Donaldson Company Earnings Call Insights: Gross Margins Guidance and Wins

Donaldson Company (NYSE:DCI) recently reported its third quarter earnings and discussed the following topics in its earnings conference call.

Gross Margins Guidance

Kevin Maczka – BB&T Capital Markets: I guess my first question is on margins. You mentioned the quarterly records of very strong in the quarter. But it looks like the guidance as we go into Q4 suggests a sequential decline of maybe 100 basis points or more and it’s possible also by your guidance that revenues could be higher. So, can you just talk about that especially in the context of the favorable Gas Turbine mix?

James F. Shaw – VP and CFO: Yeah, Kevin, this is Jim. In terms of the guidance, as we look forward, we are anticipating similar gross margins to what saw in this quarter. Revenues are up slightly, but from a practical standpoint, about the same. We did benefit a little bit this quarter from some adjustments to compensation type reserve as we look forward in terms of what the year is going to finish and that’s the way they are supposed to work. And we had a couple of other smaller one-times. So, we do anticipate in the guidance a little bit higher operating expense and part of that’s timing of some of our investments that Bill talked about whether it would be the strategic systems project and other investments. So, there is a little bit more OpEx forecast in Q4 versus Q3, but still it would project out to be a very significant finish on an operating margin.

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Richard Sheffer – IR: Yeah, Kevin, this is Rich. I think as you look at your model, we are expecting the fourth quarter operating margin currently to be pretty close to last year’s level which was 15.1%.

Kevin Maczka – BB&T Capital Markets: Are there further restructuring gains to be had here as we look out into Q4, because again, it seems like the mix maybe slightly positive. I understand what you are saying about some of the OpEx comp adjustments and things like that. But are there also – there’s always continuous improvement, but are there also further restructuring benefits coming?

William M. Cook – Chairman, President and CEO: Kevin, this is Bill. We don’t comment prospectively specifically on restructuring, but we’re always looking at opportunities as the businesses continue to shift, and we’re always focused on Continuous Improvement as you mentioned. So we’re not forecasting significant restructuring in the fourth quarter, but we continue to look at it as we have over the last couple of years for opportunities.

Kevin Maczka – BB&T Capital Markets: And Bill, can you just clarify your comment on the Gas Turbine; it looks like some of the industry orders from some of your big customer have slowed there? And you made the comment about a $180 million, was that an outlook for your fiscal ’14 or the next four quarters?

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William M. Cook – Chairman, President and CEO: Kevin, Bill. Yes, it’s roughly for fiscal ’14. It’s probably sort of rough – roughly both – the next four quarters and fiscal ’14 around that $180 million run rate. And again, that’s still a pretty good year for us in terms of Gas Turbine, but we just don’t have a reoccurrence of – we had a large number of these large unusual projects in fiscal ’13 which we’re very grateful for but we don’t see any of those in fiscal ’14. We see that there might be some out beyond that but none of them shipping in fiscal ’14.

Kevin Maczka – BB&T Capital Markets: And I think just finally on that point, you had thought at one point, we were fairly early in a multiyear up-cycle in Gas Turbine. Has that overriding view changed at all and this is a temporary pause, or how would you characterize that?

William M. Cook – Chairman, President and CEO: Kevin, Bill again. I’d probably put it in that temporary pause that you mentioned. I mean, our Gas Turbine business never really sort of grows consistently year-over-year; it’s sort of in fits and starts, as I’ve looked at it over the last 20 something years. I think what’s probably moderated it over the last maybe six months is just the back-to-back global economic weakness and which has sort of then tamped down the demand for more electricity power generation. So, I think that’s what’s part of that the impact, again, in the short-term. But longer-term, we still think, in this country with how radically the supply side of the equation has changed with natural gas and oil, but natural gas specifically; and that it remains the cleanest fossil fuel, that we think there’s a lot of things that over the next three to five years bodes very well for that industry and our business.

 

Wins

Laurence Alexander – Jeffries: On the new product or the new proprietary platform wins that you’ve mentioned, I think you had said it was about a $100 million, is that sort of spread out over three or four years or how should we think about the cadence of that?

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William M. Cook – Chairman, President and CEO: Yeah, over the next three to four years, the typical – we win the programs usually a couple of years before they actually go into productions, when our customers’ engineering teams are designing their platforms or their vehicles and that’s when we get (designed in and win) the platform. So we win them, but the launch will be out a couple of years.

Laurence Alexander – Jeffries: You mentioned that you quantified how much of a tailwind, the productivity efforts were, how much of a headwind to gross margins was the carryover or the drag from investing in the emerging markets?

James F. Shaw – VP and CFO: In terms of – could you maybe clarify that? In terms of the – we always have an ongoing investment in the emerging markets. So are you talking about the year-over-year margin comparison?

Laurence Alexander – Jeffries: Exactly. I guess what I’m trying to get at in the gross margins in particular, you’ve been or maybe on the EBIT margin level, it might be more useful, you’ve maintained the level of investment in the emerging markets despite the weaker environment. So, theirs is going to be a drag associated with that. I was just wondering if you could quantify – if you have any rough sense for how much that could have been.

William M. Cook – Chairman, President and CEO: We typically don’t break that out because that’s something, I think as Jim was suggesting, Laurence, that we’re doing on an ongoing basis. So, I guess, we could stop it to try and save money in a weaker environment, but we’re committed to the long-term – to pursue the long-term growth opportunities. So, we’re continuing to invest in that. I mean, we have some other unusual operating expenses like the increasing pension expense or the Strategic Business Systems project that we’re working. And I think we’ve quantified those in the past and those are, again, sort of in the same category. They’re critical for the achievement of our long-term goals, so we’re continuing to do those even though they do provide some headwind on our margins and operating expenses.

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James F. Shaw – VP and CFO: And Alexander, we don’t have any, like, incremental investments in emerging markets this quarter that I would call out like at times where we open a new distribution center or capacity. So, the things that are ongoing are more expanding sales force and those types of things that we consider more normal because they are also generating returns.

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