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Executives

Todd Teske – President and Chief Executive Officer

Dave Rogers - Chief Financial Officer

Analysts

Mark Rookie - Longbow Research

Sam Darkatsh - Raymond James

Ned Borland - Hudson Securities

Mike Hamilton - RBC

Brad Safalow - PAA Research

Craig Kennison - Robert W. Baird

Jad Fakhry - Farallon Capital

Briggs & Stratton (BGG) F4Q10 (Qtr End 05/31/10) August 12, 2010 10:00 AM ET

Operator

Good day and welcome to the Briggs & Stratton fourth quarter earnings release conference call. [Operator instructions.] I would now like to turn the conference over to Dave Rogers. You may begin.

Dave Rogers

Good morning and welcome to the Briggs & Stratton fiscal 2010 fourth quarter and year end conference call. I’m Dave Rogers, chief financial officer, and joining me today is Todd Teske, our 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 and 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.

This conference call will be made available on our website approximately two hours after the end of this call. A phone replay will also be available within a few hours of the completion of this call.

Now here’s Todd.

Todd Teske

Good morning everyone and thank you for joining us today. While our fiscal 2010 represented continuing challenges for our industry, it appears that demand in the U.S. for our outdoor power equipment has grown for the first time in five years.

Heading into the spring selling season, we saw OEMs, retailers, and equipment dealers continuing to manage inventory levels cautiously and as a result we saw engine shipments move from our second to our third fiscal quarter. While participants in the supply chain remain cautious, they generally stocked a reasonable level of inventory for the spring selling season. The questions at that time were whether or not the consumers would be spending their money at retail and whether reorders for product would follow.

At the time of our third quarter earnings release we discussed that the lawn and garden market in the U.S. was very active. The weather cooperated with adequate ground moisture in most key markets, along with an early spring warm-up in the northern half of the country. Due to this early spring warm-up in the northern markets, we saw both the northern and southern seasons start almost simultaneously. In the fourth quarter, it turned out that consumer demand continued strong.

Consequently, reorders for our engines were quite good during the fourth quarter. Our units shipped were higher than last year’s fourth quarter by 22%. In fact, our total units shipped for fiscal 2010 were nominally higher than last year by a few thousand units despite the negative impact of no landed hurricane activity this fiscal year.

Most of the improvement from last year was here in the U.S. While our shipments to European customers was slightly higher than last year’s fourth quarter, European channel participants continued to manage inventories to the lowest levels possible given the continued economic slowdown in Europe. We believe that here in the U.S. inventory levels throughout the channel were in good shape as we exited the spring selling season.

In addition to higher volumes, we saw an improvement in our mix of engines sold that positively contributed to our financial performance. Growth in engines sold for use in riding equipment applications outpaced sales unit growth for engines used on walk mowers.

Turning to our power products business, in addition to the lawn and garden market improving, we continued to see steady year over year growth in the pressure washer market. We believe our growth in pressure washers is due to new product introductions we delivered over the past year in response to what we heard consumers and our retail customers ask for.

We also believe that fewer water restrictions in the mid to southern U.S. and high pollen counts have contributed favorably to demand in this category. Our lawn and garden products performed as expected, although it appears the dealer base continues to manage their cash flow and thus reduce inventories in their dealerships.

Perhaps the most notable item in the product segment this fiscal year was a lack of landed hurricanes which we also discussed in earlier quarters. The lack of storms had a negative year over year effect on our products business as well as our engine business.

While our products business remains a financial challenge, we remain committed to improving the profitability of the power products segment. While the lawn and garden market has not returned to volumes seen earlier in the decade, and portable generator volumes were dampened by the lack of landed hurricanes in the past year, the power product segment had positive income from operations in the fourth fiscal quarter, an improvement over the prior year and a key milestone for this business.

The action to move our Jefferson, Wisconsin plant operations to other company facilities was completed during fiscal 2010. While it is a difficult decision to close this facility, it will have a positive impact on this segment for the longer term.

Earlier in fiscal 2010 we reduced salaries and the 401K company match contributions for all of our salaried U.S. personnel. Due to the improved results in the fourth quarter we decided to reimburse the remaining salaries and benefits that were reduced during the first half of fiscal 2010. Our employees responded to the challenges of the economic downturn with additional resolve and determination to make Briggs & Stratton successful. I couldn’t be more proud of the way our entire team responded to these challenges, which is why I am so pleased that our financial results allow us to repay those lost wages and benefits.

Now I’ll turn it back over to Dave to walk through our financial results for the fourth quarter and for fiscal 2010.

