Dover Corp

NYSE:DOV

Earnings Call Transcript 2018-Q2

[Operator]

Good morning and welcome to Dover's Second Quarter 2018 Earnings Conference Call. Speaking today are Richard J. Tobin, President and Chief Executive Officer; Brad Cerepak, Senior Vice President and CFO; and Paul Goldberg, Vice President of Investor Relations.

After the speakers' remarks, there will be a question-and-answer period. [Operator Instructions]. As a reminder, ladies and gentlemen, this conference call is being recorded and your participation implies consent to our recording of this call. If you do not agree with these terms, please disconnect at this time. Thank you.

I would now like to turn the call over to Mr. Paul Goldberg. Mr. Goldberg, please go ahead, sir.

[Paul Goldberg, VP, IR]

Thank you, Crystal. Good morning and welcome to Dover's second quarter earnings call. With me today are Rich Tobin and Brad Cerepak.

Today's call will begin with comments from Rich and Brad on Dover's second quarter operating and financial performance and some comments on our 2018 outlook. We will then open the call up for questions. As a courtesy, we kindly ask that you limit yourself to one question with a follow-up.

Dover is providing non-GAAP measures including EPS results and EPS guidance that exclude after-tax related amortization. Reconciliations between GAAP and adjusted measures reflecting adjustments for aforementioned acquisition-related amortization, rightsizing costs and other costs are included in our investor supplement and presentation materials.

Please note that our current earnings release, investor supplement and associated presentation can be found on our website dovercorporation.com. This call will be available for playback through August 2nd and the audio portion of this call will be archived on our website for three months. The replay telephone number is [phone]. When accessing the playback, you'll need to supply the following access code 3666317.

Before we get started today, I'd like to remind everyone that our comments today which are intended to supplement your understanding of Dover may contain certain 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 such forward-looking statement.

Also we undertake no obligation to publicly update or revise any forward-looking statements except as required by law. We would also direct your attention to our website where considerably more information can be found.

And with that, I'd like to turn the call over to Rich.

[Richard Tobin, President & CEO]

Thanks Paul, good morning everybody and thanks for joining us for this morning's conference call, let's get started.

In Q2, Dover posted consolidated revenue up 3% with adjusted earnings of $200 million and adjusted diluted EPS of $1.30 a share, up 19% and 21% respectively. Bookings remained solid at $1.9 billion at the end of the quarter and are broad-based across the portfolio excluding retail refrigeration.

The Apergy spin-off is completed at the beginning of the quarter and as a result we have executed a good portion of the announced share repurchase program which Brad will take you through, the impact on the share count later in the deck.

We are tightening the full-year EPS guidance range to $4.75 to $4.85 a share despite the full-year demand environment and retail refrigeration being below our original forecast and largely as a result of improved margin conversion in the Fluids segment expected in Q4, tight corporate cost controls, and share count reduction.

As we have noted in the press release this morning, we will be implementing a cost reduction program beginning in Q3 which is not reflected in our current full-year EPS guidance and will be subject to a separate announcement I will deal with that, I think, in the Q&A.

So let's go on in the presentation, let me pass it off to Brad.

[Brad Cerepak, SVP & CFO]

Thanks Rich. Good morning everyone.

Let's start on Page 4 of the presentation deck. As mentioned, our results were largely driven by solid demand in Engineered Systems and Fluids. Overall revenue grew 3% to $1.8 billion. Adjusted segment EBIT improved to $276 million and adjusted margin was essentially flat at 15.3%. This performance reflected solid conversion in Engineered Systems which was offset by continued footprint consolidation supply chain issues in Fluids and lower volume in Refrigeration & Food Equipment.

Adjusted segment EBITDA was $343 million.

Adjusted earnings increased 19% to $200 million. And adjusted EPS was $1.30. The EPS benefited from a slightly lower tax rate on discrete tax benefits whereas the full-year effective tax rate is expected to be between 21% and 22%.

On Slide 5, let's get into a little bit more detail on our revenue and bookings results in the quarter. Second quarter revenue growth of 3% was comprised of 3% organic growth and 2% from FX. Partially offsetting these results was a 2% impact from net dispositions. Importantly on a sequential basis, organic growth accelerated from 1.7% in Q1 to 3.5% in Q2. FX which was a tailwind of about 4% in Q1 decelerated into Q2 to about 2% as a result of the U.S. dollar appreciating against our other trading currencies.

We are using a U.S. dollar Euro assumption of $1.17 in our current full-year forecast.

From a segment perspective, Engineered Systems grew $39 million organically and Fluids grew $44 million. Weak retail refrigeration markets drove a $24 million decline in Refrigeration & Food Equipments revenue. Booking increased 6% overall. Organic growth was 6%. Of note Engineered Systems and Fluids organic bookings grew $62 million and $80 million respectively reflecting broad-based market demand.

From a geographics perspective, the U.S. our largest market grew 2% organically while Europe was up 1%, Asia grew 19% largely driven by strong activity in our Fluids segment.

Finally book to bill finished at 1.05.

Let's go to the earnings bridge now on Slide 6. Starting on the top, Engineered Systems adjusted segment EBIT improved $15 million largely driven by solid conversion on broad-based revenue growth. Fluids EBIT growth of $7 million reflects weak conversion due to footprint consolidation and supply chain issues. The $15 million decline at Refrigeration & Food Equipment reflected lower volume.

