Donaldson Company Annual Report 2000

Plain-text annual report

INDUSTRIAL strength Eleven Record Years 2000 Annual Report Donaldson Company, Inc., is a leading worldwide manufacturer of ﬁltration systems and replacement parts. The company’s product mix includes air and liquid filters and exhaust and emission control products for mobile equipment; in-plant air cleaning systems; air intake systems and exhaust products for industrial gas turbines; and specialized filters for such diverse applications as computer disk drives, aircraft passenger cabins and semi- conductor processing. Products are manufactured at more than three dozen Donaldson plants around the world and through ﬁve joint ventures. Our financial objective is to build shareholder value through superior share price appreciation and consistent dividend payouts. We believe value is created by delivering consistent, double-digit growth in earnings per share. Growth will be achieved by aggressively pursuing new opportunities in our existing and related markets. Consistency will be reinforced by maintaining a diversified portfolio of related ﬁltration businesses around the world. Mission Statement To provide superior return for our shareholders, through consistent, long-term earnings growth built on global leadership in ﬁltration solutions thereby creating security, opportunity and challenge for our employees. 1 8 9 Industrial Strength Financial Highlights Letter to Shareholders Operating Segment Information 19 12 14 Management’s Discussion and Analysis Consolidated Statements of Earnings Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Changes in Shareholders’ Equity 21 20 22 33 23 Notes to Consolidated Financial Statements Report of Independent Public Accountants Eleven-Year Comparison of Results Corporate and Shareholder Information Board of Directors and Corporate Officers 34 36 IBC Back Worldwide Operations Industrial strength. It’s a good descriptor of Donaldson, a strong, rock-solid company with 11 consecutive years of double-digit earnings growth. A company that has grown and diversiﬁed into numerous industries with a wide geographic reach. Industrial strength also highlights the Industrial side of our business (dust collection, gas turbine systems and special applications), which by the end of the current ﬁscal year will make up an estimated 43 percent of total revenues, up nine percentage points from just three years ago. Although our Engine business continues its solid growth, we anticipate Industrial will grow twice as fast due to tremendous international opportunities and untapped market segments. industrial STRENGTH We’ll capitalize on the opportunities by focusing on our core strengths: customer relationships, technology and interna- tional presence. Some examples… our relationship with General Electric has enabled us to beneﬁt from their explosive growth in the gas turbine business. The same holds true with IBM in the disk drive arena. Our acquisition of England-based DCE is providing solid infra- structure in Europe for future acquisitions, not to mention the growth of our dust collection business. And in the technology ﬁeld, our proprietary EonTM ﬁne ﬁber technology – the crown jewel of Donaldson technology that enables us to create self-cleaning ﬁlters – has been a big boost, enabling us to create unique solutions and ultimately solidifying client relationships. In the following pages, we’ve high- lighted a few of our Industrial businesses, as well as a story focusing on expansion on the Engine side – all demonstrating our potential as an industry leader poised for growth. STRATEGIC acquisition Complementary Products. Complementary Markets. Combined Force. It is the perfect fit – Donaldson’s Torit® business and DCE, a major player in the European industrial dust collection industry. In February 2000, the two combined when Donaldson acquired DCE, creating a new entity – Donaldson Dust Collection. Both Torit and DCE design, manufacture and market in-plant air ﬁltration and pol- lution control systems and products. Torit’s strength is in North America where we primarily offer products configured with replaceable cylindrical filter car- tridges. DCE, headquartered in Leicester, England, sells filter-bag-configured products, with approximately 70 percent of revenue coming from the United Kingdom and Europe. Together, Torit and DCE are complementary companies, with complementary products and markets. Customers receive greater access to Donaldson’s products and services, and Donaldson beneﬁts from new markets. The end result? Broad geographic range and unparalleled product strength that enable us to develop the right industrial dust collection configuration for any customer application. Fact: Donaldson provides ﬁltration solutions to a wide range of applications and dust collection markets around the globe. Fact: Worldwide, the compressor ﬁltration market is estimated at $150 million. Delivering Comprehensive Compressor Filtration Solutions When Donaldson acquired privately owned AirMaze® in November 1999, it not only gained broad access to the com- pressor ﬁltration market, we gained a technology leader in ﬁltration solutions as well. Donaldson is now the premier provider of air/oil separators to compressor OEMs in the United States, in addition to offering its extensive range of existing compressor filtration products. Our line of air/oil separators is used throughout construction and manufac- turing in both portable and stationary air compressors, which drive things like air-tools and assembly lines. Our strong domestic market presence allows us to offer comprehensive ﬁltration solutions to a range of new customers and OEMs. What’s more, with Donaldson’s global reach and experience in marketing to international customers, our worldwide opportunities are extensive and untapped. Utilizing an experienced engineering staff, we will innovate and apply tech- nology to offer the most advanced compressor ﬁltration products. market LEADERSHIP Fact: Donaldson’s Tetratex ﬁlter media is stable in almost any environment ranging in temperature from -450° to +500°F (-270° to +260°C). From Waterproof Clothing to Pollution Control Comprised of millions of small, randomly connected ﬁbers, Donaldson’s Tetratex® membrane repels water while allowing air and moisture vapor to flow freely through the membrane. The Tetratec™ business unit produces membranes in a broad range of pore structures at made-to-order lengths, which can be bonded to an array of fabric and filtration materials. This makes it ideal for a wide variety of applications including industrial dust collection and fabric for high- performance garments. We expect continued high growth from this business as it expands its share in filtration and fabric markets worldwide. Tetratec is a departure from our normal business model in that it produces and markets ﬁlter media rather than ﬁltration products. versatile MEMBRANE HIGH power Meeting Energy Needs Worldwide Industry deregulation, outdated equipment and an insatiable need for power are taxing today’s energy infrastructure. This has fueled growing demand for energy- producing gas turbines, which are low-cost and highly efﬁcient power sources – resulting in a 39 percent increase in gas turbine systems business in 2000. Donaldson designs and manufactures ﬁltration systems and silencing products that protect combustion turbines and other rotating equipment used in power gen- eration, oil and gas production, and transmission and petrochemical industries. Our customers include leading gas turbine OEMs General Electric and Seimens Westinghouse, as well as other independent power producers and end-users in emerging economies. We expect high demand for our systems and products to continue through 2001 and beyond. As cost effective and efﬁcient energy sources become even more important in the future, Donaldson plans to be there with pro- gressive ﬁltration solutions. Fact: World electricity consumption is projected to increase by 60 percent from 1997 to 2020*. *International Energy Outlook 2000, Energy Information Administration CLEANER air Helping Customers Meet EPA Requirements In its persistent effort to improve the quality of air we breathe, the EPA continues to impose regulations that further reduce harmful emissions related to diesel engine use in the United States. Other regulatory bodies are making similar demands internationally. These step reductions mean manufacturers must reduce levels of nitrogen oxide and par- ticulate in emissions by 2004 and again in 2007. That’s good news for the environment and for Donaldson. To help engine and truck manufacturers meet regulations, we’re responding with a “total ﬁltration” approach including enhanced air, liquid and exhaust products. Higher performing products with improved technology will provide better ﬁltration levels and longer wear. And the higher performance translates into higher value products. Regulations focusing specifically on exhaust may lead to a tremendous market potential for exhaust systems and an increase in the amount of Donaldson product on each vehicle. In addition, regulations now applicable to new on- road vehicles will eventually affect off-road and older vehicles, greatly expanding our opportunities for both ﬁrst-ﬁt and retroﬁt products. Fact: The proposed EPA requirements for 2007 (as compared to 2004 requirements) will further reduce by 90 percent the levels of nitrogen oxide and particulate released into the air by diesel engines. Fact: Donaldson sells more than 250 million disk drive ﬁlters per year. (Actual Size) New Initiatives in an Emerging Region The Asia Pacific region is known for its developing economies, untapped markets and tremendous opportunities for growth. And while many companies are just beginning to capitalize on the potential, Donaldson has been committed to the region for more than 30 years, with a presence today in Japan, China, Australia, India, South Korea, Indonesia and Singapore. In fiscal 2000, we began to see a resurgence in the Asia Pacific economy, which has languished in recent years. Sales from our disk drive ﬁltration products manufacturing facility in Wuxi, China increased dramatically, and we began consolidation efforts to revitalize business in Japan. We made a signiﬁcant investment to open a new headquarters in Singapore that unites all of our operations in Asia Paciﬁc and provides central leadership for ongoing initiatives. Additionally, we enhanced manufacturing and sales facilities in Australia. As the Asia Pacific economy continues to ramp up, Donaldson is poised to capitalize on the opportunities and expand. eastern SYNERGY Financial Highlights Donaldson Company, Inc. and Subsidiaries Year ended July 31 Net sales (000s) Net earnings (000s) Return on sales Return on average shareholders’ equity Long-term capitalization ratio Diluted earnings per share Dividends paid per share Shareholders’ equity per share Diluted shares outstanding (000s) Employees at year-end Sales per employee (000s) 2000 1999 Change $1,092,294 $70,233 $944,139 $62,447 6.4% 25.9% 24.9% $1.51 $.27 $6.27 46,664 8,478 $128.8 6.6% 24.1% 24.8% $1.31 $ .23 $5.69 47,793 7,056 $133.8 15.7% 12.5% (.2) pts 1.8 pts .1 pts 15.3% 17.4% 10.2% (2.4)% 20.2% (3.7)% Return on Equity (% Per annum) Net Sales (Millions of dollars) 25.9 24.1 22.8 21.4 17.8 18.0 17.2 16.9 17.6 18.8 19.3 1,092 940 944 833 759 704 594 533 482 458 423 90 91 92 93 94 95 96 97 98 99 00 90 91 92 93 94 95 96 97 98 99 00 Donaldson Company is delivering shareholder value through consistently high returns on shareholders’ equity. Donaldson