UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDING January 31, 2003 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 (I.R.S. Employer
incorporation or organization) Identification Number)
1400 West 94th Street
Minneapolis, Minnesota 55431
---- -----------------------------
(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code (952) 887-3131
--------------
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, and (2) has been subject to such filing requirements
for the past 90 days.
Yes _X_ No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 1 2b-2 of the Exchange Act).
Yes _X_ No ___
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $5 Par Value - 43,466,712 shares as of February 28, 2003
- -----------------------------------------------------------------------
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Thousands of dollars, except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
January 31 January 31
----------------------------- -----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net sales $ 284,447 $ 264,281 $ 585,501 $ 552,710
Cost of sales 193,682 183,007 399,855 383,118
------------ ------------ ------------ ------------
Gross margin 90,765 81,274 185,646 169,592
Operating expenses 62,578 52,976 125,758 112,246
------------ ------------ ------------ ------------
Operating income 28,187 28,298 59,888 57,346
Other income, net (734) (955) (2,315) (1,686)
Interest expense 1,521 1,190 3,519 3,574
------------ ------------ ------------ ------------
Earnings before income taxes 27,400 28,063 58,684 55,458
Income taxes 7,398 7,303 15,845 14,974
------------ ------------ ------------ ------------
Net earnings $ 20,002 $ 20,760 $ 42,839 $ 40,484
============ ============ ============ ============
Weighted average shares
outstanding 43,514,276 44,152,615 43,669,051 44,215,963
Diluted shares outstanding 44,958,666 45,666,536 45,070,412 45,749,289
Basic earnings per share $ .46 $ .47 $ .98 $ .92
Diluted earnings per share $ .45 $ .45 $ .95 $ .88
Dividends paid per share $ .085 $ .075 $ .170 $ .150
See Notes to Condensed Consolidated Financial Statements.
2
DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of dollars, except per share amounts)
(Unaudited)
January 31, July 31,
2003 2002
--------- ---------
ASSETS
- ------
CURRENT ASSETS
Cash and cash equivalents $ 59,101 $ 45,586
Accounts receivable 226,083 251,417
Inventories
Materials 44,572 49,162
Work in process 15,228 16,796
Finished products 46,909 51,733
--------- ---------
Total inventories 106,709 117,691
Prepaid and other current assets 39,703 41,790
--------- ---------
TOTAL CURRENT ASSETS 431,596 456,484
Property, plant and equipment, at cost 578,330 552,724
Less accumulated depreciation (326,550) (311,811)
--------- ---------
Property, plant and equipment, net 251,780 240,913
Goodwill and other intangible assets 104,218 103,681
Other assets 47,941 49,053
--------- ---------
TOTAL ASSETS $ 835,535 $ 850,131
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES
Short-term debt $ 44,938 $ 60,337
Current maturities of long-term debt 36 57
Trade accounts payable 94,644 115,299
Accrued employee compensation and related taxes 26,018 31,171
Warranty and accrued liabilities 29,454 31,542
Other current liabilities 23,216 34,384
--------- ---------
TOTAL CURRENT LIABILITIES 218,306 272,790
Long-term debt 106,887 105,019
Deferred income taxes 14,160 13,376
Other long-term liabilities 77,164 76,325
--------- ---------
TOTAL LIABILITIES 416,517 467,510
--------- ---------
SHAREHOLDERS' EQUITY
- --------------------
Preferred stock, $1 par value,
1,000,000 shares authorized, no shares issued -- --
Common stock, $5 par value, 80,000,000 shares authorized,
49,655,954 issued 248,280 248,280
Retained earnings 308,756 274,395
Accumulated other comprehensive income(loss) 2,770 (14,296)
Treasury stock, at cost - 6,160,450 and 5,741,417 shares at
January 31, 2003 and July 31, 2002, respectively (140,788) (125,758)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 419,018 382,621
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 835,535 $ 850,131
========= =========
See Notes to Condensed Consolidated Financial Statements.
3
DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of dollars)
(Unaudited)
Six Months Ended
January 31
---------------------
2003 2002
-------- --------
OPERATING ACTIVITIES
Net earnings $ 42,839 $ 40,484
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation and amortization 17,501 15,958
Changes in operating assets and liabilities 6,075 13,816
Other 5,639 3,986
-------- --------
Net cash provided by operating activities 72,054 74,244
-------- --------
INVESTING ACTIVITIES
Net expenditures on property and equipment (23,382) (25,115)
Acquisitions and investments in unconsolidated
affiliates, net of cash acquired (1,259) --
-------- --------
Net cash used in investing activities (24,641) (25,115)
-------- --------
FINANCING ACTIVITIES
Purchase of treasury stock (17,432) (8,358)
Increase in long-term debt 1,725 111
Decrease in long-term debt (39) (24)
Change in short-term debt (22,925) (17,525)
Dividends paid (7,435) (6,640)
Other 409 1,035
-------- --------
Net cash used in financing activities (45,697) (31,401)
-------- --------
Effect of exchange rate changes on cash 11,799 (1,364)
-------- --------
Increase in cash and cash equivalents 13,515 16,364
Cash and cash equivalents-beginning of year 45,586 36,136
-------- --------
Cash and cash equivalents-end of period $ 59,101 $ 52,500
======== ========
See Notes to Condensed Consolidated Financial Statements.
