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Brunswick Corp. (NYSE:BC)

Q3 2007 Earnings Call

October 26, 2007, 11:00 AM ET

Executives

Kathryn J. Chieger - VP, Corporate and IR

Dustan E. McCoy - Chairman and CEO

Peter G. Leemputte - Sr. VP and CFO

Analysts

Michael Savner - Banc of America

Laura Richardson - BB&T Capital Markets

Edward Aaron - RBC Capital Markets

Hayley Wolff - Rochdale Securities

Joseph Hovorka - Raymond James

Hakan Ipekci - Merrill Lynch

Timothy Conder - Wachovia Securities

Justin Boisseau - Gates Capital Management

Presentation

Operator

Good morning and welcome to Brunswick Corporation's 2007 Third Quarter Earnings Conference Call. All participants will be in a listen-only mode until the question-and-answer period. Today's meeting will be recorded. If you have any objections, you may disconnect at this time.

I would now like to introduce Kathryn Chieger, Vice President of Corporate and Investor Relations. Thank you. You may begin.

Kathryn J. Chieger - Vice President, Corporate and Investor Relations

Thank you and good morning everyone. With me today are Dusty McCoy, Brunswick's Chairman and CEO; and Pete Leemputte, our CFO.

Before we begin our remarks, let me remind everyone that during this call, our comments will include certain forward-looking statements about our future results. Keep in mind that our actual results could differ materially from expectations as of today. For the details on the factors to consider, please look at our 10-K for 2006, our June 10-Q, and our earnings released issued this morning. All are available upon request or by going to our website at www.brunswick.com.

We appreciate your taking time to be with us this morning. We try to keep our remarks brief and wrap up the call in about 45 minutes.

Now, I will turn the call over to Dusty.

Dustan E. McCoy - Chairman and Chief Executive Officer

Thanks, Kathryn and good morning everyone. Let me begin by telling you, we are at the coming of the third quarter, based on successes we have had in a number of areas. First, with the decline of the U.S. marine market that we delivered with since the fourth quarter of 2005. We have been forced to play catch up on an almost continued basis as we attempt to keep ourselves and our dealers healthy.

As we discussed on many occasions, a key focus has been managing our pipeline. We have had the continually decreased production levels in an attempt to stay ahead of a declining market. As we went into the third quarter, we knew we have to make substantial progress in pipeline management. Before we and our dealers going through the winter season and we did so. Obviously, to accomplish that cost real pain to our margins. Production cuts, reduced sales, lower fixed cost absorption, an increased promotional spending, together with cost associated with plant closures, the start up of our newly acquired plant in North Carolina, were all factors in our results.

But we now have nearly 3,000 fuel boats in our pipeline than at this time last year, and almost 2,000 of that fuel are high margin fiberglass boats. Our boat pipeline measured by weeks of supply decreased by one week to 26 weeks at quarter-end versus year ago. This is a significant milestone as it marks the first year-over-year decreased we have reported in about three years, and most importantly, it begins to bring stability to our operations. And we did this in a market that was down double digits.

Second, we are producing earnings in this difficult environment and we are reaffirming $1.20 to $1.30 EPS forecast for 2007. Pete will give you more details in a few minutes.

Notwithstanding our earnings issues on our boat business, we have several businesses continuing to provide important contributions to our earnings, like fitness in commercial U.S. business, marine retail, marine parts and accessories and our international marine and fitness operations. Third, maintaining our financial strength is always important and it seems to more so during the marine downtime like the one we are going through. Maintaining this efficient level of cash is important and as we ended the third quarter, we have $328 million of cash, and importantly, we continue to generate solid cash flow under these conditions. So, all in all, we are in good position in this difficult market, and marine industry continuous to be down in double digits. We discussed the factors impacting industry for several calls now and there is no need to repeat them. And we see no easing of these conditions in the near future.

The prolonged market decline in the outboard boat market is the primary driver to the $66 million pretax impairment we recorded in the quarter for certain treadmills in outboard boat businesses. These businesses have remains important to us and this charge, no way signal any reduction in our commitment to them. The market in accounting rules have collided on this one and the $66 million impairment is the result. Pete will speak shortly about this.

And with that, I am going to turn the call over to Pete.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Thanks Dusty and good morning everyone. As you saw in our press release, we reported earning of $0.15 per share from continuing operations in the third quarter. That’s excluding the impairment charge and a $0.04 tax benefit associated with prior fiscal years. Those results represents a 67% reduction in earning from the $0.48 we reported in 2006, excluding a favorable $0.06 per share tax benefit last year.

Before going into details for the quarter, let me spend a few minutes on the tax results… led to the $66.4 million pretax impairment charge for our treadmills associated with our outboard boat company. It’s important to note that we built our presence in outboard boat market before the current and I should say unprecedented marine downturn. The charge reflects the deep decline in markets for outboard powerboat as well as some share loss. For example, unit retail demand in 2007 for aluminum boat over 16 feet is down 20% compared with 2004. If you look at the upper Midwest where our brands have a much greater presence, the market is down 43% over the same period, meaning almost half of this market has disappeared. The weakness is at limited to aluminum outboard boat, but also the salt water outboard market.

Outboard fishing boat demand is down 18% nationally versus 2004, but often even larger 26% in Florida, but we tend to have a more significant presence. The slower decline become much more pronounced this year as we have experienced the rollover impact from the depressed housing market.

