Donaldson Company, Inc. (DCI) Q4 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2011 Donaldson Company, Inc. Earnings Conference Call. My name is Jasmine, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I will now turn the presentation over to your host for today's conference to Mr. Rich Sheffer, Director of Investor Relations for the Donaldson Company. You may proceed.

Good morning, and welcome to Donaldson's fiscal 2011 fourth quarter conference call and webcast. Following this brief introduction, Bill Cook, our Chairman, President and CEO; and Jim Shaw, our Corporate Controller, will review our record fourth quarter earnings and initial outlook for fiscal '12. They will be presenting their comments live from the New York Stock Exchange. Next, I will need to review our Safe Harbor statement with you. Any statements in this call regarding our business that are not historical facts are forward-looking statements, and our future results could differ materially from the forward-looking statements made today. Our actual results may be affected by many important factors, including risks and uncertainties identified in our press release and in our SEC filings. Now I'd like to turn the call over to Bill Cook. Bill?

Thanks, Rich, and good morning, everyone. It is a great pleasure to be here at the New York Stock Exchange during our earnings webcast. With me here in New York today are Jim Shaw, our Corporate Controller; and Amy Becker, our Assistant General Counsel. I also want to remind everyone that 3 of our fellow employees will be doing the closing ceremony here at the Exchange today. Jennifer Zhang from Wuxi, China; Bart Vandenplas from Belgium; and Kathleen Flanagan from our Frankfort, Indiana, plant will be representing our 11,000 fellow employees around the world in celebration of both our record year and our updated strategy. Okay, now back to our earnings call. As Rich mentioned, we issued our fourth quarter earnings release earlier this morning, and we're very pleased to report that we had a very good fourth quarter, as we set records for both quarterly sales and earnings per share. This also puts the finishing touch on a record fiscal '11 in which we had record sales of $2.3 billion and reported record gross and operating margins of 35.5% and 13.7%, respectively, which resulted in record net earnings of $225 million. And finally, we delivered record EPS of $2.87 per share. While clearly, fiscal '11 was a year with strong sales growth in most of our end markets and solid execution in our manufacturing plants and distribution centers, it may be less obvious to you that we also made key long-term strategic investments during the year. These investments will benefit us in the years to come and help us on our journey to build Donaldson into a $3 billion filter company. But first, let's briefly review our fourth quarter results. Fourth quarter sales were a record $625 million, up 21% over the past year. While foreign currency translation was a help in the quarter, accounting for nearly 8% of this year-over-year increase, our organic sales growth was 13%. The combination of our 21% sales growth and a 14.4% operating margin delivered a net income increase of 29% and an EPS record of $0.84 in the quarter. In our Engine Products segment, local currency sales increased 18% over the prior year. Our Engine Aftermarket or Replacement Filter sales were up 12%, as utilization rates of existing truck and Off-Road equipment fleets continue to improve. We have also in our Aftermarket continued to add new distribution, more part numbers to our product line and new customers. Consequently, we believe that a portion of our sales growth is a result of increased market share. This is clearly evident in Asia, where Engine Aftermarket sales were up 27% in the quarter. Our 2 Engine OEM businesses were also both up strongly in local currency terms. Off-Road Product sales were up 30%, as the agricultural, construction and mining end markets we serve have continued to strengthen and increased demand for our customers' new equipment upon which our filtration systems are installed. On-Road Product sales were up 51%, as North American and European new heavy truck build rates have continued rebounding. Now switching to our Industrial Products segments. Local currency sales increased 7%. Revenues from our Industrial Filtration Solutions product increased 14%, as sales of new dust collection equipment continued to grow in the quarter. In addition, our sales of replacement filters for those dust collection systems already in the field have remained very strong. Although our Gas Turbine sales decreased 9% in the quarter, it does now appear to us that this late-cycle business has bottomed out and should start improving soon. And finally, sales of our Special Application Products increased 3% in the quarter, as rapidly growing sales from our newer product lines, which serve the semiconductor, imaging and venting end markets, offset slower Disk Drive Filter sales. Looking at our sales by region. We had good growth in the Americas and Europe, where our local currency sales increased 17% and 15%, respectively. In Asia, our overall local currency sales growth was 7% in the quarter, as our Engine Product sales increased 24%, and our Industrial Filtration Solutions sales increased 13%. Partially offsetting these 2 strong performances were lower sales in Gas Turbine and Special Applications. I'm now going to turn the call over to Jim Shaw for his comments on our operations before I discuss our fiscal '12 sales outlook. Jim?

