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Briggs & Stratton Corporation (NYSE:BGG)

F1Q08 Earnings Call

October 18, 2007 10:00 am ET

Executives

James Brenn - Senior Vice President and Chief Financial Officer

John Shiely - Chairman, President and Chief Executive Officer

Dave Rodgers - Controller

Analysts

Sam Darkatsh - Raymond James

Peter Jacobs - Wells Fargo

Mike Hamilton - RBC Dain

Seaver Wang - Utendahl Capital Partners

Craig Kennison - Robert W. Baird

Simeon Wallis - Evercore Asset Management

Ned Borland - Next Generation

Dave Holmes - Epic Asset Management

Operator

Good day, ladies and gentlemen, and welcome to the Briggs & Stratton First Quarter Earnings Conference Call.

I would now like to introduce your host for today's program, Mr. James Brenn, Senior Vice President and Chief Financial Officer. Sir, you may begin.

James Brenn

Thank you. Good morning, everyone. As indicated, I am Jim Brenn, the Chief Financial Officer. And with me today is John Shiely, our Chairman and Chief Executive Officer, and Dave Rodgers, our Controller.

Today's presentation and our answers to your questions will include some forward-looking statements. The statements are based on our current assessment of the markets we operate in and other factors that could affect the business. Actual results could differ materially from any stated or implied projections due to changes in one or more of the factors that we described in our filings with the SEC, including, but not limited to, our 2007 annual report to shareholders on Form 10-K.

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

Now, I will turn the call over to John, who will cover the first quarter results and our outlook for the year.

John Shiely

Well, thanks for joining us this morning. As you saw in this morning's earnings release, consolidated net sales were $367 million, an increase of $28 million from the revenues in first quarter of last year. The release also reported a net loss of $20 million, which compares to a $16 million net loss experienced in the same period last year.

The consolidated net sales increase between years was a result of volume increases for our products that served the lawn and garden industry and a decrease in the engines that our Power Products segment takes from the Engine segment for our portable generator product.

The increase in the net loss between years can be attributed to $6 million of pre-tax expenses incurred in the current first quarter related to the previously announced closing of one of our domestic engine facilities and the startup of a new operation for the production of powered-lawn equipment.

The engine facility will close during our second fiscal quarter, and we have started production in the lawn equipment facility. Most projects are coming along as planned.

In general, a similarity in the consolidated operating results between years and the first quarter should be anticipated because they both contain a similar set of circumstances. Both quarters followed soft lawn and garden seasons, and both experienced an absence of storm-related demand for portable generators and the engines that power them.

In addition, our production levels are low in both quarters because last year, we were slowing production to start to decrease inventories, and this year, we are keeping our inventories lower by using our capacities to build product closer to the in-season demand, thereby, keeping our investment in working capital significantly lower.

Each segment had some variations to this general theme, which I will describe next as I talk about them individually. The Engines segment had a net sales increase of 10% between years, about half of which was driven by higher engine unit volume.

Retail sales of lawn and garden equipment were reasonably good during the first quarter of both years. In the summer of 2006, the retail demand did not translate into significant reorders of engines, because there were adequate finished goods in the channel.

In the summer of 2007, retail demand resulted in better engine reorders because retailers and OEMs had positioned their inventories much lower than the previous year and needed to meet demand through reordering and production.

We are not inclined at this time to consider this improvement in demand as an increase to our annual demand forecast because we have not seen the final results of product placement at all of the retailers this year. Several major retailers have not closed their negotiations at this time.

The two major contributors to the first quarter's improvement in the Engines segment's income from operations were the impact of favorable Euro exchange rates and the increased shipment volume.

In addition, we trended favorably in other areas of spending because of focusing on controlling costs, being on goal with targeted cost reduction projects and in some categories having the cost deferred to future quarters.

The favorable spending trends countered the impact of lower rates of production that we are using to control working capital investment and a mix of product that favored smaller displacement and lower priced engines that have smaller margins.

We believe we can continue to improve on the Engine segment performance in subsequent quarters because production volume will start to ramp up as we get closer to the spring retail season.

Now, let me turn to the Power Products segment. Net sales were very similar between years in total. Sales of premium lawn and garden equipment did well for the same reasons discussed for engine shipments. Selected areas of the country experienced good demand, especially for riding equipment that is a product for which many consumers continue to access the dealer channel.

