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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, 2004 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
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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 - 43,295,740 shares as of January 31, 2004
- ----------------------------------------------------------------------
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Thousands of dollars, except share amounts)
(Unaudited)
Three Months Ended Six Months Ended
------------------------------- -------------------------------
January 31 January 31
------------------------------- -------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net sales $ 332,210 $ 284,447 $ 660,430 $ 585,501
Cost of sales 228,774 193,682 450,417 399,855
------------ ------------ ------------ ------------
Gross margin 103,436 90,765 210,013 185,646
Operating expenses 74,509 62,578 145,393 125,758
Gain on sale of Ome land and building (5,616) -- (5,616) --
------------ ------------ ------------ ------------
Operating income 34,543 28,187 70,236 59,888
Other income, net (1,025) (734) (1,412) (2,315)
Interest expense 1,322 1,521 2,394 3,519
------------ ------------ ------------ ------------
Earnings before income taxes 34,246 27,400 69,254 58,684
Income taxes 9,247 7,398 18,699 15,845
------------ ------------ ------------ ------------
Net earnings $ 24,999 $ 20,002 $ 50,555 $ 42,839
============ ============ ------------ ============
Weighted average shares
outstanding 44,068,458 43,514,276 44,061,113 43,669,051
Diluted shares outstanding 45,336,445 44,958,666 45,275,414 45,070,412
Basic earnings per share $ .56 $ .46 $ 1.15 $ .98
Diluted earnings per share $ .56 $ .45 $ 1.12 $ .95
Dividends paid per share $ .095 $ .085 $ .190 $ .170
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,
2004 2003
--------- ---------
ASSETS
- ------
CURRENT ASSETS
Cash and cash equivalents $ 83,195 $ 67,070
Accounts receivable 246,435 226,815
Inventories
Materials 51,648 45,088
Work in process 14,174 12,374
Finished products 65,782 57,428
--------- ---------
Total inventories 131,604 114,890
Prepaid and other current assets 37,747 45,930
--------- ---------
TOTAL CURRENT ASSETS 498,981 454,705
Property, plant and equipment, at cost 624,820 580,371
Less accumulated depreciation (355,248) (324,935)
--------- ---------
Property, plant and equipment, net 269,572 255,436
Goodwill 99,065 92,143
Intangible assets 20,272 17,188
Other assets 61,953 62,525
--------- ---------
TOTAL ASSETS $ 949,843 $ 881,997
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES
Short-term debt $ 32,544 $ 14,152
Current maturities of long-term debt 637 646
Trade accounts payable 107,699 122,759
Accrued employee compensation and related taxes 30,930 33,013
Warranty and accrued liabilities 22,787 23,597
Other current liabilities 22,244 19,909
--------- ---------
TOTAL CURRENT LIABILITIES 216,841 214,076
Long-term debt 108,692 105,156
Deferred income taxes 21,553 21,316
Other long-term liabilities 90,272 94,056
--------- ---------
TOTAL LIABILITIES 437,358 434,604
--------- ---------
SHAREHOLDERS' EQUITY
- --------------------
Preferred stock, $1 par value,
1,000,000 shares authorized, no shares issued -- --
Common stock, $5 par value, 120,000,000 shares authorized,
49,655,954 issued 248,280 248,280
Retained earnings 373,846 337,245
Deferred stock compensation 21,994 14,524
Accumulated other comprehensive income (loss) 24,375 (6,888)
Treasury stock, at cost - 6,295,037 and 6,237,469 shares at
January 31, 2004 and July 31, 2003, respectively (156,010) (145,768)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 512,485 447,393
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 949,843 $ 881,997
========= =========
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
-----------------------
2004 2003
-------- --------
OPERATING ACTIVITIES
Net earnings $ 50,555 $ 42,839
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Gain on sale of Ome land and building (5,616) --
Depreciation and amortization 20,889 17,501
Changes in operating assets and liabilities (28,143) 6,075
Other 8,333 6,717
-------- --------
Net cash provided by operating activities 46,018 73,132
-------- --------
INVESTING ACTIVITIES
Net expenditures on property and equipment (27,301) (23,382)
Acquisitions and investments in unconsolidated
affiliates, net of cash acquired (4,397) (1,259)
-------- --------
Net cash used in investing activities (31,698) (24,641)
-------- --------
FINANCING ACTIVITIES
Purchase of treasury stock (15,270) (17,432)
Proceeds from long-term debt -- 688
Repayments of long-term debt (219) (80)
Change in short-term borrowings 17,899 (22,925)
Dividends paid (8,257) (7,435)
Exercise of stock options 2,747 409
-------- --------
Net cash used in financing activities (3,100) (46,775)
-------- --------
Effect of exchange rate changes on cash 4,905 11,799
-------- --------
Increase in cash and cash equivalents 16,125 13,515
Cash and cash equivalents-beginning of year 67,070 45,586
-------- --------
Cash and cash equivalents-end of period $ 83,195 $ 59,101
======== ========
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 notes 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 six-month period ended January 31, 2004 are not
necessarily indicative of the results that may be expected for future periods.
