Earnings Call Transcript
DONALDSON Co INC (DCI)
Earnings Call Transcript - DCI Q3 2020
Operator, Operator
Ladies and gentlemen, thank you for standing by and welcome to Donaldson’s Fiscal 2020 Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. I would now like to hand the conference over to your first speaker today Brad Pogalz, Director of Investor Relations. Thank you. Please go ahead, sir.
Brad Pogalz, Director of Investor Relations
Thanks, Julian. Good morning, everyone. Thank you all for joining Donaldson’s third quarter 2020 earnings conference call. With me today are Tod Carpenter, Chairman, CEO, and President of Donaldson; and Scott Robinson, Chief Financial Officer. This morning, Tod and Scott will provide a summary of our third quarter performance, including an overview of how we are navigating the complexities created by the coronavirus pandemic. I want to remind everyone that we issued a business updated press release on April 28, which included some details that we will reference on this morning's call. During today’s call, we will also reference non-GAAP metrics. We included a reconciliation of GAAP to non-GAAP metrics within the schedules attached to this morning’s press release. Finally, 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, I'll now turn the call over to Tod Carpenter. Tod?
Tod Carpenter, CEO
Thanks, Brad. Good morning, everyone. I hope that all of you and your families are staying safe as we deal with these unprecedented times. One thing the pandemic has brought to light is the hard work of everyday heroes, so I want to express our profound appreciation for the frontline workers that keep the world moving forward, and that includes thousands of Donaldson employees. I'm always impressed by our employees, but I'm particularly proud of their performance during the pandemic. Every day they show up with a relentless customer-first attitude, which is more important than ever as we support critical markets like agriculture, transportation, and food and beverage. To my Donaldson colleagues around the world, thank you for everything you do. Since the outbreak began, our decision-making has been guided by three priorities: supporting the health and safety of our employees; delivering on our customer commitments and doing our part in reducing the transmission of the virus. Providing a safe work environment is always a top priority, but we intensified our efforts. We have significantly limited business travel, implemented a thorough cleaning regimen in factories and office spaces, instituted remote work policies for all that are able, and introduced COVID-related paid leave, while promoting existing employee assistance programs. Our Crisis Response Team reviews these protocols regularly, and we adjust when appropriate. Social distancing practices and enhanced cleaning schedules will be in place for the foreseeable future, and we are reopening our offices in various locations around the world. The pace of bringing our employees back to the office will be dictated by guidance from health experts, along with our own assessments of workplace readiness. We are taking a cautious approach and we will remain flexible as we execute these plans. I also want to provide an update on the status of our operations. Overall, we're in a good position and have not experienced meaningful disruption. Our success can be attributed to a handful of factors, starting with our footprint. We have a region-to-support-region production strategy, and that allows us to be nimble and flex appropriately based on local conditions. That has been incredibly valuable as the pandemic affected different parts of the world in different ways at different times. Additionally, our diverse portfolio of businesses is heavily biased towards replacement parts and essential or critical markets, giving us the opportunity to continue production during government-mandated shutdowns. These structural benefits have been brought to life by our excellent team. There has been an unprecedented level of collaboration and coordination among us, our suppliers, and our customers, and our teams are acting quickly and decisively to mitigate risks and deliver on our commitments. Of course, things are still uneven. So, I want to provide a rundown of our operational situation today. The Asia-Pacific region is in recovery mode with China furthest along. Conditions in India are still tighter than other countries, but that has been loosening and we are on a good path. Europe is in various stages of reopening, and our supply chain risk has gone down over the past month. The temporary shutdowns due to government mandates have been lifted, and we are stabilizing rapidly. The Americas are further behind on the recovery curve with varying degrees of lockdowns continuing in South America, while large customers in North America only recently began reopening their factories. The global situation has been improving in recent weeks. All our critical suppliers are online, and our production employees are at work and engaged. Based on these factors, I am confident we can continue supporting our customers around the world. I'm going to turn now to a brief overview of our third quarter sales, which were slightly better than we expected based on a strong finish in April. Total sales for the quarter were down 11.7% from the prior year, or 9.7% without the currency headwind. Engine segment sales were down 14%, reflecting a sharp decline in our first-fit businesses. While it is impossible to precisely estimate the impact of COVID-19 on our results, our first-fit businesses were clearly under pressure as many large customers stopped producing equipment during the quarter. In our on-road segment, sales were down 47%, as customer shutdowns were compounded by an already weak truck market in the U.S. and China. As a reminder, our first-fit on-road business is only about 5% of total revenue, so our aggregate exposure to the truck market is limited. In the U.S., which is the largest portion of our on-road business, third-party data indicates that our sales fared better than total Class 8 truck