4
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note A - Basis of Presentation
- ------
The accompanying unaudited condensed consolidated financial statements of
Donaldson Company, Inc. (the company) have been prepared in accordance with
accounting principles generally accepted in the United States of America and the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required for complete financial
statements. In the opinion of management, all adjustments considered necessary
for a fair presentation have been included and are of a normal recurring nature.
Operating results for the three and six month periods ended January 31, 2003 are
not necessarily indicative of the results that may be expected for future
periods. For further information, refer to the consolidated financial statements
and footnotes thereto included in Donaldson Company, Inc. and Subsidiaries'
Annual Report on Form 10-K for the year ended July 31, 2002. Certain amounts in
prior periods have been reclassified to conform to the current presentation. The
reclassifications had no impact on the net earnings as previously reported.
Note B - Accounting for Stock-Based Compensation
- ------
The company has elected to continue to account for stock-based compensation
using the intrinsic value method. Accordingly, no compensation expense has been
recorded for the stock option plan. Had the company used the fair value-based
method of accounting to measure compensation expense for its stock option plan
and charged compensation cost against income over the vesting periods, net
income and the related basic and diluted per common share amounts would have
been reduced to the following pro forma amounts:
Three Months Ended Six Months Ended
January 31 January 31
--------------------------------- ---------------------------------
2003 2002 2003 2002
--------------------------------- ---------------------------------
Net earnings, as reported $ 20,002,242 $ 20,760,020 $ 42,839,304 $ 40,484,455
Less total stock-based employee
compensation expense under the fair
value-based method, net of tax (1,969,832) (2,222,163) (2,457,502) (2,656,922)
--------------------------------- ---------------------------------
Pro forma net earnings $ 18,032,410 $ 18,537,857 $ 40,381,802 $ 37,827,533
================================= =================================
Basic net earnings per share
As reported $ 0.46 $ 0.47 $ 0.98 $ 0.92
Pro forma $ 0.41 $ 0.42 $ 0.92 $ 0.86
Diluted net earnings per share
As reported $ 0.45 $ 0.45 $ 0.95 $ 0.88
Pro forma $ 0.40 $ 0.41 $ 0.90 $ 0.83
5
Note C - Net Earnings Per Share
- ------
The company's basic net earnings per share is computed by dividing net earnings
by the weighted average number of outstanding common shares. The company's
diluted net earnings per share is computed by dividing net earnings by the
weighted average number of outstanding common shares and dilutive shares
relating to stock options and unvested restricted stock.
The following table presents information necessary to calculate basic and
diluted net earnings per common share (in thousands, except per share amounts):
Three Months Ended Six Months Ended
January 31 January 31
2003 2002 2003 2002
Weighted average shares outstanding - basic 43,514 44,153 43,669 44,216
Diluted share equivalents 1,445 1,514 1,401 1,533
----------------------------------------
Weighted average shares outstanding - diluted 44,959 45,667 45,070 45,749
========================================
Net earnings for basic and diluted
Earnings per share computation $20,002 $20,760 $42,839 $40,484
Net earnings per share - basic $ .46 $ .47 $ .98 $ .92
Net earnings per share - diluted $ .45 $ .45 $ .95 $ .88
Note D - Comprehensive Income
- ------
The company reports accumulated other comprehensive income as a separate item in
the shareholders' equity section of the balance sheet. Other comprehensive
income consists of foreign currency translation adjustments and net gains or
losses on cash flow hedging derivatives.
Total comprehensive income and its components are as follows (in thousands):
Three Months Ended Six Months Ended
January 31 January 31
2003 2002 2003 2002
Net earnings $ 20,002 $ 20,760 $ 42,839 $ 40,484
Foreign currency translation adjustment 17,324 (6,765) 17,791 (3,762)
Net gain (loss) on cash flow hedging derivatives (643) 705 (725) 436
-----------------------------------------------
Total other comprehensive income $ 36,683 $ 14,700 $ 59,905 $ 37,158
===============================================
Total accumulated other comprehensive gain(loss) and its components at
January 31, 2003 and July 31, 2002 are as follows (in thousands):
January 31, July 31,
2003 2002
Foreign currency translation adjustment $ 7,066 $(10,725)
Net gain (loss) on cash flow hedging derivatives (699) 26
Additional minimum pension liability (3,597) (3,597)
-------- --------
Total accumulated other comprehensive gain (loss) 2,770 $(14,296)
======== ========
6
Note E - Segment Reporting
- ------
The company has two reportable segments, Engine Products and Industrial
Products, that have been identified based on the internal organization
structure, management of operations and performance evaluation. Segment detail
is summarized as follows (in thousands):
Engine Industrial Corporate & Total
Products Products Unallocated Company
-------- -------- -------- --------
Three Months Ended
January 31, 2003:
Net sales $153,148 $131,299 -- $284,447
Earnings before income taxes 17,229 11,880 $ (1,709) 27,400
January 31, 2002:
Net sales $139,693 $124,588 -- $264,281
Earnings before income taxes 13,156 17,582 $ (2,675) 28,063
Six Months Ended
January 31, 2003:
Net sales $320,106 $265,395 -- $585,501
Earnings before income taxes 41,349 22,161 $ (4,826) 58,684
January 31, 2002:
Net sales $296,198 $256,512 -- $552,710
Earnings before income taxes 31,912 36,211 $(12,665) 55,458
Note F - Derivative Instruments and Hedging Activities
- ------
The company is exposed to changes in the fair value of its fixed-rate debt
resulting from interest rate fluctuations. To hedge this exposure, the company
entered into a fixed to variable interest rate swap on June 6, 2001. This
interest rate swap is accounted for as a fair value hedge and is recorded net of
the underlying outstanding debt. Changes in the payment of interest resulting
from the interest rate swap are recorded as an offset to interest expense. As of
January 31, 2003, the interest rate swap had a fair value of $2.7 million.
