FINANCIAL TABLE OF CONTENTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION
AND ANALYSIS.................................... 17
CONSOLIDATED STATEMENTS OF EARNINGS................ 21
CONSOLIDATED BALANCE SHEETS........................ 22
CONSOLIDATED STATEMENTS
OF CASH FLOWS................................... 23
CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS' EQUITY............................ 24
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS...................................... 25
REPORT OF INDEPENDENT AUDITORS..................... 32
MANAGEMENT'S DISCUSSION AND ANALYSIS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
RESULTS OF OPERATIONS
The following discussion of the company's financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and Notes thereto and other financial information included elsewhere
in this Report.
FISCAL 1997 COMPARED TO FISCAL 1996
The company reported record sales in 1997 of $833.3 million, up 9.8 percent from
prior-year sales of $758.6 million. Strong business conditions were evident
across all businesses. Sales for the core Engine Products businesses - first-fit
and replacement parts - were up 10.2 percent over last year. Industrial Products
businesses, including the Torit Products and Gas Turbine businesses, were up 9.1
percent from last year.
Domestic Engine Products sales were up 11.6 percent, primarily from
increased shipments to original equipment manufacturers (OEMs) and overall good
economic conditions in the United States. Weakness in the heavy-duty
transportation market was more than offset by business growth in the automotive
and defense markets. In addition, domestic aftermarket sales increased 11.0
percent year over year. Domestic Industrial Products sales increased 7.1
percent, led by strong sales in the Torit Products (dust collection) market
offset by lower sales in High Purity Products and Gas Turbine Products.
Overseas sales increased almost 7 percent - 15 percent in local currencies
- -- primarily due to increased net sales in Europe, Japan and Hong Kong. Overseas
Engine Products sales were up 7.7 percent compared to the prior year as
shipments increased in Europe. Overseas Industrial Products sales increased
approximately 12.9 percent due primarily to increased sales of High Purity
Products and Gas Turbine systems in Hong Kong.
The company reported record earnings for 1997 of $50.6 million compared to
$43.4 million in 1996, an increase of 16.5 percent. Earnings per share were
$1.98, up 18.6 percent from the prior year. Increased sales levels and
improvements in the gross margin and a reduction in the effective income tax
rate were the primary reasons for the higher earnings. Overseas operating income
totaled approximately 55 percent of consolidated operating income.
Gross margin for 1997 increased to 30.0 percent compared to 29.4 percent in
the prior year. Increased manufacturing efficiencies gained by higher operating
levels, product mix and lower raw material prices in 1997 contributed to this
improvement. Margins improved for Industrial Products and remained flat for
Engine Products.
Operating expenses as a percentage of sales for 1997 and 1996 were 20.1
percent and 19.4 percent, respectively. Operating expenses in 1997 totaled
$167.6 million compared to $147.2 million in 1996, which reflects an increase of
$20.3 million, or 13.8 percent. Selling expenses in 1997 increased $6.2 million
primarily due to the higher sales levels while general and administrative
expenses increased $12.7 million due to higher pension expenses, the write-down
of purchased intangibles of $5.0 million from a previous business acquisition,
increased warranty accruals on product lines and other accruals.
Interest expense declined $0.5 million, or 18.8 percent, primarily due to
the decline in total debt. Other expense totaled $1.3 million in 1997 compared
to $1.6 million in the prior year. The $0.3 million change is due to a $0.6
million decrease in foreign exchange loss, a $0.4 million decline in interest
income, an increase in charitable contributions of $1.2 million, an increase in
earnings from joint ventures, including AFSI, a joint venture with Caterpillar,
Inc., of $.06 million and a decrease in other miscellaneous items of $0.1
million.
The effective income tax rate of 36 percent in 1997 was lower compared to
38.9 percent in 1996 due to lower overseas tax rates.
Hard order backlogs, goods scheduled for delivery in 90 days, were $164.2
million and $121.9 million at July 31, 1997 and 1996, respectively. Worldwide
Engine Products backlog increased $24.5 million and Worldwide Industrial
Products backlog increased $17.9 million from 1996. Total backlogs of $257.1
million were up 26.4 percent from the prior year-end, primarily due to higher
overall orders and strong business conditions.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
During 1997, the company completed the acquisition of two overseas
operations in our Engine Products businesses. In South Africa, the company
purchased the exhaust products manufacturing assets of the Kilber Division of
N.E.I., which will allow the company to expand its exhaust products into that
market. In Mexico, the company purchased all of the outstanding shares of Diemo,
S.A. de D.V., a supplier of liquid filter components, in what was primarily a
vertical integration. The company also completed the acquisition of the assets
of the Armada Tube Group, including Armada Products Co., located in Armada,
Michigan, and Lakeside Tube Fabricators, Inc., located in Mooresville, North
Carolina. The Armada businesses generated annual sales of more than $15 million
in manufacturing and delivering bent and fabricated tubular assemblies for
exhaust and other engine related products. In addition, the company completed
the acquisition of the assets of Aercology Incorporated, located in Old
Saybrook, Connecticut. The Aercology business generated annual sales of more
than $10 million in the manufacturing of smaller sized industrial air filtration
products. All of the above acquisitions were treated as purchases. The results
of operations of these businesses were not material in relation to the company's
consolidated results of operations for 1997. See Note B in the footnotes to the
Consolidated Financial Statements.
FISCAL 1996 COMPARED TO FISCAL 1995
Record 1996 net sales of $758.6 million were up 8 percent from prior-year sales
of $704.0 million. For the year, Engine Products sales were up 7 percent and
Industrial Products sales were up 9 percent.
Domestic Engine Products sales were up 12 percent, primarily from increased
shipments to original equipment manufacturers (OEMs). Weakness in the heavy-
duty transportation market was more than offset by new business in the
automotive and defense markets. In addition, domestic aftermarket sales
increased 7 percent year over year. Industrial Products sales increased 2
percent led by strong sales in the Torit Products (dust collection) market
offset by lower sales in High Purity Products.
Overseas sales increased almost 7 percent - 9 percent in local currencies,
primarily due to increased net sales in Europe and Hong Kong. Net sales in Japan
decreased 12 percent year over year. Overseas Industrial Products sales
increased 20 percent, primarily due to higher shipments of Torit Products and
Gas Turbine systems in Europe and increased sales of High Purity Products and
Gas Turbine systems in Hong Kong. High Purity Product sales in Hong Kong
benefited from the company's decision to consolidate all disk drive filter
production in Hong Kong in early 1996; clean room operations in the U.S. and
England were discontinued as part of this change. Overseas Engine Products sales
were flat compared to the prior year as increased shipments to European OEMs
were offset by lower OEM sales in Japan.
Record net earnings for 1996 of $43.4 million were up 13 percent from $38.5
million in the prior year. Increased net sales and improvements in the gross
margin were the primary reasons for the higher earnings. Overseas operating
income totaled approximately 53 percent of consolidated operating income
compared to 54 percent in 1995.
Gross margin for 1996 increased to 29.4 percent compared to 28.1 percent in
the prior year. Increased manufacturing efficiencies gained by higher operating
levels and lower raw material prices in 1996, were slightly offset by higher
obsolete inventory expense and a $2.0 million impaired asset write-down. Margins
improved in Japan's transportation and Industrial Products markets, Europe's
High Purity Products and Torit Products markets. In addition, margin
improvements were noted in all domestic markets. Offsetting these gains were
margin declines in Hong Kong's Industrial Products markets as well as Europe's
OEM and Gas Turbine systems markets.
Operating expenses as a percentage of sales for 1996 and 1995 were 19.4
percent and 18.8 percent, respectively. Operating expenses in 1996 totaled
$147.2 million compared to $132.4 million in 1995, which reflects an increase of
$14.8 million, or 11 percent. Selling expenses in 1996 increased $6.1 million
primarily due to the higher sales levels, while general and administrative
expenses increased $7.2 million due to higher medical expenses and increased
warranty accruals on new and existing product lines.
