Donaldson Company, Inc. (DCI) Q2 2009 Earnings Report, Transcript and Summary

Good morning ladies and gentlemen, thank you for standing by. Welcome to the Donaldson Second Quarter 2009 Conference Call. 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 Thursday, February 26, 2009. I would now like to turn the conference over to Rich Sheffer. Please go ahead sir.

Thank you Brandy, and welcome to Donaldson's 2009 second quarter conference call and webcast. Following my brief 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'll discuss our updated outlook for fiscal '09 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, three months ago we issued our first quarter press release and provided guidance for the year based on the global economic conditions as we saw them at that bad time. And we are now all painfully aware that economic conditions have deteriorated significantly and we are in the midst of a major global recession which is impacting nearly all of our end markets around the world. By now you've all had a chance to read our second quarter press release and review our financial results. Sales and operating income were below the expectations we provided three months ago. But some very favorable developments in the resolution of income tax contingencies enabled us to report EPS of $0.43 a share, $0.01 higher than last year's second quarter. Last quarter, we stated that we saw challenging economic conditions ahead of us. Fortunately, we had already initiated a number of actions to respond, including a global hiring freeze and further reductions in discretionary spending in addition to production cut backs and workforce adjustments. We then completed a bottoms-up forecast of our business in mid-November and based on our guidance at that time and what we knew about our customers built schedules and their holiday shutdown plans puts our existing backlogs in recent incoming order trends, However we saw a further rapid reduction in incoming orders and backlog beginning in early December. And by mid December, many of our customers had announced extended shutdown plans and reduced their build schedules into 2009. We quickly implemented additional plans to respond to this rapid deterioration and market conditions. As a result, in total, we have reduced our global workforce by approximately 1,850 people or 14% since the beginning of our fiscal year and incurred $4.3 million in restructuring costs to implement these unfortunate but necessary actions. We continue to see conditions weaken across many of our end-markets. So, we are planning to take further steps to reduce our cost base in the third quarter and expect to incur approximately $3 million in additional costs related to these actions. The steps already taken and those that we plan to take in the third quarter will combine to reduce our costs at an annualized rate of approximately $85 million and help us to partially offset the significantly higher under absorption of our fixed manufacturing and operating expenses resulting from our projected sales declines. We are expecting our full year operating margin to now be between 9.5 and 10% or approximately inline with our year-to-date operating margins for six months. Our third quarter margin will continue to be impacted by higher than normal under absorbed fixed costs and the $3 million of additional restructuring costs. Our gross margin was 29.1% in the quarter which was below our annual target of 32% in last year's second quarter gross margin of 31.9%. Latest driver of the decrease is the under absorbed fixed manufacturing costs. This factor (ph) loan reduced gross margin by 2.1 percentage points. Also $2.4 million of the previously mentioned 4.3 million of restructuring costs were included in gross margin which lowered our margin by 0.6 percentage points. Purchased material costs remained higher than last year's levels but have been mostly offset by a combination of internal cost reduction efforts and selective price increases to our customers. So the impact in the quarter was minimal. In operating expenses, we continued focusing on the cost containment actions we began late last fiscal year and which I mentioned earlier. The restructuring charges increased operating expenses by $1.9 million in the quarter. Also, during the quarter, we incurred $2.8 million for stock option expense which represents about two thirds of our annual stock option charge. The charge in last year's second quarter was $3 million. A significant portion of our executive officers annual compensation is as we say at risk and based on preset financial metrics such as EPS exceeding prior record, sales and profit growth within our business units and ROI targets. Given our latest financial projections for fiscal 2009, we expect that executive officer compensation will be between 30 and 50% lower than in fiscal 2008. In addition, our officers' base salaries are frozen at January 2008 levels. During our first quarter webcast, we mentioned that several tax contingencies could be wrapped up by the end of our fiscal year. It could reduce our tax rate, if they would be resolved favorably, while the good news is that we received favorable resolution on two major regulatory audits in the second quarter. These and a couple of other minor adjustments allowed us to take into income of approximately $15 million of tax contingencies in the quarter. Based on our projected global mix of earnings, we expect our normal tax rate absent additional discrete items to approximately 31% going forward. And we now expect our full year effective tax rate to be in 21 and 23%. Our CapEx came in at $11.9 million for the quarter, which is $5 million less than last year. We are continuing to move forward with strategic projects that we had previously started, but as we mentioned last quarter, we are delaying any new expansions and certain other projects until the recessionary conditions ease. Our full year CapEx guidance is 60 to $70 million and we continue to expect depreciation and amortization to be in the range 14.7 to $15.7 million, which includes the amortization of intangibles from the Western Filter acquisition that we made in October. Free cash free flow came in at $30 million, which is $23 million higher than last year and provided a cash conversion ratio of 90% in the second quarter. We expect free cash flow and our conversion ratio to continue improving during the second half of fiscal 2009, and for free cash flow to be between 120 and $150 million for the year. At the end of the quarter, our debt to cap ratio was 36% and debt to EBITDA was 1.3. Both of these are well within the financial covenance in our various debt agreements. We are now expecting interest expense in fiscal '09 to be approximately $18 million. Our balance sheet remains strong and we continue to have no issues accessing our credit lines. So, with that I'll pass over to Bill who will provide more background on our business conditions and the outlook for the remainder of the year. Bill?