Going to the bottom of the chart, adjusted earnings improved $32 million or 19%, higher segment earnings, lower interest, and corporate costs and a lower tax rate drove the improvement.

Let's look at Slide 7. Our first half free cash flow was $79 million or 28% of earnings from continuing ops. Second quarter free cash flow was largely in line with last year. Our CapEx spending was focused on multiple projects which will help drive growth and productivity. Working capital increased $59 million on volume growth although working capital as a percent of revenue came down 130 basis points to 16% of revenue.

Now on Slide 8. As previously mentioned during the second quarter we initiated an accelerated repurchase program funded by the $700 million Apergy dividend. Beyond the completion of the ASR, we expect to repurchase 150 million more in shares in the second half on the open market. By year-end, we will substantially complete the 1 billion repurchase we committed to last year. And as you know, the ending full-year 2018 weighted average drops further into 2019 on these 2018 repurchases.

With that, let me turn it back over to Rich.

[Richard Tobin, President & CEO]

Thanks Brad. Let's move on to the segment slides.

Engineered Systems delivered a solid broad-based quarter. Margin conversion organic revenue was very good at 46% in the period a result of the following. In printing and identification the positive comparable performance was driven by volume growth in Markem-Imaje and improved product mix in digital print as a result of the timing of LaRio printer deliveries which should have been expected in Q3 but delivered in Q2.

In the Industrial platform, performance was more mixed as they are more subjected to material cost and tariff issues. ESG and TWG both delivered very strong performances as a result of the continued demand strength in fleet renewal in ESG and recovery vehicle accessories demand in TWG, with volume leverage and mix more than offsetting input cost headwinds in both businesses.

DESTACO and MPG delivered good results on volume and improved mix on the back of automation demand and an uptick in military spending.

While VSG reported absolute profits up for the quarter incremental margins were lower than expected as volume leverage and pricing were unable to cover input cost increases as a result of the delays in pricing and implementation which is being enacted going into H2.

Full-year outlook for Engineered Systems is expected to remain strong with earnings levered towards Q4 as a result of industrial facility maintenance shutdowns primarily in Europe in Q3 and the timing of digital print large printer shipments pulled into Q2.

Okay, let’s go forward to Fluids. The Fluids segment posted organic revenue growth of 7% during the quarter with all operating companies growing revenue from comparable period with especially improved performances in our pumps, process solutions, and transport businesses. Consolidated margin performance for the segment was underwhelming as a result of the execution issues in fueling and transport specifically in DFS partially offsetting strong performances in the balance of the segment.

Let me comment on some of the strong results in the segment because it's a little bit of a tale of two worlds here. In pumps and process solutions, PSG colder hydro and to a lesser extent MAG all delivered top-line and bottom line conversion in the quarter. PSG's June shipment rate was the highest in three years which is a positive sign that our CapEx levered businesses continue to gain strength.

The colder business has had a strong start to the year which continued through Q2 this is becoming a business of significant attraction in the segments portfolio and one that is earmarked for capacity expansion.

Results in fueling and transport were mixed. OPW was the fastest growing business at 23% largely driven by regulatory related spending in China and U.S. below ground products. Margin conversion could have been better as a result of facility consolidation costs which we consider transitory and beneficial to margins going forward and a geographic mix of revenue with APAC revenue being dilutive to consolidated margins. The expectation is that OPW will have a solid second half as end market demand remains firm.

DFS while posting top-line growth of 3% posted negative earnings conversion as a result of the continued operational costs associated with the European footprint consolidation, significant supply chain costs and expediting fees, and discrete items in the quarter.

Our expectation is that a significant portion of these issues will be behind us by the end of Q3 and that the second half performance will be materially improved going into Q4. What I can tell you is that during the quarter we did the operational issues and discrete items that cost us approximately $7 million of earnings and if I add that back to our margins, there still remains much to do to get margins on track in this business.

The encouraging news is that we're confident it's not a product issue from the performance perspective as bench -- product benchmarking and customer feedback is positive. And it's clear that our operational execution has to improve and we have to establish and execute clear paths for profit improvement plans in Europe and APAC which are underway.

Let's move on to Refrigeration & Food Equipment. Refrigeration & Food Equipment had another tough quarter in Q2 as revenue was down 6% primarily driven by reduced demand trends especially in Dover Food Retail and calendarization of shipments out of food equipment particularly at Belvac which are back-end loaded in 2018 to Q4.

We have updated our full-year forecast for this segment and align with the current backlog and demand trends. EBITDA margin in the quarter declined over 200 basis points or $15 million on reduced earnings in Dover Food Retail, $14 million in Belvac and $4 million on a comparable basis.

Our expectations that a full-year demand will remain weak in Dover Food Retail through the balance of the year but for comparable segment margin declines to narrow in Q3 and refuse -- and reverse in Q4 as a result of improving shipment mix in United Brands through H2, Belvac and Belvac shipments in Q4 and the flow through of cost actions in Dover Food Retail which has reduced its year-over-year headcount by 18% through June.

