Donaldson Company Inc (DCI) 2009 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

Thank you for standing by.

Welcome to the Donaldson second quarter 2009 conference call.

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

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

(Operator Instructions).

This conference is being recorded today, Thursday, February 26, 2009.

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

Please go ahead sir.

Thank you, Brandi, and welcome to Donaldson's 2009 second quarter conference call and webcast.

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

Tom will then turn the call over to Bill Cook, our Chairman, President and CEO, who will discuss our updated outlook for fiscal '09 and the business conditions shaping that view.

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

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

Any statements in this call regarding our business that are not historical facts are forward-looking statements, 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.

Three months ago, we issued our first quarter press release and provided guidance for the year based on the global economic conditions as we saw them at that time.

And we are now all painfully aware that economic conditions have deteriorated significantly.

We are in the midst of a major global recession which is impacting nearly all of our end markets around the world.

By now you have all had a chance to read our second quarter press release and review our financial results.

Sales and operating income were below the expectations we provided three months ago.

But some very favorable developments in the resolution of income tax contingencies enabled us to report EPS of $0.43 a share, $0.01 higher than last year's second quarter.

Last quarter, we stated that we saw challenging economic conditions ahead of us.

Fortunately, we had already initiated a number of actions to respond, including a global hiring freeze and further reductions in discretionary spending, in addition to production cutbacks and workforce adjustments.

We then completed a bottoms up forecast of our business in mid November, and based on our guidance at that time, and what we knew about our customers' build schedules and their holiday shut-down plans, plus our existing backlogs and recent incoming order trends.

However, we saw a further rapid reduction in incoming orders and backlog beginning in early December.

And by mid December many of our customers had announced extend shut-down plans and reduced their build schedules into 2009.

We quickly implemented additional plans to respond to this rapid deterioration in market conditions.

As a result, in total, we have reduced our global workforce by approximately 1,850 people, or 14% since the beginning of our fiscal year.

We then incurred $4.3 million in restructuring costs to implement these unfortunate, but necessary, actions.

We continue to see conditions weaken across many of our end markets so we are planning to take further steps to reduce our cost base in the third quarter, and expect to incur approximately $3 million in additional costs related to these actions.

The steps already taken, and those that we plan to take in the third quarter, will combine to reduce our costs at an annualized rate of approximately $85 million and help us to partially offset the significantly higher under-absorption of our fixed manufacturing and operating expenses resulting from our projected sales decline.

We are expecting our full year operating margin to now be between 9.5% and 10%, or approximately in line with our year-to-date operating margin for six months.

Our third quarter margin will continue to be impacted by higher than normal, under absorbed fixed costs and the $3 million of additional restructuring costs.

Our gross margin was 29.1% in the quarter which was below our annual target of 32% in last year's second quarter gross margin of 31.9%.

The biggest drive of the decrease was the under absorbed fixed manufacturing costs.

This factor alone reduced gross margins by 2.1 percentage points .

Also, $2.4 million of the previously mentioned $4.3 million of restructuring costs were included in gross margin which lowered our margin by 0.6 percentage points.

Purchased material costs remained higher than last year's levels but have been mostly offset by a combination of internal cost reduction efforts and selective price increases to our customers.

So the impact in the quarter was minimal.

In operating expenses we continued focusing on the cost containment actions we began late last fiscal year, and which I mentioned earlier.

The restructuring charges increased operating expenses by $1.9 million in the quarter.

Also during the quarter we incurred $2.8 million for stock option expense which represents about two-thirds of our annual stock option charge.

The charge in last year's second quarter was $3 million.

A significant portion of our executive officers' annual compensation is, as we say, at risk, and based on preset financial metrics, such as EPS exceeding prior record, sales and profit growth within our business units, and ROI targets.

Given our latest financial projections for fiscal 2009, we expect that executive officer compensation will be between 30% and 50% lower than in fiscal 2008.

In addition, our officers' base salaries are frozen at January 2008 levels.

