Donaldson Company, Inc. Q1 FY08 Earnings Call Transcript

| About: Donaldson Co (DCI)

Donaldson Company, Inc. (NYSE:DCI)

Q1 FY08 Earnings Call

November 27, 2007, 11:00 AM ET

Executives

Rich Sheffer - Director of IR and Assistant Treasurer

Thomas R. VerHage - VP and CFO

William M. Cook - Chairman, President and CEO

Analysts

Charles Brady - BMO Capital Markets

Brian Drab - William Blair

Richard C. Eastman - Robert W. Baird

Scott R. Graham - Bears Stearns

Eli Lustgarten - Longbow Research

Operator

Good morning. My name is Tina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Donaldson Company First Quarter Fiscal 2008 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].

Thank you. Mr. Sheffer, you may begin your conference.

Rich Sheffer - Director of Investor Relations and Assistant Treasurer

Thank you, Tina. And this is Rich Sheffer, Donaldson's Assistant Treasurer and Director of Investor Relations and I welcome you to Donaldson's 2008 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 record first quarter operating results. Tom will then turn the call over to Bill Cook, our Chairman, President and CEO, who will discuss our positive outlook for the balance of fiscal 2008 and the business conditions shaping that view. Following Bill's remarks, we will 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 the 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 - Vice President and Chief Financial Officer

Well, thanks Rich and good morning everyone. Well, as you saw in our press release late yesterday, we are starting our fiscal '08 with a fine quarter. Thanks to our continued strong top line growth particularly outside of NAFTA. Stronger foreign currencies boosted our sales by 4.6%. But just to give you a sense of the strength of our business globally, year-over-year sales increases in our three regions in local currency were a 25% in Asia Pacific, 17% in Europe, Middle East and Africa and 6% in NAFTA.

As you know, heavy truck build rates are down considerably in NAFTA, which resulted in a $22 million year-over-year decrease in sales to that portion of the market. Bill will comment on global market conditions across our major product lines in just a few minutes.

Our operating margin for the quarter was 12.1% compared to 12% last year. As you know, we target a minimum operating margin of 11% for the year. Gross margin of 32.9% compares favorably to 32.2% last year, and operating expenses of 20.8% are up a bit from last year's rate of 20.2%. The operating expense ratio was impacted by investments to capture growth opportunities and the higher mix of Industrial segment sales which generally have both higher gross margins and operating expenses than Engine Segment sales.

Our gross margin and operating expense ratio will fluctuate each quarter, and be impacted by factors such as product mix, investments in new product development and various other factors. Our tax rate of 27.1% for the quarter compares to a prior year rate of 31.2%. In our year-end webcast, we mentioned that our first quarter tax rate would be lower than our annual projected rate due to a lower tax rate that was signed into law in Germany that allowed us to reduce our German deferred tax liabilities and the expiration of the statute of limitations on certain matters that were previously reserved.

Now, I would like to provide you with some further detail on a few matters for you to consider in your analysis for the remainder of 2008. We have not changed our annual margin outlook, which is for gross margin to exceed 32% and operating expense to be in the 21% range. If we achieve these targets, our operating margin should be at a minimum of 11%. We expect the operating income to grow by 13% to 18% this year compared to last year's $211 million. Interest expense should increase by $2 million to $3 million with the primary driver being the full year of debt related to our acquisition of AFS this past March.

Our tax rate will continue to fluctuate by quarter, and we are maintaining our annual guidance of 29% to 32%. You are all probably aware that we have adopted a new income tax accounting rules required by FIN 48 in fiscal '08. And this new rule did not have a significant impact on our first quarter financial statements.

Our CapEx outlook is in the range of $60 million to $70 million and we expect depreciation and amortization in a range of $51 million to $55 million, which includes $2 million of amortization related to the intangible assets of the AFS acquisition. And we are maintaining our free cash flow outlook for the year of a range of $100 million to $140 million.

As you consider your quarterly earnings estimates for the remainder of the year, we want to remind you that our second quarter is impacted by the significant number of holidays, which results in more days that both our customers and our plants are closed, making this our weakest sales quarter of the year. Also due to the timing of our annual stock option grants, approximately 75% or $3 million to $3.5 million of our annual stock option expense is recorded in the second quarter.

