UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
☒ | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended July 31, 2018 or |
☐ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from __________ to __________ |
Commission File Number: 1-7891
DONALDSON COMPANY, INC.
(Exact name of registrant as specified in its charter)
Delaware | 41-0222640 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1400 West 94th Street, Minneapolis, Minnesota | 55431 |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (952) 887-3131
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, $5 Par Value | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ☒ Yes ☐ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ☐ Yes ☒ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes ☐ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x | Accelerated filer o | |
Non-accelerated filer o | Smaller reporting company o | |
Emerging growth company o | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).☐ Yes ☒ No
As of January 31, 2018, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of voting and non-voting common stock held by non-affiliates of the registrant was $6,563,203,766 (based on the closing price of $50.66 as reported on the New York Stock Exchange as of that date).
As of September 14, 2018, there were approximately 128,068,092 shares of the registrant’s common stock outstanding.
Documents Incorporated by Reference
Portions of the registrant’s Proxy Statement for its 2018 annual meeting of stockholders (the “2018 Proxy Statement”) are incorporated by reference in Part III, as specifically set forth in Part III.
DONALDSON COMPANY, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page | ||
PART I
Item 1. Business
General
Donaldson Company, Inc. (Donaldson or the Company) was founded in 1915 and organized in its present corporate form under the laws of the State of Delaware in 1936.
The Company is a worldwide manufacturer of filtration systems and replacement parts. The Company’s core strengths are leading filtration technology, strong customer relationships and its global presence. Products are manufactured at 43 plants around the world and through three joint ventures.
The Company has two operating segments: Engine Products and Industrial Products. Products in the Engine Products segment consist of replacement filters for both air and liquid filtration applications, air filtration systems, liquid filtration systems for fuel, lube and hydraulic applications, and exhaust and emissions systems. The Engine Products segment sells to original equipment manufacturers (OEMs) in the construction, mining, agriculture, aerospace, defense and truck end markets and to independent distributors, OEM dealer networks, private label accounts and large equipment fleets. Products in the Industrial Products segment consist of dust, fume and mist collectors, compressed air purification systems, gas and liquid filtration for food, beverage and industrial processes, air filtration systems for gas turbines, polytetrafluoroethylene (PTFE) membrane-based products and specialized air and gas filtration systems for applications including hard disk drives and semi-conductor manufacturing. The Industrial Products segment sells to various dealers, distributors, OEMs of gas-fired turbines and OEMs and end users requiring clean filtration solutions and replacement filters.
As a worldwide business, the Company’s results of operations are affected by conditions in the global economic environment. Under most economic conditions, the Company’s market diversification between its OEM and replacement parts customers, its diesel engine and industrial end markets, its global end markets and its diversification through technology has helped to limit the impact of weakness in any one product line, market or geography on the consolidated operating results of the Company.
The table below shows the percentage of total net sales contributed by the principal classes of similar products for each of the years ended July 31, 2018, 2017 and 2016:
Year Ended July 31, | |||||||||
2018 | 2017 | 2016 | |||||||
Engine Products segment | |||||||||
Off-Road | 12 | % | 11 | % | 10 | % | |||
On-Road | 6 | % | 5 | % | 6 | % | |||
Aftermarket | 46 | % | 46 | % | 43 | % | |||
Aerospace and Defense | 4 | % | 4 | % | 4 | % | |||
Industrial Products segment | |||||||||
Industrial Filtration Solutions | 22 | % | 22 | % | 23 | % | |||
Gas Turbine Systems | 4 | % | 5 | % | 7 | % | |||
Special Applications | 6 | % | 7 | % | 7 | % | |||
Total net sales contributed by the principal classes of similar products and financial information about segment operations and geographic regions appear in Note 18 in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report.
The Company makes its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information (including amendments to those reports) available free of charge through its website at ir.donaldson.com, as soon as reasonably practicable after it electronically files such material with (or furnishes such material to) the Securities and Exchange Commission. Also available on the Company’s website are corporate governance documents, including the Company’s Code of Business Conduct and Business Conduct Help Line, Corporate Governance Guidelines, Director Independence Standards, Audit Committee charter, Human Resources Committee charter and Corporate Governance Committee charter. These documents are also available in print, free of charge, to any person who requests them in writing to the attention of Investor Relations, MS 102, Donaldson Company, Inc., 1400 West 94th Street, Bloomington, Minnesota 55431. The information contained on the Company’s website is not incorporated by reference into this Annual Report and should not be considered to be part of this report.
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Seasonality
A number of the Company’s end markets are dependent on the construction, agricultural and power generation industries, which are generally stronger in the second half of the Company’s fiscal year. The first two quarters of the fiscal year also contain the traditional holiday periods, which are typically characterized by more customer plant closures.
Competition
Principal methods of competition in both the Engine and Industrial Products segments are technology, innovation, price, geographic coverage, service and product performance. The Company participates in a number of highly competitive filtration markets in both segments. The Company believes it is a market leader within many of its product lines, specifically within its Off-Road and On-Road product lines for OEMs, and has a significant business in the aftermarket for replacement filters. The Engine Products segment’s principal competitors include several large global competitors and many regional competitors, especially in the Aftermarket business. The Industrial Products segment’s principal competitors vary from country to country and include several large regional and global competitors and a significant number of smaller competitors who compete in a specific geographical region or in a limited number of product applications.
Raw Materials
The principal raw materials that the Company uses are steel, filter media and petrochemical-based products, including plastics, rubber and adhesives. Purchased raw materials represent approximately 60% to 65% of the Company’s cost of goods sold. Steel, including fabricated parts, and filter media each represent approximately 20% of the cost of goods sold. The remainder is primarily made up of petroleum-based products and other raw material components.
The cost the Company paid for steel during fiscal 2018 varied by grade, but in aggregate, increased during the fiscal year. The steel cost increase was related to U.S. import restrictions placed on foreign-made steel and significant import tariffs placed on steel and aluminum products. The Company’s cost of filter media also varies by type and increased year-over-year. The filter media price increase was driven largely by global price increases on pulp products. The cost of petroleum-based products have also increased year-over-year. The Company anticipates continuing price pressure across our major commodities in fiscal 2019, as compared with fiscal 2018. The Company enters into supply arrangements with certain of its suppliers that allow the Company to reduce volatility in its costs. The Company strives to recover or offset all material cost increases through selective price increases to its customers and the Company’s cost reduction initiatives, which include material substitution, resourcing of vendors, process improvement and product redesigns.
The Company concentrates sourcing of some materials from one supplier or a few supplies, and global supplier production capacity is limited.
Patents and Trademarks
The Company owns various patents and trademarks, which it considers in the aggregate to constitute a valuable asset, including patents and trademarks for products sold under the Ultra-Web®, PowerCore®, Torit®, SynteqTM XP and Donaldson® trademarks.
Major Customers
The Company had no customers that accounted for over 10% of net sales in the years ended July 31, 2018, 2017 or 2016. The Company had no customers that accounted for over 10% of gross accounts receivable at July 31, 2018 or July 31, 2017.
Backlog
At August 31, 2018, the backlog of orders expected to be delivered within 90 days was $467.1 million. The 90-day backlog at August 31, 2017 was $395.5 million. The backlog of orders expected to be delivered within 90 days increased 26.3% for the Engine Products segment and increased 3.7% for the Industrial Products segment. The increase is due to the continued strong demand across multiple product lines. Backlog is one of many indicators of business conditions in the Company’s markets. However, it is not always indicative of future results for a number of reasons, including the timing of the receipt of orders in many of the Company’s engine OEM and industrial markets and the mix and types of orders in backlog.
Research and Development
During the years ended July 31, 2018, 2017 and 2016, the Company spent $59.9 million, $54.7 million and $55.5 million, respectively, on research and development activities, which was 2.2%, 2.3% and 2.5% of net sales, respectively. Research and development expenses include scientific research and the application of scientific advances to the development of new and improved products and their uses. Substantially all commercial research and development is performed in-house.
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Environmental Matters
The Company does not anticipate any material effect on its capital expenditures, earnings or competitive position during fiscal 2019 due to compliance with government regulations regulating the discharge of materials into the environment or otherwise relating to the protection of the environment.
Employees
The Company employed approximately 14,000 people as of July 31, 2018.
Geographic Areas
Both of the Company's operating segments serve customers in all geographic regions. The United States (U.S.) represents the largest individual market for the Company's products. Financial information by geographic region appears in Note 18 in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report.
Item 1A. Risk Factors
There are inherent risks and uncertainties associated with our global operations that involve the technology development, manufacturing and sale of products for highly demanding customer applications throughout the world. These risks and uncertainties could adversely affect our operating performance and financial condition. The following discussion, along with discussions elsewhere in this report, outlines the risks and uncertainties that we believe are the most material to our business at this time. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, unless required by law.
Economic Environment - the demand for our products is impacted by economic and industrial conditions worldwide.
Changes in economic or industrial conditions could impact our results or financial condition as our business can be sensitive to varying conditions in all major geographies and markets.
Products - maintaining a competitive advantage requires consistent investment with uncertain returns.
We operate in highly competitive markets and have numerous competitors that may already be well-established in those markets. We expect our competitors to continue improving the design and performance of their products and to introduce new products that could be competitive in both price and performance. We believe that we have certain technological advantages over our competitors, but maintaining these advantages requires us to consistently invest in research and development, sales and marketing and customer service and support. There is no guarantee that we will be successful in maintaining these advantages and we could encounter the commoditization of our key products. We make investments in new technologies that address increased performance and regulatory requirements around the globe. There is no guarantee that we will be successful in completing development or achieving sales of these products or that the margins on such products will be acceptable. Our financial performance may be negatively impacted if a competitor’s successful product innovation reaches the market before ours or gains broader market acceptance.
Evolving Customer Needs - disruptive technologies may threaten our long-term strategy.
Our long-term strategy guides the decisions we make in operating the Company, but this strategy could be threatened by disruptive technologies. We may be adversely impacted by changes in technology that could reduce or eliminate the demand for our products. These risks include wider adoption of technologies providing alternatives to diesel engines such as electrification of equipment. Such disruptive innovation could create new markets and displace existing companies and products, resulting in significantly negative consequences for the Company. If we do not properly address future customer needs in our strategy, we may be slower to adapt to such disruption, which could adversely affect our results of operations.
Competition - we participate in highly competitive markets with pricing pressure.
The businesses and product lines in which we participate are very competitive and we risk losing business based on a wide range of factors, including price, technology, product performance, product reliability and availability, geographic coverage and customer service. Our customers continue to seek technological innovation, productivity gains and competitive prices from us and their other suppliers. If we are not able to compete effectively, our margins and results of operations could be adversely affected.
Intellectual Property - demand for our products may be affected by new entrants that copy our products and/or infringe on our intellectual property.
The ability to protect and enforce intellectual property rights varies across jurisdictions. An inability to preserve our intellectual property rights may adversely affect our financial performance.
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Where possible, we seek to preserve our intellectual property rights through patents. These patents have a limited life and, in some cases, have expired or will expire in the near future. Competitors and others may also initiate litigation to challenge the validity of our intellectual property or allege that we infringe their intellectual property. We may be required to pay substantial damages if it is determined our products infringe on their intellectual property. We may also be required to develop an alternative, non-infringing product that could be costly and time-consuming, or acquire a license on terms that are not favorable to us.
Protecting or defending against such claims could significantly increase our costs, divert management’s time and attention away from other business matters and otherwise adversely affect our results of operations and financial condition.
Global Operations - we have a broad footprint that makes operating globally difficult.
We have sales and manufacturing operations throughout the world. Our stability, growth and profitability are subject to a number of risks of doing business globally that could harm our business, including:
• | political and military events, including the rise of nationalism and support for protectionist policies, |
• | tariffs, trade barriers and other trade restrictions, |
• | legal and regulatory requirements, including import, export, defense regulations, anti-corruption laws and foreign exchange controls, |
• | potential difficulties in staffing and managing local operations, |
• | credit risk of local customers and distributors, |
• | difficulties in protecting our intellectual property and |
• | local economic, political and social conditions. |
Due to the international scope of our operations, we are subject to a complex system of import- and export-related laws and regulations. Any alleged or actual violations may subject us to government scrutiny, investigation and civil and criminal penalties, and may limit our ability to import or export our products or to provide services outside the U.S.
