Donaldson Company Inc (DCI) 2003 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Donaldson fourth-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. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today, Thursday, August 28, 2003.

I would now like to turn the conference over to Mr. Bill Cook, Chief Financial Officer of Donaldson Company.

Please go ahead, sir.

Before I start with my comments I need to first do a little administrative housekeeping.

As Jeff said, I am Bill Cook, the Chief Financial Officer.

I have taken advantage of the fact that many of my colleagues were in Minneapolis this week, so we have quite a group ready to help answer any questions later in the Webcast.

This group represents most of the top management (technical difficulty).

Of course we have Bill Van Dyke, our Chairman, CEO and President; and Lowell Schwab who manages our manufacturing operation.

We have our two business unit leaders, Nick Priadka of Engine Products and Jim Giertz of Industrial and Commercial.

We have the two guys who manage our international operations, Henk Touw who manages Europe and South Africa and Dale Couch who manages our Asia-Pacific operations.

And finally we have Rich Sheffer who handles our Treasury and Investor Relations;

Tom Windfeldt, our Corporate Controller; and Norm Linnell, General Counsel.

I also need to review our safe harbor policy.

Any statements in this call regarding our business that are not historical facts are forward-looking statements, and our future results could differ materially from the forward-looking statements made today.

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

In a few moments I'm going to give you an overview of our financial results, but before I do that I'd like to take a moment to point out two key messages.

The first relates to our ability to deliver year 14, which for those of you who have not followed us very long means our 14th consecutive year of double-digit growth in earnings per share.

The fact that we've been able to deliver these 14 consecutive records may suggest that either the target is too easy or that our record performance is preordained.

However, those of you on the outside get to see only the box score but unfortunately are left without a sense for the detailed preparation and execution of the game.

Delivering these results this year was anything but boring for the employees of the company.

We fought an uphill battle all year given the combined impact of the continued global economic softness and the implosion in the North American gasturbine market.

Yet despite these headwinds we were able to win the game through the execution of growth opportunities in those of our businesses that had them coupled with a fanatical focus across the company at improving those things we could control.

A great example of a growth opportunity we realize this year is our entry into a brand-new segment for Donaldson, filtration for the diesel pickup truck segment.

Bill will talk a little bit more about this later.

And the results of our efforts to focus on those areas we could control can be seen in the improvements in our gross margin, operating expenses and working capital which I will cover in a few minutes.

The second key message is that the business model that we have created and fine-tuned over the past 20 years really does work.

The essence of the model is that if we leverage our core strengths, including our filtration technology, into a variety of different end markets around the world we should be less impacted by any one business cycle.

This diversified portfolio of filer businesses has provided a stable platform for you, our shareholders, and also for our employees and has allowed us to deliver consistent and significant increases in earnings and value.

The past several years have really tested our model and the result, another record, and now a streak of 14 speaks for itself.

While drawing upon the same core strengths, Donaldson today is significantly different and stronger than the Donaldson of the 1980s.

Before I turn this over to Bill Van Dyke, I'd like to take a minute to review our financial highlights.

As you saw in our press release, we are very fortunate to be able to once again use the word 'record' a lot.

We had record sales and earnings for both the fourth-quarter as well as the full year.

At yesterday's market close we reported record fourth-quarter revenue totaling 330 million which is up 9 percent from 304 million last year.

Our full year revenues were another record at 1.2 billion, up 8 percent from 1.1 billion last year.

There are a lot of pluses and minuses in our revenue results, the major minus was the dramatic drop in our gas turbine business which was fortunately more than offset by real growth in our engine business, some help from currency, and the addition of Ultrafilter.

Moving on to our gross margin, it increased from 31 to 32 percent -- 32.1 percent, a new record, and there are a couple of messages in our gross margin performance.

First, the addition of the higher gross margin Ultrafilter business has had a positive mix impact on our corporate gross margin average.

However, if we exclude the impact of Ultrafilter, our full year gross margin still improved from last year and set another record.

We believe that this was a significant accomplishment as we also invested more heavily in our plant rationalization efforts this past year and have continued to face severe pricing pressure in most of our markets.

