Donaldson Company, Inc. (DCI) Q1 2018 Earnings Report, Transcript and Summary

Good morning. My name is Christa and I will be your conference operator today. At this time, I would like to welcome everyone to the Donaldson First Quarter Fiscal Year 2018 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] Also please note that anybody that was dialing the 833-231-8250, we are very sorry today if you could not get into the call. We are having some technical difficulties and we're working to find a solution, again I apologize. And I would now like to turn the call over to your host Mr. Brad Pogalz. Please go ahead.

Good morning. Thank you for joining Donaldson's first quarter 2018 earnings conference call. Here with me is Tod Carpenter, Chairman, President and CEO of Donaldson; and Scott Robinson, Chief Financial Officer. This morning, we'll provide an overview of our first quarter performance, details on our guidance increase and an update on some of our strategic priorities. During today's call, we may reference non-GAAP metrics, such as adjusted earnings per share. You can find a reconciliation of GAAP to non-GAAP metrics within the schedules attached to this morning's press release. Also for reference, this morning, we posted a schedule on our Investor Relations website showing the year-over-year sales change with and without the impact from currency translation. I want to remind everyone that any forward-looking statements made during the call are subject to risks and uncertainties, the most important of which are described in our press release and SEC filings. Now, I'll turn the call over to Tod Carpenter. Tod?

Thanks, Brad, and good morning everyone. With a strong start to the fiscal year we are now projecting a much higher level of sales and profits than originally forecast. Sales are now expected to increase between 10% and 14% and EPS will be up 12% to 20% from last year’s adjusted EPS. We are pleased with the continued momentum in the Engine business which is the primary driver of our increased guidance. We are also seeing improving conditions within the Industrial segment. While still early, we are encouraged by the trend. Scott will give us some additional color on our guidance, but first I will provide some revenue highlights from the quarter. Sales increased to 645 million or 17% above last year. Engine sales jumped 25% to $442 million which is up a couple of percent from the prior quarter. A sequential increase from fourth quarter to first quarter is uncommon which speaks to the upwardly volatile nature of this recovery. In Engine, sales of first-fit and Aftermarket products were up meaningfully from last year. The largest increase was in Off-Road which was up 37%. The strength continues to be broad based with sales up in every major region and across all our end markets. While growth has been strong, we see even more runway as we are still well below peak volumes in this business. In addition to market driven strength, Off-Road is benefiting from innovative first-fit fuel solutions, sales of these products which leverage our proprietary Synteq XP media and our nearly all incremental of the Donaldson nearly doubled in first quarter. While the revenue is still small, we expect strong growth to continue as the program wins over the past several years go into production. Our On-Road business is also performing well. First quarter sales grew 26% with two thirds of the increase coming from the U.S. as heavy duty truck production ramps up. As is typical Aftermarket has led this recovery and sales have been strong for quite a while. Since bottoming in early fiscal '16, sales have been up every quarter for the past seven and first quarter of this year was a record level. Sales grew 25% to $309 million which includes a benefit of nearly $9 million from the Hy-Pro and Partmo acquisitions. We had Aftermarket strength in all major regions and both the OE and independent channels were up in the 20% range. Within the OE channel, growth still appears to be demand driven versus restocking and both channels are benefiting from increased levels of equipment utilization. The mining and energy markets are also driving growth in our independent channel. These applications have higher dollar content require more frequent change out and are coming off a deeper bottom. Based on these factors, customers expose to these markets are experiencing above average growth. These macro factors are complimenting the strategic work we've down over the past several years to drive our Aftermarket revenue, one example is our liquid business. Sales of fuel and loop products which make up about 20% of Engine sale were up more than 20% in the quarter and that’s on top of growth in the low teens last year. Hydraulic filter sales which account for slightly less than 20% of total Engine were up 30%. We've focused on what we call short cycle winds over the past several years which is where we work with OEs to provide there service parts. As end markets improve we’re seeing benefits from those winds. Aftermarket sales of PowerCore were also up in the mid 20% range last quarter. We continue to retain the vast majority of PowerCore Aftermarket given our broad number of SKU, global distribution and high service levels. Rounding out the Engine segment, sales of Aerospace and Defense were down slightly in the quarter. The decline was primarily driven by sales of replacement parts as we annualize strong growth last year. Turning to the Industrial segment, total sales increased about 2% or flat with last year when you exclude FX benefit. Sales of Industrial Filtration Solution or IFS grew more than 6% last quarter driven by both first-fit systems and replacement parts. We're encouraged by the sales trend of first-fit systems, which make up about half of total IFS. Coding activity for these products has remained stable, but the average size of coded project increased in certain regions as potential customers export greater levels of investment. Our suite of new IFS products including Downflo Evolution for dust collection and LifeTec filters for process filtration are also contribution to the strong growth in this business. Special applications revenue grew 4% last quarter which roughly half the increase coming from disk drive filters. The disk drive business which is more than half the total special applications last quarter continues to benefit from our strategic efforts to increase content for drive and growth market share. Additionally, the pace of decline in hard drive market has moderated leading to stronger than expected sales. We view the favorable market conditions as temporary and we continue to explore new ways to leverage this technology into adjacent markets. As expected our Gas Turbine business continues to face pressure in the large turbine market. Total GTS sales were down 19% in first quarter with sales to large turbines accounting for all the decline. We saw a partial offset from strong sales of replacement parts which represented nearly 60% of GTS in the quarter. We are pursuing the Aftermarket sale on every type of turbine which we believe is a powerful opportunity given the competitive dynamics in the first-fit GTS market. Overall, there was strength across our company last quarter, aggregate sales of both first-fit and replacement parts were up in the double digits and our innovative products are outpacing growth in their respective businesses. These trends give us confidence that our strategic efforts are working and our investments this year are geared towards furthering our success. I'll discuss a few examples later in the call, but first Scott will review our key financial metrics and revised guidance. Scott?

