Dover Corporation

Please stand by, your program is about to begin. If you need assistance during your conference today, please press star zero. Good morning and welcome to Dover's third quarter 2023 earnings conference call. Speaking today are Richard J. Tobin, President and Chief Executive Officer, Brad Serapak, Senior Vice President and Chief Financial Officer, and Andre Galuk, Vice President, Corporate Development and Investor Relations. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, please press star and then the number one on your telephone keypad. If you would like to withdraw your question, please press star two. 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. Andre Galluc. Please go ahead, sir.

Thank you, Angela. Good morning, everyone, and thank you for joining our call today. An audio version of this call will be available on our website through November 14th, and a replay link of the webcast will be archived for 90 days. Our comments today will include forward-looking statements based on current expectations. Actual results and events could differ from those statements due to a number of risks and uncertainties which are discussed in our SEC filings. We assume no obligation to update our forward-looking statements. With that, I will turn this call over to Rich.

Okay, thanks, Andre. We posted very encouraging results in what has become a dynamic operating environment across our different end markets and geographies. Revenue and order rates improved sequentially in the quarter on normalizing lead times and inventories, improving demand across several end markets, and a return to normal seasonality. Our backlog continued to normalize in the quarter in tandem with lead times as we shipped longer-dated orders from our books. Broadly speaking, margins performance in the quarter was exceptional, reaching an all-time high driven by productivity, cost controls, and disciplined pricing, which more than offset the negative product mix in pumps and process solutions. The proactive structural cost actions we have undertaken over the last 12 months are paying dividends and should support strong margin conversions going forward. Our recent portfolio moves, the acquisition of FW Murphy and the sale of Dosteco, follow the portfolio intent and priorities that we reiterated our investor day earlier in the year and continue our portfolio evolution towards higher growth and higher return businesses that attract evaluations. Our balance sheet position and cash flow are strong and provide attractive optionality as we continue to pursue bolt-on acquisitions in a more favorable M&A environment and evaluate opportunistic capital return strategies. We have reduced our EPS guidance for the full year and are now targeting the low end of the previous guidance range. This is driven by continued lag in biopharma recovery that we expected to happen in the second half of the year, temporary cost and supply chain issues that I will expand upon later, and general trends towards inventory liquidation across supply chains as a result of macro uncertainty and prohibitive carrying costs. I will cover the specifics in the segment commentary. Overall demand remains good across the portfolio considering the plentiful negative macro headlines. Our new product launches and capacity additions and identified areas of growth are all on track. We expect that our fourth quarter production posture will help balance our channel inventories with prevailing demand, lead times, and inventory carrying costs by the end of 2023. We are increasingly convinced that inventory position will be critical to the pricing dynamic and financial results moving into 2024. Going into 2024, we expect to see growth in our bookings driven by secular growth exposed and recovering end markets, and we expect to carry an elevated backlog into next year in select businesses. Between our demand outlook, flexible business model, and in-flight structural cost actions, we see good foundation for value creation in 2024. Let's move on to the performance highlights on page four. Consolidated revenue was down 2% in the quarter despite sequential growth in four out of five segments. Bookings were up sequentially, but down 4% organically over a year, resulting in a book to bill of 0.93, reflecting better lead times and strong shipments against our longer dated orders. As a result, our backlog continued to normalize, but remains elevated relative to pre-pandemic levels. Segment margins were up 50 basis points to 21.7, a record since the Apogee spin, as broadly based productivity and portfolio improvements were more than able to offset biopharma mix. Adjusted EPS was up 4% to $2.35 in the quarter on positive price-cost dynamics, together with cost containment actions, strong execution, more than offset lower volumes. Let's go to slide five. Engineer products was down 3% organically in the quarter. General weakness in Europe and Asia together with lower shipments and vehicle service more than offset the record quarter in aerospace and defense and strong shipments in waste hauling. Order rates in the segment were up 12% organically in the quarter, primarily driven by waste handling business, which continues to take capacity reservations well into 2024. Margins at 20% were up 260 basis points year-over-year, driven by a better mix of reoccurring and aftermarket revenue, price cost, and productivity investments made in previous periods. I'd like to mention the announcement of our agreement to divest Destaco, one of the operating units within the engineered product segments, and an attractive valuation. This is not related to the previous performance, but we leave the valuation we achieved underscores the quality and strong performance of the businesses that we have proven to have best-in-class operating margin and less cyclicality than typical capital goods businesses. Clean energy and fueling revenue was flat organically in the quarter. We saw double-digit growth in components for LNG and hydrogen markets, and the above-ground retail fueling business returned to growth as post-EMV recovery is in progress. High interest rates led to to project pushouts in vehicle wash and an unforecasted channel destocking has resulted in slower activity in LPG components and below-ground fueling, which are highly margin-accretive to the segment. Margins in the quarter were at 20 percent. We're up 40 basis points on structural cost actions in our retail fueling business and solid execution more than offset negative mix. Imaging and ID was down 4%, organically a slowing demand in China, and a difficult comparable period in marking and coding printer shipments more than offset the growth in serialization software and marking and coding consumables and professional services. Margins in imaging and ID was strong at 26%, though down year over year, against an all-time record high for the segment in the comparable quarter. Pumps and process solutions was down 7% organically in the quarter. Precision components and hygienic dosing systems posted another quarter of excellent growth, but were more than offset by the continued softness in biopharma. Industrial pumps and polymer processing were staying in the quarter. Segment margin at 27% was down to the lower mix of biopharma revenue. Top line in climate and sustainability technology was up 2% organically. CO2 systems continued its double-digit growth trajectory. Heat exchanger shipments remained strong in North America and Europe, though we experienced the beginning of demand headwinds in Asia. The segment posted strong margin performance, 18% per quarter, with our food retail business, refrigeration business, operating at a robust 15% margin. The steady margin improvement trajectory in refrigeration has been noteworthy as positive mix and productivity investments have driven excellent margin conversion. We expect the margin improvement trend to continue for the whole segment. I'll pass it on to Brad here.

