Q2 2021 Donaldson Company Inc Earnings Call
[music].
Ladies and gentlemen, thank you for spending by and welcome to the Donaldson Q2, FY 'twenty one earnings call at.
At this time all participants are in a listen only mode.
After the speaker's 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 kind of further assistance, please press star zero and one of them.
And the conference over to your Speaker today, Mr. Charlie Brady director of Investor Relations. Thank you. Please go ahead Sir.
Good morning, Thank you for joining Donaldson's second quarter 2021 earnings conference call with.
With me today are Tod Carpenter, chairman and CEO and president of Donaldson.
Scott Robinson, Chief Financial Officer.
Morning, Tod and Scott will provide a summary of our second quarter performance along with an update on key considerations for fiscal 2021 day.
During today's call, we will 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 and 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 ill now turn the call over to Tod Carpenter Tod.
Thanks, Charlie good morning, everyone.
Looking at second quarter results, we are pleased with our performance second.
Second quarter sales were up.
Some of our business model with reported.
And the stability as we grew market.
Share in key markets and geographies.
During this quarter, we also built momentum and first fit sales in our engine segment.
And we're seeing increases of incoming orders across our industrial segment.
We are pleased to see the uptick and second quarter sales and incoming orders within our first fit equipment businesses.
While this creates mixed pressures and the short term. It also sets the stage for replacement parts and our razor to sell Razorblade strategy and provides continued confidence that the worst of the pandemic related economic impacts are behind us.
And we played and the long game during the pandemic, maintaining our disciplined focus on the future and avoiding the temptation to make potentially short sighted decisions on our cost structure.
During the second quarter, we took planned full actions with the longer view towards optimizing our organization and our cost structure primarily in Europe.
We incurred $14 8 million and restructuring expense and expect annualized savings of approximately $8 million. Once the restructuring activities are completed over the next 12 months.
<unk> the impact from our restructuring actions gross margin was up 30 basis points from the prior year as lower raw material costs, including benefits from our procurement initiatives more than offset the increasing pressure from an unavoidable mix of sales.
With continuing the momentum we expect full year sales to be up 5% to 8% over 'twenty and 'twenty, including favorability from FX of about 3%.
We're also projecting adjusted operating margin to increase 60 to 100 basis points driven largely by gross margin strength.
Finally, our company remains and a strong financial position.
We had solid cash conversion during second quarter and our balance sheet is in good shape with our net debt to EBITDA ratio sitting at zero seven times.
Our balance sheet gives us ample capacity to pursue our strategic initiative to move into the life Sciences market via acquisitions and continue to invest in organic growth opportunities.
We are delivering on our strategic and financial objectives, So far and fiscal 2021, and we are planning for a strong finish to the year.
Scott will talk more about our forecast later in the call, but first let me provide some additional color on recent sales trends.
Total second quarter sales were up two 6% from the prior year or 0.2% and local currency.
Total engine segment sales rose over 6% and industrial was down 4%.
Geographically the Asia Pacific Region led our positive performance as we continued to see very good growth in China.
And the engine segment the sales increase was driven by meaningful growth in both off road and aftermarket.
The growth was partially offset by a slight decline in on road.
And the drop in the aerospace and defense.
Off road growth was widespread with sales and all major geographic regions up from the prior year.
Importantly, our incoming order rates and backlog and point to building momentum through the second half of fiscal 2021.
Within off road, our second quarter sales in China were up about 70%.
We are seeing momentum and the market with construction and equipment build rates remaining at high levels. We are also seeing strong growth of power Korea, and China and several new power core programs for tier three upgrades have gone into production.
And on road sales were down about 1% in the quarter, which is our best year over year result, since fiscal 2019.
Signaling to us that the second quarter was the cyclical trough and this business.
Our view and supported by external data with order rates for class eight trucks launching higher in the past several months and higher build rates projected in the coming quarters.
With increasingly favorable market conditions combined with our strong share in North America heavy duty trucks, we are optimistic about our opportunities to drive growth and our on road business.
Second quarter sales of aftermarket were up over 7% year over year and they were also up 4% sequentially from the first quarter, which is atypical and serves as another indicator that market conditions are improving.
In China second quarter sales of engine aftermarket were up over 30%.
We are beginning to see service parts benefit from new equipment under warranty, which includes an increasing percentage that have proprietary power core and powered air cleaners install.
