Donaldson Company Inc (DCI) 2009 Q3 法說會逐字稿

Welcome to the Donaldson third quarter conference call. During today's presentation all parties will be on a listen-only mode. Following the presentation the conference will be open for questions. (Operator instructions). This conference is being recorded today Wednesday, May 27th, 2009.

I'd now like to turn the conference over to Mr. Rich Sheffer, Director of Investor Relations. Please go ahead, sir.

Thank you, David and welcome, everyone to Donaldson's 2009 third quarter conference call and webcast. Following my brief introduction, Tom VerHage, our Vice President and CFO, will give us a brief review of our third 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 the remainder of 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. Yesterday we released our third quarter earnings after the market closed and updated or guidance for the balance of fiscal 2009. Not surprisingly with the ongoing global recession, conditions in nearly all of our end markets deteriorated in Q3. Looking forward, many of our engine products OE customers have announced reduced work schedules and plant shutdowns during our fourth quarter and with the limited visibility in our other end markets, we have updated our sales and EPS guidance for fiscal 2009. Details are included in our press release.

In response to economic conditions that continued to weaken as our third quarter progressed, we have implemented additional restructuring actions that led to a pretax restructuring charge of $6.8 million in the quarter or $0.06 per share. Of the $6.8 million, approximately $1.9 million was in cost of sales and $4.9 million was charged to operating expenses. As a result with our updated and reduced outlook for the business, we are planning additional restructuring actions in our fourth quarter that will likely result in a pretax charge of between $10 and $12 million. So for the full year we expect to take between $21 and $23 million of pretax restructuring charges which is roughly $0.19 to $0.21 per share.

In addition to the workforce restructuring actions discussed in our press release, we are also consolidating two leased distribution centers in the US into our main distribution center in Indiana and are consolidating another small leased distribution center in the UK into our central European distribution center in Belgium. We expect the cumulative impact of the restructuring actions taken during fiscal 2009 will generate approximately $100 million of annualized pretax cost savings when completed. Including the pretax restructuring charges I just discussed, we are expecting our full-year operating margin to be between 8% and 9%. Our fourth quarter margin will of course continue to be impacted by the lower than normal absorption of fixed costs and the $10 to $12 million of additional restructuring costs.

Our gross margin of 31.6% in the quarter which improved from our Q2 gross margin of 29.1% but was below the 32% we achieved in last year's third quarter. Lower absorption of fixed manufacturing costs in the quarter reduced gross margin by 3.5 percentage points net of savings from completed restructuring activities and approximately $1.9 million of the $6.8 million restructuring costs taken in the quarter were included in cost of sales. Purchase material costs were relatively flat in the quarter compared to last year and last year's third quarter contained $3.6 million of incremental costs related to the implementation of a warehouse management system. In operating expenses we continued the expense reduction programs we began a year ago including a hiring freeze, a salary freeze, targeted restructurings, reductions in executive compensation and other expense reduction actions.

The restructuring charges increased operating expenses by $4.9 million in the quarter while we realized $6 million of cost savings that are reflected in operating expense. As I mentioned last quarter, a significant portion of our executive officers' annual compensation is at risk and based on preset financial metrics such as EPS exceeding the prior record, sales and profit growth within our business units and our allied targets, given our latest projections for fiscal 2009, we expect that executive officer compensation expense will be 70% to 80% lower than in fiscal 2008 as we expect minimal incentive compensation payouts this year and we have reversed accruals made last year for our long-term incentive compensation plan which is paid out over a three-year cycle. In addition, our officers' base salaries remain frozen. Incentive compensation for incentive eligible employees at all levels is down from F 2008 by $15 million for the year and $10 million in the third quarter alone.

Our executive tax rate was favorably impacted by a conclusion to an international audit that provided a $2.6 million benefit to our third quarter tax expense. Lowering our effective rate to 24.8% 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 17% and 19%. Our CapEx is running below our forecasted spend rate coming in at $10.9 million in the quarter as we continue to prioritize our capital spending plans.

