Donaldson Company Inc (DCI) 2012 Q2 法說會逐字稿

Welcome to the Donaldson's Q2 FY '12 conference call on February 22, 2012.

Throughout today's recorded presentation, all participants will be in a listen-only mode.

After the presentation there will be an opportunity to ask questions.

(Operator Instructions).

I will now hand the conference to Rich Sheffer.

Good morning.

And welcome to Donaldson's fiscal 2012 second-quarter conference call and webcast.

Following this brief introduction, Bill Cook, our Chairman, President and CEO, and Jim Shaw, our Vice President and CFO, will review our record second-quarter earnings and our updated outlook for fiscal '12.

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.

Thanks, Rich and good morning, everyone.

As you've seen in the press release we issued earlier this morning, we had a very good quarter as we set second-quarter records for sales, operating margin, earnings per share.

In fact, this was our fifth consecutive quarter posting new records for all three of these metrics.

Now I will take a few minutes to review our results.

Our second-quarter sales were $581 million, up 8% year over year.

Excluding the negative impact of foreign currency translation, we were very pleased with our organic sales growth of 9%.

The combination of organic sales growth of 9% and a 12.9% operating margin helped to deliver a net income increase of 21%, an EPS increase of 25%, and EPS record of $0.70 per share.

As you know, we have two reporting segments.

I will cover our highlights for each.

First in our engine product segment, excluding the impact of foreign exchange, our local currency sales increased 13% over last year.

The primary drivers of this 13% year-over-year increase were our OEM businesses, on road and off road, which were up 36% and 18%, respectively.

This 36% increase in our on road product sales was primarily due to the significant rebound in North American heavy truck build rates at our customers.

For example for the past calendar year, Class 8 heavy truck builds in North America were 256,000, a 66% increase over 2010.

Our off road product sales were up 18% as the agricultural, construction and mining end markets we serve have continued to strengthen, thereby increasing the demand for our customers' new equipment, upon which our new filtration systems are installed.

We also had help from our engine aftermarket business as our replacement filter sales were up 9% as the utilization rates of existing truck and off road equipment fleets have continued to improve.

We also continue to expand our distribution networks and product line.

In fact, since our last call we've added another 75 distributors and nearly 800 part numbers to our product offering, with the majority of these adds in our emerging market businesses.

Now switching to our industrial products segment, our local currency sales increased 2% as we experienced a wide range of business conditions.

Starting first in our industrial filtration solutions business, revenues were up 8%, as sales of our new Torit dust collection equipment and our sales of replacement filters for those systems already in the field have remained strong.

Sales in gas turbine were up 6% in the quarter, driven mainly by strong replacement filter sales.

Should note that we also had a number of major new systems in process during the quarter and are now very confident that the strong second half for gas turbine system sales, which I will cover in more detail in a few minutes.

And finally, sales in our special applications products decreased 15% as the solid sales growth from our newer product line serving the membrane, semi-con and venting markets was offset by the flooding in Thailand and its impact on our hard disk drive customers.

We talked a little bit about this in our last call and I wanted to give you an update on the situation.

Let me explain a little bit about what happened in the hard disk drive market.

As you know and you may recall, we have two clean room production facilities where we manufacture our disk drive filters, one in Thailand and the other in China.

Our clean room in Thailand is located southeast of Bangkok and is outside of the flood plain.

So it remained high and dry during the floods that began ravaging a large portion of Thailand in October.

However, several of our hard disk drive customers' facilities and many of their other suppliers in Thailand were under water for a portion of the period from October until early December.

As a result, there were severe supply shortages of critical components that caused disk drive industry volumes to contract by about 40% during the first part of our second quarter.

During the worst of this disruption we were forced to reduce the production schedules at both our Thai and Chinese clean rooms.

The better news is that some of our customers and their suppliers, which had been directly impacted, were successful in shifting production to non-flooded facilities, while others were able to clean up and restart some production in December.

While this situation is not completely back to normal, industry volumes had improved significantly by the end of January.

Now I would like to switch gears and review our sales by region.

We had very good growth in the Americas with local currency sales increasing 18% in the quarter.

This is currently the strongest economic region for us.

In Europe, our local currency sales increased 7%, despite a number of European economies reporting negative GDP growth in the last calendar quarter.

And in Asia, our local currency sales declined 4% in the quarter, obviously impacted by the flood-related issues in Thailand I just discussed.