Note G - Goodwill and Other Intangible Assets
- ------
As of January 31, 2003, there have been no events or circumstances that would
indicate an impairment of the company's goodwill and other intangible asset
balances since January 31, 2002, the date of the company's initial impairment
test. Going forward, the company's annual impairment test will be performed
during the third quarter of each fiscal year. As of January 31, 2003, goodwill
was $86.6 million, a $0.2 million increase from the balance of $86.4 million at
July 31, 2002 due to foreign currency translation. There were no additions to
goodwill during the first six months of fiscal 2003.
Note H - Acquisition
- ------
During the first quarter of fiscal 2003, the company acquired the remaining 50
percent of the company's joint venture, MSCA, LCC located in Monticello, Indiana
for $1.7 million in cash, which includes $0.4 million of cash acquired. As of
January 31, 2003, the financial results for MSCA are included in the company's
consolidated results. Pro forma information is not presented due to the
immateriality of the operating results of MSCA.
7
Note I - Acquisition and Plant Restructurings
- ------
Restructuring liabilities recorded in conjunction with the July 2002 ultrafilter
acquisition were approximately $1.2 million as of July 31, 2002 for costs
associated with the termination and relocation of employees and the cancellation
of lease contracts. Costs incurred and charged to the restructuring liability
were $0.1 million and $0.7 million for the three and six months ended January
31, 2003, resulting in an ending balance in this reserve of $0.5 million as of
January 31, 2003. The integration of ultrafilter has resulted in a reduction in
the work force of approximately 100 employees during the six months ended
January 31, 2003.
The company currently has plant rationalization plans involving two of the
company's facilities, which will result in the reduction of approximately 126
employees. As of July 31, 2002, the company had a restructuring liability of
$0.7 million recorded in conjunction with plans for plant rationalization.
Additions to this reserve for the three and six months ended January 31, 2003
were $0.6 million and $0.8 million for costs associated with the termination of
employees, respectively. For the three and six months ended January 31, 2003,
costs incurred and charged to this reserve amounted to $0.1 million and $0.5
million, respectively. As of January 31, 2003, the balance of this restructuring
liability for current plant rationalization plans was $1.0 million. Costs
associated with the company's current restructuring plans are expected to be
paid by the end of fiscal 2003 when the plans are complete.
Note J - Credit Facilities
- ------
In September 2002, the company entered into a new three-year multi-currency
revolving facility with a group of banks under which the company may borrow up
to $150.0 million. The agreement provides that loans may be made under a
selection of currencies and rate formulas including Base Rate Advances or Off
Shore Rate Advances. The interest rate on each advance is based on certain
market interest rates and leverage ratios. Facility fees and other fees on the
entire loan commitment are payable over the duration of this facility.
Note K - Guarantees
- ------
The company and its partner of its unconsolidated joint venture Advanced
Filtration Systems Inc. guarantees certain debt of the joint venture. As of
January 31, 2003, the outstanding guaranteed debt of the joint venture was $5.0
million. The company does not have any other guarantees outside of this joint
venture debt, product warranties and stand-by letters of credit.
The company estimates warranty costs using standard quantitative measures based
on historical warranty claim experience and, in some cases, evaluating specific
customer warranty issues. Following is a reconciliation of warranty reserves as
of January 31, 2003 (in thousands):
Balance at August 1, 2002 $9,628
Accruals for warranties issued during the period -
Accruals related to pre-existing warranties
(including changes in estimates) 978
Less settlements made during the period (748)
---------
Balance at January 31, 2003 $9,858
=========
Also, at January 31, 2003, the company had a contingent liability for standby
letters of credit totaling $16.3 million that have been issued and are
outstanding. The letters of credit guarantee payment to beneficial third parties
in the event the company is in breach of specified contract terms as detailed in
each letter of credit. Currently, there are no amounts drawn upon these letters
of credit.
8
Note L - New Accounting Standards
- ------
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The company adopted SFAS No.
