Ryan M. Gwillim - Brunswick Corp. Mark D. Schwabero - Brunswick Corp. William L. Metzger - Brunswick Corp..

David S. MacGregor - Longbow Research LLC Scott L. Stember - C.L. King & Associates, Inc. James Hardiman - Wedbush Securities, Inc. Craig R. Kennison - Robert W. Baird & Co., Inc. Michael A. Swartz - SunTrust Robinson Humphrey, Inc. Gerrick L. Johnson - BMO Capital Markets (United States) George Arthur Kelly - Imperial Capital LLC.

Good morning, and welcome to Brunswick Corporation's 2018 Second Quarter Earnings Conference Call. All participants will be in a listen-only mode until the question-and-answer period. Today's meeting will be recorded. If you have any objections, you may disconnect at this time.

I would like to now introduce Ryan Gwillim, Vice President, Investor Relations..

Good morning. Thank you for joining us. On the call this morning are Mark Schwabero, Brunswick's Chairman and & CEO; and Bill Metzger, CFO. Before we begin with our prepared remarks, I would like to remind everyone that, during this call, our comments will include certain forward-looking statements about future results.

Please keep in mind that our actual results could differ materially from these expectations. For the details on the factors to consider, please refer to our recent SEC filings and today's press release. All of these documents are available on our website at brunswick.com.

During our presentation, we'll be referring to certain non-GAAP financial information. Reconciliations of GAAP to non-GAAP financial measures are provided in the appendix to this presentation and the reconciliation sections of the consolidated financial statements accompanying today's results.

As a reminder, as a result of the June announcement regarding Sea Ray, starting in the second quarter of 2018, the results of the entire Sea Ray business are reported in continuing operations for GAAP purposes. However, as adjusted, non-GAAP results exclude the Sea Ray sport yacht and yacht operations that are being wound down.

Therefore, all figures and outlook statements included in this release incorporate these changes unless otherwise noted. For more information, please see the Form 8-K dated July 19, 2018, which includes metrics on a GAAP and as-adjusted basis reflecting these changes. I would now like to turn the call over to Mark..

Thank you, Ryan, and good morning, everyone. During the first half of 2018, we launched or completed a number of substantial strategic and operational enhancements that we believe will strengthen our marine portfolio and continue to increase long-term shareholder value. We will discuss aspects of these actions throughout the call this morning.

We continue to have a favorable outlook on the marine business, which will benefit from unprecedented demand for outboard engines, exciting new products, the successful execution of our strategy to grow the parts and accessories businesses, and a global marine market that remains healthy.

Our product leadership strategy was significantly advanced in the quarter, as Mercury Marine completed its largest launch of outboard engines in the company's history, comprised of 19 total models of V6 and V8 engines from 175 to 200 (sic) [300] (00:03:11) horsepower.

Shipments of these products began in the quarter as expected; however, production will reach full run rates by the middle of the third quarter. There is substantial demand for these products that is far exceeding our expectations.

Consistent with our prior plans, we are planning for significant production increases in the second half of 2018, enabled by recent investments in capacity expansions. However, we expect that the demand will outpace production into 2019 and we are aggressively working on plans to further increase capacity.

In our Fitness segment, we continue to focus on stabilizing our operating performance and executing against our digital initiatives with growing acceptance evidenced by recently announced technology-enhanced partnerships with Retro Fitness, Apple, and Orangetheory Fitness.

Steady market conditions resulted in a slight top-line growth and sequential quarterly gross margin performance is beginning to stabilize, which is consistent with the plan we discussed on the first quarter call.

Turning to the second quarter financial metrics on an as-adjusted basis, revenue increased by 6.3% year-over-year with growth in all three segments. Our combined marine business had revenue growth of 7.7% in the quarter. Operating earnings were down 3%, but up slightly in our combined marine business.

Year-to-date operating earnings for the marine business are up 5% versus the first half of 2017. Diluted earnings per share of $1.50 were up 9% year-over-year, including the impact of a lower effective federal tax rate. And Bill will provide more color on some of these items later in the call. Now, I will provide you on the perspective of the U.S.

marine market. Based upon preliminary SSI data for the second quarter, which, on average, comprises about 45% of the year at retail, when fully reported, the main power Boat segments grew approximately 2%, leading to a year-to-date growth rate of 1%.

Outboard engine growth exceeded these levels, with increases of 8% for the quarter and 3% year-to-date. Saltwater fishing products over 23 feet is again seeing solid growth, with Boston Whaler's new products well-positioned to capitalize on the continued momentum in the segment.

Aluminum, fish, and pontoon segments exhibited steady improvement, although reported growth rates are based on incomplete SSI data, which excludes recent months for several key states. Weaknesses in fiberglass sterndrive categories persisted, as products 40 feet and below continued to transition to outboard propulsion.

Sea Ray sport boat and cruiser products have been leading this transition in premium categories. Finally, as I noted earlier, the SSI industry data is incomplete at this stage in the marine season, as recent months, for several key states, including Florida, Minnesota, and Wisconsin, have not been captured in June results.

