Earnings Call Transcript
Enerpac Tool Group Corp (EPAC)
Earnings Call Transcript - EPAC Q4 2021
Operator, Operator
Ladies and gentlemen, thank you for standing by. Welcome to Enerpac Tool Group's Fourth Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterward, we will conduct a question-and-answer session. As a reminder, this conference is being recorded today, September twenty-nine, twenty twenty-one. It is now my pleasure to turn the conference over to Bobbi Belstner, Director of Investor Relations and Strategy. Please go ahead, Ms. Belstner.
Bobbi Belstner, Director of Investor Relations and Strategy
Thank you, operator. Good morning, and thank you for joining us for Enerpac Tool Group's fourth quarter fiscal twenty twenty-one earnings conference call. On the call today to present the company's results are Randy Baker, President and Chief Executive Officer; Rick Dillon, Chief Financial Officer; and Jeff Schmaling, Chief Operating Officer. Also with us are Barb Bolens, Chief Strategy Officer; Fab Rasetti, General Counsel; and Bryan Johnson, Chief Accounting Officer. Our earnings release and slide presentation for today's call are available on our website at enerpac-toolgroup.com in the Investors section. We are also recording this call and will archive it on our website. During today's call, we will reference non-GAAP measures such as adjusted profit margins and adjusted earnings. You can find a reconciliation of non-GAAP to GAAP measures in the schedules to this morning's release. We would also like to remind you that we will be making statements in today's call and presentation that are not historical facts and are considered forward-looking statements. We are making those statements pursuant to the Safe Harbor provisions of federal securities law. Please see our SEC filings for the risks and other factors that may cause actual results to differ materially from forecasts, anticipated results or other forward-looking statements. Consistent with how we've conducted prior calls, we ask that you follow our one question, one follow-up practice in order to keep today's call to an hour and also allow us to address questions from as many participants as possible. Thank you in advance for your cooperation. Now, I will turn the call over to Randy.
Randy Baker, CEO
Good morning, everybody, and thanks, Bobbi. We're going to start today on slide three. But before we go through the details on the quarter, I have several key topics to cover. First, today, I announced my retirement from Enerpac Tool Group after five years as CEO. It's been a real honor being part of the Enerpac team, and I'm very proud of the transformation we've accomplished during my tenure. I'm also very happy that Paul Sternlieb will be succeeding me as CEO as he brings great operational experience and a track record of growth. I'm going to be available to help Paul through the transition through the remainder of calendar twenty twenty-one to make sure we have a smooth process. Secondly, COVID remains a serious safety concern for Enerpac globally. During the quarter, we were able to minimize potential infections and keep our employees safe, but we still have employees getting sick around the world, which remains a concern. Europe and North America have done a better job of navigating the impact while the Middle East and Asia have significant business disruption. Jeff will cover the implications later on in the call, but suffice it to say that we're experiencing more difficult growth conditions in these regions. Enerpac's fourth quarter sales grew significantly, but as with most companies, supply chain and logistics constraints played a role in the quarter. Our operations team did an outstanding job managing these difficulties and ensuring our customers' on-time delivery was not compromised. Additionally, they focused on controlling costs and keeping our plants as efficient as possible. When compared with twenty nineteen results, margins expanded by one hundred eighty basis points, and the company delivered incremental margins at the high end of our expected range. Given the inflationary factors, we are satisfied with the results in the quarter. Additionally, we are now well-positioned to actively pursue M&A growth opportunities and continue our internal investments in organic growth. As I mentioned last quarter, we have reinvigorated our M&A pipeline and I have high expectations Enerpac will make progress toward our strategic objectives. Now, let's turn over to slide four. As we discussed last quarter, sales grew nicely, and we are now nearing our historical peak demand. It's important to note that our sales growth has been predominantly in Europe and North America, while the Middle East and Asia remain at a lower level. Secondly, product sales have grown at a much faster rate than services, which aided our incremental margins in both the third and the fourth quarter. New product orders in the quarter were up forty-two percent, reflective of the significant growth in North America and Europe. Jeff will cover the details of the regional performance, but I'm very pleased with the results and the dedication of our sales and marketing teams worldwide. Now let's move on to slide five. Fourth quarter sales were sequentially better than the third, which is not typical for the normal seasonality of Enerpac. Core sales