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Briggs & Stratton Corporation, (NYSE:BGG)

F4Q 08 (Qtr End 03/30/08)Earnings Call Transcript

August 14, 2008 10:00 am ET

Executives

Jim Brenn - SVP & CFO

John Shiely - Chairman, President & CEO

Analysts

Ned Borland - Next Generation Equity Research

Sam Darkatsh - Raymond James & Associates

Peter Jacobs - Ragen MacKenzie

James Bank - Sidoti & Company

Mark Bacurin - Robert W. Baird & Company

Mike Hamilton - RBC Capital Markets

Gil Nathan - Restoration Capital

Joe Philips - Kelmer Dilo

Hannah Ruel - Investors Group

Justin Harrison - Ramsey Assets

Jack Brenton - - Private Investor

Haki Jarja - Royal Capital

Operator

Good day, ladies and gentlemen, and welcome to the Briggs & Stratton Fourth 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 be given 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 conference, Mr. James Brenn, Chief Financial Officer. Sir, you may begin.

James Brenn

Thank you, Jon. Good morning, everyone. I am Jim Brenn, Chief Financial Officer, and joining me today is John Shiely, our Chairman and Chief Executive Officer. Today's presentation and our answers to your questions will include forward-looking statements. The statements are based on our current assessment of the markets we operate in, and actual results could differ materially from any stated or implied projections due to changes in one or more of the factors as described in our filings with the SEC. The conference call will be made available on our website approximately two hours after the end of the call and a phone replay will also be available a few hours within the completion of the call. Now I am going to turn it over to John to talk about fourth quarter results and our outlook for fiscal 2009.

John Shiely

Thanks for joining us this morning. As you saw in this morning's press release, we reported fourth quarter consolidated net sales of $581 million, an amount lower than net sales in the fourth quarter of last year by $96 million. Engine segment sales for the fourth quarter were $390 million, less than last year by $73 million, and that accounts for the majority of the consolidated decrease that occurred between years. Our concern going into the fourth quarter was whether or not there would be a good retail demand, and as it turned out demand was weak. While unit shipments were down approximately 25%, dollar sales declined only 16% as revenues benefited from the effect of a stronger Euro and the mix of the shipment slightly favored certain large displacements that are typically used in commercial applications.

Our power products segment sales for the fourth quarter were $246 million, $37 million less than last year, and the decrease is primarily volume driven. The sales reduction from last year occurred in the pressure washer generator and premium lawn equipment product lines. We see the pressure washer and premium lawn equipment products decline as a result of weak consumer demand. The portable generator market continues to be soft due to a lack of significant weather events to create retail demand.

On a positive note, retail inventories of generators appear to be back to reasonable levels. Shipments of lawn equipment to major retailers were up from the prior year, the result of obtaining new placement for the product for fiscal 2008. As I mentioned before, although the new product placement is only a small portion of our overall volume, it is an important addition to our overall product offering.

Fourth quarter consolidated operating income was $14 million, approximately $9 million less than the fourth quarter of last year. The fourth quarters in both fiscal years had transactions in them which were described in the press release that when their favorable impact is removed, consolidated operating income decreased closer to $17 million.

Engine segment's $19 million operating income for the fourth quarter, after giving consideration to the snow engine recall impact, was $11 million less than last year. The decreased shipment volume that I mentioned earlier was a major element of the decrease between years. We believe that although the major power equipment markets declined versus last year, we have maintained a strong position in the key markets. Higher employee benefits and greater fourth quarter advertising expenses were responsible for the increase in our engineering, selling and administrative expenses, which was the other major component of the lower operating earnings. Offsetting the two factors that decreased operating earnings was an improvement in earnings provided by initiatives to lower targeted manufacturing costs and the closing of an engine manufacturing plant that has given us lower costs and better utilization of other manufacturing operations.

Power products segment, $4 million loss from operations after giving consideration to the asset impairment charge in fiscal 2007 and the gain from a change in employee benefits in fiscal 2008 reflects $25 million lower income from operations between years. Closer to half of the $25 million decline between years, was a result of lower production in almost all facilities that caused costs to be spread over fewer units and the higher costs for raw materials and components used in the production process. Another contributing factor was lower efficiency and increased expenses related to new operations in two plants that produce lawn and garden equipment. Finally, lower sales volume and higher expenses for employee benefits and marketing also contributed to the decline.

Volume driven margin improvement will come with an increase in consumer activity that overcomes recent declines in the key power equipment markets. We are addressing the increased commodity and raw materials costs through pricing initiatives that are being implemented, and we expect the new operations to perform significantly better in fiscal 2009.

Now, that concludes what we wanted to say about the fourth quarter results, so I will finish up with some comments on our projections for fiscal 2009. Our revenue increase projection is based upon achieving a price increase for all our products that should average in the 5% to 6% range. We have either implemented price increases or are in discussions to do so, as I speak. We believe that ourselves and the other manufacturers in this industry cannot cost reduce enough to offset the significant increase that have been added to our cost base through the run up in commodity pricing. There is some modest volume increases built into our 2009 outlook.

Saying that, it is important to understand that we did not build an increased demand for portable generators related to hurricane activity. Our US mower market forecast currently assumes a flat to slightly down year for next season. A positive factor for next year's environment is that the channel inventories appear to have been kept to a minimum in the season that's just ending. We also expect to see some slight increases in international demand year-over-year.

As this morning's press release indicates, the last two years have had a variety of moving parts, many of which were initiated to improve our operating leverage not only in the near term but for the longer term when the markets we serve reverse their recent decline. Consequently, margins are projected to improve over fiscal 2008, primarily because we believe there will be additional benefits from our plant rationalizations and the new operations should improve their efficiencies significantly in fiscal 2009. In addition, we continue to focus on cost savings initiatives in all operations to offset cost increases in areas other than commodity costs. As I have indicated, our goal is to offset our commodity cost increases through price increases.

