Donaldson Company Inc (DCI) 2004 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Donaldson's first-quarter 2004 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, Tuesday, December 2nd of 2003.

I would now like to turn the conference over to Bill Cook, CFO.

Please go ahead, sir.

Thank you Dustin.

Good morning - as Dustin said, I'm Bill Cook, the Chief Financial Officer.

We have many members of our management team on the call again today ready to help answer your questions at the end of our prepared remarks.

Those present include Bill Van Dyke -- our Chairman, CEO, and President.

Lowell Schwab, Senior Vice President of our manufacturing operations, our two business unit Senior Vice Presidents -- Nick Priadka of Engine Products and Jim Giertz, Industrial and Commercial.

Also with me today are Tom Windfeldt (ph) our corporate controller, Norm Linell (ph), our general counsel and Rich Sheffer, who handles our treasury and investor relations.

Before I start with our comments, I 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 actual or our future results could actually 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 our press release and our SEC filings.

Now I'd like to briefly review the financial highlights for our first quarter.

As you read in our press release, we were once again able to use the word 'record' a lot when describing our first-quarter sales, earnings and backlog.

At yesterday's market close, we reported record first-quarter revenue totaling 328 million, which is up 9 percent from 301 million last year.

There are a lot of pluses and minuses in our revenue results.

A major minus was the expected continuing drop in our gas turbine business as that market works its way back to a pre-bubble level.

Our major revenue pluses -- which more than offset the gas turbine drop -- included real growth in our engine business, strong local currency results at a number of our overseas operations, a significant rebound in our [indiscernible] and some help from exchange rates.

In total, our sales are up 27 million to a first-quarter record of 328 million.

Our gross margin increase from 31.5 to 32.5 percent -- also a new first-quarter record.

We achieved this record despite spending 3 cents per share in plant rationalization efforts this quarter versus no impact to earnings in last year's first quarter.

A major portion of these plant rationalization costs is related to our plant consolidation program in Japan which, we're happy to report, is almost complete.

We have finished the move of our production equipment into our newly expanded plant in Gunma (ph) from our older plant in Ome.

The final steps in the process will be completed in our second-quarter at which time we expect to report a gain on the sale of the Ome property estimated to be between 8 to 10 cents per share.

Moving to our bottom line, we reported record first-quarter diluted net earnings per share of 56 cents, up 12 percent from last year.

Our balance sheet remains very strong.

During the last two fiscal years, we were able to bring out about $70 million in working capital capital, convert it into cash -- again mostly through improvements in inventory and accounts receivable.

With our increasing sales in the first-quarter, we have begun to reinvest into working capital -- specifically inventory and accounts receivable to support this growth.

However, we remain vigilant in managing our working capital.

Our first-quarter -- at the end of our first-quarter, our accounts receivable days sales outstanding remained constant from last year's first quarter and inventory turns actually improved from this time last year.

So, in conclusion, our first-quarter was an excellent start to our fiscal 2004.

And with both our 90 day and total order backlogs at record levels, we remain confident of our ability to deliver yet another full year earnings record and a double-digit increase in EPS over last year.

Now I'd like to introduce Bill Van Dyke.

Bill.

Thanks, Bill.

My comments this morning are going to be relatively brief as our basic story hasn't changed very much since the last webcast.

The solid first-quarter results that you saw the profits up -- sales and profits up 9 and 12 percent, respectively, support the outlook that we've previously communicated regarding our expectations for the year.

With the exception of gas turbine -- that is a big exception -- with the exception of gas turbine, our worldwide backlog is up almost 25 percent over the prior year.

And while the continued softness in gas turbine draws down the consolidated total to about 10 percent, overall, we see the numbers as very encouraging.

Beyond the strength and backlog in the first-quarter, our performance really has three headlines.

No. 1 is North American trucks.

For us, sales were up 26 percent year-over-year and that is in fairly stark contrast to the widely seen heavy-duty truck industry build rate which was off 15 to 20 percent in that same period.

To understand the contrast we point to three things.

