Brunswick Corp Q3 FY2020 Earnings Call

Good morning and thank you for joining us. With me on the call this morning are Dave Foulkes, Brunswick's CEO, and Ryan Gwillim, CFO. Before we begin with our prepared remarks, I would like to remind everyone that during this call, our comments will include certain forward-looking statements about future results. Please keep in mind that our actual results could differ materially from these expectations. For details on the factors to consider, please refer to our recent SEC filings and today's press release. All of these documents are available on our website at Brunswick.com. During our presentation, we will be referring to certain non-GAAP financial information. Reconciliation of GAAP to non-GAAP financial measures are provided in the appendix to this presentation and the reconciliation sections of the consolidated financial statements accompanying today's results. I will now turn the call over to Dave.

Thanks, Chris, and good morning, everyone. Each of our businesses delivered outstanding operating results in the third quarter. Our ability to capitalize on very robust retail demand, which was enhanced by expanded boating participation and our compelling portfolio of industry-leading brands, drove excellent financial performance and value for our shareholders. The power of our platform and our investments in operational excellence were on full display as we accelerated production levels to meet retail demand, which continues to be elevated even as we exit the primary selling season in the U.S. and begin the process of replenishing historically low pipeline inventory levels. Our exceptionally strong free cash flow generation provides us with the flexibility to execute our capital strategy, which encompasses our planned investments and growth initiatives, including new products, advancing our ACS strategy, and maximizing the reach of Freedom Boat Club. Our propulsion business continues to gain appreciable retail market share, particularly in higher horsepower categories, as a direct result of our product leadership efforts and has yielded many new OEM customers and new dealer relationships. Throughout the year, our parts and accessories business delivered significant topline and earnings growth, which has increased both in participation and favorable weather, which extended the boating season in the U.S. This drove strong aftermarket sales, while OEM production ramp-ups across the industry also created high demand for our full range of OEM systems and services. Our premium brands remain market leaders in their categories, and our value brands offer attractive entry points to new and returning boaters. The surge in retail demand resulted in historically low pipeline inventory levels, with only 14 weeks of inventory on hand—48% fewer boats in dealer inventory at the end of the third quarter 2020 versus the end of the third quarter 2019. As a result, most of our brands have all production slots sold through the 2021 model year and asteria in Boston, where the brands of production slots sold out into the 2022 model year. Finally, Freedom Boat Club continues to outperform our expectations, as evidenced by its growth to 244 locations and almost 36,500 memberships company-wide, with over 3,000 new memberships added in the third quarter alone. Although we continue to operate in an uncertain environment, our enhanced visibility into the outlook for our businesses enables us to provide guidance for the remainder of 2020 as well as 2021, which Ryan and I will speak to in a few minutes. We will continue to outperform the industry in attracting new and more diverse boaters, which is positioning us very strongly for continued growth. More than half of the sales of Brunswick boats in the period from June through August were to first-time buyers or returning lapsed boaters, with the average age of Brunswick boat buyers being the youngest since 2011 and younger than the overall industry. Freedom Boat Club's membership trends towards an even younger demographic, with the average freedom member being three years younger than the average owner of Brunswick boats. The Freedom operating model allows younger boaters to get on the water frequently, with high-quality products prepared and ready to go for a day with family or friends. Boating participation has also become more diverse throughout 2020; over the last several months, the percentage of women buying boats has equaled the highest on record, while the percentage of new female boaters and female members of Freedom is double the percentage of women registering to vote. More recently, in August, we saw an uptick in Hispanic and Asian buyers of Brunswick products and an increase in Hispanic membership of Freedom. It is critical to the success of Brunswick and our industry that we continue to drive more diverse voting participation and find ways to engage with nontraditional voters through new products and participation models and advances in our digital capabilities. Regarding some highlights on our segments, the overall market of the publishing business continues to outperform due to the strength of our industry-leading product lineup. Pipeline inventory of Mercury outboard engines is significantly lower than in past years, and we continue to successfully run production to refill pipelines and meet exceptionally strong customer demand. Mercury continues to gain significant retail market share in outboard engines, especially in higher horsepower categories, while we have focused higher levels of investment in recent years as a result of our constant product innovation and the ability to quickly ramp production as a result of the capacity increases in 2018 and 2019. MotorGuide continues to successfully execute its strategy to win new OEM customers, and a new relationship with Sportsman and an expanded relationship with Beneteau, the largest manufacturer outside the U.S., were announced in just the last two months. We have many more new and enhanced partnerships in process. Outstanding products, expanding capacity, and excellent operational performance have also led to new dealer wins, with 60 new repower dealers added so far in 2020, resulting in an improved sales mix. Finally, the additional capacity has allowed us to serve more international customers where our higher horsepower commercial derivatives continue to take market share. Aggressive new product development remains on track with an all-new forward-facing outdrive launched in August and significant additional new product launches coming in the next six months. In closing, our first quarter results were bolstered by very healthy boat usage as favorable weather continued to fall for many regions of the U.S. Distribution business, which saw revenue growth of more than 30% versus 2019, was able to capitalize on increased participation and extended season in both the Marine and RV spaces. Our distribution business also enjoyed strong quarter supply products as dealers support increased service needs. They have commented that they are four, six, or even eight weeks behind on servicing, which should continue to generate sales into the traditional off-season. The OEM portion of the business also had a strong quarter as boat manufacturers ramped up production to satisfy demand and rebuild pipelines. The Advanced Systems Group demonstrated significant year-over-year sales and earnings improvements, leveraging the same aftermarket and OEM trends, including EFI business, which represented almost 40% of the company's sales in the quarter and over half of the operating earnings. With margins continuing to expand, this steady annuity-based business strengthens our overall financial profile and provides a robust baseline of earnings from which we can continuously invest in our businesses and return capital to shareholders. Overall, it was a fantastic quarter with top-line earnings and margin improvements across the lineup, and we are well-positioned for the future. I'll now turn the call over to Ryan for additional comments on our financial performance.