Dealer inventories continue at normal levels, which leads us to believe they should do well next spring. Our pressure washer shipments were also much stronger than last year, as the major retailers we serve continued to promote the product throughout the summer.

The offset to the strength we see in some of our product lines is lack of any progress in demand for generators. Our forecast for the year envisioned a base level of generator demand that did not depend on any landed hurricane activity for the year. But it appears that our projected base quantity may have been impacted negatively by 10% to 15%.

Lack of storms or even the threat of storms translates to a lack of activity in the category, and it appears to be impacting the category more than we had expected. This is likely a cycle that we will just be forced to wait out. In the interim, we will work on controlling costs and inventories related to this product line.

First quarter operating income in the Power Products segment was down $13 million between years. Lower margins for lawn and garden products accounted for about a third of that decrease.

The two main reasons for the shortfall were the $2 million of startup and rearrangement costs associated with new operations and the cost of sales programs that were moved from later in the fiscal year into the first quarter to provide better manufacturing visibility to dealer orders.

Comparability in later quarters will benefit from the movement of the programs forward. The remainder of the shortfall reflects an unfavorable mix in product shipments between years that favored lower price and lower margin units. Now, that concludes what we want to say about the first quarter results of the segment.

Now, let me address the projections for fiscal 2008. We have tightened our forecast for the year by bringing down the top end of our projected range. Our positives for this fiscal year continue to be improved placement of engines with quantities that are greater than last year and the positive impact this will have on margins from both the sales and production volume perspective.

In addition, we are encouraged by the pace of our cost reduction initiatives in all segments of our business. However, we remain cautious about the market for lawn and garden equipment next spring, especially since it remains to be seen where consumer spending and retail confidence will shake out.

In addition, the incremental weakness we are expecting in the generator market tempers our view on the margins that were realized from generator product to the extent that their loss may affect our ability to benefit from any potential upside we felt might be available for fiscal 2008.

Now, we would like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from Sam Darkatsh from Raymond James. Your question, please?

Sam Darkatsh - Raymond James

A few questions here. First off, help me understand, Jim, the pension accounting and, more specifically, the effects on fiscal year '08 earnings per share expectations? It looks like it is a $2.6 million benefit to last year's first quarter. Is the benefit to this year's first quarter similar to that as compared to the prior way you were accounting for it?

James Brenn

Sam, I am going to let Dave run through that because we have the numbers of what the adjustment would look like by quarter. And we can tell you what the impact was because it was not in our original forecast at the time that we did the annual forecast back in August, we were still discussing it with the accountants and the actuaries, trying to determine the preferability of the method. So let me just turn this over to Dave quick, and he will give you the numbers.

Dave Rodgers

Yes. Sam, for the first quarter of this year versus the first quarter of last year, as we disclosed in the earnings release, the impact is about $685,000.00 to the quarter for this year of income, as well as last year it was about $658,000.00 of income. So once last year's first quarter is restated to be comparative, it is really a minor change when looking quarter-over-quarter.

Sam Darkatsh - Raymond James

Right, but that is not my question. My question is that, when you guys gave guidance three months ago, it was, I am guessing under the old manner of pension accounting, and so was that $2.6 million swing that was recorded last year, for instance, if you never changed the way you accounted for your pension, would it have been that same $2 million expense this year as it was last year?

James Brenn

Basically, Sam, what we had forecast for the fiscal year and the budget that we put out in August, I think it was a $2.1 million pension expense for the defined benefit plan.

Sam Darkatsh - Raymond James

Per quarter?

James Brenn

No, for the year. And what it will be this year will be I think a $2.6 million income effect on a pre-tax basis.

Sam Darkatsh - Raymond James

Okay. That answers that question. Thank you. Second question, it looks like you have also changed your share count assumption for the year by a little more than a million shares, is that coming from incremental share repurchase? Is that coming from less options dilution? What is the genesis behind that change in assumption?

James Brenn

I think we are not assuming anything additional this year. I think that the account change is really because if you are comparing year-over-year, it is because there was a buyback in last year's first quarter.

Sam Darkatsh - Raymond James

Well, it looks like that in your prior guidance, you were assuming basically a 51 million share count, and now you are assuming less than 50 million. I am just trying to get a sense of why that might be if there is no incremental repurchase assumed?