We are moving forward with strategic projects but as we mentioned last quarter, we are delaying any new expansions until the recessionary conditions ease. We have reduced our full-year CapEx guidance to $40 to $50 million. We continue to expect depreciation and amortization to be in the $55 to $60 million range which includes the amortization of intangibles from the Western Filter acquisition that we made in October.

Pre cash flow came in at a record $100 million in the third quarter, which is $66 million higher than last year and provided a cash conversion ratio of 376% in the third quarter and 157% year to date. We now expect pre cash flow to be between $180 and $200 million for the year. At the end of the quarter, our debt to cap ratio was 32% 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 2009 to be approximately $17 [million]. Our balance sheet remains strong and we continue to have no issues accessing our credit lines. We do not have any material long-term debt maturities in the next two years and our revolving credit line has another four years until maturity. So with that, I'll pass it over to Bill, who will provide more background on our business conditions and outlook for the remainder of the year. Bill.

Thanks, Tom and good morning, everyone. As Tom just mentioned and we covered in detail in our press release yesterday, conditions in many of our end markets and in many regions have unfortunately continued to weaken. Although we have worked very persistently over the past two decades to diversify our company, the breadth and depth of this recession has almost simultaneously impacted many of our end markets in most parts of the world. And as we all read in the paper every day, this current economic situation is unprecedented, at least in our life times.

The major industry indicators we look at to develop our forecasts include regional GDP growth or in some cases now declined projections, heavy truck builds, ton miles, machine tool consumption, durable goods orders, hard disk drive shipments and gas turbine builds. With we also spend a lot of time talking with and listening to our major customers around the world. All of them are continuing to manage both their production schedules and parts inventories to achieve a better balance with their current lower demand. As Tom mentioned and you probably already have seen in the papers, many of our major OEM equipment customers are now planning longer summer shutdowns to better balance inventory and production schedules.

Consequently, most parts of the Donaldson world have been impacted by the resulting decrease in orders. Our total sales were down 30% in the quarter, that's 6% due to currency, the stronger dollar and the balance about 24% due to these dramatic and very sudden decreases in our customer orders. And it's hit us almost equally hard in both of our reporting segments, engine sales were down 31% in the quarter, industrial down 28%. All of our major regions were also down. Looking at these in local currency, Asia was down 17% primarily due to Japan, NAFTA was down 22% and Europe was down 32%, but we did have some good news during the quarter.

Even excluding our recent acquisition Western Filter, our sales for military and aerospace applications were up 11% primarily due to continued positive demand for filters for military equipment including the Blackhawk helicopter and MRAP vehicles. We also enjoyed continued strong growth over our retrofitted emission control systems with sales up 20% in the quarter. We also had a few good regional stories with local currency sales up 37% in Mexico, 60% in Brazil, 45% in Korea and 70% in India. So while we are obviously dealing with the very severe global recession, we fortunately still have a few bright spots. Before I talk about our outlook, I'd like to summarize our current situation.

To be clear, we are facing a very severe economic environment just as many of our customers and other industrial companies are as well. But while all companies face challenging times at different points in their lives, the true measure of a company is how well it responds to these types of crisis. I believe that the global Donaldson team has responded very well and I'll talk more in a minute about how we responded. I'm going to talk a little bit about our outlook first. We provided detail updated guidance for fiscal 2009 in our press release and to be clear, there's a lot we don't know about what lies in front of us.

There appear to be almost as many different projections as to when conditions will improve as there are forecasters. But let me talk about what we do know. We do know that capital spending in most industrial end markets continues to be very constrained. We also know that financing remains difficult for smaller and below investment grade customers and finally, we know that our 90 day open order backlog at the end of April was significantly below the level at the same point last year. So based on all that we can see or project, we are now expecting our full year local currency sales to decrease between 12% and 17% in engine and 8% to 13% in industrial.

