Q4 2019 Earnings Call
At this time I would like to welcome everyone to the analyst earnings call.
All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session.
And if you would like to ask a question. During this time simply press Star then the number one on your telephone keypad.
If youd like to withdraw your question do you May press the pound Keith.
Thank you and I would now like to turn the call over to Mr. Mark Schwertfeger, Sir you may begin.
Good morning, and welcome to the Briggs <unk> Stratton fiscal 2019 fourth quarter earnings Conference call.
I'm, Mark Schwertfeger, Chief Financial Officer, and joining me today is Todd Taski, our chairman President and Chief Executive Officer.
Today's presentation and our answers to your questions include forward looking statements. These statements are based on our current assessment of the markets in which we operate actual results could differ materially from any stated or implied projections due to changes in one or more of the factors described in the safe Harbor section of this morning's earnings release as well as our filings with the FCC.
We also refer to certain non-GAAP financial measures during today's call.
Additional information regarding these financial measures, including reconciliations to comparable U.S. GAAP amounts is available in our earnings release and in our SEC filings.
This conference call will be made available on our website or by phone replay approximately two hours. After the end of this call.
Now here's Todd.
Good morning, everyone and thank you for joining us today.
Simply put the fiscal 2019 fourth quarter results reported yesterday were not good.
The quarter capped a difficult year, which was challenged by both unprecedented external and near term internal difficulties that restricted sales and pressured margin.
We are clearly disappointed with our results, but we remain standards, that's actually confident in our strategy and view fiscal 2020, as an opportunity to get back on track.
Internally, we incurred higher than expected operational efficiencies during the ramp up our of our business optimization initiatives largely to meet our commitments to customers.
Whatever the cause we take responsibility for the results and for addressing the issues to return the company to higher levels of profitability and performance.
For the quarter net sales declined 6% to $472 million product sales were down approximately 7% and engine sales declined 5%.
Adjusted net loss for the quarter was 36 cents per share.
Externally, we dealt with several unanticipated market issues in North America sales softened considerably late in the fourth quarter from the unusually cold and wet conditions across much of the Midwest and northeast.
Our experience is consistent with industry data, which indicates that the overall sell in for residential mowers was down between five and 10% with some categories categories off as much as 20%.
The softness followed strong selling of newly branded product at major retailers earlier in the year and consumer response to the introduction of the crafts and ran at Lowe's was quite positive.
North America results also included the impact of further market disruption from the Sears bankruptcy as well as from transitions amongst Oems, including one of our customers transitioning away from a large portion of its traditional mower offerings.
In Europe dealers and retailers and to the 2019 season very cautiously following last year's drought conditions, which negatively impacted this spring sell into our OEM customers. Subsequently the record high summer temperatures reached this June and July have caused dealers and retailers to slow their reordering, which has resulted in Oems having elevated inventory for the for this point in the season.
[noise] continued issues with our ability to ship service parts also affected the ramp up of service parts revenue primarily in North America.
Well improving from the third quarter the operations did not achieve the results we anticipated.
Well, we continue to encounter headwinds the ongoing strength of our business remain in our commercial categories for the fiscal fourth 2013 fourth quarter sales of commercial engines and products increased better than 5%.
All three major commercial categories commercial turf Jobsite and commercial engines maintain growth aided by the contributions of hurricane stand on borrowers and the ground logic Sprayer, Spreaders, which were recent acquisitions.
We achieved this year over year increase despite production challenges from labor shortages encountered during the peak season. Following our recent plant move which restricted our ability to fulfill the strong order demand and to achieve higher growth.
Still for the year commercial sales were up approximately 13% in total of which 11% was organic growth.
Commercial sales accounted for 31% of total sales up from 27% for fiscal 2018, and only 24% for fiscal 2017.
Fourth quarter results also reflect the impact of temporary inefficiencies largely associated with the ramp up of our business optimization initiatives, which came in the form of lower gross margin.
We calculate that these inefficiencies totaled approximately $12 million for the quarter and $29 million for the fiscal year.
The fourth quarter inefficiencies were higher than we had anticipated and in large part due to labor shortages, we encountered in certain of our facilities as we work to ramp our employment increased our capacity as part of the business optimization program.
The shortage caused us to use more expensive temporary contract labor.
Although we along with most other companies must remain vigilant about the risk this risk during a period of low unemployment, we have accelerated our recruiting efforts and been successful as of late and locating and Onboarding new employees.
A lot of although it is yet to materialize in the numbers, we made substantial progress on alleviating the inefficiencies affecting our business optimization initiatives the pace of activity in throughput within our service parts business and production volume of Vanguard engines improved each month of the fourth quarter.
For service sales, we very much regret that we were not able to serve the market to our high historic levels. This past season.
Simply put this will not repeat next season.
We have reduced backward, we have reduced back orders and have a clear line of sight on the actions we need to take over the course of the next several months.
So again offer industry, leading fulfillment levels.
While we expect a portion of the inefficiencies to have a continued near term effect on our business principally in the first half of fiscal 2020.
We are earlier already on a path toward alleviating them.
Mark will provide color in his remarks on this as it relates to our outlook.
In addition to operational inefficiencies profitability was pressured by lower manufacturing volumes most of which was planned during the fourth quarter to control finished goods finished engine inventory.
The labor challenges I referenced earlier further curtailed production levels in the fourth quarter.
Before I turn the call over to Marc Let me to address two other topics first in addition to the financial results, we announced the project to close our plant and Murray, Kentucky, and consolidate production of our small engines into our Poplar Bluff, Missouri facility.
Following the great recession about 10 years ago, the North America gas powered residential lawn and garden market quickly dropped in size by over 25%.
At the time, we along with the industry believe the decrease would be temporary and that the market would rebound historic levels as the economy are covered.
