Ladies and gentlemen, thank you for standing by and welcome to Donaldson's First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I would now like to turn the call over to Charley Brady, Director of Investor Relations. Thank you. Please go ahead.

Good morning everyone. Thanks for joining Donaldson's first quarter 2021 earnings conference call. With me today are Tod Carpenter, Chairman, CEO, and President of Donaldson; and Scott Robinson, Chief Financial Officer; and Brad Pogalz, who you all know. This morning, Tod and Scott will provide a summary of our first-quarter performance, along with an update on key considerations for fiscal 2021. During today's call, we will also reference non-GAAP metrics. A reconciliation of GAAP to non-GAAP metrics is provided within the schedules attached to this morning's press release. Finally, please keep in mind that any forward-looking statements made during this call are subject to risks and uncertainties, which are described in our press release and SEC filings. With that, I'll now turn the call over to Tod Carpenter. Tod?

Good morning everyone. I want to start by welcoming Charley to the team. He joined Donaldson last week after two decades on the sell-side, which included 15 years of covering our company. He already knows us well, so our Investor Relations program is in good hands. Welcome Charley. Turning to the quarter, we feel good about our results. First-quarter sales were up 3% sequentially, which is not typical seasonality, signaling that the worst of the impact from the pandemic on our business may be behind us. Sales of replacement parts outperformed first-fit by a wide margin, providing valuable stability. And we saw continued evidence of share gains in strategically important markets and geographies, helped in part by our robust portfolio of innovative products. First-quarter profit performance was another highlight. Gross margin was up 60 basis points from the prior year, resulting in the highest first-quarter gross margin in four years, and the best sequential improvement in at least a decade. We reduced operating expenses by 5%, while maintaining investments in our strategic growth priorities, particularly as they relate to the industrial segment. And altogether, we had a detrimental operating margin of only 4%, which we view as very positive given the uneven economic environment. Finally, our company remains in a strong financial position. We had excellent cash conversion during the quarter and our balance sheet is solid. We're on track to deliver our strategic and financial objectives in fiscal 2021 and we'll talk about those plans later in the call. But first, let me provide some additional color on recent sales trends. Total sales were down 5.4% from prior year, or 6.4% in local currency. In the engine segment, more than a third of this decline came from aerospace and defense, due largely to the significant impact from the pandemic on commercial aerospace. We have a great team and strong customer relationships. So, we expect our aerospace business will recover. In the meantime, we are pursuing optimization initiatives to put our cost structure on a firmer footing during this rough patch. In our other engine businesses, trends seem to be improving. On-road sales were down 21% in the quarter, which is still a steep decline, but notably better than the past few quarters. Although Class 8 truck production in the U.S. remains depressed, order rates are increasing and third-party forecasts for the next calendar year suggest that Class 8 recovery is on the horizon. Should that happen, we believe our strong position with OEM customers would give us nice momentum in the on-road first-fit market. In off-road, trends were mixed by region. In Europe, sales from new exhaust and emissions programs were not yet enough to offset the lower rate of production for programs already in place. In the U.S., lower production of construction and mining equipment is still a headwind for off-road, but we had a meaningful sequential increase in first quarter and year-over-year trends are also improving. We had a very strong quarter in China, with off-road sales up more than 50%. Their economic recovery appears to be underway and we are also benefiting from new relationships with Chinese manufacturers that want our high-tech products, including PowerCore. China produces more heavy-duty equipment than any other country in the world and our team is doing an excellent job building and strengthening relationships with large local customers. While we expect to have some variability in quarter-to-quarter trends, we are also confident that we have a long runway for growth in