Briggs & Stratton Management Discusses Q3 2013 Results - Earnings Call Transcript

Apr.19.13 | About: Briggs & (BGG)

Briggs & Stratton (NYSE:BGG)

Q3 2013 Earnings Call

April 19, 2013 10:00 am ET

Executives

David J. Rodgers - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Todd J. Teske - Chairman, Chief Executive Officer, President and Member of Executive Committee

Analysts

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

Robert A. Kosowsky - Sidoti & Company, LLC

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

Timothy Meaney - Longbow Research LLC

Bradley G. Safalow - PAA Research LLC

David Post

Operator

Good day ladies and gentlemen, welcome to the Briggs & Stratton 2013 Quarterly Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would like to introduce your host for today's call, Mr. Dave Rodgers, sir, you may begin.

David J. Rodgers

Thank you, and good morning, everyone. Welcome to the Briggs & Stratton Fiscal 2013 Third Quarter Earnings Conference Call. I'm Dave Rodgers, Chief Financial Officer. And joining me today is Todd Teske, our Chairman, President and Chief Executive Officer.

Today's presentation and our answers to your questions 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 in our filings with the SEC. We'll also refer to certain non-GAAP financial measures during today's call. Additional information regarding these financial measures, including reconciliations to comparable U.S. GAAP measures, is available in our earnings release and in our SEC filings.

This conference call will be made available on our website approximately 2 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 J. Teske

Good morning, everyone, and thank you for joining us today. As you saw in this morning's earnings announcement, our third quarter consolidated net sales were $637 million, a decrease of approximately $83 million from last year's third quarter. Sales in our Products business were lower by $50 million or 18%, primarily due to our decision last year to exit the sale of lawn and garden products to large mass retailers. Engine segment sales also decreased in the quarter compared to last year by $46 million or 9%. We continue to see weakness in sales in several of our international regions, most notably on Australia and New Zealand, where we're seeing continued impact of drought conditions and in Europe, where consumer confidence has not shown signs of improvement. Here in the U.S., a slow start to spring, especially compared to prior year -- the prior year, has been offset by higher sales of engines for portable generators as we replenish inventories after Hurricane Sandy. Consolidated net income for the third quarter was $38.5 million and diluted earnings per share were $0.78 per share.

The 2013 third quarter includes $6.6 million of additional restructuring charges to carry out the cost reduction activities that we announced in fiscal 2012. Our third quarter adjusted net income, excluding these restructuring charges, was 49.3 -- or $43.9 million, a decrease of $5.6 million from last year's third quarter adjusted net income of $49.5 million. Our adjusted diluted earnings per share, excluded the impact of our restructuring charges, and were $0.89 for the quarter, a decrease from last year's adjusted diluted EPS of $0.99 per share.

The U.S. lawn and garden market has gotten off to a slow start this spring. Thinking back to last year, spring arrived early in the U.S. with significantly above average temperatures in February and March. We saw strong retail activity for the lawn and garden market through April before we began to see the impact of the drought in May that lasted into the fall. While this year seems to be more normal in terms of spring, we believe that the season is going to be 2 to 3 weeks later than normal and several weeks later than last year. Our outlook for the U.S. market for this season remains unchanged at growth of 4% to 6%.

We continue to see positive signs for our higher market this year. The U.S. drought map has shown a lot of improvement in most areas, east of the Mississippi River, which is where the majority of lawn and garden equipment is sold. The housing market continues to show signs of improvement, with new and existing home sales and home prices increasing over 2012.

To the extent the market turns out to be even better than we anticipate, our U.S. manufacturing operations are ready and able to respond to higher demand. While we wait for warmer spring weather, we've been busy executing a strategy in several areas. With respect to geographic diversification, we've been working to integrate our recent Brazilian acquisition, Branco, into Briggs & Stratton. For the first full quarter under our ownership, Branco results were in line with our expectations for sales and profitability. We held our annual dealer conference in Brazil in February and continue to be impressed with the products, the dealers and the employees of the Branco organization. Looking forward, we will continue to expand the Branco product line both in Brazil and elsewhere in Latin America.

Here in the U.S., we've previously discussed higher margin opportunities, such as providing innovative new products to our network of Simplicity Snapper and Ferris dealers. During the third quarter, we announced the launch of 40 new products to our dealers this spring. New innovation of these products include the industry's first independent suspension on our Simplicity tractors. Independent suspension allows the homeowner to cut their lawn faster while maintaining a quality of cut for a great-looking yard and a more comfortable ride at the same time. All of our new models are now in the dealer showrooms and the early responses from our dealers and consumers has been extremely positive, even with the spring weather being delayed by at least 2 to 3 weeks.