For further information, refer to the consolidated financial statements and
notes thereto included in Donaldson Company, Inc. and Subsidiaries' Annual
Report on Form 10-K for the year ended July 31, 2003. 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 as all options have exercise prices equal to
the fair value of the stock on the date of grant. 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 (in thousands, except
per share amounts):
Three Months Ended Six Months Ended
January 31 January 31
---------------------- ----------------------
2004 2003 2004 2003
---------------------------------------------------
Net earnings, as reported $ 24,999 $ 20,002 $ 50,555 $ 42,839
Less total stock-based employee
compensation expense under the fair
value-based method, net of tax (3,755) (1,969) (4,991) (2,457)
---------------------- ----------------------
Pro forma net earnings $ 21,244 $ 18,033 $ 45,564 $ 40,382
====================== ======================
Basic net earnings per share
As reported $ 0.56 $ 0.46 $ 1.15 $ 0.98
Pro forma $ 0.47 $ 0.41 $ 1.03 $ 0.92
Diluted net earnings per share
As reported $ 0.56 $ 0.45 $ 1.12 $ 0.95
Pro forma $ 0.47 $ 0.40 $ 1.01 $ 0.90
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. Certain outstanding
options were excluded from the diluted net income per share calculations because
their exercise
5
prices were greater than the average market price of the Company's common stock
during those periods. For 2004 and 2003, 439,600 and 1,120,700 options,
respectively, were excluded from the diluted net income per share calculation.
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
----------------------------------------------
2004 2003 2004 2003
----------------------------------------------
Weighted average shares outstanding - basic 44,068 43,514 44,061 43,669
Diluted share equivalents 1,268 1,445 1,214 1,401
----------------------------------------------
Weighted average shares outstanding - diluted 45,336 44,959 45,275 45,070
==============================================
Net earnings for basic and diluted
earnings per share computation $24,999 $20,002 $50,555 $42,839
Net earnings per share - basic $ .56 $ .46 $ 1.15 $ .98
Net earnings per share - diluted $ .56 $ .45 $ 1.12 $ .95
Note D - Changes in Shareholders' Equity
In December 2003, the Company established a rabbi trust for its obligations
under its deferred compensation plans and contributed 704,865 shares of treasury
stock to the rabbi trust. As a result, obligations totaling $5.5 million were
reclassified from other long-term liabilities to retained earnings.
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
-----------------------------------------------------
2004 2003 2004 2003
-----------------------------------------------------
Net earnings $ 24,999 $ 20,002 $ 50,555 $ 42,839
Foreign currency translation adjustment 19,925 17,324 30,745 17,791
Net gain (loss) on cash flow hedging derivatives 359 (643) 518 (725)
-----------------------------------------------------
Total comprehensive income $ 45,283 $ 36,683 $ 81,818 $ 59,905
=====================================================
Total accumulated other comprehensive gain (loss) and its components at January
31, 2004 and July 31, 2003 are as follows (in thousands):
January 31, July 31,
2004 2003
-----------------------
Foreign currency translation adjustment $ 42,680 $ 11,935
Net loss on cash flow hedging derivatives 245 (273)
Additional minimum pension liability (18,550) (18,550)
-----------------------
Total accumulated other comprehensive gain (loss) $ 24,375 $ (6,888)
=======================
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, 2004:
Net sales $189,133 $143,077 -- $332,210
Earnings before income taxes 20,073 9,853 $ 4,320 34,246
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
Six Months Ended
January 31, 2004:
Net sales $380,488 $279,942 -- $660,430
Earnings before income taxes 48,366 19,852 $ 1,036 69,254
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
Note F - Interest Rate Swaps
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 two fixed to variable interest rate swaps on June 6, 2001 and March
18, 2003. These interest rate swaps are accounted for as fair value hedges and
are recorded net of the underlying outstanding debt. Changes in the payment of
interest resulting from the interest rate swaps are recorded as an offset to
interest expense. As of January 31, 2004, the interest rate swaps had a fair
value of $2.3 million, which is recorded net of underlying debt in the
liabilities section of the balance sheet.
