Thank you for standing by and welcome to the Donaldson Company Fourth Quarter and Full Year 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I'd now like to turn the call over to Sarika Dhadwal, Senior Director of Investor Relations and ESG. You may begin.

Good morning. Thank you for joining Donaldson's Fourth Quarter and Full Year Fiscal 2024 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 2025. We will also provide an update on our fiscal 2026 financial targets. During today's call, we will discuss non-GAAP or adjusted results. For fourth quarter and full year fiscal 2024 non-GAAP results exclude pretax restructuring and other charges of $6.4 million related to footprint optimization and cost reduction initiatives. This compares to $4.9 million and $21.8 million of charges in fourth quarter and full year fiscal 2023, respectively, related to the organizational redesign as well as costs associated with exiting a lower-margin customer program. 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'll now turn the call over to Tod Carpenter. Please go ahead.

Thanks, Sarika. Good morning. Fiscal 2024 was another record year for Donaldson Company, record sales, record margins and record EPS. We surpassed $3.5 billion in sales, achieved operating margin of 15.4% and delivered adjusted EPS of $3.42, a 13% increase above prior year. Our cash conversion was over 97%, well above our historical average and we returned $286 million to our shareholders through dividends and share buybacks. Through mixed end market conditions, the Donaldson team furthered our mission of advancing filtration for a cleaner world through our investments and progress on our strategic initiatives, including our 2030 ESG ambitions. I'll now discuss our fourth quarter results which capped off a tremendous year for our company. Sales increased 6% over prior year, driven by higher volumes across all three operating segments, operating margin improved 200 basis points over 2023 and EPS increased 21%. Each of our segments demonstrated sales growth and improved profitability. Here are some highlights. In Mobile Solutions, volume was the primary driver of sales growth as a result of strength in our Aftermarket business. Segment profitability continued to be robust as a result of mix, higher volumes and pricing. In Industrial Solutions, Aerospace and Defense sales rose approximately 40% to a record level and drove industrial profit margin to an all-time high. In Life Sciences, sales grew above 20% and profitability improved year-over-year. Shortly after the end of the quarter, we completed the acquisition of a 49% stake in Medica S.p.A., a leader in hollow fiber membrane technology and retain a call option to purchase the remaining 51% stake in the years to come. We are pleased with this investment and our joint development agreement as we work towards developing and commercializing hollow fiber modules for applications, including bioprocessing and food and beverage. Throughout the quarter, we maintained…

Thanks, Tod. Good morning, everyone. I would like to start by thanking our teams around the globe for their hard work. We had a terrific quarter, which concluded a terrific year. Our employees delivered for our customers and our shareholders and I am proud of what we accomplished. Before I cover our outlook, I will provide details on fourth quarter results. EPS grew 21% year-over-year to $0.94 on 6% sales growth. Operating profit increased 21% and operating margin was 16.3%, 200 basis points above 2023 driven by gross margin expansion and operating expense leverage. Gross margin of 36.2% increased 190 basis points above prior year from select input cost deflation and leverage on higher sales. Operating expenses as a percent of sales were 19.9% versus 20.0% a year ago from leverage on higher sales, partially offset by higher people-related costs and acquisition-related expenses. Now we'll discuss segment profitability. Mobile Solutions pretax profit margin was 18.3%, 210 basis points above prior year due to favorable mix from strong Aftermarket performance, volume growth and pricing benefits. Improved manufacturing efficiency in our plants also contributed to strong performance. Industrial Solutions pretax profit margin was a record 20.1%, 90 basis points above a tough comparison, 19.2% in the prior year period. The year-over-year improvement was driven by volume and pricing. Our margin performance in both Mobile and Industrial has been outstanding all year, pushing Donaldson's blended margins to record levels. We look forward to continuing this robust performance in the years to come. Our Life Science business generated a pretax loss of approximately 1%, including a headwind from acquisitions of 15 percentage points. This compares to a pretax loss of 12% in the prior year period. Leverage on higher sales from our legacy businesses drove the improvement. While profitability in the segment has been…