Thanks, Bill, and good morning, everyone. Our gross margin was 36.3% in the quarter, which is even with last year. As we’ve mentioned in the last 2 quarters, we've been experiencing higher purchase material costs, which net of selected price increases, decreased gross margin by 80 basis points compared to last year. The magnitude of the cost increases were in line with our previous guidance. Much of the increase experienced in the quarter was related to the April expiration of our steel contracts in the U.S. and the increases in petroleum-based raw materials, such as plastics, urethanes and adhesives. We expect additional increases for some of these materials as well. Higher oil prices not only affected our petrochemical based raw materials, but it also increased our freight cost 10 basis points in the quarter. Fortunately, we've been able to offset most of the impact of these increases through our Continuous Improvement initiatives, but the magnitude of these increases has also required us to implement some selective price increases. On the positive side, better fixed-cost absorption and our Continuous Improvement initiatives were 90 basis points positive in the quarter. So in total, our gross margin was the same as last year's fourth quarter margin of 36.3%. Our operating expenses remain well under control, coming in at 21.9% of sales, which was relatively consistent with last year. This includes our planned strategic operating investments for growth in Asia, Europe, Latin America, for liquid filtration technology and product development as well as our Global Supply Chain project. These investments totaled $5 million this quarter and $14 million for the year. Our operating margin came in at 14.4% this quarter, and we finished the year at a record 13.7%. Looking at our operating margin forecast for fiscal '12, we expect the impact from recent price increases in our purchased raw material costs to moderate over the next couple of quarters and that we’ll continue to experience a small benefit from continued higher volumes as we leverage our fixed costs and continue to benefit from our Continuous Improvement initiatives. In total, we expect our operating margin for fiscal '12 to be between 13.7% and 14.5%, which means that anything above the bottom of this range would represent another operating margin record. Our effective tax rate was 27.3% in the fourth quarter versus 29.5% last year. During this year's fourth quarter, we had $2.6 million of tax benefits, primarily from the expiration of some statute of limitations and the favorable impact of dividends from some foreign subsidiaries. Based on our projected global mix of earnings in fiscal '12, we expect our tax rate to be between 28% and 30% for the full year. Our fourth quarter CapEx came in at $17 million, which brought us to $60 million for the year. During the quarter, we completed work on new labs in China, India and our Bloomington, Minnesota, headquarters. We plan to continue our strategic investments to support our customers this year. As previously mentioned, we are building a new air filter plant in Aguascalientes, Mexico, which will add more filter manufacturing capacity for the fast-growing Latin America region and also allow us to use our existing plant in Aguascalientes strictly for expansion of our liquid filter expansion. We expect this new plant to open during the third quarter this year. In total, we expect CapEx spending to total approximately $100 million this year, as we are continuing to invest globally to meet our strategic growth plan. We have many new projects included within our $100 million CapEx plan, and we expect these will positively impact our corporate ROI when completed, and we expect depreciation and amortization to be between $60 million and $64 million this year. Free cash flow was $60 million in the quarter, which was a conversion ratio of 91%. For the year, free cash flow was $186 million, which is a conversion ratio of 83%. While working capital was a use of cash this year driven by higher sales, the metrics we use to measure working capital effectiveness, days sales outstanding, days payables outstanding and inventory turns, all either have remained consistent or improved for the year. We expect free cash flow to be $175 million to $205 million in fiscal '12. We repatriated approximately $100 million from our foreign subsidiaries in the fourth quarter, which dropped our debt-to-cap ratio to 22.2% and debt-to-EBITDA to 0.7%. Both remain well within our financial covenants in our various debt agreements. We're expecting interest expense in fiscal '12 to be between $11 million and $13 million, and our balance sheet remains strong with $273 million of cash compared to $267 million of total debt. So with that, I'll pass it back to Bill, who will provide additional details on our outlook for fiscal '12. Bill?

