All right. Good morning, everyone, and welcome to Dover's sell side analysts meeting. We're happy to be here today with you. Up on the podium is Rich Toven, Dover's President and Chief Executive Officer and Brad Serapak, Dover's CFO. Today's meeting will begin with some comments from Rich and then follow with a question and answer session.
I'll moderate the Q and A. We kindly ask that you limit yourself to one question with a follow-up. And when you ask your question, I'll hand you the mic, so people who are webcasting can hear it. Please note that our presentation can be found on our website, dovercorporationdot com. Also, a replay of today's webcast will be archived on our website for 3 months.
And before we get started, 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 ks 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 meeting over to Rich.
Thank you, Paul. I guess as we get started, I'm sure that you've all had the chance to page through the presentation. So let me start with some opening comments and then we'll go through the slides. As I promised during the Q2 call, we are here today to accomplish several things, provide the details of the SG and A rightsizing initiative with the timing of the actions, when we expect to take the accounting charge and what the rolling 12 month impact will be to the P and L. We'll provide some color around capital allocation priorities, hurdle rates on inorganic investment and shareholder return strategies, and provide a communication calendar for 2019 guidance, rightsizing initiative delivery, footprint action plans and set a date for a more comprehensive portfolio review.
Overall, we have a good set of businesses in our priority is to improve the performance of the portfolio, especially as it relates to our cost structure and positions of our business that are not performing to our expectations, 2 of which we'll address specifically later in the presentation. I hope that it's clear during the presentation what our priorities are and that we are laying out a framework for short term actions to be taken and longer term structural changes to the group. While this presentation may be construed as tactical in nature with less vision, I'm of the strong belief that it is imperative for Dover to set a clear actionable goals and execute on upon them before we engage in a broader portfolio discussion. Today's presentation is the first step. I know I've done so already to a certain extent, but I'll give you ample time for Q and A and endeavor to answer all of your questions.
Okay. So let's move to the Slide 3, those of you following our webcast. Over the past 4 months, I visited a significant portion of Dover's operating companies with on-site visits and management team reviews. I've also largely completed a 3 year strat plan review with the major operating companies to gain an understanding of the competitive framework in which these businesses compete. The synthesis of my early observations are as follows.
We have a strong set of businesses. We've got a good entrepreneurial culture. We've got good talent that is engaged and intent in winning in the marketplaces that they serve. We've had some uneven execution to date, but that provides a significant margin for improvement. We've historically and will into the future have strong cash flow generation of balance sheet that can be further leveraged.
We have acquisition opportunity with multi platform portfolio with an M and A runway and we're set up well to sustain top quartile return for our shareholders. So by and large, it's a great company with strong businesses, but there are opportunities to get even better. Moving on to Slide 4. Dover is a different company that was last year. With the spin off with the oil and gas business, company is no longer exposed to the cyclical nature of the energy commodities market and is now levered to general GDP growth, industrial products maintenance and greenfield CapEx, spare parts and consumable sales.
As you can see in the chart, most of the group's operating companies are leaders in market structure in which they compete or in established niche positions that are protected by established brand equity positions, installed base and defensible IP in their products. On the right side of the chart is a listing of the non financial company attributes that Dover evaluates its portfolio and uses to make decisions on internal and inorganic initiative funding decisions. Unique businesses and advantaged market structures with defensible positions and reoccurring revenue streams. The good news is that we have a broad complement of these businesses without a concentration to any particular market segment or geography. We manage the performance of these businesses against a pure group of competitor companies, not against each other in the Dover portfolio.
Moving on to Slide 5. Dobre had some success in the past in extracting operating synergies across the portfolio, primarily in the centralization of commodity group purchasing and low cost country sourcing. From an operating system point of view, it has been less successful, which has been reflected in its uneven track record for extracting sustainable incremental margin performance. While there are pockets of manufacturing supply chain excellence in the operating companies, the systems employed and performance measurement methods to measure them have been fragmented. That will be the locus of the operating system plan that is developed within the group over the next several years.
Dolby will be embarking on a new multiyear effort to begin to put in an operating systems across the company. One is that is split in 2 primary avenues. The first avenue will be on the front end of the business to introduce new customer facing tools to allow customers and distributors to transact with Dover on a faster and more efficient platforms. While this will have a short term effect of reducing labor on the front end of the business, the larger and more sustainable benefit is to streamline the sales and operating planning processes with the resulting benefits of introducing smart pricing strategies, complexity reduction, SKU management and networking capital efficiency. We'll begin piloting selected OpCos in 2019.
The 2nd Avenue will be put in a common operating management system for the factory floor, where productivity can be measured, which becomes the basis of establishing year over year productivity goals and incentive systems. This project will be larger in scope and may necessitate a reclustering of our operating companies that are more manufacturing than service based. We have embarked on evaluating an internal talent pool and external talent pool to support this initiative and investing in common system platforms. I what's important to understand about the common operations management system is that Dover is largely through putting in Oracle across its businesses for, let's call, fiduciary control or financial control. What we're going to need to do is now put in the operating suites that measure the factory floor.
So it's going to be a multiyear effort. Part of that is putting in the operating system portion. The other portion of it is putting in a business system, if you will, that measures the key components of productivity. So we can look at it as 2019, bringing the management team in together, establishing what we're going to put in and then rolling that progressively starting with the larger industrial opcos. We need to introduce offsets labor and input cost inflation year over year.
And that's important for sustaining margins going forward. Moving to the next slide. Before moving to the capital allocation discussion, I thought it'd be important to reflect on Dover's history of generating cash from its portfolio as a result of its asset light construction and its record of returning excess cash to its shareholders in the form of an increasing dividend and share repurchases. The metrics for CapEx and free cash flow have been ranged to account for changes in the business cycle and the timing of organic investment projects. Our expectation is to have a self liquidating balance sheet as it relates to net working capital performance management incentive systems are weighted towards total shareholder return, which has a heavy cash generation bias.
