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Text: During today's call, we will also reference non-GAAP metrics.
I greatly appreciate the work they do every day to keep us moving forward.
As always, we remain focused on those things under our control.
Despite a significant shift in the economic environment during fiscal '20, there were several things that went as planned including: sales of replacement parts performed better than new equipment and first-fit products, gross margin increased from the prior year, we reduced our discretionary expenses while investing in growth businesses, and we maintained a strong financial position while returning cash to shareholders through dividends and share repurchase.
We are entering fiscal '21 with clear priorities and engaged employees.
We do not anticipate strong market conditions overall this year but our diverse business model and robust operational capabilities give me confidence that we can make progress on our strategic initiatives in any economic environment.
We will talk more about our longer term opportunities later in the call.
So I'll now turn to a brief overview of fourth quarter sales.
Total sales were $617 million in the quarter with sequential increases in June and July.
Compared with the prior year, sales were down 15%, which is consistent with the forecast we provided in early August.
Both segments experienced a similar decline.
However, there was quite a bit of variability within the results.
In the Engine segment our first-fit businesses remain under the most pressure.
Fourth quarter On-Road sales were down 44% from the prior year.
The U.S. is the largest portion of On-Road and it accounted for much of the decline as the cyclical slowdown in Class 8 truck production was magnified by the pandemic.
As a reminder, On-Road first-fit in the U.S. is only about 3% of total Donaldson sales so our aggregate exposure to that market is limited.
Sales in Off-Road were down 24% in the quarter.
More than half the decline was due to Exhaust and Emissions.
There were pre-buys in Europe last year related to an oncoming regulatory change and new programs for our Exhaust and Emissions products are not yet at meaningful volumes.
In the U.S. production on heavy duty Off-Road equipment remains depressed, particularly for the construction and mining industries.
On the other hand, Off-Road sales in China were up nearly 50% in the fourth quarter.
The Chinese government is investing to stimulate activity which is benefiting our Off-Road business.
Additionally, we continue to win new programs with local manufacturers and some of those programs were won with PowerCore.
These are new customer relationships in the country that produces more heavy duty equipment than anywhere in the world.
We are learning how to best support these local manufacturers and we know that will come with order volatility, but our team in China is motivated as we see the opportunity for significant long-term growth.
Sales trends for Engine aftermarket were predictably better than our first-fit businesses.
Fourth quarter aftermarket sales were down 11% reflecting a decline in the mid-teens for sales through our independent channel.
The headlines in our independent channel are fairly consistent with third quarter.
Sales in the U.S. fell with the collapse of the oil and gas market combined with slowing transportation activity.
In Latin America, utilization is slowing across the region as the spread of the virus is compounding the impact from geopolitical uncertainty.
And fourth quarter sales in Eastern Europe remain strong as we continue gaining share.
Sales through the OEM channel of aftermarket experienced a more modest, low-single-digit decline.
In the U.S., large customers pulled down inventory to match demand, which was partially offset by strong growth in China as we continue gaining share with local customers.
In fact, aftermarket sales in China were at a record level last quarter and we see a long runway as we expect to continue winning new programs with innovative technology.
Our portfolio of innovative products performed well in the fourth quarter.
This portfolio makes up nearly a quarter of the total aftermarket revenue and fourth quarter sales were up in the low-single digits.
For nearly two decades, we have been improving, expanding and reinventing our offering related to these razor-to-sell razor-blade products.
After all that time we still have very strong retention rates.
These products create a significant opportunity for growth and relative stability in our Engine business.
So, we will continue to invest in new technologies for a long time to come.
Sales of Aerospace and Defense were down 3% in fourth quarter driven by soft sales of products for commercial helicopters.
The decline was partially offset by a strong increase in sales for ground defense vehicles but some of the growth is timing-related as key distributors build inventory in the quarter.
I also want to update you on a change to our strategic portfolio classification.
Beginning in fiscal '21, we are recategorizing the defense business to critical core from mature.
Our mature businesses are committed to generating cash that allows for investment elsewhere while critical core businesses are geared toward driving share gains in existing markets with new technology, services and relationships.
The Defense business has won new programs with our robust engineering capabilities and we expect these wins will deliver solid returns over a long time horizon.
Turning to our Industrial segment, fourth quarter sales were down 15% driven in large part by the Dust Collection business within Industrial Filtration Solutions or IFS.
Sales of new dust collectors and replacement parts were down as customers continue to defer investment and reduce output.
The quote-to-order cycle remains elongated with large projects being put on hold while smaller must-do projects tend to move forward.