I will wrap up by noting that yesterday we announced our quarterly dividend. Although our financial performance has not been what we would like it to be, given the current economic environment in which we're operating, the board decided to maintain the quarterly dividend. Maintaining the dividend at its current level is one of our financial goals for fiscal 2009, so our earning plan reflects expense reductions and lower capital spending in an effort to conserve cash, which we anticipate will allow us to maintain our dividend at its current level. Of course, our actual financial performance will dictate the amount of dividends we will be able to pay in the future.

Now I would like to open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Ned Borland of Next Generation.

Ned Borland - Next Generation Equity Research

Good morning, guys. Just want to talk about market share for a minute here. Last year you had a competitor exit the market, and I was just wondering where your market share stands and what kind of Chinese presence is there in the market right now?

John Shiely

Our market share is up in a relative sense, and it is well above our traditional market share. The threat from the Chinese remains. However, I would say that the headwinds -- cost headwinds faced by the Chinese are considerably more significant than they have been in past years. The foreign currency situation, the Chinese banking situation, which is making more aggressive demands for interest and principle payments, the reduction at least in the our types of categories of export credits and other support for Chinese domestic players, commodity costs -- by our assessment tend to hit the Chinese producers harder than they do the domestic ones, because of the presence or lack of presence of secondary markets for those kinds of commodities. The demands of the Chinese government that our competitors pay their taxes -- there is a lot of things that are causing Chinese to have to go out and enforce very significant price increases. So we still recognize and understand that Chinese remains a significant threat, but our market share is holding up very strongly.

Ned Borland - Next Generation Equity Research

Are you anticipating picking up any share going into the negotiations for next lawn and garden season?

John Shiely

You never know until it is over, but we might pick up just a little bit.

Jim Brenn

I think we'll be up modestly, Ned, probably primarily in Europe.

Ned Borland - Next Generation Equity Research

Okay. So, basically with a flat production kind of reflects some share gain minus sort of market-driven -- the market being off a little bit?

Jim Brenn

Production is for the past year.

John Shiely

Right.

Ned Borland - Next Generation Equity Research

Right. Okay. And do you have a housing assumption baked into your guidance?

Jim Brenn

It is in the econometric model. I think, in effect, the econometric model this year, the market looks like it is going to be down probably in the low teens, and I think that the models that people are talking about for next year show a flat environment, maybe down 1% or 2%. So that and consumer confidence are the elements of what are built into the econometric models we look at.

John Shiely

This is John Shiely. Let me give you a sense of how difficult this market has been in recent years. Through June, our industry association shows front engine lawn tractors down 12%, and walk behind rotary lawnmowers down [13%]. If you accumulate that back to '04, you would find that since then, since '04, rides are down 38% and walks are down 32%; just a remarkable downturn. For last year -- let's talk about the home power. portable generator market, we estimate, was down 25% from '07, and the gas pressure washer market was down 21%, pressure washer being the bigger surprise to us because there was a bit of an uptick last year.

Ned Borland - Next Generation Equity Research

Right. Okay. Thanks.

Operator

Thank you. Our next question comes from Sam Darkatsh of Raymond James.

Sam Darkatsh - Raymond James & Associates

Good morning, John, good morning, Jim, how are you?

John Shiely

How are you doing Sam?

Sam Darkatsh - Raymond James & Associates

I am okay. I talked about -- I have got a few questions here. First off, baked into your '09 expectations, what are your thoughts in terms of the amount of in dollars on savings from restructuring or other productivity measures that you talked about or maybe changes in ad spending? I am just trying to get a sense of outside of fixed costs absorption or unabsorption, what's coming to the table from past actions that you have taken?

Jim Brenn

Well we think that the full closure of Rolla which occurred in the fall of '07 will give us another probably $10 million or so. Port Washington, which is scheduled to close down this October, probably is worth $5 million to us in fiscal '09. We believe somewhere between $10 million to $12 million when it's fully gone in '10. The snow engine issue that we had last year in the second quarter of $20 million should be gone, and in effect we believe that there were about $15 million start-up costs, inefficiencies related to the opening of the Newbern plant that should go away in this year. So with just add list of things that we think will change operationally in those areas, probably about $50 million pre-tax that we are looking at taking care of.

Sam Darkatsh - Raymond James & Associates

Ad spend -- you noted ad spending in this quarter was higher year-on-year. Are you anticipating, John, higher ad spending next year as well or how do you look at your discretionary decisions?

John Shiely

We are going to cut back ad spending.

Sam Darkatsh - Raymond James & Associates

Okay. And then the year-on-year change or expected delta in material costs, Jim, what are your thoughts there? How does that look right now?

Jim Brenn

Today we would tell you there is probably a good $60 million in the engine business, probably $60 million to $65 million. We are probably in the $20 million range in the generator pressure washer product line, and probably I think $15 million to $20 million in the lawn and garden part of the business. So, in total it is probably about a $100 million of commodity cost headwinds.

Sam Darkatsh - Raymond James & Associates

Okay. So if you're looking to raise prices, I know this is easy math, but if you are looking to raise prices up 5% that pretty much offsets your material costs. And then so if you have flat unit volume, then the $50 million or so in restructuring savings is basically the year-on-year change in pre-tax income, is that how to look at this?

Jim Brenn

That is the way to look at it.

Sam Darkatsh - Raymond James & Associates

Okay. Next couple of questions. John, I guess this is for you. The last few years, the econometric model that you guys have used has proven to be optimistic. Have you made changes either to your forecast process or to the model itself or something along those lines to give you more confidence that the '09 forecast has perhaps some more integrity than prior forecasts have?

John Shiely

Yes. Last month we celebrated our 100th anniversary, and we were at the exchange to ring the closing bell, and I was interviewed by CNBC, and I got the same question. For probably the better part of 2.5 decades, we have developed this econometric model that is based about 80% of the projection on a seven-year replacement cycle, and it was amazing. It was like clockwork. I mean you could look back seven years and see whether it was an up/down year, and the marginal influence was housing starts like by a year, and it was a pretty effective model. As we ran it for the last say, three years, it made no sense at all.