Interest expense declined $0.2 million, or 6 percent, primarily due to the
decline in total debt. Other expense totaled $1.6 million in 1996 compared to
other income of $0.7 million in the prior year. The $2.3 million change is
primarily due to a $1.1 million increase in foreign exchange loss, a $0.2
million decline in interest income, a $0.7 million increase in charitable
contributions, and a $0.3 million charge related to the sale of our Brazil
operation. Favorable earnings at AFSI, a joint venture with Caterpillar, Inc.,
offset $0.6 million of the unfavorable other expense variance.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
The effective income tax rate of 38.9 percent in 1996 was flat compared to
39.0 percent in 1995. For both years, the company's effective rate is higher
than the statutory federal rate due to higher effective overseas, state and
local taxes.
During the fourth quarter of 1996, the company sold the operations and
substantially all of the assets related to its Brazilian subsidiary. The sale
did not result in any material charge or credit to earnings. Net sales for this
operation total $3.0 million in 1996 compared to $6.3 million 1995. Operating
losses for 1996 and 1995 were $1.5 million and $0.3 million, respectively.
Hard order backlogs, goods scheduled for delivery in 90 days, were $121.9
million and $134.1 million at July 31, 1996 and 1995, respectively. A $2.2
million increase in worldwide Engine Products backlog was offset by a $13.5
million decline in worldwide Gas Turbine systems backlog. Backlogs, orders and
shipments in the Gas Turbine business segment typically fluctuate widely from
period to period; the most recent decline in backlogs is consistent with
historical observation and does not indicate any fundamental change in the
current market conditions. Total backlogs of $203.3 million were down 5 percent
from the prior year-end primarily due to lower Gas Turbine systems orders.
LIQUIDITY AND CAPITAL RESOURCES
FINANCIAL CONDITION
At July 31, 1997, the company's capital structure was comprised of $42.7 million
of current debt, $4.2 million of long-term debt and $243.9 million of
shareholders' equity. The ratio of long-term debt to total long-term capital was
1.7 percent, compared with 4.2 percent at July 31, 1996.
Total debt increased $23.7 million during 1997 to $46.9 million. The
increase resulted from the company's use of $25.0 million in short-term debt of
which $16.0 million was used for treasury stock repurchases at the end of fiscal
1997.
In December 1995, the company entered into a five-year multi-currency
revolving credit facility totaling $100.0 million with a group of international
banks, led by Citibank as the agent. There was $25.0 million outstanding under
this facility at July 31, 1997. The company believes that the combination of
present capital resources, internally generated funds, and unused financing
sources are more than adequate to meet cash requirements for 1998. The company
is in the process of amending some of the terms and conditions of the facility.
The amendments, if approved by the lending banks, will result in more favorable
terms for the company. The amendments are not expected to have a material effect
on the financial statements as presented.
At July 31, 1997, there was an additional $16 million available for use
under uncommitted facilities which provide unsecured borrowings for general
corporate purposes. There were no amounts outstanding under these facilities at
July 31, 1997.
Shareholders' equity increased $15.0 million in 1997 to $243.9 million. The
increase was primarily due to an increase in retained earnings of $50.6 million
from current year net earnings, issuance of stock awards of $3.2 million offset
by $24.9 million of treasury stock repurchases, a $5.1 million decrease in the
cumulative translation adjustment and $8.8 million of dividend payments.
CASH FLOWS
During 1997, $54.6 million of cash was generated from operating activities,
compared with $76.9 million in 1996 and $52.9 million in 1995. The decrease in
1997 was largely the result of the write-down of purchased intangibles, a
significant increase in accounts receivable and inventory, a significant
decrease in trade accounts payable, accruals and income taxes payable, all of
which more than offset the results of increased net earnings. Significant uses
for cash included $47.3 million for capital expenditures, $23.6 million for
business acquisitions, $24.9 million for stock repurchases, $5.3 million for
repayment of long-term debt and $8.8 million for dividend payments. Cash and
cash equivalents decreased $16.6 million during 1997.
Capital expenditures for property, plant and equipment totaled $47.3
million in 1997, compared to $39.3 million in 1996 and $25.3 million in 1995.
Significant additions in 1997 included a new lube and fuel product line in
Stevens Point, Wisconsin, and Mexico and a new plant in Port Huron, Michigan,
which was related to the Armada acquisition. In addition, the remaining capital
expenditures related to productivity enhancing improvements at various plants in
the United States and overseas and continuing upgrades to the U.S. information
systems.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
Capital spending in 1998 is planned to be $43.0 million. Significant
planned expenditures include the further upgrade of U.S. information systems and
the investment in operations and related projects. It is anticipated that 1998
capital expenditures will be financed primarily from funds from operations.
DIVIDENDS
The company's dividend policy is to maintain a payout ratio which allows
dividends to increase with the long-term growth of earnings per share, while
sustaining dividends in down years. The company's dividend payout ratio target
is 20 percent to 25 percent of the average earnings per share of the last three
years. The current quarterly dividend of 9 cents per share equates to 21.1
percent of the 1995 through 1997 average net earnings per share.
SHARE REPURCHASE PLAN
In January 1996 the Board of Directors authorized the company to repurchase 2.0
million shares of common stock. At July 31, 1997, the company had approximately
906,000 remaining shares under the repurchase authorizations. Management and the
Board of Directors believe the share repurchase program is an excellent means of
returning value to the shareholders.
In 1997, the company repurchased 0.7 million shares of common stock on the
open market for $24.9 million, at an average price of $34.50 per share. The
company repurchased 0.9 million shares for $23.1 million in 1996 and 0.6 million
shares for $14.7 million in 1995.
NEW ACCOUNTING STANDARDS
In October 1995, the Financial Accounting Standards Board issued Statement No.
123 (FAS 123), "Accounting for Stock-Based Compensation." FAS 123 encourages
companies to adopt a fair value-based method of accounting for employee stock
options, but allows companies to continue to measure compensation cost for such
plans as it is measured currently. The company continues to use the current
method of accounting for stock compensation, but has adopted the disclosure
requirements of FAS 123, making pro forma disclosure in the notes to financial
statements of net earnings and earnings per share as if the fair value-based
method had been applied. FAS 123 has no impact on the company's financial
position or results of operations.
In 1997, the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings per Share." The statement is required to be adopted in 1998. The
impact of (SFAS) No. 128 increases basic earnings per share by $.03 in 1997 and
$.02 in 1996. It has no impact on diluted earnings per share as reported.
FOREIGN CURRENCY EFFECTS
In 1997, the U.S. dollar was generally stronger relative to the currencies of
foreign countries where the company operates. A stronger dollar generally has a
negative impact on overseas results because foreign-exchange denominated
earnings translate into less U.S. dollars; a weaker dollar generally has a
positive translation effect.
It is not possible to determine the true impact of foreign currency
translation changes; however, the direct effect on net sales and net earnings
can be estimated. For 1997, the stronger U.S. dollar decreased net sales by
$20.2 million and decreased net earnings by $0.8 million. During 1996, the
generally stronger U.S. dollar decreased net sales by $7.4 million and decreased
net earnings by $0.6 million.
RISK FACTORS
Except for the historical information contained herein, certain of the matters
discussed in this annual report are "forward-looking statements" as defined in
the Private Securities Litigation Reform Act of 1995, which involve risks and
uncertainties, including, but not limited to changing economic and political
conditions in the United States and in other countries, changes in governmental
spending and budgetary policies, governmental laws and regulations surrounding
various matters such as environmental remediation, contract pricing, and
international trading restrictions, customer product acceptance, and continued
access to capital markets. All forecasts and projections in this report are
"forward-looking statements," and are based on management's current expectations
of the company's near term results, based on current information available
pertaining to the company, including the aforementioned risk factors. Actual
results could differ materially both due to the risk factors mentioned here, and
to other factors not so referenced.
