U.S. Markets open in 6 hrs 18 mins

Edited Transcript of ATU earnings conference call or presentation 26-Sep-19 3:00pm GMT

Q4 2019 Actuant Corp Earnings Call

BUTLER Sep 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Actuant Corp earnings conference call or presentation Thursday, September 26, 2019 at 3:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Barbara G. Bolens

Actuant Corporation - VP of Corporate Strategy, IR & Communications

* Randal Wayne Baker

Actuant Corporation - President, CEO & Director

* Ricky T. Dillon

Actuant Corporation - Executive VP & CFO

================================================================================

Conference Call Participants

================================================================================

* Allison Ann Marie Poliniak-Cusic

Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst

* Ann P. Duignan

JP Morgan Chase & Co, Research Division - MD

* Deane Michael Dray

RBC Capital Markets, LLC, Research Division - MD & Senior Analyst

* Jeffrey David Hammond

KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst

* Joseph Michael Grabowski

Robert W. Baird & Co. Incorporated, Research Division - Associate

* Justin Laurence Bergner

G. Research, LLC - VP

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Ladies and gentlemen, thank you for standing by. Welcome to the Enerpac Tool Group's Fourth Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded, Thursday, September 26, 2019. It is now my pleasure to turn the conference over to Barbara Bolens, VP, Corporate Strategy, Investor Relations. Thank you, Ms. Bolens, you may begin.

--------------------------------------------------------------------------------

Barbara G. Bolens, Actuant Corporation - VP of Corporate Strategy, IR & Communications [2]

--------------------------------------------------------------------------------

Thanks, Donna. Good morning, everyone, and thank you for joining us on our fourth quarter 2019 earnings conference call. On the call today to present the company's results are Randy Baker, President and Chief Executive Officer; Rick Dillon, Chief Financial Officer. Also on the call with us today are Fab Rasetti, General Counsel; Bryan Johnson, Chief Accounting Officer; and [Bobby Belzner], Director of Investor Relations and Corporate Strategy.

Our earnings release and slide presentation for today's call are available on our website at enerpactoolgroup.com in the Investor section. We are also recording this call and will archive it on our website.

Please go to Slide 2. During today's call, we will reference non-GAAP measures such as adjusted profit margins and adjusted earnings. You can find a reconciliation of non-GAAP measures to GAAP in the schedules to this morning's release. We would also like to remind you that we will be making statements in today's call and presentation that are not historical facts and are considered forward-looking statements. We are making those statements pursuant to safe harbor provisions of federal securities law. Please see our SEC filings for the risks and other factors that may cause actual results to differ materially from forecasts, anticipated results or other forward-looking statements.

Consistent with how we have conducted prior calls, we ask that you follow our one question, one follow-up practice in order to keep today's call to an hour and also allow us to answer -- address questions from as many participants as possible. Also as a reminder, we are now reporting continuing operations financial results following our announcement in July that we have reached an agreement to divest the EC&S segment. As a result, all financial information reported today, including fiscal '20 guidance, will be in the continuing operations format.

Now I will turn the call over to Randy.

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thanks, Barbara, and good morning, everybody. We're going to start today on Slide 3. But before I review the quarter and full year results, I want to announce one of the most pivotal events in our company history. This week, we officially launched the Enerpac Tool Group and the new stock symbol EPAC, which is clearly symbolic of our new company name and commitment to the tool industry. This is the culmination of multiple years of hard work to transform Actuant into a top-performing pure-play tool company and to set the stage for our future. Enerpac is a premium brand with 110 years of history providing high precision, reliable and safe products to a demanding industry. Our new company serves both the light and heavy industrial tool market, spanning a total servable customer base of over $8 billion. This provides ample space for organic growth in strategic acquisitions while delivering superior margins, cash flow and ultimately shareholder returns. We are a company focused on 4 product families, 14 tools categories and serving 13 vertical industries. The breadth of our product coverage in serving the industry creates an environment for stable growth and lower cyclicality. The 4 tool categories include, General Industrial, Bolting Technology, Hydraulic Pumps and Lifting Systems, which are the focus of our product development and acquisitions.

The General Industrial tool area has the widest variety of applications, including aerospace, power generation, manufacturing and many more. Bolting Technology is also a carrier of growth, and in the past 2 years we have increased market share through new products and increased marketing. Lastly, Hydraulic Pumps and Lifting Systems have always been a cornerstone of Enerpac through their commanding market share and innovation. The Enerpac Tool Group is a market leader and will never compromise on our effort to supply the highest quality and precision tools in the industry.

Now moving over to Slide 4. Enerpac is a high-quality business comprised of 3 sales categories: Industrial Tools & Service, which is comprised of rental operations and manpower. Our strategy to deliver growth above market conditions remain consistent for the company, given the breadth of our product line and participation widely in the 13 vertical industries, we are well-positioned for continued organic growth. More than 80% of our sales emanates from the high margin tools and rental sales, which provides an excellent platform for profitability.

Second, our investment in new product development is beginning to yield results in the form of higher sales contribution and is approaching our goal of 10%. Lastly, our effort over the last 3 years to create a more effective sales force for serving of more than 2,000 dealers worldwide has been successful. From an operations perspective, the Enerpac Tool Group is comprised of 13 manufacturing locations positioned to serve local markets. And with any company, the key to our success starts with our engaged and dedicated employees committed to delivering the highest precision in quality tools in the industry.

As I've stated in prior earnings calls, our capital allocation priorities have not changed. We are firm -- firmly committed to invest in organic growth, maintaining a strong balance sheet and making strategic acquisitions, which reside in the Tool growth plans. And lastly, we'll return capital to shareholders through opportunistic share buybacks, which we achieved in our fourth quarter through the purchase of over 1 million shares.