So I think in the past that we've put hard numbers on CapEx as a percent of sales or FCS conversion. As you can see, I've ranged it because I think that those numbers move with the business cycle. Am I implying that we are going to move into a CapEx heavy cycle going from here? No, I'm not. But I think when we get into capital allocation, I think there's a certain bias of reinvesting in our core platform, rather than a bias towards inorganic investment.
That is somewhat a reflection of timing and current valuations, but we can get into that going forward. So overall, the metrics for capital consumption and free cash are not changing as part of the portfolio, but I think it's important that we all understand that these numbers need to be ranged because they will move with the business cycle. Let's move on to capital allocation. On the left end of the slide, you see let's call it a theoretical cash generative potential of the portfolio using the metrics of Slide 6 with a 3% to 5% growth rate of the portfolio over the next 3 years at current level leverage and modeled incremental debt capacity with an additional EBITDA turn. Dover has adequate cash generative and balance sheet firepower to invest in its business, broaden its portfolio and return value to its shareholders.
In terms of the priority hierarchy, our bias is to invest organically in the portfolio, which is the best track record of high returns and execution is in our control. We are currently in the process of making material CapEx investments in the DES segment on the back of a new multiyear contract wins and a greenfield investment in our fast growing CPC business to accommodate capacity expansion. So back to this issue of measuring this on a year to year basis rather than a 12 month rolling as it relates to revenue. We are in 2018 undergoing from a Dover point of view, some at least 2 large CapEx projects, both on the back one on the back of some contracted revenue streams that we have in the DES segment and one on the back of expanding the capacity of our colder business, which is growing in excess of 20% of revenue right now. So we're not afraid to invest in the businesses that we're extracting the high returns and are winning in the marketplace.
The other 2 category priorities are more flexible in nature and dependent on the relative asset valuations and available opportunities. Clearly, we have had a bias towards capital returns in 2018. We will invest in organically where we have confidence that we can create value over time using a screening gate return on invested capital of +10 percent exit year 3 of acquisition as the primary measurement of financial criteria. I'll deal with the non financial criteria in the following slide. Our present inorganic pipeline has some interesting opportunities in it that we hope we are able to close.
We will continue to grow our dividend as we believe is a unique feature of Dover and it is a detraction to a long term investor base. And we are also committed to returning excess capital in the form of share repurchases. So I think what's important to understand is we expect to generate business where we believe that we have the highest returns. We are not going into a period of a quiet period, so to speak, which I've seen a few of you written in terms of inorganic investment. But the fact of the matter is asset valuations are quite high in the marketplace in kind of the target area that we exist in.
We are going to put a threshold of a ROIC hurdle that I've disclosed, that's exit year 3. So it's an I think it's fair to say, if we go back and look at the performance of acquisitions of Dover in the past, the urgency to extract synergies of acquired companies has not been there. And by putting this hurdle on it, I think that that forces the issue, so to speak, in terms of getting those returns into year 3. And that the dividend is solid. We'll continue to grow it and we're and keep our track record going forward in terms of growing the dividend year over year because we believe it's important to our shareholders.
Okay. Let's take let's go further on the portfolio enhancement as it relates to inorganic investment. Slide 8 is a little bit of a busy slide on inorganic portfolio enhancement. What it is, is basically a synthesis of the business characteristic criteria from Slide 4 and the return criteria of Slide 7. But let me point out a few things.
Deal size, we have performed a comprehensive review of Dover's inorganic investments and the returns on these investments versus expectations at the times at the time they were acquired. It is clear, but not exclusive that small to midsize deals and adjacencies to strong legacy portfolio positions have outperformed larger scale deals. Our bias today is to compete in deal size that we have confidence to execute and where we believe at least currently that asset valuations allow for meeting return requirements. Our current pipeline is largely made up of sub $100,000,000 deals in the pipeline. So this is just more or less the comments I gave you from the previous slide terms of where we believe the sweet spot is for Dover, I'm not saying that we will not evaluate larger deals.
As I showed you in terms of our balance sheet. We've got the capability to do larger deals. But the fact of the matter is if I look at the execution history of Dover, it's the smaller private company deals where we don't go to auctions that Dover has had a history of value creation. So that is in terms of the hierarchy where the priority is for the group. As I mentioned in the earlier slides, we are systematically evaluating our existing portfolio for our company's ability to continue to deliver future returns, their participation strategy and their market structure and the competitiveness of the products that they produce.
Those that become challenged will be candidates for divestment, but the timing of the divestment will be contingent upon maximizing the value of the asset, which may necessitate rightsizing initiatives and waiting for changes in the demand cycle. Meaning, as I mentioned earlier, today was not a portfolio discussion to a certain extent, but I think it's important to address this issue that we evaluate both the in and the out in terms of the portfolio. But I think it's also important that Dover needs to control the narrative of what comes in and out of its portfolio. And we will be the ones that determine the timing of both the in and the out to maximize the return of especially as it relates to disposals. We are working in reporting format for material acquired companies.
So the performance results are measurable in the segment disclosures for investors to monitor. So one of the commitments that we have going forward is any material sized acquisition that we do for a period of time, we will disclose the results of those of that acquisition within the segment disclosures that you see every quarter. Moving on to Slide 9. As I mentioned at the Q2 call, our initial priority was to address Dover overhead structure that had become unbalanced over time as a result of large changes to the group's portfolio, the fragmented nature of the asset base and the fragmented nature of the asset base. Dover has conducted over the last 90 to 120 days, a thorough review of its overhead structure and the results of which we'll discuss in detail today.
