Donaldson Company Inc (DCI) 2008 Q3 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by, and welcome to the Donaldson third quarter fiscal year 2008 conference call.

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

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

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded Wednesday, May 28, 2008.

I would now like the turn the call over to Rich Sheffer, please go ahead, sir.

Thanks, Mike, and welcome everybody to Donaldson's third quarter conference call and webcast.

I'm Rich Sheffer, Donaldson's Assistant Treasurer and Director of Investor Relations.

Following my brief introduction, Tom VerHage, our Vice President and CFO, will give us a brief review of our record third 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 the balance of fiscal 2008 and the business conditions shaping that view.

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

Please note that we will not be providing fiscal 2009 guidance today.

We are currently working on next year's operating plan and will provide those details on our fourth quarter call.

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 in our SEC filings.

Now I would like to introduce Tom VerHage.

Tom?

Thanks, Rich, and good morning everyone.

Well, as you all saw in our press release late yesterday we reported another quarter of record earnings, thanks to the continued broadbase strength in our sales growth.

Each of our three regions and nearly all of our major product lines contributed to our 21% sales growth with the impact of stronger foreign currencies being 7.6%.

Our bottom line was also helped by a net tax benefit of $4 million.

Both our gross margin and operating income margins as a percent of sales improved over last year's margins.

Last year during the third quarter webcast, we discussed the reasons for our lower than expected margins which included some unusually low margins on a number of large projects in the gas turbine and industrial filtration solutions product lines, increased distribution and logistics costs and an increase in plant start up and restructuring costs related to our new dust collector plant in the Czech Republic.

You will recall from our discussion last quarter that we encountered inefficiencies and delays in processing customer orders after we went live with a new warehouse management system at our distribution center in Indiana.

These inefficiencies led to a cost of $2.1 million in the second quarter and a deferral of sales of approximately $5.5 million.

So, how are we doing on this implementation?

Well, the system is working.

It is stable.

We have caught up on our late shipments, and we believe we are on track to eliminate the incremental costs resulting from this implementation by the end of our fiscal year.

Incremental costs associated with these efforts were $3.6 million in the third quarter and we are projecting another $2 million to $3 million of such costs in the fourth quarter.

More importantly, going forward, we see opportunities to optimize the benefits that this and related systems will provide in streamlining our distribution and logistics processes.

As all of you are no doubt aware, commodity costs in nearly all categories are increasing rapidly on a global basis.

Steel and petroleum-based commodities are at the top of our list of cost pressures.

The good news is that for the most part we were able to avoid a significant impact in the third quarter through intense negotiations with suppliers and our internal cost reduction efforts.

But the bad news is that some impact from these increases is inevitable.

We are taking pricing actions in many of our product groups and will continue to discuss recovery of these costs from our customers.

In addition, we remain focused on our own product cost efforts.

Because many of the uncertainties of when we will experience these cost increases, the impact of our cost reduction efforts and when we may achieve recovery through customer price increases, we are not providing a specific estimate of this impact for the fourth quarter.

However, we have not changed our annual margin outlook which is for gross margin to exceed 32% and operating expense to be in the 21% range.

If we achieve these targets, our operating margin should be a minimum of 11%.

We expect our operating income to grow by 17% to 19% this year compared to last year's $211 million.

Our tax rate for the quarter was 25.6% compared to 16.2% last year.

As I mentioned earlier, we recorded a net tax benefit of $4 million due primarily to the expiration of a statute of limitations on matters previously reserved.

Last year, in the third quarter we had an even larger benefit of $7.8 million related to the resolution of open foreign and state tax positions, the expiration of the statute of limitations and a dividend from a foreign subsidiary.

Our updated tax rate outlook range is now to 28% to 31%.

Interest expense for the fourth quarter should be relatively flat compared to last year's fourth quarter.

We have narrowed our CapEx outlook to be in the $65 million to $70 million range from the previous $60 million to $70 million, and our projection for depreciation and amortization for the year is a range of $55 million to $58 million.