Thanks, Dave, and good morning, everyone. Retail demand, together with late-season both usage had a material impact on our financial results in the quarter, making for significantly better year-over-year comparisons. Net sales in the quarter were up 26%, while operating earnings on an adjusted basis increased by 49%. Adjusted operating margins were 16.5%, up 260 basis points versus the third quarter of 2019. We finished the quarter with an adjusted EPS of $1.80, up 64% from the prior year. We generated $396 million of free cash flow in the quarter. This outstanding outcome is driven by strong earnings and favorable changes in working capital, resulting from reductions in inventory and increases in accounts payable from increased production, as well as a seasonal reduction in accounts receivable. On a year-to-date basis, net sales are flat versus 2019, and adjusted operating earnings were down 2%, with adjusted operating margins of 30.6%, which are just 20 basis points lower than the same period in 2018—a very good result considering the challenges faced by the businesses in the first half of the year with having to shut down and then ramp up production as a result of the pandemic. I will now discuss the third-quarter performance on a segment level, starting with the propulsion segment. Revenue increased 33% as each product category experienced strong demand, especially in higher horsepower outboard engine categories and related controls and systems. All customer channels showed growth in the quarter as OEM customers continued to ramp up production and increase capacity, enabling elevated sales to the dealer and international channels. Operating margins and operating earnings were up significantly in the quarter as a result of increased sales and favorable changes in sales mix, partially offset by the unfavorable impact of higher variable compensation costs. In our parts and accessories segment, revenues increased 23%, and operating earnings were up 29% versus the third quarter of 2019 due to strong sales growth across all product categories. Adjusted operating margins of 23.4% were 100 basis points better than the prior year quarter, with year-to-date margins now 20 basis points better than year-to-date 2019, showing the consistent, sustainable earnings power of this business. Revenues in the boat segment were higher by 18%, resulting from significantly higher wholesale sales to dealers, both to meet increased customer demand at the retail level and also to begin refilling pipeline inventories. All of our boat brands steadily ramped up production in the third quarter to meet the strong demand. Boston Whaler and SeaRay continue to outperform their categories. Our lineup remains the leader in premium aluminum fish boats, and our value brands also showed healthy retail demand. Increased production and sales resulted in healthy operating leverage of 35% during the third quarter, driving operating margins to 9.2%, a 470 basis point increase compared to the third quarter of 2019. All product categories contributed to margin growth, with Boston Whaler, Lund, and the Venture Group, which includes Bayliner and Heyday, all exceeding 10% margins for the quarter. As we've been discussing, as a result of the surge in retail demand, the dealer pipeline ended the quarter at historically low levels—our lowest pipeline inventory levels in over 20 years. Our brands ended the third quarter with 14 weeks of boats on hand, measured on a trailing 12-month basis, with units in the field lower by 48%. Our pipeline projections for year-end assume that dealer inventories will increase through the fourth quarter to approximately 22 weeks on hand, but that will still be approximately 13 weeks behind typical year-end levels. To help put this into perspective, we are currently estimating that we will wholesale in 2020 between 28,000 and 29,000 boats while retailing between 36,000 and 37,000 boats. Even if we assume a flat retail environment next year, we will need to manufacture and wholesale 7,000 to 9,000 more boats in 2021 just to satisfy retail demand without building dealer pipeline inventories. We believe our current manufacturing footprint will support this increase, and we continue to work with our brands to unlock even additional capacity. The resulting pipeline inventory levels will still be below desired levels by the end of 2021, but this would position us for strong wholesale sales again during 2022. While we remain very cognizant of macroeconomic headwinds and other uncertainties, our continued strong performance and a robust marine retail environment have created improved visibility into our substantial growth opportunities for the remainder of 2020 and into 2021. Despite