Good morning. My name is Denise and I will be your conference operator today. At this time, I would like to welcome everyone to the Donaldson’s Q1 Fiscal 2017 Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. Brad Pogalz, Director of Investor Relations, you may begin your conference.

Thanks, Denise. Good morning, everyone. Thank you for joining Donaldson’s fiscal 2017 first quarter earnings conference call. With me today are Tod Carpenter, President and Chief Executive Officer and Scott Robinson, Chief Financial Officer. This morning, Tod and Scott will discuss our first quarter performance and provide some insight on fiscal 2017 and an update on some of our strategic initiatives. Before we begin, I want to cover a few housekeeping items. During the call, we may reference non-GAAP metrics such as adjusted earnings per share. You can find a reconciliation of GAAP to non-GAAP metrics within the schedules attached to this morning’s press release. Also, for reference, we posted a schedule on our Investor Relations website showing the year-over-year sales change with and without the impact from currency translation. I want to remind everyone that any forward-looking statements made during this call are subject to risks and uncertainties, the most important of which are described in our press release and SEC filings. I will now turn the call over to Tod Carpenter. Tod?

Thanks Brad. Good morning, everyone. We are pleased with the start to our fiscal year with first quarter results keeping us on track to deliver full year sales and adjusted profit in line with our prior guidance. As we look more broadly, we see mixed signals in the market. On the positive side, there is further evidence of stability in some of our businesses. In the Engine segment, demand in off-road has stabilized while trends in the aftermarket business suggest we are through the broad-based destocking we experienced in prior quarters. On the industrial side, there has been a slight pickup in quoting activity and we are seeing slightly more first-fit projects move forward. While we are encouraged by the signs of stability, we are not seeing evidence of a near-term market rebound. For example, since the U.S. Presidential election there has been a lot of optimism about the possibility of increased infrastructure spending. We are also excited about that possibility, but we recognize that it would be a while before any increase would take place. Until then, we will remain cautiously optimistic and focus on what we are seeing in our business. Based on our analysis which is supported by customer perspectives and third-party data, we continue to view this operating environment as being more of the same for at least the balance of our fiscal year. With this market perspective as a backdrop, I will now turn to our first quarter sales performance. Total sales of $553 million were up 2.8% from last year driven primarily by growth of replacement part sales in both segments. Within our Engine segment, the total increase of 2.1% was led by aftermarket as first-fit sales remain under pressure. Consistent with our projections, sales of on-road products declined nearly 26% from last year…

Thanks, Tod and good morning everyone. Our company achieved an important milestone in the first quarter as we closed our consolidated books for the first time on our new global ERP. I want to thank everyone involved in reaching this milestone. We have lot of optimization work left, but I am proud of the efforts to-date. I will shift now to a recap of our first quarter performance. We were pleased with our performance as we converted a 2.8% sales increase into strong profit growth on both the GAAP and adjusted basis. First quarter GAAP EPS was up more than 48% driven in part by one-time items this year and last. In 2016, we incurred charges for restructuring and fees for the investigation into our GTS business that totaled $10 million with $3 million in gross margin and $7 million in expense. This year, the one-time impact benefited GAAP earnings. During the quarter, we settled claims against an escrow account that was established when we acquired Northern Technical, 2 years ago. For the terms of the settlement, we can only disclose the financial impact, which was $6.8 million. This benefit was recorded in the other income and expense line of our P&L, so there was no impact on our operating margin and it was excluded from adjusted EPS. Excluding the one-time items in both years, our Q1 adjusted earnings per share grew 11.8% to $0.38 from $0.34 last year. Our operating margin in the quarter grew to 13.8% from last year’s adjusted rate of 12.2% with the majority of this increase coming from gross margin improvement. Our first quarter gross margin of 35.1% benefited from higher fixed costs absorption as compared with last year’s rate, which faced pressure from under absorption. Looking back, our Q1 rate is fairly consistent with…

