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Executives

Bruce Byots - VP, Corporate and IR

Dusty McCoy - Chairman and CEO

Peter Hamilton - CFO

Analysts

Ed Aaron - RBC Capital

James Hardiman - Longbow Research

Jimmy Baker - Riley & Company

Rommel Dionisio - Wedbush Securities

Craig Kennison - Robert W. Baird

Michael Swartz - SunTrust

Tim Conder - Wells Fargo Securities

Brunswick Corporation (BC) Q2 2012 Earnings Call July 26, 2012 11:00 AM ET

Operator

Good morning and welcome to Brunswick Corporation's 2012 second quarter earnings conference call. (Operator Instructions) And I would now like to introduce Bruce Byots, Vice President, Corporate and Investor Relations.

Bruce Byots

Good morning and thank you for joining us. On the call this morning is Dusty McCoy, Brunswick's Chairman and CEO; and Peter Hamilton, our 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, our actual results could differ materially from these expectations. For the details on the factors to consider, please refer to our recent SEC Filings in today's press release. All of these documents are available on our website at brunswick.com.

I would now like to turn the call over to Dusty McCoy.

Dusty McCoy

Thanks, Bruce, and good morning, everyone. I'll start with an overview of our second quarter result. Our $0.90 EPS represents the tenth consecutive quarter of year-over-year growth. The quarter's increase demonstrates the continuing success of our business strategy.

Short-term financial performance continues to improve and even as we make increased investments for long time organic growth. As we'd anticipated consolidated sales were lower due to factors affecting our Marine segments and to a lesser extent our Recreational segment.

Preliminary U.S. retail boat industry demand was up in the quarter with improvements continuing in aluminum and fiberglass outboard product categories, although at a lesser rate increase in the first quarter. This is being partially offset by continuing weak demand in fiberglass sterndrive inboard categories, especially in boats larger than 30 feet for demand continues to decline. We experienced lower sales in Europe in all four of our segments.

For the total company, excluding Sealine, revenues declined about $41 million or 23% in this region. Revenues generated from our U.S. and the rest of world customers increased about 3%. Ending boat pipeline inventories remained at healthy levels and our weeks on hand as measured on a trailing 12-month retail basis declined.

Our gross margin of 26% represents an increase of 90 basis points from the prior year. Lower warranty, depreciation and pension expenses combined with successful cost reduction activities contributed to the higher gross margin.

Contrary to the first quarter, SG&A and R&D expenses in the aggregate increased by 3% as lower variable compensation expense was only partially offset by company-wide investments in growth initiatives. Finally, our lower income tax provision contributed the higher net earnings during the quarter.

For those of you, who may have printed out the slides and are flipping through those, I'll call out page numbers. We're now on Slide 5. Sales decreased by 3% in the second quarter. Sales generated by our ongoing European businesses declined by approximately $41 million.

Additionally, revenues from our Sealine boat brand, which we divested in Q3 of 2011, were approximately $20 million in the second quarter of 2011. I will comment in a few moments about some of the other major factors that affected our topline during the quarter.

In the first half of the year, our sales decreased by 2%. Sales from our ongoing European businesses declined by about $61 million during the first six months. Sealine sales during the first half of 2011 were approximately $32 million.

Operating earnings, excluding restructuring, exit, and impairment charges were $116 million for the quarter, an 8% increase compared to 2011. Operating margins, ex-charges increased by 110 basis points to 10.9%. The increased in operating earnings reflect gross margin improvements as well as the reductions in operating expenses that I previously mentioned.

Operating earnings, excluding restructuring, exit, and impairment charges were $184 million for the first half, an increase of 2% compared to 2011. Operating margins, ex-charges increased by about 40 basis points to 9%.

Net earnings for the quarter were $0.90 per share, including a $0.01 charge for restructuring, $0.05 of losses on debt retirements and a $0.03 benefit from special tax items. Excluding these items, our diluted earnings per share would have been $0.93 per share.

This compares to net earnings of $0.75 per share in the prior quarter, which included a $0.01 of losses on debt retirements and the $0.02 benefit from special tax items. Again, excluding these items 2011's earnings per share would have been $0.74. In summary our adjusted EPS increased by $0.19 or 26%.

I'm now going to Page 10. Net earnings for the first half were $1.34 per share, including $0.01 of restructuring charged, $0.05 of losses on debt retirement and a $0.02 benefit from special tax items. Excluding these items, our diluted earnings per share would have been $1.38 per share.

This compares to net earnings of $1.05 per share in prior year, which included $0.05 of restructuring charges and $0.05 of losses on debt retirements, and a $0.02 benefit from special tax items. Excluding these items 2011's earnings per share would have been $1.13. As adjusted, our first half EPS increased by $0.25 or 22%.

Now, let's turn to our operating segments, starting with the Marine Engine segment. From the geographic perspective, sales to U.S. markets were up 8%. Our sales to Mercury European customers decreased 19% in the quarter. Rest of world sales or sales outside of U.S. and Europe were flat year-over-year.

In the aggregate, Mercury sales were essentially flat for the quarter. U.S. sales growth was lead by strength in P&A and by modest growth in outboard engines, partially offset by declines in sterndrive engine.

In Europe, difficult business conditions had an impact on all product categories. Sales were most dramatically affected in Southern Europe, where the economic weakness is most pronounced. Rest of world sales experienced modest growth from outboards and P&A, but will offset by declines in sterndrives.

