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Briggs & Stratton Corporation (NYSE: BGG)
Q4 2018 Briggs & Stratton Corp Earnings Call
Aug. 16, 2018, 2 p.m. EDT

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Christine, and I will be your conference operator today. At this time, I would like to welcome everyone to the analyst earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star then the No. 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Mark Schwertfeger, you may begin your conference.

Mark Schwertfeger -- Chief Financial Officer

Good morning, and welcome to the Briggs & Stratton's Fiscal 2018 Fourth-Quarter Earnings Conference Call. I'm Mark Schwertfeger, chief financial officer, and joining 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.

The 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 yesterday's earnings release, as well as our filings with the SEC. We will 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. Yesterday, we reported fiscal 2018, and fiscal fourth-quarter and full-year results, which were highlighted by record commercial sales, significant progress on our business optimization initiatives, and increasingly efficient operations. While we encountered some temporary significant headwinds in the second half of the year, our results demonstrate the success of our diversification and optimization strategies, which will support more sustained long-term growth, higher profitability, and increasing capital returns.

The underlying fundamentals of our business and competitive position remains strong, which give us optimism for the future. For the quarter, net sales advanced 5.8% on the strength of our commercial job site products and commercial engines, also with favorable contributions from Ferris commercial mowers as grass-growing conditions improve, and higher generator sales. We're very pleased with the increasing success of our commercial initiatives. For the year, sales of commercial products and engines increased 16% and represented 27% of total sales, up from 24% a year ago and posting compound annual growth of 14.5% over the past five years. These results demonstrate that we're consistently winning share with innovative products that deliver the reliability and performance that help the professional get work done.

This richer mix of business contributed to increased profitability. For the quarter, adjusted gross margin was up overall, with increases in both business segments. Our culture of continuous improvement also contributed to this favorable result and adjusted earnings of $0.47 per share.

Importantly, we have achieved much toward our strategic goals. Our business optimization program is on plan, and we are on target to achieve $30 million to $35 million in projected cost savings by fiscal 2021. I want to thank all of those involved for the success of these important initiatives, which will increasingly contribute to growth and profitability in fiscal 2019 and beyond. First, part production began at our Ferris commercial mower facility. This modern operation provides much-needed capacity for growth and improves efficiency. Quality has remained high since beginning production in May, thanks to our skilled workforce. We're on track to transition the remainder of production to the new plant in the first half of fiscal 2019.

Second, in early July, we successfully went live with our ERP upgrade. Thanks to the hard work of our entire team, the overall business ramp-up has gone according to our plan. This milestone is an important step on our pathway to simplify and streamline processes, improve data integrity, and make it easier for our customers and suppliers to do business with us. Third, also in July, we began production of Vanguard commercial engines in the United States, set for full transition during the second half of fiscal 2019. The onshoring will move commercial engine production closer to our customers to improve response time while maintaining the quality and performance Vanguard engines are known for.

The transition also will result in better utilization of our capacity as it converts existing production capacity of residential engines to the production of higher-margin commercial engines. Placement of our Vanguard commercial engines remains solidly on track. Our recently introduced line of horizontal shaft engines is experiencing strong customer demand and expanding our presence in power products for construction and infrastructure applications around the globe. While pleased with the progress and execution on our business, we also encountered headwinds that restricted results in the fourth quarter and the second half of fiscal 2018.

Let me address the issues and provide an update. First, the prolonged cold and wet spring significantly delayed the start of the grass-growing season. While the retail market had a nice rebound in the latter half of the fourth quarter, it was not enough to overcome the slow start to the season for our sales. In fact, we estimate that the U.S. residential mower market was down mid-single digits through the end of June. Overall, cutting conditions remained strong across the grass-growing regions of the U.S., which has set up fairly solid late-season sales similar to a year ago.

