Donaldson Company, Inc. — Q1 FY2020 Form 10-Q
Reporting period: Three months ended October 31, 2019; comparisons are with the three months ended October 31, 2018, unless otherwise noted. Donaldson manufactures filtration systems and replacement parts. Its reportable segments are Engine Products and Industrial Products. Dollar amounts are in millions except per-share data.
Financial performance
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $672.7 | $701.4 | Down 4.1% |
| Gross profit / margin | $231.3 / 34.4% | $238.4 / 34.0% | Margin up 0.4 percentage points |
| Operating income / margin | $88.7 / 13.2% | $98.7 / 14.1% | Income down 10.1% |
| Net earnings / margin | $65.0 / 9.7% | $73.8 / 10.5% | Down 11.9% |
| Diluted EPS | $0.51 | $0.56 | Down $0.05 |
| Operating cash flow | $86.1 | $63.3 | Up $22.8 |
| Capital expenditures | $37.1 | $28.2 | Up $8.9 |
Operating cash flow less capital expenditures was $49.0, versus $35.1 a year earlier. Cash and cash equivalents were $210.0 at October 31, 2019, compared with $177.8 at July 31, 2019. The company reported $505.5 of additional borrowing capacity under existing credit facilities.
At October 31, 2019, balance-sheet debt included $596.8 of long-term debt, $50.0 of current maturities and $60.9 of short-term borrowings. The company reported debt at 43.6% of total capitalization, versus 41.6% at July 31, 2019. Interest expense was $4.7, compared with $4.2. The company entered into and fully drew an unsecured €80 million term loan (reported as $89.2), maturing in October 2024, with a floating rate tied to EURIBOR and a leverage-based margin.
Material changes and drivers
- Sales declined in both segments: Engine Products fell 4.5% to $459.2, and Industrial Products fell 3.2% to $213.5. Foreign currency translation reduced sales by $9.6, or 1.4%; management said sales declined 3.1% and 2.0%, respectively, excluding currency effects.
- Engine Products earnings before tax were $62.4, versus $63.9; segment margin improved to 13.6% from 13.3%. Lower off-road and on-road production and reduced aftermarket demand, especially in off-road markets, were partly offset by pricing, operational gains and lower raw-material costs. Aerospace and Defense sales increased.
- Industrial Products earnings before tax declined to $29.5 from $36.6; segment margin fell to 13.8% from 16.6%. Lower gas-turbine new-equipment and disk-drive filter sales and investment in strategic growth businesses weighed on results. BOFA and pricing supported sales.
- Consolidated gross margin improved with lower raw-material costs, pricing initiatives and supply-chain optimization, partly offset by lower-sales deleverage. Operating expenses rose 2.1% to $142.6 and increased to 21.2% of sales from 19.9%, reflecting lower-sales deleverage and strategic-growth personnel investments.
- Operating cash flow improved mainly due to lower days sales outstanding and lower incentive-compensation payments, partly offset by lower earnings. Investing cash use was $37.1, compared with $124.2, which included $96.0 for BOFA in the prior-year quarter. Financing cash use was $14.7, including $65.0 of treasury-stock purchases and $26.6 of dividends paid.
Outlook, risks and unusual items
- The filing provides no specific numerical earnings or revenue guidance. Management said available cash, expected operating cash generation and borrowing capacity should be adequate for the next 12 months, including working capital, debt service, capital expenditures, dividends, repurchases and potential acquisitions.
- Management cited risks including global economic and industrial conditions, cyclical demand, pricing competition, raw-material availability and inflation, foreign-exchange movements, execution of growth and acquisition plans, regulatory and tax matters, litigation, IT and cybersecurity, and Brexit-related uncertainty. A stronger U.S. dollar reduced quarterly sales by $9.6 and earnings by approximately $0.7. Commodity-price increases could pressure margins.
- Inventory rose $28.7 from July 31 to $361.5, attributed to supply-chain sourcing changes; inventory turns declined to 5.1 from 5.6. Receivables fell to $501.5, and days sales outstanding was 65, unchanged from July 31 and below 69 a year earlier.
- Adoption of lease accounting in Q1 increased assets and liabilities by $71.5 as of August 1, 2019. At October 31, right-of-use assets were $79.3 and lease liabilities totaled $79.2.
- The company guarantees half of certain AFSI joint-venture debt: the joint venture had $40.0 outstanding, and the company also disclosed $10.7 of standby letters of credit with no amounts drawn. Management said recorded litigation liabilities were not material and that material excess settlements were remote. Gross unrecognized tax benefits were $15.8, with $1.8 of accrued interest and penalties; management did not expect a material reserve adjustment in the next 12 months.
- The filing contains a potentially inconsistent stated rate for the October euro term loan: the debt note reports 0.7% at October 31, while MD&A states zero. The applicable rate is not clear from the filing text.
Most important facts for investors to verify
- Confirm the term loan’s actual interest rate and the related variable-rate debt exposure, given the filing’s 0.7% versus zero discrepancy.
- Track whether weaker equipment production and aftermarket utilization persist, and whether Industrial Products profitability recovers after strategic investments.
- Assess the effect of inventory growth and sourcing changes on working capital, inventory turns and future cash conversion.
- Monitor debt, credit-facility availability, share repurchases and dividends against cash generation and capital needs.
- Review the risk-factor disclosures in the company’s FY2019 Form 10-K, which this filing incorporates by reference for material business risks.