November 10, 2008
Terence O’Brien, Accounting Branch Chief
Tracey Houser, Staff Accountant
Division of Corporation Finance
United States Securities Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549-7010
| RE: | Donaldson Company, Inc. |
Form 10-K for the Fiscal Year Ended July 31, 2008
Filed September 26, 2008
File No. 1-7891
Dear Mr. O’Brien and Ms. Houser:
This letter is in response to your letter dated October 31, 2008 (the “SEC Comment Letter”) addressed to William M. Cook, our Chief Executive Officer, regarding the above-mentioned filing. For your ease of reference, we have reproduced your comments in the text of this letter.
Donaldson Company, Inc. (the “Company”) acknowledges that:
| • | the Company is responsible for the adequacy and accuracy of the disclosure in the filing; |
| • | Staff comments or changes to disclosure in response to Staff comments do not foreclose the Commission from taking any action with respect to the filing; and |
| • | the Company may not assert Staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States. |
Form 10-K for the Fiscal Year Ended July 31, 2008
Item 7. Managements’ Discussion and Analysis of Financial Condition and Results of Operations, Page 9
Fiscal 2008 Compared to Fiscal 2007, page 12
1. | In future filings, please expand/revise your results of operations discussion for each period presented to address the following items, at a minimum: |
| • | Quantify the impact of each factor you identify when multiple and/or offsetting factors contribute to fluctuations. For example, quantify the investment you made in information technology to improve your customer support capabilities and enhance your internal system infrastructure capabilities, which impacted your operating expenses for fiscal year 2008. Another example is your discussion of Off-Road Products’ sales where you attribute the increase to (a) the acquisition of Aerospace Filtration Systems, Inc in March 2007; (b) replacement parts growth in the defense business; (c) new vehicle programs in the defense business; (d) retrofit programs in the defense business; (e) strong sales in the agriculture market; (f) strong sales in the mining market; (g) strong sales in the non-residential construction market; which were offset by (h) decrease in residential construction markets without quantification of any of these factors. Refer to Item 303(A)(3)(iii) of Regulation S-K. |
United States Securities and Exchange Commission
November 10, 2008
Page 2
| • | We note that your CODM uses earnings before income taxes as your segment profit measure. In addition to providing a discussion of gross margin and operating expenses at a consolidated level, please also include a discussion and analysis of your segment’s earnings before income taxes as a percentage of segment sales for each period presented. Refer to Item 303 (A) of Regulation S-K. |
| • | Provide a more detailed analysis of the factors that impact the areas comprising your income from continuing operations, including a complete discussion of known trends or anticipated trends that are and/or may continue to have an impact on net sales, gross profit margins, selling, general and administrative expenses as a percentage of net sales, segment earnings before income taxes as a percentage of net sales, et cetera. Your discussion and analysis is to provide investors with sufficient information to understand the historical trends and the expectations for the future as seen through the eyes of management. |
| • | We note that you attribute several factors to the changes in net sales of the various project lines included within each of your reportable segments, including distinguishing between US sales and international sales. However, you provide limited insight as to the causes behind each of those factors. For example, you did not explain to investors why you had strong sales in the agriculture, mining and non-residential construction markets versus a decrease in sales in the residential construction markets. If you believe you included such discussion and analysis elsewhere in your Form 10-K, please consider providing investors with a reference as to where such discussion is located. |
| • | Please consider including an analysis of the historical and current trends in each of the more significant end markets you service, as the trends in your end markets appear to be the significant factors impacting your operating results. Such discussion and analysis may also address some of the concerns raised in the above sub-bullet. |
| • | We note your disclosure on page 4 that your financial performance can be impacted by your product mix in a given period. We further note your reference to a favorable product mix as a factor contributing to your increased gross margin for fiscal 2008. As such, please ensure you include an analysis of how the changes in the mix of your products impacted gross margin. |
| • | Please ensure you have included a discussion of all material factors impacting your operating results. For example, we note your discussion of the rising commodity costs and the impact your use of the LIFO method for inventory costing in the US had on your operating results and taxes during your fourth quarter earnings call. However, it doesn’t not appear as though such an analysis was included with MD&A. We also note your discussion of pricing actions in response to growing commodity costs for your raw materials including your policy regarding the timing of your pricing actions. It would appear that such information may be helpful to investors in assessing your net sales and profit margins along with quantifying the impact any pricing increases have to your net sales. |
United States Securities and Exchange Commission
November 10, 2008
Page 3
Please note that this is not meant to represent an all-inclusive list of where your MD&A could be improved. Please also note that the above are suggestions as to how to improve upon your discussion and analysis of the areas that could be improved upon. Management should consider these suggestions but arrive at its own conclusions as to how best address the areas noted for improvement. We encourage you to provide further analysis throughout your discussion. Refer to Item 303 of Regulation S-K, Section 501 of the Financial Reporting Codification, and SEC Interpretive Release No. 33-8350 dated December 19, 2003 for additional guidance.
