Donaldson Company, Inc. (DCI) Q1 2022 Earnings Report, Transcript and Summary

00:02 Good morning. My name is Chris, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Donaldson First Quarter twenty twenty two 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] 00:31 Now I'll turn the call over to Sarika Dhadwal, Donaldson's Director of Investor Relations.

00:38 Good morning. Thank you for joining Donaldson's first quarter of fiscal twenty twenty two earnings conference call. With me today are Tod Carpenter, Chairman, CEO and President; and Scott Robinson, Chief Financial Officer. This morning, Tod and Scott will provide a summary of our first quarter performance and details on our outlook for the balance of fiscal twenty twenty two. 01:01 During today's call, we will reference non-GAAP metrics. A reconciliation of GAAP to non-GAAP metrics is provided within the schedules attached to this morning's press release. Additionally, please keep in mind that any forward-looking statements made during this call are subject to risks and uncertainties, which are described in our press release and SEC filings. 01:22 With that, I'll turn the call over to Tod Carpenter.

01:25 Good morning, everyone. I’m pleased to report record first quarter results. We grew our sales to seven hundred and sixty one million dollars, sales were up twenty percent and EPS was up twenty six percent versus last year. It was an encouraging quarter for Donaldson, particularly given the backdrop of well documented supply chain disruptions, labor shortages, and significant cost inflation. 01:54 In the face of these challenges, our team rose to the occasion and delivered, and I’m proud of what we accomplished. As we look to the remainder of the year, we expect the macro headwinds to persist. While we are well-positioned to deal with these challenges, there is no doubt that we will feel near-term impacts. 02:18 To address these macro challenges, we are pulling many levers, including raising prices to mitigate the impact of cost increases, utilizing our geographically-diverse manufacturing and distribution footprint to meet the needs of our global customers and to mitigate labor-constraint issues, particularly in the U.S. and aggressively recruiting and competing for talent to expand our strong team of dedicated employees. 02:46 As we navigate the year, we are also investing for future organic and inorganic growth. We continue to spend on our R&D to ensure we remain the leader in what we do best, technology-led filtration. I'm also pleased to have two new acquisitions under our belt. First, we recently announced the acquisition of Solaris Biotech. Solaris is a designer and manufacturer of bioprocessing and filtration equipment used in food and beverage, biotechnology and other life sciences markets. 03:22 We've been working hard to expand our reach in the life sciences, and this acquisition is the first step in our string of pearls strategy to get there. We can now leverage Solaris' technology and customer relationships to advance our capabilities in this space. I’m confident in our ability to scale the Solaris business with our commercial capabilities and strong balance sheet. 03:46 Our second recent acquisition was that of P-A Industrial Services. We closed this transaction on November one with a purchase price of four million dollars. While the company only generates a little under four million dollars in revenue today, this acquisition allows us to support our Industrial segment with the addition of a services business. Donaldson and P-A Industrial share the vision of delivering superior service along with great products to help our customers' operations run better. 04:19 We believe we are heading into the balance of the year from a position of strength. And we feel good about our ability to navigate the near-term challenges, while still building our business for the future. With that said, we are raising our top and bottom-line guidance for fiscal twenty twenty two based on a few factors; first quarter results, higher sales expectations driven in part by incremental pricing and operating expense leverage. We will share more details about our fiscal twenty twenty two outlook later in the call. So, I'll now provide some context on our first quarter sales. 4:58 Total sales were seven hundred and sixty one million dollars, which is up twenty percent from last year, due in part to last year's softness related to the pandemic. In Engine, total sales were five hundred and twenty seven million dollars, up twenty one percent with our first-fit businesses leading the charge once again. 05:21 Sales in Off-Road were ninety four million dollars, up forty five percent. Nearly half of the first quarter growth was driven by Exhaust and Emissions, reflecting a production ramp up related to new emission standards in Europe. As we've talked about before, the strength in this business does create mix pressure on margin. 05:41 Beyond Exhaust and Emissions, first quarter sales in Off-Road also benefited from increased levels of equipment production across end markets and geographies. The exception was in the Asia-Pacific region where we compared against the sales increase of nearly forty percent in the prior year. 06:00 In On-Road, first quarter sales were thirty two million dollars or down one point five percent year-over-year. North America had the biggest decline, reflecting the discontinuation of some directed-buy equipment to a large OEM customer. Importantly, excluding this impact, total On-Road sales would have been up about twelve percent globally and up seven percent in North America. 06:29 As we look forward, we believe On-Road will be under additional pressure for the remainder of the year as many customers continue to struggle with supply chain issues, including the persistent chip shortage. In Engine Aftermarket, sales in the first quarter were three hundred and seventy four million dollars, an increase of eighteen percent from the prior year. 06:51 Aftermarket sales were up in all geographies and both channels. Independent channel sales grew in the mid-teens and OE channel sales were up in the low twenties. Our innovative proprietary products are always a big piece of the Aftermarket story. These products accounted for about thirty percent of total Aftermarket sales and grew about twenty percent year-over-year. 07:17 Our independent channel is benefiting from continued strength in less mature markets. Brazil, Russia and South Africa put up impressive growth rates in the first quarter and we are excited about our prospects in these geographies. 07:34 In the OE channel of Aftermarket, proprietary products are again contributing to our growth. In the first quarter, sales of these products were up in the mid twenty percent range and they now account for nearly forty percent of our Aftermarket OE channel sales. Included in these figures is PowerCore, which achieved another quarterly record for Aftermarket sales and increased more than eighteen percent. 08:04 Moving to Aerospace and Defense, first quarter sales of twenty eight million dollars were up twenty three percent year-over-year as the commercial aerospace industry rebounds from the pandemic related pressure a year ago. Activity remains below pre-COVID levels in Aerospace, so there should be more growth to come as the industry continues to recover. 08:27 Lastly on Engine, I will quickly talk about China. Engine sales were down about six percent in the quarter. However, this is against a forty percent increase last year. The increase last year reflects a faster rebound in China from the pandemic than we saw in other parts of the world. 08:46 Overall, we remain pleased with our progress in the region. We are winning new business with local Chinese manufacturers. And over time, we continue to expand our share in this massive market. 09:00 Now on to Industrial. The Industrial segment had another solid quarter with total sales increasing seventeen percent to two hundred and thirty four million dollars. Sales of Industrial Filtration Solutions or IFS, grew twenty two precent to one hundred and sixty six million dollars with two-thirds of the increase coming from industrial dust collection. 09:23 We had strong sales growth of new equipment and replacement parts, which reflects more investment and industrial capacity utilization. Process Filtration sales also contributed to first quarter growth in IFS. Process Filtration sales, which serve the food and beverage market, grew over thirty percent due to growth in new equipment and replacement parts in Europe. 09:49 First quarter sales of Special Applications were fifty two million dollars, up 23% with strong contributions across our product portfolio, including notable increases in our disk drive and membranes businesses. Also within Special Applications, first quarter sales of venting products grew nineteen percent. 10:10 We continue to build share in strategic markets, including high-tech vents for batteries and powertrains in the auto industry and expect venting solutions to contribute to our growth for years to come. First quarter sales of Gas Turbine Systems or GTS were approximately seventeen million dollars, down twenty eight percent to almost entirely to timing of orders. 10:33 Our outlook for the year has not changed and we expect to make up first quarter revenue shortfalls in the second quarter. Overall, we are off to a strong start for fiscal twenty twenty two and I feel confident about our ability to successfully navigate this uncertain and volatile environment. 10:53 With that, I will turn it over to Scott for more details on our financials. Scott?