Dave Rogers

Thanks Todd. Fourth quarter consolidated net sales were $616 million, an increase of $133 million, or 28% from net sales in the fourth quarter of last year. Fourth quarter consolidated net income was $18.2 million, or $0.36 per diluted share, an increase of $12.9 million from net income of $5.3 million or $0.11 per diluted share one year ago.

I should note that last year’s fourth quarter included an expense of $5.8 million, or $3.5 million after tax, for an impairment charge related to our decision to close the Jefferson, Wisconsin plant. In addition, the fourth quarter of fiscal 2010 included incremental expense of approximately $4.4 million to pay our employees for wage and benefit reductions from earlier in the year.

Fiscal year 2010 consolidated net sales were $2.03 billion, a decrease of approximately $64 million, or 3.1% from $2.09 billion in fiscal 2009. The sales decrease was primarily due to reduced portable generator shipment volumes and related engines due to no landed hurricanes during fiscal 2010, whereas two named storms made landfall in the southern U.S. during fiscal 2009.

Fiscal 2010 net income was $36.6 million, or $0.73 per diluted share, an increase of $4.6 million from net income of $32 million, or $0.64 per diluted share in fiscal 2009.

The fiscal 2010 results included a pre-tax expense of $30.6 million, or $18.7 million after tax, for $0.37 per diluted share associated with the settlement of litigation related to horsepower labeling. Also mentioned previously, fiscal 2009 included an expense of $5.8 million, or $3.5 million after tax, for an impairment charge related to our decision to close the Jefferson, Wisconsin plant.

As disclosed within the non-GAAP financial disclosure section of our earnings release, after adjusting fiscal 2010 for the litigation settlement in fiscal 2009 for the impairment charges, fiscal 2010 adjusted net income was $55.3 million, or $1.10 per diluted share, an increase of $19.8 million, or 56% from the fiscal 2009 adjusted net income of $35.5 million, or $0.71 per diluted share.

Engine segment sales for the fourth quarter were $423 million, an increase of $87 million over the prior year. Units shipped in the quarter were higher by 22% over last year. Reorder activity for engines continued to be strong through the end of our fiscal year. In addition, we saw a favorable mix of engines within our walk engine products and we also saw engines for rides grow at a faster rate than walk engines as expected.

We believe that our market share has not changed between years. In addition, we believe that inventories in the channel are reasonable for this time of year. For the full fiscal year total engine units sold were approximately $10 million, or just slightly ahead of fiscal 2009. Increases in engines for lawn and garden and pressure wash applications offset the decrease in engines used for portable generators.

Operating income for the engine segment was $27.2 million, an increase of $6.8 million over last year’s fourth quarter. Operating income for the fourth quarter as a percent of sales increased to 6.4% from 6.1% in the prior year.

The improvement in the operating income rate was due in part to the favorable product mix discussed earlier. In addition, manufacturing costs were lower for commodities, utilities, and freight costs and our annual cost reduction targets were fully realized.

Absorption rates in the plants also improved as production volumes were higher by approximately 15% in the fourth quarter. These favorable factors were offset in part by lower average prices in the fourth quarter compared to a year ago. Higher engineering selling and administrative expenses for employee salaries and benefits and selling and marketing expenses also favorably impacted operating income.

During fiscal 2010 we produced approximately 9.7 million engines, a decrease of about 1.4% from fiscal 2009. Planned underproduction of sales reduced our ending engine inventories by about 350,000 units to approximately 1.0 million units. We believe that this level of inventory is optimal for this time of the year.

Turning to the power product segment, sales for the fourth quarter were $249 million, an increase of approximately $54 million, or 27% over the prior year. Increased shipment volumes for lawn and garden equipment and pressure washers were the primary reasons for the increase. Within the lawn and garden category, higher volumes were driven by the overall increase in the market for walk and ride lawn mowers.

While sales of premium product to dealers grew over the prior year, we had a product mix that skewed towards walk product for mass retailers leading to higher sales and production while having an unfavorable impact on overall margin rates. Dealers continued to be somewhat cautious in reordering inventory for the current season so that they do not risk carrying over inventory to next spring.

Pressure washer sales continued to be improved year over year as Todd noted earlier. Portable generator sales were down in the fourth quarter compared to a year ago, as inventory levels of portable generators appeared to be at reasonable levels going into the hurricane season, with retailers controlling their commitment to inventory in this category.

The power product segment had income from operations of $2.1 million in the fourth quarter, an improvement from an operating loss last year of $6.1 million. However, the fourth quarter of fiscal 2009 included a $4.6 million expense to record asset impairments due to closing the Jefferson, Wisconsin plant.

After adjusting the fourth quarter of fiscal 2009 for the impairment, the power product segment income from operations improved $3.6 million over the previous year. Operating income improvements were related to higher sales and production volumes of lawn and garden equipment and pressure washers.