We were able to offset these negatives through a combination of our continued and spectacular cost reduction product and plant rationalization efforts.

The bottom line is that even without Ultrafilter we have once again been able to improve our gross margin percentage and establish a new record.

As mentioned in our press release, included in our gross margin performance was the equivalent of 10 cents per share for the year for our rationalization efforts.

A major portion of these costs is related to our plant rationalization program in Japan which we are happy to report is going very well.

We have now completed the expansion of one of our Japanese plants and last month sold the other older plants in Ome.

We are currently in the process of transferring our production capacity and expect to complete this entire process during the first half of fiscal '04 at which time we expect to report a gain on the sale of the Ome property.

Moving on to operating expenses, they were 21.3 percent of sales versus 20 percent last year.

This increase as a percent of sales is also attributable to the addition of Ultrafilter which, as a result of their end-user sales model, has higher selling expenses than our traditional businesses.

Holding aside Ultrafilter, the real story is how effectively we've been able to manage our expense base.

Given the continuing economic weakness we have faced, we have implemented numerous programs across the company to effectively manage our expenses while still getting the job done.

One great example is our reduction in travel costs.

Through the use of altrusic (ph) technologies such as video conferencing, we've been able to reduce our North American air travel costs by about 40 percent over the past two years.

The bottom line, and as noted in our press release, is that excluding Ultrafilter, and on a cost in currency basis, our operating expenses were down almost $23 million or 10 percent from the prior year.

Now moving to our bottom-line, we reported record fourth-quarter diluted net earnings per share of 60 cents, up 9 percent from last year.

Full year earnings per share is also another record at $2.11, up 11 percent from the prior year.

One highlight from our balance sheet I'd like to point out is our working capital improvements.

During the past year we generated an additional $26 million in cash flow through further improvements in both Accounts Receivable and inventory.

And over the past two years we've been able to wring out $70 million in working capital improvements, converting it into cash again mostly through improvements in inventory and Accounts Receivable.

In conclusion, we are very, very pleased with our record results and our achievement in year 14.

According to our analysis, 14 consecutive years of double-digit increases in earnings per share puts us in a very small and select group.

We count only three other public companies that have streaks this long or longer, and Donaldson is the only industrial company in that group.

Our business model and the diligent efforts of the 9,000 Donaldson employees around the world have made this work.

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

Good morning.

As you can imagine, we're very, very pleased with the results and proud of all the people here who made it happen.

In looking at fiscal '03 I'd like to point to five keys or headlines to that success.

The first of these would be our North American commercial vehicles operation.

We said coming into the year that it was going to be positive and we said that in the face of a fair amount of skepticism given the outlook for the commercial vehicle market.

It turned out to be positive and there are several reasons why it was.

First, the heavy truck build rate in North America didn't drop nearly as much as some feared, but it did fall.

But that falloff was selective and didn't effect all manufacturers equally.

It favored those where Donald happens to be sole source or very high share.

The net impact was that our unit volume was flat year-to-year from '02 to '03.

The sales went up on higher content per vehicle led by our emission control devices.

We are sole source for the emission control devices that go on the Caterpillar's bridge engine, and that engine took a fair amount of market share last year.

And the other factor in our North American commercial vehicle story is what we've talked about a couple times in the past and that is the impact of this new product that we're bringing to the market called PowerCore.

A significant advancement in filter technology, it's proprietary to Donaldson, innovative, about half the size of the products it's replacing.

And it's brought with it a fair amount of incremental business, especially in the light diesel or pickup truck market.

The second factor in '03 that I'd point to is our overseas operations, very strong operations there.

Again, about 50 percent of our sales outside of North America.

And these operations made a huge contribution toward masking the pressure that we felt in several of those North American businesses.

Japanese emission regulations drove record performance at Nipon Donaldson, our subsidiary in Japan.

Local currency sales were up 17 percent in a truly lousy Japanese economy, and yielded a 22 percent operating profit increase.

Again, this is local currency.

Our European engine operations posted a 16 percent operating profit increase on modest sales.

