Donaldson Company Inc (DCI) 2006 Q3 法說會逐字稿

Good morning.

My name is [Maryann], and I will be your conference operator today.

At this time, I would like to welcome everyone to the Donaldson Company third-quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS).

I would now like to turn the conference over to Rick Sheffer, Assistant Treasurer.

Sir, you may begin.

Thank you, Maryann.

Welcome, everyone, to Donaldson's 2006 third-quarter conference call and webcast.

Following my brief introduction, Tom VerHage, our Vice President and CFO, will give us a brief review of our third-quarter results.

Tom will then turn the call over to Bill Cook, our Chairman, President and CEO, who will discuss our outlook and the business conditions shaping that view.

Following Bill's remarks, we will open up the call to questions.

Before I turn the call over to Tom, I need to review our Safe Harbor statement with you.

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 our press release and our SEC filings.

Now, ladies and gentlemen, here is Tom VerHage.

Thanks, Rich, and good morning, everyone.

Well, as you saw in our press release late yesterday, if we are on track to deliver full-year EPS in the range of $1.49 to $1.54.

That would give us our 17th consecutive year of record EPS.

Our confidence was once again reinforced this quarter by our continued strong gross and operating margin performance in spite of the continuing commodity cost pressures.

We reported a 4.4% increase in sales in the third quarter.

However, our total open-order backlog is at an all-time record $493 million, which is 19% higher than last year at this time and suggests a very strong fourth quarter.

Currency translation had another big impact on our international sales for the quarter, reducing an 8.3 international sales gain in local currency by $13 million, resulting in a 2.2% international sales gain when translated to U.S. dollars.

When looked at on a global basis, currency translation reduced sales by over 3% in the quarter.

Assuming exchange rates do not change from today's levels, we do not expect translation to be a major factor in the fourth quarter.

Gross and operating margins remained very healthy during the quarter.

Gross margin was 33.5%, up a full percentage point from last year in spite of the cost pressures we are experiencing due to increasing petrochemical prices.

Our continuous improvement efforts are effective and are contributing to the bottom line.

Operating expenses continue to be well controlled at just over 21% of sales for the quarter, compared with 22% last year.

As you know, we are expensing stock options for the first time this year.

While stock option expense is $2.6 million for the nine months, only $200,000 was expensed in the third quarter.

We expect the fourth-quarter charge to be comparable to the third-quarter charge.

Our third-quarter tax rate was 28.6%, bringing our year-to-date rate to 27.9%.

Our third-quarter tax rate last year was only 24.6%, and that was due to the filing of an amended tax return for research and development tax credits.

In last year's fourth quarter, we took a $4 million tax charge related to our $80 million foreign cash repatriation plan.

As of the end of the third quarter, all of this cash was remitted to the United States.

On Tuesday, we announced a second $80 million repatriation plan, and I will talk about that in a moment.

We have reduced our expected fiscal 2006 CapEx spending from the range of 80 to $90 million down to 70 to $80 million.

This reduction is due to some of our major projects coming in a bit under budget and the probability that some final project payments might be made after our fiscal year end.

We expect depreciation and amortization to be in the range of 44 to $47 million for the year.

While our debt levels are down, variable interest rates are up, leading to a minimal increase in interest expense for the year.

We expect fourth-quarter interest expense to be comparable to the third quarter.

Now, I want to highlight two important matters as you update your models for the fourth quarter.

First, as I previously mentioned, we announced our second $80 million foreign cash repatriation plan this week.

This plan will be completed in the fourth quarter and will result in a one-time tax charge of $3.6 million or approximately $0.04 a share.

Including this charge, we expect our fourth-quarter tax rate to be approximately 36%.

Without this one-time charge, we expect our fourth-quarter tax rate to be comparable to our tax rate for the third quarter.

Second, we previously provided guidance for plant startup and rationalization expenses of 5 to $7 million for the year.

We are now in the fourth quarter and given the increased visibility we now have, we're narrowing that guidance to 6 to $7 million.

Year-to-date, we have incurred $3.8 million, and that leaves potentially up to $3.2 million for the fourth quarter, when we will have a high activity level in this area.

This charge in the fourth quarter compares to a $700,000 charge in the third quarter and a charge of $360,000 in the fourth quarter last year.

While this incremental charge will reduce our gross margin for the fourth quarter, we still expect to hold gross margin for the year of approximately 32.5%, which is nearly a full percentage point higher than last year.

