Donaldson Company, Inc. (DCI) Q4 2008 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Donaldson Fourth Quarter Fiscal Year 2008 Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. [Operator Instructions]. This conference is being recorded September 3rd, 2008. I would now like to turn the call over to Rich Sheffer. Please go ahead.

Thank you, Nicole and welcome to Donaldson's 2008 fourth quarter conference call and webcast. Following my brief introduction, Tom VerHage, our Vice President and CFO will give us a brief review of our record fourth quarter operating results. Tom will then turn the call over to Bill Cook, our Chairman, President and CEO, who will discuss our initial outlook for fiscal 2009 and the business conditions shaping that view. Following Bill's remarks, we'll open up the call to questions. Before I turn the call over to Tom, I need to review our Safe Harbor statement with you. Any statements in this call regarding our business that are not historical facts are 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 both another quarter and our 19th consecutive year of record earnings. Thanks to the continued broad-based strength in our sales growth. Each of our three regions and nearly all of our major product lines contributed to our 16% sales growth, with the impact of stronger foreign currencies being 7.2%. As you will recall, our fourth quarter sales last year, included an extra week of sales in the U.S. which increased prior year sales by $16 million. Looking at the remainder of the income statement, we achieved our targeted 11% operating margin for the year, just like we did last year. For the fourth quarter, our operating margin was 11.2%, which is down from 12.3% last year. This reduction is due to an increase in our operating expenses as a percent of sales. The major drivers of this increase include our business mix in the fourth quarter, information technology spending for our global customer support capabilities, end cost for product development initiatives that include a fourth quarter reclassification of some expenses or some of these expenses from cost of sales to operating expenses. For fiscal '09, we're targeting operating expenses to once again be in the 21% range, compared to 21.5% for fiscal '08. While operating expenses as a percent of sales increased in the quarter, our gross margin percentage also increased. The gross margin improvement is primarily due to the combination of higher production volumes, cost reduction and control efforts, planned productivity improvements and the recovery from customers of some previously incurred program development costs. These benefits are partially offset by the rapid escalation on commodity costs and some lingering impact of the cost associated with the warehouse management system that we implemented earlier this year. As most of you are aware, we use the Last-In First Out or LIFO accounting method for our domestic inventories, which represent approximately half of our consolidated inventories. In times of rising commodity costs, these cost increases are immediately charged to income rather than capitalized in inventory costs. We selected this method decades ago, as it lowers our taxable income, preserving cash flow for business needs rather than making higher tax payments. If you read the footnotes to our financial statements, you'll see that our LIFO reserve for year-end inventories is $38 million. This represents $38 million of lower taxable income over the many years we've used LIFO in comparison to the alternative First-In First Out or FIFO accounting method. And as stated in our press release, this LIFO method lowered our pre-tax income by $5 million in the fourth quarter alone. Like the other companies, we continue to experience significant year-over-year purchased commodity costs in nearly all categories on a global basis. Steel and petroleum based commodities are at the top of our list of cost pressures. We are taking pricing actions in many of our product groups and will continue to negotiate recovery of these costs from our customers. In addition, we remain focused on our own product cost reduction efforts. Because of the rapid commodity price increases that we experienced in the fourth quarter, it may take a number of months before we accomplish all price recovery for these costs. However, we are maintaining our longstanding gross margin target of 32% for fiscal '09. Our tax rate for the quarter was 26.6% and for the year the rate was 27.2%. This is slightly below the low end of the range that we provided last quarter of 28% to 31%. In the fourth quarter, our earnings mix was more heavily weighted to lower tax countries and we received a 1.8 percentage point benefit from a foreign dividend and a favorable resolution of a foreign tax decision. Our tax rate expectation for fiscal '09 is in range of 29% to 32%. Our CapEx came in at $70.8 million for the year, which is down from $76.6 million last year. We provided an estimate of $65 million to $70 million last quarter. It slightly exceeded the upper end of that range due to the stronger foreign currencies in the countries where much of our CapEx took place. Our CapEx outlook for fiscal '09 is a range of $70 million to $80 million and our estimate of depreciation and amortization is a range of $58 million to $62 million. Free cash flow came in at $103 million, which is above the range of $75 million to $100 million that we previously provided. The fiscal '08 performance compares favorably to the prior year amount of $40 million. Our outlook for fiscal '09 is a range of $110 million to $140 million. At this point, we expect interest expense in '09 to be comparable to the current year amount of $16.5 million. Our press release contains our fiscal '09 sales guidance, which is an increase of 9% to 11%. In previous years, our pricing has been relatively flat on a composite basis as we continue to redesign products and take out both content and cost. For fiscal '09 we have built in a 3.5% price increase into our sales to hopefully compensate for a significant portion of the commodity price increases. So we are pleased to be able to report our 19th consecutive year of record earnings, and the fiscal 2009 achieves our expected EPS between $2.30 and $2.40 per share, it will be year 20 of this record string of earnings. So with that, I will pass it over to Bill who will provide more background on our outlook. Bill?

