Ladies and gentlemen, thank you for standing by. My name is Christa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Donaldson Second Quarter Fiscal Year 2025 Earnings Conference Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. And if you would like to withdraw that question, thank you. I would now like to turn the conference over to Sarika Dhadwal, Senior Director, Investor Relations and ESG. You may begin.

Good morning. Thank you for joining Donaldson's second quarter fiscal 2025 earnings conference call. With me today are Tod Carpenter, chairman, president, and CEO, and Brad Pogalz, chief financial officer. This morning, Tod and Brad will provide a summary of our second quarter performance and our updated outlook for fiscal 2025. During today's call, we will discuss non-GAAP or adjusted results. For second quarter 2025 non-GAAP results, exclude pretax restructuring charges of $2.2 million related to footprint optimization and cost reduction initiatives, as well as $4.4 million of business development charges. 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.

Thanks, Sarika. Good morning, everyone. I'm proud of what the Donaldson team accomplished this quarter. Through resilience and dedication, we delivered for our stakeholders. Total sales increased in constant currency and earnings rose at a faster pace reflecting overall margin improvement. We executed on what was in our control in light of macro headwinds. Our team navigated a choppy operating environment and with the benefits of our diversified portfolio of businesses, delivered higher sales in key higher margin businesses. We diligently managed costs and pricing and exercised strong expense discipline while still investing for the future. Now, some highlights from each of our segments. In all three segments, sales were impacted by weak end market conditions, including in agriculture, transportation, industrial gases, dust collection, and bioprocessing. In spite of that backdrop, in mobile solutions, sales grew in constant currency driven by solid aftermarket performance, where we continue to gain share. Our recently opened distribution center in Olive Branch, Mississippi is allowing us to deliver products with speed and reliability and our fill rates remain at almost 100%. We are also planning ahead and ensuring we are well positioned to address all future engine adoption scenarios with our alternative power solutions. In January, we announced a partnership with Daimler Truck North America on their hydrogen fuel cell project. Donaldson's advanced air filter technology will be featured in the next generation Freightliner SuperTruck 2, solidifying our position at the forefront of hydrogen fuel cell innovation. In industrial solutions, our aerospace and defense business is outperforming our expectations. Demand for new equipment in commercial aerospace has been at record levels and defense orders and quoting activity are very strong. Overall, we continue to build our industrial business through our create, connect, replace, service business model. The number of connected machines and customer facilities…

Thanks, Tod. Good morning, everyone. Second quarter results reflect a team effort. Across the company, Donaldson colleagues banded together to prioritize opportunities and control what we can. All while keeping an eye on the future by pushing forward our strategic initiatives. As I walk through some key points from the quarter, please keep in mind my profit comments will exclude the impact from the charges Sarika referenced earlier. At a high level, second quarter total sales were down about 1% versus 2024. Currency was a headwind of approximately 2%. And pricing was a 1% benefit. Disciplined expense control drove operating margin up 40 basis points. And EPS of $0.83 was 3% above last year. Gross margin of 35.2% was flat to the prior year. With an unfavorable sales mix being fully offset by select input cost of operating expenses, the rate of sales was 20%. Compared with 20.4% a year ago. With this strong leverage, driving operating margin up 40 basis points, to 15.2%. In terms of segment profitability, mobile solutions pre-tax profit margin was 17.4%. Down 60 basis points year over year driven primarily by an unfavorable sales mix and expense deleveraging. Similarly, expense deleveraging on softer sales brought the industrial solutions pre-tax margin down 190 basis points to 16.1%. As we mentioned last quarter, we expect industrial pre-tax profit margins to improve throughout the year. Supported by the execution of our projects and backlog and leverage on higher sales. Life sciences had a pre-tax loss of approximately $500,000 in the quarter. Which is less than 1% as a rate of sales and significantly better than the prior year performance. The margin improvement was driven by cost optimization actions taken earlier this fiscal year, which were related to prioritization efforts. And we also benefited from leverage on higher sales.…

Thanks, Brad. When we held our investor day in April of 2023, we laid out our long-term strategic vision and fiscal 2026 financial targets. The close of this second quarter marks the halfway point to our three-year journey. Despite difficult conditions in many of our end markets, we have delivered on our expectations through the hard work and commitment of the Donaldson team executing our strategy, while making timely, tactical adjustments along the way. As the leader in technology-led filtration, we have and continue to position ourselves to consistently create value for our shareholders through market share gains, in many key businesses, and through record earnings results. We intend to remain on this trajectory by continually evolving to meet the needs of our expansive and diversified customer base. Our earnings combined with our robust balance sheet allow for continued focused investments in growth initiatives as we build on our success. Across all three segments, our R&D and cap investments are aimed at driving sales and efficient execution. Our M&A pipeline is robust, and strategically focused. Finally, I want to thank our talented employees for helping us build our future. I'm proud of the work they do, and I'm impressed by their unwavering dedication. 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. Our first question comes from the line of Bryan Blair with Oppenheimer. Please go ahead.

