Briggs & Stratton's CEO Discusses F3Q 2014 Results - Earnings Call Transcript

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 |  About: Briggs & Stratton Corporation (BGG)
by: SA Transcripts

Briggs & Stratton Corporation (NYSE:BGG)

Q3 2014 Earnings Conference Call

February 25, 2014 08:30 a.m. 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

Josh Chan – Robert W. Baird & Co.

Josh Wilson – Raymond James & Associates

Robert Kosowsky – Sidoti & Company

David MacGregor – Longbow Research

Jake Thomson – Odey Asset Management

Operator

Good day, ladies and gentlemen, and welcome to the Briggs & Stratton 2014 Quarterly Earnings Release Conference Call. (Operator instructions) As a reminder, today’s conference is being recorded.

I would like to (inaudible) conference call to Mr. Dave Rodgers. You may begin, sir.

David J. Rodgers

Good morning, and welcome to the Briggs & Stratton Fiscal 2014 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 our filings with the SEC.

We will 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 this call.

Now here's Todd.

Todd J. Teske

Good morning, everyone, and thank you for joining us a bit earlier than usual today. We released our fiscal third quarter results last night. In that release we announced our third quarter consolidated net sales were $628 million, a decrease of approximately $9 million or 1% from last year’s third quarter.

Sales in our engines segment were effectively unchanged from last year at $452 million for the quarter, while sales in our products business were lower by $26 million or 11%. Sales within both segments of our business were negatively impacted in total by an estimated $25 million due to channel refill in last year’s third quarter following Hurricane Sandy.

No major storms occurred during this past hurricane season and thus creating a headwind this year. In addition our products business also had reduced sales in the quarter of approximately $6 million as a result of our decision to exit the sale of lawn and garden products to US big box mass retailers. You will remember that our fiscal 2013 annual sales were impacted by almost $100 million in lower sales compared with fiscal 2012 as a result of no longer selling these SKUs.

During last year’s third quarter, we effectively liquidated most of the remaining inventory we had in these particular units, and we did not have any sales to these SKUs in the current year. Excluding last year’s impacts of channel refill following Superstorm Sandy and rationalized mass retail lawn and garden SKUs no longer being sold, the growth of our consolidated sales in the quarter were approximately $20 million or 3.6%. This increase was the result of higher sales of engines for the US lawn and garden market as OEMs have continued to build for an improved lawn and garden market this season.

In addition, we are seeing the impact of placement games, primarily in riding engines, which we discussed during our second quarter earnings call. In the products segment we saw third-quarter shipments of snow throwers, riding mowers and pressure washers in the quarter, which were partially offset by lower sales of generators compared to last year. Excluding restructuring activities, adjusted consolidated net income for the third quarter was $38.7 million or $0.81 per diluted share compared with adjusted consolidated net income of $43.9 million or $0.89 per diluted share in last year’s third quarter. The impact of the volume decrease is associated with less channel refill following storms was approximately $0.06 per diluted share.

Earnings were also negatively impacted by reduced production volume in the products business as we continue to curtail our inventories with the slow start to spring in order to manage inventories to retail demand and with higher corporate expenses to support some of our new product launches, and expand our international distribution in emerging regions.

Here in the US, we’re no doubt again seeing the impacts of a slow start to spring. While this has not significantly impacted the engine business as OEMs have continued to build inventories in advance of the season. This has had an impact on our products business’ dealers, particularly in the northern half of the country, have been slow to increase inventory levels and reorder equipment until retail sales begin to show normal spring trends.

We estimated that at this point we are approximately 4 weeks behind normal with respect to retail sales of equipment related primarily to below average temperatures to start the spring selling season. Our outlook for the US market for this season remains unchanged at a growth of 4% to 6%. To the extent the market turns out to be even better than we anticipate our US manufacturing operations are ready and able to respond to higher demand.

As we discuss our outlook for the season later on in this call I will have additional comments on how we believe this slow start to spring may impact our fiscal year. As we anticipate the start of the selling season, we continue to focus on providing user driven innovation to expand margins for us and other industry participants, including OEMs and retailers.