We continue to see weak conditions in Australia, offset by improving conditions in New Zealand as they recover from last year's devastating earthquake. Asia continued to demonstrate healthy growth rates.

From our product category perspective, sales in our U.S. and rest of world outboard engine businesses delivered modest growth, reflecting an improving aluminum and fiberglass outboard boat marketplace, in addition to market share gains. This growth was more than offset by lower sales in Europe.

In addition, outboard engine sales comparisons in the quarter were muted by a strong prior quarter sales resulting from the impact of the earthquake and Mercury's competitors supply and production of engine. We consequently enabled market share gains.

Also during the quarter, strong demand for our outboard engines, especially our new 150 FourStroke and engines in the 75, 90 and 115 horsepower family has outpaced Mercury's ability to meet immediate customer demands in these horsepowers.

Although, we expect this issue will affect sales for the reminder of 2012, Mercury is taking actions to achieve greater production flexibility and capacity in 2013. Sales decreased in Mercury sterndrive engine business compared to year ago levels, due to overall weaker global market demand.

Our cruiser production ramp up issues described in our first quarter call, have been addressed. And we're currently meeting daily internal production goals and rebuilding safety stock levels to return to targeted lead times. Production of sterndrive engines in the second quarter was greater than the prior year, but production volumes on a year-to-date basis trail 2011.

Now, on Page 14. Mercury's global products and accessories business has reported a solid increase in U.S. and rest of the world revenue, due to stable boat participation, new product launches and market share gains.

Record year-to-date sales and earnings were achieved by Land 'N' Sea and Attwood. Both of these organizations had done an excellent job of delivering outstanding products and services in a very demanding marine marketplace. This growth was partially offset by decrease in revenues in Europe.

This slide summarize the basic trends being experienced within the Engine segment, our product category and region. As you can see, looking at the box on the bottom right, almost 70% of the segment is selling products in the markets without a modest or strong growth by about 30% reflect declining conditions.

Mercury's operating earnings increased by approximately $5 million during the second quarter. The quarter benefited from strong performance of the P&A business, partially offset by weak European results. This segment also experienced slower warranty and variable compensation expenses, partially offset by higher material cost and spending on growth initiatives.

After taking into account all these factors, margins excluding charges were just under 18% in the quarter. This represents a 100 basis point improvement versus the prior-year quarter.

In our Boat segment, second quarter revenues were down 10% compared to the prior period. If we exclude the impact of Sealine, revenues decreased by 4% for the quarter.

On the international front, adjusting for the Sealine divestiture, our Boat segment in Europe experienced a 43% decline in sales. Rest of world sales were down by about 4%. In the U.S. which represents almost two thirds of the segment, revenues increased by 3%.

Now on Slide 18. Now let's take a look at the U.S. Powerboats industry statistics, provided by our Statistical Surveys, Inc., to get a view of how demand is unfolding about boat category in Unite States. As you can see, based on preliminary second quarter data, aluminum and fiberglass outboard boat markets continue to demonstrate strong growth, although at a slower rate in the first quarter. Fiberglass sterndrive inboard boat market was down modestly.

If we look at preliminary results for the month of June, historically the largest volume month of the year, outboard products improved nicely. The sterndrive inboard fiberglass product volumes declined by approximately 11%.

The SSI's industry report that yesterday was published in Soundings Trade Only. Boats greater than 30 feet in length, which represents about 70% of our fiberglass sterndrive revenues were down 16% in June and 3% year-to-date.

So with the U.S. boat market up 14%, year-to-date in units, I'm sure the question is, why is the Brunswick's Boat segment not enjoying sales growth in the second quarter? The answer lies in mix, the realty that we are global business and our production rate and pipeline management strategies.

This chart demonstrates how current regional trends affect our specific mix of boat categories. While the worldwide recreation of boat industry is more heavily weighted to our boat products, more than half of our global boat sales dollars are concentrated in the fiberglass sterndrive inboard category, which continues to experience market decline.

Now, on Slide 20. During the quarter, Brunswick global retail sales in units grew by approximately 7%. Global wholesale shipments on the other hand declined by 6%, as the seasonal decline in dealer inventories was more significant than the prior year.

This was the result of strong domestic retail demand and our decision to increase pipeline inventories at the end of last year in advance of the 2012 selling season. For me, an expected strong growth in aluminum fish and pontoon boat categories.

As a result, we ended the quarter at 31 weeks in hand on a trailing 12-month retail basis versus 32 weeks on hand a year earlier. Our pipelines for aluminum product were up over last year's level, reflecting strong market growth. But our pipeline for fiberglass product 24 feet and larger is down and continues at record low levels.

Assuming current retail trends continue, we would expect wholesale shipment trends in the second half to increase and better track retail growth rates as we restore our pipeline inventories to levels consistent with market dynamics. We would also expect that in 2012 with a modest increase in pipeline inventories versus the end of 2011.

Boat segment's Q2 operating earnings declined when compared to 2011, with margins excluding charges at 2.7%. The major factor for the earnings decrease was the sales decline, which in summary was caused by international weakness, primarily in Europe, continued declines in the fiberglass sterndrive inboard marketplace, and our production and pipeline management strategies, I just discussed.