Thanks, Tod. Good morning everyone we are very pleased with our first quarter performance, continued strength in the markets and disciplined expense management led to strong increases in both sales and operating profit. These increases translated to a first quarter EPS of $0.46 which was 7% on a GAAP basis, and 21% from last year's adjusted EPS. I want to remind everyone that our adjusted EPS last year excluded the one-time gain from the Northern Technical escrow settlement which is worth about $0.05 per share. Now I'll touch on a few highlights from the quarter, first quarter sales increased 16.6% or a little more than 13% when you exclude the benefits from currency translation and acquisitions. Our first quarter operating margins grew 30 basis points to 14.1% from 13.8% last year, reflecting a decline in gross margin that was more than offset by expense leverage. Gross margin was 34.8% compared with 35.1% last year, reflected in this year's rate are headwinds for mix, raw materials and the cost of chasing higher than expected demand. The mix pressure was largely driven by the resurgence in our first-fit businesses particularly Engine OE. As expected, pricing for both steel and media was unfavorable versus last year. These represent the largest two inputs into our cost of goods, so they are contributing to the year-over-year pressure in gross margin. Finally, costs related to chasing higher than expected demand continued to negatively impact gross margins. We are focused on operational efficiency and expect this pressure to abate over the course of the year. Our operating expense as the rate of sales dropped 60 basis points to 20.7%. The year over year favorability includes a negative impact of about 50 basis points from the timing change of our annual stock option grant. We also had higher incentive compensation expense in the quarter. While we had some spend towards our strategic investments including a $2 million in R&D, we expect the pace of spend on these initiatives will be greater in the coming quarters. All these expense pressures were more than offset by sales leverage. We had a $9 million swing in our other income and expense lines as expense this year is up about 1 million compared to income last year of 8 million. The prior year included the gain from Northern Technical settlement of 7 million which is a primary driver of the year over year change. Our first quarter tax rate increase to 28.1% reflecting a negative impact from the mix of earnings that was partially offset by a benefit from the county change for stock option expenses. First quarter capital expenditures were $20 million which included investments in capacity expansion and our new e-commerce platform. Both receivables and inventory increased from the last year primarily driven by the strong top line performance. Specific to inventory, we are also making incremental investments to maintain future service levels. We feel that approach is appropriate and creates a competitive advantage as demand spite. Finally, we return $66 million to shareholder last quarter through dividends and share repurchase. Of that amount, $43 million was use to buyback, 0.7% of our outstanding shares. Turning now to our fiscal 2018 outlook, we expect to deliver a higher level sales, operating profit and earnings than prior guidance. We are forecasting full year sales increase between 10% and 14% including a 3% benefit from from currency and 1% from acquisitions. At the midpoint, we added about $150 million to our FY 2018 projection. Favorable FX rates makes up more than a third of the increase with the balance coming from improving market conditions primarily in Engine. Engine segment sales are now expect to increase between 13% and 17%, up 7% from prior guidance and driven by increases in all four business units. First-fit sales are benefiting from higher levels of equipment production across all our key geographies and end markets construction, ag, mining and transportation. In terms of the industry equipment production, we estimate the strongest overall growth will come from Latin America as all end markets gain momentum. The strength in Asia-Pacific and Europe will be more specific to Off-Road equipment production while the U.S. will be led by heavy truck production. Based on our market projections, we now expect sales in both our Off-Road and On-Road first-fit businesses to increase in the mid teens in last year which is above our forecast for their respective markets. We also see additional momentum within Aftermarket so that we now expect a full year sales increase in the mid teens. The forecast includes the benefit of about 2% from Hy-Pro and Partmo, which is consistent with our previous estimates. Our Aerospace and Defense guidance also came up, we now expect a full year increase in the low single-digits, reflecting modestly stronger than expected sales in both commercial and defense businesses. Turning to the industrial segment, sales are forecast up between 4% and 8% with currency driving about two-thirds of the increase. Our IFS sales are expect to be up in the high single-digit to low double-digit range reflecting improving market conditions for first-fit systems and strong sales of replacement parts. We continue to forecast a GTS sales decline in the high single-digit range, reflecting a sharp decline in large turbine sales offset by growth of replacement parts. Finally, Special Application sales are expected to grow in the low single-digit range with the improvement coming as the decline in the disk drive market has temporarily moderated. Turning to operating margin, we raised our guidance 10 basis points to a full year rate between 14.1% and 14.5%. The midpoint of the range is now up 40 basis points from last year, reflecting strong incremental margin that is partially offset by a handful items. Let me start with those things that are consistent with what we’ve outlined in last quarter. First, we expect to spend an incremental $10 million to $15 million on strategic investments in technology development, capacity expansion and e-commerce. Second, we expect headways from steel and media cost will continue. We offset this pressure with pricing where we can, but we do expect a net headwind for the year. New to this quarter is our projection for incentive compensation. Based on our revised outlook, we now see a year-over-year headwind of a few million dollars from incentive compensation, a reversal from the modest tailwind we originally projected. I also want to point out that incremental margin is muted by the portion of our sales increase attributable to currency translation, our reach to support region production model provides a natural hedge by generally matching cost of revenue. Given that dynamic, we do not expect the incremental margin on the 3% benefit our top line will get this year from FX. Overall we are pleased with our ability to support our customers’ needs effectively managing spends and invest back into our company. Turning to other financial measures, full year interest expense will be about 21 million. Other income is forecasted between 3 million and 7 million. And our tax rate will be 27.4% to 29.4%. This year’s capital expenditures are forecasted between 80 million and 100 million. And cash conversion will be 75% to 90%. Finally, we plan to repurchase about 2% of our outstanding shares. Altogether, we expect earnings between $1.90 and $2.04 per share compared to prior guidance of $1.79 to $1.93. The midpoint of our new range implies an increase from last year’s GAAP and adjusted EPS of 13.2% and 16.6% respectively. To help with modeling let me share a few points on our FY18 cadence for sales and profit. Sales are weighted towards the back half and the first half increase will be greater than the second as comps get tougher over the course of the year. In terms of operating margin, we expect year-over-year improvement in every quarter. Additionally, the pace of spend on our strategic investments was lower in the first quarter, still we expect a ramp up over the course of the year. Finally, please keep in mind that the option expense in the first quarter will be a year-over-year tailwind in the second quarter. Overall, we expect strong performance to continue throughout the year. We are focused on meeting our customers’ needs, getting our costs more in line with the unexpectedly strong demand, and investing for the future. I will now turn the call back to Tod for a brief update on several of these investments. Tod?