Thanks, Scott. I'm excited by what lies ahead for Donaldson Company. Through our mission of advancing filtration for a cleaner world, the company has evolved, driven by the strength of our team and our dedication to executing on our long-term strategic initiatives. I am confident in our ability to deliver value to all of our stakeholders in the years to come. We are optimistic about the future in each of our segments. In Mobile Solutions, we remain the market leader with our technology-led product portfolio. Our proprietary razor-to-sell razor-blade model has been paying dividends and we expect to continue to gain share. In Industrial Solutions, we are excited about our connectivity strategy and the ongoing build-out of our services capabilities. Our one-stop shop approach is working. In Life Sciences, we are making progress in commercializing our bioprocessing business. We recently announced the expansion of our relationship through our Univercells Technologies business with the Gene Therapy Program at the University of Pennsylvania. The Gene Therapy Program or GTP is renowned for its pioneering work, seeking to make gene therapies for rare diseases accessible worldwide. This expanded relationship is aimed at determining the scalability of product manufacturing using our bioreactors. Overall, the interest in our technologies is robust, and our therapy pipeline is growing. While market conditions across our segments have and will continue to fluctuate, we are committed to investing for the future executing and remaining agile again with the overarching mission of the company as our guiding principle. In fiscal 2024, we made considerable progress on our 2030 ESG ambitions as well and we look forward to providing an update in the quarters to come and with our upcoming fiscal 2024 sustainability report. With that I will now turn the call back to the operator to open the line for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Bryan Blair from Oppenheimer. Your line is open.

Thank you. Good morning, everyone.

Good morning, Bryan.

I was hoping to level-set a bit more on Life Sciences trends and outlook, at least with our growth trends and outlook. And I know that bioprocessing trailing revenue base is quite limited. So the numbers there are impacted by that, but are you willing to speak to fiscal '24 growth rates across food and bev, disk drive, vehicle electrification and bioprocessing? And then what's contemplated in your fiscal '25 outlook for each?

Brian, we haven't broke the model out externally to that level. We can tell you that we do expect a low-double-digit growth though in food and beverage. Bioprocessing will certainly be a bit more muted and that's what we put within the model. That's really the longer-term change if you will. And then disk drive will continue to crawl forward from the bottoms we experienced here over the past year. That's just generally kind of how you would put the model together.

Okay. Understood. The step up in fiscal '26 Mobile and Industrial profit expectations is encouraging certainly supported by the trends of your operations. Maybe speak to what the key drivers have been for much stronger-than-expected margin expansion in the legacy segments particularly in Mobile. And then on the Life Sciences side, we know that the demand backdrop in for biopharma is still muted. Is that the exclusive driver of the lowered growth and profit outlook or are there also differences in the forward model in terms of investments required, cost structure et cetera?

So let's take Mobile first. And within Mobile, what you have is really the power of the mix overall, expanding the operating margin. Specifically, we have clear share gain within our Aftermarket organizations. We also have the benefit of a little bit of the tailwind due to the OE destocking in the past. So given the sense of where we are, for example, on that mix. You will have seen on our OE channel within Aftermarket, which is about 40% of that business is up, say, high-teens within the quarter. And then when you look at the independent channel, which is 60%, you'll have seen clear share gains and up high-single-digits. That really shows the power of the mix. You also have obvious headwinds within the OE sector of the first-fit production within Mobile Solutions. And specifically what really showed up in this quarter, the new piece of data would be a little bit more headwind in mining, which we had not been experiencing in the past. So net-net, we've got a good strong mix opportunity. We're very optimistic about the future and been able to hold that operating margin specifically because of the share gains we have in Aftermarket and we've been working really hard to get a fair relationship with our OEs and get the pricing opportunities appropriate there. Within the Life Sciences sector, yes, the bioprocessing upstream and downstream is really where we look to grow. That is clearly a more careful market at this point in time. We also would point out that new cell and gene therapy development is also a place where we look to grow. What's interesting about when you combine those, we see less expansion by the biopharma within the bioprocessing equipment sector. And so that has become more muted as well as in the cell and gene therapy activities, we told you we had about 140 or so development programs within therapeutics. We're up in the quarter double-digits. You can see the slowness happening, for example, with less programs going into Phase I and Phase II clinical trials. And so things are just evolving more slowly than we would have expected and it's just really the backdrop of the comprehensive sector if you will.

Understood. Appreciate the color. And one more quick one, if I may. Perhaps offer a little more color around Medica S.p.A., and then fit in the portfolio and your continued build-out of the bioprocessing puzzle that you've laid out.

Yeah. We're really optimistic about what we have within the bioprocessing activities. We look at the some of the parts and we're very positive. Clearly, the market is telling us it's going to take longer than we had originally hoped. In our typical Donaldson and other models, when programs slip, they'll slip a quarter or two quarters. But within bioprocessing, they seem to slip a year or two years. And so that's really we just thought it was prudent within the longer-term outlook to take that into account and therefore the model change. But overall, when you sum it up, we're excited about what we have. The customers are telling us they're excited about the overall products that we're bringing to them. They are disruptive. They like the efficiency output that it brings to them. We just need to continue as a company to work our process to commercialize them and push them out. It's just going to take a little bit more time than we had originally thought but on a good track.

