News Column

DONALDSON CO INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

June 6, 2014

The Company is a worldwide manufacturer of filtration systems and replacement parts. The Company's core strengths are leading filtration technology, strong Customer relationships, and its global presence. Products are manufactured at 39 plants around the world and through three joint ventures.

The Company has two reporting segments: Engine Products and Industrial Products. Products in the Engine Products segment consist of air filtration systems, exhaust and emissions systems, liquid filtration systems including hydraulics, fuel and lube, and replacement filters. The Engine Products segment sells to original equipment manufacturers (OEMs) in the construction, mining, agriculture, aerospace, defense, and truck markets, and to independent distributors, OEM dealer networks, private label accounts, and large equipment fleets. Products in the Industrial Products segment include dust, fume, and mist collectors, compressed air purification systems, air filtration systems for gas turbines, PTFE membrane-based products, and specialized air and gas filtration systems for applications including computer hard disk drives and semi-conductor manufacturing. The Industrial Products segment sells to various industrial dealers, distributors, OEMs of gas-fired turbines, and OEMs and end-users requiring clean air. The following discussion of the Company's financial condition and results of operations should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto and other financial information included elsewhere in this report. Overview The Company reported diluted net earnings per share of $0.46 for the third quarter of Fiscal 2014, consistent with the same period of the prior year. Net earnings for the current quarter were $67.3 million, compared to $69.8 million in the three months ended April 30, 2013. The Company reported sales in the third quarter of Fiscal 2014 of $624.2 million, an increase of 0.8 percent from $619.4 million in the third quarter of the prior year. The impact of foreign currency translation decreased reported sales by $0.6 million, or 0.1 percent, in the quarter. The Company saw end market conditions remain mixed, as demand for its replacement filters continued to improve in both the Company's Engine and Industrial segments, while conditions for new first-fit systems in the Company's OEM markets recovered more slowly than the Company had anticipated. The Company's Engine Products' sales increased 4.9 percent from last year, driven by its Engine Aftermarket, which grew 10.4 percent and On-Road sales, which grew 9.2 percent, compared to the prior year period. The Company's Industrial Products' sales decreased 5.9 percent. Gas Turbine sales decreased 38.9 percent as a result of an anticipated slowdown in new project sales, but were partially offset by sales growth in the Company's Industrial Filtration Solutions and Special Applications businesses, which grew 9.5 percent and 2.0 percent, respectively, compared to the prior year period. The Company's operating margin for the quarter decreased from 15.9 percent in the prior year quarter to 14.9 percent. Positively impacting operating margin were favorable mix impacts from the decline in large Gas Turbine project shipments and higher aftermarket sales. The Company also benefitted from its ongoing Continuous Improvement initiatives, which include Lean, Kaizen, Six Sigma, and cost reduction efforts. More than offsetting these margin improvements were slightly higher expenses from its multi-year implementation of a global enterprise resource planning system project (Global ERP Project) and increased incentive compensation. For additional information, refer to the gross margin and operating expenses discussions below.



Results of Operations

The Company's overall sales increased compared to the third quarter of the prior year. The Company continues to see signs of stabilization in many of its equipment end-markets, while demand for replacement filters is growing. Compared to the prior year, the Company experienced a 38.9 percent decrease in its Gas Turbine sales from last year's third quarter sales of $68.7 million. As we have discussed previously, we had a surge in our gas turbine shipments last year, and the overall industry is now absorbing that new electrical generation capacity, driving the current decrease over the prior year period. The Company's sales decreased in Asia by $7.9 million, or 5.9 percent, offset by sales increases in Europe of $15.9 million, or 9.1 percent, and the Americas of $0.8 million, or 0.3 percent, compared to the third quarter of the prior year. 14 -------------------------------------------------------------------------------- The impact of foreign currency translation during the third quarter of Fiscal 2014 decreased net sales by $0.6 million, or 0.1 percent, from the prior year third quarter. Although foreign currency translation had a minimal impact at the consolidated level, Europe experienced benefits from foreign currency translation, which was partially offset by negative foreign currency translation impacts in Asia and certain other emerging market economies. The impact of foreign currency translation on the year-to-date results as of the end of the third quarter of Fiscal 2014 decreased net sales by $16.2 million, or 0.9 percent. Worldwide sales for the third quarter of Fiscal 2014, excluding the impact of foreign currency translation, increased 0.9 percent from the third quarter of the prior year and year-to-date over the prior year. The impact of foreign currency translation decreased net earnings by $0.2 million, or 0.3 percent, and by $1.4 million, or 0.8 percent for the three and nine months ended April 30, 2014, respectively. Although net sales excluding foreign currency translation and net earnings excluding foreign currency translation are not measures of financial performance under U.S. GAAP, the Company believes they are useful in understanding its financial results. Both measures enable the Company to obtain a more clear understanding of the operating results of its foreign entities without the varying effects that changes in foreign currency exchange rates may have on those results. A shortcoming of these financial measures is that they do not reflect the Company's actual results under U.S. GAAP. Management does not intend for these items to be considered in isolation or as a substitute for the related U.S. GAAP measures.



