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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
[x]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDING October 31, 2004 OR
[   ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO ______________.

Commission File Number 1-7891

DONALDSON COMPANY, INC.
(Exact name of registrant as specified in its charter)


Delaware 41-0222640
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

1400 West 94th Street
Minneapolis, Minnesota 55431
(Address of principal executive offices)
(Zip Code)

Registrant’s telephone number, including area code (952) 887-3131

Not Applicable
(Former name, former address, and former fiscal year, if changed from last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.

Yes __X__ No _____

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 1 2b-2 of the Exchange Act).

Yes __X__ No _____

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:   Common Stock, $5 Par Value – 83,187,948 shares as of October 31, 2004


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PART I.   FINANCIAL INFORMATION

        Item 1.   Financial Statements.

DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Thousands of dollars, except share and per share amounts)
(Unaudited)


Three Months Ended
October 31
2004 2003
Net sales     $ 372,906   $ 328,220  
 
Cost of sales    256,477    221,643  
 
Gross margin    116,429    106,577  
 
Operating expenses    80,298    70,884  
 
Operating income    36,131    35,693  
 
Other income, net    (3,419 )  (387 )
 
Interest expense    2,024    1,072  
 
Earnings before income taxes    37,526    35,008  
 
Income taxes    10,132    9,452  
 
Net earnings   $ 27,394   $ 25,556  
 
Weighted average shares
 outstanding    85,721,197    86,754,154  
 
Diluted shares outstanding    88,038,004    90,606,700  
 
Basic earnings per share   $ .32   $ .29  
 
Diluted earnings per share   $ .31   $ .28  
 
Dividends paid per share   $ .055   $ .048  

See Notes to Condensed Consolidated Financial Statements.


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DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of dollars, except share amounts)
(Unaudited)

October 31,
2004		 July 31,
2004
ASSETS            
Current Assets  
   Cash and cash equivalents   $ 118,741   $ 99,504  
   Accounts receivable – net    279,531    274,120  
   Inventories  
     Materials    56,769    52,979  
     Work in process    22,622    21,109  
     Finished products    74,289    69,330  
       Total inventories    153,680    143,418  
   Prepaid and other current assets    37,335    40,338  
      Total current assets    589,287    557,380  
   
Property, plant and equipment, at cost    643,179    623,488  
  Less accumulated depreciation    (377,013 )  (361,959 )
    Property, plant and equipment, net    266,166    261,529  
Goodwill    99,134    96,574  
Intangible assets    19,650    19,127  
Other assets    67,275    66,999  
      Total Assets   $ 1,041,512   $ 1,001,609  
   
LIABILITIES AND SHAREHOLDERS’ EQUITY  
Current Liabilities  
   Short-term debt   $ 92,699   $ 19,736  
   Current maturities of long-term debt    34,960    34,346  
   Trade accounts payable    127,061    124,401  
   Other current liabilities    106,203    97,041  
      Total Current Liabilities    360,923    275,524  
   
Long-term debt    70,196    70,856  
Deferred income taxes    25,023    25,981  
Other long-term liabilities    80,990    79,955  
      Total Liabilities    537,132    452,316  
   
SHAREHOLDERS’ EQUITY  
Preferred stock, $1 par value,
  1,000,000 shares authorized, no shares issued    —    —  
Common stock, $5 par value, 120,000,000 shares authorized,  
  88,643,194 issued    443,216    443,216  
Retained earnings    132,539    111,768  
Deferred stock compensation    25,473    22,092  
Accumulated other comprehensive income    46,976    31,558  
Treasury stock, at cost – 5,285,892 and 2,361,899 shares at  
  October 31, 2004 and July 31, 2004, respectively     (143,824 )   (59,341 )
      Total Shareholders’ Equity    504,380    549,293  
   
         Total Liabilities and Shareholders’ Equity   $ 1,041,512   $ 1,001,609  

See Notes to Condensed Consolidated Financial Statements.