Thanks, Scott. We are on pace to deliver record revenue and EPS this year and we are excited about the investments we are making for future growth. As we outlined last quarter, there are three primary categories for the incremental investments on our agenda; first, capacity expansion; second, customer engagements through e-commerce; and third, technology investment. Capacity expansion this year includes both distribution and production. Our most notable distribution expansion is in Europe where the size of our largest facility will nearly be double. Production expansion is happening around the world and is largely driven by the need to support growth of our innovative PowerCore and liquid products. We expect the level of investment for these particular projects to peak in the next couple of quarters, but we are always evaluating capacity needs and we will continue to add as appropriate. Our e-commerce project is also underway, we began piloting with selective customers earlier this month and we're targeting a full roll out by fiscal year end. This new channel presents an exciting opportunity for us. We believe we can drive growth and operational efficiency by making it even easier to do business with Donaldson. Our site will offer enhance functionality, speed and convenience for our network of dealers and distributors and potential customers will find a new and efficient way to engage with us. We also increase our level of spend directed toward R&D this year, which accounts for about half of the $10 million to $15 million of strategic investments. A portion of this investment will be directed to further expanding our material science capabilities. We're focused on products that command above average growth margins and give us an opportunity to expand into new and adjacent markets. We’re also investing in connectivity solutions. Customers in both segments are increasingly interested in using connected equipment to drive more value for their customers or insure the quality of their products. We’re expanding the team and have already approached important customers with some of these innovative technologies. These technology investments are the first steps in our multi year journey to increase R&D spend by about 1% of sales. Each of these investments is targeted towards further strengthening our position as a leader in the global filtration market. I want to add that we're still a return driven company so we're taking a focused approach to our investment agenda. We're committed to delivering incremental sales and profit on increasing sales. I'm confident that this year's forecast supports that commitment. With our strong top line forecast and our operational discipline, we’re creating the capacity to make these investments while also growing our operating profit. Before closing, I want to thank our employees for doing an excellent job balancing the needs of our customers with the goal of positioning our company for the future. I sincerely appreciate their commitment to delivering on our financial and strategic targets this year. Now, I will turn the call back to Christa to open the lines for questions. Christa?