Even with these two fourth-quarter earnings charges, I am pleased to say that we are able to stay within the range of our previous 2006 EPS guidance and have now narrowed our guidance to $1.49 to $1.54 per share.

That is thanks to our strong backlog and improved margins.

So just to reemphasize, this EPS range does include a tax charge from the second repatriation plans and the higher level of plant rationalization expenses.

So just to sum up, we had a great quarter and we expect 2006 to be our 17th consecutive year of record earnings.

Now, I'd like to introduce Bill Cook, who will discuss our outlook.

Bill?

Thanks, Tom, and good morning to all of you.

Thanks again for joining us today.

As you just heard, we had a very good third quarter.

Lots of things came together for us.

Our gross margin improved, our operating expenses remained in control, and we delivered a 12.4% operating margin for the quarter.

This performance drove an 18% increase in net earnings and a 19% increase in EPS.

So the bottom line -- a very good third quarter, and we achieved this, as Tom mentioned, despite a few challenges like foreign exchange and commodity cost increases.

Our outlook for the fourth quarter and into fiscal '07 are very good as well.

As noted in our press release, we expect our engine business sales to be up in the mid single digits percentage-wise in fiscal '07 and the industrial businesses to be up in the high single digits.

Talking little bit more about each in detail, looking first at the engine side of our business, where we serve equipment manufacturers in the construction and mining equipment, farm equipment and heavy truck businesses, the end markets for our off-road filtration business remained strong, as both construction and mining end markets continue to grow globally.

As our major off-road customers have noted recently, these strong conditions are expected to continue at least through the end of calendar 2006.

Our replacement parts business for existing fleets of trucks, construction and farm equipment should also remained strong, as utilization rates for this equipment are good.

Solid equipment utilization will continue to drive the need for regular maintenance and thereby our need for our replacement filters.

The one part of our engine business where we've been asked a lot of questions over the past several months is the North American portion of our heavy truck business.

As many of you know, there are new EPA emission regulations coming into effect next January.

As a result, we are now seeing some prebuy of our customers' trucks ahead of these regulations.

As a result of this prebuying, it is widely expected that new truck production will drop during next year, during calendar '07.

So what does this mean for Donaldson?

First, I should mention that our North American heavy truck business currently represents about 7% of our total revenues.

While it remains a very important piece of our company, it is not as dominant a portion of our overall business as it was 20 years ago.

This change in that proportion is a direct result of our focused diversification efforts to grow into other filtration markets and geographies.

Now back to heavy truck, North America -- we expect our North American truck filtration sales to be up slightly during the first half of our fiscal '07, so would be the period August through December of this year, and then to be down about $25 million during the second half of our fiscal '07, so that would be next January through July.

This decrease includes the impact of the anticipated drop in NAFTA new truck production at our customers, Caterpillar's decision to insource their emission products, and the general conversion from mufflers to emission-control devices in the market.

So putting all of those elements of our engine outlook together, the bottom line for our engine business is that, despite or including this drop in North American heavy truck during the second half of our fiscal '07, we expect our overall global engine sales next year to increase organically percentage-wise in the mid single digits, due to the continued strength in off-road equipment, good conditions in our truck-related businesses overseas, and the continued growth in our aftermarket replacement parts businesses.

Now, I'd like to switch gears and talk about the outlook for our industrial business.

Within that, our IFS business, which includes our industrial dust collectors and compressed air filters, has seen broad-based volume increases during the past quarter and our incoming orders remain good for both new equipment and replacement parts.

In our gas turbine business, we have orders in-hand that provide the basis for our forecast of the strong fourth quarter, which will bring our full-year sales in where we had previously forecasted them to around $120 million, up 6% from last year.

We are forecasting next year, fiscal 2007, to be up in the low double digits from 2006.

This is as a result of continued strong gas turbine conditions in the Middle East, Asia, and parts of Africa.

The final part of our industrial business is special applications, and we foresee high single-digit growth in special applications with disk drive filters sales continuing to lead this group.

So summarizing our industrial businesses, in total, we expect overall organic revenues up in the high single digits percentage-wise in fiscal 2007, as the industrial economy we serve is healthy across most of the sectors.

Now, I'd like to switch gears again and talk about a couple of our different growth initiatives.

The first one is PowerCore.

As you may recall, this is a breakthrough filtration technology which we've been introducing in many of our markets over the last several years.

