Please standby we are about to begin. Good day and welcome to the Donaldson Company Incorporated Q4 Fiscal Year 2015 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Brad Pogalz, IR Director. Please go ahead sir.

Thank you. Good morning everyone and welcome. With me today are Tod Carpenter, Donaldson's CEO and then Jim Shaw, our CFO. Also in the room with us is Bill Cook, our Chairman. This morning Tod and Jim will cover our fourth quarter and full year 2015 performance, review the outlook for our next fiscal year, and provide an update on some of our strategic initiatives. I want to remind everyone that any statements made during the call that are not historical facts should be considered forward-looking statements. Our results could differ materially from the forward-looking statements made today as they maybe affected by many factors including risks and uncertainties identified in our press release and SEC filings. Now, I'll turn the call over to Tod Carpenter. Tod?

Thanks, Brad and good morning, everyone. One year ago as we were giving our first look at fiscal 2015 guidance we said, regardless of what is happening outside of our company we will continue to focus on those things that we can control. After navigating through an ever changing year including global uncertainty and end market headwinds that were greater than expected, I can confidently tell you that is exactly what we did. We answered last year's challenges by proactively restructuring our company and aligning expenses with market conditions while maintaining and in some cases accelerating investments for growth. I am proud of the more than 1% local currency growth that we delivered last year. Additionally, we made progress on our growth initiatives despite the many headwinds we faced. Later in the call I will share some examples of our progress and successes but first I will provide a brief overview of our sales and Jim will give some additional detail on our fiscal 2015 results and fiscal 2016 guidance. Turning to sales, despite macro pressures continuing through the end of the fiscal year, fourth quarter sales were ahead of our guidance. Our fourth quarter sales were $610 million, a decline of 9% from last year's fourth quarter but down 1% in local currency. The remainder of my remarks today will focus on our local currency fourth quarter results. As a reminder you can find a detailed analysis of currency translation by business units and region on the investor relations home page of our website. In our engine segment, the 6% decline in fourth quarter sales collapses [ph] mixed conditions in our end markets. The down trend in mining and agricultural markets drove 24% decline in off-road. Conversely strong production rates of heavy duty vehicles contributed to an on-road sales…

Thanks Tod. Good morning everyone. FX meaningfully impacted our top line results again in Q4 reducing sales by roughly 8% or $52 million. For the year, FX reduced sales by 135 million or about 5%. Net income was reduced by 8% in the fourth quarter and 6% for the full year due to foreign exchange translation. Our fourth quarter GAAP EPS was $0.41. Excluding restructuring and asset impairment charges, adjusted EPS was $0.45, above the top end of our previous guidance due to better expected sales and adjusted operating margins. Q4 adjusted operating margin was 14% ahead of the midpoint of our earlier guidance by 20 basis points due primarily to our expense management programs which was offset partially by a mix of pressure on margin. Versus last year adjusted operating margin declined 90 basis points, reflecting a 170 basis point decline in gross margin that was partially offset by lower operating expenses as a percent of sales. Our lower volume in Q4 combined with a pressure from the mix of sales negatively impacted gross margin by 200 basis points versus the prior year. Our continuous improvement initiatives partially offset these factors resulting in a net 170 basis point decline. Lower compensation expenses compared with fiscal 2014 reduced our operating expenses as a percentage of sales by about 80 basis points. Earlier in the year we also implemented discretionary expense controls across the company as we reacted to the weak environment in many of our end markets. While this improvement in fiscal 2015 include some benefit from our recent restructuring actions, the vast majority of those savings will be a realized in fiscal 2016. The fourth quarter adjusted operating margin I have been discussing excludes restructuring and asset impairment charges of $7.1 million which impacted operating margin by about 120…

