Brunswick - Q2 2023

Transcript

Operator (participant)

Good morning, welcome to Brunswick Corporation's Second Quarter 2023 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 now like to introduce Neha Clark, Senior Vice President, Enterprise Finance, Brunswick Corporation. Please proceed.

Neha Clark (SVP of Enterprise Finance)

Good morning, and thank you for joining us. With me on the call this morning are Dave Foulkes, Brunswick CEO, and Ryan Gwillim, 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 details on these 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 will 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 unaudited consolidated financial statements accompanying today's results. I will now turn the call over to Dave.

Dave Foulkes (CEO)

Thanks, Neha. Good morning, everyone. Our businesses executed a strong second quarter, benefiting from market share gains, well-received new products, solid operational performance, and diligent cost control. We delivered $1.7 billion in net sales and adjusted earnings per share of $2.35, including the financial impact of the IT security incident, which I'll discuss more in a moment. Mercury Marine continues to gain market share, with U.S. outboard retail market share up 140 basis points year-to-date versus prior year. While the new boat market continues to face headwinds, there's been relative improvement in recent months, with preliminary June U.S. FSI main powerboat retail turning positive and Brunswick outperforming the market in June and year-to-date.

As we move through the core season, boat field inventory remains at an appropriate level in most categories, and we closed the second quarter with around 19,000 units in our global pipeline. We are focused on ensuring the pipelines remain healthy, exiting 2023 and going into 2024, balancing the need for our dealers and other channel partners to carry a good representation of our portfolio at their locations while ensuring that we maintain inventory freshness. We generated strong free cash flow of $193 million in the second quarter, resulting in 2023 first half free cash flow coming in $144 million higher than prior year. In addition, we continue to be aggressive with share repurchases, executing $132 million of repurchases year to date.

We are relentlessly executing our strategic priorities, including enhancing our ACES initiatives, investing in new products, progressing our operational excellence goals, and implementing structural cost reduction actions across the enterprise. On June 13th, we announced that we'd been impacted by an IT security incident, which ultimately resulted in second quarter financial results that were lower than initial expectations. Because of the proximity to the end of the quarter, there was limited opportunity to recover fully within the same period. Within nine days, the company announced that all primary global manufacturing and distribution facilities were fully operational, with no significant residual impacts. We had the opportunity to recover some lost production and distribution across our businesses, which will partially offset lost days in the second quarter.

However, lost production days on high horsepower outboard engines will be challenging to recover because the production schedule was already full for the balance of the year. We estimate the financial impact to be approximately $80 million-$85 million of revenue in the quarter and $60 million-$70 million for the full year. I'll turn now to some of the segment highlights that facilitated a solid second quarter. Prior to the disruption from the IT security incident, our high horsepower outboard engine production ramp-up was progressing and has since resumed, allowing us to increase shipments to repower customers and OEM partners. Mercury Marine continues to expand outboard propulsion retail market share around the globe, demonstrating the strength of our comprehensive propulsion product portfolio.

During the quarter, we launched the Mercury Racing 500R outboard, shipped the first model in our Avator electric outboard lineup to global customers, and announced that we've begun serial production of the next two models. Our engine parts and accessories businesses performed as expected, reflecting anticipated sales and earnings declines versus a record second quarter of 2022. Although sales were up 12% versus the second quarter of 2019. Second quarter sales in the U.S. products portion of the business were near flat to Q2 2022, reflecting strong sales growth exiting the quarter. We continue to progress the transition to the new Brownsburg, Indiana distribution center. However, sales in the distribution portion of the business were down versus 2022, as dealers and retailers continued to hold lower levels of inventory, although turns have improved into the season.

As foreseen, Navico Group posted lower second quarter sales versus 2022, as stocking pressure by some retail channel partners continued, with improving trends in many retailers in the latter part of the period. Our recently launched products, including the Lowrance HDS PRO Fish Finder and Simrad HALO Radar, are performing very well in the market. Additionally, restructuring actions were accelerated, generating lower operating expenses versus prior year. Finally, our boat business delivered double-digit adjusted operating margins for the fifth consecutive quarter, despite increased promotions and discounting on select product lines. June retail continued the strengthening upward trend. Freedom Boat Club continues to experience strong same-store membership sales growth on a sequential basis, now has 400 locations and nearly 57,000 membership agreements covering 90,000 members network-wide, all while generating exceptionally strong synergy sales across our marine portfolio.

Shifting to external factors, higher interest rates and prices continue to be a headwind for buyers, particularly of smaller product, with boat loan rates recently exceeding 9%. Wildfires have also impacted an already softer Canadian retail market. From a dealer perspective, sentiment remains cautious, and while inventory levels for Brunswick's channel partners are healthy, dealers are proceeding with some caution and carefully monitoring sales as they plan replenishment. Discounting and promotional activity is close to or at 2019 levels and is being successful in supporting retail in the height of the selling season. Our internal boater sentiment surveys suggest boating participation remains above prior year, with Google search trends on terms related to boating also improving in June. In addition, Brunswick's Ripple Boating online community has now grown to more than 10,000 members. The positive retail numbers in peak season are very welcome.

