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 Ended October 31, 2005

or

o 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)

Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)

        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   o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes   x       No   o

        Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes   o       No   x

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 – 82,214,757 shares as of October 31, 2005

PART I.   FINANCIAL INFORMATION

DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Thousands of dollars, except share and per share amounts)
(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of dollars, except share amounts)
(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of dollars)
(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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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. Certain amounts in prior periods have been reclassified to conform to the current presentation. The reclassifications had no impact on the Company’s net earnings or shareholders’ equity as previously reported. Operating results for the three-month period ended October 31, 2005 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, 2005.

Note B – Inventories

The components of inventory as of October 31, 2005 and July 31, 2005 are as follows (thousands of dollars):

Note C – Accounting for Stock-Based Compensation

On August 1, 2005, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123R, “Share Based Payment – Revised 2004", using the modified prospective transition method. Under this method, stock-based employee compensation cost is recognized using the fair-value based method for all new awards granted after August 1, 2005. There were no stock options awarded during the first quarter of 2006. Compensation costs for unvested stock options and awards that are outstanding at August 1, 2005, will be recognized over the requisite service period based on the grant-date fair value of those options and awards as previously calculated under the pro-forma disclosures under SFAS 123. The Company determined the fair value of these awards using the Black-Scholes option pricing model using the assumptions disclosed in the Form 10-K for the year ended July 31, 2005.

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For the three months ended October 31, 2005, the Company recorded pretax compensation expense associated with stock options of $0.3 million and recorded $0.1 million of related tax benefit. Effective June 27, 2005, the Board of Directors of the Company authorized the acceleration of vesting of certain unvested and “out-of-the-money” stock options outstanding under the Company’s 2001 Master Stock Incentive Plan (the Plan). The accelerated options were granted in fiscal 2004 and fiscal 2005 with a three-year vesting period and have exercise prices per share ranging from $30.38 to $30.69. Options for the purchase of 511,242 shares of the common stock of the Company became exercisable immediately as a result of this action. As a result, the amount of pre-tax compensation expense amortized in the quarter was reduced by approximately $0.5 million from what it would have otherwise been. The first quarter expense is not indicative of the amount of future expense.

The following table summarizes stock option activity during the current quarter:

The total intrinsic value of options exercised during the quarters ended October 31, 2005 and 2004 was $1.0 million and $2.3 million, respectively.

The following table summarizes information concerning outstanding and exercisable options as of October 31, 2005:

At October 31, 2005, the aggregate intrinsic value of shares outstanding and exercisable was $68.9 million and $66.8 million, repectively.

The following table summarizes the status of non-vested shares:

As of October 31, 2005, there was $0.3 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. Of this unvested cost, $0.2 million is expected to be recognized during the remainder of fiscal 2006, and $0.1 million during fiscal 2007 and fiscal 2008. There were no shares that vested during the first quarter of 2006.

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In addition to stock options, the Company grants performance awards under the Plan. These awards are payable in common stock that are based on a formula which measures performance of the Company over a three-year period. The Company recorded pretax compensation expense for these performance awards of $0.9 million and $0.7 million for the periods ended October 31, 2005 and 2004, respectively. Total compensation cost related to nonvested performance awards not yet recognized was $3.2 million as of October 31, 2005 based on the Company’s current estimate of award achievement.

Prior to the adoption of SFAS 123R, the Company accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Boards (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. If the fair value based method prescribed in SFAS 123 had been applied in the first three months of fiscal 2005 to all stock awards, the Company’s net income and basic and diluted net income per share would have been reduced as summarized below:

Note D – 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, restricted stock and stock incentive plans. Certain outstanding options were excluded from the diluted net earnings per share calculations because their exercise prices were greater than the average market price of the Company’s common stock during those periods. For the three months ended October 31, 2005 and 2004 there were 782,642 and 1,038,040 options excluded from the diluted net earnings per share calculation, respectively.

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The following table presents information necessary to calculate basic and diluted net earnings per common share (thousands of dollars, except per share amounts):

Note E – Shareholders’ Equity

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 (thousands of dollars):

Total accumulated other comprehensive income and its components at October 31, 2005 and July 31, 2005 are as follows (thousands of dollars):

On September 3, 2004, the Company repurchased 3.0 million shares from Banc of America Securities LLC under an overnight share repurchase program. The overnight share repurchase program permitted the Company to purchase the shares immediately, while Banc of America Securities purchased the shares in the market over a six month period following the repurchase, which concluded on February 28, 2005.