Overall power core sales increased about 9% in second quarter with strong growth and both first fit and replacement parts.
As I mentioned earlier in China, we are seeing significant growth, which we expect to continue as power core becomes more mainstream.
Aerospace and defense, which represents about 3% of our business faced another tough quarter due primarily to the ongoing pandemic related weakness in commercial aerospace.
<unk> sales for helicopters continued to perform well.
As we expect the timeline for recovery and commercial aerospace to be protracted we took restructuring actions within the quarter to improve our cost structure and better position the organization for the current business environment.
Turning now to the industrial segment second quarter sales were down about 4%, including a 3% benefit from currency.
We continue to face pressure on sales of dust collector shouldn't sale products within industrial filtration solutions or ISS as utilization rates were lower and customers remain cautious and making capital investments.
Once again, a bright spot in the quarter whats the process filtration.
Our process filtration and for the food and beverage market with our life Tech brand continues to grow particularly on the replacement side.
Overall process filtration sales increased and the high teens with contributions from both first fit and replacement and we see a long runway for further expansion of this business.
We are making new inroads with some of the world's biggest food and beverage companies and we are also gaining share with existing customers. The.
The sales process for these massive brands involves winning at the parent and then selling one plant at a time, which is why we continue to grow our sales force and invest in new tools and resources.
We launched life Tech five years ago with fewer than 10 salespeople and we are on track to be over 100 by the end of this fiscal year.
Sales of gas turbine systems, or GTS were down three 5% in second quarter as large project deliveries, though a smaller part of our business were less than the prior year.
And our replacement parts business on the other hand delivered another quarter of double digit growth.
We continue to win share of aftermarket, while being selective and which large turbine projects we pursue.
The team has done a tremendous job of improving the profitability of the GTS and our more focused approach is clearly paying off and.
And special applications, we again saw very good growth and integrated venting solutions and we continue to drive adoption in the out of him out of market with our high Tech products.
However, overshadowing these wins were continuing softness in disk drive filters and lower sales of membrane products.
Second quarter results highlight the strength of our diversified portfolio of businesses and disciplined focus on the long game.
We are well positioned to benefit from the recovery and cyclical end markets and we continue to press forward on our strategic initiatives, including the recently announced investments to grow our life science business.
Talk more about that later, so now I'll turn the call to Scott Scott Good morning, everyone.
Tod said, we're pleased with our second quarter performance sales are up two 6% from the prior year and adjusted operating income grew seven 6%.
Given the uneven macroeconomic environment and was a strong quarter in terms of both absolute growth and leverage looking ahead, we plan to build on that momentum.
As I've said many times, we are committed to increasing levels of profitability and increasing sales I know I'm repeating myself, but I also want all read and know that that statement of the guiding principle for us one.
And one way and we deliver on that COVID-19 minutes through select optimization initiatives.
Which is high with characterize the restructure of actions we took in the second quarter.
Most of these activities are happening in Europe, and all of them support our long term objectives for example, we.
We are centralizing key aspects of our aerospace business given the strong platform for one of the market returns to growth.
We are moving the production of certain compressed air products the eastern Europe.
We have an excellent team and a competitive cost structure and.
We are centralizing the European accounts payable and customer service functions to.
To improve standardization and optimization and giving us the ability of leverage common tools as we grow.
The projects, we initiated in the second quarter should generate annual savings of about $8 million once fully implemented with about $1 million realized and this fiscal year.
These actions drove the second quarter charge of $14 8 million and resulted in an operating margin headwind of about 220 basis points on an EPS impact of <unk>.
We have excluded these charges from the calculation of our adjusted operating metrics and the with and without details can be found in this morning's press release.
We are confident and the value of these optimization projects will create for our company.
But I also want the knowledge that they can be tough on the team.
I appreciate all the hard work that has gone into the planning and I want to thank our employees for supporting the initiatives and helping us deliver our long term goals.
With that I will dig into our second quarter results a bit more and they said earlier adjusted operating profit, which excludes restructuring charges was up seven 6% from the prior year that.
And that translates to an adjusted operating margin of 13, 4%, which is 60 basis points up for the prior year.
Second quarter adjusted gross margin was 30 basis points to 34% accounting for half the operating margin increase.
Rice with paper and materials in the second quarter was lower than last year due in parts of our strategic procurement initiatives and the gains were partially offset by an unfavorable mix of sales.
