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, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________________ TO ________________. Commission File Number 1-7891 DONALDSON COMPANY, INC. ------------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 41-0222640 ------------------------------------------------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1400 West 94th Street Minneapolis, Minnesota 55431 ---------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (612) 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 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 -- 46,675,059 shares as of February 28, 1999 1
PART I. FINANCIAL INFORMATION Item 1. Financial Statements. CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS DONALDSON COMPANY, INC. AND SUBSIDIARIES (Thousands of Dollars Except Per Share Amounts) (Unaudited) <TABLE> <CAPTION> Three Months Ended Six Months Ended January 31 January 31 ------------------------------ ------------------------------ 1999 1998 1999 1998 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Net sales $ 220,249 $ 232,974 $ 445,680 $ 467,041 Cost of sales 157,987 167,971 321,035 333,637 ------------ ------------ ------------ ------------ Gross margin 62,262 65,003 124,645 133,404 Operating expenses 43,484 44,971 85,736 91,334 Other (income) expense (2,353) 88 (3,714) (98) Interest expense 1,761 991 3,592 1,976 ------------ ------------ ------------ ------------ Earnings before income taxes 19,370 18,953 39,031 40,192 Income taxes 6,198 6,444 12,490 13,665 ------------ ------------ ------------ ------------ Net earnings $ 13,172 $ 12,509 $ 26,541 $ 26,527 ============ ============ ============ ============ Weighted average shares outstanding - basic 47,125,314 49,593,217 47,481,330 49,528,532 Weighted average shares outstanding - diluted 47,896,535 50,697,926 48,223,003 50,594,132 Net earnings per share-basic $ .28 $ .25 $ .56 $ .54 Net earnings per share-diluted $ .27 $ .25 $ .55 $ .52 Dividends paid per share $ .06 $ .05 $ .11 $ .09 </TABLE> 2
CONDENSED CONSOLIDATED BALANCE SHEETS DONALDSON COMPANY, INC. AND SUBSIDIARIES (Thousands of Dollars) (Unaudited) <TABLE> <CAPTION> January 31 July 31 1999 1998 ---------- ---------- <S> <C> <C> ASSETS CURRENT ASSETS Cash and Cash Equivalents $ 19,818 $ 16,069 Accounts Receivable 162,713 161,914 Inventories Materials 35,277 38,346 Work in Process 12,997 14,557 Finished Products 44,560 49,114 ---------- ---------- Total Inventories 92,834 102,017 Prepaid and Other Current Assets 10,465 7,341 ---------- ---------- TOTAL CURRENT ASSETS 285,830 287,341 Property, Plant and Equipment, at Cost 418,489 391,381 Less Accumulated Depreciation (232,167) (212,514) ---------- ---------- Property, Plant and Equipment, Net 186,322 178,867 Other Assets 35,652 33,113 ---------- ---------- TOTAL ASSETS $ 507,804 $ 499,321 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Short-Term Debt $ 33,734 $ 45,491 Current Maturities of Long-Term Debt 460 405 Trade Accounts Payable 55,699 59,368 Accrued Employee Compensation & Related Taxes 21,494 26,837 Warranty and Customer Support 16,268 16,096 Other Current Liabilities 27,433 19,295 ---------- ---------- TOTAL CURRENT LIABILITIES 155,088 167,492 Long-Term Debt 75,270 50,349 Deferred Income Taxes 1,680 1,604 Other Long-Term Liabilities 24,988 24,205 SHAREHOLDERS' EQUITY Preferred Stock, $1 par value, 1,000,000 shares authorized, no shares issued -- -- Common Stock, $5 par value, 80,000,000 shares authorized, 49,655,954 issued at both dates 248,280 248,280 Additional Paid-in Capital 1,364 1,199 Retained Earnings 59,952 39,965 Accumulated Other Comprehensive Income 1,409 (5,135) Treasury Stock - 2,955,528 and 1,274,251 shares at January 31, 1999 and July 31, 1998, respectively (60,227) (28,638) ---------- ---------- TOTAL SHAREHOLDERS' EQUITY 250,778 255,671 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 507,804 $ 499,321 ========== ========== </TABLE> See Notes to Condensed Consolidated Financial Statements 3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS DONALDSON COMPANY, INC. AND SUBSIDIARIES (Thousands of Dollars) (Unaudited) <TABLE> <CAPTION> Six Months Ended January 31 1999 1998 ---------- ---------- <S> <C> <C> OPERATING ACTIVITIES Net Earnings $ 26,541 $ 26,527 Adjustments to Reconcile Net Earnings to Net Cash Provided by Operating Activities: Depreciation and Amortization 14,045 12,001 Changes in Operating Assets and Liabilities 10,811 (14,332) Other (1,785) (2,972) ---------- ---------- Net Cash Provided by Operating Activities 49,612 21,224 INVESTING ACTIVITIES Net Expenditures on Property and Equipment (17,070) (31,274) Business