Finally, it is important to keep in mind that the impairment charge in no way signal any lack of support for our outboard boat business, just the opposite, in fact. We hold sizable share positions in important segments of the market, which will allow us to capture scale advantages in manufacturing and even more over time. As an example, we announced last week that we are consolidating the manufacturer of aluminum boat for the plants in Aberdeen Mississippi to one of our Minnesota production facility. Building on the previously announced ship to pontoon from averaging to pontoon plant in Indiana.

Please note that all of the numbers I will talk from this point forward exclude the impact of the impairment charges and tax benefits in the quarter. Net sales of over $1.3 billion in the quarter were down by 1% versus 2006, led by a 10% drop at the boat group. That decline was offset in large part by double digit growth at Fitness, mid single digit growth at Mercury, and very slight increase at Bowling & Billiards.

The boat group experienced a 14% decline in sales in the United States in the quarter, offset in parts by 12% growth internationally. U.S. sales decline is driven by lower wholesale unit boat shipment. Other our boat parts and accessories business posted solid growth. International growth was most pronounced in Latin America, Canada, and the Asia-Pacific region.

Mercury reported an overall sales increase of 6%, a significant figure when compared against the boat group decline. As noted in our last call, Mercury balances from a greater concentration of international and PNA sale, accounting for 55% of the total compared to 36% for the boat group. Mercury also has the added benefit of posting outboard sales growth. As these pipelines are in good order and we continue to ship more four stroke model from our Japanese joint venture, where we suffered operational constraints a year ago.

Engine pipeline stood at 22 weeks of supply at quarter-end, up from 17 weeks a year ago. The increase was driven by the additional four stroke models from Japan as well as due to boat builders ordering engines in advance of regulatory change in California, requiring catalytic converters on sterndrive engine manufactured in past after January 1, 2008.

Turning our attention to profitability. We saw consolidated third quarter operating margin of 1.5%, down by 410 basis points versus 2006. The decline of split almost equally between gross margins and operating expenses on a percentage of sales basis. Lower sales and higher discounting at the boat group along with unfavorable fixed cost absorption across the marine portfolio and some exchanges drove the gross margin decline.

Operating expenses grew by $24 million in the quarter versus the year ago period. This is the same trend seen in the first half of 2007 and reflect the number of factors, including inflation, the weaker dollar, higher healthcare cost, marketing expenses for new product launches, restructuring cost, and bad debt accruals for receivables at our bowling products business.

Variable compensation expenses also contributed to the increased operating expenses. Although, this is largely the result of the reversal of incentive accruals in the third quarter of 2006, as the markets weaken significantly in the second half of last year. Let me also point out that we are seeing the benefited restructuring activities initiated over the past year. The significant expense reductions from these activities, however, were more than offset by these cost increases I just detailed.

You will also note that we reported the $7 million increase in the other income. As we reached a favorable legal settlement that contributed $0.05 per share in the third quarter, obviously, this is good news, since our last conference call. It is now factored into our revised guidance. So, this benefit will be almost completely offset in the fourth quarter by charges related to recently announced closure of our Mississippi boat plant and the restructuring at our Belgium operation. So, I should point out that these nonrecurring items in total have had no net impact on the $1.20 to $1.30 per share guidance for the year.

Let’s delve into our marine operation, starting with some detail on the boat group loss of just under $24 million compared to the earning of about $25 million last year. The $49 million swing comes from three key factors. First, over half of the shortfall is the direct result of reduced gross margin on lower wholesale shipment, coupled with the impact on fixed cost absorption for lower production.

Increased retail discount program and wholesale dealer support account for another quarter of profited decline. Since we still have more what to do on cleaning out 2007 model from dealer inventory, continued support will be needed as we move further into the 2008 model year.

Third, the remaining quarter is spilt between the impact from replacing sea line largest dealer went bankrupt, as we discussed on our last conference call. The delivery slippage of several larger boats in September and new product margin issues at one of our boat brand.

Turning to Mercury, operating margins were down by 100 basis points to 8.45% compared to the third quarter of 2006. And unfavorable mix shift is one key factor as we sell more small horsepower fourth stroke of our Japanese joint venture. This was offset is the large part… by the strong benefit coming from our ongoing Lean Six Sigma offer, along with successful cost reduction efforts for outboard boat manufacturing.. In addition, at Mercury we see the greatest impact from the weaker dollar of any Brunswick operation. Total currency translation for Brunswick contributed about $0.05 per share to consolidate earnings in the quarter, and let me just point out that was included in our earlier guidance.

Turning to our non-marine businesses, Life Fitness posted impressive 10% topline growth. This was down across our U.S. commercial equipment operations as well as international commercial, again, consumer market. Profit margins were down 130 basis points at fitness due to higher R&D and marketing expenses and support of product launches across our commercial cardio product line. As we enter fitness’s key selling season, we expect to post continued sales growth in the fourth, the company that with improved earnings and margin.

At Bowling & Billiards, we saw 1% sales growth. The segment benefited from three new Brunswick Zones XL centers that opened this year, but the favorable impact was offset in large part, our lowest sales from bowling products unit. We reported a slight loss in the quarter from start up expenses for the new centers as well as one currently under construction. Continuing operational challenge with Reynosa bowling ball plan and bad debt accrual at bowling product.

