Good morning for the first day of the Jefferies Global Industrials Conference. It's Laurence Alexander with the Jefferies Chemicals Team. It's my pleasure to introduce Rich Lewis, the CEO of Donaldson. Without any further ado, Rich, I'd like to pass it over to you.
All right. Thank you. Good morning, everybody. Welcome to the Donaldson presentation. As Laurence said, my name's Rich Lewis, I'm President and CEO of Donaldson Company. Looking forward to sharing our story with you today. We'll start with safe harbor statement. I know everybody's seen this a million times. We released our fourth quarter fiscal year 2026 and full year results two weeks ago to this day.
Everything will be anchored back to the guidance and the results we presented at that time. I'll spend a little bit of time on this slide because I think this is the slide that gives you a little bit more intimate picture of who we are as a company. We are a filtration company, and we are a technology-led filtration company. What does that mean?
I'll anchor on the words technology and filtration and take you down a little bit into some more detail. When we talk about filtration touches really every corner of our economy, every corner of our daily lives. It's pretty much present in all the business verticals in the industrial spaces. It's a really wide playing field. The second part is technology. We play where technology matters. We've invested and built a capability around technology over 100 years.
We're looking for applications, products, positions in the market where incremental investment in innovation or in filtration technology provides more benefit to our customers. Those are the two areas that we really play in. If you think about our customers, we're on mission-critical applications where technology matters, and we really do two things for our customers.
We provide them greater peace of mind, protecting their most critical assets. Think about their people, their products, and their processes, how they make money. We protect those things with our filtration solutions. We enable them to have greater levels of prosperity, because when they use a Donaldson product, they can make more money than they can with the alternatives.
That's through overall lower cost of ownership, through higher levels of yield, better uptime, better reliability. It's really a wide market opportunity, and we focus on mission-critical, where technology matters applications. Over the century plus that we've been in business, we've built a set of capabilities foundationally that we leverage across these markets. Think about the technology base that we have is really unique, and we can deploy it into multiple endpoints in the market.
We also have a similar operational capability that we can deploy into all these different market segments. That gives us a reinvestment advantage to invest back into the company, continuing to set the bar for technology across all these market segments. We have done that decade over decade, over product life cycles for many, many years.
That allows us to reinvest back into the company. If you think about our growth strategy as a company, it is really one of balance. First, we have a set of applications, product lines, markets that we participate in, and we reinvest into those to continue to maintain a leadership position. These are markets that foundationally are growing, and then you add in pricing and market share gains for our growth algorithm. We use the proceeds from that to broaden our technology base.
Think about higher purity, lower, smaller contaminants, and this allows us to open up new addressable markets that are in higher growth and higher margins. Continuing to grow our core while we expand our base to open up a wider swath of opportunities for Donaldson. This is really who we are, and this is how we have been successful in the company and why I think we are a great long-term investment opportunity. This is a good takeaway slide.
111-year-old company. We operate across three verticals, each with margin expansion opportunities and growth opportunities for many years to come. If you go back to technology, we have over 3,000 active patents, and a big part of our story is the resiliency and the reliability of our recurring revenue. Over two-thirds of our revenue comes from consistent, recurring, high margin replacement parts.
We deploy this across a global network, many different product lines, many different applications, and we operate globally as a company. This allows us the scale to drive efficiency, but also a local capability and a local touch. We built sales, engineering, and operational capabilities to really support our customers where they need us, which is in region and on different types of product applications.
75% of our sales are built in region, which gives us a robustness and reliability against some of the global economic challenges that we face every day. It really makes us a good, trustworthy partner for our customers. Our goal financially is very simple, deliver higher levels of profitability on higher levels of sales. Fiscal year 2026, which just ended at the end of July, we had set records for sales, operating profit margin, and EPS.
If we look to fiscal year 2027 at the midpoint, we are looking at a 7.5% top-line growth. We will set a new record on operating profit margin at 16.9%, so a 90 basis point expansion, and then we will set growth for EPS at 8%. We are doing this through higher levels of replacement parts, pricing excellence, and then really driving expense leverage and operational excellence through every layer of our company.