Thanks Tom. I'd like to begin by summarizing the performance of our operating segments during the quarter. Starting with our engine segment, sales were down 15%. Our European engine business, sales decreased 23% on a local currency basis. Our sales to our transportation or truck customers decreased by 54%. Our sales to off-road equipment customers decreased by 20% and our sales of replacement filters in the after market declined 22%. In Asia, our engine sales declined 17% in local currency. Both our off-road and transportation equipment businesses there were down sharply 27 and 31%, respectively. Our Asian after market or replacement parts business fared somewhat better, down only 4%. And in the Americas, our engine business was down 3%. Our sales to our off-road equipment customers were up slightly in the quarter due to the impact of the Western Filter which added an incremental $6.2 million of sales in our first quarter ownership. There were two other and very different stories within our off-road business during the quarter. Excluding Western Filter, the good news was that our sales for military applications were up 32% and continued strong demand particularly for filters with new MRAP vehicles and filters for existing military equipments including the Blackhawk Helicopter. The other part of the story in the off-road market is that our sales to our customers for their production of off-road equipment used in the agricultural construction, mining markets, those sales were down 25% on the quarter. The demand for large equipment was better than the demand for smaller equipment in those markets. But unfortunately, all were down in the quarter. And in our North American transportation market, our sales to our heavy and medium truck customers also suffered during the quarter. Our sales declined 45% as both Class 8 and medium duty truck builds at our customers dropped during the quarter. And then the Americas engine after-market business, sales were up 3%, primarily due to the continued strong sales of our retrofit emission control devices in the U.S. Now, I am going to switch to our industrial segment and within that our Industrial Filtration Solution business, the sales were down 2% in local currency. Sales in Europe were down 9% as demand for our dust collectors and compressed air filtration equipment fell with a dramatic downturn in general manufacturing activity. In the Americas our IFS sales declined 5% in the quarter, while in Asia they were up 22%, primarily due to several large dust collection systems that were shipped during the quarter. In our global gas turbine business, we had another strong quarter with the 46% sales increase over last year, as many of the projects in our backlog shipped during the quarter. And finally in our special applications group sales are down 26% local currency, as sales for our filters for disk drives declined sharply and these were only partially offset by some sales growth in our PTFE membrane products group. That's a little bit more color on what happened in the quarter by region and by end market. Now what I'm going to do is switch to our outlook for fiscal 2009, which we detailed in our press release yesterday. So, the following are some summary thoughts and as everyone is aware and as Tom mentioned, global economic conditions have changed dramatically since we provided our initial guidance for the year in September. Unfortunately, we saw conditions deteriorate significantly in January, in December and January. And trying to project that into the future has become unusually difficult given all of the variables currently at play in the global economy. As a senior executive, at one of our customer has told me, trying to forecast future business levels right now is like trying to drive a car in the fog. In other words, no one has the visibility we enjoyed just a year ago. But even given that, our best information about our future business levels is obviously coming from our customers. So, we have spend a lot of time talking to them both of that what they see and how we can help them. But based on what we see in our business and recent customer feedback, we are now expecting full year local currency sales decreases up 7 to 12% in engine and 5 to 10% in industrial. In addition, we know have and continue to forecast a negative impact from exchange rates for the balance of the year. We expect the foreign currency translation impact for the full year to be an additional 4 to 5% decrease. As a result of the combination of these factors, we now expect our full year sales to be between 1.9 and $2 billion or down 10 to 15% from last year with foreign currency translation accounting for about 40% of the decrease. This is very disappointing, as we've been on a very good growth track for the past six years, essentially doubling the size of the company over that period. But, we like all industrial companies are now facing unprecedented economic challenges. As we squarely face these challenges, we are fortunate, however that we are a very different company than we were in the early eighties. In addition, we also believe that our new filtration technology systems will help to soften the impact of the general economic decline on us. One example that we've talked about in previous calls is our innovative air filtration technology PowerCore. In our engine business, we released PowerCore generation 2 or G2 last year. G2 allows us to further reduce the system size and enhance the performance of our filtration systems for our customers. We've already won 13 platforms with G2, six on road and seven off road. And on the