Donaldson Company Inc. Q3 2023 Earnings Call
Earnings Conference call.
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<unk> senior director of Investor Relations you May begin your conference.
Good morning, Thank you for joining Donaldson's third quarter fiscal 2023 earnings conference call with me today are Tod Carpenter, Chairman, CEO , and President and Scott Robinson, Chief Financial Officer. This morning, Tod and Scott will provide a summary of our third quarter performance and an update on our outlook for fiscal 'twenty.
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During today's call, we will discuss non-GAAP or adjusted results a reconciliation of GAAP to non-GAAP metrics is provided within the schedules attached to this morning's press release. Additionally, please keep in mind that any forward looking statements made during this call are subject to risks and uncertainties, which are described in our press release and.
SEC filings with that ill now turn the call over to Tod Carpenter. Please go ahead.
Erika good morning.
Third quarter was another record quarter for Donaldson company, we continued the trends seen in the first half of this fiscal year.
Compared with prior year.
We grew our top line to a quarterly record.
Expanded both gross and operating margins over 100 basis points delivered double digit earnings growth.
And produce cash conversion of approximately 105%.
Before diving deeper into the quarterly results I would like to express how pleased we were to outlets pads. So many of you participate either in person or virtually at our investors day in April .
The big data for our company and I will recap some key takeaways.
We demonstrated our leadership position in strategy across all three segments that together drives our expectation to achieve sales of approximately $4 billion and operating margins in the 16% range by fiscal 2026.
More specifically I would like to highlight our new life Sciences segment, where there are significant compelling opportunities driven by organic and inorganic investments, including the recent acquisitions of Soliris.
Speaker 1: participate either in person or virtually at our Investors Day in April .
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These businesses combined with Donaldson technologies and expertise provided portfolio of opportunities across several end markets, such as food and beverage alternative proteins bio processing and medical devices.
Speaker 1: It was a big day for our company and I will recap some key takeaways
Speaker 1: We demonstrated our leadership position and strategy across all three segments that together drives our expectation to achieve sales of approximately $4 billion and operating margins in the 16% range by fiscal 2026.
Focusing in on Bioprocess Ing for example, we see game changing opportunities to support the development of vaccine and advanced cell and gene therapies with our newly acquired technologies.
Speaker 1: More specifically, I would like to highlight our new Life Sciences segment where there are significant, compelling opportunities driven by organic and inorganic investments including the recent acquisitions of Solaris, PureLogix, and Isolair Bio.
Traditional chromatography systems are slow and not optimized for larger molecules, such as mrna and plasmid DNA <unk>.
<unk> innovative technology provides faster flow rates and puts less stress on cells and eissler bio allows us to introduce breakthrough technology that provides purification and solutions with no size limitations.
Speaker 1: These businesses combined with Donaldson's technologies and expertise provide a portfolio of opportunities across several end markets such as food and beverage, alternative proteins, file processing, and medical devices.
Together and combined with Donaldson's capabilities, we are at the cusp of driving scale across vaccine and cell and gene therapies to solve the world's greatest health risks.
Speaker 1: Focusing in on bioprocessing, for example, we see game-changing opportunities to support the development of vaccine and advanced cell and gene therapies with our newly acquired technologies.
To that end, we will continue to grow these businesses by investing organically and pursuing strategic M&A and adjacent areas, which will further us on the path of continuing to create value for all of our stakeholders.
Speaker 1: Traditional chromatography systems are slow and not optimized for larger molecules such as mRNA and plasmid DNA.
Speaker 1: PureLogic's innovative technology provides faster flow rates and puts less stress on cells, and IsolarBio allows us to introduce breakthrough technology that provides purification in solutions with no size limitations.
Now some third quarter highlights sales were up 3% year over year, driven by pricing of 8% and partially offset by a currency translation headwind of approximately 3%.
Speaker 1: Together and combined with Donaldson's capabilities, we are at the cusp of driving scale across vaccine and cell and gene therapies to solve the world's greatest health risks.
Volume was down in the quarter as our aftermarket business was negatively impacted from OE customers continuing to reduce inventories as service levels normalize.
To that end, we will continue to grow these businesses by investing organically and pursuing strategic M&A in adjacent areas which will further us on the path of continuing to create value for all of our stakeholders.
Also negatively impacting volumes was our disk drive business, which remains muted from market related weakness.
EPS was <unk> 76.
A 14% increase over the prior year.
Our strategic pricing implemented to offset elevated input costs continues to be a big driver of our quarterly sales and earnings results.
Now some third quarter highlights. Sales were up 3% year over year driven by pricing of 8% and partially offset by a currency translation headwind of approximately 3%.
Most input costs have stabilized at higher levels. However, some areas such as labor remain a headwind.
Volume was down in the quarter as our aftermarket business was negatively impacted from OE customers continuing to reduce inventories as service levels normalize.
Therefore, our pricing remains critical in a recovery from this period of sharp year over year inflation.
Turning to our operations I am pleased by our improvements in fill rates.
Also, negatively impacting volumes was our disk drive business, which remains muted from market-related weakness.
On time deliveries and linked backlog levels across the organization, we are marking to meet the needs of our customers today, while investing in capacity projects, including in North America to meet the needs of our customers in the future.
EPS was 76 cents, a 14 percent increase over the prior year.
Our strategic pricing implemented to offset elevated input costs continues to be a big driver of our quarterly sales and earnings results.
We are also committed to furthering our long history of innovation to expand our product offerings for.
Most input costs have stabilized at higher levels. However, some areas such as labor remain a headwind.