143 effective August 1, 2002. The adoption of SFAS No. 143 has not had a
material impact on the company's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses recognition,
measurement and reporting of costs associated with exit and disposal activities
including restructuring. The company adopted this standard for exit and disposal
activities initiated after August 1, 2002. The adoption of SFAS No. 146 has not
had a material impact on the company's consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amends SFAS 123, "Accounting
for Stock-Based Compensation." SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value-based method of accounting
for stock-based employee compensation. Additionally, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require more prominent and more
frequent disclosures in financial statements of the effects of stock-based
compensation under the fair value-based method. SFAS No. 148 is effective for
fiscal years ending after December 15, 2002, with interim disclosure provisions
being effective for interim periods beginning after December 15, 2002. The
company has adopted the interim disclosure provisions effective for the interim
period ending January 31, 2003 (see Note B).
In November 2002, the FASB issued FASB interpretation No. (FIN) 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN 45 requires that upon issuance of a
guarantee, a guarantor must recognize a liability for the fair value of an
obligation assumed under a guarantee. FIN 45 also requires additional
disclosures by a guarantor in its interim and annual financial statements about
the obligations associated with guarantees issued. The recognition provisions of
FIN 45 are effective for any guarantees issued or modified after December 31,
2002. The disclosure requirements are effective for the company's quarter ended
January 31, 2003. The company and its partner of its unconsolidated joint
venture Advanced Filtration Systems Inc. guarantees certain debt of the joint
venture. As of January 31, 2003, the outstanding guaranteed debt of the joint
venture was $5.0 million. The company does not have any other guarantees outside
of this joint venture debt, product warranties and stand-by letters of credit.
The company has previously established reserves for product warranties, which
are disclosed in Note K, along with a summary of standby letters of credit. The
letters of credit guarantee payment to beneficial third parties in the event the
company is in breach of specified contract terms as detailed in each letter of
credit.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities - an Interpretation of ARB No. 51." FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. The transitional disclosure provisions of FIN 46 are
effective for all financial statements issued after January 31, 2003. The
company does not have any variable interests in variable interest entities as of
January 31, 2003. The measurement provisions of FIN 46 are to be applied
immediately to any variable interest in variable interest entities created after
January 31, 2003.
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Liquidity and Capital Resources
- -------------------------------
The company generated $72.1 million of cash and cash equivalents from operations
during the first six months of fiscal 2003. Operating cash flows decreased by
$2.2 million from the same period in the prior year, resulting from a decrease
in working capital offset by an increase in net earnings compared to the prior
year. These cash flows, plus borrowings from the company's credit facility, were
used during the first six months of fiscal 2003 to support $23.4 million in
capital additions, repurchase $17.4 million of treasury stock at an average
price of $33.12 per share and for the payment of $7.4 million in dividends. The
company repurchased 122,700 shares and 526,300 shares of treasury stock for the
three and six months ended January 31, 2003, respectively. At the end of the
second quarter, the company had remaining authority to purchase 4.0 million
shares of common stock under the share repurchase program authorized by the
Board of Directors in January 2003.
At the end of the second quarter, the company held $59.1 million in cash and
cash equivalents up from $45.6 million at July 31, 2002. Short-term debt totaled
$44.9 million, down from $60.3 million at July 31, 2002. The amount of unused
lines of credit as of January 31, 2003 was approximately $157.7 million.
Long-term debt of $106.9 million at January 31, 2003 was up from $105.0 million
at July 31, 2002 and represented 20.3 percent of total long-term capital,
compared to 21.5 percent at July 31, 2002.
The following table summarizes the company's fixed cash obligations as of
January 31, 2003 (in thousands):
Payments Due by Period
Contractual Cash
Obligations Less than 1 1 - 3 4 - 5 After 5
Total year year years years
-------- -------- -------- -------- --------
Long term debt $106,923 $ 36 $ 44,836 $ 39,716 $ 22,335
Short term debt 44,938 44,938 -- --
-------- -------- -------- -------- --------
Total contractual cash
obligations $151,861 $ 44,974 $ 44,836 $ 39,716 $ 22,335
======== ======== ======== ======== ========
Also, at January 31, 2003, the company had a contingent liability for standby
letters of credit totaling $16.3 million that have been issued and are
outstanding. The letters of credit guarantee payment to beneficial third parties
in the event the company is in breach of specified contract terms as detailed in
each letter of credit. Currently, there are no amounts drawn upon these letters
of credit.
In September 2002, the company entered into a new three-year multi-currency
revolving facility with a group of banks under which the company may borrow up
to $150.0 million. The agreement provides that loans may be made under a
selection of currencies and rate formulas including Base Rate Advances or Off
Shore Rate Advances. The interest rate on each advance is based on certain
10
market interest rates and leverage ratios. Facility fees and other fees on the
entire loan commitment are payable over the duration of this facility.
International subsidiaries may borrow under various credit facilities. As of
January 31, 2003, borrowings under these facilities were $9.2 million.
The company believes that the combination of present capital resources,
internally generated funds and unused financing sources are adequate to meet
cash requirements for the next twelve-month period.
