Donaldson Company Inc (DCI) 2010 Q2 法說會逐字稿

Ladies and gentlemen, thank you for stand by.

Welcome to the Donaldson, second quarter fiscal year 2010 conference call and web cast.

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) I would now like to turn the conference over to Mr.

Rich Sheffer, Director of Investor Relations.

Please go ahead, sir.

Thank you, Damian, and welcome to Donaldson's fiscal 2010 second quarter conference call and web cast.

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 2010 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 are forward-looking statements.

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 that I identified in our press release and in our SEC filings.

I would like to turn the call over to Tom VerHage.

Tom.

Thanks, Rich.

And good morning everyone.

Yesterday we released our second quarter earnings after the market closed and updated our guidance for the balance of the year.

Sales were down 5% from last year's second quarter.

Which was when the global recession really began to impact us.

Better news, is that our sales were up sequentially for the third quarter in a row as many of our early cycle businesses grew.

Now we expect more of our businesses to return to growth in the second half of the year.

Bill will discuss this further in a few minutes.

We are continuing to execute our previously announced restructuring plans.

And incurred a $5.1 million pretax cost or $0.05 a share in the quarter compared to $4.3 million or $0.04 per share in last year's second quarter.

This breaking down the second-quarter charges further, we charged $3.4 million to cost of sales versus $2.4 million last year.

And charged $1.7 million to operating expenses versus $1.9 million last year.

Price segment $500,000 was incurred in our engine segment and $4.6 million was in our industrial segment.

In last year's Q2 we had $2.3 million in our engine segment and $2 million in our industrial segment.

Since we began these restructuring efforts in January 2009, we have incurred pretax restructuring costs totaling $24.2 million or $0.21 cents per share.

We estimate that our restructuring efforts have generated approximately $100 million in annualized cost savings.

We are continuing to work our plans and anticipated incurring an additional $6 million to $11 million of restructuring costs this fiscal year.

Including the restructuring charges we have taken and expect to incur in the balance over the balance of fiscal 2010, we are now expecting our full-year operating margin to be between 11.4% and 12%.

Our gross margin was 33.5% in the quarter.

A year-over-year increase of 440 basis points.

We had a benefit of 160 basis points due to a more favorable product mix.

Including more higher margin after market sales in the second quarter.

In fact, we had our second consecutive quarter in which after market sales were over 50% of our sales mix.

The absorption of our fixed manufacturing costs was better than last year's absorption levels.

And then combined with savings from completed restructuring activities, and our other continuous improvement efforts, we improved gross margin by nearly 300 basis points in the quarter.

Our material input costs started to decline during the second half of fiscal `09.

But this decline has now started to reverse direction and we are experiencing some commodity cost increases.

We are containing the impact of these increases through our continuous improvement programs and we will respond quickly should raw material costs continue to increase.

Operating expenses were up slightly over last year's second quarter.

Our stock option expense was up $2.2 million.

As you may recall, the majority of our annual stock option expenses incurred in our second quarter, each year due to the timing of our annual option grants.

Warranty expense was $3.2 million higher in the quarter as we became aware of a few specific warranty issues that required us to increase our accruals.

Excluding incremental stock option and warranty expenses, operating expenses were down 4% from the prior year.

Our effective tax rate was 17.5% in the second quarter versus a tax benefit of 31.5% last year.

We had discreet tax benefits of $4.1 million this quarter.

Which included the expiration of the statute of limitations at a foreign subsidiary and some other miscellaneous items.

Last year's second quarter included tax benefits of $15 million.

Primarily from several long standing multi-year tax audits important cases that concluded favorably.

Based on our projected mix of global earnings, we expect our tax rate to be between 26% and 28% this year/ As our geographic mix of profits appears to be more favorable than we originally forecasted.

A second quarter CapEx came in at $10.4 million.

We are moving forward with strategic projects such as tooling for new product platforms, our new European technical center in Belgium and our facility expansion in India that was completed this quarter.

Our full-year CapEx guidance for fiscal 2010 is between $35 million and $45 million and we expect depreciation and amortization to be in the range of $58 million to $62 million.