Following is a reconciliation to the most comparable U.S. GAAP financial measure of these non-U.S. GAAP financial measures (millions of dollars):

Three Month Period Nine Month Period Percent Percent Change in Change in Net Sales Net Sales Net Sales Net Sales Period ended April 30, 2012 $ 647.2 NA $ 1,836.4 NA Net sales change, excluding foreign currency translation impact (17.8 ) (2.7 )% (3.4 ) (0.1 )% Foreign currency translation impact (10.0 ) (1.6 )% (28.6 ) (1.6 )% Period ended April 30, 2013 $ 619.4 (4.3 )% $



1,804.4 (1.7 )%

Net sales change, excluding foreign currency translation impact 5.4 0.9 % 17.0 0.9 %



Foreign currency translation impact (0.6 ) (0.1 )%

(16.2 ) (0.9 )% Period ended April 30, 2014 $ 624.2 0.8 % $ 1,805.2 0.0 % Three Month Period Nine Month Period Percent Percent Net Change in Net Change in Earnings Net Earnings Earnings Net Earnings Period ended April 30, 2012 $ 70.9 NA $ 193.3 NA Net earnings change, excluding foreign currency translation impact (0.4 ) (0.6 )% (16.6 ) (8.6 )% Foreign currency translation impact (0.7 ) (1.0 )% (1.9 ) (1.0 )% Period ended April 30, 2013 $ 69.8 (1.6 )% $ 174.8 (9.6 )% Net earnings change, excluding foreign currency translation impact (2.3 ) (3.3 )% 13.9 8.0 % Foreign currency translation impact (0.2 ) (0.3 )% (1.4 ) (0.8 )% Period ended April 30, 2014 $ 67.3 (3.6 )% $ 187.3 7.2 % 15

