Donaldson Company Inc (DCI) 2008 Q4 法說會逐字稿

Ladies and gentlemen.

Thank you for standing by and welcome to the Donaldson fourth quarter fiscal year 2008 conference call.

During today's presentation, all parties will be in a listen-only mode.

Following the presentation, the conference will be opened for questions.

(OPERATOR INSTRUCTIONS).

This conference is being recorded September 3, 2008.

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

Thank you, Nicole, and welcome to Donaldson's 2008 fourth quarter conference call and webcast.

Following my brief introduction, Tom VerHage, our Vice President and CFO, will give us a brief review and then I will turn our call over to Bill Cook, our Chairman and CEO, who will discuss our initial outlook for 2009 and the business conditions shaping that view.

Following those remarks, Bill 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 effected 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, and good morning, everyone.

As you saw in our press release late yesterday, we reported both another quarter and our 19th consecutive year of record earnings, thanks to the continued broad based strength in our sales growth.

Each of our three regions and nearly all of our major product lines contributed to our 16% sales growth, with the impact of stronger foreign currencies being 7.2%.

As you will recall, our fourth quarter sales last year included an extra week of sales in the US, which increased prior year's sales by $16 million.

Looking at the remainder of the income statement, we achieved our targeted 11% operating margin for the year just like we did last year.

For the fourth quarter, our operating margin was 11.2%, which is down from 12.3% last year.

This reduction is due to an increase in our operating expenses as a percent of sales.

The major drivers of this increase include our business mix in the fourth quarter, information technologies spending for our global customer support capabilities, and cost for product development initiatives that include a fourth quarter reclassification of some expenses -- or some of these expenses from cost of sales to operating expenses.

For fiscal '09, we are targeting operating expenses to once again be in the 21% range compared to 21.5% for fiscal '08.

While operating expenses as a percent of sales increased in the quarter, our gross margin also increased.

Our gross margin improvement is primarily due to the combination of higher production involvements, cost reduction in control efforts, plant productivity improvements and the recovery from customers of previously incurred program development costs.

These benefits are partially offset by the rapid escalation of commodity costs and some lingering impact of the costs associated with the warehouse management system that we implemented earlier this year.

As most of you are aware, we use the last in, first out or LIFO accounting method for our domestic inventories, which represent approximately half of our consolidated inventory.

In times of rising commodity costs, these cost increases are immediately charged to income rather than capitalized in inventory costs.

We selected this method decades ago, as it lowers our taxable income, preserving cash flow for business needs rather than making higher tax payments.

If you read the footnotes to our financial statements, you will see that our LIFO reserve for year end inventories is $38 million.

This represents $38 million of lower taxable income over the many years we have used LIFO in comparison to the alternative first in, first out or FIFO accounting method.

And as stated in our press release, this LIFO method lowered our pretax income by $5 million in the fourth quarter alone.

Like other companies, we continued to experience significant year-over-year commodity costs in nearly all categories on a global basis.

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

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

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

Because of the rapid commodity price increases that we experienced in the fourth quarter, it may take a number of months before we accomplish full price recovery for these costs.

However, we are maintaining our long-standing gross margin target of 32% for fiscal '09.

Our tax rate for the quarter was 26.6% and for the year the rate was 27.2%.

This is slightly below the low end of the range that we provided last quarter of 28 to 31%.

In the fourth quarter, our earnings mix was more heavily weighted to lower tax countries, and we received a 1.8 percentage point benefit from a foreign dividend and a favorable resolution of a foreign tax position.

Our tax rate expectation for fiscal '09 is a range of 29 to 32%.

Our CapEx came in at $70.8 million for the year, which is down from $76.6 million last year.

We provided an estimate of 65 to $70 million last quarter, and slightly exceeded the upper end of the range due to the stronger foreign currencies in the countries where much of our CapEx took place.

Our CapEx outlook for fiscal '09 is a range of 70 to $80 million, and our estimate of depreciation and amortization is a range of 58 to $62 million.

Precash flow came in at $103 million, which is above the range of 75 to $100 million that we previously provided.

The fiscal '08 performance compares favorably to the prior year amount of $40 million.