Thanks Jim. As I mentioned earlier we made some meaningful progress over the last year on our growth initiatives which include expansion of our core business through first-fit program wins and aftermarket growth, continued geographic expansion, and disciplined execution of our acquisition strategy. To provide a little more color here are some examples. In terms of expanding our core we remain very excited of our PowerCore. Last year PowerCore sales grew more than 10% to $185 million with growth in both engine and industrial. In engine which represents nearly 90% of the total PowerCore sales, sales growth of both first-fit and replacement parts significantly outpaced the total company. Last year total engine first-fit sales declined about 15% while sales of PowerCore first-fit grew nearly 2%. Similarly PowerCore aftermarket sales grew 12% or about 10 percentage points higher than total aftermarket. This outperformed results indicates to us that we increased our market share and we further believe that the program wins over the past 12 months plant the seeds to suggest this growth trend will continue. In 2015 we won a new engine air program on average every day including a win rate of about 75% on our must win programs. Importantly nearly all the must win programs we secured were won with proprietary solution and we’ve successfully retained 100% of the business where we were the incumbent. We had a very good year wining new air programs and planting seeds for future aftermarket revenue. Altogether we see incremental value to Donaldson over the life of these programs in hundreds of millions of dollars and those are truly incremental dollars. More than 80% of this value comes from new business where we were replacing a competitor solution. Now keep in mind that that’s our estimate today for the production value of…

[Operator Instructions]. And we’ll take our first question from Eli Lustgarten with Longbow Securities.

Good morning everyone.

Hi.

Hi. Thank you for the color you know on the second half given you know they are sort of flattish. But I am wondering if you can talk a little bit, you have very sharp declines in Ag in your numbers and continuing decline your 1020 and 510 in mining or some can you -- is that all that decline going to take place in the first half of your fiscal year which is rest of this year or are you seeing things for the full year that it just gets less and less. I mean are the profile which we can just stay at current levels and therefore it is comparative issue or is it actually another step down in production if you look out?

Eli, its Jim. We do see a little bit of an additional step down from what we’ve seen but the biggest impact is year-over-year. So the first half we were generally pretty healthy in terms of the Ag markets on a relative basis. And we also have the impact of FX hitting us significantly in the first and second quarters more so than the third and fourth. So it’s more a function of year-over-year, the impact of seeing that strength of the first of the year is that deteriorated as the year went down. So we don’t see that recovering.

It makes a sense that you are looking -- we have a serious comparative in the first half of the year but as you get into calendar 2016 there is some modest step down further from where we are at this point, what you are pointing at this point?

That’s true especially when you come to the first-fit vehicle comparisons across the off-road markets. We don’t see those same step downs. We haven’t projected those in the replacement parts business of course. We feel we have opportunity to continue to press into the markets and execute our strategies for share gain. But it is true what you are talking about on the first-fit.

And if we look at the gas turbine market I guess probably the surprise is the potential double-digit decline, is that all in the second half of the year or is that we see that’s now I mean such a lumpy business that we think can be down 10% plus. I mean we did that every quarter or that we hold up in the first two quarters and then drop off in 2016 or can you give us some feel for the gas turbine business looks?

Yes Eli this is Jim. We actually see that decline starting at the start of the year. So it’s really throughout the year we see those comparative declines although last year first quarter was a little bit of a softer quarter. So I’d say we’re probably in line with that but it’s a drop off from the levels that we’re seeing here in the fourth quarter.

But it’s pretty much a step down all year in that business?

Yes. I mean it’s hard to predict quarters because of the timing shifts of some of those projects. But for the most part it’s all year keeping in mind first quarter last year we did have a slower revenue quarter and we see this year being similar.

And as far as the businesses that you sort of have some optimism for a next year is construction and sort of truck, would you sort of I guess you go stable. Are you expecting modest improvements in construction activity for the rest of the year and into next year or is that again just sort of more of the same and it means mostly the forecast of the heavy truck market are showing declines to 2016 over 2015, is that how you factored in the years hold up the first half in declines in second half or can you give us some feel from versus what the truck -- we are hearing from the truck companies at this point?

Eli, this is Tod. So in constructions that’s exactly right. We have a modest increase. So low single-digit increases throughout the year and then when you talk about on-road we actually have it a bit more mixed, so modest in the U.S. but more positive in Europe. So therefore you roll those two together and your low single-digits is not the double-digit increases that we experienced last year, it is more 0 to 5 low single-digit range.

Alright, thank you very much.

And we will take our next question from Laurence Alexander with Jefferies.

Good morning. This is Dan Rizzo in for Laurence. Just given the FX trends or I should with the weakening environment and everything that is going on, is that like improving the M&A targets. We are seeing more people willing to sell now just given how tough things are in certain end markets?

