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 October 31, 2002 OR
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________.
Commission File Number 1-7891
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DONALDSON COMPANY, INC.
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(Exact name of registrant as specified in its charter)
Delaware 41-0222640
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1400 West 94th Street
Minneapolis, Minnesota 55431
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(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code (952) 887-3131
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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 - 43,527,955 shares as of November 30, 2002
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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)
Three Months Ended
October 31
-----------------------------
2002 2001
------------ ------------
Net sales $ 301,054 $ 288,429
Cost of sales 206,173 200,111
------------ ------------
Gross margin 94,881 88,318
Operating expenses 63,180 59,270
------------ ------------
Operating income 31,701 29,048
Other (income) expense (1,581) (731)
Interest expense 1,998 2,384
------------ ------------
Earnings before income taxes 31,284 27,395
Income taxes 8,447 7,671
------------ ------------
Net earnings $ 22,837 $ 19,724
============ ============
Weighted average shares
outstanding 43,823,839 44,252,026
Diluted shares outstanding 45,324,846 45,502,725
Basic earnings per share $ .52 $ .45
Diluted earnings per share $ .50 $ .43
Dividends paid per share $ .085 $ .075
See Notes to Condensed Consolidated Financial Statements.
2
DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of dollars, except per share amounts)
(Unaudited)
October 31, July 31,
2002 2002
--------- ---------
ASSETS
------
CURRENT ASSETS
Cash and cash equivalents $ 58,052 $ 45,586
Accounts receivable 221,956 251,417
Inventories
Materials 45,865 49,162
Work in process 15,670 16,796
Finished products 48,263 51,733
--------- ---------
Total inventories 109,798 117,691
Prepaid and other current assets 38,777 41,790
--------- ---------
TOTAL CURRENT ASSETS 428,583 456,484
Property, plant and equipment, at cost 559,433 552,724
Less accumulated depreciation (314,638) (311,811)
--------- ---------
Property, plant and equipment, net 244,795 240,913
Goodwill and other intangible assets 104,158 103,681
Other assets 49,461 49,053
--------- ---------
TOTAL ASSETS $ 826,997 $ 850,131
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Short-term debt $ 51,463 $ 60,337
Current maturities of long-term debt 57 57
Trade accounts payable 98,943 115,299
Accrued employee compensation and related taxes 30,726 31,171
Warranty and accrued liabilities 25,868 31,542
Other current liabilities 32,821 34,384
--------- ---------
TOTAL CURRENT LIABILITIES 239,878 272,790
Long-term debt 106,680 105,019
Deferred income taxes 13,707 13,376
Other long-term liabilities 76,431 76,325
--------- ---------
TOTAL LIABILITIES 436,696 467,510
--------- ---------
SHAREHOLDERS' EQUITY
--------------------
Preferred stock, $1 par value,
1,000,000 shares authorized, no shares issued -- --
Common stock, $5 par value, 80,000,000 shares
authorized, 49,655,954 issued 248,280 248,280
Retained earnings 293,999 274,395
Accumulated other comprehensive loss (13,911) (14,296)
Treasury stock - 6,107,081 and 5,741,417 shares at
October 31, 2002 and July 31, 2002, respectively (138,067) (125,758)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 390,301 382,621
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 826,997 $ 850,131
========= =========
See Notes to Condensed Consolidated Financial Statements.
3
DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of dollars)
(Unaudited)
Three Months Ended
October 31
---------------------
2002 2001
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OPERATING ACTIVITIES
Net earnings $ 22,837 $ 19,724
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation and amortization 7,672 7,921
Changes in operating assets and liabilities 17,813 17,667
Other (157) (1,375)
-------- --------
Net cash provided by operating activities 48,165 43,937
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INVESTING ACTIVITIES
Net expenditures on property and equipment (9,537) (10,954)
Acquisitions and investments in unconsolidated
affiliates, net of cash acquired (1,259) --
-------- --------
Net cash used in investing activities (10,796) (10,954)
-------- --------
FINANCING ACTIVITIES
Purchase of treasury stock (13,144) (8,358)
Increase in long-term debt 2,574 1,761
Decrease in long-term debt (523) --
Change in short-term debt (16,206) (1,323)
Dividends paid (3,733) (3,329)
Other 301 266
-------- --------
Net cash used in financing activities (30,730) (10,983)
-------- --------
Effect of exchange rate changes on cash 5,827 (606)
-------- --------
Increase in cash and cash equivalents 12,466 21,394
Cash and cash equivalents-beginning of year 45,586 36,136
-------- --------
Cash and cash equivalents-end of period $ 58,052 $ 57,530
======== ========
See Notes to Condensed Consolidated Financial Statements.
