Yahoo Finance Donaldson Company, Inc. (NYSE:DCI) Q3 2024 Earnings Call Transcript
Donaldson Company, Inc. (NYSE:DCI) Q3 2024 Earnings Call Transcript June 4, 2024
Donaldson Company, Inc. beats earnings expectations. Reported EPS is $0.92, expectations were $0.835.
Operator: Thank you for standing by, and welcome to the Donaldson Company third quarter 2024 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again press the star, one. Thank you. I’d now like to turn the call over to Sarika Dhadwal, Senior Director of Investor Relations and ESG. You may begin.
Sarika Dhadwal : Good morning. Thank you for joining Donaldson’s third quarter fiscal 2024 earnings conference call. With me today are Tod Carpenter, Chairman, CEO and President, and Scott Robinson, Chief Financial Officer. This morning, Tod and Scott will provide a summary of our third quarter performance and details on our outlook for fiscal 2024. During today’s call, we will discuss non-GAAP or adjusted results. While there were no non-GAAP adjustments in the third quarter of either fiscal 2024 or 2023, for the full year fiscal 2023, non-GAAP results exclude pre-tax, restructuring and other charges of $21.8 million. A reconciliation of GAAP to non-GAAP metrics is provided within the schedules attached to this morning’s press release.
Additionally, please keep in mind that any forward-looking statements made during this call are subject to risks and uncertainties which are described in our press release and SEC filings. With that, I’ll now turn the call over to Tod Carpenter. Please go ahead.
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Tod Carpenter: Thanks Sarika. Good morning. Donaldson Company’s third quarter results were excellent. Sales increased 6% to a record $928 million, EPS increased 22% to a record $0.92, and operating margin was at more than a decade-long high. All three operating segments demonstrated growth and profitability. In mobile solutions, volume growth exceeded pricing gains driven by strength in our aftermarket business. We continued to benefit from market share gains as well as a return to more normalized demand levels after de-stocking in the prior year period. Profitability in mobile solutions continues to be exceptional. Pre-tax profit margin hit an all-time high of 18.4%. This 340 basis point improvement over prior year was a result of favorable mix, volume growth, and pricing.
In industrial solutions, sales strength and high levels of profitability continued, driven by project wins and market share gains in dust collection and power generation. Aerospace and defense also had a strong quarter and backlogs remain robust. We maintain focus on advancing our create, connect, replace and service model. This quarter, we acquired EZ-Flow Filtration, an industrial services business in LaGrange, Georgia. EZ-Flow brings to Donaldson additional service capabilities in both hydraulic and power generation filtration and a new geographic presence in the southeast United States. In life sciences, we achieved sales growth above 20% and profitability through strength in our bio-processing and disk drive businesses. We also continued to build for the future.
In April, we entered into an agreement to acquire a 49% stake in Medica SpA, a leader in hollow fiber membrane technology based in Medolla, Italy. This transaction is expected to be completed through a public tender offer and includes a call option to acquire the remaining 51% stake in the company in the years to come. Donaldson and Medica have a previously established relationship through an exclusive joint development agreement allowing for the development and commercialization of hollow fiber modules in life sciences applications, including bio-processing and food and beverage. These modules can be used with Solaris, Univercells Technologies and Isolere products, demonstrating our vision and progress for providing customers with a complete and differentiated product portfolio.
From an operational standpoint, backlogs across all three segments remain strong, indicating the overall health of our businesses for the foreseeable future. With supply chain conditions mostly supportive, Donaldson’s customer focus remains steadfast as we continually work to improve on-time delivery rates. This quarter, R&D, capital expenditures and M&A activity continued as we invested to meet the future needs of our customers. R&D included product development initiatives in our legacy and newly acquired businesses, and we expect to grow our investment levels double digits for the full year. Capital expenditures were primarily focused on increasing capacity and expanding new products and technology, including in our life sciences segment.
In keeping with our M&A strategic focus areas, we also deployed capital on the previously mentioned industrial services acquisition, EZ-Flow. Now I will provide some detail on third quarter sales. Total company sales were $928 million, up 6% compared with prior year. Pricing contributed approximately 2%. In mobile solutions, total sales were $585 million, a 6% increase versus 2023. Mobile aftermarket sales grew 11% year-over-year to $445 million. Independent channel sales grew mid single digits from market share gains, and OE channel sales were up mid teens as demand returned to more normalized levels following de-stocking in the prior year period. Partially offsetting the strong aftermarket performance were declines in the first-fit businesses.