Our outlook for fiscal '09 is a range of 110 to $140 million.

At this point, we expect interest expense in '09 to be comparable to the current year amount of $16.5 million.

Our press release contains our fiscal '09 sales guidance, which is an increase of 9 to 11%.

In previous years our pricing has been relatively flat on a composite basis as we continue to redesign products and take out both content and cost.

For fiscal '09, we have built in a 3.5% price increase into our sales to hopefully compensate for a significant portion of the commodity price increases.

So we are pleased to be able to report our 19th consecutive year of record earnings and if fiscal 2009 achieves our expected EPS between $2.30 and $2.40 per share, it will be year 20 of this record string of earnings.

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

Bill.

Thanks, Tom, and good morning, everyone.

In the next few minutes and before we open the call up to your questions, I'd like to cover three topics.

First, I'll talk a little bit about our fourth quarter highlights, then our outlook for fiscal '09, and then I'll give you an update on two of our growth initiatives.

So starting first with our fourth quarter highlights, as Tom mentioned our sales growth was 16% and stated at constant exchange rates it was 9%.

Looking at our fourth quarter sales by region and in local currency, sales were up 9% in NAFTA, 8% in both Europe and Asia Pacific and 19% in South Africa.

As you may already know, we have two major reporting segments, engine and industrial, which are led by Jay Ward and Charlie McMurray respectively, and I'd like to give you some of their quarter highlights.

But before I get started, please note that all of the fourth quarter sales numbers I will cover will be stated at local currency, so they exclude the positive impact of exchange rate movement and, therefore, are more indicative of our real business conditions and strength.

So starting first with our engine segment in Europe, our European engine business grew by 6% due to good performances in our sales to off-road equipment OEMs as well as sales of replacement filters in the after market.

We attribute our off-road OEM growth of 7% during the quarter to the combination of solid production rates of new equipment by our customers, as well as our own market share gains.

Our European engine after-market business grew by 7%.

After-market growth in the European emerging markets has been, as we've mentioned before, one of our key growth priorities.

We continue to expand our distribution of sales coverage in eastern Europe, Russia and the Middle East.

And during the past year, this emerging market initiative delivered a 20% year-over-year sales increase.

Now, switching to Asia, all of our engine businesses, OEM off-road, OEM on-road and the after market had strong quarters, up 24, 14 and 8% respectively.

Off-road equipment production by our customers is strong across Asia, as a heavy construction mining and ag end markets there remain in the growth mode.

Truck production picked up in Japan leading to our sales increase there, and continued healthy economic activity generally throughout the Asia Pacific region had demand for our replacement filters growing in the quarter.

And now finally in NAFTA, our engine business was up 3%, off-road equipment sales were up 9%, due primarily to a very strong performance by our aerospace and defense business unit.

Their sales were up over 40% in the quarter due to the combination of continued strong demand for filters for the new M-raft vehicles, as well as replacement filters for the military equipment already in the field.

In addition, sales by one of our newest acquisitions, AFS, of our retrofit air filtration systems for the black hawk helicopters have been very good.

On the other hand, our NAFTA transportation business was down 27% in the quarter.

Heavy truck bill rates at our customers appear to have now stabilized, but medium and light duty bill rates continue to decline.

And in our NAFTA engine after market business, sales were up 8% in the quarter, a strong equipment utilization rates for larger off-road equipment that used in heavy construction, mining and ag, offset the weaker conditions in both the truck and the smaller construction equipment related to the housing industry.

Now I'll switch to the other part of our Company, the industrial group and talk about some of their highlights.

So within the industrial group, the sales for our Industrial Filtration Solutions business were up 10%, as all three major regions grew between 8 and 11%.

In Europe we saw solid demand for our IFS products in western and central Europe.

Our NAFTA sales were strong for both new equipment and replacement filters, and in addition, our third quarter acquisition of LMC West contributed about 5% of the 11% sales increase in NAFTA during the quarter.

Our gas turbine business had an extremely strong shipment quarter with sales reaching $60 million, which represented a 26% increase over the same quarter in the prior year.

Growth has been good globally in both the power generation and oil and gas end markets we serve.