However, we do not see the fundamental pressures on consumers, driven by elevated interest rates and higher prices, easing in the short term. We are taking a very balanced approach to production planning while maintaining flexibility. Shifting to a global view of revenue, overall, we saw a 7% sales decline on a constant currency basis, excluding acquisitions, including the impact of the IT security incident. Year to date, the U.S. market is showing relative strength versus international markets, with sales flat to 2022. From an industry view, U.S. FSI main powerboat second quarter retail unit sales improved sequentially from the first quarter. The main powerboat segment was down 6% versus the second quarter of 2022. However, preliminary June U.S. FSI was 2% above prior year.

Brunswick performed better than industry relative to both periods, picking up share through strong performance by our premium fiberglass and aluminum brands, supported by planned promotions and marketing of select product lines. Outboard engine industry data was down 6% in the second quarter versus prior year. Mercury continues to outperform the industry, with second quarter share now above 50%, reflecting retail share gains of 530 basis points in the 150 and above horsepower outboard engine categories. We continue to manage inventory levels closely through the season. As we look at end of quarter pipelines, we see unit inventory levels recovered versus recent years, but still below the pre-COVID level in 2019, particularly for premium product lines.

As we look at the number of units in the pipeline on a boats per dealer basis, we see approximately 75% of our dealers with inventory levels less than or equal to 2019. Moving on to recent new products and innovation. As I mentioned earlier, we recently launched the Mercury Racing 500R, which delivers high performance for fast luxury sport boats and is incredibly light, weighing only 720 pounds. The 500R replaces the 450R and joins the Mercury Racing high horsepower lineup that already includes the 300R and the new 400R. Earlier this year, we launched the award-winning Mercury Avator 7.5e electric outboard. We've now produced around 2,000 units, and we have strong orders from around the globe.

We recently announced the beginning of serial production for the next two models in the Avator lineup, the 20e and 35e, which we expect to begin shipping to customers at the end of the summer. The launch of the 500R and the production of the new Avator models reinforce our intention to be the industry leader in both internal combustion and electric propulsion. Navico Group continues to release exciting new products, but also software upgrades, facilitated by the flexible Android-based software architecture deployed on its newest products, and reinforcing the increasing importance of software and content upgrades as new sources of revenue and value creation for our business. Freedom Boat Club continues to expand rapidly, recently announcing its 400th location globally, which is located in Jupiter, Florida.

We've added an average of around one Freedom location per week since the acquisition in 2019, including 40 international locations. We're also continuing to build out the Freedom ecosystem, including successfully expanding our Boateka pre-owned boat business, which takes boats from Freedom, refurbishes them and resells them into the pre-owned market. I'll now turn the call over to Ryan to provide additional comments on our financial performance and outlook.

Ryan Gwillim (CFO)

Thanks, Dave, and good morning, everyone. As previewed last week, Brunswick delivered a solid quarter despite the impact of the June IT security incident. When compared to prior year, second quarter net sales were down 7% and adjusted EPS of $2.35 decreased 17%. Net sales benefited from pricing implemented in previous quarters and new product performance, offset by lower production and shipments resulting from the IT security incident, primarily in the propulsion and engine P&A segments and softer market conditions in value boat and lower horsepower engine markets. Adjusted operating earnings and margins were impacted by lower sales and slightly higher input costs versus the second quarter of 2022, but were partially offset by benefits from prudent cost containment efforts across the organization.

Lastly, we had strong free cash flow generation in the quarter of $193 million, primarily due to stronger working capital generation, resulting in free cash flow conversion of 116% in the quarter. Year-to-date results also remain solid, despite a slightly softer marine retail market and the impacts of the IT security incident. Sales are down slightly from the record first half 2022, with the resilience in adjusted operating margin and EPS resulting from prudent operating expense control across the company, steady gross margin performance, and in the case of adjusted EPS, continued aggressive share repurchase activity. You'll also note that each measure is greatly improved versus 2019, a testament to our continued successful portfolio management, operational excellence and capital strategy execution.

Now we'll look at each reporting segment, starting with our propulsion business, which delivered resolute sales and earnings despite being the segment most impacted by the IT security incident in the quarter. Revenue decreased 4% versus the second quarter of 2022 as benefits from pricing, favorable product mix related to continued strong high horsepower outboard engine demand, and higher sales to repower customers were offset by the impact of production stoppages and planned reductions in lower horsepower outboard engine and stern drive engine sales and production. Adjusted operating margins in the quarter were down 300 basis points as lower sales, higher input costs, and the timing related to capitalized inventory variances, which you'll remember, was an equal benefit in the first quarter, offset very aggressive cost control. Production output of high horsepower engines continues to improve, which should enable second half sales growth.