Coming into fiscal 2010 we projected additional cost to move the Jefferson operations to other plants would be approximately $5 million, and that the cost savings of $5 million in fiscal 2010 would offset these moving costs. Due to the actual timing of moving the operations and some startup inefficiencies within the plants, the actual cost to move the Jefferson operations approximated $8 million during fiscal 2010 while the achieved cost savings were approximately $3 million for the year. However, the transition was substantially completed during fiscal 2010 and we are on track to realize cost savings of approximately $11 million annually from the closure of this facility.

With respect to our balance sheet, during fiscal 2010 we reduced our investment in working capital by $116 million, excluding cash and current maturities of long term debt. This improvement was primarily driven by a reduction in inventory of $77 million, as we planned to reduce finished goods inventory within the engine segment. Net debt at the end of fiscal 2010 was $90 million, and decreased during the year by $178.

For the first time since fiscal 2007, we did not have any amounts drawn on our revolving credit facility at the end of the fiscal year. Cash flows from operations were $244 million and free cash flow was approximately $200 million. Depreciation for the fiscal year of $66 million outpaced capital expenditures of $44 million. Total funded debt and last 12 month EBITA, as defined by our credit agreements, were $207 million and $142 million respectively, resulting in a leverage ratio of 1.46 times, which is well within our debt covenants and also puts us in good shape with our maximum leverage covenant moving forward.

That concludes what we wanted to say about the fourth quarter financial results, so I’ll turn it back to Todd for our comments on our fiscal 2011 projections.

Todd Teske

Looking forward to fiscal 2011, we’ll continue to work on creating value for all of our stakeholders by focusing on three pillars that make up our strategy. The first pillar is protecting and growing the profitability of our engine business. This has been, and will continue to be, the core of Briggs & Stratton. We will continue to focus on providing quality engines at the right time at reasonable prices with the same dedication that allowed us to achieve our market leadership position.

The second pillar is investing in growing in higher margin and margin-expanding areas. We will continue to focus on innovation in all areas of our business, to provide creative solutions for customers and end users. In addition, we believe there are growth opportunities for us in the commercial markets. While Briggs & Stratton is well known in the consumer engine market, we’re not as strongly preferred by commercial users. We will focus even more on people who use equipment to do their jobs each day.

And the third pillar is expanding geographically in underserved markets. As we have seen over the past few years, relying on a few large, developed markets can be difficult if those markets experience a downturn. We believe that our engines and related applications can be successful in many of the developing regions of the world.

With these three pillars of our strategy as our focus, we believe that fiscal 2011 will be another year of improvement for the lawn and garden industry in the U.S. and we are also cautiously optimistic that markets for our products in other regions of the world may grow as well.

As indicated in our press release this morning, we are projecting net income to be in the range of $60 million to $70 million, or $1.20 to $1.40 per diluted share. We are projecting net sales to be higher by 2% to 4%, depending on the level of consumer spending in the outdoor equipment category.

Engine segment sales are expected to be higher by approximately 1.5% to 2% on slightly higher volumes and pricing improvements. Pricing improvements on engines for next year’s selling season generally range from 1% to 4%, depending on the specific product, although the weighted average factored into projections is approximately 1% for our fiscal year and considers the timing of those price increases going into effect. Given that at year end engine inventories were in line with our expectations, units produced will approximate engines sold for fiscal 2011.

As a reminder, we are currently in discussions with all of our key customers regarding product lineups for the 2011 spring and summer selling season, and we should have a better idea of placement at our fiscal 2011 second quarter conference call. The power product segment sales are expected to increase approximately 3% to 4% on higher sales of lawn and garden equipment.

We have not included any hurricane related sales into our projections for either the engines or product segment. Consolidated operating margins are forecast to be in the range of 5% to 6%, with most of the improvement from fiscal 2010 within the power product segment. The engine segment operating margins are being impacted by higher commodity and pension costs. These costs are being partially offset by the pricing improvements and continued cost reduction programs within the manufacturing environment.

The power product segment is also being faced with increased cost of commodities such as steel and copper. However, modest price increases the incremental benefit of the Jefferson closure, and cost reduction activities will offset increased commodity costs.

We anticipate that capital expenditures will increase moderately in fiscal 2011 to approximately $60 million to $65 million as we continue to invest in a new engine platform, other new product introductions, and efficient and modern manufacturing equipment.

That’s the end of our prepared comments, and now we’d like to open the call up for questions.

Question-and-Answer Session

Operator

[Operator instructions.] Our first question is from Mark Rookie of Longbow Research. Your line is open.

