DONALDSON Co INC: Form 10-Q for the period ended Jan 31, 2023

Overview

Founded in 1915, Donaldson Company, Inc. is a global leader in technology-led filtration products and solutions, serving a broad range of industries and advanced markets. Donaldson’s diverse, skilled employees at over 140 locations, 74 of which are manufacturing and distribution centers, on six continents, partner with customers from small business owners to the world’s biggest original equipment manufacturer (OEM) brands to solve complex filtration challenges. Customers choose Donaldson’s filtration solutions due to their stringent performance requirements, natural replacement change cycles and need for reliability.

The Mobile Solutions segment is organized based on a combination of customers and products and consists of the Off-Road, On-Road and Aftermarket business units. Within these business units, products consist of replacement filters for both air and liquid filtration applications as well as exhaust and emissions. Applications include air filtration systems, fuel and lube systems, exhaust and emissions systems, and sensors, indicators and monitoring systems. Mobile Solutions sells to OEMs in the construction, mining, agriculture and transportation end markets and to independent distributors, OEM dealer networks, private label accounts and large fleets.

The Industrial Solutions segment is organized based on product type and consists of the Industrial Filtration Solutions (IFS) and Aerospace and Defense business units. Within the IFS business unit, products consist of dust, fume and mist collectors, compressed air purification systems, air filtration systems for gas turbines, hydraulic applications as well as gas and liquid filtration for industrial processes. Aerospace and Defense products consist of air, fuel and lube filtration sold to the aerospace fixed-wing, rotorcraft and defense ground vehicle industries.

The Life Sciences segment consists of micro-environment gas and liquid filtration for food, beverage and industrial processes, bioprocessing equipment, including bioreactors and fermenters, polytetrafluoroethylene membrane-based products, as well as specialized air and gas filtration systems for applications including hard disk drives, semiconductor manufacturing, sensors, indicators and monitoring systems.

The Company’s results of operations are affected by conditions in the global economic and geopolitical environment. Under most economic conditions, the Company’s diversification across its end markets, its global presence, its diversification through technology and its OEM and replacement parts customers has helped to limit the impact of weakness in any one product line, market or geography on the consolidated operating results of the Company.

Operating Environment

Inflation

While inflation was not as significant in the second quarter or the first six months of fiscal 2023, as compared to the prior year, the Company continues to experience the effects of inflation related to raw materials and other expenses, including labor and energy. These inflationary pressures have had an adverse impact on the Company’s profit margins throughout the second quarter and the first six months of fiscal 2023, however they have been generally mitigated by pricing actions implemented in the prior year.

Consolidated Results of Operations

Three months ended January 31, 2023 compared with three months ended January 31, 2022

Operating Results

Operating results were as follows (in millions, except per share amounts):

Geographic Net Sales by Origination

Net sales, generally disaggregated by location where the customer’s order was received, were as follows (in millions):

Net Sales

Net sales for the three months ended January 31, 2023 increased $25.8 million, or 3.2%, from the three months ended January 31, 2022, reflecting higher sales in the Mobile Solutions segment of $9.0 million, or 1.7% growth, and the Industrial Solutions segment of $27.9 million, or 12.8% growth, partially offset by lower sales in the Life Sciences segment of $11.1 million, or a 15.6% decline. Foreign currency translation decreased net sales by $34.1 million compared to the three months ended January 31, 2022, reflecting decreases in the Mobile Solutions, Industrial Solutions and Life Sciences segments of $21.6 million, $8.6 million and $3.9 million, respectively. During the three months ended January 31, 2023, the Company’s net sales increased primarily from higher pricing, partially offset by a negative impact from foreign currency translation.

Gross Margin

Gross margin as a percentage of net sales for the three months ended January 31, 2023 was 34.3% compared with 31.1% for the three months ended January 31, 2022. The gross margin as a percentage of net sales increase was primarily driven by pricing actions, partially offset by higher input costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ended January 31, 2023 were $149.6 million, or 18.1% of net sales, compared with $137.5 million, or 17.1% of net sales, for the three months ended January 31, 2022, an increase of $12.1 million, or 8.8%. The increase in selling, general and administrative expenses as a percentage of net sales was primarily due to severance and other organizational redesign charges of $4.5 million, costs mainly associated with the exiting of a lower-margin customer program of $3.3 million and increased headcount to support future growth.

