Q4 2020 Donaldson Company Inc Earnings Call
And of course.
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Ladies and gentlemen, thank you for standing by and welcome to the Donaldson's fourth quarter and full year 2020 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 to ask a question. During the session you will need to press star one on.
Your telephone if you require any further assistance. Please press star zero I would now like to hand, the conference over to your speaker today, Brad Pogalz director of Investor Relations. Thank you. Please go ahead.
Thank you good morning, everyone. Thank you for joining donaldson's fourth quarter and full year 2020 earnings conference call with me today are Tod Carpenter, Chairman CEO and President of Donaldson, and Scott Robinson, Chief Financial Officer. This morning, Cogs, Scott will provide a summary of our 2020 performance along with an update on key considerations for 2021.
I want to remind everyone that we issued a business update press release on August six which included some details that we will reference on just one call. During today's call. We will also reference non-GAAP metric.
We included a reconciliation of GAAP to non-GAAP metrics within the schedules attached to this mornings 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 the Tod Carpenter Cod.
Thanks, Brad and good morning, everyone.
I want to start today by thanking our employees for their resilience flexibility and commitment in fiscal 2020 I greatly appreciate the work. They do every day to keep us moving forward.
As always we remained focused on those things under our control.
Despite a significant shift in the economic environment. During fiscal 20, there were several things that went as planned including sales of replacement parts performed better than new equipment and first fit products.
Gross margin increased from the prior year.
We reduced our discretionary expenses, while investing in growth businesses.
And we maintained a strong financial position, while returning cash to shareholders through dividends and share repurchase.
We are entering fiscal 21 with clear priorities and engaged employees.
We do not anticipate strong market conditions overall, this year, but our diverse business model and robust operational capabilities give me confidence that we can make progress on our strategic initiatives in any economic environment.
We will talk more about our longer term opportunities later in the call. So I'll now turn to a brief overview of fourth quarter sales.
Total sales were 617 million in the quarter with sequential increases in June and July.
Compared with the prior year sales were down 15%, which is consistent with the forecast we provided in early August.
Both segments experienced a similar decline however, there was quite a bit of variability within the results.
In the engine segment, our first fit businesses remain under the most pressure.
Fourth quarter on road sales were down 44% from the prior year.
The us is the largest portion of on road and it accounted for much of the decline as the cyclical slowdown in class eight truck production was magnified by the pandemic.
As a reminder, ionroad first fit in the US is only about 3% of formal Donaldson sales. So our aggregate exposure to that market is limited.
Sales in off road were down 24% in the quarter.
More than half the decline was due to exhaust and emissions.
There were pre buys in Europe last year related to an oncoming regulatory change and new programs for our exhaust emissions products are not yet at meaningful volumes.
In the US production of heavy duty off road equipment remains depressed, particularly for the construction and mining industries.
On the other hand off road sales in China were up nearly 50% in the fourth quarter.
The Chinese government is investing to stimulate activity, which is benefiting our off road business.
Additionally, we continue to win new programs with local manufacturers and in some of those programs were one with power core.
These are new customer relationships in the country that produces more heavy duty equipment than anywhere in the world.
We are learning how to best support these local manufacturers and we know that will come with order volatility, but our team in China is motivated as we see the opportunity for significant long term growth.
Sales trends for engine aftermarket were predictably better than our first fit businesses.
Fourth quarter aftermarket sales were down 11%, reflecting a decline in the mid teens for sales through our independent channel.
The headlines in our independent channel are fairly consistent with third quarter.
Sales in the us fell with the collapse of the oil and gas market combined with slowing transportation activity.
In Latin America utilization is slowing across the region as the spread of the virus is compounding the impact from geopolitical uncertainty.
And fourth quarter sales in eastern Europe remains strong as we continue gaining share.
Sales through the OEM channel of aftermarket experienced a more modest low single digit decline.
In the us large customers pulled down inventory to match demand, which was partially offset by strong growth in China as we continue gaining share with local customers.
In fact aftermarket sales in China were at a record level last quarter, and we see a long runway as we expect to continue winning new programs with innovative technology.
Our portfolio of innovative products performed well in the fourth quarter.
This portfolio makes up nearly a quarter of the total aftermarket revenue and fourth quarter sales were up in the low single digits.
For nearly two decades, we had been improving expanding and reinventing our offering related to these razor to sell razorblade products.
After all that time, we still have very strong retention rates.
These products create a significant opportunity for growth and relative stability in our engine business. So we will continue to invest in new technologies for a long time to come.
Sales of aerospace and defense were down 3% in fourth quarter, driven by soft sales of products for commercial helicopters.
The decline was partially offset by a strong increase in sales for ground defense vehicles, but some other growth is timing related as key distributors built inventory in the quarter.
I also want to update you on a change to our strategic portfolio classifications.