production. Based on our track record of program wins, we are well-positioned to have a strong performance when this market recovers. Third quarter sales of off-road products were down 25% with more than half the decline coming from Exhaust and Emissions. We are comparing against a large increase in Europe last year related to pre-buys for an upcoming regulatory change, so we expected pressure this fiscal year. As a side note, we continue to work on the transaction related to the sale of our Exhaust and Emissions business to Nelson Global Products. We will provide more details as we have them, but for now, I want to reiterate our commitment to the strong relationships we have with our employees, customers, and suppliers. Excluding Exhaust and Emissions, third quarter sales of our filtration related off-road products were down in the mid-teens. On a relative basis, products for the agriculture market performed better than the construction and mining markets. Overall, global demand for new equipment remains under pressure. Engine aftermarket performed much better than our first-fit businesses in the quarter, and results were mixed by channel and region. The total aftermarket decline of 8% was primarily due to a low-double-digit decline in sales through the independent channel. The pandemic is contributing to lower equipment utilization, and that impact was compounded in the U.S. by the collapse of the oil and gas market. Economic and geopolitical uncertainty in Latin America added to the pressure, but share gains in Eastern Europe and China were notable offsets as we build our presence in these markets. Sales through the OE channel of aftermarket were down only slightly in the quarter and up in local currency. We believe a portion of the demand was from large OE customers buying inventory ahead of need, so we expect additional volatility in future periods. Rounding out the Engine segment, sales of Aerospace and defense were about flat with last year. As expected, the commercial fixed-wing market is under pressure, but we were able to largely offset the impact with growth in filters for ground defense vehicles and helicopters. Turning to the Industrial segment, sales were down 6% in the third quarter, driven by a 12% decline in Industrial Filtration Solutions, or IFS. The technical difficulties business, which makes up 60% of IFS, was hit hard by the pandemic. Our quoting activity and replacement demand were under pressure as economic uncertainty rose and global industrial production dropped. We remain confident in our value proposition and expect that quoting will go back up as the economy reopens, but it is too soon to say how long that will take. But we are not just waiting for the recovery. Our industrial air filtration team has done an excellent job engaging our customers with things like virtual trainings, reinforcing our brand as a strategic and supportive partner. The pandemic has also given us an opportunity to demonstrate our value proposition in process filtration. Sales in Europe and the U.S., our two largest markets, were both up year-over-year and in local currency. Sales for all process filtration were up in the low single digits. We continue to expand our share in the food and beverage market, and this business remains a strong contributor to our future growth and profit margin expansion. Third quarter sales in Gas Turbine Systems, or GTS, were up 6%, driven by strong sales for retrofit projects. Like the large turbine projects, retrofit sales can be lumpy. We had a solid performance last quarter, and we remain very proud of the improved profitability in GTS. Special application sales were up 5% in the third quarter, driven by strong growth in disk drive venting solutions. Our disk drive business continues to benefit from share gains and increased expansion of near line storage for the cloud, and growth in venting is related to our technical difficulties. Given the state of the auto industry, the venting performance was particularly impressive. We're leveraging our technology and pressing into a new market to meet an expanding need. There are powerful examples across the company of how innovation is driving results, and the pandemic has not changed our long-term priorities. I'll talk more about that later. Before turning the call to Scott, I want to provide a few comments on trends in May. Total sales for the month are expected to be down about 24% from last year. Many of our large OE customers reopened facilities in the month, but we did not see much of a rebound, which may relate to the inventory building that occurred during our third quarter. On a regional basis, sales trends are consistent with what we saw in the third quarter. Asia-Pacific is performing the best, while sales in the Americas are the weakest. Sales in China were up in the month, which is the best performance we've seen in a while, but there is also quite a bit of uncertainty related to the durability of the increase. So, we are more cautious than optimistic at this point. The situation in both North and South America remains challenging, and it is hard to find bright spots in those geographies today. In terms of product sales, replacement parts are predictably doing better than new equipment. Businesses like engine aftermarket and process filtration offer a bit of relative stability, while new equipment production for engine-related products and capital investment for dust collection systems were still under pressure. While we would not typically go into detail on the current quarter trends, we felt it was important to give a little more context, given the extraordinary pace of change. As we contemplate the final two months of this fiscal year and our plans for fiscal 2021, we will remain focused on executing those things under our control, including promoting the safety and well-being of our employees, maintaining tight control on discretionary expenses, making targeted investments to support near and long-term growth priorities, and protecting the strength of our financial position. I'll now turn the call to Scott for an update on our other key metrics.