Research and Development Expenses

Research and development expenses for the three months ended January 31, 2023 were $18.5 million, or 2.2% of net sales, compared with $16.6 million, or 2.1% of net sales, for the three months ended January 31, 2022.

Non-Operating Items

Interest expense for the three months ended January 31, 2023 was $4.6 million, compared with $3.6 million for the three months ended January 31, 2022, an increase of $1.0 million, or 28.4%. The increase reflected rising variable interest rates and a higher debt level.

Other income, net for the three months ended January 31, 2023 was $1.6 million, compared with other income, net of $2.4 million for the three months ended January 31, 2022, a decrease of $0.8 million, which was driven primarily by lower income from joint ventures, partially offset by higher interest income.

Income Taxes

The effective tax rate was 24.1% for the three months ended January 31, 2023 and 2022. The current year effective tax rate benefitted from increased tax benefits on export income, which were offset by an unfavorable mix of earnings among tax jurisdictions and a decrease in discrete tax item benefits.

Net Earnings

Net earnings for the three months ended January 31, 2023 were $86.0 million, compared with $71.8 million for the three months ended January 31, 2022, an increase of $14.2 million, or 19.8%. Diluted EPS were $0.70 for the three months ended January 31, 2023, compared with $0.57 for the three months ended January 31, 2022, an increase of $0.13, or 22.0%.

Six months ended January 31, 2023 compared with six months ended January 31, 2022

Operating Results

Operating results were as follows (in millions, except per share amounts):

Geographic Net Sales by Origination

Net sales, generally disaggregated by location where the customer’s order was received, were as follows (in millions):

23

Net Sales

Net sales for the six months ended January 31, 2023 increased $112.2 million, or 7.2%, from the six months ended January 31, 2022, reflecting higher sales in the Mobile Solutions segment of $76.6 million, or 7.6% growth, and the Industrial Solutions segment of $56.7 million, or 13.6% growth, partially offset by lower sales in the Life Sciences segment of $21.1 million, or a 14.8% decline. Foreign currency translation decreased net sales by $93.0 million compared to the six months ended January 31, 2022, reflecting decreases in the Mobile Solutions, Industrial Solutions and Life Sciences segments of $59.0 million, $22.8 million and $11.2 million, respectively. During the six months ended January 31, 2023, the Company’s net sales increased primarily from higher pricing and volume growth, partially offset by a negative impact from foreign currency translation.

Gross Margin

Gross margin as a percentage of net sales for the six months ended January 31, 2023 was 34.1% compared with 32.4% for the six months ended January 31, 2022. The gross margin as a percentage of net sales increase was primarily driven by pricing actions, partially offset by higher input costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the six months ended January 31, 2023 were $298.8 million, or 17.8% of net sales, compared with $270.5 million, or 17.3% of net sales, for the six months ended January 31, 2022, an increase of $28.3 million, or 10.5%. The increase in selling, general and administrative expenses as a percentage of net sales was primarily due to severance and other organizational redesign charges of $12.1 million, costs mainly associated with the exiting of a lower-margin customer program of $3.3 million and increased headcount to support future growth. This was partially offset by expense leverage on higher sales.

Research and Development Expenses

Research and development expenses for the six months ended January 31, 2023 were $37.2 million, or 2.2% of net sales, compared with $33.1 million, or 2.1% of net sales, for the six months ended January 31, 2022.

Non-Operating Items

Interest expense for the six months ended January 31, 2023 was $9.2 million, compared with $7.1 million for the six months ended January 31, 2022, an increase of $2.1 million, or 30.2%. The increase reflected rising variable interest rates and a higher debt level.

Other income, net for the six months ended January 31, 2023 was $3.4 million, compared with other income, net of $2.4 million for the six months ended January 31, 2022, an increase of $1.0 million, which was driven primarily by the timing of charitable contributions and higher interest income, partially offset by lower income from joint ventures.