Note G - Goodwill and Other Intangible Assets
The Company's most recent annual impairment test for goodwill and other
intangible assets was completed during the third quarter of fiscal 2003. The
results of this test showed that the fair value of the reporting units to which
the goodwill is assigned was higher than the book values of those reporting
units, resulting in no goodwill impairment. As of January 31, 2004, there have
been no events or circumstances that would indicate an impairment of the
Company's goodwill and other intangible asset balances. As of January 31, 2004,
goodwill was $99.1 million, a $7.0 million increase from the balance of $92.1
million at July 31, 2003. This increase is partially due to the acquisition of
LHA (see Note H), which added $0.6 million of goodwill in the first quarter of
fiscal 2004. The remaining increase in goodwill is due to foreign currency
translation. As of January 31, 2004, other intangible assets were $20.3 million,
a $3.1 million increase from the balance of $17.2
7
million at July 31, 2003. This increase is mainly due to the acquisition of LHA
which added $1.9 million of other intangible assets. The remaining increase in
other intangible assets is due to foreign currency translation, partially offset
by amortization.
Note H - Acquisitions
On October 10, 2003, the Company acquired the assets of the LHA industrial
hydraulic business of Berendsen Fluid Power, Inc., located in Marietta, GA, for
$4.4 million in cash. The financial results for LHA are included in the
Company's consolidated results from the date of acquisition. Pro forma
information is not presented due to the immateriality of the operating results
of LHA.
Following is a condensed balance sheet disclosing the preliminary purchase price
allocation based on estimated fair values of the assets acquired and liabilities
assumed.
(Thousands of
dollars)
Accounts receivable $ 652
Net inventory 1,441
Current assets 9
Property, plant and equipment 298
Goodwill 610
Other intangible assets 1,946
-------------------
Total assets acquired 4,956
-------------------
Accounts payable 559
-------------------
Total liabilities assumed 559
-------------------
Net assets acquired $4,397
===================
Note I - Plant Restructurings and Closures
Restructuring liabilities recorded in conjunction with the July 2002 Ultrafilter
acquisition were approximately $0.1 million as of July 31, 2003 and related
primarily to costs associated with the termination and relocation of employees
and the cancellation of lease contracts. There were no costs incurred and
charged to the restructuring liability for the six months ended January 31,
2004.
During the second quarter of fiscal 2004, the Company completed plant
rationalization plans initiated in fiscal 2003 involving certain of the
Company's facilities. As of July 31, 2003, the Company had a restructuring
liability of $1.0 million recorded in conjunction with these plans. Additions to
this reserve for the three and six months ended January 31, 2004 were $0.1
million and $0.4 million, respectively, for costs associated with the
termination of employees recorded in cost of sales. For the three and six months
ended January 31, 2004, costs incurred and charged to this reserve amounted to
$0.2 million and $1.4 million, respectively. As of January 31, 2004, there was
no restructuring liability balance.
In July 2003, the Company closed on the sale of the land and building in Ome
City, Japan. The Company received full payment of the purchase price of $10.8
million in fiscal 2003. The Company recorded a gain on the sale of $5.6 million
in the second quarter of fiscal 2004, after completion of approvals of
environmental remediation of the site, which was a condition of the sale. The
environmental remediation was completed by the Company in the first quarter of
fiscal 2004 and
8
approvals were received in the second quarter of fiscal 2004. During the first
quarter of fiscal 2004, the Company vacated and disposed of the property, plant
and equipment. Most of the costs related to the plant closing were recorded as
they were incurred in fiscal 2003 and the first half of fiscal 2004.
Note J - Guarantees
The Company and its partner of an unconsolidated joint venture, Advanced
Filtration Systems Inc., guarantee certain debt of the joint venture. As of
January 31, 2004, the outstanding guaranteed debt of the joint venture was $3.6
million. The joint venture is in compliance with all of its debt covenants and
the debt has not been called.
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, 2004 (in thousands):
Balance at July 31, 2003 $ 8,080
Accruals related to warranties (including changes in
estimates) 666
Less settlements made during the period (1,150)
-------
Balance at January 31, 2004 $ 7,596
=======
At January 31, 2004, the Company had a contingent liability for standby letters
of credit totaling $18.4 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. At January 31, 2004, there are no amounts drawn upon these letters of
credit.
Note K - Commitments and Contingencies
The Company is a defendant in a lawsuit filed in November 1998 in the United
States District Court for the Northern District of Iowa (Eastern Division) by
Engineered Products Company ("EPC"). EPC claims patent infringement by Donaldson
arising out of its sales of graduated air restriction indicators in the period
from 1996 through the expiration of the EPC patent in May 2001 and seeks
monetary damages. EPC is also seeking damages for some period of time beyond the
expiration of the patent. A trial date has been rescheduled for April 2004. The
Company denies any liability and believes the patent is unenforceable and
invalid. The Company is vigorously defending the suit. The amount of loss, if
any, to the Company currently cannot be estimated.
