Donaldson Company, Inc. (DCI) Q3 2016 Earnings Report, Transcript and Summary

Good morning. My name is Blair and I will be your conference operator today. At this time, I would like to welcome everyone to the Donaldson’s Third Quarter Fiscal Year 2016 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Brad Pogalz, Director of Investor Relations, please go ahead.

Good morning, everyone. Welcome to Donaldson’s third quarter 2016 earnings conference call. I am joined today by Tod Carpenter, Donaldson’s President and Chief Executive Officer; and Scott Robinson, Chief Financial Officer. This morning, Tod and Scott will discuss third quarter performance, review our outlook and provide an update on some of our strategic initiatives. Before turning the call to Tod, I want to remind all of you that we provide supplemental schedules on our Investor Relations website, which show the year-over-year sales change with and without the impact from currency translation and the impact of certain adjusting items on gross profit and operating expense. I also want to remind everyone that any forward-looking statements made during this call are subject to risks and uncertainties, the most important of which are described in our press release and SEC filings. Now, I’ll turn the call over to Tod Carpenter. Tod?

Thanks, Brad. Good morning, everyone. The net effect from several moving pieces last quarter resulted in top and bottom-line performance that matched our forecast. Scott and I will elaborate on the largest of these drivers and later in call, I will provide an update on some of our strategic and operational initiatives, including a little more context on the most recent round of restructuring. Turning now to the topline, total sales for the quarter were $571 million, reflecting a strong sequential increase of 10% from last quarter and a decline of roughly 1% from last year. In local currency, our third quarter sales were slightly above last year. At a high level, our Engine segment ended a little short of forecast, while Industrial was a little ahead. In aggregate, our business is showing more signs of stability than we have seen in well over a year. And while we are not ready to call bottom, given this protracted period of volatility, we were pleased with our overall performance in the quarter. As I walk through segment performance, I want to focus first on those areas that showed some variability with our forecast, in order to highlight business trends that are not as obvious in the reported year-over-year changes. Currency translation was one of the moving pieces that affected both segments in the quarter. After unexpectedly high pressure from FX in second quarter, the Q3 negative impact of $5.5 million was roughly $5 million less than expected. Digging into the segments, we saw changing market conditions in a few of our businesses. Note that I will be primarily referencing local currency results when speaking to the year-over-year percent change. Starting with Engine, the 2% decline was primarily driven by our first-fit businesses. While sales in both on and off-road each declined about 20% from last year, their individual performance versus forecast was quite different. In on-road, we saw a steeper than expected decline as growth outside the U.S. and continued strength of medium duty production was not enough to offset the slowdown of class A truck production. In the U.S., on-road sales were down more than 35% whereas sales through the first half of the year were up nearly 5%, reflecting the shift in this highly cyclical business. As we have said all year, the question has been when and to what extent pressure from declining U.S. heavy duty truck production would affect this fiscal year versus the next. External data suggests the recent step down in our results is likely to continue as we move through the balance of the fiscal year. Specifically when we map monthly third party data to our fiscal calendar, year-over-year production rates of class A trucks experienced a sharper decline in our third quarter than prior quarters, and external data is now forecasting a further decline during our fourth quarter. On the other side, sales favorability versus our forecast in off-road partially offset this pressure. We have not yet seen a meaningful change in end-market conditions but sequential deterioration has moderated over the past few quarters. Overall, the equilibrium between our forecast and customer demand is encouraging, given the volatility in this business over the past several years. Within our industrial segment, stronger than expected sales of GTS replacement filters were largely offset by weakness in disk drives, which represent about half of their special application sales. Our disk drive business is in a well-documented secular decline as solid state memory replaces traditional hard disk drives but the pace of the decline accelerated in the past quarter and resulted in a shortfall versus our forecast. As I said earlier, the net effect from these puts and takes was that we ended the quarter a little short of forecast in Engine and a little ahead in Industrial. Beyond these business drivers, I want to highlight sales performance of replacement parts. Growing aftermarket is a critical part of our strategy, and we were pleased to have picked up some nice momentum last quarter. On average, sales of replacement parts account for about 55% of total revenue with Engine at about 70% and Industrial around 35%. In third quarter, more than 60% of our revenue came from replacement parts, reflecting an above average mix in both segments and in aggregate increase over last year in the high-single-digit range. In Engine aftermarket, we saw strong sequential performance and an increase of 5.6% from last year, reflecting year-over-year improvement in both distribution channels. Sales through the OE channel, which represent roughly 40% of aftermarket, increased in the high-single-digit range from last year. Recent performance suggests a possible end to the destocking events we have been discussing for more than a year, but erratic ordering patterns on a week-to-week basis and our customers’ ongoing working capital initiatives keep us cautious. Aftermarket sales through our independent channel also increased from last year, albeit at a more modest rate. We believe this year-over-year improvement is more a function of last year’s volatility than it is an indicator of improving market conditions. For example, sales of aftermarket products are typically weighted towards the back half of a fiscal year, but we saw a 50-50 split last year. This year, third quarter results reflected a more normal seasonality. While this performance gives us some encouragement, our customers are maintaining a very cautious stance in light of the uncertainty in the market. In our gas turbine business, aftermarket sales increased dramatically, driven in part by a softer comparison from third quarter last year. However, our proactive approach to managing the replacement cycle with current and potential customers also contributed a meaningful portion of this increase. Finally, sales of replacement parts in our industrial filtration solutions business grew about 15% from last year. Here again, the sales team is proactively managing the replacement cycle, which helps bolster results during the period where expenditures on new first-fit equipment remain somewhat stagnant. Now, I’ll turn the call over to Scott for a walk through of our other operational metrics and guidance. Scott?

