Donaldson Company Inc (DCI) 2009 Q1 法說會逐字稿

Welcome to the Donaldson first quarter 2009 conference call.

(OPERATOR INSTRUCTIONS) This conference is being recorded today, November 25, 2008.

I would now like to turn the conference over to Rich Sheffer.

Please go ahead, sir.

Thank you, Brandy, and welcome everyone to Donaldson's 2009 first 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 first quarter operating results.

Tom will then turned call over to Bill Cook, our Chairman, President and CEO who will discuss our updated outlook for fiscal 2009, the business conditions shaping that view.

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

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

Any statements in this call regarding our business that are not historical facts are forward-looking statements and our future results could differ materially from the forward-looking statements made today.

Our actual results may be affected by many important factors including risks and uncertainties identified in our press release and in our SEC filings.

Now I'd like to introduce Tom VerHage.

Tom.

Thanks, Rich, and good morning, everyone.

Well, as you saw in our press release late yesterday we reported another record quarter.

Thanks to continued strength in a number of our end markets that provided year over year sales growth and positive results in reducing our operating expenses as a percent of sales.

Each of our three regions and nearly all of our major product lines contributed to our 9% sales growth.

The impact from foreign currencies being less than a percentage point as the US dollar strengthened dramatically during the quarter.

Assuming foreign currency rates stay close to where they have been trading the last couple of weeks we, expect currency to reduce reported sales by approximately 6% for the year compared to last year.

Looking at the remainder of the income statement, our operating margin came in at 12.2%, roughly equal to last year and much better than our fourth quarter operating margin of 11.2%.

While our gross margin declined 30 basis points to 32.6% in the quarter, our operating expense ratio improved 40 basis points to 20.4%.

Our gross margin benefited from the higher growth in our industrial product segment and from product cost reductions in manufacturing efficiency improvements which are an ongoing component of our internal cost reduction efforts.

Gross margin was negatively impacted by the delay in recovering our material cost increases from several major engine customers.

We did experience the expected material price increases from our suppliers in the quarter and we did realize a portion of our targeted price increase to our customers.

We are continuing efforts to get fully recovered from the commodity cost increases and expect to achieve full recovery later in this full year.

On the positive side, the upward cost pressure on our raw materials is stabilizing.

Some commodities, such as steel, we are indexed with a number of our customer so as prices come down it will be good for both our customers and you say, come down.

In operating expenses we began focusing on cost containment.

As soon as the financial crisis and economic slow down became evident we have implemented a global hiring freeze, a reduction of contractors and temporary workers, targeted restructuring within a couple of business units and a host of discretionary spending cuts.

We saw the benefit of these efforts in the second half of the quarter and we will continue to hold the line on discretionary expenses until we see improvements in our end markets.

We continue to expect to achieve our long-term gross margin target of at least 32% now that the upward pressure on raw materials has lessened and we are beginning to benefit from some cost declines.

Combined with our operating expense containment and productivity initiatives, we plan to exceed our historical operating margin target of 11% this year.

Our tax rate for the quarter was 30%.

In the quarter we had a $1.8 million in benefits primarily from the instatement of the R&D tax credit and a positive development regarding a foreign tax contingency that we had previously reserved.

Last year our first quarter rate was 27.1% which included $3.9 million of benefits related to the expiration of statutes on unrecognized tax benefits and the German tax rate reduction.

In our guidance we noted that we have several other tax contingencies that may conclude by the end of our fiscal year and could reduce our tax rate if they are resolved favorably.

In light of this, we have widened the range of our guidance for our tax rate of 25% to 31% for the year.

Our CapEx came in at $11.5 million for the quarter, which is flat with last year.

We are moving forward with projects that we had previously started but will delay new major expansions and certain other projects until economic conditions in our end markets improve.

So we are reducing our full year CapEx guidance to $60 million to $70 million from our previous guidance of $70 million to $80 million.

We expect quarterly depreciation and amortization to be in the range of $14.7 million to $15.7 million which includes the amortization of intangibles from the Western Filter acquisition.

Free cash flow came in at $40 million which is $30 million higher than last year and gave us a cash conversion ratio of 84% in the quarter.

We expect free cash flow and our conversion ratio to continue to improve over the balance of fiscal 2009, and we have increased our free cash flow guidance to $130 million to $160 million.

Late in the quarter we acquired Western Filter Corporation.

Western is based in California and manufactures liquid filters for the aerospace and defense industries.