Yes, this is Jim. I really don’t see that we have seen any impact from, especially FX with regards to the M&A, any sellers approach to M&A. It obviously impacts some of the economics in terms of how certain countries translate back to dollars or if there is competitive advantages. But no significant shift there and maybe I will let Tod comment on this as well but I don’t see any impact of some of the tougher end markets making any companies more available for sale.

Yes, I would agree with that. I don’t see FX playing a role as a variable in any of these transactions or design of the sale. I also don’t see more stressed corporations coming forward as a result of FX. We don’t see that at all. It is a more normalized type of an acquisition environment, those two variables are present.

No, I am sorry I meant just the tough [ph] -- not FX but in regards to FX I know you guys have done a good job with your contract wins but just the tough FX environment making more or just a foreign competitors more attractive was increasing. I mean translation side, increasing competitive pressures on you guys in different markets and the different regions?

No, it hasn’t. Our strategy as a corporation that we developed long ago is to manufacture within regions, to support our regionalized customers. So where we are very mature across our airbase, we can do that all throughout the world. So Europe for Europe, United States for United States, etc. We are a little less mature in liquid because it is an unfolding strategy over the last ten years. And so, we feel the pressure where we do not have that infrastructure built within region as we grow our liquid business in a specific region. But that's the reason behind for example our Poland investments, we now have volume and it is time to serve our European based customers on liquid from Europe. So you will see us naturally have that as a strategy and therefore probably won't point directly to what you are talking about.

Alright, thank you guys.

And we will take our next question from Brian Drab with William Blair.

Good morning Tod, Jim, and Bill.

Good morning.

Thanks for taking my questions. On the market share gains that you are talking about Tod is interesting and is a huge opportunity we know you have within introducing all new proprietary technologies. I was wondering if you could in some way possibly quantify in terms of geography U.S. versus Europe and end market on-road versus off-road, maybe what sort of share gains you think you are getting there and also maybe if you could talk about first-fit share and how that's changed and then what you are seeing in the aftermarket. I know it takes a lot longer to play out in the aftermarket but just in any way that you could quantify for us what you see in terms of share gains would be really interesting?

So, the bulk of the customers that we have on those first-fit opportunities are really U.S. and Europe based. We do have the multinational decision makers that are in Europe and the Americas that then translates a win over into Asia for example. But the decision makers being European and Americas based that is where our wins come from and then as our OEs globalize we follow them in order to maximize that win if you will. So that’s where we are really focused. It happens to be kind of home game if you will. So our European colleagues are winning in Europe, the U.S. colleagues winning in the U.S. and that’s the way we divide up our OE customer base. So Volvo [ph] for example would be held out of Europe and Caterpillar here out of the United States and each account team would have a global team but really that the primary lead person in that region. We are doing very well therefore in Europe and United States. We can still do better for China based customers. We have some wins there starting to get some momentum. Going to take a little bit longer based upon the pressures of that general economy. As far as market shares in Asia, I would say our market shares are low single-digits so we have a very good opportunity. For Europe our market shares are say high single-digits to something like 8 to 12 and then in the U.S. it’s going to be better than that. But they swing very differently based upon our markets. So if you are on-road market in the U.S. is very different then the on road market in Europe and so it becomes very difficult to give you a meaningful one number on that. But I can assure you that we have plenty of opportunity ahead of us if that’s what you are curious about.

That’s helpful go ahead.

Brian its Jim. The one thing I was just going to add in addition to the OE opportunities Tod is mentioning, a good example of where we are growing faster than the end market is Latin America where in local currencies this year specifically like our engine aftermarket businesses we have been growing in excess of 10% for the year in local currency where those end markets have generally struggled.

Okay, thanks and just had a follow up on Tod’s comment on Europe 8 to 12 what number is that referring to, what market are you referring to specifically?

If I just take a look at all of Europe and I just try to macro consider the off-road and the on-road put it together it’s generally in that range I would say.

Including first-fit and after market just in general we’re seeing?

Right.

Okay, thanks and then I want to make sure I got this right, you mentioned that you are still seeing a choppy sort of inventory destocking environment in the OE distribution channel, is that are you seeing the same thing in the independent channel.

More of just caution, we are not being whip side so much by the independent. It’s just more caution with order quantities, steady orders coming in just less pieces at a time.

