Donaldson Company Inc (DCI) 2006 Q4 法說會逐字稿

Good morning.

My name is Angela, and I will be your conference operator today.

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

[OPERATOR INSTRUCTIONS].

Thank you.

Mr. Sheffer, you may begin your conference.

Welcome everyone to Donaldson's 2006 fourth quarter conference call and webcast.

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

Tom will then turn the call over to Bill Cook, our Chairman, President, and CEO, who will discuss our positive outlook for fiscal 2007 and the business conditions shaping that view.

Following Bill's remarks, we'll 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.

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 in our SEC filings.

Now I'd like to introduce Tom VerHage.

Tom?

Thanks, Rich.

Good morning everyone.

As you saw in our press release late yesterday, we had a strong finish to our fiscal year.

This strength allowed us to deliver EPS of $1.55, which was $0.01 over the top end of the range that we provided on our third quarter call.

Since I'm sure you've all had a chance to read our press release I don't want to take your time summarizing items that are disclosed there, but I do want to emphasize just a few points that we have discussed in the past and that you may want to look at for your models going into fiscal '07.

I'll start with our effective tax rate, which was 35.2% in the fourth quarter, and 30.1% for the year.

We previously announced the tax charge of $3.6 million in the fourth quarter for our second $80 million cash repatriation pursuant to the American Jobs Creation Act.

At this point, we are forecasting an effective tax rate of approximately 29% for fiscal 2007.

This estimate will we impacted, of course, by the geographic mix of our profits around the globe and any discrete items that may arise during any given quarter.

Our press release contains information regarding our gross margin and operating expenses.

Our operating margin of 12.5% for the quarter was helped by our strong volumes and ongoing productivity improvement initiatives.

We finished the year with an 11.4% operating margin, better than our target of 11%, and a lot better than last year's 9.8% operating margin.

We project our fiscal 2007 operating margin to be comparable with 2006 full year operating margin of 11.4%.

Our press release mentions our fiscal 2007 sales growth projection of mid single digits for our engine business and low double digits for our industrial segment.

A few other comments for fiscal 2007.

We expect a $1 million reduction in interest expense with the impact of our debt reduction more than offsetting slightly higher interest rates.

This projection excludes the impact of any possible acquisitions.

Fiscal 2006 Capex was $77 million, and we are projecting 2007 Capex to be in the range of $60 to 70 million, which includes a $12 million carry over from projects that began in 2006.

We expect depreciation and amortization to be $45 to 50 million in '07.

Our balance sheet remains very strong.

As you know, we have repatriated a total of $160 million of foreign cash that we will be investing in accordance with the provisions of the American Jobs Creation Act.

This has provided the opportunity to reduce non-U.S. cash on our balance sheet and to temporarily pay down short-term debt in the U.S.

And finally, just a couple of other matters that I would like to mention.

You may have noticed that we did not include backlog statistics in our press release.

As we have pointed out in our SEC filings, our backlog is not necessarily indicative of future results for a number of reasons, including short lead times in our aftermarket and the timing of the receipt of orders in many of our original equipment and industrial markets.

While our backlog is an important consideration as we develop our sales projection, we need to perform much analysis to identify and adjust our sales projections for the year-over-year anomalies in our reported backlog.

I'd also like to clarify our quarterly sales reporting cut-offs, as there will be a slight impact in the fourth quarter of 2007.

Our non-U.S. affiliates, which represent approximately half of our consolidated revenues, cut off their sales at month end.

In the U.S., due to legacy IT systems issues, we are on a 4-4-5 quarterly cut-off cycle.

And this means that in one out of every five or six years the U.S. will have an extra week of sales.

That will occur in the fourth quarter of 2007.

This extra week will be clearly immaterial to our earnings as it also carries an extra week of expenses, and it represents only half of our business.

But since this should have a few percentage point impact on our fourth quarter sales, I just wanted to bring this to your attention now.