20
CONSOLIDATED STATEMENTS OF EARNINGS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
YEAR ENDED JULY 31
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------
Net sales ................................................................ $ 833,348 $ 758,646 $ 703,959
Cost of sales ............................................................ 583,075 535,772 505,980
------------------------------------------
Gross Margin 250,273 222,874 197,979
Selling, general and administrative ...................................... 150,270 131,326 117,961
Research and development ................................................. 17,288 15,906 14,487
Interest expense ......................................................... 2,358 2,905 3,089
Other expense (income) ................................................... 1,263 1,617 (730)
------------------------------------------
Total Expenses 171,179 151,754 134,807
------------------------------------------
Earnings Before Income Taxes 79,094 71,120 63,172
Income taxes ............................................................. 28,474 27,684 24,636
------------------------------------------
Net Earnings $ 50,620 $ 43,436 $ 38,536
==========================================
Earnings per share ....................................................... $ 1.98 $ 1.67 $ 1.45
==========================================
Weighted average common equivalent shares outstanding .................... 25,608,383 26,013,424 26,666,520
==========================================
See accompanying notes to consolidated financial statements.
21
CONSOLIDATED BALANCE SHEETS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
JULY 31
(THOUSANDS OF DOLLARS) 1997 1996
- ---------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and cash equivalents ..................................................... $ 14,278 $ 30,924
Accounts receivable, net ...................................................... 161,440 137,145
Inventories
Materials ................................................................ 36,178 31,427
Work in process .......................................................... 11,488 10,184
Finished products ........................................................ 38,253 30,359
-----------------------
Total Inventories 85,919 71,970
Prepaids and other current assets ............................................. 7,181 10,712
-----------------------
Total Current Assets 268,818 250,751
Property, Plant and Equipment, at cost
Land .......................................................................... 8,356 8,216
Buildings ..................................................................... 98,289 90,136
Machinery and equipment ....................................................... 236,038 202,807
Construction in progress ...................................................... 11,471 6,820
-----------------------
354,154 307,979
Less accumulated depreciation ................................................. (199,559) (183,066)
-----------------------
154,595 124,913
Other Assets ....................................................................... 30,981 27,186
-----------------------
Total $ 454,394 $ 402,850
=======================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Short-term borrowings ......................................................... $ 42,027 $ 8,916
Current maturities of long-term debt .......................................... 647 4,229
Trade accounts payable ........................................................ 68,317 62,020
Accrued employee compensation and related taxes ............................... 28,760 23,524
Income taxes payable .......................................................... 2,738 12,756
Warranty and customer support ................................................. 16,502 9,760
Other current liabilities ..................................................... 17,306 17,373
-----------------------
Total Current Liabilities 176,297 138,578
Long-term Debt ..................................................................... 4,201 10,041
Deferred Income Taxes .............................................................. 1,442 560
Other Long-term Liabilities ........................................................ 28,589 24,791
Shareholders' Equity
Preferred stock, $1.00 par value, 1,000,000 shares authorized, none issued .... - -
Common stock, $5.00 par value, 40,000,000 shares authorized,
27,063,407 issued in 1997 and 1996 ....................................... 135,317 135,317
Additional paid-in capital .................................................... 6,212 2,994
Retained earnings ............................................................. 167,444 128,795
Cumulative translation adjustment ............................................. 934 6,065
Treasury stock -- 2,337,379 and 1,738,793 shares in 1997 and 1996, at cost .... (63,312) (41,561)
Receivable from ESOP .......................................................... (2,730) (2,730)
-----------------------
Total Shareholders' Equity 243,865 228,880
-----------------------
Total $ 454,394 $ 402,850
=======================
See accompanying notes to consolidated financial statements.
22
CONSOLIDATED STATEMENTS OF CASH FLOWS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
YEAR ENDED JULY 31
(THOUSANDS OF DOLLARS) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net earnings ...................................................... $ 50,620 $ 43,436 $ 38,536
Adjustments to reconcile net earnings to net cash
provided by operating activities
Depreciation and amortization ................................ 21,494 21,674 20,529
Write-down of impaired assets ................................ 5,029 2,009 1,427
Equity in earnings of affiliates ............................. (3,025) (2,445) (1,840)
Deferred income taxes ........................................ 950 (5,683) (153)
Other ........................................................ 6,125 6,177 5,682
Changes in operating assets and liabilities, net of
acquired businesses
Accounts receivable ..................................... (24,949) (7,150) (6,159)
Inventories ............................................. (14,498) (2,035) (9,823)
Prepaids and other current assets ....................... 3,574 (4,779) 7,093
Trade accounts payable and other accrued expenses ....... 9,246 25,720 (2,398)
----------------------------------
Net Cash Provided by Operating Activities 54,566 76,924 52,894
INVESTING ACTIVITIES
Net expenditures on property and equipment ........................ (47,327) (39,297) (25,334)
Acquisitions and investments in affiliates ........................ (23,606) (2,152) (3,911)
Dividends from affiliate .......................................... 3,749 616 -
----------------------------------
Net Cash Used in Investing Activities (67,184) (40,833) (29,245)
FINANCING ACTIVITIES
Repayment of long-term debt ....................................... (5,280) (361) (5,764)
Net change in short-term borrowings ............................... 28,976 (8,360) 1,715
Payment received from ESOP ........................................ - 2,520 2,415
Purchase of treasury stock ........................................ (24,904) (23,143) (14,692)
Dividends paid .................................................... (8,799) (7,725) (7,372)
Exercise of stock options ......................................... 1,788 129 3,201
----------------------------------
Net Cash Used in Financing Activities (8,219) (36,940) (20,497)
Effect of exchange rate changes on cash ........................... 4,191 3,208 2,468
----------------------------------
Increase (Decrease) in Cash and Cash Equivalents (16,646) 2,359 5,620
Cash and cash equivalents, beginning of year ...................... 30,924 28,565 22,945
----------------------------------
Cash and Cash Equivalents, End of Year $ 14,278 $ 30,924 $ 28,565
==================================
See accompanying notes to consolidated financial statements.
23
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
DONALDSON COMPANY, INC. AND SUBSIDIARIES
ADDITIONAL CUMULATIVE
(THOUSANDS OF DOLLARS, COMMON PAID-IN RETAINED TRANSLATION TREASURY RECEIVABLE
EXCEPT PER SHARE AMOUNTS) STOCK CAPITAL EARNINGS ADJUSTMENTS STOCK FROM ESOP TOTAL
- --------------------------------------------------------------------------------------------------------------------------
BALANCE JULY 31, 1994 $ 135,317 $ - $ 65,654 $ 8,244 $ (11,853) $ (7,665) $ 189,697
Treasury stock acquired (14,692) (14,692)
Stock options exercised (133) (3,073) 6,407 3,201
Payment received from ESOP 2,415 2,415
Performance awards 1,033 1 35 1,069
Tax reduction -- employee plans 1,739 1,739
Net earnings 38,536 38,536
Translation adjustments 6,580 6,580
Cash dividends ($.28 per share) (7,372) (7,372)
-----------------------------------------------------------------------------------------
BALANCE JULY 31, 1995 135,317 2,639 93,746 14,824 (20,103) (5,250) 221,173
Treasury stock acquired (23,143) (23,143)
Stock options exercised (140) (689) 958 129
Payment received from ESOP 2,520 2,520
Performance awards 114 27 727 868
Tax reduction -- employee plans 381 381
Net earnings 43,436 43,436
Translation adjustments (8,759) (8,759)
Cash dividends ($.30 per share) (7,725) (7,725)
-----------------------------------------------------------------------------------------
BALANCE JULY 31, 1996 135,317 2,994 128,795 6,065 (41,561) (2,730) 228,880
Treasury stock acquired (24,904) (24,904)
Stock options exercised 174 (3,266) 2,198 (894)
Performance awards 1,426 94 955 2,475
Tax reduction -- employee plans 1,618 1,618
Net earnings 50,620 50,620
Translation adjustments (5,131) (5,131)
Cash dividends ($.35 per share) (8,799) (8,799)
-----------------------------------------------------------------------------------------
BALANCE JULY 31, 1997 $ 135,317 $ 6,212 $ 167,444 $ 934 $ (63,312) $ (2,730) $ 243,865
=========================================================================================
See accompanying notes to consolidated financial statements.