The Company is currently not otherwise subject to any pending litigation other
than routine litigation arising in the ordinary course of business, none of
which is expected to have a material adverse effect on the business or financial
condition of the Company.
Note L - New Accounting Standards
Effective January 12, 2004, the FASB issued FASB Staff Position No. 106-1,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003," (the Act). This statement
permits a sponsor of a postretirement health care plan that provides a
prescription drug benefit to make a one-time election to defer accounting for
the effects of the Act. The Act introduces a prescription drug benefit under
Medicare, as well as a federal subsidy to sponsors of retiree health care
benefit plans. The Company has a postretirement plan for hourly
9
employees at one plant which provides prescription drug coverage to participants
eligible for Medicare. In accordance with this Statement, any measures of the
benefit obligation or net periodic postretirement benefit cost in the financial
statements do not reflect the effects of the Act on the one plan. Specific
authoritative guidance on the accounting for the federal subsidy is pending and
that guidance, when issued, could impact the amount of obligation recorded for
the plan. The Company does not anticipate that the plan will need to be amended
in order to benefit from new legislation, nor does it anticipate that the Act
will have a material effect on the one plan.
On December 23, 2003, the FASB issued SFAS No. 132R, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." This Statement requires
additional disclosures to be made by employers regarding pensions and other
postretirement benefit plans, but does not change the measurement or recognition
of those plans. Under this Statement, the disclosure provisions regarding
foreign plans and estimated future benefit payments are effective for fiscal
years ending after June 15, 2004. All other provisions under this Statement are
effective for fiscal years ending after December 15, 2003 and interim periods
beginning after December 15, 2003. The Company will adopt the interim provisions
of this Statement beginning in the third quarter of 2004. All other provisions
of this Statement will be adopted in the fourth quarter of 2004.
On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
requires that three types of freestanding financial instruments be classified as
liabilities: mandatorily redeemable shares; instruments that do or may require
the issuer to buy back some of its shares in exchange for cash or assets; and
obligations that can be settled with shares, the value of which is fixed, tied
to a variable or varies inversely with the share price. The Statement is
effective for all financial instruments modified or entered into after May 31,
2003 and otherwise effective for interim periods beginning after December 15,
2003. The Company will adopt the Statement as required during fiscal 2004, with
no impact on the consolidated financial statements expected.
Note M - Stock Split
On January 16, 2004, the Company announced that its Board of Directors declared
a two-for-one stock split effected in the form of a 100 percent dividend. The
stock split will be distributed March 19, 2004, to shareholders of record as of
March 5, 2004. The financial statements and related notes including share and
per share information are presented before the effect of this stock dividend.
Following is a table that presents proforma earnings per share and weighted
average shares outstanding as if the stock split had occurred as of January 31,
2004.
Three Months Ended Six Months Ended
January 31 January 31
----------------------------------------------
2004 2003 2004 2003
----------------------------------------------
Proforma weighted average shares
outstanding - basic 88,137 87,029 88,122 87,338
Proforma weighted average shares
outstanding - diluted 90,673 89,917 90,551 90,141
Net earnings as reported $24,999 $20,002 $50,555 $42,839
Proforma net earnings per share - basic $ .28 $ .23 $ .57 $ .49
Proforma net earnings per share - diluted $ .28 $ .22 $ .56 $ .47
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Results of Operations
Factors contributing to the results of operations for the second quarter ended
January 31, 2004 include:
o In the Company's Engine Products segment, North American truck build
rates increased significantly during the quarter and off-road
equipment markets strengthened. In North America and Japan,
regulations at both federal and state levels continue to create strong
demand for the Company's diesel truck emission control products. The
Company's PowerCore(TM) filtration technology continued to drive sales
in its new North American diesel pickup truck business.
o Within the Company's Industrial Products segment, the Company's disk
drive filter business delivered record sales, orders and backlogs in
the second quarter as demand for computer hard drives remained at high
levels.
o Also within the Company's Industrial Products segment, gas turbine
orders in Asia grew during the quarter, and sales of small mobile
units for Iraq increased. These new sales and orders have improved the
global outlook for the Company's gas turbine sales this year.
o The Company completed the sale of its Ome, Japan facility. A pre-tax
gain of $5.6 million was recognized but was partially offset by higher
one-time costs related to the sale and the associated consolidation of
production in the Company's Gunma, Japan facility. A spike in demand
for diesel emission products during the consolidation caused an
unexpected increase in outsourced manufacturing costs and higher
logistics costs.
The Company is a 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 thirty 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
for industrial gas turbines, computer disk drive filter products and other
specialized air filtration systems. The Industrial Products segment sells to
various industrial end-users, OEMs of gas-fired turbines, OEMs and end-users
requiring highly purified air.