In addition, we have narrowed our free cash flow outlook to a range of $75 million to $100 million.

So when you add it all up, thanks in large part to the lower tax rate in the third quarter, we have increased our EPS outlook to a range of $2.08 to $2.13 per share.

Now, with that I will pass it over to Bill, who will provide some more background on our outlook.

Bill?

Good morning, everyone, and thanks,Tom.

First, I would like to start with some of our third quarter highlights.

As Tom mentioned, our sales growth for the first quarter was up 21% and excluding the positive lift we had from foreign exchange it was over 13%.

By region, local currency sales were up 17% in NAFTA, 11% in Europe and 9% in Asia-Pacific.

All in all a very good revenue quarter.

As all of you know, we have two reporting segments, Engine and Industrial, and now I would like to give you some of their individual highlights from the quarter.

I will start first with our Engine segment and the European part of that business.

Our European Engine, OE, Off-road and On-road businesses both grew at 15% in local currency as the production build rates of new equipment by our customers continues to grow.

In addition, we continue to gain market share as we have won new customers and equipment programs.

Our European Engine Aftermarket business grew by 6% in local currency.

Aftermarket growth in the European emerging markets has been one of our key growth priorities as we continue to expand our distribution and coverage throughout this region.

Now, switching to Asia our Engine Off-road and Aftermarket businesses also had strong quarter up 28% and 9%, respectively in local currency.

Off-road production by our customers is strong across Asia including in Japan, China, India and Australia as the construction, mining and ag end markets there remain in a growth mode.

In NAFTA, our Engine business was up 11%.

Commercial Off-road equipment was particularly good in the quarter due especially to strong ag, heavy construction and mining equipment production by our customers.

In addition, our filtration sales for military equipment were up on continued strong demand particularly for filters for the new MRAP vehicles and replacement filters for the existing military equipment in the field that needs to be overhauled.

In our NAFTA Engine Aftermarket business, truck ton miles remain below last year's levels as the economy has slowed.

Equipment utilization rates remain mixed, better for large equipment and ag, but lower for small equipment and trucks.

Now, switching to our Industrial segment, our Industrial Filtration Solutions, or IFS, business had a good quarter, up 12% in Europe in local currency and up 21% in NAFTA.

In Europe, we are seeing continued solid demand for our IFS products in Western and Central Europe although conditions in the U.K.

have recently weakened.

Our NAFTA sales were strong for both new IFS and replacement filters.

In addition, our recent acquisition of LMC West in California contributed about 5% of the 21% sales increase in NAFTA.

Our Gas Turbine business had their best revenue quarter since fiscal 2002 with shipments of $59 million.

This represented a 43% sales increase over the same quarter last year.

The gas turbine markets we serve continue to enjoy an up cycle.

Growth has been good globally in both the power generation and oil and gas markets, and it is expected to continue for the next couple of years.

And finally our Special Applications sales were good again in Q3, up 13% in local currency.

As our sales of disk drive filters and PTFE membrane filtration products were strong.

That's some of the third quarter highlights.

Now I want to switch into our outlook for the balance of the year.

We are nearly a month into our fourth quarter so we have pretty good visibility for what's going to happen, and the bottom line is our sales outlook remains good for the balance of fiscal 2008.

As noted in our press release, we once again increased our full year sales expectations for both of our reporting segments.

Our full-year Engine Filtration business sales were previously forecasted to be up between 10% and 12% and now are expected to be up between 11% and 13%.

Within our Engine business, the international end markets remain particularly strong.

Both construction and mining equipment production rates by our customers remain solid, although in NAFTA the production rates for smaller equipment used primarily for residential construction remains soft.

We see our NAFTA heavy truck related business to be up slightly in our Q4 as current new truck production rates at our customers are now at slightly higher than at this time last year.

Our customers' agricultural equipment production rates are expected to remain good.

The latest public reports forecast both crop prices and farm incomes to be up which is positive for the ag equipment market.

And finally we expect our Aftermarket or replacement filter sales to continue strong growth internationally as we focus on continuing to develop new markets.