grew by twenty-eight percent in the quarter, while product orders increased by forty-two percent. Our sales growth in the quarter was muted by approximately five million dollars, which was related to logistics constraints. Incremental margins in the quarter met expectations and were at the high end of our stated range of thirty-five percent to forty-five percent. Cash flow continues to improve particularly when compared with the low levels generated in our prior year. For the full year, cash conversion was well over one hundred percent which reflects the efforts to control our inventory while supporting our sales growth. Enerpac’s net debt leverage reached a record low of zero point six times, which positions us for future strategic growth. Regionally, North America and Europe have returned to near normal operating levels benefitting from a lower COVID impact and strong economic conditions. As mentioned earlier, the Middle East and Asia Pacific are struggling to return to pre-COVID levels and are growing at a slower rate as compared with the rest of the world. Overall, I am pleased with the results in the quarter, particularly in light of the inflationary and logistics factors. Now turning over to slide six. As I reflected on my tenure as CEO, I'm proud that I’ve been part of the transformation from a small cap diversified industrial to a focused pure play tool company. The journey has been difficult but the Enerpac team has been able to continuously improve and create a much better performing business. We have always been clear on our objectives to drive organic growth through a creative product development process and support our customers through commercial processes. To that end, we have made significant progress, which is illustrated in our sales growth and consistent delivery of new product contributions above our ten percent goal. Our operations have improved significantly over the years and are now closer to achieving a true lean manufacturing objective in terms of quality, cost, delivery, and safety. There are many areas I'm proud of, but most importantly, having the opportunity to work with the Enerpac team has been a very rewarding part of my career. We launched the Enerpac Tool Group officially in twenty twenty. We were making great progress prior to the impact of COVID in March of that year. Organic growth was accelerating and we made our first acquisition as a new company. Now as we begin fiscal twenty twenty-two, we are able to restart our strategic objectives and focus on the future of the Enerpac Tool Group, which is why making the CEO transition now helps provide consistent leadership into the future that will be focused on both organic and M&A growth. I have no doubt that the management team will deliver great results and make our company even better. I'm going to turn the call over to Rick and Jeff now to go over the details in the quarter, and then I'll come back with the market outlook and the twenty twenty-two guidance. Jeff, over to you.
Jeff Schmaling, COO
Thanks, Randy. As already mentioned, we experienced continued recovery in the quarter and I'll break that down regionally to give some details on areas of strength, and in some cases, continued challenges. As always, I'll also give a brief update on our operations and I'll finish with some comments on our Cortland business. Before I jump in though, I'd like to echo Randy’s thanks to our global team for their continued execution in support of our customers through a tough quarter and a tough year from multiple respects, including, of course, the pandemic, supply chain and logistics challenges, and the overall difficulty of staying in touch with our end users. I sincerely appreciate everyone's efforts in helping us finish strong. Moving on to slide seven. Similar to Q3, all four regions significantly improved year over year in Q4, and in total, the business climbed to within about three percent of pre-COVID levels for the same period in twenty nineteen. We continue to track our product order rates using twenty nineteen as our benchmark, which was a peak demand for us. Overall, we finished slightly ahead of that pace, again, driven primarily by standard product orders. Service in the quarter was up significantly versus the prior year, but still well off twenty nineteen due to the large project work that year, the tough comparable, and the continued effects of COVID. There were, however, a few bright spots in service, which I'll talk to when I get into the regional comments. Starting with the Americas, we continue to see broad based improvement in our key verticals of industrial MRO, civil construction, and power generation. Year over year total sales improved about thirty percent due entirely to product sales. Dealer confidence continues to improve keeping with the continued return of retail demand this quarter, and we're seeing a nice build on our funnel of HLT, machining, and special projects in the civil construction space. Sell-through at our large national distribution and more typical stocking orders across all distributors continued throughout Q4. Service and rental came in slightly down compared to last year as we continue to see larger turnaround work, especially in the Gulf, and projects get pushed to the right due primarily to COVID restrictions on job sites, as well as our co-dependency on