Precash flow was $5 million this quarter versus $30 million last year.

Working capital used $13.4 million to support our sequential sales growth as our business continues to recover.

Also we made a $10 million discretionary contribution to our US pension plans.

We expect precash flow to be between $145 million and $165 million for the year.

At the end of the quarter, our debt to cap ratio was 27.6%.

Debt to EBITDA was 1.2%.

Both of these improved from previous quarter and our are well within the financial covenants in our various debt agreements.

We are now expecting interest expense in fiscal 2010 to be between $11million and $13 million.

Our balance sheet remains strong with over $180 million in cash now available.

So with that I'll pass it over to Bill, who will provide some more background on our business conditions and our updated outlook for fiscal 2010.

Bill?

Thanks, Tom.

And good morning everyone.

Well one year ago today, February 25, 2009, we held another earnings call.

And at that time we discussed the on set of the global recession and our plans to deal with it.

While the past year wasn't anything like we asked for, I am very proud at how well we've responded.

At that time we said that when the recession end we would emerge with a stronger and better deployed global organization and balance sheet.

And we have.

The benefits of our many initiatives are now apparent as our operating margin percent increased year-over-year for two consecutive quarters.

And despite a 5% sales decrease, our operating income dollars increased 40% over last year.

So we are now very well positioned to return to both top and bottom-line year-over-year growth and reflected this in both increased earnings guidance and dividend increase we announced last night.

When reviewing the early-cycle businesses return to year-over-year local currency growth.

These include our engine after market business, on-road and our special application business.

I'll cover each one of these in a little detail.

So, starting with our after market business, we saw that grow 15% in local currency globally during the quarter.

Why?

Well, a couple of reasons.

You know, first, we believe we've seen the end of the inventory destocking by our customers that started about this time a year ago.

Second, as you may recall, couple of years ago we made very significant investments in distribution center capabilities around the world.

We added or expanded our facilities in the US, Mexico, Europe, and South Africa and we believe by having the product where our customers need it we're picking up share.

Third, we've increased the number of distributors who carry our product globally and again, we believe we're picking up share for doing this.

And then finally, we think our after market business is benefiting from the increasing percentage of equipment in the field, both on and off-road, that uses our proprietary fillation systems like power core.

I'll switch and talk a little bit about our on-road products business, which was up 11% local currency during the quarter.

Most of this growth came from Asia as our Japanese OEM customers have seen an increase in orders for export.

And now switching to our disk drive business, which is within our special applications group.

Our disk drive filter business saw a sales growth of almost 50% in the quarter.

As the server and PC market -- markets continue to strengthen for our hard disk drive customers.

We've also seen some strong regional recoveries within our businesses as in China, Korea, Singapore, Thailand, and Brazil, each of those posted double-digit percent local currency increases in the second quarter versus the prior year.

So, that's some of the highlights on our early cycle businesses or markets.

Now, talking a little bit about our mid-cycle businesses, we believe that most of these are now stabilizing and we will project that they will begin growing again in the second half of our fiscal year.

We're expecting year-over-year growth in our off-road products in the second half.

Due primarily to stronger activity in the construction and mining end markets.

Within special applications, in addition to disk drive continuing to have a strong business level, we're seeing our membrane business is forecasted to have a strong second half.

And now I'll switch gears again and talk about our later cycle businesses, our industrial filtration solutions or IFS business, sales were down about 20% from local currency during the quarter.

Within IFS, we did see sales of replacement filters do well as manufacturing activity has increased, which results in more equipment maintenance.

But new equipment sales remained slow as major capital investments continue to be postponed.

We believe that as the manufacturing sector continues to recover, we expect conditions for new equipment sales to gradually improve.

And finally our gas turbine business, which we believe is our latest cycle business.

During the quarter, their sales were down 49% to local currency.

However, we believe that this business is now approaching its bottom.

And we expect that gas turbine sales in the second half will be up sequentially from our first half and that the year-over-year comparisons will be significantly less negative.

So looking at our sales level overall and our outlook, we expect our full-year sales to be approximately $1.8 billion.