Now, let's take a look at our two Recreational segments. Life Fitness completed another excellent quarter. Sales rose slightly compared to last year's second quarter, despite the 14% decline in Europe. Rest of world sales were down modestly in the quarter. U.S. sales increased by 11%.

Life Fitness' solid growth over the last two years supports our longer-term outlook for this segment. Life Fitness continues to outpace its competitors and gain market share. When we combine the organization's outstanding performance with positive demographic and healthcare trends in the fitness sector, Life Fitness is well positioned to continue to deliver excellent results.

Segment operating earnings in the quarter grew modestly, while operating margin remained strong at 13.9%. These strong results, given the difficult comparison to 2011 with sales grew about 15%.

Now, on Slide 24. Sales in Bowling and Billiards declined 6% in the quarter. We were operating a fewer bowling centers versus last year's quarter and equivalent center sales were down slightly. Although, bowling products experienced decline in the quarter, sales and earnings growth during the first half have been strong.

European sales were down 6%. The segment's operating earnings decrease modestly as a result of lower sales, partially offset by improved operating efficiencies. Operating margins were higher by 10 basis points.

Now, I'll turn the call over to Peter for a closer look at our financial, and then I'll come back to give you an updated on our perspective of 2012 and beyond.

Peter Hamilton

Thanks, Dusty. On Slide 25, I'd like to begin with an overview of certain items included in our second quarter P&L. And I'll also comment on some forward-looking data points.

Let me start with restructuring, exit and impairment charges, which were approximately $1 million in the quarter. The net charge reflects continued manufacturing consolidation activities in our Mercury and Marine segment, along with a modest gain resulting from the sale of Mercury store, Oklahoma facility.

Our current estimate for full year 2012 restructuring is now in the $3 million to $5 million range or $0.03 to $0.5 a share for previously announced actions.

Net interest expense, which includes interest expense, interest income and debt extinguishment losses was $21.6 million in the quarter, a slight increase versus the same period in 2011. Higher losses on the early extinguishment of debt, partially offset by the impact of lower debt balances contributed to the modest increase in net interest expense in the quarter.

In the second quarter we've repurchased $22 million of debt. And earlier today we announced our plans to accelerate our 2012 debt repurchase program by calling all of the 11.25% notes due in 2013. This transaction as well as the retirement of $6 million of our 7.75% bonds during July will result in approximately $8 million of extinguishment losses in the third quarter.

Our estimated net interest expense for the year is approximately $76 million to $77 million. This would result in a reduction in net interest of about $21 million compared to 2011.

Moving to Slide 27, as result of our debt reduction activities in the quarter, our debt outstanding at the end of Q2 was $675 million. After completing our planned retirements in Q3, our outstanding debt will be reduced to below $600 million. We may opportunistically repurchase additional debt during the second half. We don't anticipate the amount to be significant.

During the quarter, foreign currency had a less than 2% negative effect on our sales due primarily to a weaker euro versus the dollar. Currency also had a modest negative impact on operating earnings compared to the prior year, which reflected a mix of favorable and unfavorable exchange rate movements. This does include the impact of hedging activity, which helps to moderate the effect that currency exchange rate fluctuations have on our year-over-year earnings comparisons.

We estimate that currency will have a similar impact on a full year sales and earnings basis, unless exchange rates change significantly on current levels. They're changing as we speak for the better.

On Slide 29, our effective tax rate for the second quarter was approximately 11% compared to a rate of 20% in the second quarter of 2011. The reduced tax rate reflects our expectation that a higher percentage of our 2012 pre-tax earnings will be derived from domestic sources, which will not require a corresponding tax provision due to GAAP requirements.

In addition, our Q2 effective tax rate included specific non-recurring benefits from special tax items, which added $0.03 to our EPS. Our 2012 tax expense will continue to be comprised primarily to foreign and state income taxes as well as the effects on the non-recurring special tax items. We now expect our overall 2012 effective tax rate to be approximately 16%.

Moving to Slide 30, and turning to a review of our cash flow statement. Cash provided by operations in the first half was $45 million. Some of the key items in this section of the cash flow statement include adjustments to earnings for non-cash charges, such as depreciation and amortization of $47 million. Our current estimate for D&A in 2012 is approximately $95 million.

Pension expense, resulting from our frozen defined benefit plans, totaled $12 million in the first six months compared to $16 million in the prior year. In the first half, the company made cash contributions to its plans of approximately $21 million.

We expect our 2012 pension expense to be approximately $25 million, which is a decrease of $7 million from 2011. In 2012, the company plans on making cash contributions to its defined benefit pension plans in the range of $75 million to $85 million.

Turning to Slide 31, changes in our primarily working capital accounts, excluding the impact of divestitures resulted in a use of cash in the first half and totaled approximately $129 million. This change is largely due to the seasonal requirements of marine customers.

By category, accounts and notes receivable increased by $99 million. Inventories increased by just $1 million. Accrued expenses decreased by $70 million. And accounts payable increased by $40 million.

Given the seasonality of sales in our marine businesses, we are anticipating that we will be liquidating working capital from now through event. However, based on current assumptions we believe the changes in working capital is likely to result in use of cash for the total year.

Capital expenditures in the first half were approximately $38 million. Our 2012 plan includes approximately $120 million of capital expenditures. The increase from 2011 primarily reflects amounts required to fund our growth initiatives. Partially offsetting our capital expenditures in 2012 were $18 million in proceeds from the sale of property, plant and equipment in our Marine segment.