Thanks, Tod. Good morning, everyone. As I look close at my first months at Donaldson, I’m very proud to have joined this team and Company. During my short time here, I have had the chance to engage with our teams here in Minnesota and throughout the world. Across the Company, our employees are focused on delivering results, while being resilient during these uncertain times. Both attributes are critical as we finish this year and move in to FY17. Turning now to our third quarter performance. A theme of moving pieces existed throughout the P&L. I’ll start by elaborating on top-line impact from currency translation. As Tod said, the impact of FX translation was about $5 million less than expected. This favorability versus our forecast was primarily driven by appreciation of the euro, but we also saw some recovery in other currencies. For example, the Brazilian real strengthened by about 10%, after a dramatic weakening, earlier this year, and the Japanese yen continued to gain versus dollar. I’ll discuss the net effect on full year guidance in a few minutes. Moving down the P&L, the recent around of restructuring resulted in the charge during the third quarter of $4.1 million with roughly $3.3 million in operating expense and the balance in gross margin. We also had restructuring charges last year of $5.2 million. For ease of comparison, I’ll exclude these charges from my discussion of operating profit. For reference, our press release schedule include a reconciliation from GAAP to non-GAAP measures. Our third quarter adjusted operating margin was about 120 basis points better than last year and more than 3 full percentage points better than the prior quarter. The sequential improvement was split fairly evenly between gross margin and expense rate as absorption on increased volume, restructuring benefits, and other cost controls allowed us to leverage a 10% sequential sales increase. Compared with last year, adjusted gross margin improved by about 20 basis points to 34.6%. The improvement was driven largely by overall business performance and mix; the lower margin GTS products offset a portion of these benefits. While we were very pleased with our expense performance in the quarter, which continues to reflect our discipline and the benefits from restructuring that was implemented over the last 12 months. Excluding restructuring charges, third quarter expenses were a little more than $118 million, which translated to a year-over-year decline of about 90 basis points. Within that amount is a charge of about $2.2 million related to the reversal of a subsidy benefit we have been recording in China. For context, we entered into a six-year agreement that began in January 2014, which provided a subsidy, based on achieving certain criteria, including a target average growth rate. Sales during the first two years of the subsidy agreement were below this target. Our third quarter performance, combined with initial projections from our planning process, suggest this calendar year will also be below the target. With this level of performance, the growth we would need to achieve, during the second half of the agreement, appears unrealistic. Given that, we felt it was improper to reverse the accrual at this time. This charge was offset by a lower than expected tax rate of 24%, which included a benefit of 4.2% percentage points from the favorable settlement of tax audits. Altogether, we delivered GAAP EPS of $0.41 in the quarter, which includes an impact of $0.02 from restructuring charges. Excluding that, adjusted EPS was in line with our expectations of $0.43. Turning to our balance sheet and cash flow metrics. I am pleased with the progress we are making to appropriately manage the balance sheet. Earlier this year, each region was assigned an inventory and receivables target that was based on an improvement versus first quarter. Compared with this benchmark, global inventory is down almost 6% as we continue gaining momentum across the world. At a reporting level, our AR position is essentially flat to Q1 but each receivables and the number of days sales outstanding are down as we improve collections. The increasing strength of our balance sheet resulted in a cash conversion of almost 140% last quarter, well ahead of our recent run rate and also pulling a year-to-date rate over 100%. Turning to the full year guidance. Our expectation for top and bottom-line performance is consistent with the mid-points of our prior guidance, but there are few adjustments I would like to call out. Starting with the top line, we expect to deliver about $2.225 billion of revenue, which is roughly 6% below fiscal 2015. As of today, we expect a negative impact from currency translation of about $80 million, but keep in mind that FX rates have been very volatile. Recall that we began the year estimating an impact of $85 million and then increased that by $5 million to $10 million last quarter, only to reduce it again today. The expected tailwind from translation is being offset by net pressure within the business. Excluding currency, sales in both segments are forecast to decline about 3% from last year, which is at the lower bound of the prior guidance range. In Engine, on-road declines are expected to continue through at least the balance of the fiscal year. The recent trends in off-road are encouraging as is the return to a more normal seasonality in the aftermarket, but these are not enough to offset lower production of class A trucks. The small change to our aerospace and defense guidance reflects a slowdown in helicopter production due to the repurposing of military equipment for commercial use. With this slowdown, we no longer expect growing sales of commercial aerospace products. Within the Industrial segment, the guidance changes entirely due to the accelerated decline in disk drives which was partially offset by GTS. As Todd mentioned, third quarter sales of GTS replacement parts were very strong, and we expect that to continue. Consequently, full year GTS sales are now projected to be down 20% versus decline of 20% to 25% before. Our full year adjusted operating margin is forecasted between 12.9% and 13.3%. The midpoint of this range is down about 20 basis points from a midpoint of our prior guidance. We do expect some benefit from recent restructuring, but the China subsidy reversal and a mix impact from our changes to our sales forecast resulted in net operating margin decline. In terms of other metrics, we increased our forecast for the full year interest to about $21 million, reflecting a slower level of debt pay down than originally anticipated. Variability from this quarter’s tax settlements more than offset this impact, and we now expect the full year effective tax rate between 25% and 26%. These factors, combined with the repurchasing up to 2% of the outstanding shares, result in an adjusted EPS of $1.53 to a $1.59. The midpoint of this range is consistent with prior guidance, but we now seek GAAP EPS being about $0.09 lower than adjusted when you factor in year-to-date restructuring charges and investigation related costs. Outside the P&L, we increased our estimates of free cash flow and cash conversion due in part to our efforts to reduce working capital. Including full year capital expenditures of about $80 million, we estimate free cash flow will be $200 million to $230 million, which translates to cash conversion between 100% and 115%. Given all the moving pieces across the business, we thought it may be helpful to also provide some perspective on fiscal 2017. Keep in mind that we are still working through the planning process. So, my comments and my answers to any questions will stay at a very high level. Of course, we will provide more detailed guidance when we release fourth quarter results in a few months. In terms of market conditions, there are no early inductions within our business. Third party data or customer forecast that suggests a meaningful improvement is on the horizon. So, we are going to plan cautiously. We’d be prepared to meet additional sales demand, should there be an opportunity, but we feel that a cautious approach makes more sense in this environment. In terms of profit metrics, there are few items worth highlighting: First, in FY17, we expect to realize about $12 million of incremental restructuring benefits from the actions taken in fiscal ‘16. Second, variable compensation expense will increase as we reset the planned targets for the new fiscal year. We are yet to finalize the numbers but year-over-year headwind could be in the $17 million to $20 million range. Third, we expect completing of our ERP implementation this summer to benefit our expense run rate by a few million dollars. However, appreciation related to system and investments in optimization will likely offset the majority of any year-over-year benefit. Finally, we expect the tax rate to be at a more normalized level. This year’s discrete items and the favorable mix of earnings between tax jurisdictions, contributed to a rate below what we would expect over the long-term. Beyond the specific metrics, the priorities of expense control, capital deployment, and maintaining very strong balance sheet will remain unchanged. I am proud of the momentum we have gained in reducing our working capital needs and that will continue to be a focus of mine in the coming year. Now, I will turn the call back to Tod; now, we’ll take your questions.

