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Briggs & Stratton (NYSE:BGG)
Q2 2019 Earnings Conference Call
Jan. 24, 2019 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

To the Briggs & Stratton 2019 second-quarter earnings conference call. [Operator instructions] Thank you. It is now my pleasure to turn today's program over to Mr. Mark Schwertfeger.

You may begin the conference.

Mark Schwertfeger -- Chief Financial Officer

Good morning and welcome to the Briggs & Stratton fiscal 2019 second-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. 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'll also make reference 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, Briggs reported robust second-quarter sales growth of 13% on strength across multiple dimensions of our business. Both business segments, Engines & Power and Products, contributed to this result in both residential and commercial categories. For the fiscal second quarter, we delivered adjusted EPS of $0.20 per share.

Adjusted gross margins were lower in the second quarter due to lower engine production, some operational inefficiencies, primarily driven by lower throughput in our service distribution center hub and sales mix. We made great strides during the quarter toward improving our service parts distribution capabilities and this business is now well-positioned as we enter the peak selling season. At the same time, we announced a revision to our outlook to reflect near-term headwinds related to two issues: the effects of prolonged severe drought in Australia and Europe; and the Sears bankruptcy. Combined and including the partial offset from incremental storm-related sales, we're reducing our annual sales outlook by approximately $50 million and earnings by $0.30 per diluted share.

I'd like to provide some context to the revision. In the fiscal first -- in the fiscal 2019 first quarter, we projected that U.S. generator sales related to Hurricanes Florence and Michael would offset the weather headwinds in Australia and Europe. We recently recently concluded that the Australia and Europe weather conditions are likely to be more impactful than previously estimated.

Specifically the drought in Australia did not abate in time for the growing season to recover, and our second quarter sales in the region were lower than expected. In Europe, where the market is significantly more fragmented than in the U.S., we received more input from channel partners throughout the second quarter and learned that the historic heat and drought conditions from this past season resulted in channel inventory levels that were more elevated than previously estimated. Regarding Sears, as we previewed last quarter, we believe that the bankruptcy caused some disruption during the upcoming lawn and garden season in the U.S. Accordingly, we adjusted our outlook to account for store closures and lower channel inventory stocking.

We expect that much of this market disruption will ease by next season as consumers migrate their shopping patterns and adjust to this change in the retail landscape. Despite the near-term market headwinds, we'll make every effort to offset the challenges we highlighted during the remainder of our fiscal year. We remain confident in our long-term strategy to grow sales and profitability and are pleased that commercial sales growth remains very solid and on track for the year. In addition, with line reviews for the upcoming season now complete, I'm pleased to report that we maintained our industry leading engine placement at the major retailers, especially given the significant brand transitions that retail this season.

In particular, we are very proud to continue our long tradition of powering Craftsman-branded products and are eager to help support our channel partners as this iconic brand has launched at Lowe's this spring for a lawn and garden. Homeowner shopping for lawn mowers this season, including Craftsman-branded models, will find our engines very well represented. Equally encouraging is the exceptional progress made in building our commercial business. The quarter commercial sales were up more than 20% or approximately $30 million.

Year-to-date commercial sales have increased over 17% and we are well on track to achieve very strong growth for the year. While all parts of commercial performed well, commercial engines in Job Site stood out, both advancing more than 30% in the quarter. Vanguard commercial engines are powering more applications than ever before. With higher quality, durability, and reliability than the competition, our commercial engines are making substantial share gains in lawn and garden equipment, construction equipment, and storm-related applications.

An important element of this success has been offering new products that improve productivity and uptime for contractors. To date, this fiscal year, we've expanded business with more than 20 current customers and secured business with about as many new customers. We have been more demanding more product powered by Vanguard engines through rental houses distributors. We are pleased with the success of this multiyear strategy in which there is still considerable opportunity for the growth.

Business diversification is also benefiting Job Site. With a broader range of products and stronger distribution, we are now serving applications in entertainment infrastructure, and general rental, in addition to our traditional base in oil and gas and construction. With a full business pipeline, we announced the facility expansion for our Job Site business to increase production capacity and improve productivity and speed to market. Expansion includes new modern assembly lines, a prototyping lab to assist customers on product configuration, a new paint system, and efficient robotic welding cells.

Expansion is scheduled for completion by the end of calendar 2019. Operationally, we've made significant progress on our business optimization program. The onshoring of commercial engines is proceeding on plan with the production of Vanguard engines ramping up on schedule at our Auburn, Alabama plant. Customers are recognizing the high quality of the engines produced at the plant and appreciate the faster delivery times.

Attention has now turned to our Statesboro, Georgia plant, which began production of Vanguard engines in late December and is expected to reach full production by the end of this fiscal year. Also in the second quarter, we made all the necessary preparations to enable the remaining production of various commercial mowers to shift to our new facility in Upstate, New York early in the third quarter. Located only a few miles from our older outdated facility, the new manufacturing site doubles production capacity and improves throughput. Commercial turf has been on a steady upward trajectory for several years and the new Ferris facility gives us the production capacity needed to support further growth.

