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Briggs & Stratton Corporation (NYSE:BGG)

F1Q2011 Earnings Call

October 21, 2010 10:00 am ET

Executives

Dave Rogers - Chief Financial Officer

Todd Teske - Chairman, President, Chief Executive Officer

Analysts

Mark Rookie - Longbow Research

Steven Gregory - Mandalay Research

Craig Kennison - Robert Baird

Ned Borland - Hudson Securities

Mike Hamilton - RBC

Brad Safalow - PAA Research

John Barlow - Weiss

Sam Darkatsh - Raymond James

Jad Fakhry - Farallon Capital

Operator

Good day, ladies and gentlemen, and welcome to the Briggs & STrattong first quarter earnings release conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded. I would now like to introduce your host for today's call, Mr. Dave Rogers. Sir, you may begin.

Dave Rogers

Good morning and welcome to the Briggs & Stratton fiscal 2011 first quarter earnings conference call. I’m Dave Rogers, 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.

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. As you saw from this morning's earnings announcement, our consolidated sales and profitability improved modestly over last year's first quarter. While we typically have a net loss in our first quarter due to the seasonal nature of our business, we are pleased to report these improved results in the face of higher commodity cost and increases in other manufacturing expenses such as employee benefits and transportation expenses.

As we anticipated, continued slow growth in economic data continues to weigh on the minds of the American consumer. Lagging housing starts and resales, continued unemployment of 9.6% nationally and uncertain personal tax rates for all Americans starting in January appears to be having an impact on the levels of consumer spending and it continues to have an impact on the rate of growth for products in the outdoor power equipment industry.

In addition, we continue to have our annual discussions with our key customers regarding product placement for next spring and summer selling season. For now, we are continuing to execute on our current year plan and are slightly ahead of our internal plan through the first fiscal quarter.

Now I'll turn it back over to Dave to walk through our financial results for the first quarter of fiscal 2011.

Dave Rogers

Thanks, Todd. Our first quarter consolidated net sales were $334 million, an increase of $10 million or 3% from consolidated net sales in the first quarter of last year. First quarter consolidated net loss of $8.1 million, a $0.16 loss per diluted share, was an improvement of $600,000 from the net loss of $8.7 million and $0.18 loss per diluted share one year ago.

Our net income and diluted earnings per share were improved from last year despite, as we noted in our last quarterly earnings call, a few specific items that made our comparison to last year's first quarter rather challenging for our operations.

First, in last year's first quarter, we had temporarily reduced salaries by 10% and eliminated the company match on our 401K plan resulting in savings in last year's first quarter of $4.5 million. The salaries and the 401K match were subsequently reinstated.

Secondly, our fiscal 2011 pension expense is estimated to be approximately $18 million higher than fiscal 2010. This higher pension expense impacts each of our quarters ratably, thus pension expense was approximately $4.5 million higher in the first quarter of fiscal 2011 and in fiscal 2010.

Lastly, the more significant price increases typically do not impact our year-over-year comparisons until the second and third fiscal quarters. Even after taking these headwinds into consideration our consolidated income from operations was basically unchanged from last year.

Engine segment sales for the first quarter were $205 million, essentially unchanged from the prior year. As we noted in our release, international shipments to OEMs in Europe and Asia increased over the prior year while intercompany shipments to our own power products group for use in portable generators and pressure washers were down.

Total engine unit shipments were higher than last year by approximately 6%. The impact of the higher volumes was offset by a product mix that skewed towards small engines rather than larger engines used for riding lawnmowers and portable generators.

We continue to believe that overall inventories in the channel are reasonable for this time of year. It appears that OEMs, match retailers and dealers are continuing to be very conscientious with regard to the amount of working capital invested in inventories.

The operating loss for the engine segment was $5.5 million, an increased loss of $700,000 over last year's first quarter. Due to the seasonal nature of our business, quarterly sales and production volumes are typically the lowest in the first fiscal quarter resulting in an operating loss for the quarter.

Engine segment operating margins were favorably impacted by improved absorption of fixed costs as units produced increased 9% from last year's first quarter. We also continue to be on track with our annual cost reduction programs.

The engine segment was unfavorably impacted year-over-year by increases in materials, transportation and other manufacturing costs, a shift in product mix towards small engines and higher costs for salaries and benefits as discussed earlier.

Now, turning to the power products segment, sales for the first quarter were $168 million, an increase of approximately $2 million over the prior year. Increased shipment volumes for lawn and garden equipment were essentially offset by reduced pressure washer sales for the quarter compared to last year.

Prior year pressure washer sales were higher due to new product introductions into the channel. In the current year, channel inventories of pressure washers appear adequate and retailers appear to be managing their inventories closely.