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated finan-cial statements include the
accounts of Donaldson Company, Inc. and all majority-owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated. The
accounts of overseas subsidiaries are included for fiscal years ended June 30.
Certain amounts in prior periods have been reclassified to conform to the
current presentation.
USE OF ESTIMATES: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
FOREIGN CURRENCY TRANSLATION: For substantially all foreign operations, local
currencies are considered the functional currency. Assets and liabilities are
translated using the year-end rates of exchange. Results of operations are
translated using the average exchange rates prevailing throughout the period.
Translation gains or losses, net of applicable deferred taxes, are accumulated
in the translation adjustments in shareholders' equity. Foreign currency
transaction (losses)/gains of $(.5 million), $(1.1 million) and $47,000, in
1997, 1996 and 1995, respectively, are included in earnings before income taxes.
CASH EQUIVALENTS: The company considers all highly liquid investments with a
maturity of 90 days or less when purchased to be cash equivalents. Cash
equivalents are carried at cost which approximates market value.
INVENTORIES: Inventories are stated at the lower of cost or market. Domestic
inventories are valued using the last-in, first-out (LIFO) method, while the
overseas subsidiaries use the first-in, first-out (FIFO) method. Inventories
valued at LIFO were 57 percent and 55 percent of total inventories at July 31,
1997 and 1996, respectively.
The current cost of inventories valued under the LIFO method exceeded their
LIFO carrying values by $19.5 million and $19.9 million at July 31, 1997 and
1996, respectively.
PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are stated at cost.
Depreciation is computed principally by use of declining balance methods on
facilities and equipment acquired on or prior to July 31, 1992. The company
adopted the straight-line depreciation method for all property acquired after
July 31, 1992. Depreciation expense includes the amortization of capital lease
assets. Accelerated depreciation methods are generally used for income tax
purposes.
The estimated useful lives of property, plant and equipment are as follows:
Buildings........................ 10 to 40 years
Machinery and Equipment.......... 3 to 10 years
IMPAIRMENT OF LONG-LIVED ASSETS: The company reviews the long-lived assets,
including identifiable intangibles and associated goodwill, for impairment when
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. An asset is deemed impaired and written down to its fair
value if expected associated future cash flows are less than its carrying
amount.
INTANGIBLE ASSETS: Intangible assets are recorded at their estimated fair values
at date of acquisition and are amortized on a straight-line basis over periods
ranging up to 15 years.
The carrying value of identifiable intangible assets is assessed when
factors indicating impairment are present. If impairment indicators are present
and the estimated future undiscounted cash flows are less than the carrying
value of the assets and any related goodwill, the carrying value is reduced to
the estimated fair value as measured by the discounted cash flows.
During 1997, the company reassessed the carrying value of certain amounts
of purchased intangibles related to a previous business acquisition. As a
result, a total non-cash charge of $5.0 million was recorded and is included in
selling, general and administrative expenses on the statement of earnings in
1997.
INCOME TAXES: Deferred tax assets and liabilities are recognized for the
expected future tax consequences attributed to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are measured using the
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be reversed.
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
EARNINGS PER SHARE: Earnings per common share is based on the weighted average
number of common shares and share equivalents outstanding during the year.
TREASURY STOCK: Repurchased Common Stock is stated at cost and is presented as a
separate reduction of shareholders' equity.
RESEARCH AND DEVELOPMENT: All expenditures for research and development are
charged against earnings in the year incurred.
STOCK-BASED COMPENSATION: Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" encourages, but does not require
companies to record compensation cost for stock-based employee compensation
plans at fair value. The company has chosen to continue to account for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price of
the company's stock at the date of the grant over the amount an employee must
pay to acquire the stock. Compensation cost for performance equity units is
recorded based on the quoted market price of the company's stock at the end of
the period.
REVENUE RECOGNITION: Sales are recorded when product is shipped and invoiced or
performance of services is complete.
NEW ACCOUNTING STANDARDS: In February 1997, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings per Share." This new standard requires dual presentation of basic and
diluted earnings per share (EPS) on the statement of earnings for all entities
with complex capital structures. Adoption of SFAS No. 128 is required in the
second quarter of 1998 and requires a restatement of prior period earnings per
share. Early adoption is not permitted. The impact of SFAS No. 128 increases
basic earnings per share by $.03 in 1997 and $.02 in 1996. There will be no
impact on diluted earnings per share as reported.
DERIVATIVES AND MARKET RISK: The Securities and Exchange Commission has adopted
rules requiring expanded disclosure of risks and policies concerning derivatives
and market risk. The company utilizes derivative financial instruments to manage
its exposure to foreign currency volatility at the transactional level. The
majority of these contracts relate to European country currencies. The market
risk exposure is essentially limited to currency rate movements. The gains or
losses arising from these financial instruments are applied to offset exchange
gains or losses on related hedged exposures. Realized gains or losses in 1997
and 1996 were not material to the company's results of operations and total
outstanding contracts at July 31, 1997 and 1996 were insignificant.
NOTE B: ACQUISITIONS AND DIVESTITURE
ACQUISITIONS
All acquisitions were accounted for as purchases. The purchase prices assigned
to the net assets acquired were based on the fair value of such assets and
liabilities at the respective acquisition dates. The operating results of these
acquired companies have been included in the consolidated statement of earnings
from the dates of acquisition. Consolidated pro forma earnings and earnings per
share would not be materially different from the reported amounts for all years
presented.
During 1997, the company acquired the remaining 50.1 percent of its
Australian Torit Products distributor; acquired the exhaust products
manufacturing assets of the Kilber Division of N.E.I. in South Africa; and
acquired the common stock of Diemo, S.A. de D.V., a supplier of liquid filter
components in Mexico. Aggregate consideration for these transactions was $3.7
million.
In April 1997, the company acquired the assets of the Armada Tube Group,
including Armada Products Co., located in Armada, Michigan, and Lakeside Tube
Fabricators, Inc., located in Mooresville, North Carolina, for $11.3 million in
cash. The Armada Tube Group manufactures exhaust products. The excess of
purchase price over the fair values of the net assets acquired was $5.3 million
and has been recorded as goodwill which is being amortized on a straight-line
basis over 15 years.
In July 1997, the company acquired the assets of Aercology Incorporated,
located in Old Saybrook, Connecticut, for $9.8 million in cash. Aercology
manufactures industrial air filtration products. The excess purchase price over
the fair value of the net assets acquired was $6.7 million and has been recorded
as goodwill which is being amortized on a straight-line basis over 15 years.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
During 1996, the company acquired all of the common stock of Tecnov S.A., a
French manufacturer of heavy duty exhaust mufflers and invested in a Torit
Products manufacturer in the People's Republic of China.
During 1995, the company acquired the remaining 50 percent of Donaldson
Micro Pore Mexico, S.A. de C.V., obtained a 20 percent interest in an Indonesian
filter manufacturer and purchased an additional 9.9 percent in its Australian
Torit Products distributor.
DIVESTITURE
During the fourth quarter of 1996, the company sold the operations and
substantially all the assets related to its Brazilian subsidiary, Donaldson do
Brasil, Ltda., (DBL). The sale did not result in any material charge or credit
to earnings. DBL's results of operations prior to the divestiture date have been
included in the company's consolidated results of operations.
NOTE C: CREDIT FACILITIES
In December 1995, the company entered into a credit agreement with a group of
participating banks under which it may borrow up to $100 million. The agreement
provides that loans may be made under a selection of rate formulas including
Base Rate Advance or Eurocurrency Rate Advance. The interest rate on each
advance is based on certain adjusted leverage and debt to capitalization ratios.