James Brenn

No, I guess I would have to talk to you about this thing. Because I do not think we have changed our approach. We would have looked at what we had from an average last year.

So, I have to look at our accounts. I do not think we have done anything that would have assumed we were going to change the share count that was outstanding.

Sam Darkatsh - Raymond James

Okay. Third question, what is your expectation now for a unit production versus unit shipments in fiscal year '08?

James Brenn

On an engine basis at this point, I think we are still looking for about an 11.1 million unit shipment year. And I think we are in the kind of a 10.8 to 10.9 level of production. We believe that because we are going to run closer to the best this year into the season. We still might have a little bit of bringing the inventories down even a little bit further, so that at the end of the year, rather than ending up at around the 1.3 level, we will probably be in the 1 to 1.1 million level.

Sam Darkatsh - Raymond James

And has that been revised at all since the last time you spoke to us publicly?

James Brenn

Yes, that is the way we went out with the numbers.

Sam Darkatsh - Raymond James

That is what I thought, okay. Two more quick questions and I will defer to the others. I apologize. John, with respect to selling prices, last year you went with the surcharges. Any sense yet as to whether you would be leaning towards surcharges or going fixed pricing at this point?

John Shiely

Yes, we still have the surcharges.

James Brenn

Well, basically what we have done is the surcharge carries on through this year, but we have embedded it into the price of the product. So, it is there, but, yes, there is no increase from what it was a year ago. But now, rather than people getting invoiced and then us coming back to them and saying that there is X-number of pounds of aluminum on an engine, the agreement with all of the major customers has been that we just input it right into the price itself.

Sam Darkatsh - Raymond James

So, what I am getting at is if aluminum changes from here on out, let us say aluminum is up 10% or 15%, would your price be revised or would that impact you?

James Brenn

Our price would not be revised, but what you will find is that when we have committed to these contracts with the various OEMs, what we have been doing is hedging the aluminum or getting the counter-party so that we are fairly comfortable that we have locked in at around a buck, probably $1.06 or $1.07 that has been embedded in the price, and we have been hedging ourselves to keep it there for the year.

Sam Darkatsh - Raymond James

Last question, and I will defer to others. Newbern, what are your unit expectations for assembly this year and next?

James Brenn

At least this year, what we have is probably around 200,000 units going through there. It is the same amount we would have built in existing facilities last year, other than for maybe about 50,000 or 60,000 incremental units that we have been able to procure.

So, I would tell you that around 200,000 level this year. I do not think next year is really forecastable at this particular point in time. It really depends on how well we perform this year at various retailers and whether they believe that, we are a competent producer of mass lawn-and-garden products.

Sam Darkatsh - Raymond James

The capacity at Newbern is how much?

James Brenn

Probably upwards to one million units of both snow and lawn equipment.

Sam Darkatsh - Raymond James

Excellent. Thank you very much, gentlemen.

Operator

Thank you. Our next question comes from Peter Jacobs from Wells Fargo.

Peter Jacobs - Wells Fargo

Good morning, gentlemen. First, could you talk a little bit more about the improved product placement and that being a positive for your outlook for fiscal '08?

John Shiely

Yes, we have gained some share in the engine segment that has been well-disclosed and we picked up some of the businesses that one of our competitors who is no longer in that segment had lost. So that is a gain. We have picked up some volume in Europe through the execution of our East Czech Republic plant. So incrementally, we are talking about 0.5 million.

James Brenn

Probably 700,000 units in total or 0.5 million in the U.S.

John Shiely

Half a million in the U.S., and 200,000 overseas.

Peter Jacobs - Wells Fargo

And then in the share in the engine segment in the U.S. that you are referring to, the Tecumseh Engine Plant?

James Brenn

Yes.

Peter Jacobs - Wells Fargo

Shutdown. Okay. Secondly, bringing in the high-end of your earnings guidance range, $1.38 to $1.31, it is not that much in the whole scheme of things, but if you had to kind of isolate that would you attribute how much of that to your lower expectations for generator sales?

John Shiely

I think most of it would be attributed to that. As we went into the year, we wanted to be careful not to have insignificant projections of farm related generators in there, and we had hoped that even with a significant threat of storms, and maybe some ice storms that we would get significant activity, not great but good, and we had put in for a little high end on that. We are just not optimistic at all about the generator business. Now, that can all change if something forms in the Atlantic and hits in early November. The season is not over yet, but it is almost.