So in summary, on Slide 33, during the first half we generated $28 million of free cash flow, which was almost entirely used for debt retirement. And supplementing our cash and marketable securities balances is net available borrowing capacity from our revolver of approximately $275 million, which when combined with our cash and marketable securities provides us with total available liquidity of $784 million.

So I'll turning the call back to Dusty now for some concluding comments.

Dusty McCoy

Thanks, Peter. We continue to be pleased with the progress we're making in our numerous growth initiatives, which are underway throughout our entire organization.

I want a make a comment or two on some them, going clockwise on Page 34. Mercury Marines' new 150 horsepower four stroke engine, which is introduced earlier this year, continues to be extremely popular. Sales have been strong and the acceptance level in the marketplace is truly global.

We're quiet excited about this new engine platform. Our Marine parts and accessory business continues to be a strong contributor to our performance at both the top and bottomline.

Picture here is an example of our innovative integrated fuel system from Attwood. Revenues from these systems is expected to double this year and sales continue to grow with boat manufactures. These systems were designed and developed by Attwood to help boat manufactures economically and efficiently meet tighter EPA guidelines.

At the bottom right is our new boat plant in Brazil. Construction of the building was completed on time and on budget. And we expect to begin making a range of Sea Ray and Bayliner boats for the Brazilian and neighboring markets, beginning in the fourth quarter of this year.

Finally, Sea Ray recently announced that they will be entering in the jet boat market, with a 21-foot sport boat in the fall of this year. And will be followed shortly by a 24-foot model.

The development of the new the jet propulsion sport boats is part of our ongoing effort to reach the full spectrum of recreational boaters. Also in the second half of the year, in response to market feedback, Sea Ray will offer 22 foot and 24-foot models of its Sundeck line, which will use Mercury Marine's or Verado outboard engines.

Now, on Slide 35, new products activity is also strong in our recreation businesses. Life Fitness has introduced a number of new products recently and the two we see here, Lifescape on the top left and Synergy 360 on the top right, are doing really well in the marketplace.

Exclusive to Life Fitness, Lifescape engages the user in a truly personal experience, through immersive outdoor adventures that bring workouts to life. The new Synergy 360 combine several popular total body dynamic exercises into its system that helps personal trainers more effectively train individuals and groups, giving users fun, unlimited ways to exercise.

Look at the bottom right, as it first may appear to be just Brunswick Bowling pins. But it is really StringPin, a version of the game that is growing in popularity. Individual pins are each attached to a string, which facilitate setup during play. More economical to install and maintain than a traditional pin setter. This allows string bowling proprietors to add lanes economically.

And finally, we have seen substantial improvement in the performance at our select Brunswick Zone XL locations that have upgraded Laser Tag and other games. Recently we have seen excellent results at locations in Georgia, Colorado and Pennsylvania after installation of the laser Lazer arenas. Likewise, additional arcade in related games in Georgia and Colorado have exceeded expectations.

Now going to Slide 36. Finally, I'll conclude with the few comments regarding our outlook for the remainder of the year. We're increasing our 2012 GAAP earnings guidance to a range of $1.45 a share to $1.60 per share. During the second half of 2012, we continue to anticipate the successful execution of our strategic initiatives. A few of which I've just described.

Our current plan reflects extremely diversified set of geographic and product demand trends that affected our topline performance in the first half. We anticipate continued strong U.S. retail growth in the aluminum and fiberglass outboard marine markets and solid fundamentals in the fitness industry.

These positive trends, however, will be partially offset our weaker demand in fiberglass board and sterndrive engine categories We further anticipate sales and the European markets will continue to be under significant pressure. As a result of these factors, we're now targeting low single-digit revenue growth for the full year versus our previous outlook of mid single-digit growth.

We continue to believe, that as a result cost reductions and improvements in operating efficiencies, our target gross margin for 2012 will be approximately 24%. And although, operating expenses will be higher. We still anticipate the strong annual increase in operating earnings.

Additionally, we now expect our affected tax rate in restructuring charges for the full year to be lower than our prior estimate. And despite the seasonal weakness in marine markets in the fourth quarter, our goal is to approach breakeven EPS in that quarter due to contributions of our recreational businesses and reduced interest expense.

And that concludes the formal part of this session. And we're now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question is from the line of Ed Aaron with RBC Capital.

Ed Aaron - RBC Capital

Maybe just to start with very quick clarification on guidance, obviously sales coming down a little bit, but the earning guidance is going up with lower tax rate and such. When you look at just kind of like the ex-restructuring profit expectations at the operating line. Have those changed, I mean that basis from your product guidance at all?

Dusty McCoy

Yes. They're little better, because we're doing better on margins, Ed. We're seeing a nice gross margin pickup here in the first half of the year. We're able to manage operating expenses very well. And we're going to take what we captured in the first half and run it through the rest of the year.

Ed Aaron - RBC Capital

And then, I guess at the start of the year, you talked about plans for your increased investments this year. I'm just wondering, if either that the level of that spending or the nature of that spending has changed at all, since the start of the year.

Peter Hamilton

No, not at all. We've been able to maintain our plan for spending levels we had anticipated dealing. And we're getting at cost in other places, Ed. But we've made a firm decision here that we need to continue to invest in all the growth initiatives that give us the opportunity to make the improvements in a difficult economic environment that we've described.

