Donaldson Company, Inc. (DCI) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to day 2 of the 18th Annual Oppenheimer Industrial Growth Conference. First up today, we have Donaldson Company, led by CEO, Tod Carpenter; CFO, Scott Robinson is with us as well and Director IR, Sarika Dhadwal. Good morning, everyone. To kick things off, I guess kind of high level, for those a little less familiar with your company, maybe provide a brief history of Dallas on company overview of your current operator structure. And I guess most importantly, what you view as the key competitive advantages for the company.

Sure. We are a 107-year-old founded in 1915. Filtration Company, founded by Frank Dallas Company, Frank Donaldson. We have 14,000 employees, 140 locations around the world. We are very regional based in our manufacturing approach where we support region-based customers within that region as much as possible. Most importantly, strategically, we are a technology-led filtration company, and that technology means that we have over 2,700 active patents in our portfolio, which is a significant strength across our overall model and to our customers. We solve complex customer problems with our technologies, which really is a proprietary razor, if you will, to help drive replacement parts. And therefore, our replacement parts are actually 65% of our company revenue. And while we've turned those razors or the first-fit projects being about 35%. We have strong technology. We have very deep customer relationships being a filtration company. Our company enables a greener and more modern economy, looking forward across our entire product portfolio suite. We are very diversified being everywhere the customer wants us to be. And we have best-in-class operations. And what we mean I'd add is, although through the supply chain concerns of the past, we struggled and we talked about that in our calls, the one thing we know for sure with high confidence is that we did outperform our competitors. And we know that because our customers told us and we know that because our distribution channels told us specifically that we were doing better. And so we are returning back to certainly more normal within operations, which means we'll have over a 90% on-time delivery rate to when the customer wants the product. And so as you really wrap it all up, that's who we are at the company and how we approach this.

I appreciate the overview. We emphasized technology -- and I suspect that's going to be kind of the underpinning your answer to this next question, what is the forward growth path for Donaldson, and one of the most exciting prospects over the next 3 to 5 years or even longer term, no doubt we're going to get into life sciences in that discussion at the next second path.

Yes, sure. So we have 3 reporting segments. We had an Investors Day roughly 1 month ago, about 4 weeks here at our corporate offices, had exceptional attendance to it. And what we told everyone is that we are a $3.4 billion corporation today. We have 3 reporting segments mobile solutions. So think of that medium heavy-duty diesel agents, construction, agriculture, mining and long-haul trucks everywhere in the world. We have an industrial-based segment. The industrial segment is really across all filtration opportunities in what you might term as the industrial infrastructure type of activities. So anything from pharmaceutical dust, the weld fumes to wood chips will collect all those type of particulates and taking those away from the particular manufacturing environment and also at times to protect machinery with that within the application, then we'll do that on air and liquid-based applications. And within that sector, we'll be in the power industry will be in the compressed air gas or industrial gases industries, et cetera. So a lot of industrial infrastructure. And then the third segment is our Life Sciences segment. So think of that as everything from food and beverage, but also into the biopharmaceutical or bioprocessing stage, upstream and downstream. And I'm sure we'll talk about that later here with questions. Our growth rates that we project to be in fiscal '26, so 3 years from now that we laid out at Investor Day is that our Mobile Solutions segment will grow at 4%. Our Industrial Solutions segment will grow at 6%, and our Life Sciences segment will grow at 20% being that the entire corporation will grow at mid-single digits, and we will become a $4 billion corporation from our current $3.4 million run rate in fiscal '26. That's how we view ourselves looking forward.

That certainly sets the stage to balance high-level discussion to start, perhaps talk about what you see as the key risks to be some company near to medium term? And obviously, secular headwinds and your engine business, debatable in terms of time frame. But that's certainly an issue that your team has addressed very open for many years. How are you thinking about the fast forward there in terms of the potential engine technology adoption, battery electric time Fuel Cell, any others that you would call out, what are the favorable scenarios, what is less favorable? How does your team strategy in thinking about that go forward...