Instead, the market has not rebounded much and has remained relatively stable in recent years at levels below our current manufacturing capacity for engines.
We believe several factors have contributed to the lack of rebound, including the slow growth and sales of new and existing single family houses hampered by affordability as demand has exceeded supply.
Elevated student debt has also made it more difficult for younger people to embark on homeownership.
We believe other factors include a movement from do it yourself to do it for me.
In some adoption a battery powered equipment.
Some of these trends are creating new opportunities for us and we are investing to grow and diversify in commercial and enabling technologies to capture those opportunities.
The last two years have been on showing production of our high growth Vanguard engines in impart to enable us to more efficiently utilize our plants in Georgia, and Alabama, which produce larger engines.
To address the under utilization of our two small engine plants. We are initiating this consolidation project to adjust production capacity to better fit current market demand.
Our planted Poplar Bluff has experience in producing very similar engines to those that will be transitioning from the Murray plant.
This experienced significantly reduces the difficulty in risk of Kentucky consolidating production.
We plan to begin the consolidation in the middle of fiscal 2020 with the move of all finished goods or finish engine Assembly.
Subsequent to the peak production season, we will move the remaining equipment needed to complete the consolidation during the slower production months next summer.
When complete in fiscal 2022, the consolidation to result in pre tax cost savings of 12 million to $14 million with approximately $10 million recognized in fiscal 2020.
Our team in Marine Kentucky has done an outstanding job producing some of the finest engines in the world.
I would like to thank the team for all their great work.
So two I would like to thank the city of Murray and the Commonwealth of Kentucky for their support.
We will be assisting impacted employees and their transition, including making available other open positions within our company.
Second our board of directors. This week declared a quarterly cash dividend of five cents per share a reduction from the previous 14 cents per share.
We believe this move is the right course of action to position the company given the recent increase in debt leverage in current profitability, resulting from the near term market disruptions we have encountered.
The reduction will enable us to direct more resources to debt reduction and investment in attractive commercial products and enabling technologies.
As we work to execute our strategy to grow and diversify the company improved profitability and increase shareholder returns.
This rates, that's a sustainable payout ratio and is more in line with industry peers.
We will always evaluate the cash needs of the company and direct funds into those areas that deliver the highest risk adjusted returns.
Let me add that our employees around the world accomplish much in fiscal 2019, we completed the onshoring of commercial engines began producing Ferris commercial mowers and a new modern facility went live with our ERP upgrade and made advances in development of enabling technologies.
The foundational changes we implemented during the year and make us more competitive advance our strategy and position us well for the future.
Even though these significant achievements created temporary higher cost.
They have positioned us to extend our leadership in delivering power, where it is needed to get work done faster easier and safer.
On top of achieving these milestones, we mentioned sustainable share gains in powering more applications than ever before with Vanguard engines and built more expansive global distribution for job site products increasingly customers are voting with their dollars showing their preference for our commercial engines and products.
Now here is mark to walk you through our financial results for the fiscal 2019 fourth quarter and provide details on the revised earnings outlook for fiscal 2020. Following Mark's comments I will discuss our priorities for fiscal 2020, and our actions that will return the company to growth and higher profitability.
Thanks, Todd I'll begin by touching on some highlights from the financial results.
Fourth quarter GAAP consolidated net loss of $18.5 million included pre tax business optimization costs.
And acquisition related charges of $4.8 million as well as the $500000 pension settlement charge. Excluding these costs our fourth quarter adjusted net loss was $14.9 million or 36 cents per share down from adjusted earnings of 47 cents per diluted share for last year's fourth quarter, the engines and products segments recognized $2.1 million and $2.7 million of pre tax charges, respectively, and the pension settlement related to the engine segment. The fourth quarter. Adjusted net loss included a charge of $5.1 million or 12 cents per share for establishing valuation allowances predominantly associated with our Australia business. Excluding this charge our fourth quarter loss was 24 cents per share.
Engine segment sales for the fourth quarter were $261 million, a decrease of $14 million or 5% from the prior year.
Engine unit sales were approximately 1.5 million a decrease of approximately 100000 units or 6%.
The decline in shipments primarily related to softness in North America as Todd noted earlier, the overall North America market was down over 5% from last year due to the cool wet spring weather and near term market disruptions, including the Sears bankruptcy.
It's also worth noting that fiscal 2000 eighteens fourth quarter included approximately $15 million in sales from accelerated shipments in advance of the go live of our ERP upgrade at the beginning of fiscal 2019 to ensure adequate supply for our customers.
Quarterly service parts revenue was also down.
Continued strength in commercial sales and improved pricing helped offset weakness elsewhere.
The engine segment adjusted gross profit margin of 19% was down from 25.4% a year ago, a decrease of 640 basis points.
Inefficiencies accounted for approximately 260 basis points of the decline inefficiencies were primarily driven by higher labor levels to improve throughput of service parts and vanguard engines elevated expenditures on plant repairs and expedited shipping cost to transition Vanguard engine production.
A 24% reduction in manufacturing volume accounted for an additional 250 basis points of the margin decline unfavorable sales mix, primarily due to lower lower year over year service parts sales and higher costs for material freight and tariffs, which were partially offset by higher pricing accounted for the remaining decrease in gross margin.
Quarterly engine production volume was 1.2 million units down 24% from last year's fourth quarter production of 1.6 million units and was consistent with our projections.
Total engine into inventories at the end of fiscal 2019 were 1.4 million units.
Which was down by 22% from last year.
Engine inventory dollars are higher year over year due to proportionately more large engines in inventory and higher components on hand to support the transition of Vanguard engine production to the us.
Engine segment, adjusted EPS DNA for the quarter decreased $2.7 million largely from effective cost control.
Engine segment adjusted loss of $3.2 million was down from adjusted income of $20.5 million for the fourth quarter of fiscal 2018.