Excluding our disk drive filter sales, the rest of our Asian businesses grew at 3% year over year.

This is a lower growth rate than we've enjoyed in the prior quarters and was primarily the result of the recent economic slowdown in China, which also hurt growth in those nearby countries such as Japan and South Korea which heavily export into China.

I will now turn the call over to Jim Shaw for his comments on our operations before I discuss our fiscal '12 outlook.

Thanks, Bill.

Good morning, everyone.

Our gross margin was 34.6% in the quarter, down 70 basis points from last year.

There were some pluses and minuses in our gross margin number which I will walk you through now.

The largest impact in the quarter was lower absorption of fixed costs, which reduced gross margin by 90 basis points compared to last year.

This decrease was mainly driven by two separate factors.

First, our two disk drive filter plants were operating at lower levels of production during the quarter due to the disruption of the entire disk drive market caused by the Thailand floods.

In fact, our factory in Thailand was closed for a period of time in November, not because we were flooded, but because our customers couldn't get parts from other suppliers to assemble the hard disk drives.

Under Thailand labor laws, we continued to pay our workers there a significant portion of their normal pay during the shutdown.

We also reduced shifts at our disk drive filter plant in China due to the supply chain disruption.

Fortunately, the industry production levels have improved substantially by the end of January and should be back to pre-flood levels over the next few months.

The second driver of lower fixed cost absorption was a decrease in shipping days by five days in most of Asia, compared to last year's second quarter.

This is due to the timing of Chinese New Year which was in February of last year but fell in January this year.

There were also last of the traditional holiday shutdowns that our customer in the United States and Europe last fiscal year as demand came back strong from the recession.

This year it was a more normal holiday shutdown period.

Higher commodity prices compared to this time last year and the mix of our product sales also had an unfavorable impact to our gross margin.

Offsetting these negative impacts were our continuous improvement initiatives which increased gross margin by 100 basis points.

In total, our gross margin was down 70 basis points from last year's strong second-quarter margin of 35.3%.

Our operating expenses remain well under control coming in at 21.7% of sales, which was down 100 basis points from last year.

This improvement over last year comes from increased leverage of our fixed cost due to higher sales level, partially offset by selective investments we have made over the past year to support our strategic growth initiatives.

In addition, while we continue to assess the direction of the global economy, we did selectively slow our planned head count additions during the quarter.

Even though recent economic indicators improved during the latter part of our quarter, there is still a lot of uncertainty regarding the sustainability of these improvements, especially in Europe and China.

We will continue to be measured in the pace with which we add to our fixed expense levels.

Our operating margin came in at 12.9% this quarter which is a record.

Looking at our operating margin forecast for fiscal '12, we believe the fixed cost absorption issues that impacted Q2 are behind us and that purchased raw material costs will continue to moderate over the next couple of quarters.

We continue to benefit from higher volumes as we leverage our fixed costs and benefit from our continuous improvement initiative.

In total, we continue to expect our operating margin for fiscal '12 to be between 13.7% and 14.5%, which means that anything above the bottom of this range would represent another full year operating margin record.

Our effective tax rate was 29.6% in the quarter versus 34.4% last year.

Last year's second quarter was impacted by a $4 million charge related to the reorganization of our subsidiary holdings, which improved our global business and legal entity structure, offset by a $900,000 benefit from the retroactive reinstatement of the research and experimentation credit of the US.

Based on our projected mix of earnings of fiscal '12, we continue to forecast our tax rate to be between 27% and 30% for the full year.

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

In total, we expect CapEx spending of approximately $85 million this year.

This estimate is down slightly from our earlier estimate of $100 million for the year.

We still plan to authorize and begin work on $100 million of capital projects.

The reduction is simply related to the timing of when we estimate the cash payments to be made.

These global investments are an important part of our strategic growth plan.

We have many projects included within the $85 million of CapEx plan this year and we expect these will positively impact our corporate ROI when completed.

Approximately 25% of this year's CapEx is for capacity expansion, another 25% is tooling for new products, 25% will be related to cost reduction activities directed to continuous improvement initiatives, and the final 25% will be for our technology initiatives.

We expect depreciation and amortization to be between $60 million and $64 million this year.

Free cash flow was $27 million this quarter.

As mentioned, CapEx was $18 million this quarter, compared to $14 million in last year's second quarter.

