Dover Corporation Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2014. The interim financial statements are unaudited. Dover reported four operating segments: Energy, Engineered Systems, Fluids, and Refrigeration & Food Equipment. Historical Knowles results were reclassified to discontinued operations following its February 28, 2014 spin-off.
Financial Performance and Position
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Revenue | $2.092 billion | $1.940 billion | $6.025 billion | $5.637 billion |
| Gross profit | $801.8 million | $756.3 million | $2.334 billion | $2.194 billion |
| Gross margin | 38.3% | 39.0% | 38.7% | 38.9% |
| Operating earnings | $359.1 million | $348.1 million | $983.4 million | $933.5 million |
| Earnings from continuing operations | $232.8 million | $226.2 million | $626.6 million | $651.5 million |
| Diluted EPS from continuing operations | $1.38 | $1.31 | $3.69 | $3.75 |
| Net earnings | $231.8 million | $269.1 million | $605.9 million | $809.2 million |
- Q3 revenue increased 7.8%, consisting of 4.0% organic growth, 4.0% acquisition-related growth, and a 0.2% unfavorable currency impact. Nine-month revenue increased 6.9%, including 3.6% organic growth and 3.3% acquisition-related growth.
- Q3 continuing-operations earnings increased 2.9%, while nine-month earnings declined 3.8%, principally because 2013 included substantially larger discrete tax benefits and because of higher acquisition-related depreciation and amortization.
- Q3 gross margin declined 70 basis points, primarily due to labor inflation, production-site transition costs, and unfavorable product mix. Nine-month gross margin declined 20 basis points.
- Reported continuing-operations effective tax rates were 29.2% for Q3 and 29.9% for nine months, compared with 28.8% and 22.8%, respectively, in the prior-year periods. Excluding discrete items, the 2014 rates were 30.8% and 30.7%.
Segment Results
| Segment | Q3 Revenue | Q3 Change | Q3 Earnings Change | Q3 Margin |
|---|---|---|---|---|
| Energy | $507.3 million | +8.5% | +3.1% | 24.2% |
| Engineered Systems | $695.2 million | +8.3% | +6.7% | 17.2% |
| Fluids | $361.8 million | +17.0% | +7.1% | 18.7% |
| Refrigeration & Food Equipment | $528.8 million | +1.4% | -9.8% | 14.8% |
Fluids was the fastest-growing segment, supported by acquisitions, regulatory activity, retail fueling, and pump demand. Refrigeration & Food Equipment earnings were pressured by supply-chain costs, customer shipment push-outs, inefficiencies, product mix, and customer mix.
Cash Flow, Liquidity, and Capital Structure
- Cash flow from continuing operations was $532.1 million for the first nine months, down from $588.4 million. The decrease reflected higher working-capital investment and income-tax payments.
- Free cash flow was $419.5 million, or 7.0% of revenue, versus $490.5 million, or 8.7%, in the prior-year period.
- Capital expenditures were $112.6 million; management expected full-year capital expenditures of approximately 2.5% of revenue.
- Cash used in acquisitions was $365.6 million for six acquisitions. Cash used for share repurchases was $392.6 million, and dividends paid were $192.6 million.
- Cash and cash equivalents were $706.2 million at September 30, 2014, including $675.0 million held outside the United States.
- Total debt was $2.723 billion, including $150.5 million of commercial paper. Net debt was $2.017 billion, and net debt to net capitalization increased to 34.0% from 27.4% at December 31, 2013, primarily because of the Knowles separation, share repurchases, and dividends.
- Dover maintained a $1.0 billion unsecured revolving credit facility expiring November 10, 2016. No borrowings were outstanding under the facility; the company was in compliance with its debt covenants and reported an EBITDA-to-net-interest coverage ratio of 11.5x.
Material Changes Versus Prior Comparable Period
- Dover completed the tax-free spin-off of Knowles in February 2014. Knowles historical results are presented as discontinued operations, making reported net earnings less comparable with 2013.
- Dover completed six acquisitions for $365.6 million through September 30, 2014. The acquisitions contributed $43.5 million of Q3 revenue and $79.9 million of nine-month revenue and were expected to dilute 2014 earnings but be accretive in 2015.
- On July 2, 2014, Dover sold DEK International for proceeds of $174.9 million and recorded an after-tax loss on sale of $6.9 million. Discontinued operations produced a net loss of $1.0 million in Q3 and $20.7 million for nine months.
- Goodwill increased to $3.446 billion from $3.281 billion, primarily from acquisitions, partly offset by currency translation and the Knowles-related reallocation.
- Dover repurchased 4.7 million shares during the first nine months at an average price of $82.76. The company paid dividends of $1.15 per share, up from $1.075.
- Other comprehensive income declined by $76.0 million for the first nine months, driven primarily by foreign-currency translation losses.
Guidance, Outlook, Risks, and Unusual Items
- Management expected full-year 2014 revenue growth of approximately 8.0%, including approximately 4.0% organic growth and 4.0% acquisition-related growth.
- Adjusted full-year EPS guidance was $4.75 to $4.80, with the high end reduced by $0.05, largely because of recent acquisitions.
- Management expected 2014 free cash flow of approximately 11.0% of revenue and approximately $10.0 million of restructuring expense. Restructuring programs were expected to be substantially completed within 12 to 18 months.
- On October 1, 2014, Dover acquired Accelerated Companies LLC for approximately $430.0 million, funded with commercial paper. This acquisition increased total 2014 acquisition investment to approximately $800.0 million.
- Dover expected an approximately $9.5 million fourth-quarter pension settlement charge, including approximately $3.5 million in continuing operations and $6.0 million in discontinued operations.
- Key disclosed risks include cyclical and global market conditions, well activity, customer demand and concentration, acquisition integration and synergies, raw-material costs, supply-chain disruption, product mix, currency and interest-rate movements, regulation, litigation, environmental matters, intellectual property, tax audits, and potential credit-rating changes.
- Environmental and other matter reserves totaled $29.3 million. Management stated that no current legal proceedings were expected to have a material effect on financial position, results, or cash flows.
Investor Verification Checklist
- Verify the effect of the Knowles spin-off and DEK sale on year-over-year comparisons, continuing operations, cash flow, assets, and liabilities.
- Assess whether acquisition-related revenue growth can be converted into earnings and cash flow after integration costs and incremental amortization.
- Monitor gross-margin pressure, especially labor inflation, product mix, production transitions, and Refrigeration & Food Equipment supply-chain issues.
- Reconcile reported and adjusted EPS, including discrete tax benefits, restructuring costs, pension charges, discontinued operations, and other unusual items.
- Evaluate liquidity after the October 1 acquisition, planned capital spending, share repurchases, dividends, and commercial-paper funding.
- Track working-capital requirements, since accounts receivable and inventory growth reduced operating cash flow.
- Review foreign-currency exposure, the $18.3 million cross-currency-swap loss, and the concentration of cash held outside the United States.