The enforcement of bribery, corruption and trade laws and regulations is increasing in frequency and complexity on a global basis. The continued geographic expansion of our business increases our exposure to, and cost of complying with, these laws and regulations. If our compliance programs do not adequately prevent or deter our employees, agents, distributors, suppliers and other third parties with whom we do business from violating anti-corruption laws, we may incur defense costs, fines, penalties, reputational damage and business disruptions.
Customer Concentration and Retention - a number of our customers operate in similar cyclical industries. Economic conditions in these industries could impact our sales.
No customer accounted for ten percent or more of our net sales in fiscal 2018, 2017 or 2016. However, a number of our customers are concentrated in similar cyclical industries (e.g. construction, agriculture, mining, power generation and disk drives), resulting in additional risk based on industrial conditions in those sectors. A decline in the economic conditions of these industries could result in reduced demand for our products and difficulty in collecting amounts due from our customers. Our success is also dependent on retaining key customers, which requires us to successfully manage relationships and anticipate the needs of our customers in the channels in which we sell our products.
Supply Chain - unavailable or material cost inflation.
We obtain raw materials, including steel, filter media, petroleum-based products and other components, from third-party suppliers and tend to carry limited raw material inventories. We concentrate our sourcing of some materials from one supplier or a few suppliers. Our success is dependent on our ability to effectively manage our supplier relationships. Additionally, global supplier production capacity is limited and could be disrupted. We may experience significant disruption of the supply of raw materials, parts, components or final assemblies. An unanticipated delay in delivery by our suppliers could result in the inability to deliver our products on-time and meet the expectations of our customers. An increase in the costs of doing business, including increasing raw material commodity prices and transportation costs, could also result in lower operating margins.
Operations - inability to meet demand could result in the loss of customers.
Our ability to fulfill customer orders is dependent on our manufacturing and distribution operations overcoming capacity constraints. Although we forecast demand, additional plant capacity takes months or even years to bring online, and thus changes in demand could result in longer lead times. Efficient operations also require streamlining processes to maintain or reduce lead times, which we may not be capable of achieving. Unacceptable levels of service for key customers may result if we are not able to fulfill orders on a timely basis or if product quality or warranty issues result from compromised production. Our business, competitive position, results of operations or financial condition could be negatively impacted if we are unable to adjust our production schedules to reflect changes in customer demand on a timely basis.
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Technology Investments and Security Risks - difficulties with our information technology systems and security.
We have many information technology systems that are important to the operation of our business, some of which are managed by third parties. These systems are used to process, transmit and store electronic information and to manage or support a variety of business processes and activities. We could encounter difficulties in developing new systems, maintaining and upgrading our existing systems, managing access to these systems and preventing information security breaches. Such difficulties could lead to significant additional expenses and/or disruption in business operations that could adversely affect our results.
Additionally, information technology security threats are increasing in frequency and sophistication. We have found and addressed these threats from time to time; however, to date none of them have been material. These threats pose a risk to the security of our systems and networks and the confidentiality, availability and integrity of our data. Should such an attack succeed, it could lead to the compromising of confidential information, manipulation and destruction of data, defective products, production downtimes and operations disruptions. The occurrence of any of these events could adversely affect our reputation and could result in litigation, regulatory action, potential liability and increased costs and operational consequences of implementing further data protection matters.
Currency - an unfavorable fluctuation in foreign currency exchange rates.
We have operations in many countries, with a substantial portion of our annual revenue earned in currencies other than the U.S. dollar. We face transactional and translational risks associated with the fluctuations in foreign currency exchange rates. Transactional risk arises from changes in the value of cash flows denominated in different currencies. This can be caused by supply chains that cross borders resulting in revenues and costs being in different currencies. In addition, decreased value of local currency may make it difficult for some of our customers, distributors and end users to purchase our products. Translational risk arises from the re-measurement of our financial statements. Each of our subsidiaries reports its results of operations and financial position in its relevant functional currency, which is then translated into U.S. dollars. This translated financial information is included in our consolidated financial statements. Significant fluctuations of the U.S. dollar in comparison to the foreign currencies of our subsidiaries during discrete periods may have a negative impact on our results and financial position.
Legal and Regulatory - costs associated with lawsuits, investigations or complying with laws and regulations.
We are subject to many laws and regulations in the jurisdictions in which we operate. We routinely incur costs in order to comply with these laws and regulations. We may be adversely impacted by new or changing laws and regulations that affect both our operations and our ability to develop and sell products that meet our customers’ requirements. We are involved in various product liability, product warranty, intellectual property, environmental claims and other legal proceedings that arise in and outside of the ordinary course of our business. We are subject to increasingly stringent laws and regulations in the countries in which we operate, including those governing the environment (e.g. emissions to air; discharges to water; and the generation, handling, storage, transportation, treatment and disposal of waste materials) and data protection and privacy. It is not possible to predict the outcome of investigations and lawsuits, and we could incur judgments, fines, or penalties or enter into settlements of lawsuits and claims that could have an adverse effect on our business, results of operations and financial condition in any particular period. In addition, we may not be able to maintain our insurance at a reasonable cost or in sufficient amounts to protect us against any losses.
Income Tax - changes in our effective tax rate in various jurisdictions.
We are subject to income taxes in various jurisdictions in which we operate. Our tax liabilities are dependent upon the location of earnings among these different jurisdictions. Our provision for income taxes and cash tax liability could be adversely affected by numerous factors, including income before taxes being lower than anticipated in countries with lower statutory tax rates and higher than anticipated in countries with higher statutory tax rates, changes in the valuation of deferred tax assets and liabilities and changes in tax laws and regulations. We are also subject to the prevailing tax laws and the continuous examination of our income tax returns by tax authorities. The results of audits and examinations of previously filed tax returns and continuing assessments of our tax exposures may have an adverse effect on our provision for income taxes and cash tax liability.
Personnel - our success may be affected if we are not able to attract, engage and retain qualified personnel.
Our success depends in large part on our ability to identify, recruit, engage and retain qualified and diverse personnel worldwide and successfully execute management transitions at leadership levels of the Company. Additionally, in some locations we have experienced significant wage inflation due to a shortage of labor amid low levels of unemployment in these markets. If we are unable to attract and retain qualified personnel, it may be difficult for us to compete effectively, which could adversely affect our results of operations and financial condition.
5
Liquidity - changes in the capital and credit markets may negatively affect our ability to access financing to support strategic initiatives.
Disruption of the global financial and credit markets may have an effect on our long-term liquidity and financial condition. There can be no assurance that the cost or availability of future borrowings will not be impacted by future capital market disruptions. Some of our existing borrowings contain covenants to maintain certain financial ratios that, under certain circumstances, could restrict our ability to incur additional indebtedness, make investments and other restricted payments, create liens and sell assets.
Acquisitions - the execution of our acquisition strategy may not provide the desired return on investment.
We have made and continue to pursue acquisitions. These acquisitions could negatively impact our profitability due to operating and integration inefficiencies, the incurrence of debt, contingent liabilities and amortization of expenses related to intangible assets. There are also a number of other risks involved in acquisitions, including the potential loss of key customers, difficulties in assimilating the acquired operations, the loss of key employees and the diversion of management’s time and attention away from other business matters, that may prevent us from realizing the anticipated return on our investment.
Impairment - if our operating units do not meet performance expectations, intangible assets could be subject to impairment.
Our total assets include goodwill and other intangible assets from acquisitions. We review annually whether goodwill and other intangible assets have been impaired, or more frequently if there have been unexpected events or changes in circumstances. If future operating performance at one or more of our operating units were to fall significantly below forecast levels or if market conditions for one or more of our acquired businesses were to decline, we could be required to incur a non-cash charge to operating income for impairment. Any impairment charge would have an adverse non-cash impact on our results of operations and reduce our net worth.
Productivity Improvements - if we do not successfully manage productivity improvements, we may not realize the expected benefits.
Our financial projections assume certain ongoing productivity improvements as a key component of our business strategy to, among other things, contain operating expenses, increase operating efficiencies and align manufacturing capacity to demand. We may not be able to realize the expected benefits and cost savings if we do not successfully execute these plans while continuing to invest in business growth. If difficulties are encountered or such cost savings are otherwise not realized, it could adversely impact our results of operations.
Business Disruption - unexpected events, including natural disasters, may increase our cost of doing business or disrupt our operations.
The occurrence of one or more unexpected events, including a terrorist attack, war or civil unrest, a weather event, an earthquake, pandemic or other catastrophe in the U.S. or in other countries in which we operate or in which our suppliers are located could adversely affect our operations and financial performance. Such event could result in physical damage to and complete or partial closure of one or more of our headquarters, manufacturing facilities or distribution centers, temporary or long-term disruption in the supply of component products from some local and international suppliers, disruption in the transport of our products to customers and disruption of information systems. This could result in a prolonged disruption to our operations. Existing insurance coverage may not provide protection for all costs that may arise from such events. Any disruption in our manufacturing capacity could have an adverse impact on our ability to meet our customer needs or may require us to incur additional expenses in order to produce sufficient inventory, and therefore, may adversely affect our net sales and operating results.
Internal Controls - if we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results and prevent material fraud, which could adversely affect the value of our common stock.
Effective internal control over financial reporting, including controls within the information technology environment, is necessary for us to provide reliable financial reports and effectively prevent and detect material fraud. If we cannot provide reliable financial reports or prevent or detect material fraud, our operating results could be misstated. There can be no assurances that we will be able to prevent future control deficiencies from occurring, which could cause us to incur unforeseen costs, negatively impact our results of operations, cause the market price of our common stock to decline or have other potential adverse consequences.
Item 1B. Unresolved Staff Comments
None.
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Item 2. Properties
The Company’s principal administrative office and research facilities are located in Bloomington, Minnesota. The Company also has administrative and engineering offices in the Europe, Asia Pacific and Latin America regions.
The Company’s principal manufacturing and distribution activities are located throughout the world. The following is a summary of the principal plants and physical properties owned or leased by the Company as of July 31, 2018.
Americas | Europe, Middle East, Africa | |
Auburn, Alabama (E) | Kadan, Czech Republic (I) | |
Stockton, California (I)* | Klasterec, Czech Republic (E) | |
Valencia, California (E)* | Domjean, France (E) | |
Dixon, Illinois (E) | Paris, France (E)* | |
Anderson, Indiana (E)* | Dulmen, Germany (E) | |
Frankfort, Indiana (E) | Haan, Germany (I) | |
Cresco, Iowa (E) | Ostiglia, Italy (E) | |
Waterloo, Iowa (E) | Skarbimierz, Poland (E) | |
Nicholasville, Kentucky (I) | Cape Town, South Africa (E) | |
Bloomington, Minnesota (I) | Johannesburg, South Africa (I)* | |
Chesterfield, Missouri (E)* | Abu Dhabi, United Arab Emirates (I) | |
Chillicothe, Missouri (E) | Hull, United Kingdom (E) | |
Harrisonville, Missouri (I) | Leicester, United Kingdom (I) | |
Philadelphia, Pennsylvania (I) | Asia Pacific | |
Greeneville, Tennessee (E) | Wyong, Australia (E) | |
Baldwin, Wisconsin (I) | Wuxi, China | |
Stevens Point, Wisconsin (E) | New Delhi, India (E) | |
Sao Paulo, Brazil (E)* | Gunma, Japan (E) | |
Bucaramanga, Columbia (E) | Rayong, Thailand (I) | |
Aguascalientes, Mexico (E) | Third-Party Logistics Providers | |
Monterrey, Mexico (I) | Santiago, Chile | |
Distribution Centers | Wuxi, China | |
Wyong, Australia | Bogotá, Colombia | |
Brugge, Belgium | Cartagena, Colombia | |
Sao Paulo, Brazil* | Chennai, India (E) | |
Rensselaer, Indiana | Mumbai, India | |
Jakarta, Indonesia | Gunma, Japan | |
Aguascalientes, Mexico | Auckland, New Zealand | |
Johannesburg, South Africa | Lima, Peru | |
Seoul, South Korea* | Singapore | |
Joint Venture Facilities | Greeneville, Tennessee (I) | |
Most, Czech Republic (E) | Laredo, Texas | |
Champaign, Illinois (E) | ||
Jakarta, Indonesia (E) | ||
Dammam, Saudi Arabia (I) | ||
The Company’s properties are utilized for both the Engine and Industrial Products segments except as indicated with an (E) for Engine Products or (I) for Industrial Products. The Company leases certain of its facilities, primarily under long-term leases. The facilities denoted with an asterisk (*) are leased facilities. In Wuxi, China, and Bloomington, Minnesota, a portion of the activities are conducted in leased facilities. The Company uses third-party logistics providers for some of its product distribution and neither leases nor owns the related facilities. The Company considers its properties to be suitable for their present purposes, well-maintained and in good operating condition.