So something fundamentally different is happening to the economics of this market. So, we retain some very talented econometric statisticians, and they began running other variables, and as we suspected, housing, consumer confidence, and other factors play a much more -- in what's called a displacement cycle. We find that if there have not been sales for the last several years, that -- a significant uptick, not that seven years ago something happened. So we re-ran this model, and the regression analysis is right on. And so as we begin to forecast, and look at 2009 -- the issue of housing starts, the issue of consumer confidence, becomes a much greater in our vision for the next year. And that's why, until we see other indications, we are looking more flat than anything. Now, obviously the displacement part indicates that at some point there will be an uptick because there is a big overhang of outdoor power products, but I quit a couple years ago projecting any kind of upside.

Sam Darkatsh - Raymond James & Associates

I guess what I am getting at also, John, and thank you for that. That's very helpful, that detailed explanation is that with housing starts still down sharply, and particularly if you lagged them a year, and consumer confidence down, what, some odd 50%, depending on which survey you use -- the fact that you are forecasting a year, but perhaps the industry is forecasting basically flat '09 industry expectations seems optimistic again. What gives you the comfort or the confidence that it is conservative enough with the tweaks you guys have made?

John Shiely

I think it has gotten to the point where it is so bad that there is -- we have hit a floor in which people just have to go out and get a new lawnmower because they can't hold it together. We had housing down. We had consumer confidence down. I don't know that the projection is anything other than for it to stay down. How it can get that much worse and you can still drive around and see people with lawns that are cut, we think we have hit bottom here.

Sam Darkatsh - Raymond James & Associates

Last question and I will defer to others. Jim, your debt covenants are funded debt-to-EBITDA, and it is adjusted EBITDA, as I understand it. Could you help us with respect to what adjustments are made to your GAAP EBITDA, so we can calculate how close or not close you guys are with your existing covenants?

Jim Brenn

The major adjustments that are sitting in there that were in last year's computation would have been the impairment charges we took on for Washington and the Rolla plant. So other than that -- as I look at this, going forward -- well, the other thing that was a little unusual I guess in effecting other income, the MTI transaction was a positive in last year's numbers.

Sam Darkatsh - Raymond James & Associates

That wouldn't have been in EBITDA? Wouldn't EBITDA be above that line?

Jim Brenn

No, I was counting as part of -- you asked for the adjustments. I am giving you the adjustments now. That was an adjustment that was a positive in there. So, as we go forward, those would be the things now that the plants have aged themselves out of that complication. I would tell you the MTI one is still one of the major items. It was a bigger thing than what would have expected to see a year ago.

Sam Darkatsh - Raymond James & Associates

By your math then, your leverage, your funded debt-to-EBITDA because I think your covenant is 3.25 for the next --

Jim Brenn

In the first and fourth quarters?

Sam Darkatsh - Raymond James & Associates

Fourth quarters. So by your -- the way the banks look at that, what does that number look like for your trailing four quarters at present?

Jim Brenn

I think -- I believe it is about $140 million of EBITDA.

Sam Darkatsh - Raymond James & Associates

Okay. Thank you very much. I appreciate it.

Operator

Thank you. Our next question comes from Peter Jacobs of Ragen McKenzie.

Peter Jacobs - Ragen MacKenzie

Hi. Good morning, gentlemen.

John Shiely

Good morning, Peter.

Peter Jacobs - Ragen MacKenzie

First of all, on the balance sheet, is there any long-term debt coming due? I am looking at your current maturities and it looks to be negligible, but is there anything that I might be missing out there?

Jim Brenn

The $275 million basically of the long-term debt is -- are the bonds that are due in 2011, and the other $90 million or so, it is either $90 million to $100 million is borrowings around the revolver that we historically clear our revolver every year. Last year in September -- I am sorry, in October, we redeemed the 2007 bonds that were outstanding, would have liked to have gone into the market for longer-term financing, but the markets are so [inaudible] up that we basically funded it through the revolver. So, because we intend to refinance that, we took the short-term borrowing on the revolver and classified it as long-term at the end of this quarter. So, other than $100 million in there which doesn't need to be replaced but it is under the revolver, I would tell you there is nothing for a couple of years.

Peter Jacobs - Ragen MacKenzie

Next question. I don't know if you gave CapEx guidance earlier on the call. I was a little late getting on.

Jim Brenn

We didn't. CapEx for '09, we believe, is going to be in the $50 million range.

Peter Jacobs - Ragen MacKenzie

$50 million. Okay. So that's what, about $15 million under D&A?

Jim Brenn

$15 million to $20 million under D&A, right.

Peter Jacobs - Ragen MacKenzie

Okay. As far as asset impairment tests, when do you do that? And is it reasonable to assume, just based on the asset impairment test that looks at the current market price of the stock, relative to the full up assets levels that would suggest that most of the goodwill may need to be written down?

Jim Brenn

We do the asset impairment test on an annual basis. This year, in effect, we employed outside entities to help us do it. What the measure that you are talking about is only one measure that implies impairment, and in effect I think to some extent if you can take a look at the industry that you are operating in today and if you take a look at people that we compete with or people that we believe are our peers, you'll find that the equity risk is pretty significantly lower for everybody. So, I guess, the long and short of it is we have done the study -- we are not impaired. We will continue to take a look at it on an annual basis and probably during the interim of this year of '09.

Peter Jacobs - Ragen MacKenzie

And then but more importantly, I guess around that question and it relates to a prior question, is that as far as the debt covenants are concerned, there is no debt-to-cap ratio in there or am I mistaken on that?

Jim Brenn

There is not.

Peter Jacobs - Ragen MacKenzie

There is not. So that then is not, I guess, material then in my view. Two other quick questions. One, Jim, can you give us a sense of how ride and walk US industry sales are trending for this year in terms of absolute numbers, and what your outlook would be then for 2009? I guess you are expecting flat to slightly down, but you have a calendar projection there?

