Donaldson Company Inc (DCI) 2011 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by.

Welcome to Donaldson's third-quarter fiscal year 2011 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 Friday, May 20, 2011.

At this time, I would like to turn the conference over to Mr.

Rich Sheffer, Assistant Treasurer and Director of Investor Relations.

Please go ahead sir.

Thank you and welcome to Donaldson's fiscal 2011 third-quarter conference call and webcast.

Following this brief introduction, Bill Cook, our Chairman, President and CEO; Tom VerHage, our Vice President and CFO; and Jim Shaw, our Corporate Controller will review our record third-quarter earnings and our updated outlook for the balance of fiscal 2011.

Next, 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 would like to turn the call over to Bill Cook.

Bill?

Thanks, Rich, and good morning, everyone.

As Rich mentioned, we issued our third-quarter earnings release earlier this morning and we're obviously very pleased to report that we had another record sales and earnings quarter.

Clearly we are in a much different position than we were two years ago at this time because not only did we lead our Company through the recession, but as you can see in our operating performance numbers, we have come out of it much stronger than when we went in.

And given all the positive momentum we have with our incoming order levels and operating performance, we are confident that we will deliver full-year sales and earnings records.

We're also now very well positioned to execute our strategic growth plan with our goals of growing our business into a $3 billion and then a $5 billion filter company over our planning horizon.

Next I'd like to cover a few highlights from the quarter.

Our sales were a third-quarter record of $595 million, up 19% year over year with foreign currency translation accounting for 3% of this increase.

So excluding foreign currency exchange impact, sales were up 16%.

The combination of our strong sales growth and a 14% operating margin delivered a net income increase of 25% and an EPS record of $0.79.

Now, I'd like to briefly review each of our two reporting segments.

So starting first with our Engine Products, local currency sales increased 22% over last year.

Within engine, our aftermarket or replacement filter sales were up 19% as the utilization rates of existing truck and off-road equipment fleets have continued to increase.

We have also continued to add more distribution everywhere in the world, but especially in emerging markets we're targeting.

We've also continued to expand our product offering and we've continued to leverage our new proprietary first fit products.

Consequently we believe that a portion of our sales increase is beyond just the impact of the economic recovery and actually reflects significant marketshare gains.

Our two OEM or first fit businesses were also up strongly in local currency terms.

And our off-road products business which was up 36% due to the strength in the construction, mining and ag markets and the increased demand for our customers' new equipment upon which our filtration systems are installed.

Our On-Road Product sales were up 44% as both North American and European heavy truck build rates continue rebounding.

Now switching to our other reporting segment, industrial products, local currency sales increased 7%.

In industrial products, the revenues in our Industrial Filtration Solutions business increased 15% as the sales of new dust collection equipment continued to grow in the quarter and the sales of replacement filters for the dust collection already in the field remained very strong.

Our Gas Turbine sales were consistent with last year as the increased demand for the system used in the oil and gas industry continued to offset the later cycle rebound in the large systems used in electrical power generation.

And finally, sales of our special application products were down 4% as the rapidly growing sales in our newer product lines serving the semiconductor, imaging and venting end-markets were offset by now slower disk drive filter sales.

One other thing I wanted to comment on is that since the March 11 earthquake and tsunami in Japan, we've had a number of questions relating to how it impacted us.

As you may know, we've had a wonderful operation in Japan for over 47 years and we were very thankful that none of our 264 employees or their families were impacted.

In addition, our plant and offices were not damaged.

In fact our plant in Gunma was back up and running two shifts the day after the earthquake.

So fortunately, the impact of this tragedy was not material to our overall third-quarter results.

Now I'm going to turn the call over to Tom for a few comments on our operations before I discuss our updated sales outlook.

Tom?

Thanks, Bill, and good morning, everyone.

Our gross margin was 35.2% in the quarter which was a year-over-year decrease of 40 basis points from 35.6% last year.

As we mentioned last quarter, we have begun to experience higher purchased material costs which decreased gross margin net of selected price increases by 90 basis points compared to last year.

The magnitude of the cost increases was in line with our previous guidance.

Much of the increase experienced in the quarter was related to the expiration of our steel contracts in the US and increases in petrochemical-based raw materials such as plastics, urethanes and adhesives.

And we expect additional increases for these materials as well.

Fortunately, we have been able to offset most of the impact of these increases through our continuous improvement initiatives, but the magnitude of these increases have also required us to implement some selected price increases as well.