Facility fees and other fees on the entire loan commitment are payable for the
duration of this facility. Total amount outstanding under this credit facility
at July 31, 1997 was $25 million, leaving $75 million available for further
borrowing under such facility. There were no amounts outstanding on this
facility at July 31, 1996. The weighted average interest rate on short-term
borrowings outstanding at July 31, 1997 was 5.95 percent. The com-pany is in the
process of amending some of the terms and conditions of the above facility. The
amendments, if approved by the lending banks, will result in more favorable
terms for the company. The amendments are not expected to have a material effect
on the financial statements as presented.
At July 31, 1997, there was an additional $16 million available for use
under uncommitted facilities which provide unsecured borrowings for general
corporate purposes. There were no amounts outstanding under these facilities at
July 31, 1997.
Overseas subsidiaries may borrow under various uncommitted facilities. As
of July 31, 1997 and 1996, borrowings under these facilities were $17.0 million
and $8.9 million, respectively. The weighted average interest rate on short-term
borrowings outstanding at July 31, 1997 and 1996 was 7.4 percent and 5.6
percent, respectively.
NOTE D: LONG-TERM DEBT
Long-term debt consists of the following:
(THOUSANDS OF DOLLARS) 1997 1996
- -------------------------------------------------------------------
U.S.
ESOP promissory note due
in increasing annual installments
through 1997. Interest rate is
either 82 percent of prime or 91
percent of the adjusted CD rate ........... $ - $ 2,730
6 3/8 percent mortgage due 1997 ............. - 1,000
7 percent note due in 2008 .................. - 500
Capital leases .............................. 2,950 5,337
Overseas
Variable rate note due in 1999. Interest rate
is LIBOR plus .25 percent ................. - 3,805
Other subsidiaries .......................... 1,898 898
-----------------
Total 4,848 14,270
Less current maturities ..................... 647 4,229
-----------------
Total Long-Term Debt $4,201 $10,041
=================
Annual maturities of long-term debt and capitalized leases for the next
five years are $0.6 million in 1998, $0.7 million in 1999, $0.7 million in 2000,
$0.4 million in 2001, $0.3 million in 2002 and $2.1 million thereafter.
Total interest paid relating to all debt was $2.4 million, $2.8 million and
$2.8 million in 1997, 1996 and 1995, respectively. In addition, total interest
expense recorded in 1997, 1996 and 1995 was $2.4 million, $2.9 million and $3.1
million, respectively.
Certain note agreements contain debt covenants related to working capital
levels and limitations on indebtedness. Further, the company is restricted from
paying dividends or repurchasing Common Stock if its tangible net worth (as
defined) does not exceed certain minimum levels. At July 31, 1997, under the
most restrictive agreement, tangible net worth exceeded the minimum by $71.0
million.
NOTE E: EMPLOYEE BENEFIT PLANS
PENSION PLANS: Donaldson Company, Inc. and certain of its subsidiaries have
defined benefit pension plans for substantially all hourly and salaried
employees. The domestic plans provide benefits based on the employee's years of
service and compensation during the years immediately preceding retirement. The
overseas plans generally provide similar types of benefits.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
The company's general funding policy is to make contributions as required
by applicable regulations. The assets are primarily invested in diversified
equity and debt portfolios.
Cost for the company's pension plans includes the following components:
(THOUSANDS OF DOLLARS) 1997 1996 1995
- ---------------------------------------------------------------
Service cost ............. $ 6,184 $ 5,224 $ 5,024
Interest cost on projected
benefit obligation .... 8,189 7,029 6,167
Actual return on
plan assets ........... (26,078) (4,391) (12,238)
Net amortization
and deferral .......... 18,324 (3,221) 5,265
---------------------------------
Net Periodic
Pension Expense $ 6,619 $ 4,641 $ 4,218
=================================
The funded status of the company's pension plans as of July 31, 1997 and
1996, is as follows:
(THOUSANDS OF DOLLARS) 1997 1996
- -------------------------------------------------------------------
Plan assets at fair value ............... $ 112,161 $ 85,172
Accumulated benefit obligation:
Vested ............................... (85,393) (71,887)
Nonvested ............................ (4,015) (3,019)
Provision for future salary increases ... (28,266) (20,250)
----------------------
Plan assets less than
projected benefit obligation ......... (5,513) (9,984)
Unrecognized net loss ................... 2,547 9,040
Unrecognized prior service cost ......... 4,987 4,611
Unrecognized net transition asset ....... (7,059) (8,156)
Additional minimum liability ............ (628) (970)
----------------------
Accrued Pension Liability $ (5,666) $ (5,459)
======================
The principal actuarial assumptions:
1997 1996 1995
- ---------------------------------------------------
Discount rate ............. 7.5% 8.0% 8.0%
Rate of future compensation
increases .............. 6.0% 5.5% 5.5%
Expected long-term
rate of return ......... 9.0% 9.0% 9.0%
EMPLOYEE STOCK OWNERSHIP PLAN: In 1987, the company established an Employee
Stock Ownership Plan (ESOP) for eligible U.S. employees. The ESOP borrowed $21.0
million from the company to purchase 3,600,000 newly issued shares of Common
Stock. These shares are held in trust and are issued to employees' accounts in
the ESOP as the loan is repaid over 10 years. At July 31, 1997 and 1996,
3,600,000 and 3,237,021 shares have been allocated to employees. The loan
obligation of the ESOP is considered unearned employee benefit expense and, as
such, is recorded as a reduction of the company's shareholders' equity. The
company's contributions to the ESOP, plus dividends paid on unallocated shares
held by the ESOP, are used to repay the loan principal and interest. Both the
loan obligation and the unearned benefit expense are reduced by the amount of
loan principal repayments made by the ESOP. The ESOP contribution expense
totaled $2.6 million, $2.5 million and $2.1 million in 1997, 1996 and 1995,
respectively. The ESOP's 10-year term was completed at July 31, 1997; therefore,
no further shares will be allocated in the future.
401(k) SAVINGS PLAN: The company provides a non- contributory employee savings
plan which permits participants to make contributions by salary reduction
pursuant to section 401(k) of the Internal Revenue Code.
Subsequent to year end, the company amended certain of its employee benefit
plans. The amendments are effective for years ending in 1998. The defined
benefit pension plan was amended to provide defined benefits pursuant to a cash
balance feature whereby a participant accumulates a benefit based upon a
percentage of current salary which varies with age, and interest credits. The
401(k) savings plan was amended to include a company contribution.
NOTE F: SHAREHOLDERS' EQUITY
On January 12, 1996, the Board of Directors of the company approved the
extension of the benefits afforded by the company's existing rights plan by
adopting a new shareholder rights plan. Pursuant to the new Rights Agreement,
dated as of January 12, 1996, by and between the company and Norwest Bank
Minnesota, National Association, as Rights Agent, one Right was issued on March
4, 1996 for each outstanding share of Common Stock, par value $5.00 per share,
of the company upon the expiration of the company's existing rights. Each of the
new Rights will entitle the registered holder to purchase from the company one
one-thousandth of a share of Series A Junior Participating Preferred Stock,
without par value, at a price of $130.00 per one one-thousandth of a share. The
Rights, however, will not become exercisable unless and until, among other
things, any person acquires 15 percent or more of the outstanding Common Stock
of the company. If a person acquires 15 percent or more of the outstanding
Common Stock of the company (subject to certain conditions and exceptions more
fully described in the Rights Agreement), each Right will entitle the holder
(other than the person who acquired 15 percent or more of the outstanding Common
Stock) to purchase Common Stock of the company having a market value equal to
twice the exercise price of a Right. The new Rights are redeemable under certain
circumstances at $.01 per Right and will expire, unless earlier redeemed, on
March 3, 2006.
