Dover Corporation (DOV) Earnings Call Transcript & Summary

So welcome. It's still morning in New York. I guess it's afternoon in London or other places probably, early on the West Coast. So our next speaker is Dover. And we have Rich Tobin presenting, company's President and CEO. I've been a long-time fan of Rich since his days at CNH as the company's CFO and CEO. And I think our call when he showed up at Dover was that he's going to be a transformative CEO. I think we are right in more ways than one. So I'm very, very glad to have Rich here. And I think the way we're going to do this is we're going to go straight into the fireside chat. Those of you who know Rich, he is blunt and direct. So this is one of the most fun. This should be one of the most fun sessions. And if people have questions, the way to do it, what people have been doing, Veracast, that has worked very well. And also feel free to send it to me on Bloomberg IB. And we've done, I think, a fairly good job of incorporating your questions in our previous fireside chats.

And with that, I'm going to start out with Fueling Solutions and EMV. So Dover has sized the '21 EMV revenue decline at less than $50 million, Vontier saying $100 million to $150 million. Both of you think the EMV adoption rate today is 70%. So why the difference in pace of revenue decline between you and your big competitor in the U.S.?

Well, I think that they've begun to walk back that $150 million, but that's up to them. Look, the difference between the 2 of us is our geographic exposure is different. EMV adoption is a North American issue. It's not a global issue. Europe has already gone through an EMV transition that had been reflected in our revenues previously. So I think it's an exposure issue and a size issue, which would lead to a disparity between the 2 of us. To give you an update, I mean, we made a special presentation on this back in November of last year, which outlined all of our thoughts around the segment, inclusive of EV penetration rates and a variety of other things. We said at the time that we thought it was a $50 million headwind for '21. That remains true, except for the fact that we closed on an acquisition in that segment on December 29. Its revenue base is approximately $50 million. So we've neutralized the negative impact of EMV roll-off for '21 through inorganic investment. And the trajectory in terms of the adoption remains more or less at the same pace as it was closing the year. December is always a funny month just because of weather. The same thing with January that there's the pace of what we see from the revenue side has not changed for the worse or the better despite the deadline for adoption is the end of...

Got you. And what are we seeing? When I was in China and I saw the world's best pipe extrusion operation, I think the view was that the most efficient pipe extrusion operator -- double-wall pipe extrusion operations, sorry, double-wall pipe. I think the view was that after the expiration of the upgrade, you would have to go back and probably retrofit some of the work that was done by lower-end Chinese competitors. What are you seeing on sort of double-wall tankers in China? Because it's bigger than I think people realize. It was quite a material source of growth for you when it was happening.

It's still quiet. So a lot of that is the 2 principal drivers of the behavior of the NOx, which take their direction from the center. And right now, the activity was low in terms of build-out by the NOx on the retail operations in the latter half of '19 and through '20. We don't see that changing much so far in '21. We'll see. And there's not a lot of regulatory push going on in terms of the upgrade of the cycle. I mean these things -- because there's so much central direction, especially when it comes to regulatory compliance, they come in waves. Right now, we're at a relatively benign point in time. So built into our forecast does not incorporate a big snapback in activity of China, either on the underground or the aboveground side. So we'll see how that develops through the year, but it's not a net negative for us, what's baked into our forecast right now.

Got you. So maybe another thing, retail refrigeration improvements. Can you talk about the benefits you will see from the $40 million on automation project in retail refrigeration? What's the payback period? And when should we start to see benefits from the P&L?

You'll see the benefits in the P&L this year. The payback period, I'd have to go and refresh it. It's within 3 years at steady state. It's, I'd say, 87% operational right now. So we're doing some amount of manual work in terms of line feeding and everything else. But the balance of all of the operation has been stood up. The big trick was to build the backlog to run continuous operations. And I'll give you an update in terms of where we are. We exited '20 with a healthy backlog. That backlog has actually increased year-to-date. So despite the fact that we're -- this is a business from a seasonality point of view. You don't expect a lot of activity in Q1 and Q4. Despite that, we are and have been producing and shipping in Q1. So we're getting the fixed cost absorption benefit of that. And the backlog continues to build. So we did 12% margin in that business in Q3 of last year. Under current course and speed, I would expect to exceed that in Q3 of '21.