11:00 Thanks, Tod. Good morning, everyone. To sum up the first quarter, our employees did an excellent job delivering solid results in a tough environment. First quarter sales grew twenty percent, operating income was up twenty three percent and EPS of zero point sixty one dollars was twenty six percent above the prior year. 11:21 First quarter operating margin increased forty basis points to fourteen point one percent. The increase was from leverage on higher sales, which was partially offset by gross margin pressure. Driving into gross margin a bit further, the impact of raw material cost inflation built through the quarter. This impact was compounded by the fact that we were experiencing a deflationary environment one year ago. 11:45 As we look at the remainder of the year, we will be impacted by ongoing inflationary headwinds. We will continue to build on the success we have had implementing price increases in several of our businesses to offset the cost pressure. That said, the full impact of the pricing benefits may take longer to materialize due to certain large OEM customers. We are in ongoing discussions with these customers, and we'll continue to drive towards offsetting the incremental costs we are currently absorbing. 12:14 On the operating expense front, we are pleased with our discipline and success in optimizing our levels of spend. We continue to invest in our Advance and Accelerate portfolio. This spend was offset by controlled expense management elsewhere in the organization. First quarter operating expense as a percent of sales was favorable by approximately one hundred sixty basis points, driven primarily by volume leverage. Other expense was favorable this quarter by one point five million dollars, mostly due to a pension curtailment charge we took in the first quarter of last year. 12:51 Turning to the balance sheet and cash flow statements, I'd like to highlight a few things. Our first quarter cash conversion ratio was thirty two percent, down meaningfully from last year, driven primarily by investments in inventory to further support our increasing demand. Inventory this quarter were up sixty million dollars sequentially and one hundred and fifteen million dollars year-over-year, mainly due to the impact of inflation, a commitment we made to increased levels of inventory to ensure we're adequately prepared to meet demand and supply chain challenges we have had internally with our customers on order deliveries. 13:31 As a result, working capital was seventy one million dollars, net use of cash this quarter versus a thirty three million dollars benefit last year. First quarter capital expenditures were eighteen million dollars, as we invested in various projects, including PowerCore capacity expansion in North America. 13:49 This quarter, we continued with our track record of returning cash to shareholders. We repurchased one point three percent of our outstanding shares for one hundred and three million dollars and we paid dividends of twenty seven million dollars. 14:02 Our strong balance sheet and financial flexibility has been an important asset, while operating in this challenging supply environment. We ended the quarter with a net debt to EBITDA ratio of zero point seven times. 14:15 Now I'd like to walk through our fiscal twenty twenty two outlook. First on sales. We are now expecting fiscal twenty twenty two sales to be up between eight percent and twelve percent with the nominal impact from currency translation. This increase from our previous guidance of five percent to ten percent is driven by Q1 results as well as benefits from additional pricing actions that will be implemented and rolling over the balance of the year. 14:43 We continue to expect a greater sales year-over-year increase in the first half versus the second, driven in large part by prior year comparisons. From a segment perspective, we've increased our full year sales expectations for both Engine and Industrial. 14:59 For the Engine segment, we expect the revenue increase between eight percent and twelve percent, up from our previous expectation of between five percent to ten percent. Within Engine, sales of our first-fit businesses are forecasted to be mixed. Off-Road sales are expected to grow in the high-teens versus last year due to increased levels of equipment production and the continued success of new program wins in our Exhaust and Emissions business. The Off-Road forecast is up slightly from the low-double digit growth we've previously projected. 15:33 In On-Road, we are seeing a slowdown in demand from some of our customers as they grapple with their own supply chain issues. Based on first quarter results and our current order trends, we now expect On-Road sales to be down low-single digits versus our previous guide of up low-single digits. 15:52 For Engine Aftermarket, we are increasing our expectations slightly to high-single digit growth from our previous guidance of mid-single digit growth. Equipment utilization remained strong and we are continuing to gain share with proprietary products. 