Australia showed a currency operating profit increase of 70 percent on slightly higher sales.

And our South African operation turned a 20 percent local currency sales increase into a 50 percent operating profit increase.

Now some of these operations are larger than others, but the numbers themselves, up 22 percent, 16 percent, 70 percent, 50 percent, really underline how important our overseas operations are to the whole Donaldson story, and why we are able to post such solid results despite the soggy U.S. economy.

The third factor I'd point to is the Ultrafilter integration.

Ultrafilter, you'll remember, is the acquisition we made about this time last year based in Germany, and what we've seen is a very smooth fitting together of Ultrafilter into the Donaldson portfolio.

We logged about $120 million in sales and operating margins grew throughout the year to approach 10 percent by year end versus roughly breakeven a year ago.

We got outstanding leadership from Ultrafilter's management, solid growth in sales in a very difficult environment while reducing product cost and slashing our overheads.

There's more to do, the integration isn't completed, but we have to score this as a significant success.

We continue to be really excited about the potential over the longer-term of blending the Ultrafilter capabilities with our industrial hydraulics business and our industrial dust collection business to create a broader Donaldson presence in in plant filtration.

The fourth factor I'd point to is the gasturbine systems retreat.

That -- we don't normally focus on retreats in discussing highlights, but this is a pretty unusual story.

I think most of you know we've been working in the gasturbine market for a long time and we averaged 40 percent per year growth for three years moving into fiscal '02 where we logged $230 million in sales.

But then the North American power generation bubble burst, and we came into this year projecting a big drop in sales.

We got 44 percent, just more than a $100 million drop in revenues in our power generation market.

But that's not the news.

The news is that the gasturbine organization did an extraordinary job of managing down both manufacturing capacity and operating expenses.

They maintained gross margin and finished the year in the black.

That's just not supposed to happened.

Industrial manufacturing companies dropping 44 percent of revenue and remaining profitable.

But these people did it and they were an important part of a successful Donaldson year.

The fifth factor I'd point to is earnings quality.

I just want to underscore what many of you've already noted.

That we got year 14, like the old brokerage commercial said, the old-fashioned way, we earned it.

The evidence is that our free cash flow, again, was well in excess of profits.

We took another big bite out of working capital this year, $26 million, and lowered our debt level and interest costs and funded the highest level of share buybacks in the last three years.

So those are five highlights from a very good year, and I've noted before this is a complex company.

So our success is a complex story, it's not five headlines, it's the product of a lot of hard work by thousands of people all over the globe.

Let me shift for a minute to the focus on next year what we call year 15, and talk about why we know we're in the race and why we're confident of our ability to keep this string going.

The first thing I'd point to is again, the worldwide engine business.

We've seen orders improve for seven consecutive quarters, both OEM and aftermarket orders were at record levels in the fourth quarter.

Year-end backlog was at a record level with our hard backlog, or 90 day backlog, up 10 percent from a year ago.

Buoyed by our PowerCore programs that we've already won with Ford and GM and the diesel pickups, we project commercial vehicle sales to be up about $30 million in fiscal '04.

On the emissions retrofit side, we've got a couple million dollars of orders in hand.

Most notably from the (technical difficulty) for a new unique EPA certified emission control system from Donaldson.

And we project an incremental $10 million or perhaps more in '04 retrofit emission sales.

The second thing that fuels our optimism is the disk drive market.

I think you know, we've got about a 60 percent share of the world market for disk drive filters, and that market is on the rebound.

Industry figures show PC and server sales were up about 8 percent in the most recent quarter and the industry is projecting about a 10 percent increase in unit volume for the coming year.

On top of that we've seen the first major technology innovation introduction into the market in the last couple of years as CJ and MacStar (ph) each recently introduced a single platter 80 G drive in the 3 1/2-inch format.

And what that means is you've got very high aerial density, very high access speed and that means demanding filtrations.

That's Donaldson's business.

The end result is that we saw our last quarter disk drive orders and backlog at record levels.

We're looking for a strong start fueled by what we expect to see an August sales increase of about 40 percent over a year ago.

The third factor for us in '04 will be again Ultrafilter.