Jim Brenn

Well, the calendar projection that we have experienced in '09 is -- John referred to it. I think walk units are down almost 16%. That's where the market is. We believe it will sort out by the time we get to the end of September.

Peter Jacobs - Ragen MacKenzie

I mean for '08?

Jim Brenn

That's what I am talking about.

Peter Jacobs - Ragen MacKenzie

Okay.

Jim Brenn

I am sorry. I didn't mean to say '09. 16% for walks, 11% for rides is where the --

Peter Jacobs - Ragen MacKenzie

Do you have an aggregate number then, an absolute number of where those two combined would be tracking for this year?

Jim Brenn

I would have to blend it out. I don't have it sitting here in front of me. I had it in the walk and ride.

Peter Jacobs - Ragen MacKenzie

Okay. I might get back with you on that.

John Shiely

Historically, Peter, think of walks as historically been around 6 million units a year in the US, rides maybe of 1.5 million. So, you work off of those you can come to your -- and use those ratios I just gave you, you will probably come to a number.

Peter Jacobs - Ragen MacKenzie

Thanks. Last question, when you think about market share, not only vis-a-vis the other gas-powered engine manufacturers, what is your sense about market share that might be taken by either electrical mowers or push mowers, because we are seeing a lot more both advertising around that plus placement in stores. So how does that factor into your outlook?

John Shiely

There wasn't much of that this year. We don't expect there to be much of that next year. We -- actually I have been around here long enough to remember when we got into the battery-powered electric mower business, and just say it didn't work out very well for us. The weight in energy trade-off is really not very good on those things, and the problem with (inaudible) electric which are very popular in Europe -- in fact they represent 50% of the market in Europe really don't work very well in the United States, because in the US they can't handle heavy wet grass. In Europe, the lawns are much smaller, and they are working with 220 Volts, which gives twice the horsepower as the US version. Push mowers, I don't know. It would be hard to get my kid to push a mower.

Peter Jacobs - Ragen MacKenzie

It would be hard to get me to push one, too. Okay. Well, thank you very much. Those are my questions.

Operator

Thank you. Our next question comes from James Bank of -- excuse me if I pronounce this wrong, Sidoti and Company.

James Bank - Sidoti & Company

No. Thank you. You got that right. John, you quickly mentioned this in your prepared remarks with the generators and the engines for generators OEMs in your balance sheet and channel. Could you just circle back with those unit numbers for me?

Jim Brenn

Can you repeat that, James?

James Bank - Sidoti & Company

John just said they were normal levels. I just wanted to get a handle on how many engines are on your balance sheet for generator OEMs, and also genrack products, but then also what's in the retail channel?

Jim Brenn

Well on the -- an [RF] balance sheet, we probably have about 1.5 million engines sitting here.

John Shiely

He just wants generator engines, though?

Jim Brenn

I will just give him everything.

John Shiely

Okay.

Jim Brenn

On the generator aspect of it we probably carry a supply -- a storm stock supply that would be in the 45,000 to 60,000 unit range, and we believe retail is carrying approximately 80,000 generators in their warehouses and stores right now.

James Bank - Sidoti & Company

Okay. I am so sorry, on your balance sheet you have roughly 45,000 to 60,000 units?

Jim Brenn

Yes.

James Bank - Sidoti & Company

Okay. And if I could just go over the steel and the aluminum. Back in 2006, I believe, you went for 4% increase across the board due to aluminum cost increases. Difficult year in terms of gaining traction on that, but you are fairly confident that you will be able to do it this time around?

Jim Brenn

I think we are confident we can get it done this time. Well, get it because everybody else is in the same boat. If you take at look at our aluminum costs which probably are up 25%, I think our steel is up almost 100%, and we use a lot less steel than the OEMs that we sell engines to. So if you take a look at riding lawnmowers and walk mowers, et cetera, we believe that the OEMs in the industry -- and we can tell from our own OEM business obviously -- it is a lot greater number, and that they have to be out going to the retailers trying to recover that. So, this isn't us just trying to recover at our level. It is the industry trying to recover at retail, and that will probably push the price through.

John Shiely

We still believe because of our volume and our operating -- a very efficient and operating model, as I like to tell people, in Murray, Kentucky we are able to make an engine with a half-hour of labor. We really are, in terms of quality and efficiency -- we are, we believe, the manufacturer of choice. And that being the case, if anybody should be able to get a price increase that is justified by commodity increases, it ought to be us.

James Bank - Sidoti & Company

Okay.

John Shiely

And yes, we did enforce the 4% a couple years ago.

James Bank - Sidoti & Company

And in the quarter -- and I am sorry if you already gave this, could you split, I guess, with the margin erosion in the quarter, could you split it between costs that affected that and then also the start-up costs coming from your new Tennessee plant? I am just trying to get an idea of what that start-up costs was. and then also what --

Jim Brenn

From the quarter I guess I would say that the Newbern plant probably was about a $3 million to $4 million headwinds in the fourth quarter.

James Bank - Sidoti & Company

Okay. So that costs roughly the balance?

Jim Brenn

Yes. I think in the end it is costs. There is a little bit of productivity in a couple of the other plants in effect because while Newbern was the new plant, we changed the footprint in our McDonough, Georgia plant. So, there has been a little inefficiency, but pretty much down volume in the majority of that.

James Bank - Sidoti & Company

Okay. And wrap it up quickly. Your earnings per share guidance range is the tightest I have ever seen. Is this just stemming from that conversation you had in regard to your econometric cycle or model that you have been using that you feel a little bit more confident on?

Jim Brenn

I don't think so. I think we just tightened the range because we felt that was a valid range given all the pieces we saw in there. No magic to why we tightened it up.

