Q4 2021 Donaldson Company Inc Earnings Call
We are already facing supply chain disruptions, primarily due to labor shortages in the Americas and raw materials inflation put significant pressure on gross margin while the magnitude of these issues are greater than what we have experienced in recent years, our playbook for addressing them is time tested.
We are pursuing growth opportunities in our advance and accelerate businesses.
We are raising prices to mitigate the impact of cost increases.
And we are leveraging our strong relationships to remediate and overcome the current supply chain challenges.
When we roll these things together, we feel good about where we land. Our plan reflects continued progress on our strategic initiatives and we expect to deliver record levels of sales and record profit in fiscal 'twenty two.
We will share more details about that later in the call. So I will now provide some context on fourth quarter sales.
Total sales were $773 million, which is up 25% from last year as we compare it against the toughest patch from the pandemic.
If you normalize the trend with a two year stack comparison fourth quarter is right in line with what we had in the third quarter, suggesting we are maintaining sales momentum.
In engine total sales were up 28% and the increase was again led by our first fit businesses.
Fourth quarter sales in off road were up 58%, including about 15 points of growth from exhaust and emissions.
We want a significant amount of new business over the past few years in anticipation of a new emission standard in Europe.
These programs were slower to launch due in part to Covid and we are now seeing a dramatic ramp up in demand.
It is worth noting these sales create mix pressure for us we are enhancing the exhaust and emissions cost structure to reduce the impact on margin, but based on the nature of this business that will only get us part of the way.
Want to thank the operations and business teams for doing an excellent job balancing the needs of improving profitability, while managing through a massive amount of new demand.
Staying with off road, we continue to have strong growth in our innovative razor to sell razorblade products.
These products make up about one third of off road filter sales and they grew substantially faster than their non proprietary counterparts in fourth quarter.
This trend continues to reinforce that our strategy is working we develop value added products that drive aftermarket retention for our customers and us.
We are experienced similar trends in on road fourth quarter sales were up 36% from prior year and innovative products, which make up nearly half the business grew twice as fast as the non proprietary counterparts.
In the U S fourth quarter on road sales continue to benefit from higher class eight truck production and there was also an impact from a strategic choice we made.
During the quarter, we stopped selling some directed by equipment to a large OEM customer.
If we adjust our current and prior year sales to exclude these products the like for like growth in the U S is about 35%.
And we are left with a more profitable business that allows us to focus on what we do best.
Technology led filtration.
I also want to call out Latin America, where fourth quarter sales of on road triple versus a year ago. The growth was from large OEM customers in Brazil, and although it is exciting to see the sharp growth I want to note that is on a very small base.
In engine aftermarket sales were up almost 26%.
In fact fourth quarter sales of $376 million were the highest ever beating the record we set last quarter.
Supplier constraints are one of the more challenging parts of the aftermarket business right now and those issues seem to be more severe in the Americas.
Despite that pressure independent channel sales grew in the high 20% range and fourth quarter sales in the aftermarket OE channel were up in the low 20% range.
Innovative products remain a strong contributor to growth in aftermarket.
These razorblade products accounted for more than a quarter of total aftermarket sales and they grew in the mid 20% range during fourth quarter.
I would be remiss if I did not mentioned powered car, we launched the brand almost 20 years ago and sales of these products have grown every year since at least 2010.
We finished fiscal 'twenty, one and another record and we anticipate a long runway for continued growth.
We are compounding aftermarket growth with share gains in less developed markets like Latin America.
Russia and South Africa.
These were some of our fastest growing markets and we believe our strong distribution and comprehensive product offering position us for long term success in these regions.
In aerospace and defense fourth quarter sales declined 8% commercial aerospace remains under pressure from the pandemic, particularly in Europe.
That decrease was partially offset by higher sales of ground defense equipment.
As always aerospace and defense sales can be lumpy quarter to quarter, but we are optimistic about returning to growth in the new fiscal year.
Before turning to the industrial segment I want to make a point about our engine business in China, one year ago engine sales in China were up almost 25%, while the rest of the region suffered through the pandemic.
Fourth quarter engine sales were up again this year by about 2%.
The strategy in China continues to do well as we win new programs with local manufacturers, but it's the one place in the world, where we faced a tough comparison from last year. So I wanted to point that out.
The industrial segment also had a solid quarter with total sales growing 19, 5%.
Sales of industrial filtration solutions, or ISS were up more than 23% in fourth quarter, reflecting strong growth in new equipment and replacement parts.
New equipment makes up nearly half of Iff's sales and these products grew in the mid teens last quarter, which builds on the recovery that began six months ago.