In addition, as expected, the initial May results were revised favorably in the updated June results, reflecting comparable reporting dynamics. Similar to past years, we expect that once the reporting catches up in future months that the first half industry results will be upwardly revised.

Next, I would like to share some perspective on our retail data for boats based upon our pipeline inventory activity. Our internal U.S. retail boat registrations for the second quarter were up 1% and are up 2% year-to-date. Global retail unit sales increased 3% over the second quarter of 2017 and are also up 2% for the first half of 2018.

Similar to the first quarter, these unit results were influenced by Bass Pro's acquisition of Cabela's, which was a meaningful channel for our low boat brand. If you exclude the impact of low from these results, the year-to-date growth would be 5% in the U.S. and 4% globally.

We have been actively rebuilding and strengthening our dealer network for the low product and look for improving trends in the upcoming periods. Next, I would like to review with you our current perspective on regional marine markets.

On a constant currency basis, and excluding acquisitions, marine revenue for the first half of the year was flat in Europe, against a very strong 10% increase in 2017, reflecting the poor weather conditions in many areas, resulting in a much shorter retail selling season.

We now anticipate flat sales in Europe for the full year, which also includes a small impact of the retaliatory tariffs on boats that are imported from the U.S. that I will discuss in more detail during my outlook comments toward the end of the call. As a reminder, a large majority of our boats sold in Europe are manufactured in Europe.

In Canada, our retail and wholesale demand improved versus the prior year, reflecting a strong market environment. Our 2018 outlook assumes that the demand environment in Canada will be up for the year, but expect that second half wholesale boat demand will slow substantially as dealers reduce restocking orders of boats imported from the U.S.

due to the tariffs. Currently, a little more than half of the boats we sell in Canada are imported from the U.S. with the remainder sold by our Québec-based Princecraft brand, which is well-positioned to serve this market.

On balance, the remaining international markets continue to post revenue, consistent with a very strong first half of 2017, as we continue to benefit from engine share gains in commercial markets.

In summary, we expect the full-year 2018 global unit market growth to be at or slightly below the lower end of our 3% to 5% initial guidance range with domestic performance still within that range.

Our revenue growth will continue to outperform as the result of the increased average sales prices, market share gains, and the favorable changes in product mix, each positively affected by continued new product launches throughout the year.

Moving on to our Fitness segment, the revenue increased by 2% in the first half of 2018 with 1% growth on a constant currency basis. Fitness segment sales in the U.S. were down 2% in the first six months, primarily the result of lower Cybex cardio sales in advance of new product introductions, which are now available.

As we indicated on the previous call, these new products will start having a positive impact in the second half of the year. European sales experienced strong growth in the quarter with revenue up 8% year-to-date. Asia-Pacific is flat against the very strong high-teens growth rate in the first half of 2017.

Our plan anticipates that both of these trends will normalize for the remainder of 2018, resulting in overall international sales for the year growing slightly from the 2017 levels. And now, I'll turn the call over to Bill for some additional comments on our financial performance..

Thanks, Mark. For the second quarter, adjusted sales in our combined Marine segments increased by 8% while the Fitness segment grew 1%. On a consolidated basis, as-adjusted U.S. sales grew 6%, while international regions increased 7%. On a constant currency basis, international sales grew 4%.

For the year, adjusted sales in our combined marine segments also grew by 8% with 2% growth for the Fitness segment. On a consolidated basis, as-adjusted U.S. sales grew 5%, while international regions increased 9%. On a constant currency basis, international sales grew 5%.

Turning to our Marine Engine segment, sales in the second quarter for both propulsion and P&A grew by 9%. Propulsion performance continues to be led by double-digit sales gains in outboard engines, where we are gaining market share, especially in higher horsepower products.

Our internal outboard engine registration data is consistent with this strong growth with an 8% increase in registrations in the quarter and a 6% increase year-to-date, which is especially notable given the slow start in the first quarter resulting primarily from unfavorable weather conditions.

P&A sales again demonstrated solid consistent growth in both products and distribution businesses. We look forward to closing our announced acquisition of Power Products next month, which will bolster the already strong financial profile of our global P&A business.

Mercury's operating earnings in the quarter grew by 2% and operating margins were 18.2%. This 120-basis point reduction in operating margin was more than expected due to a number of factors. In addition to higher sales in the quarter, earnings were favorably affected by changes in sales mix and foreign currency exchange rates.

However, the favorable impacts of these two items were smaller than anticipated in the quarter. Operating earnings comparison also reflected unfavorable plant efficiencies associated with production ramp-up for new outboard products and warehouse management systems integration.

Earlier in 2018, we launched new warehouse management systems at our P&A distribution facilities in the U.S. and Europe, which substantially modernizes our capabilities moving forward. However, during the initial start-up phase, we incurred additional unexpected costs to satisfy strong seasonal demand.