While we are still in the early innings of the game so to speak, we are very excited about the early positive feedback we are getting on several new products launched this year, including our new Mow-n-Stow engine available exclusively on Toro mowers this year, our new 810 cc commercial series engine designed specifically for the durability and reliability that commercial users demand, and our new Quiet Power Engine Technology, which is the quietest engine we have ever made.

In addition to the positive consumer reviews, the order volumes for these new products have all exceeded our initial expectations helping us to realize the benefit of focusing and solving consumer problems.

Within our products business, we have launched our pressure washer products, including Powerflow + available at Lowe’s and our new Grip & Go Technology available on Craftsman product at Sears this year. These products, as well as several new products that feature on our lawn and garden equipment – (inaudible) lawn and garden equipment this year demonstrate our commitment to delivering innovative solutions to our customers, and improving the margins of our products portfolio.

Now I will turn it back over to David to walk through our segment financial results for the quarter.

David J. Rodgers

Thanks, Todd. Engine segment sales for the third quarter were $452 million, which approximated the same level of the prior year. Total engines shipped in the quarter were 3.1 6 million, which was less than 1% lower than the 3.18 million units shipped in the quarter last year. Higher engine shipments for the US lawn and garden OEMs were offset by lower shipments for portable generators after refilling the retail channel last year after Hurricane Sandy.

Fiscal year-to-date global engines shipped are approximately 6.1 million units, which represents an increase of approximately 1% even with the headwind of not having a hurricane in the current fiscal year. Further, when looking at only the US market, our year-to-date shipments increased over 8% in the current year after excluding the impact of fewer engines sold for portable generators.

Third-quarter engine segment adjusted operating income, excluding restructuring related activities, was $59.6 million, a decrease of $2.9 million from last year’s adjusted operating income of $62.5 million. The adjusted engine’s operating margin in the quarter was 13.2%, a decrease of 60 basis points from 13.8% in the prior year. Adjusted gross margins improved in the current year quarter compared with last year by 20 basis points to 23.7%. The improvement in adjusted gross margins was primarily related to an improved mix of larger engines sold in the quarter, and improved absorption of fixed costs on 4% higher volumes of engines produced.

This was partially offset by some manufacturing inefficiencies we experienced during the quarter related to new plant layouts in our small engine facilities and tooling related to new product introductions. These plants have made improvements to these areas and are currently hitting expected daily production rates at higher efficiency levels.

Our total production of 2.35 million units in the quarter was slightly higher than last year by about 50,000 units. So far this fiscal year we have produced just over 6 million engines, which is a decrease of approximately 450,000 engines or 7% compared with fiscal 2013. Total engine inventories are also lower than the prior year by approximately 440,000 engines, which is primarily related to reducing safety stock of our walk engines after transitioning to our new E series engine platform over the past 18 months.

Engine segment ESG&A spending in the third quarter increased by $3.7 million compared to last year due to increased personnel costs and investments in sales and marketing in emerging regions of the world. In the products segment, sales for the third quarter were $205 million, a decrease of approximately $26 million or 11% from the prior year.

As Todd noted, the majority of the decrease is due to channel refill of generators following Hurricane Sandy in fiscal 2013 that did not recur this year and our exit our selling lawn and garden equipment to major mass retailers.

Sales of snow throwers improved in the quarter compared with last year due to late-season snowfall in North America and reduced channel inventories during the season. In addition, we have seen higher sales of pressure washers as a result of introducing our new innovative pressure washer products to the market.

Third-quarter products adjusted loss from operations was $4.9 million, a decline of $5.9 million from last year’s adjusted income from operations of $1 million. The decline in the profitability was related to lower sales volumes as well as lower gross margin rates. The adjusted gross profit margins were 10.9% in the quarter compared to 12% in the prior year.

Adjusted gross profit margins were negatively impacted by 70 basis points due to reduced absorption as production decreased 10% for the quarter. We continue to be diligent in producing to retail demand and in reducing inventories. Excluding the impact of carrying more portable generator inventories in the current year due to lack of storms, our US products inventories have declined by approximately 33% compared with one year ago.