industrial side of our business, we've introduced PowerCore technology into our Torit dust collectors. These new dust collectors are 50% smaller than the Baghouse collectors they compete with. So far in fiscal '09, we've already received orders for almost 150 Torit PowerCore systems. What do innovative technologies like PowerCore mean for Donaldson? Well our strategy is to provide the most compelling filtration solutions for our customers, both in terms of technology and value which should help us and our customers grow our businesses. And PowerCore is just one example of how we will use our technology to do this. Now before I open up the call to your questions, I'd like to offer a few summary comments. Some of you have followed Donaldson for many years and may still remember that Donaldson of the early 1980s. I started at Donaldson in 1980 lived through that period, the twin recessions in the early 80s and when we lost money in 1983. I believe that the global... the current global downturn, while different in many aspects will be at least as severe as that one. But fortunately we are not the same company we were then. Our focus over the past two decades has been growing our company by diversifying it into a variety of filtration and markets around the world. You've seen the results of our efforts over the past two decades as we put together a solid track record of sales growth and 19 consecutive years of earnings records. We did that despite several recessions and many individual end market slowdowns. We accomplished this by diversifying our end market exposure, by increasing the percentage of our business that came from industrial markets, from the international markets and from replacement filters. This new model gave us the financial results to build and maintain a very strong balance sheet. This has allowed us to continue to generate sufficient free cash flow to fund our operations and capital needs while continuing to consistently increase dividend to our shareholders. Over the years, I've been asked what would we do if the earnings record end some day. And based on our current EPS outlook of a $1.70 to $1.90 versus the $2.12, we achieved last year, it does appear that our nineteen consecutive years of record earnings will end this year. So what will we do? If this does happen and we don't deliver another earnings record this year, we will immediately setout to rebuild our track record again. Why? Because over the past two decades, we have proven that our strategy has worked to the benefit of our customers, our shareholders and our fellow employees. We can't do anything about the current global recession and complaining about it certainly doesn't help. We also don't know when economic conditions will improve, so we can't wait for that. So, as Tom mentioned what we have been doing and what we will continue to do, is focus on everything that we can control within our businesses. We are continuing our key strategic CapEx investments including and especially our international expansion plans. These investments will help us support our customers and grow our market shares in these developing economies. We are continuing to invest in and commercialize our proprietary filtration technologies. These will help us mitigate the current economic conditions and help us build market share for both our customers and ourselves in the long-term. We will continue to focus on cost controls across our business to ensure that we balance our expenses with our current and future business levels. This focus includes material, manufacturing and operating costs with the objective of not only managing today's cost but also optimizing our business operations for the future. We will further improve our cash flow generation. We have specific return on investment initiatives, with a focus on implementing long-term improvements on working capitalization... working capital utilization, specifically inventory returns and accounts receivable. Our overwriting goals, as we do this, are to maintain and improve our service levels and value propositions for our customers, to protect the short-term financial condition and performance of our company and to continue to pursue our highest priority strategic initiatives which are the key to our future. It is a difficult balancing act, but it is one that the Donaldson team has done very successfully in the past. We have already taken a number of very difficult but very necessary steps to reduce our cost base as business conditions deteriorated. I would like to emphasize as Tom mentioned, that fortunately we started these actions early, in fact when we were still delivering both sales and earnings records. However based on the continued deterioration in economic conditions, we are planning to take additional steps this quarter, this upcoming quarter and will be prepared for future actions if conditions worsen even more than we currently expect. Our goal is to stay ahead of any negative... new negative economic developments in order to both protect the short term and long term viability of our company. Finally, while we don't know how long this recession will last, I do believe that it won't last forever and when it ends, we at Donaldson will be ready with a lean organization, right investments already made and with a balance sheet and cost structure that will allow us to capitalize on the global recovery. This is what we've done in the past and this is what we are doing now. Brandy, that concludes our prepared remarks, now we'd like to open it up for questions. Kevin Maczka - BB&T Capital Markets: Gentleman, good morning.