We expect Western Filter to generate approximately $23 million in sales the balance of this fiscal year and to be earnings neutral after accounting for the incremental interest expense and the amortization of intangibles related to the acquisition.

In addition, we sold our air dryer business in Maryville, Tennessee, at the end of the quarter.

The net of these two transaction as shown in our cash flow statement was an outflow of $74.5 million.

We repurchased 802,000 shares or 1% of our outstanding shares in September.

This share repurchase is consistent with our long-term practice of reducing our share count on average of approximately 2% a year.

In October we priced a new $80 million private placement which was funded on November 14.

This is a five-year note with a coupon rate of 6.59%.

We believe the ability to price this transaction at that time is an indication of Donaldson's financial stability.

We issued this note to free up our credit lines following the Western Filter acquisition, to provide assurance of liquidity to continue to fund our operations and other strategically important initiatives and transactions that may arise in the near term.

At the end of the quarter our debt-to-cap ratio was 37% and debt-to-EBITDA was 1.2.

Both of these are well within the financial covenants in our various debt agreements.

We are now expecting interest expense in fiscal '09 to be approximately $19 million.

Our press release contains our updated fiscal '09 sales guidance which is now between $2.15 billion and $2.23 billion for the year.

Excluding the expected foreign currency head wind of approximately 6%, we expect local currency sales to increase in the local single digits.

So, despite the very uncertain global economy, we are pleased to be able to report a good start to our fiscal 2009 with another record quarter.

And if we achieve our outlook for an EPS between $2.16 and $2.36 per share, it will be year 20 of this record string of earnings.

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

Bill.

Thanks, Tom, and good morning all.

As you may know, we had two reporting segments, engine and industrial, and what I'd like to do next is give you a few of their respective highlights from the quarter.

So starting first with our engine segment in Europe.

Our European engine OEM business declined by 2% local currency.

Sales to our European customers who manufacture agriculture equipment remain healthy.

However, the markets for our customers' new trucks and construction equipment were weak.

Now switching to Asia.

Our Asian engine businesses were up a combined 6% in local currency.

Both our OEM off-road equipment and after market businesses had strong first quarters, up 5% and 9% respectively, and in NAFTA our engine business was up 8%.

Within our off-road equipment business of particular note were our sales for military applications which were up on continued strong demand particularly for filters for the new [Amwrap] vehicles and replacement filters for existing military equipment in the field, especially for the Black Hawk helicopters.

Sales to our customers for their product of large ag and mining equipment also remain good while demand for small off-road equipment remain weak due primarily to the continued weak residential construction end market.

In our NAFTA engine after market business sales were up 10% in the quarter as demands remained strong for large off-road equipment replacement filters as well as our retrofit emission control devices.

Finally, our NAFTA heavy and medium duty truck business sales declined 17% while Class A truck builds at our customers are up 7% in the quarter the medium duty build rates dropped 31%.

I'm going to switch to the other part of our company, the industrial segment, and within that our industrial filtration solutions business had a good quarter, up 13% in local currency.

Europe was up 8% as we continue to see solid demand for our products in both western and central Europe.

Asia was up 25% with strong sales of both industrial dust collection equipment and compressed air filtration products through out the region.

Our NAFTA sales were up 13% as a result of good demand for both new dust collection equipment as well as replacement filters.

In addition, last year's acquisition of LNC West contributed about 2 of the 13% sales increase in NAFTA.

Our global gas turbine business had another strong quarter with sales of $60 million which represented a 22% increase over last year.

Both continued to be good in both the power generation and oil and gas ends markets: Finally, our global special application business, the sales were up 2% in local currency, sales of our disk drive filters declined slightly but these were offset by strong sales growth from our PTFE membrane filtration products.

Now switching to talk a little bit more about our outlook and we provided, as Tom mentioned, updated guidance for fiscal '09 in our press release yesterday, so the following are some summary thoughts.

As everyone is aware, global economic conditions have changed since we provided our initial guidance in early September.

As a result, in local currency or at constant exchange rates we are now expecting low single digit growth -- full year sales growth in both engine and industrial segments.

The good news is that we continue to expect that many of our business will deliver unit volume growth this year despite the current recessions in the US, Europe and Japan.

However, given the recent rebound in the strength of the US dollar, which is up 14% versus the Euro since August and, as Tom mentioned, we are now expecting a significant head wind from foreign currency translation, this will offset our local currency or unit volume sales growth and result in our overall Company sales to be flat or slightly down.