For example, this quarter, we released our proprietary also web filtration media. This new hydraulic technology improves fluid cleanliness up to four times and creates additional value for customers by extending critical component life.
Therefore, pricing remains critical in our recovery from this period of sharp year-over-year inflation.
Turning to our operations, I'm pleased by our improvements in fill rates, on-time deliveries, and late backlog levels across the organization.
In addition to our organic investments we are working through our M&A pipeline and actively pursuing life sciences opportunities with a focus on revolutionary technologies and applications such as those we acquired through Soliris <unk> and Eissler bio.
We are working to meet the needs of our customers today while investing in capacity projects, including in North America, to meet the needs of our customers in the future.
We are also committed to furthering our long history of innovation to expand our product offerings. For example, this quarter we released our proprietary AlphaWeb Filtration Media. This new hydraulic technology improves fluid cleanliness up to four times and creates additional value for customers by extending critical component life.
Now I'll provide some detail on third quarter sales.
Total company sales were $876 million up 3% from prior year.
In mobile solutions total sales were $555 million roughly flat versus a year ago.
Pricing added, 9% and FX was an approximate 3% headwind.
Our first fit businesses continue to perform well with sales in off road of $116 million up 11% year over year and sales in on road of $38 million up 5%.
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Now I'll provide some detail on third quarter sales.
These results reflect healthy levels of equipment production rates across all our major geographies.
Total company sales were $876 million, up 3% from prior year.
Mobile solutions aftermarket sales of $401 million were down roughly 3% year over year from OE customer inventory draw downs to more normal levels.
In mobile solutions, total sales were $555 million, roughly flat, versus a year ago. Pricing added 9% and FX was an approximate 3% headwind.
Lastly for mobile solutions on update on China.
Sales increased 5% versus 2022 and 14% in constant currency.
Our first-fit businesses continue to perform well with sales in off-road of $116 million dollars up 11% year-over-year and sales in on-road of $38 million dollars up 5%.
While this year over year growth marks a considerable improvement from what we reported in the second quarter. The one thing to note is that last year's third quarter sales were depressed from COVID-19 Lockdowns.
These results reflect healthy levels of equipment production rates across all our major geographies.
Overall, China continues to be challenging given the weaker end market conditions.
Mobile Solutions aftermarket sales of $401 million were down roughly 3% year-over-year from OE customer inventory drawdowns to more normal levels.
That said share market size combined with our world class technology and high quality offerings should result in Donaldson success in the Chinese market over the long term.
Lastly, for mobile solutions, an update on China.
Now I'll turn to the industrial solutions segment.
Sales increased 5% versus 2022 and 14% in constant currency.
Industrial sales grew 14% to $262 million.
Pricing added, 6% and FX was roughly a 3% headwind.
While this year-over-year growth marks a considerable improvement from what we reported in the second quarter, the one thing to note is that last year's third quarter sales were depressed from COVID-19 lockdowns.
Industrial filtration solutions or ISS grew 13% to $223 million driven by dust collection and industrial gases part sales.
Overall, China continues to be challenging given the weaker end market conditions.
Aerospace and defense sales were up 22% supported by the ongoing strength in the commercial aerospace industry.
That said, sheer market size combined with our world-class technology and high quality offerings should result in Donaldson's success in the Chinese market over the long term.
Now on the life Sciences segment life Sciences sales were $59 million down 13% year over year.
Now I'll turn to the industrial solution segment.
Weakness in the overall disk drive market continues to drive the majority of the decrease however, we are now seeing a flattening and forecasting of slow demand recovery during the second half of calendar 2023.
Industrial sales grew 14%, 262 million dollars.
Pricing added 6% and FX was roughly a 3% headwind.
Industrial Filtration Solutions, or IFS, grew 13% to $223 million driven by dust collection and industrial gases part sales.
Our food and beverage business remains solid in the quarter with continued momentum in both new and replacement parts sales.
We look forward to continuing to provide updates on all of our businesses within this segment in the future.
Aerospace and defense sales were up 22% supported by the ongoing strength in the commercial aerospace industry.
and sales were up 22% supported by the ongoing strength in the commercial aerospace industry. Now on the life sciences segment.
As we progress through the final quarter of fiscal 2023, we've been extremely pleased with our ability to deliver strong financial results. Thus far this year, while making strides across our strategic initiatives.
Life Sciences sales were $59 million dollars down 13% year over year.
Weakness in the overall disk drive market continues to drive the majority of the decrease, however we are now seeing a flattening and forecasting a slow demand recovery during the second half of calendar 2023.
As such we are reaffirming our sales and earnings guidance for the full year by tightening our previously provided outlook ranges and remain confident in achieving our long term targets laid out at our recent investor day.
Our food and beverage business remains solid in the quarter with continued momentum in both new and replacement parts sales.
Now I'll turn it over to Scott, who will provide more details on the financials and an update on our outlook for fiscal 'twenty three.
We look forward to continuing to provide updates on all of our businesses within this segment in the future.
Scott.
As we progress through the final quarter of fiscal 2023, we've been extremely pleased with our ability to deliver strong financial results thus far this year while making strides across our strategic initiatives.
Thanks, Todd good morning, everyone.
Third quarter results reflect another solid quarter for Donaldson in which our employees delivered for our customers and planted seeds for future profitable growth.
The groundwork for achieving our longer term financial and strategic objectives.
As such, we are reaffirming our sales and earnings guidance for the full year by tightening our previously provided outlook ranges and remain confident in our achieving our long-term targets laid out at our recent Investors' Day.
I, thank our employees around the globe for their daily contributions.
