Donaldson (DCI) Q2 2026 Earnings Call Transcript

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Date

Thursday, Feb. 26, 2026 at 10 a.m. ET

Call participants

• Chairman & Chief Executive Officer — Tod Carpenter
• President & Chief Executive Officer — Rich Lewis
• Chief Financial Officer — Brad Pogalz

Takeaways

• Total sales -- $896 million, up 3%, marking a quarterly record and driven by all three segments.
• Operating margin -- 14%, a decrease from 15.2% due to gross margin pressure from volume deleveraging, operational inefficiencies, and footprint optimization costs.
• Adjusted earnings per share -- $0.83, flat year over year and matching the previous record.
• Gross margin -- 33.7%, down 150 basis points, with 60 basis points of the decline attributed to volume deleveraging.
• Mobile Solutions sales -- $557 million, up 2%, primarily from currency benefits; aftermarket rose 1%, while OE channel declined.
• Off-Road sales -- $86 million, increased 8%, reflecting recovery from previous agriculture weakness.
• On-Road sales -- $23 million, decreased 9% because of ongoing global truck production declines.
• China mobile business sales -- Increased 8%, constituting the sixth consecutive quarter of growth, driven by Off-Road and aftermarket.
• Industrial Solutions sales -- $260 million, up 2%, mainly supported by currency impacts.
• IFS (Industrial Filtration Solutions) sales -- $223 million, up 7% due to North America and Europe power generation strength.
• Aerospace and Defense sales -- $37 million, down 19%, reflecting project timing issues, particularly in defense.
• Life Sciences sales -- $80 million, up 16%, with Food and Beverage and disk drive businesses leading growth.
• Facet acquisition -- Announced as the largest in company history, expected to add $110 million in sales, with margins and cash flow above corporate averages, and 70% of revenue recurring.
• Guidance for fiscal 2026 -- Sales expected at $3.8 billion; operating margin forecasted between 16% and 16.4%; EPS guided to a $3.93-$4.01 range, midpoint up 8% on 3% sales growth; free cash flow conversion expected at approximately 90%.
• Mobile Solutions pretax margin -- 16.8%, down 60 basis points due to OE and footprint costs.
• Industrial Solutions pretax margin -- 11.9%, declined from 16.1% from past year, reflecting operational inefficiencies and optimization costs.
• Life Sciences pretax margin -- Improved to 9.3% from a 1% loss, resulting from higher Food and Beverage and disk drive margins and expense optimization.
• Operating expenses -- Improved to 19.7% of sales from 20%, with cost optimization and expense discipline yielding benefit.
• Capital expenditures forecast -- $60 million to $75 million focused on new products and technology.
• Pending share repurchases -- Repurchased 1.2% of shares year to date to offset dilution, with no further repurchases planned for the fiscal year due to the Facet acquisition focus.
• Net leverage ratio -- Currently 0.7x, with pro forma 1.7x upon Facet transaction close, preserving financial flexibility.
• Dividend record -- Maintained for 70 consecutive years, and 30 consecutive years of increases, with continued commitment to the S&P High Yield Dividend Aristocrats Index status.

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Risks

• Gross margin pressures are projected to continue in the near term due to production inefficiencies, with a 150 basis point decline specifically reported this quarter and further drag from manufacturing footprint changes.
• Footprint optimization costs and operational disruptions remain ongoing, with the majority of U.S. plant closure projects concluding in future quarters, introducing risk to margin improvement timing.
• Aerospace and Defense faces continued declines attributed to both project timing and supply chain challenges, with single-source supplier issues called out and sales down 19%.
• Industrial Solutions sales guidance revised downward to -1% to +3% growth, below previous expectations (2%-6%), primarily from weakness in dust collection and industrial hydraulics.

Summary

Donaldson (NYSE:DCI) delivered record quarterly sales and reaffirmed its fiscal 2026 guidance for record revenue and EPS, driven by strong aftermarket, Food and Beverage, power generation, and disk drive performance. The company reported significant operational headwinds, particularly in gross margin due to manufacturing changes, footprint optimization, and inefficiencies in ramping new production facilities, but expects improvement in the second half as projects conclude and volumes rise. The Facet acquisition, the largest in company history, is positioned to immediately enhance profitability with high recurring revenue and superior margins. Upcoming CEO transition to Rich Lewis was announced, marking completion of a long-term succession plan.

• Management emphasized Facet's high recurring sales base and anticipated mix benefits to gross margin and EBITDA, stating, "Facet will make us stronger strategically and financially."
• Share gains in key markets were cited as supporting aftermarket and disk drive success, while backlog growth, especially in Aerospace and Defense, was described as robust, with post-October A&D backlog up over 20%.
• Operating expense controls and prior cost programs were reported as key drivers for holding adjusted EPS flat despite margin pressure.
• Power generation order book remains booked through the end of the fiscal year and into the next two years, with capacity expanded in Mexico to meet surging demand from data centers and energy applications.
• Mobile Solutions backlogs grew sharply after year-end inventory normalization among OE customers, positioning the segment for stronger second-half growth.
• Management noted "green shoots" in truck and agriculture first-fit markets may support sequential improvement late in the year, with a pronounced and fast return expected once underlying conditions shift.
• The Life Sciences segment's expansion into disk drive filters for HAMR technology and liquid cooling for data centers is leveraging existing filtration technology for new high-growth verticals.

