David Schulz: Yes, Sam. Again, I want to provide a little bit of perspective relative to the peer group that you outlined there. We do believe that we have a much higher percentage of our business is project related. And many of those projects include engineered components that have much longer lead times as we went through the recovery of COVID in ’22 and into ’23. We clearly saw the increase in our inventory days, primarily driven by that project and that project backlog, getting what we could get when we could get it and then waiting for those customized engineered components. This is something that we are very clearly focused on. We did not make the progress that we were expecting to make here in the back half of 2023. It’s something that we have included in our outlook for free cash flow going forward is that we will reduce our inventory days in 2024.
But clearly, some of it is relative to the competitive group, some of it is the business mix, and some of it is the types of projects that we service around the globe that, in some cases, include longer lead times and then longer time for us to service the customer.
Sam Darkatsh: Thanks. And my second question, the thinking behind lowering the target debt range, John, I know your company is historically comfortable with leverage. You have, I would say, at least an inarguably undervalued equity in a year, you’re going to call the preferreds. You’ve got countercyclical cash flows. I think you mentioned in your prepared remarks that you’re real pleased to do this. Why is this the optimal capital structure versus the prior 2 to 3.5 turns?
John Engel: Two things, Sam. One is the confidence in the upsized cash generation characteristics of the combined company. We’ve got a guide that will give us record free cash flow this year. So I mean, we’re — I remain more confident than ever about the underlying characteristics of our business model and the ability to generate cash. What we outlined at our Investor Day, we’re confident and strongly committed to, that’s the underlying cash flow characteristics of the business. What we outlined there as well as outperforming the market over the top line consistently over time and then delivering the EBITDA margin expansion. So that’s the first driver. We delevered very quickly, much faster than we had committed externally, and we’re very confident in the underlying cash flow characteristics.
Secondly, I think it’s a recognition of — and based on some investor feedback, that we should — we — in general, we should operate with a little bit lower leverage ratio. And we’ve looked at our investor peers and others. And so I think this represents — we always were going to move here at some point, Sam. It’s just a matter of when. And it’s a decision we’ve looked at for some time and made that decision, obviously. But we think it sends a very strong message that we’ll operate consistently as a target within a lower target leverage range and still with increased capital return to shareholders in the form of dividends, which were increasing, announcing the intent, our intent to increase it as well as continuing our share buyback program that we’ve got authorized.
So I think it’s a very strong message. We hope that you see it as such.
Sam Darkatsh: Thank you.
Operator: The next question comes from Christopher Glynn with Oppenheimer. Please go ahead.
Christopher Glynn: Hey, thanks. Good morning. Just wanted to dive into some of the uses of cash going forward. Share repurchase, you had $1 billion authorization intent to use it by ’26. It seems like you’re talking more about opportunistic levels now. I think we’re expecting you’ll have the cash for $540 million preferreds in the second quarter, ’25. And just curious, in those context, if you could help us think about those, what amount of balance sheet cash is appropriate is sort of a threshold benchmark?
David Schulz: Yes, Chris, let me start by just grounding everyone on the primary sources of cash. We’ve walked through that. We provided you our outlook, $700 million of free cash flow at the midpoint of the guide. The dividend payments, including the common and the preferred, rough around $140 million of cash in 2024. That still leaves us with about $560 million of cash that we can allocate against our priorities. So from that perspective, we’re going to be opportunistic on the share buyback. We have the $1 billion authorization. That is not time bound. So that is something that we can always leverage here up to that $1 billion limit. We’re still at the very early stages. We have not done a considerable amount of share buybacks over the past two years.
So from our perspective, we’ll be opportunistic on whether we continue to pay down existing debt or we leverage that cash for share buybacks. And like we use that word opportunistic quite a bit. That’s exactly how we look at it is where can we get the best return. As we think about paying down our existing debt, that just frees up capacity on our existing facilities that we’re keeping in mind that we do have that preferred that needs to be taken out in the second quarter of 2025. So that is part of our calculus as we think about deploying cash here in 2024.
Christopher Glynn: That’s great color, Dave. Just one other component, is about $0.5 billion what you should have on the balance sheet to support your operations on average?
David Schulz: That’s correct. I mean that’s the amount that we typically have been carrying. So we’re comfortable with that $500 million to $600 million of cash on the balance sheet. And again, we think about that as supporting the day-to-day business, particularly as we go through the different elements of building sequential sales throughout a typical year. So we want to make sure that we’ve got the available capital on the balance sheet.