We also made significant progress in the quarter with the upgrade of our ERP system. In addition to the improvements that are benefiting our service parts distribution throughput, we continue to make strides across the organization in adapting to streamline processes and new tools. Taken together, we now estimate that our business optimization program will deliver pre-tax savings of $35 million to $40 million by 2021, up from our previous estimate of $30 million to $35 million. The incremental improvement comes primarily from higher-than-planned efficiencies we expect to achieve from several aspects of the program.

We are well on track with our strategic priorities and I am proud of our team, which has driven the great progress made today at our challenging market conditions. And here is Mark to walk you through our financial results for the fiscal 2019 second quarter and provide details on the earnings revision.

Mark Schwertfeger -- Chief Financial Officer

Thanks, Todd. I'll begin by touching on some highlights from the financial results. Second-quarter GAAP consolidated net loss of $2.6 million included $10.7 million in business optimization pre-tax cost, $200,000 premiums paid on the repurchase of senior notes, and $200,000 on acquisition integration pre-tax costs. The net loss also includes a onetime tax charge of $1.1 million related to finalizing estimates on the inclusion of foreign earnings related to the implementation of U.S.

tax reform. Excluding these items, fiscal 2019 second-quarter adjusted net income was $8.4 million or $0.20 per diluted share, a decrease from $10.7 million or $0.25 per diluted share a year ago. The Engine segment incurred approximately $7.5 million dollars of the pre-tax business optimization costs and the Product segment incurred the remaining $3.2 million as well as the acquisition integration cost. Engine segment sales for the second quarter were $272 million, an increase of $29 million or 12%.

Engine unit sales increased by 17% or approximately 274,000 engines on the strength of shipments for commercial applications and timing of shipments for residential applications. Due to several factors, including our ERP upgrade go-live, approximately $15 million of sales shifted from the first quarter to the second. In addition, sales of approximately $20 million were accelerated from the third quarter for customers in North America to begin production earlier than last year. Sales of service parts increased year over year by over $6 million in the quarter due to reduced throughput of our distribution center hub.

We experienced a steady improvement in throughput throughout the second quarter from the improvements we drove that Todd commented on earlier. International sales decreased in the quarter due to weather-related softness in Europe and Australia. The Engine segment adjusted gross profit margin was 20.7%, which was down from 23.1% last year. The decrease was largely driven by lower manufacturing volumes, unfavorable sales mix of approximately 100 basis points, and inefficiencies from lower throughput in our service distribution centers.

Higher pricing largely offset higher material costs, including tariffs. Engine production volume in the quarter was 1.2 million units, which was 7% lower than the second quarter last year. Total engine inventories at the end of the quarter were approximately 2.1 million units, which is a decrease of approximately 230,000 units from the end of the second quarter of fiscal 2018. The decrease largely came in small engines, which is why engine inventory dollars are consistent year over year.

We continue to anticipate that fiscal 2019 year-end engine inventory dollars will be lower than at the end of fiscal 2018. Engine segment adjusted ESG&A held relatively steady with a decrease in the second quarter of 2019 by approximately $1 million from year ago, largely due to lower variable compensation. Adjusted segment income for engines was $12.2 million, up from $10.7 million last year. Product segment net sales for the second quarter increased by 15% or $33 million to $255 million.

The increase was largely driven by higher pressure washer sales and growth in sales of Allmand commercial Job Site products, Ferris commercial mowers and the hurricane acquisition, which added stand-on-blowers to our product portfolio. Product segment adjusted gross profit margin decreased from 17% to 15%, largely due to sales mix and manufacturing inefficiency. The sales mix was a result of lower storm generator sales because of a less active hurricane season this year compared to a year ago. And timing of product mix within both residential and commercial offerings.

Higher pricing offset increases in material costs, including tariffs. Products segment adjusted ESG&A expenses increased by approximately $2 million or 7% this year due to higher employee compensation costs and higher commission expense on increased sales volume. On the balance sheet, net debt at the end of the second fiscal quarter was approximately $476 million, which was $191 million higher than a year ago. The increase is primarily due to last year's discretionary pension contribution of $30 million, investments in the business optimization program, and higher working capital amounts, following the suboptimal lawn and garden season last year. We also increased inventory purchases from China in the prior -- prior to quarter end to take advantage of lower tariff costs.

Last 12-month cash used by operating activities was $58 million, which was largely due to the factors that resulted in higher net debt. Second-quarter sales were weighted toward the end of the quarter, which resulted in elevated accounts receivable that will be collected early in the third quarter. Inventory dollars at the end of the second quarter were also elevated, both to facilitate the plant transitions and progress for Vanguard engines and Ferris mowers and lower-than-planned sales in Australia from the drought conditions there. Last 12 months' free cash flow was a negative $150 million with capital expenditures totaling $92 million over the period.

For the quarter, depreciation and amortization of $16 million was higher than capital expenditures of $13 million, which are trending down following the bulk of expenditures related to our business optimization program. Year-to-date capital spending is down $11 million or over 25% and we expect capital spending of approximately $65 million for fiscal 2019. Regarding the business optimization program, we now estimate achieving up to $40 million in pre-tax savings by 2021. We also estimate that pre-tax charges related to the program will be $60 million to $70 million, up from our initial estimate of $50 to $55 million. Total program charges incurred to date through the second quarter were $52 million or approximately 80% of total expected program charges.