China. First-quarter sales in aftermarket were down only slightly from the prior year and they were up 6% from the prior quarter. All of the year-over-year decline in aftermarket came from the U.S. The independent channel is still being impacted by the oil and gas slowdown, which we partially offset with pricing actions implemented earlier this calendar year. And large OE customers are still tweaking inventory to match demand outside the U.S. Aftermarket performed very well. In Europe, first-quarter sales were up 1% in local currency as conditions improved in Western Europe. In China, first-quarter sales of engine aftermarket were up more than 30%, reflecting strong growth in both channels. We are gaining share with the new OEM customers and end users are paying greater attention to equipment maintenance. Part of our success in China is due to PowerCore, which is growing rapidly from a small base. Importantly, PowerCore continues to do well outside of China. Global sales of PowerCore replacement parts were up in the low single-digits last quarter and we set another record. PowerCore is our most mature example of how our razor-and-blade strategy works and the brand is still going strong after 20 years. Turning now to the industrial segment, first-quarter sales were down about 6% including a benefit from currency of about 2%. That decline was driven primarily by industrial filtration solutions or IFSs. The pandemic is creating a headwind in terms of equipment utilization and a lower willingness to invest. Quoting activity for new dust collectors was down in the first quarter, and the quote order cycle remains elongated. Generally, customers are focusing on must-do projects while deferring expansion and productivity investments to a future date. With the market under pressure, we are focused on building our brand and gaining share. We have strengthened our capabilities related to market analysis and virtual selling and our e-commerce platform gives us an incredible reach. We also continue to leverage our technology advantage and we are encouraged by the opportunity that presents in an underserved market, like China. For the quarter, first-quarter sales of dust collectors were up modestly in China and the needs in that region are changing in our favor. Some manufacturers are dealing with compliance upgrades related to the blue sky initiative, while others are going beyond the minimum requirements and striving for better air quality. That shift represents an exciting opportunity for us. So we will continue to invest for growth in that region. Process filtration for the food and beverage market is another exciting opportunity. We launched our LifeTech brand filter in late 2016. And we have seen tremendous growth since then. Sales of process filtration parts were up again last quarter with a low single-digit increase, which partially offset the pandemic-related pressure on sales of new equipment. Our strategy for growing process filtration is solid. We are focused on winning new contracts with large global manufacturers, which gives us the opportunity to sell to their plants. Some of these customers have hundreds of plants. So, we are once again doubling our sales team for process filtration. We also made an organizational change to better align our team with the needs of our food and beverage customers. While these types of optimization initiatives are standard work for us, I'm calling it out because during our fourth quarter call we said process filtration sales were about $50 million in fiscal 2020. Following our reorganization that number is more like $68 million. Our IFS numbers are unchanged, but we wanted you all to have the right baseline as we talked about year-over-year trends in this exciting business. Trends across the balance of our industrial segments were mixed. Sales of gas-driven systems were up 11%, driven by strong growth of replacement parts as we continue to gain share. In special applications, we face pressure from the secular decline in the disk drive market combined with lower sales of our membrane products. We partially offset the decline with strength in our venting solutions business, which is also benefiting from share gains, as we expand into new markets, including the auto industry. Overall, we see strong evidence of how our diverse business model is providing some insulation from the pandemic. We are gaining share in strategically important markets and geographies, we are investing to keep the momentum, and we continue to show progress on our initiatives to increase gross margin. I'll talk more about our longer-term plans in a few minutes. So, I'll now turn the call over to Scott. Scott?