The engine parts and accessories business delivered a steady quarter, with sales down 13% versus 2022, but up 12% over the second quarter of 2019. Sales in our U.S. products business decreased by 8.5%, but would have been essentially flat versus the second quarter of 2022, absent the IT security incident. Sales in our distribution businesses and international markets remained below prior year. Adjusted operating earnings and margins decreased due to the same factors, together with slight increases in input cost and the carryover of start-up costs related to the newly opened Brownsburg distribution center, which collectively offset benefits from cost control measures. Note that July orders in the products business continued to trend positive as boat usage remains strong.

Navico Group reported a sales decrease of 20%, driven by lower orders versus a very strong second quarter of 2022, together with slow recovery of RV OEM production, partially offset by strong new product performance. Segment operating earnings declined as a result of the lower sales and slightly elevated input costs, partially offset by accelerated cost reduction actions and reorganization efforts. Note that adjusted operating margins improved sequentially by 40 basis points versus the first quarter, with second half operating margins anticipated to exceed first half performance. We look to the remainder of the year, orders for the aftermarket channel, which represents two-thirds of Navico Group sales, are showing strength versus the back half of 2022, as retailer inventories are more normalized versus this time last year, and sell-through demand continues to be solid.

We believe this tailwind will help offset potential lag in marine, OEM, and RV orders, as wholesale production in these areas are slower as manufacturers and dealers monitor inventory levels late in the season. Our Boat Segment had another strong quarter, delivering steady top line and slight earnings growth, together with double-digit adjusted operating margins for the fifth straight quarter. The $62.5 million of adjusted operating earnings in the second quarter is the highest earnings achieved in any quarter in Boat Group history. The Boat Segment reported a 1% decrease in sales due to the favorable impact of prior year pricing actions and favorable mix towards premium products, being offset by lower shipments of value products and higher discount levels, which are still within expectations. Adjusted operating earnings growth was enabled by the above factors, coupled with share gains and sustained operational productivity gains.

Freedom Boat Club, which is included in Business Acceleration, contributed approximately 7% of the boat segment's revenue during the quarter. Our updated 2023 outlook matches our preliminary outlook shared last week. We are reiterating our full year adjusted EPS guide of approximately $9.50, with revenue of between $6.7 billion and $6.8 billion, and adjusted operating margins of approximately 14.5%. We continue to see positive free cash flow conversion and working capital trends, still anticipate generating more than $375 million of free cash flow for the year. Finally, we anticipate a solid third quarter, where revenue should be flat to slightly below Q3 of 2022, and adjusted EPS of between $2.35 and $2.45.

This slide provides additional clarity on the components of our updated EPS guidance. The midpoint of our prior EPS guidance range was $10.25. The components to get to our updated guidance of approximately $9.50 are, with each of the following being estimates: $0.35 of loss and non-recoverable earnings related to the IT security incident, primarily related to the downtime of high horsepower, outboard engine production, and missed engine P&A sales in the middle of the marine retail season. $0.65 related to channel and market dynamics, where, despite the U.S. retail market being only slightly worse than our initial expectations, channel partners across our businesses are being cautious regarding pipeline refill, given the uncertain macroeconomic environment and continued pressure on consumers domestically and in many international markets.

As we're working towards the end of the prime retail season in northern climates, we anticipate slower channel fill in the back half of 2023 in the face of these pressures and an uncertain 2024. Specific examples may include boat dealers taking fewer value boats at the end of the season, boat OEMs being satisfied with their ability to get 150 horsepower and under engine product, and having sufficient supplies to satisfy late season boat orders, and marine dealers and retailers restocking parts and accessories at a more reserved pace. Lastly, a $0.25 benefit from strong OpEx control, including acceleration of planned Navico Group integration and restructuring activities, benefits from new products, and lower share count resulting from aggressive repurchases.

Note that at an adjusted EPS of $9.50 would still be 15% higher than any result in Brunswick history, aside from 2022. We have a small handful of full year assumptions that we have updated. Given our strong cash performance and continued Brunswick share price dislocation, we are increasing our repurchase target to exceed $250 million of repurchases for the full year. Accordingly, our average diluted shares outstanding should be slightly lower for the year at 70.5 million shares. We're also seeing a slightly better foreign currency environment as it relates to our global businesses, and now anticipate a full year headwind of approximately $30 million. Please see the appendices to this presentation for additional information on other P&L and balance sheet assumptions for the year, which have not materially changed. I will now pass the call back over to Dave for concluding remarks.

Dave Foulkes (CEO)

Thanks, Ryan. Before we close out, I want to share an update on some recent awards and recognition for our company, brands, products, and people. We recently issued our sustainability report, and we're delighted to be named by USA TODAY to the inaugural list of America's Climate Leaders for 2023. We were among the 400 companies that made the final list out of the 2,000 considered. Brunswick was also named to the U.S. News & World Report list of best companies to work for, for 2023, 2024. We finished in the top 10 of all companies in the categories of Best Companies for Work-Life Balance and Quality of Pay. Mercury recently won four iF DESIGN AWARDs for its new products, including two awards for the Avator 7.5e and one each for our V10 and V12 outboard engines.

