Good day, and welcome to the Donaldson Company First Quarter Fiscal Year 2015 Earnings Call and Webcast Conference. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Rich Sheffer. Please go ahead.

Thank you, Don, and welcome to Donaldson's fiscal 2015 first quarter earnings conference call and webcast. Following this brief introduction, Bill Cook, our CEO, Tod Carpenter, our COO and Jim Shaw, our CFO will review our first quarter earnings and our updated outlook for fiscal 2015. 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?

Thanks Rich and good morning everyone. In a few minutes, Tod and Jim will cover the details of our first quarter results and our updated outlook for fiscal 2015. But, first I would like to offer some summary comments. As noted in our release, conditions in our very diverse end markets continue to be mix. Many of our OEM or first first-fit equipment end markets remain challenged particularly the global mining equipment market, and more recently the North American and European agricultural equipment markets. The Chinese construction equipment market also continues to be very weak. And we have not yet seen a rebound in our first-fit dust collection market globally. While there are some specific differences in the dynamics of each of these end markets, one common threat is that all are dependent on new CapEx investment which continues globally to be very weak. While we obviously can't control new CapEx investment by our customers or theirs, what we are doing in all of our first-fit markets is utilizing our stream of new technologies, introduce new products which are allowing us to take share today even given the current market conditions. These CapEx dependent markets will recover and when they do, we will be in a much stronger position both on our customer's first-fit equipment as well as their replacement filter aftermarket annuity. As we've discussed before, today over 50% of our revenues are replacement filters. This is a dramatic transformation from where we were 20 years ago. Almost all of our replacement filter businesses are doing well for two reasons. First, while as I mentioned new equipment CapEx investment remains weak, the better news is that the equipment that's out there in the field, whether it’s a dust collector, an excavator or a heavy truck, they're being utilized and…

Thanks, Bill and good morning. Our first quarter sales were $597 million essentially even with last year's first quarter. Foreign currency translation had a 2% negative impact at the consolidated level, however, the impact of FX varied by region. For example, our European businesses had a 4% negative impact, while our Asian businesses had a 2% negative impact. As a reminder, you can find a detailed analysis of currency translation by business unit and region on the Investor Relations homepage of our website. The rest of this review will discuss local currency first quarter results. Sales in our engine product segment increased 2% over the prior year. Our on-road OEM sales increased 17% globally. North America and Latin America on-road sales grew 19% and 23% respectively due to increased build rates of new trucks. Europe grew 33% in the quarter mainly due to our increased share on the newer Euro 6 trucks now in production. We continue to see strong conditions in our Europe aftermarket where we supply replacement – in our engine aftermarket, where we supply replacement filters through both our OEM and independent distribution channels. Our engine aftermarket sales increased 9% in the quarter with solid growth in all of our major regions. We attribute this growth to the combination of our market growth initiatives and improving equipment utilization in the field. We are continuing to see strong replacement filter sales growth in developed markets from our OEM customer dealer organization and are also benefiting from our increased aftermarket penetration with independent dealers and distributors in emerging economies. Our engine aftermarket is one of our earliest cycle end market and the improvements we have seen over the last few quarters, provides evidence that diesel equipment in the field is being used at an increasing rate generating the need…

Thanks Tod, and good morning everyone. Our gross margin this quarter was 35%, down 80 basis points from last year's first quarter. As we noted in our press release, there were a few items impacting our gross margin this quarter. Lower fixed cost absorption from lower production volumes in certain of our markets and geographies compared to last year resulted in a negative 130% basis point impact. Other investments, such as our new distribution center in Slovakia and integration of our new acquisition in the gas turbine market Northern Technical, had a negative 20 basis point impact. On the positive side, we benefited from a higher percentage of replacement filter sales which were 57% in the current quarter compared to 54% last year. In many of our end markets, the utilization of existing equipment in the field is good and that helps our replacement filter sales which carry a higher margin. Overall, product mix had a positive 20 basis point impact on gross margin. In addition, our ongoing continuous improvement initiative benefited our gross margins by approximately 50 basis points compared to last year. Our operating expenses increased by $10 million compared to last year's first quarter. As a percentage of sales, operating expenses increased by 160 basis points. Higher cost associated with employee salaries and benefits, incremental expenses related to our global ERP project, and higher travel expenses associated with our growth initiatives and increased customer visits with a primary driver of the increase. As a result of the decrease in demand we are seeing in certain of our end markets and geographies, we have implemented cost control initiatives to reduce our expense levels for the remainder of the year from our original fiscal 2015 plan. Our lower gross margin and higher operating expenses resulted in a 240 basis…

