Welcome, everyone, to the 19th annual Oppenheimer Industrial Growth Conference. Next up, we have Donaldson Company, led by CFO Scott Robinson, and head of IR, Sarika Dhadwal today. Thank you both for being here.
Thanks for having us.
Thanks, Bryan.
To.
All right, so, oh yeah, go ahead, Bryan.
To kick things off, and I can see you now, by the way. Some technical issues, I think, are resolved. To kick things off, for those a little less familiar with Donaldson Company, perhaps, offer a little bit of background, you know, history on the business, key drivers, and, most importantly, what you think really differentiates Donaldson at this point.
Sure. So I think we have a few slides that we'll just jump into, and then we can certainly jump into Q&A after that. So before we start, I just wanted to put up this forward-looking statement, Safe Harbor, which most of you have seen many times. I also wanted to point out that we will be reporting our third quarter fiscal 2024 earnings results on June 4th, just coming up here in a couple of weeks. So anything we talk about today will be backdated as of our second quarter fiscal 2024 earnings release. With that, I will turn it over to Scott Robinson, Chief Financial Officer.
All right. Good morning. Good day, everyone. I have just six slides that will hopefully provide a bit of an education on Donaldson to address Bryan's points there. The first slide is kind of five key things I would like you to be able to take away from this presentation about Donaldson. But certainly, Donaldson has been around for 108 years and has focused that entire time on filtration. We are a technology-led filtration company, so we really wanna be a leader in filtration. We wanna have best-in-class technology. We really spend a lot of energy on our core science of filtration. And I really think that ultimately is the lifeblood of the company. You know, we have the ability to leverage our technologies across our business units into new technologies or new products or new ways to help solve our customers' filtration problems.
And I think Donaldson has long been looked to by our customers as a partner that really wants to help them solve their filtration problems. As the economy in the world has really moved into a greener, more clear or clean, environment, that plays right into Donaldson's hands. We wanna enable a more green economy by utilization of our technology-led filtration solutions. So that is just a great thing for the world and a great thing for Donaldson. We really think about our capital deployment and our strategic and our growth strategy and making sure, you know, we're deploying capital to places that will help us grow again through, you know, in expanding our technologies. And the last one is really the next natural progression for Donaldson.
And we've been working on this for years and talking about it for quite a while is to, to further expand, into Life Sciences. And I think we have some good technology, that we've built internally. We have some good technology that we've acquired. And we're just starting, you know, on the journey there. But I think we have, certainly permission to play in some good technologies that we can we can bring to the market. Moving to the, the next, page, you know, an overview of Donaldson so you can see founded in 1915, 14,000 employees, 140 locations, you know, thousands of patents, you know, and, and pretty good revenue and adjusted EPS growth over the years.
In the last, you know, four years, you can see, including this year, we're gonna be adding about $1 billion of revenue into the company, you know, from $3.25 to, you know, $3.5+. And we've taken our EPS from, you know, $2 - $3. So pretty steady growth over, over time. You can see, on the bottom left slide that we are, we really wanna be a razor-to-sell razor blade company. So 36% first-fit products and 64% replacements. And then you can see the split of our three disclosed segments. Life Sciences has been disclosed the last couple of years, so that's a new segment for us. And, and that's where we're really focusing, you know, our, our next opportunity for, for the company.
In terms of, you know, Donaldson's approach to the market and our competitive advantage, you know, we have been around for over 100 years, and we really do truly have a long history of filtration leadership, with very deep customer relationships. I mean, many of our OE customers, you know, we've had for 60, 70 years as customers. And we really wanna work to help them protect their equipment, make their equipment run more efficiently, more cost-effectively, and help them fulfill their missions. I talked about, you know, the, the green economy and how things are moving that. I mean, that just is par for a filtration company and, and finding ways to help protect the world. We are very global, so, you know, over 50 manufacturing facilities around the world.
So we have the supply chain and the production capacity all around the world where we need it, which really gives the company a great ability to serve our customers and be where they are. You know, we wanna be a technology-led filtration company with a razor-to-sell razor blade approach. And that's why we have very strong aftermarket business and aftermarket retention, which really helps to stabilize the company, you know, over the long term, having that replacement parts business. And, you know, like I said, we have over 50 manufacturing facilities. We really have good operations and a long commitment and long approach to cost optimization and having a very strong operational footprint. So we report in three segments: a Mobile Solutions segment, an Industrial Solutions segment, and then recently, a Life Sciences segment. I'll start maybe with Life Sciences.