has posted 17 consecutive years of revenue increases. Earnings Per Share (Dollars) Dividends Per Share (Dollars) 1.51 1.31 1.14 .99 .84 .73 .27 .23 .19 .17 .15 .14 .12 .59 .51 .46 .42 .37 .10 .09 .07 .06 90 91 92 93 94 95 96 97 98 99 00 90 91 92 93 94 95 96 97 98 99 00 Earnings per share were up 15 percent in 2000, the 11th consecutive year of double-digit increases in EPS. Dividends paid per share increased 17 percent in 2000. The company distributes about 20 percent of net income to shareholders through regular quarterly dividends. s r e d l o h e r a h S o t r e t t e L Pictured from left to right: James R. Giertz Senior Vice President, Commercial and Industrial William M. Cook Senior Vice President, International Lowell F. Schwab Senior Vice President, Operations Nickolas Priadka Senior Vice President, Engine Systems and Parts Thomas W. VanHimbergen Senior Vice President and Chief Financial Ofﬁcer William G. Van Dyke Chairman, President and Chief Executive Ofﬁcer Fiscal 2000 was another strong year for us. We crossed the $1 billion revenue mark with sales growth of 16 percent and delivered on our promise of double-digit earnings growth for the 11th consecutive year. These results are evidence that the people who are this company have done a lot of things right, and I thank them for their dedication, commitment and hard work. Our fundamental ﬁnancial model is that consistent, above-average earnings growth will bring above-average returns to our shareholders. For the last 11 years we’ve posted sales growth averaging 10 percent and never-miss, double-digit earnings growth averaging 17 percent. By my assessment, our people have done a ﬁne job of executing the game plan. With return to shareholders over that period well above 20 percent, the model would seem to hold up pretty well. But the stock has not appreciated for three years, while EPS marched forward at a steady 15 percent per year. The stock market’s unwillingness to recognize our performance compelled us to carefully examine whether our model is outdated. In sum, we don’t think so. If this business isn’t “all about” cash ﬂow and long-term return on investment (we use consistent, long-term EPS growth as a proxy for these), then we don’t understand the game. The stock market will swing for us and against us, but we’ll hold to our long-term view: if we continue to perform every year as we have, our shareholders will win. HIGHLIGHTS We’ve helped to ensure our success – and remove cyclicality from our performance – by diversifying our business over the years. Since the mid-’80s, we’ve used our highly successful franchise in diesel engine ﬁltration to fund expansion into other ﬁltration markets. The payback is that while the Engine Products segment remains the keel of our ship, logging double-digit growth in 2000, the Industrial Products segment in the current year will deliver an estimated 43 percent of Donaldson’s revenue and almost half of its operating proﬁt. 9 Long-Term Performance (Cumulative total return) Year ended July 31 - = DCI - = S&P 400 280 228 225 203 148 142 173 172 100 100 88 133 82 89 687 623 796 580 642 590 492 461 384 317 412 294 373 236 90 91 92 93 94 95 96 97 98 99 00 We’re highlighting the Industrial Products group with our Industrial Strength theme for this year’s report to give you a good sense of our current strength on this side of the business and our future opportunities. We’re not yet to our revenue target of 50 percent Industrial, but we’ve made good progress from the mid-’80s when that sector contributed only 15 percent of sales. Engine’s strong showing in 2000, despite a 6 percent decline in the transportation business, reﬂects continued share gains in the aftermarket unit, as well as a double-digit rebound from last year in the off-road group. Concurrently, Industrial posted double-digit growth in both gas turbines and disk drives. In each case, strong underlying market growth was accom- panied by signiﬁcant Donaldson share gains. On the international front, we had a banner year. Europe turned in a powerful performance with impressive revenue and proﬁt gains across all business units. Asia Paciﬁc, buoyed by our operations in China, likewise posted strong sales and proﬁt growth; however, Japan continues to drift in the doldrums. Two acquisitions during the year – AirMaze, a supplier of air/oil separators and heavy-duty air and liquid ﬁlters, and DCE, a global leader in industrial dust collection – added $57 million to our portfolio. You will ﬁnd more detailed information about these acquisitions on pages 2 and 3 of our report. Generally, we expect acquisitions to continue to provide about a third of our targeted 10 to12 percent revenue growth over the long term. The fragmented ﬁltration industry continues to offer acquisition opportunities that match up well with Donaldson’s broad global base and established market positions. LOOKING AHEAD The coming year looks to be the logical extension of the one past. We expect continued strong ﬁnancial performance and market share gains from gas turbine. Our signiﬁcant infrastructure investments over the last several years have left us uniquely positioned to respond to today’s unprecedented demand for gas turbines. 10 Consistent Double-Digit EPS Growth (Annual EPS % change) 35 10% Goal 0 -2 15 10 10 16 24 15 19 15 15 15 89 90 91 92 93 94 95 96 97 98 99 00 We anticipate that the sharp downturn in North American heavy trucks will likely continue. However, because our ﬁrst-ﬁt sales in this sector are less than 10 percent of our total, the downturn slows rather than threatens another successful year. This makes the case for the diversiﬁcation we’ve relentlessly pursued for so many years. Aftermarket’s uptrend, past and future, is closely linked to e-commerce. Now in the third year since the launch of its DYNAMICTM online order-processing tool, aftermarket is handling more than 50 percent of its orders electronically. In the year ahead, we’ll look intently at how we can utilize this powerful tool in other areas of our business. We’ll also continue our efforts to assimilate and leverage the operations we’ve acquired in the last few years. With multiple plants and operations around the world, DCE’s integration promised to be hard work, and it has lived up to that promise. That said, Donaldson has the only global franchise in the dust collection industry and the two best known brand names in Torit and DCE. The inevitable surprises that come with an acquisition have been overwhelmingly positive, and we’re excited about the upside potential, particularly in the international arena. Overall, it’s an exciting time for Donaldson. Today’s remarkably rapid pace of change means the only sure thing in the coming year is the unexpected. But, that doesn’t leave us confused about our objective. We look forward to delivering our 12th consecutive year of double-digit growth in 2001. Thank you for your continuing support. Sincerely, William G. Van Dyke Chairman and Chief Executive Ofﬁcer 11 ENGINE PRODUCTS Operating Segment 2000 Revenue: $674 million End-Markets Representative Customers 2000 Revenue Product Families OFF-ROAD EQUIPMENT: Products sold to industrial Caterpillar, John Deere, Komatsu and Volvo equipment OEMs for agriculture, Construction Equipment construction, mining and other industrial applications. I N M I L L I O N S $193 r i A e k a t n I e n g n E i s m e t s y S n o i t a r t l i F s m e t s y S t s u a h x E s m e t s y S n o i t a r t l i F c i l u a r d y H s r e t l i F r i A n b a C i DEFENSE: Products sold to military contractors supplying land-based military equipment. General Dynamics, Stewart & Stevenson TRUCKS: Freightliner, Paccar, Products sold to manufacturers of Volvo, Scania, Renault medium- and heavy-duty trucks. and Mitsubishi $153 AUTOMOTIVE: General Motors, Products sold to manufacturers of DaimlerChrysler, Ford, passenger cars, SUVs and light-duty Audi and Hino commercial vehicles. AFTERMARKET: Broad line of replacement ﬁlters and hard parts for all of the equipment applications noted above. Original equipment dealers (such as Freightliner dealers or Caterpillar dealers), inde- pendent distributors and private label accounts $328 12 INDUSTRIAL PRODUCTS Operating Segment 2000 Revenue: $418 million Products 2000 Revenue Applications Routes to Market DUST COLLECTION: I N M I L L I O N S Product is applied in a wide variety Dedicated ﬁeld sales force Under the trade names Torit, DCE and Aercology, Donaldson provides equipment to control and capture process dust, fumes and mist in manufacturing and industrial processing plants. In addition, a full line of replacement ﬁlter cartridges, bags and spare parts are offered. GAS TURBINE SYSTEMS: Donaldson provides complete systems to deliver clean air to combustion turbines. Products include self-cleaning ﬁlter units, static air ﬁlter units, inlet ducting and silencing, evaporative coolers, chiller coils, inlet heating and anti-icing systems. Also, a full line of replacement ﬁlters and parts is offered. $193 of industrial settings including metal coordinates multiple selling working plants, paint operations, channels to end-user includ- welding stations, woodworking ing: direct selling, distribu- shops and food processing plants. tion, installers, OEM accounts and telemarketing. $117 Essentially all combustion turbines Products are primarily require inlet air ﬁltration and noise sold to gas turbine OEMs attenuation systems. These turbines (e.g., General Electric, provide base electricity, peaking Alstom Power, Seimens capacity, remote power generation Westinghouse). Replacement for special applications such as parts are sold direct to end- pipelines and off-shore oil drilling users. platforms. SPECIAL APPLICATIONS: Donaldson provides a wide range of high efﬁciency media, ﬁlters and ﬁltration $108 Products for the computer disk drive Products are sold to disk market include particulate ﬁlters, drive manufacturers by a desiccant pouches and chemical direct sales force supported systems for various commercial, industrial adsorbing ﬁlter pouches. Customers by product development and and product applications. include major disk drive manufac- application engineers. turers such as IBM, Seagate and Western Digital. Products for special market appli- Products are primarily sold cations include aircraft cabin air direct to end-users. ﬁlters, chemical ﬁlter systems for semi-conductor processing facilities, as well as other ﬁlters for process- critical applications. Donaldson sells expanded PTFE Membrane and laminates membrane through its Tetratec are sold to various ﬁlter and unit. Primary applications for garment manufacturers. this membrane are industrial dust collection, product recovery appli- cations and specialty fabrics. Donaldson sells a broad line of Products are sold through ﬁlters and housings for industrial an extensive network of hydraulic and lubricating ﬂuids. industrial distributors. 