While we expect gross margin will be up and the back half of fiscal 'twenty, one of the drivers of our predictable and changing as expected raw materials and most of the tailwind to a headwind and the pressure per mix is going to increase with the anticipated sharp growth and our first fit businesses over the next two quarters as always we remain focused.
And managing the price cost relationship net pricing for the company was of pushed last quarter, and we will take a proactive stance as raw material costs dry power.
We also remain focused on being deliberate with our operating expenses and the rate of sales second quarter. Adjusted operating expense was 30 basis points of favorable versus the prior year.
And the benefits from lower discretionary expenses due in parts of the pandemic related restrictions were partially offset by higher incentive compensation.
Importantly, we continue to invest in our strategic priorities compared with last year, we invested more in research and development and we increased our head count related expense to drive growth and our advanced and salary portfolio of businesses.
You can see the impact the <unk>.
As more prominently in our industrial segment.
Many of our high growth and this is a reported if you exclude restructuring charges and the second quarter of industrial profit rate was down about 50 basis points of the prior year, reflecting the incremental investments and businesses like process filtration and that thing solutions.
<unk> solutions are the.
The other hand solid growth of our engine segment has created and leverage across the P&L the key.
Team is doing an excellent job of focusing on share gains and market expansion, especially in China and the alpha of thinking long term yes.
We are aggressively pursuing share gains and new markets and driving higher aftermarket retention of innovative products, we have great partnerships with many of the world's largest equipment manufacturers.
And we'll be leveraging those relationships and beyond navigate inflationary pressures related to raw materials and fulfilling rapidly elevating demand.
Across the company, we believe the balanced approach we have taken the pandemic puts us and a strong position to capitalize on the economic rebound.
Instead of making deep cuts the manage the short term demand pressure, we focused on supporting us on lessors, and making targeted investments into our strategic growth priorities.
While we anticipate uneven market trend will continue we are confident and our long term positioning.
Capital deployment is another area and we have a disciplined and balanced approach we invested about 12 million in the second quarter, which is down more than 70% from the prior year.
With the economic environment, improving and many of our new App online our focus is shifting towards driving productivity gains and working towards the operating markets margin targets, we shared at our Investor day in 2019.
We returned more than $57 million of shareholders through dividend and share repurchase.
Bringing our year to day total to almost 100 million.
Maintaining our dividend and the priority for us and we have demonstrated our willingness and ability to grow over a long period of time.
We have increased our dividend each calendar year for the past 25 years.
And as part of the Elite group included in the S&P high yield dividend aristocrat index our position on the dividend is the same as it was 65 years ago. When we began paying and every quarter and I am proud of the strength.
Share repurchase is also an important part of our capital deployment priorities, but it's a bit more variable at a minimum we plan to off the dilution from stock based compensation and any given year and we are on track to meet or exceed that objective this year the.
Beyond that our share repurchase is guided by our balance sheet metrics strategic opportunities and overall market conditions.
Overall, our narrative is consistent overtime, our year to date results demonstrate both the strength of our business model and the value we create by taking the long term focus yield.
And we plan to build on this momentum and the back half of 2021, So let me share some details on our expectations.
As Todd mentioned, we've seen and building momentum and our first fit businesses throughout the past quarter with this and mine. We expect sales this year to return to the pattern that is generally in line with our typical seasonality where about 52% of our full year revenue occurs in the back half therefore.
And therefore, we expect full year sales will increase between 5% to 8%, which includes the benefit from currency translation of about 3%.
And the engine segment full year sales are projected to increase between eight and 12% with our first fit business compromising a bigger piece of the recovery story and the back half.
We expect full year off road sales to increase and the low of 20% range of building strength and commodity prices driving an acceleration and equipment production and agriculture and other select markets and on road.
We expect a full year increase and the low teens driven by the strong rebound and global truck production rose.
Expect the momentum to continue and our aftermarket business with a full year sales increase and the high single digits.
We expect the continued to benefit from improving equipment utilization trends globally and market share gains and the Asia Pacific region, particularly in China, where power Corp is experiencing significant growth.
Our aerospace and defense business as anticipated the decline in the high teens digits overall as demand and the commercial aerospace is expected to remain depressed and we do expect to see sequential improvement as we lap the pandemic related impacts and helicopter and the ground defense programs continued to grow over time.
And the industrial segment full year sales are projected to be between a 2% decline and a 2% increase as the recovery and the capital investment and environment is still emerging with the.