Also, during the quarter, the Snapper brand was reintroduced at Walmart. Consistent with our strategy, we are licensing the Snapper and Murray brands for use at Walmart and we are powering all of these mowers with Briggs & Stratton engines while other industry OEMs are manufacturing the mowers. There are 6 Murray walk mowers, 6 Murray riding mowers, plus the addition of 5 Snapper walk mowers at Walmart this spring, all with Briggs & Stratton engines. We also continue to progress against our operational objectives to streamline and take costs out of both our Engines and end product businesses. The restructuring actions that we announced last year continue to be on track for cost and timing and also deliver savings to the business. Through the end of the fiscal quarter, our total restructuring savings were over $28 million compared to the prior year. While you can more readily see the improvements in the margins of our Engine business, we are seeing operational improvements in our Products business that will allow us to achieve higher margins as production sales volumes return to more normal levels.

So while our global sales volumes and production were lower for the quarter, we have been actively improving our business and preparing to capitalize on the improved U.S. market this season.

Now I'll turn it back over to Dave to walk you through our segment financial results for the third quarter.

David J. Rodgers

Thanks, Todd. Engine segment sales for the third quarter were $452 million, a decrease of $46 million or 9% from the prior year. The majority of the decrease in units shipped was in international regions including Europe, Australasia and Asia. Engines for the Australian market continue to be down due to the extreme dry conditions in parts of Australia and New Zealand. In Europe, spring appears to be approximately 2 to 3 weeks later than normal and channel participants are closely managing their inventory levels due to the uncertainty of consumer spending in several countries. In the U.S., engine units shipped in the quarter were behind last year by 3%, which we attribute to the timing of shipments with an early spring last year and a season that appears to be delayed by a few weeks this year. Total engine unit shipments were approximately 3.1 million units and were lower than last year by about 11%. Sales in the quarter were unfavorably impacted by approximately 1% due to foreign currency, which was offset by a favorable mix of larger engines sold.

Due to the lower sales volumes, the third quarter Engines segment adjusted operating income, excluding $5.4 million of restructuring charges, was $62.5 million, a decrease of $2.5 million from last year's adjusted operating income of $65 million. The adjusted engines operating margins in the quarter were 13.8%, an improvement of 70 basis points from 13.1% in the prior year. Driving the improvement in operating margins were higher adjusted gross profit margins of 1.4%. The adjusted gross profit margins in the quarter were 23.5% compared to 22.1% last year. This improvement in adjusted gross profit margins was due to restructuring savings of 80 basis points and improved manufacturing efficiencies, cost reductions and lower cost of materials of 280 basis points.

These gains were only partially offset by 120 basis points related to foreign currency headwinds, primarily related to the euro and slightly lower pricing. Lower production of 4% in the quarter also unfavorably impacted margins by about 100 basis points. Our total production was approximately $2.3 million units in the quarter, which is lower than last year by approximately 100,000 units.

I'd also like to point out that the year-to-date adjusted gross profit margins of the Engine business has also improved 140 basis points to 21.3% from 19.9% in the prior year. In spite of foreign currency headwinds of 100 basis points and 5% lower production, resulting in lower fixed cost absorption. This improvement is being driven by savings of our restructuring actions of 1%, improved plan efficiencies after incurring costs in the prior year for launching our emissions compliant engines of approximately 1%, and manufacturing and materials cost reductions, partially offset by lower pricing.

Engine segment ESG&A spending in the third quarter decreased by $1.3 million compared to last year as a result of savings of $2.5 million related to our salaried headcount reductions, partially offset by higher pension expense. In the Product segment, sales for the third quarter were $232 million, a decrease of approximately $50 million or 18% from the prior year. As Todd noted, the majority of the decrease is due to our exit of selling lawn and garden equipment to the major mass retailers.

Sales to our dealers of lawn and garden equipment were down slightly in the quarter, which we attribute to a much later spring compared to last year. Interestingly, our sales of lawn and garden equipment to dealers is up double digits compared to the 2011 season, which represented a more typical start to the spring lawn and garden season. Sales of pressure washers were also lower in the quarter as a result of a later spring. Offsetting lower lawn and garden sales in the quarter were increases in generator sales to replenish channel inventories following Hurricane Sandy.

Third quarter Products segment adjusted income from operations, excluding $1.2 million of restructuring expenses, was $1 million in the quarter, a decrease of $7.7 million from last year's adjusted operating income of $8.7 million.

The adjusted operating margins of the Products segment were 0.4% in the quarter compared with 3.1% in the prior year. Adjusted gross profit margins were 12% in the quarter compared to 13.2% in the prior year.

The adjusted gross profit margins were negatively impacted by 3.4% due to reduced absorption as production decreased 35% in the quarter compared to last year. Production was lower in part due to pushing back the start of production on certain new lawn and garden SKUs by a few weeks as controlling inventories -- as well as controlling inventories with a later start to spring compared to last year. Offsetting the impact of lower absorption was the benefit of 1.7% in restructuring savings from the actions announced in fiscal 2012.