Sure. I'll turn to energy alternative power solutions across our Mobile Solutions segment. Obviously, currently, it's medium heavy-duty diesel engines supplied by diesel fuel. And so if you think about that, our current product portfolio is the air intake. Our fuel filtration itself of the diesel taking out particularly in water and then the lubrication of the engine. Those are the 3 primary product families. Then as you go forward and you look at alternative fuels, this is a good opportunity for us. When you think about hydrogen, for example, the most obvious or talked about company pursuing this is coming. So they're taking their current engine portfolio, which is on diesel engines, and they're turning it to hydrogen-based combustion. And what that means is there's no real change. In fact, it actually might lift up the opportunity for Donaldson Company because -- no real change means, there are still moving parts on the lubrication. On the fuel itself being hydrogen or in gas, you still need to take out particulate in water in order to the combustion stream. So no change from there. You're just doing it in more of an air than a liquid based. And you still need air in the combustion side. So for us, it's neutral. It might even step up a little bit because of Belmont really a cleaner burn, if you will. And then when you go to fuel cells, the other alternative hydrogen-based opportunity, obviously, that takes away the moving parts. So the lubrication, the most commoditized filter in our product portfolio goes away. The fuel source itself becomes really the opportunity, you'll have a little bit of air into there that might actually go down as an overall quantity opportunity inside that system. However, the fuel source itself really exponentially goes up. And the reason for that is because while you're cleaning particulate out of an air in the combustion side in today's examples, what you have to do is create a pristine gas. And so that means you have to take out the sulfur dioxide and mercury any chemical necessary to be able to have the fuel cell operate efficiently. And the challenge of that is really much more significant than just taking out particulate because particulate will be more of a set to remove it versus the gas is more of an absorbent and Donaldson Company has been absorbing that type of challenge for years and years, primarily in our disk drive-based operation. And so we know the chemical -- we know how to absorb chemical stock quite well. And so that looks to be an opportunity it'll likely be neutral to us if fuel cells go forward. Then as you get into the battery side of the type of batteries that people are chasing. One is called the lithium air battery. It's actually the battery that should they have a breakthrough has better energy density in it than the current lithium battery that you lithium-ion battery that you know today. The lithium-ion battery likely will not make it because it just doesn't supply enough power to large applications. For example, a combine, I was talking to a Board member of a large agriculture company and a large combine, I thought it would actually last about 4 hours in fee the current battery technology only lasts now 45 minutes. So you can see lithium-ion batteries have a significant jump, which is the reason why lithium air batteries are being explored. There are likely a decorated or even more away from coming to market. But if that happens, that's good for Donaldson company because now you have to have, as the name implies, you have to have a very good high air quality. And so if you look across the entire portfolio, we believe it will be a mix -- a range of outcomes and each of these opportunity these type of alternative fuels will likely step forward and have a piece. But the one that presents the most headwinds is the lithium-ion battery. The others actually are opportunities for our company.

That's very helpful. Appreciate the green Circling back to more clear catalyst. You have mentioned life sciences, you're move into that space as treating recap the strategic rationale of getting into the space. What gives you confidence that Donaldson has had and does have in a future sense, the right to play there? But what is the strategic impetus kind level for making that to?

Yes. So if you just go back to the base strategic choices that we have, we're a technology-led filtration company. And so at the end of it all, if you go down to the least common denominator and that's the filtration principles and the materials that we use in order to be able to make filters. And within those, you have cellulose, you have glass and you have polymer-based chemistries. We're exceptional at cellulose and glass, and now we're coming on strong in polymers. And because we want to be a filtration company that offers all these type of solutions, you then get excellence at that level and then look for the end markets to drive into. Now that they're achieving excellence or getting more close to where we're happy with our excellence on polymer-based chemistries, will drive into the end markets necessary to be able to use those solutions. And that means the bioprocessing world and life sciences really stands up and gives us an opportunity because we have filter -- filter company, when we look at some of the bioprocessing, kind of the upstream and the downstream opportunities, we start from a different base and a different lens than other people have looked at that. And we're finding opportunities of brine products that can help those processes become more efficient. And the most recent example, for example, I'll just touch on one very quickly is our acquisition of Pure Logix. We had projects like that in the laboratory, where we take a membrane and looking to take chromatography away from a resin be based solution into a more of a memory-based solution and improve the outputs of that particular process. Pure Logix ended up being ahead of us. And so we combine forces, we were able to buy Pure Logix because it is a fundamental principles type of activity with our company and move forward. And so that's the way we look at this life sciences opportunity. We're really excited about it. And we look to have more and more information to share with you over the course of the next 3 years. As we grow that particular business, which is now roughly about a $250 million business to become $450 million to $500 million, which is what we told all of you at our Investors Day...

Absolutely. As we have in first look at some of the technology with Solaris, Pure Logix, Isolate Bio. Maybe discuss each of those acquisitions and the role they play in strainers kind of strategy in building out bioprocessing capabilities and setting the foundation...

