Exhibit (13)* to Report on Form 10-K for Fiscal Year Ended June 30, 1998 by Parker-Hannifin Corporation Excerpts from Annual Report to Shareholders for the fiscal year ended June 30, 1998. *Numbered in accordance with Item 601 of Regulation S-K. FORWARD-LOOKING STATEMENTS This Annual Report and other written reports and oral statements made from time to time by the Company may contain "forward-looking statements", all of which are subject to risks and uncertainties. All statements which address operating performance, events or developments that we expect or anticipate will occur in the future, including statements relating to growth, operating margin performance, earnings per share or statements expressing general opinions about future operating results, are forward-looking statements. These forward-looking statements rely on a number of assumptions concerning future events, and are subject to a number of uncertainties and other factors, many of which are outside the Company's control, that could cause actual results to differ materially from such statements. Such factors include: * continuity of business relationships with and purchases by major customers, including among others, orders and delivery schedules for aircraft components, * ability of suppliers to provide materials as needed, * uncertainties surrounding timing, successful completion or integration of acquisitions, * competitive pressure on sales and pricing, * increases in material and other production costs which cannot be recovered in product pricing, * uncertainties surrounding the year 2000 issues and the new Euro currency, * difficulties in introducing new products and entering new markets, and * uncertainties surrounding the global economy and global market conditions, including among others, the economy of the Asia Pacific region and the potential devaluation of currencies. Any forward-looking statements are made based on known events and circumstances at the time. The Company undertakes no obligation to update or publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this Report. Page 13-1 DISCUSSION OF STATEMENT OF INCOME THE CONSOLIDATED STATEMENT OF INCOME summarizes the Company's operating performance over the last three years. NET SALES of $4.63 billion for 1998 were 13.2 percent higher than the $4.09 billion for 1997. Acquisitions accounted for approximately one-fifth of this increase. The Industrial operations experienced continued strong order demand within the heavy-duty truck, construction equipment, factory automation, telecommunications and refrigeration markets. The European operations continued to grow and the Company continued to penetrate markets in Asia Pacific and Latin American regions. Volume increases within International operations were partially offset by currency rate changes. The Aerospace operations experienced strong demand within the commercial transport, business jet and general aviation markets. Net sales for 1997 were 14.1 percent higher than the $3.59 billion sales in 1996. Acquisitions accounted for more than half of this increase. North American Industrial operations achieved strong order demand, especially within the factory automation, machine tool, and agricultural and construction equipment markets. There was also increased demand for sealing products, and light-truck and automotive products. International Industrial operations' results were relatively flat, with Europe experiencing a soft economy for most of the year. Volume increases were partially offset by currency rate changes. The Aerospace operations achieved the majority of the sales growth as demand was strong within the OEM commercial and general aviation industries and the maintenance, repair and overhaul business. The Company is anticipating moderate growth for the next year as growth in Industrial markets within North America is expected to be less than the current pace. European markets are expected to continue to improve and the Company expects to increase market penetration in Latin America. The Aerospace operations expect some moderation in the recent robust growth within the commercial aviation OEM, and repair and overhaul businesses. A strong backlog and participation on nearly every currently flown aircraft provide a very positive outlook. GROSS PROFIT MARGIN was 23.4 percent in 1998. Cost of sales for 1998 includes a non-cash, non-recurring charge of $15.8 million for in-process R&D purchased as part of two acquisitions. Before these charges, the gross profit margin for 1998 was 23.7 percent, compared to 22.9 percent in 1997 and 23.1 percent in 1996. The improvement in 1998 is primarily the result of better absorption of fixed costs due to higher volume and the benefits of continued integration of prior-year acquisitions. The improvement was partially offset by recently acquired operations contributing lower margins, as their integration continues. In addition, gross margins were affected by the Asian financial crisis and the depressed worldwide semiconductor market. The decrease in gross profit margin in 1997 was due to newly acquired operations contributing lower margins. In addition, weak demand throughout Europe in 1997 resulted in lower capacity utilization and reduced gross profit for the International operations. Partially offsetting these declines, the higher volume in 1997 improved capacity utilization and provided higher margins for most of the North American Industrial and Aerospace operations. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES as a percent of sales decreased to 11.5 percent, from 11.6 percent in 1997, and 11.9 percent in 1996. As volume increased these expenses remained relatively unchanged, Page 13-2 except for increased costs from acquisitions, incentive programs and initiatives to enter new markets. INTEREST EXPENSE increased by $6.1 million in 1998 and $10.0 million in 1997 due to increased borrowings to complete acquisitions. INTEREST AND OTHER INCOME, NET was $6.8 million in 1998 compared to $5.6 million in 1997. Fiscal 1998 income included $3.8 million of interest from a settlement with the IRS. Fiscal 1996 income of $8.5 million included income received from several minor Corporate investments. GAIN (LOSS) ON DISPOSAL OF ASSETS was less than $.1 million in 1998, a $3.0 million gain in 1997 and a $2.0 million loss in 1996. The 1997 gain includes $17.1 million income from the sale of real estate in California. This income was substantially offset by $13.3 million accrued for exit costs and charges for impaired assets related to the relocation of the corporate headquarters. INCOME TAXES increased to an effective rate of 35.9 percent in 1998, compared to 35.5 percent in 1997. The rate in 1996 was 36.0 percent. The increased 1998 rate is the result of receiving no tax benefit for one of the R&D charges. The reduction in the rate for 1997, as compared to 1996, is the result of increased tax benefits based on the export of products manufactured in the U.S. EXTRAORDINARY ITEM - EXTINGUISHMENT OF DEBT - On June 30, 1998 the Company called for redemption all of its outstanding $100 million, 10.375 percent debentures due 1999-2018. NET INCOME of $319.6 million for 1998 was 16.6 percent higher than 1997. Before the 1998 extraordinary item - extinguishment of debt, income increased 17.9 percent over 1997. Net income of $274.0 million for 1997 was 14.3 percent higher than 1996. Net income as a percentage of sales, before the extraordinary item, was 7.0 percent in 1998, compared to 6.7 percent in 1997 and 1996. YEAR 2000 CONSIDERATIONS - The Company has been taking actions to assure that its computerized products and systems and all external interfaces are Year 2000 compliant. The Company expects to have all internal standard application systems compliant by July 1999 by modifying present systems, installing new systems and monitoring third-party interfaces. The cost for these actions is not material to the Company's results of operations. In addition, the Company is currently contacting its key suppliers, customers, distributors and financial service providers regarding their Year 2000 status and anticipates this survey will be substantially complete by January 1999. If it is determined any key third party may not be prepared, the Company will develop an alternative contingency plan. While management does not expect that the consequences of any unsuccessful modifications would significantly affect the financial position, liquidity, or results of operations of the Company, there can be no assurance that failure to be fully compliant by 2000 would not have an impact on the Company. EURO PREPARATIONS - The Company is in the process of upgrading its systems to accommodate the Euro currency by January 1, 1999. The cost of this upgrade is immaterial to the Company's financial results. Although difficult to predict, any competitive implications and any impact on existing financial instruments are also expected to be immaterial to the Company's results of operations, financial position or liquidity. Page 13-3 DISCUSSION OF BALANCE SHEET THE CONSOLIDATED BALANCE SHEET shows the Company's financial position at year end, compared with the previous year end. This statement provides information to assist in assessing factors such as the Company's liquidity and financial resources. The effect of currency rate changes during the year caused a $32.7 million decrease in the Foreign currency translation adjustments equity account. These rate changes also caused significant decreases in accounts receivable, inventories, goodwill and plant and equipment, as well as significant decreases in accounts payable and the various accrual accounts. Working capital and the current ratio were as follows: Working Capital (millions) 1998 1997 _________________________________________________ Current Assets $ 1,780 $ 1,500 Current Liabilities 989 716 Working Capital 791 784 Current Ratio 1.8 2.1 ================================================= ACCOUNTS RECEIVABLE are primarily due from customers for sales of product ($642.3 million at June 30, 1998, compared to $554.5 million at June 30, 1997). The current year increase in accounts receivable is primarily due to acquisitions and increased volume. Days sales outstanding for the Company increased slightly from 1997. An increase in the allowance for doubtful accounts in 1998 is primarily due to receivables obtained through acquisitions. INVENTORIES increased to $944.3 million at June 30, 1998, compared to $727.8 million a year ago, partially due to acquisitions and increased volume. Additional increases occurred, primarily within work in process and finished goods, in order to improve customer service response time. Months supply of inventory on hand at June 30, 1998 increased to 3.7 months from 3.4 months at June 30, 1997. PLANT AND EQUIPMENT, net of accumulated depreciation, increased $114.5 million in 1998 as a result of acquisitions and capital expenditures which exceeded annual depreciation. INVESTMENTS AND OTHER ASSETS increased $20.5 million in 1998 primarily as a result of increases in pension assets and the cash surrender value of corporate-owned life insurance contracts, partially offset by a reduction in investments due to the acquisition and consolidation of two joint ventures. EXCESS COST OF INVESTMENTS OVER NET ASSETS ACQUIRED increased $114.4 million in 1998 as a result of acquisitions, partially offset by currency rate fluctuations and amortization. The additional excess cost of investments in 1998 is being amortized over 15 years. NOTES PAYABLE AND LONG-TERM DEBT PAYABLE WITHIN ONE YEAR increased $195.7 million due to increased investment in commercial paper and the currently payable $100 million 10.375% debentures called for redemption in June 1998. ACCOUNTS PAYABLE, TRADE increased $71.4 million in 1998 due to the timing of payments, acquisitions and the increased volume. The majority of the increase was within North American Industrial operations. ACCRUED PAYROLLS AND OTHER COMPENSATION increased $19.4 million in 1998 Page 13-4 primarily as a result of increased headcount and incentive plans which are based on sales and earnings. ACCRUED DOMESTIC AND FOREIGN TAXES decreased to $34.4 million in 1998 from $51.4 million in 1997 primarily due to higher estimated income tax payments made in 1998. LONG-TERM DEBT increased $80.1 million in 1998 primarily due to increased borrowings to fund acquisitions. See the Cash Flows From Financing Activities section on page 13-7 for further discussion. 