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Item 3. Legal Proceedings
The Company believes the recorded estimated liability in its Consolidated Financial Statements for claims or litigation is adequate in light of the probable and estimable outcomes. Any recorded liabilities were not material to the Company’s financial position, results of operations or liquidity, and the Company believes it is remote that the settlement of any of the currently identified claims or litigation will be materially in excess of what is accrued. The Company records provisions when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Claims and litigation are reviewed quarterly and provisions are taken or adjusted to reflect the status of a particular matter.
Item 4. Mine Safety Disclosures
Not applicable.
Executive Officers of the Registrant
Current information as of August 31, 2018, regarding executive officers is presented below. All officers hold office until their successors are elected and qualify, or their earlier death, resignation or removal. There are no arrangements or understandings between individual officers and any other person pursuant to which the officer was selected as an executive officer.
Name | Age | Positions and Offices Held | First Year Appointed as an Executive Officer | |||
Amy C. Becker | 53 | Vice President, General Counsel and Secretary | 2014 | |||
Tod E. Carpenter | 59 | Chairman, President and Chief Executive Officer | 2008 | |||
Sheila G. Kramer | 59 | Vice President, Human Resources | 2015 | |||
Richard B. Lewis | 47 | Vice President, Global Operations | 2017 | |||
Scott J. Robinson | 51 | Senior Vice President and Chief Financial Officer | 2015 | |||
Thomas R. Scalf | 52 | Senior Vice President, Engine Products | 2014 | |||
Jeffrey E. Spethmann | 53 | Senior Vice President, Industrial Products | 2016 | |||
Wim Vermeersch | 52 | Vice President, Europe, Middle East and Africa | 2012 | |||
Ms. Becker was appointed to Vice President, General Counsel and Secretary in August 2014. Ms. Becker joined the Company in 1998 and held positions as Senior Counsel and Assistant Corporate Secretary from 1998 to 2001 and Assistant General Counsel from 2001 to 2014. Prior to joining the Company, Ms. Becker was an attorney for Dorsey and Whitney, LLP from 1991 to 1995 and was a Project Manager and Corporate Counsel for Harmon, Ltd. from 1995 to 1998.
Mr. Carpenter was appointed Chairman, President and Chief Executive Officer in November 2017. Mr. Carpenter joined the Company in 1996 and has held various positions, including Director of Operations, Gas Turbine Systems from 1996 to 2002; General Manager, Gas Turbine Systems from 2002 to 2004; General Manager, Industrial Filtration Systems from 2004 to 2006; Vice President, Global Industrial Filtration Systems from 2006 to 2008; Vice President, Europe and Middle East from 2008 to 2011; Senior Vice President, Engine Products from 2011 to 2014. In April 2014, Mr. Carpenter was appointed Chief Operating Officer and in April 2015, appointed President and Chief Executive Officer.
Ms. Kramer was appointed Vice President, Human Resources in October 2015. Prior to joining the Company, Ms. Kramer was Vice President, Human Resources for Taylor Corporation, a print and graphics media company, from 2013 until September 2015. From 1991 to 2013, Ms. Kramer was with Lifetouch, Inc., where she held various human resources roles including Corporate Vice President, Human Resources from 2009 to 2013.
Mr. Lewis was appointed Vice President, Global Operations in August 2015. Mr. Lewis joined the Company in 2002 and has held various positions, including Plant Manager, Frankfort, Indiana from 2004 to 2007; Plant Manager, Nicholasville, Kentucky from 2007 to 2008; Director of Operations, from 2008 to 2010; General Manager, Liquid Filtration, from 2010 to 2014; General Manager, Operations, from 2014 to 2015. Prior to joining the Company, Mr. Lewis held positions of Operations Manager, Seleco Inc. from 1998 to 2002, and Operations Manager, Ventra Corporation from 1997 to 1998.
Mr. Robinson was appointed Senior Vice President and Chief Financial Officer in September 2017. Mr. Robinson joined the Company in 2015 as Vice President and Chief Financial Officer. Prior to joining the Company, Mr. Robinson was the Chief Financial Officer for Imation Corp., a global data storage and information security company, from 2014 to 2015. During his 11 years with Imation, he also served as the Investor Relations Officer, Corporate Controller and Chief Accounting Officer. Prior to that, he held positions at Deluxe Corporation and PricewaterhouseCoopers LLP.
Mr. Scalf was appointed Senior Vice President, Engine Products in April 2014. Mr. Scalf joined the Company in 1989 and has held various positions, including Director of Global Operations from 2003 to 2006; General Manager of Exhaust & Emissions
8
from 2006 to 2008; General Manager of Industrial Filtration Solutions from 2008 to 2012; and Vice President of Global Industrial Air Filtration from 2012 to 2014.
Mr. Spethmann was appointed Senior Vice President of Industrial Products in April 2016. Mr. Spethmann joined the Company in 2013 and has held various positions, including Vice President, Exhaust & Emissions from 2013 to 2014 and Vice President, Global Industrial Air Filtration from 2014 to 2016. Prior to joining the Company, Mr. Spethmann held positions of General Manager and President of Blow Molded Specialties, Inc., from 1999 to 2012.
Mr. Vermeersch was appointed Vice President, Europe, Middle East and Africa in January 2012. Mr. Vermeersch joined the Company in 1992 and has held various positions, including Director, Gas Turbine Systems, Asia Pacific from 2000 to 2005; Manager, Aftermarket and Service Industrial Filtration Solutions, Belgium from 2005 to 2006; Manager, Industrial Filtration Solutions, Belgium from 2006 to 2007; Director, Gas Turbine Systems, Europe, Middle East and North Africa from 2007 to 2010; and Director, Engine, Europe, Middle East and North Africa from 2010 to 2011.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company's common stock, par value $5.00 per share, is traded on the New York Stock Exchange under the symbol "DCI." To determine the appropriate level of dividend payouts, the Company considers recent and projected performance across key financial metrics, including earnings, cash flow from operations and total debt. As of September 14, 2018, there were 1,450 registered shareholders of common stock.
The high and low prices for the Company’s common stock for each quarterly period during the years ended July 31, 2018 and 2017 were as follows:
Year Ended July 31, | First Quarter | Second Quarter | Third Quarter | Fourth Quarter | ||||
2018 | $48.33 - 42.59 | $52.20 - 45.89 | $50.73 - 43.35 | $48.76 - 43.66 | ||||
2017 | $38.65 - 35.52 | $46.29 - 35.85 | $47.68 - 41.46 | $48.91 - 44.66 | ||||
The quarterly dividends declared for the years ended July 31, 2018 and 2017 were as follows:
Year Ended July 31, | First Quarter | Second Quarter | Third Quarter | Fourth Quarter | ||||||||||||
2018 | $ | 0.180 | $ | 0.180 | $ | 0.190 | $ | 0.190 | ||||||||
2017 | $ | 0.175 | $ | 0.175 | $ | 0.175 | $ | 0.180 | ||||||||
The following table summarizes information in connection with purchases made by, or on behalf of, the Company or any affiliated purchaser of the Company, of shares of the Company’s common stock during the three months ended July 31, 2018.
Period | Total Number of Shares Purchased (1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs | |||||||||
May 1 - May 31, 2018 | — | $ | — | — | 4,841,152 | ||||||||
June 1 - June 30, 2018 | 310,000 | $ | 46.18 | 310,000 | 4,531,152 | ||||||||
July 1 - July 31, 2018 | — | $ | — | — | 4,531,152 | ||||||||
Total | 310,000 | $ | 46.18 | 310,000 | 4,531,152 | ||||||||
(1) | The Board of Directors has authorized the repurchase of up to 14.0 million shares of the Company's common stock. This repurchase authorization is effective until terminated by the Board of Directors. The Company had remaining authorization to repurchase 4.5 million shares under this plan. There were no repurchases of common stock made outside of the Company's current repurchase authorization during the three months ended July 31, 2018. |
The table set forth in Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” of this Annual Report is also incorporated herein by reference.
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The graph below compares the cumulative total shareholder return on the Company’s common stock for the last five fiscal years with the cumulative total return of the Standard & Poor’s 500 Stock Index and the Standard & Poor’s Industrial Machinery Index. The graph and table assume the investment of $100 in each of the Company’s common stock and the specified indexes at the beginning of the applicable period and assume the reinvestment of all dividends.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Among Donaldson Company, Inc., the S&P 500 Index and the S&P Industrial Machinery Index
Year Ended July 31, | ||||||||||||||||||||||||
2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |||||||||||||||||||
Donaldson Company, Inc. | $ | 100.00 | $ | 108.53 | $ | 95.67 | $ | 105.13 | $ | 140.51 | $ | 143.32 | ||||||||||||
S&P 500 | 100.00 | 116.94 | 130.05 | 137.35 | 159.38 | 185.26 | ||||||||||||||||||
S&P Industrial Machinery | 100.00 | 117.39 | 124.64 | 144.34 | 177.50 | 200.37 | ||||||||||||||||||
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Item 6. Selected Financial Data
The following table summarizes selected financial data for each of the fiscal years in the five-year period ended July 31, 2018 (in millions, except per share data):
Year Ended July 31, | ||||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
Net sales | $ | 2,734.2 | $ | 2,371.9 | $ | 2,220.3 | $ | 2,371.2 | $ | 2,473.5 | ||||||||||
Net earnings | 180.3 | 232.8 | 190.8 | 208.1 | 260.2 | |||||||||||||||
Net earnings per share – basic | 1.38 | 1.76 | 1.43 | 1.51 | 1.79 | |||||||||||||||
Net earnings per share – diluted | 1.36 | 1.74 | 1.42 | 1.49 | 1.76 | |||||||||||||||
Total assets | 1,976.6 | 1,979.7 | 1,787.0 | 1,807.5 | 1,941.3 | |||||||||||||||
Long-term debt | 499.6 | 537.3 | 350.2 | 387.2 | 242.6 | |||||||||||||||
Dividends declared per share | 0.740 | 0.705 | 0.690 | 0.670 | 0.610 | |||||||||||||||
Dividends paid per share | 0.730 | 0.700 | 0.685 | 0.665 | 0.575 | |||||||||||||||
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand the Company's results of operations and financial condition for the three years ended July 31, 2018, 2017 and 2016. The MD&A should be read in conjunction with the Company's Consolidated Financial Statements and Notes included in Item 8 of this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. The Company’s actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed elsewhere in this Annual Report, particularly Item 1A, "Risk Factors" and in the Safe Harbor Statement under the Securities Reform Act of 1995 below.
Throughout this MD&A, the Company refers to measures used by management to evaluate performance, including a number of financial measures that are not defined under accounting principles generally accepted in the United States of America (GAAP). Excluding foreign currency translation from net sales and net earnings (i.e. constant currency) and excluding the impact of one-time transactions are not measures of financial performance under GAAP; however, the Company believes they are useful in understanding its financial results and provide comparable measures for understanding the operating results of the Company between different fiscal periods. Reconciliations within this MD&A provide more details on the use and derivation of these measures.
Overview
Net sales for the year ended July 31, 2018 were $2,734.2 million, as compared with $2,371.9 million for the year ended July 31, 2017, an increase of $362.3 million, or 15.3%. Net sales were positively impacted by foreign currency translation, which increased sales by $78.3 million. On a constant currency basis, net sales for the year ended July 31, 2018 increased 12.0% from the prior fiscal year.
Net earnings for the year ended July 31, 2018 were $180.3 million, as compared with $232.8 million for the year ended July 31, 2017, a decrease of $52.5 million, or 22.6%. Net earnings for the current year includes a provisional estimate for tax charges of $84.1 million related to the U.S. Tax Cuts and Jobs Act (TCJA), which was enacted into law during the period. Prior year net earnings do not include TCJA tax charges. Diluted earnings per share were $1.36 for the year ended July 31, 2018, as compared with $1.74 for the year ended July 31, 2017, a decrease of 21.8%. Excluding the impact of the TCJA, diluted earnings per share were $2.00 for the year ended July 31, 2018.