Thanks Tom, and good morning everyone. In the next few minutes and before we open the call up to your questions, I'd like to cover three topics. First, I'll talk a little bit about our fourth quarter highlights, then our outlook for fiscal '09 and then I'll give you an update on two of our growth initiatives. So starting first with our fourth quarter highlights, as Tom mentioned our sales growth was 16% and say that at constant exchange rates, it was 9%. Looking at our fourth quarter sales by region and in local currencies, sales were up 9% in NAFTA, 8% in both Europe and Asia-Pacific, and 19% in South Africa. As you may already know, we have two reporting segments; Engine and Industrial, which are lead by Jay Ward and Charlie McMurray respectively, and I'd like to give you some of their quarter highlights. But before I get started, please note that all of the fourth quarter sales numbers I will cover will be stated in local currency. So they exclude the positive impact of exchange rate movement, and therefore are more indicative of our real business conditions and strength. So starting first with our Engine segment in Europe, our European Engine business grew by 6%, due to good performances and our sales to off-road equipment OEMs as well as sales of replacement filters in the aftermarket. We attribute our off-road OEM growth of 7% during the quarter, to the combination of solid production rates of new equipment by our customers, as well as our own market share gains. Our European Engine aftermarket business grew by 7%, aftermarket growth in the European emerging markets has been as we've mentioned before, one of our key growth priorities. We continue to expand our distribution of sales coverage in the Eastern Europe, Russia and the Middle East. And during the past year, this emerging market initiative delivered a 20% year-over-year sales increase. Now switching to Asia, all of our engine businesses, OEM off-road, OEM on-road and the aftermarket had strong quarters up 24%, 14% and 8% respectively. Off-road equipment production by our customers is strong across Asia, as the heavy construction, mining and ag end markets there remain in the growth mode. Truck production picked up in Japan, leading to our sales increase there. And continued healthy economic activity generally throughout the Asia-Pacific region had demand for our replacement filters growing in the quarter. And now finally in NAFTA, our Engine business is up 3%, off-road equipment sales were up 9%, due primarily to a very strong performance by our aerospace and defense business unit. Their sales were up over 40% in the quarter, due to the combination of continued strong demand for filters for the new MRAP vehicles as well as replacement filters for the military equipment already in the field. In addition, sales by one of our newest acquisitions, AFS of our Retrofit Air Filtration Systems for the Blackhawk helicopters have been very good. On the other hand, our NAFTA transportation business was down 27% in the quarter. Heavy truck build rates that our customers appeared to have now stabilized, but medium and light duty build rates continue to decline. And in our NAFTA Engine aftermarket business, sales were up 8% in the quarter, a strong equipment utilization rates for larger off-road equipment that are used in heavy construction, mining and ag offset the weaker conditions in both the truck and smaller construction equipment related to the housing industry. Now I switch to the other part of our company, the Industrial Group to talk about some of their highlights. So within the Industrial Group, the sales for our Industrial Filtration Solutions business were up 10%, as all 3 major regions grew between 8% and 11%. In Europe, we saw solid demand for our IFS products in Western and Central Europe. Our NAFTA sales were strong for both new equipment and replacement filters. And in addition, our third quarter acquisition of LMC West contributed about 5% of the 11% sales increase in NAFTA during the quarter. Our Gas Turbine business had an extremely strong shipment quarter with sales reaching $60 million, which represented a 26% increase over the same quarter in the prior year. Growth has been good globally in both the power generation and oil and gas end markets we serve. And finally, our Special Applications business set... they closed out a record year with sales up... full year sales up 11%. The fourth quarter sales of our disk drive filters and membrane filtration products were up 2% over a very strong finish last year. Now I am going to switch gears and talk about our outlook for the New Year for fiscal '09. And as you can see in our press release, we have provided our initial guidance and that is for our company sales to be up between 9% and 11%. Please note that this includes the benefit of some pricing as Tom mentioned, but excludes the impact of any potential future acquisitions. It also assumes that exchange rates remain at current levels. So I'll start first with a general overall comment, we are expecting organic volume growth to be lower next year than the year we just ended, as general economic conditions are expected to be weaker in Europe. Now talking about each of the businesses, and starting first with engine. Our full year Engine business sales are forecasted to up between 10% and 12%. Within our Engine business, heavy construction and mining equipment production rates by our customers remain solid. However, production rates for smaller equipments used primarily in residential construction are expected to remain weak. We see our NAFTA truck-related business remaining at current levels through the first half of our fiscal year and then beginning to grow in the second half. It is expected that another pre-buy will begin during calendar 2009, in advance of the 2010 diesel emission regulations. And that the calendar 2009 build rates will increase by 30% to 35% over 2008. However, the exact timing of this projected improvement is difficult to gauge at this time. Our customers ag equipment production rates is expected to remain strong, as the latest reports forecast both U.S. crop prices and farmers' incomes