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. To meet this objective, the Company has established a financial goal of maintaining a ratio of debt to debt-equity of 30 to 33 percent. Debt to Debt-Equity Ratio (millions) 1998 1997 _________________________________________________________ Debt $ 778 $ 503 Debt & Equity 2,462 2,050 Ratio 31.6% 24.5% ========================================================= In fiscal 1999 additional borrowings are not anticipated for the stock repurchase program, capital investments, or for working capital purposes, but may be utilized for acquisitions. PENSIONS AND OTHER POSTRETIREMENT BENEFITS increased 5.1 percent in 1998. These costs are explained further in Note 8 to the Consolidated Financial Statements. OTHER LIABILITIES increased to $44.2 million in 1998 from $24.0 million in 1997 primarily due to increases in deferred compensation plans. DISCUSSION OF CASH FLOWS THE CONSOLIDATED STATEMENT OF CASH FLOWS reflects cash inflows and outflows from the Company's operating, investing and financing activities. Cash and cash equivalents decreased $38.5 million in 1998 after increasing $5.0 million in 1997. CASH FLOWS FROM OPERATING ACTIVITIES -- The Company's largest source of cash continues to be net cash provided by operating activities. Net cash provided by operating activities in 1998 was $320.6 million compared to $392.3 million in 1997. This decrease of $71.7 million is principally due to Inventories using cash of $185.6 million in 1998 compared to $27.0 million in 1997. Other accrued liabilities used cash of $9.1 million in 1998 compared to providing cash of $16.0 million in 1997. Accrued domestic and foreign taxes also used cash in 1998 of $15.3 million after providing cash of $4.3 million in 1997. These uses of cash in 1998 were partially offset with cash provided by an increase of $45.5 million in Net income in 1998 and a $52.9 million increase in Accounts payable in 1998 compared to an increase of $31.7 million in 1997. In addition, the 1998 write-off of purchased in- process R&D of $15.8 million was a non-cash charge added back to Net income to reconcile to the net cash provided by operating activities. The net cash provided by operating activities in 1997 increased $54.3 million compared to 1996. This increase is principally the result of an Page 13-5 increase of $34.4 million in Net income and the non-cash expenses of Depreciation and Amortization increasing $28.5 million. Accounts receivable used cash of $76.1 million in 1997 as a result of increased volume, compared to providing cash of $8.7 million in 1996. Inventories also used cash of $27.0 million in 1997, an increase of $12.0 million compared to the cash used in 1996. Partially offsetting these uses of cash, Accounts payable, trade provided cash of $31.7 million in 1997 compared to using cash of $15.5 million in 1996. Increases in Other accrued liabilities also provided cash of $16.0 million in 1997 compared to using cash of $31.8 million in 1996. CASH FLOWS FROM INVESTING ACTIVITIES -- Net cash used in investing activities was $264.4 million greater in 1998 than 1997, primarily due to Acquisitions using $201.5 million more cash in 1998. Also, Capital expenditures increased $47.8 million in 1998. These investments to support growth and efficient manufacturing technology demonstrate the Company's commitment to improving shareholder value. Net cash used in investing activities for 1997 was $359.8 million lower than in 1996 primarily due to less cash used for Acquisitions. The most significant use of cash in 1997 was Capital expenditures, which at $189.2 million was $12.5 million less than the previous year. To complete Acquisitions the Company utilized cash of $233.0 million and treasury shares valued at $11.9 million in 1998; cash of $31.5 million in 1997; and cash of $359.4 million and treasury shares valued at $6.2 million in 1996. The net assets of the acquired companies at their respective acquisition dates consisted of the following: (In thousands) 1998 1997 1996 ____________________________________________________________________ Assets acquired: Accounts receivable $ 39,286 $ 4,549 $ 70,916 Inventories 43,847 13,410 77,582 Prepaid expenses 1,393 247 1,459 Deferred income taxes 1,643 1,576 18,942 Plant & equipment 54,718 15,283 124,222 Other assets 3,762 (1,121) 23,515 Excess cost of investments over net assets acquired 162,680 11,596 223,873 ____________________________________________________________________ 307,329 45,540 540,509 ____________________________________________________________________ Page 13-6 Liabilities assumed: Notes payable 8,690 2,050 13,256 Accounts payable 21,841 2,418 26,880 Accrued payrolls 4,418 471 10,377 Accrued taxes 2,840 941 11,620 Other accrued liabilities 11,421 4,582 47,820 Long-term debt 9,706 2,454 8,235 Pensions and other postretirement benefits 477 1,163 49,798 Other liabilities 3,033 6,900 ____________________________________________________________________ 62,426 14,079 174,886 ____________________________________________________________________ Net assets acquired $ 244,903 $ 31,461 $ 365,623 ==================================================================== CASH FLOWS FROM FINANCING ACTIVITIES -- In 1998 the Company increased its outstanding borrowings by a net total of $264.9 million primarily to fund acquisitions. The majority of the funding was through the issuance of commercial paper. Additional funds were obtained through the issuance of $50 million of medium-term notes in December 1997. In July 1998 the Company issued another $100 million of medium-term notes. In 1997 the Company decreased its outstanding borrowings by a net total of $121.3 million. As of June 30, 1997, the Company paid off all commercial paper and selected notes payable attributable to the International operations. Common share activity includes the repurchase of stock and the exercise of stock options. During 1998 the Company purchased 2,522,971 shares for treasury. In July 1998, the Board of Directors of the Company increased the authorization for future repurchases to 5.05 million shares. Dividends have been paid for 192 consecutive quarters, including a yearly increase in dividends for the last 42 fiscal years. The current annual dividend rate is $.60 per share. In summary, based upon the Company's past performance and current expectations, management believes the cash flows generated from future operating activities, combined with the Company's worldwide financial capabilities, will provide adequate funds to support planned growth and continued improvements in the Company's manufacturing facilities and equipment. DISCUSSION OF BUSINESS SEGMENT INFORMATION THE BUSINESS SEGMENT INFORMATION presents sales, operating income and assets by the principal industries and geographic areas in which the Company's various businesses operate. Page 13-7 INDUSTRIAL SEGMENT 1998 1997 1996 ______________________________________________________________ Operating income as a percent of sales 12.4% 12.5% 12.4% Return on average assets 19.1% 18.7% 18.3% ______________________________________________________________ Sales for the Industrial North American operations increased to $2.48 billion in 1998, 15.0 percent over 1997, following 1997's increase of 9.1 percent over 1996. Nearly one-fifth of the increase in both years was due to acquisitions. The growth in 1998 was spread among numerous markets, but primarily was the result of growth in the light and heavy-duty truck, construction equipment, telecommunications, factory automation, machine tool and refrigeration markets. Recent order entry indicates continuing, but moderate growth for the North American operations for 1999. In addition to this growth, the Company expects to increase sales through acquisitions. International Industrial sales increased to a record $1.16 billion, 8.2 percent over 1997. Without the impact of changes in currency rates, volume for 1998 increased over 17 percent. Acquisitions contributed over half of the 1998 increase. European markets experienced steady growth during the year. The Company also continued to penetrate markets in Asia Pacific and Latin American regions. Further advances within these regions are planned for 1999 in addition to the continuing growth anticipated for Europe. International sales for 1997 increased 8.5 percent over 1996. Without the impact of changes in currency rates, volume for 1997 increased nearly 15 percent. Net of the currency impact, acquisitions accounted for a majority of the increase. Demand in Europe was relatively weak for the majority of 1997 with some improvement occurring in the fourth quarter. Latin America made an impressive recovery during the year with strength returning in Brazilian markets. Asia Pacific also contributed to the growth in 1997. Backlog for the Industrial Segment was $585.2 million at June 30, 1998, compared to $510.8 million at the end of the prior period. Acquisitions contributed over one-third of this increase. The remaining increase was due to volume growth, primarily within North America. The 1997 increase over backlog of $464.6 million at June 30, 1996 was also due to increased volume within the North American operations, as well as acquisitions. Industrial North American operating income, before a $5.2 million R&D charge in 1998, increased 13.2 percent in 1998 and 11.4 percent in 1997, with Income from operations as a percent of sales at 15.1 percent in 1998, before the R&D charge, compared to 15.3 percent in 1997 and 15.0 percent in 1996. Pricing pressures were experienced throughout most of the Industrial markets. Recently purchased acquisitions, not yet fully integrated, contributed lower margins. On the other hand, previous years' acquisitions, now fully integrated, were able to contribute higher margins, partially offsetting the decline in Income from operations as a percent of sales. Raw material prices remained relatively stable during the year. International Income from operations, before a $10.6 million