Moving on to Slide 14, as I mentioned earlier in the presentation, we've updated our full-year revenue outlook to reflect softer than forecasted demand conditions in Retail Refrigeration and tightened our range on the EPS to the higher end of the range with a bias towards the top end.

Our revenue trends and backlogs indicate we have strong businesses that are largely participating in markets with increased demand profiles. It is clear that we need to execute on better margin conversion in some areas of our portfolio and to aggressively implement actions to offset raw material and input inflation.

During the last 90 days, I have visited approximately 70% of our total company revenue and our management teams in the quarter. The commitment to deliver improved performances there and we are committed to implementing the necessary actions to achieve it.

That's the last slide, so we will move on to Q&A.

[Paul Goldberg, VP, IR]

Thanks. Crystal, if we can have the first question.

[Operator]

[Operator Instructions].

Our first question comes from the line of Julian Mitchell with Barclays.

[Julian Mitchell, Barclays]

Hi, good morning. Welcome to Richard and thank you for the candid tone. In terms of I guess any extra color you could provide on the cost reduction measures that you've talked about in terms of magnitude and perhaps also speed of execution and how quickly investors should expect to see a meaningful payback on those cost reduction efforts.

[Richard Tobin, President & CEO]

We’re well through our plans. I expect that our plans will be complete by mid-August from there we will work on the accounting treatment quite frankly because there's some issues we have to deal with war notices and a variety of other things. Before the end of Q3, we'll be announcing the timing of those measures, the cost of those measures, and the flow through on our cost going into 2019 as a separate announcement, but I guess in a nutshell we're well under way at this point.

I'm confident in our ability to execute and I think as a clarifying point what I've written in the press release, it said overhead, and I don't want to confuse that with what has gone on here before about rightsizing if you will nor do I want you to think of that as corporate cost. This is SG&A across the group including the SG&A in the segment, so the scale of this rightsizing initiative will be materially larger than some of the rightsizing initiatives that we have seen as a result of the Apergy spinoff.

[Julian Mitchell, Barclays]

Understood, thank you. And then my second and last question would just be around the Refrigeration & Food business and then I guess you’ve obviously done a lot of cost measures already at food retail. It seems like you’ve obviously decided to keep the business in light of the reviews you've done in recent months, maybe talk a little bit about your impressions on the longer-term sales growth outlook in Refrigeration & Food overall and how that informs the scale of necessary cost reduction?

[Richard Tobin, President & CEO]

The cost reduction initiatives are solely in retail refrigeration because that really is the part of the portfolio that's suffering the revenue decline. I think from an earnings point of view both UB, UB is on track for the full-year. I think that we've got some calendarization differences running through the P&L right now in Belvac. So if you look at the segment performance, it's negative to a certain extent because of Belvac, our backlog in Belvac is impressive right now it's purely a question of the timing of the deliveries right now they're loaded into Q4 and that's why in my commentary, I'd said that the comparable performance for the segment actually rolls over in Q4 where we expected to be positive which is largely as a result of the cost takeout in retail refrigeration and the shipments in Belvac.

So in terms of the portfolio review and the decision about keeping anything I mean we've gone through the portfolio review in terms of what we can expect about medium term performance but there's been no real decisions about a greater portfolio decision at this point. I think that I understand that there is this issue of well why don't we spinout refrigeration or monetize refrigeration, monetizing the business at it -- at its current demand levels. I'm not so sure about that from a decision point of view. So I think what we're doing right now is rightsizing that business in terms of what we believe the demand is going to be for the balance of the year. We'll have a better idea as we go through Q3 of what we expect to happen in 2019 and we're committed to making sure that that we maximize the segment profitability for that period. In terms of what we're going to do from a portfolio point of view I think that's a future consideration.

[Operator]

Our next question comes from the line of Andrew Obin with Bank of America Merrill Lynch.

[Andrew Obin, Bank of America Merrill Lynch]

Good morning Rich. Good morning, Paul. A long, long time, good morning Brad, long time I didn’t see you.

[Brad Cerepak, SVP & CFO]

Good morning.

[Richard Tobin, President & CEO]

Yes, long time Andrew.

[Andrew Obin, Bank of America Merrill Lynch]

So the question is I guess question for Rich as you move from the board to the CEO position and I know you sort of highlighted SG&A moves, are there any obvious things other than SG&A in terms of how the company run that you have seen as a target for improvement and the second part of my question, how long would it take for you would think to sort of steady the operation that Dover moves them in the direction where you want for you can sort of restart thinking about using the balance sheets strategically i.e. M&A?

[Richard Tobin, President & CEO]

Okay, I think there's two primary issues. One is clearly that the expectation of demand in retail refrigeration of what we thought it was going to be at the beginning of the year and what it's likely turning out to be for 2018 is significantly different and that goes through 2019. So I believe that we're reaching the bottom from what I've can ascertain so far but right now we're moving as quickly as we can to intervene on the cost space to protect margins as they are.

We'll make further decisions based on as I mentioned the previous question about where as we stack up on, we're taking a lot of costs out right now, we’re incurring those costs of the P&L of what kind of on the run margin profile is for retail refrigeration but a variety of demand scenarios into 2019 but clearly that's a significant difference between what we had thought at the beginning of the year and what it's turned out to be, so it's up to us to action that and quite frankly, segment management has been doing a lot of heavy lifting, so I can't criticize the execution of the cost takeout year-to-date.