Another reduction to our gross margin was due in part to our increasing OEE versus aftermarket mix which had a 40 basis point impact.

The fact that we are now seeing a very strong recovery at many of our OEM customers is obviously very good news.

However there is a mixed impact on our margin percent.

Helping to partially offset these gross margin detractors were a number of factors including better absorption of fixed costs due to the higher volumes in our plants and distribution centers, our ongoing continuous improvement initiatives and then finally last year's gross margin was reduced due to $3.7 million of restructuring charges.

Our operating expenses remain well under control, coming in at 21.2% of sales which is even with last year.

This includes our planned strategic operating investments for growth in Asia, Europe and Latin America for liquid filtration technology and product development, and also our global supply chain project.

These investments totaled $4 million this quarter and $9 million year to date.

We expect that our full-year FY 11 strategic operating investments will total approximately $13 million.

Our operating margin came in at 14% this quarter.

In looking at our operating margin forecast for fiscal 2011, we expect the increase in our purchased raw material costs and a less favorable sales mix to have a negative impact on our gross margin percent in the fourth quarter as compared to last year.

In total, we expect our operating margin for the year to be between 13.4% and 13.8% which means that our fourth-quarter operating margin is forecasted to be comparable to the 14% we achieved in the third quarter.

And now I'll turn it over to Jim Shaw who will cover tax and treasury related matters for the quarter.

Jim?

Thanks Tom, our effective tax rate was 24.5% in the quarter versus 29.4%.

During this year's third quarter, we had $3.5 million of tax benefits primarily from the expiration of statutes of limitations in a couple of jurisdictions and the favorable conclusion of two international tax audits.

Based on our projected global mix of earnings and this quarter's tax benefit, we have lowered the annual guidance range for our effective tax rate by 1%.

So we now expect our tax rate to be between 27 and 29% for the full year.

Our second-quarter CapEx came in at $18 million.

We completed an expansion of our engine air filter plant in China during the quarter to meet our rapidly growing demand.

We also announced the groundbreaking for a new air filter plant in Aguascalientes, Mexico during the quarter which will add more filter manufacturing capacity for the fast-growing Latin America region and allow us to use our existing plant in Aguascalientes strictly for an expansion of our liquid filter production.

We expect a majority of this capital investment to occur in the first half of fiscal 2012.

Our updated fiscal 2011 CapEx guidance is $70 million and we expect appreciation and amortization to be approximately $60 million.

Free cash flow was $57 million this quarter which has a conversion ratio of 92% in the quarter.

We expect free cash flow to be between $210 million and $230 million for the full year.

At the end of the quarter, our debt to cap ratio was 24.4% and debt to EBITDA was 0.8.

Both remain well within the financial covenants in our various debt agreements.

We are expecting interest expense in fiscal 2011 to be between $12 million and $14 million.

Our balance sheet remains strong with $335 million of cash and short-term investments compared to $308 million of short-term debt.

So with that, I'll pass it back to Bill who will provide additional details on our outlook for the remainder of fiscal 2011.

Bill?

Thanks, Jim.

Now looking forward in that updated fiscal 2011 outlook, we expect our full-year sales to be nearly $2.3 billion or an increase of between 21 and 23%.

Our Engine segment sales are forecast to be up between 26 and 29%.

And within engine, we expect our off-road product sales that the impact of the global commodity prices will continue to drive strong demand for OEM customers' ag, construction and mining equipment.

We also foresee a continued strong recovery in our On-Road Product sales as the North American forecast for Class A heavy truck builds at our customers is expected to increase from about 154,000 heavy trucks last year to approximately 255,000 in calendar 2011 or a 66% increase.

In Europe, heavy truck builds are also expected to grow by about 25% in fiscal 2011 over last year.

Finally, we expect our aftermarket and replacement filter sales in Engine Products to remain strong.

The demand for replacement filters is a function of the utilization rates within the existing fleets of heavy trucks and off-road equipment currently in the field and we expect those utilization rates to continue to increase.

In addition, we are continuing to work to expand our distribution networks especially in emerging markets.

Now switching to our industrial reporting segment, our sales are forecast to be a up between 11% and 14%.

Within industrial, we expect our Industrial Filtration Solutions business sales to be up between 16 and 19%.

This is a function of customer demand for new industrial filtration equipment which continues to improve as new plant and equipment capital spending continues to increase.