Adjusted gross margins were also negatively impacted by approximately 1.3% due to unfavorable foreign currency rates compared with last year, primarily related to the Australian and Canadian dollars and the Brazilian real. The margin rate did benefit in the quarter by approximately 50 basis points compared to last year due to improved mix of dealer products sold and incremental manufacturing efficiencies resulting from plant rationalization activities that we have done over the past several quarters.

Cash flows from operations and our balance sheet both continued to be strong. Net debt at the end of the third fiscal quarter was $118 million, a decrease of approximately $122 million from the third quarter fiscal 2013. Cash used in operating activities year-to-date was $14 million, primarily related to seasonal receivable levels. Inventory balances have been reduced $68 million in the last 12 months despite carrying more storm generator inventory in the current year.

Cash used in operations in the first nine months of fiscal 2014 decreased by $60 million compared to the first nine months of 2013. The reduction in cash used in operations in fiscal 2013 is due to lower receivables as a result of lower sales in the quarter and continued reductions in inventory levels. The reduction in cash is actually in 2014. Our LTM cash provided by operating activities is $221 million. Year-to-date depreciation and amortization of $38 million outpaced capital expenditures of $29 million.

During the third quarter, we repurchased approximately $9 million worth of outstanding common stock. Through the end of the third quarter, we have repurchased $30 million of shares outstanding this year. Regarding our debt covenants, LTM average funded debt and LTM EBITDA as defined by our credit agreements were $225 million and $117 million respectively, resulting in a leverage ratio of 1.9 times, which is well within our debt covenants of 3.5 times.

That concludes our comments on the third-quarter financial results. So I will turn it back over to Todd to discuss our outlook for the remainder of fiscal 2014.

Todd J. Teske

Thanks Dave. As we noted in our earnings release yesterday, we are taking our guidance for full fiscal year net income lower to be in the range of $43 million to $50 million, or $0.88 to $1.04 per diluted share. As I said earlier, our market projections for the US market remain at 4% to 6%, which is higher than last year. The lower end of our range contemplates a later start to the spring lawn and garden season in the US, which would extend the season past the end of our fiscal year and into our fiscal 2015.

The higher side of our guidance contemplates the US market higher by – higher than 6% assuming that we capture these sales in our fiscal fourth quarter. We are projecting consolidated net sales for fiscal 2014 to be in the range of $1.88 billion to $1.92 billion. Excluding the impact of restructuring charges, operating income margins are estimated to be in the range of 3.8% to 4.2%, and interest expense and other income are forecast 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 28% to 29%, and lastly we anticipate capital expenditures for the year to be approximately $45 million to $50 million.

That concludes our prepared comments and now we would like to open up the call to questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Josh Chan with Baird.

Josh Chan - Robert W. Baird & Co.

Hi, good morning Todd and Dave.

David J. Rodgers

Good morning.

Josh Chan - Robert W. Baird & Co.

I was wondering you commented on the slow start to the lawn and garden season, I was wondering if you have – can you give us any sense of how retail demand trends are in April that will be helpful, thanks?

Todd J. Teske

What we are seeing – obviously we don’t have clear visibility and transparency on the mass retail side, what we – anecdotally what we hear is that it is – it is tepid at best. I can tell you we do have visibility on our dealer business, and we are seeing pockets of the country that are starting to be a little bit more favorable, but then there is other areas, especially in the north, where there is still some slowness, and when you look at, you know, why that is we still have areas in the northern part of the country that have snow on the ground.

And, you know, so ultimately we look at the different regions and we can see some things breaking, but it is still pretty quiet. The other thing we track is – the other metrics that we track one of which is call centre activity and call centre volume, and we track it over a three-year period, and what we have seen one that is it a tracking very similar to last year. In fact, in some cases, some weeks it has been below -- a little bit below last year. And if you go back two years, where we had the early spring and then the drought, the call centre activity took off, you know, in a really meaningful way in early March.

And so this is where we – we are kind of as we look at the numbers and look at the range that is why we decided to take the range where the range is because we are just a bit concerned that the season isn’t necessarily going to compress from where we are today where you are going to see, you know, a significant compression in May and June.

But then what we will see is ultimately strong activity in May and June, and then like last year we will then go into July and August, in some cases last year in some regions it went to September. So that is why we did what we did with the guidance. And so, you know, we are cautiously optimistic that the rest of the season – the rest of the country will break for those areas where it hasn’t broken yet.

