Donaldson Company Inc (DCI) 2003 Q1 法說會逐字稿

Good morning, ladies and gentlemen.

And welcome to the Donaldson first quarter 2003 earnings conference call.

At this time, all participants are in a listen-only mode.

Following today's presentation, instructions will be given for the question and answer session.

If anyone needs assistance at any time during the conference, please press the star, followed by the zero.

As a reminder, this conference is being recorded on Thursday, November 21st of 2002.

I would like to turn the conference over to Mr. Bill Cook CFO of Donaldson.

Please go ahead, sir.

Thanks, Daphne.

Good morning, as Daphne mentioned I’m Bill Cook, Chief Financial Officer for Donaldson.

Joining me today are Bill Van Dyke, our chairman, CEO and President.

Rich Sheffer, Assistant Treasurer and Director of Investor Relations, Tom Windfeldt, Vice President and Controller, Norman Linell, Vice President General Council and Corporate Secretary, and Jim Giertz Senior Vice President for the Industrial and Commercial businesses.

Before we get started, I need to caution you that statements in this call regarding Donaldson's business that are not historical facts are forward-looking statements, and that future results could differ materially from the forward-looking statements made today.

Actual results may be affected by many important factors including risks and uncertainties identified in yesterday's press release and SEC filings.

We really appreciate the opportunity to talk with so many of you about the business and financial matters important to all of us at Donaldson.

Yesterday, we announced our first quarter numbers and are very pleased with our results, especially given the continuing weak economic conditions in North America.

As our press release is quite detailed, I'll start off by summarizing the financial highlights.

Bill Van Dyke will comment on the business conditions we are facing and expect to see in the near term.

At yesterday's market close, we reported record first quarter diluted net earnings per share of 50 cents versus 43 cents last year.

This represents an increase of 16% from the first quarter of fiscal '02.

Record net earnings of 23 million dollars were up 16% from 20 million dollars last year.

Revenue was a record $301 million up 4%.

We also set a record in setting generating free cash flow of $38 million.

This represents a 17% increase over the $33 million general rated in the first quarter of last year.

We were able to accomplish this through the combination of both delivering record earnings and our continued efforts in working capital utilization throughout the company.

In summary, we are very pleased with our first quarter results as we set new first quarter records in sales, earnings and cash flow.

The employees of Donaldson achieve this by executing a plan that we developed this summer to deliver the results by focusing on those areas we could control within our business and not assuming that an economic rebound would help us.

That was our plan, and we were successful in executing it in first quarter.

And we will continue to follow our plan for the balance of the year.

Now I'd like to introduce Bill Van Dyke, our Chairman, CEO and President.

Bill?

Thanks, Bill.

Those of you who know and follow our company know that our fundamental model is that effective diversification of our end markets will support consistent, superior financial results.

That model was once again tested and reinforced as the continuing upturn in our engine businesses and solid performances in most of our international operations offset weakness in our North American industrial businesses.

First quarter worldwide revenues rose in each of the three engine sectors that we report.

Trucks, off-road equipment and after market.

Incoming orders were strong across all three, and both 90 day and total backlogs were up at the end of the quarter.

We're currently expecting engine revenues to be up 50 million to 60 million dollars this fiscal year, as we'll discuss over the next several minutes.

Our truck business rose on the North American heavy truck prebuy, although it now appears that both the impact and the volatility created by that prebuy will be much less than expected.

It was originally believed that heavy truck builds were spike prior to the October 1 effective date of the new emission regulations, then fall off a cliff.

What actually happened is that the truck manufacturers have a large quantity of so-called preemission engines still in inventory that will continue to power new trucks built out through December.

In addition, caterpillar with roughly 35% of the truck engine market continues to sell the same engine offered prior to the October 1 deadline.

For users of that engine there was little impetus to prebuy nor cause to delay scheduled replacements now.

The force of this is evidence by Caterpillars recent reversal of their previously announced shutdown of their Mossville engine plant.

The end result is that second-quarter truck production will be substantially higher than any of us projected three months ago.

Our international engine sales continues strong with both Europe and Asia showing 14% increases.

