Dover Corporation — Form 10-Q Summary
Business Context and Reporting Period
Dover Corporation filed its unaudited Form 10-Q for the quarter and six months ended June 30, 2018. Following the May 9, 2018 pro rata spin-off of Apergy Corporation, Dover reports three continuing segments: Engineered Systems, Fluids, and Refrigeration & Food Equipment. Historical Apergy results are presented as discontinued operations.
Key Financial Metrics
| Metric | Three Months 2018 | Three Months 2017 | Six Months 2018 | Six Months 2017 |
|---|---|---|---|---|
| Revenue | $1.798 billion | $1.737 billion | $3.436 billion | $3.321 billion |
| Gross profit | $665.2 million | $654.1 million | $1.268 billion | $1.230 billion |
| Gross margin | 37.0% | 37.6% | 36.9% | 37.0% |
| Operating earnings | $236.5 million | $232.8 million | $404.3 million | $383.0 million |
| Earnings from continuing operations | $166.5 million | $142.5 million | $275.9 million | $297.6 million |
| Diluted EPS from continuing operations | $1.08 | $0.90 | $1.77 | $1.89 |
| Net earnings | $140.0 million | $164.1 million | $271.4 million | $336.3 million |
| Diluted net EPS | $0.91 | $1.04 | $1.74 | $2.14 |
Second-quarter revenue increased 3.5%, supported by 3.5% organic growth, 0.4% acquisition growth, and 2.2% favorable foreign currency translation, partly offset by a 2.6% decline from disposed businesses. Six-month revenue also increased 3.5%, with 2.6% organic growth, 0.5% acquisition growth, and 3.2% favorable currency effects.
Second-quarter earnings from continuing operations increased 16.8%, while six-month earnings declined 7.3% primarily because the prior-year period included a $90.1 million pretax gain on business sales, including the PMI divestiture. Excluding the PMI gain, management stated that six-month continuing earnings increased approximately 17.0%.
- Segment performance: Second-quarter revenue grew 3.6% in Engineered Systems and 9.5% in Fluids, but declined 5.8% in Refrigeration & Food Equipment.
- Segment margins: Second-quarter margins were 18.0% for Engineered Systems, 13.4% for Fluids, and 12.8% for Refrigeration & Food Equipment.
- Taxes: Effective tax rates declined to 21.3% from 28.1% for the quarter and to 20.2% from 26.5% for the six months, mainly due to U.S. tax reform.
- Dividends: Dividends paid were $0.47 per share for the quarter and $0.94 per share for the six months, compared with $0.44 and $0.88, respectively, in 2017.
Cash Flow, Debt, and Liquidity
- Six-month operating cash flow was $174.7 million, down from $198.2 million, primarily due to increased working-capital investment and higher compensation payments.
- Capital expenditures were $96.4 million, producing free cash flow of $78.4 million versus $119.3 million in the prior-year period.
- Cash and cash equivalents declined to $242.8 million from $754.0 million at December 31, 2017. Approximately $153.2 million was held outside the United States.
- Total debt was $3.260 billion, including $284.6 million of current debt and $2.975 billion of long-term debt. Dover repaid $350.0 million of notes maturing in March 2018, partly funded with commercial paper and cash.
- Dover maintained a $1.0 billion unsecured revolving credit facility expiring in November 2020, had no borrowings under the facility, and was in compliance with debt covenants. The interest coverage ratio was 10.9 to 1.0.
- Net debt to net capitalization increased to 51.5% from 39.1%, principally because of the Apergy separation, share repurchases, dividends, and lower cash balances.
Material Changes Versus the Prior Comparable Period
- Apergy separation: Dover distributed Apergy to shareholders and received net cash of $689.6 million, while transferring net assets of approximately $906.8 million after the cash payment. Apergy’s historical results are now classified as discontinued operations.
- Share repurchases: Dover paid $700 million under an accelerated share repurchase agreement and initially received 7.1 million shares. The final number of shares remains subject to the volume-weighted average share price during the calculation period. An additional $45.0 million was used to repurchase 440,608 shares under the prior authorization.
- Discontinued operations: Apergy-related discontinued operations produced a net loss of $26.5 million in the second quarter and $4.5 million for the six months, including $34.6 million and $46.4 million, respectively, of spin-off costs.
- Acquisitions: Dover acquired Ettlinger and Rosario for aggregate consideration of $68.6 million, net of cash acquired.
- Accounting: Dover adopted ASC 606 using the modified retrospective method, with an immaterial $0.2 million cumulative adjustment to retained earnings. The company also adopted other pension and tax-related accounting standards.
Outlook, Commentary, Risks, and Unusual Items
Dover did not provide a specific full-year revenue or earnings guidance figure in the filing. Management expects to continue targeted cost-reduction initiatives during 2018 and expects restructuring programs underway to be substantially completed within the following 12 months. Management expects operating cash flow and capital-market access to fund capital expenditures, acquisitions, dividends, and other obligations.
- Engineered Systems benefited from broad-based organic growth, pricing, productivity initiatives, and prior-year rightsizing actions. Bookings increased 6.6% in the quarter and backlog increased 16.6% year over year.
- Fluids benefited from international retail fueling, industrial pumps, biopharma and medical markets, and strong bookings. Margins were pressured by higher material costs, restructuring, footprint-consolidation costs, and supply-chain disruptions, including approximately $7.0 million of temporary second-quarter costs.
- Refrigeration & Food Equipment remained challenged by weak U.S. retail refrigeration demand, deferred remodel programs, unfavorable mix, and higher steel costs. Second-quarter bookings fell 8.0% and backlog declined 19.1% year over year.
- Second-quarter restructuring expense was $8.1 million, including approximately $6.8 million of rightsizing costs. Total six-month restructuring expense was $12.2 million.
- Section 232 steel and aluminum tariffs and Section 301 China tariffs increased input costs and may reduce supply availability or customer demand. Dover may be unable to fully pass these costs to customers.
- Foreign currency, interest rates, customer capital spending, economic conditions, acquisitions and integration, litigation, cybersecurity, product quality, intellectual property, and tax and trade-policy changes remain material risks.
- Dover disclosed approximately €1.35 million of second-quarter revenue and €986,000 of net profit from permitted Iran-related activity conducted by a non-U.S. subsidiary under OFAC General License H. The subsidiary planned to wind down that business by November 4, 2018.
- Dover has approximately $141.8 million of letters of credit, performance guarantees, and other guarantees outstanding. Environmental reserves were $34.0 million at June 30, 2018; management stated that no current legal proceedings were expected to have a material effect.
- Apergy pension participants retained by Dover could result in a non-cash pension settlement charge in fourth-quarter 2018; the amount was not determinable at filing.
Important Facts for Investors to Verify
- Whether the Apergy separation and discontinued-operations presentation are properly reflected when comparing 2018 and 2017 results.
- The final share count and effective price under the $700 million accelerated share repurchase program.
- Whether Refrigeration & Food Equipment demand, bookings, backlog, and margins stabilize.
- The extent to which tariffs, steel costs, supply-chain disruptions, and restructuring costs affect second-half margins and cash flow.
- Working-capital requirements and the decline in free cash flow relative to earnings.
- Future leverage, commercial-paper usage, cash balances, and the effect of continued buybacks, dividends, and acquisitions on liquidity.
- Completion of provisional Tax Cuts and Jobs Act accounting and any related tax adjustments by the fourth quarter of 2018.
- The potential timing and amount of any pension settlement charge related to former Apergy participants.