Let’s now turn our attention to free cash flow and the balance sheet. As Dusty mentioned we ended September with a cash balance of $328 million and the debt to capital ration of 27.6%. Given the uncertainty and the overall economy and the recent dislocations in credit market, it is important that we maintain a high level of liquidity. We continuing significant cash flow during the first quarter of this each calendar year as working capital build in advance of the marine season. You can expect that our first priority is to keep our cash balance about $300 million as we move into 2008.

During the quarter, we brought back 1 million shares for stock for just over $28 million. This brings our buyback share to-date of 3.6 million shares. We have 251 remaining under our current Board authorization. We obviously believe it worthwhile to repurchase stock at the current prices, and you will see the program continued to the fullest extent possible but we will not take an additional debt to increase the program and we will make sure that cash balances are at that $300 million for us.

In the third quarter of 2007, we generated $101 million of free cash flow continuing operation versus $83 million in the same period of last year. The impact of reduced earning and higher capital spending due to investments in the Navasta [ph] boat plant and in new Brunswick Zone XL is largely offset by a lower year-to-date working capital build compared to 2006.

During September 2007, our increase in working capital stood at $50 million, down from $144 million in the prior year. This is the biggest factor driving that improvement is the lack of bonus payouts in early 2007, which obviously consumed cash, due to the weak marine market in the prior year.

Looking at our balance sheet, we have some significant challenges ahead to reduce working capital by year-end, particularly for inventory, which was up $125 million at the end of the September compared with the year ago. There were two key drivers. First, Mercury hold higher inventories in Europe, due to higher dynamics. Second, we have higher boat inventories in our own backyard, including large… and I might add expensive both we didn’t shipped in September. We have planned to significantly reduce inventories during fourth quarter dealing in good measure to the extended production outages will be taken during the Thanksgiving and year-end holidays. You can also see that accounts receivable of $511 million is up $38 million versus September 2006, despite the slight sales declines for the Company. International growth at Mercury is the key driver as we offer longer payment term outside the U.S.

On a full year basis, we continue to expect capital spending to run at about $220 million. Depreciation and amortizations expense is expected to come in around $175 million for the full year.

Before turning the call back over to Dusty, let me will finish by pointing out that we realized $0.29 per share and income from discontinued operations in the quarter. This is the results of the gain we realized on the sale of the fleet management business and some associated tax related benefit. With this sale, we have completed the divestiture of BNT.

With that, let me turn the call over back to Dusty.

Dustan E. McCoy - Chairman and Chief Executive Officer

Thanks Pete. As we look ahead, we see the United Sates marine market continuing to be subjective to economic stress. 2008 will, in all likelihood, not be a rebound year in the marine industry. Notwithstanding that, we have much to look forward too. Our Zeus drive and joystick docking system is now becoming available to consumers. The demand is outstripping our ability to supply at present. Forget the supply and demand for Zeus under control and this is a high class issue.

Axius, which is the strong drive equivalent of the Zeus hot drive system, is coming to market in spring 2008. Axius just won the IBEX Innovation Award and we are thrilled by the reception of this new product. Zeus and Axius were drive demand and forever changed the boating experience. In addition to innovation on the engine side, our boat companies are working on an incredible array of new products for next year for the 2009 model year.

Life Fitness has rolled out its new treadmills and the new elliptical trainers will be released over the next several days. These releases will be followed by the new upright and recumbent bicycles early next year. These products carry new performance, interface with styling features and are receiving wonderful reviews from our customers. We continue to open Brunswick Zone XL and with each opening, we get better returns. We plan to accelerate the pace of new openings to take advantage of this truly unique idea and the entertainment and services it provides to its patrons. We are pursuing outside financing to fund a good portion of this growth. We continue to blocking and tackling needed to execute against our strategic initiatives.

As we have mentioned we announced last week the closer of our boat plant in Mississippi. This is a reflection of our March to improve our manufacturing footprint. Our dealer advantage program continues to expand and we now have over 1,000 dealers participating in the program. We plan to offer the program to our fitness and billiards dealers over the coming month. These and hundreds of others big and small activities have enabled and are going to continue to enable us to make significant progress in increasing our earnings power, as evidence by our performance during this prolonged marine downturn. However, even with our successes, we believe we can and should do more. We will be sharing with you our thinking concerning how we plan to change Brunswick’s earnings profile at our Investor Day event in December.

Thank you for listening, and we will now turn the call over to questions.

Question and Answer

Operator

Thank you. At this time, we will begin the question-and-answer session. [Operator Instructions].

Our first question comes for Michael Savner with Banc of America. Sir, your line is open.

Michael Savner - Banc of America

Thanks. Good morning. A couple of questions. First a very quick one and I thought if I just missed it. Did you explain where the $7.5 million of other income, which I assume is part of the $0.16 of adjusted EPS? Was that mentioned Pete?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Yes it was. It related to a legal settlement that we had basically that's $0.05 per share and we just pointed out, Michael, and if everybody is listening that, again, that did not affect our overall full year guidance of $1.20 to $1.30, because there’s been a number of restructuring, the plant closures, and also some restructuring going through in Europe for Mercury that’s completely offsetting that.