to be up, which is a positive sign for the ag equipment market. And finally, in the Engine business, we expect our aftermarket filter sales to grow, as we continue to create proprietary replacement opportunities for ourselves, and as we focus on developing new markets internationally. Now switching to the fiscal '09 outlook for our Industrial segment, in our Industrial business overall, we see full year sales growing at 8% to 10%. Within our IFS business, which includes our best collectors and compressed air filters, our order backlogs are good and suggest a strong start to the new year. In addition, we should benefit from market share gains from our new line of recently introduced PowerCore dust collectors. As a result, we expect sales growth of 8% to 12% in fiscal 2009. In our gas turbine business, we have good visibility for shipments over the next few quarters. We expect our full year sales growth rate to be in the 5% to 10% as there are now some industry capacity constraints. We still expect that demand for gas turbines and our filter systems will continue to grow through 2011. And finally, we expect our special application business to be up 5% to 10% in fiscal 2009. This is expected to be led by continued growth in our PTFE membrane filtration products business. Now, let me give you an update on two of our major growth initiatives, and the first is PowerCore. We talked about this for quite a while and we continue to be very successful with this breakthrough air filtration technology. Our engine-related PowerCore sales were up 56% in the quarter to $19 million, as first fit [ph] sales grew 26% and replacement filter sales grew 76%. And as you may have seen, earlier this year, we raised the bar again with the introduction of our PowerCore Generation2 or Gen2. PowerCore Gen2 allows us to further reduce the system size or enhance the system performance, which is critically important for our customers, given the new engine technologies and their vehicle space and weight constraints. We have already won 10 platforms, five on-road and five off with Gen2. And 70% of the platforms we currently have in either the proposal or development stage are with our new Gen2 technology. In the gas turbine we are continuing to market... the market introduction of our PowerCore technology. Since introduction, we shipped 32 systems and have orders for an additional two systems already in hand for fiscal '09. And finally, as I mentioned a minute ago, we've now introduced a new line of dust collectors in our IFS business, these new products also use our PowerCore technology, and allow us to deliver a system that is 50% smaller than the traditional baghouse system it replaces. We introduced this product this spring and have been very pleased with this strong initial market acceptance. The other growth initiative I want to cover is our expansion projects and as Tom mentioned, we expect the CapEx to be between $70 million and $80 million in fiscal 2009. In addition to supporting numerous process improvement and cost reduction projects, we have a number of major expansion projects underway to support our continued growth. We recently finished our major expansion of our existing engineer filter plant in Klasterec in the Czech Republic. We are nearing completion of the start up of our air filtration manufacturing line in Brazil. And we should... that should be a production later this fall. In India, we're expanding our existing filtration plant. This expansion essentially represents the tripling of the current facility and is necessary to support the continued growth of our customers in India. And finally, the expansion of our disk drive filter plant in Rayong, Thailand is proceeding on schedule. And we expect to have additional manufacturing capacity available later this year. Now before we open the call up to your questions, I'd like to offer a few summary comments. I hope what has happened into our fiscal '08 results is the strength of the business model we have pursued over the past 20 plus years. The essence of this business model is our relentless focus on growing our company through extensive geographic and end market diversification. We have determined that this diversification has reduced the negative impact of any one end market or regional economic cycle. It allows us the opportunity combined with effective execution to do two things. The first is obviously to serve our customers. The second is to continue to deliver record financial results for our shareholders. Looking forward, we will continue to grow and further diversify it within our targeted filter markets. We expect that the combination of our diversified portfolio of filtration businesses combined with our effective execution will allow us to deliver yet another record year of sales and earnings in fiscal '09. As Tom mentioned, our EPS guidance for fiscal '09 is between $2.30 and $2.40 per share, which is both a new record and up between 8% and 13% over the year we just completed. Achieving this will result in our 20th consecutive earnings record. That is our target. And finally, before we move to Q&A, I would like to remind you that we will be at the New York Stock Exchange tomorrow to do two things. The first is to host an analyst day and the second is to ring the closing bell to celebrate achieving our first $2 billon year in revenues. Our analyst day will be webcast on the Investors page of our website. We will also provide a link on that page to view the bell ringing ceremony. Regarding that ceremony, earlier this year, we decided to have some fun with this impending milestone and we created a guess the date we hit $2 billion in sales event. Approximately 6000 of our fellow employees around the world submitted guesses. Kim Webster is one of our 150 employees who guessed the correct date, which was June 30th. Kim is a senior buyer from our Leicester, UK plant and with his wife, Deborah he will represent our company and our achievement by ringing the closing bell tomorrow afternoon. Please tune into see it. Nicole, that concludes our prepared remarks. Now I'd like to open up it up to the questions. Question And Answer