Second, channel partners continued to reduce inventories in the Fourth Quarter in part related to the high degree of anticipated brand transition in the upcoming year. While creating a near-term constraint, inventories are now at unsustainably low levels across the retail channel. Line reviews are not yet complete for the upcoming season, but overall, discussions with channel partners and the progress we have made to date -- including certain reviews that are or near completion -- give us confidence that we will maintain our market-leading residential engine placement for the upcoming lawn-and-garden season. This includes line reviews of the retailers who are undertaking the most significant brand transition.

Our outlook contemplates a stronger year ahead for the outdoor power equipment category with a move toward a more normal season. Consumers continue to recognize the Briggs & Stratton brands for its reliability and innovation, that delivers features to make outdoor work safer and easier. Our power solutions continue to offer a compelling value proposition, and third as we mentioned in our Third Quarter call, certain channel partners in Europe moved quickly to transition their inventories to products that are compliant with new stage five emission standards.

The inventory reduction is now substantially complete and we are fully capable of providing product that meets the new standard. Unlike in the U.S. however, lawn cutting conditions across much of Europe have tempered somewhat throughout the summer months, due to high temperatures and low rainfall. While conditions have improved as of late the dry weather has somewhat softened late season sales. In summary, in the face of transitory market headwinds, we executed very well across multiple dimensions of our business in Fiscal 2018.

In commercial, we now have stronger channels and a larger line of innovative products to support sustainable growth into the future, including commercial products from an asset acquisitions of ground logic and hurricane. In addition, we are confident that we have maintained our leading share in residential, as the most trusted name of delivering power word is needed to get the job done. Supporting this favorable outlook we bought back $10 million of stock throughout the course of Fiscal 2018. Now, here's Mark, he will provide details on our financial results for the fiscal Fourth Quarter and our outlook for Fiscal 2019.

Mark Schwertfeger -- Chief Financial Officer

Thanks, Todd. I'll begin by touching on some highlights the financial results. Fourth-quarter gap consolidated net loss of $11.8 million included $8.3 million in pre-tax charges related to business optimization costs, $200,000 in pre-tax debt repurchase costs, a pre-tax pension settlement charge of $41.2 million and $3.1 million benefit from refining our tax reform implementation charge.

Excluding these items, our Fourth Quarter adjusted net income was $20.1 million or $0.47 per diluted share, $0.01 ahead of last year's adjusted earnings per share. The Engine segment incurred $46.7 million of pre-tax business optimization charges and the pension settlement charge and the product segment incurred $2.9 million in pre-tax business optimization charges. The $41.2 million non-cash pension settlement charge we recorded in the fourth quarter, related to a transaction we successfully completed to de-risk our pension plan.

This involves transferring $100 million of pension obligation and the offsetting assets for approximately 2,400 retired pensioners to a third-party insurance company. The transaction lowered our pension obligation by 9% and lowered the risk of funding and expense volatility going forward. In conjunction with the transaction, we made a $30 million voluntary contribution to the pension plan in the third quarter.

Based on current estimates, we do not expect any required pension contributions until fiscal 2022. We recorded an affect adjusted effective tax rate of 23% in the fourth quarter, which was favorable to what we had anticipated. The favorability was attributed to a tax planning project we were able to complete during the quarter, as well as favorable adjustments related to the filing of state tax returns during the quarter. Quarterly net sales for the engine segment were $276 million, down $17 million or 6% from the prior year.

Engine unit sales were approximately 1.6 million, a decrease of 17% or 325,000 engines. As Todd mentioned in his opening remarks, the delayed start to gross cutting in inventory reductions in the channel drove the decline. Despite a rebound in market activity midway through the Fourth Quarter, we did not see significant engine reorders as channel partners continue to manage their inventory closely.

A more favorable mix of business with higher sales of Vanguard commercial engines and timing of service part sales partially offset the weakness in shipment of residential engines. Adjusted gross profit margin for engine increased a 120 basis points to 25.4% from a year ago. The more favorable sales mix, the higher shipments of Vanguard commercial engines on service parts, as well as higher pricing in the impact of manufacturing efficiencies, more than offset a 16% decrease in production volume, higher pricing offset, higher material costs.