Got you. And what is driving this upside? Just what's the industry dynamic that's driving this upside in retail refrigeration?

A couple of things. We would have expected to get some growth in '20, but the pandemic just blew that up. So what we had was another deferred year of capital expenditure either for greenfield build-out or refurbishment. We just went through a cycle of 4 years of declining level. You would expect some amount of cyclicality in terms of maintenance repair and build-out. But I think that was exacerbated by the fact, like many industries, retail food went through a fear of disremediation because of Amazon buying Whole Foods and this notion of that everybody was going to get all of their food delivered to their home. So a lot of capital expenditure was taken away kind of from existing footprint and moved to buying web companies and standing up websites to allow for ordering and everything else. I think what crystallized the whole issue was the pandemic, the inability to go to restaurants. You have to go buy food. It drove retail traffic up significantly and it also crystallized this notion of how long is a piece of string and what's the operating model. From the worst-case scenario, there's these mega warehouses with fleets of trucks delivering bananas as opposed to it never happens. What you ended up with is a hybrid model, where online ordering with in-store pickup seems to be the sweet spot for global retailers. They've deferred their capital expenditure programs for multiple years. And what they compete on as a retail operation is the cleanliness of their stores. So when you talk to customers, how they make decisions about where they shop, sure, there are different price tierings, but a lot of what they do is what the facility looks like. So we're now moving into what we believe to be a multiyear refurbishment CapEx cycle, which is good for us. So we're expecting to do higher than single-digit revenue growth in this particular business this year. We would expect that to be a 3-year dynamic, so 10, 7, 5 if we were to guess at this point. So I mean, look, I think that, that's kind of the cycle that we're in. That's why we believe that these -- this is not just a temporal snapback of deferred CapEx of last year. We believe that it's got some legs to it. Lead times right now are longer than they've been in my tenure here, which is important because the longer lead times that we have, the better that we can plan production. And that leads to margin expansion. So we feel good about where we are on -- with our retail customers and the business model and the products that we supply to them, which is not just case and door. We do a lot of kind of small format. We do a lot of grab and go. All those platforms are growing. The regulatory environment is providing some opportunity with this change to natural refrigerants. We've been a leader in CO2 for retail food in Europe for several years, and we transferred that technology -- production technology to the United States last year. And we're seeing some good growth on the back of regulatory changes by Carbon California, which we would expect to be adopted throughout the United States progressively over the next couple of years. So I think we waited a while. I think that we went against the grain and invested in the business. I think that we're confident in terms of reaching our margin targets. And we're increasingly confident on the revenue growth profile of the business through the next cycle.

Great. That's actually a great story. Maybe we can sort of talk about municipal budgets. You've got exposure to municipal budgets from selling garbage trucks, 1/3 of the segment. We know that Q1 '21 is fully booked. But is there a risk that unit sales decline in 2021?

We cut production pretty heavily last year because we believe that the muni clients were under pressure. And then we thought that our private clients, just like everybody did during the pandemic to preserve cash, cut CapEx. So I think that we were at the front foot in that business in terms of protecting margin. Our backlog is -- was building in Q4, and it was healthy into Q1. We're not going to ship off all of that backlog in Q1. So it's probably our hardest comp for that particular business is Q1 to Q1. And then it will get progressively better because that's when we intervene on our production, largely at the end of Q2 through the second half of the year. We'll see what happens with the municipalities. What we've built into our forecast is not for it to shrink again because it was actually quite low for a variety of reasons in '20. And then we'll see what happens in terms of all of the state funding and whether any of that gets driven into municipal budgets and what they want to do. Look, at the end of the day, we believe that this is a growth platform. Waste -- the amount of waste generated does not go down any year. It is a reflection of economic activity. So we believe economic activity is going to increase. It will lag somewhat, but we will be a participant in that. And I also think that we've got some unique solutions outside of the truck body in terms of being able to measure operator performance, operator safety and to do dynamic billing on the truck are something that's being welcomed by our customer base. So in May -- I think we'll start the year with some tough comps, but we're confident in terms of the full year performance.

