Donaldson Co Inc DCI
Q3 2013 Earnings Call Transcript
Transcript Call Date 05/17/2013

Operator: Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Donaldson Company's Fiscal Year 2013 Third Quarter Conference Call Webcast. During today's presentation, all parties will be in a listen-only mode. Following the presentation, there will be a question-and-answer session and instructions will be given at that time. As a reminder, this call is being recorded today, May 17, 2013.

I would now like to turn the call over to Rich Sheffer. Please go ahead, sir.

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

Next, I need to review our Safe Harbor statement with you. Any statements in this call regarding our business that are not historical facts are forward-looking statements, and our future results could differ materially from the forward-looking statements made today. Our actual results may be affected by many important factors, including risks and uncertainties identified in our press release and in our SEC filings.

Now, I'd like to turn the call over to Bill Cook. Bill?

William M. Cook - Chairman, President and CEO: Thanks Rich, and good morning, everyone. There are three key messages that we're going to spend the majority of our time discussing today. And just to summarize, the first is that economic conditions are still challenging in a number of our end markets; second that despite these conditions by aggressively focusing on what we can control we are operating our Company very well. A few examples of this include our record operating margin percent and our second best quarter ever for cash flow generation. And third and finally, we remain confident of our long-term growth opportunities and are continuing to execute and invest in support of our strategic growth plan.

I'll begin by discussing our third quarter sales and then Jim will discuss our operating performance and then I'll conclude our presentation by discussing our outlook. So, now talking about our sales by segment, the story in our Engine Products segment is very similar to last quarter. Conditions in our Ag equipment market, especially for large farm equipment, remained strong, while our other Engine OEM end markets had another weak quarter, with on-road truck sales decreasing 24% and off-road equipment sales decreasing 4%, both in local currency. Excluding the Ag sector, many of our OEM customers continue to schedule their production levels below last year to reflect the drop-off in their end user demand for new equipment and also to reduce their own finished good inventory levels.

Among those end markets that had notable decreases were the North American and Asian heavy truck and the global construction and mining equipment markets. While some recent economic reports suggest that end user conditions may be starting to improve in some of these markets, a number of our customers have reported that they are still working to reduce their own new equipment finished good inventories. Therefore, we believe it will take several more months for our customers' productions rates for new equipment to prove enough for our businesses serving those markets to post year-over-year growth.

Now, fortunately, we saw better conditions in our Engine Aftermarket where we supply replacement filters and exhaust products through both our OEM and independent channels. Our Engine Aftermarket businesses in both the Americas and Europe were up in local currency.

So, now, I am going to switch and talk about our Industrial Products reporting segment. And starting first with our Gas Turbine business, which had another outstanding quarter with sales of $69 million, up 35% from the same quarter last year

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

And finally, in our Special Applications business, our sales decreased 21% for two reasons. First, there was a global decline in PC sales which drove a decrease for our disk drive filters; and second, we saw weak demand in industrial end markets, which drove a decrease for our membrane products.

Now, fortunately, we continue to see the positive impact from our efforts over the past 20 years to diversify, both by end markets and geographically. In addition to the help provided by our GTS business, we also had a number of regions which delivered year-over-year local currency sales growth, including Latin America, South Africa, Australia and India.

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

James F. Shaw - VP and CFO: Thanks Bill, and good morning, everyone. Our gross margin was 35.8%, an increase of 50 basis points from the 35.3% in last year's third quarter. As we noted in our press release, one of the biggest drivers of the increasing gross margin were our continuous improvement initiatives, which benefited our gross margin by approximately 100 basis points compared to last year. Product mix also helped our gross margin with an increase in the percentage of our sales coming from replacement filters. Replacement filter sales were 52% in the current quarter compared to 50% last year. In many of our end markets the utilization of existing equipment in the field is good, which is obviously good for our replacement filter sales.

Slightly offsetting these positive drivers on our gross margin were a higher mix of GTS project sales as well as slightly lower absorption of fixed costs due to the lower production volumes in our plants. In spite of these slightly negative year-over-year fixed cost absorption comparisons, the measures that we have implemented to aggressively control our manufacturing costs since volumes began declining last fall have really paid off to minimize the impact of the under-absorption of fixed costs. As part of these actions, we incurred $600,000 of restructuring costs in gross margin, which did reduce gross margin by another 10 basis points in the quarter.

Our operating expenses declined by $7 million compared to last year's third quarter. The impact from our ongoing cost containment initiatives and lower incentive compensation reduced our operating expenses as a percentage of sales by 120 basis points. These cost containment actions helped offset the 90 basis of increases resulting from higher pension expense, the incremental expenses related to our Strategic Business Systems project, slightly higher insurance costs, and the $500,000 of restructuring expenses. So, net-net, our operating expenses were lower in dollars and as a percentage of sales improved by 30 basis points compared to last year's third quarter.

As a result of our strong gross margin and operating expense performance, our operating margin was a record 15.9%. This is up 70 basis points from last year's third quarter and 400 basis points sequentially from the second quarter. For the full year, we now expect our operating margin to be between 13.6% and 14.2%.

Our effective tax rate was 29.8% in the quarter versus 29% last year. In last year's third quarter, we had $1.8 million of tax benefits, primarily from a statute limitation expiration which didn't reoccur this year. Based on our projected mix of earnings in fiscal '13, we forecast our full year tax rate to be between 29% and 30%.

