Q3 2019 Earnings Call
Greetings and welcome to the rough group Inc. third quarter 2019 earnings Conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad. As a reminder, this conference is being recorded it is now my pleasure to introduce your host Mr. drew caught up Vice President of Investor Relations. Thank you may begin.
Thanks, Michelle good morning, and thank you for joining US last night, we issued our third quarter 2019 results a copy of the release is available on our website at investors that Red Green Dot com.
Today's call is being webcast and accompanied by a slide presentation, which includes a reconciliation of non-GAAP to get to GAAP financial measures that we will use during this call and is also available on our website.
Please refer now to slide two of that presentation.
[laughter] our remarks and answers will include forward looking statements within the meaning of the private Securities Litigation Reform Act. These forward looking statements are subject to risks that could cause actual results to be materially materially different from those expressed or implied by such forward. Looking statements. These risks include among others matters that we have described in our form 8-K filed with the FCC last night and other filings we make with the FCC.
We disclaim any obligation to update these forward looking statements.
Which may not be updated until our next quarterly earnings conference call if at all.
All references on this call to a quarter or year are fiscal quarter or fiscal year, unless otherwise stated.
Joining me on the call today are president and CEO , Tim Sullivan and CFO deemed all done.
Please turn to slide three.
I'll now turn the call over to Tim.
Thanks drew good morning, everyone and thank you for joining us to discuss rubbed group's third quarter results.
So what happened in the past three months that caused us to fall short of our goals in the third quarter and reduce our full year earnings guidance by approximately 30%.
A large portion change can be defined in one word labor.
Strategic decisions, we made pertaining to labor during this fiscal year cannot be blamed entirely on our current situation with the tariffs, but they were certainly were a significant significant contributor I will provide some commentary on what has transpired and then dean will follow with details on our Q3 financial performance.
As well as the detailed financial analysis of our revised guidance.
First and foremost we believe the fundamentals that drive our business remained strong with the exception of softness in the RV market.
Notwithstanding the overall strength of our markets and backlog.
Third quarter performance was well below our expectations and we now know that what occurred in the third quarter will flow into our fourth quarter.
Slide three identifies three primary drivers of underperformance as well as some positives within the quarter, including the actions we are taking to improve our financial results and drive shareholder value.
I'll walk you through the challenges we faced in the quarter in order of the impact it had on our third quarter and full year guidance.
Consolidated results were primarily driven by underperformance at our three largest businesses.
First the production ramp in plant expansion and one of our primary fire facilities has progressed slower than we anticipated.
As a reminder, we had been ramping at this facility to expand capacity in order to service increasing customer demand.
To fully understand our current situation I must first offer some historical perspective.
When this business was purchased at a bankruptcy in 2006, there was a major reduction in the physical footprint of the plant as well as a reduction in the workforce workforce of over 800 people.
As our brand and market presence has recovered in recent years, we have a meeting our shipping requirements by engaging in an inordinate amount of overtime.
This large amount of overtime was no longer sustainable in our current manufacturing labor market.
In other words turnover became a major deterrent to continuing to rely on over time to meet our production needs.
Manufacturing labor is in high demand and people have many choices where they work.
In Q1, we embarked on a 36% expansion of our manufacturing footprint, which constituted expanding into three new buildings in close proximity to our current plan.
This expansion also required to 38% increase in labor.
Those of you that appreciate manufacturing to understand that this level of expansion is arduous.
In normal times, let alone in a very tight labor market.
Our challenges have been overcoming bottlenecks as we balance our new plant flow and higher labor costs, as we onboard and train new employees to fulfill our goal of doubling our plant capacity from 202017 levels.
Basically we are carrying excess labor as we expand and balance the expanded plant.
As we train and position this new labor they are inefficient and unproductive thus significantly deteriorating our earnings.
We expect these conditions to alleviate in the fourth quarter, but we do not expect to hit our originally planned run rate until the first half of fiscal 2020.
It is important to note that through these challenges we have worked with our customers to continue to deliver quality fire trucks.
We have not experienced any order cancellations.
Additionally, as part of our expansion we are implementing our proprietary Rev production systems, or Rps, which has added to the accountability predictability and stability of our operations.
Rps has already allowed us to reap additional operational benefits in our commercial segment, which is performing at very high levels.
Second we had two situations that our ambulance business that created a slow start to our year similar to our commercial division last year, we experienced delays in large orders from some of our normal municipal accounts.
In particular, a delay in one large order reduced our normal booking levels early in the year by approximately 40%.
We have now received that order and we will finish the year with a strong backlog for fiscal year 2020, although none of this particular large order will ship in fiscal 2019.
Additionally, we experienced an unusual amount of remote activity in markets. This year.
Although remodels have been an alternative solution to purchase a new units for some time they have become more popular recently delaying replacement of new units for two to three years.
Re amounts are approximately half the margin opportunity of a new unit sales.
Notwithstanding the initial lack of booking activity, we decided to maintain a full workforce in anticipation of delivering against the delayed municipal orders.
Quite frankly, this is the new normal and manufacturing in the era of tariffs. Unlike the past if you have labor you retain it.
Again, we made a strategic decision that during an unusual times like this scarcity of manufacturing labor means you carry the labor you have during times of temporary booking shortfalls.
We believe that we could carry the additional labor costs in the first two quarters and a porch and approach more normal levels of absorption in the last two quarters, we have been unable to adequately absorb these costs in the back half of the year and they have negatively impacted our earnings guidance for year end.
We do believe that now with a well defined backlog that this excessive labor costs will be absorbed by higher expected production rates as our new backlog begins production towards the end of Q4.
On a positive note targeted inventory that was left over from the 2018 supply chain disruption has largely been liquidated and our new general manager at our largest daimler's business is making strides with production process improvements and level load in the production line.