Acquisitions, Net of Cash Acquired (200) -- Return of Investment in Affiliate -- 1,500 Dividends From Affiliate 47 -- ---------- ---------- Net Cash Used in Investing Activities (17,223) (29,774) FINANCING ACTIVITIES Purchase of Treasury Stock (33,586) (6,149) Net Change in Debt 11,279 10,049 Dividends Paid (5,250) (4,707) Payment Received from ESOP -- 2,730 Other 1,154 157 ---------- ---------- Net Cash (Used In) Provided by Financing Activities (26,403) 2,080 Effect of Exchange Rate Changes on Cash (2,237) (1,517) ---------- ---------- Increase (Decrease) in Cash and Cash Equivalents 3,749 (7,987) Cash and Cash Equivalents-Beginning of Year 16,069 14,278 ---------- ---------- Cash and Cash Equivalents-End of Period $ 19,818 $ 6,291 ========== ========== </TABLE> 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 have been prepared in accordance with generally accepted accounting principles and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of only normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six month period ended January 31, 1999 are not necessarily indicative of the results that may be expected for the year ended July 31, 1999. For further information, refer to the consolidated financial statements and footnotes thereto included in Donaldson Company, Inc. and subsidiaries' annual report on Form 10-K for the year ended July 31, 1998. Note B - 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 common share equivalents relating to stock options, when dilutive. The following table presents information necessary to calculate basic and diluted net earnings per common share: <TABLE> <CAPTION> Three Months Ended Six Months Ended January 31 January 31 -------------------------- -------------------------- 1999 1998 1999 1998 ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Weighted average shares outstanding-Basic 47,125,314 49,593,217 47,481,330 49,528,532 Dilutive share equivalents 771,221 1,104,709 741,673 1,065,600 ----------- ----------- ----------- ----------- Weighted average shares outstanding- Diluted 47,896,535 50,697,926 48,223,003 50,594,132 =========== =========== =========== =========== Net earnings for basic and diluted earnings per share computation $13,172,000 $12,509,000 $26,541,000 $26,527,000 ----------- ----------- ----------- ----------- Net earnings per share - Basic $ .28 $ .25 $ .56 $ .54 =========== =========== =========== =========== Net earnings per share - Diluted $ .27 $ .25 $ .55 $ .52 =========== =========== =========== =========== </TABLE> 5
Note C - Comprehensive Income The Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income," which was adopted by the Company in the first quarter of fiscal 1999. Upon adoption of SFAS No. 130, the Company is reporting Accumulated Other Comprehensive Income as a separate item in the shareholders' equity section of the balance sheet and disclosing components of other comprehensive income. The adoption of this Statement has no impact on the Company's net earnings or shareholders' equity. Other comprehensive income consists solely of foreign currency translation adjustments. Prior financial statements have been restated to conform to the provisions of SFAS 130. Total comprehensive income and its components are as follows (in thousands): <TABLE> <CAPTION> Three Months Ended Six Months Ended January 31 January 31 ------------------- ------------------- 1999 1998 1999 1998 ------- ------- ------- ------- <S> <C> <C> <C> <C> Net earnings $13,172 $12,509 $26,541 $26,527 Foreign currency translation adjustment 4,013 (3,000) 6,544 (5,787) Total other comprehensive income $17,185 $ 9,509 $33,085 $20,740 </TABLE> Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. A. Financial Condition The Company generated $49.6 million of cash and cash equivalents from operations during the first six months of fiscal 1999. Operating cash flows more than doubled from the prior year period primarily due to a decrease in inventory levels compared to an increase for the same period in the prior year, as well as a decrease in accounts receivable factoring in the effects of foreign exchange translation. These cash flows plus borrowings from the Company's credit facility were used primarily to support $17.1 million in capital additions (a 45.4% decrease from prior year), repurchase $33.6 million of treasury stock, and the payment of $5.3 million in dividends during the first six months of fiscal 1999. At the end of the second quarter, the Company held $19.8 million in cash and cash equivalents. Short-term debt totaled $33.7 million, down from $45.5 million at July 31, 1998. Long-term debt of $75.3 million at January 31, 1999, represented 23.1% of total long-term capital, up from 16.5% at July 31, 1998. The Company believes that the combination of present capital resources, internally generated funds, and unused financing sources are more than adequate to meet cash requirements for 1999. 6