During our 1st quarter webcast, we mentioned that several tax contingencies could be wrapped up by the end of our fiscal year and could reduce our tax rate if they would be resolved favorably.

The good news is that we received favorable resolution on two major regulatory audits in the second quarter.

These, and a couple of other minor adjustments, allowed us to take into income approximately $15 million of tax contingencies in the quarter.

Based on our projected global mix of earnings, we expect our normal tax rate, absent additional discrete items, to approximate 31% going forward.

We now expect our full year effective tax rate to be between 21% and 23%.

Our CapEx came in at $11.9 million for the quarter, which is $5 million less than last year.

We are continuing to move forward with strategic projects that we had previously started, but as we mentioned last quarter, we are delaying any new expansions and certain other projects until the recessionary conditions ease.

Our full CapEx guidance is $60 million to $70 million, and we continue to expect 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 that we made in October.

Free cash flow came in at $30 million, which is $23 million higher than last year, and provided a cash conversion ratio of 90% in the second quarter.

We expect free cash flow and our conversion ratio to continue improving during the second half of fiscal 2009.

And for free cash flow to be between $120 million and $150 million for the year.

At the end of the quarter our debt to cap ratio was 36% and debt to EBITDA was 1.3.

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 $18 million.

Our balance sheet remains strong and we continue to have no issues accessing our credit lines.

With that, I will pass it over to Bill who will provide more background on our business conditions and the outlook for the remainder of the year.

Thanks Tom.

I'd like to begin by summarizing the performance of our operating segments during the quarter.

Starting with our Engine segment, sales were down 15%.

Our European engine business, sales decreased 23% on a local currency basis.

Sales to our transportation or truck customers decreased by 54%.

Our sales to off road equipment customers decreased by 20% and our sales of replacement filters in the after-market declined 22%.

In Asia our engine sales declined 17% in local currency.

Both our off road and transportation equipment businesses there were down sharply, 27% and 31% respectively.

Our Asian after-market or replacement parts business fared somewhat better, down only 4%.

In the Americas our engine business was down 3%.

Our sales to our off-road equipment customers were up slightly in the quarter due to the impact of Western Filter which added an incremental $6.2 million of sales in our first quarter of ownership.

There were two other and very different stories within our off-road business during the quarter.

Excluding Western Filter, the good news was that our sales for military applications were up 32% on continued strong demand particularly for filters for the new MRAP vehicles and filters for existing military equipment, including the Blackhawk helicopter.

The other part of the story in the off-road market is that our sales to our customers for their production of off-road equipment used in the agricultural, construction and mining markets, those sales were down 25% in the quarter.

Demand for large equipment was better than the demand for smaller equipment in those markets, but unfortunately, all were down in the quarter.

And in our North American transportation market, our sales to our heavy and medium truck customers also suffered during the quarter.

Our sales declined 45% as both Class 8s and medium duty truck builds at our customers dropped during the quarter.

In the Americas engine after-market business, sales were up 3% primarily due to the continued strong sales of our retrofit emission control devices in the US.

Now I will switch to our Industrial segment.

Within that, our industrial filtration solution business, sales were down 2% in local currency.

Sales in Europe were down 9% as demands for our dust collectors and compressed air filtration equipment fell with the dramatic downturn in general manufacturing activity.

In the Americas, our IFS sales declined 5% in the quarter, while in Asia they were up 22%, primarily due to several large dust collection systems that were shipped during the quarter.

In our global gas turbine business, we had another strong quarter with a 46% sales increase over last year, as many of the projects in our backlog shipped during the quarter.

Finally, in our special applications group, sales were down 26% in local currency as sales for our filters for disk drives declined sharply, and these were only partially offset by some sales growth in our PTFE membrane products group.

That's a little bit more color on what happened in the quarter by region and by end market.

Now, what I will do is switch to the outlook for fiscal 2009, which we detailed in our press release yesterday.

The following are some summary thoughts.