Scott Robinson, CFO
Good morning, everyone. I want to echo Tod's sentiment. Donaldson has great employees. The way we work has changed rapidly during the pandemic, and our teams have stayed connected, remained productive and delivered results. I want to thank our employees around the world for everything you’re doing to keep us moving forward. As predicted, the third quarter was a volatile period. The demand environment deteriorated from month to month and things became more uncertain as COVID-19 spread broadly. Unfortunately, the situation is still unclear. Economic conditions are varied by region and markets, resulting in uneven and unpredictable demand. Given that, we feel it's prudent to continue to withhold fiscal 2020 and 2021 guidance for our key financial metrics. I will, however, talk about some general expectations during my remarks. So, I'll turn now to a recap of third quarter performance. All things considered, we are in a good position today. Despite a sales decline of 12%, our third quarter EBITDA margin was flat with the prior year. Additionally, our decremental margin was about 19%, which is significantly better than our historic average in the mid to high 20% range. The favorability was due in part to product mix and lower incentive compensation. So let me take you through some of the puts and takes. Third quarter operating margin was 13.4%, compared with 14% in the prior year. Loss leverage on lower sales was a primary driver of the decline, and that impact was compounded by a higher depreciation related to our capacity expansion projects. Based on the nature of these investments, the third quarter depreciation impact was skewed towards gross margin in the Engine segment. Overall, our teams are doing an excellent job mitigating the pressure created by lower sales. In terms of gross margin, plant managers are quickly adjusting labor to account for changes in demand, and our procurement and supply chain teams continue to drive optimization initiatives that will have long-term benefits. These efforts, combined with a favorable mix of sales and lower raw material costs, narrowed the third quarter gross margin decrease to 60 basis points. Additionally, we had strong operating expense performance in the third quarter. On a dollar basis, operating expenses were at the lowest level in three years, which comes after three years of incremental investments related to our advanced and accelerate portfolio and R&D capabilities. I want to add that we are not pausing investments in these initiatives, which are critical to our long-term growth plans. As a rate of sales, third quarter operating expenses were up only slightly from the prior year. We had favorability from incentive compensation, which was down nearly $6 million, and discretionary expenses were significantly reduced in relation to COVID-19. Despite the near-term pressures from the pandemic, we are pushing forward on our margin initiatives. New capacity that brings a lower cost of manufacturers is coming online. We are steadily adjusting the supply chain, our procurement teams are driving cost reductions, and our commercial teams continue to manage pricing. The list is the same as what we have been sharing for more than a year. These are our top priorities, and regardless of the macro backdrop, we feel confident in our ability to continue making progress. We also feel confident in our financial position. At the end of the third quarter, our leverage ratio was 1.0x net debt to EBITDA, which is where we were at the end of the second quarter and right in line with our long-term target. Working capital was down from the prior year, driven by reductions to receivables and inventory, and our cash conversion in the quarter was 98%. We continue to work with our suppliers and customers to manage credit and supply chain risk, and we are also working with our valued banking partners to further bolster our liquidity position. Out of an abundance of caution, we drew an additional $100 million from our revolving credit facility during the third quarter. Then later in May, we entered into an additional 364-day credit agreement that gives us access to another $100 million. At the same time, our pace of capital expenditures is decelerating. Third quarter CapEx declined by more than 40%, and the spend trajectory is consistent with what we communicated previously. Importantly, the projects were already in various stages of completion as COVID-19 spread, so we could finish these projects without putting our financial position at risk. Although the demand environment today is materially different than it was a year ago, we still feel confident these projects will improve our cost structure, strengthen our customer service at a local level and position us to grow in strategically important markets and geographies. Let me share a few examples of what we're working on. We are setting up our first PowerCore line in China to support new program wins and work with local manufacturers. We've doubled the production capacity for process filtration, positioning us for a larger presence in the food and beverage industry. New capacity in the Americas and Europe allows us to optimize the point of manufacture for