Beginning in fiscal 2001, we're re categorizing the defense business two critical core from mature.
Our mature businesses are committed to generating cash that allows for investments elsewhere. While critical core businesses are geared towards driving share gains in existing markets with new technology services and relationships.
The defense business has won new programs with our robust engineering capabilities and we expect these wins will delivered solid returns over a long time horizon.
Turning to our industrial segment fourth quarter sales were down 15% driven in large part by the dust collection business within industrial filtration solutions or ISS.
Sales of new dust collectors and replacement parts were down as customers continues to defer investment and reduced output.
The quote to order cycle remains elongated with large projects being put on hold while smaller must do projects tend to move forward.
At the same time, our value proposition still resonates.
Fourth quarter sales of our Downflo evolution dust collection systems were up in the low teens.
And the sales of those replacement parts grew more than 30%.
The Downflow family of products is only about 15% of total dust collection sales today, but it has grown rapidly as customers appreciate the space and energy savings it offers and we value the ability to retain the aftermarket.
We're also building the dust collection business through our E Commerce platform shop that Donaldson dotcom.
We turned on the ability to take guest orders earlier this year and we are encouraged by the results while incremental dollars are still small we have seen a significant number of new dust collection customers.
With our robust sales and delivery model, we believe the simplicity of our ecommerce platform gives customers another reason to choose Donaldson.
Fourth quarter sales of process filtration were down in the low single digits. After an increase of more than 10% last year.
The decline was driven by new equipment, while replacement parts were about flat with the prior year.
We continue to make progress penetrating the highly valuable food and beverage industry.
We position ourselves as an engaged partner and we market our ability to quickly fulfill orders with a product that can help improve efficiency in our customers processes.
The pandemic gave us the opportunity to prove this value proposition to our customers in the food and beverage industry and our process filtration team delivered.
We remain very excited about this market. So we will continue to invest in growing the salesforce and adding new tools to drive this profitable business.
Sales of special applications were down 10% in fourth quarter.
Described was down from the prior year after having a significant increase in third quarter, while the slowdown in autumn and the automotive market resulted in lower sales of venting solutions.
Fourth quarter sales in gas turbine systems are GTS were up 6% due primarily to strength in small turbans.
Once again, the GTS team delivered another profit increase in terms of both dollars.
And the rate.
As you know we shifted the GTS go to market strategy for years ago.
We determined that the best path forward was to focus on replacement parts and small turbans wild being highly selective in deciding which large turban projects we pursue.
The GTS team has done an incredible job executing this strategy and we see it in the results.
In the past quarter, we also chose to consolidate our joint venture in Saudi Arabia into our company.
Once again, we're focused on rightsizing and streamlining GTS to enhance our profitability.
Based on what the GPS team has delivered and the opportunities in front of US we're reclassifying GTS as a mature business in our portfolio.
The GTS team has transitioned from fixing the business to driving profitability and we are on solid footing today.
I want to thank them for the incredible job, they did executing that strategy and delivering on their commitments.
The success in GTS is not an isolated incident.
Our company is filled with great people working together to deliver results and create value for all our stakeholders.
That's why I'm comfortable and confident in our future.
Before turning the call to Scott I want to briefly touch on fiscal 2021.
We're not sure how long the pandemic will last nor are we sure about its ultimate impact on our business.
Given those uncertainties, we will remain focused on what we control.
Prioritizing the health and safety of our employees.
Fulfilling our customer commitments.
Pursuing market share and growth opportunities around the world.
Executing margin enhancement initiative.
And maintaining a balanced approach to expense management, which includes making targeted investments to advance our strategic priorities.
Scott will share some more fiscal 2001 details so I'll now turn the call over to him Scott. Thanks, Todd Good morning, everyone.
Like most companies, we had to quickly adjust to a new way of working over the past six months.
And our employees in excellent job with that table.
The increase that level of collaboration.
Deepened our relationships with customers and suppliers.
And we supported critical businesses around the world with minimal disruption over.
Overall I'm very impressed by what our team accomplished to my colleagues around the world. Thanks for all you do.
As we turn into fiscal 2001, we have a solid foundation.
At the markets are not yet on firm footing.
Even the wide range of possible on problems, including a pilot timing and shape of the inevitable recovery. We are not issuing detailed guidance at this time.
The new however, I want to provide some of our 2021 planning assumptions.
Ill cover those later in the call, but first I'll share some thoughts on fiscal 2008 results.
Detrimental margin was inaudible highlight for US we delivered 20% in the fourth quarter and 18% for the full year. Those results are stronger than our historic averages. So let me walk through some of the details.
I'll start with the operating expenses, which declined 10% to 125 million in the fourth quarter Thats flat sequentially and it's our lowest fourth quarter level in four years.
