Donaldson Company, Inc. (DCI)

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Donaldson (DCI)

Q1 2013 Earnings Call

November 21, 2012 11:00 am ET

Executives

Richard Sheffer - Director of Investor Relations and Assistant Treasurer

William M. Cook - Chairman of the Board, Chief Executive Officer and President

James F. Shaw - Chief Financial Officer and Vice President

Analysts

Hamzah Mazari - Crédit Suisse AG, Research Division

Charles D. Brady - BMO Capital Markets U.S.

Lucy Watson - Jefferies & Company, Inc., Research Division

Brian Drab - William Blair & Company L.L.C., Research Division

Brian Sponheimer - Gabelli & Company, Inc.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Eli S. Lustgarten - Longbow Research LLC

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Donaldson First Quarter FY '13 Conference Call. [Operator Instructions] Today's conference is being recorded, November 21, 2012.

I would now like to turn the conference over to Rich Sheffer. Please go ahead.

Richard Sheffer

Thank you, Alicia, and welcome to Donaldson's Fiscal 2013 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 first quarter earnings and our updated outlook for fiscal '13.

Next, I need to review our Safe Harbor statement with you. Statements in this call regarding our business that are not historical facts are forward-looking statements, and our future results could differ materially from these forward-looking statements made today. Our actual results may be affected by many important factors, including risks and uncertainties identified in our press release and in our SEC filings.

Now I'd like to turn the call over to Bill Cook. Bill?

William M. Cook

Thanks, Rich, and good morning, everyone. As you saw in our press release we issued earlier this morning, our first quarter sales and EPS were very consistent with the updated outlook we announced in October. As we discussed last month and summarized again in our release today, we had started our new fiscal year in August with excellent operating momentum and a good open order backlog. However, we then began to see conditions at many of our customers start to quickly decelerate in September and into October. Our sense is that what has caused this slowdown is the significant decline in business confidence due to the ongoing high levels of global uncertainty. The Wall Street Journal earlier this week summarized the probable causal factors of this uncertainty issue, including the U.S. elections, the government transition in China and the impending fiscal cliff issue in the U.S. The list goes on, but I think we all get the point. There is a high level of uncertainty now negatively impacting business confidence and investment decisions generally.

Consequently, we see many of our Engine OEM on-road and off-road equipment customers reduce their production schedules to both deal with their declining end market demand and their own now higher-than-desired inventory levels. For example, according to ACT Research, North American Class 8 year-over-year truck build rates decreased 9% in August, 18% in September and were down 19% in October; and our OEM on-road sales declined 16% in local currency during our first quarter. Based on ACT's latest forecast, North American heavy truck build rates are now expected to be down 15% year-over-year in total in our fiscal '13. Our OEM off-road sales were a better story, down less than 1% in local currency.

As a reminder, our off-road sales include construction, ag and mining equipment. According to Caterpillar's earning call last month, they are cutting production of both construction and mining equipment to -- production levels to below their end market demand to achieve their inventory reduction targets in their fourth quarter, which ends in December.

In ag equipment, which we currently see as the best of our OEM end markets, North American ag equipment sales continue to be strong, as just evidenced by John Deere's announcement this morning that they had a 16% increase in ag equipment sales in their recent quarter. So net-net, in total, our OEM off-road sales decreased less than 1% in local currency during the quarter.

The utilization rates of the existing fleets of on-road and off-road equipment in the field have also softened during the last 2 months, resulting in lower order rates for our replacement filters from our OE distributors, independent dealers and distributors. We do also believe that some of our larger aftermarket customers have been destocking their replacement filter inventory levels to adjust to their newly revised expected market demand, so there is a short-term compounding impact of the current lower end-user demand. In total, our engine aftermarket sales decreased less than 1% in local currency during the quarter.

Moving to our Industrial Products reporting segment. Our Industrial Filtration Solutions sales were even with last year with continued growth in the Americas, offsetting weaker conditions in Europe and Asia.

In our Special Applications Products, we have seen hard disk drive -- our hard disk drive filter customers reduce their production schedules to adjust for reduced corporate IT spending and also to adjust their own inventory levels. According to both Western Digital and Seagate's recent earning announcements, industry drive volumes were down 11% in the quarter ending September, but started to improve in October.

Helping to offset this for us and also within Special Applications, our newer venting products had a good quarter as we continue to expand the products that our filters are being incorporated into, including hearing aids, ostomy bags and automotive sensors. In total, our Special Applications sales declined 6% in local currency during the quarter.

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