Peter Jacobs - Wells Fargo

Anecdotally, can you comment a little bit more on what you are seeing at the end-retailers' side of things, at The Home Depots, the Lowe's and some of the bigger sellers of the equipment?

James Brenn

Well, I will just go from an inventory point of view. I think that what we are seeing is that they are being very conscious about their working capital spends. And in fact, I think in the script, when we kind of talked about what our concerns are for next year, it is not just the consumer but it is the retailer who is the gatekeeper, and depending on how they come out of the blocks next year and they do not have a lot of inventory today, we think that they sold reasonably well through the summer, because it caused some of that reordering that went on and because they had low inventories.

But there is a concern whether or not they believe that the consumer will be there, and whether they go as actively at the category as they should.

Peter Jacobs - Wells Fargo

So, if I make this characterization and not to put words in your mouth, that at least the inventory draw-down that has occurred over the past, let us say, 12 months that those retailers has played out, and now, it is just a matter of where the demand is going to be. But the impact from at least the inventory draw-down on their side of things has stabilized?

John Shiely

Yes, they are all spooked. They are all concerned. I mean, we had three down years in a row. If you read my shareholders letter, it is really unprecedented in this industry. And as we look at the econometric models that we had developed over the last couple of decades, the highest percentage of demand is explained by a seven-year replacement cycle. And so, there is a huge amount of deferred maintenance out there in the lawn and garden business. And at some point, that is going to break loose but until it does, you are going to see the retailers managing their inventories very tightly and being pessimistic.

Peter Jacobs - Wells Fargo

Yes, and just two real quick ones. First of all, on the pension expense that was asked earlier. I thought I heard that you went from a $2.1 million expense to now a $2.6 million income? Did I get that right or is that expense the end expense?

James Brenn

No, that is correct. In the expenses, we would have recognized for the defined benefit plans. Our original model at the start of the year had a $2.1 million expense, and now this year and when it wraps up we will literally have reported a $2.6 million pre-tax income number.

Peter Jacobs - Wells Fargo

Okay. So we basically have a $4 million or $4.5 million positive swing?

James Brenn

Yes, pre-tax swing.

Peter Jacobs - Wells Fargo

Okay, which was not included previously?

James Brenn

That is correct.

Peter Jacobs - Wells Fargo

Okay. And this will be my final question here, the revolving-credit facility. Jim, you and I have talked in the past about how you have the rolling income kind of bucket that your lenders would look at in terms of then the company’s ability to pay the dividend and/or repurchase stock. Has anything changed in that with this new credit facility? Could you just kind of talk about some of the constraints perhaps on share repurchases and dividends, perhaps with any kind of covenants involved in this debt?

James Brenn

The dividend issue has gone away. In the revision of this when we did it basically we wanted the ability to not have the dividends be part of that basket. So, I would tell you that some of the prior concerns about the dividends and share repurchases being in the same basket is no longer there.

Peter Jacobs - Wells Fargo

Okay. Share repurchase is, but now the dividend, if you under earn the dividend or something like that, you can make a strategic decision perhaps to maintain that and do not have the constraints from the loans?

James Brenn

That is correct.

Peter Jacobs - Wells Fargo

Okay, great. Thanks. And that is all I have.

Operator

Thank you. Our next question comes from Mike Hamilton from RBC Dain.

Mike Hamilton - RBC Dain

John, could we start with the econometric model you alluded to a little bit ago? On the one hand, we can look at it and argue that we have got pent-up demand building. And on the other, we can argue that in the unprecedented boom of the prior six or seven years, perhaps demand was inflated a little bit by people, as they were taking down mortgages and revised doing more purchasing that would have been the norm. How anecdotally do you look at it in terms of what you are seeing? Do you see anything out there that really gives confidence that there is a building pent-up demand?

John Shiely

Well, historically our model would have said that 10% to 15% of demand was explained by new housing starts lagged by a year. This is still though fundamentally a replacement market and the activity that the household activity has seemed to have crept in and may now represent a higher percentage of the model than may have been true in the past.

