Donaldson Company Annual Report 2001

Plain-text annual report

Expect the BEST in UNEXPECTED Places 2001 Annual Report TWELVE CONSECUTIVE Record Years TM Expect the BEST in UNEXPECTED Places You expect to see Donaldson Company’s ﬁltration products on the heavy-duty truck traveling the interstate highway, or on the construction equipment on the side of the road. After all, that’s where our company began. But you aren’t as likely to expect our ﬁlters in the camera that captures memories of your daughter’s birthday party. Or in the backup generator providing electricity to your computer center or office. How about in the lawn tractor that mows your lawn? Donaldson ﬁlters and related products are in many unexpected places – in products you see, touch and use every day. Our long-term, focused investment in ﬁltration technology has created the leverage to carry us into new product lines, new markets and new geography. This diversiﬁcation in end markets, linked by a common technology base, has enabled us to smooth out the ups and downs of the various market segments and to achieve our 12th consecu- tive year of double-digit earnings growth – no small feat in these turbulent economic times. We’re proud of our progress so far. Our industrial businesses are approach- ing our goal of 50 percent of total revenues, and our international businesses make up almost 38 percent of total revenues with operations in 19 countries. Donaldson Company holds more than 370 U.S. patents and related patents ﬁled around the world and our employees are constantly developing new ways to utilize superior ﬁltration and acoustic technology for products that are still years away from market. So expect the best in unexpected places – today and in the future. 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) 2001 $1,137,015 75,548 2000 $1,092,294 $70,233 6.6% 25.2% 23.7% $1.66 $.295 $7.19 45,612 8,230 $138.2 6.4% 25.9% 24.9% $1.51 $.27 $6.27 46,664 8,478 $128.8 % Change 4.1% 7.6% .2 pts. (.7) pts. (1.2) pts. 10.0% 9.2% 14.7% (2.3)% (2.9)% 7.3% 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 for industrial gas turbines; and specialized ﬁlters for such diverse applications as computer disk drives, aircraft passenger cabins and semiconductor processing. Products are manufactured at more than three dozen Donaldson plants around the world and through three 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 solu- tions, thereby creating security, opportunity and challenge for our employees. 1 Expanding south of the border Our new 200,000-square-foot facility in Monterrey will enable us to bring more gas turbine ﬁlter production in-house and From the heart of America to the far reaches expand our capacity to meet increasing of the world, Donaldson sells, services and customer demands. The facility, our fourth manufactures products our customers plant worldwide devoted to gas turbines, need, where and when they need them. will produce ﬁlter housings, inlet ducting Long before NAFTA, we realized the geo- and silencing products. graphic and market advantages of working We’re also expanding our Aguascalientes in Mexico. From a relatively modest start facility, where 200 employees manufacture 20 years ago, our presence has grown to 5 million air, liquid and oil ﬁlters each year. include three manufacturing plants. In addition to producing large volumes of ﬁlters for shipment to the United States and Mexico, our Mexican facilities also serve our European and South American customers. We’re around the WORLD We’re there for special MEMORIES ﬁlters, as disk drives expand beyond the per- And you just never know where our disk sonal computer market and make their way drive ﬁlters will show up. Did you ever imag- into more consumer and office products. ine in a sewing machine? In the near future, Helping technology products run smoothly As disk drives become increasingly com- plex, so do their ﬁltration needs. Our ﬁlters remove harmful particles and chemicals Digital cameras, TV set-top boxes, MP3 from the drive and help keep the drives players, navigational systems in automo- operating reliably. biles – these are just some of the many places you’ll ﬁnd Donaldson disk drive In ﬁscal 2001, Donaldson manufactured more than 250 million disk drive ﬁlters. To keep up with our growth and provide the lat- est in state-of-the-art cleanroom facilities, we’re expanding our Wuxi, China, operation. We’ll continue to evolve and adapt our tech- nology to meet the needs of our customers. a disk drive in a sewing machine will allow the operator to log on to a Web site, down- load a pattern, store it and direct the machine to follow it. Although growth in the personal computer market has recently slowed, the demand for disk drives and our ﬁlters will continue to grow with new and future applications such as cell phones; game machines, like Microsoft’s XBox and Sony’s Playstation2; personal digital assistants and more. We’re keeping the LIGHTS on Supplying power to the people For example, diesel generators are provid- Manufacturers are using our patent-pending ing much-needed backup power to com- air, chemical and noise ﬁltration technology puter centers, office buildings, hospitals on fuel cells that power mass transit buses, Donaldson is a key player in the booming and municipalities and are often the sole which are expected to be introduced in gas turbine business – an industry that’s sources of power for remote locations 2002. Future applications are likely to include striving to keep pace with the world’s in the Third World. As the key supplier of passenger cars, residential power genera- immense demand for power. We entered air and liquid ﬁlters to Caterpillar’s diesel tion and portable devices including cell this market more than 30 years ago with the generator business, the industry leader, phones and laptop computers. The possibil- first self-cleaning ﬁlter system and today our diesel generator business was up ities for the use of fuel cells are vast, and hold the leadership position in air ﬁltration 28 percent over last year, and we expect Donaldson’s FC3 systems will be there systems worldwide working with all of the 20 percent annual growth over the next ensuring their reliability and performance. makers of large and small turbines, includ- ﬁve years. ing General Electric, Siemens Westinghouse and Solar. We experienced yet another record year in 2001 with sales up more than 66 percent over last year. The next chapter of this unfolding power story centers on fuel cells – the energy- saving and environmentally sound power source that will revolutionize the way we From permanent solutions like gas turbines view and use energy. Utilizing hydrogen to backup power sources, Donaldson is and oxygen, the only byproducts of fuel uniquely positioned to capitalize on the cell energy are water and heat. Though insatiable demand for energy with ﬁltration the technology has been around for more technology that protects a broad spectrum than a century, it’s now on the brink of of power generation. commercial viability, and Donaldson’s Fuel Cell Contamination Control™ (FC3 ™) business is playing a key role. Solving more than ﬁltration problems Donaldson unveiled its breakthrough PowerCore™ air-intake system in 1999, and it’s now being used in a variety of products, from a John Deere lawn and garden tractor else worked. For Volvo, the space saved to a Caterpillar power generator to a Volvo with our smaller ﬁlter enabled them to mid-sized truck. design their truck with more cargo space. PowerCore systems offer superior ﬁltration With worldwide patents, PowerCore performance in a smaller package, and system’s unique conﬁguration and perfor- that’s what manufacturers love. As our mance are difficult to duplicate, allowing customers’ products become more com- us and our OEMs to retain the important pact and stylized, space is at a premium. replacement parts, or aftermarket, business. Our PowerCore systems give designers First-year sales exceeded our expectations, and engineers more freedom and choice as did customer eagerness to try this inno- in their designs. For John Deere, a PowerCore system was the best solution to its problem of superior ﬁltration in a very small space – nothing vative technology. PowerCore systems will be on at least seven new models of trucks, tractors and equipment next year. We’re in your BACKYARD Improving air quality for the workplace One metalworking customer, using the new DFO, was able to more than double produc- tion capacity. Their “old” dust collector was More than 21 million U.S. workers are extremely undersized because of restricted exposed to poor indoor air quality, not to ﬂoor space, and thus several of their steel mention many millions more around the cutting tables could run at only 40 percent world. We’re doing our part to clean the capacity. Our new, smaller DFO ﬁt into the air with dust collection systems that ﬁlter available space and enabled them to ramp harmful particles and fumes, enhancing up to full production. conditions for employees, products, and manufacturing processes. Customer acceptance has been excellent with over 300 DFO units already sold. This In 2001, we introduced the Torit Downﬂo® new product introduction, combined with Oval 1™ (DFO™) dust collection system, our new Sample Analysis Lab that enables which offers a revolutionary oval cartridge us to more accurately determine the best ﬁlter, redesigned cabinet and an enhanced product solution, reinforces our leading cleaning system applicable in thousands position in the worldwide industrial dust of businesses in the powder, metal, wood- collection market. working and processing industries world- wide. For our customers, this patented system means more effective and efficient ﬁltration while requiring less ﬂoor space. We’re enhancing worker SAFETY We’re on the job at HOME Helping engines run smoothly As the supplier of choice to Bobcat, the We’ve also supported other important skid-steer market leader, Donaldson plays customers as they’ve entered the skid- a big part in the healthy skid-steer market. steer market, including Case-New Holland, Not just for the construction site anymore, For more than 30 years, we’ve been work- Caterpillar and John Deere. Skid-steer loaders skid-steer loaders are becoming more pop- ing with Bobcat to supply a variety of ﬁlter are tough machines that require heavy-duty ular than ever. They’re increasingly used by and exhaust systems. It’s a true partnership ﬁltration, and Donaldson ﬁlters are there to consumers for home improvement projects that has grown through Bobcat’s new ensure they keep running smoothly. and landscaping, in addition to the heavy- designs and international expansion. duty construction, agriculture and masonry industries. They’re a bright spot – with 12 percent yearly growth – in a construction equipment industry that has been relatively ﬂat over the past year. Pictured from left to right: WILLIAM M. COOK Senior Vice President, International and Chief Financial Officer WILLIAM G. VAN DYKE Chairman, President and Chief Executive Officer JAMES R. GIERTZ Senior Vice President, Commercial and Industrial NICKOLAS PRIADKA Senior Vice President, Engine Systems and Parts LOWELL F. SCHWAB Senior Vice President, Operations High-quality