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The Company repurchased 1.6 million shares for $48.1 million at an average price of $30.04 per share during the first quarter of fiscal 2006. Pursuant to the share repurchase program approved by the Board of Directors on January 17, 2003, as of October 31, 2005 the Company has remaining authorization to repurchase up to 1.1 million shares.

Note F – 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. Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments, interest income and expense and non-operating income and expenses. During the first quarter of 2006, the Company adjusted its basis of measurement for earnings before income taxes such that certain expenses, such as amortization of intangibles, which were previously considered to be Corporate and Unallocated, are now included in the Engine and Industrial Products segment results. The impact of the change in the basis of measurement resulted in approximately $4.0 million of corporate and unallocated expenses being charged to the Engine and Industrial Products segments’ earnings before income taxes in the first quarter of fiscal 2006 as compared to the first quarter of fiscal 2005. This change resulted in approximately $2.0 million of additional expense to each of the Engine and Industrial Products segments during the first quarter of fiscal 2006. This adjustment to the basis of measurement of segment earnings did not change the business components included in each of the Company’s reportable segments. Segment detail is summarized as follows (thousands of dollars):

Sales to one customer accounted for 12 percent and 10 percent of net sales for the first quarter ended October 31, 2005 and 2004, respectively. There were no customers over 10 percent of gross accounts receivable as of October 31, 2005 and 2004, respectively.

Note G – Goodwill and Other Intangible Assets

The Company’s most recent annual impairment test for goodwill was completed during the third quarter of fiscal 2005. The results of this test showed that the fair value of the reporting unit to which goodwill is assigned was higher than the book value of that reporting unit, resulting in no goodwill impairment. The Company has allocated goodwill to its Industrial Products and Engine Products segments. Following is a reconciliation of goodwill for the three months ending October 31, 2005:

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As of October 31, 2005, other intangible assets were $22.6 million, a $0.6 million decrease from the balance of $23.2 million at July 31, 2005. The decrease in other intangible assets is due to foreign currency translation and amortization.

Note H – Guarantees

The Company and its partner, Caterpillar, Inc., in an unconsolidated joint venture, Advanced Filtration Systems Inc., guarantee certain debt of the joint venture. As of October 31, 2005, the joint venture did not have any outstanding debt.

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 for the three months ended October 31, 2005 and 2004 (thousands of dollars):

At October 31, 2005, the Company had a contingent liability for standby letters of credit totaling $18.7 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 October 31, 2005, there are no amounts drawn upon these letters of credit.

Note I – Employee Benefit Plans

The Company and certain of its subsidiaries have defined benefit pension plans for substantially all hourly and salaried employees. The domestic plans include plans that provide defined benefits as well as a plan for salaried workers that provides defined benefits pursuant to a cash balance feature whereby a participant accumulates a benefit comprised of a percentage of current salary that varies with years of service, interest credits and transition credits. The international plans generally provide pension benefits based on years of service and compensation level.

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Net periodic pension costs for the Company’s pension plans include the following components (thousands of dollars):

The Company’s general funding policy for its pension plans is to make at least the minimum contributions as required by applicable regulations. Additionally, the Company may elect to make additional contributions up to the maximum deductible contribution. For the three months ended October 31, 2005, the Company has made no contributions to its U.S. pension plans. Contributions to the plans for fiscal 2006 are expected to range between $15 and $30 million.

Note J – Commitments and Contingencies

The Company was a defendant in a patent infringement lawsuit filed in November 1998 in the United States District Court for the Northern District of Iowa (Eastern Division) by Engineered Products Co. (EPC). On August 31, 2005, the U.S. Court of Appeals for the Federal Circuit issued a ruling lowering the jury verdict against the Company from $15,839,004 to $11,480,667. The court also directed the District Court to recalculate prejudgment interest (which had previously been awarded in the amount of approximately $1.1 million), attorneys’ fees (which had previously been awarded in the amount of $1,844,933), costs (which had been awarded in the amount of $132,725) and post-judgment interest for EPC in light of the Court’s revision to the damages.