Total engine inventories at the end of the quarter were approximately 1.7 million units, an increase of approximately 200,000 units or 13% from the end of the Fourth Quarter a year ago. The higher inventories positioned us adequately for an elongated shutdown period in July to facilitate the go-live of our upgraded ERP system.

Engine segment adjusted ESG&A increased $5.5 million from the Fourth Quarter of fiscal 2017, primarily related to the timing of incentive compensation costs, higher marketing expenditures, and investment in our ERP upgrade. Engine segment adjusted segment income was $20.8 million down from $26.9 million for the prior year's Fourth Quarter.

For the products segment, Fourth Quarter net sales increased 23% to $250 million. Sales of our Allmand commercial job site products were particularly strong as we made further progress in developing business through the rental channels. Ferris Brand Commercial Mowers, Pressure Washers and Generators also had strong growth for the quarter. Adjusted gross profit margin in the products segment was 16.2% increased 140 basis points and improved sales mix of more commercial products as well as the benefit of higher production volumes.

Higher pricing offsets higher material costs. Higher freight costs partially offset the benefits of a richer mix and higher pricing. Product segment adjusted SG&A expenses increased $2.9 million, from higher compensation expense, primarily related to incentive compensation in addition to higher costs associated with growing commercial offerings.

On a full year basis, our products segment achieved adjusted operating margins of 3.3% which reflects an improvement of a 170 basis points from last year's operating margins. This was strong progress in advancing toward our targeted margins of 68%. Our balance sheet remains strong. Net debt at the end of the fiscal year was approximately $204 million, which was $43 million higher than last year.

The higher net debt resulted from elevated capital spend in support of our business optimization initiatives, as well as, the voluntary pension contribution. Cash flow remains strong.

Last 12-months cash provided by operating activities totaled $93 million, including the $30 million voluntary contribution to the pension fund, which occurred in the Third Quarter. As a result, last 12-months free cash flow was approximately negative $10 million and elevated capital expenditures of $103 million, to fund our investment and business optimization. For Fiscal 2019, we project a 35% to 40% reduction in capital expenditures to approximately $65 million.

At the end of the quarter last 12-month average funded debt was $314 million. In last 12-month EBITDA was $175 million, both as defined by our credit agreement, resulting in a leverage ratio of a modest 1.8 times, which is well within our debt covenants. Before I turn the call back over to Todd for his closing remarks, let me spend a moment on our outlook for Fiscal 2019.

For fiscal year 2019, we expect sales in the range of $1.93 billion to $1.99 billion, up 7% from Fiscal 2018 excluding an estimated $55 million in storm-related sales in Fiscal 2018. Our Fiscal 2019 outlook does not include hurricanes. Outlook contemplates mid-single digit market growth and commercial products and further share gains, as well as, 3% to 5% growth in residential sales before price increases, with a movement toward more normal spring weather, in some increase in share inventories, both in the U.S. and Europe.

The benefit of our recent bolt-on commercial acquisitions of hurricane and ground logic are expected to add approximately $8 million to $10 million in net sales. We will implement price increases of approximately 1% to 2% combined with efficiency improvements and product cost reductions to offset expected material and freight cost increases. Included in the price increases are planned surcharges to offset an estimated impact of $10 million pre-tax for the section 301 Ferris implemented in July and August.

We expect unfavorable foreign exchange primarily due to the euro as well as the dry summer conditions to have an unfavorable impact on engine segment net sales of $10 million to $15 million. We expect this amount to be offset in our products segment by higher sales of our end products into Australia in the upcoming year following the difficult growing conditions this past season. Operating margins before business optimization and acquisition charges are expected to be in a range of 5.3% to 5.5%. An improvement from the 5.1% margins earned in Fiscal 2018. Operating margins are expected to improve unfavorable sales mix from growth of higher-margin commercial products.