In addition, we continue to forecast the negative impact from the stronger dollar for the balance of the year. We expect foreign currency translation to impact the full year by an additional 4% to 5%. Putting all of this together, we now expect our full-year sales to be between $1.8 and $1.9 billion or down 15% to 20% from last year with foreign currency translation accounting for about a quarter of this decrease. So while we accept that there are a lot of things in this economic situation that we can't control, we also recognize that there are many things within our business that we can and we have focused all of our energy on those things that we can impact to protect our business and our customers and I'm very encouraged by the results of our efforts and you can see the tangible results of this in our latest numbers. For example, despite a precipitous 30% drop in our revenues last quarter over the prior year, we did a good job of protecting both our gross and operating margins.

As noted in our press release, our operating margin improved from 6% in the second quarter to over 9% in the third. We will continue to focus on these improvement initiatives to ensure that we balance our expenses with our current and future business levels. We have dozens of specific project teams working to further reduce costs and improve our efficiencies. Their focus includes making improvements in our purchase materials, our manufacturing processes and our operating departments with the objective of not only managing today's costs, but also optimizing our business for the future.

We also have ongoing return on investment or ROI initiatives focused on implementing long-term improvements in our working capital utilization, specifically inventory turns, accounts payable and accounts receivable and our initiatives to improve working capital utilization really paid off in the third quarter as Tom mentioned we realized record free cash flow of $100 million. Now, in the spirit of continuous improvement, we accept that we will always have opportunities to improve but it is very gratifying to see how well our employee team has banded together to respond to this current economic crisis. And we haven't forgotten about our future.

We are continuing to invest in select new filtration technologies and projects that will help us to return to our growth plans over the long term. One example is PowerCore technology. Last year we released PowerCore generation 2 or G2. G2 allows us to further reduce the system size and enhance the performance for our customers versus our original PowerCore technology. We have already won 15 platforms, seven on road, eight off road with G2 and we have another 22 programs in the proposal stage so our prospects remain very bright.

On the industrial side of our business we introduced PowerCore technology into our Torit dust collectors last year. These new dust collectors are 50% smaller than the bag house collectors they compete with. So far in fiscal 2009 and despite very difficult market conditions, we have already received orders for 285 Torit PowerCore systems and are quoting activity remains high. So what do innovative technologies like PowerCore mean? Well, our strategy is to provide the most compelling filtration solutions for our customers both in terms of technology and value to help us and them grow and PowerCore is just one example of how we will use our technology innovations to do this.

We are also making great progress on our long-term international growth plans recently in China and India we have won three new engine OE platforms with major local customers and we are completing two key plan expansions in Thailand and India. These investments will help us to support our global customers as well as grow our market share in these developing economies. Our overriding goals remain. First to improve our service levels and value propositions for our customers, second to protect the short-term financial condition of our company, and finally, to continue to pursue our highest priority strategic initiatives which are keys to our long-term future. It is a difficult balancing act but is one that the Donaldson team has done very successfully in the past. But unfortunately we have had to take a number of very difficult but necessary steps to reduce our cost base as business conditions deteriorated.

We will continue to proactively balance our resources and capacity with our current and projected market conditions. This isn't work that any of us want to do but we have to do it if we are going to maintain both the short and long-term financial strength of our company. When this recession eventually ends, and it will, we will have our company positioned with the right global organization, the right investments already made and with both the balance sheet and cost structure that will allow us to fully capitalize on the global recovery. I am very proud at how well we responded to this crisis so far and I remain very excited about our long term future. David, that concludes our prepared remarks, now we would like to open it up to questions.

Thank you sir. We will now begin the question and answer session. (Operator instructions). Our first question comes from the line of Kevin Maczka with BB and C Capital Markets. Please go ahead.

Good morning.

Good morning, Kevin.

