Donaldson Company Inc. announces net earnings of $102.4 million in fourth quarter and $180.3 million for full-year 2018, compared with $68.2 million and $232.8 million, respectively, in 2017. Net earnings in the current and prior years were impacted by non-recurring items, including the Federal Tax Cuts and Jobs Act (TCJA) in fiscal 2018 and an escrow settlement in 2017 related to the company’s acquisition of Northern Technical, L.L.C. (settlement). These items were excluded from the adjusted earnings per share (EPS) calculation.
“We had a strong finish to fiscal 2018, with fourth quarter performance reflecting sales momentum and margin improvement as price realization and expense leverage more than offset inflationary pressure,” says Tod Carpenter, Chairman, President and Chief Executive Officer. “Our employees did an excellent job last year meeting our customers’ needs while delivering on our strategic objectives, which contributed to record levels of sales and adjusted EPS.
“We expect to deliver another year of record performance in 2019, and we are maintaining our momentum related to further penetrating key markets, investing in technology development and adding capacity. While macro-factors like geopolitical uncertainty and continued inflationary pressure temper our perspective, sales growth in both the Engine and Industrial segments combined with a targeted approach to expense planning allow us to fund our strategic investments and drive incremental profit to the bottom line. I am confident that our fiscal 2019 strategic agenda balances near- and long-term opportunities, further strengthening our foundation for future success.”
Fiscal 2018 Performance
Fourth quarter 2018 sales increased 9.8% to $724.7 million from $660.1 million in 2017, including a 1.3% benefit from currency translation. Fourth quarter sales increased 14.0% for Engine Products and 1.9% for Industrial Products. Excluding benefits from currency translation, fourth quarter sales increased 8.5%, reflecting 13.1% growth in Engine Products and flat sales of Industrial Products.
Full-year 2018 sales increased 15.3% to $2.73 billion from $2.37 billion in 2017, including benefits from currency translation and acquisitions completed in the prior year of 3.3% and 1.1%, respectively. Full-year sales increased 19.0% for Engine Products and 8.1% for Industrial Products, or 16.1% and 4.2%, respectively, excluding the benefit from currency translation.
Fourth quarter 2018 operating income as a rate of sales (operating margin) increased to 14.7% from 14.3% in 2017, reflecting expense leverage and gross margin improvement. Fourth quarter gross margin was 34.9%, compared with 34.8% last year, primarily due to benefits from price increases, partially offset by higher raw materials costs. Operating expense as a percentage of sales (expense rate) improved approximately 0.4 percentage points to 20.1% from 20.5%, reflecting leverage on increasing sales, partially offset by higher freight expense.
Fiscal 2018 operating margin of 13.9% was flat with the prior year, reflecting expense leverage that was offset by lower gross margin. Gross margin declined to 34.2% from 34.7% last year, reflecting higher raw materials and supply chain costs combined with an unfavorable mix of sales. The full-year 2018 expense rate improved to 20.3% compared with 20.9% in 2017, reflecting leverage on increasing sales, partially offset by higher compensation costs and freight expense.
Fourth quarter 2018 other income was $2.3 million, compared with $2.5 million in 2017. Full-year other income declined to $4.9 million from $12.9 million last year, primarily driven by a one-time benefit in the prior year related to the settlement. Interest expense was $5.6 million in fourth quarter and $21.3 million for full-year 2018, compared with $5.1 million and $19.5 million, respectively, in 2017.
Donaldson’s continued assessment of the TCJA impact resulted in a tax benefit of $26.0 million in fourth quarter and a full-year charge of $84.1 million. Excluding these impacts, the company’s effective income tax rate was 26.2% in fourth quarter and 27.3% for the full year, compared with prior-year adjusted rates of 25.6% and 28.3%, respectively. The fourth quarter and full-year rates benefited from a lower U.S. corporate tax rate, stock option activity and favorable settlements of tax audits. Offsetting factors included foreign withholding tax and other matters related to the TCJA, combined with an unfavorable mix of earnings across tax jurisdictions.