And as everyone is aware, as Tom mentioned, global economic conditions have changed dramatically since we provided our initial guidance for the year in September.

Unfortunately, we saw conditions deteriorate significantly in January -- in December and January.

And trying to project out into the future has become unusually difficult given all the variables currently at play in the global economy.

As a senior executive at one of our customers told me, trying to forecast future business levels right now is like trying to drive a car in the fog.

In other words no one has the visibility we enjoyed just a year ago.

Even given that, our best information about our future business levels is obviously coming from our customers.

We have spent a lot of time talking to them both about what they see and how we can help them.

And based on what we see in our business, and recent customer feedback, we are now expecting full year local currency sales decreases of 7% to 12% in Engine and 5% to 10% in Industrial.

In addition, we now have and continue to forecast a negative impact from exchange rates for the balance of the year.

We expect the foreign currency translation impact for the full year to be an additional 4% to 5% decrease.

As a result of the combination of these factors, we now expect our full year sales to be between $1.9 billion and $2.0 billion, or down 10% to 15% from last year, with foreign currency translation accounting for about 40% of of the decrease.

This is very disappointing as we have been on a good growth track for the past six years, essentially doubling the size of the company over that period.

But we, like all industrial companies, are now facing unprecedented economic challenges.

As we squarely face these challenges we are fortunate, however, that we are a very different company than we were in the early '80s.

In addition, we also believe our new filtration technology symptoms will help soften the impact of the general economic decline on us.

One example that we've talked about in previous calls is our innovative air filtration technology PowerCore.

In our engine business we released PowerCore generation 2, or G2, last year.

G2 allows us to further reduce the system size and enhance the performance of our filtration systems for our customers.

We've already won 13 performs with G2, six on road and seven off road.

And on the Industrial side of our business, we've introduced PowerCore technology into our Torit dust collectors.

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

So far in fiscal '09 we've already received orders for almost 150 Torit PowerCore systems.

What do innovative technologies like PowerCore mean for Donaldson?

Our strategy is to provide the most compelling filtration solutions for our customers both in terms of technology and value, which should help us and our customers grow our businesses.

And PowerCore is just one example of how we will use our technology to do this.

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

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

I started at Donaldson in 1980 and lived through that period, the twin recessions in the early '80s, and when we lost money in 1983.

I believe the current global downturn, while different in many aspects, will be at least as severe as that one.

But fortunately we are not the same company we were there.

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

You have seen the results of our efforts over the past two decades as we put together a solid track record of sales growth and 19 consecutive years of earning records.

We did that despite several recessions and many individual end market slow downs.

We accomplished this by diversifying our end market disclosure, by increasing the percentage of our business that came from industrial markets, from the international markets and from replacement filters.

This new model gave us the financial results to build and maintain a very strong balance sheet.

This has allowed us to continue to generate sufficient free cash flow to fund our operations and capital needs while continuing to consistently increase the dividends to our shareholders.

Over the years, I have been asked what would we do if the earnings record ends some day.

And based on our current EPS outlook of $1.70 to $1.90 versus the $2.12 we achieved last year, it does appear that our 19 consecutive years of record earnings will end this year.

So, what will we do?

If this does happen and we don't deliver another earnings record this year we will immediately set out to rebuild our track record again.

Why?

Because over the past two decades, we have proven that our strategy has worked to the benefit of our customers, our shareholders and our fellow employees.

We can't do anything about the current global recession and complaining about it certainly doesn't help.

We also don't know when economic conditions will improve so we can't wait for that.

So, as Tom mentioned, what we have been doing and what we will continue to do is focus on everything we can control within our businesses.

We are continuing our key strategic CapEx investments including and especially our international expansion plans.

These investments will help us support our customers and grow our market shares in these developing economies.

We are continuing to invest in and commercialize our proprietary filtration technologies.

This will help us mitigate the current economic conditions and help us build market share for both our customers and ourselves in the long term.

We will continue to focus on cost controls across our business, to ensure that we balance our expenses with our current and future business levels.