Most products within the lawn and garden saw growth over the prior year with the most growth coming from ZTR and snow thrower units. Dealers of premium lawn and garden products continue to be somewhat cautious in reordering inventory for the current season so that they do not risk carrying over inventory to next spring.

Portable generator sales were in line with last year given that there were no significant weather events in the year creating demand. Inventory levels of portable generators appear to be at adequate levels given no storm activity.

The power products segment had a loss from operations of $5 million in the first quarter, a decline of $7.5 million from operating income of $2.5 million in the first quarter of last year. The decline in income from operations was related to reduced absorption of fixed costs as generator production decreased by almost 50%. Increased manufacturing costs for commodities, transportation, utilities and other manufacturing costs also impacted operating margins.

The power products segment was impacted by higher salaries and benefit costs as was previously discussed in the engine segment. Our cost savings programs within power products are substantially on target through the first quarter with the exception of our Jefferson plant cost savings, which are being impacted by lower production volumes of certain products as we manage our inventory levels.

As we reported last quarter, moving the production to our other facilities is complete. However, we are continuing to work towards targeted efficiencies within each of the new facilities to ensure that we hit our cost savings goal of $11 million annually.

With respect to our balance sheet, net debt at the end of the first fiscal quarter was $156 million, a decrease of $106 million from the first quarter of fiscal 2010. We did not have any amounts drawn on our $500 million revolving credit facility at the end of the quarter.

Cash used in operating activities for the quarter was $55 million primarily related to seasonal build of inventory levels and reduction of accounts payable in the quarter. Accounts payable typically is reduced in our first fiscal quarter since production levels are less than our fourth fiscal quarter.

Last 12 months cash provided by operating activities was $176 million and LTM free cash flow was approximately $130 million. Depreciation for the quarter of $16 million outpaced capital expenditures of $9 million.

Total funded debt and last 12 months EBITDA as defined by our credit agreements were $205 million and $141 million respectively resulting in a leverage ratio of 1.45 times, which is well within our debt covenants.

We continue to have approximately $201 million of 8 7/8 senior notes outstanding which mature in March of 2011. During the last quarter we have actively solicited input on our alternatives to refinance these bonds and continue to be encouraged by the liquidity in the debt capital markets and a favorable interest rate environment.

We also filed an S3 shelf registration statement to be used in the event that we would tap into the high-yield market again. We are continuing to evaluate all of our alternatives and expect to make a decision during this quarter regarding the structure and timing of our refinancing.

That concludes what we wanted to say about the first quarter financial results so I'll turn it back to Todd for his concluding remarks.

Todd Teske

As we noted in today's earnings release, we are not changing our guidance with respect to sales or earnings for fiscal 2011. We remain cautiously optimistic about the rate of economic recovery both here in the US and abroad and about the levels of consumer confidence.

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 power equipment category.

Engine segment sales are expected to be higher by approximately 1% to 2% on slightly higher volumes and pricing improvements. As a reminder, we are currently in discussion 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 completed placement at or fiscal 2011 second quarter conference call in January.

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 products segment.

Consolidated operating margins are forecasted to be in the range of 5% to 6% with most of the improvement from fiscal 2010 within the power products segment. While we are not providing specific guidance for our quarterly results, it is pertinent to point out that there are several items we believe will impact our second quarter of fiscal 2011 compared to fiscal 2010.

Gross margins are expected to be lower than the prior year primarily in the engine business due to planned lower production, higher cost of raw materials and timing of certain price increases. In addition, we expect the timing of our engineering selling, general and administrative costs to be more consistent between each quarter in fiscal 2011 without the impact of temporary salary and benefit reductions and higher pension expenses that are spread evenly throughout the year.

Lastly, our forecasted interest expense of $23 million to $25 million for the year contemplates refinancing our debt in the second fiscal quarter and includes a make-whole premium of approximately $4 million to refinance the bonds prior to maturity.

We anticipate that capital expenditures will increase moderately in fiscal 2011 to approximately $60 million to $65 million.

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

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Mark Rookie - Longbow Research.

Mark Rookie - Longbow Research

On the engine shipments you said 1% to 2%. I'm not sure if that's changed at all since the last time that you kind of guided. I know you're in negotiations right now. Is there any risk of placement given the price increases or is that pretty much -- or are they the major customers that you know are anticipating and accepting those?

Todd Teske

Yes, Mark, I will tell you that this is not different that what we had told you at the end of the fiscal year, at the beginning of the quarter. So it's pretty much the same. When you look at what our expected placement is for this next year, we're not anticipating significant changes. There might be a couple share points that we go down simply because of the price increase but it should not be dramatic by any means.

Mark Rookie - Longbow Research

Then as far as kind of the domestic versus the European, Asian OEM strength how do you kind of see that playing out? Do you expect the international strength to continue? I know that's been weak for the last several quarters.