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DONALDSON COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of dollars)
(Unaudited)

Three Months Ended
October 31
2004 2003
OPERATING ACTIVITIES            
     Net earnings   $ 27,394   $ 25,556  
     Adjustments to reconcile net earnings to  
        net cash provided by operating activities:  
          Depreciation and amortization    11,041    10,974  
          Changes in operating assets and liabilities    4,634    (17,490 )
          Other    (1,770 )  3,411  
             Net cash provided by operating activities    41,299    22,451  
   
INVESTING ACTIVITIES  
     Net expenditures on property and equipment    (7,050 )  (13,516 )
        Acquisitions, net of cash acquired and investments in
          unconsolidated affiliates    —    (4,397 )
             Net cash used in investing activities    (7,050 )  (17,913 )
   
FINANCING ACTIVITIES  
     Purchase of treasury stock    (86,542 )  (5,697 )
     Repayments of long-term debt    (185 )  (104 )
     Change in short-term borrowings    72,713    12,395  
     Dividends paid    (4,746 )  (4,128 )
     Exercise of stock options    145    1,622  
           Net cash (used in) provided by financing activities    (18,615 )  4,088  
   
Effect of exchange rate changes on cash    3,603    3,302  
   
Increase in cash and cash equivalents    19,237    11,928  
   
Cash and cash equivalents – beginning of year    99,504    67,070  
   
Cash and cash equivalents – end of period   $ 118,741   $ 78,998  

See Notes to Condensed Consolidated Financial Statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note A – Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Donaldson Company, Inc. (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal recurring nature. Operating results for the three-month period ended October 31, 2004 are not necessarily indicative of the results that may be expected for future periods. For further information, refer to the consolidated financial statements and notes thereto included in Donaldson Company, Inc. and Subsidiaries’ Annual Report on Form 10-K for the year ended July 31, 2004.

Note B – Accounting for Stock-Based Compensation

The Company accounts for stock-based compensation under the recognition and measurement principles using the intrinsic value method. Accordingly, no stock-based compensation cost related to stock options is reflected in net income because all options granted under the Company’s stock option plans have exercise prices equal to the fair value of the stock on the date of grant. The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value-based method of accounting to measure compensation expense for its stock option plans and charged compensation cost against income over the vesting periods. Amounts are in thousands of dollars, except per share amounts:

Three Months Ended
October 31
2004 2003
Net earnings, as reported     $ 27,394   $ 25,556  
Less total stock-based employee  
    compensation expense under the fair  
    value-based method, net of tax    (921 )  (1,236 )
Pro forma net earnings   $ 26,473   $ 24,320  
Basic net earnings per share  
    As reported   $ .32   $ .29  
    Pro forma   $ .31   $ .28  
Diluted net earnings per share  
     As reported   $ .31   $ .28  
     Pro forma   $ .30   $ .27  

Note C – Net Earnings Per Share

The Company’s basic net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares. The Company’s diluted net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares and dilutive shares relating to stock options, restricted stock and stock incentive plans. Certain


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outstanding options were excluded from the diluted net earnings per share calculations because their exercise prices were greater than the average market price of the Company’s common stock during those periods. For the three months ended October 31, 2004 and 2003, 1,038,040 and 110,854 options, respectively, were excluded from the diluted net earnings per share calculation.

The following table presents information necessary to calculate basic and diluted net earnings per common share (thousands of dollars, except per share amounts):

Three Months Ended
October 31
2004 2003
Weighted average shares outstanding – basic      85,721    86,754  
   Diluted share equivalents    2,317    3,853  
Weighted average shares outstanding – diluted    88,038    90,607  
Net earnings for basic and diluted  
  earnings per share computation   $ 27,394   $ 25,556  
Net earnings per share – basic   $ .32   $ .29  
Net earnings per share – diluted   $ .31   $ .28  

Note D – Shareholders’ Equity

The Company reports accumulated other comprehensive income as a separate item in the shareholders’ equity section of the balance sheet. Other comprehensive income consists of foreign currency translation adjustments and net gains or losses on cash flow hedging derivatives.