In industrial we also expect our replacement filter sales to continue to grow, again with the increased utilization by our customers with those dust collectors already installed in their plants.

In gas turbines we expect that the large gas turbine power generation market will remain stable, our Gas Turbine sales in total should be up slightly due to the continued strength in the oil and gas segment.

And finally, within Special Applications, we're forecasting sales to increase approximately 7% primarily as a result of the continued growth in the end-markets for our new products.

Incorporating the sales guidance into the operating guidance that Tom gave earlier, we expect our full-year EPS to be between $2.76 and $2.86 per share and a new record.

I'd like to switch gears and talk a little bit about some of our new technologies before we wrap up our prepared comments.

Over the past few years, we've highlighted PowerCore technology as one great example of how we continually reinvest back into our business in order to grow our business by introducing new filtration technologies for our customers.

Our first-generation Powercore for engine was a tremendous success and our second generation PowerCore looks to be that it will be every bit as successful as it continues to deliver breakthrough filtration performance in a 30% smaller footprint.

Our engine PowerCore sales in the third quarter totaled $21 million, up 38% over last year.

The ramp-up in our OEM customers' production rates resulted in the first fit side of that growing 56% in the quarter.

And likewise the aftermarket sales of PowerCore were up 29% in the quarter.

So bottom line, our engine PowerCore sales for both first fit applications and in the aftermarket continue to grow faster than our base business which is exactly what we had forecasted it to do.

Now looking at the industrial side of our business as we mentioned in the past, we've introduced PowerCore there and just last weekend at our national sales meeting here in Minneapolis, we introduced our third Torit PowerCore line.

This new product line is targeted toward the high abrasive heavy loading mining and metalworking market segments.

It's up to 70% smaller than comparable collectors and our sales team started this week to actively quote this product.

This introduction follows our product families targeted for bulk powder, backhouse markets and the thermally generated dust collection markets.

In Q3 we sold another 250 Torit PowerCore systems which accounted for over $3.5 million of sales.

Switching to the liquid filtration market, we've continued to make great progress there as well.

We unveiled our new select fuel filters with our Synteq XP media at the CONEXPO show in March.

We have already won four OEM platforms with SELECT fuel filters and interest in this new generation of diesel fuel filters is very high.

We're also winning new customers with our bulk fuel and lube liquid filtration products.

These filters clean the fluids prior to entering storage tanks, protect the fluids while they're in the tanks and then polish or final filter them as they are pumped out of the storage tanks into the equipment.

This is a growing opportunity for us as the new diesel engines that are being introduced require cleaner fuel and cleanliness standards differ greatly on a local level.

Our bulk fuel and lube filters are helping our customers deal with contamination issues during storage.

So these are just two of the many liquid filtration opportunities we're working on.

In total our liquid filtration sales were up 27% in the third quarter and we are well on pace to exceed $400 million in sales for the full fiscal year.

And then one other thing I'd like to touch on is our BRIC market development.

And we actually -- BRIC for us includes Brazil, Russia, India, China, and South Africa.

Our sales in those five countries or regions were up 39% in the quarter over the last year.

They now represent almost 12% of our total sales.

So we're getting very, very strong growth there and that's as a result of many of the initiatives we've already touched on in terms of adding new distribution and expanding our product line.

So just in closing, some summary comments.

We had another record quarter and are confident that fiscal 2011 will be a new sales and earnings record.

And while we're not providing fiscal 2012 guidance today, our strategic growth plan is focused on becoming first a $3 billion filter company by fiscal 2016 and then a $5 billion filter company by fiscal 2021.

Our progress so far this year and our guidance for fiscal 2011 puts us well on our way to achieving our goals.

Now that concludes our prepared remarks.

Now we would like to open it up to questions.

(Operator Instructions) Charlie Brady, BMO Capital Markets.

Thanks, just a clarification to make sure I heard it correctly.

On the gross margin, the impact that you expect to see from raw material pricing net of price increases for the remainder of the year in the fourth quarter, did you break that out specifically?

Charlie, this is Tom.

I did not break it out for the fourth quarter, but I can tell you that we continue to expect inflation in our commodity costs and there will be an impact in our fourth quarter, roughly a little half than a percentage point, and then we plan to make that up through our continuous improvement initiatives and selected price increases.

Just so I'm clear, are you saying that the net effect then would be that you would make it up so that it would not be a net effect?

You did have a net effect in Q3, correct?

We did have a net effect in Q3.

That was the 90 basis points that I mentioned.