Two questions, just to follow up on what you said. So the first one, does the stimulus -- does the President stimulus plan figure in your forecast? Or is it fairly neutral to -- did you have sort of a form of stimulus in your forecast when thinking about municipal budgets? That's the first question. The second one, you're going to like more.

Okay. The first one, we did not factor in the stimulus, but we did not believe the municipal spending would decline further in '21 versus '20.

Got you. And the second one, it's interesting you sort of talked about automation solutions and software solutions in the segment. I know that internally, it is a very, very big focus. Can you just talk maybe more about what have you been able to do in this segment and how can you take that experience and sort of take it across Dover? Because, as I said, I know it's a big, big internal focus for you guys.

Yes. Look, software in industrials is a popular thematic for a variety of reasons. I mean we look at software as an adjacency to existing positions that we can build upon. So more of the reoccurring revenue stream and bringing value-add to our customers as a base that we can build around the traditional good that we sell. So if you think about the truck body, in the past, what we were is a body builder. We receive the chassis, we build the truck body to spec. We put the truck body on, and we'd ship it to our clients whether they be private or public. Over the last 4 years, we've made 2 acquisitions, 1 on camera-based technology, primarily around safety at its onset because one of the cost to our clients is safety management with the operator side. And then what we've done with that is broaden that product offering not only to include safety, but to allow dynamic billing. Because if you know anything about this industry, you bid for contracts, which is very difficult because you basically say, "I'm going to do this service for this amount to customers over a 3- year period, and I'm going to charge it X, maybe with some fuel surcharges built in." The way that we believe that the market is going to move, especially in the industrial side, is to do dynamic billing because you don't -- you're not allowed to bill -- well, it's very difficult to bill for underfill and overfill. And the economics say if you can move to the model -- or I pull up to an industrial container that's behind a -- let's call it a manufacturing site for lack of a better word. As I pull up to it, I take a picture of it, if it's overfilled, here comes the surcharge that one of our clients can charge. So that's very important to the big national operators because they are the ones that bid for the lion's share of the big industrial contracts. We follow up that investment with a back-office software, which just allows to do the billing and take the payments. And that -- so what you have now is an integrated offering where I buy the truck body. I get the safety camera benefit in terms of reliability on safety. And I also buy the back-office system that allows the smaller operators to do dynamic billing. So we've installed a lot of these units with some of the bigger public operators, and it's been very successful in terms of revenue growth and gross margin expansion. But we have just scratched the surface in terms of municipalities and a very fragmented private operator base.

And is this approach scalable to your other businesses? Can you sort of -- it seems that you've taken sort of stand-alone pieces of technology and were able to sort of integrate it into your day-to-day workflow. Do you see opportunities like that elsewhere in the business? Or is this a unique business? Or are you tasking sort of folks at other businesses to look at something similar?

Well, I mean I think that the business model itself is interesting across a variety of portions of the portfolio. So there's a lot of learning that -- between the operating company presidents that see success over here and saying, "You know what, I can do that same model." In terms of scale benefits, the scale benefits that Dover brings is these are cloud-based solutions that require sophisticated kind of infrastructure behind it. A lot of the work that we've done over the last 2 years was to consolidate an incredibly fragmented IT infrastructure to allow that transition to happen with all of the required, whatever, safety is the wrong word, but you have to be careful when you sell software, right? I mean for a variety of different reasons, especially when you're doing billing and other things. So by bringing the scale benefit of Dover and by doing the consolidation of our server footprint, it allows these smaller companies to use the scale benefits that we bring to them to deliver cloud-based services, which are on their own. They just don't have the capability to do it at a cost-effective basis.