4
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note A - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Donaldson Company, Inc. (the company) have been prepared in accordance with
accounting principles generally accepted in the United States of America and the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required for complete financial
statements. In the opinion of management, all adjustments considered necessary
for a fair presentation have been included and are of a normal recurring nature.
Operating results for the three month period ended October 31, 2002 are not
necessarily indicative of the results that may be expected for future periods.
For further information, refer to the consolidated financial statements and
footnotes thereto included in Donaldson Company, Inc. and Subsidiaries' Annual
Report on Form 10-K for the year ended July 31, 2002. Certain amounts in prior
periods have been reclassified to conform to the current presentation. The
reclassifications had no impact on the net earnings as previously reported.
Note B - 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.
The following table presents information necessary to calculate basic and
diluted net earnings per common share (in thousands, except per share amounts):
Three Months Ended
October 31
------------------
2002 2001
------- -------
Weighted average shares outstanding - basic 43,824 44,252
Diluted share equivalents 1,501 1,251
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Weighted average shares outstanding - diluted 45,325 45,503
======= =======
Net earnings for basic and diluted
earnings per share computation $22,837 $19,724
------- -------
Net earnings per share - basic $ .52 $ .45
======= =======
Net earnings per share - diluted $ .50 $ .43
======= =======
5
Note C - Comprehensive Income
The company reports accumulated other comprehensive income as a separate item in
the shareholders' equity section of the balance sheet. Other comprehensive
income consists of foreign currency translation adjustments and net gains or
losses on cash flow hedging derivatives. Total comprehensive income and its
components are as follows (in thousands):
Three Months Ended
October 31
---------------------
2002 2001
-------- --------
Net earnings $ 22,837 $ 19,724
Foreign currency translation adjustment 467 3,003
Net gain (loss) on cash flow hedging derivatives (82) (269)
-------- --------
Total other comprehensive income $ 23,222 $ 22,458
======== ========
Total accumulated other comprehensive loss and its components are as follows (in
thousands):
October 31, July 31,
2002 2002
-------- --------
Foreign currency translation adjustment $(10,258) $(10,725)
Net gain (loss) on cash flow hedging derivatives (56) 26
Additional minimum pension liability (3,597) (3,597)
-------- --------
Total accumulated other comprehensive loss $(13,911) $(14,296)
======== ========
Note D - Segment Reporting
The company has two reportable segments, Engine Products and Industrial
Products, that have been identified based on the internal organization
structure, management of operations and performance evaluation. Segment detail
is summarized as follows (in thousands):
Engine Industrial Corporate & Total
Products Products Unallocated Company
-------- -------- -------- --------
Three Months Ended
October 31, 2002:
Net sales $166,958 $134,096 -- $301,054
Earnings before income taxes 24,120 10,281 $ (3,117) 31,284
October 31, 2001:
Net sales $156,505 $131,924 -- $288,429
Earnings before income taxes 18,756 18,629 $ (9,990) 27,395
Note E - Derivative Instruments and Hedging Activities
The company is exposed to changes in the fair value of its fixed-rate debt
resulting from interest rate fluctuations. To hedge this exposure, the company
entered into a fixed to variable interest rate swap on June 6, 2001. This
interest rate swap is accounted for as a fair value hedge and is recorded net of
the underlying outstanding debt. Changes in the payment of interest resulting
from the interest rate
6
swap are recorded as an offset to interest expense. As of October 31, 2002, the
interest rate swap had a fair value of $3.1 million.
