Donaldson Company Inc (DCI) 2015 Q1 法說會逐字稿

Good day and welcome to the Donaldson Company first-quarter FY15 earnings call and webcast conference. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Rich Sheffer. Please go ahead.

Thank you, Don, and welcome to Donaldson's FY15 first-quarter earnings conference call and webcast. Following this brief introduction, Bill Cook, our CEO; Tod Carpenter, our COO; and Jim Shaw, our CFO, will review our first-quarter earnings and our updated outlook for FY15.

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.

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. In a few minutes, Tod and Jim will cover the details of our first-quarter results and our updated outlook for FY15. But first, I would like to offer some summary comments.

As noted in our release, conditions in our very diverse end markets continue to be mixed. Many of our OEM, or first-fit equipment end markets, remain challenged, particularly the global mining equipment market and more recently, the North American and European agricultural equipment markets.

The Chinese construction equipment market also continues to be very weak. And we have not yet seen a rebound in our first-fit dust collection market globally.

While there are some specific differences in the dynamics of each of these end markets, one common thread is that all are dependent on new CapEx investment, which continues globally to be very weak. While we obviously can't control new CapEx investment by our customers or theirs, what we are doing in all of our first-fit markets is utilizing our stream of new technologies to introduce new products, which are allowing us to take share today, even given the current market conditions. These CapEx-dependent markets will recover, and when they do, we will be in a much stronger position, both on our customers' first-fit equipment, as well as their replacement filter after-market annuity.

As we've discussed before, today over 50% of our revenues are replacement filters. This is a dramatic transformation from where we were 20 years ago.

Almost all of our replacement filter businesses are doing well for two reasons. First, while as I mentioned, new equipment CapEx investment remains weak, the better news is that the equipment that's out there in the field, whether it's a dust collector, an excavator or a heavy truck, they are being utilized and they need to be regularly maintained, thereby generating a need for our replacement filters.

In addition, we continue to gain share as a result of all the new first-fit systems we've installed in our customers' equipment over the past five years. We also continue to make investments in new distribution centers, field sales people or parts. All of these are allowing us to gain business in previously under-served markets and regions. Though our after-market businesses, in both engine and industrial, were really the heroes in our first quarter, offsetting the weakness in many of our first-fit markets, as well as the foreign currency headwind.

With all of these puts and takes in our end markets, we were able to deliver 2% local currency growth this quarter. Not what we had planned when we started the year, but when you peel back all the parts of our Company, you can still see that our model of diversification continues to work well.

While we would like to obviously see a CapEx-related rebound soon, we aren't waiting for it, or for our first-fit equipment markets to recover. As always, we'll continue to manage our cost structure, while feeding our growth opportunities.

Given our strategic plan of growing to $5 billion in FY21, we are continuing to make the significant long-term investments in our business, especially in the areas of technology, market presence, and new growth initiatives. All of these will pay big dividends for us down the road.

I'll now turn the call over to Tod for a review of our first-quarter sales. Tod?

Thanks, Bill, and good morning. Our first-quarter sales were 597 million, essentially even with last year's first quarter. Foreign currency translation had a 2% negative impact at the consolidated level, however, the impact of FX varied by region. For example, our European businesses had a 4% negative impact, while our Asian businesses had a 2% negative impact. As a reminder, you can find a detailed analysis of currency translation by business unit and region on the Investor Relations home page of our website.

The rest of this review will discuss local currency first-quarter results. Sales in our engine product segment increased 2% over the prior year. Our on-road OEM sales increased 17% globally. North America and Latin America on-road sales grew 19% and 23% respectively due to increased build rates of new trucks. Europe grew 33% in the quarter, mainly due to our increased share on the newer Euro 6 trucks now in production.

We continue to see strong conditions in our engine after-market where we supply replacement filters through both our OEM and independent distribution channels. Our engine after-market sales increased 9% in the quarter, with solid growth in all of our major regions. We attribute this growth to the combination of our market growth initiatives and improving equipment utilization in the field.