Thanks Scott. We believe our guidance appropriately reflects the mixed market conditions we are seeing. As we discussed, we continue to see evidence of stability in certain businesses, but we are not expecting a return to broader market growth during our fiscal year. Given the current environment, we think growing profit with flat sales reflects our focus on controlling what we can. To deliver our fiscal ‘17 commitments and position us for the future, we are prioritizing a core set of actions. For future success, we are leveraging our technology to drive first-fit program wins. Engine liquid is the significant example of this opportunity. Our innovative Synteq XP technology addresses challenges from low sulfur and bio-diesel fuels and higher fuel injection pressures, creating a first-fit opportunity for this fuel filtration solution that did not previously exist. We have had a number of significant wins over the past few years and we continued to work a very large pipeline of opportunity. We are also investing in businesses that have near-term growth opportunities, including replacement parts. Engine Liquid is playing a key role here as well. Over the past year, we have been winning new business in the OE service channels by adding new parts to our offering. During first quarter, our liquid business grew in the low double-digits compared with last year, reflecting the progress we are making by expanding our business with existing customers and adding new ones. Another core priority is improving operational efficiency. Across the company, we are identifying opportunities to refine our operations and capture more cost savings where appropriate. Given the work we did last year and our current project pipeline, we believe we are well-positioned to grow our profitability with relatively flat sales. Finally, we are making thoughtful investments in our business. For example, we are developing a global e-commerce system that will go live during our next fiscal year. This new system will allow customers around the world to order our products with ease. We also continued to pursue inorganic growth through acquisitions. There is nothing to announce today, but we remain a disciplined buyer and continue to work our pipeline. Our fiscal ‘17 plans align with our strategic priorities to grow our business through our core technologies, geographic expansion and acquisitions. We are confident that our efforts position us to deliver our commitments this year and strengthen our foundation for future growth. I sincerely want to thank our employees across the world for their dedication to helping us achieve our priorities. With that, I will turn the call back to Denise to open the line for questions. Denise?

[Operator Instructions] Your first question comes from Charlie Brady from SunTrust Robinson. Your line is open.

Thanks. Good morning, guys. I guess with respect to the GTS business, I know obviously it’s hugely lumpy business, but I wonder if you could just maybe give us some sense of how you think the rest of the year plays out in terms of how the sales might come in for the rest of the year understanding that it’s pretty lumpy business?

Charlie, this is Tod. In the GTS, our first quarter is actually on a comparative basis year-over-year, the best quarter we are going to have. It’s really going to be now more tougher comps as we lay out our expectations for the balance of this fiscal year every quarter going forward. Our full guide on GTS was 10% down for the year roughly and that still holds.

Okay, that’s helpful. Thanks. And just kind of a bigger picture question on the cash, you noted almost all the cash is outside the U.S. I guess, given the incoming administration, what’s your big picture thought on if there were some legislation or changes in tax law that would allow you to repatriate cash at a more reasonable rate? Is that something you are inclined to do? And does that help you one way or the other in terms of potential M&A transactions or anything like that?

Yes, so this is Scott. So, it’s certainly something we think about a lot. Our cash historically has mainly been outside the U.S. and we repatriate when we can and where it makes sense. Certainly, if the incoming administration were to facilitate monies moving back to the U.S., we would be glad to take advantage of that.

Okay, thanks guys.

Your next question comes from Ben Hearnsberger with Stephens. Your line is open.

Hey, thanks for taking my question. If you look at your guidance, I am curious if you would give us the gross margin implied in your full year guide?

Ben, we haven’t broken – this is Brad. We haven’t broken out the specific line items, but full year improvement is going to be driven more by expense leverage versus gross margin.

Okay. And then looking at expense leverage, I think 1Q adjusted OpEx was up slightly year-over-year. Can you give us the puts and takes? How much did you see – how much of a tailwind did you see from some of the restructuring actions? How much bonus accrual did we see in 1Q?

Yes. So, this was in our guidance, but just to recap, we had approximately $12 million of benefit coming in from the restructuring programs from last year. That was offset by $20 million of incremental variable compensation expense. Those two amounts were inherent in the guidance. Obviously, our profitability in our guidance increased. So, we were able to offset that headwind with disciplined cost management throughout the company.

Yes, I am sorry. So, the $12 million that was all incremental to 1Q?

No, that wasn’t – that was to the first half.

Yes, that was mainly for the first half of the year and included in our full year guidance.

Sure. Can you tell us how much you experienced in 1Q out of that $12 million?

It’s not that precise. If you just take the announcements we did over the past fiscal year and assumed it was perfectly ratable by quarter, there would be more of that $12 million in first quarter than there would be in second quarter, but it’s not perfectly precise.

Okay. And then I had a higher level question for Tod and I know this is real time. But clearly, Parker and you know Clarcor’s filtration business, I am just curious at a high level, how do you think about the potential change in the competitive dynamics of the market if the deal does go through?

We compete with Parker in the compressed air space of industrial – so industrial uses of compressed air and we also compete with Parker in diesel fuel within their Parker Racor brand. Clarcor is not in the compressed air space. However, they are in the diesel fuel. Putting the two together, clearly, allow some synergy of a larger company, but for us from a competitive standpoint of view, it’s really kind of more of the same at this point.