So really, you know, we completed a company redesign, a couple of years ago whereby we went to straight business unit focus. For the past 40 years before that, we had a matrix organization where we had kinda two segments. It was engine or Mobile Solutions and Industrial. And we had a geographic split. And so with the redesign, we put everybody into a business unit, so one of the three business units. And we created a separate Life Sciences standalone unit. I think that's been a great move for the company. And basically, when we thought about Life Sciences, what we really thought about was the opportunities we have, but we also thought about the technologies we have. And most of these technologies in Life Sciences are more of a membrane-based approach. And we put all the membranes in the Life Sciences.
And that way, we can leverage that technology, you know, out into the market. I think it also freed Industrial Solutions from having, you know, some of these traditional Donaldson businesses. And now, Industrial Solutions is able to better focus. So I think we, we did Industrial Solutions a favor, and we created a whole third business unit for the company, which now we report on. So you can all see how we're doing. We guide upon. We gave investor-day targets for. And so I think that that's been a great move for the company. It was not easy to redesign. And we did take quite a bit of the regional cost out, but we were essentially able to, to reinvest those in our new Life Sciences unit. So that's a full business unit now with P&L accountability, and, you know, some great opportunities as, as we move forward.
You know, the Mobile business has always been there. And we still have opportunities in the Mobile business, and we'll continue to capitalize on those. In terms of a little bit more about the balance sheet and cash flow generation, you know, a very strong history of cash flows. You know, we have a net debt to EBITDA target of 1. We're running slightly under that even after investing some dollars in our Life Sciences acquisitions, and paying out, you know, a dividend and buying back 2% of our shares for the last several years. So very strong ability to continue to invest. We wanna be smart about how we invest. We have very strong returns in the company. And we have to keep that in mind when we're making acquisitions 'cause you're not gonna get, you know, a 20% return on day one.
But we do wanna invest, and deploy capital into the company, where it makes sense. Our free cash flow conversion has averaged 85% for the long history. Last year and this year, we'll do over 100 or right around 100. So we continue to, you know, generate strong cash. We've paid a dividend, you know, for over 60 years. We've been increasing that dividend for 25 years. So we're now in the S&P High Yield Dividend Aristocrats Fund. We've been buying back 2% of our shares for the last several years, you know. So we have strong, you know, cash generation that really puts the company in a good position. And we have, you know, quite a bit of available liquidity, if it were needed, you know, either in terms of another pandemic or in terms, hopefully, maybe a larger acquisition.
So, you know, the company is in a very strong position. And certainly, we are holding powder available for acquisitions. And we'll see how that goes in the future. My last slide, we did an investor day, in April, of last year. And we did give out targets, three-year targets. So you can see the midpoint of Mobile at 4, industrial at 6, and Life Sciences at 20. So, you know, we're growing. All of our business units, the highest margin business is growing at the fastest rate. And that would be, you know, an average of 6% growth for the company over three years on an annual basis. We wanna continue to increase the operating margin company of the company. I would say we're committed to higher levels of profitability on higher levels of sales.
So, you know, we gave a midpoint of operating margin guidance of 16%. We just bumped up our operating margin guidance for this year at a midpoint of 15.2%. So that's, you know, growth in operating margin this year. That means if we can hit the 15.2%, we would need 80 points of operating margin improvement over the next two years. You know, we feel like we're well-positioned to deliver that. And we have to continue to increase the company's level of profitability in percentages increasing sales. And finally, you know, we have to leverage. So 20- to 24-point 20- to 24-point 4% incremental margins is what obviously increases that operating margin over growing revenues. So that completes the slides. I think Sarika will take them down.
Yep.
Bryan, maybe you could move into your Q&A.
Yeah. Absolutely. Thank you, Scott. You know, good walkthrough. We have been the foundation, you know, kind of in place for discussion now. You know, with that, you know, being the case, you know, how, how should we think about your, your forward growth path, you know, high level, the most attractive, you know, opportunities to continue to scale the business and improve profitability? No doubt, we'll get into Life Sciences on, on that front. And, you know, to balance high-level discussion, you know, what are the biggest risks that your team faces looking forward? There's always discussion, some degree of pushback, from investors on, you know, secular headwinds in, in Mobile. Very debatable in terms of timeframe. But how does your team view those? How are you positioned, you know, relative to the, you know, potential spectrum of next-gen engines?