One another reminder is that last year contained an extra week of domestic sales in our fourth quarter, which provided a one-time boost of approximately $16 million. So, thanks primarily to our robust sales growth in the first quarter, we have increased our EPS outlook for the year to a range of $1.97 to $2.07. And with that, I'll pass it over to Bill, who will provide more background on our outlook. Bill?

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

Thanks Tom and good morning everyone. Our first quarter results proved again the power of our diversified portfolio of filter businesses around the world. So, although we saw some weaker end markets in NAFTA including on-road heavy truck and residential construction, these were balanced by a strong growth in Europe and Asia in both our Engine and Industrial business segments. And in addition, with our strong international presence we benefited from the weaker dollar.

Now, I'd like to briefly cover some highlights by segments and I will start with our Engine business in Europe. In Europe, our off-road and on-road businesses, both grew over 20% and our Engine aftermarket grew by more than 30% in the quarter. European business conditions for us continued to be good due to the combination of general economic growth together with new business we won at both existing and new customers. And with our aftermarket growth in the European emerging markets, which we include Eastern Europe, Middle East and North Africa, this has been a priority for us as we've had more distributors throughout these developing regions.

In Asia, our Engine off-road and aftermarket businesses also had a strong quarter. The strength was seen across the region. Japan, we saw continued strong construction market. In China, we added new off-road customers and increased our aftermarket distribution and in Australia, we saw good growth as a result of the mining boom.

Now, switching to NAFTA, as expected our NAFTA engine businesses were mixture of different stories this quarter. In off-road, the small construction market and our sales to it remained weak due to the much publicized residential housing crisis. However, this was offset by the Ag equipment sector which was strong by... which was fueled by strong farm and crop conditions. Our aerospace and defense sales were up on strong military demand, particularly for filters for the new MRAP vehicles and replacement parts for existing military equipment that needs overhauling. In addition, our acquisition last year of AFS also added about $4.4 million to quarter one sales.

In our replacement parts, our aftermarket business truck ton miles in NAFTA moderated as the economy has slowed and general equipment utilization rates are mixed, better for large equipment in ag but slower or less for small construction equipment, resulting in a good quarter for aftermarket, which ended up 9%. And, finally the heavy truck downturn was about what we expected. Our NAFTA on-road sales were down 56% following last year's Big 3 buy in front of the January 2007 new emission regulations.

Now, I'm going to switch to our Industrial businesses and I'll start with our industrial filtration solution business, which had a great quarter internationally, up 20% in both Asia and Europe.

In Asia, our sales in China were very strong, reflecting the continued strong manufacturing investment climate there. In Europe, we also benefited from the continued capital investment across the continent as Western Europe continued adding capacity and Eastern and Central Europe continue to make new investments. And in NAFTA our sales were up 6% as we continued to see good demand for both our systems and replacement filters.

In our gas turbine business, we started the year very strong, but I should remind everyone that these are typically large systems, in fact the largest we make and the result, our shipments to our customers by quarter are volatile and tend to bounce around a bit. But overall the gas turbine market we serve continues to enjoy a strong up cycle in both the power generation and oil and gas markets.

And then finally, our special application sales were good in quarter one as we saw solid growth in both our disk drive filter and PTFE membranes businesses.

Now switching to our outlook for the balance of the fiscal year, it's good for fiscal '08 as noted in our press release; we have just increased our full year sales expectations for both business segments. Earnings and business sales are now expected to be up between 7% to 9%, up from our previous forecast of 5% to 7%. And our Industrial business segment should be up between 11% and 13% and we previously forecast that to be up between 8% and 10%. So we picked up both of our forecast for both the Engine and Industrial sides of our company.

Now many of you may be thinking, after an 18% revenue increase in quarter one why our full year numbers aren't higher, so let me briefly explain. During quarter one, we did receive a benefit on the revenue line of about 4.6% due to foreign exchange as Tom mentioned. And we don't expect to see a similar size benefit during the second half of this year.

Second reason is as I mentioned our GTS shipments by nature bounce around by quarter. We had an outstanding quarter one, but we don't forecast the next several quarters to be quite as large. And then third, remember we had a strong second half last year with our first $500 million quarter in the fourth. So our comps would be getting tougher. But having said that, we are looking at another good revenue year, with total sales up approximately 11% and our first $2 billion sales year ever.