Working capital was a source of cash this year as sales decreased sequentially from the first quarter, as our second quarter is seasonally weakest quarter.

We expect cash flow from operating activities to be $250 million to $280 million in fiscal '12.

We didn't repurchase any shares in Q2, leaving us at about 1.4 million shares, or 1.8% of our diluted outstanding for $74 million year to date.

The absence of share repurchase activity in the second quarter was the primary driver for the $45 million decrease in debt.

With this decrease, our debt to cap and debt to EBITDA ratios are now at 24.7% and 0.7%, respectively, well within the financial covenants of our various credit and note agreements.

We continue to expect interest expense in fiscal '12 will be between $11 million and $13 million.

Our balance sheet remains strong with $272 million of cash and short-term investments.

With that, I will pass it back to Bill who will provide additional details on our updated outlook for fiscal '12.

Thanks, Jim.

I think we've covered the quarter pretty well and now we are going to switch gears and look forward.

Our current guidance is based on the expectation that the overall European economy will remain at the current levels during the second half of our fiscal year and for the Chinese economy to improve, which will obviously benefit China as well as the rest of Asia.

We anticipate that the US dollar will remain stronger than what we had assumed in our previous guidance that we issued November.

This stronger US dollar does create about $0.05 EPS headwind for us compared to our earlier outlook.

We expect our full year sales to be between $2.45 billion and $2.55 billion, or an increase of between 7% and 12% over last year's record of $2.3 billion.

Bottom line, we continue to see many growth opportunities and expect that we will continue to grow faster than the end market averages through the introduction of new filtration technologies and products and also by increasing our sales coverage and emerging geographies.

Now we will review our outlook by segment.

Our full year engine sales are forecast to be an 8% to 12% increase over the prior year.

Within off road product sales, we expect continued strong demand for our OEM customers' ag, construction and mining equipment as the average age of equipment in the field still remains historically high.

This should support an ongoing stronger equipment replacement cycle.

We are also forecasting continued strength in our on road product sales.

For example, ACT Research forecast that heavy truck build for our North American customers is expected to increase from 256,000 in calendar '11 to 296,000 in calendar '12, or a 16% increase and then increase again in calendar '13 by another 8% to approximately 320,000 trucks.

The average age of the current truck fleet is also historically very old, indicating a need for the continuation of the current replacement cycle.

Finally, we expect our aftermarket or replacement filter sales to remain good.

The demand for replacement filters is a function of the increased utilization rates in the existing fleets of heavy trucks and off road equipment in the field and our ability to retain the after market opportunity where we are the first fit OEM supplier.

In addition, we are aggressively working to further expand our distribution networks, especially in our targeted emerging markets.

Now switching to our other reporting segment, industrial.

Our sales there are forecast to be up between 7% and 11%.

Within industrial, we expect our industrial filtration solution business sales to be up between 7% and 11% as customer demand for new industrial filtration equipment continues to improve due to new plant and manufacturing capital investment decisions.

We also expect our replacement filter sales to continue to grow, again, with the increased utilization by our customers of those filtration systems and dust collectors already in the field.

As I mentioned earlier, we anticipate a significant increase in our gas turbine business as we see two very positive trends.

First, there are currently many large gas turbine system projects underway at our customers.

These are typically 200-megawatt projects, each of which could provide equivalent power for 200,000 homes.

Many of these projects are underway in the Middle East, China and the US.

The second positive trend relates to high oil prices and the resulting demand for smaller turbines, which are needed as more investments are made in energy exploration and transportation.

Overall, we expect our gas turbine product sales to increase 18% to 22% year over year.

Finally, we are forecasting special applications sales to be level year over year as growth in our membrane and venting product sales should offset the second-quarter reduction in our disk drive filter sales that Jim and I talked about earlier.

Incorporating the sales guidance into the operating guidance that Jim covered earlier and accounting for the estimated $0.05 negative impact from foreign currency translation, we have adjusted our full year EPS forecast for fiscal '12 to be between $3.25 and $3.45 per share.

The mid-point of this range is up 17% from last year.

Obviously, this would be another EPS record and it would be our 21st record in the last 23 years.

Finally, I'd like to give you a quick update on some of the new technologies and major investments we are making before we wrap up our prepared comments.

Over the past few years we've highlighted our PowerCore technology as an example of how we continually introduce new filtration technologies to help our customers in order to help grow both their and our businesses.