Donaldson Response
In future filings, beginning with our Form 10-Q for the first quarter of fiscal year 2009, we will expand our MD&A based on a management review of the current MD&A, and we will incorporate the Staff’s comments to make the following improvements as well as any other changes we conclude necessary to improve an investors understanding of our results of operations.
| • | We will provide more quantitative analysis of factors that contribute to fluctuations in sales and operating results. |
| • | We will add discussion and analysis of earnings before income taxes as a percentage of segment sales for each period presented in the Engine and Industrial sections of our MD&A. |
| • | We will provide a more detailed analysis of the factors that impact the areas comprising our income from continuing operations, including the inclusion of the known trends or anticipated trends that may impact our operating performance. |
Note A Summary of Significant Accounting Policies, page 31
Foreign Currency Translation, page 31
2. | In future filings, please disclose |
| • | Your foreign operations that you do not use the local currency as the functional currency; |
| • | The currency you are using as these foreign operations’ functional currency; and |
| • | The reason the local currency is not the foreign operations’ functional currency. |
If you believe such disclosure is not required as these foreign operations are immaterial in the aggregate, please remove your reference to “most” foreign operations in your discussion of your foreign operations’ functional currency. Refer to paragraphs 5-11 of SFAS 52 for guidance.
United States Securities and Exchange Commission
November 10, 2008
Page 4
Donaldson Response
We have two entities that utilize the US dollar as their functional currency. However, those entities are not material to our results of operations as their combined revenues and earnings before income taxes are less than 3% of our consolidated results.
As a result, we will remove the reference to “most” in our discussion of our foreign operations’ functional currency in future filings.
Recoverability of Long-Lived Assets, page 32
3. | We note your statement, “[i]f impairment indicators are present and estimated future undiscounted cash flows are less than the carrying value of the assets, the carrying value is reduced to estimated fair value as measure by the undiscounted cash flows.” It is unclear what you mean by “as measured by the undiscounted cash flows”, as this amount is not fair value. Please revise your disclosure in future filings to clarify. Refer to 7 of SFAS 144 for guidance. |
Donaldson Response
We agree with the Staff comment. In future filings, we will remove the words “as measured by the undiscounted cash flows” in the last sentence of the “Recoverability of Long-Lived Assets” policy footnote.
Note E Derivatives and Other Financial Instruments, page 38
4. | In future filings, please disclose the value of the forward exchange contracts outstanding for each period presented. Refer to paragraph 44C of SFAS 133 for guidance. |
Donaldson Response
In future filings we will disclose the value of the forward exchange contracts outstanding for each period presented, unless they are not material. In such a case, we will add a statement to indicate the value is not material for the period presented.
United States Securities and Exchange Commission
November 10, 2008
Page 5
5. | We note your reference to interest rate swaps here and in your market risk discussion within MD&A. Please include the necessary disclosures for your interest rate swaps required by SFAS 133 as amended. Otherwise please confirm to us and revise your disclosures in future filings to clarify that the interest rate swaps for each period presented are immaterial. |
Donaldson Response
We have from time to time utilized interest rate swaps. However, we did not utilize interest rate swaps during the periods presented in this Form 10-K. In future filings, we will no longer include the reference to interest rate swaps in this section and the market risk discussion unless we have entered into any interest rate swaps during the periods presented.
Note K Commitments and Contingencies, page 52
6. | In future filings, please revise your warranty reserves rollforward to separately present changes in the liability related to warranties issued during the reporting period from changes in the liability for preexisting warranties/changes in estimates. Refer to paragraph 14.b. of FIN 45 for guidance. Please also disclose the material terms of your warranties and how you estimate your warranty reserve. Refer to paragraph 14.a. of FIN 45 for guidance. |
Donaldson Response
In future filings we will separately present changes in the liability related to warranties issued during the reporting period from changes in the liability for preexisting warranties/changes in estimates. In addition we will add disclosure of the material terms of our warranties and how we estimate our reserve.
