賓士域 (BC) 2020 Q3 法說會逐字稿

Good morning and welcome to Brunswick Corporation's Third Quarter 2020 Earnings Conference Call. (Operator Instructions) And this meeting will be recorded. (Operator Instructions)

I would now like to introduce Chris Dekker, Vice President, General Counsel and Corporate Secretary.

Good morning, and thank you for joining us. With me on the call this morning are Dave Foulkes, Brunswick's 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 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 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 consolidated financial statements accompanying today's results.

I will now turn the call over to Dave.

Thanks, Chris, and good morning, everyone. Each of our businesses delivered outstanding operating results in the third quarter. Our ability to capitalize on very robust retail demand, which was enhanced by expanded boating participation and our compelling portfolio of industry-leading brands, drove excellent financial performance and value for our shareholders.

The power of our marine platform and our investments in operational excellence were on full display as we accelerated production levels to both meet retail demand, which continues to be elevated even as we exit the primary selling season in the U.S. and begin the process of replenishing historically low pipeline inventory levels.

Our extraordinarily strong free cash flow generation provides us with the flexibility to execute our capital strategy which, amongst other things, encompasses our planned investments in growth initiatives, including new products, advancing our ACES strategy and maximizing the reach of Freedom Boat Club.

Our Propulsion business continues to gain appreciable retail market share, particularly in higher horsepower categories, as a direct result of our product leadership efforts and has yielded many new OEM customers and new dealer relationships throughout the year.

Our Parts and Accessories business delivered significant top line and earnings growth as increased boating participation and favorable weather, which extended the boating season in the U.S., drove strong aftermarket sales, while OEM production ramp-ups across the industry also created high demand for our full range of OEM systems and services.

Our premium boat brands remain market leaders in their categories and our value brands offered attractive entry points to new and returning former boaters. The surge in retail demand resulted in historically low pipeline inventory levels with only 14 weeks of inventory on hand or 48% fewer boats in dealer inventory at the end of the third quarter 2020 versus the end of the third quarter 2019. As a result, most of our brands have all production slots sold through the 2021 model year, and our Sea Ray and Boston Whaler brands have production slots sold out into the 2022 model year.

Finally, Freedom Boat Club continues to outperform our expectations as evidenced by its growth to 244 locations and almost 36,500 memberships company-wide, with over 3,000 new memberships added in the third quarter alone. Finally, although we continue to operate in an uncertain environment, our enhanced visibility into the outlook for our businesses enables us to provide guidance for the remainder of 2020 as well as 2021, which Ryan and I will speak to in a few minutes.

Brunswick continues to outperform the industry in attracting new and more diverse boaters, which is positioning us very strongly for continued growth. Similar to our commentary in the second quarter call, more than half of the sales of Brunswick boats in the period from June through August were to first-time buyers or returning lapsed boaters, with the average age of Brunswick boat buyers being the youngest since 2011 and younger than the overall industry.

Freedom Boat Club membership trends towards an even younger demographic, with the average Freedom member being 3 years younger than the average owner of Brunswick boat. The Freedom operating model allows younger boaters to get on the water frequently with high-quality products prepared and ready to go for a day with family or friends.

Boating participation has also been more diverse throughout 2020. Over the last several months, the percentage of women buying boats has equaled the highest on record, while the percentage of new female boaters -- female members of Freedom is double the percentage of women registering new boats.

More recently, in August, we saw an uptick in Hispanic and Asian buyers of Brunswick products and an increase in Hispanic membership of Freedom. It is critical to the success of Brunswick in our industry that we continue to drive more diverse boating participation and find ways to engage with nontraditional boaters through new products and participation models and advances in our digital capabilities.

I'll now provide some highlights on our segments and the overall marine market. Our Propulsion business continues to outperform the market due to the strength of our industry-leading product lineup. Pipeline inventory of Mercury outboard engines is significantly lower than in past years. And we continue to successfully ramp production to refill pipelines and meet exceptionally strong customer demand. Mercury continues to gain significant retail market share in outboard engines, especially in high horsepower categories, where we have focused higher levels of investment in recent years.

As a result of our constant product innovation and the ability to quickly ramp production as a result of the capacity increases in 2018 and '19, Mercury continues to successfully execute its strategy to win new OEM customers. A new relationship with Sportsman and an expanded relationship with Beneteau, the largest boat manufacturer outside the U.S., were announced in just the last 2 months. And there are many more new and enhanced partnerships and process.

Mercury's outstanding products, expanded capacity and excellent operational performance have also led to new dealer wins, with 60 new repower dealers added so far in 2020, resulting in an improved sales mix. Finally, the additional capacity has allowed us to serve more international customers, where our higher horsepower commercial derivatives continue to take market share.

Mercury's aggressive new product development cadence remains on track with an all-new forward-facing wake sports drive launched in August and significant additional new product launches coming in the next 6 months.

For our P&A segment, third quarter results were bolstered by very healthy boat usage as favorable weather continued into the fall for many regions of the U.S. Our distribution business, which saw revenue growth of more than 30% versus 2019 was able to capitalize on increased participation and extended season in both the marine and RV spaces.

