Donaldson Company, Inc. announces a net loss in second quarter 2018 of $52.9 million, or $0.40 per share,1 compared with net earnings of $46.5 million, or $0.35 per share, in 2017. The company’s second quarter 2018 results included a one-time charge of $109.7 million, or $0.83 per share, related to the Federal Tax Cuts and Jobs Act (TCJA). Excluding this charge, Donaldson delivered second quarter 2018 adjusted earnings per share (EPS)2 of $0.43, an increase of 22.9% from 2017.
“Market strength combined with benefits from consistent execution of our strategy drove notable sales increases across our business last quarter, and we expect to be at the high end of the full-year sales forecast we provided last quarter,” says Tod Carpenter, Chairman, President and Chief Executive Officer. “We remain encouraged by the operating environment, with continued strength in engine-related markets and further improvement in several industrial markets.
“With improving market conditions, we are also experiencing pressure on gross margin from raw materials inflation, mix of sales and other costs related to higher-than-expected demand. While we pursue additional cost-reduction and pricing initiatives to mitigate these pressures, we are also focused on executing our strategic agenda, including: increasing the level of investment in technology development, launching our e-commerce site and expanding capacity. The commitment and effort shown by our employees gives me confidence that we will deliver on our key objectives this year while further strengthening our foundation for long-term value creation.”
1 All earnings per share figures refer to diluted earnings per share.
2 Adjusted earnings per share is a non-GAAP financial measure that excludes the impact of certain matters not related to the company’s ongoing operations.
Second Quarter 2018 Performance
Second quarter 2018 sales increased 20.7% to $664.7 million from $550.6 million last year. The year-over-year increase includes a benefit of approximately 4.6% from currency translation and 1.5% from acquisitions completed by the company during fiscal 2017.
Compared with the prior year, second quarter 2018 sales increased 22.3% in the Engine Products segment and 17.7% in the Industrial Products segment, or 18.1% and 12.2%, respectively, excluding the benefit from currency translation.
Second quarter 2018 operating income rate declined to 12.3% from 12.6% in 2017, reflecting lower gross margin that was partially offset by operating expense leverage. Gross margin declined 1.2 percentage points to 32.9% from 34.1%, reflecting the negative impacts from higher raw materials and supply chain costs combined with an unfavorable mix of sales. Operating expense as a rate of sales (expense rate) improved 0.9 percentage points to 20.6% from 21.5%, reflecting leverage on increasing sales, partially offset by strategic investments and higher incentive compensation. Additionally, this fiscal year Donaldson moved its annual stock option incentive grant from second quarter to first quarter, which contributed approximately 0.5 percentage points to the year-over-year expense rate favorability.
Donaldson’s second quarter 2018 net other expense was $0.1 million, compared with net other income in 2017 of $1.7 million. Second quarter interest expense was $5.1 million in 2018, compared with $4.8 million in 2017. The company’s second quarter 2018 effective income tax rate includes additional tax expense of $109.7 million related to the TCJA. Excluding this impact, the second quarter 2018 rate declined to 25.7% from 29.8% in 2017, reflecting tax benefits of stock option activity combined with a lower U.S. corporate tax rate.
During second quarter 2018, Donaldson repurchased 400 thousand shares, or 0.3%, of its common stock at an average price of $50.55 for a total investment of $20.2 million. Year to date, the company has repurchased 1.3 million shares, or 1.0%, of its common stock at an average price of $47.17 for a total investment of $62.9 million. Donaldson paid dividends of $23.4 million in second quarter 2018.
Fiscal 2018 Outlook
Donaldson expects fiscal 2018 adjusted EPS between $1.93 and $2.01, consistent with prior guidance at the midpoint. Fiscal 2018 GAAP EPS is expected to be approximately $0.83 lower than adjusted EPS, reflecting charges taken in second quarter 2018 related to the TCJA.
Donaldson increased the midpoint of its full-year 2018 sales guidance range, with sales now expected to grow between 13 and 15%, compared with 10-14% in prior guidance. The total sales forecast includes benefits of approximately 3% from currency translation and 1% from acquisitions completed in fiscal 2017.
Sales of Engine Products are now expected to increase between 17 and 19%, compared with prior forecast of 13-17%. Donaldson raised its growth projections for Off-Road and On-Road, while Aftermarket and Aerospace and Defense year-over-year growth rates are consistent with prior guidance. Industrial Products sales are expected to increase 5-7%, reflecting growth in Industrial Filtration Solutions and Special Applications, partially offset by declining sales in Gas Turbine Systems. The midpoint of the Industrial Products sales range is consistent with prior guidance.
Donaldson expects fiscal 2018 operating margin between 13.8 and 14.2%, or 0.3 percentage points below prior guidance due to increased pressure on gross margin. The Company expects full-year 2018 interest expense of approximately $21 million, and the forecast for other income is now $1 million to $5 million, compared with prior forecast of $3 million to $7 million. Excluding one-time charges related to the TCJA, Donaldson’s fiscal 2018 effective income tax rate will be 26.5-28.5%. The revised guidance reflects the estimated net impact from the TCJA, which includes a partial-year benefit from the U.S. corporate tax rate reduction that is largely offset by foreign withholding tax and other matters related to the TCJA.
The company expects fiscal 2018 capital expenditures of $90 million to $100 million and cash conversion between 60 and 75%, with increased working capital needs resulting in lower cash conversion than previously expected. Donaldson plans to repurchase approximately 2% of its outstanding shares in fiscal 2018.
Accounting Considerations
Donaldson’s second quarter 2018 results include non-cash charges related to the company’s provisional estimates of the impact from the TCJA. These charges include $108.3 million related to the deemed repatriation of undistributed foreign earnings, which will be paid over 8 years beginning in fiscal 2019, and $1.4 million related to the re-measurement of Donaldson’s net deferred tax assets. These items were excluded from the calculation of adjusted EPS.
During first quarter 2017, Donaldson recorded income of $6.8 million related to the settlement of claims against an escrow account that had been established with the company’s acquisition of Northern Technical, L.L.C., which was completed in first quarter 2015. The income was recorded as other income in Donaldson’s first quarter 2017 consolidated statement of earnings and within the Industrial Products segment earnings. The income was excluded from the calculation of adjusted EPS.