Now, switching gears to talk about the outlook for our Industrial segment.

In our Industrial business we see full-year sales higher in all three major product groups.

In total, our full-year Industrial businesses had been previously forecasted to be up between 14% and 16% and now we are projecting them to be up between 17% and 19% for the year.

Within our IFS business, which includes our industrial dust collectors and compressed air and gas filters we expect that our current strong shipment patterns will continue through the end of the year, and as a result, we expect the sales growth, full year sales growth of 15% to 20%.

In our Gas Turbine Filtration business we see also a good finish to the year based on the shipment schedule for the orders already in process.

And as a result, we have increased our full year outlook to 25% to 30% sales growth.

And finally we have increased our expectations for our sales for our Specialty Applications business.

We now expect sales to be up between 15% and 20% versus our prior outlook of 10% to 15%.

This continues to be led by the sales of our hard disk drive filters and PTFE membrane filtration products.

I would like to give you an update on two of our major growth initiatives we've talked about in the past, and the first is PowerCore.

We continue to be very successful with this breakthrough air filtration technology.

We have now won 124 equipment platforms with our OEM customers with an additional five wins this past quarter; 86 of these total 124 wins are already in production and another 11 are expected to go into production during the balance though fiscal year.

Our PowerCore sales are up 47% in the quarter to $16 million as both the first fit and replacement filter sales increased over 45%.

As we look forward, we still have another 55 platforms in the proposal stage with our OEM customers.

In addition, we are happy to report that we have raised the bar once again with our introduction at the Conexpo show in March of PowerCore G2.

This new technology allows us to either further reduce the system size or enhance the performance for our customers.

We have already won six platforms with G2, three on-road and three off-road.

And with the new G2 technology, 30 of the 55 platforms in the proposal stage I mentioned a minute ago were proposing the G2 technology.

Finally, one more PowerCore milestone I would like to announce is that during our third quarter, we entered into our first license agreement with another filter company, granting them a limited license to utilize certain of our patents related to our PowerCore technology.

We believe that this is further validation of the uniqueness of our PowerCore technology.

The second major growth initiative I would like to cover is our expansion projects.

As Tom mentioned, we will spend between $65 million and $70 million on CapEx this year.

In addition to supporting numerous process improvement and cost reduction projects around the world, we also have four major expansion projects underway to support our continued growth.

The first is that we are in the final stages of completing a major expansion of our existing engine air filter plant in the Czech Republic.

We expect to be in full production with our expanded capacity before the end of our fiscal year.

The second project relates to Brazil.

I visited our new operation in Brazil last month and I am very pleased to report that the start-up of our air filtration manufacturing line is proceeding very well and we expect to bring this online in the coming months.

The third project is that we are expanding our existing air filtration plant in India and expect this to be completed within the year.

This represents essentially a tripling of our current facility and is necessary to support the continued growth of our customers in India.

And finally, as mentioned in my comments, our disk drive filter business is having another very good year, and to support this business we are expanding our disk drive filter plant in Thailand.

We expect to have that additional clean room manufacturing capacity available later this calendar year.

Now before we open the call up to your questions I would like to offer a few summary comments.

We have completed the first nine months of fiscal 2008 with strong sales growth and a 10.9% operating margin.

Our sales outlook for the balance of the year is good.

And we have again increased our full year expectations for both our Engine and Industrial segments.

We now expect total Company sales to be up between 12% and 15% over last year.

I hope what is evident in our results is the strength of the business model we have pursued over the past 20 years.

The essence of our business model is our relentless focus to be a filtration Company with both extensive geographic and end market diversification.

This diversification reduces the negative impact of any one end market or regional economic cycle and allows us the opportunity through effective execution to both serve our customers and to continue to deliver record financial results for our shareholders.

Bottom line is that we expect the strength of our diversified portfolio of filter businesses combined with effective execution to deliver yet another year of record sales and earnings.

As Tom mentioned earlier, we have increased our full year EPS estimate range and now expect to be between $2.08 and $2.13 per share.