Mark Rookie - Longbow Research

Just had a couple questions here. Relative to your guidance going into the fourth quarter, obviously it came in a lot better than you expected and I think you painted somewhat of a picture that the guidance was laid out that if the season continued to be strong that there would be upside, but was it all pretty much on the reorders that led to the upside?

Dave Rogers

I would tell you it was primarily two things. First, it was on reorders for the year, as we had our conference call at the end of the third quarter there was a fair amount of, I would tell you, excitement and activity going on at the retail level in the lawn and garden equipment market. And at that point in time we weren’t necessarily sure if it was the weather, the warm weather in the north, that was contributing to everything popping at once or whether the reorders would be there. And in the lawn and garden market I think what happened over the next three months is that reorders continued pretty strongly. I would tell you that the market’s been up and down a little bit here as everybody tries to figure out exactly where the consumer is at and how much they’re going to be committed to spending dollars in the future.

The second thing that drove the engines in the fourth quarter, perhaps a bit above what we thought, was that pressure washers continued to be selling through pretty well. We introduced some new products to the market last fall and those have continued to sell through pretty well. And so pressure washers contributed to the fourth quarter engine sales as well.

Mark Rookie

Perfect. And then your commentary on the channel being reasonable, I know in year’s past the inventory in the channel has been kind of maybe characterized as light. Just curious to see if there’s any commentary you might have on how trends have continued beyond the fourth quarter and whether the inventory, obviously, reasonable. Just kind of more color on that, the reasonable comment.

Dave Rogers

The best we can tell is that overall the inventories are reasonable. I think we have a better sense that some OEMs and some retailers than others, where some may be higher and lower, but here in the U.S. I would tell you that on average we think they’re what I would call normal for this time of year. Having said that, I think in Europe, as an example, Europe’s been a little bit slower of a market as Todd indicated in our prepared comments. And Europe has a bit higher inventory levels than probably what we’d like to see at this point in time of the year.

Todd Teske

The other thing I would add is everybody keeps talking about “new normal” and everything else. The fact is everybody is really keeping a close eye on their inventories and so with the amount of sell through that happened during the season and everything else, we would tell you that we don’t see the retailers taking inventories down dramatically going forward, which is why I think as we look at it we’re kind of at this level where now, and we said it in the prepared comments, whatever we produce we’ll sell. And we’ll keep our inventories down but I think everybody else in the channel will do the same thing.

Mark Rookie

Okay, and as far as the season, the sell through trends in July, I know the season kind of winds down, the lawn and garden season. Is that fair to say that’s similar this year?

Todd Teske

Well I would tell you that we’re not seeing anything unusually different than what we’ve seen in the prior years. We’ve seen situations where into the fall it’s continued to go very strongly I would tell you that what we’re seeing right now is really very typical from what we would normally see.

Mark Rookie

Okay, and then Dave on the cost, I know there was some obviously, from 2011 versus 2010, there’s obviously in 2010 you get some cost headwinds on maybe the salary reimbursement and some of the moving costs, and as you look into 2011 there’s the incremental cost savings. Is there a number that we can kind of point to at the operating line that’s truly incremental, from like a tailwind from the headwinds from last year, and then the cost savings?

Dave Rogers

First let me clarify your comment that you made on the salary and benefit reimbursement. For the full fiscal year 2010 there’s really no difference. However, when looking at the quarters, there’s some quarterly timing that you have to take into account. Just to be clear, the impact of the salary wage reductions and repayments, if you look at fiscal 2010 compared to fiscal 2009, was reduced in Q1 of about $4.4 million, there would be no net change between 2009 and 2010 in Q2 or Q3. And then we would have had higher expense of about $4.4 million in Q4. But when you look at the entire fiscal year, ’10 versus ’09, the salaries and benefits were the same. Now flipping forward, we have historically talked about cost savings programs that we typically have going on within our manufacturing operations. I would tell you that our targets for the next year total about $26 million to $27 million and it’s split evenly between our power product segment and our engine segment.

Mark Rookie

And then just lastly, on the mix, obviously it’s come down a little bit on the price over the last few years. You saw some improvement on some of the, I think the rider side, where are we as far as the possibility that mix could be a favorable benefit for the next couple of years, or into 2011 in particular?

Dave Rogers

Well I would tell you as we look at ‘11 mix doesn’t have a bit impact, which tells you two things. It tells you that it’s not going to mix up and we don’t expect a significant mix down if you will. As we look at going forward, until the consumer really starts feeling better about everything that’s going on in the economy, until they stop worrying about their jobs and the value of their homes go up, those are the couple of indicators we look at to say when will this market return to maybe a little bit more favorable mix. We don’t think that will be 2011. We certainly are hopeful. We see it in ‘12 and beyond.