We'll provide more clarity into our long-term growth strategy during our Investor Day later this year. However, we are consistent in our approach of achieving organic growth, maintaining world-class operations, making disciplined acquisitions and strict adherence to our capital allocation strategy.

Now turning over to Slide 5. Our fourth quarter demand was weaker than expected, impacted by the developing global economic uncertainty. Our dealers are becoming more conservative, driven by slower retail demand. Secondly, the fourth quarter was impacted by our efforts to reduce low margin service sales, which we announced as part of our IT&S restructuring earlier this year and the seasonally lower Middle East market. As a result, core sales declined by 3% in the quarter.

While the low sales volume impacted the quarter, our adjusted operating margin maintained steady versus last year. EPS was also flat to last year and both results were driven by actions we took to restructure the business, reduce our cost and deploy cash to reduce interest expense. Our restructuring actions, which we initiated in the third quarter, will improve our cost position and positively impact detrimental margins going forward, should the economy continue to slow. Lastly, we are taking swift actions to reduce inventory to align with the lower volume expectations.

Now turning over to Slide 6. Our fiscal 2019 was a very successful year in terms of growth, profitability expansion and execution of our portfolio rationalization strategy. Core sales grew by 4%, with solid performance from most product lines in regions. Operating profit increased by 190 basis points, with a very high incremental margin of 102%. The higher profitability translated to EPS growth of almost 50%, bringing us one step closer to our long-term objective.

2019 was our best new product introduction in many years. We released more than 30 new products to the market, which further advanced us towards our 10% contribution goal. Our strategic objective of delivering growth above the prevailing market condition was achieved through our intense sales focus and commitment to new product introductions.

As I earlier stated, the launch of the new Enerpac Tool Group is the culmination of our portfolio strategy execution. During the year, we sold 2 smaller business in preparation for the Engineered Components & Systems segment sale. We are continuing the separation process, and we remain confident the sale closure will occur in the calendar fourth quarter of 2019. Overall, we're very pleased with the continued progress towards becoming a top performing pure-play tool company.

And now I'll turn the call over to Rick Dillon to go through the details on the quarter, and I'll come back with a market update and our guidance. Rick?

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [4]

--------------------------------------------------------------------------------

Thanks, Randy, and good morning, everyone. So let's take a deeper dive into our adjusted fourth quarter results. Just a quick note that a reconciliation of the one-time items excluded from our adjusted results has been included in the appendix.

So if you turn to Slide 7, fiscal 2019 fourth quarter core sales decreased by 3%. Tools & Service sales were down 4%, partially offset by growth in the Cortland medical business. The impact from the stronger dollar reduced net sales by an additional 2%.

If we turn to Slide 8, Tools & Service core sales declined 4%. It is comprised of flattish core tool products, a low to mid-single digit decline in service and a double-digit decline in heavy lift products.

In North America, our largest region, product sales demand decelerated during the quarter and ended up flat to prior year, and this is in line with the U.S. manufacturing indicators. We believe our distributors are being more cautious on inventory levels due to the uncertainty of market conditions. Product sales in Europe were down low to mid-single digits as Brexit and another geopolitical issues weighed heavily on demand. The rest of the world was also relatively flat.

Service was down 3%, with the largest driver being the strategic exit we took earlier this year to exit our less profitable, more commoditized, North American service work. The top line impact was a little stronger than anticipated as we exited these activities during the quarter, but the impact on profit was favorable. As expected, the large service projects that drove significant oversize service growth this year were completed in the third quarter and contributes to the fourth quarter year-over-year and sequential decline.

Heavy lift sales were also down in the quarter as we discontinued the large custom products. These declines were partially offset by pricing, which covered the impact of tariff and another commodity costs. We launched 7 new products in the quarter, bringing the full year total to over 30. As Randy mentioned, we continue to get closer to our target of 10% of sales from products introduced in the last few years as we ended the year over 7%.

As noted on Slide 7, despite the reduction in core sales, our adjusted operating profit held steady. So let's walk through the key drivers, turning to Slide 9. As expected, the North American service strategic exit and restructuring provided an immediate benefit to operating profit, partially offset -- offsetting other market-driven volume declines. Pricing net of tariffs and other known commodity cost increases was slightly positive. As far as other cost activity in the quarter, the benefit from reduced incentive compensation expense offset lower productivity, increased medical cost and lower bad debt recoveries in the current quarter. The detrimental profit margin on the sales volume decline was approximately 13%, reflecting the service strategic exits and the elimination of the lower heavy lift custom project work.

Continuing operations includes the $13 million of EC&S corporate cost. Excluding these costs, our operating profit margin for 2019 would be approximately 14%. If we turn to Slide 10, the overall adjusted EBITDA story for the quarter is essentially the same as operating profit, so we won't spend any time here.

And moving on to Slide 11, adjusted EPS for the second quarter was $0.21, in line with last year. Tax expense was lower than expected, primarily as a result of lower European earnings than expected, driven by core sales declines and resulting in lower GILTI tax. Slide 12 is our normal segment slide because we're reporting containing operations only, we just included this for comparability purposes, so we won't cover this slide.

Slide 13 is our core sales trend for IT&S. We have broken out tools, heavy lifting and service. The Tools product trend continues to be relatively stable, and we have seen more fluctuations from both service and heavy lift. We'll provide more information on historical product and service performance for the new Enerpac Tool Group at our Investor Day coming up.