Good morning, everyone. I also want to welcome Charley. He's got great perspective and he's a strong addition to our team. We're excited to have him join us and I hope you all will have a chance to connect or reconnect with him soon. Now, turning to the quarter, like Tod said, we are pleased with our results. Economic conditions were better than what we had in the fourth quarter and we made progress in our strategic initiatives. First-quarter margin was a highlight for us in terms of year-over-year and quarter-over-quarter performance. Versus the prior year, operating margin was up 50 basis points, driven entirely by gross margin. That translates to a detrimental margin of 4%. But that's probably not the level to expect over time. For a better comparison, I pointed to our sequential trends. First-quarter sales were up 3% in the fourth quarter and our operating profit was up almost 6%. That yields an incremental margin of 24.5%, which is in line with our longer-term targets from Investor Day and several points are above our historic average. As I've said many times, we are committed to increasing levels of profitability on increasing sales and we have solid plans to keep driving margins higher. We saw evidence of those actions last quarter. So, let me share some details. First-quarter gross margin increased 60 basis points to 35%, despite the impact from loss leverage and higher depreciation. On the other hand, gross margin benefited from lower raw material costs; our procurement team has done an excellent job capturing cost improvements by working with existing suppliers and identifying new ones, which added to the benefits from lower market prices. We also had a favorable mix of sales in the first quarter, specifically aggregate sales of our advanced and accelerate portfolio, which includes a significant portion of our replacement parts sales, along with many of our higher-tech businesses, outperform the company and our advanced and accelerate portfolio also comes with a higher average gross margin. As we continue to drive investments into these businesses, we are shifting more weight towards higher-margin categories. Over time, mix should be a constant factor in driving up our gross margin. Our strong gross margin performance in the first quarter was complemented by disciplined expense management. Operating expenses were down 5% from the prior year, which resulted in a slight increase as a rate of sales. We've had significant savings in discretionary categories like travel and entertainment, due in large part to pandemic-related restrictions. At the same time, we continue to invest in our strategic priorities. We are building teams and adding resources to areas like R&D, process filtration, connected solutions, and dust collection. These investments are tilted heavily towards the industrial segment, which contains most of the advanced and accelerate portfolio. Given that dynamic, you're not surprised that the first-quarter industrial profit margin was down slightly. Importantly, first-quarter gross margin was up in both segments. So, we feel good about where we ended. As an investment translated, we expect our margin and return on invested capital will go up over time. Moving down the P&L, first-quarter other expense was $1.5 million. Compared with income in the prior year of $2.6 million, the delta was largely due to a pension charge and the impact of certain charitable options. During the first quarter, we contributed to the Donaldson Foundation and there was also a charge for securing face masks that will go to frontline workers in our communities. We generally spread these contributions over a fiscal year, so the impact is more timing-related and a change in trajectory for us. I also want to share some highlights of our capital deployment in the first quarter. As expected, capital expenditures dropped neatly from the prior year with our large projects related to capacity expansion mostly complete, we are turning our attention to optimization and productivity initiatives. We returned more than $40 million of cash to shareholders last quarter, including the repurchase of 0.3% of outstanding shares and dividends of $27 million. We have paid a dividend every quarter for 65 years and we're on track to hit another milestone next month. January marks the five-year anniversary of when we were added to the S&P High Yield Dividend Aristocrat fund. So, this anniversary signals that we have increased our dividend annually for the past 25 years. We are proud of this record, and we intend to maintain our standing in this elite group. As we look at the balance of fiscal 2021, there are still plenty of reasons to be cautious. The magnitude and ultimate impact of the pandemic are still unknown and we continue to face uneven economic conditions. Given these dynamics, we feel prudent to hold back on detailed guidance, but we did want to expand our information provided during our last earnings call. In terms of sales, we expect the second quarter will end between a 4% decline and a 1% increase in the prior year and that means sales should be up sequentially from the first quarter. We also expect a year-over-year sales increase in the second half of fiscal 2021. And sales are planned to migrate towards a market-cold seasonality, meaning the second half will carry slightly more weight than the first. We are modeling a full year increase in operating margins driven by gross margin. Our productivity initiatives should ramp up over the fiscal year and we expect benefits from lower raw material costs and mix will still contribute to a higher gross margin, but to a lesser extent than what we have been seeing. Of course, the caveat is gross margin impacts on a strong recovery. While we would be happy if our first two businesses accelerate beyond our expectations, that could create a scenario where mix goes from a tailwind to a headwind. That's obviously a hybrid problem and we would address that situation if that's the case. As for operating expenses, we intend to keep fiscal 2021 operating expenses about flat with the prior year, especially in the second half of the year. We are still expecting headwinds from higher incentive compensation and pending the return to a more normal operating environment. We would anticipate a year-over-year increase in expense categories that have been significantly depressed by the pandemic. But as always, we are exploring optimization initiatives to offset these headwinds. I'm confident that we can maintain an appropriate balance, allowing us to invest in our long-term growth opportunities by driving efficiency elsewhere in the company. For a full year tax rate, we are now expecting something between 24% and 26%. The forecast range is more narrow than last quarter simply due to having clarity with the first quarter complete. There are no changes to our other planning assumptions, but let me share some context. Capital expenditures are planned meaningfully lower than last year, reflecting the completion of our multi-year investment cycle. Our long-term target is plus or minus 3% of sales and we would expect our CapEx to be below that level this year. We plan to repurchase at least 1% of our outstanding shares, which would offset dilution from stock-based compensation. Should we see incremental improvement in the economic environment, it is reasonable to expect that we would repurchase more than 1% this fiscal year. Finally, our cash conversion is still expected to exceed 100%. We had a very strong cash conversion in the first quarter driven by reduced working capital, lower capital expenditures, and lower bonus payouts. As sales trends improve versus the first quarter, we would expect our cash conversion to drift down a bit over the year, which is typical of a more favorable selling environment. Stepping back from the numbers, our objectives for the year are consistent with what I shared last quarter; we will invest for growth and market share gains in our advanced and accelerate portfolio, execute productivity initiatives that will strengthen gross margin, maintain control of operating expenses including the implementation of select optimization initiatives, and protect our strong financial position through disciplined capital deployment and working capital management. As I close my section, I want to take a moment to thank my colleagues around the world for their continued resilience. We had a solid start to the fiscal year despite the pandemic challenges that I know everyone is feeling. I am proud of what you all accomplished and I look forward to continued success. I also want to thank Brad for his great contributions and his friendship. I wish you and your family my best as you move to Europe. The good news is we will still work together. With the emotional remarks concluded, I'll turn the call back to Tod.