Yes, time for closing remarks. Thanks Scott. So, within our business, we are seeing pockets of strength and stability but continued uncertainty in certain markets make us hesitant to call bottom. Given the uncertainty, we took action during the quarter to further reduce our cost base through restructuring. Across the globe, Donaldson leaders identified opportunities to cut about $8 million of expenses out of their respective businesses. We believe these actions better position us for the future by protecting operating margin while maintaining the structure to support growth. In terms of driving growth, developing; launching; and expanding our innovative product offerings remains at the core of our long-term strategy. PowerCore is the most mature example of our strategy in action. Year-to-date sales of PowerCore in the Engine segment were just over $120 million, which represents about 20% of total sales of Engine air products. Despite being subject to the end market volatility, sales of PowerCore are up almost 3% for the year as we continued to benefit from increasing replacement on the first-fit and higher retention rates in the aftermarket. We expect similar dynamics will play out with our liquid offering as challenges related to high fuel injector pressures and bio-diesel fuels demand more advanced filtration. Our Synteq XP Media addresses these challenges, and it has contributed to our ability to win first-fit programs. Over the past 12 months, we have won more than 50 new engine liquid programs that will generate hundreds of millions of dollars in revenue over their respective 10-year life. Beyond these wins, we see a large pipeline to continue gaining share of the first-fit market, which will contribute to aftermarket growth in the replacement cycle. I also want to touch on a couple of examples within the Industrial segment where our technology is contributing to growth. In our dust collection business, Downflo Evolution or DFE delivers similar customer advantages as PowerCore. The technology enables comparable performance with a smaller footprint; and the innovative design will lead to increased aftermarket retention. We launched DFE in the U.S. about 18 months ago and our year-to-date sales are triple what they were at this time last year. To build on the success in the U.S., we made DFE a global product. We began selling the product in Asia Pacific at the beginning of this year, and third quarter sales in that region were more than double the sales during the first half of the year. We have also generated sales in Latin America, as we continue to expand the availability. Although the product is still early in its lifecycle, the positive response to the first-fit offering makes us optimistic about our aftermarket opportunities, once we enter the replacement cycle. Another area where we are leveraging our technology is within our Integrated Venting Solutions business or IVS. Although IVS is a small portion of our special applications business today, it has been growing very nicely. So far this year, we have generated growth in mid-teens compared with 2015, making IVS one of our strongest year-over-year performers. As we look to offset the impact from the declining disk drive market, IVS opens new markets for us such as automotive, consumer electronics, and medical devices. For example, our automotive vents can be used to protect the electronics, powertrains and lighting systems on any vehicle including passenger cars. We are excited about the prospects with IVS. So, we are continuing to look for new ways to apply this technology. Across our Company, we are controlling those things under our control. Given the uncertainty in the market, we are taking actions to improve operational efficiency while at the same time, pursuing opportunities to further leverage our technology. I am confident that our actions position us well for future growth. With that, I’ll turn the call back over to Blair to open the line for questions. Blair?