earnings came the old-fashioned way – strong revenue, lower costs and tight expense control. We maintained ROI in the 19 to 20 percent range and ROE above 25 percent – levels that com- pare favorably with our long-term performance. DEAR SHAREHOLDERS, If there is beauty in watching a complex organiza- We kept the operations growing and delivered tion run well in rough water, then Donaldson’s year 12 – the consistent, above-average perfor- ﬁscal 2001 was an artwork. Together, the people mance that creates shareholder value, and who operate the many, disparate parts of this security and opportunity for our people. ﬁltration portfolio turned in what might be their ﬁnest performance ever. Numerically, the results were perhaps less than eye-popping – a 10 per- cent earnings increase is the slowest progress we’ve made in years. The beauty was that this occurred in the face of a strong and sometimes dispiriting headwind that many expected would deny us our 12th consecutive double-digit growth year. Overcoming the obstacles and delivering the results speak volumes about the people who did the work and about the strength of the company’s strategy. Twelve consecutive years, despite the economic dips of ’91, ’96 and ’01, belie the indict- ment that as an industrial manufacturer, we have to be a cyclical performer. Over this 12-year period, This year’s results reaffirm that our long-term, focused investment in ﬁltration technology deployed into leadership positions in distinct and divergent end markets will drive consistent, superior results. Our heroes have been different every year, as various pieces of this ﬁltration portfolio have compensated for others that were having a difficult time. This year, the North American heavy truck market experienced a truly breathtaking plunge. Donaldson experienced a drop in truck and automotive rev- enue of almost 50 percent. But, our portfolio structure meant the drop in these applications would slow, but not cripple, the company. 2 we have averaged 16 percent EPS growth, but The transportation revenue loss was washed away each year have delivered at least 10 percent. by the continuing boom in our gas turbine busi- ness, where sales grew by more than 66 percent LONG-TERM PERFORMANCE (Cumulative total return) Year ended July 31 = DCI = S&P 400 1,015 729 796 687 580 623 642 590 492 461 384 317 412 294 373 236 280 228 225 203 173 172 91 92 93 94 95 96 97 98 99 00 01 100 100 88 133 82 89 148 142 90 to $195 million. Special recognition and thanks go engages almost every area of our operation, to the Donaldson people who ramped up output e.g., plant rationalization can’t succeed without and made it happen. Donaldson’s leading, world- aggressive product line rationalization. Despite wide market share derives from our unique, the difficult business conditions this past year, proven ability to deliver the best gas turbine air we funneled resources to this work – closing ﬁve inlet systems in the industry at the required cost manufacturing and assembly facilities. This invest- and quality, and do it on time – over and over. ment in cleaning up our infrastructure cost us 17 But this year was more than just a gas turbine story. Gas turbine offset transportation, while other markets, such as the engine aftermarket and special applications, provided modest growth. cents per share, about two-thirds of this coming in the ﬁrst half. We started to see the beneﬁts of those expenditures in the fourth quarter, reener- gizing the work that’s in front of us. And most of our businesses maintained or improved Donaldson takes a pay-as-you-go approach to their margins. Another part of the story this year came from over- seas as both Europe and Asia-Paciﬁc turned in great local currency results. Europe participated in the gas turbine upswing, completed the DCE integration and showed improved results in almost every market, driving a 16 percent increase in operating income. Asia-Paciﬁc operating income increased 44 percent, derived from a strong disk plant rationalization costs, absorbing them into the operating earnings of the year – no “special charges.” This may explain the pride we take in our numbers. We made our 12th consecutive double-digit earnings growth year – up 15 cents per share – after absorbing 17 cents in plant rationalization costs – investments in our future. Effectively, we spent the year to secure our future – then we made the year. drive business and Nippon-Donaldson’s ROI Plant rationalization also includes opening new improvement project, which produced Japan’s facilities to gain scale and cost advantages. We best results and highest returns in a decade. have four new facilities coming on stream this year. Plant rationalization has emerged as the major initiative in managing our cost structure. This work A new plant near Philadelphia for our Tetratec™ PTFE membrane business will allow us to close 3 CONSISTENT DOUBLE-DIGIT EPS GROWTH (Annual EPS % change) 35 10% Goal 0 15 10 10 24 16 19 15 15 15 15 10 90 91 92 93 94 95 96 97 98 99 00 01 three smaller facilities nearby, while doubling to repeat in 2002. Completion of the DCE acquisi- manufacturing capacity. Our new gas turbine tion integration and last year’s plant rationalization plant in Monterrey, Mexico, will bring a portion moves will produce beneﬁts. The sum was to be of the now-subcontracted work back inside our an easier year than the one just past. But now walls. We target producing about two-thirds of our the picture is less clear. While we might see a gas turbine work internally, and this allows us to lift from defense and construction spending, the move back toward that standard. We are also build- unknowns around the economy as a whole erase ing a new clean room in China for disk drive ﬁlter any sense of comfort. production and a new ﬁlter plant in Eastern Europe. Yet despite the circumstances, our focus remains In sum, we will continue to pare those facilities on delivering superior return on investment, while that don’t work for us from a cost standpoint, while striving to bring in our 13th consecutive year of adding plants that will. Looking into the next ﬁscal double-digit earnings growth. Our 8,200 capable, year, we will continue to invest in plant rationaliza- tough-minded people and a sound, vital strategy tion, but cost levels aren’t expected to approach are a powerful combination. We know that we are the levels of ﬁscal 2001. in control of most of the work that will determine At this juncture, we can’t speak with much assurance about the business outlook. Prior to September 11, our expectation was for business levels to be generally consistent with our fourth quarter. While we didn’t see a meaningful upturn our success. DCI’s demonstrated ability to repeat- edly deliver, even while on a sharp economic downslope, reassures us of our ability to manage successfully through another tough year, if that’s what comes. coming, the harsh conditions of ﬁscal 2001 were Sincerely, to provide easier comparisons going forward. Growth was again projected for gas turbines and disk drives. The big negatives from 2001, such as foreign currency, the truck market collapse and WILLIAM G. VAN DYKE 4 contracting capital spending, appeared unlikely Chairman, President and Chief Executive Officer NET SALES (Millions of dollars) EARNINGS PER SHARE (Dollars) 1,137 1,092 940 944 833 759 704 594 533 482 458 1.66 1.51 1.31 1.14 .99 .84 .73 .59 .51 .46 .42 91 92 93 94 95 96 97 98 99 00 01 Donaldson has posted 18 consecutive years of revenue increases. 91 92 93 94 95 96 97 98 99 00 01 Earnings per share were up 10 percent in 2001, the 12th consecutive year of double-digit increases in EPS. RETURN ON EQUITY (% Per annum) DIVIDENDS PER SHARE (Dollars) 25.9 25.2 24.1 22.8 21.4 18.0 17.2 16.9 17.6 19.3 18.8 .295 .27 .23 .19 .17 .15 .14 .12 .10 .09 .07 91 92 93 94 95 96 97 98 99 00 01 91 92 93 94 95 96 97 98 99 00 01 Donaldson Company is delivering shareholder value through consistently high returns on shareholders' equity. Dividends paid per share increased 9 percent in 2001. The company distributes about 20 percent of net income to shareholders through regular quarterly dividends. 5 INDUSTRIAL PRODUCTS Operating Segment 2001 Revenue $530 MILLION DUST COLLECTION Under the trade names Torit, DCE and Aercology, Donaldson provides equipment to control and capture process dust, fumes and mist in manufactur- ing 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 duct- ing and silencing, evaporative coolers, chiller coils, inlet heating and anti-icing systems. Also, a full line of replacement ﬁlters and parts is offered. SPECIAL APPLICATIONS Donaldson provides a wide range of high efficiency media, ﬁlters and ﬁltration systems for various commercial, industrial and product applications. Product is applied in a wide variety of industrial settings including metal working plants, paint operations, welding stations, woodworking shops and food processing plants. Essentially all combustion tur- bines require inlet air ﬁltration and noise attenuation systems. These turbines provide base electricity, peaking capacity, remote power generation for special applications such as pipelines and off-shore oil drilling platforms. Products for the computer disk drive market include particulate ﬁlters, desiccant pouches and chemical adsorbing ﬁlter pouches. Customers include major disk drive manufacturers such as IBM, Seagate and Western Digital. Products for special market applications include aircraft cabin air ﬁlters, chemical ﬁlter systems for semi-conductor processing facilities, as well as other ﬁlters for process-critical applications. Donaldson sells expanded PTFE membrane through its Tetratec unit. Primary appli- cations for this membrane are industrial dust collection, product recovery applications and specialty fabrics. $217 MILLION $195 MILLION $118 MILLION Dedicated ﬁeld sales force coordinates multiple selling channels to end-users includ- ing: direct selling, distribution, installers, OEM accounts and telemarketing. Products are primarily sold to gas turbine OEMs (e.g., General Electric, Solar, Siemens Westinghouse). Replacement parts are sold direct to end-users. Products are sold to disk drive manufacturers by a direct sales force supported by product development and application engineers. Products are primarily sold direct to end-users. Membrane and laminates are sold to various ﬁlter and garment manufacturers. S T C U D O R P S N O I T A C I L P P A E U N E V E R 1 0 0 2 T E K R A M O T S E T U O R 6 ENGINE PRODUCTS Operating Segment 2001 Revenue $607MILLION OFF-ROAD EQUIPMENT Products sold to industrial equipment and defense con- tractor OEMs for agriculture, construction, mining, military and other industrial applications. TRUCKS Products sold to manufacturers of medium- and heavy-duty trucks. AFTERMARKET Broad line of replacement ﬁlters and hard parts for all of the equipment applications noted at left. Caterpillar, John Deere, Komatsu, CNH, Volvo Construction Equipment, General Dynamics and Stewart & Stevenson Freightliner, PACCAR, Volvo, Scania, International and Mitsubishi Original equipment dealers (such as Freightliner dealers or Caterpillar dealers), independent distributors and private label accounts $182 MILLION $80 MILLION $345 MILLION Engine Intake Air Filtration Systems Exhaust Systems Hydraulic Filtration Systems Lube, Fuel and Coolant Filtration Systems (cid:2) Cabin Air Filters 7 S T E K R A M - D N E S R E M O T S U C E V I T A T N E S E R P E R E U N E V E R 1 0 0 2 S E I L I M A F T C U D O R P Donaldson sells a broad line of ﬁlters and housings for industrial hydraulic and lubricating ﬂuids. Products are sold through an extensive network of industrial distributors. (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) ELEVEN-YEAR COMPARISON OF RESULTS Donaldson Company, Inc. and Subsidiaries (Thousands of dollars, except per share amounts) 2001 2000 1999 1998 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 – assuming dilution Dividends paid per share Shareholders’ equity per share Shares outstanding (000s) Common stock price range, per share High Low $1,137,015 $ 341,734 30.1% $ 112,108 9.9% 11,608 $ $ 104,928 29,380 $ 28.0% $ 75,548 6.6% 25.2% 19.1% $ 706,830 $ 407,227 $ 217,279 $ 189,948 1.9 $ 59,416 99,259 $ $ 158,675 $ 319,093 $1,092,294 327,521 $944,139 275,681 $940,351 263,262 30.0% 105,594 9.7% 9,880 100,333 30,100 30.0% 70,233 6.4% 25.9% 19.4% 677,525 383,347 243,590 139,757 1.6 85,313 92,645 177,958 280,165 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 97,449 255,671 23.7% 24.9% 24.8% 16.8% $ 207,658 38,924 $ 38,577 $ $ $ $ 1.66 .295 7.19 44,383 $ $ 33.05 19.13 204,545 36,417 34,326 1.51 .27 6.27 44,658 24.81 19.13 182,180 29,539 27,686 1.31 .23 5.69 46,197 25.88 14.44 178,867 54,705 25,272 1.14 .19 5.28 48,382 27.19 18.56 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. 