16:06 Our outlook for Aerospace and Defense has not changed. We are still forecasting low-double digit growth for the year, due in large part to comping against the COVID-related market weakness in fiscal twenty twenty one. 16:20 Now on to the Industrial segment. We expect sales to be up between seven percent and eleven percent, which brings up the bottom end of our previous guidance range of six percent to eleven percent by a point. 16:32 Sales of Industrial Filtration Solutions are planned up in the low-double digit range consistent with the guidance we gave last quarter. Improved sales of new equipment and replacement parts, particularly dust collection as well as strength in process filtration will continue to be the drivers. 16:49 In terms of IFS, I would just like to mention that while revenue related to our recent acquisition of Solaris Biotech will follow in the segment, we do not expect a material impact this fiscal year. Solaris bookings for this calendar year are expected to be approximately eleven million euros. And revenue related to those bookings should flow through over the next several quarters. 17:13 Moving to GTS, we continue to expect fiscal twenty twenty two sales up high-single digits. As Tod noted in his remarks, the first quarter sales decrease was a result of timing and we do expect to recover those sales. Special Applications revenue is forecasted to be up low-single digits versus our initial guidance of down low-single digits, reflecting stronger than expected growth across the portfolio in the first quarter. 17:40 Now let's move to operating margin. We maintained our expectation for a full year rate between fourteen point one percent and fourteen point seven percent. As a reminder, last year's adjusted operating margin was fourteen point zero percent. Expense leverage will be the primary driver of the year-over-year benefit. 18:03 On gross margin, given what we saw in the first quarter and the trends we are seeing in raw material, freight and labor crisis, we believe the inflation headwind will be more significant than we originally planned. We expect to offset the higher costs with pricing over time. However, the net impact on gross margin will be greater than anticipated. And we now expect gross margin to be down fifty basis points to one hundred basis points from the prior year. 18:31 To expand further on this point, last quarter we said we expected to pay eight percent to ten percent more for our raw materials this year, which equated to about three hundred basis points. That estimate is now twelve percent to fourteen percent or a little shy of four hundred basis points. 18:49 Additionally, freight and labor costs have now become a more significant headwind than we anticipated, which results in additional one hundred basis points of gross margin pressure. So as a result of these dynamics and our typical seasonality, we should see operating margin improve in the second half of the year versus the first half. 19:11 Based on our updated forecast, we plan for a new EPS record of between two point fifty seven dollars and two point seventy three dollars, implying an increase from last year's adjusted EPS of eleven percent to eighteen percent. 19:11 Just briefly on the balance sheet and cash flow outlook. In terms of capital expenditures, we are lowering our planned spend for this year to a range of between ninety million dollars and one hundred and ten million dollars. So essentially, a ten million dollars reduction to the range we provided in September of one hundred million dollars to one hundred and twenty million dollars. 19:45 The macro headwinds we've been talking about this quarter are impacting almost every part of our business. Given supply chain uncertainty and other variables, the timing of execution on some of our capacity expansion projects could be slowed. So we felt it prudent to bring the range down in line with current expectations. 20:03 In terms of free cash flow, increased inventory levels, partially offset by the lower CapEx, result in a reduction to our free cash flow conversion forecast to between seventy percent and eighty percent, down from our initial guidance of eighty percent to ninety percent. On share repurchases, we still plan to repurchase about two percent of our outstanding shares this fiscal year. 20:27 In summary, I’m pleased with our first quarter results. I am also confident our business model is equipped to manage the uncertain times ahead. While the results of our more recent pricing actions will take a bit of time to flow through our financials, we are taking the right steps to protect our margins and deliver record level of sales and profit this fiscal year. We are also committed to managing the business for long-term, and we'll continue to make thoughtful investments for future growth. 20:58 I'll now turn the call back to Tod.