At the same time, our value proposition still resonates.
Fourth quarter sales of our Downflo Evolution dust collection systems were up in the low teens and the sales of those replacement parts grew more than 30%.
The Downflo family of products is only about 15% of total dust collection sales today, but it has grown rapidly as customers appreciate the space and energy savings it offers and we value the ability to retain the aftermarket.
We are also building the dust collection business through our e-commerce platform shop.
We turned on the ability to take guest orders earlier this year and we are encouraged by the results.
While incremental dollars are still small, we have seen a significant number of new dust collection customers.
With our robust sales and delivery model, we believe the simplicity of our e-commerce platform gives customers another reason to choose Donaldson.
Fourth quarter sales of Process Filtration were down in the low-single digits after an increase of more than 10% last year.
The decline was driven by new equipment while replacement parts were about flat with the prior year.
We continue to make progress penetrating the highly valuable food and beverage industry.
We position ourselves as an engaged partner and we market our ability to quickly fulfill orders with a product that can help improve efficiency in our customer's processes.
The pandemic gave us the opportunity to prove this value proposition to our customers in the food and beverage industry and our Process Filtration team delivered.
We remain very excited about this market, so we will continue to invest in growing the sales force and adding new tools to drive this profitable business.
Sales of Special Applications were down 10% in fourth quarter.
Disk Drive was down from the prior year after having a significant increase in third quarter while the slowdown in the automotive market resulted in lower sales of Venting Solutions.
Fourth quarter sales in Gas Turbine Systems or GTS were up 6% due primarily to strength in small turbines.
Once again the GTS team delivered another profit increase in terms of both dollars and rates.
As you know, we shifted the GTS go-to-market strategy four years ago.
We determined that the best path forward was to focus on replacement parts and small turbines while being highly selective in deciding which large turbine projects we pursue.
The GTS team has done an incredible job executing their strategy and we see it in the results.
In the past quarter we also chose to consolidate our joint venture in Saudi Arabia into our company.
Once again, we are focused on rightsizing and streamlining GTS to enhance our profitability.
Based on what the GTS team has delivered and the opportunities in front of us, we are reclassifying GTS as a mature business in our portfolio.
The GTS team has transitioned from fixing the business to driving profitability and we are on solid footing today.
The success in GTS is not an isolated incident.
Our company is filled with great people working together to deliver results and create value for all our stakeholders.
That's why I'm comfortable and confident in our future.
Before turning the call to Scott, I want to briefly touch on fiscal 2021.
We're not sure how long the pandemic will last nor are we sure about its ultimate impact on our business.
Given those uncertainties, we will remain focused on what we control, prioritizing the health and safety of our employees, fulfilling our customer commitments, pursuing market share and growth opportunities around the world, executing margin enhancement initiatives and maintaining a balanced approach to expense management, which includes making targeted investments to advance our strategic priorities.
Scott will share some more fiscal '21 details.
Like most companies, we had to quickly adjust to a new way of working over the past six months, and our employees did an excellent job at that period.
We increased our level of collaboration, we deepened our relationships with customers and suppliers, and we performed in critical businesses around the world with minimal disruption.
Overall, I'm very impressed by what our team accomplished.
As we turn to fiscal '21, we have a solid foundation.
But the markets are not yet on firm footing.
Given the wide range of possible outcomes, including the timing and shape of the inevitable recovery, we are not issuing detailed guidance at this time.
We do however want to provide some of our 2021 planning assumptions.
I'll cover those later in the call, but first I'll share some thoughts on fiscal '20 results.
Decremental margin was a notable highlight for us.
We delivered 20% in the fourth quarter and 18% for the full year.
Those results are stronger than our historic averages.
So let me walk through some of the details.
I'll start with operating expenses, which declined 10% to $125 million in the fourth quarter, that's flat sequentially, and it's our lowest fourth quarter level in four years.
Discretionary expenses were down significantly, due in part to pandemic-related travel restrictions, and we maintained our investments in strategic growth businesses like Process Filtration, Dust Collection and Connected Solutions.
We will continue to focus on balancing expense [Indecipherable] investments, and we are pleased with the performance in the fourth quarter.
We are also pleased with our gross margin performance.
Fourth quarter gross margin was up 20 basis points in the prior year, and our full year rate was up 50 basis points despite headwinds in lower sales and higher depreciation related to our capacity expansion projects.
As a side note, many of these projects are now completed.
That's why our capital expenditures in fiscal '21 are planned well below the $122 million we invested last year.
Our focus has now shifted to the optimization opportunities enabled by these investments.
