Donaldson Co. Inc.
Donaldson Co. Inc.
Sales: $703.96 million (1995)
Stock Exchanges: New York
SICs: 3569 General Industrial Machinery, Not Elsewhere Classified
With operations in North and South America, Europe and Asia, Donaldson Co. Inc. is one of the world’s largest manufacturers of specialty air and liquid filters. Donaldson’s products are used in applications ranging from whole factory air filters to tractors and construction equipment, to computer disk drives. After suffering its first and only net loss in 1983, the company that Money magazine has characterized as a “baby blue chip” made a long, difficult comeback. Having made the shift from its mature, cyclical core business, Donaldson chalked up six consecutive earnings records and average annual sales increases of 10.7 percent from 1990 to 1995.
Pre- World War I Foundation
Founder and company namesake Frank Donaldson was born and raised in southern Minnesota. After earning a degree in engineering from the University of Minnesota in 1912, he went to work as the western U.S. sales representative of Bull Tractor Company in Minneapolis. Donaldson found that one unhappy customer in Utah was having a great deal of difficulty keeping his new Bull tractor running. Donaldson had the dust-choked vehicle completely refurbished, but within a few days it was again out of commission. Taking matters into his own hands, Donaldson improvised a filter from a wire cage, eiderdown cloth, and an eight-foot-long pipe. When the enterprising young salesman proudly told his supervisors of his “modification,” he was promptly fired for pointing up Bull’s flaws.
Donaldson realized that although he was out of a job, he had something better: an invention that could be sold to tractor companies throughout the farm belt. With some help from his father W.H.L. Donaldson, who owned a St. Paul hardware store, and his brother Bob, a sheetmetal fabricator, Frank designed a filter he called the “Twister.” The conical device used centrifugal force to spin dirt out of the air before it passed into the engine. In 1916, Frank and his father each made an initial $200 investment in the new enterprise and named it Donaldson Engineering Company. Frank began demonstrating prototypes to former employer Bull Tractor, as well as other major midwestern equipment manufacturers.
External and internal pressures made Donaldson’s early years a bumpy roller coaster ride. Sales were rather slow that first year, but in 1917 the company won a contract to manufacture air cleaners for artillery tractors used in World War I. Before the year was through, Frank was drafted into the Army Corps of Engineers, leaving his father to run the fast-growing business. Overwhelmed, W.H.L. brought Bob into the firm at a salary of $150 per month and 25 percent of the company’s profits (or half of W.H.L.’s stake). But when a competing filter company, Wilcox-Bennet, brought a potentially expensive patent infringement suit against Donaldson later that same year, the patriarch went back on his employment agreement with Bob, applying the funds he saved to the company’s legal defense. Bob withheld access to his machine shop in retribution, throwing the business further into chaos. Worse yet, W.H.L. began claiming sole ownership of the busy company that Frank had founded.
Interwar Reorganization and Early Growth
Months of infighting followed Frank’s postwar homecoming. In the fall of 1918, the family settled its disagreement by incorporating the business as Donaldson Co., Inc. Frank owned 45 percent of the new corporate entity, Bob got 25 percent, their sisters Amanda and Mae each owned 12.5 percent, and mother Lottie held 5 percent. W.H.L. relinquished corporate ownership, settling instead for a royalty on any air filter he invented. Since he never came up with a product for Donaldson, the company’s incorporation marked his final formal involvement in the firm. (Lottie gave Frank her shares upon W.H.L.’s death in 1926.) The lawsuit that precipitated this ownership crisis remained unsettled until 1919, when Donaldson agreed to purchase a U.S. license for Wilcox-Bennet air filters for $15,000 and a royalty on each unit.
The 1920s brought stability, new products, and increased prosperity. In 1920, Donaldson launched a second type and brand of filter, the Simplex. This air cleaner used oil-soaked moss to trap dust before it could enter a motor or engine and cause damage. The company combined characteristics of both its filters with the introduction of the patented Duplex that same year. Donaldson also forged its first contract with the John Deere Tractor Company during the 1920s. John Deere would become a major customer, accounting for one-third of annual sales by the end of the decade. After suffering a $4,000 loss in 1921, the company’s sales multiplied from $19,554 in 1924 to $204,667 by 1928. By 1929, Donaldson was selling 200,000 units per year.