Within our international Products business, while we have seen the expected favorable margin impacts from the Branco acquisition, these have been offset by reduced volumes of lawn and garden equipment in Australia, which also carry higher margins relative to the U.S. market.

Product segment ESG&A expense have decreased $1.7 million from the prior year quarter due to the headcount reductions in the prior year as well as lower bad debt expense related to international distributors.

Turning to our balance sheet. Net debt at the end of the third fiscal quarter was $240 million, a decrease of $18 million from the third quarter of fiscal 2012. Cash used in operating activities year-to-date was $74 million, primarily related to seasonal receivable levels and inventory build. Cash used in operations in the first 9 months of fiscal 2013 decreased by $93 million compared to the first 9 months of 2012. The reduction in cash used in operations in fiscal year 2013 is due to lower receivables as a result of lower sales in the quarter and continued reductions in inventory levels.

LTM cash provided by operating activities was $159 million. Year-to-date depreciation and amortization of $41 million outpaced capital expenditures of $26 million. During the quarter, we repurchased approximately 20 -- approximately $4 million worth of outstanding common stock. Through the end of the third quarter we've repurchased 23 million of shares outstanding this year. Regarding debt covenants, our last 12 months average funded debt and LTM EBITDA as defined by our credit agreements, were $242 million and $140 million, respectively, resulting in a leverage ratio of 1.7x, which is well within our debt covenant of 3.5x.

That concludes our comments on the third quarter financial results. So I'll turn it back over to Todd to discuss our outlook for the remainder of fiscal 2013.

Todd J. Teske

Thanks, Dave. As we noted in our earnings release today, we are taking our guidance for the full fiscal year net income lower to be in a range of $56 million to $65 million or $1.16 to $1.33 per diluted share. I should note that the diluted EPS range does not consider the impact of restructuring expenses or share repurchases, but does include the impact of Branco since the acquisition. The reduced guidance reflects the weakness in our international markets that we discussed earlier, which generally have higher margins. Specifically, reduced product sales and profitability within the Australasia region due to the extremely dry conditions over the past 6 months, have impacted our business beyond our downside projections. In addition, we continue to see channel participants in Europe use extreme caution in building up inventory in advance of the spring lawn and garden season with consumer confidence not showing signs of improving.

As I said earlier, market projections for the U.S. market remain at 4% to 6%, higher than last year's season. The lower end of our range contemplates a later start to the spring lawn and garden season in the U.S. and in Europe, which could potentially have the impact of extending the season past the end of our fiscal year and into fiscal 2014. The higher side of our guidance contemplates an additional 5% increase in the U.S. market for the season, assuming that we capture those sales on our fiscal fourth quarter. We are projecting consolidated net sales for fiscal 2013 to be in the range of $1.95 billion to $2 billion. Excluding the impact of restructuring charges, operating margins are estimated to be in the range of 4.8% to 5.3% and interest expense and other income are forecasted to be approximately $18 million and $7 million, respectively.

Excluding the impact of restructuring charges, the effective tax rate for the year is anticipated to be between 30% and 33%. Lastly, we anticipate capital expenditures for the year to be approximately $45 million to $50 million. That concludes our prepared comments, and I would like to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] First question comes from Robert Lisnic from Robert Baird.

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

It's Pete Lisnic from Baird. Can you give us a little color, that 46% that you're talking about for the U.S. lawn and garden market, still sound pretty confident in it. I would guess there could be some regions where whether it's somewhat normal. Are you getting any sort of indications that would support that forecast from those types of regions?

Todd J. Teske

Yes. What's interesting, Pete, is when you look at the entire country, and we have a tendency to also now look at temperature maps because especially down in the South, where you have situations where grass needs a little bit -- a lot more warmth to grow, it has been certainly delayed. What we've been seeing here as of late is, over the last couple of weekends, although the comps get difficult because of where Easter fell a year ago, we're starting to see some reason to be optimistic given that it seems like spring has made its way, albeit later, to some of the regions in the South. But it's still really early. I mean, we're talking about 1 weekend where the comps are starting to look a little bit more favorable than they had been the prior weekends. It really is -- most of the country is -- has been delayed by at least 2 to 3 weeks.

David J. Rodgers

The other thing I'd add to that, Pete, is that as we look at the retail sales of our dealer network and we've looked at it over a period of 5 to 10 years, by month, and when you look at that, you are able to identify how strong retails were towards the end of February and March last year. And if you try to compare the 2013 season with last year, of course, you're going to see comps being down. But if you look at how strong 2012 was, you could actually see comps being down by greater than 30% for the month of March and still be even with where we were 2 years ago. So that gives you kind of an idea of how much the season moved up last year and even to get back to what I call normal trend lines, you can see that late February and March compared to last year will be down pretty significantly.

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

Okay, got it.

David J. Rodgers

Having said that, that means that we think the season is still out there in front of us.

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

Okay, all right. And then just along those lines, can you maybe talk a little bit about what your customers are telling you in regards to how they feel about their inventory positions?