The increase is primarily related to costs associated with the go-liveof our upgraded ERP. At the end of the quarter, last 12-month average funded debt was $382 million and last 12-month EBITDA was $147 million, both as defined by our credit agreements, resulting in a leverage ratio of 2.6 times, which is well within our debt covenants. Before I turn the call back over to Todd for his closing remarks, I want to offer some further insights into our updated fiscal 2019 outlook. There were three primary reasons for the revised guidance, which Todd commented on earlier.

First, we are adjusting our outlook for the Sears Holdings bankruptcy. This past season, Sears' full-line stores covered approximately 500 locations and represented a little over 10% of the residential lawn and garden market in the U.S. Should Sears emerge from bankruptcy, it is expected to operate less than half the stores that were in place last season. It is also unknown what products the remaining stores will offer and how frequently consumers will visit the stores.

We continue to believe that Sears' channel inventory is low but liquidation of inventory from closed stores is likely to cause some market disruptions. In addition, we expect that a portion of consumers, who previously shopped at Sears, will not immediately migrate to new retailers. We estimate the sales impact of Sears at $30 million and earnings at $0.15 per share. The impact is predominantly comprised of engine and service part sales, the majority of which would have been sold in during our third quarter.

Second, poor weather conditions in Australia have extended beyond our original expectations and have resulted in lower overall demand in season. In addition, the drought in Europe last summer has contributed to high inventories in the channel of engines, mowers, and service parts. Together, we expect lower sales of $40 million due to weather in Australia and Europe, of which we have incurred approximately $30 million of the decrease through December. We expect the remaining amount of $10 million to largely impact the third quarter.

Partially offsetting this is the benefit of approximately $20 million of generator sales in the first half of fiscal 2019 related to hurricanes Florence and Michael. Net, we estimate these weather-related items will reduce sales by approximately $20 million and EPS by $0.15. Lastly, in order to proactively manage working capital, we played the lower engine production volumes by 10% compared to last year's production volume. With this change, we expect third-quarter production to be approximately 300,000 units or 15% lower than last year's third-quarter production.

Despite this reduction, we are confident that we have adequate safety stock in-plant production to meet customer demand in the back half of the year. We will actively work to reduce expenses to help offset the impact of lower plant throughput through the remainder of the fiscal year. Partially offsetting the near-term headwinds, we expect the Engine segment will encounter in the third quarter, we anticipate robust sales growth in the third quarter within our product segment due to our focus on selling higher-end commercial and residential lawn and garden equipment through our North America dealer channel. 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 entered the second half of fiscal 2019 with favorable momentum in our commercial business and a stronger leading position serving the power needs of the consumer. We have made great progress improving the efficiency of our part distribution business and are now well-positioned as we approach the peak selling season for lawn and garden in North America. At the same time, we recognize the temporary headwinds caused by weather conditions in Europe and Australia as well as the channel-related matters around Sears.

As a result, we're taking appropriate responsible actions to align production with demand to ensure adequate product availability while focusing on generating an improved cash flow stream. Overall, Briggs is in a stronger competitive position today, which is a direct result of our focus on innovation and driving consumer-driven power solutions, expanding global channels to reach our -- reach more customers and diversifying into high-growth commercial businesses. As a result, we are now in the latter stages of our business optimization program. And as a result, we are well-positioned to drive costs lower, improve working capital efficiency, and deliver better returns on investment.

In addition to driving further profitable growth in commercial, our priorities for the second half of fiscal 2019 are, one, focusing on executing on the upcoming lawn and garden season. We are encouraged by our placement for the upcoming season and excited about the support we are seeing promoting the brand transitions. Two, internally, we will be working to manage working capital to improve cash generation. We ended the second quarter with higher inventories in part to support the Vanguard and Ferris manufacturing transitions we are completing this year.

As Mark commented earlier, in response to lower-than-planned sales, we intend to adjust production downward in the second half of the year to control inventories. Three, maintaining our high level of innovation. We are very pleased with the success of our commercial business, which has built the foundation of offering customers demonstrably better products. To maintain this momentum, plans are now under way to refresh and expand our line of Job Site equipment, which is also experiencing strong growth.

In commercial engines, we will be launching an expanded range of horizontal engines to complement our 200 cc model, which is meeting with strong customer acceptance and an important element in our success in expanding the range of power applications we serve. Finally, we will continue to follow through on our business optimization program. The third-quarter transition of the remaining Ferris mower production into a larger more efficient plant and our ERP upgrade as well as the smooth ramp-up of Vanguard commercial engines brought onshore, we are now nearing the end of implementing this broad-based initiative. Financial benefits from it will begin flowing in the second half of this fiscal year with substantially further cost savings coming in fiscal 2020 and the full benefit of fiscal 2021.Let me finish with a word on capital allocation.