the potential impact of the pandemic on our global labor availability and supply chain, elevated production levels will be required to rebuild the engine pipelines, and together with significant upcoming product launches should drive wholesale growth into next year and beyond. As a result, we are providing the following guidance for the remainder of 2020. We anticipate that U.S. marine industry retail unit demand will be up high single-digit percent for the year, with slightly stronger demand in the U.S. than in international regions. We expect fourth-quarter revenue to increase low to mid-teen percent over Q4 2019, with adjusted operating leverage in the high teens percent. Lastly, we believe these efforts will drive full-year adjusted diluted EPS of approximately $4.75, with free cash flow generation in excess of $600 million. These 2020 expectations and the initial thoughts on 2021 will be discussed shortly, assuming no additional major pandemic-related business continuity issues. Additionally, as we have cautioned in the past quarters, it cannot be overstated that the level of recovery of the global economy, continued stable channel operations, the ability to moderate labor and input costs, and the absence of significant additional disruption to our global operations and supply chain will all be important factors in determining whether we ultimately perform in line with our targets. Our current liquidity position is very strong. Our liquidity planning is influenced by several factors, including our cash position, our ability to generate free cash flow and retain full access to our revolving credit facility, as well as our plans surrounding debt repayment, share repurchases, and dividends. We anticipate generating free cash flow for the year in excess of $600 million, and we plan to have total liquidity of more than $970 million by year-end. We ended Q3 with cash balances totaling $660 million versus $332 million at year-end. This increase included free cash flow generation of $520 million in the first nine months of 2020, which is approximately $441 million more than the same period in 2019, principally related to favorable changes in working capital driven mainly by reductions in inventory. The significant free cash flow generation in the third quarter allowed the company to repay the remaining $185 million of borrowings under its revolving credit facility and further reduce our long-term debt obligations by $39 billion as planned. I will conclude with an update on certain items that will impact our capital plan and cash flow for the remainder of the year. Aside from the updated anticipated free cash flow just discussed, most of these estimates have changed only slightly since the July call. The one exception remains working capital, where we now estimate a reduction in excess of $175 million for the year. Given the demand and production dynamics we have discussed, inventory levels are down significantly through the first nine months of the year. Although we do anticipate building inventory in the fourth quarter in our propulsion and pinay segments, we expect to end the year with reduced working capital. We anticipate between $115 and $120 million in depreciation and amortization. Our effective tax rate is estimated to be between 21% and 22% for the year, with the cash tax rate anticipated to be in the low double digits. Our average shares outstanding figure remained at approximately 80 million shares. Also, as a result of the strong cash flow generation, we've made significant changes to our capital strategy assumptions reflecting actions we plan to take in the fourth quarter. We anticipate that we will use an additional $60 million of our considerable free cash flow to continue paying down our 2023 term loan, resulting in total debt retirement of $160 million for the year. This incremental repayment would lower our debt-EBITDA leverage below 1.5 times on a gross basis by the end of the year. In September, we also announced that we are restarting our systematic share repurchase program, with a goal of repurchasing $100 million of shares in 2020, which is consistent with our target to start the year. We completed $45 million of repurchases in the third quarter, leaving us with $21 million of planned repurchases in the fourth quarter. Finally, as discussed last week, we have increased our quarterly dividend by $0.05 to $0.27 per share, which represents the eighth straight year of dividend increases. That decision is enabled by our strong financial position and consistent cash generation, benefitting from the growth of our less cyclical business and Freedom Boat Club initiatives. I will now turn the call back over to Dave to continue our outlook comments.