And we anticipate that our 2014, longer-term guidance still remains in place, not withstanding what's happening in the marketplace. And it's going to be driven by our growth initiatives and it's therefore imperative that we continue to investment in.

Ed Aaron - RBC Capital

And then just one last, and then I'll pass it along. But what do you think about kind of the dynamics that the cruiser market which has still been a big challenge. How are you thinking about allocating investment dollars in research and development and in other areas towards that business in particular? I guess is that a business that you think you can make and kind of move the needle through innovation or is it a more a matter of the consumer just coming back at some point in time?

Dusty McCoy

It's both and without giving too much away. First, I've been pretty open in this call and a lot of investor and analysis meetings, Ed. The cruiser consumers still buying these boats and tell us they're going to buy a new boat, but they need the economy to improve, tax rate to be set, et cetera. And all that's going to come with the passage of time.

And we think it's important that we stay well positioned in this market. But the other side of this is, this market sort of gone from 6,000 units to a 1,000 units. And there are in round number, 50 models that are going into this market. And we have a heck of a lot of market share there. And we think there's a good opportunity for us to continue to invest in the innovative and new product, because we probably are one of the few people that has the volume to do it.

Operator

Your next question is from the line of James Hardiman with Longbow Research

James Hardiman - Longbow Research

Couple of things I wanted to hone in on. You talked in the Boat segment about a world wide retail growth up 7%, wholesale down 6%, obviously, the two big factors driving the delta there. One, obviously, pricing and mix given what you're selling and two, the inventory reductions.

I was hoping you could maybe quantify the relative impact of those two items and help us understand how we should think about that going forward. I think you mentioned that inventories would be such that wholesale would more closely match retail or should I think that wholesale maybe even exceeds retailing in the back half of the year little bit?

Dusty McCoy

It could exceed a little bit in the back half of the year, as we try to get pipeline levels, so that we go into '13 feeling well. Here is what fundamentally happened at a high level. We added a couple of thousand units to the pipeline and I think at the end of '11 and I think we reported on that in our first quarter call.

And that was primarily driven by our aluminum business and I think our guys there made a fabulous decision, that the market had a real opportunity to favor, to be very hard and moving very fast. And there view was, let's get the product out there then we can maintain production, in a why that we talked about before. If we have to increase production by more than 15% or 20%, on the spring capacity basis, leave worry about quality and the greatness of the product we're putting out.

Our guys made a great decision there. Let's get them out in the pipeline and it proved to be a perfect decision, at great uptick. We've gained nice share in the aluminum market. In fact, I would say outstanding share. And we've been able to run our plans in a way that we're maintaining a quality of product that we want.

So what now has to happen in the second half is, if we didn't call out by product type, we've just set over own boats, we've had a one-week reduction on weeks on hand. The reduction in weeks on hand has been much more significant than that in our aluminum business, and our guys are going to have to get back work with the dealer network to get on position great for '13.

In the fiber glass, we've had almost no up tick in the number of units that we have in the pipeline. We are up a little bit in weeks on hand, but that's just because of weakness in the market. But we've already said, the number of units we have there are driven by minimum stocking levels that we and our dealers to talk about.

Last year, we shut down lot of our fiberglass plants for a good part of the early winter. In order to make sure that the result we're seeing now, that we got the right number of boats out in the pipeline occurred, and even with relatively low selling levels we are selling boats, and therefore, we're going to need to run our plants in the second half of this year when we did last year.

So when we add all that up, our wholesale might need to be double-digits in the second half of the year in order for us to get our pipelines at appropriate levels. Is that help of, James.

James Hardiman - Longbow Research

And then, I guess, sort of along those lines as I think about the fourth quarter. The comment you made about breaking even in 4Q, would be an enormous accomplishment. Can you just give us a little bit more color on that, obviously, the impediment previously to accomplishing that has primarily been the Boat segment. Is it that we're going to see improvement in the Boat segment or is it the other segments are going to more than enough to offset that?

And how should I think about your commentary from a quarter or two ago, that you're hoping to finish the year at breakevenish levels that in the Boat segment coming out of 2012?

Peter Hamilton

First, you'll see improvement in the Boat segment, but you'll also see improvement in our other business. The answer there is all the above. This goal of having our boat business on a run rate basis be running at breakeven as we exit '12. Frankly, it's going to be difficult in the market we're in.

This European market is pretty touch and you saw this in our statistics and how far we're down there. And I just don't see that get any better as we finish out this year. So that's a pretty big decline.

We will talk about it when we get to yearend as to where we are, James but I'm not going to be upset on run rate, breakeven basis leaving '12 just because of what's begun to happen in the marketplace.

Operator

Your next question is from Jimmy Baker with Riley & Company.

Jimmy Baker - Riley & Company

I'm hoping you could start by talking a little bit more about the tightness in outboard engine availability. May be how much that as a function of the overall market outgrowing your expectations versus share gains that you maybe retained some share gains from last year that you thought were more onetime in nature related to Tsunami or maybe just to stronger than anticipated response to some of your new offering?

Peter Hamilton

It's both of those, but I think the first thing is as we said, production capacities and it's started with that the new 150. We thought, we made some fairly aggressive assumptions, Jimmy, about what market reaction would be. And the 150 just has dramatically exceeded our expectations.

