Donaldson Company Inc (DCI) 2013 Q3 法說會逐字稿

Good morning, ladies and gentlemen.

Thank you for standing by.

Welcome to the Donaldson Company's fiscal year 2013 third-quarter conference call.

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

Following the presentation there will be a question-and-answer session, and instructions will be given at that time.

(Operator Instructions)

And, as a reminder, this call is being recorded today, May 17, 2013.

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

Please go ahead, sir.

Thank you, Greg.

Following this brief introduction, Bill Cook, our Chairman, President and CEO, and Jim Shaw, our Vice President and CFO, will review our third-quarter earnings and our updated outlook for the balance of fiscal '13.

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'd like to turn the call over to Bill Cook.

Bill?

Thanks, Rich, and good morning everyone.

There are three key messages that we're going to spend the majority of our time discussing today.

Just to summarize, the first is that economic conditions are still challenging in a number of our end markets.

Second, that, despite these conditions, by aggressively focusing on what we can control, we are operating our Company very well.

A few examples of this include our record operating margin percent and our second best quarter ever for cash flow generation.

And third, or finally, we remain confident of our long-term growth opportunities.

And are continuing to execute and invest in support of our strategic growth plan.

I'll begin by discussing our third-quarter sales and then Jim will discuss our operating performance.

And then I'll conclude our presentation by discussing our outlook.

So now talking about our sales by segment, the story in our Engine Products segment is very similar to last quarter.

Conditions in our ag equipment market, especially for large farm equipment, remains strong.

While our other engine OEM end markets had another weak quarter, with on-road truck sales decreasing 24% and off-road equipment sales decreasing 4%, both in local currency.

Excluding the ag sector, many of our OEM customers continue to schedule their production levels below last year to reflect the drop-off in their end-user demand for new equipment.

And also to reduce their own finished good inventory levels.

Among those end markets that had notable decreases were the North American and Asian heavy truck and the global construction and mining equipment markets.

While some recent economic reports suggest that end-user conditions may be starting to improve in some of these markets, a number of our customers have reported that they are still working to reduce their own new equipment finished good inventories.

Therefore, we believe it will take several more months for our customers' production rates for new equipment to improve enough for our businesses serving those markets to post year-over-year growth.

Now, fortunately, we saw better conditions in our engine after market where we supply replacement filters and exhaust products through both our OEM and independent channels.

Our engine after-market businesses in both the Americas and Europe were up in local currency.

Now I'm going to switch and talk about our Industrial Products reporting segment.

And starting first with our gas turbine business, which had another outstanding quarter, with sales of $69 million, up 35% from the same quarter last year.

Moving to our Industrial Filtration Solutions business, our global sales were down 6% in local currency as a continuing weak capital spending environment reduced demand for our dust collectors and compressed air filtration systems.

And, finally, in our Special Applications business, our sales decreased 21% for two reasons.

First, there was a global decline in PC sales which drove a decrease for our disk drive filters.

And, second, we saw weak demand in industrial end markets which drove a decrease for our membrane products.

Now, fortunately, we continue to see the positive impact from our efforts over the past 20 years to diversify, both by end markets and geographically.

In addition to the help provided by our GTS business, we also had a number of regions which delivered year-over-year local currency sales growth, including Latin America, South Africa, Australia, and India.

I'll now turn the call over to Jim for his comments on our operational metrics before we discuss our updated outlook for fiscal '13.

Jim?

Thanks, Bill.

And good morning, everyone.

Our gross margin was 35.8%, an increase of 50 basis points from the 35.3% in last year's third quarter.

As we noted in our press release, one of the biggest drivers of the increase in gross margin were our continuous improvement initiatives which benefited our gross margin by approximately 100 basis points compared to last year.

Product mix also helped our gross margin, with an increase in the percentage of our sales coming from replacement filters.

Replacement filter sales were 52% in the current quarter compared to 50% last year.

In many of our end markets the utilization of existing equipment in the field is good, which is obviously good for our replacement filter sales.

Slightly offsetting these positive drivers on our gross margin were a higher mix of GTS project sales, as well as slightly lower absorption of fixed costs due to the lower production volumes in our plants.

In spite of these slightly negative year-over-year fixed-cost absorption comparisons, the measures that we have implemented to aggressively control our manufacturing costs, since volumes began declining last fall, have really paid off to minimize the impact of the under-absorption of fixed costs.

As part of these actions, we incurred $600,000 of restructuring costs in gross margin, which did reduce gross margin by another 10 basis points in the quarter.

Our operating expenses declined by $7 million compared to last year's third quarter.

The impact from our ongoing cost containment initiatives and lower incentive compensation reduced our operating expenses as a percentage of sales by 120 basis points.

These cost containment actions helped offset the 90 basis of increases resulting from higher pension expense, the incremental expenses related to our strategic business systems project, slightly higher insurance costs, and the $500,000 of restructuring expenses.

So net-net, our operating expenses were lower in dollars.

And as a percentage of sales improved by 30 basis points compared to last year's third quarter.

As a result of our strong gross margin and operating expense performance, our operating margin was a record 15.9%.