Thanks, Ryan. 2020 has presented many challenges, but our businesses are executing extremely well against our operating and strategic priorities. In the propulsion segment, we continue to leverage the strongest product lineup in the industry to gain market share in the parts of the market where we've been historically underrepresented. Further growth into saltwater, repower international commercial markets is being enabled by the manufacturing capacity added in 2018 and 2019, and will be bolstered by exciting new product launches in the coming months. We anticipate steady demand for aftermarket parts and accessories as boat servicing in northern markets continues. We expect OEM product lines and integration services will also see high demand as boat builders continue to ramp up production to replenish pipelines ahead of the 2021 retail season. In our boat segment, we will continue to focus on launching new products across the portfolio, including new products designed for younger boaters, ramping up production to meet demand and result pipelines, and making progress with our stated plan to further improve operating margins. Freedom Boat Club continues to expand and execute against its strategic growth objectives. We've added over 30 locations thus far in 2020, with franchisee demand for products peaking well ahead of anticipated levels. We're making rapid progress with our enterprise-wide initiatives in digital marketing, eCommerce, consumer insights, and data analytics while also driving our ACS strategy forward. One recent example of our ACS investments is our partnership with the marine autonomy company Sea Machines, in which we announced yesterday an additional investment aimed at advancing autonomous piloting for marine vessels. These initiatives will be accelerated by new leaders with contemporary skill sets joining our senior leadership team in the last few weeks. We welcomed our new president of Brunswick and Mike Adams, who has been leading many of our digital initiatives, promoted to the CIO role. We also announced that Reggie Feltham is joining the Brunswick board. Reggie is the former president and CEO of Nintendo North America and has deep knowledge of digital technology and developing compelling consumer concepts and experiences. Before we close, I'd like to provide a brief update on our initial view of 2021. As you know, the progression of the global pandemic remains very dynamic, and the potential impact on our dealers, OEM partners, suppliers, and the macroeconomy is difficult to predict. However, we have gained improved insight into next year due to increased clarity on wholesale boat demand, the impact of Mercury's continued propulsion strength, the consistent growth of the business, and the availability of cash to fund our planned capital strategy actions and growth initiatives. We will provide a clearer view on our forecasts for the 2021 marine market during our Q4 earnings call in early 2021. However, in a reference scenario, if U.S. marine industry unit demand is flat to up low single-digit percent for the year, we would anticipate consolidated revenue between $4.7 to $4.9 billion, adjusted operating leverage of high teens to low 20%, and adjusted diluted EPS in 2021 of $5.75 to $6.25, with growth coming in several areas. First, we forecast strong gains in our propulsion business as we continue to take market share as a result of an enhanced and stable industry-leading product line. Next, we anticipate capturing significant growth in wholesale boat sales given the historically low pipelines and strong retail demand, backed not only by strong dealer orders ahead of the 2021 retail season but also from an increased dollar value of dealer orders that are already retail sales. Note that these projections do not assume we will fully rebuild the pipeline in 2021. We also expect the Freedom Boat Club to continue its steady expansion as boat sales increase. Finally, our capital strategy should generate favorability as a result of that reduction and systematic share repurchases. I want to reiterate our continued confidence in our ability to successfully execute a 2020 strategic plan while also ensuring that we continue to prioritize protecting the health and welfare of our employees in the COVID-19 environment. Given our strong financial position, which enables continued investment in new products and technology development, industry-leading products, which are generating continued market share gains, current levels of pipeline inventory, the performance of Freedom Boat Club, and our focus on operational efficiency and cost containment, we expect to meet the 2020 financial objectives shared in Miami in February. This morning, we announced that our board of directors has elected Nancy Cooper as its new non-executive board chair, effective November 1. Nancy is the first female board chair in Brunswick's history. She succeeds Manny Fernandez, who has announced his intention to retire after more than 20 years of service to the company. I want to personally thank Manny for his decades of support and leadership at Brunswick, and I look forward to continuing to work with Nancy as we successfully execute our marine-focused strategy. Finally, operations teams are keenly focused on applying and enhancing our COVID-19 health and safety protocols while continuing to ramp up global production to meet unprecedented market demand. I want to once again thank our 13,000 global employees for their commitment, hard work, and vigilance during this challenging time. I also want to thank our loyal long-term customers and welcome the new Brunswick boaters and Freedom members who have been able to enjoy safe outdoor fun with their family and friends in 2020. I will now open the line for questions.