Turning now to liquidity on Slide 14. We generated $50 million of cash during the quarter, which was well below our expectations. The key drivers being the lower EBITDA and higher primary working capital for both continuing and discontinuing operations. We also saw increased cash restructuring as we accelerate the timing of some of our planned action. For the full year, we generated $27 million in cash, reflective of the fourth quarter miss. On a year-over-year basis, increased EBITDA and primary working capital improvements from our containing operations was offset by the large tax refund from the Viking planning received last year, increased cash compensation cost from the fiscal 2018 bonus payout and essentially no-stock option proceeds in the current year. All of these combine with approximately $30 million less cash from the EC&S business during the year and $9 million in cash divestiture cost drove the year-over-year cash flow reduction.

EC&S had lower EBITDA, increased working capital and increased capital expenses. Primary working capital for the EC&S business increased $15 million year-over-year. These balances are subject to a postclosing working capital true up that could potentially result in increase in the sales proceeds.

Working capital management for our continuing operations will remain the area of focus. We ended the year with higher than anticipated levels, specifically in inventory. We anticipate cash flows for fiscal 2020 to be between $50 million and $75 million. This guidance range assumes a $10 million to $20 million reduction in working capital. The impact of lower cash taxes and interest will offset cash restructuring and other divestiture charges. CapEx for next year is expected to be approximately $10 million.

So we ended the quarter with $211 million of cash on hand after buying back just over 1 million shares of stock at a cost of $22 million and preparing another $14 million on our term loan. In fiscal 2019, we paid down the term loan approximately $72 million. Both all in line with our capital allocation priorities, as we manage our balance sheet and opportunistically return capital to our shareholders.

Our leverage continues to trend down and now sits at 1.7x versus 1.9x in Q4 of 2018. Our balance sheet condition provides us with a lot of flexibility to continue to execute our growth strategy.

Before I turn the back over to Randy, I will walk through the key assumptions behind our fiscal 2020 guidance. With the EC&S divestiture as well as some of the strategic exits we are planning in the fiscal year, we are providing a little more detail here.

First, I'll look at our sales walk on Slide 15. The strong dollar seems to be staying with us for the foreseeable future, so we will see a negative impact from the average rate from last year. In addition to the impact from strategic exit of our lower profitable service in North America, we have identified several other noncore product lines we will be exiting during the year. As we discussed last quarter, these product offerings are each relatively small and they have a negative impact on our overall profit margins. These products include subsea connectors, strand jacks and tie rod cylinders.

We expect to complete these divestitures in the front half of the year and have completed 1 so far. Collectively, strategic service and product line exits will reduce sales by about $50 million for the year and have a positive impact on operating profit. Using these 2 changes to anchor the fiscal '20 starting point, we will guide what we see core sales performance for the ongoing business for 2020.

We're expecting the tools market environment to be flat to down low single digits, with market's performance similar to our fourth quarter. Our NPD and commercial actions will continue to allow us to outperform the market by approximately 200 basis points. We also expect the service market environment to be flat to down low single digits. The oversize service projects we had in fiscal '19 are not expected in fiscal 2020, which would be the primary driver of the overall decline. This will get us to a sales range of $575 million to $600 million for the year.

If we move on to Slide 16, we are expecting a 200 basis point improvement in EBITDA margin in fiscal 2020. The improvement reflects the impact of our strategic decisions on operating margins. We also are anticipating that approximately $9 million of the $13 million ECS corporate costs remaining in containing operations will either be reduced

(technical difficulty)

recovery from the TSA or actions taken throughout the year as those services are no longer needed. So this assumes $4 million of cost will impact the first quarter and the balance of the cost will be offset or eliminated through the balance of the year.

From an EPS perspective, we have made the assumption that cash proceeds from the EC&S transaction will be used to pay down the term loan after closing the transaction, reducing interest expense for the year. With that, I'll turn the call back over to Randy.

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [5]

--------------------------------------------------------------------------------

Thanks, Rick. So moving over to Slide 17, the general economic drivers changed substantially in the fourth quarter. Growth rates in the major markets, including the U.S. and Europe, have reached an inflection point. GDP and PMI indexes are shifting to lower growth rates, which is projected to continue through the near future.

Additionally, industry surveys are reflecting a more conservative outlook, resulting in lower inventory and retail forecast. Vertical industries impacted by these dynamics include industrial maintenance, on and off highway vehicle repair and general manufacturing. Civil construction, aerospace and oil gas continue to be healthy, although at a lower growth rate.

Rick's fully covered the core sales projection, so I'll move on to the guidance summary on Slide 19. 2020 full year guidance is based on the new structure of new Enerpac Tool Group. As Rick covered, our projections for 2020 include the strategic exits, which has an approximate $55 million impact, but increases profitability, which I want to stress, it increases profitability. As a result, the sales will be in the range of $575 million to $600 million. Our projected EBITDA will be in the range of $94 million to $104 million, and EPS will be in the range of $68 million to $81 million.

Cash flow is expected to be in the range of $50 million to $75 million, and our first quarter range will be in $135 million to $144 million, with EPS of between $0.08 and $0.12 a share. Our objective in 2020 is clear. We will continue to execute our tool company strategy while systematically improving the operating performance of the Enerpac Tool Group, with our ultimate goal of achieving a 20% plus EBITDA margin.

I'd also like to thank all of our employees and distributors worldwide for their continued commitment to delivering the highest quality tools and services in the industry. So operator, Donna, let's open it up for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question is coming from Jeff Hammond of KeyBanc Capital Markets.

--------------------------------------------------------------------------------

Jeffrey David Hammond, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [2]

--------------------------------------------------------------------------------

So I really wanted to just understand a little bit better the cadence of these -- the $55 million of exits, how do they flow through? And I think you mentioned, it sounds like you're selling the product lines or you sold one, so maybe just clarify. And then just also touch on the service comps, the down 5 to 9 and I don't know if there's particular quarters where you have particularly tough comps. Just trying to flesh all that out.