If you look at the midpoint of our guidance for Q4, you will see that our gross margins will not change much at all from Q3.

So the impact of commodity price increases should be offset by the other factors that I mentioned.

Okay, and just in terms of the OE aftermarket mix, at what point does that start swinging back in your favor do you think?

I mean how much further down the road do you think until we switch -- it flips back into your favor?

Charlie, Bill here.

I think it's in our favor already.

We like that both parts of the business are growing very aggressively.

I think the -- as I mentioned in my comments in the outlook, we're continuing to see very strong growth for new equipment and that was sort of a later cycle recovery versus the aftermarket.

But I think it's great news that the first fit is growing not only because it helps us in the near term, but that allows us to get the new proprietary filtration systems on more new equipment, so we're planting the seeds for the aftermarket in the future.

So it's not negative that the first fit is growing better now, it's a good thing.

No, I didn't mean to imply it was negative.

I was (inaudible) in terms of a margin profile of the business I guess is how I meant to interpret that.

Charlie, this is Tom.

On a sequential basis, we do not expect much more impact in the fourth quarter than in the third quarter.

It's the year-over-year impact where there has been a couple of point change in that product mix, but we think it's leveling out as we speak.

On a more normal or historical basis now.

Right.

Just one more and I'll hop back in queue.

On the special apps guidance, embedded in that, your expectation for hard disk drive business, do you still embed kind of a down market for hard disk drives?

Charlie, Bill here.

What we see based on what our customers and the industry forecasts is that the second calendar quarter will be essentially flat with the first one and that the second half of the calendar year it will start to increase sequentially then over the first half.

So we do see a recovery in the disk drive market.

This is tied to obviously that there's a couple of factors there.

One is that consumer spending on PCs is flat or down.

Some of the consumer spending on PCs is going to tablets, tablet computers and (inaudible) and those are being at least partially offset in the near term by growth in the servers for companies and for mass storage.

But we do see that recovering or increasing in the second half over the first half of the calendar year.

Hamzah Mazari, Credit Suisse.

The first question is just around your current footprint.

Is your capacity utilization still running upwards of 85% or around that level?

And just if you could comment on how investors should think about flexing up capacity from where you are currently?

What you have on the drawing board both on manufacturing and distribution?

This is Tom.

I will start and then Bill will probably add a few comments too on our footprint for the future.

We are at about the same capacity level that we were at pre-recession which is in that 80 to 85% area.

So we are about there.

Bill here.

We are making investments.

We referenced some of those already.

We just finished an expansion of one of our main plants in China and we're now in the process of installing more production equipment.

So we built out the -- we expanded the building and adding more equipment or production capacity there.

As Jim mentioned, we broke ground on another new plant in Mexico in the quarter.

So that is coming on -- that will be coming on stream.

We also have a number of production lines for plants in the US in process.

So we are adding capacity in some of our existing plants as well.

We just opened up a distribution center in Chile in the last month.

So we're continuing to add production capacity and distribution capacity around the world really as part of not only the rebound in the business we see today, but really as part of our strategic growth plan.

So a lot of this is being driven by where we need to be three and five years out.

Okay, thank you.

Then just on the liquid filtration side, how aggressive and how strong is your pipeline in terms of deals and your appetite there?

It seems like you guys are investing in that business more organically now as opposed to getting more aggressive on the acquisition front.

How should we think about that?

This is Bill again.

We're mostly an organic growth company.

We're fortunate to be in an industry and have the opportunities to grow organically and we have been doing that successfully over the last 25 years.

That's our primary focus but we also look for acquisition opportunities.

The last one that we did which is a little bit over two years ago was a liquid filtration company in California, Western Filter, aerospace liquid filtration.

And that is a great part of our portfolio.

So we look for acquisitions but we're primarily focused on using our technology to develop new products so we can have differentiated products to offer our customers, and then expanding our distribution especially in emerging markets.

Last question just on IFS on the industrial side, the topline was a little weaker than we expected.

Could you comment on how it came in relative to your expectation and maybe some comments on just geography differences within that business?

Thank you.

This is Tom.

I'll make an overall comment, then Bill might want to chime in.

For the quarter, IFS was up 19% which actually was very close to our expectations and maybe exceeded them a little bit.

So there was no disappointment there at all on our part.

I think what we are seeing there is the equipment side of our IFS business, and this is the dust collectors, is a say maybe a later cycle.