This means our EPS should be up between 14% and 16%, also marking our 19th consecutive year of record earnings.

Finally, before we move to the Q&A, I'd like to announce that we will be at the New York Stock Exchange on September 4, the day of our fourth quarter earnings call, to host an analysts day and also to ring the closing bell to celebrate achieving our first $2 billion year in revenues.

One of our fellow Donaldson employees will ring the bell based on the winner of our "Guess the Date We Hit $2 Billion" contest.

In order to conduct our "Guess the Date" contest, we will be providing regular updates on our Web site for both our employees and shareholders to track our year-to-date sales progress until we hit the $2 billion milestone.

This concludes our prepared remarks, Mike.

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

Thank you, sir.

(OPERATOR INSTRUCTIONS).

One moment, please, for first question.

First question comes from the line of Kevin Maczka with BB&T Capital Markets.

Please go ahead, sir.

Good morning.

Morning, Kevin.

Tom, can you just talk a little bit more about the commodity cost issue?

You mentioned steel and petroleum, having some issues there, but it sounds like it is pretty well contained given that your gross margins were up.

But I'm just wondering if can you quantify what kind of inflation you are seeing in general and what kind of pricing you are taking to offset that?

Good morning, Kevin.

Yes, I did mention the commodity price issue, and I did mention that it did not have a significant impact on our operations in the third quarter.

We have been successful in deferring the impact, but it is upon us in the fourth quarter.

So I mentioned steel.

We buy a lot of different types of commodities.

Year-over-year steel prices might be up about 30% to 50% and it continues from there.

Diesel fuel up about 60% and anything petrochemical related is going to be up significantly.

We are, we are working with our customers on recovering what we can from these price increases and we are also working on our cost reduction efforts.

So as I indicated, we aren't going to be providing guidance in the forth quarter on what that impact might be just because of all of the variables that surround this issue.

Okay.

But you also won't talk about the magnitude of price increase that you have been able to take already?

No, we aren't going to talk about specific customer pricing actions, Kevin.

Okay.

On the operating expenses, the jump that we saw there, it sounds like a portion of that is still the ongoing distribution center issues, but I think that those costs were still up significantly even if I back that out.

So, I guess my question is some of the other things that you are spending money on there, are those, is that a new run rate going forward or are some of these things more one-time in nature like the DC issue?

Yes, Kevin, the DC issue is primarily in gross margin as opposed to operating expenses.

So we haven't changed our operating expense guidance for the year.

We are still estimating 21% of sales, and in our business units, in order to achieve this higher level of sales we've had to make some investments.

We have had to make investments in product development initiatives, in, in our sales force.

We have IT initiatives.

And in all of those are pretty critical in order for us to achieve the robust sales growth that you have seen.

So, it has been intentional, and necessary to support the growth that you have been seeing.

Kevin, this is Bill, just to reiterate what Tom was saying in his remarks is that, even including the headwinds from the material cost increases through the pricing and cost reduction actions, we are continuing with the same gross margin guidance we've been talking about of 32%, and the same thing applies to the operating expenses is that we are holding firm to the 21% for the year.

Okay.

And I guess my last question, as it relates to margins is just you are spending money to drive the higher revenue growth, which I understand, but I guess I am wondering if at some point, once you are achieving this higher revenue growth, if it is reasonable to expect more of that to drop to the bottom line?

I know margins were up year-over-year this quarter, but could they be up even more than that, at some point going forward or will you have to continue spending to drive the revenue growth?

Kevin, there is Bill.

I think we've been asked this question probably in every meeting in terms of margin expansion on the operating income line.

What we are trying to do is a balance between funding higher growth than we have achieved historically and maintain an operating margin of at least 11%.

So to Tom's point our assumption is we will continue to invest back in the business to get higher growth and protect the 11% margin.

The 11% margin is also a relatively recent high water market for the Company.

We achieved that just a couple of years ago.

So we want to maintain that while growing faster than we have historically.