I suspect that the downturn in consumer confidence that most companies in the kind of business that we are in and are seeing are more related to the increase in energy costs, food costs, and housing costs in the form of increased monthly payments, and I think that is squeezing the discretionary income for the kind of things that we sell. And that said, if we do get the right kind of weather, if we do get at least some restoration of consumer confidence, you can expect to see a sharp comeback.

Many years ago we did a regression analysis in the United Kingdom where we related our sales first to leading economic indicators and then to weather, to rainfall. We use the United Kingdom because it is basically homogeneous. In the United States you can have a drought in the Southeast and floods in Texas, but we found the higher correlation with rainfall and we actually did leading economic indicators.

Now, having said all of that, we are all scratching our heads, all of the people involved in our industry association are scratching their heads. I do not think there is a real good answer to this. There is some things going on out there that are inconsistent with traditional models. I do not think that represents a fundamental change, but it certainly does represent a near-term challenge for this industry.

Mike Hamilton - RBC Dain

Sure. Next when I realized you may have nothing to say, but wondering if you look out over the next two years, if you have got any thoughts on where we are going environmentally and how that is playing out in your thinking in terms of what you are trying to prepare for.

John Shiely

Well, I think the environmental implications of our business is a given. I believe that there will be more pressure on green issues. We have accomplished very significant reductions of emissions in the last decade-and-a-half, 70% in the first decade of emissions controls. I think that you will find that as we work through the issues of global warming, the best information we get from experts in our field are that the act of maintaining and cutting turf has a very net positive.

In fact, by a factor of several, has a very positive impact on carbon dioxide. In other words, a well-maintained lawn generates much more carbon dioxide than the engine generates in maintaining that lawn. I think you are going to see messages like that out there. I think a lot of issues relative to warming are due to the fact that with a lot of development there is been a loss of green space.

And what our industry can contribute to restoring very strong vital turf makes a huge contribution to the whole issue of climate improvement.

Be that as it may, there are other reasons to choose a green path, none the least of which is to reduce the cost to get your operating cost down for your products, particularly for the commercial cutters. That is going to be a big challenge.

We are well prepared to deal with the current range of regulations that are out there. You probably followed that for the last couple of years. We reached a meeting of the minds on that. We are prepared to deal with that and we are prepared to deal with it in a way that we do not believe will have a material impact on our business. But I think people will rediscover our industry as a green industry and find that we really do have a lot to offer.

Mike Hamilton - RBC Dain

Thanks. Could you comment at all on the progress you are seeing in the European plant?

John Shiely

Yes. I was over there about three weeks ago; the plant looks great. It is coming along beautifully. They are doing a marvelous job of making product. It is the fastest plant we have ever brought up; it is a marvelous workforce. The Czech Republic is a great place to do business. We are getting the costs under control; it really has become a competitive advantage for us with what happened with Tecumseh in Europe a couple of years ago, we will really be the only high-volume, major, outdoor-power-equipment-engine producer in Europe. And it is the fact that we have always been that in the United States has always given us a competitive advantage over people, selling from halfway around the world.

We started to see a slip in our market share to the Chinese because both us and the Chinese were shipping engines halfway around the world to get them to Europe. We now have the same geographic advantage we have in the United States we now have in the Czech Republic and that plant came online, on time, on budget, and they are just really producing great engines. In fact, many of our customers would just as prefer to have those engines out of the Czech Republic and ship them from the United States.

Mike Hamilton - RBC Capital Markets

Great. Thanks. A couple detail questions for Jim. When you look at the $6 million pre-tax impact on transition, where did that show up?

James Brenn

It shows up in the cost of sales.

Mike Hamilton - RBC Capital Markets

Okay. Thanks. And the tax rate outlook currently on the year?

James Brenn

We are staying with that 30 to 32 range. So use the average, use 31.

Mike Hamilton - RBC Capital Markets

Thanks for all of the help. That is it for me.

Operator

Thank you. Our next question comes from Seaver Wang from Utendahl Capital.

Seaver Wang - Utendahl Capital Partners

Just a quick question on pressure washers, there was not much detail as the last quarter. Last quarter was a pretty good up take in that particular quarter, just wondering where it is trending and what is going on in that specific product line?

James Brenn

On a year-over-year basis, I would tell you that the shipment unit volume is up almost 120% for us. The strength we saw in the fourth quarter of last year continued on through the summer with the retailers that we serve and they continue to promote it and move it. So it was much stronger than it was a year ago at this time.