13 Management’s Discussion and Analysis 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 (including Note H, Segment Reporting) and other ﬁnancial information included elsewhere in this Report. Fiscal 2000 Compared to Fiscal 1999 The company exceeded one billion dollars in sales in 2000, reporting record sales of $1.092 billion. This was an increase of 15.7 percent over prior- year sales of $944.1 million. Businesses acquired in this ﬁscal year contributed $56.7 million of revenues for the year. Excluding the impact of acquisitions, sales for the year ended July 31, 2000 were up 9.7 percent over the prior year. Sales for the Engine Products segment of $674.0 million were up 10.2 percent over the prior year. Sales for the Industrial Products segment of $418.3 million were up 25.7 percent over the prior year. Overall, growth was strong across essentially all the mar- kets within both the Engine Products and Industrial Products segments with the exception of a 5.9 percent decline in sales of transportation products within the Engine Products segment, reﬂecting a slowdown in the North America heavy-duty truck market and a decrease in automotive sales due to the loss of the CK platform business. Continued increases in sales for the gas turbine systems and special application products reﬂected con- tinued high demand in those markets. The increase in sales also reﬂected strengthening in other markets such as dust collection, engine aftermarket and off-road products. Domestic Engine Products sales were up 8.7 percent from the prior year. This increase was led by strong sales in engine aftermarket products, which increased domestically by 23.6 per- cent including businesses acquired during the year. Exclusive of acquisitions, domestic aftermarket product sales increased 10.4 percent. Domestic sales in off-road equipment products were also strong with an increase of 14.7 percent from the prior year reﬂecting growth in the agricultural, mining and large equipment markets compared to the prior year. Domestic sales in transportation products were down 1.8 percent with mixed results coming from an increase of 10.2 percent in domestic truck sales offset by a sharp decline in domestic automotive sales. Domestic Industrial Products sales increased 17.8 percent from the prior year including businesses acquired during the year. 14 Exclusive of acquisitions, domestic Industrial Products sales were still strong with an increase of 15.6 percent. This increase was led by continued strong sales of gas turbine systems prod- ucts (55.4 percent increase from the prior year) reﬂecting con- tinued demand for large turbines in North America. Domestic dust collection product sales grew at a more modest rate with an increase of 7.2 percent while increases in special applications products increased only slightly overall. In U.S. dollars, total international sales increased 23.0 per- cent from the prior year. Excluding the negative impact of for- eign currency translation of $12.3 million, sales increased 26.8 percent over the prior year. Total international Engine Products sales were up 13.3 percent compared to the prior year despite lower overall sales of automotive products. International sales of off-road products and aftermarket products were strong, posting increases of 21.9 percent and 20.1 percent from the prior year, respectively. International Industrial Products sales were up 39.0 percent from the prior year including businesses acquired during the year. Businesses acquired during the year contributed $28.7 million of international sales in the Industrial Products segment. Excluding these sales, the Industrial Products segment showed an increase of 15.9 percent in international sales from the prior year. A sharp increase in international sales in dust collection products was due largely to acquisitions during the year but excluding acquisitions, sales still showed an increase of 6.7 percent. Also contributing to the increase in international sales for the Industrial Products segment were disk drive products and gas turbine products with increases of 18.8 percent and 14.9 percent, respectively, over the prior year. The company reported record net earnings for 2000 of $70.2 million compared to $62.4 million in 1999, an increase of 12.5 percent. Net earnings per share - diluted were $1.51, up 15.3 percent from the prior year and reﬂects revenue growth as well as the impact of the company’s stock repurchase program. An increase in sales levels from the prior year and the beneﬁt from continued cost reduction efforts were the primary reasons for the higher earnings. The Industrial Products segment con- tributed almost half of the operating proﬁt and all of the earn- ings growth for 2000. International operating income totaled approximately 62.1 percent and 57.6 percent of consolidated operating income in 2000 and 1999, respectively. Gross margin for 2000 increased to 30.0 percent compared to 29.2 percent in the prior year. The increase in gross margin for the year reﬂects the growth in net sales achieved in both operating segments of the company as well as the positive impact of the continuous focus on productivity improvements. Operating expenses as a percentage of sales for 2000 and 1999 were 20.3 percent and 19.8 percent, respectively. Operating expenses in 2000 totaled $221.9 million compared to $187.3 mil- lion in 1999, an increase of $34.6 million, or 18.5 percent. The increase in operating expenses relative to the prior year reﬂects higher sales levels and the impact of the acquired businesses. Selling expenses in 2000 increased $17.1 million, primarily due to the higher sales levels. General and administrative expenses increased $13.8 million from the prior year due to several fac- tors including increased programming and information technol- ogy costs associated with Year 2000 efforts, increases in workers’ compensation, increases in medical costs and employee compensation. In addition, there was $1.8 million of goodwill amortization related to the businesses acquired during the year. Interest expense increased $2.9 million, or 41.3 percent, primarily due to an increase in debt for the ﬁnancing of acquisi- tions in the year as well as an increase in short-term borrowing. Other income totaled $4.6 million in 2000 compared to other income of $7.8 million in the prior year. The major components of other income in 2000 were: interest income of $2.7 million, earnings from non-consolidated joint ventures of $4.4 million, charitable contributions of $0.9 million, loss on sale of ﬁxed assets of $1.0 million, and other miscellaneous income and expense items netting to $0.6 million of miscellaneous expense. The effective income tax rate of 30.0 percent in 2000 was unchanged from the 30.0 percent tax rate in 1999. The com- pany anticipates that its effective income tax rate will remain at approximately 30.0 percent in 2001. Total backlogs of $331.3 million were up 16.8 percent from the prior year-end. Hard order backlogs, goods scheduled for delivery in 90 days, were $183.7 million and $157.1 million at July 31, 2000 and 1999, respectively. Hard order backlog for the Engine Products segment decreased slightly from 1999. This decrease resulted from a decrease in backlog for truck and auto- motive products of 32.1 percent, offset by double-digit increases in both aftermarket products and off-road equipment products of 22.2 percent and 15.5 percent, respectively. Hard order back- log for the Industrial Products segment increased $28.2 million from 1999. This increase was due to signiﬁcant increases in backlog for both dust collection and gas turbine products of 81.1 percent and 45.6 percent, respectively, followed by a more modest increase in special application products of 6.6 percent. Fiscal 1999 Compared to Fiscal 1998 The company reported record sales in 1999 of $944.1 million, a slight increase over prior-year sales of $940.4 million. Sales for the Engine Products segment of $611.0 million were down 1.7 percent over the prior year. Sales for the Industrial Products segment of $333.0 million were up 4.6 percent from the prior year. Overall, end-market conditions varied widely for the various products and geo- graphic locations. Demand in some markets, such as agricul- tural equipment, was down sharply, while other markets, such as gas turbine systems, experienced rapid growth. Most of the markets served by the company experienced sluggish growth or modest contractions in demand. Domestic Engine Products sales were down 3.0 percent from the prior year. This decrease is primarily due to an ongoing weakness in the agricultural equipment markets and, to a lesser extent, lower production of mining and large equipment result- ing in a decrease in sales in off-road equipment products of 9.5 percent. This decrease was offset by an increase in sales of truck products of 13.6 percent from the prior year. Domestic Industrial Products sales increased 6.7 percent. This increase was led by strong sales of gas turbine systems products (38.5 percent increase from the prior year) as well as modest sales growth in dust collection products. This increase was partially offset by lower sales in special applications products. In U.S. dollars, total international sales increased 1.0 per- cent from the prior year. Excluding the negative impact of foreign currency translation of $1.2 million, sales increased 1.4 percent over the prior year. Total international Engine Products sales were up 0.9 percent compared to the prior year despite lower overall sales of off-road and truck products. Aftermarket product sales showed an increase of 8.2 percent over the prior year largely due to increased activity in Mexico. Total international Industrial Products sales increased 1.2 per- cent from the prior year. This increase was primarily a result of an increase in sales of ﬁlters for computer disk drives partially offset by a decrease in sales of gas turbine systems products of 24.0 percent. The company reported record net earnings for 1999 of $62.4 million compared to $57.1 million in 1998, an increase of 9.5 percent. Net earnings per share - diluted were $1.31, up 14.9 percent from the prior year and reﬂects the impact of the company’s stock repurchase program. The increase in net earnings, with only a slight increase in net sales, was primarily due to cost reduction and productivity initiatives, an increase in other income as discussed below and a reduction in the effective income tax rate. International operating income totaled approx- imately 57.6 percent and 50.3 percent of consolidated operating income in 1999 and 1998, respectively. 