Finally, we had planned spending increases for production, product promotion and development in the quarter, which negatively affected margin comparisons. In our Boat segment, second quarter adjusted revenues increased by 4%.

The aluminum freshwater business grew by 7% in the quarter, including strong pontoon sales, which reflected successful efforts to increase production. Aluminum fishing performance also included the impact of Bass Pro's acquisition of Cabela's, which was a large distribution channel for low boats, as Mark discussed earlier.

The recreational fiberglass boat businesses had revenue growth of 4% in the quarter led by Sea Ray. Saltwater fishing revenues included solid gains – gains and growth at Boston Whaler, evidencing the ongoing trend of consumers favoring outboard powered boats, while smaller brands reported in this category posted declines.

Global wholesale shipments for the second quarter decreased 2% and were down 5% in the U.S. Year-to-date, wholesale shipments were down a similar amount against a strong first half of 2017. Changes in average selling prices increased by 6% on a constant currency basis in both the quarter and year-to-date periods.

These increases resulted from changes in mix across the portfolio as customers continue to migrate to boats with more content and higher horsepower engines, which is adding top line benefits. In addition, we have raised prices in response to inflation, particularly in pontoons.

Our 2018 plan anticipates continued growth in average selling prices for the full year, similar to the first half. Dealer pipeline inventories ended the quarter at 30 weeks of boats on hand measured on a trailing 12-month retail basis, consistent with prior-year levels.

We believe that our pipeline inventory levels are appropriate at this point in the marine season. For the full year, we are planning for weeks of inventory on hand to be at approximately one week lower than year-end 2017 levels, primarily related to lower stocking of U.S. imported boats by Canadian dealers due to tariffs.

Consistent with this assumption, we are also assuming retail unit growth rates will outpace wholesale performance.

The Boat segment's adjusted operating earnings for the quarter were slightly below Q2 2017 levels, with inefficiencies at certain of our boat facilities due in part to new boat product introductions being the factor that contributed to this. For the second quarter, adjusted operating margins were 7.7%, which is 50 basis points lower than Q2 of 2017.

Year-to-date, our adjusted operating margins of 7.3% are up slightly. In the second half, we anticipate stronger year-over-year performance with mid-teens leverage targeted for the year. Shifting to our Fitness segment, sales for the second quarter increased by 1%.

Global commercial strength sales continue to grow as demand for these products increased mostly due to our well-positioned product offering and changing exerciser preferences. Sales of commercial cardio decreased slightly in the quarter, resulting from declines in sales of Cybex product.

Sales growth was also negatively influenced in the quarter by shipping challenges at certain domestic warehouses, resulting in sales moving into the third quarter. Adjusted operating margins for the quarter were at 6.5%, which was 270 basis points lower than a year ago.

This reduction was caused by several factors, including higher freight costs, cost inflation and inefficiencies, and an unfavorable impact from changes in sales mix. These factors were partially offset by benefits from higher sales.

The Fitness business continues to address challenges related to the launches of new cardio equipment, which have contributed to higher freight cost and cost inefficiencies and can be partly attributed to initial complexities around the manufacture, shipment, and installation of the new products.

We expect these factors to improve over the second half of 2018. Our GAAP results include the impact of several items, which we've excluded from our as-adjusted results. We recorded restructuring, exit, and integration charges in the quarter totaling $35 million, mostly related to the wind down of the Sea Ray sport yacht and yacht operations.

We also incurred losses of $27 million related to this business in excess of restructuring charges, including accruals for additional sales discounts offered to dealers to assist with pipeline inventories.

Finally, we incurred costs related to the Fitness business including separation costs and a charge related to an additional product field campaign. And Mercury incurred costs related to the announced acquisition of Power Products. Next, I will discuss the impact of foreign currency is having on our performance.

In the second quarter, sales comparisons were positively affected by approximately 1% and operating earnings comparisons were positively affected by approximately $5 million, which was slightly below our plan. Our estimates for the full year are less favorable than our previous expectations.

We are now expecting favorable full-year impacts on sales of less than 1% and on operating earnings of less than $5 million. This implies a negative effect on both sales and operating earnings in the second half of 2018. These estimates for 2018 assume that foreign exchange rates remain consistent with current rates.

Our second quarter book tax rate, as adjusted, was 21%, which is consistent with the year-to-date rate. This includes net tax benefits resulting from share-based compensation activity of $1.5 million in the second quarter and $2.9 million year-to-date. Our tax rate continues to be lower than the previous year due mostly to the impact of tax reform.

Our updated estimated effective book tax rate for the full year, as adjusted, is between 21% and 22%, which is based on tax guidance to date and is also subject to change as additional interpretation of new tax law becomes known.

Our estimated cash tax rate for 2018 is now expected to be in the low-single-digit percent range, reflecting the favorable impact of a tax refund, along with deductions from planned capital expenditures and increased pension contributions. Turning to a review of our cash flow statement.