8 1997 1996 1995 1994 1993 1992 1991 $833,348 250,273 $758,646 222,874 $703,959 197,979 $593,503 166,599 $533,327 152,236 $482,104 133,574 $457,692 129,858 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 46,875 243,865 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 23,186 228,880 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 30,967 221,173 1.7% 4.2% 4.4% 154,595 47,327 21,494 .99 .17 4.93 49,452 20.38 12.69 124,913 39,297 21,674 .84 .15 4.52 50,650 14.00 11.94 110,640 25,334 20,529 .73 .14 4.23 52,370 14.00 10.94 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 32,984 189,697 7.8% 99,559 24,642 16,365 .59(1) .12 3.58 53,020 13.06 9.13 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 26,515 174,008 9.8% 90,515 15,005 14,752 .51 .10 3.19 54,564 10.06 7.00 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 34,907 160,303 12.8% 84,899 15,538 14,047 .46 .09 2.91 55,138 7.94 5.19 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 32,053 138,947 15.6% 72,863 16,208 12,187 .42 .07 2.51 55,478 6.56 4.06 9 MANAGEMENT’S DISCUSSION AND ANALYSIS Results of Operations The following discussion of the company’s ﬁnancial condi- tion and results of operations should be read in conjunc- tion with the Consolidated Financial Statements and Notes thereto (including Note H, Segment Reporting) and other ﬁnancial information included elsewhere in this Report. Fiscal 2001 Compared to Fiscal 2000 The company reported record sales in 2001 of $1.137 billion. This was an increase of 4.1 percent over prior-year sales of $1.092 bil- lion. Excluding the impact of businesses acquired in 2000, sales for the year ended July 31, 2001 were up 0.5 percent over the prior year. This modest growth in sales for the year reﬂected the diversiﬁcation of our Industrial Products and Engine Products segments as shown by the strength in the gas turbine market offsetting the slump in the North American truck market. Sales for the Industrial Products segment were a record $530.2 million, up 26.7 percent over the prior year. Excluding the acquisition of DCE, sales for the year were up 18.9 percent from the prior year. Leading this increase were sales in gas turbine products with an increase over the prior year of 66.6 percent to record sales of $195.0 million, reﬂecting the continued high demand in this market. Sales in dust collection and special application products also increased from the prior year by 12.5 percent and 8.9 percent, respectively. Excluding the acquisition of DCE, dust collection product sales decreased 4.4 percent from the prior year. Sales for the Engine Products segment of $606.8 million were down 10.0 percent over the prior year reﬂecting the U.S. economic weakness and the strong U.S. dollar overseas. Worldwide markets for medium and heavy-duty trucks were severely depressed, reﬂected in a decrease in transportation product sales of 47.6 percent from the prior year. Excluding the company’s second quar- ter exit from a block of truck related business due to unfa- vorable commercial terms, sales were down 37.1 percent from the prior year. Sales in off-road products decreased 5.9 percent from the prior year while aftermarket product sales increased 5.0 percent. Domestic Industrial Products sales increased 28.1 per- cent from the prior year. This increase was led by strong sales of gas turbine systems products domestically reﬂect- ing continued demand for large turbines in North America, with domestic sales almost doubling from the prior year. Domestic dust collection product sales grew slightly with an increase of 1.7 percent while sales in special application products domestically decreased 8.2 percent. Domestic 10 Engine Products sales were down 10.5 percent from the prior year. The medium and heavy-duty truck market con- tinued to show its effects on the company’s transportation product sales domestically with a decrease of 51.8 percent from the prior year. This was somewhat offset by increases in domestic aftermarket and off-road product sales of 1.7 percent and 13.1 percent, respectively. In U.S. dollars, total international sales increased 5.6 percent from the prior year. Excluding the negative impact of foreign currency translation of $35.6 million, sales increased 14.4 percent over the prior year. Total inter- national Industrial Products sales were up 24.9 percent from the prior year. Sales of all products within this seg- ment were strong internationally, with increases across the board. Leading this growth were sales of dust collection products with an increase of 34.1 percent from the prior year. Sales of gas turbine products and special application products increased 20.2 percent and 18.9 percent from the prior year, respectively. Total international Engine Products sales were down 8.9 percent compared to the prior year despite an increase in aftermarket product sales of 11.3 percent. International sales of off-road and transportation products decreased from the prior year by 28.3 percent and 29.0 percent, respectively. The company reported record net earnings for 2001 of $75.5 million compared to $70.2 million in 2000, an increase of 7.6 percent. Net earnings per share – diluted were $1.66, up 10.0 percent from $1.51 in the prior year. With only a modest increase in sales, the increase in net earnings is also a result of cost management, particularly in plant rationalization efforts throughout the year and other cost reduction initiatives in the second half of the year. This along with the decrease in the company’s effec- tive tax rate due to increased proﬁtability from foreign operations helped to offset the effect of negative foreign currency exchange rates. The Industrial Products segment continued to grow, contributing 46.6 percent of consoli- dated sales, approximately 70.0 percent of the operating income and all of the growth in operating income for the year. International operating income totaled approximately 68.9 percent and 62.1 percent of consolidated operating income in 2001 and 2000, respectively. International operations also contributed all of the growth in operating income. Europe’s operating income increased 7.1 percent (16.2 percent in local currency) as a result of strong gas turbine results, the completion of the DCE integration and improved results in most markets. Asia-Paciﬁc’s operating income increased by 38.0 percent (44.4 percent in local currency), led by increases from Japan’s ROI improvement project and strong disk drive results in the Hong Kong and Wuxi, China, operations. Gross margin for 2001 remained virtually ﬂat with only a slight increase to 30.1 percent compared to 30.0 percent in the prior year. This reﬂects an improved product mix and beneﬁts of plant rationalization efforts, offsetting strong pricing pressure from major customers. Operating expenses as a percentage of sales for 2001 and 2000 were 20.2 percent and 20.3 percent, respectively. Operating expenses in 2001 totaled $229.6 million com- pared to $221.9 million in 2000, an increase of $7.7 mil- lion, or 3.5 percent. The increase in operating expenses relative to the prior year reﬂects higher sales levels and the continued impact of the businesses acquired in 2000. Selling expenses in 2001 were ﬂat as compared to 2000. General and administrative expenses increased $7.2 mil- lion from the prior year. Interest expense increased $1.7 million, or 17.5 percent, primarily due to higher short-term debt levels throughout the year related to last year’s acquisitions. Other income totaled $4.4 million in 2001 compared to other income of $4.6 million in the prior year. The major components of other income in 2001 were: interest income of $1.2 mil- lion, earnings from non-consolidated joint ventures of $3.0 million, and other miscellaneous income and expense items netting to $0.2 million of miscellaneous income. The effective income tax rate of 28.0 percent in 2001 decreased from the 30.0 percent tax rate in 2000. The tax rate was adjusted in the third quarter to provide for the increased contributions from the company’s international operations in lower tax rate countries and reﬂects the foreign tax credit generated by the receipt of a dividend from the company’s operations in Japan. The company anticipates that it will have a comparable proportion of income coming from its international operations located in lower tax rate countries in 2002. The company anticipates that its effective income tax rate will be approximately 28.0 percent in 2002. Total backlog was $355.3 million, up 7.2 percent from the same period last year. In the Industrial Products seg- ment, total backlog increased 16.8 percent from the same period last year. In the Engine Products segment, total backlog was down 1.3 percent compared to the same period last year. Hard order backlog, goods scheduled for delivery in 90 days, was $179.9 million, down 2.1 percent from $183.7 million in the prior year. Within the Industrial Products segment, hard order backlog for gas turbine products increased 28.7 percent from the prior year. This increase was offset by decreases in dust collection and spe- cial application products of 26.2 percent and 24.1 percent, respectively, resulting in a slight overall increase in the Industrial Products segment from the prior year. In the Engine products segment, overall hard order backlog decreased 4.5 percent from the prior year. Within this segment, off-road and transportation products posted decreases of 6.4 percent and 16.3 percent, respectively, while aftermarket hard order backlog increased 4.5 per- cent from the prior year. 