Hello, and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Donaldson Company Incorporated Fourth Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Sarika Dhadwal, Director of Investor Relations. Please go ahead.

Good morning. Thank you for joining Donaldson's fourth quarter and full year fiscal 2023 earnings conference call. With me today are Tod Carpenter, Chairman, CEO and President, and Scott Robinson, Chief Financial Officer. This morning, Tod and Scott will provide a summary of our fourth quarter and full year performance and details on our outlook for fiscal 2024. During today's call, we will discuss non-GAAP or adjusted results. For fourth quarter and full year fiscal 2023 non-GAAP results exclude restructuring and other charges of $4.9 million and $21.8 million, respectively. Fourth quarter and full year fiscal 2022 non-GAAP results exclude $3.4 million of charges related to the conflict in Eastern Europe. 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 Tod Carpenter. Please go ahead.

Thanks, Sarika. Good morning. Fiscal year 2023 was a milestone year for Donaldson Company. From a financial perspective, we made great progress on the objectives laid out during our Investor Day in April. We delivered record top and bottom line results, ending the year with $3.4 billion in revenue and $3.04 in adjusted earnings per share, increases of 4% and 13%, respectively. Improved our operating margin by 110 basis points by expanding gross margin while continuing to invest in our strategically important higher-margin growth areas. Delivered cash conversion of 114%, primarily by reducing our inventory levels by over $84 million and returned $256 million to our shareholders in the form of dividends and share buybacks. We also made significant strategic changes to our operating structure laying the foundation to drive Donaldson to the next stage of its evolution and position ourselves for future profitable growth. First, we completed our organizational redesign aimed at better serving our end market customers. Second, we introduced Life Sciences as a separate operating segment, allowing for increased transparency as we build out our presence in this important growth area. And third, we completed two new Life Sciences acquisitions, Isolere Bio and Univercells Technologies, companies with game-changing disruptive technologies that complement our existing capabilities and offerings in the space. Importantly, and in conjunction with Investor Day, we also announced our Filtration for a Thriving Future sustainability strategy and 2030 environmental and social ambitions. I am continually impressed by the resilience and dedication of the Donaldson employees, particularly with the backdrop of such a dynamic and pivotal year, and I am proud of their accomplishments. Now I'll cover some highlights from the fourth quarter. Sales of $880 million were down 1% year-over-year, driven by a decline in volume, partially offset by pricing benefits. The impact from current…

Thanks, Tod. Good morning, everyone. Fiscal 2023 was a record year for Donaldson. I would like to thank our global teams who came together, managed through our company-wide organizational redesign and delivered results consistent with the expectations we laid out at the beginning of the year. Fiscal 2023 serves as a strong foundational year as we work towards the 2026 financial and strategic targets we laid out at Investor Day, and I'm excited about continuing to report on our progress. I will provide color on our outlook for fiscal 2024 in a few minutes, but first, will give additional details on the results for the fourth quarter. To summarize, sales declined 1% versus 2022. Operating income decreased 7%, driven by investments primarily in Life Sciences. EPS of $0.78 decreased 7%, and cash conversion was 173% versus 78% a year ago. Gross margin was 34.3%, a 140 basis-point improvement versus prior year. Pricing was the largest driver of the gross margin improvement, followed by benefits from the stabilization of input costs, including lower freight costs. Operating expenses, as a percentage of sales, were 20.0% compared with 18.0% a year ago. The deleveraging of operating expenses in the quarter was due to increased post-pandemic hiring expenses. And importantly, nearly half of the deleveraging was from incremental expenses related to our Life Sciences acquisitions. Operating margin was 14.3%, down 60 basis points versus prior year as operating expense deleveraging more than offset the year-over-year improvement in gross margin. Now I'll discuss segment profitability. Mobile Solutions pretax profit margin was 16.2%, up 40 basis points year-over-year and Industrial Solutions pretax profit margin was 19.2%, up 60 basis points. Gross margin expansion, driven in large part by pricing, was a key driver in both of these segments. With respect to Life Sciences, the pretax loss…

