Donaldson Company Inc (DCI) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by.

Welcome to Donaldson's first quarter fiscal year 2012 conference call.

During today's presentation, all parties will be in a listen-only mode.

Following the presentation, the conference will be open for questions.

(Operator Instructions) This conference is being recorded today, Thursday, November 17, 2011.

I would now like to turn the conference over to Mr Rich Sheffer.

Please go ahead, sir.

Welcome, everyone, to Donaldson's fiscal 2012 first quarter earnings conference call and webcast.

Following this brief introduction, Bill Cook, our Chairman, President and CEO; and Jim Shaw, our Vice President and CFO, will review our record first quarter earnings and our updated outlook for fiscal '12.

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 would like to turn the call over to Bill Cook.

Bill?

Thanks, Rich, and good morning, everyone.

As you've probably already seen in the earnings release we issued earlier this morning, we are very pleased to report that we had a very good first quarter.

We set first quarter record for sales and all-time records for both operating margins and earnings per share.

This continues a streak of records that began in last year's second quarter.

I will now take a few minutes to briefly review our first quarter results.

Our sales were $608 million, up 13% year-over-year.

While we did have some help from foreign currency translation in the quarter, accounting for about 2.5% of the increase, it's important to note that our organic sales growth, excluding the currency impact, was 11%.

The combination of our 11% organic sales growth and 14.8% operating margin delivered a net income increase of 29%, and EPS record of $0.90 per share.

As you know, we have two reporting segments.

I'll now cover a few highlights for each.

In our engine products segment, local currency sales increased 16% over last year.

Our engine after market or replacement filter business, sales were up 10%, as utilization rates of existing truck and off-road equipment fleets continued to improve.

We've also continued to add new distributors in almost and part numbers -- and also added almost 500 part numbers to our product offering.

In fact, we had 58 new distributors during the period, August and September alone, and most of these in emerging markets.

Consequently, we believe that a portion of our sales growth in the after market is a result of our increased market share.

Our two OEM -- engine OEM businesses were also both up strongly in local currency terms.

Our off-road product sales were up 26%, as the agricultural, construction and mining end markets we serve have continued to strengthen and increase demand for our customer's new equipment, upon which our filtration systems are installed.

On-road product sales were up 43%, as North American new heavy truck build rates at our customers have continued rebounding.

Switching to our industrial product segment, local currency sales increased 3%.

Revenues from our industrial filtration solutions products increased 9%, as sales of our Torit dust collection equipment continued to grow in the quarter.

In addition, our sales of replacement filters for those systems already installed in the field have remained strong.

Sales of our special application products decreased 9%, as the rapidly growing sales from our newer product lines serving the membrane and venting end markets were offset by the flooding in Thailand and its impact on the disk drive market.

Now, let me take a minute to further explain this situation in a little more detail.

As many of you know, we have two clean room production facilities, where we manufacture our disk drive filters.

One's in Thailand, and the other in China.

Our clean room in Thailand is located southeast of Bangkok and outside the flood plane, so it has remained fortunately high and dry during the floods that began ravaging a large portion of Thailand in October.

However, many of our disk drive customers and many of their other suppliers in Thailand were or still are currently under water.

While these companies are looking to shift production to other facilities as rapidly as they can, there are severe supply shortages of some critical drive components that will cause disk drive industry volumes to contract by an estimated 40% over the next couple months.

It is estimated that it will take months for our customers to fully bring their production capacity and supply chains back online.

In response to these conditions and our customers, we've adjusted our production schedules in both our Thai and Chinese fab facilities.

It's important to note that while the disk drive filter business is a very important business to us, as a result of our aggressive diversification efforts over the past 10 years.

It now represents about 5% of our total sales, so it's not a major part of our total company.

Finally, we hope for a quick and full recovery from this disaster for the country and people of Thailand, including and especially our 1,100 fellow employees.

Now, getting back to our release, talking about our sales by region, we had good growth in the Americas and Europe, where our local currency sales increased 16% and 10% respectively.

In Asia, our overall local currency sales growth was 4% in the quarter.

Obviously, impacted by the issues in Thailand I just discussed.

However, excluding our disk drive filter sales, the rest of our Asian businesses grew at 10% rate in the quarter.

Now, I'm going to turn the call over to Jim Shaw for his comments on our operations before I discuss our fiscal '12 outlook.