Our engine PowerCore sales in the second quarter totaled $25 million and were up 35% over the prior year.

On the industrial side of our business, we introduced our third Torit PowerCore product line last May.

This new product line is targeted towards the high abrasive, heavy loading mining and metal working markets.

For our customers this offers many advantages including that it is up 70% smaller than competitive collectors.

And in our second quarter, we sold another 310 Torit PowerCore systems which accounted for over $400 million in sales.

In total, our total PowerCore sales are now approaching $30 million a quarter, or $120 million on an annual basis.

We also continue to make progress in liquid filtration markets.

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

We've already won six OEM platforms with this technology and interest remains high.

We are also continuing development on our next generation of Duramax hydraulic filters.

When launched, we expect these filters will offer our customers improved filtration performance and longer filter life.

Finally, I'd like to highlight the recent completion of one of our emerging market investments.

Last week I was honored to attend the grand opening of our new plant in Aguascalientes, Mexico.

This is our third plant in Mexico and our second plant in Aguascalientes.

This latest investment in Aguascalientes, totaling $20 million, adds significantly more liquid and air filtration production capacity to serve our customers throughout the Americas with a special focus on those in Mexico, Brazil and the balance of Latin America.

Now to summarize, we've reached the midpoint of our fiscal '12 with record results and with significant forward momentum in many of our businesses and regions.

We are very well positioned for a strong second half and as a result, we are projecting another record for both full year sales and earnings.

We will continue investing and developing new technologies and products to help meet our customers' changing filtration needs.

We will also continue to make the key long-term investments, such as the one I just highlighted in Mexico, to support our $3 billion and $5 billion sales targets that we established in our strategic growth plan.

That concludes our prepared remarks.

And now we would like to open up to your questions.

(Operator Instructions).

Hamzah Mazari, Credit Suisse.

A question on how to think about incremental margins in your business going forward, given most of the fixed cost absorption issues you are behind you now.

At the same time, you are slowing down head count, but also making some capacity investments.

How should we think about those incremental margins long term, given where you are in the cycle right now?

I think as we talked before, in terms of coming back from the recession, we had a little bit of a pick up in terms of incremental margins on some of those first sales that came back.

We are well past that at this point.

I think as you look at maybe first gross margin, I think the challenges we had this quarter that I referred to in my prepared comments are past us.

I think the wild card is commodity prices and as of right now those are fairly stable.

I think from an operating margin, what our longer term goal is to continue to expand that in small increments.

We aren't out to maximize operating margin because we do want to continue making some of these investments.

But over time we do see opportunities to slowly expand the operating margin.

Just to add on to what Jim said, longer term, we have a goal of achieving and maintaining a 15% plus operating margin.

That's not this year.

Point back to the guidance that Jim gave earlier between 13.7% and 14.5%.

But over the next handful of years, our goal is to get to and maintain a 15% plus op margin.

You spoke of PowerCore currently being at a $120 million annual run rate.

Could you maybe talk about what your current aftermarket capture rate is and as PowerCore gradually becomes a larger part of the install base, how we should be thinking about that capture rate moving up.

Is it going to be a very gradual process?

How should we think about that longer term?

I think as we've discussed and I will recap this.

PowerCore offers advantages, both on the first bid.

In some cases we are picking up first bid business for share we didn't have before, but probably the most significant opportunity creates for both us and our customers is in the aftermarket.

With the non-proprietary technology maybe a year after a system is in the field, we might only be capturing -- we and our customers might be only capturing 30% or 40% of the aftermarket.

With technologies like PowerCore or like Synteq XP, we can get that up to 100% for a period of time.

We can maintain a higher share for a longer period of time with the proprietary technologies and then our goal going forward is to continue to refresh and introduce new technologies to keep that number up as high as possible.

It is growing very nicely, as we mentioned.

Our engine power core sales are up 35% over the same quarter last year.

We are at this $120 million annualized rate at the end of the second quarter.

We see that continuing to grow or accelerate, it's really dependent on the launch by our customers of their new equipment platforms.

A lot of the programs that we've won are won, but they are in the process of being launched.

We see that happening over the next couple of years, that they will be out there and then we'll see that big pickup in the aftermarket.

And then the last question from me on the acquisition side.

Could you update us on your thinking on acquisitions, particularly on the liquid side and how much is liquid of your business right now?

About 18% of our sales are liquid today.

This business has continued to grow very nicely, so it's by itself it's a $400 million plus business.