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Consolidated Results of Operations
The following table summarizes consolidated results of operations for each of the three fiscal years ended July 31, 2018, 2017 and 2016 (in millions, except per share data):
Year Ended July 31, | Percent of Net Sales | ||||||||||||||||||||
2018 | 2017 | 2016 | 2018 | 2017 | 2016 | ||||||||||||||||
Net sales | $ | 2,734.2 | $ | 2,371.9 | $ | 2,220.3 | 100.0 | % | 100.0 | % | 100.0 | % | |||||||||
Cost of sales | 1,798.7 | 1,548.8 | 1,465.5 | 65.8 | % | 65.3 | % | 66.0 | % | ||||||||||||
Gross profit | 935.5 | 823.1 | 754.8 | 34.2 | % | 34.7 | % | 34.0 | % | ||||||||||||
Selling, general and administrative | 495.6 | 439.8 | 425.1 | 18.1 | % | 18.5 | % | 19.1 | % | ||||||||||||
Research and development | 59.9 | 54.7 | 55.5 | 2.2 | % | 2.3 | % | 2.5 | % | ||||||||||||
Operating income | 380.0 | 328.6 | 274.2 | 13.9 | % | 13.9 | % | 12.3 | % | ||||||||||||
Other income, net | (4.9 | ) | (12.9 | ) | (3.9 | ) | (0.2 | )% | (0.5 | )% | (0.2 | )% | |||||||||
Interest expense | 21.3 | 19.5 | 20.7 | 0.8 | % | 0.8 | % | 0.9 | % | ||||||||||||
Earnings before income taxes | 363.6 | 322.0 | 257.4 | 13.3 | % | 13.6 | % | 11.6 | % | ||||||||||||
Income taxes | 183.3 | 89.2 | 66.6 | 6.7 | % | 3.8 | % | 3.0 | % | ||||||||||||
Net earnings | $ | 180.3 | $ | 232.8 | $ | 190.8 | 6.6 | % | 9.8 | % | 8.6 | % | |||||||||
Net earnings per share – diluted | $ | 1.36 | $ | 1.74 | $ | 1.42 | |||||||||||||||
Net Sales
Net sales by operating segment are as follows (in millions):
Year Ended July 31, | Percent of Net Sales | ||||||||||||||||||||
2018 | 2017 | 2016 | 2018 | 2017 | 2016 | ||||||||||||||||
Engine Products | $ | 1,849.0 | $ | 1,553.3 | $ | 1,391.3 | 67.6 | % | 65.5 | % | 62.7 | % | |||||||||
Industrial Products | 885.2 | 818.6 | 829.0 | 32.4 | % | 34.5 | % | 37.3 | % | ||||||||||||
Net sales | $ | 2,734.2 | $ | 2,371.9 | $ | 2,220.3 | 100.0 | % | 100.0 | % | 100.0 | % | |||||||||
Net sales by origination(1) for the years ended July 31, 2018, 2017 and 2016 are as follows (in millions):
Year Ended July 31, | Percent of Net Sales | ||||||||||||||||||||
2018 | 2017 | 2016 | 2018 | 2017 | 2016 | ||||||||||||||||
United States | $ | 1,120.8 | $ | 990.4 | $ | 937.7 | 41.0 | % | 41.8 | % | 42.2 | % | |||||||||
Europe, Middle East and Africa | 791.5 | 679.1 | 665.5 | 29.0 | % | 28.6 | % | 30.0 | % | ||||||||||||
Asia Pacific | 599.2 | 500.5 | 449.9 | 21.9 | % | 21.1 | % | 20.3 | % | ||||||||||||
Latin America | 222.7 | 201.9 | 167.2 | 8.1 | % | 8.5 | % | 7.5 | % | ||||||||||||
Net sales | $ | 2,734.2 | $ | 2,371.9 | $ | 2,220.3 | 100.0 | % | 100.0 | % | 100.0 | % | |||||||||
(1) | Net sales by origination is based on the country of the Company's legal entity where the customer's order was placed. |
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The Company's net sales are impacted by fluctuations in foreign currency exchange rates. The following table reflects the impact of these fluctuations on net sales for the years ended July 31, 2018, 2017 and 2016 (in millions):
Year Ended July 31, | ||||||||||||
2018 | 2017 | 2016 | ||||||||||
Prior year net sales | $ | 2,371.9 | $ | 2,220.3 | $ | 2,371.2 | ||||||
Change in net sales excluding translation | 284.0 | 159.8 | (76.7 | ) | ||||||||
Impact of foreign currency translation (1) | 78.3 | (8.2 | ) | (74.2 | ) | |||||||
Current year net sales | $ | 2,734.2 | $ | 2,371.9 | $ | 2,220.3 | ||||||
(1) | The impact of foreign currency translation is calculated by translating current period foreign currency revenue into U.S. dollars using the average foreign currency exchange rates for the prior fiscal year period rather than actual current period foreign currency exchange rates. |
The fiscal 2018 net sales increase of $362.3 million from fiscal 2017 was primarily driven by the Engine Products segment, which increased $295.7 million due to strong growth in the Aftermarket, Off-Road and On-Road product groups. The Company’s Industrial Products segment contributed $66.6 million to the fiscal 2018 total year-over-year increase, driven primarily by the Industrial Filtration Solutions product group. Foreign currency translation increased total sales by $78.3 million, reflecting increases in the Engine and Industrial Products segments of $45.9 million and $32.4 million, respectively. Acquisitions completed during the prior year increased total sales by $25.6 million. The Company’s primary engine-related markets, including global agriculture, mining and construction are in various stages of cyclical growth, and certain industrial markets exhibited further signs of recovery during the fiscal year. Fiscal 2018 net sales reflected typical seasonality, with a larger percent of full-year revenue realized during the second half of the fiscal year.
Gross Margin
Cost of sales for the year ended July 31, 2018 was $1,798.7 million, compared with $1,548.8 million for the year ended July 31, 2017, an increase of $249.9 million or 16.1%. Gross margin for the year ended July 31, 2018 was 34.2%, or a 0.5 percentage point decrease from 34.7% for the year ended July 31, 2017. The decrease in gross margin reflects higher raw materials and supply chain costs combined with an unfavorable mix of sales.
Cost of sales for the year ended July 31, 2017 was $1,548.8 million, compared with $1,465.5 million for the year ended July 31, 2016, an increase of $83.3 million or 5.7%. Gross margin for the year ended July 31, 2017 was 34.7%, or a 0.7 percentage point increase from 34.0% for the year ended July 31, 2016. The fiscal 2017 rate benefited from greater absorption of fixed costs on the year-over-year sales increase, partially offset by higher variable costs, including raw materials as well as freight charges, related to meeting higher-than-expected customer demand. The fiscal 2017 rate does not include restructuring charges, which negatively affected the fiscal 2016 rate by approximately 0.3 percentage points.
Operating Expenses
Operating expenses for the year ended July 31, 2018 were $555.5 million, or 20.3% of net sales, compared with $494.5 million, or 20.9% of net sales, for the year ended July 31, 2017. The improvement in operating expenses as a percentage of sales was primarily driven by expense leverage gained on increasing sales, partially offset by higher compensation costs and freight expense.
Operating expenses for the year ended July 31, 2017 were $494.5 million, or 20.9% of net sales, compared with $480.6 million, or 21.6% of net sales, for the year ended July 31, 2016. The decrease in operating expenses as a percentage of sales was primarily driven by the lack of restructuring charges in fiscal 2017 combined with leverage gained on the year-over-year sales increase, partially offset by higher variable compensation expense than fiscal 2016.
Non-Operating Items
Interest expense for the year ended July 31, 2018 was $21.3 million, compared with $19.5 million for the year ended July 31, 2017, an increase of $1.8 million. The increase reflects a higher average level of debt outstanding than the prior year and interest rate increases on certain portions of the Company’s debt. Other income, net for the year ended July 31, 2018 was $4.9 million, compared with $12.9 million for the year ended July 31, 2017. The decrease was primarily due to $6.8 million of income recognized in the prior year period that was related to a favorable settlement of claims associated with general representations and warranties in connection with the Company's acquisition of Northern Technical L.L.C. (Northern Technical) in fiscal 2015.
Interest expense for the year ended July 31, 2017 was $19.5 million, compared with $20.7 million for the year ended July 31, 2016, an decrease of $1.2 million. The decrease reflects a lower average level of debt outstanding during fiscal 2017 than fiscal 2016. Other income, net for the year ended July 31, 2017 was $12.9 million, compared with $3.9 million for the year ended July 31, 2016. The increase in other income, net for fiscal 2017 was primarily due to the $6.8 million favorable settlement.
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Income Taxes
The effective tax rate for the year ended July 31, 2018 was 50.4%, as compared with 27.7% for the year ended July 31, 2017. Income taxes for the current year includes a provisional estimate for tax charges of $84.1 million related to the TCJA. Excluding the impact of the TCJA adjustments (refer to Note 12 in the Notes to Consolidated Financial Statements included in Item 8 of this report for further discussion of TCJA), the effective tax rate for the year ended July 31, 2018 was 27.3%. The decrease of 0.4 percentage points was primarily due to a reduced U.S. corporate tax rate, excess tax benefits on stock-based compensation resulting from the adoption of ASU 2016-09 (refer to Note 1 in the Notes to Consolidated Financial Statements included in Item 8 of this report for further discussion of the new accounting standard) and the favorable settlement of tax audits, which combined to decrease the Company’s effective tax rate by 4.5 percentage points. The decrease in the effective tax rate for the year ended July 31, 2018 was partially offset by foreign withholding taxes and other matters related to the TCJA, and an unfavorable shift in the mix of earnings across tax jurisdictions, which combined to increase the Company’s effective tax rate by 4.1 percentage points.
The effective tax rate for the year ended July 31, 2017 was 27.7%, as compared with 25.9% for the year ended July 31, 2016. The year-over-year change was primarily driven by nonrecurring tax benefits recorded in fiscal 2017 from the favorable settlements of tax audits, which reduced the fiscal 2016 effective tax rate by 1.7 percentage points.
Net Earnings
Net earnings for the year ended July 31, 2018 were $180.3 million, as compared with $232.8 million for the year ended July 31, 2017, a decrease of $52.5 million, or 22.6%. Fiscal 2018 net earnings include net provisional tax charges of $84.1 million related to the TCJA, primarily driven by the one-time transition tax on deemed repatriated earnings of the Company's non-U.S. subsidiaries. See Note 12 in the Notes to the Consolidated Financial Statements included in Item 8 of this report for additional information on the impact of the TCJA. Diluted earnings per share were $1.36 for the year ended July 31, 2018, as compared with $1.74 for the year ended July 31, 2017. The impact from the TCJA negatively impacted fiscal 2018 earnings per share by $0.64.
Net earnings for the year ended July 31, 2017 were $232.8 million, as compared with $190.8 million for the year ended July 31, 2016, an increase of $42.0 million, or 22.0%. Diluted net earnings per share were $1.74 for the year ended July 31, 2017, as compared with $1.42 for the year ended July 31, 2016, an increase of 22.5%. The favorable settlement of claims associated with general representations and warranties in connection with the Company's acquisition of Northern Technical benefited fiscal 2017 net earnings per share by $0.05.