This was up 70 basis points from last year's third quarter, and 400 basis points sequentially from the second quarter.

For the full year, we now expect our operating margin to be between 13.6% and 14.2%.

Our effective tax rate was 29.8% in the quarter versus 29% last year.

In last year's third quarter we had $1.8 million of tax benefits, primarily from a statute of limitation expiration which didn't recur this year.

Based on our projected mix of earnings in fiscal '13, we forecast our full-year tax rate to be between 29% and 30%.

Our third-quarter CapEx was $18 million, bringing us to $69 million year to date.

As we mentioned last quarter, we have responded to the ongoing slowdown in many of our end markets by delaying a number of capital projects that we originally expected to complete during fiscal '13.

We now expect to spend approximately $85 million on CapEx this year.

About $40 million of this is carryover from fiscal '12 projects that were authorized but not spent prior to last year end.

And the balance will be selectively spent from fiscal '13 to reduce capital project budget of $60 million.

However, not all of that will be spent this fiscal year.

The breakdown of this year's CapEx of $85 million is projected to be approximately 20% related to capacity expansion, 30% for our technology initiatives, which includes our strategic business systems projects.

Another 25% is for tooling for new products.

And 25% will be related to cost-reduction activities through our continuous improvement initiative.

We expect depreciation and amortization will be between $64 million and $66 million in fiscal '13.

Free cash flow was $91 million this quarter, which is our second-best quarter ever.

Working capital was an $8 million use of cash this quarter, as an increase in accounts receivable was partially offset by a decrease in inventory and an increase in payables.

Changes in other assets and liabilities were a $26 million source of cash in the quarter.

For fiscal '13, we expect full-year cash flow from operating activities to be $260 million to $280 million.

Our debt-to-cap and debt-to-EBITDA ratios are now at 18% and 0.5%, respectively.

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

And our balance sheet remains very strong, with $330 million of cash and investments.

So with that, I'll pass it back to Bill who will provide additional details on our updated outlook for fiscal '13.

Bill?

Thanks, Jim.

We recently completed our recent sales forecast this week, incorporating the latest data from the market and input from our key customers.

It appears that the weak end market conditions that we have seen with many of our OEM customers may now just be beginning to stabilize.

Unfortunately, we're still not yet seeing the signs that these conditions will materially improve in any of our capital equipment related end markets.

This is disappointing, as we had previously anticipated that by now we would be seeing signs of improvement in many of these markets.

But the general global recovery that we've all been waiting for has just been pushed out further into the future.

And for us this means at least another quarter based on what we can see today.

In total, we now expect our full-year fiscal '13 sales to be between $2.4 billion and $2.45 billion, down slightly from the record $2.5 billion we delivered last year.

For us to be down even slightly from our prior year is unusual, as we posted 21 sales records out of the past 24 years.

But we have dealt with this before and we know what to do.

Now I'd like to review each of our segments.

Within our Engine Products segment, recent forecast announcements from our key global ag equipment OEM customers suggests that their production rates in both the US and Brazil will increase over last year's strong levels.

However, in our other OEM equipment categories we have not yet seen signs that our customer production rates for new construction and mining equipment or heavy trucks will improve materially before the end of our fiscal year in July.

Particularly for new mining equipment, we're now expecting ongoing weak conditions through the end of this calendar year.

In our engine after-market business, we are expecting a gradual improvement, as utilization rates of existing off-road ag and construction equipment, and on-road heavy truck fleets, continues to improve.

And, as I'll talk about more in a minute, we continue to see higher growth rates for our proprietary replacement filters.

So in summary, we expect our full-year sales in Engine Products to be down between 4% and 6% year over year versus last year's record.

Now switching to our Industrial Products segment, our gas turbine sales for the full year are now expected to be up between 27% and 30% over last year.

We have longer lead times in this business than we have in any of our other businesses.

And we can see that the strong sales we recorded, especially over the last two quarters, to now be over.

A significant reason for this is that, as we mentioned last quarter, we shipped several unusually large projects in the last six months.

One of these, the Qurayyah project in Saudi Arabia, totaled $25 million.

And we do not see a repeat of these types of unusually large projects in fiscal '14.

So our fourth-quarter gas turbine sales should be similar to what we shipped in the first quarter this year, approximately $50 million.

While the gas turbine market remains a great long-term growth opportunity for us, due to the absence of any large projects during the next 12 months, and the ongoing weak global economic impact on the demand for new electricity power generation, we expect our gas turbine shipments over the next 12 months to be more similar to fiscal '12's $180 million.

Now looking at the next part of our industrial segment, our Global Industrial Filtration Solutions sales are expecting a mid single-digit percentage decline year over year.

Manufacturing indicators in the US have flattened out in the recent quarter.

However, Europe remains stuck in its longest recession since World War II.

Similarly, manufacturing indicators in China are not as strong as they were a quarter ago.

The better news here is that overall we're seeing good demand for industrial replacement filters, which indicates that, while the demand for new equipment remains weak, there is still a solid level of manufacturing activity that's taking place.

And, finally, in our special application products we're forecasting full-year fiscal '13 sales to decrease 8% to 11% due to ongoing weakness in both our Disk Drive Filter and Membrane Products businesses.