We continue to evaluate the allocation of our resources to those areas that deliver the highest risk-adjusted returns. To date, we are pleased with the value-creating investments in the business optimization program. In addition, we look forward to the first full year's contribution from the Hurricane and Ground Logic acquisitions, which should advance our strategy of filling out the professionals' trailer with innovative power equipment. As we look for further investment opportunities, our M&A pipeline is filling with a range of bolt-on acquisition opportunities that would accelerate the diversification of our business, enhance long-term growth, and improve the overall profit profile of the company.

Along with our investment discipline, we remain mindful of ensuring that we maintain a strong balance sheet with appropriate financial leverage. Finally, we continue to view stock repurchases as part of our investment options. During the second quarter, we repurchased $6.3 million of Briggs shares and committed $11.4 million to stock buybacks in the year to date. That concludes our prepared comments.

I would like to open up the call for questions. 

Questions and Answers:

Mark Schwertfeger -- Chief Financial Officer

Renz, we can now open up the call to questions.

Operator

Certainly, sir. [Operator instructions] Your first question comes from the line of Mr. Joe Mondillo. Your line is now open.

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

Hi, guys. Good morning.

Todd Teske -- Chairman, President and Chief Executive Officer

Good morning, Joe.

Mark Schwertfeger -- Chief Financial Officer

Good morning, Joe.

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

So, I wanted to just touch on the guidance first off. So, you brought the revenue down 2.5% roughly and the EPS comes down 20%. So, I'm just curious just given what's going on, we had the Sears headwind, which we knew about; we had the weather in Europe and the inventory levels there that we sort of knew about. Is there any other -- I'm just wondering is there any other flexibility that we have within the business model to try to prevent such volatility and the bottom line relative to fluctuations in the top line like that?

Mark Schwertfeger -- Chief Financial Officer

Yes, Joe, the other factors that contributes to the bottom line versus top line, one is the production volume. And we're doing the responsible thing from a working capital perspective in taking down the engine production as much as 500,000 units, compared to what we've talked through previously when we came out with guidance at the beginning of the year and has to keep the inventory levels in check. And that has a pretty big impact on the absorption of our manufacturing facilities. The second piece has to do with sales mix as well.

And the European and Australian lawn and garden markets are a little bit different than the U.S. from a price point perspective, and so having some headwinds there can create some margin pressure from a sales mix perspective, which is what you're seeing. Also as part of the Australia and Europe as well as Sears impact, there is a component of service parts sales that are impacted by that reduction. And those as many -- with many other manufacturers come at a higher margin profile relative to the whole book.

Todd Teske -- Chairman, President and Chief Executive Officer

And what I'd tell you, Joe, is that as we look forward, if you think about all the things we've done over the last few years with commercial engines and products and that sort of thing, I mean, that adds diversification of the business. And so the business will be exposed to weather-related type things, whether it be hurricanes, whether it be spring selling seasons, whatever it is. But at the end of the day, when you look at commercial and our opportunities to, not only grow in a higher market growth, we also have the opportunity to gain share, which you've seen us do. And then, the margin profile is also better.

So -- I mean, going forward, the mix of business has changed, will continue to change and -- but you get to these kind of transitory things, whether it be the weather in the international markets or Sears, and they're going to have a near-term impact, but we're still very confident with where things are at in the long term.

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

OK. And then sort of just to transition with your comments there, Todd. Commercial doing good, I mean, better than even I was expecting. In terms of residential side, we had a really tough challenging spring last year and we were anticipating somewhat a rebound but obviously things have changed a little bit just in terms of the overall U.S.

economy. I think there's still growth there. So, do you have any visibility into the spring season? Can you talk about that and what you have sort of baked into your guidance, what you're anticipating in terms of any rebound at all considering the comparison to last year?

Todd Teske -- Chairman, President and Chief Executive Officer

Yes. So, when you look at what happened last year, we had inventory destocking, right, in the channel. So, what was happening is with the brand transitions that were anticipated, some of the retailers, especially Lowe's, they took their inventories down because they knew they were going to bringing in Craftsman this year. So, if you go back to a year ago, it was pretty evident what was happening, which is why when you look at what our guidance has been and is, I mean, we continue to see growth.

Here, a big part of that has to do with channel restocking, and that's kind of what you saw here in Q2. When you think about earlier production and earlier stocking, that's why I mentioned in the prepared comments, you get into the situation where we're starting to see some favorable things happen in North America lawn and garden. Now you got to remember, too, last year, and you pointed out, the weather wasn't -- it was snowing in the middle of April and whatever that happens, it's starts to delay the season. So, I don't know what the weather forecast is going to be, but at the end of the day, we're feeling quite good about where the channel is going to be inventory-wise, and we're confident that if the season is a normal season, remember, we haven't had a normal season since 2015.

If it's a normal season, we're there to serve the market.

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

OK. Great. And then last question from me. Just in terms of engine placement, could you provide any more color there? It sounds like you're pretty pleased, but do you have any sort of, I don't know, statistics or anything you also -- you can sort of provide regarding the engine placement?