And has begun in earnest to review its industrial footprint, capacity utilization and cost basis. Any footprint actions will be announced progressively as they prepare to be executed and we will report and follow-up on each of these material initiatives in the format that we are using today. We have learned some important lessons on footprint consolidations and as such we will be deliberate in planning and execution to ensure that we execute efficiently. An important note, the overhead initiative will not impact research and development spending in 2019. Dover reports R and D as in SG and A.
I think that we're going to try to separate that out going into 2019, so it's clear. But this SG and A initiative that we're undertaking now will not impact R and D and our expectation is R and D will rise going into 20 19 and as part of the plow back of the spending of the $30,000,000 which we'll deal with on the following slide. Let's go to Slide 10. The results of the SGA initiative as released this morning is as follows. Gross savings from the initiative is $130,000,000 on a 12 month rolling basis.
Approximately $30,000,000 of the savings will be reinvested progressively to implement the 2 avenues of structurally improving the group's performance and customer facing platforms, operational systems deployment and management and an increase in R and D. The one time charge from the initiative is approximately $40,000,000 and we expect that the bulk of $30,000,000 of the charge will be taken in this quarter. The remaining amount will be taken as we are given the approvals necessary to enact the initiatives, but we do not expect any of the initiative charges to go beyond Q1 of 2019. We're a little early. I would have liked to have this all done and dusted, but I think that we're very confident the numbers that we're giving you, how we're going to take the charge.
I would like to have been able to give you the specific timing of the charges, but I think this is as close as we can be right now. But in terms of the 12 month rolling benefit, we're very confident in that number. To be clear, this is the cost in the rolling P and L benefit on a 12 month basis, which does not include any of the costs or P and L impact of any future footprint actions, which will be disclosed as they are incurred. To contextualize what we have covered at this point and to emphasize our intention to move Dover to a tactical and methodical execution stance, here is a synopsis of what we've covered so far. Will specifically address retail refrigeration and fueling systems in the next slide.
So where are we here today? We're here to deliver on the SG and A rightsizing initiative. We issued the press release this morning. So now we own it. To improve the performance of retail fueling, transportation business and retail refrigeration, which I'll cover on the following slide.
Continue organic growth and productivity investments, complete the $1,000,000,000 buyback program by the end of 2018, to pursue bolt on M and A around existing platforms and to begin a comprehensive footprint evaluation with the potential for rightsizing actions to begin in Q4. In terms of the second half and beyond is to invest behind Dover's leading businesses and future growth potential, solidify focus on reliable execution as a key tenant of the Dover culture, further opportunity for margin improvement, footprint rationalization and automation over time, pursue inorganic opportunities to build on out Dover platforms, to repurchase our own stock opportunistically and to continue to grow our dividend. So that's really the meat and potatoes, kind of what we said we were going to do at the end of Q2 and what we're here today to give you. So that's pretty much a synopsis. I'll get into some more of the specifics and the timing as we finish up the presentation.
But I think hopefully, it's clear not in just what we're attempting to do in the short term, but more that we're moving to a methodical and tactical mindset over the next couple of years where we establish a track record of delivery of what we say we're going to do, we're going to do. Okay. Let's move on to some of the portfolio performing some issues around the portfolio. I think I spent significant time around this in Q2, but let's expand upon it a little bit. This slide gives you a clear understanding where Dover needs to improve to improve its consolidated margin.
And as such, the requirement for addressing the cost structure of both the retail refrigeration and Dover fueling solutions has been a priority. I'll address each one specifically. Retail and refrigeration first. The bottom line is that we and our customers have been too optimistic about where we were in the demand cycle for some time and the cost actions being taken now should have been taken previously. Today, we have a business that's been aggressively attacking its variable cost structure, but chasing it down as revenue expectations have been missed, providing for no demonstrable improvement for the cost out as a result of negative leverage.
Clearly, we're going to have to make a call on the fixed cost structure and the size of the business for what we believe is the future demand for retail refrigeration is going to be and that process is underway. In terms of the margin target, we believe there is a path to the 15% to 16% margin based on cost out actions and the timing of which is subject to demand stabilization. This has been a difficult couple of years for the business, but we are encouraged by some interesting product initiatives in the pipeline and that pricing seems to have stabilized recently in the marketplace. This is a business that is a valuable cash generating asset, but it clearly needs to be right sized. It's still difficult in terms of the demand cycle and I expect it's going to be remain difficult through at least the balance of the year.
We've seen some stability in terms of pricing recently, which is hopeful. And we are working on a couple interesting new product opportunities that we expect to have some news flow on between now and the end of the year. Between now and the end of the year, we're going to have to make a call on what we believe to be the ongoing volume demand for this business. And I don't think we're prepared to do that today because we haven't reached stabilization or a floor, let's say. So my expectation is that this is one of the areas of the business that we're going to have to deal with the footprint rationalization.
That process has begun. And as soon as we've got those plans in place, we'll come back and disclose them to you all. I think I believe that we're below replacement rate right now. So part of the margin target is some of the benefit of the cost work that's been taken out, adding some volume back on. I can't tell you what that volume is right now.
And then the further part of that margin contribution will be from the fixed cost reduction and the incremental margin that we get from consolidating the industrial footprint. I think what's important to understand about this business is from a market structure point of view, we're arguably number 1 and number 2 in the marketplace. So we like the market structure. It's a business that does not consume a lot of capital. So it is a platform of cash generation for Dover to reinvest in its business.