One independent indication of the uniqueness of this technology is that, during this past quarter, our PowerCore technology received the 2006 Product Innovation of the Year Award from Frost & Sullivan.

This just (indiscernible) further our reinforcement (indiscernible) our encouragement by both the market acceptance and our continued growth of this technology.

During the past quarter, we won another 4 equipment platforms with our OEM customers, bringing our total wins today to 57. 29 of these 57 wins are already in production with another 12 to go into production yet this year.

Our PowerCore sales are up 37% in the third quarter due to a combination of growth in new first fit platforms and replacement parts.

We continue to propose PowerCore for our customers' new equipment or vehicle platforms.

As a result, we have another 60 platforms in the proposal stage with our OEM customers and with our current win rate of over 90%, we remain very confident of the continued growth of our PowerCore technology.

The second growth initiative I'd like to review with you is our emissions opportunity.

I talked a minute ago about the impact of the current round of U.S. emission regulations on our business over the next year.

Longer-term, these emission regulations will provide a significant growth opportunity for Donaldson.

We have the technology to solve this problem, and we anticipate that emission control systems will add another $100 million in annual revenues by 2010.

Earlier this month, we were pleased to announce that we've been selected by DaimlerChrysler to supply the emission after-treatment system for their U.S. medium-duty engines starting in 2007.

So we remain very encouraged by our progress.

The third area I would like to review is our international expansion projects.

This is a very exciting time at Donaldson, as we have more facility expansion projects underway than at any time during my career.

In China, we have two more plants under construction, our fifth and sixth, both of which should be opening this quarter.

One is for our engine filter-related products, the other for industrial filtration.

The focus of these two new plants is to serve the growing Chinese market for our products as well as the Asia-Pacific region generally.

We also have a new distribution center under construction in South Africa to be completed this fall.

We are expanding by about 50% our main U.S. distribution center in Rensselaer, Indiana.

This project will be completed later this summer.

We have the second plant going up in the Czech Republic, which will begin production this quarter.

Finally, a new project was approved in January by our Board of a new distribution center in Mexico, which will be completed this fall.

So you may be thinking, what do all of these projects mean?

Well, I believe they should be indication to you of both our confidence in our business as well as an indication of the growth opportunities we see ahead.

All of these expansion projects support our revenue growth plans in two ways.

First is that we are expanding into new geographies to better serve our current and potential customers.

Secondly, we're making significant investments worldwide to expand and upgrade our distribution capabilities, again in order to better serve our existing and potential customers.

Now, Tom mentioned that we will have higher-than-normal fourth quarter plant startup and rationalization expenses as we start these operations up.

However, we have very high expectations that the longer-term benefits of these facilities will bring by way of both growth and operating efficiencies.

So in conclusion, the sales outlooks for the balance of this year and next year are good.

The strength of our business model -- that is a portfolio of diversified filtration businesses around the world -- will be evident again next year as the revenue drop in our North American heavy truck business during the second half of fiscal '07 should be offset by the continued strength in our other engine businesses, by the good conditions across our industrial group.

In addition, as we've discussed in the last couple of webcasts, we have been and remain focused on improving both our gross and operating margins.

As Tom reported, we made very good progress again in this past quarter.

We will be continuing to work our cost-reduction and efficiency efforts, both with our customers and our suppliers, to maintain our overall competitiveness and to support our revenue growth objectives.

The bottom line, as Tom mentioned, is that we expect fiscal 2006 to be another year of record sales and earnings, making this our 17th consecutive EPS record.

Our goal for next fiscal year, fiscal 2007, is to again leverage our diversified portfolio of filtration businesses, both grow our top line as well as deliver our 18th consecutive earnings record.

Maryann, that complete our prepared remarks.

Now, we'd like to open it up to your questions.

(OPERATOR INSTRUCTIONS).

Jeff Hammond, Keybanc Capital Markets.

Hi.

Good morning.

I guess I wanted to focus on the backlog strength and maybe get a little more granularity on what you saw in terms of any acceleration.

Then along the same lines, are there any either industry capacity constraints or constraints on your ends that are holding back some of that backlog from getting let go?

Jeff, Bill here.

Starting with the second part of your question, on the industry constraints, no we have plenty of capacity and we are in constant communications or discussions with our customers because that would be an obvious question they would ask us.

So we have no constraints on our capacity.

In terms of the backlog, as we mentioned, we see a big lump of backlog in our gas turbine business.

We are looking at a very strong fourth quarter for gas turbine.

