Summary of Donaldson Company (DCI) Q4 2012 Earnings Conference Call August 27, 2012

Overview of company operations.

Donaldson Company sets fourth quarter records for sales, operating margin, net earnings and earnings per share.  It also had record sales and profits for the full fiscal year 2012.  Donaldson Company has now reported record earnings in 21 of the last 23 years.

Donaldson Company's new PowerCore technology is successfully introducing new filtration technology to its customers and sales increased 39 percent in Q4.  PowerCore sales were $130 million for fiscal year 2012.  In the liquid filtration market, Donaldson Company has won seven OEM platforms since it unveiled its Select Fuel filters with Synteq XP Media last year.  The company should be seeing revenue from the PowerCore and new liquid filtration products in the beginning of fiscal year 2013. 

Engine product segment

The engine product segment reported a 6 percent increase in sales after excluding currency effects. The increase in the engine product segment was driven by the off-road and on-road OEM business. Off-road product sales in the Americas and Europe were particularly strong as the agricultural markets are strong globally. This offset weakness in China where there is an excess inventory of mining and construction equipment.  Donaldson Company expects agricultural equipment sales to remain strong globally.  It also expects construction equipment sales to remain good in North America as the age of the existing equipment is historically old.  Demand for mining equipment will remain soft. 

On-road product sales increased by 6 percent due to higher heavy truck build rates in North America.  Class A heavy truck builds increased by 24 percent.  By contrast, new truck sales in Japan declined by 5 percent. 

In Donaldson Company's aftermarket business, replacement filter sales in the Americas increased by 10 percent and 1 percent in Europe, offsetting  a 5 percent decrease in China.   Donaldson Company continues to expand its distribution networks by adding 126 distributors in the last quarter, most of which were in Asia, Latin America and the United States.  It also added another 500 part numbers to its product offerings, mostly in the emerging markets.  Aftermarket sales were 48 percent of total sales versus 52 percent last year.  Donaldson expects aftermarket and replacement filter sales to increase moderately, as European and Asian dealers will remain cautious with their inventory, and American dealers could become more cautious if economic conditions deteriorate.

Donaldson Company is expanding its liquid filtration product offerings in its aftermarket channels.

Industrial product segment

Local currency sales in the industrial product segment increased by 20 percent.  The industrial filtration solutions segment, the largest in the business segment, increased local currency sales by 17 percent.  Sales for the new Torit dust collection equipment and replacement filters were good in both the United States and Europe.   The company expects industrial filtration sales to remain good in the Americas since new plant and manufacturing equipment spending is healthy.

Sales in turbine gas increased by 51 percent due to demand to new power generation systems.  Donaldson Company expects a significant increase in its gas turbine business for two reasons.  First, there are many large gas turbine projects already underway, especially in the Middle East, China and the United States.  Second, high oil prices have increased the demand for small turbines for use in energy exploration. 

Sales of special application products grew by 3 percent. 

Future prospects

Donaldson Company expects Europe to remain in a shallow recession for the first half of fiscal year 2013 and to start slowly recovering in the second half.  It also expects China to slowly recover in the next 2 quarters.  It expects the Americas to remain the strongest regions.  Donaldson Company also expects the dollar to be at 1.24 versus the euro.  Its first quarter of fiscal year 2013 will have the most difficult comparisons. 

Donaldson Company plans to launch a global ERP project in fiscal year 2013.  It is a 4-year project and the company will be cautious  in executing it, but it believes the project is necessary for it to meet its goal of becoming a $5 billion company by fiscal year 2021.

Donaldson Company is continuing to increase is presence in emerging markets and believes a significant opportunity exists there to expand distribution of its products.

Financials.

Sales increased by 5 percent in Q4 or 11 percent after excluding currency effects.  Local currency sales increased by 9 percent in the Americas, 11 percent in Europe, and 7 percent in Asia.  Donaldson Company expects sales in fiscal year 2013 to increase between 5 and 9 percent. 

Gross margin was 35 percent versus 36.3 a year ago.  The decline was the result of (1) softer customer demand in Asia,  (2) the planned ramp up of the company's plant in Aguascalientes, Mexico and related product transfer costs, (3) higher commodity costs outside the United States due to the strong U.S. dollar, and (4) a shift in sales toward first fit and away from aftermarket, a trend that the compnay expects to continue going forward.   Improvement initiatives reduced the negative impact on gross margin by 110 basis points. 

Donaldson Company's operating expenses were 19.8 percent of sales, down 210 basis points from last year.  It will continue to manage its expenses cautiously due to the economic issues in Europe and China and the potential for a fiscal cliff in the United States. 

Operating margin in Q4 was 15.1 percent.  Donaldson Company anticipates that fixed cost absorption will be positive in fiscal year 2013 and that material costs will be stable in the United States and slightly higher overseas.  The ERP project and pension expenses will impact operating expenses in fiscal year 2013 by approximately $6 million each.  The increase in pension expenses is due to lower interest rates in the United States.  Donaldson Company expects its operating margin in fiscal year 2013 to be 14.6 percent to 15.4 percent.

Earnings per share in Q4 was $.43, an increase of 12 percent.  The company expects EPS for fiscal year 2013 to be between $1.82 and $1.96.

Donaldson Company expects to spend approximately $125 million in CapEx in fiscal year 2013, allocated as follows:  (1) 30 percent for capacity expansion, (2) 30 percent for technology initiatives, including the global ERP implementation, (3) 20 percent for tooling new products, and (4) 20 percent for cost reduction activities. 

Donaldson Company repurchased 1.5 million shares in Q4, and 4.5 million shares in fiscal year 2012, which approximately 2.9 percent of diluted shares. 

The transcript of the earnings conference call can be located on Seeking Alpha at the following link:
http://seekingalpha.com/article/830791-donaldson-company-s-ceo-discusses-f4q2012-results-earnings-call-transcript?part=single

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