engine-related projects. We still have a little work to do, but our teams are working hard to get them online soon. Returning cash to shareholders is another important part of our capital deployment priorities. We are committed to the quarterly dividend, which has been paid every year for more than 60 years and increased annually for 24 years in a row. That's an excellent track record, and I don't want to be the person that messes it up. We regularly review our dividend policy and based on forward-looking scenarios, we feel comfortable with our ability to continue this impressive run. Share repurchase has always been the more variable component of our capital deployment. We have been regularly repurchasing our shares for decades, and we know that's a valuable activity to many of our shareholders. We take a thoughtful and measured approach in the execution of our share repurchase plans. Our minimum objective in any given year is to offset the dilution related to stock-based compensation, which is about 1% of shares. The level of repurchase beyond that amount is governed by our balance sheet and other opportunities to deploy capital. We repurchased 1.6% of outstanding shares so far this year. Based on the uncertainty created by the pandemic, we do not expect additional share repurchase in the fourth quarter. As the situation with the pandemic evolves, we will continue to prioritize a strong financial position and remain focused on executing our strategic priorities. That has been our approach for a very long time, and we believe it will serve us well for a long time to come. Again, I would like to sincerely thank my colleagues around the world for their strong performance, and I wish all of you health and safety during these times. I'll now turn the call back to Tod.
Tod Carpenter, CEO
Thanks, Scott. Donaldson company turns 105 this year. We have experience with every type of economic environment, and we have always emerged to become an even stronger company. Our playbook is simple and consistent. We leverage our deep technical expertise to build a portfolio of filtration capabilities that we deploy into a diverse set of markets. We are a returns-focused company. We think long-term, while maintaining a clear focus on those things we control in the near-term. The pandemic has no impact on this playbook or our strategic priorities, which always starts with technology. Along those lines, I'm very excited to share that our new material research center is nearing completion. This R&D facility is a $15 million investment in building our material science capabilities. We leverage some of this know-how in our process filtration business today. But the new facility is going to give us significantly stronger platform. We plan to further penetrate the food and beverage market, followed by future expansion in specialty chemicals, electronics, and eventually life sciences. These markets are less cyclical, highly technical, and therefore highly profitable, making them an attractive complement to our strong engine business. Technology remains a core part of our engine strategy as well. We want to win new business with products that drive aftermarket retention. While the pandemic has created uncertainty, we are still working with large OE customers on new programs, and their demand for proprietary products is going up as they look to grow their parts business. Through our technology, Donaldson becomes a core part of the customer's growth strategy, giving us a wide competitive moat. The value of these products to our company has been demonstrated year after year, so we continue to make investments. We recently introduced a new generation PowerCore filter called PowerCore Edge. It has the smallest footprint of any generation yet, and our world-class media makes it an excellent solution for off-road applications that face heavy dust environments. PowerCore Edge will be another powerful tool for driving long-term share gains in our core markets. Additionally, we are building our first PowerCore line in China. As large Chinese manufacturers move up the technology curve, a couple of things happen that create opportunity for us. First, a higher-performing piece of equipment requires more advanced filtration. With our strong global brand, decades-long presence in the country, and significant experience supporting world-class OEMs, we are a natural partner for the Chinese manufacturers. Second, when end users buy a more expensive piece of equipment, they're more likely to maintain it properly. That makes PowerCore particularly interesting as a replacement cycle is created in China, retaining the parts business is now valuable to those manufacturers. Advancing our R&D capabilities and growing our portfolio of innovative products are what we would consider standard work at Donaldson. As I mentioned, we think long-term and we are committed to creating value for all our stakeholders. I'm confident we can deliver on that commitment because we have dedicated, talented and incredibly smart teams in every part of our company. Once again, I want to thank our employees for all they do. I'm proud to be on the team with them. Now let's turn the call back to Julian to open the line for questions.