Jim?

Thanks, Bill, and good morning, everyone.

Our gross margin was 35.3% in the quarter, up 30 basis points from last year.

There were some pluses and minuses in our gross margin number, which I'll walk you through.

First, even though we did see some easing in the market prices of purchased commodity costs during the quarter, we did still experience higher costs when compared to year-ago levels.

This was worth approximately 60 basis points.

Much of the commodity cost increase we experienced was related to the April expiration of our steel contracts in the US and increases in petro chemical base raw materials, such as plastics, urethanes, and adhesives.

While the cost of some commodities did begin moderating during the quarter, it is likely that we will continue to experience some negative year-over-year comparisons for the next two quarters.

In addition, mix was also slightly unfavorable, by 20 basis points, as our [first fit] sales grew faster than after market sales in the quarter.

On the positive side, our continuous improvement initiatives and selected price increases combined to increase margins by 110 basis points.

So in total, our gross margin was up 30 basis points from last year's margin of 35%.

Our operating expenses remain well under control, coming in at 20.5% of sales, which was down 70 basis points from last year.

The improvement in the operating expense percentage over last year comes from increased leverage of our fixed costs due to the higher sales levels, partially offset by selective investments we have made over the past year to support our strategic growth initiatives.

In addition, while we assess the direction of the global economy, we did selectively slow our planned head count additions during the quarter.

With much uncertainty remaining and many regional GDP forecasts being reduced, we'll continue to be measured in the pace with which we add to our fixed expense levels.

Our operating margin came in at 14.8% this quarter, which is a record.

Looking at our operating margin forecast for fiscal '12, we expect the impact from recent increases in our purchase raw material costs to moderate over the next couple of quarters.

That will continue to benefit from higher volumes, as we leverage our fixed costs and benefit from our continuous improvement initiatives.

In total, we continue to expect our operating margin for fiscal '12 to be between 13.7% and 14.5%, which means that anything above the bottom of this range would represent another full year operating margin record.

While we don't provide specific quarterly guidance, it's important to note that there are several factors that normally make our second fiscal quarter margin the lowest of the year.

First, there's fewer shipping days due to Christmas and New Year's holidays, with some customers fully shut down during that time for annual maintenance.

Also, Chinese New Year occurs in our second quarter this year.

Last year, it occurred in our third quarter.

These holidays will impact the absorption of fixed costs in the quarter.

In addition, the floods in Thailand and their impact on the disk drive industry will result in a drop in customer orders for that business unit.

Finally, our annual stock option grants occur in the second quarter.

So, about half of our expected $7 million to $9 million of annual stock option expense is expected to be incurred in the second quarter.

Our effective tax rate was 25.5% in the first quarter versus 26.2% last year.

In both this year and last year's first quarters, we had tax benefits related to the favorable settlements of tax audits.

This year's benefit was $4.3 million, compared to $2.7 million last year.

Based on our projected global mix of earnings in fiscal '12, we expect our tax rate to be between 27% and 30% for the full year.

Our first quarter CapEx came in at $18.5 million.

During the quarter, we continued to work on our new air filter plant in Aguas Caliente Mexico, which will add more filter manufacturing for the fast growing Latin America region, and also allow us to use our existing plant in Aguas Caliente for significant expansion of our liquid filter production.

We expect this new plant to open in February.

In total, we expect CapEx spending of approximately $100 million this year, as we are continuing to invest globally to meet our strategic growth plan.

We have many new projects included within our $100 million of CapEx this year, and we expect these will positively impact our corporate ROI once completed.

Approximately 25% of this year's CapEx is for capacity expansion.

Another 25% is for tooling for new products.

25% will be related to cost reduction activities through our continuous improvement initiatives, and the final 25% will be for our technology initiatives.

We expect depreciation and amortization to be between $60 million and $64 million this year.

Free cash flow was $39 million this quarter.

As mentioned, CapEx was $18.5 million, compared to $10 million in last year's first quarter.

Working capital was a use of cash this quarter, as we continued to grow our business.

We expect free cash flow will be $260 million to $290 million in fiscal '12.

We repurchased about 1.4 million shares in the quarter, or 1.8% of our diluted outstanding, for $74 million.

This was the primary driver for the $79 million increase in short-term debt this quarter.

Even with this increase, our debt-to-cap and debt to EBITDA ratios remain low, at 27.9, and 0.9 respectively.