We expect continued revenue growth from Ultrafilter and combining that with the full year impact of the profit improvement work that's already been done last year, and the effect of the continuing improvements in process today.

Finally, I come back to this ongoing program in manufacturing rationalization.

We're finally, as Bill suggested earlier, we're finally going to have one break our way instead of it always being a constant drag on earnings.

Those of you who followed the Company know that for several years we've focused on improved efficiency through consolidating our manufacturing capacity, and we've made tremendous progress through the efforts of lots of people.

But it's expensive work.

We booked 17 cents a share earnings a couple of years ago and, as I think Bill mentioned a minute ago, 10 cents per share in the last year.

As always, we booked that to operating income.

And another step in that ongoing process of consolidation is the consolidation in Japan, our Japanese operations that Bill talked earlier, to go to one plant from two.

The new plant is finished, the move in is in progress.

The folks who are executing that have done really a superb job.

They've already sold the old facility and, when the move is complete sometime in the first half, we're going to book 8 to 10 cents a share in gain.

Again, 8 to 10 cents a share in gain.

The accountants say that, unlike all the costs we've incurred, this will show up in other income, but it's just as real a part of running this business as all of the costs that we book today.

And it will certainly support our fiscal '04.

That's a brief review of the past and the future.

Let me stop at this point, operator, and open the lines up for questions.

(OPERATOR INSTRUCTIONS) Lorraine Maikis.

Could you just comment for a minute on PowerCore, what the level of revenue was for '03 and where you see that growth rate going over the next two to three years?

Good morning.

PowerCore, as Bill mentioned, is a very interesting product for us, a very exciting product for us.

We don't disclose the individual product sales amount, but I can tell you this, that our production of that product, sales of that product more than doubled this year.

We expect a redoubling of our sales next year.

It's going to be a very, very large component of our growth.

And as you probably saw in our results, 55 or so percent of our total business is replacement parts.

The beauty of PowerCore is we're in the first fit stage.

Most of our sales over the past year have been first fit business.

The replacement elements are yet to come, and that's what's going to grow and drive our growth in future years.

What is the replacement cycle for PowerCore?

It varies depending on market.

And it can be anywhere from two to four elements a year depending on the kind of conditions the vehicle operates in.

Switching over to UltraPure, you mentioned that there was an adjustment on there for a change in quarter end, but what did that relate to exactly?

Ultrafilter?

Is that what you're talking about?

Ultrafilter, yes, sorry.

I'll ask Tom Windfeldt to respond on that one.

When we acquired Ultrafilter a year ago, financials were under German GAAP and they were not closing their books monthly.

So in the first month last year we ended up bringing them on on a lag base simply because we couldn't get their financial statements timely.

We've worked hard this year at getting their operations in the financial area and working well, and by year end this fourth quarter we were able to bring them up on our July year end.

So they ended up in the fourth-quarter having four months of activity instead of three.

Okay.

You have an organic growth rate for Ultrafilter revenues taking out that extra month.

Yes, if we take it in local currency terms, in local currency terms or in euros, Ultrafilter's revenue was up about 5 percent year-over-year.

Finally, Rich, do you have the currency effect by business line?

In the quarter the transportation business had a benefit of 1.4 million.

For the year it was 4.7.

Off-road 4.7 million in the quarter, 14.1 million for the year.

Engine aftermarket 3.3 million in the quarter and 8.1 million in the year.

So for the total engine business 9.4 million for the year, 26.9 million -- or the 9.4 million was for the quarter, pardon me, and 26.9 million for the year.

In the industrial business is gasturbine had a benefit of 1.9 million in the quarter, and 6 million for the year.

Industrial air filtration, 3.4 million benefit in the quarter and 9.7 million for the year.

Special applications, 1.3 million in the quarter, 3.3 million for the year.

At Ultrafilter 5.3 million in the quarter and 14.1 million for the year.

So the total industrial 11.8 million in the quarter and 33.1 million for the year.

Thank you very much.

Bill Benton.

Congratulations on another solid quarter.

Just a couple of question.

You touched a little bit on the engine outlook.