Our third quarter CapEx was $18 million, bringing us to $69 million year-to-date. As we mentioned last quarter, we've responded to the ongoing slowdown in many of our end markets by delaying a number of capital projects that we'd originally expected to complete during fiscal '13. We now expect to spend approximately $85 million on CapEx this year. About $40 million of this is carryover from fiscal '12 projects that were authorized but not spent prior to last year end and the balance will be selectively spent from fiscal '13 to reduce capital project budget of $60 million. However, not all of that will be spent this fiscal year.

The breakdown of this year's CapEx of $85 million is projected to be approximately 20% related to capacity expansion, 30% for our technology initiatives which includes our Strategic Business Systems projects, another 25% is for tooling for new products, and 25% will be related to cost reduction activities through our Continuous Improvement initiatives.

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

Free cash flow was $91 million this quarter, which is our second best quarter ever. Working capital was an $8 million use of cash this quarter as an increase in accounts receivable was partially offset by a decrease in inventory and an increase in payables.

Changes in other assets and liabilities were a $26 million source of cash in the quarter. For fiscal '13, we expect full year cash flow from operating activities to be $260 million to $280 million.

Our debt to cap and debt to EBITDA ratios are now at 18% and 0.5% respectively. We expect interest expense in fiscal '13 to be between $11 million and $13 million, and our balance sheet remains very strong with $330 million of cash and investments.

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

William M. Cook - Chairman, President and CEO: Thanks Jim. We recently completed our most recent sales forecast this week incorporating the latest data from the market and inputs from our key customers. It appears that the weak end market conditions that we have seen with many of our OEM customers may now just beginning to stabilize. Unfortunately, we're still not yet seeing the signs of these conditions will materially improve in any of our capital equipment related end markets.

This is disappointing, as we previously anticipated that by now we will be seeing signs of improvement in many of these end markets. But the general global recovery that we've all been waiting for has just been pushed out further into the future. And for us, this means at least another quarter based on what we can see today.

In total, we now expect our full year fiscal '13 sales to be between $2.4 billion and $2.45 billion, down slightly from the record $2.5 billion we delivered last year. For us to be down even slightly from our prior year is unusual as we posted 21 sales records out of the past 24 years. But we have dealt with this before and we know what to do.

Now, I'd like to review each of our segments. Within our Engine Products segment, recent forecasts and announcements from our key global Ag equipment OEM customers suggests that their production rates in both the U.S. and Brazil will increase over last year's strong levels. However, in our other OEM equipment categories we have not yet seen signs that our customer production rates for new constructions and mining equipment or heavy trucks will improve materially before the end of our fiscal year in July. Particularly, for new mining equipment, we're now expecting ongoing weak conditions through the end of this calendar year.

In our Engine Aftermarket business, we are expecting a gradual improvement as utilization rates of existing off-road Ag and construction equipment and on-road heavy truck fleets continues to improve. And as I'll talk about more in a minute, we continue to see higher growth grades for our proprietary replacement filters.

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

Now, switching to our Industrial Product, segment, our Gas Turbine sales for the full year are now expected to be up between 27% to 30% over last year. We have longer lead times in this business than we have in any of our other businesses and we can see that the strong sales we recorded, especially over the last two quarters to now be over. A significant reason for this is that as we mentioned last quarter, we shipped several unusually large projects in last six months. One of these, the (Karaia) project in Saudi Arabia totaled $25 million and we do not see a repeat of these types of unusually large projects in fiscal '14. So our fourth quarter Gas Turbine sales should be similar to what we shipped in the first quarter this year, approximately $50 million.

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

Now, looking at the next part of Industrial segment, our global Industrial Filtration Solutions sales are expecting a mid-single-digit percentage decline year-over-year. Manufacturing indicators in the U.S. have flattened out in the recent quarter; however, Europe remained stuck in its longest recession since the World War II. Similarly, manufacturing indicators in China are not as strong as they were a quarter ago. The better news here is that overall we're seeing good demand for industrial replacement filters, which indicates that while the demand for new equipment remains weak, there is still a solid level of manufacturing activity that's taking place.

Finally, in our Special Application Products, we're forecasting full year fiscal '13 sales to decrease 8% to 11% due to ongoing weakness in both our disk drive filter and membrane products businesses. In total, we now forecast our full year Industrial Products' segment sales to be consistent with last year.

If, or should I say when these ongoing levels of global economic uncertainty are reduced, businesses will be more confident making new investment decisions which will drive the demand for our customers' equipment and obviously then for our filtration systems. But bottom line, given the high levels of uncertainty in all three major regions of the world, we will continue to focus on those things we can control within our Company and strive for further improvements in our key operating metrics until we see concrete signs of a general business rebound.

Now, as we've discussed in previous calls, we continue to have significant growth opportunities in the faster-growing emerging economies. So even in a weak global environment, we are continuing to add sales resources, distribution capabilities, and distributors, and actually even OEM customers in these regions.

For example, in our Engine Aftermarket, we added 110 new distributors and 830 new part numbers to our product offering in the last quarter.