And so it went into the recession later than most of the other businesses fortunately for us and came out of it on the equipment side a little bit later.

But we're very happy with it.

It's growing very well right now and we see that continuing.

And we see that continuing more or less everywhere in terms of the geographical split.

Eli Lustgarten, Longbow Research.

A couple of (inaudible) questions.

Your tax rate guidance is implying that your tax rate in the fourth quarter is something in the vicinity more likely of 27% or maybe a little less than that.

Is there any special things going or does that -- and the real question is what does it imply for your tax rate next year?

Eli, this is Tom.

I think the way to look at it is our normal going forward rate absent any what we call discrete items is going to be a little bit under 30%.

Just lowering that a little bit for the fourth quarter, we have a couple of things wrapping up which could be slightly favorable which will just bring that down just a little bit in the fourth quarter.

But again our normal rate from recurring operations is just slightly under 30%.

That is what you expect for next year, I would assume, correct?

We didn't offer any guidance for next year and we continue to work on that tax rate.

But at least based on the mix of earnings at this point, we would feel comfortable with something just under 30%.

The other technical thing in the income statement, the corporate unallocated was $7.7 million, that's a big step up from where we've been run rate.

Can you talk about what fourth quarter looks like and what drives the number from the $4 million or $5 million to $7 million and staying up there next in the fourth quarter (inaudible) next year look like in that?

Eli, this is Tom again.

First of all, I think what is important is that we haven't changed any methodologies at all in calculating what goes into the segments and what goes into corporate in unallocated.

As we talked in the past, corporate and unallocated will fluctuate a bit.

First included in that number are things like interest and foreign exchange fluctuations.

But the key driver of the increase this quarter is our intercompany shipment activity because we ship products between segments, between plants, and we need to eliminate that intercompany profit in inventory.

Because there was a step up in that activity, that resulted in a bigger elimination this quarter than last year.

It's hard to predict going forward.

Generally that number will increase as our volumes increase, and then it will level off as our volumes level off.

So the expectation is the fourth quarter will be similar or bigger than the third quarter?

No, I would not say that, Eli, because of the intercompany activity that we are seeing right now and again, it's different.

It's hard to predict what's going to happen from a foreign exchange standpoint.

So I would not predict that going any higher in the fourth quarter.

(multiple speakers) lower.

Now in your guidance, you have a gas turbine sector I believe going down in the fourth quarter (inaudible) did the math correctly.

I mean GE was actually very bullish this week at the Electrical Product Group meeting talking about they thought it was going to be -- gas turbine would be flat now and they expect it to be up materially for the rest of the year.

Are you seeing any of that?

Do you get that in the fourth quarter or was it next year before you see that benefit?

Eli, it's Bill here.

We are seeing and we follow obviously GE's announcements very, very closely.

And you're right, their guidance is increasing for turbines and we do see that longer term.

But just given the leadtime in terms of these projects, a lot of when we will see that will be in our next fiscal year near the second end of calendar year 2011 or calendar year 2012.

So not in the fourth quarter, it's a longer leadtime opportunity for us.

Can you talk about in your Engine business where are you seeing acceleration in demand from your products on the segment basis?

I mean it's pretty clear that the truck sector or the on-road market will be much longer in the fourth quarter than the third quarter just on the raise in production that's going on in that.

But are you seeing it also in the off-the-road and in the aftermarket business or are those things relatively stable quarter to quarter?

Bill again.

The aftermarket business in Engine came back earliest.

So as I mentioned earlier, we were talking about sort of the mix between first fit and aftermarket on engine.

And Tom and Jim mentioned, it sort of stabilized to more of a historical level.

So we see both the first fit and the aftermarket continuing to grow.

I think you mentioned the heavy truck.

That's probably coming back off of pretty low levels last year to maybe more of a historical production and sales run rate.

And we see that -- we talked about the numbers there.

We saw on the off-road side, we've seen announcements from two of our largest customers, Caterpillar and Dear, where they raised their guidance for this year.

So I think we're generally seeing it -- increases in all segments both first fit and aftermarket on the engine side.

I guess what I'm asking is versus the third quarter, I mean it's easy to understand that you'll see a material improvement in the transportation product volume in the fourth quarter versus the third quarter.

And I guess what I'm trying to ask is whether you're seeing that in off-the-road and in aftermarkets relative to the third quarter.

Eli, this is Tom.

Relative to the third quarter, I don't think we're going to see any significant change.