21:00 Thanks, Scott. As we look to the rest of the fiscal year and beyond, I would like to touch on a few key paths we are pursuing to build on our success and push the company forward to the next stage of its evolution through profitable growth. 21:17 First, we are continuing to invest in our existing Advance and Accelerate solutions, including Process Filtration, dust collection and replacement parts and Engine Aftermarket. Second, we are diversifying the company's offerings, both organically and inorganically to ensure we meet the needs of our existing and future customers globally. 21:39 On the organic side, we are committed to our R&D. We previously invested fifteen million dollars for our materials research center, which will enable further development of our polymer-based chemistry solutions. It is also important to note, we increased our R&D budget this fiscal year by ten percent over last year. 22:01 On inorganic diversification, the recent acquisitions of Solaris and P-A Industrial Services are just the beginning. Solaris is the first inorganic step on our journey to create a life sciences business. We are excited about the value we can add through our global market reach, science and technology, filtration capabilities and our ability to invest for future growth. This, combined with Solaris' market reputation and product portfolio are a winning combination. 22:35 Third, we are investing in our people and recruiting the right talent to drive the company forward. We have made people investments in areas such as life sciences, food and beverage, and ESG. Donaldson employees with their dedication and hard work are the core of our business. 22:53 Before we close, I also want to touch on our ESG efforts as this is an important part of our culture. We began global implementation of our environmental health and safety policies in twenty eighteen. Safety and greenhouse gas emission reductions are near-term priorities and we're making progress. 23:16 We are well on our way of reducing CO2 emissions by six thousand metric tons by the end of fiscal twenty twenty two. Our company is geographically and culturally diverse. We have strong governance, including a seasoned board with balanced tenure. Also critically important is the alignment of the compensation of our board and management with shareholder interest. So, as I look out over the long-term, I strongly believe we have the right strategy in place to continue delivering value to our stakeholders for years to come. 23:54 Now I'll turn the call back to the operator to open the line for questions.

