DONALDSON Co INC Q4 2025 earnings call

Good morning.

Thank you for joining Donaldson Company's fourth quarter.

fiscal 2025 earnings conference call.

With me today are Tod E. Carpenter, Chairman.

President and CEO and Brad Pogalz, Chief Financial Officer. This morning Tod and Brad will provide a summary of our fourth quarter performance.

Our outlook for fiscal 2026.

During today's call we will discuss non-GAAP measures.

GAAP or adjusted results for fourth quarter 2025.

Non-GAAP results exclude pre-tax charges of $9.5 million for restructuring and other charges primarily related to footprint optimization.

Cost reduction initiatives.

A reconciliation of GAAP to non-GAAP metrics is provided within the schedules attached.

To this morning's press release, additionally, please keep in mind that any forward looking statements made during this call.

Thanks, Sarika. Good morning. fiscal 2025 was a record year for Donaldson Company as we did what we do best: help our customers solve critical filtration challenges through the delivery of our high-tech solutions, which protect precision equipment and help maintain a cleaner work environment, increasing efficiency, mitigating risks, and reducing downtime. We did this through consistent execution of our strategy and created value for our shareholders. I will start with some full-year highlights, discuss our fourth quarter performance, and touch briefly on our expectations for fiscal 2026. Brad will then detail our financials. Lastly, I will provide some closing remarks before opening the call to questions.

In fiscal 2025, we grew sales to an all-time high of $3.7 billion with growth across all segments, expanded operating profit margin to a record 15.7% with an incremental margin of nearly 30%, delivered earnings per share of $3.68 towards the higher end of the guidance range we laid out at the beginning of the year, returned $465 million to shareholders largely through the repurchase of 4% of our shares outstanding while increasing our dividend 11%, and focused our cost structure, including in Life Sciences, and made progress towards footprint optimization, strengthening our foundation for future profitability while still investing for growth. Our team accomplished a tremendous amount in fiscal 2025 through macro uncertainty and cyclical headwinds. We ended the year on a high note, and I will provide some details on the fourth quarter, including by segment.

In Mobile Solutions, our strength in aftermarket is contributing to record results as we continue to win and gain share in our independent channel, which eclipsed $1 billion in sales this year. Partnerships like NAPA allow us to expand our reach, and we continue to build these types of relationships. For example, in the fourth quarter, we signed a new partnership with Mitei Distributing System of America. Donaldson is Mitei's sole heavy-duty filtration supplier of Donaldson branded products, and we are pleased with the early results. With respect to our largest first fit business within Mobile, off-road sales grew after eight consecutive quarters of declines as we see tangible signs of trough or moving out of trough conditions in the agriculture market. For Industrial solutions, IFS sales grew double digits. Through our Create Connect Replace service model, I would like to touch on each piece briefly.

Create in dust collection we are building new customer relationships and our OE channel sales hit record levels. Our generation sales were also strong. As we continue to benefit from the Power Gen Super Cycle connect, we are deploying our connected solutions. This quarter we increased the number of connected machines and connected facilities and in fiscal 2026 we expect to grow the number of connected machines over 30%. Through this we are strengthening our customer relationships and building this revenue stream for the future. Replace our razor-to-sell razor blade aftermarket model is working with almost 50% of our quarterly industrial segment sales now driven by higher margin aftermarket sales service. This quarter we acquired our third service business, RPS Associates of New England.

RPS brings 40 years of experience in dust collection services with customers in aerospace, defense, and other metal manufacturing industries and also adds a new geography to our service footprint. Moving to life sciences, food and beverage sales grew over 20% both in new and replacement parts sales. We are winning share through key OEMs and channel partners in this high margin business. In bioprocessing, through our downstream purologic business, we announced the availability of the first manufacturing grade product within the Purexa portfolio to support customers' GMP or good manufacturing processes. The Purexa membrane chromatography products enhance productivity with their high dynamic binding capacity, fast cycle times, and efficient and scalable format, allowing users to process their product more quickly and reduce process costs. Now I'll cover some consolidated company highlights for the quarter.

Overall sales increased 5% year-over-year to $981 million, driven by volume growth, currency translation benefits, and pricing. Adjusted EPS was $1.03, up approximately 10% year-over-year. I'm proud of our results and would like to give a special thanks to our global operations team who once again this quarter navigated the difficult macro landscape, including the ever-changing global tariff dynamics. Brad will talk a bit more about the impact from tariffs, but I want to emphasize my confidence in the muscle we have built to address challenges quickly and effectively. Also in the quarter, we progressed on our footprint and cost optimization initiatives. We remain in the heavy lift phase of this work and expect to be mostly complete by the second half of fiscal 2026. Through this we have stayed focused on our customer needs.