Thank you, sir. [Operator Instructions]. Our first question comes from the line of Eli Lustgarten with Longbow Securities. Please go ahead.

Good morning.

Good morning, Eli.

I have a couple of quick questions on the outlook. One, in the guidance you talked about foreign currency exchange rates not changing. Can you give us some idea, what kind of foreign currency assumptions you have built into your guidance at this point, assuming rates don't change?

Eli, this is Rich Sheffer. What we are expecting is assuming that the dollar stays about where it is now, where it's been trading the last few weeks, it's going to still be a little bit of a tailwind in the first half of the year and somewhere around mid-year at these rates it would flip over and create a headwind in the second half. So, overall right now the total impact could be a slight headwind for the full year.

And that means that the... you have to fully replace the $0.16 of earnings that you reported this year from currency or will we be able to generate a little bit of that... we would not fully have to replace it?

The thought is whatever the impact is going to be, compared to last year it's baked into the guidance. So yes, we would replace it.

Yes, but so... the assumption doesn't have any of the $0.16 in it at all?

Hi Eli, this is Tom. That is correct.

Okay. Because it's an impressive gain without the foreign currency that where I am driving to. You mentioned 3%, 3.5% pricing. Is that pretty well evenly distributed across these businesses or is it skewed in any one action by either an engines or industrial products?

Hi. Eli, this is Tom. It really varies not only between engine and industrial, but within engine and industrial. So it's hard to be specific without getting into each individual product line, but short answer is it really varies.

Yes, and this is will go from like zero to 7% or 8%, that kind of magnitude?

Even more, the upper end is even more, Eli.

Okay, so... you are viewing [ph] that. And finally, when looking at your guidance, probably the number of the biggest risk is probably the truck recovery which the base of how you do the recovery, pre-buy will be next year. And whether it even occur because of the July fiscal year, it could not even occur in 2000... in your fiscal 2009 just on a timing basis. And I think you cited that. If we did not see upturn until almost your fiscal 2010, would that be lower end of your guidance be flooding by that, is that critical to your lower end of the guidance?