R&D charge in 1998, increased 27.1 percent in 1998 after a 1997 increase of 2.7 percent over 1996. Income as a percent of sales, before the R&D charge, increased to 8.1 percent after a decrease to 6.9 percent in 1997 from 7.3 percent in 1996. Page 13-8 The European Industrial markets performed well during 1998. Increased volume improved capacity utilization and previous acquisitions became integrated, resulting in improved margins. Recent acquisitions, with lower margins, partially offset these improvements. The Company's direct exposure to Asia Pacific is immaterial, but due to the current financial crisis, extreme pricing pressures were realized in the semiconductor markets, having an indirect effect on the Company. Operating income for 1997 was affected by acquisitions which contributed lower operating margins primarily within International, but also within North America, because of integration costs incurred without the benefit of synergies yet to be realized. Assets for the Industrial segment increased 17.9 percent in 1998 after only a slight increase in 1997. The increase in 1998 is primarily due to acquisitions and increases in inventories, partially offset by currency fluctuations. In 1997 currency fluctuations offset increases from acquisitions and increases in accounts receivable and inventories. In both years net plant and equipment increased due to capital expenditures exceeding depreciation. AEROSPACE SEGMENT 1998 1997 1996 ______________________________________________________________ Operating income as a percent of sales 16.0% 12.7% 13.7% Return on average assets 22.5% 17.7% 19.2% ______________________________________________________________ Sales increased 15.1 percent in 1998 and 38.8 percent in 1997. Increased commercial aircraft deliveries and continued penetration of the commercial repair and overhaul businesses contributed to the higher volume in 1998. Over one-half of the 1997 increase was due to an acquisition. Aerospace markets experienced strong growth during both 1998 and 1997. Gains were primarily within the commercial-transport original equipment market as the military market remained relatively flat for the past several years. Backlog at June 30, 1998 was $1.06 billion compared to $976.2 million in 1997 and $866.3 million in 1996, reflecting the strong growth of the commercial aircraft market. Operating income increased 45.3 percent in 1998 and 28.3 percent in 1997. As a percent of sales 1998 income was 16.0 percent compared to 12.7 percent in 1997 and 13.7 percent in 1996. Current year margins benefited from improved capacity utilization due to higher volume and a more favorable product mix. The 1997 decline in margins was primarily the result of lower margins contributed by the Abex operations which were still in the integration phase. Increases to long-term contract reserves also impacted the 1997 margins. Assets increased 19.9 percent in 1998 after an 8.0 percent increase in 1997. For both periods the increases were primarily in customer receivables, inventories and property, plant and equipment, partially offset by a decrease in net goodwill. Page 13-9 CORPORATE ASSETS increased 5.5 percent in 1998 after a 33.2 percent increase in 1997. The increase in 1998 is primarily due to capital additions. The 1997 increase was the result of the construction of a new corporate headquarters, a net receivable resulting from two currency hedges and an increase in short-term investments. Page 13-10 CONSOLIDATED STATEMENT OF INCOME (Dollars in thousands, except per share amounts)
For the years ended June 30, 1998 1997 1996 NET SALES $ 4,633,023 $ 4,091,081 $ 3,586,448 Cost of sales 3,550,992 3,152,988 2,756,343 ___________ ___________ ___________ Gross profit 1,082,031 938,093 830,105 Selling, general and administrative expenses 532,134 475,180 425,449 ___________ ___________ ___________ INCOME FROM OPERATIONS 549,897 462,913 404,656 Other income (deductions): Interest expense (52,787) (46,659) (36,667) Interest and other income, net 6,783 5,623 8,537 Gain (loss) on disposal of assets 95 2,990 (2,047) ___________ ___________ ___________ (45,909) (38,046) (30,177) ___________ ___________ ___________ Income before income taxes 503,988 424,867 374,479 Income taxes (Note 3) 180,762 150,828 134,812 ___________ ___________ ___________ Income before extraordinary item 323,226 274,039 239,667 Extraordinary item - extinguishment of debt (Note 7) (3,675) ___________ ___________ ___________ NET INCOME $ 319,551 $ 274,039 $ 239,667 =========== =========== =========== EARNINGS PER SHARE (Note 4) Basic earnings per share before extraordinary item $ 2.91 $ 2.46 $ 2.15 Extraordinary item - extinguishment of debt (.03) ___________ ___________ ___________ Basic earnings per share $ 2.88 $ 2.46 $ 2.15 =========== =========== =========== Diluted earnings per share before extraordinary item $ 2.88 $ 2.44 $ 2.14 Extraordinary item - extinguishment of debt (.03) ___________ ___________ ___________ Diluted earnings per share $ 2.85 $ 2.44 $ 2.14 =========== =========== ===========
The accompanying notes are an integral part of the financial statements. Page 13-11 QUARTERLY INFORMATION (Dollars in thousands, except per share amounts)
1998 (a)(b) 1st 2nd 3rd 4th Total ______________________________________________________________________________________________________ Net sales $ 1,083,169 $ 1,114,948 $ 1,196,548 $ 1,238,358 $ 4,633,023 Gross profit 256,030 252,739 284,226 289,036 1,082,031 Income before extraordinary item 78,261 71,314 83,225 90,426 323,226 Net income 78,261 71,314 83,225 86,751 319,551 Diluted earnings per share before extraordinary item .70 .63 .75 .80 2.88 Diluted earnings per share .70 .63 .75 .77 2.85 ====================================================================================================== 1997 (a) 1st 2nd 3rd 4th Total ______________________________________________________________________________________________________ Net sales $ 959,328 $ 969,587 $ 1,047,100 $ 1,115,066 $ 4,091,081 Gross profit 204,830 208,264 246,522 278,477 938,093 Net income 51,105 52,564 77,964 92,406 274,039 Diluted earnings per share .45 .47 .70 .82 2.44 ====================================================================================================== (a) Quarterly Information is unaudited. (b) Results for the third and fourth quarters include a non-cash, non- recurring pretax charge of $5.2 million and $10.6 million, respectively, for in-process R&D purchased as part of two acquisitions. The after-tax impact was $5.2 million ($.05 per share) and $6.8 million ($.06 per share), respectively.
Page 13-12 CONSOLIDATED BALANCE SHEET (Dollars in thousands) June 30, 1998 1997 ASSETS CURRENT ASSETS Cash and cash equivalents $ 30,488 $ 68,997 Accounts receivable, less allowance for doubtful accounts (1998 - $9,004; 1997 - $5,904) 699,179 601,724 Inventories (Notes 1 and 5): Finished products 416,034 317,494 Work in process 392,880 304,743 Raw materials 135,357 105,610 ___________ ___________ 944,271 727,847 Prepaid expenses 22,035 17,366 Deferred income taxes (Notes 1 and 3) 84,102 83,627 ___________ ___________ TOTAL CURRENT ASSETS 1,780,075 1,499,561 Plant and equipment (Note 1): Land and land improvements 113,774 96,995 Buildings and building equipment 552,177 486,655 Machinery and equipment 1,560,016 1,443,820 Construction in progress 119,142 111,121 ___________ ___________ 2,345,109 2,138,591 Less accumulated depreciation 1,209,884 1,117,848 ___________ ___________ 1,135,225 1,020,743 Investments and other assets (Note 1) 194,632 174,142 Excess cost of investments over net assets acquired (Note 1) 399,681 285,264 Deferred income taxes (Notes 1 and 3) 15,208 19,236 ___________ ___________ TOTAL ASSETS $ 3,524,821 $ 2,998,946 =========== =========== Page 13-13 LIABILITIES AND SHAREHOLDERS' EQUITYCURRENT LIABILITIES Notes payable and long-term debt payable within one year (Notes 6 and 7) $ 265,485 $ 69,738 Accounts payable, trade 338,249 266,848 Accrued payrolls and other compensation 163,879 144,481 Accrued domestic and foreign taxes 34,374 51,374 Other accrued liabilities 186,783 183,570 ___________ ___________ TOTAL CURRENT LIABILITIES 988,770 716,011 Long-term debt (Note 7) 512,943 432,885 Pensions and other postretirement benefits (Notes 1 and 8) 265,675 252,709 Deferred income taxes (Notes 1 and 3) 29,739 26,007 Other liabilities 44,244 24,033 ___________ ___________ TOTAL LIABILITIES 1,841,371 1,451,645 ___________ ___________ SHAREHOLDERS' EQUITY (Note 9) Serial preferred stock, $.50 par value, authorized 3,000,000 shares; none issued Common stock, $.50 par value, authorized 600,000,000 shares; issued 111,812,025 shares in 1998 and 111,809,085 shares in 1997 at par value 55,906 55,905 Additional capital 139,726 150,702 Retained earnings 1,631,316 1,378,297 Foreign currency translation adjustments (60,026) (27,345) ___________ ___________ 1,766,922 1,557,559 Common stock in treasury at cost; 1,938,762 shares in 1998 and 282,915 shares in 1997 (83,472) (10,258) ___________ ___________ TOTAL SHAREHOLDERS' EQUITY 1,683,450 1,547,301 ___________ ___________ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 3,524,821 $ 2,998,946 =========== =========== The accompanying notes are an integral part of the financial statements. Page 13-14 CONSOLIDATED STATEMENT OF CASH FLOWS (Dollars in thousands)
For the years ended June 30, 1998 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 319,551 $ 274,039 $ 239,667 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 153,633 146,253 126,544 Amortization 29,046 23,580 14,819 Deferred income taxes 7,680 (1,269) (3,691) Foreign currency transaction loss 3,697 1,947 1,733 Loss (gain) on sale of plant and equipment 291 (9,811) 3,506 Write-off of purchased in-process research and development 15,800 Net effect of extraordinary loss 3,675 Changes in assets and liabilities, net of effects from acquisitions and dispositions: Accounts receivable (71,034) (76,081) 8,723 Inventories (185,569) (27,007) (15,046) Prepaid expenses (3,473) (1,234) (157) Other assets (31,620) (26,130) (20,444) Accounts payable, trade 52,947 31,672 (15,503) Accrued payrolls and other compensation 27,531 23,929 11,586 Accrued domestic and foreign taxes (15,282) 4,282 (3,589) Other accrued liabilities (9,129) 16,026 (31,800) Pensions and other postretirement benefits 14,276 6,823 19,404 Other liabilities 8,579 5,291 2,229 _________ _________ _________ Net cash provided by operating activities 320,599 392,310 337,981 CASH FLOWS FROM INVESTING ACTIVITIES Acquisitions (less cash acquired of $4,260 in 1998, $1,394 in 1997 and $20,479 in 1996) (232,953) (31,461) (359,447) Capital expenditures (236,945) (189,201) (201,693) Proceeds from sale of plant and equipment 7,151 11,307 9,387 Other 3,630 14,624 (2,812) _________ _________ _________ Net cash (used in) investing activities (459,117) (194,731) (554,565) Page 13-15 CASH FLOWS FROM FINANCING ACTIVITIES (Payments for) common share activity (96,887) (10,184) (1,209) Proceeds from (payments of) notes payable, net 190,865 (100,655) 81,194 Proceeds from long-term borrowings 87,085 9,390 201,724 (Payments of) long-term borrowings (13,054) (30,059) (9,696) Dividends paid, net of tax benefit of ESOP shares (66,501) (56,570) (53,325) _________ _________ _________ Net cash provided by (used in) financing activities 101,508 (188,078) 218,688 Effect of exchange rate changes on cash (1,499) (4,457) (1,981) _________ _________ _________ Net (decrease) increase in cash and cash equivalents (38,509) 5,044 123 Cash and cash equivalents at beginning of year 68,997 63,953 63,830 _________ _________ _________ Cash and cash equivalents at end of year $ 30,488 $ 68,997 $ 63,953 ========= ========= ========= Supplemental Data: Cash paid during the year for: Interest, net of capitalized interest $ 48,105 $ 46,812 $ 35,554 Income taxes 175,546 145,663 135,380 Non-cash investing activities: Treasury stock issued for acquisitions 11,950 6,176 Non-cash financing activities: Principal reduction of ESOP debt guarantee 13,468