This is unchanged from three months ago as we see our improving local currency sales being offset by the recent strengthening of the US dollar.

If we break this $1.8 billion full-year forecast down further, we are expecting sales of approximately $936 million in the second half.

This is approximately 12% higher year-over-year than the $835 million in last year's second half.

And it's 8% higher than the $864 million we just did in the first half.

Looking at it by segment, our engine business second half sales are forecast to be up between 17% and 23% from the $451 million we did in last year's second half.

And our industrial sales are forecast to be up between 2% and 10% from last year's second-half sales of $384 million.

Coupled with our overall higher second half sales, we are expecting our full year operating margin to be between 11.4% and 12%.

And as noted before, this includes all the restructuring charges Tom mentioned earlier.

Year-to-date we are at 10.6%.

Wo we are expecting sequential improvement in our second half.

And a significant improvement from the 8.7% we did in last year's second half.

Qe still have available manufacturing capacity, which will allow us to handle this forecasted increase volume in our plants without having to add back significant fixed costs or investments.

Combined with our ongoing continuous improvement programs, these will create the operating leverage necessary to achieve our operating margin targets.

Now I'm give you a little bit of update on our new technology platforms.

Throughout the recession we have continue with new product introductions, building on the incredible success of our first-generation power core.

We released power core generation two or G2, as we call it.

G2 allows us to further reduce the system size and enhanced performance for our customers versus anything on our the market.

We have already won 23 platforms, ten on road, 13 off-road with G2 and we have another 15 programs in the proposal stage.

G2 is now in preproduction and already running in our customer's trucks in the US and Japan.

And we expect full production will begin in the next few months.

On the industrial decide of our business, we introduced power core technology in our Torit dust collectors.

These systems are 50% smaller and much easier to maintain than legacy products they replace.

Despite the recession, demand for these has taken off and we have already received orders for almost 500 torit power core systems.

We believe that the majority of these orders represent incremental business for us.

We've also continue to make progress with international expansion plans to support our customers in the rapidly-growing developing economies.

One example is in India.

In December, I was in India for the grand opening of major plant expansion in Gurgaon which is southwest of Delhi.

This plant supports our customer in the rapidly-growing Indian on and off road markets as well as gas turbine market.

Last year, we also broke ground on a new technical center in Belgium.

Tto support our European based OEM customers.

This tech center will be completed in the next few months.

Rhese represent a few of our technology and capital investments to support our growth and customer service plans for the future.

Now, to briefly summarize my comments on our outlook, We believe we've seen most of our early cycle businesses return to year-over-year growth.

We believe we've seen that many of our mid-cycle business have now stabilized and expect many of them to begin growing in the second half of our fiscal year, which is the period February through July.

And we've seen the rates of decline in our late-cycle businesses moderate.

So in conclusion, I want to say I'm very proud of how well we've managed our company through the challenging past 12 months.

And I'm very happy at how well our company is now positioned for top-and-bottom-line growth over the next year.

Danny, and that concludes our prepared remarks.

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

Thank you, Mr.

Cook.

We will now begin the question and answer session.

(Operator Instructions) Our first question come from the line of Lawrence Alexander with Jefferies & Company.

Please go ahead.

Hi, this is Amanda Siglin, in for Lawrence.

I guess first question, holding the $1.8 billion sales outlook for the year does imply some stronger local currency growth.

Just wondering if you could flesh out a little bit which regions and segments you now expect to be a little bit stronger for the second half of the year.

Amanda, this is Rich.

As we look at the second half of the year, we're continuing to see growth coming from our after market businesses.

As Bill mentioned, we've increased the number of distributors carrying our products, picked up some shares.

So, you know, we're expecting to see that pretty much globally.

Another area of year-over-year strength for us will be disk drive.

Recently -- in fact, earlier this week the estimates for disk drive builds for 2010 as published by Trend Focus was increased.

Now the range is up to 650 million to 675 million drives.

Previously it was in the low 600 million and compared to last year it was in the mid 500 million range.

So those are couple of areas that we expect to see some year-over-year growth in the second half.

Amanda, this is Bill.