Now looking at the outlook conditions by segment, starting first with our Engine business. Despite some current weakness in NAFTA, both the construction and mining equipment sales continue to grow internationally. In the Ag equipment sector, we see strong growth there globally. The latest reports forecast both good crop prices and farmer incomes to be up, which is positive for the Ag equipment market. We expect demand to continue growing in out Aerospace and Defense business and in addition last March's acquisition of AFS will continue to benefit our sales line.

We expect our aftermarket sales to continue to grow strong internationally as we focus on continuing to develop new markets and adding distribution. And finally, as Tom mentioned we continue to see the NAFTA Truck business being down about $30 million to $40 million this year through our third quarter before starting to pick up in the fourth quarter of fiscal '08.

In our Industrial businesses, we see all of the major business groups up in fiscal '08. In IFS which includes our industrial dust collectors and compressed air filters, incoming orders remain good for both equipment and replacement filters. So we have increased our sales growth guidance up 10% to 15% for fiscal '08.

In our GTS business, we have significant orders in hand already for fiscal '08 and we're expecting a 10... 15% to 20% sales growth for the full year as we continue to see good conditions in the Middle East, Asia and parts of Africa. And finally we're expecting 5% to 10% revenue growth in our special application business this year.

As Tom mentioned, we expect our fiscal 2008 operating margin to be a minimum of 11%. We have now increased our full year EPS to that range and expect EPS to be between $1.97 and $2.07 per share and which would be our 19th consecutive year of record earnings.

Now as our habit, I want to give you an update on two of the new platforms that we have talked about; one is PowerCore and the other one is the diesel emissions. And I'll start first with PowerCore. We have now won 93 equipment platforms with our OEM customers, 73 of these are already in production and another dozen are expected to go into production during the fiscal '08.

Our sales... our PowerCore sales in the first quarter were up 20% to $12.5 million and we still have another 80 plus platforms in the proposal stage with our OEM customers. So with our current win rate of over 90%, we are confident of the continued growth of PowerCore technology. Then finally, we will be releasing our next generation PowerCore technology in 2008, which utilizes the latest advances in Donaldson technology which will allow us to further reduce the footprint of the filtration systems by about one-third.

Switching to emissions; while we continue to be positive regarding our long-term participation in the diesel emissions market, we have now reduced our estimate for our on-road business to $80 million by the end of 2012. So why make this adjustment? Well, based on our current expectations of platform wins for 2010, coupled with current volume projections for those wins, we feel that $80 million is our best estimate today.

In addition, we believe that it will take approximately 2 years from the implementation of the 2010 EPA regulations, the industry market volumes to recover to normal production levels. We will continue to support our existing on-road emission customers, while we increase our focus to the retrofit off-road market, which we now believe are better fit for our product development skills.

So, the bottom line around this emissions opportunity is that we continue to see the on-road and off-road diesel emissions as a good growth opportunity for Donaldson, although not quite as large as we had first hoped.

Now I want to offer some wrap up comments on the quarter. We are off to a very good start in fiscal '08 with strong sales, a new record and a 12% operating margin. Our overall sales outlook for fiscal '08 is good for both the Engine segment and the Industrial segment. The strength of our business model, which is a portfolio of diversified filtration businesses around the globe, continues to work as the weakness in those end markets in the midst of cyclical downturns like heavy truck, has been and will be offset this year by the strength in our Industrial businesses globally and our international Engine business.

In addition, in this period of continuous improvement, we have been remained focused on improving the long-term profitability of our business. As Tom reported, we made good progress this quarter, specifically one of the areas of immediate focus for us is that we will be continuing to improve our distribution efficiencies by investing in people, processes and systems to yield a long-term sustainable improvement. The bottom line with all this is that we expect to deliver another record year of sales and earnings, making fiscal 2008 our 19th consecutive EPS record.

Tina that concludes our prepared remarks. Now, we'd like to open it up to questions.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from the line of Charlie Brady with BMO Capital Market.

Charles Brady - BMO Capital Markets

Hi, thanks. Good morning, guys.

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

Good morning, Charlie.

