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Briggs & Stratton Corporation (NYSE:BGG)

F2Q13 Earnings Call

January 24, 2013 10:00 a.m. ET

Executives

Dave Rodgers - SVP & CFO

Todd Teske - Chairman, President & CEO

Analysts

Josh Borstein - Longbow Research

Robert Kosowsky - Sidoti & Company

Brad Safalow - PAA Research

Peter Lisnic - Robert W. Baird

Operator

Good day, ladies and gentlemen, and welcome to 2013 Quarterly Earnings Release Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Dave Rogers. Sir, you may begin.

Dave Rodgers

Thank you, Norma. Good morning and welcome everyone to the Briggs & Stratton fiscal 2013 second quarter earnings conference call. I am Dave Rogers, Chief Financial Officer and joining me today is Todd Teske, our Chairman, President and CEO.

Today’s presentation and our answers to your questions will include forward-looking statements. These statements are based on our current assessment of the markets we operate in. Actual results could differ materially from any stated or implied projections due to changes in one or more of the factors as described in the Safe Harbor section of today’s earnings release as well as our filings with the SEC.

We will also make reference to certain non-GAAP financial measures during today's call. Additional information regarding these financial measures including reconciliations to comparable US GAAP measures is available in our earnings release and in our SEC filings. This conference call will be made available on our website approximately two hours after the end of this call. A phone replay will also be available within a few hours of the completion of the call.

Now here's Todd.

Todd Teske

Good morning everyone and thank you for joining us today. I will start our call today by providing an overview of our second quarter results. Than Dave will provide you with some additional details about our financial performance and then I will wrap up with comments by discussing our engine placement for the upcoming season and our outlook for the remainder of the fiscal year before taking your questions.

Our second quarter fiscal 2013 was impacted by weather related events as well as continued execution of our strategic plan to profitably grow our business. Second quarter consolidated net sales of $439 million was a decrease of approximately 2% from the second quarter of last year. During the quarter we saw solid demand of our products in response to hurricane Sandy, which has roughly the same geographic region as hurricane Irene and the early season snowstorms in the fall of 2011.

We also had increased sales of lawn mower engines to our domestic and European OEM customers compared to last year’s second quarter, as the OEMs began to produce products for the upcoming spring lawn and garden season. These year-over-year sales gains were not enough to overcome significant decreases in snow throwers and engines for snow throwers in the U.S. and European markets, both of which are experiencing lower than average snowfall for the second year in a row.

Back here in Milwaukee we set an all time record this winter for the most days in a row without measurable snowfall at 288 days. U.S. industry shipments of snow throwers were down over 55% for our fiscal year to date. In Australia, after having two year of sales increases in lawn and garden products and engines, the mover market has declined approximately 25% from last year due to exceptionally dry conditions in Queensland, New South Wales, South Australia, and the Northwest portion of Victoria.

Lastly, the dry weather conditions in the summer and fall and the lack of snowfall in the U.S. have caused a decrease in sales of higher margin service parts as consumers have not had to maintain or repair their equipment as much since they have not been using it as much. For the second fiscal quarter we reported consolidated net loss of $600,000 or $0.02 per diluted share, which compares to net income of $2.7 million or $0.05 per diluted share last year. The 2013 second quarter includes $6.6 million of additional restructuring charges to carry out the cost reduction activities that we announced in fiscal 2012.

It is also important to note that in the second fiscal quarter of 2012, we had a benefit of reserving approximately $5 million of tax reserves that did not occur again this fiscal year. Our second quarter consolidated adjusted operating earnings which excludes these two items, improved by $10.3 million to $10.9 million from approximately $600,000 last year. This improvement would not have been possible without the efforts of all our employees focusing on the execution of our strategy and achieving operating efficiencies by reducing cost throughout the business.

In addition to the improvement in adjusted operating earnings, we have improved cash flow by reducing our investment in net working capital by almost $16 million compared to last year. For the first six months of the fiscal year during which we typically build inventory for the upcoming spring, cash used in operations decreased by $90 million compared to last year despite higher contributions to our pension of approximately $11 million. Consistent with our strategy, we invested these cash flows into higher margin opportunities in an emerging market region of the world via the acquisition of Branco, Brazil’s leading brand of light commercial power equipment including generators, pumps and diesel engines.

Branco has a leading market position in over 1200 dealers throughout the country. In addition, Brazil’s economy continues to outpace the developed markets that we operate in. We closed on the acquisition on December 7, and we are extremely excited about the opportunity to grow our business in Brazil and throughout Latin America. We welcome all of Branco’s employees to Briggs and Stratton and look forward to building on an already successful business.

Now I will turn it back over to Dave to walk you through more details of our segment financial results for the second quarter.

Dave Rodgers

Thanks, Todd. Engine segment sales for the second quarter were $274 million, a decrease of $12 million or 4.2% from the prior year. Shipments to third party OEM customers increased in the United States and in Europe, while shipments to OEMs in Australia decreased in the current year. In addition, intercompany shipments to our own products group for using portable and standby generators increased over last year. Quarterly shipments of snow thrower engines for the U.S. and European markets decreased compared to last year’s second quarter.

