Dover Corporation (DOV) Earnings Call Transcript & Summary

Hi, everyone. So we're getting ready for the third presentation of the day. This is Joe Ritchie, who runs the multis coverage for Goldman. And we're excited to have Dover's CEO, Rich Tobin; and CFO, Brad Cerepak, here with us today. Guys, thanks so much for joining us today.

Thanks, Joe.

Thank you.

Before we kind of kick it off with questions, just a reminder to the audience, if you do want to send in or submit a question, you can do it via the web link or feel free to shoot me an e-mail at [email protected]. So maybe just kind of kicking things off, Rich, I guess one of the things that I constantly talk to investors about is really your portfolio. And I think a lot of folks underappreciate the strength of your portfolio. You've had 4 out of 5 segments that have really put up really solid growth over the last 10 years. As you think about this downturn specifically and the businesses like within your segments, do you think that there are certain segments and certain subsegments that can hold up well and potentially grow into 2020? Maybe just talk a little bit about your portfolio.

Sure, Joe. I mean look, FX aside, which I think is also underappreciated about the portfolio, but let's just deal with organic growth rates. I think there are some individual companies in the portfolio that have the potential to post revenue growth in 2020. They mainly reside in our biopharma platform, our hygiene business, I think our plastics production components business, aluminum can production business and possibly on above-ground fueling solutions, depending on how EMV progresses in the second half of the year, have the ability to post growth. I don't foresee any of the particular segments under current conditions posting year-over-year growth, but we do have a collection of individual companies that have the potential to do so.

Yes. And maybe just kind of like the flip side to that question. Where do you think you're going to see the most pressure? Are there certain businesses that you think could be down maybe north of 50%? Just maybe talk about some of those other businesses.

Well, I think that 50% seems a bit severe, considering the fact that all of our businesses, with a few exceptions, have reoccurring revenue streams of component parts and kind of servicing the installed base as opposed to whole good sales. So 50% seems a rough one. But I think that, look, the bottom line is we have some businesses under stress, food equipment, industrial components and pumps, bearings and compressors. Our business that serves the textile industry and then the automotive OEM and aftermarket business is under pressure as you can imagine.

Yes. That makes sense. And I know, look, I know it's -- it doesn't seem that long ago, but you guys we're one of the first ones to kind of report 3 weeks ago. And I guess in this market, a lot can happen in 3 weeks. So care to update us on whether there's been any kind of any change on the margin between what you've communicated to us a few weeks ago and where we are today?

Sure. Trends, the tough trends for Q2 are largely in line with what we thought. I think that industrial pumps has weakened somewhat. And despite a healthy backlog and green shoots of reopening announcements, we still cannot access installs on the refrigeration side. So as a result, we'll be taking down additional production days for both of those businesses in Q2. Our biopharma connectors business had a record month in April, and we continue to book well on plastics processing equipment. And heat exchangers are beginning to look better in terms of backlog. So it's a bit of a mixed bag, but those are the 2 puts and takes from 3 weeks ago.

Yes. That's super helpful, and I appreciate you giving us that color. I guess as you think about the demand environment, hopefully stabilizing in the near term and maybe accelerating into next year, just like which businesses do you think are likely to recover the quickest? And which ones within your portfolio will likely take longer?

Okay. The businesses with our strong order backlogs, which we closed Q1 relatively strong across the portfolio and have a heavy proportion of consumables or nondiscretionary maintenance revenue streams, will bounce first, marking and coding, fueling solutions, some pump and component applications and refrigeration come to mind. Industrial components for the energy complex, including our winch business, food equipment and textiles are probably going to take more time.

Okay, great. Switching gears a little bit, Rich, you guys announced some actions, some cost actions in the quarter. I think there was some confusion on the earnings call just around like the commentary that you made around the $35 million to $40 million in fixed costs absorption and the $50 million in offsetting actions. So just to make sure we're clear on like how to think about this and the actions that you're taking, basically your -- the presumption to make is that you're taking temporary actions that are going to more than offset the absorption that you expect to see in the second quarter. Is that a fair statement?

