Donaldson Company, Inc.

and expect this to continue through the balance of the year. That said, our pricing discipline remains critical as we are still experiencing pockets of inflation. APS in the quarter was 81 cents, an 8% increase versus prior year as gross margin improvement and favorability in other income and tax were partially offset by investments in long-term growth, including in our life sciences business. Backlogs remain strong and give us confidence in our outlook through the balance of the year. While overall supply chain conditions have improved, we are seeing some challenging areas, such as certain material shortages. That said, our customers come first, and through our global operations teams, we are continually working to improve our on-time delivery rates and work down our backlog. We are striving for optimal execution today and are also building for tomorrow through our investments in R&D and capital expenditures. As of the end of the second quarter, we remain on track to increase R&D investments by double digits this fiscal year, ensuring we remain the leader in technology-led filtration for decades to come. CapEx's quarter included investments in capacity, IT and infrastructure, as well as new products and technology, including for the support of the further commercialization of our life sciences acquisitions. Now I'll provide some detail on second quarter sales. Total company sales were $877 million, up 6% compared with prior year. Pricing was a benefit of approximately 2%. In mobile solutions, total sales were $550 million, a 5% increase versus 2023. Pricing added 3%, and volumes grew year over year. Within the mobile segment, strength in aftermarket offset declines in the first fit businesses. Aftermarket sales of $425 million were up 11% year-over-year, driven by market share gains in both the independent and OE channels and by elevated levels of global equipment utilization. In the independent channel, sales continued to be solid and increased high single digits. OE channel sales grew mid-teens. As we mentioned last quarter, we believe destocking is largely behind us. The destocking began in Q2 of last year, and we are now seeing a return to more normalized growth rates. Sales in on-road of $34 million declined 3% due to lower levels of equipment production in APAC. Off-road sales of $92 million were down 13% as weaker end-market conditions, including in agricultural markets and in China, persist. We are generating solid overall growth and strong profitability in the mobile solutions segment, despite softer first-fit performance. And I would like to highlight a few ways in which our strategic execution is driving these results. First, on the aftermarket side. We are developing and expanding our relationships with key customers in both channels. Our relationship with NAPA, which we announced in August of 2023, is a great example. Through this relationship, our heavy-duty air filtration products are being sold through NAPA's extensive U.S. network. As a reminder, Donaldson is focused on heavy-duty applications and are not targeting the light truck or car market. While we have not provided specifics on the financials around this partnership, this has been and will continue to be a meaningful driver of performance and market share gains. On the OE side, while first fit results have been impacted by weaker end market conditions, our customers value our technology and innovation. In air filtration, our power core intake filters provide high quality, compact solutions in demanding commercial applications. Our ability to meet stringent customer requirements recently yielded a significant commercial win in Europe, increasing share in this important category. In China, while the broader market remains weak, we have gained traction with our power core investments and are optimistic about our ability to gain share in the future. In liquid, we are expanding our position with our Syntec XP advanced fuel filtration technology. This is a specific area in which we see tremendous opportunity, and we are seeing growth with OEM customers, particularly in India and Japan. Across the entire mobile business, we're focused on our profitability enablers, which remain consistent with what we outlined at Investors Day last April. These include continually optimizing our footprint while efficiently managing costs, refining our supply chain while maintaining quality for our customers, optimizing prices, in other words, consistently managing the price equation, and consistently striving for operational excellence through ongoing initiatives to eliminate waste and improve performance. Now, before moving to the industrial segment, I'll take this opportunity to make a few comments about performance in China. The market continues to be very challenging. Sales were approximately flat versus 2023 and increased 3% in constant currency. Aftermarket showed particular strength in the quarter, offsetting significant declines in first fifth. It is important to note that while year-over-year performance improved this quarter, prior year's results were negatively impacted by COVID lockdowns and the inclusion of Chinese New Year a year ago. This resulted in fewer shipping days in the prior year period. Turning to the industrial solution segment. Industrial segment sales increased 7% to $263 million with our project-based products driving much of the growth. Industrial filtration solutions, or IFS, sales grew 6% to $225 million. Market share gains and supportive end market conditions continue to drive IFS sales strength. Aerospace and defense sales rose 12% to $39 million from program wins in defense. On the life sciences segment, life sciences sales were $63 million, a 6% year-over-year increase driven by a rebound in disk drive performance. As expected, sales are slowly recovering, supported by stronger data center and cloud computing demand. With the first half of fiscal 2024 behind us, I'm pleased with our performance, which reflects ongoing efforts and progress on delivering on our commitments to all of our stakeholders, including our global customers and shareholders. Given our strong year-to-date performance and our expectations for the balance of the year, we remain on track to deliver record sales, record operating margin, and record earnings in fiscal 2024. Now, I will turn it over to Scott, who will provide more details on the financials and our outlook for fiscal 24. Scott?

