Briggs & Stratton Corporation F2Q09 (Qtr End 12/28/08) Earnings Call Transcript

Jan.15.09 | About: Briggs & (BGG)

Briggs & Stratton Corporation (NYSE:BGG)

F2Q09 Earnings Call

January 15, 2009 10:00 am ET

Executives

John S. Shiely - Chief Executive Officer

James E. Brenn - Chief Financial Officer

Analysts

Sam Darkatsh - Raymond James

Gil Nathan - Restoration Capital

Michael Hamilton - RBC Capital Markets

Analyst for Craig Kennison - Robert W. Baird & Co.

Daniel Ultzer – [Hogue] Capital Events

Dax Vlassis - Gates Capital

Operator

Welcome to the Briggs & Stratton second quarter earnings release conference call. (Operator Instructions) I would now like to introduce your host for today’s conference, Mr. Jim Brenn, Chief Financial Officer.

James E. Brenn

Good morning everyone. Thanks for joining us this morning. I’m here today along with John Shiely, our Chairman and Chief Executive Officer. Today’s presentation, the answers to your questions, will include some forward-looking statements. The statements are based on our current assessment of the markets we operate in and other factors that could affect the business and the actual results could differ materially from any stated or implied projections due to changes in one or more other factors as described in our public filings with the SEC. This conference call will be made available on our website and by phone replay will shortly after the end of the call.

So now here’s John to cover the second quarter results.

John S. Shiely

Good morning. As you saw in this morning’s earnings release, consolidated net sales were $477.0 million, consistent with the revenues in the second quarter of last year. The release also reported net income of $3.0 million versus the $4.0 million experienced in the same period last year.

While the consolidated net sales total was similar between years, the Engine segment performance was stronger than a year ago, to a large part being driven by demand for engines for portable generators and snow removal products. The majority of gains in Engines was consumed in finished goods that we manufacture.

The Power Products segment was softer in the second quarter compared to the prior year, primarily because of lower shipments of pressure washer product. Net income at $3.0 million appears also to be very similar to last year’s results, but what occurred operationally to get to that result is significantly different than the prior year.

Results for the second quarter last year contain a $13.0 million after-tax operating expense associated with a snow engine recall. However, last year’s second quarter other income also contained an after-tax gain of $25.0 million related to the redemption of a preferred stock investment.

The net of these two items improved last year’s second quarter net income by $12.0 million. This year’s second quarter has had to improve operating income results by $11.0 million to make results between years comparable.

I will address where these improvements occurred as I talk next about the segments individually.

Let me start out by talking about our Engine segment. The Engine segment had a second quarter net sales increase of 10% between years, driven primarily by an 11% increase in engine unit volume. The majority in the improvement between years is related to increased demand for generator engines that we used to restock depleted inventories after the hurricane season, as well as to support the early ice storms we experienced.

There was very little replenishment demand a year ago because there had been no hurricanes and early ice storm activity last year was basically handled by on-hand finished product inventories at the OEM and retail levels. The increased snow engine demand reflects a good retail selling season as well as market share improvement.

Regarding engines for mower sales, domestic shipments of engines for the 2009 spring lawn and garden selling season are about as projected. We believe the domestic inventories at the OEMs and major retailers are at reasonable levels going into the spring.

Our placement is about where we anticipated and potentially provides us with some incremental market share. While there are quite a few unknowns relative to the 2009 selling season there is some feeling among several of the major retailers that the lawn and garden market could be flat to slightly down from last year, as last spring as down so significantly.

We are anticipating some softness in Engine orders for riding equipment because of the higher price points for that equipment. We believe that the European market will be soft because of their declining economic indicators and inventory carry-over from last year. Similar to last year, the question in the end is, how will the current economic environment affect the consumer during the upcoming season?

Income from operations for the second quarter, after considering the non-recurring impact of last year’s snow engine recall, improved $13.0 million between years. A major contributor to the second quarter’s improvement was driven by the 11% increase in unit shipments mentioned earlier.

We also experienced better utilization of the production facilities with production volumes being up 3% between years and we are benefiting from the closure of one U.S. manufacturing plant last year, with the placement of its volume moving into our remaining domestic and international plants. We also have benefited from planned reductions in our engineering selling and administrative expense categories.