15 Gross margin for 1999 increased to 29.2 percent compared Liquidity and Capital Resources to 28.0 percent in the prior year. Gross margin improved over the course of the year; gross margin in the second half of 1999 was 30.3 percent. The improvement in gross margin reﬂects the positive impact of cost reduction and productivity initiatives partially offset by the negative impact of lower production vol- umes in some facilities. Operating expenses as a percentage of sales for 1999 and 1998 were 19.8 percent and 18.8 percent, respectively. Operating expenses in 1999 totaled $187.3 million compared to $176.5 million in 1998, an increase of $10.8 million, or 6.1 percent. Selling expenses in 1999 decreased $2.1 million, reﬂecting the positive impact of cost reduction and productivity initiatives, while general and administrative expenses increased $12.8 million consisting primarily of increases in product liabil- ity expense, legal expense, system and programming costs and employee compensation. In addition, there were $2.8 million of costs related to the closing of the Oelwein plant. Interest expense increased $2.3 million, or 49.7 percent, primarily due to the increase in long-term debt for the full year. Other income totaled $7.8 million in 1999 compared to other income of $4.3 million in the prior year. The major components of other income in 1999 were: interest income of $1.4 million, earnings from non-consolidated joint ventures of $3.6 million, gain on sale of assets and product lines of $0.9 million, and other miscellaneous items of $1.9 million. The effective income tax rate of 30.0 percent in 1999 was lower compared to 34.0 percent in 1998, primarily due to lower international taxes and foreign tax credits from foreign dividends. The company anticipates that its effective income tax rate will remain at 30.0 percent in 2000. Total backlogs of $283.7 million were up 16.6 percent from the prior year-end. Hard order backlogs, goods scheduled for delivery in 90 days, were $157.1 million and $138.8 million at July 31, 1999 and 1998, respectively. Hard order backlog for the Engine Products segment increased $7.7 million from 1998. This increase was due primarily to an increase in backlog for truck and automotive products of 25.5 percent, offset by a decrease in off-road equipment products backlog of 8.2 percent. Hard order backlog for the Industrial Products segment increased $10.7 million from 1998. This increase was due to signiﬁcant increases in backlog for both gas turbine and special applications products of 53.0 percent and 58.6 percent, respec- tively, offset by a decrease in dust collection products backlog of 19.1 percent. Financial Condition At July 31, 2000, the company’s capital structure was comprised of $85.3 million of current debt, $92.6 million of long-term debt and $280.2 million of share- holders’ equity. The ratio of long-term debt to total long-term capital was 24.9 percent and 24.8 percent at July 31, 2000 and July 31, 1999, respectively. Total debt outstanding increased $70.6 million to $178.0 million outstanding at July 31, 2000. The increase resulted from an increase in short-term borrowings outstanding at the end of the year of $64.7 million as compared to the prior year. Additionally, during the year the company obtained $8.0 mil- lion in Industrial Development Revenue Bond Financing for the construction of a new manufacturing facility of which $5.7 mil- lion was outstanding as of July 31, 2000. The company has a multi-currency revolving credit facility totaling $100.0 million with a group of banks and an additional $35.0 million available for use under uncommitted facilities which provide unsecured borrowings for general corporate pur- poses. There was $62.6 million outstanding under these facilities at July 31, 2000. The company believes that the combination of present capital resources, internally generated funds, and unused ﬁnancing sources are more than adequate to meet cash require- ments for 2001. Shareholders’ equity increased $17.4 million in 2000 to $280.2 million. The increase was primarily due to current year earnings of $70.2 million offset primarily by $35.9 million of treasury stock repurchases and $12.4 million of dividend payments. Cash Flows During 2000, $88.3 million of cash was generated from operating activities, compared with $99.8 million in 1999 and $37.0 million in 1998. The decrease in 2000 was primarily due to an increase in inventory of $26.2 million during the year in contrast to the prior year when inventory decreased. In addi- tion, increased earnings offset by changes in other working capi- tal items resulted in increased operating cash ﬂow in 2000. In addition to cash generated from operating activities, the company obtained an additional $66.3 million in short-term debt and $1.2 million in net long-term debt. These cash ﬂows were used primarily to support $36.4 million for capital expen- ditures, $35.9 million for stock repurchases and $12.4 million for dividend payments. Cash and cash equivalents decreased $17.8 million during 2000. 16 Capital expenditures for property, plant and equipment totaled $36.4 million in 2000, compared to $29.5 million in 1999 and $54.7 million in 1998. Capital expenditures primarily related to productivity enhancing investments at various plants worldwide and continuing upgrades to the U.S. information systems. Capital spending in 2001 is planned to be $55.0 million. Signiﬁcant planned expenditures include the further upgrade of U.S. information systems and investment in manufacturing equipment and tooling. It is anticipated that 2001 capital expen- ditures 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 20.0 percent to 25.0 percent of the average earnings per share of the last three years. The current quarterly dividend of 7 cents per share equates to 21.2 percent of the 1998 through 2000 average net earnings per share. Share Repurchase Plan In November 1998, the Board of Directors authorized the company to repurchase 5.0 million shares of common stock. At July 31, 2000, the company had approximately 2.0 million remaining shares under the repur- chase authorizations. Management and the Board of Directors believe the share repurchase program is an excellent means of returning value to the shareholders. In 2000, the company repurchased 1.7 million shares of common stock on the open market for $35.9 million, at an average price of $21.65 per share. The company repurchased 2.4 million shares for $44.5 million in 1999 and 1.3 million shares for $33.3 million in 1998. Environmental Matters The company has established reserves for potential environmental liabilities and plans to continue to accrue reserves in appropriate amounts. While uncertainties exist with respect to the amounts and timing of the company’s ultimate environmental liabilities, management believes that such liabilities, individually and in the aggregate, will not have a material adverse effect on the company’s ﬁnancial condition or results of operations. New Accounting Standards The company will adopt Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities – an amendment of FASB Statement No. 133,” which is effective beginning ﬁscal 2001. SFAS 133 requires a company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the hedged assets, liabilities or ﬁrm commitments are recognized through earnings or in other com- prehensive income until the hedged item is recognized in earn- ings. The ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings. The company has determined that the effect of adopting SFAS 133 and SFAS 138 is immaterial to the earnings and the ﬁnancial position of the company as of August 1, 2000. The company has adopted Statement of Position (SOP) No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” effective beginning ﬁscal 2000. This SOP provides guidance on accounting for the costs of computer software developed or obtained for internal use. The company has determined that the effect of SOP 98-1 is immaterial to the earnings and the ﬁnancial position of the company. Market Risk The company’s market risk includes the potential loss arising from adverse changes in foreign currency exchange rates and interest rates. The company manages foreign currency market risk, from time to time, through the use of a variety of ﬁnancial and derivative instruments. The company does not enter into any of these instruments for trading purposes to generate revenue. Rather, the company’s objective in managing these risks is to reduce ﬂuctuations in earnings and cash ﬂows associated with changes in foreign currency exchange rates. The company uses forward exchange contracts and other hedging activities to hedge the U.S. dollar value resulting from antici- pated foreign currency transactions. The company’s market risk on interest rates is the potential increase in fair value of long- term debt resulting from a potential decrease in interest rates. See further discussion of these market risks below. 17 Foreign Currency In 2000, the U.S. dollar was mixed relative to the currencies of foreign countries where the company operates. A stronger dollar generally has a negative impact on interna- tional results because foreign-currency denominated earnings translates 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 2000, the impact of foreign currency translation resulted in a decrease in net sales by $12.3 million and a decrease in net earnings by $16.5 mil- lion. During 1999, the impact of foreign currency translation resulted in a decrease in net sales by $1.2 million and an increase in net earnings by $0.8 million. The company maintained signiﬁcant assets and operations in Europe, countries of the Asia-Paciﬁc Rim, South Africa and Mexico. As a result, exposure to foreign currency gains and losses exists. A portion of foreign currency exposure is hedged by incurring liabilities, including bank debt, denominated in the local currency where subsidiaries are located. The subsidiaries of the company purchase products and parts in various currencies. As a result, the company may be exposed to cost increases relative to local currencies in the mar- kets to which it sells. To mitigate such adverse trends, the com- pany, from time to time, enters into forward exchange contracts and other hedging activities. Also, foreign currency positions are partially offsetting and are netted against one another to reduce exposure. Some products made in the United States are sold abroad, primarily in Canada. As a result, sales of such products are affected by the value of the U.S. dollar relative to other curren- cies. Any long-term strengthening of the U.S. dollar could depress these sales. Also, competitive conditions in the com- pany’s markets may limit its ability to increase product pricing in the face of adverse currency movements. Interest At July 31, 2000, the fair value of the company’s long- term debt approximates market. Market risk is estimated as the potential decrease in fair value resulting from a hypothetical one-half percent increase in interest rates and amounts to approximately $3.6 million. Forward-Looking Statements The company desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 and is making this cautionary statement in connection with such safe harbor legislation. This Annual Report to Shareholders, any Form 10-K, Form 10-Q or Form 8-K of the company or any other written or oral statements made by or on behalf of the company may include forward-looking state- ments which reﬂect the company’s current views with respect to future events and ﬁnancial performance. The words “believe,” “expect,” “anticipate,” “intends,” “estimate,” “forecast,” “project,” “should” and similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. All fore- casts and projections in this Annual Report are “forward- looking statements,” and are based on management’s current expectations of the company’s near-term results, based on cur- rent information available pertaining to the company, including the risk factors noted below. The company wishes to caution investors that any forward- looking statements made by or on behalf of the company are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other risk factors include, but are 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 sur- rounding various matters such as environmental remediation, contract pricing, and international trading restrictions, customer product acceptance, continued access to capital mar- kets and foreign currency risks. For a more detailed explanation of the foregoing and other risks, see exhibit 99, which is ﬁled with the Securities and Exchange Commission. The company wishes to caution investors that other factors may in the future prove to be important in affecting the company’s results of operations. New factors emerge from time to time and it is not possible for management to predict all such factors, nor can it assess the impact of each such factor on the business or the extent to which any factor, or a combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Investors are further cautioned not to place undue reliance on such forward-looking statements as they speak only to the company’s views as of the date the statement is made. The com- pany undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new infor- mation, future events or otherwise. 