John Shiely

Which is an interesting thing, you would think that in the outdoor-power-equipment category, there is probably no more discretionary a product as a pressure washer, but there have been things that weather events that tend to favor a thing like pressure washers. If it is dry, if it is dusty, if there is floods and such, I think it establishes the fact that if there is not a fundamental weather environment that is working against us, that we can show improvement over the prior year. And, I think that is well demonstrated in with the recent surge in pressure washer demand.

Seaver Wang - Utendahl Capital Partners

Can you give a quick ratio of kind of garden products or, I guess, lawnmowers, pressure washers and then generators for the Power Products segment? Is it close to one-third for all three?

James Brenn

You know, that is not too bad, Seaver. At one time, I would have told you that it was closer to a third, a third and a third. I think what the weakness that we have seen in the generator part of the business, it has probably overshadowed it now. It is probably 15% to 20% generators and then split reasonably equally between the other two. It depends on the season, or it depends on the year that we are having in various categories.

Seaver Wang - Utendahl Capital Partners

Okay. Thank you.

Operator

Thank you. Our next question comes from Craig Kennison from Robert W. Baird.

Craig Kennison - Robert W. Baird

Good morning, guys. First question just, Jim, with respect to guidance. Are those in GAAP numbers?

James Brenn

Yes.

Craig Kennison - Robert W. Baird

Okay. And then as it relates to the roll of facility, expenses were higher than we had modeled for the quarter. Could you explain maybe the timing and magnitude of future expenses? I think in the past, you thought it would take about eight quarters, but you have taken, I think, $4 million of the $6 million in this quarter. Should we expect approximately $2 million for the remainder of the seven quarters?

James Brenn

Actually, the plant will be completely shutdown by December. And so, what your model ought to contain is the rest of the expenses will be incurred in the second quarter. When we talk about $6 million, there is $4 million related to the plant.

I do not remember the earlier discussions, but we would have come back and told you that we thought we had about $8 million of expenses, and that the benefit in the year would be about $10 to $12 million.

So we are expecting the full year to benefit by $3 million to $4 million. So I think that the $4 you saw in the first quarter literally will be replicated in the second quarter, but then we should be ahead of the game from that point on. The plant will be shut down on December 31.

Craig Kennison - Robert W. Baird

Okay. So $4 million of expense in the second quarter and nothing thereafter?

James Brenn

Correct.

Craig Kennison - Robert W. Baird

Okay. And then as it relates to the placements at the four major retailers, how many of those four major retailers have committed, and how many are left?

James Brenn

There is really only one that is closed, and the other three are still open.

Craig Kennison - Robert W. Baird

But you would expect those negotiations to finalize this quarter?

James Brenn

Yes. They do. I think two of the major players should be at the very end of October, maybe slightly into November. And then, the largest one will be probably at the end of November.

Craig Kennison - Robert W. Baird

Okay. And then finally, you talked about your generator business, but as it relates to these standby generator business which was a growth opportunity that you have identified through the partnership with Ream, could you just give us an update on that project?

James Brenn

I think what we were looking for was to significantly or probably we were looking for at least a 50% increase in this year. And I think that, at least right now, that is still in our targets for that. We have signed Ream. That program has been launched.

There is a second HVAC person out there that is going to also use us and we will brand a product for them, but that one is probably in the fourth quarter of '08 or even in the first quarter of ‘09. So the project still remains on track. We still think that we have got the benefit of being in those HVAC channels, which some of our competitors do not.

Craig Kennison - Robert W. Baird

Okay. Thank you.

Operator

Our next question comes from Simeon Wallis from Evercore Asset Management.

Simeon Wallis - Evercore Asset Management

I was wondering if you could comment on the business that you won after Tecumseh. You mentioned that it did contribute in the quarter. Did it contribute to the levels that you expected it to when you gave your forecast?

James Brenn

Yes. It did. I think in the end, what you will find is that the benefit of that business is lawn-and-garden-related. And so therefore, what you will find is that when the OEM gears up to produce that product for retail in the spring that actually starts in late November, December, and then very strongly in January, February, March.

And so, as with this year have kind of changed our mode of operation to call it chase demand, rather than to pre-build everything because we think we have more than enough capacity to handle where the demand is this year. It really just moves everything to the back-end of the year, again, because it is lawn-and-garden oriented.

