Dover Corporation: Q1 2016 Form 10-Q Summary
Business context and reporting period
Dover is a diversified global manufacturer operating through four segments: Energy, Engineered Systems, Fluids, and Refrigeration & Food Equipment. This unaudited Form 10-Q covers the three months ended March 31, 2016, compared with the same period of 2015.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $1.622 billion | $1.716 billion | Down 5.4% |
| Gross profit | $589.3 million | $627.2 million | Down 6.0% |
| Gross margin | 36.3% | 36.6% | Down 30 basis points |
| Operating earnings | $145.8 million | $192.5 million | Down 24.3% |
| Operating margin | Approximately 9.0% | Approximately 11.2% | Lower |
| Earnings from continuing operations | $99.4 million | $117.2 million | Down 15.2% |
| Diluted EPS from continuing operations | $0.64 | $0.72 | Down 11.1% |
| Net earnings | $99.4 million | $209.5 million | Prior year included $92.3 million from discontinued operations |
| Operating cash flow | $133.4 million | $131.3 million | Up $2.1 million |
| Free cash flow | $96.2 million | $103.4 million | Down $7.2 million |
Selling and administrative expense increased 2.0% to $443.4 million, or 27.3% of revenue versus 25.3% in the prior year, reflecting acquisition-related costs, deleveraging, and lower revenue. Net interest expense was $31.7 million, essentially flat year over year. The effective tax rate declined to 22.1% from 28.8%, including favorable discrete tax items of $7.3 million in 2016 and $0.7 million in 2015.
At March 31, 2016, cash and cash equivalents were $243.7 million, total debt was $3.016 billion, and net debt was $2.773 billion. Net debt to net capitalization increased to 42.8% from 39.6% at December 31, 2015. Dover maintained a $1.0 billion unsecured revolving credit facility, had not drawn on it, and was in compliance with debt covenants, with a coverage ratio of 12.3 to 1.
Material changes versus the prior comparable period
- Revenue declined organically by 7.4%, with additional unfavorable effects from dispositions of 2.5% and foreign currency translation of 1.4%, partly offset by 5.9% acquisition-related growth.
- Energy revenue declined 34.2% and segment earnings declined 78.5%, primarily because of historically weak U.S. oil and gas activity, lower rig counts, and reduced customer capital spending. Energy operating margin fell to 4.0% from 12.2%.
- Fluids revenue increased 17.3%, primarily from acquisitions, including Tokheim, but organic revenue declined 3.4% and segment earnings fell 15.7%. Fluids operating margin declined to 11.5% from 16.1%.
- Engineered Systems revenue increased 0.7% and segment earnings increased 6.4%, supported by organic growth and productivity improvements.
- Refrigeration & Food Equipment revenue decreased 2.4%, while segment earnings increased 5.6% and operating margin improved to 10.5% from 9.7%.
- Dover acquired Tokheim’s dispenser and system businesses on January 7, 2016, for $436.1 million net of cash acquired. The acquisition added $281.9 million of goodwill and $176.7 million of intangible assets and was included in the Fluids segment.
- Dover sold Texas Hydraulics for $47.3 million and recognized an $11.2 million pretax gain. The transaction was not classified as discontinued operations.
- Restructuring charges declined to $14.4 million from $24.1 million. The company expects approximately $40.0 million of restructuring expense for full-year 2016 and expects programs to be substantially completed within 12 to 18 months.
- The company repurchased no shares in Q1 2016, compared with $200.1 million of repurchases in Q1 2015. The remaining authorization was 6.8 million shares.
Guidance, outlook, risks, contingencies, and unusual items
Management lowered its full-year outlook because of continued weakness in oil and gas markets. It expects revenue to decline 2% to 5%, including organic decline of 5% to 8%, acquisition-related growth of 4%, and an unfavorable foreign-currency impact of 1%. Full-year diluted EPS guidance is $3.51 to $3.66, including approximately $0.18 of restructuring charges, $0.05 of discrete tax benefits, and a $0.07 disposition gain. Management expects full-year free cash flow to approximate 11.0% of revenue and capital expenditures to approximate 2.3% of revenue.
Principal risks include oil and natural gas demand and pricing, customer capital spending, global economic conditions, foreign exchange and interest rates, acquisition integration, cost-reduction execution, pricing pressure, raw-material costs, customer concentration, legal and environmental matters, intellectual property, regulation, financing access, and credit-rating changes. Management concluded that the decline in oil and gas markets had not triggered an interim goodwill impairment test.
Environmental and other probable, estimable matter reserves totaled $32.5 million at March 31, 2016. Letters of credit and guarantees outstanding totaled approximately $91.8 million. Management stated that no pending legal proceedings were expected to have a material effect on financial position, results of operations, or cash flows. Potential reductions in unrecognized tax benefits over the next twelve months were estimated at approximately zero to $19.6 million.
Important facts for investors to verify
- Whether oil and gas market weakness, rig counts, and customer capital-spending reductions continue to pressure Energy and Fluids results.
- Tokheim’s revenue, margin contribution, integration progress, and effect on leverage and cash flow.
- Progress against the approximately $95 million to $105 million of expected 2016 cost savings and the approximately $40 million restructuring forecast.
- Ability to achieve the revised $3.51 to $3.66 EPS and 11.0% free-cash-flow outlook.
- Changes in commercial paper borrowings, cash balances, refinancing needs, and the 42.8% net debt-to-net-capitalization ratio.
- Whether goodwill impairment indicators emerge in Energy or other businesses exposed to oil and gas markets.
- Actual results excluding the prior-year $92.3 million discontinued-operations benefit and the current-year Texas Hydraulics gain.