Good morning. My name is Tashan and I will be your conference operator today. At this time, I would like to welcome everyone to Donaldson's Third Quarter Fiscal Year 2017 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to Brad Pogalz, Director of Investor Relations. The floor is yours.

Thanks Tashan. Good morning, everyone, and thank you for joining Donaldson's fiscal 2017 third 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 recap our third quarter performance, the drivers of our increased guidance for fiscal 2017, and provide an update on some of our strategic initiatives. During today's 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, this morning we posted a schedule on our Investor Relations Web-site 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. Now, I'll turn the call over to Tod Carpenter. Tod?

Thanks Brad. Good morning, everyone. I want to begin by welcoming the Hy-Pro employees and their valued customers to Donaldson Company. With their focus on stationary applications, Hy-Pro is a strong complement to Donaldson's mobile hydraulic business. Our two companies leverage product innovation and world-class customer support to solve complex filtration problems. We're looking forward to combining our global footprint and technology with their application expertise to accelerate growth in the strategically important liquid business. I also want to thank our Donaldson employees worldwide for their contribution to our strong results. They are doing an excellent job addressing demand and meeting our customers' needs. At the same time, they are pressing forward on our strategic initiatives, further strengthening our foundation for continued success. I sincerely appreciate their hard work and commitment. Turning now to a recap of our performance, we had another strong quarter on the top and bottom lines, driven primarily by the Engine segment. We anticipate recent trends to continue, so we increased our full-year forecast for sales, operating margins, and earnings. In total, we see fiscal 2017 sales up approximately 6% and adjusted EPS up more than 10%. Scott will cover our guidance in a few minutes, but first I'll share some third quarter sales highlights. Total sales increased 6.5%, with Engine up 13.5% and Industrial down 5%. Compared with recent trends, our Engine first-fit businesses performed very well last quarter. In Off-Road, sales grew 27.5% to $69 million, representing the highest volume in 10 quarters. A portion of this increase is due to an easy comparison from last year, but there are a couple of other noteworthy drivers. One factor is a mix benefit from the type of equipment being produced. The largest mine haul truck for example have somewhere around 20x the dollar content of…

Thanks Tod. Good morning, everyone. As Tod said, we had another strong quarter. I'll briefly touch on the highlights and then I'll cover the details of our increased sales and profit outlook. Third quarter total sales were up 6.5%, or 7.7% in local currency. Total operating margin increased to 14.5% from 13.1% last year. Net earnings were up 10%, and GAAP EPS grew to $0.45 from $0.41 in 2016. As a reminder, our prior year results included pre-tax restructuring charges of $4.1 million. Excluding the impact from restructuring in the prior year results, third quarter 2017 EPS was up $0.02 and operating margin was up 70 basis points, reflecting higher gross margin and expense leverage. There were several moving pieces in our gross margin, which was up 20 basis points on an adjusted basis. We captured some benefits from cost reduction initiatives, but higher than expected demand is creating a variety of incremental costs like premium freight and overtime in our plants. The expense leverage last quarter was primarily driven by sales volume, but the benefit was partially offset by higher incentive compensation. Our other income went down by $2 million, with the difference attributable to a swing from a gain on foreign exchange last year to a loss this year. Our third quarter tax rate increased to 28.7% from 24% last year. Discrete benefits in the prior year accounted for nearly all the increase. In terms of cash management, we feel good about our working capital in light of the higher demand. The increase in receivables and inventory levels contributed to the cash conversion rate that was below 100% but not out of line with where we expected it to be. Meeting our customers' needs is always a priority and the increases were in line with the momentum in…