Total engine unit shipments were slightly under $2 million units and represented a decrease of approximately 3% from the prior year. In addition to the lower volumes, we began to see the impacts of pricing decreases on certain engines of approximately 1% to 2% during the quarter, which related to lower cost of materials. We also sold a higher percentage of smaller, less expensive engines in the quarter, unfavorably impacting our net sales dollars year-over-year.

For the second quarter, the engine segment had operating income of $9 million, an increase of $6.7 million from $2.3 million in the second quarter of last year. This year’s second quarter included restructuring charges of $4.3 million related to additional planned costs to execute the restructuring actions announced last year. Excluding the impact of these restricting charges, engines segment adjusted income from operations in the second quarter of fiscal 2013 was $13.3 million, an improvement of $11 million from 2012.

The adjusted operating earnings were impacted by 3.6% higher adjusted gross margins in the engines segment. Approximately 1% of the increase is related to savings from the restructuring actions initiated in fiscal 2012. Manufacturing and efficiencies experienced in fiscal 2012 in launching the Phase 3 emissions compliant engines did not recur in fiscal 2013, accounted for approximately 2% of the margin gains. We have also had productivity gains and cost reductions throughout our engine manufacturing operations, lower average cost of commodities and higher absorption of fixed costs and higher production levels, that have only partially been offset by certain pricing decreases to reflect lower cost of materials from the past year.

We produced approximately $2.3 million engines in the second quarter, an increase of approximately 3.8% from last year’s second quarter. ESG&A spending in the engines segment decreased in the quarter by approximately $3.2 million, after excluding $3.4 million of additional restructuring charges related to severance for headcount reductions and pension curtailment expense. Pension curtailment was required as a result of our announcement that our defined benefit plan will freeze effective January 1 of 2014. ESG&A spending has decreased due to the headcount reduction activities in the past year, partially offset by higher planned pension expenses.

Turning to the products segment, sales for the second quarter were $197 million, a decrease of approximately $18 million or 8% from the prior year. Increased shipment volumes of portable and standby generators and pressure washers were more than offset by decreases in lawn and garden products, in particular snow throwers. During the quarter, hurricane Sandy made landfall in the U.S. in November, generating demand for both portable and standby generators near the time of the event, but also for replenishing portables in the channel subsequent to the storm.

Order volume for standbys has increased over the last year even though in the prior fiscal year hurricane Irene landed in August and the October snowstorm on the East Coast knocked out power to millions creating additional interest and demand for these products. We are continuing to manufacture portable generators to replenish the channel inventories as well as our own inventories that we have committed to our retail customers. We estimate that channel inventories are as low as they have been in several years due to the significant consumer demand during the quarter.

Decreased snow thrower sales in the U.S. and in Europe, as well as decreased sales of mowers in Australia, more than offset the increased sales of generators in the quarter. Coming into this fall and winter, channel inventories of snow throwers were adequate for the season given that we had below average snow throughout the U.S. last winter. Retailers and dealers carried over inventory from last year, meaning that there was not much channel inventory fill needed for this season.

In addition, limited snowfall in the U.S. and Europe this year has not created much retail demand for snow throwers in the current year. While not typically a large quarter for selling lawn and garden equipment in the U.S., sales of these products were also down in the quarter compared to last year due to continued dry weather into the fall season in many parts of the country, and dealers waiting for spring to take additional inventory.

Dealer inventory levels are overall slightly lower than last year at this same time, meaning that on the whole dealers don’t have unusually high inventories on hand as a result of the drought last summer and the lack of snow this winter, which potentially bodes well for reorders as we head into the spring. Our decision to exit mass retail lawn and garden also decreased our sales slightly during the quarter. We anticipate that our quarterly comparisons will be impacted more significantly as we head into the spring and summer selling season.

Due to the timing of closing on the Branco acquisition in December 7, Branco did not add significant sales to our top line in the quarter. Products segment had a loss from operations of $6.8 million in the second quarter, compared with operating income of $600,000 in the second quarter of fiscal 2012. This year’s second quarter included restructuring charges of $2.4 million related to additional plan costs to execute the restructuring actions announced last year. Excluding the impact of these restructuring charges, products segment adjusted loss from operations in the second quarter of fiscal 2013 was $4.5 million.

The second quarter adjusted gross margin rate for the product segment was 10.6%, which compares to last year’s second quarter rate of 12.4%, a decrease of 180 basis points. Margins were negatively impacted by approximately 4% related to reduced production levels and thus reduced absorption of costs in the quarter. In order to proactively manage our inventory levels, we idled our McDonough, Georgia products manufacturing facility for four weeks during the quarter. This time was also effectively used in order to tool the plant for new product launches coming up for the spring lawn and garden season.

Offsetting the reduced absorption was the benefit of our cost reductions we initiated last year. The benefit of 2.2% was related to the closure of our Newbern facility and salaries headcount reductions last year. ESG&A expenses for the products business were $25.4 million, a decrease of $900,000 from the second quarter of fiscal 2012. The decrease was related to reductions in salaries and benefits associated with salaried headcount reductions in the last year, favorable foreign currency and lower bad debt costs, partially offset by increased expenses related to Branco.