Thanks Scott. This year, we have a straightforward plan. We play offense where we can and defense where we must. Our defensive efforts are all about managing costs and one way we are doing that is through optimization. The most significant example relates to productivity improvements in our plants, which are being enabled by the capital investments we made over the last two years. But it's not just about large projects for us. Our employees have a continuous improvement mindset and our culture has a shared commitment to operating efficiently. Our teams are consistently finding ways to leverage tools and technology and their work allows us to deploy more resources to support our strategic growth priorities. As we look forward, we're excited about those opportunities. For example, food and beverage is the first step on our journey into life sciences. We expanded production capabilities of our LifeTech filters and our new R&D facility in Minnesota; we believe we are in an excellent position to press forward. At the same time, we're pressing forward in our more mature markets. Driven by our spirit of innovation, we continue to bring new technology to applications that have been using old technology for a long time. An excellent example is our recently launched product for baghouse dust collection. Baghouses have used the same low-tech solutions for decades and they represent about half of the $3 billion to $4 billion industrial air filtration market. Our game-changing product, the Rugged Pleat Collector, delivers improved performance and lower cost of operation for customers in heavy-duty applications like mining, woodworking, and grain processing. So, we will deploy new technology to gain share in this significant market. In the engine segment, we continue to lead with technology, which is critical given the size of the opportunity. We are currently competing for projects with an aggregate tenure value of more than $3.5 billion, telling us the market for innovation is healthy, and we have a significant opportunity to win new business. Our OE customers are working to improve fuel economy and reduce emissions from diesel engines, and they're also increasingly interested in growing their parts business. Our products meet both of those needs. We have a multi-decade track record of providing industry-leading performance and we can also show that our technical and design characteristics help our customers retain their parts business. Based on the opportunities in front of us, we believe the diesel engine will remain a valuable part of our growth story for a long time. But we also know the market is changing. So, our focus on growing the industrial segment, while expanding our global share of the engine market, including new technologies related to air filtration for hydrogen fuel cells, puts us in a strong position for long-term growth. I also want to touch on the role of acquisitions and our growth formula. With capital markets recovering from the pandemic, we've been getting more questions lately about our philosophy, so I thought I'd take a minute to realign everyone. Our focus is very consistent with what we laid out 18 months ago at our Investor Day. At a high level, we remain a disciplined buyer. We're most interested in new capabilities and technologies, especially those that accelerate our entrance into strategically important markets. And we are targeting companies that will be accretive to our EBITDA margin. As always, we will pursue companies that align with our long-term plans versus simply buying share. The filtration market is split between a small number of large companies, us included, and a significant number of smaller companies. The timing for executing an acquisition is always uncertain, so we will continue to work our process. Additionally, we recognize and appreciate that filtration is a high-value market. So, our goal is finding the best opportunity at a reasonable price. With a robust acquisition strategy and significant organic growth options, we feel confident that we can continue to drive strong returns on invested capital for a long time to come. Before closing, I want to thank our employees for their continued commitment to our company. The level of global coordination and collaboration continues to impress me and I believe we have done very well during the pandemic, as a business and as a culture. To the Donaldson employees around the world, thank you for your commitment to advancing filtration for a cleaner world. Now, I'll turn the call back to Denise to open the line for questions. Denise?

