Q3 2021 Donaldson Company Inc Earnings Call
And 13% sequentially from second quarter, the largest second to third quarter increase in over 10 years gross margin improved 50 basis points year over year and earnings per share grew 32%.
This could not have been accomplished without our dedicated Donaldson employees, who come to work every day, whether at home or in the office to ensure we are meeting our goals and serving our customers.
Thank you to all of my fellow teammates for the work you do.
Now, let me provide some insights on our third quarter sales.
Total company sales increased 22% in third quarter from prior year in local currency sales rose 17%.
While we acknowledge this as the soft comparisons of last year when the pandemic slowed things. We also note. This result is 7% above the strong pre pandemic third quarter of fiscal 2019.
We are pleased with this level of growth and believe our momentum will continue.
Engine sales recorded strong year over year growth of 26%, 22% in local currency.
Our 51% off road business growth was widespread with all regions experiencing an increase in sales.
In particular local currency sales in Europe, and Asia Pacific were up 78% and 42% respectively.
China sales increased almost 50%.
The factors give us confidence in the outlook for off road.
Global demand for construction and agriculture equipment remains high and mining is also seeing increased demand.
<unk> continues to gain traction in China, and we are on track to deliver 2 times as many power core air cleaners in 2021 compared to 2020, and our backlogs continue to build as we exited third quarter.
On road sales experienced a sharp rebound from the 1% year over year decline in second quarter, increasing 58% from 2020.
Order in bill rates for class 8 trucks in the U S have risen significantly over the past few months on our projected by external data sources to remain at a high level over the next several quarters.
In China, our on road sales more than doubled driven by increased heavy duty truck production and market share gains.
With the favorable economic backdrop, our strong market position in North America, and the significant opportunity to grow in China. We are optimistic on the outlook for our on road business.
Aftermarket sales increased 23% in third quarter, including a 4% currency benefit.
The utilization rates for construction and agriculture equipment and heavy duty trucks remain at a high level, which is driving increased demand for replacement products.
In local currency sales Latin America increased by over 40% in Europe, and Asia Pacific were up 17% and 18% respectively.
Aerospace and defense continues to be pressured primarily due to a weak commercial aerospace market as a result of the COVID-19 pandemic.
A bright spot in aerospace and defense as rotary aircraft, where sales increased due to previous program wins now coming online.
Looking at the industrial segment sales in third quarter increased 12% or 7%, excluding the favorable impact of currency translation and growth was widespread across geographies.
Industrial filtration solutions or ISS saw a significant sequential uptick in quoting activity for dust collection systems, Inc. Third quarter.
Iff's benefited from increased sales of the dust collection products on both a first fit and replacement parts basis.
This was a nice turnaround from the declines experienced in second quarter, which we believe was the trough.
We have seen this business move from the if it breaks you fix it cycle through the if it breaks you replace it cycle and now move to the investment and expansion cycle, where we see increased purchases for new projects.
We also saw increased sales in first fit and replacement products across the rest of the iff's businesses, including greater than 50% growth at bopha and mid twenties percentage of growth in process filtration sales.
These growth rates the indicate to us that not only are we winning share in targeted growth areas. We are also retaining the replacement business, which should only increase as our installed base becomes larger.
Sales of gas turbine systems, or GTS declined about 13% year over year due to a decline in demand for gas turbines used in the oil and gas market.
Slowing of retrofit activity and the timing of projects.
Sales in special applications saw double digit growth in integrated venting solutions and membranes, which was partially offset by a high single digit decline in our disk drive business.
The broad based positive company results give us increased confidence in our ability to have a strong finish to our fiscal 2021.
Finally, we believe supporting the communities in which our people live and work and where we do business is the right thing to do.
Therefore in third quarter Donaldson contributed $1 million to support our local community and help rebuild areas in Minneapolis and St. Paul that were damaged from the unrest over the last year.
With that I'll now turn the call over to Scott Scott.
Good morning, everyone.
Tod Im also very pleased with our results in the third quarter, which were stronger than our expectations and as previously mentioned the highest quarterly sales in the company's history.
Want to thank our employees from the remarkable accomplishment in light of the challenges faced.
Total sales increased 22% year over year, and operating margin increased 90 basis points to 14, 3%.
As you have heard me say many times.
We are committed to generating higher levels of profitability and higher sales and our third quarter results demonstrate our commitment to this even in the face of pressures from higher raw material costs and supply chain disruptions.
As we entered the third quarter, we were building momentum and that continued through the <unk>.
End of the quarter, given our incoming order rates and backlog levels. We expect this momentum should maintained through the end of fiscal 'twenty 1.