Thanks, Rich. Good morning, everyone. I'm on slide seven. The top bridge shows our organic revenue decline of 2%. Both acquisitions and FX translation contributed positive 1% to the top line in the quarter. FX, which has been a headwind for the past year and a half, resulted in 2 cents of positive EPS impact in the quarter. Based on recent movement in the euro-dollar exchange rate, we now expect FX to be a 1 to 2 cent headwind in the fourth quarter. From a geographic perspective, the U.S., our largest market, was down 7% in the quarter due to lower shipments in vehicle service, biopharma, LPG components, and below-ground retail fueling. Europe was down 5% and Asia was down 3%. China, which represents about half of our revenue base in Asia, was down 5% organically in the quarter. On the bottom chart, bookings were down year-over-year due to normalization of lead times and strong shipments against elevated backlogs. Now on our cash flow statement, slide 8. Year-to-date, free cash flow came in at $688 million, or 11% of revenue, representing an increase of nearly $400 million year-over-year. As discussed previously with supply chains improving, We have begun actively working to liquidate our working capital balances in 2023. We accelerated our inventory reduction in the third quarter and expect the trend to continue as we plan to balance our inventory levels by the end of the year. Free cash flow generation has historically peaked in the fourth quarter, and again, we expect strong fourth quarter cash flow to finish the year. Our forecast for 2021 2023 free cash flow is 13 to 15% of revenue. Let me turn it back to Rich.