Mark Rookie

Okay, and then just lastly, on the aluminum. I know that you typically kind of enter into some hedging at the beginning of the year. Any comment on what your stance is on that, ’10 into ’11?

Dave Rogers

It’s no different going into fiscal 2011 than it has been in previous years. I think what we’ve seen over the past several quarters is that aluminum continued to creep up during fiscal 2010 and even as late as the last 7-14 days it’s continued to go up. And so we do some forward buying and try to smooth out some of those peaks. We are hedged into fiscal 2011 but we never quite get fully hedged for the entire fiscal year at this point in time.

Operator

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

Sam Darkatsh - Raymond James

Todd, congratulations on the chairmanship post. Couple questions and follow up actually on the prior questions. Todd, you mentioned that you’re anticipating mix to be flat. Is that mix of tractors versus walk behinds, or is that mix within mix? I know you were talking about ASP mix and then also mix of engines. If you could put a little color on that.

Todd Teske

Really when you look at it we’re not, it’s, let me be real clear, we’re not expecting a significant mix within the engine family, so in other words we’re not expecting a significant mix within walk mowers if you will, or within riders. And then when you look at the mix between rides and walks, there’s not a significant change there. This past year we saw riders do extremely well. We’re hoping that trend continues, but I wouldn’t tell you that I’ve got a lot of that baked into the numbers at all. So I would tell you it’s really in both instances, if you will, within the category and then between the categories. We’re not anticipating seeing a real lot of activity.

Sam Darkatsh

To what do you attribute the outsized demand for rides this season as compared to plan?

Todd Teske

I would tell you that I think part of it is the replacement cycle finally caught up, and so when people, you know a couple of years ago when the economy started to turn down and we saw a lot of spare parts being sold for repairing people’s tractors. Remember the old days when they were firing their lawn service and we didn’t see a bump in equipment sales. It’s because people took their old mowers that they apparently had hidden away in their garage, and they just told the dealer to get them running. I think what you saw this last year was a couple things happen. You saw people having to now, the replacement cycle catching up. I also think there’s a little bit of – there’s some new products that some of our customers introduced into the market that I think had a little bit of an impact on that as well.

Sam Darkatsh

Next question. You touched on this, Dave, in terms of the aluminum hedging, but what are you, best you can tell, baking into fiscal year ’11 for total input inflation? To total raw material inflation?

Dave Rogers

It’s a little difficult to give you a complete number at this point in time. And to be honest with you, as we look forward we’re not exactly sure where the inflation’s going to stop. As I mentioned, aluminum is higher today than it has been in the last several quarters and steel has been all over the map in the last couple of months. And so I would tell you that essentially, baked into our plan for fiscal 2011, what we’ve done is that we’ve tried to take the price increases as well as our internal cost reduction programs to effectively try to neutralize as much as the cost increase as possible.

Sam Darkatsh

Are the price increases, then, going to be fluid? Or depending on what materials do? Or is it going to be the one bite out of the apple and then hedge as much as you can ahead of that?

Dave Rogers

I think our approach as far as going out and working on the lineups with our customers and discussing pricing is fairly consistent with what it’s been in the past. We typically get one bite at the apple. That’s happening right now as we speak and will continue on for the next several months until the lines get locked down some time in the early November, early December time frame. And as we said at the last call we’re out with a range of price increases, as Todd said today, from about 1% to 4%. We’ve baked in a 1% average and the 1% to 4% is depending on what type of product there is. But the approach is essentially the same.

Sam Darkatsh

Okay, so if we were to take the cost savings, the $26 million, $27 million, plus the point of pricing, what you’re saying is that would aggregate to roughly your plan for material inflation? Is that how to read that?

Dave Rogers

Along with the cost savings it’s probably going to have a slight negative impact year over year. Again, we were out trying to achieve more price increases than what we’ve ultimately baked into our plan here. The team is continuing to negotiate those, but for right now based on when the pricing increases go into effect we negotiate it based on a season but many of these price increases don’t go into effect starting July 1 of our fiscal year. So what’s built in there right now is 1% on the whole.

Sam Darkatsh

Gotcha. And then on the final question. I’ll defer to others. The growth assumption next year of 2% to 4%, I might be missing some of the elements but I guess almost a point of that would be price and you’re saying mix is roughly the same, and I’m guessing currency is pretty flattish, so I guess 1% to 3% unit growth, first off is that right? And does that approximate the industry growth that you’re anticipating next year?