-------------------------------------------------------------------------------- Gross margin was 35.8 percent for the third quarter of 2014, consistent with the prior year period. Gross margin was 35.4 percent year-to-date, compared to 34.3 percent in the prior year. The increase for the nine-month period is primarily attributable to positive mix impacts from the reduction in large Gas Turbine projects, and a higher percentage of replacement filter sales which was due to strong utilization of existing equipment in the field and new business gains. Overall, product mix had a positive 60 basis points impact on gross margin. In addition, ongoing Continuous Improvement initiatives improved gross margin by approximately 60 basis points compared to the prior year period. Offsetting these benefits was the 10 basis points impact on margin from higher incentive compensation costs and indirect costs as the Company made higher investments in engineering and operations. Additionally, there were $0.1 million of restructuring expenses in the quarter. Purchased raw materials generally represent approximately 60 to 65 percent of the Company's cost of sales. Of that amount, steel, including fabricated parts, represents approximately 25 percent. Filter media represents approximately 15 to 20 percent and the remainder is primarily made up of petroleum-based products and other components. The cost the Company paid for steel during the three months ended April 30, 2014 varied by grade, but in aggregate it increased slightly compared to the prior year. The Company's cost of filter media also varies by type, but was generally flat compared to the third quarter of Fiscal 2013. The cost of petroleum-based products was generally flat over the prior year quarter. Currently, the market prices for steel and petroleum-based products are expected to increase slightly over the near term. The Company enters into selective supply arrangements with certain of our steel suppliers that allow us to reduce volatility in the Company's costs. The Company currently has steel purchase arrangements in the U.S. with durations ranging from three months to five months for approximately 70 percent of its requirements. The Company believes these arrangements will help reduce the impact of an increasing steel market through July 2014. The Company does strive to recover or offset all material cost increases through selective price increases to its Customers and the Company's Continuous Improvement initiatives, which include material substitution, process improvement, and product redesigns. Operating expenses were $130.7 million for the third quarter, up 6.4 percent from $122.9 million in the prior year period. As a percent of sales, operating expenses for the third quarter were 20.9 percent, up from 19.8 percent of sales during the prior year quarter. The increase in operating expenses as a percent of sales was primarily due to higher compensation expenses, incremental expenses related to our Global ERP Project, and increased travel and business meeting expenses, which contributed 150 basis points in total. These increases were partially offset by lower pension, insurance, and warranty expenses, which reduced our operating expenses as a percent of sales by 40 basis points. Operating expenses year-to-date were $382.9 million, or 21.2 percent of sales, compared to $375.5 million, or 20.8 percent of sales, in the prior year. Other income, net for the third quarter of Fiscal 2014 totaled $3.8 million, compared to $3.6 million in the third quarter of the prior year. Year-to-date other income totaled $10.2 million compared to $12.0 million reported in the prior year. The decrease was driven by $0.9 million of restructuring expenses related to the sale of a facility in Germany. In addition, the prior year included the impact of a favorable insurance recovery. These decreases were partially offset by an increase in foreign exchange gains of $1.3 million and an increase of $0.8 million in income generated from the Company's joint venture with Caterpillar. The effective tax rate for the three and nine months ended April 30, 2014 was 28.5 percent and 27.9 percent, respectively. The effective tax rate for the three and nine months ended April 30, 2013 was 29.8 percent and 29.2 percent, respectively. The decrease in our effective tax rate for the three months ended April 30, 2014 was primarily due to changes to the mix of earnings between tax jurisdictions. The decrease in our effective tax rate for the nine months ended April 30, 2014 was primarily due to a tax benefit associated with the favorable settlement of a tax audit. This benefit was partially offset by a tax expense related to an intercompany dividend and non-recurring tax benefits recorded during the prior year nine-month period primarily related to the expiration of some statutes of limitations, the retroactive reinstatement of the Research and Experimentation Credit in the United States, and the tax impact of foreign dividend distributions. 16



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Operations by Segment

Following is financial information for the Company's Engine and Industrial Products segments. Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments and interest income and expense. Segment detail is summarized as follows (thousands of dollars): Engine Industrial Corporate & Total Products Products Unallocated Company Three Months Ended April 30, 2014: Net sales $ 402,157$ 222,077 $ - $ 624,234 Earnings before income taxes $ 61,432$ 32,507 $ 243 94,182 Three Months Ended April 30, 2013: Net sales $ 383,314$ 236,057 $ - $ 619,371 Earnings before income taxes $ 65,680$ 37,555$ (3,759 ) 99,476 Nine Months Ended April 30, 2014: Net sales $ 1,160,948$ 644,292 $ - $ 1,805,240 Earnings before income taxes $ 170,799$ 91,682$ (2,630 ) 259,851 Assets $ 890,639$ 552,533$ 454,829 1,898,001 Nine Months Ended April 30, 2013: Net sales $ 1,107,814$ 696,540 $ - $ 1,804,354 Earnings before income taxes $ 152,129$ 102,709$ (7,835 ) 247,003 Assets $ 815,604$ 539,151$ 402,853 1,757,608



Following are net sales by product within the Engine and Industrial Products segments (thousands of dollars):

Three Months Ended Nine Months Ended April 30, April 30, 2014 2013 2014 2013 Engine Products segment: Off-Road Products $ 88,791$ 93,797$ 260,302$ 268,056 On-Road Products 33,081 30,288 95,398 96,207 Aftermarket Products* 255,818 231,747 729,052 668,264 Aerospace and Defense Products 24,467 27,482 76,196 75,287 Total Engine Products segment 402,157 383,314