Thanks Scott. We are encouraged by the stability in the Engine end markets, but the variability between our segments remind us that we are still in a mixed operating environment. As we look forward, we expect the recovery to be choppy, especially in our Industrial segment, so we will plan cautiously. At the same time, we are making strategic investments in sales-driving initiatives, expanding our technology portfolio, and strengthening our infrastructure. The most obvious investment to drive near-term growth is adding sales staff to the businesses where we can grow first-fit and/or replacement part sales. Additionally, we are seeking to accelerate growth in some of our newer product offering, such as venting solutions and the LifeTec filters for the food and beverage industry. We also began building an e-commerce platform this year. We are complete with the design phase and our 'into the application build' phase. We expect to launch next fiscal year in select businesses. This platform will make it even easier to engage with Donaldson for new and existing customers. In terms of our technology, we will scale up our R&D investment. We have historically spent between 2% and 3% of sales and we expect to increase that to somewhere between 3% and 4% over the coming years. We want to further widen our technology gap by developing best-in-class media, innovative form factors, and new filtration processes. Another technology focus is connectivity. End users are looking for more ways to efficiently manage their equipment and we believe Donaldson can play an important role in their quest. We are very early in this process but one tactic to drive this strategy is leveraging our acquisition last year of EPC and their Filter Minder brand. This company brought a well-known brand and it had a strong focus on sensors and…

[Operator Instructions] Your first question comes from the line of George Godfrey with C.L. King. Your line is open.

Really nice revenue growth and total revenue coming in over $600 million, I would have thought the gross margin would have been just a tad higher on such a strong performance on the top line. Could you talk about the first-fit products or specific platforms perhaps that are pressuring the gross margin on such a strong revenue number?

Sure. This is Scott, I can take that. So, in terms of gross margin, I wouldn't say it was related to any one particular product category. As we said, there was some gross margin pressures with the accelerated demand, we had a little bump in overtime costs as well as freight, and we also had a tough comp from last year, so those couple of factors I would say is what drove probably the point that you are thinking about.

Got it. And then just a follow-up, this morning Deere announced they are buying Wirtgen Group for about $5 billion and focusing more on construction. Do you have relationship with that company, and if so, is it meaningful or does the Deere open up that door?

This is Tod. We do have a relationship with them. They are a customer of ours and we enjoy a nice position. The Deere relationship really just further strengthens between the two companies what we already enjoy with both of them.

Got it. Thank you for taking my questions.

Your next question comes from the line of Charlie Brady with SunTrust Robinson Humphrey. Your line is open.

Just on the ERP system that's essentially done from what I understand, can you just talk a little bit about kind of leveraging that as you go through? You've spent the past few years, three or four years, engaged in that in a pretty heavy way and now it's kind of essentially behind you with some small blocking and tackling, but how do you leverage that going forward? I think in the past you've talked about some opportunities, but maybe just a little more granular on where you can take that and what that can mean to margins over say a two or three year period?

Sure. This is Scott. So yes, we've talked about our ERP implementation quite a bit. We spent four years and approximately $90 million on that implementation to convert the Company to Oracle R12. Our last conversion was completed on the first day of this fiscal year. So that brings the Company onto a single platform and we feel that we have a long runway of opportunity to have better information, to manage global processes, to standardize processes, and to be able to leverage that into a stronger performance of the Company. So, we are on a long journey of creating centers of excellence and standardizing our processes to both be faster and have better information. We've used the leverage of that system already in our cost-cutting initiatives, and we think we have a long runway to continue that. We're not going to make changes overnight, it's going to be slow and steady, we'll win that race, and I think we have a long runway to leverage that and make the Company operate more efficiently. Tod mentioned, we want to increase our R&D spend, but we don't want to take profitability backwards to do that. We would envision reducing our transaction processing costs and leveraging some of those dollars into investments to further the Company. Also, that system allowed us to begin the e-commerce project this year, which comes right on the heels of finishing the ERP, because we needed a global ERP to link the new e-commerce system into. It also facilitates the HR project that Tod mentioned because we want to link either an Oracle or another HR system, all to R12.

Thanks. And just as a quick follow-up, in the commentary about adding additional capacity to product lines like PowerCore and liquids, are you talking about building out capacity in an existing footprint that you have or is this additional brick-and-mortar footprint that gets put down?

This is Tod. Typically there is both options available to us. Right now, we're looking at adding capacity in our current footprint for both of those as we continue to support growth. Longer-term, we have a region for region-based operation strategy, and so we look for, for example, EMEA to support all the EMEA-based customers, APAC to support all the APAC customers. And so, longer-term, over a five-year period, we're likely to add bricks and mortar over time, but in the near-term, it's more expanding to meet the current demand within the current footprints that we have.