Another key initiative benefiting us is the ever-increasing numbers of filtration systems in the field installed with our innovative filters. For those of you who have followed Donaldson for a while, you know that we have a very unique position in our markets since we are the leader in providing the first fit air filtration systems to our OEM customers. We focus on continually developing breakthrough filtration technologies for these customers. We then use the combination of these innovations and our engineering capabilities to design first fit systems that provide both better value and performance as well as helping our OEM customers and us retain a higher percentage of the ongoing replacement filter sales. We have a number of different breakthrough designs and technologies that we're using to accomplish these objectives.

We now estimate that approximately 30% of the first fit air filtration systems we're currently manufacturing for our OEM customers are already in this proprietary category. And in the last quarter alone, we won another $100 million of new OEM programs which we'll launch in the future. Most of these programs were one with our latest proprietary filtration systems, which bodes well for continued growth of our aftermarket business.

So, we feel very optimistic about our future prospects despite the current uncertain economic environment, and since most of these new programs – we're currently working on will be with new technologies.

One of these technologies that we have specifically highlighted is PowerCore. It's also a great example of how we invest centrally into R&D and then leverage a new technology into as many applications and as many of our businesses as possible. We're now very successfully using PowerCore in both our Engine and Industrial segments. Our Engine PowerCore sales in the third quarter were $30 million, up 9% over last year. Within that, sales of PowerCore replacement filters were up 25%.

On the Industrial side of our business, we sold another 350 Torit PowerCore dust collection systems while our Torit PowerCore replacement filter sales increased 77%. In total, for the Company, PowerCore sales totaled $35 million in the quarter, up 6% over last year.

Now, to quickly summarize, the current challenging global industrial environment is both weaker and has persisted longer than we had originally expected or hoped. But enough about the global economy, which we obviously can't control.

What I want to highlight is the great job the entire Donaldson team has done by proactively running our Company. As I noted earlier, despite our lower sales, our operating margin percentage was a record and our cash flow generation was outstanding. These performances are the compilation of numerous Continuous Improvement initiatives across our businesses and regions and I want to thank all my fellow employees for their efforts and persistence which have really paid off.

Our good operating performance is allowing us to continue to invest in our Company for the future, both to support our growth opportunities as well as to add the necessary infrastructure for the long-term. So, we will continue to utilize, grow, and expand our global diversified portfolio of filtration businesses. This has been proven over time to be the right business model for our Company and our shareholders.

Greg, this concludes our prepared comments. We'd now like to open the call up to questions.

Transcript Call Date 05/17/2013

Operator: Kevin Maczka, BB&T Capital Markets.

Kevin Maczka - BB&T Capital Markets: I guess my first question on margins. You mentioned the quarterly records of very strong in the quarter. But it looks like the guidance as we go into Q4 suggests a sequential decline of maybe 100 basis points or more and it's possible also by your guidance that revenues could be higher. So, can you just talk about that especially in the context of the favorable Gas Turbine mix?

James F. Shaw - VP and CFO: Yeah, Kevin, this is Jim. In terms of the guidance, as we look forward, we are anticipating similar gross margins to what saw in this quarter. Revenues are up slightly, but from a practical standpoint, about the same. We did benefit a little bit this quarter from some adjustments to compensation type reserve as we look forward in terms of what the year is going to finish and that's the way they are supposed to work. And we had a couple of other smaller one-times. So, we do anticipate in the guidance a little bit higher operating expense and part of that's timing of some of our investments that Bill talked about whether it would be the strategic systems project and other investments. So, there is a little bit more OpEx forecast in Q4 versus Q3, but still it would project out to be a very significant finish on an operating margin.

Richard Sheffer - IR: Yeah, Kevin, this is Rich. I think as you look at your model, we are expecting the fourth quarter operating margin currently to be pretty close to last year's level which was 15.1%.

Kevin Maczka - BB&T Capital Markets: Are there further restructuring gains to be had here as we look out into Q4, because again, it seems like the mix maybe slightly positive. I understand what you are saying about some of the OpEx comp adjustments and things like that. But are there also – there's always continuous improvement, but are there also further restructuring benefits coming?

William M. Cook - Chairman, President and CEO: Kevin, this is Bill. We don't comment prospectively specifically on restructuring, but we're always looking at opportunities as the businesses continue to shift, and we're always focused on Continuous Improvement as you mentioned. So we're not forecasting significant restructuring in the fourth quarter, but we continue to look at it as we have over the last couple of years for opportunities.

Kevin Maczka - BB&T Capital Markets: And Bill, can you just clarify your comment on the Gas Turbine; it looks like some of the industry orders from some of your big customer have slowed there? And you made the comment about a $180 million, was that an outlook for your fiscal '14 or the next four quarters?

William M. Cook - Chairman, President and CEO: Kevin, Bill. Yes, it's roughly for fiscal '14. It's probably sort of rough – roughly both – the next four quarters and fiscal '14 around that $180 million run rate. And again, that's still a pretty good year for us in terms of Gas Turbine, but we just don't have a reoccurrence of – we had a large number of these large unusual projects in fiscal '13 which we're very grateful for but we don't see any of those in fiscal '14. We see that there might be some out beyond that but none of them shipping in fiscal '14.

Kevin Maczka - BB&T Capital Markets: And I think just finally on that point, you had thought at one point, we were fairly early in a multiyear up-cycle in Gas Turbine. Has that overriding view changed at all and this is a temporary pause, or how would you characterize that?