[Operator Instructions] The first question comes from the line of Laurence Alexander from Jefferies. Your line is open.

Good morning. I guess couple of questions. First, can you help give us a sense of how you think your trends this year are doing compared to your end-markets, that is, to what degree are the results that we’re seeing benefiting from market share gains? Secondly, the comment about the normalized taxes for next year; is that -- do you think 200 to 300 basis points year-over-year increases too much or is that roughly the range that you’re thinking of? And then lastly, if you can just speak a little bit to how you think about operating leverage to a volume recovery, if it does start to show up in the back half of next year?

Laurence, I’ll start; this is Tod. With regards to market share gains, we believe that particularly in our aftermarket organization, we have been winning market share and therefore, we are outperforming the end markets. And we see our strategic initiatives there such as strengthening our distribution channel by adding more distribution partners globally, by broadening the base of our product portfolio, and offering that more globally as working throughout, both the Engine and the Industrial portions of our Company. So, we believe that we are outperforming the overall end markets, both on Industrial and Engine, particularly in the replacement cycles. When we win the OE side of business, of course that takes some time to come through, while those programs are launched. And that could be as much as much two to three years before we see any of that revenue. So, while we continue to win and we’re very pleased with our win rate on the first-fit cycle; that really has not shown overall within our business. Maybe, I’ll turn the tax comment question over to Scott.