All right, I'm on slide nine. We expect engineered products to generate moderate growth in the fourth quarter. Aerospace events should remain strong. Meanwhile, the auto strike will weigh on several businesses in the near term. Growth in our waste handling business, which is expected to be robust in the fourth quarter, into 24 will be reduced in the near term by recent strike at a major truck OEM impacting deliveries. Shipments and vehicle aftermarket expect to be lower versus a record previous year on higher interest rates way on service shops' ability to finance capex. We expect margins to improve in the quarter on positive price cost tailwinds and benefits for our recent productivity capital investments. Clean energy and fuel is expected to remain steady. clean energy, LNG, and hydrogen components should continue their robust trajectory and order trends and above-ground retail fueling point to continued post-EMV recovery. We expect channel destocking and interest rate-driven headwinds in the below-ground fueling segment, LPG components, and vehicle wash to maintain through year-end. We expect stable margin performance as the $60 million in aggregate structural cost containment actions and retail fueling should offset negative mix from lower below-ground and lower car wash volumes. Imaging and ideas expect to be down organically against a difficult comparable period driven by slowing demand in Asia and a skewed outlook for textiles. Serialization software should continue its growth trajectory. A new customer conversion margin performs should remain attractive levels at this segment. Pumps and processes expect to remain roughly flat organically in the fourth quarter. Precision components should continue growth tailwinds from energy transition projects. Polymer processing is booked for the year. The recovery in biopharma components has been very subdued, and although channel inventory levels are now below pre-pandemic levels and customer demand has not recovered enough to drive 2023 growth despite earlier forecasts indicating recovery. We have reduced our production and inventory levels appropriately and will remain in this posture for the balance of the year. This is generally a short cycle business and we can ramp as order rates recover in 24. We expect year-over-year margin headwinds on negative mix and biopharma. And after several years of impressive top-line growth, climate and sustainability technologies expect to moderate in the fourth quarter as demand for heat exchangers abruptly slowed in Q3 due to near-term uncertainty in European heat pumps. As a result, we're reducing production levels to allow for inventory to be cleared in the fourth quarter. Traditional refrigeration demand will retain its seasonality with reduced activity during the holiday season. but we continue to see robust demand for our CO2 refrigeration systems and are ramping up production and go-to-market efforts appropriately. We expect continued year-over-year margin improvement through year-end on productivity gains and improved mix. Go to slide 10. Our updated EPS guide reflects the near-term changes in demand and our production posture, temporary and isolated issues in the supply chain, and costs related to acquisitions integration, and divestment activities. We expect these headwinds to be partially offset by a lower effective tax rate in Q4 as a result of tax reorganization activities driven by upcoming regulatory changes. As I've highlighted, we believe our changed operating and production posture focused on reducing inventories and prioritizing cash flow over volume in reaction to the dynamic operating environment is critical to setting up 2024 outlook where we can maintain and expand operating margins. Let's go to slide 11 and take a quick look at the inorganic moves that we made during the quarter. Here we summarize the two recently announced transactions that align well with our portfolio priorities and enhance the overall quality of donor's portfolio through margin growth and reoccurring revenue uplift, all while reducing our exposure to automotive and China. Importantly, we're able to acquire FW Murphy at a lower valuation multiple than our sale of Destaco, and the after-tax proceeds from the Destaco sale more than pay for FW Murphy, preserving significant balance sheet capacity for additional capital deployment options. Slide 12 provides more color on the rationale for the acquisition of FW Murphy by our precision components operating unit. which is part of pumps and process solution segment. F.W. Murphy brings a highly complimentary product offering to our existing position in reciprocating compression industry. F.W. Murphy solutions capitalize on the growing adoption of advanced remote monitoring, control, real-time optimization solutions as customers seek to reduce costs, improve uptime, and lower emissions. In combination with our best-in-class cook-clean technology and our leading position in sealing and valve technology for alternative energy applications, including in hydrogen, the F.W. Murphy acquisition offers a compelling value proposition into a global industry where we see robust demand from energy transition investments. The F.W. Murphy acquisition provides a good segue into our next topic, which is to highlight the recent developments in investment in sustainability-driven markets starting on slide 13. There has been plenty of interest around hydrogen as a result of the recent announcement of $7 billion in federal funding for multiple regional hydrogen hubs that are expected to also attract $40 billion in private funding and a roster of blue-chip industry participants. Dover has established a position in hydrogen with the 2021 acquisition of ACME. which supplies flow control components for liquid hydrogen, and LECAL, which offers turnkey hydrogen refueling sites. Additionally, we are organically invested in extending DPC's gas compression components to participate in gaseous hydrogen applications. In short, there is no hydrogen economy without compression. We have great relationships with the industrial gas and hydrogen players and aim to participate throughout the whole value chain through transport and storage through end use in collaboration with equipment OEMs. We are well positioned to capitalize on growth in hydrogen in industry with a high focus on safety and regulatory compliance with high technological requirements for participation. Moving to slide 14, the EPA recently finalized its rule under the AIM Act with a deadline for new installation of refrigeration systems to be compliant with lower GWP requirements by January of 2027. We believe this rule is a clear tailwind to our CO2 systems business. We have had a leading position in European CO2 market for over a decade where we enjoyed steady double-digit growth trajectory. We were the early mover in translating this technology to the U.S. We currently enjoy a technological lead and have the largest installed base and broadest differentiated offering. We have proactively expanded our capacity in addition in anticipation of market growth and have been investing behind a platform-based product strategy to drive standardization, thereby reducing costs for ourselves and our customers, improving product quality, and simplifying the sales process. Our global CO2 business is approximately $200 million in revenue. The U.S. market is in the early innings, and we're in our businesses on track for 30% growth in 2023 with a strong outlook. We are also excited about our new CO2-based heat pump offerings for industrial and district heating applications. It's early days, but we have an active pipeline of orders. And finally, on slide 15 shows our latest views on heat exchangers since it has become a battleground topic. Our heat exchanger business supplies brazed plate technology which is currently the most sustainable commercialized heat transfer technology for fluids. We have been the clear beneficiary of the sustainability and climate tailwinds across various applications, with a lot of attention drawn recently from our participation as a key supplier to hydronic heat pumps. Heat pumps have emerged in recent years as a technology of choice to decarbonize residential heating, which is responsible for a significant portion of global emissions with hydraulic heat pumps as a primary technology to retrofit houses that rely on water-based heating. Legislative initiatives in the European Union and individual countries are driving the conversion of fossil fuel boilers to heat pumps. Recent uncertainties about subsidies in select European countries have weighed on near-term volumes, as I indicated earlier. Our exposure across multiple OEMs and geographies, and as such, we are not over-indexed to any product or customer concentration risk. We remain confident about the long-term growth prospects for heat pumps and our technology. It's important to note that European residential heat pumps represent only a quarter of our heat exchanger business. We see several solid growth vectors driven by sustainability tailwinds, and continue to share gains from other legacy heat exchanger technologies. We have proactively expanded our capacity as we expect continued robust growth trajectory in heat exchangers, albeit with slightly lower rates in the near term as various dynamics in Europe slow down. I close my prepared remarks by thanking our global teams for driving our strong financial performance during the quarter. And it's time for Q&A.