There is still a cautious tone in the market, but we see some signs of improvement in our order intake trends add to our confidence.
The replacement parts of dust collection, or a more optimistic story with fourth quarter sales up nearly 40%.
Activity continues to accelerate and factories and we continue to gain share with our proprietary dust collection products.
Another growth engine within ISS as process filtration, which serves the food and beverage market.
Fourth quarter sales were up almost 20% reflecting growth in new equipment and replacement parts.
The market opportunity for process filtration is fantastic and new high growth areas like plant based foods and beverages has only increased our opportunities.
Consequently, we will continue to expand the team and look for another year of strong growth in fiscal 'twenty two.
Sales of special applications grew 27% in fourth quarter with strong contributions from both disk drive and venting solutions.
Disk drive benefited from timing and venting solutions continue to make ground with automotive customers.
Fourth quarter sales of venting products grew 50% with almost two thirds of the increase coming from Asia Pacific with our high Tech powertrain and battery events, we are winning new programs and expanding with existing customers across the world, resulting in another year of growth for venting solutions.
Fourth quarter sales of gas turbine systems, or GTS were down 11% the.
The decline came from the U S, which is typically our largest GTS market as sales to small turbines were under pressure.
We continue to operate this business with discipline. So our focus in GTS remains squarely on growing replacement parts, while being selective in which new turbine projects we pursue.
Overall, the theme of discipline comes into everything we do and that gave us a significant advantage during the pandemic.
We achieved record sales in each of the last two quarters and our full year EPS is an all time high.
We did that work safely.
We've focused on our people we implemented protocols that made sense based on local conditions.
And our employees acted as one team to deliver outstanding results.
We plan to follow that up with another year of record sales and record profit in fiscal 'twenty, two and I'm excited about what we can accomplish.
Now I will turn the call to Scott for his update Scott.
Thanks, Bob Good morning, everyone. Although when you look at fiscal 'twenty, one with a solid yield we generated strong sales.
Spike the pandemic hanging over us and margin growth contributed to record full year EPS.
What was more impressive with how our people operate at the level of teamwork with unbelievable.
Im spire by the commitment they showed I want to thank my colleagues around the world.
Ill begin in fiscal 'twenty one.
And for putting us in an excellent position to deliver record sales and profit in fiscal 'twenty two.
Before getting to the details of the new year, let me share some 2021 highlights.
Fourth quarter sales grew 25%.
Operating income was up 36%.
And EPS as I know you've heard me say we are profitability.
Profitability on increasing sales.
And we did that in two ways.
2021.
Well I want to add a short disclaimer that commitment is over time.
And it won't be easy to achieve in the first half of fiscal 'twenty two.
So on that in a few minutes.
So back to the fourth quarter recap fourth quarter operating margin was 14, 5% an increase of 110 basis points from the prior year.
Most of the increase is from gross margin, which grew 70 basis points.
To 34, 4% strong volume leverage and initial pricing benefits more than offset the impact from higher raw material cost and mix headwinds.
The impact from raw materials increased throughout the quarter as inflation has began coming through in full force.
And frankly, this impact with price increases in certain businesses, while increases in areas of the supply agreements that had index clauses tend to lag the market, that's true and prices go up or down so it works out over time.
Leverage and pricing also calling for higher fourth quarter gross margin in both segments. However challenges from inflation and unfavorable mix will likely be attained in fiscal 'twenty two.
Operating expenses at a rate of sales was favorable by 40 basis points, driven primarily by volume leverage that was true in both segments with industrial are gaining a lot of improvement from leverage to.
Strong volume leverage was partially offset by higher incentive compensation due in part to a soft comparison last year and incremental investments in our strategic growth priorities, which will continue in fiscal 'twenty two.
I also want to touch on corporate and unallocated line in our segment reporting the fourth quarter, an increase of almost $10 million reflects a couple of factors <unk> expense, which includes additional incentive compensation and higher benefit costs and a much easier comparison in the prior year.
Moving down the P&L fourth quarter.
Other income was $5 million, while the amount itself is not material I bring it up because we ended the year above our guidance. So in case there are questions. The favorability reflects a handful of nonrecurring items, including a tax settlement in Brazil at a lower loss on foreign exchange.
In terms of our other financial metrics fourth quarter was in line with expectations. Therefore, our full year interest expense and tax rate were both consistent with guidance.
Fiscal 'twenty one capital expenditures were also in line with our forecast and way down from 2020, as we took our planned pause following the investment cycle over the past three years.
We directed about a quarter of a $1 billion to shareholders in fiscal 'twenty one.
We repurchased one 9% of our outstanding shares for $142 million and we paid dividends of 107 million <unk>.