Sure. So, we had unusually lower tax rate this quarter due to the settlement of some tax audits. And so, we would not expect that sort of tax rate to continue in the future. So, I think you said two to three basis points increase, and we would consider that to be a reasonable proxy for the future.

And then, as far as operating leverage. As we look forward within our model, typically, we look within an operating margin to get somewhere in the neighborhood of 10 to 30 basis points of operating leverage, as we see our Company grow. Now, when -- to what degree that normalcy will return, will clearly depend upon the -- on the end markets. But that’s the way that we view it to be able to leverage in the out margin.

Laurence, this is Brad, one thing I’d add to that is just doing the short hand for decremental margins year-to-date, clearly, the restructuring benefits are coming in and obviously we’re able to leverage some of the sales. So, I think to the extent that sales normalize, there is opportunity on gross margin, as we see volume from that or even just a more stable environment. The volatility last year was very difficult to manage, simply from a cost of production standpoint. So, obviously, if we get to a more stable level at any level, that would help us too.

Your next question comes from the line of Charlie Brady from SunTrust Robinson Humphrey. Your line is open.

Can you just talk for a minute about the operating margin kind of outlook? And I guess first, given that you’ve brought up 2017, and I know you’ve given guidance here. But would you expect further margin improvement in ‘17 over ‘16, given where you see the markets today?

So, we just are in our preliminary planning process. So, we’re not prepared to give FY17 guidance yet. But, we will focus on that during our planning session, and we will be back to you with fourth quarter guidance projected margins.

All right. Can you talk a little bit about pricing then and the impact that that’s having one way or the other on the margins? And I guess, as I look to the aftermarket mix in this quarter, which was a bit stronger than we had modeled, and your guidance for margins looking into Q4 for the remainder of the year, I guess, I would think that was a more mix shift towards better aftermarket that the margins would be moving the other direction rather than coming in from where you thought that they were going to be a quarter ago?

Charlie, this is Brad, I can take part of that. You’re right and that we get some help from aftermarket. But, disk drives have an above average margin. And we haven’t specifically disclosed what margins are at any sub-segment level, so we won’t go into those details. But, disk drives are above average. But also just keeping our GTS guidance with aftermarket growing nicely that’s part of what we increased, but we still had a big fourth quarter plan for GTS as a function of projects, and that’s a more below average margin. So, there is sort of net mix effect from those things as well.

So Charlie, then, this is Tod, I’ll take the pricing action. Clearly, what we’ve done globally is where we had a particular country that was a net importer. For example, we took pricing actions to help offset some of those FX pressures where the end markets would allow us. But that’s just normal courses of business for us. And each region stands on its own to be able to compete within that region. So, from our perspective, we do not have pricing leverage across the comprehensive Donaldson model. We do have opportunity within aftermarket and we take it when we can. But then of course we have the offsetting pressure of the OE first-fit where we have price downs on an overall contractual basis across all of our OEM markets. So, net-net, it’s usually a zero-sum game on pricing, overall as you look at our Company.

Okay. Just one more and I’ll get back in the queue here. On the aerospace defense, you called out commercial aerospace, you called out helicopters; is that the only area of the kind of near term softness or new softness you’ve seen or is in other areas of commercial aerospace as well?

Charlie, it’s helicopters. So, what’s happening is some of the Blackhawk helicopters are being released into more of the commercial space, if you will. And that’s driving down demand for new helicopters, if you will. And so, while we see that military conversion into the commercial side, we’re going to see overall offsetting softness. And that’s why we call it out.

The next question comes from the line of Eli Lustgarten from Longbow Securities. Your line is open.

Just couple of questions on the guidance, the gas turbine was up I guess surprisingly more in a quarter than I had expected, you said because the aftermarket filters. The implication of your guidance is that fourth quarter gas turbine sales will be, unless I have made a mistake in mathematics, which is possible right now, will be somewhat lower than the third quarter and well below last year, I mean even though you talk about some step up in shipments?

Yes. I mean it’s right in line. So, the aftermarket is part of it and obviously we still have some project pressure that we’re working through. I think as we are thinking about - and my comment on mix, specifically, GTS in the second half of the year will be a little under double what it was in the first half.