Our heavy-duty truck filtration sales were about flat on increased share.

The surging demand for the emissions product that we've talked quite a bit about in the past took our heavy-duty truck total up about 15 percent and the remainder of the growth was fueled by PowerCore -- that new product innovation that we've spent quite a bit of time on in previous sessions which brought meaningful incremetal sales, mostly in a new market for Donaldson -- that is, diesel pickup trucks.

The second headline is in our computer disk drive business -- a very different market where we have the leading share worldwide.

The industry has seen strong growth in both computer and non-computer applications and our sales are well up, well in excess of the industry up about 40 percent in the quarter.

And the third piece -- the third headline is our overseas operation.

Japan was strong, generally, but particularly so in heavy-duty truck, posting impressive increases in both sales and profits in both dollar and local currency terms.

These were very good results but they didn't keep -- come close to keeping up with the real improvements that is, excluding the lift we got from foreign exchange and real improvements in Australia and South Africa.

So, as with last year, our overseas results continue to play a key role in our success.

The sum of all this, though it's way too early to declare victory, is that our first-quarter solid P&L in the first-quarter and the climbing backlog encourages our commitment to make this our 15th consecutive year of double-digit earnings growth.

Dustin, that's the end of my prepared comments and we're open for questions.

[Operator Instructions].

William Benton.

Bill Benton, William Blair.

Just a couple of questions, guys.

First is on the operating expenses - if you could just help me on a sequential basis.

In the prior quarter did you -- you conformed to, I think, Ultrafilter so they may have been a little higher and so I kind of expected those to drop this quarter -- wondering if you could offer kind of like what some of the gives and takes are there in that line item this quarter?

I will ask Tom Windfeldt (ph) to answer that question for you.

You're right -- we had four months in our fourth quarter of last year for Ultrafilter and their expenses on a quarterly basis did come down.

Overall for the quarter versus the first-quarter a year ago about 64 percent of our increase related to the translation effect of the weaker dollar.

The other third related to personnel costs additions in some of our growing businesses and some insurance -- health insurance cost increases.

Was this on a sequential basis -- was it, was it some of the latter issues that you're referring to?

Yes.

And then if you could just help me on the balance sheet a little bit.

There were a couple of items that seem to move around a little bit -- the prepaid on a sequential basis and the accrual seem to shift around.

Just trying to see if there's anything unusual there?

Bill, we had some reclasses (ph) that we made related to disclosure -- we all made plans that some moved out of trade payables and into different accrual accounts and also took down some of the prepaid that was the primary mover on those items.

Okay and then just one question on the backlog.

Recent history at least suggested that it actually fell on a sequential basis this quarter and obviously it was up nicely this quarter on a sequential basis.

And I'm just trying to figure out if it gives you obviously a better confidence that this current quarter that you're in may be actually more of a flat quarter versus maybe a down quarter historically.

Bill, the backlog -- the 90 day backlog is up for the Company about 15 percent over the same time last year and that gives us a lot of confidence looking out over the next quarter.

What I was referring to was maybe on a sequential basis typically July and October at least in recent history suggests that it goes down or has gone down.

And this time it was up, does that -- I mean, typically, revenue at least in recent history has fallen in the January quarter ...

The second quarter is usually one of the weaker quarters -- yes.

Do you think it could be more flat given the backlog?

Look at it again year-over-year, I would say it is going to be better than second quarter of last year.

Okay.

The backlog (indiscernible) that much.

Okay, guys -- great quarter.

Charlie Brady.

Hibernia South (indiscernible) Capital.

Could you spend a little bit on working capital needs going forward for the rest of '04?

Charlie, I will ask Rich to field that one.

Charlie, we expect that working capital -- we'll be investing in working capital along with the growth in the sales line of the business.

We're still vigilant on the metrics that Bill mentioned in his comments regarding the receivables and inventory.

We do measure terms (ph) and days sales outstanding pretty closely and have a number of people [indiscernible] within the business so we're not going to lose our focus on that but you can expect it to grow in total terms along with day sales.