James Bank - Sidoti & Company

Because the one -- not now but certainly twelve months forward, I guess the problem that I am having as I look at your dividend payment, roughly $44 million expected this year if your share count doesn't change. And the lower end of your net income guidance is below that by roughly $2 million. So, I guess that being said and Sam was alluding to earlier, sometimes the guidance has been a little bit off. I am just curious as to what restructuring, if any, you might have to do twelve months from now should this guidance not work out in your favor?

John Shiely

Well there is a $15 million to $16 million cushion in there, in that we are managing down CapEx with significant gap below depreciation. So, in terms of cash, we think we have got a bit of a cushion in anyway.

James Bank - Sidoti & Company

Okay. And then the $100 million shift from short-term revolver to long-term, that isn't something I saw last year. You were able to pay off roughly $145 million in that short-term debt. And, Jim, I am sorry, you did say why you pushed it down there, but this year, will you be borrowing under revolver for seasonal use or are you going to just -- ?

Jim Brenn

We historically take the revolver from $0 on July 1 up to probably a $250 million to $300 million range and back down to $0 again. I think as we commented, what we also did last year besides having our normal working capital usage of the revolver, we took out the bonds that had come due in 2007, which were about $80 million and then there was a term note for $35 million. We took that out with the revolver, paid off a portion of it this year obviously through cash flow, and we would be working towards continuing to decrease that to get back to the -- it all depends on how the year shapes out, but I would tell you next year there still might be at the end of the year maybe another $40 million to $50 million left on the balance sheet that would represent that revolver being used. And that's if we can't get better financing markets where we're able to go back out and try to place that debt on a longer term basis.

James Bank - Sidoti & Company

Okay. So roughly by the end of fiscal '09 more or less zero short-term borrowing and then about $315 million long-term, or ballpark?

Jim Brenn

Prospectively, maybe $320 million, $315 million to $325 million.

James Bank - Sidoti & Company

Well, thank you very much. That's all I have.

Operator

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

Mark Bacurin - Robert W. Baird & Company

This is actually Mark for Craig. A few questions. Can you talk about the demand picture in Europe? Have things slowed recently?

Jim Brenn

The Europe market was still very strong for us in the season that just ended. So, where its going to go as we take a look forward into '09 for that spring season, it is a season ahead of us now. The one that we just experienced was a relatively strong lawn and garden season in Europe.

Mark Bacurin - Robert W. Baird & Company

And then with the 5% to 6% price increase, what percent of your orders are locked in with that price increase and how much is still being negotiated at this point?

Jim Brenn

I would tell you none is locked in.

Mark Bacurin - Robert W. Baird & Company

Now is the season where a lot of those orders are happening, at what point do you expect to have a better idea of whether those are going to be able to get pushed through or not?

Jim Brenn

At the end of the day, the Lowe's and Home Depot major accounts that the OEMs are trying to negotiate right now probably will not lock up until mid to late October. That's the historic timeframe. The other major retailers out there, close even later. I think Sears has a tendency to close in the late November timeframe. So that's really what you're looking at. We're trying to put prices through to the OEM who are going out and pricing in the marketplace to the retailers, and that is not resolved yet.

Mark Bacurin - Robert W. Baird & Company

And then with the guidance for next year, flat to slightly down, how many units does that assume are produced and shipped on the engine side?

Jim Brenn

On the engine side, you would find that probably up -- we are up 3% in units. We'll probably move from a range of approximately 10 million engines to probably closer to 10.3 million, with a little bit more emphasis on what we believe is going to be in Europe.

Mark Bacurin - Robert W. Baird & Company

And then one final one. You recently celebrated the 100th year, and we touched on this a little bit. How much of your R&D spend is dedicated to developing the next generation of engines, whether it be battery or lower emission technologies? In 10 to 15 years do you see the combustible engine as the still the dominant small engine?

Jim Brenn

That is an interesting question. I think we talked all along, and John can chime in here too, but today electric is not very efficient because of things John mentioned, and battery technology has really been kind of held back there. We watch carefully electric, and we look at alternative fuels and those types of things. We are not trying to create the next solar-powered lawn mower or anything like that at this particular point in time. So, your guess is as good as mine as what the world will look like 10 years from now.

John Shiely

Right now in terms of weight energy tradeoff, the gasoline internal combustion engine, we can’t see a current horizon for that. However, we’re constantly testing other technologies. We have run Briggs & Stratton engines on hydrogen. We have had relationships with the fuel cell companies. The whole issue comes down to -- these are interesting technologies, and they may sometime enter our market.

If they do, the people who are promoting those technologies have a tendency to come to Briggs & Stratton because they believe that if they were to introduce these technologies, that there will be no better entry in the market than through Briggs & Stratton in terms of its ability to manage the product and service the product. So, we get a lot of people coming through here with ideas for different kinds of engines, and different kinds of approaches to power.

We are always and one of the reasons we’ve become an integrated player, we are working very hard at developing products that have a unique features and benefits. And you can expect that we will continue to do that and to bring very interesting innovation. That’s how we stayed in business for 100 years. I mean, if we’ve had to do it to stay in business, we made crystal radio sets. We made refrigerators. We made grenades in World War I, and fighter plane magnetos in World War II, automotive parts.

We’ve always -- and we made the -- some of the early engines that we made have some of the greatest innovations in the history of the industry. We will do what we have to do to stay at the forefront. And the fact that we’re now an integrated player gives us a unique view on how to develop products that truly integrate the engine into the end product. If you’re looking for an area where you’re likely to see the most innovation from us in the next few years, that’s where it will be.

Mark Bacurin - Robert W. Baird & Company

Yeah. And then just a little more on the emissions side. I think the EPA just passed a law and it’s phased through regulations for further reduction in exhaust emissions. Do the Briggs products comply with those standards, and what about the competitive front? Do Chinese engines comply with those sorts of standards and does that affect the competitive environment at this point?