Thank you. Your first question comes from Bryan Blair with Oppenheimer. Your line is open.

Thanks. Good morning guys.

Good morning, Bryan.

Bryan.

In terms of your second quarter sales expectations, can you offer a little more color on what you're thinking about by segments?

Certainly. As we look ahead, we believe that the recovery in the U.S. will drive the on-road segment, while China is becoming an increasingly important part of our story. We expect to see an improvement in these markets. Additionally, we anticipate a growth in agriculture across the globe, which is quite broad-based. However, the construction sector seems to remain somewhat subdued, and mining continues to fluctuate at lower levels.

Helpful detail. I'm sorry, if I missed this detail in the prepared remarks, but how did innovative products perform in engine aftermarket for the quarter?

Hey, Bryan, this is Brad. The performance overall was really good. Tod touched on PowerCore; we hit another record and that was a little bit in the quarter. And then if we look at the total IT products, so that was maybe 25% of aftermarket, they were not in the mid-single-digits in the quarter.

Got it. Thanks Brad. And then any more color you can offer on process filtration trends? I know that on the new equipment side, there has been pressure for a while. Are you seeing stabilizing orders early in the second quarter? Or is that still pressured on that side?

Yes. So, on the new equipment side, we would say we still see some pressure, some headwinds across that CapEx faced in investments, just like we do on our dust collection business and process filtration. But on the replacement part cycles, we'd say we still continue to gain share evidenced by the fact that it was up in low single-digits in the quarter.

Got it. Okay, thanks again.

Thanks Bryan.

Your next question comes from Rick Eastman with Baird. Your line is open.

Yes, and thank you for the questions. A couple of things, and welcome to Charley and Brad; we will miss you.

Thanks.

Hey, I have a quick question. Tod, could you provide a bit more insight into why the U.S. aftermarket business didn't perform better, particularly in engine, considering the easier comparison we had? Also, did any of the growth in the China aftermarket stem from the U.S., meaning did we previously fulfill that demand through exports?

Yes, it's a question Rick. So, the China growth is just true share gain growth. It's not a realignment of exports or anything like that. So, China is truly fair game. Within the U.S., you're seeing many parts of the end markets pick up clearly within utilization. The headwinds that we still have is oil and gas and the oil and gas comps where fracking really stepped down and still remains a headwind to us on the comp side. So, that's really the story in the U.S. All of the parts are that. Now, there's one other nuance. So you talked about the potential for China. That didn't happen in China, but it did happen a bit in the U.S. So, we did have some movement out of the United States to Latin America, where we now service customers in Latin America and so that's a bit of a headwind as well. So, it's oil and gas, and that line transfer as well.

Okay, is the expectation that the engine aftermarket business has finally moved past the negative comparisons? Can we expect a positive comparison in the fiscal second quarter for the engine aftermarket?

Yes, that's our view.

Okay. And Tod, you mentioned this earlier, but when I compare the sales of the on-road and off-road businesses during the fiscal first quarter to the fourth quarter, I’m curious about the dollar amounts. How confident are you in the significant increase in sales for both the on-road and off-road engine businesses? The on-road business had a $32 million quarter, while the off-road business reached nearly $65 million, which is quite a substantial increase. When you consider these two original equipment businesses, do you believe the order flow justifies this growth, or do you think the first quarter performance is more reflective of the third and fourth quarters?

Yes. So, Rick it goes back to kind of how I opened with the first answer. So, on-road U.S. is clearly a U.S.-based story and all the statistics with ATT and all of what you see out there on the new truck orders fueling in is clearly what we're experiencing. And so we would see that we have some tailwinds within that market, still unsettled as to how long that will last or how big that step up would be. But we are seeing more positive momentum in the on-road particularly a U.S. story, but also an emerging part of that story is our share gains across China. And then on the off-road side, it's really an ag story. It's a broad-based story, you hear that out of Deere's reports, and many of the others, and so we do see some momentum in that area, as well.