Okay.

In line with whatever the sales growth is going to be?

(indiscernible)

Then on gas turbine business obviously wasn't quite as weak as I thought it was going to be in the first quarter which is a plus.

But I'm just wondering if you're still saying it's going to be down 30 to 35 percent for the year versus '03?

Is there a timing issue there to where some orders may have been pulled into the first quarter for the rest of year so the rest of the year to even out to 30 percent is a little bit lumpier than it might normally have been?

Or -- what drove the lower weakness in Q1 and does it imply that the rest of year, particularly the second half, we have a little easier comp.

Is going to be a little bit worse than the 30 percent on second half?

I am going to ask Jim Giertz to handle that one.

I think on the last call we said that we thought the first half of this fiscal year would be stronger for gas turbine with the second half being a little bit weaker and I think that's still going to be the case.

The first-quarter was a little bit stronger than we had anticipated, honestly, but we're going to stick with the full year forecast down about 30 percent or so still seems valid to us.

So the next three quarters are going to be weaker than our first-quarter.

Okay and is that all driven primarily overseas -- is that correct?

Are there any specific areas -- is it coming out of Taiwan, Indonesia, or any specific areas of strength?

It's many little things.

I guess I would say we are doing better in our European business -- that is one point of positive for us.

We have done a little bit of business in Iraq which we didn't anticipate.

We've actually down some business with some customers that we've not been historically very successful with -- particularly in Asia so it's a number of small things, little stories that are adding up to a slightly more positive [indiscernible] in the business.

Kevin Monroe.

Good morning.

It's Thomas Weisel Partners.

Question on the backlog improvement.

Where are the areas of the improvement on the industrial side engine or across the board?

Are there any particular areas that stand out as improving?

Bill Cook here on the backlog.

The engine is quite far and away the leader of backlog increases but we're seeing the industrial businesses -- even including gas turbine -- were up with the 90 day backlog.

So it's pretty broad-based in many of the businesses that we're seeing improvements but the engine is way up.

Okay.

Can you guys break out the foreign currency contribution by revenue segments?

Sure, Kevin, I will turn it over to Rich for that.

Good morning, Kevin.

Starting with the engine business in total engine -- the impact on engine was 9.6 million and that breaks down into the following components. 1.2 million for transportation, 2.6 million for off-road, and 5.8 million for aftermarket.

On the industrial side, it breaks down to 9 million even.

Components there would be gas turbine 1.7 million, industrial air filtration 3 million, special applications 800,000 and Ultrafilter 3.6 million.

So, total, it was 18.6 million.

Okay.

Thank you.

Lorraine Maikis.

Merrill Lynch.

Can you guys just talk a little bit about the plant rationalization cost going forward?

It sounds like you're wrapping up on Japan.

Is there anything else you're working on that we should expect to see coming through for the rest of the year?

I will turn that over to Lowell to answer for you.

Good morning and yes, we are now completing our rationalization in Mexico and that should happen in the second quarter and then for the rest of the year it will be mostly smaller transfers and redeployments which won't have a material impact.

So we would expect our net rationalization costs for F '04 to be similar to what we had enough in F '02.

And then can you just talk about how IFSG (ph) is going?

Have you been able to realize any cross selling opportunities or take any cost set of that

I'll ask Jim Giertz to handle that one.

Yes I think the IFSG organization is going very well, actually.

Most of the work is being done in Europe today.

Where our organization is strong -- we had strong business in both the Torit [indiscernible] product line and the Ultrafilter product line in Europe.

Most of the integration work is happening in European geography, but we're doing very well.

We have combined the organizations, we have common management both in both product families.

And we are seeing real examples of lead sharing for product and specific opportunities especially with compressor OEMs to cross sell products across two or three of our different business units.

So we are seeing good success there.

And then onto the retrofit.

Sounds like you've booked about half of the estimated 10 million that you're planning on for '04.

Is that just a front end loaded business or do you think there's further opportunity up and beyond what you're expecting?

Diesel engine retrofit North America, I will ask Nick to comment on that.