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

Okay. Well, Jeff, let me cover some of the broader strategic issues surrounding the exited product lines, because as we predicted internally that this would result in many questions from investors. So I'm going to try to cover it from a strategic standpoint first and then I'll hand it off to Rick to go through some details on the financials.

As we structurally change to the Enerpac Tool Group, as I mentioned in the prepared remarks, we sold 2 small businesses prepared for the EC&S sales. And then the remnants of the original energy sector and also some remnants of the original component manufacturing company needed to be dealt with as well. And so as we talked through the strategic decision to limit our service revenue and particularly in very low margin aspects, and we talked about that in our third quarter, and that has a very positive impact. You saw that $2 million of sales coming out of the quarter equity, the flow through was under 50%. So we picked the right stuff not to do. And I think it's an important thing that we're running a business for profitability, not for fun. And we intend to continue that.

So secondly, when it comes to the divested product lines, the first one I'll talk about is the connector business. Subsea connectors was a remnant of the original energy company, and it is a business which provides repair systems for subsea pipelines and inherently is a very complex business and one that is so far away from our tool strategy that it had to be dealt with. And unfortunately, over time, it had not been particularly profitable. So that's one.

Number two is our Milwaukee cylinder company, which goes back many years and is a component manufacturer in tie rod cylinder manufacturing. It is been part of the Actuant Group for a long time and has been part either of the EC&S business or in the industrial tools business due to the convenience of manufacturing. But largely, it's never made much money. And it had to be dealt with in terms of moving it out of the Group and establishing it out of our revenue stream.

The final one is really a company called UNI-LIFT, or a product line called UNI-LIFT, which is simply an adaptation of the screw jack system and is a component. And again that was also part -- it's manufacturing location was in the Milwaukee cylinder. And so when you bundle all that together, it was the final steps that we needed to make to complete the formation of a really high-quality tool company. Although painful, it was the right thing to do.

So I'll turn it over to Rick to provide a little more insight into the financials that you had questions.

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [4]

--------------------------------------------------------------------------------

Sure. So for the $55 million, we said about $25 million of that is service. The -- that activity in terms of exiting is largely behind us. And so we expect to see that starting right away in Q1. From a comps perspective, you look at last year Q2 and Q3 is where we had the large project revenue coming through. So if you think about that as well as the North American service top line going down, that's where you're going to particularly have the strongest impact in terms of tough comps.

From a noncore product perspective, those products, I think we mentioned one, was complete, we expect all of them to be completed in the front half of the year, either in our Q1 or early in our Q2. That revenue comes with very low and in some cases no profitability, so there's little impact on EBITDA. But from a top line perspective, that's about $30 million, and that will show itself mostly in the back half but a little bit in Q2.

--------------------------------------------------------------------------------

Jeffrey David Hammond, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [5]

--------------------------------------------------------------------------------

Okay. Great. And then just kind of getting back to some of the slowing in the IT&S business, it sounds like Europe is a little heavier, but maybe just talk about end markets and geographies, where it feels a little bit heavier or conversely more resilient?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [6]

--------------------------------------------------------------------------------

Jeff, what we saw in the quarter was, in the early quarter when the new tariffs were announced and some other issues had developed around the world, there was a almost immediate reaction with order rates. And that wasn't just the U.S. market, it was in parts of Southern Europe. And as we progress through the quarter, things improved, and we saw a distinct increase in order rates. So the reality is that the market feels like it's slowing in parts of Southern Europe. We've seen some issues in some of the Northern European countries that have been slowing. During my last dealer visits just a few weeks ago, I was on multiple different job sites in Europe as well as several distributors, and from a civil wind energy side, there's still a lot of activity out there. The amount of new wind farms going offshore in Europe is significant, which we're playing a big part of.

But from a general manufacturing, if you look at vehicle repair and vehicle assembly, to the extent that we ship into those markets, those are definitely on the weaker side. In the U.S. market, certainly, we've seen fluctuation in onshore bolting, which is really surrounding some of the onshore oil and gas. But on the good side, the power gen, nuclear and wind energy has been fairly strong. So again, we see a little bit of a mixed bag. And one of the things I wanted to continue to stress on the 2 major markets, the U.S. and Europe, is that we do participate widely in 13 verticals, which really provides a lot of potential customers and locations to sell to. So the fact that we've improved our sales and marketing and coverage has helped that a great deal.

And when you shift into Australia and into Latin America where mining plays a bigger role, we've seen some slowing in mining, but obviously, they still have large fleets of equipment and processing mills that need to be maintained and we've done fairly well in those markets.

Now China and Asia is another story. There have been a very distinct slowing effect in that part of the world. And we all know why that's occurring. So I think as we look forward into our forward projection that we laid in there, on the distinct tool side of the business, the down 3% to about -- up about 1% I think is a forecast that feels right at the moment. I don't see an instance where we should be calling it down mid-single digits. But I do think the potential for some decremental sales in 2020 is certainly there.

--------------------------------------------------------------------------------

Operator [7]

--------------------------------------------------------------------------------

Our next question is coming from Allison Poliniak of Wells Fargo.