The Company's net earnings are impacted by fluctuations in foreign currency exchange rates. The following table reflects the impact of these fluctuations on net earnings for the years ended July 31, 2018, 2017 and 2016 (in millions):
Year Ended July 31, | ||||||||||||
2018 | 2017 | 2016 | ||||||||||
Prior year net earnings | $ | 232.8 | $ | 190.8 | $ | 208.1 | ||||||
Change in net earnings excluding translation | (62.9 | ) | 43.3 | (9.4 | ) | |||||||
Impact of foreign currency translation (1) | 10.4 | (1.3 | ) | (7.9 | ) | |||||||
Current year net earnings | $ | 180.3 | $ | 232.8 | $ | 190.8 | ||||||
(1) | The impact of foreign currency translation is calculated by translating current period foreign currency net earnings into U.S. dollars using the average foreign currency exchange rates for the prior fiscal year period rather than actual current period foreign currency exchange rates. |
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Segment Results of Operation
Net sales and earnings before income taxes by operating segment for each of the three years ended July 31, 2018, 2017 and 2016 are summarized as follows (in millions):
Year Ended July 31, | Increase (Decrease) | |||||||||||||||||||
2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | ||||||||||||||||
Net sales | ||||||||||||||||||||
Engine Products segment | $ | 1,849.0 | $ | 1,553.3 | $ | 1,391.3 | $ | 295.7 | $ | 162.0 | ||||||||||
Industrial Products segment | 885.2 | 818.6 | 829.0 | 66.6 | (10.4 | ) | ||||||||||||||
Total | $ | 2,734.2 | $ | 2,371.9 | $ | 2,220.3 | $ | 362.3 | $ | 151.6 | ||||||||||
Earnings before income taxes | ||||||||||||||||||||
Engine Products segment | $ | 261.3 | $ | 219.7 | $ | 163.5 | $ | 41.6 | $ | 56.2 | ||||||||||
Industrial Products segment | 137.1 | 129.1 | 119.0 | 8.0 | 10.1 | |||||||||||||||
Corporate and Unallocated (1) | (34.8 | ) | (26.8 | ) | (25.1 | ) | (8.0 | ) | (1.7 | ) | ||||||||||
Total | $ | 363.6 | $ | 322.0 | $ | 257.4 | $ | 41.6 | $ | 64.6 | ||||||||||
(1) | Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments, such as interest expense. |
Engine Products Segment
The following is a summary of net sales by product group within the Company’s Engine Products segment for the years ended July 31, 2018, 2017 and 2016 (in millions):
Year Ended July 31, | Increase (Decrease) | |||||||||||||||||||
2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | ||||||||||||||||
Engine Products segment | ||||||||||||||||||||
Off-Road | $ | 327.4 | $ | 252.1 | $ | 216.6 | $ | 75.3 | $ | 35.5 | ||||||||||
On-Road | 154.2 | 110.7 | 127.2 | 43.5 | (16.5 | ) | ||||||||||||||
Aftermarket | 1,261.9 | 1,086.2 | 951.5 | 175.7 | 134.7 | |||||||||||||||
Aerospace and Defense | 105.5 | 104.3 | 96.0 | 1.2 | 8.3 | |||||||||||||||
Engine Products segment net sales | $ | 1,849.0 | $ | 1,553.3 | $ | 1,391.3 | $ | 295.7 | $ | 162.0 | ||||||||||
Engine Products segment earnings before income taxes | $ | 261.3 | $ | 219.7 | $ | 163.5 | $ | 41.6 | $ | 56.2 | ||||||||||
Fiscal 2018 compared with Fiscal 2017
Net sales for the Engine Products segment for the year ended July 31, 2018 were $1,849.0 million, as compared with $1,553.3 million for the year ended July 31, 2017, an increase of $295.7 million, or 19.0%. Excluding the $45.9 million benefit from foreign currency translation, fiscal 2018 sales increased 16.1%.
Worldwide sales from Off-Road were $327.4 million, an increase of 29.9% from fiscal 2017. In constant currency, sales increased $63.9 million, or 25.3%. The increase in Off-Road sales was driven by continued strength in demand for heavy-duty off-road equipment production across all regions and industries, including global mining, agriculture and construction. Sales also benefited from the Company’s success in winning new programs for air and liquid filtration systems with innovative products.
Worldwide sales of On-Road were $154.2 million, an increase of 39.3% from fiscal 2017. In constant currency, sales increased $40.6 million, or 36.6%. The increase in On-Road sales reflects increasing production of heavy-duty trucks compared with a sales decline in the prior year, primarily in the U.S., combined with benefits from new first-fit program wins.
Worldwide sales of Aftermarket were $1,261.9 million, an increase of 16.2% from fiscal 2017. In constant currency, sales increased $147.0 million, or 13.5%. Within Aftermarket, sales increased in all major regions as the Company benefited from strong market conditions and end-user demand and growth in innovative product categories, including both air and liquid filtration products. Additionally, Aftermarket sales included $25.6 million of incremental sales from the Company's acquisitions of Partmo and Hy-Pro, which were both completed during fiscal 2017 (refer to Note 2 in the Notes to Consolidated Financial Statements included in Item 8 of this report for further discussion of the acquisitions).
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Worldwide sales of Aerospace and Defense were $105.5 million, an increase of 1.1% from fiscal 2017. In constant currency, sales decreased $1.6 million, or 1.5%. Sales within Aerospace and Defense were mixed, with growing sales of aerospace replacement parts partially offset by declining sales of ground defense vehicle products, due in part to strong sales in the prior year.
Earnings before income taxes for the Engine Products segment for the year ended July 31, 2018 were $261.3 million, or 14.1% of Engine Products' sales, consistent with 14.1% of sales for the year ended July 31, 2017. The rate reflects higher raw materials and supply chain costs combined with an unfavorable mix of products, offset by operating expense leverage on higher sales than the prior year.
Fiscal 2017 compared with Fiscal 2016
Net sales for the Engine Products segment for the year ended July 31, 2017 were $1,553.3 million, as compared with $1,391.3 million for the year ended July 31, 2016, an increase of $162.0 million, or 11.6%. Excluding the $0.6 million benefit from foreign currency translation, fiscal 2018 sales increased 11.6%.
Worldwide sales from Off-Road were $252.1 million, an increase of 16.4% from fiscal 2016. In constant currency, sales increased $37.2 million, or 17.2%. Sales in fiscal 2017 benefited from the Company’s success in winning new programs for air and liquid filtration systems with innovative products, combined with improving market conditions in the global mining, agriculture and construction industries.
Worldwide sales of On-Road were $110.7 million, a decrease of 13.0% from fiscal 2016. In constant currency, sales decreased $17.2 million, or 13.5%. Decreasing production of heavy-duty trucks in all regions drove the year-over-year decline.
Worldwide sales of Aftermarket were $1,086.2 million, an increase of 14.2% from fiscal 2016. In constant currency, sales increased $132.3 million, or 13.9%. The increase was primarily driven by strength in the Company’s innovative air and liquid filtration products combined with benefits from further geographic expansion of distribution and production of aftermarket products. Aftermarket sales also included a combined benefit of approximately $21.7 million from the acquisitions of Hy-Pro and Partmo.
Worldwide sales of Aerospace and Defense were $104.3 million, an increase of 8.7% from fiscal 2016. In constant currency, sales increased $9.0 million, or 9.4%. The increase from fiscal 2016 was driven by sales growth of aerospace replacement parts and defense products for ground vehicles, partially offset by first-fit sales of aerospace products to rotary-wing aircraft that remained under pressure.
Earnings before income taxes for the Engine Products segment for the year ended July 31, 2017 were $219.7 million, or 14.1% of Engine Products' sales, an increase from 11.8% of sales for the year ended July 31, 2016. Improved cost absorption on higher sales than the prior year drove the improvement, which was partially offset by incremental costs, such as freight charges, related to meeting higher-than-expected demand.
Industrial Products Segment
The following is a summary of net sales by product group within the Company’s Industrial Products segment for the years ended July 31, 2018, 2017 and 2016 (in millions):
Year Ended July 31, | Increase (Decrease) | |||||||||||||||||||
2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | ||||||||||||||||
Industrial Products segment: | ||||||||||||||||||||
Industrial Filtration Solutions | $ | 594.3 | $ | 533.2 | $ | 517.9 | $ | 61.1 | $ | 15.3 | ||||||||||
Gas Turbine Systems | 115.5 | 122.9 | 149.6 | (7.4 | ) | (26.7 | ) | |||||||||||||
Special Applications | 175.4 | 162.5 | 161.5 | 12.9 | 1.0 | |||||||||||||||
Industrial Products segment net sales | $ | 885.2 | $ | 818.6 | $ | 829.0 | $ | 66.6 | $ | (10.4 | ) | |||||||||
Industrial Products segment earnings before income taxes | $ | 137.1 | $ | 129.1 | $ | 119.0 | $ | 8.0 | $ | 10.1 | ||||||||||
Fiscal 2018 compared with Fiscal 2017
Net sales for the Industrial Products segment for the year ended July 31, 2018 were $885.2 million, as compared with $818.6 million for the year ended July 31, 2017, an increase of $66.6 million, or 8.1%. Excluding the $32.4 million benefit from foreign currency translation, fiscal 2018 sales increased 4.2%.
Worldwide sales of Industrial Filtration Solutions were $594.3 million, a 11.4% increase from fiscal 2017. In constant currency, sales increased $39.8 million, or 7.5%. The increase in Industrial Filtration Solutions sales was driven by growth in sales of both
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new equipment and replacement parts, reflecting further stabilization in the global markets combined with the Company’s efforts to proactively manage the replacement cycle for its large customer base and grow its business in under-penetrated existing and new markets.
Worldwide sales of Gas Turbine Systems were $115.5 million, a 6.0% decrease from fiscal 2017. In constant currency, sales declined $10.3 million, or 8.4%. The sales decline was primarily driven by market-related pressures related to large turbine demand, including the Company’s decision to be more selective in bidding large turbine projects. The year-over-year decline was partially offset by strong sales of replacement parts. Gas Turbine Systems sales are typically large systems and, as a result, the Company's shipments and revenues fluctuate from period to period.
Worldwide sales of Special Applications were $175.4 million, a 8.0% increase from fiscal 2017. In constant currency, sales increased $4.7 million, or 2.9%. The increase in Special Applications sales was primarily driven by sales of disk drive filters, reflecting temporary moderation in the secular declining hard disk drive market and share gains with certain customers, combined with growth in sales of membrane products and venting solutions.
Earnings before income taxes for the Industrial Products segment for the year ended July 31, 2018 were $137.1 million, or 15.5% of Industrial Products' sales, a decrease from 15.8% of sales for the year ended July 31, 2017. The decrease was primarily driven by the $6.8 million of income recognized in the prior year period that was related to a favorable settlement of claims associated with general representations and warranties in connection with the Company's acquisition of Northern Technical, partially offset by a favorable mix of sales.
Fiscal 2017 compared with Fiscal 2016
Net sales for the Industrial Products segment for the year ended July 31, 2017 were $818.6 million, as compared with $829.0 million for the year ended July 31, 2016, a decrease of $10.4 million, or 1.2%. Excluding the $8.8 million negative impact from foreign currency translation, fiscal 2017 sales decreased 0.2%.
Worldwide sales of Industrial Filtration Solutions were $533.2 million, a 3.0% increase from fiscal 2016. In constant currency, sales increased $20.7 million, or 4.0%. Sales of replacement parts drove the increase, partially offset by lower sales of new equipment from market pressures related to global capital expenditures and investments.
Worldwide sales of Gas Turbine Systems were $122.9 million, a 17.9% decrease from fiscal 2016. In constant currency, sales declined $25.6 million, or 17.1%. The sales decline was primarily driven by market-related pressures, including the Company’s decision to be more selective in bidding large turbine projects. Gas Turbine Systems sales are typically large systems and, as a result, the Company's shipments and revenues fluctuate from period to period.
Worldwide sales of Special Applications were $162.5 million, a 0.6% increase from fiscal 2016. In constant currency, sales increased $3.4 million, or 2.1%. The increase was driven primarily by sales of venting solutions and products for semiconductor applications. Although the hard disk drive market remains in secular decline, temporarily favorable market conditions during fiscal 2017 combined with the Company’s efforts to increase content per drive resulted in sales of disk drive filters that were slightly higher than the prior year.
Earnings before income taxes for the Industrial Products segment for the year ended July 31, 2017 were $129.1 million, or 15.8% of Industrial Products' sales, an increase from 14.4% of sales for the year ended July 31, 2016. The earnings before income taxes percentage increase was driven by the benefit from the escrow settlement of $6.8 million related to the Northern Technical acquisition combined with the lack of restructuring charges in fiscal 2017 versus the prior year, during which $7.3 million were recorded.
Liquidity and Capital Resources
Liquidity Analysis
Liquidity is assessed in terms of the Company's ability to generate cash to fund its operating, investing and financing activities. Significant factors affecting liquidity are: cash flows generated from operating activities, capital expenditures, acquisitions, dividends, repurchases of outstanding shares, adequacy of available bank lines of credit and the ability to attract long-term capital with satisfactory terms. The Company generates substantial cash from the operation of its businesses as its primary source of liquidity, with sufficient liquidity available to fund growth through reinvestment in existing businesses and strategic acquisitions. This provides flexibility for capital deployment.
Secondary sources of liquidity are existing cash and available credit facilities. At July 31, 2018 and 2017, cash and cash equivalents were $204.7 million and $308.4 million, respectively. The Company’s cash and cash equivalents are held by subsidiaries throughout the world as over half of the Company’s earnings occur outside the U.S. The TCJA tax reform legislation enacted on December 22, 2017 resulted in a one-time transition tax imposed on deemed repatriated earnings of the Company's non-U.S. subsidiaries. The resulting tax liability is payable over an eight-year period. The TCJA has and will allow for more efficient global cash utilization.
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The Company's balance sheet provides access to credit and the capital markets. The Company has borrowing capacity of $583.3 million and $553.3 million available for further borrowing under existing credit facilities at July 31, 2018 and July 31, 2017, respectively.