Michael Savner - Banc of America

Okay, sorry I missed that. And then going back to your guidance, you did reduce it a little bit, you brought it to the lower end of the previous range. I guess just conceptually, can you take us through… when you spoke to us in late July, it sounded like you expected to absorber most of the downturn in the third quarter until we see a progression of improvements in the third quarter to the fourth quarter, but when you… when we back into the new guide, essentially it’s for the fourth quarter, it’s looks obviously lower than what you did this quarter. So, how do we think about that change and combined with that, it's a kind of a double question, how comfortable are you with the current inventory levels on your balance sheet? Is that… it’s all time high 14% higher than previously. How do we think about that as you continue to manage the pipeline, that you are building that it appears to be a build up of inventory on the balance sheet?

Dustan E. McCoy - Chairman and Chief Executive Officer

First, we are comfortable with the level of inventory on our balance sheet, and Pete mentioned and I want to make sure we highlight it. We are going to be taking significant outages in both engine and boat production in the fourth quarter. And as we have been working with our dealers to plant for the quarter, we have a good view for all those… where all the product is going. A second item and it was, frankly, a bit of a surprise to us, but we are working our way through it. As we had a group of large yachts that we did not get shipped in September and that's why they were hung up on the balance sheet at September end and we will be bring those through in the fourth quarter. In terms of our guidance, the market continues to be in key states, which influence the fourth quarter, California and Florida are really terrible. As we look at Florida, it’s down 20%, California is down 30%, and we are… and 40% of retail in Q4 actually happens in California and Florida. So, as we thought our way through what we think we are going to be able to do in the fourth quarter we factored that in, Michael. Pete, do you want to add to that.

Michael Savner - Banc of America

Okay.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Yes, I don’t think we have that… we got some very preliminary information on the industry trends yesterday actually. And the initial data that we have seen, the fourth, a double digit decline in fiber glass, both purchases at retail and its pretty much along the same lines as what we thought in the second quarter, which was down 12%.

Michael Savner - Banc of America

Was that monthly or quarter-to-date data?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

That’s quarter, but it’s preliminary, there’s some states that have not reported yet.

Michael Savner - Banc of America

Okay. Thank you very much.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

You are welcome.

Operator

Our next question comes from Laura Richardson with BB&T Capital Markets.

Laura Richardson - BB&T Capital Markets

Hi, thanks. This could be… it's a simple question, it could be too simple but, or could be hard but I am just trying to understand. For ’08 it sounds like you are not forecasting your recovery that's for sure. Let’s say it was flat this year in terms of the sales? Is the restructuring sufficient now that you will be more profitable on the same amount of sales in ‘08 than you were in ’07?

Dustan E. McCoy - Chairman and Chief Executive Officer

Well, it's a simple question and I do not want to be offensive at all, but its one I am not going to answer right now Laura because I just don't want to get into giving guidance for 2008 yet.

Unidentified Analyst

Darn I was hoping I could ask it that way. Okay thanks.

Dustan E. McCoy - Chairman and Chief Executive Officer

You are welcome.

Operator

Our next question comes from Edward Aaron, of RBC Capital Markets. Sir, you line is open.

Edward Aaron - RBC Capital Markets

Thanks, good morning, guys.

Dustan E. McCoy - Chairman and Chief Executive Officer

Hi, Ed.

Edward Aaron - RBC Capital Markets

I am going to take a different stab at the previous question. You have talked about in the past about trough earnings and then the cycle being higher than trough earnings in the prior cycle. In light of the current market conditions do you still have comfort with that statement?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Well if you look at our performance this year Ed, with a $1.20 to a $ 1.30 per share It’s higher than the $0.96 we reported back in 2001 and if that's Dusty said we are not making any comments about next year. We should point out though too, that in our last call back in July, we indicated that we are taking our production down significantly just to make, because production was falling, excuse me because retail demand continued to fall. We wanted to stay ahead of the curve and when we talked about that we talked about the fact that we tend to make pipe line corrections over the course of the model year which would really run until… through the end of the second quarter in 2008. So, should expect that production rates and hope there are shipments there for… there’s some key pieces of our…. both of them in particular and probably MerCruiser would be at lower levels than they were in the first half of 2007.

Edward Aaron - RBC Capital Markets

That, that makes sense and your outboard business is actually showing positive growth now, that's the decline in that business by the rest of the industry by perhaps a year. Would it be fair to say that borrowing something absolutely disastrous that the broader boat business would be up in 2009 model year?

Dustan E. McCoy - Chairman and Chief Executive Officer

Here again, in order for us to make that statement we have to factor in what’s going to happen to retail, and I just don't want to start making that prediction right now.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

What I would tell you, what you are seeing for outboards as well, obviously for some of our aluminum boat business as well as for outboards we saw the weakness there. Actually in 2005 before we started to see the weakness in the fiber glass boat segment, so we have been at this pipeline correction for a longer period of time with those particular segments and remember what we are doing right now is we are producing at a level well below retail demand. Our fiber glass boat was 17% current production this year, but what tends to happen is once you get the pipe line in good shape you generally will see your production rate go up as long as retail does not drop any further. And that's the impact that we are seeing right now with our outboard engine business as well as the fact that we have more of those small horsepower four strokes available to us.

Edward Aaron - RBC Capital Markets

Okay, thanks that's helpful and then on the engine side the catalytic converter issue. What we have heard is that it is some… the over all additional cost is somewhere close to maybe a $1000. Is that a… for an engine, is that about right from a retail standpoint?

Dustan E. McCoy - Chairman and Chief Executive Officer

In a range for… here’s the… its got a lot… where depend add upon size of the engines because with smaller engines that are carbureted engines, they first got to be made DFI and then from there once you put the converter on them so they will have a little more larger engines which are already DFI and have almost nothing in terms of the percentage.