For the first six months of 2018, cash provided by operating activities was $201 million, which was $29 million greater than last year. This improvement includes the previously mentioned tax refund received in the first quarter and lower working capital usage.

Capital spending was $90 million for the year-to-date period, which includes investments in new products, as well as capacity expansion initiatives, mostly in our marine segments. Free cash flow for the first half of 2018 was $122 million, up $38 million versus 2017.

The cost associated with the Fitness separation and Sea Ray sport yacht and yacht operations and wind down have not been included in free cash flow, as we will be treating those costs consistent with our as-adjusted earnings metrics.

So, I'd like to conclude with comments on certain items that will impact our P&L and cash flow for 2018, focusing on the estimates that have changed since the last quarter.

We have revised our estimates for depreciation and amortization to include the impacts of Sea Ray and Power Products depreciation, as well as refine projections for our other businesses.

We have excluded any impact of purchase accounting-related amortization for Power Products, as we plan to exclude these non-cash expenditures from our ex items reporting.

Estimated net interest expense is now between $40 million and $50 million with the increase almost entirely related to the planned $800 million of financing for the Power Products acquisition as we discussed in detail last month.

Our guidance for free cash flow has been revised to $200 million to $220 million versus the prior guide of exceeding $275 million.

This estimate now includes pension contributions of between $150 million and $160 million for 2018, which is a $75 million to $90 million increase and is consistent with our accelerated de-risking plan and actions announced at the end of last month.

Excluding the after-tax impact of pension contributions, free cash flow would be between $300 million and $320 million. As a reminder, accelerating contributions into 2018 is lowering our after-tax funding costs of exiting the plans by over $20 million.

Moving forward, there is a residual requirement of up to $30 million pre-tax funding to fully exit the plans. Our business units remain focused on generating strong free cash flow, which will allow us to continue to fund future investments in growth and successfully implement our capital strategy.

We plan to have slightly higher levels of capital expenditures than previously anticipated, with capacity expansion activities at Mercury and Boston Whaler driving the increase versus last year. We continue to execute against our share repurchase program in the second quarter with $70 million completed in the first half of the year.

Aside from a small amount of repurchases already completed earlier in the third quarter, we will pause our repurchase program until later in 2019 as we complete the previously discussed financing activities associated with Power Products acquisition and the Fitness separation actions.

I will now turn the call back to Mark to continue our outlook comments..

Thanks, Bill. Our outlook for 2018 remains generally consistent with our recently updated three-year strategic plan targets and reflects another year of outstanding revenue in earnings growth, with excellent cash flow generation.

We expect that our marine businesses top line performance will benefit from a steady global marine market, new products, and the successful execution of our M&A strategy as evidenced by our announced acquisition of Power Products.

In the Fitness segment, we plan to benefit from recently introduced new product, including console and technology enhancements that we believe will stimulate demand.

We now anticipate consolidated revenue growth of 8% to 9% for the full year, including the impact of announced acquisitions, the tariffs, and changes in foreign exchange – foreign currency exchange rates.

For the full year, we continue to anticipate improvement in both gross and operating margins in our combined marine business as we plan for ongoing benefit from the new products and volume leverage.

These factors, along with certain pricing actions should more than offset the impacts related to cost inflation, as well as the enacted tariffs and other known trade policy changes. In the Fitness business, we continue to project a decline in margins.

However, our year-over-year comparisons are expected to stabilize in the fourth quarter, consistent with our discussions on our last earnings call.

As a reminder, these targets, along with EPS guidance and the Q3 targets on the subsequent slides, assume a mid-August close of the Power Products acquisition and exclude the impacts of purchase accounting related to the transaction.

And all comparisons are against the adjusted figures provided in the Form 8-K dated July 19 of this year, which removes the sport yacht and yacht results from prior periods. Bill and I have referenced tariffs in a number of places on this call.

Two different tariffs, which went in to effect in the beginning of July, will negatively impact the second half results in our marine businesses. First, the U.S. has implemented Section 301 Tariffs, which place a 25% tariff on over 1,300 products imported from China.

Mercury manufactures 40 to 60 horsepower engines at our wholly owned facility in China, and the tariffs will apply to those engines, along with a small amount of P&A imported into the U.S. for sale to our domestic OEM partners and our dealer base.

Note that competitive products imported from Japan is not subject to this tariff, even though part of their supply base is sourced from China, making it difficult to raise prices to offset these tariff effects. We will request an exemption from the U.S. Government. But absent a successful exemption, we'll pay the tariffs on these imports.

On the Boat side, Canada and the EU have implemented Section 232 Retaliatory Tariffs on boats not including the engines that are imported from the U.S. into their regions.

Sales of boats manufactured and sold within the region are not subject to the tariffs, meaning less than half of the Canadian sales and a large percentage of the EU sales will not be subject to tariffs. The impacts to the company is most significant for products sold in Canada with a 10% tariff on these imports paid by the importing dealer.

Sales into the EU, where the tariff is 25%, comprises the remaining impact. The result is a negative impact on second half earnings as a result of lower projected demand for boats being imported into these locations.