Thank you. Ladies and gentlemen, the first question comes from the line of James Hardiman at Wedbush Securities. Hey, good morning, guys.

So I'm going to ask sort of a weird question, but bear with me here. I have been covering you guys for the better part of, well, I don't know myself, but a big part of analyzing the business and certainly managing the business has been just understanding the cycle, right? We find ourselves in a situation where we're in the midst of a recession and yet the industry is going to be up high single digits. So my question is, as we look to 2021, should we be thinking about that as the first year of an economic recovery or the eleventh year? I think most industry observers had sort of resigned to the fact that maybe we'd get to, you know, 200,000 units at the peak of a cycle or maybe a little bit better. And that was about it. I'm curious how you think about the long-term potential from an industry perspective and whether or not anything has changed and how you're sort of cycle thought informing your capital strategy, right? Sitting on $600 million in cash, $600 million free cash flow. Obviously, the way you think about the next few years is going to inform what you invest in. So sort of a big picture question there, but any thoughts would be welcome.

Thanks very much for that question. I think this year has some unusual trends in it, but we intend to fully capitalize on those trends in a way that I think will influence our business for many years to come. It is clear that we are over-investing in new boaters and diverse boaters versus the industry, and we will be working hard to retain those new boaters and bring additional people in next year and the years beyond. I believe that there is a potential network effect here, which will expand significantly. If you think about this year, we have all these new voters and returning lapsed voters. That decision time was very short. They had to decide between essentially April, when we were in the depths of the first stage of the pandemic, whether they were going to suddenly buy a boat. Given the amount of publicity around boating and its safety, utility, and enjoyment, I believe that there will be many more people making long-term decisions that will support us for a number of years to come. In terms of the way we kind of think about the business right now, I think we've made it clear that we're in the middle of a multi-year effect from a wholesale perspective, as Ryan mentioned earlier. Even producing at historically high levels, we will not make significant progress in increasing the pipeline in 2021. So we believe that the wholesale drivers here are multi-year wholesale drivers. I would tell you that when we talked about our reference strategy here, it is a reference strategy. I would say it's a cautious strategy. Every leading indicator that we have points to much more robust retail demand, but we don't know exactly what we don't know right now. So we thought we would offer a strategy that presents the business in a kind of neutral market way. How would we do in a neutral market? The way we generated cash this year certainly puts us in a strong position to accelerate some of our growth investments, whether those are organic or potentially inorganic, and position ourselves extremely well for a range of scenarios, probably more quickly than we would have anticipated just a few months ago or even a year ago. We find new energy in the business right now around the retail demand and wholesale demand, and our objectives are to capitalize on that, not just in the short term but also in the long term.