Thanks, Jim. As all of you know, there have been many discouraging economic reports in the media over the past 4 weeks. Obviously, how all of these indicators impact our future business conditions remains to be seen. So it is clear that we're beginning our fiscal '12 with a lot of economic uncertainty on the horizon, but we're also beginning our new fiscal year with a lot of momentum, both with our open order backlog and our operating metrics. And based on our fiscal '12 plan, we are expecting our full year sales to be between $2.45 billion and $2.6 billion, up 7% to 15% over the prior year. This is supported by our recent order trends in our current backlogs. Our forecast does assume positive global economic growth, but it also anticipates that it will be lower than what we enjoyed in fiscal '11. Bottom line, we still expect to grow faster than the global economy through the introduction of new filtration technologies and products and also by increasing our sales, especially in emerging geographies. Now I'll review our outlook by segment. Our engine sales are forecast to increase between 8% and 15%. Within Off-Road Product sales, we expect continued strong demand for OEM customers' agricultural, construction and mining equipment, as the average age of equipment in the field remains historically old. This should support an ongoing equipment replacement cycle. We're also forecasting a continued strong recovery in our On-Road Product sales, as the North American forecast for heavy truck builds is expected to increase from about 154,000 in calendar '10 to about 255,000 in calendar '11, a 66% increase. Current truck fleets are also historically very old, indicating the need for a continuation of the current replacement cycle. In Europe, trucks builds are also expected to grow, although at a slower pace than what I just mentioned in North America. And finally, within our Engine segment, we expect our Aftermarket or Replacement Filter sales to remain strong. The demand for replacement filters is a function of the increased utilization rates within the existing fleets of heavy trucks and Off-Road equipment currently in the field. In addition, we're aggressively working to further expand our distribution networks, especially in our targeted emerging markets. Now I'm going to switch and talk about our other reporting segment, Industrial, where our sales for fiscal '12 are forecast to be up between 7% and 15%. We expect our Industrial Filtration Solution business to be up between 7% and 15%, as customer demand for new industrial dust collection equipment continues to improve, as new plant and manufacturing equipment capital spending increases. We also expect our replacement filter sales for dust collection equipment in the field to continue to grow, again with increased utilization by our customers for that equipment already installed in their plants or in the field. In Gas Turbine, we expect the demand for large gas turbines used for power generation to begin rebounding in fiscal '12. In addition, the demand for smaller turbines for the oil and gas market we’ve forecast should remain strong. Overall, we expect our Gas Turbine sales to increase between 14% and 22% in fiscal '12. And the final part of our Industrial segment is Special Applications. We're forecasting our sales to increase between 2% and 9%, primarily as a result of the continued growth for our Membrane products and our ongoing market penetration for some of our new venting products. Incorporating this sales guidance into the operating guidance that Jim just covered, we expect our full year earnings per share for fiscal '12 to be between $3.15 and $3.45 per share, which would be a new record. Now finally, I'd like to provide a quick update on some of our new technologies before we wrap up our prepared comments. As we’ve discussed over the past few years, we've highlighted our PowerCore technology as an example of how we continually introduced our new filtration technologies for our customers in order to help both growth their and our businesses. Our first-generation PowerCore was a tremendous success, and our second-generation PowerCore looks like it will be every bit as successful, as it delivers breakthrough filtration in a 30% smaller footprint than our first generation. Our Engine PowerCore sales in the fourth quarter were a record $23 million, up 47% over the prior year. The ramp-up in our OEM customers' production rates resulted in our first PowerCore sales growing 71% in the quarter. In addition, our Aftermarket or Replacement Filters sales of PowerCore were up 35%. On the industrial side of our business, we introduced our third Torit PowerCore product in May. This new part of our product line is targeted towards a high-abrasive, heavy-loading mining and metalworking market segments. For our customer, this product offers many advantages, including that it is up to 70% smaller than the comparable competitive collectors. In our fourth quarter, we sold another 250 Torit PowerCore systems, which accounted for about $2.5 million in sales. We talked over the past couple of years about our goals to build a bigger presence in liquid filtration. We've unveiled a new line of SELECT fuel filters with our proprietary Synteq XP media at the CONEXPO show in March. Since then, we've already won 5 OEM platforms with SELECT, and interest in this new generation of diesel fuel filters is very high. As we mentioned last quarter, we're also winning new customers with our new Bulk Fuel and Lube Filtration product line. These filters clean the fluids prior to entering a storage tank, protect the fluids while they're in the tank and then final-filter them as they're pumped out of the storage tank for use in equipment. This is a growing opportunity for us as the new diesel engines introduced by our customers require cleaner and cleaner fuel. Finally, we're continuing development work in our next-generation of Duramax hydraulic filters. When launched, we expect these filters will offer our customers improved filtration performance and longer filter life. These are just a couple of examples of the many liquid filtration opportunities we're working on. In total, our liquid filtration sales were up 24% in fiscal '11 with sales exceeding the $400 million mark. So to summarize, we delivered record results in fiscal '11 with sales exceeding our long-term 10% growth target by a wide margin. This puts us very well on pace to achieve our fiscal '16 $3 billion sales target, which we established in our strategic growth plan a year ago. We acknowledged that the past month has increased the level of uncertainty regarding global economic growth, but we currently have good momentum, which should get our fiscal '12 off to a great start. As we successfully did during the recent recession, we will continue to focus on those things within our control. We will focus on developing new technologies and products to help our customers’ changing filtration needs. We will continue to make the key long-term investments to achieve our fiscal '16 and fiscal '21 growth targets. That concludes our prepared remarks, Jasmine. Now we'd like to open it up to questions.