The accompanying notes are an integral part of the financial statements. Page 13-16 BUSINESS SEGMENT INFORMATION - BY INDUSTRY (Dollars in thousands)
1998 1997 1996 NET SALES, including intersegment sales: Industrial: North America $ 2,480,231 $ 2,156,043 $ 1,976,351 International 1,161,530 1,073,201 989,359 Aerospace 992,994 862,659 621,465 Intersegment sales (1,732) (822) (727) ___________ ___________ ___________ $ 4,633,023 $ 4,091,081 $ 3,586,448 =========== =========== =========== INCOME FROM OPERATIONS before corporate general and administrative expenses: Industrial: North America $ 368,314 $ 329,967 $ 296,081 International 83,534 74,058 72,093 Aerospace 159,067 109,470 85,329 ___________ ___________ ___________ 610,915 513,495 453,503 Corporate general and administrative expenses 61,018 50,582 48,847 ___________ ___________ ___________ Income from operations 549,897 462,913 404,656 Other deductions 45,909 38,046 30,177 ___________ ___________ ___________ Income before income taxes $ 503,988 $ 424,867 $ 374,479 =========== =========== =========== IDENTIFIABLE ASSETS: Industrial $ 2,555,500 $ 2,167,820 $ 2,150,506 Aerospace 771,488 643,694 595,865 ___________ ___________ ___________ 3,326,988 2,811,514 2,746,371 Corporate assets (a) 197,833 187,432 140,753 ___________ ___________ ___________ $ 3,524,821 $ 2,998,946 $ 2,887,124 =========== =========== =========== PROPERTY ADDITIONS: (b) Industrial $ 245,995 $ 173,635 $ 259,356 Aerospace 33,733 20,608 63,437 Corporate (c) 11,935 32,078 3,122 ___________ ___________ ___________ $ 291,663 $ 226,321 $ 325,915 =========== =========== =========== Page 13-17 DEPRECIATION: Industrial $ 129,183 $ 119,948 $ 106,553 Aerospace 17,191 19,517 17,267 Corporate 7,259 6,788 2,724 ___________ ___________ ___________ $ 153,633 $ 146,253 $ 126,544 =========== =========== =========== (a) Corporate assets are principally cash and cash equivalents, domestic deferred income taxes, investments, headquarters facilities, idle facilities held for sale and the major portion of the Company's domestic data processing equipment. (b) Includes value of net plant and equipment at the date of acquisition of acquired companies accounted for by the purchase method (1998 - $54,718; 1997 - $15,283; 1996 - $124,222). (c) Fiscal 1997 includes $21,837 for real estate acquired in a tax-free exchange of property.
Page 13-18 BUSINESS SEGMENT INFORMATION - BY GEOGRAPHIC AREA (Dollars in thousands)
1998 1997 1996 NET SALES, including interarea sales: North America $ 3,549,425 $ 3,062,947 $ 2,669,201 Europe 1,071,554 1,055,401 918,493 All Other 199,796 190,584 155,963 Interarea (187,752) (217,851) (157,209) ___________ ___________ ___________ $ 4,633,023 $ 4,091,081 $ 3,586,448 =========== =========== =========== INCOME FROM OPERATIONS before corporate general and administrative expenses: North America $ 515,073 $ 429,432 $ 381,154 Europe 84,944 70,926 63,083 All Other 10,898 13,137 9,266 ___________ ___________ ___________ 610,915 513,495 453,503 Corporate general and administrative expenses 61,018 50,582 48,847 ___________ ___________ ___________ Income from operations $ 549,897 $ 462,913 $ 404,656 =========== =========== =========== IDENTIFIABLE ASSETS: North America $ 2,199,948 $ 1,808,154 $ 1,678,680 Europe 947,880 859,774 933,201 All Other 179,160 143,586 134,490 ___________ ___________ ___________ 3,326,988 2,811,514 2,746,371 Corporate assets (a) 197,833 187,432 140,753 ___________ ___________ ___________ $ 3,524,821 $ 2,998,946 $ 2,887,124 =========== =========== =========== (a) Corporate assets are principally cash and cash equivalents, domestic deferred income taxes, investments, headquarters facilities, idle facilities held for sale and the major portion of the Company's domestic data processing equipment.
Page 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 producer of motion control products, including fluid power systems, electromechanical controls and related components. The Company operates in two principal business segments: Industrial and Aerospace. The Industrial Segment produces motion-control and fluid power system components for builders and users of various types of manufacturing, packaging, processing, transportation, agricultural, construction, and military machinery, vehicles and equipment. Industrial Segment products are marketed primarily through field sales employees and more than 7,500 independent distributors. The North American Industrial business represents the largest portion of the Company's manufacturing plants and distribution networks and primarily services North America. The International Industrial operations bring Parker products and services to countries throughout Europe, Asia Pacific and Latin America. The Aerospace Segment produces hydraulic, pneumatic and fuel systems and components which are utilized on virtually every domestic commercial, military and general aviation aircraft. Its components also perform a vital role in naval vessels, land-based weapons systems, satellites and space vehicles. This Segment serves original equipment and maintenance, repair and overhaul customers worldwide. Its products are marketed by field sales employees and are sold directly to the manufacturer and to the end user. There are no individual customers to whom sales are 6 percent or more 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 significantly the risk that adverse changes in any event would materially affect the Company's operating results. USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles 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 domestic and foreign subsidiaries. All material intercompany transactions and profits have been eliminated in the consolidated financial statements. Within the Business Segment Information, intersegment and interarea sales are recorded at fair market value. CASH - Cash equivalents consist of short-term highly liquid investments, Page 13-20 with a three-month or less maturity, carried at cost plus accrued interest, which are readily convertible into cash. 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. LONG-TERM CONTRACTS - The Company enters into long-term contracts for the production of aerospace products. For financial statement purposes, sales are recorded as deliveries are made (units of delivery method of percentage-of- completion). Unbilled costs on these contracts are included in inventory. Progress payments are netted against the inventory balances. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. 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. Improvements which extend the useful life of property are capitalized, and maintenance and repairs are expensed. When property is 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% or less 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. EXCESS COST OF INVESTMENTS - The excess cost of investments over net assets acquired is being amortized, on a straight-line basis, primarily over 15 years and not exceeding 40 years. Unamortized cost in excess of associated expected operating cash flows is considered to be impaired and is written down to fair value. 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. 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 a separate 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 income. Page 13-21 FINANCIAL INSTRUMENTS - The Company's financial instruments consist primarily of investments in cash, cash equivalents and long-term investments as well as obligations under notes payable and long-term debt. The carrying values for Cash and cash equivalents, Investments and other assets and Notes payable approximate fair value. The Company enters into forward exchange contracts (forward contracts) and cross-currency swap agreements to reduce its exposure to fluctuations in related foreign currencies. These contracts are with major financial institutions and the risk of loss is considered remote. The Company does not hold or issue derivative financial instruments for trading purposes. Gains or losses on forward contracts which hedge dividends from consolidated subsidiaries are accrued in Shareholders' equity. Gains or losses on forward contracts which hedge specific transactions are recognized in Net income, offsetting the underlying foreign currency gains or losses. Cross-currency swap agreements are recorded in Long-term debt as dollar- denominated receivables with offsetting foreign-currency payables. If the receivables more than offset the payables, the net difference is reclassified to an asset. Gains or losses are accrued monthly as an adjustment to Net income, offsetting the underlying foreign currency gains or losses. The differential between interest to be received and interest to be paid is accrued monthly as an adjustment to Interest expense. In addition, the Company's foreign locations, in the ordinary course of business, enter into financial guarantees, through financial institutions, which enable customers to be reimbursed in the event of nonperformance by the Company. The total value of open contracts and any risk to the Company as a result of the above mentioned arrangements is not material. STOCK OPTIONS - The Company applies the intrinsic-value based method to account for stock options granted to employees or outside Directors to purchase common shares. The option price equals the market price of the underlying common shares on the date of grant, therefore no compensation expense is recognized. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income". SFAS No. 130 requires an additional disclosure for comprehensive income. It will not change Net income or Shareholders' equity. The Company must adopt SFAS No. 130 in the first quarter of 1999. The FASB has also issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information". This standard requires segment information to be disclosed based upon how management internally evaluates the operating performance of its business units. Application of this standard, required by year-end 1999, is not expected to result in materially different disclosures for the Company. The FASB has also issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". This standard establishes a new model for accounting for derivatives and hedging activities. Due to the immaterial amount of derivative and hedging activity within the Company, application of this standard, required in the first quarter of 2000, is not expected to have a material impact on results. Page 13-22 In March 1998 the Accounting Standards Executive Committee issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". SOP 98-1 requires expenses incurred during the application development stage of a software implementation project to be capitalized and amortized over the useful life of the project. Application of this standard, required beginning with the first quarter of 2000, is not expected to have a material impact on the results of the Company. 