This is a big part of who we are as a company and a big part of our success. We are really excited about fiscal year 2027. We see a lot of opportunities ahead, and I will talk about some of the verticals here in a second. I want to spend a little bit of time on our competitive advantages.
I think this is a tough one for people to digest, so I want to take a little bit of time because it actually is layers of advantages. It's not one individual thing, and it changes over time as we compete in markets. Generally speaking, we engage with our customers when they have a filtration problem that they need to have solved.
So we're solving their toughest filtration problems. A lot of times, that happens at the very outset of a market that's being developed for the first time or at an inflection point where something is changing with our customer's technology that requires them to have a better filtration solution that's been available to them in the past. We do that, we solve their problem.
That starts to seed a foundation of trust that we build on, and we build on that by working back and forth with that customer many times over decades to develop a deep application expertise. So if you think about an air filter in the Mobile Solutions market, it's not one product. It's dozens and dozens of applications that require very unique engineering capabilities, and then if you look across all of our end markets, they require very unique operational capabilities.
The foundation is consistent, but there's bespoke capabilities required to serve each one of those markets at a leading level of service. We develop those two capabilities over decades of working with our customers, then reinvest to create other advantages through cost and efficiency based on that scale that we have built. Then we protect that with a relentless focus on continuous improvement.
It's really a technology, application, operational capability that all comes together to make our markets very defendable. Three segments. We talked a lot about the markets at our last earnings call. I'm sure there'll be some questions on this. Mobile Solutions business is performing quite well. They've expanded profit margins. They've continued to grow that business in spite of some of the end markets being in sort of downturns over the last two or three years.
We are seeing more green shoots across this space as we look into FY 2027. We're really optimistic about the growth opportunities in this business. The interesting part is they've continued to grow through a market downturn, and the business has done quite well, both in share gain and executing the strategy. Industrial Solutions, aerospace and defense, power gen, very strong secular tailwinds in that space.
We're starting to see opportunities on the non-power gen CapEx side. We're seeing some additional quote activity, so a lot of opportunities in the industrial space, and we're expecting a big step-up on an execution in fiscal year 2027. Life Sciences is anchored by our process filtration and disk drive businesses who have been doing quite excellently while we build out our technology base for high-purity filtration.
So three segments all have really excellent growth opportunities and margin expansion opportunities. Capital allocation remains the same. A very balanced, disciplined approach to capital allocation, our first priority. Our second priority is to invest back in organically. We have a great business strategy, a great business model. We want to grow organically in our core businesses while we build out our technology foundation. We will continue to do strategic M&A. I'll talk about Facet here in a second.
That was our largest acquisition in the company history. We just closed that on May 4. We will continue to disperse monies back to our investors through dividends and share repurchases. We have been a proud member of the S&P High Yield Dividend Aristocrat Index for 10 years.
It takes 20 years of increasing dividends to get into that fund, so we have got 30 years in a row of increasing dividends. It is a big part of our strategy. We are going to continue to be great cash generators and invest back into the business. A little bit on Facet. Facet was our largest acquisition. We closed on May 4. We have talked a lot about this acquisition. It is an industrial business, but it has, I would say, Life Sciences attributes.
Very high margins, very sticky customer relationships, all based on high critical applications in the aerospace and defense industries, and with expanding opportunities into power generation. Really good business, high margins, about 2x our company average, and 70% replaceable consumable parts. Really fits our strategy quite well. Thus far, it is performing exactly to the business case that we had put out there for this one. We are happy with the team.
They are very Donaldson-like in their culture, very customer-centric, and they have a great product in the market. I will wrap up here. We are a filtration company. We lead with technology. It is a very wide market. We have a lot of critical applications where we have opportunities. We will continue to grow the company organically. That is a big part of our balanced or growth strategy while we build out our technology base. I think we are going to have a great FY 2027, and the outlook for the company is quite bright for years to come. With that, I will turn it over to Laurence.