Todd Teske

Well, what we anticipate is over in Europe might be slightly stronger than in the US. So the US we're projecting just moderate increases, very slight increases, in fact, in the market. Over in Europe it might be slightly better than that but we're not anticipating anything dramatic. Then when you look at kind of the rest of the world it's relatively small in comparison to what the consolidated numbers would be. So when you look at just the developed markets that's pretty much where we're at.

Mark Rookie - Longbow Research

Then just on kind of the raw material front, obviously some of the -- copper and aluminum are up. Any color on kind of where you're hedged and what we should anticipate? I know you didn't change your overall kind of margin stance but if there's any puts and takes on that, that would be helpful as well.

Todd Teske

Yes, when you look at aluminum we came into the year and had a fair amount of our expected usage hedged. There is a little bit of risk depending on where the volumes shake out. There's a little bit of risk along the way but we'll manage through that with spot buys and be a little more opportunistic if necessary with spot buys.

On the copper side, copper is way up there but when you look at where our inventories are at today now as we had ramped up generators a lot of copper gets used in generators. As we ramped up for the hurricane season -- that was extremely active. It just didn't knock out any power in the US. We're able to carry over much of that inventory and so the risk on copper isn't nearly as significant as it would be had inventory levels been substantially lower.

Mark Rookie - Longbow Research

Just lastly, I know that on the last call you talked about your three strategic pillars going forward. I mean, should we anticipate any kind of new products on the commercial side or increased geographic expansion or anything like that in this year or is that more of a longer-term thought process?

Todd Teske

Well, I would tell you that certainly some of the actions that we're taking are short term. Some are mid term. Some are longer term. I would tell you some of the things in the emerging markets and that sort of thing are a little bit longer term.

You can anticipate seeing -- and this is normal -- but you would anticipate seeing new products coming out for this next season that kind of fall in that short-term category. So we've baked a lot of that into these forecasts. I wouldn’t tell you that we're anticipating them to have significant impacts but we are making investments that will benefit us in the mid to longer term.

Operator

Your next question comes from the line of Carlos Guillen - Wall Street.

Steven Gregory - Mandalay Research

This is Steven Gregory from Mandalay Research. A couple of things -- congratulations on the good quarter. Can you provide some color on the call today as what is your economic vision, your e-commerce vision going forward and how do you plan to sell more goods and get more revenue online?

Todd Teske

Well, when you look at -- e-commerce will play a role. When you look at some of the things that are happening in terms of just overall trends in e-commerce we'd be silly not to be able to take a look at it. Are we at this point ready to disclose to the world exactly what it is we're working on? We're not.

On the other hand, I would tell you that the customer experience, I think, can be heightened as they continue to do research and other things on the internet whether they buy the products on an Add to Cart button or whether they go into a dealer or a retailer. We really believe that the whole worldwide web is a place we need to be and we'll work through our strategy on selling over the internet.

There's ways, I believe, that we can either sell and have the dealer fulfill or there's ways in which we can drive people to the dealer when it comes to kind of the higher end whole goods piece of the business. So we've got resources dedicated to that and we continue to work on that.

Carlos Guillen - Wall Street

I know you guys are selling a lot of repair parts, maintenance products [because your line is very] -- and you mentioned that you're going to be selling a lot of the mowers directly through your site or is that going to be going through the dealers?

Todd Teske

Well, when you look at it, it kind of depends on the product and when you think about a tractor, trying to drop ship a tractor to somebody's house gets kind of interesting. On the other hand, if you think through a simplicity tractor that will be several thousand dollars, people will go out and they will do research on that but then there needs to be some support that goes on after the sale as well.

So when you look at that I'm not sure that tractors, per se, will lend themselves to Add to Card and drop ship but, on the other hand, I think there's some ways that the e-commerce trends that are going on can be useful to our business.

Carlos Guillen - Wall Street

What are you guys doing to drive more people to the site? You have a great site. It sells a lot of products, gets a lot of people to your dealer network. How are you driving people to the site so that they know Briggs & Stratton is the place to be for mowers, engines, et cetera?

Todd Teske

Yes, one of the things that -- we have made some changes to our ad mix here over the last few years. You go back four or five years we would have done more regional television. We would have done a little bit more radio. Our focus has now been on the internet and what we do is we do a fair amount with things like banner ads on sites where we know the demographics go to. That has helped us fairly dramatically.

We just had over the last few months a relaunch of the Briggs & Stratton site itself and so we're doing things like a lot of other companies are doing things with regards to key word searches and banner ads to really make sure that they're hitting our site.

The other thing we do is we have a significant effort behind enginesmatter.com because, as you know, a big part of our business has to do with engines and we believe that engines truly do matter in the purchasing process and we want people looking for Briggs & Stratton engines when they go out and buy a piece of equipment.