We are continuing to see strong replacement filter sales growth in developed markets from our OEM customers' dealer organization, and are also benefiting from our increased after-market penetration with independent dealers and distributors in emerging economies. Our engine after-market is one of our earliest cycle end markets and the improvements we have seen over the last few quarters provides evidence that diesel equipment in the field is being used at an increasing rate, generating the need for more maintenance, including filters. This higher utilization of equipment in the field will in time result in improving demand for new equipment. We see data supporting this in the on-road heavy truck and construction equipment markets, although at different rates regionally.

One new area of relative softness we saw in this quarter was some inventory destocking in the agricultural service channel. We expect this to continue until the spring planting season.

Our off-road OEM sales decreased 16% due to a slowdown in end-market demand for new agricultural equipment in both Europe and the Americas, and the continued soft mining and construction equipment demand in Asia-Pacific. Based on our customers' forecasts, we believe the mining equipment market will remain at the current low levels throughout our fiscal year and that demand in the agricultural equipment market will continue to soften through our FY15.

Finishing my review of our engine products business, our aerospace and defense sales decreased 15% as the slowdown in defense spending for ground-based military equipment continued this quarter. Also impacting the year-over-year comparison were sales from a Blackhawk helicopter program that peaked in last year's first quarter.

Switching to our industrial product segment, sales were even with last year's first quarter. In our industrial filtration solutions business, our sales increased 1% as good levels of manufacturing activity, along with our after-market-focused growth initiative, continued to drive record demand for replacement filters for our Torit dust collectors.

Our global double-digit after-market growth in our dust collection business was enough to offset continued weak manufacturing capital spending levels in North America, which has dampened demand for our new industrial dust collectors. In our special applications business, our sales increased 2% on an increase in our disk drive filter sales.

Offsetting the increases in the industrial filtration solutions and special applications was a 9% decline in our gas turbine business. As we have previously discussed, our gas turbine business is what we describe as lumpy. That is, this is a project-based business with large systems where the timing of shipments can be adjusted due to the readiness of a project build site to take delivery.

This lumpiness impacted our first quarter, as we had some large projects that were scheduled to ship in our first quarter rescheduled by our customers and they are now scheduled to ship in our second quarter. We also saw this lumpiness impact our new acquisition within the gas turbine market, Northern Technical, which had sales of less than $1 million in the quarter due to the timing of shipments. We continue to expect a solid contribution from Northern Technical over the balance of our FY15.

In summary, our diversified portfolio provides exposure to many different end markets in regions that typically are cycling up or down at different times. This quarter, solid growth from our engine after market, dust collection after market and OEM on-road businesses offset weaker than expected conditions in our OEM off-road business, shipment delays in our gas turbine business, and an unexpected 2% headwind from foreign currency translation.

I'll now turn the call over to Jim Shaw for his comments on our operational metrics and our outlook for FY15. Jim?

Thanks, Tod, and good morning, everyone. Our gross margin this quarter was 35%, down 80 basis points from last year's first quarter. As we noted in our press release, there were a few items impacting our gross margin this quarter.

Lower fixed cost absorption from lower production volumes in certain of our markets and geographies compared to last year, resulted in a negative 130 basis point impact. Other investments, such as our new distribution center in Slovakia and integration of our new acquisition in the gas turbine market, Northern Technical, had a negative 20 basis point impact.

On the positive side, we benefited from a higher percentage of replacement filter sales, which were 57% in the current quarter compared to 54% last year. In many of our end markets, utilization of existing equipment in the field is good and that helps our replacement filter sales, which carry a higher margin.

Overall, product mix had a positive 20 basis point impact on gross margin. In addition, our ongoing continuous improvement initiatives benefited our gross margin by approximately 50 basis points compared to last year.

Our operating expenses increased by $10 million compared to last year's first quarter. As a percentage of sales, operating expenses increased by 160 basis points.

Higher costs associated with employee salaries and benefits, incremental expenses related to our global ERP project, and higher travel expenses associated with our growth initiatives and increased customer visits, were the primary driver of the increase. As a result of the decrease in demand we are seeing in certain of our end markets and geographies, we have implemented cost control initiatives to reduce our expense levels for the remainder of the year from our original FY15 plan.

Our lower gross margin and higher operating expenses resulted in a 240 basis point decrease to our operating margin in the quarter, which was 12.9%. Looking forward, we expect our full-year FY15 operating margin to be between 13.9% and 14.7%.