Results of Operations
- ---------------------
The company is a leading worldwide manufacturer of filtration systems and
replacement parts. The company's product mix includes air and liquid filters and
exhaust and emission control products for mobile equipment; in-plant air
cleaning systems; compressed air purification systems; air intake systems for
industrial gas turbines; and specialized filters for such diverse applications
as computer disk drives, aircraft passenger cabins and semi-conductor
processing. Products are manufactured at more than three dozen plants around the
world and through three joint ventures.
The company has two reporting segments engaged in the design, manufacture and
sale of systems to filter air and liquid and other complementary products. The
two segments are Engine Products and Industrial Products. Products in the Engine
Products segment consist of air intake systems, exhaust systems, liquid
filtration systems and replacement filters. The Engine Products segment sells to
original equipment manufacturers (OEMs) in the construction, industrial, mining,
agriculture and transportation markets and to independent distributors, OEM
dealer networks, private label accounts and large private fleets. Products in
the Industrial Products segment consist of dust, fume and mist collectors,
compressed air purification systems, static and pulse-clean air filter systems
and specialized air filtration systems for diverse applications including
computer disk drives. The Industrial Products segment sells to various
industrial end-users, OEMs of gas-fired turbines and OEMs and end-users
requiring highly purified air.
The company reported net earnings for the second quarter ended January 31, 2003
of $20.0 million, down 3.7 percent from $20.8 million recorded in the prior
year. Total net sales for the three months ended January 31, 2003 of $284.4
million were up 7.6 percent from prior year sales of $264.3 million. Diluted net
earnings per share for the second quarter were 45 cents, unchanged from the
second quarter of prior year. Productivity improvements, product cost reductions
and infrastructure improvements continued to be a focus for the company in the
second quarter of fiscal 2003. For the six month period ended January 31, 2003,
net earnings were $42.8 million, up 5.8 percent from $40.5 million in the prior
year. Total net sales for the six months ended January 31, 2003 were $585.5
million, up 5.9 percent from $552.7 in the prior year.
For the second quarter of fiscal 2003, total international sales in U.S. dollars
increased 33.7 percent from the prior year. Year-to-date, in international
sales, Europe led with an increase in sales of 52.3 percent from the prior year,
while sales in Asia-Pacific and South Africa also increased by 12.9 percent and
20.3 percent, respectively, from the prior year. Sales in Mexico posted a
decrease of 10.4 percent from the prior year.
The impact of foreign currency translation during the second quarter, led by the
strengthening of the Euro to the U.S. Dollar, increased sales by $12.7 million
and net earnings by $1.1 million. On a year-to-date basis, foreign currency
translation increased sales by $18.3 million and net earnings by $1.5 million.
Worldwide revenues, excluding the impact of foreign currency translation,
increased 2.8 percent during the second quarter and 2.6 percent year-to-date.
11
Gross margin for the second quarter of fiscal 2003 was 31.9 percent, up from
30.8 percent in the prior year, driven by the higher gross margin ultrafilter
business. Costs incurred for continuing plant rationalization came to $.02 per
share in the quarter and year-to-date. Year-to-date, gross margin improved to
31.7 percent versus 30.7 percent last year, due to ultrafilter.
Operating expenses during the second quarter of fiscal 2003 were $62.6 million,
or 22.0 percent of sales, compared to $53.0 million, or 20.0 percent of sales in
the prior year. The increase over last year is attributable to the addition of
ultrafilter, which has a relatively higher run-rate for operating expenses than
the company's other businesses. For the year, operating expenses were $125.8
million, or 21.5 percent, up from $112.2 million, or 20.3 percent in the prior
year.
Other income for the second quarter of fiscal 2003 totaled $0.7 million, a
decrease of $0.3 million from $1.0 million in the prior year. Other income for
the second quarter of fiscal 2003 consisted primarily of income from
unconsolidated affiliates of $0.4 million and interest income of $0.3 million.
For the quarter, interest expense was $1.5 million, up 27.8 percent from $1.2
million in the prior year. This increase reflects higher debt levels due to the
ultrafilter acquisition.
The income tax rate as of January 31, 2003 remained at 27.0 percent, the same as
the prior year and consistent with the income tax rate as of July 31, 2002. The
company anticipates maintaining the 27.0 percent tax rate for the forseeable
future.
Total backlog of $313 million at January 31, 2003 was down 8 percent, or $28
million, relative to the prior year, reflecting a $59 million drop in backlog
for North American gas turbine sales. Total backlog decreased 2 percent from the
prior quarter end. In the Engine Products segment, total backlog increased 12
percent from the prior year and increased 1 percent from the prior quarter end.
In the Industrial Products segment, total backlog decreased 26 percent from the
prior year and decreased 5 percent from the prior quarter end, again reflecting
the North American gas turbine downturn.
Hard order backlog - goods scheduled for delivery in 90 days - was $168 million,
down 4 percent or $7 million from the prior year. Hard order backlog increased 2
percent from the prior quarter end. In the Engine Products segment, hard order
backlog increased 10 percent from the prior year and increased 7 percent from
the prior quarter end. In the Industrial Products segment, hard order backlog
decreased 19 percent from the prior year and decreased 5 percent from the prior
quarter end.
