Market Overview

Donaldson Company Reports First Quarter 2019 Earnings

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Donaldson achieved record first quarter sales and EPS1

First quarter 2019 sales and EPS grew 8.8 percent and 21.7
percent, respectively

First quarter operating margin was 14.1 percent, 0.3 percentage
points above last year

Donaldson Company, Inc. (NYSE:DCI) today reported 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),2 which has been
excluded from the calculation of adjusted earnings.3 The
tables attached to this press release include a reconciliation of GAAP
to non-GAAP measures.

"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," said 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."

     
1   All earnings per share figures refer to diluted earnings per share.
2 See the "Accounting Considerations" section for more information
about the TCJA and adoption of new accounting standards.
3   Adjusted earnings are a non-GAAP financial measure that exclude the
impact of certain items not related to ongoing operations.
 

Fiscal 2019 Performance

First quarter 2019 sales increased 8.8 percent 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 percent from 2018, or 10.9 percent
and 10.3 percent, 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.

   
Three Months Ended
October 31, 2018
    Constant
Reported

Currency

% Change

% Change

Off-Road 1.6 % 3.4 %
On-Road 37.7 39.4
Aftermarket 7.2 9.5
Aerospace and Defense 11.7     12.6    
Total Engine Products segment 8.8   % 10.9   %
Industrial Filtration Solutions 11.1 % 12.9 %
Gas Turbine Systems (3.1

)

 

(2.2

)

 

Special Applications 8.8     9.9    
Total Industrial Products segment 8.8   % 10.3   %
Total Company 8.8   % 10.7   %
 

First quarter 2019 operating income as a rate of sales (operating
margin) increased to 14.1 percent from 13.8 percent in 2018.4
First quarter 2019 gross margin of 34.0 percent 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 percent from 21.0 percent in
2018, reflecting leverage on increasing sales and lower warranty costs,
partially offset by costs related to the BOFA acquisition and higher
freight costs.

     
4   Prior-period rates reflect adoption of the pension accounting
standard beginning in fiscal 2019.
 

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 percent from 28.1 percent 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 percent, 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 Outlook5

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 percent to total Donaldson sales, or 4 percent 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 percent, including a negative impact from currency
translation of approximately 2 percent. 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 percent 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 percent, 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 percent.

The Company continues to forecast fiscal 2019 capital expenditures of
$130 million to $150 million and cash conversion between 60 and 75
percent. Donaldson remains committed to repurchasing approximately
2 percent of its outstanding shares during fiscal 2019.

     
5   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.
 

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 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

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