Okay. Understood. Thanks again.

Your next question comes from the line of Tim Thein from Raymond James. Your line is open.

Good. Thank you. Good morning.

Hi, Tim.

The first question was on, hey, good morning. Yeah, just on the Industrial segment, I was hoping you could maybe give a little bit more color specifically on IFS and you mentioned in the release some of the timing issues that may have impacted sales in the quarter, but the kind of a step-up in growth projected here in '25. And I guess it's a little hard to generalize for that segment just given the number of end-markets. But one of the themes has kind of been around larger-scale CapEx, just a little slower to move forward and just maybe just some mainly is around larger capital projects. And I know that's not a great generalization for what drives that segment, but maybe just give some color around the pieces within the portfolio that are giving you confidence in that high-single-digit growth projected in '25?

Yeah, Tim, just generally, as you describe the macro of what we're experiencing, I think you're very spot on to the overall condition that we're experiencing. For example, IAF, so dust collection equipment in Europe certainly is muted. It's the biggest headwind that we have. And it's specific to Europe. It's not other region-based and so that is the biggest headwind that we have. And then the other one is timing relative to power generation projects. We still feel very good. It's a multi-year positive trend within power generation, certainly going up. Our backlogs are healthy. It's a very lumpy business as we talked about many times before. It's just in a lumpy moment again. Therefore, it was down in the quarter. But as we look forward, we do not expect it to be down. Next year, we do expect it to be up year-over-year and we see that within our backlogs. So we feel like that gives us confidence on the movement up. And then in dust collection, IAF in Europe, it's pretty tough there. We do expect conditions to repair slightly going forward. So the comp becomes a little bit easier to give us some tailwinds there. And then the third thing, very importantly is our connected-based products really are gaining momentum. We put up and stood up about another 1,000 in the last fiscal year. We do see they help us drive Aftermarket and we are gaining share really across the world, largely though in the United States within our Aftermarket execution. And so net-net, when you roll out it together, that gives us the positive outlook for IFS within fiscal '25.

Very good. Thank you. And then just I guess turning to capital deployment with, I guess, half a turn of net leverage obviously in a really good position to be on the offensive. Maybe just with respect to the growth aspirations in Life Sciences in light of the tougher cyclical backdrop, does it change your motivation or just change your plan in terms of how much you want to invest in that area in light of a market that's maybe shaping up to be tougher than you thought? And I guess maybe the corollary to that would be, is there potentially less, maybe you're competing for less investment just broadly speaking or is that just not the case and sort of I don't know the open-ended question, but however you want to touch on that. Thank you.

Yeah, let me try to unpack that. There's a lot there. So just generally at the company level relative to capital deployment, our priorities have not changed. I mean, Scott points it out within the script. We specifically will invest back into the company organically and inorganically, we are targeted specifically at Life Sciences as well as service aspects in some pieces of the Industrial, primarily Life Sciences. We like the play that we have within Life Sciences. Sure, it's a little bit elongated, but the longer-term returns within that space still look very positive for us as we continue to enter it. As far as opportunities for M&A within the space at this point in time, it has gone, let's say, that's also perhaps a little bit more elongated than it has been in the past, but we saw a very full pipeline. We're still developing good relationships. It's very strategic. I'm very pleased. Nothing changes at all relative to our strategy and we sit in good shape.

Maybe I can just add on a bit to that. I mean, if you, back to your comment about our half a turn debt level, I mean, we generated cash conversion of 113% last year, 97% this year. We're forecasting in our guide 85% to 95%. So very strong cash flows over the last few years and another strong year projected. I mean we've stomached the acquisitions that we've completed. Bought 2% of our shares increased the dividend and our debt slowly trickles down. So, in the guide, we also noted this year, we are forecasting a share repurchase of 2% to 3% of our shares outstanding. If you look back the last several years, it's been spot-on 2%. And so we've increased that a little bit in light of the very strong cash flows that the company has generated in the last two years and again expected for next year. So we feel like we're in a really good shape from a strategic capital deployment perspective and that we're really being smart with how we're allocating capital into this business, which is evidenced by the debt slowly coming down. So we feel like we're in a pretty strong position. We do look to execute acquisitions and those you know the timing of which is always something that's impossible to estimate, but we feel like we're in a very strong position and we did slightly tick-up the share buyback guide for this year because of those strong cash flows.