Good morning.

The diesel retrofit opportunity we have anticipated continue to anticipate at least 10 million in sales coming up this fiscal year and we have over 50 percent of that in the backlog, either in the form of hard orders or commitments from local government [indiscernible].

The rates or increase -- the rate of increase in that business is evident.

We're seeing more activity and certainly in California and in some of the other major metropolitan areas where we are looking at school buses as well as other types of vehicle retrofits.

So we would anticipate that it would continue to increase.

Our plan continues to be at least 10 million for the year.

Okay and then, finally, just looking at your truck content for vehicle.

Could you comment either a dollar amount or a percentage increase from this time last year?

Yes.

In a market -- as Bill Van Dyke mentioned earlier -- in a market that is 15 percent to 20 percent lower in terms of actual build rates this quarter versus last -- last versus the previous first-quarter of last year, we have increased our overall revenue by about 15 percent.

Now that would indicate that we have had a pretty significant increase in dollar content.

I can't give you the exact percentage but those numbers will tell you that in a declining market we actually increased revenues and that's all based on market share gain and dollar content gain per vehicle.

Stuart Sharpe (ph).

[indiscernible] Research Services.

Just wanted to get an idea of the gas turbine breakdown as a percentage of sales that you see for fiscal '04 and including the gas turbine the projected sales forecast? (indiscernible)

Percentage of total sales, Stuart.

Yes.

We take a look at it basically we take last year where we did $130 million and we're looking at as Jim mentioned, between a 30-35 percent decrease for fiscal '04.

Okay so just -- what would the -- you project for the investment product groups for sales growth?

Excluding GTS it is low double digits.

Including?

Excluding.

You take the GTS out [indiscernible] we anticipate is going to go up low double digits for industrial.

Richard Eastman.

Robert W. Baird.

Just quickly, Bill, could you break down the truck business just roughly into percentages by U.S. and international?

Is that business 80/20 or how's that running roughly?

Hang on a second.

Rich is looking that up.

Just in the interest of time -- will that -- curious about the North American aftermarket business being flat.

I mean it -- pretty much any freight index or miles per tractor type of metric suggests there was growth year-over-year.

And I am a little bit curious what's happening in that piece of the business?

I think, Rick, I'll ask Rich to comment.

I think he's got the answer to both your questions so -- Rich.

First Rich on a split 60 percent of revenue per truck is North America.

On the aftermarket domestically flat to last year.

First of all we had a pretty good quarter last year and so the comparisons were such.

We have seen slight mix change within the aftermarket product group in North America.

We have actually seen an increase as would be evidenced by increased utilization rates on trucks we see higher sales of preventive maintenance products such as our liquid filtration product are actually up.

Little bit of a decline in the ag segment offset that, plus a bit of a change in our hard parts segment because products we sell into that -- into the aftermarket -- are more than just replacement parts.

So overall we saw replacement parts or replacement builder business actually increasing slightly but the mix change coupled with those two market -- that is up in truck, down in ag, netted out as flat.

Recently we've seen a fairly aggressive increase in our daily sales rates in the aftermarket and that kind of forecast with growing retrofit business and ultimately a pickup in the PowerCore replacement -- our confidence is still that we will be in high single digits low double digits growth domestically and aftermarket by the end of the year.

Very good -- let me ask you one other question.

Just trying to weight the pieces by international sales and domestic sales, our math kind of suggests that North America in total -- this is international and gas turbine or excuse me international and engine for both the industrial and engine maybe it was down 3.5 percent but if you pull the gas turbine business out we saw growth in North America of maybe 4 to 5 percent.

Does that sound about right?

The U.S. business in total was down 2.5 percent.

So you're pretty close there, excluding gas turbine downturn.

Yes, it's probably up around 5.

But we saw growth outside of gas turbine in North America.

Yes.

For the most part, yes.

Okay -- thank you.

Dana Walker.

I'm with Cal Market.

How about a comment or two on your off-road outlook that might expand upon your comments in the press release.