Bottom line, we now expect our full year fiscal '09 sales to be between $2.15 billion and $2.23 billion.

Continuing with our outlook, and I will talk about our engine business first.

The end markets for aerospace, defense, and larger off-road equipment remain good.

Recent forecasts from our customers indicate that both heavy construction and mining equipment rates, production rates should remain solid and our customers have produced agriculture equipment continue to expect growth in the sale of larger tractors and combines.

We should also benefit from the recent acquisition of Western Filter.

Western brings us extensive liquid filtration capabilities and customers in the military and aerospace markets that we already serve with our air filtration products.

Within our transportation or truck business we expect NAFTA Class A truck builds to remain flat through the remainder of our fiscal year as we no longer expect a pre buy in advance of the 2010 diesel emission regulations.

We also expect NAFTA class five to seven build rates to be lower than last year.

Finally, we are expecting new truck build rates to decline at least 10% in both Europe and Japan.

In our engine after market we expect our sales to grow as we focus on continuing to develop new geographic markets and create proprietary replacement opportunities.

Now switching to the outlook for our industrial segment, within our IFS business, which includes our industrial dust collectors and compressed air filters, while our visibility is typically weeks versus months, we do expect that our recent strong shipment patterns should continue for awhile.

In addition, we believe that we will benefit from the demand from our newly introduced products.

As a result, we expect low single-digit sales growth in local currency in fiscal '09.

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

We expect our full year local currency growth rate to be in the low single digits.

The industry is still expecting demand for turbines to continue growing at least through the balance of our fiscal year.

Finally, we expect our global special applications business to be flat in local currency.

We are expecting continued growth in our PTFE membrane products to offset lower disk drive filter sales.

Now I'll give you a brief update on two of our major growth initiatives and the first is PowerCore.

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

Our sales of engine PowerCore sales were up 25% in the quarter to $16 million, as first fit sales grew 21% and replacement filter sales grew 27%.

Also very happy to report on the progress of our PowerCore generation two, or gen two.

Gen two allows to us further reduce the system size or enhance the system performance for our customers.

We have already won ten platforms, five on road and five off road with our gen two technology.

A combination of PowerCore and our other proprietary filtration solutions have allowed us to be very successful in winning air intake programs for the upcoming on and off road diesel emission regulations in the US and Europe.

For these upcoming programs, we have won over 90% of the programs award to do date by the big seven OEMs and there are still many other new programs in play with these and other major OEM customers.

On the industrial side of our business we introduced PowerCore in our Torit dust collectors.

These new dust collectors are 50% smaller than the bag house collectors they compete with.

Since we launched Torit PowerCore this past spring, we have already received orders for 125 systems and shipped 90.

What do these breakthrough technologies like PowerCore mean for Donaldson?

Remember, our strategy is to provide the most compelling filtration solutions for our customers both in terms of technology and value.

This strategy is working and we will grow our global OEM market share as these systems are installed over the coming years.

Furthermore, we will also grow our market share in the replacement filter market as the ultimate owners of this equipment in the field will come back to our customers and us for their replacement filters.

Second growth initiatives I'd like to give you an update on is our expansion products.

As Tom mentioned, we now expect to spend between $60 million and $70 million on CapEx.

Given the uncertain economic climate, we have prioritized these projects to focus on those with the best and quickest paybacks.

These investments are focused on two areas.

First, supporting numerous process improvement and cost reduction projects around the world.

And, second, selective manufacturing capacity expansions to support our continued long-term growth and local customer support plans.

So there are three of those that I'd like to give you an update on.

First is in Brazil and our air filtration manufacturing line is complete there and we will begin production now for customers in Brazil.

Second is we are continuing to expand our existing air filtration plant in India.

This should be completed by the end of our fiscal year.

This represents essentially a tripling of our current facility and is necessary to support a 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 that additional clean room manufacturing capacity available in the next few months.

Now before I open the call up to your questions, I'd like to offer a few closing summary comments.

Some of you have followed Donaldson for many years and may still remember the Donaldson of the 1980s.

It was a great Company but very cyclical as it was mostly focus on a handful of end markets and mostly in the US.

Our focus over the past two plus decades has been growing our Company by diversifying it into a variety of filtration end markets around the world.

I believe that you can see the results of our efforts over the past 20 years in our first quarter numbers.

The first quarter, 56% of our sales were outside of NAFTA, 43% were in replacement parts and 46% was in our industrial business.