The offset to the aforementioned improvements in the second quarter has been the cost of commodities, components, and fuel where average costs were higher than they were a year ago. Contracts and commitments that were made prior to the start of the fiscal year locked a portion of these cost increases in for the full fiscal year.

Now let me turn to the Power Products segment. Net sales were down for the quarter by approximately 2%. The sales of pressure washer products were the cause of the shortfall. Year-to-date shipments of pressure washers are better than last year.

The second quarter lagged last year because there are not as many new model introductions as there were last year so there’s not the same level of channel fill occurring this year as there was a year ago. Our projections for this product line for the full year are softer than a year ago because this product may be more of a discretionary purchase for the consumer.

Portable generator sales were similar between years. Last year there was significant demand as a result of several major ice storms in the second quarter. Although we experienced ice storms this year, they created less demand than last year, resulting in lower sales. However, these sales were supplemented by continued hurricane-related replenishment demand.

In total, lawn and garden equipment sales are up due to the first-time inclusion of the acquisition of Victa in Australia that added $12.0 million to the sales in the second quarter.

Domestically, our lawn and garden equipment sales benefited from increased volumes but the mix of the product has been to lower-priced snow removal and walk-more products versus more profitable riding equipment.

We continue to hold to our projections for lawn and garden equipment sales to major retailers. We have, however, moderated our projections of the sales of premium lawn and garden equipment sold through the dealer channel. Because of this premium-priced product we believe the consumer may trend to lower-cost alternatives.

The second quarter operating loss for the Power Product segment improved from the same period a year ago by $8.0 million. A combination of more favorable sales mix of portable generator product and better plant utilization due to higher production levels of portable generators were the major reasons for improved profitability in the second quarter.

Now while we had greater volume of shipments in the lawn and garden equipment category, the mix to lower-margin snow and push-mower product versus premium riding equipment neutralized the volume gains. In addition, price improvements implemented at the start of the fiscal year were mostly offset by the increased cost of commodities, components, and transportation.

Finally, I want to mention a fire that occurred during the second quarter at a leased warehouse where we kept finished goods and components for our manufacturers of walk-mores and small frame snow throwers. Almost all of the contents were a total loss but we expect essentially a 100% recovery of the loss through insurance.

In addition, we have gotten back to normal levels of operation and the loss occurred far enough in advance of the spring lawn and garden season that we will be able to meet all of our commitments to the retailers.

That concludes what we wanted to say about second quarter results. And now I will close up with some comments on our projections for fiscal 2009.

We are reaffirming our forecast for the full fiscal year. Portable generators, snow products, and the engines that power that equipment have been favorable to date and support the top end of our projected earnings range.

We are seeing areas that are less favorable than our initial projections would have contemplated, for example European engine demand and certain currency exchange rates. However, we continue to look to further reduce certain operating costs and we should experience some benefit from commodity cost decreases during the second half of the fiscal year.

The lower end of the forecast of the earnings range still continues to reflect the uncertainty of the upcoming spring selling season for outdoor power equipment, given the current economic conditions.

We are projecting that the third quarter’s results will lag the comparable period from a year ago because we expect major retailers to control their working capital commitment to the category and be more comfortable with chasing demand this year while they assess the strength of consumer demand during the spring. As usual, the actions of both the consumers and major retailers will ultimately define the season.

And now we would like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Sam Darkatsh - Raymond James.

Sam Darkatsh - Raymond James

Talk about, John, what Q2 results were versus your own internal expectations. You talked about them quite a bit in terms of a year-on-year change, but versus what you had originally expected back in October, November or so, what were the primary variances?

John S. Shiely

I would say they were very consistent with what we expected. Our hope was to break even in the second quarter and as you understand, that is obviously an achievement over last year’s quarter because of the offsetting, positive impact of the preferred stock redemption and the snow thrower recall.

So what we achieved was pretty close to our expectations.

Sam Darkatsh - Raymond James

The fire at the leased warehouse, was there a P&L impact in the quarter from that fire?

John S. Shiely

No.