Now, let me get into our third quarter results in a bit more detail.
Our engine segment profitability increased 250 basis points year over year, as we leverage the significant uptick in sales the.
The industrial segment in contrast, recording of 50 basis the client profitability.
This decline is a result of the business unit mix within industrial and weaker gross margins in GTS and disk drive products.
Third quarter of company gross margin improved by 50 basis points to 33, 7%.
Which accounted for a bit over half of the 90 basis point increase in operating margin.
Raw material and freight cost inflation headwinds.
And the reversal from the tail and we experienced in the first half of the fiscal year.
Sales mix was also unfavorable to gross margin primarily as a result of strong engine sales.
However, we were able to offset the margin pressures with sales leverage and pricing.
We continue to expect second half gross margin will be up year over year. However, the headwinds from higher raw material and freight costs are increasing from what we experienced in the third quarter.
Given the sharp increases in our raw material and freight costs, we are focused on pricing actions to mitigate the impact on our margin.
We remain committed to managing our price cost relationship, particularly in an environment of strong demand for our products.
We are also committed to controlling operating expenses in the third quarter operating expenses as a percentage of sales declined 40 basis points year over year.
This was driven by leverage on increased sales, partially offset by increased incentive compensation expense.
Investing in our strategic priorities remains a focus for us our advanced and accelerated portfolio received the largest amount of our investment and overtime is expected to generate sales growth and higher margins than company average.
We are also excited about the growth opportunities with our first fit engine businesses.
These businesses tend to be more cyclical and command leadership positions in their markets.
In the case of on road off road and defend their.
There are multi year programs that provide a solid base of business to help grow our aftermarket sales.
We see opportunities for additional program wins and further penetration in markets, where we have a smaller share.
1 example is China, where the market is large and there is an increasing willingness of Oems to adopt the filtration technology, we provide and we are winning new programs.
We have taken a disciplined approach to managing our business and opportunities by focusing on selective cost optimization projects and leveraging our global presence, while continuing to invest in growth areas.
As the world recovers from the pandemic, we are in a great position to participate in the post pandemic upswing some of which is represented in our third quarter results.
We made capital investments of approximately 10 million in the third quarter of decline of over 60% from the third quarter of last year as we bring to completion of many of our significant capital projects from the prior 2 years.
We paid over $26 million in dividends and repurchased over $32 million of our stock in the third quarter.
Year to date, we have returned almost $160 million to shareholders.
We are paying the dividend every quarter for the past 65 years and increased our dividend every calendar year for the past 25 years, making Donaldson among a small group of companies that are included in the S&P high yield dividend aristocrat index maintain.
Maintaining this track record is important to us.
Our results for the third quarter of fiscal 'twenty, 1 demonstrate that our focus on higher margin and higher sales is working.
The result also on as part of the diversification of our business model and that our long term view adds value to the company and our shareholders.
We have good sales momentum as we head towards the end of the fiscal year, which should carry through into fiscal 'twenty..2 as such we are raising our fiscal 'twenty, 1 sales and EPS guidance.
With that let me share updated expectations for fiscal 'twenty 1.
In the third quarter, we saw a continued sales momentum in our off road on road in aftermarket engine the businesses.
And an uptick in our industrial filtration solutions business.
Given the strong results, we experienced and our visibility into the remainder of fiscal year.
We expect full year sales will be up 9% of 11%.
Year over year versus our prior guidance of 5% to 8% increase.
Our annual guidance assumes a full year, 3% benefit from currency translation.
In our engine segment, we project the sales increase of 12% to 14%, which is up from our prior guidance of an 8% to 11% increase.
We project full year off road sales will now increase in the mid to high 20% range driven by continued strong demand for construction and agricultural equipment.
And increase our activity in mining or.
Our prior guidance was for a low of 20% range growth.
And on road, we expect full year sales will increase in the mid teens compared to our prior guidance of low teens. This increase is due to a stronger improvement in global heavy duty truck production rates.
Our engine aftermarket business has continued to see stronger than expected sales momentum as global equipment utilization continues to improve.
Now believes sales the increase in the mid teens compared to our prior guidance of high single digit increase.
We believe utilization rates for construction and agriculture equipment as well as onno of trucks will remain at a high level through our fiscal year end.
The continuing to expect our full year sales of aerospace and defense of the decline in the mid to high 20% range given the pandemic related soft conditions in commercial aerospace resulted in weak demand.
In the industrial segment, we expect the full year sales increase of 3% to 5%.
Most of our previous guidance of down 2 to up 2%.