23:59 Thank you. [Operator Instructions] Our first question is from Brian Drab with William Blair. Your line is open.

24:12 Hi. Good morning. Thanks for taking my questions.

24:14 Good morning, Brian.

24:15 Good morning. First, can you -- and I may have missed this. But can you talk about the big step up in the operating margin in Industrial versus what you saw in Engine and just the difference in the end markets and raw material situation that you're seeing in those two segments?

24:40 Yeah. Hi. This is Scott. Hi, Brian. Nice to talk to you. So, our Industrial products operating margin last year was thirteen point seven percent and this year it was sixteen point four percent. So first of all, keep in mind, we're coming off of COVID comps with tough volumes and then weaker leverage. So, we're pleased with the performance of our Industrial business. 25:06 We're investing in higher margin opportunities that are driving the mix up and they're doing an excellent job of leveraging the new volumes that they're experiencing, especially as compared to last year when we were kind of under the COVID bug a bit. Engine margins were down twenty basis points from thirteen point nine to thirteen point seven. And that's a result of the inflationary pressures we're seeing and the pricing actions we're executing and our pricing actions are behind our cost increases. 25:44 And that's one of the reasons we brought our margin guidance down for the year because we're assessing our inflation and our pricing and trying to determine the ultimate impact of both of those two. So, we're pleased with our margin performance this year. Overall, we're committed to higher levels of profitability on higher sales. We did fourteen point zero total last year. This year we have a guide of fourteen point one to fourteen point seven. So, at the midpoint, that's fourteen point four or forty basis points of improvement this year, which I think would be a good accomplishment for the company and something I think we can deliver.

26:22 Yeah, Brian. This is Tod. Maybe just one point to add. So as Scott referred to and as we have referred to in prior calls, our ability to mix up on the Industrial side with our strategic execution is really what you're seeing sum up, but also, as we've talked about multiple times about our pricing model in Industrial and the fact that we can take quicker action in Industrial rather than against some of the other backdrops and headwinds that we feel on the Engine-based OE side. So, Industrial, it does reflect some positive pricing actions as well.

27:00 Got it. And in IFS, you have this momentum in food and beverage, is that higher margin business…

27:10 Yes, entire company average.

27:13 Okay. And can you say maybe give us a rough idea of what percentage now does process filtration account for within IFS?

27:22 Yeah. I believe we said in the past, it’s roughly between eighty million dollars and ninety million dollars So we've grown it rather nicely and we continue to have good momentum.

27:36 Okay. And then last one just on this topic, are there specific applications I guess particularly in Europe and that you're winning and are there some big share gain opportunities potentially in those applications as you look globally or even with other customers in Europe?

27:57 Yeah. So, we're pretty broad-based with the wins that we have. It's heavily replacement parts related at the moment with the acquisition of Soliris though it brings us the opportunity to do more food and beverage type project-based work as well, because they have the applications expertise and we have the sales teams to be able to combine those strengths. And so, we would look to grow our food and beverage business based upon a combination of those two into a broadening product portfolio, if you will.

28:36 Got it. Okay. Thank you very much.

28:39 Thanks, Brian.

28:41 Our next question is from Dillon Cumming with Morgan Stanley. Your line is open.

28:47 Great. Good morning, guys. Thanks for the question.

28:51 Good morning, Dillon.

28:51 Good morning. Wondering [indiscernible] I think it was Soliris for a second, I mean, obviously, I know a huge transaction from a revenue perspective, but it does seem like the technology and kind of market advantages were a big focus of the deal. So, I guess just to what extent do you feel like some of the value proposition there was just being able to leverage any kind of technology advantages that they had within kind of the larger Donaldson platforms as you kind of go after these new customers and new end markets.

29:14 Sure. A couple of things that they bring to Donaldson Company from a product standpoint of view. So, they manufactured bioreactors. So, if you don't know a bioreactor essentially is a piece of equipment that allows you to grow sales or tissues in R&D or manufacturing a buyer -- biopharmaceutical type applications, but also food and food additives. And so, when you get into that overlap with our sales force, where we're have growing momentum within the food and beverage activity, it allows us now to really take our sales team combined with their applications and equipment experience and look to drive into that type of the food and beverage type business as well. 29:55 But it also brings a foundational filtration capability called tangential flow filtration within biopharmaceutical and within that whole business process. It's a filtration capability that Donaldson currently does not have. We have overall polymer chemistry-based membranes that we could use, but this is a specific type of application in biopharmaceutical that allows us now to really step a little deeper into that medical space with the application of that technology and we'll look to do that.