So just to sum up, we were very pleased with our fourth quarter results from the standpoint of both sales and operating margins, and our press release provides EPS guidance for 2007 of $1.72 to $1.82 per share, which would provide yet another year of record earnings.

So with that, I'll pass it over to Bill who will provide more background on our outlook.

Bill?

Thanks, Tom.

And again, good morning to all of you.

We are very pleased to be with you this morning.

Over the next couple of minutes, I'd like to cover three different areas.

First I'd like to give you my perspective on the fourth quarter, some highlights, and I'd like to switch into talk a little bit about our outlook for 2007.

And finally I'd like to give you an update on two of our growth initiatives, PowerCore, and our expansion project.

I'll start first with fourth quarter highlights.

We finished with our best quarterly performance in a year.

Sales grew by more than 10%, and as Tom mentioned, our operating margins remained at very high levels.

This strong finish delivered our 17th consecutive earnings record.

By group, some of the highlights, and I'll start with the engine group, in Europe our engine business was strong across the board.

We had double-digit sales growth in the truck, off-road, and aftermarket segments.

Local market conditions were good and we picked up share.

In NAFTA our engine business had good fourth quarter as well.

The business conditions for our customers and construction and mining segments remain very strong.

New heavy truck build rates at our truck OEMs continued at record levels and equipment utilization rates of the existing fleets of construction,, truck, and ag equipment remained high, and all of this drove demand for our replacement filters.

I'll switch to the industrial group.

We had forecasted in our last conference call that our gas turbine business would have a strong finish to the year, and they delivered as expected.

It's important to note our gas turbine business had its first full-year sales growth since fiscal 2002, the last year of the North American power generation bubble.

So from our perspective this business has clearly turned the corner.

We also saw a dramatic improvement in the profitability of our industrial filtration, or IFS business.

This business includes our dust collection and compressed air filtration segments.

Many factors contributed to this profit lift, including numerous internal improvement initiatives, higher sales volume, and a higher mix of replacement filters.

Now I'm going to switch gears and talk about our outlook for 2007.

And based on the strong finish we have in the fourth quarter, I can hope you can appreciate how much momentum we have as we start the new fiscal year.

As Tom mentioned, our sales outlook for fiscal '07 is very good.

Looking first at the engine side of our business, the end markets for our off-road customers remain strong.

Both the construction and mining segments continue to grow globally.

Our replacement parts business for existing fleets of trucks, construction, and ag equipment should remain strong as the utilization rates remain good.

Again, solid equipment utilization will continue to drive the need for regular maintenance and therefore drive the need for our replacement filters.

The one part of our engine business where we expect to have a tougher 2007 is our truck business.

We forecast our North American truck sales to be up slightly during the first half of our new fiscal year, then down $30 to 35 million during the second half.

The good news is that for the year, despite the second half drop in the North American truck business, we expect our global engineer sales to grow overall in the mid single digits.

Now, switching to our industrial group, we see the general industrial economy is healthy across most sectors.

In our IFS business, incoming orders remain good for both new equipment and replacement orders, and in our gas turbine business we have many orders in hand already for 2007, so we have confidence in our outlook for our GT S sales to be up approximately 20% over 2006.

As we see continued continued GTS -- strong conditions for GTS business in the Middle East, Asia, and parts of Africa.

Finally, we expect high single-digit growth in our special applications business with our filter sales continuing to lead this group.

So overall for our industrial businesses we see revenue group in the low teens percentage-wise in fiscal 2007.

Now I'm going to talk about two of our growth initiatives.

I'll start with PowerCore.

We won another three platforms in the quarter this brings our total wins to 60. 29 of these 60 wins are already in production with the majority of the remaining 31 expected to go into production during fiscal 2007.

PowerCore sales in the fourth quarter were up 33% due to a combination of new first fit platform and growth of replacement part.

We still have another 67 PowerCore platforms in the proposal stage with our OEM customers, and with our win rate of over 90%, we are confident of the continued growth of our PowerCore technology.

