Thank you for joining the Donaldson Company Second Quarter Fiscal 2008 Conference Call. Hosting the call today is Bill Cook, Chairman, President and Chief Executive Officer; and Tom VerHage, Vice President and Chief Financial Officer. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. [Operator Instructions]. This conference is being recorded today, Tuesday, February 26th of 2008. I will now turn the conference over to Rich Sheffer, Donaldson's Assistant Treasurer and Director of Investor Relations to begin the call.

Thank you Vince, and welcome everybody to Donaldson's 2008 second quarter conference call and webcast. The order of business today is following my introduction, Tom VerHage, our Vice President and CFO will give us a brief review of our second quarter operating results. Tom will then turn the call over to Bill Cook, our Chairman, President and CEO, who will discuss our positive outlook for the balance of fiscal 2008 and the business conditions shaping that view. Following Bill's remarks we will open up the call to questions. Before I turn the call over to Tom I need to review our Safe Harbor statement with you. Any statements in this call regarding our business that are not historical facts are forward-looking statements, and our future results could differ materially from the forward-looking statements made today. Our actual results may be affected by many important factors, including risks and uncertainties identified in our press release and in our SEC filings. Now I'd like to introduce Tom VerHage. Tom?

Well thanks Rich, and good morning everyone. Well, as you saw in our press release late yesterday, we reported another quarter of record earnings. Thanks in part to our continued strong top-line growth particularly outside of NAFTA. Stronger foreign currencies boosted our sales by 5 percentage points. Our sales growth was once again broad-based, with each of our regions participating and for the most part all of our product lines with the exceptions being our Gas Turbine business which as you know it can fluctuate greatly on a quarter-to-quarter basis. And our NAFTA Heavy Truck business, which as expected had a $15 million decline in the quarter. Given the top-line growth, we have now seen in the first half of our year, and the continuing strength in a number of our end markets, we have increased our full year sales growth outlook in our Engine segment to 10% to 12%. And in our industrial segment our sales growth estimate is now 14% to 16%. So, while we had a good quarter, it could have been a better quarter. We have talked for some time about our efforts and investments to enhance our distribution capabilities on a global basis. You may recall last year that we converted a manufacturing plant in Belgium to a distribution center, and implemented a new warehouse management system. After some initial start-up in efficiencies, that project is proving to be a success. In January of this year we went live with the same warehouse management system at our distribution center in Indiana. Despite our efforts to properly plan and test this implementation, issues quickly arose in order management, shipping and document processing. This led to inefficiencies and delays in processing customer orders, and our press release discloses the $2.1 million cost impact of these issues and…

Thanks Tom and good morning everyone. I think there are two takeaways from our second quarter release. The first is that our model of continually building upon and expanding our portfolio of filter businesses really does work. And the second is that despite the operational challenge Tom discussed and which we are working through, we had a good quarter of both sales and earnings records. Now I'd like to briefly review a few of our second quarter highlights. We saw continued growth in NAFTA with sales up 4%. I should also add that this was despite and including the downturn we are still experiencing in the North American heavy duty truck market. This 4% overall increase in NAFTA, was driven by strong performances in our Filtration Systems for Ag equipment and defense applications, and our engine aftermarket business. Our international businesses also had a good quarter with revenues up 5%, excluding the impact of foreign exchange. Here are a few of our highlights within our international numbers. In our European engine products business, we saw strong performances in both our OEM truck and off-road equipment businesses, as well as our aftermarket or parts business. In total, our European engine revenues were up 9% over the prior year and this is in euros excluding the foreign currency impact. In our European industrial products business, we saw strong performance in our industrial dust collection business, with our Euro revenues up 10% over the prior year. In Asia, our engine OEM off-road business and our after-market businesses both had strong quarters, with sales up 31% and 10% respectively. Our significant Asian off-road sales increase was driven by strong construction equipment demand for our customers across the Asian region. Our Industrial Filtration Solution business in Asia had a good quarter with sales up 6%…

Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. [Operator Instructions]. And our first question's from the line of Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Hi, good morning gentlemen.

Good morning, Jeff.

Can you just speak to... as you look at the second half, how you're thinking about organic growth, if you take into account FX within the forecast?

Jeff, on the... we don't forecast any change in the exchange rates from where they are today. And then first organic growth versus maybe acquisitions, if that's where it's headed, we can't forecast acquisitions. So we don't have any of those included if we did happen to do something in the second half that would be incremental.

