Dover Corporation (DOV) Earnings Call Transcript & Summary

Dover Corporation with us. Rich Tobin started as CEO of Dover in March 2018. He's been on the company's Board since 2016. Prior to Dover, he was the CEO of CNH. We did have some discussions back then, you might not remember. But Brad Cerepak also with us today, long-standing CFO of the company since August 2009.

So I think the best way to start out, Rich, is just referring to when you took over in March 2018, obviously, there was a bit of a transformation that people started talking about with you. And I think -- in my opinion, I think you've been very successful. But maybe you can talk about what you've done so far, what you're most proud of, what you still have as your biggest challenge moving forward? Just a nice softball to start.

Okay. All right. Look, I'm proud of the management team, not so much myself, at the end of the day. I think that they were given a significant challenge to rightsize Dover post the spin-off Apergy in May of 2018. And it served 2 purposes at the end of the day. I think that it was -- Dover at the time had not benchmarked well versus its competitive base in terms of overhead cost, so that needed to be rectified. But it also served as an opportunity for me to evaluate the management team and for them to deliver on a significant task. So overall, I think that we -- or I was pleased in terms of the execution. When we announced it in September -- in mid-September of 2018 to take out $130 million of SG&A costs, we were complete with that exercise by December of the same year. So I was pleased with reaching the target and pleased with the speed of execution. At the same time, we had laid out some margin targets for some businesses that, in the evaluation of the portfolio, were not comping well vis-à-vis either the capability of the competition. We delivered on 1 of the 2 of those objectives in the Fueling Solutions group in 2019. We actually beat the objective, which I believe was in excess of a 300 basis point improvement in terms of operating margin for a significant piece of the business. So I think that, that worked well. But if you look at the performance overall, I think that the more -- that we have begun the journey in terms of getting a kind of a operating company philosophy as opposed to what was traditionally more of a holding bias at Dover. It's a long multiyear journey, but I think that we made good progress so far. I think we've announced an additional $50 million of kind of cost savings objectives for 2020. We believe that, that quantum we can extract from the group over a multiyear period, which is on the back of some successful investments that the company has made in terms of back office infrastructure, offshoring of engineering and our Digital Labs in Boston that we've stood up.

So Rich, I want to follow up on the comment you just made about, obviously, we joke about the famous $50 million, right? But like, if you go past 2020, last year when we had you here, we talked a little bit about things like footprint consolidation. You mentioned Dover Digital Labs. You have a lot of things going on, right? So how does that translate in '21 and beyond? Is it more like, every year, we can get higher-than-normal incremental margins if we're doing this right? Or how do you think about it?

Yes, we've bifurcated between investments that the corporation is making on behalf of the portfolio companies, meaning we believe strongly that Dover Corporation has to earn its right to exist at the end of the day because why do multi-industrials with disparate portfolios exist in the first place? Well, they exist if only -- and are successful only if the corporation can come up with strategies to provide leverage across a wider portfolio of smaller companies if they individually invested in these endeavors on their own, it wouldn't be that efficient because they wouldn't get the scale benefits of it. So our penetration on back office systems, our penetration on offshoring engineering, our penetration in terms of standing up our digital endeavors, we've made progress, but we're no -- by no means 50% or 80% penetrated across the group. So that's why we feel just as we try to get productivity out of our operating companies year-over-year, that same type of productivity needs to be demonstrated by the corporation itself to earn its right to exist. So I think that we've made the right investments. It's up to us to utilize those investments, but be prudent in terms of the speed of application because, make no mistake, when you're moving up back office processing, you need to be careful in terms of the execution. You don't want to -- it's very nice to say I'm moving accounts payable, accounts receivable and general ledger processing and offshoring it, but there's some risk associated with that. So you need to be relatively deliberate, and that's why we believe it's a multiyear journey.

And to your point, I think you said recently that you're only 15% to 25% "done with this process" of developing Dover Business Services. So when I think about your sort of long-term target of 25% to 30% incrementals on the core business, this process is on top of that if I think about over the long term.

Yes. Right. I mean at the end of the day, the way that we measure the operating companies at an optimal -- in an optimal state, an operating company would be converting revenue at gross margin, right? It means that they've got enough productivity embedded that they're offsetting all inflationary inputs, whether that's labor or raw materials, right, and they're not attracting SG&A as they grow because they're offloading SG&A into these centralized processes. So it would be converted gross margin minus change in R&D because you want to plow back a portion of that conversion back into R&D. Now that is, a, an optimal performance, which is a goal, but very few reach it unless you just have a significant change of mix that changes your gross margin profile. But it is a goal and it's how we measure the performance of the group or the operating companies year-over-year. We're far away from there. So even at our current 25% to 35% conversion that we have out there, at least as it relates to this year's guidance, there is a significant difference between our gross margin at the segment level and that conversion rate. So that just gives you an idea of where the opportunity set and how we attack it from both sides.