Okay. Okay. And just my last question, promise, Tod time when you mentioned aftermarket sales vs first-fit or equipment sales in the quarter, from the total Donaldson perspective, what are those growth rates or declines look like, across engine and across industrial? Is that a number you have?

For the sequential performance?

No, just year-over-year, so against your revenue decline of about 5% in the aftermarket overall, was it flat or did it increase slightly in the equipment or first-fit segment?

I think we are considering the information we provided in the release, which indicates that aftermarket sales were down 1% compared to last year, while off-road sales were also down.

Yes, I couldn't quite hear that.

I just touched, didn’t I?

Just total sales for Donaldson include aftermarket and replacement sales on the industrial side as well as dust collection. I think you mentioned that parts of those are improving. I'm curious if you have a specific number regarding that.

I misunderstood Rick. Apologies. Yes, both segments were down low single digits compared to low double digits in both segments.

Down low double-digit. Okay.

Yes. So, pretty consistent where, Tod's opening remark about how aftermarket significantly outperformed. That was pretty much true at all segments.

Got you. Okay, perfect. Thank you again and good luck to you and your family Brad.

Thank you.

Your next question comes from Nathan Jones with Stifel. Your line is open.

Good morning everyone.

Hi Nathan.

Maybe just talk a little bit about gross margins, those get back to 35% here. Just looking back at the Analyst Day presentation a couple years ago, I think the targets were probably 35.5%, 36%. Clearly, we've had a little demand disruption in the interim here. Do you guys still think you're on target to get kind of to those kind of 35.5%, 36% gross margin level? If we get volume back to say 2019 levels and then what's the path forward from there?

Good morning Nathan, this is Scott. So we still feel good about our Investor Day targets. As we've said, the timeline certainly got pushed out during the pandemic, and the revenue declines we've experienced, but we still feel good about those targets, we will continue to work to drive up that margin, we were pleased with the performance in the last quarter, and in the fourth quarter of last year. So, good growth and gross margins. We still see that Investor Day target of op margin between 15% and 15.8% that we gave out in the Investor Day as a reasonable target for us. And as revenues grow, we're going to be working to continue to improve our operating margin. So, I think we still have those targets inside, and we're still driving that direction.

Okay, the next question on inventory. I think, Tod, in your comments, you mentioned that the OEMs were still tweaking inventory levels, do you feel like they felt a little destocking in the OEM channel? I think for the last quarter or two, you've said the aftermarket is pretty much flat. And with the prospect here that we're going to see sequential growth in your end market demand, should we also start to see some restocking, both at the distributor and the OEMs?

Nathan, I visited customers in the independent channel this quarter and I feel confident that it's at pull-through levels. I will meet with more customers tomorrow. Overall, the independent channel seems quite stable. On the original equipment side, there have been some fluctuations, which is why I mentioned the need for adjustments at the end of the year. As we are in December, it’s typical for them to manage their balance sheets, which impacts restocking, and we expect to see a rebound in January. In summary, these are just minor changes, but it feels like there is a slight increase in pull-through, and we're starting to see some restocking in China driven by our gain in market share.

Do you think that calendar year 2021 should see meaningful restocking in these channels just given your demand outlook over the next few quarters here?

Tough to say Nathan, how will this unfold relative to the pandemic, will it walk up or will it step up? I'm not really sure. But as economies open up worldwide, clearly, they might add back carefully, because cash is still very important to many businesses, especially the independent channels. And so we're really not sure what the behavior will be like this time out of this recession; it may be different on the restocking behavior than previous.

If maybe different on the restocking behavior than previous. Okay, just one more on the dust collector business; you did say that dust collector orders were down in the quarter you just recorded. Are we still in the phase where we're going down at a faster rate or going down at a slower rate?

Slower rate still elongate and at least double order cycles, but must-do projects are being done; other projects are just being put off as long as they can. So, we've clearly worked through much of that. But there's a carefulness cloud that hangs over that type of investment still.