Okay. And I'll squeeze one last one in. And this -- the risk of cutting this or slicing this too finely, but I'll just ask on with respect to the growth in Aftermarket within the Mobile business, does the, the fact that you had the contract win and that share gain that you experienced in the independent channel. Is that normalizes is there a much of a mix impact in '25 if you have maybe the independent channel doesn't see the level of growth vis-a-vis the OE channel in '25? I know there's some can be some different margin dynamics there, but just curious if that's a meaningful factor in any way.

I think the more meaningful factor to really take into account here is the OE destocking portion of the mix that you referred to because we do end up lapping when that was -- when that began last fiscal year. And we start to lap that within this fiscal year in Q2. And so maybe that's something more important than what you're calling out rather to a particular large win on the independent channel. That's something to think about. And you kind of when you roll that within our overall growth rate than expected from that maybe [indiscernible] it from that perspective.

Excellent. Thanks for all the time.

Your next question comes from the line of Nathan Jones from Stifel. Your line is open.

Good morning. This is Adam Farley on for Nathan.

Hi, Adam.

Hi, Adam.

So gross margin improvement has been very impressive. Besides price cost, what are the main buckets leading to better-than-expected gross margins in the businesses? And any thoughts on expectations for gross margin going forward as the environment normalizes?

Yeah. I mean, the company has obviously worked very hard on its gross margins over the last several years, getting back to the spikes of inflation that we saw and we just want to have reasonable commercial relationships with our customers. And so if costs are going up, we got to fast price increases on and they do the same to their customers. And certainly, we think things are stabilizing now. We have some costs still going up, but some going down. So that's a good place to be. I think the world is hopefully normalizing and we've worked hard on all aspects of gross margin to get to a 36.2% gross margin for the fourth quarter and 35.6% for the year is where Donaldson should be right now. We're expecting to maintain that level of gross margins going forward. So we're not projecting any massive increases. Price for next year is forecasted to only be 1% of revenues. So we're pretty pleased with our gross margin performance. The plants have performed very well. And so hats off to their work to maintain costs and ensure we're executing as efficiently as possible. And then we always have to be able to continue to leverage. You know, what we're doing with higher levels of sales should generate higher levels of property and profitability. We are generating higher levels of sales. And as things have calmed down now we've really moved back to our traditional roots of improving our cost structure and we did announce a fourth quarter program whereby we're looking at a footprint and cost optimization program and while that won't necessarily provide benefits immediately, longer-term, there'll be benefits from that. So we're going to keep working on our gross margin. We feel like we're definitely headed in the right direction with how things are performing and that's why we think we can maintain these current levels.

That's really helpful. And then just a quick follow-up. What is the On-Road product line that is it related to? And do you expect to do any more product-line rationalization?

Yeah. If you remember a while back, we talked about the exit of some product lines across the company and we have one particular product. It's a DEF tank product that's really not in our core and we've been producing those for years and years and years. And because it's really not a technology-led filtration solution, we're going to move out of that business and work with our customer to transition elsewhere. And there is a revenue haircut from that. But thinking about the capital we employ, the investments for future, we decided that wasn't strategic to the company. So that's a headwind that we've accounted for in our guidance this year in terms of first-fit sales, but I think it's the right decision for the company.

Okay. Thank you for taking my questions.

Your next question comes from the line of Brian Drab from William Blair. Your line is open.

Hi, good morning. Thanks for taking my questions. I just have a couple at the moment now. I was wondering if you could talk more specifically about the NAPA partnership and what went into that win. Specifically, I'm curious if you could talk about the NAPA Gold product line. What end markets are you getting increased access to? And anything else that you can do just to flesh out that win and add some detail to that.

Yes, sure. So just basically, it really hits the strengths of the company as to why we won, right? So one, we have the technologies necessary that they cover across the full portfolio of product that covers all the medium heavy-duty diesel engine opportunities across multiple end market segments like construction, ag, mining, et cetera, and that really targeted because of our catalog. Second is because of we really take great pride in customer service and customer relationships. And we have taken time to really get a strong relationship and good information share between the two companies, such that our service levels to them are really quite good. And so you roll those things together and it allows us to win this thing over time, and we believe it will allow us to have a strong relationship with them as well. So really place the strengths.

Yeah. Great. Thank you. And then just to be clear, I see a press release from August, but this is a partnership where you stepped up your business with them prior to August, right. And this has been contributing to the growth in the independent channel.

It has been -- we felt as though we should put that press release out because it is material and we wanted to signal to everybody that, hey, we do have this program win. And now it is clearly continuing to add to the growth on the independent channel, yes.