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 mil- lion were up 25.7 percent over the prior year. Overall, growth was strong across essentially all the markets 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 continued 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 domesti- cally by 23.6 percent 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 11 in domestic truck sales offset by a sharp decline in domes- tic automotive sales. Domestic Industrial Products sales increased 17.8 percent from the prior year including busi- nesses acquired during the year. 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 products (55.4 percent increase from the prior year) reﬂecting contin- ued 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 percent from the prior year. Excluding the negative impact of foreign 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 busi- nesses 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. This reﬂects revenue growth as well as the impact of the com- pany’s stock repurchase program. An increase in sales lev- els from the prior year and the beneﬁt from continued cost reduction efforts were the primary reasons for the higher earnings. The Industrial Products segment contributed almost half of the operating proﬁt and all of the earnings growth for 2000. International operating income totaled approximately 62.1 percent and 57.6 percent of consoli- dated operating income in 2000 and 1999, respectively. Gross margin for 2000 increased to 30.0 percent com- pared 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 com- pared to $187.3 million in 1999, an increase of $34.6 mil- lion, 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 factors including increased programming and information tech- nology costs associated with Year 2000 efforts, increases in workers’ compensation, increases in medical costs and employee compensation. In addition, there was $1.8 mil- lion 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 acquisitions 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: inter- est 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. Total backlog of $331.3 million was up 16.8 percent from the prior year-end. Hard order backlog, goods scheduled for delivery in 90 days, was $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 automotive 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 backlog for the Industrial Products segment increased $28.2 million from 1999. This increase was due to signiﬁ- cant increases in backlog for both dust collection and 12 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. Liquidity and Capital Resources Financial Condition At July 31, 2001, the company’s capital structure was comprised of $59.4 million of current debt, $99.3 million of long-term debt and $319.1 million of shareholders’ equity. The ratio of long-term debt to total long-term capital was 23.7 percent and 24.9 percent at July 31, 2001 and 2000, respectively. Total debt outstanding decreased $19.3 million to $158.7 million outstanding at July 31, 2001. The decrease resulted from a reduction in short-term borrowings out- standing at the end of the year of $25.6 million as com- pared to the prior year, offset by an increase in long-term debt of $6.6 million from the prior year. The increase in long-term debt is primarily due to the addition of a guar- anteed note of $6.4 million in our Japan operations. 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 borrow- ings for general corporate purposes. There was $57.7 mil- lion outstanding under these facilities at July 31, 2001. The company believes that the combination of present capital resources, internally generated funds, and unused ﬁnancing sources are adequate to meet cash requirements for 2002. Shareholders’ equity increased $38.9 million in 2001 to $319.1 million. The increase was primarily due to current year earnings of $75.5 million offset primarily by $10.3 million of treasury stock repurchases and $13.1 million of dividend payments as well as a foreign currency translation adjustment in other comprehensive income of $13.7 million. Cash Flows During ﬁscal 2001, $82.8 million of cash was generated from operating activities, compared with $88.5 million in 2000 and $100.9 million in 1999. The decrease in 2001 was primarily due to an increase in accounts receivable of $35.2 million during the year and contribution to employee pension plans offsetting increased earnings. In addition to cash generated from operating activities, the company decreased its outstanding short-term debt by $24.4 million while net long-term debt increased by $8.3 million. Cash ﬂow generated by operations was used primarily to support $38.9 million for capital expenditures, $10.3 million for stock repurchases and $13.1 million for dividend payments. Cash and cash equivalents increased $4.1 million during 2001. Capital expenditures for property, plant and equipment totaled $38.9 million in 2001, compared to $36.4 million in 2000 and $29.5 million in 1999. Capital expenditures primarily related to productivity enhancing investments at various plants worldwide and continuing upgrades to the U.S. information systems. Capital spending in 2002 is planned to be $45.1 mil- lion. Signiﬁcant planned expenditures include the further upgrade of U.S. information systems and investment in manufacturing equipment and tooling. It is anticipated that 2002 capital expenditures will be ﬁnanced primarily by cash generated 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 quar- terly dividend of 7.5 cents per share equates to 20.1 percent of the 1999 through 2001 average net earnings per share. Share Repurchase Plan In January 2001, the Board of Directors authorized the company to repurchase 4.5 mil- lion shares of common stock of which no shares had been repurchased as of July 31, 2001. Management and the Board of Directors believe the share repurchase program is an excellent means of returning value to the shareholders. In ﬁscal 2001, the company repurchased 0.5 million shares of common stock on the open market for $10.3 million under the share repurchase plan authorized in November 1998, at an average price of $21.16 per share. The company repurchased 1.7 million shares for $35.9 million in 2000 and 2.4 million shares for $44.5 million in 1999. 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 13 of the company’s ultimate environmental liabilities, man- agement 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 In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 141, “Business Com- binations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” Major provisions of these statements are as follows: all business combinations must now use the purchase method of accounting, the pooling of interest method of accounting is now prohibited; intangible assets acquired in a business combination must be recorded sepa- rately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as a part of a related contract, asset or liability; goodwill and intangible assets with indeﬁnite lives are not amortized, but tested for impairment annu- ally, except in certain circumstances, and whenever there is an impairment indicator; all acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting; effective August 1, 2002, goodwill is no longer subject to amortization. The com- pany has adopted the provisions of these statements as of August 1, 2001. As required by SFAS 142, the company will perform an impairment test on goodwill and other intangible assets as of the adoption date. Thereafter, the company will perform impairment tests annually and whenever events or circumstances occur indicating that goodwill or other intangible assets might be impaired. Beginning August 1, 2001, amortization of goodwill will cease. Goodwill amortization expense was $3.8 million, $2.7 million and $0.7 million at July 31, 2001, 2000 and 1999, respectively. The company estimates that goodwill amortization expense would have been approximately $3.5 million in 2002. Market Risk The company’s market risk includes the poten- tial 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 com- pany’s objective in managing these risks is to reduce ﬂuctu- ations 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 anticipated 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 inter- est rates. See further discussion of these market risks below. Foreign Currency During 2001, the U.S. dollar strengthened throughout the year relative to the currencies of the foreign countries in which the company operates. The stronger dollar had a negative impact on the company’s international results because the foreign denominated revenues and earnings directly translated into fewer U.S. dollars. 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 the year ended July 31, 2001, the impact of foreign currency translation resulted in an overall decrease in net sales of $35.6 million and a decrease in net earnings of $3.2 mil- lion. The most signiﬁcant impact on the company’s results due to foreign currency translation was in Europe, where the stronger U.S. dollar relative to both the euro and pound sterling directly resulted in a decrease in net sales of $23.2 million and a decrease in net earnings of $2.9 mil- lion. The strength of the U.S. dollar relative to the Japanese yen during 2001 resulted in a decrease in net sales of $6.7 million and a decrease in net earnings of $0.2 million. In addition, ﬂuctuation in the exchange rates for the Australian dollar and the South African rand also contributed to the company’s translation losses, resulting in a decrease in net sales of $2.4 million and $3.0 million respectively. Going forward, the company expects local currency results to remain strong; excluding the effect of translation, revenues outside the U.S. increased 14.4 per- cent for the year ended July 31, 2001. The company maintains signiﬁcant assets and opera- tions in Europe, countries of the Asia-Paciﬁc Rim, South Africa and Mexico. As a result, exposure to foreign cur- rency gains and losses exists. A portion of the company’s foreign currency exposure is hedged by incurring liabilities, including bank debt, denominated in the local currency in which the company’s foreign subsidiaries are located. The foreign subsidiaries of the company purchase prod- ucts and parts in various currencies. As a result, the com- pany may be exposed to cost increases relative to local currencies in the markets to which it sells. To mitigate such adverse trends, the company, from time to time, enters into forward exchange contracts and other hedging 14 activities. Additionally, 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 rela- tive to other currencies. Any long-term strengthening of the U.S. dollar could depress these sales. Also, competitive conditions in the company’s markets may limit its ability to increase product pricing in the face of adverse currency movements. Interest Our exposure to market risks for changes in interest rates relates primarily to our short-term investments, short-term borrowings and interest rate swap agreement. We have no earnings or cash ﬂow expo- sure due to market risks on our long-term debt obligations as a result of the ﬁxed-rate nature of the debt. However, interest rate changes would affect the fair market value of the debt. At July 31, 2001, the fair value of the company’s long-term debt approximates market. Market risk