Our engine P&A business also enjoyed a strong quarter, supplying products to our dealers to support increased service needs. Dealers have commented that they are 4, 6 or even 8 weeks behind on servicing, which should continue to generate P&A sales into the traditional off-season.

The OEM portion of the P&A business also had a strong quarter as boat manufacturers ramped up production to satisfy demand and rebuild pipelines. The Advanced Systems Group, which includes our Power Products and Attwood businesses demonstrated significant year-over-year sales and earnings improvements, leveraging the same aftermarket and OEM trends.

Including ASG, our P&A business represented almost 40% of the company's sales in the quarter and over half of the operating earnings. With margins continuing to expand, the steady annuity-based business strengthens our overall financial profile and provides a robust baseline of earnings from which we can continuously invest in our businesses and return capital to shareholders.

Our Boat business had a fantastic quarter, with top line earnings and margin improvements across the lineup. With adjusted operating leverage of over 35%, the operating performance of the business and the presence of strong wholesale demand, but also the challenge of rapidly ramping up production, creates confidence that this business will achieve its strategic goals.

Pipeline inventory levels, a key driver of future wholesale boat sales, ended the quarter at approximately 14 weeks, the lowest level at the end of the third quarter for the last 2 decades. Boston Whaler and Sea Ray has seen very strong retail sales and their dealer inventories are especially low.

Our value brands have also performed well at retail and will also require significant pipeline replenishment. We continue to hire additional workers at most facilities to ramp up production, but it is very unlikely that pipelines will be fully rebuilt in 2021.

Freedom Boat Club continues to exceed our growth expectations, with memberships increasing 61% since we acquired the business last May. In addition, sales of Brunswick products into the franchise network are exceeding expectations, with over 800 boats either purchased or on order since acquisition, each rigged with a Mercury engine and equipped with our P&A products.

Just recently, Freedom was named Entrepreneur magazine's first Top Growth Franchises list, which recognizes the 150 companies with the greatest positive franchise unit growth in North America over a 3-year period.

Just a few weeks ago, the NHL's Stanley Cup champions, Tampa Bay Lightning, held the championship parade on the water in Tampa using 20 boats from Freedom Boat Club, making national headlines for one of the most unique championship celebrations in history.

Finally, our investments in accelerating and improving our digital assets and capabilities continue to bear fruit as many in-person industry shows are scaled down or canceled due to COVID-19. This morning's announcement regarding the cancellation of the Miami International Boat Show, along with many other early season 2021 shows, was anticipated and does not influence our wholesale and retail demand projections.

Our digital and e-commerce technology is enabling us to reach and engage with a wider audience of potential new boaters, dealers and other customers in addition to launching new products online. A recent virtual trade show held by our Land N' Sea distribution business generated 16% high sales from the equivalent physical show last year.

Next, I'd like to review the sales performance of our business by region on a constant currency basis. Third quarter sales increased versus 2019 in all regions and across most businesses. In the U.S., total revenues were 27% higher, while international sales were up 24%. Asia continues to experience robust demand for higher horsepower outboards, mainly for commercial purposes, and steady P&A sales.

Other regions of the world, including Europe and Canada, reversed the challenges of the previous quarter and reported strong year-over-year growth. International sales are up 5% year-to-date, led by gains in the Propulsion business in most regions.

This table provides some color on the performance of the U.S. marine retail market. The first 3 quarters represent approximately 90% of total sales volume for the year, and it's becoming a very strong year, as most of you know. Outboard categories reported retail gains in the third quarter and positive growth for the year. The main Powerboat segments were up 39% in the third quarter and are up over 8% year-to-date, with Brunswick's retail performance exceeding the market.

Outboard engine unit registrations were up 34% in the quarter, with Mercury significantly outperforming the market as they have done for all of 2020. Mercury gained retail share in the third quarter and just about every horsepower node, with outsized increases in large outboard engines over 200 horsepower.

Closing out the year, we anticipate fourth quarter retail to continue in growth mode as lead generation, finance applications, dealer sentiment and other leading indicators are all very positive.

As another reminder that the pipelines remain both lean and current, our Blue Water retail finance business is seeing more than 75% of applications being related to current model year boats, approximately double the percentage at the same time last year when pipeline inventory was less current. All these factors give us confidence in the retail market as we move into 2021.

I'll now turn the call over to Ryan for additional comments on our financial performance.

Thanks, Dave, and good morning, everyone. Robust retail demand, together with late -- strong late-season boat usage had a material impact on our financial results in the quarter, making for significantly better year-over-year comparisons.

Net sales in the quarter were up 26%, while operating earnings on an as-adjusted basis increased by 49%. Adjusted operating margins were 16.5%, up 260 basis points versus third quarter 2019, and we finished the quarter with an adjusted EPS of $1.80 and up 64% from prior year.

We generated $396 million of free cash flow in the quarter. This outstanding outcome was driven by strong earnings and favorable changes in working capital, resulting from reductions in inventory and increases in accounts payable from increased production, as well as a seasonal reduction in accounts receivable.