Dave Rogers

Just to clarify something you said, yes, the FX impact year over year is essentially flat. The unit growth is, as far as different econometric models and industry forecasts, I would tell you there is a very wide range of where the industry thinks that walks and rides will be next year. So effectively what we’ve built in here is exactly what you said. It’s somewhere around the 1% to 2% for volume on the engine side. And effectively with a lot of the uncertainty that you see out there in the market, we’ve talked in the past about what the inputs are to some of these econometric models, including changes in unemployment, new housing starts, house re-sales, all of those things have been very uncertain as of late and that’s why we’ve taken the position we have on the volume.

Sam Darkatsh

But your approximate, your unit growth is going to approximate the industry? Is that the assumption that you have in the numbers? You mentioned that the line reviews aren’t completed as of yet.

Todd Teske

Yeah, what’s really tough, Sam, is they’re not done yet, and so we’ve taken a cautious approach, and so we’ll have a better idea on how to answer your question as we get into the second quarter, but that’s really what we baked into numbers, is something that is a little bit more cautious. We don’t think it’s overly aggressive in the whole scheme of things.

Dave Rogers

The last thing I’d add on that is that if I go back to how we forecast fiscal 2010, a lot of the econometric models we were looking at had pretty big increases in them, and we simply weren’t going to run the business or forecast our business to those numbers given a lot of the uncertainty in the economic inputs.

Sam Darkatsh

Okay, and Dave, what do you peg your incremental margins on, like every 1% of sales, what do your contribution margins look like?

Dave Rogers

Are you talking about the incremental volume for next year?

Sam Darkatsh

Like for every 1% change in volume versus plan, what the incremental pass through would be on a percentage basis to the EBIT line? Plus or minus?

Dave Rogers

The way we typically look at is that the engine margins approximate somewhere in the area of 18% to 20%.

Operator

Our next question is from Ned Borland of Hudson Securities.

Ned Borland - Hudson Securities

We’ve covered the inventory on the lawn and garden side. I was wondering if maybe you could give us a feel for how the retailers are approaching the peak period in storm season, with regard to generator inventory? How does that shake out?

Todd Teske

It’s relatively similar to how it’s been in the past. Obviously they’re trying to be very cautious, and so last year we saw them come in with a little less than maybe what we would otherwise see, which is kind of similar to where we’re at this year. It’s really, we’ve got commitments, they’ve got commitments. I would tell you there’s nothing that’s highly unusual in terms of where those inventories sit right now.

Ned Borland

Okay and then second question, more of the housekeeping variety. The jump in pension costs on the balance sheet, what is the delta for pension expense in 2011 versus 2010?

Todd Teske

The total delta is going to be $18 million year over year, an increase. And effectively what’s driving that is the asset returns over the last few years have been down and in addition to that the discount rate that’s used in the plan has decreased as well, therefore driving up the liability.

Operator

Our next question is from Mike Hamilton of RBC.

Mike Hamilton - RBC

I was wondering if you could start with a few observations on where you want to go on emerging markets. By that I mean how meaningful would you like it to be three, five years out and what kind of product categories do you see trying to drive there?

Todd Teske

I would tell you that we, three to five years out we want it to be very meaningful in terms of a base of business for our company. It’s going to take a while to get there, but I think a three to five year timeframe is realistic to say that we haven’t gone out and we’re not going to go out with any specific goals.

I will tell you we’re looking. And we’ve been doing a fair amount in some of these regions of the world already, and we’re looking to do even more and put more resources behind them. When you look at places like Southeast Asia and specifically China, and then you look at places like India, you’ve got a lot of people. You’ve got an economy that is changing, and they’re trying to change from an agricultural economy to an industrialized economy. But you still have a lot of people to feed. And so we think that as we look at it, agriculture, engines for agriculture products, and maybe even agriculture products themselves depending on who is producing, or maybe we produce, in those regions, could be very interesting for us because of the fact that a lot of the kids that would otherwise be working on the farms are now going into the cities and you do have an aging rural population in those areas.

Construction also, places like India, last I heard they were going to spend about a half a trillion dollars on infrastructure over the next 10 years or so. That becomes very interesting for us, and the same in China, where they continue to develop, and with their Western movement, beyond the coast. Beyond that, you look at other regions of the world, you look at Latin America, and certainly there’s opportunities down there. You’ve got places like Brazil, where you’ve got a lot of infrastructure spending that’s going to be going on with regards to the World Cup, the Olympics, things like that. That becomes very interesting to us, and I can’t leave out Central and Easter Europe, because you look at that region and there are a lot of folks who do cut grass, and that sort of thing.

And so as we look at it it’s not necessarily going to be the same products or engines for products that we’ve historically been in in terms of lawn and garden and riding tractors. It’s going to be where people use them to develop their economies, develop their infrastructure, and that sort of thing, and so that’s how we’re looking at it. We’ve got infrastructure, in terms of distribution, really everywhere in the world, and we’re going to look to enhance that with the products that are needed for those individual markets. And so we’ve got product development resources, and distribution resources going behind those efforts.