The other issue is the execution on the facility consolidation in DFS and the margin profile of that portion of the Fluids segment has been disappointing. This has been ongoing for some period of time. I think it is demonstrated that there are some gaps in the organization about handling facility consolidation and complex industrial moves and we're paying the price for that. So right now in terms of margin of dilution accretion, we've got a significant portion of the Fluid segment that is very dilutive to the balance of the portfolio and that's a problem. We're getting our hands around about on the run profitability for that segment, if I can strip out some of the noise. But we're not moving fast enough in my mind in terms of the execution. I think that we will make some progress in Q3, so comparable earnings trajectory versus the first half move up in H2 but we're still far away from expectation in terms of the margin of that business and it's significant to our revenue stream, so it's something that that we need to fix and I think that that is going to undertake us bringing in a mix of some other kind of talents into the group to ensure that because there is other footprint initiatives that I think that will be coming through 2019 and we just got to do a better job of executing there.

In terms of inorganic investment this is not a scenario of while we're going to go through a cleanup period here and then we're going to come out of the other side. We're still looking at inorganic opportunity and the balance of the portfolio we've got certain portions of our business that are executing very well I mean I highlighted some of them in the opening commentary. We're looking at a few right now and the scale in terms of purchase price is somewhere, it’s less than $0.5 billion but more in the $250 million range.

[Operator]

Our next question comes from the line of Jeffrey Sprague with Vertical Research Partners.

[Jeffrey Sprague, Vertical Research Partners]

Thank you. Good morning. Hey Rich thanks for all the color on kind of the operational and CEO kind of new view just on the maybe some of the more kind of practical near-term operational things, can you just give us a little color on really what the supply chain disruptions are, how do you tackle those and also just a little bit of an update on what is happening on price cost in particular your efforts to get price in the business?

[Richard Tobin, President & CEO]

Sure. For the most part in supply chain issues that we've had, that have been negative to earnings have been mostly isolated in Fluids and almost exclusively in DFS. And that is part and parcel to this facility consolidation to a certain extent and trying to manage our SNL pieces systems of getting the right product out. So we've had a bunch of frictional costs associated that whether that's freight expediting.

On the balance of the group, it's being reflected in working capital performance where I think that the supply chains in certain parts of the business have been somewhat strained. I think in certain areas we've tried to buy forward a little bit on the industrial businesses for steel to kind of mask price increases to a certain extent and that really needs to be normalized going to the second half because we're not entirely pleased with the cash flow performance year-to-date. So those are really two of the areas where it's manifesting itself.

[Jeffrey Sprague, Vertical Research Partners]

And how about on price attempts specifically Rich, how is the market accepting that, is there kind of negative demand response when attempting to get price or any blow back anywhere on that?

[Richard Tobin, President & CEO]

Yes, we've got a pretty mixed portfolio, so any answer I give you is going to be kind of mixed, I mean I think that we've estimated that our commodity headwind is approximately $55 million or so, that needs to be offset in price. Clearly in the business, I called out VSG where we've been negative so far and that's a little bit because of -- that's a distribution business and there's a pal on kind of rolling that into distribution which we're committed to fixing in the second half of the year.

The other businesses like TWG and ESG which are heavily levered towards commodity prices because of the demand profile has been there. They're doing reasonably well on price and they're offsetting the balance because of the volume leverage on the industrial side.

[Operator]

Our next question comes from the line of Steve Tusa with J.P. Morgan.

[Steve Tusa, J.P. Morgan]

Thanks for the abbreviated script and a lot of time for Q&A. We appreciate that. On the free cash flow, you mentioned you just mentioned some working capital. I know the prior guidance was 10% of revenue, well, I know you have a big second half usually can you maybe just update us on that metric for the year and then may be little color on how that may improve in the next couple of years and just a quick follow-up on that.

[Richard Tobin, President & CEO]

I'll take the time to avoid the next couple of years Steve for the time being.

[Steve Tusa, J.P. Morgan]

Okay.

[Richard Tobin, President & CEO]

I can deal with that in Q3 but let's deal with between now and the end of the year. I'm not aware of anything that's changed in the dynamic or the cash flow dynamic of the business right now. So I'm not taking 10% of revenue off the table by any means.

Clearly as I'm sure you’ve heard during the Q3 commentary we did -- we are backend loaded in certain of our businesses and that would imply that receivable balances in Q4 may be going up but that, so we're going to have to work pretty hard in terms of the industrial inventory and payables to offset that, but I don't see any fundamental change that we've moved to at a heavier profile in terms of inventory or cash conversion but getting into kind of doing the timing quarter-by-quarter, it's hard for me to say right now I've gone through it at the Opco level, I think any kind of fluctuation in that is going to be based on timing of receivable balances and at the end of the year we're shipping out a bunch of LaRio machines and shipping out a lot of Belvac, I mean that's going to be negative unless we can carry some payables to offset into it. But right now I don't see any reason to come off 10% of revenue in terms of a target.

[Steve Tusa, J.P. Morgan]

Okay. And then just a quick one on RF&E you talked about taking rightsizing actions I don't see really any restructuring in the quarter at refrigeration is that because a lot of the plan that you're going to kind of come up with and announce it's more kind of let's put stop saying let's evaluate and that would be a big part of kind of what we hear about in Q3 like kind of a calm before the storm if you will?