And finally our special applications business closed out a record year with full year sales up 11%.

Their fourth quarter sales of our disk drive filters and membrane filtration products were up 2% over a very strong finish last year.

Now I'm going to switch gears and talk about our outlook for the new year for fiscal '09, and as you can see in our press release, we have provided our initial guidance and that is for our Company's sales to be up between 9 and 11%.

Please note that this includes the benefit of some pricing as Tom mentioned, but excludes the impact of any potential future acquisitions.

It also assumes that exchange rates remain at current levels.

So I'll start first with a general overall comment.

We are expecting organic volume growth to be lower next year than the year we just ended, as general economic conditions are expected to be weaker in Europe.

I'm talking about each of the businesses and starting first with engine, our full year engine business sales are forecasted to be up between 10 and 12%.

Within our engine business, heavy construction and mining equipment production rates by our customers remain solid.

However, production rates for smaller equipment used primarily in residential construction are expected to remain weak.

We see our NAFTA truck-related business remaining at current levels through the first half of our fiscal year, and then beginning to grow in the second half.

It is expected that another prebuy will begin during calendar 2009 in advance of the 2010 diesel emission regulations, and that the calendar 2009 bill rates will increase by 30 to 35% over 2008.

However, the exact timing of this projected improvement is difficult to gauge at this time.

Our customer's ag equipment production rates are expected to remain strong, as the latest reports forecast both US crop prices and farmers' incomes to be up, which is a positive sign for the ag equipment market.

And finally in the engine business, we expect our after-market filter sales to grow as we continue to create proprietary replacement opportunities for ourselves, and as we focus on developing new markets internationally.

Now, switching to the fiscal '09 outlook for our industrial segment, in our industrial business overall, we see full year sales growing at 8 to 10%.

Within our IFS business, which includes our dust collectors and compressed air filters, our order back logs are good and suggest a strong start to the new year.

In addition, we should benefit from market share gains from our new line of recently introduced power cord dust collectors.

As a result, we expect sales growth of 8 to 12% in fiscal 2009.

In our gas turbine business, we have good visibility for shipments over the next few quarters.

We expect our full year sales growth rate to be in the 5 to 10%, as there are now some industry capacity constraints.

We still expect the demand for gas turbines and our filter systems will continue to grow through 2011.

And finally, we expect our special application business to be up 5 to 10% in fiscal 2009.

This is expected to be led by continued growth in our PTFE membrane filtration products business.

Now I'm going to give you an update on two of our major growth initiatives, and the first is PowerCore.

We've talked about this for quite a while and we continue to be very successful with this break-through air filtration technology.

Our engine related PowerCore sales were up 56% in the quarter to $19 million, as first fit sales grew 26% and replacement filter sales grew 76%.

And as you may have seen, earlier this year we raised the bar again with the introduction of our PowerCore generation 2 or Gen2.

PowerCore Gen2 allows us to further reduce the system size or enhance the system performance, which is critically important for our customers given their new engine technologies, and their vehicle space and weight constraints.

We have already won ten platforms, five on- and five off- with Gen2, and 70% of the platforms we currently have in either the proposal or development stage are with our new Gen2 technology.

In gas turbine, we're continuing to market -- the market introduction of our PowerCore technology.

Since introduction, we shipped 32 systems and have orders for an additional two systems already in hand for fiscal '09.

And finally as I mentioned a minute ago, we have now introduced a new line of dust collectors in our IFS business.

These new products also use our PowerCore technology and allow us to deliver a system that is 50% smaller than the traditional bag house system it replaces.

We introduced this product this spring and have been very pleased with the strong initial market acceptance.

The other growth initiative I want to cover is our expansion projects, and as Tom mentioned, we expect CapEx to be between 70 and $80 million in fiscal 2009.

In addition to supporting numerous process improvement and cost reduction projects, we have a number of major expansion projects underway to support our continued growth.

We recently finished our major expansion of our existing engineer and filter plant in Klasterec in the Czech Republic.

We are nearing completion of the start up of our air filtration manufacturing line in Brazil.

That should be in production later this fall.

In India, we are expanding our existing filtration plant.