Eli, this is Bill. North American heavy truck represents 3% of our overall sales. So even if it didn't happen like or we talked about in our guidance, based on with the industry forecast are, it's really a very small part of our company and it's really part of that whole diversification story that we've talked about as we... 20 years ago that would have been a big deal for Donaldson as you know because you've followed us for a long time. Now it's not that big a deal, 3% of our revenues for fiscal '09.

Alright. You feel pretty comfortable no matter as long as this will depend on your...

Right. I mean it's an important... we have... what we want to have is lots of 3% or 4% segments so it's an important segment. But if we're not, we are not writing that up and down as a company like we used to.

And one of that question, are there any new developments in platforms or something that would make the 2010 emission then... the subsequent 2011 emissions for a construction act on the AK4 [ph] engine, a significant market for Donaldson directly?

Eli, this is Bill again. I think that's baked into our guidance. We are working on those programs now for both the on and off-road and that's part of what we are using our new PowerCore technology is to lock up as many those as we can.

So there is no contract and new awards you talked about that you referred 2010 emissions and is that part of your--

They are related to the emission regulation as you pointed out so it's not just emission control devices, but it's new generation air and liquid filters as well.

Okay, thank you.

Sure, thank you.

Thank you. Our next question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Hi guys.

Good morning, Jeff.

Just wanted to dig into some of the segments to understand a little bit better, some of the moving pieces and I think this plays into the guidance little bit. But your off-road is just, if you strip out the FX, it's just been growing exceptionally not the parse, still good growth in this quarter but after three quarters at 20% plus, it slowed to 10%. I just wanted to know, wanted to understand within that, what might be driving that if it's a specific region or sub-vertical? And then also special apps, I think you mentioned some of that slower growth in disk drive. That also slowed pretty materially in the fourth quarter, and I just want to understand that dynamic as well?

Jeff, Bill. I'll start with your second question on the special apps. I think part of that is it had a very strong finish last year. So it's a tough comparable quarter-over-quarter. As I noted that they had a... year-over-year, they had a very good year. In terms of our guidance going forward, I think, would be may be just... a lot of that's driven by the PC market and we're using published data to factor into our forecast in terms of what's seen out there. On the off-road, I think as I mentioned, the part of the off-road are off-road business that's the weakest is the smaller equipment that's mostly related to residential. We do not see that improving anytime soon. We still see strong conditions for the larger equipment which is used for heavy construction and mining. So it's a mixture of the two. And on top of that, you have the ag business which has grown quite a bit. We see that maintaining sort of a high level, but probably not growing much beyond that, and our defense business, which we had a great quarter. So it's... there are some pluses and minuses and there the weakest part is that smaller equipment related to residential construction.

Okay. And then just overall, you commented at the beginning that you definitely see lower organic growth in fiscal '09. I think your main comment around that was some slower growth in Europe and what specifically have you seen near term in terms of a change in momentum in Europe in general that would facilitate that comment?

I think what we... Jeff, Bill again. I think what we are doing there is we are... as we are reading in the paper about the calling down the GDP growth rates in the UK and the Germany and other parts of Europe and that's what's making us cautious. We had a strong finish to our business in Europe so that... but I think it's that we are seeing at least reports of weakness in the general sectors in the Western Europe and we are factoring that into our guidance for next year.

Okay. And then finally on the price increases, have you already announced all of your price increase that would get you to that 3% or do you have to announce more and may be just give us a sense of what the feedback you've been getting in terms of push back being able to realize that, any kind of demand instruction around some of these more substantial price increases?

Jeff, Bill again. Nobody, whether as a consumer or in a business likes the word price increase, so there is... you are not welcomed with open arms when you come in for those types of discussions. I think the thing is that everybody now understands that this isn't the temporary situation and it's here to stay. So, generally our initial focus is trying to figure out with our customers ways of offsetting the impact of price increases and as Tom mentioned, through, whether it's cost reductions or process improvements to mitigate the impact and then try and negotiate for the recovery of whatever is left. We do that as we incur the cost on an actual basis. So the 3.5% that Tom mentioned is our projection for the year. In some cases, depending on the products, if there is a lot of steel for example, we've already raised prices, we're working that. In other cases, where the materials are different, we have not and we're already doing that based on the actual cost that we've incurred and so we'll be doing that throughout the balance in this new fiscal year.