The comparability of our consolidated net income for the year has been significantly impacted by favorable tax adjustments recorded in the second quarter of fiscal 2012 that did not reoccur in fiscal year 2013. As we called out in our second quarter last year, our consolidated net income for the second quarter of 2012, was favorably impacted by a net amount of approximately $5 million related to the settlement of certain state and local audits and the lapsing of statute of limitations in a foreign jurisdiction, for which we had reserves in our balance sheet related to an uncertain tax position.

Our effective tax rate in the second quarter of fiscal 2013 was also impacted by non-deductible acquisition related expenses. We anticipate that our full year effective tax rate will still be in a range of 31% to 34%. Turning to our balance sheet. Net debt at the end of the second fiscal quarter was approximately $229 million, essentially unchanged from a year ago. This is somewhat remarkable, as over the last 12 months, we have increased our quarterly dividend by 9%, used approximately $47 million to repurchase common stock, made contributions of $40 million to our pensions plan, and paid approximately $58 million for the acquisition of Branco.

These cash requirements have been effectively funded through reducing our investment and working capital, including reductions in accounts receivable and inventory from last year, totaling over $80 million net of the working capital added for Branco. In addition to $225 million of senior notes outstanding, we had drawn $18 million on our $500 million revolving credit facility at the end of the quarter. Cash used in operating activities year-to-date was $75 million, primarily related to seasonal build of inventory levels. Last 12 months cash provided by operating activities was $156 million. Year-to-date depreciation and amortization of $28 million outpaced capital expenditures of $17 million.

We did continue our share repurchase activity during the quarter, repurchasing an additional $6.3 million worth of shares outstanding. Year-to-date we have purchase $19.2 million worth of shares. We have authorization from the board to repurchase approximately $40 million worth of additional shares through the end of fiscal 2014. Last 12 months average funded debt and EBITDA as defined by our credit agreements were $245 million and $150 million respectively, resulting in an average leverage ratio of 1.6 times, which is well within our debt covenant of 3.5 times.

That concludes my comments on our second quarter financial results so now I will turn it back over to Todd.

Todd Teske

Thanks, Dave. Before I get into our outlook for the upcoming season and reminder of the fiscal year, I would like to make a few comments related to the execution of our strategy over the last few months. First, we continue to make progress towards completing our restructuring activities that we began last year in order to streamline our operations and take cost out of our business. We remain on track in terms of these costs related to our restructuring programs and the financial benefits as well.

Second, while we have taken some extended shutdowns in our products business in order to control inventories, the team has not stopped working on simplifying our product development and new product introduction processes. I was recently at our McDonough, Georgia products manufacturing plant and the changes our team is making to that facility in terms of simplifying processes, reducing complexity, reducing square footage and inventory, are significant. Make no mistake, we need to further improve the operation but we are headed in the right direction. I want to thank each and every one of our employees for making these changes happen.

Third, we recently announced that a lineup of Snapper walk mowers would be sold at Wal-Mart this spring. Consistent with our decision to exit mass retail lawn and garden products, we are licensing the Snapper brand. The license agreement requires that the units are powered by Briggs and Stratton engines. This is similar to our arrangements for the Murray branded product that was at Wal-Mart last year. We believe that others in the industry are better suited to manufacturing products for the mass channel and we will continue to sell engines to these OEMs.

Fourth, I would like to provide an update on our engine placement for the upcoming season. Over the last couple of years we have discussed our annual evaluation of the engine placement in conjunction with annual pricing discussions. When (inaudible) exited the engine market in 2007, our share of engines in the ultra-power equipment market reached all time highs in the following years. Over time we expected that other competitors may price aggressively in order to take (inaudible) place in the market. And we did not price to retain our record market share. Consequently, you have heard us say that we lost skew placement and a few share points in each of the last two years.

For the upcoming season, we believe that our engine placement in the market will increase from the 2012 season on both walk mowers and riding mowers. Also, since our decision to exit the sale of lawn and garden products to big box mass retailers, some have questioned who will garner this market share and more important to us, will those units be powered by Briggs and Stratton engines. We have been working with our various OEM customers to place our engines on those new skews at retail and today we believe that Briggs and Stratton engines will be on most of the skews that replace the products we formerly sold to the big box retailers.

These decisions to use Briggs and Stratton engines are the result of our team working diligently everyday to deliver on our value proposition that our customers expect from a Briggs and Stratton engine at a reasonable price. There is no doubt that the first half of our fiscal year has been impacted both positively and negatively by weather related events or the lack thereof. We continue to be encouraged by the revitalization of the housing market in the U.S. and also the prospects for economic growth in improving and emerging market regions where we do business.

Having said that, our team remains focused on achieving full year objectives and helping our customers achieve success as well. Looking forward to the remainder of the fiscal year, we are reaffirming our fiscal year 2013 projections for net income to be in the range of $60 million to $75 million, or $1.25 to $1.55 per diluted share prior to the impact of any additional share purchase activity or cost related to our announced restructuring programs in pension curtailment. We continue to be cautious with respect to the magnitude and the pace of economic recovery for both in the U.S. and abroad, the level of sustained consumer confidence and the ongoing, if any, of the drought conditions in the U.S.