Yes, that's helpful, Rich. And then just -- I feel like I'm greedy asking this, but you know I'm going to ask it anyway. Like so SG&A as a percent of sales, low 20s now. You -- definitely, as you said, you tackled it. It's the first thing you sort of did. I mean if I think -- I know you have R&D and SG&A, right? So if I think about best-in-class, it's, call it, mid to high teens. Is there any more room on SG&A or is it just -- this is where we are now?

Well, it depends on what your benchmark is. Look, I come from large industrial world where SG&A as a percent of revenue is really low, right, because of scale at the end of the day and then the ticket price of -- so you're never going to get to the optimal state because we are a portfolio of company of a lot of small companies. You can do your best of using the scale benefits of what we talked about before, but the fact of the matter is the reason that these businesses are so profitable is because of their proximity of the customer and the amount of co-engineering we do, and that is always going to be reflected in SG&A. So think that we need -- I think we're realistic about the benchmarking. But if you compare it to a large industrial world, we're never going to get that close in terms of SG&A as a percent of sales. And hopefully, we don't get that close in terms of the operating margin either.

Yes. You don't want to be that.

Right.

so let me back up and talk about the markets in terms of an update. Obviously, everybody wants to talk about coronavirus. Your backlog was actually strong coming into the year. There's a little bit of fear about industrial pumps. So maybe just reset us on where we are here in the first quarter. Any updates do you want to give on coronavirus impact?

Sure. We do not have any of our 2,400 employees in China that have reported coronavirus to date. 90% of our facilities are up and running at some level of production. So we have 1 out of our 14 sites that has not received a permit now to start up. We get a report on this daily and so it's a little bit of a moving target. Our estimate right now and lost EBIT at Q1 at current state is $11 million. We believe if this doesn't -- if this issue does not continue outside of Q1 that to the extent that, that revenue was not lost, that we can make that up from a production point of view. We have only one business and one facility that materially makes finished goods and ships finished goods out of China for not Chinese consumption. For the vast majority of our industrial footprint is for China consumption alone. So in terms of finished good risk coming out of China, it's one business that we have, which is vehicle services group, which we have somewhat redundant production capability in the United States and it's a distribution business, so there is a lot of inventory in the channel anyway. So if this situation does not run significantly longer out of Q1, we're not going to run into a supply disruption in terms of our own production. I think on the component side, I think we're like everybody else. Our 2 biggest risk categories are basic electronics, so PC boards and lighting systems, things like that, and in casting for cast steel meaning the molds are in China. And to the extent that steel production does not come back, which I doubt, we would run into a headwind there. But right now, we don't believe that outside of lost revenue and profits in -- for domestic China that we'll be revisiting our Q1 because of componentry supplier back shipment of finished goods.

That's helpful. And so maybe to follow up there, Rich, would be like you've been pretty strong in places like Europe, for instance, where a lot of companies have not. So maybe you can talk geographically for a second and the contribution to that 2% to 3% guidance that you've got out there.

Yes. I mean, look, at multi-industrial world, everybody -- because of the portfolio complexity, everybody kind of collapses around macro numbers. So like...

If you want key...

GDP plus and I get it, right? It's better than putting out 24 different estimates on a variety of different companies. So look, at the end of the day, when you do the math and then consolidation, it ends up being reasonably right in terms of GDP plus and GDP plays. But having said that, Dover's participation in any geographic market is somewhat of a rounding error at the end of the day. So we've done well in Europe in terms of growth and in terms of expanding margins. But remember, that Europe is more of an EMEA issue for us, so it's not just Continental Europe. It's the balance of EMEA, which is really a lot of what we export out of European operations goes to a wider area of the world. So if you think about textile printing, for example, we make all of the machines in Italy and we ship them around the world. Revenue recognition of whether it's recognized in Southeast Asia or recognized in Italy is always a little bit of a slippery number at the end of the day. So I get it that we benchmark well in terms of -- compared to GDP in Europe, which has been very low. But at the end of the day, I don't think it's unreasonable for us to expect our operating companies not to hold themselves about. You can't come in and say I'm doing great because GDP in Europe is 1% and I did a 1.25%. Big deal, right? I mean we're just not that big at the end of the day in relation to our participation.

So let me respond on the context of end markets. One of your big end markets, obviously, is printing. And so Markem-Imaje has been, I think, you've said kind of a little bit weak in places like China. Is it just the market? Is there any sort of product refresh that's going to help you? Any sort of comments you can make on that particular business because that's been one -- we'll get to refrigeration, I'm sure, but that's been one that has been strong and kind of a little bit weaker lately.