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

And finally, the expansion of our disk drive filter plant in Thailand is proceeding on schedule, and we expect to have additional manufacturing capacity available later this year.

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

I hope what is evident in our fiscal '08 results is the strength of the business model we've pursued over the past 20 plus years.

The essence of this business model is our relentless focus on growing our Company through extensive geographic and end market diversification.

We have determined that this diversification has reduced the negative impact of any one end market or regional economic cycle.

It allows us the opportunity, combined with effective execution, to do two things.

The first is obviously to serve our customers.

The second is to continue to deliver record financial results for our shareholders.

Looking forward, we will continue to grow and further diversify within our targeted filter markets.

We expect that the combination of our diversified portfolio of filtration businesses, combined with our effective execution, will allow us to deliver yet another record year of sales and earnings in fiscal '09.

As Tom mentioned, our EPS guidance for fiscal '09 is between $2.30 and $2.40 per share, which is both a new record and up between 8 and 13% over the year we just completed.

Achieving this will result in our 20th consecutive earnings record.

That is our target.

And finally, before we move to Q&A, I'd like to remind you that we will be at the New York Stock Exchange tomorrow to do two things.

The first is to host an analyst day, and the second is to ring the closing bell to celebrate achieving our first $2 billion year in revenues.

Our analyst day will be webcast on the investors page of our website.

We will also provide a link on that page to view the bell ringing ceremony.

Regarding that ceremony, earlier this year we decided to have some fun with this impending milestone and we created a guess the date we hit $2 billion in sales event.

Approximately 6,000 of our fellow employees around the world submitted guesses.

Kim Webster was one of 150 employees who guessed the correct date, which was June 30.

Kim is a senior buyer from our Lester, UK plant, and with his wife, Debra, he will represent our Company and our achievement by ringing the closing bell tomorrow afternoon.

Please tune in to see it.

Nicole, that concludes our prepared remarks.

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

Thank you, sir.

(OPERATOR INSTRUCTIONS).

Our first question comes from the line of Eli Lustgarten with Longbow Securities.

Please go ahead.

Good morning.

Good morning.

I have a couple of quick questions on the outlook.

One, in the guidance you talk about foreign currency exchange rates not changing.

Can you give us some idea of what kind of foreign currency is something you have built in to your guidance at this point, assuming rates don't change?

Eli, this is Rich Sheffer.

What we're expecting is -- assuming that the dollar stays about where it is now, where it's been trading the last few weeks, it's going to still be a little bit of a tail wind in the first half of the year, and somewhere around mid-year at these rates, it would flip over and create a head wind in the second half.

So overall, right now, the total impact would be a slight head wind for the full year.

And that means that the -- you have to fully replace the $0.16 of earnings that you reported this year from currency, or will you be able to generate a little bit of that -- will we have to replace it?

No.

The thought is is whatever the impact is going to be compared to last year, it's baked into the guidance, so, yes, we would replace it.

Yes.

So the assumption doesn't have any of the $0.16 in it at all?

Eli, this is Tom.

That is correct.

Okay.

Because it's an impressive gain without the -- without the foreign currency is what I'm driving to.

You mentioned 3, 3.5% pricing.

Is that pretty well just evenly distributed across the businesses or is it skewed in any one direction by, either in engines or in industrial products?

Eli, this is Tom.

It really varies not only between engine and industrial, but within engine and industrial.

So it's hard to be specific without getting into each individual product line, but the short answer is it really varies.

This is going from like 0 to 7 or 8%, that kind of magnitude swing?

Even more.

The upper end is even more, Eli.

Okay.

Finally, when looking at your guidance, probably the number that's the biggest risk is probably the truck recovery, which there are debates of how muted the prebuy will be next year and whether it would even incur -- because of your July fiscal year, it could not even occur in your fiscal 2009, just on a timing basis and I think you cited that.

If we did not see that upturn until fiscal year 2010, would that -- the lower end of your guidance be threatened by that?

Is that critical to the lower end of your guidance?

Eli, this is Bill.

North American heavy truck represents 3% of our overall sales.

So even if it didn't happen like we're -- we talked about in our guidance or based on what the industry forecasts are, it's really a very small part of our Company.