Just to add onto what Rich was saying, you know, in addition, some of the mid-and-later-cycle businesses that I discussed are either stabilizing or they're going to be going down at a slower rate.

So that whole stabilization's going to help us in the second half in conjunction with the businesses that Rich mentioned that are going to be growing.

Okay.

And just one follow up, if I can -- regarding the after market business, it sound like the real benefit so far has been a lack of destocking rather than seeing restocking which it sounds like you expect in the second half of the year fiscal year.

Just wondering if you could flesh out a little bit how you expect that to play out out and how many quarters that could be a tail wind?

Amanda, Bill here again.

You know, the lack of the destocking is one of the positive impacts in our quarter and in the first half.

I think through the first half of our year there's still been some of that, and maybe there's a little bit more to go, but it's not like the second half of last year.

So that's helping.

But I think the more positive story for us for the future is really around the market share gains that I believe we're winning.

You know, as I mentioned in terms of the using the new capabilities we have in the distribution centers, the investments we made a couple years ago, and the aggressively expanded distribution that we have globally to carry our products.

Great.

Thank you.

Those are both share gains.

Thank you.

Our next question comes from the line of Hamzah Mazari of Credit Suisse.

Please go ahead.

Pardon me, Hamzah Mazari, your line is open.

Good Morning.

Can you hear me okay?

I can.

Good morning.

Just a question on your restructuring.

You know, you mentioned the annualized cost savings, you know, how should we think about restructuring going forward?

You know, is this an ongoing process?

What additional savings are you expecting?

You know, are there any costs that are going to come back based on the analyzed savings number you gave?

You know, how should investors be looking at that process?

Good morning, Hamzah.

This is Tom.

So I mentioned in my prepared remarks, that based on the restructuring that we have done that, that will represent and is representing approximately $100 million of annualized savings.

I think we said in the past that we think of that $100 million, 60% is variable.

And the remaining 40% is, you know, somewhat variable, just depending on when and how quickly volumes come back.

With respect to the initial charges that we plan to take this year, we aren't going to comment, you know, specifically on what that relates to but post those charges, we have no other plans to take additional restructuring costs.

So based on business activity that we see today, we think once we get beyond the charges that we talked about, we don't really see any additional charges.

Okay.

Thank you.

And then just one more question -- you know, how should we think about normalized after market or replacement filter business as part of your mix?

You know, when the first fit side does come back and the OEM cycle does come back.

You know, what should after market percent on that and then longer term, you know, could you give us an update on how much of your business right now, install based is power core and how you see that growing over the next, you know, five years?

Hamzah, this is Bill.

I'll start with the answer to the first question.

As we mentioned, over the second quarter in a row, over 50% of our sales are replacement parts.

Which is our long-term goal, to get it to 50% and closer to 60%.

You're right.

Part of the reason why we probably got to 50% in the first and second quarter is because the first fit business is down while the after market's in earlier-cycle recovery.

But we also think with the share gains that I mentioned a minute ago that we're accelerating that movement from say where we were in the mid 40's the last couple of years closer to the 50%.

So it's a little bit of an anomaly we reached 50% so quickly.

But we're taking share and think we will reach the 50% even when the first fit business recovers on an on-going basis and then our next goal our next goal will be 60%.

Okay.

Thank you very much.

going to talk about the power core.

right.

Hamzah, this is rich.

You know, to-date power core represents around 7% of our engine OEM so that would be both the on road and off road sales and our after market sales.

So the combination of those.

Over the next couple of years, we sweet that moving to 10% by 2012.

And as the years click by, we should continue to see that grow.

Maybe even at a faster pace, as some of the older equipment with our nonproprietary systems get retired and replaced with power core.

Either currently -- current generations or our next generations after what we're already making.

Okay.

Great.

Thanks a lot.

thank you.

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

Please go ahead.

Good morning.

First question just on the operating margins -- and the mix of aftermark to first fit equipment -- so it looks like you're expecting significantly improved margin in the back half of the year, and I wouldn't think that -- and here's my question -- do you think the after market mix in the back half of the year is going to be as favorable as the first half of the year?