Note F - Goodwill and Other Intangible Assets
The company's most recent annual impairment test for goodwill and other
intangible assets was completed during the quarter ended January 31, 2002. The
results of this test showed that the fair market value of the reporting units
that the goodwill is assigned to was higher than the book values of those
reporting units, resulting in no goodwill impairment. As of October 31, 2002,
there have been no events or circumstances that would indicate an impairment of
the company's goodwill and other intangible asset balances since January 31,
2002. As of October 31, 2002, goodwill was $86.5 million, a $0.1 million
increase from the balance of $86.4 million at July 31, 2002 due to foreign
currency translation. There were no additions to goodwill during the first three
months of fiscal 2003.
Note G - Acquisitions
The company completed the purchase of all of the outstanding shares of
ultrafilter international AG ("ultrafilter") for $68.3 million in cash on July
12, 2002. Ultrafilter is headquartered in Haan, Germany, with operations in 30
countries. Ultrafilter is a global leader in the design and manufacture of
components, replacement parts and complete systems for the compressed air
purification industry. Its products include compressed air filters and a wide
assortment of replacement filters, a complete offering of refrigeration and
desiccant dryers and condensate management devices. The company completed a
preliminary purchase price allocation as of July 31, 2002 resulting in an excess
of purchase price over the fair values of the net assets acquired of $28.1
million. The company is still in the process of evaluating the assets acquired
and liabilities assumed and thus has not yet finalized the allocation of the
purchase price. Ultrafilter's operations are a part of the company's Industrial
Products segment. Restructuring liabilities recorded in conjunction with the
acquisition were approximately $1.2 million as of July 31, 2002 for costs
associated with the termination and relocation of employees and the cancellation
of lease contracts. Costs incurred and charged to the restructuring liability
were $0.6 million for the three months ended October 31, 2002, resulting in an
ending balance in this reserve of $0.6 million as of October 31, 2002. The
integration of ultrafilter has resulted in a reduction in the work force of
approximately 60 employees during the three months ended October 31, 2002.
During the first quarter of fiscal 2003, the company acquired the remaining 50
percent of the company's joint venture, MSCA, LLC located in Monticello, Indiana
for $1.7 million in cash. This additional investment brought the company's total
ownership to 100 percent. As of October 31, 2002, the financial results for MSCA
are included in the company's consolidated results.
Note H - Credit Facilities
In September 2002, the company entered into a new three year multi-currency
revolving facility with a group of banks under which the company may borrow up
to $150.0 million. The agreement provides that loans may be made under a
selection of currencies and rate formulas including Base Rate Advances or Off
Shore Rate Advances. The interest rate on each advance is based on certain
leverage ratios. Facility fees and other fees on the entire loan commitment are
payable over the duration of this facility.
7
Note I - New Accounting Standards
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses recognition,
measurement and reporting of costs associated with exit and disposal activities
including restructuring. The company adopted this standard for exit and disposal
activities initiated after August 1, 2002.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Liquidity and Capital Resources
The company generated $48.2 million of cash and cash equivalents from operations
during the first quarter of fiscal 2003. Operating cash flows increased by $4.2
million from the same period in the prior year, resulting primarily from an
increase in net earnings compared to the prior year of $3.1 million. These cash
flows, plus borrowings from the company's credit facility, were used during the
first quarter of fiscal 2003 to support $9.5 million in capital additions,
repurchase $13.1 million of treasury stock at an average price of $32.57 per
share and for the payment of $3.7 million in dividends. At the end of the first
quarter, the company had remaining authority to purchase 3.4 million shares of
common stock under the share repurchase program authorized by the Board of
Directors in January 2001.
At the end of the first quarter, the company held $58.1 million in cash and cash
equivalents up from $57.5 million at October 31, 2001. Short-term debt totaled
$51.5 million, down from $60.3 million at July 31, 2002. The amount of unused
lines of credit as of October 31, 2002 was approximately $168.7 million.
Long-term debt of $106.7 million at October 31, 2002 was up from $105.0 million
at July 31, 2002 and represented 21.5 percent of total long-term capital, the
same as July 31, 2002.