John Shiely

The latest version of the EPA regulations, some of our engines will meet those quite handily. Some will have to be modified or redesigned. We are comfortable that we’ll be able to do that. A lot of people don’t realize that since the early 1990s we have actually reduced the emissions in these engines by 70%. And with the new wave of regulations we’ll probably take 30% or so off of that. So, these engines are much, much cleaner than your father’s engine, if you will. And in many ways that’s the internal combustion engine is not the smoky choky thing that you used to push around 30 years ago.

Mark Bacurin - Robert W. Baird & Company

Okay. Thanks for taking the questions.

John Shiely

Sure.

Operator

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

Mike Hamilton - RBC

Good morning.

John Shiely

Hi.

Mike Hamilton - RBC

John, could you spend a little time on what you are doing strategically in Europe? Obviously you’ve made some great inroads in execution here kind of what you see over the next two or three years?

John Shiely

Yes. Europe is an interesting market. It’s one that we’ve long served and we have long had two-thirds market share better in the engine market in Europe. Our long time competitor used to have engine operations there, and shut those down. And so recently we built the planted in Ostrava in the Czech Republic, very cost effective, very efficient. However, now with the euro/dollar exchange rate where it is, it’s actually cheaper to bring an engine in from Murray, Kentucky.

But the trade off there is the engine we produce in Ostrava can be rapidly delivered in the market, so there is a competitive advantage. It’s an advantage that we never had until we began to actually produce engines in Europe, and in large part it was the response to the Chinese because we in Europe had no competitive advantage from over them like we do in the United States, because we weren’t producing in market.

The problem is in the near term, the Ostrava facility like every other lawn and garden facility in Europe, is having a difficult time competing with imports from the United States. The question then becomes is the dollar/euro going to track towards parity. At parity, in fact, even at $1.20, Ostrava looks good. And you can’t make long-term strategic decisions based on where currency is right now, and we see it coming back. It is a marvelous facility, hard working; very focused people, right in the middle of the developing eastern European market where the growth is, and we are pleased we did it.

Now, we’re going to have to manage the mix between US and European produced product in order to try to deliver the best results we can financially. And you’ll see that as we go forward. But it is an effective hedge, and it is a competitive advantage against those who are not producing engines in market in Europe. And in a market with it basically goes down in three months, producing end market is really where you want to be.

Now, the facility is fed a lot with lower cost components, some from China, some from the United States to get that European production cost down as low as we possibly can. But again when it has to compete against an engine coming out of Murray, Kentucky, with half-hour labor, with the dollar/euro exchange rate over $1.50, it’s a tough gig.

Mike Hamilton - RBC

Thanks. Jim, a couple questions for you. Given what’s going on in the plant rationalization, does working capital at fourth quarter end reflect that now, or is there still some working capital benefit to be achieved?

Jim Brenn

There is still some to be achieved. I think we anticipate closing the port plant down in October, as we pre-built there to make that transition go more smoothly down to Georgia. So, I would tell you that while there was some accomplished this year, there is probably, there is some more to be found there next year.

Mike Hamilton - RBC

Okay. And then finally what’s your current run rate on engineering SG&A expense. It has been fairly volatile here in recent quarters. What would you anticipate a go forward run rate is?

Jim Brenn

I would call it exactly the same level that you just saw in the year just ended.

Mike Hamilton - RBC

Okay. Thanks. That’s it for me.

Jim Brenn

Okay.

Operator

Thank you. Our next question comes from Gil Nathan of Restoration Capital.

Gil Nathan - Restoration Capital

Hey, guys. I have a question for you on your covenants for your bank facility. It looks like you’re supposed to be 3.25 times for the leverage covenant, and you said bank EBITDA was, what, about $140 million or so?

Jim Brenn

I did say that, yes.

Gil Nathan - Restoration Capital

Is the debt level an average set or is it at the end of each quarter? It looks like –

Jim Brenn

It’s the trailing -- no, it’s the debt, the funded debt at the end of the quarter.

Gil Nathan - Restoration Capital

It’s actual debt at the end of the quarter?

Jim Brenn

Actually it’s total funded debt. It’s not net debt, total funded debt at the end of the quarter.

Gil Nathan - Restoration Capital

But it’s not an average of the previous –

Jim Brenn

No.

Gil Nathan - Restoration Capital

Four quarters? Okay. Just from looking at your numbers, the add-back in the second quarter from selling the preferred, do you guys expect to meet your fourth quarter covenant?

Jim Brenn

Well, that’s our second quarter, and –

Gil Nathan - Restoration Capital

I am sorry. Yes.

Jim Brenn

That’s okay. But basically we think that’s a tight quarter. The other thing you’re missing as you look at it is there was $20 million worth of expenses in the second quarter related to a snow engine recall that will not be there. And so that plus whatever we project for earnings and cost reductions, there was also some start-up costs related to the Newbern plant that were occurring in the second quarter. So I guess the honest answer to that is it is going to be a tight computation in Q1 and Q2, but right now we’re anticipating we can make it.

Gil Nathan - Restoration Capital

And you said you assume the inventory level will remain about the same, so you should have the same seasonal working capital draws that you normally have?

Jim Brenn

Well, no, I actually said I think in the prior question we asked whether working capital could still benefit as we go forward into next year and 2008. And we are carrying extra inventory on the balance sheet on June 30th related to a plant closure and a move that we’re going to make. So we will continue to be working on the level of the inventory as we go forward. So I would hope to have it lower during the course of the year next year, certainly by the end of the year it will be -- could be lower. I would have to look at it quarter by quarter.

Gil Nathan - Restoration Capital

Okay. And you said on the dividend you’re obviously, your plan is to keep it intact right now, but you’re going to go with how operations go if the second quarter is very tight, would you maybe lower the dividend to be able to pay down the revolver some to meet that covenant? Or are you going to talk to your banks first?

Jim Brenn

The second quarter is actually, the ship has sailed on that and in fact with the declaration of the dividend done yesterday, that is an October 1st payment. And that will be the last and only dividend payment within that second quarter. The other dividend payments literally fall in the second half of the year, so we’ve already made that decision.