Thanks, Scott. As we begin fiscal 2024 through each of our segments, we are steadfast in fulfilling our purpose of advancing filtration for a cleaner world. In Mobile, we are addressing a growing need, helping our customers solve sustainability challenges by delivering higher performance solutions and utilizing our technology to improve efficiencies and fuel economy. We continue to build our alternative power solutions portfolio to ensure we remain well positioned to address all future engine adoption scenarios. In Industrial, we are growing our technologies and solutions to form strategic customer partnerships. Our expanded connectivity applications enable monitoring and alerting, and drive energy efficiency. Our Dust & Fume Control product portfolio designed for optimized energy consumption and carbon footprint reduction provides solutions for customer environmental filtration challenges. In Life Sciences, we are building out capabilities to address process integrity in Food and Beverage and improve the sustainability of the global food supply through entry into alternative proteins. We are also leveraging our existing technology, R&D capabilities and acquisitions to support the development of new therapeutics through differentiated and disruptive technologies. A few comments on our progress in this regard, which gives us confidence in achieving our growth objectives. We have added over 1,000 years of bioprocessing experience to our team, including 150 scientists, engineers and commercial and operations personnel. Customer interest in our Purelogics and Isolere technology is tremendous. We are building onto a $210 million opportunity pipeline with large customers and over 20% of this pipeline has already achieved technical approval. And lastly, sales of Solaris bioreactor products more than doubled year-over-year in the fourth quarter and we enter fiscal 2024 with backlogs at record highs. In closing, I look forward to the journey that lies ahead as we execute on our longer-term strategy and drive towards our financial targets, and I'm confident we have the right team in place to achieve those goals. With that, I will now turn the call back to the operator to open the line to questions.

[Operator Instructions] Our first question will come from the line of Bryan Blair with Oppenheimer. Please go ahead.

Thank you. Good morning, everyone.

Good morning.

Starting with your top line outlook, maybe offer some more color on what you're seeing in current order rates and how your team is contemplating first and second half growth by segment, there's now quite a bit of nuance there and certainly different comps that the segments face as fiscal '24 moves forward.

So maybe what I'll do is -- this is Tod. So maybe what I'll do is talk at the macro, and Scott could give you a little bit up feel for numbers on cadence as you work to build your model. Just at a macro level, we see strength in Europe, followed by good markets in the United States, okay markets in Latin America and troubled markets in APAC. As you kind of look at across our businesses, clearly, the Mobile Solutions segment is experiencing destocking largely because of the OE portion of our Aftermarket business. And that is what's keeping us into the low single digits type of growth level. IFS continues to be strong, both Aftermarket as well as the Equipment side, and that's more of a broad-based type of comment. And within Life Sciences, we would look to continue to execute and see growth across those base businesses that we have been growing in the prior years. So as we just maybe look at the macro model, we're returning more to a more normal cadence of Donaldson Company, whereby last year, we were 49% first half, 51% second half. We would expect this fiscal year to be more of a 48-52 type of a split.

So maybe I'll just add on a little bit to that, Bryan. So in terms of quarterly sequencing, in total, like Tod said, we're kind of back to normal seasonality. So that means revenues in the second half will be higher than in the first half. And also in terms of profitability, both gross margin and operating margin, I mean we've given you guidance for the year in total. But generally, both the gross margin and the operating margin are going to be generally sequential up quarter-over-quarter in each of the quarters throughout the year. So it's a little bit of a ramp this year on both gross margin and operating margin, with revenues a little bit higher in the back half than in the front half, as Tod mentioned. So we're kind of sticking to the guidance at the whole level from a quarterly perspective. There is some pluses and minuses within each of the business units. But I think if you stick with the normal seasonality and revenues generally increasing first half to back half and gross margins and operating margins generally sequentially improving in each of the quarters throughout the year.