Third the RV market in particular classes and campers experienced a greater than anticipated slowdown of wholesale shipments within the quarter.
Although we entered the year expecting a 20% decline with in the class eight market certain product types experienced a more severe slowdown and dealer orders in wholesale shipments lagged our retail sales as a result, we have taken measures to reduce costs in our class a business by consolidating plants from two to one and shutdown one extra week during the July 4th holiday.
We have already reduced the share of class a motor homes in this segment mix from roughly 60% to closer to 45%.
And we continue to shift our production mix.
Two our stronger performing lines during the demand reduction in the class a market.
As we approach the September opened higher house, we are excited about the 2020 lineup of vehicles that we will be showcasing and we feel that dealer inventories for our products will respond quickly to any upturn in the overall market should or should it occur this year.
Finally, you'll recall that at the end of Q2, we reported that we have begun to experience more normal material lead times as our suppliers continue to adjust to the tariffs. While this remains the case, we did experience some critical material supply issues during the quarter, which negatively impacted our ability to ship product.
Until such time that the tariffs are removed we expect to continue to manage through some inconsistency in our material supply.
Despite the underperformance, we would like to highlight three key positives in the quarter that set Rev up for our intermediate and long term production of financial improvements.
First.
Net cash provided by operating activities in the third quarter was $61 million compared to a $13 million for use in the third quarter last year. The significant year over year increase was the result of our focus on efficient management of net working capital and specifically the sale of targeted excess inventory.
While we have reduced our full year cash flow guidance due to lower earnings we anticipate paying down additional debt in the fourth quarter and we continue to target a normalized debt level of two times, which would allow rev to once again consider strategic capital allocation deployment within our key end markets.
Second.
We also added key personnel within the commercial segment in Amiens divisions.
Brian period joined Us as president of the commercial segment in July .
Brian brings wide operational experienced previously managing 21 facilities and his addition will continue upon the solid execution momentum we have built in the commercial segment.
Within the ambulance Division, we are pleased to announce the addition of a new per cash as the new president when we hired subsequent to the close of our fiscal third quarter.
Our new ERP led the start up of Harley Davidson's commercial operations in India.
Harley Davidson's direct selling initiatives in Canada, and realignment of its use dealer network.
We look forward to the positive contributions these gentlemen will bring to their respective positions.
Finally, we are formally introducing Rev production systems.
Our Rps team has leveraged sustainable processes to enhance operational efficiencies. This involves close closely working closely with the individual businesses to enhance install and measure processes, which have contributed to this year's stability and growth within our commercial segment.
The Rps team has now been dispatched to our fire and emergency segment to assist driving higher accountability output and profitability improvements.
We're optimistic that they can leverage the local teams and their experience to get our ethanol segment headed in the right direction.
Let's shift to our outlook for the fourth quarter and fiscal 2020, as we begin our planning process for next year.
Again first and foremost we believe fundamental demand across the majority of our end markets remain solid and we have continued to deliver high quality products against our roughly $1.3 billion backlog.
Fire and emergency backlog is up 28% year over year, which has been the result of an increase of orders across our fire truck and certain ambulance brand categories.
We believe addressing the performance issues in the two fire and emergency businesses. Our two largest by far we have mentioned is fully within our control as we leveraged the key personnel additions and continued to improve and measure the processes at these locations.
While the production cadence within fire has not increased as rapidly as anticipated in our unit sales are essentially flat sequentially. The primary cause of underperformance year to date has been lower absorption of increased labor.
Our full year guidance now on beds, a slight increase to fires third quarter production exit rate along with a small amount of margin improvement as we again begin to normalize operations from the from the disruption of training workers Reconfiguring the flat the factory footprint and realigning sales in the production line.
We fully expect that the new plant layout and staff returned the fire divisions to its historical profitability and higher production rates over time. However, this guidance reset reflects the current situation within the business.
Our largest ambulance facility, we liquidated much of the targeted inventory that resulted from the chassis disruption late last year, albeit at lower margins due to a higher labor content.
We believe.
For some time that they have become more popular recently.
Ambulance rebounds at dealers and contractors have increased throughout the year, leading to irregular order timing within the industry and some near term booking headwinds as I mentioned, we retained at current staffing levels, rather than downsizing and flexing up to produce some of the large municipal orders that are now in our backlog looking toward the end of the fiscal year and towards next fiscal year, We anticipate unit production at that plant to increase sequentially, which should alleviate the margin pressure we experienced within the business.
Recreation end markets have continued to decline in our largest class a category class has been a primary driver of recent underperformance through this downturn, we have focused on what we can control within the quarter, we took costs out by rationalizing facilities from two to one and reduced production at our class eight indicator business.
We have a solid lineup of products that we were introduced at the September open House, we remain confident that these will be well received this trade show serves as a significant venue for wholesale ordering.
Dealer inventories of our products are at a very low level as retail sales have outpaced replenishment orders our current factory footprint would support dealer restock should it occur.
However, our current full year guidance does not rely on this happening.
Outside of class a we have continued to deliver against a solid backlog in class B and supersede products.
But again, our revised guidance takes a more cautious view of those markets as well on a reduced outlook for towables.
In commercial the segment has benefited from improved mix to date versus 2018, and I would like to reiterate that all businesses. In this segment have met or beat expectations. This quarter. This group is doing a great job of executing on their backlog and they have embraced the model of continuous improvement and refine processes that we're deploying.
Across these businesses, we are seeing examples of improvement in throughput lower cost of quality and higher overall profitability versus 2018, while we expect typical seasonality result, lower sales and EBITDA sequentially. The businesses are expected to continue on the path of improved year over year performance this quarter.
And into 2020.
I will now turn the call over to Dean to go through the financials.
Thank you Tim and good morning.
I will start on slide four.
As Tim discussed the performance at our three largest businesses was lower than expected in the quarter on a topline and bottom line basis and the impact of those misses is evident on a consolidated adjusted EBITDA.