Good morning, Kevin. Kevin Maczka - BB&T Capital Markets: I guess my first question is on the margin guidance 9.5 to 10% and Tom, I think you said that was in line with your first half run rate. But Q2 if you exclude restructuring, I think was more like 7%. So, can you just talk about how confident you are or what gives you the confidence that 9.5 to 10 is the right number given that things continue to seem to deteriorate so rapidly?

Yeah, Kevin, that's a good question. As you know, we had a good first quarter and the second quarter is typically our toughest quarter of the year in normal years. So, our margins are generally the lowest in the second quarter, we did a bottom's up forecast. We looked at what we thought we could do in the second half. We factored in the additional restructuring costs that I mentioned before. And then added all of that up with the benefits that we expect in the second half from the restructuring actions and that gave us the range of 9.5 to 10% in the second half. And just to break that out a little bit more, gross margin would look to be in 31% range, so that it is less than our typical guidance of 32 for the year and operating expenses slightly more than 21%. Kevin Maczka - BB&T Capital Markets: Okay, great. And then Tom on the restructuring, so you took some restructuring charges in Q2. You're going to have some more in Q3, then you expect on a annual rate to save 85 million, give us some timing if you could about when these things will be implemented and when you'll start to actually see that, maybe when you'll achieve the full run rate of that 85 million?

Kevin, the full run rate should be achieved later on in the fourth quarter. The second half benefit that we think we're going to get out of this is roughly $38 million and about $25 million of that would be at the gross margin line and 13 million at the operating expense line. And then of course there is $3 million of restructuring cost in there which gets you down to a net of about $35 million for the second half. So, certainly as we enter F'10, we'd be running at that $85 million annual lower rate. Kevin Maczka - BB&T Capital Markets: Okay, great. Thank you.

Thanks Kevin. Thank you.

Thank you. Our next question comes from the line of Antonio Antezano with Macquarie Capital. Please go ahead.

Good morning.

Good morning.

I was wondering if... have you provided margin outlook for engines versus industrial businesses?

We have not broken out our guidance by engine and industrial, Antonio.

Okay. And then I was wondering in terms of your outlook for after market. You mentioned there is very low utilization rates there, if you could provide more color on what on the outlook for after market, what you see in terms utilization in these different markets?

Antonio this is Bill. I think what we are seeing more equipment both on and off-road, not being as fully utilized as it was earlier this fiscal year. So, I mean we look at statistics like ton miles and other indicators like that in terms of forming our... or developing our forecast and building our guidance.

Little more color on that, Antonio this Rich. From published forecast that we see, we expect ton miles the utilization of on-road equipment to be down about another 6% during our second half of our year. Construction spending continues to decelerate, we expect that to continue during the balance of our fiscal year, anybody's guess is related to the housing market, residential construction with expected deceleration in the commercial markets. So, that would be the utilization of that equipment. Mining with the commodity prices, most of the metal markets are down 15% plus on pricing, there's a lot of mining equipment that isn't going to be utilized for the second quarter, because the prices just don't support that. Those are kind of things that we're looking at in our after market guidance.

