Okay, we'll go ahead and get started. Thank you all for coming to the Donaldson presentation. I'm Brian Drab, the Industrial Technology Analyst at William Blair. I've covered Donaldson for 17 years now. Today we're happy to have with us CEO Tod Carpenter, CFO Brad Pogalz. It's not Pogalz.
Pogalz.
Pogalz. Okay.
Yeah, you got it.
See every detail, and I blew one of them. And Sarika Dhadwal, who is the Senior Director of Investor Relations and ESG. Thank you all for coming to the presentation. Donaldson, as many of you in the audience will know, is a world leader in filtration, specifically in engine markets, heavy-duty engine, on-road and off-road, also many different industrial applications. Most recently, the company, over the last few years, has been expanding their presence in the medical bioprocessing markets. We'll get an update there. Of course, that's a very challenging end market right now. Everyone who has exposure to life sciences has been having some challenges. Maybe we'll have some questions on that. I know it came up on the earnings call. At this point, I'll turn it over to Tod. Thank you very much for being with us today.
Thanks, Brian. And thanks to all of you for being here. We want to start, of course, with our forward-looking safe harbor to satisfy all the lawyers across the world, I suppose. We are in an enviable position right now, having reported earnings on Tuesday. Typically, we have to always reach back a number of months. All the information that we'll talk about today is very fresh. That will be very nice timing. Five key points that I want you to take away from this presentation and about our company. Our strategy is to be a technology-led filtration company. We are a leader in filtration around the world for all the markets that we serve. Second, we have best-in-class technology where we solve very complex customer problems, which gives us deeper relations to the customers. That kind of relationship is very important in our company model.
Third, those customers are global in nature, and we are everywhere that the customer wants us to be. Particularly important in this time of tariffs, and we'll talk a little bit more in the presentation about that, that we have a clear strategic growth strategy. It's very balanced organically as well as M&A. We'll talk about that. Fifth, we are progressing toward a life sciences type of business where our products that we are inventing organically to go into there, as well as the M&A, the acquisitions that we have done, are differentiated products. They're also disruptive products that we bring into those spaces. Specifically, Donaldson is a 110-year-old technology-led filtration company. You see our revenue breakout in the lower left. We have three reporting segments. Mobile Solutions is 62%, Industrial is 30%, the balance is life sciences.
Very importantly, we sell proprietary razors to sell razor blades. We do it through our filtration businesses. We do it in every business that we have. Therefore, roughly 68% of our revenue is razor blades, the balance being first fit or in our industrial-based businesses, we would say that would be first fit equipment using our proprietary filtration technologies. Our overall results, you see each of the last 4 years there, we continue to grow. Everything you see with regards to revenue and adjusted earnings per share are all records for each of the prior 4 years. When I say we are a 2019 and our investor day of April of 2023, that means somewhere in the world, on average, Donaldson was granted a patent every day. We're serious about our strategy. We continue to invent cool things.
I often say I should be wearing a black turtleneck, but that gig had been taken. We really have some cool technologies within our company. Very important in this time of tariffs. Our particular model has 44% of our revenue in the U.S. and Canada, 28% Europe, 10% or so, 10% or 11% in Latin America, and 17% in Asia. Important is that 75% of all of our revenue is built within the region that it is consumed. That gives us really good advantage within a natural hedge of the tariff activities going on and obviously the constant movement of that. We are able to shift quite nicely. The U.S. is a net exporter for Donaldson Company. We have roughly 150 locations around the world. We have about 65 manufacturing plants. They're in every region of the world.
That allows us, from a supply chain standpoint of view, as the economics make sense, to shift from one region to the other to build it if we are not completely in that region. We have a nice way of moving that 25% around. It is the reason why on Tuesday we said that with the current tariff situation, what is implemented, the headwinds that we have in the company are about $35 million, roughly. We have ways to offset all of that, either through supply chain, pricing, we will use surcharges, etc. Relative to tariffs, our story is pretty straightforward. We feel pretty comfortable that we can offset it all. The one thing we do want to mention with that is we are looking to offset the dollars.