Industry glossary

• IFS: Industrial Filtration Solutions, a sub-segment focusing on industrial air filtration, power generation, and related filtration systems.
• HAMR: Heat-Assisted Magnetic Recording, an advanced magnetic storage technology that increases the density and capacity of hard drives, requiring specialized air and gas filtration.

Full Conference Call Transcript

Tod Carpenter: Thanks, Sarika. Good morning, everyone. Donaldson Company, Inc. achieved record sales in the second quarter as we worked hard to meet strong customer demand across all three of our segments. Our underlying business is robust as evidenced by our high backlogs and continued strong order intake. While we faced short-term execution challenges in our Industrial segment, we saw strength in areas such as independent aftermarket within Mobile Solutions and Food and Beverage and disk drive within Life Sciences. We also announced the acquisition of Facet, the largest acquisition in company history, which I will discuss in a few minutes.

Entering the second half of the year, I have confidence in the strength of our organization and our commitment to deliver on our updated fiscal 2026 outlook, which represents record sales of approximately $3.8 billion with operating margin and adjusted earnings per share at all-time highs. Throughout our history, our talented global teams have demonstrated a commitment to deliver for all of our stakeholders, including our customers, shareholders, and employees.

We continually do this through our leadership position in filtration, which was built on decades of solving our customers' most difficult filtration problems; our best-in-class technology uniquely powerful because we focus on filtration capabilities and then leverage these technologies across markets; our ability to help customers meet evolving environmental goals by helping to protect equipment, processes, and people; and our clear, strategic, and balanced growth strategy. This is how we have and will continue to win. In late January, we announced our next President and CEO, Rich Lewis, effective next week on March 2.

This transition reflects a long-term succession planning process that comes at a time when we are well positioned for the future thanks to the talent, dedication, and discipline of our global team. Rich has been with Donaldson Company, Inc. since 2002 and has been our Chief Operating Officer since August. On behalf of the entire organization, I want to congratulate him and I look forward to his future success. Before I turn it over to Rich to discuss our second quarter results in more detail, I want to touch on our recent acquisition of Facet, which we are very excited about.

This acquisition complements and expands Donaldson Company, Inc.'s product portfolio, bringing high-performance fuel and fluid filtration capabilities for mission-critical applications and broadening our exposure to durable end markets such as aerospace and defense, and power generation. Importantly, approximately 70% of Facet's revenue is driven by recurring, regulated replacement part sales, a nice fit with our already large composition of replacement parts. Facet makes us stronger, adding nearly $110 million in sales with gross margins and EBITDA margins significantly above our current company average. The company has low capital intensity and strong cash flows. We look forward to welcoming the Facet team to Donaldson Company, Inc. and reporting on our combined performance.

Now I will turn it over to Rich, who will talk more about the second quarter highlights, and then Brad will take us through the financials in more detail. Rich?

Rich Lewis: Thanks, Tod. Good morning, everyone. First, I would like to thank Tod for his leadership and congratulate him on his successful Donaldson Company, Inc. career, including his impact as CEO over the past 11 years. I am honored to step into the CEO role and look forward to working alongside our broader leadership team to build on our momentum and deliver for our stakeholders. I also look forward to my continued partnership with Tod as he transitions to the Executive Chairman position. Now I will cover our second quarter results. At a high level, sales were a record $896 million, 3% above prior year, with growth across all three segments.

Currency translation and pricing benefits were partially offset by volume declines in both Mobile and Industrial Solutions. Operating margin was 14%, down from 15.2% a year ago as a result of gross margin pressure. Volume deleveraging, concentrated operational inefficiencies related to our production shifts to support higher demand in power generation, and footprint optimization costs negatively impacted gross margin in the quarter. Adjusted earnings per share were $0.83, flat versus the record achieved in 2025. Now looking at our segments, Mobile Solutions sales were $557 million, up 2% driven by currency benefits. Aftermarket sales were $447 million, up 1% with high single-digit growth in our independent channel, offset by OE channel declines.

Overall, we are benefiting from share gains and increases in global vehicle utilization. On the first-fit side, Off-Road sales of $86 million increased 8% as we cycle against weak market conditions from prior year, particularly in agriculture. On-Road sales of $23 million decreased 9% as a result of continued declines in global truck production. Touching on our mobile business in China, sales were up 8% due to strength in Off-Road and aftermarket. This marks our sixth consecutive quarter of growth in China, and we are optimistic about the future opportunities in this important market. In Industrial Solutions, sales were $260 million, a 2% increase compared with 2025, driven by currency benefits.