We expect to use a portion of the efficiency gains that would have otherwise been accretive to operating margins to offset a portion of material and freight cost increases. We estimate the impact of this to be worth 60 basis points of operating margin or $0.20 per diluted share. We also plan to produce approximately 150 less engines in Fiscal 2019 compared to Fiscal 2018. This will enable us to reduce inventories from the elevated levels at the end of Fiscal 18. We plan to reduce consolidated inventories by $15 million to $20 million the end of Fiscal 2019.

We are pleased to begin our first year of achieving savings from our business optimization programs. We expect Fiscal 2019 savings to be $6 million to $8 million which is in line with our expectations. I hope that contemplates an effective tax rate of 24% to 26% in 2019, which reflects our first four year under U.S. tax reform. We now estimate that our go-forward effective tax rate under tax reform will be closer to 26% compared to the 27% we had previously estimated.

Favorable regional earnings mix is expected to drive the rate slightly lower than 26% in Fiscal 2019. For the full year, we expect diluted earnings-per-share to be in the range of $1.35 to $1.55 times per diluted share. Before business optimization charges, acquisition costs and the benefit of any stock repurchases. The midpoint of this range implies 9% over the EPS of $1.31 for Fiscal 2018, an increase of over 25% excluding storm-related generator sales in Fiscal 2018. Remember we do not forecast hurricane activity. I would also like to comment briefly on a couple of items to keep in mind regarding the first-quarter of 2019.

First, the First Quarter of Fiscal 2018 included storm-related sales of $35 million and approximately $0.10 per share. As previously mentioned, the 2019 outlook does not anticipate hurricanes. Second, our Fourth Quarter of 2018 included a modest acceleration of sales to ensure customers were adequately covered during the first week of July when our shipments were suspended for the go-live of our ERP upgrade. In addition, we resumed production of our engine plants a week later than normal this July, in order to help facilitate a smooth ramp up post go-live.

Therefore, we expect lower engine sales and production in the First Quarter of 2019 compared to a year ago. This is expected to have an unfavorable impact on our first-quarter 2019 results of approximately $3 million to $4 million before taxes or $0.05 to $0.07 per share.

Lastly, we will be adopting two new accounting standards in the First Quarter of Fiscal 2019. The first is the new revenue recognition standard, ASC 606. We do not expect the adoption of this standard to have a material impact to our financial statements. Second, we'll be adopting a new standard that impacts the geography of where we report a portion of pension expense on our income statement. Pension costs other than service costs will be reported in other income instead of operating income where they have historically been reported. This presentation change will shift $2 million of expense from operating income to below the line in other income. Now, let me turn the call back over to Todd for some closing remarks.

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

Thanks, Mark. We're into 2019, a stronger and more capable company in a solid financial position. Our diversification strategy is delivering high growth and share gains and attractive commercial end markets. Professionals in turf and landscaping, infrastructure, and other industries are recognizing the value we provide in innovative power solutions that maximize uptime where and when it is needed. In residential, we continue to maintain our global leadership position with products and engines that make work easier at compelling value propositions. New products and features now in the pipeline will enhance our competitive position even further as we build a broader portfolio to reach new customers and serve more applications.

In Fiscal 2019, acquisitions will continue to be an important focus in advancing our strategy. In addition to the ride-on spreaders and sprayers we acquired in the Fiscal 2019 ground logic acquisition, the recently completed acquisition of hurricane brings commercial stand-on blowers to our product offering for the professional lawn care industry. With strong and unique intellectual property, hurricane's products give us another line of innovative products in our growth roadmap and further filling out the landscaper's trailer with commercial turf and lawn care products. Now, with financial leverage of only 1.8 times, we have ample capacity to pursue additional acquisitions of products and technologies to enhance growth and returns.