With both the 90 day and total backlogs for overseas engine up over 10% and incoming order trends strong we expect continued solid performance going forward.

Last week, we received level one certification from CARB, the California air resources board for our retro fit diesel emissions system.

Ours is the only verified level one solution applicable across virtually all engine operations and operating conditions.

We expect to begin selling units in the second half of our fiscal year and expect attractive incremental sales as demand grows.

As important, our success here builds both our credibility and our technical base as we attempt to carve out a significant piece of the emerging diesel emissions opportunity.

Another important piece of this story is that we're on track to begin shipments for the new light diesel PowerCore program shortly after the first of the year.

Donaldson has traditionally been the leader in air intake systems for medium and heavy duty trucks but hasn't played in the diesel pickup truck market.

Those trucks have been using automotive-style filters which are inadequate for the higher air flow needs and harsh operating environments that most of these vehicles see.

Our unique and proprietary PowerCore system is the only choice to deliver diesel class filtration in an automotive -sized package.

This translates into more efficient and lower cost systems for our customers and new business for us.

We expect to generate up to 25 million dollars in incremental revenues in the second half of fiscal '03 from this new market.

Geographic diversification played an important role in the first quarter's results and should continue to do so.

International sales growth outpaced domestic in five of our six major product groups, and we move closer to our goal of 50% of revenues from outside of the U.S., as international sales grew to 40 -- 46% of the total from 39% last year.

We also saw a Good year over year performance from our expanded PTFE membrane business with first quarter sales up more than 20%.

The membrane business is seeing substantial growth in its technical performance fabric in military applications, and we're expecting to generate roughly 15 million dollars in sales growth this year.

Our recently acquired ultra filter business performed well in its first quarter as part of Donaldson.

Sales grew about 5% during the quarter.

While we were able to quickly capture savings from both product cost and operating expenses.

Despite encouraging early progress, we are still projecting this business as earnings neutral in fiscal '03.

There is upside potential if we can complete a number of integration steps faster than currently planned.

Balancing the good news, we saw industrial capital investment retreat again in August and September after six months of slow, but study improvement.

Our industrial air filtration business is aggressively pairing existing product lines while adding new performance optimized products to open new niches.

Despite first quarter revenue down turn, these initiatives have us projecting a modest revenue increase this year.

Finally, as many of you know, our North American gas turbine business began experiencing the long predicted weakness.

Partially offsetting the softening in the U.S. where double digit sales increases internationally and in the gas turbine after market.

However, the North American turbine producers outlook remains volatile as calendar '03 forecast dropped again during the quarter.

The persistence of investor doubts about Donaldson's ability to absorb the sharp contraction in North American gas turbines has been helpful for us in underlining one truth.

We see the strength of Donaldson's diversification much more clearly than do many investors and analysts from outside the company.

We now expect the North American gas turbine contraction to take as much as 30 to 35% from last years $231 million in turbine sales.

Nonetheless, projecting from order trends, backlogs, and new opportunities in our other businesses we still expect organic growth to roughly offset the gas turbine drop.

With the addition of ultrafilter revenues in fiscal '03 should increase mid to high single digits.

Granted, this isn't a particularly bullish outlook, but we see it as sufficient to keep us in the hunt in pursuit of our 14th year.

The strength of this company is in its broad base.

Of market served and global presence.

One sector in North America will hurt us this year.

That's only a piece of the story.

This is a game we've been able to play with success through three consecutive recessions over the last 13-plus years.

The 35% drop in gas turbine for the year is in line with our first quarter experience.

When you know we bought a 16% earnings increase.

This reinforces our expectation that we can absorb this market contraction and still deliver financially.

Specifically, despite the first quarter contraction in gas turbine, we were able to significantly improve Donaldson's profitability.

Post margin grew to 1331.5% from 30.6.

Pretax margins expanded to 10.4% from 9.5.

And as Bill Cook pointed out, we threw off a lot of cash.

In conclusion, we have yet to feel much of a tail wind from the economy.

But the head wind has abated for some of our businesses.