How does this all net in terms of, you know, forward outlook, the fiscal 2026 targets that you have to end beyond?
Yeah. So I mean, I feel like we're pretty well-positioned and pretty lucky to have, you know, had all the people who've come before us to deliver the company to this point. So we have, you know, very strong technologies, you know, at the core of all of our businesses, especially in the Mobile Solutions and Industrial businesses. We are blessed with, you know, a global company with a great footprint and great manufacturing and really well-positioned assets. So we should have the ability to serve our customers in a very strong position from which to grow from. You know, we continue to add new technology into the company every day. And I think, you know, ultimately, that's what pushes the company forward. And so we feel like we're in good position.
We've been putting up, you know, record sales and record profits for the last few years. So we're definitely heading on a good trajectory. And we've been doing that while we've been investing in Life Sciences. So it's not like our profitability our profit is declining. We continue to generate record levels of both operating margin percent, operating margin dollars, EPS, while we're investing in Life Sciences, which will certainly serve the company well in the longer term. In terms of, you know, headwinds and, and maybe you mentioned electrification, you know, I think clearly, the narrative everyone can have their own opinion. They're, they're certainly have that right. But clearly, the narrative on electrification has changed from several years ago where it was very binary.
You know, it's either gonna be electric or internal combustion to really a range of outcomes that are moving through the system today, albeit at a very slow pace. So we are we wanna help facilitate, you know, that more green economy. We wanna help our customers, you know, bring solutions to market. And we're working with many of our large customers on, you know, their future platforms, whether they be hydrogen fuels or synthetic fuels or different things along those lines. And so that's there. I think ultimately, we would say we feel very comfortable that we can grow Mobile Solutions for at least the next 10 years, and probably long beyond that, that we will be involved with our customers and their solutions.
And ultimately, there's gonna be a range of outcomes all the way from electrification to continued, you know, internal combustion and everything in between. So we feel like we're, we're in pretty good position. Certainly, people have the electrification question, but we feel like we're, we're in pretty good position to, to address that.
I appreciate all the filler, and it just to level set on, I guess, what would be worst-case scenario in terms of engine adoption that, you know, everything goes battery electric, including, you know, large off-road vehicles, which seems unlikely, but just playing devil's advocate on that. What would the, you know, aftermarket stream be for you? 'Cause I assume that that would still remain quite attractive for you. You said a decade-plus of growth, but just the, the aftermarket.
Yeah. So.
Retention, you'd still have a lot of cash flow.
Yeah. I mean, the company is, you know, and Mobile Solutions is essentially 2/3 replacement parts. So I mean, if you could suddenly snap your fingers and create or convert everything to 100% electrification, first of all, we still do have venting applications. And we have some things to help, you know, battery-powered equipment operate. So we have sales there. But you have the whole aftermarket business. So you have all these pieces of equipment in the world. And I don't know if this happens country by country or suddenly, magically, in the world all at one place. But you have all the equipment that can live for 20, 30, 40 years into the future.
So you're still gonna have aftermarket or replacement parts that are gonna be, you know, needing to satisfy those products as they continue to operate while these hypothetical electrified equipment, you know, comes to the market. It just seems like such a long ways away. We wanted to kinda put a stake in the sand. So we, you know, we talked about what statement we wanted to make at our investor day. We actually have a model whereby we, we use our R&D team to help us. We basically have every platform in the world in existence. We, we also forecast future platforms that are coming. So we know all the equipment in the world. We can project, you know, the business we're gonna get from that existing equipment and from future programs.
And so we have the benefit of working with our OEs. So we know that they're working on their next, you know, internal combustion platform, which buys, you know, quite a while 'cause it'll take years to come into existence. So we do get kind of a firsthand view into what our customers are working on to satisfy their customers. But at the end of the day, our investor day statement was we, we expected to be able to grow Mobile Solutions revenues for at least 10 years. And that's, that's kinda how we see it.
Understood. A very, very helpful color. And circling back to Donaldson Catalyst, the, you know, build-out of Life Sciences that is attracting more attention, you know, appropriately. So, and the string of pearls kind of M&A strategy that you're utilizing is, is pretty intriguing. Maybe you walk us through, you know, each of the pieces that you put in place so far, the kind of portfolio role of those assets and, you know, how that, you know, it has helped to build the, the momentum that your team very confidently speaks to.
