 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.


13-26





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:

 
2013

 
2012

 
2011

Numerator:
 
 
 
 
 
Net income attributable to common shareholders
$
948,427

 
$
1,151,823

 
$
1,049,130

Denominator:
 
 
 
 
 
Basic - weighted-average common shares
149,218,257

 
151,222,033

 
161,125,869

Increase in weighted-average common shares from dilutive effect of stock-based awards
2,369,774

 
3,442,477

 
3,672,352

Diluted - weighted-average common shares, assuming exercise of stock-based awards
151,588,031

 
154,664,510

 
164,798,221

Basic earnings per share
$
6.36

 
$
7.62

 
$
6.51

Diluted earnings per share
$
6.26

 
$
7.45

 
$
6.37


For 2013, 2012 and 2011, 1.3 million, 0.7 million, and 1.6 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 29 percent of total inventories in 2013 and 31 percent of total inventories in 2012. The current cost of these inventories exceeds their valuation determined on the LIFO basis by $207,277 in 2013 and $212,033 in 2012. Progress payments of $42,446 in 2013 and $36,087 in 2012 are netted against inventories.

7.
Goodwill and Intangible Assets
The Company's annual impairment tests performed in 2013, 2012, and 2011 resulted in no impairment loss being recognized.
The changes in the carrying amount of goodwill are as follows:
 
Industrial Segment
 
Aerospace Segment
 
Climate & Industrial Controls Segment
 
Total
Balance June 30, 2011
$
2,595,989

 
$
98,914

 
$
314,213

 
$
3,009,116

Acquisitions
65,480

 
(193
)
 

 
65,287

Foreign currency translation and other
(143,348
)
 
(47
)
 
(5,152
)
 
(148,547
)
Balance June 30, 2012
$
2,518,121

 
$
98,674

 
$
309,061

 
$
2,925,856

Acquisitions
316,857

 

 

 
316,857

Divestitures
(61
)
 

 
(20,044
)
 
(20,105
)
Foreign currency translation and other