I think that we were disappointed in Markem-Imaje's performance from a top line perspective, but not from a margin perspective. So despite only growing 1%, I believe, for the full year, it expanded margins significantly. So look, when the market's not there, it doesn't mean you can't work on your productivity. So on one hand, I think that Asia consistently weakened for Markem-Imaje, particularly China, throughout the second half of 2019. But to management's credit, they were able to offset that demand weakness with significant increases in productivity. We just made it, but that despite my soliloquy about GDP, you understand that marketplace, it's a triopoly at the end of the day. It does grow in low to mid-single digits depending on kind of activity cycle. And you understand that a lot of that business is driven by consumables. So it's a barometer of activity level, so to speak. So we recognize that. We also understand that it's built out in terms of its penetration in a large way across the world. So we love the business because the margins are high and the amount of consumables that ride through it, but we just did an acquisition in the space in January, which we believe is a -- which is an interesting adjacency to the Printing & ID business that we have that goes into track and trace because we have a significant entrée into high-value consumer goods. And we believe that pharma has been -- always been the leader because of regulatory issues in track and trace, but we think that there is a significant opportunity in track and trace for high-value consumer goods and into food products. So that's why we've made some inorganic investment to kind of drive the top line in that particular business.

So obviously, the coronavirus could have some impacts on the business in Q1 like -- but absent that, does this business -- how do you look at the growth profile of this business in 2020 and 2021?

It is a low to mid-single digit dependent on global economic activity because it's throughput-based at the end of the day, right? So just think about any kind of consumer product that's made, let's pick one. Danone makes yogurt. So our business is a reflection of how much yogurt that Danone makes in a given period because a significant proportion of the revenue is the consumption of the ink that runs down the printing lines, for the most part, just being relatively basic. So that is the expectation of the growth business now, but it is also a platform where we have got significant global penetration into consumer goods. So the question is what kind of other services and products can you sell around that space. And I just mentioned Track-and-Trace is one, but there's a variety of other software applications and hardware applications that we can build off of that base. And really, that's how we look at that particular business over the long term, is what adjacencies can you pack on to a significant installed base with some of the biggest global consumer business -- consumer companies around the world.

Got it. So I want to open it up to the audience in a second, but let me ask you because we'll talk about refrigeration at some point, so why not now?

Sure.

So like do you feel, Rich, like you have your arms around the -- like, I mean, again, I think you've said it, right? Refrigeration as an end market has been all over the place. There's a lot of different things in there, right, systems, door and -- case and door, like there's a lot of stuff, right? So when you look at it all, do you now have a good feel for the markets because the backlog leaving 2019 was very, very strong. You've got pretty conservative estimates for in 2020. So look, I want to get excited that the turn is here, but maybe I shouldn't.

I hope everybody is excited because we spent -- look, we've got a margin target for that business, which effectively almost doubles the margin by the exit of this particular year. We've made a significant investment in terms of changing the business model on the door case or the refrigeration units that you see in supermarkets, right, so -- and we're endeavoring to take out 50% of the assembly cost in that operation. The market is what it is, right, especially when it comes to big-box retail. It is -- we've got a significantly large installed base, but it's largely driven by replacement activity. So we're sizing our operations to accommodate that reality. So we don't believe the market is shrinking anymore. It's reaching some level of stabilization. The work that we're doing is to reduce our production costs because the fact of the matter is it's a very price-sensitive market out there, and we need to do a lot of work and product standardization and reduce assembly hours, which was a very high content of labor cost in making one of these units that we got a big target in it. In terms of the segment backlog, you see a big number there, which is not really a reflection of the Refrigeration business because despite the fact that we've got a better backlog in Refrigeration, that really turns in 90-day periods. This is a "get the order and you run it down the line and you make the business." What you see in terms of the backlog is more levered towards Belvac, which is can-making equipment for aluminum cans, which we believe is moving into a secular growth story because this issue with the transition from PET to aluminum is real. And we believe that there's going to be significant capacity expansion for the production of aluminum cans to replace some proportion of PET. And it's not driven by economics, it's driven by recycling rates and environmental concerns. So we are making a significant investment in Belvac this year proportion to the size of the business, but these are high -- these got lead times of 9 months. So a lot of the backlog that you see building up in the segment is related to those orders are beginning to come in.

But I guess the thing is, Rich, as you know, Belvac didn't do much in 2019.

Right. I'm well aware.

And so -- I know you are. So -- and it's a very high-margin business, right? So like it really can impact the business in 2020, right?

Yes. That's our intention, right, to really impact it positively.