Todd J. Teske

Yes. What's interesting about inventories is that what we're hearing and obviously we don't have full visibility all the way through the channel, and we don't always have visibility to the OEM inventories, but we do have a better idea. Having said that, what's happening -- what we can tell that's happening at retail to a certain extent, is that there is a carryover of snow inventory and even though there was significant snow in February and March throughout the country, you got to understand that by the time you hit about the end of January, and we said this on the last call, by the time you hit the end of January, the first maybe week or so of February, I mean, the season is basically over. So even there's a lot of snow, there wasn't a whole lot of retail sell-through to speak of, if you will. And so what's happened is, retail inventories are generally a little stronger with snow and with retailers controlling it, inventory dollars, they've been reluctant to take inventories and build up the preseason green goods, if you will. At the same time, the OEMs, best as we can tell, have been -- being very cautious also because what they don't want to do is be hung with a lot of inventory throughout the season. Although we continue to hear optimism along the way. So when you look at kind of where inventories are, I think inventories for green goods are probably, maybe a little bit on the light side at retail because of the inventory dollars we're trying to control. Our inventories, we've been working to control our inventories as well. And the real advantage then that we have throughout this whole thing and we've talked about this on prior calls, is the fact that we produce here in the U.S., where many of our competitors don't. And so, if -- as I said before, if the market does break and it's even better than what we think, we're in a great position to be able to deliver to the market.

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

Okay. And that actually -- that actually leads to my final question, which is, on your own inventories, given the, I guess, the exit from mass retail, I would have maybe expected to see a bit more inventory taken out of your balance sheet in the quarter. Do you feel pretty comfortable or maybe I should ask the question as, how you're thinking about the production outlook for the fourth quarter given the inventory levels that you've got?

Todd J. Teske

Yes, that's a great question, Pete, and I'll break it down between the Engines and the Products business. On a year-over-year basis, the engines inventories are higher as you would expect based on the conversation that we've had to this point. That will have the impact depending on what happens with the season as far as when it breaks on our manufacturing for the fourth quarter. The Products business, to get to the point of your question, which is how inventories come down there, the Products business is down and inventories in the $30 million to $35 million range here in the states. And so we do continue to see pretty -- see inventories coming down in line with what our expectations were relative to the products that we're exiting with the exception being of snow because of the relatively weak snow season that we have.

Operator

Next question comes from Robert Kosowsky from Sidoti.

Robert A. Kosowsky - Sidoti & Company, LLC

I just had a question about what's implicit in the engine volume guidance for the fourth quarter, because we were down about 19% last year and I'm wondering what you think engine volumes are going to be up this year and just to kind of like reaffirm the question to, if you look at last year, it was about $500 million of revenue in the fourth quarter, you back off, say $30 million for exited business, to get to the low in the guidance you're still looking for about 20% revenue growth for the fourth quarter, and I'm just wondering where that growth does come from as well?

David J. Rodgers

No, I think for the Engine business, their growth is going to be south of that, Rob. And again, some of this is just timing related issues, related to last year versus this year in spring. I think the part that you may be missing is that in the Products business, there's also some higher growth rates in Products in the fourth quarter year-over-year than what I would call 4% to 6%. For example, we are anticipating higher growth rates in things like pressure washers, as well as service parts, which we expect to rebound from last year's fourth quarter due to the really, the drought conditions that we saw here. We're also looking for generators to be up higher than 4% to 6% as we continue restocking after the Hurricane Sandy last fall. So those are some of the things that we'll kind of round out. In addition to that, we've got -- we're going to have the addition of Branco in the fourth quarter as well, which is just another piece of that.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay, that's helpful. And then can you talk a little bit about product mix changes and where you selling kind of more -- as we're kind of further into the season, are you seeing a mix change positively or negatively on the engine side?

Todd J. Teske

Well, so far what we've seen is a shift towards the larger engines for this particular quarter. Our call in the market is up 4% to 6%, and that is really fairly similar between walks and rides. What it looks like to us as far as industry shipments for the quarter is that walks were down more than rides in the quarter. And so our shipments kind of reflect what we appear to be seeing in the industry as well. So I think the mix shift has been a little favorable towards some of the larger engines. We continue to see a shift of the consumer going from riding units to Zs. Again, those are similar types of engines. But just to give you a little bit more color about what we see happening there.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay, that's helpful. And then finally, it looks like there's a big kind of fourth quarter back end load to the CapEx guidance, is that true and kind of what's the big spend in the fourth quarter?

David J. Rodgers

I think you'll find that historically, that's been the case is that we will spend more in the fourth quarter. And some of that, I will tell you, is a little dependent upon what happens with the season here. To the extent that we do get a later season, I will tell you, you may see that CapEx number be a little lower than what that guidance is because we're busy in the plants making product as opposed to doing some of our year end maintenance type things and CapEx.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay, that's helpful. And then finally, could you just expand a little bit on the intentional production decline in power products and kind of what you guys saw and like what you pulled back on, just kind of any more color on that would be great.