Income Taxes

The effective tax rates were 24.7% and 25.0% for the six months ended January 31, 2023 and 2022, respectively. The decrease in the effective tax rate was primarily due to increased tax benefits on export income, which were partially offset by an unfavorable mix of earnings between tax jurisdictions.

Net Earnings

Net earnings for the six months ended January 31, 2023 were $173.2 million, compared with $148.8 million for the six months ended January 31, 2022, an increase of $24.4 million, or 16.4%. Diluted EPS were $1.40 for the six months ended January 31, 2023, compared with $1.18 for the six months ended January 31, 2022, an increase of $0.22, or 18.5%.

Segment Results of Operations

Net sales and earnings (loss) before income taxes were as follows (in millions):

(1) Corporate and unallocated includes interest expense and certain corporate expenses determined to be non-allocable to the segments, such as restructuring charges and incentive compensation.

Mobile Solutions Segment

Net sales were as follows (in millions):

Three months ended January 31, 2023 compared with three months ended January 31, 2022

Net sales for the Mobile Solutions segment for the three months ended January 31, 2023 were $522.5 million, compared with $513.5 million for the three months ended January 31, 2022, an increase of $9.0 million, or 1.7%. Excluding a $21.6 million decrease from foreign currency translation, net sales for the Mobile Solutions segment increased 5.9%.

Net sales of Off-Road increased $14.3 million, benefitting from pricing actions and high levels of global equipment production. The increase was partially offset by a decline in net sales of Aftermarket, which decreased $6.7 million, where customer inventory reductions more than offset pricing benefits. All business units were negatively impacted by foreign currency translation.

Earnings before income taxes for the Mobile Solutions segment for the three months ended January 31, 2023 were $78.6 million, or 15.0% of net sales, an increase from 11.4% of net sales for the three months ended January 31, 2022. The increase was driven by pricing actions and expense leverage on increased sales, which were partially offset by higher input costs.

Six months ended January 31, 2023 compared with six months ended January 31, 2022

Net sales for the Mobile Solutions segment for the six months ended January 31, 2023 were $1,077.4 million, compared with $1,000.8 million for the six months ended January 31, 2022, an increase of $76.6 million, or 7.6%. Excluding a $59.0 million decrease from foreign currency translation, net sales for the Mobile Solutions segment increased 13.5%.

Net sales of Off-Road increased $27.5 million, primarily due to pricing actions and high levels of global equipment production. Net sales of Aftermarket increased $43.2 million, primarily driven by pricing and high end-market demand, partially offset by customer inventory reductions. The increased sales for all business units were partially offset by negative impacts from foreign currency translation.

Earnings before income taxes for the Mobile Solutions segment for the six months ended January 31, 2023 were $158.9 million, or 14.7% of net sales, an increase from 12.4% of net sales for the six months ended January 31, 2022. The increase was driven by pricing actions and expense leverage on increased sales, which were partially offset by higher input costs.

Industrial Solutions Segment

Net sales were as follows (in millions):

Three months ended January 31, 2023 compared with three months ended January 31, 2022

Net sales for the Industrial Solutions segment for the three months ended January 31, 2023 were $246.4 million, compared with $218.5 million for the three months ended January 31, 2022, an increase of $27.9 million, or 12.8%. Excluding an $8.6 million decrease from foreign currency translation, net sales for the Industrial Solutions segment increased 16.7%.

Net sales of IFS increased $20.4 million, reflecting higher volume in industrial dust collection, timing of power generation projects and pricing benefits. Aerospace and Defense increased by $7.5 million due to strong demand for replacement parts in the U.S as air travel increased. Both business units were negatively impacted by foreign currency translation.

Earnings before income taxes for the Industrial Solutions segment for the three months ended January 31, 2023 were $46.3 million, or 18.8% of net sales, an increase from 12.4% of net sales for the three months ended January 31, 2022. The increase was primarily due to the impact from pricing actions, partially offset by higher input costs.