And adjusted EBITDA margin graphs on this page.
As well as the update to fiscal 2019 guidance, we have provided.
While net sales have increased slightly for Rev. As a whole the poor margin performance at these three specific business units make up nearly the entirety of our miss versus our expectations.
Total net sales for the third quarter were $617 million up 3.2% compared to the third quarter of last year.
The increase in consolidated net sales was primarily due to an increase in net sales in the commercial and fire emergency segments offset by a decrease in net sales in the recreation segment.
Net income for the quarter decreased by 69% to $5.6 million or nine cents per diluted share.
Adjusted net income decreased by 45% to $13.6 million or 21 cents per diluted share.
The decrease in the third quarter 2019, net income and adjusted net income was primarily the result of a decrease in gross profit in the fire and emergency and recreation segment.
Partially offset by an increase in the commercial segment.
Adjusted EBITDA for the third quarter was $33.5 million versus $47.6 million in the year ago period.
The decrease in third quarter was primarily due to lower gross margins in our largest fire largest ambulance and largest recreation business units, partially offset by strong earnings in our commercial businesses.
As well as continued strong performance in recreation by our class B Super C and Towables businesses.
Please now turn to slide five to discuss the performance of our segments individually.
Fire and emergency segment sales increased by 3.7% to $248 million for the third quarter 2019 versus the year ago period.
The primary drivers of this result were improved pricing and mix of fire trucks, and ambulances slightly offset by a decrease in volume of ambulance shipments.
Anthony adjusted EBITDA for the quarter declined 52% to $12.1 million.
Due primarily to two drivers that Tim referred to earlier, one higher labor costs associated with the process to increase the output of fire trucks, and our largest fire facility.
This labor is currently less productive than needed to achieve our targeted line rate.
And second maintaining staffing levels at one ambulance facility during a period of softness of incoming orders and buildable backlog.
Total company backlog remains healthy and was up 28% year over year to 760 $776 million due both to fire trucks and ambulances.
As Tim mentioned, we now expect the production ramp at our largest fire facility to be delayed into the first half of fiscal 2020, while our operational excellence team continues to implement defined measureable continuous improvement processes to assist the movement of chassis cabs and trucks.
Through production and final Assembly.
And our largest ambulance business incoming orders production levels and staffing levels will start to come into balance at the end of the fourth quarter.
These two factors give us confidence that profitability should improve from here, albeit as albeit at a slower rate than expected because we won't start delivering on our recently awarded large municipal contract this year.
But we believe this sets us up for better performance in fiscal 2020.
In addition, our new general manager at our largest ambulance business is hitting stride with improvements to operational efficiency commercial strategies and adoption of the Rev production system.
We'll move next to the commercial segment on slide six.
Quarterly sales were up 29% compared to the prior year period, driven by an increase in the volume of transit and school bus shipments improved pricing and increased sales of shuttle bus and terminal trucks.
Commercial backlog at the end of the third quarter was down 6% to $395 million compared to the third quarter 2018, resulting from the continued delivery of transit buses to a large municipal customer in the quarter.
Commercial adjusted EBITDA of $19.4 million was up 64% compared to the third quarter of last year.
The increase this increase was due to increased sales of higher margin school and transit buses.
Terminal trucks and improved efficiencies driven by the implementation of our Rev production system, which started in late fiscal 2018.
Adjusted EBITDA margin increased 200 basis points year over year to 9.5% in the third quarter.
The results in this segment are evidence of the strength of our products and market positions the capabilities of our production and management teams and the benefits of deployment of our Rps Opex tools.
Turning to slide seven.
Quarterly sales in the recreation segment declined 16% over the year ago period to $167 million.
The decrease in net sales compared to the prior year period was primarily due to a decrease in the shipment volume of class a motor homes and higher discounting levels as dealers continue to reduce inventory and connect connection with soft RV end markets.
Net sales of truck campers also decreased slightly while net sales of our class B and supersedes increased.
Recreation, adjusted EBITDA decreased 29% compared to the third quarter of last year to $12.8 million.
The decrease in adjusted EBITDA compared to the prior year period was primarily due to the lower class eight volumes and competitive discounting.
Tim mentioned actions, we have taken to reduce class eight production volumes and costs. It is important to note that while we have downsized our footprint and cost structure within the current class environment. We have we have retained manufacturing floor space. It could be ramped in the event that a more robust future dealers restock within this category should happen.
On slide eight we provided an update to our full year outlook, we are which reflects the lower year to date performance as well as the expectation for continued slower pace of production within fire, while we train and integrate the additional workforce.
At ambulance due to that due to the timing of our recently awarded larger municipal contract.
And in recreation anticipation for continued softness in the class a RV market at least through this falls open house event.
While both the fire production ramp energy and their trajectory of the RV market were identified during our last conference call as key challenges in the second half of fiscal 2019, we did not anticipate the magnitude of either outcome.
At the time, we announced our second quarter results, we had seen progress in the planning for the production ramp up within fire and fully expected that the project plan to our target cadence by year end was underway.
Unfortunately, we reached the limits within the fact the facility footprint in the third quarter, given the new labor and production volume that was introduced to the shop floor.
This created bottlenecks, which have been challenging to resolve.
Considering the higher number of new employees, who are currently under productive our adjusted EBITDA margin dropped 128 120 basis points sequentially on approximately flat sales.
This was exacerbated within the F. any segment by retaining our staffing staffing levels in the ambulance business.
Despite the late award of that large municipal contract we'd be we believe both decisions first to hire and train labor within fire and two to retain labor, an ambulance will benefit our customers and investors over the long term.
Deploying rps teams to FSP has identified several opportunities to adjust our production plans and processes for improvement across the segment and will add to the stability of continuous improvement as we move into fiscal 2020.