We are projecting sales to be in the range of $1.95 billion to $2.15 billion, which takes into consideration lower sales of approximately $100 million due to exiting the sale of lawn and garden products to national retailers and lower sales of snow throwers in the current year. It is worth noting that half of this decrease would potentially impact our third quarter sales. Our fiscal year 2013 forecast anticipates the U.S. lawn and garden market being higher by 4% to 6%, assuming the current drought conditions do not persist in the next season.

Given the difficulties of managing through significant drought last summer and fall and the lack of snow so far this winter, we believe that channel participants will manage inventories very closely in order to minimize their investment in working capital. As we had indicated in our last quarterly call, we anticipate that this could have an impact of shifting both engine and product sales from our third fiscal quarter to our fourth fiscal quarter this year.

Consolidated operating margins are forecast to be in the range of 5.1% to 5.6%, the improved operating margins include the benefit of over $30 million of savings as a result of our restructuring activities announced in fiscal year 2012. Offsetting these savings is higher pensions expense in fiscal year 2013 of approximately $9 million caused by lower discount rates used to value the liabilities in the plan. From a cash flow perspective, cash flows are estimated to be higher in fiscal year 2013 due to higher earnings and additional cash generated from net working capital reductions of approximately $80 million to $100 million, primarily related to inventory reductions partially offset by required contributions of approximately $30 million to our pension plan.

The effective tax rate for the year is anticipated to be 31% to 34%. Lastly, we anticipate that capital expenditures in fiscal year 2013 will be in the range of $50 million to $60 million. That concludes our prepared comments and now we would like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Josh Borstein of Longbow Research. Your line is open.

Josh Borstein - Longbow Research

This is Josh Borstein in for David MacGregor. Could you discuss a little bit of the aluminum prices that you have locked-in during the October, November timeframe. How much you have hedged and at what amount?

Dave Rodgers

Well, as a matter of fact, Josh, we typically don’t specify exactly what we have hedged and at what cost. Certainly those are relevant to our pricing discussions that are ongoing with our customers moving forward. Having said that, our approach to how we think about both hedging of aluminum and other material costs as well as how we think about it in terms of our pricing, has not changed from really the last several years.

What we attempt to do is smooth out some of the increases and decreases in the commodities market so that we have a clear understanding of what our costs are going to be. And then certainly to the extent that materials increase, we attempt to recover that through price increases for our engines and our products. And to the extent that the commodities have gone down, we do anticipate that we need to reduced some of our pricing to our customers as they would expect.

When you think about what's happened with the cost of aluminum, right now the spot prices for aluminum compared to last year at this same time are about even with last year to down very slightly. If you look at it for the first six months of our fiscal year compared to the first six months of fiscal year 2012, the cost of aluminum is down from the prior year and so that’s why you heard us comment about some of the price decreases to put in to our engine pricing on a global basis.

Josh Borstein - Longbow Research

And if aluminum should go up during the year, do you have the ability to raise prices or price is pretty much locked for the remainder of the year?

Dave Rodgers

We typically -- it varies depending on what part of the world that you are talking about. But for our U.S. business, we typically have one time during the year where we will commit to pricing during the course of the year. That’s typically worked out okay for us. To the extent that our cost would go up significantly, we do have ongoing dialogue with our customers as well.

Todd Teske

Josh, it’s part of the hedging philosophy. I mean when we go out and price we try to make sure that we have some certainty on the cost as well as the price. And so that all goes into our hedging philosophy.

Josh Borstein - Longbow Research

Okay. Great. Thanks for that color. And then you announced with respect to the cost savings, $30 million for the year, I think you had cost savings at $10 million in the first quarter, around $9 million it seems like in this quarter. And so it puts you on a run rate of closer to $40 million in savings for FY ’13. What changes in the back half of that year that you kept your savings guidance at around $30 million to $35 million?

Dave Rodgers

Well, not a whole lot, Josh. I think that we still think that we will garner somewhere, it might be towards that 35 number so we may do better than the 30. But suffice to say that our restructuring programs are going really as planned, both from a timing standpoint and from a cost standpoint and then certainly the savings are going as planned as well.

Josh Borstein - Longbow Research

And then just one more from me. With respect to snow thrower sales, I understand that if you get to far in the in-season without any significant weather events to generate sales, there comes a point when consumer just kind of opt and wait for the following year. When is that tipping point and what do you think is playing out this year so far?

Todd Teske

Yeah, Josh, I would tell you that when you look at how shipments go, once you get kind of beyond January then life gets a little bit more interesting with consumers. You know trying to make a judgment in terms of what they want to do. Unless you see a really significant snowfall in February, often times the inflection point gets to be late January, early February along the way. And so as we look at it, there was really no sell-in, much sell-in to the channel this year. There has been minimal snowfall to date. And so as we look at it, if we don’t get something here in the next month or so, than I think a normal behavior might tend towards to what you were suggesting.

As we then roll out of the season and then think about next year, we will obviously consider that with our fiscal year 2014 guidance.

Operator

Our next question comes from Sam Darkatsh of Raymond James. Your line is open.