This year, while coping with gas turbine's contraction, we see new opportunities in other businesses, strong growth overseas, and potentially help from ultrafilter.

In addition, we maintain impressive momentum and improved margins and asset management.

It would certainly be easier with a little more lift on the revenue line.

But either way, we remain committed to sustaining our earnings growth record by delivering year 14.

That concludes my prepared comments, and Daphne, we can now open up for questions.

Thank you, sir.

Ladies and gentlemen, at this time we will begin the question and answer session.

If you have a question, please press the star followed by the one on your push button phone.

If you would like to decline from the calling process, press the star and then the two.

You will hear a 3 tone prompt acknowledging your selection.

Your questions will be pulled in the order they're received.

If you're using speaker equipment, you will need to lift the handset before pressing the numbers.

One moment, please, for the first question.

Our first question comes from David Sereno with Gabelli and Company, please go ahead with your question.

Hey good morning David Sereno, Gabelli and company.

Two questions.

First, Bill, how do you get to mid to high digits if you're up 1.7% in first quarter.

Things probably won't change much -- well, I guess in gas turbines but also are you anticipating a pickup on the dust side?

How do -- if you can walk us through that?

The -- I don't think I said mid to high single dim its for industrial.

I think I said mid to high single digits for the corporation as a whole.

Oh, that's the entire company?

Does that change your question?

It does.

Sorry.

I misunderstood.

I guess the second one was gross margins you managed to boost that in spite of ultrafilter.

And I guess it would appear to be negative mix with engine growing faster than industrial.

I guess where did you get most of the improvement from?

Was it pricing or productivity or what was in there?

David, Bill Cook there.

If we pull out ultrafilter, the organic business was up.

I would say probably the biggest factor there was product --continued realization of our productivity improvements.

Okay.

Thank you.

Our next question comes from Kevin Monroe with Thomas Weisel Partners.

Good morning.

A question on the gas turbine business.

Basically, down 30 to 35% in '03 I guess about $70 to $80 million and that's different from your previous last quarter we were talking about $50 million decline.

Last quarter we're saying we could -- you can make that back up through organic growth.

If you could just -- and you're saying the same thing this quarter, if you can kind of just explain where that incremental $30 million in organic growth will come from.

Because the economy is still kind of a question mark, and, you know, some parts of the business do look like they're improving, but where do you see that extra $30 million coming to pick up the extra decline in gas turbine?

Kevin, Bill Cook again.

I think we see continued strength or maybe more strengthen that we saw internationally.

With our businesses there.

So that's part of the story.

We're actually seeing some better news than we had expected three months ago from say the heavy duty truck market and some of the new light vehicle programs.

You're right, at the same time, at the prognosis on gas turbine has weakened, we are seeing better news in some of the other segments, internationally and some of the new programs.

Again, we're not betting on a recovery in the economy yet.

Okay.

In terms of the free cash flow and, guys, pretty significant, you know, strong free cash flow quarter.

What are your plans to utilize that cash in the third quarter?

I know you might be hesitant to do more acquisition, so how do you plan on utilizing free cash flow in next 12 months or so?

Well, I think it's probably more of the same, as what you have seen over the last year or two, Kevin.

You know, we're going to continue to look at opportunities to support our stock repurchase program the long-term goal of reacquiring the gross of 3% of the shares outstanding.

That's not a target for any one year, but we're going to continue to work on that.

We'll continue to take a look at paying down debt and we'll continue to invest in the business.

So those are probably the three of the main focus areas.

And acquisitions we look at sort of opportunistically instead of looking out there.

We're always looking but not compelled to do every one.

Right.

One more question if I can.

The other income line was a bit stronger than -- at least what I was looking for and, you know, historically.

What are your -- you know what is that from and what are your expectations for that going forward?

This is Tom Windfeldt the Controller.

Really, the other income grew for three different reasons.

The first is with a dollar change against the Euro, we actually had close to half a million dollars of foreign exchange gang.

Our joint ventures around the world have contributed additional income of $440,000 and with more cash on hand, our interest income is up $430,000.