But then beyond that, we are seeing very strong strength across all of the other segments as well.

So, it's higher than the average in gas turbine but it's up in all of our segments.

Okay.

Then a follow-on on the gas turbine piece -- it seems like you have some of these orders at least seem to be getting pushed to the right fairly consistently.

I just wanted to gauge your confidence level that this fourth quarter materializes.

It looks pretty back-end loaded to hit your -- and what kind of -- a better understanding of what's going on there, or maybe I am just misunderstanding the timing of it.

You know, the guidance we have given, Jeff -- this is Bill again -- the 120, we feel pretty confident of that, but there's always the risk that a job site isn't ready in a project (inaudible) -- that we don't see now that a project does get pushed into the next year.

But we've accounted for everything that we already have seen with that, and these are orders that we obviously haven't (indiscernible) they are major projects, major construction projects, filter projects.

We've got a good handle on what we see in front of us, but there's always the risk that something could get delayed.

The 120 is our best estimate at this point.

Then just a final question on the truck side, I wanted to understand, you know, your comments around trucks in the second half of fiscal '07 decline.

I wanted to see if you had any kind of basis, what you're looking at in terms of NAFTA truck production along those lines.

Then also, the DaimlerChrysler win, is that one incremental to your two previous wins or one of the two?

First, on the North American heavy truck market, Jeff, mostly we follow other people's numbers who are closer to it, but current numbers that we factored in is that this year, in calendar 2006, I would say production should be about 345,000 vehicles, dropping to around 210 in calendar 2007.

So those are the assumptions that we've baked into our numbers, okay?

Then on the DaimlerChrysler announcement, that was a program that was included in our previous guidance.

But we didn't have -- we had the capability of announcing the specific customer during the quarter, so we did.

Great, thanks, guys.

Andrew Obin, Merrill Lynch.

Yes, good morning.

I just have a couple of questions.

The first question is on gross margin.

I went back into my model and I've checked.

It seems this is the best gross margin you guys have gotten.

My model goes back to '97, so I don't know but it seems it's the best you've ever gotten, or at least in the past ten years.

First, were there any one-time items or lack of any one-time items, in particular, that caused you to get such nice margin?

And B, the second question is, how sustainable is this gross margin and can it be repeated going forward?

Andrew, this is Tom.

First, to answer your first question, there really were no one-time items gross -- or no one-time significant items in the third quarter.

Secondly, is it sustainable?

We'd like to think it is.

You might recall that we've provided a long-term gross margin target of 32% and we are well north of that, thankfully, for the third quarter.

But, moving into the fourth quarter, we do expect some continued -- in fact some increase in commodity prices, which could pull that down a couple tenths of a point.

Sure.

Look, my question is, you know, I understand that, every quarter, there are one-time items, but it's sort of a longer-term question because, historically, we've been able to grow earnings at 16%;

I think that's the average.

Just looking at next year, it seems that, overall, we are targeting the growth for the Company in high single digits.

The question I have is do you have any operating leverage, any sort of -- call it whatever you want -- or any opportunities for operating improvement to continue to deliver sort of double-digit EPS growth?

I mean, that's really what the question really is, what I'm trying to get out of you guys.

Okay, Andrew, Bill here.

I will take a stab at this.

Our long-term objectives, as I've mentioned in the past, are to grow our top line 10 to 12%, and then maintain an operating margin on an ongoing basis of 11%.

So that would -- if we do all of that, then we're going to have a double-digit increase in earnings.

But back to the point I wanted to make with that is we're trying to find a balance between making sure that we're growing our top line enough while maintaining that 11% operating margin.

So the guidance that we sort of have been shooting for, as Thomas pointed out in the past, is to have a gross margin of around 32.5%, plus or minus, operating expenses of around 21 to 21.5%, which would give us that 11% operating margin, and then on top of that to get that revenue growth I just mentioned. (multiple speakers)

So given that, in the quarter, and look, you (indiscernible) my numbers, I have no problem with the quarter.

But given that, in the quarter, the topline growth I think came in below your target, even if you adjust it for currency, are we trading off some -- a little bit more margin for a little bit less growth?

Will this reverse going forward, or should I be thinking about it this way?

The objectives I laid out, Andrew, are what we are shooting for longer-term.

In this quarter, our revenue growth, even if you factor out the exchange, was a little to less than our target; we admit that.

But things really came together for us on our business improvement efforts, and we have -- for years Donaldson has focused on cost reduction, process improvements, and we've really ratcheted that up in the last couple of years.