Sales in on-road were $36 million, down 6% due to lower levels of equipment production, particularly in APAC. Off-road sales of $104 million declined 10% as agriculture markets remained soft and business in China continues to be weak. To that end, I will touch on our mobile solutions business in China in aggregate, where sales decreased 32% over prior year. Both first-fit and aftermarket sales declined, impacted by weak overall demand and the timing of Chinese New Year, which fell into the third quarter this year versus the second quarter a year ago, resulting in fewer ship days this year. Despite the challenging nature of the China market today, we remain optimistic with respect to the long term market growth opportunities and our ability to gain share there over time.
Now I’ll move onto the industrial solutions segment. Industrial sales increased 3% to $269 million. Industrial filtration solutions, or IFS sales grew 2% to $229 million due to strong dust collection replacement parts sales and power generation product timing. Aerospace and defense sales grew 6% to $41 million, driven by robust aerospace end market conditions. In the life sciences segment, sales were $74 million, up 24% year-over-year as a result of bio-processing equipment and disk drive strength. Acquisitions added approximately $10 million or 15 percentage points of sales growth, due in large part to the timing of project shipments. In summary, I am proud of what the Donaldson team accomplished this quarter. Driven by the strong results and our outlook for the fourth quarter, we are increasing our full year earnings guidance, which Scott will detail.
Fiscal 2024 is forecasted to be a year of record sales, record operating margin, and record earnings. Now I’ll turn it over to Scott, who will provide more details on the financials. Scott?
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Scott Robinson: Thanks Tod. Good morning everyone. I want to thank our entire Donaldson team for their fantastic work this quarter. Without them, we would not have been able to deliver such a strong performance, and I am confident in our collective ability to drive continued success in future. Before discussing our outlook for fiscal 2024, I will give additional details on the results for the third quarter. Sales increased 6% versus 2023, operating income increased 16%, and EPS of $0.92 was up 22% year-over-year. Gross margin of 35.6% expanded 260 basis points above prior year from leverage on higher sales, pricing, and select input cost deflation. Operating expenses as a percent of sales were 20.1% versus 18.8% a year ago. Expense deleveraging was largely due to higher people-related costs, partially as a result of increased headcount.
Acquisition-related expenses also contributed. Operating margin was 15.5%, 130 basis points above 2023 driven by gross margin expansion, partially offset by operating expense deleveraging. As I always say, we are committed to higher levels of profitability on higher levels of sales, and we clearly delivered that this quarter. Now I’ll discuss segment profitability. As Tod mentioned, mobile solutions’ pre-tax profit margin was a record of 18.4%, 340 basis points above prior year, resulting from favorable mix, volume growth and pricing benefits. Industrial solutions’ pre-tax profit margin was 18.7%, approximately flat versus prior year. We are pleased with the high levels of profitability the industrial business has been delivering and look forward to growing this business, which will increase blended margins for the company.
Our life sciences business generated a pre-tax profit margin of approximately 1%, including a headwind from acquisitions of 16 percentage points. We are encouraged by our improved performance in the quarter, however we are tracking below previous expectations and now expect full year profit margin to be down low single digits. The nature of our acquisition-related revenue brings with it some timing uncertainty. This layered on top of ongoing investments to support scaling has delayed our full-year projected profitability inflection point. That said, our confidence in the longer term sales growth and profitability potential of our life sciences business has not wavered. Given the year-to-date trends we have been seeing in all three segments, with two of three tracking ahead of expectations, we are evaluating our longer term financial targets and will provide an update with our fiscal 2025 guidance during the fourth quarter call.
Turning to a few balance sheet and cash flow statement highlights, third quarter capital expenditures were approximately $21 million. Cash conversion in the quarter was 106%, on par with prior year, driven by our continued focus on working capital efficiencies. In terms of other capital deployment, we returned approximately $57 million to shareholders, inclusive of $30 million in the form of dividends and $27 million in share repurchases. We also invested $2 million on the EZ-Flow acquisition. We ended the quarter with a net debt to EBITDA ratio of 0.5 times. Now moving to our fiscal ’24 outlook, first on sales, we are narrowing our full-year total sales guidance to an increase of between 4% and 6%, consistent with our prior forecast. This includes a pricing benefit of approximately 2% and a minimal impact from currency translation.
For mobile solutions, we are forecasting an increase of between 2% and 4%, unchanged from our previous expectation. Off-road sales remain projected to be down low double digits as global air culture markets and China remain weak. On-road markets have continued to soften, driving a reduction in our forecast to negative low single digits versus flat previously. Our outlook for aftermarket continues to be mid single digit growth as a result of market share gains and the lapping of de-stocking in the prior year period. Industrial solutions sales are expected to increase between 6% and 8% with a midpoint of 7%, up from our previous guidance range which carried a midpoint of 5%. IFS sales driven by strength in dust collection and power generation are forecast to grow mid single digits, in line with our prior expectations.