B. Results of Operations The Company reported net earnings for the second quarter ended January 31, 1999 of $13.2 million, up 5.3% from the $12.5 million recorded in the second quarter last year. Total net sales for the three months ended January 31, 1999 of $220.2 million were down 5.5% from prior year sales of $233.0 million. The lower sales volume is primarily due to depressed demand in the agricultural, mining and other off-road end-user markets and generally unfavorable economic conditions in those markets. Diluted net earnings per share were 27 cents, up 8.0% from prior year diluted net earnings per share of 25 cents as the average number of shares outstanding decreased 5.5% compared to the prior year period. The increase in net earnings, despite the decrease in net sales, was primarily due to a reduction in the effective income tax rate, cost reduction measures taken in general operating expenses and the favorable impact from various other income/expense items described below. For the six months ended January 31, 1999, net earnings were $26.5 million, unchanged from the six months ended in the prior year. Diluted net earnings per share were 55 cents, up 5.8% from prior year's diluted net earnings per share of 52 cents. The net earnings remained unchanged from prior year as lower gross margin was offset by a reduction in operating expenses, a reduction in the effective income tax rate and the favorable impact of various other income/expense items. Total net sales for the six months ended January 31, 1999 of $445.7 million were down 4.6% from the prior years sales of $467.0 million. Excluding the negative impact of foreign currency translation of $2.6 million, sales were down 4.0% from last year. For the quarter Engine products showed an 8.1% decrease in net sales from the same period in the prior year. The most significant factors contributing to this decrease were lower demand in the agricultural and other off-road markets and lower sales to automotive customers. Net sales for the Industrial products were essentially unchanged for the quarter from the same period in the prior year. Within the Industrial products area, the dust collection and disk drive product lines showed revenue growth, but gas turbine and other high purity product lines posted lower sales than the prior year. Disk drive gains reflect a strong disk drive market resulting in an increase in sales of disk drive products. Although gas turbine sales are lower, backlogs are significantly higher for this product line and the Company expects that net sales for gas turbine for the full year will be essentially unchanged from the prior full year. Geographically, domestic sales were down 7.0% in the second quarter, primarily attributed to weakness in end markets for Engine products. Europe posted a sales increase of about 10.0% from the prior year while our sales in Japan were about 10.0% below last year. The strength in the European market is primarily attributed to Engine products, both first-fit and aftermarket. Overall, activity in the off-road end-user markets has slowed and we anticipate revenue for the fiscal year 1999 will be at or slightly below the level of 1998. The gross margins for the second quarter of fiscal 1999 were 28.3%--about one half of one percentage points above the same quarter last year. The improvement in gross margin for the quarter reflects the positive impact of cost reduction and product improvement initiatives, 7
partially offset by the negative impact of lower production volumes. The six months figures are 28.0% and 28.6% respectively. Operating expenses during the second quarter of fiscal 1999 were $43.5 million, 19.7% of sales, compared to $45.0 million, 19.3% of sales in the same quarter of fiscal 1998. Year-to-date operating expense as a percentage of sales have decreased from 19.6% to 19.2% from the prior year period. This reduction in operating expense was due primarily to lower levels of warranty expense and lower salary compensation expense. Other income has increased $2.4 million and $3.6 million from the prior years three and six month periods ending January 31. These increases are due to lower charitable contributions, the gain on sale of surplus land in Minnesota, the sale of a product line in Hong Kong, an increase in income from the Company's joint venture activities and a general weakening of the dollar primarily in Japan in fiscal 1999. The