Okay and then on the restructuring we’d like to just maybe put a finer point on the timing here and maybe get a little more help on how to think about this one building the model. So the 35 million in annual savings, when did you achieve that run rate or when will you achieve that run rate and then is there more restructuring to be done in fiscal 2016 and the timing of those charges and what potential cost cuts will we see as a result of those?

Brian its Jim, in terms of the annualization of those savings we got to about 90% run rate. There is a couple things that yet occur in the first quarter. There is a plant we’re still in the process of closing in the U.S. that won’t hit full run rate till the end of the first quarter. About 90% of the run rate will be achieved in the first quarter and we got of the $35 million, we got $3 million to $5 million of that in the fourth quarter of this year. So next year’s number is about $30 million given that we have achieved roughly $5 million of it already. In terms of additional restructuring, we are continually fine tuning our headcount, matching up our production employees with volumes that is standard work that we are doing all the time. So, that while we don’t call that out as restructuring that is something that we are consistently doing just trying to align our expense base with the end market demands. So we don’t have any restructuring planned at this point but we just have to stay tuned to what the end markets do.

Okay, thanks for all the details. Thanks.

And we will take our next question from Kevin Maczka with BB&T.

Thanks, good morning. Jim just said another way on that restructuring savings, so 30 million is the incremental number in fiscal 2016 versus 2015?

That's right.

Okay, got it, thanks. Going back to the engine guidance, up 2% to 6% local currency, I guess we were negative 1 in 2015 and I guess just listening to your comments, I didn’t hear a lot, it sounded like it was plus 6 or better here. It sounds like truck and construction maybe low single and of course mining and Ag are still down sharply and even the aftermarket maybe only modest growth. So, can we just revisit some of those details and what is the scenario whereby we would be up in the 5% to 6% range?

Kevin, I will start on that, a couple of things in terms of the local currency growth. As you recall, third quarter of this year we really started to see a significant decline in our engine aftermarket business partially due to end market weakening but also due to inventory adjustments that we saw on the OE channels all the way through the end of the year. In our forecasted plan we expect that to normalize and not recur so that is a little bit of a lift on our aftermarket year-over-year. Additionally some of our end markets that have come down significantly, even though we are not projecting significant increases, we to the extent these end markets are stable, we will be able to continue to deploy equipment out in the field to grow our replacement parts that are proprietary in nature which we project to grow double-digit still with respect to that. So, aftermarket is a positive. Additionally we do have some new programs that are launching that will launch into lower volumes than we originally anticipated but those will begin to launch in terms of some of the liquid programs we have talked about and some other wins.

Yeah, just adding to summarize that Kevin, it is as you said construction and it is on-road. Both of those are positive on the first-fit side and then really all of our aftermarket investments, our aftermarket initiatives such as those new distribution centres in Columbia as well as our pressing forward with more sales people in Europe and our activities in the U.S.

Got it and then shifting over to special apps, specifically the disk drive portion of that, what are your seeing there as you look out. I know that business has been under pressure with the tablet PC shift but it seems like a lot of PCs now are shipping without disk drivers altogether. So, there is maybe some additional pressure there. What do you see for that business in 2016 and longer-term?

Lot of -- this is Tod, what we look at in that business in 2016 is essentially a flat business. We have a very good relationship and a very good share with our customer base. We have opportunities for additional share gain to offset any weakness that we would see in that market. So, we see in 2016 at this point a pretty flat business. Longer-term it is an interesting conversation because ever since I have been at Donaldson people have been calling death to the disk drive and it really hasn’t happened. So, we see long-term that this is really still a strong business for us. We have to continue to keep up with the drive makers as they migrate technology into larger platforms and so on. And we believe we have the technology to do so but we believe that has a long standing future for our company.

Okay, thank you.

And we’ll take our next question from Brian Sponheimer with Gabelli & Company.

Hi, good morning Tod.

Good morning Brian.

Tod just strategically how are you thinking about the business maybe relative to your own expectations three to four months ago when you became or when you took over for Bill. Has there been any change given the overall market environment, you spoke to the 5 billion in sales being a matter of when and not if but just talk about how that’s progressed as you seeing the last four five months take place?