That does not mean we get profit on tariffs, so there will be slight gross margin pressure as a result of that, obviously, because you are not able to roll that all the way through. We are with tariffs looking to have very fair relationships with our customer base. It is working out quite well so far. As a company, we are able to flex quite well so far with everything that has taken place. Along the bottom, you see our end markets, how we really are comprised within our business units, and the split within each of those business units of first fit or, say, proprietary first fit. The lighter blue is the replacement parts. Here you see our financials and including the guidance that we have out for this fiscal year. This fiscal year expects to turn with one quarter remaining.
We are through three quarters of our fiscal year, just reported on Tuesday of this week, which means one quarter left. We fully expect to have record revenues and record earnings this fiscal year yet again. You see all of that. Our adjusted operating margin for this year is 15.8%. We have given guidance for fiscal 2026, which would be next year, early guidance that our midpoint is to get to 16.2%. We continue to expand our operating margin, as you see here, over a number of years. We will come out with guidance when we give the full year report here in about 90 days. Again, we are the filtration leader with many durable competitive advantages. We have a long history of filtration technology leadership, as I talked about. We do have the deep customer relationships. You see the balance.
I do want to emphasize that we have best-in-class operations. We are everywhere that the customer wants us to be. We get close to them when we have the volumes necessary. We expand our manufacturing footprint or do what is necessary to get that customer taken care of. We are very, very proud of how we go to market that way. That allows us, one of the many reasons, technology as well as deep customer relationships, to have a high aftermarket retention that you saw at 68% on that first slide. We have three reporting segments: mobile solutions, industrial solutions, and life sciences. The mobile solutions is medium and heavy-duty diesel engines, construction, mining, agriculture, long-haul trucks. That has been the traditional—that is how our company started. We have been the traditional leader in that particular space. We remain the leader. We are working on alternative fuel solutions with customers.
Recently, we announced that we have won the fuel cell program at Daimler, for example, where we'll help them do all the filtration. Now, it's interesting to understand on the alternative fuels. If you're moving away from diesel fuel and let's say you're going to go to hydrogen, there's two ways. You could do it in a fuel cell. You could do it as the combustion engine portion. Either way, you still need air filtration. The fuel itself actually has to take particulate and water out of it, which is exactly what you do for diesel fuel. We are best in class to be able to do that.
However, there's also a third need, particularly in fuel cells, and that is you have to take out some of the other concentrates, such as sulfur dioxide or mercury, because you need more of a pristine type of a fuel, especially on fuel cells. We are excellent at that. We've been doing chemical absorption within other business units within Donaldson for decades. We can tailor-make that for the particular customer. That's the reason why we've been winning in the alternative fuels relative to hydrogen. It's very important to really understand that not all fuel cells are exactly the same. One customer's fuel cell may have to have sulfur dioxide, but the others may be more susceptible to a different type of a contaminant. We will be able to absorb that out for them. It's a very broad-ranged type of spectrum.
Good growth opportunities within the mobile solutions segment. We're growing very well in our aftermarket business. As we reported this week, we are low single-digit growth, even in an environment where a lot of our first-fit vehicle end markets have headwinds. They're a bit troubled at this point. We continue to grow in the mobile solution space. In industrial, we have a number of different applications within that space. What we are doing, if you have a process where it's an industrial dust, a mist, or a particulate of some sort, we will filter that out for you to either make your environment better, have the machine protected, anything that you need. Additionally, we have a power generation business inside there. Think of basin peak load power stations, oil and gas type of power stations all around the world.