ENGINE PRODUCTS SEGMENT For the second quarter of fiscal 2003, net sales in the
Engine Products segment of $153.1 million increased 9.6 percent from $139.7
million in the prior year. Year-to-date, net sales were $320.1 million, an
increase of 8.1 percent from $296.2 million in the prior year. Net sales for
both the quarter and year-to-date increased from the prior year in all three
product groups within the Engine Products segment.
Worldwide sales in truck products in the second quarter of fiscal 2003 were
$23.5 million, an increase of 25.1 percent from $18.8 million in the prior year.
North American heavy-duty truck sales
12
increased by 6.5 percent from the prior year as the truck market maintained its
cyclical rebound following the North American Class 8 diesel emissions prebuy.
North American light-duty diesel sales doubled over last year, reflecting
additional revenues from new PowerCore(TM) filtration programs. Internationally,
truck sales increased by 32.4 percent and were particularly strong in the
Asia-Pacific region. Year-to-date, worldwide truck product sales were $50.2
million, an increase of 24.3 percent from $40.4 million in the prior year.
Worldwide sales of off-road products in the second quarter of fiscal 2003 were
$42.6 million, an increase of 6.2 percent from $40.1 million in the prior year.
North American sales were up 2.3 percent and Asia-Pacific and Europe sales were
up 13.7 percent and 15.7 percent, respectively. Year-to-date, worldwide off-road
product sales were $90.9 million, an increase of 5.6 percent from $86.0 million
in the prior year.
Worldwide sales of aftermarket products in the second quarter of fiscal 2003
were $87.1 million, an increase of 7.8 percent from $80.8 million in the prior
year. Aftermarket sales comprised 56.9 percent of total Engine Product sales in
the quarter. Year-to-date, worldwide aftermarket product sales were $179.0
million, an increase of 5.4 percent from $169.8 million in the prior year.
Total second quarter international Engine Product sales were up 17.7 percent
compared to the same period of the prior year. International sales for all three
product groups within this segment increased over the same period from the prior
year. International sales of truck products led these increases with an increase
of 32.4 percent for the quarter, while sales in off-road and aftermarket
products increased from the prior year by 20.0 percent and 16.8 percent,
respectively. Year-to-date, total international Engine Product sales were up
15.0 percent from prior year.
Certain fiscal 2002 product sales amounts have been reclassified within the
Engine Products segment to conform to the current presentation. There is no
impact to the total Engine Products segment for fiscal 2002.
INDUSTRIAL PRODUCTS SEGMENT For the second quarter of fiscal 2003, net sales in
the Industrial Products segment of $131.3 million increased 5.4 percent from
$124.6 million in the prior year. Second quarter sales from recently acquired
ultrafilter were $27.4 million. Excluding these ultrafilter revenues, sales in
the Industrial Products segment decreased 16.6 percent to $103.9 million.
Year-to-date, net sales were $265.4 million, an increase of 3.5 percent from
$256.5 million in the prior year. Excluding ultrafilter sales of $53.4 million
for the year, year-to-date sales decreased 17.4 percent to $212.0 million from
the prior year.
Worldwide sales of gas turbine products in the second quarter of fiscal 2003
were $34.2 million, a decrease of 34.7 percent from a record $52.4 million in
the prior year. Sales declined in North America by 48.2 percent for the second
consecutive quarter as the three-year demand-bubble has ended. International
sales in gas turbine products for the quarter increased by 1.8 percent over the
prior year to $14.4 million and replacement part sales were up 20.0 percent,
softening the impact of the North American downturn. Year-to-date, worldwide gas
turbine product sales were $72.8 million, a decrease of 33.6 percent from a
record $109.7 million in the prior year.
Worldwide sales of industrial air filtration products in the second quarter of
fiscal 2003 were $43.3 million, a decrease of 1.7 percent from $44.1 million in
the prior year. North American revenue decreased 9.2 percent as market
conditions continued to be weak with no reported improvement in
13
industrial production or capacity utilization. International sales were up 8.3
percent, although business conditions are still weak in Germany. Year-to-date,
worldwide industrial air filtration product sales were $86.2 million, a decrease
of 6.7 percent from $92.3 million in the prior year.
Worldwide sales of special application products in the second quarter of fiscal
2003 were $26.4 million, a decrease of 6.2 percent from $28.1 million in the
prior year. Within special application products, disk drive filter sales were
down from the prior year, as were expanded PTFE membrane sales. Photolithography
filtration sales and aircraft cabin air filtration sales were up, driven by
increases in Europe. Year-to-date, worldwide special application product sales
were $53.0 million, a decrease of 2.8 percent from $54.6 million in the prior
year.
Worldwide sales of ultrafilter products were $27.4 million in the second quarter
of fiscal 2003 and $53.4 million year-to-date. Comparative sales from the
pre-acquisition period, not included in the company's prior year results, were
$23.3 million in the second quarter of the prior year and $45.8 million
year-to-date, representing revenue growth of 17.7 percent for the quarter and
16.7 percent year-to-date.