IFS sales of $223 million grew 7% from continued strength in power generation, particularly in North America and Europe, and demand for new equipment remains significant. Rounding out our Industrial Solutions performance, Aerospace and Defense sales were $37 million, down 19% versus prior year due to project timing, primarily in defense. In Life Sciences, sales of $80 million increased 16% year over year largely as a result of robust growth in Food and Beverage and disk drive. In Food and Beverage, our largest business within Life Sciences, new equipment sales grew substantially in all regions, laying the foundation for future replacement part sales growth.

We continue to win, including in areas such as liquid cooling for data centers, and we are winning with key OEMs and channel partners through our strong sales processes and technology-led products. Given our second quarter results and our expectations for the second half of the year, we are updating our margin and earnings outlook for fiscal 2026.

At the midpoint of our revised guidance ranges, we continue to expect a record year for Donaldson Company, Inc., now inclusive of record sales of $3.8 billion and sales growth in each of our segments, consistent with our previous expectations; operating margin expansion of 50 basis points to an all-time high of 16.2%, including second-half operating margin consistent with our prior guidance; earnings per share of $3.97, roughly 8% above prior year; and free cash flow conversion of approximately 90%, which provides us capital allocation optionality to return value to our shareholders.

In summary, I am proud of the agility and resilience displayed by the Donaldson Company, Inc. team as we navigate some short-term operational headwinds to set ourselves up for stronger performance over the long term. With that, I will now turn it over to Brad, who will provide more details on the financials and our outlook for fiscal 2026. Brad?

Brad Pogalz: Thanks, Rich. Good morning, everyone. I want to start by thanking the Donaldson Company, Inc. team. They demonstrated tremendous agility as we worked to deliver for our customers while making progress on several big projects, including the work done on the Facet acquisition. Facet will be an important addition to our company. We expect to close in the next couple of quarters, and as Tod mentioned, Facet will make us stronger strategically and financially. Beyond Facet, we are focused on delivering the strong second-half performance reflected in our guidance. But first, a summary of our results. Note that my profit comments exclude the impact from the nonrecurring charges Sarika referenced earlier.

Total sales increased 3%, and adjusted EPS of $0.83 was flat year over year. Operating margin declined 120 basis points to 14% due primarily to the impact from discrete operational issues on gross margin. Second quarter gross margin was 33.7%, down 150 basis points from the prior year and below our expectations. About 60 basis points of the total gross margin decline was due to deleveraging from lower volume in the Mobile and Industrial segments. We anticipated some year-over-year gross margin pressure in the quarter; there were certain businesses, particularly OE aftermarket and defense, with difficult comparisons from last year. But the timing of orders and delivery had a greater impact than planned.

For fiscal 2026, we expect the volume pressures to abate based on our strong backlogs and the leverage that comes with our typical second-half sales step-up. Second quarter gross margin was also impacted by inefficiencies driven by changes we are making to our manufacturing footprint. One item that spiked this quarter relates to power generation, and specifically the production of our large turbine systems. To meet the super-cycle demand and deliver on customer-specific requirements of producing in North America, last year we began producing these large systems for the first time at one of our facilities in Mexico.

The combination of a protracted start-up process in Mexico and surging demand resulted in a gross margin headwind of about 40 basis points in the quarter. We have plans in place to accelerate our improvement and expect to make progress in the second half of this fiscal year. Another area where we expect improvement in the second half relates to our ongoing footprint optimization initiatives. This fiscal year is an important milestone for this work, with the most significant projects expected to be completed, and the work has driven about 30 basis points of gross margin pressure as we go through the final stages of a plant closure in the U.S. and associated transfer of production.

Once through this heavy-lift period, we will begin to realize cost benefits later in this fiscal year and into the future. While gross margin in the second quarter was not to our expectation, the drivers of the performance reflect short-term headwinds from the work we are doing to establish long-term efficiencies in several of our most important businesses. Our forecast contemplates sequential improvement in gross margin and full-year expansion. I am confident we will deliver on that target. At the same time, our team continues to do an excellent job managing our operating expenses.

As a rate of sales, operating expenses improved to 19.7% from 20% a year ago, reflecting benefits from the structural cost optimization initiatives launched during the prior fiscal year as well as continued expense discipline. We are prioritizing opportunities while conserving where we can, providing necessary offsets to the footprint work we are doing. In terms of segment profitability, Mobile Solutions pretax profit margin was 16.8%, down 60 basis points from prior year, primarily due to volume deleveraging in the aftermarket OE channel and footprint optimization efforts. Industrial Solutions pretax margin was 11.9%, down from 16.1% in 2025, stemming from the previously mentioned operational inefficiencies and footprint optimization costs.