Yes. I guess…

Your math…

I am sorry.

We had a good quarter.

Yes. But, both gas turbine and special applications fourth quarter number should be similar to third quarter numbers is that a fair statement?

Yes, it’s in line. Yes.

Yes, and you’re still expecting the step up in IFS, the normal seasonal step up in shipments to take place, even though it might trail last year’s quarter slightly?

We have a forecasted step up, yes.

And when you look at the Engine business, we had a big decline in transportation, probably very similar to fourth quarter, but when just look at fourth quarter in off the road, we now anniversary the big declines that started last year. So, is it fair to say that we should see relatively similar numbers in again in off the road to the third quarter and actually to last year because we’re now anniversarying the step down and we should be relatively flattish or closer to it?

Eli, I’ll start. So, yes, but the concern that we have is really the potential for an acute happening primarily our worry [ph] in the ag sector. The ag sector in the service model is a little bit uneven, more uneven than it has been showing over the last six months. And so, while generally I would agree with your statement, I think we also have concern over how that end market is going to behave in Q4 and beyond.

And is that going to be biggest risk to the [indiscernible] between being in this middle to upper part of your guidance to the lower in the guidance turning out to be ag at this point; is that probably the full guidance, make delivery of off road -- on road falling?

Just generally, I would also say though that globally construction is mixed, right? So, if you just take a look at it, on-road is clearly a U.S. story falling pretty hard; off-road, it’s ag and the uncertainties across the service channel and ag; construction is a bit mix; mining is kind of bouncing along at very, very low levels. That’s just kind of generally how we see it.

Your next question comes from the line of Brian Drab from William Blair & Company. Your line is open.

I am going to try and ask about 2017 as well. I just want to make sure I heard you correctly. So, in terms of the market conditions, you said you are not expecting improvement. Is that you said no improvement is going to be embedded in your forecast?

No dramatic end market changes is what we’ve said, correct.

Okay. And we just had a quarter here where the net result was about flat on the top line. Is it reasonable to infer that no improvement would mean, you are feeling like may be we’ve leveled off here in aggregate and your business is about flat or no improvement mean continued declines in some of these end markets?

So Brian, I think we are going to be smarter in about three months when we actually try to help you through that guidance. And, I think it’s appropriate for us to work through that process and finalize our planning before commenting.

And then I just want to make sure -- there are some numbers that are with respect to OpEx, it seems like some of those was headwind, $12 million incremental savings and then the variable comp was up 17 to 20 and the ERP was a wash. Did I hear that correctly?

That is correct.

Okay.

As we work through the planning process, we will work to offset that but those are some numbers that we felt important to note right now.

Okay. I am just a little curious regarding the variable comp in a year when you’ve had to make some tough decisions across the business in terms of personnel, and net income is going to be down high single-digits probably this year. Can you just comment a little bit further on what drives -- what seems like a pretty significant increase in variable comp?

It’s really more of a function of this year. So, as we’ve had to take our numbers down throughout the year, that’s resulted in us falling behind plan and therefore the bonus amounts have been reduced. And we’ll restore those in the plan to 100% level next year, as we’ve planned for FY17.

Brian, this is Brad; I’ll jump in. Recall that at the beginning of this fiscal year, we talked about a $20 million headwind for fiscal ‘16 for exactly the same effect. So, in any given year, it’s less of a headwind, assuming that things are about as expected. But, clearly in the last couple of years we’ve seen a pressure and that’s created a headwind in the subsequent fiscal year.

So, in summary, the variable comp is negligible almost this year and 17 to 20 is kind of a normal level?

It was not a headwind this year, that’s correct. It ended up not being a headwind.

And then, I just want to make sure I understand on the OpEx line, you didn’t adjust in your 13.8% op margin for the China expansion. So, I would add back $2.2 million to your op income to get maybe a more realistic kind of run rate of what op income margin is?

We did not -- the $2.2 million is included in the op expenses…

Yes. And analytically Brian to your point, the operational run rate would be 2.2 less than that.

So, it would have been more like 14.2% operating margin than 13.8%, I guess. Okay, and then lastly, can you just comment on the gas turbine market? And you’ve modified your strategy there a little bit, avoiding some of these lower margin projects. So, anything changed in the competitive landscape, or can you comment on what -- if any structural changes have taken place in that market?