The following table summarizes our fixed cash obligations as of October 31, 2002
(in thousands):
Contractual Cash Payments Due by Period
Obligations Less than 1 - 3 4 - 5 After 5
1 year years Years
Total Year
----------------------------------------------------------------
Long term debt $106,737 $ 57 $ 44,309 $ 40,074 $ 22,297
Short term debt 51,463 51,463 -- -- --
-------- -------- -------- -------- --------
Total contractual
cash obligations $158,200 $ 51,520 $ 44,309 $ 40,074 $ 22,297
======== ======== ======== ======== ========
Also, at October 31, 2002, the company had a contingent liability for standby
letters of credit totaling $16.3 million that have been issued and are
outstanding. Currently, there are no amounts drawn upon these letters of credit.
In September 2002, the company entered into a new three year multi-currency
revolving facility with a group of banks under which the company may borrow up
to $150.0 million. The agreement provides that loans may be made under a
selection of currencies and rate formulas including Base
8
Rate Advances or Off Shore Rate Advances. The interest rate on each advance is
based on certain leverage ratios. Facility fees and other fees on the entire
loan commitment are payable over the duration of this facility.
The company believes that the combination of present capital resources,
internally generated funds and unused financing sources are adequate to meet
cash requirements for the next twelve month period.
Results of Operations
The company is a leading worldwide manufacturer of filtration systems and
replacement parts. The company's product mix includes air and liquid filters and
exhaust and emission control products for mobile equipment; in-plant air
cleaning systems; compressed air purification systems; air intake systems for
industrial gas turbines; and specialized filters for such diverse applications
as computer disk drives, aircraft passenger cabins and semi-conductor
processing. Products are manufactured at more than three dozen plants around the
world and through three joint ventures.
The company has two reporting segments engaged in the design, manufacture and
sale of systems to filter air and liquid and other complementary products. The
two segments are Industrial Products and Engine Products. Products in the Engine
Products segment consist of air intake systems, exhaust systems, liquid
filtration systems and replacement filters. The Engine Products segment sells to
original equipment manufacturers (OEMs) in the construction, industrial, mining,
agriculture and transportation markets and to independent distributors, OEM
dealer networks, private label accounts and large private fleets. Products in
the Industrial Products segment consist of dust, fume and mist collectors,
compressed air purification systems, static and pulse-clean air filter systems
and specialized air filtration systems for diverse applications including
computer disk drives. The Industrial Products segment sells to various
industrial end-users, OEMs of gas-fired turbines and OEMs and end-users
requiring highly purified air.
Despite only modest growth in net sales compared to the first quarter in the
prior year, the company reported record net earnings. Net earnings for the first
quarter of fiscal 2003 of $22.8 million were up 15.8 percent from the $19.7
million recorded in the prior year. Total net sales for the first quarter of
fiscal 2003 were a record $301.1 million, up 4.4 percent from prior year sales
of $288.4 million. Record diluted net earnings per share of 50 cents were up
16.3 percent from prior year diluted net earnings per share of 43 cents,
slightly better than the increase in net income as the average number of shares
outstanding decreased compared to the prior year period. Productivity
improvements, product cost reductions and infrastructure improvements continued
to be a focus for the company in the first quarter of fiscal 2003. Sales
overseas were up 32.3 percent, comprising just under 50 percent of total first
quarter net sales. This helped to offset weaker than expected North American
sales in gas turbine products.
For the first quarter of fiscal 2003, net sales in the Engine Products segment
of $167.0 million increased 6.7 percent from $156.5 million in the prior year.
All three product groups within the Engine Products segment reported
year-over-year increases in sales for the second consecutive quarter. Worldwide
sales in truck products in the first quarter of fiscal 2003 were $26.7 million,
an increase of 23.6 percent from $21.6 million in the prior year. North American
heavy-duty truck sales increased by 11.3 percent from the prior year, reflecting
the North American Class 8 diesel emissions
9
prebuy. North American light-duty vehicle sales more than tripled over last
year, reflecting additional revenues from new PowerCore(TM) filtration programs.