Mark Schwertfeger -- Chief Financial Officer

Yes. If you look across the board, we commented that largely consistent year over year despite of the brand transition. So, we're particularly pleased with some of the larger engines that power riding lawn mowers and that we picked up some volume there this last year. And then the other thing from an overall lineup perspective is that the major retailers, we indeed expect a similar number of SKUs in the lineup compared to a year ago as it related to products that we power as well as the other gas engine companies power as well.

So, those are really the encouraging things. And like Todd mentioned in the remarks, too, we've very nice placement on the Craftsman mowers at Lowe's, which was the big -- one of the big transitions coming into this upcoming year.

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

So, at the retailers on the residential side, it sounds like sort of similar year over year. Are you achieving growth or more placement at the commercial side with your new engines?

Todd Teske -- Chairman, President and Chief Executive Officer

Yes. We've seen continued upticks on the commercial side. Remember, that doesn't -- that's not part of -- and you know, this is not part of the retail channel. It's really part of the dealer channel.

And so when you look at what we've been able to do, I think we've got 20 new -- at least somewhere around 20 new customers this year and then the customers that we've had, we're seeing increased placements. That's why you're seeing such tremendous growth in that commercial engine business because the people, who are expecting our engines, are continuing to do more and more of that.

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

Great. Thanks a lot.

Todd Teske -- Chairman, President and Chief Executive Officer

Thank you.

Mark Schwertfeger -- Chief Financial Officer

Thanks, Joe.

Operator

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

Tom Hayes -- Northcoast Research -- Analyst

Thanks. Good morning, gentlemen.

Todd Teske -- Chairman, President and Chief Executive Officer

Hi, Tom.

Mark Schwertfeger -- Chief Financial Officer

Hi, Tom.

Tom Hayes -- Northcoast Research -- Analyst

Todd, I was wondering maybe -- it sounds like you're having great success in the commercial segment, specifically with Vanguard. Just maybe help us update the total opportunity you see there and kind of maybe where you are as a share position right now?

Todd Teske -- Chairman, President and Chief Executive Officer

Yes. So, when you look at kind of share, it's a very large market. So, we have a tendency to break the share down a little bit in terms of different segments. And so if you think, Tom, where we've been -- if you think about where we've been playing here as of late, it's in that commercial turf space.

It's been a big piece, although there's a lot of other applications that we've been powering. And so when you look at the commercial side, our share is substantially lower than it would be, for example, on the residential side, which is part of the reason you're seeing the tremendous growth in commercial engine. So think about it this way, if the market in these commercial areas generally go -- grow at about 2 time GDP, we've got substantially, let's say, it's about 2.5%, 3%, we also have a 5% growth. We're seeing substantially higher growth than that, which means we're taking share.

But I would tell you, we still have a fair amount of ways to -- fair ways to go in terms of the ability to take share and continue growth in that area. And then on top of that, I would tell you that on the Vanguard V-Twin side, where we're going to Auburn and Statesboro, there's a lot of other applications that are out there that we can now really participate in. And it's little bit more nichey, but actually they're really good segments for us and they're really interesting things like mud boats, powering mud boats, and things like that where people actually go out and use the equipment to have fun. So, there's a whole aspect there.

And then, when you look at the horizontal shaft, we still have a very, very low share in the horizontal -- think of single-cylinder horizontal shaft market, Vanguard engines. We've got 200 cc. We're coming out with 400, we'll have a 300 and 160 following. So, as we continue to broaden out that product offering on the single-cylinder side, there's some tremendous opportunities out there.

And so we're still encouraged because we think there are ways to go with the market growth, but even probably more impactful is really opportunities to get new and more market share.

Tom Hayes -- Northcoast Research -- Analyst

OK. Great. I appreciate the color. Just wanted to follow-up.

I think you mentioned in your prepared remarks, Todd, that the rental equipment market was holding up well. I just wanted to kind of circle back and make sure I heard that right.

Todd Teske -- Chairman, President and Chief Executive Officer

Yes. We've been doing very well on the rental equipment market, and we've been keeping a close eye on that to just to understand what some of the CAPEX requirements will be now as we get into calendar 2019, and we're still seeing it hold up really pretty well. There's obviously always noise around various aspects of that, but overall, we think that the -- we make great strides because we'd be able to gain share. So, should a market turn down a bit, we think we have more opportunities though because our share is pretty low, and we can go and take share.

Overall, though I will tell you what we're hearing from the channel is that CAPEX levels aren't going to drop dramatically. They're going to be either flat to slightly up.

Tom Hayes -- Northcoast Research -- Analyst

OK. I appreciate it. And then, Mark, I think you mentioned that 80% of the business optimization expenses have been occurred earlier in the first half of the year. I mean, should the balance be then split equally over the back half of the year or should most be done in 3Q?

Mark Schwertfeger -- Chief Financial Officer

Yes, my comment was actually 80% of the program cost to date, but that also includes some [Inaudible] in 2018. And so indeed if you were to expect quite a bit of deceleration in the back half of the year of expenditures of, say, roughly another $10 million-or-so to $15 million. And indeed that would be fairly split between quarters.