The Company increased its reserves for the fourth quarter of fiscal 2005 by an additional $6.4 million to reflect the ruling of the Federal Circuit. The Company and EPC did not appeal the decision of the Federal Circuit. The parties subsequently agreed on a settlement amount for the recalculation of attorneys’ fees, expenses and interest and the case was concluded on September 30, 2005. The amount reserved in the fourth quarter of 2005 was adequate to cover the settlement reached by EPC and the Company.

The Company is not currently subject to pending litigation other than litigation which arises out of and is incidental to the conduct of the Company’s business. All such matters are subject to many uncertainties and outcomes that are not predictable with assurance. The Company does not consider any of such proceedings that are currently pending to be likely to result in a material adverse effect on the Company’s consolidated financial position or results of operation.

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Note K – Income Taxes

The income tax rate as of October 31, 2005 and 2004 was 26.7 percent and 27.0 percent, respectively. During the first quarter of fiscal 2006, the Company recorded $0.9 million benefit related to research and development tax credits as a result of filing an amended tax return related to a prior year, which resulted in the lower tax rate for the quarter.

Note L – New Accounting Standards

In December 2004, the FASB issued FASB Staff Position No. FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (FSP 109-1). FSP 109-1 concludes that the deduction should be accounted for as a special deduction in accordance with SFAS No. 109. This deduction, which is available to the Company beginning in fiscal 2006, will not have a material impact on the Company’s consolidated financial statements.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs.” This statement requires that abnormal amounts of idle facility expense, freight, handling costs and spoilage be recognized as current-period charges. This statement also requires that fixed production overhead be allocated to conversion costs based on normal capacity of the production facilities. SFAS No. 151 is effective for inventory costs incurred by the Company beginning in fiscal 2006. The adoption of this statement did not have a material impact on the Company’s consolidated financial statements for the quarter ended October 31, 2005.

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, industrial bags 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 and emissions systems, liquid filtration systems and replacement parts. 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, liquid filters and parts; static and pulse-clean air filter systems, specialized air filtration systems for diverse applications including computer disk drives and membranes and laminates. The Industrial Products segment sells to various industrial end-users, OEMs of gas-fired turbines and OEMs and end-users requiring highly purified air.

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The following discussion of the Company’s financial condition and results of operation should be read in conjunction with the Consolidated Financial Statements and Notes thereto and other financial information included elsewhere in this report.

Overview

The Company reported record diluted net earnings per share of $.37 for the first quarter of fiscal 2006, up from $.31 in the first quarter of the prior year. Net income increased 18 percent to a record $32.2 million compared to $27.4 million in the first quarter of the prior year. The Company reported record sales in the first quarter of fiscal 2006 of $403.4 million, an increase of 8.2 percent from $372.9 million in the first quarter of the prior year.

Overall, continuing strong business conditions in both of the Company’s reporting segments drove the 8.2 percent increase in net sales. The Engine Products segment experienced growth due to increased new truck build rates in North America, partially offset by lower sales in Asia due to lower diesel emission product sales. Off-road product sales increased in North America, Europe and Asia due to continued strength in new construction and mining equipment. Aftermarket sales were strong in all regions as equipment utilization rates remained high and diesel emission retrofit sales continued to ramp up in North America. Within the Industrial Products segment, business for industrial filtration solutions products and special application products remained strong and gas turbine products showed a slight increase over the prior year.

The Company continued its cost reduction efforts with its customers and selective price increases in some markets, which helped achieve an operating margin of 10.8 percent in the first quarter, a 1.1 percent improvement over the prior year. The prior year operating margin was impacted by a sharp increase in commodity prices, predominantly steel.

Results of Operations

Sales in the United States increased $17.6 million or 9.9 percent for the first quarter of fiscal 2006 compared to the first quarter of the prior year. Total international sales in U.S. dollars increased $12.9 million, or 6.6 percent in the first quarter compared to the prior year. The growth in international sales was led by Asia-Pacific, which reported increases of $6.5 million or 8.7 percent. Europe reported increases of $2.6 million or 2.4 percent. In addition, Mexico and South Africa recorded increases of $2.0 million or 39.3 percent and $0.7 million or 9.3 percent, respectively.