Six months ended January 31, 2023 compared with six months ended January 31, 2022

Net sales for the Industrial Solutions segment for the six months ended January 31, 2023 were $476.0 million, compared with $419.3 million for the six months ended January 31, 2022, an increase of $56.7 million, or 13.6%. Excluding a $22.8 million decrease from foreign currency translation, net sales for the Industrial Solutions segment increased 19.0%.

Net sales of IFS increased $43.1 million, reflecting higher volume in industrial dust collection, timing of power generation projects and pricing benefits. Aerospace and Defense increased by $13.6 million due to strong demand for replacement parts in the U.S as air travel increased. Both business units were negatively impacted by foreign currency translation.

Earnings before income taxes for the Industrial Solutions segment for the six months ended January 31, 2023 were $83.9 million, or 17.6% of net sales, an increase from 12.4% of net sales for the six months ended January 31, 2022. The increase was primarily due to the impact from pricing actions, partially offset by higher input costs.

Life Sciences Segment

Net sales and earnings before income taxes were as follows (in millions):

26

Three months ended January 31, 2023 compared with three months ended January 31, 2022

Net sales for the Life Sciences segment for the three months ended January 31, 2023 were $59.4 million, compared with $70.5 million for the three months ended January 31, 2022, a decrease of $11.1 million, or 15.6%. Excluding a $3.9 million decrease from foreign currency translation, net sales for the Life Sciences segment declined 10.1%. The decrease was primarily driven by weakness in market demand for products in the disk drive business, partially offset by growth in the food and beverage business.

Earnings before income taxes for the Life Sciences segment for the three months ended January 31, 2023 were $6.3 million, or 10.6% of net sales, a decrease from 23.7% of net sales for the three months ended January 31, 2022. The decrease was driven by lower disk drive volumes causing a decline in profitability and the expected initial negative earnings impact from the recent acquisitions.

Six months ended January 31, 2023 compared with six months ended January 31, 2022

Net sales for the Life Sciences segment for the six months ended January 31, 2023 were $122.2 million, compared with $143.3 million for the six months ended January 31, 2022, a decrease of $21.1 million, or 14.8%. Excluding a $11.2 million decrease from foreign currency translation, net sales for the Life Sciences segment declined 6.9%. The decrease was primarily driven by weakness in market demand for products in the disk drive business, partially offset by growth in the food and beverage business.

Earnings before income taxes for the Life Sciences segment for the six months ended January 31, 2023 were $17.1 million, or 14.0% of net sales, a decrease from 25.9% of net sales for the six months ended January 31, 2022. The decrease was driven by lower disk drive volumes causing a decline in profitability and the expected initial negative earnings impact from the recent acquisitions.

Liquidity, Capital Resources and Financial Condition

Liquidity

Liquidity is assessed in terms of the Company’s ability to generate cash to fund its operating, investing and financing activities. Significant factors affecting liquidity are cash flows generated from operating activities, capital expenditures, acquisitions, dividends, repurchases of outstanding shares, adequacy of available credit facilities and the ability to attract long-term capital with satisfactory terms. The Company generates substantial cash from the operation of its businesses as its primary source of liquidity, with sufficient liquidity available to fund growth through reinvestment in existing businesses and strategic acquisitions.

Cash Flow Summary

Cash flows were as follows (in millions):

Operating Activities

Cash provided by operating activities for the six months ended January 31, 2023 was $220.5 million, compared with $79.8 million for the six months ended January 31, 2022, an increase of $140.7 million. The increase in cash provided by operating activities was primarily driven by a reduction in inventory in the first six months of the current year compared to a significant increase in inventory in the first six months of the prior year, as well as higher earnings.

Investing Activities

Cash used in investing activities for the six months ended January 31, 2023 was $57.6 million, compared with $82.5 million for the six months ended January 31, 2022, a decrease of $24.9 million. The decrease in cash used was due to the $49.0 million of acquisitions in the first six months of the prior year, partially offset by the higher investment of capital in various projects, including capacity expansion and tooling for new programs, in the first six months of the current year.

