UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2018
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 1-1043
____________
Brunswick Corporation
(Exact name of registrant as specified in its charter)
Delaware | 36-0848180 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
26125 N. Riverwoods Boulevard, Mettawa, Illinois 60045-3420
(Address of principal executive offices, including zip code)
(847) 735-4700
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock ($0.75 par value) New York Stock Exchange, Chicago Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Large accelerated filer | x | Accelerated filer | o |
Non-accelerated filer | o | Smaller reporting company | o |
Emerging growth company | o | ||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of June 29, 2018, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the voting stock of the registrant held by non-affiliates was $5,551,034,582. Such number excludes stock beneficially owned by officers and directors. This does not constitute an admission that they are affiliates.
The number of shares of Common Stock ($0.75 par value) of the registrant outstanding as of February 15, 2019 was 87,028,425.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Report on Form 10-K incorporates by reference certain information that will be set forth in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 8, 2019.
BRUNSWICK CORPORATION
INDEX TO ANNUAL REPORT ON FORM 10-K
December 31, 2018
TABLE OF CONTENTS
PART I | Page | |
PART II | ||
PART III | ||
PART IV | ||
PART I
Item 1. Business
Brunswick Corporation is a Delaware corporation incorporated on December 31, 1907. We are a leading global designer, manufacturer, and marketer of recreation products including marine engines, boats, fitness equipment, and active recreation products. Our engine-related products include: outboard, sterndrive, and inboard engines; trolling motors; propellers; engine control systems; electrical components and integrated systems; and marine parts and accessories. The boats we make include fiberglass sport boats, cruisers, sport fishing and center-console, offshore fishing, aluminum and fiberglass fishing, pontoon, utility, deck, inflatable, and heavy-gauge aluminum boats. Our fitness products include cardiovascular and strength training equipment for both the commercial and consumer markets. We also sell products for active aging and rehabilitation, a complete line of billiards tables, and other game room tables and accessories.
In 2018, we continued to successfully execute our growth strategy, acquiring new parts and accessories brands and investing in innovative products, productivity, and efficiency initiatives. We expect to continue our focus on growth in the combined marine business in 2019. With respect to the Fitness segment, our focus remains firmly on completing the separation of this business from the portfolio in a timely fashion, and in a manner that maximizes value to our shareholders. The spin-off process remains on plan, and we continue to evaluate other options, including a sale of the business. In 2019, our marine business will emphasize continued product leadership, targeted acquisitions, and other growth-related investments. In the longer term, our strategy remains consistent: to design, develop, and introduce high-quality products featuring innovative technology and styling; to distribute products through a model that benefits our partners - dealers and distributors; to provide world-class service to our customers; to develop and maintain low-cost manufacturing processes, and to continually improve productivity and efficiency; to manufacture and distribute products globally with local and regional styling; to continue implementing our capital strategy, which includes allocating capital to organic growth initiatives and strategic acquisition opportunities, managing debt levels and maturities, maintaining strong cash and liquidity positions, funding pension obligations, and continuing to return capital to shareholders through dividends and share repurchases; and to attract and retain skilled employees. These strategic objectives support our plans to grow by expanding our existing businesses. Our primary objective is to enhance shareholder value by achieving returns on investments that exceed our cost of capital.
Refer to Note 7 – Segment Information and Note 3 – Discontinued Operations in the Notes to Consolidated Financial Statements for additional information regarding our segments and discontinued operations, including net sales, operating earnings, and total assets by segment.
Marine Engine Segment
The Marine Engine segment, which had net sales of $2,993.6 million in 2018, consists of the Mercury Marine Group (Mercury Marine). We believe our Marine Engine segment is a world leader in the manufacturing and sale of recreational marine engines and marine parts and accessories.
Mercury Marine manufactures and markets a full range of outboard, sterndrive, and inboard engine and propulsion systems under, among other brand names, Mercury, Mercury MerCruiser, Mercury Racing, and MotorGuide brands. In addition, Mercury Marine manufactures and markets parts and accessories under the Ancor, Attwood, BEP, Besto, BLA, Blue Sea Systems, CZone, FulTyme RV, Garelick, Lenco Marine, Marinco, Mastervolt, Mercury, Mercury Precision Parts, MotorGuide, Park Power, Progressive Industries, ProMariner, Quicksilver, and Seachoice brand names, including marine electronics and control integration systems, steering systems, instruments, controls, propellers, trolling motors, fuel systems, electrical systems, service parts, and lubricants, as well as specialty vehicle, mobile, and transportation aftermarket products. Mercury Marine supplies integrated propulsion systems to the worldwide recreational and commercial marine markets. To promote advanced propulsion systems with improved handling, performance, and efficiency, Mercury Marine also manufactures and markets advanced boat steering and engine control systems.
Mercury Marine's outboard, sterndrive, and inboard engines are sold to independent boat builders, local, state, and foreign governments, and to Brunswick's Boat segment. In addition, Mercury Marine sells outboard engines through a global network of more than 6,000 marine dealers and distributors, specialty marine retailers, and marine service centers. White River Marine Group, LLC and its subsidiaries (including Tracker and Ranger Boats) is Mercury Marine’s most significant external customer.