For fiscal 2019, we now expect net sales net sales to be in the range of $2.35 billion to $2.45 billion and adjusted EBITDA in the range of $100 million to $110 million.
Net income is forecasted to be in the range of a loss of $8 million to positive income of $5 million.
And adjusted net income is expected to be in the range of $28 million to $41 million.
You will note the decrease in adjusted EBITDA is much greater than the reduction in sales, reflecting primarily the additional labor that we carried in the third quarter and the longer anticipate will be fully efficient in the fourth quarter.
However, we believe the path to greater profitability is within our control and we will and we will realize healthy incremental margins as we absorb this labor implement rps throughout the organization and further execute on our backlog within any.
Please turn to slide nine.
It is important at this point to provide a reconciliation of where we stood with regard to our full year outlook. When we spoke to you last in early June for our second quarter results and our current guidance.
After the end of the second quarter, we had line of sight to achieving the full to achieving the range of full year adjusted EBITDA guidance.
As we disclosed in connection with our mid year results.
The biggest risks to achievement of our full year guidance, where the successful execution of our ramp up in the fire division and the progression of the RV markets during the seasonally strong summer month month.
As the third quarter progressed, our largest fire business unit progress stalled despite the investment in the large number of new production employees support staff additional factory space and related costs.
We made the conscious effort to maintain employment and battle through the ramp up with the assistance of our op X teams and the and certain external expert expert resources.
In this tight labor market. We also made the decision to retain our complement a skilled manufacturing plays in one ambulance business unit. Despite the late award of the municipal contract.
When these contracts are awarded we don't include the opportunity in backlog.
Or our production schedules until formal purchase orders are issued against the contract in this case Peos Peos under this contract. We are not provided in time and we are now not physically capable of manufacturing and delivering on any of the any of these trucks under this contract until fiscal 2020.
Lastly, as the summer months progressed, the RV market remain softer than anticipated and further worsened as wholesale shipments slowed faster than retail sales.
Dealers remain cautious about the overall trajectory of demand and continued to manage their own balance sheets for minimum leverage and risk.
Dealer inventories are now at low levels compared to history as a result.
All of these three items together resulted in approximately $26 million of EBITDA leakage during the third quarter from our previous forecast.
The magnitude of this impact is consistent with the relative size and profitability of the businesses that were impacted.
As we look into the fourth quarter and towards updating our full year guidance.
This $26 million shortfall, primarily from three business units is not recoverable as it relates to period costs and at the end of and we are at the end of the summer peak season for RV and for our model year 2020 coaches.
Given the nature of these issues and are realistic look at the remainder of our fiscal year, we do not expect meaningful production output increases inefficiencies in our fire businesses, nor delivery against the larger municipal ambulance contract order within this fiscal year and is not reasonable to anticipate a meaningful rebound in the RV end markets at this point in the RV season.
Although the fourth quarter impact of these items on our full year outlook is not as significant as it was in the third quarter in proportion to the size of the quarter in our fiscal year.
Due to some improvement and the benefit of certain cost reductions the reasonable expectation for the impact in the fourth quarter is another approximately $26 million.
The combination of our third quarter adjusted EBITDA Miss plus the anticipated Miss from these same issues in the fourth quarter totaled approximately $50 million of second half impact, resulting in our updated guidance range of $100 million to $110 million.
On the positive note approximately two thirds of this adjusted EBITDA reduction is unrelated to end market demand and we believe a return to prior profitability levels for these any businesses is within our control.
Turning to the balance sheet and cash flow results for the quarter, which is a significant positive net cash provided by operating activities in the third quarter 2019 was positive $61 million compared to a use of cash of negative $13 million in the third quarter of 2018.
This significant $74 million increase in cash from operating activities over the prior year quarter was due to the companys ongoing focus on efficient management of networking capital. In addition to the sale of targeted excess inventory, which encompass which included completed inventory inventory some of which was left over from the supply chain chain disruptions in late 2018.
Our net increase of inventory within the third quarter includes an increase of working work in process against our backlog and these lot in the large municipal orders.
Net debt at July 31, 2019 was $399 million and our net leverage ratio was 3.3 times, reflecting over $50 million of net debt reduction within the quarter.
We now expect $70 million to $80 million of cash from operations.
And over $25 million of cash flow for for the full year from other initiatives.
Due purely to the lower EBITDA forecast over the near term not any liquidity our interest coverage issues. We now expect our year end net debt to EBITDA ratio to end in a low three times range.
Which is still below our covenant maximum.
Having said that we believe we have strong partnerships with our lender group, we will be proactive managing the situation as appropriate in our long term net debt to EBITDA target remains at two times or less and we plan to continue to pay down debt as we strive to improve EBITDA through the fourth quarter and into fiscal 2020.
With that I will turn the call back to Tim for some closing comments. Thanks Deane.
Maybe to help with understanding the magnitude of the dollars involved.
It's good to know that approximately 25% of our 8000 employees work in these two facilities. So clearly those are the two largest facilities in our entire portfolio.
And they happened to create these issues at the identical time.
Once again, though with the exception of RV. We believe we have strong tax base markets. The good news is that we are ramping our manufacturing capability to deal with record backlogs. Most people would say that that is a good problem to have.
True Harbor, we need to be better with our execution in meeting that demand. This has been particular exasperate in our current markets and the challenges presented by the tariffs, but we still need to manage through it better than we have in the recent past.
We have mentioned many times that 10% EBITDA margins as a target for individual businesses and Rev. As a whole.
It has been almost three years since our IPO, we are behind at this goal on a consolidated basis.
Many of our businesses are performing above that level and I would like to recognize them for the good work that they're doing.
Nevertheless, it is time to take another look at those businesses, where a near term path of this target is not yet apparent.
With that operator, I'd like to open up the line to questions.
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One moment please poll for your questions.