Thank you. Your next question comes from the line of Scott Stember with a question.

My main question is just on the creditworthiness of the people that you have coming into the market. And obviously, we're in the early stages of a potentially multi-year cycle here of a lot of much younger consumers coming into this market. Could you give us any additional color on their creditworthiness and give us some comfort that we won't have some issues potentially down the road?

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

Thank you. Next question comes from the line of Craig Kennison with Baird.

Hey, good morning. Thanks for taking my question. I hope it's different than what I just heard, but wanted to really understand mercury in the market share trends better. I know you've had Evinrude, and you've also had OEM wins with Sportsman and Beneteau. I guess I'm wondering if you can help us understand or quantify really the share gains that you've seen. Then help us understand what's driving. It feels like it's been a huge year in terms of market share wins, and I'm guessing maybe some of your OEM partners are getting a peek at what your future innovation looks like, but just want to understand those trends better.

Thank you. Great to hear from you. The market share gains are significant, and we, as we said earlier in the year, we are already trending ahead of our 2022 objectives, which were part of our Miami presentation. Mercury is accelerating even faster than we had anticipated. I think we clearly have the best product lineup in the marketplace, and I'm excited about what is frankly just around the corner, which I think will expand that leadership. But I would say, though, that Mercury is a very reliable partner, and it's essential for our customers not just to have the best product but also to be able to get it reliably. The investments that we've made over recent years and the level of partnership that we demonstrate is superior to our competition. These wins don't just come overnight. They come after long periods of investment in relationship building, as well as displaying the benefits of our new technology. I would say that you mentioned some of the bigger wins, but just over the past year, we have 44 new OEM customers, so you can tell how fast this is happening, and we are well positioned to capitalize on that. This trend is very significant, and it has a lot of momentum in it.

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

Thank you. Next question comes from the line of Eric Wold with B. Riley Securities.

A couple of questions around M&A as you think about the increased comfort you now have with the 2020 financial targets back in February. Are you seeing an easier path getting there without acquisitions, or is the assumed M&A contribution the same as it was back when you first gave those targets? And then as you think about the acquisition opportunities out there, have you seen any change with the recent surge around the number of opportunities, expectations becoming elevated? Does this change your view of potentially increasing further in the boat category itself, or is that something you're still somewhat against?

We still have a very active M&A funnel, so we are proceeding as we've previously indicated, looking at organic growth opportunities. We continue to focus the majority of our efforts on play annuity-oriented businesses and service businesses like Freedom. So our focus has not really changed for 2021. For simplicity, we did not include any inorganic growth opportunities, but we remain very actively looking in that area, and we see a number of interesting opportunities.

Thank you. Next question comes from the line of Joe Altobello with Raymond James.

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

Yes, it's a good question. In the middle of the year, we definitely had a significant contribution from new and lapsed boaters. I would say, though, that because of somewhat constrained inventory, they probably displaced more traditional boaters who would have in other circumstances probably upgraded their boats this year. Given the inventory constraints, it is a little difficult to understand exactly what the dynamics of that effect would look like in eight years. I think it is possible next year that we'll see similar levels of influx from new voters and people who wanted to upgrade this year but didn't have an opportunity to reenter the market. So there's no great answer to your question, but in a supply constrained environment, it is challenging to pinpoint the specifics.

I understand. And I guess, secondly, Ryan, you gave some really good numbers and color on units and pipeline we built for 2021. I'm curious what you're seeing on the home front. I mean, obviously, Whaler and SeaRay are selling very nicely and tend to be higher priced. So, yes, I know what next year looks like as well on the boat.