Including a 5% increase we announced early this year, we are on pace for more than.
The 25 years in a row of annual dividend increases.
Which is a trend we are extremely proud of them.
I also want to highlight the fiscal 'twenty, one adjusted cash conversion of $100 inventory turns improved and Capex was down.
While strong net income obviously help their cash flow.
Conversion I am pleased with the way, we manage our balance sheet.
We continue to have the flexibility, we need to invest in our strategic priorities, including organic and inorganic growth.
That's a set up for fiscal 'twenty to.
We begin the year on solid ground.
And we are well positioned to deliver our objectives.
Before getting into the details I want to acknowledge that there is still a lot of economic uncertainty and high variability across our end markets and geographies.
Based on that we use wide ranges for total and segment level guidance can we talk a reality.
Of course, we will tighten things up as the year progresses.
With that physical.
<unk> sales are expected to grow between 5% and 10% with currency translation being negligible.
Engine is also planned up between five and 10% and industrial is a bit higher at 6% to 11%.
In engine sales of our first fit businesses are expected to remain healthy.
Particularly in the first half of the year.
Fiscal 'twenty two onwards sales are planned up in the low single digits.
<unk> sales are projected on a low double digits.
The off road first fit growth also includes benefits from new programs and exhaust and emissions, which gives us top line leverage and gross margin mix headwinds.
For engine aftermarket, we expect full year sales growth in the mid single digits with equipment utilization being complemented by share gains from our innovative products and underpenetrated markets.
We anticipate low double digit growth in aerospace and defense due in large part to comparing against the challenges of fiscal 'twenty one.
Sales of industrial filtration solutions are often a low double digit range, reflecting a few things.
We expect a rebound in sales of new equipment, particularly for dust collection and continued growth in dust collection replacement parts.
Also expect another year of strong growth in process filtration.
This reflects benefits from further investments to expand the team.
Fiscal 'twenty two sales in GTS are planned up in the high single digits, while sales of special applications are planned down a low single digits.
Within special applications, we expect lower sales of disk drive filters can be partially offset by growth in venting solutions.
In terms of operating margin, we expect our full year rate between 14, 1% and 14, 7%.
This range implies an increase of 10% to 70 basis points from the fiscal 'twenty, one adjusted operating margin and we expect the improvement to come from expense leverage.
Gross margin is expected to be flat to slightly down from the prior year with raw materials being the single biggest headwind.
At today's prices, we expect to pay 8% to 10% more for our raw materials. This year and that translates to a gross margin impact. It is only a modest change relative to the massive run up over the past few months.
So we do not yet have signs of meaningful relief.
And one final dynamic to keep in mind is that we have raw material favorability during the first half of fiscal 'twenty one.
Consequently, we expect substantial pressure on our first half gross margin.
And then moderating pressure as the timing of our price increases were all in and catch up to the current market pricing.
Importantly, we have already taken action to limit the impact we implemented several off cycle pricing actions over the past few months and we have more plan for this fiscal year, but those will take time to roll in.
Benefits from pricing compound on cost stabilized, we anticipate gross margin in the second half of fiscal 'twenty, two should be up versus 'twenty one.
Restructuring actions, we initiated in fiscal 'twenty, one will help reduce the impact a bit we continue to expect annualized savings of about $8 million with about $5 million to $6 million landing in fiscal 'twenty two.
A large portion of these savings benefit operating expense and there are a handful of other puts and takes we considered in our operating expense budget.
For example, we anticipate savings from incentive compensation as we reset our annual bonus plans.
And we expect the increased travel and to get back to visiting customers.
Yes.
We are also making incremental investments in our advance and accelerate businesses.
Including in that.
Another 10% increase in research and development spending.
Altogether, we expect total operating expenses will be up from the prior year, but to a lesser.
Interest expense is planned to be about.
A $14 million.
Net income is projected between seven and $11 million and the tax rate is expected to between 24% and 26%.
Capital expenditures are planned up in fiscal 'twenty, two with a full year estimate of $100 million to $120 million.
We are expanding power core capacity, primarily in North America, and investing in tooling for new programs and cost reduction initiatives.
At the same time, we will further optimize and leverage the investments we made a few years ago with the goal of growing ROI above next year.
Additionally, we expect to repurchase about 2% of our shares in fiscal 'twenty, two and keeping with our multi decade trend and reaffirming our commitment to shareholders.
Finally, we will maintain a strong balance sheet to allow us to act on any acquisition opportunities in the life Sciences space.
Based on these forecasts, we plan for a new EPS record between $52.0
And $68.0
And implying an increase from last year's adjusted EPS of 8% to 15%.