Continue to press forward with market share gains during this period and our investments and building the advance and accelerate portfolio are expected to continue to result in sales growth above the company average.
We expect <unk> sales to be roughly flat for the full year.
Selecting a return to growth and the back half of the year.
While uncertainty remains we are seeing signs of increased quoting activity and expect we are well positioned to capitalize on any recovery and addition to our gains in share and continued progress with our innovative products and important markets markets like food and beverage.
GTS revenue is expected to increase by the mid single digits, driven by continued growth and replacement parts and.
And special applications, we are anticipating and decline in low single digits based on our year to date results and expected softness and the market for disk drive products.
And a company level, we are expecting and adjusted operating margin to increase to within a range of $13 eight and 14, 2% compared to 13, 2% and 2020.
This implies a sequential step up and our operating margin to 14, 4% of the back half of the year and aligns with our commitment to increasing profitability on increasing sales.
Gross margin expansion and continues to be an important lever for us we expect the benefit from our ongoing initiatives to drive top of efficiency in our operations and.
And they're positioned to gain leverage on the higher sales volume of.
At the time mix should also be of consistent factor and driving our gross margin up.
And you think about the near term however.
Net is likely to be a headwind of improving market conditions and our strong positioning with our large OEM customers will likely result in stronger first fit sales growth and replacement parts.
And are also beginning to see increases our input cost, including steel and freight rates.
Some of our expecting the cost headwinds of the remainder of fiscal 2021.
We continue to invest and our customer relationships and and maintaining our position as the top tier supplier.
And we'll continue to work to align our pricing with the increases and our input and supply chain costs.
Additionally, we expect to maintain a disciplined approach to our operating expenses and deliver further leverage in the back half of the year. Despite an expected full year headwind of approximately $20 million from Inc.
Increased incentive compensation.
About two thirds of which is in the back half of the fiscal year.
For our other operating metrics, we expect interest expense of about 13 million of.
Other income of two to 4 million and of tax rate between 20 and 25%.
Capital expenditures are planned and meaningfully below last year, reflecting the completion of our multiyear investment cycle taken.
Taking the midpoint of our sales and Capex guidance for 2021.
I'd put it at just over two percentage of sales.
We expect to repurchase one 2% of our outstanding shares.
Finally, our cash conversion was very good and the first half and we continue to expect to exceed 100%, reflecting strong first half conversion and anticipated increases in working capital later in the fiscal year.
As I close my section I wanted to take a moment the thank my colleagues around the world for their continued dedication of Donaldson and our customers.
We have had a solid first half of our fiscal year.
And are expecting even better results and the second half.
And im very proud of what our employees have been able to achieve and the.
Unprecedented time, and I am optimistic about <unk> future I'll now turn the call back to Tod Tod.
Thanks Scott.
As we saw during the first year of our fiscal year, improving economic conditions are complementing the benefits from consistently strong execution of our strategic priorities of.
Of course, achieving the significant sales and profit growth projected in the second half is not without risks.
Costs are going up and demand for raw materials was quickly increasing the global supply chain is getting stretched and above everything else. The pandemic is still hanging over all of us.
While the pandemic is certainly a new of current no occurrence the other pressures.
Not.
We have successfully navigated them time and again due in large part to our talented employees and strong customer relationships.
As always we will manage our costs.
Execute strategic price increases and pursue profitable sales.
It's a straightforward plan and it has served us well for 106 years, giving the confidence we are and in excellent position to deliver a strong finish to fiscal 2021.
I will also say that I'm more excited than ever about our long term prospects and.
As a reminder, our strategic priorities include expanding our technologies and solutions Inc.
Expanding our market access and executing thoughtful acquisitions.
The recent announcement of our newly formed life Sciences business development team represents a significant move that supports all of those priorities.
As previously announced we hired a new vice president to build the and lead the life Sciences team and drive our growth strategy.
This team comes to Donaldson with tremendous industry experience, including strong M&A background.
With the leadership in place we are now poised to drive our expansion plans into the fast growing highly technical and highly profitable life Sciences markets.
While there are no specific details to share today, we are highly confident that technology led filtration has a critical role in these spaces.
With our strong balance sheet and disciplined approach to capital deployment, we are well positioned to pursue acquisition opportunities that make strategic and financial sense.
And we are also enhancing our internal capabilities to drive organic growth.
Our new materials Research Center, which was completed last year will further strengthen our material science capabilities the.