Mercury Marine manufactures four-stroke outboard engine models ranging from 2.5 to 400 horsepower. These low-emission engines are in compliance with applicable U.S. Environmental Protection Agency (EPA) requirements. Mercury Marine's four-stroke outboard engines include Verado, a collection of outboards ranging from 250 to 400 horsepower, and Mercury Marine's naturally aspirated four-stroke outboards, ranging from 2.5 to 300 horsepower. Mercury Marine and Mercury Racing manufacture
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inboard and sterndrive engine models ranging from 115 to 1,750 horsepower. Mercury Marine also manufactures two-stroke, non-DFI engines for certain markets outside the United States. In addition, most of Mercury Marine's sterndrive and inboard engines are now available with catalyst exhaust treatment and monitoring systems, and all are compliant with applicable U.S. state and federal environmental regulations. Mercury Marine also makes engines that comply with global emissions and noise regulations.
Mercury Marine continues to develop innovative products, including its all-new V8 FourStroke outboard family of engines, winning the 2018 Most Innovative Product at the New Zealand Boat Show, and a 2018 Innovation Award from the National Marine Manufacturers Association for the 3.4L V6 FourStroke outboard engines. Mercury Marine was awarded an IBEX Innovation Award in 2018 for its tiller handle assembly for portable outboard motors. 2018 also saw Mercury Marine open a state-of-the-art NVH (Noise, Vibration, Harshness) Technical Center at its global headquarters in Fond du Lac, Wisconsin.
Mercury Marine produces its gasoline sterndrive and outboard engines domestically in Fond du Lac, Wisconsin, with outboard engines also produced internationally in China and Japan. Mercury Marine manufactures 40, 50 and 60 horsepower four-stroke outboard engines in a facility in China, and produces smaller outboard engines in Japan pursuant to a joint venture with its partner, Tohatsu Corporation. Mercury Marine sources engine components from a global supply base and manufactures additional engine component parts at its Fond du Lac facility and plants in Florida and Mexico. Mercury Marine also operates a remanufacturing business for engines and service parts in Wisconsin.
For the eighth consecutive year, the Wisconsin Sustainable Business Council awarded Mercury Marine a “Green Masters” designation, a program measuring a broad range of sustainability issues including energy and water conservation, waste management, community outreach, and education. The designation highlights Mercury Marine's commitment to sustainability as discussed in its 2018 Sustainability Report, detailing specific goals related to energy, environment, products, and people, all of which goals Mercury Marine has met or exceeded. In addition, Mercury Marine won Sustainable Product of the Year from the Wisconsin Sustainable Business Council for its Active Trim technology and was presented a Wisconsin Business Friend of the Environment Award in 2018.
Mercury Marine's Parts and Accessories Group distribution businesses include: Land 'N' Sea, Kellogg Marine Supply, Lankhorst Taselaar, BLA, Payne's Marine Group, and Del City. Parts and Accessories manufacturing businesses include Attwood, Garelick Mfg. Co.,Whale, Ancor, BEP, Blue Sea Systems, CZone, Lenco Marine, Marinco, Mastervolt, Park Power, Progressive Industries, and ProMariner. These businesses are leading manufacturers and distributors of marine parts and accessories throughout North America, Europe, and Asia-Pacific, offering same-day or next-day delivery service to a broad array of marine service facilities.
On August 9, 2018, Brunswick acquired 100 percent of the Global Marine & Mobile business of Power Products Holdings, LLC (Power Products), including the global marine, specialty vehicle, mobile, industrial power, and transportation aftermarket products businesses of Power Products, for $910 million in cash from San Francisco-based private equity firm Genstar Capital. The acquisition added a broad, complementary product portfolio of 11 new brands to Mercury Marine's parts and accessories business.
Intercompany sales to Brunswick's Boat segment represented approximately 11 percent of Mercury Marine's sales in 2018. Domestic demand for the Marine Engine segment's products is seasonal, with sales generally highest in the second calendar quarter of the year.
Boat Segment
The Boat segment consists of the Brunswick Boat Group (Boat Group), which manufactures and markets the following types of boats: fiberglass sport boats, cruisers, sport fishing and center-console, offshore fishing, aluminum and fiberglass fishing, pontoon, utility, deck, inflatable, and heavy-gauge aluminum. We believe that the Boat Group, which had net sales of $1,471.3 million during 2018, is a world leader in the manufacturing and sale of pleasure motorboats.
The Boat Group manages Brunswick's boat brands; evaluates and optimizes the Boat segment's boat portfolio; promotes recreational boating services and activities to enhance the consumer experience and dealer profitability; and speeds the introduction of new technologies into boat manufacturing and design processes, including through its Business Acceleration initiatives.