And then this is Bill again, there's one other factor that I'll add to that is that we have seen customers whether its OEMs or distributors working our inventories down, so that's converting that into cash, so we've factored in an impact from that as well

And just a final question if I may, I look at your outlook for the gas turbine segment to decrease 2 to 7%. However, the first two quarters, that sector was up strongly, so we're going to see a big swing. Is that just entirely, I guess a big part of that is currency but if you can comment on what is driving this swing going forward.

Antonio, Bill again. Our gas turbine business is very lumpy, if that's the right technical term quarter-by-quarter. It's very large projects in and so we don't get a nice 25% of our annual sales quarter-by-quarter. So, they bounce around quit a bit. So, our second quarter was very good, we don't see continuing at that pace for the second half of the year and that's just a function of that lumpiness. Our guidance for the year was at essentially by units our gas turbine business will be flat year-over-year, but down slightly because of the impact of foreign exchange.

Thank you. Operator: Thank you. Our next question comes from the line of Richard Eastman with Robert W. Baird. Please go ahead.

Yep. Good morning. Bill, can I just explore for a second, the operating margin in the quarter. If I try to adjust for currency and restructuring, it still looks like that the decremental margin was maybe 60% and I'm curious, did the sales mix have a lot to do with the profitability in the quarter, namely say transportation at $16 million quarter is that loosing meaningful money?

Bill here, I'm going to turn it over to Tom, he is raring to go to answer you so.

Okay, get underway.

Yeah, thanks. But I will try. Okay, I guess I'm on Rick. Let just help you out on gross margin in the quarter and give you a little color on the quarter-to-quarter reconciliation. The big mover Rick, in the second quarter was the unabsorbed overhead. So, if you look at last year at 31.9% and you get down to 29.1%, which we were at this year, 2.1 percentage points of that was the unabsorbed overhead. Now as you looked at our segment results in the disclosure, you saw that in Jan, deteriorated much more than industrial and in the recession hit engine first, the unabsorption that we had in the plants was primarily engine in the second quarter and then also I gave you the restructuring charge that was charged to gross margin in the quarter and that was point six... it was six-tenths of 1%. So that pretty much gives you the entire reconciliation and that were just a couple of other minor factors in there, but the big mover was in engine and that was pretty much all volume related.

And as it, I guess what I'm kind of getting at is that is there significant difference within off-road trends and after-market because again, I noted that $16 million trans-quarter had to be a big problem in terms of, most of the unabsorbed overhead there versus after market?

Yeah, Rick, Tom again. No there is not a big difference between those end-markets. Of course the unabsorbed overhead impacted transportation more.

Yeah

But as we look at it from sort of a standard margin basis setting aside the unabsorbed overhead, there is a not a big difference there from a mix standpoint.

And Rick, Bill here, as you know many, I'll remind you, many of our plans support multiple markets, so.

Right.

A plant isn't just transportation or a just off-road focus that they support multiple markets both engine and industrial typically.

Okay. And then another question for Tom, if I look at your tax rate guidance, it's a little bit confusing to get to 21 to 23% for the year, you need to have a tax rate in the 45% range for the second half, is that what you're suggesting?

I think Rich, the math would suggest that the second half would be 30 to 31% to get us to that full year guidance of 21 to 23. Keep in mind our first half tax rate, turned out to be... 13.2%.

Okay. So, I see, so you're adjusting the second quarter for normalized tax rate to do that?

Yeah, yeah. So, a core example in the second quarter, the normalized tax rate would have been about 30%.

Okay. I see, okay, so alright.

As you go through that math Rick and if you want us to follow up with you further, we can walk you through that.

Okay. I understand. Okay. Thank you.

Thank you. Your next question comes in the line of Brian Drab with William Blair. Please go ahead. Brian Drab - William Blair & Company: Good morning.

Good morning Brian. Brian Drab - William Blair & Company: Speaking of the tax rate, last quarter you gave us a much broader guidance range because I think you're expecting some of these one time items and may be you just weren't certain of the magnitude, do you have more confidence now that those one time items are have passed and that's why we are seeing a more narrow guidance range?