So it's part of those numbers that we went through on free cash flow from the group. I understand that the path to margin improvement ends up being potentially dilutive to our longer term aspirations. But I don't think that that makes it a have to disposal candidate because it's return on invested capital actually outperformed some of our higher margin businesses. So we're committed to fixing this. I think we recognize that we got it wrong.
We read the signals wrong from the marketplace in terms of what our customers said about the demand cycle. But this is not a situation of let's throw the baby out with the bathwater right now. Moving on to Dover Fueling Solutions, we discussed in Q2, we've not done ourselves any favors from an operational perspective in DFS. Our footprint consolidation in Europe has not been executed plan and we've incurred material amount of frictional costs associated with the move. This has also spilled over to the balance of our operations trying to plug the gap where we've incurred costs for supplier premiums, logistics costs and over time.
We expect to have the bulk of this behind us by Q4 this year. Having said all that, we are still underperforming from a margin perspective, predominantly our European operations where we need to extract the operating synergies out of the combination of the Tokaym and Wayne businesses. The margin expectations of 15% to 17%, our target margins exit 2019 and our results of adding back the non recurring costs and structural costs take out being enacted, but there remains much to do in this segment. So again, we've had some self inflicted wounds this year. Clearly, I think there was always going to be a cost associated with doing a footprint synergy.
And I think that we should have been more transparent of disclosing what that would have been. We did not execute well. But again, this is a market, a business that we like the market structure, we like our competitive position. I think that our North American operations are performing quite well. Our European operations, once we get some of this footprint consolidation, will perform better.
But still, there's a long way to go in terms of meeting its margin aspirations. So we need a lot more work in 2019 to have this compete with its peers from a performance point of view. Okay. So everything that we've gone through to date has brought us to Slide 13. So using 2018 as a basis, so we had the completion of the $1,000,000,000 share repurchase to the balance of the year and reset the share count to January 1.
We have a positive impact of $0.18 a share for once you move from average shares outstanding to resetting the number. And we are highly confident that we will complete the balance of the $150,000,000 buyback between now and the end of the year. The SG and A initiative adds $0.53 and the runway of margin improvement without 2019 revenue impact is $0.13 or $0.11 I believe, with a bias towards DFS until such time as we can call the demand cycle for refrigeration, which we'll do in January of 2019. You'll get color on it at the end of the year. Generally So I'm generally not a reader of slides, but I hope we haven't done this at this point, but you're going to have to bear with me as the last three slides are pretty much wrap ups and I'm going to read all of this.
But if we move to the 3rd row down, We have a balanced model to Dover has a balanced model to deliver sustainable top quartile total shareholder return. Growth should be GDP plus outperformance. We expect to have double digit near term EBIT growth, high single digit growth over the longer term and operating cash flow of approximately 10% of revenue with a healthy dividend payout. We'll reinvest our free cash flow to enhance the strategic platforms and for compounding returns. We have moving to 15, we have a good business.
The foundation has not changed for Dover. We have a good business with leading positions in attractive markets. We have strong capabilities, customer focus, supply chain and entrepreneurial talent. We generate significant cash and we have the opportunity to deliver inorganic growth on top of our organic growth aspirations. Today, we are introducing a new emphasis on greater operational focus to deliver margin improvement and optimize the businesses.
Our 3, we expect to have there in about $3,500,000,000 plus capital deployment going over into the next 3 years. We expect to add M and A over that period with deeper, faster synergy capture and stricter criteria. And we are committing to a return on capital in shareholder friendly manner and will not let cash build on the Dover balance sheet. So we have, in essence, significant value creation runway and it's a great time to invest in Dover. We think it's important to give you a calendar of our communication going forward from here.
So today, we are sharing the results from the initial business assessment, our near set near term priorities, commit to improve the execution of the operations and announce the new rightsizing plan and communicate capital allocation framework. In January, we'll give you a report card on our interim progress on the measures that we've announced today. We'll give you 2019 guidance. We will continue to execute on smart allocation capital allocation, applying our framework and we'll update everyone on the footprint optimization initiatives as they are finalized. There in about September of 2019, we will continue to report on our operational progress, including facility consolidation actions.
We'll give you a more holistic view on the portfolio strategy, growth drivers and areas of investments. We'll demonstrate progress on capital allocation priorities and we will articulate a longer term goals for the new Dover. So that concludes the presentation. I'll take a deep breath and I think that we're going to move it on to Q and A. Everybody's got their hands.
If you
could just say your name and what firm we'll be able to get it on the transcript. Scott, let's start with you.
Thanks, Paul. Thanks, Rich. Rich, you commented a couple of times on more of an internal focus spending plan. When I hear that, the implication is that either the business were underinvested in the past or some sort of variation in that theme. Can you expand a little bit on that as it relates to more specifically what was under invested?
Is it just opportunistically like you'd like to take R and D up or do you feel like you've missed some opportunities and some growth based on past decisions that were made?
A couple of things. I think that the fragmented nature of the footprint well, I think by addressing the footprint, we have the opportunity to address automation, which is going to require CapEx, okay? So if I go back and take a look at incremental margin performance over Dover, you don't see the operating leverage that I would have expected to see. So you see kind of core operating margin as revenue rises and falls to a certain extent. So I think there's an opportunity with these footprint consolidations to take a look at the total volume and put some automation in, which allows to deliver that operating leverage as one.
And I mentioned 2 relatively large capital projects that we're undertaking right now. And that maybe just happenstance. I can't go look in the past. But we are in the process of spending on 1 and concluding to spend on the other one. One is on the back of some wins that we have in the marketplace on some longer term contracts, which is going to have us invest in capital equipment in order to deliver it.