18 Consolidated Statements of Earnings Donaldson Company, Inc. and Subsidiaries (Thousands of dollars, except share and per share amounts) Year ended July 31, 2000 1999 1998 Net sales Cost of sales Gross Margin Selling, general and administrative Research and development Operating Income Interest expense Other (income) expense Earnings Before Income Taxes Income taxes Net Earnings Weighted Average Shares – Basic Weighted Average Shares – Diluted Net Earnings Per Share – Basic Net Earnings Per Share – Diluted The accompanying notes are an integral part of these consolidated ﬁnancial statements. $1,092,294 $944,139 $940,351 764,773 327,521 194,623 27,304 105,594 9,880 (4,619) 100,333 30,100 668,458 275,681 163,688 23,603 88,390 6,993 (7,813) 89,210 26,763 677,089 263,262 152,954 23,509 86,799 4,671 (4,313) 86,441 29,390 $ 70,233 $62,447 $ 57,051 45,716,482 46,899,127 49,332,266 46,664,196 47,793,180 50,229,005 $ $ 1.54 1.51 $ $ 1.33 1.31 $ $ 1.16 1.14 19 Consolidated Balance Sheets Donaldson Company, Inc. and Subsidiaries (Thousands of dollars, except share amounts) At July 31, 2000 1999 ASSETS Current Assets Cash and cash equivalents Accounts receivable, less allowance of $4,380 and $4,341 Inventories Raw materials Work in process Finished products Total Inventories Deferred income taxes Prepaids and other current assets Total Current Assets Property, Plant and Equipment, at cost Land Buildings Machinery and equipment Construction in progress Less accumulated depreciation Deferred Income Taxes Intangible Assets Other Assets LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities Short-term borrowings Current maturities of long-term debt Trade accounts payable Accrued employee compensation and related taxes Income taxes payable Accrued liabilities Other current liabilities Total Current Liabilities Long-term Debt Deferred Income Taxes Other Long-term Liabilities Commitments and Contingencies (Note J) Shareholders’ Equity Preferred stock, $1.00 par value, 1,000,000 shares authorized, none issued Common stock, $5.00 par value, 80,000,000 shares authorized, 49,655,954 shares issued in 2000 and 1999 Additional paid-in capital Retained earnings Accumulated other comprehensive income Treasury stock – 4,998,342 and 3,458,670 shares in 2000 and 1999, at cost Total Shareholders’ Equity The accompanying notes are an integral part of these consolidated ﬁnancial statements. $ 24,149 202,361 $ 41,944 178,419 45,064 20,171 54,128 119,363 18,411 11,195 375,479 7,432 119,203 333,310 9,756 469,701 (265,156) 204,545 408 63,885 25,340 32,722 13,758 35,618 82,098 14,911 9,016 326,388 7,166 105,913 296,038 12,308 421,425 (239,245) 182,180 – 10,984 22,694 $ 669,657 $ 542,246 $ 85,034 $ 20,287 279 82,320 29,759 58 27,974 10,298 235,722 92,645 – 61,125 409 63,361 23,720 4,448 22,680 7,150 142,055 86,691 132 50,605 – – 248,280 2,018 143,125 (10,523) (102,735) 280,165 248,280 1,611 87,909 (5,670) (69,367) 262,763 $ 669,657 $ 542,246 Consolidated Statements of Cash Flows Donaldson Company, Inc. and Subsidiaries (Thousands of dollars) Year ended July 31, OPERATING ACTIVITIES Net earnings Adjustments to reconcile net earnings to net cash provided by operating activities Depreciation and amortization Write-down of impaired assets Equity in earnings of afﬁliates Deferred income taxes Other Changes in operating assets and liabilities, net of acquired businesses Accounts receivable Inventories Prepaids and other current assets Trade accounts payable and other accrued expenses Net Cash Provided by Operating Activities INVESTING ACTIVITIES Purchases of property and equipment, net Acquisitions and investments in afﬁliates Net Cash Used in Investing Activities FINANCING ACTIVITIES Proceeds from long-term debt Repayments of long-term debt Change in short-term borrowings Payment received from ESOP Purchase of treasury stock Dividends paid Exercise of stock options Net Cash (Used in) Provided by Financing Activities Effect of exchange rate changes on cash Increase (Decrease) in Cash and Cash Equivalents Cash and Cash Equivalents, Beginning of Year Cash and Cash Equivalents, End of Year The accompanying notes are an integral part of these consolidated ﬁnancial statements. 2000 1999 1998 $ 70,233 $ 62,447 $ 57,051 34,326 – 74 (449) 2,454 (6,441) (26,227) (4,913) 19,261 88,318 (36,417) (88,220) (124,637) 5,752 (4,522) 66,328 – (35,923) (12,384) 326 19,577 (1,053) (17,795) 41,944 27,686 – (2,187) 489 10,344 (13,244) 21,382 (3,095) (4,066) 99,756 (29,539) (230) (29,769) 35,546 (404) (24,422) – (44,535) (10,830) 1,617 (43,028) (1,084) 25,875 16,069 $ 24,149 $ 41,944 25,272 1,000 (1,944) 4,226 (6,817) (6,780) (20,037) 417 (15,350) 37,038 (54,705) (920) (55,625) 50,000 (2,890) 4,582 2,730 (33,250) (9,630) 2,619 14,161 6,217 1,791 14,278 $ 16,069 21 Consolidated Statements of Changes in Shareholders’ Equity Donaldson Company, Inc. and Subsidiaries (Thousands of dollars, except per share amounts) Common Stock Additional Paid-in Capital Accumulated Other Retained Comprehensive Treasury Receivable Earnings Income Stock from ESOP Total BALANCE JULY 31, 1997 $ 135,317 $ 6,212 $ 167,444 $ 934 $ (63,312) $(2,730) $ 243,865 Comprehensive income Net earnings Foreign currency translation Comprehensive income Treasury stock acquired Stock options exercised Performance awards Payment received from ESOP Tax reduction – employee plans Two-for-one stock split Cash dividends ($.19 per share) 57,051 (6,069) 143 (5,145) (1,546) 594 2,444 (33,250) 3,135 1,349 2,730 112,963 (6,054) (170,349) 63,440 BALANCE JULY 31, 1998 248,280 1,199 Comprehensive income Net earnings Foreign currency translation Comprehensive income Treasury stock acquired Stock options exercised Performance awards Tax reduction – employee plans Cash dividends ($.23 per share) 149 (1,071) 1,334 BALANCE JULY 31, 1999 248,280 1,611 (5,135) (28,638) – 255,671 (535) (44,535) 3,004 802 62,447 (535) 61,912 (44,535) (346) (443) 1,334 (10,830) (5,670) (69,367) – 262,763 (9,630) 39,965 62,447 (3,499) (174) (10,830) 87,909 70,233 Comprehensive income Net earnings Foreign currency translation Comprehensive income Treasury stock acquired Stock options exercised Tax reduction – employee plans Cash dividends ($.27 per share) (4,853) (35,923) 2,555 (727) 1,134 (2,633) (12,384) 57,051 (6,069) 50,982 (33,250) (1,867) 397 2,730 2,444 – (9,630) 70,233 (4,853) 65,380 (35,923) (805) 1,134 (12,384) BALANCE JULY 31, 2000 $248,280 $2,018 $143,125 $(10,523) $(102,735) $ – $280,165 The accompanying notes are an integral part of these consolidated ﬁnancial statements. 22 Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements Donaldson Company, Inc. and Subsidiaries Note A Summary of Signiﬁcant Accounting Policies Description of Business Donaldson Company, Inc., is a leading worldwide manufacturer of ﬁltration systems and replacement parts. The company’s product mix includes air and liquid ﬁlters and exhaust and emission control products for mobile equip- ment; in-plant air cleaning systems; air intake systems and exhaust products for industrial gas turbines; and specialized ﬁlters for such diverse applications as computer disk drives, air- craft passenger cabins and semiconductor processing. Products are manufactured at more than three dozen Donaldson plants around the world and through ﬁve joint ventures. Principles of Consolidation The consolidated ﬁnancial state- ments include the accounts of Donaldson Company, Inc. and all majority-owned subsidiaries (the company). All signiﬁcant intercompany accounts and transactions have been eliminated. The company also has four joint ventures that are not majority- owned; three are accounted for on the equity method and one on the cost method. Additionally, the company has one majority- owned joint venture. Certain amounts in prior periods have been reclassiﬁed to conform to the current presentation. The reclassiﬁcations had no impact on the net earnings as previously reported. 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 most foreign operations, local currencies are considered the functional currency. Assets and liabilities are translated using the exchange rates in effect at the balance sheet date. 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 foreign currency adjustment in accumulated other comprehensive income in shareholders’ equity. Foreign currency transaction losses of $0.2 million in 2000, gains of $0.2 million in 1999 and losses of $1.4 million in 1998 are included in earnings before income taxes. Cash Equivalents The company considers all highly liquid temporary investments with a maturity of three months 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 mar- ket. Domestic inventories are valued using the last-in, ﬁrst-out (LIFO) method, while the international subsidiaries use the ﬁrst-in, ﬁrst-out (FIFO) method. Inventories valued at LIFO were approximately 52 percent and 53 percent of total inven- tories at July 31, 2000 and 1999, respectively. The FIFO cost of inventories valued under the LIFO method exceeded the LIFO carrying values by $21.2 million and $19.7 million at July 31, 2000 and 1999, respectively. Property, Plant and Equipment Property, plant and equipment are stated at cost. Additions, improvements or major renewals are capitalized, while expenditures that do not enhance or extend the asset’s useful life are charged to operating expense as incurred. 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. Accelerated depreciation methods are generally used for income tax purposes. The estimated useful lives of property, plant and equipment are as follows: Buildings Machinery and equipment 10 to 40 years 3 to 10 years Intangible Assets Intangible assets, primarily consisting of goodwill, are amortized on a straight-line basis over periods ranging up to 20 years. Impairment of Long-Lived Assets The company reviews the long-lived assets, including identiﬁable intangibles and associ- ated goodwill, for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. 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. Income Taxes Deferred tax assets and liabilities are recognized for the expected future tax consequences attributed to differ- ences between the ﬁnancial statement carrying amounts of exist- ing 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. 