[Operator Instructions] And your first question comes from the line of Laurence Alexander with Jefferies. Laurence Alexander - Jefferies & Company, Inc.: I guess 2 quick questions. One is what type of market share assumptions are embedded in your 2012 forecast? And also, could you revisit what productivity measures you might have available as a Plan B? And what you are watching -- and like what kind of deterioration in your end markets would you need to see to trigger tightening the bell towards [indiscernible] in such small steps?

Okay. On your first question, in terms of market share, when we take a look at our long-term growth target of the 9% to 10% that we've mentioned, we're looking at probably 2% to 4% per year for market share growth. This is in addition to the normal growth in the filtration market. And then, we supplement that with a little bit of acquisitions, but about 2% to 4% per year for market share growth. And I'll add that's not just aspirational. That's actually what we've averaged over the past 20 years. That's new products, new geographies, new customers, product line extensions, the combination of all those factors. On your second question, we look at lots of indicators to try and figure out what's in front of us. We have -- about 1/2 of our business is very short cycle. That's our Replacement Parts business. The other half of the business, the first-fit business, we have longer order backlogs from our customers. So we have more visibility with that business. We look at that on an essentially a monthly and weekly basis to determine what's out in front of us. And we're looking at what other companies are seeing, and especially our customers in terms of their outlook. So customers like Caterpillar, we follow their announcements very closely. What we have, we have a very strong Continuous Improvement philosophy in many programs that are embedded in our operations, in our plants, in our engineering departments, in our sales organizations that are always working on cost reductions. That's part of the normal Donaldson practice. But what we did in the last recession is when we saw that things were deteriorating, we shifted some of our resources from some of our growth investments to the Continuous Improvement to sort of help us get through the recession, not all of them, but we shifted more of our resources to work on cost reduction and margin protection. And we'll do the same thing if we do see things deteriorating.

Your next question comes from the line of Kevin Maczka with BB&T Capital Markets. Kevin Maczka - BB&T Capital Markets: Bill, first a couple of questions on margins. As it relates to Industrial, it looks like you had a little higher revenue but lower margin this time. I'm just wondering if there was a mix issue in there at all or if you can provide more color on that, just generally.

Kevin, I'll turn it over to Jim for that one.

Yes, this is Jim. Within Industrial, we will, from time to time, see some fluctuation there because it really does depend on the mix of products versus Aftermarket, especially GTS and IF can really influence that. So I think the decrease this quarter is not a surprise and pretty consistent with the range at which that will move around. Kevin Maczka - BB&T Capital Markets: And then as we look out to '12, you're expecting total company operating margins to increase. Is that all coming from the engine side? Is that fair to assume? Or should there be some contribution there from the Industrial side as well?

Kevin, Bill here. I'll to start off, and maybe Jim wants to add something. But it's from both reporting segments, Engine and Industrial. And the margin improvement, the operating margin improvement is consistent with what we talked about in our strategic plan, is that over time, we want to continue to expand our operating margins with our -- as we target both fiscal '16 and fiscal '21. Jim, you want to add anything?

No. I think that's consistent. As I mentioned in the prepared comments, we will continue to see some challenge on the gross margin line, but with volumes and the continuous improvements, we hope to leverage that a little bit through operating expenses and continue to expand that on both sides. Kevin Maczka - BB&T Capital Markets: Okay. Bill, and then, if I could just ask one more kind of high-level question as it relates to the increased uncertainty that everyone's seeing. In your early cycle units, are you seeing anything anywhere from your customer that would suggest a slowdown there? And how concerned are you about IFS, just because that's generally tied to global industrial CapEx?

So Kevin, good questions. I think -- we were in lots of different end markets and we’re in lots of different -- that follow lots different cycles. I think our experience from the recession that started in 2008 was that, probably, we -- even though that we’re in lots of different end markets that we'll probably start to see things sort of in mid-cycle. So we're very -- compared to some other companies, we're not one of the first ones to see something that's happening either good or bad. We usually -- it usually, it takes maybe a couple of months. So we recognize that. So we follow lots of other companies to see what they're saying or seeing. As I mentioned earlier, I mean, one of our biggest customers, Caterpillar, so we follow their forecast very closely. And a month ago, they increased their sales guidance for calendar '11 over their previous guidance. So we're very focused on watching things. We hope that it doesn't -- things don't fall off, but we're going to -- we’ll watch, and then we'll react proactively, if things do weaken. In the IFS business specifically, you asked about -- that, for us, is clearly a mid-cycle business. The equipment side of it, that typically if people have projects underway, new capital projects, new plants where our equipment is incorporated, they'll continue with those. So it ends up being a mid-cycle. But the replacement part of that business, which is about 40% of the sales is an earlier cycle. And we've seen that business, as we mentioned in our comments, has been very, very strong, which indicates that people are using the equipment, the production equipment, that's out there in the field.