--------------------------------------------------------------------------------

Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [8]

--------------------------------------------------------------------------------

Just on the sort of I guess expanding the sales commentary, it sounds like there had been a little bit inventory build. Any color, do you feel like the inventory system is bloated or it's just overall macro concerns that's driving some of the weakness right now?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [9]

--------------------------------------------------------------------------------

Well, the inventory side from our tools company is actually a number that is quite manageable. It's directly resulted from the wholesale miss in our third -- fourth quarter. And as a number that we can work through and we plan to work through in our first quarter, one of the unique things about the Enerpac Tool Group and I think we probably discussed this with investors openly before is that our wholesale to retail chain is actually quite short. Many of our distributors do not stock large quantities of our product because our catalog is quite extensive. And there are products that they do inventory, they turn it quite quickly. See if you looked at the average churn ratio of the dealers I'm very familiar with, they're going to have a turn rate of between 6% and as high as 10% in some cases. So in that context that they're -- the items that they're stocking, they're turning quickly. The things that they're not stocking, we're able to supply from our warehouses either in Europe or in the U.S. quite quickly. And so you see that immediate inventory build in our part, but we can respond and work it through quite effectively over the next quarter. So that's the plan right now. Certainly, it's the thing to watch as we go through our first quarter in making sure we align with that, we throw our significant cash associated with the inventory draw down and that's something we will definitely report on in Q1.

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [10]

--------------------------------------------------------------------------------

So just a little -- adding a little more there, when we think about our year, obviously the fourth quarter is the biggest quarter on the tool side. And as we saw things decelerate quickly, really starting in July, we had inventory positioned for that, our actual estimate for the quarter. So we ended up -- we planned it in August with more inventory, but we've already -- to Randy's point, it's the inventory that is moving. And we've really kind of set the plan in place to drive that working capital back to levels that we would expect for the business. So don't have a whole lot of, or any, concern today on our ability to get the inventory under control, just the nature of the business. But we did end high and have plans to drive that back to a normalized level.

--------------------------------------------------------------------------------

Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [11]

--------------------------------------------------------------------------------

Okay. That's helpful. And then just on your 2020 guidance. Are you, once again, it's a means to an end, net positive price impact in there as well?

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [12]

--------------------------------------------------------------------------------

It's slightly positive. Slightly positive.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

Our next question is coming from Mig Dobre of Robert W. Baird.

--------------------------------------------------------------------------------

Joseph Michael Grabowski, Robert W. Baird & Co. Incorporated, Research Division - Associate [14]

--------------------------------------------------------------------------------

This is Joe Grabowski, I'm for Mig this morning. I guess just another question on fourth quarter demand trend. You mentioned in North America, product sales demand decelerated during the quarter. Could you just talk a little bit more about that rate of deceleration and if you've seen things stabilize here in September? Again, you said you're comfortable with your core sales guidance, but what is the risk if demand continues to decelerate?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [15]

--------------------------------------------------------------------------------

Well, we watch our daily order rates quite closely and it's one of the things that's very well-organized with the Enerpac Tool Group as we have very tight visibility to our wholesale; our backlog of product and which plant it's scheduled to come from. And so as we watch those daily order rates, we're comfortable with what we're seeing early on. And as I mentioned as we walk through the quarter, there was a very strong reaction in the first 2 months of the quarter -- of our quarter four followed by a rebound in the final month of the quarter. And I think as people got their mind around the fact that the new tariffs and a lot of the political environment that was going on in Europe was going to settle down, that they went back to work. And so we're watching it very closely. But I do believe that our forward forecast is correct as we know it today.

--------------------------------------------------------------------------------

Joseph Michael Grabowski, Robert W. Baird & Co. Incorporated, Research Division - Associate [16]

--------------------------------------------------------------------------------

Got it. Okay. And then circling back again on the strategic exits, the $55 million of strategic exits, I'm just curious, will those actually be sort of backed out sort of like negative acquired sales out of the core sales calculation or will there sort of be a core sales calculation and then an adjusted core sales calculation, like an adjustment on the waterfall chart, but actually the reported core sales will be less than the guidance that was provided, if that makes sense?

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [17]

--------------------------------------------------------------------------------

So we'll always -- will going forward will show a report core sales on an equivalent basis to the guidance. The strategic exits we will adjust out of our core sales number that we give you and we'll try to be clear with that even in our reporting. So just like we did on these bridges, we'll start with the strategic exits and then we'll go forward with what we call really the go forward business and the core activity there.

And then just a little more color on the strategic exits. When you look at product, that product number, which is $20 million or $30 million, that will happen somewhat evenly over the quarters. The service number will be about the same until Q3, with Q4 being the lowest piece of that. So that gives you some kind of spacing of how you'll see those year-over-year drops.

--------------------------------------------------------------------------------

Operator [18]

--------------------------------------------------------------------------------

Our next question is coming from Deane Dray of RBC Capital Markets.

--------------------------------------------------------------------------------

Deane Michael Dray, RBC Capital Markets, LLC, Research Division - MD & Senior Analyst [19]

--------------------------------------------------------------------------------

I was hoping you can go through the expectations regarding stranded cost after the EC&S sale? The pace of ramping down, where's corporate cost today and what should it look like in the exit, either midyear, next year, or year-end?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [20]

--------------------------------------------------------------------------------

Sure. So we started talking about last quarter, this $13 million of "EC&S stranded cost." What we've assumed in the guide is we'll have a fourth quarter close at the transaction. That means business as usual, we'll incur about $4 million of cost that would otherwise be allocated to the EC&S business. For the remainder of the year, we've assumed that $9 million we will either get direct reimbursement from -- through the transition services agreement, and as those services are no longer required, the cost will either go down naturally or we'll take the actions to eliminate those costs. So from a year perspective, where last year we reflected $13 million of those EC&S cost, we expect only to see $4 million for the year included in the continuing operations.