David J. Rodgers

Josh, this is Dave. One of the things that I will just add to that that is very encouraging is that down in some of the southern portions of the United States, our dealer network in particular for things like zero turn mowers has seen some pretty decent year-over-year increases in sales in retail sales, as well as what we have seen in our wholesale sales into the dealer channels.

So in some of those pockets as Todd said where we have seen some decent weather, the early indications are that, you know, the consumer has been out there and actively purchasing some of those products. So, we are still encouraged by that and looking forward to, you know, as the weather kind of warms up from south to north seeing those types of results, you know, moving forward.

Todd J. Teske

And I think just follow on to that as well. I mean we had noted in our prepared remarks that pressure washers have been doing well, and so, you know, pressure washers don’t need the grass to grow for units to move and I think what we’re seeing is, you know, after a long winter there is just a lot of cleanup and everything else that needs to be done whether it is, you know, road salt or whatever it might be, and we are seeing strength in that – in that pressure washer category.

Josh Chan - Robert W. Baird & Co.

Okay. That is very helpful. Thanks for the color on the trends, and if I can ask about the engine shipments, could you put into context the growth that you saw in the US lawn and garden market because I think previously you said that engine shipments may not grow too much in 3Q and there might be more growth towards 4Q. So was this growth that you saw this quarter unexpected, and how were you thinking about the next quarter?

David J. Rodgers

Well, as we look at the quarter for, you know, I will split it into two for the US. So for walk mowers we were – I will slightly (inaudible) 1% or so. In riding mowers, we were up, you know, in excess of 10%. And some of that was anticipated because we knew as we said in our last quarterly conference call that we had picked up placement of riding engines in the market for the coming season, and so we anticipated share gains coming into this year, and some of that is the strength that we are seeing in the third quarter.

I think overall what we are seeing is that the OEMs have continued to build fairly strongly in anticipation of this season, and, you know, as they build they have got the inventory and they are starting to push that inventory out to retail because, you know, we like others in the industry do continue to think that the market will continue to improve for the lawn and garden equipment in the US.

Josh Chan - Robert W. Baird & Co.

So then, you know, given the build in 3Q and the slow start would you – would your expectation for a ramp in 4Q be tempered related to previously?

Todd J. Teske

Well, I mean, we gave our guidance that we gave you today. Obviously, you know, it does indicate that in the fourth quarter we will have higher sales year-over-year, and you know, that is our best estimate of it at this point in time. The risk is that things continue to drag out to be a little slow here over the next couple of weeks. I mean if I remember back last year, we really didn’t start to see retails top until the third, fourth week of May. And as I think back to last year, retail through the end of June at the end of our fiscal year was relatively flat when compared to the prior fiscal year.

Now we said last year that we thought that the market would be up somewhere again in the area of 4% to 6%. It didn’t happen in our fiscal year. By the time we got to the end of the season, walks were up about 3%, rides were up 9%. So, you know, sometimes it is just a matter of timing. We try not to worry too much about what order it is going to go in. We try to give you our best cut at it. But, you know, we try to build that into the guidance as far as the range that we have put out today.

Josh Chan - Robert W. Baird & Co.

Okay. Thanks for the color and I will hop back in the queue.

Todd J. Teske

Thanks Josh.

Operator

The next question comes from Sam Darkatsh with Raymond James.

Josh Wilson - Raymond James & Associates

Hi, this is Josh Wilson filling in for Sam. Thanks for taking my questions.

David J. Rodgers

Good morning Josh.

Josh Wilson - Raymond James & Associates

Good morning. I wanted to ask about the low end of the sales guidance range. It doesn’t appear you have reduced the sales dollars that you are guiding for at the low end even with this weather delay. Could you talk about what some of the other moving parts are that might be offsetting that?

David J. Rodgers

Well, you know, without going through each line of model that we have, you know, I would tell you that we have taken down, you know, the sales as far as our thinking for the lower end. One of the other – there is a couple of other things that maybe factoring into the OI portion of the earnings model. One is foreign currencies.