Foreign currency translation had a minimal impact on first quarter results. Worldwide sales for the first quarter of fiscal 2006, excluding the impact of foreign currency translation, increased 8.2 percent from the first quarter of the prior year. Excluding the impact of foreign currency translation, first quarter sales outside the United States increased 6.6 percent, primarily reflecting strong sales growth in Asia. The impact of foreign currency translation during the first quarter of fiscal 2006 increased net income by $0.2 million.

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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 measures enable the Company to obtain a more clear understanding of the operating results of its foreign entities without the varying effects that changes in foreign currency exchange rates may have on those results. 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 (thousands of dollars):

Gross margin for the first quarter of fiscal 2006 was 32.6 percent compared to 31.2 percent for the first quarter in the prior year. Higher costs for petroleum-based raw materials and freight were offset by cost reduction efforts with customers and selective price increases. The first quarter of the prior year was impacted by increases in steel prices. Plant rationalization and start-up costs totaled $1.2 million in the first quarter of fiscal 2006 compared to prior year plant rationalization costs of $0.7 million. Operating expenses during the first quarter of fiscal 2006 were $88.1 million, or 21.8 percent of sales, fairly consistent as a percentage of sales with $80.1 million, or 21.5 percent of sales in the first quarter of the prior year and in line with the Company’s expectations.

Other income for the first quarter of fiscal 2006 totaled $2.9 million, down from $3.4 million in the first quarter of the prior year. Other income for the first quarter of fiscal 2006 consisted of income from unconsolidated affiliates of $1.2 million, foreign exchange gain of $1.0 million and interest income of $0.7 million. For the first quarter of fiscal 2006, interest expense was $2.4 million, up from $2.0 million in the first quarter of the prior year as a result of higher short-term interest rates.

The income tax rate as of October 31, 2005 was 26.7 percent, slightly lower than the income tax rate of 27.0 percent for the first quarter of the prior year. During the quarter, the Company recorded $0.9 million benefit related to research and development tax credits as a result of filing an amended tax return related to a prior year, which drove the lower tax rate for the quarter. The Company expects the effective tax rate to be approximately 28 percent for the balance of the fiscal year.

Total backlog at October 31, 2005 was $432 million, up 6 percent, or $23 million, compared to the prior year. Backlog is one of many indicators of business conditions in our markets. However, it is not always indicative of future results for a number of reasons, including short lead times in our aftermarkets and the timing of receipt of orders in many of our original equipment and industrial markets. In the Engine Products segment, total backlog increased 14 percent from the prior year. In the Industrial Products segment, total backlog decreased 11 percent from the prior year.

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Operations by Segment

Following is financial information for the Company’s Engine Products and Industrial Products segments. Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments, interest income and expense and non-operating income and expenses. During the first quarter of 2006, the Company adjusted its basis of measurement for earnings before income taxes such that certain expenses, such as amortization of intangibles, which were previously considered to be Corporate and Unallocated, are now included in the Engine and Industrial Products segment results. The impact of the change in the basis of measurement resulted in approximately $4.0 million of corporate and unallocated expenses being charged to the Engine and Industrial Products segments’ earnings before income taxes in the first quarter of fiscal 2006 as compared to the first quarter of fiscal 2005. This change resulted in approximately $2.0 million of additional expense to each of the Engine and Industrial Products segments during the first quarter of fiscal 2006. This adjustment to the basis of measurement of segment earnings did not change the business components included in each of our reportable segments. Segment detail is summarized as follows (thousands of dollars):

Following are net sales by product within the Engine Products and Industrial Products segment (thousands of dollars):

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Engine Products Segment   For the first quarter of fiscal 2006, worldwide sales in the Engine Products segment continued to be strong, reporting year-over-year increases across all products within that segment. Engine Product sales were a record $238.4 million in the first quarter of fiscal 2006, an increase of 9.6 percent from $217.6 million in the first quarter of the prior year. Total first quarter Engine Product sales in the United States were up 10.1 percent compared to the same period in the prior year and international sales increased by 8.8 percent.