Okay, thanks for taking my questions.

Thanks, Ben.

Your next question comes from Laurence Alexander with Jefferies. Your line is open.

Good morning. This is Dan Rizzo on for Laurence. So, the recent rebound in metal commodity prices, is it too soon to tell if that’s going to, I mean, drive growth later in the fiscal year? I mean, is there any signs of anything yet?

No, we have not seen any signs of that. We have longer contracts for our critical materials like steel. They will go out 6 months. And until we lap those contracts, then we will get a little bit better visibility depending upon where the steel is as we renegotiate, but all of that and what we know currently is baked into the current guidance.

Okay. And then you mentioned you gave that example of Engine Liquid as an example of a new product or new contract win. I mean, is there any others that you could provide color on that’s showing that, I mean, there is more in terms of fresh-fit wins that are kind of driving growth?

Sure. We have – if you just take our air-based products, if you look – split the company in air and liquid. On air, we have won over 75% of what we define as a must-win project in the last 12 months. And in liquid, we are also over 75% of what we defined as a must-win project. Must-win to us means it would drive $5 million worth of revenue for the company over a 10-year period. So, you can see our win rates across our product families are really quite high and we are very proud of that.

Okay. Actually, that was very helpful. Thank you very much.

Thank you.

Your next question comes from Brian Drab with William Blair. Your line is open.

Thanks for taking my questions. First, are you starting to see – de-stocking has been such a theme here for several quarters. Are you starting to see some restocking potentially in any of your end markets?

Tough to say, Brian. We still have uneven ordering patterns across our aftermarket. We have some real successes to point to within our strategic initiatives of adding to our strong distribution channel as well as broadening our product portfolio. So, we can point specifically to driving that within that growth that you saw in our first quarter. But we also had a little bit of easier comps because of that de-stocking you referred to in the first quarter last year. So, we believe there is certainly the range of possible outcomes across the aftermarket channel have narrowed and there is a little bit more stability, but it’s – we are not calling it as hey, we are on the floor. We are still just a little bit uneasy as we turn into the end of this calendar year.

Okay, thanks. And then just turning to gas turbine and actually, on the smaller scale gas turbine business, which I understand a lot of that will go into oil and gas, what are you seeing in the oil and gas market, are you seeing any – many signs of stability or potential growth there given that’s really fallen off of a cliff, hasn’t it, for you over the last several quarters – or many quarters?

Yes. Oil and gas is certainly pressured especially on our aftermarket channel. And then what we would consider our small turbine business of oil and gas and pipeline gas turbine, they certainly pressure that over the last couple of quarters. As we pair back and look deeply into inside of our aftermarket business, we wouldn’t point to any specific indicator that suggest oil and gas is helping us with the lift at this moment. We continue to look for that, but really nothing appreciable to discuss.

Okay. And which lines, if any, would you highlight in this first quarter that – which business lines outperformed what you are expecting?

I think the quarter is pretty much what we had thought we talked about in our guide, that our strategy is to press hard in our replacement parts businesses to help offset the headwinds of our first-fit. And you see that across our company in all of our numbers. And so really, we just have very good strategic execution and I am really proud of every region and what they are pressing for right now in that strategic focus.

Okay, thanks. Would you mind if I ask one more, in light of this Clarcor agreement with GE, can we just – can you drill down into the dynamics in that market a little bit and talk about, first of all in the gas turbine market, my understanding is that there is some pressure from your customers to maybe move away from buying the whole system, meaning including the housing and the internal filtration components and that housing as I understand is a major part of the purchase – the overall purchase price of the filtration system and how does that affect may be the top line for you, how has it affected and how does it affect going forward the top line in the Gas Turbine segment. And can you also comment on just how important GE is to your gas turbine business for the large scale gas turbine filtration systems? Thanks.

So what you are referring to is a large turbine filter house has some components in the middle that are what’s called smart parts, the filters themselves and for example, compressed air component that goes into keep those parts running effectively in front of the turbine, so it can supply ambient air. It’s roughly 20% to 25% of the overall cost of the filter house per se. There is – there was a move by one customer GE, to actually go in that direction on one platform. And clearly, market information indicates that, that’s what they have done and they have reached an agreement to do so. We don’t see that behavior everywhere across the market, but what that does do, if you are going to supply that smart parts, if you will, that allows some of that cheap metal fabrication to really be extended out to any sheet metal fabricator around the world. So that 75% to 80% of the price of a larger filter house could go elsewhere. Now, you still have to make it to the project specifications and GE welding requirements and so on, which are also very specialized, but that’s the net effect in the relationship of those. As far as GE and the importance to our overall gas turbine business, well GE is the number one gas turbine manufacturer in the world. So clearly, they are important as well as all of their competitors. They are, are currently not our largest customer within our Gas Turbine segment at this point.

