DONALDSON Co INC Q1 2026 earnings call

Good morning. Thank you for joining Donaldson's Q1 fiscal 2026 earnings conference call. With me today are Todd Carpenter, Chairman, President, and CEO, Brad Pogalz, Chief Financial Officer, and Rich Lewis, Chief Operating Officer. This morning, Todd and Brad will provide a summary of our Q1 performance and our outlook for fiscal 2026. During today's call, we will discuss non-GAAP or adjusted results. Q1 2026 non-GAAP results exclude a pre-tax gain on the sale of fixed assets of $9.3 million and a pre-tax charge of $5 million for restructuring and other charges primarily related to footprint optimization and 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 are subject to risks and uncertainties, which are described in our press release and SEC filings. With that, I will now turn the call over to Todd.

Thanks, Sarika. Good morning, everyone. Donaldson Company's Q1 results were strong, and I'm proud of what our team was able to accomplish: growing sales, operating profit margin, and earnings. We delivered once again on our commitments to all of our stakeholders: our customers, our shareholders, and our employees. We did this through our leadership position in filtration, which was built on decades of solving our customers' most difficult filtration problems with our razor-and-blade razor blades model, our best-in-class technology, which is uniquely powerful because we focus on filtration capabilities and then leverage these technologies across markets, our ability to help customers meet evolving environmental and operational goals by helping to protect equipment and maintain cleaner work environments, and our clear strategic and balanced growth strategy. That is why our success continues.

I will start by discussing our Q1 performance, touch briefly on our expectations for fiscal 2026, then Brad will detail our financials. Lastly, I'll provide some closing remarks before opening the call to questions. In the Q1, we grew sales to an all-time Q1 high of $935 million, a 4% year-over-year increase, with growth across many key businesses, including mobile aftermarket, power generation, food and beverage, and disk drive. Expanded operating profit margin to a record 15.5%, driven by leverage on higher sales and cost optimization initiatives. Delivered record earnings per share of $0.94, 13% above prior year. Returned $127 million to shareholders through share repurchase and dividends, and continued cost optimization initiatives, including our footprint optimization, laying the foundation for higher future profitability. Now, a few highlights by segment. In mobile solutions, our razor-and-blade model continues to drive through-cycle performance.

Our aftermarket results are robust. For example, we continue to gain share in the independent channel, where sales grew nearly double digits. We have expanded partnerships with customers like NAPA. Our distribution centers are performing well. Stock availability is at desired levels, and our on-time delivery rates are high. While cyclical headwinds continue, our largest first-fit business, Off-Road, grew for the second consecutive quarter with supportive end market conditions in construction more than offsetting muted conditions in agriculture. In Industrial Solutions, our power generation business is robust, supported by the current electricity demand supercycle, including data center and AI infrastructure buildouts. Our power generation order books are full through the rest of this fiscal year. Dust collection replacement part sales growth was solid, another example of our razor-and-blade strategy at work as we continue to build out our service and aftermarket capabilities.

To that end, this quarter, over half of our total industrial sales were replacement part sales. In Life Sciences, we're excited by the market share we are gaining in food and beverage, where sales grew over 20%. We are winning with key OEMs and channel partners, growing first-fit sales and planting seeds for future replacement part sales. Our disk drive business also grew over 20% through share gains and supportive market conditions, and we are investing in new technologies to support capabilities for HAMR, pronounced Hammer, short for heat-assisted magnetic recording, which will contribute to future growth. Our strong overall results are a testament to the capabilities and agility of the Donaldson team. Our global operations teams, in particular, continue to deliver for our customers through the changing tariff landscape and with a keen focus on efficiency.

Our global region-for-region footprint is a strong asset for the company and one of our key competitive advantages. Leveraging this decades-long foundation, we have successfully offset residual tariff impacts through pricing and optimized supply chain. I am proud of how we are also stepping up and helping our customers mitigate tariff impacts through collaboration, education, and production transfers. To that end, our current annualized estimate for the impact of tariffs is approximately $25 million, down from $35 million previously. We are also building long-term structural efficiencies through our footprint and cost optimization initiatives. We expect to be mostly complete with our current activities by the second half of this fiscal year. Our commitment to serving our customers through any market conditions while maintaining high on-time delivery rates is driving demand, and our backlogs are reflective of the confidence our customers have in Donaldson.