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
EMPLOYEE INCENTIVE PLANS: In November 1991, shareholders approved
the 1991 Master Stock Compensation Plan. The Plan extends through December 2001
and allows for the granting of nonqualified stock options, incentive stock
options, restricted stock, stock appreciation rights (SARs), dividend
equivalents, dollar-denominated awards and other stock-based awards.
The 1980 Master Stock Compensation Plan allows for the granting of
nonqualified stock options and incentive stock options. Both plans allow for the
granting of performance awards to a limited number of key executives. The awards
are payable in Common Stock and are based on a formula which measures
performance of the company over a three-year period. Performance award expense
totaled $3.5 million, $2.1 million and $2.1 million in 1997, 1996 and 1995,
respectively. Options under both Plans are granted to key employees at or above
100 percent of the market price at the date of grant. Options are exercisable
for up to 10 years from the date of grant.
STOCK OPTIONS: Stock options issued during fiscal 1997 become exercisable in
each of the following three years, in an equal number of shares each year, for
both executives and non-executives. Stock options issued prior to fiscal 1997
for non-executives and during fiscal 1997 for executives become exercisable in a
four-year period. Prior to fiscal 1996 stock options vested immediately for
executives. At July 31, 1997, options to purchase 1,658,654 shares are
outstanding under these plans.
In fiscal 1997, the company adopted the disclosure-only provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123). SFAS 123 encourages entities to adopt a fair
value-based method of accounting for employee stock compensation plans, but
allows companies to continue to account for those plans using the accounting
prescribed by APB Opinion 25, "Accounting for Stock Issued to Employees." The
company has elected to continue to account for stock based compensation using
APB 25, making pro forma disclosures of net earnings and earnings per share as
if the fair value-based method had been applied. Accordingly, no compensation
expense has been recorded for the stock option plans. Had compensation expense
for the stock option plans been determined under SFAS No. 123 in fiscal 1997 and
1996, the company's net income and earnings per share would have been
approximately $49.0 million and $1.94, and $42.8 million and $1.65,
respectively. The pro forma effect on net income and earnings per share is not
representative of the pro forma net earnings in future years because it does not
take into consideration pro forma compensation expense related to grants made
prior to 1996.
For purposes of computing compensation cost of stock options granted, the
fair value of each stock option grant was estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions: 6.13 percent risk free interest rate in 1997 and 1996, five or
seven year lives in 1997 and 1996, 19.4 percent expected volatility in 1997 and
1996, and 1 percent expected dividend yield in 1997 and 1996. Black-Scholes is a
widely accepted stock option pricing model; however, the ultimate value of stock
options granted will be determined by the actual lives of options granted and
future price levels of the company's Common Stock.
The weighted average fair value for options granted during fiscal 1997 and
1996 is $15.52 and $12.37 per share, respectively.
The number and option price of options granted under these plans were as
follows:
OPTIONS WEIGHTED AVERAGE
OUTSTANDING EXERCISE PRICE
- ------------------------------------------------------------------
Outstanding at July 31, 1994 ... 1,604,846 $16.62
Granted ..................... 321,799 23.69
Exercised ................... (378,657) 14.85
Canceled .................... (5,497) 14.39
-----------------------------
Outstanding at July 31, 1995 ... 1,542,491 18.54
Granted ..................... 201,291 25.15
Exercised ................... (95,899) 18.24
Canceled .................... (17,000) 15.36
-----------------------------
Outstanding at July 31, 1996 ... 1,630,883 19.40
Granted ..................... 313,889 31.87
Exercised ................... (283,868) 18.28
Canceled .................... (2,250) 24.75
-----------------------------
Outstanding at July 31, 1997 1,658,654 $21.95
=============================
At July 31, 1997 and 1996 there were 1,324,129 and 1,445,932 options
exercisable, respectively. Shares reserved at July 31, 1997 for outstanding
options and future grants were 3,624,729.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
The following table summarizes information concerning currently outstanding
and exercisable options:
WEIGHTED AVG. WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE AVERAGE
EXERCISE OUT- CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES STANDING LIFE(YEARS) PRICE EXERCISABLE PRICE
- -----------------------------------------------------------------------------
$0 to $10 52,950 1.52 $ 6.13 52,950 $ 6.13
$10 to $20 733,506 3.47 17.21 733,506 17.21
$20 to $30 619,400 6.95 24.53 492,375 24.57
$30 to $40 252,798 9.13 32.68 45,298 33.48
- -----------------------------------------------------------------------------
$0 to $40 1,658,654 5.57 $21.95 1,324,129 $20.06
NOTE G: INCOME TAXES
The components of earnings before income taxes are as follows:
(THOUSANDS OF DOLLARS) 1997 1996 1995
- ------------------------------------------------------------
Earnings Before
Income Taxes:
United States ....... $50,259 $47,589 $42,355
Overseas ............ 28,835 23,531 20,817
---------------------------------
Total $79,094 $71,120 $63,172
=================================
The components of the provision for income taxes are as follows:
(THOUSANDS OF DOLLARS) 1997 1996 1995
- ----------------------------------------------------------------
Income Taxes:
Current:
Federal ......... $ 18,527 $ 21,796 $ 12,425
State ........... 2,092 2,047 1,810
Overseas ........ 8,805 9,524 10,554
--------------------------------------
29,424 33,367 24,789
--------------------------------------
Deferred:
Federal ......... (525) (5,424) 716
State ........... (30) (470) 49
Overseas ........ (395) 211 (918)
--------------------------------------
(950) (5,683) (153)
--------------------------------------
Total $ 28,474 $ 27,684 $ 24,636
======================================
The tax effects of temporary differences that give rise to deferred tax
assets and liabilities are as follows:
(THOUSANDS OF DOLLARS) 1997 1996 1995
- --------------------------------------------------------------------------
Deferred Tax Assets:
Compensation and
retirement plans ........ $ 6,979 $ 10,587 $ 8,514
Accrued expenses .......... 9,758 7,155 4,572
Brazilian asset write-down 498 571 1,040
NOL carryforwards ......... 2,115 1,553 1,263
Inventories ............... 1,074 1,861 1,260
Investment in joint venture 1,306 957 1,606
Other ..................... 3,650 4,689 3,210
--------------------------------------
Gross Deferred
Tax Assets 25,380 27,373 21,465
Valuation Allowance ....... (1,316) (1,615) (1,426)
--------------------------------------
Net Deferred Tax Assets 24,064 25,758 20,039
Deferred Tax Liabilities:
Depreciation and
amortization ............ (6,756) (5,397) (1,844)
Cumulative translation
adjustment .............. (502) (3,264) (7,980)
Other ..................... (1,987) (1,445) (2,192)
--------------------------------------
Gross Deferred
Tax Liabilities (9,245) (10,106) (12,016)
--------------------------------------
Net Deferred Taxes $ 14,819 $ 15,652 $ 8,023
======================================
The following table reconciles the U.S. statutory income tax rate with the
effective income tax rate:
1997 1996 1995
- ------------------------------------------------------------------------
Statutory U.S.
federal rate .............. 35.0% 35.0% 35.0%
State income taxes ........... 1.7 1.5 1.9
Overseas taxes at
higher rates .............. (2.1) 2.1 1.9
Other ........................ 1.4 0.3 0.2
-----------------------------------
36.0% 38.9% 39.0%
===================================
At July 31, 1997, certain overseas subsidiaries had available net operating
loss carryforwards of approximately $6.0 million to offset future taxable
income. The majority of such carryforwards expire after 2001. Unremitted
earnings of overseas subsidiaries amounted to approximately $72.5 million at
July 31, 1997. Those earnings are intended to be indefinitely reinvested and,
accordingly, no income taxes have been provided. If a portion were to be
remitted, foreign tax credits would substantially offset any resulting tax
liability. It is not practicable to estimate the amount of unrecognized taxes on
these undistributed earnings due to the complexity of the computation.