So we are not, our guidance only talks about a minimum of 11%, not any more than that at this point.

Got it.

Thanks for the time, guys.

Thank you, sir.

The next question comes from the line of Charlie Brady with BMO Capital Markets.

Please go ahead.

Hi, thanks, good morning.

Good morning, Charlie.

With respect to the commodity costs, can you give us a sense of how much cost of goods sold would come out of steel and other commodity costs that have been going up?

Yes, Charlie.

This is Tom, again.

You know, just roughly, and this is really going to vary depending on our individual products, but if you look at our cost of sales line, approximately 60% of that line is material.

And then of that 60%, roughly 20% to 25% is steel fabricated parts and the like.

Another 20% is media that goes in our filters.

And then the, the third significant commodity is anything petroleum-based again, plastics, urethane and the like.

So that gives you a little bit of a ranking of our key commodities.

Thanks.

That's helpful.

Just with respect to, I guess, Bill's prior comment in your guidance, it sounds as though, obviously, you have embedded the headwind from commodity costs into your existing Q4 guidance.

Would it be fair to say then that as part of your cost recovery efforts, would you expect to, if you were successful, to realize any of that cost recovery in Q4?

And I guess what I am really trying to get to is it sounds like maybe there's upside to the guidance you have put out there, if you were successful in recovering some of these costs in Q4.

Yes, Charlie, our guidance includes what I mentioned, the commodity price increases, some recovery from our customers, and our cost reduction efforts.

So all three of those variables are baked into that guidance.

Okay.

Thanks.

And one quick question and I will get back in the queue.

On the Thailand facility expansion, how much increase in capacity is that going to give you there?

Charlie, Bill here.

It is, I think, it is probably in the low double-digits in that facility in terms of increased capacity.

The disk drive market generally is growing up in the high teens, so it should give us enough capacity probably for another maybe two years.

Great.

Thanks very much.

Thank you.

The next question comes from the line of Brian Drab with William Blair.

Please go ahead.

Good morning.

Morning, Brian.

Hi.

A couple of questions.

First, in the heavy duty truck market it looks like you did reach the bottom in the quarter, and I was wondering if you could tell us about when in the quarter you feel like you reached the bottom and what type of growth should we expect going forward here in the next quarter or maybe over the next 12 months?

Brian Bill here.

It is, I think we think it bottomed out probably in March or April.

Now it is starting to come back up, slightly up.

So we will see some slight recovery in our fourth quarter, which is good news over the last couple of quarters certainly.

Directionally, it is going up rather than what we've seen over the last year.

I think the biggest uptick we are projecting is in the second half of this calendar year which is in our fiscal '09.

Our current assumption for full year class A production is about 220,000 trucks.

Okay.

That's based into sort of our assumptions about the balance of this year and overlooking that for next year.

Okay.

Thanks.

It seems like a lot of the focus this morning has been on commodity costs and I haven't heard you mention the system, pricing system you used to index for steel and my, my understanding is that your pricing is indexed to steel, and I was wondering if you could talk about that a little bit?

Brian, Bill, here, again.

After the last time steel took off, which was about four years ago, we did put into place with our major Engine OEM customers agreements that indexed our pricing with steel going up or down.

So that is still true.

A lot of what Tom was saying is the fact we are seeing commodity increases more broadbased than that around petrochemicals and media.

So those will be separate discussions.

The other is the price recovery efforts on the Industrial side of our business where those are sort of a case-by-case type of negotiation.

So, yes, we do have, we still have the mechanism around our Engine OEM customers in terms of steel price relief.

Okay.

Thanks.

The last quick one is it looks like you are probably going to come in a little bit under the $7 million regarding the warehouse management incremental expenses, you mentioned $7 million at the end of the second quarter.

Am I doing the math here correctly in thinking that you are going to come in a little bit under that?

Brian, this is Tom.

I think you have to go back to the second quarter as well.

So just to give you a reminder, in the second quarter we had extra costs of $2.1 million and the $3.6 million that I mentioned in the third quarter, and then on top of that, the $2 million to $3 million in the fourth quarter that we are projecting.

