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

So one of the prime companies [indiscernible] for the year the company [indiscernible]. A global manufacturing aliases and their portfolio this past fiscal year are company on businesses. To better reconnect [indiscernible] and also the high growth profile for putting in the Life Science business. We love to have [indiscernible] here. At Donaldson's Chairman, President and CEO joined on [indiscernible] also create and now, [indiscernible] social companies and Life Science. [indiscernible] now, Tod?

Thanks, Brian. Appreciate that. [Technical Difficulty] that they prove to us on how to get a relationship with our customer. Strategy is best to drive as choices and students and new technology [indiscernible]. That allows us to get to have a broadening of end markets on the technology. We mutually -- we organized a corporation a year ago in order to [indiscernible], to go faster for our customer [indiscernible] relationships specifically within [indiscernible]. Our customers, [ sample ] [indiscernible] challenging problems allows us to be an enablers that are [indiscernible] economy that everyone has talked about, but we're helping our customer achieve their [indiscernible]. We have a nice balanced strategy organically as well as acquisitions. Each of our 3 segments [indiscernible] in April here a bit as well as we will decide on [indiscernible]. And we broke out the third segment, our Life Sciences segment, and we continue to build that out both organically and acquisitions. And we look for that to be a long-term growth rate for our corporation. So who are we? We are 108-year-old filtration company. We are $3.4 billion. We are global. I talked to you about being a technology-led filtration company since [ 2019 ], when we last had our Investors Day until this past April of 2023. Donaldson Company was granted a patent somewhere in the world on average every day. We are a technology-led filtration company that would take our investments in research and development [indiscernible] very seriously, that is our strategy and will continue to be the best in the world in filtration. We have a razor blade space model shown in the [indiscernible] on the left-hand side, 65% of our revenue in Razor Blades, 35% is Razors. All of the numbers that you see here, our fiscal year is August 1 to July 31. So this is representing last year, roughly about 3 months ago. All of the numbers you see here are records for our company. We're now 6 main durable competent advantages. I talked about technology leadership. We have deep customer relationships also the high after retention that we have within our technology and [ investment ] moving forward. And then we have best-in-class operations. We have roughly 55 manufacturing plants around the world, which is to say we are everywhere the customer wants us to be. We are proud to be global but in the real [ world ] touch and that also helped us to drive deeper customer relationships. We repositioned the company into 3 main segments. We have long [indiscernible] Mobile Solutions and the Industrial Solutions site segmented company. And last about 6 months ago or so when we were on Life Sciences. And the reason we did that is because we said we're going to continue to broaden the corporation. This is not new for us. We have been in things such as [indiscernible] the #1 filtration manufacturing for us [indiscernible], for hearing aids. Or things like -- we just have the focus on those bet markets, we hold to them very long. But now that's [indiscernible] for the Life Sciences segment. So we're going to break it out. So you can hold us accountable for our strategy and the execution that we expect to be forward. So we are now a 3 segment companies. Mobile Solutions is where we come with the company. It's still the largest portion of the company. We're focused there on driving new technology introductions for all of the alternative energies that are out there in the market. Within Industrial Science, we have and [indiscernible] with our customer base and then within Life Sciences, we're mostly focused on bioprocessing and we build out both upstream and downstream. We have a very strong balance sheet. When I talk about organic growth, this would focus [indiscernible] of our acquisition strategy. I want to be clear, we are an acquirer of choice. We have a strong balance sheet. We use it to our advantage, and we see our net debt-to-EBITDA ratio. We target a lot of our actions below that [indiscernible] right now. [Technical Difficulty].

Also, I think we're having some issues with the Zoom as far as with grabbing the microphones. Okay. So let's dig in here. And by the way, this is a collaborative event. If you have a question for any of our management, please raise your hand, we'll make sure we get you a microphone as soon as possible. Tod, I want to go back to just the decision at the company level to get into the Life Sciences business. And I would say that if you were to go back 15 years, this would not have been an avenue that Donaldson would have gone down. Talk about just the process from management perspective, deciding to jump in. And then we'll get into some of the acquisitions that have been made to push into this business.