Finally, on our expansion projects, our two new plants in Wuxi, China, which are our fifth and sixth plants in China, both began production in our fourth quarter.

As did our new industrial plant in Kadan, the Czech Republic.

In addition to our new manufacturing investments, we've made major investments in our distribution centers globally to better serve our customers.

Our new distribution centers in Johannesburg, south Africa, Belgium, and Mexico are nearing completion.

Our 50% increase to our main U.S. distribution center in Rensselaer , Indiana, is almost done as well.

Just a couple of interesting statistics, these investments that i just mentioned represent over 350,000 square feet of new manufacturing space and 450,000 square feet of new distribution capacity for our company.

Each of these facility investments I think are a great indication of our commitment and investment strategy to both better support our customers as well as continue to grow our business.

So in conclusion, our sales outlook for fiscal 2007 is good.

As we've talked about in the past, a key strength of our business model is the well-diversified portfolio of filtration businesses we have around the world.

So although we see a cyclical downturn in our North American truck business during the second half of the new fiscal year, this should be more than offset by strength in our other engine businesses as well as solid sales growth across our industrial group.

In addition, as we've discussed in our last couple of conference calls, we have been and remain focused on improving the core profitability of our businesses.

As Tom mentioned we made good progress again in the fourth quarter.

We will be looking to continue our work on our cost reduction and efficiency efforts.

The bottom line is that we expect the strength of our diversified portfolio filtration businesses and our continued focus on improvements within our business to deliver another year of record sales and earnings.

Our EPS guidance for 2007 is between $1.72 to $1.82, which would make this our 18th consecutive EPS record.

Angela, that concludes our prepared remarks.

That you we would like to open it up for questions.

[OPERATOR INSTRUCTIONS].

Your first question comes from the line of James Gentile of BB&T Capital Markets.

Good morning, guys.

Excellent quarter.

I was wondering if you would comment on the geographic concentration of the gas turbine strength a little bit more specifically with regard to the number of projects that are currently included in the backlog and where we're seeing particular capacity additions.

James, it's Bill Cook here.

What we're seeing is conditions sort of flat in the U.S. but strong in other parts of the world.

And as I mentioned, especially in the Middle East, Asia, and in some parts of Africa where they're putting new turbines on line or replacing existing turbine capacity.

I guess more specifically within those regions, are we looking at that time addition of Chinese capacity or certain areas in southeast Asia, or in the Middle East, in Iran or Iraq or some other areas there?

James, beyond the regions we don't comment specifically.

Okay.

Thank you.

Yep.

Your next question comes from the line of Richard Eastman of Robert W. Baird.

Yes, good morning, all.

Good morning.

Couple thoughts.

On the aftermarket side of the business, Bill, could you just, you know, break that down a little bit?

There isn't a whole lot of international exposure, but I'm a little bit curious on the domestic front, by end market, so off-road, ag, and transportation is there any meaningful difference relative to the essential 11% growth rate that you showed there?

Rick, Bill here.

Generally we're focused wherever we have put the first fit air cleaner at capturing that replacement part.

I would say historically our shares have been higher on the off Road, and lower in the on Road, but we're focused equally at growing both of those because we have a lot of opportunity to do that.

And is there a price component year-over-year that could you break out for us in that business?

I would say, Rick, as you know, because you've followed us for a long time, pricing isn't a big deal for us generally in terms of growing our sales.

We get a little bit in the aftermarket, but I would say it's not really material.

Okay.

And is the PowerCore growth rate year-over-year, is that a material number?

PowerCore I think still only represents about roughly 5% of our aftermarket business.

So it's high growth percentages, but from a pretty low base still.

But we see that, as we've discussed, over the next couple of years really transforming the filter industry and market.

Sure.

Okay.

Then also, did you run any restructuring costs through the P&L in the fourth quarter?

Hi, Rick.

This is Tom.

Yes, we did.