Carlos Guillen - Wall Street

You had mentioned banner ads. Are you guys building any mobile apps? So most people out there obviously think mobile is the way to go. Are you building any mobile apps so those customers can actually go right to your site from their iPhone?

Todd Teske

The short answer is we continue to work on that sort of stuff. The longer answer is there's some really cool stuff that's out there that we are in the process of utilizing and developing.

Carlos Guillen - Wall Street

Final question -- going forward for 2011, where would you guys, if you could go out one year, what is your goal for the company? Where would you like to be? Not say in terms of revenue projections but where do you see the company headed a year from now to drive more revenue to the top line, more profits online?

Todd Teske

Well, I'll take you right back to the three pillars of our strategy which basically are protect and grow the profitability of the engine business and there's various ways to do that, whether it's through emerging markets and trying to penetrate overseas markets or whether it's trying to do more -- and we are doing more -- in the commercial engine market.

The second piece of it is investing in higher-margin products and margin expanding products. You'll see us come out with some things specifically in the home standby area that are rather interesting.

The third pillar of the strategy really comes down to the emerging markets, which, as I had mentioned before on the question before, was a little longer term but you will see us make some headway. Will it make huge impacts on the numbers? I would tell you it should be some nice growth but I’m not going to tell you that it's going to vault us by 2012. That's a little bit longer-term viewpoint. So I mean there's a number of things that we've got going on and we've gone through and have these strategies and are executing to these strategies.

Carlos Guillen - Wall Street

Emerging markets probably four or five years from now you think, maybe a little farther out?

Todd Teske

Yes, I would tell you that's kind of three plus years out but there's a lot of interesting stuff going on and the world seems to be getting smaller so there's more and more opportunities out there for us to take advantage of.

Operator

Your next question comes from the line of Ned Borland - Hudson Securities. We'll come back to Mr. Borland. Your next question comes from the line of Craig Kennison - Robert Baird.

Craig Kennison - Robert Baird

Dave, you're going to be hit by this $4 million to refinance debt. That hits in the second quarter, correct?

Dave Rogers

It'll ultimately hit whenever we refinance. As we indicated, the current market, as far as refinancing, is very good. We have a number of alternatives available to us, whether it's the private placement market or whether it's the public high-yield market, bank debt. We have lots of different alternatives.

We will pay a make-whole to the extent that we refinance early. That number would go down by about $1.3 million each month we don't refinance.

Craig Kennison - Robert Baird

So the quarter -- .

Dave Rogers

I just wanted you to understand that in our projections, when you look at the quarter year-over-year, that there is in our projections $4 million in the second quarter from a timing perspective.

Craig Kennison - Robert Baird

Yes, that's helpful. That’s what I was getting at because the second quarter could ultimately have that make-whole provision plus all of the interest expense, so it could be a high-cost interest expense quarter.

Dave Rogers

Well, I think if you look at where our debt and our cash positions have been over the last 12 months one of the things because of the strong cash flow that we've been able to do is borrow less money on our revolving line of credit. Even though that's a very favorable interest rate it is helping us out with our total interest expense on a year-over-year comparison. In addition to that, once we do refinance we do expect the rates to be quite a bit lower than the 8 7/8 that are on the bonds today.

Craig Kennison - Robert Baird

Dave, do you have a sense of what the range might be in terms of interest expense?

Dave Rogers

I don't think I -- well, what we've said is $23 million to $25 million and, again, that contemplates the refinancing.

Craig Kennison - Robert Baird

Switching gears here, just can you give us an update on the competitive landscape especially as it relates to China? I know you've recently -- in recent years taken some shelf space back from Chinese vendors. Is that trend continuing or is there a new sense of competition there?

Todd Teske

Well, Craig, I think the competition really continues. Are we anticipating significant share loss for the upcoming season? No. When you look at it, the competition is generally coming from the small engine area and what we call the char engine area, which is the horizontal shafts that are used on things like tillers and snow throwers.

We're not seeing a lot coming out on the large engine side. Now, remember that on January 1 of 2011 the emissions regulations changed on the large side and then they will change again on the -- well, they change for the small side on 1/1/2012. So there are things that are coming into play with regards to that. So we're not seeing what I would consider to be heightened competition. It's still there and we still, for all intensive purposes, continue to hold our position.

Craig Kennison - Robert Baird

How would you see those regulations impacting your share?

Todd Teske

Well, when you look at it, the regulations become more stringent. Depending on how the manufacturers -- and now I’m speaking more sort of the small side than the large side because the large side is pretty much in play right now -- it just depends on how the competition decides to meet those regulations and we believe that we have -- our situation is that we have made changes but the cost -- there is a cost impact but we believe that our competition will have a more significant cost impact than perhaps we will.