Sure. We do think about a filtration company, if you allow me to be a little bit deep in that for a moment, what we do is we make the best filtration products out of raw materials, be it glass or cellulose or polymer-based chemistries -- more polymer-based chemistries, and we do that to be able to then put those new type of construction necessary to meet the needs of the customer. So that's new e-com fantastic as we are world class within those raw material opportunities. We then look to the end market base needs in order to decide what end markets can go into. So we go across that type of development technology. Life science is not really new for us in terms of -- when we talked about -- we were in some of the fish markets. This time though, we have said less than we're going to target what we believe there are some unmet needs and be disruptive into the bioprocessing base subculture manufacturing opportunities for us because we have the technologies to be able to do that. We can either invented in our laboratories or use our balance sheet, put it to work and acquire companies. And so for us, this is a natural extension of filtration technologies that allows us to broaden the overall market opportunities for our corporation. And that's the strategic decision as to why this one looks attractive. Additionally, it's above company average operating margin. It will overall help pick the company up. And within those types of technologies, it's a very sticky market.

So you've made several acquisitions to get into this space. Can you maybe -- can you please discuss what attracted you to them at this point in their maturation? And what each gives you as you move forward, whether it's Univercells or Solaris or Purilogics?

Sure. We've done 4 in the last 18 months or so. The first one is Solaris, it was very foundational. It's bioreactors. It allows us to actually get upfront -- the upstream portion of bioprocessing. It was really foundational relative to the product families that it brings. The next 3, Univercells Technologies, Purilogics and Isolere Bio are all disruptive-based technologies. A couple of those we are working on in the laboratories. These companies had a better solution. They were ahead of us. And so we decided, hey, let's combine forces and put that in our arsenal. Two of those are pre revenue-based companies. We look to build those out. Obviously, that puts pressure on that segment of Life Sciences and will for the next couple of years at least. It will be, as we said in the fourth quarter, it was negative, relative to profitability in the fourth quarter. It will gradually ramp up to our targets of about 20% operating margin within the 3-year period that we put out. But I want to emphasize, what are we doing? We just set record revenues, record profitability, and we invested back in the corporation to go and continue to be longer term in the Life Sciences segment. We're investing back in so we can have a stronger, larger company in the future. And that's what it looks like in Life Sciences when you're going through the start-ups. So that's the path and the journey we're on. And we'll just continue to put records up while we invest back in.

I think it's an excellent strategy. What is that line of sight to revenue need to be in order for you to really engage with some of these pre-revenue companies that could have some really exciting technology that you can commercialize?

What ends up happening with some of those pre-revenue corporations is -- and we have been through our pipeline, we have brought a number of those into our laboratories. We've tested them out. Some of them were not as sexy as the ones we ended up teaming up with. We do very strong diligence. But when we see a line of sight that we think can be disruptive to the current base processes, then we team up with them. Overall, we look for strong growth to support our 20% expected growth within that path. We're currently roughly about a $250 million business. We said we would be in the neighborhood of about $450 million in 36 months, and that is without any future acquisitions that we would look at as well.

Great. I think that's enough for now. This is an Aftermarket conference. I want to talk about the kind of the bread and butter of your company, and that's the Aftermarket business. And we'll start with Mobile Solutions. Your fiscal '23, the fiscal year that just ended, you had some softness within your Aftermarket business. You see that as a growth business in 2024. Maybe talk about what you're seeing, maybe at the distributor level, end market demand, et cetera, just to frame it for the audience?

Sure. Within our Mobile Solutions Aftermarket organization, we have 2 portions of that business. One is the OE base, which is about 40% of our Mobile Solutions Aftermarket and then the independent channel is about 60%. If you take a look at what's been happening, the OEs have been destocking. For example, the last 3 quarters, going back into fiscal '23, Q2 was minus 11% on the OE side, plus 6% on the independent side. Q3, minus 15%, Q4, [ minus 15% on the OE side, plus 7% and minus 1% ] on the independent side. So you see the independent -- the OE side is really destocking heavily. However, it wasn't broad-based. It was very situational. It was very company-specific on how they were destocking within the last 3 quarters. But we feel comfortable in why we guided positivity within this fiscal year is that seems to be now moderating, normalizing itself, and we are gaining additional share, particularly within the independent channel, and we would look for that to go forward. On the Industrial side of our business, we continue to grow very nicely within there. We do have more pricing power on the Industrial side than we do on the Mobile Solutions side. We do take those activities whenever necessary. We are back to a more normalized pricing behavior on the Industrial side, but we do believe we continue to execute really well as a result of that connected-based strategy that we have in our corporation, and we'll continue to expand that this fiscal year.