The other thing that's happened in the 75, 90, 115 category is that a lot of folks who are buying aluminum fishing boats and pontoons are moving their horsepower up. So we see things like people who normally would have bought a 60, now are buying a 75. People who've bought a 75 were buying a 90. And as a result, we have run through the first half substantially in excess of what our planning capacity was in these product launch for 2012. But we've not narrowed all the demand. And we have quiet a backlog around these horsepower categories.

Now, a couple of things are going to happen here. Folks, who have a backlog as they walk out of the season, may or may not leave the orders in place. And if they don't, we're going to able to bill from stock to take care of '13. I say, leave the orders in place which hopeful will happen.

We have allocated capital. And we're in the process right now in our Mercury Organization of increasing capacity for '13, so that we can meet anticipated market demand. But fundamentally, in those categories we're sort of running out what we'd anticipated would have been 2016, 2017 maybe 2015 levels. And it came on us very suddenly.

And this is all, I want to be clear, a really high class problem. And we've gotten a lot of questions over the years about as you get to set your capacity. What you're going to do if it's more and we've said, we'll go invest and that's exactly what we're going to do.

My anticipation now is that we could lose a little share in these horsepower categories in the coming months, because I believe there are customers who had boats to sale. And we couldn't get them Mercury engine, in horsepower categories and my judgment is they've likely gone to some of the competition. Hopefully, we'll always get them back because of the power of our product offerings. But we need to be upfront that that's probably getting right ahead into this

Jimmy Baker - Riley & Company

My follow-up which was I'll ask it for the just for the Boat segment. I think you previously said you can service the U.S. boat market at 200,000 to 225,000 units with your current footprint. But that's obviously very mix sensitive. So I'm just interested to hear, you spoke about it now from the Mercury angle, but just from the boat group side, what level let's just say in the outboard market, could we get to before you have to start making some pretty significant CapEx on that side?

Dusty McCoy

I think we can make another turn in improvement in the outboard market before we would need to do capacity investments. But there is big difference here. Capacity investment in engines can involves more machining and tooling which a fair bit more expensive than what we have to do especially in the outboard boat business.

The CapEx, it takes there to add additional capacity is fractions of what it is to add capacity in the engine business. And it's something we can do and move on a heck of a lot quicker than we can in the engine business.

So I'm anticipating, our outboard boat guys and again, I call it's a great issues, are going to show up in front of Peter and I here one of these days and say, we need little money to do capacity expansion and we're going to say, you got it, where you want it and how you fast that you need to get it done.

Jimmy Baker - Riley & Company

Just really outstanding operating margins at Mercury in the quarter, up year-over-year again, so that was a really strong quarter last year and frankly, it's a little bit difficult for me to reconcile the strength there with the fact of that business is running at or above capacity. At least in the outboard side, can you talk a little bit about what drove that improvement and how we should think about margins year-over-year in that business in the back half?

Peter Hamilton

I think the couple of things. First, when you're running these lands as hot and heavy as Mercury is running them, and if you can do it efficiently, you start to get real margin improvement on the plant floor. And even though our Mercury fellows with the issues we had in bringing up the sterndrive line and the over capacity issues, we've had with these outboard ranges that I've previously spoke about. They've just done a magnificent job in keeping our heads and making every operation as efficient as it be. I think that's number one.

Number two, we're getting really nice growth in P&A. And P&A is good high margin business. Now, a lot of the growth is what I would call in lower margin segments of our P&A business. Land 'N' Sea, which is primarily a distribution business, Atwood which for lack of a better term is a bit of specialty in marine engineering company have had, as we said record growth.

They've reported record quarters this quarter. And their margins are good, not where the lot of other P&A margins are, but when we add all that together, that's where we're getting some margin growth.

And then lastly, that we're seeing the fully benefit of the plan consolidation benefits. And then I can add one more, Jimmy I know how you are. You're going to comeback to modify each. I can't say enough to about the quality of the product that we've been sending out of Mercury.

And what happens is as you keep improving quality, you gradually overtime, so you're warranty gets better. And we've begun to see that from a lot of hard work on Mercury guys did, three years ago, two years ago, a year ago and now showing up in warranty rates for our product. So when you add all that together, lot of good operating sweat muscle keeping nose-to-the-grindstone by our Mercury guys to get all this.

Operator

Your next question is from the line of Rommel Dionisio with Wedbush Securities.

Rommel Dionisio - Wedbush Securities

At the Miami Boat Show I think talked about to expanding dealership networks and distribution as a key focus area. One of you can just update us on that with the way you see as boat market and is that part of the reason, why you're expecting wholesale to be fairly strong in the back half of the year. Is some of that inventory fill for these new dealers that you're adding?

Dusty McCoy

We're continuing to add dealers as we go through the year. And in a way that works in the real world, we lose a few dealers, add a few more. And that's what all of our boat brands are out there doing on a day-to-day basis. The increase in wholesale that we're talking about is not really going to be impacted significantly by these additional dealer centers. It is back to we've really played the pipelines down in certain categories. And we need to get a refill so that the dealers can be well positioned for '13.