On a year-to-date basis, net sales were flat versus 2019, and adjusted operating earnings were down 2%. Adjusted operating margins of 13.6%, which are just 20 basis points lower than the same period in 2019, is a very good result considering the challenges faced by the businesses in the first half of the year with having to shut down then ramp up production as a result of the pandemic.

I will now discuss our third quarter performance on a segment level. Starting with the Propulsion segment, revenue increased 33% as each product category experienced strong demand especially in higher-horsepower outboard engine categories and related controls and systems.

All customer channels showed growth in the quarter as OEM customers continue to ramp up production, and increased capacity enabled elevated sales to the dealer and international channels.

Operating margins and operating earnings were up significantly in the quarter as a result of increased sales and favorable changes in sales mix, partially offset by the unfavorable impact of higher variable compensation costs.

In our Parts and Accessories segment, revenues increased 23% and operating earnings were up 29% versus third quarter 2019 due to strong sales growth across all product categories. Adjusted operating margins of 23.4% were 100 basis points better than the prior year quarter, with year-to-date margins now 20 basis points better than year-to-date 2019, showing the consistent, sustainable earnings power of this business.

Revenues in the Boat segment were higher by 18%, resulting from significantly higher wholesale sales to dealers both to meet increased customer demand at the retail level as well as to begin refilling pipeline inventories. All of our boat brands steadily ramped up production in the third quarter to meet the strong demand. Boston Whaler and Sea Ray continue to outperform their categories, Lund remains the leader in premium and aluminum fish boats and our value brands also showed healthy retail demand.

Increased production and sales resulted in healthy operating leverage of 35% during the third quarter, driving operating margins to 9.2%, a 470 basis point increase compared to the third quarter of 2019. All product categories contributed to margin growth with Boston Whaler, Lund and the Venture Boat Group, which includes Bayliner and Heyday, all exceeding 10% margins for the quarter.

As we've been discussing, as a result of the surge in retail demand, dealer pipelines ended the quarter at historically low levels, our lowest pipeline inventory levels in over 20 years. Our Boat brands ended the third quarter with 14 weeks of boats on hand measured on a trailing 12-month basis, with units in the field lower by 48%. Our pipeline projections for year-end assume that dealer inventories will increase through the fourth quarter to approximately 22 weeks on hand, but that will still be approximately 13 weeks behind typical year-end levels.

To help put this into perspective, we are currently estimating that we will wholesale in 2020 between 28,000 and 29,000 boats while retailing between 36,000 and 37,000 boats. Even if we assume a flat retail environment next year, we will need to manufacture and wholesale 7,000 to 9,000 more boats in 2021 just to satisfy retail demand without building dealer pipeline inventories.

We believe our current manufacturing footprint will support this increase, and we continue to work with our brands to unlock even additional capacity. The resulting pipeline inventory levels would still be below desired levels by the end of 2021, but this would position us for strong wholesale sales again during 2022.

While we remain very cognizant of macroeconomic headwinds and other uncertainties, our continued strong performance in a robust marine retail environment has created improved visibility into our substantial growth opportunities for the remainder of 2020 and 2021.

Despite the potential impact of the pandemic on our global labor availability and supply chain, elevated production levels over time will be required to rebuild boat and engine pipelines and, together with significant upcoming product -- new product offerings, should drive wholesale growth into next year and beyond.

As a result, we are providing the following guidance for the remainder of 2020. We anticipate that U.S. marine industry retail unit demand will be up high single-digit percent for the year, with slightly stronger demand in the U.S. than in international regions. We expect fourth quarter revenue to increase low to mid-teens percent over Q4 2019, with adjusted operating leverage in the high teens percent. Lastly, we believe these inputs will drive full year adjusted diluted EPS of approximately $4.75, with free cash flow generation in excess of $600 million.

These 2020 expectations and the initial thoughts on 2021 that Dave will discuss shortly, assume no additional major pandemic-related business continuity issues. In addition, as we have cautioned in the past quarters, it cannot be overstated that the level of recovery of the global economy, continued stable channel operations, the ability to moderate labor and input costs and the absence of significant additional disruption to our global operations and supply chain will all be important factors in determining whether we ultimately perform in line with our targets.

Our current liquidity position is very strong. Our liquidity planning is influenced by several factors, including our cash position, our ability to generate free cash flow and retain full access to our revolving credit facility, as well as our plans around debt repayment, share repurchases and dividends. We anticipate generating free cash flow for the year in excess of $600 million, and we plan to have total liquidity of more than $970 million by year-end.

We ended Q3 with cash balances totaling $660 million versus $332 million at year-end. This increase included free cash flow generation of $520 million in the first 9 months of 2020 or approximately $441 million more than the same period in 2019, principally related to favorable changes in working capital, driven mainly by reductions in inventory.

The significant free cash flow generation in the third quarter allowed the company to repay the remaining $185 million of borrowings under its revolving credit facility, and further reduce our long-term debt obligations by $39 million as planned.