Overall, we anticipate a $10 million to $15 million negative impact on second half earnings resulting from these tariffs, with the engine tariff accounting for approximately two-thirds of the impact. We are narrowing the range of our full-year expectations of diluted EPS as adjusted to $4.55 to $4.65.

This guidance now incorporates the projected earning benefits from Power Products, as well as the additional interest expense incurred in connection with the financing of this transaction. It also includes the Sea Ray sport boat and cruiser business.

The tariffs implemented thus far in 2018 that I just discussed will affect the 2018 earnings by $0.10 to $0.15. This guidance also takes into account the recent unfavorable changes in foreign exchange rate and other balanced risk and opportunities that we've gone through on this call.

Overall, we still expect 2018 to be another record-breaking EPS performance. Looking at third quarter, we anticipate revenue growth to accelerate and to be in the low- to mid-teen percent range over the third quarter of 2017 and in the low-double-digit percent range if you exclude the benefits from Power Products.

We expect solid operating margin growth for our combined marine business and adjusted EPS to grow approximately 20% each as compared to our Q3 2017 figure. Turning to our segments, our 2018 forecast includes ongoing revenue and operating earnings growth in our Marine Engine segment.

Fortified by the revenue expected from the Power Products acquisition and unprecedented levels of demand for outboard engines, we're increasing our revenue growth target again for the year to the low-teens percent range.

Due to the enacted tariffs, we are lowering our margin expectations, but still anticipate slight improvements for the year with the second half gains benefiting from the Power Products acquisition and our new outboard engines.

Absent both the tariff effects and the impact of Power Products, we would still be experiencing margin accretion for the segment. We also anticipate that start-up costs related to the product and system launches that were discussed on this call will abate in the second half.

In response to the substantial demand for outboard engines, we're going to continue investing to enhance and expand our manufacturing capabilities to capture this future growth while investing in research and development to support the achievement of our growth aspirations.

In summary, 2018 will be another year of outstanding success and financial performance from the Marine Engine segment. Moving to the Boat segment, we're now targeting our annual revenue growth for 2018 to be 5% to 6%, with growth in all categories.

This revised target incorporates our latest outlook on the global retail demand that I discussed earlier, as well as continued growth in the average selling prices, market share gains, and our pipeline assumptions.

We are also anticipating improvement in our operating margins, which Bill addressed earlier, and the low- to mid-teens earnings growth for the full year. We remain confident in the global marine market.

We believe our Boat business will continue to succeed behind the strength of many of the industry's most recognizable brands, our product leadership, and the improved operating performance. Our view of the Fitness segment outlook had not materially changed since our last call.

Our plan projects revenue growth in the low-single digit percent range over 2017 levels with third quarter growth exceeding our fourth quarter performance due to changes in our relationship with Planet Fitness, which I'll address shortly.

We expect our operating margins comparisons to remain under pressure in the third quarter, which was the strongest gross margin quarter last year, while stabilizing in the fourth quarter as we have discussed.

With the recent new cardio product launches, we expect demand from club refresh activity to help grow revenue and earnings as operators look at the improved console options as a benefit to attract and retain members and capitalize on new revenue sources.

The uptake of premium connectible consoles continues to increase, enabling the business to execute on its digital strategy.

We continue to have a strong relationship with Planet Fitness, and despite the decision to offer broader equipment choices to its franchisees starting in the second half of this year, we remain confident that we are well-positioned to be the leading partner to support their goals for growth, technology development, and improved club operator and user experiences.

Our plan assumptions related to Planet Fitness have not materially changed versus our first quarter guidance. Finally, we continue to execute against our plan to accomplish the spin transaction by the end of the first quarter of 2019. In closing, I'd like to reiterate what I've already said when I opened this call.

This has been a truly eventful last six months with more to come as we still have work to do to complete several of our strategic and operational enhancements.

However, we have not lost sight of the need for continued operating excellence and we believe that 2018 will result in another strong – a year of strong revenue and earnings performance, along with excellent cash flow generation.

Our second quarter results include the impact of considerable new product introductions and other initiatives, which have had some unfavorable short-term implications, but are expected to yield significant benefits moving forward.

I want to assure everyone that's listening to this call that we remain highly confident in the success of the momentous engine launch at Mercury and the unparalleled levels of demand for these products that are paving the way for increased sales, market share gains, and strong margin improvements for the foreseeable future.

I'm excited about our business moving forward. I am confident our management team and our 15,000 dedicated Brunswick colleagues are committed to delivering and executing our growth strategy in 2018 and beyond as we continue our efforts to deliver value to our shareholders. And with that, I'll take question – we will all take questions. Thank you..

Thank you. We'll now begin the question answer session. And our first question comes from David MacGregor from Longbow Research..

Yes. Good morning, and thanks for taking my question. A lot of concern here, I guess....

Good morning, David..