Rommel Dionisio - Wedbush Securities

I just want a quick follow-up. I don't want to quibble too much on data that's coming from the third party source, but I notice that the fiberglass sterndrive. Do you guys have revise number for Q1 being up 6%, and that's remarkably different number from the kind of flat trend that I think you have said on the prior conference calls, you've talking about. Is just strikes me as being a pretty unique statistical anomaly, is there something wrong there, is it normally revised upward to that significantly?

Dusty McCoy

I'm sorry, who is revising third party data?

Rommel Dionisio - Wedbush Securities

I just noticed on slide 19. Q1 fiberglass sterndrive is up 6% and I realize you're getting some of the third party source. But all along we've been hearing it flat sterndrive market and that's pretty big difference. So I just wondered, if there is something unusual there in the data?

Dusty McCoy

I think its a little small boat. What we talked about is for us the type of boats that make us the most money are larger boat. But I would say if you go to that slide, it's primarily driven by small boats.

Operator

Your next question is from the line of Craig Kennison with Robert W. Baird.

Craig Kennison - Robert W. Baird

Dusty, could you comment on used prices and maybe break down by maybe lower end versus higher end boats.

Dusty McCoy

From what we hear with dealers and I always want to be clear our view about used pricing is a bit anecdotal. But it's something we have a lot of conversation about with our dealer network is these prices continue to hold up or even increase, because especially, lets say, Cruiser product there is a relative great used boats out there.

Dealers do not feel they have enough and when they can get a good one, it's sold in a matter of hours and days. And I believe, the marketplace is gradually raising prices there.

In terms of splits by brand strength, we continue to believe that the premium brands not only ours, but those brands that are out there in the industry are having better price increases than or the value bands in the used market.

Craig Kennison - Robert W. Baird

And as a follow-up are you seeing any change in finance underwriting standards in the last few quarter or the last years or so?

Dusty McCoy

Are you talking of retail?

Craig Kennison - Robert W. Baird

Yes, I am.

Dusty McCoy

No. Thing seems to be continuing the same. But we need to be open with one thought in our mind is we need to watch Europe and see what really starts to happen over there. Haven't seen or heard of anything, but then I wouldn't be surprise if it don't tighten up there.

Operator

Your next question is from line of Michael Swartz with SunTrust

Michael Swartz - SunTrust

With regards to your guidance and in light of kind of the strong double-digit declines out of Europe, I mean what are you, kind of, baking in for the continent, I guess the second-half of the year. Are you looking forward to continue declining at current rates or to decelerate even further?

Peter Hamilton

We're thinking continuous decline at current rates, but the second half is fair bit different and you really know this as the cover us. We saw a lot fewer boats at retail in the second half. And therefore second-half risk is not like first-half risk for us. So our view is that that the client we've seen are likely to be in the area, in the second half that we saw on the first half.

Michael Swartz - SunTrust

Right, when you talk about just wholesale shipments being head of retail demand, you're talking specifically about the U.S.?

Peter Hamilton

Primarily yes. No questions. There may be a little bit, but it's not going to be move overall needle in with some of our brands and models in the European market.

Michael Swartz - SunTrust

Could you also, maybe just comment on how Canada is performing on the Marine side?

Dusty McCoy

Canada is doing well. I'm pulling out something here so that I can be accurate. Canada is fundamentally flat.

Michael Swartz - SunTrust

And then one final question on the Fitness business and I know you have talked about this in past quarters about potential margin pressure coming down the pipe. And some of your competitors fight back on some loss share over the past years or a two. Have you started to see any of that materialize or is kind of as is?

Peter Hamilton

Well, our guys did a great job with some margins that we reported, but I would tell you in certain geographic regions, they are beginning to see very strong pricing pressure for some of what I'll call the bigger opportunities. In fact, prices that we don't understand, but our guys are dealing with it.

Operator

Your next question is from the line of Tim Conder with Wells Fargo Securities.

Tim Conder - Wells Fargo Securities

Circling back to the sterndrive issues, that you said you have corrected. Any type of color or frame work you can give us on what that cost you in the first half of the year as far as sterndrive engine revenue and then also clearly those engines going to your boats and competitors boat.

So that the engine revenue on the one side and then the boat revenue that may be cost you, that'd be question number one. And then, looking at Europe, could you just remind us what your expectations in general were for Europe, entering the year 30 days ago and then now as it pertain to the whole 2012 year.

Dusty McCoy

Well, first on the engine side, we probably lost in the engine business to mid-single digit operating dollars. On the boat business, it actually didn't impacted and the reason is not that we fight an allocation game with our focus was in others. I think our fellows, and a lot of customers did a lot of adjusting as to what they brought to market. So that they were almost on a weekly basis, and I think this is happening throughout the industry, bearing their production in order to meet the engines that we were going to be able to get out, I think in a week. So I think our focus didn't really changed much.

Tim Conder - Wells Fargo Securities

In relation to that, Dusty, then granted probably, I think you said on the last call. You don't anticipate making a lot of that up in the back half of the year and I guess, that's similar to the commentary you made on the outboard engine side. But how sticky do you think some of that loss business was as far as carrying over into next year.

Dusty McCoy

I don't think it going to be. In fact, Tim, as we're looking at share we yet have been able to see that we lost any share. And a bit of that is that this sterndrive market has, as you see the statistics, especially what was published in Trade Only today. If you look at June, gasoline sterndrive market is looking pretty tough here. But I think we saw demand continuing to decrease as we were ramping up. And it all came together in a nice way for us.