1,160,948 1,107,814

Industrial Products segment: Industrial Filtration Solutions Products 137,364 125,447 401,642 386,475 Gas Turbine Products 42,005 68,733 110,106 182,295 Special Applications Products 42,708 41,877 132,544 127,770 Total Industrial Products segment 222,077 236,057 644,292 696,540 Total Company $ 624,234$ 619,371$ 1,805,240$ 1,804,354 * Includes replacement part sales to the Company's OEM Engine Products Customers. 17

-------------------------------------------------------------------------------- Engine Products Segment For the third quarter of Fiscal 2014, worldwide Engine Products sales were $402.2 million, an increase of 4.9 percent from $383.3 million in the third quarter of the prior year, driven by a 10.4 percent increase in Aftermarket Products. Sales in Europe increased by 12.9 percent, partially due to positive impacts of foreign currency during the quarter, and 4.6 percent in the Americas, somewhat offset by a decrease in Asia of 1.2 percent due to the negative impacts of foreign currency compared to the same period in the prior year. The impact of foreign currency translation during the third quarter of Fiscal 2014 decreased sales by $1.9 million, or 0.5 percent. Year-to-date worldwide Engine Products sales were $1,160.9 million, an increase of 4.8 percent from $1,107.8 million in the prior year period, driven by a 9.1 percent increase in Aftermarket Products and a 1.2 percent sales increase in Aerospace and Defense Products. Sales in Europe and the Americas increased by 13.8 percent and 4.4 percent, respectively, partially offset by a decrease in Asia of 2.8 percent compared to the same period in the prior year. The impact of foreign currency translation on the year-to-date results as of the third quarter of Fiscal 2014 decreased sales by $15.8 million, or 1.4 percent. For the three months ended April 30, 2014, earnings before income taxes as a percentage of Engine Product segment sales were 15.3 percent, a decrease from 17.1 percent in the prior year period. The decrease was primarily due to $2.0 million in incremental expenses related to incentive compensation, $0.6 million of incremental expenses related to the Company's Global ERP project, and $0.1 million of restructuring expenses in the quarter. Year-to-date earnings before income taxes as a percentage of Engine Products segment sales were 14.7 percent, an increase from 13.7 percent in the prior year. The percentage earnings increase for the nine months ended April 30, 2014 was driven by improved fixed cost absorption, due to an increase in production volumes, and the positive mix impacts from higher aftermarket sales, partially offset by $6.7 million of incremental expenses related to incentive compensation, $2.1 million of incremental expenses related to the Company's Global ERP project, and $0.9 million of restructuring expenses. Worldwide sales of Off-Road Products in the current quarter were $88.8 million, a decrease of 5.3 percent from $93.8 million in the third quarter of the prior year. Sales of Off-Road Products were down 3.2 percent from the third quarter of the prior year in the Americas, 1.6 percent in Europe, and 14.6 percent in Asia. Year-to-date worldwide sales of Off-Road Products totaled $260.3 million, a decrease of 2.9 percent from $268.1 million in the prior year. Year-to-date sales of Off-Road Products were down 5.9 and 10.1 percent from the prior year in the Americas and Asia, respectively. These decreases were partially offset by an increase of 5.5 percent in Europe. For the three and nine months ended April 30, 2014, the sales decreases were driven by continued weakness in mining equipment markets and softening in the agricultural equipment market, which were partially offset by an improving construction equipment market and sales of new and additional products per vehicle in Europe. Worldwide sales of On-Road Products in the current quarter were $33.1 million, an increase of 9.2 percent from $30.3 million in the third quarter of the prior year. Sales increased during the quarter 55.2 percent in Europe and 6.2 percent in Asia. The increase in the current quarter compared to the prior year period was due primarily to continued growth in Europe after the Euro VI diesel emissions regulations went into effect January 1, 2014. Year-to-date worldwide sales of On-Road Products were $95.4 million, a decrease of 0.8 percent from $96.2 million in the prior year. Year-to-date sales decreased 6.7 percent in the Americas and 5.1 percent in Asia, offset by a sales increase of 36.5 percent in Europe. For the nine months ended April 30, 2014, sales decreased primarily due to lower emissions sales in the Americas for an OEM program the Company no longer supplies totaling $5.0 million. Worldwide sales of Aftermarket Products in the current quarter were $255.8 million, an increase of 10.4 percent from $231.7 million in the third quarter of the prior year. Aftermarket Products sales during the quarter increased 17.2 percent in Europe, 11.8 percent in the Americas, and 4.7 percent in Asia. Year-to-date, worldwide sales of Aftermarket Products were $729.1 million, an increase of 9.1 percent from $668.3 million in the prior year. Aftermarket Products sales increased 15.4 percent in Europe, 10.6 percent in the Americas, and 1.8 percent in Asia. Sales for the three and nine months ended April 30, 2014, were primarily driven by increases in utilization rates of equipment fleets, increased sales of the Company's proprietary replacement filters, and expansion of the Company's product portfolio and distribution. PowerCore brand replacement filter sales contributed $2.7 million to the increase over the prior year quarter and $10.5 million year-to-date. 18 -------------------------------------------------------------------------------- Worldwide sales of Aerospace and Defense Products were $24.5 million, a decrease of 11.0 percent from $27.5 million in the third quarter of the