[Operator Instructions] Your first question comes from the line of Charley Brady from SunTrust Robinson Humphrey. Please go ahead. Your line is open.

Just looking at the margin on Engine kind on a year-over-year basis, what’s your expectation going forward? You continue to expect to see that number, that margin increase because you've got some higher expenses going into that or is that just kind all run to corporate? I guess I'm trying to get a sense of I would have thought that the internal margin as you went through the year as particular on the Industrial Products too, more so that can get better margin pick up on that. So what's driving that?

Hi, Charley, this is Scott. So, we would expect the Engine margin to increase. We're having volume we're able to leverage that. We do have some headwinds that we’re experiencing, raw material cost, our increase and we have to work to offset that to pricing but we can't immediately offset it all and we’re working to do that and we have some additional cost that we encore when demands by to satisfy customer deliveries, I mean when you pull all that together along with the mix of sales that we’re experiencing and I will increase although, I understand at a rate a little bit less than you would expect, but it will increase.

I guess just specifically on Industrial Products in the quarter that pre-tax margin was down year-on-year on higher sales. I guess, I’m really trying to understand that the driver of that in Q1?

Yes, the biggest piece of that is the Northern Technical segment that we incurred last year. So we had a gain of 7 million in the first quarter of last year, and in that number that when you look at last year’s number. So, you have to back that out, when comparing to this year’s number.

Your next question comes from the line of Brian Drab from William Blair. Please go ahead. Your line is open.

Scott, first thanks for this comment on the cadence for the year. Just wondered if you could maybe give us a little more detail or color on the second quarter and given the -- I think you made the comment that the start to the year kind of the seasonality that you saw from the fourth quarter, the first quarter was atypical. What should we expect about first quarter to second quarter because usually of course you have seasonally softest quarter on the Engine side in the second quarter?

Yes. So, there was a jump and we’ve been experiencing increasing revenues. So I guess that’s not unreasonable to see. We expect stronger sales in the second half of the year than in the first half. So that’s relatively consistent with our historical trends. So you’ll see a little bit of increase in the second half versus the first half. We do project revenues continue to grow albeit at a rate slightly lower as we move forward, especially in the second half as comps give a little more challenging based on the strong second half growth that we experience last year.