Yeah, Joe. As we do continue to climb in, even in light of a little bit more strength on our value products this year, I think people are putting more content on their products across the board—whether it's value or premium—this is really driving that. So, yes, I would tell you that probably some tailwinds there, combined with the fact that some of our more premium brands, such as Whalers, specifically have new product lineups coming out, which will likely see more retail next year compared to what they did this year. So I would say yes on your ASP question.

I just thought this helps, but we're only a day into the Fort Lauderdale Boat Show, but we're already seeing sales from the first day of Whalers ahead of last year, even with the extended delivery times that we are now closing. It is clear that there are people who may have delayed their purchases this year and are now thinking they better get in the queue, otherwise they're not going to get anything.

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

I think one of the things you see, David, when you address 2021 guidance you mentioned having more clarity and visibility on all the drivers. You didn't mention clarity on supply costs. Can you talk about that part of the equation? Does your guidance for 2021 anticipate new capacity? At what level of capacity utilization will you need to be to achieve your 2021 numbers?

Thank you. I think maybe I can answer that by saying we do not anticipate any new capacity in our production. We do not expect any major bricks and mortar. There may be, you know, some localized and smaller things that we might work on, but given the demand, we are certainly looking at not adding a lot of bricks and mortar. But we are actively studying other ways to potentially increase capacity. On the cost side, we are seeing a little more pressure from suppliers who are constrained at the moment, probably by their own internal capacity and may be experiencing pressures as well. I would say, on the cost side from the supply chain, it doesn't look like anything that we couldn't contain or largely contain. Our ability to ramp up has been very good. We've been hiring many people—900 people across operations in Q3, and we are still hiring successfully. As we go through the dynamics of COVID in different states, we see different levels of absenteeism that we have to account for. So our 2021 forecast really does not assume any new, major capacity actions, assuming that we can continue at reasonable levels of operational ramp-up. In that scenario, as Ryan mentioned, we do not expect to make a significant impact on the pipeline.

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

Well, so far, we're actively managing and monitoring our supply chain. I would say that while we are experiencing issues that we need to manage on a daily basis, nothing is really slowing us down. It is possible that that could happen. But that is not the current situation. I think we are managing our way through the corporate environment as best as we can—both us and our suppliers. So far, we've managed to do that. So, essentially, while we have short-term shortages, we seem to be managing and believe we can ramp up as needed to deliver the 2020 forecast.

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

Good morning, guys. In your 2020 guidance range, can you help us with this? So the operating leverage for the fourth quarter and third quarter—I don't see a lot of change in terms of strong demand still for us. So I guess why should we expect that step down between the third-quarter and fourth-quarter?

Yeah, thanks, Mike. This is something we anticipated coming into the call. The third quarter is quite strong, really at the gross margin line. We had very favorable mix in propulsion and throughout some of the Pinay categories as well, and also some lower retail discounts in the boat group, as you can imagine, given the state of play in the retail market. Also, OpEx was down in the quarter, which is obviously up as a percentage of stronger sales, benefiting from the cost-cutting measures we took in 2019 and earlier this year. When you look to the fourth quarter, there will still be some benefits on the gross margin line, but it may be a bit more muted due to the smaller sales increase we’re anticipating. We’ve got some seasonality in there, obviously, with lower projected sales, and in propulsion and pinay due to the usual course of play. So while the leverage is still within our usual cadence of high teens and low 20% levels, the fourth quarter leverage is still anticipated but there are a couple of things that will sway it a little bit.

The second question is more philosophical level, I guess, given the amount of visibility you have and the liquidity you have. How does it change when you think about financial leverage in the business over the next several years?

Yeah, Mike, we are going to end up in a position at the end of the year, which is where we strive to be—at about 1.5 times leverage. I assume you mean our financial leverage from a debt capacity standpoint? By the end of the year, we will be in a good place. As we continue to pay down our term loan debt, that number will get closer to one time. All that does is enable us to ramp up as needed for large investment—whether it's product or M&A or the like. We've shown with the power products deal that we can leverage up for the right deal. The rating agencies seem to be okay with that, given that these are good merger and acquisition deals and good assets out there. We are okay leveraging up for the right asset but plan to continue to work it down over time. I think keeping leverage at two times or lower, or really at 1.5 times or lower, will remain our goal.