Well certainly the overall macro view that I had coming into this position took a pretty strong turn in March and April. And so it put us a bit more defensive than playing offense than we wanted. That’s absolutely sure, that’s a significantly different look than coming in. However, behind all of that those are things and cycle that Donaldson company has experience dealing with. We know how to do that work. It’s not fun work but we do that very well. We stay disciplined in our financial and fiscal management. We’ll continue to do so but what hasn’t changed is the base and foundation of our strategy and that we are a technology lead filtration company and we need to continue to press forward with that to execute well for growth on 5 billion. I talked a lot about those program wins. Those program wins that I talked about will not bring revenue in fiscal 2016 and that’s unfortunate because we’d all love to have more revenue in fiscal 2016 but those are very critical for 5 billion and 2017 and 2018 and so on because you can’t lose those programs. If you lose those programs you put the long-term health of the company in jeopardy. And I am very proud to say that we are winning and so that hasn’t changed that outlook. Surely FX and all those things we can’t control are going to force to change the year of 5 billion but how we slice that pie and what it looks like at 5 billion that still looks very same.

And given that the balance sheet is in terrific shape and you have made a few acquisitions of the smaller variety, just talk a little bit about the potential portfolio of assets that are out there. I know you mentioned that end market volatility isn’t really changing much but is your scope on M&A potentially getting a little bit bigger or I guess I’ll leave it there?

So about 14 months ago we took a good honest hard look at our self and said we need to make our profits more robust. We had as part of our strategic growth plans 1% to 3% overtime of growth through acquisition and we had only done one in the last five years. So it’s just -- we are just honest with each other and said look we are not performing to our promise. And so we refurbished the whole process and I think you see the result now and the way we started that is we started with every business with what is the strategy that they have in the business and where is there an opportunity to accelerate a piece of that strategy through adding a new -- expanding the product family, adding a channel, some variable that we were going to take a little bit too long to add to that portfolio. Create a target list and go start knocking on doors and we are having some success. Now I want to say it that way because I want to emphasize we are staying very disciplined and we are not playing on the fringe. We are playing on strategic bulls eyes and I am very comfortable with that process and that is the process we’ll continue to use as we go forward. The one we announced yesterday after Industrias Partmo closes that’s four acquisitions for our company in 12 months. I am not saying that every year we’ll do four acquisitions, that’s not a promise we are going to make. I am just saying that we have a process we are very proud of now and we’ll stay disciplined in our process, we’ll continue to use that as part of our overall strategy.

Great, thank you so much.

[Operator Instructions]. And we’ll go next to Rob Mason with Robert W. Baird.

Yes, good morning. Just real quick housekeeping, Jim do you happen to have the first-fit versus aftermarket split total company for the quarter?

Yes just give me one second.

And maybe if you are looking for that, the liquid filtration revenue in the quarter as well?

Yes, the liquid filtration oh I got the year, so the split between replacement and first-fit total company is for the quarter or for the year?

For the quarter or if you have that?

We were about 69% replacement, 31% first-fit for the quarter, and I am sorry, bear with me and 57% and 43% for the year.

Okay

And then I am finding the liquid here.

Sure.

Well Brad, maybe we could move to the next question.

Yes I’ve got the liquid.

Okay.

So liquid for the quarter was a 120 million.

Okay, could we just drill down into the IFS business just a second. The expectation will grow low single-digits in 2016, how does that shake out between the aftermarket and the first-fit side and specifically on the first-fit side, I am curious how you mentioned some quoting activity in the U.S. but I am curious how your exposure to capital spending globally is in the first-fit side of IFS?

So this is Tod, I’ll start, our exposure to capital spending globally for our IFS business or dust collection business is significant. I mean that is the first-fit portion or the equipment portion of that business. So it’s clearly a good indicator as capital spending has come down that business has also softened and we see a pretty good correlation there. It’s true in Europe and its true in United States. However, that doesn’t when you see capital spending come down, that does not correlate at all to the replacement parts portion of that business. For example we’ve had somewhat modest CAPEX spending in the U.S. all last year for dust collection and so you see that in our first-fit more modest first-fit growth. But our dust collection after market in the U.S. grew double digits last year. So there is a different indicator, its more machine use for the aftermarket.

I guess maybe more pointedly would we expect to first-fit side of IFS to grow in 2016?

Yes.