Total comprehensive income and its components are as follows (thousands of dollars):

Three Months Ended
October 31
2004 2003
Net earnings     $ 27,394   $ 25,556  
Foreign currency translation gain    15,237    10,820  
Net gain on cash flow hedging derivatives    181    159  
Total comprehensive income   $ 42,812   $ 36,535  

Total accumulated other comprehensive income and its components at October 31, 2004 and July 31, 2004 are as follows (thousands of dollars):

October 31,
2004		 July 31,
2004
Foreign currency translation adjustment     $ 50,846   $ 35,610  
Net gain (loss) on cash flow hedging derivatives    (646 )  142  
Net gain from termination of fair value hedge    970    —  
Additional minimum pension liability    (4,194 )  (4,194 )
Total accumulated other comprehensive income   $ 46,976   $ 31,558  

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On September 3, 2004, the Company repurchased 3.0 million shares from Banc of America Securities LLC under an overnight share repurchase program at a total cost of approximately $86.5 million. The overnight share repurchase program permitted the Company to purchase the shares immediately, while Banc of America Securities will purchase the shares in the market over a six-to- nine-month period following the repurchase. At the end of the program, the Company may receive or be required to pay a price adjustment based on the actual cost of Banc of America Securities share purchases.

Note E – Segment Reporting

The Company has two reportable segments, Engine Products and Industrial Products, that have been identified based on the internal organization structure, management of operations and performance evaluation. Certain prior year amounts have been reclassified between the segments to conform to the current structure. Amounts reclassified in net sales and earnings before income taxes are not significant. Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments, interest income and expense and non-operating income and expenses. Segment detail is summarized as follows (thousands of dollars):

Engine
Products 		Industrial
Products 		Corporate and
Unallocated 		Total
Company
Three Months Ended October 31, 2004:                    
Net sales   $ 217,585   $ 155,321    —   $ 372,906  
Earnings before income taxes    30,873    12,694    (6,041 )  37,526  
Assets    381,028    414,321    246,163    1,041,512  
   
Three Months Ended October 31, 2003:  
Net sales   $ 186,739   $ 141,481    —   $ 328,220  
Earnings before income taxes    27,931    10,361    (3,284 )  35,008  
Assets    344,713    379,428    198,677    922,818  

Sales to one customer accounted for 10 percent of net sales for the first quarter ended October 31, 2004. There were no customers over 10 percent of gross accounts receivable as of October 31, 2004.

Note F – Interest Rate Swaps

The Company is exposed to changes in the fair value of its fixed-rate debt resulting from interest rate fluctuations. To hedge this exposure, the Company entered into two fixed-to-variable interest rate swaps on June 6, 2001 and March 18, 2003. At July 31, 2004, these interest rate swaps were accounted for as fair value hedges and were recorded net of the underlying outstanding debt; changes in the payment of interest resulting from the interest rate swaps were recorded as an offset to interest expense. On August 2, 2004, the Company terminated these two interest rate swaps. The aggregate value of the two interest rate swaps at the termination date of $1.0 million will be amortized over the remaining life of the underlying debt.

On August 2, 2004, the Company entered into an interest rate swap to hedge its exposure to changes in the fair value of the $30.0 million senior notes that it had engaged a placement agent to issue. The interest rate on the $30.0 million senior notes offering was locked at 4.85 percent on August 2, 2004. The interest rate swap agreement has a notional amount of $30.0 million maturing on December 17, 2011. The variable rate on the swap is based on the six-month London Interbank Offered Rates “LIBOR”). Because the interest rate swap will not qualify as a hedge of the underlying debt until the debt is issued on December 17, 2004, the market value of the interest rate swap of $0.8 million as of October 31, 2004 was recorded as other income on the accompanying Condensed


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Consolidated Statement of Earnings. Upon issuance of the debt, it is the Company's current intention that the interest rate swap will be designated as a hedge to offset changes in the fair value of the debt due to interest rate fluctuations and will qualify for hedge accounting at that time.

Note G – Goodwill and Other Intangible Assets

The Company completed its annual impairment test for goodwill during the third quarter of fiscal 2004. The results of this test showed that the fair value of the reporting units to which the goodwill is assigned was higher than the book values of those reporting units, resulting in no goodwill impairment. As of August 1, 2004, the Company transferred a component of its Engine Products segment to its Industrial Products segment along with the goodwill associated with this component. Due to this reclassification, as of August 1, 2004, the Company performed an impairment test of the reporting unit to which this goodwill is now assigned. The results of this test showed that the fair value of the reporting unit was higher than the book value of that reporting unit, resulting in no goodwill impairment.

The Company has allocated goodwill to its Industrial Products and Engine Products segments. Following is a reconciliation of goodwill for the three months ending October 31, 2004:

Industrial
Products		 Engine
Products		 Total
Goodwill
(Thousands of dollars)