Okay, but there's no impact -- you talked about Japan not being a problem but there's a lot of production in construction equipment in Japan that's affected by the impact.

It's not you but it's some of your customers.

Dear basically announced a $300 million shortfall because it's Hitachi production, basically the best way to describe it being down.

I'm just wondering whether there's any impact on you at all from any of your customers on that?

Eli, Bill here.

The easiest part we can see is obviously the impact within our facility and as I mentioned, we were very fortunate that we didn't have any.

In Japan we do see some customers that are coming up to -- back to normal production slowly or in some cases -- a few cases haven't even come back.

I think we're looking at the truck market in Japan not to be back to a normal state until sometime this fall.

In terms of our global supply chain, we have not seen anything outside of Japan that's been a big factor for us in terms of where we couldn't get things from Japan.

It is harder to see for our customers and we're just trying to stay on top of that with communications.

I think there are supply issues generally.

We mentioned the heavy truck market, talking to customers there even unrelated to Japan, just trying to get as many other -- not related to our parts but other parts they need that might constrain their demand.

But all of that as best as we know it today is baked into our guidance for both the fourth quarter and the full year.

Lawrence Alexander, Jefferies & Co.

This is Rob Walker on for Lawrence.

In terms of breaking down your sales growth, the 19% further, so 3.5% from FX, passthroughs may have been another 4% for steel.

How much did volumes rise in the quarter?

Bill here.

So if you take the 3% out, you get down to the 16%, there's a little bit for pricing recovery but almost all of the remaining 16% is volume.

Rob, this is Tom.

About a half a point from pricing.

Perfect, thanks.

And then just kind of an update on incremental margins.

Clearly with all the investment there being constrained, I guess what do you expect -- when should those start to expand?

And then also if you could update us on given liquid filtration's increase in the mix, how that is going to affect margins going forward.

Rob, this is Tom again.

We talked earlier about the fact that our plants are pretty much at pre-recession levels.

So we had really significant incremental margins on the first 10, 15, 20% of that sales increase.

But now what we are looking at going forward with some of the capacity expansions that both Jim and Bill talked about earlier, we really aren't predicting margin growth from additional leverage.

What we're going to be looking at is continuing growth over time in our aftermarket business and liquid filtration.

But really we're not looking for incremental margins from additional volume growth.

Okay and I guess just two quick questions.

In a good year, typically how much do you guys get in pricing?

And also you mentioned you had significant share gains.

How much did industry volumes rise?

Rob, Bill.

So in a good year, we generally assume over time that pricing is zero or neutral.

We do get pricing recovery when commodities go up.

But over time, we're actually reducing the price of our products for our customers and that has been like that for 25 years at Donaldson.

So we use technology to reduce the cost for our customers.

And that's how we really expand our market.

I used examples, we were talking about the new VH dust collector in Torit.

We're selling that for less than the previous unit.

We get a similar type of margin, but we're able to expand the market and grow our business overall.

So pricing over long periods of time absent sort of the current commodity spike is -- we assume to be zero.

And then liquid filtration, we're going to continue -- I think it was the second part of your question was liquid filtration.

We're looking at over time our strategic planning horizon, growing that to be 25% of our revenues.

So we get to a $5 billion filter company as I mentioned earlier, that would be about a $1.2 billion or $1.3 billion filter business.

As we mentioned earlier, we're about $400 million forecast for this year.

So obviously we have to grow liquid a lot faster than we grow almost all the other businesses and that's our goal.

And then just how much did industry volumes rise?

Industry volumes, generally we -- over long periods of time, we assume that the industry volumes grow at about 100 to 200 basis points faster than GDP.

This is not a typical time, so they're growing faster than that.

But we look at some of our comparables, a few that we can see and that's how we conclude at least that we're picking up share because we're growing those businesses faster than we see other people doing it.

Brian Drab, William Blair & Co.

Congratulations on a solid quarter.

I think all of my -- most of my questions have been answered at this point.

But just want to make sure that I have a couple of details straight.

So in terms of pricing for the quarter, price added about half a percentage point to the topline growth.

How is that going to play out for the year?

Is it going to be about a half to a full point in terms of topline growth related to pricing?

Brian, there wasn't a lot of pricing prior to this quarter.

So if you take about that half of a percentage point in Q3, and we're going to continue to work this in Q4 and just roughly, we have baked into our guidance another 0.2 points in Q4.

Another 0.2 points on top of the 0.5?