On-time delivery rates remain high, and our backlogs support our outlook over multiple quarters. I'm also pleased with our thoughtful expense management while we lay the groundwork for a more efficient operating structure. It is important to note that we are making disciplined growth investments in strategically important areas through our R&D and capital expenditures, including in areas such as solvent recovery and new disk drive technologies in life sciences and air and alternative fuels. Filtration in Mobile Solutions is cementing our leadership position in diversified technology-led filtration. Now I'll provide some detail on fourth quarter sales in Mobile Solutions. Total sales were $588 million, a 2% increase versus prior year. Aftermarket sales were $468 million, up 3%, driven by strong demand in the OE channel from larger customers and market share gains in the independent channel.

On the first fit side, off-road sales of $95 million increased 5% as we cycled against weaker agriculture market conditions in the prior year. On-road sales of $26 million declined 20% as a result of cyclical declines in global truck production. Now on our Mobile Solutions business in China, sales grew 14% year-over-year with increases in first fit and aftermarket, marking the fourth consecutive quarter of growth. While we are still cautious in the near term on the overall market in China, we are encouraged by the traction we are gaining with local customers. This quarter we won another hydraulics program with a local manufacturer in the agriculture market, a sign of customer confidence in the Donaldson value proposition. Turning to Industrial Solutions, industrial sales rose 8% to $310 million.

IFS sales of $262 million grew 11% from new equipment sales in dust collection in Europe and North America and power generation project timing. Aerospace and defense sales were $47 million, a 6% decrease driven by a decline in defense sales following the completion of a few large projects. In Life Sciences, sales of $82 million rose 14% compared with prior year. Double-digit growth in food and beverage and disk drive was partially offset by a decline in bioprocessing sales. In total, our results this quarter capped off a tremendous year for the company. Looking ahead, Donaldson Company is well positioned to further strengthen our foundation and capitalize on improving market conditions and cyclical trends.

As such, we are forecasting at the midpoint of our guidance ranges another record year in fiscal 2026 with total sales of $3.8 billion, inclusive of sales growth in each of our segments, an all-time high operating margin of 16.4% ahead of the fiscal 2026 target we laid out one year ago, and record earnings of $4 per share. Now I'll turn it over to Brad, who will provide more details on the financials and our outlook for fiscal 2026.

Brad, thanks Tod. Good morning everyone. I want to start by thanking the Donaldson team for delivering another strong year. We were navigating a complicated environment and had to make some difficult decisions, particularly related to structural cost changes, and the teams delivered. Our approach is simple: grow the company, grow profitability, maintain expense discipline, make thoughtful investments, and return cash to our shareholders. We did that in fiscal 2025 and expect to do it again in fiscal 2026. Now turning to a few highlights from the quarter, note that my profit comments will exclude the impact from the restructuring and other charges Sarika referenced earlier. Total sales increased 5%. Operating margin was a record 16.4%, up 10 basis points over the prior year.

Adjusted EPS was $1.03, 10% above the prior year, and as expected, cash conversion was strong at 123% as we successfully worked down inventory and delivered to our customers. Going further into the P&L, gross margin was 34.8%, down 140 basis points from 2024. The impact from tariff-related inflation on our LIFO inventory valuation was significant this quarter. Expanding on this point, we use LIFO accounting for our U.S. business and can experience increased costs or benefits depending on whether we are in an inflationary or deflationary environment. The current inflationary environment resulted in higher costs, accounting for nearly all of the year-over-year change. Said differently, excluding the impact of LIFO in fiscal 2025 and 2024, gross margin would have been approximately flat to the prior year. In terms of underlying business gross margin, we remain in a solid position.

Productivity headwinds in the quarter from optimization projects are being offset by efficiency and fixed cost leverage in our facilities, and we continue to do an excellent job managing price versus cost, including those costs related to tariffs. Given the importance of the topic, I want to underscore our view that over time we plan to be profit neutral with respect to ongoing tariffs. We remain confident in this due to a few things. First, our region-for-region global footprint. Second, nearly 90% of our goods shipped from Mexico, where our biggest exposure lies, are USMCA qualified and currently exempt from tariffs. Third, our pricing muscle, which is strong and supported by the high-tech value of our solutions and our ability to deliver reliably to our customers.