Your next question comes from the line of Brian Drab with William Blair. Brian Drab - William Blair & Company L.L.C.: It's hard to picture getting back to record revenue level in 2009, but you're back there at the Stock Exchange, so it's great to see. First question, going back to just market share discussion, can you give us an update on roughly where your market share is in the Asia Engine market at this point?

Brian, Bill. So in Japan, where we've been operating for over 40 years, we have very high market share on first-fit air on the engine side, okay? Really not anything on liquid. So that's an opportunity for us that we're building out. So high end in Japan. In China and the rest of Asia, it's pretty low. And a lot of that is a function that historically a lot of the equipment didn't need our level of technology, but that's changing, as we've discussed before. So the Chinese truck and equipment manufacturers need better filtration, and that's opening up the opportunity for us. So in China, our market share on engine products is in the mid-single digits. And so, it's a huge opportunity for us. Brian Drab - William Blair & Company L.L.C.: Okay. And where’s the bigger opportunity, do you think, in China in the Aftermarket or in the first-fit? And can you talk just a little bit about how you're going to market in China?

So Brian, the opportunity is big on both sides, first-fit and replacement filters. There is a lot of equipment that has -- that's in China that has our air filtration systems already installed. There was -- some of our western customers are exporting equipment in there. So there's an available Aftermarket that we're going after. And we're doing that through distribution models, similar to what we use in the U.S. and in Europe, setting up local distribution and managing that with our own direct sales force. On the first-fit side, we're going after the new -- we’re working with both the Western OEMs that are setting up production there. But we're also going after the local Chinese equipment manufacturers that again are making this transition to using a -- needing a higher level of filtration technology. So we've mentioned we’ve won a couple of Chinese truck platforms already that are starting up in production, and there's a lot more opportunities there for us to continue to grow that. The Chinese heavy truck market, they will build something over 900,000 heavy trucks this year, which is like 3x the U.S. market. So it's a huge opportunity, and that opportunity is going to open up to us as more and more of those trucks need higher level of filtration. Brian Drab - William Blair & Company L.L.C.: Okay, great. And then just one more question, maybe looking at the income statement and percentage of sales that SG&A accounted for in the quarter, it's a little bit above where we expected. Can you give us any more specific sense and what we should expect in terms of SG&A as a percentage of sales, 22% plus or minus, might be the range you're expecting?

I'll start, Brian, then I'll turn it over to Jim. We did have $5 million worth of strategic operating expenses in the quarter. So that was a little bit higher run rate. And that is by design because, as we’ve talked, we're trying to optimize our operating margin, not maximize it. What we want to do is grow the company and optimize that margin, and we're going to invest back in the business. But Jim, do you have some additional comments?

Yes. I think if I just kind of take a look through the components in terms of walk [ph] from fiscal '10 of 21.8% to 21.9%, we were running very efficiently last year at this time. So when we add a little bit of volume, net of these investments that Bill talked about, I don't think there's really anything new or unusual there. We're actually quite happy that we ended up pretty close to last year. There probably was a little bit more spend in the quarter as we -- with our good results had a little bit of a true-up on things like incentive compensation, but nothing out of the ordinary.

Your next question comes from the line of Hamzah Mazari with Crédit Suisse. Hamzah Mazari - Crédit Suisse AG: The first question is just on your capacity expansions. Could you remind us where you are in that process? What's coming online soon? And then what kind of incremental margins are you guys baking in for next year in your guidance?

I'll start, Hamzah. This is Bill. The production capacity -- the biggest ones that we have coming online over the next year are the ones that Jim mentioned, we have -- we're building a new plant in Mexico. It will be our third plant in Mexico. This one will be dedicated to air filtration products. We're also investing in another plant, one of our existing plants in Mexico, to put more liquid filtration production capacity there. We're also making investments in some of our existing plants in the U.S. and Wisconsin. We have a liquid filtration plant that we're putting more capacity into and some of our air filtration plants in the U.S. as well. So there's -- the one that Jim mentioned and I started with is a bricks-and-mortar investment with a new plant. A lot of production capacity expansions in both Europe and the U.S. as well that don't require bricks and mortar. Of the $100 million that we mentioned in terms of CapEx, it's basically about 4 parts, okay? About 1/4 of it is capacity improvements or expansions. About 1/4 of it is for new product processes, new product tooling. About 1/4 of it is for Continuous Improvement initiatives to take cost out of our products. And then, the final is for new technology, so whether it's IT, corporate technology or R&D. So that's split roughly in quarters. It's not exact, but that's sort of a rough way that we're investing. Hamzah Mazari - Crédit Suisse AG: Okay, that's helpful. I appreciate that. And then, on your distribution network, the expansion of that, where are you guys in that process? Are those early -- is this early innings in terms of distribution expansion in emerging markets? Or how much more runway do you have to go there?