Todd J. Teske

Yes. I'll be honest about it. Some of it was start-up issues where we ended up pushing some product manufacturing from the third quarter into the fourth quarter as we launched all of these new products. I do think that those issues are behind us and that all of those things are going as expected at this point in time where things may have moved by just a couple of weeks. Other than that, we are just trying to stay very close to the market using the market intelligence that we have from our dealers to make sure that we don't overextend it. Most of it is intentional takedown of manufacturing. I will tell you, as I've said in the past, I think we have a lot of opportunity in particular in our Products group, to continue leaning out the operations and build up inventory in advance of the season. But also make sure that we come out of the season with the appropriate levels of inventory and you see us working on that pretty diligently. So you'll see us continue to stay very close to what retail demands are and how that impacts what our manufacturing schedules are in our plants. And you'll see us continue to work those inventory balances moving forward.

Operator

The question comes from Sam Darkatsh from Raymond James.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

A couple of questions. First off, housekeeping. Can you quantify the impact in sales for the quarter for the departure from the OEM mass margin business?

Todd J. Teske

Sam, it's right around $40 million. It's just a little bit north of $40 million. And on an annual or through 9 months, it's just north of $70 million. I will tell you, it's a litter hard to split out because one of the categories that we have exited for the large mass retailers is snow throwers. And so I didn't want to -- we wanted to give a accurate picture, if you will, of what snow throwers are down and what the mass retail is down. But if you compare it to what we planned on, I can tell you it's about $70 million year-to-date.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

Got you. Okay. So then my first question would be, what gives you confidence that if -- that the season might get extended past your June quarter, that would seem to be -- I can't remember the last time that's really happened in the industry, you would think, I guess, intuitively if the season gets longer that the consumer would be less apt to expend a fair amount of money for a mower when his mowing season might be over pretty soon. So what gives you confidence that, that might develop?

Todd J. Teske

Well, Sam, this is Todd. We've seen seasons extend all the way into the fall. I mean, it's one of those things where if you get off to a later start, it depends on how the pent up demand, the replacement demand, because we think there's some replacement demand that's out there. And also it has a tendency to depend on consumer confidence. And so we're not telling you that it's going to happen, but I've seen it happen in the years that I've been here. And so it's one of those things where the mowing season, even the mowing season here in the upper Midwest, generally starts about now. Although I haven't mowed my lawn yet, but it generally starts about now and it goes through the end of October up here. And so once you get to -- not everybody buys early in the season. And even if you get into, for example, July and into August, we have seen years in the past where it has extended out. Which is why we wanted to just to make sure people understood that, that is a possibility and we're not saying it's going to happen, we're saying that it's possible that it will happen.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

Final question, I'll defer to others. So, Dave, as I see, it looks like your margin guidance is cut by 30 basis points prior to your prior guidance. What's the derivation of that specifically?

Todd J. Teske

Production levels, primarily. And making sure that we hit our cost targets with all the new products coming out this year.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

So you may have answered this already and I apologize if you did. Your expected production in the fourth quarter, in terms of units?

Todd J. Teske

I historically haven't given out forecasted production or unit sales moving forward.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

But do you expect that to be down based on current commentary?

Todd J. Teske

Well, here's what I would tell you, that we have heavier inventories than we did last year at the end of the third quarter within the Engines business. We also have a plan for this year to end inventories down slightly from where we were at the end of last fiscal year, by around 100,000 to 150,000 engines.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

In terms of dollars, where should we peg fiscal year end inventories. It's hard because the OEM departure just to see that sometime.

David J. Rodgers

Yes. I think for the total business, Sam, we're really anchoring in on the inventories being down by at least $40 million to $50 million.

Operator

Our next question comes from Timothy Meaney from Longbow Research.

Timothy Meaney - Longbow Research LLC

First question, just with regards to the exiting of the mass retail business and more focused on the dealer channel, maybe if you could just provide some color on some of the various things you guys may be doing to further support the dealer channel. I'm thinking maybe you've previously haven't focused as much on in the past?

Todd J. Teske

Well, I'm not sure that we haven't focused on it. This year, we've got 40 new units coming out. And I personally sat -- by the way, this is Todd. I personally sat through some of the dealer meetings and have talked to a number of dealers and they are really excited about some of these new units coming out. And so, whereas that 40 new models coming out and new products that sort of thing is different, it's much more than what we would have had in the past. And so, that's very useful along the way. And really just getting our business focused on making sure we're serving that dealer customer. Obviously, when you have a lot of things going on and you try to serve the mass and trying to serve the dealer, by us simply focus, getting focused to that business, obviously allows us to serve that -- those dealers much better. So we're doing a number of things that we're really not in a position to talk about publicly right now. In terms of enhancing our ability to communicate with the dealer, enhancing our ability for -- the dealer's ability to have more visibility in the business, and obviously continue to come out with new products and services that will help those dealers be successful. So it's really helped us a tremendous amount here over the last 12 months since we made the announcement of exiting the lawn and garden products mass business to put a tremendous amount of focus on making sure that dealer channel is strong and viable.