We filter out the ambient air, make that proper so the gas turbine can actually do its job and create power in the national grids around the world, all the way to industrial hydraulics and a number of other diverse businesses in that particular segment of industrial. It is growing nicely. It also has a good operating margin of 18%. Our strategy within that segment to grow it is to digitize it. Much like you have seen in a car with OnStar, we now have, when we send your dust collector out, we now have it, when you plug it in, it will actually tell how it's operating back to Donaldson Company. We can call the maintenance person and say, "Hey, go do this to your dust collector so you don't shut down your production." It's really giving us, again, deeper relationships with the customer.
You're seeing our aftermarket business grow there. I would tell you, as much as 7 years or 8 years ago, our aftermarket in that business used to be about 30%, or first fit was 70%. We've gotten good momentum with this strategy. Now it's about 50/50. You can see our aftermarket business is really going quite well within there. We expect good things going forward to help us drive growth within that segment. Within life sciences, life sciences, we entered that segment as a new segment. It's small for our company, $250 million or so. We like the space because of the difficult challenges of filtration that the space actually allows us to help solve for our customers. We are not going in on a me-too type of a basis. We did do acquisitions. We did pre-revenue-based acquisitions. We also have some really cool inventions in our laboratories.
Each of those will be rolling out over time in order to grow it. As we entered that space, that particular market did start to create some new headwinds, particularly on the bioprocessing side. You see that within those end markets. It's going to take us a little bit more time than we had hoped, for sure, to be able to grow into that particular space. Make no mistake, we really like the space. We like what we're bringing forward. We really have some differentiated products, and we'll be talking more about that here in the months and quarters to come. Here are the acquisitions that we have done. Our addressable market in life sciences is large, $21 billion. Traditional mobile solutions segment, we are roughly about $2.2 billion-$2.3 billion currently in revenue of the $14 billion in that segment.
Again, that segment likely could grow if hydrogen goes to be the winner in that space. That looks to be more the direction that that particular market is heading. Within industrial solutions, it is $15 billion. We are about $1.2-$1.3 billion within that space. You see the five acquisitions that we have done across the life sciences space. Our most recent one, Medica, out of Italy, where we now own 49%, brings a brand new technology to our company. It is called Hollow Fiber Membranes. If you think about your hair, your hair is about 10-15 microns in diameter. What this does is give you almost like an extruded straw, if you will, kind of oversimplifying this. It is important to understand the wall structure, the pores of that wall structure.
Your hair, again, is 10 microns, will be 0.2 microns in order to be able to get into the bioprocessing spaces and help with the drug applications. That's why we bought it. It's another really cool technology add to Donaldson Company. We are really excited about the future that that can help us bring for our company. As far as balanced capital allocation, our first priority is to invest back into the company organically and through acquisition. Third is dividend. We raised our dividend this week, or sorry, last Friday, by 11%. It is the 30th year in a row we have raised our dividend. We are a proud member of the Dividend Aristocrats Fund. That means you have to have raised your dividend 20 years or more in a row. As I said, we are at 30 years. Dividend is very important to us and for our shareholders.
We continue to prioritize that. The fourth one is share buyback. You can see how we've used capital over the last 3 years for share buyback. Important to know that in this quarter, we entered the quarter at 0.9%, roughly 1% of shares bought back. Our guidance was midpoint 2.5% on the buyback. As we stand here today, based upon what was going on in the last quarter, we saw opportunity. We took it. We are now at 3.3% bought back. We were above the guide. It just made sense for us to do that. Yes, that means I feel like the company was undervalued, and we did it. Looking forward, we gave a guide of between 3.5%-4% as far as share buyback. Again, we'll invest back in the company organically. We'll buy companies through M&A, dividends, and then share repurchases.
Those are our capital allocations. Over the last 3 years, we allocated $1.4 billion in that fashion. When you look at our balance sheet and you look at the model, what it brings, roughly our debt ratio, we like to operate at about 1%. Today, we sit in the neighborhood of about 0.8%. We are in a strong position there. Free cash flow of roughly about 85%. That is right about our guide today. We have available to us $800 million worth of capital, which means that we can be an acquirer of choice. On that acquisition piece, we still do look for targets that we continue to work across our strategic pipeline and feel very good about. Again, going back to the five points, we are a leader in filtration. We are best in class in technology. We have got a lot of really, really cool things.