William M. Cook - Chairman, President and CEO: Kevin, Bill again. I'd probably put it in that temporary pause that you mentioned. I mean, our Gas Turbine business never really sort of grows consistently year-over-year; it's sort of in fits and starts, as I've looked at it over the last 20 something years. I think what's probably moderated it over the last maybe six months is just the back-to-back global economic weakness and which has sort of then tamped down the demand for more electricity power generation. So, I think that's what's part of that the impact, again, in the short-term. But longer-term, we still think, in this country with how radically the supply side of the equation has changed with natural gas and oil, but natural gas specifically; and that it remains the cleanest fossil fuel, that we think there's a lot of things that over the next three to five years bodes very well for that industry and our business.

Operator: Laurence Alexander, Jeffries.

Laurence Alexander - Jeffries: On the new product or the new proprietary platform wins that you've mentioned, I think you had said it was about a $100 million, is that sort of spread out over three or four years or how should we think about the cadence of that?

William M. Cook - Chairman, President and CEO: Yeah, over the next three to four years, the typical – we win the programs usually a couple of years before they actually go into productions, when our customers' engineering teams are designing their platforms or their vehicles and that's when we get (designed in and win) the platform. So we win them, but the launch will be out a couple of years.

Laurence Alexander - Jeffries: You mentioned that you quantified how much of a tailwind, the productivity efforts were, how much of a headwind to gross margins was the carryover or the drag from investing in the emerging markets?

James F. Shaw - VP and CFO: In terms of – could you maybe clarify that? In terms of the – we always have an ongoing investment in the emerging markets. So are you talking about the year-over-year margin comparison?

Laurence Alexander - Jeffries: Exactly. I guess what I'm trying to get at in the gross margins in particular, you've been or maybe on the EBIT margin level, it might be more useful, you've maintained the level of investment in the emerging markets despite the weaker environment. So, theirs is going to be a drag associated with that. I was just wondering if you could quantify – if you have any rough sense for how much that could have been.

William M. Cook - Chairman, President and CEO: We typically don't break that out because that's something, I think as Jim was suggesting, Laurence, that we're doing on an ongoing basis. So, I guess, we could stop it to try and save money in a weaker environment, but we're committed to the long-term – to pursue the long-term growth opportunities. So, we're continuing to invest in that. I mean, we have some other unusual operating expenses like the increasing pension expense or the Strategic Business Systems project that we're working. And I think we've quantified those in the past and those are, again, sort of in the same category. They're critical for the achievement of our long-term goals, so we're continuing to do those even though they do provide some headwind on our margins and operating expenses.

James F. Shaw - VP and CFO: And Alexander, we don't have any, like, incremental investments in emerging markets this quarter that I would call out like at times where we open a new distribution center or capacity. So, the things that are ongoing are more expanding sales force and those types of things that we consider more normal because they are also generating returns.

Operator: Charlie Brady, BMO Capital Markets.

Charles Brady - BMO Capital Markets: Just on the Special Apps business, can you quantify between disk drives and membrane, how much those businesses were down?

William M. Cook - Chairman, President and CEO: Charlie, Rich is looking out for the specifics. They were both down and as we mentioned, part of it is – the disk drive part of is which is the larger part of that group is due to just the weakness in global PC sales and then the membrane products is really tied to industrial markets. A lot of the products in membranes go into industrial filtration applications that we sell where we sell the material to other customer. So those are the two drivers. And Rich you want to add a comment on numbers?

Richard Sheffer - IR: Yeah, Charlie, disk drive sales – I'm going to give you local currency results on this. Disk drive was down between 25% and 30% in the quarter compared to last year's third quarter where we were experiencing a rebound following the Thailand floods. The membrane business was down between 15% and 20%, so both had pretty weak quarters.

Charles Brady - BMO Capital Markets: And if you could just switch gears back to Engine Products for a minute, and I guess what I am really trying to get a better handle on is the extent of your visibility into your customers' production schedules and sort of how those discussions go as you are looking not only next quarter but maybe even beyond fiscal fourth quarter, I guess, I am trying to get a better sense of how far out do you guys see – how the discussions go with the customers and what's your comfort level I guess even looking beyond the fourth quarter?

William M. Cook - Chairman, President and CEO: Charlie, so Bill again. We are having those types of discussions on an ongoing basis. And to be fair, our customers don't have a tremendous amount of visibility. But I would say we have a pretty high level of confidence over the next 90 days which is our fourth quarter. We track internally our backlogs, our open order backlogs and then we can extrapolate from that. The other thing is talking to our customers about what they are planning in terms of the OEM side in terms of their build rates and that's usually pretty solid for the next 30 to 60 days. So, I would say our guidance on the fourth quarter, our fourth quarter, which was – we didn't see a dramatic pick-up in our OEM markets. Maybe unfortunately, we feel pretty confident about that because we just based on conversations and orders we can already see, but beyond that, it's probably too soon to tell. We'll be talking to our customers later in June and July to see what they're looking at coming into the first quarter of our fiscal '14 which starts in August. But we really don't have much visibility out beyond 90 days for our OEM businesses.

Charles Brady - BMO Capital Markets: And then just on the Gas Turbine business, the guidance you have for the year, kind of applies fourth quarter of minus 8 to minus 17, is that variance there just kind of on a – because there's chunky stuff that can slip a week into the next quarter, or what's the driving factor behind that delta?