And we have plans, as we've discussed on other calls and presentations to significantly grow our liquid business, essentially get that to $1 billion plus by fiscal '21.

We are doing that, both organically and through acquisitions, and we look at acquisitions on the air filter side as well.

Most of our growth target, the 9% to 10% that we are targeting as a CAGR on sales, is organic.

We think we can do roughly 8% organically and say roughly 2% per year in acquisition.

We are still mostly an organic growth story, but we are always looking.

We have a focused team looking at acquisitions, both on the air and liquid side.

But we probably are more focused on trying to find the liquid ones today.

In fact, the last acquisition that we did, which is a couple years ago, was Western Filter which was liquid.

Charlie Brady, BMO Capital Markets.

Could you remind us in a special apps segment, the mix between the membranes and the hard disk drives?

Is it still around 50?

The hard disk drive business is probably about 60% of the total special apps.

On a normalized basis, correct, or obviously lower than that recently?

Right.

Membranes would be 25% to 30% of the balance of special applications.

Then some of our more niche businesses in semi-con imaging and then benzene solutions make up the balance.

I wanted to ask on your guidance as it relates to your assumptions for currency on the Euro and the Yen.

Specifically on the Yen, you are assuming a 76 rate on the Yen, which is where it was in the quarter, but it's trading at 80.

And I'm wondering, the impact of that could have potentially if we were to stay at the current level on fiscal '12 revenues and EPS.

Basically how much of your business gets denominated in Yen?

Well, our subsidiary in Japan is our largest single subsidiary we have globally today at $100 million, $120 million of annual sales.

The impact of that moving a couple of percent might be a million or two on the top line and by the time you get to the bottom line, it will be a pretty small impact.

The one that impacts us to a much higher degree is the Euro.

Can you give us some more granularity what you are seeing in the South American markets, particularly Brazil?

We see very strong growth in Brazil and throughout the rest of South America.

We just opened up a distribution center this past year in Chile to help serve the market down there.

Part of what the investment that I was talking about in Aguascalientes is directly focused on, not just serving Mexico, but the growing South American market as well.

We see very good prospects there.

Kevin Maczka, BB&T.

Can I ask an incremental margin question in a little different way?

I think we understand that at this point in the cycle we shouldn't see the big outsized incremental for the total Company, but in industrial in the first half and again here in Q2 we did see that very strong incremental margins, even with this underabsorption from the disk drive issue.

Are you saying for industrial as well that that will settle out to a more normal incremental in line with this 15% margin where we are now?

We don't give operating margin guidance by segment.

We only do it for the Company and there are pluses and minuses in that and I will point back to our full year guidance and the comments I made earlier about the longer term.

We do see the opportunity to get to a 15% plus op margin.

As Jim mentioned, we made a good step function jump the last couple of years.

We don't see repeating that because that was the advantage or the benefit of some of the restructuring that we did coming through the recession and we are not planning to repeat that.

And we are also, as Jim mentioned, we are balancing operating margin expansion with focusing on investing back in the business so we can get that 8% organic growth that I mentioned a minute ago.

I think the other thing, too, is when you step down to the company level to the segment level, the mix of products from one quarter to the next can play into that as well.

We talked first quarter about having a real good start on the margin within industrial, but that can fluctuate depending on project sales and the like.

I wouldn't call it a trend yet, but we are certainly happy with where it's at.

And if I can shift gears over to what you are seeing in engine aftermarket, that's dipped down a little bit here in terms of revenue sequentially.

Looks like it grew on a year-over-year basis about 10% in the first half, but you are now calling for moderate growth for the year as a whole.

Can you describe a little more about what you are seeing in terms of incoming order rates?

Are you suggesting that that may even turn negative in the back half on a year-over-year basis?

No, we aren't suggesting it will turn negative.

I think it's just moderating is really what we are seeing.

We saw coming out of the recession it was probably some restocking by parts of our distribution channel that helped with higher numbers and we are seeing maybe a more normalized type of growth rate there with the addition of the fact that we are adding more products in our product line and more distribution.

We still feel as though, as I tried to say in my comments, that we are growing faster than the market but the market rate has moderated.

Laurence Alexander, Jefferies.

This is Jeff on for Laurence.

Can you provide any initial color post the Chinese New Year of demand trends in Asia in the auto market, and also if you can update us again on any order trends in the aerospace market?