other suppliers of parts and labor at those sites. In Latin America, the continued strength in iron and copper drove sales in mining despite continued significant challenges around COVID and political uncertainty in certain countries. Now moving onto Europe, the region delivered another solid quarter with over thirty percent year over year core growth and about ten percent core product growth compared to fiscal nineteen. While travel restrictions are still limiting customer visits, the impact to the business was relatively small as our customers are finding ways to work around the impacts of COVID. From a vertical market perspective, power generation, infrastructure, and oil and gas contributed to the strong results, and we again delivered several large orders from our heavy lifting group into infrastructure, Aero, and civil construction. Channel performance at both general and value-add distribution was strong, and inventories appear to be well balanced with the demand. Service in Europe was a very good news story as we benefited from some large projects in the North Sea; both labor and rentals were up sharply compared to the past several years. Moving on to the Asia Pacific region, the region delivered nearly twenty percent year over year core sales improvement despite continued challenges with the COVID-related restrictions and lockdowns, again, particularly in Southeast Asia. Similar to my comments last quarter, we are keeping a close eye on this region as it hasn't experienced the same level of recovery as the Americas and Europe with continued lockdowns and our distributors and staff's inability to travel. Mining continues to drive sales in Australia, particularly in iron, and we're looking for improvement in our oil and gas related product and service rental opportunities as we enter twenty twenty-two with increases in the plant shutdowns and maintenance activities in the region. Moving on to slide eight and the MENAC region, I'm pleased to report this region delivered nearly thirty percent year over year core growth in the quarter as well, again, despite continued COVID-related shutdowns and travel restrictions. Consistent with Q3, our focus on expanding product sales into non-oil and gas verticals continues to deliver positive results, again, especially in power generation this quarter. We saw a thirty percent year over year service growth as projects are slowly coming back online. As I mentioned earlier, we are still down versus twenty nineteen as the large service projects that drove our strong performance that year still have not come back. Our ability to move people around the region is our number one priority, and we continue to navigate various restrictions country by country. Service backlog improved over the course of the quarter as we enter our seasonally busier time ahead. Now moving into operations, the headline was certainly the significant supply chain challenges, material cost increases, and logistics constraints that continue to ramp up throughout the fourth quarter. I'm pleased that we continue to deliver strong on-time delivery performance despite these various challenges, but we do expect these factors will continue to present headwinds as we move into fiscal twenty twenty-two. We're taking steps to counter risk by working with existing suppliers to provide better forecasts, placing additional advance orders, and establishing additional suppliers where we can to backstop regional variations and supplier performance. From an inventory perspective, we did end the quarter slightly higher than Q3, and this comes as a planned move to stay ahead of demand and longer than normal lead times. We've been working proactively with many of our OEMs and national accounts to secure longer than usual advanced orders and forecasts to stay ahead of these extended supplier deliveries and have gotten a lot of great participation so far from these partners. In terms of price actions, we did execute the June action as we discussed last quarter, as well as taking some additional targeted pricing in August as we continue to see our cost move throughout the quarter. We continue to be laser-focused on cost as we move through our first quarter here in twenty twenty-two and are poised to take further actions as required. Now finishing up with Cortland. The business experienced core growth of twenty-eight percent year over year in the fourth quarter compared to eight percent in the third. In our industrial business, order rates held up well in the fourth quarter, lead times improved despite working through several production challenges, but we did not make as much headway working down the backlog as we hoped in the fourth quarter. We expect to see that backlog reduce in the first half of fiscal twenty twenty-two as labor shortages have improved and productivity increases. As for the medical side of the business, we saw a meaningful increase in orders in the fourth quarter compared to the third quarter, and we succeeded in moving our new textile technology platform into the production phase, which was an important step in our medical expansion strategy. We expect the transfer of additional platforms in fiscal twenty twenty-two as we complete ongoing development and qualification activities with several customers. And with that, I'll turn the call over to Rick for the financials.