As far as corporate cost, as we talked last call, we've got restructuring activity. We're working through those for standalone company. We still have opportunities from a corporate perspective, but you still seeing in our guide roughly $30 million of corporate cost, which is basically flat to last year. As we continue to migrate through the TSA, we'll be able to take some of those structural moves that align our corporate structure to a smaller business. It will come out of the $13 million we expect. By the end of the year, it's fully gone. And by the end of the year, we'll be in a position, as those services stop, to start to level set on our corporate structure, and should there be charges associated with that, we will announce them on a go-forward basis. But right now, the guide assumes $30 million and $4 million of stranded ECS cost.

--------------------------------------------------------------------------------

Deane Michael Dray, RBC Capital Markets, LLC, Research Division - MD & Senior Analyst [21]

--------------------------------------------------------------------------------

That's really helpful detail. And then if we just circle back on the 2020 look, maybe next layer of detail on what you're basing the market growth on, is this a bottom up by your 13 verticals? How did you land at that range? And then the basis for the 200 basis of out growth that you're expecting?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [22]

--------------------------------------------------------------------------------

So what we always do, Dean, is we start with a bottom up forecast to gauge from a country manager all the way to a region of what they believe that the market is going to look like. We also look sequentially at the run rates of orders and look at those trends of where those orders rates have landed. And then third, I look at the macroeconomics. I spend a lot of time on the macros coming out of the mineral industries -- industry for a long time. You had to do that and I've kind of carried that forward with this company. And when you bring those all together, you start looking at Opt from a corporate standpoint of what we think it's going to be from a macro. And as you build it up from the bottom, you can see it from their level. And then you come to the middle where we've landed.

So then you think about, okay, how do you beat the market by about 200 basis points? What are the elements of a company that's capable of doing that? And over the past 3 years, we've built a pretty effective sales force now. We have sales goals down to a salesman level all over the world. We know who achieves. We know where we have weak areas. For the first time ever, we really started working through our distribution development and where we have blank spots. So our capability of dealer support, dealer development, channel expansion as well as sales is better -- is good as it's been in a long, long time. And then when you have got an array of new products coming out, and I can name a lot of companies that do extremely well in that regard, new products will help balance a soft market because it builds excitement and a desire from your customers that helps offset that. So when you pull all that together, that's how we expect to outperform. And we've shown that we can do that.

--------------------------------------------------------------------------------

Operator [23]

--------------------------------------------------------------------------------

Our next question is coming from Ann Duignan of JPMorgan.

--------------------------------------------------------------------------------

Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [24]

--------------------------------------------------------------------------------

If we went back to Slide 13, where you have the breakdown of tools, heavy lifting and service, if we put that into the pie chart looking into 2020, what is the mix of the ongoing business?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [25]

--------------------------------------------------------------------------------

Just a second, Ann, we're flipping pages.

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [26]

--------------------------------------------------------------------------------

I think it's about the same as we turn to the page.

--------------------------------------------------------------------------------

Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [27]

--------------------------------------------------------------------------------

Yes. But what -- this is by quarter, just -- is that what, 20% service? 10% heavy lift? And rest is tools? Is that about right?

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [28]

--------------------------------------------------------------------------------

So we talk about it in terms of products, and 75% products and 25% service roughly.

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [29]

--------------------------------------------------------------------------------

Ann, if you refer to the chart on Slide 4, which was really the profile of business today, and so 73%, roughly, is all product sales, including the Cortland business. So 73% are generally high-margin products. Now there are certainly the [road] product, which is within Cortland just lower margin, but the medical side of that is definitely -- category is a high margin product. But the remainder is all high value, high-margin tools.

The other piece I want to point out is that within our service revenue, we have this thing called rental. And we have a large tool rental fleet, which is quite profitable. And we rent it in two ways. It's equipment that goes out with our service rep, and it's equipment that goes out to a customer that they're just simply going to rent from us. That has a very, very attractive margin profile as well. So my comments in my opening statement is very true that the 80% plus of our revenue comes from product and rental that is quite high margin. And that's a very unique place to be. And it's something that one of the reasons why I believe our tool company now is well-positioned.

--------------------------------------------------------------------------------

Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [30]

--------------------------------------------------------------------------------

Yes. That wasn't really my point. Randy, of the tools business, remind us also because so many things have changed, what percent of the tools business is direct versus distribution? Is it all distribution?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [31]

--------------------------------------------------------------------------------

Yes. A high, high percentage is distribution. We have 2,000 dealers with over 4,000 points of sale. Of those 2,000 deaders, they're going to address many, many verticals of the 13 that we talked about. We have essentially I think between 15 to 20 company stores that will primarily be rental and service dispatch points. We did do a grand opening of our first full-blown retail center in Deer Park, Texas, where we are actually running the entire Enerpac tool portfolio through that store. And that's our test case of developing a true retail center. And the most important thing, it's not in competition with our distributions, it's filling in white space that not necessarily is covered well and also creates a very, very good supplemental service to distributors that surround that contiguous trade area. I've seen it in my past with other companies very effectively done, but I think the strength of our company really is always -- it has been in our distribution channels, taken Enerpac 50-plus years to develop that strength in that channel and something that gives us the ability to serve all those vertical industries.

--------------------------------------------------------------------------------

Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [32]

--------------------------------------------------------------------------------

Okay. And remind us the mix geographically now of the tools business overall?

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [33]

--------------------------------------------------------------------------------

About 50% North America, 30% Europe-ish.

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [34]

--------------------------------------------------------------------------------

Yes. And the remainder is Latin America, Asia. Certainly, we'll provide the new fact sheet that will give the regional breakdown for the Investor Day. But fractionally that's about what it is.