Thanks, Todd. Good morning, everyone. I would like to start by expressing my gratitude to our employees around the globe who once again came together and helped Donaldson deliver a strong quarter. I am continually impressed by their ongoing efforts, which are driving the company forward. I will provide color on our outlook for fiscal 2024 in a few minutes, but first we'll give additional details on the results for the second quarter. In summary, sales increased 6% versus 2023, operating income increased 3%, and EPS of 81 cents was up 8% year-over-year. Gross margin was 35.2%, a 70 basis point improvement versus prior year. Benefits from pricing combined with deflation of freight and select material costs were the largest drivers of the year-over-year increase. Operating expenses as a percent of sales were 20.4%, compared with 19.3% a year ago. Expense fee leveraging in the quarter was driven by increased people-related expenses due in part to higher headcount and approximately half of the year-over-year increase in operating expense dollars was related to the scaling of our life sciences acquisitions. Operating margin was 14.8%, 40 basis points below 2023, as the operating expense fee leveraging more than offset the gross margin increase. Now I'll discuss segment profitability. Mobile Solutions' pre-tax profit margin was 18.0%, up 300 basis points from prior year, as the segment benefited from mixed pricing and deflation of freight and select material costs. Industrial Solutions' pre-tax profit margin was 18.0%, down 80 basis points year over year, We are pleased with the ongoing strength of the industrial segment, and while margins decline versus 2023 due to a sales mix shift towards lower margin products, they remain at a high level. Life Sciences pre-tax loss was roughly $6 million, including a headwind from acquisitions of approximately $15 million. Our Life Sciences profitability targets have not material changed, and we are confident in the profitable growth potential of our acquired business Turning to a few balance sheet and cash flow statement highlights, second quarter capital expenditures were approximately $22 million. Cash conversion in the quarter was 67% versus 78% in 2023. Conversion was lower year over year to an increase in working capital, including higher receivables as a result of January sales strength. In terms of other capital employment, we returned approximately $63 million to shareholders, inclusive of $30 million in the form of dividends and $33 million in share repurchases. We ended the quarter with a net debt-to-evita ratio of 0.7 times. Now moving to our fiscal 24 outlook. First on sales, we are reiterating our full-year sales guidance of an increase between 3% and 7%, which includes pricing of approximately 2%, and a currency translation benefit of about 1%. For mobile solutions, we are forecasting a sales increase of between 1% and 5%, consistent with our previous expectations. Within mobile, we are now expecting operating sales to be down low double digits versus our previous guidance of down mid-single digits, as in-market conditions in agriculture markets and in China continue to soften. Onward sales are forecast to be flat, in line with previous expectations. Our outlook for aftermarket is unchanged at mid-single-digit growth as market share gains and elevated levels of equipment utilization continue to benefit results. In industrial solutions, sales are expected to increase between 3% and 7%, with IFS sales and aerospace and defense sales forecast to grow mid-single digits, consistent with our previous guidance. Within IFS, demand strength and market share gains in dust collection and power generation are expected to continue. Within aerospace and defense, defense sales strength and supportive overall end market conditions are forecast to drive results. In life sciences, we continue to expect sales to increase approximately 20% with a notable step up in sales in the second half of the year. We have started to see a return to growth in our disk drive business. and anticipate continued improvement. We are also anticipating sales momentum through the balance of the year in food and beverage as we expand geographically and in bioprocessing equipment and consumables with the scaling of those businesses. With respect to profitability of the segment, we expect to be approximately breakeven. On a consolidated basis, with the benefit of our first half operating performance, We are increasing total company operating margin guidance to a record level of between 15.0 and 15.4% from the previous range of between 14.7 and 15.3%. The midpoint of our guidance rate represents a 60 basis point year-over-year improvement from adjusted operating margin of 14.6% in fiscal 2023. Gross margin expansion is expected to be the driver of the improvement. With respect to gross margin, we are pleased with our performance through the first half of the year and expect our second half gross margin rate to approximate that of the first half. For the full year, higher operating expenses as a rate of sales should partially offset the gross margin increase as we continue investing for future profitable growth.