Yeah. Okay. Got it. Thank you. And then we talked a lot about margins, but I just want to ask one more there. I'm not sure that this was discussed in great detail, but I'm just thinking that one of the things that I believe has been helping margins lately is has been the mix, right, between kind of Aftermarket and first-fit. First-fit has been a little bit soft. And can you just comment specifically on whether there could be a headwind from the first-fit business eventually recovering and the proportion of sales from first-fit increasing? Thanks.

Yeah, Brian, I think you have it right. Certainly, our Aftermarket sales, which is one of the critical strengths of the company to have two-thirds of your business being replacement parts is really what drives the company. And we want to continue to sell proprietary first-fit solutions because every time we do that, we secure Aftermarket business for many, many years to come. So as things cycle up and down in Off-Road and On-Road and first-fit sales, obviously tend to cycle, there is a mix impact to that. And if your Aftermarket business is growing at a rate much faster than your first-fit businesses, you're going to have margin accretion. And if it switches the other way around, you're going to have some dilution. We think we can continue to weather those storms. And we've really factored that into our guidance going forward. So we do expect longer-term that certainly the first-fit businesses are not going to be in decline. And certainly there's some well-publicized short-term issues in the first-fit business where you see some of our big customers retrenching just a bit and we expect that to happen for a while and then ultimately return to growth. And so I think you have it right. We factored those concepts into our guide for next year as well as our revised Investor Day targets where we're taking Mobile Solutions and Industrial Solutions up quite a bit. So we feel pretty good about the operating margin even in light of the fact that at some point, first-fit will come back.

Right. Okay. Thank you very much.

Your next question comes from the line of Rob Mason from Baird. Your line is open.

Hi. Good morning.

Good morning, Rob.

Just real quickly, I had a question on the fiscal '25 outlook. How are you thinking about the sales cadence? If you just want to break it down between first half and second half, yeah, if you could just comment on that.

Sure. We're closer to a 49-51 than we are at 48, our traditional 48-52.

I see. Well, that kind of bleeds into my second question. Just around the Mobile Solutions outlook. The share gains have been notable here. I think you outlined or detailed some would seem like maybe incremental share gains in the Off-Road business that support the outlook there. Just that my read is those are somewhat meaningful. Just your customer base is talking about a more pressure there certainly through the back half of the calendar year. Just if you could comment on your thoughts around how you may be performing there versus market volumes within your outlook.

Yeah, we definitely have some share gain there. No question about it. And we did bake that within the guide

Any particular region that bias to?

Well, they're global-based customers. So when we win, we really win by platform. And so it's tough to specifically, on this particular win say, hey, this is the region because it will be more broad-based.

Sure, sure. Okay. And then just last question, stepping back to the 2026 target revisions. Scott, I think in your commentary, you talked about R&D would continue to increase, which is something we would expect. But could you put a little more context around how you think R&D trends over the next couple of years relative to your upwardly revised OP margin guidance and really on more specifically how should we think about that as a percent of sales? Does it go up as a percent of sales? Does it stay where it is?

Now Tod and I have been pretty consistent over the years. R&D is of critical importance to Donaldson. We are a technology-led filtration company and when we start thinking about our budget for the next year we really think hard about what monies we want to allocate to R&D and we expect to continue to increase our R&D spend, both in terms of dollars and in terms of rate of sales. If you look at the you know it does go up and down but in the longer trend is a pretty significant increase over the last few years and we want to continue that. We want to continue to invest in new technologies. We have some great opportunities in Life Sciences to invest. You know and we're nearing 3% of sales. And we've been under that and we're going to continue to allocate both capital and expense dollars into R&D because that's really our best opportunity for returns on invested capital is to do it in-house with our spectacular R&D team that we have.

Yeah. And the way we talk throughout the company is we're a technology-led company. We want to continue to invent cool things. Pretty straightforward.

No. Understood. And just one last quick one. Just related to the restructuring that you outlined, Scott, you mentioned that would those benefits would play out over time. Is there something included in the '25 outlook related to the benefits from those or they extend beyond '25?

No, there would be much impact in '25. We're going to continue to focus on our footprint and cost optimization and there will be some more actions that I'm sure we can identify this year. But they take a while to run through and start to show up. But we're just trying to make the company consistent with our historical approach of things more efficient every year and that takes some investment, but the returns on those investment while not a one-year payback usually shows up in year two or year three for sure.

Very good. Appreciate the update. Thank you.

That concludes our question-and-answer session. I will now turn the call back over to Tod Carpenter for some final closing remarks.

That concludes the call today. Thanks to everyone who participated and we look forward to reporting our first quarter fiscal 2025 results in November. Goodbye.

This concludes today's conference call. Thank you for your participation. You may now disconnect.