That’s all very helpful. Thank you.

Your next question comes from Rob Mason with Robert Baird. Your line is open.

Yes. Good morning, just a clarification question first, Scott. I want to make sure that I heard you correctly, you said that your guidance you planned does not really contemplate any operating margin expansion in the second half of the year, that would all be in the first year, did I hear that correctly?

Yes, it’s essentially correct.

And then I am curious, given the FX movements that we have seen of late, what are you assuming in the minus 2 to plus 2 sales guidance for the currency impact now?

Well, we had some tailwind in the first part of the year and that slipped to a slight headwind. And currently as where the rate sits today, so that benefit that we achieved from currencies in the first part of the year would be raised. We still maintained our current guidance and essentially all respects for our revenues for the year.

Okay. And then Tod, I have noticed the – your engine aftermarket business demonstrated another strong quarter in Europe and that’s a string of several solid quarters there, could you just drill down into what’s driving the engine aftermarket strength in Europe, whether that’s Western Europe or is that emerging Europe, where that’s coming from and some of the drivers there?

Sure. So within Europe, we are really just executing the strategy that we have been talking about for several quarters, which is strengthening our distribution channel, adding distributors to our current business as well as broadening our product offering. It’s really both. We have done – had success in both Western Europe and Eastern Europe and even up into Russia actually. And so we are just continuing to work our strategic plan, continuing to have that unfold. And the next step that we would look to do is even expand our distribution centers across Europe to support our growing business. But really, that’s what’s happening and they are just doing a great job.

And then shifting gears just to the IFS business real quick, you mentioned some slight uptick in quoting activity, what do you think – one, is that region specific or is that a broader comment in IFS. And then two, what are you hearing from the field that it will take those customers to actually pull the trigger on spending on the capital equipment side there?

So it is both in Europe and the United States. However, the reason why we remain a bit more cautiously optimistic about it is, because we still have what we would consider to be large projects, elephant projects, rather than a consistent base of say, lower six digit type of projects. When we have a lot of those type of projects going on, then we know that the overall CapEx spend across the industrial base is back. But this is a bit of a more lumpier type of a move and so that’s why we have cautious – a bit more cautiousness in that. What would it take, just really industrial production is going to really have people start to believe and spend CapEx and then you will get a more broad based first-fit project buy, if you will.

Okay, very helpful. Thank you.

[Operator Instructions] Your next question comes from George Godfrey with CLK. Your line is open.

Good morning and thank you for taking my question.

Good morning George.

Good morning. I wanted to ask about the desire today versus may be 1 year or 2 years ago for acquisition, I heard your comments about looking at doing deals, but I am just wondering if the appetite level, given Parker Hannifin’s action this morning, might increase your sense of urgency or the magnitude and size looking at the last couple of years, you have spent some money on acquisitions, but nothing really all that large, I m just wondering if that’s changing today and has it changed over the last year?

When you take a look at our strategy within acquisitions, we have always had or looking to add over time, 1% to 2% acquisition revenue on an annual basis as part of our strategy. 5 years to 6 years ago, we just weren’t very good at executing on that. And so we stepped back a couple of years and we refurbished our entire process. And out of that process, we were honest with our self and said look, if it’s part of the strategy then embrace it. If it’s not, then let’s stop trying to execute. Well, we took action to embrace it and you see our four acquisitions over the last couple of years as a net result of that. I would say that our process in our pipeline is still robust. It is strategic in nature and selective and that we remain a disciplined buyer.

Okay. And if I could just follow-up on that, just one quick question, leverage based on my estimates, net debt to EBITDA, 0.8x what would you be comfortable taking up that to? Do you have a threshold or a limit or a target range in mind?

We are certainly comfortable with where we sit today. We were a bit higher last year. And if you recall, we said we are working to bring that down. We were comfortable with where we sat last year, but we just thought we had room in the balance sheet to improve our asset efficiency and we work to improve that to bring that down to the current 1.5 level that we sit at today. We certainly like that position. It gives us powder. Should we need it? And we just look to maintain a strong balance sheet going forward.

Great, thank you very much.

Thanks, George.

There are no further questions at this time. I turn the call back over to Tod Carpenter.

That concludes today’s call. I would like to thank everyone for their time and their interest in Donaldson and particularly, Donaldson employees across the world for their wonderful performance in our first quarter. Thank you. Have a good holiday.

This concludes today’s conference call. You may now disconnect.