Total international Industrial Product sales for the second quarter were up 48.3
percent from the same period of prior year and excluding ultrafilter, were up
2.1 percent . Within this segment, international sales for the second quarter
for industrial air filtration products posted an increase of 8.3 percent from
the same period of the prior year, while international sales in gas turbine
products increased 1.8 percent. These second-quarter increases were partially
offset by a decrease in special application products of 3.2 percent during the
second quarter. Year-to-date, total international Industrial Product sales were
up 50.9 percent over the prior year.
Critical Accounting Policies
- ----------------------------
The company's consolidated financial statements are prepared in conformity with
accounting principles generally accepted in the United States of America. The
preparation of these financial statements requires the use of estimates,
judgments and assumptions 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 these
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 the recorded values of certain assets and
liabilities. The company believes its use of estimates and underlying accounting
assumptions adhere to accounting principles generally accepted in the United
States of America and are consistently applied. Valuations based on estimates
and underlying accounting assumptions are reviewed for reasonableness on a
consistent basis throughout the company. Management believes the company's
critical accounting policies that require more significant judgments and
estimates in the preparation of its consolidated financial statements are the
following:
ALLOWANCE FOR DOUBTFUL ACCOUNTS RECEIVABLE - The allowance for doubtful accounts
is estimated by management based on evaluation of potential losses related to
customer receivable balances. Estimates are developed by using standard
quantitative measures based on historical losses, adjusting for current economic
conditions and, in some cases, evaluating specific customer accounts for risk of
loss. The establishment of this reserve requires the use of judgment and
assumptions regarding the potential for losses on receivable balances. Though
management considers these balances adequate
14
and proper, changes in economic conditions in specific markets in which the
company operates could have an effect on reserve balances required.
INVENTORY - The company's inventories are valued at the lower of cost or market.
Reserves for shrink and obsolescence are estimated using standard quantitative
measures based on historical losses, including issues related to specific
inventory items. Though management considers these balances adequate and proper,
changes in economic conditions in specific markets in which the company operates
could have an effect on reserve balances required.
PRODUCT WARRANTY - The company estimates warranty costs using standard
quantitative measures based on historical warranty claim experience and, in some
cases, evaluating specific customer warranty issues. The establishment of
reserves requires the use of judgment and assumptions regarding the potential
for losses relating to warranty issues. Though management considers these
balances adequate and proper, changes in the future could impact these
determinations.
INCOME TAXES - As part of the process of preparing the company's consolidated
financial statements, management is required to estimate income taxes in each of
the jurisdictions in which the company operates. This process involves
estimating actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and book
accounting purposes. These differences result in deferred tax assets and
liabilities, which are included within the company's consolidated balance sheet.
These assets and liabilities are evaluated by using estimates of future taxable
income streams and the impact of tax planning strategies. Management assesses
the likelihood that deferred tax assets will be recovered from future taxable
income and to the extent management believes that recovery is not likely, a
valuation allowance is established. To the extent that a valuation allowance is
established or increased, an expense within the tax provision is included in the
statement of operations. Reserves are also estimated for ongoing audits
regarding federal, state and international issues that are currently unresolved.
The company routinely monitors the potential impact of such situations and
believes that it is properly reserved. Valuations related to tax accruals and
assets can be impacted by changes to tax codes, changes in statutory tax rates
and the company's future taxable income levels.
Outlook
- -------
North American heavy-duty truck build rates are expected to begin improving this
spring, and orders suggest demand for new heavy-duty trucks is growing and
should last for several quarters. New PowerCore systems for light-duty diesel
truck programs have ramped up quickly and are expected to lift truck results for
the remainder of this year. Order trends and ending backlogs indicate continued
strength in Europe and Asia. Off-road sales are expected to remain steady as
slight improvement in the agriculture market is tempered by continued weak
global construction outlook. North American aftermarket sales are expected to
begin growing as freight shipments are expected to increase in 2003, following
two years of declines. Both North American and international aftermarket order
rates have continued to improve. Overall, the company continues to expect high
single-digit revenue growth for the Engine Products segment.
The company expects industrial air filtration markets to remain stable
near-term, while last year's third quarter offers a low comparable. The outlook
for global gas turbine sales continues at 35 percent down from last year's
record $231 million. Aftermarket parts growth and more stable
15
conditions internationally are expected to soften the sharp North American
decline in the gas turbine markets. In special applications products, order
trends and backlogs continue to indicate stable conditions in the various end
markets. ultrafilter products are expecting continued revenue growth, despite
market conditions similar to the industrial air filtration markets.
The company's outlook is very similar to the one provided after the first
quarter. The company anticipates strong growth in its engine businesses,
declining gas turbine sales, and other industrial businesses either stable or
slowly improving. Against that backdrop, the company is focused on continually
improving operating efficiency through product cost reductions, manufacturing
infrastructure improvements, discretionary expense controls and completing the
integration of ultrafilter. Donaldson remains committed to delivering its 14th
consecutive year of double-digit earnings growth in 2003.