It's really part of that whole diversification story that we talk about as we -- 20 years ago, that would have been a big deal for Donaldson, as you know, because you've followed us for a long time.

Now it's not that big of a deal.

3% of our revenues for fiscal --

You feel pretty comfortable no matter -- as long as the world doesn't end on you.

Right.

It's important -- what we want to have is lots of 3% or 4% segments, so it's an important segment, but we're not riding that up and down as a Company like we used to.

One last question.

Are there any new developments and platforms or something that would make the 2010 emissions and the subsequent 2011 emissions for construction and ag in the engines a significant market for Donaldson directly?

Eli, this is Bill again.

I think that's baked into our guidance.

We're working on those programs now for both the on- and off-road, and that's part of what we're using our new PowerCore technology is to lock up as many of those as we can.

So those contracts and new awards you talked about are really for 2010 emissions and --

They're related to the emission regulations as you pointed out, so it's not just emission control devices, but it's new generation air and liquid filters as well.

All right.

Thank you.

Sure, thank you.

Thank you.

Our next question comes from the line of Jeff Hammond with KeyBanc Capital Markets.

Please go ahead.

Hi, guys.

Good morning, Jeff.

Just wanted to dig into some of the segments to understand a little bit better some of the moving pieces, and I think this plays into the guidance a little bit, but your off-road is just -- if you strip out the FX, has just been growing exceptionally, not to parse, still good growth in this quarter, after three quarters of 20% plus, it slowed to 10.

I just want to know -- want to understand within that what might be driving that, if it's a specific region or subvertical.

And then also special apps, I think you mentioned something about slower growth in disk drive, that also slowed pretty materially in the fourth quarter, and I just want to understand that dynamic as well.

Jeff, Bill.

I'll start with your second question on the special apps, I think part of that is they had a very strong finish last year, so it's a tough comparable quarter over quarter.

I noted that year-over-year they had a very good year.

In terms of our guidance going forward, I think we're being maybe -- a lot of that is driven by the PC market, and we're using published data to factor into our forecast in terms of what's seen out there.

On the off-road, I think, as I mentioned, the part of the off-road -- our off-road business that's the weakest is the smaller equipment that's mostly related to residential.

We do not see that improving any time soon.

We still see strong conditions for the larger equipment, which is the use for heavy construction and mining.

So it's a mixture of the two.

On top of that you have our -- the ag business, which has grown quite a bit, and we see that maintaining sort of a high level, but probably not growing much beyond that, and our defense business, which we had a great quarter.

So there's some pluses and minuses in there.

The weakest part is that smaller equipment related to residential construction.

Okay.

And then just overall, you commented at the beginning that you definitely see lower organic growth in fiscal '09.

I think your main comment around that was some slower growth in Europe.

I mean, what specifically have you seen, near term in terms of a change in momentum in Europe in general that would facilitate that comment?

I think what we're -- Jeff, Bill again.

I think what we're doing there is we're -- it's what we're reading in the paper about the -- calling down the GDP growth rates in the UK and Germany and other parts of Europe, and that's what's making us cautious.

We had a strong finish to our business in Europe, so that -- but I think it's that we're seeing at least reports of weakness in the general economic sectors in western Europe and we're factoring that into our guidance for next year.

Okay.

And then finally on the price increases, have you already announced all of your price increase that would get you to that 3% or do you have to announce more, and maybe just give us a sense of what the feedback you've been getting in terms of push back, being able to realize that, any kind of demand destruction around some of these more substantial price increases?

Jeff, Bill again.

Nobody, whether as a consumer or in a business likes the word price increase.

So there's -- you're not welcomed with open arms when you come in for those type of discussions.

I think the thing is that everybody is -- now understands that this isn't a temporary situation and it's here to stay.

So generally our initial focus is trying to figure out, with our customers, ways of offsetting the impact of price increases, as Tom mentioned, through -- whether it's cost reductions or process improvements, to mitigate the impact, and then try and negotiate for the recovery of whatever is left.

We do that as we incur the costs on an actual basis.

So the 3.5% that Tom mentioned is our projection for the year.

