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Briggs & Stratton (BGG) Q4 2019 Earnings Call Transcript

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Briggs & Stratton (NYSE: BGG)
Q4 2019 Earnings Call
Aug 15, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good day. My name is Kyle, and I will be your conference operator for today. At this time, I would like to welcome everyone to the analyst earnings call. [Operator instructions] Thank you.

And I would now like to turn the call over to Mr. Mark Schwertfeger. Sir, you may begin.

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

Good morning, and welcome to the Briggs & Stratton fiscal 2019 fourth-quarter earnings conference call. I am Mark Schwertfeger, chief financial officer; and joining with me today is Todd Teske, 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 SEC 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.

Todd Teske -- Chairman, President, and Chief Executive Officer

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 remain steadfastly confident in our strategy and view fiscal 2020 as an opportunity to get back on track.

During the year, we encountered weather-related headwinds in all three major lawn and garden markets around the globe. This challenging and highly unusual environment was coupled with the Sears bankruptcy and several brand and OEM transitions. Internally, we incurred higher than expected operational efficiencies during the ramp-up of our business optimization initiatives, largely to meet our commitments to customers. Whatever the cost, 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 $0.36 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 selling for residential mowers was down between 5% and 10%, with some 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 Craftsman brand 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 among OEMs, including one of our customers transitioning away from a large portion of its traditional mower offerings.

In Europe, dealers and retailers entered the 2019 season very cautiously, following last year's drought conditions, which negatively impacted the spring selling to 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 this point in the season. Continued issues with our ability to shift service parts also affected the ramp-up of service parts revenue, primarily in North America. While improving from the third quarter, the operations did not achieve the results we anticipated.

While we continue to encounter headwinds, the ongoing strength of our business remain in our commercial categories. For the fiscal fourth -- 2019 fourth quarter, sales of commercial engines and products increased better than 5%. All three major commercial categories, commercial turf, job site and commercial engines, maintained growth aided by the contributions of hurricane stand-on blowers 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, to increase 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 then successful as of late in locating and onboarding new employees. Although it's yet to materialize in the numbers, we made substantial progress on alleviating the inefficiencies affecting our business optimization initiatives.

The pace of activity and throughput with our service parts business and production volume of Vanguard engines improved each month of the fourth quarter. With 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 back -- we have reduced backorders and have a clear line of sight on the actions we need to take over the course of this next several months to again, offer industry-leading fulfillment levels.

While we expect a portion of the inefficiencies to have a continued near-term effect in our business, principally in the first half of fiscal 2020, we are 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 Mark, let me address two other topics. First, in addition to the financial results, we announced a project to close our plant in 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, believed the decrease would be temporary and that the market would rebound to historic levels as the economy recover.

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 in 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 and some adoption of 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, we've been onshoring production of our high growth Vanguard engines in part to enable us to more efficiently utilize our plants in Georgia and Alabama, which produce larger engines. To address the underutilization of our two small engine plants, we are initiating this consolidation project to adjust production capacity to better fit current market demand. Our plant in Poplar Bluff is experienced in producing very similar engines to those that will be transitioning from the Murray plant.

This experience significantly reduces the difficulty and risk of consolidating production. We plan to begin the consolidation in the middle of fiscal 2020 with the move of all finished goods or finished-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 results in pre-tax cost savings of $12 million to $14 million, with approximately $10 million recognized in fiscal 2020.

Our team in Murray, 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 too, I would like to thank the city of Murray and the commonwealth of Kentucky for their support. We will be assisting impacted employees in their transition, including making available other open positions within our company.

Second, our board of directors this week declared a quarterly cash dividend of $0.05 per share, a reduction from the previous $0.14 per share. We believe this move is the right course of action to position the company, given the recent increase in debt leverage and 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, improve profitability and increase shareholder returns. This rate sets 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 accomplished much in fiscal 2019. We completed the onshoring of commercial engines, began producing Ferris commercial mowers in 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 make us more competitive, advance our strategy and positions well for the future.

Even though these significant achievements create a 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 made sustainable share gains and powered 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 turn the company to growth and higher profitability.