Unidentified Analyst

This is [Josh] filing in for Sam. I appreciate you taking my question. First question from me, I was wondering if you could give any quantification to the benefits from the hurricane and also talk about the timing. I know you said that not all of it fell in the quarter you just reported and that there is going to be some restocking going on going forward. Could you talk about that?

Dave Rodgers

Josh, we typically don’t break out the impact of our individual product lines and in this case what you are really speaking about is portable generators as well as standby generators. I think to be fair if you look at this particular storm compared to other significant storms in the past, and I would put Irene into that category as well. Irene coupled with the snowstorm that the East Coast saw in October of last year. This would be very similar to the impact that we saw in previous significant events.

Unidentified Analyst

And that would be what you are baking into the guidance as well?

Dave Rodgers

That’s correct.

Unidentified Analyst

And then you talked about the channel inventory for the dealers of your power products being in an interesting position. Could you talk a little bit more about what the engine inventories look like at the OEM level?

Dave Rodgers

Well, I think at this point in time during the year the OEMs are ramping up their production in order to prepare more product for spring. And so typically we will start shipping heavier engine inventories into the OEMs during this time of year as well.

Todd Teske

And, Josh, what I would do is, in the prepared comments and I will emphasize the point again, given kind of when we came out of the drought from last year and OEMs and ultimately retailers not wanting to leave the season with a lot of inventory, we fully expect that what's going to happen. And we are seeing it that they will start to produce closer to the season. So I think what you are finding is that there is nothing out of the -- there aren’t unusually high inventories necessarily in terms of engines at the OEMs. But what the order pattern will do is somewhat shift from Q3 to Q4.

And so it will be -- what will happen is, they will produce closer to the season, meaning that if they will otherwise ramp up in a significant now, you will see them ramping up probably more towards latter half of February into March and then produce very heavily March into April, and then take a look and see where the season is starting to shake out.

So that’s the one caution that -- as you know we quarterly guidance but as you guys think about how 3Q, 4Q should shape up, I think you guys need to really make sure you consider how that might play out given the fact that there is just a lot of caution in terms of building up inventory.

Operator

Our next question comes from Robert Kosowsky of Sidoti & Company. Your line is open.

Robert Kosowsky - Sidoti & Company

Just a quick question about the revenue guidance. So if I take the midpoint of the annualized guidance and I assume $80 million of the exited business, you have about 14% second half implied revenue growth. You know kind of ex-ing out the exited business. And with the U.S. market up 4% to 6%, kind of later start for the year, I wonder how you can explain the positive delta in excess of the U.S. market growth, especially with Europe being weak.

Dave Rodgers

Our call on the U.S. up 4% to 6%, Rob, as well as Europe being flat for the year, we can get to, I will call it the midpoint of our guidance. Clearly, to get to the higher end of our guidance it would require the market to be better than what our assumptions are that we have kind of baked in. One of the things that we did come in into this year particular related to our guidance is we had a very wide range at the top end. And so that was related to us exiting mass retail lawn and garden at mass, but also there is some uncertainty related to what the market can do this year.

So on the downside if the drought persists, which we are not necessarily planning on, that could have a negative impact to the upcoming spring. However, if it’s a normal year with some of the positive indicators around housing etcetera, you could see sales to be higher than assumed 4% to 6% market in the United States.

Todd Teske

And Rob the thing I find interesting as I kind of reflect back on the last year, is we have the worst drought in 50 years, best as anybody can tell. And the market for walks and rides were off low single digits. And when you look at that -- I am talking about this last season -- when you look at that, if you would have told me that there was going to be a 50-year drought if you will, the worst drought in 50 years, I would have told you the market would have been off a lot more than that. I think we are beginning to see the impact of housing and obviously a market that has been down very substantially since 2005.

And so as we kind of look into the year, this upcoming season, I will put it cautiously optimistic. The optimism comes from obviously I think the cycle is turning for the industry. The cautious side is, when you don’t have any snow on the ground in the spring to melt to ultimately get a jump start on the growing season, that can have some indications too. That’s why we are giving you guys the kind of guidance we are because we are -- there is just cautious optimism out there.

Robert Kosowsky - Sidoti & Company

Okay. But I am still kind of unclear because the mid-point of the guidance says about 14% growth in the second half of the year. So just kind of curious what is maybe upside greater than the U.S. market or Europe?

Dave Rodgers

I am not sure I follow your question Rob. I mean, something we can take a look at but we have kind of outlined what our thoughts are as far as how we get to the sales numbers for the year taking all of those variable into consideration.

Robert Kosowsky - Sidoti & Company

Okay. And then just also on the standby sales. I was wondering how those trended or how the penetration rate kind of increased throughout the hurricane Sandy impact. And also I noticed you have a new financing agreement with GE and I am wondering how that changes the value proposition that you guys offer.