[Richard Tobin, President & CEO]

A little bit less those than you think, I think that that the rightsizing that's been going on in refrigeration has been flowing through the P&L and it's on the variable labor side more than anything else I think that what we're going to do in the segment is take a look at the footprint because the footprint is probably well it is right now at current demand levels a lot larger than we would need, so there's going to be a part of that in it but to be clear the restructuring that we're going to announce in Q3 is not -- is more of a group wide SG&A reduction there will be some amount of footprint in it but quite frankly I think that the footprint decisions are going to take a little longer and that'll be done I don't want to say separately but I mean as you can imagine you need to prepare a supply chains and do a variety of other things to deal with a footprint so a lot of that will probably go into 2019.

What we're going to do in this coming quarter is take a look at across all of the segments, so group wide SG&A because clearly as we've taken a look at the benchmarking versus our peer set, we’re a bit heavy I think we've done a lot of work in the past to put in systems to allow us to take out some non-customer facing kind of costs and that's what we're going to do.

[Operator]

Our next question comes from the line of Steve Winoker with UBS.

[Steve Winoker, UBS]

Thanks very much, good morning and thanks for the color this is really helpful across the business. I just wanted to start with a little bit more of that operational review that you had across the whole business you've talked about, hitting 70% of the revenue base, you’ve talked about SG&A and some of the supply chain issues but to what extent is there sort of a broader operational and lean opportunity when you see about -- see how the businesses are working, do you think these are really just isolated incidents or is this more of an opportunity kind of rethinking the operations of the business forward on a portfolio basis?

[Richard Tobin, President & CEO]

Yes, I think that right now we are concentrating on the actionable items, so SG&A clearly as an actionable, addressable item and as we have mentioned we've got some pretty big execution issues that we need to deal with in DFS and DFS as a material portion of our total group revenues and clearly we're kind of swimming upstream a little bit on retail refrigeration until that business stabilizes itself, so there is a lot we can do in terms of operational performance. That it's going to require that's but that is more of a sustained kind of grinded out effort. So I mean it's not something that we can turn the dial between now and the end of the year. I think other than just begin to turn it philosophically.

But in my going around I think that that we do need to bring into some of our businesses some expertise in terms of operational efficiency. I think we do a fantastic job of keeping close to the customer. I think we do a really good job in terms of new product development, so kind of close to the customer and developing the products which is reflected in our top-line which has been very competitive against our peer set. I think that part of it we do quite well I think that we just need to take that kind of effort and turn some of it back in terms of operational execution. But that is something that is we can put it in it as an ethos between now and the end of the year but we're going to have to grind that out and that's more of a 18 months before we really get on a cadence that I'd like to see it out.

[Steve Winoker, UBS]

Okay. And just to clarify on the comment this morning when you talk about asset intensity, you mean driving higher asset utilization across the business.

[Richard Tobin, President & CEO]

Yes, yes, absolutely, absolutely.

[Steve Winoker, UBS]

Okay.

[Richard Tobin, President & CEO]

I won't use intensity again we're not going to become more asset heavy. We are going to sweat the assets that we have more intensely.

[Steve Winoker, UBS]

Perfect and then so I had to get that in but on the EMV side, can you just talk to us a little bit about EMV growth.

[Richard Tobin, President & CEO]

Somewhere in this pile here is the chart where do we say we were on EMV penetration 40%?

[Brad Cerepak, SVP & CFO]

Yes, roughly 40% that's hard -- that's hard to know because we're seeing more and more -- we're seeing more and more new dispensers a lot of customers are looking at the age of the dispenser in the field and making decisions about earlier upgrade and maybe they normally would do and we're seeing that manifest itself in order rates on dispensers. The first half as you know was a challenging first half as EMV last year was pretty solid in terms of kits and conversions. The back half we'll see that more to dispenser, so but roughly speaking the number Rich gave is about where we think we are with a lot of room to consumer to run here in the back half into 2019.

[Operator]

Our next question comes from the line of Deane Dray with RBC Capital.

[Deane Dray, RBC Capital]

Thank you. Good morning everyone and welcome Rich.

[Richard Tobin, President & CEO]

Thanks.

[Deane Dray, RBC Capital]

Hey maybe we can start with what you're thinking and I know it's a moving target regarding potential tariff exposures and you mentioned $55 million in commodity headwinds you need to offset but any color there for starters would be helpful?

[Richard Tobin, President & CEO]

The $55 million is a mixed number which is, it's got tariff in there and it's got price escalation right and parsing that out --

[Brad Cerepak, SVP & CFO]

It's small.

[Richard Tobin, President & CEO]

Yes, parsing that out is relatively difficult. We are keeping a close look at our exposure to China in terms of our revenue base clearly and not only our exposure from a revenue point of view but also the mismatch between what we make in China and selling to China versus what we import exports. So we're running the traps on all of that it looks manageable at this point, so I don't see any significant issue. I'd like to see our Asia-Pac margins move up group wide a little bit but and I’d mention that in the color around LPW but at the end of the day from a growth point of view it's from a absolute profit point of view we will take it, so we're running the traps on both kind of tariff scenarios but for us right now it's less tariff and more commodity cost headwinds and then it's just a challenge for us to offset it between price and productivity.