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

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 a $500,000 pension settlement charge. Excluding these costs, the fourth-quarter adjusted net loss was $14.9 million or $0.36 per share, down from adjusted earnings of $0.47 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 Engines segment. The fourth-quarter adjusted net loss included a charge of $5.1 million or $0.12 per share for establishing valuation allowances, predominantly associated with our Australia business. Excluding this charge, our fourth-quarter loss was $0.24 per share. Engines 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 100,000 units or 6%. The decline in shipment 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 2018's 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 to offset weakness elsewhere. The Engines 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 in Vanguard engines, elevated expenditures on plant repairs and expedited shipping costs 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 year-over-year service parts sales and higher cost from 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 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 and inventory and higher components on hand to support the transition of Vanguard engine production to the U.S. Engines segment adjusted ESG&A for the quarter decreased $2.7 million, largely from effect of cost control. Engines segment adjusted loss of $3.2 million was down from adjusted income of $20.5 million for the fourth quarter of fiscal 2018.

Products 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'd 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 Products 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 increase cost for raw materials, freight costs and tariffs, net of higher pricing. Sales mix included a shift toward lower-priced products in 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 mower plant during peak production months. We also incurred elevated freight costs to help compensate for product availability caused by lower than planned production. On pricing, net of incentives to stimulate demand did not fully offset elevated product and tariff cost. Products segment adjusted ESG&A expenses were up $400,000.

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 30, 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 products segment due to lower than planned sales and production in the fourth quarter, which left us at 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 our credit agreement, where -- 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 with the end of the fourth quarter.

Although leverage is elevated from historical levels, we project an improve earnings, working capital reductions, lower capital expenditures and the reduced dividend will result in lowering the company's debt leverage in the future. 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 delever 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 2020, 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 secure 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's 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 are taking the opportunity of this seasonally low point in the selling cycle to level load the operation and build adequate stocks of parts to serve global customer needs. The outlook also contemplates a more modest outlook for residential engine recovery.

Specifically, we're assuming some improvement from 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 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 tariff 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 benefit from recent price increases 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 headwind 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 cost 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 unfavorable sales mix, including higher commercial and service part 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 2/3 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 revised expectation is first due to taking longer to ramp up the program efficiencies.

Second, we have devoted more time toward 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 ESG&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 the range of $0.20 to $0.40 per share.

And I would comment that our engine 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 impacted by slow service parts throughput, approximately $20 million of sales which has been pulled into the prior year to support the system go-live and slightly lower production levels. Except for generator sales, we had expected 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 ESG&A costs 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 Todd, 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 buildup 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 will 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 that 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 incurred in 2019. We estimate capital expenditures to remain around $55 million in 2020, as I mentioned earlier.

All together, 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.

Todd Teske -- Chairman, President, and Chief Executive Officer

Thanks, Mark. Clearly, 2019 was an exceptionally challenging year, but it was also foundational. We have nearly completed our multiyear 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 accounts to 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, grow sales of higher-margin products and further diversify the business. To accomplish these goals, we will be focusing on five top priorities to deliver on our 2020 outlook and help ensure we can make equally significant strides in getting back on track to profitability in 2021.

We'll 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 inefficiency improvement. This progress leaves $10 million of inefficiencies that will resolve beyond 2020. In addition, once we have accomplished our 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 incremental $10 million to $15 million of business optimization savings. Taken together, these items will contribute over $25 million of pre-tax improvement beyond our 2020 outlook and go a long way to restoring our profitability. Beyond these cost improvements, we also anticipate continued growth in commercial and the 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 streamlines operations and will make us more responsive to customer demand. It will lower operating cost by an estimated $14 million when complete in fiscal 2022. Third, we will be devoting increased time and focus early in fiscal 2020 to 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 working capital and lowering debt. Through modest capital expenditures and the action 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 update throughout fiscal 2020. In addition to these goals, we will continue to innovate, to grow revenue and increase margins. We continue to look to commercialize 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 delivers 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 toward diversifying our business and driving greater growth in commercial markets.

Combined with our expertise in 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 a family of products, the new 48-volt commercial battery system is 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 10kW and 2.5kW packs soon. Since previewing it, 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 the 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 midsize vehicles and equipment for both indoor and outdoor use, with OEMs mainly in government and municipal, shore and agriculture and outdoor power. You will hear more about this initiative as we progress through this year and in the next. Everyone at our company has worked exceptionally hard in an environment of unprecedented market change and 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 under way 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, to strengthen the balance sheet and undertake a comprehensive review of the factors impacting our business to sharpen focus on those areas that 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-market channels, a broader range of innovative products and exciting new enabling technologies. We'll now open the call up to questions.