We will however remain disciplined, responsible stewards of capital with the goal of allocating capital to those investments that deliver the highest risk-adjusted returns. Internally, the significant progress made on our business optimization initiatives will begin to deliver benefits in Fiscal 2019. Much needed and more efficient commercial more capacity is now online. With the ERP upgrade now live, we will be streamlining processes to improve efficiencies. The on-shoring of commercial engines increases production of higher-margin commercial products and moves production closer to our primary customer base. With great progress in Fiscal 2019, we will continue to focus on initiatives in four key areas to create value, accelerate growth and diversity in some targeted commercial areas, maintain share in residential engines and improve profitability, execute on the business optimization program, and drive operational excellence.We remain on track with all dimensions of the strategic framework.

We finish by thanking our employees for their hard work and commitment on achieving our goals and positioning the company for growth and higher capital returns. There is a lot of work to be done this past year, especially with the ERP system upgrade and footprint changes. The team executed very well. I couldn't be more proud of what they've accomplished. Thank you for listening, and now we'll open the call for questions.

Questions and Answers:

Operator

At this time, I'd like to remind everyone, in order to ask a question, please press star then the No. 1 on your telephone keypad. Again, that's star then the No. 1 on your telephone keypad. Your first question comes from the line of Sam Darkatsh. Sam, you may begin.

Sam Darkatsh -- Raymond James -- Analyst

Good morning, Todd. Good morning, Mark. How are you?

Mark Schwertfeger -- Chief Financial Officer

Good morning.

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

How are you, Sam?

Sam Darkatsh -- Raymond James -- Analyst

Nice solid quarter with a very challenging operating backdrop. I got a couple of questions here. First, a clarification, Mark, with respect to the first fiscal quarter coming up. Should we just assume, then, that you have about $0.15 to $0.17 of headwinds on a year-on-year basis, and then just assume that that's where your thinking is versus their loss of $0.27 of last year? Or are there other moving parts also, besides just the storm comparison and the lower engine sales and production?

Mark Schwertfeger -- Chief Financial Officer

Yeah, I think that you captured a couple of the big one. The other thing to keep in mind, too, is with the new lower tax rate, we typically operate in a loss in the first quarter. And so, that has the opposite impact of what a lower tax rate will benefit. Otherwise, I think what you said is right on.

Sam Darkatsh -- Raymond James -- Analyst

Okay, thank you. Then Todd, the commercial growth has been terrific and I see that it looks like not only are you anticipating that the commercial industry will be up mid-single, but that your share gains are going to continue. Trying to figure out how conservative or reasonable it is to expect to that kind of mid-teens growth over and above the industry from your commercial line off of a very good year in fiscal '18. Could you help us understand as to why you have such confidence with that kind of market outgrowth, if you could?

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

Sure. So, let me go -- and,Sam, back up for one second to sales overall. So I think there's a couple of puts and takes that you just have to remember when you look at the overall sales growth, and then I'll touch on the commercial side. The first thing you got to remember is that we're coming off of the year where the weather, we told you guys that the weather, we thought, was going to have an impact of up to $40 million. And I think we're pretty close with the impact that the weather had in fiscal '18. Then you got to remember with the inventory destocking that went on over the last couple of years, actually, these inventory levels are at low levels.

Then remember the other thing to consider is that we did just comment about the price increases that are going through to offset some of these commodity and freight costs and everything else. So, you got to think about it that way in terms of, there's a lot of different puts and takes overall. Then as you pointed out, there is very strong commercial sales. So, couple of things there. One is, remember that we did the two acquisitions that -- I'm not sure we told everybody what the impact of that was going to be until now we just did. So it's in the neighborhood of $8 million to $10 million. So that helps, but that's acquisition top line, but it's helpful.