James E. Brenn

There was a $250,000 deductible that we booked but basically that would be it.

Sam Darkatsh - Raymond James

It looks like the payables were stretched. Was that by design or was that a timing issue?

James E. Brenn

It was a timing issue. Our quarter ends different than the other quarters end so basically everyone else was paid off by the end of the calendar month and ours were, we held just a little bit at the end.

Sam Darkatsh - Raymond James

I was looking at it on a year-on-year basis as opposed to sequentially. Was there a change in payment policy on a year-on-year basis?

James E. Brenn

A little bit of one. Our receivables run around 60 days, our payables have a tendency to run in the kind of 35 day, 40 day period. So we are trying to stretch those out a little bit.

Sam Darkatsh - Raymond James

Year-to-date Engine production and shipments, do you have those figures? In terms of numbers.

James E. Brenn

From a production of view, we have probably produced about 50% of what we believe is the demand for the full year. So we are now looking at full-year demand, probably shipments in the 10.2 million unit range. But I would tell you that we have built about half of that by this time. We have only shipped about a third of it.

Sam Darkatsh - Raymond James

So you have produced about 5.0 million units.

James E. Brenn

Yes.

Sam Darkatsh - Raymond James

You are expecting shipments of 10.2 million units, you have actually shipped about 3.0 million units to date?

James E. Brenn

Probably about 4.0 million units. You can call it 4.0 million, in terms of units. In terms of dollars it’s about one third of where we think we are going to be.

Sam Darkatsh - Raymond James

So 4.0 million units shipped to date and about one third in dollars. Now, how would that break down? So you’ve got maybe 6.0 million units to go or so, over Q3 and Q4, how do you suspect that’s going to break down between the quarters because of the assemblers going more JIT this year?

James E. Brenn

Next year, from the Engines perspective, 60% third quarter, 40% fourth quarter.

Sam Darkatsh - Raymond James

What would that have been last year? The ballpark.

James E. Brenn

It actually looks pretty similar.

Sam Darkatsh - Raymond James

Why would it be similar if you’re looking at the assemblers taking inventory closer to season start, or is that just a matter of timing within the quarter as opposed to pushing from Q3 to Q4?

James E. Brenn

One of the things in our numbers when we talk about this stuff is the end product part of the business. It’s the lawn mowers and it’s the dealer business that we would also think is going to drift closer into the fourth quarter. So I think that your OEMs will probably push pretty hard through March and then in effect, Easter’s a little bit later this year, but if everybody is going to dry up, it will probably dry up in that April time frame.

Sam Darkatsh - Raymond James

So you believe you’re going to start shipping engines late February, mid February, early February? When does it start?

James E. Brenn

We have already started the shipment of engines to OEMs for the spring lawn and garden season. And that always happens relatively strongly January, February. It’s where people start to get reluctant, or start pushing their orders out, is if in fact we’ve had a cooler or drier March and April hasn’t shown up yet. So that’s the fulcrum. The focal point is probably March, April. Because you’ve got to take the product in January, February to have enough on hand. The OEMs have to have enough on hand to satisfy retail demand if it’s there.

Sam Darkatsh - Raymond James

So there’s been no real change versus your expectations so far, at mid-January here? There’s been no real change in OEM assembler behavior or order activity versus prior year?

James E. Brenn

No, in fact they have been approaching the upcoming spring, I would tell you, in a relatively normal basis, even back as far late November, early December. They are working, as John indicated, we are working to the assumption that the retailers believe that this will be a flat season between years.

Our internal forecasts call it down. Maybe we are being conservative. The retailers are looking at it as if it could potentially be flat. So they are not backing off from their demand on the OEMs, the OEMs are not backing off from engines.

John S. Shiely

And as you understand the industry, if they didn’t look at this as a flat, if they anticipated it down, they might get in a position where there isn’t enough product there to satisfy things even though there is demand.

So if it becomes clear in the March, April time frame that it’s not going to be there, then things will really start backing up.

Sam Darkatsh - Raymond James

And that would be spurred by the retailers or that would be spurred by the assemblers?

James E. Brenn

That would be spurred by the retailers.