Please put up your hand if you have any questions. Maybe just to start off, can you unpack the growth algorithm for 2027? How much of that is share gains, and how much of that you are thinking about as price mix? Really on the price mix, just to kind of put the lead out there is, are you seeing that there is a mix in your end markets that might reverse towards the end of the decade, or do you see the price mix dynamics as kind of sticky and stable to the margin expansion?
Sure. Yeah. Let's think about the 7.5. We'll go to the midpoint. You can pick whatever endpoint you want. So 2% price, 2% year-over-year Facet sales, since we only closed them on May 4, 1% FX, and then the rest would be market share gains. That's the algorithm for FY 2027. Of course, as our OE markets come back on the first-fit side, we'll see a little bit of gross margin pressure. But I would assume that the margins that you've seen will continue through the end of the decade, through other business initiatives.
With the share gains, some companies in the industrials have been talking about as their end markets accelerate, they see the rate of share gains also accelerating, so there's a bit of an amplification effect. Do you expect that to happen in this market, in your markets?
I think if you look across all of our markets, and you probably have to go market by market to really answer that question. There are some that we're seeing accelerating share gains. I would say others are pretty static with what we've traditionally seen. Share gains is a big part of our growth strategy, and it varies business to business. You can think about it in the 1%-2% range overall. A good example would be our Mobile Solutions business.
These are sales cycles that are three to four years long, and then there's another three or four years before the service part revenue really starts to accelerate. We can measure our share gains today and look at project revenue sometimes 6-10 years out. We know exactly how much share we're taking today that will manifest in years to come. We're able to measure that pretty accurately in a market like that. Other markets, it's a little bit tougher, but
Now, you've commented about how the businesses need to kind of earn their place in Donaldson.
Correct.
Can you talk a little bit about what criteria you're using? Particularly when you identify a part of the business that needs to be upgraded, how much time or what resources they're given to upgrade? Is it the whip or the carrot or a combination?
Well, the criteria we're looking at is how attractive is the niche we're in from a growth, how durable is the growth? What position are we in? Can we be in a leadership position in that particular niche? What's the ultimate financial performance of that industry as a whole, and where can we play into that?
Most of our businesses, we're looking for durable, scalable growth with a path to operating profits that are in excess of what we are generating today. Those are the ones that are barely being goosed and funded. If they're on the side of they're below that, there's a process we put in place to sort of manage that portfolio, and the timeframe varies. If it's a long-term investment and we're really seeding a long-term market, we'll give it more time.
If it's an execution problem, then the expectations is one or two years, it's fixed. There's a good example where we had a business years ago that was underperforming profitability-wise, and it sort of was a little bit of a challenge. We reshaped that business, turned it into actually one of the leaders in our portfolio. It took about five years on that one to get that exactly where we wanted it. It varies business by business, but there are very specific criteria that we're looking for. Number one, are we the best owner? Do we have a right to win? Then can we get it to the levels that we expect the company to be at?
I have a question, which is more about how you manage complexity in the business, but really around growth opportunities. There's kind of a proliferation of strong secular trends in the industrial markets, and each year there seems to be a new one, like data centers now is sort of the favor-
Right
but there's several others coming down the pike that seem to be emerging. How do you allocate resources across those, and are there any secular trends that you think will really change Donaldson's growth algorithm over, say, five, 10 years? Which ones are you just not playing in and you have no interest in?
Yeah. If you think about, we talked about this wide filtration market. Two markets that we typically don't focus on are markets that touch consumers. Think about automotive, and home HVAC, where a consumer is ultimately making the last replacement filter decision. Those are not markets that we traditionally focus on. We are usually B2B, where the applications are mission-critical, and we can help them make more money.
If the overall cost of the filtration system is relatively small to their operating budgets and the profits they generate from those secular trends, of course, we see a lot of opportunities in the aerospace and the data center side of things. How long the data center will go is anybody's guess, but it's not months, it's years. That's one that we're well-positioned for across multiple product lines. We're in a good spot on that one.
I think if you look at other secular trends that are out there, it's sort of the ones we've always been dealing with, sort of more income is driving higher levels of consumption of certain types of food products, which has really been helping our food and beverage market. Data storage is driving our disk drive business as more people put things in the cloud.