Timothy Meaney - Longbow Research LLC

That's helpful. So it sounds like a combination, paying more attention to them, helping them, providing them with some advice on how to better sell the products as well as new products. Is promotional activity or increased, providing them with increased promotional tools, part of the plan as well?

Todd J. Teske

It is. And we've also upped our advertising and we're doing more national advertising with Simplicity and Snapper. We continue to work with them on a co-op basis. And so, yes, there's just a number of things where we're putting our energy into that part of the business. And by the way, the dealers, having a strong dealer network is really good, not just for us, but it's also good for the industry overall.

Timothy Meaney - Longbow Research LLC

Sure. Well, I appreciate that color. And I guess as a follow-up, given the phasing out of the lawn and garden products at the mass retailers, I know you talked about the impact on sales for the year you expect us to have, I guess thinking longer-term, where do you see the more ideal mix or split between revenue between Engine and the Products business just kind of directionally?

Todd J. Teske

Yes, Tim. I don't pay -- that's not necessarily a key metric I follow. The key metric that I pay a lot of attention to is international versus U.S. Now, having said that, to get to your question, the focus that we have on a lot of the international markets will be much more skewed toward products than engines. Simply because when you go to places in the world, there aren't necessarily well-established OEMs to whom we can sell engines. And so often times, we become the OEM or we really -- we want to make sure that we have a lot of influence over the distribution that goes on and so often times we'll have companies and subsidiaries that own distribution in these regions. And so what'll happen is, it'll be more skewed towards product, which then by definition, I would tell you SKUs that mix of engines to products much more toward the products end of the business. That doesn't mean that -- obviously the engine business isn't important to us. It's extremely important to us and what we look at is on a by market basis, can we sell engines and can we still lots of engines first. And if we find that we have a difficult time doing that because of the OEM structure in the region, then what we'll do is we will step into the distribution and potentially step into that OEM end of the business. So I would tell you, it'll skew more toward 50-50 longer-term. But that's because of the focus we have on international as it relates to penetrating some of the emerging markets.

Timothy Meaney - Longbow Research LLC

Sure. And just finally, just quickly here. Can you just remind us maybe what the current engine capacity is currently at and maybe what kind of utilization rates you saw in this third quarter here?

David J. Rodgers

Yes, this is Dave. The current capacity is about 11.5 million to 12 million units using normal production rates. We have the ability, using our flexible lines in our plants, to go up to about 12.5 million units, depending on what the mix is.

Timothy Meaney - Longbow Research LLC

And then utilization that you saw and the return this quarter?

David J. Rodgers

Well, during this particular quarter, utilization rates are relatively high. We are probably somewhere in the 80% to 85% range typically in the third quarter. Yes, high end to that.

Todd J. Teske

Well, if you think about it, I mean, Dave, when you talk about 3 million, 3.1 million engines being produced, and if you just straight line that 11.5 million capacity, that will give you an idea kind of where utilization is.

Operator

Next question comes from Brad Safalow from PAA research.

Bradley G. Safalow - PAA Research LLC

Can you just give me the actual production year-to-date and the shipments year-to-date number?

David J. Rodgers

The production number is about 6.8 million units. I'm sorry, that was last year. 6.5 million units, it's down about 5%.

And the shipments are about close to 6.1%.

Bradley G. Safalow - PAA Research LLC

Okay. And are you guys -- it sounds like you're making a slight tweak to your target for year ending inventory. I thought at the beginning of the year you said you wanted to be closer to 1% to 1.1% and now it sounds like you're going to be around like 1.2% plus, is that right?

David J. Rodgers

No, I think we'll be pretty close in line with our expectations from the beginning of the year.

Bradley G. Safalow - PAA Research LLC

Okay. And then just maybe another way of thinking about this question of the impact of weather here in the states. You guys referenced state-by-state analysis you've done in terms of sales trends per state going back many, many years. In the states that are less impacted by seasonal weather and you've seen, let's say, a recovery in housing, your sell-through in those states from what you can tell is -- does it tie out to what you would expect, given what’s happened in the housing market, I guess is the question.

Todd J. Teske

Well, what I can tell you is, even down in Florida, there is seasonality to the business as far as the grass growing and so, pretty much the entire country is subject to, I'll call it, the seasonal nature of grass cutting. Having said that, I think I'd go back to the comment that I made earlier which is, if you look at our dealer business and compare this year's third quarter compared to 2 years ago third quarter, we're up strong double digits. And so the other comment I'd make is, going back to last year, the market seemed to be getting off to a pretty strong start and we think a lot of that was due to housing getting it's legs underneath it, as well as Todd said, some of that pent up demand that we've seen in the market as well since it's been -- since about the 2004, 2005 timeframe since we've had a peak at the market.