Okay. But for second quarter, would we be correct to model typical season decline in Engine, sequential decline? Because typically you’ve done a 25% your revenue in Engine in the first quarter and then 23% in the second quarter roughly speaking. Is that the kind of seasonality we should expect?

Yes. I think that’s reasonable.

And then Tod, just question for you and one of the last things that you mentioned there was the connectivity solutions rollout. Could you give us any better sense for what the latest is there in terms of what types of products and solutions we could expect from you guys?

Sure. If you look at the Engine business and contrast to what we’re doing on the industrial business, so really two different stories. On the Engine business, I’ll take that first connectivity is really an enabler to continuing to win at the OEs, because all of our OEs, OE based customers within their platform are looking to connect their devices for their end users. So ours is an enabler to continue to play. And you know that a few years ago, we did the acquisition of Filter Minder in Iowa to help us accelerate that and that working very nicely. So, that’s how we view the Engine piece of the business. On the industrial side though since we sell more direct to end user based product particularly for example in Torit that will be more providing the end user, the experience to run their machine more efficiently, for example. And that’s how we’re using connected devices within that type of an application, so two very different purposes within the two segments.

Okay. Thanks. And then I guess just one last question timely question, I don’t know if you have comments on. What you’re seeing in the proposed tax legislation? And what that overall effect would on your business? Thanks.

Yes. So, our tax team is anxiously awaiting any final laws that are adopted. I would say overall we feel we’re well position for the things that are being talked about -- almost all of our cash is outside of the U.S., so any sort of repatriation that will be a positive for us. And our reduction in corporate tax rate would certainly also be a positive for what we see. So, we feel like we’re well position and we -- I know the guys are studying everyday and we’re just kind of waiting for what the final revolution will be.

Your next question comes from Jim Giannakouros from Oppenheimer. Please go ahead. Your line is open.

So, we saw the market reads during the course according your initial outlooks in engines specifically. But I think that you had a bit more line of sight you always intentions or plans for build rates. Can you walk us through what you were seeing three months ago? And what ensued or what changed specifically over the last three months to increase your outlook going forward?

Sure, if you step back from our business, Jim, and you’re really look at the way this recovery is happen, we have always maintain that we would see in our Aftermarket businesses first, and so as driving the growth over the previous multiple quarters was really the success we’ve been having on our strategic initiatives with Aftermarket as well as then the vehicle utilization across all of the end markets really driving that. Now, what has -- what started to happen at the beginning of our nearly end of last fiscal year was you started to see the vehicle production rates to kick in, and now you’re starting to see that more substantially. You take a look for example across our Engine base business and you look at how we performed geographically, and you would see a very broad base business all across the world pickup, but with a little bit favorability where there is a larger OE presence. So for example Western Europe and the U.S., those businesses are going to be a higher percentage of gain or growth than those that are Aftermarket, and that’s the difference.

And in IFS you mentioned in your prepared remarks, project activity picking up or I guess order rates or I guess your pipeline of opportunities kind of as expected, but customers reevaluating the size of scope of the projects. Can you put any final point on that any end market that you’d call out there?

Yes. So, if you step back and look at it, it’s still a fairly elongated quote to order cycle, but we’re starting to see more quotes. So, the quote activity has picked up and therefore when you look at the quantity of the projects and the size of projects that are happening and it’s primarily U.S. driven. When you look at that, that brings up the overall average of projects, now the conversion rates still is slow, but we are very pleased with the roughly 6% growth that we’ve had in our IFS business within the quarter. And therefore we have increased that outlook for IFS which will the positivity within industrial.

And one last one on incrementals, I mean if you -- modeling the midpoint I think we’re still kind of at that 20%. And you’ve highlighted that you have variable cost that are weighing that down. You also have the raws, high raws. Can you put any numbers to that as far as which ones impacting more? Or can you size those two weights on your incremental? And when we should be thinking about those variable costs specifically that you do take on as you mentioned as demand spike? When does that normalize? When does that kind of roll off if it does?