Yeah Brian, Tom here. We did give a broader range last quarter and that's because the two major regulatory items that I refer to in my comments were open at that time. What happened in the second quarter, was that we, for the most part we solved those items we're. We're able take those contingency reserves into income. So those two major uncertainties are no longer present and with those uncertainties gone we're able to narrow guidance. Brian Drab - William Blair & Company: Okay. Thanks and looking at the transportation business going forward here. I know Rich you mentioned ton miles according to your sources projected rebound 6% for the rest of your fiscal year that and if you backend given your guidance back-end of what the gross, of what the decline would be in the second half. Looks like transportation is down about 25% is that, I guess like Bill mentioned, distributors working through inventory and how much inventory is there to work through that its going to depress your growth for that one?

Let me clarify my early response slightly. The ton miles really is an impact on, or an indicator by after market rather than what we report as transportation, what we report as transportations, strictly the new builds of trucks and they were work expecting in new truck builds to be down roughly 30%, 25 to 30%, the latest public statistics that got issued on that, we're expecting for the calendar year of '09 140 to 150 down from 205,000 last calendar '08. So, in the truck market on the heavy side there is another leg down, we are looking at medium duty trucks, their build rates being similar to that for calendar '09 as well in that around 150 number. So the transportation market has still got a difficult year ahead of it. Brian Drab - William Blair & Company: Okay. And then in the aftermarket, if you are forecasting roughly down 20% for the balance of the year, is the difference between that ton mile projection and the negative 20% level also deal with inventory reductions or primarily?

Yeah, I don't know that we gave out specific forecast for aftermarket. Brian Drab - William Blair & Company: I am just backing into that from your guidance came down, I've down roughly low double-digits based on your guidance in the second half... you gave guidance, I guess for the engine product segment overall?

Yeah.

Hey, Brian this is Bill here. And we didn't give it by the specific sub-segment. Brian Drab - William Blair & Company: Yeah, sorry.

That's where we are sort of struggling a little bit. But I think just sort of sub-directionally, Rick you talked about the transportation, which is new trucks or products related to that, what's going to happen there and we talked a little bit about global mining construction and the off-road markets and that's a mixture of off-road or construction equipment and there we really look some of our customer announcements and so Caterpillar announced calendar '09 being down 25% over '08, that will be the probably the best published statistic that we can use. The ag market being a little bit better than that. (inaudible) announcement last week. The aftermarket is probably is not down... is probably down a little bit less than the engine average, it's more stable, utilization has weekend, that there is some inventory adjustment. But I believe it's going to be less than the average for the engine products group. Brian Drab - William Blair & Company: Okay, great. Thanks very much.

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

Hi, good morning guys.

Good morning Jeff.

Just wanted to get a better sense of in the industrial business and gas turbine, what you are seeing from an order perspective?

Jeff, Bill here. I think we've got that baked into our guidance that the business is going to be just sort of leveled-off right now and the projects are... we have good visibility through the end of our fiscal year, but we really haven't given guidance beyond that. We will start doing that at the end of the next quarter.

But I guess, like gas turbine being down in the second half, is that more of a function that things are slowing there, in terms of incoming orders or to your earlier points, it just timing of.

It's the timing, the lumpy factor I mentioned before Jeff.

Okay. And I guess within IFS, you gave some good color by region, I mean would you expect that that strength in Asia continues or whether some one time orders in there that helped things up?

There were some one time orders that helped it out.

Okay. And then not the... (inaudible) on the after market but I guess, you guys were down 11.5 in this quarter, I mean is that kind of the right run-rate to think about on go forward basis, or do you actually see a further deceleration?

Jeff, Bill again. I'm not going to probably get pinned down to the percent, I'm trying to avoid doing that, but I think generally we see the after-market over holding a side sort of the de-leveraging of inventories and things like that as being more stable than the first fit business.

Okay. Can you just run through, I think you gave some detail on the after market business in the quarter either by a subvertical or geography, can you just a lot of numbers coming at me. Can you just run through those again?

Sure. So, in Europe... I'll tell you just the after market numbers, with an engine, okay. In Europe, the sales were down 4% in the quarter.