As we said in our prepared remarks, there has been few foreign currencies that even though we hedge head into any given fiscal year we don’t hedge 100%, and in some cases for example in Canada, we actually sold a lot more snow throwers this year than what we had anticipated. And so for areas that have been more volatile like the Australian dollar and the Brazilian real we have had some headwinds year-to-date in currencies, and we have expected that we will continue to see that – those levels of currencies throughout the rest of our fourth quarter.

In addition, one of the things that you have noticed that we have done over the last several quarters is we have been very consistent in bringing down our inventory levels, and that has caused us to – while it has been good for cash flow, what we have done is we have reduced some of our manufacturing and had a near-term impact on our gross margins.

It has been great in terms of bringing down the amount invested in working capital. We brought down the inventory levels significantly in both the engine and the products business over the last 12 months and I think you are seeing that in our operating cash flows. But it does have a near-term impact on gross margins. So, I think the foreign currency as well as the gross margins because of the reduced production are perhaps what is – accounts for your question Josh.

Josh Wilson - Raymond James & Associates

But specifically the sales guidance, maybe I am making a mistake here, but I believe the bottom end of the sales dollars is unchanged, correct or not?

Todd J. Teske

It may not be in the bottom end. You know, as we said, we had pretty strong sales of engines in the US for primarily riding mowers and again most of the risk that we have with respect to things like portable generators for storms are typically in our first, second and maybe a little bit in our third quarter. So we had already taken any risk related to portable generators out.

Josh Wilson - Raymond James & Associates

Okay, and then the 3 to 4 weeks delay, can you give us a sense of what that might represent in terms of dollars or as a percentage of the season’s demand?

David J. Rodgers

Well, yeah, [Indiscernible] Josh, because at the end of the day, there is activity that is going on. It really comes back to – the question really comes down to is it going to be a compression in demand in June or is it going to be a normal May, June and then an abnormal July. And so, it is – it is next to impossible to try to – there are so many different permutations on that that it is next to impossible trying to quantify that.

Josh Wilson - Raymond James & Associates

That is fair, and one more if I could still squeeze it in. Yesterday (inaudible) talked about some major product line reviews and discussions with vendors and rationalizing SKUs on their conference call, I know it is early, but could you give us any sort of thoughts on what implications might be for you guys?

David J. Rodgers

You know, the best way to sum it up Josh is that we have been working very, very closely with (inaudible) and have been – have been participating in a big way with some other SKU rationalization so that we can support them in a very, going forward in a very important way.

Todd J. Teske

One of the other things they talked about in their call Josh is that they are working with their large suppliers to make actually fewer changes to their product lines over the long haul and perhaps even do longer-term agreements with some of those suppliers. So those are obviously opportunities for us as well.

Josh Wilson - Raymond James & Associates

Thank you so much.

Operator

Our next question comes from Robert Kosowsky with Sidoti.

Robert Kosowsky - Sidoti & Company

Hi good morning guys. How are you doing?

David J. Rodgers

Good Robert.

Robert Kosowsky - Sidoti & Company

Doing all right. The question is on the power products segment, it looks like, you know, from what I understand this year it is not going to be – it is going to be very difficult to get to profitability this year. We had a lot of cost cuts over the past couple of years. And really just, you know, what is needed to get this thing back in the block I guess over the next two years?

David J. Rodgers

What it comes down Rob is continued focus on what we have set out to do and that is on the higher margin products and so continue to participate and gain along the way and additional market growth in some of the commercial cutting equipment. It also comes down to much higher and lawn and garden equipment, so (inaudible) type units. We do continue to invest in standby business. Obviously that business has clearly softened from the demand that we saw with Hurricane Sandy, but we still believe in that business.

And so it really comes back to a continued focus on areas where there is growth opportunities in higher margin areas. And so that is what you will see us continue to execute on as we move forward.