William M. Cook - Chairman, President and CEO: Yeah, I mean we're – our guidance says about $50 million a quarter and that's after the $69 million that we had in the quarter we just reported. And as you mentioned, we term the technical terms for our Gas Turbine business by quarter are lumpy or chunky, as you put it, there's so many large projects and it's really about which quarter they ship in. And as I mentioned, the last two quarters we had a couple of these unusually large projects, in fact, the largest project we ever shipped, the (Karaia) project. That's not sort of normal business that we see. So, we love the business, but it's sort of an unusual and we don't see something like that recurring. So, the $50 million of fourth quarter which we still see as a pretty good quarter in terms of the sort of historically how Gas Turbine performs.

Operator: Andrew Obin, Bank of America Merrill Lynch.

Andrew Obin - Bank of America Merrill Lynch: Just looking at your Asia exposure and Asia contribution in the quarter, how – Asia, you just say that you're really focused on emerging markets. But Asia has been a drag. Are you seeing anything different in Asia and beyond sort of a broader macro framework? What gives you confidence that Asia is going to come back over the next six to 12 months?

William M. Cook - Chairman, President and CEO: Well, good question, Andrew. Well, we start by reading reports like you publish, so that helps us always; a little bit facetious. I think our Asian business has a couple of different maybe buckets I would put it in. I mean we have sort of our Japanese business which was down a lot, which is very tied to the OEM on-road and off-road equipment markets and we referenced that in our guidance as that that continues to be pretty weak. We have our China business which – they didn't have a – they had a pretty good quarter all-in, but it was of course different by end markets. We're hoping that that's going to start to get sequentially better. I mean we take a look at customers in China like Caterpillar who have reported that their excavator sales production was up in the last month and that they've burned through all the inventory that they've built up last year. So I think that gives us the confidence for China and I think that, to some extent what happens in China effects also can positively impact the rest of East Asia, like Japan and South Korea. Then finally, the third bucket is sort of the other economies, sort of like India, which had a very good quarter in Southeast Asia. So which I would – we still sort of put all of those in sort of the emerging category where our market share is low and we have the opportunity maybe despite the economic conditions to continue to grow. So that's the way we look at Asia, Andrew. So a lot of its driven by that whole China story, and we think that the inventory is being burned off and that we're still going to start to see sequential production rates – on a sequential basis, production rates going up.

Andrew Obin - Bank of America Merrill Lynch: On the U.S. just another sort of macro question. What are you guys seeing specifically on constructed related markets in the U.S., because by and large I think results in Q1, calendar Q1 were weak with anything construction related, seems like people think that we can accelerate in the second half of the year. But are you guys seeing things actually getting better in April and May or it's still sort of wait and see approach. You've clearly stated that you think the market has bottomed.

William M. Cook - Chairman, President and CEO: So, I'll start with the punch line. We think that we're sort of in the wait and see. It's a mixture of, I think, what's happening and I'll put the construction and mining sort of together because when we look at our customers, it's hard to pull it apart. But we see – the mining market is, as we mentioned in our comments, we see that's going to be down or stay down for probably about rest of this calendar year. This is new equipment. We think the parts business for mining is still good. They are still running equipment. They are just not buying any new equipment. Then looking at construction, if you take a look at the non-res, that's still pretty weak. There's not a lot of uptick there. Now, conversely the residential construction is doing better. So, when we look at non-res and residential construction spending, the first one is down; the second one is up. So, there is sort of a mixture. Then we sort of look to the guidance that customers like Caterpillar are pointing towards for the second half of the calendar year, and we try and factor that all in. So, we sort of tick all those pieces and put it together.

Operator: Richard Eastman, Robert W. Baird.

Richard Eastman - Robert W. Baird: Bill, just a couple of thoughts on the off-road business, just to follow on what you are talking about, I was surprised in the quarter in Europe, a good quarter, plus like 8% I think in local currency. Is there any particular end market exposure there? Is that – again, is that more Ag driven or…?

William M. Cook - Chairman, President and CEO: Rick, it's Bill. It's Ag driven and we're launching a new Ag emissions program actually in Europe that's helping quite a bit. So, it's Ag end market and a new platform we are launching.

Richard Eastman - Robert W. Baird: So we'll have a bigger – we'll be a bigger participant in air emission market than we have been here in the U.S. that can be a nice driver there?

William M. Cook - Chairman, President and CEO: Yeah, I think, we are going to be a bigger participant, yes, in the Ag emissions in Europe than we are in the U.S., yes, that's true.

Richard Eastman - Robert W. Baird: And then switch over to Industrial, again in the IFS business, again maybe a little bit surprised that Asia was weaker than Europe and I am curious is there any particular exposure in Asia in IFS or is that just maybe a comp issue year-over-year?

William M. Cook - Chairman, President and CEO: Rick, probably part a comp issue and then part is just when we take a look at sort of the Japanese industrial market which is down a bunch, and I talked about Japan earlier just in terms of the capital equipment related activities in Japan are down and then China. On the China, we believe that that will start to improve going forward. I am not quite as sure as when the Japanese one will.