And as you said on the cash side we might expect interest income to continue growing a little.

The joint ventures we don't expect further growth nor much additional on foreign exchange.

Great.

Thank you.

Our next question comes from Keith Hughes with Suntrust Robinson Humphrey.

Good morning.

This is Scott Phillips on Keith's behalf.

I was looking at the overseas business, I was wondering to get more detail on what's propelling the results here?

Is that market share gain or a little more color there?

It's a couple different things, Scott.

A lot of it is market share gain in Europe.

We are seeing in the off-road business, the construction business that growing very steadily.

We believe that's market share gain.

Partly as a result of new products that we are releasing.

The PowerCore that Bill Van Dyke mentioned.

In Japan actually we have seen our business uptick there as well, and as we sort of roll down into what's happening there there's an uptick in construction equipment spending and production.

In association with exports to support the Chinese Olympics.

So it's a combination of business opportunities, new business opportunities and market share gains.

Okay.

So that's pretty much the case in all the businesses?

Right.

Thank you very much.

Our next question comes from Richard Eastman with Robert W Baird.

Please go ahead.

A couple of questions.

I wanted to circle back to the gas turbine business.

Given the current quarterly run rate at, you know, 38.6, $39 million, what did the EBIT margin look like there?

I know you don't like to segment that, but is the business profitable, and is the margin --is the negative incremental margin, you know, greater than, you know A 10% number?

In other words, I know you outsource some of the business.

So if you pull that back in, my guess is you lose the 10% margin on that business.

But where do we stand in terms of overhead absorption at this level?

You know, Rick, it's Jim Giertz.

We can't be specific obviously about the margins in our business units.

But I would say that -- to answer your question, is the business profitable, was et profitable in the first quarter and will it be profitable this year?

The answer is yes, solidly profitable.

Are the margins lower this year than last year?

Yes.

Okay.

But it should stay profitable even with this 35% down outlook?

Yes.

Absolutely.

Then also just a quick question, similar question on the same piece of business.

Normally our visibility is pretty good.

I mean, once we get an order it seemed like the production was well under way at GE.

Are we starting to get cancellations, and is there any cancellation fees recorded in gas turbine?

Rick, again it's Jim.

The visibility -- certainly visibility is less now than it was.

We look on our forecast, you know, last year our forecast --we would have been able to forecast on backlog in hand.

This year it's not that easy.

There are cancellations.

In some cases we do receive cancellation payments from our customers.

In other situations we will reschedule a job for a different program, a different project.

So it depends on what -- where we stand within the project, and at what stage the project has been completed.

Whether we take a cancellation payment or we will reassign the job.

Caller: Okay.

And then just lastly, maybe Bill could you give just a dollar figure for ultrafilters SG&A in the quarter?

We don't disclose down to that deta as we noted in the press release, ultra filter’s gross margin as a percentage of sales is higher than our average but their SG&A is as well.

Ultrafilter, we're forecasting to be neutral to our EPS for this year.

But as Bill Van Dyke mentioned, it is bun of the opportunities in the year if we can get through the year.

But your core S db & A without core ultrafilter declined?

Bill Cook Yes.

Okay.

Thanks.

Our next question comes from Bill Thomas with (inaudible), please go ahead with your question.

Yes.

You seem to be pretty confident of good gains from the international markets.

I'm just wondering how your confidence might be affected if the economies over there were weaker or weakened during the area, particularly with respect to Germany which seems to be in a bit of trouble?

Bill, I think -- one thing we have going for us, because we started internationally later than we built our presence in North America, our market shares are significantly lower, so we're less dependent on the economic cycles.

We have seen steady growth in all the segments internationally over the last is a, 18 months.

And so -- with a slow down that's already, you know, mostly happened in Germany.

We're still seeing good business growth in Europe.

How much are your businesses in Germany?

We've got something in excess of $300 million in revenue in western Europe.

So I don't know what the German piece of it is.

In my earlier comments I mentioned that ultrafilter is up 5%, and that is probably indicative of -- and ultrafilter is heavily German based.

40% of the revenues are in Germany.