Brain, nothing has changed in the end market. We still view the end market as a very good long-term market for us. We are very pleased to be to in the gas turbine business. We just felt as though with the pricing pressures across that end market that we had to be more selective and really disciplined about our projects. And that is a strategy that we’ve implemented. And we are also pursuing aftermarket, as you can see by the success that we’ve had in the third quarter with more field sales personnel as well as essentially just not making sure that we’re having good market coverage for the aftermarket sales availability; in other words knocking on everyone’s door. Those strategies have helped us in this quarter. As I said, long-term, we like the gas turbine business; nothing has changed in our long-term view.

The next question comes from the line of Brian Sponheimer from Gabelli. Your line is open.

I want to go back a little bit on Eli’s question, just around end markets, because it sounds like if ag is concerning you and global construction is weak, and mining is bouncing on the bottom, that doesn’t to me feel like, it’s consistent with you guys thinking that off-road is finding a floor. So, maybe talk to that and if am getting something wrong there?

Brian, this is Tod. No, I think what we’re saying is that the range of possible outcomes has narrowed. Certainly, we would agree and in fact in my statements it reflects that we’re not calling bottom. But, we would also say that mining for example, you talk -- you listen to our customer base, people are on a cursory basis using the word stability for the first time in roughly two years; so, mining maybe approaching that type of the behavior. But then, in aggregate in the off-road, we’re clearly not saying bottom, but we do think that it’s a more narrow range of outcomes.

Okay. And if I am thinking about on-road, clearly the first Class A market is having its own issues with production cuts and excess inventory. Give me some color please as to what you’re seeing from an aftermarket perspective on utilization in the field?

We’re not seeing any appreciably behavioral change. In fact, aftermarket is performing well; it’s really all about truck utilization, over the road miles that seems to be doing fine. And overall, our aftermarket replacement parts reflects that.

The next question comes from the line of Rob Mason from Robert W. Baird. Your line is open.

Tod, I was wondering if you could just speak to your broader geographies and how those performed in the quarter relative to the aftermarket related businesses. It looks like EMEA was the strongest geography in the quarter, in aggregate. But, just in terms of utilization rates within the bigger geographies?

Sure. So, EMEA was the strongest performer. And in fact, if you take out where we put South Africa and EMEA, if you take out South Africa, which was weak, then Europe really shines in the high-single-digits year-over-year growth. The U.S. also grew and Asia Pacific grew. So, when you look across all of our end markets with the exception of South Africa, our aftermarket business grew globally in the third quarter.

And maybe specifically targeting the IFS business, where I think you said that aftermarket business there was up 15%, if I’m correct. Just how did the first systems business do in there, in that segment and are you seeing any signs of capital spend for those systems loosening?

We haven’t seen any change in behavior from previous quarters. So, what I mean is coating activity is stable, but they’re also very slow to turn into first-fit orders. There has been no behavioral change from previous quarters.

Okay. And then maybe just last question, to circle back to the gas turbine business, in your prior comments about being little more selective on the type of projects we take on there. That business will probably come in it looks around $150 million for this year in revenue. If you were to overlay the strategy that you’re going to take going forward in terms of selectivity, is there any way to give us a sense, at least order of magnitudes of how that business would have looked this year under that new strategy?

So, under new strategy, when you take a look at this year, because the large turbine projects that we talk about have a very long project cycle, if you talk -- if you remember, we’ve rolled that strategy out only three months ago. We get as much as 9 and 12 months visibility on those large turbine projects that I talked about with that new strategy. So overall, there is not much change to this fiscal year, as a result of this strategy. What it does signal is more of a careful approach going forward, while we work through this particular market dynamic.

Right, correct. So, if we had started this strategy a year and half ago, are we talking a couple of points variants between how this year, the 150 maybe being a couple of points lower or is it more significant than that?

So, I think, at this point what we’re going to do is continuing to work through our planning relative to F17. And then, we’ll come out and we’ll give you a better look at how that lays out for the fiscal year in about three months, when we’re altogether talking again.

Your next question comes from the line of Nick Prendergast from BB&T. Your line is open.

Hi, good morning. I just had a quick question on your cost savings here, and I just want to be clear. The $8 million that you called out, that’s new on top of the previous cost actions. Is that correct?