Forward-Looking Statements
- --------------------------
The company desires to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 and is making this cautionary
statement in connection with such safe harbor legislation. This Form 10-Q,
earnings releases or other press releases, the company's Annual Report to
Shareholders, any Form 10-K, 10-Q or Form 8-K of the company or any other
written or oral statements made by or on behalf of the company may include
forward-looking statements which reflect the company's current views with
respect to future events and financial performance. The words "believe,"
"expect," "anticipate," "intends," "estimate," "forecast," "plan," "project,"
"should" and similar expressions are intended to identify "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. All forecasts and projections are "forward-looking statements" and are
based on management's current expectations of the company's near-term results,
based on current information available to the company.
The company wishes to caution investors that any forward-looking statements made
by or on behalf of the company are subject to uncertainties and other factors
that could cause actual results to differ materially from such statements. These
uncertainties and other risk factors include, but are not limited to: risks
associated with currency fluctuations, commodity prices, world economic factors,
political factors, the company's substantial international operations, highly
competitive markets, changes in product demand and changes in the geographic and
product mix of sales, acquisition opportunities and integration of recent
acquisitions, facility and product line rationalization, research and
development expenditures, including ongoing information technology improvements,
and governmental laws and regulations, including diesel emissions controls. For
a more detailed explanation of the foregoing and other risks, see Exhibit 99,
which is part of the company's Form 10-K for the year ended July 31, 2002 filed
with the Securities and Exchange Commission. The company wishes to caution
investors that other factors may in the future prove to be important in
affecting the company's results of operations. New factors emerge from time to
time and it is not possible for management to predict all such factors, nor can
it assess the impact of each such factor on the business or the extent to which
any factor, or a combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statements.
Investors are further cautioned not to place undue reliance on such
forward-looking statements as they speak only to the company's views as of the
date the statement is made. 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.
16
Item 3. Quantitative and Qualitative Disclosure about Market Risk
The company's exposure to market risks for changes in interest rates
relates primarily to our short-term investments, short-term borrowings
and interest rate swap agreement. We have no earnings or cash flow
exposure due to market risks on our long-term debt obligations as a
result of the fixed-rate nature of the debt. However, interest rate
changes would affect the fair market value of the debt. At January 31,
2003, the fair value of the company's long-term debt approximates
market. Market risk for the company's debt is estimated as the
potential decrease in fair value resulting from a hypothetical one-half
percent increase in interest rates and amounts to approximately $3.0
million.
On June 6, 2001, the company entered into an interest rate swap
agreement effectively converting a portion of the company's interest
rate exposure from a fixed rate to a variable rate basis to hedge
against the risk of higher borrowing costs in a declining interest rate
environment. The company does not enter into interest rate swap
contracts for speculative or trading purposes; the differential to be
paid or received on the interest rate swap agreement is accrued and
recognized as an adjustment to interest expense as interest rates
change. The interest rate swap agreement has an aggregate notional
amount of $27.0 million maturing on July 15, 2008. The variable rate is
based on the current six-month London Interbank Offered Rates
("LIBOR"). As of January 31, 2003, the interest rate swap has a fair
value of $2.7 million, which is recorded net of the underlying debt in
the liabilities section of the balance sheet.
The company does not enter into market risk-sensitive instruments for
trading purposes to generate revenues. There have been no material
changes in the reported market risk of the company since July 31, 2002.
See further discussion of these market risks in the Donaldson Company,
Inc. Annual Report on Form 10-K for the year ended July 31, 2002.
Item 4. Controls and Procedures
(a) Disclosure Controls and Procedures: Within 90 days prior to
the date of this report (the "Evaluation Date"), we carried
out an evaluation, under the supervision and with the
participation of management, including the Chief Executive
Officer and the Chief Financial Officer, of the effectiveness
of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-14 of the Securities
Exchange Act of 1934, as amended (the "Exchange Act")). Based
upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the Evaluation Date,
our disclosure controls and procedures were adequately
designed to ensure that information required to be disclosed
by the Company in the reports that it files or submits under
the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in applicable rules
and forms.
17
(b) Internal Controls: No significant changes in the Company's
internal controls or in other factors that could significantly
affect those controls subsequent to the Evaluation Date,
including any corrective actions taken with regard to
significant deficiencies and material weaknesses, were made as
a result of the evaluation.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Index
Exhibit 99A & B - Certifications pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
(b) Reports on Form 8-K.
None
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DONALDSON COMPANY, INC.
-----------------------
(Registrant)
Date March 14, 2003 By /s/ William G. Van Dyke
------------------------- --------------------------------
William G. Van Dyke
Chairman, President and
Chief Executive Officer
Date March 14, 2003 By /s/ William M. Cook
------------------------- --------------------------------
William M. Cook
Senior Vice President,
International and
Chief Financial Officer
19
CERTIFICATIONS
I, William G. Van Dyke, Chief Executive Officer of Donaldson Company, Inc.,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Donaldson Company,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 14, 2003 /s/ William G. Van Dyke
--------------------------- ---------------------------
William G. Van Dyke
Chief Executive Officer
20
I, William M. Cook, Chief Financial Officer of Donaldson Company, Inc., certify
that:
1. I have reviewed this quarterly report on Form 10-Q of Donaldson Company,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 14, 2003 /s/ William M. Cook
--------------------------- ---------------------------
William M. Cook
Chief Financial Officer
21