23 Comprehensive Income The company adopted Statement of Financial Accounting Standards (SFAS) 130, “Reporting Comprehensive Income,” in the ﬁrst quarter of ﬁscal 1999. Comprehensive income consists of net income and foreign currency translation adjustments and is presented in the Consolidated Statements of Changes in Shareholders’ Equity. Accumulated other comprehensive income consists only of accumulated foreign currency translation adjustment. The adoption of SFAS 130 has no impact on the company’s net earnings or shareholders’ equity. Earnings Per Share The company follows SFAS 128, “Earnings per Share,” to present earnings per share calculations. The company’s basic net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares. The company’s diluted net earn- ings per share is computed by dividing net earnings by the weighted average number of outstanding common shares and dilutive shares relating to stock options. The following table presents information necessary to cal- culate basic and diluted earnings per share: (In thousands, except per share amounts) 2000 1999 1998 Weighted average shares – basic 45,716 46,899 49,332 Dilutive shares 948 894 897 Weighted average shares – diluted 46,664 47,793 50,229 Net earnings for basic and diluted earnings per share computation $70,233 $62,447 $57,051 Net earnings per share – basic $ 1.54 $ 1.33 $ 1.16 Net earnings per share – diluted $ 1.51 $ 1.31 $ 1.14 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 SFAS 123, “Accounting for Stock- Based Compensation,” encourages, but does not require, com- panies 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 (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Accordingly, compen- sation 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 Revenue is recognized when product is shipped and invoiced or performance of services is complete. Product Warranties The company provides for estimated warranty costs and accrues for speciﬁc items at the time their existence is known and the amounts are determinable. New Accounting Standards The company will adopt Statement of Financial Accounting Standards (SFAS) No.133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities – an amendment of FASB Statement No. 133,” which is effective beginning ﬁscal 2001. SFAS 133 requires a company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the hedged assets, liabilities or ﬁrm commitments are recognized through earnings or in other com- prehensive income until the hedged item is recognized in earn- ings. The ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings. The company has determined that the effect of adopting SFAS 133 and SFAS 138 is immaterial to the earnings and the ﬁnancial position of the company as of August 1, 2000. The company has adopted Statement of Position (SOP) No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” effective beginning ﬁscal 2000. This SOP provides guidance on accounting for the costs of computer software developed or obtained for internal use. The company has determined that the effect of SOP 98-1 is immaterial to the earnings and the ﬁnancial position of the company. 24 Note B Acquisitions, Plant Closure and Plant Opening 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 respec- tive 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 differ- ent from the reported amounts for all years presented. During the second quarter of ﬁscal 2000, the company completed the purchase of all of the outstanding shares of AirMaze Corporation, for $31.9 million in cash. AirMaze is a privately held supplier of heavy-duty air and liquid ﬁlters, air/oil separators and high purity air ﬁlter products. AirMaze has manufacturing facilities in Stow, Ohio and Greeneville, Tennessee. The excess of purchase price over the fair values of the net assets acquired was $27.2 million and has been recorded as goodwill which is being amortized on a straight-line basis over 20 years. AirMaze operations are a part of the company’s Engine Products segment. During the third quarter of ﬁscal 2000, the company acquired the DCE dust control business of Invensys plc, for $56.4 million. DCE, headquartered in Leicester, England (UK) with smaller facilities in Germany and the United States and assembly operations in South Africa, Australia and Japan, is a major participant in the global dust collection industry. The excess of purchase price over the fair values of the net assets acquired was $31.5 million and has been recorded as goodwill which is being amortized on a straight-line basis over 20 years. DCE operations are a part of the company’s Industrial Products segment. The purchase price allocations for AirMaze and DCE are based on preliminary estimates of the fair value of assets and liabilities and are subject to change. Plant Closure During 2000, the company closed its manufac- turing facilities located in Oelwein, Iowa. The closure of the facility was completed by the end of the calendar year. A pretax charge of $2.8 million was recorded in ﬁscal 1999 in general and administrative expense in the company’s consolidated state- ment of earnings. The charge was primarily related to severance and other employee related costs associated with the elimina- tion of approximately 125 positions. As of July 31, 2000, $0.2 million remains as a liability which relates to costs associated with building maintenance. Plant Opening During 2000, the company opened a new manufacturing facility in Auburn, Alabama. The facility was constructed to produce mufﬂers for the truck manufacturers located in the southwestern U.S. region and employs approxi- mately 100 employees. Note C Credit Facilities In December 1997, the company amended and renewed a ﬁve- year multi-currency revolving facility with a group of participat- ing banks under which it may borrow up to $100.0 million. The agreement provides that loans may be made under a selection of currencies and 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. There was $50.0 mil- lion outstanding under this credit facility at July 31, 2000 and no amounts outstanding at July 31, 1999, leaving $50.0 million and $100.0 million available for further borrowing under such facility at July 31, 2000 and 1999, respectively. The weighted average interest rate on short-term borrowings outstanding at July 31, 2000 was 6.83 percent. At July 31, 2000, there was an additional $35.0 million available for use under uncommitted facilities which provide unsecured borrowings for general corporate purposes. There was $12.6 million outstanding under these facilities at July 31, 2000 and no amounts outstanding under these facilities at July 31, 1999. The weighted average interest rate on short-term borrowings outstanding at July 31, 2000 was 6.89 percent. International subsidiaries may borrow under various credit facilities. As of July 31, 2000 and 1999, borrowings under these facilities were $22.4 million and $20.3 million, respectively. The weighted average interest rate on these inter- national borrowings outstanding at July 31, 2000 and 1999 was 4.07 percent and 3.04 percent, respectively. 25 Note E Employee Beneﬁt Plans Pension Plans Donaldson Company, Inc. and certain of its sub- sidiaries have deﬁned beneﬁt pension plans for substantially all hourly and salaried employees. The domestic plan provides deﬁned beneﬁts pursuant to a cash balance feature whereby a participant accumulates a beneﬁt comprised of a percentage of current salary which varies with years of service, interest credits and transition credits. The international plans generally provide pension beneﬁts based on years of service and compensation level. The company’s general funding policy is to make contri- butions as required by applicable regulations. The assets are primarily invested in diversiﬁed equity and debt portfolios. In 2000, the actuarial valuation date was changed from July 31 to April 30. This change did not have a material impact on the actuarial valuation. Cost for the company’s domestic pension plans includes the following components: (Thousands of dollars) Net periodic cost: Service cost Interest cost 2000 1999 1998 $ 6,025 $ 5,609 $ 4,833 9,506 9,188 8,465 Expected return on assets (11,081) (10,006) (8,838) Transition amount amortization (1,097) (1,097) (1,097) Prior service cost amortization Actuarial loss amortization Curtailment loss 64 71 – 30 1,094 684 (18) 259 – Net periodic beneﬁt cost $ 3,488 $ 5,502 $ 3,604 Note D Long-Term Debt Long-term debt consists of the following: (Thousands of dollars) 2000 1999 6.20% Unsecured senior notes due July 15, 2005, interest payable semi-annually, principal payment of $23.0 million is due July 15, 2005 6.31% Unsecured senior notes due July 15, 2008, interest payable semi-annually, principal payment of $27.0 million is due July 15, 2008 6.39% Unsecured senior notes due August 15, 2010, interest payable semi-annually, principal payments of $5.0 million, to be paid annually commencing August 16, 2006 1.9475% Guaranteed senior note due January 29, 2005, interest payable semi-annually, principal amount of 1.2 billion Yen is due January 29, 2005 Variable Rate Industrial Development Revenue Bonds (“Lower Floaters”) due September 1, 2024, principal amount of $8.0 million, interest payable monthly, and an interest rate of 4.40% as of July 31, 2000 Other Total Less current maturities Total long-term debt $23,000 $23,000 27,000 27,000 25,000 25,000 10,962 10,358 5,667 1,295 – 1,742 92,924 87,100 279 409 $92,645 $86,691 Annual maturities of long-term debt for the next ﬁve years are $0.3 million in 2001 and $34.0 million in 2005. Annual maturities in 2002, 2003 and 2004 are not signiﬁcant. The company estimates that the carrying value of long-term debt approximates its fair market value. Total interest paid relating to all debt was $ 9.1 million, $6.0 million and $4.6 million in 2000, 1999 and 1998, respec- tively. In addition, total interest expense recorded in 2000, 1999 and 1998 was $9.9 million, $7.0 million and $4.7 million, respectively. Certain note agreements contain debt covenants related to working capital levels and limitations on indebted- ness. 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, 2000, under the most restrictive agreement, tangible net worth exceeded the minimum by $70.4 million. 26 The funded status of the company’s domestic pension plans The projected beneﬁt obligation and accumulated beneﬁt as of April 30, 2000 and July 31, 1999, is as follows: (Thousands of dollars) Change in beneﬁt obligation: 2000 1999 Beneﬁt obligation at beginning of year $131,996 $121,213 Adjustment for change in measurement date Beneﬁt obligation, new measurement date Service cost Interest cost Plan amendments Actuarial (gain) /loss Beneﬁts paid 1,841 133,837 6,025 9,506 568 (11,025) N/A N/A 5,609 9,188 1,338 1,392 (7,663) (6,744) obligation for domestic pension plans with accumulated beneﬁt obligations in excess of plan assets were $7.8 million and $4.6 million, respectively, as of April 30, 2000 and $7.9 million and $4.4 million, respectively, as of July 31, 1999. There was no fair value of plan assets for domestic pension plans with accumu- lated beneﬁt obligations in excess of plan assets as of April 30, 2000 and July 31, 1999, respectively. Weighted-average actuarial assumptions Discount rate Expected return on plan assets Rate of compensation increase April 30 2000 8.00% 9.00% 6.00% July 31 1999 7.50% 9.00% 6.00% July 31 1998 7.25% 9.00% 6.00% Beneﬁt obligation at April 30 and July 31 $131,248 $131,996 Pension expense related to international plans were $2.5 million, $2.5 million and $1.7 million for 2000, 1999 and 1998, respectively. 