Product segment net sales for the fourth quarter of $233 million declined by $17 million or 7%.
The decrease was primarily due to declines in pressure washer and generator sales as North America retailers implemented initiatives to control inventories.
We accelerated shipments of approximately $5 million of products into the fourth quarter last year ahead of our ERP go live during the first quarter of fiscal 2019.
Fiscal 2019 fourth quarter product sales also fell short of our expectations due to the challenging market conditions, including the unusually wet spring weather in North America, and lower than planned product availability due to labor constraints at our plants.
Sales benefited from higher prices to offset cost inflation and tariffs.
Adjusted gross profit margin in the product segment of 9.3% for the quarter was down from 16.2% for the same quarter last year.
Of the 690 basis point decline 270 basis points was attributable to an unfavorable sales mix 220 points to manufacturing inefficiencies and 200 points to increased cost for raw materials freight costs than tariffs net of higher pricing.
Sales mix included a shift towards lower priced products and pressure washers.
Generators and lawn tractors.
Manufacturing inefficiencies included temporary higher costs related to near term challenges in labor availability, notably skilled labor in our New York more plant during peak production months.
We also incurred elevated freight cost to help compensate for product availability caused by lower than planned production.
Pricing net of incentives to stimulate demand did not fully offset elevated product in tariff costs.
Product segment adjusted EPS DNA expenses were up $400000. The segment's adjusted loss for the quarter was $8.4 million compared with adjusted income of $10.5 million for the fourth quarter of fiscal 2018.
Turning to the balance sheet net debt was $326 million as of June Thirtyth, which was down from $383 million of debt.
At the end of the first fiscal third quarter and up from $203 million at the end of fiscal 2018.
The higher than expected debt level at year end was due to a lower than expected reduction in inventories and lower cash flows from the business, partially from the lower sales and profitability.
Inventory remained elevated particularly within our product segment due to lower than planned sales and production in the fourth quarter, which left us in an elevated position on both components and finished goods.
Last 12 month cash used in operating activities was $35 million and last 12 month free cash flow was negative $17 million depreciation and amortization for the quarter of approximately $17 million was lower than capital expenditures of $6 million largely due to the winding down of investments in our business optimization program.
Capital expenditures for the fiscal year totaled $52 million.
A decrease from $103 million or 49% from fiscal 2018.
For fiscal 2020, we are projecting capital expenditures of approximately $55 million, which includes the capital we intend to spend in fiscal 2020 on the small engine plant consolidation project.
At the end of the quarter last 12 month average funded debt was $429 million and last 12 month EBITDA was $104 million, both as defined by our credit agreement.
Resulting in a leverage ratio of 4.1 times.
This leverage exceeded the upper limit in our credit agreement and we successfully obtained a waiver from our bank group.
We were in compliance with all other debt covenants as of the end of the fourth quarter.
Although leverages elevated from historical levels, We project, an improved earnings working capital reductions lower capital expenditures and the reduced dividend will result in lowering the company's debt leverage in the future.
Well, let me be clear Delevering, our balance sheet is a key focus.
Regarding the company's debt I'm pleased to announce that we have made solid progress on refinancing our revolving credit agreement in advance of its maturity in March 2021.
The new revolving credit facility, which would be secured by certain of the company's working capital and other assets is designed to give us more flexibility as we de lever the balance sheet.
In addition, we plan to size the deal to have a larger borrowing capacity than our current revolving credit agreement, which could provide us the debt capacity to ultimately retire the outstanding senior notes, which come due in December 2000, Twentys over one year from now.
We believe that interest rates under the new credit facility would be roughly similar to those of our current revolving credit facility.
We are very encouraged that we now have signed commitments from our banks, who are leading the deal for over 70% of the capacity, we wish to six year under the new debt facility.
We have plans in place to launch the deal to our bank group about a week from now and our process would call for us to close and fund on the new debt facility by the end of the fiscal first quarter.
While there is more work to do to bring this to completion I am pleased with our progress to date and believe this new debt structure will position us nicely for the future.
Let me now turn to comment on the outlook for fiscal 2020.
For the year, we expect sales in the range of 1.91 billion to $1.97 billion for a midpoint increase of 5.5%.
This outlook is a revision from our preliminary guidance on sales of approximately $1.98 billion to $2.03 billion and relates predominantly to the lower starting base of fiscal 2019 into results.
Outlook contemplates that residential sales will contribute approximately 2% to 4% of the year over year sales growth.
This outlook includes an expected rebound in service parts revenue due to improved throughput, which has already started to occur results for July were encouraging and we're taking the opportunity of the seasonally low point in the selling cycle to level load the operation and build adequate stacks of parts to serve global customer needs.
The outlook also contemplates a more modest outlook for residential engine recovery.
Specifically, we are assuming some improvement for more normal seasonal weather in North America as well as a reduction in inventory liquidation from channel partner transitions.
We also expect increased European sales given some improvement in channel inventories from last year, our outlook contemplates that our residential engine placement rate remains consistent in 2020.
Although it's early in the process results to date have us encouraged about meeting these expectations.
We expect commercial sales to continue their robust growth contributing approximately 2.5% to 3.5% of total revenue growth.
The growth rate is consistent with the assumptions in our April preliminary guidance, but growing from a lower base fiscal 2019 fourth quarter commercial sales growth fell short of our expectations in light of the unusually wet spring weather and our own production challenges.
We expect to implement price increases to help offset higher carrying costs and product cost increases.
Given our practice of buying forward for many of the larger commodities, we use namely aluminum and steel.
We expect that the release the benefit from recent price decreases will be muted in fiscal 2020.
We will also continue to devote a portion of our ongoing cost reduction efforts.
To offset the impact of tariff costs.
We expect foreign exchange headwinds of approximately $15 million or less than 1% on net sales.