The technical skills, we gain can be used right of way by fueling growth and our current markets like food and beverage and that can be used to support longer term growth and broader life Sciences markets.
We are committed to these new markets and establishing the life Sciences business development team is one step on a long journey, but it was an important step.
Im excited about our opportunities and look forward to sharing our success with all of you over time.
Before closing I want to thank our employees for their hard work over the last two quarters and the last year.
One year ago, we were all wondering about how COVID-19 was going to ripple through the economy and.
And there were more questions than answers.
We all still have questions, but one thing that I am more certain about is the quality of our employees there.
They are truly remarkable.
Seen that personally.
And we can all see it and our company's results.
To my more than 12000 colleagues around the world. Thank you for all you continue to do to support our goal of advancing filtration for a cleaner world.
Now I'll turn the call back to tab of the to open the line for questions.
Yes.
Ladies and gentlemen at this time, if you would like to ask the question. Please press star and the number one on the telephone keypad and that.
And just wanted to ask a question.
And your first question is from the line of Bryan Blair with Oppenheimer.
Thanks, Good morning, guys.
And Brian.
I just wanted to level set if we can and a couple of the guidance points with ISS flattish for the year that implies approaching high single digit rebound and the back half.
And so decent momentum there and how does that breakdown between first fit and and replacement sales.
And Brian what's happening is right now I would tell you and the ISS markets as we went into the pandemic.
Essentially people started too on the Capex side.
Pull back and go to if it breaks fix the type of mentality wed.
We've now seen our Capex base orders change from just the fix it mode to hey, let's replace it and you see that and our incoming order cycle.
What we have ahead of us is that mental shift from a replacement type of the cycle to and invest and expand cycle. So we see orders now picking up on the first fit cycle of Iff's and picking up on the equipment side and that's being led by the U S and <unk>.
China, we haven't given specific breakout of overall of the two pieces, but we do see and increasing momentum on the equipment side today.
Okay very helpful color.
And then it looks like the midpoint of guidance range implies.
A little over 20% incremental margin and the back half how should we think about the price segments and.
But in that context, and any additional color on volume mix price cost impacts would be appreciated.
Yes, so there's a lot of factors in there.
Maybe starting with and the first of all you're going to have.
In terms of gross margin.
In general we're going to have raw material increases in freight increase and across both businesses.
And so those will be of constant.
In terms of volume our volume it will be.
Relatively flat and industrial with the pluses and minus two guide and up pretty significantly and engine with the guidance. So engine and will have a stronger ability to leverage the volume and that will help them and that our cost reduction projects that we have going and operations.
Well.
And reduce.
The reducer offset the headwinds we're facing so so we expect positivity and balls.
Engine has a much larger growth.
Foreseen and so they'll have a little bit of and add job because of their ability to leverage that industrial won't have.
That makes sense and Scott you mentioned the the.
The Investor day targets from 2019, and obviously the world has changed since then.
And if we if we think of what was put out there by segment and it looks like engine may.
Maybe and maybe comfortably in the revenue range debt.
You had targeted initially for fiscal 'twenty one.
And the 14 H plus the operating margin in play assuming momentum continues into next year and.
And then on the industrial side I know that's a.
And more of a stretch from from run rate revenue, but has the scale to $1 billion plus.
Is the 17% margin or higher.
Still achievable or are there have there been some structural changes or increase the investment rate that may may lower that target.
So I'm going to have that have the book right here and my hand, and they carry with me and everywhere I go because we still keep these targets in mind and we're still driving towards those numbers that we laid out certainly engine.
As further along than industrial because of their growth has picked up so I think you've captured it appropriately and that we're closer to.
And to the engine targets and we are of the industrial targets because of their current growth trajectories and so therefore, they are a little bit ahead of the race, but we expect and are still driving.
Both sides of the equation to get to the finish line and as we've said before the targets are still in play, but we've just pushed them out.
Cause of the pandemic related styles and revenue growth.
Okay fair enough. Thanks again guys.
And the next question is from the line of Brian Drab with William Blair.
Hi, good morning, Thanks for taking my questions and debt.
And I may have missed the.
The answer.
The answer to this one but just quickly the restructuring and EMEA.
Focus on which segments.
Is it more industrial or.
And you just talk about where the.
The focus sensors aerospace.
Yes, I can take that Brian and Scott.
Good morning, everyone.