Rick Dillon, CFO
Thanks, Jeff, and good morning, everyone. Before we move on, let's just continue with Cortland for a moment. Adjusted results exclude an approximately six million dollars impairment charge on our Cortland Industrial business. The charges are a result of the extended impact that COVID has had on the business and our inability to realize three million dollars in annual savings from our previous footprint optimization actions. As market conditions return to normal, our team remains focused on driving commercial growth and operating efficiencies that will improve the performance of the business going forward. So, now let's recap our fourth quarter adjusted results on slide nine. Fiscal twenty twenty-one fourth quarter results were one hundred and forty-five million dollars, which increased two percent from the third quarter and thirty-one percent when compared to the fourth quarter of the prior year. This was below our expectations and directly attributable to supply chain and logistics constraints. Tool products core sales were up approximately twenty-two percent compared to the prior year and two percent compared to the third quarter. Service sales of thirty million dollars were down slightly versus the third quarter, but increased fifty-five percent compared to the fourth quarter of fiscal twenty twenty, which was the trough for our service business during the pandemic. Cortland sales were up twenty-eight percent compared to the prior year and nine percent sequentially. Adjusted EBITDA margin for the quarter was just under seventeen percent, up from the nine percent reported in the prior year and down fifty basis points from the third quarter. The adjusted tax rate for the quarter was thirty-six percent, which is down from fifty-one percent reported in the prior year. The full year adjusted effective tax rate was approximately twenty-one percent and in line with our expectations. Turning now to slide ten. As mentioned earlier, both product and service sales were up significantly compared to the prior year. FX continued to have a favorable year-over-year impact on sales, providing a two million dollar tailwind in the quarter. Targeted pricing actions, which we will get into in more detail here later, had roughly a one million dollar impact on the top line as well. Turning to adjusted EBITDA on slide eleven. Previous fourth quarter results reflect temporary cost savings actions in response to COVID that yielded approximately nine million dollars in savings. The return of product and service volume continues to have the impact we expected on both EBITDA margin and dollars. We saw a sixty-seven percent flow through on year-over-year product volume improvement and fifty-three percent flow through on year-over-year service volume. Consistent with the third quarter, the increased volume drove favorable manufacturing variances, improved labor productivity, fixed cost absorption, and service utilization. Pricing actions in the quarter offset higher freight and material costs, and this is the primary driver of the fifty basis point margin compression in comparison to the third quarter. This leads me to an update on supply chain on slide twelve. The expanding supplier lead times and logistics bottlenecks in response to increased demand and material shortages have not improved. We continue to navigate these delays through extreme focus on sales and operations planning, leveraging two second and third supplier relationships, qualifying alternative materials and components to address shortages, and utilizing all available transportation lanes. We estimate that these delays have resulted in approximately four million dollars to five million dollars of increased backlog as we exited the fiscal year. As supply and logistic challenges continue, we do not expect a material reduction in the amount of constrained backlog as we progress through the first half of fiscal twenty twenty-two. We did experience one million dollars in headwinds from both freight and material costs during the quarter. As we discussed on the third quarter call, we announced pricing actions to cover these costs, which neutralized the impact on our fourth quarter results. We implemented additional targeted pricing and surcharges in the quarter as inflationary pressures continue. We estimate that fiscal twenty twenty-one pricing actions will result in approximately ten million dollars to thirteen million dollars of incremental top-line annual sales in fiscal twenty twenty-two. As we saw this quarter, we do expect margin compression as the announced pricing will serve to offset anticipated inflationary costs, which we believe will be around throughout the first half of our fiscal year. We are assuming moderation in both material and freight costs in the back half of the year, and coupled with normal annual pricing actions, this should yield one percent to two percent price realization for fiscal twenty twenty-two. As Jeff stated, we will continue to monitor our incoming costs and if necessary, we will implement targeted pricing and/or surcharges in twenty twenty-two. A few more comments here before I wrap up with liquidity. As Randy noted, our fourth quarter marks the fifth consecutive quarter of sequential improvement, continuing to break from normal seasonality. As we look to fiscal twenty twenty-two, we do anticipate falling back into our normal quarterly pattern. Historically, our first two quarters are sequentially down from the fourth quarter, followed by accelerated growth in the third quarter, which is the seasonal peak for both tools and service and moderating into the fourth quarter. As has been true historically, large service projects and heavy lift orders can cause some lumpiness, but generally, this is the sales pattern we expect going forward. We have included a few details on our seasonality and typical quarterly revenue spread in the appendix. We have also included on slide fourteen some additional baseline fiscal twenty twenty-two modeling assumptions on the tax rate, cash taxes, depreciation, amortization, interest expense, and CapEx based on what we know today. So wrapping up with liquidity on slide thirteen. We generated twenty-seven million dollars in free cash flow during the quarter, working capital improved by eight million dollars, offset by capital expenditures of three million dollars. Receivables improved eight million dollars in the quarter compared to a third quarter increase of seventeen million dollars, so improved from that third quarter increase of seventeen million dollars. Inventory did go up in the quarter by approximately two million dollars reflecting a continuation of balancing supply chain constraints and increasing demand. We generated over sixty-nine million dollars of free cash flow in fiscal twenty twenty-one and our free cash flow conversion for the year was well in excess of one hundred percent. We paid down twenty million dollars in debt and ended the quarter with one hundred and forty million dollars in cash on hand and net debt of thirty-five million dollars. This is in comparison to a net debt of one hundred and three million dollars at the end of fiscal twenty twenty. Our leverage is at zero point six, down from one point one at the end of the third quarter and one point eight in the prior year. We expect our leverage will continue to improve in fiscal twenty twenty-two with year-over-year EBITDA growth and as COVID-impacted quarters drop off from our trailing twelve-month EBITDA. Our strong balance sheet positions us well as we look to continue our strategy execution and disciplined capital allocation. Randy, I will now turn it back over to you.