Charles Brady - BMO Capital Markets

Hey, a great quarter by the way. In your gas turbine business and I know it's lumpy, but, it's clear the expectation for that business relative to where you were at the end of the year, you've really ratcheted that it up a lot. I am just wondering is that just being driven by a more near term influx of customer orders that have come in or projects that may be we're in the pipeline that were possible. But a little more uncertainty now that the uncertainty there has increased such that is always coming over much more highly probable, I mean the outlook for that business is up significantly from where you previously thought it was going to be?

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

Charlie, this is Bill. It's mostly around I think the second point which is orders firming up. So we can see the projects but always see now as the orders firming up so that's why we've increased our guidance.

Charles Brady - BMO Capital Markets

Okay. And switching gears on special applications business. How much of that business is disk drive business now?

Thomas R. VerHage - Vice President and Chief Financial Officer

Charlie, this is Tom, approximately two-thirds of that business is disk drive.

Charles Brady - BMO Capital Markets

Okay. I mean, the performance in the Ag business in the quarter was also pretty strong and I am just wondering given the strength in Q1 why the rest of the year, if you had all together why the overall year performance wouldn't be little bit even stronger than kind of what you are projecting right now?

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

Charlie, this is Bill. I think we don't have a tremendous amount of visibility in the described business. So, what we must rely on is sort of industry estimates of hard described shipments and that's what we factored into our guidance.

Charles Brady - BMO Capital Markets

Okay. Thanks. I'll get back in the queue.

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

Okay.

Operator

Your next question comes from the line of Brian Drab of William Blair.

Brian Drab - William Blair

Hi. Good morning.

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

Good morning Brian.

Brian Drab - William Blair

First question, just around working capital. Looks like there is a slight up tick in accounts receivable and inventory days, wondering if you could just talk a little bit about that?

Thomas R. VerHage - Vice President and Chief Financial Officer

Hey Brian, this is Tom. Receivables are up actually quite a bit less than sales. I think receivables increased in the first quarter about 10% and as you know our sales growth was up 17% to 18%. So, we are fairly comfortable with where the receivables are. I'd say also on receivables, as you know; a lot of our sales growth took place overseas and generally overseas customers get longer terms than domestic customers. I mean on inventories, inventories were up by, I believe about 7%. Keep in mind that about half of that's currency with the stronger currencies.

Brian Drab - William Blair

Right.

Thomas R. VerHage - Vice President and Chief Financial Officer

And, then consistent with our growing aftermarket model and having enough inventory and distribution centers to supply our customers as they need them, that would be another reason why inventories are up a bit.

Brian Drab - William Blair

Okay. And then thanks for the update on PowerCore, wondering if you could just talk a little bit about the dynamic, competitive dynamic between PowerCore and channel flowing? How you are seeing that develop?

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

Brain, this is Bill. I think as we've talked about this the last couple of years, we knew or expected that if PowerCore was successful, other people would try and copy it and so may be in the spirit of imitation being the most sincere form of flattery other people are trying to copy it.

Brian Drab - William Blair

Right.

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

That's absolutely why we had started a couple of years working on the next generation and why we are going to be releasing this year. So, we are going to raise the bar again with the next generation PowerCore for our customers improve value in a smaller size. That's the way we are dealing with that. So, we do see competitors trying to copy our first generation technology, we are going to release the next generation.

Brian Drab - William Blair

Okay, great. Thank you.

Operator

Your next question comes from line of Richard Eastman with Robert W. Baird.

Richard C. Eastman - Robert W. Baird

Good morning.

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

Good morning Rick.

Richard C. Eastman - Robert W. Baird

Hey Bill, I just want to clarify the sales growth rates that you are providing the boost 7 and 9 for Engine and 11 to 13 for Industrial, is that in local currency for the full year?

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

That's in dollars, Rick.

Richard C. Eastman - Robert W. Baird

Okay. So that's in reported dollars. Okay.

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

Right.

Richard C. Eastman - Robert W. Baird

And then you had referenced the defense and aerospace business as part of the Engine segment, which I understand, but could you give us... could you size that for us? How bigger piece do you talk to when you think of aerospace and defense and is that in the off-road piece or is that kind of the whole Engine segment?

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

Rick, it is in the off-road piece and in fact this is between 3% and 4% of our total sales.