To help with modeling I want to also offer a few comments about the anticipated cadence of results in fiscal 'twenty, two it's actually pretty straightforward.
The first half as an easier sales comparison, meaning we plan for more of our full year increase to come from in the first half and the second one.
Reverse is two of our operating margin.
I said, a moment ago gross margin will be under substantial pressure in the first half.
While we foresee expense leverage all year and won't be enough in the first half than I think normalize and pricing takes hold operating margin should be up year over year in the second half.
Overall, our company has a long history of solid expense management, and we have responsible leaders across the world that we will invest where appropriate.
We need to do is achieve pricing.
I'll take the global coordinated response.
<unk> talked about it a lot during our planning process and I know every level of the organization is committed.
Fifth protecting gross margin and delivering another year of strong profit improvement.
I think we are in an excellent position to deliver on our strategic and financial.
And so all of them in fiscal 'twenty, two due to the dedicated employees around the world to all my Donaldson colleagues I want to thank you again for a great year and your continued commitment to our long term success.
I'll now turn the call back to Bob Bob.
Thanks, Scott, while Theres a lot to consider in our fiscal 'twenty two plan our priorities are straightforward.
<unk> share and outperform our markets.
Protect gross margin delay.
<unk> delivered best in class levels of service.
And continue to invest in our team and company culture.
Let me share a few of the ways we are attacking these priorities.
The best tactic for growing our share is continued investment in our advance and accelerate portfolio.
We are adding staff in developing tools to help these teams deliver strong growth again in fiscal 'twenty two.
Areas like process filtration of above market growth by capitalizing on the market recovery related to new equipment fifth season, both segments from engine products to new industrial equipment, and we must take advantage of this moment to capture.
Strong value proposition for every customer and this year, we have aggressive plans to get back in.
Additionally, we remain committed to growth we continue to work a robust pipeline.
And a potential targets with the primary focus on expanding into life Sciences, and supporting our industrial segment growth.
While there is no update to share today, I am confident that our strong balance sheet laser focus and disciplined adherence to our long term strategy gives us an excellent opportunity for success.
Another priority in fiscal 'twenty, two is protecting our gross margin.
At our Investor day, two years ago, we talked about our plans to improve gross margin.
Since then we have executed.
Compared with fiscal 19 fiscal 'twenty, one sales are about flat and gross margin is up 90 basis points.
We acted with speed in fiscal 'twenty, two will be no different.
We proactively took price increases when we saw early signs of inflation and we plan for additional increases to catch up with the massive acceleration we saw in raw material costs.
Given the magnitude of the incremental headwinds, especially in the first half of fiscal 'twenty. Two we will stay vigilant and continue to pursue margin accretive price and cost reduction opportunities.
We are also closely monitoring our supply chain to improve the situation with labor shortages now superseding raw materials availability as a top concern our global operations team is having to adapt quickly.
With our global footprint and strong relationships with customers and suppliers I'm confident we will navigate the situation and delivered a best in class service Donaldson is known for.
Finally, we will continue to invest in our team as part of our multiyear journey to further strengthen our human resources processes. This.
This year, our focus is on global alignment around career planning and development.
We are also expanding our diversity equity and inclusion efforts, which will be part of how we continue to build out and strengthen our ESG program.
Returned 106 years old this year, so we clearly value long term thinking.
Our investments in supporting our team and embracing the positive changes in society are critical part of how we will succeed in advancing filtration for a cleaner world.
As I close I want to again acknowledge our Donaldson employees I've been with the company for 25 years and this team continues to find new ways to impress me.
Thank you all for what you accomplished in fiscal 'twenty, one and I'm looking forward to another great year in fiscal 'twenty two.
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 to press star one on your telephone to withdraw your question press the pound key please standby, while we compile the Q&A roster.
Your first question comes from the line of Bryan Blair with Oppenheimer.
Thanks, Good morning, guys.
Good morning, Brad.
I was hoping you could frame run rate demands versus pre pandemic levels a bit more in total.
<unk> sales were up little over 6% versus.
Fiscal 19, although I suspect supply chain constraints, maybe masking some underlying strength beyond that level.
For a little more color on backlog the order rates or any other metrics you should keep in mind versus.
Pandemic right.
Yes. This is tod. So if you take a look at our backlog our backlog is obviously very high.
Higher than than frankly, we would like to see it.
And it really reflects the difficulties across the supply chain, primarily a U S. Based story, it's very difficult right now to get steel and European based products.
So given the given the guide that we have we have baked that consideration and additionally, we are really under pressure now to get employees hired in the United States in order to be able to build off the backlog.