Financing Activities

Cash used in financing activities generally relates to the use of cash for payment of dividends and repurchases of the Company’s common stock, net of borrowing activity and proceeds from the exercise of stock options. Cash used in financing activities for the six months ended January 31, 2023 was $176.8 million, compared with $45.7 million for the six months ended January 31, 2022, an increase of $131.1 million. The increase was primarily driven by a net debt repayment of $24.7 million in the first six months of the current year, compared to net proceeds of $115.2 million from the issuance of debt in the first six months of the prior year.

To determine the level of dividend and share repurchases, the Company considers recent and projected performance across key financial metrics, including earnings, cash flow from operations and total debt. Dividends paid for the six months ended January 31, 2023 and 2022 were $56.2 million and $54.6 million, respectively. Share repurchases for the six months ended January 31, 2023 and 2022 were $115.2 million and $115.6 million, respectively.

Capital Resources

Additional sources of liquidity are existing cash and available credit facilities. Cash and cash equivalents as of January 31, 2023 was $179.4 million, compared with $193.3 million as of July 31, 2022. The Company has capacity of $648.0 million available for further borrowing under existing credit facilities as of January 31, 2023, which includes $392.5 million available on the Company’s $500.0 million unsecured revolving credit facility that expires on May 21, 2026.

The Company believes the liquidity available from the combination of expected cash generated by operating activities, existing cash and available credit under existing credit facilities will be sufficient to meet its cash requirements for the next 12 months and beyond, including working capital needs, debt service obligations, capital expenditures, payment of anticipated dividends, share repurchase activity and potential acquisitions.

Financial Condition

Short-Term Borrowings and Long-Term Debt

As of January 31, 2023, total debt, including short-term borrowings and long-term debt, represented 34.5% of total capitalization, defined as total debt plus total stockholders’ equity, compared with 36.4% as of July 31, 2022. As of January 31, 2023, the Company was in compliance with its financial covenants.

Long-term debt outstanding was $624.8 million as of January 31, 2023, compared with $644.3 million as of July 31, 2022, a decrease of $19.5 million, primarily due to a repayment on the unsecured revolving credit facility during the first six months of fiscal 2023. As of January 31, 2023, there was $392.5 million available and $100.0 million outstanding on the Company’s $500.0 million unsecured revolving credit facility that expires on May 21, 2026.

Working Capital

In order to help measure and analyze the impact of working capital management, the Company reviews its cash conversion cycle. The Company calculates days sales outstanding as the average accounts receivable, net for the quarter, divided by net sales for the quarter multiplied by the number of days in the quarter. The Company calculates days inventory outstanding as the average inventories, net for the quarter, divided by cost of sales for the quarter multiplied by the number of days in the quarter, and calculates inventory turns as the cost of sales for the quarter, annualized by the ratio of the number of days in the year to the number of days in the quarter, divided by the average inventories, net for the quarter. The Company calculates days payable outstanding as the average accounts payable for the quarter, divided by cost of sales for the quarter multiplied by the number of days in the quarter.

Accounts receivable, net as of January 31, 2023, was $574.5 million, compared with $616.6 million as of July 31, 2022, a decrease of $42.1 million. Days sales outstanding were 64 days as of January 31, 2023, an increase from 62 days as of July 31, 2022.

Inventories, net as of January 31, 2023, was $501.3 million, compared with $502.4 million as of July 31, 2022, a decrease of $1.1 million. Days inventory outstanding were 84 days as of January 31, 2023, an increase from 78 days as of July 31, 2022. Inventory turns were 4.4 times and 4.7 times per year as of January 31, 2023 and July 31, 2022, respectively.

Accounts payable as of January 31, 2023, was $302.1 million, compared with $338.5 million as of July 31, 2022, a decrease of $36.4 million. Days payable outstanding were 53 days as of January 31, 2023, an increase from 52 days as of July 31, 2022.

Off-Balance Sheet Arrangements

The Company guarantees 50% of certain debt of its joint venture, Advanced Filtration Systems Inc., as discussed in Note 16 in the Notes to Condensed Consolidated Financial Statements included in Item 1 of this report.