As Todd mentioned earlier, we are experiencing increased demand for industrial dust collection products.
Particularly replacement products.
We have increased our outlook for ISS sales and now project sales growth in the mid single digits compared to our previous expectation of flat sales.
And sales activity of increased more quickly than we previously forecasted.
GTS sales are expected to decline in the low single digits versus our prior expectation of of mid single digit increase.
In special applications, we continue to anticipate the decline in the low single digits based on our year to date results and expected softness in the market for disk drive products.
Expanding our gross margin remains a key focus for US we continue to work the reduced costs and drive operational efficiency the leverage higher sales.
In the near term, however increases in raw material prices and higher freight costs will pressure margins through fiscal 'twenty, 1 and into at least the early part of fiscal 'twenty 2.
To offset some of the sharp increases in our input costs, we have selectively raised prices and may do so again.
We know the value we bring to our customers and we will continue to demonstrate the value the technology lab products and best in class service.
We are expecting adjusted operating margin.
In a range of $13.8 of 14, 2%.
Compared to 13, 2% in 'twenty 'twenty.
The midpoint of this range implies a sequential step up in operating margin to about 14, 5% for the back half of the year compared to 13, 5% in the first half.
Additionally, we expect to maintain a disciplined approach to our operating expenses and deliver further leverage in the remainder of the year. Despite an expected full year headwind of approximately $25 million from increased incentive compensation.
The half of which was incurred in the third quarter.
Other fiscal 'twenty, 1 operating metric of expectations, our interest expense of about $13 million.
The income of 5 to 7 million and of tax rate between 24 of 25%.
Capital expenditures are planned to be in the range of $55 million to $60 million.
Taking the midpoint of our sales on capital expenditure guidance for 2021 would put us at just over 2 percentage of sales.
As we previously noted as loan in the last few years due to the completion of major projects.
We also plan to repurchase 1.5% to 2% of our shares outstanding.
Our cash conversion has been very good in the first 9 months of the fiscal 'twenty, 1 and we expect to exceed 100% cash conversion for the full year.
We will provide detailed guidance for fiscal 'twenty, 2 with our fourth quarter earnings release, However, I did want to provide a framework to help with modeling the.
The sales momentum. We're currently experiencing is likely to carry through to the first half of fiscal 2022, we expect first half of fiscal 'twenty 'twenty 2 sales to account for a greater percentage of our full year sales as compared to the first half of fiscal 2021.
Looking at our fiscal of 'twenty to gross margin, we expect the headwinds from higher raw material and freight costs to increase from what we've experienced in FY 2021, particularly in the first half of FY 2022.
Our operating expenses in fiscal 'twenty, 2 we will have some pluses and minuses relative to fiscal 'twenty 1.
As we begin to operate on a more normal post pandemic environment.
We expect to see an increase in expenses related to Inc.
In person customer engagement costs, including marketing and travel costs as our sales and engineering employees return to onsite visits and the 10 Tradeshows.
Investment in our Dallas of employees, including training and development.
And <unk>.
The increased head count the meat demand.
However, we should see an offset and reduced incentive compensation expense on the year over year basis, as we reset our annual compensation plans.
Our objectives for the remainder of this fiscal year and 22 are unchanged, we will continue to invest for growth and market share gains in our advanced the accelerated portfolio, including inorganic growth in life Sciences.
Execute productivity initiatives and pricing actions that will strengthen gross margin.
Maintaining control of operating expenses and.
Protect our strong financial position through disciplined capital deployment and working capital management.
As I finished my commentary I want to acknowledge all of the Donaldson employees globally for the outstanding work they have done and continue to do every day.
Our second half started off strong and we have solid momentum to carry us through the end of fiscal 'twenty, 1 and enter fiscal 'twenty 2.
I'll now turn the call back to Tod.
<unk>.
Yeah.
Thanks, Scott our third quarter results demonstrate the momentum we have in our business and the benefits of having a diversified portfolio.
We continue to maintain a disciplined long term focus on our strategy.
To remind you of our strategic priorities remain unchanged and we are focused on expanding our technologies and solutions.
Spending our market access and executing thoughtful acquisitions, particularly in life Sciences.
Some recent examples of new products include our new Ultra pack smart driver for compressed air process filtration.
An upgrade to our IQ connected filtration service, which now come standard on many of our industrial dust collectors and overtime will provide recurring revenue.
The expansion of our filter Minder real time monitoring service to engine liquid filtration. In addition to air filtration.
Our rugged backhouse industrial dust collector that we introduced in first quarter, which is already on pace to generate 2 times. Our initial first year forecasted sales.