The restructuring the total charge was $14 8 million if you break that down between gross margin and Opex. It was in all of about $5 8 million and gross margin and $8 9 million.
And opex and that split.
Across the company boat and engine and and industrial and engine. It's a little more focused on aerospace as we mentioned and the Industrial example, I gave was the move of some of the production.
The Eastern Europe, and then some corporate functions, which included for example, the centralization of accounts payable.
And also the centralization of the customer service functions. So it's relatively.
The spread out and broad across various functions with the targeted initiatives that I talk to the so hopefully that provides you with a little more color and it's.
On the eight tenths of EPS.
Got it and is that something.
And contemplated and is this more of a response to.
Operations, we're seeing now kind of the pen.
Yes, Brian this is Tod so I would tell you on the aerospace and defense move we had contemplated them I think the pandemic has exacerbated the need to do them much quicker than we had expected. So clearly that's more of a pandemic response of.
All of the rest of the other moves were in our longer term plans and they were in our sites and it was time to move forward.
Got it and.
Tod theres quite a bit of discussion around China and thinking.
And really well there now.
Can you update us on and whatever you're willing to disclose in terms of the percentage of total sales of the China accounted for in the quarter and.
Percent of on road sales of China accounted for in the corner.
Yes, let me have Charlie look that up within the model and get back of the here, Brian So and welcome.
And while Canadian wealth.
And maybe while he is looking that up can I just ask.
And just generally.
And Todd you talked about power and quite a bit in China and.
How are your.
Margins and power core and China relative to the rest of the world and and.
Just in general.
Hello, and margins and the I guess, particularly and the engine business in China versus outside of China lately overall.
The overall power core right now and China is a little bit tougher, but it's because it's an important products for us today, we don't have our.
Powerful and line up and running and China. It is now in China, it's being installed in China. So when we get that pivot to.
And in country for country revenue.
And then it will be on par with the with the balance of the world and power core right now, it's a little bit trouble because of the importation and touch and a long way of shipping.
Overall the engine based margins.
In China our.
And on par with the balance of the World I would say off road is on par with off road on the road is on fire with on road.
With the rest of the world.
Yes.
I think Brian just to answer your question on the China growth for the for the entire company and the quarter China was up.
The 31% or and local currency up 23%.
And then we'll follow up with you on the balance of of the splits relative to the segments Brian.
Okay.
Okay and next operator.
The next question is from the line of Richard Eastman with Baird.
Yes. Thank you thanks for the questions.
Nice work on the quarter.
Okay.
And I'm just.
Just curious you know, we're all kind of watch and the commodity prices and you've referenced a number of times here for free.
The second half being a little bit more of a headwind, but I'm curious if you kind of back up a little bit I'm listening to a lot of the Oems of the two supply.
And in particular one of them.
On the AG side is really.
Suggesting some pretty significant price increases for their products into the marketplace.
But is there is there an acknowledgement on the OE side that customer base the.
And maybe theres more of and acceptance if you were to raise prices as a vendor to them and the current market with the current commodity pressures.
The emerging post pandemic.
The environment to you feel a little bit more flexible than maybe it has other past rebounds.
Short answer no I think it's.
Okay.
I think Rick it's going to behave as it has every other time.
The standard work for US we know of.
And then overall inflationary pressures up down.
It's the same type of the cycle all the time.
The constant constant support of the Oes with whats happening I would acknowledge the inflationary pressures that we're seeing particularly on steel.
<unk> is a pretty rough commodity out there right now and the increases are frankly.
And frankly.
Seeming.
The excessive.
And so that's forcing us.
Because of the availability to buy on the spot so spot markets and so consequently, we are seeing some inflationary pressures across steel and as you know that's our largest commodity across our products.
Do have protections that would that would push some of that off into the fourth quarter those inflationary pressures, though likely come harder next year, because we would have the full year of wells.
And then it would for the balance of this fiscal.
Okay. Okay fair enough. So we will have the headwind and then just just as of kind of dovetail into.
We see the pressures here on the commodity side, obviously the incentive.
Recovery here instead of.
Wages incentives back into the model.
But as you think about out too.
Fiscal 'twenty, two and we're looking for maybe a normalized conversion March and incremental margin of at the op line.
Are we how do we feel about that because it looks like and the second half year with the pressures we've spoken to will be around 20% conversion.
But how do you start to think about this model.
Producing the <unk>.