The iF DESIGN AWARDs are one of the most prestigious international design awards, crossing all business sectors. In May, Brunswick received a record 11 2023 top product awards from Boating Industry Magazine, recognizing innovative, industry-leading new products from Mercury Marine, Brunswick Boat Group, and Navico Group. Four Brunswick female leaders were named by Boating Industry Magazine to its 2023 list of Women Making Waves, marking the second consecutive year that four of our outstanding women leaders have featured on the list.

Before I close, I'd like to remind you about our Investor and Analyst Day event on September 18th, 2023, at the New York Stock Exchange, which will be followed by an opportunity to experience exciting new products and technologies from across our businesses on the water, as well as meet with members of our management team. Thank you for joining the call. That concludes our prepared remarks. We'll now open the line for questions.

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. To allow for as many questions as possible, please limit yourselves to one question and one follow-up. One moment, please, while we poll for questions. Thank you. Our first question comes from James Hardiman with Citi. Please proceed with your question.

James Hardiman (Director and Leisure and Travel Analyst)

Hi, good morning. Thanks for taking my call. Obviously, it sounds like you're trying to take us down the path of, and I think a lot of people are trying to do the math of, how much of the revised guidance is the IT incident and how much is sort of what's going on in the channel? You've got some good slides in the deck that help us with that. I guess maybe if we think about the outlook on a segment-by-segment basis, right? You guys have got the slide where we sort of go through what you're assuming for sales and operating margins for each of those segments. Each of them looks to be down versus the previous guide.

I guess maybe walk us through what's IT and what's not IT in those segments. I feel like I can comfortably say that the propulsion piece on one end of the spectrum is almost all IT, whereas the boat piece on the other end of the spectrum seems like it's more demand and market dynamics. Maybe walk us through how to think about those various items.

Dave Foulkes (CEO)

Thanks, James. Thanks for the question. Yeah, I think the, as you mentioned, certainly Mercury was impacted by the IT incident most. The issue there, as we mentioned, is recovery or ability to recover high horsepower. I think there was some kind of questions earlier in the year about whether Mercury could continue to gain market share. You saw even on a rolling three basis, we're above 50% market share now. Demand, particularly for high horsepower, remains high. Our ability to recover that may be limited. Obviously, we'll be doing what we can. We're not counting on it. Broadly on P&A, we continue to see, I think, more modest spending.

We didn't really talk about this much on a regional basis, but I would say it's probably overall better in the U.S. and slightly weaker in some of the international markets. In Navico in particular, though, although we said that Navico was not one of the most impacted areas in by the security incident, we noted about $15 million of revenue impact on other segments. The majority of that was Navico. Navico was about $12 million-$13 million of revenue and associated earnings in the quarter. Navico continues also to be impacted by the slow recovery of RV. That's probably about another $15 million of top line there for Navico. Our Boat Group is really about inventory restocking patterns. As you mentioned earlier, we're going to be extremely disciplined. We have been extremely disciplined.

I think the first half of Boat Group has been extraordinarily strong. You know, margins have held up really well. As we, if you look at Q3 last year, though, for Boat Group, it was pretty strong. You know, margins held up reasonably well. Q3 is generally a weaker quarter for boats overall because of shutdowns, but we'll be reducing production in Q3 to try and make sure that we don't, you know, build inventory as we go into the back half. Yeah, Boat Group is certainly a response to normalization of inventory levels.

James Hardiman (Director and Leisure and Travel Analyst)

Got it. Just as a follow-up, maybe to that last point, and what's happening in the Boat Group. It's interesting. Timing's interesting because it feels like we thought we've seen better industry numbers as of late than we've seen in some time. Maybe tease out how much of the Boat Group guide down is actual demand, right? It seems like maybe the industry is now a little bit worse than you thought, versus how you think about weeks on hand to finish the year.

I guess I should read into this that you think the channel is going to be leaner than you initially thought, or is maybe there, there's some, some of this that we're not seeing, you know, maybe, you know, other brands are, are higher, and so dealers are, are scaling back on everybody, despite the fact that you guys seem to be in an okay inventory position?

Dave Foulkes (CEO)

Yeah, it's a good question. I understand how our how those are slightly contrarian kind of indicators. I think the, this is kind of not just about the year 2023 and 2024, it's a bit about the shape of the year, kind of 2023 and 2024. The overall year-to-date retail is trending a bit more towards where we thought it would be earlier in the year and where we indicated it would be, but kind of at the lower end of that, I would say. Better than I think some other people thought the market might be.

As because of high interest rates, and because of dealer inventory levels and carrying costs, I think what we're expecting is that there is not a high incentive to carry a lot of inventory through the back half of the year. I think customers probably in towards the end of the season, are going to be less willing to buy a boat and pay the interest fees through several months in the northern market, where they might not be using the boat, especially if they believe that boat availability is going to be better in the early part of 2024. In terms of inventory levels, I think there are quite a number of things for us to think about. One is the unit level on an aggregate basis, another is the unit level by dealer.