Todd Teske

When you look at -- not sure about the penetration yet because obviously there is a lot that’s happening with regards to purchase interest. I can tell you purchase interest has jumped dramatically even after a pretty strong year last year. And so as we see the orders coming in, as we ultimately plan our production, we are very, very encouraged on a year-over-year basis to see how significant that product and awareness is. And so it’s one of those things where I don’t have a quantification at this point, Rob, in terms of household penetration. But remember, the household penetration is incredibly low and people are now figuring out that they do have an alternative to their power being out. And quite honestly what we have been doing in terms of making these things more affordable, it really just creates more interest in the category.

With regards to the retail financing, we have had retail financing on our lawn and garden equipment and now we think that the value proposition on the standbys is really interesting. So it’s really an offshoot of some of the things we have been doing in other parts of our business. And when you think about the outlay, although we are making the product much more affordable for the homeowner, when you think about the capital outlay, for many it’s still a chunk of change. And so what we want to do is provide an alternative for them to having the initial cash outlay. We think that there is a really strong tie-in between our GE branded product as well as the GE financing end of things. And so we really enjoy our relationship with GE in this category. And so we think that it just enhances the value proposition along the way.

Robert Kosowsky - Sidoti & Company

Okay. That’s helpful. And then also on the, I guess the placement that you picked up. I am wondering how sticky you think it might be from kind of a longer term standpoint? And would the OEMs, considering it might be a little bit of a leaner inventory start for the year, would the OEMs maybe chose you because you have better kind of -- you are closer to that manufacturing. So it’s kind of a more tactical decision to go with you this year on engines than maybe next year when it’s a more normalized better housing environment. Maybe go back to another competitor. I am just wondering if they ever get tactical on that standpoint because they think it’s going to be a later season.

Todd Teske

Well, what we do, Rob, obviously the value proposition that we present to the market, there is a lot of different components to it. I don’t know that anyone is going to go back to building huge inventories in the future. And so when you think about leading out supply chains, I don’t see that shifting really at all other than continuing down the trend that has been to lean out the supply chain, keep the inventories low. That creates an advantage for us given our manufacturing location in close proximity of the OEMs. I would also tell you that as we move forward, we have talked an awful lot about innovation on our business and we are putting more money behind innovation and new product development in both the sides of our business, both segments, the products group and the engine group.

And one of the things that’s going to be really important going forward on the engine side is to continue to deliver new and exciting products and we have got more things coming out in the next few years than perhaps we have had in the past. So when you look at it it’s more than just what's the price of this individual engine, it comes down to how do you deliver, what's your quality, can you give me new stuff that excites the market. And so we are looking at all the -- we have all those different things and we look to enhanced the value proposition of all those things.

And so, does that create a stickier environment? The fact is are we delivering on the value we need to deliver on relative to the competition. And that’s really how we look at it.

Operator

Our next question comes from Brad Safalow of PAA Research. Your line is open.

Brad Safalow - PAA Research

I don’t know if you guys can comment on this. You just talked a little bit about the demand for [power gens] generally between standbys and portables. You have had two major storms in front of the country that normally you are not seeing that kind of storm activity. What can you speak to in general to the kind of secular shift in demand for these products?

Dave Rodgers

I think Brad, this is Dave, only time will tell. The East Coast and a very populated portion of the East Coast, has seen several storms here in the last, call it 15 months. And so these storms have come on top of each other and so what is yet to be seen is the type of long term or shift as you call that in-demand that there may be for standby solutions into the future. And so what we have seen so far has been somewhat normal in terms of the immediate impact on both our portable business and our standby business. The order activity and the interest in standbys continues to be very strong not only in the east part of the country for us, but also nationwide.

And so we think that this is a category that moving forward is more interesting for consumers that are out there but also it’s interesting to us as we continue to build out our product line and our dealer network and provide these types of products for the market.

Todd Teske

And Brad I will add that. When you go all the way back to when we bought Generac Portable Products back in 2001, we did extensive study on the power grid in the U.S. And we have continued obviously to monitor the grid. And although there is a lot of discussion on infrastructure spend as it relates to enhancing the grid, the grid is not getting the kind of investment that it needs to keep up with the energy demands, the electricity demands that are out there in today's society and environment. So if you look at all the different things that people now plug into the wall and compare that to where it was 10 or 11 years ago of 12 years ago, it’s just increasing.

And so as we look at it, we think that there will continue to be a lot of demand into the future. I think you will see more demand obviously as it relates to when the events happen. But the frequency of whether it’s weather events of just simply the grid not being able to keep up with demand because there are power outages that do occur across the country that are non-weather related. Just due to increased demand and/or not storm related, it might be due to the heat or whatever it might be. We just think that as that continues, people are going to become even more aware of the category. And I think you will see the category continue to grow into the future.

Brad Safalow - PAA Research

Is there any way you can quantify the growth in demand for standbys? For example outside of the areas that were impacted by the storm?

Todd Teske

From a market standpoint we can kind of take a guess. I can tell you from our internal sales, we do see increases outside of just the east coast. And so we see pretty much throughout the country, demand increasing.

Brad Safalow - PAA Research

Care to quantify order of magnitude, just general range? Like mid-single digit, high-single digit.

Todd Teske

Unfortunately we are not going to get on the path of quantifying individual product categories for us. And in terms of -- I am not aware of any market studies that are out there that take the regional approach, quite honestly.