I will provide color on our outlook for the balance of the year in a few minutes, but first we will give more details on the results this quarter.
Now I'll turn it over to Scott who will provide more details on the financials and an update on our outlook for fiscal 23.
more details on the financials and an update on our outlook for fiscal 23. Scott?
Summarize.
Sales grew 3% versus 2022 opt.
Operating income was up 12%.
Thanks, Todd. Good morning, everyone.
And EPS of <unk>, 76 increased 14% year over year.
Third quarter results reflect another solid quarter for Donaldson.
Gross margin was 33.0%.
in which our employees delivered for our customers and planted seeds for future profitable growth.
150 basis point improvement versus prior year.
laying the groundwork for achieving our longer-term financial and strategic objectives.
Similar to the first half of the year. This quarter, we saw benefits from our pricing and the stabilization of input cost inflation.
I thank our employees around the globe for their daily contributions.
Gross margin was down sequentially as expected due.
I will provide color on our outlook for the balance of the year in a few minutes, but first we'll give more details on the results this quarter.
on our outlook for the balance of the year in a few minutes, but first we'll give more details on the results this quarter. To summarize...
Due to an unseasonably strong second quarter, driven in part by inventory valuation and the timing of deflation.
Sales grew 3% versus 2022.
Overall third quarter gross margin results were consistent with our internal expectations.
Operating income was up 12%.
Operating.
EPS of 76 cents increased 14% year-over-year. Gross margin was 33.0%.
<unk> expenses as a percentage of sales were 18, 8%.
Slightly above 18, 5% a year ago.
The deleveraging of operating expenses in the quarter was due to an increase in life Sciences investments and post COVID-19 hiring.
A 150 basis point improvement versus prior year.
Similar to the first half of the year, this quarter we saw benefits from our pricing and the stabilization of input cost inflation.
Operating margin was 14, 2% up 120 basis points versus prior year, driven by gross margin improvement.
Gross margin was down sequentially as expected.
In line with my comments on gross margin operating margin was down sequentially due to an unseasonably high second quarter.
due to an unseasonably strong second quarter driven in part by inventory valuation and the timing of deflation.
Overall, third quarter gross margin results were consistent with our internal expectations.
Now I'll discuss segment profitability.
Mobile solutions pre tax profit margin was 15% up 70 basis points year over year and.
Operating expenses as a percentage of sales were 18.8%.
Slightly above 18.5% a year ago.
In industrial solutions pre tax profit margin was 18, 8% up 390 basis points from the prior year.
The deleveraging of operating expenses in the corridor was due to an increase in life sciences investments and post-COVID hiring.
Gross margin expansion was a key driver in both of these segments.
Operating margin was 14.2% up 120 basis points versus prior year driven by gross margin improvement.
On the life Sciences side pre tax profit margin was 0.3% versus 26% a year ago.
In line with my comments on gross margin, operating margin was down sequentially due to an unseasonably high second quarter.
The decline in disk drive sales of the largest driver.
However, investment and are pre revenue acquisitions, including Eissler bile also negatively impacted results.
Now I'll discuss segment profitability. Digital Solutions pre-tax profit margin was 15%, up 70 basis points year over year.
We are in the investment phase of these acquisitions and our priming them for future growth excluding acquisitions pre tax profit margin would have been better by approximately 800 basis points.
And Industrial Solutions pre-tax profit margin was 18.8%, up 390 basis points from the prior year.
Turning to a few balance sheet and cash flow statement high levels.
Gross margin expansion was a key driver in both of these segments.
Third quarter capital expenditures, mainly.
On the life sciences side, pre-tax profit margin was 0.3% versus 20.6% a year ago.
Mainly inclusive of continued capacity expansion investments in North America, where approximately $36 million.
Cash conversion in the quarter was 105% versus 49% in 2022.
The decline in disk drive sales was the largest driver, however, investments in our pre-revenue acquisitions, including Isolier Bio, also negatively impacted results.
We are now experiencing above average levels of conversion, resulting from inventory related working capital benefits from the easing of supply chain constraints.
We are in the investment phase of these acquisitions and are priming them for future growth.
In terms of other capital deployment, we acquired icily or bio for $62 million and returned $32 million to shareholders includes a $28 million in the form of dividends and $4 million in share repurchase.
Excluding acquisitions, pre-tax profit margin would have been better by approximately 800 basis points.
Turning to a few balance sheet and cash flow statement highlights.
Turning to a few balance sheet and cash flow statement highlights. Third quarter capital expenditures.
Our balance sheet is strong and we ended the quarter with a net debt to EBITDA ratio of <unk> seven times.
Mainly inclusive of continued capacity expansion investments in North America were approximately 36 million. Cash conversion in the quarter was 105% versus 49% in 2022. We are now experiencing above average levels of conversion resulting from inventory related working capital benefits.
Now moving to our updated fiscal 'twenty three outlook first on sales.
We expect fiscal 2023 sales to increase between 3% and 5%.
The midpoint of which is in line with our previous guidance.
This includes pricing of approximately 8% and a negative impact from currency translation of about 4%.
from the easing of supply chain constraints.
In terms of other capital employment, we acquired Isolier Bio for $62 million and returned $32 million to shareholders, inclusive of $28 million in the form of dividends and $4 million in share repurchase. To learn more, head to Isolier.Meshonarea.org
As forecasted as the year has progressed, we have lapped stronger prior year pricing actions each quarter, resulting in less of an incremental benefit as we move through the year.
Our balance sheet is strong and we end the quarter with a net debt to EBITDA ratio of 0.7 times.