Worldwide sales of off-road products in the first quarter of fiscal 2006 were $70.2 million, an increase of 10.9 percent from $63.3 million in the first quarter of the prior year. North American sales in off-road products increased 7.8 percent due to continued improvement in new construction and mining equipment demand. International sales were up 14.2 percent from the first quarter of the prior year with increases in both Asia and Europe of 23.6 percent and 10.8 percent, respectively. The Company’s off-road business is strong globally and conditions remained favorable as the construction and mining end markets remain robust around the world.

Worldwide sales in transportation products in the first quarter of fiscal 2006 were $46.2 million, an increase of 5.2 percent from $43.9 million in the first quarter of the prior year. North American transportation sales increased 11.9 percent from the first quarter of the prior year from growing new truck build rates. Transportation sales in Europe increased 2.7 percent while transportation sales in Asia decreased 20.9 percent on lower diesel emission product sales in Japan.

Worldwide sales of aftermarket products in the first quarter of fiscal 2006 were $122.0 million, an increase of 10.5 percent from $110.4 million in the first quarter of the prior year. North American aftermarket sales grew 11.3 percent as equipment utilization rates remained strong and sales of diesel emission retrofit equipment in North America continued ramping up. International aftermarket sales were up 10.5 percent from the first quarter of the prior year with increases in most regions but most notably in Asia Pacific, Europe and Mexico of 16.7 percent, 7.9 percent and 25.3 percent, respectively.

Industrial Products Segment   Worldwide Industrial Products sales in the first quarter of fiscal 2006 were $165.0 million, an increase of 6.2 percent from $155.3 million in the first quarter of the prior year. Total first quarter sales in the United States were up 9.4 percent compared to the same period in the prior year while international sales of Industrial Products increased by 4.8 percent.

Worldwide sales of industrial filtration solutions products in the first quarter of fiscal 2006 were $105.9 million, an increase of 6.3 percent from $99.6 million in the first quarter of the prior year. North American sales increased 21 percent due to strong sales of industrial dust collectors. International sales increased 0.7 percent in the first quarter of fiscal 2006 over the prior year with sales in Europe and Asia showing decreases of 2.9 percent and 7.4 percent, respectively, which were more than offset by increased sales in Mexico and South Africa.

Worldwide sales of gas turbine products in the first quarter of fiscal 2006 were $24.4 million, an increase of 2.0 percent from sales of $23.9 million in the first quarter of the prior year. North American gas turbine sales declined 1.3 percent. International sales in gas turbine products grew 4.3 percent due to strengthening in the international and oil and gas markets.

Worldwide sales of special application products in the first quarter of fiscal 2006 were $34.7 million, an increase of 9.1 percent from $31.8 million in the first quarter of the prior year. Disk drive filter sales were up 23.4 percent, reflecting a continued strong market. Membrane sales decreased 18.3 percent. International sales in special application products increased 14.6 percent in the first quarter of fiscal 2006 over the prior year with increases in Asia and Europe of 16.8 percent and 1.5 percent, respectively.

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Liquidity and Capital Resources

The Company generated $30.8 million of cash and cash equivalents from operations during the first quarter of fiscal 2006. Operating cash flows decreased by $10.5 million from the same period in the prior year mainly as a result of the payment of the previously accrued EPC judgment. Operating cash flows and additional borrowings were used during the first three months of fiscal 2006 to support $13.3 million in capital additions, the repurchase of 1.6 million outstanding shares of the Company’s common stock for $48.1 million, the payment of $15.6 million in debt and the payment of $6.7 million in dividends. For additional information regarding share repurchase see Part II. Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds.”

At the end of the first quarter, the Company held $93.3 million in cash and cash equivalents, down from $134.1 million at July 31, 2005. Short-term debt totaled $86.5 million, down from $102.0 million at July 31, 2005. The amount of unused lines of credit as of October 31, 2005 was approximately $124.1 million. Long-term debt of $97.7 million at October 31, 2005 was virtually unchanged from $103.3 million at July 31, 2005 and represented 16.3 percent of total long-term capital, compared to 16.5 percent at July 31, 2005. The Company believes that it will generate sufficient cash from operations to meet its short-term debt obligations.