Bradley G. Safalow - PAA Research LLC

Okay. And then how much were sales of Australia down in the quarter or shipments?

Todd J. Teske

Yes. We don't break out each individual country. What I can tell you is that for the year, the market in Australia and we are the market share leader in Australia, is down somewhere between 25% and 30%.

Bradley G. Safalow - PAA Research LLC

And just as we get further away from Sandy's impact on your generator business and you're, I guess, getting towards the latter stages of inventory replenishment in the channel, what can you say, I mean I asked this question last quarter, I know you have some new distribution arrangements on the generator side, what can you say about what you think is the secular growth of the business now?

David J. Rodgers

Well, it continues -- we think that growth continues to be -- we're optimistic about the growth. The issue is, is that the further you get away from the storm as you point out, obviously, you start to see demand not nearly as strong as it had been right after the storm. Now having said that, I would tell you that -- and I'm talking more so standbys now than portables, when you look at purchase interests and kind of the order book, I would tell you that it remain -- it continues to be stronger than perhaps it was a year ago. And so as these storms continue, you continue to drive interest, certainly. And now we're basically 1 1/2 month away from the start of hurricane season again. And obviously, the prognosticators have come out with what their predictions are and everything else. The fact is, is that, as outages continue throughout the country, whether it be hurricane-related or otherwise, because there's other reasons that power is out, I would tell you that interest in the category continues to be strong. Is it as strong as it was after the -- for the month after the storm? No. But at the end of the day, we believe and we're seeing that the interest is and the activity is better than it was, for example, last year.

Operator

The next question comes from David Post from Point Lobos.

David Post

I guess just taking a step back kind of looking at things high-level, you guys kind of guided, you guys have kind of cut about $35 million of cost out of the business and that's kind of better than this guidance. And so if I back those cost cuts out of this new kind of lower guidance number, your EPS guidance is down pretty substantially from where you were guys last year, you would have done -- you're kind of guiding to about $0.10 or $0.17 or so. So I'm just wondering, what and that would also be kind of the lowest EPS number you guys have done since going back to 2008. So I'm just wondering what's causing that and kind of how should we think about these cost cuts as far as the impact on the business and kind of the earnings power of this business. Were they kind of just going to offset other changes happening in the business or was there something else I'm missing here? I'm just trying to kind of bridge from these cost cuts to kind of where your EPS guidance is.

Todd J. Teske

Yes, so if you step back, because I've done exactly what you just did, and basically what's going on is volume. The volume is down when you look at the market, overall, the market has been down substantially since 2005. Certainly now you look at it on a year-over-year basis, volume has had a significant impact, whether it be because of a lack of snow sales, lack of snow and then snow thrower sales, engine sales that relate to those snow throwers and whether it relates to the fact that the Australian market was down 25% to 30% this year. And whether it relates to the fact that you had a drought that continued on through the fall, which then had an impact on things like service parts along the way. And then Dave, the pension expense increased year-over-year...

David J. Rodgers

It's about $7 million to $8 million.

Todd J. Teske

So you take all of those factors together, and it has an impact. And so we did what we needed to do by restructuring the business. The fact is, is when you step back then and look at the changes we've made, both to the focus of the business. And now more importantly, to your question, the future earning power of this business. By taking the cost out, we don't believe that we've substantially or in any way, I should say, impacted the future earning capability of this company. We still have capacity within the Engine business to ultimately have a significant -- take advantage of a significant market up. And we have the opportunity to innovate now whereas in the past, we were focused on things like emissions regulations, which obviously are important. But when we restructured our R&D group, and now we have the capability of bringing innovation to the market, we believe, today, I firmly believe, today, that we are in a substantially better position to take advantage of market conditions, and to help influence the market as it relates to new products coming out into the market than we've been in the 17 years that I've been with the company and during doing those 17 years, we had some very good years and we had some very good results. But I can tell you that today, given where the market is at, and where the market has come from, if you will, we are in the position to take advantage of that for future earnings growth for this company. I'll also tell you and refer you to our website where we have our Investor Relations information where it talks about the correlation of the lawn and garden -- U.S. lawn and garden market to the housing market. And the housing market has been down, as I'm sure you know, very substantially. And there's a very strong correlation. And so as housing comes back, both in new single-family homes, as well as existing single-family homes sales, we -- our estimates indicate that there will be a significant impact into the future with regards to the market itself. And obviously, being a significant market share player, we believe that there will be some -- we'll enjoy the benefits of all of that. At the same time, we're not relying just on the U.S. market. We're also looking at opportunities in the emerging markets where -- places where we've really never played very strongly in the past. So the acquisition of Branco down in Brazil is significant, and what you will see us do is to continue to look for ways to expand in the stronger margin businesses globally, so we get geographic diversification, as well as product line diversification. So I'll tell you that hopefully, that sheds a little bit of light on why I firmly believe the earnings capacity of this company has substantially improved from perhaps where it's been, given the market here in the U.S.