Internationally, truck sales increased by 24.6 percent and were particularly
strong in the Asia-Pacific region. Worldwide sales of off-road products in the
first quarter of fiscal 2003 were $48.3 million, an increase of 5.2 percent from
$45.9 million in the prior year. Weak North American conditions in construction
and agriculture were more than offset by strong results from Europe and
Asia-Pacific, which were up 17.2 percent and 20.1 percent, respectively.
Aftermarket product sales in the first quarter of fiscal 2003 were $91.9
million, an increase of 3.3 percent from $88.9 million in the prior year. Flat
North American results were offset by strong sales growth in Europe and
Asia-Pacific, which were up 13.9 percent and 10.1 percent, respectively.
For the first quarter of fiscal 2003, net sales in the Industrial Products
segment of $134.1 million increased 1.6 percent from $131.9 million in the prior
year. Sales from recently-acquired ultrafilter were $26.0 million. Excluding
these ultrafilter revenues, sales in the Industrial Products segment decreased
18.1 percent. Within the Industrial Products segment, worldwide gas turbine
product sales for the first quarter of fiscal 2003 were $38.6 million, a
decrease of 32.6 percent from $57.2 million in the prior year. Gas turbine
product sales in North America decreased 48.0 percent as the three-year
demand-bubble has ended. International sales in gas turbine products increased
by 35.7 percent over the prior year led by solid increases in both Europe and
Asia-Pacific, which softened the impact of the downturn in North America.
Worldwide sales in industrial air filtration products for the first quarter of
fiscal 2003 were $42.8 million, a decrease of 11.2 percent from $48.2 million in
the prior year. North American business conditions weakened again in the first
quarter of fiscal 2003 after slowly improving over the past six months. Sales in
Europe were up 6.0 percent, but were offset by weak sales in Asia-Pacific (a
decrease of 17.0 percent) as the Japanese industrial economy continues to
struggle. For the first quarter of fiscal 2003, worldwide sales of special
application products were $26.7 million, a slight increase of 0.9 percent from
prior year sales of $26.4 million. Within special application products, disk
drive filter sales were down from the prior year but were offset by strong
membrane sales in Asia-Pacific.
For the first quarter of fiscal 2003, total international sales in U.S. dollars
increased 32.3 percent from the same period in the prior year. Total
international Engine Product sales were up 12.4 percent compared to the prior
year. International sales for all three product groups within this segment,
increased over the prior year. International sales of off-road products led
these increases with an increase of 18.2 percent, while sales in truck and
aftermarket products increased from the prior year by 12.7 percent and 9.3
percent, respectively. Total international Industrial Product sales were up 53.7
percent from the prior year. Within this segment, international sales of gas
turbine products posted a strong increase of 35.7 percent from the prior year,
while international sales in special application products increased 5.3 percent.
These increases were partially offset by a decrease in industrial air filtration
products of 2.8 percent. In international sales, Europe led with an increase in
sales of 51.3 percent from the prior year, while sales in Asia-Pacific and South
Africa also increased by 14.3 percent and 4.9 percent, respectively, from the
prior year. Sales in Mexico posted a decrease of 9.8 percent from the prior
year.
Gross margin for the first quarter of fiscal 2003 was 31.5 percent, up from 30.6
percent in the prior year. Ongoing efforts to reduce product costs and improve
manufacturing infrastructure continued to drive margin improvements. Plant
rationalization activities had no material impact on net earnings in the first
quarter of fiscal 2003.
10
Operating expenses during the first quarter of fiscal 2003 were $63.2 million,
or 21.0 percent of sales, compared to $59.3 million, or 20.5 percent of sales in
the prior year. The increase over last year is attributable to the addition of
ultrafilter, which has a relatively higher run-rate for operating expenses than
the company's existing businesses.
Other income for the first quarter of fiscal 2003 totaled $1.6 million, an
increase of $0.9 million from $0.7 million in the same period in the prior year.