In short, your takeaway is correct. We are taking actions to more than offset the underabsorption. I will say that I'm, I guess, a bit disappointed that there was some confusion. I believe we're the only company in Q2 to give a fixed cost underabsorption number in addition to a full year decremental or decremental margin target. But if you refer to Slide 12 in our analyst deck that we used for Q1, we were forecasting a negative underabsorption of fixed costs due to curtailments of production of $35 million to $40 million for the quarter. That remains an accurate figure, but that we had also announced that we had $65 million of costs takeout, $15 million of which was the roll forward of our initiatives that we announced last year, and the other $50 million would be temporary costs takeout just managing the P&L.

And I do think you guys were the only one, at least the one that I can remember, to give us the fixed costs underabsorption numbers, so that's right. So I think we're all pretty clear on that number going forward. And you did mention that $15 million really kind of part of the $50 million that you guys had locked and loaded for this year. You made reference to the fact that you guys are already working on plans for another $50 million for next year. So maybe give a little bit of color on how to think about where the extra $50 million could potentially come from in 2021.

Sure. I mean largely the same sources, but with a little bit of a change in mix. We expect to get savings from 3 specific initiatives. It's digitizing the customer front end, back office consolidation and engineering offshoring. These are all multiyear initiatives. We are also not complete with our rightsizing and footprint, and we'll provide color on those items as we take charges to implement. So I would expect even in 2020 outside of the guidance we've given on what we're taking out in costs in Q2 and what our capabilities are in the second half of the year in terms of managing or flexing the cost structure, you can expect that we will be taking additional footprint-related or rightsizing charges of a permanent nature in the second half of the year.

Okay. Okay, got you. That's helpful. And I guess like those plans will likely to be, I guess, just communicated to us a little bit later in the year once you finalize them. Is that the right way to think about it?

I think the right way to think about it is you can look at exactly what we did in Q1. It's on the record. We've given some pretty specific guidance for Q2. You can roll forward the second half of the $50 million to come out in the second half of the year. And then depending on the development of order backlogs and revenue forecast, we've got the ability to flex our cost structure in Q3 and Q4 in a similar fashion. My other comment was that outside of that, we will be taking other structural costs takeout, which is kind of this roll forward of the additional $50 million. And we'll be more specific with that as we take the charges to address it.

No, that makes sense. One of the things that you guys highlighted last year at your Investor Day was just the rollout of Dover Business Services and the fact I think that you were planning to roll out to 2 of the opcos this year. Just a couple of questions there. One, how is the rollout going? And then secondly, how much margin opportunity do you think there is in just DBS alone over the long term?

The rollout is going really well. And knock wood, thank the Lord that we actually begun that process several years ago, because it allowed us to remotely close our books in an efficient and accurate manner and allows -- what allowed us to report so early quite frankly, or part of the reason. We would expect that under current trajectory to provide savings in the order of about $10 million a year just on the DBS portion of it.

Okay. Got it. And then is the expectation, I guess, just 2 out of the 18 this year and then accelerating into next year? Or how are you guys thinking about the rollout and phasing it across the opcos?

I -- well look, I mean it's -- I'd be careful. I think we gave a slide that showed the penetration and what we had in the pipeline as of September of '19. It's a rolling number, and we count them as they're completed but we actually have more opcos in the roll right now. It's just dependent on the size and the complexity. Then you've got an accordion-like implementation phase. So I wouldn't get caught up in the math. I would -- we'll probably, at some point update kind of a penetration number the next time we do a Capital Markets Day of where we are and what's left to go.

Got it. Okay. No, that makes sense. And just maybe the last question just around all the cost-out discussion. You guys have been pretty clear on the path forward. You did mention that it was taking a little bit longer to just coordinate your plans this year. Has that started to improve? As we're kind of just thinking about like the decremental margins for the business, is it just safe to assume you guys are kind of managing to like a 25% to 30% type decremental?

Well, I mean that's the target that we've given, and we'll see. We're going to have to watch the revenue line, but based under current forecast and then kind of some overlays that we do on better and worse scenarios, we think that that's a number that we could hit for a full year basis, not necessarily in Q2. I don't think that we're really delayed in terms of implementation, unlike the $50 million. We feel extremely confident that we're going to get that out, and that's why we're being pretty specific about it. So I don't think that we're being held back with all the other things that we have going on. I think the management team's juggling all this curtailment and working on their longer-term structural costs adequately.

Okay. Great. That's clear. So maybe moving forward and just kind of going into the segments and starting with DFS first. So actually getting a question from the audience here. And how do you -- how are you viewing the refueling business in like a post-COVID-type world? Is there are some likelihood that less mass transit and more people driving is going to essentially be a trend that emerges that could benefit this business over the long term?