prior year. Sales decreased 23.8 percent in the Americas, partially offset by a sales increase of 31.5 percent in Europe and 7.5 percent in Asia. For the three months ended April 30, 2014, the sales decreases were primarily due to the continued slowdown in U.S. military ground vehicle spending. Year-to-date worldwide sales of Aerospace and Defense Products were $76.2 million, an increase of 1.2 percent from $75.3 million in the prior year. Sales increased 30.7 percent in Europe, partially offset by a 6.3 percent sales decrease in the Americas and 21.6 percent in Asia. For the nine months ended April 30, 2014, the sales increases were mostly due to higher helicopter air filter sales, which increased $4.7 million, partially offset by the continued slowdown in U.S. military ground vehicle spending. Industrial Products Segment For the current quarter, worldwide sales in the Industrial Products segment were $222.1 million, a decrease of 5.9 percent from $236.1 million in the third quarter of the prior year. This decrease was driven by a 38.9 percent decrease in Gas Turbine Products, partially offset by sales increases in Industrial Filtration Solutions Products and Special Applications Products of 9.5 percent and 2.0 percent, respectively. Sales in Asia and the Americas decreased by 10.7 percent, and 9.7 percent, respectively, partly due to the negative impacts of foreign currency translation in Asia, partially offset by a sales increase in Europe of 4.2 percent, which was partly due to positive impacts of foreign currency translation. The impact of foreign currency translation during the third quarter of Fiscal 2014 increased sales by $1.3 million, or 0.6 percent. Year-to-date global net sales were $644.3 million, a decrease of 7.5 percent from $696.5 million in the prior year. This decrease was driven by a 39.6 percent decrease in Gas Turbine Products, partially offset by sales increases in Industrial Filtration Solutions Products and Special Applications Products of 3.9 percent and 3.7 percent, respectively. Year-to-date sales in Asia, Europe, and the Americas decreased by 14.4 percent, 4.1 percent, and 3.7 percent, respectively, compared to the same period in the prior year. The impact of foreign currency translation on the year-to-date results decreased sales by $0.4 million, or 0.1 percent. For the three months ended April 30, 2014, earnings before income taxes as a percentage of sales were 14.6 percent, a decrease from 15.9 percent in the prior year period due to lower sales, incremental expenses related to incentive compensation of $1.6 million, and the costs of the Company's Global ERP Project of $0.3 million. Year-to-date earnings before income taxes as a percentage of Industrial Products segment sales were 14.2 percent, a decrease from 14.7 percent in the prior year. The earnings percentage decrease for the nine months ended April 30, 2014, was due to restructuring expenses primarily related to the sale of a facility in Germany, incremental expenses related to incentive compensation of $5.2 million, and the costs of the Company's Global ERP Project of $1.1 million. Worldwide sales of Industrial Filtration Solutions Products in the current quarter were $137.4 million, an increase of 9.5 percent from $125.4 million in the prior year. Sales increased in Asia, Europe, and the Americas by 20.2 percent, 11.2 percent, and 6.4 percent, respectively. Year-to-date worldwide sales of Industrial Filtration Solutions Products were $401.6 million, an increase of 3.9 percent from $386.5 million in the prior year. Sales increased 6.9 percent, 4.9 percent, and 2.4 percent in Europe, Asia, and the Americas, respectively. For the three and nine months ended April 30, 2014, the Company continued to experience mixed market conditions globally. Strong replacement air filter sales, due to improved manufacturing activity, were partially offset by continued soft new equipment sales, due to the continued weak capital spending environment, particularly in the Americas. The externally published durable goods index in the U.S., which has historically been a leading indicator for equipment sales, increased 6.6 percent during the third quarter of Fiscal 2014 as compared to last year. Worldwide sales of the Company's Gas Turbine Products in the third quarter were $42.0 million, a decrease of 38.9 percent compared to record sales of $68.7 million in the prior year quarter. Year-to-date global sales of the Company's Gas Turbine Products were $110.1 million, a decrease of 39.6 percent compared to sales of $182.3 million in the prior year period. Gas Turbine Products sales are typically large systems and, as a result, the Company's shipments and revenues fluctuate from period to period. Sales of Gas Turbine Products systems were down for the three and nine months ended April 30, 2014, primarily due to fewer shipments of large systems used in power generation. 19 -------------------------------------------------------------------------------- Worldwide sales of Special Application Products were $42.7 million in the current quarter, an increase of 2.0 percent from $41.9 million in the prior year quarter. Sales increased by 8.5 percent and 5.8 percent in Europe and Asia, respectively, partially offset by a sales decrease of 13.7 percent in the Americas, from the prior year period. Year-to-date worldwide sales of Special Application Products were $132.5 million, an increase of 3.7 percent from $127.8 million in the prior year. Sales increased by 10.6 percent and 4.8 percent in Europe and Asia, respectively, partially offset by a sales decrease 6.0 percent in the Americas, from the prior year period. For the three and nine months ended April 30, 2014, the sales increases were driven by a worldwide increase in demand for the Company's disk drive, semiconductor, and venting products, partially offset by weakness in industrial end-markets negatively impacting the Company's membrane product sales.