In total, we now forecast our full-year Industrial Products segment sales to be consistent with last year.

If, or should I say when, these ongoing levels of global economic uncertainty are reduced, businesses will be more confident making new investment decisions, which will drive the demand for our customers' equipment, and obviously then for our filtration systems.

But, bottom line, given the high levels of uncertainty in all three major regions of the world, we will continue to focus on those things we can control within our Company and strive for further improvements in our key operating metrics until we see concrete signs of a general business rebound.

Now, as we've discussed in previous calls, we continue to have significant growth opportunities in the faster growing emerging economies.

So even in a weak global environment we're continuing to add sales resources, distribution capabilities and distributors, and actually even OEM customers, in these regions.

For example, in our engine after-market we added 110 new distributors and 830 new part numbers to our product offering in the last quarter.

Another key initiative benefiting us is the ever increasing numbers of filtration systems in the field installed with our innovative filters.

For those of you who have followed Donaldson for awhile, you know that we have a very unique position in our markets, since we are the leader in providing the first-fit air filtration systems to our OEM customers.

We focus on continually developing breakthrough filtration technologies for these customers.

We then use the combination of these innovations and our engineering capabilities to design first-fit systems that provide both better value and performance, as well as helping our OEM customers and us retain a higher percentage of the ongoing replacement filter sales.

We have a number of different breakthrough designs and technologies that we're using to accomplish these objectives.

We now estimate that approximately 30% of the first-fit air filtration systems we're currently manufacturing for our OEM customers are already in this proprietary category.

And in the last quarter alone, we've won another $100 million of new OEM programs which will launch in the future.

Most of these programs were won with our latest proprietary filtration systems, which bodes well for continued growth of our after-market business.

So we feel very optimistic about our future prospects, despite the current uncertain economic environment.

And since most of these new programs we are currently working on will be with new technologies.

One of these technologies that we've specifically highlighted is PowerCore.

It's also a great example of how we invest centrally into R&D and then leverage a new technology into as many applications and as many of our businesses as possible.

We are now very successfully using PowerCore in both our Engine and Industrial segments.

Our engine power core sales in the third quarter were $30 million, up 9% over last year.

Within that, sales of PowerCore replacement filters were up 25%.

On the Industrial side of our business, we sold another 350 Torit PowerCore dust collection systems, while our Torit PowerCore replacement filter sales increased 77%.

In total, for the Company, PowerCore sales totaled $35 million in the quarter, up 6% over last year.

Now to quickly summarize.

The current challenging global industrial environment is both weaker and has persisted longer than we had originally expected or hoped.

But enough about the global economy, which we obviously can't control.

What I want to highlight is the great job the entire Donaldson team has done by proactively running our Company.

As I noted earlier, despite our lower sales, our operating margin percentage was a record.

And our cash flow generation was outstanding.

These performances are the compilation of numerous continuous improvement initiatives across our businesses and regions.

And I want to thank all my fellow employees for their efforts and persistence, which have really paid off.

Our good operating performance is allowing us to continue to invest in our Company for the future, both to support our growth opportunities, as well as to add the necessary infrastructure for the long term.

So we will continue to utilize, grow and expand our global diversified portfolio of filtration businesses.

This has been proven over time to be the right business model for our Company and our shareholders.

Greg, this concludes our prepared comments.

We would now like to open the call up to questions.

(Operator Instructions)

Kevin Maczka with BB&T Capital Markets.

Thanks, good morning.

My first question on margins, you mentioned the quarterly record, very strong in the quarter.

But it looks like the guidance as we go into Q4 suggests a sequential decline of maybe 100 basis points or more.

And it's possible, also by your guidance, that revenues could be higher.

So can you just talk about that, especially in the context of the favorable gas turbine mix?

Yes, Kevin, this is Jim.

In terms of the guidance, as we look forward, we're anticipating similar gross margins to what we saw in this quarter.

Revenues are up slightly, but from a practical standpoint about the same.

We did benefit a little bit this quarter from some adjustments to compensation-type reserves as we looked forward in terms of what the year is going to finish.

And that's the way they are supposed to work.

And we had a couple other smaller one-times.

So we do anticipate in the guidance a little bit higher operating expense.

And part of that's timing of some of our investments that Bill talked about, whether it be the strategic systems project and other investments.

So there is a little bit more OpEx forecast in Q4 versus Q3.

But, still, it would project out to be a very significant finish on an operating margin.

Yes, Kevin, this is Rich.

I think, as you look at your model, we're expecting the fourth quarter operating margin currently to be pretty close to last year's level which was 15.1%.

Okay.

And are there further restructuring gains to be had here as we look out into Q4?

Because, again, it seems like the mix may be slightly positive.

I understand what you're saying about some of the OpEx, comp adjustments, and things like that.

But are there also -- there's always continuous improvement -- but are there also further restructuring benefits coming?

Kevin, this is Bill.

We don't comment prospectively specifically on restructuring.

But we're always looking at opportunities as the businesses continue to shift.

And we are always focused on continuous improvement, as you mentioned.