Brad Safalow - PAA Research

Okay. And then can you help us understand in this quarter, how large is Australia in terms of a percentage of your total, roughly speaking?

Dave Rodgers

This is Dave. It’s our third largest market but in terms of our overall footprints for both products and engines in that market, it’s somewhere in the area of -- I will call it $75 million to $100 million.

Brad Safalow - PAA Research

Okay. And then can you give us what your expected contribution is from Branco in the second half of the year?

Dave Rodgers

What we said when we announced the acquisition of Branco, Brad, was that on an annual basis they had sales of approximately $40 million historically. And that there operating margins were in a range of, I think we said 13% to 17%. So they are in that mid-teens areas in terms of operating performance. Beyond that information and what they have done historically, we are not going to include specifics for moving forward.

Brad Safalow - PAA Research

Okay. But from a seasonal perspective, obviously, opposite side in terms of seasons, there is no major difference between what you see in the second half and your annual guidance. We can just assume it’s a 50:50 split?

Dave Rodgers

Well, remember, one of the things that we really like about the Branco business is that it’s in that light commercial type of equipment. Meaning that it’s not lawn movers and it’s not snow throwers, and so what we really like about it is that it’s not necessarily weather dependent. And so some of the other seasonal things that you see in our business are not going to necessarily apply to Branco.

Todd Teske

So, Brad, although they have some ebbs and flows, it’s much smoother than perhaps it would be in what you see in our U.S. business, for example.

Brad Safalow - PAA Research

Okay. And then just last question. Obviously, housing recovery at least from most people’s opinion at this point is somewhat entrenched. There is plenty of evidence of it. This is the first time in six, seven years you have had the dynamic getting into this spring. I recognize that retailers are cautious because what happened last year and maybe the replacement cycle and some improvement in housing explains the variance you outlined between the trialed and the actual shipments of walks and rides last year. Help us understand, how in your conversations with OEM partners and retailers and what not, I mean actually they are cognizant of that so is it, hey, if we get the right weather scenario we want to be able to rely on you to drive down very quickly. Like is there a kind of, all else being equal, we get a normal weather pattern that, hey, we are really interested in increasing inventories but we are not going to yet. I mean help us understand what the conversation is like in the context of where housing is today versus where it’s been the last seven years.

Todd Teske

Well, the conversation has been pretty similar in terms of, look, we don’t want to carry a bunch of inventory and so we are looking to take our inventory levels down. But the whole idea, and these conversations happen all the time. If it’s a good season, we expect you guys to deliver. And so this is where the value proposition that we have really comes in. Look, when things were going hot and heavy a few year ago and the season really heated up, we can get an engine from an engine plant to an OEM, to a DC to a store in six days.

And so when you look at that, the expectation of these retailers and obviously the OEMs then, and then all the way back down to us, is that we have got to be nimble enough and be able to ramp fast enough to be able to get our engines and then the OEMs getting their products into these retailers if they have a big weekend. And that’s where life gets really interesting in terms of supply chain management and being able to react to a season that could be good.

Now, that’s not particular to this season. Obviously, we kind of have that discussion every year but now, as you point out, maybe probabilities being what they are, maybe this year is going to be the year where it’s going to be up substantially. If that’s the case, we are prepared. And I can tell you the OEMs are prepared. And so it is one of those things that if we see upside, and we started seeing it a year ago in March. And we had some very good planning meetings in terms of production with our OEMs, that if last year was going to be continue on the way March shook out, that we were going to have a situation where we were all going to be able to deliver to the market.

No difference this year. And that’s why when you look at the benefit that we can achieve because of our U.S. manufacturing base, it’s substantial.

Operator

Our next question comes from Peter Lisnic of Robert W. Baird. Your line is open.

Peter Lisnic - Robert W. Baird

I guess first quick question just on Australia. I would assume the carryover of those headwinds doesn’t really have a major impact into the second half of the year. Is that right or if I am off on that? Can you help us get a little bit of understanding on how that translates into the back half of the year?

Dave Rodgers

There will be some impact to the back half of the year, Pete. But because of their season which is opposite of ours, we have already seen some most significant portion of their downside for the year.

Peter Lisnic - Robert W. Baird

Fairly nominal. And then on the Branco acquisition, you have disclosed some things but I am wondering if you can give a little bit of color on what that portfolio looks like from a growth standpoint. I mean I know you mentioned $40 million of revenue, but as you kind of look forward and look at that marketplace, how significant is the growth opportunity there. What might the next 12 months versus 36 months look like for that business from a growth perspective and just what you can do to kind of leverage the growth now that you have got your hands on that business?

Dave Rodgers

Remember that as you get into some of these emerging markets of the world, there is a much more, I will call it segmentation of the market. So Branco is number one is Brazil as far as the seller of these types of pieces of equipment, and they are not all that large relative to what the type of businesses are that we do here in the United States. So when you think about it from that standpoint, they are number one in there market, but there are clearly opportunities for us to grow not only as Brazil grows from a GDP standpoint, but throughout Latin America.