Our strategy also involves seeking of inorganic growth opportunities and we are well positioned to expand our addressable market in life Sciences.
We have of solid roadmap and a pipeline of potential opportunities in life Sciences, while I can't comment on when or if the deal might happen I can say I'm very encouraged by the work the life Sciences business development team is doing.
They have increased our understanding of the life sciences market and improves our strategic focus in that area. We have the right people in place to execute our strategy.
We continue to maintain a strong balance sheet and disciplined on our capital deployment, which positions us well to make acquisitions that will expand our markets.
Increase our margins over time and allow us to further leverage our filtration technology expertise.
We have the ability to continue to invest in organic growth to extend our market reach increased market share and maintain our market leadership positions.
This is a very exciting time for Donaldson and I look forward to sharing our successes with you.
Before I close I want to again, thank our employees around the world for their continued dedication to Donaldson each other and our customers to meet our goal of advancing filtration for a cleaner world.
Now I will turn the call back to the operator to open the line for questions.
As a reminder to ask a question you will need the breadth of star 1 on your telephone.
John a question first the found Keith the standby, while we compile the Q&A roster.
First question comes from the line of Bryan Blair with Oppenheimer. Your line is open.
Thanks, Good morning, guys.
Volume run.
Really strong momentum.
Overall for the most part in the quarter definitely encouraging to see.
The growth accelerate in ISS and Todd you mentioned kind of the mentality shift in the markets from break and fix to replace to more of an investment cycle of at least the early stages of 1 I was wondering if you could parse out replacement first.
First of all growth rates in the quarter, our order rates going into your fourth quarter any color there would be very helpful.
Sure. So typically that business runs at about 40% replacement parts and 60%.
On the first fit cycle until we're starting that had shifted during the pandemic almost reversed itself.
And so now we start to see that first of all bounce starting to happen.
With momentum carrying forward.
First with the replacement parts bouncing. So we see strong replacement parts orders led by U S as well as side of it.
Western Europe, and now, especially with our new products that we have.
Bottom line within the Q1 this year, we really start to see the momentum on the first fit picking up quite nicely.
We also see a reduction in the order cycle.
Understood.
Yes.
When you look across your businesses. Many of you noted increasing backlog entering the fourth quarter expecting momentum into the the first half of <unk>.
Your fiscal 'twenty 2.
But as you think of the the related moving parts how.
How does your team look at underlying demand inflection.
Versus the pull forward of shipments based on your own pricing actions general supply chain, uncertainties et cetera I'm.
I'm just trying to get the sense of I guess that mosaic because when you look at the next couple of quarters.
Yes.
It's good if we step and look at the macro step back look of the macro we've seen overall, our backlogs are increasing through the quarter.
Off of continued as we turn the pages in the fourth quarter.
See if you just take an important data point, which is our engine aftermarket business and you look at the aftermarket OE versus the aftermarket independent channel the growth within those 2 pieces of our company was roughly equal and so therefore, we see everything is of pull through based demand.
Taking place within the corporation, we have not really begun to see the stocking events happen that still lies ahead of us that as evidenced by the growing backlog that we have.
That's very helpful.
And last 1 for me if I can any additional details you can offer on.
And any major supply chain challenges that you faced in the quarter and what's anticipated.
In in your fiscal Q4 and on that front.
You could.
Describe how your capacity investments and the.
The scale of it that you now have and the efficiencies that you now have.
I have a lot of your team to manage the the unique environment. We're in in the surgeon demand relative to what you faced in the run up of the fiscal 18.
As you remember we were talking about 3 years ago, or so that we were going to accelerate investments back in capacity expansion as the corporation and we made the strategic thrust to do so much as our competitors Marsh marsh the path so to speak within that last ramp up that is paying quite in dividend.
Wonderful dividends to US right now clearly, we got that strategic decision correct.
The reason why we have good sales momentum, we would tell you that our capacity utilization rates right now in the engine business of Lee in the mid <unk> in the industrial business are in the 70, so we have room to run.
However, we would also say the supply chain challenges within the quarter and that we see progressing or really continuing into the fourth quarter.
Have been significant.
Now that said I would tell you that our operations teams worldwide are doing absolutely a stellar job.
We feel comfortable that we are out executing our competition.
And we hear that through our customer feedback on a pretty consistent basis.
We do have supply chain challenges still remaining.
With the most notable being the Texas storm the 4 day event that happened.
Earlier in this calendar year still presenting force matures on us for some of the raw material base. Then we look for the portion of the <unk> to start to abate within the fourth quarter. Some may go into the first quarter of next fiscal year.