This focus includes material, manufacturing, and operating costs with the objective of not only managing today's costs but also optimizing our business operations for the future.

We will further improve our cashflow generation.

We have specific return on investment initiatives with a focus on implementing long term improvements on working capital utilization.

Specifically inventory turns and accounts receivable.

Our overriding goals as we do this, are to maintain and improve our service levels and value propositions for our customers, to protect the short term financial condition and performance of our company, and to continue to pursue our highest priority strategic initiatives which are the key to our future.

It is a difficult balancing act but it is one that the Donaldson team has done very successfully in the past.

We have already taken a number of very difficult but very necessary steps to reduce our cost base as business conditions deteriorated.

I would like to emphasize, as Tom mentioned, that fortunately we started these actions early.

In fact, when we were still delivering both sales and earnings records.

However, based on the continued deterioration in economic conditions, we are planning to take additional steps this quarter, this upcoming quarter, and we will be prepared for future actions if conditions worsen even more than we currently expect.

Our goal is to stay ahead of any new negative economic developments in order to both protect the short term and long term viable of our company.

Finally, while I don't know how long this recession will last, I I don't believe it will last forever.

And when it ends, we at Donaldson will be ready with a lean organization, right investments already made, and with a balance sheet and cost structure that will allow us to capitalize on the global recovery.

This is what we have done in the past and this is what we are doing now.

Brandi, that concludes our prepared remarks.

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

Thank you, sir.

We will now begin the question-and-answer session.

(Operator Instructions).

One moment for the first question.

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

Gentlemen, good morning.

My first question is on the margin guidance, 9.5% to 10%.

And Tom, I think you said that was in line with your first half run rate, but Q2, if you exclude restructuring, it was more like 7%.

Can you talk about how confident you are or what gives you the confidence that 9.5% to 10% is the right number given that things continue to deteriorate so rapidly?

Yes, Kevin, that is a good question.

As you know, we had a good 1st quarter.

And the 2nd quarter is typically our toughest quarter of the year in normal years.

So our margins are generally the lowest in the second quarter.

We did a bottoms up forecast.

We looked at what we thought we could do in the second half.

We factored in the additional restructuring costs that I mentioned before.

and then added all of that up with the benefits that we expect in the second half from the restructuring actions and that gave us the range of 9.5% to 10% in the second half.

And just to break it out a little bit more, gross margin would look to be in the 31% range.

So that is less than our typical guidance of 32% for the year, and operating expenses slightly more than 21%.

And Tom, on the restructuring, so you took some restructuring charges in Q2, you're going to have some more in Q3 and you expect on an annual rate to save $85 million.

Give us some timing, if you could, about when these things will be implemented.

And when you're start to actually see that, when you will achieve the full run rate of that $85 million.

The full run rate should be achieved later on in the fourth quarter.

The second half benefit that we think we are going to get out of this is roughly $38 million, and about $25 million of that would be at the gross margin line.

And $13 million at the operating expense line, and then, of course there is $3 million of restructuring costs in there.

Which gets you down to a net of about $35 million for the second half.

So, certainly as we enter F10, we would be running at the $85 million annual lower rate.

Okay, great.

Thank you.

Thank you, Kevin.

Thank you.

Our next question comes from the line of Antonio Antezano with Macquarie Capital.

Please go ahead.

Good morning.

Have you provided margin outlook for Engine compared to Industrial businesses?

We have not broken out our guidance by Engine and Industrial, Antonio.

Okay.

Then I was wondering in terms of your outlook for after market, you mentioned there is very low utilization rates there.

If you could provide more color on the outlook for after market, what you see in terms in utilization in these different markets.

Antonio, this is Bill.

We are seeing more equipment both on and off road not being as fully utilized as it was earlier this fiscal year.

We look at statistics like ton miles and other indicators like that in terms of developing our forecast and building our guidance.

Little more color on that, Antonio.

This is Rich.