I think first off you mentioned the auto market and we're really not in the auto market.

We will be talking about heavy trucks and construction equipment and ag equipment on the engine side.

I think what we saw before Chinese New Year was some of the moves the Chinese government was making to loosen things up a little bit to facilitate building more momentum in the economy that we are very hopeful of that second half of our year is we'll see recovery.

Our team in China just completed a forecast in the last couple of weeks.

This is our outlook is based on their forecast and incorporates what they are seeing in ordering trends and from their conversations with customers.

We do see that picking up.

And then on the aerospace and defense, it's sort of a mixed bag.

The commercial side, it's stronger and offsetting the weakness we are seeing on the defense side.

We are working on some more significant defense programs.

But those are going to help us in the out years, a couple years out.

Right now it's a mix.

Commercial strong, being offset by a weakening on the defense market.

Richard Eastman, Robert W Baird.

Could you just split out the Asian growth rate by engine and industrial?

Maybe speak to the 3% non-disk drive impact growth number.

The 3% excluding disk drives split between engine and the rest of industrial.

Yes, yes.

Is that possible on short notice?

In total, in local currency terms, the engine business in Asia was up a little over 3% and as we mentioned, total industrial was down about 12%, excluding special applications.

The rest of industrial was up between 4% to 5% in local currency terms.

The softness was broad based and, again, one can look basically to the China PMI and then obviously the Chinese New Year's was in there.

Basically as you look to the second half and you expect an improvement in Asia/China, is that both pieces of the business?

Or does engine maybe lead that?

We see it in essentially all pieces of the business.

And then can you give us what China sales were in the quarter?

Or an annualized rate?

Two seconds, Rick.

Bill, maybe I'll jump to the next question real quickly.

The IFG business, that 8% growth rate was, I thought, a pretty good number.

Are you seeing a material kind of measurable impact from the Torit dust collection systems in that IFG number and also, is there anything at our conference back in the fall you talked about the bag house business being a big opportunity for PowerCore cartridges.

Is there anything in there that is starting to be measurable?

Yes.

A significant portion of these new Torit PowerCore systems, we are selling those into applications where we really didn't have -- it was a bag house product before and we didn't really have a significant market share.

It's both a significant first fit opportunity for us, as well as what I talk about with the replacement filters.

So yes, it's allowing us to play in some segments where we didn't really have a perfect product before.

Then on your China question, our sales in China in the quarter were $31 million.

And that -- for the first half they were $66 million.

When you were talking I think it was either you or -- might have been Jim, but when you were talking about the CapEx and you split out the quarter pieces here.

The one piece you mentioned, 25% was for technology initiatives.

Is that basically -- can you explain that?

Is that tooling or is that just pure research?

How does that end up in CapEx or what is that?

What that is, is a combination of IT type technology initiatives to improve the business, as well as technology initiatives in our labs and our product development.

It's more of a systems upgrades or spend?

I understand.

So it's more systems and labs and equipment related to the labs.

Brian Sponheimer, Gabelli and Company.

Just had a question for you on return of capital going forward.

Obviously, dividend policy and tax treatment thereof is an issue on the front page today.

And you didn't repurchase any shares in the quarter.

Thinking about some sort of major policy change regarding dividends.

How does that affect the Donaldson strategy going forward?

Major policy change of the government or at Donaldson?

Well, yes, if dividends start being taxed at 39%.

We will wait and see on that.

I will say as of today, our policy remains the same and it's been very consistent for the past 20 something years.

Our dividend policy is to pay out between 20% and 30% of the average of the prior three years EPS.

Over the last probably half a dozen years we've really targeted to stay in the upper half of that range, 25% to 30%, which would give us sort of an approximate 1% yield.

We don't promise that, but that's what we've decided we would do.

On share repurchase, historically we've targeted 3% gross which should result in a net 2% reduction per year.

We moderated that a little bit in the last couple of years to say we might want to use more of the cash there for acquisitions.

A 2% gross, but we also commit that we are going to buy enough each year at a minimum that options would never be dilutive.

As you know over the last 20 something years, we've averaged a net 2% reduction and share count has always gone down.

I would say at this point, we are going to maintain the course.

If there is a significant change in the tax treatment of dividends, we will take a look at that.

What we are trying to do there is deliver a combination of components of value for our shareholders and that's the way we have been doing it, but we will revisit that if there is a significant change.