But we are continuing to work through those.
We do see those challenges kind of.
The holding us back a bit in the fourth quarter should they are being a little bit better and again our supply chain team.
Really doing absolutely yeoman's work all of it is just really exemplary what's taken place should they start to abate a little quicker we do see debt we can have the.
A better outcome.
Then as currently envisioned.
Again, it's helpful detail, Thanks again guys.
Okay. Next question comes from the line of Nathan Jones with Stifel.
Your line is open.
Good morning, everyone, Hi, Nathan's line.
I'm going to say what I can do on of 2022 of your question here.
I go back to your 2018 analyst day, the target revenue for 'twenty, 1, which will give you a pass on not hitting it.
Covid.
3 to $3.3 billion.
Current revenue trends looks like youll be kind of around the middle of that range somewhere in the next year.
And you had a 15% operating margin target on that revenue.
Is there any reason why is that the kind of revenue range that year end debt you can't get to that 15% operating margin are that the price cost dynamics and things going on around that at the moment, maybe negate you being able to get to quite that level next year.
Hi, Nathan this is Scott so if you take the midpoint of our guidance.
Sales finished for this year it would take about a 6% growth.
Hit the low end of the range of the target and so we can likely get to the low end of that range out of 6% revenue growth in FY 'twenty 2.
So thats clearly in sight for FY 'twenty 2.
In terms of the operating margin when all you saw that we had.
We maintain the guidance of $13.8 of $14.2 because of some of the the supply chain and the input cost challenges that we've noted the.
Guidance in the Investor day targets was 15 of $15.8 so that would be 1.
100 basis point improvement.
Over.
A 2 year period, and so that would be a pretty significant growth.
I think we could get in that vicinity, but probably still a little bit below that range, so probably sort of in a reasonable to get at end of the revenue range and probably.
Around the operating margin range.
Fair enough Thats helpful.
Okay.
Maybe a question on price cost.
You guys had some fixed price contracts, particularly the OEM engine side.
And have the balance.
Obtaining pricing with the driving customers towards more of your proprietary products that generate better revenue and better retention at the time.
I got to the heat on on today's comments that you may be paying a little more aggressive with pricing. This time around than you were in 2019, which is reasonable we've got significantly more inflation.
Can you talk about how you're balancing those 2 things and if you are being a little more aggressive on pricing of this go round.
Sure Nathan this is Tod. So if you just split our company into that OE first fit side, which is 35% of the revenue 65% on debt replacement parts of our project based activities Youre right on the 65% of the corporation, we are being aggressive there of pricing activities in flight everywhere in the world as we speak.
The.
We'll start to see those coming.
Early next fiscal year, they will be and the fact that I do want to want to caution, though that we do have to work through some backlog as we see the new pricing actually take effect and then start the leverage right, but we are being.
The more aggressive with the pricing.
Mid single digit to low double digit based increase was dependent upon the business.
With regards to the OE side of things.
<unk> based conversations with the bumps of as much as 50% of business expansion on the OE side has really taken all of the energy of <unk>.
Both our customers as well as us to coordinate more of the demand.
Satisfaction, if you will rather than the pricing conversation some pricing conversations are happening and you are right. They are absolutely more aggressive than they have been in the past.
And it is a better environment than perhaps we have ever.
Felt on the OE side relative to being able to enact pricing actions, but as you know and as we've talked about many times they'll likely stretch out longer than the options that we have in flight.
With regards to that 65% of our corporation.
Great. Thanks for the color cutoff profit alone.
We have our next question will.
From Richard Eastman with Baird.
Line is open.
Yes, Thank you and thanks for the question.
Just to pick up on the Scott just to pick up on the last question. There was the was the price cost.
Positive or negative in the quarter.
While we were able to increase our margin.
All in all all things.
Being considered or was positive.
There's a lot of pluses and minuses.
Going on in the REIT, we have.
Price is obviously a benefit mix.
As a headwind commodities are obviously a headwind for <unk> is obviously a headwind we talked about the bonus.
The increase being a headwind and then you get a big benefit from leverage so there's a lot of pieces in there.
The margin of probably a bit more complicated than typical.
But we were pleased that we were.
Able to continue to drive up the margins for the company on increasing sales, but there's also a lot of the soup there.
You can see.
Yes.
And just to clarify your comments.
Scott I think you made them.
But as we roll into the first half of 'twenty to your comment was the first half of 'twenty 2 would be a greater percentage of the full year revenue.
When was the first half of 'twenty 1.
Sure.
That is correct. So if you take the midpoint of our guidance this year.