In some cases, depending on the products, if there's a lot of steel, for example, we've already raised prices more than that.

In other cases where the materials are different, we have not and we're always doing that based on the actual costs that we've incurred, and so we'll probably be doing that throughout the balance of this new fiscal year.

But would you say what you've already announced, you're getting the realization you need to to get to this 3.5%?

No.

We haven't.

We haven't done all the pricing actions that would total up to the 3.5%.

Because we probably -- we haven't seen all of that impact.

Some of that's based on anticipated impact in fiscal '09, and as I mentioned, we don't ask for the price increase until we actually incur it.

Okay.

Perfect.

Thanks, guys.

Thanks.

Thank you.

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

Please go ahead.

Bill, Tom, good morning.

Good morning, Kevin.

Good morning, Kevin.

I have a question on some of the operating costs and some of the things that may be one time in nature, maybe not.

Things like IT spending, the four plants that you're expanding or launching this year, are some of those costs one time in nature that may not recur in '09?

And the third bucket I guess is R&D.

I'm assuming that will recur next year.

But if you can just comment on those three items.

Is there anything big there that won't repeat to the same extent in '09?

Kevin, this is Tom.

I guess first of all, keep in mind we provided the guidance of 21% operating expenses as a percent of sales for next year.

But as we look at -- I think you're primarily interested in the fourth quarter '07 to '08.

First, '07 was just a very low quarter from an operating expense standpoint at I believe 20.1%.

A couple of things, Kevin.

I did mention a reclassification of some R&D expenses from cost of sales to operating expenses, and that created about a half a point impact in the quarter.

Now, that has no impact for the year because that was an adjustment from the first three quarters to the fourth quarter, no impact for the year, but that did have an impact in the fourth quarter and, of course, we don't anticipate for that to increase.

There was a little bit of a mix issue, both if you think about the very high sales in our industrial segment versus the engine segment.

Industrial runs a little higher operating expenses and a little higher gross margin than the engine segment.

So mix is going to really vary quarter to quarter.

The product development expenses were up year-over-year.

That was about just 2/10 of a point and that will very likely continue in the future as we focus on a lot of the product development initiatives that Bill mentioned.

IT infrastructure costs, I think we had a bit of a blip in the fourth quarter.

That was about a half of a point of the increase.

So I would expect that to be a more normal level of spend in F '09, and then as in any quarter, there were some small one-time items that came up.

None of them individually at all significant, but that had a couple of tenths of a point impact as well.

So I hope that -- I hope that answers your question, Kevin.

Okay.

And then on the expansion projects, Bill, you mentioned the four plants that are either very close to completion or will be completed later this year.

I guess once those are complete, give us an update on how you feel about your capacity at that point.

Is maybe the plan to have another phase necessary of further expansions beyond that?

Good question.

I think it is unlikely that we'll have four projects underway at the same time if we look at it like six or nine months from now because I think we -- this is sort of an unusual period where we had four at the same time.

But typically, Kevin, we're always going to have probably one or two or three under way adding capacity, different parts of the world.

How do we feel about our capacity situation right now?

I think we're in pretty good shape.

We have some plans that we haven't announced yet, so I can't disclose it, for additional capacity, but that's more a part of that normal process that I mentioned where we have to add some every year.

And it's a consequence of growth.

So it's a good thing.

Okay.

And just one more, if I could.

Tom, can you just help me reconcile?

You said 3.5 percentage points of price is baked into your revenue guidance.

But did you say organic volume growth would be negative?

My question is, if that's true with very little foreign exchange impact, how do we get to the 9 to 11% on the top line?

Kevin, Tom again.

I don't think anybody said that organic growth would be negative.

So if you take our sales guidance and back off the 3.5% for selling price increases, the remainder would essentially be organic growth.

Okay.

Got it.

Thanks for the clarification.

Thank you.

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

Please go ahead.

Good morning.

Good morning, Brian.

Congratulations on a great year in a tough environment.

Thank you.

Yes, I think most of my questions have been asked at this point, but just a follow-up question on the operating expenses.