We are expecting additional benefits for the full year from non-operating items, including higher other income and a tax rate at the lower end of our previously guided range.

Overall, we are increasing our EPS guidance range to between $3.24 and $3.32, a 24% or 8% increase at the midpoint from adjusted EPS of $3.04 in fiscal 2023. In summary, we are in track to deliver higher levels of profitability on higher levels of sales to our shareholders in fiscal 2024. Now on to our balance sheet and cash flow outlook. Consistent with previous expectations, we plan to deliver cash conversion above historical averages fiscal year and with a range of between 95% and 105%. We are tightening our capital expenditure forecast to between 95 million to 110 million, from a range of 95 million to 115 million previously. Capital expenditures are weighted towards growth investments, including capacity, and new products and technologies across all three segments. In terms of strategic capital deployment, our strategy has not changed. Our first priority is to reinvest back into Donaldson either organically, as I just outlined, or inorganically through M&A, primarily in life sciences or industrial services, both areas in which our pipeline remains strong. We are also steadfast in our commitment to returning value to our shareholders through our dividends, which we have been increasing for 28 consecutive years and paying for 68 years, and also through our share repurchases. Now I'll turn the call back to Todd.

Thanks, Scott. Donaldson Company is in as strong a position as ever to remain the leader in technology-led filtration while fulfilling our purpose of advancing filtration for a cleaner world. I am confident in our ability to achieve our investor day targets. We are committed to our fiscal 2026 financial and strategic goals, including in life sciences and our 2030 ESG ambitions, And I'd like to close with some progress we've made on both fronts. First, on life sciences, and in particular, our opportunity pipeline for advanced therapies. We are presently supporting the development of over 100 therapies across the cell and gene therapy, mRNA vaccine, and traditional vaccine modalities. Most therapies are in the preclinical stage. However, we do have some that are in clinical trials and a few that will likely be entering commercial production this calendar year. Importantly, these include projects originated organically and from our universe cells, pyrologics, and isoler bioacquisitions. While the therapy development process can take over a decade, we are extremely happy with the pace at which we are building and executing our pipeline. Our technology significantly increases bioprocessing productivity and purity and is helping bring more affordable, life-changing therapies to those in need. Donaldson is creating long-term value for our stakeholders through our products and also our practices. Through our ESG strategy, we aim to have a positive impact today and create a thriving future for people and the planet. To that end, As of the end of fiscal 2023, we reduced our scope 1 and scope 2 greenhouse gas emissions by 25% from our fiscal 2021 baseline, grew our renewable energy usage by approximately 20% over the same period, And in fiscal 2023, we donated $1.2 million through the Donaldson Foundation to benefit communities with a focus on educational initiatives. We look forward to publishing our full fiscal 2023 sustainability report in the spring, which will provide additional details on our accomplishments. To close, I would like to thank all of the Donaldson employees who are critical

every day in our customer success and in building donaldson's future with that i will now turn the call back to the operator to open the line for questions at this time i would like to remind everyone in order to ask a question simply press star then the number one on your telephone keypad your first question is from the line of nathan jones with people please go ahead good morning everyone good morning nathan

I'll start off on life sciences. Obviously, there's quite a big ramp in the back half of fiscal 24. We've been expecting that for a few quarters based on the guidance and based on the ramping up of some of these acquisitions. So I'm just initially hoping to get some color on how that ramps up in the back of the year. Is it kind of a linear ramp up as we go in the back half or there's some step up in 3Q and flattened out in 4Q? And then just the contribution of the acquisitions ramping up versus rebound in the dish drive business versus expansion of the food and beverage business. Just any additional color you can give us on how you see the back half playing out.