Okay. And then specifically in special applications, I mean that business has been up around 20% in the first half, you are looking for 10% to 15% in the... for the full year. I mean what's driving the significant deceleration there?

I wouldn't probably call it significant deceleration, Jeff. It's... we don't have incredible amount of visibility in that business... in the disk drive market. So, just based on what we see that's what we are forecasting at this time for the full year.

Okay. And then just on the working capital management, I mean, how much of this is a function of this warehouse management system. And working capital's been a little bit on the challenging side last year and end of the first half of this year. And I am just trying to get a better understand of what's really driving that and where do you see the improvement coming going forward?

Jeff, this is Tom. As I mentioned in my comments we think inventory turns are an improvement opportunity for us. So as you look at inventory level increases on a year-to-date basis, there is really three categories there. One is our Gas Turbine growth and there's about $8 million of additional inventory in gas turbine. Foreign currency represents about $7 million of that growth. And then the rest is all distribution related. Now of the remainder we are sending more product around the world, so international shipments are accounting for a portion of that, maybe about $6 million, $7 million. We have ramped up some inventory levels in our DCs. Around the world, as you know, we added quite a bit of distribution center capacity to better serve our aftermarket customers, there's some additional inventory related to that and then we are guessing Jeff at this point that there is maybe about $8 million of that increase related to our distribution center in Indiana where we have some temporary excess inventory. So we are hopeful for inventory turns to improve a bit this year. We are looking for inventories to come down a bit between now and the end of the year. But keep in mind too as we ramp up our gas turbine business that we might be increasing inventories there.

Okay, and then final question. Just as you look at your expansion plans and just given some of the issues you've had on the distribution side over the last four, five quarters. Is there anything on a go-forward basis over the next 12, 18 months that suggests that there is potential issues down the road of a similar magnitude or --?

Jeff, this is Bill. No, there's nothing that we see that would... there will be any repeats of what we are experiencing right now.

Okay, thanks.

Okay.

Thank you. Our next question is from the line of Eli Lustgarten with Longbow Securities. Please go ahead.

Good morning.

Good morning, Eli.

A couple of quick questions, just clarification. The $2.1 million charges in the engine business or is it spread out between the two sectors and the operating profit numbers?

Eli, this is, Tom. It's allocated between both segments but the engine share... the engine segment gets the lion share of that $2.1 million.

And, I guess, I'm looking at the profitability levels of engines and difficulty just stating them [ph]. Just maybe can you make some comments on what's going on in the overall profitability of the divisions? I mean you see a little bit of improvement in industrial products but engine is a... sort of, given the level of profitability that's going on in most of the markets except truck, I'm just surprised to see so much difficulty in the operating margin pieces there?

Well, Eli, this is Tom, I think you are looking at our segment detail and if I have done the math right, for the quarter the earnings before tax last year was 10.9% and this year is 10.4%. So you are probably referring to that half point reduction. It's certainly a good portion of that half point. It does relate to the increased distribution costs. And then, over and above that, every quarter we are going to have some mix issues within the segments, in some quarters there are going to be slightly positive, some quarter slightly negative. So, that's going to account for another couple of tenths of that 0.5 point.

During your comments you talked about the truck business, can you update us... has anything happened for 2010 emissions, we are starting to get a bunch of announcements, and when you factored '09 we are now really beginning to look at the new engines and philosophies. Has anything happened in your business outlook for the 2010 emission for the truck sector at all?

Eli this is Bill. There is nothing new for us and I will go back to comments that we had in our last webcast.

Okay, Bill. And then finally have you seen any change in international business conditions at all, we keep hearing all these worry factors at this point... has there been any change in international business market conditions at all anywhere?

I'll just point to our guidance, Eli, Bill again. We see the international markets generally as being pretty robust.

So, but you haven't seen any recent stuff [ph] and cost price pressures are not hurting you at any great degree at this point?

No.

Okay, thank you.

Thank you. Our next question's from the line of Charlie Brady with BMO Capital Markets. Please go ahead.

Hi, thanks. Just... good morning. Kind of follow-up on what Eli's question was with regard to the pre-tax margin in engine. As that NAFTA starts improving, would you expect that we should get a natural lift just on the year-over-year increase starting in Q3?

Hi Charlie, this is Tom. No, I don't think you'd expect an increase in that margin percent from that mix issue. So I think you should expect margins comparable with last year.