Other income for the first quarter of fiscal 2003 consisted of income from
unconsolidated affiliates of $1.5 million, interest income of $0.6 million and
other expense of $0.5 million. For the quarter, interest expense was $2.0
million, down 16.2 percent from $2.4 million in the first quarter of the prior
year. This decrease reflected lower short-term debt levels compared to the prior
year as well as lower short-term interest rates.
The income tax rate for the first quarter of fiscal 2003 remained at 27.0
percent, down from 28.0 percent a year ago and consistent with the income tax
rate as of July 31, 2002. The company anticipates maintaining the 27.0 percent
tax rate for the forseeable future.
Total backlog of $318 million at October 31, 2002 was down 4 percent, or $13
million, relative to the prior year, reflecting a $20 million drop in backlog
for North American gas turbine sales. Total backlog increased 3 percent from the
prior quarter end. In the Engine Products segment, total backlog increased 5
percent from the prior year and decreased slightly from the prior quarter end.
In the Industrial Products segment, total backlog decreased 13 percent from the
prior year but increased 9 percent from the prior quarter end.
Hard order backlog - goods scheduled for delivery in 90 days - was $165 million,
down 6 percent or $11 million from the prior year, reflecting a $19 million drop
in backlog for North American gas turbine sales. Hard order backlog decreased 7
percent from the prior quarter end. In the Engine Products segment, hard order
backlog increased 4 percent from the prior year and decreased 8 percent from the
prior quarter end. In the Industrial Products segment, hard order backlog,
excluding North American gas turbine and ultrafilter, was down 5 percent from
the same period in the prior year, reflecting the continued softness in
industrial capital equipment.
Foreign currency translation, resulted in an increase in net sales of $5.6
million and net earnings of $0.4 million. The impact of the euro resulted in a
translation gain on net sales of $4.5 million. A translation gain on sales of
$0.3 million was also recorded due to the strengthening of the Australian dollar
to the U.S. dollar. These gains were offset by translation losses recorded to
sales due to the weakness of the South African rand and the Mexican peso against
the U.S. dollar of $0.9 million and $0.3 million, respectively. During the first
quarter of fiscal 2003, a translation gain on sales of $2.0 million was recorded
for ultrafilter mainly due to the strengthening of the euro to the U.S. dollar.
On a local currency basis, revenues outside the U.S. increased 30.8 percent in
the quarter compared the prior year. Exclusive of the impact of the
recently-acquired ultrafilter, the increase was 7.8 percent. Excluding foreign
currency translation, worldwide revenue would have increased by 2.4 percent.
Critical Accounting Policies
The company's consolidated financial statements are prepared in conformity with
accounting principles generally accepted in the United States of America. The
preparation of these financial
11
statements requires the use of estimates, judgments and assumptions that affect
the reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the periods
presented. Management bases these estimates on historical experience and various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the recorded
values of certain assets and liabilities. The company believes its use of
estimates and underlying accounting assumptions adhere to accounting principles
generally accepted in the United States of America and are consistently applied.
Valuations based on estimates and underlying accounting assumptions are reviewed
for reasonableness on a consistent basis throughout the company. Management
believes the company's critical accounting policies that require more
significant judgments and estimates in the preparation of its consolidated
financial statements are the following:
ALLOWANCE FOR DOUBTFUL ACCOUNTS - The allowance for doubtful accounts is
estimated by management based on evaluation of potential losses related to
customer receivable balances. Estimates are developed by using standard
quantitative measures based on historical losses, adjusting for current economic
conditions and, in some cases, evaluating specific customer accounts for risk of
loss. The establishment of this reserve requires the use of judgment and
assumptions regarding the potential for losses on receivable balances. Though
management considers these balances adequate and proper, changes in economic
conditions in specific markets in which the company operates could have an
effect on reserve balances required.
INVENTORY - The company's inventories are valued at the lower of cost or market.
Reserves for shrink and obsolescence are estimated using standard quantitative
measures based on historical losses, including issues related to specific
inventory items. Though management considers these balances adequate and proper,
changes in economic conditions in specific markets in which the company operates
could have an effect on reserve balances required.