James F. Shaw - VP and CFO: Rick, we had an increase in China last quarter, down a little bit this quarter. Again, it seems as a younger business that it's still a little bit more volatile versus our more established Japanese business. So, I'm not reading too much into it yet, because it's a one quarter. We don't think it's a trend at this point either way.

Richard Eastman - Robert W. Baird: And is that more dust collection or compressed there?

Richard Sheffer - IR: That'd be dust collection.

Richard Eastman - Robert W. Baird: It is, okay. And just a question, Bill, on the high purity business, given what we're seeing maybe in the PC market and kind of this movement towards flash versus disk drive, do you feel that this is a cyclical soft spot or is there a secular shift there, and if there is and it impacts your business, is there other areas within high purity that you're targeting to grow?

William M. Cook - Chairman, President and CEO: So, great question. I think on the disk drive business what we're seeing there is that a couple of factors; one is just sort of weaker global economic conditions. People and companies are spending less or investing less in new PCs and so there's fewer hard drives, and fewer hard drives means fewer filters. So, when we take a look at industry volumes, they've sort of been stuck at around, I think, about $580 million is sort of the estimate for hard drive annually. And the forecast for this year is about the same as last year. We do not see the hard drive market growing like it has over the last 10 or 15 years because of the reason that you mentioned with the move towards tablets and smartphones, which people are using in conjunction with PCs. But they're not buying as many PCs because they're buying more of the other stuff. So, I think prospectively, we think it's going to be maybe a mid or low-single-digit growth market. It's still not bad; that's still pretty good, but not like we saw over the last 15 years. I don't think the tablets and smartphones are going to replace hard drives because all of these devices continue to increase the need for more and more storage somewhere, whether it's in the cloud or computer rooms or whatever, which is done best on hard drives. So, whether it's digital cameras or smartphones or iPads, they create more storage needs. So, hard drives are still going to be a good business. It's just not going to grow at the mid-teen rate that it approximated over the last 15 years.

Richard Eastman - Robert W. Baird: And do we have – I mean there are couple other – is there a couple other projects? I know we've talked about some different medical products, and is there a couple other things that we could start to maybe focus on a little bit to drive some growth in that high-purity?

William M. Cook - Chairman, President and CEO: That was the final part of your question which I forget to answer. And we are. We've over the last couple of years, Peggy Herrmann who leads that combined business has been looking at taking the capabilities that we have in disk drives for making high precision very small filters in high volumes and where else we can use that. We're finding applications in hearing aids, some medical applications like ostomy bags and filters, the new headlights need breather filters, bent filters. So, again, using the same technology and the same manufacturing capabilities. That business is now about, Rich?

Richard Sheffer - IR: Yeah, it's on a pace to be about $12 million to $15 million this year, up about 50% over last year.

William M. Cook - Chairman, President and CEO: So it's still small but the percentage increases are high and we see a good opportunity there to start to fill in with those higher growth rates on that smaller base, fill that in on top of the disk drive using the sort of the same technology and capabilities.

Richard Eastman - Robert W. Baird: Then just one last question, Rich. Can you just tell me what the FX impact year-over-year will be now for the fiscal year? Our currency model is kind of broken down as the emphasis has shifted to the yen. We've been using the euro. I mean, it still would be fractional, like, not more than 1% negative impact, correct?

James F. Shaw - VP and CFO: Yeah, this is Jim. That's correct. The yen has gone, I guess, unfavorable from a translation basis and the euro sort of held in there. So, for the full year right now through the – we're down $10 million or 1.6 year-over-year through three quarters. It's probably about $5 million or so. So, it might bring it down to maybe 1% as we look at – the year-over-year euro comparison is favorable but the yen is unfavorable.

Richard Eastman - Robert W. Baird: So just minus 1% for the full year all-in including the fourth?

James F. Shaw - VP and CFO: It's somewhere in that neighborhood, yeah.

Operator: Stanley Elliott, Stanley Elliott.

Stanley Elliott - Stanley Elliott: On the Industrial Products business, within kind of the margin section there, nice improvement. Is that more or is it strictly kind of the mix from the Gas Turbine business or what all is going on in there?

James F. Shaw - VP and CFO: From quarter-to-quarter?

Stanley Elliott - Stanley Elliott: Yeah, from quarter-to-quarter.

James F. Shaw - VP and CFO: Yeah, it's a combination of things. All of these cost improvement initiatives have benefited both businesses, Industrial and Engine. I think the other thing that helped us quarter-over-quarter, as Bill mentioned last quarter, we had these very large, specifically one very large GTS or Gas Turbine project. Those very large projects just given their nature of pass-through in terms of material content being large do tend to sometime skew our margins down on the first fit. So, Gas Turbine, the sales we shipped were good margin projects this quarter, so that's one improvement and then the other one is just all of the improvement initiatives that we've talked about.

James F. Shaw - VP and CFO: We did have a little bit of a positive mix first fit versus aftermarket also with better sales of replacement filters in IFS in particular as investment environment in industrial equipment is still challenged.

Stanley Elliott - Stanley Elliott: When you talk about the mix impact from Gas Turbines, is there any way to kind of quantify how much of the headwind it was or will be for fiscal '13 especially as we're looking out towards '14?