I will conclude with an update on certain items that will impact our P&L and cash flow for the remainder of the year. Aside from the updated anticipated free cash flow just discussed, most of these estimates have changed only slightly since the July call. The one exception remains working capital, where we now estimate a reduction in excess of $175 million for the year.

Given the demand and production dynamics we had discussed, inventory levels are down significantly to the first 9 months of the year. And although we do anticipate building inventory in the fourth quarter in our Propulsion and P&A segments, we anticipate ending the year with reduced working capital.

We anticipate between $115 million and $120 million of depreciation and amortization. Our effective tax rate is estimated to be between 21% to 22% for the year, with a cash tax rate anticipated to be in the low double-digit percent. Our average shares outstanding figure remains at approximately 80 million shares.

Also as a result of the strong cash flow generation, we have made some significant changes to our capital strategy assumptions, reflecting actions we plan to take in the fourth quarter. We are now anticipating that we will use an additional $60 million of our considerable free cash flow to continue paying down our 2023 term loan, resulting in total debt retirement of $160 million for the year. This incremental repayment would lower our debt-to-EBITDA leverage below 1.5x on a gross basis by the end of the year.

In September, we also announced that we were restarting our systematic share repurchase program with the goal of repurchasing $100 million of shares in 2020, which is consistent with our target to start the year. We completed $45 million of repurchases in the third quarter, leaving us with $21 million of planned repurchases in the fourth quarter.

Finally, as discussed last week, we have increased our quarterly dividend by 12.5% to $0.27 per share, which represents the 8th straight year of dividend increases. This decision is enabled by our strong financial position and consistent cash generation, which is benefited by the growth of our less-cyclical P&A and Freedom Boat Club businesses and is consistent with our policy objectives of sustaining our dividend throughout an economic cycle.

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

Thanks, Ryan. Although 2020 has presented many challenges, our businesses are executing extremely well against our operating and strategic priorities.

In the Propulsion segment, we continue to leverage the strongest product lineup in the industry to gain market share in the parts of the market where we've been historically underrepresented. Our further growth into saltwater, repower and international commercial markets is being enabled by the manufacturing capacity added in 2018 and '19 and will be bolstered by exciting new product launches in the coming months. Finally, with lower engine inventory levels across the globe, we continue to increase production in an efficient manner to refill the pipeline.

In the P&A segment, we anticipate steady demand for aftermarket parts and accessories as boaters complete their end-of-season servicing in northern markets. We also expect demand to remain high for our OEM product lines and integration services as boat-builders continue to ramp up production to replenish pipelines ahead of the 2021 retail season.

In our Boat segment, we will continue to focus on launching new products across the portfolio, including some new products designed for younger boaters, ramping up production to meet demand and refill pipelines and making progress with our stated plan to further improve operating margins. Freedom Boat Club continues to expand and execute against its strategic growth objectives. We've added over 30 locations thus far in 2020, with franchisee demand for Brunswick products pacing well ahead of anticipated levels.

We're making rapid progress with our enterprise-wide initiatives in digital marketing, e-commerce, consumer insights and data analytics, while also driving our ACES strategy forward. One recent example of our ACES investments is our growing partnership with the marine autonomy company, Sea Machines, in which we announced yesterday an additional investment aimed at advancing autonomous piloting for marine vessels.

Progress with these initiatives will be accelerated by new leaders with very contemporary skill sets joining our senior leadership team. In the last few weeks, we welcomed Aine Denari, who has deep experience in advanced mobility systems, as the new President of our Brunswick Boat Group. While Mike Adams, who's been leading many of our digital initiatives, has been promoted to the CIO role. And Brent Dahl has been named Vice President, Investor Relations.

Earlier this week, we also announced that Reggie Fils-Aimé is joining the Brunswick Board. Reggie is the former President and COO in Nintendo North America and has deep knowledge of digital technology and developing compelling consumer content and experiences.

Before we close, I want to provide a brief update on our initial view of 2021. As you know, the progression of the global pandemic remains very dynamic and the potential impact to our dealers, OEM partners, suppliers and the macroeconomy is difficult to predict.

However, we do have improved insight into next year due to increased clarity on wholesale boat demand the impact of Mercury's continued propulsion strength, the consistent growth of the P&A business and the availability of cash to fund our planned capital strategy actions and growth initiatives.

We will provide a clearer view on our forecast for the 2021 marine market during our Q4 earnings call in early 2021. However, in a reference scenario where U.S. marine industry unit demand is flat to up low single-digit percent for the year, we would anticipate consolidated revenue between $4.7 billion and $4.9 billion, adjusted operating leverage of high teens to low 20s percent and an adjusted diluted EPS in 2021 of $5.75 to $6.25, with growth coming in several areas.

First, we forecast strong gains in our propulsion business as we continue to take market share, resulting from an enhanced stable of industry-leading products. Next, we believe that we will capture significant growth in wholesale boat sales given the historically low pipelines and strong retail demand, which is backed not only by strong dealer orders ahead of the 2021 retail season but also from an increased percent of dealer orders that are already retail sold. However, note these projections do not assume that we will fully rebuild the pipeline in 2021.