Thanks, Jim. And as mentioned earlier, we’ve continued to make the key investments in our business to support the long term objectives outlined in our strategic plan. Our plan is a compilation of the very detailed plans by business and region that support our sales targets of $3 billion and then $5 billion in revenues. As a result of our plans, we have number of very focused initiatives underway today that will help us grow overtime regardless of the global economic environment. I’d like to take a few minutes to highlight a couple of these initiatives. And the first is with emerging economies such as Latin America, Southeast Asia, India, China, Eastern Europe. We have entered these regions more recently, and as a result our businesses there are still small and our current market presences are lower than they are in North America, Western Europe, or Japan, each of which we’ve been in for decades. The other way of saying this, is that we’ve got very significant regional opportunities for growth. So in our targeted emerging markets, we are continuing to add sales resources, parts to our product line, distribution capabilities, distributors, and OEM customers. We have determined overtime that if we have good sales people and local product availability, we can grow our aftermarket businesses and we continue to do this all over the world. For example, in our engine aftermarket business we added 67 new distributors and over 460 new part numbers in the quarter. Another key part of this growth model is our continued investment and our own distribution capabilities. During the past quarter we opened two new distribution centers, one in Peru in August, and another in Slovakia, at the end of October. By having more of our product available locally and supported by local distributors…

Thank you. [Operator Instructions] We'll go first to, Charlie Brady with BMO Capital Markets.

Thanks. Good morning, guys.

Good morning, Charlie

How much can you quantify the gas turbine shipments - slippage in the quarter?

Charlie, this is Jim. Compared to our initial estimates, it’s about $6 million to $8 million of sales that we anticipated initially this quarter that are now into the second quarter.

Okay. And can you quantify what the liquid filtration sales were in the quarter?

Two seconds, Charlie. This is Rich. Total liquid sales were a little over $120 million in the quarter.

Okay. And one more on your -- you said you're adding capacity. Where are you adding capacity? What product lines, in terms of your CapEx explanations?

It’s more regional. So, we're in the process right now of adding a plant in Poland, which will support our growth in Eastern Europe and also address them of our capacity needs in Europe as we continue to grow there over the next several years. So, that's one, and then the other capacity is distribution center related that Bill mentioned in Slovakia and Peru.

And we're also adding, Charlie, some production capacity in existing plants for technologies like PowerCore to bring more of that production into more regions as the businesses there are growing.

Great. Thanks guys.

We'll take our next question from Eli Lustgarten with Longbow Securities.

Good morning, everyone.

Hi Eli.

Can we talk a little bit about the change in outlook in the engine division? You brought the forecast down to slightly up. I understand, I assume 2% of that is currency, but can you talk about the various mix and how far down are you forecasting the ag business to be? I assume mining is relatively flat, but can you give us some insight of where the weakness is and the magnitude of the decline?

Yeah, Charlie, this is Tod. So let me just do a walk through the markets. As you said, mining is in our outlook going to continue at the current low levels. We have transportation being strong in North America, and as we roll that up globally about - between 8% to 12% up for us, we have construction modestly up, so low-single digits, 2%, 3%. But the big change for us in this outlook is really in the ag markets. So ag, we have down between 25% and 35%. Now that maybe a larger piece, a larger number than, for example, you’re used to from a customer standpoint of view, but for us it’s more of mixed explanation. So within the larger row crop type of products, our products carry a higher average sales price, so hundreds of dollars versus in the more stable portion of the ag markets which would be dairy and small farms, where our pricing is more about $25 to $30. Additionally, in the row crops where we’re feeling a lot of pressure across the market, we also have our emissions-based business. So when you roll all that up for us due to the reduction outlook in the larger pieces of equipment on the first-fit side of ag, that’s the reason why we have ag coming down between 25% and 35%.