And the other one is we've got a business a connector business, colder, which is performing very, very well. And we think it's time to expand that business and to invest into its future and to grow that platform. So what do I think that Dover was underinvested? Hard to say, but I think it may be a reflection of not being so productivity related. I mean, one of the things that to extract productivity, you need to invest to get that productivity.
So if you don't have that kind of mindset, maybe you're not looking at that as hard or as closely as maybe we are now.
Okay, good answer. Just quickly, what percentage of your portfolio you think is non core or red zone or open to debate on whether you should get rid of it?
None of it's non core now. I think it's we have if I look at the participation, we try to look at each company within its own market structure, not kind of versus each other, but how they participate. So I'd answer it in a different way. We've got a couple of businesses that provide high returns. But if you looked at their participation within their market structure, they're very small and very niche businesses.
So one could argue, one has to look at that and say, is that a sustainable position over time, right? So that's kind of the way we look at it. I don't believe that there's any off the top of my head other than a few very minor ones, where on one hand we like the returns we're getting, but we're a little bit concerned of what happens to this marketplace. Is it consolidating or something like that. So there's a few minor ones right now that over time we may address, but quite frankly, because we've got some bigger ones that are underperforming from a margin point of view, now is not the time to make that trade, but we'll be opportunistic.
If someone comes in and says, hey, look, we value that asset more than Dover does, then we'll take that on a case to case basis.
Hey, Rich. Andy Gabel, it's Citi. So if you look at your SG and A, you're going to take out almost 1.5% of sales of 100,000,000 dollars Is there anything structural in the way of getting to where sort of that midpoint is of those guys that you have on that slide closer to that 20% range? Is it the automation answer that you gave that the next opportunity is the right goal closer to 20% or not?
I don't know yet, I guess is the answer. I mean, I'm working my way through on a the only fair way to do this is company by company. Because of the fragmented nature of the portfolio, the peanut butter numbers across it and then say everybody can pursue this operating plan as if it's a panacea is not the right thing to do because it treats everybody equally and they're not all performing equally, right? And they're not some are more advantaged than others in terms of where they sit in terms of the market structure. So I guess I don't know yet.
I think that what we do know is that there was an actionable piece that was the SG and A. So we've worked very hard over the last 120 days to deliver what we're talking about here today. Part of this issue about the plowback of the 30,000,000 dollars is we're committed to making this cost takeout sustainable. And arguably, we're taking out more cost now that we can sustain over time. So we need to reinvest in systems to make it sustainable.
I think just to say, one of the ways to force a transition to a certain extent is to take assets away to make that transition happen. So if you think about the customer facing investments that we're going to make, we had to take away some of those customer facing assets to drive that change, okay? So that's why the numbers we're committed to taking out that gross number. So what we've taken out won't come back, but we recognize that we need to reinvest to make it sustainable over time. So I don't know right now of what the kind of the target is either on an SG and A as a percent of sales or from a consolidated margin point of view.
I think that we'll get that we'll get there. But I think that we need to kind of get to a point where we're disclosing tangible actions and we deliver upon them. And once we establish that track record, I think then we can start talking about future aspirations.
Just on Refrigeration, we know there's a lot
of moving pieces, but you must have some visibility to even throw out their path at the sort of 15% to 16% margin rate. So like your comments are kind of similar to what you had on the earnings call, but your test management talked about new customers, potential for improvement. Does that just not materialize starting sort of the near term changes to that to 4% that you guys have for the year? And maybe you can give us how you go down that path to 15% to 16% what
Sure. I mean, I think if you look at the revenue decline versus the absolute margin decline, it does demonstrate that management has been taking out variable cost at the same speed as the revenues coming out because the so called decremental margin isn't massive, right? And it's also a reflection of the capital intensity of the refrigeration businesses, which is part of the reason we kind of like it despite the fact that we're taking it in the neck right now in terms of year over year profitability. I've gone since I've been here, I've gone through all of the communications with the customer in terms of what they want to do in terms of maintenance and build out capital, it just continually gets revised. So I know I was kind of harsh in the commentary about we should have known better.
And I guess that's what get management gets paid for it is to make those kind of calls. But if I look at the communication between the customer base and ourselves, it would lead you to believe that it was finding kind of its floor earlier in the year and it just hasn't, right? And that's because of the uncertainty of what's happening in retail food right now and are we on a CapEx strike or where we are. So I can run the business at current revenues plus 5% and then take the full benefit of the variable cost takeout and then some benefit from a footprint consolidation point of view and kind of work the math to get to those margins to a certain extent. But what I need is for the revenue to stabilize and right now it hasn't.
So I need to find that kind of floor from where we are. In terms of the new product development, I'm not in a position to say anything right now, but this is not a scorched earth where we've just basically taken all the cost out and we're not looking at other opportunities, right? It's a $1,000,000,000 business at the end of the day. It's in a difficult time, but we're we also have to try to kind of change the dynamic of the business also at the same time. So I
guess just to get this out of the way. So if Refrigeration is substantially weaker than you would have expected, what is offsetting that? And are you guys officially kind of reaffirming annual guidance for EPS? And then on free cash flow, you talked about the range. What range of percentage of sales do you expect free cash flow to come in this year?
We're not as part of this discussion today, we're not talking about guidance either this year or next year, all right. So we'll come out in Q3. But to answer the first part of your question, the engineering systems portion of the portfolio is outperforming our expectation in terms of margin contribution.
And will you report in the same format as you reported historically? Or will you be making some adjustments? Sometimes new management teams come in and make different types of adjustments. Will you be adjusting anything or what's going to be pretty straightforward?