Our restructuring costs -- by the way, this also includes our plant start-up costs.

We're approximately $1.5 million in the fourth quarter, and that's a total of about $5.3 million for the year.

Okay.

And then -- so some of that may be -- I think at one point you had had had forecast maybe twice that.

Does some of that spill over into the fourth quarter?

We never forecast twice that.

The guidance that we previously gave was 6 to $7 million.

So we came in slightly below the low end of that guidance.

Okay.

And, you know, there's really no spill-over into '07.

We think '07 will be a relatively comparable year to '06 from the standpoint of plant start-up and restructuring expenses.

Okay.

And then just -- the last question that I have, just on the gas turbine side of the business, you know, GE's comments suggested that their unit volume, their backlog, would be, you know, loaded towards the second half of '06, which would be your first half of '07.

And as you see that business playing out in'07, and the 20% growth number that you put on the table, would you expect that to be weighted towards your first half, given your view of the backlog right now, or --

Rick, Bill here.

I don't think we've really forecasted as much by quarter, at least publicly.

And maybe a comment.

We're dealing with all the major turbine manufacturers, so GE is an important part of our business but we have many other customers.

So there's some smoothing by customer, based on the shipments.

But as you know, historically our gas turbine shipments sort of bounce around quarter to quarter.

Okay.

And I presume -- it doesn't sound like you really -- you want to give the backlog number, but that will be in the K, or will you -- will you just give us the backlog number?

Rick this is Tom.

We're still scrubbing the numbers, and it will be included in the K.

Okay.

Thank you.

Sure.

Thanks, Rick.

Your next question comes from the line of Andrew Obin of Merrill Lynch.

Yes, good morning.

Just a little follow-up question on the turbine business.

How much of the up-swing has to do with the replacement of the old filters, the replacement cycle versus new installs?

Would you quantify that?

Yeah, I think for the past fiscal year, Andrew, replacement business was about a third of our total 121.

So that has been growing over the past couple of years.

And some of that, as we discussed in the past, we think is related to the turbines that were installed back in the North American bubble.

Yeah.

So how much of the positive outlook for next year is the replacement cycle for these turbines as opposed to demand coming from other end markets?

I think the growth in the -- it's probably more around the new equipment.

Okay.

Replacement parts is going to continue to grow, but it's -- the majority of the increase is probably driven -- is being driven by new equipment.

Can I ask you more of a macro question, what are your customers, particularly on the machinery side, telling you given that we're seeing something of a follow-off in residential construction.

Do you perceive it as a big risk to your outlook or is some sort of residential downturn is already baked into your outlook?

We feel it's already baked into our customers' outlook, and therefore into ours.

Thank you very much.

Thank you.

Your next question comes from the line of Charlie Brady of BMO capital markets.

Hi, thanks.

Good morning, guys.

Hi, Charlie.

On the PowerCore, on the platforms that you have in production, the 60-some-odd is there a time frame you can give us where you think those might transfer into actual order wins, over 12 months, 18 months?

You mean the 67, Charlie, that are in the proposal stage?

Yeah.

Probably over the next year or two.

Okay.

And then just some clarification on your comments on your truck business, first half versus second half in '07.

You're saying down 30 to $35 million.

Is that second -- is that second half year-over-year, or first half to second half?

Second half year-over-year.

So, Charlie, just the assumption that we're looking at is we see in calendar '06 class D ash truck builds in North America should be about 365,000, and in calendar '07 they should drop to between 180 and 250.

So somewhere around 200,000.

And that's the major factor driving our second half drop, is that cyclical downturn after the new emission regulations.

So second half of our fiscal '07 emission regulations.

So second half of our fiscal '07 over second half of our fiscal '06, and we're looking at that $30 to 35 million drop that I mentioned.

Okay.

Just looking out a little farther down the road -- probably tough to answer -- but with the 2010 emission standards coming into play, is it fair to say that this is sort of a temporary drop, and, once again as we start ramping up and moving closer to 2010 you're going to start seeing another ramp-up as people try and move to that new standard?