It's also important to remember that we did not assume incremental sales from hurricanes in our outlook. However fiscal 2019 did include approximately $25 million of sales due to Hurricanes, Florence and Michael last year.
For fiscal 2020, we expect operating margins excluding costs from the business optimization program and the engine manufacturing consolidation to be approximately 2.5% to 3%, which is an improvement from 0.7% in fiscal 2019.
Margins are expected to increase and favorable sales mix, including higher commercial and service parts sales increased plant utilization improved efficiencies and cost savings from our business optimization program.
In fiscal 2020, we expect to recover approximately $20 million or two thirds of the inefficiencies we encountered in fiscal 2019.
We expect the residual $10 million of inefficiencies to be incurred in the first half of fiscal 2020.
Improvements will be driven by improved throughput in our global service parts operation as well as with the production of Vanguard engines.
We also reduced freight expenditures and elevated labor costs, we experienced throughout fiscal 2019 to overcome ramp up challenges.
We also expect to achieve an incremental $5 million of business optimization program savings in fiscal 2020.
This amount will bring program savings to date to $10 million, which is roughly half of what we plan to achieve by fiscal 2020.
Nevertheless, we continue to expect the program to deliver $35 million to $40 million of savings. However, it is clear it will take longer to fully realize than previously contemplated.
This revision revised expectation its first due to taking longer to ramp up the program efficiencies.
Second we have devoted more time towards addressing other elevated product and manufacturing cost activities, including efforts to offset tariff costs and other inflationary pressures such as freight costs. As a result, we now expect to fully realize the value of business optimization program by 2022, one year later than the original plan.
Partially offsetting the expected improvement in gross margins is our expectation that SGN a expenses will increase approximately 5.6%.
Largely from higher variable compensation costs on improved profitability.
In addition, we expect income from unconsolidated affiliates to decrease by about $2 million as planned due to the wind down of our Japanese joint venture as the onshoring of commercial engine production is now substantially complete.
We also expect other income to be a loss of $2.5 million, reflecting an increase in pension expense of approximately $3 million.
Interest expense is expected to be $34 million, which reflects higher average borrowings in 2020 than in 2019. The consolidated tax rate is expected to be 25% on adjusted pre tax earnings for the full year, we expect adjusted diluted earnings to be in a range of 20 cents to 40 cents per share.
And I would comment that our engine and manufacturing plant consolidation project is not expected to contribute savings in 2020, but is expected to contribute $10 million of savings beginning in 2021.
It's important to keep in mind that last year's first quarter benefited from $15 million of generator sales to support Hurricanes and was negatively impact by slow service parts throughput approximately $20 million of sales, which have been pulled into the prior year to support the system go lives and slightly lower production levels.
Except for generator sales, we'd expect the other items impacting last year's first quarter to reverse this year.
Somewhat constraining margin growth in the first quarter of 2020, we expect inefficiencies of approximately $5 million.
Higher SGN, a cost and lower equity and earnings of unconsolidated affiliates. All these factors taken together would suggest a modest increase in net sales and slightly lower operating margins in the first quarter of fiscal 2020 compared to last year.
We also expect interest expense to increase by approximately $2 million.
Before I turn the call back over to Ted Let me conclude my remarks with comments on our efforts to deleverage the balance sheet.
We ended fiscal 2019 with debt inventory and payables well above our historical averages.
Several factors contributed to the increase including low 2019 earnings investment in the business optimization program and a build up of component inventory to support production transitions as well as high finished goods inventory due to weak residential end markets in North America, Europe and Australia.
For fiscal 2020, we'll be focusing on bringing them back into line.
This year, we will focus on reducing inventories by $100 million and bringing down payables by approximately $80 million.
We will constrain normal production levels, primarily of residential engines as part of achieving this goal.
While the lower production will have a negative near term impact on profitability of approximately $6 million to $8 million. The long term benefits of reducing inventories generating cash and strengthening the balance sheet are important.
Longer term consolidating engine production and driving more efficient more responsive manufacturing will enable us to manage inventories better.
In addition, we estimate the fiscal 2020 cash charges associated with completing the business optimization program and initiating the engine manufacturing consolidation program to be approximately $10 million to $15 million, which is substantially less than the cash charges of $42 million we occurred in 2019.
We estimate capital expenditures to remain around 55 million in 2020 as I mentioned earlier.
Altogether this will enable us to generate positive, albeit modest cash flow from operations net of capital spending in fiscal 2020.
Now, let me turn the call back over to Todd for some closing remarks.
Thanks, Mark clearly 2019 was an exceptionally challenging year, but it was also foundational.
We have nearly completed our multi year business optimization program, which has enabled us to enter fiscal 2020 as a more diversified competitive company in those areas that position us to enhance growth profitability and capital returns.
Commercial engines and products now constitute more than 30% of our total sales.
Our user driven innovation, which is the basis of our long term success.
Is winning in the marketplace as more customers are choosing our brands to power their applications to make them more productive.
We are working with great urgency to improve the company's profitability and cash generation at the same time, we remain committed as ever to our strategy, which is to grow the engines business gross sales of higher margin products and further diversify the business.
To accomplish these goals will be focusing on five top priorities to deliver on our 2020 outlook.
And help ensure we can make equally significant strides and getting back on track with profitability in 2021.
We'd be focused on these five goals.
First.
We will be working aggressively to improve operating efficiencies and realize the value from our business optimization program. The foundation is now in place.
We learned much during this recent peak production and shipping period.
We are committed to applying these learnings during the months of seasonally slower activity to invest and drive out the inefficiencies. So that we can enter the 2020 peak season in a significantly better position.
Our 2020 outlook contemplates $20 million of efficiency improvement.
This progress leaves $10 million of inefficiencies that we will resolve beyond 2020. In addition, once we have accomplished your inventory reduction goals for 2020, we estimate there is a benefit to be gained by operating our plants at more normal production volumes worth more than $5 million.