Gil Nathan - Restoration Capital

Okay. I think that’s it, guys. Thanks.

Jim Brenn

Okay.

Operator

Thank you. Our next question comes from Joe Phillips of Kellner Dileo.

Joe Phillips - Kellner Dileo

Good morning. Given how significant price increases are to your plan, do you feel there is any areas of pushback that you may meet, any particular segments or markets that will be more difficult to pass through and have them stick?

John Shiely

It is always the concentrated mass retail segment where you have the most torque if you will on price increases. But it is a situation where everybody knows what the costs are, everybody knows that it is coming. There will be torque, but as I said before, we think that being the efficient producer we are that if anybody can justify the pass-through of components cost increase, it should be us.

Jim Brenn

Maybe another way of looking at also is that we have been out talking these prices since May, June, July. And so, these things are built into the OEM’s model in their decision on how they’re going to go to the retailers, and I don’t think that the price is probably as much of a concern getting it this year. Mix might ultimately be a concern when you get to next spring. So in effect if the consumer is out there and sees the price increases that are going to move through on riding tractors and mowers, except we may actually buy down a little bit next year.

So, we may experience some mix change in the product that we ultimately sell. But right now while nothing is closed as we said earlier, every OEM that we talk to, we both look at the same commodity charts. We both know we’re in that situation. So I think that the price is generally accepted as going through.

Joe Phillips - Kellner Dileo

And do you believe that we’ll experience that degree of acceptance at the consumer level?

Jim Brenn

If you can tell me what the consumer is going to look like next spring; if he is feeling more confident, maybe he does. If he is not, then maybe instead of buying the $1,300 factory goes out and gets the $999. We just don’t know that.

Joe Phillips - Kellner Dileo

Are we at the end of the seven years?

Jim Brenn

Looking for the fat cows.

John Shiely

As I say, there is a point in which at which – there is some anecdotal stuff out there that’s interesting. Because of the housing crisis, there are a number of houses out there that are abandoned, and abandoned houses don’t cut their grass. So we are starting to see municipalities pass ordinances that say that once grass gets to 4 or 5 inches, it has to be cut or it becomes a criminal or quasi-criminal violation not to cut your grass. I think -- forget the replacement cycle. Forget the displacement cycle. I think there does come a point where you just have to cut the grass, and your neighbors are not going to let you get by in not doing it, and the lawn mower is falling apart.

Joe Philips - Kelmer Dilo

I understand. Listen, thanks very much. That was very helpful.

Operator

Thank you. Our next question comes from [Hannah Ruel] of Investors Group.

Hannah Ruel - Investors Group

Hi. I was wondering if you could talk a little bit about where you see industrial generator sales going in the -- how those performed in the past quarter and where you see those going in the coming year?

Jim Brenn

I think we don't -- the primary generators that we provide are consumer generators, and we're probably only up to -- the bulk of them are probably in the 8 to 10 KW range. So we don't really deal in -- are you thinking about the industrial generators that would be much greater and provide backup power for industrial applications?

Hannah Ruel - Investors Group

Yes, for industrial or commercial use.

Jim Brenn

But that is not really where our product sells.

Hannah Ruel - Investors Group

Okay. Then on the consumer side?

Jim Brenn

Okay. On the consumer side, basically we actually -- the demand is driven primarily by hurricanes. There is a base level out there today that probably, oh, we would guess somewhere around 400,000 portable generators are sold a year absent any driving weather event like ice storms, flooding, or primarily hurricanes. And that number has gotten as high in the past as -- it has been up to probably 1.2 million units. So until we get an active storm season, we're now operating on the basis of we have probably about 40% to 50% market share of that 400,000 unit base.

John Shiely

For example, in '05 there was probably about 150 generators sold. In '08 probably 450,000. So that represents a downturn from '07 of 25%. So it is heavily influenced by weather events. We've been here before in '01 and '02. There were no weather events, and it wasn't a very good business, and in '03 Hurricane Isabel and the East Coast blackout hit, and the market went up to 800,000 units. In '04 with Hurricane Charlie to -- and the other three Florida hurricanes -- it went up to about 1.1 million, and then in '05 about 1.2 million, but that's the way the market is.

The thing about when you look at the generator business, in many ways the generator business for us is the means of supporting our engine business. Some of our highest margin engines are the kind of engines that are used on a generator application. So in many ways we cultivate that market in order to support the engine sales. And engine margins are often two or more times what the margins of the end product are. So it is all about supporting a market that -- when it is strong is a really powerful driver of our large displacement engine business. If you hear about a hurricane, that really drives our business. That's bad news for a lot of people, but it is good news for the generator business.

Hannah Ruel - Investors Group

Thank you.

Operator

Thank you. Our next question comes from Justin Harrison of Ramsey Assets.

Justin Harrison - Ramsey Assets

Hello.

John Shiely

Go ahead.

Jim Brenn

Hello.

Justin Harrison - Ramsey Assets

Hello, can you hear me?

John Shiely

Yes. Go ahead.

Justin Harrison - Ramsey Assets

The $13.3 million gain, just curious where that gets reconciled on the income statement here?

Jim Brenn

That's up in the cost of goods sold.

Justin Harrison - Ramsey Assets

Okay. And then is it all in the power products segment?

Jim Brenn

It is.

Justin Harrison - Ramsey Assets

Okay. And then so that had a $13 million gain and then there was a start-up cost also in there, right?

Jim Brenn

That's correct.

Justin Harrison - Ramsey Assets

And that was about $3 million or $4 million?

Jim Brenn

About $3 million to $4 million would have been the cost in the quarter.

Justin Harrison - Ramsey Assets

So net about $9 million.

John Shiely

Over a year.

Jim Brenn

Yes.

Justin Harrison - Ramsey Assets

Got you. $3 million to $4 million was over the year?

Jim Brenn

$3 million to $4 million was in the quarter. Over the year there has probably been about $11 million.

Justin Harrison - Ramsey Assets

Okay. That was it, guys. Thanks.