Our first question comes from the line of Jerry Ritchie with Goldman Sachs. Please proceed with your question.
Yes, hi, good morning, everyone.
Good morning, Gary.
Tim I am wondering if we could just continue the discussion along my last comment that you made the areas that you folks are working hard on our C Corps part so the portfolio in terms of businesses that are performing well now so how big is the.
Part of the portfolio that you're evaluating whether it's a strategic fit it doesnt sound like its the businesses that we're working through now based on.
The fit within the business model, but I just want to get your comments on that to make sure. We're thinking about it the right way and understand what's the magnitude of the portfolio that you are looking at for potential divestiture.
It's really two areas they are pretty clear, we have Taipei RV that is not.
At the 10% level and with our other segments performing at that level.
And it is shuttle bus those are the two specific areas that right now are lagging to our goal.
Okay, and then on the fire truck side. It can be it can you talk about as you are making that transition to go bigger manufacturing footprint.
What are you finding as you make that transition on the product development side, I guess, what weve seen plant consolidation on plant moves and news in the fire truck industry in the past, it's been tougher to get the institutional knowledge on on the floor in terms of all the custom made components and how they fit together I'm wondering if you could comment on how that part of the transition is playing out and whether that's impacting the cost structure that we're seeing this quarter and into next quarter.
You you hit the nail on the head.
We're really talking about the one facility in Ocala, Florida, which is by far our largest fire apparatus plant that's exactly the issue Jerry we're trying to bring in a lot of new people and it's very difficult to have them ramp to the expertise the level of expertise, we need them to be productive.
Having said that we've been at this now for a few months and we're starting to see some light at the end of the tunnel, but you hit the nail on the head Thats exact with issues are.
Gary maybe to put that in a little bit of context, you know, it's a couple of hundred additional employees.
Over previous levels.
On a on a base of approximately 700.
Direct labor employees in that in that facility. So its a pretty large magnitude.
Okay, and you know the way we've seen this issue addressed in the past. So most recently at a competitor of yours has been to really reduce well production rates lock in the process and then ramp back up is that part of the thinking here or the customer delivery requirements, making it tough to take that path to right the ship here.
Yes, it's the good news is that the customers have specter product and they've been infinitely really patient with us obviously, it's not easy for them because they get the money they need to spend it but I think the other thing that that they.
Appreciate too so high level is the fact that we will not ship an inferior quality product.
And I think they're willing to to wait I've I've met with a couple of customers who are just recently there were not happy that we were late in one instances, we're two months late.
But he complimented me on the level of quality that we're producing he says never been any better so.
They have been patient we've got to pick it up though I mean, where our backlog is now approaching 16 months, which is way too long.
Okay. Thank you.
Thank you. Our next question comes from the line of Stephen Volkmann with Jefferies. Please proceed with your question.
Hi, Good morning, guys morning, Steve.
I guess I guess I want to just try to step back here, a little bit and try to understand.
What's going on in the sense that.
Obviously companies have issues here and there and they sort of address them and it sounds like you are doing that in some cases, but they just keep coming up and Tim just feels like you don't have the reporting.
Processes in place or maybe the people.
How does this stuff just keep coming up and you mean 90 days ago, we had a very different message from you guys and obviously things have really gone off the rails during the quarter and I'm just I don't understand how that can change that quickly and that it seems like.
You guys just don't have the sort of the feedback loops that you'd need to stay on top of this stuff I don't know if you can address that but.
As it's Steve It's a fair comment obviously, when we're sitting here in the first week in June .
And we were laser focused on material demand and material lead time, not believing that the ramping up at a you won and sustain the labor at Revel would not write itself during the third quarter, a little in the fourth quarter.
It's a fair comment I mean, we've got to get better at execution, we got to get better at looking to see what's coming at US I think in many respects. We thought we had some light at the end of the tunnel with the one.
We had been added for six months and.
We were making progress.
I don't think there is a person in this company that really fully appreciated. The fact that we were not going to get to the production levels in the third and fourth quarter, because we always got there before.
The problem is that this was a massive increase in capacity.
And I mentioned in my remarks. This is this is something that's difficult in normal times, let alone times that we're in right now we're battling 30% labor turnover on average in our plants right now.
And that's not that's not normal and that really has to do with the fact that the labor market is incredibly tight. So every time you train somebody in there for a couple of weeks, they're gone and as you try to ramp. Your production you are bringing people in that they don't know anything about the work you're doing so you're starting from scratch.
It's just a tough situation your point's well taken I mean, you get to the point, where you say when you guys going to get under game. We've had two years in a row now last year with really the materials side of the tariffs this year, the labor side and just other delays.
We've got to get on top of it and we're dedicated to get that done.
So I guess I mean, you talk about things may be starting to improve through the fourth quarter, and then getting better in 2020, but how do you have any confidence in that.
Well, we talked about Rps right and that's a fairly new phenomena for us It started in Walsh and his team attacked the commercial segment last year last year about this time has started the process and you can see how that has stabilized and done extremely well.
We believe in the process, we think it's going to have a very positive effect on not only.
Commercial going forward, obviously from an emergency.
And it starts to it starts to address your concerns or the things that you've raised we need to know daily what's happening on their production floor and these people have to have goals set and hit targets and those disciplines have really not been in these businesses that we bought specialty vehicle businesses or not and we as we talked about an upper sophisticated we got to get them a lot more sophisticated and we are very encouraged by the results of Rps in commercial it's done really well in a fairly short period of time.
Okay and have you changed any of the incentive programs around how people get paid or or.
Other opportunity for job security I guess relative to hitting these targets.
Yes, we actually broke it down into finer detail, we used to have when we first started.
Three years ago four it will I guess will be four years in November as being Rev.
It was a pretty broad incentive plan, where we had a hit certain.
Global targets for the company.