is esti- mated as the potential decrease in fair value resulting from a hypothetical one-half percent increase in interest rates and amounts to approximately $3.2 million. On June 6, 2001, the company entered into an interest rate swap agreement effectively converting a portion of the company’s interest rate exposure from a ﬁxed rate to a variable rate basis to hedge against the risk of higher borrowing costs in a declining interest rate environment. The company does not enter into interest rate swap con- tracts for speculative or trading purposes; as the differen- tial to be paid or received on the interest rate swap agree- ment is accrued and recognized as an adjustment to interest expense as interest rates change. The interest rate swap agreement has an aggregate notional amount of $27.0 million maturing on July 15, 2008. The variable rate is based on the current six-month London Interbank Offered Rates (“LIBOR”). This transaction resulted in a decrease to interest expense of $45,000 for the year ended July 31, 2001. Forward-Looking Statements The company desires to take advantage of the “safe har- bor” 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 statements which reﬂect the com- pany’s current views with respect to future events and ﬁnancial performance but involve uncertainties that could signiﬁcantly impact results. The words “believe,” “expect,” “anticipate,” “intends,” “estimate,” “forecast,” “project,” “should” and similar expressions are intended to identify “forward-looking statements” within the mean- ing of the Private Securities Litigation Reform Act of 1995. All forecasts and projections in this Annual Report are “forward-looking statements,” and are based on man- agement’s current expectations of the company’s near-term results, based on current information available pertaining to the company. 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: risks associated with chang- ing world economic and political factors, the company’s international operations, interest and currency rate ﬂuctu- ations, commodity prices, highly competitive markets, changes in capital spending levels by customers, changes in product demand and changes in the geographic and product mix of sales, integration of acquisitions and acquisition opportunities, ongoing plant and product line rationalization projects, ongoing information technology improvements, research and development expenditures, government laws and regulations, including diesel emis- sions controls. For a more detailed explanation of the fore- going and other risks, see exhibit 99 to our current Annual Report on Form 10-K, 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 possi- ble 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 fac- tors, 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 company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. 15 CONSOLIDATED STATEMENTS OF EARNINGS Donaldson Company, Inc. and Subsidiaries (Thousands of dollars, except share and per share amounts) Year ended July 31, Net sales Cost of sales Gross Margin Selling, general and administrative Research and development Operating Income Interest expense Other (income) expense, net 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. 2001 $1,137,015 795,281 341,734 201,201 28,425 112,108 11,608 (4,428) 104,928 29,380 $ 75,548 2000 $1,092,294 764,773 327,521 194,623 27,304 105,594 9,880 (4,619) 100,333 30,100 $ 70,233 1999 $944,139 668,458 275,681 163,688 23,603 88,390 6,993 (7,813) 89,210 26,763 $ 62,447 44,381,082 45,716,482 46,899,127 45,612,165 46,664,196 47,793,180 $ 1.70 $ 1.54 $ 1.66 $ 1.51 $ 1.33 $ 1.31 16 CONSOLIDATED BALANCE SHEETS Donaldson Company, Inc. and Subsidiaries (Thousands of dollars, except share amounts) At July 31, 2001 2000 ASSETS Current Assets Cash and cash equivalents Accounts receivable, less allowance of $6,309 and $4,380 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 & SHAREHOLDERS’ EQUITY Current Liabilities Short-term borrowings Current maturities of long-term debt Trade accounts payable Accrued employee compensation and related taxes 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 2001 and 2000 Additional paid-in capital Retained earnings Accumulated other comprehensive loss Treasury stock – 5,273,121 and 4,998,342 shares in 2001 and 2000, at cost Total Shareholders’ Equity The accompanying notes are an integral part of these consolidated ﬁnancial statements. $ 36,136 230,046 $ 32,017 202,361 50,426 21,209 40,999 112,634 12,746 15,665 407,227 6,890 117,029 345,073 22,603 491,595 (283,937) 207,658 – 61,658 30,287 $ 706,830 $ 59,393 23 100,287 29,945 17,597 10,034 217,279 99,259 9,189 62,010 45,064 20,171 54,128 119,363 18,411 11,195 383,347 7,432 119,203 333,310 9,756 469,701 (265,156) 204,545 408 63,885 25,340 $ 677,525 $ 85,034 279 90,188 29,759 27,974 10,356 243,590 92,645 – 61,125 – – 248,280 – 203,499 (24,235) (108,451) 319,093 $ 706,830 248,280 2,967 142,176 (10,523) (102,735) 280,165 $ 677,525 17 CONSOLIDATED STATEMENTS OF CASH FLOWS Donaldson Company, Inc. and Subsidiaries (Thousands of dollars) Year ended July 31, 2001 2000 1999 OPERATING ACTIVITIES Net earnings Adjustments to reconcile net earnings to net cash provided by operating activities $ 75,548 $ 70,233 $ 62,447 Depreciation and amortization Equity in (earnings) loss 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 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. 38,577 (635) 7,093 (12,949) (35,220) 2,816 2,838 4,731 82,799 (38,924) – (38,924) 9,462 (1,136) (24,417) (10,297) (13,092) 525 (38,955) (801) 4,119 32,017 $ 36,136 34,326 74 (449) 3,121 (5,704) (26,227) (3,316) 16,437 88,495 (36,417) (88,220) (124,637) 5,752 (4,522) 66,328 (35,923) (12,384) 326 19,577 (1,053) (17,618) 49,635 $ 32,017 27,686 (2,187) 489 10,344 (13,244) 21,382 (3,095) (2,960) 100,862 (29,539) (230) (29,769) 35,546 (404) (24,422) (44,535) (10,830) 1,617 (43,028) (1,084) 26,981 22,654 $ 49,635 18 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY Donaldson Company, Inc. and Subsidiaries (Thousands of dollars, except per share amounts) BALANCE JULY 31, 1998 Common Stock $248,280 Additional Paid-in Capital $ 1,570 Comprehensive income Net earnings Foreign currency translation Comprehensive income Treasury stock acquired Stock options exercised Performance awards Tax reduction – employee plans Cash dividends ($.23 per share) BALANCE JULY 31, 1999 Comprehensive income Net earnings Foreign currency translation Comprehensive income Treasury stock acquired Stock options exercised Tax reduction – employee plans Cash dividends ($.27 per share) BALANCE JULY 31, 2000 Comprehensive income Net earnings Foreign currency translation Additional minimum pension liability Net gain on cash ﬂow hedging derivatives Comprehensive income Treasury stock acquired Stock options exercised Performance awards Tax reduction – employee plans Cash dividends ($.295 per share) BALANCE JULY 31, 2001 (1,071) 1,334 248,280 1,833 1,134 248,280 2,967 (6,196) 3,229 $248,280 $ – The accompanying notes are an integral part of these consolidated ﬁnancial statements. Accumulated Other Comprehensive Income (Loss) Treasury Stock Total $ (5,135) $ (28,638) $255,671 (535) (44,535) 3,004 802 (5,670) (69,367) (4,853) (35,923) 2,555 (10,523) (102,735) (13,717) (341) 346 (10,297) 4,262 319 $(24,235) $(108,451) 62,447 (535) 61,912 (44,535) (346) (443) 1,334 (10,830) 262,763 70,233 (4,853) 65,380 (35,923) (805) 1,134 (12,384) 280,165 75,548 (13,717) (341) 346 61,836 (10,297) (3,058) 310 3,229 (13,092) $319,093 Retained Earnings $ 39,594 62,447 (3,350) (174) (10,830) 87,687 70,233 (3,360) (12,384) 142,176 75,548 (1,124) (9) (13,092) $203,499 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Donaldson Company, Inc. and Subsidiaries •A Summary of Signiﬁcant Accounting Policies Description of Business Donaldson Company, Inc., is a lead- ing 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 three 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 inter-company accounts and transactions have been eliminated. The company also has three joint ventures that are not majority-owned, all accounted for on the equity method. Certain amounts in prior periods have been reclassiﬁed to conform to the current presentation. The reclassiﬁcations had no impact on the company’s net earnings or shareholders’ equity as previously reported. Use of Estimates The preparation of ﬁnancial statements in conformity with generally accepted accounting principles in the United States 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(loss) in shareholders’ equity. There were no signiﬁ- cant foreign currency transaction gains or losses in 2001. Foreign currency transaction losses of $0.2 million in 2000 and gains of $0.2 million in 1999 are included in earnings before income taxes. 20 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 equiva- lents 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 53 percent and 52 percent of total inventories at July 31, 2001 and 2000, respectively. The FIFO cost of inventories valued under the LIFO method exceeded the LIFO carrying values by $22.5 million and $21.2 million at July 31, 2001 and 2000, 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 facili- ties 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 equip- ment 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. Amortization expense was $3.8 million, $2.7 million and $0.7 million at July 31, 2001, 2000 and 1999, respectively. Accumulated amortization was $9.6 million and $5.8 million as of July 31, 2001 and 2000, respectively. Impairment of Long-Lived Assets The company reviews the long-lived assets, including identiﬁable intangibles and asso- ciated 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 undiscounted cash ﬂows. Income Taxes Deferred tax assets and liabilities are recog- nized for the expected future tax consequences attributed to differences between the ﬁnancial statement carrying amounts of existing assets and liabilities and their respec- tive tax basis. Deferred tax assets and liabilities are mea- sured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. 