So we're not forecasting significant restructuring in the fourth quarter.

But we continue to look at it, as we have over the last couple years, for opportunities.

Okay.

And, Bill, can you just clarify your comment on the gas turbine.

It looks like some of the industry orders from some of your big customers have slowed there.

And you made the comment about $180 million.

Was that an outlook for your fiscal '14 or the next four quarters?

Kevin, Bill.

Yes, it's roughly for fiscal '14.

It's probably roughly, preferably both -- next four quarters and fiscal '14 -- around that $180 million run rate.

And, again, that's still a pretty good year for us in terms of gas turbine.

But we just don't have a recurrence -- we had a large number of these large unusual projects in fiscal '13.

Which we are very grateful for but we don't see any of those in fiscal '14.

We see that there might be some out beyond that but none of them shipping in fiscal '14.

And I think just finally on that point, you had thought at one point we were fairly early in a multi-year up cycle in gas turbine.

Has that overriding view changed at all, and this is a temporary pause?

Or how would you characterize that?

Kevin, Bill again.

I'd probably put it in that temporary pause that you mentioned.

The gas turbine business never really grows consistently year-over-year.

It's in fits and starts, as I've looked at it over the last 20 something years.

I think what's probably moderated it over the last maybe six months is just back to that global economic weakness, which has then tamped down the demand for more electricity power generation.

So I think that's what's part of impacting it in the short term.

But longer term, we still think, in this country with how radically the supply side of the equation has changed with natural gas and oil, but natural gas specifically, and that it remains the cleanest fossil fuel.

That we think there's a lot of things that over the next three to five years bode very well for that industry and our business.

Okay, thank you.

Laurence Alexander with Jefferies & Company.

Good morning.

On the new products or the new proprietary platform wins that you mentioned, I think you had said it was about $100 million, is that spread out over three or four years?

Or how should we think about the cadence of that?

Yes, over the next three to four years.

The typical -- we win the program usually a couple years before they actually go into production.

It's when our customers' engineering teams are designing their platforms or their vehicles, and that's when we get designed in and win the platform.

So we win them but the launch will be out a couple of years.

Okay.

And you mentioned that you quantified how much of a tail wind the productivity efforts were.

How much of a head wind to gross margins was the carryover or the drag from investing in the emerging markets?

In terms of -- could you maybe clarify that?

In terms of the -- we always have an ongoing investment in the emerging markets.

Are you talking about the year-over-year margin comparison?

Exactly.

What I'm trying to get at is, in the gross margins in particular, you've been -- or maybe on the EBIT margin level, might be more useful -- you've maintained the level of investment in the emerging markets despite the weaker environment.

So there's going to be a drag associated with that.

I'm just wondering if you have any rough sense for how much that could have been?

Yes, we typically don't break that out because that's something, I think as Jim was suggesting, Laurence, that we're doing on an ongoing basis.

So we could stop it to try and save money in a weaker environment, but we're committed to the pursuit of the long-term growth opportunities so we are continuing to invest in that.

We have some other unusual operating expenses, like the increase in pension expense or the strategic business systems project that we're working on.

And I think we've quantified those in the past, and those are again in the same category.

They are critical for the achievement of our long-term goals so we're continuing to do those, even though they do provide some headwind on our margins and operating expenses.

And Alexander, we don't have any incremental investments in emerging markets this quarter that I would call out, like at times where we would open a new distribution center or capacity.

So the things that are ongoing are more expanding sales force and those types of things that we consider more normal because they are also generating returns.

Got it.

Okay thanks.

Charley Brady with BMO Capital Markets.

Hello, thanks.

Good morning, guys.

Just on the special apps business, can you quantify between disk drives and membrane how much those businesses were down?

Charley, Rich is looking up the specifics.

They were both down.

And, as we mentioned, part of it, the disk drive part of it, which is the larger part of that group, is due to just the weakness in global PC sales.

And then the membrane products is really tied to industrial markets.

A lot of the products and membranes go into industrial filtration applications that we sell when we sell material to other customers.

So those are the two drivers.

And, Rich, do you want to add a comment on the numbers?

Yes, Charley, disk drive sales -- and I'm going to give you local currency results on this -- disk drive was down between 25% and 30% in the quarter compared to last year's third quarter, where we were experiencing a rebound following the Thailand floods.

The membrane business was down between 15% and 20%.

So both had pretty weak quarters.

Okay, that's helpful, thanks.

And then if we could just switch gears back over to Engine Products for a minute.

And what I'm really trying to get a better handle on is the extent of your visibility into your customers' production schedules.

And how those discussions go as you're looking not only next quarter but maybe even beyond fiscal fourth quarter.

I'm trying to get a better sense of how far out do you guys see?

And how the discussions go with the customers.

And what's your comfort level, even looking beyond the fourth quarter?

Charley, Bill again.

We're having those type of discussions on an ongoing basis.

And to be fair, our customers don't have a tremendous amount of visibility.

But I would say we have a pretty high level of confidence over the next 90 days, which is our fourth quarter.

We track internally our backlogs, our open order backlogs, and then we can extrapolate from that.