--------------------------------------------------------------------------------

Operator [35]

--------------------------------------------------------------------------------

Our next question is coming from Justin Bergner of Gabelli & Company.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [36]

--------------------------------------------------------------------------------

I wanted to just better understand the businesses you're exiting. Would it be possible for you to provide a specific EBITDA number or talk about what would be your expected margin improvement if you don't exclude the $55 million of exits when looking at your fiscal year 2020 guide?

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [37]

--------------------------------------------------------------------------------

The -- we'll do margin by product. But the $55 million, as I mentioned, came with little to no profitability. So you look at the bridge, I think we have given our profit rate, in the bridge we give the impact of the exits. And so the...

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [38]

--------------------------------------------------------------------------------

Just stay with us, Justin. We're trying to make sure we get you the right answer.

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [39]

--------------------------------------------------------------------------------

So there's very profitability in there. And as we said, there's a 200 basis point improvement, and that's largely driven by removing those sales. But no, no OP. And so that's really the basis, without getting into EBITDA by product line. So that combined with the $13 million of year-over-year EC&S cost really drive that improvement.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [40]

--------------------------------------------------------------------------------

Okay. So no OP, maybe a little EBITDA, sort of...

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [41]

--------------------------------------------------------------------------------

Yes. Definitely.

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [42]

--------------------------------------------------------------------------------

Yes. Exactly.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [43]

--------------------------------------------------------------------------------

Okay. And then my other question was on cash flow. I mean I understand that free cash flow in 2020 is making up for some of the shortfall in 2019, and you can adjust for that for the working capital, but how much cash restructuring was in 2019 in your 2020 guide? And then is the $10 million of CapEx a normal run rate, sub-2% of sales, CapEx or is -- should we think of something higher as we look out past this current fiscal year?

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [44]

--------------------------------------------------------------------------------

So the CapEx number is definitely a normalized number. And we don't foresee in the short term any real drivers to get us anything but that. When you look at cash restructuring, we kind of assumed maybe approximately 10-ish -- $10 million for cash restructuring for the year and then about $5 million was in 2019.

--------------------------------------------------------------------------------

Operator [45]

--------------------------------------------------------------------------------

(Operator Instructions) Our next question is coming from the line of Mig Dobre of Robert W. Baird.

--------------------------------------------------------------------------------

Joseph Michael Grabowski, Robert W. Baird & Co. Incorporated, Research Division - Associate [46]

--------------------------------------------------------------------------------

It's Joe, again. I wanted to ask about M&A. Thoughts on M&A for the upcoming fiscal year? What's the pipeline look like? And did you expect there'll be some M&A activity during the year or is fiscal year '20 going to be more a year of kind of internal organization after the business sale?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [47]

--------------------------------------------------------------------------------

Well, we've been working really hard to build the pipeline because what we wanted to do was be able to look at our product families, be really investing on the organic growth side for the last couple of years to get products coming out. But areas that we didn't feel we have the ability, the time or the expense of doing it internally, we've been building a pretty significant pipeline of M&A. So in 2020, you will see some M&A activity. I want to stress, we're going to be very, very cautious about it. We'll make sure that the company is of the quality that we want, that's firmly within the verticals that we want and that we believe really advance not only our technology but in fact brings in some either distribution or in other aspects that can advance the company. So we're actively working on it right now, but I don't want any investor to go away thinking that we're going to make a bad decision that would repeat something that they're worried about. And so I'm very disciplined on how we look at M&A, and I'm very picky on the types of companies. And quite honestly, if they're not on our worksheet of target businesses and product lines, I'm probably not interested. So just stick with us on this for a couple of quarters, you'll see more on that later on.

--------------------------------------------------------------------------------

Joseph Michael Grabowski, Robert W. Baird & Co. Incorporated, Research Division - Associate [48]

--------------------------------------------------------------------------------

Great. I'm sure everyone's glad to hear that. And then if I could maybe just sneak in just one last one, I'm sure this is going to be covered at the upcoming Investor Day, but I thought I'd just throw it out here. The 20% long term EBITDA margin goal versus the 17% EBITDA margin guidance for fiscal year '20, what is the take to capture those additional 300 basis points and maybe kind of how long will it take to get there?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [49]

--------------------------------------------------------------------------------

Well, Rick's going to give you -- it's kind of a walk and I'll just give you the top-level view on that. We have felt and know very well that we can get to that 20%. We've operated there in the past, the Enerpac Tool Group. If you recall back to Q3, it's just Enerpac was in the mid-20s. So we know as we go through the transition services agreement, we exit those cost, which as Rick mentioned, there's $9 million of billable, there's about $4 million worth of sunk cost because it will be preclosure. So that's a headwind that you can't really do much about in the short term, but in the long term, it's going with the transaction.

And then obviously, we look at the corporate expenses to align this company with the structure of a smaller business, which we're doing. And then as we've also been working through our actions in Q3, which was to take out unnecessary business functions in the tool company, was also prep work for that. So I hope I haven't taken everything away from Rick's comments, but I would flip it over to him.

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [50]

--------------------------------------------------------------------------------

No. It's a similar discussion, you're right, we'll going into this in more detail, but if you just look at the incremental $4 million, you take kind of the midpoint of our guide, look at the incremental $4 million of savings from EC&S, you look at total run rate savings of the $15 million of savings we talked about from the service restructuring, you look at -- Randy talked about streamlining and improving the operation of the Cortland business as well as exiting some of these noncore product lines, all of those things together will get us essentially to the 20%, but we're not done. And so that doesn't capture the taking a hard look at the corporate cost needed to run a business of our size and scale. So we believe clear line of sight to '20, the goal is to exceed that and we're collecting all of the actions we can stage here post-sale to kind of rightsize the structure of the organization. More to come.