The Company reported record net earnings for the second quarter ended January
31, 2004 of $25.0 million, up 25.0 percent from $20.0 million recorded in the
prior year. Total net sales for the three months ended January 31, 2003 were a
record $332.2, million up 16.8 percent from prior year net sales of $284.4
million. Diluted net earnings per share for the second quarter were 56 cents, up
24.4 percent from 45 cents in the second quarter of the prior year.
11
For the six month period ended January 31, 2004, net earnings were $50.6
million, up 18.0 percent from $42.8 million in the prior year. Total net sales
for the six months ended January 31, 2004 were $660.4 million, up 12.8 percent
from $585.5 million in the prior year.
Total international sales in U.S. dollars increased 29.7 percent and 26.1
percent from the prior year for the quarter and year-to-date, respectively.
Year-to-date, in international sales, South Africa led the sales growth with an
increase in sales of 42.0 percent while the Asia-Pacific region showed increased
sales of 40.7 percent. Mexico and Europe also posted year-to-date sales
increases of 24.5 and 16.7 percent, respectively.
The impact of foreign currency translation during the second quarter, led by the
Euro, increased sales by $22.5 million and net earnings by $1.5 million.
Year-to-date, foreign currency translation increased sales by $41.1 million and
net earnings by $3.1 million. Worldwide sales, excluding the impact of foreign
currency translation, increased 8.9 percent during the quarter and 5.8 percent
for the year. Excluding the impact of foreign currency translation, second
quarter sales outside the U.S. increased 13.7 percent, primarily reflecting
strong sales growth in Asia. Year-to-date, sales outside the U.S. increased 11.3
percent.
Although net sales excluding foreign currency translation and net earnings
excluding foreign currency translation are not measures of financial performance
under GAAP, the Company believes they are useful in understanding its financial
results. Both net sales excluding foreign currency translation and net earnings
excluding foreign currency translation provide a comparable measure for
understanding the operating results of the Company's foreign entities excluding
the impact of foreign currency translation. A shortcoming of these financial
measures is that they do not reflect the Company's actual results under GAAP.
Management does not intend these items to be considered in isolation or as a
substitute for the related GAAP measures.
Following is a reconciliation to the most comparable GAAP financial measure of
this non-GAAP financial measure:
Three Months Ended Six Months Ended
January 31 January 31
2004 2003 2004 2003
-------- -------- -------- --------
Net sales, excluding foreign currency translation $309,725 $271,707 $619,330 $567,174
Foreign currency translation 22,485 12,740 41,100 18,327
-------- -------- -------- --------
Net sales $332,210 $284,447 $660,430 $585,501
======== ======== ======== ========
Net earnings, excluding foreign currency translation $ 23,502 $ 18,952 $ 47,433 $ 41,359
Foreign currency translation 1,497 1,050 3,122 1,480
-------- -------- -------- --------
Net earnings $ 24,999 $ 20,002 $ 50,555 $ 42,839
======== ======== ======== ========
Gross margin for the second quarter of fiscal 2004 was 31.1 percent, down from
31.9 percent in the prior year. Gross margin was impacted by higher
manufacturing costs in Japan as the Company managed through a volume spike for
emission products while completing the plant consolidation and by an increase in
lower margin exhaust and emission sales in the overall mix of business.
Year-to-date, gross margin improved slightly to 31.8 percent versus 31.7 percent
last year. Current plant rationalization activities were $.06 per share in the
quarter and related to the completion of the plans in Japan and Mexico. In the
prior year, plant rationalization activities cost $.02 per share on second
12
quarter earnings. Year-to-date, plant rationalization costs were $.09 per share
versus $.03 per share in the prior year.
Operating expenses during the second quarter of fiscal 2004 were $74.5 million,
or 22.4 percent of sales, up from $62.6 million, or 22.0 percent of sales in the
prior year. Year-to-date, operating expenses were $145.4 million, or 22.0
percent of sales, up from $125.8 million, or 21.5 percent of sales last year.
Operating expenses were impacted by higher costs in Japan while managing through
the plant consolidation, which negatively impacted operating expenses by 0.2
percent. A one-time increase in worker's compensation expense impacted operating
expenses by 0.2 percent. Costs associated with Sarbanes-Oxley Section 404
compliance impacted operating expenses by 0.1 percent. The gain on sale of the
Ome, Japan land and building of $5.6 million was included in operating income
during the quarter.