It seems like given the PowerCore ramp that that actually could even be a little better, and I'm trying to get maybe an update on kind of where -- how things are ramping in terms of expanding the production capacity there?

Then I have a follow-up on the industrial outlook.

Good morning, again.

PowerCore production, as I indicated in the last conference call, will be double this year.

We're putting in more capacity and (indiscernible) our capacity by the end of the first quarter we'll be double over what we had last year.

By the end of our fiscal year '04 we will have doubled that capacity again as we expand that further.

Just to expand on that a minute.

We're really in the early innings of the PowerCore product.

It's moved out of our production development labs and within the last six or eight months into a line factory.

And the progress there has been pretty dramatic.

We've seen the line speed increase by about 75 percent, we've seen the scrap drop by two-thirds.

So we've made lots of gains in the production capacity just in what we have in place, and then we're going to double that capacity this fall sometime.

And we expect to use up that capacity before we get to year end.

So the original plan on doubling it there, have there been any delays in terms of being able to expand?

No, that's going full speed ahead.

Nick referred earlier to the fact that most of the sales have been first fit.

For the most part that's been by design, but we're really tapped out.

We're selling all the product we can make.

And then I had a question on your industrial outlook, it's a lot better than what I was thinking it was going to be.

And I know you touched on the special amps on the disk drive side.

But you also mentioned I think in the text of the release that you expect market share gains internationally.

And I was wondering if you could just maybe touch on what's driving some of that and the overall low double-digit growth in industrial excluding gasturbines?

Your question about the market share gains, which business were you referencing there?

I believe it was in, and I'm looking at my old notes here, I believe it was in your international -- you talked about market share gains internationally in industrial.

Specifically talking about the international piece of our business, let's take them piece by piece.

Industrial air filtration I think we have market share opportunities there.

The market continues to be fairly difficult.

Over the last year we've added quite a bit of sales -- added quite a number of people to our sales organization.

Our impression is that the competitive situation that we have there is much more in our favor now.

So we're quite optimistic that even though market conditions continue to be difficult in Europe that we can produce share gains.

In the industrial air filtration business outside North America the other positive story would be in China.

We had a very successful year last year, very solid growth, over 20, percent, there were additional salespeople on the ground in China, and we're looking for continued growth there.

Some of the other areas, of course Ultrafilter is an international story really.

Ultrafilter continues to show good progress in our markets particularly in Europe, and we're expecting solid growth from them again this year, double-digit growth in local currency terms.

Okay.

That's great.

Just one real quick one.

I presume that you obviously conformed the operating expenses as well and that accounted for probably some of the sequential gain there in operating expenses on Ultrafilter?

Say that again, Bill.

The operating expense sequential growth would've incorporated obviously the conforming of the Ultrafilter acquisition on a local sales and operating expenses basis, correct?

Yes.

Thanks, nice quarter.

Kevin Monroe.

It's Thomas Weisel Partners.

A quick question on the margins, given your focus on improving cost and your outlook for an improving economy on the industrial side, where can margins get to?

I know prior to the -- on the operating margin line -- prior to the Ultrafilter acquisition we had a quarter where operating margins were around 12 percent.

Is that achievable now that Ultrafilter is kind of approaching Donaldson levels?

Where do you think margins can go in '04 and '05?

Kevin, I think you've asked this question every time we've spoken.

I'm going to probably give you a similar type of answer.

We don't comment on a plus factor basis, how good the margins could be.

But I think your point is a good one, that is moving forward that the Ultrafilter margin, since it just recently approached the Donaldson lake average, is going to help provide some lift.

But we don't comment specifically on what we're planning for next year in terms of the margin.

But there is some upside and there'll also be further upside if the economy comes back strongly.

Just to expand that point.

The plants -- our manufacturing capacity is running more efficiently than it ever has in the past, and the prospect of pushing more volume through those plants is pretty tantalizing, but we've got to get the volume.

One other question on Ultrafilter, how significant has the cross selling been to date in terms of selling dust collectors in Europe and air compressors in North America?

The impact to date has been very minor.