Yeah. Good morning. I just – I want to talk around capacity. Clearly, within the outboard engine business, your new products, the V6 in particular, doing extremely well in the market, but you're in backlog and it's creating plant inefficiencies.

I just wonder if you could talk a little bit about how you remedy that situation, how fast you can increase the velocity through those plants and the incremental expense and burden to the second half P&L?.

Well, we've got a number of – obviously, as we're ramping up those – the new product launches, as we've talked before, we've added incremental assembly capacity as part of doing that, and we're actually in the process right now of also adding a partial third shift, which wasn't part of our initial plan.

So, some of this is just a matter, David, of adding more people and resources and ramping up. Some of it is physical capital and capacity in either our facilities or into our supplier – or from our suppliers. But clearly, the things that are within our control and capability, we're ramping up and working on, David..

And David, the only thing I'd point – David, I'd point out, too, that the industry grows above 75 horsepower has been trending in the low teens for the last several years. Our capacity increases that we had planned for the second half outpace that by quite a bit.

So, we didn't go into the second half of the year with what I would call – we went in with fairly aggressive capacity expansions and demand has just outpaced what we expected..

Is there a large incremental cost associated with putting that extra day or putting that extra shift on? Can you fill that incremental capacity?.

No, because....

Sorry. Go ahead..

No, it's not an incremental – it's a start-up expense as you train the workforce..

Right..

But beyond that, the volume and the production pays it..

So, do we see some alleviation on this in the third quarter?.

Yes. Yes. Absolutely..

Okay. Thanks very much..

And our next question comes from Scott Stember from C.L. King..

Good morning..

Good morning..

Can you maybe talk about – you put through some price increases for commodity inflation and freight, I guess.

Can you maybe just talk about how the sensitivity is there as far as the acceptance at the consumer level?.

Yeah. The place we put the most in, which I would comment on, have been in the pontoon segment, which have had some material inflation has hit us the most in that area. And the demand's very strong in that category. Many of the suppliers are sold out, running at capacities.

So, I think on first gulp, people don't like price increase, but it really hasn't affected the demand or the market..

And maybe just talk about the retaliatory impacts in Canada. You talked about – and again, you flushed it out very nicely in the deck about in this back half of the year some dealers might start to cut back on what they're taking in.

Are you concerned that that could accelerate beyond what you already have or what you're already factoring with your guidance or do you think this covers that pretty good, what's in your guidance?.

I think we've covered it fairly well. We had product that was able to get out before the tariff went into effect. And I think we've weighed that in. You'll see that we, as we mentioned, we've taken the pipeline down by a week for the year ending. And again, I think we've dialed in what we think is going to happen there..

All right. That's all I have for now. Thanks..

And our next question comes from James Hardiman from Wedbush. Please go ahead..

Hey, good morning. Thanks for taking my call. I thought the bridge on page 31 was extremely helpful. Should we ultimately be taking from that the notion that, on a core basis, your guidance is unchanged with maybe a little bit better Engine offsetting a little bit worse Boats? That was sort of my takeaway.

Just wanted to see how you guys are thinking about that..

Yeah. I'd say that's an appropriate conclusion, James..

Okay. And then....

Maybe a little bit better – when you start to factor out FX, maybe a bit more from the core business, so a bit more of a positive, but that's an appropriate conclusion..

Okay.

And just to dig into that a little bit, so the Marine Engine guidance going from high single to low double, obviously you've got Power Products in there, but it sounds like what you're telling me is that on a core basis that would still be going up a little bit, and then on the Boat segment we're going from high single – this is obviously all revenue guidance, but we're going from high single to 5% to 6%.

I don't know how, if at all, Sea Ray, the Sea Ray reinclusion affects that. Obviously, we've got some tariff stuff in there.

But is it safe to say that that guidance on a core basis is coming down a little bit?.

Yeah, to your first part about the engines are spot on, James. On the Boat side, boy, the Sea Ray piece is a small, small piece of that. So, you shouldn't be concerned there at all.

Part of what happens in some of the revenue is there is as we talked and changed the view on what Europe's going to be for the year, and parts of those things factor into some of those numbers, James..

Europe and the Canadian stocking orders in the second half of the year are really the two big headline changes in the Boat number..

Okay..

Very, very little as a result of Sea Ray..

Got it. And then it seems like you're now saying the industry is going to come in sort of at or below that 3% to 5% number.

I guess, first, why shouldn't I be concerned with that and assume that the industry is slowing and will continue to slow? And second, maybe, I thought the discrepancy between the 8% outboard growth and the, call it, 1% to 2% growth for you in the industry in the second quarter was interesting. Maybe any explanation of sort of what's going on there.

Typically, those numbers don't see that wide of a gap, but how should we think about that?.

Yeah, James, we spent a little bit of time looking in that, trying to understand really on a state-by-state basis what some of the discrepancies might be, and I would say that some of the states that have been excluded from SSI are the ones where we're seeing a bit more outboard momentum.

That's ultimately what we think is going to get reflected in the SSI data when it's fully reported..

But you don't....