That's a good question. And I think it's too early to tell. The way that we look at this business is we're managing right now. Put COVID aside. I think our performance in Q1 was actually quite good, and that was driven by EMV adoption rates. As you know, Visa and Mastercard have now postponed the deadline to April. So what you're living through was a pull forward in Q4 and Q1 now because of lobbying on the behalf of the retail fueling that deadline date has been postponed for 6 months. Quite frankly I don't think that moves the needle one way or the other for us, right, because it was always going to be a little bit choppy in terms of the implementation period. So we look at this business that this so-called EMV cliff was never going to be something that was insurmountable. We'll maximize the profits while we go through the transition in North America, just as we did during the transition in Europe. But I think it's a bigger story around the retail complex. We're -- our underground business is as large as the above-ground business. And the underground business is largely driven by the regulatory environment, which we don't expect on a global basis to be held back at all. So overall, we'll see what happens structurally with due to COVID. But right now, we're just trying to execute, and then right now dealing with at least on the underground side, some amount of delay in terms of our ability or our customers' ability to conduct operations on some of their sites depending on the region.

Yes. That's fair. I know that like, look, the retail fueling business is super short cycle. You guys have commented on that extensively in the past. And so as you're kind of thinking though, about like 2021 and whether it's a cliff or sunsetting, are there parts of your business that you think are going to hold up better? Like I'm thinking about kind of like the -- inside the convenience store, the software side of the business. Or are there growth avenues, maybe geographically, that can kind of help offset, like North America potentially sunsetting?

Yes. I mean look, you said it. We've always maintained that the EMV-driven business will extend beyond the deadline for some period of time. We have a variety of growth avenues in fueling solutions, including software, above ground, below ground, vehicle wash, international expansion. We've really never believed in the EMV cliff, so to speak, is something that was insurmountable. And we've got enough growth drivers that we think while we'll deal with the roll-off of EMV, I think that we've got enough in the pipe in terms of our ability to expand our geographic reach that we can accommodate that.

Got it. Okay. Maybe kind of switching gears then to [ DFR&E ], so food and the food equipment segment. And so look, you look at this portfolio, right, and it's 2/3 of your business is basically tied to supermarkets. You mentioned like that this is an area that could potentially come back faster. Just how are you kind of thinking about the replacement cycle here and are there pieces of your business, and maybe you can kind of help with the audience, just talk through like the pieces of your business that maybe a little bit more impacted, like the hotel and restaurant piece of the business, and how you see that trending?

Sure. Let's start with the refrigeration side. Our backlog is actually quite constructive there. We're just dealing with an inability due to a combination of high-traffic in food retail and COVID-related restrictions of getting the projects implemented. So a lot of deferred -- deferment in terms of the delivery date, so we're taking action in Q2 that despite having a robust backlog, that we're going to take production down in Q2 because we just don't want to carry the working capital. And we believe that we've got a catch-up ability in the second half of the year to make the deliveries as things open up. So that's why I referenced before that we've got the -- we think that is a business based on just our existing backlogs that should snap back just because of the amount of traffic that food retail, just on a replacement basis, that food retail has been getting. So we'll see. We're a bit disappointed that it hasn't opened up quicker. And the fact that we just had -- but I think we're making the decision and a prudent one about not carrying the inventory and running the risk of further deferments and then just ramping up production in the second half as we get called off. On the food equipment side, a lot of pressure in that business. I mean if you think about -- I think that the only portion of the business that's showing any sign of life is food platforms like Domino's and the like, quick takeout. As you can imagine, the restaurant business and some of the -- and things like schools and the like is down significantly. We are taking a lot of actions to rightsize that business. I think I mentioned in my -- in your first question, that one is probably going to be slow to come back.

Yes. No, that makes sense. And that business though is -- the food equipment side of the business is like roughly 10% to 15% of your business or it's...

Yes, it's just north of $100 million in turnover.

Got it. And then maybe at this point, it makes sense probably just to give us an update on the automation project. I think it was expected to be completed this quarter. And then obviously there's been a lot of discussion around the mid-teens 2020 exit rate in food retail. But obviously this backdrop is something that no one could have imagined. So how are you kind of thinking about maybe just the update on the automation project, and then also kind of like the margin target for that piece of the business?