I guess my first question on the cost savings, this 100 million-dollar annualized goal in your release you say that's your expectation when the restructuring actions are completed. Will they be completed in Q4 and if so, how much of that $100 million do you expect to realize in fiscal 2009?

Good morning, Kevin. Tom here. Yes, those actions that we are talking about that lead up to the $100 million will be completed in this fiscal year. The savings that we are projecting this year are $20 million in the Q3, so that's what we have announced for Q3, and approximately $24 million for Q4 so if you just take the $100 million, divide it by four on a quarterly basis, you can see that we are realizing almost all of the savings starting in Q4.

Okay. Got it. And then the revenue guidance implies at the low end that you could see a further 15% sequential revenue decline in Q4 and I'm just wondering if you can give a little more color on what the scenario might be that would drive a further sequential decline like that. I know Tom, you mentioned things like summer shutdowns at some of your bigger customers. Is that kind of the scenario that would really drive that much more sequential decline?

Yes, Kevin, as you point out, that's the low end of our guidance and I think it's simply more a function of all of the global uncertainty rather than anything specific that we can point to in any of our businesses.

Okay. And then just maybe finally if I could, all the talk about destocking, maybe it's run its course, maybe not entirely, what's your view of that and the channel inventory at this point?

Kevin, Bill here. I think a lot of that has been done but we do not think that it's over yet. Some channels there may be further ahead than others but I would say overall that we see with many of our customers have announced specific initiatives to further reduce inventories so we believe that's going to continue for a while and that's baked into our guidance.

Okay. Great. Thank you. I'll get back in line.

Thank you, sir. And our next question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Hi. Good morning, guys.

Good morning, Jeff.

My question -- just a follow-on on the cost savings. As you look at the $100 million of savings, how much would you think of as, permanent structural improvements versus temporary that once business starts to improve, they come back online?

Yes, Jeff, Tom here. That is a good question. At these volume levels, of course, we believe the $100 million is permanent, but your question is what happens when volumes come back. I can share with you that there's sort of a 60/40 relationship in this $100 million. About 60% relates to the cost of sales, about 40% relates to operating expenses. The cost of sales, 60% is clearly much more variable, while we have taken some structural costs out by consolidating some distribution centers, obviously when volumes come back, we are going to have to bring workers back into the plants. So that 60 -- or that $60 million is variable or quite variable. The $40 million related to operating expenses, we are going to be very cautious before we start bringing those expenses back online. We have made targeted restructurings. We think we are making some additional operating improvements, some re-engineering initiatives and the like that will prevent us from needing to bring all of those costs back online, but I can't give you a specific percent, for example, if sales come back 10% or 15%, how much of those costs come back, I'd be misleading you if I would give you a specific percent.

Okay. No. That color is great. And then you said tax rate going forward 31%. I guess as you look through your pipeline and tax planning strategies, I mean when we get out to fiscal 2010, should we be thinking about a 31% tax rate or do you have things in the pipeline that bring that back down to a more reasonable level?

Well, Jeff, we are looking at 31%. We will give you more guidance in our year-end webcast but at this point 31% represents a pretty good estimate of what our global mix of earnings are, the tax rate in those countries that have those earnings and that would be the best guess that we could give you at this point.

Okay. And then finally, can you just give us a little more color on your aftermarket business by region either on a core basis or directionally what was more stable, weaker.

Jeff, this is Rich. If we look at the regional breakdown, the weakest region we had in the aftermarket was in Europe again. Local currency terms down about 30%, a little better in Asia, down 10% and in the Americas we were down about 14%, down a little more in our traditional aftermarket business with an offset from retrofitting emissions that also gets reported through there.

Okay. Thanks, guys.

Thank you, sir. And our next question comes from the line of Andrew Obin with Merrill Lynch. Please go ahead.