Mike Hamilton

Nice color there. How are you thinking about make, versus buy, versus partnering as you look at all of that?

Todd Teske

It really depends on a number of things, region of the world an things like that. Being an EDA company, obviously we want to figure out how to do it with very little capital, and so if that means when we looka t make versus buy obviously that becomes important. Oftentimes you need to be in market, and so we’ll either look at it from the standpoint of having a partner and I can tell you there are certain regions of the world where having a partner is more important than other regions, and we will also look to see if there are acquisitions we might be able to effect that will help us do two things, obviously gain resources, product lines, distribution, things like that, that can supplement what we already have in those regions, and also really jumpstart our opportunity to participate in those markets. And so we will look at, we won’t rule out, obviously, JVs, acquisitions, or organic growth. We’re not going to do that, but any one of those three. So it really depends on the market and it depends on the resources we have in the market and the capabilities we need to be successful.

Mike Hamilton

I have one question in base lawn and garden. Are your consultants able to get enough detail to have a guess on what the impact of the new buyers tax credit incentives we saw in the market this year are going to have going forward?

Todd Teske

Are you referring to new home buyers?

Mike Hamilton

Exactly. Just to what degree you get a sense that there was a lift on follow through there?

Dave Rogers

There’s nothing that we’ve got that directly correlates it other than the econometric models that take those into consideration, but nothing directly.

Operator

Our next question is from Brad Safalow of PAA Research.

Brad Safalow - PAA Research

The first question I had was just on the portable generator market. Can you guys just characterize where inventory levels are heading into peak hurricane season here? Last year I think on your first quarter call you spoke a little bit to the inventory levels. Just wondering where they stand as of this moment.

Dave Rogers

The inventory levels are basically right where we want them to be. We have an idea of what the retailers are currently holding in their stores and in their warehouses and they are satisfied with what they have on hand, and we have also committed to our retail customers how much inventory we will hold and we are very satisfied with those levels for this time of year.

Brad Safalow

And just to be clear, based on your earlier comments, your guidance assumes no storm activity, so anything beyond that, any storm activity could lead to incremental sell through reorders on the portable generator side.

Dave Rogers

That is correct.

Brad Safalow

And then just shifting to the lawn and garden market, can you guys somehow characterize how replacement demand affected sell through for the fourth quarter and really for the full year? Our checks with dealers suggest that there was a replacement driven demand. I know it’s an element you guys have been talking about for a number of years. Can you characterize not only how that drove this quarter, this year, and how you expect that to evolve into next year?

Todd Teske

Anecdotally we don’t have exactly what happened and why it happened, but anecdotally we’ll tell you that a fair amount of it was driven by replacement, because of what I’d mentioned before in terms of consumers choosing to buy versus continuing to repair. We would tell you that based on our research from prior years, and we continue to do this at least every other year, and we’ve actually taken to doing it more often than that, the replacement cycle for this equipment really hasn’t changed much. It’s still somewhere in the neighborhood of six to seven years generally, and we anticipate, based on what we’ve seen on our econometric models, because we do look at what we call displacement, which really comes down to it’s a regression of the mean model, that basically says if you are above the mean there’s overconsumption and if you’re below the mean there’s underconsumption. We would tell you that going forward we anticipate that there will be a snapback, if you will, in terms of replacement and the replacement cycle. Now having said that, we’re not going to bake that into our guidance and we haven’t baked that into our guidance for this next year given that we’re calling for moderate increases with regards to slight increases with regard to the market. But we would anticipate that at some point here we are going to see a fairly healthy comeback. I’m not going to tell you the market’s going to go all the way back to where it was in ’05, because that was an artificially high level, but I will tell you that we anticipate that the market will come back as the replacement cycle kind of catches up.

Brad Safalow

Okay, just to be clear, even though your model suggests that you should see – I mean there’s – you had four consecutive years of declines – that there’s deferred demand out there in the channel. You’re not necessarily using that as a driver of your unit forecasts for fiscal ’11.

Todd Teske

That’s correct. As Dave said before, the models that we follow, including two of our one and one from the outside, are kind of all over the map, and so we’ve decided to take the cautious view, if you will.

Brad Safalow

And just the last question on inventory levels and just generally free cash flow. Obviously you did a very good job from a free cash flow perspective this year. You talked about cap ex. Are you at a point now where your inventory levels, when you close the year, and how you managed them last year, that you can’t necessarily do any better than that and we can’t necessarily expect a significant source of free cash flow coming in the form of lower inventories outside of, again, stronger sell through. Can you comment on that?