We expect interest expense in fiscal 2012 will be between $11 million and $13 million.

Our balance sheet remains strong, with $302 million of cash.

So, with that, I'll pass it back to Bill, who will provide additional details on our outlook for fiscal '12.

Bill?

Thanks, Jim.

As all of you well know, there have been many discouraging economic reports in the media since August.

Earlier this month, many regional GDP forecasts were revised downward again.

So, we continue to operate in a very uncertain climate.

The much better news is that we got off to a very good start in fiscal '12; the evidence of this is in our first quarter results.

Also, our backlog and incoming orders remain healthy, and while we see some moderation to our incoming order trends in a few regions, we see sufficient strength globally to retain our overall sales outlook for the year.

So, we continue to expect our full year sales to be between $2.45 billion and $2.6 billion, or an increase of between 7% and 15% over last year.

Bottom line, we continue to see growth opportunities, and we expect that we will grow faster than the averages through the introduction of new filtration technologies and products, and also by increasing our sales in emerging geographies.

Now, I'll review our outlook by segment.

Our full year engine sales are forecast to be up 8% to 15% over the prior year.

Within our off-road product sales, we expect continued strong demand for our OEM customers, ag, construction and mining equipment.

As the average age of the equipment in the field remains historically old, which should support an ongoing equipment replacement cycle.

We are also forecasting a continued strong recovery in our on-road or heavy truck product sales, as the North American forecast for heavy truck builds at our customers, is expected to increase from the 154,000 they did last year, to about 255,000 this year, calendar '11; and increase again, calendar '12 to approximately 280,000.

The current truck fleets also are historically very old, indicating the need for a continuation of the current replacement cycle.

In Europe, truck build rates are also expected to grow, although at a slower pace than in North America.

Finally, within our engine segment, we expect our after market or replacement filter sales to remain strong.

The demand for replacement filters is a function of the increased utilization rates within the existing fleets of heavy trucks and off-road equipment currently in the field.

In addition, as I mentioned earlier, we're aggressively working to further expand our distribution networks, especially in our targeted emerging markets.

Now, switching to the outlook for industrial segment, our sales are forecast to be up between 7% and 15% over last year.

We expect industrial filtration solution sales to be up, also 7% to 15%, as customer demand for new industrial filtration, or dust collection equipment, continues to improve, as new plant and manufacturing equipment capital spending increases.

We also expect our replacement filter sales to continue to grow, again, with the increased utilization by our customers of those dust collection systems already installed in their plants or in the field.

We expect the demand for our large gas turbines used for power generation to begin rebounding in fiscal '12 and demand for the smaller turbines used in the oil and gas end markets to remain strong.

Overall, we expect our gas turbine product sales to increase between 18% and 25% in fiscal '12.

Finally, within our industrial segment, we are now forecasting our special application sales to decrease between 1% and 7% year-over-year.

Primarily due to the impact I mentioned earlier, of the floods in Thailand on our disk drive filter sales.

Incorporating the sales guidance into the operating guidance that Jim covered a few minutes ago, we have increased our full year EPS forecast for fiscal '12 to between $3.25 per share and $3.50 per share, which would be a new record.

I would like to switch gears and give you a quick update on some of our new technologies before we wrap up our prepared comments.

Over the past few years, we've highlighted our PowerCore technology as a great example of how we continually introduce new filtration technologies for our customers in order to help them both grow their and our businesses.

Our first generation PowerCore was a tremendous success and our second generation of PowerCore, or G2 as we call it, looks like it will be every bit as successful as it delivers yet another break through in air filtration.

During the last quarter, we won four new programs with our G2 technology.

There are another 15 programs in the proposal stage and we're working hard to win as many of those as we can.

In the quarter, our engine PowerCore sales totaled $24 million, up 24% over last year.

On the industrial side of our business, we've introduced our third Torit PowerCore product in May.

This new product line is targeted towards the high abrasive, heavy loading, mining and metal working market segments.

For our customers, this product offers many advantages, including that it is up to 70%, that is 7-0% smaller than competitive collectors.

In our first quarter, we sold another 280 Torit PowerCore systems, which accounted for over $3 million in sales.

We've talked a lot about our plans to grow our liquid filtration business.

We continue to make progress in that market.