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, foreign cur- rency translation adjustments, additional minimum pension liability and net gain or loss on cash ﬂow hedging deriva- tives, and is presented in the Consolidated Statements of Changes in Shareholders’ Equity. Accumulated other comprehensive income consists of accumulated foreign currency translation adjustment, accumulated additional minimum liability related to pension and accumulated net gain or loss on cash ﬂow hedging derivatives. The adop- tion of SFAS 130 had no impact on the company’s results of operations 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 earnings per share is computed by dividing net earn- ings by the weighted average number of outstanding com- mon shares and dilutive shares relating to stock options. The following table presents information necessary to calculate basic and diluted earnings per share: (In thousands, except per share amounts) Weighted average shares – basic Dilutive shares Weighted average shares – diluted 2001 44,381 1,231 45,612 Net earnings for basic and diluted earnings per share computation $75,548 Net earnings per share – basic Net earnings per share – diluted $ 1.70 $ 1.66 2000 45,716 948 46,664 $70,233 $ 1.54 $ 1.51 1999 46,899 894 47,793 $62,447 $ 1.33 $ 1.31 Treasury Stock Repurchased Common Stock is stated at cost and is presented as a separate reduction of sharehold- ers’ 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, companies to record compensation cost for stock- based employee compensation plans at fair value. The company has chosen to continue to account for stock- based compensation using the intrinsic value method pre- scribed in Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the company’s stock at the date of the grant over the amount an employee must pay to acquire the stock. Compensation cost for performance equity units is recorded based on the quoted market price of the company’s stock at the end of the period. Revenue Recognition 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. Derivative Instruments and Hedging Activities The company adopted 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,” effective beginning ﬁscal 2001. SFAS 133 and SFAS 138 require the 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 comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value will be imme- diately recognized in earnings. The company enters into foreign exchange contracts and other hedging activities to mitigate potential foreign currency gains and losses relative to local currencies in the markets to which it sells. 21 In order to comply with the implementation requirements of SFAS 133 and SFAS 138, the company undertook a comprehensive review of its contractual relationships to ensure that all potential free-standing and embedded derivatives were identiﬁed. As a result, all of the company’s existing derivative positions qualiﬁed for hedge accounting per SFAS 133 and SFAS 138, and the impact of adoption was not considered material to the company’s results of operations or ﬁnancial position. The company’s documentation policies for derivatives were revised as con- sidered necessary to comply with SFAS 133 requirements. However, the company made no substantive changes to its risk management strategy as a result of adopting SFAS 133 and SFAS 138. As a result of the implementa- tion of SFAS 133 and SFAS 138, the company has recorded a credit to other comprehensive income of $0.3 million for the year ended July 31, 2001. In June 2001 the company entered into an interest rate swap agreement which was determined to be a fair value hedge under SFAS 133 and SFAS 138 (see Note D). As of July 31, 2001, the interest rate swap had a fair value of $0.2 million which has been recorded as an increase to long-term debt. As a result of adopting these new account- ing standards, there has been no material impact on the results of operations of the company for ﬁscal year ended July 31, 2001. New Accounting Standards In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” Major provisions of these statements are as follows: all business combinations must now use the purchase method of accounting, the pooling of interest method of accounting is now prohibited; intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as a part of a related contract, asset or liability; goodwill and intangible assets with indeﬁnite lives are not amortized, but tested for impairment annu- ally, except in certain circumstances, and whenever there is an impairment indicator; all acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting; effective August 1, 2002, 22 goodwill is no longer subject to amortization. The com- pany has adopted the provisions of these statements as of August 1, 2001. As required by SFAS 142, the com- pany will perform an impairment test on goodwill and other intangible assets as of the adoption date. Thereafter, the company will perform impairment tests annually and whenever events or circumstances occur indicating that goodwill or other intangible assets might be impaired. Beginning August 1, 2001, amortization of goodwill will cease. Goodwill amortization expense was $3.8 million, $2.7 million and $0.7 million at July 31, 2001, 2000 and 1999, respectively. The company estimates that goodwill amortization expense would have been approximately and Plant Opening $3.5 million in 2002.•B Acquisitions, Plant Closure Acquisitions All acquisitions were accounted for as purchases. The purchase prices assigned to the net assets acquired were based on the fair value of such assets and liabilities at the respective acquisition dates. The operating results of these acquired companies have been included in the consolidated statement of earnings from the dates of acquisition. Consolidated pro forma earnings and earnings per share would not be materially different from the reported amounts for all years presented. The company completed the purchase of all of the outstanding shares of AirMaze Corporation for $31.9 mil- lion in cash effective November 1, 1999. AirMaze Corporation was merged into Donaldson Company, Inc. effective April 1, 2000. AirMaze products include heavy- duty air and liquid ﬁlters, air/oil separators and high purity air ﬁlter products. AirMaze manufacturing facilities are located in Stow, Ohio and Greeneville, Tennessee. The excess of purchase price over the fair values of the net assets acquired was $26.8 million and has been recorded as good- will which is being amortized on a straight-line basis over 20 years. AirMaze operations are a part of the company’s Engine Products segment. As of July 31, 2001, the balance of restructuring liabilities recorded in conjunction with the acquisition was approximately $0.2 million for costs asso- ciated with the termination and relocation of employees. Costs incurred and charged to this reserve associated with the termination and relocation of employees amounted to $0.3 million for the ﬁscal year ended July 31, 2001. The integration of AirMaze resulted in a reduction in the work force of approximately 15 employees during ﬁscal 2001. Adjustments to this reserve for the ﬁscal year ended July 31, 2001, amounted to a decrease of $0.7 million. The remaining employee terminations and relocations are expected to be completed by the end of ﬁscal 2002. The company acquired the DCE dust control business of Invensys, plc for $56.4 million effective February 1, 2000. 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 $33.2 million and has been recorded as goodwill which is being amor- tized on a straight-line basis over 20 years. DCE operations are part of the company’s Industrial Products segment. As of July 31, 2001, the balance of restructuring liabilities recorded in conjunction with the acquisition was approximately $2.1 million of costs associated with the closure and sale of acquired facilities as well as termination and relocation of employees. Costs incurred and charged to these reserves associated with the closure and sale of acquired facilities amounted to $0.8 million for the ﬁscal year ended July 31, 2001. Costs incurred and charged to these reserves associated with the termination and reloca- tion of employees amounted to $0.8 million during the year ended July 31, 2001. The integration of DCE resulted in a reduction in the work force of approximately 140 employ- ees during ﬁscal 2001. Adjustments to these reserves for the fiscal year ended July 31, 2001, amounted to an increase of $0.9 million. The remaining closure or sale of facilities and employee terminations and relocations are expected to be completed by the end of ﬁscal 2002. Plant Closures During 2001, the company closed its manu- facturing facilities located in Mooresville, North Carolina, and Louisville, Kentucky. The closures of these facilities were completed by the end of the ﬁscal year. For the closure of the Mooresville manufacturing facility, a pretax charge of $0.7 million was recorded in ﬁscal 2001 in general and administrative expense in the company’s consolidated statement of earnings. For the closure of the Louisville manufacturing facility, costs were charged against the purchase liabilities recorded in conjunction with the acqui- sition of DCE. See discussion of these purchase liabilities in Note B. These charges were primarily related to sever- ance and other employee related costs associated with the elimination of approximately 130 positions in Mooresville and 80 positions in Louisville. During 2000, the company closed its manufacturing 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 com- pany’s consolidated statement of earnings. The charge was primarily related to severance and other employee related costs associated with the elimination of approximately 125 positions. Plant Opening During ﬁscal 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 approximately 100 employees. •C Credit Facilities In December 1997, the company amended and renewed a ﬁve-year multi-currency revolving facility with a group of participating 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 million outstanding under this credit facility, leaving $50.0 million available for further borrowing under such facility at both July 31, 2001 and 2000. The weighted average interest rate on short-term borrowings outstand- ing at July 31, 2001 and 2000 was 3.99 percent and 6.83 percent, respectively. The company also has three agreements under uncom- mitted credit facilities which provide unsecured borrowings for general corporate purposes. At July 31, 2001, there was $35.0 million available for use under these facilities. There was $7.7 million and $12.6 million outstanding under these facilities at July 31, 2001 and 2000, respec- tively. The weighted average interest rate on short-term borrowings outstanding at July 31, 2001 and 2000 was 3.98 percent and 6.89 percent, respectively. 23 International subsidiaries may borrow under various credit facilities. As of July 31, 2001 and 2000, borrowings under these facilities were $1.7 million and $22.4 million, respectively. The weighted average interest rate on these international borrowings outstanding at July 31, 2001 and 2000 was 10.7 percent and 4.7 percent, respectively. •D Long-Term Debt (Thousands of dollars) Long-term debt consists of the following: 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 $27.2 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 1.51% Guaranteed note due March 28, 2006, interest payable quarterly, principal amount of .8 billion Yen is due March 28, 2006. 