Hamzah, Bill again. I think we have a lot of runway left. We're building out both the distribution and our product line, so we're making sure that we can give the distributors more products to sell. In some cases, that's products where we weren't on the first fit, where we’re fitting somebody else but giving them the broadest product lines, and then just adding -- building distribution. And that's really in all the BRICs. So the Brazil, India, Russia, China, South Africa, South East Asia, that we're building out rapidly, building out our distribution. And we think we have a lot more to go. Hamzah Mazari - Crédit Suisse AG: Okay. And then, just lastly on your balance sheet, how are you thinking about leveraging that? Are you getting more aggressive on M&A? It seems like you're just focusing more on organic right now. Is that fair? Are you seeing any opportunities out there in the marketplace?

Well, this is Bill, Hamzah. Going back to our overall growth target of 9% to 10% per year, we assume in that, that we'd be doing acquisitions of, say, 1% to 3% per year. So that means that 7% to 9% of our revenue growth is going to be organic. And that's what we've historically done, that's what we're comfortable doing. We see the opportunities to continue to do that. And that's also consistent with delivering more consistent financial results, we think, is focusing on our organic growth. But we do look for acquisitions, and we are continually looking at those. Even though it's not the major part of our growth story, it is an important part. And so, we have a small team that's focused on looking at those, and we can't comment prospectively, but on average, we'd like to do 1% to 3% of our annual revenue growth through acquisitions, which would mean we’d need about $50 million roughly in acquired sales each year at this current size. So we're looking. And I think the last one we did was our Western Filter acquisition. That was liquid filtration in an end market that we already knew. That would be sort of typical of the things that we're looking, extensions of things that we know will bring us additional products, additional Aftermarket presence or additional reach into new geographies.

Your next question comes from the line of Charles Brady with BMO Capital Markets.

This is actually Tom Brinkmann standing in for Charlie Brady. Just a couple of questions. First of all, you talked about your expectation that purchased raw materials could -- the cost could continue to rise. Could you talk about your expectation for gross margin in 2012 and how that's going to sort of trend over time, you think?

Yes. This is Jim. I did mention in the prepared comments about commodity prices. And even though, since April, there has been some softening in certain of the commodities, such as steel and petroleum-based products, we're still up about -- for steel, for example, we're still up 20% year-over-year because, for much of the year, we had been protected by some long-term agreements, specifically in the U.S. So even if the costs hold at their current levels, we’re still going to have some challenges next year in terms of margin, as well as some of our other key commodities, petroleum-based and media. So we’ve worked into the forecast to hit the midpoint of that range that we have out there for next year's goal would be a 14.1% operating margin. So we’ve factored in these higher commodity costs but also factored in our Continuous Improvement initiatives and leveraging the volume that we hope to see next year as part of that. So that's kind of how we took a look at putting together the plan for next year.

There is some pricing in there, too, Tom, selectively in certain select market segments, where we either have Index agreement or where we could recover it, based on justification that we do recover some of that on sort of a dollar-for-dollar basis.

Okay. And then just moving on to some of your broader comments about geography. Can you talk about what you've seen in the European market recently in, I guess, just across you markets, but also in on-road or build rates, what you’ve been hearing from your customers?

Tom, this is Bill again. I think I mentioned what our -- talking about sort of the build rates for on-road trucks being -- in Europe, certainly, being up again in calendar '11 over calendar '10, that's -- we follow up a lot of industry forecasts, and so that's baked into our forecast and our guidance. This is a difficult time to get a lot of information on what's happening in Europe, given the fact that our customers are still mostly on vacation. So over the next month, as they come back and they update their forecasts, we'll get better information. But going back from what we can get over the past 4 to 6 weeks, that's all baked into our guidance. So on-road heavy truck builds in Europe, up year-over-year, but not up as much the U.S. numbers that I mentioned.

Okay. And then can you give any more granularity on some, I guess, geography, some results you had elsewhere, in terms of the growth rates from other markets, South America, Asia, elsewhere?

Tom, I'll turn it over to Rich. I think he has some of those details. Rich, can you help us with that one?