--------------------------------------------------------------------------------

Operator [51]

--------------------------------------------------------------------------------

Our next question is coming from Justin Bergner of Gabelli & Company.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [52]

--------------------------------------------------------------------------------

And most of it was answered in the prior set of questions. In regards to the 20% target, it seems like you have confidence that you can do better than that because there was an expectation before that you could get to or close to 20% even inclusive of the $55 million of low profitability business that is being divested. Is that a fair conclusion?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [53]

--------------------------------------------------------------------------------

Yes. I think the $55 million was not an action required to get to the 20%. It certainly -- it helps accelerate that. But as I said and maybe I'm being too blunt, we do not want businesses that don't make money. We will place them with strategic owners that can place them with similar businesses that can make money, and it's better for the employee and it's certainly better for us. So the $55 million was not a catalyst in order to get to the 20%. That $55 million helps us get beyond there and clearly sets the stage for the Enerpac Tool Group to be a truly high-quality and pure-play tool company and subsea connectors are not tools. Screw jacks for lifting systems, for OEMs is not tools. And tie rod cylinders are components that are sold to all sorts of suppliers all over the world. That is not tools. It takes management oversight, it takes cash and it takes investment to run those types of businesses. And as I said on the divestiture of the other companies, if you cannot or are unwilling to invest in it, you shouldn't own it. And so the monetization of those small businesses brings in some cash and it helps make us a truly high-quality tool company.

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [54]

--------------------------------------------------------------------------------

So if you think back to Q3, similar questions on how we get to the 20%, at that point, fiscal 2019 includes 3 quarters and a couple of months of all $55 million, and we were able to walk you through the 20%. So the $55 million coming out doesn't -- is it needed to get to the 20%? It is reflective of how you get over the 20%. And there's more actions we can take to exceed the 20% as well. So that walk I just did didn't change from Q3, with the caveat that we can get even better just like we were at Q3.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [55]

--------------------------------------------------------------------------------

Okay. And then lastly on that service restructuring piece, I mean you've spoken about the $4 million, but you can obviously add that back to the EBITDA guide, but the service restructuring piece, how much sort of flows over beyond fiscal year 2020? Or how much of run rate is not captured in fiscal year '20?

--------------------------------------------------------------------------------

Ricky T. Dillon, Actuant Corporation - Executive VP & CFO [56]

--------------------------------------------------------------------------------

Sure. There's about $8 million of it in our plan. We said $12 million to $15 million, so you got $3 million to $4 million incremental that's not captured in '20.

--------------------------------------------------------------------------------

Operator [57]

--------------------------------------------------------------------------------

Our next question is coming from Ann Duignan of JPMorgan.

--------------------------------------------------------------------------------

Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [58]

--------------------------------------------------------------------------------

I'm surprised that everybody is so focused on the 20% EBITDA margin. I mean I know it's an important metric for us to look at, but Randy, you also committed to $600 million in free cash flow by 2021 (inaudible). If you make the 2020 numbers will be at $127 million, roughly. I mean what's the lesson learned there? I mean that's much more important because that's money you could have allocated to growth or share repurchase or whatever? And 20% margin on a much lower number is maybe not what investors were expecting?

--------------------------------------------------------------------------------

Randal Wayne Baker, Actuant Corporation - President, CEO & Director [59]

--------------------------------------------------------------------------------

So let's try to frame up our strategy going forward. So in our Investor Day that will come up, we will give the profile of cash generation going forward. Now one very important thing to remember about the remainder of Actuant, Actuant in its original state, that where did the cash come from? A large percentage of it came from our tool group, very, very large percentage. And so if you think about the numbers that we reported today and the numbers reported last year in terms of free cash flow and what we've just guided today between $50 million and $75 million, the alignment of that is quite close.

Now as I've said, if we were to keep the EC&S business and keep flowing forward to try to execute to a diversified industrial strategy, then we would have had to deploy significant amount of cash to those businesses that we retained, which was fundamental to the separation of the company and going to a pure-play tool business was that very fundamental strategy that we did not believe investing more in businesses that weren't going to have the same returns was unwise. So that's why when we think about the strategy going forward, and you do the modeling of the new Enerpac Tool Group, you wind up looking at a very compelling profile that says that you've now got a business, as we reported today, of liquidity of somewhere north of $200 million of cash on hand, a debt-to-EBITDA ratio of 1.7, margin profiles that at the final run rate postseparation that will be at or greater than 20%. Gross margin on all products that are extremely high. You can't say everything is above 50% because there's pieces in Cortland, but very high percentage of everything we sell is above 50%.

There is very little that I can think about if you were going to rate high-quality companies of great balance sheet, great margin profile, less cyclicality and a strategy on how to bring in strategic acquisitions and then have started to build a track record for organic growth, that's exactly how we want to run our company. So realize that it's a departure from the original strategy, but I think this strategy is going to deliver much better TSR over the next 10-year profile.

--------------------------------------------------------------------------------

Operator [60]

--------------------------------------------------------------------------------

At this time, I'd like to turn the floor back over to management for any additional or closing comments.

--------------------------------------------------------------------------------

Barbara G. Bolens, Actuant Corporation - VP of Corporate Strategy, IR & Communications [61]

--------------------------------------------------------------------------------

Thank you, everybody, for joining us today. As we mentioned in the call, we will be scheduling an Investor Day later this year, and we will be back in touch and send out the formal invitations once we have solidified that date. Thanks, again, for your interest in the Enerpac Tool Group.

--------------------------------------------------------------------------------

Operator [62]

--------------------------------------------------------------------------------

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time, and have a wonderful day.