Other income for the second quarter of fiscal 2004 totaled $1.0 million, up from
$0.7 million in the prior year. Other income for the second quarter of fiscal
2004 consisted primarily of income from unconsolidated affiliates of $0.8
million and interest income of $0.3 million, partially offset by net other
expense of $0.1 million. For the second quarter, interest expense was $1.3
million, down 13.1 percent from $1.5 million in the prior year, reflecting lower
interest rates and debt levels from the prior year. Year-to-date other income
totaled $1.4 million, a decrease from the $2.3 million reported in the prior
year, primarily relating to the change in foreign currency. Interest expense was
$2.4 million compared to the $3.5 million reported in the prior year.
The income tax rate as of January 31, 2004 remained at 27.0 percent, the same as
the prior year and consistent with the income tax rate as of July 31, 2003.
Total backlog at January 31, 2004 was a record $380 million, up 21 percent, or
$67 million, compared to the prior year. In the Engine Products segment, total
backlog increased 33 percent from the prior year. In the Industrial Products
segment, total backlog increased 5 percent from the prior year despite a $28
million decrease in North American gas turbine.
Hard order backlog - goods scheduled for delivery in 90 days - was a record $234
million at January 31, 2004, up 39 percent or $66 million from the prior year.
In the Engine Products segment, hard order backlog increased 44 percent from the
prior year. In the Industrial Products segment, hard order backlog increased 32
percent from the prior year, on broad strength, most particularly, a sharply
improved near-turn outlook for gas turbine.
ENGINE PRODUCTS SEGMENT For the second quarter of fiscal 2004, worldwide net
sales in the Engine Products segment of $189.1 million increased 23.5 percent
from $153.1 million in the prior year. Sales in the Engine Product segment have
reported year-over-year growth for seven consecutive quarters and remain very
strong. Total second quarter international Engine Product sales were up 43.0
percent compared to the same period in the prior year. Year-to-date, worldwide
net sales were $380.5 million, an increase of 18.9 percent from $320.1 million
in the prior year. International Engine Product sales increased 37.0 percent
from the prior year on a year-to-date basis.
Worldwide sales in truck products in the second quarter of fiscal 2004 were
$38.1 million, an increase of 62.4 percent from $23.5 million in the prior year.
North American truck sales increased 26.0 percent from the prior year from
growing truck build rates, strong diesel emission sales and new PowerCoreTM
programs. International truck sales increased 160.0 percent on the continued
high demand for emissions control products in Japan. Year-to-date, worldwide
truck sales totaled $75.4
13
million, an increase of 50.2 percent from $50.2 million in the prior year.
International truck sales increased 117.3 percent from the prior year on a
year-to-date basis.
Worldwide sales of off-road products in the second quarter of fiscal 2004 were
$54.8 million, an increase of 28.6 percent from $42.6 million in the prior year.
North American sales in off-road products increased 7.6 percent on improving
construction and agriculture equipment demand. International sales were up 70.1
percent from the prior year with increases in both Asia and Europe posting
increases of over 70 percent. Year-to-date, worldwide off-road sales totaled
$105.8 million, an increase of 16.4 percent from $90.9 million in the prior
year. International off-road sales increased 35.7 percent from the prior year on
a year-to-date basis.
Worldwide sales of aftermarket products in the second quarter of fiscal 2004
were $96.3 million, an increase of 10.5 percent from $87.1 million in the prior
year. North American sales grew 8.1 percent as equipment utilization rates
improved. International sales were strong, showing growth of 13.6 percent from
the prior year with Europe and Asia-Pacific sales up 9.9 percent and 11.5
percent, respectively. For the quarter, aftermarket sales comprised 50.9 percent
of total Engine Products sales. Year-to-date, worldwide aftermarket sales
totaled $199.3 million, an increase of 11.4 percent from $179.0 million in the
prior year. International aftermarket sales increased 23.0 percent from the
prior year on a year-to-date basis.
INDUSTRIAL PRODUCTS SEGMENT For the second quarter of fiscal 2004, worldwide net
sales in the Industrial Products segment of $143.1 million increased 9.0 percent
from $131.3 million in the prior year. Total second quarter international
Industrial Product sales were up 20.0 percent compared to the same period of the
prior year. Year-to-date, worldwide net sales were $279.9 million, an increase
of 5.5 percent from $265.4 million in the prior year. International Industrial
Product sales increased 17.8 percent from the prior year on a year-to-date
basis.
Worldwide sales of gas turbine products in the second quarter of fiscal 2004
were $29.0 million, a decrease of 15.2 percent from $34.2 million in the prior
year reflecting the continued decline in that market. Sales in North America
declined by 44.9 percent while international equipment sales in gas turbine
products grew 25.4 percent in the quarter on improving Asia-Pacific sales and
additional mobile units for Iraq. Year-to-date, worldwide gas turbine sales were
$57.2 million, down 21.4 percent from $72.8 million in the prior year.