Richard C. Eastman - Robert W. Baird

Okay. And then the last thing is and I struggle with this just a little bit, but the leverage in the business given the sales growth we've seen and I know you have made investments which may explain this. But if I try to adjust the sales and op profit for currency impact, my incremental op margin is around 10%. And by your segment disclosure, it would look like the greater incremental margin is coming out of the Industrial business than the Engine business. And I am just struggling a little bit as to why... are we intentionally absorbing some of that leverage with what I think is growth investments or why are we not showing a bit more incremental profit on the sales group?

Thomas R. VerHage - Vice President and Chief Financial Officer

Rick, this is Tom. Actually, I anticipated your question.

Richard C. Eastman - Robert W. Baird

I must ask you too much.

Thomas R. VerHage - Vice President and Chief Financial Officer

I think you did notice year-over-year that our Industrial Products margins did improve and that's going to fluctuate quarter-to-quarter. Last year as you might recall, we were opening up a new plant in the Czech Republic for dust collectors and that had some plant start-up cost and the like. As far as growth investments, there is no question, we are going to continue to do that and I think that's paid for itself if you look at our growth in the first quarter, we wouldn't have that growth, if we wouldn't have made some of those growth investment. So, there is a lot of new product platforms coming out particularly on the Engine side that we are investing in. We are investing in sales and marketing both especially outside the United States. So, I think it's primarily the growth opportunities that we see and we are just going to need to continue to make those investments.

Richard C. Eastman - Robert W. Baird

Okay. And do you feel that... exports up significantly for you or is again the international growth coming, product is manufactured there. But is the weaker dollar helped you in terms of exports?

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

Rick, this is Bill. We do supply from our plants in the U.S. outside of NAFTA. But primarily most of what we sell outside of NAFTA, we make in the region and that actually helps us in terms of being naturally hedged. So, from a weaker dollar perspective, we haven't seen a big gain because we export a lot.

Richard C. Eastman - Robert W. Baird

Yes, I understand. Okay, great. Thank you.

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

Sure.

Operator

Your next question comes from the line of Scott Graham with Bears Stearns.

Scott R. Graham - Bears Stearns

Hey good morning.

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

Good morning Scott.

Scott R. Graham - Bears Stearns

Couple of questions; one on the margin, one on the sales. We were... you indicated to us sort of during the middle two quarters of last year that you had this organizational spending to improve service rates to help out some of the newer facilities with logistics and what have you, that number I think raced all the way up to as much as $4 million and I think always the second or third quarter of last year. And then came off a bit in the fourth quarter, I was just kind of wondering if you would may recall out that what that number was this quarter?

Thomas R. VerHage - Vice President and Chief Financial Officer

Scott, this is Tom. I think what you are referring to is the third quarter last year when we did see that spike and identified the need to make some significant investments. We had two projects, key projects underway; one was in Belgium where we converted a manufacturing plant to a distribution center. That project is pretty much behind us, and now we are working on our distribution center in the United States on some important technology and process and organizational initiatives. So, that spending will continue for a bit yet and perhaps later on in the fiscal year, we'll hope we start to see some of those benefits. But that's going to be a long-term gain and we are going to see the benefits in the future.

Scott R. Graham - Bears Stearns

It doesn't though appears if it was as high this quarter as it was in that quarter that you indicated that was $4 million. Is that a fair statement?

Thomas R. VerHage - Vice President and Chief Financial Officer

The $4 million back in the third quarter of last year included both of those distribution centers.

Scott R. Graham - Bears Stearns

Yes.

Thomas R. VerHage - Vice President and Chief Financial Officer

We are still incurring some extra expenses in the first quarter of this year. And on a year-over-year basis, those extra expenses are approximately couple of million dollars.

Scott R. Graham - Bears Stearns

Thank you. On the sales growth, 5 of your 6 segment sales growth were really terrific and I was just wondering 2 of them in particular, off-road and aftermarket. Those sales looks like they accelerated this past quarter and maybe I've even lumped into that the IFS and I am just wondering if you could call out what other than strong international, was it more of a new customers, new distribution been to that and also the IFS being up 15, we had slower factory activity in United States and Europe. Yet, those sales were also were quite strong. I was just maybe wondering if you could give us a little bit more color on off-road, aftermarket and IFS.