From published forecasts that we see, we expect ton miles, utilization of on road equipment to be down about another 6% during the second half of the year.

Construction spending continues to decelerate and we expect that to continue during the balance of our fiscal year.

And anybody's guess is, related to the housing market and residential construction with expected deceleration in the commercial markets.

So that would be the utilization of that equipment.

Mining with the commodity prices, most of the metal markets are down 50% plus in pricing.

There is a lot of mining equipment that isn't going to be utilized in the second quarter because prices just don't support that.

So those are the kinds of things we are looking at in our after market guidance.

This is Bill again.

There is one other factor I will add to that.

We have seen customers, whether it is OEMs or distributors working their inventories down, converting that into cash, so we factored in an impact from that as well.

Just a final question, if I may.

I look at your outlook for the gas turbine segment to decrease 2% to 7%.

However, the first two quarters, that sector was up strongly.

So we are going to see a big swing.

I guess a big part of that is currency.

But if you comment on what is driving the swing going forward.

Antonio, Bill again.

Our gas turbine business is very lumpy, if that's the right technical term, quarter by quarter.

It's very large projects and so, we don't get a nice 25% of our annual sales quarter by quarter.

They bounce around quite a bit.

So our 2nd quarter was very good.

And we don't see continuing at the pace for the second half of the year and that's just a function of that lumpiness.

Our guidance for the year was essentially by units, our gas turbine business would be flat year over year, but down slightly because of the impact of the foreign exchange.

Thank you.

Thank you, our next question comes from the line of Richard Eastman with Robert W.

Baird.

Please go ahead.

Yes, good morning.

Bill, can I just explore for a second the operating margin in the quarter.

If I try to adjust for currency and restructuring, it still looks like the decremental margin was maybe 60%.

I am curious, did the sales mix have a lot to do with the profitability in the quarter, namely, say, transportation at a $16 million quarter?

Is that losing meaningful money?

Bill here.

I'm going to turn it over to Tom, he's raring to go to answer you.

I will try.

Let me just help you out on gross margin in the quarter and give you a little color on the quarter to quarter reconciliation.

The big mover, Rick, in the second quarter was the unabsorbed overhead.

If you look at last year at 31.9% and you get down to 29.1% which we were at this year, 2.1 percentage points of that was the unabsorbed overhead.

As you looked at our segment results in the disclosure, you saw that Engine deteriorated much more than Industrial, and the recession hit Engine first.

Unabsorption that we had in the plant was primarily Engine in the second quarter.

And then also, I gave you the restructuring charge that was charged to gross margin in the quarter.

And that was 0.6 of 1%.

And that pretty much gives you the entire reconciliation, and there were just a couple other minor factors in there.

But the big move was in Engine and that was pretty much all volume related.

I guess what I am getting at, is there significant difference within off road trans and after market?

Again, I have noted that $16 million trans quarter had to be a big problem in terms of most of the unabsorbed overhead there versus, say, after market.

Tom again.

No, there is not a big difference between those end markets.

Of course, the unabsorbed overhead impacted transportation more, but as we look at it from a standard margin basis, setting aside the unabsorbed overhead, there is not a big difference there from a mixed standpoint.

Rick, Bill here.

As you know, I will remind you, many of our plants support multiple markets.

A plant isn't just transportation or just off road focused.

They support multiple markets, both Engine and Industrial, typically.

And then another question for Tom.

If I look at your tax rate guidance, it is a little bit confusing.

To get to 21% to 23% for the year you need to have a tax rate in the 45% range for the second half.

Is that what you are suggesting?

I think, Rick, the math would suggest that the second half would be 30% to 31% to get us to the full year guidance of 21% to 23%.

Keep in mind, our first half tax rate turned out to be 13.2%.

I see, so you are adjusting the second quarter for a normalized tax rate to do that?

Yes.

For example, in the 2nd quarter a normalized tax rate would have been about 30%.

Okay.

I see.

All right.

Go through the math, Rick, and if you want us to follow up with you further, we can walk you through that.