Discretionary expenses were down significantly due in part to pandemic related travel restrictions and we maintained our investments and strategic growth businesses. Both process fluctuations. Thus collections on connected solutions, we will continue to focus on balancing expense savings with investments.
We are pleased with performance on the fourth quarter.
We're also pleased with our gross margin performance.
Fourth quarter gross margin was up 20 basis points in the prior year and our full year rate was up 50 basis point.
Despite headwinds from lower sales and higher depreciation related to our capacity expansion projects.
As a side note. Many of these projects are now completed which is why our capital expenditures in fiscal 2001, our plan well below for 122 million, we invested last year.
Our focus has now shifted to the optimization opportunity is enabled by these investments.
We plan to lower our cost structure, while maintaining or improving service levels.
While benefits from these initiatives will ramp up over time, our list of optimization projects gives me confidence that we can deliver strong returns will be more assets.
Lower raw material costs, and Rob will offset the loss of leverage impact on gross margin, we have seen favorability and market prices for steel media and petroleum based products on a procurement team and driving incremental savings as a strengthen our supplier network, while improving terms.
I also wanted to touch on pricing cloud hasn't been a major contributor to the year over year gross margin increase it hasn't had a headwind.
Have more latitude to drive sites in many of our replacement part businesses.
And teams lifestyle is in the independent channel of engine aftermarket and have done an excellent job consistently exceed our pricing strategy.
I know that takes a lot of Workstyle other bank a commercial teams around the world for meeting our customers' needs while promoting the value we bring in terms of technology and service.
That makes a big difference, especially in this economic environment.
A favorable mix of sales is also making a difference to gross margin in the fourth quarter and for most of the year, we have realized mix benefits as replacement parts makeup a greater share of total sales.
Certain expense is mixed benefits are but by dissolve.
We invest in technology to win first fit programs that dry aftermarket retention.
As we move direct economic cycle, our strong base of recurring revenue creates some relative stability and provide some gross margin installation.
Replacement parts now account for 64% of total sales, giving us confidence in the durability of our business model.
Before moving forward on the CNL I want to quickly talk about segment profit margins.
Sorry is engine is consistent with the consolidated results.
Mix benefit and lower raw material costs offset the loss of leverage resulting in a year over year margin increase of 20 basis points in the fourth quarter.
Within the industrial segment the loss of leverage was magnified by continued investments in our strategic growth businesses.
We expect industrial margins will bounce back helping us deliver our goal of mixing the company's margin up overtime.
Moving back to the TNL. Other income was 2.7 million in the fourth quarter compared to the extent of half a million dollars in the prior year improved performance in our joint ventures was a benefit in fiscal 2000, and the fourth quarter expands in a prior year reflects a charge related to our global cash optimization initiative.
Yes.
These initiatives, which allowed us to streamline our legal entity structure or enabled by tax reform.
We excluded the charge in last year's calculation of adjusted earnings per share and we also excluded a nonrecurring charge related to tax reform legislation.
With that in mind, it's best to compare the reported fourth quarter tax rate of 21.1% with the prior years adjusted tax rate of 21.4%.
While the delta between rates is not significant I'll point out that current and prior rates were well below what we typically expect a fourth quarter 2020 rate benefit from a favorable mix of earnings across jurisdictions.
While the 2019 adjusted rate included non recurring benefit related to the favorable settlement of an item.
Everything about fiscal 2001, we see our full year tax rate going up from 2020 to be more in line with our long term estimate of 24% to 27%.
In terms of our financial position, we feel good about where we ended the year our leverage ratio was 0.9 times net debt to EBITDA.
And in the fourth quarter, we paid off a term loan for 50 million and we reduced borrowings on our revolver by 110 million.
We proactively do from our revolver and early days of the pandemic as a way to bolster our liquidity out of an abundance of caution.
While market still are uncertain.
We are confident in our current position and no longer feel the need for that extra layer of security.
Receivables are down meaningfully from the prior year, which is what we expect in this environment inventory was also down but we plan further improvement this year as we focus on level in with demand.
Our fourth quarter and full year 2020, cash conversion rates increase meaningfully to 165% and 103% respectively.
And we plan to exceed 100% again this year.
Our fiscal 21 assumptions for sales are directionally consistent with recent trends sales are expected to vary widely by geography end market and sales of our replacement parts and products for new market should continue to outperform the company average.
Additionally, we expect sales during the first half of 21 will be down versus the prior year due to the timing of when the pandemic began.
We have seen these sales trends play out in August, which we expect will be down about 10% from the prior year.
Total sales for the month loss will be down from July Devops typical seasonality.
Regional trends in August natural we saw in the fourth quarter sales in the eight top reaching outperforming the best versus the prior year led by growth in China.
Europe is faring better due in part to currency, while being you add that Latin America remain under most pressure.