AI is driving that. There's a lot of opportunities. But I would say our core business, the foundation of that, is still going to continue to grow, and that'll be a big part of our focus. Because we want to protect those number one and number two positions, and those businesses have a lot of opportunity in front of them.
When you think about, I am going to ask a broad question.
Sure
It has three pieces to it, and this is around automation. One is, I think your process know-how is often given short shrift. If you can talk a little bit about your differentiated manufacturing process and how that is changing with the ability to scale up and automate different steps.
Also, if you think about the end market implications, I have always been curious about just how much human error contributes to people needing to replace the filters. Is it better for you if you have a mining vehicle that is automated versus a human operator? Is automation a net benefit, or is it going to turn into a bit of a smaller end market because there is fewer mistakes being made?
Yeah, I think if you think about, let us just take automation for us, because I think it is an important part of our story. A lot of people think about the filter and the technology that we give to our customers and 3,000 patents and all of the IP around that. That is an important part of the story, but equally important is the advanced manufacturing group that supports that.
A lot of our manufacturing processes are also trade secret, IP protected, because they are very unique filters that we are deploying. The automation in a lot of our manufacturing lines has increased significantly over the years because the products have become more complex, more challenging to make. We have a factory in Indiana. It is a very advanced line. I think it has 25, 30 robots on it.
It is an extensive acceleration of a 10 or 15 year ago line that might have one or two robots. A lot of opportunities to continue to drive complexity, and that is where the scale gets hard to replicate for people, because we are setting those standards. Automation as a trend in our markets and the impact on us, I think is relatively small, whether there is an operator in the vehicle or not.
We do not play a lot in the cabin filtration space, which obviously you would need less cabin filtration if there is no operator. We are protecting the power unit, and as long as those power units continue to be what they have traditionally been, and we expect that to be that way for quite some time into the future, they will need the same level of filtration.
If anything, connecting the vehicles and putting more sensors on them makes for the change outs to be more reliable. So that part of it has been very successful. We see a higher level of retention rate and a higher level of on-time changes when there's monitoring involved on the application.
I was just wondering what your exposure is to, I think this HAMR product at Seagate. Is that gross margin accretive or dilutive? In general, it seems to me that you have a lot of end markets that have, at least on the OE side, have kind of troughed and should be heading upward. So when you gave guidance for this next fiscal year, what were your underlying assumptions? Maybe you could just walk us through the big end markets you have and where you think you are in those cycles.
Sure. Yeah, let's take the HAMR example. HAMR is a new technology released into the disk drive market. It's really an important step for that market because they need to continue to stay ahead of alternative technology, solid-state. With the density of these new drives, it requires a new manufacturing process for our customers.
The level of intensity in the filtration is significantly higher than the prior generation, which was significantly higher than the prior generation. So, you're talking about the cost per drive and filtration has gone up significantly. Margin accretive for sure. Just generally that's a higher margin business for us. We're very well positioned for that technology shift. Just a quick side story.
I was at our disk drive facility in Thailand a couple of years ago with one of our disk drive customers, trying to get that HAMR technology up off the ground, and it was pretty cool experience to watch our people working with their people. That's when I really understood the depth of our technology capability in that business.
We were actually solving problems that had nothing to do with our product, but was helping them solve problems with their drive, and that's that stickiness we get from a technology-based company. On the OE side, yes, ag has troughed. I think if you go back a couple quarters ago, we were starting to see green shoots in ag, but it was very selective where it was at. Certain size vehicles, certain customers.
You fast-forward to today, and we just talked about this a couple of weeks ago, it is more broad, the green shoots, but not to the magnitude that we've seen other markets step up. So we think we're in the early innings of that because these markets, when they come back, they come back usually 20%, 30% in volume. So we're starting to see ag come back more broadly, but still not to those higher levels yet.
So we'll see how the year goes on, but it certainly feels like it's starting to turn in ag. Mining's been pretty solid for the last two or three years. Construction has strengthened. We're seeing a lot of strength across our construction products.