We are also building for our future through our disciplined investments in R&D and capital expenditures. This quarter, these included continued focused investments in growth areas such as solvent recovery, new disk drive technologies, and air and alternative fuels filtration. Now I'll provide some detail on Q1 sales. Mobile Solutions total sales were $598 million, 5% above prior year. Aftermarket sales were $480 million, up 7%, driven by strength in both the OE and independent channel. On the first-fit side, Off-Road sales of $95 million increased 6%. Gains in construction offset continued weakness in agriculture. On-Road sales of $23 million declined 27% as a result of decreased global truck production. Within Mobile Solutions, our China business was solid, with overall sales up 15% from strength in Off-Road and Aftermarket.

This marks the fifth consecutive quarter of growth, and we recently won another hydraulics program with a top agriculture equipment manufacturer, another sign that customer trust in Donaldson is building in this massive market. Now on to Industrial Solutions. Industrial sales were $258 million, flat to prior year. Industrial Filtration Solutions, or IFS, sales of $216 million grew 2% from continued strength in power generation, particularly in Europe, and dust collection replacement part sales in the U.S. Aerospace and Defense sales were $42 million, a 7% decrease driven by softer defense sales following the completion of a few large projects. In Life Sciences, sales of $79 million grew 13% year-over-year as a result of double-digit growth in food and beverage and disk drive, bolstered by project timing in our upstream biotechnology businesses.

Given our robust start to the year and our confidence in delivering on our financial and strategic objectives through the balance of the year, we are increasing our operating margin and EPS outlook. At the midpoint of our updated guidance ranges, we expect record sales of $3.8 billion and sales growth in each of our segments, operating margin expansion of 80 basis points to a record of 16.5%, which puts our incremental margin above 40%, and all-time high earnings per share of $4.03. With that, I will now turn it over to Brad, who will provide more details on the financials and our outlook for fiscal 2026. Brad.

Thanks, Todd. Good morning, everyone. Before getting into the financials, I want to thank the Donaldson team for producing strong Q1 results, giving us confidence in our ability to deliver on our increased profit guidance for the full year. The team continues to display their talent and focus quarter after quarter, and we're excited to build on our momentum. I want to start this morning with a few highlights. Note that my profit comments exclude the impact from the non-recurring net gain that Sarika referenced earlier. Total sales increased 4%. Operating margin was a Q1 record of 15.5%, up 60 basis points over prior year, with an incremental margin over 30%. Adjusted EPS was $0.94, up 13%, and cash conversion was strong at 101% due to improved working capital management. Altogether, a solid quarter for Donaldson Company.

Digging deeper into the P&L, our strong Q1 operating margin was driven by expense favorability. Operating expense as a rate of sales improved to 19.9% from 20.7% a year ago, reflecting leverage on higher sales that was compounded by benefits from the structural cost optimization initiatives launched during the prior fiscal year. Gross margin was 35.4%, down 20 basis points from the prior year, and slightly better than our internal expectations. We partially offset increased operating costs with pricing, including pricing related to tariffs, as we are successfully mitigating that impact. We still expect gross margin expansion for the full year, with most of the favorability in the second half as our footprint optimization projects come to completion, and we benefit from volume leverage that accompanies our typical seasonality.

In terms of segment profitability, Mobile Solutions' pre-tax profit margin was 18.6%, up 30 basis points from prior year, due to mixed benefits from higher aftermarket sales and leverage on higher sales. Industrial Solutions' pre-tax margin was 12.5%, down from 15.9% in 2025 due to an unfavorable sales mix and loss of leverage and operating costs. We expect segment profitability to increase through the balance of the year as sales leverage translates into gross margin and expense rate improvements. Life Sciences' pre-tax margin improved notably to 9.2% from a loss of 7.6% a year ago. Strong sales in our higher margin food and beverage and disk drive businesses, combined with benefits from last year's optimization programs, drove the improvement. A quick comment on last year's optimization efforts.

We initiated the first and most substantial round of restructuring in Life Sciences late in the Q1, and then performed additional rounds over the course of fiscal 2025. Given that cadence, the year-over-year improvement we just recognized in Q1 is at a much higher level than what we expect in future quarters over the balance of this fiscal year. Turning to our fiscal 2026 outlook, first on sales, we are reiterating our sales guidance for every business except On-Road within Mobile Solutions. This business represents less than 3% of total company sales. Consequently, the change to the On-Road forecast does not have a meaningful impact on our growth expectations for the total company or Mobile Solutions. We still expect total company sales to increase between 1% and 5%, including pricing of about 1%. And Mobile Solutions sales are expected to be flat to up 4%.