<unk> and margin can.
Can you give me a range where that should start to normalize here.
Yes. This is Scott good morning, Rick So.
We're definitely come in at the higher levels of profit available and increasing sales so.
We need to continue to drive the incremental.
Earnings and we're committed to that and we had a 37% this quarter, which is much higher than our historical average day and the 20% to 25% range. So we're going to continue to drive the both numbers, we wanted to invest and the company.
And our advance and accelerate portfolio, which we will continue to do but with an eye towards and we need to be able to deliver those incremental margins I would say consistent with our overall history and it can jump around and any one quarter of longer term I think you'll see where and the 2025% range and we want to continue at the drive to that because we're committed to it.
Increasing levels of profitability on increasing sales and you got to have margins in that range to feel comfortable about delivering that at least that's how we look at it.
Okay, Alright fair enough and and then just my last question really quickly Tod.
As we add resources into the.
The advance and accelerate portfolio and in particular on the life sciences, and adding to those capabilities and and maybe using M&A to boost the technology portfolio for life Sciences.
Sure.
The willingness or whats the thought process around looking.
At more of the.
When adjusted EPS type of metric and I'm thinking as much about comp plans.
For senior management as I am just from a reported standpoint, and again the assumption being that it.
It would be somewhat costly there could be some more could could be increased.
Purchase accounting amortization and and just curious how you think about that metric given the long standing objective of Donaldson.
EPS growth.
That's the <unk>.
Excellent question and.
It's something we've thought about and it's a little bit hard.
To know until you have a deal and hand, how youre going to address that but I think those are all excellent points to consider.
As we move forward with this life Sciences strategy, and and I think we will consider those points.
Just maybe a little bit more color here for you Rick.
We certainly discuss that we havent landed on hardcourt spot as to whether unadjusted type of metric is the appropriate way to go.
Certainly.
It makes it all more comfortable if there are no adjustments.
And.
But.
But we do have those conversations we just haven't landed and the hard spot on that yet.
Yes.
I think of it more of as from my Vantage point of our maybe our vantage point and adjusted EPS numbers almost accepted these days, but but I think.
And my point being that.
It's always felt like a bit of of restraint at Donaldson to pay up for some of these <unk>.
Developing.
And if presence and some of these other markets.
And I can tell you Rick that.
We are of strategic plan, where we recognize particularly and in the life sciences sector with the multiples are to enter that point and to do the deals we're very realistic about that multiple and that type of behavior will not hold us back yeah fair enough. Okay, great. Thank you.
Yes.
Okay.
And the next question is from the line of Laurence Alexander with Jefferies.
Hi, just following up on that.
Extend your footprint and the life Sciences should your R&D to sales or your capital intensity change.
So if we think of what is the total of investments you'll be making that area with the re shifted the.
Two of the business.
And that's great question lines as Tod. So if you remember we have long been of 2% to 3% R&D as a percentage of sales type of the company and at Investor Day, I had referenced that we would be moving two of 3% to 4% of sales.
And it was all with this change in mind and in order to support that so we've already put that target out there letting you know that hey, we're going to go into three to four that feel very comfortable to us in order to be able to do everything that we would need to do to go organically into the life Sciences sector, and then support it as well given the overall size of our <unk>.
<unk> it would support it on the <unk>.
R&D.
And for supporting acquisitions as well.
Okay, great. Thanks.
And the next question is from the line of of Nathan Jones with Stifel.
Yes. Good morning, this is Adam Farley on for Nathan.
And Adam.
Now turning to our engine aftermarket.
The business returned to growth after five quarters of year over year decline.
Sequentially from the second and third quarter.
So are you guys seeing any restocking, yet and the different channels and the independent channel where the.
Okay.
Yeah, Great question, so what we have seen us pull through levels at the independent channel and.
The OE channel and so we would tell you that the majority of our growth clearly is being pulled through we would however, caveat and say maybe 1% of that particular growth that we see would be increased as a result of some of the supply chain issues that is.
Being felt across the industries and that we have some of the oes as well as the independent channel worried about stock outs and so they've probably ordered ahead and just a little bit.
But it's not like it's been a big.
The inventory step up or anything like that its really pull through levels with the slight.
Retention, if you will for their markets.
Okay, and then on the pricing side I know it's harder.
For the first.
The split is going to help any price increases on the.
And im not going up market side.
We've returned to our typical pricing behavior, which would <unk>.