If you would like to ask a question, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, please press star 2. We ask that participants limit themselves to one question and one follow-up question. Once again, if you would like to ask a question, press star 1. Our first question comes from Steve Tusa with JP Morgan. Please go ahead.

Hey, guys. Good morning.

Nice to meet you.

So I think you were a little more positive in early September than this fourth quarter guidance. Understand maybe the world's changed a little bit since then. Maybe you could just discuss that. But then just looking ahead, thinking about perhaps a more cautious view of the world for next year, what's kind of a low-end assumption for next year when it comes to organic and margins? Just to kind of level set us on that. You know, a case where perhaps the orders don't recouple as strongly to the trend lines or the trend lines are a little bit weaker, like in your macro view, what does a more cautious outlook for next year bring, you know, for Dover? Because you've been talking about growth there, you know, as things recouple the trend. It seems like that would have changed over the last month or so.

Okay, that's a lot to... take on there. Steve, let's give it a try. Look, I think if we look at our forecast of the year, we were just wrong about biopharma. I mean, we were getting indications from our customers that there was going to be some nascent recovery. We actually did see some order upticks, but quite frankly, it just never turned into much So that's a little bit different than we were back in September. I think we just have to throw in the towel on biopharma demand and it gets pushed to 2024. What we didn't expect in terms of market dynamics was this UAW on trucks, right? We thought it would stay limited into the car sector. And unfortunately, what we were betting on is being able to ship quite heavily out of ESG in Q4. We'll actually have a good quarter in Q4, but it's not going to be as robust in our plans. I think I mentioned on the heat exchangers, that was a little bit of an abrupt reversal and really didn't happen until almost the end of Q3, so up until about 30 days ago. Everything looked good there, and I think that we've got a little bit of a pivot as what we understand is there's a lot of finished goods in the supply chain that need to be reduced from there. So, you know, at the end of the day, I think it's slowed some, which leads into the next question. is to drive for cash because I think that the way we're going to be able to protect margins into 2024 is not to be long inventory. We had a lot of discussions around here about incentivizing revenue in 2024, driving revenue, but then you start touching on things like price, and you start touching on things like payment terms, and we're not going there. I mean, I think that the strategy that we have is to adapt quickly and efficiently to the market demand, bring down our inventory with the hope of, you know, with the strategy of protecting margin into next year. And I think if you look how we've handled demand this year, it's exactly what we've done at the end of the day. I mean, we talked about it before. What we'd seen over the previous two years was not a lot of unitary demand. You saw a lot of pricing going into the system. So we came into this year saying, you know, there's probably going to be less price and some unitary demand. But the important, and I think that we've done that in terms of managing, which is reflected in our margins here to date, is managing not getting oversupply and over our skis a little bit in terms of inventory. And we're going to take that on for next year. You want me to make a call on the market next year? I think we're going to have to wait on that. Clearly, There's a lot of headwinds in the system. I don't want to get on a personal soapbox, but the amount of liquidity that's being withdrawn is going to show up somewhere. And this notion that we're all going to wait on the government to bail us out because there's this wave of government spending coming, I find that a problematic strategy. So I think it all is going to be triggered by monetary policy between now and the end of the year, which is going to allow for us to predict growth into next year. What I can tell you is, is if we do what we're planning on doing in Q4, we will not be long inventory and we're not going to get into a situation where if there are kind of top line headwinds that we're going to have to start playing price to drive growth.

So like, should we just think about flat as a starting point for next year?

No, I don't think so. I think that we're ahead of the curve. Remember, we're a component supplier into end market industries, right? So we're first at the end of the day. So I think that if we get this right, we've got top line growth next year, even in a pretty benign kind of macro environment, I think that we can drive growth. And I think that's part of the reason that we covered some of those growth factors in terms of our investment at the end of the presentation.

Great. All right. Thanks a lot.

Thanks.

The next question comes from Jeff Sprague with Vertical Research Partners. Please go ahead.