William M. Cook - Chairman, President and CEO: For this quarter, we calculated that was about a 40 basis point impact. And I think last quarter it was closer to 100 basis points. I think it was similar earlier in the year to maybe this quarter. So, I'd say if you kind of average out the quarter it's probably about a 50 basis point to 60 basis point type of a headwind on the Company overall.

Stanley Elliott - Stanley Elliott: Then kind of switching gears to the balance sheet. Cash flows are improving taking the CapEx down. What are your plans for kind of the near-term maturities that you have? Is there any thoughts on getting more aggressive with taking advantage of the very favorable debt markets out there, or what are your thoughts generally speaking?

James F. Shaw - VP and CFO: I think we're watching what kinds of opportunities are out there. As you know, we've been somewhat quite over the last couple of years on acquisitions, but we're continually looking and our plan is over time to add 1% to 3% of our revenue growth through acquisition over time. So I think we'll probably take a cautious approach here, and to the extent other opportunities present themselves we'll take advantage of the debt market. But I think our current intention now would be to pay down the current maturity with our available credit line.

Operator: Eli Lustgarten, Longbow.

Eli Lustgarten - Longbow Research: I got cut off accidentally, so I just hope (indiscernible). What percentage of your business was actually mining-related…?

James F. Shaw - VP and CFO: It's between 20% and 25% of what we call, off-road. So, as a total percentage of the Company, it would be less than 10%; maybe about 5%.

Eli Lustgarten - Longbow Research: And just on the balance sheet you talked, one of the things you didn't do in the quarter was buy any stock. So, I mean, do you expect to reaccelerate in the fourth quarter and look out – maybe take advantage of the financial strength that you have or is something else going on that not to see you get to your couple of percentage share…?

William M. Cook - Chairman, President and CEO: Eli, this is Bill. You follow us for a long time. You know we never comment prospectively on whether we're going to buy stock back, but I can say, generally, our target is always to buy. And we look at the stock repurchase in two pieces. The first is always to buy enough each year; that options are never dilutive, and that the total shares outstanding go down. And we already did that in the first half of the year; we purchased 1.2% or about 1.8 million shares. So, we already got the first part of that done and then some. And then we're opportunistic above that. Our target would be to try and reduce shares by about – or to repurchase roughly 2% or sometimes a little bit more on a gross level, and so we take a look at that – reviewing where the stock price is and other possible uses of the cash. So, we're always looking. And so, we'll see what we can do in the fourth quarter but we don't make any commitments since we've already gotten the first piece done.

Eli Lustgarten - Longbow Research: Now, is there anything in the gross margin and operating margin movement that would prohibit you showing normal manufacturing leverage, assuming volume picked up, and I guess, we're talking fiscal '14, that would briefly lead us to probably a higher margin and probably better margins I think we anticipated when we talked about?

William M. Cook - Chairman, President and CEO: Yeah, I think as we've gone through other downturns like this, like say 40 years ago, I think we saw two things when business recovered or rebounded and it really depends on sort of the slope of that rebound. Sometimes if it comes back really steeply or very aggressively, it's actually hard to ramp up to get our plants up (basically). And so, I want to rebound and I'll take it in any form or fashion it comes, but I rather that it didn't comeback – we went from foot on one pedal and then the brake to the accelerator, because that would be a little bit hard to handle. But there are some – some part of the expenses are variable as well. So, some of the things that we've been controlling, like travel and other expenses, would come back with the rebound. Certainly, the incentive comp would come back hopefully with the rebound. So, it's not – we would get operating leverage and that's what we're striving for, that's what we got coming out of the last – out of the recession – I shouldn't say last recession, the recession, and I think we'll get some out of this downturn. But it's not all upside because you have to make investments to capture that rebound as well.

Eli Lustgarten - Longbow Research: Do you guys – give us some help with measures – we talk about you just won $100 million in the platforms and you've been – debt comes up every couple of quarters. So, do you have any guides to give us what kind of incremental volume you can look out for '14 and '15 from new wins? I know all of these things are spread out, but do you have some sort of guideline of how to look at '14 and '15. Not worried about what the market is doing, but the new incremental platforms and projects that you've won recently that would help us what gains you'd get from those…

William M. Cook - Chairman, President and CEO: Eli, Bill again. We have our strategic plan to grow the Company to $3 billion by fiscal '16 and $5 billion in sales by fiscal '21. We finished last year, fiscal '12, we were ahead of the pace to do both of those. This year we're coming in even a little less than last year. So, I would say, we're not off the pace. We're probably back on the pace. We still see and obviously the exact year might be dependent on how things remain stuck like this. But our best guess right now is that we're on track to get to the $3 billion in fiscal '16. And that $100 million in OEM programs is one example of the pieces that we're working on and that are part of getting from where we are today to there.

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

William M. Cook - Chairman, President and CEO: Yeah, we haven't quantified that, Eli.

Eli Lustgarten - Longbow Research: And one final question. You talked about mining being weak all year, Gas Turbines (indiscernible). But you haven't heard for anything from any of your other OEM guys about any problems with improvement. I mean the truck one is probably the easiest one. We know it's down in the first; we know the production is down in the second. But there has been enough orders in trucks that the second half comparisons are very, very easy. And even if production stays flat in the second quarter, you get positive comparisons and now between construction equipment also. So, I mean, none of your OEMs have given you any guidance that things may not just work out according to your current plans, have they?