We also anticipate our P&A business to continue its steady expansion as boaters to spend time on the water. Finally, our capital strategy should generate favorability as a result of debt reduction and systematic share repurchases.

I want to reiterate our continued confidence in our ability to successfully execute our 2022 strategic plan, while also ensuring that we continue to prioritize protecting the health and welfare of our employees in the COVID-19 environment.

Given our strong financial position, which enables continued investment in new product and technology development; our industry-leading products, which are generating continued market share gains; current low pipeline levels; the performance of Freedom Boat Club; and our focus on operational efficiency and cost containment, we expect to meet the 2022 financial objectives shared in Miami in February.

This morning, we announced that our Board of Directors has elected Nancy Cooper as its new nonexecutive Board Chair effective November 1. Nancy is the first female Board Chair in Brunswick's history. Nancy succeeds Manny Fernandez, who has announced his intention to retire after more than 20 years of service to the company.

I want to personally thank Manny for his decades of support and leadership to Brunswick. And I look forward to continuing to work with Nancy as we successfully execute our marine-focused strategy.

Finally, our operations teams are keenly focused on applying and enhancing our COVID-19 health and safety protocols while continuing to ramp up global production to meet unprecedented market demand. I want to once again thank our 13,000 global employees for their commitment, hard work and vigilance during this challenging time.

I also want to thank our loyal long-term customers and welcome the new Brunswick boaters and Freedom members who've been able to enjoy safe, outdoor fun with their family and friends in 2020.

I will now open the line for questions.

(Operator Instructions) And our first question comes from the line of James Hardiman with Wedbush Securities.

So I'm going to ask sort of a weird question, so bear with me here. I mean I've been covering you guys for the better part of -- well, I don't want to age myself. But a big part of, I think, analyzing the business and certainly managing the business has been just understanding the cycle, right? And we find ourselves in a situation where we're in the midst of a recession and yet the industry is going to be up high single digits. So my question is, as we look to 2021, should we be thinking about that as the first year of an economic recovery or the 11th year?

I think most industry observers had sort of resigned to the fact that maybe we'd get to 200,000 units at the peak of a cycle or maybe a little bit better and that was about it. I'm curious how you think about the long-term potential from an industry perspective and whether or not anything has changed. And how your sort of cycle thoughts inform your capital strategy, right, sitting on $600 million in cash, $600 million in free cash flow. Obviously, the way you think about the next few years is going to inform what you invest in. So sort of a big picture question there, but any thoughts would be welcome.

Thanks, James, very much. Well, it is a big picture question, but thank you for asking it. I think, obviously, this year is -- has some unusual trends in it, but we intend to fully capitalize on those trends in a way that I think will influence our business for many years to come. It is clear that we are overindexing on new boaters and diverse boaters versus the industry. And we will be working hard to retain both new boaters, and indeed, in next year and the year beyond, make sure that additional people join. I believe there's a potential network effect here, which will be extended.

If you think about this year, we have all these new boaters and returning lapsed boaters, but that really their decision time was very short. They had to decide between essentially April, when we were in the depths of the first stage of the pandemic, whether they were going to suddenly buy a boat. I think given the amount of felicity around boating and the safety and utility and enjoyment, I believe that there will be many more people making longer-term decisions that will support us for a number of years to come.

In terms of the way we kind of think about the business right now, I think we've made it clear today that we're in the middle of a multiyear effect from a wholesale perspective. As Ryan mentioned earlier, even producing at historically high levels, we will not make significant progress in increasing the pipeline in 2021. So we believe that the wholesale drivers here are multi-year wholesale drivers.

I would tell you that when we talked about our reference strategy here, it is a reference strategy. I would say it's a cautious strategy. Every leading indicator that we have points to much more robust retail demand. But we don't know exactly what we don't know right now. So we thought we would offer the strategy that presents the business in a way -- kind of in a neutral-market way, how would we do in a neutral market.

The way that we've generated cash this year certainly puts us in, I think, a strong position to accelerate some of our growth investments, whether those are organic or potentially inorganic, and position ourselves extremely well for a range of scenarios probably more quickly than we would have anticipated just a few months ago or even a year ago.

So I think we find new energy in the business right now around the retail demand and wholesale demand. And our objectives are to capitalize on that, not just in the short term but also in the long term.

Our next question comes from the line of Scott Stember with CL King.

My main question is just on the creditworthiness of the people that have come in, and obviously, we're in the early stages of a potentially multiyear cycle here of a lot -- of much younger consumers coming into this market. Could you give us any additional color on what the -- I know they're younger, you mentioned it before, but the income level and the creditworthiness. And give us some comfort that we won't have some issues potentially down the road.

Yes, Scott, this is Ryan. We've actually been tracking this obviously through our Blue Water retail finance organization, and we are not seeing any major changes or shifts in the creditworthiness of the potential buyers. So interest rates remain low, financing remains very available. And to date, we have not seen any market shift.

Our next question comes from the line of Craig Kennison with Baird.