In addition, looking to fiscal 2021, we expect to achieve an increase incremental $10 million to $15 million of business optimization savings.
Taken together these items will contribute over $25 million with pre tax improvement beyond our 2020 outlook and go a long way to restoring our profitability beyond these cost improvements. We also anticipate anticipate continued growth in commercial and a benefit from residential markets, including more normal weather in Australia and Europe .
Second we will begin the consolidation of small engine production the action aligns our production capacity with current and anticipated future needs as it also streamline streamlined operations and will make us more responsive to customer demand.
It will lower operating costs by an estimated $14 million when complete in fiscal 2022.
Third we will be devoting increased time and focus early in fiscal 2022 more fully analyzing the dynamics of our market with outside help so that we properly position our business for more sustained growth at higher returns.
As I mentioned earlier, there are a number of disruptions that have impacted our market in recent years, gaining an outside perspective will help sharpen our thinking planning and actions to further adapt to the continually changing environment.
This is all done to enhance shareholder value.
Fourth we intend to strengthen the balance sheet with the near term objective of improving girton capital and lowering debt.
Through modest capital expenditures and the actions announced today to reduce the dividend, we will be more directing more funds to reduce debt and invest in attractive commercial products, enabling technologies.
Fifth we will complete the refinancing of our revolving credit agreement that Mark discussed earlier to ensure that we have good financial flexibility to execute our strategy.
We will report our progress in all of these goals with each quarterly updates throughout fiscal 2020.
In addition to these goals, we will continue to innovate to grow revenue and increase margins. We continue to look to commercial as an important vehicle for growth as we align residential capacity with market demand.
To that end, we are excited about the expanding line of Vanguard commercial engines to serve a greater variety of commercial power applications.
In the first half of this year, we will introduce a new horizontal shaft engine. The 400 series targeted at industrial and commercial applications.
Designed from the ground up this new engine deliver superior performance over competing engines and better positions us to win in this billion dollar addressable market.
We also announced last week the launch of our proprietary lithium ion Vanguard battery system, which is another step towards diversifying our business and driving greater growth in commercial markets.
Combined with our expertise and power application. We are now offering an exciting path for Oems to electrify their current and future products at a lower cost of development.
The first in the fan in a family of products. The new 48 volt commercial battery system as a fully integrated solution complete with proprietary programmable battery management system that gives the OEM and end user the ability to optimize performance by customizing the power profile to the application.
We'll be following this launch with 10 kw.
In two and a half kw packs soon.
Since previewing at various trade shows interest in our battery system has been high and growing current and potential OEM customers see us as a trusted natural partner in this space, which gives them the confidence to engage with us in a variety of projects.
Our goal is to help create power systems for the largely untapped middle market for mid sized vehicles and equipment for both indoor and outdoor use with Oems mainly in government and municipal.
Sure in agriculture and outdoor power.
You will hear more about this initiative as we progress progress through this year and into next.
Everyone at our company has worked exceptionally hard in an environment of unprecedented market change in near term challenges, we accomplished much in fiscal 2019 toward our goal of delivering the benefits of the business optimization program.
The infrastructure is now in place to achieve our savings goal and we now have initiatives underway to eliminate the near term inefficiencies to fully realize the benefits of our actions.
In addition, we are moving forward to align our business with market needs strengthen the balance sheet and undertake a comprehensive review of the factors impacting our business to sharpen focus on those areas that offer the offer the greatest opportunity for higher returns.
And more sustained long term performance, we are undertaking these activities with a high sense of urgency commitment and fiscal discipline.
Our success in achieving high growth in commercial reinforces our confidence that our strategy is sound.
We enter fiscal 2020 with a stronger go to Mark Strat was stronger go to market channels, a broader range of innovative products and exciting new enabling technologies.
Well now open the call up to questions.
At this time I would like to remind everyone in order to ask a question. Please press Star then the number one on your telephone keypad once again Daddy's Tar wants to ask a question.
We'll pause for just a moment to compile the community roster.
Your first question comes from the line of Sam Darkatsh. Your line is open.
Good morning, Todd Good morning, Mark Good morning, Sam.
Lots of process obviously.
I've got a couple of basic questions.
If you'll allow me so.
So.
This all came about apparently in the last two months or so of the quarter.
You missed your sales at the low end of guidance by let's call it $24 million or so.
You missed your EBIT dollars. However, at the low end of guidance by 36 million. So the EBIT Miss was far greater than the sales Miss yet the production.
It was pretty similar I guess to where you were originally thinking so it wasn't as if you had a dramatic production cut I'm just I think Mark you might have mentioned that there was an Australian valuation allowance of like 5 million, but I'm just could you dumb it down for me and just help me understand why the EBIT Miss was so much greater than the sales Miss and it only took two months to do it.
Yes, I think embedded in that manufacturing volume was really two pieces Sam the first was even though our overall volume was relatively similar we mixed a little bit more towards producing small engines and did less large engines overall and so that had a negative impact on overall absorption dollars on factory utilization and the other thing is that we did have a noncash charge in the quarter related to our LIFO reserve as you'll see when our 10-K comes out that was roughly about $4 million as well that would factor into some of the lower volumes. The other piece was the efficiencies that we commented on as well, where we did not remediate.
To improve the efficiencies to the extent that we had anticipated in fact, they were higher than we thought as we went through that peak shipping months and so that also drove.
And.
Decrease in the overall margin of both segments.
All in for the company that was roughly around $12 million for the quarter as we commented on.
And then the last piece really related to our our expectations. Overall was what we commented on related to commercial sales, particularly commercial mower sales being short of what we had planned for the quarter that came both in the market softness that you saw as the indeed the market drastically decelerated throughout at least the ship and decelerated drastically throughout the fourth quarter.