7. | We note your statement regarding litigation, “[t]he Company does not consider any of such proceedings that are currently pending to be likely to result in a material adverse effect on the Company’s consolidated financial position or results of operations.” The language you use to describe these loss contingencies is not contemplated by SFAS 5. Please revise your disclosure in future filings to clarify whether you believe it is probable, reasonably possible or remote that losses could be material. Please note that a statement that a contingency is not expected to be material does not satisfy the requirements of SFAS 5, if there is at least a reasonable possibility that a loss exceeding amounts already recognized may have been incurred and the amount of that additional loss would be material to a decision to buy or sell your securities. Please also revise your disclosure in future filings to address the materiality of your litigation to your liquidity in addition to your financial position and results of operations. Refer to paragraphs 8-10 of SFAS 5 for guidance. |
United States Securities and Exchange Commission
November 10, 2008
Page 6
Donaldson Response
We will revise our disclosure in future filings to clarify whether we believe it is probable, reasonably possible or remote that losses could be material to our financial position, results of operations and liquidity.
Item 15. Exhibits and Financial Statements Schedules, page 56
8. | Please be advised that no document on file with the Commission for more than five years may be incorporated by reference, subject to certain limited exceptions. See Item 10(d) of Regulation S-K. We note that the following documents you incorporate by reference into the Form 10-K have been on file with the Commission for more than five years and do not appear to satisfy any of the exceptions listed in Item 10(d): |
| 10-B | 1980 Master Stock Compensation Plan as Amended |
| 10-C | Form of Performance Award Agreement under 1991 Master Stock Compensation Plan |
| 10-E | Deferred Compensation Plan for Non-employee Directors as amended |
| 10-F | Independent Director Retirement and Benefit Plan as amended |
| 10-I | 1991 Master Stock Compensation Plan as amended |
| 10-J | Form of Restricted Stock Award under 1991 Master Stock Compensation Plan |
| 10-K | Form of Agreement to Defer Compensation for certain Executive Officers |
| 10-L | Stock Option Program for Non-employee Directors |
| 10-M | Note Purchase Agreement among Donaldson Company, Inc. and certain listed Insurance Companies Dated as of July 15, 1998 |
In future filings, please revise accordingly.
Donaldson Response
In conjunction with our filing of our Form 10-Q for the first quarter of our fiscal year 2009 in December, we will file the documents which are incorporated by reference but have not been filed with the Commission in the last five years.
United States Securities and Exchange Commission
November 10, 2008
Page 7
Schedule 14A Filed on October 6, 2008
Director Compensation, page 13
9. | We note the disclosure in the second sentence of the first paragraph regarding the director stock ownership requirement. In future filings, please disclose whether each director is in compliance with this requirement. |
Donaldson Response
As of July 31, 2008, all directors who have been directors for five years have met their stock ownership requirements. In future filings, we will disclose whether directors have met the ownership requirements.
Compensation Process, page 19
10. | We note the disclosure regarding Towers Perrin’s recommendations. Please tell us, with a view toward future disclosure, whether any recommendations were not adopted and the reason(s) for not adopting them. |
Donaldson Response
Towers Perrin recommended the removal of the reload provision in our stock option grants to new officers during their first five years. The Human Resources Committee reviewed and discussed this recommendation and decided to maintain the reload provision because of our high stock ownership requirements. Towers Perrin noted that our stock ownership requirements for officers are significantly higher than the market average. We included disclosure on the inclusion of the reload provision in our stock option grants to new officers in our Schedule 14A in Stock Options, page 24, as follows:
“Stock options that are granted to an executive officer within the first five years of being named an officer have a reload provision. Given the Company’s high stock ownership requirements for our executive officers (see the Stock Ownership Requirements section of this Compensation Discussion and Analysis), the Committee believes the reload option helps our officers meet those requirements. This provision provides a new option grant to be established upon exercise of the original grant. Reload stock options are automatically granted under the terms of the original stock option agreement to which they relate and no further action of the Committee is required. The reload stock option is granted for the number of shares tendered as payment for the exercise price and tax withholding obligation. The option price of the reload option is equal to the market price of the stock on the date of exercise and will expire on the same date as the original option which was exercised. The new option does not have a reload provision.”
United States Securities and Exchange Commission
November 10, 2008
Page 8
Towers Perrin also recommended the removal of all perquisites. The committee decided to remove the CEO social country club membership but at this time maintain the other perquisites (financial planning, cars, and executive physicals) which are disclosed in Perquisites, page 25. We are continuing to review the appropriateness of any perquisites provided to our executive officers.
If you have any further questions, please contact the undersigned at (952) 887-3505 (phone) or (952) 703-4556 (fax).
Sincerely,
/s/ Thomas R. VerHage
Thomas R. VerHage
Vice President and Chief Financial Officer
Enclosure
cc: Bill Cook