Off-road is several segments for us -- includes ag, construction, and mining.

What we see is heavy construction up and most recently in the mining area up.

We saw a little bit of a decline in ag although outlook now has perked up quite a bit as our backlogs reflect so we're looking at something in the low single digits growth in North America for our off-road business.

For fiscal year '04.

That would be fully reflective of the waiting that you just described?

Or is that not trying to put too much emphasis on more recent trend (ph) change?

Reflects -- my comments have to do with the market growth.

We're looking at a market growth somewhere in the 2 to 5 percent range in North America primarily driven by kind of a comeback in the heavy construction area.

And that's what we're seeing today and my assumption is that's what we will continue in the future.

As to how we will perform in that market, I think our performance in that market could be better than that based on some of our new applications [indiscernible] (inaudible).

Let me (indiscernible) back, when I saw this [indiscernible] Rick's (ph) comments about your replacement market business in North America and went back to last year's press release where it said your replacement business in North America appeared to be flat -- now that may have been flat in what was a very soft market, but is there anything about the comparison that you would want to expand upon?

In the replacement revenue?

Performance?

As I mentioned earlier the way we report that market is all aftermarket products are -- and that includes segments such as our air cleaners, our hard parts as well as other components.

And when that mix changes and it does change it gives you a picture of our aftermarket.

What I can say today -- based on our first-quarter results -- is our replacement elements sales appear to be growing and of late that rate is picking up.

So that's driven, I think, primarily, by increased utilization rates on trucks because that's the area where we see most of the replacement element (ph) growth.

But as I look forward I see with those other segments retrofit market, the growth in PowerCore, we're confident we're going to hit our number.

Question on gross margin.

You likely have Ultrafilter benefits in this year's first-quarter that you did not have in last year's first-quarter.

You also appear to have mixed opportunity with replacement parts' burgeoning strength as well as a reduction in plant rationalization drag.

What sort of updated suggestions might you offer about gross margin comparisons as we work our way through the year?

Well, we believe that we will maintain excellent gross margins during the year but we can't forecast an increase at this point.

There's too many dynamics of what's going on there.

One other point.

Ultrafilter was in our first-quarter of last year so that was in the year-over-year comparison.

But I think your -- improved -- the point I was trying to make is that the improvements that you had begun that you ultimately made in Ultrafilter would not have been reflected early in the year.

They only became more evident later in the year.

As I recall.

More than a few of those improvements were below the gross margin and the operating expenses.

Final question.

Could you talk about the relatively large order you just announced, where you would be shipping air filtration systems to the post office?

Will that just happen (indiscernible) as time goes on or is that going to be lumpy?

Yes, well, first, we got the order.

We've been working on that for quite a long time so it was a major achievement for us to finally get that order in hand.

Production shipments of the product will begin sometime in the first and in the first of the year -- January, February -- and the shipments will continue for about 18 months after that.

So I don't know if there's any big lumps in there or not.

I think it's pretty much a steady pace over the 18 months if I recall correctly.

William Benton.

William Blair.

Couple of follow-up questions here.

Could you guys talk about -- all the comments seem to suggest the patterns of sales improved as the quarter progressed and continued to improve -- I just wanted to, I guess, clarify or verify that.

Patterns of sales, Bill?

Just the pattern of sales month-to-month.

Sounds like it improved every single month throughout the quarter and continues to improve -- is that an understatement?

Yes.

And could you update us on the PowerCore line [indiscernible]

In terms of the capacity expansion for PowerCore, that is on track.

And we have achieved all the milestones we had set out in terms of productivity and scrap reduction and all those [indiscernible] things.

In fact, we have our next PowerCore line being set up in our Iowa plant as we speak, so we will be able to handle capacity for the next year at least.

[indiscernible]

Let me throw in, fun fact, we talked about just before we started the web cast and Nick commented that we had just produced our millionth PowerCore filter after a year and a half production and that is roughly a third the time, a third the elapsed time that it took when we brought in the last best in class product about 12 years ago.

This thing is taking off very quickly for us.