And then the other piece was our production challenges, where we had some labor shortfalls at a bad time of the year relative to the production we needed to achieve and so we did not get out as many units as we could have sold to support the market.
Okay.
My second question.
If I understood you correctly, Mark I think you mentioned that you're.
Expecting positive free cash flow.
In fiscal 20, I guess thats defined as cash from ops less the $55 million in Capex.
I think you said it was a it was modest or what have you you have now with the five cents quarterly dividend, maybe eight $8.5 million worth of dividends cash outlay. So it's basically I'm guessing a push.
From a free cash flow standpoint net of dividends.
So I'm trying to figure out why would that be elevated.
In fiscal 20.
If your cash flows are basically neutral my guess is that the $100 million or so an inventory drawdown wont occur until late in the fiscal year fish in fiscal 20, but how else should we think about why the debt levels will be elevated.
Despite the contemplated cash flow expectations.
Yes, I think the probably the biggest piece in there is the elevated accounts payable we had at the end of the year, which was probably $80 million higher than normal which related to supporting the higher inventory balance than what we expected as well as some timing of payments and so that flipped into debt pretty quickly as we got into July and then what we're going to do in 20 is really focus on taking down the inventory taking down that $80 million of debt offsetting that and combine that with.
The earnings power, which is projected to improve and thats designed to deliver some positive free cash flow to support that the dividend ultimately.
So so the inventory comes out when the $100 million that could that comes out in the spring season, that's right same EPS thats. The challenge of our situation being seasonal is that to really impact that it is more back half related even though we're going to be really watching it as we go through all the quarters.
Okay, and then I have one last question, then I'll defer to others.
The the Todd the outreach for third party assistance for for market analytics.
I'm trying to understand because I guess in many respects you or the industry you are the market.
So what.
Skills. This probably unfair question, but what skill sets or processes internally are lacking or need.
Need help in order to to ascertain what market dynamics might look like I'm surprised you're you're looking externally for that.
Yes, Sam it's not so much the industry per se in terms of we know the players and everything else.
Well, we're really looking at is okay. So you look at retail and how retail is changing and ultimately you got a lot of ecommerce that's happening here in the us lot of ecommerce, especially over in Europe .
And so you think about that the retail side of things and how that all shapes up you also have some OEM transitions that I'm not sure that the upside from is going to help us a lot with those transitions other than if you think about.
New entrants coming in that can help that can help us.
Ultimately with this market and that sort of thing. So when it comes down to is just spent a lot of things that have happened from the from the go to market standpoint, not we know the players in the industry. We understand all of that is how does retail shape up in the future and then there's also the electrification side of things and we've been investing money in our in our battery technology, which we're really pleased now that we've got.
Some some things coming out into the market now starting here in 20, and so part of that comes back to let's just gain some insight into how others think about how fast we should go to other markets because we know our market, but the battery side of things allows us the opportunity to actually expand into other markets too and so that's really some of the focus in terms of the things that are happening it's not so much the industry per se. It really comes back to some of the retail factors and then and then some of the things we have opportunities on the cover on the commercial side in areas that maybe were not as familiar with.
Thank you both thanks, Sam Thanks, Sam.
Your next question comes from the line of Joe Mondillo, Joe Your line is open.
Hi, good morning, guys.
Oh, Yes, I was hoping if you could potentially do similar to what you just did with the fourth quarter to how we get to the what the puts and takes are what the guidance just because there's so many variables.
Yes, I think as you look forward to next year roughly.
You look at the 5.5% midpoint guide on the top line.
And we think that the margin that would come along with that would be reasonably good from a standpoint of that went to contemplate some rebound in our service part business and some nice momentum on the commercial side, which comes at nice margins.
We would estimate looking forward that manufacturing volume would be a little bit higher and 20 than it was in 20 then in 19.
And so roughly around 30 basis points of improvement or five to 6 million.
I commented that efficiency improvements are expected to benefit by $20 million or about a 100 basis points and our business optimization program is designed to deliver 5 million benefit or about 30 basis points, and then that will be offset by some higher SGN a.
Roughly 60 basis points.
On higher variable comp.
Lower joint venture income, which is about 10 basis points down.
And the wrap up of our Japanese joint venture and then other income down about $3 million for that higher pension expense.
Which is about 20 basis points down that would get roughly two.
The midpoint of what we'd be anticipating.
Okay.
And then on an operating cash flow perspective.
If you're generating $100 million of inventory and given the bottom line guidance on an earnings perspective.
I mean I'm just.
And half of the.
Expenses related to the closing of the merger the facility our non cash.
I'm having trouble.
I guess getting to just.
Sort of slightly above on a positive on a positive cash flow perspective.
And probably the one thing that you want to think about is on the higher sales you had especially at the fourth quarter are winding up as it did this last year you would expect there to be a little bit of growth in accounts receivable year over year, which would have a little bit of an offsetting benefit against the benefits of inventory take down.
Okay, and what was the payables guidance again.
Well roughly about 80 million elevated at the end of the year and we'd expect that to normalize back to around the 200 million or so.
Back to the end of next year, and then that would go against the inventory reduction of $100 million. If you will.
Okay, I think Thats, maybe where I was missing actually.
And in terms of the business observation optimization plan.
We're pretty much fully done and completed with the three main aspects of that is that correct.
Yes, I think the the one that we are wrapping now is finishing up the vanguard onshoring, which will have done early in fiscal 2020, where all the engines will be up and running in plants here in the U.S. and Thats when we will.
Conclude the all production in Japan joint venture, but yes, mainly up and running and we only anticipate $5 million or more charges in 20 to finish that program up.
So I guess I'm just wondering is that the biggest reason why the benefits are being pushed out.
Because of that.
The Japanese production just being delayed in terms of on starring Matt.
Because I thought most of the plan was actually on time on schedule. So I'm just trying to understand the delay on.
