Donaldson Company, Inc. — Fiscal 2018 Second-Quarter 10-Q
Reporting period: Three and six months ended January 31, 2018; balance-sheet comparisons are with July 31, 2017. Donaldson manufactures filtration systems and replacement parts through its Engine Products and Industrial Products segments.
Financial performance
| Metric | Quarter | Six months |
|---|---|---|
| Net sales | $664.7 million, up 20.7% year over year | $1,309.5 million, up 18.7% |
| Gross margin | 32.9%, versus 34.1% | 33.8%, versus 34.6% |
| Operating income | $81.6 million; 12.3% of sales | $172.3 million; 13.2% of sales |
| Pre-tax earnings | $76.4 million | $161.1 million |
| Net earnings (loss) | $(52.9) million; $(0.40) per diluted share | $8.0 million; $0.06 per diluted share |
| Operating cash flow | Not reported separately for the quarter | $109.8 million, versus $169.5 million |
Quarterly sales growth was led by Engine Products, up 22.3%, and Industrial Products, up 17.7%; foreign-currency translation added $25.6 million to sales. For the six months, Engine Products sales rose 23.6% and Industrial Products sales rose 9.6%; currency added $35.1 million. Engine segment pre-tax earnings were $54.5 million for the quarter and $118.1 million for the half. Industrial segment pre-tax earnings were $32.2 million and $62.2 million, respectively.
Cash, debt and liquidity
- Cash and equivalents were $362.2 million at January 31, up from $308.4 million at July 31.
- Long-term debt was $667.7 million, up $130.4 million from July 31. The company cited share repurchases, dividends and working-capital needs; $50.0 million of current maturities was refinanced as long-term debt.
- Cash from operations declined by $59.7 million year over year, primarily reflecting working-capital changes associated with higher sales and expected demand. Net investing cash use was $45.0 million, including $45.8 million of capital expenditures.
- The company reported $442.9 million available under credit facilities and said cash, credit availability and expected operating cash generation should meet requirements for the next 12 months, including debt service, pensions, dividends, possible repurchases, acquisitions and capital spending.
- Inventories rose to $344.9 million from $293.5 million; inventory turns fell to 5.4 from 6.1. Days sales outstanding rose to 69 from 67.
Material changes, outlook and risks
- Tax law charge: The Tax Cuts and Jobs Act (TCJA) resulted in provisional tax charges of $109.7 million: $108.3 million for the transition tax on deemed repatriated foreign earnings and $1.4 million from deferred-tax remeasurement. The transition-tax liability is payable over eight years; $99.4 million was classified as long-term. The charges caused the quarterly net loss and sharply reduced half-year earnings. Tax accounting remained provisional, with further analysis expected during the measurement period. Excluding TCJA one-time adjustments, reported effective tax rates were 25.7% for the quarter and 26.9% for the half-year.
- Margins and costs: Gross margin fell year over year, which management attributed to unfavorable product mix and higher supply-chain and raw-material costs. Operating expenses as a share of sales improved with sales leverage, partly offset by higher incentive compensation.
- Other comparability item: Prior-year six-month other income included $6.8 million from a favorable settlement related to the Northern Technical acquisition. Higher foreign-exchange losses also weighed on current-period other results.
- Management commentary: Management described improving demand in several markets, including aftermarket, off-road and heavy-duty trucks. Gas-turbine first-fit activity remained affected by selective pursuit of large projects, weaker new-project demand and customer site delays. The filing provides no quantified earnings or sales guidance.
- Contingencies and risks: Recorded litigation liabilities were not material, and management did not expect currently identified claims to materially exceed accruals. Donaldson guarantees half of certain Advanced Filtration Systems Inc. debt; the joint venture had $31.2 million outstanding. The company also disclosed $8.4 million of undrawn standby letters of credit. Risks include cyclical global markets, pricing and commodity costs, foreign exchange, tax-law implementation and examinations, and execution of acquisitions and other plans. The IRS was examining fiscal 2015 and 2016; gross unrecognized tax benefits were $19.8 million, with $2.6 million of accrued interest and penalties.
Key facts for investors to verify
- How provisional TCJA accounting and future repatriation decisions affect tax expense, cash taxes and the transition-tax liability.
- Whether sales growth converts into improved margins amid raw-material and supply-chain cost pressure.
- Whether working-capital investment and lower inventory turns unwind as demand and production normalize.
- Debt levels, repurchases and dividends relative to operating cash flow and planned capital expenditures.
- Segment demand trends, particularly Industrial Products’ first-fit gas-turbine business and cyclical end markets.