Operator, Operator
Thank you. Your first question comes from Nathan Jones from Stifel. Your line is open.
Nathan Jones, Analyst
Good morning, everyone.
Tod Carpenter, CEO
Good morning, Nathan.
Scott Robinson, CFO
Hi, Nathan.
Nathan Jones, Analyst
I guess, I'll start with the short-term questions. Your guys' third quarter here stands a pretty wide range of business conditions covering February, March, and April. You said you expect May to be down 24%. Can you compare that to what April was down? I think, out in the market at the moment, we're hearing customers going back to work, but not really doing that much in terms of buying in May, more kind of figuring out what they're going to make, what they need in order to do that, and with some expectation that maybe June gets a little bit better. So, can you comment on whether or not you think April and May are kind of the bottom of this cycle for you?
Tod Carpenter, CEO
Sure, Nathan. This is Tod. In April, we had some project-based businesses that experienced some pull-forwards at the end of the month, leading to a better-than-expected pickup, although those projects were originally scheduled for May. When we analyze April and May together, they turn out to be roughly equal in performance. We did not observe any significant changes either way in May. It's hard to determine if we've reached the bottom. We noticed several OEs returning to work in May, but we anticipate a mixed experience moving forward, as OEs will be assessing their overall production rates and demand. Overall, we view April and May as comparable, but we are more cautious about June and July based on the first-fit businesses we are monitoring.
Nathan Jones, Analyst
Okay. Thanks for that. You guys have finished a lot of these capacity additions; those were supposed to be accretive to your gross margin level. So, I'm sure that probably helps with the decrementals as we go through this. Can you comment on what kind of decrementals you're expecting to post here in the fiscal fourth quarter?
Scott Robinson, CFO
Hey Nathan, this is Scott. Good morning. So, yes, we are proud of the accomplishments that we've had with all of our expansion projects, and those help us to normalize the supply chain as we’ve talked about to reduce our cost, to improve our freight situation. And so, as you stated, we would agree that that helps our margin in the fourth quarter to be, let down. In the third quarter, the fourth quarter, we would expect that help to continue. The big question is, what will the volume be that will drive the absorption, and that's kind of a tough call right now. But we expect to continue the tailwind from the initiatives that we've undertaken.
Tod Carpenter, CEO
Nathan, this is Tod. Maybe just a little bit more color. So, the discretionary expenses are being fantastically controlled by decision-makers all across our company, everywhere in the world. And some of those things such as travel and entertainment, we're down 80% on normal run rates. We're not going to be able to withhold that over the months ahead. Eventually, we have to lighten that back up and let people really press back into the marketplaces. And so, there's some puts and takes there such as the comp activities that Scott talked about also that give us a little bit more favorable wind in the third quarter than we would expect looking forward. A little bit tough to predict the overall decremental margins. Clearly, we're running better than we would have expected on the models as we went into February. And the commitment that we have to all of you is that we will continue to be very diligent in controlling what we can in our operational expenses.
Nathan Jones, Analyst
Thanks, Tod. Just one quick one on the potential OEM aftermarket channel inventory stocking. It might be a bit of a hard question to answer, but do you have any information on maybe what that additive revenue or how many points of growth that additive to revenue that we might have to pay back here at some point? And I would think that maybe that inventory destocking doesn't come for a little while if those OEMs are still worried about their own supply chain; they might run that inventory a little higher for a little longer.
Tod Carpenter, CEO
Yes, I think that's a fair comment. We’re uncertain about the timing. Clearly, the original equipment manufacturers are holding onto their inventory. We have already noticed some destocking in the independent channel. It seems that the manufacturers are likely to hold on a bit longer until they determine their pull-through rates, which makes it really difficult for us to predict at this time.
Brad Pogalz, Director of Investor Relations
Nathan, this is Brad. And maybe to put a fine point on some of the details that Tod mentioned in his remarks, the independent channel of our aftermarket business, sales through that channel typically are in the neighborhood of 60% of aftermarket, and in the last quarter, it was about 55%. That channel slowed more substantially than the OE channel. Now, we never know precisely whether or not an order is a restock or a destock, so we can't really talk to that specifically, but we do look at the trend between independent and OE to see if there's any sort of alignment or lack of alignment. And clearly, this last quarter, there was a lot of lack of alignment. About a 10-point spread year-over-year between the two. So that gives you a little bit of a sense of magnitude of what we saw on the OE channel, but to the point Tod made, I mean, it's really tough to see where that would come back to.