Suggests to you that we took pricing actions effective January one across multiple businesses and the corporation, we did that as normal.
And so we are in the normal type of of pricing activities and our businesses should we see that inflationary pressure increase as it has in other inflationary cycles.
And not hesitate to take a secondary second pricing action.
Where needed anywhere in the world, but right now we've returned to our normal pricing behavior.
Okay, and thanks for taking my questions.
And the next question is from the line of dealing Dillon Cumming with Morgan Stanley.
Great. Good morning, guys. Thanks for the question.
Donlin and ask the question good morning.
Sorry to ask the question on the automotive business and I think it's pretty clear that everyone's kind of accepting and inflection here over the next couple of quarters and.
Just wanted to ask and you've talked a little bit of out in the past some of your exposure on the hydrogen side. So as you look across the order book.
Are you seeing customers within Iran, and the business that are starting to look at more industrial air filtration offerings for hydrogen trucks.
The AMA.
And do you feel I guess, it's mostly still kind of legacy as the business.
We would tell you that across the hydrogen sectors, we see more customers talking about it curious about it and working with our engineers to try to understand what would be necessary from an absorption of infiltration standpoint of view.
And they've not announced formal programs to actually build powertrains and that.
And that sense, but.
It's certainly an increased level of conversation across the overall market yes.
That's helpful kind of things and then.
Maybe if I can just in the conversation.
And so asking the question a little bit of a different way, but Scott.
Scott you were very clear you outlined the number of headwinds that you see kind of in the back half and into next year, we're talking about the price cost and for Tom.
And the mix headwind here.
I was just getting a pretty strong margin guidance thats already been alluded to do you see the restructuring actions that you've taken about $8 million.
Fully offsetting those headwinds that you've outlined do you still feel like there's some kind of low.
Cost creep and the back half of it is kind of offsetting some of those restructuring tailwind there.
Well I mean, we're we're really complete with the restructuring actions. So we don't foresee any more restructuring coming.
Currently and so we wanted to show it with and without numbers. So we took the $14 $8 million and we pulled it out and so all of the the guidance provided is on an adjusted metric basis.
B and $1 million estimated of savings from the restructuring this year, and then and $8 million.
Estimated savings.
Once the actions are completed within the next 12 months. So we feel good about that so we project margins to improve.
So we are trying to offset that by improving and our.
Nicely and the back half, but those costs are behind us now.
And we expect margin and op margin improvements.
And the third and fourth quarters of this year and doing it.
As Todd it's important for everybody and I understand that the restructuring actions that we took are complete.
And that we do not have any additional plans pending out there and that they have all been rolled out of the organization.
Got it that's helpful. Thanks, Thanks, Todd and then maybe it's the wrap it up.
It's clear and you guys outlined at the Investor Day, you can't engine, obviously Donaldson is definitely a different company now than it was over the last of industrial Upcycle you guys have taken a lot of cost out you know kind of realigned your the capacity footprint and UK.
And some of these more attractive end markets I guess Scott.
Scott you alluded to kind of committing to profitable growth revenue increase, but I guess looking backwards over the last cycle, you kind of confident and youre not going to see the same level of margin Choppiness as these inflationary factors impact the business or do you feel like it's still a bit too early to tell there and.
And it gets a little bit too early to tell them.
When we talk about the inflationary pressures and clearly the commodities that we have our steel there is number one meeting of the number to.
Call it oil and oil based products or year things number three.
And what the long term outlook for oil of barrel of oil is which would give us pressures.
Media has its own pressures and steel frankly, right. Now is is frankly, a bit unfair to the world I would expect if you look at the at the indexes that are going out there. So there are clearly now and some headwinds that could.
Crop up that would provide choppiness to us, but and the company the more choppiness I think that that could happen and immediate is.
The mix situation that we typically get off of the OE based bounce that we're seeing on the engine and so the bigger of the OE mix.
And that we get.
That would likely provide some choppiness in the more near term quarters with the inflationary headwinds being in the out quarters that standard work for us we get it.
But as you build your model that would be.
The type of thing to consider.
Okay, Great appreciate the time guys.
Thanks.
And there are no further questions.
Thanks, Tabitha that concludes today's call I want to thank everyone listening for your time and interest and Donaldson company and I Hope that you your families and friends are safe and healthy.
Goodbye.
Ladies and gentlemen. This concludes today's conference call you may now disconnect.
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