And as expected we have pockets of relative strength from some of our more stable businesses, including engine aftermarket and process filtration, which are most up in Europe.
While new equipment remains under more pressure.
In terms of fiscal 21 gross margin.
Fits from product mix and lower raw material costs should lessen as we compare against strong tailwinds in the prior year.
At the same time, we will execute our optimization projects to position ourselves for long term increases in gross margin.
Our fiscal 21 operating expenses will also have some puts and takes resetting our annual incentive compensation plan generates a headwind of about $13 million and we are planning to make further investments in our strategic growth businesses and technology development.
We plan to substantially offset these increases by controlling expenses.
Which we'll likely see from benefits from pandemic related restrictions and comparing against the higher levels than on the first off of the prior year.
Should we see an opportunity that makes sense, we will also explore additional optimization initiatives.
Finally, we plan to repurchase at least 1% of outstanding shares in fiscal 2001, which would offset any dilution from stock based compensation.
Any repurchases beyond that level will be governed by macroeconomic conditions, our investment opportunities and our balance sheet metrics.
Should conditions improve it is not unreasonable to assume we will go above the 1% in fiscal 2001.
At a high level our objective for the new year are consistent with our long term strategic agenda, we will pursue growth and market share opportunities in our advancing accelerate portfolio businesses.
Drive optimization initiatives that will strengthen gross margins.
Control discretionary expenses, while making targeted investments and protect our strong financial position through disciplined capital deployment and working capital management.
These are the actions, we can control and I'm confident in our build ability to deliver in 2021.
Before turning the call back to Todd I want to share some news.
After five years as our Investor Relations director, Brad is going to be moving to Belgium to take over as finance director of our Europe Middle East region.
Colin make the timing a little uncertain, but I know is committed to facilitating a smooth transition when we find his replacement.
Thanks, Brad for all your work and I are you have done an excellent job.
And congratulations on the exciting we went venture with Donaldson.
I'll now turn the call back to Tom Todd.
Thanks, Scott and I offer my congratulations to brand as well you will clearly be missed in this role, but we all know it's a great opportunity. So we're very excited for you.
I'm confident in our ability to navigate the complexities of the current environment and I'm equally confident in our ability to create long term value by meeting the evolving needs of our customers.
We have strong relationships with our customers and they range from some of the world biggest brands to small business owners.
We are grateful for the partnerships, we have and I want to thank our customers around the world for their continued support of our company.
Our goal is to solve our customers' complicated filtration challenges in a way that allows them to deliver great products efficiently and I think we're doing well against that objective.
Let me share some examples of what I mean.
In the engine segment, our filter minor team released a wireless monitoring system that helps fleet managers optimize their maintenance schedules for on road and off road equipment.
Our system integrates into the existing telematics and fleet management infrastructure, making it easy for our customers to adopt this valuable technology.
We're also expanding connecting solutions into the dust collection market with our Ifyou offering.
This service provides customers with real time monitoring of their equipment performance, helping them save energy costs and reduce unplanned downtime.
Once again, we made it easy to adopt our eye to set up can be used on any brand of dust collector and the retrofit process is very simple.
Our E Commerce platform is another tool for helping customers operate more efficiently.
Shop Dot Donaldson Dotcom has a global reach and offers features like real time availability and personalization functionality, making it easy for customers to find what they need and place new or repeat orders.
As always new technology is a critical part of our success Formula and we continue to expand our technologies and solutions to drive growth.
Many of our engine customers are looking to improve fuel economy, and reduce emissions and our products can help them achieve their goals.
We have shown that consistent use of our power core product can help end users improved fuel economy and it provides value to our OEM customers as they can retain more of their parts business.
We still see many opportunities with diesel engines, we also see a growing opportunity with alternative power trains like hybrid solutions and hydrogen fuel cells.
Hybrid platforms leverage the portfolio air and liquid solutions, we have today. So we had good opportunity with adequately.
The needs are different for fuel cells, and we have a specialized air filtration system that is specifically designed to meet those needs.
In addition to our air systems, We also had venting products that special.
Products and specialized membranes for fuel cells.
With our technical capabilities, we are well positioned to participate in this growing market.
We're also pursuing non engine markets like food and beverage.
Sales of process filtration were about $50 million in fiscal 2000 invest an increase of more than 60% over the past three years. We have continued investing in new technologies and we are building capabilities that will facilitate our future expansion into life Sciences.
Our long term success is dependent on our team. So we're committed to making our company of great place to work.
We have a strong culture and replace a high value on integrity.
Commitment.
Respect and innovation.
We also have a continuous improvement mindset. So we recently created a diversity equity and inclusion council that will help identify and implement practices to make us a stronger company.
The council is being led by a passionate group of employees and I want to thank them for stepping up to move us along in this important journey.
We are all foreign a journey with our sustainability practices.