So we'll see. I mean, we'll see how they ultimately decide to deal with it. So our costs are going to go up. I believe their costs are going to go up more.

Craig Kennison - Robert Baird

Lastly, I think the big thing we're waiting for is a replacement cycle to come back. What is your kind of metric model saying, if anything, that's different than what it said before?

Todd Teske

No, it's pretty much saying the market will be up slightly and that's pretty much where we were back last quarter when we talked to you guys.

Operator

Your next question comes from the line of Ned Borland - Hudson Securities.

Ned Borland - Hudson Securities

I just want to circle back to the raw materials comments from a couple questions ago. Am I assuming that you're assuming basically kind of a stable price to raw material relationship in your outlook or does it even improve a little bit? Can you just help us think through that?

Dave Rogers

If anything, Ned, we would expect that the costs of raw materials will stay where they're at or continue to trend up slightly. One of the things that's really difficult to gauge with respect to raw materials is the impact that some of the buying in China has on certain of these commodities. That one is a little bit difficult to forecast.

But our folks here that follow some of that stuff internally on aluminum specifically it's probably not going down. If anything it may trend up a little bit. Again, as Todd said, we're protected on that to a certain extent. If it runs away from us it will impact our quarter but for right now it's not impacting our projections for this year.

With respect to steel, that one, again, is maybe a tick lower for the moment but we continue to see that one rise as production comes up for things like automobiles and other items.

Ned Borland - Hudson Securities

On engine production, you guys were talking about shipping what you produce, not really having to burn off inventory. Is that still the case? I mean, are you assuming basically a 1% to 3% increase this year on engine production?

Dave Rogers

Yes, last year, just as a reminder, we underproduced to our sales by about 300,000 units. I believe the guidance that we gave in August -- you're correct in that we're going to produce what we sell and it's going to be around that 10 million unit level for this year.

Ned Borland - Hudson Securities

Finally, on how the lawn and garden season shapes up here, is it going to be like the last two years where it's sort of this shortened season where people are really gearing up production closer to the start of the season or is it something a little more normal?

Todd Teske

No, I think it's going to be similar. We're anticipating that it's going to be similar to what it's been in the past. When you look at kind of where some of the retailers are today and some of the other categories that we deal in, they've been trying to preserve cash and we would anticipate that the OEMs will do the same. So I would expect that we will continue to see the concentration of the season play out similar to what it's been here more recently.

Operator

Your next question comes from the line of Mike Hamilton - RBC.

Mike Hamilton - RBC

Just a couple of connect-the-dot questions to start -- one, I'm assuming the $1.20, $1.40 is including the anticipated make-whole.

Dave Rogers

That is correct, Mike.

Mike Hamilton - RBC

Is there anything else in there on a one-time nature that need to be called out?

Dave Rogers

No. All of the other items that are in that guidance are from what I would call a normal operating standpoint. It includes the cost savings initiatives that we typically talk about each year. But as far as other one-timers in there I'd tell you no.

Mike Hamilton - RBC

$60 million to $65 million still the CapEx outlook?

Dave Rogers

Yes, we were probably running a little bit lighter than that in the first quarter as you saw with CapEx being about $9 million. But the $60 million to $65 million is still the range that we're going with. I think you'll see some of that start to pick up here in the latter part of the year. As we talked about, we have a new engine initiative that has been a three-year program between 2010 and fiscal 2012 and a lot of that spending will start to gear up here as we move throughout the year.

Mike Hamilton - RBC

Could you give some highlights on what you'd like to achieve in inventory in coming quarters?

Dave Rogers

Well, I don't know if I'd give it to you -- .

Mike Hamilton - RBC

I'm not looking for numbers, more -- .

Dave Rogers

Yes, well, overall, Mike, what we're trying to achieve in the engines group to start out with -- last year we ended with about 1 million units in inventory. What our operating folks would tell you is that's about where they would like to be as we head into a new fiscal year and so our plan, as I said before, is to basically produce what we sell and end up in a relatively similar position at the end of this year for engines.

In power products, as we look at the opportunities to continue to work down inventories after moving Jefferson and things like that, we think there are some additional opportunities to continue to reduce our inventories by anywhere from $20 million to $30 million by the time we get to the end of the fiscal year.

Todd Teske

Yes, Mike, we've got a number of lean initiatives going on. We continue to focus on inventories to free up the cash flow. Will we be able to achieve the dramatic things we did last year? No. But on the other hand, that continues to be a significant focus for us.

As you know, the issue comes down to the timing of when a lot of our engines are taken though, as well, because we don't -- we always talk about not building the church for Easter Sunday, so we level schedule our production generally and with some ups and downs. But if the season does continue to concentrate that will have an impact on quarterly inventories as well.

Mike Hamilton - RBC

One last one, if I may, as you reflect back on the last lawn and garden season and mix, is there any conclusions that you're drawing that you'd take for a longer-term perspective?