Randy Baker, CEO
Thanks, Rick. We're going to turn over to the last slide on page fourteen. Now with twenty twenty-one behind us and the effects of COVID largely diminishing in our key market areas, including North America and Europe, we have a more optimistic view of twenty twenty-two. The consistent and sequential growth experienced in the third and fourth quarter and the return to a normal operating range has facilitated our twenty twenty-two guidance of five ninety million dollars to six ten million dollars. We expect growth rates for Enerpac Tools to be in the low to mid-teens, while service continues to grow at a slower rate in the low single digits. Cortland is projected to grow in the low twenty to mid-thirty percent range, driven by strong medical device sales. Our incremental margins for twenty twenty-two are projected to be in the normal operating range of thirty-five percent to forty-five percent, excluding the impact of currency. We also expect Enerpac to return to normal seasonal flow, where Q1 and Q2 are the weakest quarters followed by a stronger second half. Additionally, we have considered the headwinds we are experiencing from microeconomic inflation, supply chain constraints, and the continued impact of COVID in APAC and the Middle East. Secondly, we have considered the potential for the positive effect of the U.S. infrastructure bill in the latter portion of twenty twenty-two. Our assumptions for fiscal twenty twenty-two remain consistent with prior quarters, although we are monitoring the potential for U.S. tax code changes. As I said earlier, the opportunity to lead Enerpac has been a very gratifying portion of my career. And I would like to extend my sincere thanks to all our employees for their dedication, as well as our investors for their support. Operator, that concludes today's prepared remarks; we can open it up for questions.
Operator, Operator
Thank you. We will now be conducting a question-and-answer session. Our first question comes from the line of Brendan Popson with CJS Securities. Please proceed with your questions.
Brendan Popson, Analyst
Hi, good morning. I would like to ask about the impact of the supply chain and freight on your EBITDA margin. Can you quantify how much the impact is? If everything were normal, where would you expect it to be, and how many basis points do you think you are losing this year because of that?
Rick Dillon, CFO
In focusing on the fourth quarter, despite a fifty basis point impact mainly from pricing offsetting increased freight costs, we expect to be slightly above seventeen million dollars, similar to what we reported in the third quarter. Looking ahead to our 2022 guidance, we anticipate pricing in the range of ten to thirteen million dollars, primarily realized in the second half, along with other pricing strategies contributing to one to two percent realization. This calculation indicates that our net flow from pricing actions is lower, reflecting margin compression as we work towards returning to our 2019 levels for both products and services, which are significant factors in our decision to guide just below the twenty percent target. We remain confident that once we overcome supply chain and logistics challenges, we will be back on the right path.
Brendan Popson, Analyst
Thank you. Could you provide more details about what happened with Cortland and the challenges in achieving the cost savings from the restructuring?
Rick Dillon, CFO
Sure. I'll start, and then Jeff can add his thoughts. The impairment reflects a long-term perspective based on current market conditions and the ongoing challenges we're facing, particularly in our industrial sector. It also considers our ability to achieve operational efficiencies, as well as the impacts from COVID and reduced volume, which affect our long-range forecast. In 2019, we made changes to separate the medical and industrial businesses, which we anticipated would yield approximately five million dollars in savings. However, COVID-related operational inefficiencies, labor shortages, and a sluggish market have hindered those expectations, with forecasts indicating that recovery won't be as robust as initially predicted. As we've discussed, the improvement in margins for that business relies on volume and restructuring savings, and these challenges have prevented us from achieving that. The impairment charge this quarter resulted from our annual review of the long-term forecast and anticipated profitability, with no specific issues triggering it, just the usual assessment process.
Brendan Popson, Analyst
Okay. Thank you for the color. I appreciate that. And best of luck Randy.
Randy Baker, CEO
Thanks. Appreciate it.
Operator, Operator
Thank you. Our next question comes from the line of Jeff Hammond with Keybanc Capital Markets. Please proceed with your questions.
David Tarantino, Analyst
Hey, good morning. This is David Tarantino on for Jeff. So just to follow-up on supply chain, maybe could you talk a little bit more about your ability to capitalize on the underlying demand, given it appears demand continues to recover and you have been building your inventories?