Sure. If we look at growth rates in some of our other markets, Latin America, so Mexico, Brazil, Chile, we were up about 27% year-over-year. We mentioned Asia Pacific, up 17% in total. But places like China, we were up 40%. Some of the other -- even Japan, with them coming back now, we were up 26%. So we had some clear pockets of strength in the quarter.

Okay, great. That's very helpful. And then just about the comment you mentioned, you continue to benefit from increased market share on customers’ Tier 4 equipment platforms. Can you provide some more color on that and sort of what you -- I guess what your market share is on Tier 4?

Tom, Bill here again. I think the opportunity is around these new equipment platforms that the new engines require a higher level of both air and liquid filtration technology. So that's really opened the door for us to -- and we're on the air side. We already had a high market share in first-fit is to put in new products where we can lock up the Aftermarket or protect the Aftermarket for a longer period of time for our customers. So it's more maybe a market share opportunity on the replacement parts. On the liquid side, where we were not doing very much in terms of first-fit before, it's an opportunity to get in there and win on both the first-fit and replacement parts. In terms of the actual shares, so in North America, our air, on the engine OEM side, our first-fit air is very high. It depends on the segment, but it might be between 70% to 80% or 90% on the first-fit. On the replacement parts, it's probably between 20% and 40%, depending on which segments. So there's opportunities on air still on the first-fit but especially on the aftermarket. In Europe, the percentages are far lower than those on both first-fit and air. So opportunities on both. As I mentioned on the liquid side, it's a huge opportunity on both sides as well where we really haven't had much first-fit share other than our hydraulic filtration. We're really not much on either fuel or lube. So it's really all upside on both.

Okay. And then the last question is just you talked about Special Applications Products sales forecast that it’s going to be mostly driven by Membrane sales, the growth will be [ph]. Do you expect positive growth in the Disk Drive space? What do you expect there?

Tom, Bill again. Yes, I think we have seen the second half of our fiscal year that the Disk Drive sales were softer. I mean that was an early-cycle business that recovered very quickly out of the recession, and it's sort of been flattish for the past 6 months. The industry forecasts suggest that drive volumes, hard drive volumes, by our customers will be up 6% on the back half of this calendar year over the first half. So we are looking at -- I think it's going to go from 327 million drives produced in the first half to about 345 million or 350 million drives in the back half. So there is going to be growth, but it's going to be sort of in the mid- to high-single digits versus what they saw coming out of the recession initially.

Your next question comes from the line of Richard Eastman with Robert W. Baird. Richard Eastman - Robert W. Baird & Co. Incorporated: In terms of sales, the sales forecast, Bill, if I take a look at the 7% to 15% sales forecast for '12, and I take out my currency assumption on the 1.42 euro, against that local currency growth rate of maybe 5% to 13%, how were you looking at the distribution relative to the Americas, Europe and Asia? Do you expect a low end out of Europe or...

Rick, Bill here. I don’t have the numbers in front of me, the exact numbers, but I don't think we anticipate seeing very different percentages between the U.S. and Europe, but we do expect to see higher percentages in Asia than either of the other 2. Richard Eastman - Robert W. Baird & Co. Incorporated: Okay, all right. So that trend will continue. And then, also, when I look at the Asian growth rate in the quarter, it was plus 7% I think is the number you mentioned. And I'm curious, I think you have said the Engine Products were plus 24%, and in the industrial, I don’t know, maybe it’s IFS was plus 13%. Is that how -- is that what you were saying there?

Yes. I'm looking up the exact numbers, Rick. But essentially, what -- both of those were very strong in the quarter, you're right, engine and Industrial Filtration Solutions, so Industrial dust collection equipment. Those 2 were partially offset by Disk Drive. We just talked about that. That's basically almost -- it's entirely an Asian business so that was flat. And then the other one was Gas Turbine, was down a little bit in the quarter. And as you know, Rick, the Gas Turbine sales sort of bounce around from quarter-to-quarter, so fourth quarter over fourth quarter, year-over-year, Gas Turbine was down a little bit. But what we tend to do, Rick, is take a look at the other 2 businesses as sort of indicative of what the real strength is in that region in Asia, and that's the engine business then and the IFS, the Industrial Filtration Solutions. Richard Eastman - Robert W. Baird & Co. Incorporated: Sure. And the larger Gas Turbine Systems that you would expect to maybe start to bounce off the bottom here, those would be skewed more towards to Asia then, correct?