Yes. I mean, look, I think that you've seen the adjustments that we made last quarter in terms of how we disclose the segment performance. So to eliminate kind of the changes in portfolio that in the past had polluted is the wrong word and made it difficult to ascertain kind of core earnings. So we'll change that and that's permanent. This SG and A takeout today, we will continue to disclose that probably through the end of 2019.
From footprint point of view, we'll use the same methodology that we're using today. So if it's material, if we take a footprint action, we'll disclose it. I'm not going to make any change to the segment construction this year through the end of the year. We may in the future. I think it's unlikely in 2019, but I can't promise that.
Because it's and not look, my bias would be not to change it because I think it's important to have a look back, right? If you start changing segments, its comparability becomes a problem and we recognize that. But on the other hand, in order to put this operation system, there's an argument to cluster the service oriented businesses. So does that necessitate a change in terms of segments? I'm not sure yet, but it would lead me to believe that I don't think so until 2020.
Okay.
And then when it comes to the payback on the $40,000,000 to $100,000,000 off, how do we kind of wrap our arms around how you get $100,000,000 out of $40,000,000 spending? And then at a higher level, just a little color, we just I didn't know you previously at N H or R. Some of the pushback we've been getting is that you would set some margin targets there that were ultimately not hit. Can you maybe just describe perhaps what the track record, what that what was different there than what is different here after you just talk about kind of the near term dynamics around the math?
Yes. Well, in a certain way, I'm happy that Apergy is out of the portfolio because establishing long term margin targets for commodity levered businesses, one learns lessons in life and that's one of them. So 6 months after putting in margin targets out there in commodity prices to go down by 55%, one would have difficulty doing it. So I know that there's a variety of people out there scrutinizing my past track record. Fair enough.
I'm not a big believer in 5 year plans, my old boss was. I'm not in a position to give long term targets for Dover, because quite frankly, I don't know it well enough. I know what I know and I know what I think I can we can deliver as a management team. I think in 2000 when we come back here a year from now when we have the broader portfolio discussion, I think that whether that ends up being segment margin targets or what it ends up being, I think it will be more expansive in terms of kind of Dover's capability to deliver earnings growth over time. I think we could take that offline.
I mean, at the end of the day, it's very much weighted towards headcount, right. So there's a cost of taking it out. And as long as you don't replace, if you did it all on an FTE basis, as long as it's permanently out, you don't replace it, then you get the full year benefit of the cost.
Thanks. Maybe just a first question around you talked a lot about the Phase 1 rightsizing around SG and A. When you're thinking about the footprint side of things that you're obviously just starting more in January and so on, should we think about that as in Refrigeration and Food Equipment, the savings from that are much bigger than they are from SG and A than the other 2 businesses, they're much lower. Any color you could give on sort of size
Yes. I don't try to extrapolate 1 versus the other. Actually, SG and A. SG and A, in the shorter term provides much larger paybacks because it's pure cost. Footprint, couple of things.
Number 1, the charges are higher, but the cash proportionality of that charge is lower. So SG and A is cash, right? Footprint becomes a mix of cash and asset. So when we do a footprint run, we'll say, here's the charge and here's the cash portion of that charge versus the cost associated with writing down assets of closing plants and things like that. But footprint over time pays back more to the extent that volume remains stable or goes up over time because you get the volume leverage of taking that fixed cost out.
So it ends up being a little bit of a messier number footprint than SG and A.
And then secondly, you talked in the slides about double digit EBIT growth in the near term. I just wondered, is that something we see over the next sort of 12, 18 months? Is that the right way to think about it? So I guess you don't want to give
Yes, I don't want to give. I just think that that's kind of a range of what we can expect without getting into giving 2019 guidance at this particular meeting.
Rich, it's Deane Dray at RBC. I want to go back to the Page 14 goals for free cash flow. And it looks like you've taken a middle of the road estimate in terms of guidance is what you can do as a percent free cash flow to revenues. But if you go back to Page 6, Dover has performed much better historically on free cash flow by our estimates 118% average for the last 5 years. It begs the question whether that's benefited from some underinvesting in CapEx and maybe that's part of the signal today.
But just in general with the separation of Apergy, Dover should be a much better free cash flow converter. And maybe you're under promising here, but there's a lot of moving parts and maybe you can provide some clarity.
It depends on your starting point. You got to remember with Apergy, Apergy despite having significant earnings headwinds was liquidating its balance sheet at the same time. So that when I said self that in certain cases, when your earnings go down, you actually become very cash generative, right, because you're liquidating your receivable balances, your inventory and everything else. So if you look over the last 5 years of Dover, you need to account for the fact that Apergy or the assets that were in Apergy were providing a
And then just as a follow-up, a lot of discussion here about CapEx decisions and Greenfield. Could you share for us the return assumptions on those projects, maybe just broad strokes?
Yes. Those are that's no, I can't because they're so they're individual, right? So I'll give you the 2 that we're talking about that I mentioned today. The investment that we're making on the back of contract wins is capital equipment, which is an existing fixed cost basis. So it's the margin of that particular contract win, if you will.
So we would expect that margin because it's using an existing fixed cost base to be higher without using the word depends and it depends on the businesses we're talking about, but let's leave it at that. And investment in greenfield capacity expansion takes longer, right, because you're adding fixed cost at the end of the day, right, because you're investing in future growth. So the payback that we would expect is to be take longer just because you're building out a greenfield site, but you expect that that investment will pay dividends over time because you're investing in a business?
How kind of entangled is just the working capital in this organization? And do you see a significant trade working capital opportunity?
Some degree?
I think that Dover has done a decent job over the last couple of years. I mean, back to this working capital, the other question. I mean, let's to be fair to Dover, it has done a decent job over the last, I guess, 3 years on improving working capital. And making sure that incentive goals are TSR, which is weighted towards cash flow at the end of the day. I mean, the bad part of this is when you have TSR goals, you can actually harvest business too.