[Deane Dray, RBC Capital]

Got it. And then, Rich, I appreciate that we're still early in your tenure and you're laying out some broad strokes on the operating side and what needs fixing, but can you address capital allocation broadly? You mentioned that you're not going to stop on acquisitions. You're looking at $250 million to $500 million-sized deals. But broadly, how are you thinking about return requirements? Are there any changes that we should be sensitive to in terms of how you're looking at capital allocation broadly?

[Richard Tobin, President & CEO]

Right. We're looking closely at it. We -- I'm very cognizant that everyone is looking for a structured answer from me on that, our intent is hopefully before the end of Q3 around the close of Q3 that we're going to come out and I'll give you a whole presentation in terms of my thoughts on capital allocation in the short-term Brad alluded to what we're doing in terms of the share repurchase as, a) it was a commitment in the past but it's a relative valuation play at the same time, so I think we've given you a lot of color in terms of our intent there. But I understand that everybody is waiting to hear from me about capital allocation and I'm working on the presentation as we speak.

[Deane Dray, RBC Capital]

Understand we'll be patient. Thank you.

[Operator]

Our next question comes from the line of Andrew Kaplowitz with Citi.

[Andrew Kaplowitz, Citi]

So when you look at refrigeration, I know there has been a few questions there but it's been a couple of years where it's been little tougher go over so when you look this quarter I know Bob had talked last quarter about a couple of new customers coming in and booking more, what’s happening in the business, what is worse? The CapEx environment we all know looks weak but Bob had talked about specialty store growth so what -- it just seems like it's a moving target and what should it look like from here are you think that, where we are in terms of guidance is pretty conservative now, Rich.

[Richard Tobin, President & CEO]

I hope it's conservative. I guess maybe we're talking about retail refrigeration. I think when we look at the segment. It's going to have enough it's going to have a tough Q3 and then -- these are comparable numbers now it’s going have a tough Q3. And then it's going to roll over in Q4 because quite frankly the comps get better and as I mentioned the non-retail refrigeration portion of the portfolio is backend loaded right now based on our forecast, so you're going to get that kind of uptick. But the fact of the matter is we're nothing's really changed, we're in a bit of a CapEx strike by food retail as everybody struggles with the digitization and what they're going to do to react to that.

It is clearly below replacement demand now so I wouldn't say does it get worse from here, I don't think that it gets worse from here but we don't see a runway for it to get demonstrably better other than to run the trap lines to say at some point maintenance capital, replacement capital has got to come back so but clearly the proportion of new build to replacement build is changed forever to a certain extent and we're going to have to size ourselves based on that.

In terms of other revenues streams there you guys you could imagine we are working strenuously to diversify the business from case and door to other products within in food retail. I think that we've got some interesting irons in the fire in that regard but they are not going to impact earnings in 2018.

And assumes we can put some color around it and I'm sure you'll hear from us about it but for the medium term this is all hands on deck of rightsizing ensuring that our quality remains best in class setting ourselves up for even at flat revenue we actually make comparable profits go up because of cost takeout and then working strenuously in kind of diversified the revenue stream from a product point of view.

[Andrew Kaplowitz, Citi]

That’s helpful. Then if you just back up last year this time or maybe early in the last summer and there was an Analyst Day Bob had talked about some of these long-term growth guidance for the different segments obviously refrigeration has changed but when you look at ES and Fluids you've laid out 3% to 5% growth and it looks like ES have been pretty strong so as you've looked at the overall segments Rich in terms of growth is that the way you’ve looked at ES and Fluids look solid versus that 3% to 5% growth or situation looks little worse any comments on how those targets that were set last year?

[Richard Tobin, President & CEO]

Yes, I know that there's a need or everybody wants me to reconcile the 2019 targets. I can just guess and I've looked at them closely. Clearly as you articulated both Fluids -- all right let's go back Engineering Systems from a top-line growth and a margin accretion point of view is largely on track. Fluids because of the negative conversion in DFS is problematic and I think we've beaten this issue of food retail. I'm more of a consolidated margin person, this is a portfolio there's going to be ups and downs in terms of the demand cycle in the portfolio but if I look at it from a consolidated point of view part of the reason that we're taking this action in terms of overhead costs is to close that gap which is a portion of it is our execution issues that we have in DFS that need to be reconciled and more importantly the headwinds that we have on refrigeration.

[Operator]

Our next question comes from line of Charley Brady with SunTrust Robinson Humphrey.

[Charley Brady, SunTrust Robinson Humphrey]

Just on a bigger picture you talked about you particularly in refrigeration and I guess more fluids bringing some more talent on the operational execution issue, do you think as you and I know it's a little bit far to 2019 but these type of things generally take a bit more time you've got to bring people and you've got to get the plan in place and you've got to execute. I mean as we look from a margin perspective particularly on that DFS business and more into refrigeration do you see kind of going through 2019 before you and exiting 2019 before you see any real meaningful margin improvement there or should we expect it sooner than that timeframe trying to get a framework of how long do we see sort of some of these subpar margins in parts of the business before they start getting really better on the plan you going to put in place.