Not surprising in this environment. Thanks for taking my questions. I'll pass it on.

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

Hey, good morning. Thanks for taking my questions and hi, Charley. Looking forward to working with you and Brad I've already sent probably 80 emails wishing you good luck, but good luck again.

Thanks Brian.

Could you provide the percentage of revenue for the engine and what portion of total revenue is generated in China during the first quarter?

Sure Brian, this is Brad, I'll take that one. Engine was about 6% of engine sales came from China in the quarter and industrial was higher at about 12%. But I'd remind everybody that our disk drive business; about half of that comes out of China. So, that's inflated a bit. And the nice thing with engine is with these growth rates, we've seen that share grow pretty meaningfully over the last five or so years.

I appreciate that. Tod, you discussed the advanced and accelerate portion of the portfolio, specifically in processed filtration. Can you provide insights on some other areas you mentioned during the Investor Day, such as venting, semiconductor, and hydraulics? I believe you touched on these topics, but how are those businesses performing outside of process filtration? Additionally, is the advanced and accelerate category still experiencing growth during the time of the Investor Day, at a rate of five to seven points above the corporate average?

Yes, so first-off touch with our venting business, we're very pleased with the share gains we've had in venting; it's still coming off of a low base of the company. But we're looking to get that to be a 4% level of the overall corporation; it's still between one and two. So, we've had some nice growth, and we also have some significant program wins ahead of us. So, very pleased with the team and the progress and the growth and the venting side. Relative to other portions of the portfolio, hydraulic, we also continue to grow more of a mid-single-digit in this type of an environment situation than venting, which is clearly within the double digits. So, we're very pleased with the investments we've made across the advance and accelerate portfolio; it's delivering quite nicely. As far as performance outside or above the overall company averages, yes, we would say that mid-single-digits above company averages is clearly our expectation, and the reason why we continue to invest within that particular segment of our portfolio.

Okay, and then just last, I'd be interested if he had any update on the market reception of the remote monitoring technology they introduced recently?

As you can imagine, within our IAF with our dust collection-based businesses, where the overall market is still very careful on quote order cycles, are also very careful on any types of investments. And so we're still in that push type of a mode out to the marketplace. We do have hundreds of installations. But we still continue to push it out to the marketplace and the market has not switched to a poll yet. We would look for that sometime in the future and we would have to get more market normalcy certainly before we would expect that to happen.

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

Hey, guys, this is Dan Rizzo on for Laurence, how are you?

Hi Dan.

You mentioned savings in A&D, some optimization or you mentioned an optimization program; I was wondering if there's a target for the savings you expect over the next couple of years?

We're still working on the plan on that. We clearly will come out with some additional guidance once we form those types of activities up. But those kinds of adjustments really still lie ahead of us.

And this is Scott, just want to say as we mentioned, we're working hard to explore cost optimization initiatives across the company. We work hard to manage that OpEx effect, especially as we move into the next few quarters here.

Okay. And then you mentioned being disciplined and sticking to a plan in terms of looking for inorganic growth. I was wondering if the pandemic has altered the landscape of potential targets; whereas there might be more or less or have entities changed in the last nine months, whatever?

The situation has shifted somewhat. For instance, in the mask industry, there are now opportunities to acquire mask-making companies that weren't available before, suggesting that some are looking to benefit from that filtration market, which is surprisingly a low-technology area. This is one of the changes we've seen, but the general interest in the sectors we focus on has remained consistent. It continues to be a highly valued market, and we are actively pursuing opportunities.

Okay. Thank you very much.

And your last question comes from Dillon Cumming with Morgan Stanley. Your line is open.

Great. Good morning, guys. Thanks for the questions. Just first Tod, you mentioned that you're kind of doubling the salesforce round process filtration in beverage; I guess, first, what does that imply that level of growth that you see for that business, both, I guess, this year and next? And related to that, Scott, I think you mentioned that you front-loaded some costing associated with those salesforce as an industrial; do you feel like you front-loaded enough of those where you can get back to kind of year-over-year EBIT margin improvement industrial next quarter or is that something that will play out in the next quarter or two?