Yes. Just a more specific question and I do believe you addressed part of it but just looking at your aftermarket business on the engine side, are you seeing any sort of light at the end of the tunnel in terms of utilization rates improving at the fleets or it's just you're waiting for people to de-stock with existing inventory?

Andrew, it's Bill here and actually we follow a lot of your statistics and we think it's maybe bumping along the bottom but we haven't seen any light at the end of the tunnel yet.

A broader question for you guys. I mean, you are in an enviable position of having strong currency in terms of your equity being fairly healthy, you're generating real cash flow this year and the balance sheet is starting to look very attractive. I would imagine that the valuations in your space have come down quite a bit particularly given your experience over the past five years being very reluctant to make acquisitions because of the evaluations. Are you considering maybe stepping up your pace of acquisitions relative to history yes, it is a one in a lifetime probably economic crisis but probably for a company like yours could present once in a lifetime opportunity to look at something which you might not have opportunity to look under any other conditions.

Andrew, Bill again. I think we don't comment, as you know, prospectively specifically what we are going to do but I point back to we did one just back in October an acquisition with Western Filter when this crisis was starting to unfold so we are not precluding doing more acquisitions and we continue to look for opportunities all the time.

But I guess I want to just think about a little more. Are you changing possibly your view about just being the --because usually I guess you just don't do acquisitions as a percent of your revenue. Historical has been relatively small per year. This current environment change your thinking in way, shape or form or are you just going to stick to your netting.

Andrew, Bill again, I would say our strategy remains the same. We are mostly an organic growth story. Over long periods of time we would say two thirds or maybe a little bit more would be organic growth we'd like to get and then the balance would be acquisitions so maybe 3% of our revenue growth on average per year through acquisitions and that remains our strategy going forward.

Okay. Thank you very much.

Thank you, sir. And our next question comes from the line of Charles Brady with BMO Capital Markets. Please go ahead.

Thanks. Good morning. Respect to the restructuring charge in Q4, how should we look at that as far as allocation in cost of sales and ops expense, the 60/40 you mentioned or not?

Charles, Tom here. Looking at Q4, I mentioned the total number was $11 million, actually it's $11.2 at this point, and that would break down approximately $5.7 million in gross margin and $5.5 million in operating expense.

Okay. Thanks. And getting back to the tax rate, that range, is that -- are you expecting additional potential benefit in the fourth quarter or is that more a function of how the sales may or may not flow across the different business and geographies?

Yes, Charles, Tom here. That's more of a normal rate in the fourth quarter so we aren't predicting any significant one off or discrete items in the fourth quarter.

Okay. And if I could just switch gears to the special applications business and your guidance of it being where it's going to be down in the quarter, is the weakness -- I guess what's the difference in weakness between the hard disk side and the membrane side of the business?

Charlie, Bill here. Well, we only talk about that in aggregate so the 17% to 22% that we talked about for the full year and there's soft conditions on both sides, both the membrane and the disk drive.

Okay. But one is not more outsized than the other, more meaningfully outsized?

Over the course of the year they are pretty close.

Okay. Thanks. I'll hop back into queue.

Thank you. And our next question comes from the line of Brian Drab with William Blair. Please go ahead.

Good morning.

Good morning, Brian.

I was wondering if you could drill down a little bit into the aerospace and defense business so that done well in the quarter but you talked a little bit about moderating growth, I guess, in that business. Do you expect some or do you see some specific programs coming to a close and how should we think about the length of the opportunity in the Blackhawk and MRAP programs?

Brian, Bill here. We haven't given specific guidance for fiscal 2010 so I'll qualify that what I'm going to say next with that. With the change in the administration, some of the spending, there is some uncertainty in terms of what's going to happen there and also in terms of as the -- as we shift our focus from Iraq to Afghanistan, which equipment and which types of equipment. So that's sort of factored into that moderating comment. We have had a great year with our aerospace and defense business and we are basically saying we don't think that same slope is going to continue in fiscal 2010 but we haven't given specific guidance yet.