Sure. Thanks. So just first of all, you think your bioprocessing type of process itself. One is upstream. One is downstream. Let's talk upstream first within the upstream portion of things, you look for system-based capabilities that allow you then to sell the filtration of the replacement parts around it. That's why Solaris was the first entry point for Donaldson company. We had all the life tech elements that we're filtering the solutions that go into bioreactors. So we bought a company with bioreactors much like we do on the industrial side of our company, where we make systems to be able to sell filters the same as here with bioreactors. So -- to we look at that systems entry point is really just an extension of how we act across our corporation -- and so we have this whole filtration opportunity now within the bioreactors. However, we also have technologies -- fundamental technologies and technologic company that help our customers with their processes. For example, there is a company called Wildtype out in San Francisco that we have now teamed with, and we are helping them reduce the cost of growing salmon proteins, so they can bring salmon cultivated sand to the market for human consumption. They've been at this for quite some time and have been looking for the FDA -- working with the FDA to approve its presuming consumption. The FDA has approved cultivated chicken out of bioreactors -- and this is a tremendous opportunity for us because we can help them increase the quality of their products and drive -- help them drive the cost down of the product through filtration and through the system. And if you just think about wild-type approach, if they had 1% of the fish market consumed in the world within cultivated bioreactors for human consumption, just 1% consumes and uses every bioreactor in the world. So there's a tremendous growth opportunity here, and it's a cleaner food source for people. So we're -- that was our first entry point, which then allows us to go into keeping upstream, if you will, goes into Isolere Bio, which essentially through the reagent type of activities and the filtration downstream of that helps people improve the outcomes of their products and the efficiencies of the product and the efficiency of the capture within the bioreaction process. Then this move all the way downstream, and downstream will get more into the chromatography activities which is Pure Logix, as I was referencing. And just to kind of get your head around that. On chromatography, it's a cylindrical-based type of application or system, if you will. So think of 6 befall maybe 2 feet wide, and you pack that with these things called resin beads in order to extract a protein of choice out of that solution, and that's a very long time. It's very slow. So instead of a resin beams, you'll throw the resides the way you won't use it anymore. But you'll do what you have to in the bioreactor with the solution, and then you will put it directly over the membrane and it's -- at least 10x faster, and it captures more purity of the protein of choice. So a larger portion of that protein of choice. And that's what that membrane may sit, if you will, does. And so we're excited to bring that product to market, working with many customers at this point in time. And so that's downstream. We have other applications that we have in our laboratory that we're pushing forward all go into this organic portion of the strategy now that we really share with you our targets at Investors Day. So really excited about life sciences, the opportunities and really the technology that we bring to help the overall marketplace...

With regard to the faces of the bioproduction puzzle that you're putting together, not whether it's organic initiatives or M&A investments, continuing to prefer strategy. What's next for your team? What are the key pieces that are missing or lacking to some degree and building out a more comprehensive product?

Sure.

Yes. One. Will give you...

No, it's okay. I'll give you the next one. So when we look at this overall map, there's really 2 approaches to it, okay? One is within that upstream, downstream process. So something that has filtration in it and maybe has an established product family or technology, and we'll look to buy that in order to help our portfolio. Something, for example, that could be free revenue, as we've done on the last 2 that we believe we could scale it and move forward, something that might be established in itself higher-than-company average gross margins or operating partners where we could help lift the company up and mix it up. But we know as we look at this product suite that we want to add that in. But then there's a third type, and that's our type is also important, and that is some of the fundamental core technologies of filtration inside there that may be applicable. And what I mean by that is -- not only filters are made the same and across the bioprocessing world, they're shaped differently than, for example, Donaldson has had experience in doing. So many of you will say, hey, you start a flat sheet and then you'll pleat it, meaning it comes out like an accordion, if you will. What we're fantastic at that. However, in the bioprocessing world, you have things that you have to turn the overall polymers into like straws for lack of a better description. We call that hall of fiber-based membranes and very complicated structures in order to be able to meet those other opportunities. So we would look to add those type of core foundational shapes, if you will, or technologies to the company as the third piece of opportunity within bioscience bioprocessing and the life sciences side. And so that's how we look at the acquisition front. There's still quite a bit of opportunity out there for us. We're very active on not being on or on establishing relationships. We like the pipeline that we have. It's very strategic, and we'll continue to press forward with that part of our strategy.

Bryan, maybe I could just add. I mean if you remember our last got pay in 2019, right, we talked about going into life sciences then. And so we've been at this quite a while. Our big decision in this Investor Day was really to break it out as a separate reporting segment. And so even prior to 2019, we had activities going on in life sciences. And we continue -- I think you got to go on a tour to see the materials research center, right? We put that building up years ago. I mean, so we've been working on this a while, and we're just becoming more direct with our reporting on life sciences. And so we've been on this puzzle that you referred to in Slide 100 of our Investor Day deck. And we've been working on that for quite a while. I mean Dave has been with us now a couple of years. So it's not like this is really a new thing for us. I mean, in my mind, we've been doing this for at least 5 years. Now we're just becoming more public and we want to come forward with targets in maybe a little bit more open with the current assets that we have and how we're going to fill up the future. So I think we've been slowly moving into this for a long time, and it's not why we just decided to do it with Investor Day. We've been on this for quite a while. And we had this vision to build out this segment for years and now is the time to come for a new reportable segment...