Christopher Glynn: Okay. Great. Thank you.
Operator: The next question comes from David Manthey with Baird. Please go ahead.
David Manthey: Hi. Good morning, guys.
David Schulz: Hello, David.
David Manthey: First question, so this time next year, when we look at the right-hand side of slide nine, that EBITDA bridge, what you’re telling us is that all three of those bars should be green? They might be really skinny, but they’ll be green. Is that your expectation?
David Schulz: So Dave, we did highlight that — and just for the audience, we’re referring to the fiscal year 2023 sales and EBITDA bridges that were in our prepared remarks, slide nine. We would anticipate that sales will be a positive green, gross margin rate and gross margin sales as we commented, we would expect that to improve year-over-year. SG&A would still be negative, but we expect to get leverage — operating leverage on SG&A.
David Manthey: Okay. All right. That’s fair. And then I’m thinking about the — what you mentioned on rebates being stable. When I think about the supply chain issues working out, backlogs down, I mean the inventories are still somewhat elevated as we’ve kind of talked about, maybe you don’t think that relative to the project business, et cetera. But when you say rebates are going to be stable, it would seem like downside would be more likely. Can you just talk us through why you think that flat is the right idea there?
David Schulz: Yes, certainly. We negotiate our supplier volume rebate programs with our supplier partners every year. And it’s generally based on a joint view of what the market growth opportunities are and then what are the specific products or product categories that our suppliers are incenting us to ensure that we push through to the channel. The — as you take a look at the history of our supplier volume rebates, we did about 1.6% of sales in 2022. That was on a performance that included us being at the higher end of those growth rates during 2022. That moderated here in 2023. So we lost about 20 basis points, about 1.4%. Our expectation is that we’re going to continue to negotiate and hold that supplier volume rebate given our outlook for sales that we provided to you.
Again, those supplier volume rebates get reset to market expectations every year. So you can see what some of our supplier partners have put out in terms of their expectations for 2024. We’re still negotiating but our expectation is that our SVR as a percentage of sales will be relatively consistent 2024 versus 2023.
David Manthey: Okay. And if I can just close the loop on this thought finally here. Dave, you said you don’t want to talk too much about the SG&A reductions. But maybe if you could talk about the areas you’re targeting for reduction as opposed to quantifying that? You talked about two-thirds of your increase in the current quarter coming through facilities, IT, sales promotions, the other third benefits in health care. Is it one of those? Is it something outside of those? Can you just talk in broad strokes about the areas that you’re targeting?
David Schulz: Certainly. And again, we’ve done this before. And we are coming off of two years with significant double-digit increases in ’21 and ’22, our sales growth moderated unexpectedly in the back half of 2023. We had some SG&A items. There’s always some puts and calls whenever we close the year. In 2023, everything went the wrong way. And again, as we think about what we’ve got to target from an SG&A perspective going forward is we’ve got to get the profitability back. And that means we’ve got to reduce our SG&A as a percentage of sales. Like we’ve done in the past, we’ll target a combination of discretionary spend plus some structural spend. That includes how do we consolidate some of our facilities to reduce our costs.
We’ll be very, very focused on headcount management based on the demand that we see out there. We do want to continue to invest in our digital transformation. So that is something that we want to make sure that we’re able to continue to pull forward. And so from my perspective, this is a combination of tighten the belt on discretionary expenses and then focus on some of the structural changes that we need to make to ensure that we’ve got the profitability that we expect internally but also you and our investors expect from us.
David Manthey: Thank you very much.
Operator: The next question comes from Patrick Baumann with JPMorgan. Please go ahead.
Patrick Baumann: Hi. Good morning. Thanks. Just wanted to go back to slide six and go over some of these fourth quarter items in terms of missing on the sales expectations you had. Maybe first on the CSS business. Can you talk about like where specifically you saw projects delayed? Was this like the Rahi business you acquired? Is it data center-related? And then what’s your visibility of that coming back in ’24? Is that embedded in your outlook? And then on the EES segment, a couple of ones here. Like how big is solar for you? I don’t remember you guys talking much about that before. And then what’s in OEM, like what’s declining? I mean, I feel like this is a business where you don’t have a lot of visibility to — over the course of the year, you talked about manufactured housing. You’ve talked about small vehicles. It’s not clear to me what exactly is in the OEM business besides that and kind of what drove the weakness here in the fourth quarter would be helpful.