Okay and just maybe last question Tod, as I know this past year 2015 was a tough year to call with the OEMs and just some of your channel inventory activity moving around pretty volatile. A similar situation I guess in 2013, difficult to call those as you move through the year from a guidance standpoint. Has there been any since you’ve come on, have you and Jim incorporated any difference, maybe changes to your forecasting methodology so that as you enter 2016 you are able to get a little bit more confidence around the guidance you are delivering today?

Yes Rob, this is Jim. We have certainly taken into account the challenges we’ve had as we in many cases chased some of the end markets down. We typically going back a year ago would have taken the best estimates we can get from our customers. The other intelligence we can get and make our call in terms of our guidance based on that. The challenges, our visibility in many of our end markets isn’t more than 30 to 60 days in some cases and what happened over this past year was we came out with our best estimate and a matter of weeks later some of those numbers changed. So, we have tried to take into account the fact that these end markets are very uncertain and contemplated that as best we can. It is just very difficult when the end markets were changing as volatively as they were to adjust our guidance. But we have taken some steps to try to address that.

We have and last year was clearly difficult. I mean if you -- we baked in Caterpillar's guidance that they were going to go down $5 billion and then now they are down another $1 billion and people are all trying to understand what are the variables within that. We have stepped back and tried to make sure that we really canvassed the entire organization to make sure we have the best information to roll out into our forecast.

Okay, now understand the challenge, thank you.

Hey Rob before you leave, I apologise but as I was grabbing those numbers I grabbed the wrong first-fit replacement so let me give you the corrections. So, for the quarter it is 57% replacement, 43% first-fit, and for the year it is 56%, and 44%. I think one of the numbers I might have grabbed was engine only, so I apologise.

Okay, thanks. Appreciate that.

And we will take our next question from Larry Pfeffer with Avondale Partners.

Good morning gentlemen.

Good morning.

Just a couple of questions on the guidance range again, do you have an underlying kind of industrial production both in the U.S. and internationally assumption for your fiscal 2016?

Well, each of the -- Larry, each of the end markets operate differently. So, unlike the industrial dust collection business we will look at like machine tool index these and those types of things which even vary by region. So there is not like one index we can look at. Gas turbine we look at some of our major OE customers projections and take into account what kinds of win rates they are getting because then those will be our opportunities. Special applications, we talked a little bit earlier about disk drives. We looked at PC builds and some of those statistics. But for the overall industrial groups given our businesses are in so many different end markets there is not just one index that we can point to. Unfortunately it makes it challenging.

Right, I guess I was more asking are you expecting kind of just a similar pace in the overall industrial environment to what we are seeing right now as you move through the end of this year and the next year?

Yes, I am sorry. So yes, we are not forecasting any significant improvements but at the same time the -- again it varies by geography. So we are less optimistic in places like China or Asia-Pacific than we are in the U.S. and Europe. But that is fairly consistent with what we are seeing today.

Okay, and then just do you have an overall kind of market share gain assumption built into your engine guidance?

So, Larry this is Tod. The way we look at each year is we believe that and we hold ourselves accountable to gain between 2% and 4% market share gain across our businesses and that is what we ask of our leadership. So, that is within our overall growth model.

Okay, fair enough. Thank you, gentlemen.

And we will take our final question from Charlie Brady with SunTrust Robinson Humphrey.

Hi, good morning guys.

Good morning Charlie.

Hey just a quick one on the -- with regard to the mix and the margin expectation in fiscal 2016, are you expecting any kind of material shift in that first-fit replacement mix to drive in that margin whereas kind of the 57% or 43% we saw in the quarter or maybe I guess for the year 56%, 44% give or take a percentage point. You are not looking for a major shift there or are you?

No Charlie, this is Jim. We aren’t seeing any significant shifts there. A lot of our improvement opportunities are, Tod mentioned localizing production. We have taken a look at how third quarter the volume is really dropped on us unexpectedly and we had worse absorption of some of our fixed cost than we would have liked. So we have tried to adjust those types of things. But there is not a dramatic mix shift that we are forecasting for next year.

So great. Thanks, that's all I had.

And we have no further questions. I would now like to turn the conference back over to our speakers for any additional and closing remarks.

That concludes today's call. I want to thank everyone for their time and their continued support of Donaldson. Most importantly I would like to thank all of the Donaldson employees for what they do every day to help make our company the filtration leader. Have a good day. Good bye.

And this concludes today's conference. Thank you for your participation. You may now disconnect.