Liquidity and Capital Resources

During the first nine months of Fiscal 2014, $230.1 million of cash was generated from operating activities, compared with $217.4 million in the prior year period. The current year had increases in accrued compensation and accounts payable of $28.1 million and $26.9 million compared to the prior year, respectively. These were partially offset by increases in inventory and receivables which used $37.5 million and $20.4 million, respectively, of cash compared to the prior year. The Company's inventory balance was $254.2 million as of April 30, 2014, as compared to $234.8 million as of July 31, 2013. This increase was driven by foreign currency translation as well as inventory build in anticipation of increased sales in late fiscal 2014 and early fiscal 2015. The Company's accounts receivable balance was $453.2 million as of April 30, 2014, as compared to $430.8 million as of July 31, 2013. This increase was driven by the timing of receipt of payments from some of our larger Customers compared to the fourth quarter of the prior fiscal year as well as by impacts from foreign currency translation. In the first nine months of Fiscal 2014, operating cash flows and cash on hand were used to repurchase 4,039,000 shares of treasury stock for $165.9 million, to make $66.0 million in capital investments, and to pay $59.7 million in dividends. For additional information regarding share repurchases see Part II, Item 2, "Unregistered Sales of Equity Securities and Use of Proceeds." At the end of the third quarter, the Company held $238.2 million in cash and cash equivalents, up from $224.1 million at July 31, 2013. Short-term investments were $152.5 million compared to $99.8 million at July 31, 2013. Short-term investments may change quarter to quarter based on maturity dates of existing investments, the Company's outlook for cash needs, and available access to other sources of liquidity. The amount of unused lines of credit as of April 30, 2014 was approximately $487.4 million. Current maturities of long-term debt of $17.7 million at quarter-end decreased from $98.7 million at July 31, 2013, as the Company repaid $80.0 million of current maturities of long-term debt in the second quarter of the current fiscal year. Long-term debt of $227.8 million at April 30, 2014, increased from $102.8 million at July 31, 2013, due to the issuance of $125.0 million of senior unsecured notes during the quarter. Long-term debt represented 16.8 percent of total long-term capital, defined as long-term debt plus total shareholders' equity, compared to 8.7 percent at July 31, 2013. The majority of the Company's cash and cash equivalents and short-term investments are held by its foreign subsidiaries, as over half of the Company's earnings occur outside the U.S. Most of these funds are considered permanently reinvested outside the U.S., and will only be repatriated when it is tax effective to do so, as the cash generated from U.S. operations and the Company's access to liquidity in the U.S. is anticipated to be sufficient for the U.S cash needs. If additional cash were required for the Company's operations in the U.S. and funds were repatriated from certain foreign subsidiaries, the Company may be subject to additional U.S. taxes. The Company's general funding policy for its pension plans is to make at least the minimum contributions as required by applicable regulations. The Company may elect to make additional contributions up to the maximum tax deductible contribution. For the nine months ended April 30, 2014, the Company made contributions of $2.7 million to its non-U.S. pension plans and $0.5 million to its U.S. pension plans. The minimum funding requirement for the Company's U.S. plans for Fiscal 2014 is $12.1 million. Per the Pension Protection Act of 2006, this obligation can be met with existing credit balances that resulted from payments above the minimum obligation in prior years. The Company plans to utilize existing credit balances to meet the minimum obligation. The Company currently estimates that it will contribute an additional $2.9 million to its non-U.S. pension plans during the remainder of Fiscal 2014. 20