That was Americas.

They were down 4% in the quarter, in Europe and the Americas they were down -- they were up 3% and that included the emission control devices and I am sorry, we back up Jeff, okay.

Okay.

In Europe, they were down 22%.

Okay.

Asia was down 4%, and the Americas were up 3%.

Okay. Why do you get the sense that Europe was such an outlier? Is the model a little bit different? Do they carry more inventory and there is more stock and things are just that much more challenged in Europe?

Jeff, as I... we went through the numbers for the OEM segments, both transportation and off-road. We saw how big the percentages where there? Our European business in total was down 23% in the quarter on a local currency basis. It's almost like somebody hit a switch in Europe during the quarter.

Okay.

A lot of very extended customer shutdowns beyond their normal holiday shutdowns and that affected both the first fit and the after-market business.

Okay. But the North American piece kind a hangs in there, okay.

It was better, right.

Okay. And then just finally a housekeeping, how are you thinking of the corporate expense number for the full year?

Lower is better.

Yeah, Jeff, lets look at it as a percent of sales. Are you talking all of operating expense?

Just corporate and unallocated and I guess year-to-date your 4.3?

Okay, Yes I don't, that's going to fluctuate quarter-to-quarter by say a million or a couple of million dollars. There is a consolidating entries in there, eliminations of inter company profit and inventory as we ship inventory between business units. A big portion of that Jeff is interest expense and that is going to be a very steady number. I mentioned to you I think in my comments that that will be $18 million for the year.

I am just trying to reconcile, in last year in the first half, I think you had the over 8 million, now you running down 50% and then you had big... that was a big number in the second half. So, versus that 25 million in fiscal '08, I mean should we think of that as getting cut in half or?

Yeah, Jeff, the run rate for 2009 is going to be a better number to use.

Okay.

Because last year we had a lot of inter company shipments, so we had a lot of that inter company profit to eliminate and inner company shipments are down a bit this year, so the 2009 run rate is a little more normal at least for this year.

Okay. Perfect, thanks guys.

Thanks. Operator: Thank you. Our next question comes from the line of Adam Brooks with Sidoti & Company. Please go ahead Adam Brooks - Sidoti & Company: Yes, good morning guys. Quick question, kind of with market share, it seems like this could be a situation where you'll merge in the other side and gain a bunch of share, clearly you pulled back as far as any further expansion plans. But do you see anything as far as smaller competitors along by the way side or is kind of your market share holding steady?

Adam, Bill here. We have as Tom mentioned reduced any or eliminated any new capital expansion projects but we're continuing with the ones we already had in place. So we are expanding in India, we're expanded into Thailand. So, we set up an operation in Brazil, we expanded in the Czech Republic. So, we continued those and or finished those because we want to be positioned on the other side of this poor market share gains. So, I think that was the first part to your question. We are still making strategic investments. In terms of smaller competitors by falling by the way side well, I won't may be comment specifically on other companies, but I think we bring to this economic challenge a very strong balance sheet, and we are going to mange our business very proactively to protect that and I think that's an advantage that we have going through this is that as customers look at their supply base including Donaldson Company, hopefully they look at us and say we don't have to worry about these guys. Adam Brooks - Sidoti & Company: Right. And as far you talk, touched a little bit on suppose you have emerging markets, sales overall in those areas such as Brazil and India was that up, or have you... well you not really kind of break that down as far as to them new share?

We don't break it down to that detail. The number are still relatively small but we look over time just given the conditions there that those will be a future growth markets for us. Adam Brooks - Sidoti & Company: All right, thanks a lot.

Sure. Operator: Thank you. Our next question comes from the line of Gregory (inaudible) Lord Abbott and Company. Please go ahead.

Yes. Most of my questions have been answered. One perhaps some minor question would be in the area of special applications. Are you seeing any expansion there or additional product applications, I realize it's down pretty well but could you talk about that?

Gregory, Bill here. We continue to look for ways of leveraging what we do in for disk drive filters and other segments and we see some possibly interesting opportunities but they are not material yet at this point.

And is there... if you look at the different segments, would they be electronics that was the most difficult of that within that group?