2. ACQUISITIONS AND WRITE-OFFS OF PURCHASED IN-PROCESS RESEARCH & DEVELOPMENT On May 1, 1998 the Company acquired the equity of Extrudit Ltd., a tubing manufacturer located in Buxton, England. On April 30, 1998 the Company purchased the equity of UCC Securities Limited of Thetford, Norfolk, England, a manufacturer of technology-based hydraulic filtration products. On April 1, 1998 the Company acquired the equity of Sempress Pneumatics, a manufacturer of pneumatic cylinders and valves located near Rotterdam, the Netherlands. On March 31, 1998 the Company acquired the assets of Temeto AB located in Flen, Sweden, a distributor of hydraulic components. On March 26, 1998 the Company purchased the remaining 51% of two Korean joint ventures - HS Parker Company Ltd., in Yangsan, and the HS Parker Air Conditioning Components Company Ltd., in Chonan, manufacturers of hydraulic hose, fittings, hose assemblies and accumulators. On February 27, 1998 Computer Technology Corporation of Milford, Ohio, a manufacturer of human-machine interface solutions, was merged into the Company. On September 26, 1997 the Company acquired the assets of the Skinner solenoid valve division of Honeywell Inc. and the equity of Honeywell Lucifer, S.A. Skinner is headquartered in New Britain, Connecticut, and Lucifer is headquartered in Geneva, Switzerland. On August 4, 1997 the Company acquired the assets of EWAL Manufacturing of Belleville, New Jersey, a leading producer of precision fittings and valves. Combined annual sales for operations acquired in fiscal 1998, for their most recent fiscal year prior to acquisition, were approximately $243 million. Total purchase price for these businesses was approximately $236.5 million cash and 263,279 shares of common stock valued at $11.9 million. The purchase price allocations of Computer Technology Corporation and UCC Securities Limited, as determined by independent appraisal, included a $15.8 million asset for purchased in-process research and development. Generally accepted accounting principles do no allow the capitalization of R&D of this nature, therefore, a write-off of $15.8 million ($12.0 million after tax or $.11 per share) is included in Cost of sales in 1998. On June 4, 1997 the Company acquired the remaining 50 percent of SAES- Parker UHP Components Corp., a manufacturer of valves for ultra-pure gas used in semiconductor manufacturing. On February 3, 1997 the Company purchased Hydroflex S.A. de C.V., a leading Mexican manufacturer of hydraulic hose, fittings and adapters located in Toluca, Mexico. On September 5, 1996 the Company purchased the assets of the industrial hydraulic product line of Hydraulik-Ring AG, of Nurtingen, Germany. Total purchase price for these businesses was approximately $29.3 million cash. Combined annual sales for these operations, for their most recent fiscal year prior to acquisition, were approximately $52 million. Effective April 15, 1996 the Company acquired the aerospace assets of the Page 13-23 Abex NWL Division of Pneumo Abex Corporation, a major international producer of aerospace hydraulic and electromechanical actuation equipment, engine thrust-reverser actuators, hydraulic pumps, and electrohydraulic servovalves headquartered in Kalamazoo, Michigan, for approximately $201 million cash. On February 29, 1996 the Company acquired VOAC Hydraulics AB, a worldwide leader in manufacturing mobile hydraulic equipment located in Boras, Sweden for approximately $163 million cash. Sales by these operations for their most recent fiscal year prior to acquisition approximated $366 million. In June 1996 the Company acquired the remaining 60 percent of Schrader Bellows Parker, S.A. de C.V., a Mexico City-based manufacturer of pneumatic and hydraulic products. On August 4, 1995 the Company purchased inventory and machinery from Teledyne Fluid Systems consisting of the Republic Valve product line, the Sprague double-diaphragm pump line and the Sprague airborne accumulator product line. On July 31, 1995 the Company purchased the assets of General Valve Corp. of Fairfield, New Jersey, a leading producer of miniature solenoid valves for high-technology applications. Total purchase price for these businesses was approximately $9.2 million cash and 228,000 shares of common stock valued at $6.2 million. Sales by these operations for their most recent fiscal year prior to acquisition approximated $24.8 million. These acquisitions were accounted for by the purchase method, and results are included as of the respective dates of acquisition. 3. INCOME TAXES Income taxes include the following: 1998 1997 1996 __________________________________________________ Federal $ 129,462 $ 113,819 $ 95,127 Foreign 27,847 27,411 29,635 State and local 16,928 13,587 14,897 Deferred 6,525 (3,989) (4,847) __________________________________________________ $ 180,762 $ 150,828 $ 134,812 ================================================== A reconciliation of the Company's effective income tax rate to the statutory Federal rate follows: 1998 1997 1996 __________________________________________________________ Statutory Federal income tax rate 35.0% 35.0% 35.0% State and local income taxes 2.1 2.0 2.3 FSC income not taxed (1.7) (1.8) (1.1) Foreign tax rate difference .3 .3 .7 Recognized loss carryforwards (.1) (.6) (1.1) Other .3 .6 .2 __________________________________________________________ Effective income tax rate 35.9% 35.5% 36.0% ========================================================== Page 13-24 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: 1998 1997 _____________________________________________________________________ Postretirement benefits $ 63,277 $ 48,320 Other liabilities and reserves 52,430 63,700 Long-term contracts 14,816 16,349 Operating loss carryforwards 9,440 23,286 Foreign tax credit carryforwards 3,773 1,405 Valuation allowance (1,591) (1,768) Depreciation (80,508) (84,853) Inventory 11,088 11,852 _____________________________________________________________________ Net deferred tax asset (liability) $ 72,725 $ 78,291 ===================================================================== Change in net deferred tax asset (liability): Provision for deferred tax $ (6,525) $ 3,989 Translation adjustment 175 (2,932) Acquisitions 784 (2,418) _____________________________________________________________________ Total change in net deferred tax $ (5,566) $ (1,361) ===================================================================== The classifications of deferred tax balances for 1997 have been revised to be consistent with 1998. At June 30, 1998, foreign subsidiaries had benefits for operating loss carryforwards of $11,624 for tax and $13,215 for financial reporting, most of which can be carried forward indefinitely. Use of operating loss carryforwards and currency adjustments reduced the valuation allowance. Non-current deferred income tax assets include a $7,529 tax benefit for the net operating loss carryforwards of the Company's German operations. The Company has not provided a valuation allowance that would be required under SFAS No. 109 if it is more likely that these benefits would not be realized. Although future events cannot be predicted with certainty, management continues to believe these benefits will be realized because the tax loss carryforward period is unlimited and the Company's German operations are currently profitable. 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. 4. EARNINGS PER SHARE Earnings per share have been computed according to SFAS No. 128, "Earnings per Share". Basic earnings per share is computed using the weighted average number of shares of common stock outstanding during the year. Diluted earnings Page 13-25 per share is 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 options. The computation of net income per share was as follows: 1998 1997 1996 _______________________________________________________________________ Numerator: Net income applicable to common shares $ 319,551 $ 274,039 $ 239,667 ======================================================================= Denominator: Basic - weighted average common shares 110,868,834 111,601,484 111,260,717 Increase in weighted average from dilutive effect of exercise of stock options 1,090,437 916,569 928,000 _______________________________________________________________________ Diluted - weighted average common shares, assuming exercise of stock options 111,959,271 112,518,053 112,188,717 ======================================================================= Basic earnings per share $ 2.88 $ 2.46 $ 2.15 Diluted earnings per share $ 2.85 $ 2.44 $ 2.14 ======================================================================= 5. INVENTORIES Inventories valued on the last-in, first-out cost method are approximately 36% of total inventories in 1998 and 1997. The current cost of these inventories exceeds their valuation determined on the LIFO basis by $139,011 in 1998 and $140,364 in 1997. Progress payments of $23,454 in 1998 and $20,728 in 1997 are netted against inventories. 6. FINANCING ARRANGEMENTS The Company has committed lines of credit totaling $450,000 through several multi-currency unsecured revolving credit agreements with a group of banks, of which $226,525 was available at June 30, 1998. The majority of these agreements expire October 2002. The interest on borrowings is based upon the terms of each specific borrowing and is subject to market conditions. The agreements also require facility fees of up to 8/100ths of one percent of the commitment per annum. Covenants in some of the agreements include a limitation on the Company's ratio of secured debt to net tangible assets. The Company has other lines of credit, primarily short-term, aggregating $108,584, from various foreign banks, of which $72,013 was available at June 30, 1998. Most of these agreements are renewed annually. During March 1998 the Company registered additional medium-term notes bringing the total available for issuance to $755,000 at June 30, 1998. Page 13-26 Subsequently, in July 1998, the Company issued $100,000 of these medium-term notes. The Company is authorized to sell up to $400,000 of short-term commercial paper notes, rated A-1 by Standard & Poor's, P-1 by Moody's and D-1 by Duff & Phelps. At June 30, 1998 there were $191,250 of commercial paper notes outstanding which were supported by the available domestic lines of credit. Of the total commercial paper, $100,000 has been classified in the Balance Sheet as Long-term debt, as further discussed in Note 7. There were no commercial paper notes outstanding at June 30, 1997. Commercial paper, along with short-term borrowings from foreign banks, primarily make up the balance of Notes payable. The balance and weighted average interest rate of the Notes payable at June 30, 1998 and 1997 were $155,259 and 6.1%, and $58,945 and 5.7%, respectively. 