With improving plant efficiency and benefits from leverage on higher sales, we expect Industrial pretax operating margin to step up notably in the second half. Life Sciences pretax margin improved to 9.3% from a loss of about 1% a year ago. Strong sales in our higher-margin Food and Beverage and disk drive businesses, and benefits from a more focused expense structure following optimization programs a year ago, drove the improvement. Turning to our fiscal 2026 outlook. First, on sales, we are reaffirming our consolidated sales guidance of 1% to 5% growth, with stronger-than-expected sales in Mobile Solutions and Life Sciences being offset by lower Industrial Solutions sales.

Our forecast assumes pricing and currency translation will each contribute about 1% to growth. Within Mobile Solutions, we are increasing our growth forecast to a range between flat and 6%, compared with flat to up 4% previously, primarily due to favorable currency. We are raising our guidance for aftermarket and now expect sales up mid-single digits versus our previous low single-digit forecast, primarily due to strength in our independent channel from currency, pricing, and volume. Consistent with our prior guidance, Off-Road sales remain on track to grow mid-single digits, mainly due to a modest rebound following significant declines in agriculture a year ago.

On-Road sales are expected to be flat for the year, also in line with our prior guidance, due to muted global truck production. In Industrial Solutions, sales are forecast between a decline of 1% and an increase of 3%, versus the previous expectation for growth between 2% and 6%. Sales of IFS are now expected to grow in the low single digits, down from mid-single digits previously, due largely to declines in sales of dust collection and industrial hydraulics systems. Aerospace and Defense sales are projected to decline mid-single digits versus flat previously, due to the timing of certain programs.

In Life Sciences, we are increasing our sales forecast as benefits from favorable currency translation are expected to complement already-strong Food and Beverage and disk drive momentum. To that end, we project sales to increase between 5% and 9%, versus a 1% to 5% increase previously. We expect benefits from sales leverage and continued cost discipline to generate full-year pretax margin in the mid- to high-single digits, up from mid-single digits previously. Given our second quarter performance and our outlook for the balance of the year, we revised our operating margin guidance to a range between 16% and 16.4%, a decline of 30 basis points at the midpoint from our prior forecast.

Despite the temporary gross margin headwinds in second quarter, the full-year operating margin forecast still reflects a record level and, at the midpoint, an incremental margin approaching 35%. With that change, we now expect fiscal 2026 EPS between $3.93 and $4.01 per share. At the midpoint of $3.97, we are projecting EPS growth of 8% on 3% sales growth. Our earnings guidance contemplates a second-half step-up in sales supported by our strong backlogs as well as gross margin expansion resulting from the operating improvements I discussed earlier. Now on to our balance sheet and cash flow outlook.

Our capital expenditures are expected to be between $60 million and $75 million, with focused investments including new products and technologies across all verticals. We continue to project cash conversion in the range of 85% to 95%, an improvement versus 2025 and consistent with historical averages. The balance sheet remains a strength of Donaldson Company, Inc., with our net leverage ratio currently at 0.7 times. Adjusting for the Facet acquisition, Donaldson Company, Inc. would have a net leverage ratio of approximately 1.7 times, still leaving us ample financial flexibility to thoughtfully invest for our future growth. As we think about shareholder value creation for the long term, our capital allocation priorities are unchanged. First, reinvest back into the company.

We are the leader in technology-led filtration and intend on maintaining our position. R&D investments in strategically important high-growth, high-margin areas where we have a clear path to win will drive our returns. Our longer-term efforts are also supported by ongoing working capital investments and capital expenditures. Our second capital deployment priority is disciplined M&A. We actively work through a pipeline of opportunities. Discipline is key to our approach. We are excited about our Facet acquisition and look forward to pursuing additional opportunities that meet our strategic and financial criteria. We are creating long-term value through our growth investments, but also through the return of cash to our shareholders. Our third capital allocation priority is dividends.

Calendar year 2025 was our 70th year in a row of paying dividends and the 30th in a row of increasing our dividend. We have every intention of maintaining our status as a proud member of the S&P High Yield Dividend Aristocrats Index. Share repurchase is our fourth capital deployment priority, and it has always been the variable component. Given the pending close on our acquisition of Facet, we do not expect to repurchase additional shares in the balance of this fiscal year. Year to date, we have repurchased 1.2%, which offsets dilution, and our focus now is using the strength of our business to rapidly pay down debt.

Looking beyond the quarter, the underlying fundamentals of our business are strong, and we have the right priorities to deliver another year of profitable growth and value creation. Now I will turn the call back to Tod.

Tod Carpenter: Thanks, Brad. As I sit and reflect today, I am particularly pleased with Donaldson Company, Inc.'s continued evolution as a premier global provider of technology-led filtration solutions, and I am excited for the opportunities that lie ahead. It has been a privilege to be part of this organization for the last 30 years and an honor to have led the company for the last 11. I will not be far away as I take on the role of Executive Chairman. I am highly confident in our teams around the globe who make Donaldson Company, Inc. what it is and who I know will reach new heights under Rich's leadership.

With that, I will now turn the call back to the operator to open the line for questions.