The largest of these facilities is a multi-currency revolving credit facility. On July 21, 2017, the Company entered into an amended and restated credit agreement that increases the borrowing availability to $500.0 million and extends the maturity date of the credit facility to July 21, 2022. The credit facility also has an accordion feature that allows the Company to request an increase to the commitment under the facility by up to $250.0 million. At July 31, 2018 and 2017, $167.4 million and $190.0 million, respectively, was outstanding. The weighted average interest rate on these borrowings outstanding at July 31, 2018 was 1.62%. At July 31, 2018 and 2017, $324.5 million and $299.5 million, respectively, was available for further borrowing under this facility. For further discussion on this facility, refer to Note 16 in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report.
The Company also has two uncommitted credit facilities in the U.S., which provide unsecured borrowings for general corporate purposes. There were no amounts outstanding at July 31, 2018 and $19.2 million was outstanding at July 31, 2017, and all borrowings that were outstanding on that date had maturities that were less than twelve months. At July 31, 2018 and 2017, there was $80.0 million and $45.7 million, respectively, available under these two credit facilities.
The Company has a €100.0 million (approximately $117.4 million at July 31, 2018) program for issuing treasury notes for raising short-term financing for its European operations. There was €24.0 million (approximately $28.2 million at July 31, 2018) outstanding under this program at July 31, 2018 and no amounts outstanding at July 31, 2017. The weighted average interest rate on these short-term borrowings outstanding at July 31, 2018 was 0.26%. Additionally, the Company’s European operations have lines of credit with an available limit of €39.9 million (approximately $46.8 million at July 31, 2018). There were no amounts outstanding at July 31, 2018 or 2017.
Other international subsidiaries may borrow under various credit facilities. There were no amounts outstanding under these credit facilities as of July 31, 2018 and $4.1 million was outstanding as of July 31, 2017. At July 31, 2018 and 2017, there was approximately $42.8 million and $39.8 million, respectively, available for use under these facilities.
Certain debt agreements, including the $500.0 million revolving credit facility and the Company's long-term private placements, contain financial covenants related to interest coverage and leverage ratios, as well as other non-financial covenants. As of July 31, 2018, the Company was in compliance with all such covenants.
The Company believes that the liquidity available from the combination of the expected cash generated by operating activities, existing cash and available credit under existing credit facilities will be adequate to meet cash requirements for the next twelve months, including working capital needs, debt service obligations, payment of anticipated dividends, share repurchase activity, potential acquisitions and capital expenditures.
Cash Flow Summary
Cash flows for the years ended July 31, 2018, 2017 and 2016 are summarized as follows (in millions):
July 31, | ||||||||||||
2018 | 2017 | 2016 | ||||||||||
Net cash provided by (used in): | ||||||||||||
Operating activities | $ | 262.9 | $ | 317.8 | $ | 291.3 | ||||||
Investing activities | (95.4 | ) | (95.7 | ) | (55.6 | ) | ||||||
Financing activities | (268.8 | ) | (165.2 | ) | (180.2 | ) | ||||||
Effect of exchange rate changes on cash | (2.4 | ) | 8.3 | (2.2 | ) | |||||||
Increase (decrease) in cash and cash equivalents | $ | (103.7 | ) | $ | 65.2 | $ | 53.3 | |||||
Operating Activities
Cash provided by operating activities for the year ended July 31, 2018 was $262.9 million, as compared with $317.8 million for the year ended July 31, 2017, a decrease of $54.9 million. This decrease is primarily the result of $35.0 million of discretionary pension plan contributions and changes in working capital, as cash flows provided by accounts payable decreased by $34.3 million and cash flows used in accounts receivable increased by $9.9 million. The decrease is partially offset by an increase in pretax earnings of $41.6 million.
Cash provided by operating activities for the year ended July 31, 2017 was $317.8 million, as compared with $291.3 million for the year ended July 31, 2016, an increase of $26.5 million. The increase in cash generated by operating activities resulted from higher net earnings of $42.0 million, partially offset by several changes in working capital items that resulted in a net cash reduction.
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Investing Activities
Cash used in investing activities for the year ended July 31, 2018 was $95.4 million, as compared with $95.7 million for the year ended July 31, 2017, a decrease of $0.3 million. The primary changes in cash used in investing activities include an increase in capital expenditures of $31.6 million to expand capacity and invest in technology, offset by a decrease in net cash used for acquisitions of $32.7 million.
Cash used in investing activities for the year ended July 31, 2017 was $95.7 million, as compared with $55.6 million for the year ended July 31, 2016, an increase of $40.1 million. The increase in cash used in investing activities between the periods resulted from a decrease in proceeds from sales of short-term investments of $28.0 million and an increase in cash outflows for acquisitions of $19.3 million as the Company acquired Partmo and Hy-Pro. The increase in cash utilized was partially offset by a decrease in capital expenditures of $7.0 million.
Financing Activities
Cash flows used in financing activities generally relate to the use of cash for payment of dividends and repurchases of the Company's common stock, net borrowing activity and proceeds from the exercise of stock options. To determine the appropriate level of dividend payouts, the Company considers recent and projected performance across key financial metrics, including earnings, cash flow from operations and total debt. Dividends paid for years ended July 31, 2018, 2017 and 2016 were $94.7 million, $92.4 million and $91.2 million, respectively. The Company's Board of Directors authorized the repurchase of up to 14.0 million shares of common stock under the Company’s stock repurchase plan. During the year ended July 31, 2018, the Company repurchased 2.6 million shares for $122.0 million. During the year ended July 31, 2017, the Company repurchased 3.3 million shares for $140.4 million. As of July 31, 2018, the Company had remaining authorization to repurchase 4.5 million shares under this plan.
Cash used in financing activities for the year ended July 31, 2018 was $268.8 million, as compared with $165.2 million for the year ended July 31, 2017, an increase of $103.6 million. The increase in cash used in financing activities is primarily due to a net increase in repayments of long-term debt and short-term borrowings of $116.2 million between the periods, driven by the greater flexibility afforded by the TCJA, that enables more efficient global cash utilization.
Cash used in financing activities for the year ended July 31, 2017 was $165.2 million, as compared with $180.2 million for the year ended July 31, 2016, a decrease of $15.0 million. The decrease was driven by increased short-term borrowings and long-term debt, including current maturities for the year ended July 31, 2017 compared with the prior year of $62.9 million, partially offset by higher share repurchases for the year ended July 31, 2017 compared with the prior year of $56.1 million.
Financial Condition
The Company's total capitalization components and debt-to-capitalization ratio at July 31, 2018 and July 31, 2017 was as follows (in millions):
July 31, | ||||||||
2018 | 2017 | |||||||
Short-term borrowings | $ | 28.2 | $ | 23.3 | ||||
Current maturities of long-term debt | 15.3 | 50.6 | ||||||
Long-term debt | 499.6 | 537.3 | ||||||
Shareholders' equity | 857.8 | 854.5 | ||||||
Total capitalization | $ | 1,400.9 | $ | 1,465.7 | ||||
Debt-to-capitalization ratio | 38.8 | % | 41.7 | % | ||||
As of July 31, 2018, total debt, including short-term borrowings and long-term debt, represented 38.8% of total capitalization, defined as total debt plus total shareholders’ equity, compared with 41.7% at July 31, 2017.
Long-term debt outstanding at July 31, 2018 was $499.6 million compared with $537.3 million at the prior year end, a decrease of $37.7 million, primarily due to the use of repatriated cash to pay down debt subsequent to the TCJA.
Accounts receivable, net at July 31, 2018 was $534.6 million, as compared with $497.7 million at July 31, 2017, an increase of $36.9 million. While accounts receivable, net increased between periods due to higher levels of sales, days sales outstanding was essentially flat at 66 days as of July 31, 2018, from 67 days as of July 31, 2017. Days sales outstanding is calculated using the count back method, which calculates the number of days of most recent revenue that is reflected in the net accounts receivable balance.
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Inventories, net at July 31, 2018 was $334.1 million, as compared with $293.5 million at July 31, 2017, an increase of $40.6 million. Inventory turns were 5.6 times per year as of July 31, 2018, compared to 6.1 times per year as of July 31, 2017. Inventory turns are calculated by taking the annualized cost of sales based on the trailing three-month period divided by the average of the beginning and ending net inventory values of the three-month period. The changes were primarily driven by inventory increases across the regions to meet current and expected future customer demand given the sales momentum.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements, with the exception of the guarantee of 50% of certain debt of its joint venture with Caterpillar Inc., Advanced Filtration Systems Inc. (AFSI). As of July 31, 2018, the joint venture had $35.5 million of outstanding debt, of which the Company guarantees half. The Company does not believe that this guarantee will have a current or future effect on its financial condition, results of operations, liquidity or capital resources.
Contractual Obligations
The following table summarizes the Company’s contractual obligations as of July 31, 2018, for the years indicated (in millions):
Payments Due by Period | ||||||||||||||||||||
Total | Less than 1 year | 1 - 3 years | 3 - 5 years | More than 5 years | ||||||||||||||||
Long-term debt obligations | $ | 514.3 | $ | 14.9 | $ | 58.0 | $ | 167.0 | $ | 274.4 | ||||||||||
Capital lease obligations | 0.6 | 0.4 | 0.2 | — | — | |||||||||||||||
Interest on long-term debt obligations | 81.4 | 9.8 | 18.8 | 18.7 | 34.1 | |||||||||||||||
Operating lease obligations | 60.3 | 18.9 | 25.9 | 11.7 | 3.8 | |||||||||||||||
Purchase obligations (1) | 183.5 | 174.3 | 3.4 | 5.8 | — | |||||||||||||||
Pension and deferred compensation (2) | 51.4 | 7.0 | 7.4 | 7.1 | 29.9 | |||||||||||||||
Total (3) | $ | 891.5 | $ | 225.3 | $ | 113.7 | $ | 210.3 | $ | 342.2 | ||||||||||
(1) | Purchase obligations consist primarily of inventory, tooling and capital expenditures. The Company’s purchase orders for inventory are based on expected customer demand and, as a result, quantities and dollar volumes are subject to change. |
(2) | Pension and deferred compensation consists of long-term pension liabilities and salary and bonus deferrals elected by certain executives under the Company’s deferred compensation plan. Deferred compensation balances earn interest based on a treasury bond rate as defined by the plan (10-year treasury bond STRIP rate plus two percent for deferrals prior to January 1, 2011 and 10-year treasury bond rates for deferrals after December 31, 2010), are approved by the Human Resources Committee of the Board of Directors and are payable at the election of the participants. |
(3) | In addition to the above contractual obligations, the Company may be obligated for additional cash outflows of $20.2 million for potential tax obligations, including accrued interest and penalties. The payment and timing of any such payments is affected by the ultimate resolution of the tax years that are under audit or remain subject to examination by the relevant taxing authorities. Therefore, quantification of an estimated range and timing of future payments cannot be made at this time. Additionally, the transition tax on deemed repatriated earnings of non-U.S. subsidiaries resulting from the TCJA is not included in contractual obligations. |
Critical Accounting Policies
The Company’s Consolidated Financial Statements are prepared in conformity with GAAP. The preparation of these financial statements requires the use of estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. Management bases estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about recorded amounts. The Company believes its use of estimates and underlying accounting assumptions adheres to GAAP and are reasonable and consistently applied. The Company’s Critical Accounting Policies are those that require more significant estimates and judgments used in the preparation of its Consolidated Financial Statements and that are the most important to aid in fully understanding its financial results. The Company's Critical Accounting Policies are the following:
Revenue recognition The Company sells a wide range of filtration solutions into many industries around the globe. Revenue is recognized when both product ownership and the risk of loss have transferred to the customer, the Company has no remaining obligations, the selling price is fixed and determinable and collectability is reasonably assured. The vast majority of the Company’s sales contracts are for standard products with product ownership and risk of loss transferring to the customer when the product has shipped, at which point revenue is recognized. Although less common, the Company does have sales contracts with customers requiring product ownership and risk of loss to transfer at the customer’s location. For these non-standard terms, the Company defers revenue on these product sales until the product has been delivered.
For the Company’s Gas Turbine Systems sales, which typically consist of multiple shipments of components that will comprise the entire Gas Turbine Systems project, the Company must carefully monitor the transfer of title related to each portion of a system
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sale. The Company defers revenue recognition until product ownership and risk of loss has transferred to the customer for all components and when all terms specified in the contract are met, which may include requirements such as the Company delivering technical documentation to the customer or a quality inspection approved by the customer.