Todd Teske

From a longer-term perspective, the answer is not sure there's much to conclude because what we continue to talk about is is there a new normal, what is the new normal? That's the buzz words these days.

I would tell you that what we saw that was encouraging is that although people bought because they needed and not because they wanted because people continue to separate wants from needs, we did see the kind of mix that comes through that says, "I'm not just going to migrate down to the lowest common denominator." In other words, I'm not going to go straight down to OPP, opening price point.

They may not go all the way up to premium but that mid market that's been so solid for a long time, people look at it and they see good values out there in that mid market and, to us, that's encouraging because it means that people will pay for the value that you can deliver. So anything, though, other than that to draw for the long term, I think we're all just kind of waiting and seeing what's going to happen with the housing market and just the overall economy and consumer confidence to see what, in fact, the new norm will be going out there.

Operator

Your next question comes from the line of Brad Safalow - PAA Research.

Brad Safalow - PAA Research

First question, just your guidance, what does it contemplate for currency exchange rates for the year?

Dave Rogers

Basically, for the year, currency and exchange rates were relatively flat.

Brad Safalow - PAA Research

Flat based on -- I guess -- .

Dave Rogers

Year-over-year.

Brad Safalow - PAA Research

Then just going back to this issue on pricing, you're having these price discussions now. Can you talk a little bit about what you're seeing competitively? I guess there's some talk that the Chinese may or may not be -- manufacturers may or may not be more aggressive on pricing. What are you hearing competitively from that standpoint?

Todd Teske

Well, what we're hearing is that some of the competition is not necessarily going up. Some of the competition has gotten somewhat more aggressive along the way but there's a lot of folks that are kind of flat to down when we're kind of slightly up.

Brad Safalow - PAA Research

I guess you reference earlier that you think that could cost you a couple share points on the engine side but nothing more meaningful than that.

Todd Teske

That's our expectation right now.

Brad Safalow - PAA Research

Then just on the engines, I think you said earlier in the call that you plan to have production down in the second quarter year-over-year. Is that correct?

Todd Teske

That’s correct.

Brad Safalow - PAA Research

I guess you -- inventories were flat at the end of the last fiscal year, production down in the second quarter. Does that mean as we get to the second half of the year you're going to have some catch up in production to get to what you're talking about on unit volumes?

Dave Rogers

That's correct.

Brad Safalow - PAA Research

Is that normally just a function of what you're seeing and kind of how demand has been trending for the last few years?

Dave Rogers

Sometimes what comes into play is the timing of when the lineups get set up and ultimately when the orders come through based on those lineups. So with respect to inventories we don't see any inventory backup out in the channel when looking at the channel as a whole. But it's just a slight movement from a year-over-year perspective between Q2 and Q3.

Brad Safalow - PAA Research

Then did you also say that your production of power generators in the first quarter was down 50% year-over-year? Did I get that right?

Dave Rogers

That is correct. It was down 50%. I think what you saw last fiscal year was still building up inventories to the level that the retailers expect us to have on hand from the hurricane and the ice storm activity that happened during our fiscal year 2009. So last year was an inventory build towards those levels and we've not had any significant weather events to take those inventories down. So we've taken the corrective actions in order to maintain proper inventory levels here at the company.

Brad Safalow - PAA Research

Just based on what we hear from people the channel inventory of the power generators seem to be acceptable. So I guess if there is storm activity you would expect a commensurate increase in production.

Dave Rogers

That's consistent with our understand, yes.

Brad Safalow - PAA Research

Then just for my last question -- can you guys comment at all what you're seeing in terms of differences in demand or order expectations between commercial users versus your clients that are more consumer oriented?

Dave Rogers

Well consumer is by far the larger piece of our business as opposed to commercial and I’m talking about engines now. But what we see out in the market is that for the last few years the commercial space, in particular, was probably off even sharper than what it was for consumers and so we've seen a bit more of an uptick in commercial over the last several months.

Having said that, because it's a much smaller piece of our business, you don't see a significant uptick as far as impacting the overall numbers.

Operator

Your next question comes from the line of John Barlow - Weiss.

John Barlow - Weiss

Can you give us some detail on how much snow thrower shipments increased during the quarter?

Dave Rogers

Well, we don't typically give out specific products as far as growth or decline year-over-year. If I go back to where we were at the end of last snow season, the channel here in the United States was pretty clean. There was a fairly significant or fairly good snow throughout several regions of the country.

Having said that, Canada had a little bit of inventory overhand due to having less snow in the Toronto region, in particular, last year and so overall channel inventories were in pretty good shape and that's translated into a bit better snow thrower sales this year.

John Barlow - Weiss

Can you give us a sense for how much on a relative basis your engine shipments to Europe and Asia outperformed your shipments to the US this quarter?