This thing is now being being broken down has been broken down into quarters months and weeks.
So these guys have weak weekly targets that they need to hit.
We can see what's happening the problem is it's very exasperating to attack them when it gets down to a labor situation.
No material as crazy as it was last year with chassis isn't material lead times that sort of thing.
You can kind of it you can see that comedy can kind of muscle through it labors labors like Mercury I mean, you've got you there here today, they're gone tomorrow.
You got to get 10 under under training as welders and by the end of next week you got you got two left.
We will get that stabilized and we're looking at different ways to incense retention.
Just because the market. We're in right now we've never had to do that before we add very experienced workforces and as we ramp.
And increase our production capability.
We have to figure out how to retain some of these new employees.
The good news is the longer serving employs the more experienced employees, they're sticking with us those those aren't the people that revenue problem with the the problem is when you're increasing your labor in one plan by 38% and you're fighting the 30% retention issue as a tall order.
I will get there I mean, we're we're absolutely convinced that we will get there, but we got to prove it we havent the last two years.
Not only is it serves as an excuse but it's been hard enough to kind of grow this business and manage it.
As an operating company as Rob.
Without having that.
No that anchor around our neck as well trying to reach our goals not excuse we will get there I think with Rps, we will get there with with some new incentive programs are going to induce here in about six weeks for the new fiscal year and we have the demonstrated.
All right. Thank you I'll pass it on.
Thank you. Our next question comes from the line of Mig Dobre with Robert W. Baird and company. Please proceed with your question.
Good morning, guys.
Just to sort of follow up on.
On the.
Good questions already asked.
Im just trying to understand kind of what's going on in fire and emergency I mean, if I if I look at your your implied revenue guidance you haven't adjusted that a whole lot. So the way I am kind of interpreting it is the shipments that are coming out of this segment.
Seems to be kind of materially different than what youre thinking, but obviously the costs are so you know I understand that you're talking about labor is being an issue the part that I'm not.
Quite clear on is.
Are you essentially in a lot of labor turnover and if so.
Presuming that these newer employees are coming on board and they are not as efficient.
Shouldn't that resulting in lower production schedules.
As well or is it that it simply takes more man hours just to get the product Don.
I'm.
Im not quite clear as to exactly whats happening here and maybe think gerrys.
Or rather steves question.
How do you gain comfort that you can resolve this problem within call. It the next three months or so.
Well there are two different issues. They are both labor related in the instance of the ambulance.
We basically started the new year with a very meager small backlog.
And we decided to hold that labour retain it to the full extent possible just for the fact that we had to retain we felt our more experienced workers because we felt.
Because were in municipal tax based revenue.
We would eventually get that backlog, we did get that backlog.
And now as we go into 2020, our ambulance business in Orlando has got a nice backlog, we retain the labor and that will self heal itself as we move into into the new fiscal year. The orders that we got were just too late to really affect the fourth quarter actually half the third quarter. The fourth quarter. So that was that was carrying a higher expense than we really thought we were going to when we gave the guidance back the first week in June .
Each one is a whole different situation you know we are approaching a 16 month backlog, we're trying to significantly ramp the capability of that plant.
And that is really the inefficiencies of the workforce. So its not holding in retaining people waiting for new business to come which was the situation an ambulance.
This is this is a much more complicated problem.
We are teaching people how to build fire trucks and these are people who have never done it before.
There will be good employs over time, we'll hit our marks over time, but if you ask me my confidence and give you give you a date when Amazon is going to turn around I can tell you we're going to start hitting stride immediately as we move into fiscal 2020 is going to be a ramping up effect in Ocala just for the fact that we got to retain these people train them and make them productive.
And maybe I can also provide a little bit of context on the on the bridge that we provided on slide nine where we talk about $12 million of the third quarter being fire related about half of that is volume.
And about half of that is labor.
So, even though where we're producing and shipping units.
Sequentially and year over year, they are pretty consistent we did have.
Goals and targets at a higher level to start to bring our backlog into shorter a shorter timeframe and so we're short by about 15% or 40 units versus where we thought we'd be year to date are in the third quarter, sorry third quarter in fire.
And that provides about half of the the miss from the standpoint of the EBITDA.
The other piece the other half is labor and if you think about the couple of hundred employees that we had in they're not efficient and over $30 per hour kind of fully.
Fully burden rate.
And then the remaining employees being almost 20% inefficient as they help to integrate and train the new employees the numbers kind of climb pretty quickly and thats. The other half of that 12 million.
Okay. That's helpful. I appreciate that.
And then.
You mentioned you had Walsh earlier, Tim I mean, he has been on the job now about a year.
As the Chief operating officer and.
Yes.
I'm wondering two things one.
What kind of work if you do on or what is your view as an operating officer of this.
Feedback loop as has been described in a previous question and the improvements that you need to be potentially making there to have better control on the business and then second.
Hi, how are you approaching his deployment in terms of next things to tackle because.
Clearly youre because businesses are the ones that are currently hurting and it seems to me like there was a lot of meat on this phone rather than commercial at this point. Thanks.
Well is sitting right next to me so I'll, let him answer for himself.
Hi, Good morning, I think it's it's the right question and as Tim described.
The focus of main effort.
Starting with commercial was.
Our worst performing segment last year.
There is a lot of opportunity that we went after and we talked in Architected, what Tim described as our our new Rps and have you talk a little bit about what the components are of that but I think to your point. The focus right now is shifting pretty dramatically over to fire and emergency we didn't anticipate I think that the timing issues that theyre playing them today.
My team myself.
Im spending literally all of my time with those teams and putting together the plans that we need to have to execute against not just the remainder of the quarter, but more importantly, setting themselves up for success in 2020.
Thank you.
Thank you. Our next question comes from the line of Chad Dillard with Deutsche Bank. Please proceed with your question.
Hi, good morning, guys.