[Richard Tobin, President & CEO]

Right. As I mentioned earlier from an execution point of view on refrigeration and the actions that have been taken on the cost basis I'm confident that the plans are in place for the comparable margin to rise it's purely a question of demand so it's a top-line issue, right, so I think that's the segment management is on it from a cost point of view it's not there's not an execution issue going on in retail refrigeration it's more of -- it's got a significant top-line headwind and because of that your fixed cost absorption becomes problematic, so it's easy you know what they've done up until this point is do with a variable cost which they take through the P&Ls on a comparable basis even a flat revenues it actually moves up going into 2019.

And then it's clear that we're probably going to have to take some action in terms of the fixed cost in that business to right size it based on future demand. We're not there yet because I'm not I think we need to see some stabilization in terms of the demand profile on that portion of the business.

On DFS I can tell you that if I clear out of the noise of the facility consolidation and everything else it's a material amount of earnings increase at flat revenue. But I'll also tell you that the profit margin even if I clear out the noise is unacceptable from a comp base. And that is likely to take, I think we will make improvement I think you're going to see some improvements in the second half of this year largely in Q4, I think that you'll see improvement assuming we clear out the noise which we're committed to doing in 2019 but it’s going to likely take throughout 2019 to materially get this closer to benchmark profitability which is our target.

[Charley Brady, SunTrust Robinson Humphrey]

Understood thanks and just one more quick one on, you talked about one of the things you think you guys are pretty good at are new product development that doesn’t seem to be an issue but I’m wondering if you look across the portfolio, are there areas where things may have been under invested in terms of new product development and that's an area that need a little more focus or is that kind of squared up across the board?

[Richard Tobin, President & CEO]

It’s such a mixed bag, I think it's very difficult to answer, I think by and large as I mentioned before the customer facing portion of the business is executing. So and that includes new product development, right a lot of what we do is I would almost classify as co-engineering in a lot of cases. I think from an investment point of view, if there's been any opportunity in terms of investment it would be at the industrial level and that's a productivity issue, right. So there may be some amount of flex of investing in the industrial footprint to derive future productivity out of it and be less labor intensive in some of our more industrial businesses.

[Operator]

Our next question comes from the line of Mircea Dobre with Baird.

[Mircea Dobre, Baird]

Yes, good morning and welcome Rich. If I may, I’d like to maybe ask you kind of a longer-term question if you're looking out three to four years I mean I certainly understand what you're trying to do from a cost reduction in restructuring standpoint in the near-term but what is your sense on where the biggest opportunity for value creation would be in the company, is it on self help driving margins or is it more along the capital deployment portfolio management side?

[Richard Tobin, President & CEO]

In the -- in the near-term it's driven by self-help and in the longer-term it moves more into investing where we are advantaged from a market structure point of view and we believe that we've got advantage. So over the next 18 months, I think it's more of operational execution and self-help I think that I've basically pointed my finger of where we believe that the biggest material changes can take place. But over the -- but at a certain point if we execute on that then it becomes more of an issue of capital allocation and allocating our capital where we believe that we’re structurally advantaged in terms of whether it's market structure or product or a variety of other considerations. So but it's not to say I think I should repeat myself that we're going into some kind of black period where we're going to almost exclusively concentrate on execution issues, I think that we're able to do a little bit of both.

So we are going to be considering inorganic investment over that period of time. So it's not a black white, so if you're asking a longer term question I think that once we get beyond kind of some of the operational challenges that we have in front of us then I think it becomes more of a -- are we going to be a disciplined allocator of capital. And I think we're committed to doing so.

[Mircea Dobre, Baird]

I see. And then maybe clarification on guidance, if you're willing to provide it, can you comment at all on how you’re thinking about segment margins for the full-year by each segment?

[Richard Tobin, President & CEO]

No, I won't give you segment margin for the whole year I think that if you go back and you look of what my comments were I think that I've given a good amount of color in terms of what our expectations are by segment in terms of calendarization between Q3 and Q4.

[Operator]

Our next question comes from the line of Joe Ritchie with Goldman Sachs.

[Joe Ritchie, Goldman Sachs]

Rich, it sounds just maybe just asking the margin longer-term margin guidance question directly, it sounds like we've talked a little bit about bridging the gap to what the old targets were for 2019, when do you think you're going to be in a position to either affirm or provide new margin guidance on a longer-term basis?

[Richard Tobin, President & CEO]

No, I think that what I alluded to before about coming out and doing let’s call it a Capital Markets Day for lack of better word about presenting something about capital allocation clearly as part of that it's going to be something about what we think about future margin performance is going to be. I just need some time to get it all sorted and I think it's important that we have a definitive answer in terms of the costs and the role forward about the actions that we’re going to be taking in the next 90 days as part of that presentation.

[Joe Ritchie, Goldman Sachs]

Got it, that makes sense and following up maybe on that question earlier on asset intensity and running your assets harder, I'd be curious just based on your first few months on the job, how do you evaluate the level of investment that’s been made across the businesses and what and whether you have to make incremental investments in your assets to drive better productivity?

[Richard Tobin, President & CEO]

I think that the opposite. As you're aware, I think that the asset base of Dover is diverse, I think to be kind. So there is ample slack capacity throughout the group and even if you drove down that by operating coming in second and everything else. So I think that there is an amount of opportunity if we're talking about driving longer-term productivity of changing the profile of some of our industrial assets to make them less labor intensive over time.