And if not, you know, what really is driving the margin improvement and is that type of margin that you're expecting the back half of the year sustainable?

Brian, this is Tom .

We do think the after market mix will hold in the second half of the year.

But as Bill pointed out, it will be partially dependent on how quickly the OE business comes back.

If I look at just year-over-year margin improvement, which was pretty significant from the 29.1% last year to the 33.5% this year, 1.6% of that we believe was related to mix with a large portion of that this after market issue.

And we see that favorability continuing for the second half of the

Okay.

Thanks.

And just one more question.

You know, it looks like you're continuing to gain traction with G2.

23 platforms now.

Could you talk about the bigger picture, for a second, in terms of the platform wind and updates us on, you know, how many platforms have been announced related to the, you know, new regulations and on-road and off road and how many won and give us a feel for the bigger picture?

Hey, Brian.

This is Rich.

You know, we've talked about the big seven OE's, global OEs, in that we define as CAD Fear CNH on the off roadside and then Padgar, Volvo, Daimler and ITech on the on-roadside.

In total so far, they have awarded 71 programs and we have won 66 of those with our proprietary systems.

In total, we believe that they're going to award approximately in the mid-90's when it's all said and done through 2012.

So obviously our win rate, so far, is over 90%.

We see no reason why that shouldn't continue, given the advantage power core gives to our major customers.

And our win rates with the rest of the OE's, some smaller global OE's or regional OE's is about the same.

It's still around 90%.

Okay.

And if I could ask one more follow-up, 66 platform wins, 23 of those -- is this how I should think about it?

23 of those is with G2?

I don't know if all of the G2 are with the big seven.

There might be so other regional players.

Okay.

Okay.

That would include that, though.

Okay and if it's not G2 then it's most likely what next?

Is it G1?

G1 or another proprietary technology, Brian.

Okay.

Thank you.

Thank you.

Our next question come from the line of Derek Rose with Longbow Research.

Please go ahead.

Hi, guys.

Can you clarify on the tax rate where the change in geographic mix is coming from?

If not, you know, directly maybe on a relative basis to last year?

Yes, Derek.

Tom here.

The change would primarily be Asia.

There's lower tax rates in Asia than we have -- this excludes Japan -- so the highest tax country that we operate in is Japan.

United States is running a close second.

And then other countries in Asia have much lower rates.

Okay, and is there any more clarification like in terms of, you know, where in Asia, you know, we should be -- we should be thinking about going forward?

Rhose lower tax rates are going to be, I guess, the growth in business?

You know, the two countries in Asia that stand out from a lower tax rate standpoint would be China and Thailand.

We hope to grow our business more rapidly in China than in many other countries.

So we -- our hope is that trend will continue.

Okay.

Thanks guys.

Derek, this is Bill.

Just to add on to that, as I mention in my comments, those were two of our fastest-growing regions in the quarter, China and Thailand with both had double-digit local currency sales increases year-over-year.

That's part of why we're seeing this mix, is that they're recovering faster than the other economies.

Okay.

Thanks guys.

thank you.

our next question come from the line of Josh Pokerwinski with KeyBanc Capital Markets.

Good morning, guys.

Good morning, Josh.

Just to kind of follow up on Brian's question earlier -- if you look, you know, at first quarter to second quarter sequentially, kind of backing out some of these one-time items or restructuring stock option expense and the warranty adjustment, it looks like most of your businesses were up profit, flat to down a little bit, not a lot of incremental flow through.

Presumably, you're getting, you know, more restructuring quarter to quarter.

You know, what gives you the confidence that the incrementals are better in the second half?

Josh, this is Tom.

Just a couple of high level comments, you know, you'll recall that in our second quarter we have a lot of holidays.

So we have plant shutdowns, our customers are shut down.

And that gives us a little bit more relative unabsorbed overhead.

Then also if you think back to our seasonality as we've demonstrated in prior years, our second half of the year will generally have higher margins than the first half.

Higher volumes going through our plants, makes a difference.

And then you did mention the one offs but, you know, just to point them out going from Q1 to Q2, stock option expense was actually $4.7 million higher.