Staying within the Mobile business, predominantly you're in Off-Road with supplier. A lot of that is construction and ag. Can you talk about those end markets and what your customers are telling you about what's coming down the path there?

Yes. So we have really good linkage directly from EDI-based computer-to-computer ordering within all the OE-based customers worldwide. And so we get quite a long look. And as we said in the call, at the end of the fourth quarter, orders and build rates continue to hold up on the OE side, on the first fit, construction and mining, and we're very comfortable with what we're seeing. And it's really hasn't changed for over a year now.

I want to go back to what you were talking about on the destocking with some OE customers. Why do you think they needed to do that? What was it about their buying patterns before that created the need to destock now?

Well, they have more buying power than the independent channel. And frankly, while the supply chains were really quite difficult, they use their muscle and they had the most success beating us up and getting more parts than anybody else. We did our best in order to frankly move it around as much as we could, but we do have contractual obligations. We met them and that means they were able to ramp up far more than the independent channel. The independent channel never really got to that level that you see across the OE base. And so we believe that the independent channel would certainly be more moderated simply because it never got to its wish point.

Thinking globally, China, not a huge portion of your business, but was down 10% on a constant currency basis. Maybe talk about what you're seeing out of China?

Yes, China is still tough. Still very tough. It hasn't really picked up. We have lapped the really strong step down across China. However, China is also a very small portion of our company. It's less than 10%, it's about 6% or 7%. We do have wins with technology-based solutions inside China to all the Chinese national branded companies that when it does pick up, we do believe we'll start to see some lift over there. But there's no secret that China is tough.

Let's have a discussion about electrification. You are a filtration company, and you have an Engine business that is not an electric vehicle engine business. However, you're not necessarily exposed to some of the more grossy parts of EVs. Maybe talk about what the Donaldson view is on your own end markets and your exposure to electric vehicle issues?

Yes. So first, I should tell you that relative to passenger cars, we have 0 revenue on internal combustion engines or liquid and air on passenger cars. None, okay? So what our exposure is, is heavy-duty diesel engines, construction, mining, agriculture, et cetera. Where is battery technology today? As I talked to one large agricultural board member, where we thought that batteries were up on a large combine used in the field, we thought they could be used to 4 hours which is just what our math had showed. I was corrected and told it's 45 minutes. Look, batteries got to have a multi step breakthrough to push forward. However, there are still challenges out there or I mean people chasing alternative fuels. If you look at what Cummins is doing, if Cummins is successful with hydrogen, as they tried with natural gas within the combustion engine some years ago, it didn't really take there. But if they're successful with hydrogen because now the world is ready to take that on, what you have to take out of hydrogen is particulate and water. It's exactly the same challenge as it is with diesel engine liquid, okay, with diesel fuel. Same stuff. So for us, it still needs air to go into the combustion process. If hydrogen is the winner into combustion engines to replace overall diesel and you just get that alternative fuel, our markets will grow. They will take off. If you go to fuel cells, not all fuels are created equal, the energy density of some fuel cells are different, but they are still very good. But think in terms of -- sometimes you got to take sulfur dioxide, sometimes you have to take some other chemical, Donaldson leads the world in chemical absorption with infiltration, and so we can apply our technologies to answer the call. Now what you have to understand there is while we'll lose the liquid portion, the overall lubrication, et cetera, we will gain that hydrogen-based. And in the case of fuel cells, hydrogen has to be pristine. So it will drive overall on the air, a much higher technical base requirement, and we'll get some expansion on the air, lose some of the liquid. And overall, be down just maybe low single digits when you're comparable on a vehicle-based solution. So we're excited about bringing alternative energy technology solutions to our customers. We're working with all of them around the world. They are not all chasing the same things, especially with fuel cells, but we believe we've got cards to play there. I think we had a question here.

In each one of your segments, which competitors are you most concerned with in each one of your segments that you guys are [ voted ] into run now?