In addition to new product development, Donaldson sought close involvement with its customers’ design processes so that their filters would work as well as possible in each manufacturer’s tractors. In fact, the company began producing oil-bath type air cleaners in response to customer demand. In 1929, the corporation hired William Lowther to design a proprietary oil-washed air cleaner. His N.S. Filter was patented in 1932, but by that time the company would be scrambling to come up with the funds needed to begin manufacturing the new product.
Donaldson also diversified into tractor seats and spark-arresting mufflers in the late 1920s. The company had hoped to use a stock offering to fund the launch of an aftermarket car heater during this period as well, but the stock market’s 1929 crash postponed that first public equity flotation.
Nature conspired with the worsening economy, wreaking havoc on America’s farmers and the industries that served them. A five-year drought and grasshopper plagues denuded the mid-western landscape, turning the heartland into a dust bowl. When farmers hurt, tractor companies hurt and so did Donaldson. During the 1930s, the Minnesota manufacturer slashed its payroll by 70 percent, from 40 to 12, and its chief executives halved their own salaries and borrowed against life insurance policies to keep their business afloat. In 1934, Donaldson defaulted on payments to several suppliers.
It was then that Frank Donaldson and corporate attorney Ken Owen devised a plan to get the company’s new oil-washed air cleaner into production and revive its cash flow. They sold the device’s patent for $4,000 to a group of investors composed primarily of Donaldson stockholders. In exchange for a small royalty on each unit sold, the new owners licensed rights to produce the filter back to the company. Ford Motor Company started testing the filter mid-year and soon found that the device served its purpose well without sacrificing speed or efficiency. The contract that resulted took Donaldson from famine back to feast within months. Sales to Caterpillar, John Deere, Cummins Engine, and many other manufacturers of heavy vehicles boosted sales to $465,000 and profits to $88,000 by 1935.
By the end of this traumatic decade, annual sales hovered near $1 million, and the company’s 200 employees manufactured 300,000 air cleaners each year. With a dominant 90 percent share of the market for farm and construction engine air cleaners, Donaldson sought growth through exports to Great Britain, Sweden, New Zealand, and Australia.
World War II and Beyond
During World War II, Donaldson manufactured bomber gun sights, bayonet holders, crankcase valves for tanks, and, most important, air cleaners for tanks used in the difficult and dusty conditions of the North African desert.
The early 1940s brought a management shakeup as well. After Frank Donaldson suffered a stroke in 1942, brother Bob retired from day-to-day oversight of the company to become chairman. While Frank Donaldson continued as president, John Enblom was promoted from acting general manager to executive vice-president with effective control. This administrative arrangement lasted only two years. When Frank died of heart failure in 1945, John Enblom advanced to the presidency. Upon his return from World War II service, Frank Donaldson, Jr. assumed the title of vice-president.
In spite of this unexpected leadership transition and a month-long strike, Donaldson did well during the early 1940s. Having established its first branch office in Milwaukee, Wisconsin in 1938, the company added satellite offices in Cleveland, Chicago, and Detroit, and launched its first international production facility in Canada. Sales multiplied from less than $1 million in 1939 to $3.5 million by 1947, with profits topping $359,000.
But in the late 1940s, the Internal Revenue Service began to question the royalty plan that had saved Donaldson from bankruptcy during the Great Depression. The government agency charged that the royalties were “dividends in disguise,” and that the company owed back and current taxes on these diverted profits. The IRS contended that royalties are paid before taxes and, therefore, are considered a tax-deductible business expense and that dividends are paid out of after-tax profits. By paying “royalties” to what was essentially a group of shareholders, the company had avoided $1.3 million in taxes in the process. Donaldson, which was only worth $1.27 million at the time, struggled to reach a lower settlement with the IRS over the next two years, but finally had to go to court.