Thank you. Morning, everyone. Good morning. Hi, Bryan.

Todd, you called out a recent win in China that's perhaps reflective of a structural shift that worsened Donaldson's favor. I found that comment very intriguing. It'll be great to hear more about the noted win and more importantly, the implications of that and what's beside the shift transition could mean for Donaldson going forward.

It's just a continuation of technology wins for us within the overall sector of China. Remember we've been talking for a number of quarters of really bringing our technology-based platform proprietary razors, to sell razor blades across that particular sector. And we have done that. This particular one happened to be in the liquid sector and hydraulics specifically for tractors, and so you see us now getting traction within that in a type of application in addition to the momentum that we have on air-based applications.

Understood. Appreciate the color. A level setting question, within life sciences, if we were to simplify the segment to disk drives, food and beverage, bioprocessing, and other, or even just bioprocessing and legacy applications. What is the split of profitability at this point? The impetus here is trying to gauge as you gain scale, it has, excuse me, a top-line inflection in bioprocessing. What that's going to mean on a run-rate basis when that business is on the trajectory that your team's targeting.

So the way to think about that is if you take the traditional business that we had, they're all profitable. Remember that the acquisitions that we did were pre-revenue, largely and so consequently obviously, those have headwinds really mixing down the overall current profitability of the segment as we continue to push those new products out which we fully expect to happen here within the next year of twelve months or so, you'll start to see some of those new products come out and we gain traction. That will only lift the overall sector even more positive.

Bryan, this is Brad. I'll just add a point in reference back to my remarks to remember in the first quarter, we did some restructuring and that was all about prioritization within these specific businesses. As Tod mentioned, we have a project pipeline that we're working on to bring some of these items from pre-revenue to revenue and so the teams have done really good work to try and sharpen the pencil on where are we really gonna invest that's giving us some momentum in life sciences profitability as well.

Understood. Appreciate the call.

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

Yes. Good morning all. The first question is around the mobile solution that's just the aftermarket in general. You know, there's a couple of quarters now, we've seen a meaningful divergence between the OE channel and the independent channel. And I was just curious, what better explains that if that's just focused from the OEs on their parts business or share gains, what have you. That's one. And then the second question, still in the aftermarket, is I know you didn't change the outlook there, but it doesn't look like for the second half, there's much in the way of normal seasonality built into the guidance. And I'm just curious if that's conservatism or if that's reflecting somewhat underlying weaker demand or how you're viewing that?

Yeah. Sure. So when you look at our aftermarket business, what ended up happening here within the quarter is a little bit of a shift in the behavior between the independent and the OE channel. The OE channel clearly has some more focus from the OEs on their parts-based businesses as you call out. You know, we clearly see that and we see that a little bit more demand from that side. On the independent channel, which is if I remind you, it is about 60% of the overall business. That felt a little bit more of a pullback, a little bit more cautious tone. And, you know, net-net, we were up. Now that's kind of some interesting adjustments for us that we see in behavior changes. However, you know, the story remains for us as share gains. And how we continue to execute really well. Our fill rates are near 100% when the customer wants the product. We're doing very well within that channel, servicing that channel. And we're very happy overall with where we are. Now we didn't change the guide, but we didn't change the guide because one basically offsets the other and so that felt about a push.

Understood. And just as a follow-up, you just talked, Todd, just around the visibility in IFS. You know, understand that can be lumpier with the projects. That move around, and you did pull the guide down there, but how are you I guess, risk adjusting for those projects in the second half of the year. And, you know, are those biased either to PowerGen, which my impression is that maybe those could be larger or the dust collection business.

Yeah. So PowerGen is clearly the largest project. And they move from quarter to quarter. Based upon-site availability, etcetera. We did see movement on power generation. It is about half that represents about half of the down in the quarter if you will year over year, but those move out. And so consequently that revenue will come, but in the quarter it's clearly a notable headwind. Our part generation business remains very strong, we expect it to remain strong at a minimum for another year, year and a half, we have that much visibility so very positive things. That's not really the story here for us and the change of the guide. Because we're still very bullish on power generation. The story really for us is in our capital-based project businesses that are more related to manufacturing. Specifically, we saw some movements within what we would say is the automotive arenas of that particular business where projects really uphold back and you could say that's more related to an electrification type of a situation, so battery manufacture electric car manufacturing, those kind of activities. Certainly, abated in the quarter more than we had expected. All other industries feel pretty good. Quotes remain still at a good level. But that meaningful shift is really more further indication that this electrification phenomenon is clearly not gonna happen as quickly as many had hoped, and you see that over also in our vehicle electric programs, supporting automotive for specifically electric cars, in venting based applications where that also felt a lot of pullbacks. So electrification really in the automotive sector really explains a lot of that and, you know, we did not see that meaningful shift forthcoming, but it certainly happened with import.