Okay. And on the PowerCore. As you introduce the next generation, are you anticipating or how are you planning for potential, I guess, cannibalization of existing technology or sort of delays on waiting for the next technology to come out?

Charlie, Bill here. We don't really see any delays. The reintroduction's really dependent on the... our OEM customers' launch... designer launch schedules, and this is an advantage for them; this next generation, because it reduces the amount of space and weight that the system requires... so... in addition to other advantages. So it's a big deal for them. So the new technology actually is... the response has been very encouraging. So there's sort of a pull, it's being pulled into the market as we are offering it.

Okay, great. And just final question. On your segment guidance for engines and industrials, the 10 to 12 and the 14 to 16, how much of that is pure organic non-FX, non-acquisition related?

The only acquisition in there, Charlie, this is Bill again, is the one we did last year about this time AFS. And so the year-over-year impact of that is probably about $20 million or something like that.

Actually we did... we closed on AFS last year on March 1, so during this quarter we will have reached that one year anniversary. AFS will still provide some lift because it has experienced some growth this year. We also closed at the beginning of February on a small dust collection acquisition.

All right.

LMC West. It's about $10 million run rate business that will help a little bit in the second half of this year. From a currency standpoint, baked in our guidance is that the rates stay about where they have been here for last month, which as we move further out into the year, we will create less benefit. So, the assumption can be made that organic is providing a little more lift in the second half versus currency.

Thanks a lot.

Charlie, this is Tom. Just to round it out. AFS generates $4 million to $5 million of sales a quarter.

Okay. So, essentially pretty much all pretty good solid organic growth is what it looks like. Thanks.

Thank you. Our next question's from the line of Scott Graham from Bear Stearns. Please go ahead.

Good morning.

Good morning, Scott.

I know and I can hear it in your voice your frustration with this technology stuff going on in the distribution centre. How do you... why is this happing? This is kind of you second go round with this and I know how terrific a planner you guys are and what is sort of... may be give us the next layer of detail here as to why this would have occurred and maybe in answering that question, $7 million of second half cost to the same end. Is that a number that you can really draw a circle around and be comfortable with?

Scott, I'll start and maybe Tom will add some comments. I think what happened last year in our Brugge facility in Belgium was not exactly the same thing that we are experiencing in Rensselaer. What happened in Brugge as we got ready to do this and we... it was a very complicated move, we're moving production out of this facility and at the same time we are converting it into a warehouse and then the business took off. So... and that we had not planned for. So it wasn't a technology thing, it was sort of a combination of maybe sort of Murphy's law factors, the technology works. And as Tom mentioned, the system we are putting into our Rensselaer facility is the same as the one we put into Brugge. The Rensselaer operation is a very large operation, it's a lot larger than Brugge and we ran into... I would say there was a planning issue there and we didn't cover all the bases. So, it's not a second one of those, it's may be the first one of those from a technology side.

And Scott, this is Tom, I'll jump in. We wanted to give you some guidance on what the impact would be in the second half of the year. The $7 million that I mentioned is an estimate and it's simply that. And it's an estimate for an increase in temporary labor. We have more employees at this distribution center right now then we will in another 5 or 6 months. We are also going to be making some revisions to the software, so we have some internal IT effort, incremental effort. We are also going to be using some consultants to help us tweak the software a bit where we are using some 3PLs, third party logistic centers on a temporary basis. So there's maybe a bit of extra freight, and then employees are traveling as well. So, you add it all up, our guess is approximately $7 million. The final numbers are going to be more or less and stay tuned. We'll update you next quarter.

Okay. And on that Tom, if you would -- the comment in the press release that you are comfortable or confident and you will be able to put and get a lot of these shipments out early, they catch up early in the third quarter, does that suggest that most of that seven is in 3Q and stays mostly in Engine or is that more of a steady stay next two quarters.

Yes, Scott, what that comment suggested is that we are going to be caught up from a late delivery standpoint very quickly. However, the extra costs that we are incurring will certainly run into the fourth quarter. So, slightly more of that $7 million should be in the third quarter than in the fourth quarter. And in addition, Engine will continue to get more than half of the allocation of those costs.

Very good. On the sales side, the IFS business and the gas turbines business, two really different questions here. IFS in the domestic market, have you seen any slowdown in that business because of its factory nature and conversely that was still a really good number and... on a very difficult comparison? How much of that... I think was that 9% growth was currency related in IFS this quarter?