Sure. So, may be two different angles to the question. The first one is overall if you go back to FY16, our adjusted operating margin was 13.2% and the midpoint of our current forecast is 14.3%. So that represents a 110 basis points improvement over that time. So, we feel pretty good about that. In terms of the specific things that we are experiencing now, as you remember last quarter we talked about the strategic investment that was 10 million to 15 million, and that’s approximately 40 to 60 basis points. So that would be the biggest impact that we would see this year. The second largest impact would be raw materials. And then the third would be incentive comp. So those are the three main drivers of that. And we still get increase to 10 basis points with this recent update to guidance and that represents a 40 basis points improvement over last year. So we are committed to growing our levels of profitability and increasing sales. And that’s what we are focused on everyday here.

I understand that. Just you’ve initiated guidance at about 20% incremental margin, you are still there. So I just figured something moved on in the quarter and I assumed with the 10 million to 15 million, not being locked in there that be the raws or the variable cost and to the extent that you can -- which one moved on you, that would be helpful just to understand the puts and take there?

Yes, I think you have it right. So raw material cost and incentive comp.

But I think, yes, in terms of movement incentives comps versus three months ago -- this is Brad. Incentive comp as Scott mentioned, I’d also underscore a comment he made about leverage on the sales coming from currency, guidance up about a 150 and about a third of that is coming from a spot where we don’t really have incremental, Jim.

Your next question comes from the line of Nathan Jones from Stifel. Please go ahead. Your line is open.

I am going to follow up on some of Jim's questions there. If we -- looking at the raw material impacts on incremental margins. So you talked about not being able to recoup raw material price increases, straight away. Can you may be talk us a little bit through, how long you expect that to take whether or not you expect to be able to recapture at all, the difference between the channels. I imaging your dependent channel is probably the easiest, on new OEs probably the most difficult. But just if you could give us a little more color on, how much, when, how, kind of, you go about recapturing as increased raw material costs?

Sure. This is Tod. So, I think you have it framed up correctly. So when you look at the OE portion of the business, we do have indexed pricing if you will with our largest customers based upon material indexes, and so that work is in place, where possible, where the contracts allow. We do have latitude as you suggested within the independent Aftermarket, which is roughly about 60% of our Aftermarket based business or on the Engine side about 40% of our Engine business, and where geographically possible that work is also in place. and then on the industrial side, the industrial side is really more of a project base business particularly in our IFS based business and so that really the coding activity of role forward that we. A lot of background noise so someone. So as that business continues to roll forward, we continue to look at the opportunities on a project by project basis to price appropriately.

Sorry about that background noise. I'm in the airport. Any ideas on maybe when we can expect that to start positively impacting the incremental margins or the overall margins?

Likely later this fiscal year, this work is really a lot of blocking and tackling this is really drawn out particularly as you deal with the OE portion of our business and then contractually if we take pricing actions, we're before that can become effective in many of the Aftermarket areas about a quarter away before that starts to hit. So it's really quietly long gated as an overall pricing cycle.

Okay, that helps. And then on incentive comp, are you now accruing at maximum levels for fiscal 2018? If things get better, and God forbid you have to raise guidance again, you're hitting better numbers there, is there a potential for a further ramp in incentive comp? Or have you got to the max levels at this point?

This is Scott, so we're not at max levels at this point, so if we have to raise guidance again then there would be an additional expense associated with higher levels of expected profitability in sales.

Your next question comes from the line of Laurence Alexander from Jefferies. Please go ahead. Your line is open.

Two quick questions, as you look at the way order trends have evolved. Can you tease out a little bit how it affects your thinking about the longer term prospects for your business? In terms of either, how much capacity you think you need to have in 2018, 2019? But also can you tease out what's your spend in a little bit more detail, what you're seeing in terms of the opportunity set in China, either to upgrade the technology or selling there or the way demand order trends are changing?

Let me take first portion of that and then I will circle back and talk a little bit about China. Relative to capacity across the Company, we do have projects in flights specifically addressing our Engine based business. Our capacity and the two sided the companies is very different. Our industrial based growth is a bit more modest, so plants that support that segment are have utilization runway ahead of them. On the Engine side, we have capacity expansion taking place to support all of this growth, and we continue to take a look at our overall model and we take a look at on a five year basis and have plans for further capacity expansion over the course of the next five years as we look at the potential Engine growth going forward. That is all inclusive of product manufacturing as well as distribution and as I pointed out within Europe we're nearly doubling our largest distribution facility. If I then roll over to China and take a look at our opportunities in China, we have very low share in China, low single digit share primarily within our Engine business as well as what would drive us there would be our IFS space business in China. So consequently what we're doing is, we're taking our technology and now winning at the national based China companies. We always have had a nice base in China of the multinational customers, but now we're winning at the national basis just simply because what they have is over capacity of vehicle production opportunities. And so they are looking to export which means they have to meet western-based standards which gives Donaldson Technology an opportunity for sales within those national Chinese corporation and we are winning on that basis. So we look as time goes forward that to support the growth to meet future investment all across Asia to build more manufacturing plants as we continue to properly execute or actually execute on that strategy in Asia.