7. DEBT June 30, 1998 1997 ________________________________________________________________________ Domestic: Debentures and notes 9.75%, due 2002-2021 $ 100,000 $ 100,000 7.3%, due 2011 100,000 100,000 10.375%, due 1999-2018 100,000 100,000 9.6%, due 1998 1,714 Medium-term notes 6.35% to 7.39%, due 2004-2010 145,000 95,000 Commercial paper 100,000 Variable rate demand bonds 3.85% to 3.95%, due 2010-2025 20,035 20,035 Foreign: Bank loans, including revolving credit 1.0% to 17.25%, due 1999-2018 54,653 25,704 Other long-term debt, including capitalized leases 3,481 1,225 ________________________________________________________________________ Total long-term debt 623,169 443,678 Less long-term debt payable within one year 110,226 10,793 ________________________________________________________________________ Long-term debt, net $ 512,943 $ 432,885 ======================================================================== On June 30, 1998, the Company called for redemption its outstanding $100,000, 10.375 percent debentures due 1999-2018. The after-tax extraordinary loss for this transaction, including an early-redemption premium and the write-off of deferred issuance costs, was $3,675 or $.03 per share. As a result of the call, these debentures have been reclassified to long-term debt payable within one year. The retirement of the debt was financed on July 15, 1998, through the issuance of $100,000 of medium term notes, due 2018, at an annual interest rate of 6.55 percent. As of June 30, 1998, $100,000 of commercial paper was classified as long-term debt, recognizing management's intentions. Principal amounts of long-term debt payable in the five years ending June Page 13-27 30, 1999 through 2003 are $10,226, $20,217, $16,598, $19,917, and $19,825, respectively. The carrying value of the Company's long-term debt (excluding leases and cross-currency swaps) was $519,688 and $443,673 at June 30, 1998 and 1997, respectively, and was estimated to have a fair value of $545,140 and $454,689, at June 30, 1998 and 1997, respectively. The estimated fair value of the Long-term debt was estimated using discounted cash flow analyses based on the Company's current incremental borrowing rate for similar types of borrowing arrangements. LEASE COMMITMENTS -- Future minimum rental commitments as of June 30, 1998, under noncancelable operating leases, which expire at various dates, are as follows: 1999-$46,175; 2000-$25,390; 2001-$14,531; 2002-$7,066; 2003- $5,414 and after 2003-$24,278. Rental expense in 1998, 1997 and 1996 was $37,065, $33,305, and $29,899, respectively. 8. RETIREMENT BENEFITS PENSIONS -- The Company has noncontributory defined benefit pension plans covering eligible employees, including certain employees in foreign countries. Plans for most salaried employees provide pay-related benefits based on years of service. Plans for hourly employees generally provide benefits based on flat-dollar amounts and years of service. The Company also has contractual arrangements with certain key employees which provide for supplemental retirement benefits. In general, the Company's policy is to fund these plans based on legal requirements, tax considerations, local practices and investment opportunities. The Company also sponsors defined contribution plans and participates in government-sponsored programs in certain foreign countries. Pension costs for all plans were $19,989, $22,773 and $22,514 for 1998, 1997 and 1996, respectively. Pension costs for all defined benefit plans accounted for using SFAS No. 87, Employers' Accounting for Pensions, are as follows: 1998 1997 1996 ______________________________________________________________________ Service cost-benefits earned during the period $ 28,190 $ 23,715 $ 20,731 Interest cost on projected benefit obligation 57,892 52,726 44,384 Actual return on assets (161,737) (89,614) (74,926) Net amortization and deferral 93,719 33,703 30,111 ______________________________________________________________________ Net periodic pension costs $ 18,064 $ 20,530 $ 20,300 ====================================================================== The following tables set forth the funded status of all the plans accounted for under SFAS No. 87 and the amounts recognized in the Company's consolidated balance sheet: Page 13-28 Assets Exceed Accumulated Benefits 1998 1997 ____________________________________________________________________________ Actuarial present value of benefit obligations: Vested benefit obligation $ (608,260) $ (493,681) ============================================================================ Accumulated benefit obligation $ (634,207) $ (510,385) ============================================================================ Projected benefit obligation $ (745,036) $ (593,241) Plan assets at fair value 974,131 749,386 ____________________________________________________________________________ Projected benefit obligation less than plan assets 229,095 156,145 Unrecognized net (gain) or loss (135,827) (61,122) Unrecognized prior service cost 18,160 15,198 Unrecognized net (asset) obligation (13,310) (16,848) ____________________________________________________________________________ Prepaid pension cost (pension liability) recognized $ 98,118 $ 93,373 ============================================================================ Accumulated Benefits Exceed Assets 1998 1997 ____________________________________________________________________________ Actuarial present value of benefit obligations: Vested benefit obligation $ (101,464) $ (79,521) ============================================================================ Accumulated benefit obligation $ (112,916) $ (95,707) ============================================================================ Projected benefit obligation $ (132,716) $ (121,458) Plan assets at fair value 23,782 18,301 ____________________________________________________________________________ Projected benefit obligation in excess of plan assets (108,934) (103,157) Unrecognized net (gain) or loss 10,218 6,000 Unrecognized prior service cost 4,466 4,714 Unrecognized net (asset) obligation 579 1,794 ____________________________________________________________________________ Prepaid pension cost (pension liability) recognized $ (93,671) $ (90,649) ============================================================================ The majority of the underfunded plans relate to foreign and supplemental executive plans. The plans' assets consist primarily of listed common stocks, corporate and government bonds, and real estate investments. At June 30, 1998 and 1997, the plans' assets included Company stock with market values of $20,262 and $21,502, respectively. Page 13-29 The assumptions used to measure the benefit obligations and to compute the expected long-term return on assets for the Company's significant defined benefit plans are: 1998 1997 1996 _________________________________________________________________________ U.S. defined benefit plans Discount rate 7.5% 8% 8% Average increase in compensation 4.9% 5% 5% Expected long-term return on assets 9.5% 9% 9% _________________________________________________________________________ Non-U.S. defined benefit plans Discount rate 4.5 to 7% 7 to 8% 7 to 8% Average increase in compensation 3 to 4.5% 3.5 to 6% 4.5 to 6% Expected long-term return on assets 5.5 to 9% 7 to 9% 7 to 9% ========================================================================= EMPLOYEE SAVINGS PLAN -- The Company sponsors an employee stock ownership plan (ESOP) as part of its existing savings and investment 401(k) plan, which is available to eligible domestic employees. Parker-Hannifin Common Stock is used to match contributions made by employees to the savings plan up to a maximum of 5 percent of an employee's annual compensation. A breakdown of shares held by the ESOP is as follows: 1998 1997 1996 ________________________________________________________________________ Allocated shares 7,631,677 7,460,378 6,934,194 Committed to be released 60,231 ________________________________________________________________________ Total shares held by the ESOP 7,631,677 7,460,378 6,994,425 ======================================================================== Through June 30, 1996 the ESOP was leveraged and the loan was unconditionally guaranteed by the Company. Company contributions to the ESOP, recorded as compensation and interest expense, were $23,093 in 1998, $21,235 in 1997 and $18,626 in 1996. The interest expense portion (interest on ESOP debt) was $856 in 1996. Dividends earned by the unallocated shares and interest income within the ESOP, totalling $218 in 1996, were used to service the ESOP debt. ESOP shares are considered outstanding for purposes of earnings per share computations. In addition to shares within the ESOP, as of June 30, 1998 employees have elected to invest in 3,011,654 shares of Common Stock within the Company Stock Fund of the Parker Retirement Savings Plan. OTHER POSTRETIREMENT BENEFITS --The Company provides postretirement medical and life insurance benefits to certain retirees and eligible dependents. Most plans are contributory, with retiree contributions adjusted annually. The plans are unfunded and pay stated percentages of covered medically necessary expenses incurred by retirees, after subtracting payments by Medicare or other providers and after stated deductibles have been met. For most plans, the Company has established cost maximums to more effectively control future medical costs. The Company has reserved the right to change or eliminate these Page 13-30 benefit plans. Postretirement benefit costs included the following components: 1998 1997 1996 ___________________________________________________________________________ Service cost-benefits attributed to service during the period $ 4,021 $ 3,296 $ 3,515 Interest cost on accumulated postretirement benefit obligations 11,077 11,316 11,126 Net amortization and deferral (1,815) (830) (708) ___________________________________________________________________________ Net periodic postretirement benefit costs $ 13,283 $ 13,782 $ 13,933 =========================================================================== The following table reconciles the plans' combined funded status to amounts recognized in the Company's consolidated balance sheet: 1998 1997 _______________________________________________________________________________ Accumulated postretirement benefit obligation: Retirees $ (62,204) $ (78,114) Fully eligible active plan participants (38,798) (31,019) Other active plan participants (54,931) (40,741) Unrecognized (gain) loss (2,251) (15,918) Unrecognized prior service cost (15,046) 131 _______________________________________________________________________________ Accrued postretirement benefit costs $ (173,230) $ (165,661) =============================================================================== The assumptions used to measure the post-retirement benefit obligations are: 1998 1997 1996 ________________________________________________________________________ Discount rate 7.5% 8% 8% Current medical cost trend rate 10.25% 10.5% 10.75% Ultimate medical cost trend rate 6% 6% 6% Medical cost trend rate decreases to ultimate in year 2007 2007 2007 Effect of a 1% increase in the medical cost trend rate: Increase in benefit obligation $ 8,194 $ 8,161 $ 9,382 Increase in annual retiree medical cost $ 658 $ 772 $ 568 __________________________________________________________________ OTHER -- The Company has established nonqualified deferred compensation programs which permit officers, directors and certain management employees to annually elect to defer a portion of their compensation, on a pre-tax basis, until their retirement. The retirement benefit to be provided is based on the amount of compensation deferred, Company match, and earnings on the deferrals. Deferred compensation expense was $20,426, $4,862 and $4,129 in 1998, 1997 and 1996, respectively. The Company has invested in corporate-owned life insurance policies to Page 13-31 assist in funding these programs. The cash surrender values of these policies are maintained in an irrevocable rabbi trust and are recorded as assets of the Company. 