Dave Rogers

Well, as Todd mentioned earlier, because the shipments or the numbers or the volumes to Europe and Asia are significantly less than the US, the percentages that they're up are much more significant for the consumer business.

Todd Teske

But just to give you a sense, I mean, Europe had a -- we believe to be a fairly strong end of the season. So as they got into the fall strong shipments and so we saw some uptick in activity there. Asia just is too small in terms of what's going on over there to make an impact at this point.

Operator

Your next question comes from the line of Sam Darkatsh - Raymond James.

Sam Darkatsh - Raymond James

A couple quick ones here and if you mentioned this and I missed it I apologize. Did you quantify -- could you quantify what you are looking for in terms of engine pricing this year? I think last quarter you were mentioning 1% for the year. Is that still 1% or with the recent uptick in materials, even though a lot of it's hedged, that you're going to raise that a little bit from 1%?

Dave Rogers

As we indicated in the last conference call, there is a range that we're going out with and trying to achieve depending on what products you're speaking about. But our guidance with respect to pricing hasn't changed from our last call.

Sam Darkatsh - Raymond James

With respect to pricing, you mean.

Dave Rogers

That's correct.

Sam Darkatsh - Raymond James

Then you mentioned, Todd, in your very first statement that the quarter ran slightly ahead of your internal plan. Could you help us as to where the primary variances were with the results versus what you folks were looking for internally?

Dave Rogers

I think the volumes were better than what we had thought and most of that was in the international areas, as Todd talked about. The productivity in the engine group was very good. The production, again, was a little bit better than what we had thought from that standpoint and so it was primarily in the engine business where we overachieved a bit compared to our plan.

Sam Darkatsh - Raymond James

The last question, the eliminations line was a favorable $2 million. How should we look at that from a modeling perspective going forward from an expense versus gain perspective?

Dave Rogers

Yes, that line item, Sam, is basically -- has to do with our intercompany profit eliminations and there's two things that really drive it, the amount of intercompany inventories that we have, which is related to the amount of intercompany sales.

As we said in our comments, the engine shipments to our power products group was down year-over-year and it was driven by decreased pressure washer and decreased portable generator sales. So that's having a positive impact on the amount of that elimination in the quarter.

Sam Darkatsh - Raymond James

Is that on a go-forward basis on the EBIT line? How should we look at that?

Dave Rogers

It all depends on the amount of intercompany shipments, which is driven by those product categories. So how many engines we're going to sell to our products business for lawn and garden equipment, pressure washers and generators to the extent that more is transferred, then it depends on the timing of when those products go out the door.

Todd Teske

Part of it, Sam, if you think through -- I don't know if this helps you at all or not -- if you think through the seasonality of how the production works, if you will, we start to build inventories for pressure washers toward the end of our fiscal second quarter. We start to ship in February, March and so then we go big shipments in the fourth fiscal quarter, if you will.

So if you think about how that production versus sales works that hopefully will give you a sense on kind of how that line item might swing quarter to quarter.

Operator

Your next question comes from the line of Jad Fakhry - Farallon Capital.

Jad Fakhry - Farallon Capital

So I just had three questions. The first one was just following up on a question that's been asked a few times but I went back and looked at the transcript from the fourth quarter call. I think you guys -- so I'm just trying to be careful here on this market share.

You guys had said -- Todd, I think you said 1.5% to 2% was your guidance on engine growth in the fourth quarter, on the call for the fourth quarter. Now you're saying 1% to 2%. So you've taken a midpoint down slightly from 1.75% to 1.5%.

Then, I think, Dave you just said that pricing is kind of consistent with what you've outlined before in that range of 1% to 4% with a blended average of 1%. So what I'm trying to understand is two things. One is did your competitors not follow you on price and is that why you're [ceding] market share and is that just kind of a change in strategy where you're saying, "Look, we need to restore our margins that we had in the old days and, therefore, we're willing to lose market share?"

My second follow-up question is who won that incremental share that you guys -- the placements that you guys are going to lose because it sounds like you were a little more aggressive on price?

Todd Teske

Well, there's a lot in that question, so let me try and just kind of step back for a minute. When you look at kind of what we said, is it a change in strategy? The fact is, when costs go up we've got to find a way to recover those costs to maintain our margin percentages. We do that partially through productivity and cost savings as best we can. Then at times we need to go out to the market and try and get some of that.

So we felt we needed to go up on pricing and as we go along, I mean, if that causes us to have some blips, if you will, minor blips as we would think about it in the market in terms of share, then it is -- that's what happens.

But when you look at have our competitors become more aggressive, as I mentioned before, I don't know that they become more aggressive. They certainly did not follow us. I'm not sure that they are seeing -- I mean, when you look at raw material costs we all pay consistent on the raw material costs.