And just a follow-up to this. So what piece of the portfolio you think have the most opportunity to move? Clearly, I think, this is the business that has done it very well. But what's the next piece of the portfolio to move up the learning curve, to add software sort of through bolt-ons or organic?

Look, I mean the bigger opportunity is a significant portion of our portfolio sales goes to market through distribution, all of which can be digitized, right? I mean you're taking catalog-based businesses with traditional sales force and you're basically uploading all of that business into a digital format, which allows you to do direct interface with our customers that a lot of times are application engineers without having all the frictional costs of traveling around and discussing these up and going back and forth. You could just put these on digitized platforms, which is a lot of the work that we're doing, especially the ones that -- the business model is through distribution because we think that we can take out a significant amount of the traditional sales costs of that interaction. You get the ancillary benefit of once you move to a platform like that, of being able to do SKU management effectively because you can see your order data. You can do production planning more effectively because you're seeing real-time as orders build up. And you can do pricing more effectively because this notion of standard lead times cost X; standard product, it costs Y. If you want that varying, it costs B. To the extent that you can move what has been a traditional model businesses up into a digital platform, I think that, that is part and parcel to a lot of our expectation of widening margins over the next 2 to 3 years.

Got you. Maybe we can sort of focus on imaging and ID. So a, you've also done some -- so 2 questions. A, what are you seeing near term in this business because it is very sort of sensitive to short-cycle economic activity? I think there was this whole question about what's happening with fast fashion, and this industry has its own sort of selling cycle tied to some big shows. But -- and also, once again, on imaging and ID, I think it's another example. You bought a small software company that does pharma ID coding, Systech. And just strategically, what can you do in imaging and ID in terms of continuing to build out this platform that has worked very, very well for you over the years?

Okay. Well, let's split the answer. The traditional printing and ID business or Markem-Imaje actually did very well last year despite the pandemic. The pandemic was difficult because of getting access to our customer sites, which depressed printer volume or hardware volume in '20. But because of fast good -- consumer goods lifting off through the pandemic, the amount of consumables consumed last year was actually quite good, which is very margin enhancing. And during all of that, there was a lot of really good work by the management team, worked on their cost structure in 2019 that rolled over into '20. So unfortunately, that was -- that performance was masked by the textile printing part of the business, which suffered greatly during the year. But going back to the printing and ID business, look, it's -- if not the, it's one of the highest gross margin businesses that we have in the portfolio. It's attractive because of its market structure, which is more or less a global triopoly. It's attractive because of the percentage of revenue that is consumable goods at very attractive margins. But it's consolidated. And so its growth aspects are what you would expect, low single digits, mid-single digits depending on the year and everything else. So to grow that business, you need to move into adjacencies or into enhancing the products. We did a smaller acquisition that we built out our laser product offering. We closed that in the first half of the year. And then we did an adjacency into Systech, which is more in track and trace as opposed to just serialization because a lot of we believe we can take is a pharma software company for track and trace who are the early adopters for obvious reasons and bring that to high-value consumer goods. It's going to take some time to get there because we need to work on the nuances of the application to be attractive there. But we believe it's structural that track and trace software or track and trace itself is going to become much more attractive to high-value consumer goods over time. So that's of an adjacency building off a position that we have with existing customers outside of kind of the traditional printing and serialization business. On the textile side, yes, look, at the end of the day, if any industry got suffered with the global textile industry for all the reasons we understand, shopping mall traffic and a variety of other things, we -- our revenue was down 40%-ish, if not more. And that business between '19 and '20, that is margin-enhancing business to the segment. I think that we've got a forecast that builds in some return or some acceleration from a low in '20. But we believe that, that's likely to be a second half of the year story and much more a '22 story rather than a '21 story. It's going to take some time for that industry to ramp up just in terms of production capacity before they move into a CapEx cycle.