That said other parts of the world are really uneven as a result of Covid and so what we have tried to do is recognize and embrace those difficulties and we have put that into our guidance.
So full color and in terms of your topline dynamics, certainly makes sense, particularly first versus second half an engine and we will see how the next couple of quarters shake out overall.
Is there any more detail you can offer on segment margin outlook, and how understood price cost headwinds and <unk>.
Some.
Potentially unique mix impacts are likely to flow through of Western Europe.
Hey, Brian It's Scott here. So I mean, we were we were obviously pleased with the margin performance of both segments. This year.
We had good volume growth.
And good pricing and good leverage.
And next year.
We see headwinds for both segments.
As Todd mentioned the supply chain is pretty stressed and obviously raw material pricing is way up and so we said in my script that we have.
8% to 10% increase in typical commodity cost, representing and 300 basis points of operating margin headwind that we need to offset.
So we're focused on driving pricing in both segments.
To counter that and we've done some already and we have some to go.
Said, our gross margins would be flat to just slightly down so we're expecting to the pall both pull that 300 basis points back through our own actions that we're focused on which again is is really price driven.
And then volume leverage so I think both segments.
Equally challenged in terms of commodities.
And raw material pricing in the guide overall is expecting another year of operating margin growth.
And that comes from relatively flat gross margin and then leverage on the operating expenses to allow us to drive.
Operating margin improvement from.
10, 70.80 basis points.
Okay I appreciate the details guys.
And.
I mean, I think you've mentioned in process filtration sales of around 20% in <unk>.
<unk>.
Sorry, if I missed the detail what was the full year sales level and what's contemplated for process growth in your 'twenty two guidance.
Yes, so we'd be mid teens for the full year.
On the growth level from a participation and we also expect to have double digit growth looking forward in 2020.
That's excellent one one more if I can portfolio question.
It was advanced and accelerate revenue as a percentages fiscal 'twenty one total.
On the other side of things is it only exhaust and emissions at this point in the fix and reposition bucket.
Yes. So currently look at the portion of the first question. The first question on <unk> question.
Exhausted emissions remains.
Fix and reposition but we also have our aerospace.
<unk> in there as you might imagine we do expect aerospace to come out of it at the end of this year, but we actually bring come from bringing a portion of the company out of the fix and reposition after they delivered we're very confident and comfortable with the plan that we've had this year. However, now you have to deliver it and then we would expect them to probably come out of it next year.
Understood. Thanks again.
<unk>.
Your next question comes from the line I'll answer yes, yes, so before the next question Charlie.
Yes.
Advancing solid portfolio.
Fourth quarter sales were up in the mid <unk>.
20% range.
Thereabout.
950 basis points better on a margin than the overall company, excluding the A&H business.
Okay and then.
As a percentage of companies.
60% to 65 Yep, Okay. Thank you operator excellent okay.
Your next question comes from the line of Nathan Jones with Stifel.
Good morning, Nathan good morning, everyone.
I wanted to start digging a bit further into gross margin.
Overall, roughly flat, but there's a lot of moving pieces in there.
It added some capacity to remove bottlenecks couple of years ago.
Leveraging the pace it was supposed to be lifting up gross margins and you're all set here, obviously by significant cost inflation.
And.
The pricing is.
Making up for that or not.
So I was hoping that you could maybe give us a little bit more color on the puts and takes there what is the headwind from price cost to gross margin.
Just any more color you can give us around the puts and takes into the gross margin line yes.
So certainly there is.
A fair amount drawn on our Nathan as you noted.
Again, the biggest impact is obviously.
Commodity cost increases.
I'll say that to 10%, which gives us a 300 basis point headwind that we have to offset okay.
And we're offsetting that with pricing and higher.
Higher volume, which allows us to leverage our facilities and so the way we see the year Rolling out is what we have termed a a bit of a bathtub curve and so your first quarter will be down the most significant and that will be offset by improvements in the fourth quarter.
Your second quarter will be down a bit and that will be offset by improvements in the third quarter. So as we we layer and probably seen and hopefully commodities begin to stabilize a bit we're going to work our way out of this cycle and hopefully.
Gross margins for the year will be flat to just slightly down and so you can imagine the first quarter being the toughest quarter, and then things slowly start to improve or by when you lay out in the fourth quarter. You are essentially offsetting the gross profit negativity from the first quarter to allow in a flat to slightly down margins for the whole year.
So its number one commodity pricing.
It drives our raw material input costs up there was also certainly some some interest that we had in increasing our salaries because demand is high for people and not the headwind.
We have our cost reduction improvements at our operations team is consistently operating on we've had the capacity expansion that we've talked about previously which allows us to operate more efficiently.