Okay.

I understand.

Thank you.

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

Please go ahead.

Good morning.

You gave a much broader guidance range Ann expecting one time items and there was some magnitude.

Speaking of the tax rate, last quarter you gave a much broader guidance range.

I think you were expecting some of these one time items, maybe you just weren't certain of the magnitude.

Do you have more confidence now that those one-time items have passed and that's why we are seeing a more narrow guidance range?

Brian, Tom here.

We did give a broader range last quarter and that's because the two major regulatory items that I referred to in my comments were open at that time.

What happened in the second quarter was that we, for the most part, resolved those items, were able to take those contingency reserves into income.

So those two major uncertainties are no longer present.

And with those uncertainties gone we were able to narrow our guidance.

Okay, thanks.

Looking at the transportation business, going forward here, Rich, you mentioned ton-miles, according to your sources, projected to be down maybe 6% for the rest of the fiscal year.

And if you back in to giving your guidance back in to what the growth or the decline would be in the second half, it looks like transportation down about 25%.

Is that, like Bill mentioned, just distributors working through inventory?

And how much inventory is there to work through that it is going to depress your growth for that long?

Let me clarify my earlier response slightly.

A ton-mile is an impact or an indicator of our after market rather than what we report as transportation.

What we report as transportation is strictly the new build of trucks.

And there, we are expecting new truck builds to be down roughly 30%, 25% to 30%.

The latest public statistics I got issued on that we are expecting for the calendar year of '09 140,000 to 150,000, down from 205,000 last calendar '08.

In the truck market, on the heavy side, there is another letdown.

We are looking at medium duty trucks, their build rates being being similar to that for calendar '09, as well, around the 150,000 number.

So the the transportation market has still got a difficult year ahead of it.

Okay, and then in the after market, if you are forecasting roughly down 20% for the balance of the year, is the difference between that ton-mile project, the negative 20% level, all to do with inventory reduction primarily?

I don't know that we gave a specific forecast for after market.

I am just backing into that from your guidance down.

I have down roughly low double-digits based on your guidance in the second half.

You gave guidance for the engine products segment overall.

Yes.

Brian, this is Bill here.

We didn't give it by the specific subsegment.

That's where we are struggling a little bit.

I think it's directionally.

Rich already talked about the transportation which is new trucks or products related to that, what's going to happen there.

And we talked a little bit about global mining, construction and the off road markets, and that's a mixture of off road or construction equipment.

And there we really looked to some of our customer announcements.

And so Caterpillar announced calendar '09 being down 25% over '08.

That would be probably the best public published statistic that we can use.

The ag market being a little better than that with John Deere's announcement last week.

The after-market, it's probably down a little bit less than the Engine average.

It's more stable.

utilization has weakened.

There is some inventory adjustment.

But I believe it's going to be less than the average for the Engine products group.

Thanks very much.

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

Hi, good morning, guys.

Wanted to get a better sense of, in the Industrial business and gas turbine what you are seeing from an order perspective.

Jeff, Bill here.

I think we have that baked into our guidance that the business is going to be leveled off right now.

And we have good visibility through the end of our fiscal year but we really haven't given any guidance beyond that.

We will start doing that at the end of the next quarter.

But gas turbine being down in the second half, is that more a function that things are slowing there in terms of incoming orders, or, to your earlier point, it is just timing?

It is the timing, the lumpy factor I mentioned before, Jeff.

Okay.

And I guess with IFS you give some good color by region.

Would you expect the strength in Asia continues or were there some one time orders in there that helped things out?

There were some one-time orders that helped it out.

And then not to beat a dead horse on the after market but I guess you were down 11.5 in this quarter.

Is that the right run rate to think about on a go forward basis, or do you actually see a further deceleration?

Jeff, Bill again.

I am not going to probably get pinned down to the percent.

I'm going to try to avoid doing that.

But I'd say generally we see the after market, holding aside the deleveraging of inventories and things like that, as being more stable than the first fit business.