Simeon Wallis - Evercore Asset Management

So it should follow the traditional path of your existing business is what you are saying.

James Brenn

That is correct.

Simeon Wallis - Evercore Asset Management

And is there any potential effect from that business on mix? You have cited negative mix in the engines business for the last several quarters. Does this change that at all?

James Brenn

It probably for the full year somewhat continues that because the product that we gained from Tecumseh was small, it was smaller engines, five or six horsepower-type engines to go on walk equipment. So by definition, the volume increase that we have experienced or projected that we are going to have coming from 10.4 million units to 11.1 million units this year is really being driven by smaller engines. So on an overall basis, we were going to skew ourselves even a little bit more greatly to a smaller engine.

John Shiely

Some of our highest margin engines and highest aggregate gross margin engines because of the selling prices are in generators and riding equipment. And those are the ones that have been hurt most significantly by the recent downturn.

Simeon Wallis - Evercore Asset Management

Then my second real question has to do with has business been affected at all by the drought in the Southeast?

James Brenn

Big time.

Simeon Wallis - Evercore Asset Management

What has been there, I guess, to compensate for that?

John Shiely

Well, we had a bit of a comeback in pressure washers. We had a fairly brisk comeback at the end of the season in the North, particularly with the professional equipment, the simplicity equipment, the ferrous equipment and the bottom line is, we have just picked up more business.

We have found ways to compensate for that, but we really do need, I do not know if you saw the report on the lake outside of Atlanta, but the things are getting very tough for them in terms of their water reservoir, I think its Lake Lanier. And so, the storms would be doubly helpful to us, and to the extent that the demand is not there, we just hunker down on the cost side and do our best to deliver the maximum return available to what the environment offers us.

Simeon Wallis - Evercore Asset Management

I guess, going with that scenario, if things continue to remain challenging in the Southeast, where are there opportunities to take out further costs?

John Shiely

Everywhere. I mean, the problem with managing the cost issue is we are rather integrated operations. Our more recent plants are less integrated, so we suffer less from the fixed cost and absorption relative to, let us say, the China plant and the plant in Ostrava.

But we do need reasonable volumes to achieve a lot of price increases or cost improvements but selling G&A is where you have got to get it done. You have got to say, “We are just going to tighten things up. We are not going to spend on this, and we are not going to spend on that.”

James Brenn

Another way of looking at it is that the drought or the really dry conditions as you are talking about have somewhat affected more so the lawn-and-garden part of the market, and we have launched from a relatively, the 10.4 million units that we shipped last year, which included, the soft lawn-and-garden market that was affected by the drier weather is really only moving to 11.1 because we have added market share basically because Tecumseh as a competitor has left the engine business.

So, we actually, from an engine perspective for lawn-and-garden equipment in the drought, we are looking to have a kind of the same year as we had last year.

The other storm environment that really impact us pretty significantly is the lack of the landed hurricanes. And in that particular part of the business, the plants that make generators and pressure washers, those plants have been taken down from employee levels that were 1100 to 1200 people down, they are now down to less than 500.

We started to cut deeply into the permanent employees, and so from that aspect that is the part of the business that we will continue to try to look for ways to do even more in to control those costs.

The engine part of the business as it relates to lawn and garden, we, at least in this point of time, we believe is relatively stable and can absorb another year like we had last year from a volume perspective.

Simeon Wallis - Evercore Asset Management

Thank you very much.

Operator

Our next question comes from Ned Borland from Next Generation.

Ned Borland - Next Generation

Just a couple of short ones here, I guess, as this lawn-and-garden season builds up, and you have talked about how you saw some share gain in this quarter, when would you expect to see the bulk of potential share gain? I mean, is that a sort of a second quarter event, or is it more even in the third quarter?

James Brenn

Actually, third quarter, Ned. The way we are gearing ourselves up this year in order to keep our inventories in better shape than they have been historically and work with the working capital issue is that we will build extremely heavily January, February, March and April, so in-season, we believe we have the capacity to address everyone's needs. Now, obviously, there is a little bit of ramp up that occurs November-December, but the real bulk of what will go out of here will go out in that third quarter.