effective income tax rate for the six month period ending January 31, 1999 was 32% compared to 34% for the same period last year due to taxes on overseas earnings. Hard order backlogs -- goods scheduled for delivery in 90 days -- of $149.1 million for the second quarter of fiscal 1999 are down 3.5% from the same period last year and up 2.5% from the prior quarter end. Relative to last year, the majority of the decline in backlog is attributed to the automotive, defense and heavy duty truck market product lines in North America. Excluding the impact of discontinued product lines and other special factors in these three businesses, backlogs are essentially unchanged from prior year. The US dollar has weakened relative to the currencies of foreign countries where the Company operates. The weakening of the dollar, primarily in Japan, has had positive effects on net income for the three and six month periods ending January 31, 1999. The impact of foreign exchange rates on net income was an increase of approximately $800,000 over the prior year six month period. Year 2000 The Company has developed plans to address the potential for business interruption related to the impact of Year 2000 on computer systems. Financial, information and operating systems (including any equipment with embedded microprocessors) have been surveyed and assessed. In most cases, identified problems have already been rectified. In the remaining cases identified problems will be addressed with repair projects with target completion dates of no later than October 1999. Progress against these plans is monitored and reported to senior management and to the Audit Committee of the Board of Directors on a regular basis. Implementation of required changes to, and testing of, critical business systems was substantially completed at the end of 1998. Changes to all other systems are expected to be complete by no later than October 1999. The Company has also surveyed its significant suppliers to assess the potential impact on operations if key third parties are not successful in converting their systems in a timely manner. A survey of all significant suppliers has been completed. Responses received to date indicate 8
that our suppliers are aware of the Year 2000 issue and are implementing all necessary changes, mostly scheduled for completion by mid-1999. A contingency plan for potentially non-compliant suppliers is now being implemented. Incremental costs (including contractor expenses and the cost of internal resources dedicated to achieving Year 2000 compliance) are charged to expense as incurred. Total costs for all relevant Year 2000 specific activity is estimated to be $5 million, of which approximately 80 percent has been spent to date. The source of funds for these costs is operating cash flow. In general, only a small percentage of our products contain microprocessors and all of our product range is now Year 2000 compliant. Our information systems (financial, purchasing, manufacturing planning, etc.) have been inventoried and detailed modification plans exist and are being executed. Our manufacturing systems are, in general, standard pieces of equipment with relatively few proprietary or unique operating systems or controls. The Company is in the process of developing and implementing a comprehensive, global contingency plan relative to potential Year 2000 disruptions. Each significant system either has been repaired and tested, or is being repaired. For systems currently being reworked, contingency plans exist to address the most reasonably likely negative scenarios. The most reasonably likely negative scenario is that modification work will not proceed on schedule, causing some increase to the total cost of achieving Year 2000 compliance although modification work will be completed for year 2000 compliance purposes. The impact on the Company's results of operations if the Company or its suppliers or customers are not fully Year 2000 compliant and the scope of resulting difficulties and related costs are not reasonably determinable. Our dependence on the performance of our employees, contractors, vendors and customers, as it relates to the Year 2000 issue, can be compared to our dependence on these groups relative to a wide range of other expectations (e.g., product quality, dependable delivery, technical support, timely payment, etc.) Euro Currency The Company has a significant number of customers located in the European Union countries participating in the conversion to a new European Currency (the "Euro Conversion"). The Company does not expect the costs of any modifications to its internal systems to have a material effect on the Company's results of operations or financial condition. The Euro Conversion may also have competitive implications for the sale of the Company's products, which could be material in nature, however, any such impact is not known at this time. There can be no assurance that unforeseen difficulties will not arise for the Company or its customers and that related costs will not thereby be incurred. Market Risk The Company's market risk includes the potential loss arising from adverse changes in foreign currency exchange rates and interest rates. The Company manages foreign currency market risk through the use of a variety of financial and derivative instruments. The Company's objective in 9