John S. Shiely

At some point the assemblers have to including Briggs & Stratton. We have to making this stuff in the assumption that there’s going to be a decent market. Otherwise, it’s a self-fulfilling prophecy. But at a point in time it will become clear as to what this season is going to be like and then the retailers will choke and they will move that back through the OEMs to us.

Operator

Your next question comes from Gil Nathan - Restoration Capital.

Gil Nathan - Restoration Capital

Your inventory, you had $608.0 million, can you break that out between work in process and raw materials and finished products?

James E. Brenn

I would tell you basically that finished goods is about $400.0 million, off the top of my head. I don’t have the number right in front of me and I can follow through with you on that.

Gil Nathan - Restoration Capital

You were just talking about retailers have the expectation of a kind of flat season. I guess what you are saying is your conservative forecast, if demand is down. Do you think that will change the pattern? Is there a chance that they just don’t order any more? I’m just a little confused, how much inventory is there at their level to meet demand?

James E. Brenn

I think the issue is that they won’t reorder. They have to do their store sets, fill their stores in the January, February, March time frame. If their sense is that the season is not going to be as good as they had hoped, for whatever variety of reason, be it weather, be it economy, there will not be reorders. And it’s reorders that start to occur in the April, May, June time frame, that ultimately make the season or break the season.

So don’t think of it so much as they are going to temper their buying in this quarter per se, in the third quarter, it’s just that there won’t be a whole lot of reorders.

Gil Nathan - Restoration Capital

Maybe I’m missing something. You talked about 10.2 million units, you’ve built half of them, you’ve shipped 4.0 million units, but it’s only a third of the dollars. Is that because there is a more expensive product in the unfinished?

John S. Shiely

Yes. The OEMs and the retailers tend to take delivery of the more expensive and often higher-margin riding equipment closer to the market in order to keep their inventories down. Whereas the lower-cost, lower-margin walk-behind lawn movers are less of a burden on your inventory carrying costs.

Gil Nathan - Restoration Capital

And typically when is the order season for the riding mowers?

John S. Shiely

Those have to be delivered in the same time frame that Jim mentioned, so ultimately they’re going to get out there in the late-January, February, March. If you want to get a handle on this thing, it’s basically a four-month season and ground zero is the Southeast. And keep an eye on the Southeast, Florida, Georgia, the Carolinas, if things start off brisk there, the retailers will take a look at that and say, boy, this is a year.

You know, we’ve had four down years in a row and there’s a lot of product out there with deferred maintenance. And I’m not going to say it’s this year, but one of these years some of that overhanging, deferred maintenance on these movers is going to kick in and people are going to replace them.

Gil Nathan - Restoration Capital

And what is the normal life span?

John S. Shiely

Probably six or seven years.

Gil Nathan - Restoration Capital

Your revolver, you had about $180.0 million drawn?

James E. Brenn

$199.0 million I think it was.

Gil Nathan - Restoration Capital

And availability?

James E. Brenn

$500.0 million.

Gil Nathan - Restoration Capital

No, I meant net of LCs and drawn. The total availability of the line is $500.0 million.

John S. Shiely

Availability is about $300.0 million.

Gil Nathan - Restoration Capital

So what’s left is fully available. And I think covenant-wise you are in decent shape, right? Bank EBITDA is about $159.0 million?

James E. Brenn

Right.

As to your first question, probably about 76% of the inventory is finished goods and about another 23% is work in process and raw materials.

Operator

Your next question comes from Michael Hamilton - RBC Capital Markets.

Michael Hamilton - RBC Capital Markets

Could you start off just commenting on currency impact in second quarter?

James E. Brenn

Actually there were multiple currencies. Historically we would have only told you that we had the Euro would have been of concern. I think the Canadian dollar, because we had sold snow throwers up into Canada in Canadian dollars this year for kind of the first time, and in effect even the Mexican peso kind of was irky-jerky and went against us.

On a quarterly basis, I don’t have the quarter, I would tell you that on a six-month basis we probably had about a $7.0 million currency negative. From where we were expecting life to be.

Michael Hamilton - RBC Capital Markets

And so it’s on balance a year?