We began developing our global sustainability strategy last year.
We had engaged our stakeholders and we have identified a long list of projects for reducing greenhouse gas emission.
Energy consumption and wastewater.
Implementing and maintaining sustainable practices is one more way, we drive towards our purpose of advancing filtration for cleaner world.
As I close todays call I want to thank again, our employees for their contributions during fiscal 2020 I'm proud of what we accomplished as one Donaldson and I look forward.
To another successful new year.
Now I'll turn the call back to Lisa to open the line for questions Lisa.
Thank you as a reminder, task a question you will need to press star one on your telephone to try your question press the pound or hash key please standby will we compile acuity roster.
And our first question comes from the line as Nathan Jones from Stifel. Your line is open.
Good morning, everyone.
And a warning.
Many of you didn't start on the top line both quarter thousand aggregate down about 15%. You said August is down about 10% can you talk a little bit about how that how the comparisons in the fourth quarter progressed.
And is that all days down 10%, a better comparison than the kind of the exit right out of the fourth quarter.
Or add to have being started to settle down here and thats kind of hovering in that minus 10 range. Just any color you can give us on how that at that progressed over the last few months.
Nathan This is Brad I'll start and.
As a reminder for you in the group a few months ago, we announced that May sales will be down 24% and of course that came out the way we expected. So when you put June and July together, they were down in the low double digits, which is pretty consistent with the trend we saw year over year in April the decline that or excuse me.
In August.
A decline in August from July is also not atypical seasonality, we typically see that falling off as we get more towards the fall and winter months.
Maybe then as I said June July and August that have been fairly consistent on the comparison levels there.
Can you talk about which parts of the business there are seeing a recovery, which cost there are slow to recover and would you anticipate some of those lagging part of the business to gradually begin to improve as we go through the back half of the calendar year here.
Sure Nathan this is Todd so.
The businesses are very mixed the as you might.
Might imagine so any any first at type business. So on road.
Vehicles or off road vehicles with first fit production have the most significant headwinds and the most significant headwinds in the company is on roads, United States first that business.
The rest of the businesses.
Such as aftermarket.
Both in the independent channel in the OE channel are more modest headwinds and we do see that.
With the Destocking that has occurred in the previous two quarters really on a pull through like level.
As we turn to the industrial side. The most significant headwinds are going to be first fit equipment in our industrial air filtration business. We also see slight headwinds in the replacement parts because industrial production is has not come back, particularly in the United States, but to the levels that we would expect.
That's where we are at the moment, we would expect the first half, especially because coded hit in the second half of last year, we would expect the headwind to be more predominant in the first half and then of course.
With that easier comps in such a growth overall for the company to be in the second half of our fiscal year.
So I guess, if where you're at now kind of low double digit declines in July on June 10 in August.
You should probably say some of the lag businesses get a little bit better as we go through the backup. So is at least that day debt that first half revenue comparison should be down in the single digit some way rather than the potential for it to be down in the double digits.
Tough to say.
You know specifically.
Were clearly.
A high single to low doubles than in the first half is not out of not out of any of the models that we have built here.
Okay. Thanks, very much I'll pass it on.
Any statements also level.
Our next question comes from the line of Brian Blair from Oppenheimer. Your line is on thin.
Thanks, Good morning, guys.
But on a brand.
Certainly could dig in a little more on your gross margin performance ups 50, bips for for the year.
Despite the topline headwinds that.
Really stands out so maybe you could parse out the operational lifts premier initiatives and you were targeting 50 to 75 basis points. There and then the benefits of favorable mix and lower material costs relative to the clear hit from utilization.
We also and we were pleased with them, we overall gross margin performance.
It's obviously, that's something we focused on for quite awhile and I think you've covered the.
The main points there if we look out quite a mix and raw materials, what I would probably put that in 100 basis points.
Range.
Look at a loss of leverage.
Paul.
Offset somewhat by all the imperatives that we've had you know that's obviously thats down 80 basis points and then you have a lot of little plus in days when added depreciation.
Then on tomorrow things to decline asylum for that overall improvement so as Ben.
Next in raw materials.
Want to handle mannion, our lots of leverage that we.
We saved their spared quite a bit of AD buy hall, the great projects that have been completed we look forward to those in our projects moving to more of an optimization phase this year, which will help our margins in our next year and in the future.
Yes, I appreciate the detail.
And on that front it sounds like gross margin dynamics will be somewhat similar to fiscal 21, just lessening impact from.
The favorable mix and lower Ross that Youve event.
Given your current outlook is the expectation for further gross margin improvement this year or is it too early to call.
Dollar in our committed to improving those gross margins and I I think it hit it right on the ahead.
And we're going to continue to push to drive.
In our margin improvement in our pending reasonable level results.
Okay.