We expect this tend to continue in the fourth quarter.
For mobile solutions, we are anticipating a sales increase of between two and 4% <unk>.
Now moving to our updated Fiscal 23 outlook. First on sales. We have normal normal COVID results
Consistent with our prior expectations.
On road and off road sales are forecast to be up mid single digits and high single digits respectively.
We expect fiscal 2023 sales to increase between 3 and 5 percent, the midpoint of which is in line with our previous guidance.
Aftermarket sales are projected to be up low single digits.
This includes pricing of approximately 8% and a negative impact from currency translation of about 4%.
For the industrial solutions segment, we are increasing the midpoint of our guidance with sales now expected to increase between 11% and 13% up from 8% to 12% previously.
As forecasted, as the year has progressed, we have lapped stronger prior year pricing actions each corridor, resulting in less of an incremental benefit as we move through the year. We expect this tent to continue in the fourth corridor.
Robust volume growth and pricing essentially across the entire segment are driving the improvement.
Within industrial solutions.
For Mobile Solutions, we are anticipating a sales increase of between 2 and 4 percent, consistent with our prior expectations.
Iff's sales strengthened by robust dust collection and industrial gases part sales are forecast to grow low double digits on increase from high single digits previously.
On-road and off-road sales are forecast to be up, mid-single digits, and high single digits respectively.
Aerospace and defense sales are projected to grow mid teens up from our previous low double digit expectation.
Aftermarket sales are projected to be up low single digits.
For the industrial solutions segment, we are increasing the midpoint of our guidance with sales now expected to increase between 11 and 13 percent, up from 8 to 12 percent previously.
Within the life Sciences segment, where Norfolk casting a sales decline between 10 and 12% versus a decline between 5% to 9% previously.
Robust volume, growth, and pricing, essentially across the entire segment, are driving the improvement.
The main drivers of the reduced outlook, our continued disk drive sales weakness and a change in timing of Soliris, our bioprocess and equipment sales.
Within industrial solutions,
IFS sales strengthened by robust dust collection and industrial gases parts sales.
Now on operating margin, we expect full year operating margin to fall within a range of between $14 four and 14, 8% slightly.
are forecast to grow at low double digits and increased from high single digits previously.
Slightly down from our previous guidance of between $14 six and 15.0%.
Aerospace and defense sales are projected to grow mid-teens.
up from our previous low double-digit expectation.
This is mainly the result of our life science investments as we focus on scaling our pre revenue acquisitions.
Within the life sciences segment, we are now forecasting a sales decline between 10 and 12 percent versus a decline between 5 and 9 percent previously.
As we have consistently stated we continue to exercise expense discipline.
Particularly given the uncertain macro environment. However, we are committed to building for the future through our reinvestments back into the business.
The main drivers of the reduced outlook are continued disk drive sales weakness and the change in timing of Solaris or bioprocessing equipment sales.
The midpoint of our updated operating margin range reflects a 110 basis point increase from the prior year and is driven by gross margin expansion.
Now on operating margin. We expect full year operating margin to fall within a range of between 14.4 and 14.8 percent.
In terms of EPS, we are maintaining our outlook for the year, but narrowing our adjusted guidance range to between $3 and $3 six.
slightly down from our previous guidance of between 14.6 and 15.0 percent.
This is mainly the result of our life science investments as we focus on scaling our pre-revenue acquisitions.
From $2 99, and $3 seven previously.
The midpoint of this range represents an approximately 13% increase from a record fiscal 2022.
As we have consistently stated, we continue to exercise expense discipline, particularly given the uncertain macro environment.
Now onto our balance sheet and cash flow outlook.
However, we are committed to building for the future through our reinvestments back into the business.
Cash conversion is forecast in the range of 105% to 115%.
The midpoint of our updated operating margin range reflects a 110 basis point increase from the prior year and is driven by gross margin expansion.
Slightly down from 110% to 120% however are still above our historic averages.
Our above average cash conversion. This year is driven by a move towards more normalized working capital levels.
In terms of EPS, we are maintaining our outlook for the year, but narrowing our adjusted guidance range to between $3 and $3.06.
As we increased inventory efficiency through optimization of our processes and our supply chain conditions normalize.
from $2.99 and $3.07 previously.
Our capital expenditures forecast remains at $115 million to $130 million and is heavily weighted towards growth initiatives, including investments in capacity expansion.
The midpoint of this range represents an approximately 13% increase from record fiscal 2022.
Now, onto our balance sheet and cash flow outlook.
And tooling and equipment for our new products and technology.
Cash conversion is forecast in the range of 105 to 115 percent, slightly down from 110 percent to 120 percent, however still above our historic averages.
With respect to other capital allocation priorities, we continue to evaluate the best acquisition opportunities for our life Sciences business.
And maintain our long standing commitment to dividends and share repurchases.
Our above average cash conversion this year is driven by a move towards more normalized working capital levels.
Now I'll turn the call back to Tom.
Todd.
as we increase inventory efficiency through optimization of our processes and as supply change conditions normalize.
Thanks, Scott as we close out another record quarter I want to thank Mike Donaldson colleagues around the globe for their dedication and hard work with.
Our capital expenses forecast remains at $115 million to $130 million.
With this outstanding team in place the future is bright and I am excited about what lies ahead for our company.
and is heavily weighted towards growth initiatives, including investments in capacity expansion and tooling and equipment for new products and technology. With respect to other capital allocation priorities, we continue to evaluate the best acquisition opportunities for our life sciences business and maintain our longstanding commitment to dividends and share repurchases.