So, maybe I'll start and then I'll let Scott pick up. So, relative to the growth rate that we would expect that affected an investment, particularly in this type of an environment, we have to be able to be let into the plants to be able to make those sales. So, we would expect mid-single-digits to high single-digit type of growth rates across our process filtration business, and I'll let Scott pick up from there.

Yes, I think you've heard Tod say, we're essentially doubling the salesforce, so we're making a big investment there. And certainly, new sales folks when they come on take time. You could say things are a little bit challenging right now with the pandemic, but we still feel that's a strong investment for our future. We noted industrial margins were down 10 basis points this quarter and that's because we're making investments in the industrial. So, I can see the need for your question. And I would submit that as people come up to speed and hopefully things get a little bit better here with a pandemic, that those investments will begin to return at a higher rate and that industrial margin will start to increase. So, we need to leverage those investments. Certainly, there's front-loaded costs, which are impacting us now, as revenues are a little softer on the industrial side. But we expect that situation to improve over time. And we're going to continue to invest in high-margin opportunities in our advanced and accelerate portfolio, but over time, we expect the margins of the company to increase and our advanced and accelerated portfolio carries a higher than average corporate gross margin and that will be a positive tailwind for the company.

Yes. Okay, got it. That's helpful. And then maybe you kind of switching back some of your longer cycle businesses and IFS and dust collection. I know you guys have been calling out CapEx as an initiative kind of longer growth cycles for several quarters now; it's certainly understandable. And you're talking about that earlier. But I guess, what do you think these customers are kind of looking for at this point, because it seems like PMI is probably more stable than a couple of quarters ago. And we're bumping up against about a year of project deferrals at this point. So, I guess, how sustainable is it for customers to kind of be maintaining this current level of CapEx spending in that business?

Well, dust collectors' lifespan is between 15 and 20 years, typically, consequently, they can go a little bit longer and continue to run and just have the replacement parts changed out if you will, and that's on the upgrade side. The other part of it is new equipment or plant expansion. So, you haven't seen a whole lot of plant expansions going on. So that cycle is still pretty dormant out there, which would normally give us a good lift. So overall, we do need more confidence across the economic recovery, both in the U.S. and Western Europe in order to really be able to be comfortable that we're looking at an uptick within that business deal.

Dillon, this is Brad, I'll add one point, if you think about PMI and this activity, that's, that's good for the aftermarket side of our business. We would watch capacity utilization as probably more a trigger for new equipment. So, keep your eye on that metric. We are too.

Thank you, Brad. I appreciate your insights, Tod. For my final question, regarding the cash balance, I know you mentioned your capital allocation priorities. You have the 1% repurchase framework in place, but is there a specific cash level you're targeting for the end of the year or a number we can use as a reference? Also, if we assume there won't be any M&A activity by year-end, can you provide a benchmark for buybacks in relation to that cash level and your capital holdings?

So, we kind of run the company on a net debt to EBITDA target of 1.0. So, that's our target; we're slightly below that now. We want to be conservative in light of the situation we have. Our capital deployment strategy is invest either organically or inorganically in the company, pay that dividend, which has been going on for 65 years and then buy back shares. We knew this is kind of an awkward year, which is why we came out with a share buyback target initially at 1%. We bought 0.3% of the outstanding shares for the first quarter and I made a statement that if things continue to improve, you could very well reasonably expect us to increase that 1% up to a fair amount. So, that's kind of where we sit right now as things crystallize here, we'll be a bit firmer with our guidance, but we're committed to 1% and we said if things continue to improve, we'll likely increase that because we are generating very strong cash conversion in the first quarter; that will come down a bit as revenue trajectory changes and our CapEx is down, so we feel that our free cash flow is a very strong kind of print right now. So, we're happy about that and we'll manage as we go forward and we'll keep you appraised of our estimates.

Okay, great. Thanks for the time, guys.

Thanks Dillon.

Thanks Dillon.

And now I would like to call back over to Tod Carpenter, CEO for closing remarks.

Thanks Denise. That concludes today's call. I want to thank everyone listening for your time and interest in Donaldson Company and I hope that you, your families, and friends are safe. And I wish you all a happy holiday season. Goodbye.

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