We do help our customers solve very, very complex problems for themselves. We have a good strategic and clear balanced growth plan. We are progressing into the life sciences segment, a little slower than we would want due to the end market moves. We still love the space and what it could bring for our company. With that, I will open it up for questions.
Yeah. Thanks very much, Tod. It is great to have you here, Brad and Sarika, of course. Brad, I am looking at some of my notes from Donaldson from 10 years ago and conversations that we had. I do not know if you, Brad, just want to—I know that the investment community at large is familiar with you and you joined, or you took the CFO role on recently. Some of my clients might not know your background.
Do you mind just saying a couple of things and the opportunity from your perspective as well?
Yeah. I joined Donaldson 10 years ago. I started as Head of IR in the role Sarika has today. I was in that job for about 5 years. I moved during COVID to Belgium to head up and be the CFO of our AMEA finance region. I was there for the last 5 years. During that time, I also took on global head of FPA for the company. In the last—I was named CFO and took over 1st of November and now here since. Opportunity, I do want to take a moment on that. The thing that impressed me about Donaldson when I joined and continues to be part of our conversation is what Tod said about technology-led filtration.
I think when I came on, it was a retail background, and I really did not realize where all the filters were in the world. I thought about my furnace and my car. We do not sell on any of those things. It is low tech. We make different choices at the company. I think what gives me a lot of optimism and part of where I am happy to be in this chair and grow more with Donaldson is, as the world gets more complicated, regardless of what happens with AI or robots and manufacturing, these things still get manufactured or equipment is still moving around. With complicated problems in the world, there is more need for filtration, not less. I really do think that creates an exciting opportunity for us as a company.
Even robots need filters. It is a beautiful thing.
You want to elaborate on that, Tod? Even robots need filters, you said.
They have to have vent filters because they actually breathe relative to how it operates. There is a lot of venting applications across a lot of the machinery that you see, particularly EVs, for example, headlamps, a lot of different applications. We do that extremely well.
In a conversation that you and I had this year, we were talking about margin expansion potential and longer-term margin potential. You said some—I do not want to put—I am not going to say a number. Can you talk about what you see as the long-term margin potential? Where can operating margin go for Donaldson over long-term and why?
Yeah. We are currently coming out this year at 15.8%. I think 5 years or 6 years ago, we had been down at 12%, high 12s, maybe something like that. Our investor day, we set a target at 16%. Clearly, next year, we'll be above 16%. We have programs in place to continue to expand our operating margin. 17% is clearly in sight. We have a path to be able to get to 17%. You say, "Well, okay, well, how about 18%?" It's a sure. We do believe we'll continue to expand our operating margin. It'll take time. We're not going to just go cut the middle out so hard that we get the operating margin and hurt the company. That's not the way we do business. We do take our customer relationships very, very seriously. There are obvious efficiencies that we can gain. For example, we're currently shutting down two manufacturing plants, one in England, one in California. There are other opportunities to really help optimize our footprint. There are other efficiency plays that we have.
Important to understand that our company is now 97% of our revenue goes through one business system. We have gone through all of that metamorphosis. The only thing that really is not done right now is Brazil. It will go live later this calendar year, maybe January or so. That means we will be 100% on a business system. That allows you to take this distributed model of certain business processes and centralize them wherever in the world you want to centralize them in order to become more efficient and control processes and drive cost reduction, as well as now pricing-based models that we have coming out of supply chain situation. We have really done a good job at resetting all the pricing activities in the company. We now have a much fairer relationship with our customer base. That is how we talk to them and really embrace that challenge collectively.