The other things that are going on when you look at the commercial business, then, more on an organic basis, we do have some pricing that's going through there that's included in the overall 1% to 2% because we do see commodity costs, especially steel in that part of the business, so there would be some lift off of that. Then you look at where we're at with the individual areas. So, for example, when you look at the light power business and the industrial heater business, our job site business, we've seen nice rental growth from the standpoint of infrastructure projects and everything else.

We still think that there's more tailwinds as it relates to oil and gas. And so remember, when we bought Allmand three-plus years ago, that was heavy in the oil and gas, and it didn't have a whole lot in necessarily some of the other areas that would benefit from those products. Well, we've now had the opportunity to pivot to those products, which is why we've seen nice growth. We anticipate nice growth from that area as well, and then oil and gas, with some tailwinds coming there, I think will be helpful. Then the other thing to think about is on the commercial mowers side. The commercial mowers, they weren't quite as robust as we had hoped, although we did see some really -- we believe we gained some share with Ferris this past year.

So, the overall market wasn't quite as robust as perhaps it otherwise could have been, so we do think that there will be some nice lift in the market, and then we're coming out with some new products along the way. So on the Ferris side, we'll have some new things coming out. And then you got to remember, the other thing we have going on, on the Vanguard engine side, is this new line of horizontal shells that really -- we soft-launched, if you will, in '18. And now we're starting to get some really very, very good traction along the way on the single cylinders, as well as some of the tailwinds that we're now starting to make here in the U.S.

So you look at it, it's been 14.5% compound annual growth rate over the last five years. As we both know, that gets harder as the number gets bigger. But when you look at where we're at it's over $500 million, and we think that between the acquisition growth and then a lot of the puts and takes I just talked about, we're feeling pretty good about where our commercial businesses is at these days.

Sam Darkatsh -- Raymond James -- Analyst

Very comprehensive answer. thank you for that, Todd. The final question I have, the 3% to 5% residential growth that you're anticipating for fiscal '19. How much of that is from the channel restock or the absence of destock I suppose?

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

Yeah, I think I would say a little bit less than half of it is related to that. Your call on the third quarter, we took our outlook down by roughly around $30 million or so, $20 million to $30 million of our EBITDA, and so, that's what we're assuming comes back.

Sam Darkatsh -- Raymond James -- Analyst

Okay, so a point or two from the restock, a point or two from price, and then volume's kind of a point or two kind of thing?

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

Market normalization related to normal weather.

Sam Darkatsh -- Raymond James -- Analyst

Got it. Okay. Thank you gentlemen. I appreciate it.

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

Thanks, Sam.

Operator

Your next question comes from the line of Timothy Wojs. Timothy, you may proceed.

Timothy Wojs -- Baird -- Analyst

Hey, good morning guys.

Mark Schwertfeger -- Chief Financial Officer

Good morning, Tim .

Timothy Wojs -- Baird -- Analyst

So tied, I was hoping to get maybe just a little bit more color on. I know it's early but you made some comments in your prepared remarks around just the discussions that you're having with some of your channel partners to date. I just wondering if you could put a little bit more context or color around that just given a lot of the moving parts with some of the home centers and then some of your customers actually more specifically.

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

Sure Tim. So basically when you, we're not done completely with all the line reviews but the big guys started early and so we're really far down the path with you know some of the bigger home centers. And I know there's been a lot of concern in the market as it relates to some of the brand transitions that have been going on, and I can tell you that where we're at today and they're either pretty close to being done or done. We're in a really nice position. So we've at least held the placement in some of those major home centers. Again they're not all done. In fact, there's a couple that I've just started but the ones that have the major brand transitions we are feeling quite confident in terms of where we're at today.

Timothy Wojs -- Baird -- Analyst

Okay. And would you say, when you say you're kind of maintaining you know the placements, does that mean you know even though the brands are transitioning, you have the same number of kind of shelf skews? Is that the right way to think about it?

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

Yeah. That's exactly the right way to think about it.