What we tried to show in that kind of histogram was, our dealers are not over-inventoried at all by historical standards. In fact, 75% are below or at 2019 levels. We do need them to keep a representation of, a good representation of our portfolio. I think they are feeling the higher dollar value of the inventory. That's certainly a consideration for them. They are cautious on the customer, I think. I think we're going to hit a reasonable spot where we get good portfolio representation, but don't have dealers carrying what they believe are excess amounts of inventory. In terms of weeks on hand, that's probably going to be in the U.S., 35-40, maybe 35+.

Which should be roughly a historical level, on a kind of weeks-on-hand basis, but lower on a unit basis than kind of pre-COVID. I'm not sure if I exactly answered your question, but those are some of the considerations as we think about the back half of the year. We're very pleased with the performance of the Boat Group. I think the benefit of new models, the cost control, expense control, restructuring that we've done in the Boat Group is really paying dividends, but we just want to set ourselves up for a successful 2024.

Ryan Gwillim (CFO)

Dave, you know, we are outperforming the market as a whole and taking share in outboard, fiberglass outboard, pontoon, and fish. In terms of James' question on vis-à-vis other manufacturers, we feel like we're more than holding our own.

James Hardiman (Director and Leisure and Travel Analyst)

That makes a ton of sense. Maybe just to clarify, I apologize, I'm going to sneak in one more here. Just to clarify, Dave, my point on carrying costs and, and consumers maybe being hesitant in the off-season, that kind of sounds like a, a cautious or a bearish outlook as we think about retail into the fourth quarter. Is that the way I should read that?

Dave Foulkes (CEO)

I, I wouldn't say it's particularly bearish, I'll be honest with you, James, because by the time we get to the fourth quarter, we're looking at 10% of total retail. We're already at 70% of retail for the season. I think these are relatively small number, issues from the consumer perspective. Obviously, consumer drives retail. More of a consideration from a wholesale perspective with, I think, dealers being cautious.

James Hardiman (Director and Leisure and Travel Analyst)

Got it. That makes sense. Thanks, guys.

Operator (participant)

Thank you. Our next question comes from Mike Swartz with Truist Securities. Please proceed with your question.

Mike Swartz (Equity Research Analyst)

Hey, good morning, everyone. Maybe just a broader question on affordability and how you think about that, particularly on the boat side of the business going forward. Obviously, there's a lot of concerns near term with interest rates and affordability, but in terms of your pricing strategy for model year 2024, and I guess longer term, how do you think about turning that or moving that more in favor of the consumer, I guess, if you do at all?

Dave Foulkes (CEO)

Yeah, we had pretty modest price increases in 2024, like in the 3%-4% range was typical across. That doesn't, of course, represent transaction prices. Transaction prices are impacted by discounts and promotional activity. Obviously, we've been upping that level. We have a lot of tools to try and, you know, present an attractive overall proposition to the consumer, and I think you've seen the impact of that. We've been kind of trying different mixes of those things, and I think we've settled on what works pretty well currently. You saw the rebound, particularly in aluminum fish, which was, you know, down significantly earlier in the year and rebounded, I think, based on a kind of raw demand, but also on the fact that we were offering, I think, attractive proposition to consumers.

I think we're back to kind of good news is back to once a year and back to very normal levels of price increase, especially when you look at overall inflation. I think we do have a real advantage with the breadth of our portfolio. We have a lot of entry points for any consumer into the marketplace. I'm happy, you know, with the, the brands that we have that represent the different segments and, and kind of geographic orientations.

If you look at how the market is down this year, boats above 30 feet are really not down much at all. Boats in the, kind of 16 to 24 feet are the bulk of the reductions. That's why we've been targeting a lot of our promotions and discounts. This is really not about a kind of a uniform approach. It's about targeting the approach to the segment. I think based on recent retail, we seem to have found a good balance.

Mike Swartz (Equity Research Analyst)

Okay. Then just a follow-up. If I'm looking at the numbers correctly, I would assume that boat production in the second quarter was down year-over-year, just given the pricing benefit you have running through the line there. Segment margins were up, I think 40 basis points or so. Typically, though, I guess we don't see that kind of, that kind of dislocation when volume is down, margins are up. Maybe help us understand why that was. Was that just positive price, you know, net pricing, or is there something else to that in the quarter?

Dave Foulkes (CEO)

I think Ryan might be able to be more specific here, but I think certainly the benefits of historic of pricing that occurred last year are flowing through to this year. We do have pretty good mix, I think, towards some of our premium product that's probably helping. I don't know if there's anything else.

Ryan Gwillim (CFO)

Yeah, no, those are the main two. The main two components.

Mike Swartz (Equity Research Analyst)

Great. Thank you.

Operator (participant)

Thank you. Our next question comes from Joe Altobello with Raymond James. Please proceed with your question.