Okay. Thanks. And you mentioned some OE shutdowns or slowdown -- further slowdowns on the engine product side. Can you give us any color on whether that's going to come more in the off-road side or the transport side or both?

Brian, Bill again. It's in both that we are seeing customers use what might be a typical summer shutdown, lengthening it to try and get a better balance between their production and current inventory levels. So it's on both sides, on and off road.

Okay. Great. Thank you.

Sure.

Thank you, sir. And our next question comes from the line of Adam Brooks with Sidoti & Company. Please go ahead.

Yes, good morning, guys. Can you maybe provide some color on the pricing environment on the industrial and the engine side as far as pushback from customers how much more so is it than in traditional environments, just kind of maybe a little bit of an overview.

Adam, Bill here. I would say it's always pretty intense. I mean, we are over periods of time as we have mentioned in the past, our ASPs go down, not in just -- not adjusted for inflation, just our raw ASPs and that's part of how we use our CapEx and our technology improvements to be able to do that and protect our margins. I think what we have seen, one thing that's changed as Tom mentioned that raw material prices have -- are flat now versus this time a year ago so they came down from where they were earlier in our fiscal year, say last fall and so a lot of that was indexed and is coming down as we start to realize going back to our customers. So, I would say it's abnormal. It's always pretty intense and we are always trying to stay ahead of that by being -- by proactively improving the value that we are offering our customers.

And one quick thing. Specifically on PowerCore, I mean, are you capturing -- I know you don't talk necessary specifically but do you capture similar margins in comparable products say in cellulose filters.

We do, similar margins, yes.

Thank you, that's all.Thank you, that' all.

Thank you, and our next question comes for the line of Richard Eastman with Robert W. Baird. Please go ahead.

Bill could you just talk for a second or two about Europe. I think Rich you gave local currency there sales were down 32%. Did they look much different than that on the engine or the industrial side and is the trend, the downward trend more obvious in either piece of the business at this point?

Rick, Bill here. I said in my comments that the local currency sales were down 32%. I think in terms of the difference in trends between the two, I think we believe that the industrial is going to be sort of a later cycle than the engine in terms of going down and in terms of the specific percents, Rich, it's -- engine was down 36%, Rick, and industrial was down 28%.

Okay, and so the thought is do you think that maybe we are scraping the bottom on the engine side or, again, I think seasonally with that business engine probably weakens from here just into the summer months, right?

Yes. I think what Tom mentioned about the summer shutdowns, that's the one impact that we are going to have to see, Rick, how it unfolds, if customers really take advantage, especially in Europe of this period to slash production, to get a better balance between demand and inventories. I don't know whether we have bottomed out yet or not. I mean, I'd like to say I hope so in the engine business in Europe but we are going to have to wait and see.

Okay. That's fair. And then I just have a question on the margins. If I think about the detrimental margin at the EBIT line and I adjust for currency and the restructuring savings, it surprises me that the detrimental margin was only about 27% in local currency core, the core business and when I look at the -- when I look at the year-over-year decline in core revenue about $140 million and I -- again, it -- it seems to me that the under absorption should have had a much bigger impact and if I roll up to the gross margin line, it's even more surprising. Our gross margin year over year was off 40 basis points on $140 million core decline in revenue and I don't quite -- it just seems to me that it should be a bigger number, I mean good job that it wasn't. But I'm trying to understand why.

Are you happy or not? I --

Well, it's a little hard to model against, I'll say that, but for instance, the gross margin was off 40 -- what, 40 basis points year over year and just the restructuring cost that you absorbed in the cost of sales was 50 basis points year over year. So I don't see the unabsorbed overhead impact here. Is there some reason? I mean, was there any other reason?

Well, Rick, good question and Bill and Rich are pointing at me so I guess --

You can try to figure out my math?

Yes, yes. I could have guessed, though if therein a tough question, it would come from you, Rick.