Rich is looking up the currency part of that, Scott. I'll start on the -- the growth rates... because we talk about it in our comments and then the press release, we see IFS growth rates higher outside of North America and then in... but we still see some pretty good opportunities in NAFTA as well. On the currency, Rich?

Currency, Scott, IFS benefited by $8.8 million. We do... for all the listeners on the call we do have a currency schedule that you can download off our website on the IR page that will give both the quarter and year-to-date by business unit.

You are saying IFS specifically, was --?

IFS $8.8 million benefit in the quarter.

Okay, which suggests that the real growth was nominal in the business?

It was a few percent on a consolidated basis, right, excluding currency.

Okay, for comparison, okay. The gas turbine business, I know that shipments move around a lot what have you. Would I be correct in saying that the second half shipment activity would be a benefit to mix?

No, Scott, Bill here. From a mix perspective I don't think it's going to provide anything. It's... I mean in terms of you are looking for a margin expansion or something like that it's not... it's close to the average on an operating margin. That's our objective for that business.

Okay.

But we are going to have a lot... but your first part of your question is, yes, the second half is going to be a lot stronger than the first half. We shipped... in the first half of the fiscal year we shipped $90 million and we are talking about a range in the second half of between $190 million and $205 million. So, that means we are going to have a very strong second half. And we can see that based on new orders we have in hand.

Got you. And last question is in the current quarter was mix positive or negative in the company overall?

Scott, Tom here. It was slightly positive.

Thanks very much.

Thanks.

Thank you. Our next question is from the line of Brian Drab with William Blair. Please go ahead. Brian Drab - William Blair & Co.: Hi, good morning.

Hi, Brian. Brian Drab - William Blair & Co.: First in the transportation segment, you were previously talking about a range of $30 million to $40 million decline in revenue for the first three quarters and we're at about $35 million now and you said you are expecting a slight decline in the third quarter. Could you make a comment on whether you think we will still fall within that $30 million to $40 million range?

Yes Brian, we think we will. Brian Drab - William Blair & Co.: Okay. And then in the aftermarket segment, it looks like still relatively strong growth and I imagine that it's obviously much stronger and off road than on road. And do you... could you break that out for us, what you are seeing in aftermarket filter sales for off-road versus on-road?

Brian, Bill here. We don't break it out between whether it's off-road or on-road. Brian Drab - William Blair & Co.: Okay. So... and any perspective from you guys on the outlook for truck utilization for the balance of the year? Maybe some help in how you forecast that?

Brain, this is Rich. Looking at the published data that we get from... like ACT Research as they are forecasting ton miles, which would correlate really well with truck aftermarket... utilization rates for trucks. It was down in calendar year '07 over the prior year to frame. It's... right now the forecast is at... for calendar year '08, it's going to be up but I think their forecast is a little bit weighted to the second half. So I think we are probably in the second half of our fiscal year going to see similar conditions, maybe a slight benefit, but probably not a lot until we get about mid-calendar year. Brian Drab - William Blair & Co.: Okay, and then last question. Within off-road in the first quarter you had a pretty solid benefit, I guess, from military orders. Did you see that same... did that help you get to this 33% growth number in the second quarter and what are you expecting as far as these military orders for the balance of '08?

We see very strong conditions for military business. It's the MRAP vehicles we talked about last quarter, spare parts and new programs. Brian Drab - William Blair & Co.: Can you help us at all understand what that contributed to growth in the second quarter?

Brian, this is Rich again. Our aerospace and defense business was up just a little under $9 million in the quarter. A part of that was due to AFS acquisition as well so about half of that was due to AFS, the other half was growth. Brian Drab - William Blair & Co.: Okay, thank you very much.

Thank you. [Operator Instructions]. And our next question's from the line of Richard Eastman with Robert Baird. Please go ahead.

Bill, the couple of things, on the after-market business, should we think of this $5.5 million of delayed sales being aftermarket or is that distribution center pretty much run through everything OE business and everything?

Rich, it's Bill. It's primarily engine aftermarket, you are right.

And there isn't any risk there of lost share... is there? I mean, are these going to... your kind of captive dealers, exclusive dealers and they all just wait for the filters or would they go somewhere else with the delay.

Rich, Bill again. There is... it's a function of how long the delay is. In an aftermarket or parts business the customer usually needs it's pretty quickly and typically we are selling to distributors who have some inventory. But they don't have a lot of inventory. So, a lot of our focus has been to Tom's comments really on trying to restore the service as quickly as possible and that's one of the reasons that's driven this cost issue that Tom was talking about is really paramount for us is restoring customer service. So, we are throwing some dollars at it to restore the customer service to minimize to your question any possible losses. In short term would there be some, there probably would be if somebody needs a filter today and they can't... we can't get it to a more let's say a couple of weeks ago because today we can.