But I think that the payback on those investments will be solid. But it is very much a mixed bag between how old the assets are and whether they’re industrial assets or non-industrial in terms of their profile. So it's -- I'll just give you anecdotal comments but there are opportunities, if we're confident about the revenue streams going forward and the volume for some amount of automation that may require some amount of CapEx but quite frankly I don't think it's going to flex CapEx of revenue as a percentage of revenue demonstratively and I think that the payback will be satisfactory.

[Joe Ritchie, Goldman Sachs]

Got it. Helpful, if I could sneak one more in just on price cost. But just on price cost, it looks like you got in roughly $25 million or so price in the first half of the year, you're talking about $55 million or so of commodity inflation for the year, I'm just curious is the expectation in the back half of the year that price cost is going to be positive based on what you know today just completely offsetting or how are you guys thinking about it within the guide?

[Richard Tobin, President & CEO]

I think neutral is the best answer I can give you, I mean you got so much flex in mix going into the second half and a lot of comparable performance changes. Clearly, we didn't I think that DES in most of their industrial businesses did a great job in Q2 or some high value shipments but we got out the door quickly. So from a comparative basis, we're going to be really leaning on DFS in Q3 and really leaning on DFS and retail refrigeration from a comp basis in Q4 and because of retail refrigeration not retail refrigeration because of DFR being reliant upon Belvac in Q4 which are low shipments in number but very lucrative in terms of its margin profile.

[Operator]

Our next question comes from the line of Scott Graham with BMO Capital Markets.

[Scott Graham, BMO Capital Markets.]

So we've seen, in the past, facility consolidation issues. We've seen supply chain issues. These are, unfortunately, not new things. So what I'm wondering here is, as we look to slim down improved processes, what is the risk that 2019 becomes one of the -- those infamous transition years for you guys?

[Richard Tobin, President & CEO]

I don’t want it to be my transition. So I think the commitment of clearly from an execution point of view in DFS, I can't speak to the past. I can just speak to what we're dealing with right now; I think that we could have handled this better, right. I think that I'll put it in my lap; I know how to do that stuff. So I think that it's just a question of doing the preparation beforehand and executing on the plan. And just so I think also as I mentioned that we are going to be taking the industrial footprint but over the course of the next 18 months. And we may have targeted actions there but what I can assure you is, is that when we take those actions that will tell you upfront what the cost is going to be and what the timeline of the execution is and it's not going to be modeled in kind of on the run results.

[Scott Graham, BMO Capital Markets.]

So it's entirely possible that, let's say, for example, the first half of next year could be a little, for lack of a better term, squishy off of what you're trying to do over the next 2018?

[Richard Tobin, President & CEO]

I'd like is it possible, I don't think so. I guess is my answer right I mean I think if it’s squishy let's take an example. If we want to intervene in 2019 on the industrial footprint of retail refrigeration for example, it would be squishy to the extent of there are some amount of redundant costs both in preparation for and working capital to prepare to make that transition.

All right, but those are relatively known and easily measured right as opposed to having difficulty with the transition and not starting up appropriately where you're basically having difficulty executing on your backlog and then you get all of the frictional costs associated with that whether that is redundant labor significant overtime, freight expediting, paying supplier premiums, that part of it is execution and that's the part that while we may intervene on the industrial footprint, I think that the planning of that and our ability to demonstrate this is what it's going to cost and this is what the timeline, that part we'll fix.

[Scott Graham, BMO Capital Markets.]

All right. That's very helpful. And let me just be sort of a -- maybe a little bit more near-term-oriented here with my sort of second question. You laid it out very clearly that you're leaning fairly heavily on DFS for Q3 and retail refrigeration for Q4. And, I guess, I would say -- and I know that you don't want to go back to the past, but we've kind of done this. We're relying on this thing in the past. And I'm just wondering, do you have sort of plan Bs in those areas or in other areas to make sure that you stay within the guidance range?

[Richard Tobin, President & CEO]

Well I mean we put the guidance out there and I can see that there's some pushback on the $4.85. So I think -- and I told -- what I said was the bias was to the upper end, right. So I think that we're trying to take into account all forecasts are associated with executing the business. Clearly, I think that the comp to comp in Q3 is going to be unexciting and it's going to be backend loaded, I don't see anything in Q4 that could swing the number significantly that wouldn't allow us to make it up, right.

As I said it may be from a segmental point of view, it maybe puts and takes, I mentioned before we're ever reliant on Belvac shipments in Q4, if those get deferred into Q1, that's something that we're going to have to make up in DES or somewhere else. So we're again I’m taking that into account in terms of the movement of the total portfolio.

[Operator]

Thank you. That concludes our Q&A session for the day. I would now like to turn the call back to Mr. Goldberg for closing remarks.

[Paul Goldberg, VP, IR]

Thank you. This concludes our conference call. With that, we want to thank you for your continued interest in Dover and look forward to speaking to you again next quarter. Have a good day, thanks.

[Operator]

Thank you. That concludes today’s second quarter 2018 Dover earnings conference call. You may now disconnect your lines at this time and have a wonderful day.