Krista: Thank you. We will now open for questions. Your first question comes from the line of Angel Castillo with Morgan Stanley. Please go ahead.

Oliver (for Angel Castillo, Morgan Stanley): Hi. Good morning. This is Oliver on for Angel today. Can I just double click on A&D? I know you have it down here for 2026. Is that because of projects shifting into 2027, or something to do with underlying demand? And then how should we think about your guide versus what you are seeing for Facet? Is that just a product of different portfolios and aftermarket?

Rich Lewis: Hey. Good morning, Oliver. This is Rich. I will take your first question. When you think about A&D, we are coming off record sales levels the last couple of years, and clearly, we have had suppressed revenue in the first half of the year. It is really a combination of two things. We have some timing issues on some of our military projects. These can be lumpy. We also have supply chain challenges as well that are ongoing. I would say this: overall, we are very comfortable with the order intake. If you think about the backlog of this business sort of post-October, it is up over 20%. So orders are coming in nicely.

We feel really good that the second-half run rate is going to significantly improve. The name of the game is really going to be working with our suppliers and making sure we can ship all the orders. Some of these suppliers are single-sourced, directed buys. We are trying to qualify new suppliers. These projects can take quite some time. But overall, it is really about muscling through this order book. So we will see a significant step up in the second half. And then as far as Facet goes, we do play in different parts of the market. They are exposed to different types of programs. They are more military fixed wing. There are also a lot of marine.

We tend to be more ground vehicle. And so we play in different parts of the market. But we will start to see improved performance in the second half on the revenue.

Oliver (for Angel Castillo, Morgan Stanley): Great. That is really helpful. And then just maybe one follow-up on Industrial. I know some footprint changes this quarter. Do you expect that to continue, or abate somewhat into fiscal Q3 and Q4? And then can you talk a little bit about what that buys you in terms of PowerGen? Does that potentially expand throughput or potentially even a bigger portfolio there? Any color there would be helpful.

Rich Lewis: Sure. Let us take the footprint optimization work. I know we have been talking about this for a while. These projects are pretty complex. They typically last 12 to 24 months. We have had an accelerated amount of activity in this space over the last couple of years. Just to put it into perspective, we have four plant closures that we have been working on, none of which touch PowerGen. It is other parts of the Industrial business. Two of these are in their final phase, which basically means the plants are closed, the assets have been transferred to the new location, and they are working through the learning curve and the productivity increase.

We would expect that work to come to a conclusion in the balance of the fiscal year. We also have two other ones. We will close those plants in quarter three, and they will be working through the learning curve and the productivity increase in Q4. Maybe a way to think about it is you will start to see the benefit, the margin improvement benefit, in our guide in fiscal 2027. We also do these projects for a couple of reasons. We are trying to reduce our asset base. We are also trying to reduce or improve our risk profile. So we believe these projects ultimately will be very successful.

But we do have a few more months here of work ahead of us.

Krista: Your next question comes from the line of Brian Blair with Oppenheimer. Please go ahead.

Brian Blair: Thank you. Good morning, everyone. Tod, congratulations on a very successful career, including over a decade as CEO, and Rich, congrats on the transition.

Tod Carpenter: Thanks, Brian.

Brian Blair: Of course. I was hoping that you could offer a little more color on how IFS orders trended through fiscal Q2 and what your team is seeing thus far in Q3. Year-on-year growth was stronger sequentially, aligning with the prior guidance framework of mid-single-digit growth. PowerGen, some inefficiencies in the second quarter, certainly a good guide in terms of growth path. Brad, I know you called out dust collection and hydraulic systems as the areas of relative weakness. Can you offer some finer points on whether there is accelerated weakness through fiscal Q2 and Q3 in those areas, or you are simply taking a more cautious or conservative stance on continued macro uncertainty?

Rich Lewis: Yes. Maybe I will take the business side, the macro, and then if Brad wants to add anything on the numbers, he can weigh in as well. If we sort of disaggregate IFS, you mentioned it. PowerGen is clearly very, very strong right now. Just at a big picture, we are booked through the end of the fiscal, and we have loaded fairly solid bookings already the next two fiscal years. So we are feeling really good about the demand on PowerGen, and it is pretty broad-based. We are seeing it across sort of the compressed gas side on the oil and gas piece and on peak and baseload energy generation.

A lot of that is tied to the data center push that is going on. On the IAF side, yes, we are seeing it is a bit mixed. Globally, we see relatively decent order patterns outside of the Americas. The Americas have been pretty soft. We are still seeing a fair bit of quoting activity in the Americas. I think the uncertainty in the economy is driving people to be cautious on pulling the trigger on POs. On the board, if you look at replacement parts, those continue to perform very well. We see good utilization rates and good order intake on the replacement side.

Brad Pogalz: Brian, this is Brad. I will just add. I think as you look at the first couple of quarters, dust collection is about where it was in second quarter in terms of the overall year-over-year conditions. So not much to comment there, but I do want to underscore a point Rich made. It is really about our new systems and the first-fit side of the business. The machines are still running. Aftermarket is still doing well in IFS, and we have good opportunities there with our replacement. It is just about getting these capital expenditure decisions of our customers to break free a little bit.