I mean I can follow-up off-line. It's probably more detail than you want to cover on the call but it just --

I can give you some additional information. Maybe I'll start, Rick, with a bit of a reconciliation from the margin last year in Q3 of 32% to this year of 31.6% at the gross margin line.

Yes.

We calculate, and I think I said in my prepared remarks that absorption, net of the cost take outs that we had, dropped margins by about 3 1/2 points.

Yes. I caught that. Okay.

And then our restructuring actions that are included in margin drop -- in gross margin dropped our margins another half a point. Now, we had some positives on a year-over-year basis.

Yes.

One was the incremental warehouse management expenses last year, which were $3.6 million. That added back about .9 of a point and then we had -- we had a few other things that are hard to quantify but they were real in the quarter. We did have what I'll call generally favorable product mix, some of that was between aftermarket and first fit, some of it was product mix within our business units.

Okay.

We had a couple of favorable pricing or favorable margin orders on the industrial side. I also mentioned that we had some incentive comp reserve reversals due to the drop in our profits for the year.

Okay.

And then I think as you know Rick when commodity prices go up, our pricing lags but it also lags a little bit on the way down, so there was a tiny bit of improvement there in the margin in the third quarter as well.

Okay.

When you add all of that up, along with if you then move to operating expenses, I think I did mention in the quarter, again, year over year total incentive compensation was down by $10 million.

Right.

I think all of that added up with a severance costs net of the cost savings will help you reconcile your numbers.

Okay. All right. Well, that's helpful. The positive add-backs here aren't easy to see but they are obviously there so that's real helpful and then just one additional question. In the press release there was talk about potentially some additional cost actions kind of heading into fiscal 2010 and would the cost of those potential actions be in your guidance, in other words, will there be some added cost or did you capture that in your 21 to 23 for the year?

Rick, it's Bill. First I want to go back to your first question. I think the other thing that I'd like to at least get up on the table is that we started early with our trying to get ahead of this whole recession actually back last summer in terms of managing our costs and I think that's -- that's the other good news in why the gross margin and operating margins were as good as they were despite a 30% drop year over year in the quarter.

Okay.

We are getting the benefit of what we did in the fourth quarter of last year and the first two quarters of this year is flowing through. It's hard to quantify that and, I mean, we talked about how what we had done in our last press release through January, so, this is one of the things that I sort of put in the category of how well I feel we responded to this, that fortunately we got ahead of it as early as we did. So that's the other part with all the pluses and minuses and why with that $140 million sales shortfall, why we have been able to protect both margins. That's what I was alluding to earlier.

Good point. Excellent.

On your question about the guidance for this year, we, as Tom mentioned, in the fourth quarter we are taking a look at the business conditions and we -- and we are -- we see this weakness that we are going to have to deal with. The fourth quarter this year is going to be down roughly the same, about 30% from the fourth quarter last year. So it's going to be so similar roughly to what we saw in the third quarter over third quarter and we are going to have to do -- we were contemplating additional restructuring. That is in the guidance that we provided.

Okay. So we will be taking the cost in the fourth quarter, the benefits then would flow into all 10 depending on what we do?

Right. Exactly.

Okay. I can't imagine that you would want to give us any feel for how you're thinking 2010 may shake out at this point? Is that fair?

That's real fair Rick.

That's what I thought. Thank you anyway.

Thank you, sir. (Operator instructions). Our next question comes from the line of Eli Lustgarten with Longbow Securities.

Good morning.

Good morning, Eli.

You'll be happy to know after the first conference call they connected to me I'm glad I found the right one. (laughter). Very strange connection to the conference. On the background online but very funny.

There's no hint there Eli, was there?

A couple quick questions. Terrific quarter given the environment by the way. Power Jen you're still showing really a minus decline because the currency and what have you but you indicate that volume is falling off. That's a visibility backlog business. Can you (inaudible) what we are looking on the in power Jen in fourth quarter and at this point you probably have idea, you know, the couple quarters after that. Were you looking at a 10% to 20% decline in that business unfolding over the next several quarters?