The other thing is talking to our customers about what they're planning in terms of the OEM side in terms of their build rates.

And that's usually pretty solid for the next 30 to 60 days.

So I would say our guidance on the fourth quarter, our fourth quarter, we didn't see a dramatic pick up in our OEM markets.

Maybe unfortunately we feel pretty confident about that because that's based on conversations and orders we can already see.

But beyond that it's probably too soon to tell.

We'll be talking to our customers later in June and July to see what they're looking at coming into the first quarter of our fiscal '14, which starts in August.

But we really don't have much visibility out beyond 90 days for our OEM businesses.

Okay.

And then just on the gas turbine business, the guidance you have for the year implies a fourth quarter of a minus 8% to minus 17%.

Is that variance there just to this chunky stuff that can slip a week into the next quarter?

Or what's the driving factor behind that delta?

Yes, our guidance says about a $50 million quarter.

And that's after the $69 million we had in the quarter we just reported.

And, as you mentioned, we term -- the technical terms for our gas turbine business by quarter are lumpier, or chunky, as you put it.

There's so many large projects and it's really about which quarter they ship in.

Not to mentioned, the last two quarters we had a couple of these unusually large projects.

In fact, the largest project we ever shipped, the Qurayyah project.

That's not normal business that we see.

We love the business but it's unusual and we don't see something like that recurring.

So a $50 million fourth quarter, which we still see as a pretty good quarter on terms of historically how gas turbines performs.

Great, thanks very much.

Andrew Obin with Bank of America Merrill Lynch.

Yes, good morning.

Just looking at your Asia exposure and Asia contribution in the quarter.

You did say that you're really focused on emerging markets but Asia has been a drag.

Are you seeing anything different in Asia?

And beyond a broader macro framework, what gives you confidence that Asia is going to come back over the next 6 to 12 months?

Good question, Andrew.

We start by reading reports like you publish, so that helps us always -- I'm being a little bit facetious.

I think we're -- our Asian business is a couple of different maybe buckets I would put it in.

We have our Japanese business, which was down a lot, which is very tied to the OEM on-road and off-road equipment markets.

And we referenced that in our guidance, that, that continues to be pretty weak.

We have our China business, which they didn't have -- they had a pretty good quarter all-in but it was, of course, different by end markets.

We are hoping that, that's going to start to get sequentially better.

We take a look at customers in China like Caterpillar, who have reported that their excavator production was up in the last month, and that they've burned through all the inventory that they had built up last year.

So I think that gives us the confidence for China.

And I think, to some extent, what happens in China also can positively impact the rest of East Asia, like Japan and South Korea.

And then, finally, the third bucket is the other economies, like India, which had a very good quarter, and Southeast Asia.

Which we still put all those in the emerging category where our market share is low and we have the opportunity, maybe despite the economic conditions, to continue to grow.

So that's the way we look at Asia, Andrew.

A lot of it's driven by that whole China story.

And we think that the inventory is being burned off and that we're still going to start to see sequential production rates -- on a sequential basis, production rates going up.

On the US, just another macro question.

What are you guys seeing specifically on construction related markets in the US?

Because, by and large, I think results in calendar Q1 were weak with anything construction related.

It seems like people think that we're going to accelerate in the second half of the year.

But are you guys seeing things actually getting better in April and May?

Or it's still a wait-and-see approach?

And you've clearly stated that you think the market has bottomed.

I'll start with the punch line.

We think that we're in a wait-and-see.

It's a mixture, I think, what's happening.

And I'll put the construction and mining together because when we look at our customers it's hard to pull it apart.

But we see the mining market, as we mentioned in our comments, we see that's going to be down or stay down for probably the rest of this calendar year.

This is new equipment.

We think the parts business for mining is still good.

They are still running equipment, they're just not buying any new equipment.

Then looking at construction, if you take a look at the non-res, that's still pretty weak.

There's not a lot of uptick there.

Now, conversely, the residential construction is doing better.

So when we take a look at non-res and residential construction spending, the first one is down, the second one is up.

So there is a mixture.

And then we look to the guidance that customers like Caterpillar are pointing towards for the second half of the calendar year, and we try and factor that all in.

So we take all those pieces and put it all together.

Thank you very much.

Richard Eastman with Robert W. Baird.

Good morning.

Just a couple thoughts.

The off-road business, just to follow on what you were talking about, I was surprised in the quarter in Europe -- a good quarter, 8%-plus, I think, in local currency.

Is there any particular end market exposure there or is that again more ag driven?

Rick, Bill.

It's ag driven and we're launching a new ag emissions program actually in Europe that's helping quite a bit.

So it's ag end market and a new platform we're launching.

Okay.

So we'll be a bigger participant in their emission market than we have been here in the US?

That can be a nice driver there?

Yes, we're going to be a bigger participant, yes, in the ag emissions in Europe than we are in the US.

Yes, that's true.

Okay, And then switch over to industrial.

Again, in the IFS business, again maybe a little bit surprised that Asia was weaker than Europe.

I'm curious, is there any particular exposure in Asia in IFS?

Or is that just maybe a comp issue year-over-year?

Rick, probably part a comp issue.