Critical Accounting Estimates

There have been no material changes to the Company’s critical accounting estimates as disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2022.

New Accounting Standards Not Yet Adopted

For new accounting standards not yet adopted, refer to Note 1 in the Notes to Condensed Consolidated Financial Statements included in Item 1 of this report.

Safe Harbor Statement Under the Private Securities Litigation 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 expectations, such as forecasts, plans, trends and projections relating to the Company’s business 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 Part I, Item 1A, “Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2022, which could cause actual results to differ materially from historical results or those anticipated. The words or phrases such as “will likely result,” “are expected to,” “will continue,” “will allow,” “estimate,” “project,” “believe,” “expect,” “anticipate,” “forecast,” “plan” 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. All statements other than statements of historical fact are forward-looking statements. These statements do not guarantee future performance.

These forward-looking statements speak only as of the date such statements are made and are subject to risks and uncertainties that 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, challenges in global operations; impacts of global economic, industrial and political conditions on product demand, including the Russia and Ukraine conflict; impacts from unexpected events, including the COVID-19 pandemic; effects of unavailable raw materials or material cost inflation; inability to attract and retain qualified personnel; inability to meet customer demand; inability to maintain competitive advantages; threats from disruptive technologies; effects of highly competitive markets with pricing pressure; exposure to customer concentration in certain cyclical industries; inability to manage productivity improvements; results of execution of any acquisition, divestiture and other strategic transactions; vulnerabilities associated with information technology systems and security; inability to protect and enforce intellectual property rights; costs associated with governmental laws and regulations; impacts of foreign currency fluctuations; and effects of changes in capital and credit markets. These and other factors are described in Part I, Item 1A, “Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2022. 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, unless required by law.

The Company’s market risk includes the potential loss arising from adverse changes in foreign currency exchange rates, interest rates and commodity prices. To manage these risks, the Company employs certain strategies to mitigate the effect of these fluctuations. The Company does not enter into any of these strategies for trading or speculative purposes.

The Company maintains significant assets and operations outside the U.S., resulting in exposure to foreign currency gains and losses. A portion of the Company’s foreign currency exposure is naturally hedged by incurring liabilities, including bank debt, denominated in the local currency in which the Company’s foreign subsidiaries are located.

During the six months ended January 31, 2023, the U.S. dollar was generally stronger than in the six months ended January 31, 2022 compared with many of the currencies of the foreign countries in which the Company operates. The overall stronger dollar had a negative impact on the Company’s international net sales and net earnings because the foreign denominated revenues translated into less U.S. dollars in many regions around the world. The estimated impact of foreign currency translation for the six months ended January 31, 2023 resulted in an overall decrease in reported net sales of $93.0 million and a decrease in reported net earnings of $11.8 million.

Derivative Fair Value Measurements

The Company enters into derivative instrument agreements, including foreign currency forward contracts and net investment hedges, to manage risk in connection with changes in foreign currency. The Company only enters into derivative instrument agreements with counterparties who have highly rated credit. See Notes 11, 14 and 15 in the Notes to Condensed Consolidated Financial Statements included in Item 1 of this report.

Foreign Currency Forward Contracts - Cash Flow Hedges and Derivatives Not Designated as Hedging Instruments

The Company buys materials from foreign suppliers. Those transactions can be denominated in those suppliers’ local currency. The Company also sells to customers in foreign countries. Those transactions can be denominated in those customers’ local currency. Both of these transaction types can create volatility in the Company’s financial statements. The Company uses foreign currency forward contracts to manage those exposures and fluctuations. These contracts generally mature in 12 months or less, which is consistent with the forecasts of the related purchases and sales. Certain contracts are designated as cash flow hedges, whereas the remaining contracts, most of which are related to certain intercompany transactions which offset balance sheet exposure, are not designated as hedging instruments. The total notional amounts of the foreign currency forward contracts designated as hedges were $77.2 million and $158.0 million as of January 31, 2023 and July 31, 2022, respectively. The total notional amounts of the foreign currency forward contracts not designated as hedges were $207.9 million and $151.6 million as of January 31, 2023 and July 31, 2022, respectively.