Good morning said.
So just trying to understand the puts and takes on that side.
Most importantly, just I guess like your view on how the pace of margin improvement progresses over let's say the next three to nine months.
It sounds like in a lot of it has to do with one facility and labor issues I just want to understand I guess in your from your perspective, how long does it take for labor to ramp up to like the.
Optimal productivity and how far away are we from that baseline.
Yes, well beans, and answer financial year with some numbers here, but we clearly think that we will be hitting stride as we approach the second quarter of 2020.
And I would say that from the standpoint of fire and emergency and profitability and volumes implied in our guidance for the fourth quarter is it's kind of a sequential flat.
Quarter in F., any although we're going to strive to two to beat that.
We don't want to assume that's going to happen at this point, given where we are in the year and so therefore from a from a margin and a in a revenue perspective, new you'd probably see a pretty flat fourth quarter compared to the third quarter with opportunity and goals to beat that but we're at this point.
Im not projecting that until early fiscal 2020, and as Tim talked about we've seen.
In the ambulance business that particularly larger.
Unit that we talked about we do have that contract we are starting to see the purchase orders those will go on our backlog and they will start to help us.
Absorb that labor in that ambulance business, starting immediately next year as we deliver those products. So we'll see.
A ramp up in margins and ambulance much quicker than fire because of the that the proximity of that order and if you remember fire and ambulance are roughly 50 50 in terms of our total segment.
That's helpful and then on the revenue.
Production systems opportunity.
I know you've got some good improvement on the commercial side. So maybe you could perhaps just quantify how much that was.
What sort of overlaps in terms of are commonalities in terms of problems are you seeing vis-a-vis.
The fire and emergency group and how big of an opportunity do you see for for margin improvement and over what timeframe.
Maybe I, maybe I can start from the standpoint of what we've seen in commercial and let Tim or in follow up on that and the benefits of Rps I think first of all we don't want to.
Say that that is the be all end all of the of the results. We've seen because obviously, there's a lot of good products people and processes currently in place in the mix has helped us but.
But the Rps has provided the stability and the predictability on the plans and the accountability that it takes or a tough to increase the production at two of our largest facilities.
Our transit bus and our most more profitable as well and transit bus facility.
And our school bus facility that have approximately doubled or more than double their output. Since 2018. Now you can say that that was kind of a mix benefit but in comparison to fire who is also trying to increase their output. We had relatively fewer hiccups. There are lot of things going on I think to manage but you can see that the benefits of just that predictability and the and the tools and processes that were put in place to make sure that happened in the in the due course as we as we expected that was the benefit our rps income or in commercial this year to date so far.
Anything else.
Yes.
Thank you. Our next question comes from the line of Andrew Casey with Wells Fargo Securities. Please proceed with your question.
Thanks, a lot good morning.
Hi, good morning.
A few questions on the cash flow guide.
First do you expect all that other 25 million.
The cash generated from other sources outside of operating cash.
To occur in the fourth quarter. If so is it kind of looks like the Q4 debt reduction should be about $50 million to $60 million to get to that low three X leverage range are those are those correct assumptions.
Yes, you are correct.
Year to date on our.
On our opportunities for cash reductions outside of regular cash flow we're right on.
Right on pace, we've got most of it in through the third quarter Theres a bit left to go in the fourth quarter that will help us but.
Your estimates are pretty accurate.
Okay. Thanks, Dan and then separately.
The the guide.
Again, the cash flow guidance, it seems to imply Q4 working capital benefit.
There's going to be about half of the Q3 benefit.
Im just wondering what what's driving that and does it does it impact any of the normal seasonality as we look into next year.
This will be.
You are correct in that typically at the end of the fourth quarter. There in the past there has been a much bigger reduction in inventory and working capital.
And given the status of our backlogs, especially in a funny the opportunities that are in front of us starting in fiscal 2020.
To increase our throughput to.
Required levels in fire and to start delivering on those larger contracts and ambulances, let me have a little bit higher inventory at the end of this year than we would in a typical year end. So it wouldnt be something that setting us up for continual year over year seasonality difference in change on a permanent basis I think the circumstances today.
We'll have a little bit more in inventory at the end of the year, but still there's still projecting a positive cash from working capital in the fourth quarter.
Okay. Thanks, and then lastly.
There's been there's been a lot of discussion on M&A. So I wanted to ask about the commercial.
Margin the improvement year over year was good.
But I'm wondering how should we.
Look at potential upside from the 9% that you did this quarter.
Because if I look at it a little differently the incremental adjusted EBITDA margin seemed to moderate.
16 unchanged versus last quarter about 43%.
Im just wondering are we seeing the best that commercial can.
Can deliver at this point or.
Was there theres something in the quarter that.
That impact that that incremental margin.
We're not seeing the best the commercial can do because we got to businesses that are dragging us down and that's the two shuttle bus businesses.
And those are the ones that are on watch the rest of them are outperforming at very good levels above the 10% EBITDA levels. So more improvement to come in commercial we're just getting started.
Okay. Thank you very much.
Thank you. Our next question comes from the line of Courtney Jack of bonus with Morgan Stanley . Please proceed with your question.
Thanks for the question.
Just wanted to understand but back on the attorney lever point.
I thought that most of your hiring.
With Don as of the second quarter, obviously, you referenced that 30% churn rate. So is it fair to say you guys are continuing to hire.
Yes, this quarter and into the fourth quarter or.
Is this all done and it is just about training and then secondly on the on the capacity side you mentioned the new facilities.
Are those.
Brady to go right now and it's literally just training or or is there still some are going there and then I think also you had referenced.
Increasing traction I think seven trucks. So we you know to 14.
I think the target was supposed to be 10 by the end of this year. So kind of how should we be thinking about that weekly production rate and in the first half of 2020. Thanks.