We unveiled our new select fuel filters with our proprietary Synteq XP media at the CONEXPO show in March.

And we've already won six OEM platforms with this technology and interest remains high for this new generation of diesel fuel filters.

Finally, we're continuing development in liquid filtration on our next generation of Duramax hydraulic filters.

When launched, we expect these filters will offer our customers improved filtration performance and longer filter life.

So, to summarize, we're off to a good start in fiscal '12 with record sales, record margins, and record EPS.

Looking forward, we're projecting record full year sales and earnings.

We will continue to focus on developing new technologies and products to help meet our customers' changing filtration needs.

We will continue to make the key long term investments in our business to achieve the $3 billion and $5 billion sales targets we established in our strategic growth plan.

Alisa, that concludes our prepared remarks.

Now, we would like to open it up for questions.

(Operator Instructions) Our first question comes from the line of Hamzah Mazari with Credit Suisse.

Please go ahead.

Good morning.

Thank you.

Bill, the first question is just if you could just touch on your European exposure, what you are seeing there.

You spoke of some moderation in order trends.

Maybe if you could touch on which businesses you're seeing that in.

And maybe frame for us how quickly you can react, if you see a significant pullback in the macro and whether the work that you did in the last downturn, whether there's some structural benefits there that will materialize going forward as well.

Hamzah, this is Bill and I'll start.

Good morning.

As we mentioned in our comments, generally the uncertainty in the economic, global economic environment, and I think, Europe is one area that we focused a lot of time and attention to, and I'll start by saying that we did make adjustments to our forecast in Europe.

Some of that's related to our engine OEM business and what we see with our customers going there.

But -- that's incorporated in our guidance.

So, we've already incorporated our latest view in terms of what we think is going to happen.

We're going to continue to, obviously, very closely monitor what's happening over the next month or two, especially as we get through the holidays, and I think to your last point, we really focus in our business in terms of both gathering the intelligence in terms of what's going out there and then as we did three years ago, if we have to make adjustments, we strive to react very quickly to try and stay ahead of it.

But we didn't see a dramatic change in our end markets.

We saw some moderation.

And that moderation is baked into the outlook that I talked about earlier.

The changes will react quickly.

Okay.

On this electric price increases in your portfolio, for Donaldson, pricing hasn't been a material driver, just given the nature of your business.

Could you frame for us some more detail as to where you're pricing?

Is this just a cost push, or is this flowing through the bottom line?

Hamzah, Bill again.

You're right.

You know the Company well.

Typically pricing isn't part of our sales growth numbers, given the OEM markets that we, we operate in.

And also, our focus on introducing better technology in both our products and processes that allow us to take costs out and grow market share.

So, part of that is by our strategy of increasing our penetration.

Generally, when we talk about the selective price increases, it's purely around cost recovery.

We do have some pricing indexed with OEMs around the steel.

That was a result of what happened maybe five or six years ago.

But it's really focused at cost recovery, not margin expansion.

Okay, great.

Thank you very much.

Thank you.

And we have a question from the line of Kevin Maczka with BB&T Capital Markets.

Please go ahead.

Bill, I guess everybody's so focused on the macro, maybe I'll start there, too.

You addressed Europe, but I was wondering if you could say a little bit more about Asia.

I thought I heard you say that, that was up about 10%, excluding the disk drive situation there.

Can you just talk about that?

Are you seeing any signs of slowing there, excluding the temporary disruption in disk drive?

Kevin, Bill.

I think I covered the disk drive and that's sort of an anomaly, unrelated to the global economic conditions, because our customers could build and ship a lot more hard drives if they had the parts.

And we stand ready to supply them when they are ready to take them.

I think the area that we've seen, and we read about in the paper, is just in China, that there's a government trying to slow things down slightly.

And we've seen some moderation in China as well.

And we believe that's a temporary condition as they try and bring that down over the next couple of months.

Okay.

Some moderation in China.

On PowerCore, Bill, we talk about that every quarter and that's been a great success and you're on to generation two and beyond now.

I was wondering if you could say a little bit more about the competitive landscape there.

Of course you've got competitors trying to catch you.

You're always trying to stay one step ahead with the next generation.

On any of these generation two, are you starting to see competitors that can do what you can do there yet, or is your product still very unique in that application?

Kevin, Bill again.

I think we assume in our technology and new product launches that if we're successful with new technology, that our competitors will be compelled to try and copy it or design around it.