That's realistic actually. Most of the companies have been underestimating, and the decline is going to be at least that big, so I have no problem with that. Can you talk about with that mix change, you're still relatively holding profitability in the business. Is that because the after-markets are strong and making up for the shortfalls in the OEM stuff?

Yeah Eli, this is Jim. So it's sort of a mixed story in terms of some of our plants. Some of them are operating very robustly, especially those serving the aftermarkets where Tod, just mentioned certain aren't. So it’s a combination of us adjusting here, so we are having to adjust some our spending levels in terms of discretionary spend. But then also because some of our plants are shared, the aftermarket is helping to offset some of the weakness in terms of the absorption.

Okay. And one final question. We talked about the shift over to gas turbine. If I do the math right, it looks like you've taken the gas turbine outlook ex the acquisition, towards the lower end of your ranges before. At least that's what it looks like to me that is there some slippage in gas turbine? I don't mean first quarter, second quarter, but some being pushed out into 2016 at this point? Or is this just the way it looks? Because that looks like it should have been a little bit stronger than what you're showing.

Yeah, Eli you’re reading it correctly. There were a couple of projects that we had originally scheduled in our fourth quarter that we’ve now just determined there’s too much uncertainty, they are related to some locations in the Middle East that are going through turmoil. So we’ve taken a couple of those projects out of our forecast which is the reason for that.

Okay. Thank you very much.

Thanks.

We'll take our next question from Kevin Maczka with BB&T

Thanks, good morning.

Good morning.

Just to clarify that comment on ag from Tod, the 25% to 35% decline, that's you're speaking directly to the OE portion, right? That's about 5% of sales. Not the after-market portion, or both?

We have seen both. So we have seen destocking across the service channel. And we experienced that within the quarter. We see that continuing the softness within the agricultural aftermarket piece until spring when planting season comes back, but really we’re driven mostly because of our first-fit business in that outlook.

Okay, got it. And can I ask a question about margins in the second half? On a year-over-year basis, your operating margins were down in the first quarter. You're suggesting down in the second quarter as well. But the full year then, of course, implies that you have a nice lift in the second half. I know there's continuous improvement activities happening, productivity initiatives. Can you just talk about what are some of the drivers, given this lower revenue outlook that still give us comfort that margins will be up significantly in the second half?

Yeah, Kevin, this is Jim. As we entered this year we were obviously hoping for a little bit better result in terms of the topline this quarter. So as we - we're in the middle of this quarter, took a look at some of those sales forecast, we have began to adjust some of our more discretionary type spending and personnel within the plants to adjust to the new levels. You won’t see that full effect of that quarter-over-quarter from first to second because of some of things I mentioned in terms of the second quarter generally being a little bit softer we - having the option expense some other things. But as we get to third and fourth quarter with the sales increases, we do anticipate and we typically do see a picked up seasonally for our third and fourth quarter, those volume should get our margins back to what we were operating at the end of last year.

Okay. And if I can just sneak one more in, on industrial filtration, down slightly in the first quarter, we're guiding 1% to 5%. But the comps get much harder in the second half of the year. If we don't have a CapEx recovery, like it sounds like you're not banking on, how do we get that acceleration in that business unit?

This is, Jim. A big piece of that is the gas turbine growth. So we’re $30 million roughly this quarter, as we get to second and third quarter that number is going to about double. So that’s the big piece of it. And then we do anticipate the benefit of some of the new products we've launched in the industrial side to benefit. And then I think there is some level of recovery that we do foresee within the dust collector business just based on some of the quotes and some of the backlog we see.

Okay. Jim, I was speaking specifically to IFS, within the industrial segment, so not to the gas turbine piece. So you're talking more about new products and dust collection and others that give you that confidence?

Yeah, that’s correct. So we recently launched new products just two months ago that are really receiving nice acceptance across our markets. And as we continue to push those out through the year, we have seen a nice conversion rate on the quotes. So as we look forward we have a more positive outlook in our dust collection business.