If you wanna follow up that slide.
Yeah. Oh, well, I don't know. I guess we got to follow up on, you know, I saw in the way I think about this is the way we presented it on investor day. And it's actually slide 100 in the Investor Day deck. And it's just basically a puzzle which shows all the different opportunities in Life Sciences. And first of all, I just wanna say, you know, we've been working on a lot of these membrane-based technologies for many, many years. And so we had a lot of organic activities ongoing. And when we did the redesign, which I mentioned, we pulled all those into the Life Sciences segment.
But in terms of the puzzle, you can see and this is kinda how I look at it is if we have an asset that we're looking at, you know, where does it fit into the puzzle? And we don't have to fill out the whole puzzle. We just wanna be very smart about where we're gonna play and what a new asset would bring to us. And we've done some things organically. And we've acquired, you know, four companies: Solaris, Purilogics, Isolere Bio, and UTEC. And we recently announced an opportunity. We're working out with an Italian public company called Medica. So we continue to invest in this area, to fill out our portfolio and to bring new technologies into the company. You know, I think we have very good technologies here that will gain traction as they scale into the future.
It's not gonna be immediate. It's a small business, say, $240 million-$250 million right now. We think we have good opportunities to continue to grow that in ways to deploy capital, you know, that bring a return relatively quickly. You know, you're not gonna run do a 20% return on day one of an investment. We think longer term, these margins are very high. We'll have strong returns for the company. As we scale them and bring them together and fill out this puzzle, you know, we feel like we're in good position. In the meantime, you know, we're able to generate record levels of sales and record levels of profit while making these investments. Our debt is, you know, 0.7, you know. It's not like we've leveraged up the company to get there.
And we feel like we're in good position.
Yeah. Absolutely. And circling back to one of your, your earlier points, you know, hopefully, the dry powder that you have and all the flexibility is utilized for growth investment as opposed to we're responding to another pandemic or, you know, any, anything along those lines, putting it in there.
I'm with you there. I'm with you there.
All right. And you kind of offered a segue into discussing Medica. What's the background to Donaldson's relationship with Medica? Maybe touch on the, you know, proposed deal terms, how that asset fits within the, you know, the puzzle that is steadily being filled in, and then how that should accelerate growth for the platform overall.
Sure. So I can take that one, Bryan. So, I mean, over the past couple of years, you know, we've developed a relationship with the founders and the management team of Medica, which is a world leader in hollow fiber membrane technology. And so Medica is a profitable EUR 80 million top-line company that sells these products, currently into the med device space for the purification of blood and for microbiological purification of water. So with that being said, in December of last year, Donaldson entered into a joint development agreement with Medica for the development and commercialization of hollow fiber modules in specific Life Sciences applications. And most importantly, for TFF, for tangential flow filtration in bioprocessing in food and beverage. You know, TFF hollow fiber consumables can play into the Solaris TFF skids. They can be used for our Univercells commercial scale integrated system.
And they can also be used with Isolere IsoTag reagents. So why I mention that is it's a very complementary investment and joint development agreement with respect to the acquisitions we already have in our portfolio. You know, a couple of weeks ago, we further strengthened this relationship that we have with Medica by signing an agreement to acquire 49% of the company, which would take them private. And that's through a public tender offer. 20% of that tender offer is through public float. And then the other 29% would be from the founders. So, you know, that would have us owning 49% of the company. And then we have a call option to acquire the remaining 51% of Medica between years 4 and 5 of the deal.
And so that currently, once this tender offer is complete, 49% of Medica's earnings will be in our Life Sciences reported in our Life Sciences segment. So, you know, I think the technology is certainly complementary. It's something we really appreciate. And we have appreciated it. And we've been very impressed with it for a while. We've developed a relationship for a while. So we're really excited about the prospect of folding this into the Donaldson portfolio. I don't know if there's.
Yeah. Bryan, I mean, to your point, I mean, you know, we've been talking to Medica for years. You know, in December, we got the joint development agreement with them. But we could see, I mean, there's not many companies in the world that can produce these hollow fiber membranes and some of the membranes that they can and their manufacturing facilities. I mean, that's a very limited skill in the world. And Bryan, you've seen our Materials Research Center, you know, here in Bloomington on the campus. And we've been working on doing some of those things in that facility. And so we know how hard it is. And we've been working on that for a while. And there's certain capabilities that they have that we don't have.