46% in the first half of 54% and the <unk>.
Second half so that's a pretty big.
Difference for US generally, we're a bit closer to Eden and.
And so we expect the momentum that we're seeing.
In all of this this.
<unk> to continue into the into next year.
We don't think that kind of 50% growth rates in off road kind of.
Momentum can continue for an extended period of time, so we see that reversing next year. So we wanted you to help with your models and that those percentages will probably flip next year because of the momentum will.
It will be strong and it will be harder to keep growing sequentially. The keep those kind of percentages continuing.
Yes understood.
In total.
Maybe to build off of the.
When you look at.
Build slots as for the Oes, both on the off road and on the on road side.
We're hearing a lot of about the build slots.
For the next 12 to 18 months.
Being pretty full.
Maybe just your thoughts around how that may or may not impact that number the Scott just referenced but.
Your sales outlook on the OE side has it.
Being constrained by your customer supply chain issues as well as the.
The forecast looking like maybe build slots of getting.
Getting pretty tight.
Yes, Thanks, Rick So as you really look back at our business and where we are in backlog clearly the on road sector is.
Really seeing a quite a nice bump the.
Off road sector on the person has also seen of bump, but the but the level of jump on the on road sector is really quite impressive year over year as they are just looking to build more trucks as we turned into F. 'twenty 2 but really all they're doing is getting back to 2019 based levels may be of <unk>.
Little bit above that so we've been able to satisfy that base requirement during that timeframe and we have since that time additional capacity expansion online. So what we really need to do to be able to get the necessary.
Bump and take care of our customers is as we get past the mostly raw material based shortages that we had been seeing.
And really continue working hard on the supply chain activities because of our capacity is there.
And so once we get past the raw material portions then it becomes of people based conversation in the United States and can we get more additional personnel into our manufacturing plants. Other parts of the World Latin America Western Europe, we're absolutely fine and even in China, and we're doing really quite well there so that will.
Likely become a little bit of the U S. Based story as you have been hearing in the news.
Not immune to some of those conversations.
Okay, Okay, and just sort of.
1 last thing.
And just from your comments around.
The analyst day plan some of your comments here around raw materials pricing when you put the soul in the bucket.
<unk>.
It does sound like the expectations going into.
The fiscal 'twenty 2 are still somewhere around the 100 bps of op margin leverage with all the levers.
The pool and pushed.
It's still just a realistic starting spot the assumption for op profit in 'twenty 2.
Yes, so we're working hard through our plan right now our <unk> team is the space of a very dynamic environment and sort of doing an excellent job keeping track of things and so back to the FY.
In all of the targets that were in the Investor day. So we had a 15% was the low end of the range.
And as you point out.
Current range of 14% at the midpoint and so I would view that more of the 2 year.
Journey versus the 1 year journey, I mean, we're committed to increasing levels of profitability on increasing sales.
And we think we can do that while continuing to invest in.
Our growth initiatives. So we want to continue the push money into the places that have good growth opportunities and so I would look at that journey more and more of a 2 year stack and I think you might have been looking at it more as of 1 year step.
Okay with incentive.
1 more lever within the with with the investment Youre, suggesting 50, 50 bps would be the better 'twenty 2 target.
But that's that's what you are implying there yes.
Yes, I mean, we have to finish our plan and we will give you a detailed guidance in at the end of the Q4 here, but when I look at it as more of a 2 year journey.
Okay excellent. Thank you in the script to see the grip the suite of volumes return.
Okay.
Okay next question.
We have the line of Brian drab with William Blair.
And so forth.
Hey, good morning, Thank you for taking my questions.
The first 1.
Alright, so on.
The specific question just some of the cost that youre seeing this year.
For the full year fiscal 'twenty, 1 as a result of.
Supply chain issues input.
Input costs and freight just with the.
The thought that the.
These are temp.
Temporary I know you said clearly some of it will trail into fiscal 'twenty, 2 but I'm just trying to gauge.
Of the magnitude of the potential gross margin tailwind in fiscal 'twenty 2 relative to 'twenty 1 with all of these unusual items that are happening this year.
Yes, so I mean like I said, it's kind of a dynamic environment.
Predict where some of these input costs well.
Go and will they come back down and when will they come back down. So we're expecting obviously pressure of the fourth quarter.
And the next year.
And so our raw materials in our freight are going to be pressured.
And so we'll have to see where that goes and where we want to kind of cast of our final plan assumptions.
And so right now I don't know if I can predict right of there is a headwind or a tailwind I would I would predict for sure. There is a headwind in the first part of next year and then the Big question is when will the <unk>.