I think the outboard data for the second quarter is more reflective of demand than perhaps what the SSI data is because of incomplete reporting..

Okay. But you....

I'd just add the other little piece there. James, the Bass Pro's acquisition of Cabela's helps us on the – as we mention, there's a little low impact, Boat impact, but from a channel – but there's actually a little positive lift coming on the Engine side with that acquisition. So, that's there as well, James..

Okay. But I'm assuming you feel comfortable with your own internal data, which also seems to be underperforming, that 8% number. Now, some of that you talked about being the Bass Pro acquisition..

Yes..

But is that – it seems like you're still underperforming the outboard number.

Why would that be the case?.

Well, first let me go to the first part. We do feel very comfortable about our numbers. I'm not sure that – I'm not sure I'm at the same conclusion you are.

Could you explain that a little more, James?.

Well, I just – the outboard number for the industry seems really strong at 8%. I get that the SSI is behind, but even your own internal numbers have you at, call it, low-single digits on an absolute basis and maybe more like mid-single digits excluding....

James, I....

Yeah. Go ahead..

James, I would look at it this way. At this point in time in the season, we're a lot more focused on the first six-month number than we are the quarterly numbers just given some of the historical disconnects we see when you're kind of going through month-to-month, quarter-to-quarter data.

The 3% outboard data for the first half of the year is probably a bit more indicative of kind of where we see the industry..

Got it..

And when you think about what the data is, excluding the impact of low Boats, we are trending a bit north of that number. So, we think we're holding up very well from a share perspective..

Okay.

And then to the question about sort of maybe lower industry guidance for the year at or below that 3% to 5%, I don't know if all of the trade war activity has maybe, on a global basis, hurt growth to a degree, but why shouldn't I be concerned with that? Or should I be?.

Well, go back, first of all, when we said the – could be below, that was global, and we said the domestic is probably still within that range. So, I want to make sure that's clear.

The other part is that, given the fact – stay with the examples on the trade, on the Boat side particularly and the industry, our production's over – largely all over in Europe already. And it's not going to be subject to some of that, as well as our Princecraft brand up in Québec has a lot of domestic production and content in Canada as well.

So, we think we've dialed in what the impact is going to be. I don't think any of us know exactly everything that's going on. It changes daily up to including yesterday. So, I think we've got it dialed as good as we can based upon everything we know today..

And, James, remember that the boats that are sold in Canada are the same boats that are sold in the U.S. So, there's opportunities there to shift production and demand for periods of time and still be in a very good position. So....

Our next question comes from Craig Kennison from Baird. Please go ahead..

Hey, good morning. Thanks for taking my question. Obviously, it has been a busy year so far.

Bill, maybe you can just remind me of the earnings contribution from Power Products for the rest of 2018?.

Yeah, I'd say what we've got modeled in to the – what we have modeled in to the bridge that we provided, it's about two-thirds of the earnings contribution with Sea Ray comprising the remainder is the way to look at it..

That helps a lot. Thank you.

And then, Mark, with the Sea Ray dynamic this year, how disruptive has that been for either your people internally or with your dealer community? And is that something that could see a resurgence next year?.

Well, I think our employees, by and large, would fall in – those who have obviously being displaced because of the elimination of some of the models, but we're working with them, trying to find other employment, job fairs. We're – and I think in general people are pretty appreciative of how we're handling that.

The portions of the business that stayed with us, they're very excited to remain part of the Brunswick Corporation. I think if you look at the dealer side of it, we have a great partnership with MarineMax and that continues going forward.

And I think there's a lot of Sea Ray dealers that get excited about as we talk about the reinvention and reinvigorate, all the things we want to do with what's staying. So, I think in general, if people took – take a little longer-term view, they're pretty positive.

There's a little short-term disruption and we're, again, we're, as we mentioned on the call, we're being aggressive in helping dealers move their inventory through the system. I think we're doing the right things..

Have you lost any Sea Ray dealers as a result of this?.

We have not lost a Sea Ray dealer going through this process..

Great. Thank you..

The only thing I'd comment on, Craig, is we're very excited about the product lineup of the sport boats, sport cruiser business. There's a lot of new product there that is going to have, we think, a good impact over the second half and into 2019.

And if you think about dealers trying to replace lost volume on models that we're taking out of the system, there's certainly opportunities for them to focus more of their resources around selling products that we still have in the lineup, and that should bode very well for demand moving in to the second half as well as into 2019..

That makes sense. Thank you..

I'd just amplify. Craig, I'd just amplify the one piece. I think we're going to be more focused, obviously, and I think the dealers can be more focused and I think both of those have positive results..

Got it. Thanks..

Our next question comes from Michael Swartz from SunTrust. Please go ahead..

Hey, good morning, guys. Just a quick clarification on Sea Ray.

Did you break out what the sport cruiser business, the piece that's sticking around, did in the second quarter, sorry, from a revenue perspective and from an earnings perspective? And the reason I ask is because most of us had not built that back into our model, so I'm just wondering how incremental that was to the quarter..