Realizing the benefits from that and also I wanted also confirm I was under the understanding that this whole plan is not really.
Based on revenue now you could see flat revenue and still see the benefits.
That's right Joe.
No I think it's the biggest change that we comment on briefly was.
2019 has been a pretty crazy year of many things that we've had to deal with both externally and internally think about externally the impact of tariffs the impact of inflationary measures that and some part of have been caused by tariffs and some other that really came through that we've been battling back and then we also.
We.
Ramped less quickly from a standpoint of the efficiencies that kicked out of a lot of the business optimization program. That's what really contributed not all but the majority of the $30 million of inefficiencies and in 2019, and what we showed to ourselves that it's going to take a little bit longer to work those efficiencies out. So we are looking to take two thirds of those efficiencies out in 2020 and generate $5 million more business optimization effort.
But that obviously takes some work that we hadnt contemplated even a quarter ago.
In order to accomplish both of those goals together to deliver the improved profitability, what's really key to this is having that down to the slower time, if you will now.
In the first two quarters, when we have a slower shipped through and that gives us some extra time to apply the learnings we made during the peak shipping months to ensure that we are set up much better to avoid those inefficiencies as we go into the back half of 2020, you know Joe It's interesting is.
We can see.
We can see the improvements we can see the benefits. It's just the the effort it's taken with everything going on lot of things happening all at once and stretch the team, but what's really encouraging to me is that we we have line of sight and we have seen the benefits come through its a matter of eliminating inefficiencies and then and then we realized what we anticipated we're going to realize.
Okay, and then I had a question on the sort of the.
The new Guy restructuring that you announced.
It's been sort of like 10 years with this market being so sort of slow and I'm. Just curious why has it taken so long to recognize that that mark but that small engine markets not kind of come back why did it take a full 10 years to sort of address sort of your capacity utilization there.
Yes so.
Give you a couple of things on that Joe first off.
If you think of the business optimization program. It had more to do with us investing in commercial and it did with any kind of as it relates to any kind of restructuring, yes, we closed down the DBS joint venture, but when you look at the business optimization program. It was really set up to invest in the growth areas of the company. This second action now with regards to.
The marine facility, you're right is more rationalization and restructuring and so we start we obviously recognized.
Several years ago that the housing market just wasn't acting as we had anticipated. There's also the aspect of Europe as well, where we started to see a weather related things in Europe early in that it recovered started feel better and then we started to see some things now as of late.
Over the last couple of years with drought and high temperatures and things like that.
We contemplated doing this a couple of years ago.
But felt it was more appropriate to do the commercial investment to onshore the vanguard engines and to make sure that we have the opportunity to grow in that area, which we've proven we can grow and so that when you look at the team I mean, we do not have certainly infinite resources at the company and so when you look at it the same team that has now executed on.
Much of the business optimization on the engine side now has to many of them have to execute on the Murray consolidation as well. So we acknowledge 10 years is a long time for several years, everyone is calling for the housing market to return we still believe at some point the housing market will return.
But we're not waiting for that to happen to take action when the housing market does turn and you start to see more starter homes.
Come into play.
We'll be we'll be able to react with capacity.
Of adding a third shift and things like that at our facility, but at the end of the day what it comes down to is it's really pacing of these projects and you can't do everything at once.
That kind of proved itself out this year and we had a lot going on and then you pile on a bankruptcy and market headwinds and tariffs and everything else and you want to make sure you can keep the team focused on execution.
Alright, and then just last question.
And I'll hop back in queue.
The sort of channel partner disruptions with Sears and.
Other things that are going on what does your visibility into that.
Do you see these headwinds.
Going away anytime soon or what are your sort of thoughts and visibility regarding those challenges.
Well when you look at Sears, we tried to give you guys an estimate on Sears and we actually think Sears was probably impact us here is a little bit bigger than perhaps what we even we thought because of the way the whole bankruptcy kind of play it out because.
When you look at how they exited it was an anticipation that there would be there would be an ongoing entity, which apparently they are but we don't see a whole lot of activity other than liquidation going on of their inventories. So we don't see a lot of cell and going into Sears.
We think that some of that will normalize although I think there's still is this open question in terms of where the ultimate Sears Craftsman buyer goes.
And some of them I think are going so clearly some of them are going to Lowe's and buying craftsman there, but there's also the situation where they could be going to dealers and other places. So you will see some of that kind of work. We saw some of that work its way through a 19, there might be some of that going on in 20, So a year or two to kind of normalize as what we would anticipate.
And then there is other transitions that are going on as well Husqvarna has announced that they're going to get out of.
A significant chunk of business now here again in 20, and so that is causing some.
OEM disruption, if you will and we're working with existing Oems and then quite frankly, so theres retailers that are trying to bring in new Oems and we're working with those new Oems as well and so there will be some situations here in 20 I'm sure as.
Husqvarna exits and ultimately liquidate some of their inventory and so there's just.
They're going to be some churn yet left in 20, which is included in our in our in our guidance.
But it's not going to be as clean as people otherwise would want it to be.
The husqvarna, though it should not affect you greatly right. We address this when they announce that I don't know three or four quarters ago, and you guys I thought they did.
That it's a very small percentage of the engines that are going into I forgot the brand that they sell but I think it starts are the p., but.
It was a small portion of your business almost insignificant I thought you stated.
If you go back to a split it into two pieces, Joe and the initial piece that they announced.
We had a lot of handheld I believe in it and so yes. The second piece, though they really only recently have come out and indicated.
What the second piece is in the second piece is more dramatic to us as it relates to walk behind mowers.
And also some tractor business that we think is that they're they're kind of moving through so the the first piece I think you're correct directionally, but the second piece here now that they're getting out of the 20 is a bit more significant but again I come back to I think theres liquid is probably going to be some inventory liquidation that happens, but the market is also addressing it through existing Oems that are in the in the in the space as well as bringing in some new entrants.