I spoke earlier about some of the game changing opportunities we are pursuing in our life Sciences segment.
We're also investing in pursuing growth in our mobile solutions and industrial solutions segments.
For example in mobile we are making progress on building our portfolio of alternative power solutions and in industrial we are pushing ahead with our goal of increasing our industrial services business by leveraging our connected solutions offerings.
Now I'll turn the call back to Todd. Todd?
Thanks, Scott. As we close out another record quarter, I want to thank my Donaldson colleagues around the globe for their dedication and hard work.
Underpinning all of our future growth initiatives is donaldson's commitment to our people customers and communities through our purpose of advancing filtration for a cleaner world.
With this outstanding team in place, the future is bright and I'm excited about what lies ahead for our company.
I spoke earlier about some of the game-changing opportunities we are pursuing in our life sciences segment.
To that end coinciding with our investors day in April we published our 2022 sustainability report in which we outlined 2030 ESG ambitions.
We are also investing in pursuing growth in our mobile solutions and industrial solution segments.
For example, in mobile, we are making progress on building our portfolio of alternative power solutions, and in industrial, we are pushing ahead with our goal of increasing our industrial services business by leveraging our connected solutions offerings.
In summary by physical 2030.
We are targeting an absolute reduction of scope, one and two greenhouse gas emissions by 42% from fiscal 2021 baseline.
We expect to reach 35% in terms of women and global leadership positions starting from a January 2023 baseline.
Underpinning all of our future growth initiatives is Donaldson's commitment to our people, customers, and communities through our purpose of advancing filtration for a cleaner world. To that end, coinciding with our investors day in April , we published our 2022 Sustainability Report.
And we plan to increase charitable giving through the balancing foundation by 25% every four years, giving cumulatively at least $13 $5 million starting from fiscal year 2022.
which we outlined 2030 ESG ambitions.
In closing, we look forward to reporting on the progress we are making towards all of our key strategic initiatives and longer term financial goals in the future.
In summary, by fiscal 2030,
We are targeting an absolute reduction of scope 1 and 2 greenhouse gas emissions by 42% from fiscal 2021 baseline. We expect to reach 35% in terms of women and global leadership positions starting from a January 2023 baseline.
Now I will turn the call back to the operator to open the line for questions.
As a reminder, if you would like to ask a question Press Star then the number one on your telephone keypad.
Your first question today comes from the line of Nathan Jones with Stifel. Your line is open.
And we plan to increase charitable giving through the Donaldson Foundation by 25% every four years, giving cumulatively at least $13.5 million starting from fiscal year 2022.
Good morning, everyone.
Nathan.
Maybe we could just start with a bit more color on gross margins.
Obviously.
You guys talked about <unk> being <unk> hi.
In closing, we look forward to reporting on the progress we are making towards all of our key strategic initiatives and longer term financial goals in the future.
Gross margin is a bit lower than maybe I would have expected here with cross catching up to cost.
Maybe you could talk about.
Now I'll turn the call back to the operator to open the line for questions. As a reminder, if you would like to ask a question, press star and the number one on your telephone keypad. This is Allison observed with graphic Evie Q and a LA region today.
The inputs there I mean I assume disk drives is higher gross margin. So it's probably a headwind there.
Just where we could where you think once we see all the normalization of.
Your first question today comes from the line of Nathan Jones with Stiefel. Your line is open.
As price cost headwind kind of disk drives maybe what you're thinking about for gross margins at a normalized level.
Good morning everyone. Good morning Nathan. Maybe we could just start with a bit more colour around gross margins. Obviously you guys talked about 2Q being unseasonally high. But gross margins a bit lower than maybe I would have expected here with price catching up to close.
Yes, Nathan this is Scott so yes, we've had kind of an interesting rado gross margins in the first quarter was $33 nine second quarter to 34, five and then the third quarter came in at 33 as you remember we said at the end of the second quarter, we expected third quarter to be down and it was.
And there is continues to be a lot of things going on in our income statement.
With inflation and inventory costing and the pretty significant reduction in inventories that we took this quarter along with.
of price-cost and the headwinds out of discharges maybe, what you're thinking about for gross margins at a normalized level.
A decline in disk drive sales.
There's really a lot in the soup there, but we landed at 33% we expect.
Yeah, hey Nathan this is Scott. So yeah we've had kind of an interesting run of gross margins. The first quarter was 33.9, second quarter 34.5, and then the third quarter came in at 33. As you remember we said at the end of the second quarter we expected third quarter to be down, you know, and it was.
Fourth quarter is certainly be up from third quarter.
As things normalize and hopefully in our price cost situation for the whole world.
Starts to kind of slow down and balance out a bit so.
It was a little bit tougher quarter on gross margin, we expect it to come down in a dead, we expect fourth quarter to be up.
And there continues to be a lot of things going on in our income statement, you know, with inflation and inventory costing and the pretty significant reduction in inventories that we took this quarter along with a decline in disk drive sales.
So that's kind of a high level summary for you.
So we're going to get maybe between 33 and a half and 34 for the full year.
So I'll go back a few years I know you had some capacity issues back in 19, and 20, and obviously Covid has created a lot of noise. We were kind of being 34 to 35 range before that is that a reasonable expectation for what the business should be running at for gross margins.
So there's really a lot in the soup there, but we landed at 33%. We expect, you know, fourth quarter to certainly be up from third quarter, you know, as things normalize and hopefully, you know, our price cost situation for the whole world starts to kind of slow down and balance out a bit. So, you know, it was a little bit tougher quarter on gross margin. We expected it to come down and it did.
Yes, Nathan this is Todd yes. It is.