It paid dividends for us during the quarter in terms of the gross margin, operating margin, when we didn't have as much revenue growth -- (multiple speakers).

So you don't feel that the topline growth in the quarter had any relationship to the fact that you were able to achieve very, very nice margin, so the two are not necessarily -- one did not come at the expense of the other in the quarter? (multiple speakers) -- really good execution?

Right.

Okay, thank you very much.

Eli Lustgarten, Longbow Securities.

Good morning.

A couple of quick follow-on questions -- one, can you talk about what price realizations were in the quarter -- (technical difficulty) -- and how that relates to cost?

I mean, I see you indicated that your pricing data is what offset costs, but what can we assume pricing was in the quarter?

Eli, Bill here.

Pricing for us just generally, as you know, because you've followed us for a long-term, is mostly negative because in most of our markets with our OEMs, over time, we are redesigning products and offering cost reductions.

So what this means when we have been able to improve our gross margin over the past year and over the past 15 years is really that we've been able to leverage our business improvement and cost reduction efforts ahead of negative pricing.

So, in the quarter specifically, I would say assume 0 but longer-term, it's generally negative.

Okay.

You are expecting there will be some modest pricing in the fourth quarter, based on the material that you talked about?

It will be very selective, as we said in the press release, Eli.

Mostly what we're doing is using our technology and investments in our manufacturing processes to cost-reduce to offset commodity increases, and working with our customers and suppliers to accomplish that.

Okay.

Can you also talk a little about the gas turbine business?

I mean, you are implying a 30% sales gain in the fourth quarter.

You know, you talked about low double-digit I think (indiscernible) '07 which is probably a little conservative at this point.

When you talk about not so much your fourth quarter (indiscernible) but the backlog that strong set for '07 until GE's adoption of PowerCore (indiscernible) moving at all towards [that] area?

On the first question, just the health of the gas turbine business, I think there are a couple of factors that are in play there.

One is that the North American market that went through the boom and the bust, we think that bottomed out over the last year and now it's stabilized, so we don't have that dragging down the overall number.

The second factor is that the international business never went through the boom and bust, and there's been some nice steady growth over the last couple of years and this year.

Then the third factor is really around what's happening with a segment of the gas turbine business related to oil and gas.

With the rise or ramp-up in oil prices, there has been a resurgence of investment back in infrastructure.

That's driving the need for turbines around the world.

So it's a combination of one maybe, one, the first factor being not a negative but neutral North America, and then two positives that's driving the business in the fourth quarter and into fiscal '07.

Then on the PowerCore, Eli, it isn't just GE that we are introducing it with.

We are talking with all over turbine customers about the adoption of the PowerCore technology.

It's the same advantages that we see with our engine customers -- same performance, same efficiency, same life in a smaller package.

With the gas turbine installation, that's a big deal as well.

So it started there.

We have a number of systems out in the field, a number of systems in proposal and a number that will be shipped over the next year as well.

So it's -- (multiple speakers).

(multiple speakers) -- to it yet?

I don't want to comment specifically on customers, Eli, but just I would say, generally, we are seeing good acceptance in the gas turbine market.

One final question -- you talked, in the industrial business, the other application.

I mean you have an optimistic, I guess, high single digit growth number for that with sort of (indiscernible) (indiscernible) this year.

What's driving the improvement?

Is that just the new capacity in China that's doing some of it, or what is driving the -- you know, probably the acceleration of demand?

Probably two things, Eli, one is the continued strength in our disk drive filter business.

You know we have added capacity over the last year or so for that business, and we are encouraged there.

Disk drives continue to be put into consumer electronics devices.

We are seeing some good growth with that.

Then the other factor driving the special applications growth is there are some other smaller businesses within that segment that are also seeing some pretty good growth.

So, it's a combination of the factors around the disk drive business and then some of our smaller businesses are seeing some good opportunities as well.

How much of the other applications -- the application business is disk drives, roughly?

I think it's probably two-thirds or more.

Linc Werden, H.G.

Wellington & Company.

Okay, morning.

The two shocks of your $80 million of repatriated funds, how are you using that money?

Also, could you share with us your plans, if any, for further stock buybacks?

Finally, could you comment on the impact of steel prices in the recent quarter?

Linc, this is Tom.

How are we using the proceeds from the repatriation?

Right.

We need to invest those proceeds in accordance with the provisions of the American Jobs Creation Act.