In limited circumstances, the Company enters into sales contracts that involve multiple elements (such as equipment, replacement filter elements and installation services). In these instances, the Company determines if the multiple elements in the arrangement represent separate units of accounting. If separate units of accounting exist, the price of the entire arrangement is allocated to the separate units of account using the Company’s best estimate of relative selling price if the unit of account was sold separately. Revenue is then recognized separately for each unit of account when the criteria for revenue recognition have been met.
Additionally, the Company records estimated discounts and rebates offered to customers as a reduction of sales in the same period revenue is recognized.
For fiscal 2019, the Company will adopt ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which amended revenue recognition guidance to clarify the principles for recognizing revenue from contracts with customers. This new standard will be reflected in the Company's revenue recognition policy for fiscal 2019. Refer to Note 16 in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for more information.
Goodwill Goodwill represents the excess of the purchase price over the fair value of net assets acquired in business combinations under the purchase method of accounting. Goodwill is assessed for impairment annually, which for the Company occurs during the third quarter, or more frequently if an event occurs or circumstances change that would indicate the asset may be impaired. The goodwill impairment assessment is conducted at a reporting unit level, which is one level below the operating segment level, and utilizes either a qualitative or quantitative assessment. The optional qualitative assessment evaluates general economic, industry and entity-specific factors that could impact the reporting units’ fair values. For reporting units evaluated using a qualitative assessment, if it is determined that the fair value more likely than not exceeds the carrying value, no further assessment is necessary. The Company has elected this option for certain reporting units. For reporting units evaluated using a quantitative assessment, the fair values are determined using an income approach, a market approach or a weighting of the two. The income approach determines fair value based on discounted cash flows models derived from the reporting units’ long-term forecasts. The market approach determines fair value based on earnings multiples derived from prices investors paid for the stocks of comparable, publicly traded companies. An impairment loss would be recognized when the carrying amount of a reporting unit’s net assets exceeds the estimated fair value of the reporting unit. Significant estimates and assumptions are utilized in the valuations, including discounted projected cash flows, terminal value growth rates, discount rates, and the determination of comparable, publicly traded companies. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment.
The Company performed its annual impairment assessment during the third quarter of fiscal 2018 and determined that there were no indicators of impairment for any of the reporting units evaluated.
Income taxes Management is required to estimate income taxes in each of the jurisdictions in which the Company operates. This process involves estimating current tax exposure and assessing future tax consequences attributable to temporary differences between the financial statement carrying amount of existing assets and liabilities and their respective tax basis. These deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are anticipated to reverse based on future taxable income projections and the impact of tax planning strategies. The Company intends to indefinitely reinvest undistributed earnings for certain of its non-U.S. subsidiaries and thus has not provided for income taxes on these earnings.
Additionally, benefits of tax return positions are recognized in the financial statements when the position is “more-likely-than-not” to be sustained by the taxing authorities based solely on the technical merits of the position. If the recognition threshold is met, the tax benefit is measured and recognized as the largest amount of tax benefit that in the Company's judgment is greater than 50% likely to be realized. The Company maintains a reserve for uncertain tax benefits that are currently unresolved and routinely monitors the potential impact of such situations. The liability for unrecognized tax benefits, accrued interest and penalties was $20.2 million and $21.1 million as of July 31, 2018 and 2017, respectively.
On May 29, 2018, the United States Internal Revenue Service (IRS) proposed an adjustment related to the Company’s foreign legal entity restructuring which was completed in fiscal 2015. The Company disagrees with the IRS proposal and believes their claims to be without merit. The Company will vigorously defend its position, beginning with an attempt to resolve these matters at the IRS Appellate level and through litigation if necessary.
The Company believes that it is remote that any adjustment necessary to the reserve for income taxes for the next 12-month period will be material. However, it is possible the ultimate resolution of audits or disputes may result in a material change to our reserve for income taxes, although the quantification of such potential adjustments cannot be made at this time.
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Defined benefit pension plans The Company incurs expenses for employee benefits provided through defined benefit pension plans. In accounting for these defined benefit pension plans, management must make a variety of estimates and assumptions including mortality rates, discount rates, overall Company compensation increases and expected return on plan assets. The Company considers historical data as well as current facts and circumstances and uses a third-party specialist to assist management in determining these estimates.
To develop the assumption for the expected long-term rate of return on assets for its U.S. pension plans, the Company considered historical returns and future expected returns for each asset class, as well as the target asset allocation of the pension portfolio. The expected return on plan assets assumption for the plans outside the U.S. reflects the investment allocation and expected total portfolio returns specific to each plan and country. The Company utilized a 6.25% and 6.58% asset-based weighted average expected return on plan assets for its U.S. plans as of the measurement dates July 31, 2018 and 2017, respectively. The Company utilized a 4.08% and 4.19% asset-based weighted average expected return on plan assets for its non-U.S. plans for the years ended July 31, 2018 and 2017, respectively. The expected returns on plan assets are used to develop the following years' expense for the plans.
The Company’s objective in selecting a discount rate for its pension plans is to select the best estimate of the rate at which the benefit obligations could be effectively settled on the measurement date, taking into account the nature and duration of the benefit obligations of the plan. In making this best estimate, the Company looks at the rates of return on high-quality, fixed-income investments currently available, and expected to be available, during the period to maturity of the benefits. This process includes assessing the universe of bonds available on the measurement date with a quality rating of Aa or better. Similar appropriate benchmarks are used to determine the discount rate for the non-U.S. plans. The Company utilized a 4.43% and 3.94% weighted average discount rate for its U.S. plans for the years ended July 31, 2018 and 2017, respectively. The Company utilized a 2.43% and 2.40% weighted average discount rate for its non-U.S. plans for the years ended July 31, 2018 and 2017, respectively.
The Company utilizes a full yield curve approach to estimate service and interest costs for pension benefits by applying specific spot rates along the yield curve used to determine the benefit obligation of relevant projected cash outflows. This method provides a precise measurement of service and interest costs by aligning the timing of the plans' liability cash flows to the corresponding spot rate on the yield curve.
The Company’s net periodic benefit cost recognized in the Consolidated Statements of Earnings was $5.1 million, $3.3 million and $17.8 million for the years ended July 31, 2018, 2017 and 2016, respectively. While changes to the Company’s pension plan assumptions would not be expected to impact its net periodic benefit cost by a material amount, such changes could significantly impact the Company’s projected benefit obligation.
New Accounting Standards Not Yet Adopted
For new accounting standards not yet adopted, refer to Note 1 in the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report.
Safe Harbor Statement under the Securities Reform Act of 1995
The Company, through its management, may make forward-looking statements reflecting the Company’s current views with respect to future events and expectations, such as forecasts, plans, trends and projections relating to the Company's business and financial performance. These forward-looking statements, which may be included in reports filed under the Securities Exchange Act of 1934, as amended (the Exchange Act), in press releases and in other documents and materials as well as in written or oral statements made by or on behalf of the Company, are subject to certain risks and uncertainties, including those discussed in Part I, Item 1A, "Risk Factors" of this Annual Report, which could cause actual results to differ materially from historical results or those anticipated. The words or phrases “will likely result,” “are expected to,” “will continue,” “will allow,” “estimate,” “project,” “believe,” “expect,” “anticipate,” “forecast,” “plan” and similar expressions are intended to identify forward-looking statements within the meaning of Section 21e of the Exchange Act and Section 27A of the Securities Act of 1933, as amended, as enacted by the Private Securities Litigation Reform Act of 1995 (PSLRA). In particular, the Company desires to take advantage of the protections of the PSLRA in connection with the forward-looking statements made in this Annual Report. All statements other than statements of historical fact are forward-looking statements. These statements do not guarantee future performance.
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date such statements are made. In addition, the Company wishes to advise readers that the factors listed in Part I, Item 1A, "Risk Factors" of this Annual Report, as well as other factors, could affect the Company’s performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed. These factors include, but are not limited to, economic and industrial conditions worldwide; the Company's ability to maintain competitive advantages; threats from disruptive innovation; pricing pressures; the Company's ability to protect and enforce its intellectual property; the difficulties in operating globally; customer concentration in certain cyclical industries; unavailable raw materials or material cost inflation; inability of operations to meet customer demand; difficulties with information technology systems and security; foreign currency fluctuations; governmental laws and regulations; litigation; changes in tax laws, regulations and results of examinations; the
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Company's ability to attract and retain qualified personnel; changes in capital and credit markets; execution of the Company's acquisition strategy; the possibility of intangible asset impairment; the Company's ability to manage productivity improvements; unexpected events and the disruption on operations; the Company's ability to maintain an effective system of internal control over financial reporting and other factors included in Part I, Item 1A, "Risk Factors" of this Annual Report. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company’s market risk includes the potential loss arising from adverse changes in foreign currency exchange rates, interest rates and commodity prices. See further discussion of these market risks below.
Foreign currency exchange rates The Company manages foreign currency market risk from time to time through the use of a variety of financial and derivative instruments. The Company does not enter into any of these instruments for speculative trading purposes. Rather, the Company’s objective in managing these risks is to reduce fluctuations in earnings and cash flows associated with changes in foreign currency exchange rates. The Company uses forward exchange contracts and other hedging activities to hedge the U.S. dollar value resulting from existing recognized foreign currency denominated asset and liability balances and also for anticipated foreign currency transactions. The Company also naturally hedges foreign currency through its production in the countries in which it sells its products.
During fiscal 2018, the U.S. dollar was generally weaker than in fiscal 2017 compared with many of the currencies of the foreign countries in which the Company operates. The overall weaker dollar had a positive impact on the Company’s international net sales results because the foreign denominated revenues translated into more U.S. dollars.
It is not possible to determine the exact impact of foreign currency translation changes. However, the direct effect on reported net sales and net earnings can be estimated. For the year ended July 31, 2018, the estimated impact of foreign currency translation resulted in an overall increase in reported net sales of $78.3 million and an increase in reported net earnings of approximately $10.4 million. Foreign currency translation had a positive impact to net sales and net earnings in many regions around the world.
The Company maintains significant assets and operations in Europe, Middle East, Africa, Asia Pacific and Latin America, resulting in exposure to foreign currency gains and losses. A portion of the Company’s foreign currency exposure is naturally hedged by incurring liabilities, including bank debt, denominated in the local currency in which the Company’s foreign subsidiaries are located.
The foreign subsidiaries of the Company generally purchase the majority of their input costs and then sell to many of their customers in the same local currency. However, the Company still may be exposed to cost increases relative to local currencies in the markets to which it sells. To mitigate such adverse trends, the Company, from time to time, enters into forward exchange contracts and other hedging activities. Additionally, foreign currency positions are partially offsetting and are netted against one another to reduce exposure.
Some products made by the Company in the U.S. are sold internationally. As a result, sales of such products are affected by the value of the U.S. dollar relative to other currencies. All else equal, any long-term strengthening of the U.S. dollar could depress these sales. Also, competitive conditions in the Company’s markets may limit its ability to increase product pricing in the face of adverse currency movements.
Interest rates The Company’s exposure to market risk for changes in interest rates relates primarily to debt obligations that are at variable rates, as well as the potential increase in fair value of long-term debt resulting from a potential decrease in interest rates. As of July 31, 2018, the Company’s financial liabilities with exposure to changes in interest rates consisted mainly of $217.4 million outstanding on the Company's revolving credit facility and term loan, ¥2.65 billion, or $23.8 million, of variable rate long-term debt and $28.2 million of short-term borrowings outstanding. Assuming a hypothetical increase of one-half percent in short-term interest rates, with all other variables remaining constant, interest expense would have increased $2.0 million and interest income would have increased $1.2 million in fiscal 2018. Interest rate changes would also affect the fair market value of fixed-rate debt. As of July 31, 2018, the estimated fair value of long-term debt with fixed interest rates was $263.3 million compared to its carrying value of $275.0 million. The fair value is estimated by discounting the projected cash flows using the rate that similar amounts of debt could currently be borrowed.
In addition, the Company is exposed to market risk for changes in interest rates for the impact to its qualified defined benefit pension plans. The plans' projected benefit obligation is inversely related to changes in interest rates. Consistent with published bond indices, in fiscal 2018 the Company increased its discount rate from 3.94% to 4.43% on its U.S. plans and increased its rates from 2.40% to 2.43% for its non-U.S. plans. To protect against declines in interest rates, the pension plans hold high-quality, long-duration bonds. The plans were underfunded by $1.9 million at July 31, 2018, since the projected benefit obligation exceeded the fair value of the plan assets.
