Donaldson Company Inc. reports record first quarter net earnings of $73.8 million, or $0.56 per share, compared with $60.9 million, or $0.46 per share, in 2018. First quarter 2019 net earnings include a discrete tax benefit of $0.9 million related to the Federal Tax Cuts and Jobs Act (TCJA), which has been excluded from the calculation of adjusted earnings.
“We had a strong start to the fiscal year, with benefits from consistent execution of our strategic priorities and significant expense leverage contributing to record first quarter sales and earnings,” says Tod Carpenter, Chairman, President and Chief Executive Officer. “Strength from program wins and further penetration into existing and adjacent markets built on favorable market conditions, and we are on track to deliver record sales and profit in 2019.
“We remain encouraged by the operating environment, despite geopolitical uncertainty and inflationary pressure, and we are investing for the future. We are pursuing organic opportunities with technology development and capacity expansion, and the recent acquisition of BOFA complements our already-strong portfolio of Industrial businesses. Through our focused expense planning and efforts to offset inflation with pricing, we can make these investments while driving incremental profit to the bottom line. We have momentum across the company, and I am confident that executing our strategic agenda will further strengthen our position as a leader in the global filtration industry.”
Fiscal 2019 Performance
First quarter 2019 sales increased 8.8% to $701.4 million from $644.8 million in 2018. The first quarter year-over-year sales change was impacted by the following items:
- Currency translation negatively impacted sales by approximately 1.9 percentage points,
- Adoption of the new revenue recognition accounting standard added approximately 0.7 percentage points, and
- The recently completed acquisition of BOFA International LTD (BOFA) added approximately 0.2 percentage points.
Sales in both the Engine Products (Engine) and Industrial Products (Industrial) segments increased 8.8% from 2018, or 10.9 and 10.3%, respectively, in constant currency. The revenue recognition change added approximately 0.9 percentage points to Engine’s sales growth rate, and BOFA added approximately 0.7 percentage points to Industrial’s sales growth rate.
First quarter 2019 operating income as a rate of sales (operating margin) increased to 14.1% from 13.8% in 2018.1 First quarter 2019 gross margin of 34.0% was below last year’s rate by 0.8 percentage points, or 0.6 percentage points when adjusting for the impact from new revenue recognition accounting. First quarter 2019 gross margin was negatively impacted by higher raw materials and supply chain costs, combined with an unfavorable mix of sales, partially offset by pricing benefits. Operating expense as a percentage of sales improved 1.1 percentage points to 19.9% from 21.0% in 2018, reflecting leverage on increasing sales and lower warranty costs, partially offset by costs related to the BOFA acquisition and higher freight costs.
First quarter 2019 other income was $1.9 million, compared with $0.8 million in 2018. The company’s global cash optimization efforts following the TCJA resulted in lower first quarter 2019 interest expense, which was $4.2 million compared with $5.2 million last year, and a discrete tax benefit of $0.9 million. Excluding this benefit, the adjusted tax rate declined to 24.3% from 28.1% last year, driven primarily by a lower U.S. corporate tax rate and stock option activity, partially offset by other matters related to the TCJA.
During first quarter 2019, Donaldson repurchased 1.6 million shares, or 1.2%, of its common stock at an average price of $49.40 for a total investment of $80.9 million. Donaldson paid dividends during first quarter of $24.4 million.
Fiscal 2019 Outlook 2
Donaldson increased its fiscal 2019 forecast to reflect the impact from the BOFA acquisition.
The company now expects full-year EPS between $2.31 and $2.45, an increase of 2 cents from prior guidance. Sales from BOFA are expected to add about 1% to total Donaldson sales, or 4% to Industrial sales. Excluding this impact, the company’s full-year 2019 sales forecast is consistent with prior guidance.
Full-year sales in total and for both segments are expected to increase between 7 and 11%, including a negative impact from currency translation of approximately 2%. The Engine sales forecast reflects growth in On-Road, Off-Road and Aftermarket, along with flat sales of Aerospace and Defense. Additionally, the revenue recognition accounting change is expected to add approximately 1% to Engine sales. The Industrial forecast, which includes BOFA sales, reflects growth in Industrial Filtration Solutions, flat sales of Special Applications and a decline in Gas Turbine Systems.
Donaldson now expects full-year 2019 operating margin between 14.2 and 14.6%, up 0.1 percentage point from prior guidance. Adoption of the revenue recognition standard dilutes the year-over-year change by approximately 0.1 percentage point.
The company’s full-year 2019 interest expense forecast increased by $1 million to $23 million, while the other income forecast remains at $12 million to $16 million. Donaldson’s fiscal 2019 effective income tax rate is still projected between 24.7 and 26.7%.
The company continues to forecast fiscal 2019 capital expenditures of $130 million to $150 million and cash conversion between 60 and 75%. Donaldson remains committed to repurchasing approximately 2% of its outstanding shares during fiscal 2019.
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 adopt the new revenue recognition standard using the modified retrospective method; 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 standard. Adoption of the new standard resulted in additional sales of $4.2 million in first quarter 2019 with a minimal impact to gross profit. This change effectively reduces 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 reduces full-year 2018 operating margin by approximately 0.1 percentage point, reflecting a decline of 0.2 percentage points in each of the first three quarters, while the restated fourth quarter 2018 operating margin increases by approximately 0.2 percentage points. These adjustments are offset by a corresponding change to other income.
Following the TCJA, the company engaged in additional efforts related to global cash optimization. Changes implemented during first quarter 2019 resulted in a discrete tax benefit of $0.9 million, which is excluded from the company’s calculation of adjusted earnings. The company expects to finalize the impact from the TCJA during second quarter 2019, while global cash optimization is a continuous focus for Donaldson.
1 Prior-period rates reflect adoption of the pension accounting standard beginning in fiscal 2019.
2 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.