Contributing to the decrease is an expected $5 million to $6 million of higher costs for our global ERP investment in FY15 compared to FY14. We successfully finished our implementation in the Americas earlier this month and are beginning to implement the new system in Europe, with the first go-lives there scheduled for February. In addition to our ERP project, we are planning to make a number of other sales growth-related investments this year for which we will spend an incremental $4 million in FY15.

Our effective tax rate was 27.6% in the quarter versus 32.2% last year. Last year's first quarter included $2.1 million of tax expense, primarily related to an inter-Company dividend, while we had a favorable shift in the mix of earnings between tax jurisdictions in this year's first quarter. Based on our projected global mix of earnings for FY15, we are continuing to forecast our full-year tax rate to be between 27% and 30%.

Our first-quarter CapEx was $27 million. Looking at our forecast for FY15, we expect to spend between $90 million and $100 million on CapEx over the full year.

The breakdown of our CapEx spending is projected to be approximately 25% for our technology initiatives, which include our global ERP project and our R&D lab projects. Another 30% is for tooling for new products, 30% related to cost-reduction activities through our continuous improvement initiatives, and 15% related to capacity expansion. We expect depreciation and amortization will be between $70 million and $75 million in FY15.

Free cash flow was $22 million this quarter, which was impacted by the increase in inventory associated with the large number of gas turbine orders we expect to ship in the next two quarters. For FY15, we expect full-year cash flow from operating activities to be $275 million to $315 million. And with our forecasted CapEx, we expect to generate $175 million to $225 million of free cash flow this year.

We repurchased 3.3 million shares, or 2.3% of our outstanding shares in the first quarter, for $144 million. We anticipate repurchasing up to 4% of our diluted outstanding shares in FY15.

We expect interest expense in FY15 to be between $14 million and $16 million. And our balance sheet remains very strong, with $268 million of cash and short-term investments.

Now, I would like to provide some comments on our updated outlook for FY15. Our first-quarter results have shown that conditions in our OEM first-fit equipment end markets remains mixed with some improving, some stable, and some weakening. Conditions are much better for after-market sales, as we are seeing continued strength and demand for replacement filters in both our engine and industrial segments.

Based on the outlook in our press release, we're now forecasting sales growth of 1% to 5% in FY15. This range is 3% lower than our initial outlook, with the majority of the 3% decrease attributable to foreign currency translation as a result of the strength in dollar.

In our engine product segment, we forecast full-year sales growth of 0% to 3%. In our OEM end markets, we expect to see continued improvement in North and Latin American and European truck builds, and North and Latin American construction equipment builds.

We have lowered our expectations for new agriculture equipment builds compared to our initial outlook. In addition, new mining equipment builds are expected to remain weak.

Demand for our after-market products is forecasted to remain strong, as utilization rates of equipment that is in service remains good. We continue to successfully execute our strategic growth strategies. We believe there has been some inventory destocking through the service channel, serving the agriculture equipment markets that we forecast will subside by the time spring planting begins.

Finally, we continue to expect mid single-digit growth in our aerospace and defense group. The defense portion is expected to remain weak, but we continue to see better prospects for growth on the commercial aerospace side of the business.

In our industrial product segment, we're still forecasting sales to increase between 5% and 9%. We expect gas turbine sales to increase 25% to 30% in FY15, as the industry rebounds from the pause it experienced in FY14. We typically have six to eight months of visibility in our gas turbine business, so we have a reasonable degree of confidence in our forecast based on orders we've received, plus projects we are quoting on with our customers. This forecast does include Northern Technical's forecasted sales of $17 million to $20 million.

We are expecting industrial filtration solution sales to increase 1% to 5%. Sales of replacement filters have been at record levels and we expect them to remain strong.

We anticipate seeing some modest growth in new filtration system sales, as manufacturing capital investments slowly improves. In addition, we are expecting to benefit from the first-quarter launch of new product lines that should support our top-line growth plans. Finally, we forecast for special applications to be steady in FY15, as we anticipate sales increases of our integrated venting solutions and semiconductor filters, with slight decreases in disk drive and membrane product sales.

As previously mentioned, we are forecasting our operating margin to be between 13.9% and 14.7%. As we disclosed in our press release, we anticipate incurring approximately $5 million of restructuring charges related to the closing of our muffler plant in Grinnell, Iowa.