That is correct, Brian.

Okay, thanks, I'm sure that I'm making you repeat yourself but I missed it on the call.

Did you say what the mix was between first fit and aftermarket for the quarter?

Brian, it's about 52/48.

Just I think aftermarket is just slightly under 52 but I'd call it 52.

Okay, got it.

And then congratulations on this new product or the new Torit product, mining segment, that sounds like a great idea.

Can you elaborate a little bit as to whether that's going to be on the engine side or is that industrial processing within mining or what is that product exactly?

Brian, it's Bill.

It is industrial processing related to mining.

It's in the IFS business within the industrial group.

Any goals that you have set or any expectations that you could give us at this point?

I know it's still early stages for that.

We have very high expectations for it.

But we haven't said anything publicly about it.

But as I mentioned, we launched it literally last weekend at the national sales meeting we had here in Minneapolis.

And our salespeople are already active -- have many active quotes already out there in the field.

So the reaction from our sales force and dealers was very, very good.

I was at the meeting.

And we're very optimistic about the market acceptance.

Great, thanks a lot.

That's all for me.

Gary Farber, CL King & Associates.

I just had a few questions.

One was just on your comments on marketshare gains.

Are you grabbing share more so you think with existing customers or new customers?

Is it sort of equally weighted?

And is there any particular geographies you think that is really the case?

Gary, Bill here.

I think on the geography I think it's especially true in the emerging markets where we probably didn't have as much coverage and where there's more of the equipment -- of our customers' equipment that's going into those areas.

So being there, being able to support them with the replacement filters is a great opportunity for us.

So a lot of -- adding a lot of distribution and product coverage in the emerging markets as they are both growing at higher rates and there's more of the equipment with our first fit product going in.

And then generally even in the developed markets, we are adding -- we're growing the business with some distribution adds but also more with products.

So really building out our liquid filter product offering is one of the things that we are doing and we're doing that both on the engine side, building out the product offering, and the industrial side.

Right, okay.

Can you also just address your cash balance is growing pretty nicely.

Any kind of updates on your thoughts on the market for acquisitions or just other uses of cash?

Gary, Bill again.

So we are always looking for acquisitions.

We're mostly focused on organic growth.

So we're using a good portion of the cash that we're generating for capital investment.

As Jim mentioned, we've launched another major plant project in Mexico.

We have a lot of capital investment going into our existing plants in the US and Europe.

So it's not just the emerging markets, it's also the developed markets.

That's probably our first focus is investing that back into the business.

We can control that but while we're looking for acquisitions -- so we are looking, we just can't time those.

The other uses of the cash -- obviously we have -- we talked about in the press release, we did repurchase some shares in the quarter consistent with our long-term share purchase philosophy and we have our dividend policy -- long-standing dividend policy that we follow as well.

Do you see any change in the acquisition market say in the last three months versus the prior three months as far as the number of opportunities or the prices being paid or has there been any changes?

I would say we haven't seen really any changes in terms of either the number or the pricing.

Okay, thanks.

But we're patient.

We continue to look.

Adam Brooks, Sidoti & Co.

Just real quickly on the strategic initiatives.

It seems like what you said with process liquid in emerging markets, that's going to be a continuing thing.

Can we assume we will have similar expenses next year and maybe the year after that as we did this year?

Adam, Bill here.

We talk about our strategic growth plan and our objectives, we will continue to invest in those consistent with our plans as I just talked a minute ago about, growing our liquid filter business.

But we haven't commented specifically on fiscal 2012 yet.

We will in our next earnings call.

And real quick, not to grill you down, as far as you said really not expecting incremental margins on additional volume growth, does that really assume that margins kind of flatten out at this point?

Is that the best way to look at it?

Over longer periods of time, Adam, and we've talked about this in other calls, our goal is to continue to expand our operating margin.

I think what Tom was trying to describe is that the boost that we got as our volumes picked up coming out of the recession from that operating leverage, that one-time hop in margins from that operating leverage gain, that's mostly behind us because we're back to the 80 to 85% capacity utilization we were at pre-recession.

But we're going to continue to expand the margins as we have if you look at our history.

That's not just aspirational.

If you look back over Donaldson's operating margin over the 20 years, we've sequentially increased the margin and our goal is to continue to do that.

Part of that is as Tom mentioned by growing the aftermarket business where our operating margins are better.

Part of that is getting into using new technologies to prove the value to our customers and improve the margins.