And then part is just we take a look at the Japanese industrial market, which is down a bunch.

And I talked about Japan earlier, just in terms of the capital equipment related activities in Japan are down.

And then China.

On the China, we believe that, that will start to improve going forward.

I'm not quite as sure as when the Japanese one will.

Rick, we had an increase in China last quarter, down a little bit this quarter, again.

It seems as a younger business that it's still a little bit more volatile versus our more established Japanese business.

So I'm not reading too much into it yet because it's a one quarter.

We don't think it's a trend at this point either way.

(technical difficulty)

Is that more dust collection or compressed air?

That would be dust collection.

It is, okay.

And then just a question, Bill, on the high purity business.

Given what we're seeing maybe in the PC market and this movement towards flash versus disk drive, do you feel that this is a cyclical soft spot?

Or is there a secular shift there?

And if there is, and it impacts your business, is there other areas within high purity that you're targeting to grow?

Rick, Bill.

Great question.

I think on the disk drive business what we're seeing there is a couple of factors.

One is just weaker global economic conditions.

People and companies are spending less -- or, are investing less in new PCs.

And so there are fewer hard drives, and fewer hard drives mean fewer filters.

When we take a look at industry volumes, they've been stuck at around, I think, about $580 million, is the estimate for hard drive annually.

And the forecast for this year is about the same as last year.

We do not see the hard drive market growing like it has over the last 10 to 15 years because of the reason that you mentioned with the move towards tablets and smartphones.

Which people are using in conjunction with PCs but they're not buying as many PCs because they are buying more of the other stuff.

So I think prospectively we think it's going to be maybe a mid or low single-digit growth market.

Still not bad.

That's still pretty good but not like we saw over the last 15 years.

I don't think the tablets and smartphones are going to replace hard drives because all of these devices continue to increase the need for more and more storage somewhere, whether it's in the cloud or computer rooms or whatever, which is done best on hard drives.

So whether it's digital cameras or smartphones or iPads, they create more storage needs.

So hard drives are still going to be a good business.

It's just not going to grow at the mid teen rate that it approximated over the last 15 years.

Okay.

And do we have, is there a couple other projects?

I know we've talked about some different medical products.

Is there a couple other things that we could start to maybe focus on a little bit to drive some growth in that high purity?

Thanks, Rick.

That was the final part of your question which I forgot to answer.

We are.

Over the last couple years, Peggy Herrmann, who leads that combined business, has been looking at taking the capabilities that we have in disk drives for making high precision, very small filters in high volumes, and where else we can use that.

We're finding applications in hearing aids, some medical applications like ostomy bag vent filters.

The new headlight need breather filters -- vent filters.

So, again, using the same technology and the same manufacturing capabilities.

That business is now about -- Rich?

It's on a pace to be about $12 million to $15 million this year, up about 50% over last year.

So it's still small but the percentage increases are high.

And we see a good opportunity there to start to fill in, with those higher growth rates on that smaller base, fill that in on top of the disk drive, using the same technology and capabilities.

Okay, excellent.

And then just one last question, Rich.

Can you just tell me what the FX impact year-over-year will be now for the fiscal year?

Our currency model is broken down, as the emphasis has shifted to the yen.

We'd been using the euro.

It still would be fractional, like not more than 1% negative impact, correct?

This is Jim.

That's correct.

The yen has gone unfavorable from a translation basis, and the euro held in there.

So for the full year, right now we're down $10 million, or 1.6% year-over-year through three quarters.

It's probably about $5 million or so.

So it might bring it down to maybe 1% as we look.

The year-over-year euro comparison is favorable but the yen is unfavorable.

Okay.

So just minus 1% for the full year all-in including the fourth?

Somewhere in that neighborhood, yes.

Okay, very good.

Thank you very much.

Stanley Elliott with Stifel Nicolaus.

Good morning guys.

Thank you for taking my question.

On the Industrial Products business, within the margin section there, nice improvement.

Is that more or is it strictly the mix of from the gas turbine business?

Or what all is going on in there?

From quarter-to-quarter?

Yes, from quarter-to-quarter.

Yes, it's a combination of things.

All of these cost improvement initiatives have benefited both businesses -- Industrial and Engine.

I think the other thing that's helped us quarter-over-quarter is, Bill mentioned last quarter we had these very large, specifically one very large, GTS, or gas turbine project.

Those very large projects, just given their nature of pass through, in terms of material content being large, do tend to sometimes skew our margins down on the first-fit.

So gas turbine, the sales we shipped were good margin projects this quarter, so that's one improvement.

And then the other one is just all of the improvement initiatives that we've talked about.

We did have a little bit of a positive mix first-fit versus aftermarket also, with better sales of replacement filters in IFS, in particular, as the investment environment for new industrial equipment is still challenged.

When you talk about the mix impact from gas turbines, is there any way to quantify how much of a headwind it was or will be for fiscal '13, especially as we're looking out towards '14?

For this quarter we calculated that was about a 40 basis point impact.

And I think last quarter it was closer to 100 basis points.

And I think it was similar earlier in the year to maybe this quarter.