So, that includes things like research and development, pension funding, capital expenditures and perhaps acquisitions.

Now, we have a number of years to do that, so the $160 million does not have to be spent in this fiscal year or even next fiscal year.

We have a number of years that we have in order to invest those repatriated funds. (multiple speakers)

Okay, and you haven't spelled out your plans yet?

We have.

We need to do that in a filing for the Internal Revenue Service, but we don't disclose the details publicly.

With respect to stock buybacks, I think they are aware of our long-standing policy of buying back approximately 3% a year.

We don't comment on that prospectively, but that has been our historical plans.

The net reduction in our shares has been 2% because of the 1% impact of stock-option exercises and grants to employee plans. (multiple speakers).

You're going to keep that in force?

Yes, yes.

I think your third question was around the steel prices?

We buy a number of grades of steel and really, over the last couple of quarters, I would say the average or the composite price that we pay has been pretty flat.

So it's not an influence at this time -- (multiple speakers)?

Not at this time.

Richard Eastman, Robert W. Baird.

Good morning.

Bill, could you just address the backlog for one second?

If we strip out -- I'm thinking last year at this time, we didn't have a big gas turbine backlog.

We clearly do at this point.

But if you were to look at that 19% year-over-year increase in backlog and pull the gas turbine piece of business out of there, how much would our backlog be up in the balance of the business?

Rick, Bill here.

Rich is curiously punching the keys on his calculator, okay?

All right.

Well, I'm not going to ask the local-currency question, so I can give you something to do -- (multiple speakers).

(indiscernible) on them right now, but as I mentioned earlier in my remarks, we see the strength in the backlog, ex-gas turbine, is very strong in all the other business as well, so our engine business is up, and the rest of the industrial businesses are up as well.

Would you expect this running kind of at your '07 sales guidance?

In other words, engine mid single and industrial high single?

I mean, is that a fair --?

Yes, that's -- as we've mentioned in the past, the backlog has probably become less of a perfect indicator of our business because a good portion of our business never appears in the backlog, our replacement parts business.

That's about 44% of our revenues on average, so a good part of that never really -- the order comes in, it gets shipped out that day or the next day.

The other has is just that I think what we find is that our customers generally are not placing orders out as far as they used to, or they are changing orders in closer more than they used to.

So there's a lot more variability in the backlog.

So if your question is, if the backlog of that much, does that change your guidance?

I think we have tried to connect the dots on the two of those.

We feel pretty good about our guidance.

I think Rich has an answer for you.

Okay, Rick, if I strip out the gas turbine on the backlog, we still have a 17% increase in the backlog, reinforcing Bill's earlier comments that the strength really is broad-based.

Okay.

Then I have a question on the second tranche or second phase of the repatriation.

Are you going to be borrowing in Europe to do that?

Rick, this is Tom.

We may borrow temporarily in -- I will just say outside the United States, but it will not be a long-term borrowing.

Okay.

So I guess let me just rephrase this.

Because as we try to model this out, if we borrow 80 million outside the U.S. and it's, whatever, short-term debt, and we bring that cash back, should we be thinking the arbitrage between the cost of capital overseas and the cash interest here in the U.S.?

Is that how we should be modeling this?

Rick, we still have, if you've looked at the balance sheet, we still have a fair amount of cash on the balance sheet, and all of that cash is in the United States -- or I'm sorry, all of that cash is outside the United States.

So we're going to be repatriating that cash first.

Then just given the strong cash flows that we have outside the United States, we plan to borrow a bit to really represent the cash flows that we plan to generate in fiscal '07. (multiple speakers)

Okay, so that 72 million that's on the balance sheet is sitting outside the U.S.?

Yes, it is.

Okay.

Then also I have a question on PowerCore, Bill.

A tremendous product for you -- it's ramping up.

I'm just sensing, though, that some of these platforms -- these can't all be incremental platforms, presumably.

Rick, Bill again.

You're right.

In many cases, on the first fit side, we are replacing an existing balance of product or an old technology.

In some cases, it is new business on the first fit but you're right; in many, we are replacing ourselves.

But the big uptick for us, the big opportunity for us is on the replacement parts because, as we've mentioned in the past, on the old technology air cleaners that are out there, many of those were only getting maybe one in five or one in three of the replacement parts.

With PowerCore, we're going to get five out of five or 100%, for a period of time.

That's what we're seeing now, is that ramp up of -- in the aftermarket is starting as these platforms that out there start kicking in on their replacement cycles.