Tod Carpenter, CEO
That's helpful. Thank you very much. I'll pass it on.
Brad Pogalz, Director of Investor Relations
Thank you.
Operator, Operator
Your next question comes from Brian Drab from William Blair. Your line is open.
Brian Drab, Analyst
Hi, good morning. Thanks for taking my questions.
Tod Carpenter, CEO
Good morning, Brian.
Scott Robinson, CFO
Hi, Brian.
Brian Drab, Analyst
So if I consider some near-term questions regarding the impact of the pandemic, is it reasonable to assume that since April and May were similarly challenging, based on what you observed as you left May and what you're hearing from customers, June and July are likely tougher than the conditions you experienced in February and March, leading to a sequential decline in the top line for the fourth quarter?
Tod Carpenter, CEO
Yes, really hard to say Brian.
Brian Drab, Analyst
Could you give any …
Tod Carpenter, CEO
Yes. Let me just give a little bit of color. Really hard to say on that Brian, just simply because clearly we see order incoming patterns and we try to match that up with all the plant shutdown notices. We do have some customers that came back in May, then shut down, then plant shutdowns in June and so that's the fits and starts that I referred to earlier. And so therefore because of that situation, and then on again, off again, it's really difficult to predict where we are on this first-fit cycle of things. There is no consistent line to be drawn at this point.
Brian Drab, Analyst
So there's no way, Tod, that you can say, well, I saw things better at the end of May versus the beginning?
Tod Carpenter, CEO
No, I actually did that analysis. I was very curious about it, and after going through all the details, I gave up because I couldn't confidently provide you with a clear answer on that.
Brian Drab, Analyst
Okay. And then just asking that – I mean, it's a question about decrementals, but just asked in another way. Let's just say, given all the levers that you pulled, if revenue, just as a scenario, if revenue were to be similar in the fourth quarter compared with the third, would gross margin be about the same, or up or down from what you reported in the third?
Scott Robinson, CFO
Yes, I will start. So we had a good mix in this last quarter. So I think if you made some assumptions, it's obviously you’ve to do in this kind of situation. But if our mix held, I think we can maintain those margins. We have a lot of different businesses in there; there are a lot of puts and takes going on, so it's hard to say. But I think if we presumed a relatively consistent mix and reasonable sales, I think our margins could hold.
Tod Carpenter, CEO
Yes, and I would agree with Scott. I think obviously our biggest variable, if you will, is how much of the first-fit business will come back within the fourth quarter, which is headwinds overall to margin base mix, and then our Special Applications business also, if should that experience some headwinds as we would expect, that will also be some headwinds to the overall gross margin performance in the corporation. And so those are two of the significant mix components that we continue to keep a strong eye on in order to best understand where we are.
Brian Drab, Analyst
Okay. And then just the same question on operating margin, given the flat revenue scenario.
Scott Robinson, CFO
Yes, the biggest impact would be we had some incentive comp adjustments this quarter. So that was a $6 million expense reduction, and naturally catch-up from the first three quarters. So you have to annualize that; it wouldn't be as large in the fourth quarter. We would continue to manage our expenses aggressively and work to keep our discretionary expenses at low levels in light of the sales situation. So I would expect that to continue. We are at our lowest level in three years in terms of OpEx, so we are pretty proud of that performance. I think that shows that we're managing expenses tightly, especially in light of the fact that we continue to invest in the initiatives that we've talked about in the past. So I think save the incentive comp adjustments, I would expect our operating expenses to continue to be managed tightly in the fourth quarter.
Tod Carpenter, CEO
Yes, and I just want to add a little bit of color, Brian. I think it's important to understand that we are controlling what we can control. But throughout all of this, we are taking a long-term view, and we are not going to jeopardize the strategic health of this corporation. And that is the way we are managing.