Then I say on road trucking, it's primarily been a U.S. story, where we're starting to see that market really start to inflect through the end of this calendar year and then probably into the first half of next year. Then we'll kind of see what happens with the regulations and where the market's at. But yes, they've all sort of inflected, and they're all in positive territory. I think if you go across our entire company, it's very rare to see all of our markets sort of moving in one direction. I think other than maybe one, they're all moving in a positive direction.
Part of the guide was if you think about the split of first-fit versus replacement parts in that OE business, that Mobile Solutions business, we're very heavily weighted towards the service part side, and that business has been going very strong for now over a couple of years. So the first-fit's going to inflect, but it's still a relatively small part of that business. Yes.
Yeah. So just touching on what you said in terms of U.S. trucking-
Yep
and those orders in general, can you just walk through a little bit about what you're seeing in terms of the Class 8 trucking orders, kind of at what point that sort of inflects, how much revenue, and just generally how that can contribute to you guys on a top-line basis? Do you see that kind of contributing to aftermarket in years to come going forward, or will these new orders just kind of replace older trucks on the road, and that number of trucks would be relatively stagnant, if that makes sense? How do you see first-fit and sort of just general A trucking orders contributing over time to the aftermarket?
Yeah. So the market has inflected, specifically in the U.S. We've seen significant uptick in build rates. Keep in mind, that's still a very small percentage of our overall company on the first-fit. It does drive long-term revenue because we are layering in new intellectual property, new technology to those customers. Over time, as those trucks get later in those years, it gets a little bit harder to protect that. So as they renew those cycles, our retention rate goes up.
So I think from an overall standpoint, continuing to turn over programs and continuing to see build rates improve will affect the long term. Probably more importantly, and we talked about this I think either one or two quarters ago, we had a nice market share gain on the aftermarket side, and a lot of that runs through both independent distributors and OE distributors.
When we win these products from the competitors, not only do we get on the shelves for that particular end customer, but we're now on the shelves for all their customers they sell to. That gives us additional pull-through. So each incremental win there is a nice early revenue gain, but it also provides longer-term revenue opportunities because now we're on the shelf, and when those customers come in, they may not be on contract. They can buy Donaldson product. So really happy with the performance on the U.S. truck business and where it's headed.
Can you just give us a sense from a corporate planning perspective about the mining cycle? It's been strong for a while. Is it a long cycle? Are you planning for that? Would there be future acquisitions in that space? Thank you.
Mining specifically, I would say it's not a target from an acquisition standpoint because we have pretty much a full product line portfolio. We have global reach. We have great dealer network. It's an area where we are really focused on organic growth and making sure we're touching those customers in unique ways from a product availability.
There's maybe one particular product line extension we could do in that space, but it would be small in nature. The base business and the organic market is really what's going to drive that. It has been pretty solid for a while. We're still not back to levels we saw in, let's maybe say 2012. I mean, that was really peaked out back then. It's been pretty strong, and I would expect that's going to continue for quite some time.
If you look at all the key statistics that we see and our customers talk to us about, it certainly feels, minus some sort of global economic shock, that this thing has legs for quite some time. It's a great market for us, that mining market. That's where technology matters probably more than anywhere in the Mobile Solutions space.
Just a quick question, just 30,000 ft. I mean, the move in general, we're moving to electric. I don't know. Is there filtration? Does that create some sort of existential risk to your company?
Yeah, no to the existential risk. Obviously, if you go back five or six years ago, this was a fairly discussed point, I think. We have a very extensive electrification model. It's quite elaborate. It manages a lot of inputs and helps us predict what's going to happen in that space. Plus, you have all sorts of external inputs as well at this point. Our position has never changed.
I think the world sort of came to the same conclusion that we were at, which is this thing is way out there. Just to give you kind of an anecdote, we did a deep strategy review with our board in January. We had two large OE customers present electrification at that meeting. The message across in two completely different markets was this thing is significantly further out in the future than we anticipated.
If anything, they have a bunch of investments they've made that they're not really getting leverage on to date. So long term, we can't ignore it. I would say if you think about the next 15 years, it's immaterial, and then after that, I think it will drive probably opportunity for about 15 years. The technology that wins in the end will dictate how much filtration.