The company made cash payments for income taxes of $41.5 million, $20.5
million and $21.8 million in 1997, 1996 and 1995, respectively.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
NOTE H: SEGMENT INFORMATION
The company operates on a worldwide basis in a single business segment which
consists of the design, manufacture and sale of filtration products. The
company's key markets for filters are heavy-duty truck and equipment, light-duty
truck, in-plant air cleaning systems, industrial gas turbines and computer disk
drives.
The table below sets forth information about operations in different
geographic areas:
UNITED OTHER
(THOUSANDS OF DOLLARS) STATES EUROPE JAPAN COUNTRIES ELIMINATIONS CONSOLIDATED
- ----------------------------------------------------------------------------------------------------------------------------
1997
Sales to customers ...................... $522,289 $141,358 $78,704 $90,997 $ - $833,348
Sales between geographic areas .......... 46,414 1,930 2,006 2,452 (52,802) -
-----------------------------------------------------------------------------
Net Sales $568,703 $143,288 $80,710 $93,449 $(52,802) $833,348
=============================================================================
Operating Income $ 37,397 $ 17,739 $ 9,331 $18,435 $ (187) $ 82,715
=============================================================================
Identifiable Assets:
Accounts receivable, net ................ $ 77,201 $ 38,766 $22,635 $22,838 $ - $161,440
Other ................................... 157,235 104,445 23,788 49,815 (56,096) 279,187
-----------------------------------------------------------------------------
Total identifiable assets ............... $234,436 $143,211 $46,423 $72,653 $(56,096) $440,627
General corporate assets ................ 13,767
--------
Total Assets $454,394
========
1996
Sales to customers ...................... $474,831 $129,765 $80,734 $73,316 $ - $758,646
Sales between geographic areas .......... 36,566 1,137 1,910 2,184 (41,797) -
-----------------------------------------------------------------------------
Net Sales $511,397 $130,902 $82,644 $75,500 $(41,797) $758,646
=============================================================================
Operating Income $ 35,535 $ 17,713 $10,955 $11,639 $ (200) $ 75,642
=============================================================================
Identifiable Assets:
Accounts receivable, net ................ $ 58,591 $ 37,403 $24,515 $16,598 $ 38 $137,145
Other ................................... 143,975 59,616 24,169 25,875 (29,216) 224,419
-----------------------------------------------------------------------------
Total identifiable assets ............... $202,566 $ 97,019 $48,684 $42,473 $(29,178) $361,564
General corporate assets ................ 41,286
--------
Total Assets $402,850
========
1995
Sales to customers ...................... $437,463 $114,731 $91,248 $60,517 $ - $703,959
Sales between geographic areas .......... 28,416 1,163 2,254 2,424 (34,257) -
-----------------------------------------------------------------------------
Net Sales $465,879 $115,894 $93,502 $62,941 $(34,257) $703,959
=============================================================================
Operating Income $ 29,968 $ 15,384 $10,741 $10,148 $ (710) $ 65,531
=============================================================================
Identifiable Assets:
Accounts receivable, net ................ $ 58,146 $ 31,705 $33,740 $13,548 $ 16 $137,155
Other ................................... 117,249 61,753 35,324 28,511 (29,650) 213,187
-----------------------------------------------------------------------------
Total identifiable assets ............... $175,395 $ 93,458 $69,064 $42,059 $(29,634) $350,342
General corporate assets ................ 30,700
--------
Total Assets $381,042
========
Sales between geographic areas are made at cost plus a proportionate share
of operating profit. Net income of foreign operations includes royalty income
and reflects the gain or loss in foreign currency exchange. General corporate
assets include corporate cash and cash equivalents and buildings and equipment
used for corporate purposes. Sales to Caterpillar, Inc. accounted for 11
percent, 12 percent and 13 percent of net sales in 1997, 1996 and 1995,
respectively.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
NOTE I: QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
NET GROSS NET EARNINGS DIVIDENDS
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) SALES MARGIN EARNINGS PER SHARE PER SHARE
- -----------------------------------------------------------------------------------------------------------------------------
1997
First Quarter .............................. $ 187,176 $ 56,132 $ 11,590 $ .45 $ .09
Second Quarter ............................. 196,849 58,195 10,976 .43 .09
Third Quarter ............................. 213,876 66,204 14,200 .56 .09
Fourth Quarter ............................. 235,447 69,742 13,854 .54 .09
1996
First Quarter .............................. $ 188,867 $ 53,899 $ 10,131 $ .39 $ .07
Second Quarter ............................. 182,165 52,439 9,247 .35 .07
Third Quarter .............................. 185,225 55,372 12,625 .49 .08
Fourth Quarter ............................. 202,389 61,164 11,433 .44 .08
NOTE J: CONTINGENCIES
The company is involved on an ongoing basis in litigation arising in the
ordinary course of business. In the opinion of management, the outcome of
litigation currently pending will not materially affect the company's results of
operations, financial condition or liquidity.
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Donaldson Company, Inc.
We have audited the accompanying consolidated balance sheets of Donaldson
Company, Inc. and subsidiaries as of July 31, 1997 and 1996, and the related
consolidated statements of earnings, changes in shareholders' equity and cash
flows for each of the three years in the period ended July 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Donaldson
Company, Inc. and subsidiaries at July 31, 1997 and 1996, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended July 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
September 12, 1997
32
SHAREHOLDER INFORMATION
DONALDSON COMPANY, INC. AND SUBSIDIARIES
CORPORATE AND SHAREHOLDER INFORMATION
NYSE LISTING: The common shares of Donaldson Company, Inc. are traded on the New
York Stock Exchange, under the symbol DCI.
SHAREHOLDER INFORMATION: For any concerns relating to your current or
prospective shareholdings, please contact Shareholder Services at (800)468-9716
or (612)450-4064.
DIVIDEND REINVESTMENT PLAN: As of September 26, 1997, more than 850 of Donaldson
Company's approximately 1,500 shareholders of record were participating in the
Dividend Reinvestment Plan. Under the plan, shareholders can invest Donaldson
Company dividends in additional shares of company stock. They may also make
periodic voluntary cash investments for the purchase of company stock.
Both alternatives are provided without service charges or brokerage
commissions. Shareholders may obtain a brochure giving further details by
writing Shareholder Services, Donaldson Company, Inc., M.S. 101, P.O. Box 1299,
Minneapolis, Minnesota 55440.
ANNUAL MEETING: The annual meeting of shareholders will be held at 10 a.m. on
Friday, November 21, 1997, at The Conference Center at Atrium Center, 3105 E.
80th Street, Bloomington, Minnesota.
10-K REPORTS: Copies of the Report 10-k, filed with the Securities and Exchange
Commission, are available on request from Shareholder Services, Donaldson
Company, Inc., M.S. 101, P.O. Box 1299, Minneapolis, Minnesota 55440.