We also expect to record a charge of approximately $4 million in our second quarter related to pension lump sum settlements. Neither of these charges are included in our operating margin outlook, I just mentioned.

In total, we expect our EPS to be between $1.77 and $1.97, excluding the restructuring and pension settlement charges. The midpoint of this new range represents a 6% increase over FY14.

Based on this guidance, we are expecting mid single-digit sales growth in the remaining quarters of FY15. Our operating margin is expected to be roughly even with our prior year in our second quarter, before increasing in our third and fourth quarters.

As a reminder, as you update your models, our second quarter operating margin is normally our lowest of the year, due to seasonal holidays causing the fewest shipping days of any quarter for us. In addition, we have almost half of our annual stock option expense occur in our second quarter, so about $5 million. So in total, we're anticipating our second-quarter operating margin to be between 11.8% and 12.3% and EPS to be between $0.35 and $0.39. As a reminder, last year's second quarter included a $6.2 million tax benefit related to a favorable settlement of an audit.

So with that, I'll pass it over to Bill, who will discuss some of our growth initiatives. Bill?

Thanks, Jim. As mentioned earlier, we've continued to make the key investments in our business to support the long-term objectives outlined in our strategic plan. Our plan is a compilation of the very detailed plans by business and region that support our sales targets of $3 billion and then $5 billion in revenues.

As a result of our plans, we have a number of very focused initiatives under way today that will help us grow over time, regardless of the global economic environment. I would like to take a few minutes to highlight a couple of these initiatives.

The first is with emerging economies, such as Latin America, Southeast Asia, India, China, and Eastern Europe. We have entered these regions more recently and as a result, our businesses there are still small and our current market presences are lower than they are in North America, Western Europe or Japan, each of which we've been in for decades.

The other way of saying this is that we've got very significant regional opportunities for growth. So in our targeted emerging markets, we are continuing to add sales resources, parts to our product line, distribution capabilities, distributors, and OEM customers.

We have determined over time that if we had good sales people and local product availability, we can grow our after-market businesses. So we continue to do this all over the world.

For example, in our engine after-market business, we added 67 new distributors and over 460 new part numbers in the quarter. Another key part of this growth model is our continued investment in our own distribution capabilities. During the past quarter, we opened two new distribution centers, one in Peru in August, and another in Slovakia at the end of October.

By having more of our product available locally and supported by local distributors and sales people, we will grow our business. The Peruvian distribution center will help us grow faster in Peru and its neighboring countries. And the Slovakian distribution center will help us grow our Central and Eastern European businesses.

So how are our emerging economy initiatives working? Generally, very well. For example, local currency sales in our Latin American business were up 20% in the quarter, India was up 27% and Southeast Asia was up 17%. While the absolute sales numbers are still relatively small, the growth percentages are large and as a result, each of these regions will become a much larger part of our Company down the road.

Another of our key growth initiatives is the utilization of our technologies to help better solve our customers' filtration issues. One of our most successful technology introductions over the past decade for air filtration has been PowerCore.

As a company, we invest centrally into R&D and then leverage our new technologies into as many different customer applications and as many of our businesses as possible. And we are now very successfully using the newest generations of PowerCore in both our engine and industrial segments.

Our engine PowerCore sales in the quarter were $37 million, up 11% over last year. We had great growth of PowerCore replacement filters, which increased 15% in the quarter. We now have a number of new PowerCore programs, generation two technology, going to production with our OEM customers.

On the industrial side of our business, we launched our fourth PowerCore product in our Torit dust collector line, this one called the VL Series. The VL is targeted at capturing fibrous dust in applications such as grain handling and textile, pulp and paper manufacturing, all of which have traditionally been collected by baghouse collectors.

In total, across the current Torit PowerCore product family, we sold another 370 new systems in the quarter. And in addition, the sales of our Torit PowerCore replacement filters for those systems already in the field, increased 25%. So in total, our Company's PowerCore sales totaled $43 million in the quarter, up 7% over last year.

Now, PowerCore isn't our only new air filtration technology, as we're now launching a complementary product technology called PowerPleat. PowerPleat will also provide improved filtration system performance and a 20% space savings, while protecting our customers' replacement filter business. We've already won four programs with PowerPleat with production starting in FY15.