When will the costs start to abate or will they abated and when will that happen and how will that both of our results. So we want to get a bit smarter with another 90 day. So again, the big piece of it will be raw materials and freight.
We'll certainly start out as a headwind we have of $25 million.
The incentive comp tailwind that all debt because we can reset bonuses. So that will obviously bring us some early the against those first 2 items I mentioned and then we will expect to get continued leverage on increasing sales. So those are the big pieces.
That will go into our calculus on the plan.
And I promise to come back the at the end of the fourth quarter with.
It's the more specifics in that regard yes, Brian. This is Tod I'd, just add a little bit of color and tell you that we are laser focused on the issue laser focused on the math.
And also the commodity based spreadsheets that we have in order to be able to put pricing actions in flight and that is consumed.
Consuming our energy these days across the organization in order to make sure. We can press forward, but as Scott says the.
The the.
The more difficult piece to predict is the back half of next fiscal year and so therefore.
Therefore, we'll be smarter in about 90 days and really update the full full year picture.
Okay got it thank you.
The 1 more question I just wanted to understand.
What youre thinking for the fourth quarter here because the.
Industrial sales were up.
8% sequentially and engine sales were up 15% sequentially in the third quarter, but the.
The full year guide implies a sequential downtick slightly.
In the engine about flat industrial I'm just wondering.
Why that is not conservative in this environment and then also the fourth quarter historically is up seasonally isn't it.
Yes, historically, our fourth quarter would be up just slightly and so as you know the we're kind of more in the flat, but just barely down in the fourth quarter with the current guidance.
And also we're really focused on the supply chain issues.
Are there that's the governing how fast we can run the plants and our operations team is doing an excellent job of the carrying all of the materials. They can get their hands on sales.
<unk> has many filters as we can get in get them out the door.
We have may in hand for the most part.
May was a little bit softer than the current run rate and we expect June and July will pick up.
And so therefore, we wanted to take what we thought was a reasonable posture with regard to our Q4.
With EBIT being generally.
The flattish area will still be up 25% over the last year and pretty consistent with the third quarter, which was a really big quarter for the company in fact, the biggest quarter at our company history.
So we wanted to keep that in mind as we look at the fourth quarter, Yes, Brian. This is tod, maybe a little bit more color I would tell you. This is not of incoming order question. This is not our ability to execute inside of manufacturing plants weighted question. This is the raw materials input question in.
Also.
Really the supply chain issues and challenges that we continue to work through.
We're really proud of the way that we are executing in the moment.
But that is that is the question that still remains couldnt get even more.
Then our current record that we just set in third quarter.
Got it thanks for that color and congrats on the record quarter.
Thanks, Brian.
Thank you.
The question comes from the line of Florida, and Phoenix Center with Jefferies. Your line is open.
Good morning, it's Dan Rizzo on for Laurence Thank you for taking my questions.
You mentioned that the capital projects were coming to an end and Capex is a bit lower I was just wondering as we look out over the next 2 or 3 years.
Which of slow processes for additional capital projects are you comfortable with where you are or I mean are you looking at more expansion sort of what.
Yes, so capex thats a good question so.
We've said.
For the last several quarters that our capex youre going to come down this year as we really focus on completion of many of the large scale projects that we have have undertaken and so we're very pleased to be bringing these projects the completion and beginning to get the return.
Out of those projects that we all as expected and so this year. We spent more time kind of fine tuning and completing projects and really buying new equipment, and we said that that would happen in that next year, we would expect to return to a more normal level. So our capex is clearly going to go up from this year probably back to more along the line.
Of our historical average if you look at the Investor day. It seems like people have the Investor Day book out Youll see Theres a slide in there that shows our long term history and then projected.
An increase for a short period of time, and we would expect to be down from the big years that we've had and more in line with with what we've done in the past. So you can take of 2.5% to 3% of sales is kind of a reasonable range for us. If we can find projects that are bigger that ABA.
The good return, we will always be willing to execute on those projects, we want to be good stewards of capital, but we wanted to deploy capital to help increase the capital invested and help increase the return on capital in Boston. So we look at that as part of our planning process, but maybe in short it will go up from this year.
That's very helpful. And then just wondering the question you mentioned, obviously improved profitability of <unk> is a focus but.
I was wondering if there are still areas, where you could do some volume pricing or discontinuing certain sales.
Of products or just areas, where where you would be removing things just to improve overall profitability that would maybe be a sales headwind.
Yes, so I mean I think.
Or are we talked for years about our Oracle implementation that we completed about 4 years ago, and our finance team and our it team has done excellent work to improve the visibility.