Yes. I mean it starts up in July, to be clear. Look, assuming that we start up without hiccups, or just your normal hiccups of a complex project like this, I'm confident that we're going to get the productivity basis on a standard cost -- on our standard costs for case assembly. But the exit rate is going to be relying on the total volume across the portfolio. So we're going to have to see where we are in H2, whether we can hit those exit rates. I don't think it's impossible, but we're going to have to be churning out that backlog in the second half of the year to reach that number. So we haven't stopped in terms of -- I mentioned before that we've taken some of the plants down that make this product. We have not taken any of the engineering resources. So we expect to be getting the beta 2 units off in July and then move right into production. And I think we feel good about hitting the targets on a unitary basis of reducing our costs.

Yes. That makes a ton of sense. And it was interesting, just staying with the segment, your comments earlier on the heat exchanger business, seeing some more kind of stable trends in that business. That's a business that you've been calling out weakness, I think, for at least a year. Just maybe talk to us a little bit about where you're starting to see stabilization. Is it on the HVAC side of the business, the industrial side of the business? And then what's kind of driving that?

Well, that business has got a material position in Asia. So it was one of the first hit as COVID started going around the world. In the first quarter, it suffered kind of Asia slightly coming back but nothing material, and Europe going down. We're seeing signs of life in Asia in terms of the ramp-up in production. We're at least getting the announcements of Europe in restarts of some of our customers. But we expect North America to be very weak in Q2. So I think the good signs that we're seeing is, as we took the pain, as this problem circled the globe, we're getting beyond it in Asia and somewhat in Europe. We'll take it in Q2 in North America and see where we go from here.

Got it. And then I guess maybe one last one on the segment, just Belvac specifically, just around the backlog. Is there any risk that you think shipments get deferred beyond the second half of the year? I know that there's been a little bit that's been held up. But what are your thoughts around that?

Well, if you -- well, we don't give out individual company backlogs, but part of the backlog in Belvac, just because of the nature of the projects, is already beyond 2020. But specifically on your question, is there a risk? Yes, there's always a risk. We don't expect it because we like the structural growth drivers of aluminum over plastics in beverage packaging and the supply-demand balance in can making that supports the need for new capacity. So we're going to have to deal with the timing. I'm hoping that we'll convert on the backlog that we have, but I'm not saying -- I can't definitively say that there's no risk there.

Okay. Fair enough. Maybe turning over to DII. A decent portion of this business is consumables driven. So maybe you can kind of help level set in the segment, how much of your business is consumables versus equipment driven? And should we be thinking about the consumables business as being any more resilient? Specifically as I'm thinking about kind of like the textile business, which is a business that's been hit a little bit harder during this downturn.

Yes. Look, I'd refer you back to our 2019 Investor Day presentation that fast-moving consumer goods is nearly half of the marking and coding segment, and over half of the revenue is on the consumables side. So we expect that held up very well in Q1, and we expect that to continue through the year. Where the weakness that we have on the marking and coding business is on the equipment and service side, and that is because of access issues. And we're hoping for that to pick up in the second half. But on the consumables side on Printing & ID or marking and coding, we expect that to do well because fast-moving consumer goods production is holding up quite strong. On the textile-related businesses, that as I mentioned in my opening comments, the textile industry is suffering. We expect that business to have a difficult year. And we're just managing our cost base because it's not unlike the Printing & ID business where our customers are consuming the consumables on the textile business. The activity levels of both machine consumption, which is a capacity or productivity buy, and on the consumables side, which I think are both severely down. So we're just going to have to manage that.

Okay. Got it. No, that makes sense and is pretty clear. I guess maybe just touching the last segment, obviously we've been spending a lot of time kind of talking through the portfolio. But the pumps and process business, about 40% of that business is tied to plastics and biopharma. And you kind of mentioned that piece of the business holding up better versus maybe some of the other industrial or oil and gas applications. I guess as you kind of think through the demand drivers for biopharma and hygienic, I mean, it -- I would imagine that, that's a scenario where there's continued investment in this backdrop and probably remains good for the foreseeable future. And I'd be curious to hear any of your thoughts on that business. And then also on the plastics business, which has been holding up better as well.