Thank you. Good morning. Hey, Rich, maybe a question on restructuring and thinking fueling in particular. I think you had a lot of restructuring planned there for Q4, but it looks like you're guiding margins kind of flat, I guess, on a year-over-year basis. Could you speak to that? Maybe it's some of the absorption issues you're talking about on inventory, but love some more color on the margin trajectory there.

Sure. I think if you go back and look at the script, basically what it says is the restructuring that we took is going to protect margins into Q4 because we actually have a poor mix forecasted for Q4 because where we've seen the headwinds, in fueling solutions is in the below ground portion of the segment, and that is highly accretive to margins. We're basically, you heard me answer Steve's question there, we're taking the position of let's allow inventory to be draw down even, we would argue at this point, below even normal levels between now and the end of the year and protect production performance into next year. You know, the restructuring benefit, the restructuring that we've done is actually protecting margins into Q4.

And on these questions of just kind of what's at the customer level, right, whether it was biopharma earlier this year, heat pumps maybe now, you know, some other pockets, how would you kind of square up your visibility and kind of comfort level on, you know,

understanding what the what the right level of inventory is or when the customer demand you know equation might turn a little bit yeah i think we're getting a lot better at it at the end of the day where we sell through distribution we have visibility right because we've just got a material position within distribution so we can see pretty much stocking levels at the oem level it becomes a lot more difficult at the end of the day we're relying on the oems to basically tell us their own position so Let's take heat exchangers. Up until 45 days ago, it was still a demand capacity deficit of give us everything you've got, and then all of a sudden, for reasons that I tried to cover, the market's come to a halt because there's a recognition of there seemingly is a lot of finished goods in the chain now that need to be bled off. So, like I said, if it's distribution, I think that we've got a pretty good handle on it, When it's OEM, we just got to take the signals from them.

I'm sorry, just a quick one for Brad. Does the tax rate bounce back to 20-something next year, or what should we expect going forward?

Yeah, Jeff, you know, the things we're seeing here in Q3 and into Q4 on taxes will not carry into next year. So said differently, I think our 24 tax rate is going to be much like we saw earlier in this year when we gave guidance, you know, somewhere in that 20% to 22% rate. Great.

Thank you.

The next question comes from Andrew Obin with Bank of America. Please go ahead.

Good morning. This is David Ridley Lane on for Andrew Obin. Rich, how would you characterize, you know, kind of the excess backlog at this point in time and how that kind of interplays into the revenue you'll see versus kind of the bookings trends that you need?

I don't think that we have excess backlog anymore. I mean, I think that we're, by the end of the year, we'll have drawn down our longer cycle backlog, particularly in Belvac and Mogg. which drove a lot of it. I think it will end up being a little bit higher than kind of on average in terms of its aggregate if you go back and look over the last five years, but that is more related to portfolio, general portfolio mix as opposed to anything else. So, you know, like I said, at the end of the year, we think that we'll be in balance between our inventory and our customer distribution inventory, I would expect the long cycle business backlogs to be done, that reduction to be done by the end of the year.

Got it. And then, I know it's tough to ask about bookings, but do you see bookings potentially increasing in the fourth quarter then?

I got to go back and take a look. I mean, I would say flat. If I think about where bookings are coming from, we got a lot in ESG at high dollar value. Because quite frankly, we're booking well into 24 in that particular business just because of supply constraints. Flat, I would call it right now. I think that there's an overall caution there. With the macro, everybody recognizes that lead times have been vastly reduced. So I think that there's going to be a lot of hurry for bookings in Q4, but we would expect a pretty large acceleration in Q1.

Understood. Thank you very much.

The next question comes from Mike Holleran with Baird. Please go ahead.

Hey, good morning, everyone. Two here. So first, on the inventory side, you're obviously bringing your inventory down a fair amount, pretty aggressively, more so than what we're hearing elsewhere. Do you have the same sense of urgency in the channel when you look at your channel partners, or do you think they're lagging the pace of your inventory drawdown?

No, I think that our channel partners are, in certain cases, below normal holding patterns. And that is because of the cost of carry with interest rates. So if you think about a typical distributor that's got $100 million of inventory, a working capital loan that they would have been able to have 18 months ago is probably 2% or 3%. They're probably paying 9% now. So there's a dynamic now because of higher interest rates of everybody trying to liquidate working capital because of the cost of that working capital, us included, by the way. And we're at a little bit of a standoff in certain end markets where we would argue that inventories are down too low, but we are not going to incentivize revenue into the system either through price or through terms. We're just going to sit tight and we'll cut our own production into Q4 because that's just harvesting demand revenue. That's in 24 into 23.

So the comment that you made to the previous question about order having a better chance to turn positive in the first quarter, I'm guessing part of it is the comments you just made that inventory flush through the channel essentially normalizes by year-end, and you should have at least normal throughput, if not a little bit more, given where inventory levels are in certain channels.