They'd be some in Asia and some in the Middle East. We've seen a lot of quoting activity from the Middle East as well. Richard Eastman - Robert W. Baird & Co. Incorporated: Okay. And then last question, when you talked about the build-out of your capacity on the engine mobile to liquid side, that sounds like a nice growth driver. How do you source that product into Asia? Do you have liquid Engine/Mobile Filtration capacity and manufacturing in Asia?

We do. We source it a couple of different ways, Rick. Some of it is actually coming from the U.S. and Mexico, from our liquid filtration plants there. And that's one of the products that we have that actually ships pretty well. I mean, the value per cube is pretty good, so you can ship it versus some of our larger air filters. As you know, it's hard to ship those long distances. So we're shipping a lot from the U.S. and from Mexico into Asia. We also have a plant in Indonesia, a long-standing joint venture up in Jakarta that we source a lot of product for Asia and, actually, for other parts of the world as well, primarily liquid but also some air. So we have liquid capacity earning already in Asia through our operation in Jakarta. Richard Eastman - Robert W. Baird & Co. Incorporated: And is the most of the Asian liquid business -- is that mostly first-fit at this point in time?

It's mostly replacement parts.

[Operator Instructions] Your next question comes from the line of Gary Farber with CL King. Gary Farber - CL King & Associates, Inc.: Just 2 questions. One, is it possible to quantify roughly what you're running at as far as capacity utilization as a company? And then, give us maybe where is your low end of that, what region? Where is your high end? And also, can you discuss what overall, what your hiring plans are for employees for this year and how that might be different from last year?

Okay, Gary, This is Jim Shaw. I'll take the first part of the question and then turn it over to Bill for the second half. But in terms of our capacity, we're running pretty consistent with what we have the last couple of quarters, and that's at about 80% to 85% of our capacity. We’ve, I think, talked about this in previous quarters, but initially, when we were coming back from the recession, we did get a benefit from being able to use that capacity and get some incremental margins. We're really at the point now where our -- any incremental margin benefit is gone, and any new sales are really at our existing margin levels. So that's kind of where we're at from a capacity level, but I can let Bill fill in a little bit more detail on that.

And I'll add to that, Gary. So we measured capacity as 80% of 2 shifts. So it's -- that 80% that Jim mentioned is 80% of, essentially, a 2-shift operation. We do run many of our plants at 3 shifts, but we tend to use that for sort of surge capacity until we can add more permanent capacity. So we have the ability to flex up a bunch still. We are adding capacity, and you asked about sort of regionally. We take a look at our capacity investments and needs, really, in 3 buckets. We take a look at it for Europe, and we take a look at it at the Americas, and then we take a look at it for Asia. And we make the investments there to try and make sure that we have enough capacity where we need it and close to the customers. And that's part of what we're doing, as we mentioned earlier with our CapEx, is making -- we talked about a new plant in Mexico, the production line investments in the U.S., Mexico. There's investments in Europe. We just put another -- we expanded one of our factories in China. We just completed that. We're putting more equipment in there. So we tend to make those all regionally, because that's what works the best for us in terms of customer support and logistics penalties. In terms of the hiring, I think we're up about 800 people from where we were this time a year ago. We're very happy about that. We're up to where we were pre-recession. Our hiring plans are really dependent on what we see happening with the business going forward. And we really can't comment on those prospectively, but if you take a look at what we've done as our business has come back, as we've added back a lot of people in the developed economies in Europe and in the U.S. And then, where we're really making a lot of new investments is in the emerging economies, and we're aggressively highly there, so in China, in Brazil and the other parts of Latin America. We just opened an operation in Chile, as Jim mentioned, distribution centers. So lots of hiring in the emerging markets as well to support our growth there. Gary Farber - CL King & Associates, Inc.: And that mix of 800 people you've hired, is it weighted towards a different product line than it was in the past? Or did you have a different geography in the past?

I think it's all over. It's not all in any one region. So when we went down, we took it -- it took came down all over, and we’ve added it back all over. I'd say, probably, maybe the percent is a little bit higher in the emerging markets, I would guess, because of the investments we're making there, and we had very few people or in some cases no people. So it may be weighted a little bit more towards the emerging markets, but it's -- we've been hiring back everywhere.

And at this time, there are no further questions. I would like to turn the call back to Mr. Bill Cook for closing remarks.

Okay, now I'll just wrap up our call. And first, I'd like to thank everyone for your time and continued interest in Donaldson. As I mentioned, fiscal '11 was a very good year with strong sales growth and solid execution across our company. My 13,000 colleagues made all of this possible. I'm very proud to be part of the Donaldson team and what we're creating together today and for the future as we continue with our long-term growth objectives. A very sincere thank you to all of you. Goodbye, and I hope you can see us on the closing ceremony later today. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.