Rick Dillon, CFO
As we consider demand, we are managing our way through lead times while building inventory. For our high-volume products, we have made strategic decisions to ensure that inventory is available, allowing us to take advantage of growing demand. This is reflected in our product growth guidance, as we aim to leverage demand and maintain a strong supply chain to capture sales. Some of our products have longer lead times, and we are carefully deciding which inventories to build as demand increases. We anticipate some backlog, particularly within the five million dollars mentioned, related to longer lead time sales, and we expect some challenges as we head into the first half of the year. Our sales planning is focused on meeting the demand for our high-volume and fast-moving products.
Jeff Schmaling, COO
Yes. The only thing I would add is that, in my comments I mentioned our pretty strong efforts throughout the third, actually in the fourth quarter, working with certain larger partners to get a better advanced view of their requirements. Normally, we would be talking to them about our quarter or two outlook and we're actually pushing them to talk to us more on an annual basis in terms of what the requirements are going to be. And that's really all meant to give us a chance to provision those, especially those longer lead components, and be responsive to the time delivery that they continue to expect, despite the challenges we're facing. So, yes, it's a balancing act for sure.
Rick Dillon, CFO
That's a great point to add that I skipped over. We do see that in our backlog, it's not necessarily incremental sales, but having that forward view of demand is key to navigating in this environment.
David Tarantino, Analyst
Great. Thank you. That's helpful. As a follow-up, could you elaborate on your expectations for fiscal twenty twenty-one from an oil and gas perspective, as well as how it performed in the quarter, considering you mentioned seeing some pent-up demand in last quarter's earnings call?
Jeff Schmaling, COO
It's really kind of a region by region answer to your question. We anticipated, frankly, a little stronger quarter in the Gulf, which did not materialize. In the Middle East and North Africa, sales did improve pretty much the way we saw it in the quarter. So really this is all about just getting plants back to work, getting our folks able to travel. I would say the Gulf was slightly disappointing, Middle East pretty much what we expected, and we expect both of those to continue to improve as we go into twenty twenty-two.
Operator, Operator
Thank you. Our next question comes from the line of Deane Dray with RBC Capital Markets. Please proceed with your questions.
Deane Dray, Analyst
Thank you. Good morning, everyone. Just start off with the awkward question and from our perspective, this leadership change looks abrupt and unexpected. Randy, I know you don't speak for the Board. So, I guess what I could ask is, when would the earliest that we would hear from Paul, the new CEO in terms of the operating plan, longer-term strategy? I know you suggested that there wasn't going to be any change, but in this transition, when would the earliest point that we would hear from new leadership?
Randy Baker, CEO
Well, first off, any time you have a CEO change, you try to do it in an extremely orderly manner. And as I mentioned in my commentary, one of the things that's extremely important to me is we continue through the execution of our strategy is that there is an M&A component to that. And I have always felt that if you acquire, you need to run it. You can't just decide to retire midstream as you acquire something, particularly when putting something in scale. From my perspective, that has always weighed on my mind as I approach the big 60 in my life; I always felt that that was a time frame in my commitment to my family that I needed to fulfill. So that was out there. And I think our Board has done a great job of looking at what was available in the market, thinking about what they wanted for CEO transition, finding somebody with extremely good operational experience and also a track record of growth. They could take what we built here and move on. I think in the first quarter, you will definitely hear from Paul. It's part of the process for any CEO to come in, assess the business, get to know the people, number one; get to know our major shareholders and then start discussing with the sell side. So I would expect you'll see things in Q1 for sure.
Deane Dray, Analyst
That's actually really helpful, thoughtful response. So I appreciate it, especially as we recognize that the company is on the threshold of pivoting to growth. And I fully appreciate that if you're making a no-go decision on a larger deal, you should be around to see it through as well. So I appreciate that as part of your answer. And just looking at Paul's background, he comes and has had experiences in a number of impressive organizations. And so that certainly looks as though there will be lots of his expertise. So we appreciate that. And I wish you all the well and the Big 6 though is not that big a deal, let me tell you.
Randy Baker, CEO
It's just a number.
Deane Dray, Analyst
Yes, I have a follow-up question regarding the current business situation. I'm really interested in the fact that you have incorporated some advantages from infrastructure spending for the second half of fiscal year 2022. Could you share what types of spending you expect to benefit from, both in quantitative and qualitative terms, and what you foresee in a shorter timeframe? I would appreciate that. Thank you.