Okay. Appreciate the color there. And sticking with margin. Industrial profitability was again actually pretty exceptional in the quarter, and Industrial performance overall has been very solid. The last three quarters, you've come in well ahead of your fiscal '26 targets for Industrial margin, seems a pretty good momentum going into fiscal '24. Are run rate margins sustainable for the segments? Or are there cost mix, other factors that we should keep in mind that may moderate profit level going forward?

Well, let me just start and I'll turn it over to Scott here for a little bit more color. But just at the macro level, we're executing extremely well with our strategy on industrial. Clearly, that we talked about at Investors Day with connected-based products, we are seeing share gain within our Aftermarket businesses. Our Equipment-based businesses are hanging quite well overall at the macro atmosphere. So we're pretty comfortable with where we are, what we're seeing, and we'll continue to press and execute our strategy.

Yeah. And maybe I'd just add, Bryan, we -- like you said, we did have very good performance and we really had strong project-based shipments in the last part of last year. So that really drove a very strong leverage and high profitability. So we're very pleased to see the progress and success of the organization. So we probably overleveraged a bit, but we expect Industrial margins to continue to be strong and we do think about our Investor Day targets. At this point, we've chosen not to change them. We're certainly committed to achieving all of those Investor Day targets. And kind of as you've noted, Industrial has got a very good jump on achieving their operating margin targets that we laid out in Investor Day is actually slightly ahead right now.

Absolutely. And then for Life Sciences, Scott, I think you called out last quarter 800 basis points or thereabout margin impact from acquisitions. It sounds like that was worse than that at $8 million or so in dollar impact for fiscal 4Q. We know there's a lot of investment there, and it's a long-term outlook for the build-out of the platform. But how should we think about the near-term progression of margin impact from the acquisitions and how that is ultimately contemplated in your fiscal '24 guide?

Yeah. So I mean we certainly talk about that quite a bit. And first off, just to note, we're very proud of the fact that the company continues to put up record levels of sales and record levels of property while we are investing in our Life Sciences and other businesses to really make sure we secure long-term growth potential for the company. And we've done some acquisitions, and with that comes some amortization and some start-up costs. And we've done some investments like that, and we want to make sure we properly fund those businesses. I said in my script that we expect the Life Sciences operating margin to be positive next year. So we definitely invested heavily, and we took on a bit of a run rate expenses, and you see that in our OpEx. But we do expect the operating margin for Life Sciences to be positive for next year's fiscal results.

Understood. Thanks, again.

Your next question will come from the line of Nathan Jones with Stifel. Please go ahead.

Good morning, everyone.

Good morning, Nathan.

I am going to follow up on Bryan's last question on the Life Sciences margin and see if we can get any more help with the progression of that through '24. Margins swung by 30 points from the first quarter of ’23 to fourth quarter of '23. Just -- I know, Scott, you said positive for the year. Is there any help you can give us with -- I mean, I assume they're going to start out negative in the first quarter. Should we be thinking about something like the fourth quarter margin in the first quarter? And how that kind of ramps up through the year to get to positive?

Yeah. I mean we're looking at next year where we definitely stepped up our investments in the fourth quarter. So as sales increase, it'll certainly help cover those costs. Don't forget we also have the Disk Drive headwinds this year that we expect to abate next year. So we're looking at low single-digit profitability. And for the most part, relatively consistent throughout the fiscal year, achieving a positive operating margin for the next year. So there's not any massive swings contemplated. The really big investment period was the fourth quarter, and we had the Disk Drive headwinds that will normalize sequentially going forward. So we feel like we're in a better position and the results will reflect that.

So the margins -- you're not thinking the margins in Life Sciences have a big ramp up throughout the year, they're relatively consistent? I mean if you're assuming volume gets sequentially better through the year, I assume margins would get sequentially better through the year, but there's not a huge variance in those numbers.

There's not a huge variance in the numbers, Nathan. And Life Science will be actually a little bit lumpy in the year more than some of the other -- than the other two segments, but just slight degrees of difference throughout the year.

And we put out the Investor Day target, right, of 22.5% operating margin for Life Sciences three years out, and we're still committed to that number and believe it's achievable.

Right.

