Donaldson Company, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended April 30, 2019. Donaldson manufactures filtration systems and replacement parts and reports Engine Products and Industrial Products segments. Amounts are in U.S. dollars; financial statements are unaudited.
Financial performance
| Metric | Three months ended Apr. 30, 2019 | Year-over-year | Nine months ended Apr. 30, 2019 | Year-over-year |
|---|---|---|---|---|
| Net sales | $712.8 million | +$12.8 million; +1.8% | $2,117.9 million | +$108.4 million; +5.4% |
| Gross profit / margin | $240.7 million / 33.8% | Margin down 0.4 percentage points | $704.5 million / 33.3% | Margin down 0.7 percentage points |
| Operating income / margin | $100.0 million / 14.0% | $99.6 million / 14.2% in 2018 | $283.8 million / 13.4% | $268.8 million / 13.4% in 2018 |
| Net earnings | $75.2 million | +$5.3 million | $209.1 million | +$131.2 million |
| Diluted EPS | $0.58 | $0.53 in 2018 | $1.60 | $0.59 in 2018 |
Quarterly sales growth was led by Engine Products (+3.6%); Industrial Products sales declined 1.9%. For the nine-month period, Engine Products grew 6.1% and Industrial Products 4.0%. Foreign currency translation reduced sales by $28.9 million in the quarter and $59.3 million year to date. Higher raw-material and supply-chain costs pressured gross margin; pricing partly offset this impact. Nine-month margin also reflected unfavorable sales mix. Operating expenses were lower as a percentage of sales, reflecting expense leverage and lower incentive compensation.
Nine-month net earnings comparisons are heavily affected by the prior-year period’s $110.1 million provisional tax charge related to the Tax Cuts and Jobs Act (TCJA). Effective tax rates were 24.4% for the 2019 nine-month period and 70.1% in 2018; excluding TCJA adjustments, the filing reports 24.5% and 27.7%, respectively. Quarterly effective rates were 24.5% and 29.4%.
Cash flow, liquidity and capital
- Nine-month operating cash flow was $223.2 million, versus $158.7 million in 2018. Capital expenditures were $112.4 million, versus $73.1 million; acquisition cash outflow was $96.0 million. Net cash used in investing was $208.4 million.
- Cash ended at $203.8 million, compared with $204.7 million at July 31, 2018. Financing activities used $13.7 million; the company paid $72.9 million in dividends and repurchased $104.4 million of stock during the nine months.
- At April 30, short-term borrowings were $50.3 million, current maturities of long-term debt $0.3 million and long-term debt $644.4 million. Total debt was therefore approximately $695.0 million. Long-term debt was up $144.8 million from July 31, 2018, largely to fund the BOFA acquisition, repurchases and capital spending. Debt was 42.4% of total capitalization, compared with 38.8% at July 31.
- Available borrowing capacity under existing credit facilities was $424.8 million. Management said cash, operating cash generation and available credit should be adequate for the next 12 months, including operating needs, debt service, dividends, repurchases, potential acquisitions and capital expenditures.
- Inventories rose $25.4 million to $359.5 million; inventory turns fell to 5.2 from 5.6. Management cited capacity constraints, supply-chain inventory and stronger customer demand. Receivables were essentially flat at $534.3 million; days sales outstanding remained 66.
Material developments, outlook and risks
- Donaldson acquired 88% of BOFA International for $98.2 million cash consideration, less $2.2 million cash acquired. BOFA contributed $21.0 million of Industrial Products sales during the nine months. Purchase accounting remained preliminary; the remaining 12% is subject to call and put options exercisable after three years at a performance-linked price.
- Engine Products’ quarterly earnings before tax margin improved to 14.6% from 14.2%, supported by pricing and operating leverage; year-to-date margin declined to 13.1% from 13.6%, reflecting input and supply-chain costs and mix. Industrial Products’ quarterly margin declined to 14.6% from 15.1%, while its year-to-date margin improved to 15.0% from 14.7%.
- Market commentary was mixed: aftermarket, on-road, and aerospace and defense demand supported Engine Products; off-road conditions and ordering were variable. Industrial filtration replacement parts grew, while gas-turbine first-fit demand was lower and disk-drive filtration faced secular-market pressure. Donaldson said it was being more selective in pursuing large-turbine projects.
- The filing provides no specific numerical earnings or sales guidance. Management’s liquidity assessment is the principal explicit near-term outlook statement.
- Risks identified include global economic and industrial conditions, competition and pricing, raw-material inflation or shortages, ability to meet demand, foreign exchange, cybersecurity and IT, regulatory and tax changes, litigation, acquisitions, and potential impairment. The company is contesting proposed IRS adjustments for fiscal 2015 and 2016, considers the claims without merit and says it will defend its position. Recorded litigation liabilities were not material; management considered material excess settlement costs remote.
- The company guarantees 50% of $38.2 million of debt at its unconsolidated joint venture, AFSI. Outstanding standby letters of credit totaled $11.2 million, with none drawn. A May 31, 2019 board action replaced the remaining share-repurchase authorization with a new authorization for 13.0 million shares; the board also declared a $0.21-per-share dividend payable June 28, 2019.
Important facts for investors to verify
- Separate underlying earnings growth from the prior-year $110.1 million TCJA charge, and monitor future effective tax rates and tax-audit developments.
- Track whether pricing can continue to offset raw-material and supply-chain cost inflation and restore gross margin.
- Assess BOFA’s integration, performance, preliminary purchase-price allocation and the eventual cost of the remaining 12% stake.
- Monitor debt, borrowing capacity, working-capital and inventory trends, and the level of capital expenditures and share repurchases.
- Follow foreign-exchange impacts and demand trends in off-road, gas-turbine and disk-drive markets, as well as the company’s ability to meet customer demand.