In fiscal 2005, the Company approved a plan to repatriate a total of $90.8 million of its accumulated foreign earnings in fiscal 2006 of which $80.0 million will be taxed under the favorable terms of the American Jobs Creation Act of 2004. The incremental tax expense related to this plan was recorded in fiscal 2005. As of October 31, 2005, cash totaling $63.6 million was repatriated to the United States pursuant to the plan.

The following table summarizes the Company’s contractual obligations as of October 31, 2005 (in thousands):

⁽¹⁾   Purchase obligations consist primarily of inventory, tooling, contract employment services and capital expenditures. The Company’s purchase orders for inventory are based on expected customer demand, and quantities and dollar volumes are subject to change.

⁽²⁾   Deferred compensation and other consists primarily of salary and bonus deferrals elected by certain executives under the Company’s deferred compensation plan. Deferred compensation balances earn interest based on a treasury bond rate as defined by the plan, and are payable at the election of the participants.

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At October 31, 2005, the Company had a contingent liability for standby letters of credit totaling $18.7 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 October 31, 2005, there are no amounts drawn upon these letters of credit.

The Company has a five-year, unsecured, multi-currency revolving facility with a group of banks under which the Company may borrow up to $150.0 million. As of October 31, 2005, borrowings under these facilities were $55.0 million. This facility expires on September 2, 2009.

Certain note agreements contain debt covenants related to working capital levels and limitations on indebtedness. Further, the Company may be restricted from paying dividends or repurchasing common stock if its tangible net worth (as defined) does not exceed certain minimum levels. As of October 31, 2005, the Company was 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.

The Company does not have any off-balance sheet arrangements, with the exception of the guarantee of 50 percent of certain debt of its joint venture, Advanced Filtration Systems, Inc. as further discussed in Note H of the Company’s Notes to Condensed Consolidated Financial Statements.

Critical Accounting Policies

There have been no material 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, 2005.

Outlook

Overall, the Company expects approximately 10 percent sales growth for the Engine Products segment in fiscal 2006. The Company expects North American heavy-duty new truck build rates throughout fiscal 2006 to remain high as truck manufacturers are near capacity. Sales in off-road products are expected to remain strong worldwide with robust conditions continuing in the production of new construction and mining equipment. Both North American and international aftermarket sales are expected to continue growing with continued strong equipment utilization, continued growth by our OEM customers of their replacement part businesses, and the growing amount of equipment with our PowerCore™ filtration systems driving replacement filter sales growth.

The Company expects high single digit sales growth in fiscal 2006 for its Industrial Products segment. Industrial filtration solutions sales growth is expected to moderate following two consecutive years of strong growth. Globally, business conditions for gas turbine products are expected to improve modestly while strength is seen in both the international and the oil and gas markets. Special applications products are expected to remain strong.

The Company began expensing stock options in the first quarter of fiscal 2006. Based on our current estimate of new grants and their expected vesting provisions, we expect our pre-tax stock compensation expense for the year to be between $3.0 and $4.0 million, with the majority of the expense occurring in the second quarter.

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Forward-Looking Statements

The Company, through its management, may make forward-looking statements reflecting the Company’s current views with respect to future events and financial performance. These forwarding-looking statements, which may be in reports filed under the Securities Exchange Act of 1934, as amended (the Exchange Act), in press releases and in other documents and materials as well as in written or oral statements made by or on behalf of the Company, are subject to certain risks and uncertainties, including those discussed below, which could cause actual results to differ materially from historical results or those anticipated. The words or phrases “will likely result,” “are expected to,” “will continue,” “estimate,” “project,” “believe,” “expect,” “anticipate,” “forecast,” and similar expressions are intended to identify forward-looking statements within the meaning of Section 21e of the Exchange Act and Section 27A of the Securities Act of 1933, as amended, as enacted by the Private Securities Litigation Reform Act of 1995 (PSLRA). In particular the Company desires to take advantage of the protections of the PSLRA in connection with the forward-looking statements made in this Quarterly Report on Form 10-Q.

Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date such statements are made. In addition, the Company wishes to advise readers that the factors listed below, as well as other factors, could affect the Company’s financial or other performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods or events in any current statement. This discussion of factors is not intended to be exhaustive, but rather to highlight important risk factors that impact results. General economic and political conditions and many other contingencies that may cause the Company’s actual results to differ from those currently anticipated are not separately discussed. 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.

