Donaldson Company, Inc. (DCI)

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Donaldson Company, Inc. (DCI)

F2Q09 (Qtr End 1/31/09) Earnings Call

February 26, 2009 11:00 AM ET

Executives

Richard Sheffer - Director of Investor Relations

Thomas R. VerHage - Vice President and Chief Financial Officer

William M. Cook - Chairman, President and Chief Executive Officer

Analysts

Kevin Maczka - BB&T Capital Markets

Antonio Antezano - Macquarie Capital

Richard Eastman - Robert W. Baird

Brian Drab - William Blair & Company

Jeffrey Hammond - Keybanc Capital Markets

Adam Brooks - Sidoti & Company

Presentation

Operator

Good morning ladies and gentlemen, thank you for standing by. Welcome to the Donaldson Second Quarter 2009 Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions). This conference is being recorded today Thursday, February 26, 2009.

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

Richard Sheffer

Thank you Brandy, and welcome to Donaldson's 2009 second quarter conference call and webcast. Following my brief introduction, Tom VerHage, our Vice President and CFO will give us a brief review of our second quarter operating results.

Tom will then turn the call over to Bill Cook, our Chairman, President, and CEO, who'll discuss our updated outlook for fiscal '09 and the business conditions shaping that view. Following Bill's remarks, we'll open up the call to questions.

Before I turn the call over to Tom, I need to review our Safe Harbor statement with you. Any statements in this call regarding our business that are not historical facts are forward-looking statements and our future results could differ materially from the forward-looking statements made today.

Our actual results may be affected by many important factors, including risks, and uncertainties identified in our press release and in our SEC filings. Now I'd like to introduce Tom VerHage. Tom?

Thomas R. VerHage

Well, thanks Rich and good morning everyone. Well, three months ago we issued our first quarter press release and provided guidance for the year based on the global economic conditions as we saw them at that bad time. And we are now all painfully aware that economic conditions have deteriorated significantly and we are in the midst of a major global recession which is impacting nearly all of our end markets around the world.

By now you've all had a chance to read our second quarter press release and review our financial results. Sales and operating income were below the expectations we provided three months ago. But some very favorable developments in the resolution of income tax contingencies enabled us to report EPS of $0.43 a share, $0.01 higher than last year's second quarter.

Last quarter, we stated that we saw challenging economic conditions ahead of us. Fortunately, we had already initiated a number of actions to respond, including a global hiring freeze and further reductions in discretionary spending in addition to production cut backs and workforce adjustments.

We then completed a bottoms-up forecast of our business in mid-November and based on our guidance at that time and what we knew about our customers built schedules and their holiday shutdown plans puts our existing backlogs in recent incoming order trends, However we saw a further rapid reduction in incoming orders and backlog beginning in early December. And by mid December, many of our customers had announced extended shutdown plans and reduced their build schedules into 2009.

We quickly implemented additional plans to respond to this rapid deterioration and market conditions. As a result, in total, we have reduced our global workforce by approximately 1,850 people or 14% since the beginning of our fiscal year and incurred $4.3 million in restructuring costs to implement these unfortunate but necessary actions.

We continue to see conditions weaken across many of our end-markets. So, we are planning to take further steps to reduce our cost base in the third quarter and expect to incur approximately $3 million in additional costs related to these actions. The steps already taken and those that we plan to take in the third quarter will combine to reduce our costs at an annualized rate of approximately $85 million and help us to partially offset the significantly higher under absorption of our fixed manufacturing and operating expenses resulting from our projected sales declines.

We are expecting our full year operating margin to now be between 9.5 and 10% or approximately inline with our year-to-date operating margins for six months. Our third quarter margin will continue to be impacted by higher than normal under absorbed fixed costs and the $3 million of additional restructuring costs. Our gross margin was 29.1% in the quarter which was below our annual target of 32% in last year's second quarter gross margin of 31.9%. Latest driver of the decrease is the under absorbed fixed manufacturing costs. This factor (ph) loan reduced gross margin by 2.1 percentage points.

Also $2.4 million of the previously mentioned 4.3 million of restructuring costs were included in gross margin which lowered our margin by 0.6 percentage points. Purchased material costs remained higher than last year's levels but have been mostly offset by a combination of internal cost reduction efforts and selective price increases to our customers. So the impact in the quarter was minimal.

In operating expenses, we continued focusing on the cost containment actions we began late last fiscal year and which I mentioned earlier. The restructuring charges increased operating expenses by $1.9 million in the quarter. Also, during the quarter, we incurred $2.8 million for stock option expense which represents about two thirds of our annual stock option charge.

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