PRODUCT WARRANTY - The company estimates warranty costs using standard
quantitative measures based on historical warranty claim experience and, in some
cases, evaluating specific customer warranty issues. The establishment of
reserves requires the use of judgment and assumptions regarding the potential
for losses relating to warranty issues. Though management considers these
balances adequate and proper, changes in the future could impact these
determinations.
INCOME TAXES - As part of the process of preparing the company's consolidated
financial statements, management is required to estimate income taxes in each of
the jurisdictions in which the company operates. This process involves
estimating actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and book
accounting purposes. These differences result in deferred tax assets and
liabilities, which are included within the company's consolidated balance sheet.
These assets and liabilities are evaluated by using estimates of future taxable
income streams and the impact of tax planning strategies. Management assesses
the likelihood that deferred tax assets will be recovered from future taxable
income and to the extent management believes that recovery is not likely, a
valuation allowance is established. To the extent that a valuation allowance is
established or increased, an expense within the tax provision is included in the
statement of operations. Reserves are also estimated for ongoing audits
regarding federal, state and international issues that are currently unresolved.
The company routinely monitors the potential impact of such situations and
believes that it is properly reserved. Valuations related to
12
tax accruals and assets can be impacted by changes to tax codes, changes in
statutory tax rates and the company's future taxable income levels.
Outlook
North American truck sales should be stronger than previously expected as the
projections of a post-October 1 downturn appear to be exaggerated. The company
also expects to begin shipping new PowerCore systems for light-duty diesel truck
programs late in the second quarter, along with catalytic converter mufflers and
Spiracle crankcase emissions systems for the California retrofit market. Order
trends indicate continued strength in both Europe and Asia. Off-road sales are
expected to remain steady, led by strong performances in international markets.
Incoming orders for engine aftermarket products have improved for three
consecutive quarters and market conditions have continued to improve. Overall,
the company is expecting engine products year-over-year revenue growth in the
high single digits in fiscal 2003.
The company expects global gas turbine sales to decrease 30 to 35 percent from
last year's record $231 million. Strong business internationally and replacement
parts growth are expected to soften the North American downturn. The company
expects industrial air filtration markets to be stable near-term. In special
applications products, order trends and backlogs indicate continued stable
conditions in the various end markets. Compressed air products are expecting
continued revenue growth.
With strong growth expected in our engine businesses, declining gas turbine
sales, and other industrial businesses either stable or slowly improving, the
company remains committed to maximizing operating efficiency through product
cost reductions, manufacturing infrastructure improvements, discretionary
expense controls, and completing the integration of ultrafilter. Continued
improvements in working capital will fund debt reduction and share repurchase.
Forward-Looking Statements
The company desires to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 and is making this cautionary
statement in connection with such safe harbor legislation. This Form 10-Q,
earnings releases or other press releases, the company's Annual Report to
Shareholders, any Form 10-K, 10-Q or Form 8-K of the company or any other
written or oral statements made by or on behalf of the company may include
forward-looking statements which reflect the company's current views with
respect to future events and financial performance. The words "believe,"
"expect," "anticipate," "intends," "estimate," "forecast," "plan," "project,"
"should" and similar expressions are intended to identify "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. All forecasts and projections are "forward-looking statements" and are
based on management's current expectations of the company's near-term results,
based on current information available to the company.
The company wishes to caution investors that any forward-looking statements made
by or on behalf of the company are subject to uncertainties and other factors
that could cause actual results to differ materially from such statements. These
uncertainties and other risk factors include, but are not
13
limited to: risks associated with currency fluctuations, commodity prices, world
economic factors, political factors, the company's substantial international
operations, highly competitive markets, changes in product demand and changes in
the geographic and product mix of sales, acquisition opportunities and
integration of recent acquisitions, facility and product line rationalization,
research and development expenditures, including ongoing information technology
improvements, and governmental laws and regulations, including diesel emissions
controls. For a more detailed explanation of the foregoing and other risks, see
Exhibit 99, which is part of the company's Form 10-K filed with the Securities
and Exchange Commission. The company wishes to caution investors that other
factors may in the future prove to be important in affecting the company's
results of operations. New factors emerge from time to time and it is not
possible for management to predict all such factors, nor can it assess the
impact of each such factor on the business or the extent to which any factor, or
a combination of factors, may cause actual results to differ materially from
those contained in any forward-looking statements.