Risks Associated with Currency Fluctuations   The Company maintains international operations in many countries, and the results of operations and the financial position of each of the company’s subsidiaries is reported in the relevant foreign currency and then translated into United States dollars at the applicable foreign currency exchange rate for inclusion in the Company’s consolidated financial statements. As exchange rates between these foreign currencies and the U.S. dollar fluctuate, the translation effect of such fluctuations may have an adverse effect on the Company’s results of operations or financial position as reported in U.S. dollars.

Risks Associated with International Operations   The Company has sales and/or manufacturing operations in numerous countries and regions, including China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore and other Asia-Pacific countries, Western and Eastern Europe, the Middle East, Africa, Canada, Mexico, Central America and South America. The stability, growth and profitability of this portion of the Company’s business may be affected by changes in political and military events, trade, monetary and fiscal policies and the laws and regulations of the United States and other nations. In addition, the Company’s international operations are subject to the risk of new and different political and military events, legal and regulatory requirements in local jurisdictions, tariffs and trade barriers, potential difficulties in staffing and managing local operations, credit risk of local customers and distributors, potential difficulties in protecting intellectual property and local economic, political and social conditions.

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Competition and Technology Issues   The markets in which the Company operates are highly competitive and fragmented both geographically and by application. As a result, the Company competes with numerous competitors, many of which are well established in their respective markets. The Company has, from time to time, experienced price pressures from competitors in certain product lines and geographic markets. The Company’s competitors and new entrants into the Company’s lines of business can be expected to continue to improve the design and performance of their products and to introduce new products with competitive price and performance characteristics. Although the Company believes that it has certain technological and other advantages over its competitors, realizing and maintaining these advantages will require continued productive investment by the Company in research and development, sales and marketing and customer service and support. There can be no assurance that the Company will be successful in maintaining such advantages. Successful product innovation by competitors that reach the market prior to comparable innovation by the Company or that are amenable to patent protection may adversely affect the Company’s financial performance.

A number of the Company’s major OEM customers manufacture component products for their own use. Although these OEM customers rely on outside suppliers, the OEMs could elect to manufacture additional component products for their own use and in place of the products supplied by the Company.

Risks Relating to Acquisitions   The Company has in the past and may in the future pursue acquisitions of complementary product lines, technologies or businesses. Acquisitions by the Company may result in potentially dilutive issuance’s of equity securities, the incurrence of debt and contingent liabilities and amortization expenses related to goodwill and other intangible assets, which could adversely affect the Company’s profitability. In addition, acquisitions involve numerous risks, including difficulties in the assimilation of the operations, corporate culture conflicts, assumption of unanticipated legal liabilities and the potential loss of key employees of the acquired company. There can be no assurance as to the effect of acquisitions on the Company’s business or operating results.

Environmental Matters   The Company is subject to various environmental laws and regulations in the jurisdictions in which it operates. The Company, like many of its competitors, has incurred and will continue to incur, capital and operating expenditures and other costs in complying with such laws and regulations in both the United States and abroad.

Product Demand Considerations   Demand for certain of the Company’s products tends to be cyclical, responding historically to varying levels of construction, agricultural, heavy equipment manufacturing, mining and industrial activity in the United States and in other industrialized nations.

Sales to each of Caterpillar, Inc. and its subsidiaries and General Electric and its subsidiaries have accounted for greater than 10 percent of the Company’s net sales in one or more of the last five fiscal years. An adverse change in Caterpillar’s or General Electric’s financial performance, condition or results of operations or a material reduction in sales to these customers for any other reason could negatively impact the Company’s operating results.

Availability and Cost of Product Components   The Company obtains raw material and certain manufactured components from third-party suppliers. The Company maintains limited raw material inventories, and as a result, even brief unanticipated delays in delivery or increases in prices by suppliers may adversely affect the Company’s ability to satisfy its customers on delivery and pricing and thereby affect the Company’s financial performance.

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Changes in the Mix of Products Comprising Revenue   The Company’s products constitute various product lines, which have varying profit margins. A change in the mix of products sold by the Company from that currently experienced could adversely affect the Company’s financial performance.

Other Factors   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.

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PART II.   OTHER INFORMATION

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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.

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