That is correct.

And does any of that fall within this fiscal year? It looks like you bunched up the incrementals in ‘17. But is any of that fall in fiscal ‘16?

Yes, small amount, because we implemented in third quarter; so, you have a fourth quarter benefit.

Okay. And then, I guess the other question I have is on your buyback. You haven’t done any buybacks for the last few quarters. I think you’re more interested in reducing your debt. Debt looks pretty manageable at this level. Do you think buybacks start back up?

Yes, I mean, as you’d expect, we look at all uses for our cash including investing in the business M&A, dividends and buybacks. And we have a long history of share repurchase, especially to set up any dilution from the impacts of stock-based compensation. And, I’m sure in the future, we’ll continue to manage as we have in the past.

The next question comes from the line of Larry Pfeffer from Avondale Partners. Your line is open.

So, just kind of looking through kind of near-term, I promise not to ask you about 2017. But, I will ask about what you’ve seen in May. Any color you can give on the aftermarket, and just kind of what you saw on the Engine piece in May?

I apologize; we don’t talk about forward quarters. So, sorry for that Larry.

Well, within the last quarter, just looking at the individual pieces within the Engine aftermarket, I know we’ve talked a lot about OE on the call here today, but within mining, ag, trucks, construction, what’s -- relative to that 5.6 ex-currency, where would those for end markets fall within aftermarket?

Honestly, Larry, we don’t have a breakout at that level but parts can cross end market. So, when we give you the general mix, we don’t have specific trends by business by quarter. I think to Tod’s earlier points on when we were talking about on-road and utilization, I mean there are aspects there that were encouraging on the OE channel. Obviously last year, we were hitting that first part of a destocking event that carried through the back half of the last year. So that creates some relative ease in the year-over-year comp, but in terms of end market specific there was nothing really that I could point to.

And then, I appreciate the color you gave on the year-to-date trends in PowerCore but could you give us the year-over-year comp for PowerCore aftermarket in Q3?

Sure.

Brad is looking that up. And while he does that, I think we’ll move on to the next question.

All right. I have got it here, Larry. So for the year so far, PowerCore was, as Tod mentioned, the $120 million for the quarter; it was up in the low single-digit range right around 3% for Engine. I think we said that. Aftermarket was in the mid-single-digit increase and first-fit was in the mid-single-digit decline.

And your next question comes from the line of Jim Giannakouros from Oppenheimer. Your line is open.

Sticking onto last couple of question that were asked, first, I guess on restructuring; I was curious if you are still looking at options or are you pretty much kind of done, or I guess identified what you’re comfortable with? Should we be looking at potential upside in your -- in the next quarter or two on what you can do on the restructuring side specifically?

Jim, this is Tod. First, I would just really like to say that I am really very proud of the global organization for the expense control that they have shown and their resilience throughout this fiscal year. While we don’t have anything to announce today, I also want to make the point that we always look at our business within an ongoing process, if you will, to make sure that we align expenses with overriding business conditions for Donaldson Company; it’s just standard work.

Understood, okay. And then on the aftermarket, Engine aftermarket specifically, I know by end market, it was tough to kind of get granular that way. But, may be by channel, if you could speak specifically to what you’re seeing on the independent channel, understanding that that channel runs leaner; do you suspect that your current flow of product is currently matched with demand and if you have any comments at all on share shifts, whether it would be trends or opportunities? Thanks.

So, our independent channel was up overall in the quarter mid-single-digits, low to mid-single-digits and than our OE channel was up low double-digits.

High single, sorry.

High single, sorry. Overall, when you take the two components, it’s clear to us that our strategies are working, they are working in Europe; they are working in United States; they are working over in Asia where we feel that we are winning share with our strategy, and that’s indicative in this tough environment of this aftermarket performance.

Jim, this is Brad. The one thing I’d jump in onto is independent -- you’re exactly right, independent typically is going to match demand more closely than OED. So, given the more apparent relative stability in that number, I would say, it’s closer to demand just because there isn’t a lot of destocking opportunities compared with the OE channel.

I will now turn the call over to the presenters for closing remarks.

That concludes today’s call. I want to thank everyone for their time and interest in Donaldson Company. I also want to thank our employees for what they do every day to support our customers. Thank you and goodbye.

This concludes today’s conference call. You may now disconnect.