Joe Altobello (Managing Director and Senior Equity Research Analyst)

Thanks. Hey, guys. Good morning. The first question, quick housekeeping item. You mentioned earlier that the industry is trending a little bit worse than you thought. I think your prior outlook for the U.S. industry in particular, was units down mid to high singles. Just to be clear, it sounds like you're thinking industry down high singles for this year?

Dave Foulkes (CEO)

The U.S. industry? Yeah, I think that's, you know, high singles, maybe low double, maybe 10, something like that. I'd say that's probably where we are. Yeah.

Joe Altobello (Managing Director and Senior Equity Research Analyst)

Okay.

Dave Foulkes (CEO)

U.S.

Joe Altobello (Managing Director and Senior Equity Research Analyst)

In terms of inventory, I think, Ryan, you mentioned that you expect us to get back to, you know, 35 weeks plus. That's pretty close to where we were pre-COVID, despite the fact that a lot of dealers, you know, want to hold less. Is that overly optimistic or overly aggressive?

Ryan Gwillim (CFO)

I think we, I think overall, we have more dealers, for one thing. Obviously, we continue to expand our dealer base. In terms of on hand, I think as, as you get lower in terms of absolute unit sales, there are some other kind of flaws that come into place, and, and they're really around a dealer is really holding a representation, a good representation of our portfolio. That's what we tried to indicate with that histogram that I referred to earlier. We do need dealers to hold, you know, a good representation of our portfolio. Even though weeks on hand could be in the 35 plus area, units will be down versus pre-COVID levels, based on, you know, overall market at the moment.

Joe Altobello (Managing Director and Senior Equity Research Analyst)

Okay. When do you think we get there?

Ryan Gwillim (CFO)

I'm sorry, Joe, get to?

Joe Altobello (Managing Director and Senior Equity Research Analyst)

35 weeks.

Ryan Gwillim (CFO)

That's the year-end number.

Joe Altobello (Managing Director and Senior Equity Research Analyst)

Okay. Thank you, guys.

Operator (participant)

Thank you. Our next question comes from Craig Kennison with Baird. Please proceed with your question.

Craig Kennison (Senior Research Analyst and Director of Research Operations)

Hey, good morning. Thanks for taking my question. You've had some questions on the boat side with respect to the channel. My question is on P&A. That business has been facing a destocking cycle for some time now. How far along in that cycle are we? Might we get to the point where dealers are kind of replenishing, not dealers, but your retail partners are replenishing at a one-to-one level?

Dave Foulkes (CEO)

It might depend a bit on the parts of the business, to be honest, Craig, but I think what we are clearly seeing, Navico, aftermarket and retail stabilizing and even possibly increasing. One of the reasons is as we go into the, you know, season where we have Black Friday and the holiday season, dealers will begin to stock up again. That's a typical pattern. I would say for Navico, the destocking has stabilized, and if anything, I would say we're gonna enter a bit more restocking as we go forward. What we have seen is a really strong response to new product. If we launch new product, as we did with the Lowrance HDS PRO, that's, you know, ahead of the competition significantly, we see no hesitation by dealers.

hold that inventory. If you look at Navico overall, the two things are essential really for us to do with Navico. One was to get a lot of fresh products in the pipeline to support revenues and accelerate this restocking, and we're beginning to do that, I think, quite nicely. The other was to get operating margins stabilized, and I think we're doing that nicely too. On the engine P&A and distribution side, I think we're coming into some easier comps in the back half of the year. I think you'll see kind of lower reductions there in the back half. I don't know, Ryan, if you have any comments?

Ryan Gwillim (CFO)

Yeah, the only other item would be the Brownsburg transition, which, was a pretty. It's a big, a big task that we undertook in the first half of the year which is primarily complete and running at more full speed. That's probably hampered us a little bit in the first half, more than we anticipated, but should be good moving forward.

Craig Kennison (Senior Research Analyst and Director of Research Operations)

Got it. Thank you.

Dave Foulkes (CEO)

Thank you.

Operator (participant)

Our next question is from Matthew Boss with JPMorgan. Please proceed with your question.

Matthew Boss (Managing Director and Senior Equity Research Analyst)

Great, thanks. First, on, on your revised full year operating margin guidance, could you just help break down the factors driving 3Q margins to contract more than 100 basis points? Separately, just the confidence in 4Q's implied margin expansion? As we look ahead, just help us to think about maybe early puts and takes to consider on 2024 operating margins, just given your level of visibility today?

Ryan Gwillim (CFO)

Hey, Matt. I'll start on Q3. You know, Q3 is off of a really strong comp last year, really from all of our businesses, maybe aside from Navico Group, which actually has a bit of an easier comp. If I think about segment propulsion, we anticipate to have a stronger, high horsepower manufacturing, which obviously comes at a good margin structure. That would be the biggest driver there. As Dave just said, Engine P&A is coming off of really challenging first half comps, a little bit easier in the second half. That gives us some operating margin kind of stability.

