Donaldson Company, Inc. — Q2 FY2021 Form 10-Q
Reporting period: Quarter and six months ended January 31, 2021. Donaldson manufactures filtration systems and replacement parts through its Engine Products and Industrial Products segments. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data.
Financial performance
| Metric | Q2 FY2021 | Q2 FY2020 | Six months FY2021 | Six months FY2020 |
|---|---|---|---|---|
| Net sales | $679.1 | $662.0 | $1,315.8 | $1,334.7 |
| Gross profit / margin | $225.3 / 33.2% | $223.2 / 33.7% | $448.0 / 34.0% | $454.4 / 34.0% |
| Operating income / margin | $76.1 / 11.2% | $84.5 / 12.8% | $163.3 / 12.4% | $173.0 / 13.0% |
| Net earnings | $56.2 | $64.4 | $118.1 | $129.5 |
| Diluted EPS | $0.44 | $0.50 | $0.92 | $1.01 |
- Quarterly sales rose 2.6%; six-month sales declined 1.4%. Foreign currency translation added $15.9 million to quarterly sales and $23.2 million to six-month sales.
- For the quarter, gross margin fell 0.5 percentage points and operating margin fell 1.6 points. Management attributed pressure principally to $14.8 million of restructuring costs and, for gross margin, unfavorable sales mix; lower raw-material costs partly offset the impact.
- Six-month operating cash flow was $202.3 million, versus $176.8 million. Investing cash outflow, primarily capital expenditures, was $30.4 million, versus $79.7 million. Financing cash outflow was $210.6 million, including debt repayments, dividends, share repurchases and the BOFA non-controlling-interest purchase.
- Cash was $207.3 million at January 31, 2021, versus $236.6 million at July 31, 2020. Long-term debt was $495.1 million; short-term borrowings were $16.7 million and current long-term maturities were $5.7 million. Debt was 32.5% of total capitalization, down from 38.7% at fiscal year-end.
- Donaldson reported $743 million of available borrowing capacity, was in compliance with debt covenants, and said cash, expected operating cash generation and available credit should meet requirements for the next 12 months. Its $100 million 364-day facility matures May 17, 2021; an extension may be requested.
Segment and period comparisons
- Engine Products: Q2 sales increased 6.2% to $462.4 million and pretax segment earnings rose to $61.3 million from $53.3 million. Six-month sales were nearly flat at $898.6 million; pretax earnings increased to $121.7 million from $115.7 million. Aftermarket and off-road strength helped, while aerospace and defense remained weak amid COVID-19-related lower commercial aircraft utilization.
- Industrial Products: Q2 sales fell 4.3% to $216.7 million and pretax segment earnings declined to $25.8 million from $34.6 million. Six-month sales fell 5.2% to $417.2 million and pretax earnings were $53.3 million versus $64.1 million. Management cited weak industrial production and customer capital spending, partly offset by China and food-and-beverage process filtration demand.
- Quarterly U.S. and Canada sales declined 4.2%, while Asia Pacific, Latin America and EMEA sales increased 11.7%, 7.7% and 3.6%, respectively. For the six-month period, U.S. sales declined 8.5%; Asia Pacific rose 9.9%, Latin America 0.5%, and EMEA was flat.
Outlook, risks and unusual items
- The company initiated restructuring, primarily in EMEA, recording $14.8 million of second-quarter expense ($5.8 million in cost of sales and $9.0 million in operating expenses). It expected no further restructuring expenses in fiscal 2021 and estimated $8 million of annualized savings once actions are completed over the next 12 months. $14.2 million remained accrued at January 31.
- Management gave no broader earnings or revenue forecast in the provided filing text. It warned that COVID-19 effects remain uncertain and that supply-chain, logistics and production constraints may continue; site-specific conditions or government orders could disrupt operations.
- Other risks identified include cyclical and fluctuating demand, raw-material cost inflation and availability, pricing competition, foreign-exchange and interest-rate movements, global operating and regulatory risks, and execution of strategic transactions. Commodity increases could pressure margins despite pricing and cost-reduction efforts.
- Six-month other expense included community support related to COVID-19, foreign-exchange losses and a $0.8 million pension curtailment charge. The pension-plan freeze also reduced pension obligations, with a $4.0 million adjustment reflected in other comprehensive income.
- Unrecognized tax benefits were $18.6 million, with $2.4 million of accrued interest and penalties. The company said uncertain tax positions could decrease by up to $5.4 million within 12 months due to statute expirations; it could not quantify possible outcomes of audits or disputes. Recorded litigation liabilities were described as not material, and material excess settlement costs were considered remote.
Important facts for investors to verify
- Whether the announced $8 million annualized restructuring savings are achieved, and whether implementation costs or further actions differ from expectations.
- Whether industrial demand, commercial aerospace activity and COVID-19-related supply or production constraints improve or deteriorate.
- Whether working capital remains controlled: receivables increased to $492.9 million and days sales outstanding rose to 65 from 63 at July 31, 2020; inventories increased to $347.6 million.
- How the May 17, 2021 maturity of the 364-day credit facility is addressed, and whether debt reduction and covenant compliance continue.
- How foreign exchange, raw-material prices, tax exposures and the AFSI joint-venture guarantees affect results and liquidity. The company guaranteed half of AFSI debt of $33.7 million and reported $7.7 million of contingent standby-letter-of-credit liability.