23
Commodity prices The Company is exposed to market risk from fluctuating market prices of certain purchased commodity raw materials, including steel, filter media and petrochemical-based products including plastics, rubber and adhesives. On an ongoing basis, the Company enters into selective supply arrangements with certain of its suppliers that allow the Company to reduce volatility in its costs. The Company strives to recover or offset all material cost increases through selective price increases to its customers and the Company’s cost reduction initiatives, which include material substitution, process improvement and product redesigns. However, an increase in commodity prices could result in lower operating margins.
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Item 8. Financial Statements and Supplementary Data
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Management of the Company has assessed the effectiveness of the Company’s internal control over financial reporting as of July 31, 2018. In making its assessment of internal control over financial reporting, management used the criteria described in Internal Control - Integrated Framework - version 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of July 31, 2018 based on criteria in Internal Control-Integrated Framework issued by the COSO. The Company’s independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited the effectiveness of the Company’s internal control over financial reporting as of July 31, 2018, as stated in its report, which appears herein.
/s/ Tod E. Carpenter | /s/ Scott J. Robinson | |
Tod E. Carpenter | Scott J. Robinson | |
Chairman, President and Chief Executive Officer | Senior Vice President and Chief Financial Officer | |
October 1, 2018 | October 1, 2018 | |
25
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of Donaldson Company, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Donaldson Company, Inc. and its subsidiaries as of July 31, 2018 and 2017, and the related consolidated statements of earnings, comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended July 31, 2018, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of July 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of July 31, 2018 and 2017, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of July 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
October 1, 2018
We have served as the Company’s auditor since 2002.
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DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(In millions, except per share amounts)
Year ended July 31, | ||||||||||||
2018 | 2017 | 2016 | ||||||||||
Net sales | $ | 2,734.2 | $ | 2,371.9 | $ | 2,220.3 | ||||||
Cost of sales | 1,798.7 | 1,548.8 | 1,465.5 | |||||||||
Gross profit | 935.5 | 823.1 | 754.8 | |||||||||
Selling, general and administrative | 495.6 | 439.8 | 425.1 | |||||||||
Research and development | 59.9 | 54.7 | 55.5 | |||||||||
Operating income | 380.0 | 328.6 | 274.2 | |||||||||
Interest expense | 21.3 | 19.5 | 20.7 | |||||||||
Other income, net | (4.9 | ) | (12.9 | ) | (3.9 | ) | ||||||
Earnings before income taxes | 363.6 | 322.0 | 257.4 | |||||||||
Income taxes | 183.3 | 89.2 | 66.6 | |||||||||
Net earnings | $ | 180.3 | $ | 232.8 | $ | 190.8 | ||||||
Weighted average shares – basic | 130.3 | 132.6 | 133.8 | |||||||||
Weighted average shares – diluted | 132.2 | 134.1 | 134.8 | |||||||||
Net earnings per share – basic | $ | 1.38 | $ | 1.76 | $ | 1.43 | ||||||
Net earnings per share – diluted | $ | 1.36 | $ | 1.74 | $ | 1.42 | ||||||
Dividends paid per share | $ | 0.730 | $ | 0.700 | $ | 0.685 | ||||||
See Notes to Consolidated Financial Statements.
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DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In millions)
Year ended July 31, | ||||||||||||
2018 | 2017 | 2016 | ||||||||||
Net earnings | $ | 180.3 | $ | 232.8 | $ | 190.8 | ||||||
Other comprehensive income (loss): | ||||||||||||
Foreign currency translation (loss) income | (7.3 | ) | 30.5 | (18.5 | ) | |||||||
Pension liability adjustment, net of deferred taxes of $(4.7), $(11.2) and $14.4, respectively | 12.2 | 20.7 | (25.2 | ) | ||||||||
Gain (loss) on hedging derivatives, net of deferred taxes of $(1.1), $1.2 and $(0.1), respectively | 2.3 | (2.6 | ) | 0.1 | ||||||||
Net other comprehensive income (loss) | 7.2 | 48.6 | (43.6 | ) | ||||||||
Comprehensive income | $ | 187.5 | $ | 281.4 | $ | 147.2 | ||||||
See Notes to Consolidated Financial Statements.
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DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share amounts)
As of July 31, | |||||||
2018 | 2017 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 204.7 | $ | 308.4 | |||
Accounts receivable, less allowance of $8.3 and $8.7, respectively | 534.6 | 497.7 | |||||
Inventories, net | 334.1 | 293.5 | |||||
Prepaid expenses and other current assets | 52.3 | 51.4 | |||||
Total current assets | 1,125.7 | 1,151.0 | |||||
Property, plant and equipment, net | 509.3 | 484.6 | |||||
Goodwill | 238.4 | 238.1 | |||||
Intangible assets, net | 35.6 | 40.6 | |||||
Deferred income taxes | 19.2 | 30.3 | |||||
Other long-term assets | 48.4 | 35.1 | |||||
Total assets | $ | 1,976.6 | $ | 1,979.7 | |||
Liabilities and shareholders' equity | |||||||
Current liabilities: | |||||||
Short-term borrowings | $ | 28.2 | $ | 23.3 | |||
Current maturities of long-term debt | 15.3 | 50.6 | |||||
Trade accounts payable | 201.3 | 194.0 | |||||
Accrued employee compensation and related taxes | 103.5 | 100.0 | |||||
Accrued liabilities | 34.5 | 31.1 | |||||
Other current liabilities | 86.6 | 85.1 | |||||
Total current liabilities | 469.4 | 484.1 | |||||
Long-term debt | 499.6 | 537.3 | |||||
Non-current income taxes payable | 105.3 | 21.1 | |||||
Deferred income taxes | 4.2 | 3.6 | |||||
Other long-term liabilities | 40.3 | 79.1 | |||||
Total liabilities | 1,118.8 | 1,125.2 | |||||
Commitments and contingencies (Note 17) | |||||||
Shareholders’ equity: | |||||||
Preferred stock, $1.00 par value, 1,000,000 shares authorized, none issued | — | — | |||||
Common stock, $5.00 par value, 240,000,000 shares authorized, 151,643,194 shares issued | 758.2 | 758.2 | |||||
Retained earnings | 1,122.1 | 1,041.2 | |||||
Non-controlling interest | 4.8 | 4.4 | |||||
Stock compensation plans | 21.3 | 15.7 | |||||
Accumulated other comprehensive loss | (149.8 | ) | (157.0 | ) | |||
Treasury stock, 22,871,145 and 21,037,353 shares, respectively, at cost | (898.8 | ) | (808.0 | ) | |||
Total shareholders’ equity | 857.8 | 854.5 | |||||
Total liabilities and shareholders’ equity | $ | 1,976.6 | $ | 1,979.7 | |||
See Notes to Consolidated Financial Statements.
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DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
Year ended July 31, | ||||||||||||
2018 | 2017 | 2016 | ||||||||||
Operating Activities | ||||||||||||
Net earnings | $ | 180.3 | $ | 232.8 | $ | 190.8 | ||||||
Adjustments to reconcile net earnings to net cash provided by operating activities: | ||||||||||||
Depreciation and amortization | 76.7 | 75.2 | 74.9 | |||||||||
Equity in earnings of affiliates, net of distributions | (2.7 | ) | (0.5 | ) | (0.3 | ) | ||||||
Deferred income taxes | 7.0 | (10.6 | ) | (3.3 | ) | |||||||
Stock-based compensation plan expense | 16.7 | 9.1 | 7.3 | |||||||||
Other, net | (27.6 | ) | 5.1 | 11.7 | ||||||||
Changes in operating assets and liabilities, excluding effect of acquired businesses: | ||||||||||||
Accounts receivable | (41.7 | ) | (31.8 | ) | 8.5 | |||||||
Inventories | (43.8 | ) | (42.4 | ) | 29.1 | |||||||
Prepaid expenses and other current assets | 3.6 | 12.8 | 0.8 | |||||||||
Income taxes payable | 87.9 | 8.5 | 2.8 | |||||||||
Trade accounts payable and other accrued expenses | 6.5 | 59.6 | (31.0 | ) | ||||||||
Net cash provided by operating activities | 262.9 | 317.8 | 291.3 | |||||||||
Investing Activities | ||||||||||||
Purchases of property, plant and equipment | (97.5 | ) | (65.9 | ) | (72.9 | ) | ||||||
Proceeds from sale of property, plant and equipment | 1.6 | 2.4 | 2.2 | |||||||||
Proceeds from sale of short-term investments | — | — | 28.0 | |||||||||
Acquisitions, net of cash acquired | 0.5 | (32.2 | ) | (12.9 | ) | |||||||
Net cash used in investing activities | (95.4 | ) | (95.7 | ) | (55.6 | ) | ||||||
Financing Activities | ||||||||||||
Proceeds from long-term debt | 197.7 | — | 9.6 | |||||||||
Repayments of long-term debt | (272.4 | ) | (81.7 | ) | (1.4 | ) | ||||||
Change in short-term borrowings | 6.0 | 129.2 | (23.6 | ) | ||||||||
Purchase of treasury stock | (122.0 | ) | (140.4 | ) | (84.3 | ) | ||||||
Dividends paid | (94.7 | ) | (92.4 | ) | (91.2 | ) | ||||||
Tax withholding for stock compensation transactions | (2.6 | ) | (2.6 | ) | (2.5 | ) | ||||||
Exercise of stock options | 19.2 | 22.7 | 13.2 | |||||||||
Net cash used in financing activities | (268.8 | ) | (165.2 | ) | (180.2 | ) | ||||||
Effect of exchange rate changes on cash | (2.4 | ) | 8.3 | (2.2 | ) | |||||||
(Decrease) increase in cash and cash equivalents | (103.7 | ) | 65.2 | 53.3 | ||||||||
Cash and cash equivalents, beginning of year | 308.4 | 243.2 | 189.9 | |||||||||
Cash and cash equivalents, end of year | $ | 204.7 | $ | 308.4 | $ | 243.2 | ||||||
Supplemental Cash Flow Information | ||||||||||||
Cash paid during the year for: | ||||||||||||
Income taxes | $ | 82.6 | $ | 88.0 | $ | 67.8 | ||||||
Interest | $ | 21.9 | $ | 19.9 | $ | 19.7 | ||||||
See Notes to Consolidated Financial Statements.
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DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In millions, except per share amounts)
Common Stock | Additional Paid-in Capital | Retained Earnings | Non- Controlling Interest | Stock Compensation Plans | Accumulated Other Comprehensive Loss | Treasury Stock | Total | ||||||||||||||||||||||||
Balance July 31, 2015 | $ | 758.2 | $ | — | $ | 815.2 | $ | 3.9 | $ | 17.9 | $ | (162.0 | ) | $ | (654.5 | ) | $ | 778.7 | |||||||||||||
Comprehensive income | |||||||||||||||||||||||||||||||
Net earnings | 190.8 | 190.8 | |||||||||||||||||||||||||||||
Foreign currency translation | (18.5 | ) | (18.5 | ) | |||||||||||||||||||||||||||
Pension liability adjustment, net of deferred taxes | (25.2 | ) | (25.2 | ) | |||||||||||||||||||||||||||
Gain on hedging derivatives, net of deferred taxes | 0.1 | 0.1 | |||||||||||||||||||||||||||||
Comprehensive income | 147.2 | ||||||||||||||||||||||||||||||
Treasury stock acquired | (84.3 | ) | (84.3 | ) | |||||||||||||||||||||||||||
Stock options exercised | (1.4 | ) | (14.7 | ) | 29.0 | 12.9 | |||||||||||||||||||||||||
Stock compensation expense | 6.6 | 0.3 | 0.4 | 7.3 | |||||||||||||||||||||||||||
Deferred stock and other activity | 1.4 | (1.3 | ) | 0.1 | (1.5 | ) | 2.4 | 1.1 | |||||||||||||||||||||||
Dividends ($0.69 per share) | (91.5 | ) | (91.5 | ) | |||||||||||||||||||||||||||
Balance July 31, 2016 | 758.2 | — | 905.1 | 4.0 | 16.7 | (205.6 | ) | (707.0 | ) | 771.4 | |||||||||||||||||||||
Comprehensive income | |||||||||||||||||||||||||||||||
Net earnings | 232.8 | 232.8 | |||||||||||||||||||||||||||||
Foreign currency translation | |||||||||||||||||||||||||||||||