Investors are further cautioned not to place undue reliance on such
forward-looking statements as they speak only to the company's views as of the
date the statement is made. The company undertakes no obligation to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
14
Item 3. Quantitative and Qualitative Disclosure about Market Risk
The company's exposure to market risks for changes in interest rates
relates primarily to our short-term investments, short-term borrowings
and interest rate swap agreement. We have no earnings or cash flow
exposure due to market risks on our long-term debt obligations as a
result of the fixed-rate nature of the debt. However, interest rate
changes would affect the fair market value of the debt. At October 31,
2002, the fair value of the company's long-term debt approximates
market. Market risk for the company's debt is estimated as the
potential decrease in fair value resulting from a hypothetical one-half
percent increase in interest rates and amounts to approximately $3.2
million.
On June 6, 2001, the company entered into an interest rate swap
agreement effectively converting a portion of the company's interest
rate exposure from a fixed rate to a variable rate basis to hedge
against the risk of higher borrowing costs in a declining interest rate
environment. The company does not enter into interest rate swap
contracts for speculative or trading purposes; the differential to be
paid or received on the interest rate swap agreement is accrued and
recognized as an adjustment to interest expense as interest rates
change. The interest rate swap agreement has an aggregate notional
amount of $27.0 million maturing on July 15, 2008. The variable rate is
based on the current six-month London Interbank Offered Rates
("LIBOR"). The interest rate swap decreased interest expense by $0.3
million for the three months ended October 31, 2002. As of October 31,
2002, the interest rate swap has a fair value of $3.1 million, which is
recorded net of the underlying debt.
The company does not enter into market risk-sensitive instruments for
trading purposes to generate revenues. There have been no material
changes in the reported market risk of the company since July 31, 2002.
See further discussion of these market risks in the Donaldson Company,
Inc. Annual Report on Form 10-K for the year ended July 31, 2002.
Item 4. Controls and Procedures
(a) Disclosure Controls and Procedures: Within 90 days prior to
the date of this report (the "Evaluation Date"), we carried
out an evaluation, under the supervision and with the
participation of management, including the Chief Executive
Officer and the Chief Financial Officer, of the effectiveness
of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-14 of the Securities
Exchange Act of 1934, as amended (the "Exchange Act")). Based
upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the Evaluation Date,
our disclosure controls and procedures were adequately
designed to ensure that information required to be disclosed
by the Company in the reports that it files or submits under
the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in applicable rules
and forms.
15
(b) Internal Controls: No significant changes in the Company's
internal controls or in other factors that could significantly
affect those controls subsequent to the Evaluation Date,
including any corrective actions taken with regard to
significant deficiencies and material weaknesses, were made as
a result of the evaluation.
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security holders
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Index
Exhibit 99A & B - Certifications pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
(b) Reports on Form 8-K.
None
16
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 December 13, 2002 By /s/ William G. Van Dyke
------------------------- -----------------------------
William G. Van Dyke
Chairman, President and
Chief Executive Officer
Date December 13, 2002 By /s/ William M. Cook
------------------------- -----------------------------
William M. Cook
Senior Vice President,
International and
Chief Financial Officer
Date December 13, 2002 By /s/ Thomas A. Windfeldt
------------------------- -----------------------------
Thomas A. Windfeldt
Vice President and Controller
and chief accounting officer
17
CERTIFICATIONS
I, William G. Van Dyke, Chief Executive Officer of Donaldson Company, Inc.,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Donaldson Company,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 13, 2002 /s/ William G. Van Dyke
--------------------------- ---------------------------
William G. Van Dyke
Chief Executive Officer
18
I, William M. Cook, Chief Financial Officer of Donaldson Company, Inc., certify
that:
1. I have reviewed this quarterly report on Form 10-Q of Donaldson Company,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 13, 2002 /s/ William M. Cook
--------------------------- ------------------------------
William M. Cook
Chief Financial Officer
19