Timothy-Timothy Wojs -- Baird -- Analyst

Okay. I got you. And is there any sort of inventory restock that helps with that or inventory push or load-in that helps or does that kind of eaten up by some of the transition.

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

No. When you look at kind how we're contemplating especially on the residential side, the 3% to 5% growth. That would contemplate the channel restock because where one retailer in particular took inventory way down to try to help with the transition. We expect that to come back in a very meaningful way. And so when you look at the growth that we're anticipating in residential's and in particular residential business, in particular residential products, some of that, as Mark pointed out, there is some of that and we haven't priced, there some of that we have in market growth, and then but a chunk of that, it has to do with channel restock. That number Mark again?

Mark Schwertfeger -- Chief Financial Officer

The channel restock is close to $20 million to $30 million of revenue.

Timothy Wojs -- Baird -- Analyst

Got you. Okay. Then just on the ERP expenses, could you remind us how much you guys spent in the P&L in Fiscal 18 and what that number looks like for Fiscal 19?

Mark Schwertfeger -- Chief Financial Officer

Yeah. It's up $4 million year-over-year which would bring it to call it around $17 million or so. What happens now going forward we want anticipate that growing what happens is your place a lot of, call it project costs with the beginning depreciating. But you capitalise as you built the system. So you would expect it to be somewhat level and just any SG&A perspective with those two factors involved and then our business optimization benefits bring into account just the start of us starting to gain the efficiency benefits to work down what incremental costs we've built and get ahead with all the process improvements as we go through the next three year period.

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

So the way to perhaps the way to think about it is we went live, we're right on plan, the team is doing a great job, and so on the first part of the year, first half of the year roughly we're working the system, we're getting efficient, we did a lot of training before hand but once you go live with it it really causes you to now figure out how we're going to most efficiently use the system. So then you get to the back half of the year and that's where the business optimization that we talked about the $6 million to $8 million, you start to see that more toward the back-half half the year especially on the granite benefits. So even though the ESG&A remains somewhat level on the ERP side, now you finally get to start to get the benefits and so we'll start to achieve the benefits more toward the last half of 19, certainly into 20 with a full run rate in 21.

Timothy Wojs -- Baird -- Analyst

Got you. Okay. Okay, that's helpful and then on the production just kind of taking out some of the inventory next year is that mostly weighted in the First Quarter mark or what kind of bleed into the second and third?

Mark Schwertfeger -- Chief Financial Officer

Yeah. I think the production volumes will be down probably most significantly in the First Quarter level, and that's where we commented them between that and sales have enough $3 million to $4 million pre-tax headwind to deal with.

Timothy Wojs -- Baird -- Analyst

Okay and then last one, just free cash flow. What's just the expected conversion in 2019. I don't think you'll make a pension contribution and capex goes down. I'm just trying to think about the working capital use and and kind of what free cash flow. Free cash flow should convert that next year.

Mark Schwertfeger -- Chief Financial Officer

Yes. I think that we should be far closer to our goal of roughly around 75% of net income, would you anticipate bringing the capex down to $65 million more run rate level, and we have that the working capital inventory improvement with our goal to take out some inventory.

A little bit offsetting that will be likely a bit higher accounts receivable just on the projected sales growth that we have contemplated. So, all those things factored in, I do think that we'll get closer to our goal at 75% conversion.

Timothy Wojs -- Baird -- Analyst

Great, we can work on a Fiscal 19. Thanks guys.

Operator

Your next question comes from the line of Tom Hayes. Tom, your line is open.

Tom Hayes -- Northcoast Research -- Analyst

Great, good morning gentlemen.

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

Good morning.

Tom Hayes -- Northcoast Research -- Analyst

Hey Todd, I was wondering maybe you could fill out a little bit more color on the recent acquisitions between Ground Logic and Hurricane Power. You mentioned filling out the track of the professional [inaudible] surprise and comments on, I guess going forward you still see more opportunities on the M&A front.