Okay. Thank you.

We’ll take our next question from Laurence Alexander with Jefferies.

Good morning. Two questions. First, can you help us with the destocking that you're seeing? In the past when you've seen these kinds of destock cycles, how would you benchmark the sequential trends that you might see once the destocking ends? So not so much when will you see the destocking end? But when this happens, what do you see as a reasonable bridge? And secondly, with the PowerCore and other new technology platforms, is the rollout of additional platforms likely to also lead to an acceleration in the growth rates? Or how should we think about the impacts of rolling out additional technologies?

Laurence, Bill here. I’ll try to take both of those, or start on them. On the first one, destocking, let me - I guess the short answer is, it always depends on sort of certain characteristics of the market. I think what we’re seeing right now and as Tod and Jim mentioned on the agriculture side is, given what’s happened to the new equipment and that market generally is that there’s been a pretty major pullback in terms of production and in the channels in terms of inventory levels. Part of that is also a function of the fact that - and some of our customers who have their own parts distribution systems have their calendar year ends coming up, so that’s sort of on top of that. So I think our expectation on that is that, that we'd continue through our second quarter, and then as we get close, our third quarter which starts in February that we'd start to see that come back. Typically, that usually comes back, it can come back like a bull whip, very strongly depending on how the utilization equipment is in the field, that there's restocking in addition to the satisfying the utilization needs. So I guess - we think that’s going to continue for ag through the second quarter and then come back in the third. On the introduction of new technologies, it’s sort of evolutionary in the sense that we have to get these new PowerCore systems for our engine OEs, not only have to win them but then have to go through the development cycle on their equipment. So it’s usually probably two years after we win it before it goes into production. So a lot of the wins that we have now are still not slated. If we got them this quarter, then some of them are out to or calendar year 2017. But it’s one, and so when it goes into production, then we get the advantages of both that improved first-fit, greater first-fit business as well as the aftermarket retention. So it continues to build every quarter. That's why we like to talk about the PowerCore numbers over the quarter in terms of - to show and demonstrate that it is building.

Thank you.

We'll go next to Brian Drab with William Blair.

Good morning, Bill, Tod, Jim.

Good morning, Brian.

First on the gas turbine, when you look at the orders that are set to ship in the fiscal second half of the year, how are the margins on those orders compared with the longer-term corporate average of around 14%?

This is, Jim. In terms of the overall margin, they're going to have a little bit less just due to the nature of them being large project sales, but generally I think it really comes down to the difference between our first-fit and aftermarket sales. But they're inline to maybe just a touch lower than our overall corporate average when you take into account their generally first-fit versus replacement parts which we say on average are replacement filter sales have 100 to 200 basis points better margin.

And clearly, with the big step up in the second half of the year, you're saying the first-fit, we're going to lean a little more toward first-fit than after-market?

Correct.

Okay. And then the revenue guidance, Jim, you talked about the currency headwind. So we went from 4% to 8% to 1% to 5%. I want to make sure I understand the components in the bridge from the previous guide to the new guide. So I think Northern Technical adds a little less than 1 point in fiscal 2015. Currency, that's about a two point headwind. And then the other two points of headwind comes from end markets and order timing. Is that about right?

The currency is actually more in the lines of 2% to 3%, and then the other piece is sort of a combination of both some positive and negative. So Tod talked about the impact of ag, but then our aftermarket we're actually even a little more optimistic there than we were. So those kind of offset each other a little bit, so it’s really currency a little bit of negative on the ag from where we started, net of those other things and then Northern Technical being added in.

Okay. Thanks. And just one quick modeling item. Do you have the end-of-quarter share count for us? The end of the first-quarter share count as opposed to the weighted average?

Yeah, it was $141.1 million.

And just to be really clear, that's the diluted count?

Correct.

Right, okay. I guess that's all I have for now. Thanks a lot.

[Operator Instructions] We’ll take our next question from Brian Sponheimer with Gabelli & Company.