Edward Aaron - RBC Capital Markets

Okay. And then final question just with your comments about you balance sheet inventory by the end of the year. Can you give us some order of magnitude on how much you expect that to come down?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

We are looking for a fairly significant drop and I don't want to give a specific number as because it gets very difficult. Some of our… actually we are extending some of our origins over into the first week of January and a point in time number but, its at a minimum, many tens of millions.

Edward Aaron - RBC Capital Markets

Okay. Thanks for taking my question.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

You are quite welcome Ed. Thank you.

Operator

Our next question comes from Hayley Wolff from Rochdale Securities. You may ask your question.

Hayley Wolff - Rochdale Securities

Actually most of my questions were asked. Just a few more. Can you just comment in more detail on the slippage of the boats that are in inventory? I missed you comments on them.

Dustan E. McCoy - Chairman and Chief Executive Officer

They were very large product. And we didn’t get them completed to the customer satisfaction during the quarter.

Hayley Wolff - Rochdale Securities

Anyway are you going to attach a number to that?

Dustan E. McCoy - Chairman and Chief Executive Officer

I would like not to.

Hayley Wolff - Rochdale Securities

Okay.

Dustan E. McCoy - Chairman and Chief Executive Officer

But it’s big numbers.

Hayley Wolff - Rochdale Securities

Big numbers. Second, in terms of the… half of the gross margin pressure came from absorption of all of the discounting.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

No, half of it came from… half of the $49 million swing in earning at flow through, came from a combination of lower shipments as well as the impact of that fixed cost associated with lower production.

Dustan E. McCoy - Chairman and Chief Executive Officer

And then a quarter was discounting,

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Talking about the dollar change in earning for both segments.

Hayley Wolff - Rochdale Securities

Right. Is there a way to quantify the rebating that you did comes off your topline right,

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Yes, it comes off your topline… it’s reflected in that sales and goes all the way through to the bottom line.

Hayley Wolff - Rochdale Securities

Is there anyway you can get a sense of what that might have cost.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

The discounting in total was 25% of $49… I say $50 million. So that's $12 or $13 million.

Hayley Wolff - Rochdale Securities

Okay. The margin of Life Fitness, I thought they were… we are going to start to see some margin improvement in the second half of the year.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

There’s still right before this selling season in the quarter, Hayely. And what tends to happen is we are finishing up the R&D which is running at a higher pace than the prior year and we are also spending more on marketing and promotional materials to get ready for those launches that are coming up that Dusty mentioned. So, it’s really kind of a timing impact, but as I stated in the fourth quarter you are going to see the sales increase and you are going to see higher earnings versus the prior year as well as higher margin in the quarter. So, you will start to see the benefits of that this quarter.

Hayley Wolff - Rochdale Securities

Is there a way that as we look into 2008 on lower sales volume as the restructuring initiative that you put in place over the past three years, can be significant enough to over come. Any kind of modest sales decline in marine.

Dustan E. McCoy - Chairman and Chief Executive Officer

Again, Hayley, I want to be polite, but I just don't want to keep talking about 2008 if I may at this term.

Hayley Wolff - Rochdale Securities

Okay. I understand. All right. That's it.

Dustan E. McCoy - Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from Joe Hovorka with Raymond James. You may ask your question.

Joseph Hovorka - Raymond James

]

Thanks, a couple of quick questions. The tens of millions reduction in inventory year end, is that year-over-year or from the third quarter?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

It’s from the third quarter.

Joseph Hovorka - Raymond James

Okay, would we see a year over year decline?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

No you probably won’t, just as well. We have got a couple of acquisitions since then which has picked it up around $10 million but we still believe we probably be higher than we would be at the year, at the prior year end although a fairly significant decline, versus the third quarter.

Joseph Hovorka - Raymond James

Okay and then you gave the engine weeks numbers, 22 weeks versus 17 weeks?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Yes

Joseph Hovorka - Raymond James

The third quarter last year you reported at 20 weeks, what changed? What’s that three weeks difference?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

That's an excellent question. We are continually looking at the figures. What’s proven to be difficult is our business switches more to reaching higher growth in the international market place. We don't get good information back from the European market in terms of registration of that product. And so we have actually done a more detailed analysis using export data from brands other than the Brunswick boat brand and we made an adjustment in that methodology to incorporate the international growth. So, it accounted for the two to two weeks reduction versus the same level last year.

Joseph Hovorka - Raymond James

Okay, so, is there… did you just fall off your week’s inventory for engines going back.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Everything that I gave you, the 22 week and the 17 week last year are adjusted.

Joseph Hovorka - Raymond James

Okay, but if I look at like earlier this year you gave us 26 and 31 for 2Q and 3Q… and 1Q respectively.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

No those are not adjusted and if you hang on a sec I can get it for you.

Joseph Hovorka - Raymond James

Okay.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

What, is there a particular…

Joseph Hovorka - Raymond James

I could actually just fall… I would like to just… I mean I am assuming you would adjust all of ’06 and maybe all of ‘05 as well.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

We can give you ’06 and ’07 right now. It might be better to give it to everybody

Joseph Hovorka - Raymond James

That's great.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Than a number of them through a phone call.