Todd J. Teske

Rob to add to that, when you think about what we have talked about over the last couple of years, really since April of 2012 when we said we were going to exit the sale of lawn and garden products at the big box mass retailers, we have shifted our focus over the last couple of years to our dealer business. And what we have said is we have done that because there is higher margin opportunities in that dealer business. We have launched a number of new products that we have seen produce results and to be honest, but it's pretty early in terms of what the longer term results will be for those products but the dealers are pretty excited about it, the early returns from the customers have been very good. But, we will still continue to focus on looking at that dealer product portfolio and for certain skews to the extent that we need to make more margins on those skews. We will look at that in terms of cost reducing those skews and continue to potentially rationalize that portfolio so that we ultimately mix up in terms of our overall product portfolio to get to the margins that we expect in that business.

Todd J. Teske

And Rob what Dave points out, I mean, we continue, you never stop working on cost and so we continue to work through the footprint. We continue to try and get our operations to be more efficient and we will be very diligent in that as we move forward.

Robert Kosowsky - Sidoti & Company

And give as sense as to whether or not these initiatives can drive profitability say next year or do you still kind of few years out and you’re just on the glide path towards improvement?

Todd J. Teske

No, I wouldn't tell you, where we are kind of, we are improving and trending. We are not gliding. We are going to accelerate whatever we can to improve the profitability. So, I would anticipate continued improvements, the thing that has tendency to mass the numbers a little bit Rob is the fact that you get into situations where that business is very much weather dependent as it relates to snow because we do okay on snow and as it relates to portable generators and under standby generators. And so, when you look at a good, we had a good snow year this year certainly was up year-over-year, but a lot of this snow year was channel, emptying out the channel. And so, now as we look forward, I mean we are encouraged by the fact that channel inventories are very low and there are some opportunities now for us on snow. But, you will have some volatility in this business given the fact that it is weather dependent and its weather dependent on weather events in some parts of the business.

Robert Kosowsky - Sidoti & Company

Okay, thank you and otherwise by my math, my math could be off a little bit, but it looks sales per engine was down about 3% and I was wondering A, if that is in the right ballpark and B, how much was aluminum and was there any impacts from lower pricing demanded by customers (inaudible) yesterday I talked about how they got a good amount of raw material cost savings. I am just wondering just if that was more on the engine component and just kind of any thoughts you can give on just the decline in sales per engine if that is correct?

Todd J. Teske

Yes, I’m not sure Rob, check the math on the sales dollar per engine because our mix is actually been favorable Rob and the reason it has been favorable is related to our comments about, you know, we have mixed up in terms of larger engines which have a higher ASP than a smaller engine. So, we will take a look at that but getting back to aluminum, if I look at aluminum over the last I call it 12 to 15 months, it's been a little less volatile than it was over the last several years.

We did see slight decreases in aluminum over the last 12 months. It's actually been increased year over the last several weeks to the last couple of months and so we did share some of that decrease with our customers. But I can't comment on any particular customer but when you take a look at the cost reductions that we have done and the cost of aluminum it wasn’t anything significant related to us for this year.

Robert Kosowsky - Sidoti & Company

Okay that's helpful, and then finally, Todd you mentioned the standby generator obviously that’s a nice growth opportunity, you mentioned that it was a little bit weaker now and this is obviously just because we are a little bit further task, hurricane Sandy, and I was wondering if you maybe talk about the magnitude of how much weaker it is now versus last year and secondly maybe you can talk about what your distribution network looks like now versus a couple of years ago as well.

Todd J. Teske

Yes, the distribution network, we start there as a distribution network is, we are expanding it. We have got about 2,500 dealers now and we have been doing an awful lot of work with regards to continuing to grow those points of light. With regards to the magnitude of the business, the business is still pretty small for us obviously which is not a surprise because we just got into this business about three or four years ago. It has been a pretty large drop on a year-over-year basis which we had anticipated because of the fact that if you get beyond 12, 13, 14 months from a hurricane you do have a situation where the standby business does soften.

The other thing that's happened we believe is that with as much snow as there was in the northern part of the country, we find that installations are harder to do when there is a lot of snow sitting next to the house. So, I think that had a bit of an impact here over the last few months but I will tell you is that as we track our website activity we are up substantially as in terms of people who are interested in leads and things like that. So, we are starting to see a bit of a pick up here this month now as the weather starts to melt the snow if you will in the northern parts of the country.

Robert Kosowsky - Sidoti & Company

Okay. Thank you very much and good luck for the back half of the year.