Randy Baker, CEO
Let me share my experience with past infrastructure spending, specifically related to the T21 bill from many years ago. Once that bill was signed, there was a specific process for allocating funds to states and projects, involving design, bid letting, and awarding, which takes several quarters. As we consider fiscal year 2022, if a bill progresses, we could see some activity before the end of this calendar year. If that occurs, we would likely experience bidding and awarding activity in the third quarter, with potential project impacts in the fourth quarter. The contents of the bill are variable, but we've noticed segments focusing on true infrastructure. Enerpac benefits from road construction, bridge repairs, significant airport expansions, and rail projects, all of which positively affect our tool sales. The timeline depends on how quickly firms awarded contracts can assess their heavy equipment and maintenance needs, where we fit in. We considered this in our outlook, and while we are optimistic that it may provide a favorable boost for us in Q4, we cannot quantify that impact with certainty at this time.
Deane Dray, Analyst
I appreciate that color. Thank you.
Operator, Operator
Thank you. Our next question comes from the line of Ann Duignan with JP Morgan. Please proceed with your questions.
Ann Duignan, Analyst
We have a rigorous process for developing our guidance, and I’ve discussed this with Paul. While he can't comment in detail from a company perspective yet, he understands the macroeconomic factors that affect us. He is aware of our run rate and the sequential improvements we’ve made. When we established our guidance range, it reflected a sense of comfort from our Board of Directors and from Paul. I have discussed the business with him extensively. I appreciate his background, similar to mine, working at large corporations early in his career, including experiences at Sandvik, Ingersoll Rand, Komatsu, and CNH. Each of those roles provided me with significant insights into M&A, business growth, and operational management. Paul has a similar background, and Danaher is recognized as one of the best-run companies, which impresses me about his career and his perspective on business operations. He will have the opportunity to engage with our investors and share more about his career and its relevance to Enerpac. I view Paul as a great athlete who can transition between companies and leverage his experiences in major organizations here at Enerpac. I have high expectations for him, and I know that the Board of Directors supports him, which is crucial.
Ricky Dillon, CFO
Just adding one thing. To be fair, Paul has not set or really had any opportunity to weigh in on our guide. He's still a JBT employee. As a management, we believe this is the appropriate guide and certainly walked him through it. But he has not set the guide and he's not signing off on the guide. You have to do a lot of work to be able to do that. We believe we've gotten him to the right answer, and we believe it's reflective of where we are and what we can do in twenty twenty-two, but I don't want to say that he signed off on the guide.
Ann Duignan, Analyst
Thank you for that. I appreciate the color. And then maybe my follow-up would be on the guidance and the notion that we will see normal seasonality. Again, given the lack of visibility and given the overhang of COVID and whether we get an infrastructure bill or don't, how much confidence do you really have in achieving normal seasonality? I mean, is Q1 already turning out like a normal Q1 or do we have to correct it a little bit more because we still have all these supply chain issues? I'm just trying to get a sense of how much visibility you have into normal seasonality from where we stand today. Thank you.
Randy Baker, CEO
I'll begin, and Jeff or Ricky can add in. When we refer to normal seasonality, we mean the transition from last year's Q4 to Q1, where we actually saw an increase. Typically, you wouldn't expect that; instead, you'd anticipate a decline in Q1 compared to Q4, which is what we anticipate will occur this time. Given that last year's Q1 was significantly affected by COVID, you would expect to see some year-over-year growth based on our annual guidance. Therefore, when we mention normal seasonal patterns, we are referring to the relative performance of each quarter. Additionally, I want to emphasize that we see infrastructure as a supportive factor for our guidance. We do not require an infrastructure bill to achieve the guidance range we have set.
Ann Duignan, Analyst
Okay. That's great. So normal seasonality is just more directional; we shouldn't take it as an absolute X percent buffer beyond this. Okay. Well, Randy, I wish you luck, I've known you a long time. So keep in touch.
Randy Baker, CEO
I appreciate that, Ann. Thanks. All the best to you.
Operator, Operator
Thank you. Our next question comes from the line of Michael McGinn with Wells Fargo. Please proceed with your questions.
Michael McGinn, Analyst
Hey, good morning, afternoon. I'll echo the earlier comments from my peers. Randy, it's been a pleasure and best of luck.
Randy Baker, CEO
Thank you.
Michael McGinn, Analyst
Digging into the guidance, it looks like you have products outpacing services, and that makes sense given the start-stop nature of this COVID-driven economy. So, I guess my question is, if you had the visibility on the services, and that's a relatively high fixed cost manpower business, what would the incrementals look like, especially as the bulk of pricing discussions thus far have been based on products? But any commentary on wages and baking that into your service assumptions long-term given wage inflation seems a little less transitory.