Joseph Hovorka - Raymond James

Sure.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

But in the first quarter ’07, we were at 28 weeks versus 26 weeks in the first quarter of ’06. And then in the second quarter of’07 we were at 23 weeks up from 18 weeks in the second quarter of’06. You have the ’03 data that I mentioned, 22 this year versus 17 in the third quarter last year and the year end number at the end of the fourth quarter in 2006 it was 23 weeks.

Joseph Hovorka - Raymond James

Okay. And how do you… I guess this question can apply to both boats and engines and may be I will issue the boat data since it goes back a couple of years. You did a week better in ’07 versus ’06, right 26 versus 27 but no ’05 and really back to ‘02 you were around the 21, 22 weeks of inventory. Where are you? Is there a target you want to? Is the 26 weeks good enough, you want to be at 22, do you want to be at 24?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

A lots going to depend upon what we think is going to be happening at retail. I would tell you that today in the market that we are in, I am quite please with where we are, both pipelines as a matter of fact I am ecstatic because the declines we have had and what we have had to do in our production rate et cetera, in order to get to this number has caused us to take almost heroic actins and you have seen it come on the bottom line. This decline in knowing what are production rates are going to be for the fourth quarter, I am for the first time in a while beginning to get comfortable about where we are.

Joseph Hovorka - Raymond James

So, you don't feel that… you feel 26 is okay, you don't need to get to 25 or 24 for boats for instance.

Dustan E. McCoy - Chairman and Chief Executive Officer

Well, I would love to be at something much lower, obviously, so that there is a lot more consumer pull, but, yes, we can live with 26 very nicely right here. You will see us continue work on the numbers as we go forward, and it will continue to come down, but we had to take a lot of pain in order to get it here in this quarter

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

And remember what we said too that the pipeline correction can become over a full model year, that's what we are running at. And so, you will see continued improvement as we more forward.

Joseph Hovorka - Raymond James

Right. Okay. And just a couple of questions on the write-down. Can you disclose which branch broke down? And then can you also reconcile the gain in the outboard engine business and the timing of the write-down. It seems kind of intuitive that as you are seeing an improvement in your engine side of your business and outboard, you would be writhing down outboard boat brands as oppose to doing it maybe a quarter 2 ago or maybe it’s just an accounting thing.

Dustan E. McCoy - Chairman and Chief Executive Officer

It is an accounting thing and that's why I was very careful to say in my discussion we have had a collision here of accounting and market. And with great deference to my very good friend Pete, who keeps me educated on this. Joe, I do not want to disclose the brands, but realistically I think we have told you everything you need to know that a conclusion.

Joseph Hovorka - Raymond James

Yes. Okay.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

And the delta again between why is Mercury up like outboard is up. Most of Mercury’s growth though really was not in the domestic market. Since MerCruiser was down, but most of the growth really came form the international marketplace and the P&A businesses. And as I stated in my prepared remarks Mercury has 55% of their sales that are coming from the international marketplace, the boat group has about 36% for those same too. So, it’s really kind of a mix issue between the two businesses.

Joseph Hovorka - Raymond James

Right, and okay. so its international growth in outboard engines as opposed to maybe domestic boat brands we're talking about?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

International boats and engines

Joseph Hovorka - Raymond James

Right. That’s good enough. And the right on the impairment charges. This is where you take the undiscounted future cash flows and compare it to what's on the balance sheet and when it is less and then you have to do the impairment?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

No that would be good will.

Joseph Hovorka - Raymond James

Okay.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

And nobody said that accounting had to be reasonable. When you’re looking at impairment for trade days.

Joseph Hovorka - Raymond James

Yep.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

What you do is, you basically have to put a values on the brand name and when you acquire a company you sit back and evaluate what’s the royalty stream somebody would pay you for. So you forecast sales of prior royalty rates, and then you just kind of and then you discount it back to the present and remember you bought these companies with a lot of our acquisitions. Now if you look at the timing over 2004, 2003 of the market was just coming out of it, was entering a recovery phase. You're required to look at that valuation for trade names on the annual basis or more frequently if market conditions dictate. Then what happens is … so we reforecast sales and we obviously have sales of the lower level and we're anticipating excellent growth in those sales. Let me just take a hypothetical example and this is not how the map works but the sales were up 10% from the current level for a number of years moving forward and you're discounting them back at 15. It doesn’t give you anything in terms of valuation for the trade name so that’s kind of the situation that we're in right now.

Joseph Hovorka - Raymond James

Okay. and then just one last question. You mentioned I think couple times the unprecedented declines here. Are we, we still have sharper declines in the early 90’s, right or is this even worse that it was then.

Dustan E. McCoy - Chairman and Chief Executive Officer

This is worse and here’s why. This is an interesting This is an interesting dilemma. The early '90s, I apologize. We can look statistically These are approaching the early '90s. This company lost money in the early '90s.

Joseph Hovorka - Raymond James

Right. Okay. That’s all I had. Thanks guys.

Dustan E. McCoy - Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from Hakan Ipekci with Merrill Lynch. Sir your line is open.

Hakan Ipekci - Merrill Lynch

Two questions. One is recently the President of Volvo Venza indicated or Penta indicated that there was some weakness in the small boat market in Europe. Especially and towards the end of the third quarter, similar to what happened in the U.S. a couple of years ago. What’s your take on that? What are you seeing in Europe across different product lines? And the other question is, on your last call you said, in the markets, the boat markets, going forward the next peak could be lower than the previous peak and then given the write-down today, what’s… are you feeling more cautious with the outlook? Do you think there is a permanent shift in the way people look at boats?