Todd J. Teske

Great. Thanks.

Operator

Our next question comes from Josh Borstein with Longbow Research.

David MacGregor - Longbow Research

Hi, good morning. It is David on for Josh. I wonder if you could just update us on the commercial portion of the business and you mentioned sales of large engines increased in excess of 10% just reflecting gains in retail placement. Does that mean we are commercial mode or you are seeing success in like utility vehicles and other commercial equipments?

Todd J. Teske

Yes, David the increase in rise is in both the consumer side of the business as well as the commercial side of the business. When you look at it, it's primarily this new 810cc has been a big success for us and in that engine we have used primarily in commercial VTRs and so we have seen great success with that. We continue to have good success with our big block which is the 990cc engine that's the step up from 810. And so, we continue to see on the price side of the business we have been using that 810cc engine now in our products business. We continue to see very nice growth in our commercial cutting units as well as the engines that are sold out not only consumed internally but also sold outside. So, the investments we have made there are very encouraging, we brought in new people as we talked about on the last call and we are very encouraged by what those folks can do and so right now you are seeing the growth in commercial turf, but I can tell you that there is a lot of other categories that we are going after.

David MacGregor - Longbow Research

That's good encouraging. Can you talk a little bit about the lawn and garden season, how it started in Europe where weather impacts do not appear to have been as bad as here in the U.S.?

Todd J. Teske

Yes, the European weather has been better, in fact they doesn’t have much from a winter which impacted everyone in snow business including ours. And when you look at now they are only start of the season, we are seeing some good signs. Everybody though is cautious at least all the folks we deal with, we deal with everybody, people are cautious on reorders because they are concerned that this industry is kind of gone through so many things both in the U.S., Europe and Australia when it comes to lawn and garden that no one wants to get caught with too much inventory coming out of the season. So, we are seeing some good strength early season but we are seeing some caution out there with regards to the reorders coming in and so stay tuned on that the next three or four weeks will be critical in terms of the reorder business.

David MacGregor - Longbow Research

Thanks very much.

Todd J. Teske

Thank you.

Operator

Our next question comes from Jake Thomson of Odey.

Jake Thomson - Odey Asset Management

Hi, good morning Todd and Dave, thanks for taking my call. I’m impressed to see you guys pulling all the leave as you can given pretty extraordinary weather out there and I spoke, there is three quick questions, this is a follow-up to previous question on Europe. Would you give a number to the growth that you have seen in engines in Europe?

Todd J. Teske

Yes, our forecast has inflated that the European market would be relatively flat and the reason Jake that we did that is in pockets in Europe, we are starting to see things get stabilized a little bit with respect to the retail consumer. It's not anything as far as break growth and I am talking about the macro, not necessarily just lawn and garden equipment. But our forecast was that it would be flat and we are seeing flat to maybe up just a very slightly but it's still pretty early as far as the season goes.

Jake Thomson - Odey Asset Management

Okay that’s really helpful and then in terms of moving onto the U.S. Engines business, some inventory build going on the OEM that’s a capture later on in the season, could you – is that in line with your expectations of the 4% to 6% industry growth? I mean is that inventory build would you consider no more, does it make you worry at all that would be very helpful and I have got one last question.

Todd J. Teske

Sure. It's certainly consistent with the 4% to 6% market up. The inventory, now let me talk that was -- kind of normal now we are getting to the point where the inventory is building up. We would have expected – we would have hoped under normal situation and hope we would expect it that the season would have broken by now and that inventory levels would not be where they are today and so I would tell you that the inventory that's out there when the season breaks, if we are right, everything will be okay. It will all sail through. It’s just the matter of the pig going to the pipe if you will a bit because it's just – the season hasn’t quite broken yet. Where we start to get concerned is and this is where the caution comes in, where we start to get concerned is when the inventory doesn't now start – if it doesn’t flow out over the next three to four weeks that will cause perhaps some to pull back under expectations for the season at retail and therefore that could have implications a little bit later on in the season. We saw that last year. However, what happened last year was people continued to produce, they did pull back in kind of the late May, early June time frame, then they started producing again and that’s really the benefit of having the U.S. based manufacturing in the biggest market in the world for lawn and garden equipment. And so, we were able last year to even flow as everyone else have been flowed, control the inventories yet be able to meet demand. So, I am cautiously optimistic but the caution comes from the fact that we are seeing the inventory a little bit higher than we would like to see it because the season hasn’t broken yet. I am sorry, the inventory, and the retail and OEM level our inventories as you can see are in pretty good shape.