Kind of housekeeping question and understand you're not providing a hard number on your Capex guide is there a range as a percentage of revenue. We should think about for for 2021, and then looking forward any shifts you and normalized capex in that 3% to sales range.
So thats, what I was going to say account a normalized range all dollars had a 3% or sales I think we can be under that than last year on quite a bit. We said, we're now at a net number of $122 million for those here, which is part of the completion of our investment period by we're quite happy to be kind of downward.
So we would expect will be under our normal run rate and learned obviously significantly under our authorized quantity. So we're getting into applied I noted that we expect our cash conversion for next year to be greater than 100% an hour and that's driven partly by improvements in working capital and then I'll lower leg.
Well off Dropbox.
One last one if I can any quick update you can offer on your M&A pipeline seems like there's been.
A little bit of an uptick in activity at least for companies that have more proprietary funnels and you certainly have capacity at the right deals with them.
Brian This is Todd we continue to work the M&A pipeline that we have we would suggest season, it's still remains robust and.
No no.
Change in our our stance our philosophy, our ability to deal.
We just continue to work it and.
We will continue to do so because we believe that's an important part of our long term strategy.
Okay. Thanks Candice.
Thanks.
Our next question comes from the line of Chill Aiken from William Blair. Your line is open.
Hi, This is Joe on for Brian today, Thanks for taking my questions again.
So first of all just on the model looking at operating expense you mentioned the.
13 million incremental incentive comp.
Expected for fiscal 2001 is that expected to hit any quarters and in particular can you remind me.
Yes, I will do.
Most of it year over year and the second half of 2021.
Okay, and looking at kind of the run rate Opex dollars.
1.5 million in the fourth quarter, how much of that is that primarily temporary costs will be taken out or are there. Some permanent cost will be taken out there as well.
I mean, we haven't had any like big restructurings or permanent top.
Structure changes, we have then obviously working hard to control our expenses you do get some benefit from yet our travel restrictions that are an exist as in the world today, and we've been working hard to control our discretionary expenses that we could still spend because we're really trying to protect.
Those investments that we're making to help drive the longer term success in the company.
So Joe I'll, just any other color. So just look at the macro level from from the way. We're approaching this we're playing a long term game here and and our people around the world are doing a fantastic job controlling what they can control the discretionary expenses, while the company continues to invest in the long term strategy and the controlling the expenses right now as a way.
Showing us to play offense, where we can play off Hudson. So that's that's how we're looking at it and we would congratulate and thank all the employees around the world. We're doing just an excellent job.
Got it appreciate the color there and then just switching gears looking at some of momentum you're seeing in China right now.
How long can some of these tailwinds last you see some projects pulled forward as a result, the blue Sky initiative and.
Some of the investments China is making stimulating the economy.
As you think projects pulled forward and how long can consumables tailwind flat.
So it's important I understand that that are representation in China is still low single digit across almost every one of our markets there and so consequently, they can last a very very very long time, and we're just now getting some momentum with technology based wins that are actually shipping too.
China based China National based customers.
Which is expansion for off from the multi national based customers that we had there so our expansion in China can last a very long time as as we continue to gain momentum and its broad. It's it's in our engine based business on the first fit with the first technologies of of power core it's on the aftermarket side that we're gaining momentum and it's also blue Sky and.
Initiatives on the industrial side, particularly in the high a half business.
Okay. Thanks, a lot of Aslam.
Thanks to our next question comes from the line Galan coming from Morgan Stanley. Your line is open.
Great. Thanks, Good morning, guys.
Good morning line.
I just wanted to kind of jump back in the Ocean Marine interest again, I think you guys have been expanding marine but a pretty good clip kind of year to date, but then.
Obviously, the detrimental stepped up a good this quarter I guess, Scott you mentioned in your prepared remarks, but how much of the detrimental use those don't driven by some of the more internal investments you mention versus elegant and we will mix. It is kind of general lost operating leverage.
Yes, I mean, I think you hinted at exactly on the had I was sort of spread across both most those three factors.
CNL hit the leverage.
Cost of volume, we keep talking about even in the questions here about how we want to continue to make investments and will continue in dollars allows us our targeted in a higher percentage to industrial and then finally, we had a little weaker mix in the quarter CNL compared to.
The year over year comps, which which drove down a little both so we expect that mix to improve.
And so that headwind will ultimately probably a made.
And we got to get those sales and starting to increase.
Overtime, so we can.
Get ready to do deleveraging issue.
Got it Thats helpful. Thanks, and then maybe on the aftermarket side that was kind of one of the few of the verticals within engine were in them as a still falling a bit I guess, you kind of ahead to rank order the headwinds on aftermarket sales there.
How much would you say is going to related is going to general because the utilization versus the more kind of acute America pressure in.
Areas like oil and gas or something else.
Yes.