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 2.8% as of July 31, 2001 Other Total Less current maturities 2001 2000 $23,000 $23,000 27,157 27,000 25,000 25,000 9,592 10,962 6,395 – 8,000 138 99,282 23 5,667 1,295 92,924 279 Total long-term debt $99,259 $92,645 Annual maturities of long-term debt for the next ﬁve years are $32.6 million in 2005 and $6.4 million in 2006. Annual maturities in 2002, 2003 and 2004 are not signiﬁ- cant. The company estimates that the carrying value of long-term debt approximates its fair market value. On June 6, 2001, the company entered into an interest rate swap agreement effectively converting a portion of the company’s interest rate exposure from a ﬁxed rate to a variable rate basis to hedge against the risk of higher bor- rowing costs in a declining interest rate environment. The company does not enter into interest rate swap contracts for speculative or trading purposes; as the differential to be paid or received on the interest rate swap agreement is accrued and recognized as an adjustment to interest 24 expense as interest rates change. The interest rate swap agreement has an aggregate notional amount of $27.0 mil- lion maturing on July 15, 2008. The variable rate is based on the current six-month London Interbank Offered Rates (“LIBOR”). This transaction resulted in a decrease to inter- est expense of $45,000 for the year ended July 31, 2001. Total interest paid relating to all debt was $11.1 million, $9.1 million and $6.0 million in 2001, 2000 and 1999, respectively. In addition, total interest expense recorded in 2001, 2000 and 1999 was $11.6 million, $9.9 million and $7.0 million, respectively. Certain note agreements contain debt covenants related to working capital levels and limi- tations on indebtedness. Further, the company is restricted from paying dividends or repurchasing Common Stock if its tangible net worth (as deﬁned) does not exceed certain minimum levels. As of July 31, 2001, the company was in compliance with all such covenants. •E Employee Beneﬁt Plans Pension Plans Donaldson Company, Inc. and certain of its subsidiaries have deﬁned beneﬁt pension plans for substan- tially 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 interna- tional plans generally provide pension beneﬁts based on years of service and compensation level. The company’s general funding policy is to make contributions as required by applicable regulations. The assets are primarily invested in diversiﬁed equity and debt portfolios. In 2000, the actu- arial valuation date was changed from July 31 to April 30. This change did not have a material impact on the actuar- ial valuation. Costs for the company’s pension plans include the fol- lowing components: (Thousands of dollars) Net periodic cost: Service cost Interest cost Expected return on assets Transition amount amortization Prior service cost amortization Actuarial (gain) loss amortization Curtailment loss 2001 2000 1999 $ 6,935 $ 6,084 $ 5,609 11,626 (12,862) 173 119 (829) – 9,852 (11,475) (1,097) 64 71 – 9,188 (10,006) (1,097) 30 1,094 684 Net periodic beneﬁt cost $ 5,162 $ 3,499 $ 5,502 The funded status of the company’s pension plans as of April 30, 2001 and April 30, 2000, is as follows: (Thousands of dollars) Change in beneﬁt obligation: Beneﬁt obligation, August 1 Adjustment for change in measurement date Beneﬁt obligation, May 1 Addition of non-U.S. plans Service cost Interest cost Participant contributions Plan amendments Actuarial (gain)/loss Currency exchange rates Acquisition Beneﬁts paid 2001 N/A N/A $137,056 16,589 6,936 11,626 125 174 (10,012) (2,022) – (10,371) 2000 $131,996 1,841 133,837 – 6,085 9,852 – 568 (11,472) – 6,419 (8,233) Beneﬁt obligations, April 30 $150,101 $137,056 Change in plan assets: Fair value of plan assets, August 1 Adjustments for change in measurement date Fair value of plan assets, May 1 Addition of non-U.S. plans Actual return on plan assets Company contributions Participant contributions Currency exchange rates Acquisition Beneﬁts paid N/A N/A $146,210 7,857 (10,978) 11,250 125 (892) – (10,371) $130,387 17,461 147,848 – (1,659) 2,168 – – 6,086 (8,233) Fair value of plan assets, April 30 $143,201 $146,210 Reconciliation of funded status: Funded (unfunded) status $ (6,900) $ 9,154 Unrecognized actuarial (gain) loss Unrecognized prior service cost Unrecognized net transition obligation Fourth quarter contributions 2,322 2,527 3,792 1,891 (12,196) 2,472 (3,769) 52 Net amount recognized in consolidated balance sheet $ 3,632 (4,287) Amounts recognized in consolidated balance sheet consist of: Prepaid beneﬁt cost Accrued beneﬁt liability Additional minimum liability Intangible asset Accumulated other comprehensive income Net amount recognized in consolidated $ 9,853 $ 4,614 (6,220) (5,126) 4,784 341 (8,901) (280) 280 – balance sheet $ 3,632 $ (4,287) The 2000 actuarial valuation results have been revised to reﬂect the ﬁnal valuation of a plan assumed in the acquisition of AirMaze (see Note B). The projected beneﬁt obligation, accumulated beneﬁt obligation, and fair value of plan assets for pension plans with accumulated beneﬁt obligations in excess of plan assets were $20.9 million, $17.1 million, and $5.8 million, respectively, as of April 30, 2001 and $8.6 million, $5.4 million and $0.8 million, respectively, as of April 30, 2000. Weighted-average actuarial assumptions April 30, 2001 July 31, 2000 July 31, 1999 Discount rate Expected return on plan assets Rate of compensation increase 7.50% 9.50% 5.50% 8.00% 9.00% 6.00% 7.50% 9.00% 6.00% Pension expense related to international plans were $4.3 million, $2.5 million and $2.5 million for 2001, 2000 and 1999, 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 contribu- tions 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 $4.1 million, $4.2 million and $4.9 million for the years ended July 31, 2001, 2000 and 1999, respectively. •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 shareholder rights plan. Pursuant to the new Rights Agreement, dated as of January 12, 1996, by and between the company and Wells Fargo Bank Minnesota, National Association, as Rights Agent, one Right was issued on March 4, 1996 for each outstanding share of Common Stock, par value $5.00 per share, of the company upon the expiration of the company’s existing Rights. Each of the new Rights 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. 25 If a person acquires 15 percent or more of the outstanding Common Stock of the company (subject to certain condi- tions and exceptions more fully described in the Rights Agreement), each Right will entitle the holder (other than the person who acquired 15 percent or more of the out- standing 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 Plan allows 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 $2.4 million and $1.7 million in 2001 and 2000, respectively. There was no performance award expense in 1999. Options under the Plan are granted to key employees at or above 100 percent of the market price at the date of grant. Options are exercisable for up to 10 years from the date of grant. Stock Options Stock options issued during ﬁscal 1999, 2000 and 2001 become exercisable for non-executives in each of the following 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, 2001, options to purchase 3,464,159 shares are outstanding. 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 compensation plans, but allows companies to continue to account for those plans using the accounting prescribed by APB Opinion 25, “Accounting for Stock Issued to Employees.” The company has elected to continue to account for stock-based compensation using APB 25, making pro forma disclosures of net earnings and earnings per share as if the fair value-based method had been applied. Accordingly, no compensation expense has been recorded for the stock option plan. Had compensation expense for the stock option plan been determined under SFAS 123 in ﬁscal 2001, 2000 and 1999, the company’s net income and diluted earnings per share would have been approximately $71.0 million and $1.56, and $67.7 million and $1.45, and $61.1 million and $1.28, respec- tively. The pro forma effect on net income and earnings per share is not representative of the pro forma net earn- ings in future years because it does not take into consider- ation pro forma compensation expense related to grants made prior to 1996. For purposes of computing compensation cost of stock options granted, the fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: risk free interest rate of 4.72 percent, 6.50 percent and 5.50 percent in 2001, 2000 and 1999, respec- tively; two or seven year lives in 2001 and 2000 and two, three, or seven year lives in 1999; expected volatility of 30.5 percent, 29.7 percent and 26.3 percent in 2001, 2000 and 1999, respectively; and 1 percent expected dividend yield in 2001, 2000 and 1999. 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 common stock. The weighted average fair value for options granted during ﬁscal 2001, 2000 and 1999 is $8.01, $7.49 and $5.62 per share, respectively. 26 The number and option price of options granted were The components of the provision for income taxes are as follows: Outstanding at July 31, 1998 Granted Exercised Canceled Outstanding at July 31, 1999 Granted Exercised Canceled Outstanding at July 31, 2000 Granted Exercised Canceled Options Outstanding Weighted Average Exercise Price 3,348,176 $12.95 495,149 (432,505) (28,498) 3,382,322 489,086 (204,004) (14,468) 3,652,936 862,515 (1,025,995) (25,297) 20.10 8.65 18.35 14.50 23.01 10.09 20.41 15.86 26.04 12.88 21.19 as follows: (Thousands of dollars) Income Taxes: Current: Federal State Foreign Deferred: Federal State Foreign Total 2001 2000 1999 $ 8,502 $18,192 $16,717 622 13,163 22,287 7,304 417 (628) 7,093 $29,380 2,361 9,996 30,549 52 3 (504) (449) 2,471 7,086 26,274 426 24 39 489 $30,100 $26,763 The tax effects of temporary differences that give rise to Outstanding at July 31, 2001 3,464,159 $19.24 deferred tax assets and liabilities are as follows: At July 31, 2001 and 2000 there were 2,954,542 and 3,109,926 options exercisable, respectively. Shares reserved at July 31, 2001 for outstanding options and future grants were 8,140,639. The following table summarizes information concern- ing currently outstanding and exercisable options: Range of Exercise Prices $5 to $10 $10 to $15 $15 to $20 $20 to $25 Number Outstanding 201,888 837,194 738,728 964,827 $25 and above 721,522 Weighted Average Remaining Contractual Life (Years) 1.21 2.69 6.11 7.22 8.34 Weighted Average Exercise Price $ 8.73 12.15 18.08 22.90 26.67 Number Exercisable 201,888 837,194 670,441 794,297 450,722 Weighted Average Exercise Price $ 8.73 12.15 17.89 22.92 27.17 (Thousands of dollars) Deferred tax assets: Compensation and retirement plans Accrued expenses NOL carryforwards Inventories Investment in joint venture Cumulative translation adjustment Other Gross deferred tax assets 2001 2000 1999 $ 3,619 $ 12,839 $ 8,950 6,938 6,092 1,938 636 – 3,215 22,438 7,818 8,174 1,526 754 4,574 3,162 38,847 9,617 3,560 1,595 588 2,494 3,267 30,071 Valuation allowance $ (2,054) $ (4,499) $ (2,432) Net deferred tax assets 20,384 34,348 27,639 Deferred tax liabilities: Depreciation and amortization (16,209) $19.24 2,954,542 $18.41 Other (618) Gross deferred tax liabilities (16,827) Net deferred tax assets $ 3,557 5.77 3,464,159 •G Income Taxes (Thousands of dollars) Earnings before income taxes: United States Foreign Total The components of earnings before income taxes are as follows: 2001 2000 1999 $ 48,705 $ 54,913 56,223 45,420 $104,928 $100,333 $55,811 33,399 $89,210 (14,626) (903) (15,529) $ 18,819 (11,235) (1,625) (12,860) $ 14,779 27 The following table reconciles the U.S. statutory income tax rate with the effective income tax rate: Statutory U.S. federal rate State income taxes Foreign taxes at lower rates Other 2001 35.0% 0.4 (8.2) 0.8 2000 35.0% 1.5 (6.1) (0.4) 1999 35.0% 1.8 (5.5) (1.3) 28.0% 30.0% 30.0% At July 31, 2001, certain international subsidiaries had available net operating loss carryforwards of approximately $20.0 million to offset future taxable income. The major- ity of such carryforwards expire after 2003. Due to the uncertainty of the realizability of a portion of these losses, a valuation allowance of $2.1 million has been recorded as of July 31, 2001. Unremitted earnings of international subsidiaries amounted to approximately $133.5 million at July 31, 2001. 