Questions & Answers:


Operator

[Operator instructions] Your first question comes from the line of Sam Darkatsh. Your line is open.

Sam Darkatsh -- Raymond James -- Analyst

Good morning, Todd. Todd, Mark, a lot to process obviously. I've got a couple of basic questions, if you'll allow me. 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 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, 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?

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

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 toward 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 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 or improve the efficiencies to the extent that we had anticipated. In fact, they were higher than we thought as we went through the peak shipping months. And so that also drove a 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 -- about commercial sales, particularly commercial mower sales being short of what we had planned for the quarter, that came both and the market softness that you saw as the -- indeed, the market drastically decelerated throughout -- at least the shipment decelerated drastically throughout the fourth quarter. And then the other piece was our production challenges, where we had some labor shortfalls, it 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've sold to support the market.

Sam Darkatsh -- Raymond James -- Analyst

OK. 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 that's defined as cash from ops less the $55 million in capex. I think you said it was modest or what have you.

If you have now with the $0.05 quarterly dividend, maybe $8.5 million worth of dividend 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 debt be elevated in fiscal '20 if your cash flows are basically neutral. My guess is that the $100 million or so in inventory drawdown won't occur until late in the fiscal year, in fiscal '20. But how else should we think about why the debt levels would be elevated despite the contemplated cash flow expectations?

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

Yes, I think part of 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 combining that with the earnings power which is projected to improve, and that's designed to deliver some positive free cash flow to support that dividend ultimately.

Sam Darkatsh -- Raymond James -- Analyst

So the inventory comes out when the $100 million -- that comes out in the spring season?

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

That's right, Sam. That's 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.

Sam Darkatsh -- Raymond James -- Analyst

OK. And then I've one last question, and I'll defer to others. Todd, the outreach for third-party assistance for market analytics, I'm trying to understand because, I guess, in many respects, you are the industry, you are the market. So what skill set -- it's probably an unfair question, but what skill sets or processes internally are lacking or need help in order to ascertain what market dynamics might look like? I'm surprised you're looking externally for that.

Todd Teske -- Chairman, President, and Chief Executive Officer

Yes. Sam, it's not so much the industry per se in terms of we know the players and everything else. What we're really looking at is, OK, so you look at retail and how retail is changing. And ultimately, you've got a lot of e-commerce that's happening here in the U.S., a lot of e-commerce especially over in Europe.

And so you think about that the retail side of things and how that all shapes up. We also have some OEM transitions that I'm not sure the outside firm is going to help us a lot with those transitions other than if you think about new entrants coming in that can help us ultimately with this market, and that sort of thing. So -- and what it comes down to is there's just been a lot of things that have happened from the go-to-market standpoint, not -- we know the players in the industry. We understand all of that, it's 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 battery technology, which we're really pleased now that we've got 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 some of the things we have opportunities out on the commercial side and areas that maybe we're not as familiar with.

Sam Darkatsh -- Raymond James -- Analyst

Thank you, both.

Todd Teske -- Chairman, President, and Chief Executive Officer

Thanks, Sam.

Operator

Your next question comes from the line of Joe Mondillo. Your line is open.

Joe Mondillo -- Sidoti and Company, LLC -- Analyst

Hi. Good morning, guys. 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 with the guidance just because there's so many variables?

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

Yes. I think if 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 would contemplate some rebound in our service parts business and some nice momentum on the commercial side, which comes with nice margins. We had estimated, looking forward the manufacturing volume would be a little bit higher in '20 than it was -- in '20 than in '19, and so roughly around 30 basis points of improvement or $5 million to $6 million. I commented that the efficiency improvements are expected to benefit by $20 million or about 100 basis points.

And our business optimization program is designed to deliver $5 million of benefit or about 30 basis points. And then there will be offset by some higher ESG&A, roughly 60 basis points on higher variable comp. Lower joint venture income, which is about 10 basis points down on 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 to the midpoint of what we'd be anticipating.

Joe Mondillo -- Sidoti and Company, LLC -- Analyst

OK. 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 Murray facility are noncash, I'm having trouble, I guess, getting to just sort of slightly above on a positive cash flow perspective.