Yeah, sure. So this is Todd. So when you really look across the whole portfolio in life sciences, everyone is contributing. They're contributing as expected as we have really planned out the full year. And that's a contribution of the acquisitions to the extent that we plan them to with a mix as well as our overall traditional-based businesses. I would tell you that to support the second-half ramp-up, that it is important that we are ramping up those businesses and they'll contribute in the second half, that our backlogs do support the second-half projections and the math that you properly call out. And additionally, the way to look at that is we have some very large projects, bioreactor-based projects out of our Solaris acquisition that go in the second half. And then it's really a myriad of different technologies that will really combine to deliver the outlook.

Okay, then I guess my follow-up is around the investments that you've made, I guess, primarily in life sciences. We're seeing some increase in SG&A as a percentage of sales. I'm just wondering about the... how that plays out going forward like are you continuing to make investments in 2025 will they kind of be ramping up at the same pace as 2024 should we start to see you know a time where we start to see some leverage on the sgna line rather than building expenses to support this growth but just how you see that playing out i guess maybe 25 and beyond yeah hi scott all right nathan this is scott um

You know, certainly we're seeing an increase in the OPEX associated with the acquisitions this year as we lap the initial completion of the acquisitions. We want to continue to deploy capital into the life sciences business. And as you know, we've got some pre-revenue companies that are beginning to scale. So, I mean, I think the trends will become less stark in the future as the business scales. We certainly are going to continue to invest in life sciences, but, you know, we reiterated Our investor day targets are operating margin today, so we still see higher levels of profitability on higher sales. So I think we're going to continue to invest. But I think over time, as the revenues start to come at a good rate, the rate of increases will slow, and our margins will mix up, and so we'll be able to deliver higher levels of profitability on higher sales.

Yeah, and I think, Nathan, just kind of building on that, I would suggest to you that the plateau of those investments is ahead of us.

Great, thanks for taking my questions.

Your next question is from the line of Angel Castillo with Morgan Stanley. Please go ahead.

Hi, this is Grace for Angel. Thank you for the question. So you lowered off-road equipment outlook from mid-second digit to low double digit. So can you help us unpack that a bit more and talk about what you're seeing in the various off-road markets you serve? Thank you.

Sure, and across that end market, as a reminder, we consider off-road to comprise construction, agriculture, and mining. Construction and mining had no change within the quarter. This is an agricultural story, and it's a broad-based story globally, and that's really why we have reduced the outlook within that category. It's well publicized across our customer base in ag. If you just continue to follow the stories that they're telling, we have done everything to bake what we know into this particular guide.

Got it. Got it. Thank you. And can you also talk about your M&A pipeline, whether we should view any incremental opportunities as more imminent?

We continue to work the M&A portion, the integrated portion of our strategy really quite well. We suggest to you that our pipeline remains strategic, robust, and we'll continue to work on it directly aligned with our strategies. And as Scott properly called out in the script, we primarily lean toward life sciences and industrial-based service acquisitions at this point.

All right, thank you.

Your next question comes from the line of Brian Blair with Oppenheimer. Please go ahead.

Thank you. Morning, everyone. Morning, Brian.

Todd, you offered quite a bit with regard to the bioprocessing pipeline and the exciting opportunities ahead. And I'm sorry if I missed this within the detail provided, but is there any way to quantify the continued ramp in You know, the opportunity set if we look forward however many years is appropriate to factor in.

You know, Brian, as you know, we follow them directly where they're at preclinical, phase one, phase two, phase three. We aren't publicizing where they are, frankly, out of contractual obligation not to do so. That portion of what we're supporting is really not our story to tell at this point. It's usually our customer-based story. We'll do everything in our power to help you understand where we are as far as quantity as we ramp our opportunity backlog, and that we feel is the best way to approach this.

