Donaldson Company, Inc. — fiscal 2019 first quarter
Reporting period: Three months ended October 31, 2018; comparisons are with the three months ended October 31, 2017 unless otherwise noted. The filing is an unaudited Form 10-Q.
Financial results
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $701.4 million | $644.8 million | +8.8% |
| Gross profit / margin | $238.4 million / 34.0% | $224.3 million / 34.8% | Margin down 0.8 percentage points |
| Operating income / margin | $98.7 million / 14.1% | $89.1 million / 13.8% | Income +10.8% |
| Net earnings | $73.8 million | $60.9 million | +21.2% |
| Diluted EPS | $0.56 | $0.46 | +$0.10 |
| Operating cash flow | $63.3 million | $63.9 million | Down $0.6 million |
Engine Products sales rose 8.8% to $480.9 million; segment pretax earnings were $63.9 million versus $62.7 million. Industrial Products sales rose 8.8% to $220.5 million; segment pretax earnings increased to $36.6 million from $29.4 million. The effective tax rate was 23.5%, versus 28.1%, including a $0.9 million discrete tax benefit; excluding TCJA adjustments, the current-quarter rate was 24.3%.
Cash, debt, and liquidity
Cash and cash equivalents were $199.9 million at October 31, 2018, compared with $204.7 million at July 31, 2018. Investing activities used $124.2 million, including $96.0 million net cash paid for BOFA and $28.2 million of capital expenditures. Financing activities provided $61.3 million, including increased borrowing and $80.9 million of share repurchases. The company reported $704.6 million of total debt, including short-term borrowings and current maturities, and $630.6 million of long-term debt. Total debt was 45.2% of total capitalization, up from 38.8% at fiscal year-end. It had $419.6 million of borrowing capacity available and said expected operating cash generation, cash, and credit availability should meet requirements for the next 12 months.
Material changes and management commentary
- Sales growth was broad-based, but foreign-currency translation reduced year-over-year sales by $12.7 million. Engine Aftermarket and On-Road sales benefited from demand and market conditions; Industrial Filtration Solutions and Special Applications also grew. Gas Turbine Systems sales declined.
- Gross margin declined due to higher raw-material and supply-chain costs and unfavorable sales mix, partly offset by pricing. Operating expenses were 19.9% of sales versus 21.0%, reflecting sales leverage and lower warranty costs, partly offset by BOFA-related and freight costs.
- Donaldson acquired 88% of UK-based BOFA International for $98.2 million in cash consideration, net of $2.2 million cash acquired. BOFA contributed $1.5 million in the quarter; preliminary purchase accounting included $71.0 million goodwill. The company has call and put options relating to the remaining 12% stake.
- Operating cash flow was approximately flat as higher earnings were offset by increased working capital. Receivables rose to $542.4 million and days sales outstanding increased to 69 from 66; inventory rose to $360.5 million and inventory turns declined to 5.3 from 5.6.
- The company adopted ASC 606. The opening retained-earnings adjustment was $5.3 million, and the adoption did not materially affect current-quarter revenue timing. A principal-versus-agent change increased both sales and cost of sales by $5.1 million in the quarter.
Outlook, risks, and contingencies
The filing provides no specific revenue or earnings guidance. Management stated that available cash, expected operating cash flow, and credit facilities should be adequate for the next 12 months. Risks cited include global economic and industrial conditions, pricing pressure, raw-material inflation or availability, customer demand and operational capacity, foreign exchange, competition, cybersecurity and IT issues, regulation, tax matters, litigation, acquisitions, and potential intangible-asset impairment. The company reported no material change in market risk since July 31, 2018.
The IRS is in administrative appeals over proposed adjustments for fiscal 2015 and 2016; the company disputes the claims and says it will defend its position. Recorded litigation liabilities were described as not material, and management considered material excess settlements remote. The company guarantees half of $35.8 million of debt at its AFSI joint venture and had $11.2 million of outstanding standby letters of credit, with none drawn.
Important facts for investors to verify
- Whether pricing and productivity can offset raw-material, supply-chain, and mix-related pressure on gross margin.
- BOFA’s ongoing contribution, final purchase-price allocation, and potential cost or cash implications of the remaining-stake options.
- Working-capital trends, particularly receivables, inventory, and the effect on cash conversion.
- Debt levels and borrowing capacity following the acquisition and share repurchases.
- Resolution of the IRS appeals and any changes to provisional TCJA accounting or related tax exposures.