30:36 Okay. Yeah. That's very interesting. Maybe switching over to the guidance for a second. I mean, given the level of top line out performance this quarter, it just seems like that might have supported a bit of a higher increase I guess, in terms of the revenue outlook versus where you revised guidance too. I mean, are you able to say are you kind of baking in any kind of cautions regardless the supply chain backdrop still. I guess, do you feel like you might have visibility into kind of a sharper growth acceleration in the back half of the year. I'm just kind of underwriting that view.

31:01 Yeah. I mean, we talked about this last quarter and we're trying to take a prudent view towards the overall supply chain difficulties that we face and trying to balance that with our revenue forecast. So, we were able to do a bit better in the first quarter, but our costs are also up. So, we have to factor in that we have to raise prices a bit more than we originally planned and that also drives revenues up. So, it could always be higher. We try to take a reasonable approach. We were at a midpoint of seven point five and now we're at a midpoint of ten. We think that's a reasonable place for the company based on where we sit right now.

31:50 Okay. That’s helpful color, Scott. Thanks. And then maybe just one last one for me. Todd, I think you mentioned the kind of figure out the venting business for batteries and power trends in the auto industry. I'm not sure those meant to be a comment around battery electric powertrains or kind of legacy IC out of those, I was curious if -- just kind of provide some more color there? If it was the comment around battery electric, I guess I'd also be curious you kind of apply similar technology and batteries from the of highway space as well?

32:16 Sure. It's really meant to be a statement about our technology and our opportunity for growth that where we feel like we have a very strong technological leadership position within that space that we have brought over from frankly our disk drive-based technologies as well as other foundational technologies invented in our corporate technology group. And we often look to spread those across the technology that we invent spread those across multiple business units and in this case, integrated venting solutions is clearly the winner there. And so, we're looking to press harder to the automotive opportunity because we frankly can and we see a lot of the battery based automotive space, really given us double-digit and about company average growth and you'll see that we'll expand that business and we'll continue to invest strongly in that business to be able to get that to at least between three percent and four percent of our overall company revenue.

33:17 Okay. Great. Thanks for the time, guys.

33:21 Our next question is from Robert Mason with Baird. Your line is open.

33:26 Yes. Good morning and thanks for the question as well. I wanted to go just a little bit deeper on, I guess the first quarter, you did outperform your typical seasonality in the quarter and deliver more revenue. Todd, I just want to see if you could comment just on how the incoming order rate look where your backlog ended up at the end of the quarter versus year end? And just your thoughts on where maybe channel inventories are at this stage as well?

33:56 Sure. Incoming order activity remains very strong across the corporation. It's obviously led by the United States across all Industrial and Engine-based businesses all in markets, so very strong in the U.S. I would say it's strong in Latin America, same across both segments. I would say it's strong in Europe across both segments all end markets. Asia-Pacific, I would say it's good across Asia Pacific, but a little bit more trouble than China. So, China is the only weak spot in both Engine and Industrial, we have seen a bit of a bit of a pullback there. We baked all of that within the guide. 34:37 Our backlog remains very high. Our delinquency rate to our customers remained at an uncomfortable position and non-Donaldson like position that we continue to work very hard to improve and even as we see this higher order level come in our backlogs are at -- our higher ship levels, our backlogs have not gone down. We do see the typical seasonality that you see in the December timeframe. So, nothing out of the ordinary, nothing suggesting that it's falling down out there.

35:21 And so it's fair to infer that your customers really are not restocking. This is almost hand to mouth type deliveries.

35:30 Yeah. On the inventory restocking question, the supply chains are really causing a more troubled ability for our customers to be able to accomplish restocking. And so consequently, at these high levels, it's still all pull through and so we've not seen on the independent or the OE channels, the ability of our customers to be able to build that inventory up.

35:59 Yes. Just as a follow-up, I wanted to see if you could provide any color on how the gross margin curve may look as we go through the balance of the year. So, the extent you expected to be down fifty basis points to one hundred basis points. For the full year, are you comfortable saying that the second quarter could be a trough in the gross margin? Do we – we go lower and then come back up with some better pricing, better volume leverage in the second half of the year?