(Operator Instructions).

Eli Lustgarten, Longbow Securities.

Just one clarification on China.

Given the size, which is $130 million annual rate at this point, if Chinese markets didn't pick up for the rest of your fiscal year because your consensus now is post-July, that really won't have any material impact on your guidance, it's $0.01 or $0.02 or something like that.

Is that fair?

We haven't quantified that and I will point back to the guidance that we gave.

We think that it will pick up.

If it didn't then we will revisit our guidance at the end of the next quarter.

Reports from our people and what we saw before Chinese New Year would suggest that the Chinese government is trying to move the growth rate back up and that's --

That's a macro call the Chinese PMIs in February came out at 49.7 and not much change and what we are hearing all the economists now have given up the post-Chinese New Year up turn and put it in July and that's why I asked the question.

I want to know if this has any -- I don't know what's right or wrong.

Asking about the magnitude of the impact.

I will leave you two thoughts.

One is that our share in China is small in many of our markets.

To some extent, the overall economic indicator is we want to grow faster than the markets anyway.

Again, we have to share upside to do that.

That will be one thing I would mention.

The other thing, to your point though, is if the Chinese economy remained in the doldrums as you are suggesting is a possibility.

It would impact our business in China and some of the other businesses in Asia because, as I mentioned in my comments, our businesses in South Korea and Japan serve customers that are exporting into China.

There is some rollover effect outside of China, given how fast or how slow the Chinese economy grows.

You gave us the Japanese business is about $130 odd million, $120 million to $130 million, the Chinese business running the same annual rate.

How much is the rest of the other parts of Asian business?

What's total Asia at this point?

Asian total is about 20% of our sales.

About 25% of our sales.

Asia is a little over $0.5 billion at this run rate.

Japan and China on their own make up about 50% of our Asian sales.

Now you talk about in the new food business winning six OEM platforms.

Can you give us the type of platform that those are mostly construction equipment platforms or is it multiple customers, or one major customer putting on multiple platforms?

It's multiple customers.

It's around fuel filtration and it's both on road and off road.

Do you have any targets set for the next 6 to 12 months of how many more platforms you think you can do on that?

We do internally, but we haven't made those public.

We are trying, obviously, to win every one that we can.

We do have targets that would support the growth plans that we laid out in terms of the revenue numbers that I mentioned earlier in the call.

And are we seeing anything in the order patterns from most of the markets that would prevent your slight improvement in operating margins in the second half year over year at this point?

Sort of what you've indicated you are striving for.

I don't see anything that would prevent that from happening at this point.

Is there anything?

Anything could happen tomorrow or next month or next quarter.

Right now, this guidance that we are providing is very fresh and it is based on a forecast from all of our leaders and businesses from around the world.

I think we're, as Jim mentioned, that doesn't mean that we are not continuing to reassess what's happening out there and we are being conservative in terms of which investments or in terms of head count we are adding because there is some uncertainty around what's happening in Europe, or to your question, around China.

The forecast is -- the incline is drying so it is very fresh and that is our best guidance at this point.

Can you talk a little bit about what you are seeing acquisition-wise and whether that's taking a little more important priority around the Company over the next 6 to 18 months?

I would say we are still mostly an organic growth story.

You followed the Company for many years so we want to get about 7% or 8% of our revenue growth per year through organic growth and that's what we have done over the past two decades, so we think we can continue to do that with investments we are making in technology and sales and distribution.

That leaves about 2%, roughly from acquisitions.

At our current size, that would mean we would have to acquire a company with sales of about $50 million each year.

We are always looking.

We remain mostly focused on organic, but we do have a small team focused on acquisition looking.

But we were patient.

We have our financial metrics that an acquisition would have to deliver so we look at a lot and then walk away from a lot, but we are always looking.

The pipeline, I don't think it's any better or any worse than it was six or eight months ago.

There is some activity but not a tremendous amount of activity.

We are always looking to see what's out there.

There appears to be no further questions.

Please continue with any other points you wish to raise.

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

I would like to especially thank my almost 13,000 colleagues for their efforts and contributions in creating the wonderful results we delivered in our second quarter.

This quarter demonstrates further significant progress in our execution of our strategic growth plan with our objective of building our Company into first a $3 billion and then a $5 billion filter company.

Thank you all and have a great day.

This concludes the Donaldson's Q2 FY '12 conference call.

Thank you for participating.

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