Can you just run through.

You gave some detail on the after market business in the quarter either by sub vertical or geography.

A lot of numbers coming at me.

Can you just run through those again?

Sure.

So, in Europe -- these are just the after market numbers within Engine.

In Europe the sales were down 4% in the quarter.

That was the Americas.

I am sorry.

They were down 4% in the quarter in Europe.

In the Americas, they were up 3%, and that included the mission control devices.

And did I skip Asia there?

I am sorry.

Let me back up, Jeff.

In Europe, they were down 22%, Asia was down 4%, and the Americas were up 3%.

Okay.

Why do you get the sense that Europe was such an outlier?

Is the model a little bit different?

Do they carry more inventory and there's more to stock and things are just that much more challenged in Europe?

Jeff, as we went through the numbers for the OEM segments, both transportation and off road, you saw how big the percentages were there.

Our European business in total was down 23% in the quarter on a local currency basis.

It is almost like somebody hit a switch in Europe during the quarter.

A lot of very extended customer shutdowns beyond their normal holiday shutdowns.

And that affected both the first fit and the after market business.

The North American piece kind of hangs in there okay.

It is better, right.

Finally, housekeeping.

How were you thinking of the corporate expense number for the full year?

Lower is better.

Jeff, let's look at it as a percent of sales.

Are you talking all of operating expense?

Just corporate and unallocated.

Year-to-date you are at 4.3.

Okay.

That's going to fluctuate quarter to quarter by, say, a million or a couple million dollars.

There is consolidating entries in there and elimination of inner-company profit and inventory as we ship inventory between business units.

A big portion of that, Jeff, is interest expense and that is going to be a very steady number.

I mentioned in my comments that that will be $18 million for the year.

I am just trying to reconcile last year and first half, you had over $8 million.

Now, you are running down 50% and then you had a big, that was a big number in the second half.

So versus that $25 million in fiscal '08.

Should we think of that as getting cut in half?

The run rate for 2009 is going to be a better number to use.

Because last year we had a lot of inner company shipments so we had a lot of that inner company profit to eliminate.

And inner company shipments are down a bit this year so the 2009 run rate is a little more normal, at least for this year.

Okay, perfect.

Thanks, guys.

Thank you.

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

Please go ahead.

Good morning, guys.

Two questions with market share.

It seems like this could be a situation where you emerge on the other side and gain a bunch of share.

Clearly you have pulled back as far as any further expansion plans.

Do you see anything as far as smaller competitors falling by the wayside, or is your market share holding steady?

Adam, Bill here.

We have, as Tom mentioned, reduced or eliminated, any new capital expansion products, but we are continuing with the ones we already had in play.

So we're expanding in India, we're expanding in Thailand.

And we set up an operation in Brazil, expanded in the Czech Republic.

So we continued those or finished those because we want to be positioned on the other side of this poor market share gains.

I think that was the first part of your question.

We are still making strategic investments.

In terms of smaller competitors falling by the wayside,I won't maybe comment specifically on other companies but I think we bring to the economic challenge a very strong balance sheet and we're going to manage our business very proactively to protect that, and I think that is an advantage we have going through this.

As customers look at their supply base, including Donaldson Company, hopefully they look at us and say, "We don't have to worry about these guys."

You touched a little bit on as far as you having emerging markets.

Sales overall in those areas such as Brazil and India, was that up or will you not break that down to that minutiae?

We don't break it down into that detail.

The numbers are still relatively small, but when we look over time, just given the conditions there, that those will be future growth markets for us.

Thanks a lot.

Your next question comes from the line of Gregory Marcosko with Lord Abbett and Company.

Most of my questions have been answered.

One perhaps minor question would be in the area of special applications.

Are you seeing any expansion there or additional product applications?

I realize it is down pretty well, but could you talk about that.

Gregory, Bill here.

We continue to look for ways of leveraging what we do, or just drive filters into other segments, and we see some possibly interesting opportunities but they are not material yet at this point.