So I'd say if you average out the quarters, it's probably about a 50 basis point to 60 basis point type of a head wind on the Company overall.

Okay.

Switching gears to the balance sheet, cash flows are improving, taking the CapEx down.

What are your plans for the near-term maturities that you have?

Is there any thoughts on getting more aggressive with taking advantage of the very favorable debt market sales?

Or what are your thoughts, generally speaking?

We're watching what kinds of opportunities are out there.

As you know, we have been somewhat quiet over the last couple years on acquisitions but we're continually looking.

And our plan is, over time, to add 1% to 3% of our revenue growth through acquisition over time.

So I think we'll probably take a cautious approach here.

And to the extent other opportunities present themselves, we'll take advantage of the debt markets.

But I think our current intention now would be to pay down the current maturity with our available credit lines.

Great.

That is all I had.

Thank you very much.

Eli Lustgarten with Longbow.

Good morning, everyone.

What percentage of your business is actually mining related?

It's between 20% and 25% of what we call off road.

So, as a total percentage of the Company, it would be less than 10%, maybe about 5%.

5%, that business, okay.

And just on the balance sheet you talked -- one of the things you didn't do in the quarter was buy any stock.

Do you expect to reaccelerate in the fourth quarter and look out, maybe take advantage of the financial strength that you have?

Or is there something else going on that, not to see you get to your couple percentage share of sales.

Eli, this is Bill.

You've followed us for a long time.

You know we never comment prospectively on whether we're going to buy stock back.

But I can say, generally our target is always to -- we look at stock repurchase in two pieces.

The first is always to buy enough each year that options are never dilutive and that the total shares outstanding go down.

And we already did that in the first half of the year.

We purchased 1.2% or about 1.8 million shares.

So we already got the first part of that done, and then some.

And then we're opportunistic above that.

Our target would be to try and reduce shares by about -- or to repurchase roughly 2%, or sometimes a little bit more on a gross level.

And so we take a look at that, reviewing where the stock price is and other possible uses of the cash.

So we're always looking, so we'll see what we can do in the fourth quarter.

We don't make any commitments since we've already gotten the first piece done.

Now, is there anything in the gross margin and operating margin improvement that would prohibit you showing normal manufacturing leverage, assuming volume picked up -- we're talking fiscal '14 -- that would lead us to probably higher margin, probably better margins than I think we've anticipated, that we talked about?

Yes, I think, as we've gone through other downturns like this, say, four years ago, I think we saw two things when business recovered or rebounded.

And it really depends on the slope of that rebound.

Sometimes if it comes back really steeply or very aggressively, it's actually hard to ramp up to get our plants up.

I want a rebound, and I'll take it in any form or fashion it comes, but I'd rather that it didn't come back where we went from foot on one pedal, and then the brake to the accelerator.

Because that would be a little bit hard to handle.

But there are -- some part of the expenses are variable, as well.

So some of the things that we've been controlling, like travel and other expenses, would come back with a rebound.

Certainly the incentive comp would come back, hopefully, with the rebound.

So we would get operating leverage, and that's what we're striving for.

That's what we got coming out of the last -- out of the recession, I shouldn't say the last recession -- the recession.

And I think we'll get some out of this downturn.

But it's not all upside because you have to make investments to capture that rebound, as well.

And could you give us some help, we talk about you just won $100 million in platforms.

That comes up every couple of quarters.

Do you have any guide to give us of what kind of incremental volume you can look at for '14 and '15 from new wins.

I know all these things are spread out but do you have some sort of a guideline of how to look at '14 and '15?

Not worried about what the market is doing but for new incremental platforms and projects that you've won recently, that would help us with what gains we'd get from those.

Eli, Bill again.

We have our strategic plan to grow the Company into $3 billion by fiscal '16, and $5 billion in sales by fiscal '21.

When we finished last year, fiscal '12, we were ahead of the pace to do both of those.

This year we're coming in even a little bit less than last year.

So I would say we're not off the pace, we're probably back on the pace.

We still see -- and obviously the exact year might be dependent on how long things remain stuck like this -- but our best guess right now is that we're on track to get to the $3 billion in fiscal '16.

And that $100 million in OEM programs is one example of the pieces that we're working on and that are part of getting from where we are today to there.

I understand.

What I'm trying to get at, is that $100 million that you just won, you said it's probably over three or four years, it was $25 million a year, I was wondering if you have a lump sum total of some of the things that you've won to say that in '14 we'll probably see $75 million or $100 million of incremental wins flow through.

That's what I'm actually looking for.

Yes, we haven't quantified that, Eli.

Okay.

And one final question.

You talk about mining being weak all year, gas turbine you gave us.

You haven't heard anything from any of your other OEM guys about any problems with improvement.

The truck one is probably the easiest one.

We know it's down in the first.

We know the production is down in the second.

But there's been enough orders in trucks that the second-half comparisons are very easy.

Even if production stays flat in the second quarter you get positive comparisons.

And that would be true in construction equipment also.

None of your OEMs have given you any guidance that things may not just work out according to the current plans, have they?

No.

And I think, just talking on heavy truck -- and you're right.

When you take a look at the comps, they have some pretty easy comps right now.