Ricky Dillon, CFO
I can address that or would you like me to start? Looking at the business, the primary factor influencing margin is labor, which acts as a variable cost for us. The challenge arises during periods of mobilization when labor can become underutilized due to a start-stop effect. In our forecast, services are lagging behind product sales, and we won't reach the levels we consider normal, which we refer to as twenty nineteen standards. This is largely because, as Randy mentioned, certain regions are still being significantly affected by COVID. Therefore, we're seeing a slower start in service activity compared to what we would classify as normal. We believe we've adjusted our labor resources accordingly. The main impact you will notice, reflected in our forecast, is the loss of volume, which could have yielded margins as high as 40%. That's our perspective on the situation. Randy, Jeff, do you have anything to add about the regions and their anticipated progress?
Jeff Schmaling, COO
No, I think you've got it Rick.
Michael McGinn, Analyst
Great. And in the deck, you allude to six new product categories within NPD. So if we're in a more normalized environment, I'm curious on whether you think that momentum drives more sales or more gross margin? And maybe with the impact of having the second and third store suppliers does to R&D development heading into fiscal twenty twenty-two and rationalizing older products faster to put material to use of better suited product suites?
Jeff Schmaling, COO
Yes. New products lead to increased sales, especially as we focus on a few specific verticals where we aim to understand the required products and attract new customers for our existing offerings. In short, we anticipate additional sales from our new product development initiatives. Regarding your question about whether the current supply chain challenges prompt us to reconsider older products, as Rick mentioned earlier, we usually deal with longer lead time products which tend to have lower sales volumes. As these consume resources, we are closely evaluating the possibility of retiring some of these lower volume products that have become more problematic in the current supply chain situation. So, yes, this situation compels us to take action, and it is beneficial for our organization to phase out some of the older products. Nevertheless, our new products remain a key focus of our strategy, and we will continue to make significant efforts in this area throughout the year.
Michael McGinn, Analyst
Got it. And if I could sneak one more in, clearly the balance sheet is in great shape here, free cash flow generation is over one hundred percent of your target. I’m asking this because this company is undergoing a few changes as a conglomerate. When you mention that the acquisition pipeline has been reshuffled or developed again, what does the ideal acquisition candidate look like for Enerpac moving forward?
Randy Baker, CEO
Let me just weigh in on that and then Jeff and Rick certainly should as well. But we believe, and our Board of Directors believes that acquisitions surrounding the tool industry that support the heavy, light, and vehicle repair market are the correct targets for capital allocation. There are verticals that we see as very interesting, which we've spoken to in the past at length. The verticals that I think we have growth opportunity, obviously, is infrastructure. We're very good at that. We know the things that surround the power generation industry, both renewables and traditional are extremely important vertical and acquisition targets. On and off-highway vehicle repair is also a very strong one for us. And then lastly, and this is no ranking order, but we are also very good in the general industrial repair market, which means the repair names, any facility, factory manufacturing, any type of product, we're very well placed. And products that expand that are the ones that we're highly interested in. The reassurance that we do not believe becoming a diversified industrial company is a strategy that makes sense. What makes sense is what we took several years to create, which is a pure-play, very focused tool company with outstanding margins and cash generation that speaks for itself; a balance sheet that lends itself to make those acquisitions, but all the time keeping focus on this so that what we've built here is not damaged in any way. And I know that the Board of Directors are very focused on that. So that's where you'll see activity. Certainly, Paul will look at it with new invigorated life, but that's the beauty of having a new CEO; you come in full of energy and looking at ways to not only enhance it but to accelerate it in some cases. So I'm really, really hopeful that that's the case. But I don't believe that it's a complete deviation from a strategy is something that an investor or the market should be concerned about.
Michael McGinn, Analyst
Got it. Appreciate the time.
Randy Baker, CEO
Thank you.
Operator, Operator
Thank you. There are no further questions at this time. I'd like to hand the call back over to management for any closing comments.
Randy Baker, CEO
Once again, I want to thank all of our investors and our employees worldwide for their support over the years. This has been a very gratifying piece of my career. And I look back at the last five point five years with a lot of fun memories and a lot of good friends and everybody that I've had the opportunity to work with in my career; it's been a real pleasure. And I hope everybody has a very safe and happy rest of this calendar year and into twenty twenty-two. So, operator, thanks very much, and that concludes today's call.
Operator, Operator
Thank you. That does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Have a great day.