Dustan E. McCoy - Chairman and Chief Executive Officer

Let's do Volvo Penta question first in and around Europe. Europe continues to be a good market for us. I think Pete mentioned where a lot of the growth came from in the quarter and we saw great growth in Latin America, Asia and to some extent in Europe. So, we can… all of our brands, there wasn't any brands that are not U.S. brands that are based in Europe continue to do well. In terms of are we in a secular decline I think that is your question?

Hakan Ipekci - Merrill Lynch

Yes.

Dustan E. McCoy - Chairman and Chief Executive Officer

My judgment is, no. Over time. I think this market is going to come back, slowly because we have couple of factors we haven’t seen in past markets. The housing market availability of credit, insurance etc. on the other hand this entire industry continues to bring incredible new products to the market. The ability to get into boating is going to be significantly easier than its ever been. The ability to boat and use a boat for friendly activities is going to be better than its ever been and what we got to do is work our way through these economic conditions and I continue to be quite confident about where we will be once we get through these.

Hakan Ipekci - Merrill Lynch

Thank you. Just as a follow up. How is the dealership networks doing and obviously it is a tough time, but I know you have some initiatives in place to support them. But there have been increased weakness in that area? Are we seeing more excess these days?

Dustan E. McCoy - Chairman and Chief Executive Officer

Not seeing more exits and like during any difficult times or as in any difficult times there are some dealers who suffer more than others that’s why as we work with our dealer network and work on controlling pipelines we need to continue to be good partners with them. That’s evident in the level of discounting that we did in the third quarter. to help our dealers through that … I believe that dealer network compared to the early ‘90’s till 2001 to today, is doing much, much better. Most dealers operate their businesses much better today than they did 20 years ago. Yes, it is difficult for all of us, but the dealer network is holding up just fine.

Hakan Ipekci - Merrill Lynch

Okay. Great. Thank you very much.

Dustan E. McCoy - Chairman and Chief Executive Officer

You're welcome.

Operator

Tim Conder with Wachovia. Your line is open.

Timothy Conder - Wachovia Securities

Thank you a couple of questions. Back to just to stay on the channel, ramp that up a little bit. How do you view your… the channel inventories, Dusty, if you look at the industry versus yourself a product that‘s 12 to 18 months old and a product that’s 18 months plus.

Dustan E. McCoy - Chairman and Chief Executive Officer

Versus the industry, I suspect there are going to be some builders who are better than we and others who are worse than we. We’re not concerned about 2006 model year boats. We still have some 2007 models in the network that we need to work our way through. We spent a lot of money in the third quarter to do that. And we’re developing to be with our dealers. What we’ll need to do in this quarter as well as going into the winter boat show in order to complete moving that out. Tim, it’s not though for the market that we’re in, that worries me at all. Had we not made all the progress we made in this quarter and undergone the earnings pay we did, I might not be as comfortable in saying that. So, we’re working our way through this one.

Timothy Conder - Wachovia Securities

So, with the progress definitely that you made and it’s fair to say you feel that Brunswick’s in better shape than the industry collectively and--?

Dustan E. McCoy - Chairman and Chief Executive Officer

No. As I said, I suspect there are some people who are in better shape than we are and some who could be in worse. I just don’t know.

Timothy Conder - Wachovia Securities

Okay.

Dustan E. McCoy - Chairman and Chief Executive Officer

I believe the industry, overall, is actually pretty healthy and everybody is managing quite well.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

I think we’re in better shape, Tim, to manage through than the competition, another smaller players.

Timothy Conder - Wachovia Securities

Right, just given your position. Okay. And then, you mentioned product issues in one boat brand that surfaced as one of the issues in the quarter. Should we infer given the… what you talked about in some of the large dollar boat delivery delays, the whole slip into the fourth because of some issues. Are those linked?

Dustan E. McCoy - Chairman and Chief Executive Officer

No.

Timothy Conder - Wachovia Securities

Okay.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

What we had is we had one brand that’s coming out with a new product and it’s ramping up production. It’s not hitting the margins it had projected for that product and that was the decline there, which is different than our slipping delivery dates on some large boats.

Timothy Conder - Wachovia Securities

Okay. And back to the California issue there with the converters. First of all, what percentage does California of the engines that will be impacted for the industry’s sales or for you? And then, again, will this cause a little air pocket in that segment and maybe it’s not material, but will cause a little air pocket in the segment for ’08 or if that is material?

Dustan E. McCoy - Chairman and Chief Executive Officer

First, California is dropping off on a monthly rate, 30% a month.

Timothy Conder - Wachovia Securities

Right, it’s becoming less important.

Dustan E. McCoy - Chairman and Chief Executive Officer

Which would have been barely double digits is less than that right now. And whether it accretes above or not is really going to be very interesting. So, it’s something where I think all of us who sell boats into that state are going to be watching. My guess is, yes, there will be a slight bubble there, but it’s certainly not going to be material.

Timothy Conder - Wachovia Securities

Okay. And then back to your S-bom [ph] initiatives, the strategic bill of materials. What type of time line, Dusty or Pete whoever wants to answer this? Where are you in that progress? And are we looking at model year 10 or 11 before that whole process is basically completed?

Dustan E. McCoy - Chairman and Chief Executive Officer

Well, I don’t want to sound like a smart Alec, Tim, but it will be a never ending process.