Todd Teske

Yeah. That’s one aspect of it, Pete. I mean basically we -- there is two ways that I have a tendency and we, as a team we look at it. One is, we get the kind of GDP growth plus. Okay. And what I mean by that is, as Brazil’s economy grows, we would expect to grow at least at that level. And then when you look at the infrastructure spend that kind of goes -- that gets, if you will, proportionately larger than just the overall GDP, I think we can participate in that infrastructure spend. It’s going to be significant here over the next three to five years. That’s one aspect of the growth we see in terms of the macroeconomic conditions and then more to the sector in which we operate.

Then we look at the second part of it, is we look at it as an opportunity to utilize that distribution channel of products that they currently don’t have in their portfolio but things that we have in our portfolio that we can use that distribution channel. And that’s part of the integration that’s going on right now with the team to understand what products we can now enhance through the channel itself. So with regards to Brazil, we look at the opportunities to grow that business. Within Brazil, it’s very very bright here over the next one to three, three to five especially.

Then you got to look at it from the standpoint of the region. And Brazil plays a really important role in terms of Latin America overall. Now, obviously there is a lot of protectionist economies that are down there where we just take something from Brazil and ship it to someplace else within the region. But there are opportunities for us to take some of the Branco products we believe through our distribution channel. Channels that we have elsewhere within that region. So there is really two specific things, there are two general things I would say to Brazil, and then one more general in terms of the region overall.

So we haven’t provided any guidance. We are working on our way through. We have an idea of what those numbers might be but we are not a position today in terms of what those numbers are going to be into the future.

Peter Lisnic - Robert W. Baird

Has there been anything in the first 30 days or whatever it’s been that you [own] it’ caught you by surprise, plus or minus?

Todd Teske

I would tell you that whenever you -- as you know whenever you do these deals there are always things that you find out. Though I would tell you on the -- in terms of the [ledger] is concerned, on the plus side of the ledger, I think it’s been even better than we had anticipated. There is a lot of talent that the company has down in Brazil, down at Branco. And there is a lot of excitement that’s going on both from our team and there team to understand the possibilities that we have as a joint company.

On the negative side of the ledger, I would tell you there is really nothing that has surprised us. Obviously, when you deal with emerging markets, and emerging market governments and tax laws and things like that, there is always things that ebb and flow on the duty tax side, things like that. But all in all, we are really excited and pleased to be, to have this company.

Peter Lisnic - Robert W. Baird

And then the last question, just on the free cash flow and the ability to take out working capital. It looks the quarter was really strong, so I am just wondering if you could talk about the longer term, the cash generation profile of the business. Structurally are you looking at an entity that is much improved versus historical numbers? I think we are but I am wondering if you can maybe give us a little bit of help on what working capital efficiency might look like or cash conversion cycle as we get back to more normal demand levels.

Dave Rodgers

I think moving forward, Pete, you will see the cash that is coming out in terms of working capital reductions this year. You will see that continue into the future. Not in terms of continuing to take out fair amount of cash but I don’t see us needing to add that cash into the future. There is a couple of key things that are causing that. Number one is the amount of inventory and receivables that we had in the business related to providing products to the big box retailers, was fairly significant. And so with effectively getting out of that business, that’s going to help us moving forward. The second things is, from taking a look at the dealer business as well as our engines business, we are working on a number of different initiatives internally in order to, as Todd said, be more nimble as we move forward so that we can meet our customer demands but also to the extent that you have a season that doesn’t turn out like you think it does that you are able to manage the balance sheet accordingly in terms of the investment and working capital. So beyond that I am not going to give you any guidance with respect to the operating earnings for 2014 and beyond. We will get into more of that in future quarters but I think the advances that you are seeing in our balance sheet in this year you will see continue into the future.

Peter Lisnic - Robert W. Baird

Okay. And if I could just follow up on that. Your working capital as a percentage of sales, just ratio has been somewhere in that, call it mid-20s maybe high 20s range in the past decade or so. Should we think about the business structurally being lower 20s, maybe teens even? Is that a fair assumption or still to be determined, I guess?

Dave Rodgers

I think we obviously model it out for several years but I think as far as giving you guidance on what that might be, that we are not in a position to do that today.

Operator

There is a follow up from Josh Borstein of Longbow Research. Your line is open.

Josh Borstein - Longbow Research

One quick follow up for you. You had cautioned us about inventory shifting from 3Q to 4Q. Historically 3Q has been your biggest revenue quarter, 4Q looks like the second biggest. Is there a possibility that 3Q and 4Q now show more parity in terms of revenue or how should we maybe think about this new shift in inventories?

Dave Rodgers

Josh, 3Q will still be our highest revenue quarter and so all the comments that we made earlier are applicable where you will some of that shift. The other thing that we are trying to provide some light on is the impact of that mass retail business for our products group. That was largely weighted towards the third quarter and when you think about it in terms of needing to get that product into the channel, that was the heaviest portion of that happen in the third quarter.

Operator

There are no other callers in the queue at this time. I am going to turn it back over to you.

Dave Rodgers

Great. Thank you everybody for joining us today. We look forward to speaking with you again for our third quarter earnings conference call in April. Have a great day.

Operator

Ladies and gentlemen, thank you for participating in today's conference. You may disconnect. Have a wonderful day.

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