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

Hey, good morning. I may have missed this, but how much of your boat production slots have a customer name on it, or is retail sold at this point versus how much is allocated to dealer restocking?

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

Okay. I met on slide 525 where you talk about the 21 EPS bridge, just a question on the smaller Pinay contribution in that slide. What are the underlying assumptions there? Is that underwriting boat usage or restocking next year versus the other segments?

Yeah, this is another one that we anticipated. It's straightforward. Just because it comes out a little bit on the chart, it shouldn't be surprising because this is a more steady grower—a more annuity-based business. It grows a little bit with inflation, plus some market share gains and other things in the OEM business. I think, you know, we had a strong second half in that business, as evidenced by revenue gains in the third quarter. We're guiding for the fourth quarter, which includes strong growth there as well. That segment has the ability to restock a bit more continuously, whereas for engines and boats, it takes longer to refill the pipeline. This segment, as we've mentioned, does not include M&A on that page or in the 75 to 76. It's probably a bit conservative, but this is a fantastic business that elevates our earnings floor in any economy, as shown by its second quarter performance when the world essentially shut down for two months.

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

Great. Hey, David, Ryan, and Brant, good afternoon. So to speak, you have so much. My question is on margins, specifically the margins in the boat segment. Top-line trends are healthy; however, your operating margin really came in at what I believe is a record margin of 9.2%. I know you have done a lot of hard work around cost realignment and restructurings. I wanted to ask you about margin sustainability and a level of profitability that you think is sustainable in the future.

Thank you for the question. We certainly believe it's sustainable, and we plan to grow that even further. I think we obviously in the third quarter and fourth quarter are benefiting from volume, but we are also working through onboarding and training people, which may lead to some inefficiencies in that process. Our strategic actions are flowing through nicely, and we have room to run on those margins, both on the efficiency side and on gross margin as well. We are very pleased with this trend and expect more going forward.

That's great. Thank you, David. Maybe just a quick second question on supply chain. I know you just touched upon it to some extent already, but we certainly hear a lot of questions on this subject. As Ryan said, the world stopped for two months and then restarted all at the same time, which created some logjam. Can you just talk about specific areas where you've seen more challenges and where you're putting more effort to navigate any supply chain concerns?

I think that we have the benefit of a propulsion supplier, Mercury, that invests tremendously in capacity and efficiency and continues to invest there. So I think all of Mercury's customers uniformly benefit from not only Mercury's great products but also from its tremendous investment in capacity. That takes that issue off the table that other companies might be experiencing. As we go through the various ways COVID affects different states and countries differently, for example, in northern Mexico, where a lot of wiring harnesses and other electrical systems are developed, we have experienced ups and downs. However, right now, that area is producing very well, so I would not isolate any specific subsystem as an issue. I would just say that we are continuing to manage and are working extremely well with our supplier partners, and we are very thankful for all their efforts. There is nothing currently that is significantly holding the business back.

I understand that; that's helpful. Thank you for the time and insight.

Thank you. At this time, we would like to turn the call back to Dave for some concluding remarks.

Well, thank you all very much for attending today, and thank you all for the wonderful questions. As you've heard, it has been a challenging year for all of us, including our employees. However, our whole team is very excited about the energy in the marine market. We believe we have a unique platform, and our investments in products, technology, and capacity position us exceptionally well to capitalize on the current situation. All of our retail and wholesale-leading indicators suggest this is a multi-year and very robust opportunity. I would like to close by personally thanking outgoing chairman Manny Fernandez for his tremendous partnership over the last two years and wish him every success in the future. I know we'll stay closely in touch, and I warmly welcome Nancy Cooper as our new board chair, and I look forward to working together.

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