The one the one new variable that we have coming in there is obviously.
All of the investments that we're putting into the life sciences activities, which will give us a little bit of a mix pressures but.
We expect fourth quarter to be up. So that's kind of a high level summary for you.
So we're going to get maybe between 33 and a half and 34 for the full year. If I go back a few years, I know you had some capacity issues back in like 19 and 20 and obviously COVID's created a lot of noise. We're kind of in the 34 to 35 range before that. So we set a reasonable expectation for COVID-19.
We would leave still 30% to 35 is reasonable and where we expect to.
The land.
And maybe just one more on those investments in life Sciences can you talk about.
The magnitude of does the duration or does this.
This year net those are likely to continue to step up year on year as we go forward as you continue to invest in those businesses I mean, like you said <unk> been at.
Generating any revenue yet so is there an expectation that this is an investment cycle that lost a few days here.
Yes, Nathan so the way we look at this thing so far it's actually evolving as we would've expected. We believe that we're going to give you a bit more information here. When we guide full year in about 90 days, but we would expect clearly as we see through the balance of this fiscal year.
that we're putting into the life sciences activities, which will give us a little bit of a mix of pressures, but we would believe still 34 to 35 is reasonable and where we expect to land.
And maybe just one more on those investments in life sciences. Can you talk about the magnitude of those, the duration of those? I mean, I would assume that those are likely to continue to step up year on year as we go forward, as you continue to invest in those businesses. I mean, like you said, we're not even at them generating any revenue yet. So is there an expectation that this is an investment?
For it to be all in an investment column for the for the balance sorry said physical for the balance of this calendar year. It will be all in the investment column, but we'll come out with more detail here.
When we are full year guidance.
Okay. Thanks for taking my questions.
Yes Nathan.
Your next question comes from the line of Brian Drab with William Blair. Your line is open.
Good morning, I was wondering if you can just start by elaborating a little bit on the timing on this issue of the timing and the processing equipment.
And.
as we see through the balance of this fiscal year for it to be all in the investment column for the balance of this calendar year, it'll be all in the investment column. But we'll come out with more detail here when we foil your guide.
When does when does it shift one was expected to ship et cetera.
Yes.
Brian This is tod so three components right Solaris is already revenue generating it's project based.
<unk> is the project type of activities that could go from quarter to quarter based upon.
Okay, thanks for taking my questions. Thanks, Nathan. Your next question comes from the line of Brian Dragg with William Blair. Your line is open.
When customers are ready to take shipments and so we're actually on plan to.
To meet what was in the full year guide.
Sure <unk> Act.
Morning, I was wondering if you could just start by elaborating a little bit on the timing, this issue of the timing of the bio processing equipment and when does. When did it ship? When was it expected to ship? Et cetera.
Activities in shipments this year.
We'll again guide next year here in about 90 days, but then when you look at the other two eissler bio and.
Pure logic, that's revenue generating ahead of us.
Yeah, Brian , this is Todd. So three components, right? Solaris is already revenue generating, it's project based. That is the project type of activities that could go from quarter to quarter based upon when customers are ready to take shipments. And so we're actually on a plan to support higher-655 salaries with our working group. Okay, the third component, roto is already. One of the forms that get
That their revenue today is zero and so that we're planting solid seeds for future growth with both of those activities in both of those businesses. So that's future revenue will give you a little bit more color here next year.
When we report next physical but certainly we would expect that to be more headwinds for the balance of this calendar year.
to meet what was in the full year guide for Solaris' activities and shipments this year. We'll again guide next year here in about 90 days. But then when you look at the other two, Isolarbio and PureLogix...
Okay, Alright, Thanks, and then.
In the disk drive business.
At the analyst meeting that you had recently.
I guess under the impression that.
Headwind in this fiscal year.
That's revenue generating ahead of us. Their revenue today is zero. We're planting solid seeds for future growth with both of those activities and both of those businesses. So that's future revenue. We'll give you a little bit more color here next year.
But.
Normalizing and maybe.
I guess I got the impression at least be stable in the next fiscal year is is that a growth business.
You think going forward or is it just is it stable and then the whole segment starts to grow when we get the.
or when we report next fiscal. But certainly we would expect that to be more headwinds for the balance of this calendar year.
The life Sciences, the newer life sciences pieces growing.
We believe that we're stabilizing now flattening if you will.
Okay, all right, thanks. In the disk drive business, at the analyst meeting that you had recently, I was...
Been a very difficult run for that business.
Almost cut in half within this fiscal year for example, we have taken the necessary cost actions.
I guess under the impression that headwind in this fiscal year, but normalizing and maybe, I don't know, I guess I got the impression at least be stable in the next fiscal year. Is that a growth business, do you think, going forward, or is it stable and then the whole segment starts to grow?
To support the current levels of that business.
We're flattening at this point in time, we think we'll start to crawl forward or get slight lift for the balance of this calendar year.
So it will turn into a slight growth business looking forward.
And then just lastly, I missed it but what did you say about food and beverage in this most recent period, how does that business to specifically yes.
Food and beverage did really strong again continues to do quite well in the portfolio.
And at this point in time were up in local currency.
Low double digits.
In the quarter and continued to expand in.
in the necessary cost actions to support the current levels of that business. We're flattening at this point in time. We think we'll start to crawl forward or get slight lift for the balance of this calendar year. So it will turn into a slight growth business looking forward. And then just lastly, I missed it, but what did you say about food and beverage in this?
Really are very happy with our performance.
Great. Thanks, a lot.
Thanks.