Within Mobile Solutions, On-Road sales are now expected to be flat versus 2025. This compares to our previous estimate of high single-digit growth, and the change is driven by the timing of a few key projects that were pushed out beyond this fiscal year. Off-Road sales are forecast to be up mid-single digits, due in large part to easier comparisons from sharp declines in agriculture a year ago. We continue to see that end market at trough or near trough levels. Aftermarket sales are projected to grow low single digits due to market share gains and vehicle utilization rates. In Industrial Solutions, sales are forecast to grow between 2% and 6%, with a mid-single digit increase in IFS, where sales are expected to grow across all businesses, including in strategically important areas such as aftermarket enabled by services and connectivity.

Aerospace and Defense sales are projected to be flat after cycling against record levels in the prior year. This forecast also reflects a rebound from the decline in Q1, as the timing of orders can be lumpy in this business. In Life Sciences, we expect sales growth between 1% and 5%, with continued momentum in food and beverage and disk drive. Through benefits from sales leverage and our improved cost structure, we anticipate full-year Life Sciences profit margin to be mid-single digits. One side note to help with calendarization of this profit: we expect Life Sciences will be profitable in every quarter, but at a lower level than Q1, which benefited from leverage that was due in part to the timing of project sales in our acquired businesses, which we anticipated later in this year. Overall, we're pleased with our profitability expansion in this segment.

Given our Q1 performance and our outlook for the balance of the year, we are increasing our full-year operating margin guidance by 10 basis points to between 16.2% and 16.8%. This includes year-over-year sales growth in all three segments, gross margin expansion, and expense leverage. The midpoint of our guidance range implies an incremental margin of more than 40%. With that, we are also increasing our fiscal 2026 EPS guidance by $0.03 to $3.95-$4.11 per share, or $4.03 at the midpoint. To help with modeling for the rest of the year, I would like to make a few points on calendarization.

As is typical, our sales are weighted towards the back half of the year, representing about 52% of full-year sales due to seasonal dynamics such as holiday timing in the Q2 and peak activity in our end markets in the back half of the year. Operating profit is even more heavily skewed towards the back half, with about 55% of full-year profit being generated between February and July. We'll benefit from higher leverage on the normal step-up in second-half sales volume, and we also expect abating headwinds from footprint optimization initiatives as those projects complete. Now onto our balance sheet and cash flow outlook. We project cash conversion to be in the range of 85%-95%, an improvement versus 2025 and consistent with historical averages.

Combined with our supportive balance sheet and low net leverage ratio, which currently sits at 0.7 times, Donaldson has the financial flexibility to thoughtfully invest for our future growth. Our strategic capital allocation priorities are unchanged. First, reinvest back into the company. We are the leader in technology-led filtration and are committed to maintaining our position. We continue to make R&D investments in strategically important, high-growth, high-margin areas. And we also invest in our supply chain and working capital to ensure best-in-class delivery for our customers, which is part of the value we provide. Our longer-term efforts are also supported by capital expenditures, which include investments in new products and technologies across all of our segments. Our second capital deployment priority is disciplined M&A.

We are actively working through a pipeline of opportunities, and discipline is key to our approach as we pursue opportunities that meet our strategic and financial criteria. The value we create comes through reinvestment and also through the return of cash to our shareholders. As such, our third capital allocation priority is dividends. Speaking to our long-standing commitment to our shareholders, this calendar year is our 70th in a row of paying dividends and the 30th in a row of increasing our dividend, maintaining our status as a proud member of the S&P High Yield Dividend Aristocrat Index. Our fourth priority is share repurchase. For fiscal 2026, we're forecasting a repurchase of 2%-3% of shares outstanding, which more than offsets dilution and is in line with our historic levels. To summarize, we are growing Donaldson Company and growing profitably.

Taking the midpoints of our top and bottom line guidance ranges, we're projecting 10% earnings growth on 3% sales growth, with incremental operating margin leverage of more than 40%. We have the balance sheet to invest in growth, and we'll do that responsibly. We started the year strong, and I expect to maintain that momentum well beyond fiscal 2026. Now I'll turn the call back to Todd.

Thanks, Brad. As we turn the page to our Q2, Donaldson is in a position of strength. We are maintaining our focus on doing what we do best, solving our customers' complex filtration challenges through our technology-led products and services. With this focus and through our execution, key investments, and strategic initiatives, I am confident in our ability to create value for all of our stakeholders in the future, and we look forward to reporting on our ongoing progress. To close, I want to thank our talented employees around the globe who each day are building our future success. With that, I will now turn the call back to the operator to open the line for questions.