So there's lots of different initiatives that will over time continue to improve the operating margin.

Real quick, maybe just trying to -- kind of changing pace, can you maybe talk about the competitive landscape within the BRIC nations compared to say the US and Europe?

Well, we see -- this is Bill again.

Competitive landscape is different in some ways because there are local competitors there that we don't have in the developed economies.

But we also see many of the same competitors we have in the developed economies going into the BRIC.

We think we have a pretty good footprint.

We've been very strong in China.

We've invested a lot in China, we continue to.

We're in Brazil (technical difficulty) added distribution there in Chile.

We've moved into Eastern Europe a number of years ago to serve the eastern markets.

Strong position in South Africa, we've invested there.

India, we expanded the plant there about a year ago.

So we've really focused a lot of our investment to get a leadership position in those markets both versus the local competitors and our developed economy competitors as well.

So it's a -- back to your -- there's some of the same competitors and there's some new ones that are specific to those geographies.

Rob Mason, Robert W.

Baird.

Tom, I wanted to go back to a comment you made I guess last quarter.

You had suggested gross margins could be down about half a point in the second half versus the first.

But you clearly seem to be doing better than that based on the quarter and your guidance.

What would you attribute that to?

Is that just better performance on the absorption and the continuous improvement side?

Rob, it is partly that.

It is partly estimation error when we are dealing with just a couple of tenths of a point.

But our plants are performing very well.

And with that leverage that we have seen and the continuous improvement initiatives, we are indeed pretty close to that guess.

I think you had commented earlier that from here or going forward, you don't really expect fluctuations in the OE aftermarket mix to really -- as you see them to not really impact gross margin.

Is that true or is that correct?

Rob, this is Tom.

We took a look at that for the fourth quarter and just based on what we're seeing right now, we aren't seeing much of a change once again sequentially from Q3 to Q4, there still is that couple percentage point difference from last year.

But going forward right now, it seems like it's steadying out.

So absent strong movements one way or the other I guess in raw materials, is a 35% gross margin a good way to think going forward?

Well going forward through the fourth quarter, yes.

Stay tuned, we will be talking to you in late August for our fiscal 12 guidance.

But yes, the midpoint of our guidance for the fourth quarter is about just over 35%.

Sure, okay.

And maybe just one last comment or question.

Do you have a growth rate for China in the quarter?

Rob, Bill here.

For China in the quarter?

Yes, I think we do.

Give us a second, we will pull it out.

Rich is looking for it, Rob.

Did you have another question?

Also do you happen to have a breakdown on the IFS business, just the growth rates there between aftermarket and the new equipment sales?

And Rich is also (multiple speakers) looking that up.

We're fortunate to have Rich here today.

The China question, China was up 37% in total in the quarter.

So it would have been up higher in the faster growing engine and IFS markets, down a bit in the Special Applications related to what we are talking about in the disk drive market.

On the IFS question, just give me a second here, I will see what we have for breakdown there.

Rob, while Rich is looking for that, did you have anything else?

I can just follow up with Rich later on.

That's fine.

Thanks.

Maybe before we wrap up the call, Rich will find it.

Were there any other questions?

Charlie Brady, BMO Capital Markets.

Just a quick one on the aerospace defense segment.

The revenues came in a bit higher than I would've thought.

Were there any in that quarter that maybe bumped it up in the quarter?

Was there any pullthrough from upcoming quarters that maybe made a little bit stronger Q3?

Charlie, Tom.

No, the quarter came in pretty much as we expected it to.

So you're right, it was very, very flat with last year at that $27 million level.

But there wasn't any unexpected pullthrough at all.

Thank you.

There are no further questions in the queue.

I will turn it back over to Mr.

Cook for any closing comments.

Now to conclude our call, I would like to thank everyone for your time and interest in Donaldson.

I hope that you all have a great weekend.

And to everyone on the Donaldson team, your hard work and continual focus on our priorities has helped to deliver another great quarter.

This allows us to continue to reinvest in our business as we work towards achieving our long-term growth targets.

I'm very proud to be part of the Donaldson team and what we're creating together.

A sincere thank you to all of you.

Good bye and have a great weekend.

Thank you, ladies and gentlemen, if you'd like to listen to a replay of today's call, please dial 303-590-3030 or 1-800-406-7325 and enter the passcode 443-6559.

That does conclude Donaldson third-quarter fiscal year 2011 conference call.

Thank you for your participation.

You may now disconnect.