And one last new air filtration product introduction we mentioned is our new Downflo Evolution, or DFE, cartridge collector. While Torit PowerCore is revolutionizing the baghouse market, we believe that our new DFE will do the same to the current cartridge collector market. The DFE is the next generation of technology, bringing improved pulsing technology into a 40% smaller collector as compared to existing collectors on the market.

Reception has been very strong, as we've received 44 orders since we launched this product in September and shipped our first eight systems in the quarter. As these new DFE collectors are put into service, we will also be able to protect our after market.

And last, but not least, I would like to give a brief update on our liquid filtration growth initiatives. Our liquid filtration sales increased 6% in the quarter. Our new select diesel fuel filters, which use our innovative Synteq XP media, have now gone into production, as our OEM customers began launching their new engine and equipment platforms.

Other recently launched product lines that use this Synteq media include our new hydraulic and bulk fuel product lines. While sales of these last two are still relatively small, they generated 27% growth in the quarter, so we're off to a very good start.

In summary, we've had many new product releases recently, which are bringing enhanced value to our customers. Market reception to all of these has been great. Our goal, as always, is to remain the technology innovation leader in our markets to better meet our customers' filtration needs and to provide ongoing growth opportunities for ourselves and value creation for our shareholders.

Don, that concludes our prepared comments. We'd now like to open the call up to questions.

Thank you.

(Operator Instructions)

We'll go first to Charley Brady with BMO Capital Markets.

Thanks. Good morning, guys.

Good morning, Charley.

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

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

Okay, and can you quantify what the liquid filtration sales were in the quarter?

One second.

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

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

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

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

Great. Thanks, guys.

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

Good morning, everyone.

Good morning, Eli.

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

Charley, this is Tod. Let me do a walk through the markets. As you said, mining is in our outlook, going to continue at current low levels. We have transportation being strong in North America and as we roll that up globally, about between 8% to 12% up for us. We have construction modestly up, so low single-digits, 2%, 3%.

But the big change for us in this outlook is really in the ag markets. So ag, we have down between 25% and 35%. Now, that may be a larger piece, a larger number than, for example, you're used to from a customer standpoint of view. But for us, it's more of a mix explanation. So within the larger row crop type of products, our products carry a higher average sales price, so hundreds of dollars. Versus in the more stable portion of the ag markets, which would be dairy and small farms, where our pricing is more about $25 to $30.

Additionally, in the row crops, where we are feeling a lot of pressure across the market, we also have our emissions-based business. So when you roll all that up for us, due to the reduction outlook in the larger pieces of equipment on the first-fit side of ag, that's the reason why we have ag coming down between 25% and 35%.

That's realistic actually. Most of the companies have been underestimating, and the decline is going to be at least that big, so I have no problem with that.

Can you talk about with that mix change, you're still relatively holding profitability in the business. Is that because the after-markets are strong and making up for the shortfalls in the OEM stuff?

Eli, this is Jim. It's a mixed story in terms of some of our plants, so some of them are operating very robustly, especially those serving the after markets where Tod just mentioned certain aren't. So it's a combination of us adjusting here.

We are having to adjust some of our spending levels in terms of discretionary spend. But then also, because some of our plants are shared, the after market is helping offset some of the weakness in terms of the absorption.

Okay, and one final question. When we talk about the shift over to gas turbine. If I do the math right, it looks like you've taken the gas turbine outlook ex the acquisition, towards the lower end of your ranges before. At least that's what it looks like to me.

Is there some slippage in gas turbine? I don't mean first quarter, second quarter, but some being pushed out into 2016 at this point? Or is this just the way it looks? Because that looks like it should have been a little bit stronger than what you're showing.

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

Okay, thank you very much.

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

Thanks, good morning.

Good morning.

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

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

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

Kevin, this is Jim. As we entered this year, we were obviously hoping for a little bit better result in terms of the top line this quarter. So as we were in the middle of this quarter, took a look at some of those sales forecasts, we have begun to adjust some of our more discretionary type spending, and personnel within the plants to adjust to the new levels.

You won't see that full effect of that quarter over quarter from first to second, because of some of the things I mentioned in terms of the second quarter generally being a little bit softer. We're having the option expense, some other things. But as we get to third and fourth quarter with the sales increases we do anticipate, and we typically do see, a pickup seasonally for our third and fourth quarter. Those volumes should get our margins back to what we were operating at the end of last year.