That's correct. If you look at the top line revenue trajectory in some of our businesses, you have to take destocking into it. That's not a reflection of end market demand. It's end market demand minus destocking.

Great. And then on the DPPS side, maybe just kind of parse out the moving pieces there. Obviously, you have the continued destock on the biopharm piece, creating some pretty easy comps in the next year, but a lot of your other pieces are a little bit more IP sensitive. So maybe just talk about some of the moving pieces you're seeing on that side.

Well, I think that overall it's underestimated the amount of profit loss that we've had on the biopharma reduction. To the extent that we're clocking at record margins in the quarter while eating this pretty bad sandwich here, I think that we're quite frankly, I think we're pretty proud of. So to the extent that it's pushed into 24, at the end of the day, the comps get pretty damn easy. Once we get into Q1 of next year, the balance of the underlying business, uh, precision components, uh, where we basically bought FW Murphy into look, we're behind, uh, energy transition. We're betting on gas in total LNG, hydrogen, you name it. Um, Order rates there we expect to be really good. I think MOG on plastics and polymers, we've driven down a lot of that backlog. That's probably the one business that's probably going to be weaker next year, but I think it gets completely offset by DPC and by F.W. Murphy and some amount of bio.

Great. Appreciate it.

The next question comes from Andrew Kaplowitz with Citigroup. Please go ahead.

Hey, good morning, guys. Good morning. Rich, you've talked about being proactive regarding cost, but if economic conditions stay somewhat difficult, what kind of opportunities do you have to deliver the kind of margins you just delivered in Q3? And then I think you were fearful at the beginning of the year that pricing and industrials might erode a bit. Have you seen any erosion or do you expect any erosion there? your markets or would you still expect resilient price costs moving forward?

Look, we're always working on efficiency and structural cost takeout at the end of the day. So that's just part and parcel to the business model here. You know, look, in a dire demand environment, if I point back to how we performed during the COVID period, we've got the ability to flex the cost structure. We don't want to, other than kind of productivity and efficiency driven, not from a demand point of view. As it relates to pricing, look, I think there was a comment in the script, if you go back and look, is that we fundamentally believe that inventory position is going to be incredibly important as it relates to pricing as it goes into 24. And that's why we're taking a little bit of hard medicine here between now and the end of the year of not to incentivize demand through pricing action, right? We've done a lot of hard work of moving the margins up here, and we're keeping these margins.

Helpful, Rich. And then maybe just a little more color into the puts and takes you're seeing in DCST and You mentioned the slowdown in heat exchangers, but the strength in CO2 systems you mentioned as well, and you did deliver strong margin. Do you still see DCST as a growth segment for you in 2024, and how would you assess margin potential from here, given what you just reported in Q3?

Well, look, I think that the heat exchanger is temporal, right? I mean, we went through this incredible amount of demand. I don't know what we were clocking up until – a month ago, but it was very high demand that we had there. I think this is just a little bit of an inventory clearing thing, so we expect growth out of the heat exchanger business next year. I think we did our highest margin quarter in refrigeration in the last five years here. We don't think that we're going to give back there. Now, just recall, though, that Q4, we have to take production down due to seasonality there. So that has some amount of impact on margins. But the trajectory on refrigeration, coupled with CO2, which is margin accretive, we would expect margins to increase there next year. Clearly, that will likely offset the negative impact from Belvac, which we expect will run off its backlog next year and have a little bit of a down year in 2024. Appreciate all the color.

The next question comes from Joe Ritchie with Goldman Sachs. Please go ahead.

Thanks. Good morning, guys.

Joe?

Hey, just a few quick follow-ups on just the inventory dynamics because, Rich, you've been doing this a while. It typically, based on what we've seen, it typically takes longer than a quarter to normalize inventory. And so just any color on your confidence on being able to get inventory where you need it to be. by the end of the year? Or is there a good likelihood that some of this kind of spills into 2024?

Well, I mean, when we're talking about total inventory, we're talking about our own inventory, which we're in control of, which is reflected in the cash flow that we're signing up for, right? That takes a working capital liquidation. A big chunk of that is inventory. I think if you look at the 600 million of free cash flow during the quarter, a material chunk of that was our own inventory reduction. But when we're talking about channel inventory, like I said before, the channel inventory in a lot of our end markets has been coming down progressively over the year. And now we're adopting a posture between now and the end of the year in certain businesses to allow that inventory to clear rather than try to push revenue into either channel inventory or OEM inventory, because the only way you can do that is to start modifying commercial conditions, and we're not doing that. So should it clear? We believe that we're on the front foot here, and so we think we'll be in balance in kind of most of our end markets. by the end of the year. And then it just becomes a question of what does growth look like next year and how much confidence there is in the end markets of how much that channel and how quickly they build it back. But we feel good about the trajectory we're on. So that it's, it's an end of the year phenomenon based on current demand rates.