And the plans so that's kind of all in the soup.
We expect this year to be flat to just slightly down in terms of gross margin with improving operating margin based on in our expense leverage maybe just a strategic comment on our two Nathan is the capacity expansion in really good shape.
To take advantage of the leverage with the higher book of business.
Clearly if we can win.
That we are experiencing raw material activities right now.
Given our ability to produce and.
And where we stand right now.
And do you expect for the full year fiscal 2020.
Cost headwinds.
On a dollar basis, but it is still dilutive to margin.
Well, we think our gross margin will be flat to just slightly down or flat.
Percentage perspective, we should be flat to just slightly down.
But our dollars because our sales are up significantly our gross profit dollars will be higher obviously, and we're going to leverage our opex.
So we're going to grow opex, but not nearly as fast as revenues and so that gives us a bigger driver and operating margin as well as operating profit.
Got it and then just a question on the labor shortages you are talking about labor shortages for your own facilities in order to produce products.
What kind of steps, you're taking to try and get more skilled labor and retaining labor that you've got currently and how you see that playing out going forward. It.
It is not just Donaldson company with labor shortages. It is our supply base that has labor shortages.
The point of where we have actually called retirees into help Donaldson company to say that our supply base to try to help with overall scheduling to get our demands we have done.
Overall.
Typical type of.
Salary based adjustments across our manufacturing plants and recruiting base adjustments with sign on bonuses et cetera, It's primarily U S based story relative that.
We're pulling all the levers that you typically would read anyone else doing right now across the United States, but I would suggest to you that in in other parts of the world.
It's not a labor story.
It is really more of a raw material story.
Do you have an expectation for labor inflation this year.
We baked it into the guidance that we're giving you at this point.
Okay fair enough I'll pass it on thanks.
Your next question comes from the line of Brian Drab with William Blair.
Good morning, Brian is open.
How is your line Brian.
Yes, yes to me button presses.
We all know that.
Myself I can get to the right person.
Alright, good morning.
Gratulation a great year.
Pretty tough environment.
So I just want to make sure first of all that I understand what we're saying about the 300 basis points.
Is that from.
What's the time period that we're talking about there because we just finished the year at.
34% gross margin is that to say that first quarter 'twenty two is going to be around 31, and then we build from there.
I think we already have some things that are building. So clearly our first quarter would be would be less than 300. That's the total dollar impact of the raw materials cost, but we've been layering in price increases.
And we'll have good volume growth in the first half because of the softer comps so it'll be less than 300.
And it'll be the highest in the first quarter, and then a little bit less in the second quarter, but but less than 300, because we have some things that are already in place and we will also be working on that in the first quarter.
I see so the 300 is just the impact related to raw materials, and you're already dealing with some significant.
What's the magnitude of kind of how would you quantify what the <unk>.
Headwind from raw materials in the second half of 'twenty one.
Fiscal 'twenty, one DIY normally had right. Good question. So we had actually that's an interesting dynamic of last fiscal year is that we actually had raw material favorability in the first half.
Cause things or really hadn't started to take off yet and so the impact that we've seen from a negative perspective are primarily related to the second half of the fiscal year and now those are layering into next year. So.
I think you have it kind of analyzed properly.
Okay.
And then.
You talked about the segments and the margin, but just kind of help us model there the segments.
And ended the year with industrial operating margin.
Above engine.
For the year they are pretty even.
And I know you said you expect to see.
Similar pressure from.
Raw materials across both segments.
Should we.
And I don't know if you said this in the guidance already.
The segment is going to probably have similar operating margins in the next year or one have more pressure than the others.
Yes, I mean from a cost perspective.
They're going to both have similar raw material issues, and obviously mix is a big driver.
And we generally don't.
I will provide specific guidance in terms of each segment and their profitability, but we look for continued growth.
And profitability from both sides, yes, Bryan maybe a little bit more color on south of the model is that if you just remember how we how we drive our industrial based business. It's a project based business and so as we watch those projects out were able to adjust to the pricing.
Across that business as well as the independent channels on our aftermarket, which we control more on the industrial side than we do on the.
Engine side, we do quite well on the independent aftermarket channels, but it's the OE portion of that business, which is roughly 35% of our business that always lags within the pricing and so youll see likely more headwinds on the engine side in the first portion of the year as we work through it.
Okay. Thanks, and then just the last question high level strategic.
Question.
Over the last 18 months.
<unk>.
Given how fragmented the filtration industry is that.
<unk> seen some competitors either really struggling are disappearing.
And obviously, that's not the case with Donaldson.
Very strong established company. So I'm just wondering are you seeing opportunities that take.
Sure when customers are there new opportunities.