So -- and that's what you're observing here today, right?

Right now, we're doing a lot of -- what we can see is ink consumption is going up month after month, which means the machines in the field are coming back online. And we're doing more quoting about new machines in the marketplace, but we need to see that quoting move into tangible backlog.

So another sort of topic that I think sort of -- you've been sort of laser-focused on, structural cost improvement, right? So order of magnitude, $50 million a year out of $1.5 billion SG&A spend. That's 2% productivity lift to a year. How sustainable is this? And how much of a runway do you have? I know you've gotten this question before once or twice. I don't -- I think I know what the answer is too, but I'll just ask.

Yes. Look, back in 2018, it was very important to be very definitive about structural cost takeout and what that meant. I think quite frankly, we're -- we may have taken that a little bit too far because some of the feedback we began to get in the beginning of '20 was, well, this is a cost takeout story. And when do you run out of room? Because when you run out of room, I got to get out of this because the margin enhancement goes away. Fair enough. But look, I look at the $50 million as a percentage of COGS. Forget SG&A. So it's not herculean to take out $50 million a year in structural cost year after year after year after year. We've got plans that stretch well into '22 right now on footprint alone, right? But those are complex projects, and we have to be careful. So if $50 million is the bogey that everybody wants, fair enough, I'll give you $50 million as long as I'm here year-over-year in structural cost takeout. And by the way, that dwarfs in comparison to the expectation in raw productivity that we push down to our operating yards. So I think we need to move away from the structural cost takeout. I think it's -- it is what it is. I think that the opportunity set is there. If people want to size it, go ahead and put $50 million there. But I -- to me, what we're going to get out of raw productivity and mix enhancement is significantly larger than that opportunity.

No. I mean, look, Rich, I think over time, we'll see people get more and more comfortable because I think best-in-class companies absolutely get credit for being able to do it for 10, 20 years. And that seems to be sort of where you guys are moving in terms of investor sentiment. So hopefully, we'll stop asking that question. Sort of automation projects. You announced 2 small automation projects for '21 on the fourth quarter call, one in vehicle services group and one in ESG. Can you tell us a little bit more about those?

Look, I mean at the end of the day, we do a lot of benchmarking around here between external comps and internal comps. ESG and VSG are really good businesses. We like them in terms of their participation within the market structure. We like them in terms of what we think that we can do from a growth- and margin-enhancement point of view. But the fact of the matter is that from a gross margin point of view, that they're in the bottom half of the portfolio. So we need, at times, to intervene on these production processes where we can to lift that gross margin. And sometimes, that takes CapEx to do it. And we shouldn't be afraid of deploying CapEx to drive margins into the future. We did it with refrigeration. And now we're circling back, and we're going to do with VSG and ESG because we think that we've got some opportunity to take traditional manufacturing processes and move them into at least a bigger proportion of automation. And to the extent that we get it right, it should have a good impact in terms of its gross margin. So many you can do in a given year. It's not a question of we're starving these businesses of capital, but these are relatively large interventions that were taking place during this year. We would expect to see the benefit of these interventions in maybe the latter half of '21, but clearly in '22 and beyond.

Yes. One of the internal discussions we actually had is that everything you're doing, I remember, is sort of Dover old. You always had to sort of figure out which business could miss in -- like 5, 10 years ago would miss every quarter. And that seemingly is gone. And from that perspective, right, what is -- how should we think about -- as you put together -- your focused on cost, your focus on automation, all these growth initiatives, how should we think about sort of medium-term growth algorithm for Dover, right? Meaning, if GDP is X, how much of outgrow should we think? How much of capital deployment? And what kind of incremental margin should we think? Because clearly, I think your guidance for '21 is showing emergence of this framework that you have publicly stated multiple times. But maybe just unpack it for us a little bit, what are the key components. Because I think it's a very different way of thinking about Dover where top-down, actually, that's what gets you the answer as opposed to sort of thinking about sausage-making business in Germany.