But let's not you know what I mean? Let's get into that. But I think so it's not a question of going around and giving turn goals to the operating companies at this point. My from what I've seen so far that turns have improved over the last 36 months in the Dover, but what's really going to change working capital consumption going forward is SKU complexity. Dover is making in Dover's a lot of businesses, Dover's first product they ever made is still in the catalog, right?
And to extract productivity on the factory floor, which has which you get the working capital benefit is discipline around SKU management, meaning 80% of our profits come from these products that we make and it's 100 out of the 1,000 that are in portfolio, right? And you need to be very disciplined about how you manage that process. There's a couple of ways to do it, right? You can manage it through price out or SKU takedown, both of which improve cash flow either in margin or working capital reduction. And that's kind of I think for the most as a general statement is kind of the next phase in improving cash flow at the operating companies.
My second question, you touched on a little bit in that answer. You mentioned incentives. Can you be a little bit more explicit about what you have changed or what you may change? We heard about the ROIC, you mentioned TSR.
What needs to
be done just to make sure everybody's got the horse in the water in the same way?
I don't have a particular problem with the incentive systems within Dover because they are relative PSR related. So it's very much after tax free cash flow basis, right, which it should be at the end of the day. I think so I haven't changed them. I think that there are add ons that we can put on there to make some things not optional. I'll just give you an example.
This SG and A takeout, if it's if by the end of 2019, you've added the same positions back, it's going to be in your incentive system. So there's modifiers that we can put. So in general terms, I like the systems that are there, but I think there are certain things you can do to manage behavior, right? And that is some areas that we'll address. John?
Good morning, Rich. Good morning.
John Inch, Gordon Haskett. Years ago, Bob embarked upon supply chain. And he had these quaint stories with more suppliers and customers. And they got into kind of a process of talking about how many you get produced. So it's kind of a numbers rationalization game.
We stopped that. The reason my question is, it's obviously not part of the savings that you've articulated today. We talked about IDLD earlier in the discussion and they are realizing substantial amounts of savings still years after they started their enterprise initiatives from supply chain, they employed a person in charge of it. How are you thinking about this opportunity in the context of Dover being the follow on? And is it as big as IPWs, it may not be, but just I'm curious if you can help decide this potential for us?
Yes. I think in the commodity group aggregation, Dover did a good job. But it never made its way into the sales and operations planning portion, right? It was the aggregation of spend, which is where you start, I mean, to be fair, right? That's you kind of go around and you figure out who's buying what from whom and you tried to aggregate it and use the scale of total Dover.
And I think you can see that in the raw material side, which is kind of low hanging fruit for lack of better word. Once you go down but that's part of the issue. The other part of the issue is driving that down into the S and OP processes, which back to the question I answered a moment ago about SKU management and everything else. It's very if you don't start managing your SKUs, once you get beyond commodities groups, you stop at the end of the day. So overall, I think that the work that had been done has been good.
But it's now you need to move the purchasing function and meld it with the S and OP function. And if there's a real weakness in Dover, it's in S and OP. We just tend to take orders and make the orders, right, without understanding how we price it and why we do it, that there's a de linkage there. So that with that de linkage, you just you end up ordering components from thousands of suppliers and very small lot sizes and it's very inefficient.
My second question, just to help us get inside your head a little bit in terms of your thinking on portfolio. If you were given a blank sheet of paper and Brad and Paul and lots of money, How would you think of populating this portfolio to create a company that creates value? And the context is also digital technology change, all the things that are going on around us at a fairly rapid pace. And you came from a machinery company, you kind of now you're just thinking of a hybrid multi machinery company. How are you thinking about that so we can get some close to what the future of build might actually look like?
Well, you're asking for next year's presentation. Look, I like a lot of what I see truly. I mean, we have some really fantastic businesses if I benchmark them, that benchmark incredibly well. But I'm also cognizant that first impressions are one thing and I need to be more deliberate in my actions, right before I start. Like I said before, I think it's very important for Dover to control its own narrative, which arguably it has not done well.
So I'm not going to contribute to not controlling that narrative to by making a bunch of expounding comments about the portfolio today. I need to learn a lot about market structure and the balance of Dover before we get to that point.
Thanks. Steve Winoker from UBS. Just when it comes to Health Phoenix, that was always one of the few businesses inside that industry that ever figured out how to make money over a long period of time. However, these are also the toughest, I'll use a nice word, toughest buyers that I know of most in the industry. So what gives you the confidence already to think that you can keep price keep those cost reductions you're talking about when it comes to pricing in that environment?
The manual intensity of that process is extreme for what should be a relatively common product.
So the sealable combination, you're talking about factory cost?
I mean, have you went into the Hill Phoenix factory and you looked at the complexity of manufacturing for a relatively common product, we'd be surprised.
And you believe that once they do that, you'll be able to hold pricing?
Look, all I can say is that pricing my only comment on pricing is pricing has begun to stabilize despite the fact that revenue has gone down significantly. So you've seen some pricing announcements that have been made by certain competitors of ours, whether they stick or not is one thing, but at least from a signaling effect, it's positive. But having said that, we're picking positives out of a pretty negative situation right now.
Okay. And then on SG and A, so in terms of some of these comparisons, I know you mentioned you built a bottom up. But a lot of those comparisons are also with companies with a lot larger scale. And so when you think about that, are you hoping to create more sort of subscale on these platforms internally that align and get to where some of these other companies are?
I think the benchmarking is important because one can't ignore comparables in the marketplace. But when we did the exercise, are we going to get to an SG and A of Honeywell? No. And are we ever going to have the SG and A of Roper? No.