And information, we get out of the system such that we have much more granular information out of product level and so I think our business units have been doing an excellent job and are looking at their product level of profitability by part by region and so we can give them reports that show of the.
They are weakest price products or projects and then they can begin to focus on those by either deemphasizing the products and are increasing the prices on those products. So I would say that that's something we work on.
On our daily daily basis in our finance people I think are doing a good job out that identify those opportunities.
Instead of growing revenue and improving the profitability on your existing revenue. So I would say, we're doing that and we still have room to improve.
But thats something we will definitely continue to focus on.
Alright, Thank you very much.
Yes.
Sure.
Thank you. Our next question, we have been on coming with Morgan Stanley.
Thanks, Good morning, guys. Thanks for the question I wanted to go back because of the.
Just wanted to go back to the kind of the commentary around the the restocking.
I guess, you kind of alluded to the meru the comments, but what's your sense of kind of debt. The supply chain is not in a position to kind of meet the demands of the restock and when I say that I guess, what I'm looking at the production rates that early partners and then of your commentary about utilization in the aftermarket channel I mean, that's amazing.
It should be suggesting a more meaningful restocking at this point of the cycle. So because it is question again, you can't predict that.
You kind of looks like the 2 that more meaningfully as we look into the next year.
I think you handy handicapped that very well.
Okay got it.
And maybe that's the kind of along the same lines of that kind of piggyback on the those question, but you've kind of laid out some of the company.
Larry on the capacity of lessons equally feel like Youre kind of well aligned for the next year.
I should say cycle here, but I guess, taking a step back and look at where inventories are relative to sort of wherever you that youre kind of customers and within the independent distribution channel.
And you kind of see the utilization and the production trends that are materializing more recently.
What is your view of this kind of current industrial up cycle, maybe versus the 1 you saw in 17 and 18 viewing of you're expecting this to be a 3 to 4 year cycle versus the kind of of 2.2 in the half 1 that we saw over.
Of the 17.18 period.
Yes, it's a great question. So we take a look of that and debated internally as well.
Clearly, we think it's the multiyear cycle for sure.
As of the fact that if you just spoke of the AD.
We're probably early cycle on AG. If you look at mining mining is frankly, just waking up compared to a pay day construction might be early late cycle. However.
If we do get an infrastructure. Bill then then overall utilization goes up across the country and so consequently that that probably then those mid cycle, because we should see a bump in a pickup from that overall truck rate production. They are not building net at the level that they were I'd say 350000 trucks sure they have the orders, but theyre not being.
Kicked out at this point in time, so we see of lift there that is going to be of multiyear list and then on the industrial side of what we just talked about as a result of all of the OE based of the mandate, we have that debt. That's when capex starts to flow real well and bode well for our project based industrial businesses. So we overall when you step back and you look at our Corporation, we do see this as the multiyear upturn.
The uptick.
And we looked at the in a position based upon the capacity investments that we've made across our corporation and the strategic choices to invest in our people and really protect our foundation of our corporation long term throughout the pandemic as really excellent strategic choices that we will be paying dividends for our company for this multiyear cycle for sure.
Got it that's really helpful color and maybe just 1 last sort of wrap it up I wanted to go back to your commentary on kind of honored in particular, I think you were calling out higher build rates in China and kind of an increase of revenues there just for the honor of business.
Some of the bit surprising that made the mention of the more recent market data you're seeing coming out of there that suggest that that market is going to be rolling over a bit I mean, obviously, you've got a lot of share gain there of about 2 years. So I guess do you feel like that level of coming out of performance is just the more reflective of some of those share gain efforts or the kind of going out of by the end market for you guys.
Yes, we do believe that we can outperform the market within China, but please remember we're coming from a low share and so we were low single digits and so the number of the percentages look pretty wonderful, but that also gets us state of a mid single digit share and so we have some some wonderful runway ahead of us and the <unk>.
Share gains that we're winning on the first fit production does see us have capacity expansion in China to be able to meet our region for region based manufacturing strategy going forward, but we do expect to outperform the growth rates within the China based markets, just simply because of the share gains there.
We have but also because frankly the comps are a little easier.
Okay got it thanks for the time guys.
There are no further questions.
Thanks, Brian So that concludes today's call I want to thank everyone listening for your time and interest in balancing company Goodbye.
Ladies and gentlemen. This concludes today's conference call you may now disconnect.
Great.
Yes.
Okay.
Sure.
Yes.
Yes.
Got it.
Of course.
Right.
Net.
Okay.
Okay.