Todd Teske

Yeah. I would tell you that it depends on the segment of our business. Where we’re at in the engine business I’m not sure that there’s, on a finished goods side, there’s a lot to be taken out, if you will, on a year over year basis. We do continue to work on the work in process in the component side of that piece of the business. But we also think that there are some opportunities to improve our turns on our products business. And so I would tell you that there is some opportunity for us. This last year was relatively dramatic. But there are some opportunities for us to do some improvements on the product side and on the component side of the engine business.

Operator

Our next question is from Craig Kennison of Robert W. Baird.

Craig Kennison - Robert W. Baird

Most of my questions have been asked, but Todd, maybe you could elaborate on the adjacency strategy? I know we’ve talked about a three to five year outlook, but how meaningful could it be, if at all, in 2011, and what kind of volume, additional volume, might we be seeing given the long term perspective?

Todd Teske

Help me understand your question with regards to adjacency. You’re talking about the emerging markets, or are you talking about the higher margin products?

Craig Kennison

I’m talking about, well, both, but in particular the higher margin products.

Todd Teske

When you look at the higher margin products we continue to invest very heavily into the standby business. Obviously that’s very important. We continue to invest in premium lawn and garden equipment. And so when you look at ’11, based on some of the comments I made before we’re not anticipating a significant mix up, but we are preparing ourselves that when the economy does turn around that we’re going to be really well positioned to be able to do well in that piece of the strategy within the next couple of years. Beyond that, and so in other words, for ’11, again, we’ve been fairly cautious with regard to that. We’ve got some slight growth on, we anticipate, on home standbys, but we don’t anticipate a big snapback coming back in terms of demand for premium lawn and garden. Having said that, I would tell you that beyond ’11 I think there are some very interesting things that we’re working on that, it’s difficult to tell you at this point just how meaningful they could be, but there’s a whole series of different opportunities we’re evaluating, and we believe could be pretty meaningful as you get into things like ’13 and ’14.

Craig Kennison

You have a very strong brand in lawn and garden. Could you elaborate on whether you have any licensing opportunities, pure licensing opportunities, just with the brand itself?

Todd Teske

Yeah, we’ve done some things on the licensing side. We’ve done some things that I would consider to be a little bit more tangential, things like gas cans and oil and things like that. When you get beyond that, we are – the brand plays extremely well in outdoor power, and that’s where we play as a company in our core, so although we continue to look for opportunities to license, I wouldn’t tell you that licensing is at the top of the list in terms of opportunities to try and get people to license our brand more. As opportunities come up, we continually look for those opportunities. But as we look at it, it’s make really good engines. Let’s look to do some things where people will pay a little bit more money for it because they’re really good stuff, and then how can we serve the emerging markets?

Craig Kennison

Thanks, and then Dave, you mentioned in the press release that you have a senior note coming due in March. If you were to refinance that today how meaningful would the savings be and could you refinance that early?

Dave Rogers

The answer to your question is yes, we could refinance it early. There is some [unintelligible] in order to take it out for the current year. If we do take it out early we are going to pay a premium. So because of that premium there’s really not a significant savings to do that in fiscal ’11.

Operator

Our next question is from Jad Fakhry from Farallon Capital. Your line is open.

Jad Fakhry - Farallon Capital

I had a couple of quick questions. The first one is just, I’m trying to understand the sales trends post the quarter. You guys had a huge sales quarter this quarter. I’m just trying to understand, how does it look year over year in the months and ten days that we’ve had since the quarter ended.

Todd Teske

Are you asking about the month of July?

Jad Fakhry

Yeah, July and then August to date. If you looked at it 2010 versus 2009, have the sales trends continued at this level, the level we saw in Q4 in terms of the year over year growth rate?

Todd Teske

Yeah, unfortunately we really can’t comment on that given the fact that we’re in a new quarter if you will. So we really can’t make a comment on that.

Jad Fakhry

Got it. Okay. And then I just had another question. On the price increases, I think in the third quarter you guys had talked about 2.5% to 3% was the goal on pricing, and it ended up, it sounds like the weighted average of 1%. What happened? Is that intensified competition and bidding for placement that caused a shortfall? Or what happened there? What created the shortfall in pricing?

Todd Teske

First off, remember that we’re not done with the line reviews at this point in time. What we’re giving you is guidance in terms of where we think it might end up, and so ultimately we’ll have a better view on this at the end of the second quarter when the placements have been made and things are pretty much known. So I would not read a whole lot into it at this point. What we told you on the last call versus this call, I would hang my hat on what we’re going to tell you on the next call.

Operator

There are no further questions in the queue.

Dave Rogers

Thank you everyone. That concludes our conference call today. We will talk with you again in October.

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