And we get a business that's, you know, operating and generating, you know, positive profit right now. But the thing that really excites me the most is we get these technologies under the company's umbrella. And we could definitely develop them over time. But I think it expedites our movement of some of these technologies. And we get the ability to leverage those technologies across the Donaldson company, which is what we do with all of our technologies. And one of the coolest things about Donaldson is we got all these cool technologies. And we can leverage those technologies across business units. So instead of just, you know, investing in a technology for one single, you know, use, we get the ability to leverage these technologies across more than one unit or more than one product or more than one capability.
And it just expands the company's core science of filtration. And I just believe this is kinda the next frontier for Donaldson. And so, you know, they did go public with 20% of their shares a few years ago. And we'll hopefully be acquiring that 20% through a tender offer. And then we'll acquire the remaining 29% to get to 49%. And then ultimately, we can get to 100%, you know, a few years down the road. So we're quite excited about Medica, and what they bring to the Donaldson technology and really their existing business.
Got it. No, very, very helpful detail. I, I did spend some time on the Medica site, the, you know, the technologies applications, all, all very interesting. I would be blatantly lying if I said that I really understood all of it, but, but certainly fascinating stuff. And, you know, no doubt your team can leverage that.
Researchers had their products in our labs and been working with them on a joint development, you know, arrangement. And you could just see when the Donaldson scientists get their products or they get together, you know, with these other companies' scientists. It's pretty exciting, you know, opportunity for both companies. So I think it's a great combination. And this is really how we do acquisitions. It's through relationships. You know, it's not through, you know, a bid situation where you got 10 companies, you know, trying to bid on a company. And the highest bidder's gonna win. We wanna find companies that are interested in teaming with Donaldson and whereby we can get into a relationship where certainly we have to pay a fair price. But you're not just in some bidding war. It's a situation where we know the companies.
They know us. And both sides kinda know what they're getting. And I think it makes for a higher chance of success in the future.
All makes sense. The catalyst that is a little closer to home, certainly more tangible, for me, is IFS connectivity, your continued rollout there. We can see in the numbers that the strategy has been successful. You know, the profile of the industrial segment has really transformed the last couple of years, you know, perhaps implying some upside to the investor day targets that you put out. How has that worked, you know, to date? What are the next steps? Am I overstepping and saying that there, you know, there's implied upside? Just, it seems like you have a lot of momentum. You know, the strategy is really, really clicking. Just curious what you can offer on that.
Yeah. So, I mean, we're very excited about, you know, our industrial position, the technologies we have, and the ability to overlay connectivity on top of that. So we have a very strong set of capabilities, you know, whereby we can pretty much handle any sort of industrial filtration need that a customer might have. So we have a very strong suite of products. And we can see, you know, based on our efforts to date of the value of connectivity, we can compare the average revenues from our connected customers to those that are not connected. And we can see the incremental benefit we achieve from connectivity. And we're early in this. We have literally tens of thousands of pieces of equipment in the world that, you know, we sold that we can go connect. We can connect other people's products.
And for most of our new equipment that's sold, it's coming out with a connectivity embedded in it. Now, we won't turn it on if the customer says, "You know, you can't turn it on." But certainly, there'll be no need to go visit a customer if they wanna connect their solutions. And generally, what we've seen is, you know, everybody's got priorities. And everybody's got stuff they gotta deal with. But once we get them to convert to a connected solution, you know, their experience improves. And our revenues with them go up. And their ability to manage their operations improves. So, you know, I think there's upside in the whole company, Bryan, not just industrial, for the record. That's why I'm an employee here. And I'm a big investor.
But I think that's just one of the opportunities, you know, that we have for long-term, you know, strong returns. Is you're really improving our connectivity and then improving our service offerings that go along with that. So I think we're in good position there. We have a lot of opportunity in front of us. And we're gonna continue to invest. And as we get more into it, it's easier for me to calculate the returns and see the investments that we're making and the returns that they're bringing. So that's a pretty exciting opportunity for us.
Excellent. I think we have about a minute left. We've covered quite a bit. Anything else you'd like to leave the audience with today?
No. I think we pretty much covered the gamut.
Oh, we certainly appreciate your support, Bryan, and your coverage of the company and your fine work and all your investors' interest in Donaldson Company. So, thanks so much to everyone for attending. You know, we look forward to seeing you down the road.
Thank you very much. Always good to see you both.
Thanks.
Thank you.