36:32 Yeah. So, we maybe – just at a high level, right, if you think about our prior guidance to our current guidance, so we essentially said at the end of the last quarter, we thought we had three hundred basis points of headwind. And if you go through my comments on the script, we now forecast that to be five hundred basis points of headwind. And that's one of the reasons that -- that's the main reason we took the overall margin guidance from flat to slightly down to down fifty to one hundred. So, you can see, we have additional two hundred basis points of headwind and we won't be able to offset that one hundred percent this fiscal year. We do think over the longer term, we will balance out the price versus cost. And we have to work through that with our customers. But the hardest quarter with the new headwind that we're seeing is the first quarter -- is the next quarter, right, so obviously, as the raising prices we're chasing the cost going up. 37:36 So our next quarter will be the heaviest headwind quarter. So, I think your thinking is correct. The biggest challenge will be the next quarter, and then as pricing layers in from what we've done last year and through this quarter and into next quarter, that will help offset the price increases that we're facing.

37:56 How much within the fifty basis points to one hundred basis points down for the year? How much -- we've seen inflation continue up since you’ve guided in September. How much additional inflation is built into that from where we stand today?

38:14 Yeah. So well, I mean, we originally projected the cost we were paying for materials, for example to be up eight to ten and we now project that to be up twelve percent to fourteen. And so that's the additional headwind that we're facing. In addition, we've added one hundred basis points of headwind forfeit rate and labor costs. So that's the kind of the cost increases that we're experiencing and why we have to continue to raise prices to offset those headwinds.

38:46 And that -- but that is, Scott that assumes some the curve continues upward from current spot rates at the high level of those increases?

38:57 Yeah. There is some additional increases expected. I mean, our procurement job does an excellent job of assessing all the indexes where we're purchasing and trying to forecast that forward and manage the price increases the best we can. So, it's a combination of current prices and expected future prices.

39:18 Very good. Thanks for the questions.

39:22 Thank you, Rob.

39:24 Our next question is from Laurence Alexander with Jefferies. Your line is open.

39:29 Hey, guys. It's Dan Rizzo on for Laurence. Thank you for taking my question. If we look past to twenty twenty two, you mentioned a holy hiring inventory to kind of meet customer needs. And I don't know, if this has been asked before but I was just wondering if this is kind of changing the way you think longer term with the amount of inventory that needs to be held. given the logistical smallest [indiscernible] we're seeing around the world.

39:51 Yes. It's a great question. As we spoke about during the last couple of quarters, we're going to use the strength of our balance sheet and really take our inventory up so that we can look to take care of our customers in the best possible fashion during all of these uncertain times. You see that clearly within our inventory actions but we do think that this is more of a finding a new normal and after we get to the new normal, we'll get back to more properly managed inventory levels that we would expect the company to need in order to be able to meet our customer delivery expectation percentages. 40:33 So we think this is likely not the new model going forward. In other words, we're not going to drive our overall inventory turns down to very low-single digits just to hold on. That doesn't make sense. But in this moment of uncertainty, we're just using every strength that the company has make too sure our customers are taken care of.

40:59 That's very helpful. Then, with the price increases again, this is just more -- little more philosophical. Are we at the point where customers are kind of trying [indiscernible] so to speak where I mean you have to raise prices because cost is so high, but our customers starting to push back or is it their demand trends so much that it's just kind of accepted at this point we will be for the foreseeable future?

41:21 I think we've got the best type of an environment working cooperative environment relative to pricing that I've seen in my entire Donaldson career. I think people get it. They understand this is very unusual, everybody is trying to work hard leading each other in order to be able to get through it. Obviously, there is some back and forth with regards to it. But what's really important is you have to move quickly in order to wash out the old prices from your backlogs and get to the new situation if you will. I think the receptivity is really good. We've had a lot of success. We do have some severance out there, but we're working through that and we'll drive that to ground here in short order.

42:15 And then finally in your history or have you in the past given price concessions, some instant times, I guess, would it be a give back if things normalize?

42:24 Sure. On some of our longer-term contracts, particularly with the OEs, we have annual based price downs and so we'll start on that part of the model in the negative position on an annual basis. Right now, it's a bit different, obviously. But then also if inflation does abate and let's say they give all of this back down in the indexes for raw materials, truly do go down and stay down than, sure It's a matter of competitiveness. And so yes, we have done that in the past and we would look to do that. The stable type of environment that you referenced there though it's something we look forward to, let's say.

43:14 Okay. Thank you very much.

43:18 We have no further questions at this time. I'll turn the call back over to Mr. Carpenter for any closing remarks.

43:25 I want to wish everyone a happy and safe holiday season and I look forward to reporting our second quarter results in the new year. That concludes today's call. Goodbye.

43:37 Ladies and gentlemen, this concludes today's conference call. You may now disconnect. Thank you.