But I wanted to really understand Mercury and the market share trends better. I know you've had the Evinrude win. You've also had OEM wins with Sportsman and Beneteau. I guess I'm wondering if you could help us understand or quantify, really, the share gains that you've seen. And then help us understand what's driving it. It feels like it's been a huge year in terms of market share wins. And I'm guessing maybe some of your OEM partners are getting a peek at what your future innovation looks like. But just want to understand those trends better.

Thank you. Craig, great to hear from you. The market share gains are significant. And we have -- we said earlier in the year that we are already trending ahead of our 2022 objectives, which were part of our Miami presentation. So clearly, Mercury is accelerating even faster than we had anticipated. I think we clearly have the best product lineup in the marketplace. And I'm very excited about what is, frankly, just around the corner as well, which I think will expand that leadership.

I would say, though, that Mercury is a very, very reliable partner. And it's important for our customers not just to have the best product, but be able to get it reliably. And so the investments that we've made over recent years and also the level of partnership that we demonstrate, I think, is superior to our competition. These wins don't just come overnight. They come after long periods of investment in terms of relationship building as well as displaying the benefits of our new technology.

I would say that -- you mentioned some of the bigger wins, but just over the past year, we have for 40, 4-0, new OEM customers. So you can tell how fast this is happening. And we are well positioned to capitalize on that trend. It's very significant, and it has a lot of momentum in it.

And then, Craig, I would also add to that, that we still have areas including repower, international markets and saltwater, where we still are underindexed to our U.S. share. So there is still runway to go, ample runway to go on the share gain. So it's not a -- we're not close to the finish line there, there's still work to be done. And as Dave said, with the best products in the industry and more to come, we're excited to go out and tackle that.

And since James opened the door on these big-picture questions, I'll slip one in here. Your new president of the Boat Group has an automotive background, including work in this ADAS field, and I know you just made that investment in Sea Ray -- or in Sea Machines Robotics. To what extent are we on the cusps of some significant revolution in kind of the operations of a boat, is that something that's -- am I overstating it?

I would say that there is significant progress in a lot of the same areas of technology that you will see in other verticals. We do have a difficult and different use case in a boat. But nevertheless, these things are going to be more material to our business in the next several years. And so we need to position ourselves with the right talent to be able to fully capitalize on that and differentiate ourselves.

Our new BBG boat President, Aine Denari is indeed most recently from a field of electronics and ADAS systems. However, he has a long history in operational excellence strategy and product development in addition, which I think will equip her to run that business in a very, very contemporary way, in addition to advancing the technology suite in a way that I think differentiates -- will differentiate our product lines.

And our next question comes from the line of Eric Wold with B. Riley Securities.

A couple of questions around M&A. As you think about the increased comfort you now have with the 2022 financial targets back in February, are you seeing an easier path getting there without acquisitions? Or is the assumed M&A contribution the same as it was back when you first gave those targets?

And then as you think about the acquisition opportunities out there, have you seen any change with the recent surge around the number of opportunities, expectations becoming elevated? And does this change your view of potentially increasing further in the Boat category itself? Or is that something you're still somewhat against?

We still have a very active M&A funnel, so we are proceeding as we previously indicated, looking to add inorganic growth opportunities. So we continue to focus the majority of our efforts exactly as we indicated, which is in kind of P&A annuity-orientated businesses, service businesses like Freedom, et cetera. So our kind of bull's eye, if you like, has not really changed.

For 2021, for the purposes of simplicity, we did not include any inorganic growth opportunities, but we remain very actively looking in that area. And we do indeed see a number of interesting opportunities.

Our next question comes from the line of Joe Altobello with Raymond James.

So I guess, first question, this is probably a hard number to tease out. But within that high single-digit U.S. retail industry growth that you guys are looking for this year, how much of that do you think is coming from the unusually high number of new and lapsed boaters this year versus what we would see in a normal year? I'm just trying to quantify maybe what the COVID tailwind, for lack of a better term, is for this year.

Yes, it's a good question, Joe. I think in the middle of the year, we definitely had a significant contribution from new and lapsed boaters. I would say that we do believe, though, that because of somewhat constrained inventory, they probably displaced more traditional boaters who would have, in other circumstances, probably upgraded that boat this year. So given the inventory constraints, it is a little difficult to kind of understand exactly what the dynamics of that effect would look like in the out years.

I think it is possible next year that we'll be seeing similar levels of influx of new bolters and people who wanted to upgrade this year but didn't have an opportunity to kind of reentering the market as well. I'm sorry, it's not a great answer to your question. But in a supply-constrained environment, which we kind of are in right now, it's difficult to know than that.

No, I understand. And I guess, secondly for Ryan, you did some really good numbers, some really good color on units and pipeline refill for 2021. I'm curious what you're seeing on the ASP front. I mean, obviously, Whaler and Sea Ray are selling very nicely, and those tend to be higher-priced boats. So do they just continue to be a nice tailwind next year as well on the Boat business?