Peter Hamilton

On your Europe question, we headed into the year assuming sort of steady European economy. By the end of the first quarter, we have seen a 12% reduction in sales and assumed at that point, that's about what it would be for the remainder of the year. As you can see in the second quarter, we were off 23% exceed line.

And that equates to, you put it two together, about 20% down and that's what we're expecting for the reminder of the year, but it is fast moving target and the events of this morning, may be we could change in a little bit.

Tim Conder - Wells Fargo Securities

And then in expansion of Peter's Christmas card list, Dusty, I'll ask you to put on your swamy hand and bring out your crystal ball here, this is an update. As thing stand now for 2012, what are your for the industry as a whole for the U.S. market and then globally as for as retail unit boat sales?

Dusty McCoy

I think the industry as whole, if we add it all up right now. It's sort of 14%.

Tim Conder - Wells Fargo Securities

Domestically?

Dusty McCoy

Domestically, yes.

Peter Hamilton

My guess is that it will stay up double-digits, but it will decline a little from 14%, because we have seen progressive slowing as we've gone through the year. And I think as we go through the election cycle, people worry about so called fiscal cleft. The cleft is not so called, what it's called and so called. That's coming at us, I think its reason what to expect that we'll continue to see some slowing, like we did in June.

But we have got great momentum that continues in a lot of the really high volume product which is the aluminum product, and therefore, on unit basis, I think it will be up a double-digit. I think when we look around the world, because Europe is the second largest Marine market after the U.S. and because Europe is going to go such difficulty. I think low-to-mid single-digit is likely to be what the entire world looks like, Tim.

Tim Conder - Wells Fargo Securities

And then, finally, I guess revisiting that the used boat market, in general it sounds like you talked about the Cruiser segment. On the one hand, you've got a limited amount of product there, but on the other as you move up, especially over the 30-feet, you've said before that segment of the market in the U.S. continues to be challenged.

Is it just people are hesitant given the small business owners and the fiscal tax cliff, yet when they are buying there may be gravitating to the used boats. Is that the dynamic going on? And I guess, then taking the step further back it appears and please correct me I'm wrong that that broader dynamic of just the lack of used boats is further helping fuel the new boat side of the market, just a color on each of those two pieces, Dusty?

Dusty McCoy

Those buyers as they think about buying a new boat, in our view continue to be strongly inhabited by the overall economic climate which includes the whole bundle of, what are tax is going to be, or what's unemployment going to actually do, what are we going to do about the fiscal cliff, all of that.

But what's happening is the used boat market in that category is very robust, to the extent there are used boats available. So it's happening. As dealers, I believe are mining the marketplace on the drum of every way possible to get there hands on one of those boats because they can sell them and that's very important.

I think as we think about this segment as the market going forward, those buyers are still there. They've gone from 6,000 to 1,000, but the 6,000 are continuing to boat. All of our work is says boating is a part of their DNA and their lifestyle. But right now, they only want to buy a new used boat versus a new, because they feel more comfortable about the purchase in their personal economic situation than they do in new purchase.

And that's the world we're living in. And that's the world we're prepared to play in. And it doesn't impact over view of the medium and long-term health of that segment for our brands that participate there. And our guys are just are going to had to do a good job of managing, expand some product development, et cetera as we work our way through that dynamic.

Operator

At this time, we'd like to turn the call back to Dusty McCoy for some for some concluding remarks.

Dusty McCoy

Thanks a million. As always, I appreciate the interest, the quality of the questions that we get. I happened to believe that the folks who follow us are better than we've seen in most industries.

I want to close by doing three things. I want to congratulate all of our employees who get on these calls. And we already said, when we were going in a height of the downturn, life was easier for us as managers than it would ever be, because we knew what we had to do, that's pretty simple.

And we always anticipated, then we got to this part of the evolution of the economy and our rolling at managing the businesses would be very, very difficult, and our guys have done a magnificent job.

The men and women who work in this company and you're dealing with the really tough economic conditions and changing economic conditions, are hitting the ball everyday and I can't congratulate them enough.

Secondly, we are not perplexed or perturbed at all about what's unfolding in the marketplace. Of course, we would like Europe to be better, but that's why and Europe is going to be what its going to be and then we've got to go do other things throughout the company.

And we will continue to do that but the main aim is we've got to stay focus on our growth initiatives and deliver against those growth initiatives, as we go forward. And then got a question early on and it was a good question.

Are you still continuing to invest in your growth initiatives? The answer is yes, absolutely. And we will continue to do that and even if we have adjusts our cost structure to live with a market. We're not going to back off on the growth investments.

And then thirdly, and the tie-up to all of that is our management team continues to be confident in the 24 team guidance that we gave beginning in depth at the Miami Boat Show and the one thing that's always true about guidance, at long term. How you get there is never going to be the way you talked about. And we'd like to say, we know, we're heading south but there are 14 roads to south and we're going to have to travel the ones that are open for us.

And that's what we'll be doing, but we're not backing off at what we think this company can do and we're confident our ability to go do it.

So with that, I'll close. And, again, thanks everybody for the time and attention. And I'm sure Bruce, will be more then happy to clear up all the confusion that I've created on this call. So thank you very much.

Operator

Ladies and gentlemen, that will conclude today's conference. Thank you for joining us. You may now disconnect and have a great day.

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