William M. Cook - Chairman, President and CEO: No. I think just talking on the heavy truck and you are right there. When you take a look at the comps they have pretty easy comps right now. But we take a look at some of that – we tend to look at that more on a sequential basis and as we saw in April, Class A truck orders were up 6% sequentially. So those are the things that provide us with a confidence in terms of that as we look at fiscal '14 that businesses will start to improve.

Operator: Brian Drab, William Blair.

Brian Drab - William Blair: Most of my questions have been answered, so I'll just be brief. But on the Engine Products side, it looks like your guidance is implying that you will be about flat sequentially, maybe up a touch. Can you talk a bit just directionally about the sub-segments and which will be maybe up slightly which down slightly?

William M. Cook - Chairman, President and CEO: Brian, Bill here. I think you are right. I think what we're seeing is some sequential improvement from the third quarter to the fourth quarter in Engine and I think most of the improvement is driven by the Aftermarket business.

Brian Drab - William Blair: And then you gave the statistic that I'm not sure that I got it exactly, around PowerCore, you said it's – actually, the proprietary products you said were 30% of something. Could you repeat that statistic? And then also, a follow-up question is what portion of that proprietary product is actually PowerCore?

James F. Shaw - VP and CFO: Brian, the statistic is 30% of the first fit air systems that we're shipping today are proprietary. PowerCore makes up 40% to 50% of that.

Operator: Hamzah Mazari, Credit Suisse.

Hamzah Mazari - Credit Suisse: Bill, just a question on, if you could just talk about how different is your visibility right now in this particular environment relative to years past? If we look at your track record, I think you've never cut guidance in about 19 years; you cut it in the downturn price and now again. Maybe help us understand how different is this in operating environment for you guys relative to past cycles, and how is your visibility different?

William M. Cook - Chairman, President and CEO: Hamzah, Bill here. So, this cycle is different than all the ones I've experienced in my career, and maybe all of them have been different in some ways, so maybe that's not that unusual. This certainly isn't like four years ago when sort of the bottom dropped out of almost everything at the same time. And what we're seeing is many of the capital equipment-related markets, so whether that's on the Industrial side with dust collectors or on the Engine side with on-road and off-road equipment; that just sort of stuck, people aren't willing to make those investments. The aftermarket side is more vibrant because a lot of the equipment that's out in the field is still running and still being serviced and filters need to be replaced. So, part of what we've seen is that on the OEM side, is that our customers are waiting until like the last possible moment to provide us with the orders. So we have a lot less visibility, whether it's an on-road heavy truck or construction or even ag equipment than we did, say, 15 months ago, and I would say that's really globally. So they're waiting longer until actually desperately need the product before they place the order. So, we're not getting as much in the backlog. And I think as I was trying to say earlier, we just beyond 30 days or 60 days, we just don't have a lot of visibility, precisely around what the order levels would be. We spent a lot of time talking to our customers to try and get some sense of what they're seeing; if it's not in the numbers, just sort of like qualitatively beyond that. On the aftermarket side of our business, the replacement parts, we have almost no visibility. So, as Rich and Jim have mentioned, that part of our business has held up and it's a higher percentage of our total, but that's also the shortest visibility part because a dealer or distributor can call today for a dust collection filter or for a heavy truck filter and we're going to ship it today. So it actually never shows up in the backlog. So, unfortunately, we don't have – we have less visibility than I would say we had 15 months ago because of those conditions.

Hamzah Mazari - Credit Suisse: And just a last question from me, you touched on acquisition a little bit, could you talk about what you're seeing in the – could you talk about your acquisition pipeline? Is it as strong or as robust as it was before? How are you sourcing deals? It seems like you haven't done a deal in a long, long time, but you have this target of 1% to 3% revenue growth from acquisition? Is it because some of the larger players are just boxing you out, multiples are high or is it that the pipeline has gone down?

William M. Cook - Chairman, President and CEO: Hamzah, Bill. I think the pipeline is probably about the same as it's been the last couple of years since we came out of the recession. During the recession there just weren't really any properties. People weren't didn't want to sell a business during the recession because of the – how it was operating or what they thought they could get for it. The challenge that we've had for the last couple of years is that there is a lot of money out there looking for deals whether it's strategic or non-strategic buyers and we have our financial metrics in terms of earnings accretion and ROI that we target. So, we've ended up – we have a small team focused on it. We've ended up pursuing some deals, but being able to close them because we couldn't justify the prices they went at. Somebody else could, that's fine, but we couldn't. I think our strategy is to try and focus on smaller deals that are tend to be bolt-ons to our business, the smaller deals, it's more of a likelihood that we can keep it a proprietary process, pay a fair price and then it also fits our model. We're not greatly acquisitive. 2% of our revenues this year would only total about $50 million. So, we're biased towards smaller deals and those are the ones we keep trying to pursue. We're always looking, but you're right, we haven't done one in a while.

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

William M. Cook - Chairman, President and CEO: Thanks Greg. Now, to conclude our call, first, I'd like to again recognize and thank all my fellow employees for their contributions to our great operating performance and I like to thank everyone on the call for your time and continued interest in our Company. Thank you all and have a great weekend. Good bye.

Operator: Thank you very much. Ladies and gentlemen, that will conclude the conference for today. We do thank you for your participation. You may now disconnect your lines at this time.