Donaldson Company, Inc. (DCI)

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Donaldson Company Inc. (DCI)

F1Q10 Earnings Call

November 19, 2009; 11:00 am ET

Executives

Tom VerHage - Vice President & Chief Financial Officer

Bill Cook - Chairman, President & Chief Executive Officer

Rich Sheffer - Director of Investor Relations

Analysts

Hamzah Mazari - Credit Suisse

Amanda Sigouin - Jefferies & Co.

Kevin Maczka - BB&T Capital Markets

[Derrick Jose] - Longbow Research

Jeff Hammond - KeyBanc Capital Markets

Adam Brooks - Sidoti & Co.

Charley Brady - BMO Capital Markets

Brian Drab - William Blair

Richard Eastman - Robert W. Baird

Presentation

Operator

Welcome to the Donaldson Q1 fiscal year 2010 webcast. During today’s presentation all parties will be in a listen-only mode. (Operator Instructions) This conference is being recorded today Thursday, November 19, 2009.

I’d now like to turn the conference over to Rich Sheffer; please go ahead.

Rich Sheffer

Thank you, Brandey. Welcome to Donaldson’s fiscal 2010 first quarter conference call and webcast. Following my brief introduction, Tom VerHage, our Vice President and CFO will give us a brief review of our first quarter operating results.

Tom will then turn the call over to Bill Cook our Chairman, President and CEO who will discuss our updated outlook for fiscal 2010 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 Safe Harbor statement with you. Any statements in this call regarding our business that are not historical facts are forward looking statements. Our future results could differ materially from the statements made today.

Our actual results maybe affected by many important factors including risks and uncertainties identified in our press release in our SEC filings. One more note before I turn it over to Tom. In yesterday’s release, you will notice that we have added two new product groups.

Our aerospace and defense products, which was previously products, which was previously included in Off-Road products, and our Retrofit Emissions products, which was previously included in our aftermarket products, all of those within our Engine segment.

We have added a schedule to our website that shows our fiscal 2008 and 2009 historical net sales in this new reporting format. You can go to the Investor Relations section of our website, www.donaldson.com to see this schedule and our normally posted foreign exchange translation schedule.

Now, I’d like to introduce Tom VerHage. Tom.

Tom VerHage

Thanks Rich and good morning everyone. Yesterday we released our fiscal 2010 first quarter earnings. After the market closed and updated our guidance for the balance of the year. For the second consecutive quarter, our sales were up 2% on a sequential quarter basis after bottoming in the third quarter of fiscal 2009. Conditions in many of our end markets have either stabilized or are slowly beginning to recover.

So, we have increased our earnings guidance and Bill will discuss this further in a few minutes. We are continuing to execute our previously announced restructuring plans and incurred an additional $1.3 million pre-tax cost or $0.01 per share in the quarter, with approximately $800,000 charge to cost of sales and $500,000 charge to operating expenses.

By segment, $900,000 was incurred in our Engine product segment and $400,000 was incurred in our Industrial segment. Since we began these restructuring efforts last January, we have incurred restructuring costs totaling $19.1 million pre-tax, or $0.16 per share.

We are continuing to work our plans and anticipate incurring an additional $11 million to 16 million of restructuring this fiscal year, assuming we can get the necessary government and labor related approvals. While we hope to incur the majority of these costs over the next two quarters, the regulatory approval process creates some uncertainty.

The realized savings of $27 million in the quarter from restructuring actions we have completed since January of this $27 million savings, $12 million was in cost of sales, and $15 million was in operating expenses. By segment, $13 million of savings was in the Engine segment and $14 million was in the Industrial segment.

Including the pre-tax restructuring charges we expect to incur in fiscal 2010 we are now expecting our full year operating margin to be between 11% and 12%. Our operating margin will continue to be impacted by lower than normal absorption of fixed costs and the $11 million to $16 million of additional restructuring costs.

Our gross margin was 34.7% in the quarter, a year-over-year increase of 210 basis points, and a sequential quarter increase of 190 basis points. We had year-over-year benefit of 180 basis points from a greater mix of higher margin aftermarket sales versus the lower margin first-fit product sales in the first quarter and we achieved our first quarter where aftermarket sales were over 50% of our sales mix.

Lower absorption of fixed manufacturing costs in the quarter reduced gross margin by 130 basis points, net of savings from completed restructuring activities, all other factors, including production cost reduction activities, the $800,000 of additional restructuring costs and improved distribution efficiencies combined to increase gross margin by 160 basis points.

Operating expenses decreased by $21 million year-over-year. We have continue the operating expense reduction programs that we have discussed the last few quarters, including targeted restructurings and various other expense reduction actions. Our effective tax rate was 30.9% in the first quarter versus 30% last year.

Last year’s first quarter included a benefit of $1.8 million from the reinstatement of the R&D tax credit and a positive development regarding a foreign tax contingency. Based on our projected global mix of earnings, we expect our normal tax rate to approximate 31% going forward, but our geographic earnings mix and any unplanned discrete items will continue to cause the rate to vary from quarter-to-quarter.

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