Now, that's in SG&A.

Warranty expense was nearly $3 million higher going from Q1 to Q2 and the restructuring costs going from Q1 to Q2 were $3.8 million higher.

So those three run -- one offs total up to $11 million to $12 million.

And, you know, you can -- if you're extrapolating this forward, the stock option charge goes back to a very normal charge of $400,000 to $500,000 per quarter.

We don't expect the warranty claims to continue.

And then you have our estimate on the restructuring charges.

So, I think that will help you out looking at this sequentially.

Okay.

Yes, I just meant the flat comment kind of excluding that $8 million of warranty and stock options but now I understand.

And then I guess, just the, you know, shifting gears, you know, kind of a longer term focus incrementals over the last cycle, you know, bounced around a little bit but generally in the teens.

In the context of this $100 million, it sound like, you know, at least $60 million comes back at some point.

You know, what should we think about as a good proxy for incrementals over the next, you know, call it year or two entering the recovery?

Yes, Josh, that is clearly a tough one to pin down.

But as we have done some analysis on this and I think we mentioned in the past, we think the incremental margin, incremental profit margin for up to, say, the first 10% of our sales volume increase, that margin could be about 30%.

Beyond that, it will depend a little bit on what products are taking off and where in the world.

But there will be a sliding scale, of course, down from that 30% down to something in the teens.

Yes.

So kind of back to normal after that first bar?

Well, it'll depend on product mix.

We talked about our after market focus.

So after we get back to normal volumes, we would hope that some of our productivity improvement programs, process improvement programs, and this after market mix will help us target a higher operating income percent level than we have had in the past.

Got you.

No, that's good color.

Thanks a lot guys.

Thank you.

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

Please go ahead.

Thank you.

Good morning.

This is actually Tom Brinkmann standing in for Charlie Brady.

Juat a couple of questions.

First of all, you mentioned that build rates were heavy and medium duty trucks should improve incrementally.

Would you quantify that for us?

What kind of build rates are you assuming in North America and in Europe?

Yeah, Tom, we're just -- we have a couple different sheet here's.

We're taking a look at both what ACT talks about and what some of our major customers are talking about.

And what we've seem is a range that's really pretty wide from 110 to 145 or 150 for calendar 2010.

And we think that -- so, and that's up over the year we just concluded.

We think that most of the impact of that will -- is not -- we're not going to see for a couple of months.

It will start the help our fourth quarter, which is a period made through July and then first half of fiscal 2011.

Tom, this is Rich.

In Europe, you know, last year, 2009, build rates were down 60%.

They're expected to rebound maybe about 15% this year.

So that would be the other half of that improvement that we're expecting.

Okay.

And then I guess -- if you guys could talk about the tax rate you expect in the second half of the year, do you expect the third quarter to be significantly different from the fourth quarter, I guess in terms of trends?

I know you gave us the overall fiscal year guidance.

Yes, Tom.

This is Tom VerHage.

So we gave you the annual guidance of 26% to 28%.

Just I think the rate you ought to be thinking about as we look at the global mix of earnings that I discussed before, that normal rate is right now at 30%.

Last couple of years, it's fluctuated a little bit between, say, 30% and almost up to 32%.

But where we are right now is at 30%.

The unknown that comes up from time to time are these discreet items I referred to earlier.

And we just can't predict when they will come in or whether they will be favorable or unfavorable.

Okay.

That's all I had.

Thank you.

Thank you.

Our next question come from the line of Brian Sponheimer with Gabelli & Company.

Please go ahead.

Hi.

Good morning, Bill, Tom, and Rich.

I wanted to dig in a little bit more on the on-road truck side.

Obviously there's still excess capacity out there that is going to be to need utilized to which should help your after market business.

I'm wondering,how much slack you see before see any meaningful up tick and first fit sales in on road truck?

Brian, this is Bill.

You know, as I mentioned a minute ago, we don't -- we see it sort of stable right now, I'm talking about starting with the North American market that is not getting any worse.

we just had the latest round of emission regulations that went into effect last month and so if there was a prebuy, that happened last year so I think we just see the market sort of stable right now.