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The following table summarizes the Company's contractual obligations as of April 30, 2014 (in thousands):

Payments Due by Period Less than 1 More than 5 Contractual Obligations Total year 1 - 3 years 3 - 5 years years Long-term debt obligations $ 241,135,341$ 16,135,341 $ - $ 100,000,000$ 125,000,000 Capital lease obligations 3,006,924 1,184,532 1,822,392 - - Interest on long-term debt obligations 66,493,738 10,217,385 20,301,353 12,725,000 23,250,000 Operating lease obligations 26,567,984 11,205,380 12,089,334 3,101,683 171,587 Purchase obligations (1) 165,333,069 155,839,144 9,471,075 3,973 18,877 Pension and deferred compensation (2) 114,965,607 15,485,238 14,370,718 14,298,127 70,811,524 Total (3) $ 617,502,663$ 210,067,020$ 58,054,872$ 130,128,783$ 219,251,988



(1) Purchase obligations consist primarily of inventory, tooling, contract

employment services, and capital expenditures. The Company's purchase orders

for inventory are based on expected Customer demand and quantities and dollar

volumes are subject to change. (2) Pension and deferred compensation consists of long-term pension liabilities and

salary and bonus deferrals elected by certain executives under the Company's

deferred compensation plan. Deferred compensation balances earn interest based

on a treasury bond rate as defined by the plan (10-year treasury bond STRIP

rate plus two percent for deferrals prior to January 1, 2011, and 10-year

treasury bond rates for deferrals after December 31, 2010) and approved by the

Human Resources Committee of the Board of Directors, and are payable at the

election of the participants. (3) In addition to the above contractual obligations, the Company may be obligated

for additional cash outflows of $15.0 million of potential tax obligations,

including accrued interest and penalties. The payment and timing of any such

payments is affected by the ultimate resolution of the tax years that are under

audit or remain subject to examination by the relevant taxing authorities.

At April 30, 2014, the Company had a contingent liability for standby letters of credit totaling $7.8 million that have been issued and are outstanding. The letters of credit guarantee payment to third parties in the event the Company is in breach of insurance contract terms as detailed in each letter of credit. At April 30, 2014, there were no amounts drawn upon these letters of credit. The Company has a five-year, multi-currency revolving credit facility with a group of banks under which the Company may borrow up to $250.0 million. The agreement provides that loans may be made under a selection of currencies and rate formulas including Base Rate Loans or LIBOR Rate Loans. The interest rate on each advance is based on certain market interest rates and leverage ratios. Facility fees and other fees on the entire loan commitment are payable over the duration of this facility. As of April 30, 2014, there was $60.0 million outstanding on this facility. The multi-currency revolving facility contains debt covenants specifically related to maintaining a certain interest coverage ratio, and a certain leverage ratio as well as other covenants that, under certain circumstances, can restrict the Company's ability to incur additional indebtedness, make investments and other restricted payments, create liens, and sell assets. As of April 30, 2014, the Company was in compliance with all such covenants. The Company expects to remain in compliance with these covenants. On March 27, 2014, the Company issued $125.0 million of senior unsecured notes due March 27, 2024. The debt was issued at face value and bears interest payable semi-annually at an annual rate of interest of 3.72 percent. The proceeds from the notes were used to refinance existing debt and for general corporate purposes. The notes contain debt covenants specifically related to maintaining a certain leverage ratio as well as other covenants that, under certain circumstances, can restrict the Company's ability to incur additional indebtedness, make investments and other restricted payments, create liens, and sell assets. As of April 30, 2014, the Company was in compliance with all such covenants. During the quarter, credit in the global credit markets was accessible and market interest rates remained low. The Company believes that its current financial resources, together with cash generated by operations, are sufficient to continue financing its operations for the next twelve months. There can be no assurance, however, that the cost or availability of future borrowings will not be impacted by future capital market disruptions.