And I guess just on the capacity question, I guess sort of what I was getting at is we have given how strong volumes were in this quarter, you have sketched in the last few quarters you plan to add capacity. Do you think you need to accelerate those plans or do a second round of capacity expansions above what you had initially planned, have the order trends changed enough to warrant that.

It's possible, we have current a project in flight to expand our air filtration capacity and we have also a very large project in flight to expand liquid based capacity right now and we are currently looking at when we will need the next manufacturing plant and what looked like was potentially more than a year away now is going to be measured in quarters.

Your next question comes from the line of Brian Sponheimer from Gabelli. Please go ahead your line is open.

Tod, I was wondering, do you have any metrics on the Gas Turbine business whether it be book to bill or anything else you can share about just project activity going forward.

When you look at a large turbine project what we really have is a smaller number of projects that we're even quoting, Brian. I think you see that within the GE for example press releases they are the largest turbine manufacturer in the world, you see that within Siemens. So everybody is calling that large turbine project outlook down and we're no different. So we really see that stretching out for some period of time; however, we do suggest that we have based upon our strategic change well over a year ago where we saw this difficult moment in large turbine projects coming therefore we changed our strategy to be more selective. We have fought through a lot of that downturn and therefore as a company we would suggest that this fiscal year that we're living now is will likely to bottom for our GTS business looking forward.

Okay. If I’m taking that a step further, if you see GE and Siemens is driving guiding that business down what gives you the confidence that is in fact the bottom?

Well, because what our exposure to large turban projects which is really driving their negative outlook has really been greatly reduced as a overall percentage of the business. It’s very low now. And so what’s driving our sales there are really be Aftermarket business as well as any what we would call smart, small turban base projects which are oil and gas related moving oil or gas up and down pipelines or that type of activity not power grid base projects. So, our exposure we’ve work through over the more than last year, we’ve work through minimizing that as a company. Therefore we have the confidence.

And what would be the signs first and Aftermarket side and then I guess from a project side that would potentially turn that business around?

Well, it’s going to be really the larger portion of what we’ll see when you see a big huge uptake if you will. It’s going to be driven again by the large turban projects. And so, when you see global GDP start to pop or you have energy base demands worldwide come on board and pressuring grid around the world will then large projects are going to pick up. And that will – that would then allow us spike, but until then we really stay focused on that short cycle portion of that particular business as we did within the overall company strategy when other businesses were in the difficult moment.

Your next question comes from the line of Richard Eastman from Robert W. Baird. Please go ahead. Your line is open.

Tod, could you maybe just want to circle back for a minute or two to the Engine Aftermarket business. I mean just a really nice as you alluded to kind of seasonal uptake. And when you reference that in your comments you kind of suggest the first fit business is still running well below quarterly revenue run-rate. But, if you look at the Aftermarket business and its well above anything you’ve been able to deliver in past history here. And then also maybe five points better seasonally from the fourth quarter to first quarter. Could you just kind of sift through that a little bit? Is the liquid Aftermarket sales driving some of that increase that abnormally high increase in the growth rate and Aftermarkets? Or is there a geography there where you feel like you really gain some traction?

It’s actually both. So, if I just deal with the liquid portion of it, Rich, you look at the wins that we had across our liquid based initiative it’s really about overall expanding our product portfolio which we continue to do as a strategic portion of that liquid base drop initiative and we’re doing that quite well. So, we’re really trying to bring all products available to all regions and then second step is really strengthening distribution in a particular geography. The third step is acquisition were possible. And if you look at the acquisition piece for example we made the acquisition in Columbia and so you’d see all three pieces of that portion of the strategy being enacted in Latin America. And therefore our Latin America sales are up year-over-year quite nicely well into the double-digits. So you have a little bit of geography based upon the acquisition piece but you really have more broadly every region is up just simply because I think we are executing quite well. And the end markets have recovered a bit.