We would tell you that the oil and gas as well as the fracking pullback specifically were significant headwinds.
Even more so than we had originally modeled.
To be fully transparent there so thats the most significant headwind that we have it and then of course, just a general more broad based.
Realization slowdown, which would likely be the second largest it.
Okay got it thanks, Doug in the state Memorial here.
It seems like the aftermarket inventory levels again pretty volatile over the past few quarters and particularly on the OEM sales declined a bit in the quarter I guess deal. We view on kind of whether inventory levels are was cited this plant or do you kind of cylinder spinning low destock in the first half.
Yes, we pay the independent channel actually be stopped for studio, we channel just tweaked a little bit not not a dramatic destocking and so we would be would suggest to you that based upon the behaviors and the forward looking order that we have today that that both channels are older level.
Got it Thats helpful. Thank you as time goes.
Thank you are thinking.
Our next question comes from the line of Laurence Alexander from Jefferies. Your line is on plan.
Hey, guys Daniel on prolonged how are you are down and then hey can we just circle back on the pricing you mentioned before how does it work.
Just some color there isn't negotiated every time.
You have the rebates or you have to justify a price increase just any any code degree.
On the first that side of pricing, particularly within the.
Engine side of our business, we have price downs on annual long term contracts. So each year, we started in a negative position relative to that revenue.
And that was also being the OE aftermarket piece of that business and the independent channels of aftermarket in England, clearly, we have more leeway there and we do it on a region by region basis based upon local conditions on the industrial side of the company it more recess quickly.
With our product more more of that revenue being project based business. So as you wash out our project base lead times typically 345 months.
You will wash out the old pricing and come back with the New quoted project base and then after market of course is more like an independent channel, where we have a better control.
That's actually very helpful. Thank you and then just one other question on Capex are you mentioned is going down Im sorry, the Mrs book.
Is there potential that this is temporary response to the pandemic because I know you have to be project and but I was wondering with the with the mix was there and how we should be but over the long term. Yeah. I think you have right. So we had those and so that we are in a period of high investment as we have many projects that were in flight than we were happy to re.
Part that we've completed the majority of those projects.
And so our investment in our will come way down and in early next year.
We're going to be really focused on driving the optimization of those projects has done a breakeven new equipment. So.
Thats a great high for the company and not we get to fine tune the things we already have.
Drive improvements from that versus having to invest additional dollars, which is why we expect a strong cash conversion.
On slide 20, warm and just maybe a little bit of colors. So you know people.
Often will we'll try to connect the died of the pandemic.
Equating to our Capex based reductions here this fiscal year, and that's not really what you're seeing and our behavior remember those in the past three years, we've had a significant run up based upon our strategic plan to optimize our supply chain internally and so we are now coming to the end of that.
Pretty significant investments and now we will be essentially shuffling the deck internally to continue to expand our gross margins and.
Optimize our supply chain. So the fact that we have less capex. This fiscal year is is less connected to the pandemic and more to our strategic priorities and what we're executing longer term.
Thank you very much guys.
Our next question comes from the line as Richard Eastman from Baird. Your line is open.
Richard Eastman Your line is open.
Yes. Thank you so I was on mute.
Yes, and thanks for the questions and.
I'd like to Brad Congrats Brad this can be exciting.
Congrats.
Just.
Quick question around gross margins I just want to go back to this for one second in total.
The gross margins for the full year were what plus 50, beeps and Im curious the progress that was made in the engine versus industrial.
Segments.
And also just.
Todd you spoke to price there a little bit, but net net was priced kind of a neutral on gross margin for the year I mean again, it's going to move with.
Presumably would move with the mix but.
I presume, it's more the volume than it is a price impact on gross margin for the year.
And then that Rick pricing was flat.
Across the company, obviously very mixed results in different businesses, but to a total company at it comes out flat.
Okay. Okay, and then the progress on on the engine versus industrial side relative to that 50 basis points overall consolidated.
Yes, I noted in my script.
Overall, the engine story as part of some systems.
With the consolidated results.
Which is deal mix benefit lower raw material cost.
Offsetting by the.
Lots of ravaged for industrial you know they had the similar factors, but they also have the added Todd that does a little more investment.
And probably a little bit weaker mix.
So those two additional factors come into play when you think about industrial.
Okay. So was there any progress made in gross margin on the industrial side year over year or was that a bit of a dragon and the 50 basis points consolidated was driven by the engine side.
Hello.
Rick This is Brad I would say the Theres progress made it just unfortunately massive that bite off so the the things that we've been talking about with procurement savings for example.
The team there is doing a lot of work to try and find ways to either negotiate differently locally by new qualified vendors things like that that help us in that benefits both segments I would say the same is true on pricing discipline that that's happening across the company as Todd mentioned as it is quite varied by business and then this year as we grow.