We are not trying to maximize our overall pricing with the customers. We're just trying to optimize it. Because remember, every razor blade we sell, we get the razor. Every razor we sell, we get the razor blade. That is an important type of significance to that. We are trying to optimize the overall gross margins and the pricing with fair relationships with customers. We use all of these macro-based opportunities. You roll it all up. We clearly have room to expand our operating margin, and we will.
On that pricing note, one thing that has happened at the company—you correct me if I'm wrong—for the 2008 to 2020 period, as I was following the company, it seemed that every year for most of your business lines, especially on the engine side, it's kind of prices down one point. How do we become more efficient in the operation to get that back? That is different today, right? This is one of the things that, from my perspective, gives you that potential.
Yeah. We are a 110-year-old company. We got our beginning in many of the large OEs in construction and agriculture and mining. Those relationships had gone a little bit more to the favor on the OE, whereby we would start every year with a price down. We would start negative 1 or negative 2 in business segments and have to make that up with cost reduction on an annual basis. In the supply chain disruptions, that was just not tenable for anybody, for them, for us. Consequently, we were able to get rid of all those clauses, make all those contracts, reset, and really now have a much more fair relationship.
In fact, we get price increases on a number of those particular relationships on an annual basis now, as appropriate, based upon inflation and all the rest. It was a massive undertaking for the company. The company now has, I think, a lot more confidence in our relationships with our customers, that they are more fair and proper, and really set for a long-term opportunity.
I just think that is a huge structural change in the business that really is important going forward. If there are any questions from the audience, please raise your hand. Otherwise, I will ask a couple more. We have four minutes here. One of the other things that you talked about earlier this year in a conversation with me was the potential for some of these end markets that are under pressure right now to bounce back. We've seen in the past when the engine market comes back, it's not up 5%, right? What do you see for these businesses over the next few years?
It is actually simple, straightforward. I'll just go back to this one slide here. Okay? Oops. There. Okay. That's what we've done the last 4 years in spite of the fact that our major end markets have headwinds. Construction, agriculture is legendary. You hear it from John Deere. All of those people are our customers. It continues to walk down. Over-the-road trucking just walked down again in the last 90 days. They thought it was going to be between, say, 250,000 and 300,000 trucks. Now they're more down to between 200,000 and 250,000 trucks. From a year or 1 years ago, roughly 330,000 trucks. That's a significant market for us.
Every one of those OE markets, those first-fit vehicles and equipment builds right now are down. Yet our company is performing like this. My point to Brian is, when those markets bounce, they do not bounce low single digits. They bounce double digits and sometimes over 20%. That is what gives me confidence that we will leverage even more to the operating margin when we get the volumes back on the first-fit side of our company. Our gross margin will come down a little bit because of mix, but the overall operating margin will go up because we will leverage that through the organization. It gives me confidence that we can expand our operating margin and that our company is in excellent, excellent shape to take advantage of that next economic upturn around the world.
One of the reasons that those results have been so resilient is that you have such a strong aftermarket revenue stream, right? We've talked about this over the years. There's sometimes an impression that on-road truck is going to be weak. It is 3% of your revenue, though, right? You have 60% plus of your sales in the aftermarket, which also are somewhat higher margin products as well too.
The other important piece about our company, and a lot of people will tag a particular end market and say, "Wow, that one's down. Your company is going to have a little bit of trouble." The diversity of the businesses, the portfolio of businesses that we have in our company give us some natural hedges on some of that activity. You take a look, our company is growing, and yet we have multiple end markets facing headwinds, right?
Why? Because we have other ones that do not have those headwinds and are doing really well. Power generation being one that is helping offset some of those kinds of activities. The diversity of portfolio really helps us go forward and gives us confidence that, look, our company is going to be less cyclical. We work very, very hard to make our company less and less cyclical coming off of 110 years. That is work that will never end for us. We are doing okay from that perspective, I would say. I am a little biased.
Right. We are just about out of time, so I think we will wrap up. Thanks very much, Tod, Brad, Sarika, thanks for being here.
Thank you.
Thank you. Thank you, everyone.
Thanks, everyone.