But would you say, what you've already announced, you're getting that the realization you need to get to this 3.5%?

No, we haven't. We haven't done all the pricing actions that would total up to the 3.5%. Because we probably haven't seen all of that impact, some of that's based on an anticipated impact to the fiscal '09. And as I mentioned, we don't ask for the price increase until we actually incur it.

Okay. Perfect, thanks guys.

Thanks.

Thank you. Our next question comes from the line of Kevin Maczka with BB&T Capital Markets. Please go ahead. Kevin Maczka - BB&T Capital Markets: Bill, Tom, good morning.

Good morning, Kevin.

Good morning, Kevin. Kevin Maczka - BB&T Capital Markets: I have a question on some of the operating costs and some of the things that may be one-time in nature may be not, things like IT spending, the four plants that you're expanding or launching this year. Are some of those costs one-time in nature that may not recur in '09 and the third bucket I guess is R&D, I'm assuming that will recur next year. But if you can just comment on those three items, is there anything big there that won't repeat to the same extent in '09?

Kevin, this is Tom. I guess first of all, keep in mind, we've provided the guidance of 21% operating expenses as a percent of sales for next year. As we look at, I think you're primarily interested in the fourth quarter '07 to '08. First, '07 was just a very low quarter from an operating expenses standpoint, I believe 20.1%. But a couple of things, Kevin I did mention a reclassification of some R&D expenses from cost of sales to operating expenses. And that created about a half a point impact in the quarter. Now, that has no impact for the year because that was an adjustment from the first three quarters to the fourth quarter, no impact for the year, but that did have an impact in the fourth quarter and of course we don't anticipate for that to increase. There was a little bit of a mix issue, both if you think about the very high sales in our Industrial segment versus the Engine segment. Industrial runs a little higher operating expenses and a little higher gross margin than the Engine segment. So mix is going to really vary quarter-to-quarter. The product development expenses were up year-over-year. That was about just two-tenths of a point and that will very likely continue in the future as we focus on a lot of the product development initiatives that Bill mentioned. IT infrastructure cost, I think we had a bit of a blip in the fourth quarter. That was about a half of a point of the increase. So I would expect that to be a more normal level of spend in F '09. And then as in any quarter there is... there were some small one-time items that came up, none of them individually at all significant, but that had a couple of tenths of a point impact as well. So I hope that answers your question, Kevin. Kevin Maczka - BB&T Capital Markets: Okay. And then on the expansion projects, Bill, you mentioned the four plants that are either very closed to completion or will be completed later this year. I guess once those are complete give us an update on how you feel about your capacity at that point, is maybe the plan to have another phase necessary of further expansions beyond that?

Good question. I think it's unlikely that we'll have four projects underway at the same time if we look at like 6 or 9 months from now. Just because of I think we... this is a sort of unusual period where we had four at the same time. But typically Kevin, we are always going to have probably 1 or 2 or 3 underway, adding capacity in different parts of the world. How do we feel about our capacity situation right now? I think we're in pretty good shape. We have some plants that we haven't announced yet, so I can't disclose it for additional capacity. But that's more of... is part of that normal process that I mentioned, where we have to add some every year. And it's a consequence approach, so it's a good thing. Kevin Maczka - BB&T Capital Markets: Okay. And just one more if I could, Tom, can you just help me reconcile, you said 3.5 percentage points of prices baked into your revenue guidance. But did you say organic volume growth would be negative and so my question is if that's true, with very little foreign exchange impact, how do we get to the 9% to 11% on the top line?

Kevin, Tom again. I don't think anybody said that organic growth would be negative. So if you take our sales guidance and back off the 3.5% for selling price increases, the remainder would essentially be organic growth. Kevin Maczka - BB&T Capital Markets: Okay, got it. Thanks for the clarification.

Thank you. Our next question comes from the line of Brian Drab with William Blair. Please go ahead.

Good morning.

Good morning, Brian.

Congratulations on a great year in a tough environment.

Thank you.