Okay.

The last question -- geographically, can you just give us a sense of your local currency growth, you know, Europe, Asia and North America, as it would consolidate into your local currency growth rate that you reported?

By the way, isn't that a higher number?

I thought -- did you mention the local currency growth was 2.2%?

No.

Local currency growth, Rick, was about 7.5.

All right, that's a number I have.

I thought earlier you said something differently.

But can you just reconcile that by geography?

Yes.

If we look at Europe, let's see here, Europe would have been up about 8% in local currency terms under -- it is basically flat in GAAP terms.

Asia-Pacific was up approximately 11% in local currency, up about 6% in reported numbers.

As you can see, it was a pretty big impact.

Okay.

I don't know the weighting here but -- I mean I could do it if I knew the weighting and the revenue, but what did North American do, then?

Like, five or --?

North America would have been up about 6%.

All right, very good.

Thank you.

Charles Brady, Harris Nesbitt.

This is [Kuni Hieckle] sitting in for Charlie.

Thanks for taking my question.

Just following up on your special application products, do you expect the upcoming acquisition of Maxtor by Seagate to impact sales in any way longer-term?

This is Bill.

No, we don't.

They are both very good customers of ours, so we don't expect there to be any negative impact.

Okay.

Also, do you anticipate any additional foreign cash repatriation plans in the near future?

This is Tom.

No.

The $80 million that we announced, the second tranche will be our last for the year.

Okay, that's all I had.

Thank you.

Richard Rinkoff, Craig-Hallum Capital Group.

(technical difficulty) -- agreement with Corning Life Sciences for your nano fibre cell culture product.

I was wondering.

What is the outlook for this product?

Could it actually be significant to your company, given that your revenues are $400 million or so a quarter?

Rick, Bill here.

It's still very early innings with this product line, and we have two partners here with [Cermotix] and Corning.

We're very excited about their ability to take our technology and to -- you know, it's a completely new segment for Donaldson.

But we don't really understand that market, so when I say it's early innings, we are excited about what we've seen so far in terms of the acceptance of the technology, but it's going to take some time before this gets traction in terms of a big impact on the Company, if it ever happens.

But I would say just stay tuned over maybe the next year or two and as we get smarter about it, we will talk more about it.

(OPERATOR INSTRUCTIONS).

A follow-up question from Jeff Hammond, Keybanc Capital.

You guys had changed your reporting to pull some of the corporate expenses out and allocate them to the business units.

Can you give us a sense of how that impacted business unit performance in the quarter?

Yes, Jeff, this is Tom.

We did make that change in the first quarter and approximately for each quarter -- and this is approximate -- we've taken about $4 million of expense which was previously unallocated and approximately half of that $4 million, so $2 million each went into the Industrial segment and $2 million went into the Engine segment.

And again, these are costs that really are segment expenses, operating expenses (indiscernible) segment.

So that's in line with the previous couple of quarters.

It's a fairly stable number.

Yes, it is.

So your incrementals in the Engine business were actually even better if you adjust for that?

Because you didn't restate the previous year on that basis, did you?

We did not restate, Jeff.

Marc Schwartz, Bloomberg.

Good morning, gentlemen.

A question for either one of you guys -- a couple of questions ago, you focused on one of the two factors of your firm's pay-off policy, which was the shares repurchase program that you guys have.

My question revolves around the second factor, your dividend policy.

Taking fundamentals completely out of the equation, it seems, over the past two years or so, every three quarters, you guys have increased your dividend, which would have led me to believe that this most recent dividend that you guys declared two days ago would have also been an increase but you kept it the same at $0.08.

I am wondering if you guys could shed any light as to some of the fundamental reasons why you kept it at 8 and then any kind of guidance over the next couple of quarters would also be very helpful.

Marc, this is Bill Cook.

Our dividend policy is to pay out between 20 and 30% of the average of the prior three years' EPS.

What we did last July was we started to operate sort of in the higher half of that band, okay, and we are still on the higher half between 25 and 30%.

Some, we don't comment prospectively on what we're going to do in terms of dividend increases, but as our earnings go up -- (technical difficulty) -- our dividend policy, then you can draw your own conclusions I guess.

Just reiterate that again.

You said it was -- you pay out about 20 or 30% of the past --

The policy is to pay out 20 to 30% of -- (multiple speakers) -- prior three years' EPS.

Prior three years?