From other from other places.
Okay I understand all right. Thanks.
Thank you.
Your next question comes from the line of Josh Chan Josh Your line is open.
Hi, good morning, and kind of Mark.
Good morning, Josh.
Hi, good morning.
Could you help us.
Put our arms around sort of the operational inefficiency.
I think the press release mentioned some things related to ERP.
But then you also mentioned.
Labor availability issues it seems like in multiple plan so.
I guess it is how much of that inefficiency ties to the ERP and the resulting lead for labor or.
Or are they totally different issues and you're dealing with multiple issues across several plants I suppose.
Yes, so Josh I would tell you that the inefficiencies really were directly attributable to the business optimization, which includes the ERP as well as some of the plant moves.
And when you when you look at for example, the ERP I think we've been pretty transparent as it relates to service parts and those sorts of things where the ERP system had a direct impact on that now that we're 12 months down the road from our go live we earn a substantially better position.
Then we were as we were going into the go lives and so ultimately.
As we said those at the service parts levels, we expect those to work their way through here in 20 and get back to normalized levels here, especially second half of the year then you look at.
The other part of the business optimization had to do with our Cheryl New York facility, where.
We we had some customer demand that was a little bit greater than what we had anticipated and so what we try to do is ramp up the facility. We had a plan to get the labor, which we got but then when we tried to get even more labor it became inefficient and so we were we had shortfalls on things like welders and other things. So we had to go to some contract welders, along the way and so as we worked our way through kind of the peak season, we wanted to make sure that were meeting customer to customer demand.
The interesting part of our business now is as we ramp down.
Into the the less seasonal part of our our business lowered the lower season, if you will.
We've been able to address a lot of these issues get the labor force in get caught up with where we needed to be because we got short on on some of that inventory and although we had higher component inventory. So we'll utilize the component inventory in finished goods and have now salable inventory. So the thing we were really encouraged by in that part of the business had to do with the just the demand I mean, the demand was really strong.
But because of the fact that we had to ramp faster than we had anticipated it got to be a bit inefficient along the way and then the third piece I would tell you that relates to the transition from Japan to the U.S., where again, we wanted to make sure that we had inventory availability and we got ourselves into some issues on freight where we needed to have we had some higher freight costs than anticipated as we brought components and remember we we still source a lot of the components offshore and some of which we'll continue to do some of which will bring back onshore here as we execute our program, but we did have some elevated freight cost along the way as it related to those transitions again, we wanted to make sure that we're meeting market demand because we saw solid market demand along the way and so as we go through now 20, there's some spending will have that ultimately will help us get through the efficiencies some improvements that we're making we're spending some money on some of the improvements and.
Then back half of the year, we would expect that these things are at much much more.
Level loading if you will from this or I should say more normalized type of operations along the way.
All right that's helpful color. Thanks, Todd.
On the.
On the market analytics.
Topic.
I guess I was just wondering you know.
What is sort of the scope of the potential outcomes that you're considering I mean does it does it potentially include like.
Acquisition, and then new area or some business exits I mean.
What's in that what's in the.
Possibility realm here.
Yes, Josh I'm not going to comment on the specifics of what the out and conjecture on what the outcomes might be.
At the end of the day, what it really comes back to is.
As I mentioned before you we've got a situation where there is a lot of changes happening at retail and we want to work our way through that and then two quick quite honestly, there's some opportunities that we have that when it comes to things like electrification that can allow us to get into markets were not currently in so as we as we think through some of those things.
Some outside help with would be that's my point of view is useful and it's not that we don't have a point of view, we certainly do but when you look at now having some folks who deal in these sorts of markets. If you will so the retail space and some of these other adjacencies that we can go after there they have different points of view, maybe than we do or they have more refined points of view and that's where a lot of the learning comes from but in terms of what the outcomes are going to be I am not going to I'm not going to.
Have any conjecture on that and try to because it's just it's not the appropriate time, nor is it the scope is not necessarily.
Going to dictate what outcome or another.
Okay Thats fair.
And then.
Maybe maybe on free cash flow Mark.
I know you said modestly positive in fiscal 20.
Is there any sort of a road map that you can provide in terms of getting back to a more normalized level or free cash flow and how should we think about.
That that more normalized level.
Yes, I think the biggest thing is the earnings.
And that's what.
Todd commented on the call, which is that clearly the outlook for 2020 is below the historical levels of profitability that we've delivered and as we look forward to taking out some of the efficiencies that will remain in 2020 as we look at more normalized production. When we don't have to remove as much inventory in one given year.
And then as we look at some of the.
Continued potentials for growth related to the both the commercial area as well as some rebounding.
Some of the international situation, because remember, we didnt add much back for Australia, which went through a historic drought. This last year. The last two years and our add back for Europe is really quite modest relative to how far it was down on bad weather. This last year. So as a result, those are things that ultimately can bridge. The profitability. In addition to our new engine manufacturing consolidation savings that can resume profitability back to the levels, where we were and then we manage working capital closely even if we left at consistent yet we will continue to work on it.
That generates.
The potential for more cash flow from operations and.
Our capital spending we brought down quite a bit than in.
Both 2019, and our projections for 20, and we think we can continue to maintain it at lower levels than Weve, where we've certainly been during the elevated years of 17, 18, and 19 and having a smaller manufacturing footprint better enables that as well. So that's that's essentially the roadmap forward.
Cash.
All right. Thank you both for your time and hop back in queue.
There are no further questions. Please continue.
Well. Thank you all for joining us today, I'm, sorry that we ran a little bit longer than normal, but certainly a lot to cover and we look forward to speaking with you again in October thanks, and have a great day.
Thank you for joining US and this concludes today's conference call you may now disconnect.