Hi, Bill. Hi, Tod. Thank you for having me on.

Good morning, Brian.

Just a question, going back to gas turbine, when you say six to eight months of visibility, and you called out a couple of projects based on geopolitical turmoil, that may not be in fiscal 2015. What's the impact do you think overall, from lower energy prices? And does that put some risk potentially into your July quarter?

Brian, Bill here. I think that lower energy price is probably would have an impact we think further out in that. I think we’re pretty confident in terms of the backlog that we see through the end of the fiscal year. And as Jim mentioned, we are being a little bit cautious just given what’s going on in the Middle East, that’s how we took a couple of those projects where we have the orders. But we don't think they’re probably going to be shipped just given the site has to be ready for them in the Middle East and we pushed those out until the next fiscal year or so. I think we're feeling pretty good about our forecast because these projects - our customer projects are all in flight already, so we think that they’re going to continue. Energy prices, higher or lower, would have a longer term impact on the market.

All right, that's helpful. And then one on the buyback, was surprised to see you get as aggressive as you were in the first quarter. If you were to buy back 4% of your shares for the year, that gets you north of 5 million to 5.5 million shares, at around $225 million. Why the cadence in the first quarter? Does that affect your decision for the remainder of the year, let's say, if shares were to continue to slide here a little bit?

Yeah Brian, Bill. I think - as we talked about in the past, maybe just take a look at the share buyback, first we have a consistent philosophy around it. So we're always trying to buy back shares. So we look at it in two tranches. We're always going to buyback enough - say, roughly 1% is a new option, aren’t dilutive. And then we're more opportunistic above that. So I say generally the first quarter of the year we try and go for that 1%. Right, this quarter we did more than that. That’s not - we've done that before. I think we just given our cash deployment strategy and where we saw the stock we thought it was a appropriate thing to do. As Jim mentioned, we're looking at for the full year a range between, up to 4% since we’re above 2% now. And we’re not committing to do the whole 4%, but that’s - we're operating within the range from where we are today up to that 4%.

Okay. I apologize if I missed it, but what was the average price that you bought back shares during the quarter?

This is Jim. It was $40 - Rich is looking for it.

Yeah, it’s $40.30, Brian.

Okay, all right. Thank you very much, I appreciate the color. And good luck with the Minnesota winter.

Thank you. This is Jim, I’ll add one other - to Brian's question earlier, I think I misspoke, I said 141.1 in terms of diluted share count, it's 140.1

[Operator Instructions] We’ll go next to Richard Eastman with Robert W. Baird

Yes, good morning. Jim, could you just -- I'm listening off-site. Did you say that currency for the full year was, in the guide, was minus 2%?

It was 2% to 3%. So as we looked at our revenue year-over-year, it was probably more on the lines of the 3% in terms of the impact compared to our original guidance.

Okay, okay. And in the original guidance, you had 0% essentially? Correct?

Well, in the original guidance we assumed the exchange rate at the time which the Euro was in the $1.35 type range, and now it’s just adjusting to newer reality. So that was based on the exchange rate at the time.

Okay, okay. And then, Bill, could you just maybe just roughly, when you speak to emerging markets, and we have some of these initiatives in India and Peru and the ones mentioned, what percentage of Donaldson sales do you bucket into emerging markets, just about?

Rick, it’s about 20%, right now.

Yes. And then, again, with the strategies mentioned and the upwards on the distribution side, the part numbers, you lead in those emerging markets with the aftermarket business, correct?

Right.

Okay. And then just one last thought, in the IFS business, what percentage of that business in terms of total revenue, is now replacement sales?

In IFS, it's right now running about little over 45% of our sales, Rick.

Okay, okay, very good. All right, thank you very much.

Thanks, Rick.

It appears there are no further questions at this time. I’d like to turn the conference back to Mr. Bill Cook, for any additional remarks.

Thanks, Don. Just to conclude our call, I’d like to thank everyone on the call today for your time and continued interest in our company. I’d like to thank my fellow employees for their efforts during the first quarter. So thank you all and have a great day. Good bye.

This concludes today’s conference. Thank you for your participation.