9. SHAREHOLDERS' EQUITY COMMON SHARES 1998 1997 1996 ______________________________________________________________________________ Balance July 1 $ 55,905 $ 55,719 $ 55,502 Shares issued under stock option plans (1998 - 3,650; 1997 - 432,096; 1996 - 513,836) 1 139 189 Shares issued as restricted stock 47 28 ______________________________________________________________________________ Balance June 30 $ 55,906 $ 55,905 $ 55,719 ============================================================================== ADDITIONAL CAPITAL ______________________________________________________________________________ Balance July 1 $ 150,702 $ 146,686 $ 139,953 Net (decrease) increase for treasury or common shares issued under stock option plans (11,481) 1,684 5,481 Shares issued for purchase acquisition 478 (176) Shares issued as restricted stock 27 2,332 1,428 ______________________________________________________________________________ Balance June 30 $ 139,726 $ 150,702 $ 146,686 ============================================================================== RETAINED EARNINGS ______________________________________________________________________________ Balance July 1 $ 1,378,297 $ 1,160,828 $ 974,486 Net income 319,551 274,039 239,667 Cash dividends paid on common shares, net of tax benefit of ESOP shares (66,501) (56,570) (53,325) Cash payments for stock split fractional shares (31) ______________________________________________________________________________ Balance June 30 $ 1,631,316 $ 1,378,297 $ 1,160,828 ============================================================================== TRANSLATION ADJUSTMENTS ______________________________________________________________________________ Balance July 1 $ (27,345) $ 20,725 $ 35,041 Translation adjustments (Note 12) (32,681) (48,070) (14,316) ______________________________________________________________________________ Balance June 30 $ (60,026) $ (27,345) $ 20,725 ============================================================================== Page 13-32 COMMON STOCK IN TREASURY ______________________________________________________________________________ Balance July 1 $ (10,258) $ -- $ -- Shares purchased at cost (1998 - 2,522,971; 1997 - 576,021; 1996 - 247,500) (109,645) (18,690) (6,703) Shares issued under stock option plans (1998 - 559,668; 1997 - 223,184) 23,187 6,676 Shares issued for purchase acquisition 11,471 6,176 Shares issued as restricted stock 1,773 1,756 527 ______________________________________________________________________________ Balance June 30 $ (83,472) $ (10,258) $ -- ============================================================================== Shares surrendered upon exercise of stock options; 1998 - 159,869; 1997 - 153,770; 1996 - 136,686. SHARE REPURCHASES - In July 1998 the Board of Directors authorized the repurchase of an additional 4.0 million shares of its common stock, extending the initial repurchase plan started in August 1990. This increased the total number of shares authorized for repurchase to 5.05 million. Repurchases are made on the open market, at prevailing prices, and are funded from operating cash flows. The shares are initially held as treasury stock. 10. STOCK INCENTIVE PLANS EMPLOYEES' STOCK OPTIONS -- The Company's stock option and stock incentive plans provide for the granting of nonqualified options to officers and key employees to purchase shares of common stock at a price not less than 100 percent of the fair market value of the stock on the dates options are granted. Outstanding options generally are exercisable one year after the date of grant and expire no more than ten years after grant. The Company derives a tax deduction measured by the excess of the market value over the option price at the date nonqualified options are exercised. The related tax benefit is credited to additional capital. As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, the Company continues to account for its stock option and stock incentive plans in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and makes no charges against capital with respect to options granted. SFAS No. 123 does, however, require the disclosure of pro forma information regarding Net Income and Earnings per share determined as if the Company had accounted for its stock options under the fair value method. For purposes of this pro forma disclosure the estimated fair value of the options is amortized to expense over the options' vesting period. Page 13-33 1998 1997 1996 _____________________________________________________________ Net income: As reported $ 319,551 $ 274,039 $ 239,667 Pro forma $ 315,567 $ 270,758 $ 238,330 Earnings per share: Basic As reported $ 2.88 $ 2.46 $ 2.15 Pro forma $ 2.85 $ 2.43 $ 2.14 Diluted As reported $ 2.85 $ 2.44 $ 2.14 Pro forma $ 2.82 $ 2.41 $ 2.12 ============================================================= Because the SFAS No. 123 method of accounting has not been applied to options granted prior to 1996, the above pro forma effect may not be representative of that to be expected in future years. The fair value for all options granted in 1998, 1997 and 1996 were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: Aug/97 Jan/97 Aug/96 Aug/95 ______________________________________________________________________ Risk-free interest rate 5.6% 6.3% 6.4% 6.4% Expected life of option 5 yrs 5 yrs 5 yrs 5 yrs Expected dividend yield of stock 2.3% 2.6% 2.6% 3.0% Expected volatility of stock 26.9% 26.5% 26.2% 25.2% ====================================================================== Options exercisable and shares available for future grant on June 30: 1998 1997 1996 _______________________________________________________________________ Options exercisable 3,476,016 2,905,887 3,195,767 Weighted-average option price per share of options exercisable $ 20.57 $ 16.41 $ 14.90 Weighted-average fair value of options granted during the year $ 11.43 $ 7.30 $ 6.44 Shares available for grant 3,256,232 3,304,627 3,295,347 ======================================================================= Page 13-34 A summary of the status and changes of shares subject to options and the related average price per share follows: Shares Subject Average Option To Options Price Per Share ______________________________________________________________ Outstanding June 30, 1996 3,578,492 $ 16.09 ______________________________________________________________ Granted 1,351,500 27.37 Exercised (655,280) 14.48 Canceled (50,625) ______________________________________________________________ Outstanding June 30, 1997 4,224,087 $ 19.82 ______________________________________________________________ Granted 190,815 43.04 Exercised (721,687) 19.83 Canceled (31,409) ______________________________________________________________ Outstanding June 30, 1998 3,661,806 $ 21.71 ============================================================== The range of exercise prices and the remaining contractual life of options as of June 30, 1998 were: _____________________________________________________________________ Range of exercise prices $12-$19 $20-$29 $43-$44 _____________________________________________________________________ Options outstanding: Outstanding as of June 30, 1998 1,390,268 2,085,748 185,790 Weighted-average remaining contractual life 3.8 yrs 7.8 yrs 9.1 yrs Weighted-average exercise price $ 13.54 $ 25.26 $ 43.05 Options exercisable: Outstanding as of June 30, 1998 1,390,268 2,085,748 Weighted-average remaining contractual life 3.8 yrs 7.8 yrs Weighted-average exercise price $ 13.54 $ 25.26 ====================================================================== RESTRICTED STOCK -- Restricted stock was issued, under the Company's 1993 Stock Incentive Program, to certain key employees under the Company's 1995-96- 97, 1994-95-96 and 1993-94-95 Long Term Incentive Plans (LTIP). Value of the payments was set at the market value of the Company's common stock on the date of issuance. Shares were earned and awarded, and an estimated value was accrued, based upon attainment of criteria specified in the LTIP over the cumulative years of the 3-year Plans. Plan participants are entitled to cash dividends and to vote their respective shares, but the shares are restricted as to transferability for three years following issuance. Page 13-35 Restricted Shares for LTIP Plan 1998 1997 1996 __________________________________________________________________ Number of shares issued 39,619 152,916 73,361 Per share value on date of issuance $ 40.00 $ 25.36 $ 26.05 Total value $ 1,585 $ 3,878 $ 1,911 ================================================================== Under the Company's 1996-97-98 LTIP, a payout of 15,774 shares of restricted stock, from the Company's 1993 Stock Incentive Program, will be issued to certain key employees in 1999. The balance of the 1996-97-98 LTIP payout will be made as deferred cash compensation, as individually elected by the participants. The total payout, valued at $6,359, has been accrued over the three years of the plan. In addition, non-employee members of the Board of Directors have been given the opportunity to receive all or a portion of their fees in the form of restricted stock. These shares vest ratably, on an annual basis, over the term of office of the director. In 1998, 1997 and 1996, 4,558, 9,923 and 3,243 shares were issued, respectively, in lieu of directors' fees. NON-EMPLOYEE DIRECTORS' STOCK OPTIONS -- In August 1996, the Company adopted a stock option plan for non-employee directors to purchase shares of common stock at a price not less than 100 percent of the fair market value of the stock on the dates options are granted. All outstanding options are exercisable one year after the date of grant and expire no more than ten years after grant. A summary of the status and changes of shares subject to options and the related average price per share follows: Shares Subject Average Option To Options Price Per Share ______________________________________________________________ Outstanding June 30, 1997 14,250 $ 24.85 ______________________________________________________________ Granted 8,250 42.96 Exercised (1,500) 24.67 ______________________________________________________________ Outstanding June 30, 1998 21,000 $ 31.97 ============================================================== As of June 30, 1998, 12,750 options were exercisable and 352,500 shares were available for grant. At June 30, 1998, the Company had 7,344,328 common shares reserved for issuance in connection with its stock incentive plans. 