All into some of the new capacity industrial we're certainly benefit from that and then one more thing the long game with Industrials also favorability with mix. These high tech markets are and where we're putting a lot of technology dollars are going to benefit the industrial segment, probably disproportionately overtime.
Okay. Okay.
And then just just maybe.
Just kind of leads me into my next question, but.
Lots of commentary around the puts and takes on the gross margin side as you just addressed and then also the opex.
Obviously, we have been.
In incentive coming back in.
And then some other cost actions there I think the reference was also made to some additional cost optimization.
If necessary, but I'm curious when you when you look at where you.
Exited or or finished fiscal 20, I think you're you're operating margins were 13.2.
With the puts and takes in the commentary here run gross margins in Opex.
Under the assumption that maybe sales are flat to shoot that'd be my assumption, but under that assumption would the target be here too you know to have flat operating margins here as well.
I mean, I'm trying to figure out how you're you're maybe looking at.
The Incrementals decrementals, but if the assumption is flat flat revenue for the year.
Is the goal in the target your to hold margins flat as well as a percentage of sales.
Rick as Todd so.
With all of the moving pieces, we would still expect even on flat sales to expand our operating margin, though very slightly obviously.
And that would likely.
Be driven by the gross margin work that we continue to across the company because we are very focused on on gross margin.
Okay, Okay all right.
Good and just maybe one last thought around.
The first fit businesses and maybe ISS in particular.
Anything that you're seeing you talked about elongated close to two orders a trend, but does or is there any sense there that your backlog around some of these first fit businesses.
It is hit bottom here and we're waiting for maybe maybe calendar 21 capital budgets to start kicking in or.
How do you look at where your backlog use in some of these in your first fit business in particular.
So it NFS, we on the first of business, we've seen roughly on the conversion rate from quota order. It it's kind of double than its behavior right. So.
It's out it's out over 100 days before people are making decisions. The there. They are deciding on the must be projects the things that that they have to do in order to protect.
Say.
A particular environmental issue or whatever the case, maybe im they're doing the must choose but but the rest there. They are really pushing out and it's been slow and thats pretty broad based around the world with a notable exception of China, China is a little slower, but not as low as the rest of the world. They continue to move forward.
So what do we what do we look on on the backlog when will that change I think people are waiting waiting for industrial production to gain a little bit more confidence that they can they can really gear up their factories again and that level of confidence is just on out there.
Yet across our customer base, okay. Okay Yep Yep, Okay mix makes total sense. Okay. Thank you again and again thanks, thanks retro so.
And I'm sure will be fully engaged in.
And a contributor on your from Europe.
Thanks.
But congrats ship thanks, guys.
Our next question comes from the line as Nathan Jones from Stifel. Your line is open.
Hi, guys I, just want to put a finer point on the operating expense expectations here.
I think maybe you've narrowed in on this.
After the year is running at that 140 level second half of the years running at about 125 per call it off.
You've got.
Obviously that the stock comp coming back it and you probably going to have submit a temporary cost reductions things like travel that are going to increase here as we go forward.
I think you said you know on flat sales you'd look at operating margins expanding a little bit that mostly on gross margins, which would imply that the annual operating expense in 20 ones probably targeted to be roughly flat. So is it a reasonable expectation for us that the decline of these low one.
Yes.
Is where we're going to go to and see that through 2021 and as a temporary costs start to naturally roll off as the economy's reopened are there any plans to take some more structural cost action in order to offset those expenses coming back.
Nathan below one thirtys would be aggressive.
We would not expect on a quarterly basis to hit that level of rate.
Simply because we do have the investments.
Coming online. So for example, we have our new material research center that will be staffing up and putting online here in Q2.
Other strategic investments that we have so so below one thirtys would would be aggressive we was we would suggest and then than longer longer term.
With all this expansion that we've done to normalize internal supply chain to really get after our gross margin initiative always done.
As we've advanced our strategic plan, our three to five year plan within operations and we've we've built out our internal.
Footprint, if you will and so we continue to look at what are our next steps within that plan and looking forward should there be any kind of.
Say tweaks or on moves or restructuring actions relative to that operations plan that are necessary clearly we would take those actions and that would be the first place that we would look relative to where were added in the.
In the company's actions, but that's.
What we're doing is what we're just play in our operations playbook in order to continue to expand our gross margins and that's how we're looking at it.
Okay, just to clarify that I said low but is not below what the eight Oh I'm sorry, okay. Thank you beat I heard be low one thirtys and that would be aggressive so low one thirtys makes more sense.
Okay. Thanks, very much for the clarification.
Thanks, Tim Thank you thanks due to as well.
I'll now turn the call back over to Tod Carpenter for closing remarks.
That concludes today's call and I want to thank everyone listening for your time and interest in balancing company and I hope that you and your families and friends are all safe.
Good bye.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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