Brian Blair: Understood. It is helpful color. Facet is an intriguing deal, their team certainly mix-enhancing. Can you speak to the historical growth rates of the asset, whether we should expect accelerated growth under Donaldson Company, Inc. ownership, and if so, what the drivers are there? Then how we should think about P&L impact looking to fiscal 2027? I know you had said close within the next couple of quarters, so sometime in the fiscal back half. But if we look to next year, how should we think about impacts? Thank you.

Rich Lewis: Maybe I will just take a step back, if it is okay, and just talk a little bit about Facet from a broader perspective. We are really excited about Facet potentially joining the Donaldson Company, Inc. family. Obviously, we will continue to work through the regulatory process to close the deal in the next couple of quarters. But this is a business that we have been following and, frankly, admiring for a long time. It is a perfect fit for what we are trying to do on the M&A side. So it is high-level recurring filtration revenue. They have a durable competitive advantage given the regulatory nature of their end market. And it sits in a high-margin, high-growth business.

We will talk about the growth rates here in a second. And as we have gotten to know the team there, we think it is also a very good fit culturally. Really good folks, very committed to their customers. Deep, deep knowledge. Now the growth rate, so as we put in the deck that we posted on our website, they are high single digits, and it is a mix of volume and pricing. And we would expect that to continue. They have a lot of potential growth opportunities outside of their core military and commercial markets on the aerospace side. And those are a lot of markets that we play well in on our Industrial.

So we hope over time that we will find significant growth synergies. We have not baked that into our expectations. That is all upside. But yes, it is going to be a good fit for us, and we are really excited about it.

Brad Pogalz: Brian, on the P&L side then, obviously, we expect to close in a couple of quarters, so nothing factored into the fiscal 2026 guidance. But you mentioned fiscal 2027 as we think ahead. I think the important point that we said in the prepared remarks is that it is mix-positive on our most important operating metrics: gross margin and EBITDA. Obviously, this is a business that we will work to integrate properly. We do not have much in the way of cost synergies, a few million dollars, but more from procurement, because it sits in a unique spot relative to where we sit in these markets.

So I think overall, we will get more detail with fiscal 2027 guidance, but we are excited about this from the strategic side that Rich mentioned and the financial implications to Donaldson Company, Inc.

Brian Blair: All makes sense. Thanks again.

Krista: Your next question comes from the line of Tim Thein with Raymond James. Please go ahead.

Tim Thein: Thank you. Good morning, and congrats again to both Rich and Tod. And, Tod, I am hopeful that you are able to observe its turnaround and go for basketball in retirement. So

Tod Carpenter: Thanks. Thanks, Tim.

Tim Thein: Only one way to go. The question is on the mobile business. Based on the full-year guide, would it imply that the growth in that line picks up a little bit in the second half? Maybe you can just talk about the strength and continued strength in the independent channel. Just maybe what you are seeing and hearing from the OEM dealers. And then looking out a bit, eventually as the first-fit business hopefully rebounds, how would you expect the interplay between those two? Maybe just what you have observed historically when you start to see the first-fit side begin to pick up.

Rich Lewis: Thanks, Tim. Maybe let me break this down. Let us talk about the replacement part side for a second. As you pointed out, the replacement part orders through our independent channel have been very strong. We still continue to see that performance continuing. No slowdown there at all. When we think about the OE side, this year we returned to what I would call a typical, normal year-end, their fiscal year-end, inventory management practices. So we did see a pretty good pullback relative to the prior year where we actually saw people stocking up, which was pretty atypical. So year over year, it was a pretty drastic change.

What we always look for is when you come out of those holidays, what happens with your backlogs, and we saw a sharp increase. Unlike our independent aftermarket, which is really you get orders, you ship them within 24 hours, our OE partners do give us really good visibility on lead times. And we have seen a sharp increase in our hard backlogs on the OE. So we are really confident second half will be a significant improvement there. Maybe touching on the first-fit markets. If you think about ag and truck, they still continue to be performing near what we would call bottom of the cycle.

We are monitoring this closely because when these markets come back—and hopefully this answers your question—they come back aggressively. Think 20% to 30%, and we want to be really ready to make sure we address our customers' needs. So we are staying very tight with our customers on that. I will say we are seeing signs of optimism in ag with some increased order intake on the first-fit side with select OEs, but it is not broad-based at this point. Also, in the truck market, we are having signals from some of our truck manufacturers that in the second half of calendar year 2026—so which would be our fiscal year 2027—they are planning for increased truck builds.

I would say we remain cautious on this and being ready for the upturn because when it does happen, it happens aggressively. But that is how we would characterize the markets as we sit here today.