Yeah. Michael, it wasn't in our prior guidance, so you are correct there. It's only a couple pennies in the quarter, so not a big impact there. And so you're correct in your assumption there..

Okay. And then, maybe, Bill, operating leverage this year going to high-single digits from your prior outlook of mid- to low-double digits, I believe it was – or, sorry, low- to mid-double digits. I guess help us bridge that gap.

How much of that reduction is from Power Products or Sea Ray versus the tariffs, currency, and just core operations? I'm just trying to understand the moving pieces there..

Well, tariffs is obviously the big negative in the equation. But positives, Power Products is actually accretive or in line with what we'd expect leverage to be given their strong margin profile. And if you think about first half versus back half, the second half performance we're projecting is significantly improved from the first half.

A lot of that has to do with the new products that we're coming out with at Mercury. A lot of that has to do with improved operating performance in our manufacturing operations really across the board, as well as I'd say a bit more reasonable and a bit more muted year-over-year investment spending between the two.

So, I'd say our second half performance really starts to show the benefits of some of the things we've talked about getting done in the first half of the year from a product perspective, really starts to effect the second half and then sets us up very well going into 2019..

Okay. Thanks a lot. That's it for me..

And our next question comes from Gerrick Johnson from BMO Capital. Please go ahead..

Hey. Good morning. So, if I'm reading your reconciliation properly, it looks like the yacht business dropped about 62%, 63%.

Is that – am I right, one, and, two, is that because you're going to sell it and stop really supporting it? Or is that a result of just weak demand?.

I would say, Gerrick, it's more of a function of the sale process and dealers dropping their ordering activity in advance of the sale process..

Okay, that makes sense..

So, it was a little bit due to demand. It was a little bit due to dealer stocking activity..

Okay. Thank you. Thank you, Bill.

And then on Engines, of the products you've released between Miami and the products release – or announced in May, what would have been the most popular? Which ones are you chasing right now? And which ones are you seeing the most traction with?.

Well, it's the range, Gerrick. As you know, from 175 to 300 horsepower, and I would tell you, we're literally seeing demand across that range both at the V6 and the V8 level, and CMS and AMS versions. So, we've had success across that entire spectrum. I wouldn't....

Okay. So, it would be – the answer would be....

Yeah..

It would be all of the above..

All of the above. Yeah..

And then....

And there's actually still very strong demand in the rest of the product lineup as well..

And I was going to say, the 350, the Verados and the horsepowers above have been going extremely well, and I don't want anyone to forget our 150 horsepower demand has just been going up extremely strongly as well. So, we've got the new products we're very proud of.

But we're seeing Verado on the top end and 150s on both products that have been there, getting very nice lifts to them as well..

Okay. Okay. Great.

And then, in the Boat segment, what was the new product that caused the plant inefficiency you're talking about?.

Well, we've had the – we've had things around the 400 and the 320 cruisers and stuff on the Sea Ray side. And then just the other part is typically in the second quarter, we'd be doing all the new model launches for 2019, and so that's just a series of products that can be going on at Lund, Lowe, Harris, Princecraft, et cetera.

So, collectively, second quarter will always have – and we're – there's not a specific item on the aluminum boat side. It's more a case of just lots of things that happened in the quarter, getting ready for dealer. I mean, we'll start the Lowe dealer meetings next week and Lund the week after, so all that stuff had to happen in Q2..

And the next question comes from George Kelly from Imperial Capital..

Hi, guys. Thanks for taking my questions. So, first, just on the new engines, clearly very positive trend that you're seeing. Wondering if that gives you confidence or how you view pricing with the engines.

As you look to 2019, do you think there's an opportunity to be more aggressive?.

Yeah, I mean, one of the – we took some pricing actions in the second quarter on our outboard engines for the U.S., and I think we'll continue to look at where and how we're positioned against competition as we move through the balance of 2018 into 2019.

Clearly, it's – I think there's any number of things that could say there's probably some opportunity there. But when you're just launching a new product, it's probably not the most opportune time. But we'll continue looking at the opportunities there, George..

Okay.

And then, second question, I may have missed this in your prepared remarks, but what's after your pension payment this year? What will be left? And do you anticipate paying that in 2019?.

It's up to $30 million, George, and that would be a 2019 payment..

Okay. Thank you..

And we're done. Yep..

Got you. Great..

And this concludes our question-and-answer session. I'll now turn the call over to Mark for final comments..

Yeah, I just want to thank everybody for participating today. As you all know, there's been lots of puts and takes in this particular quarter, but that speaks to all the things we really have had going on.

I truly believe that at a later point, when people really look back at the first half of 2018 that people are just going to marvel about what's all been accomplished from a strategic standpoint and a transformation of this company and the long-term benefits it's going to provide to our shareholders.

The first half of 2018 has been a really, really exciting time, and we fully intend to execute against the actions we've taken in the quarter. Thank you..

Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for your participation, and you may now disconnect..