Some have speculated that the current economic crisis could be as bad as the twin recessions of the early 1980s.

If it is, Donaldson Company that will have to deal with it is significantly different and much stronger than the Donaldson of 1980.

The essence of our business model has been our relentless focus to have both extensive geographic and end market diversification.

Over time our diversification has reduced the negative impact of any one end market cycle and allows us the opportunity through effective execution to serve our customers and deliver consistent financial results for our shareholders.

So what are we doing today?

So although we had a good first quarter with 9% revenue growth, a 12% operating margin, and EPS up 13%, we have been very focused on proactively managing our business in order to protect our customers, our employee base and our shareholders.

We have taken a number of difficult but very necessary steps to prepare ourselves in the event that our business conditions dramatically deteriorate.

Tom mentioned a few of these actions earlier in our call.

We can't forecast what is going to happen in the global economy over the balance of our fiscal year, but I can tell you that we have been through other downturns and we are using our lessons learned to -- we will use our lessons learned to successfully get through this downturn as we have in the past.

We are focusing on numerous product and process cost reduction activities in our plants and in our sales and administrative operations in order to reduce our costs and protect our margins and the consistency of our financials.

We know how to do this work and as a result of our plans and efforts we expect to deliver an operating margin that exceeds our long-term target of 11%.

So I hope what is evident to you in both our first quarter results and our outlook is the many strengths of the business model we developed over the past 20 plus years.

The bottom line is we have our sites set on delivering our 20th consecutive earnings record with our EPS guidance for this year of between $2.16 and $2.36 per share.

Brandy, that concludes our remarks and we would like to open it up to questions.

Thank you, sir.

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Kevin Maczka with BB&T Capital Markets.

Please go ahead.

Bill, Tom good morning.

I guess my first question on capacity.

Tom, you mentioned the projects in Brazil, India and Thailand and those are complete or nearly complete.

And I guess my question is once they are all complete, as you look at your capacity give us some color on how you view your capacity situation, how much excess capacity you have and some of these targeted restructurings you're talking about, does that involve significant downsizing of your capacity elsewhere?

Kevin, this is Bill.

Those capacity additions are really focused on their regional needs so the needs in Brazil or India or in Asia with our disk drive business.

I would say generally around the world we have been making capacity adjustments in our plants and distribution centers just to respond to the local demand.

So we have reduced product employees in the US and Europe starting first with contract and temporary employees, as Tom mentioned.

I think in terms of where does that put us in terms of capacity.

I would say generally we wait a long time before we decide to add capacity so it doesn't put us in a significant overcapacity situation, these additions, they are small and sort of stepped investments that we'll add to as those local markets build.

Kevin, you also asked about targeted restructurings, this is Tom.

And really those are restructurings or more efficient and better ways to do things within our business units rather a major exit of a business or anything like that .

Okay, thanks for that.

Separate question on pricing, if I could.

You talked about some pricing actions in the press release but you obviously had some issues with some customers in the engine business.

I guess, can you quantify for us what kind of pricing actions you're talking about, maybe how your strategy is changing now that the global macro has changed so much in the last couple of months?

And maybe also if you could, how much were your margins impacted in engine because of these customer delays?

Kevin, this is Bill.

I'll start and then I'll pass it to Tom.

But generally our pricing actions this year and through time have really been just about recovery of material cost increases that we've incurred.

It's not about expanding our margins, it's essentially protecting our margins.

We, when we talked about in the press release is there have been a few delays.

Those are for material cost increases that we started incurring this past summer and we are still negotiating with the recovery of those.

Even in advance of what happens with commodity prices if they continue to come down, we want to try and recover an impact for that period of time that we were exposed to it.

But just about material cost recovery for actual increases that we felt.

And, Kevin, on your gross margin question.

For the Company in total, and this is maybe on a little bit of a rough as opposed to a precise number, we felt in the first quarter that the unrecovered commodity price increases were about 1.2 percentage points.

Now that impact was greater in the engine business for reasons that you're aware of and a lower number in the industrial side.

Okay.

Great.

And just one more and I'll jump back in line.

The gas turbine business, such strong revenue growth this quarter but your guidance for the full year I guess implies that you'll turn negative at some point in the back half.

Is this still a function of some supply chain constraints with other companies in the supply chain or is this more a function of a true slowing in demand?

Kevin, Bill here.