International gas turbine sales increased 14.0 percent from the prior year on a
year-to-date basis.
Worldwide sales of industrial air filtration products in the second quarter of
fiscal 2004 were $48.3 million, an increase of 11.6 percent from $43.3 million
in the prior year. North American sales increased 4.0 percent. International
sales increased 19.9 percent in the quarter over the prior year. Sales in Europe
showed an increase of 11.2 percent, primarily due to currency translation.
Asia-Pacific sales were up 36.8 percent on continued growth in China.
Year-to-date, worldwide industrial air filtration sales were $94.9 million, up
10.1 percent from $86.2 million in the prior year. International industrial air
filtration sales increased 20.7 percent from the prior year on a year-to-date
basis.
Worldwide sales of Ultrafilter products for the second quarter of fiscal 2004
were $30.1 million, up 9.9 percent from $27.4 million in the prior year. North
American sales were up 4.3 percent resulting from new market penetration.
International sales increased 10.4 percent in the quarter over the prior year
with an increase in Europe of 8.9 percent, primarily from currency translation.
Asia-Pacific sales were up by 31.6 percent also by new market penetration.
Year-to-date, worldwide ultrafilter
14
sales were $59.6 million, up 11.6 percent from $53.4 million in the prior year.
International ultrafilter sales increased 13.6 percent from the prior year on a
year-to-date basis.
Worldwide sales of special application products in the second quarter of fiscal
2004 were $35.6 million, an increase of 35.1 percent from $26.4 million in the
prior year. Disk drive sales were up 29.3 percent on strong demand for computer
hard drives. Membrane sales increased 71.3 percent on improvement in its core
industrial and fabric markets. Industrial hydraulic sales were up 49.4 percent,
driven by the LHA acquisition in the first quarter. International sales
increased 27.9 percent in the quarter over the prior year with the strongest
growth in Asia-Pacific of 39.6 million from the prior year. Year-to-date,
worldwide special application sales were $68.2 million, an increase of 28.6
percent from $53.0 million in the prior year. International special application
sales increased 22.7 percent from the prior year on a year-to-date basis.
Liquidity and Capital Resources
The Company generated $46.0 million of cash and cash equivalents from operations
during the first six months of fiscal 2004. Operating cash flows decreased by
$27.1 million from the same period in the prior year, resulting primarily from
an increase in working capital as a result of higher inventory and accounts
receivable balances compared to the prior year, partially offset by an increase
in net earnings. These cash flows, plus borrowings from the Company's credit
facility, were used during the six months of fiscal 2004 to support $27.3
million in capital additions, repurchase $15.3 million of treasury stock, for
the payment of $8.3 million in dividends and for the purchase of LHA of $4.4
million. The Company repurchased 166,500 shares and 270,000 shares of treasury
stock for the three and six months ended January 31, 2004, respectively. For the
six months ended January 31, 2004, shares of treasury stock were purchased at an
average price of $56.56. At the end of the second quarter, the Company had
remaining authority to purchase 3.5 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 $83.2 million in cash and
cash equivalents, up from $67.1 million at July 31, 2003. Short-term debt
totaled $32.5 million, up from $14.2 million at July 31, 2003. The amount of
unused lines of credit as of October 31, 2003 was approximately $153.5 million.
Long-term debt of $109.3 million at January 31, 2004 was up from $105.8 million
at July 31, 2003 and represented 17.6 percent of total long-term capital,
compared to 19.0 percent at July 31, 2003. The increase in long-term debt is
primarily due to an increase of $1.0 million in the fair market value of the
interest rate swaps (discussed in Note F in the Company's Notes to Condensed
Consolidated Financial Statements) and foreign exchange translation of $2.5
million.
The following table summarizes the Company's fixed cash obligations as of
January 31, 2004 (in thousands):
Payments Due by Period
Contractual Cash Less than 1 1 - 3 4 - 5 After 5
Obligations Total year year years years
----------------------------------------------------------------
Long term debt $109,329 $ 637 $ 48,483 $ 40,771 $ 19,438
Short term debt 32,544 32,544 -- --
----------------------------------------------------------------
Total contractual cash
obligations $141,873 $ 33,181 $ 48,483 $ 40,771 $ 19,438
================================================================
The Company and its partner of an unconsolidated joint venture, Advanced
Filtration Systems Inc., guarantees certain debt of the joint venture. As of
January 31, 2004, the outstanding guaranteed debt of the joint venture was $3.6
million.
At January 31, 2004, the Company had a contingent liability for standby letters
of credit totaling $18.4 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. At January 31, 2004, there are no amounts drawn upon these letters of
credit.
15
The Company has a three-year multi-currency revolving facility with a group of
banks under which the Company may borrow up to $150.0 million. As of January 31,
2004, borrowings under these facilities were $15.0 million.