I see. Very good. I'll turn it back. Thank you.

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

Hi. Good morning. I think that you touched on this somewhat, but can you just further elaborate on the IFS segment, the average about $210 million a quarter. In the first half of the year and then is this project-based business, is that what's driving this big step up to, you know, the guidance implies going to more like $250 million a quarter in the second half.

Yeah. So it's clearly project-based. And again, Brian, so the power generation business really saw timing move. It explained about half of the reduction in this quarter, but those project-based businesses for power generation move. They just moved into the next quarter, the third or fourth quarter. And in fact, currently in the company within power generation, we did not change our annual guide for that business at all.

Okay. So that's all that's the power gen that's all power generation. Okay. Thanks. The call is actually cutting in and out a little bit, so I'm not catching everything. So sorry if I asked something that was if I'm repeating the question. Oh, no worries. On the aerospace and defense side, can you talk a little bit about where the particular strength is there, more on the aerospace, more on the defense side, and just kind of give us a little more granularity there. Thank you.

Yeah. So it's both. And what, you know, we have good strength in both pieces of the business. What we had factored in when we gave our original guide this year is supply chain problems and difficulties within the supply chain that we had expected. Keeping in mind that if we were to try to requalify a new supplier for a particular part of that business, that could take as much as a year or a year and a half or two. And so we had expected that kind of a situation to us headwinds and therefore flat. The supplier of course that we do have has actually improved performance to a little bit of our surprise, but through some fantastic work of hard work of our people here. Working with that supplier and so consequently that's why it's up. You know, the backlog has always been there, the orders have always been there, it was more of a reflection of supply chain and with us now knocking down some of those supply chain hurdles, that's what you're seeing in the guide.

Okay. Thanks very much.

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

Good morning. Just a question about the dynamic you're seeing in off-road. I guess two parts. One, to what degree are the auto OEMs talking about if there are tariffs that it triggers the destock cycle or do they see sort of a bit of a pre-buy to get ahead of it? So you can just give a sense for kind of do you see kind of the initial impact kind of which way it swings? But then secondly, when you think about your overall outlook adjustment for this year, how much of that do you think is lost demand as opposed to pent-up demand that comes back in 2026?

Yeah. So let me take the first one. Within the off-road sector, we have not had pre-buys, we have not had any of those kind of activities. Out of our customers as a result of any of the tariff type of activities that's, you know, remember some of those off-road markets like ag are really difficult for them. You know, to see them taking on inventory right now would be kind of an interesting move as they try to really work down the inventory that's out of the channel. So we'll see. We'll keep an eye on that. We don't really see that happening. It's a bit more right the macro business as usual across that base. Relative to manufacturing and delivering for them. I would say that the one change that maybe has happened or accelerated in the behavior is asking our, you know, specifically always asking us our capability of building their products outside the United States. As Brad said in his script that you know, we are a net exporter from the US and so to the extent that always will want to have us rotate and build it more closely to their factories rather than having in US and export it. You know, that we have received questions regarding that. That's the only behavioral change, really. And then the second question I

It's just around to what degree do you see kind of the slightly softer near-term outlook being kind of a sign of pent-up demand for next year or is it just kind of

Right. Right. You know, that's really tough to say because, you know, we're really being driven by the end markets. Nobody's nobody is behaving differently as a result of the uncertainty that are clearly being introduced into the business markets if you will. And so to suggest that people are holding back or pulling forward that's not what we're seeing at all. Now that's not to suggest that it won't happen, but you know, for us, that's not the macro, that we see. And for our guide, we're taking in taking what we know and we applied that within today's guidance.

Thank you.

Your next question comes from the line of Angel Castillo with Morgan Stanley. Please go ahead.

Hi. Good morning. This is actually Stefan Diaz sitting in for Angel. Thanks for taking my question. Maybe if we could dig back into mobile solutions aftermarket growth. Would you be able to parse out share gains versus market growth and then maybe what sort of line of sight do you have into share gains continuing into your fiscal 2026?

So, you know, as a macro, you know, we have interim models to really track us against competition, etcetera. The benefit for us is we have factual data even though our quarters may be very different etcetera. You know, we have factual data that we can track. And that specifically tells us we are winning share gains and we have won share gains, you know, quarter after quarter after quarter. And so we're really very proud of our Internet to market team and what's taking place out there and we expect those share gains to continue looking forward.

Great. Thanks. And then, I believe last quarter, you mentioned some CapEx projects being pushed out within life sciences. Can we have an update there? Like, has there been any step change, you know, in either bringing projects back forward or maybe pushed out further. Thanks.