Okay, understood. That's fair. And your fiscal 2QB and the guidance areas were based on margin strength, so solid execution from your team overall. I believe it was noted, please correct me if I'm wrong, the life science should be about even for the year. To level set on margin outlook, how should we think about the level of margin in mobile and industrial in the back half? and then circling back to life sciences, what's a reasonable exit rate to assume for jumping off point going into fiscal 25?

Yeah, so there's quite a bit there in the soup, Brian. But I said in the script that we expect our gross margins in the back half to be relatively flat as compared to the first half. If you think about our operating margin guidance, you know, for the year at the midpoint of 15.2, you'll see there's a bit of a ramp up in terms of operating margin in Q3 and Q4. In terms of our revenues, you know, I would say we've kind of returned to normal seasonality, kind of the 48, 52% range. If you look at the first half and then the total guidance, you know, we mentioned that we expected life sciences to be about break even. So clearly, you know, as we ramp there, you know, the profitability will improve. And then kind of for the future, I would kind of direct you back to the investor day targets for operating margin. I mean, we're still committed to, you know, achieving 16% at the midpoint, you know, from a current guidance of 15.2. So we're on a three-year journey to deliver higher levels of profitability and higher sales and, you know, going from 14.6 to 15.2 this year. with a goal of 16 after the next two years, I think is a, would be a good achievement for the company and something that we're definitely focused on.

Okay. Well understood. Appreciate the detail.

Thanks again.

Your next question is from the, your next question is from the line of Brian Drab with William Blair. Please go ahead.

Hey, good morning. This is Tyler Hooten on for Brian. Thanks for taking my questions. Just really quick, you mentioned a discussion with larger customers about pricing before. How have those discussions gone since you're still seeing some material inflation? And are those same discussions still going on with some of your new China and India customers?

Yeah, so when you look – you're right. When you look across the macro situation that we have across our raw materials and such, it's really quite mixed. We certainly have not seen that abating significantly to the point at where pricing discussions are changing. We are – we've returned back to a more normal pricing cadence. whereby we still have the need to increase pricing. This year, we have said that pricing will be an add of about 2% across the corporation. We did take pricing actions in January. Again, we're back to a more normal cadence, and the conversations really have not turned at all from just trying to deal with what's out there in the world.

I appreciate the color on that. And then my final question is just a little more broad. Obviously, artificial intelligence has been a big focus for several industries. How could applications within Donaldson's portfolio benefit from AI? And have you guys been having those discussions? And then kind of along with that, can you just kind of describe your opportunity with data center solutions? Thank you.

Sure. So we continue to obviously talk about AI within the company. There's two approaches to that. One is, as you alluded to, what would we be able to put inside our product families? And then the other one is, is there operations or process efficiencies that can we gain by using AI inside the corporations? I would say our focus is more on the internal looking one relative to process improvement inside the company using AI rather than on the product-based activities. The product-based activities will likely be more in the sense of supporting our connected-based products for quicker analysis in our industrial-based segments for performance and outcomes of those That's the way we look at it. Overall, AI is likely still early innings for us, much like so many other corporations in the industrial space will continue to invest and learn about it.

I appreciate it. I'll pass it on.

Once again, if you would like to ask a question, simply press star, then the number one on your telephone keypad. Our next question is from the line of Loris Alexander with Jefferies. Please go ahead.

Good morning. Two quick ones. Could you tease out a little bit, you know, how you're thinking about sequentially the development of the on-road market? And secondly, given how the life sciences business is evolving, how has your thinking changed, if at all, around the opportunity set for acquisition targets?