In other words, I think we get a little bit of an advantage simply because of our scale. But are they doing anything that's giving them significant advantages over us? I don't think so. So as we go along, what we want to do is be prudent in how we go about with our margin percentages and things like that.

So all in all I would tell you that things are relatively consistent with where we thought they were going to be. Did they move a percent here or percent there? Perhaps, but when you look at it overall, we're pretty comfortable with what we said at the last quarter and this quarter.

Jad Fakhry - Farallon Capital

Isn't the risk there -- just one follow-up on that one. Isn't the risk there that your customers, the assemblers like [MTD, Husafarna and Tora and Deer] -- isn't the risk that they try to be competitors, they play some of the competitors engines that are essentially lower cost? They didn't raise prices. It's not like they held prices flat for this upcoming season. They try them, they get used to them and the kind of minor share loss becomes something bigger.

The risk is that potentially they have the same costs as you guys on everything but a few key items like labor because it's China and it's cheaper labor. So isn't the issue that that kind of minor share loss could eventually grow over time as the customers and the end users get used to a Chinese engine and that it goes from a minor problem to a bigger one?

Todd Teske

Well, here's what I would indicate to you there. The costs are not the same. Yes, they may have a lower labor cost per person but at the end of the day when you look at our end labor cost and how many hours or, I should say, fractions of an hour are in an engine you quickly find that, yes, on a per hour basis it's one thing but then you look at other things like transportation and shipping and that sort of thing. I wouldn't tell you that our costs are the same.

We don't pay the same for shipping as they would because they're shipping from several thousand miles away and we're here for the market. The other thing that you need to understand and recognize is that there's a tremendous amount of value we believe we bring to the market that our competition specifically from China doesn't bring.

We bring a service network that still matters. The service network still matters. We provide a lot of things in terms of assistance on some product development and other things too that the Chinese wouldn't provide.

When on occasion there are issues we are able -- we have the capability of stepping up and dealing with the issues where perhaps the OEMs were going to go buy from a competitor. They certainly don't have the infrastructure, don't have the ability to take care of it. So, I mean, there's a tremendous amount of value that we bring to the market and part of that then translates into getting paid for the value that we do bring to the market.

So in the end do we pay a lot of attention to market share? Of course, and are we going to [cede] market share very easily? No, I can tell you we won't. But on the other hand there is an awful lot that we do to bring value to the market that we think is useful to the OEMs and to the retailers and ultimately to the people who use these products day in, day out.

Jad Fakhry - Farallon Capital

Then just two other quick follow-ups -- gross margins, you're saying Q2 is going to be down. When do we start seeing the gross margin kind of come up because it implied in your margin guidance the 5% to 6% you're kind of saying that margins should come back at some point later in the year. Do we start to see that improve in Q3, Q4 as the price of commodities relationship improves?

I guess the second question is related to the how much is gross margin in Q2 going to be down? Is there -- can you guys talk about that at all?

Dave Rogers

Well, we're not giving specific guidance on how much it's going to be down other than for the engine business it'll be down year-over-year. Again, it does pick up in the back half of the year as the sales volumes pick up and as the manufacturing volume picks up significantly in the third quarter.

Jad Fakhry - Farallon Capital

Then last question -- pension, how are the credit agencies thinking about your pension plan? How does that affect kind of where your cost of capital when you guys refinance the 8 7/8 note? Any kind of cash contributions above and beyond what you outlined in the 10-K for this year or next year?

Dave Rogers

First, with respect to the rating agencies, they take a holistic approach to looking at our balance sheet and they do contemplate how much do we have on our balance sheet with respect to the pension plan. I do not believe at this point in time that it will impact us any differently than any other company that has a DB plan that may be an underfunded status.

The rates in the market right now for paper such as ours continue to be below 10-year averages even for investment grade paper. So one way or another we will be able to achieve taking that rate down from the 8 7/8. What was the second part of your question, Jad?

Jad Fakhry - Farallon Capital

Oh, I was just curious if there were going to be any other contributions, cash contributions that will be required to the pension plan, just as rates stay low and above and beyond what you outlined in the K, which was pretty clear, the 10-K.

Dave Rogers

Yes, it's no different than what we had outlined in the K at this point. There is no required contributions until fiscal '12.

Operator

(Operator Instructions). I'm showing no additional audio questions at this time, sir.

Todd Teske

One last thing I would like to do before we wrap up the call -- sitting in the room with us is Jim Brenn who is -- Jim has been with us for 33 years and I would like to just thank Jim for all he has done for the company. I know he's dealt with a lot of you folks periodically and, as you know, we will miss Jim dearly and we wish him the best in retirement. So, Jim, thank you very much. Thank you very much for joining our call. We will talk to you next quarter. Thank you.

Operator

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

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