We've had a couple of success stories, we can point to a couple of cases where we've actually scored.

So to date not much, but it's a primary area of focus for the current fiscal year.

And part of the reason that there is low progress to date is that we've very consciously stayed away from that.

We didn't want to distract the work that had to get done to integrate Ultrafilter into the Company and we feel like we've got much of that work behind us, and so the focus is shifting.

So now it's more of an '04 event in terms of leveraging than cross selling opportunity.

Right, by original plan.

Yes.

Great, thank you.

Richard Eastman.

Robert W. Baird.

Bill, could you talk for a minute about Japan and the demand for emission control product there?

That's partially being driven by a CAT (ph) -- I'm curious, their regs are on the same time line as ours?

Is that a fair comment?

Rick, since I have Dale here sitting next to me I'm going to ask him to comment on that since he's the closest to it.

The emission control legislation and the new rules coming out in Japan certainly have impacted our subsidiary's production of emission control equipment, particularly in the retrofit area.

That going forward into the next year, we're not depending upon that to continue as robust as it has in the past.

Indeed the forecast for next year sees that market flattening out.

But then there's also another level of regulations that's further out there.

The regulations aren't exactly on the same timetable, Rick, as they are in North America.

But the same progression over the next couple of years.

And ultimately that gets (multiple speakers).

And then secondly, on the gasturbine side of the business, pretty impressive that you could hold margin there.

I presume that that's been a function of pulling more work in-house verses outsourcing.

As you push into '04 and we see again this suggested deadline that most of us expect to see, what happens to margins, can you still manage those margins flat with 40 to 50 million less of sales?

Rick, I'm going to ask Lowell to take that one.

Your assumption there is right.

We are doing more of the work in-house now than we did.

If you remember, in the past we have specifically stated we were trying not to invest in all the production capability for that productline.

So, historically over the last two or three years, we have outsourced two-thirds to three-quarters of the production of that product and now bringing it back in-house.

We have also taken all of the U.S. production out of place.

So virtually, all our North American production is now in Mexico.

So a combination of all of those things is what has allowed us to maintain the gross margin for that business.

And 40 to 50 million less in sales, are we still going to be able to hold that up?

We believe so, yes.

We have lots of opportunities to continue to execute on the things that Lowell just mentioned in terms of moving to low-cost menus and the consolidation also within our own facilities.

Lastly, just a big picture.

In the press release you talk and speak to the revenue guidance in some detail for FY '04.

Are there any FX assumptions embedded in those growth rates that you lay out in the press release?

We assume that exchange rates will stay about where they are today.

Okay, thank you.

James Gentile.

James Gentile at Sidoti & Co. I guess I was just going to ask what Rich just previously asked regarding the expectation for currency going forward, given your double-digit revenue expectations.

It just seems that you explicitly stated, and I hate to ask you a question about something that you'd have little control over, but your sales were 60 million higher.

Your earnings, you figure it was 10 cents accretive as a result of the foreign currency translation.

Now what I guess are the things that will be -- the dollar has been trending upward, so it looks like you won't be getting as positive of a benefit going forward and your expectation of a neutral exchange scenario next year still indicates some stretches with regard, I guess, to your engine mobile segment in particular.

I was wondering how you're going to fill in the hole that in the event of a translation decline next year, what will occur?

We typically don't plan for either helping or hurting us.

This past year was the first in seven years that it actually helped us.

We lost ground the previous six years.

So we operate our business as sort of independent of that.

I think as we've mentioned in the past, our businesses around the world are more or less naturally hedged sine we sell and produce generally in the same currency.

So in Europe, we produce in euros, we sell in euros.

So we don't have that type of exposure, but we do have the exposure in terms of the translation back into our consolidated income statements.

But guessing what the exchange rates are going to be over this year, we don't factor that into the plan.

If it goes against us, we'll look for other ways of making it up.

But that is really how we operate the company.

Fair enough.

You mentioned the double-digit year 15, if you will, will that include that gain in the first half?

On the sale of the Ome?

Yes.

Yes, because as Bill mentioned, we have been taking the costs of all of the work to get to that point in the income statement as well.