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

Yes. And probably the one thing you want to think about is on the higher sales. You would, especially at the fourth quarter, winding up as it did this last year. You would expect there to be a little bit growth on accounts receivable year over year, which would have a little bit of an offsetting benefit against the benefits of inventory takedown.

Joe Mondillo -- Sidoti and Company, LLC -- Analyst

OK. And what was the payables guidance again?

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

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 that would go against the inventory reduction of $100 million, if you will.

Joe Mondillo -- Sidoti and Company, LLC -- Analyst

OK. I think that's maybe where I was missing that actually. And in terms of the business optimization plan, we're pretty much fully done and completed with the three main aspects of that. Is that correct?

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

Yes. I think 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 that's when we will conclude the oil production in our Japan joint venture. But yes, mainly up and running and we only anticipate $5 million more charges in '20 to finish that program up.

Joe Mondillo -- Sidoti and Company, LLC -- Analyst

So I guess, I'm just wondering is that the biggest reason why the benefits are being pushed out because of the Japanese production just being delayed in terms of onshoring that? Because I thought most of the plan was actually on time, on schedule, so I'm just trying to understand the delay in realizing the benefits from this. And also, I wanted also to confirm, I was under the understanding that this whole plan is not really based on revenue. You could see flat revenue and still see the benefits.

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

That's right, Joe. No, I think it's the -- the biggest change that we commented on briefly was 2019 has been a pretty crazy year of many things that we've had to deal with, both externally and internally. When you think about externally, the impact of tariffs, the impact of inflationary measures that in some parts 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 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're looking to take 2/3 of those efficiencies out in 2020 and generate $5 million more business optimization effort. But that obviously takes some work that we haven't 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 the down to the slower time, if you will, now in the first two quarters when we have a slower shift through. And that gives us some extra time to acquire 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.

Todd Teske -- Chairman, President, and Chief Executive Officer

Yes, Joe. What's interesting is we can see the improvements. We can see the benefits. It's just the effort it's taken with everything going on.

A lot of things happening all at once besides the team. But what's really encouraging to me is that we have line of sight, and we have seen the benefits come through. It's a matter of eliminating the inefficiencies and then we realize what we anticipated we're going to realize.

Joe Mondillo -- Sidoti and Company, LLC -- Analyst

OK. And then I had a question on sort of the new 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 is it taking so long to recognize that small engine market's not going to come back. Why did it take a full 10 years to sort of address sort of your capacity utilization there?

Todd Teske -- Chairman, President, and Chief Executive Officer

Yes. So I'll 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 than 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 Murray facility, you're right, it's more of a rationalization and restructuring. And so we start -- we have 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 weather-related things in Europe early and then it recovered, started to 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 did 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 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, when 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 that you can keep the team focused on execution.

Joe Mondillo -- Sidoti and Company, LLC -- Analyst

All right. And then just last question. The sort of channel partner disruptions with Sears and other things that are going on, what is your visibility into that? Do you see these headwinds going away at any time soon? Or what are your sort of thoughts and visibility regarding those challenges?

Todd Teske -- Chairman, President, and Chief Executive Officer

Well, when you look at Sears, we try to give you guys an estimate on Sears. And we actually think Sears is probably, in fact, Sears is a little bit bigger than perhaps what we even thought because of the way the whole bankruptcy kind of played out because when you look at how they exited, it was in anticipation that 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 at their inventory. So we don't see a lot of selling going into Sears. We think that some of that will normalize although I think there still is this open question in terms of where the ultimate Sears Craftsman buyer goes, and some of them, I think, are going certainly 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'll see some of that kind of working -- we saw some of that work its way through in '19. There might be some of that going on in '20. So a year or two to kind of normalize is what we would anticipate. And then there's other transitions that are going on as well, Husqvarna 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 there's 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 liquidates some of their inventory. And so there's just -- there's going to be some churn yet left in '20, which is included in our guidance.

But it's not going to be as clean as people otherwise would want it to be.

Joe Mondillo -- Sidoti and Company, LLC -- Analyst

The Husqvarna, though, should not affect you greatly, right? We addressed this when they announced that, I don't know, three or four quarters ago. And you guys, I thought, stated 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 with a P. But it was a small portion of your business, almost insignificant, I thought you stated.