And we plan to be successful.

So given that, our strategy has been to continue to reinvest in new technologies, so we introduce G1.

We started on G2.

We've introduced G2.

We're working on a G3 and G4.

The idea being that we -- as competitors start to work on design arounds, we're working on the next generation, so that we release next generation before they catch up with the previous generation.

So, that's our model going forward.

We have seen competitors in G1.

We were successful, so that I guess if we weren't, they wouldn't feel compelled to copy us, so they do.

We aggressively defend our intellectual property, but we think probably our best defense is sort of the constant reinvestment in technology and introduction of new technologies and products.

We have not seen anybody on G2 yet and we're working already on G3 and G4, as I mentioned.

Got it.

And then just finally from me, can you touch on this other income line and the corporate expense line, how we should think about that going forward?

We had other income much higher than it normally is, corporate expense much lower.

Just how we should think about that for the next few quarters.

This is Jim.

In terms of other income, there's a couple different drivers in there.

We do have a little bit more interest income that's part of that.

We also have some royalties and our joint venture income is included in there.

And as the economy is improved, both of those have improved.

And then the third driver is FX.

So, we did have some positive FX amounts that are in there, and that also is part of the amount when you look at the segment footnote, part of that difference is FX and interest expense, income and expense on that line.

Okay.

Thank you.

Thank you.

And we have a question from the line of Charlie Brady with BMO Capital Markets.

Please go ahead.

Quick clarification on the last comment.

So, interest income is in other income, not netted out in interest expense line?

Correct.

Correct, and that's about 300,000 of that number.

Okay, thanks for the clarification.

Can you talk about, in terms of the gas turbine sales, inherently a lumpy business.

As you look out towards what your customers are giving you a sense of, is it a much more back half weighted or does it start to really climb in Q2?

And then could you talk a little bit about what you're seeing on the aerospace, commercial aerospace segment?

Obviously, defense spending is down, but I guess I'm curious, it sounds like commercial aerospace seems to be getting a little bit better and it sounds maybe you're not quite as optimistic in that space.

This is Bill.

I'll start.

Maybe Jim and Rich, if they have further comments, they can jump in.

On the gas turbine, it is sequentially increased each quarter.

That's what we see.

We don't comment specifically on the numbers.

I think specifically to your point, it's going to be more back half loaded.

We are seeing a lot of large turbine order actually, and actually a lot of those orders are actually going to ship next year, given the lead time, which we're already starting to fill the order book for fiscal '13.

This is, this is one of the increases in our guidance, sales guidance within the different segments, is the good news story about gas turbine.

And these are many large projects, around large turbines in the Middle East and in the Far East.

On defense and aerospace, I don't think our outlook on the aerospace is changed.

It's just that we've dialed back the defense a little bit.

And that's sort of a net-net, that we're assuming it's going to be essentially flat year over year.

Great.

Thank you.

Thank you.

And our next question comes from the line of Eli Lustgarten with Longbow Securities.

Please go ahead.

Just a couple of clarifications.

When you talk about Europe, you're talking about a EUR1.39 and the odds are that is probably going to be materially lower than that, EUR1.34, EUR1.35 now.

What would that do?

Does that have any material impact on anything?

Eli, this is Jim.

I think the guidance we used previously at our year end release was EUR1.42.

Now we're EUR1.39.

That, that shifted up to about 2%, so I think you could extrapolate that to where we're at now would be another couple percent.

Is that a 2% positive impact?

Negative.

Okay.

Previously, if we look at our guidance compared to prior year, it would have resulted in a 1% increase in our sales.

Now we look at our new guidance, which is at the EUR1.39, it will actually be a 1% headwind to our sales.

Okay.

The margins in industrial products were almost nothing short of phenomenal, particularly with gas turbines flat and not much going on in the special applications.

16% is quite a margin.

Any idea of what's happening there and, obviously, your forecast at this point dictates that, that number's coming down a bit.

Do you have any idea how we should treat that?

This is Jim.

I'll start off.

I think a lot of it is related to the improvements we've made over the last several years going back to the recession.

We've looked at where we could make some permanent changes through the recession.

We've improved some distribution.

And that's, that's improving both engine and industrial.

And then I think we have taken a look at some of the areas where maybe we weren't operating as effectively as we could and through the recession took some steps to improve that.