James E. Brenn

Yes. And versus where we thought we would be in our forecast.

Michael Hamilton - RBC Capital Markets

Could you comment on magnitude of inventory involved in the fire?

James E. Brenn

Roughly there was about $25.0 million of inventory. I can tell you that there was probably another $25.0 million, $15.0 million of it was finished and $10.0 million of it was work in process. There were just a few snow throwers. The timing was very good. It was after the snow thrower season and we had started to build walk movers in advance of the lawn and garden season and we lost those but we are so far ahead of the lawn and garden season that we are able to not miss a beat on the production, basically.

Michael Hamilton - RBC Capital Markets

Could you comment, without getting into specifics, on how you are feeling on financial position in your customer base? I mean, if you’ve got any places where you’ve got concerns in this financial arena and it’s leading you to take actions on how you are working with them.

James E. Brenn

I don’t think we’re doing anything than what we normally do. If we have people who have dropped beyond 60 days past due, we start to put them on cash-in-advance until they get themselves current.

We have a wide range of different customers. We go all the way from very large OEMs to small OEMs to dealers, so we are being fairly consistent and we’re calling sooner, being a little bit more pushy, I would tell you, on trying to collect if it seems to be drifting away.

But to date, we haven’t seen any real negatives.

Michael Hamilton - RBC Capital Markets

If you could kind of go to 30,000 feet and talk a little bit about how, given the bulge in raw material costs that hit us last year and what’s going on now, what you see playing out in the whole inventory pricing mechanism and anything in terms of how you’re thinking about approaching hedges in here?

James E. Brenn

At this point in time, the way we would approach it, because the costs are going down, we are not hedging for the remainder of the year. We are actually letting the market, they’ve now moved a little bit lower than where they were last year in some cases, and so we are just kind of watching them because they are falling.

If our sense is that there is going to be some stiffening up in the costs and that type of thing, we will look at it. And we would certainly take a look at it in the May, June time frame, maybe even a little earlier, as we try to figure out what we’re going to do for next year.

Again, like we did this year, in order to ensure where we will be, our costs versus our pricing strategy, we will start to lock things in if we think we have a good chance at making those balance.

Michael Hamilton - RBC Capital Markets

Is lawn and garden pricing pretty well locked or are you getting some pushback due to the environment?

John S. Shiely

I think our sales people have come back to us and said that people are asking about the pricing. I think as we kind of pointed out, and you can see it in the numbers to some extent, any pricing that we got this year was pretty much consumed by the cost of raw materials, because they had gone up so high we had locked those costs, and if you think about, probably almost our first quarter’s worth of inventory shipments was really of inventory that had built in kind of the April, May, June time frame last year, where the costs were at their peak.

So I think people have questioned and asked about it but at the end of the day, the pricing is locked.

Michael Hamilton - RBC Capital Markets

You have really done an excellent job on your SG&A and is what we see what we get? Is there anything unusual flowing?

James E. Brenn

No. It really is attention to detail and it was knowing that this year was maybe not the best that we see and we had to make sure we were very safe on our covenants. I mean, we worked hard to prioritize things in engineering and in marketing and I would tell you that the organization really responded very well in terms of identifying how we could prioritize. So there is nothing unusual in this. This is pretty clean.

Michael Hamilton - RBC Capital Markets

You’re not changing your capex outlook at all?

James E. Brenn

No, I think we’re going to stay at the $50.0 million. Some say cash is still king and we don’t know what the rest of the year is going to show us, so we are staying of our capex number of around $50.0 million.

John S. Shiely

Somebody made an interesting observation yesterday around our Board meeting and that is that we experienced four down years in a row so we kind of had, if you will, some preparation for this, again, difficult year. And we’ve made some of the tough calls in terms of shutting down plants and cleaning up our manufacturing footprint and pushing down capex and SG&A and I think it was a pretty incisive comment to say that, you know, you hate to get too good at tightening yourself up because sooner or later the market will come back and a big key to our success is our ability to deliver large volumes of product. And I will tell you that we are still ready to do that, despite what we have done in the last few years.

Operator

Your next question comes from Analyst for Craig Kennison - Robert W. Baird & Co.