And that just comes from absorbing these costs with revenue as those businesses ramp up, right? I mean you're still in a position with a number of those businesses where revenue is pretty minimal.

Exactly. And when you look at what additional CapEx might be needed in the businesses, that particular -- the way we look at that is we will need some additional manufacturing capability across the Life Sciences segment. We will have that investment within the next three years, adding that in to be able to meet the manufacturing capabilities. But we take that all within this guide, we put that all within the investors' targets and gives us confidence within the targets that we talked about last April.

Maybe we could get some more color on the $210 million opportunity pipeline that you talked about, Tod. Half has achieved technical approval, I guess that means the other half is still waiting for it. Is that $210 million all business that you expect to win? Or is that business that you still have to compete to win? And how should we think about that kind of those projects being released and ramping up?

So the $210 million is the opportunity pipeline, and that's why we pointed out that we're 20% of it is approved, right? So 80% of it, we are still looking to go through with the particular OE approval process or we are in flight of the approval process. So -- but that's near term what we're chasing. And we've looked at that $210 million over a seven-year period. It's important to also understand that what we baked into this particular guide out of those seed planting-based businesses is very little revenue for this fiscal year. It really starts to show a bit more next year and then ramps up.

Great. Thanks for taking my questions. I’ll pass it along.

Your next question comes from the line of Brian Drab with William Blair. Please go ahead.

Hi, good morning. Thanks for taking my questions. The Univercells acquisition, curious, that was $10 million in revenue in '22. You paid a good multiple for that, I think it's like 13.5 times trailing sales. So I assume that's growing rapidly. What should we model for that business in roughly for fiscal '24? It must be in the, I guess, like $15 million range or something thereabouts?

Yeah. We baked that into the current guide that we gave you, obviously, on with what our expectations are. We do expect it to grow double digits within that business. But we also have some pieces to put in place in order to be able to execute that, which we have all put in on the revenue side as well as any particular cost on that into this guide that we just gave you, remembering that we have not owned that business very long. So we'll be integrating it throughout this year.

Yeah. Okay. Got it. Makes sense. And -- so with the 20% forecast for the Life Sciences segment, I guess maybe like I'm going to probably model it like 15% organic revenue growth. And I'm just wondering -- can you -- should I discern anything from the press release in terms of the order that you listed the drivers of growth in Life Sciences because Food and Beverage, Bioprocessing then Disk Drives? I'm just wondering like which of those is expected to contribute most of the incremental organic revenue in fiscal '24, which of those three segments...

Yes, it's going to be broad-based, Brian, but you're right. We've grown the Food and Beverage business double digits for a number of years. We expect that to happen again this year. And then, of course, we noted that our Solaris backlogs are at all-time highs. We would have expected that. That just is a good indicator to you that we're executing quite well. And then we would expect Disk Drive coming off easier comps to have a low double-digit type of a growth rate. So you pack all that together, that's how -- that's what really gives us confidence in the numbers we're giving.

Okay. Got it. Thanks. And then just one last one. Can you talk about customer development within the -- like acquisition progress that you're making with customers within the Life Sciences segment? How many customers do you have now? The Solaris backlog, is that across many different customers? Or is it one big project for one customer? Any color on that would be really helpful. Thanks.

Yeah. Thanks, Brian. So it's not one big project. It is more broad-based. And remember that Solaris makes the very small desktop type of bioreactors that would go into laboratory type of use as well as the larger project type of bioreactors that you're referring to. Their backlog is a bit more broad-based than one big elephant, so to speak. So we're happy with the progress that we have there. And then with the newer acquisitions, we're also happy with the very, very broad-based customer acceptance of those particular products and are working with a number of opportunities.

Okay. Thanks, Tod.

Your next question comes from the line of Laurence Alexander with Jefferies. Please go ahead.

Hi, good morning. This is Kevin on for Laurence. So my questions have largely already been asked. But I guess just -- do you guys see any risk of a recession impacting any of your end markets in 24? And I guess, if so, which areas have denoted risk? And when you said that you expect your top line and APAC to be troubled next year, is that most related to China? Or are there issues elsewhere in the region that you're seeing?