We're hoping to capitalize on over the next year.
So we have seen some small kind of column mom and pop shops go away, obviously they've been pressured.
Across the world.
It really hasnt changed the overall long term environment for us and we look to win every single day, and we look to plant seeds for future growth with our leading technology based products.
Those that are falling off by the wayside or typically chasing the commodity based activities.
And so while they may change the filtration landscape it doesn't change donaldson's.
<unk> to capture share or or to go often and.
Really embedded in cool things, which we continue to do every day, so not not really a lot of competitive changes if you will landscape.
Okay got it thanks a lot.
Your next question comes from the line of Laurence Alexander with Jefferies.
Hi, Good morning. This is Dan Rizzo on for Laurence how are you.
And while you mentioned your good morning, you mentioned Youre seeing I think is one of the raw material costs that are kind of on the horizon.
We are supply constrained I was wondering if the storm in the Gulf earlier this week.
Players have signaled to you that that might make things even worse.
Yes, it's a fantastic question actually we've been dealing with that here obviously throughout the last.
Short period of time, and yes, we do have some urethane based concerns taking place across the supply chain right now.
We are working with that.
Group of suppliers.
Do have that concern it's an immediate concern.
And damage.
As being.
Inventory at this point to see how quickly they can come back online. So so yes, we have that concern, but we did bake in what we think we understand about all of that into the guidance that we gave you as well and that's part of the risks that we have.
We have talked about on the overall top line and our ability to deliver its more than a typical things now we have the storm last weather event and in Texas.
But the bad one really hurts us supply chain significantly and this hurricane season.
And has us all very concerned as well.
Okay.
That's very helpful. And then just with the labor the labor issues.
I guess, it's not happening, but I was wondering if UBM to enhanced benefits.
Makes these ease starting right now basically I don't know, but I guess, you're not seeing that.
We've done some of that already.
The Corporation.
It's not really driving.
People to come back into the offices.
Our into the into the look for gathering and come to our manufacturing plants. So we clearly have done those things.
I'm not sure what's going to change the overall <unk> in the United States, but.
We'll we'll look to see where we are as as schools open up in kids go back in September and hope for the room for us to pick up back then until then.
Right now, it's very good to be a global company.
Alright, Thank you very much.
Yes.
Again to ask a question or make a comment. Please press star. One. Your next question comes from the line of Dillon Cumming with Morgan Stanley.
Great. Good morning, guys. Thanks for question.
Todd I don't know if I can just ask you you made some comments on your prepared remarks, the thing Thats kind of an immediate update here.
So curious kind of around the outlook for the life science eliminated over the next year or so I think we're kind of coming up on a couple of quarters now where you made some hires in areas. So just curious you kind of update us around.
The pipeline and what your kind of expectations are around M&A for this year sure.
Sure.
All you that our pipeline is more robust than it's ever been.
It's really healthy within the life science sector like the game that we're playing here continue to knock on doors have very talented people, helping us to really execute that.
Obviously, you can't predict when deals will happen wouldnt comment on any specific deal.
But strategically what we're trying to accomplish and I'm very pleased with our progress and the execution to date.
Got it that's helpful color and then maybe to ask the kind of competitive question and the landscape there a different way.
One of your larger peers have made public their intention to kind of spin or sell their own filtration business will.
I'm just curious your kind of view there as to whether that business is kind of operating as a stand alone entity might actually contribute toward disciplined market or kind of any other competitive implications you might call out as a result to that dynamic.
So we're very aware of what.
It may have been talking about and the potential options that they face.
And so we'll follow that very closely obviously, we wouldn't specifically comment.
A competitor like that it's inappropriate and so.
Consequently, we'll just we'll just continue to keep a keen eye on that watch the proceedings and.
Move forward.
Got it.
And maybe one last question for me I think you were kind of clear calling out the disconnect between your kind of build guidance versus where call. It ACP and might have their class eight forecast for the year, whether you kind of attributed to the product line exits you were discussing.
I'm just curious if you could kind of quantify that headwind for the year and kind of whether or not we should expect that over the next few quarters or so.
The building is that you mean for the.
Could you maybe set against yes, sorry, I was just.
For the on road business that you were discussing in the prepared remarks, you were saying that you were kind of exiting some product lines there.
Yeah, so what.
What we did is there is there is a particular directed by.
Non filter business that we've been doing because we have strong customer relationship we've been doing in the on road business submissions related to <unk>.
Not even our typical emissions business and.
And we.
There were some contracting a portion of that and we just helped with the sourcing transfer to make it go to a subcontractor directly and balancing that out of the business.
That's really helped that's a positive mix to us.