The Company does not have any off-balance sheet arrangements, with the exception of the guarantee of 50 percent of certain debt of its joint venture, AFSI, as further discussed in Note I of the Company's Notes to Condensed Consolidated Financial Statements.

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New Accounting Standards Not Yet Adopted

In February 2013, the Financial Accounting Standards Board (FASB) issued guidance related to obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. This guidance is effective for the Company beginning the first quarter of Fiscal 2015. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial statements.



Critical Accounting Policies

There have been no material changes to the Company's critical accounting policies as disclosed in the Company's Annual Report on Form 10-K for the year ended July 31, 2013. Outlook



We project our Company's full fiscal year sales to be between $2.44 and

$2.48 billion, or a slight increase over the prior year including the negative impact of foreign currency exchange rates. Our forecast is based on the Euro at US$1.35 and 102 Yen to the US$.



Our full-year operating margin forecast is 14.1 to 14.5 percent.

Included in this forecast is approximately $22 million in operating

expense increases for our Global ERP project and incentive compensation.

Our Fiscal 2014 tax rate is anticipated to be between 28 and 29 percent. We forecast our full-year FY14 EPS to be between $1.69 and $1.77.



Cash generated by operating activities for Fiscal 2014 is projected to

be between $310 and $330 million. Our capital spending for Fiscal 2014

is estimated to be approximately $90 million. Our share repurchase

target remains at 4 percent of our diluted outstanding shares in FY14. SAFE HARBOR STATEMENT UNDER THE SECURITIES REFORM ACT OF 1995 The Company, through its management, may make forward-looking statements reflecting the Company's current views with respect to future events and financial performance. These forward-looking statements, which may be included in reports filed under the Securities Exchange Act of 1934, as amended (the Exchange Act), in press releases and in other documents and materials as well as in written or oral statements made by or on behalf of the Company, are subject to certain risks and uncertainties, including those discussed in Item 1A of the Company's Annual Report on Form 10-K for the year ended July 31, 2013, which could cause actual results to differ materially from historical results or those anticipated. The words or phrases "will likely result," "are expected to," "will continue," "estimate," "project," "believe," "expect," "anticipate," "forecast" and similar expressions are intended to identify forward-looking statements within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act of 1933, as amended, as enacted by the Private Securities Litigation Reform Act of 1995 (PSLRA). In particular, the Company desires to take advantage of the protections of the PSLRA in connection with the forward-looking statements made in this Quarterly Report on Form 10-Q, including those contained in the "Outlook" section of Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations." Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date such statements are made. In addition, the Company wishes to advise readers that the factors listed in Item 1A of the Company's Annual Report on Form 10-K for the year ended July 31, 2013, as well as other factors, could affect the Company's performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed. These factors include, but are not limited to, risks associated with: world economic factors and the ongoing economic uncertainty, the reduced demand for hard disk drive products with the increased use of flash memory, the potential for some Customers to increase their reliance on their own filtration capabilities, currency fluctuations, commodity prices, political factors, the Company's international operations, highly competitive markets, governmental laws and regulations, including the impact of the various economic stimulus and financial reform measures, the implementation of our new information technology systems, information security and data breaches, potential global events resulting in market instability including financial bailouts and defaults of sovereign nations, military and terrorist activities, health outbreaks, natural disasters, and other factors included in Item 1A of the Company's Annual Report on Form 10-K for the year ended July 31, 2013. 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. 22



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