Yes, Joe, ASPs do continue to climb even in light of a little bit more strength on our value product this year. I think people putting more content on their product up and down the lineup, whether it's value or premium, is really driving that. So yes, I would tell you there's probably some tailwinds there. Also combined with the fact that some of our more premium brands, such as Whaler specifically, has new product lineup, new products that is ramping now and probably will see a little bit more retail next year as opposed to what they did this year. So I would say, yes, on your ASP question.

Maybe just a bit -- Joe, I don't know if this helps, but we're only a day into the Fort Lauderdale Boat Show, but we're already seeing sales from the first day of Whalers ahead of last year, even with the extended delivery times that we would now be quoting. So it is clear that there are people who may be delayed their purchases this year and they're now thinking I'd better get in the queue, otherwise, I'm not going to get anything.

Your next question comes from the line of Gerrick Johnson with BMO Capital Markets.

David, when you address 2021 guidance, you mentioned to have more clarity and the clarity with overall demand drivers. You didn't mention clarity on supply or costs or anything like that. So maybe if you could talk about that part of the equation. And is your guidance for 2021 anticipate new capacity? And what levels of capacity utilization will you be at to achieve your 2021 numbers?

Yes. Thanks, Gerrick. I think maybe answering the last first. No, it does not anticipate any new capacity. It does not anticipate any bricks and mortar. There may be some local, smaller things that we need to do. But given the demand, we are certainly looking -- not really a lot of bricks and mortar, but other ways to potentially increase capacity, and we're actively studying that right now.

On the cost side, we're certainly seeing a little more pressure from suppliers who are constrained at the moment, probably by their own internal capacity and may be experiencing kind of Tier 2 pressures as well. At the moment, I would say on the cost side from -- on the supply chain side, it doesn't look like thing -- anything that we couldn't contain or very largely contain.

Our ability to ramp up has been very good. And I think we've been hiring a lot of people. We hired 900 people across the operation in Q3, 900 production workers in Q3. We're still hiring pretty successfully. But certainly, as we go through the dynamics of COVID in the different states, we see different levels of absenteeism that we have to compensate for.

So the 2021 forecast is really a no new major capacity actions, assuming that we can continue at reasonable levels of operational ramp-up. And in that scenario, as Ryan mentioned, we don't really put a big dent in the -- or we're not able to recover a lot of pipeline. Obviously, that is not -- that is less than we really would like to do ideally. So we are certainly studying ways in which we could ramp up faster, but it would not materially impact our footprint.

Okay. And then right now your inventory is down 27% year-over-year. It looks like you'll have to flow a lot of materials in the next couple of months to hit that sales guidance. So given the state of supply chains, how confident are you in being able to achieve revenue growth of, what, 13% to 15%, I guess?

Well, so far, we're very actively managing and monitoring our supply chain. We -- I would say that although we're experiencing issues that we need to manage on a daily basis, nothing is really slowing us down. So it's possible that, that will happen, but that is not the current situation. I think we're all managing our way through the COVID environment as best we can, both us and our suppliers. And so far, we've managed to do that.

So essentially, we -- while we have short-term shortages, we manage that. I can't foresee exactly what might happen in the next year. But obviously, if there's a major disruption that's going to impact us, right now we seem to be managing it okay. And I believe that we can ramp up as we need to, to deliver the 2021 forecast.

And our next question comes from the line of Mike Swartz with Truist.

To start off with the 2020 guidance. Maybe, Ryan, you can help us with this. So the operating leverage for fourth quarter is expected to be in the high teens to mid-20s in the third quarter. Don't see a lot of change in terms of what you're talking about strong demand, favorable mix, et cetera. So I guess why should we expect that step-down between the third quarter and the fourth quarter?

Yes. Thanks, Mike. And then this is something we obviously anticipated coming into the call. The third quarter was quite strong, really at the gross margin line. We had very favorable mix in Propulsion and really throughout some of the P&A categories as well, and also some lower retail discounts in the Boat group, as you would imagine, given the state of play in the retail market. Also, OpEx was down in the quarter. Obviously, OpEx percentage of stronger sales. And frankly, just operating efficiency across the board benefiting from the cost takeout measures that we did in 2019 and earlier this year.

And then when you look to the fourth quarter, there's still going to be some benefits on the gross margin line. Probably a bit muted, a little bit more muted due to the smaller sales increase that we're anticipating. Mix benefits probably would continue a little bit, but not quite to the same extent. And remember, we've got some seasonality in there, obviously, with lower sales projected in Propulsion and P&A, just due to the usual course of play.

And then on OpEx, in the fourth quarter, there's a couple of things. There's a little bit more R&D expense coming out of Mercury, which I think most people will say that's a good thing because that means good things on the horizon. And a little bit more variable comp that is associated with our better performance. So it's not a big number, obviously, with the fourth quarter leverage is still within our usual kind of between high teens and low 20s goal, but a couple of things sway it a little bit in the fourth.

Okay. That's helpful. And just a second question. Just more of a philosophical level, I guess. Given the amount of visibility you have in the business, given the ample liquidity you have, how does that change when you think about financial leverage in the business over the next several years?

Yes. I mean that's -- Mike, we obviously are going to end up in a position at the end of the year, which is where we strive to be, 1.5x. And I assume you mean our financial leverage from a debt capacity standpoint?