You mentioned that the IT expense in the fourth quarter was a little bit of a blip, and I was wondering if you could give us some more color on that, and also talk a little bit about the warehouse management system at your Rensselaer operation and whether your expenses came in line with expectations and if that project is done.

Yes, Brian, Tom here.

I'll take the last one first.

For the distribution expenses at our US facility in Indiana, we came in very close to the guidance we provided last quarter.

The incremental expenses there in the fourth quarter were about $1.9 million, so for the second half of the year, that totaled up to about 7.6 million, and we think we have that pretty much behind us now.

So we aren't expecting any of those incremental expenses to go forward in the future.

And then on the IT expenses, we had a couple of systems initiatives wrap up in the fourth quarter and at the conclusion of those implementations there's a bit of a blip in spending.

So I -- again, customer care systems, wrapping up ERP modules and things like that came up in the fourth quarter and that caused the increase in spending.

Okay.

Great.

That's all I had.

Thank you.

Thank you.

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

Please go ahead.

Good morning.

This is actually Tom Brinkman standing in for Charlie Brady.

Morning, Tom.

Just a couple of questions.

You mentioned that the gross margin, you had some impacts from the -- you said some recovery of previously incurred product development costs.

Can you go into detail about that a little bit, please?

Tom, this is Tom VerHage.

That was a relatively small impact, about 4/10 of a point, and that happens from time to time where we bill out costs that we previously incurred, recover them from customers in a quarter later than when we actually incurred the costs.

Okay.

And you -- you mentioned a little bit about how it's a small percentage of your sales, but first half '09 transportation product sales, I guess you were talking about how the trucks, on-road trucks are only about 3% of your sales, but can you just talk about expectations for transportation products in general, first half '09?

First half of -- Tom, this is Bill Cook.

First half of our fiscal '09?

Yes.

Pretty flat and then in the next calendar year, in advance of the emission regulations in 2010, that we -- we anticipate another prebuy or at least a volume increase for whatever reasons, but probably mostly due to a prebuy.

So I think I said 30 to 35% calendar '09 over calendar '08, so that would effect the second half of our fiscal '09.

Got you.

And the Special Applications Products, you also mentioned this again, you were saying what's causing the slow down in growth, just to go into a little bit more detail about that?

Tom, Bill again.

I think it's just based on what we see with the industry forecast for hard drive shipments, hard disk drive shipments.

Okay.

Yes.

And finally, the -- did you have a gross margin percentage that was for the commodity costs?

Did you break that out just for the quarter?

Tom, Tom VerHage, I'm actually glad you asked.

That impact for the quarter was about 1%, and as we mentioned in the press release and I mentioned in my comments, that is almost entirely due to our optional election of the LIFO method of accounting.

Because all of those -- when we purchase those commodities at those increased costs, that goes into our income statement immediately rather than capitalizing that in inventory.

So had we been on FIFO, we would have reported $5 million more of additional pretax income in the quarter than we did, being on the LIFO method here in the US.

Okay.

And -- okay.

So going forward, you said that you've already put through price increases that's going to offset the steel cost pressures you've seen, but as far as other commodity costs, I mean I guess in the near future, maybe the next quarter or so, you may still see the pressures, but after that the price hike should flow through.

I guess I just wonder about how quickly the price hikes will flow through?

Tom, it's Bill Cook.

On a gradual basis and, again, on an as-incurred basis, so as they effect us, we go to our customers and start negotiating for price increases for any part that we can't mitigate through cost reductions.

So it's happening now and it's going to happen through -- at least through the first half of the fiscal year -- new fiscal year.

I got you.

Okay.

Thank you.

Sure.

Thank you.

(OPERATOR INSTRUCTIONS).

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

Please go ahead.

Hi, guys, good morning.

Good morning, Andrew.

Just a couple of small questions.

What percentage of off-highway equipment is ag equipment?

Could you comment on that?

Andrew, this is Rich.

Ag makes up between 20 and 25% of our off-road equipment.

Has the mix shifted -- as ag has been growing, has the mix shifted or have you had enough international growth on the construction side that the mix has remained fairly constant over the past couple of years?

Given the strength in a lot of our off-road end markets, we've seen maybe a 1 or 2%, but still staying within that band, so basically all the boats have been lifting.