I think most of my questions have been answered at this point. But just a follow-up question on the operating expenses. You mentioned that the IT expense in the fourth quarter was a little bit of a blip, and I was just wondering if you could give us some more color on that, and also talk a little bit about the warehouse management system at your Rensselaer operation, to whether your expenses came in inline with expectations and if that project is done?

Yes Brain, Tom here. I'll take the last one first. For the distribution expenses at our U.S. facility in Indiana, we came in very close to the guidance we provided last quarter. The incremental expenses there in the fourth quarter were about $1.9 million, so for the second half of the year that totaled up to about $7.6 million. And we think we have that pretty much behind us now. So we aren't expecting any of those incremental expenses to go forward in the future. And then on the IT expenses, we had a couple of systems initiatives wrap up in the fourth quarter and at the conclusion of those implementation there is a bit of a blip in spending. So again, customer care systems wrapping up ERP modules and things like that came up in the fourth quarter and that caused the increase in spending.

Okay, great. That's all I have. Thank you.

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

Good morning this is actually Tom Brickman [ph] standing in for Charlie Brady.

Good morning, Tom.

Just a couple of questions. You mentioned that the gross margin, you had some impacts from the... you said some recovery of previously incurred product development cost. Can you go in a detail about that a little bit, please?

Tom, this is Thomas VerHage. That was a relatively small impact about four-tenths of a point and that happens from time to time where we feel a loud costs that we previously incurred. We covered them from customers in a quarter later than when we actually incurred the costs.

Okay. And you've mentioned a little bit about how it's a small percentage of your sales but first half '09 translation product sales. I guess you were talking about how the trucks... on-road trucks are only about 3% of your sales, but can you just talk about expectations for translational products in general first half '09?

First half of what? Tom, this is Bill, first half of our fiscal '09?

Yes.

Pretty flat and then in the next calendar year in advance of the emission regulations in 2010 that we anticipate that another pre-buy or at least a volume increase for whatever reasons but we probably most are dealers pre-buy. So I think I said 30% to 35% calendar year '09 over calendar '08. So that would affect a second half of our fiscal '09.

Got you. Okay, yes. In the special applications products, you also mentioned this again. You were saying what's causing the slowdown in growth just to going into more detail about that?

Tom, Bill again. I think it's just based on what we see with the industry forecasts for hard drive shipments, hard disk drive shipments.

Okay. Yes, and finally the... did you have a gross margin percentage that was for the commodity costs? Did you break that out just for the quarter?

Yes Tom, Tom VerHage. Actually I am glad you asked. That impact for the quarter was about 1% and as we mentioned in the press release, and I mentioned in my comments, that is almost entirely due to our optional election of the LIFO method of accounting, because all of those... when we purchase those commodities at those increased costs, that goes into our income statement immediately, rather than capitalizing that in inventory. So had we been on FIFO, we would have reported $5 million more for additional pre-tax income in the quarter than we did by being under LIFO method here in the U.S.

Okay. And okay, so going forward you said we've already put through price increases going offset the steel, cost pressures you've seen. But as far as other commodity cost, I mean I guess in the near future maybe in the next quarter or so, you may still see the pressures but after that the price hike should flow through. I guess just wondering about how quickly the price hikes will flow through?

Tom, it is Bill Cook. On a gradual basis and again as I... on a as incurred basis, so as we... as it affect us, we go to our customers and start negotiating for price increases for any part that we can't mitigate through cost reductions. So it's happening now and it's going to happen through, at least the first half of the fiscal year, new fiscal year.

I got you. Okay, thank you.

Sure.

Thank you. [Operator Instructions] Our next question comes from the line Andrew Obin with Merrill Lynch. Please go ahead.

Hi guys, good morning.

Good morning, Andrew.

Just a couple of small questions. What percentage of off-highway equipment is ag equipment. Could you comment on that?

Andrew, this is Rich. Ag makes up between 20% and 25% of our off-road equipment.

Has the mix shifted as ag has been growing, has the mix shifted or have you had enough international growth on the construction side that the mix has remained fairly comparable in the past couple of years?

Yes, given the strength in a lot of our off-road end markets, we've seen maybe 1% or 2%, but still stand in within that band. So basically all the bolts have been lifting.