Donaldson repurchased 0.3 million shares, or 0.2%, of its common stock in fourth quarter and 2.6 million shares, or 2.0%, during fiscal 2018. The fourth quarter and full-year repurchases reflect total investments of $14.3 million and $122.0 million, respectively, at an average price of $46.18 for both periods. Donaldson paid dividends during fourth quarter and full-year 2018 of $24.5 million and $94.7 million, respectively.
Fiscal 2019 Outlook
Donaldson’s fiscal 2019 guidance for revenue, operating margin and other income conforms to the adoption of new FASB standards related to revenue recognition and pension accounting.
Donaldson expects fiscal 2019 GAAP EPS between $2.29 and $2.43, compared with prior-year GAAP and adjusted EPS of $1.36 and $2.00, respectively.
Full-year 2019 sales are expected to increase between 6 and 10%, including additional sales related to the new revenue recognition standard. The sales forecasts for total Donaldson and both the Engine and Industrial Products segments include a negative impact from currency translation of approximately 2%. Engine Products sales are expected to increase between 7 and 11%, reflecting growth in On-Road, Off-Road and Aftermarket, along with flat sales of Aerospace and Defense. The Engine Products forecast also includes additional sales of approximately $25 million related to the new revenue recognition standard. Industrial Products sales are expected to increase between 3 and 7%, reflecting growth in Industrial Filtration Solutions, flat sales of Special Applications and a decline in Gas Turbine Systems.
Donaldson expects full-year 2019 operating margin between 14.1 and 14.5%, compared with a prior-year rate of 13.8% when conforming to the new pension accounting standard. The operating margin guidance includes a negative impact of approximately 0.1 percentage points related to the adoption of the new revenue recognition standard.
The company expects full-year 2019 interest expense of approximately $22 million and other income between $12 million and $16 million. Donaldson’s fiscal 2019 effective income tax rate is projected between 24.7 and 26.7%.
The company expects fiscal 2019 capital expenditures of $130 million to $150 million and cash conversion between 60 and 75%. Donaldson plans to repurchase approximately 2% of its outstanding shares during fiscal 2019.
Accounting Considerations
On August 1, 2018, Donaldson adopted the FASB standards ASU 2014-09, Revenue from Contracts with Customers (revenue recognition) and ASU 2017-07, Compensation – Retirement Benefits (pension accounting).
Donaldson elected to use the modified retrospective method in adopting the revenue recognition standard; therefore, fiscal 2019 results will be presented in conformity with the new standard, while results prior to August 1, 2018, will conform to the previous revenue recognition standard. While the assessment of the impact of the revenue recognition standard on future consolidated financial statements is ongoing, the company has identified one aspect of the new standard that affects the Engine Products segment. Donaldson expects the new standard will increase sales without an associated change to gross profit, effectively reducing the company’s gross margin and operating margin when compared to rates reported in prior fiscal years.
Under the new pension accounting standard, Donaldson will continue to report the service component of retirement costs in operating income and the non-service components will now be reported in other income. The new standard requires use of a retrospective method in accounting for the change; therefore, results in all periods presented will conform with the new standard. Restating fiscal 2018 results to conform with the new standard reduces operating income by approximately $3.0 million, or 0.1 percentage points as a rate of sales, offset by a corresponding increase in other income. Similarly, operating income in fiscal years 2017 and 2016 are reduced by $5.0 million and $0.6 million, respectively, with corresponding increases in other income.
Based on provisional estimates of the TCJA impact, Donaldson recorded a $26.0 million benefit in fourth quarter and a charge of $84.1 million for the full-year 2018. The company continues to estimate the impact from the TCJA, with fiscal 2018 amounts primarily reflecting the transition tax related to repatriation of undistributed foreign earnings.
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.