Got it. Okay. That's, that's helpful. And then I guess just a real quick one on just 4Q. in DPPS, so I think you called out, you know, flat growth in the segment. You said it says sequentially revenues down a little bit. I'm curious just from a margin standpoint, similar revenues to 3Q, similar margins to 3Q, or how do you think about the margins in 4Q for DPPS?

They're either, it'll be immaterial up or down, right, subject to mix.

Okay, great. Perfect. Thanks, guys.

Thanks.

The next question comes from Brett Lindsey with Mizuho. Please go ahead.

Hey, good morning. Yeah, I just wanted to ask a question on the portfolio. I guess as you consider additional pruning, is there a way to maybe quantify what percent of revenue could be under review? And, you know, certainly understand M&A is episodic, but are you seeking to, you know, find comparable sized acquisitions to offset or how should we think about this portfolio shuffle?

The portfolio, the whole portfolio is under review all the time. Look, no. Look, we don't go around and say, you know, we've got a business that's got 200 million revenue. Let's go buy one at 200 million revenue. No one can orchestrate that. But I think that we've gone over a lot about where our priorities are to the extent that we can make a change to our portfolio that we did without touching our balance sheet I think is a positive. So to the extent that we could do that repeatedly, that would be great, but that is subject to a lot of timing differences both in and out at the end of the day. But just as an overall comment, what we did this quarter in M&A is what we would like to do progressively every year.

Got it. Makes sense. Just shifting back to the heat exchangers and the D-Stock in Europe and Asia, I guess does this slow the rollout of some of those capacity additions or change the way you're at least thinking about the near term from a capacity standpoint? And then what is your level of visibility there in terms of these imbalances that have maybe skewed more negatively here?

No, I think the capacity is coming on sequentially. These are highly automated plants, so it's not like we've got to ramp employees. They're almost blackout plants at the end of the day. So we needed the standing capacity. Remember, heat exchangers is 40% of the revenue. So it's getting a lot of headlines, and that's why we wanted to address it. Our visibility, as I mentioned, is not great because it's an OEM sale mostly for us. So up until the point where They decide they want to slow down. That's when we find out. And the slowdown that we've been called out for the balance of the year manifested itself over the last 45 days or so. So are we worried about the capacity investment? Absolutely not. We think that the technology is fundamental. It's going to grow over time. There's been a massive amount of capacity in heat pumps that's been announced. It always seems a little bit implausible, so I think at the end of the day, the market reset is going to be on the finished goods, not so much on the consumption of the heat exchangers.

Okay, great. Appreciate the insight.

Thanks.

The next question comes from Julian Mitchell with Barclays. Please go ahead.

Hi, good morning. One element I just wanted to circle back to in context of the inventory discussion is around the free cash flow margin guide. So I think that it's very high still for this year, but maybe moved down a little bit. And that's despite the good progress on the inventory liquidation that you cited in Q3. So maybe just any sort of color around the moving parts inside, free cash flow, and it has been very volatile. So any sort of thoughts on maybe next 12 months as it's more sort of normalized?

Well, it's been volatile only because of the amount of demand that was there. And to meet that demand, you had basically an expansion of everybody's balance sheet from an inventory point of view. I think that when we put out the guidance for this year, we basically said, you know, now that we're in a more normalized market that we were going to bring inventories down. I think we're making really good progress on raw materials. I think by cutting production in Q4, we should clear whip and finish goods. Then it's all about receivables from here to the end of the year.

I see. And so receivables was kind of the main delta on the change in the free cash margin guide.

Well, it's part of it, but if you go back and look at what our commentary has been over the course of the year, we've indicated it's tough to bring inventories down, but we did that in the Q3. We see that continuing into Q4. As we look back, you know, and the actual good performance in Q3, receivables, given the timing of sales, actually built in the quarter a bit. So that liquidation is due to come here in the fourth quarter, and I think we'll see very robust cash flow. Again, based on the commentary that we already provided, that fourth quarter is always seasonally strong. But I think given the actions we're taking, it'll be even more robust cash

in line with our guide yeah between cash flow and the proceeds of the disposal of the disposal which will receive in q1 we're in a very healthy cash position that makes sense thank you and and maybe um just to um follow up on the um question around the sort of the sales outlook so i think it's very clear and the right thing to do that you're sort of underselling into the channel, if you like, short term to make sure channel partners have low inventories entering the new year. When you sort of take that comment plus the improvement in some orders figures you've seen recently, does that make you sort of confident around the revenue growth outlook despite what the backlog has done? And so we should sort of take the low inventories in the channel plus the orders movement. That's a better determinant of sort of sales into early next year than perhaps what the backlog has been doing recently.