Yeah. So you remembering life sciences specifically in the bio process and you have an upstream process and you have a downstream process. And those larger projects are in the upstream process specifically with bioreactors and activities like that. Last year we had very large projects, you know, five, six, seven million dollar projects that were in flight those are now shipped giving us tougher comps as we look ahead. Within life sciences in the second half and this is the reason why our commentary says that it's certainly more guarded in that industry because those projects have not been replaced and large life sciences companies are not kicking off the multiple million dollar CapEx based projects and specifically our Solaris business tells us that. So we've not seen, you know, green shoots in that area at this point. But, you know, we'll continue to press forward and manage our business appropriately.

Great. Thanks for the call. I'll send it over.

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

Yeah. Good morning. This is Adam Farley on for Nathan. Good morning. I wanted to start on Hey. Good morning, guys. I wanted to start on operating margins within mobile. You know, how should we think about margins for the remainder of the year? I think in the quarter, called out a little bit of a mix headwind, but with aftermarket growth, how should we think about margins?

Adam, this is Brad. But all three segments pick up from here at this point if you look. Second half versus first half. So some of it comes with the natural leveraging on sales, and then some of it comes with the quality of the work that the teams have done around the company to be smart about where we're pulling out expenses. Just a side note on that, we're not just we're there isn't a mandate that says take x percent out. It's teams reflecting what they need in certain regions or in certain businesses and then prioritizing that. So I think that's where you'll see this take up. Again, it's across the company.

Alright. Thanks for that, Brad. You know, turning back to industrial and your connected solutions, are you seeing any changes there on the adoption rate just given some of the it sounds like there might be some deceleration in the industrial markets.

Yeah. So we are. We've actually picked up our overall connectivity. So for example, the year-to-date growth in connected machines alone is 30% so far through the first six months and in facility, so remembering a facility can have multiple machines, is 29%. So we're getting a broad adoption across the customer base as well as customers often put more than one machine on base. I can tell you a story that happened within the quarter that was very fun. One particular customer I won't mention my name, but they contracted to hook up all 60 collectors on their site at a very large manufacturing site after they hooked the very first one and ran it for a while. So we're really starting to get a name out there now, gather momentum and looking to continue the pace quickly to hook them up. Keep in mind that each time we hook those up, what we have seen is an increase in really customer relationships depth of that relationship, and more importantly an increase in parts and replacement parts sale. So we're really proud of the efforts. We think we have really the best-connected product out there and we'll continue to push forward with that strategy.

K. Great. Thank you for taking my questions.

If you would like to ask a question, please press comes from Brian Drab with William Blair. Please go ahead.

Hi. I just want to ask one follow-up question. I was wondering, Todd, if you could talk about, you know, irrespective of what's happening in the life sciences market and the challenges there, how is the development of the technology going just kind of the pipeline that you're developing for when the market improves, you know, within bioprocessing, therapeutics, the bioreactor products that you're developing. Just how is the technology development going? Thanks.

Yeah. So Brian, what we did is, Brad mentioned earlier, is we had a very broad agenda of products that we had in flight, all kind of fun ideas. And clearly, the market said, hey, you better focus, and so that's what we did do as a corporation. But those that we focused on is coming really nicely. We really are pretty happy with the disruptive technologies that we have going forward. Still some time ahead of us before we bring those out to the market, but for example, we have some in testing right now. So we're not it's not years away. I would say it's quarters away and we've made significant progress.

Okay. Thanks very much.

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

Yes. Thanks for taking the follow-up. Brad, you may have addressed this just a moment ago with your commentary around margins, but just maybe to put a finer point on it. It sounds like for the second half of the year, it looks like your guidance kind of implies about a, you know, 50 basis points or so of year-over-year margin expansion. You're saying that we will see both gross margin expansion and OpEx leverage in the second half.

First versus second, yes. Now, again, the OpEx leverage would be a bigger

I'm sorry, Brad. You broke up for me a little bit.

Yep. It's the first half is it will improve in the second half from the first half.

So

And then I want to say operating expense leverage is a more meaningful contributor to that.

Okay. Because, yeah, I know your SG&A in the second quarter was kind of unseasonably low. Does that carry forward, or are there just some adjustments in the second quarter specifically?

No. We expect that to carry forward. So we've got lower headcount year over year. We've got a real focus on any sort of discretionary activities. Again, it's really broad-based. This is about the whole company sort of rallying around. You know, we have this unexpected FX headwind, for example, that we have to address. And we're pulling down where it makes sense and prioritizing.

Understood. Okay.

That concludes our question and answer session. And I will now turn the conference back over to Tod Carpenter for closing comments.

That concludes the call today. Thanks to everyone who participated. Look forward to reporting our third quarter fiscal 2025 results in June. Have a great day. Goodbye.

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation and you may now disconnect.