First, in terms of high refuse news in the quarter, and $60 million we are very happy about that, but that's typical of the gas turbine business that it's very lumpy quarter by quarter.

If you go back over the past ten years, you can see that.

So it's not a linear business like most of our others because of the nature of these large projects and when they just happen to ship.

So that's maybe the first, the question about the sales in the quarter, in terms of the year, I think we are still as I mentioned in my comments that it's expected that the gas turbine market will continue to grow.

But as we mentioned in our guidance in September and our call in September actually as well, what we had heard from our customers is that there were capacity constraints, not our products but other supplier capacity constraints that have reduced the number of their turbines to be built for this year and we think that that is still at play.

I think the other factor that I think you alluded to is how much of the current economic conditions is affecting the market.

I think it would be specifically around financing for these approach.

And we haven't really seen any significant impact of that yet.

We have seen a two projects, one in the US and one in Europe, be deferred or delayed slightly but I'm not sure if that's the result of financing or the economic crisis because some of that happens almost every year that projects get delayed because of construction delays.

We are still pretty positive longer term on the gas turbine market at this point.

Okay.

Bill, Tom, Rich, thank you.

You're welcome.

Thank you.

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

Please go ahead.

Thanks.

Good morning.

With respect to the cost recovery and negotiations, does your guidance embed an expectation of receiving that recovery in fiscal '09?

Yes, Charlie, this is Tom and I think you are referring again to the OE portion of our engine business.

But, yes, for whatever commodity cost increases that we are not recovering at this point our intent is late in fiscal '09 that we would get recovered for those cost increases.

Okay.

With regard to do special applications, can you just a mind us, as I understand it the bulk of that is hard disk drive, a smaller portion is membrane.

Is that correct?

Right.

What's your visibility into that market specifically into the hard disk drive market?

Charlie, this is Tom again.

We get public projections of disk drive builds and we review those.

We factor those into our guidance.

But they are changing rapidly.

Generally the market seems to be very positive with the increased storage demands but given the economic concerns at this point there certainly could be a dip in purchases, for example, personal computers and the like.

So we see the public guidance.

We don't have any particular information that's any better than that.

But long-term we feel very positive about that business.

Thanks.

Just to clarify in your EPS guidance and do have dovetail that with your tax rate guidance, bottom end of your EPS guidance assumes bottom end of the -- I'm sorry, the top end of your guidance assumes bottom end of the tax rate and vice versa or is there a mid point estimate in your tax rate you're assuming in your estimates?

No, the tax rate sort of book ends that guidance pretty well, Charlie.

Okay.

Thanks, I'll get back in queue.

Thank you.

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

Please go ahead.

Good morning.

Good morning.

One clarification.

You mentioned the Western Filter acquisition is $23 million but you have a a divestiture.

How much does the investor take away or what's the sort of net sales gain from the acquisition less the divestiture?

Eli, this is Tom, I did mention that the Western revenues for the remainder of this fiscal year we think are going to be in about the $23 million range.

The very small divestiture that we did in Maryville, Tennessee, has annual sales roughly in the $15 million range.

So basically sort of like a net $10million, $12 million revenue gain?

You're close there, Eli.

To get some idea.

So you're implying little bit weaker markets than the overall sales number we are talking when you factor out the acquisition.

Can you talk a little bit now on the tax settlements that you potentially are talking about?

Are those one-shot deals or do those carry on to lower the tax rate for 2010 also?

Eli, we have a number of tax investigations by the authorities in process and any settlements there would principally be one-time deals.

We do have a situation in China where we think we have a good chance of receiving a lower rate than we have been accruing thus far this year.

So that would be ongoing.

But for the most part any significant impact for the rest of this year would be one time.

So when we model this year, which will be somewhere in the higher 20s, we actually have to go back to 30% for 2010.

Eli, that's a good point.

Our underlying tax rate without any of these so-called discrete items is roughly in that 31% to 32% range.

Okay.

That makes a difference.

Now it was, nice to see -- well, I'm not sure nice but to see almost a reversal of margins between engine products and industrial products on a year basis where industrial products was the star for the quarter.

Mostly the engine product margin decline you are saying is mostly cross price in some product mix and is that expected to probably stay like this for the year?

I know you are going to get the cross price improvement but volume is going to weaken as you look out the rest of the year.

I guess the same question for industrial product, it's a very impressive step up in profitability.

How much is that sustainable and how much do we give back as we go through the rest of the year?

Eli, I think actually you summarized it pretty well.