We plan to lower our cost structure while maintaining or improving service levels.
While benefits from these initiatives will ramp up over time our list of optimization projects give me confidence that we can deliver strong returns with these new assets.
Lower raw material costs are helping us offset the loss of leverage, impact on gross margin.
We have seen favorability in market prices for steel, media and petroleum-based products and our procurement team is driving incremental savings as they strengthen our supplier network while improving terms.
I also want to touch on pricing, while it has been a major contributor to the year-over-year gross margin increase it hasn't been a headwind.
We have more latitude to drive pricing in many of our replacement parts businesses and teams like those in the independent channel of Engine Aftermarket have done an excellent job consistently executing our pricing strategy.
It makes a big difference especially in this economic environment.
A favorable mix of sales is also making a difference to gross margin.
In the fourth quarter and for most of the year we have realized mixed benefits as replacement parts make up a greater share of total sales.
To a certain extent these mixed benefits are by design.
We invest in technology to win first-fit programs that drive aftermarket retention.
As we move through an economic cycle, our strong base of recurring revenue creates some relative stability and provide some gross margin inflation [Phonetic].
Replacement parts now account for 64% of total sales giving us confidence in the durability of our business model.
Before moving further down the P&L, I want to quickly talk about segment profit margins.
The story is Engine is consistent with the consolidated results.
Mix benefits and lower raw material costs after the loss of leverage results in a year-over-year margin increase of 20 basis points in the fourth quarter.
Within the Industrial segment, the loss of leverage was magnified by continued investments in our strategic growth businesses.
We expect Industrial margins will bounce back helping us deliver our goal of mixing the company's margins up over time.
Moving back to the P&L, Other income was $2.7 million in the fourth quarter compared with an expense of $0.5 million in the prior year, and improved performance in our joint ventures was a benefit in fiscal '20 and the fourth quarter expense in the prior year reflects a charge related to our global cash optimization initiatives.
These initiatives, which allowed us to streamline our legal and fee structure were enabled by tax reform.
We excluded the charge of last year's calculation of adjusted earnings per share and we also excluded a non-recurring charge related to tax reform legislation.
With that in mind, it's best to compare the reported fourth quarter tax rate of 21.1% with the prior year's adjusted tax rate of 21.4%.
While the delta between rates is not significant, I'll point out that current and prior year rates were well below what we would typically expect.
The fourth quarter 2020 rate benefit from a favorable mix of earnings across jurisdictions while the 2019 adjusted rate included a non-recurring benefit related to the favorable settlement of an audit.
As we think about fiscal '21, we see our full year tax rate going up in 2020 to be more in line with our long-term estimate of 24% to 27%.
In terms of our financial position, we feel good about where we ended the year.
Our leverage ratio was 0.9 times net-debt-to-EBITDA and in the fourth quarter we paid off a term loan for $50 million and we reduced borrowings in our revolver by $110 million.
We proactively reduce from our revolver in the early days of the pandemic as a way to bolster our liquidity out of an abundance of caution.
While markets still are uncertain, we are confident in our strong position and no longer feel the need for that extra layer of security.
Receivables were down meaningfully from the prior year, which is what we expect in this environment.
Inventory was also down.
So we plan further improvements this year as we focus on leveling with demand.
Our fourth quarter and full year 2020 cash conversion rates increased meaningfully to 165% and 103% respectively and we plan to exceed 100% again this year.
Our fiscal '21 assumptions for sales are directionally consistent with recent trends.
Sales are expected to vary widely by geography and market and sales of our replacement parts and products for new markets should continue to outperform the company average.
Additionally, we expect sales during the first half of '21 will be down versus the prior year due to the timing of when the pandemic began.
We are seeing these sales trends play out in August, which we expect will be down about 10% from the prior year.
Total sales for the month will also be down from July, but that's typical seasonality.
Regional trends in August match what we saw in the fourth quarter.
Sales in the APAC region are performing the best versus the prior led by growth in China.
Europe is faring better due in part to currency while the U.S. and Latin America remain under the most pressure.
And as expected we have pockets of relative strength from some of our more stable businesses including Engine Aftermarket and Process Filtration, which are both up in Europe while new equipment remains under more pressure.
In terms of fiscal '21 gross margin, benefits from product mix and lower raw material costs would lessen as we compare against strong tailwinds in the prior year.
At the same time, we will execute our optimization projects to position ourselves for long-term increases in gross margin.
Our fiscal '21 operating expenses will also have some puts and takes.
Resetting our annual incentive compensation plan generates a headwind of about $13 million and we are planning to make further investments in our strategic growth businesses and technology development.