So it would be fair?

We believe it is fair, right.

Okay, thank you.

(OPERATOR INSTRUCTIONS).

Bill Benton.

William Blair.

Just a quick couple of follow-ups here.

On the off road area I know last quarter was very strong (technical difficulty) Japan you're expecting it to be more flattish.

Did that already start to slow this last quarter or did North America weaken this quarter?

Obviously from last quarter, I know was very strong?

If you could just touch on that.

Bill, one point maybe and then I'll turn it over to Nick.

We talked about the emissions business in Japan.

That is an on-road business.

The off-road spike in Japan that we've seen is really related to them exporting (multiple speakers) China.

Nick, do you want to follow-up with that?

In terms of the outlook, we are planning a relatively stable year.

We see gains offshore, we see gains in both Europe and Asia Pacific.

We see a relatively flat business here in North America.

In the aggregate however, it is an overall gain.

We believe the total global situation in off road will be up in single digits.

Was there a pull-in last quarter, was that China business just unusual, or the shipments to China unusually strong last quarter?

I will ask Dale to comment on that.

The shipments to China, the export shipments out of Japan to China, were strong and certainly in the final quarter they were strong as well.

We forecasted the strength in that industry in exports because we were very, very close to our Japanese OE customers.

We forecast in '04, as Nick said, for a very stable ongoing export market to Japan and we intend to capitalize on that.

Just a quick question on the aftermarket that obviously improved nicely on a sequential basis and I know you have talked about improved utilization rates.

Do you think there is also, and I know you (technical difficulty) PowerCore contributing later on, but do you think you are taking share now in the aftermarket segment?

We certainly believe we are taking share internationally and globally offshore.

We are holding our own and then some in North America and we are gaining within the light vehicle segment.

As you saw our increase this past year in the quarter was 12 percent and something like 10 percent, 8 to 10 percent overall.

We have an expectation that we are going to continue to grow in that same range, low double-digits for next year, and several drivers, share gain overseas, a better utilization in North America, much greater proportion of replacement parts next year on power cord versus the emphasis on first fit this year.

I don't know if this is nourishing or not but I think it is maybe helpful to add that there isn't anything in our plan for next year that it is conflict with the order trends that we have seen in each of the businesses, in each of the geographies, where we have defined a specific sales outlook.

We are not just picking the numbers out because they make us feel good, but they are really supported by the trends in the business.

Thanks again.

Richard Henderson.

Pershing LLP.

I had a couple of questions.

First, if you could comment on the trend in your input costs versus your pricing flexibility?

Our input costs, Richard?

Yes, what is the trends in your cost of filter media, labor, materials, and so forth?

The other part of that question would be in terms of generally in your markets, is your ability to change prices, increasing, the same or what?

On the first part of that Richard, I will ask Lowell to comment on the material labor costs.

Generally our material costs are flat.

We have small increases in our labor costs going forward at this point, similar to our cost in salaried employees.

And the way we have been able to mitigate that is to improve performance in our operations as well as focusing on redesigning products and improving the usage of cost-effective materials to take our product cost down.

This is an area that we've focused on and improved on in the last couple of years.

It's a very competitive market environment, as you've heard us indicate over the last several conferences.

That continues to be the case but we feel where we can we take opportunistic approaches there.

Aftermarket pricing did change a bit last year upwards.

We anticipate that we're going to continue that trend.

But the primary way that we maintain margins in our business is that we are replacing old technology with new technology at higher margins.

That's the way we go at this business.

The other questions I had was your focus on asset management, and you've been very successful in managing the primary working working capital components generating $26 million of cash over the last two years.

That has been an environment where you've kind of had level volume or weak volume.

Assuming a strengthening as volume picks up, how much working capital would be tied up in an incremental sales dollar?

Before we get to that one, I just want to make a comment on the pricing and the cost question.

It all comes out in the wash when you take a look at our gross margin.

It might be some modest pressure on cost going up on the inputs, as you mentioned, and our pricing flexibility is maybe somewhat restricted.