Okay, great.

but we've sort of tightened that a little bit over last year to say we're going to try to stay in the up after of that band, so -- (multiple speakers) -- 25 and 30.

Silke Kueck, JPMorgan.

Good morning.

I have a couple of questions, if I may?

Can you talk about the contribution from Aerospace applications to volume growth in the quarter?

Silke, Bill Cook here.

Aerospace is an important business for us but it's still small as a percentage of our total revenues.

Rich is pulling a percentage out.

In terms of total revenues, it's between 2 and 3%.

Okay.

In terms of your capacity expansion in China and Eastern Europe, will that lead to shutdowns in other Western European regions, like namely Germany or Belgium or the UK, over time?

Generally, we're putting our investments to support our growth in those markets, so I will start with China.

So, in the case of China, the plants that we're putting there are to support production -- our needs in China and the rest of Asia-Pacific.

We do move production around because we'd have to remain competitive.

The same thing goes for NAFTA and in Europe.

So we have moved production, say, in North America between some of our U.S. plants and our Mexican operations and in Europe between our Western European operations and our two Eastern Europe plants in the Czech Republic.

But generally, we need to maintain a production capability close to our customers, but mostly what we're doing is we're moving where our customers are moving.

To the extent that our customers are in the U.S. or in Japan or in Western Europe, and they will be, we are going to continue to have manufacturing facilities there as well.

So, when I look at your 10-K year-to-date that Caterpillar represents roughly 12% of your sales in fiscal '05.

Will that number change meaningfully with the announcement that the Company is insourcing emission-control products?

If it changes, it will change only slightly.

I would say not materially.

In the IFS, if you look at the IFS business, which had very good results, were those comparable to industry trends or do you believe you gained share in that area?

Well, I think, over time, we believe that we have gained share, a combination of our -- the different businesses we put together, ultrafilter, DCE and our torque business, so I can't comment specifically on the last quarter what are share gains were but we believe, over time, that our business model has led to share gains.

How about like the past year?

Quite honestly, I can't quantify what the share gain would be.

Then I have like two small last ones.

How large is the 90-day backlog compared to the total backlog at the end of the quarter?

We're only at this point disclosing the total backlog number.

Then maybe I guess the last one -- what are the key raw materials that you purchased?

What was the percentage of cost inflation that you saw there?

The key raw materials -- the major -- the largest single raw material is steel, which is about 12% of our cost of sales.

After that, it's materials with filter media, the paper that actually does the filtering in our elements, and plastic-related components.

So those -- steel is the largest and followed by the other two.

In terms of the percentage inflation --.

This is Tom.

Maybe I can comment.

The impact for us in the third quarter was about $1.5 million of inflation in the third quarter over the second quarter.

Okay, thank you very much.

Richard Eastman, Robert W. Baird.

Bill, could you just maybe spend a minute or two on -- you know, within the transportation piece of your businesses, we seem to be shifting from Class 8 exposure to Class 5 through 7, medium duty, as we won at least the Daimler business.

I'm curious.

You know, what is the implication behind that?

Is the ASP on those emission products lower?

There's certainly a lower build rate if you just look at units in that medium duty.

I'm trying to understand.

Are we pushing into medium-duty or did we win there with expectation that we will be able to leverage that in the Class 8 business in 2010?

Or just give us a flavor for what the strategy is there.

Rick, Bill here.

We've been in the medium duty for many years, so in air cleaners and other filtration equipment, so it's not a brand new segment for us.

I think this win and maybe to your point about expanding our position in medium duty is great news for us and for the Company because, A, it's a growth opportunity and, B, generally the medium duty truck cycle runs on a different cycle than the heavy truck cycle, or at least it has to some extent.

So I think, for those reasons, both growth and continued diversification, it's good news for us.

Okay.

Do we expect to walk our way back up into Class 8 in kind of -- with the old [10] regs?

Our goal is to try and limit as much of that business where our technology can play as we can, Rick, and it will play in both the medium duty and the heavy duty and then down the road in the off-road as well.

At this time, there are no further questions.

I will turn the call back over to Bill Cook for closing remarks.

Okay, to all of you participating and listing, I'd like to thank you again for your time and interest.

To my fellow employees, none of what we've discussed today would have been possible without the efforts of each and every one of you.

So congratulations to you for our success and many thanks for your contributions and continued support.

Thank you and good-bye.

Thank you.

This concludes today's Donaldson Company third-quarter 2006 earnings conference call.

You may now disconnect.