Charlie, that's exactly what we're hearing from our customers, that there will be another prebuy ahead of 2010.

So calendar '07 will be down, then there will be a prebuy in 2009.

Thanks very much.

Thank you. [OPERATOR INSTRUCTIONS].

Your next question comes from the line of Jeff Hammond of Keybanc Capital Markets.

Hi, good morning.

Good morning, Jeff.

Question -- follow-on question on the gas turbine -- in general, on the industrial segment.

Could you give us a sense of how much the profitability improvement was attributable to the gas tor bun versus the other industrial businesses?

Well we look at -- within the industrial group, we like at the IFS business, which is the dust collection and compressed air.

We look at that separately than gas turbine.

But as I mentioned in my comments, in the IFS business it was strong focus on improvements within the business - improving the gross and operating margins.

Helped by sales volumes and some product mix.

Gas turbine was the combination of some of the same but probably more around the volume.

Would you say gas turbine has historically higher margins than the overall segment average?

Generally our margins across the businesses are pretty much the same, Jeff.

Just looking it at your fiscal '07 guidance, you said you were ear looking at comparable operating margins for the year.

Can you just bifurcate between engines and industrial, given the moving pieces therein?

I'll comment corporately then turn it over to Tom.

I'll go back to our stated objective.

We want to grow revenues ona long term basis 10 - 12% per year, with an operating margin of around 11%.

Our specific guidance, Tom's specific guidance, was to keep our operating margin year-over-year at about the same percent.

So we finished at 11.4, somewhere around there for fiscal '07.

Tom, you want to add to that?

No, I think I just echo what Bill said.

I think if you look at how we performed in fiscal '06, I think that would be a good extrapolation forward from the standpoint of gross and operating margin.

Yes, I guess what I'm trying to get at, with the truck drop-off, you know, on one hand, and the turbine emergence and the stronger overall growth, do you see a divergence of margin contraction in the engine business, margin expansion, to kind of get to you flat?

This is Tom again.

You know, there could be a little bit of that, but I just don't think there's going to be a major change in operating margin percentages.

Pointing back to the guidance we gave on the engine business, we're still looking at that business growing next year.

So the North American truck business is an important segment for us.

But it only represents 7% of our total sales.

Even with that drop that we talked about, our engine sales, we're projecting will still grow in the mid single digits, including that.

Okay.

Then finally, I think you said 20% growth in gas turbines, high single digits for special apps.

I think I missed what kind of growth rate you're looking for for industrial filtration.

Did you comment on that?

That would be probably high single digits as well.

Okay.

And are you seeing -- with regard to special apps and industrial filtration, those businesses grew kind of 4, 5% in'06.

What drives that acceleration into '07?

Part of it is how we finish the the year, and looking at the orders and business conditions.

A combination of that, Jeff.

So you are seeing, in an acceleration in the order trends in those two businesses?

Right.

Okay.

Then I guess one last thing.

PowerCore, do you have a quantification of what the revenues were in fiscal '06?

Fiscal '06 revenues were $34 million.

Okay.

Great.

Thanks, guys.

Sure, thanks, Jeff.

There are no further questions at this time.

Mr. Cook, do you have any closing remarks?

Yes, thanks, Angela.

First I'd like to say to my fellow employees, we're getting a little bit of feedback here, apologize for that.

I want to say a few words.

Our success starts with our outstanding support each and every day of our customers.

Each of you in every department around the world played a keep part serving our customers.

Your outstanding performance has resulted in our financial success and the setting of many new records.

Together we built a track record that is the envy of many companies.

It makes me incredibly proud to be part of the Company.

I hope you are as well.

Thank you all for your efforts.

To all of our listeners, thank you for your time and attention.

Good-bye.

Ladies and gentlemen, this concludes today's conference call.

You may now disconnect.