So we're up 5% in ultrafilter with most of the single largest market being Germany.

Another way, another response to the question is we've run two consecutive years of record results over Japanese operation, and I don't think there are many people reporting record financial returns out of Japan.

There's nothing good happening in the economy there.

First quarter is good for us again.

Thank you.

Ladies and gentlemen if there are any additional questions at this time, please press the star followed by the one on your push button phone.

Again if you're using speaker equipment, you need to lift the handset before pressing the numbers.

Our next question comes from David Kurzman with H.C. Wainright.

Please go ahead with your question.

Hi and good morning.

Quick and just a housekeeping question.

I noticed that interest expense went up sequentially at a time when you're paying down debt and interest rates are going down.

What is the cause of that?

David, Rich Sheffer.

If I remember right, I think interest expense went down year over year.

I think se sequentially you're right, it did go up.

A lot of that is related to the increase right we took at the end of the jeer related to the ultrafilter acquisition.

We started this year with roughly the same level of debt what we did last year, August 1.

And the decrease year over year is really the interest rate differential.

And given the fact that a lot of folks are talking of pension, how much pension affect was there on the quarter what happened do you see foresee going forward?

Right now, our pension expense is projected to go up about one cent of earnings this year.

And because some of the conservative approaches we have taken over the last several years we're expecting it to go up 1 to 2 cents in fiscal '04.

So we believe we've got it pretty much under control.

Sounds like it.

Great.

Thanks.

Our next question comes from Philip -- I'm sorry Philip Palmer with (inaudible).

Please go ahead.

Yes.

You sort of answered this already, but I want to make sure I understand it.

If the sales short fall in gas turbine is being offset by added growth in international and heavy truck, what is the net effect on operating margin of that?

Are they roughly the same or would that substantial add a one into the other tend to push operating margin higher or lower?

Thank you.

Broadly speaking, they're very, very comparable gross margin.

Very comparable profitability.

Shouldn't see much of a mix effect there.

Thank you.

Our next question comes from Richard Eastman with Robert W. Baird.

I'm going to try to ask another question that you don't have an answer for.

Let me just ask you, in terms of the heavy duty truck business, the on-road business, that business looked lighter in the quarter than I think some of us might have expected, and I think Bill, you answered this in the beginning where some of the build rate is being pushed into the second quarter.

With that said, can our second quarter transportation business, can it look comparable to the first quarter's?

In terms of dollars.

This is going or the more answered than you want, but there are a number of things going on in there.

The focus in the press has been on the heavy truck builds.

A significant portion of our truck business is medium duty, classified up to seven.

So we saw an -- buried in that is 11% number that you saw in the domestic truck sales growth --maybe you didn't see it.

Anyway the 11% domestic sales growth in the first quarter was about a 60% increase in heavy truck units, about a 6% increase in medium truck, and buried in that is movement between painted air cleaners and stainless steel air cleaners, very different price points, and movement between the exhaust treatment devices for medium trucks and from heavy trucks.

And so it's tough to look at that sales number and see what's underneath there.

I will tell you this.

That our incoming orders for trucks, North American trucks, incoming orders for the first quarter were equivalent to the first quarter a year earlier.

Okay.

And then there's some pickup on top of the heavy duty and the medium duty trucks, then we have some incremental volume from the light duty truck products which start to ship?

That's right.

About the middle of the year.

All right.

I'll try to work with that.

Thanks.

Again, ladies and gentlemen, if you have a question, please press the star, followed by the one at in time.

Gentlemen, it looks like we have no further questions.

Please go ahead.

Thank you.

I think that's the end of our comments.

I want to thank all of you for participating in the call, and finally and especially thank you to thank all of the people at Donaldson for delivering another great set of results for us.

Thank you, and good day.

Ladies and gentlemen, this concludes the Donaldson first quarter 2003 earnings conference call.

If you'd like to listen to a replay of today's conference, you may do so by dialing 1-800-405-2236 using an access code of 509627.

Again if you would you want to listen to a replay of today's conference, you may dial 1-800-405-2236 using an access code of 509627.

Thank you for your participation.