Tim Thein: That is great. That is super helpful. And then maybe, Brad, just how to think about the mix impact on margins in that segment as that growth again, as you outlined, if and when that begins to come in? I am sure there are multiple variables that go into that, but any help you can give on that in terms of how we should be thinking about incrementals as that mix eventually normalizes?

Brad Pogalz: Sure. You hit the main point. It is multivariable, but there is a mix impact as we sell more to the OEs and especially on the new equipment as that comes back. But honestly, to Rich's point, that is something that we are getting ready for. And while we may have a little bit of a rate mix impact that we talk about in future quarters, the earnings will flow to the bottom line from that, and I think we will get very nice leverage on it as it moves through the P&L.

And then the other side—and it is a modest tangent to your question—but to the point Rich made about these markets, I think we will also see some bounce back in the Mobile Solutions segment in the quarter. There was a part of my script where I talked about the volume deleveraging. This will bounce back. So when we think specifically about the second half of the year, we would expect Mobile Solutions profit acceleration from here as the volume starts to come in as well.

Tim Thein: Very helpful. Thank you, guys.

Krista: Your next question comes from the line of Adam Farley with Stifel. Please go ahead.

Adam Farley: Yes. Good morning, everyone.

Rich Lewis: Hi, Adam. Good morning.

Adam Farley: I believe, can we go back to the operating efficiencies in power generation? I just wanted to put a finer point on what exactly happened there. What was the underlying cause? And then expectations on how that ramps going forward.

Rich Lewis: Yes. I gave you the macro perspective on PowerGen. Clearly, the demand is very strong. We are in the middle of rebalancing our product portfolio across both sites so we can maximize output. We have moved production into our facility in Monterrey, Mexico. We have ramped that facility's capacity up significantly through a combination of process improvements, increased flow, and a dramatic increase in staffing. And so we are working through the learning curve and onboarding these employees. A lot of the hiring is behind us, and now it is really about training and onboarding these employees in the third quarter.

We do expect output from this site to continue to improve with this increased capacity, and their productivity will continue to get better throughout the fiscal year.

Adam Farley: Okay. Thank you for that detail. Then maybe one more on the pending acquisition of Facet. Could you talk about the total addressable market for Facet, Facet's market position, and primary competitors in this space?

Rich Lewis: From a competitor standpoint, they are one of the leaders. There are a couple of historic players that lead in this space, and then it fragments from there. They play in a lot of different markets. They are in the commercial, the marine, and military space. We believe there is a lot of headroom for continued growth, and some of the interesting opportunities are actually in what I would consider maybe our core industrial markets, which would be relatively new to them. And so there is a lot of space for us to grow this business over the coming years.

Adam Farley: Alright. Thank you for taking my questions.

Krista: Your next question comes from the line of Brian Drab with William Blair. Please go ahead.

Brian Drab: Hi, good morning. Thanks for taking my questions, and congratulations, Tod and Rich. I will follow up more with both of you later and save the sentimental stuff for the nonpublic call. Some of the strongest growth lately has been coming from the Life Sciences segment, of course, and I was wondering if you could talk a little bit about that disk drive business. I know you have talked about the HAMR technology in the past that is driving incremental demand for your products. What is the—even though the growth is so strong lately, I am wondering—could that accelerate? Could that business be much bigger? And how tied are you to the data center build-out?

And can you talk a little bit about the business, who your customers are, and what the TAM is for you in that space?

Rich Lewis: Yes. Brian, as you point out, the Life Sciences business has been doing very well. We restructured that business last year to bring more focus, and the two largest businesses, Food and Beverage and disk drive, have been really excelling. On the disk drive side, if you think about what is driving a lot of that demand, it is AI and cloud storage. There is a strong demand for drives in more and more dense storage. HAMR clearly addresses that. I would say our growth is a combination of market comeback and share gains. And we do believe that the market has runway to grow.

A lot of our customers are building at high utilization rates right now, and so as they bring on more capacity, the demand feels like it is there for the foreseeable future. So HAMR has been a big success so far. We have ramped that business up with one of our OE customers this year, and we look forward to that continuing to gain market penetration.

Brian Drab: And your technology or products that you are using in that application is what exactly? Can you just remind me?

Rich Lewis: Yes. It is a filter. In the early days, a filter that removed particles, much like some of the air filters, but as these drives have become way more sophisticated, we are doing absorption technologies that really take out harmful gas and fumes. These drives are very, very, very sensitive, and that is part of our share gain in this space. As the technology continues to increase, we were able to continue to differentiate our capabilities and take additional market share there.

Brian Drab: And then is there any detail that you can give on your liquid cooling exposure? I know you mentioned it today on the call again, but what products, technologies are you supplying there, and what is the potential addressable market for Donaldson Company, Inc. there?

Rich Lewis: Yes. On the liquid cooling, it is really an outgrowth of the products that we sell in Food and Beverage. Those products have applicability in several other process filtration applications, and this is one. We have seen a sharp uptick in interest. A lot of these data centers are converting from air cooling to liquid cooling, and our products fit very nicely with that. It is a pretty fragmented market right now because there are really no clear standards on the systems. And so I would say it is a bit early to judge how big it is going to be, but certainly we are seeing a lot of activity and a lot of interest in that space.