Yes, I think it's probably the business that we can be definitive in terms of our expectations for 2020. We had a record shipment month on the biopharma connector business in April, and our backlogs indicate that we don't see that slowing down for the balance of the year. So that's good from both a top line, and it's margin accretive to the segment. So it's the best of both worlds. On the plastics equipment side, as you know, that's a bit more lumpy. It's project driven. Our backlogs have continued to grow beyond Q1, but as -- that's a bit lumpy. But we don't have the indications now that there will be deferrals in the second half because a lot of those shipments are timed to the second half of the year. So our expectation, if you go back to my opening comments to your questions, we said that in a kind of an update in Q2 that industrial pumps were slowing some, so we were taking some actions in terms of production. We're not going to be able to offset that in Q2, but what we have in terms of a tailwind is that if we're able to deliver the backlog that we have in plastics processing, that should let the segment hold up well.

Yes. That's pretty clear. Maybe just one last question on the portfolio since we've kind of gone through it in some good detail here, Rich. I guess as you think about your portfolio today, and there's been a bunch of companies across the space that have been kind of pruning assets. And you guys, over the last several years, have also done your fair share of divestitures. Like do you think you have the right portfolio today? How are you thinking about the portfolio longer term and whether there are portions of it that you would potentially consider putting under strategic review over the longer term?

We review the portfolio in a very robust way once a year, but we're constantly reviewing it. I think that we've been pretty transparent in terms of return on invested capital within the portfolio, both today and what we think that we can get out of individual pieces of it. We'd like to double down on investment where we think that we've got an advantage either in terms of size, scale or technology, but everything's always on the table in terms of doubling down and/or pruning.

Yes. And I'm curious. In this environment where clearly the market is, or at least fundamentals have pulled back a lot, are you getting more interest from private equity or strategics in parts of your portfolio?

On the buying side, no. I think that all of the chatter out in the marketplace is assets coming for sale. Whether it's distressed or a new reality that this is -- I think that it remains to be seen what happens in terms of purchase multiples whether they moderate. I think that the pain has been so short and so quick that it's a bit early for that. But our expectation is as we move into the second half of the year that attractive assets and the purchase price associated with them will become more attractive.

Got it. And then I guess maybe a question either for you or for Brad, but just thinking about your own balance sheet and your cash flow. Your balance sheet is in -- it's in really good shape. And as I think about your free cash flow, I think you're targeting still kind of call it, 100% of net income. How do I think about that in terms of like the historical range? Like you guys have historically given kind of like an 8% to 12% of revenue-type range. Like in this backdrop, is that -- like where do you see yourself kind of shaking out towards the lower end or higher end of that range, just based on what you're seeing?

I'll let Brad handle that one. Go ahead, Brad.

Yes. As you know, percent of revenue will depend a lot on earnings margin performance. We talked a lot about that on this call, given you a view on decrementals and the actions related to reduce costs to demand. So we are focused as we continued move forward here on moving to 100% plus on adjusted net income. That's going to take aggressive CapEx and net working capital actions. As it relates to a percent of revenue though, I mean it will depend a lot on what I just said around what exactly is the demand function in the decrementals and the margin profile. So at this stage, we're really focused on conversion at the net income side.

Got it. Great. And then maybe just one last question for me, and I really appreciate the time today. But Rich, you mentioned earlier that you were happy that you guys have kind of accelerated some of your plans around DBS, just given the environment that we're in today. I mean has any of your like priorities shifted because of this backdrop? And any changes that you're contemplating making strategically across the business because of what we're seeing, whether it's supply chain oriented? I'd just be curious to hear your thoughts on that.

I think that the open question, I mean if we can take anything good out of a really bad situation is that we're running a test case with all of our companies of what we actually need to run the business. And that goes for both in terms of our let's call it overhead, and what we need in terms of general infrastructure to support the business with a significant proportion of our SG&A working from home. So I don't think that we're prepared to articulate it today, but we are very cognizant that there's an opportunity to revisit how we've been conducting business and whether -- and what we're working with the management team is to say, "You're doing a great job. You're taking the actions." But it can't just be, "Well, when everything comes back, we're going to go back to normal." We've got to learn something from what we're undergoing right now. And I think that there's an opportunity for us to make some of the actions that we're taking more permanent in nature. I'm not going to put any kind of guideposts around that, but you just -- we're working very hard and kind of taking a look at how we're going to conduct business once we get beyond kind of the shock of this COVID situation.

Yes. That makes a lot of sense. Guys, Rich and Brad, thanks so much for agreeing to be part of this today and spending time with us. Hope you have a great rest of your week.

Thanks, Joe.

You, too. Thanks, Joe.