So if you add that all up I think it works out to $7.7 million to $8.7 million.

Right.

Okay.

That is what I was thinking.

Okay.

Thank you very much.

Thank you.

The next question comes from the line after Andrew DeAngelis with KeyBanc Capital Markets.

Please go ahead.

Hi, guys.

Just to be clear on the commodity costs issue, I guess, net of pricing that you anticipate getting in the fourth quarter is it your intent to signal some net headwind during the fourth quarter after considering the pricing?

Andrew, Bill, here.

Everybody is reading about what's happening in the paper, so we thought we might as well get it out there that we are not going to be unaffected by this, as is no other industrial company, but we are working on it, and we started working on it early and that's baked into the guidance around the fourth quarter in terms of there is a headwind there but we are going to offset it in terms of cost reductions and price increases.

And we are sticking to our guidance for the full year.

In the real headwind though, it would come in the Industrial part of the business, with the GTS and the IFS businesses?

It would really be almost all of our businesses because we use a lot of steel and petrochemical-based commodities and media in both reporting segments.

Okay.

Then I guess just last question, I certainly appreciate what you are try to go achieve in terms of worldwide growth, just kind of wondering about what rigors you guys have in place in terms of capital efficiency and really using your organic capabilities as effectively as you can that you already have in place rather than making additional capital outlays?

Andrew, Bill, again, it is a good question.

We always try to look at making sure that we are fully utilizing any assets that we deploy.

To some extent the nature of our products and good customer service requires us to be local with our manufacturing.

It also provides us with a natural currency hedge that we are producing in Japan in yen and selling in yen for example.

But going back to the first point it is hard to ship filters long distances because you are shipping a lot of air.

So you have to be local from a cost perspective and you have to be also local from a service perspective.

But we are always taking a look at capacity utilization around the world and making sure before we make an investment that we really need to.

In the shipping costs, would that will included within cost of sales or OpEx?

Andrew, Tom, here again.

The extra distribution costs that I mentioned are almost all in cost of sales.

Okay.

I'm sorry that I missed that.

There's a little bit in shipping which would be in operating expenses, but the lion's share is in cost of sales.

Thanks.

Thank you, sir.

The next question comes from the line of Scott Graham with Bear Stearns.

Please go ahead.

Hey, good morning, nice quarter.

Thanks, Scott.

One question for you regarding the roll-off of these, the warehouse costs.

It looks like this was maybe at or near the peak, perhaps, and heading down next quarter.

Is that a trend line we can expect to continue, downward from here?

Scott, good morning.

Tom, here.

Yes, the answer is, yes.

I mentioned $3.6 million in the third quarter, a range of $2 million to $3 million in the fourth quarter, and as I think I mentioned in my opening comments, we expect that those incremental costs are not going to be with us come the first quarter of next fiscal year.

Very good.

I missed that.

And you captured all of the sales, the shipments that were delayed last quarter, this quarter?

Yes, we did.

We mentioned about $5.5 million in the second quarter were deferred and we caught up in those actually early in the third quarter.

Those were really all my questions, thank you.

Sure, thanks.

Thank you, sir.

The next question comes from the line of Richard Eastman with Robert W.

Baird.

Please go ahead.

Hi, Bill, Tom.

Morning, Rick.

Nice quarter, a couple of questions on the NAFTA business, did you suggest that the Aftermarket business was down year-over-year?

Or was --

No, it is up.

Sorry.

Rich, is looking for the number, Rick.

We were up 14% in the NAFTA Aftermarket, Rick.

Oh, okay.

All right.

That's just the Aftermarket.

The overall NAFTA Engine business, you said, was up 11%, is that right?

I did, in my comments, Rick, I did talk about that some of the industry conditions have weakened, the ton miles and the utilization rates, but our mix, our business is up.

It is still up 14%.

Okay.

And then the Industrial piece in NAFTA, I guess, I don't have, I can't, I don't have the ability to weight these, but NAFTA was up 17% in local currency, Engine was plus 11%.