If it goes more fuel cells, there's actually more content in filtration on a fuel cell than a diesel engine. If it goes battery, there's less. We continue to diversify into high-purity filtration in our Industrial Solutions business. So it'll never be an existential question or just be how important is that vertical versus the others. I would say for the next 10 years, think about Mobile Solutions being very critical to the company. I do believe this market will consolidate eventually.
There's a highly fragmented 50% of the market where I believe the competitors will really struggle to try to maintain, because they're very exposed to automotive, which is going to electrify faster. Without that base of business, I'm not sure how they're going to fund themselves. So we believe that we'll be a consolidator of choice in this space, and there'll be a lot of opportunities to sort of pull that together and get more scale over time. But long term, we continue to diversify into other places, strengthen the company in other ways. But think about that as a 15, 20 year problem, not a five year to 10 year problem.
Exactly. In terms of exposure to WFE or clean rooms and a lot more semiconductor capacity going forward.
Yep.
Do you guys benefit from that?
We do. Yeah. We have a microelectronics business that we just folded in with our food and beverage. They are called process filtration. We are on all the lithography equipment inside these clean rooms. The clean room has a filter, the lithography equipment has a better filter, and that is the one we provide. It is not a huge business. It is a niche.
But inside those same fabs are lots of liquid opportunities, and the technology we sell into food and beverage and pharma actually is very similar to the technology they use on specialty chemicals and some of their liquids. That is why we combined the two businesses. We have a great, robust sales force in our food and beverage. We have a great market reputation with the one product we have on lithography equipment.
We want to combine those two, and expand our product line to press into the liquid side, and get even more exposure to the microelectronics. That is a great space for us. When we think high purity, everybody a lot of times goes all the way to pharma, bioprocessing. But it is these advanced industrials, there is a large market share opportunity there as well in high purity filtration. Microelectronics and food and beverage probably being at the top of the list.
Then just very quickly, can you touch on the strategy going forward for Life Sciences? Also, can you touch on do you have the right assets to be competitive in fluid, or do you still need to scale up there?
On Life Sciences, I mean, Laurence, if I do not answer your question correctly, let me get another shot at it. I think the way I understand your question is what does Life Science look like for us going forward? The base in that business right now is disk drive and process filtration. You would ask, "Well, what does disk drive have to do with Life Science?" It is a high-purity filtration solution.
The solutions we deploy for HAMR is actually very, very small contaminants, sometimes even gases that have to be absorbed. That technology is part of the high-purity space that we are in. Our food and beverage business that we have renamed process filtration, probably 15% of that business is actually pharma. The same products that are used in food and beverage can be used in pharma.
They are also a part of our data center cooling product offering. It is a broader process filtration business. We see a lot of opportunity to grow that business. We have invested in four bioprocessing products. These are all early stage, sort of disruptive type products. Time will tell how disruptive they are going to be. We have commercialized a lot of products across those four businesses. Market receptivity will be judged over the next couple of years.
The goal, getting customer access, and then we will continue to build out our technology foundation. Think about that as a long-term seeding effort to get access into that market. It is not a meaningful contributor for the next two or three years, the bioprocessing. But it is an attractive market over time that if we can find the right access point, we believe will be a meaningful part of the company further down the road. We like that market. We think filtration matters in that space. Our ability to access it is what we are working on right now.
Okay. Thank you very much. Or if very, very quickly.
I think I remember your slide from a little back. You're going to earn like $3 this year, and next you guided to like $3.30 or something? It looked like less than 10% EPS growth.
Yep.
It seems so low. Like why?
Yeah, I think if you deconstruct that, the acquisition of Facet and the debt financing and the amortization costs are what's putting pressure on that. Brad, if you strip that out, EPS would be up how much?
Yeah. The dilution from Facet this year is $0.12.
Yeah.
Think about tacking $0.12 on to give you a sense of the organic growth. Now you are in that nine-ish percent range.
We will crank that debt down over the next couple of years. Yes, that is the immediate pressure from that acquisition we just closed on May 4.