And the second question I have is just as I said, it's a small question, but you noted relatively flat production, I guess in trucks in Europe, and is that based on an industry forecast or is that based on specific conversations you guys had with your customers in Europe?

Andrew, Rich again.

It's based on our internal forecasts.

We take into account both the published forecasts and our conversations with our customers specifically.

So we're looking for single digit growth in the truck business in Europe in fiscal '09.

Okay.

Andrew, this is Bill.

We always start with your reports and then factor in what we hear from our customers as well.

Great.

Good to know when I ask you guys for industry color.

I appreciate it.

Thank you very much.

Thank you.

Our next question comes from the line of Craig Stone with Cane Anderson Investments.

Please go ahead.

Have you seen any competition for the second fit of PowerCore applications?

If you haven't, why not and are the OEMs building any language into the warranties about PowerCore?

This is Bill.

On the PowerCore, what we had anticipated initially when we launched the first generation, that when it was successful, because we intended for it to be successful, that there would be people trying to copy it.

We have a lot of intellectual property around it and we defend that aggressively, but our best defense with PowerCore is to replace ourselves with new technology, and that's what we've done with the generation 2 or the Gen2.

So we are seeing some people trying to get into the market on the replacement with the Gen1 and now we raised the bar again with our Gen2.

In terms of the questions about the OEs, the OEs like our PowerCore because they're very interested in protecting the replacement parts.

That's an important part of their business.

So it allows them and us through them, to lock up that replacement parts business.

So they're very positive.

I'm not sure if I answered your question, but were you talking about a warranty specifically?

I'm asking if the OEMs require PowerCore as replacement filters in order to maintain the warranty?

Oh, I -- okay.

The OEMs -- well, today nothing else will fit generally and deliver the performance, so I guess in the sense in order to protect the warranty, they have to -- you have to use a filter that's going to work, the answer is yes.

But I am not sure there's specific warranty language that requires -- that says PowerCore.

Thank you.

Thank you.

Our next question is a follow-up question from the line of Kevin Maczka with BB&T Capital Markets.

Please go ahead.

I just had a question on the gas turbine business.

It was such a huge year this year, so you've got tough comps obviously, but, Bill, you talked about some new PowerCore products coming soon, you're in the middle of an up cycle, there's still strength in your international power Gen and oil and gas markets.

I'm just wondering if you could give a little bit more color on what you're seeing that would dictate a 5 to 10% top line?

I think, Kevin, the issue there is that there are other -- not related to Donaldson, but there are other supplier constraints for the turbine manufacturers that are limiting how many turbines they can manufacture.

So the market is -- as you're suggesting, market conditions are stronger than that, but there's a capacity constraint in the production of turbines.

Okay.

Can you just talk a little bit on your -- is there a notable mix there between power gen and oil and gas, and maybe any other end market?

Kevin, notable mix between the two?

I don't think -- nothing's really changed over the last year between the two.

Okay.

Okay.

That's all I had.

Thank you.

Okay.

Sure.

Thank you.

And there are no additional questions at this time.

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

Thanks, Nicole.

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

I look forward to seeing those of you who will be attending our analyst meeting tomorrow at the New York Stock Exchange.

At that meeting we will be sharing our strategy and the plans for our continued growth and financial performance.

To my fellow employees, I want to thank you for what you do each day to serve our customers.

Each of you, each of us, plays a key role in our ability to deliver value to our customers, and without your efforts and their business, we have nothing.

And finally, thank you for your efforts in delivering our 19th consecutive year of record earnings.

We had some challenges during the year, but we did it.

Congratulations.

Thank you all.

Good-bye.

Ladies and gentlemen, that does conclude the Donaldson fourth quarter fiscal year 2008 conference call.

If you would like to listen to a replay of today's conference, please dial 303-590-3030 and enter in the pass code number of 3910647.

You may also dial 1-800-406-7325 entering the pass code number of 3910647.

Again, those telephone numbers are 303-590-3030 and 1-800-406-7325 and enter in the pass code number of 3910647.

Ladies and gentlemen, thank you for your participation.

You may now disconnect.