Eli, Bill here. I think we talked about what's in the fourth quarter -- full year is going to be essentially flat with a little bit of downward due to the stronger dollar and I think just generally we have said that we see a slowdown over the next 12 months but we haven't put any percentages around it. It's still a moving target, Eli and that's probably as specific as we can get. A lot of that was driven by what happened with the credit crisis last fall and then a lot of projects were pulled back and the question is, is whether they get restarted or whether they stay pulled back or not.

Okay. And, speaking of currency, in your guidance, you use much better currencies than I guess the last quarter where I think you use a 136 Euro and a yen number that's far better. Are we seeing some currency benefit in the third -- fourth quarter versus the third quarter or less penalty because of the new numbers that seem to be unfolding because of the weakness in dollars.

Eli, Bill here, we said in our press release we are assuming a Euro at $1.36 and 96 yen to the dollar and we think that's going to be less penalizing in the fourth quarter than it was in the third quarter and that's year-over-year type comparisons.

I guess the original guidance was -- the second quarter you think 129 if I remember for the Euro correct or something like that so there's been an improvement on that. All right I know you don't want to talk about 2010. Can you give us some idea of what is better in the third quarter -- in the fourth quarter than the third quarter? I mean, is there anything improving at all, anything that's not deteriorating at this point?

Eli, Bill again. You're right we don't want to talk about 2010 yet. I think we are just trying to see where generally things bottom out and I think it's going to be something that we are not going to know that it's actually happened until we get a couple of months in the rear view mirror. Okay? There's a lot of as I mentioned earlier with these summer shutdowns, that's a little bit of noise in this whole thing, how much is going to be added to the normal summer shutdowns and we are sort of heading into that right now so our guidance for the fourth quarter is sort of a similar type of sales decrease year over year for the fourth quarter that we saw in the third.

Are you seeing summer shutdowns affecting mostly the fourth quarter or does that spill over, because summer shutdowns means they would be past the July 31 date, wouldn't it?

It could be but right now we are only commenting on the fourth quarter and typically our parts would be ordered in advance of when when they are actually going to need them on their production line.

You're taking most of the hit at this point but at this point is there anything that's showing any up sick or any signs of improvement in any market or anything of that sort? I know we are straws but we are all looking for something.

I think Eli, I talked to my comments about some of the some of the better regional stories that we have and admittedly they are smaller like our business in Brazil or Korea, India. We also think that China is more positive as well with going forward, that effects of their stimulus package are really gaining traction. But I would say the other economies, North America, US or NAFTA and Europe, it's too soon to call anything and we follow a lot of the same public announcements our major like caterpillar and Deere and the last couple of weeks Packar and sort of look for them in terms of what they are seeing and bake that into our guidance and I don't think any of them have called turnarounds yet that I've seen.

All right. Thank you.

Thanks.

Thank you. (Operator instructions). One moment, please. (Operator instructions). I show no further questions in the queue. I'd like to hand the call back over to management for any closing remarks.

Thanks, David and to all those participating and listening I'd like to thank you for your time and interest. To everyone on the Donaldson team, I know it's a very difficult time that we have been going through and unfortunately it isn't completely over yet but we will get through this successfully and we will return to our long-term growth plans. I am very proud of how wonderfully we have responded to this crisis. Because of our collective efforts, I truly believe that the best days for Donaldson remain ahead of us. Thanks for your support and your efforts. Goodbye, all.

Ladies and gentlemen, this concludes the Donaldson third quarter conference call. This conference will be available for replay after 1:00 central standard time today through June 4th at midnight. You may access our replay system at any time by dialing 303-590-3030 or toll free 18004067325 and entering the access code number of 405-8491. We thank you for your participation and you may now disconnect.