Correct.

Yes. We're going to be in a good place, obviously, by the end of the year. And as we continue to pay down our term loan, that number is going to be closer to 1x. And all that does is it enables us to ramp up as needed for a large investment, whether it's product or M&A or the like. I think we've shown with the Power Products deal that we are able to leverage up and will for the right deal. And the rating agencies seem to be okay with that, given that we -- these are good mergers and acquisitions deals and good assets out there. So we are okay leveraging up for the right asset, but continue to work it down over time. I think given the nature of what we do in our industry, I think keeping it 2x or lower or really 1.5x lower will still remain our goal.

Our next question comes from the line of Brett Andress with KeyBanc Capital Markets.

I may have missed this, but how much of your Boat production slots have a customer name on it? Or is retail sold at this point versus maybe how much is allocated to dealer restocking?

Yes. We really don't give that exact number, Brett. I would tell you it's less than half, but it's more than usual at this time of year.

Got it. Okay. And then on Slide 25, where you talk about the '21 EPS bridge. Just a question on the smaller P&A contribution in that slide. I mean what are the underlying assumptions there? And is that underwriting less boat usage or restocking next year versus the other segments?

Yes. This is another one we anticipated pretty straightforward just because it comes -- it pops out a little bit on the chart. This shouldn't be surprising. I mean the P&A business is a more steady grower, more annuity-based. It grows a little bit with inflation plus some market share gains and other things in the OEM businesses.

I think we had a very strong -- we're having a very strong second half in that business. You saw the revenue gains in the third quarter. I think if you take our guide for the fourth quarter, that imputes some pretty strong P&A growth there as well. So that's a business that's able to kind of restock a little bit more continuous; whereas engines and boats, it takes a little bit of time to refill the pipeline.

I would note, obviously, that P&A segment, as Dave mentioned, is one where -- M&A is where -- is one area where we're targeting. That description does not include M&A on that page are in the $5.75 to $6.25. So there's probably a little bit of -- maybe a little bit of conservatism there. But this is a fantastic business that really elevates our earnings floor in any economy, in any marketplace, as shown by its performance in the second quarter this year when essentially the world stopped for 2 months.

And our next question comes from the line of Shawn Collins with Citigroup.

So my question is on margins and specifically margins at the Boat segment. Top line trends are obviously quite healthy. But in addition, your operating margin really came in at what I believe is a record margin of 9.2%. I know you have done a lot of hard work around costs, realignment and restructurings. I wanted to ask, is this a margin and a level of profitability that you think is sustainable in the future?

Yes, thank you for the question. Yes, we certainly believe it's sustainable, and we certainly plan to grow that even further. I think we, obviously, in the third quarter and fourth quarter are benefiting from volume. But we're also working through ramping up onboarding people, training people and having some inefficiencies in that process. So I think our strategic actions in the Boat group are flowing through nicely cost reductions, organizational consolidation, in addition to the strong product line and a little -- some of the new products coming through. But we have room to run on those margins, both on the efficiency side and I think on the gross margin side as well. So we're -- I think that this is a great trend. I'm very glad to see it, but expect more.

That's great. Maybe just a quick second question on supply chain. I know you just touched upon it to some extent already. But we certainly here get a lot of questions on this subject. As Ryan accurately said, the world stopped for 2 months and then restarted all at the same time, and that's created some log jam. Can you just talk about some specific areas where you've seen more challenges and where you're putting a little bit more of your time to, obviously, successfully navigate any supply chain concerns there?

I think that we have the benefit of a Propulsion supplier that -- from Mercury that invested tremendously in capacity and efficiency and continues to invest there. So I think all of Mercury's customers uniformly are benefiting from not only Mercury's great products but its tremendous investment in capacity. And so that takes an issue off the table that the other people might be experiencing.

I would say that as we go through the various waves of COVID, it affects different states and even different countries somewhat differently. So for example, Mexico, or the northern states in Mexico where a lot of wiring harnesses and other electrical systems are developed, have experienced some ups and downs. Although right now, that area is producing very well. So I would not isolate any specific kind of subsystem as an issue. I would just say that we are continuing to manage. And we're working extremely well with our supplier partners, and we're very thankful for all the efforts that they're putting in. There is nothing right now that is -- rises to the kind of area of holding the business back.

And at this time, we would like to turn the call back to Dave for some concluding remarks.

Well, thank you all very much for attending today, and thank you all for the wonderful questions. As you've heard, it's been in some ways a challenging year for all of us, including our employees. But our whole team is very, very excited about the energy in the marine market. We believe we have a unique platform and our investments in products and technology and capacity position us exceptionally well to capitalize on this situation. All of our retail and wholesale leading indicators suggest this is a multiyear and very robust effect.

I'd like to close by personally thanking our outgoing Chairman, Manny Fernandez, for his tremendous partnership over the last 2 years. I wish him every success in the future. I know we'll stay closely in touch. And by warmly welcoming Nancy Cooper as our new Board Chair and Reggie Fils-Aimé as a great new Board member. Thank you all very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect.