Business context and reporting period
Donaldson Company, Inc. manufactures filtration systems and replacement parts. This Form 10-Q covers its fiscal third quarter and nine months ended April 30, 2020; comparisons are with the corresponding periods of fiscal 2019. Its reportable segments are Engine Products and Industrial Products.
Financial performance
| Metric | Three months ended April 30 | Nine months ended April 30 |
|---|---|---|
| Net sales | $629.7 million, down 11.7% | $1,964.4 million, down 7.2% |
| Gross margin | 33.2%, versus 33.8% | 33.8%, versus 33.3% |
| Operating income / margin | $84.5 million / 13.4%; prior year $100.0 million / 14.0% | $257.6 million / 13.1%; prior year $283.8 million / 13.4% |
| Net earnings | $63.4 million; prior year $75.2 million | $192.9 million; prior year $209.1 million |
| Diluted earnings per share | $0.50; prior year $0.58 | $1.50; prior year $1.60 |
| Operating cash flow | Not separately presented for the quarter | $265.2 million; prior year $223.2 million |
Quarterly gross margin declined as lower sales reduced operating leverage, including against higher depreciation from capacity expansions. For the nine-month period, gross margin improved, reflecting cost, procurement and pricing initiatives, favorable mix and lower raw-material costs, partly offset by reduced leverage and higher depreciation.
Cash and cash equivalents were $326.5 million at April 30, 2020, versus $177.8 million at July 31, 2019. Nine-month capital expenditures were $106.2 million. At April 30, reported debt included $735.1 million of long-term debt, $50.0 million of current maturities and $8.1 million of short-term borrowings. Total debt was 45.6% of total capitalization, compared with 41.6% at fiscal year-end. The company reported $399.4 million of borrowing capacity under existing facilities, including $142.5 million available on its $500 million revolver. It was in compliance with debt covenants.
Material changes versus prior period
- Third-quarter sales fell in both segments: Engine Products decreased 14.1% and Industrial Products 6.3%. Engine Products earnings before tax declined to $56.5 million from $71.5 million; Industrial Products earnings rose to $34.7 million from $32.7 million.
- For nine months, Engine Products sales declined 8.6% and Industrial Products sales declined 4.3%. Segment earnings before tax were $172.2 million and $98.8 million, respectively, versus $188.6 million and $101.5 million.
- Foreign-currency translation reduced nine-month sales by $28.3 million and net earnings by approximately $2.0 million. The stronger U.S. dollar also weighed on quarterly sales.
- Nine-month operating cash flow increased by $42.0 million, mainly from improved management of operating assets and liabilities. Cash used in investing was lower year over year, primarily because the prior-year period included the BOFA acquisition.
- Long-term debt increased from $584.4 million at July 31, 2019. The company borrowed $100 million on its revolver in March as a precaution amid COVID-19 uncertainty and entered into a new $100 million, 364-day revolving credit agreement on May 18, 2020.
Outlook, risks and unusual items
No quantified earnings or revenue guidance is provided. Management said the future impact of COVID-19—particularly on revenue—could not be reasonably estimated and would likely be material. Most facilities continued operating as essential or critical businesses, but temporary closures and reduced customer demand had occurred. Future shutdowns, health and safety constraints, supply disruptions and the pace of economic recovery remain risks. Management stated available cash, expected operating cash flow and borrowing capacity should meet requirements for the next 12 months.
The company recorded a $2.3 million pension settlement charge in the quarter; related remeasurement increased pension obligations and generated a $7.9 million adjustment to other comprehensive loss. No goodwill impairment was recorded in the annual assessment, though management cautioned that future COVID-19 effects could lead to impairment or higher allowances. On February 21, 2020, the company received a binding offer for its Exhaust and Emissions business and said discussions were ongoing; no completed sale is reported. Recorded litigation liabilities were not material, and management considered material excess exposure remote. The company also guarantees half of certain joint-venture debt; the joint venture’s outstanding debt was $39.6 million.
Important facts for investors to verify
- How demand, customer shutdowns and the pandemic’s duration affect sales and margins in subsequent quarters, especially in Engine Products.
- Actual revolver usage, total available liquidity, debt maturities and covenant headroom; distinguish the existing facility’s $142.5 million availability from the reported $399.4 million capacity across existing facilities.
- Whether the proposed Exhaust and Emissions business sale proceeds, and its eventual terms and effects, are disclosed.
- Whether inventory levels and turns recover as demand changes; inventory was $346.5 million and turns were 4.8 times at April 30, versus 5.6 times at July 31, 2019.
- Potential effects of COVID-19 on asset valuations, credit-loss allowances, pension obligations and cash flows, notwithstanding the absence of an impairment charge this quarter.