Timothy Conder - Wachovia Securities

Right, right, understood.

Dustan E. McCoy - Chairman and Chief Executive Officer

We do have significant savings coming through in this year and we will have more savings next year, and we will have more savings the year after that.

Timothy Conder - Wachovia Securities

Meaning model year only, correct?

Dustan E. McCoy - Chairman and Chief Executive Officer

Calendar year ’08.

Timothy Conder - Wachovia Securities

Okay.

Dustan E. McCoy - Chairman and Chief Executive Officer

March… the calendar, it doesn’t really matter, Tim. We’re working our way through it and actually making significant progress.

Timothy Conder - Wachovia Securities

Okay. But I mean… if you… again, always wanting to continually improve. If you had to say, okay, we started here at zero and here’s where we’re from our major initiative or major push or major upgrade, a type of percentage time line are we looking like 10, 30, 70… a 100 over a four year period, five year period, and then you do the everyday incremental after that? I mean, I guess that’s where I’m kind of coming from with the question.

Dustan E. McCoy - Chairman and Chief Executive Officer

I understand. If we go back to two or three calls ago, somebody asked me what inning are you in. So, to bring ourselves back as we began talking about this a couple of years ago and that we said five to seven years. I think the last time… I spoke about this using the base ball example, I said we are in the second innings, and we are in the third inning now.

Timothy Conder - Wachovia Securities

Okay. And then one housekeeping and one other question. The promise with the ramp up in the bowling operations in Mexico seem to be kind of dragging out. Any additional color, timeframe of conclusion there? And then, Pete, just more of a… two housekeeping items. What is your… what was your ending share count either basic or diluted at $9.30 and a normalized tax rate ex the charges and everything?

Dustan E. McCoy - Chairman and Chief Executive Officer

As we look at the bowling plant… the bowling ball plant in Reynosa, we’re working our way through a list of items that had to get knocked off in order for us to have this fixed in. We’ve gotten through a bunch of the big items. We think we got our arms now around the few smaller items. We put a lot of resources into that plant in order to get it fixed. We’ve actually gotten up to the volumes we wanted now. We’re just not getting the margins we want. And we know the items that have to be fixed in order to get us to our margin count. And frankly, getting to the volume count was really important.

Timothy Conder - Wachovia Securities

Okay.

Dustan E. McCoy - Chairman and Chief Executive Officer

Now we got to go back and get the margin work done, and we sure better be seeing it here by year-end or early next year.

Timothy Conder - Wachovia Securities

Okay.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

I think with your question, Tim, on tax rate… the effective rate was 30.6% you know on a year-to-date basis as of the third quarter and that’s stripping off all the unusual tax items that’s for continuing operations. And then with regard to the number of shares we have outstanding including common stock of global and et cetera. It was about… it was just under $89 million at the end of the quarter.

Timothy Conder - Wachovia Securities

Okay. And one last one, Pete. Could you just remind us of the percentage of sales from P&A, both for boats, and then also for engines?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

P&A specifically, but P&A and international combines were about 55% for Mercury, 36% for both group.

Timothy Conder - Wachovia Securities

P&A and international, so, that lumps in domestic P&A also?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Yes, the international sales for the Company are roughly 32%... excuse me… in the quarter, it is about 35% on a year-to-date basis. So, you can extrapolate off that. And the international sales for both groups were lower than Mercury.

Timothy Conder - Wachovia Securities

Okay. Great. Thank you.

Dustan E. McCoy - Chairman and Chief Executive Officer

You’re welcome Tim.

Operator

Our final question comes from Justin Boisseau with Gates Capital Management.

Justin Boisseau - Gates Capital Management

Hi. Thanks. A quick pipeline question. What exactly are you measuring when you guys give the pipeline inventories? Is that just inventory at dealers?

Dustan E. McCoy - Chairman and Chief Executive Officer

No. It’s in transit, backyard, and then the dealers.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

The pipeline figures are here. We actually work internally on our own backyard inventory as well. But the pipeline numbers that we give you is… the product that has been shipped, but has not been sold at retail yet. And some of that could be fitting in for like on the engine side, because it’s sitting in boat builder’s plant more often or not it’s sitting on a finished product in a dealer’s hand.

Justin Boisseau - Gates Capital Management

Okay. So, it’s shipped, but not yet sold.

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

Shipped and sold by us, but not sold at retail yet.

Justin Boisseau - Gates Capital Management

Right. And then what are the remaining cash restructuring charges you expect for the year?

Peter G. Leemputte - Senior Vice President and Chief Financial Officer

We would probably see… I mean that’s part of our guidance. I think in terms of what we are going to see incrementally the two things that I mentioned the European restructuring for Mercury coupled with closure of the Aberdeen plant, is going to be about $0.06 per share in the fourth quarter for those two items and on a full year basis in terms of estimated charges, I think we’re expecting to see something on the order of about just under $20 million for the full year.

Justin Boisseau - Gates Capital Management

Terrific, thanks.

Dustan E. McCoy - Chairman and Chief Executive Officer

You’re welcome. With that we’ve run out of time and I apologize for that, but I wanted to make sure we take questions. Thanks all of you for listening and I hope we see most of you, all of, you are welcome at our December meeting. Thank you very much.

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Source: Brunswick Corp. Q3 2007 Earnings Call Transcript
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