Tom Hayes -- Northcoast Research -- Analyst

Appreciate it. Thanks for the color.

Operator

Your next question comes from the line of Josh Chan. Your line is now open.

Josh Chan -- Private Investor

Hi. Good morning, Todd and Mark.

Todd Teske -- Chairman, President and Chief Executive Officer

Good morning, Josh.

Josh Chan -- Private Investor

Hi, good morning. Yes, thanks for the color on the guidance related to weather. I just wanted to ask about the Sears piece of it. Is it fair to assume that that reduction comes out primarily in the second half? And are you basically assuming that not much sales goes into that channel for the year basically?

Mark Schwertfeger -- Chief Financial Officer

Yes, we actually believe that most of the impact will be in the third quarter because that's typically when the market would load up Sears or other retailers to be prepared for the season. And at this point in time, there's just a lot of uncertainty as to whether Sears will merge and how it will merge. And so, therefore, we do think that that impact will be back half and mainly Q3.

Todd Teske -- Chairman, President and Chief Executive Officer

Yes, Josh, let me just even a little bit more color. So, if you think about the inventory stock up that would normally happen, because their hearing isn't until the first week of February, you -- which again they've kind of missed the stock-up because normally store set start in the south about now and then they work their way up. And so we just don't think that they're going to have the kind of inventory stocking they would otherwise have, especially given fewer stores. Then you think about they have very low inventory, we believe.

We don't have full visibility but we believe low inventory at the DC level but they'll use that inventory then to stock up the existing stores should they emerge from bankruptcy. And -- but ultimately what it comes back to is what kind of then -- will the consumers -- there's less points of light out there, how will they adjust. And so ultimately we believe that it really is more Q3 and -- because they will take whatever inventory they have and then try to sell that out and then quite honestly the OEMs, I don't know that the OEMs -- I know they're not building for Sears right now. The question is when will they slot them in for production should they emerge from bankruptcy.

So, there's just a lot of moving pieces around the Sears situation, which is why we took the tack we did and expect that in Q3, where we'll see most of the impact.

Josh Chan -- Private Investor

OK. Yes, appreciate the color there. I think that definitely makes sense. And then on the -- on the pull ahead that you saw in North America, could -- why do you think that is and do you think it's related to tariff's price increases or that Craftsman outside of Sears weld in in Q2.

Why did you see that pull ahead in the quarter?

Todd Teske -- Chairman, President and Chief Executive Officer

Yes, so what happened is if you go back through the last few years, you kind of alluded to this, is that OEMs were pushing back production. And so ultimately this year was a little bit different. And a big part of it was the fact that this ramp up that's going on at Lowe's where the OEMs and then also remember we do pressure washers and generators under Craftsman at Lowe's. And so ultimately what you saw was preparation for what we expect to be a really robust launch of Craftsman at Lowe's.

And so the last thing, I think, anybody wants to do is be short at inventory when this -- with the kind of marketing dollars and the kind of splash that Lowe's and others will be making for that brand transition. So, ultimately that's the biggest piece of what you saw come through in Q2.

Josh Chan -- Private Investor

OK. That makes sense. And then on the guidance for the second half, it sounds like engine production is going to come down, so can you just talk about the level of confidence that you can hold margins kind of flat to up, which is what seems to be implied by the guidance in the second half?

Mark Schwertfeger -- Chief Financial Officer

I think it's a little bit different between segments from a standpoint of with engine taking out the sort of production contemplated in the third order that would have a pretty significant margin impact, unfavorable year over year but it's the right thing to do. I mean, could be as much as 150 basis points to take out that much volume, which is 15% in the quarter, which is almost as much as we took out of the first two quarters alone, but it's the right thing to do from a working capital perspective in a year like this. On the other side, within our product segment, we anticipate some nice growth in the third quarter because the product segment is a little less augured in on Europe as well as a little bit less from a Sears perspective because of our focus we placed on our independent dealer channel for that business. And so, you can see the margin lift and a nice revenue growth in the product segment offsetting some of the headwind the near-term headwind in the Engine business.

Josh Chan -- Private Investor

All right. And then the last question, Mark. I guess, on free cash flow for the year, we had been thinking that it would be a modestly positive number, but the first half is quite a use and so just kind of talking about what kind of cash flow you think you can generate for the year. Thanks.

Mark Schwertfeger -- Chief Financial Officer

Yes, I think the biggest thing that's going to come down to, how we can manage our inventory levels as we go to the back half of the year, which is why we're taking the actions we are from an engine perspective. We do believe that it'll probably be fairly tight on free cash flow for the fiscal year when you take a look at where EBITDA would check out what the revised forecast such that we could be pretty flat from a pretty quick cash flow perspective to just modestly negative. We would anticipate that rebounding quite a bit as we would go into fiscal year '20 as we start to sunset the business optimization investments and then keep our capital spending in check at around $65 million and begin to garner more benefits from the business optimization program.

Josh Chan -- Private Investor

All right. Thanks, guys for the color and good luck in the second half.

Todd Teske -- Chairman, President and Chief Executive Officer

Thanks.

Mark Schwertfeger -- Chief Financial Officer

Thanks, Josh.