David Post

Okay. I guess another question sort of along those lines. As we've kind of seen the Chinese continue to increase their capacity to build engines over the last year, I'm just wondering from your standpoint, and that's kind of both in China as well as building out their footprint in the U.S., I'm just wondering from your standpoint, how does that impact your views for the business going forward and do you still feel confident in your competitive positioning versus the Chinese or do you think that they're kind of still kind of encroaching on your business like they have over the last 5 or 6 years?

Todd J. Teske

Well, let me back you up then all the way back to -- first off let me comment on this. I'm not aware of any Chinese company making engines in the U.S. first off. Secondly, capacity in China, I don't know that it's increased necessarily over the last year. Certainly over the last 3 to 5 years, there's been capacity increases. When you go back and take a look at history, we, the players, and I'm talking more so about the walk engine market than the rider market, we've seen some units come out on rides, but it's more so on the walks. If you go back in time, you'll find that the major competition -- competitors in the market, say, 5 -- 4, 5, 6, 7 years ago, something like that, was Briggs & Stratton, Tecumseh and Honda. And essentially, Tecumseh went out of business, we picked up substantial market share when Tecumseh went out of business, to the point where we had more than 90% market share on walk engines here in the U.S., to give you an idea of how significant that was, up from our traditional 70% to 75%. And when you look then and what we said back then, is we said that we were not going to price to hold on the market, 90% market share because it was going to be detrimental to the business and our profitability overall. And so we predicted that the Chinese would step into Tecumseh's position, which is exactly what they've done. I will tell you, we have been in China since 1986. We put up a new plant in 2003 or '04. We understand what it is to do business in China and we've seen our cost rise substantially in China. Not only for some energy and other things, but also as it relates to labor. At the same time, the RMB, the Renminbi, is now trading somewhere in the neighborhood of 6.2, in fact, below 6.2. And where it was a few years ago it was 8. -- it was pegged to RMB 8.28 to $1. And so essentially, what you're seeing is a substantial increase in -- or headwinds in terms of foreign currency for the Chinese. Our position, we're in a position now where we -- the Chinese have a position in this market, but the fact is, is that we've been able to defend that position -- our position very well. And do we see at times, Chinese companies pricing because we know that they need to keep their volume? Yes, we see that. But the fact is, is we have a value proposition that is based more than simply on the price of an engine. And so, I would tell you that we do see continued competition in the market. But we sell our value proposition extremely well. And in fact, over time, if you go back to 2007, you'll see that we ultimately shut down a plant here in the U.S. and are sourcing more horizontal shaft engines from China. And so we're much more competitive in that market. So we've been competing with the Chinese for quite some time. And at the end of the day, it really comes down to the value proposition we bring to the market and our ability to deliver. As I said before, we have the advantage of producing here in the U.S. And as people keep inventories low, we have the ability to supply the market when needed. So from that perspective, I would tell you that we're well positioned for the future.

David Post

And so is it too early to kind of have an insight into where replacements look for 2014?

Todd J. Teske

Way too early because we haven't even -- no one has started line reviews and we haven't started negotiating with -- we got to get through this season first to see what sells and what doesn't sell, so that we can ultimately then start negotiating on 2014. So it's way too early to figure out what replacement is going to be for '14.

David J. Rodgers

David? And one last thing just going back to your last question. One thing that I think sometimes lost is the impact that our pension plan has had on our financial statements in total. I mean if you just compare 2009 to 2012 or '13, as an example, you're going to see that the pension plan has had a negative drag on our earnings pretax by somewhere around $25 million during that time period. Now as we announced in October, we've taken actions to freeze the pension plan starting 1/1 of 2014. And so we continue to work on the volatility that's in the plan and try to minimize the impact that as to our overall financial statements, but we've taken actions there. But that's one thing that sometimes people forget about is that, that's had a pretty significant drag over the last 4 years.

David Post

And I guess one last thing since you brought it up on the pension, where does the liability sit right now, is it around $300 million or so? I think that's what I remember from the last 10-K.

David J. Rodgers

Yes. The last 10-K, we're underfunded on a GAAP basis by about $300 million. Since that point in time, but that's the last valuation that we've had done. But what I can tell you since that point in time is that the assets, as you would expect, have performed quite well. At the same time, the interest rates that are used to value the liability, have also gone down slightly since last June, as well. And so I think without having a full valuation done it's a little hard to tell, but I think it's probably somewhere in the same area as far as underfunded, maybe a little bit better. But that's something we'll update here at the end of our fiscal year.

Operator

I'm not showing any questions at this time, sir.

Todd J. Teske

Great. Well, thanks everybody for joining us on today's call. We will have our next quarterly earnings conference call in August. Have a great day.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. And have a wonderful day.

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