Donaldson Reports Third Quarter 2016 Earnings

Donaldson's third quarter 2016 sales declined 0.7% from the same period in 2015, and anticipates sales for 2016 as a whole to be 6% below last year.

Donaldson Company Inc. has reported third quarter 2016 net earnings of $54.8 million, or 41 cents per share, compared with $47.8 million, or 34 cents per share, in 2015. Foreign currency translation reduced net income in the third quarters of fiscal 2016 and 2015 by $0.9 million and $3.1 million, respectively. Third quarter 2016 adjusted EPS3 was 43 cents, compared with 37 cents last year. 

“We delivered strong sequential improvement in both sales and operating margin last quarter, which contributed to overall performance that was in line with our expectations,” says Tod Carpenter, President and Chief Executive Officer. “Compared with our sales forecast, favorability in certain areas was offset by accelerated weakening in others.

“As this period of market-level volatility continues, we remain focused on operational efficiency. During the quarter we delivered strong expense performance, and we also identified opportunities to reduce our costs through additional restructuring. The broad-based reductions are expected to generate annual savings of $8 million. Overall, the combined variability in revenue by business and across the income statement results in a full-year forecast for sales and earnings that is aligned with prior guidance.”

Sales Results

Third quarter 2016 sales declined 0.7% to $571.3 million from $575.6 million in 2015. Foreign currency translation negatively affected third quarter 2016 sales by 1.0%, or $5.5 million.

Excluding the impact from currency translation, third quarter 2016 sales increased 0.2% from last year, driven by a year-over-year sales increase in the Industrial segment of 4.4% that was largely offset by a 2.1% sales decline in the Engine segment. 

Operating Profit Results

Third quarter 2016 operating margin was 13.1%, compared with 11.7% last year. Excluding restructuring charges in both current- and prior-year periods, third quarter 2016 adjusted operating margin increased approximately 1.2 percentage points to 13.8% from 12.6% last year.

Third quarter 2016 gross margin rate was 34.4%, compared with 33.7% in 2015. The current- and prior-year rates include restructuring charges, which reduced gross margin by approximately 0.2 percentage points and 0.5 percentage points, respectively. Excluding the impacts from each period, third quarter 2016 gross margin increased to 34.6% from 34.2% last year, reflecting favorability from volume and mix that was partially offset by lower-margin projects in the Gas Turbine Systems business.

Third quarter 2016 operating expense as a percent of sales (expense rate) declined to 21.3% from 22.1% in 2015. Restructuring charges increased third quarter expense rates in fiscal 2016 and 2015 by 0.6 percentage points and 0.5 percentage points, respectively. Excluding these charges, third quarter 2016 adjusted expense rate was 20.7%, or approximately 0.9 percentage points below last year. The lower expense rate was primarily due to disciplined expense management, including benefits from restructuring actions taken in prior quarters, which was partially offset by a charge of approximately $2.2 million related to the reversal of an accrued subsidy benefit in China.

Interest expense increased to $5.3 million in third quarter from $3.9 million last year, reflecting a higher level of debt than 2015.

The effective income tax rate declined in third quarter 2016 to 24.0% from 29.6% in 2015, primarily driven by a favorable settlement of tax audits, which benefited the rate by approximately 4.2 percentage points, and a favorable mix of earnings between tax jurisdictions.

Capital Returned to Shareholders

Donaldson paid dividends of $22.6 million in third quarter and $67.9 million year to date. The company did not repurchase any shares of its common stock during third quarter. Year to date, Donaldson invested $68.0 million to repurchase 1.5% of its outstanding shares at an average price of $32.85 per share.

Fiscal 2016 Outlook

Donaldson now expects fiscal 2016 adjusted EPS of $1.53 to $1.59. The midpoint of this range is consistent with prior guidance. Full-year GAAP EPS is now expected to be approximately 9 cents lower than adjusted EPS, reflecting the year-to-date impact from restructuring charges and investigation-related costs.

Donaldson’s full-year 2016 guidance reflects:

  • Sales of approximately $2.225 billion, or about 6% below last year, consistent with the midpoint of the prior guidance range. Excluding a negative impact from currency translation of approximately $80 million, sales in local currencies are expected to decline approximately 3%, compared with prior guidance of a year-over-year decline between 1 and 3%.
  • Adjusted operating margin in a range between 12.9% and 13.3%, compared with prior guidance of 13.0-13.6%.
  • Interest expense of $21 million, or approximately $5.8 million above last year.
  • An effective income tax rate between 25.0% and 26.0%, compared with prior guidance of 25.5-27.5%.
  • Repurchasing up to 2% of its outstanding shares.

Engine Products: Fiscal 2016 Engine sales are now expected to decline approximately 6% from 2015. In local currency, sales are expected to decline approximately 3%, compared with prior guidance of a year-over-year decline between 1 and 3%.

The Engine forecast reflects the following market conditions:

  • A decline during the second half of fiscal 2016 in heavy-duty on-road transportation, weakness in the global agriculture and mining equipment markets and a slowdown in the construction market.
  • Stable utilization rates of on-road heavy-duty trucks offset by a decline in utilization of off-road equipment, resulting in a year-over-year sales decline for replacement filters.
  • A continued slowdown in U.S. defense spending and a moderate slowdown in commercial aerospace.

Industrial Products: Fiscal 2016 Industrial sales are now expected to decline approximately 6% from 2015. In local currency, sales are expected to decline approximately 3%, compared with prior guidance of a year-over-year decline between 1 and 3%. Within the Industrial segment:

  • Industrial Filtration Solutions’ sales are expected to decline in the low-single-digit range compared with last year.
  • Gas Turbine Systems’ sales are now expected to decline approximately 20%, reflecting project deferrals and volatility in global demand, partially offset by growth of replacement part sales.
  • Special Applications’ sales are now expected to decline in the mid-single-digit range compared with last year, driven by declines in the disk drive, membrane and semiconductor businesses, partially offset by growth in venting products.

Accounting Considerations

During the current and prior fiscal years, Donaldson implemented restructuring actions to align its cost structure with customer demand. These activities resulted in pre-tax restructuring charges of $4.1 million in third quarter 2016 and $12.6 million year to date, compared with charges of $5.2 million and $5.8 million, respectively, in the prior year.

During first quarter 2016, the Audit Committee of Donaldson’s Board of Directors engaged independent external counsel and independent forensic accountants to investigate revenue recognition issues in Donaldson’s European Gas Turbine Systems business. The investigation was completed in second quarter 2016 and resulted in pre-tax charges of $3.1 million during fiscal 2016.