Your next question comes from the line of Laurence Alexander with Jefferies. Your line is open.
Good morning. This is Dan Rizzo on for Laurence. Thank you for taking my question.
Just with regards to China, just given everything that's kind of occurred in is occurring.
Have your expectations for the region been kind of I don't know.
Diminished at all.
As we look in the next two to three quarters, just given the I guess the lack.
Of a strong rebound as of yet.
Not at all actually when you look at China, and the opportunity for the company long term and it remains very strong we continue to win national based programs, which will continue to gain share within region I just want to remind everyone that we are in China to support China.
continue to expand and really are very happy with our performance.
Great, thanks a lot, Todd. Thanks. Your next question comes from the line of Lord's Alexander with Jeffries. Your line is open.
We are not a China based exporter for example.
Good morning, this is Dan Resolone for Lawrence. Thank you for taking my question. Just in regards to China, just given everything that's kind of occurred and it is occurring, have your expectations for the region been kind of, I don't know, how they diminished it all? As we look in the next two or three quarters, just given the, I guess, the lack of a strong rebound as of yet.
It's China to support China based customers largely nationally now.
<unk>.
Technologies, such as power core.
And.
The thing that the thing Thats a bit muted.
With China is just simply the economic recovery, obviously, and so we're experiencing that but even given the careful outlook on China's based economy, we continue to win programs, which gives us confidence in the long term direction of.
Not at all. Actually, when you look at China and the opportunity for the company long term, it remains very strong. We continue to win national-based programs, which we'll continue to gain share within region. I just want to remind everyone that we are in China to support China. We are not a China-based exporter, for example.
Of China.
Okay, and then one of the things you mentioned I think.
Labor costs being up.
Except understandable, but you also mentioned doing more hiring I was wondering if it's hard to find people now still given what we're reading.
Labor tightness and if you are going to be doing significantly more hiring over the next couple of quarters or years or whatever.
So within our.
Manufacturing base, if you will it's a little bit different by region I would say that within the U S. It certainly improved but not.
So we're experiencing that. But even given the careful outlook on China's base economy, we continue to win programs, which gives us confidence in the long-term direction of China.
Not great not pre COVID-19 base levels, but certainly improved.
Within Europe , It's fine Asia, it's fine.
Okay and then one of the things you mentioned I think was was labor cost being up well that's acceptable but you also mentioned doing more hiring. I was wondering if it's hard to find people now still giving what we're reading with with you know labor tightness and if you are going to be doing significantly more hiring over the next couple quarters or years or whatever. So within our manufacturing base if you will it's
Latin America is strong so really the headwinds really and the concerns if anything our U S based.
Within salary based positions little bit more.
Careful.
Everywhere actually.
People are people are just being careful to come on board, we do expect to be able to support the expansions that we have of the strategic plans that we have so.
It's a little bit different by region. I would say that within the U.S. it's certainly improved, but not great, not pre-COVID-based levels, but certainly improved. Within Europe , it's fine. Asia, it's fine. Latin America, it's strong. So really the headwinds really and the concerns of...
We have to work a little bit harder and harder to get there, but we're pretty pleased with our progress.
Okay, and then final question on the free cash flow conversion could you just remind us what the long term target as I know it was elevated because of all the fluctuations, but how should we think about as we model out over the next couple of years.
Yes.
End of unusual cash conversion as a.
As I'm sure you've seen right. So we.
We took inventory is up by $100 million.
During the call it to help fight the supply chain and make sure we were living up to our commitments to our customers and then we got into this year. We said we were going to take that 100 million out.
of the strategic plans that we have. So we have to work a little bit harder in order to get there, but we're pretty pleased with our progress.
<unk>.
As of the third quarter, our inventory has gone from $502 million down to $449 million. So we've made good progress there and youre starting to see that flow through our cash our cash conversion. This year and if you go to page 99, or the my slides in the investor deck.
Okay, then final question. On a free classical conversion, can you just remind us what the long-term target is? I know it was elevated because of all the fluctuations, but what should we think about as we model out over the next couple years?
Yeah, so we've had kind of unusual cash conversion as I'm sure you've seen, right? So we took inventories up by $100 million during COVID to help fight the supply chain and make sure we were living up to our commitments to our customers. And then we got into this year.
We said that our longer term averages about 85% cash flow conversion.
Okay. Thank you very much.
Yes, Thanks, Dan.
As a reminder, if you would like to ask a question press star and the number one on your telephone keypad.
we said we were going to take that $100 million out. As of the third quarter, our inventory has gone from $502 million down to $449 million, so we've made good progress there, and you're starting to see that flow through our cash conversion this year. And if you go to page 99 or...
Your next question comes from the line of Rob Mason with Baird. Your line is open.
Okay, great. Thanks.
Todd when you were commenting on the mobile solutions business aftermarket you talked about the OE dealer channel bringing.
Inventory down to normal levels.
Is that action is that activity destocking activity complete here in the third quarter.
My slides in the investor deck, we said that our longer term average was about 85% on cash flow conversion. Okay, thank you very much. Yeah, thanks. Thanks, Dan.
And then I'm also just.
I'm, just curious what kind of impact that had on the on the third quarter aftermarket business as well.
So what you see across the OE channel in mobile solutions aftermarket specifically to overly to OE is a step down in the third quarter.
As a reminder, if you would like to ask a question, press star then the number one on your telephone keypad. Your next question comes from the line of Rob Mason with Baird. Your line is open.
So think in terms of certainly teens level being pulled out in the quarter, whereas on the independent channel you would see that we have growth.