In addition to managing price versus cost, our team has successfully managed operating expenses during a fluid environment, including with restructuring actions in the quarter. Operating expense as a rate of sales improved to 18.3% from 19.9% a year ago, a continuation of the positive trend we've seen all year in terms of segment profitability. Mobile Solutions pre-tax profit margin was a record 19.1%, up 80 basis points year-over-year due to the timing of inventory adjustments and leverage on higher sales. Industrial Solutions pre-tax margin was also a record at 20.9%, up 80 basis points due to leverage on higher sales. Life Sciences pre-tax margin improved to 5.3% from a negative 1.2% a year ago.

Strength in high margin food and beverage and disk drive sales and leverage from an optimized cost structure across the segment more than offset continued investment in bioprocessing as we work to scale these businesses. Now I'll walk through the details of our fiscal 2026 outlook. First, on sales, we're projecting full year total sales to increase between 1% and 5%, with sales of $3.8 billion at the midpoint of this range. This includes pricing of approximately 1%. The impacts from both currency translation and tariffs are expected to be negligible. For Mobile Solutions, we're projecting sales to be flat to up 4%. We expect first fit sales to rebound after comparing against 2025, a year in which we saw significant end market weakness in agriculture and transportation. Off-road sales are expected to grow mid single digits and on-road sales are projected to increase high single digits.

Aftermarket sales are expected to grow low single digits from continued market share gains and vehicle utilization rates. In Industrial Solutions, sales are forecast to grow between 2% and 6% driven by a mid single digit increase. In IFS, where sales are expected to improve across all businesses, including strategically important areas such as aftermarket and services, aerospace and defense sales are projected to be flat after cycling against record levels in the prior year. In Life Sciences, we expect sales growth between 1% and 5% from continued momentum in our larger legacy businesses, food and beverage and disk drive. We also project an increase in segment profit margin in fiscal 2026, growing to mid single digits as a rate of sales and building on our momentum from 2025.

For the total company, we are projecting full year operating margin once again at record levels and between 16.1% and 16.7% at the midpoint. This is a 70 basis point year-over-year improvement driven by gross margin expansion and expense leverage. Our expected performance represents an incremental margin of approximately 40%. Our EPS guidance is $3.92-$4.08 centered on $4 per share. The midpoints of our top and bottom line guidance ranges represent 9% earnings growth on 3% sales growth, underscoring our ability to deliver higher levels of profitability on higher sales. During our investor day in 2023, we projected fiscal 2026 operating margin at the midpoint of our guidance range to be 16% along with an incremental margin over a cycle between 20% and 24%.

While our end markets have not behaved as expected, taking the midpoint of our current fiscal 2026 guidance ranges, we have more than delivered on our profit targets, demonstrating our strong commitment to margin expansion over time. Importantly, our profit growth is about long term structural changes that involve both subtraction and addition, meaning we are optimizing costs while investing in the most important strategic opportunities. Back to the fiscal 2026 outlook, cash conversion is expected to be in the range of 85%-95%, a year-over-year improvement and consistent with historic averages. Our cash generation combined with our low leverage ratio gives us tremendous financial flexibility to invest for future growth, and that is always our top priority when it comes to strategic capital deployment.

From an organic perspective, we're continuing to find new ways to penetrate new and existing markets through our R&D investments as well as capital expenditures, which are forecast between $65 million and $85 million and include key investments in new products and technologies across all of our segments. We're highly committed to expansion through M&A and actively work through a pipeline of opportunities largely in our life sciences and industrial businesses. While we have the capability and the commitment, we are disciplined in our activities, pursuing opportunities with our strategic and financial criteria in mind. As we've demonstrated, the ongoing return of cash to shareholders is part of the Donaldson DNA and the value we create. Our financial performance has allowed us to pay and increase dividends annually for decades.

Calendar year 2025 is expected to be no exception, marking the 30th year in a row of increases, allowing us to maintain our constituency in the S&P High Yield Dividend Aristocrat Index. Further, in fiscal 2026 we are forecasting a repurchase of 2% to 3% of our outstanding shares. Through the strength of our global teams, technological expertise, and deep customer relationships, we look forward to delivering for all of our stakeholders in fiscal 2026. Now I'll turn the call back to Tod.

Thanks, Brad. Donaldson Company is the leader in technology-led filtration, and we are strengthening that position. We have a proven history of focusing on our customers' needs through all market conditions and continue to advance our value proposition through our strategic initiatives and disciplined investments. The essential nature of our products for customers enables our razor-to-sell razor blade aftermarket model, which has penetrated across our business, fueling our durable, profitable growth today and for the future. Our success would not be possible without the talented Donaldson Company employees around the globe. I would like to close by thanking them for their dedication and service, and I am excited about what we will collectively accomplish in the future. With that, I will now turn the call back to the operator to open the line for questions.