Operator

Your next question comes from the line of Josh Wilson. Your line is now open.

Josh Wilson -- Graham Partners -- Analyst

Good morning, Mark and Todd. This is Josh filling in for Sam Darkats. Thanks for taking my questions.

Todd Teske -- Chairman, President and Chief Executive Officer

Good morning.

Josh Wilson -- Graham Partners -- Analyst

A few for me here. First the impacts in the service distribution center. Could you give us some more specificity on what the issues were and what the progress is on resolving them?

Todd Teske -- Chairman, President and Chief Executive Officer

Yes, so what happened, Josh, is we basically went live with with SFP in July and we did an extensive amount of testing but the thing that is probably most complicated in our business has to do with our service part centers. There's tens of thousands of parts in a lot of different permutations. So as we as we went live, we worked through some of the issues and then we had to make a few changes as to how we process some of the pics if you will. So we picked throughout the warehouse.

So, we made some changes there. And so what's happened is we've made tremendous progress here over the last quarter or so -- over the last three months and and now we're we believe we're at a point where we'll be just fine here for the upcoming season. Arguably then, there's going to be some restock that's going to happen here back half of the year because inventory levels are lower at our distributors and dealers than we would like them to be. And so that's why it was really important to get the flow of the materials through the distribution center where they needed to be and we believe we're there.

Josh Wilson -- Graham Partners -- Analyst

Good. Glad to hear that. And then a few regarding Sears, just confirm for me again the $30 million. Is that the entirety of the serious exposure is there some potential further downside depending on how this unfolds?

Mark Schwertfeger -- Chief Financial Officer

No, that's not the full amount of sales that we contemplated to Sears in fiscal '19. We commented last year that our full amount of sales -- or last quarter we commented that our full sales are less than 3% of our total outlook of the year. So, it's a little bit more than that. It really is under the assumption that some of the volume that would've shopped at Sears stores in the year will go elsewhere in this first year.

And then in subsequent years, we'd see more of that volume rebound in other locations as consumers migrated from where they typically shopped in the past due to new outlets.

Josh Wilson -- Graham Partners -- Analyst

And how long do you think it will take for some of the $30 million to come back for the channel to settle out again?

Mark Schwertfeger -- Chief Financial Officer

Difficult to say. I think the inventory liquidation piece associated with closed stores, that one should bounce back pretty quickly as you think about that next year. And then we believe that a consumer conversion happened fairly rapidly from a standpoint of the Craftsman brand is now so available at locations outside of Sears, which is really helpful but it's difficult to say precisely when the volume would return other than to say we expect to see a lot of the headwind abate even as early as 2020 for us.

Josh Wilson -- Graham Partners -- Analyst

Got it. Good luck with the next quarter.

Todd Teske -- Chairman, President and Chief Executive Officer

Thank you.

Mark Schwertfeger -- Chief Financial Officer

Thanks, Josh.

Operator

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

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

Hi, guys. Just a couple of follow-up questions. Could you provide any more color or detail on where the additional saving is coming from regarding the business op plan?

Mark Schwertfeger -- Chief Financial Officer

Yes, I didn't mentioned in the comment. It's really several aspects if you think about just getting further along in the program, where now that we have our ERP upgrade live, we're starting to discover more and more of the process benefits to light. At the same time, we also have now our Vanguard production up and running in our U.S. plants and a lot of production going into our new Ferris plant.

And all of the early signs we've seen have been really promising such that we're able to modestly increase what we think our outlook is for the program savings.

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

OK. So, it's sort of across the board in terms of the three biggest buckets that are coming from the op plan?

Mark Schwertfeger -- Chief Financial Officer

That's right.

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

OK. And then just on -- how much could you -- can you quantify how much of the benefits we've seen of that $35 million to $40 million? How much have we sort of gotten finish with or seen? And when you say by '21 -- fiscal 2021, will there be any benefits in fiscal 2021 or are all the benefits are going to completely seen in fiscal '20 and -- by fiscal '20. That's really it.

Mark Schwertfeger -- Chief Financial Officer

We continue to expect to earn about $6 million to $8 million of benefits in the back half of fiscal 2019. We really haven't recognized many to date because the program has been ongoing in many regards. So, now that we're starting to get to that pace where things are live and the like in the plants as well as with ERP, we expect to begin realizing the benefits. And then, the remaining portion of the benefits, we expect to earn somewhat ratably between fiscal '20 and fiscal '21, such by at the end of '21, we would be up to that full savings rate.

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

OK. Great. And then, looking at the balance sheet, how much of that do you think, just given the sort of free cash flow estimates that you sort of provided. Are you going to use most of that free cash flow to try to bring down that debt in the back half or just how much that, do you think, you can bring down in the back half?