managing these risks is to reduce fluctuations in earnings and cash flows associated with changes in foreign currency exchange rates. The Company uses forward exchange contracts and other hedging activities to hedge the U.S. dollar value resulting from anticipated foreign currency transactions. The Company's market risk on interest rates is the potential increase in fair value of long-term debt resulting from a potential decrease in interest rates. There have been no material changes in the reported market risks of the Company since July 31, 1998. See further discussion of these market risks in the Donaldson Company, Inc. annual report on Form 10-K for the year ended July 31, 1998. Private Securities Litigation Reform Act of 1995 "Safe Harbor" The Company desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is making this cautionary statement in connection with such safe harbor legislation. This Form 10-Q, the Company's Annual Report to Shareholders, any Form 10-K, Form 10-Q or Form 8-K of the Company or any other written or oral statements made by or on behalf of the Company may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. The words "believe," "expect," "anticipate," "intends," "estimate," "forecast," "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 pertaining to the Company, including the risk factors noted below. 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: changing economic and political conditions in the U.S. and in other countries, changes in governmental spending and budgetary policies, governmental laws and regulations surrounding various matters such as environmental remediation, contract pricing, and international trading restrictions, customer product acceptance, continued access to capital markets, issues related to the Company's Year 2000 compliance program, and foreign currency risks (including risks associated with the introduction of the Euro currency). For a more detailed explanation of the foregoing and other risks see exhibit 99 attached hereto. 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. 10
Item 3. Quantitative and Qualitative Disclosure about Market Risk See discussion of quantitative and qualitative disclosure about market risk in "Market Risk" section of Management's Discussion and Analysis. PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security holders (a) The Annual meeting of shareholders of Registrant was held on November 20, 1998. A total of 47,587,174 shares were outstanding and entitled to vote at the meeting. (b) Not Applicable. (c) Matters Submitted and Voting Results: (i) Election of Directors: Name of Nominee Vote Tabulation For Withheld --- -------- Paul B. Burke 43,411,205 1,094,625 Kendrick B. Melrose 43,921,108 584,722 Stephen W. Sanger 43,950,942 554,888 (ii) Ratified selection of Ernst & Young LLP as Registrant's independent public auditors for the fiscal year ending July 31, 1999 with the following vote: For - 44,010,960: Against - 316,312; Abstaining - 178,558. (iii) Approved the adoption of the amendment of the Company's 1991 Master Stock Compensation Plan with the following vote: For - 41,757,594; Against - 2,082,745; Abstaining - 665,491. (d) Not Applicable. Item 6. Exhibits and Reports on Form 8-K (a) Exhibit Index 3-B Bylaws of Registrant as currently in effect 10-G Form of "Change in Control" Agreement with key employees 99 Factors Affecting Future Operating Results 11
Note: Exhibits have been furnished only to the Securities and Exchange Commission. Copies will be furnished to individuals upon request and payment of $20 representing Registrant's reasonable expense in furnishing such exhibits. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the quarter ended January 31, 1999. 12
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DONALDSON COMPANY, INC. (Registrant) Date March 17, 1999 By /s/ James R. Giertz ---------------------- ------------------- James R. Giertz Senior Vice President and Chief Financial Officer 13