Our outlook for aerospace and defense has improved and we now expect sales to grow low double digits, up from mid single digits previously as robust end market conditions continue. For life sciences, we are reducing our sales guidance for the full year to a mid-teens increase compared with the approximate 20% growth previously forecast. We are pleased with and encouraged by the interest in our bio-processing technologies and product portfolio; however, capital remains constricted in many biopharmaceutical markets, particularly for research and early stage assets. While we navigate the current challenging macro conditions, we remain focused on building out our technology and capabilities and laying the groundwork for future success. In the near term, we expect ongoing momentum in businesses such as disk drive, food and beverage, and vehicle electrification.
With respect to consolidated operating margin, we are reaffirming our previous guidance of 15.0% to 15.4%, which is an all-time record compared with an adjusted operating margin of 14.6% a year ago. At the midpoint, this approximately 60 basis point year-over-year improvement is driven by gross margin expansion, partially offset by expense deleveraging as we maintain our commitment to investing for future profitable growth. We are adjusting our outlook for interest, other income and tax. Interest is expected to be approximately $22 million, down slightly from $23 million previously. Other income is projected between $15 million and $17 million, up from prior guidance of $10 million to $12 million due to better than expected joint venture income and FX benefits.
Our tax rate is forecast between 23% and 24%, down 100 basis points from prior guidance. For EPS, we are increasing our outlook to between $3.33 and $3.39, a $0.32 or 11% increase at the midpoint from adjusted EPS of $3.04 in fiscal 2023. With three quarters of the year behind us, we are pleased with our performance and better positioned than ever to deliver to all our stakeholders in fiscal 2024 and beyond. Now onto our balance sheet and cash flow outlook. Cash conversion is forecast above historical averages at 95% to 105% for the full year. Capital expenditures weighted towards growth investments, including capacity and new products and technologies, are projected between $90 million to $105 million, down slightly from the previous $95 million to $110 million range.
Capital deployment is vital for Donaldson and our strategy is unchanged. First, we are focused on reinvesting back into the company, either organically or inorganically through M&A, as we continue to demonstrate. We also look to return value to shareholders through our dividends and share repurchases. Last week, we announced an 8% increase in our quarterly cash dividend and we intend to repurchase approximately 2% of our shares outstanding this fiscal year. Now I’ll turn the call back to Tod.
Tod Carpenter: Thanks Scott. I am more confident than ever in the Donaldson team, our long term strategy, technology pipeline, and ongoing investments. We are committed to working towards our investor day targets, both our fiscal 2026 financial objectives as well as our 2030 ESG ambitions. During the quarter, we published our fiscal 2023 sustainability report, which can be accessed on our website or via the QR code within our earnings slide presentation. The report highlights our sustainability strategy which is underpinned by creating sustainable value through our products, fostering a safe and diverse environment for our people, and operating sustainably with a focus on our planet. I’ll touch on a few recent highlights in these areas.
Products - we are proud of our innovative technology and development capabilities in life sciences. In May, we announced our partnership with PolyPeptide Group to improve sustainability in the manufacturing of peptides, which are active pharmaceutical ingredients used in various medical therapies. Our collaboration on the development of a production scale solvent recovery system marked a milestone in the pharmaceutical industry’s pursuit of environmentally friendly manufacturing processes. Donaldson is also creating sustainable value through our life-changing technologies. We are currently supporting over 140 therapies, including 50 proofs of concept and 90 drug development programs, where our technologies are utilized by customers to trial, develop and scale processes crucial for advancing cell and gene therapies and RNA and traditional vaccines.
Many of these programs are currently in the preclinical stage, however we do have some that are in clinical trials and a few that are likely to enter commercial production this calendar year. Importantly, these include customers that originated both organically and via our Univercells, Purilogics, and Isolere acquisitions, demonstrating the power of our M&A strategy. Now on our people and our planet, we have made notable progress towards our 2030 people and planet ambitions, including promoting safety and diversity and operating sustainably. Many of our achievements are documented in our sustainability report and much of our work has been publicly recognized. For 2024, Donaldson is included in the U.S. News & World Report’s Best Companies to Work For, and Newsweek’s lists of Greatest Workplaces for Diversity and America’s Most Responsible Companies.
To close, I am proud of this team and the work we are doing and want to thank all of our valued Donaldson employees. With that, I will now turn the call back to the Operator to open the line for questions.
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