Net Investment Hedges

The Company uses fixed-to-fixed cross-currency swap agreements to hedge its exposure to adverse foreign currency exchange rate movements for its operations in Europe. The Company has elected the spot method for designating these contracts as net investment hedges.

The total notional amount of net investment hedges was €80 million, or $88.8 million, as of January 31, 2023 and July 31, 2022. The maturity dates range from 2027 to 2029.

Based on the net investment hedges outstanding as of January 31, 2023, a 10% appreciation of the U.S. dollar compared to the Euro would result in a net gain of $7.6 million in the fair value of these contracts.

Interest Rates

The Company’s exposure to market risk for changes in interest rates primarily relates to debt obligations that are at variable rates, as well as the potential increase in the fair value of long-term debt resulting from a potential decrease in interest rates. As of January 31, 2023, the Company’s financial liabilities with exposure to changes in interest rates consisted mainly of $100.0 million outstanding on the Company’s unsecured revolving credit facility, €80.0 million, or $86.6 million, of a variable rate term loan and ¥2.0 billion, or $15.3 million, of variable rate senior notes. Assuming a hypothetical 0.5 percentage point increase in short-term interest rates, with all other variables remaining constant, interest expense would have increased approximately $0.4 million in the six months ended January 31, 2023. We have no interest rate hedging agreements. Interest rate changes would also affect the fair market value of fixed-rate debt. As of January 31, 2023, the estimated fair values of fixed interest rate long-term debt were $386.4 million compared to the carrying values of $425.0 million. The fair values are estimated by discounting the projected cash flows using the interest rates at which similar amounts of debt could currently be borrowed.

The interest on cash and cash equivalents will vary as short-term yields change. Assuming a hypothetical 0.5 percentage point increase in yields, with all other variables remaining constant, interest income would have increased approximately $0.4 million in the six months ended January 31, 2023.

Commodity Prices

The Company is exposed to market risk from fluctuating prices of purchased commodity raw materials, including steel, filter media and petrochemical-based products including plastics, rubber and adhesives. On an ongoing basis, the Company enters into selective supply arrangements that allow the Company to reduce volatility in its costs. The Company strives to recover or offset all material cost increases through price increases to its customers and the Company’s cost reduction initiatives, which include material substitution, process improvement and product redesigns. However, an increase in commodity prices could result in lower gross profit.

Bankers’ Acceptance Notes

Consistent with common business practice in APAC, the Company has subsidiaries which accept bankers’ acceptance notes from their customers in settlement of certain customer billed accounts receivable. Bankers’ acceptance notes represent a commitment by the issuing financial institution to pay a certain amount of money at a specified future maturity date to the legal owner of the bankers’ acceptance note as of the maturity date. The maturity dates of bankers’ acceptance notes vary, but it is the Company’s policy to only accept bankers’ acceptance notes with maturity dates no more than 180 days from the date of the Company’s receipt of such draft. As of January 31, 2023 and July 31, 2022, the Company owned $7.0 million and $12.6 million, respectively, of these bankers’ acceptance notes and includes them in accounts receivable on the Condensed Consolidated Balance Sheets.

Evaluation of Disclosure Controls and Procedures

Management of the Company, with the participation of its Chief Executive Officer and its Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on their evaluation, as of the end of the period covered, the Company’s Chief Executive Officer and Chief Financial Officer concluded the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective. The Company’s disclosure controls and procedures are designed so information required to be disclosed by the issuer in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and such information is accumulated and communicated to management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

No change in the Company’s internal control over financial reporting (as defined by Rule 13a-15(f) under the Exchange Act) occurred during the fiscal quarter ended January 31, 2023, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

There are inherent risks and uncertainties associated with the Company’s global operations that involve the manufacturing and sale of products for highly demanding customer applications throughout the world. These risks and uncertainties could adversely affect the Company’s operating performances or financial condition. The “Risk Factors” section in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2022 outlines the risks and uncertainties the Company believes are the most material to its business.