The deterioration on the engine side is primarily because of the inability to recover our cost increases.

And the improvement on the industrial side we entered the fiscal year with significant backlogs.

As you saw, our sales volumes on the industrial side were very positive in the first quarter.

So the lion share of that year-over-year improvement on the industrial side is due to volume.

We had relatively low unabsorbed overhead in our plants because of all the volume that was going through our plants.

So just to follow up on your second question, if volumes would tends to come down on the industrial side for the rest of the year, then we would indeed see that margin due to that factor coming down.

Thank you.

Thank you.

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

Please go ahead.

Yes, good morning.

Just a question, just a follow up on the industrial performance.

The revenue performance in Europe and Asia has been very strong.

Could you give us a little bit more color as to what specific end markets by industry generated this demand and how much visibility you have in to this demand and what metrics you use to gauge the demand?

Thank you.

Andrew, it's Bill.

I don't think we really disclose specific industry's but generally it's tied to either new manufacturing investments, new plants or upgrading of facilities already in place.

I think we've just seen that coupled with our new products and services and a move to our type of technology have been factors that have really driven the growth.

So in Europe it's both western and central Europe and in Asia it's really all around the region that we've seen that growth.

So it's, okay.

How big is China for you, Asia?

Is that a big portion?

On the industrial side?

Yes.

It's, it's still small but rapidly growing.

So I don't think we've broken it out but it's a smaller.

Over time disproportionate driver of the growth in the quarter or no?

No.

And just a broader question.

As we go back, and I appreciate your looking at the early 80s and the double recession back then, but if you go back to sort of '99, 2000 time frame, could you describe as you see the markets what is similar and how are the current markets different from your perspective as you get ready for the next downturn?

It's a good question, Andrew.

I'm trying to think of a good answer.

I think that maybe the causal factors are always going to be maybe different or how they align.

I think what I will comment on is what we see in front of us and I'll go back to the outlook.

We see some markets, as you well know, that are down or heading down and that would be small construction equipment and the trucks in both Europe and in the US.

But we see, say, our aerospace and defense business going the other way, we see larger construction equipment holding up well, and we see our penetration in a lot of these newer geographies for us with lots of upside.

So again it's the combination of some minuses in end markets offset by some pluses that really we think is the basis for our outlook for the year.

And when you talk about geographies, is it you guys entering geographies or is it your ability that these geographies will hold out particularly well just because they are more in the a growth mode than the western world, your hope?

I think it's a combination of both, Andrew.

In Brazil we have a very small market share and now we are there with a plant.

So we have good expectations going forward.

Just from a share perspective of growing our business there.

In China we are already there.

And even though some of the experts are calling down the GDP growth rates for China maybe to 8%, that's still very healthy and our market share is very low.

Even in markets not growing at 10% only 8% we have high expectations for it.

So it's a combination of new geographies we are entering or ones we are in with still very good growth rates.

Just, if global growth rates will not meet your expectations, is there a short-term contingency plan to meet these more challenging conditions or will you just take it one step at a time?

Andrew, we have developed contingency plans.

A lot of the actions we have taken were taken during a quarter where we were doing pretty well because we want to be prepared in case the Tsunami crashes over thus we are ahead of it.

So we gave our best guidance in terms of what we see for this year based on what we see happening out there and talking to our customers, but we are preparing with our contingency plans in the event that it gets worse than that.

Yes.

Thank you very much.

Thanks.

Thank you, next question comes from Brian Drab with William Blair, please go ahead.

Good morning.

Good morning, Brian.

A couple questions.

First, at the end of the fiscal fourth quarter you talked about pricing contributing about 3.5 percentage points to overall sales growth rate.

I know there's been a lot of questions on pricing today but I don't think you've commented specifically as to whether that's still a part of your revenue forecast, has that been modified?

Yes, Brian, this is Tom.

That is a tough one to answer with all the commodity price increases but we do expect it probably won't be 3.5% but perhaps something closer to the 3% range.

And I'd say keep in mind that's sort of a composite of all of our products, so some will be more, some will be less, but something in that 3% range I think is fairly reasonable.

Okay.

Thanks.

And just wanted to follow up on some of the end markets.

First in, you talked about mining on the engine side of the business is the being a source of growth in the quarter.

With commodity prices having fallen off, do you expect that's going to be a driver of growth throughout the year?

Brian, this is Rich.