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

Yes. So, when you look at a couple of things on the Ground Logic and Hurricane acquisitions, we're really excited to bring both those product offerings into the lineup. As I said it helps fill up the trailer. A lot of folks don't fully understand what these types of products are and the chassis and things like that. It really revolves around making the landscape or much more productive. So, these are ride on spreader sprayers for example, these are ride on blower. So, these aren't things that you push around. So, the physical labor gets out of it, you basically you ride on it. If you look at the chassis, very similar to the stand on units that we make today.

So, we know how to make this stuff. We know how to make it very efficiently. So, we'll integrate that into our existing facilities. Nothing's ever easy but I will tell you that this is just a natural that team will do a great job on. So, when you think about continuing to be more productive for these landscapers, because remember with unemployment down around 4% or whatever it is. Ultimately, finding labor is a real problem for commercial businesses and commercial cutters in particular. We will continue to focus on acquisitions that allow us the opportunity to either fill out the product lineup. Which is what you've seen with Ground Logic and Hurricane, or we can also look for things that ultimately give us better channel access along the way.

So, as we think about those types of things, it takes two to do a deal, but we look at our pipeline and the pipeline is pretty robust. The question is, can we get to economic terms on some of these things that ultimately allow us to achieve our goals of returning the cost to capital in three years on a risk adjusted basis EPS accretive out of the shoot, and that sort of thing. So, we will continue to look for things that will help make the commercial cutters landscapers that much more productive because for the next foreseeable future, we think that's where the name of the game for these folks.

Timothy Wojs -- Baird -- Analyst

Okay, great. Appreciate Titus, I guess is maybe secondly you touched on it a little bit I think in your prepared remarks, but maybe just talking about the growth trajectory that you're seeing or the opportunity as well as on the vanguard horizontal agencies to come up with.

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

Yeah. So, we just launched the Vanguard 200. We got a whole line of engines that will be coming out over the next couple of years, and we launched the Vanguard 200 single cylinder horizontal this past year on a more of a soft launch on a limited basis and now, we've got it out in the marketplace and there is some real opportunities there. If you remember back a couple of years ago there was an offshore competitor that ultimately decided to get out of that business which left a void in the market if you will.

So, we have to a certain extent stepped into some of that position, I think there's more to be heard. Then when you look at the type of product that it is, the feature, set, this was a ground-up design that really took into consideration voice of customer. So, we checked it and all the different features that these customers wanted and we believe a far superior engine to what's being offered. So, we're seeing really great interest, we are seeing customer demand on that, and so, if you look at it over the next two to three years as we continue to fill out that product line, we're very encouraged and very optimistic about what that can yield.

At the same time when you look at the overall Vanguard lineup which would include the twin cylinders and the moves that we're making to onshore that here in the U-class, and we're seeing continued enthusiasm and demand for that type of product as well. Now, when you couple that with one of the enabling technologies that we talked about with electronic fuel injection, we got some pretty exciting stuff that's going to be coming out over the next several years including some of the things coming out here in '19. So, that's why when you look at the growth we talked about in commercial, I'm really excited about it because we've been doing a lot of the hard work to get the products where they need to be. They're where they need to be, and so, now it's the fun part of going out and really showing the market what we can do.

Tom Hayes -- Northcoast Research -- Analyst

Great. Appreciate the color.

Operator

If you would like to ask a question, please press start then the No.1 on your telephone keypad. Again that's star one to ask a question. There are no questions at this time, presenters, please continue.

Mark Schwertfeger -- Chief Financial Officer

Thank you for joining today's conference call. Our next quarterly earnings conference call for the First Quarter of Fiscal 2019 will be held on October. Have a great day.

Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.

Duration: 44 minutes

Call participants:

Mark Schwertfeger -- Chief Financial Officer

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

Sam Darkatsh -- Raymond James -- Analyst

Timothy Wojs -- Baird -- Analyst

Tom Hayes -- Northcoast Research -- Analyst

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