Your next question comes from the line of Jim Giannakouros with Oppenheimer. Your line is open.

Tacking on to that I think Charlie just I think was asking just about EMEA, but I wanted to focus specifically on China, curious as to what you're seeing specifically there and if there are any changes to your approach there, recalling you were pulling back investments there, maybe a year or two ago was when I think you announced that?

Jim, this is Tod. We have seen a bit of a pickup in China, mid-single-digit increases for example in the Q, but nothing that would suggest that we're going to pickup CapEx spending within that particular region or that the customer demand is driving the need to do so. So, still remaining on the current strategy, which is a bit more cautious, but longer-term China remains strategically very important for the Company.

Okay, thank you. And independent aftermarket I think you said up low-teens, and I believe that's more reflective of end market demand versus restocking, if I piece your comments of this quarter and last quarter appropriately. Are you seeing that more in Off-Road or in On-Road and can you talk about sequential trends versus say year-over-year comps influencing that double-digit increase that you've now posted?

This is Tod again. It's really broad-based. It's across all regions, it's both double-digits at a minimum across all regions, it's across – Off-Road certainly driving the higher of the two, but in On-Road for example in the Americas we saw a nice uptick as well. So, it's pretty broad-based regionally and now we're starting to see On-Road even enter the picture, but I would say it's more heavily weighted Off-Road right now.

Jim, this is Brad. I'll add to that that your question about sequential, both On and Off-Road in that channel were up sequentially as well, high-single/low-double range.

Anything above and beyond what you would expect from a seasonal perspective there, Brad?

I think it was the normal seasonality. What was unique was the baseline, in that Q2 was very inflated from the restocking. I think that's the thing we are all watching, and you guys included, is what's going to happen after that big bulge of restocking in second quarter, and to see the momentum continue is good for us.

Yes, okay, thanks. Last one if I may, hard disk drives, appreciating that you probably expect continued pressures there as we do, they are beyond the near-term benefits you are citing and the industry is citing, how would you frame your desire or willingness to stay in what is apparently a secularly declining market? Is it a margin or a cash flow contributor such that staying there makes sense, or given where you are in your cycle let's say in Engine, does it make more sense to make some portfolio moves into higher growth and/or margin areas where you can leverage your current channel, et cetera?

So we enjoy a strong position in the market within our disk drive business. We understand that that is an industry under secular pressure. It will continue to decline for years to come, but it will not go away. That business will not eviscerate. So, we look at it as a cash cow, we run it to make sure that it's very efficient, but also to stay in the number one position and it has continued to spin up new technologies and new technology concepts for us as the demands from the customer base continued to remain high. So, we like that business for a lot of reasons, but we do run that as a cash cow type of the business.

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

Congrats on the results. I just wanted to start with just pointing out that obviously the tone on this call is much different from the 2Q call, where I think on the 2Q call the message was, one data point is in the trend and we're cautious on the outlook, cautiously optimistic. Today, clearly I think it's we've got two really good quarters logged in, but it sounds like you are able to look out farther. Scott made the comments on fiscal 2018. Is that just the results we're seeing from Cat and Deere and can you add a little more color as to what is giving you what I'm interpreting as optimism on the medium-term outlook now?

This is Tod. So, if you look at our customer base, and the Deere or the Cat, even Cummins, when they talk about engines produced, all three of those raised their recent guidance for the balance of this calendar year. And so we point to them as really good data points that suggest people are feeling a bit more positivity for the balance of this calendar year. For us, short-term, we've got three more months to go, we got another quarter here, we'll end our fiscal year, but we'll take all those data points at that time and we'll come out in about three months or so and bake that in and give you full year guidance, past obviously the calendar year. But right now, there is certainly a bit more optimism across our customer base and you are seeing that through some of the end market increase, and therefore our numbers.

Okay, thanks. And then, we don't get a great look into what's happening at CLARCOR anymore, but they had recently introduced Channel Flow product that they claimed was going to be a perfect replacement for PowerCore in some SKUs. I'm wondering if you could tell us anything about whether you're seeing them in the market, and secondarily, is that product being on the shelves at distributors giving you the opportunity to put PowerCore product into the broader independent distribution channel and maybe resulting in any measurable uptick in your aftermarket business as you stock that product?