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

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

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

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

Okay. Thank you.

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

Good morning. Two questions. First, can you help us with the destocking that you're seeing? In the past when you've seen these kinds of destock cycles, how would you benchmark the sequential trends that you might see once the destocking ends? So not so much when will you see the destocking end? But when this happens, what do you see as a reasonable bridge?

And secondly, with the PowerCore and other new technology platforms, is the rollout of additional platforms likely to also lead to an acceleration in the growth rate? Or how should we think about the impacts of rolling out additional technologies?

Laurence, Bill here. I'll try and take both of those, or start on them. On the first one, on destocking, the short answer was it always depends on certain characteristics of the market. I think what we're seeing right now, as Tod and Jim mentioned on the agricultural side, is given what's happened to the new equipment and that market generally, is that there's been a pretty major pullback in terms of production, and then in the channels in terms of inventory levels. Part of that is also a function of the fact that some of our customers who have their own parts distribution systems, have their calendar year ends coming up, so that's on top of that.

So I think our expectation on that is that would continue through our second quarter. Then as we get close, our third quarter, which starts in February, that we would start to see that come back. Typically that usually comes back, it can come back like a bull whip, very strongly, depending on how the utilization equipment is in the field, that there's restocking in addition to the satisfying that utilization need. We think it's going to continue for ag through the second quarter and then come back in the third.

On the introduction of new technologies, it's evolutionary in the sense that we have to get these new, like new PowerCore systems for our engine OEs. Not only have to win them, but then they have to go through the development cycle on their equipment. So it's usually probably two years after we win it before it goes into production. So a lot of the wins that we have now are still not slated. If we got them this quarter, then some of them are out to calendar year 2017. But it's won.

When it goes into production, then we get the advantages of both that improved first-fit, or greater first-fit business, as well as the after-market retention. So it continues to build every quarter. That's why we like to talk about the PowerCore numbers every quarter in terms of to show and demonstrate that it is building.

Thank you.

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

Good morning, Bill, Tod, Jim.

Good morning, Brad.

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

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

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

Correct.

Okay. And then the revenue guidance, Jim, you talked about the currency headwind. So we went from 4% to 8% to 1% to 5%. I want to make sure I understand the components in the bridge from the previous guide to the new guide. So I think Northern Technical adds a little less than 1 point in FY15. Currency, that's about a 2-point headwind. And then the other 2 points of headwind comes from end markets and order timing. Is that about right?

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

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

Yes, it was 141.1 million.

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

Correct.

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

Thanks.

(Operator Instructions)

We'll take our next question from Brian Sponheimer with Gabelli & Company.

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

Good morning, Brian.

Good morning.

Just a question, going back to gas turbine, when you say six to eight months of visibility, and you called out a couple projects based on geopolitical turmoil, that may not be in FY15. What's the impact do you think overall, from lower energy prices? And does that put some risk potentially into your July quarter?

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

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

Brian, Bill. I think as we talked about in the past, maybe just to reiterate, take a look at the share buyback. First, we have a consistent philosophy around it, so we're always trying to buy back shares. We look at it in two tranches. We're always going to buy back enough, let's say roughly 1% is a new option, aren't dilutive. And then we're more opportunistic above that. I would say generally, the first quarter of the year we try and go for that 1%.

You're right, this quarter we did more than that. We've done that before. I think we -- just given our cash deployment strategy where we saw the stock, we thought it was the appropriate thing to do. As Jim mentioned, we're looking at for the full year, a range of between 2% and 4% -- I guess up to 4%, since we're above 2% now. We're not committing to do the whole 4%, but we're operating within the range from where we are today up to that 4%.

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

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

Yes, it was $40.20, Brian.

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

(laughter) Well, thank you. This is Jim. I'll add one other -- to Brian's question earlier, I think I misspoke. I said 141.1 million in terms of diluted share count. It's 140.1 million.

(Operator Instructions)

We'll go next to Richard Eastman with Robert W. Baird.

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

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

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

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

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

Rick, it's about 20% right now.

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

Right.

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

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

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

Thanks, Rick.

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

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

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