As we listen to some of our customers, as they are giving us their forecast for builds, the demand for large mining equipment is still good and this is with updates within the last week or so, commodity prices were already down.

We are seeing good activity in coal mining still our customers are we should say we don't actually do the mining equipment, we do the filters for it.

The demand is there.

There's been a huge backlog because they haven't been able to build enough to satisfy demand.

So their order books are holding in and that's what they are passing on to us.

Okay, thanks, I'll jump back in the queue.

Thank you.

Our next question comes from the line of [Adam Brooks] with Sidoti & Company.

Please go ahead.

Good afternoon.

Looking at the balance sheet, you guys look like did you a pretty good managing working capital, obviously especially sequentially, generally the first quarter is higher than the fourth, it was lower for receivables and inventories.

Is this sustainable going forward and kind of what was the catalyst for this?

Was this the retool distribution centers or is there another factor?

Adam, this is Tom.

One of the reasons that you see the balance sheet sort of getting smaller, for example, on the asset side is the impact of foreign currency translation.

As we translate the weaker foreign currencies, our assets in those foreign currencies into the US dollar.

That reduced the value of our assets on the balance sheet.

So you mentioned inventories in particular.

Actually, the majority of that decline or essentially all of that decline is foreign currency related.

I would call your attention to the Western Filter acquisition which added about $4 million to our inventories.

But we do indeed have plans to do our best to bring inventories in constant dollars down this fiscal year.

We'll have to see what the impact of the economy is, but we are working that issue really hard.

So have you seen any impact from the retool distribution centers?

I know we talked about how you obviously insourced in western Europe and everything going on in North America that you originally had maybe a little difficulty with but seems like you got it under control.

Have you seen any impact of that helping inventory turns so far or no impact yet?

Yes, Adam.

Tom here.

Yes, those inventories have come down.

So we are seeing an impact and really good news is that we are pulling inventory levels down in those distribution centers but we are keeping our customer service levels high, our bill rates are very high.

So we are quite pleased with that progress but we know we have a long ways to go.

And one quick question kind of on a PowerCore.

Is there a significant margin difference between say PowerCore and the Donaldson endurance air filters or do you not speak about that or is there any way you can maybe quantify the margin difference between those two types of products?

Adam, this is Bill.

Typically we try and market the new tech nothing products at about the same margin as the ones they are replacing because what we are trying to do is get them installed and the big win for us in addition to the first fit is the replacement parts is locking that up.

It's better longer term for us from an after market perspective.

And over time the operating margin on after market products is better but it's sort of a, it's a sales growth and over time and margin improvement but it's not going into it, the they are priced about the same.

Okay, thank you very much.

Thank you.

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

Please go ahead.

Hi, good morning, guys.

Hi, Jeff.

Just, I mean a lot has changed from a macro perspective since you initially gave guidance and you are certainly trying to reflect that but I wanted to get a better sense of just the pace of business through the quarter.

I mean we had heard through our field that things have really deteriorated in October, November.

And I'm just wondering how the business flushed out through the quarter?

And then in the areas where you are seeing deterioration, where are you kind of most surprised by that deterioration from end market perspective or you maybe vice versa were you more surprised on things proving out to be more resilient?

Jeff, it's Bill here.

I'll start to say that we are sort of heading into an unusual time of the year for us any way with the holidays.

So it's normally our second quarter revenue is weaker typically than the other quarters.

But, and I would say that all of what we see today is baked into our guidance for the going forward.

So I think the big surprises that we are seeing, we are not projecting a rebound in the North American heavy truck market in advance of the the 2010 emission regulations.

So now we are not looking at a prebuy.

We are seeing more extended shutdowns for with many of our customers around the holidays this year than we had been anticipating.

Again, I'll point back and say that's all baked into our outlook guidance that we gave yesterday in the release and in the call today.

But it is obviously from a revenue perspective we've called down our revenue both for foreign exchange and the change in the dollar versus the Euro primarily, but also because we are seeing some generally weaker conditions.

Right.

But would you say your October, your second half of the quarter was materially weaker than the first half on this last reported, or has it been kind of on a stable deceleration?

Jeff, this is Tom.

We did have, as we talked on the last call, a good backlog and a lot of strength going into the quarter or the fiscal year.

Incoming orders did drop, as you might expect, because I know you've been reading the news, incoming orders did drop in October.

So there definitely was a down trend in the quarter but, as Bill mentioned, that is baked into our guidance.

Okay.

Great.