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

Scott, Bill here. First on the off-road, I think there, we are getting a benefit within that as we mentioned earlier in response to Rick's question about that our defense business is often its small portion of that, but it's up alive. It's up for two reasons: stronger sales to military customers and then the second is the inclusion of the AFS acquisition which we didn't have this time a year ago. So that helps. But aside from that, when we see very strong off-road conditions internationally, and we also see very strong Ag equipment conditions both in the U.S. and internationally, so, it's combination of those positive factors and off-road and more than offsetting what we see is some weakness in say residential construction equipment smaller, construction equipment that some of our customers have talked about in their releases. So the positives are more than offsetting that in the off-road.

In the aftermarket, I think it's to your point and as we discussed in our comments, it's around new distribution, more proprietary products and expanding internationally, it's a combination of those factors, we saw in the emerging markets in Europe that I referenced we saw very significant growth as a result of those efforts. And so that's a... those are the types of things that are add up to good aftermarket growth globally.

And then the last one in IFS; we see stronger growth there in Asia and Europe than we do in NAFTA, although as I mentioned our NAFTA business was up. But it's up a lot more in Asia and Europe and we really haven't seen what you've referenced, a slow down in Europe in that business. So we've seen continued strength at least through the first quarter there as well.

Scott R. Graham - Bears Stearns

That's very helpful, Thank you.

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

Okay.

Operator

[Operator Instructions]. Your next question comes from the line of Eli Lustgarten, with Longbow Securities.

Eli Lustgarten - Longbow Research

Good morning.

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

Good morning Eli.

Eli Lustgarten - Longbow Research

Couple of quick... just wanted to make sure I understood. You said, aerospace defense was 3% to 4% up total corporate sales or total engine sales?

Thomas R. VerHage - Vice President and Chief Financial Officer

Total corporate sales Eli.

Eli Lustgarten - Longbow Research

The corporate sales, okay. And you also indicated in the prepared remarks the $2.5 million of option expense in the second quarter, that's coming. Do you have an idea what the share count change will look like over the year, are you expecting to buyback most of the pre-book, what's going on with share count based on the options?

Thomas R. VerHage - Vice President and Chief Financial Officer

Yes, Eli I'm going to go back to history on the share count. Think you might be aware that we bought back on average about 3% of our shares per year over the last 18 years and that's resulted in a net reduction of 2% after the stock options and grants, employee plans. We really don't comment prospectively, I think our press release indicated what we bought back in the --

Eli Lustgarten - Longbow Research

In the quarter, yes.

Thomas R. VerHage - Vice President and Chief Financial Officer

So, what we do in the future will just depend on market conditions, share price and --

Eli Lustgarten - Longbow Research

But the game plan hasn't changed to make sure that to continue the process of hopefully offsetting share base.

Thomas R. VerHage - Vice President and Chief Financial Officer

Yes, over the long-term Eli that would continue to be our plan.

Eli Lustgarten - Longbow Research

Okay. And what percentage of your off-road business is North American residential construction?

Rich Sheffer - Director of Investor Relations and Assistant Treasurer

Eli, this is Rich. North America is about 55% of our off-road business.

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

And you said residential.

Eli Lustgarten - Longbow Research

Yes, how much of that is residential... is the small step with the medium lot?

Thomas R. VerHage - Vice President and Chief Financial Officer

We look at the mix within off-road 20% to 25% is related to construction, less than half of that would be related to residential.

Eli Lustgarten - Longbow Research

Okay, and the rest of it is mining and aerospace, to tell you that how you're defining off-road?

Thomas R. VerHage - Vice President and Chief Financial Officer

Yes mining...

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

And residential construction.

Eli Lustgarten - Longbow Research

And average in that, right?

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

Right.

Eli Lustgarten - Longbow Research

Same question in the aftermarket business, what percentage is North American construction in the aftermarket business in Engine?

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

Eli, this is Bill, I don't think we break that out typically.

Thomas R. VerHage - Vice President and Chief Financial Officer

Yes, the way we report off our aftermarket sales is a combination of both off-road and on-road replacement.

Eli Lustgarten - Longbow Research

I realize that.