Sure, so I'll take on road 1st, I would tell you on road for us as you kind of move around the world. Us remains as we would have expected it year over year. It's comfortable. In in higher rates, we expect to kind of bounce along where it is. In Europe, we have expected on-road to be, say, a bit more guarded than the United States, probably more of a bit more of a negative outlook, but not dramatically so. And then over in Asia, obviously, we still have a lot of headwinds in China, as everyone does. And then Japan is also a bit more of a down market in the on-road sector. And so we've combined that geographical look and baked that within the guide, and that's how we see it planning going forward. As far as the life sciences acquisition piece, So we have a pretty complicated puzzle. I think we showed many pieces of that to you in the investor day deck. If you follow along in the investor day deck and kind of look where we've added technology or process type of improvements. You'll be able to see where we believe we still have gaps. We are focused on filling out that puzzle, either organically or inorganically. We do not believe we have changed anything material in approach to what we still have to buy. And we will remain active to fill out that puzzle, either organically or inorganically, and build on our life sciences segment.

Thank you.

Follow-up from the line of Nathan Jones. Please go ahead. Nathan Jones Hi, guys.

A couple of follow-ups on the mobile segment, specifically on the margins. Obviously, quarterly records are very well done there. You called out price, lower freight, and mix. It doesn't seem like any of those should change in the short term. Is there any reason why the margins at that kind of level are not sustainable in the short term? And then as a follow up to that, the pricing gains that you've made in mobile solutions were very hard fought during COVID and during the inflationary period. Is there a threat to the pricing on that as your OEM customers are starting to see volume declines, particularly in places like ag? and how you go about defending those price gains, and I'll leave it there, thanks.

First, Nathan, on your first question, relative to do we see anything short-term that's going to be changing pricing outlooks or margin outlooks, and we agree with you. There is nothing really short-term. I think it's important to understand the mixed components of all of that. However, the mixed component is very important, right, because we have – volume gains, market share gains, and we have pricing working at our backs on the replacement part business, in the independent channel particularly, and that mixes up the overall margins. And then to the other tailwind to us as far as a percentage basis, the OE business is down, particularly in ag, and when we ship less ag, obviously our margins are going up. As ag would come back whenever that market does turn, obviously we feel some margin-based pressures. But like you mentioned, we don't see that as imminent. And so in the short term, we would not expect that to change. Looking forward, though, the price gains across the OEA, Look, we're just trying to have fair relationships with our customer base. And, yes, they were long and hard-fought battles. But I think we've achieved a good end for both our customer base as well as Donaldson Company. And so far, our customers believe that, too. You know, we're not trying to maximize margins here. We're just trying to have fair relationships. And that's where, for the most part, where we sit today. And so we would expect it to be able to hold. And so the headwind we would feel is, to your first point, is more of a mix-based conversation rather than a pricing-based conversation.

Thank you.

Your next question is from the line with Baird. Please go ahead.

Hi, guys. How are you doing?

Hi. All right, cool. So just looking ahead, you mentioned these large bioreactor wins potentially shipping the second half. Does that mean that when we start thinking about the first half of next year, we shouldn't necessarily run rate revenues from this second half? And then I'll just get my second question now. Can you give a little bit more color on what specifically is pushing up R&D spend in the second half to meet the 20% growth?

Yeah, so as far as next year, you know, we're going to be a lot smarter in. When we guide next year and about gosh, maybe 70 from now they, it does make when you have large projects like we have, it makes it a bit bumpy. So we'll, we'll kind of appropriately looking forward at that time as far as the R and D spend. Um, you know, the overall is the ramping up of the of the acquisitions so that we can continue to bring those product to market, et cetera. And that's as we would have expected it. We are intentionally being aggressive in order to bring those products to market as quickly as we can. And the reason why we feel like we can do that is because at the macro, if you just step back at our company, we have just told you in the last quarter, we put up record, top line, record, bottom line, and we're aggressively investing for tomorrow and building out a new leg to our corporation. And so consequently, strategically, we're very proud of what we're accomplishing. And what you're calling out in the R&D spin for life sciences, we feel is building a stronger company for our shareholders and for our future.

Got it. Thank you.

At this time, there are no further questions. I will now turn the call over to Bob Carpenter for closing remarks.

That concludes the call today. Thanks to everyone who participated. And I look forward to reporting our third quarter fiscal 2024 results in June. Have a great day. Goodbye.

This includes the Dalton Company second quarter 2024 earnings call. Thank you for your participation.