Basically that about 60% of the special applications build is for hard disk drives and I would say that both the electronics portion of that as well as the computer were down significantly.

Okay. Thank you very much.

Okay.

(Operator Instructions). And our next question comes from the line of Charles Brady with BMO Capital Markets. Please go ahead.

Yes good morning this is actually Tom Britman (ph) standing in for Charlie Brady. Just a couple of quick questions, follow up on that last question. The as the mix shift in special applications sort of changes and that you go more towards PTFE membrane filtration products and less towards hard disk drive, just wondering what the margin outlook would be based on that?

Tom, this is Bill Cook. We're basically trying to grow both parts of that special applications, both the hard disk drive filters as well as the PTFE membrane products. And the margins are, we don't break them out but overall they are roughly the same.

Okay. And then only other question I had was just to follow up on last quarters discussion about cost recovery negotiations, I think there was particularly focusing on OE portion of the engine business? Is there any update on that? Or I think you talked about a little bit of offset for your margins that came from some pricing this quarter?

Tom, Bill again. I think as we discussed in this press release as well as last quarter, with the rapid increase in commodity cost that started to see last spring and summer, we really approach dealing with after a combination of some selective price increases as well as very aggressive cost reduction projects, internal projects and that continues, where we're also seeing, we hope to see some moderation and commodity cost that will flow through in the coming quarters as well.

Okay, thank you very much.

Thank you. And our next question comes from the line... a follow-up question from the line of Jeff Hammond. Please go ahead.

Hey guys. Just a follow up on the restructuring. Can you just talk about year-to-date including the next quarter, what you've spent on restructuring it, I just want to understand the pay back a little bit better, because it seems like your spend is fairly small relative to the $85 million payback?

Yeah, Jeff, Tom here. So, again in the second quarter, the spend was about $4.3 million and 2.4 of that was in gross margin 1.9 in operating expenses. And in the second half, we see another $3 million included in that 3 million is a couple of $100,000 related to a couple of small distribution centers, leased distribution centers that were going to be consolidated into our major owned distribution centers. So there is some moving costs, some lease cost in that number. So, that debt gets you to I think 7.34 for the year and we are hopeful that that will lead to $85 million of annual savings.

Did you incur any in the first quarter?

No, no, it was really all second quarter, Jeff there.

Okay. So, as a lot of the cost saving really just hungering down on discretionary spend?

Yeah, its workforce adjustment and really looking at ever dollar we can from a discretionary spending standpoint.

Okay, thanks guys.

Thanks.

Thank you. And our next question comes from the line of Steven (inaudible) with First Pacific Advisors. Please go ahead.

Yes, good morning. I just had a question on CapEx spending. For the first six months of the year, you spend roughly 23 million and earlier you indicated that for the full year it would 60 to 70 million, which would indicate, the quite a step up in the CapEx spending, for the next six months. Can you talk about that and where that money is going?

Steven, Tom here. That represents the combination of wrapping up the projects that we have in existence that Bill mentioned before, an expansion in India, Brazil but then also we have just a normal maintenance CapEx as well that will probably pick up a little bit in the second half of the year. There are no, as Bill mentioned I believe, there are no specific new projects that we're undertaking at this time. So, I think you want to look at, look at that primarily on a more of a timing type basis.

Okay. Thank you.

Thank you. And at this time, there are no further questions in the queue. I'd like to turn the call back over to management for any closing remarks.

Thanks Brandy. And to all of you participating and listening, I'd like to thank you for your time and interest, to everyone on the Donaldson team, I know this is a very difficult time and there will likely be more tough days ahead of us before we emerge from this recession. We need to continue to focus on what each of us can do to control within our jobs for the benefit... what we can control our jobs for the benefit of our customers and shareholders and our fellow employees. The sun will come out again and when it does, we will be ready. So, thank you for your support, goodbye.

Thank you. Ladies and gentleman, this concludes the Donaldson second quarter 2009 conference call. If you'd like to listen to a replay of today's conference, please dial 303-590-3030 or 1800-406-7325, followed by the pass code of 3971205. AT&T would like to thank you for your participation. You may now disconnect.