Dover Corp (DOV) — Q4 2018 Earnings Call Transcript

Thank you, Maria. Good morning and welcome to Dover's fourth quarter and full-year 2018 earnings call. We'll begin with comments from Rich and Brad and will then open the call for questions. This call will be available for playback through February '19 and the audio portion of this call will be archived on our website for three months. The replay telephone number is 800-585-8367. While accessing the playback, you'll need to supply the following access code 6883448. Dover provides non-GAAP information such as adjusted EBITDA results and guidance. Reconciliations between GAAP and adjusted measures are included in our investor supplement and presentation materials, which are available on our website dovercorporation.com. Our comments today may contain forward-looking statements that are inherently subject to uncertainties; we caution everyone to be guided in their analysis of Dover by referring to our form 10-K for a list of factors that could cause our results to differ from those anticipated in any forward-looking statements. Also, we undertake no obligation to publicly update or revise any forward-looking statements except as required by law. With that, I'd like to turn this call over to Rich.

Thanks, Andrey, and good morning everyone from balmy Chicago. Let's get started on Slide 3. Q4 again organic revenue growth was up 6.2% for the quarter and solid demand trends and engineering systems and exceptionally strong performance in our fluid segment more than offset the continued weak demand environment in Refrigeration & Food Equipment particularly and can making equipment in Food Retail. Thus adjusted Q4 earnings were up 17% driven by top line growth, volume leverage, and cost actions initiated in Q3. Adjusted EPS was $1.43 per share, up 25% inclusive of $0.08 of favorable impact from tax. As we discussed at the end of Q3, we had some heavy lifting to do to offset the Q4 forecast for the trading environment in Refrigeration & Food Equipment. The organization made a determined effort to convert its backlogs, crystallize cost-saving targets, and focus on cash conversion with good effects. Despite the excellent shipping performance through Q4 and many of our businesses, bookings remained solid at the end of the quarter, posting a book-to-bill ratio above one, which were broad-based across the portfolio. Our SG&A rightsizing initiative is largely complete and during the quarter, we began the first projects of our footprint rationalization plan, particularly with the three to one production sites rationalization in Unified Brands, which is underway. In Q4, we took our initial restructuring charge of $5 million as a result of the announced footprint consolidation efforts, which we forecast to deliver $4 million into 2019 and an annualized run rate savings of $18 million. Finally, on the inorganic growth front, last Friday, we completed the acquisition of Belanger, a leading car wash equipment manufacturer, which we announced earlier in the month. Belanger meets all of the criteria for inorganic investment in terms of market attractiveness, execution profile, and return on invested capital that we laid out at our analyst day in September. It's been a busy quarter for the Company; I’m pleased that we were able to deliver solid top line growth and generate significant cash flow from operations while concurrently delivering on our productivity initiatives since September. So that’s the balance of the opening comments. From here, I will pass it on to Brad.

Thanks, Rich. Good morning, everyone. Let’s go through the details starting on Slide 4. As mentioned, our results for the quarter were driven by strong demand in Engineered Systems and Fluids, solid margin conversion on revenue growth and cost actions. Adjusted segment EBIT increased 9% to 285 million and adjusted margin was 15.7%, an increase of 80 basis points. This performance reflected strong growth in conversion in Engineered Systems and improved performance in Fluids, partially offset by lower volume in Refrigeration & Food Equipment. Adjusted segment EBITDA was 352 million. Adjusted earnings were 211 million in the quarter, and adjusted diluted EPS was $1.43, an increase of 25% over last year. The EPS increase was supported by share repurchases and a lower tax rate. Full year 2018 results followed the same narrative as the fourth quarter. Results were largely driven by strong growth across our Engineered Systems and Fluids segments, partially offset by lower volume within our Refrigeration & Food Equipment segments. Adjusted full year 2018 segment EBIT increased 4% to just over 1 billion. Adjusted EBIT margin was 14.8%, an increase of 30 basis points driven by stronger conversion on revenue growth and by the impact of our margin improvement plan. The effective tax rate for the full year was 21.4% when normalized for discrete tax benefits, excluding the additional Tax Act regulatory guidance covered by SAB 118.