Analyst for Craig Kennison - Robert W. Baird & Co.

Could you go over again the timing of some of these steel contracts? When do you expect to renegotiate and when would we see that flow through the income statement? I know you mentioned something about the second half, but could you quantify that and do you anticipate any raw material tailwinds for the 2010 fiscal year?

John S. Shiely

I think it’s hard to quantify. The contracts end with different players at different times, for different types of steel. I think suffice it to say that we do think that there is some benefit in the second half of the year.

As we said on the conference call, we’ve actually pulled back on some of the volume. We think Europe is soft, because some of the currencies have move a little bit different than we thought, and yet we’re holding to the forecast that we had out there. So I think you can assume that we are seeing some benefits, that we’re building in some benefits, anticipating some, and it’s allowing us to offset some of the other things.

But there are a lot of moving parts still out there, as we go into the last six months of the year.

Analyst for Craig Kennison - Robert W. Baird & Co.

Relating to the employee pension, do you anticipate increased funding costs as expectations from market returns fall?

James E. Brenn

Obviously we are looking at it and I think that you will find in our Q, we are going to be like most people, putting out a cautionary statement in the Q that says we had left the year overfunded, at the end of June. I would tell you where we stand today is that we are underfunded. But that’s our look at where we think discount rates are as of today and where the assets are. We have six months so we will put in the normal cautionary things that kind of give you a range. Tells you where we think we are and probably if the discount rate moves up a percent or half, either way, what our potential range should be.

I would tell you that there is no funding problem. We are not going to have to fund for 2009, we know that already. The issue will be, depending on where we end up, might there be some funding in 2010. And at least the range I’ve seen to date from the actuaries would tell me I’m probably in the $5.0 million to $10.0 million on funding. Where we are today.

Analyst for Craig Kennison - Robert W. Baird & Co.

But not on income?

James E. Brenn

Nothing on income. You still would not have an increased pension expense but you would potentially have some funding, and again, I’d call it $5.0 million to $10.0 million, nothing significant, at this point in life.

Analyst for Craig Kennison - Robert W. Baird & Co.

Since your last call some of the inputs for the econometric model must have deteriorated. Can you discuss implications on your model, how you’re looking at that today?

James E. Brenn

We are in the process of reviewing our model and I would tell you that the one that we have come up with, which has a pretty good back-look to it, actually would tell you that there are some elements that are potentially improving.

We have looked at not replacement as much as displacement and the message on the displacement is that if the weighted average of numbers that have been bought in during the prior four years are increasing, that portends a decrease going forward, because it says that people, for whatever reason, economy, need whatever, they bought early and therefore you are going to be down. Now, we’ve had four years of down, which tends to tell you that the displacement cycle would actually call for a little bit of an uptick.

Another factor that we’ve looked at recently is housing starts, or just total houses, and also unemployment. And interestingly enough, there is a high correlation to when unemployment, not the amount of unemployment but the change between periods, gets better, in effect it portends more buying of lawn mowers, according to the model.

So there are several things that we have looked at that would tell us that we are potentially on the cusp of a turnaround. The question is when does that occur and is there enough economic noise out there right now that would prevent it from happening.

John S. Shiely

But the wildcard in the whole thing and one that you can’t work into the model is the issue of weather. And if you look at the first two quarters, we found that compelling weather events caused people to part with their money for generators and snow throwers even though they might have wanted to spend that money on something else.

If we continue the situation with a lot of precipitation you will see that some of the drought areas are moistening up. Texas is getting a little drier but the Southeast is starting to moisten up.

I think I mentioned this before, we did a regression analysis a long time in the U.K., which is pretty homogeneous in terms of weather and found a higher correlation between rainfall and engine sales than leading economic indicators and engine sales.

But, again, this whole issue of overhang and demand from several down years of lawn mower sales, if there’s good weather the product that’s out there is not going to be able to handle it. You saw a lot of empirical evidence of people fixing their lawn mowers last summer and they’re holding them together with baling wire and duct tape.

So that’s a very strong part of the new econometric model that we’ve been developing.

Analyst for Craig Kennison - Robert W. Baird & Co.