Great and then just one final small question.

On the other -- the JV -- kind of JV (ph) income kind of created maybe small [indiscernible] there?

Is that something -- anything to that or is that just swinging around a little bit quarter to quarter?

Bill, I'll ask Rich to comment on that.

You are just asking about other expense and other income.

Yes, I am just asking about the other income and I know that JV you noted it may be a lower contributor.

I know the interest rates are lower but I was just looking at the JV.

Bill, joint venture income does move around a little bit quarter to quarter.

We were down a little bit this time around.

That could swing back again next quarter, as we get it to 50-50 joint venture with a rather large partner so it isn't in our charge.

We also have two other joint ventures that are affecting that as well.

The Indonesian joint venture was down this quarter and that one, also, swings around rather cyclically.

So predicting it with any precision is a difficult task.

There's no big message in there, Bill.

Charlie Brady.

Thanks -- want to jump back to the truck business just so I get some clarification.

On the breakdown as far as the -- you said North American truck sales up 26 percent year-over-year.

And I think you said the filtration was flat.

Heavy-duty was 15 percent of that 26 and the rest of that would be PowerCore.

Am I reading that correctly?

Charlie, I'll ask Nick to comment on that.

What we've seen together combined is the 26 percent increase with both the light vehicle and heavy-duty are all in that number.

The PowerCore piece of that business is -- as Lowell mentioned earlier -- primarily is focused on the two to five class.

And, prior to PowerCore, we really didn't participate in that class.

So we have seen some tremendous [indiscernible] in that segment of the market.

So that's how it really breaks out.

Even though we've had heavy-duty applications and continue to have heavy-duty applications, the big story with PowerCore is that it's targeted at that light vehicle segment in two to five.

The other piece of the story has to do with CCMs and our continuing increase of [indiscernible] emission products.

Over -- I think we saw a $7 million increase in the quarter on BCM (ph) products.

And this is we're talking just North America when you talk about these numbers.

Yes.

Is that PowerCore product, are there class two to five trucks that that PowerCore is outside North America?

We do have applications outside of North America.

They tend to be in similar classes.

Right now, most of the later class is in North America, however.

What's the growth profile, then, outside North America?

Is it just -- is it similar but just smaller on an actual unit basis but growth-wise it's the same?

How does that work?

Our expectation is that the growth profile will be similar.

And it will be consistent with our strategy here in North America.

[Operator Instructions].

James Gentile.

Sidoti & Company.

I just have -- as a result of your PowerCore line taking off rather quickly, as commented by Mr. Van Dyke, do you have any insight into the aftermarket opportunity in how some potentially reverse engineered replacement filters will kind of chew into a market that could potentially be yours?

I'll ask Nick to comment on that one as well.

Well, we're always cognizant of [indiscernible].

We focus on first [indiscernible] business and try to develop a proprietary position in that segment.

For PowerCore, we have -- in fact -- gone considerably further in terms of IP and the type of investment that we are making.

So we're pretty confident that it is going to be a very difficult hurdle, both from an intellectual property standpoint and a production investment standpoint.

Now from the standpoint of functional equivalents, or will fits (ph), we can always see the possibility of something like that evolving.

But everything that we've looked at is substandard in terms of the performance expectations of our customers.

Thank you.

Mr. Cook, there are no further questions at this time.

Please continue.

All right -- I mentioned earlier when we started out that there were really three keys to our first quarter -- the North American trucks and disk drives and overseas operations.

But there are, obviously, in a company as complex as this one many, many other pieces to the story of our progress.

Pieces that were created by the 9,000 or more employees that we've got all around the world and it is the sum of the work of all these people that created the very solid track record this Company enjoys and I want to take this opportunity -- once again -- to thank them for the impressive results.

And then, finally, thank all the listeners for your attention and good morning.

Ladies and gentlemen, this concludes the Donaldson first-quarter 2004 earnings conference call.

If you'd like to listen to a replay of today's conference, please dial 1-800-405-2236, followed by the passcode 560237.

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