Thanks, Brad. Let’s go on to Slide 9. Engineered Systems had a solid broad-based quarter with top line organic growth of 4.3%. Incremental margin conversion in the quarter was excellent, driven by favorable mix and cost actions largely in the printing and IT platform despite a more modest top line growth rate in Q4. The industrial platform performed well across the board as our CapEx levered businesses continued to operate in a constructive demand environment, all posting top line comparable revenue increases. Our ESG business continued to deliver strong results with a robust positive bookings trend building a runway for solid forecasted performance for 2019. OKI, DESTACO, and TWG all finished the year contributing solid single-digit growth and margin expansion as microwave products delivered as expected in a robust military spending environment. Going into 2019, bookings for engineering systems remained solid. We expect the segment to contribute positively to both the top and bottom line despite the forecasted FX headwinds in our businesses that are materially exposed to Europe predominantly marking margin digital printing and ESG. The Fluid segment posted organic growth of 17% for the quarter with the majority of the portfolio posting double-digit comparable growth rates. Incremental margins were solid for the quarter as volume leverage and cost controls were able to offset the impact of favorable product and geographic mix. Refrigeration & Food Equipment revenue declined in the fourth quarter with the segment's organic revenue down 10%. We expected another difficult quarter at Belvac, and in retail refrigeration results came in line with forecasts; margin performance in the quarter was negatively impacted by volume in refrigeration and mix at Belvac. The segment also incurred transitory costs associated with product rationalization programs in refrigeration and preparation for our automation efforts that will build out in 2019. Positively, retail refrigeration bookings were up for the first time in six quarters during the period as project activity has increased. We’ve begun in earnest to address our footprint and productivity actions by starting in our Unified Brands business as it presents the clearest path to improving margins in the segments. We are in the planning and preparation phase for our automation and production consolidation programs in refrigeration and have committed 2019 capital spending to fund these projects. We're cautiously optimistic for improved revenue performance in 2019 for the segment based on our initial order backlog and retail refrigeration activity as you see in our full-year guidance.

Maria, we can open up to the Q&A.

I'm curious about the increase in CapEx next year, yet you are still guiding for 8% to 12% of sales and free cash flow. Could you clarify, given the restructuring noise this year and some working capital challenges? Please help us understand how to connect these points and other factors aside from CapEx.

Sure, as Brad mentioned, we provided a normalized cash flow for the impact of restructuring operations, which is just under 10% for the year. With strong revenue growth in Q4, some cash flow was tied up in receivables. Looking ahead to next year, the revenue growth will not maintain that same momentum, so we will see some of that Q4 revenue reflected in cash flow. Honestly, we are not operating at full capacity in terms of cash conversions. I expect to cover the $30 million to $40 million over the year, and we have the ability to achieve that. I understand we forecasted an increase in CapEx, but we are confident in the projects we are undertaking. Yes, I mean, look at digital printing in terms of its margin performance year-over-year did a fantastic job. But as you know, these are high dollar printers, so the revenue tends to be a little bit lumpy. It is reflected in our book-to-bill in printing, and ID is not so much the Markem-Imaje piece; it's more just the lumpiness of the orders, but our expectation for digital print for 2019 is to increase revenue.

I would just add that Markem-Imaje has been steady all year long at above one book-to-bill; that business remains solid for us.

I think it's not any particular customer. It's broad-based since our traditional customers. I think overall it's just a reflection of capital investment in retail food has been low for quite a long period of time, and it's coming off easier and easier comps as regards to the cycle. If we go back and look at Belvac's performance over time, it's a lumpy business. I think it's just become more material to the segment because the refrigeration segment has shrunk so much. So, there is nothing particularly wrong with Belvac because it’s a CapEx driven business from the beverage side, and it was just a bad year, a lot of projects got deferred. On the working capital slide of DFS or retail fueling, I think we have the conversion on our orders was as strong in Q4. So, we go into 2019 with not a lot of inventory, but we do have the receivable balance from that strong growth. So in total working capital, we highlighted that we were going to build safety stock to accommodate what we thought was going to be a robust demand environment. We got it, but from a working capital point of view, if there is any negativity of growing, it's the fact that we are hung up on receivables.

When I talk about EMV, just a reminder, I'm not talking about dispensers that are EMV ready. It's really the component pieces and we see on track and track it very, very carefully. I would say the second half of '18 including the fourth quarter was above '17. So, we came out of that air pocket in the first half. Sequentially, we go into '19 and we see growth sequentially and solid year-over-year growth in EMV.

Overall, I don't think there is anything in there except for the fact that we've been on a pretty good trend with the exception of refrigeration, being in a good place in terms of top line growth, and there is an overhang and worry about our supply chain causing delays. Yes, we have been having quite the dialogue around here between our very good performance and conversion and how that affected the top line versus what our guidance was going to be versus the market saying that there's a slowdown in horizon and everything else. We feel great about what happened in Q4. I don’t think that we can keep that level up through the year, but there's no reason for us not to be at the top end of the range. I think I will feel really good if we execute our plans in 2019. I mean 2018 was a tough year for the management of the business and for us. I think we got a good plan. I want to see this executed. Yes, I think the way to answer is twofold. When we had the meeting in September, we said that the priority was to go after SG&A first because it was a one-for-one benefit, and it was in your control so you can execute it. Now we said we moved on to footprint, which is a lot more risky and the timing of acting on footprint is a lot longer.

This concludes our conference call. Thank you for your interest in Dover and we'll look forward to speaking to you next quarter.