401(k) Savings Plan The company provides a contributory employee savings plan which permits participants to make contributions by salary reduction pursuant to section 401(k) of the Internal Revenue Code. The company’s contributions under this plan are based on the level of employee contributions including a variable contribution based on performance of the company. Total contribution expense was $4.2 million, $4.9 million and $2.9 million for the years ended July 31, 2000, 1999 and 1998, respectively. Change in plan assets: Fair value of plan assets at beginning of year $130,387 $123,956 Adjustment for change in measurement date 17,461 N/A Fair value of plan assets, new measurement date Actual return on plan assets Company contributions Beneﬁts paid 147,848 (2,072) 2,132 N/A 9,282 3,893 (7,663) (6,744) Fair value of plan assets at April 30 and July 31 $140,245 $130,387 Reconciliation of funded status: Funded (unfunded) status $ 8,997 $ (1,609) Unrecognized actuarial (gain) loss Unrecognized prior service cost (11,678) 2,472 1,885 1,968 Unrecognized net transition obligation (3,769) (4,866) Net amount recognized in consolidated balance sheet $ (3,978) $ (2,622) Amounts recognized in consolidated balance sheet consist of: Prepaid beneﬁt cost Accrued beneﬁt liability Additional minimum liability Intangible asset Net amount recognized in consolidated balance sheet $ 4,614 $ 3,500 (8,592) (6,122) (280) 280 (653) 653 $ (3,978) $ (2,622) 27 Stock Options Stock options issued during ﬁscal 1999 and 2000 become exercisable for non-executives in each of the fol- lowing three years, in an equal number of shares each year and become exercisable for executives immediately upon the date of grant. Stock options issued during ﬁscal 1997 and 1998 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 l997 for non- executives and during ﬁscal 1996 for executives become exercisable in a four-year period in an equal number of shares each year. Prior to ﬁscal 1996, stock options vested immediately for executives. At July 31, 2000, options to purchase 3,652,936 shares are outstanding under these plans. In ﬁscal 1997, the company adopted the disclosure- only provisions of SFAS 123, “Accounting for Stock-Based Compensation.” SFAS 123 encourages entities to adopt a fair value-based method of accounting for employee stock compen- sation 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 123 in ﬁscal 2000, 1999 and 1998, the company’s net income and earnings per share would have been approximately $67.7 mil- lion and $1.45, $61.1 million and $1.28, and $55.7 million and $1.11, 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. Note F Shareholders’ Equity Stock Rights 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 share- holder 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 out- standing 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 entitles 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 per- cent 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. 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 $1.7 million and $0.7 million in 2000 and 1998, respectively. There was no performance award expense in 1999. 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. 28 For purposes of computing compensation cost of stock The following table summarizes information concerning 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 assump- tions: risk free interest rate of 6.50 percent, 5.50 percent and 5.63 percent in 2000, 1999 and 1998, respectively; two or seven year lives in 2000, two, three, or seven year lives in 1999 and three, six, seven, or nine year lives in 1998; expected volatility of 29.7 percent, 26.3 percent and 22.5 percent in 2000, 1999 and 1998, respectively; and 1 percent expected dividend yield in 2000, 1999 and 1998. 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 the actual future price levels of the company’s com- mon stock. The weighted average fair value for options granted during ﬁscal 2000, 1999 and 1998 is $7.49, $5.62 and $6.35 per share, respectively. currently outstanding and exercisable options: Weighted Average Remaining Number Contractual Outstanding Life (Years) Range of Exercise Prices $5 to $10 718,592 $10 to $15 1,096,624 $15 to $20 841,251 1.24 3.90 7.22 Weighted Average Exercise Number Price Exercisable Weighted Average Exercise Price $ 8.85 718,592 $ 8.85 12.30 1,092,624 18.23 697,835 12.30 17.86 $20 and above 996,469 8.22 22.82 600,875 22.83 3,652,936 5.32 $15.86 3,109,926 $14.79 Note G Income Taxes The number and option price of options granted under The components of earnings before income taxes are as follows: these plans were as follows: Outstanding at July 31, 1997 3,317,308 $ 10.98 Weighted Average Outstanding Exercise Price Options Granted Exercised Canceled Outstanding at July 31, 1998 Granted Exercised Canceled Outstanding at July 31, 1999 Granted Exercised Canceled 472,595 (419,728) (21,999) 3,348,176 495,149 (432,505) (28,498) 3,382,322 489,086 (204,004) (14,468) 22.83 8.40 14.98 12.95 20.10 8.65 18.35 14.50 23.01 10.09 20.41 Outstanding at July 31, 2000 3,652,936 $15.86 At July 31, 2000 and 1999 there were 3,109,926 and 2,451,657 options exercisable, respectively. Shares reserved at July 31, 2000 for outstanding options and future grants were 9,237,912. (Thousands of dollars) 2000 1999 1998 Earnings before income taxes: United States $ 54,913 $55,811 $60,673 Foreign Total 45,420 33,399 25,768 $100,333 $89,210 $86,441 The components of the provision for income taxes are as follows: (Thousands of dollars) 2000 1999 1998 Income Taxes: Current: Federal State Foreign Deferred: Federal State Foreign $18,192 $16,717 $15,931 2,361 9,996 2,471 7,086 1,837 7,396 30,549 26,274 25,164 52 3 (504) (449) 426 24 39 489 3,410 195 621 4,226 Total $30,100 $26,763 $29,390 29 The tax effects of temporary differences that give rise to The following table reconciles the U.S. statutory income deferred tax assets and liabilities are as follows: tax rate with the effective income tax rate: (Thousands of dollars) Deferred tax assets: 2000 1999 1998 2000 1999 1998 Statutory U.S. federal rate 35.0% 35.0% 35.0% Compensation and retirement plans $ 12,839 $ 8,950 $ 5,705 State income taxes Accrued expenses 7,818 9,617 8,365 Foreign taxes at lower rates 720 Other 1.5 (6.1) (.4) 1.8 (5.5) (1.3) 1.4 (1.3) (1.1) 30.0% 30.0% 34.0% At July 31, 2000, certain international subsidiaries had available net operating loss carryforwards of approximately $10.0 million to offset future taxable income. The majority of such carryforwards expire after 2002. Unremitted earnings of international subsidiaries amounted to approximately $104.6 million at July 31, 2000. The majority of those earnings are intended to be indeﬁnitely reinvested and, accordingly, no deferred U.S. income taxes have been provided. If a portion were to be remitted, foreign tax credits would substantially offset any resulting incremental U.S. income 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 $24.6 million, $20.8 million and $22.5 million in 2000, 1999 and 1998, respectively. Note H Segment Reporting The company adopted SFAS 131, “Disclosures about Segments of an Enterprise and Related Information,” effective with ﬁscal year-end 1999. This standard requires companies to disclose selected ﬁnancial data by operating segment. A segment is deﬁned as a component with business activity resulting in revenue and expense that has separate ﬁnancial information evaluated regularly by the company’s chief operating decision maker in determining resource allocation and assessing performance. Brazilian asset write-down NOL carryforwards Inventories Investment in joint venture Cumulative translation adjustment Other – 6,120 1,526 754 4,574 3,162 – 3,560 1,595 588 2,494 3,267 2,070 1,095 1,195 2,646 3,630 Gross deferred tax assets 36,793 30,071 25,426 Valuation allowance (2,445) (2,432) (1,172) Net deferred tax assets 34,348 27,639 24,254 Deferred tax liabilities: Depreciation and amortization (14,626) (11,235) (8,573) Other (903) (1,625) (2,224) Gross deferred tax liabilities (15,529) (12,860) (10,797) Net deferred tax assets $ 18,819 $ 14,779 $ 13,457 30 The company has identiﬁed two reportable segments: Engine Products and Industrial Products. Segment selection was based on the internal organizational structure, management of opera- tions and performance evaluation by management and the company’s Board of Directors. The Engine Products segment sells to original equipment manufacturers (OEMs) in the construction, industrial, mining, agriculture and transportation markets and to independent distributors, OEM dealer networks, private label accounts and large private ﬂeets. Products include air intake systems, exhaust systems, liquid ﬁltration systems and replacement ﬁlters. The Industrial Products segment sells to various industrial end-users, OEMs of gas-ﬁred turbines, OEMs and end-users requiring highly puriﬁed air. Products include dust, fume and mist collectors, static and pulse-clean air ﬁlter systems and specialized air ﬁltration systems. Corporate and Unallocated include corporate expenses determined to be non-allocable to the segments, interest income and expense, non-operating income and expense, and expenses not allocated to the business segments in the same period. Assets included in Corporate and Unallocated principally are cash and cash equivalents, inventory reserves, certain prepaids, certain investments, other assets and assets allocated to intercompany transactions. The company has developed an internal measurement system to evaluate performance and allocate resources based on proﬁt or loss from operations before income taxes. The com- pany’s manufacturing facilities serve both reporting segments. Therefore, the company uses a complex allocation methodology to assign costs and assets to the segments. A certain amount of costs and assets are assigned to intercompany activity and are not assigned to either segment. Certain accounting policies applied to the reportable segments differ from those described in the summary of signiﬁcant accounting policies. The reportable segments account for receivables on a gross basis and account for inventory on a standard cost basis. Segment detail is summarized as follows (in thousands): Engine Products Industrial Corporate & Unallocated Products Total Company $673,982 $418,312 $ – $1,092,294 20,959 8,509 4,858 34,326 4,392 – – 4,392 57,453 53,862 (10,982) 100,333 2000 Net sales Depreciation and amortization Equity in earnings of unconsolidated afﬁliates Earnings before income taxes Assets 320,805 172,837 176,015 669,657 Equity investments in unconsolidated afﬁliates Capital expenditures, net of acquired businesses 1999 Net sales Depreciation and amortization Equity in earnings of unconsolidated afﬁliates Earnings before income taxes 13,600 – – 13,600 22,236 9,028 5,153 36,417 $ 611,378 $ 332,761 $ – $ 944,139 18,486 7,506 1,694 27,686 3,610 – – 3,610 61,896 36,373 (9,059) 89,210 Assets 327,035 160,201 55,010 542,246 Equity investments in unconsolidated afﬁliates Capital expenditures, net of acquired businesses 13,833 – – 13,833 19,723 8,008 1,808 29,539 Segment allocated assets are primarily accounts receivable, 1998 inventories and property, plant and equipment. Reconciling items included in Corporate and Unallocated are created based on accounting differences between segment reporting and the consolidated, external reporting as well as internal allocation methodologies. Net sales $ 622,096 $ 318,255 $ – $ 940,351 Depreciation and amortization Equity in earnings of unconsolidated afﬁliates Earnings before income taxes 16,551 6,437 2,284 25,272 3,654 – – 3,654 62,987 29,057 (5,603) 86,441 Assets 321,872 151,221 39,894 512,987 Equity investments in unconsolidated afﬁliates Capital expenditures, net of acquired businesses 11,414 – – 11,414 35,826 13,934 4,945 54,705 31 Geographic sales by origination and property, plant and equipment (in thousands): 2000 United States Europe Asia Paciﬁc Other Total 1999 United States Europe Asia Paciﬁc Other Total 1998 United States Europe Asia Paciﬁc Other Total Property, Plant & Net Sales Equipment – Net $ 690,899 $135,480 206,429 166,221 30,745 37,698 22,304 9,063 $1,092,294 $204,545 $ 616,254 $ 122,513 166,431 138,453 23,001 28,616 21,911 9,140 $ 944,139 $ 182,180 $ 615,770 $ 119,623 160,211 139,606 24,764 29,620 18,848 10,776 $ 940,351 $ 178,867 There were no sales over 10 percent of net sales to one cus- tomer in 2000. Sales to one customer accounted for 11 percent of net sales in 1999 and 1998. Note I Quarterly Financial Information (Unaudited) (Thousand of dollars, except per share amounts) First Quarter Second Quarter Third Quarter Fourth Quarter 2000 Net Sales Gross Margin Net Earnings Diluted Earnings Per Share Dividends Declared Per Share 1999 Net Sales Gross Margin Net Earnings Diluted Earnings Per Share Dividends Declared Per Share $246,550 $259,256 $285,277 $301,211 73,881 79,595 84,812 89,233 17,008 17,406 17,450 18,369 .36 .07 .37 .07 .38 .07 .40 .07 $ 225,431 $ 220,249 $ 244,219 $ 254,240 62,329 62,262 74,212 76,878 13,369 13,172 17,418 18,488 .28 .06 .27 .06 .37 .06 .39 .06 Note J Commitments and Contingencies The company is involved 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. 