Mark Schwertfeger -- Chief Financial Officer

I think it's probable that our -- the borrowing level will be a little bit higher than it was at the end of the last year, but we do believe that the borrowing level will be substantially lower at the end of the year than it is now, as we seasonally collect from the upcoming two quarters. I also mentioned that there's two things at the end of the second quarter that impacted where we were from our borrowing level, one of which was some of the pre-buying we did on inventories, to facilitate our plant transitions as well as the pre-buy a little bit ahead of what we expected to be some of the tariff rate increases in the early part of calendar 2019. And then, the second piece was our sales in the second quarter were somewhat weighted toward the back of the quarter such that accounts receivable was elevated quite a bit year over year in all collectible in our estimation as we get into Q3, which should be beneficial from a debt and cash flow perspective.

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

OK. Great. And then, the D&A. I'm just wondering, with -- what's going on at the Ferris facility, and I guess, the Vanguard facility and maybe even ERP.

I don't know how that's sort of accounted for, but the D&A levels, should that be sort of consistent going forward or that climb or decline actually potentially?

Mark Schwertfeger -- Chief Financial Officer

I think it's pretty consistently such that depreciation would largely offset capital spending of around $65 million a year.

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

OK. So at the current levels, I guess, it should be -- remain around the current levels, some $16.3 million, roughly?

Mark Schwertfeger -- Chief Financial Officer

That's right with maybe a little bit...

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

OK. OK. And why is -- the next thing I was going to ask was the CAPEX. Why is the CAPEX not, -- shouldn't it fall a little bit because you're spending on the Ferris facility, capitalizing certain things.

Wouldn't it fall on next year or no?

Mark Schwertfeger -- Chief Financial Officer

No, we're are just -- what working on prioritizing the most important things to advance our strategy was the $65 million in capital spending that we have allotted for in 2019. As we get into 2020, we expect to have other funding needs as well that we need to get to in order to support the strategy more so from a product basis and things like that less major initiative. The other thing too is both the Vanguard project and the Ferris project, we've been able to do fairly -- in a fairly capital unintensive manner because if you think about, especially with the Vanguard area, we're using our existing footprint. We're not adding square footage.

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

Great. OK. Yes, that's why I was sort of maybe thinking -- I think square footage is declining, right, or -- anyways, the last question I just had was related to sort of the macro consumer. Just wondering sort of we've seen housing data in the U.S.

continue to trend pretty weak, Europe economies, the PMIs just came out today, those were pretty weak itself. Just wondering if you could sort of comment on the consumer? How you're sort of thinking about that, baking that in your guidance just in terms of the macro market both in the U.S. and Europe?

Todd Teske -- Chairman, President and Chief Executive Officer

Yes, so you look at, Joe, the North America or U.S. primarily, yes, housing has ticked down a bit, but remember, I mean, the housing market for us, especially in the lower end, there is still a lot of demand out there. And so the question is when will it ultimately turn where there's a lot more supply and that will be helpful to us, but so we've been -- we've seen that part of the market down pretty substantially over the last several years. Now if the higher end of the market continues to rotate, and that's where you're starting to see some weakness perhaps, we still think that the commercial do it for me is perhaps more driven by people willing to trade money for time than anything else.

And so we would expect that to be fairly robust. And so, yes, housing has driven our business in the past. We've been very clear on that, but when you look at the impacts sequentially from where we've been, it's still not where it would return to normal. And so it's a little bit -- we don't know if there's significant downdrafts.

When you look at Europe, Europe is interesting because the biggest impact we saw was ultimately, the weather. But assuming that the drought you saw, the snow and everything else they got over there, assuming that it's a more normal spring, we're still pretty encouraged by what's going to happen because even though there's an economic downturn you still have to cut your grass. And so ultimately, I would tell you that we don't have significant growth in our model because it's just that wouldn't be prudent. But we didn't put a significant downsize the model other than what we've already talked to you about because I think that has a tendency to mute some of the economic impacts as well.

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

OK. Great. Thank you.

Todd Teske -- Chairman, President and Chief Executive Officer

Thank you.

Operator

[Operator instructions] Your next question comes from the line of Brett Reese. Your line is now open.

Unidentified speaker

Yes. Hi, thanks for taking my question. With so many balls up in the air and these turbulence you're navigating through, how committed do you think the Board is going to be in maintaining the dividend?

Todd Teske -- Chairman, President and Chief Executive Officer

We -- there has been no discussion of taking a dividend down. We're very committed to holding the dividend. We want to get back to growing the dividend. But basically, I -- we don't talk about taking the dividend down because still cash flow just fine.

The last couple of years have been interesting because we continue to invest in the business. But I would tell you that we've not had any discussion with regards to taking the dividend down.

Unidentified speaker

Great. Thanks for answering the question.

Operator

[Operator instructions] We don't have any other questions at this time, sir. Please continue.

Todd Teske -- Chairman, President and Chief Executive Officer

Well, thank you very much for joining today's conference call. Our next quarterly earnings call will be held in April. Have a great day.

Operator

[Operator signoff]

Duration: 61 minutes

Call Participants:

Mark Schwertfeger -- Chief Financial Officer

Todd Teske -- Chairman, President and Chief Executive Officer

Mark Schwertfeger -- Chief Financial Officer

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

Tom Hayes -- Northcoast Research -- Analyst

Josh Chan -- Private Investor

Josh Wilson -- Graham Partners -- Analyst

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