The Boat Group is always a third quarter is a bit challenged, as Dave mentioned, with the model year switchover and also shutdowns in most of our facilities that just have fewer production days. That also kind of gets better in the fourth quarter. You get to a number that's slightly below last year, which again, was kind of a banner quarter. That leads into the fourth quarter, where I think the comps get a little bit easier from prior year. Propulsion, high horsepower production continues to be strong. You have a little bit more restocking in Navico Group and Engine P&A, the Boat Group continuing to operate well.

The other item I'll mention is, and we don't really talk specific brands very often, but Boston Whaler continues to have a really nice run this year. Remember last year, we were opening up and really getting underway a brand new facility, a second facility for the larger product. That is now behind us, and we're starting to see the benefits there. Despite lower production, in terms of units, the production at Whaler and some of the premium continues to be strong, and that gives you margin benefits both in Q3 and Q4.

Matthew Boss (Managing Director and Senior Equity Research Analyst)

That's helpful.

Operator (participant)

Thank you. Our next question is from Xian Siew with BNP Paribas. Please proceed with your question.

Xian Siew (Senior Analyst)

Hi, guys. Thanks for the question. Maybe first, can you just share how many units you shipped in the quarter? I think you sounded like it was down, but just if you had the number.

Ryan Gwillim (CFO)

Let me, yeah, just below 10,000, 97-ish.

Xian Siew (Senior Analyst)

Okay, got it. The -6% retail, you, it sounds like you were better than that, internally. Is it the magnitude, like half? I think in the first quarter, you were down 10 versus industry, down 20, something like that. Is the spread still the same, or how do we think about the outperformance in retail?

Dave Foulkes (CEO)

I would say we were quite a bit better than, I would say, than the market, in the quarter and in June. I think we had strong performance across a number of brands. I think a lot of new products supported by some, I think, very appropriate and targeted promotions. We had a good Q2 and a good June.

Operator (participant)

Thank you. Our next question comes from Scott Stember with Roth MKM. Please proceed with your question.

Scott Stember (Executive Director and Senior Research Analyst)

Good morning. Thanks for taking my question as well.

Ryan Gwillim (CFO)

Hey, Scott.

Scott Stember (Executive Director and Senior Research Analyst)

Can we talk about, I guess, engine parts, and accessories? You said that if you were to back out the impact from the security breach, that you would have been flat. Can you maybe talk about RV versus boat, and what the marine side would have looked like if you didn't have to contend with RV?

Ryan Gwillim (CFO)

Yeah, I'll take that. The U.S. products piece is primarily marine, almost all marine. If you look at our comment there, that was really, Scott, a fully marine number, because that is kind of captive engine parts and accessories, if you would. Where RV comes into play is really distribution in the engine P&A segment as well as Navico. Products being flat in the U.S., absent the IT, is really just marine.

Scott Stember (Executive Director and Senior Research Analyst)

Okay, gotcha. Then, on the repower side, maybe talk about what you're seeing there? Your expectations if we go into a tighter boat market, do you expect, or are you starting to see people deciding that they want to repower what they have, with your products instead of buying something new?

Dave Foulkes (CEO)

I think, I mean, there may be some of that. I think the bigger factor is just availability of high horsepower product for repower, which is something that we've not been able to supply and weren't able to supply really prior to the capacity increases that we introduced at the end of last year. I think improvements are being driven more by the supply side than the demand side. There may be some demand creation, as you mentioned, because of people repowering versus buying new, but I'm not sure if we would be able to kind of deflate that. I would say it's almost certainly driven by supply availability.

Scott Stember (Executive Director and Senior Research Analyst)

Gotcha. That's all I have. Thank you.

Dave Foulkes (CEO)

Thank you.

Operator (participant)

Thank you. Our next question comes from Fred Wightman with Wolfe Research. Please proceed with your question.

Fred Wightman (Director and SVP in Equity Research)

Hey, guys. I just wanted to come back to the boat margin performance. you know, having 10% operating margins is something that you guys have really hung your hat on for a while. Obviously, the guide for this year calls for that to be a little bit lower, and I'm just wondering in sort of, you know, the out years, if you still think 10% is sort of the right margin profile of that business, or if the floor is maybe a little bit lower than you had anticipated?

Dave Foulkes (CEO)

I think the in a more normalized market condition, above 10% is very achievable, and certainly our goal as we go out strategically, we were planning for margins significantly above 10%. It's obviously a very dynamic situation at the moment as we move from supply constraint to demand constraint. If you look at us matching production to anticipated retail, obviously, we're going to have to underproduce retail at some point. I think this is a short-term dynamic that will return to a very constructive trend longer term.

Fred Wightman (Director and SVP in Equity Research)

If you look at the chart that you provided, talking about the dealer breakdown in terms of inventories relative to 2019, is there any commonality among those 25% of dealers where inventories are above 2019 levels? Do they skew towards one product category? Are they concentrated in one geography? Anything that sort of stands out?

Dave Foulkes (CEO)

I don't think so. I think it's more statistical than category-based. I don't know if anybody else is.