And frankly, it's also good for our customer in the AMOLED segments. So that's part of the part of the positive mix.
Overall mix headwinds that we have.
In the emissions business is certainly.
Overall a tough.
Headwind for us typically.
Operating profitability level, roughly half of Donaldson average.
And so we're going to have significant growth in that business.
As well as some other mix challenges that we have OE business for example.
Okay got it thanks for the time guys.
Thank you.
Again to ask a question or make a comment please press star one.
Next question comes from the line of Rob Mason with Baird.
Martin Thanks for good morning, Thanks for taking the question.
Just quickly.
Quickly a lot of discussions around price, but I'm, just curious within the 5% to 10%.
Guidance for the year, what are you assuming for price or what range.
Yes, it is built into that so.
So we talked about the 300 basis.
Basis points of commodity cost.
Headwind that we face.
And we think our gross margins can be flat to slightly down. So so our plan is the.
Offset.
A significant portion of that commodity cost increase with pricing.
And volume as well.
And volume leverage.
Just.
You also had this.
Discuss the backlog backlog, maybe above where you would normally expect it like it.
How are you thinking about your ability to work down that backlog either in the first half or the second half and it really maybe where I'm going with this is just trying to get at how you think about your second half.
Of the year visibility.
Versus how it you may typically start out a fiscal year.
Whether on the first yes. So we typically are in a much more comfortable position with our DUC backlog execution as we started fiscal year than we are at this point, we'll we'll grind through the supply shortages inventory levels across the independent channels and the only channels are low low.
Other than day, one loan and we want them.
So we looked at.
So cute and get back on our feet.
Take into the next thing working through this first half.
Of this.
Fiscal year for us.
And then we should be able to see some.
Some improvement on the back half and that also goes.
<unk>.
We're typically a 48% 52% type of a company.
On the swings and of course, Alaska.
54, and so we look to return a bit more of a normal we're actually thinking will do about $100.0
On the split.
So how much of a jump in the first half as we work through that backlog.
And get that.
Get our customers really serviced and that's how we're kind of kind of breaking out working through it.
Okay.
How much of your backlog is a function of your first fit customers.
Planning further ahead.
Given the supply chain challenges.
Are you seeing that are you seeing.
Longer.
<unk>.
Longer ranging forecast or is there.
<unk> is so dynamic.
Maybe the inverse.
Tough to quantify we talk about that all the time, it's clear absolutely clear we are seeing some order ahead in order to try to the theory being if you have more of an owner you'll get more.
Not really working that way, but people do think that when we do see that behavior in our backlog no question about it.
But we can't really quantify it Rob I mean, the computers are linked to each other on the Oasis right now we would tell you are back.
There are probably now.
Ended two maybe as much as four or five months as being solid as the way we look at it in a normal behavior.
Period, we would tell you. It's 90 days so its probably like three months and then in really tough cycles. It cuts down to 30 days, but but we would tell you that our backlogs.
<unk>, probably four five as messaged five months of solid in the high <unk>.
And Thats, an indication that people are trying to restock to us and now we just have to work through and get it to them.
Okay.
Just the last question is again framing the outlook for the year, how do you think about that geographically in particular.
China, Obviously, you had the tough comp this past quarter, but how are you thinking about China.
In particular in the context of the five to 10.
Yes, China.
It's interesting right because if we just look at the.
Q4, 'twenty, China as a country had record excavator production.
Record equipment utilization as they were coming out of the pandemic right.
And we're big in escalators heavy production was down double digits low double digits heavy duty truck production was down.
In the high teens and equipment utilization was down in the mid teens and yet our business was actually in local currency down single digits. So we know we're winning share there.
We baked that into our overall China.
Based model, if you will into the guidance and one other thing that's really important to note to suggest how we're doing in China is we have quoted in the last year high teens worth of first fit production products with proprietary.
With proprietary products first fit programs in China.
And of those high teens, we want them. All so that's that is planting seeds for future growth and that's the momentum that we see ahead of us.
In China.
And so we're still very bullish on the excellent work that our teams are doing over there.
Very good.
Thank you.
There are no further questions I will now turn the call over to Tod Carpenter for any closing remarks.
Thank you.
Before before signing off I just want to acknowledge.
College that we have talked to a number of our customers.
That have been affected by the hurricanes of the past week and just want to acknowledge that you are important to us.
And then our company standby to help you.
Get through the through the difficult times. So please raise your hand, we'll help where we can that concludes today's call.
I want to thank everyone listening for your time.
Time, and your interest in Donaldson Company Goodbye.
This concludes today's conference call. Thank you for participating you may now disconnect.
Yes.
Sure.
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