11. SHAREHOLDERS' PROTECTION RIGHTS AGREEMENT The Board of Directors of the Company declared a dividend of one Right for each share of Common Stock outstanding on February 17, 1997 in relation to the Company's Shareholder Protection Rights Agreement. As of June 30, 1998, 109,873,263 shares of Common Stock were reserved for issuance under this Agreement. Under certain conditions involving acquisition of or an offer for 15 percent or more of the Company's Common Stock, all holders of Rights, Page 13-36 except an acquiring entity, would be entitled to purchase, at an exercise price of $100, a value of $200 of Common Stock of the Company or an acquiring entity, or at the option of the Board, to exchange each Right for one share of Common Stock. The Rights remain in existence until February 17, 2007, unless earlier redeemed (at one cent per Right), exercised or exchanged under the terms of the agreement. In the event of an unfriendly business combination attempt, the Rights will cause substantial dilution to the person attempting the merger. The Rights should not interfere with any business combination that is in the best interest of the Company and its shareholders since the Rights may be redeemed. 12. FOREIGN OPERATIONS The Company's major foreign operations are located in Germany, the United Kingdom, France, Sweden, and Italy. Their business activities are conducted principally in their local currency. Net transaction and translation adjustments reduced Net income in 1998 and 1997 by $2,284 and $1,267, respectively, and increased Net income in 1996 by $873. Net sales, Income before income taxes and Net income include the following amounts from foreign operations: 1998 1997 1996 _____________________________________________________________________ Net sales $ 1,340,080 $ 1,234,669 $ 1,085,676 _____________________________________________________________________ Income before income taxes 101,307 85,234 70,118 _____________________________________________________________________ Net income 57,651 50,067 42,563 ===================================================================== Net assets of foreign operations at June 30, 1998 and 1997 amounted to $806,596 and $734,820, respectively. Accumulated undistributed earnings of foreign operations reinvested in their operations amounted to $153,831, $121,871 and $103,059, at June 30, 1998, 1997 and 1996, respectively. 13. RESEARCH AND DEVELOPMENT Research and development costs amounted to $83,117 in 1998, $103,155 in 1997, and $91,706 in 1996. Customer reimbursements included in the total cost for each of the respective years were $15,753, $35,986 and $33,018. Costs include those costs related to independent research and development as well as customer reimbursed and unreimbursed development programs. 14. CONTINGENCIES The Company is involved in various litigation arising in the normal course of business, including proceedings based on product liability claims, workers' compensation claims and alleged violations of various environmental laws. The Company is self-insured in the U.S. for health care, workers' compensation, Page 13-37 general liability and product liability up to predetermined amounts, above which third party insurance applies. The Company purchases third party product liability insurance for products manufactured by its international operations and for products that are used in aerospace applications. Management regularly reviews the probable outcome of these proceedings, the expenses expected to be incurred, the availability and limits of the insurance coverage, and the established accruals for uninsured liabilities. While the outcome of pending proceedings cannot be predicted with certainty, management believes that any liabilities that may result from these proceedings are not reasonably likely to have a material effect on the Company's liquidity, financial condition or results of operations. ENVIRONMENTAL - The Company is currently involved in environmental remediation at 19 manufacturing facilities presently or formerly operated by the Company and has been named as a "potentially responsible party", along with other companies, at 11 off-site waste disposal facilities. As of June 30, 1998, the Company has a reserve of $8,640 for environmental matters which are probable and reasonably estimable. This reserve is recorded based upon the best estimate of net costs to be incurred in light of the progress made in determining the magnitude of remediation costs, the timing and extent of remedial actions required by governmental authorities, the amount of the Company's liability in proportion to other responsible parties and any recoveries receivable. This reserve is net of $555 for discounting, at a 7.5% annual rate, a portion of the costs at 7 locations for established treatment procedures required over periods ranging from 3 to 16 years. The Company also has an account receivable of $490 for anticipated insurance recoveries. The Company's estimated total liability for the above mentioned sites ranges from a minimum of $8,226 to a maximum of $20,610. The actual costs to be incurred by the Company will be dependent on final delineation of contamination, final determination of remedial action required, negotiations with federal and state agencies with respect to cleanup levels, changes in regulatory requirements, innovations in investigatory and remedial technology, effectiveness of remedial technologies employed, the ultimate ability to pay of the other responsible parties, and any insurance recoveries. Page 13-38 Report of Management The Company's management is responsible for the integrity and accuracy of the financial information contained in this annual report. Management believes that the financial statements have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances and that the other information in this annual report is consistent with those statements. In preparing the financial statements, management makes informed judgments and estimates where necessary to reflect the expected effects of events and transactions that have not been completed. Management is also responsible for maintaining an internal control system designed to provide reasonable assurance at reasonable cost that assets are safeguarded against loss or unauthorized use and that financial records are adequate and can be relied upon to produce financial statements in accordance with generally accepted accounting principles. The system is supported by written policies and guidelines, by careful selection and training of financial management personnel and by an internal audit staff which coordinates its activities with the Company's independent accountants. To foster a strong ethical climate, the Parker Hannifin Code of Ethics is publicized throughout the Company. This addresses, among other things, compliance with all laws and accuracy and integrity of books and records. The Company maintains a systematic program to assess compliance. PricewaterhouseCoopers LLP, independent accountants, are retained to conduct an audit of Parker Hannifin's consolidated financial statements in accordance with generally accepted auditing standards and to provide an independent assessment that helps ensure fair presentation of the Company's consolidated financial position, results of operations and cash flows. The Audit Committee of the Board of Directors is composed entirely of outside directors. The Committee meets periodically with management, internal auditors and the independent accountants to discuss internal accounting controls and the quality of financial reporting. Financial management, as well as the internal auditors and the independent accountants, have full and free access to the Audit Committee. Duane E. Collins Michael J. Hiemstra Duane E. Collins Michael J. Hiemstra President and Vice President - Chief Executive Officer Finance and Administration and Chief Financial Officer Page 13-39 Report of Independent Accountants To the Shareholders and Board of Directors Parker Hannifin Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income and cash flows present fairly, in all material respects, the financial position of Parker Hannifin Corporation and its subsidiaries at June 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Cleveland, Ohio July 30, 1998 Page 13-40 FIVE-YEAR FINANCIAL SUMMARY
(Amounts in thousands, except per share information) 1998 (a) 1997 1996 1995 1994 (a) ___________________________________________________________________________________________________________________ Net sales $ 4,633,023 $ 4,091,081 $ 3,586,448 $ 3,214,370 $ 2,576,337 Cost of sales 3,550,992 3,152,988 2,756,343 2,448,264 2,053,376 Selling, general and administrative expenses 532,134 475,180 425,449 384,581 302,668 Non-recurring charges - Restructuring & Asset impairment 54,256 Interest expense 52,787 46,659 36,667 30,922 37,832 Income taxes 180,762 150,828 134,812 130,169 60,274 Income - continuing operations 323,226 274,039 239,667 218,238 52,175 Net income 319,551 274,039 239,667 218,238 47,652 Basic earnings per share - continuing operations 2.91 2.46 2.15 1.97 .48 Diluted earnings per share - continuing operations 2.88 2.44 2.14 1.96 .48 Basic earnings per share 2.88 2.46 2.15 1.97 .43 Diluted earnings per share $ 2.85 $ 2.44 $ 2.14 $ 1.96 $ .43 Average number of shares outstanding - Basic 110,869 111,602 111,261 110,576 109,661 Average number of shares outstanding - Diluted 111,959 112,518 112,189 111,149 110,270 Cash dividends per share $ .600 $ .506 $ .480 $ .453 $ .436 Net income as a percent of net sales 6.9% 6.7% 6.7% 6.8% 1.8% Return on average assets 9.8% 9.3% 9.2% 10.3% 2.5% Return on average equity 19.8% 18.7% 18.6% 20.2% 5.0% ___________________________________________________________________________________________________________________ Book value per share $ 15.32 $ 13.87 $ 12.42 $ 10.73 $ 8.78 Working capital $ 791,305 $ 783,550 $ 635,242 $ 593,761 $ 526,864 Ratio of current assets to current liabilities 1.8 2.1 1.8 1.9 2.0 Plant and equipment, net $ 1,135,225 $ 1,020,743 $ 991,777 $ 815,771 $ 717,300 Total assets 3,524,821 2,998,946 2,887,124 2,302,209 1,925,744 Long-term debt 512,943 432,885 439,797 237,157 257,259 Shareholders' equity $ 1,683,450 $ 1,547,301 $ 1,383,958 $ 1,191,514 $ 966,351 Debt to debt-equity percent 31.6% 24.5% 30.7% 21.9% 22.7% ___________________________________________________________________________________________________________________ Depreciation $ 153,633 $ 146,253 $ 126,544 $ 110,527 $ 106,546 Capital expenditures $ 236,945 $ 189,201 $ 201,693 $ 151,963 $ 99,914 Number of employees 39,873 34,927 33,289 30,590 26,730 Number of shareholders 44,250 43,014 35,403 35,629 29,625 Number of shares outstanding at year-end 109,873 111,527 111,438 111,003 110,115 ___________________________________________________________________________________________________________________ (a) Includes an extraordinary item for the early retirement of debt.
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