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 $16.2 million, $24.6 million and $20.8 million in 2001, 2000 and 1999, respectively.•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 busi- ness 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. The com- pany has identiﬁed two reportable segments: Engine Products and Industrial Products. Segment selection was based on the internal organizational structure, manage- ment of operations and performance evaluation by man- agement and the company’s Board of Directors. The Engine Products segment sells to original equip- ment manufacturers (OEMs) in the construction, indus- trial, 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 ﬁltra- tion systems and replacement ﬁlters. The Industrial Products segment sells to various indus- trial 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 company’s manufacturing facilities serve both reporting segments. Therefore, the company uses a com- plex 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 allocated assets are primarily accounts receiv- able, inventories and property, plant and equipment. Reconciling items included in Corporate and Unallocated are created based on accounting differences between seg- ment reporting and the consolidated, external reporting as well as internal allocation methodologies. 28 Segment detail is summarized as follows (in thousands): Following are net sales by product within the Engine 2001 Net sales Depreciation and amortization Equity earnings in unconsolidated affiliates Earnings before income taxes Assets Equity investments in unconsolidated affiliates Capital expenditures, net of acquired businesses 2000 Net sales Depreciation and amortization Equity earnings in unconsolidated affiliates Earnings before income taxes Assets Equity investments in unconsolidated affiliates Capital expenditures, net of acquired businesses 1999 Net sales Depreciation and amortization Equity earnings in unconsolidated affiliates Earnings before income taxes Assets Equity investments in unconsolidated affiliates Capital expenditures, net of acquired businesses Engine Products Industrial Products Corporate & Unallocated Total Company $606,810 $530,205 $ – $1,137,015 23,100 11,268 4,209 38,577 3,017 – – 3,017 49,539 315,706 72,891 228,505 (17,502) 162,619 104,928 706,830 Products segment and Industrial Products segment: (In thousands) 2001 2000 1999 Engine Product segment: Off-road products $ 181,795 $ 193,229 $181,200 Transportation products Aftermarket products Total Engine Product segment Industrial Product segment: 79,670 345,345 151,950 328,803 162,291 267,887 606,810 673,982 611,378 Dust collection products Gas turbine products Special application products 217,343 195,042 117,820 193,119 117,038 108,155 153,480 84,229 95,052 332,761 $944,139 14,115 – – 14,115 Total Industrial Product segment 530,205 418,312 Total company $1,137,015 $1,092,294 23,308 11,370 4,246 38,924 $673,982 $418,312 $ – $1,092,294 equipment (in thousands): Geographic sales by origination and property, plant and 20,959 8,509 4,858 34,326 4,392 – – 4,392 57,453 320,805 53,862 172,837 (10,982) 183,883 100,333 677,525 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 61,896 327,035 36,373 160,201 (9,059) 55,010 89,210 542,246 2001 United States Europe Asia-Paciﬁc Other Total 2000 United States Europe Asia-Paciﬁc Other Total 1999 United States Europe Asia-Paciﬁc Other Total Net Sales Property, Plant & Equipment – Net $ 711,268 $138,631 211,397 185,395 28,955 36,801 19,609 12,617 $1,137,015 $207,658 $ 688,899 $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 13,833 – – 13,833 19,723 8,008 1,808 29,539 Sales to one customer accounted for 12 percent of net sales in 2001. There were no sales over 10 percent of net sales to any customer in 2000. Sales to one customer accounted for 11 percent of net sales in 1999. 29 •I 2001 Net Sales (Thousands of dollars, except per share amounts) Gross Margin Net Earnings Diluted Earnings Per Share Dividends Declared Per Share 2000 Net Sales Gross Margin Net Earnings Diluted Earnings Per Share Quarterly Financial Information (Unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter $289,869 $279,631 $269,721 $297,794 85,956 16,804 .37 .075 86,316 18,105 .40 .075 79,180 17,826 .39 .075 90,282 22,813 .50 .075 $246,550 $259,256 $285,277 $301,211 73,881 17,008 79,595 17,406 84,812 17,450 89,233 18,369 .40 .07 .36 .37 .38 .07 .07 .07 Dividends Declared Per Share •J Commitments and Contingencies The company is involved in litigation arising in the ordi- nary course of business. In the opinion of management, the outcome of litigation currently pending will not mate- rially affect the company’s results of operations, ﬁnancial condition or liquidity. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of Donaldson Company, Inc. We have audited the accompanying consolidated balance sheets of Donaldson Company, Inc. (a Delaware corpora- tion) and subsidiaries as of July 31, 2001 and 2000, and the related consolidated statements of earnings, changes in shareholders’ equity and cash ﬂows for the years 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 audits. The consolidated ﬁnancial statements of Donaldson Company, Inc. and subsidiaries as of July 31, 1999, were audited by other auditors whose report dated September 8, 1999, expressed an unqualiﬁed opinion on those statements. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁnancial statements. An audit also includes assessing the accounting principles used and signiﬁcant estimates made by management, as well as evaluating the overall ﬁnancial statement presenta- tion. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the ﬁnancial statements referred to above present fairly, in all material respects, the ﬁnancial position of Donaldson Company, Inc. and subsidiaries as of July 31, 2001 and 2000, and the results of their operations and their cash ﬂows for the years then ended, in conformity with accounting principles generally accepted in the United States. Minneapolis, Minnesota, August 27, 2001 30 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 Nicholasville, Kentucky Port Huron, Michigan Chillicothe, Missouri 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 PT Panata Jaya Mandiri Jakarta, Indonesia Subsidiaries Torit Australia Pty. Ltd. Sydney, Australia Donaldson Filtration Industrial S. de R.L. de C.V. Monterrey, Mexico Donaldson Australasia Pty. Limited Wyong, Australia Donaldson Torit, B.V. Haarlem, Netherlands Donaldson Sales, Inc. Barbados DCE Benelux B.V. Krommenie, Netherlands Donaldson Coordination Center, B.V.B.A. Leuven, Belgium Donaldson Europe, B.V.B.A. Leuven, Belgium Brugge, Belgium (plant) 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 Donaldson India 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 Diemo S.A. de C.V. Guadalajara, Mexico Air Master China Ltd. Hong Kong, S.A.R., People’s Republic of China Donaldson Far East Limited Hong Kong, S.A.R., People’s Republic of China Guilin Air King Enterprises Ltd. Guilin, 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 Iberica S.L. Madrid, Spain Donaldson Filter Components Limited Hull, United Kingdom DCE Donaldson Ltd. Leicester, United Kingdom Tetratec Europe Limited Wigan, United Kingdom 31 CORPORATE AND SHAREHOLDER INFORMATION NYSE Listing Annual Meeting The common shares of Donaldson Company, Inc. are traded on the New York Stock Exchange, under the symbol DCI. Shareholder Information For any concerns relating to your current or prospective shareholdings, please contact Shareowner Services at (800)468-9716 or (651)450-4064. Dividend Reinvestment Plan As of September 21, 2001, 1,107 of Donaldson Company’s approximately 1,799 shareholders of record were partici- pating 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. The annual meeting of shareholders will be held at 10 a.m. on Friday, November 16, 2001, at Donaldson Company, Inc., 1400 West 94th 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. Auditors 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 13.19 13.06 13.94 14.00 14.63 17.00 18.31 20.38 27.19 25.69 26.19 25.13 21.94 21.00 23.50 25.88 23.50 24.81 24.06 24.25 23.86 29.48 28.92 33.05 Low 11.94 12.06 12.81 12.00 12.69 14.31 15.38 17.75 20.31 22.25 22.63 18.56 14.44 17.69 17.25 21.94 19.50 20.63 20.25 19.13 19.13 21.62 24.39 27.30 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1996 1997 1998 1999 2000 2001 32 BOARD OF DIRECTORS F. Guillaume Bastiaens, 58, Vice Chairman, Cargill, Inc., Minneapolis (Agribusiness). Director since 1995.(2) (3) Jack W. Eugster, 56, Non-Executive Chairman, ShopKo Stores, Inc., Green Bay, WI (Specialty Discount Retailer). Director since 1993.(1) (3) Paul B. Burke, 45, Chairman and Chief Executive Officer, BMC Industries, Inc., Minneapolis (Manufacturing). Director since 1996.(1) (3) John F. Grundhofer, 62, Chairman, U.S. Bancorp, Minneapolis (Financial Services). Director since 1997.(1) (3) Janet M. Dolan, 52, President and Chief Executive Officer, Tennant Company, Minneapolis (Manufacturing). Director since 1996.(2) (3) Kendrick B. Melrose, 61, Chairman and Chief Executive Officer, The Toro Company, Minneapolis (Manufacturing). Director since 1991.(1) (2) Jeffrey Noddle, 55, President and Chief Executive Officer, SUPERVALU INC., Minneapolis (Food Retailer and Distributor). Director since 2000.(1) (2) S. Walter Richey, 65, Retired Chairman, President and Chief Executive Officer, Meritex, Inc., Minneapolis (Distribution Services). Director since 1991.(2) (3) Stephen W. Sanger, 55, Chairman and Chief Executive Officer, General Mills, Inc., Minneapolis (Consumer Products). Director since 1992.(1) (2) William G. Van Dyke, 56, Chairman, President and Chief Executive Officer, Donaldson Company, Inc. Director since 1994. (1) Human Resources Committee (2) Audit Committee (3) Corporate Governance Committee CORPORATE OFFICERS William G. Van Dyke, 56, Chairman, President and Chief Executive Officer. 29 years service. Nickolas Priadka, 55, Senior Vice President, Engine Systems and Parts. 32 years service. Norman C. Linnell, 42, Vice President, General Counsel and Secretary. 6 years service. William M. Cook, 48, Senior Vice President, International and Chief Financial Officer. 21 years service. James R. Giertz, 44, Senior Vice President, Commercial and Industrial. 8 years service. Lowell F. Schwab, 53, Senior Vice President, Operations. 22 years service. John E. Thames, 51, Vice President, Human Resources. 13 years service. Dale M. Couch, 58, Vice President and General Manager, Asia Paciﬁc. 4 years service. Geert Henk Touw, 56, Vice President and General Manager, Europe/Africa/Middle East. 16 years service. Thomas A. Windfeldt, 52, Vice President, Controller and Treasurer. 21 years service. 33 TM Donaldson Company, Inc. 1400 West 94th Street Minneapolis, Minnesota U.S.A. (952) 887-3131 www.donaldson.com Mailing Address: P.O. Box 1299 Minneapolis, Minnesota 55440 U.S.A

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