If you look at the different segments would it be electronics that was the most difficult in that group?

Basically, about 60% of the special applications is filters for hard-disk drives.

And I would say that both the electronics portion of that as well as the computer were down significantly.

Thank you very much.

(Operator Instructions).

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

Please go ahead.

Yes, good morning, this is actually Tom Brinkman standing in for Charlie Brady.

Just a couple quick questions, a follow up on the last questioner.

As the mix shift in special operations changes and you go a little bit more forwards PTFE membrane filtration products and less towards hard disk drive, I'm just wondering what the margin outlook would be based on that.

Tom, this is Bill Cook.

We are basically trying to grow both parts of that special application, both the hard disk rive filters as well as the PTFE membrane product.

And the margins, we don't break them out, but overall, they are roughly the same.

Okay.

The only other question I had was, just to follow up on last quarter's discussion about cost recovery negotiations.

I think that was particularly focusing on the OE portion of the engine business.

Is there any update on that?

I think you talked about a little bit of offset for your margins that came from some pricing this quarter.

Tom, Bill again.

As we discussed in this press release as well as this quarter, with the rapid increase in commodity cost that we started to see last spring and summer, we we really approach dealing with that through a combination of some selective price increases as well as very aggressive cost reduction projects, internal projects.

And that continues.

We're also seeing, we hope to see some moderation in commodity costs start to flow through in the coming quarters, as well.

Thank you very much.

Thank you, our next question, a following up question, comes from the line of Jeff Hammond.

Please go ahead.

Just a follow up on the restructuring.

Can you talk about year to date, including the next quarter, what you've spent on restructuring?

I just want to understand the payback a little bit better because it seems like your spend is fairly small relative to the $80 million paycheck.

Jeff, Tom here.

So, again in the second quarter the spend was about $4.3 million, and $2.4 million of that was in gross margin and $1.9 million in operating expenses.

And in the second half, we see another $3 million.

Included in the $3 million is a couple hundred thousand dollars related to a couple of small leased distribution centers that we're going to be consolidating into our major owned distribution centers.

So there's some moving costs, some lease costs in that numbers.

That job gets you to I think $7.23 million for the year.

And we are hopeful that will lead to $85 million of annual savings.

Did you incur any in the 1st quarter?

No, it was really all second quarter.

So was a lot of the cost saving really hunkering down on discretion spend?

It is workforce adjustment and really looking at every dollar we can from a discretionary spending standpoint.

Thanks, guys.

The next line comes from Steven Geist with First Pacific Advisors.

Please go ahead.

Yes, good morning.

I had a question on capex spending.

For the first six months of the year, you spent roughly $23 million and earlier you indicated that for the full year it would be $60 million or $70 million which would indicate quite a step up in the capex spending for your next six months.

Can you talk about that and where that money is going.

Steven, Tom here.

That represents a combination of wrapping up the projects that we have in existence that Bill mentioned before, an expansion in India, Brazil.

But then also we have just our normal maintenance capex, as well that will probably pick up a little bit in the second half of the year.

There are no, as Bill mentioned, I believe, there are no specific new projects that we are undertaking at this time.

I think you want to look at that primarily on more of a timing type basis.

Okay, thank you.

At this time there are no further questions in the queue.

I would like to turn the call back over to management for any closing remarks.

Thanks, Brandi, and to all of you participating and listening, I would like to thank you for your time and interest.

For everyone on the Donaldson team, I know this is a very difficult time and there will likely be more tough days ahead of us before we emerge from this recession.

We need to continue to focus on what each of us can do, what we can control within our jobs for the benefits of our customers, our shareholders and our fellow employees.

The sun will come out again and when it does we will be ready, so thank you for your support.

Good-bye.

Thank you, ladies and gentlemen, this concludes the Donaldson second quarter 2009 conference call.

If you would like to listen to a replay of today's conference please dial 303-590-3030 or 1-800-406-7325, followed by pass code 3971205.

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You may now disconnect.