At the end of the day, through all the things that Lowell mentioned, the cost reduction efforts and product rationalizations -- planned rationalizations, our gross margin has improved, and it's improved to a new record this year.

So that's really the way -- I guess the rubber hits the road is in terms of how we've been able to maintain and improve our gross margin performance.

And when we get there we've got teams set up in each of the plants with specific cost reduction targets, and we've got commodity teams based here in Bloomington working each of the major commodities.

And they worked them hard and we saw record cost reductions last year out of this group.

So even in the face of several of our markets where we've got a good deal of downward price pressure, as Bill said, we end up net net, gross margin goes up.

We've had a lot of success -- it isn't all driven by volumes improvement in working capital.

We've improved our day sales outstanding and receivables for specific programs that we've had.

We've improved our inventory turns again through the good work that Lowell's group does in the operations.

And those are benefits that we should be able to continue to hold going forward.

So we're not looking at dramatic increases in working capital as we start putting some volume back through the business.

But just kind of roughly, would it be kind of 10 cents on the dollar, 15 cents or --?

As you can project forward, the balance sheet will look proportionately, relatively pretty much as it does now.

We have a continuing program to increase our inventory turns and increase our receivables turns.

And so that will be counteracted I hope by increased sales and the effect that those increased sales have on receivables and inventory.

But you ought to see it be proportional.

One last question on the gasturbine operation.

How are you doing in terms of market share?

Our performance in market share has been very good.

Our market share has held, there's really not been a significant amount of change.

Where we have seen market share shifts it's actually been in our favor.

So good news there.

Pretty much held in North America, we've gained share in the overseas portion of the business.

And on that topic, roughly what's the OE component versus the replacement?

It's about 80 percent OEM, 20 percent aftermarket -- this past year.

Right.

Replacements should be improving relative, right?

Aftermarket will continue to be (multiple speakers).

As the gasturbine units that were built in recent years increase the usage of filters and so forth you would benefit?

Yes, absolutely.

Okay, thanks.

Marcy Yeamans.

Banc One.

I'm wondering in the IGT run rate that you have right now, you're expecting volumes to decrease in the next year, but have you already hit the run rate necessary to produce at that lower volume, or do use see a continued decrease in your run rate and manufacturing, and how much might that be?

Run rate on the gasturbine business for next year.

Yes.

I'm not sure that I understand the question but I'll take a crack at it.

We're suggesting that we are going to drop about 3 percent additional decline in revenue for next year.

Drop from?

We did 130 last year.

Right, but you've been decreasing your rate of production throughout this year because the volumes have been falling throughout the year.

You need to decrease your production rate further next year to meet that drop in volume, or are you already at that level now or close to it?

There's another decrease in our run rate in fiscal '04.

The first half of fiscal '04 will be stronger and then there'll be another drop in our production rate in the second half of fiscal '04.

The first half will be stronger than the second half.

The first half being weaker than the fourth-quarter I believe.

Okay.

And I'm guess that when you've talked about the ways in which you're trying to offset that, it sounds like you've got a really definite plan so your cost reduction activities should be pretty well set up to meet those planned production decreases, is that correct?

They are in place and we have the plans already in place to manage it through next year, yes.

Because you've done a really commendable job thus far.

Thank you.

We have no further questions at this time.

Let me close then with a couple of thoughts.

As then is probably obvious to anybody who looks that last year wasn't easy, and we have to give tremendous credit to all the people in Donaldson who made it happen, and I want to thank every one of those folks who were part of this success.

It was a very, very gratifying win.

That win reflects both the capabilities and commitment of the Donaldson people, and the soundness and enduring strength of this highly diversified filtration business portfolio that we've put together over the years.

Those two factors have produced 14 consecutive years of double-digit earnings growth.

Finally, though we're still waiting for a tail wind, we believe we can do it again on the strength of this strong engine business driven by some really great new products that are gaining traction every day, a resurgent disk drive market, the continuing flowering of our Ultrafilter acquisition, and as always the power of a great operations organization delivering an ever more efficient manufacturing platform.

We're committed to making year 15.

Thanks for your attention today.

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

Thank you for participating in today's conference, you may now disconnect.