Brian Drab, Analyst
Got it. Understood, Tod. Thanks. And Scott, just to be clear, are you saying that the bonus accrual contributed to margins this quarter but won't be as significant in the fourth quarter? Did I understand that correctly?
Scott Robinson, CFO
Yes, that is correct, both bonus and long-term incentives.
Brian Drab, Analyst
Okay. And lastly, regarding the aerospace and defense orders, this has been a strong market for you. Does that trend continue, or will some of these larger projects you are working on start to decline? Thanks.
Tod Carpenter, CEO
There are clearly challenges with fixed-wing aircraft, which are being offset by ground-based defense vehicles and helicopters. We anticipate that performance will remain stable at its current level. Our teams globally have done an excellent job addressing the challenges posed by fixed-wing aircraft.
Brian Drab, Analyst
All right. Thanks very much.
Tod Carpenter, CEO
Thanks.
Scott Robinson, CFO
Thanks.
Operator, Operator
Your next question comes from Laurence Alexander from Jefferies. Your line is open.
Laurence Alexander, Analyst
Good morning. So just a couple of things. First, on the bonus accruals. Can you help us think through what normalization would look like? Is that a headwind in 2021, or 2022?
Tod Carpenter, CEO
Yes.
Laurence Alexander, Analyst
Can you elaborate on your planning assumptions for 2021 and also share your perspective on longer-term growth? What has changed from your approach following the industrial recession and the financial crisis? Is there anything in your strategy that is evolving in this current environment?
Scott Robinson, CFO
Yes, maybe I will start with question number one and I will let Tod take question number two. In terms of the incentive comp, so we had a $6 million benefit from adjustments to the first three quarters and that results when we expect that performance to be less than planned. We don't plan to pay full incentives, and therefore we have a reduction. We haven't finalized our plan for next year, but I would expect our plan will be established for next year and that plan would include a bonus that would likely be higher than this year's bonus, and so therefore you would get a headwind from those expenses, assuming everything else equal, and through the third quarter benefit was $6 million; we will get a fourth quarter benefit as well. So that will be a headwind for next year.
Tod Carpenter, CEO
And Laurence, this is Tod. The long-term strategy remains unchanged for us. In fact, we believe that the investments we made in our company over the last two years, particularly in capacity expansion to normalize our supply chain, are now working to our advantage. We are heavily engaged in this re-normalization and the realignment of our internal supply chain, which is really aiding in driving gross margin improvement. We are pleased with our current execution and take pride in the progress of our ongoing projects. We feel confident in our position. Additionally, our long-term investment plans and efforts to diversify the corporation have not slowed down, and I want to highlight that we are committed to playing the long-term game.
Laurence Alexander, Analyst
And then could you also give an update on your thinking about the Asian market, specifically, I think the Chinese NPC had a lot of themes around sort of tighter environmental controls in the work environment and so forth. How is that playing into your thinking about investments in Asia relative to other regions?
Tod Carpenter, CEO
Sure. In China, we’ve actually had some good momentum, China with their Blue Sky initiatives relative to our dust collection business over there is really helping draw project-based business forward. And so we’ve growth in China, very nice growth on the industrial base side of things that help support the Blue Sky initiative. We continue to invest and bring technology over to China to answer those needs of the Blue Sky initiative. And then on the Engine side of things, as they continue to increase the technology, we have been winning there with PowerCore. We've been winning so much so that we're putting a PowerCore line in China because that aligns best with our region to support region growth. So we continue to press forward with our strategy. The regulation changes that are happening in China are working to our favor, and we are doing a good job at share gain there.
Laurence Alexander, Analyst
Okay. Thank you.
Operator, Operator
We have no further questions. I will turn the call over to Tod Carpenter for closing remarks.
Tod Carpenter, CEO
Thanks, Julian. As we end today's call, I want to make one more comment. The tragic event that recently took place in our Twin City's community and the violence that followed are greatly disturbing. I offer my deepest condolences to the family and friends of George Floyd and with healing to those affected by the subsequent events that unfolded following the tragedy. I want to stress that Donaldson is committed to sustainable change and we stand united with our communities and nation to stop the senseless cycle of discrimination. That concludes today's call. I want to thank everyone listening for your time and interest in Donaldson Company, and I hope that you and your family and friends are safe. Goodbye.
Operator, Operator
Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.