I want to add here to list though. PowerCore did really well in the quarter again. PowerCore has been up every quarter for literally years, really strong growth rate. So it’s not just a liquid or geography story. I mean it really is broad-based within Aftermarket based on what we’ve done for a long time to win those programs.

And just kind of final thought on the Aftermarket. Is the liquid component there -- I am just trying to circle back the liquid component into the Aftermarket. Have you gotten better traction on the Aftermarket side with liquid than you have on the first-fit side? I know we’ve talked about some wins in first-fit. Have those started to kick in as well in liquids specifically?

Yes, so we’ve been really in Aftermarket in liquid much longer than on the OE side. And so consequently we had momentum within the Aftermarket to support liquid. And so that’s been the addition throughout the customer base where we’ve always enjoyed a strong air position, now we are really gaining momentum on the liquid position as well.

And then just two quick questions on the industrial side, you gave a pretty clean picture on the Gas Turbine side. But for the second quarter Gas Turbine sales, do they match the first quarter? I mean I am just trying to look for a little bit of cadence here with Gas Turbine sales or would they be expected to be down meaningfully from first quarter to second quarter?

Rick this is Brad. Gas turbine sales we’re actually -- we’re projecting them to be up in second quarter given the very, very low level from one year ago. So when you are looking at quarterly year-over-year change as second quarter is the anomaly in our FY18 forecast. Third and fourth quarters are both expected to be down again.

So up in the second quarter year-over-year, sequentially still somewhat down from the 26 million, just to get that? At least have a pretty good beat on that yes.

Sequentially it will be up. We expect it to be up from first to fourth.

And then just Tod a just a quick question. Now that you’ve broken out Latin America, I am a little bit curious and I am sure this is a small number, but it’s a big percent of change. In specialty apps, Latin America was up like 28%. But I am curious that’s unlikely to be disk drive business. What is that? What are you guys selling in the Latin America on the special app side?

First of all, it’s very, very small. It’s less than 1% of the Company. And then second, it really starts with our LifeTec filters. So that we’ve talked enough for -- at least we had some sales down there, integrating venting and what we call our stretch membrane based business. All three of those have sales within what we call Special Applications in Latin America.

But no dark horse to come on strong there with material side of the business or anything like that?

I want to emphasize it’s a large percentage but a very small number.

Your next question comes from the line of George Godfrey from CL King. Please go ahead. Your line is open.

Tod, I just want to talk about the $10 million to $15 million in incremental spend for capacity expansion. If I look at that as a percentage of CapEx and apply that same percentage of the mid points and everything went right, that’s about 14% greater looking at the revenue projection for this year. Would that translate into your, you're thinking about a $350 million from a revenue basis on the up building to expand your capacity, not making any predictions on revenue, but just trying to get an idea of how much more runway you could do with that expansion?

So, it's very different between an air expansion and a liquid expansion. So, it mix plays a significant role in any number we would try to draw throughout there and then also obviously the level of expansion. So within air we’ve multiple expansions throughout the world and adding multiple airlines, and so it's not as if you have one manufacturing plant today and Donaldson that you can point to and say we're duplicating that. So consequently what we look to be adding is roughly between a 100 million and 200 million of air capability, but then when you, then rotate over to the liquid expansion that we’re currently doing that is going to be a bit of a slower ramp up based upon the learning curve of where some of that expansion will take place. So that again a typical plant can do between a 100 million and 150 million we have one that can do more than that. So roughly, if you use smash all that together somewhere between 200 million to 300 million is likely within that capacity expansion.

Thank you very much for that and then my follow-up. I realized the semi market is not an area you plan in, you like dirty environment, lots of earth moving components. I'm just curious anecdotally if any of your customers have made any comments about Tesla's introduction of an electric semi?

No, no conversations along those lines.

And we have no further questions in the queue at this time. Tod Carpenter, I will turn the call over to you.

That concludes today's call. I just want to thank all of you for taking your time and for your interest in our company. Have a great day. Goodbye.