Brian Drab: Okay. I will leave it there. Thank you very much.

Krista: Your next question comes from the line of Laurence Alexander with Jefferies. Please go ahead.

Laurence Alexander: Good morning. Just two quick ones. First, on the PowerGen side, can you give some perspective on how you think the competitive market has changed, or the competitive landscape has changed, since the last cycle? And how much more capacity expansion do you think you would need to do to keep up with the order books that have been announced by the equipment makers? And secondly, on the acquisition, what is your time frame for the acquisition to get to an acceptable return on capital?

Rich Lewis: I will take the PowerGen, and then I will let Brad address the second question. From a PowerGen perspective, the demand is very, very high. I would say the dynamic that is different now is, as you are aware, we sort of narrowed our focus after the last cycle. We are seeing more interest in being fair and balanced with the commercial deals. And so we will continue to take orders that make sense for us commercially. We are increasing our capacity in our Mexico facility fairly significantly, and so we believe we are in a good position to address our customers' needs.

They have many other constraints besides our product, and so it feels like we are well aligned with what their build capability is right now.

Brad Pogalz: Laurence, this is Brad. In terms of the returns, this is much more of a strategic acquisition than a synergy play. And with that, thinking about it on a cash basis, probably more at our cost of capital in the five-year time horizon. I think the really positive side of this business is it is throwing off cash immediately. We get to earnings accretion pretty rapidly. We said year two, and of course our goal is to make that even faster.

Laurence Alexander: Thank you.

Krista: Your next question comes from the line of Rob Mason with Baird. Please go ahead.

Rob Mason: Yes. Good morning. And Tod, Rich, I will offer my congrats on passing the baton there as well.

Rich Lewis: Thank you.

Rob Mason: Rich, I think in your comments earlier, you talked about the second-half margin outlook did not really change in the updated guidance. But it does sound like there is more work to do on the footprint optimization effort. To just give us a feel for the confidence level around the ability to ramp margins, whether that means the third-quarter margin step up more meaningfully or if that happens more in the fourth, and just the confidence level to keep that second-half margin outlook intact, given the second-quarter challenges.

Rich Lewis: I think you hit on it, Rob. Clearly, we need to see the volume come back in our OE Aerospace and Defense businesses. We have those backlogs, so we feel really confident on that part. We will have to continue to fight through the supply chain issues on the A&D, but the team is really focused on that, and they are working hand in hand with our suppliers. So that part of it, we feel pretty strongly that we are in good position. The restructuring work, as I mentioned, a couple of these are done. And so we should start to see the costs go down and some of the benefits start to feather in.

Probably the risk there is if there is a delay or any unexpected problems. The other two are still ongoing in Q3. But right now, we are on track, and certainly, we would expect to have those finished up here by the end of the fiscal for sure. And then PowerGen, as we mentioned, we have doubled the work down there just in our first quarter. And so we feel good. The turnover is low. The staffing is starting to become productive. So we need to see continued progress on that in the second half.

But based on all the observations and with the team, we are well on track for them to continue to accelerate improvement through the second half of the year.

Brad Pogalz: Rob, I am going to add one point too, and I think an important note here is as we look at the second-half step up, some of that comes with expense leverage as well. We have got really good controls over what is going on with expenses in the company. When you think about the improvement in the second half, a big portion of that also comes from the natural leverage. So as Rich said, we have the backlogs to deliver the sales. We will keep expenses at a rate that is, give or take, or at a dollar level it is, give or take, where we were in the first half.

So there is the leverage that comes with that too.

Rob Mason: Okay. Very good. That is actually my next question. Just the jumping-off point there, given second-quarter OpEx stepped down sequentially. Maybe just last question. Thought process—again, it is a smaller business, I understand, on the first-fit side. We are certainly aware of the On-Road truck challenges, but to reach flat for the year does infer that you see some recovery in that business. Should we just be putting all that recovery, sequentially, in the fourth quarter?

Brad Pogalz: Yes. I think the move toward the second half and late in the second half is it. I will—of course, Rich said this earlier about the trough. We are seeing some green shoots out there. I think that public data sources that many of us follow suggest even an increase in truck production in Class 8 heavy-duty in North America this year. So there are some things that give us encouragement. On top of it, we talked last quarter about some of the moves of programs within this business that we have won. I think that is an important part of our first-fit business. We are still gaining share with the OEs.

So to the extent that production comes back, that is just incremental growth for us.

Rob Mason: I see. Thank you.

Krista: And that concludes our question-and-answer session, and I will now turn the conference back over to Rich Lewis for closing comments.

Rich Lewis: That concludes our call today. Thanks to everyone who participated. We look forward to reporting our third quarter fiscal 2026 results in June. Goodbye.

Krista: Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation, and you may now disconnect.

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