Jake Thomson - Odey Asset Management

Sure. And then lastly from me, you mentioned I think in the products division some selling and investment in emerging market as well as a bit more kind of segment sales orientation activity. Can you just give us a quick flavor on where the investments are being made?

Todd J. Teske

Yes. The focus, our focus is primarily on Mexico, Brazil, and certain extent Australia even though Australia is not an emerging market, we do have some incremental spend that’s going on down on Australia because we see some opportunities there. And so, when you look at where we are started to add headcount for some of these – some of the growth we have added some headcounts in some of the other what I will call minor regions for us, but important places like southeast Asia and we are doing a little bit more in the middle east as well. But primarily the focus is on Brazil. It's on Mexico and it's on Australia when you look beyond the U.S. And Europe and the promotional activities, obviously we come out with a lot of innovation. And one of the key areas of focus, in fact, one of the most important areas of focus for this year has been on merchandizing and marketing this innovation and so we have had some incremental spending that we have done with regards to things like Quiet Power Technology™ quiet engine and Powerflow + and grip-and-go and even the 810cc in the commercial market. So that's really where you are seeing some of the increases kind of on the SG&A line if you will.

Jake Thomson - Odey Asset Management

Okay, fantastic. Thanks guys.

Todd J. Teske

Thank you.

Operator

Our next question comes from (inaudible).

Unidentified Analyst

Hi, this is a follow-up on the power products gross margin. It looks like the two previous quarters that you guys were operating at 13% rate or so, but this quarter you stepped down to 11% despite higher sales, so I was just wondering if what headwinds you’re facing this quarter that you didn't face in the previous two quarters in terms of the gross margin line?

Todd J. Teske

A couple of different things [Josh], number one is as we said in our prepared remarks, FX has continued to be a headwind for our product business and that's primarily gone down in Brazil as well as in Australia. And then, also in Canada as I mentioned earlier Canada where we had higher snow blower sales this year than what we may have planned from an FX standpoint has also hit down, I mean that was worked about 130 basis points in the quarter foreign currency loss. The other thing that’s happening is, you think about the mix of products that are sold in the quarter also had an impact and again we reduced the production year-over-year. So, I mean even if you go back and look at margins last year, we were impacted by about 70 basis points because we again took production down, but we are seeing the benefit of that in terms of taking inventories down. So, at some point here moving forward we will take the inventories down and we will need to continue to then at that point production will level out at some point we will have an inflection point here where we start to take production up as sales increase.

David J. Rodgers

We’ll then have a improved absorption leads to higher gross margin rates.

Unidentified Analyst

Okay, great. Thank you.

Operator

Our next question comes from Robert A. Kosowsky with Sidoti.

Robert Kosowsky - Sidoti & Company

Yes, just a quick question on other income. It seems like that's stepped up a little bit versus what you are thinking last quarter, at least your expectations for the full year and is that due to your JV in Japan?

Todd J. Teske

It's not due to any particular JV, the joint venture that we have interest in some of them do provide component parts to our engine business and to the extent that that they are performing better than what they had planned, we get the benefit of that in our other income.

Robert Kosowsky - Sidoti & Company

Okay. So does that mean it's reflecting your better engine volume or is it that it could be also turn off sales?

Todd J. Teske

That's right. No, that's right.

Robert Kosowsky - Sidoti & Company

Okay. Thanks.

Todd J. Teske

It's reflecting the better engine volume, Rob.

Robert Kosowsky - Sidoti & Company

Okay. Thank you.

Operator

I'm not showing any further questions at this time.

Todd J. Teske

Very good, thanks everyone for joining us on today's call. Our next quarterly earning calls will be in August when we will report our fiscal 2014 year end results. Thank you and have a great day.

Operator

Ladies and gentlemen that concludes today's presentation. You may now disconnect and have a wonderful day.

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