And then just as I look at the -- your margins over the last few years, they've been essentially stable around that 11% target and within that period you've had healthy volume rates.

And just as I look at your guidance it seems like you're calling for some margin -- actual margin expansion into fiscal '09.

Conversely, volume seemed to be coming under some deceleration or pressure so I'm trying to understand how you're able to start to get margin expansion in a slowing growth period versus the past few years where margins have been fairly stable?

Jeff, this is Tom again.

So I think there's probably a number of responses to your question.

One is what Bill mentioned and what I mentioned, we are going after discretionary spending very aggressively.

So that's an important part of our sort of margin maintenance objective.

Also, I know you recall this very well as we talked with you over the last couple of years about challenges in our distribution centers, efficiency improvement opportunities and the like, new warehouse management system that we put in last year, while I said before we have a ways to go those one-time problems are indeed behind us.

And you'll also recall that we talked from a time to time about low margins on some big projects in the gas turbine area, in the IFS area, and we don't have any of those baked into our guidance.

So hopefully it's going to be a combination of all of those things that will be able to maintain our operating margin target at a minimum of 11%.

Okay.

Great.

Thanks, guys.

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

Baird & Company.

Please go ahead.

Bill, could you just review for a second, on the engine side of the business you mentioned Asia was down in local currency by 6%, and I think you said off road was up and after market was up, was the OE business there down double digits?

Is that, am I interpreting that right?

Hang on a second, Rich is looking at the numbers to make sure I get that right.

We are pretty flat in the truck business.

Mostly in Japan.

And then we had, it looks like we had growth in both modest growth in off road, better growth in the after mark.

Okay.

So the OE business in Asia accounted for the decline in local currency overall.

When I look at fiscal '09, and guidance was basically local currency growth in the low single digits.

How do you see that playing out in the three regions?

Rick, I want to correct something.

We said that our Asia engine business the sales were up 6% local currency.

Plus six.

: Plus six, right.

Okay.

And Asia engine, okay, that makes more sense.

Okay.

I was trying to connect the dots here.

So the off road, what we said was the off road was up five and the after market was up nine.

And as Rich mentioned a minute ago, the one that was not up was up less than average was the truck business in Japan.

Okay.

That makes sense.

When I look at again '09 local currency, low single digits is kind of the overall sales guidance in local currency, how do you think that plays out geographically, NAFTA, Europe and Asia?

For the engine business or overall?

Overall sales guidance for the fiscal '09 was kind of low single-digit local currency sales growth, and I'm curious, I mean, are you thinking that any of the three geographies will be down?

Europe I think we would say Europe would be down.

Okay.

And the US I would say would probably be flat and Asia up, just looking directionally.

Okay.

Okay.

And then what was the, I think I just missed this but the dollar amount on the private placement, the five-year note, what was that, how large was that?

Rick, this is Tom.

That was $80 million.

Oh, okay, not a huge number.

Thank you.

(OPERATOR INSTRUCTIONS) We have a follow-up question from the line of Charlie Brady with BMO Capital Markets.

Please go ahead.

Thanks.

Just with regards to foreign currency, I'm assuming the majority of it is in Euro related exposure.

How much, can you quantify how much of that would be out of Japanese Yen or pound sterling in the UK?

Charlie, it's Bill.

It's mostly the downward pressure is on our results has been the Euro, mostly the Euro.

The Yen is has actually gone the other way.

Okay.

Thanks.

Sure.

We have a follow-up question from the line of Richard Eastman with Robert W.

Baird & Company.

Please go ahead.

Sorry.

One more thought.

On the sale of this air business in Tennessee, I believe, were there net proceeds from that sale?

Rick, this is Tom.

The net proceeds were approximately $4 million.

Okay.

And so by definition then on Western Filter, is that kind of a $70 million -- I mean that was the only thing you acquired in the period, right?

Yes, Rick, your math is pretty good.

I know what you're trying to figure out.

The Western Filter acquisition was $78.5 million.

So if you're reconciling to the cash flow statement, the proceeds from the southern business were $4 million.

Okay.

All right.

Thank you.

Thanks.

Thank you.

And at this time there are no further questions.

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

Thanks, Brandy.

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

To everyone on the Donaldson team, thank you for delivering another record equal and for your continuing support.

We all have a lot to be thankful for so have a great Thanksgiving holiday.

Good bye.

Thank you, ladies and gentlemen.

This concludes the Donaldson first quarter 2009 conference call.

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