The legal crisis brought on a mutiny of sorts at Donaldson. President John Enblom, along with pivotal employees Bill Lowther and Roger Cresswell, all members of the executive committee, issued an ultimatum: either Frank Jr. sold them 51 percent of the company for $200,000, or they would all quit and start a competing company. Frank Jr. marshaled the Donaldson family—which still owned the vast majority of the company’s equity—and they agreed not to sell.
True to their word, the three executives quit to form Crenlo Corp. in 1951. At the age of 31, Frank Jr. became president of a company with $5.5 million in annual sales. Although he had a degree in engineering from Harvard, where he minored in economics and graduated cum laude, his lack of day-to-day experience made the early 1950s a difficult period of transition for the business.
Frank Jr.’s first order of business was to replenish the “brain trust.” He sought management help from his cousin, Dick Donaldson, who became vice-president of sales and engineering. The new president established the company’s first formal research and development department in 1951 and brought in consultants from the Stanford Research Institute the following year. Seven years of research and testing resulted in the 1959 launch of the “Donaclone,” the first heavy-duty air cleaner to use a paper filter. The brand name combined Donaldson and cyclone, and the device harked back to the company’s original Twister brand filter. It used a series of “cyclone tubes” to spin dirt out of the air. The Duralife paper filter served as a final dirt trap. The new product was such a success that, during its first year, it accounted for 20 percent of Donaldson’s annual sales.
In the meantime, Donaldson had gone public with a modest $124,000 offering. Frank Jr.’s first decade in office was incredibly successful. Sales nearly doubled, from $5.5 million in 1950 to a record $10.1 million in 1959, and profits more than doubled, from $315,000 to $669,000 during the same period.
But this was only the beginning of what a company history dubbed “the age of the Donaclone.” Sales tripled over the course of the 1960s, to $35.9 million in 1969, as clients ranging from Caterpillar to the U.S. Army adopted the new filter for their heavy-duty machinery. Geographic expansion also contributed to this growth, as Donaldson established joint ventures and licensing agreements with businesses in Britain, France, Germany, Brazil, and Australia. By the end of the decade, it had wholly owned subsidiaries in Germany, Belgium, and South Africa as well. Formalized in 1963, the International Division grew 30-fold from 1963 to 1970.
Frank Donaldson, Jr. advanced to chairman and CEO in 1973. In a departure from the traditional promotion from within, Donaldson hired William Hodder, formerly president of Target Stores and a director of Donaldson for just four years, to succeed the founder’s son. Hodder took the company on something of an acquisition spree, merging with St. Paul, Minnesota’s Torit Corp. and acquiring Majac, Inc. and Kittell Muffler and Engineering in rapid succession. The new affiliates helped diversify Donaldson from its core. Torit added dust collectors that could clear the air in whole factories, while Majac specialized in making dust (it disintegrated materials to specifically sized bits) and Kittell produced heavy-duty sound controllers. Donaldson also diversified from within, establishing a hydraulic fluid filter division in 1975.
In spite of inflation and the energy crunch, Donaldson’s strategy of “focused diversification” kept the company’s sales and earnings on a counter-cyclical rise throughout the decade. Sales broke both the $100 million and $200 million thresholds over the course of the decade, and net income more than doubled from $6 million to $14.2 million. In 1979, the company was listed on the New York Stock Exchange.
We believe all of the people of Donaldson Company should strive to conduct themselves in such a manner that the Company and those associated with it will stand for: Integrity in our dealings with customers, employees, shareholders, government authorities, suppliers, neighbors and the public; Quality in our products and services, in our manufacturing methods and general management; Technology in our particular fields of research, product development, engineering, and manufacturing; Growth in sales profits and strength within our areas of special interest and competence; Progress toward an environment where our people have increasing opportunities for contribution, fulfillment and reward.
Reorganization and Retrenchment in the 1980s
After this stellar decade, however, “stagflation” hit Donaldson’s core constituencies hard in the early 1980s. Two prominent examples of the recession in the heavy machinery industry were International Harvester, which lost $3 billion, and John Deere, whose plants came to a standstill for two months during the early 1980s. Donaldson’s sales skidded from $264 million in 1981 to $203 million by 1983, when the company suffered its first-ever annual loss, a $3.5 million shortfall. Blaming its difficulties in part on overexpansion in the late 1970s, the company closed two plants and scaled back the remaining U.S. production to 50 percent of capacity. Employment was reduced by more than 25 percent from 1980 to 1985. Administrative personnel accepted mandatory unpaid leave and a salary freeze. Sales and profits began to recover in 1984, the same year that Frank Donaldson, Jr. announced his retirement.