We plan to substantially offset these increases by controlling expenses, which will likely see some benefits from pandemic-related restrictions and comparing against a higher level spend in the first half of the prior year.
Should we see an opportunity that makes sense, we will also explore additional optimization initiatives.
Finally, we plan to repurchase at least 1% of outstanding shares in fiscal '21, which would offset any dilution from stock-based compensation.
Any repurchases beyond that level would be governed by macroeconomic conditions, our investment opportunities and our balance sheet metrics.
Should conditions improve, it is not unreasonable to assume this goal above the 1% in fiscal '21.
At a high level, our objectives for the New Year are consistent with our long-term strategic agenda.
We will pursue growth and market share opportunities in our Advance & Accelerate portfolio of businesses, drive optimization initiatives that will strengthen gross margins, control discretionary expenses while making targeted investments and protect our strong financial position to discipline capital deployment and working capital management.
These are the actions we can control and I am confident in our ability to deliver in 2021.
Before turning the call back to Tod, I want to share some news.
After five years as our Investor Relations Director, Brad is going to be moving to Belgium to take over as Finance Director of our Europe-Middle East region.
COVID makes the timing a little uncertain, but I know he's committed to facilitate a smooth transition when we find his replacement.
You have done an excellent job and congratulations on the exciting new adventure with Donaldson.
You'll clearly be missed in this role, but we all know it's a great opportunity, so we're very excited for you.
I'm confident in our ability to navigate the complexities of the current environment and I'm equally confident in our ability to create long-term value by meeting the evolving needs of our customers.
We have strong relationships with our customers and they range from some of the world's biggest brands to small business owners.
Our goal is to solve our customers' complicated filtration challenges in a way that allows them to deliver great products efficiently and I think we're doing well against that objective.
Let me share some examples of what I mean.
In the Engine segment, our Filter Minder team released a wireless monitoring system that helps fleet managers optimize their maintenance schedules for On-Road and Off-Road equipment.
Our system integrates into the existing telematics and fleet management infrastructure making it easy for our customers to adopt this valuable technology.
We're also expanding connecting solutions into the dust collection market with our IQ offering.
This service provides customers with real-time monitoring of their equipment performance helping them save energy costs and reduce unplanned downtime.
Once again, we made it easy to adopt, our IQ set up can be used on any brand of dust collector and the retrofit process is very simple.
Our e-commerce platform is another tool for helping customers operate more efficiently.
donaldson.com has a global reach and offers features like real-time availability and personalization functionality making it easy for customers to find what they need and place new or repeat orders.
As always, new technology is a critical part of our success formula and we continue to expand our technologies and solutions to drive growth.
Many of our Engine customers are looking to improve fuel economy and reduce emissions and our products can help them achieve their goals.
We have shown that consistent use of our PowerCore products can help end-users improve fuel economy and it provides value to our OEM customers as they can retain more of their parts business.
We still see many opportunities with diesel engines and we also see a growing opportunity with alternative powertrains like hybrid solutions and hydrogen fuel cells.
Hybrid platforms leverage the portfolio of air and liquid solutions we have today so we have good opportunity with that equipment.
The needs are different for fuel cells and we have a specialized air filtration system that is specifically designed to meet those needs.
In addition to our air systems, we also have venting products and specialized membranes for fuel cells.
With our technical capabilities, we are well-positioned to participate in this growing market.
We are also pursuing non-Engine markets like food and beverage.
Sales of process filtration were about $15 million in fiscal '20, that's an increase of more than 60% over the past three years.
We have continued investing in new technologies and we are building capabilities that will facilitate our future expansion into life sciences.
Our long-term success is dependent on our team, so we're committed to making our company a great place to work.
We have a strong culture and we place a high value on integrity, commitment, respect and innovation.
We also have a continuous improvement mindset, so we've recently created a diversity, equity and inclusion council that will help identify and implement practices to make us a stronger company.
We are also on a journey with our sustainability practices.
We began developing our global sustainability strategy last year.
We have engaged our stakeholders and we have identified a long list of projects while reducing greenhouse gas emission, energy consumption and wastewater.
Implementing and maintaining sustainable practices is one more way we drive toward our purpose of advancing filtration for a cleaner world.
I'm proud of what we accomplished as One Donaldson and I look forward to another successful new year.

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fiscal 2021 market conditions expected to be uneven.
expects to repurchase at least 1 percent of its outstanding shares in fiscal 2021.
sales in the first half of fiscal 2021 will likely experience year-over-year declines.
full-year sales trends are expected to vary widely by geography and market.

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