Right. There's product mix versus scale. Those are like the two ends of the spectrum. So it wasn't an exercise of we took all the competitors and said what's midpoint and we sent out an e mail and said everybody gets to midpoint, right? I think that we kind of traveled a lot around the individual businesses, got a feel for how they were operating and just kind of made some decisions that said, just you need to take this cost out, recognizing that there was a commitment on the group's part to say, you're going to take the cost out and we're going to reinvest in systems to make it permanent.
So as I mentioned before, the harder part about this is, it's you got to rip the band aid off to a certain extent. So that's the 130. But to make it permanent, we need and that's why we've taken the 130 down to 100, right? Forget the timing and the calendarization and everything else. You got to kind of take away the punch ball to change the mindset and then reinvest behind it.
So it was benchmarking is important, but once you get down to the tactics, it's something completely different.
Rich, you kind of touched a little bit on this already in terms of taking maybe an eightytwenty approach to where some of the margin opportunity is. You mentioned product line complexity are there any other elements that
you would put kind of in
the tail of activity where you would benchmark yourself and say, in something like lead times or in sales force productivity, kind of like pick discipline where that's the tail and it's a big part of that $100,000,000 of net savings?
Of what this savings program meant?
Or what you want to do on the facility side. I'm not ready to quantify yet.
Yes. On the facilities
Is it big buckets or is it
a lot of little things that add up?
It's a lot of little things that add up. We have certain businesses where a significant proportion of their revenue is sold through distribution, okay? So there's a way to put in customer facing platforms that those distributors can basically pick out of your catalog. So the interaction is reasonably slick. So you have a business that's making a product, it goes through distribution.
It retains a small amount of a sales team, but more importantly co engineering assets because a lot of one of our the beauty of Dover is a lot of what we do. And the reason that R and D, once we even disclose it as a percentage of revenue is not very high is because a lot of these small businesses do co engineering with their customers. So the customer is almost bearing the R and D cost, at least the testing and everything else. So what we're trying to take out is, so if we go find a business like that, we say, well, look, we can put in a system where your customers can just pick because it's distribution. They're managing their own inventory to a certain extent.
You re divert more of your SG and A into kind of, let's call it, product development, right? And we can take rate kind of just the managing of order entry and a lot of basic processes. And those and we're not reinventing the wheel here. But that Offloading more of your infrastructure to distribution? Well, it's not a matter of offloading.
It's just a matter of it's a traditional way of doing business. Someone calls up, someone picks up the phone, I'd like to order X, Y and Z. I mean, to put that into a system where that's non value added labor at the end
of the day, right? And then just a follow-up, we talked a little bit about this upfront. On the measurement side, I think there are a lot of things that you think there's
a path to what that's in class
is like. How much of that are you able to measure today from a systems perspective? Is there some step up in cost you anticipate that you're not ready to quite get that involves getting those systems kind of punched up to be able to measure some of the things you all
Yes, there's very little that we can measure today. From a systems point of view, the good news is those operating systems run off of ERP system backbones. And don't know where we are and I want to give out a number, but we're well along in the path of putting the ERP system out there. But the financial modules, now you just have to put the operations modules in there, right, and begin. So you kind of need to develop a, what you want, you got to get it in the system, you can start populating the system and then you can start measuring productivity of what comes out.
So the big spend is to put the ERP infrastructure in there and that's either, let's say, halfway behind us and ongoing, so on the run costs. The second part is going to be systems development, getting the personnel and then putting those systems in. And that's what I mentioned before about the potential for reclustering the assets to a certain extent. It doesn't apply to everybody, right? So if you're a business that's got a bigger service component, you don't need that, right?
You need these are for the guys that are machining housings every day, for lack of better word, right?
Okay. This is going to be the last question. And I'm sorry, I didn't get to everybody, but a lot of analysts today. So, John?
Hi, Rich. Joe Ritchie Goldman Sachs. So maybe just along those lines, the full concept of basically you're talking about 0 cost based budgeting from a planned productivity perspective. Just maybe provide a little bit more color as you look at the footprint that you have today. What percentage or how many plants do you feel like are
you getting far along the way?
Do you have any sense give us a sense for
the opportunity there.
Brad and I are laughing because we went back and forth whether to try to put a number in or not. Look, I've got 10 in scope right now. Does it end there or is there more to go? I'm not I haven't seen all of our plants yet. So it's almost unfair for me to kind of put percentages on and everything else.
And look, and by and large, the operating management knows what it wants to do. I think that we're just very cognizant that we need to put in the systems and the people to execute efficiently. So it's not as if I showed up one day and started saying, let's start taking a look at the footprint. I mean, that I think there's an intuition that there's some opportunity there. We'll undertake it, but I need to be pretty deliberate because we just can't have these execution issues that we've that we're incurring in DFS.
That just can't happen, right, as part of doing it. So we've got a bunch of balls in the air. We may start on 1 or 2 in Q4, depending how confident I am in terms of the evaluation or ability to execute.
Okay. Fair enough. And I guess my one follow-up question is back to refrigeration for a minute. So it sounds like pricing has stabilized, the demand environment is still not that great. But your expectation is that it will be, call it, 2% to 3% type growth in the business.
So is there anything that's at this point giving you any confidence in that number or still kind of a wait and see?
I think it's a wait and see. I think it's a wait and see without putting any color around it. I can't come up here and say, I'm reticent to say anything that I think it looks like it's getting better. It's still in a difficult position right now.
It's Rich. Do you want to make any closing comments?
Nope. But thanks for everybody coming today. Happy to meet some new faces and some old ones. So we'll talk again at the end of Q3.
Thanks, everyone. Thanks.