Todd Teske -- Chairman, President, and Chief Executive Officer

If you go back and split it into two pieces, Joe and the initial piece that they announced, 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. And 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 are kind of moving through. So the first piece, I think you're correct directionally, but the second piece here now that they're getting out of in '20 is a bit more significant.

But again, I come back to -- I think there's probably going to be some inventory liquidation that happens. But the market is also addressing it through existing OEMs that are in the States as well as bringing in some new entrants from other places.

Joe Mondillo -- Sidoti and Company, LLC -- Analyst

OK. I understand. All right. Thanks.

Todd Teske -- Chairman, President, and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Josh Chan.

Josh Chan -- Robert W. Baird and Company -- Analyst

Hi. Good morning, Mark.

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

Good morning, Josh.

Josh Chan -- Robert W. Baird and Company -- Analyst

Hi. Morning. Just -- could you help us put our arms around sort of the operational inefficiency? I think the press release mentioned something related to ERP. But then you also mentioned labor availability issues at seems like in multiple plants.

So I guess -- is how much of that inefficiency ties to the ERP and the resulting need for labor? Or are they totally different issues than you're dealing with multiple issues that caused several plants I suppose?

Todd Teske -- Chairman, President, and Chief Executive Officer

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 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 are in a substantially better position than we were, as we were going into the go-live.

And so ultimately, as we said, those at the service parts level, 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 Sherrill, New York facility, where 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 planned to get the labor, which we got.

But then when we try to get even more labor, it became inefficient. And so we had shortfalls on things like welders and other things that 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 we were meeting customer demand. The interesting part of our business now is as we ramp down into the less seasonal part of our business, 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 get short on some of that inventory although we had higher component inventory.

So we'll utilize the component inventory and the finished goods and have now saleable inventory. So the thing we're 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 that I'd tell you 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 cost than anticipated as we brought components in, because remember, we still source a lot of the components offshore, and some of which, we'll continue to do, some of which we'll bring back onshore here as we execute our program. But we did had some elevated freight cost along the way as it related to those transitions.

Again, we wanted to make sure that we were meeting market demand because we saw solid market demand along the way. And so as we go through now '20, there's some spending we'll have that ultimately will help us get through the efficiencies, some improvements that we're making with respect to money and some of the improvements. And then back half for the year, we would expect that these things are at much more level loading, if you will, or I should say more normalized type of operations along the way.

Josh Chan -- Robert W. Baird and Company -- Analyst

Yes. That's helpful color. Thanks, Todd. On the market analytics topic, I guess, I was just wondering what is sort of the scope of the potential outcomes that you're considering.

I mean does it potentially include like acquisition and then new area? Or some business exits? I mean what's in the possibility realm here?

Todd Teske -- Chairman, President, and Chief Executive Officer

Yes, Josh. I'm not going to comment on the specifics of what the -- in conjecture on what the outcomes might be. At the end of the day, what it really comes back to is, as I mentioned before, we got the situation where there's a lot of changes happening at retail, and we want to work our way through that. And then 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 we're not currently in.

So as we think through some of those things, some outside help would be -- the outside 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, 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'm not going to have any conjecture on that and try to -- because it's just not appropriate time nor is it -- the scope is not necessarily going to dictate one outcome or another.

Josh Chan -- Robert W. Baird and Company -- Analyst

OK. That's fair. And then maybe on free cash flow, Mark, I know you said modestly positive in fiscal '20. Is there a sort of a road map that you can provide in terms of getting back to a more normalized level of free cash flow? And how should we think about that more normalized level?

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

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 both commercial area as well as some rebounding of some of the international situation because remember, we didn't add much back for Australia, which went through a historic drought this last year, 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 it consistent, 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 then in both 2019 and our projections for '20.

And we think we can continue to maintain it at lower levels than where we 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 essentially the road map forward, Josh.

Josh Chan -- Robert W. Baird and Company -- Analyst

All right. Yes. Thank you both for your time.

Operator

There are no further questions. Please continue.

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

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.

Operator

[Operator signoff]

Duration: 70 minutes

Call participants:

Mark Schwertfeger -- Chief Financial Officer and Senior Vice President

Todd Teske -- Chairman, President, and Chief Executive Officer

Sam Darkatsh -- Raymond James -- Analyst

Joe Mondillo -- Sidoti and Company, LLC -- Analyst

Josh Chan -- Robert W. Baird and Company -- Analyst

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