And the second question I have is just as I said it's a small question, but you noted a relatively flat production I guess in trucks in Europe and is that based on an industry forecast or is that based on specific conversations you guys had with your customers in Europe?

Andrew, Rich again, just based on our internal forecast, we take into account both fee the published forecast and our conversations with our customers specifically. So we are looking for single-digit growth in the truck business in Europe in fiscal '09.

Okay.

Andrew, this is Bill. We always start with your reports and then factor in what we hear from our customers as well.

Great, need to know when I ask you guys for industry color. No, but I appreciate it. Thank you very much.

Thank you. Our next question comes from the line of Craig Stone with Kayne Anderson Investment. Please go ahead.

Have you seen any competition for the second fit of PowerCore applications? If you haven't, why not and are the OEMs building any language into the warranties about PowerCore?

This is Bill. On the PowerCore, what we had anticipated initially when we launched the first generation that when it was successful because we intended for it to be successful that there wouldn't be people trying to copy it. We have lot in intellectual property around it and we defend that aggressively but our best defense with PowerCore is to replace our cells with new technology and that's what we've done with the generation2 or the Gen2. So, we're trying to see some people trying to get into the market on a replacement with the Gen1 and now we've raised the bar again with our Gen2. In terms of the question about the OEs, the OEs like our PowerCore because they're very interested in protecting the replacement parts and that's an important part of their business. So, it allows them and us through them to lock up that replacement parts business. So, they are very positive. I am not sure if I answered your question. But were you talking about warranty specifically?

I am asking if the OEMs require PowerCore as replacement filters in order to maintain the warranty.

Okay. The OEMs both... today nothing else will fit generally and deliver the performance. So, I guess in the sense in order to protect the warranty they have to gap these filter that's going to work. The answer is yes. But I'm not sure there is specific warranty language that requires the PowerCore.

Thank you.

Thank you. Our next question is a follow-up question from the line of Kevin Maczka with BB&T Capital Markets. Please go ahead. Kevin Maczka - BB&T Capital Markets: I just had a question on the gas turbine business. It was such a huge year this year, so you've got tough comps obviously, but Bill you talked about some new PowerCore products coming soon. You're in the middle of an upcycle. There is still strength in your international power gen and oil and gas markets. I'm just wondering if you could give a little bit more color on what you are seeing that would dictate a 5% to 10% top line.

I think Kevin, the issue there is, there are other not related to Donaldson. But there are other supplier constraints for the turbine manufacturers that are limiting how many turbines they can manufacture. And so that the market is as you're suggesting is marketing conditions are stronger in that but there is a capacity constraint in the production of turbines. Kevin Maczka - BB&T Capital Markets: Okay. And can you just talk a little bit on your... is there a notable mix there between power gen and oil and gas and maybe any other end market?

Yes, Kevin I am not... a notable mix between the two. Nothing has really changed over the last year between the two. Kevin Maczka - BB&T Capital Markets: Okay. Okay, that's all I had. Thank you.

Thank you. And there are no additional questions at this time. I would like to turn the call back over to Will Cook for closing remarks.

Thanks Nicole. To all of you participating and listening, I want to thank you for your time and interest. I look forward to seeing those of you who will be attending our analysts meeting tomorrow at the New York Stock Exchange. At that meeting, we'll be sharing our strategy and the plans for our continued growth and financial performance. To my fellow employees, I want to thank you for what you do each day to serve our customers. Each of you... each of us, plays a key role in our ability to deliver value to our customers. And without your efforts and their business, we have nothing. And finally, thank you for your efforts in delivering our 19th consecutive year of record earnings. We had some challenges during the year but we did it. Congratulations, thank you all. Goodbye.

Ladies and gentlemen, that does conclude the Donaldson fourth quarter fiscal year 2008 conference call. If you would like to listen to a replay of today's conference please dial 303-590-3030 and entering the passcode number of 3910647 you may also dial 1800-406-7325 entering in the passcode number of 3910647. Again the telephone numbers are 303-590-3030 and 1800-406-7325 and entering the passcode number of 3910647. Ladies and gentlemen, thank you for your participation. You may now disconnect.