So Industrial was what, like plus 20% something?

Yes, IFS in local currency is about 21%.

Okay.

Okay.

And then, just a question, Bill, when we talked about these plants that we're expanding here, can you give me a sense of the air filter expansion in the Czech Republic, is that dust collection primarily?

Rick, it is for the elements that go into either an engine air cleaner or potentially a dust collector.

So it is the actual element , not the metal housings,

Then can I just ask the same question with Brazil and India, again, you termed it as air filtration.

Is this, is this the same general product lines that --

The Brazil is initially is going to be focused on engine air as well and India is both.

We do both Industrial and Engine air filters there today.

Okay.

But nothing on, no initiative at all on the HVAC side or anything or commercial HVAC or anything like that?

No, Rick, that is not a business we are in today.

So --

I realize that.

I thought maybe you might be thinking about it.

[laughter]

We have enough good opportunities right now.

Okay.

Okay.

And, Bill, when you look at how the year has played out through nine months, we track through the year, pushing, pushing sales forecasts up and, obviously, the corresponding EPS numbers up.

When you look at how the year unfolded versus where we sit today, what part of the plan would you say are we well above your expectations early in the year?

Is it mainly geography or is it, is it more product line?

It is a good question, Rick.

To start with and to be very candid about it we are getting more lift than we anticipated from foreign exchange, but stripping that out, I would say we have seen, especially internationally stronger local currency growth than we expected starting the year.

I think we have also been surprised that some of the resilience of the businesses in North America because six months ago people were talking about business conditions really falling off in NAFTA and we have been doing better, a lot better than that.

So, primarily internationally has been a big surprise, but also in NAFTA conditions have been better than we had maybe thought six months ago.

On the negative side, sorry, Rick, I would just say that the, what happened with the warehouse management implementation was a negative surprise, so not everything has gone our way.

We had some things go pluses and minuses and certainly the commodity headwinds Tom talked about, we will deal with that, but that's another challenge we hadn't anticipated six months ago.

Okay.

And then just one last question on the international business, you had talked about share gains in Europe and I think you suggested both on the first fit side as well as aftermarket, but can you just give us any color there, I mean is that a function of PowerCore or is that a function of relationships with some OEs that you weren't involved with?

What has transpired there that suggests that that is ongoing on and --

First, in a historical perspective you have to realize our market share is on, say the Engine side are a lot lower than they are in the U.S.

because we got started there later.

We have been in Europe for about 40 years, but I'd say we really focused on growing the business over the last 20 years.

So our market shares are lower.

There's lots of opportunity to grow.

We have been growing on the first fit side by offering innovative technologies like PowerCore and other technologies, not just, PowerCore isn't the only story.

But it starts with the technology and then I think it's the geographic presence as we continue to expand and site operations we also driving a lot of cost out of our products so we have technology at a very competitive price.

That's the first fit side.

I think on the aftermarket side, Rick, it is around expanding our coverage and really as I mentioned in my comments making a push in really where we were not well represented in Eastern Europe, in the Middle East, where there were markets where there's a lot of equipment with Donaldson product on it, but we weren't capturing our fair share of the aftermarket.

So that's more a distribution or coverage story there.

And following the OEs from here?

Right.

Exactly.

Okay.

Well, thank you.

Sure.

Thank you.

Thank you, sir.

(OPERATOR INSTRUCTIONS) At this time, there are no further questions.

I would like to turn it over to Bill for concluding remarks.

Thanks, Mike, and to all of you participating and listening, I want thank you for your time and interest.

To my fellow employees, I want to thank you for delivering yet another record quarter in both sales and earnings.

I look forward to your continued support and efforts as we achieve our first $2 billion sales year and our 19th consecutive EPS record.

Thank you all, and good-bye.

Thank you, sir.

Ladies and gentlemen, this does conclude the Donaldson third quarter fiscal year 2008 conference call.

You may now disconnect, and thank you for using the Teleconferencing Center.