AUDITORS: Ernst & Young LLP, Minneapolis, Minnesota
GENERAL COUNSEL: Dorsey & Whitney LLP,
Minneapolis, Minnesota
PATENT COUNSEL: Merchant, Gould, Smith, Edell, Welter & Schmidt, Minneapolis,
Minnesota
PUBLIC RELATIONS COUNSEL: Padilla Speer Beardsley Inc., Minneapolis, Minnesota
TRANSFER AGENT AND REGISTRAR: Norwest Bank Minnesota, N.A., South St. Paul,
Minnesota
SIX YEAR QUARTERLY HIGH-LOW STOCK PRICES
[PLOT POINTS CHART OMITTED]
33
ELEVEN-YEAR COMPARISON OF RESULTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------
OPERATING RESULTS
Net sales ............................ $833,348 $758,646 $703,959 $593,503
Gross margin ......................... $250,273 222,874 197,979 166,599
Gross margin percentage .............. 30.0% 29.4% 28.1% 28.1%
Operating income ..................... $ 82,715 75,642 65,531 52,079
Operating income percentage .......... 9.9% 10.0% 9.3% 8.8%
Interest expense ..................... $ 2,358 2,905 3,089 3,362
Earnings before income taxes ......... $ 79,094 71,120 63,172 50,193
Income taxes ......................... $ 28,474 27,684 24,636 18,244
Effective income tax rate ............ 36.0% 38.9% 39.0% 36.3%
Net earnings ......................... $ 50,620 43,436 38,536 31,949(1)
Return on sales ...................... 6.1% 5.7% 5.5% 5.4%
Return on average shareholders' equity 21.4% 19.3% 18.8% 17.6%
Return on investment ................. 18.2% 18.5% 17.6% 16.0%
---------------------------------------------------------
FINANCIAL POSITION
Total assets ......................... $454,394 402,850 381,042 337,360
Current assets ....................... $268,818 250,751 247,904 220,308
Current liabilities .................. $176,297 138,578 123,747 115,757
Working capital ...................... $ 92,521 112,173 124,157 104,551
Current ratio ........................ 1.5 1.8 2.0 1.9
Current debt ......................... $ 42,674 13,145 20,800 16,956
Long-term debt ....................... $ 4,201 10,041 10,167 16,028
Total debt ........................... $ 46,875 23,186 30,967 32,984
Shareholders' equity ................. $243,865 228,880 221,173 189,697
Long-term capitalization ratio ....... 1.7% 4.2% 4.4% 7.8%
Property, plant and equipment, net ... $154,595 124,913 110,640 99,559
Net expenditures on
property, plant and equipment ... $ 47,327 39,297 25,334 24,642
Depreciation and amortization ........ $ 21,494 21,674 20,529 16,365
---------------------------------------------------------
SHAREHOLDER INFORMATION
Net earnings per share ............... $ 1.98 1.67 1.45 1.17(1)
Dividends paid per share ............. $ .35 .30 .28 .25
Shareholders' equity per share ....... $ 9.86 9.04 8.45 7.16
Shares outstanding (000s) ............ 24,726 25,325 26,185 26,510
Common stock price range, per share
High ............................ $ 40 3/4 28 28 26 1/8
Low ............................. $ 25 1/4 23 7/8 20 7/8 18 1/4
---------------------------------------------------------
Amounts are adjusted for all stock splits.
Operating income is gross margin less selling, general and administrative, and
research and development expense.
Return on investment is net earnings divided by average long-term debt plus
average shareholders' equity.
Long-term capitalization ratio is long-term debt divided by long-term debt plus
shareholders' equity.
(I) Excludes the cumulative effect of an accounting change of $2,206, or $.08
per share, in 1994 and extraordinary credits of $1,384, or $.05 per share, in
1988 and $1,375, or $.04 per share, in 1987.
34
1993 1992 1991 1990 1989 1988 1987
- ------------------------------------------------------------------------------------------------------------------
$533,327 $482,104 $457,692 $422,885 $397,535 $362,862 $294,993
152,236 133,574 129,858 121,454 105,275 104,828 83,336
28.5% 27.7% 28.4% 28.7% 26.5% 28.9% 28.3%
45,246 41,249 41,304 44,354 37,851 36,047 24,648
8.5% 8.6% 9.0% 10.5% 9.5% 9.9% 8.4%
2,723 2,681 3,526 3,731 3,555 3,229 2,359
44,682 41,721 39,385 34,875 27,664 29,868 21,748
16,468 15,952 15,337 13,849 12,230 13,630 10,782
36.9% 38.2% 38.9% 39.7% 44.2% 45.6% 49.6%
28,214 25,769 24,048 21,026 15,434 16,238(1) 10,966(1)
5.3% 5.3% 5.3% 5.0% 3.9% 4.5% 3.7%
16.9% 17.2% 18.0% 17.8% 15.1% 15.6% 9.8%
15.0% 14.8% 14.9% 14.2% 11.5% 11.7% 7.9%
- ------------------------------------------------------------------------------------------------------------------
300,217 286,348 253,194 245,947 204,813 193,548 200,827
196,014 187,360 169,398 168,522 130,848 122,602 128,370
93,666 89,956 77,537 79,917 58,009 52,126 44,609
102,348 97,404 91,861 88,605 72,839 70,476 83,761
2.1 2.1 2.2 2.1 2.3 2.4 2.9
7,595 11,425 6,380 11,384 8,602 3,875 4,302
18,920 23,482 25,673 28,320 30,750 33,784 35,353
26,515 34,907 32,053 39,704 39,352 37,659 39,655
174,008 160,303 138,947 128,787 107,516 97,254 110,517
9.8% 12.8% 15.6% 18.0% 22.2% 25.8% 24.2%
90,515 84,899 72,863 68,290 61,914 62,160 62,575
15,005 15,538 16,208 16,055 11,567 9,954 15,460
14,752 14,047 12,187 10,857 10,583 10,351 8,857
- ------------------------------------------------------------------------------------------------------------------
1.01 .92 .84 .73 .54 .55(1) .36(1)
.20 .19 .14 .13 .12 .11 .11
6.38 5.81 5.01 4.46 3.75 3.40 3.34
27,282 27,569 27,739 28,864 28,693 28,597 33,131
20 1/8 15 7/8 13 3/8 11 5/8 5 7/8 8 5/8 6 3/4
14 11 5/8 8 1/8 5 5/8 5 1/2 3 5/8 5 3/8
- ------------------------------------------------------------------------------------------------------------------
35
DONALDSON WORLDWIDE OPERATIONS
WORLD HEADQUARTERS DISTRIBUTION CENTERS Donaldson Torit, B.V.,
HAARLEM, NETHERLANDS
Donaldson Company, Inc. RENSSELAER, INDIANA
MINNEAPOLIS, MINNESOTA ONTARIO, CALIFORNIA Donaldson France, S.A.,
ANTWERP, BELGIUM BRON, FRANCE
U.S. PLANTS Tecnov-Donaldson, S.A.,
JOINT VENTURES DOMJEAN, FRANCE
OLD SAYBROOK, CONNECTICUT
DIXON, ILLINOIS Advanced Filtration Systems Inc., Donaldson Italia s.r.l.,
FRANKFORT, INDIANA CHAMPAIGN, ILLINOIS OSTIGLIA, ITALY
CRESCO, IOWA
GRINNELL, IOWA MSCA, LLC, Nippon Donaldson, Ltd.,
OELWEIN, IOWA MONTICELLO, INDIANA TOKYO, JAPAN
NICHOLASVILLE, KENTUCKY
PORT HURON, MICHIGAN D.I. Filter Systems Pvt. Ltd., Donaldson Korea Co., Ltd.,
CHILLICOTHE, MISSOURI NEW DELHI, INDIA SEOUL, SOUTH KOREA
MOORESVILLE, NORTH CAROLINA
PHILADELPHIA, PENNSYLVANIA Guilin Air King Enterprise Ltd., Donaldson Far East Ltd.,
BALDWIN, WISCONSIN GUILIN, PEOPLE'S REPUBLIC OF CHINA HONG KONG, S.A.R., PEOPLE'S REPUBLIC
STEVENS POINT, WISCONSIN OF CHINA
PT Panata Jaya Mandiri,
JAKARTA, INDONESIA Donaldson (Wuxi) Filters Co., Ltd.,
WUXI, PEOPLE'S REPUBLIC OF CHINA
SUBSIDIARIES Donaldson Australasia (Pty.) Ltd.,
WYONG, AUSTRALIA
ENV Services, Inc.,
MINNEAPOLIS, MINNESOTA Donaldson Filtration
Systems (Pty.) Ltd.,
Donaldson Europe, N.V., CAPE TOWN, SOUTH AFRICA
LEUVEN, BELGIUM
Donaldson, S.A. de C.V.,
Donaldson Coordination AGUASCALIENTES, MEXICO
Center, N.V.,
LEUVEN, BELGIUM
LICENSEE
Donaldson Gesellschaft m.b.H.,
DULMEN, GERMANY Parker Hannifin Ind. Com. Ltda.,
SAO PAULO, BRAZIL
Donaldson Filter
Components, Ltd.,
HULL, ENGLAND
36