But perhaps most important, the early 1980s crisis highlighted Donaldson’s dependence on a mature market and precipitated a more thorough diversification. From 1984 to 1990, the company poured $40 million into acquisitions and joint ventures and plowed another $50 million into research and development. Hoping to eliminate duplication of effort and gain efficiencies, top executives reorganized the company into five groups: Industrial; International; Original Equipment; After-market; and Worldwide Support. Having focused almost exclusively on the original equipment market throughout its history, the company began to target the filter aftermarket. Research and development efforts paid off in the form of new products for industries ranging from computers to passenger autos to pharmaceuticals. Sales in nontraditional markets grew to $129.5 million by 1990, almost one-third of annual sales.
It took most of the 1980s for these new strategies to corne to full fruition, but the geographic, product, and market diversification helped even out Donaldson’s cyclical performance. The budding conglomerate began to realize its goal of steady growth in profitability in the early 1990s, when rising net salea combined with an annual return on sales of more than 5 percent. Revenues increased from $422.89 million in 1990 to $703.96 million in 1995, and net income jumped from $21.03 million to $38.54 million.
With Chairman and CEO William Hodder nearing mandatory retirement, Donaldson settled the question of succession. In 1994, William Van Dyke capped a more than 20-year career at the company with his appointment to the positions of president and chief operating officer. He was expected to advance to the chief executive office in 1996. The company planned to achieve double-digit annual earnings per share increases by developing air filters for passenger cars, forging strategic alliances, and maintaining its long-standing clients.
ENV Services, Inc.; Donaldson Europe, N.V. (Belgium); Donaldson Coordination Center, N.V. (Belgium); Donaldson Gesellschaft m.b.H. (Germany); Donaldson Filter Components, Ltd. (England); Donaldson Torit, B.V. (Netherlands); Donaldson France, S.A.; Donaldson Italia s.r.1; Nippon Donaldson, Ltd. (Japan); Donaldson Far East Limited (Hong Kong); Donaldson Australasia (Pty.) Ltd. (Australia); Donaldson Filtration Systems (Pty.) Ltd. (South Africa); Donaldson, S.A. de C.V.; Donaldson do Brasil Ltda. (Brazil).
Abelson, Reed, “Exhausting the Possibilities,” Forbes, May 25, 1992, p. 260.
Croghan, Lore, “Don’t Look Back,” Financial World, July 18, 1995, p. 50.
Goodman, Jordan E., “These Baby Blue Chips Promise To Become Grown-up Champs,” Money, May 1991, p. 65.
Jaffe, Thomas, “Cleaner Air Company,” Forbes, September 14, 1992, p. 562.
Keenan, Tim, “Let’s Clear the Air: Donaldson, Hoechst Celanese Develop New Filter,” Ward’s Auto World, September 1995, p. 85.
Martin, Norman, Sawyer, Christopher A., and Sorge, Marjorie, “The Ultimate in Air Fresheners,” Automotive Industries, February 1996, p. 173.
Morais, Richard C., “Hong Kong Is Just Around the Corner,” Forbes, October 12, 1992, p. 50.
Peterson, Susan E., “Van Dyke Heir Apparent To Take Over Donaldson,” Star Tribune, August 11, 1994, p. 3D.
“Salesman’s Solution to Tractor-Choking Dust Leads to Founding of Filter Manufacturing Company,” Hydraulics & Pneumatics, May 1983, p. 80.
Toward a Cleaner, Quieter World: History of the Donaldson Company, 1915-1985, Minneapolis, Minn.: Donaldson Co., Inc., 1985.
Youngblood, Dick, “Diversified Firm Yields Dividends,” Star Tribune, February 4, 1991, p. 1D.
—April Dougal Gasbarre