The Company is required to meet various debt covenant tests for its debt
agreements. As of January 31, 2004, the Company is in compliance with these debt
covenants.
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.
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. There have been no changes to the
Company's critical accounting policies as disclosed in the Company's Annual
Report on Form 10-K for the year ended July 31, 2003.
Outlook
Overall, the Company expects high-teens sales growth for the Engine Products
segment in fiscal 2004. The Company expects continued growth in North American
heavy-duty truck build rates for the balance of fiscal 2004. Order rates and
backlogs for diesel emission products continue to ramp up quickly. Business
conditions remain strong in Europe and Asia. Off-road sales are expected to
remain strong in Asia and improve in North America as conditions in construction
and agriculture equipment markets have brightened. North American engine
aftermarket sales are expected to continue growing as increasing economic
activity improves equipment utilization and spurs replacements filter sales.
Both North American and international aftermarket order rates have continued to
improve. Diesel emission retrofit sales in North America are anticipated to
continue growing as the Company's technology solution gains acceptance.
Excluding gas turbine, the Company expects improving conditions for the
businesses in its Industrial Products segment to generate low double-digit sales
growth in fiscal 2004. International conditions have improved for gas turbine,
but North American volumes are expected to continue declining. Full-year sales
for gas turbine are expected to decline by an additional 15 to 20 percent from
fiscal 2003's $130 million, an improvement from prior guidance of a 30 to 35
percent decline. The Company
16
expects North American industrial air filtration markets to continue slowly
improving near-term as order trends are slightly stronger than last year's
levels. Internationally, the Company expects weak conditions in Europe to be
offset by market share gains, while business conditions in Asia are improving
rapidly. Ultrafilter is expecting recovering industrial markets and additional
market penetration to drive sales growth. Special applications products showed
continued strength in orders and backlogs for both disk drive filters and
membranes. Disk drive's backlog remains at an all-time high.
The Company expects sales to improve in the second half of fiscal 2004, and is
committed to managing this growth profitably. The Company remains focused on
delivering its 15th consecutive year of double-digit earnings growth in 2004.
Forward-Looking Statements
The Company desires to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 (the "Act") and is making this
cautionary statement in connection with such safe harbor legislation. This Form
10-Q, the Company's Annual Report to Shareholders, any Form 10-K, 10-Q or Form
8-K, earnings releases or other press releases 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 in this Form 10-Q 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 including
key disk drive filter production facilities in China, highly competitive
markets, changes in product demand and changes in the geographic and product mix
of sales, acquisition opportunities and integration of recent acquisitions,
including Ultrafilter, 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, 2003 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
17
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
There have been no material changes in the reported market risk of the
Company since July 31, 2003. See further discussion of these market
risks in the Donaldson Company, Inc. Annual Report on Form 10-K for the
year ended July 31, 2003.
Item 4. Controls and Procedures
(a) Disclosure Controls and Procedures: As of the end of the
period covered by 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.
(b) Internal Controls: No change in the Company's internal control
over financial reporting identified in connection with such
evaluation during the fiscal quarter ended January 31, 2004,
has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is a defendant in a lawsuit filed in November 1998 in the
United States District Court for the Northern District of Iowa (Eastern
Division) by Engineered Products Company ("EPC"). EPC claims patent
infringement by Donaldson arising out of its sales of graduated air
restriction indicators in the period from 1996 through the expiration
of the EPC patent in May 2001 and seeks monetary damages. EPC is also
seeking damages for some period of time beyond the expiration of the
patent. A trial date has been rescheduled for April 2004. The Company
denies any liability and believes the patent is unenforceable and
invalid. The Company is vigorously defending the suit. The amount of
loss, if any, to the Company currently cannot be estimated.
The Company is currently not otherwise subject to any pending
litigation other than routine litigation arising in the ordinary course
of business, none of which is expected
18
to have a material adverse effect on the business or financial
condition of the Company.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Index
31-A - Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31-B - Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxely Act of 2002
32 - Certifications of Chief Executive Officer and Chief
Financial Officer 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.
Current Report on Form 8-K containing the Company's earnings
release for quarter ended October 31, 2003 was furnished on
December 2, 2003.
Current Report on Form 8-K announcing that Tom VerHage will
join the Company as Vice President and Chief Financial Officer
as of March 1, 2004 was furnished on January 20, 2004.
19
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 February 27, 2004 By /s/ William M. Cook
--------------------- -----------------------------
William M. Cook
Senior Vice President,
International and
Chief Financial Officer
Date February 27, 2004 By /s/ Thomas A. Windfeldt
--------------------- -----------------------------
Thomas A. Windfeldt
Vice President and Controller
20