Yeah, let me take them one at a time here I'll give you. An example in the third quarter, we hired 225, new people in Ocala to get 95.
And those 95, our fingers crossed that we're going to retain them. So the churn churn is really tough its a.
You know you're going from a very stable workforce to 38% more bodies in those in that plant that have never touched a fire truck in their lives. So it's a big challenge as far as the footprint.
We're in all three facilities and we're up and running I think our biggest challenge right now besides the labor side is making sure we smoothed out the flow.
We are we are de bottlenecking some areas in the flow of obviously, we got new footprint to overcome that.
And having said all that.
It's Tom Dyer.
But we actually really think there's some really good light at the end of the tunnel I think ends team has been on the ground now for about three months to actually three and a half months.
And we're really making good progress I think the good news about that too as some of the new players that are coming into play they're embracing some of the new rps practices. They actually like them I think they like people like to know the right way to do things so.
As bad as it's been and as bad as it's going to be as we move through the fourth quarter here and burned through more dollars.
I think we're positioned well I think we will have some good positive news as we get into 2020.
Okay Gotcha, and then I took on the recreational side I think that's where you guys have actually decreased year outlook not just for the ease but it sounds like also for some of the Towables wannabes seeds. So is it fair to say that in in that segment. You are adjusting your labor or are we going to see the same thing that.
You guys mentioned, an ambulance kind of retaining the labor since it's been trained.
Yes, no I think that's a great question, because we have not.
In RV just for the fact that we don't have good visibility into that market.
It's one of the markets. That's that's not as predictable as are other businesses, which are tax base. We can see the business. It's it's in advance of US we can see it coming and we know which ones were kind of going it yet we don't have that visibility in RV. So we have not retained labor.
To the extent that we have in our other businesses.
Okay. So the view is that this will be.
I'm more downturn.
On the recreation side.
Well, we're prepared for it I mean, it's been down all year in quite frankly.
In other predictions for 2020 from our VA. They are not very encouraging. So we think we've got everything rightsized right now.
We can react we haven't we haven't cuts so deep that we can't react to good business that might come up this month that at open house.
But we're we're we're low we're quite a bit lower than what we were just even three months ago. So we're trying to find that right spot that we don't cut so deep that we can't react.
If this thing look there's going to be more protracted.
We'll do some words remain if we have to.
Okay, and then just lastly on commercial obviously.
We saw some pretty decent sales growth there, but this was the first time that we had seen the backlog down year over year in a while.
Just curious if you have any comments.
On that.
On the backlog and we are aggressively and appropriately delivering on our larger Lea County contract of buses through the end of this fiscal year and into the first quarter next year. So that's a big focus for us and Thats been a big benefit for us and hopefully our customer as well, but we have good line of sight.
On transit bus market and projects and believe that that's just something we'll be filling up again.
Fairly shortly with additional kind of base level business, largely largely municipal contracts that are multiyear so that.
Thats not an issue, yes, I think the again stay tuned for news we're at that point right now where we should be hearing on follow on business from both Chicago and L.A.
And so it's just kind of a timing thing we don't we don't announce and we don't put in backlog until we got from uncountable business. So stay tuned we're.
When watch that backlog number.
Okay got you and then just lastly, you mentioned you did a critical supply issues during the quarter I don't think Dean that you called it out in the bridge.
But just if you can quantify that.
And which segments impacted the most.
That that is in the bridge is kind of in that other on it's not huge but it was enough to kind of move the needle slightly.
It was in some areas in the in the shuttle bus business. Some of them are in our control some of them were not but.
Again, we don't want to overemphasize it it's not huge but it does.
Did provide some disruption.
And a shout out to our sourcing people they've been unbelievable the last 12 months and.
They mitigated that the full extent they could in the quarter and I think we'll be better off here in the fourth quarter I guess the point, we just want to make is we're not over it and just what do you think it's going to come out from the bunker, there's more tariffs thrown out into the marketplace.
And the new the new wave will affect us to some extent probably not that as much as last year, but our sourcing teams are staying on top of you know when I when I look at the us market and the fact that it only took the materials suppliers 12 months to get their lead times back into line.
That's that's pretty amazing.
They are doing the best that Ken is just.
It's it's challenging.
Thanks.
Thank you. Our final question comes from the line of Joel Tiss with BMO capital markets. Please proceed with your question.
Hey, I was gone.
Foreign Joel.
So just.
I mean, I think a lots been asked and answered and can you update us on your parts initiative I guess, you got to put that on hold a little bit why you've got all these other issues to work through.
No. We we should put that as a positive Joe were up again year over year, 10%.
We're not we're not setting the world on fire, obviously, but.
We'll take it.
And I think the team has done a really nice job, we have some really pockets of excellence their words above the 10, but the average is 10, we've hit as much as 18% and some of the segments. So the initiatives are not on hold.
They're they're they're full speed ahead, and we're making good progress.
Thank you there are no further questions at this time I would like to turn the call back over to Mr. Sullivan for closing remarks.
Well, thanks again, everyone for joining us today, obviously this is a.
Another year and another tough year for US. This is not unusual for any of US. We're all experience we've been in this in this business of manufacturing things for a long time.
We really felt obviously with the comments I made at the second quarter that we were through a lot of the worst situations that we could face with the tariff situation.
It's just you can't you can't ramp easily in this environment right now it's hard enough just to retain let alone ramp.
And we in the question earlier why didn't we see a common maybe we should have.
We're dealing with it.
You know, it's it's something we just ask your patience as we asked our customers to be patient.
We will get there we know we can and we will I think a lot of the things we're doing on the Rps side of the business are going to reach some tremendous benefits as we go into 2020.
Again, thanks for joining us today keep the faith and we'll talk to you again in December .
Thank you. This concludes today's teleconference. You may disconnect. Your lines at this time. Thank you for your participation have a wonderful day.