Ryan Gwillim (CFO)

No, that's right. It's, it, you know, just the law of numbers there. I would say, again, certainly premium fiberglass inventories continue to be extremely low in the field. Most of that you would see as value-based product. Again, there's no concentration of brand or geography in there.

Fred Wightman (Director and SVP in Equity Research)

Fair enough. Thanks a lot.

Dave Foulkes (CEO)

Thank you.

Operator (participant)

Thank you. Our next question comes from Tristan Thomas-Martin with BMO Capital Markets. Please proceed with your question.

Tristan Thomas-Martin (Senior Equity Analyst)

Good morning. I have two questions tied to 2024, or effectively trying to look out to 2024. If dealers are very cautious about carrying excess inventory through the winter, how do you think they approach 2024 ordering? Also, there's been a lot of moving pieces this year with the boat kind of channel refill and the P&A destocking. Could you maybe quantify those just to give us a little bit of a better sense of what a normalized run rate is?

Dave Foulkes (CEO)

Yeah. On the first question, we go through a pretty structured process several times a year with our dealers to align on restocking, that process is going exactly to plan at the moment. There are no canceled, you know, major canceled orders or anything like that. We're just kind of working through a normal process of aligning inventory levels. I think the, you know, one of the considerations for us is, we don't want dealers to have inventory that is not fresh. We want, we want them to have products they're going to be able to sell as they go into the season.

It is in all of our interests to balance, them carrying, a good representation of our product portfolio, with us all making sure that they have fresh product, and we don't get into the RV situation, right now, where we, you know, we have dealers loaded up with, two-year-old product. The process is proceeding exactly as it normally does, every year. We're aligning on, inventory levels as we go into the off-season. It's just a very normal process. We've all been through this before. This is not the first time. What is, what's the second question?

Ryan Gwillim (CFO)

Yeah, Tristan, I mean, if you want to dimensionalize, I mean, you know, our P&A business is still on a kind of year-to-year CAGR since 2019, are still 10+%, I think it's closer to 12, actually. I mean, if you want to look at a normalized situation, you know, that is some pretty strong growth there. I would tell you that Navico Group, in a normalized situation, probably outpaces Engine P&A, which is a bit more annuity and more constant. You could kind of go back and look at the trend lines there. The boat is really just what we've been talking about, a wholesale versus retail restocking story. When you.

You know, if you are retailing 30,000, then, you know, ideally, once pipelines are filled, you want to wholesale those 30,000, so that wholesale and retail match each other. That's probably the land we're living in starting next year. That, you know, we're probably at a spot where, especially in value product, one in, one out retail wholesale, with still catch up to do, and probably a bias on growth towards the premium product. Dollars will look better than units.

Noah Zatzkin (VP and Equity Research Analyst)

Thank you.

Operator (participant)

Thank you. Our next question comes from Noah Zatzkin with KeyBanc Capital Markets. Please proceed with your question.

Noah Zatzkin (VP and Equity Research Analyst)

Hi, thanks for taking my question. Just a quick one from me. In terms of high horsepower backlog for new customers, kind of how much is left in the back half there, and how much of the remaining, I guess, propulsion guide, is satisfying existing dealers and OEMs? Thanks.

Dave Foulkes (CEO)

Yeah, there's quite a bit of backlog in high horsepower still. We are still running flat out in at Mercury on high horsepower. Obviously, in terms of satisfying existing OEMs and dealers, that continues to be a priority, but we're gradually transitioning other customers as well, and we've seen our retail market share continue to rise as we begin to do that. Yeah, we have a good backlog still and continue to introduce new product, you know, to stimulate things like the 500R is a, you know, great new product that will also stimulate additional demand. Yeah, the backlogs are strong.

Noah Zatzkin (VP and Equity Research Analyst)

Thank you.

Operator (participant)

Thank you. I would now like to turn the call back over to Dave for some concluding remarks.

Dave Foulkes (CEO)

Thank you. Thank you all for joining us. Thank you for your questions. As you've seen, despite some unique challenges in the quarter, we delivered another very solid quarter. We have very strong brands. We've continued to invest in products and technology and capacity, particularly in things like high horsepower outboard and premium boats, and those are obviously strong parts of the market right now. We're also continuing with our restructuring and cost control efforts. You've seen that particularly in the Navico Group, but of course, it's occurring across the enterprise to prepare us for some of the uncertainties going forward.

It is notable, we didn't really talk about it, but Freedom Boat Club hitting 400 clubs is very notable, but we see it as a marker on a journey to a much higher numbers than that, so that's very exciting. continues to be a market where it's, you know, difficult exactly to predict, but we seem to be getting some relative stability, and I think that hopefully allows investors to see a bit through the short term and more to some of the really constructive longer term trends that we see in some of the secular benefits that we have in our business, which we will talk about, and we're very excited to have you join us at our Investor Day in September, in New York.

We'll provide an update on the strategy, talk about some of those secular long-term growth drivers, and also have an opportunity to get you out on the water on some of the exciting new products. We look forward very much to you joining us then. Thank you very much. Bye now.

Operator (participant)

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.