But the full-year forecast we are seeing both from ACT and some of our major customers, suggests there's going to be some improvement calendar 2010 over calendar 2009.

It's a pretty wide range.

So it could be, you know, a couple of percent to maybe, you know, 30% or something like that.

So I think there's a lot of uncertainty.

But I think our assumption is whatever improvement that we're going to see in build rates is going to happen a couple -- starting at least a couple months out.

So again, probably effecting at the earliest our fourth quarter of this year.

So it's stable, which is good news, because, you know, this time a year ago we weren't sure where it was going.

And it's projected by both customers and independent folks to start increase during this calendar year.

Okay.

And if we move along to the gas turbine business, with certainly discoveries in the east coast making some headlines.

Can you give us a sense on what Donaldson content would be per, I guess, per discovery site once those sites start getting developed and what we can maybe look for in `11 '12, as far as incremental revenues for North American discoveries?

I think what Brian -- Bill again.

You know, we see with our gas turbine business, this is going to be -- this year is going to be down fiscal 2010 versus `09.

Our gas turbine business was one of our heros last year but, you know, what happened is the recession started to develop is that the requirements for global electricity went down.

So, you know, plants weren't running so the requirement went down and what happened, the consequence of that, is that a lot of major power projects using gas turbines were deferred or canceled and so, you know, we continue to shift through fiscal `09.

You know, we still have some projects because there are still some turbines going out.

But it's really going to be dependent, the market for us is more about electricity requirements increasing again, which will create more need for power generation.

Now, within that, as you pointed out, the recent discoveries of gas, you know, whether it's through the new technologies to the crack it out of existing reservoirs in this country or, you know, offshore.

Having increased the availability of natural gas, especially in North America, so our -- we're very bullish long-term on gas turbine increasing as a share of power generation, say, versus cold, so that the prospects are very good but it has to start with an increase in electricity requirements so that these projects come back online.

Okay.

Thank you very much.

Thank you.

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

Baird.

Please go ahead.

Hi.

Just a couple of questions.

Good morning.

Good morning Rick.

Bill, do we have within that stable of power core wind -- are there international wind in there -- tucked in there?

I know some of the big stuff international companies.

But I'm curious if there's any international platforms that we've won or if we have a product, you know, prepared for that market?

Rick, Bill.

Yes, we're selling power core both in Japan and Europe to our OEM's there and you're right a lot of these are global OEM's so they have different subsidiaries around the world and we're pitching it to all of them.

We actually have -- also have power core capability in Europe so we're, you know, we can produce it there already now.

Okay.

And as we restructured over the last 12 months, have we taken out, you know, some of the maybe legacy technology capacity?

You know, as we move forward, is most of our bidding activity on these new platforms, you know, going to gravitate towards the power core technology?

Is it going to displace some of the older capacity?

Rick, Bill again.

Yes.

Exactly.

So on every new platform, and whether it's on the engine side of our business or we're trying to do this in our other business as well.

We're trying to pitch more proprietary technologies and power core is the one headline example.

And we're doing that for a couple of reasons.

One is o prove value on a first fit basis.

You know, make a smaller system, which is important whether it's a dust collector or on a truck or on a excavator.

But the other is, is that our customers are also very interest in retaining their parts business and that's what technologies like power core do.

It is a focus, on all front,s to offer wherever we can a proprietary technology solution to protect --- increase the value, protect the after market.

Wow, having said that, you know, there's, you know, millions of pieces of equipment out there that were launched, you know 30, 40 years ago with older technologies and we have to, of course, support those.

So some of our older technologies that we've talked with you about like radio seal, there's still a need to continue to make those parts and we do.

But most of the new investment is in the proprietary technology like power core.

Understood.

Okay.

And the -- the other question I have on the after market side of the business, obviously, you know, good growth rate, we're seeing some recovery in the markets and the destocking, your references -- I'm curious, your references to market share, are they more specific to the international markets where you have seem to make really good progress?

Rick, it's Bill again.

I think it's everywhere.

I mean, you know, you remember that we had the expansion of our main distribution center here a couple years ago.