Yeah, I mean, at the end of the day, everything that's in our control for 2024, I think that we're taking the right move. So we discussed managing channel. right, from an inventory point of view. The reason that we highlighted some of the investments, we think that those are growth vectors that those businesses are going to grow despite the macro, right, that they're not subject to kind of general sentiment at the end of the day or interest rates or anything else just because they've got a demand there. So, yeah, I mean, look, you know, we're – you know, knock wood, we're feeling – positive about our setup going into 2024 based on how we've managed and will continue to manage 2023.

That's helpful. Thank you. Thanks.

The next question comes from Dean Dre with RBC Capital Markets. Please go ahead. Thank you.

Good morning, everyone.

Good morning.

I was hoping to get some color on the retail fueling, and it just sounded like there was a bit of a disconnect between below ground and above ground. Below ground seemed to be feeling the effects of higher rates and maybe some destock, but you weren't seeing that above ground. But just can you square those, please?

Sure. We had in 2022, we had a great year in below ground and a bad year in above ground. So if you think about kind of the time it takes to build sites or refurbishment sites, you had kind of capacity that got built and then they finished the job on the top this year. Below ground now is in a bit of a headwind because of the fact that if you think about like a retailer, a retailer is going to spec in the product that they want at a fueling site and then going to go contract the installation. And part of the problem is it's no longer labor anymore, and it's no longer product availability. It's the fact that those contractors need working capital loans in order to do these projects, and the cost of those loans now is probably quintupled over the last year or so. And it's very nice for everybody to be talking about 5%. 5% is a baseline. You're a contractor. You need a working capital loan. You're paying 9 or 10. And so that is putting a little bit of a drag in terms of getting that work done, number one. And number two, just a general comment, as I gave the example before, a lot of that underground business, at least the recurring revenue portion of it, is sold through distribution. The carrying cost of that inventory has gone up quite a bit, and you basically see almost an over-liquidation of inventory in the chain because They know that our lead times are down low, so they're taking their inventory down because they don't want to pay the carrying cost. At some point, that's got to give, and we're not incentivizing through price or terms to push that inventory back into the system. We'll deal with that on the come when we get into 2024.

All right, that's real helpful. And then, Just a follow-up on the geographies. Just the idea, what were the surprises? And maybe you're seeing some of the macro begin to be felt on the U.S. side was down 7%. But what surprised you there?

I think it's more and more. Look, no one came into this year thinking that Europe was going to be robust. It hasn't been. I think that CO2 systems... And heat exchangers are running counter to that argument. CO2 is actually performing quite well. The heat exchanger issue, like I said, up until 45 days ago, you couldn't make enough of them to supply heat pump demand, and that just came to quite a halt here. I think in a recognition that there's too much inventory in the chain. We were not very hopeful about China, and China's been poor. And I think in the U.S., it's just the general... what I just answered, I gave you the example a second ago. In the U.S., you know, you can't raise rates at the rate we're doing and not to have knock-on effects in terms of the carrying cost. And that's what we're seeing now.

Thank you.

Our final question comes from Nigel Coe with Wolf Research. Please go ahead.

Oh, thanks, guys. Thanks for putting me in. So going back to the non-core kind of portfolio review, I mean, obviously, there's a parlor game about trying to guess which assets might not meet the cut going forward. But the stock wasn't one of those assets that I think broadly seen as potentially non-core. So I'm just curious, given the decent growth, obviously very good margins, what was it that led that asset to being sold?

I think that the growth was okay. at least in my tenure here. You know, the end market exposure, both from the end market exposure and the geographical exposure, we did not find attractive.

Too much Europe, I think?

Too much auto and too much Asia.

Too much China, yeah. Okay. And then just on buybacks, you did an ASL last year. You've got a fair amount of bounty flexibility if you get your free cash flow forecast with the sale as well. Any thoughts on buybacks at these levels?

Yeah. I mean, look, buying back our stock at these levels has become very attractive. I think that we've got A lot of moving parts right here in terms of delivering on the fourth quarter in the cash flow. And then we've got an outbound on the acquisition and an inbound on the disposal. After all that is settled, we'll clearly be in a very healthy balance sheet position. And I'm sure that capital return discussion will come to the forefront.

Okay. Leave it at that. Thanks, guys.

Thanks.

Thank you. That concludes our question and answer period and Dover's third quarter 2023 earnings conference call. You may disconnect your line at this time and have a wonderful day.