Yeah. So when you talk about the recession, it's really China for us all the time. We're really happy with where we are with China based upon -- we know that that's a very troubled economy over there. Everybody knows that in the world. But we're happy with where we sit, position to when it comes out. That should give us tailwind. We have a number of different market share gains over there that should be able to give us some positive outcomes. However, we have not baked any of that type of lift into F '24 guidance. We believe that will just be a little bit more protracted than it's currently or then was, let's say, seen six months ago. So we're very careful about projecting China. But for the rest of the world, we have not really seen any early indicators of recessionary type of behavior in any of the other geographies. And so we have not contemplated that at this time.

Okay, thank you.

Your next question comes from the line of Rob Mason with Baird. Please go ahead.

Yes, good morning. Maybe, Tod, I just wanted to follow up on that last comment. I mean, to the extent that you've not baked in any recessionary impact, I guess how do you reconcile some of the PMIs that we see out of Europe versus your results, which seem to be very good? It just seems like there's some disconnect there given the results. Is that more share gain-oriented on your side? Or just kind of help us versus what we historically would have expected given those macro indices.

Sure. So we've long said that we're a diverse portfolio of businesses across our company. You're starting to see the strength of that, particularly, as you read about particular sectors having some headwinds. Donaldson Company is more broad than that. Some of the execution within the strategies that we talked about at Investor Day is actually going extremely well. We clearly have share gains in some of our replacement part based businesses. And so we have good momentum at this point in time, and we'll continue to press, continue to invest and look for a continuation of the solid execution that we're seeing across our company.

Yep. To the extent -- and speaking to the Mobile business, I think, particularly to the extent destocking was heavy in the fourth quarter. It's been going on for several quarters. I thought your commentary around the Aftermarket -- Mobile Aftermarket business implied that it may continue. And I was just curious if that's the case, you said it could weigh on the low single digit or influence that low single-digit growth rate. How much longer do you think are you anticipating that destocking headwinds impact that business?

Yeah. Thanks, Rob. Let me just give a little bit more specific color on that. If you recall in our Mobile Solutions aftermarket business, our OE portion of that business is 40% of the revenue. Our independent channel is 60% of the revenue. If you look at just the fourth quarter, we would tell you that our independent channel was roughly flat year-over-year and the OE channel was down mid-teens. So that suggests to you that the destocking across the OE channel, and it's not specific to one end market, but now has more broadened to multiple customers. It has really created a headwind across our Aftermarket. It is not the independent distributor channels. In fact, looking forward, we would expect that destocking from all the behaviors we've seen from the OE to pick up just a little bit, looking forward here in the first two quarters but not appreciably. So therefore, our estimation is that the destocking at the OE side would go in the first Q and likely the second quarter because there's a lot of balance sheet management across the OE sector in our second quarter as we end the calendar year and then pick up in the second half of the year.

Yeah. And maybe just to take the other side of that, the First Fit side in Mobile. Now the supply chains have largely normalized, lead times have come down. Are your OE customers still giving you the same level of visibility on their production schedules? Or has that shortened up as well? How do you feel about the level of visibility?

So nothing’s changed. Yeah, nothing's changed about the models between the way we operate with our OEs and Donaldson Company. We do things where our computers are linked. And so we get a longer look at their production build rates. They may firm the build rates a little tighter. So say, at more like 90 days rather than 150 days, but we're still very comfortable with what we're seeing across all of the end markets in the Mobile Solutions. So that's agriculture, construction, mining and On-Road, with On-Road likely showing a bit more resiliency than the others.

Very good. I’ll hop back in the queue. Thank you.

[Operator Instructions] And we have no further questions at this time. I'll turn the call back over to Tod Carpenter for any closing remarks.

That concludes the call today. Thanks to everyone who participated, and I look forward to reporting our first quarter fiscal 2024 results in November. Have a great day. Goodbye.

That will conclude today's call. We thank you all for joining. You may now disconnect.