That initially didn't go as smoothly as we had planned, but we've gotten that all behind us and that's really humming along and I think we're -- from a service level perspective, that's really helping us.

That's now a competitive advantage and is helping us win business in this country as well.

Certainly internationally as we add distribution or leverage the investments in distribution centers that we've made, that's helping as well.

But it's both a US and an international story.

Understand.

Okay.

And then just one clarification -- on the aerospace business, I think the reference in the press release you're just talking about that business being slightly lower in the second half.

Is that reference second half versus first half or is it reference year-over-year?

Rick, Bill.

It's year-over-year.

It is.

okay.

Remember, that was -- you may recall that was one of our heros last year.

Very strong business despite the recession and what we're seeing here is really a change in the types of products our customers are using as we change our focus from Iraq to Afghanistan.

And it's a different type of vehicle and for us, it's less filter content on average than what we had with the equipment being used in Iraq.

And is -- and that's -- that category is mostly first fit?

It's first-fit and replacement parts.

It's both.

Okay.

Because it seems like that business running out, I don't know, call it a $28 million, $29 million quarterly rate and is that -- again, the growth dynamics in that business are really going to be just, you know, general spend on first fit.

The replacement cycle is probably going to be just that, like a GDP type of growth?

Well we're -- that's part of it.

We're also introducing more proprietary technologies there as well.

So some of the new -- we talked about the Amraqvehicles that were used in Iraq, which had a lot of filter content because of the conditions.

Smaller vehicles typically being used in Afghanistan.

MATV.

We have filters there but we're also pitching proprietary systems like power core for the military applications, again, to try and protect that after market.

So, I think it's going to be around the changes in government spending but the adder will be around what the things we can do to increase our after market retention.

I see.

Okay.

Great.

Thank you.

Sure, thanks.

(Operator Instructions) Our next question comes from the line of Adam Brooks with Sidoti & Company.

Please go ahead.

Yes, real quick.

I guess a few quick questions on China.

I guess what percentage of sales is at this point?

And, I guess, what, kind of the competition looking like over there?

Adam, this is Bill.

China right now represents about 7% of our overall sales.

And the competition there -- it's good or fierce like it is everywhere else in the world.

I think what we're seeing is many of our global competitors are trying to do like we have done and enter China.

We're also seeing sort of a rise in the level of the Chinese competitors because what's happening the Chinese customers, whether they're global OEM's go in or local Chinese companies, are really now looking for the China market for the increasing in the level of technology and performance.

So this fits the Donaldson model.

Is that more Chinese customers, both current and potential, want better technology.

But it's also making our competitors become better as well.

So I -- sorry.

Go ahead.

Sorry, go ahead, Adam.

I was going to say, as far as what's the breakdown, I guess then, versus local OEM versus the international OEM's at this point?

Adam, I don't think we have broken it down at that level of detail.

It's still, you know, 7% of our sales.

Right.

We're still pretty small.

over time we will talk more about China because we do see it and talked about it before as one of our strategic growth focuses over the next couple of years and put a lot of investment in China over the past ten years with the manufacturing facilities we have on our WUSHI campus and continue will develop that campus for the Chinese market.

All right.

Thank you.

Thanks.

Mr.

Cook, I show there are no further questions at this time.

Please continue with any closing remarks.

Okay, thank you.

Thanks, Damian.

To everyone on the Donaldson team, your efforts are make it possible to very successfully navigate one of the worst economic storms in 70 years and emerge an even stronger company.

As the global economy continues to improve, we will continue to focus on providing the best possible product and service to our customers wherever they need us.

Sincere thanks for your efforts.

Finally, to all of you participating and listening, this is Bill Cook, and I want to thank you for your time and interest in our company.

Good-bye.

Ladies and gentlemen, if you would like to listen to a replay of today's conference, dial 800-406-7325 or 1-303-590-3030 and enter in the access code 4204892 follow by the pound key.

The replay will be available until March 4, 2010.

This concludes the Donaldson fiscal year 2010 conference call and web cast.

ACT would like to thank you for your participation.

You may now disconnect.