John Shiely

There is an interesting ebb and flow in the timing of demand in this industry, and we have experienced it time and time again. When you have a season or a couple of seasons of demand that is down, and retailers seeing that the product is not moving, they begin to push the ordering of that equipment further and further into our fiscal year.

On the other hand, in those years where we have had a shortage of engines, all of a sudden there will be an acceleration of ordering of engines for fear of not getting adequate volume to take care of the market. Obviously, we are in the former condition rather than the latter, and probably as acute as we have ever seen.

Ned Borland - Next Generation

Okay. And, I guess, on the competitive front, I mean, I think it was referenced a couple questions ago, but competition from Chinese OEMs, I think you had talked about in the context of Europe, but, I guess, overall globally, are there anymore Chinese competitors sort of popping up or what is the outlook there for what the total units out of China would be from some competitors over there?

John Shiely

There are a lot of potential competitors in China, but delivering a quality engine on time in a highly seasonal marketplace is a real challenge, and, yes, they continue to aggressively attempt to take share.

We have, as you may have seen in the letter to shareholders, we have a strategy called the Powerful Solution Strategy that we think is well-geared to dealing with that high Chinese competition. So, I think that we expect only marginal gains by the Chinese this year, and the United States, and we expect to get some back in Europe.

Are they going to go away? No.

But in the long run, in the ground zero market, and that is the United States, we have a tremendous geographic advantage, and we have the advantage of very highly efficient factories in the mid-South that can build an engine in less than half an hour of labor.

Ned Borland - Next Generation

Okay. And then just a last question, is there a potential with the exit of Tecumseh, I think they are is still in this business, but to take some share in the snow side of things?

James Brenn

Well, they have always had a very, very strong position in snow, so I would assume at this point in time that that is a viable business and people will continue to use them to the full extent that they have used them in the past, and it is probably more of a question, Ned, if something should happen further than what has happened already, snow season for us is really over, and we will go back into snow engines probably in the May, June, July time frame, so there could be something in the future, but right now, I would assume that they are stable in that business as they have always been.

Ned Borland - Next Generation

That is all I had. Thanks.

Operator

Thank you. Our next question comes from Dave Holmes from Epic Asset Management.

Dave Holmes - Epic Asset Management

I just wanted to see if you could clarify a little bit just going back to the Ream business. You said you were looking for a 50% increase. Can you tell me a little more about how the generator sales are stratifying at all, whether you are seeing better or worse performance in standby versus the portable systems?

James Brenn

I think we see, obviously, we would have called the portable generator business this year flat, and so, consequently, by now, remember we are starting from a relatively small base of standby generators. I think we, last year, shipped about 11,000 so we would be looking for numbers that are up into the 17,000 to 18,000 range this year.

We think that we have tapped into a distribution partner that no one else in the industry has. It is almost topsy-turvy from where we are in the engine business, where we are a very significant market-share person, but in this part of business, we are kind of the new guy in the block, probably in the 10% to 12% market share.

So, we think that there are things we can do with the new product that we have introduced, larger KW output. We think we have some features on there that are interesting to the consumer in terms of being able to monitor their power feeds and come out automatically, et cetera.

So we think that standby is a more elegant solution than portables, and there still is a market, a growing market for people who look at it and say, “I would like that standby power because I have offices in the home, medical equipment, security, whatever. And so, we think that we can push that channel a little bit more, and actually, again get 50% growth, and some of it is market share, probably a lot of it is market share and some will be just that market growing itself.

John Shiely

The standby-generator purchase is not an impulse buy. It is one you have to make before the weather event occurs. And so the ebb and flow of demand for that product seems to be somewhat slower than for standby. If there is a cessation of hurricane activity, the standby would just kind of drop right off the earth.

The standbys hang on a little bit longer, but at the same time, people need to be reminded that they need one. And at least as to the United States, this has been a remarkably quiet hurricane season. And I mean, Mexico got it very badly, but the United States, there has not even been credible threats that would cause people to run out and want to get something like this.

Dave Holmes - Epic Asset Management

All right. Thank you very much.

Operator

Thank you. There are no further questions in the queue. At this time, I would like to turn the program back to you.

James Brenn

Okay. Well, thank you very much for attending today. And we will talk with you again next quarter. Take care.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

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Source: Briggs & Stratton Corporation F1Q08 (Qtr End 09/30/2007) Earnings Call Transcript
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