Thomas R. VerHage - Vice President and Chief Financial Officer

Yes. If you look at North America aftermarket is about 50% to 55% of our total aftermarket. So you're looking at a pretty small fraction once you get down to residential construction.

Eli Lustgarten - Longbow Research

All right. Thank you.

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

Sure.

Operator

We have a follow up question from the Charlie Brady with BMO Capital Markets.

Charles Brady - BMO Capital Markets

Thanks. If you could just get back to the diesel emission opportunity and sort of ratchet it down your expectation. There was fairly significant down tick in your expectation, can you just give a little more detail to what sort of played into that over the past I guess three months relative to where you were thinking before?

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

Charlie, this is Bill, I think what we saw happen is the business started to be awarded for the next couple of years that we didn't win some of the platforms that we expected. And so, that's why we updated our guidance and provided. We still think that, that's a good growth opportunity, its not going to be as large as we hoped on the on-road side but as there is growth opportunity there for us and we are still pursuing it and then in the next decade around the off-road regulations, which come in 2011 and 2014, we think that there is going to be may be an opportunity that we are better suited to go after. So, we're going to be a long-term player, we just wanted to update the guidance based on what we see happening now.

Charles Brady - BMO Capital Markets

Are there still platforms yet to be awarded?

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

For the on-road for 2010; most of those have been awarded at this point.

Charles Brady - BMO Capital Markets

When would you expect the off-road awards to start coming out?

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

Bill again here, the off-road we're probably over the next couple of, say, year to two years, okay. They are going to be at advance of the 2011, so in 2008, 2009.

Charles Brady - BMO Capital Markets

Great. Thanks very much.

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

Sure.

Operator

Your next question comes from the line of Andrew DeAngelis [ph] with KeyBanc Capital Markets.

Unidentified Analyst

Hi, guys.

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

Good morning.

Unidentified Analyst

My first question is a follow up from question asked earlier as it relates to PowerCore. I was just wondering what percentage of the aftermarket you currently expect that you're capturing as it relates to PowerCore sales?

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

Which percentage, systems that we put out there or we captured with our --

Unidentified Analyst

From an aftermarket perspective, yes.

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

The PowerCore systems that we put out there, we're capturing, if not... may be not a 100% but pretty darn close to 100% of the replacement parts for those systems.

Unidentified Analyst

Okay, that's helpful. And then I wanted to focus not specifically on your GTS business. I know you don't provide margin by unit, but we're just kind of curious as to the margin trajectory of that business over the last several quarters and what we can expect going forward?

Thomas R. VerHage - Vice President and Chief Financial Officer

Andrew, this is Tom. You are right in your earlier comment. We don't provide margin guidance by product line, so I guess we won't be able to answer that question.

Unidentified Analyst

I mean can you talk implicitly though as to what the margins in that unit have done over the last several quarters and what you'd expect from the profile going forward?

Rich Sheffer - Director of Investor Relations and Assistant Treasurer

Sure. Andrew, this is Rich. I think what you are referring to is last year we had one or two issues with some large systems. I think its safe to say, since we didn't call anything out that we do not have recurrence of that this quarter that caused a down draft in the margins. So, I think things are operating fairly normally there.

Unidentified Analyst

Okay. And then my last question relates to your Transportation Products Group. There is an ongoing share shift in the on-road segment in terms of the engine and I know your guidance hasn't changed in terms of the revenue growth profile that unit over fiscal 2008. I was just wondering what part of that $30 million to $40 million fall off in the first three quarters is kind of related to the market and what the impact of the share shift in that segment of the business might have to plan to the expectations over the next 3 or 4 quarters?

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

It's essentially all market.

Unidentified Analyst

Okay

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

Production volumes being down.

Unidentified Analyst

So you are not seeing a notable impact from the ongoing share shift there in on the engine side?

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

No

Unidentified Analyst

Okay, that's helpful. Thank you.

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

Sure.

Operator

At this time there are no further questions. Are there any closing remarks?

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

Yes Tina. Thank you. To all of you participating and listening, I would like to thank you all for your time and interest. To my fellow employees, I want to thank you for your efforts and support in our achievement of another record quarter for both sales and earnings. Happy holidays and thank you all. Good bye.

Operator

Thank you. This concludes the Donaldson Company's first quarter fiscal 2008 earnings conference call. You may now disconnect.

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