But when we take a look at some of that, we tend to look at that more on a sequential basis.

And as we saw in April, Class A truck counters were up 6% sequentially.

Those are the things that provide us with the confidence in terms of, as we look at fiscal '14, that businesses will start to improve.

All right, thank you.

Brian Drab with William Blair.

Good morning.

Most of my questions have been answered so I'll just be brief.

On the Engine Products side, it looks like your guidance is implying that you'll be about flat sequentially, maybe up a touch.

Can you talk a little bit just directionally about the sub segments, and which will be maybe up slightly, which down slightly?

Brian, Bill here.

I think you're right.

I think what we're seeing is some sequential improvement from the third quarter to the fourth quarter in Engine.

And I think most of that improvement is driven by the aftermarket business.

Okay, great.

And then you gave a statistic that I'm not sure that I got it exactly, around PowerCore.

Actually the proprietary product you said were 30% of something.

Could you repeat that statistic?

And then, also, a follow-up question is what portion of that proprietary product is actually PowerCore?

Brian, the statistic is 30% of the first-fit air systems that we're shipping today are proprietary.

PowerCore makes up 40% to 50% of that.

Okay, great.

Thank you.

Hamzah Mazari with Credit Suisse.

Good morning, thank you.

Bill, just a question on, if you could just talk about how different is your visibility right now in this particular environment, relative to years past?

If we look at your track record, I think you've never cut guidance in about 19 years.

You've cut it in the downturn twice and now again.

Maybe help us understand, how different is this operating environment for you guys relative to past cycles, and how is your visibility different?

Hamzah, Bill here.

This cycle is different than all the ones I've experienced in my career.

And maybe all of them have been different in some ways, so maybe that's not that unusual.

This certainly isn't like four years ago when the bottom dropped out of almost everything at the same time.

What we're seeing in many of the capital equipment related markets.

So, whether that's on the Industrial side with dust collectors, or the Engine side with on-road and off-road equipment, that's just sort of stuck.

People aren't willing to make those investments.

The aftermarket side is more vibrant because a lot of the equipment that's out in the field is still running and still being serviced, and filters need to be replaced.

So part of what we see is that on the OEM side, is that our customers are waiting until the last possible moment to provide us with the orders.

So we have a lot less visibility, whether it's an on-road heavy truck or construction or even ag equipment, than we did, say, 15 months ago.

And I would say that's really globally.

So they are waiting longer until they actually desperately need the product before they place the order.

So we're not getting as much in the backlog.

And, I think as I was trying to say earlier, beyond 30 or 60 days we just don't have a lot of visibility precisely around what the order levels will be.

But we spend a lot of time talking to our customers to try and get some sense of what they're seeing.

If it's not in the numbers, just qualitatively beyond that.

On the aftermarket side of our business, the replacement parts, we have almost no visibility.

As Rich and Jim have mentioned, that part of our business has held up and is a higher percentage of our total.

But that's also the shortest visibility part because the dealer or distributer can call today for a dust collection filter or for a heavy truck filter and we're going to ship it today.

So it actually never shows up in the backlog.

Unfortunately, we have less visibility than I would say we had 15 months ago because of those conditions.

Right.

That makes sense.

And just the last question from me.

You touched on acquisition.

Could you talk about what you're seeing, could you talk about your acquisition pipeline?

Is it as strong or as robust as it was before?

How are you sourcing deals?

It seems like you haven't done a deal in a long time, but you have this target of 1% to 3% revenue growth from acquisition.

Is it because some of the larger players are just boxing you out, multiples are high?

Or is it that the pipeline has gone down?

Hamzah, Bill.

I think the pipeline is probably about the same as it's been the last couple years, since we came out of the recession.

During the recession there just weren't really any properties.

People didn't want to sell a business during the recession because of however it was operating or what they thought they could get for it.

The challenge that we've had for the last couple years is there's a lot of money out there looking for deals, whether it's strategic or non-strategic buyers.

And we have our financial metrics in terms of earnings accretion and ROI that we target.

So we've ended up -- we have a small team focused on it, and we've ended up pursuing some deals, but not being able to close them because we couldn't justify the prices they went at.

Somebody else could.

That's fine, but we couldn't.

I think our strategy is to try and focus on smaller deals that tend to be bolt ons to our business.

Smaller deals is more of a likelihood that if we can keep it a proprietary process, pay a fair price, and then it also fits our model.

We're not greatly acquisitive.

2% of our revenues this year would only total about $50 million.

So they're not -- we're biased towards smaller deals, and those are the ones we keep trying to pursue.

We're always looking but, you're right, we haven't done one in awhile.

Right.

Okay, great.

Thank you.

At this time I would now like to turn the call back over to Bill Cook for any closing comments.

Thanks, Craig.

And now to conclude our call, first I'd like to again recognize and thank all my fellow employees for their contributions to our great operating performance.

And I'd like to thank everyone on the call for your time and continued interest in our Company.

Thank you all and have a great weekend.

Goodbye.

Thank you very much.

Ladies and gentlemen, that will conclude the conference for today.

We do thank you for your participation.

You may now disconnect your lines at this time.