Great, thanks. Todd, when you were commenting on the Mobile Solutions business aftermarket, you talked about the OE dealer channel bringing inventory down to normal levels. Is that action, is that activity, de-stocking activity complete here in the third quarter? And then I'm also just curious what kind of impact that had on the third quarter aftermarket business as well.
<unk>.
At the revenue level, so call it call it low to mid single digits growth on the independent now that needs. The volume on the independent is slightly down.
Based upon pricing, so youll see a little bit of a pullback there that would be the behavior that we would've expected because they were never able to actually get their stock levels up to where we would have expected them to and the oes kind of what kind of one out. So the oes are pulling it back down we would expect that to kind of normalize here as we get through the summer.
So what you see across the OE channel in Mobile Solutions Aftermarket, specifically to OE is a step down in the third quarter. So think in terms of certainly teams level being pulled out in the quarter, whereas on the independent channel you would see that we have growth.
But the independent channel, we feel is that pull through levels pretty comfortable at this point.
That's helpful.
at the revenue level, so call it low to mid single digits growth on the independent. Now that means the volume on the independent is slightly down based upon pricing, so you'll see a little bit of a pullback there. That would be the behavior that we would have expected because they were never able to actually get their stock.
Just.
Im doing some quick back of the math.
Back of the envelope math here, but it looks like for the.
First fit.
<unk> business in the fourth quarter.
The revenue would decelerate sequentially.
I just wanted to check that and if that's the case is that set a function of just normal seasonality or.
Where there is some catch up shipments in the third quarter, yes.
Yes so.
Actually we would we would see it just kind of being normal seasonality type of activity for us.
Very comfortable with the first fit side our production at this point.
Based upon what we're seeing in backlogs et cetera.
at this point.
That's helpful. And just, I'm doing some quick back of the math, or back of the envelope math here, but it looks like for the first bit mobile business in the fourth quarter, the revenue would decelerate sequentially. I just wanted to check that and if that's the case, is that
The first that continues to do quite well, we're happy with it and.
And that's across all.
All end markets construction AG mining for Smith.
Over the road trucks.
It was the aftermarket that kind of came in a little bit.
More on the pullback to the OE side this quarter than we would've expected.
Is that a function of just normal seasonality, or were there some catch-up shipments in the third quarter? Yeah, so actually we would see it just kind of be a normal seasonality type of activity for us. Very comfortable with the first bit side of production at this point.
Sure and then just finally, a larger question around price you did take up your price expectations for the full year I'm just curious.
What were the main drivers behind that increase and then how do you think about pricing going forward from here to the extent that you noted raw material prices are kind of normalized but.
based upon what we're seeing in backlogs, et cetera. First it continues to do quite well. We're happy with it. And that's across all end markets, construction, ag, mining, first bit on the over the road trucks. It was the aftermarket that kind of came in a little bit.
But to the extent labor is still a pressure your ability to.
To offset the labor impact if needed.
I'll, let Scott start here with the first part of the question then I'll jump in for the additional color on the second half, Yes, Hi, Rob. This is Scott. So we did take our guide for price up 2%.
more on the pullback to the OE side this quarter than we would have expected. Sure, and then just finally a larger question around price. You did take up your price expectations for the full year. I'm just curious what were the main drivers behind that increase and then how do you think about pricing going forward from here to the extent that you noted?
Part of that is just a refinement of our calculation and our estimate for the year part of that is is related to the labor comments Todd previously made in and we got to continue to make sure we manage our price and cost and we're going to continue to adjust prices.
For the next 10 years.
If our costs are going up we have to be.
raw material prices are kind of normalized, but to the extent labor is still a pressure, you know, your ability to to offset the labor impact if needed.
Be compensated for that in the market and we're going to pass those prices on so a 2% increase is within.
Within a normal range for us I would say, but we we continue to push price where appropriate and we're going to continue to drive those increases into the market to just make sure we have a reasonable commercial relationship with our customers and that we treat our suppliers.
Maybe I'll let Scott start here with the first part of the question, then I'll jump in for additional color on the second half. Yeah, hi Rob, this is Scott. So we did take our guide for price up 2%. I mean part of that is just a refinement of our calculation and our estimate for the year. Part of that is related to the labor comments Todd previously made.
Early.
So I would say that we've returned to a more normal behaving price.
We got to continue to make sure we manage our our price and cost and we're going to continue to adjust prices you know for the next 10 years as you know if our costs are going up we have to be compensated for that in the market we're going to pass those prices on so you know a 2% increase is within the
Activity across the company in all regions of the World. However, I also want to say that we remain very committed to.
<unk>.
Cost recovery and so we keep an eye on it which means we would taken out of the cycle action should that be necessary.
Very good I'll turn it back thank you.
within a normal range for us, I would say, but we continue to push price where appropriate, and we're going to continue to drive those increases into the market to just make sure we have a reasonable commercial relationship with our customers, and that we treat our suppliers properly. Yeah, so I would say that we've returned to a more normal behaving price.
This concludes our Q&A session for today I now turn the call back to Tod Carpenter for closing remarks.
That concludes the call today, thanks to everyone, who participated and I look forward.
activity across the company in all regions of the world. However, I also want to say that we remain very committed to price cost recovery and so we keep an eye on it, which means we would take an out of cycle action should that be necessary.
Very good. I'll turn it back. Thank you. This concludes our Q&A session for today. I now will turn the call back to Todd Carpenter for closing remarks.
That concludes the call today. Thanks to everyone who participated and I look forward to reporting our fourth quarter results in late August . Have a great rest of the week. Goodbye!
This concludes today's call. You may now disconnect.