Can you give us a quick update on the Snapper strategy and the progress you are making at Sears?

John S. Shiely

The whole strategy of Snapper was to afford one of our customers the opportunity to sell a differentiated product and the success with that in the last selling season was modest, because there was a bit of a short fuse on it. As has been described to me by our marketing folks, we expect a stronger push on that this year. And given that our spokes person for that product is Brett Favre, and he seems to be getting a lot of attention these days, maybe it depends on whether he decides to go back to the Jets or not as to whether we do any good this year.

Operator

Your next question comes from Daniel Ultzer – [Hough] Capital Events.

Daniel Ultzer – [Hough] Capital Events

On the revolver, can you remind us what the pricing is now, based upon the leverage ratios?

James E. Brenn

I think it’s LIBOR plus 75 basis points.

Daniel Ultzer – [Hough] Capital Events

And that’s with the 4 times?

James E. Brenn

Yes.

Daniel Ultzer – [Hough] Capital Events

And that’s up on the 3.25?

James E. Brenn

Yes, we are 3.25 in Q2 and Q4 and we are 4 in the second quarter and third quarter.

Daniel Ultzer – [Hough] Capital Events

I meant with the pricing?

James E. Brenn

The pricing is pretty stable.

James E. Brenn

And it will be the same throughout the four quarters, as long as we meet some of the requirements.

Daniel Ultzer – [Hough] Capital Events

On the dividend, you declared that the other day. Any concerns with funding that?

John S. Shiely

No, as we mentioned in the last quarterly conference call, we expect to earn the $40.0 million that we need to pay the dividend. As the time, as Jim mentioned, there is some healthy Kentucky windage on the cash side in that our expectation is that capex would be about $20.0 million than depreciation.

Daniel Ultzer – [Hough] Capital Events

On the revolver, if needed, per se, could that be used to fund the dividend or is there a restriction in the credit agreement?

James E. Brenn

There is a restriction but it is so high that it would not impact U.S. In a near-term basis it doesn’t impact us at all.

Operator

Your next question comes from Dax Vlassis - Gates Capital.

Dax Vlassis - Gates Capital

On your Engine segment, I see that the revenues were up 7.5% but I think you said units were up 11%. Can you reconcile the difference?

James E. Brenn

Probably mix. If you take a look, we shipped an inordinate amount of the smaller engines and as John kind of indicated in the call, we are not shipping large engines. And that’s because we are seeing different than what we saw a year ago and even different than what we had forecast. People are holding back on building that big product until later in the season so that they don’t build up a lot of working capital at the OEM level.

Dax Vlassis - Gates Capital

Does that also help your margins? I think the small engines are a better margin business for you.

James E. Brenn

They actually are not that different. From a percentage perspective maybe not much difference. Obviously on a larger engine for a riding lawn mower, call it an average of $275 or so versus an $85 small engine, you would certainly get a lot more gross margin dollars out of the large. Percentage-wise there is not that big a difference between the profit margin on the two products.

Operator

Your next question is a follow-up from Gil Nathan - Restoration Capital.

Gil Nathan - Restoration Capital

How much exposure or how big of a customer is Sears for you?

James E. Brenn

Sears is, indirectly I would say, a very large customer. From an engine perspective. We sell our engines to an OEM that is their main supplier. We think that if something would happen to Sears, we think our engines would go someplace else. Our financial exposure to them would be on generators, pressure washers, and some lawn mowers, like the Snapper lawn mower that we sell to them. But we are not as exposed to them as you might expect.

Gil Nathan - Restoration Capital

And you think that if Sears were to go out of business that the OEM would place that product elsewhere?

James E. Brenn

Well, it’s interesting because, in our opinion at least, Sears is probably has the largest market share of lawn and garden equipment in the United States. And to the extent that the demand is still there for lawn and garden equipment, if something would happen to them or their brand, then if effect you would assume that people are going to go to the other mass retailers and dealers and so there still would be lawn mower sales per se.

Operator

There are no further questions in the queue.

John S. Shiely

Thanks for joining us this call and hopefully we will be with you again in April with good news.

Operator

This concludes today’s conference call.

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