So, as we look at PowerCore for year-to-date in the replacement parts area where CLARCOR's entry would compete, we're up in the high teens year-over-year. So we're really proud and comfortable with our position there. They have really released that to a small subset of parts, and so therefore, in really keeping with our strategy and teaming with our OEs, we will continue to honor our strategy of razors to sell razor blades and support them to help them acquire their aftermarket wherever possible. The fact that they have, that CLARCOR have put just a couple of part numbers out there does not throw the channel wide open [at this time] [ph].

Okay, that's helpful. And then, this is going to be a reach but I'm just going to ask it, is there a chance in fiscal 2018 or a level of revenue growth where if achieved that you could generate above 15% operating margin?

Yes, I would say that's a bit of a reach. We're still working through our plan. We're committed to delivering incremental profit on revenue growth. We have some unique factors that I talked about earlier in my script. And I promise we'll roll out together and we'll give you the best information we can come the fourth quarter earnings release.

Okay. And just to be – I want to make sure it is clear, I was saying it's a reach in asking that question trying to get you to say something, and then you acknowledged it's a reach. You're not saying that the margin level is a reach, you're saying my question is a reach?

No, I would say your question is a reach.

Yes, we would agree with you, your question is a reach, yes.

Right, I just wanted to make that clear in the transcript. Okay, thanks.

We appreciate that.

Fair clarification and a good one.

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

This is Dan Rizzo on for Laurence. If we back out Gas Turbine and Special Applications, it seems like your sales were 10% in Q3, 11% in Q2, compared to 2% in Q1. Is there any reason why you can't sustain mid single-digit growth once you lap the step-up in Q2?

You lost me in the math, Dan. Sorry about that. This is Brad.

I'm sorry. So if we back out Gas Turbine and Special Applications, I think sales were up 10% in Q3, 11% in Q2, up from 2% in Q1. Is there any reason why we can't sustain mid single-digit growth once we lap the step-up in Q2?

In aggregate?

Yes.

Our full year guide, I mean I'm looking at a total number, but the implied Q4 guide is up in the high singles, if you just pick a part of the math. I haven't done with the subtractions that you're talking about, but I mean clearly Gas Turbine is a lot of noise in the system. The implied guide on that is in the down 20% range.

So maybe – this is Tod. I would add also that if we're going to take a look at the full year and go from Q2 to Q3, we do have some acute events on the Engine side on the restocking that we would have to normalize looking forward. So that would tamp that down just a little bit. We can't just roll it all in. I mean Brad could do some activities and start to try to figure that out going forward. We've not done that suggestive math that you're pointing to.

No, that's actually very helpful. Thank you. And then, a longer term question, can you please update us on how that you think the electric vehicles could affect your business, both near-term and over the next decade or so?

This is Tod. So, we look at the electrification question obviously very closely in light of Europe and some of the legislation that's going on there for the inner-city electric buses as well as small vehicles. For example, small construction equipment in some cities in Europe would likely have to move away from diesel. It's an important question for us. However, when we look toward electrification, while electric will win and displace some diesel engines, it will likely enter into the smaller diesel engine sector and at best go into more of the return-to-home type of a vehicle. So for example, it may win some share in a garbage truck for example or something like that that returns in municipality to a home-base. But overall there has to be a much greater technology advance for electrification to win in the heavy-duty diesel engines. So, electrification has a place in the future, but it is going to take decades to really displace much of the overall diesel engine shares that we see out there today, but it will have a small entry point. All forecasting that you see today, even taking into account worst-case situations, worst-case being electrification has a breakthrough et cetera, would suggest diesel engines are still going to grow across the world for decades to come.

This concludes today's Q&A session. I'll now turn the call back over to Tod Carpenter for closing remarks.

That concludes today's call. I want to thank everybody for their time and interest in our Company. I also want to thank our employees again. I am very appreciative of their efforts and I look forward to a strong finish to our fiscal 2017. Goodbye.

And this concludes today's conference call. You may now disconnect.