Operator

Thank you. Our next question -- I'm sorry, sir?

Justin Harrison - Ramsey Assets

Any word –

Jim Brenn

Kevin, are there any more calls?

Operator

Yes sir. Our next question comes from Jack Brenton, an individual investor.

Jack Brenton - Private Investor

Good morning, gentlemen. I have a very simple question from a layman's point of view that I am sure you have looked at, but I have noticed that throughout the country and industry that forklifts are running on propane, either converted or manufactured that way. Would it be viable to use propane –

John Shiely

Update on power equipment?

Jack Brenton - Private Investor

Yes.

John Shiely

We do. Automatic standby generators that are mounted on your house on a platform much the same way your air conditioner is, and those are designed to run on either natural gas or propane. And a lot of people in areas where they don't have access to natural gas, and they have power outages, they'll have a sizable propane tank contiguous to the generator. The beauty of our product is -- now I am doing marketing here.

The beauty of the product is that it kicks in automatically when the power goes out, and I have one in my house, eight seconds after the power goes out, and the electric starter kicks in the V-twin engine and provides several thousand watts of power to your house. Other people in the industry have used propane to operate cleaning equipment. Some lawn and garden equipment is now being run on propane tanks. Our engines will run propane and/or natural gas, but instead of having a carburetor, you have what's called a regulator. And so we -- if there is a significant market for something powered by other than regular gasoline, we would be there and we are there.

Jack Brenton - Private Investor

I would think that would be a real alternative. Like I said, the forklifts in all of our plants and all have either been converted to propane because of emissions, and it seems like it did very well. I was just wondering what the drawback would be to doing that, for riding mowers especially.

John Shiely

It is a cost issue. If you at least listen to T. Boone Pickens we'll all be running our cars on natural gas, and we can run our engines on it. Our engines will run on Jack Daniels if you can't find anything else.

Jack Brenton - Private Investor

Okay. Thank you. I appreciate it.

Operator

Thank you. Our next question comes from -- excuse me if I pronounce this wrong, [Haki Jarja of Royal Capital].

Haki Jarja - Royal Capital

That's close enough. I had a question on your inventory costing in the quarter. How much was -- how much of your inventory is on LIFO base and how much is on FIFO? And then what was the LIFO charge for the quarter?

Jim Brenn

Our engine inventories have always been on LIFO. We have some of our end products that is on FIFO at this point in time, and I don't have right offhand the LIFO charge. It will be in the annual report. If you call me back a little bit later, I can tell you what we've got drafted in the annual report. I don't have that number right in front of me, to be honest.

Haki Jarja - Royal Capital

Okay. And then in terms of the 5% pricing increase for fiscal '09, when do you think that will start trickling in? Is there a bit of a lag by a quarter?

Jim Brenn

It depends on the product line. The price increases are already effective on July 1 for most of our end product stuff related to lawn and garden. The price increase on things like generators and pressure washers will be implement when we do the line reviews, which is more like October and November. And the engine part of the business depends on our contract with the -- whatever agreement we have with the various OEMs. It starts anywhere from July 1 to probably as late as October 31st. So it is variable.

Haki Jarja - Royal Capital

Okay. I know you've got a lot of questions on this, but I wanted to revisit the covenants a little bit. You said the first and second quarter a little tight, but you felt comfortable that you've already declared the dividend for the first half. Is there -- how secure is the dividend for the second half? And if there is any covenant issue, why wouldn't you just try to get a waiver now beforehand?

Jim Brenn

Well, I would tell you that I guess I answered the question that we believe it is tight. You can be assured we've already had conversations with our banks in terms of if we think we're not going to get there because of something that occurs from an operational perspective, from an earnings perspective, or a cash flow perspective, we have talked about whether or not we would go forward. But we have prepared to do that, but we have not triggered that event.

Haki Jarja - Royal Capital

Okay. Thank you.

Operator

Thank you. Our final question comes from Sam Darkatsh of Raymond James.

Sam Darkatsh - Raymond James

I know it has been a long call, so I will be brief with this. Hopefully just a couple follow-ups. A couple years ago, John, your OEMs even though they accepted the price increases, they then went back to their retailer customers and tried to get them and ultimately succeeded in getting lower horsepower engines put on the same SKUs in a prior year. What gives you confidence that that sort of mix shift downward wouldn't occur again but would thereby mitigate some of your price increase efforts?

John Shiely

Jim just talked about that. That can happen. The issue is you get to the point where if you take too much power out, you significantly reduce performance. And so, yes, there can be a trade-down in mix, but some of that’s occurred already.

Sam Darkatsh - Raymond James

So you're assuming in your expectations for next year that any activity to that end would be modest or mild?

John Shiely

I think so.

Sam Darkatsh - Raymond James

Okay. And last question. What was -- you mentioned the US market both this year and next year's expectations. What was the European market, Jim, lawn and garden market this year and your expectations for it next year?

Jim Brenn

I would tell you that Europe probably was in the range of about 2.2 million units for this year. We would look for maybe about 2.3 million next year.

Sam Darkatsh - Raymond James

What was that last year, so I get the idea of the growth?

Jim Brenn

About 2.2 million.

Sam Darkatsh - Raymond James

Last year and this year was both 2.2 million?

Jim Brenn

You got me. When you say last year and this year, 2008 was 2.2 million. Going into fiscal '09 we're anticipating around 2.3 million.

Sam Darkatsh - Raymond James

The prior year to this year, the '07 year, what was the European market?

Jim Brenn

Back in 2003, probably around 2 million.

Sam Darkatsh - Raymond James

Okay. Thank you very much.

Operator

Thank you. I am showing no further questions, sir.

John Shiely

Okay. With that, then, we'll thank everyone for participating. We'll see you again in October. Take care.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Thank you and have a nice day.

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Source: Briggs & Stratton Corporation F4Q 08 (Qtr End 03/30/08)Earnings Call Transcript
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