There's nothing that sticks out.

I think it's something that we've just been continuously striving to improve.

Eli, this is Bill.

Just looking forward, we have a little bit of a headwind with what we talked about with the disk drives, at least temporarily.

We're quantifying that as about $15 million in sales in the disk drive, down.

You are saying it is basically execution, I'm just wondering, with that number that high, it has to come down pretty far in order to be within the range of your operating margin guidance.

Well, and I think you've got to consider some of the things I talked about in my prepared comments in terms of second quarter being an expectation we will come in less than that for second quarter, so when you average it out.

Okay.

And one other clarification, in the corporate unallocated, when you look at the segment data, there's a little over $2 million.

That's well below what we thought.

Is there a new run rate to that number for the rest of that year or what number -- It was well down from what was the number that was a couple times that the last several of years?

And that one, I think we've talked about before.

It does fluctuates from time to time, because not only does it have the things I talked about previously, like foreign exchange and interest expense, it also has eliminations of inter company profit, and that can vary from time to time in terms of the timing of that.

So, it can fluctuate slightly, so it does get a little hard to predict.

But I just wondered if there is any sort of guide you could of us as some quarter run rate because the difference between $6 million, $7 million and $2 million is $0.05 a share in the quarter.

It runs materially.

Should we be looking at numbers staying in the $2 million to $3 million range, I don't need precision, or does it go back up to $4 million, $5 million, $6 million, $7 million, just trying to get an idea of how to model that.

Yes, I think maybe somewhere between those two is probably a best guess.

But like I said, there's so many variables.

Like foreign exchange, we really can't predict what's going to happen there.

Yes, Eli, this is Rich.

On the foreign exchange piece, what we typically see as it impacts the corporate and unallocated, the US dollar is strengthening against foreign currencies.

We tend to have a pick up in other income and that flows through the corporate and unallocated line.

It shrinks that expense.

When the US dollar weakens against foreign currencies, it has the opposite effect.

It will be a hit there.

Obviously, when we put together our guidance, and pick a foreign exchange rate to use, we just take, take the rate on the date that we start rolling up our latest forecast, because it's pretty impossible to forecast what direction they are going to go.

By the end of the quarter, we could see the euro dollar well over 1.40 again.

Who knows --

And my final question, with sales effectively flat in gas turbines in the quarter, you increased your outlook.

Were some shipments postponed into the second, third or fourth quarter or is it just a build up of business later in the year and you always expected the first quarter to be flat?

I was surprised the first quarter was flat, given the type of gains in the year.

Eli, this is Bill.

I think the technical question for gas turbine schedule by quarter is lumpy.

There's always -- these are very large projects and typically at quarter end, just making sure all the paperwork, all the I's and T's are all dotted.

There's always the probability that something could move from one quarter to the next.

But the bigger, the -- it's not that a bunch of stuff got delayed or deferred this quarter.

It's mostly that just the way the backlog filled in for the second half of the year, with, especially with these large turbines orders that we mentioned, which we started getting over the summer that they are scheduled to ship in the second half.

All right.

Thank you very much.

Sure, thanks.

Thank you, and our next question comes from the line of Laurence Alexander with Jefferies & Company.

Please go ahead.

Hi, this is Jeff on for Laurence.

In the OEM business, how are you doing in terms of winning new platforms?

And if you can look to the next few years, how might this -- what might this mean for the visibility on market share gains as we look forward?

Jeff, this is Rich.

I think Bill's comments, he mentioned that we won four new PowerCore G2 programs.

Those will launch probably in 2014, as both a final tier 4 and the euro 6 standards go into effect.

We've won also the select fuel programs that Bill mentioned.

Again, those are going into production over the next couple of years.

We've already won and talked a lot about prior PowerCore wins and a lot of those are still to go into production with these next rounds of emission implementations.

And we're starting to win programs in some of the emerging markets as well.

They have got emission regulations coming into effect kind of the middle to later part of this decade.

Some of those regional OEMs are beginning to adopt western technology and at that -- now that they are starting to do that, they need Donaldson's technology and we're starting to win programs with those customers as well.

But usually when you win, it's a year, two years, maybe three years out before it actually goes into production.

So, there is a lag effect there, but we believe we're set up pretty good over the next several years in our OEM business.

Jeff, this is Bill.