Yes. Look, I think -- and we've talked about it. I mean I think that we're getting credit for being able to run the assets more effectively and a pathway for margin expansion that is not solely dependent upon revenue growth by business, right? I think there's an operating model there that allows for a believable pathway of center-led initiatives, arbitraging cost away from across the portfolio, which is -- which allows the individual businesses to concentrate their efforts on product development, R&D and customer management that kind of drives this cycle. So we went through a phase of cost takeout. We went through a phase of more investor transparency with the resegmentation, which we did, at the same time, change the management structure here and push down autonomy for customer management and R&D but, at the same time, took away autonomy for central processes whether that be IT or benefits administration or a variety of other noncustomer-facing initiatives. The next question that even we had internally was, "Okay, we've been making good progress. What happens in the downturn?" Whether we like it or not, we dealt with '20, and that was a real good test for the individual management team. Could they manage up-cycle, down cycle? I mean I think that we're one of the few of our industrial peers that expanded margins in '20 despite the fact we had a negative 6% growth in the top line, which is part and parcel to -- if you've got cost initiatives that are constantly running through your portfolio year after year, it provides you a buffer against any kind of volatility for temporary cyclicality in terms of the demand cycle. So we end up here today where I think that we're confident in terms of the operating profile of the business. I think we're very confident in the management team that we have out there, managing the product and the customer-facing aspects of the business. And now we're moving into more of capital deployment. So before we get into capital deployment, so despite all that and some credit that we're getting at being more effective operationally, I guess, when we got on this -- I got on the soapbox, I think, at the end of the year, if I look out for organic growth projections for Dover outside of the forecast year, it just looks low and it doesn't give us credit for just the inherent growth rate, organic growth rate of the portfolio even without inorganic investments. I mean we're bottom quartile, and I don't know why. So we're going to spend a lot, I guess, this year of kind of moving the messaging on to this is a platform that can expand margins and, by the way, grows higher than 3% organically as a total portfolio. So that means -- so to me, if I -- if you believe that we can get 1% realized price increases year-over-year,and we get 1% of growth because of mix, that leads me to a 1% embedded organic growth rate, which I find to be conservative, right? So it's up to us to kind of move that narrative on because if I look at average implied growth rates out there for Dover right now, it's 3% for 2022, and we're going to have to solve that. On the inorganic side...

The problems we have -- a lot of companies that had the opposite problem, the opposite problem doesn't end well.

Well, the good news is let's move to the inorganic side. In 2018, we basically came out and said, "We're going to take some time. We're going to be internally focused. We're going to concentrate on our own knitting, and we're going to deliver some margin expansion." And that would -- we did it. So and not to get crazy, but at the end of the day, because we've got an operating system that stood up, because we've got a management team that can execute, I think we're now transitioning into more portfolio management, which implies, hopefully, more inorganic investment than we've done over the previous 36 months. I don't want that anybody to walk away and say, "You know what, we're going to start swinging for the fences around here or we're going to go and enter in a new segment and we're going to get into something that we don't know how to operate or we're going to chase some thematic, whether that's software or water or whatever you want because multiples are what they are." But on the other hand, we're at the point now because the margins expanded and the cash flow is going up that we're at a tipping point of we're either going to be more aggressive on the inorganic investment. But if we can't get the capital returns we want, then we're going to be more aggressive on the capital reduction.

I think we are right on time, and I think that was a great answer. I think that sort of summarizes our thesis on your stock. So very happy you gave that answer. And it's always a pleasure to have you, and I really, really appreciate you joining us. And I hope sooner rather than later, we all can do this in person. Thank you so much.

See you, Andrew. Thanks.

Thank you.