Okay.

But I think longer term we are doing everything that we can to maintain the relationships that we have.

Okay understood. Then is there... when I look at the aftermarket business, could you just remind me approximately how much of that is NAFTA and how much is international? What is it?

And we are just... we are looking right now Rick to make sure we are not guessing. So --

Right... it's about half and half.

Half and half, right.

Okay, okay. And then I just wanted to circle back for a second on the IFS business, again. The local currency growth rate again was a little bit modest in the quarter. How did the... how did the book-to-bill look there. I know you guys don't like to talk to orders, but I mean was it better than one. I mean was there any... I presume there were fewer shipping days here in the quarter, but --?

Rick, this is Tom. Just approximately incoming orders approximated shipments so --

Okay.

So book-to-bill was fairly flat.

Okay. And you are comfortable that you are not feeling a macro economic impact on that business?

Rick, this is Tom. Certainly not globally, as I think Bill mentioned in his comments there continues to be a fair modest strength particularly outside the United States.

Rick, Bill here. But if I add to what Tom said, because we've been talking about sort of what's happening in the industrial marketplace for good year now, and I think I would go back and point to the fact that our industrial business in NAFTA is outperformed sort of the industry factors for the last year. So we haven't really seen what we've been reading about although again the strength isn't as strong as what we see internationally.

Okay. And then correct me if I am wrong, but again just, I'm going back to maybe the guidance that was provided and again when the original guidance was given out by segment and this goes back to September, because I think we didn't necessarily change the guidance with the first quarter, but we were using about a 1% FX benefit and now as we recalibrate off of FX rates, we would probably be showing more like a 4% benefit this year, is that a fair way to characterize it?

Rick, this is Bill. Yes, that's fair. I think just a point of clarification. We have increased our guidance twice already since September. So we increased it at the end of the first quarter and we just increased it again, and you are right some of that is like the added lift we are getting from currency.

Okay, and then just one last question. If we look at three, six months and maybe it would be even helpful just to look at the quarter. But when we look at price versus cost, is there any positive or negative variance there at the gross margin line?

Rick, Tom here. No, I... we look at gross margins pretty carefully and I don't think particularly companywide there is nothing there to speak of.

Okay, very good. Thank you.

Okay.

Thank you. Our next is a follow-up from the line of Eli Lustgarten. Please go ahead.

Hi, thank you. Just a very quick question. In the tax rate guidance you don't have anything for an R&D tax credit this year, I assume?

We do not Eli.

That would 1% benefit or something like that to you if we have... if it does get reinstated which we assume it will?

No, we haven't really calculated that number and it's comparable to our R&D tax credits from previous years, but at this point it is not in our projections.

Okay. And then one longer-term follow-up. With emissions in 2010 in sort of -- is there any threat to your existing business with the truck sector from the change of admissions if you don't pull... participate significantly. I assume that it just lost some incremental opportunity as opposed to the existing business that would change?

Eli, Bill here. Just overtime the muffler business will go away and we participate in that. So that's maybe on the negative side. On the positive side whether we have... we win the emissions business or not, the whole changes around this technology are actually creating opportunities around... for us around air and liquid filters. So... because the Engines have to run differently and they need better filtration. So, a little bit on the muffler side, there's a risk there but a positive on the air and liquid side.

But you are expecting most of the muffler business, basically the commodity stuff to disappear anyway, weren't you?

Over time, right, yes.

That's okay, thank you.

Sure.

Thank you. And at this time there are no additional questions. I will turn it back Bill Cook for any closing remarks?

Thanks Vince. To all of you listening, I would like to thank you for your time and interest. My fellow of 13,000 employees, I want to thank you for your efforts. I recognize that this hasn't always been easy although you make setting new records look like it is. We are on track to deliver anther great year, our 19th consecutive EPS record. Congratulations and thank you all. Good bye.

Ladies and gentleman, this does conclude the Donaldson Company's second quarter fiscal 2008 conference call. If you would like to listen to the replay of today's conference, please dial 303-590-3030 or 1800-406-7325 using the access code of 3843469 followed by the pound key. ACT would like to thank you for your participation, you may now disconnect.