Just to add onto that, so far, we've won over 150 platforms with PowerCore, including 15 with G2.

And as Rich mentioned, many of those are won and not yet in production.

It will continue to ramp up over the next couple of years.

Great.

Thanks for the color.

(Operator Instructions) Our next question comes from the line of Rob Mason.

Please go ahead.

Yes, good morning.

I was hoping that you could, Bill, perhaps elaborate a little more on the engine products outlook for the year.

Obviously, guidance at the top line was unchanged, but a couple items appeared to work against you with currency, maybe a little bit more negative aerospace and defense perhaps a little bit lower.

And also you mentioned that you updated your European outlook in engine, and my sense is that was not towards the positive, but perhaps some things that work the other way?

This is Bill.

I think you're right on all those that there was some moderation.

The aerospace and defense, that I mentioned earlier, that the defense we brought that down.

So, in aggregate, defense and aerospace we are thinking is going to be flat and I think we did moderate our forecast for Europe looking forward.

You have to add into that sort of the strong performance we had in the first quarter.

We had a very strong engine performance and better than we expected.

So, there's some other pieces that we got off the start of the fiscal year with a stronger start.

And those are also incorporated in the guidance going forward.

Okay, and then also, perhaps how you're thinking about the pacing in the hard disk drive business.

I know you don't like to give quarterly guidance, but it would seem fair to assume that this current quarter's probably the weakest trends that you'll experience there.

But when might you expect that business to normalize again or what's anticipated in the 1% to 7% decline for special apps?

I will sort of start with -- I think we mentioned this earlier, that we took out about $15 million in disk drive sales from the year, that we had forecast.

And that's not because of the economy.

That's because of the supply chain.

To the extent that they come back sooner, maybe there's an opportunity, but that's our best guess at this point in time.

I think some of these facilities are still under water and they are aggressively trying to find alternative sources and move tooling and production equipment to get back into production.

Our guess is that the second quarter, quarter that we just started at the beginning of this month will be the hardest hit, but it will take some period of time, probably beyond our second fiscal quarter, for them to get fully back into production.

Okay.

Very good.

Thank you.

Thank you.

Thank you, and we have a follow up question from the line of Charlie Brady with BMO Capital Markets.

Please go ahead.

Great.

I apologize if I missed this earlier.

But on the cash flow from operations guidance, it looks like that got taken down by $15 million or so.

What's the driver behind that?

Hard to describe business related?

No, not necessarily.

I think as we looked at our performance first quarter, we probably have a little bit of an opportunity in terms of some of our working capital.

That used a little bit more than I think we ideally would have liked.

However, some of that relates to some things that we think will flip here within the next quarter.

We talked about some GTS projects.

Those are sitting in inventories.

To the extent we can get those out in the next month or two, that will help.

The other thing is we are, as we invest in the business, looking out over time here, continuing to add selective inventory in some of our distribution centers as we expand in South America and other places.

So, those things are more on the opportunity side.

The one that I think probably drove some of our change in guidance is our accounts payable did end up being a use of cash for working capital this period, and I think what we're seeing there is, as our last year, we were really in a growth, significant growth mode in terms of trying to keep up.

While things haven't slowed down, we've more leveled out to more normal growth pace and because of that, our AP balances have come down a little bit and I think that affected our outlook, because we didn't probably anticipate that as fully in our original guidance.

Charlie, one more comment on the inventory, this is Rich.

As Bill mentioned, we've got a slug of GTS orders in and the backlog is starting to fill now for the beginning of fiscal '13.

That's going to drive a little higher inventory levels at year end, and make some of those, make some of the comps be a little less favorable at year end than what we had originally modeled.

So, we brought it down slightly to cash from operations, down to that $15 million.

Great.

That's helpful.

Thanks very much.

Yes.

And I show no further questions in queue at this time.

Gentlemen, please continue.

Okay.

I'll wrap up.

This is Bill.

To conclude our call, I would like to thank everyone for your time and continued interest in Donaldson.

As I mentioned earlier, we're off to a great start to fiscal '12 and continue to expect this to be another record year.

My 12,900 colleagues around the world continue to make all of this happen.

I'm very proud to be part of the Donaldson team and what we're creating together for both today and as we continue to make progress in our long-term growth objectives.

A sincere thanks to all of you.

Good-bye.

Ladies and gentlemen, that concludes our call for today.

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