32 Report of Independent Public Accountants To the Shareholders and Board of Directors of Donaldson Company, Inc. We have audited the accompanying consolidated balance sheet of Donaldson Company, Inc. (a Delaware corporation) and subsidiaries as of July 31, 2000, and the related consolidated statements of earnings, changes in shareholders’ equity and cash ﬂows for the year then ended. 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 audit. The consolidated ﬁnancial statements of Donaldson Company, Inc. and subsidiaries as of July 31, 1999 and 1998, were audited by other auditors whose report dated September 8, 1999, expressed an unqualiﬁed opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain rea- sonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and dis- closures 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated ﬁnancial statements referred to above present fairly, in all material respects, the ﬁnancial position of Donaldson Company, Inc. and subsidiaries as of July 31, 2000, and the results of their operations and their cash ﬂows for the year then ended, in conformity with accounting principles generally accepted in the United States. Minneapolis, Minnesota, August 29, 2000 33 Eleven-Year Comparison of Results Donaldson Company, Inc. and Subsidiaries (Thousands of dollars, except per share amounts) 2000 1999 1998 1997 OPERATING RESULTS Net sales Gross margin Gross margin percentage Operating income Operating income percentage Interest expense Earnings before income taxes Income taxes Effective income tax rate Net earnings Return on sales Return on average shareholders’ equity Return on investment FINANCIAL POSITION Total assets Current assets Current liabilities Working capital Current ratio Current debt Long-term debt Total debt Shareholders’ equity Long-term capitalization ratio Property, plant and equipment, net Net expenditures on property, plant and equipment Depreciation and amortization SHAREHOLDER INFORMATION Net earnings per share – Diluted Dividends paid per share Shareholders’ equity per share Shares outstanding (000s) Common stock price range, per share High Low $1,092,294 $ 327,521 30.0% $ 105,594 9.7% $ 9,880 $ 100,333 $ 30,100 30.0% $ 70,233 6.4% 25.9% 19.4% $ 669,657 $ 375,479 $ 235,722 $ 139,757 1.6 $ $ 85,313 92,645 $ 177,958 $ 280,165 $944,139 275,681 $940,351 263,262 $833,348 250,273 29.2% 88,390 9.4% 6,993 89,210 26,763 30.0% 62,447 6.6% 24.1% 19.0% 542,246 326,388 142,055 184,333 2.3 20,696 86,691 107,387 262,763 28.0% 86,799 9.2% 4,671 86,441 29,390 34.0% 57,051 6.1% 22.8% 20.5% 512,987 300,817 165,068 135,749 1.8 45,896 51,553 97,449 30.0% 82,715 9.9% 2,358 79,094 28,474 36.0% 50,620 6.1% 21.4% 20.8% 467,501 283,367 177,346 106,021 1.6 42,674 4,201 46,875 255,671 243,865 24.9% 24.8% 16.8% 1.7% $ 204,545 36,417 34,326 1.51 .27 6.27 $ $ $ $ $ $ $ 182,180 29,539 27,686 1.31 .23 5.69 178,867 54,705 25,272 1.14 .19 5.28 154,595 47,327 21,494 .99 .17 4.93 44,658 46,197 48,382 49,452 2413⁄16 191⁄8 25 7⁄8 14 7⁄16 27 3⁄16 18 9⁄16 20 3⁄8 125⁄8 Amounts are adjusted for all stock splits and reﬂect adoption of SFAS 128. 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. (1)Excludes the cumulative effect of an accounting change of $2,206, or $.08 per share, in 1994. 34 1996 1995 1994 1993 1992 1991 1990 $758,646 222,874 $703,959 197,979 $593,503 166,599 $533,327 152,236 $482,104 133,574 $457,692 129,858 $422,885 121,454 29.4% 75,642 10.0% 2,905 71,120 27,684 38.9% 43,436 5.7% 19.3% 18.5% 402,850 250,751 138,578 112,173 1.8 13,145 10,041 23,186 28.1% 65,531 9.3% 3,089 63,172 24,636 39.0% 38,536 5.5% 18.8% 17.6% 381,042 247,904 123,747 124,157 2.0 20,800 10,167 30,967 28.1% 52,079 8.8% 3,362 50,193 18,244 36.3% 31,949 (1) 5.4% 17.6% 16.0% 337,360 220,308 115,757 104,551 1.9 16,956 16,028 32,984 28.5% 45,246 8.5% 2,723 44,682 16,468 36.9% 28,214 5.3% 16.9% 15.0% 300,217 196,014 93,666 102,348 2.1 7,595 18,920 26,515 27.7% 41,249 8.6% 2,681 41,721 15,952 38.2% 25,769 5.3% 17.2% 14.8% 286,348 187,360 89,956 97,404 2.1 11,425 23,482 34,907 28.4% 41,304 9.0% 3,526 39,385 15,337 38.9% 24,048 5.3% 18.0% 14.9% 253,194 169,398 77,537 91,861 2.2 6,380 25,673 32,053 28.7% 44,354 10.5% 3,731 34,875 13,849 39.7% 21,026 5.0% 17.8% 14.2% 245,947 168,522 79,917 88,605 2.1 11,384 28,320 39,704 228,880 221,173 189,697 174,008 160,303 138,947 128,787 4.2% 4.4% 7.8% 9.8% 12.8% 15.6% 18.0% 124,913 39,297 21,674 .84 .15 4.52 110,640 25,334 20,529 .73 .14 4.23 50,650 52,370 14 1115⁄16 14 10 15⁄16 99,559 24,642 16,365 .59 (1) .12 3.58 53,020 131⁄16 9 1⁄8 90,515 15,005 14,752 .51 .10 3.19 84,899 15,538 14,047 .46 .09 2.91 72,863 16,208 12,187 .42 .07 2.51 68,290 16,055 10,857 .37 .06 2.23 54,564 55,138 55,478 57,728 10 1⁄16 7 715⁄16 53⁄16 6 9⁄16 4 1⁄16 5 13⁄16 2 13⁄16 35 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 share- holdings, please contact Shareowner Services at (800) 468-9716 or (651) 450-4064. Dividend Reinvestment Plan As of September 26, 2000, 1,116 of Donaldson Company’s approximately 1,870 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 Wells Fargo Bank Minnesota, N.A., Shareowner Services, P.O. Box 64854, St. Paul, MN 55164-0854. Annual Meeting The annual meeting of shareholders will be held at 10 a.m. on Friday, November 17, 2000, at The Conference Center at Atrium Center, 3105 E. 80th Street, Bloomington, Minnesota. You are welcome to attend. 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, MN 55440. Independent Public Accountants Arthur Andersen LLP, Minneapolis, Minnesota Public Relations Counsel Padilla Speer Beardsley Inc., Minneapolis, Minnesota Transfer Agent and Registrar Wells Fargo Bank Minnesota, N.A., South St. Paul, Minnesota Six-Year Quarterly High-Low Stock Prices High Low 13 121⁄8 127⁄8 14 13 3⁄16 131⁄16 1315⁄16 107⁄16 107⁄16 111⁄4 121⁄16 1115⁄16 121⁄16 1213⁄16 14 12 145⁄8 17 18 5⁄16 20 3⁄8 273⁄16 2511⁄16 263⁄16 251⁄8 2115⁄16 21 231⁄2 257⁄8 231⁄2 2413⁄16 241⁄16 241⁄4 1211⁄16 145⁄16 153⁄8 173⁄4 20 5⁄16 221⁄4 22 5⁄8 18 9⁄16 147⁄16 1711⁄16 171⁄4 2115⁄16 191⁄2 20 5⁄8 201⁄4 191⁄8 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 1995 1996 1997 1998 1999 3Q 2Q 2000 4Q 36 Board of Directors and Corporate Ofﬁcers S. Walter Richey, 64 Retired Chairman, President and Chief Executive Ofﬁcer, Meritex, Inc., Minneapolis, (Distribution Services). Director since 1991. (2) (3) Stephen W. Sanger, 54 Chairman and Chief Executive Ofﬁcer, General Mills, Inc., Minneapolis (Consumer Products). Director since 1992. (1) (2) William G. Van Dyke, 55 Chairman, President and Chief Executive Ofﬁcer, Donaldson Company, Inc. Director since 1994. (1) Human Resources Committee (2) Audit Committee (3) Directors’ Affairs Committee Board of Directors F. Guillaume Bastiaens, 57 Vice Chairman, Cargill Inc., Minneapolis (Agribusiness). Director since 1995.(2) (3) Paul B. Burke, 44 Chairman, President and Chief Executive Ofﬁcer, BMC Industries, Inc., Minneapolis (Manufacturing). Director since 1996. (1) (3) Janet M. Dolan, 51 President and Chief Executive Ofﬁcer, Tennant Company, Minneapolis (Manufacturing). Director since 1996. (2) (3) Jack W. Eugster, 55 Chairman, President and Chief Executive Ofﬁcer, The Musicland Group, Inc., Minneapolis (Consumer Products). Director since 1993. (1) (3) John F. Grundhofer, 61 Chairman and Chief Executive Ofﬁcer, U.S. Bancorp, Minneapolis (Financial Services). Director since 1997. (1) (3) Kendrick B. Melrose, 60 Chairman and Chief Executive Ofﬁcer, The Toro Company, Minneapolis (Manufacturing). Director since 1991. (1) (2) Corporate Ofﬁcers William G. Van Dyke, 55 Chairman, President and Chief Executive Ofﬁcer. 28 years service. William M. Cook, 47 Senior Vice President, International. 20 years service. James R. Giertz, 43 Senior Vice President, Commercial and Industrial. 7 years service. Nickolas Priadka, 54 Senior Vice President, Engine Systems and Parts. 31 years service. Lowell F. Schwab, 52 Senior Vice President, Operations. 21 years service. Thomas W. VanHimbergen, 52 Senior Vice President and Chief Financial Ofﬁcer. 1 year service. Dale M. Couch, 57 Vice President and General Manager, Asia Paciﬁc. 3 years service. Norman C. Linnell, 41 Vice President, General Counsel and Secretary. 5 years service. John E. Thames, 50 Vice President, Human Resources. 12 years service. Geert Henk Touw, 55 Vice President and General Manager, Europe/Africa/Middle East. 15 years service. Thomas A. Windfeldt, 51 Vice President, Controller and Treasurer. 20 years service. Diemo S.A. de C.V. Guadalajara, Mexico Donaldson Filtration Industrial S. de R.L. de C.V. Monterrey, Mexico Donaldson Torit B.V. Haarlem, Netherlands DCE Benelux B.V. Krommenie, Netherlands Donaldson Far East Limited Hong Kong, S.A.R., People’s Republic of China Donaldson (Wuxi) Filters Co., Ltd. Wuxi, People’s Republic of China Donaldson Filtration (Asia Paciﬁc) Pte. Ltd. Singapore Donaldson Filtration Systems (Proprietary) Ltd. Cape Town, South Africa Donaldson Korea Co., Ltd. Seoul, South Korea DCE Donaldson Sistemas de Filtracion, S.L. Barcelona, Spain Donaldson Filtros Ibérica S.L. Madrid, Spain Donaldson Filter Components Limited Hull, United Kingdom DCE Donaldson Ltd. Leicester, United Kingdom DCE Group Ltd. Leicester, United Kingdom Tetratec Europe Limited Wigan, United Kingdom Donaldson International, Inc. U.S. Virgin Islands Licensee Parker Hanniﬁn Ind. Com. Ltda. São Paulo, Brazil Worldwide Operations World Headquarters Donaldson Company, Inc. Minneapolis, Minnesota U.S. Plants Auburn, Alabama Old Saybrook, Connecticut Dixon, Illinois Frankfort, Indiana Cresco, Iowa Grinnell, Iowa Louisville, Kentucky Nicholasville, Kentucky Port Huron, Michigan Chillicothe, Missouri Mooresville, North Carolina Stow, Ohio Philadelphia, Pennsylvania Greeneville, Tennessee Baldwin, Wisconsin Stevens Point, Wisconsin Distribution Centers Ontario, California Rensselaer, Indiana Antwerp, Belgium Singapore Joint Ventures Advanced Filtration Systems Inc. Champaign, Illinois MSCA, LLC Monticello, Indiana Air Master China Ltd. Hong Kong, S.A.R., People’s Republic of China Guilin Air King Enterprises Ltd. Guilin, People’s Republic of China PT Panata Jaya Mandiri Jakarta, Indonesia TM Donaldson Company, Inc. 1400 West 94th Street Minneapolis, Minnesota U.S.A. (952) 887-3131 www.donaldson.com Subsidiaries Torit Australia Pty. Ltd. Sydney, Australia Donaldson Australasia Pty. Limited Wyong, Australia Donaldson Sales, Inc. Barbados Donaldson Coordination Center, B.V.B.A. Leuven, Belgium Donaldson Europe, B.V.B.A. Leuven, Belgium DCE Scandinavia APS Horsholm, Denmark Donaldson France, S.A.S. Bron, France Tecnov Donaldson, S.A.S. Domjean, France DCE S.A. Paris, France DCE Neotechnik GmbH Bielefeld, Germany Donaldson Gesellschaft m.b.H. Dülmen, Germany D.I. Filter Systems Pvt. Ltd. New Delhi, India PT Donaldson Systems Indonesia Jakarta, Indonesia Donaldson Italia s.r.l. Ostiglia, Italy Nippon Donaldson Limited Tokyo, Japan Donaldson Luxembourg S.a.r.l. Luxembourg Donaldson, S.A. de C.V. Aguascalientes, Mexico Mailing Address: P.O. Box 1299 Minneapolis, Minnesota 55440 U.S.A

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