The Boat Group includes the following boat brands: Sea Ray sport boats and cruisers; Bayliner sport cruisers, runabouts, and Heyday wake boats; Boston Whaler fiberglass offshore boats; Lund fiberglass fishing boats; Crestliner, Cypress Cay, Harris, Lowe, Lund, and Princecraft aluminum fishing, utility, pontoon boats, and deck boats; and Thunder Jet heavy-gauge aluminum boats. The Boat Group procures most of its outboard engines, gasoline sterndrive engines, and gasoline inboard engines from Brunswick's Marine Engine segment.
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The Boat Group also includes Brunswick boat brands based in Europe and Asia-Pacific, which include Quicksilver, Uttern, and Rayglass (including Protector and Legend), that are typically equipped with Mercury Marine engines and often include other parts and accessories supplied by Mercury Marine.
The Boat Group operates manufacturing facilities in Florida, Indiana, Minnesota, Missouri, Washington, Canada, Mexico, New Zealand, and Portugal, and owns an inactive manufacturing facility in North Carolina. The Boat Group also utilizes two contract manufacturing facilities in Poland.
The Boat Group sells its products through a global network of nearly 1,300 dealers and distributors, with some dealers operating in more than one location and some dealers carrying more than one of our boat brands. Sales to the Boat Group's largest dealer, MarineMax, Inc., which has multiple locations and carries a number of the Boat Group's product lines, represented approximately 24 percent of Boat Group sales in 2018. Domestic demand for pleasure boats is seasonal, with sales generally highest in the second calendar quarter of the year.
Fitness Segment
Our Fitness segment is comprised of the Fitness division (Fitness), which designs, manufactures, and distributes a broad portfolio of reliable, high-quality cardiovascular fitness equipment (including treadmills, total body cross-trainers, stair climbers, and stationary exercise bicycles) and strength-training equipment under the Life Fitness, Hammer Strength, Cybex, Indoor Cycling Group, and SCIFIT brands. The Fitness segment also includes an active recreation business, including billiards tables, accessories, and game room furniture.
We believe that our Fitness segment, which had net sales of $1,038.3 million during 2018, is one of the world's largest manufacturers of commercial fitness equipment and a leading manufacturer of high-quality consumer fitness equipment. Fitness' commercial customers include health clubs, hospitality locations, multi-unit housing, corporations, schools and universities, military and governmental agencies, retirement and assisted living facilities, professional and collegiate sports teams, and community centers. Planet Fitness Inc. is the segment's most significant customer. Fitness makes commercial sales through its direct sales force, domestic dealers, and international distributors. Consumer products are available at specialty retailers, select mass merchants, sporting goods stores, through international distributors, and on the Life Fitness website. Further details about the Fitness business can be found in Amendment No. 1 to the Registration Statement on Form 10, File No. 001-38741, filed on February 8, 2019 by Life Fitness Holdings, Inc. However, we are not incorporating the Form 10 by reference into this Annual Report on Form 10-K.
The billiards business was established in 1845 and is Brunswick's heritage business. The billiards business designs and markets billiards tables, table tennis tables, and Air Hockey tables, as well as game room furniture and related accessories, under the Brunswick and Contender brands.
The Fitness segment's principal manufacturing facilities are located in Illinois, Kentucky, Minnesota, Oklahoma, Wisconsin, and Hungary, with principal third party contract manufacturing partners in China, Mexico, Taiwan, and Indonesia. Fitness distributes its products worldwide from regional warehouses and production facilities. Demand for Fitness products is seasonal, with sales generally highest in the fourth quarter of the year.
Discontinued Operations
In December 2017, the Board of Directors authorized the Company to exit its Sea Ray business, including the Meridian brand, as a result of, among other things, a material change in strategic direction and a review of the expected future cash flows, market conditions and business trends. The Company engaged in a thorough sales process and ultimately determined that the offers received did not reflect an appropriate value for the brand. As a result, in June 2018, the Board of Directors authorized the Company to end the sale process for its Sea Ray business. As part of this action, the Company decided to restructure the businesses, including discontinuing Sea Ray Sport Yacht and Yacht models and winding down yacht production, while reinventing Sea Ray Sport Boat and Sport Cruiser operations. The winding down of Sea Ray Sport Yacht and Yacht operations was largely completed in 2018. The assets and liabilities of the Sea Ray business, which were reported as held for sale in the 2017 Form 10-K, have been reclassified to assets and liabilities in the Consolidated Balance Sheets for all periods presented. Additionally, the results of these businesses are no longer presented as discontinued operations in the Consolidated Statements of Cash Flows, the Consolidated Statements of Operations and the Notes to Consolidated Financial Statements in any period presented.
In the fourth quarter of 2018, the Company made adjustments to certain liabilities that were retained as part of the sale of the retail bowling business in 2014 and the bowling products business in 2015. The Company does not have continuing involvement or cash flows associated with these businesses, which were previously reported as discontinued operations in the Consolidated
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Statements of Operations for the years ended December 31, 2016, 2015 and 2014. As a result of these adjustments, the Company recognized $2.2 million of after-tax earnings as discontinued operations in the Consolidated Statements of Operations for the year ended December 31, 2018.
Refer to Note 3 – Discontinued Operations in the Notes to Consolidated Financial Statements for additional information regarding discontinued operations.
Boating Services Network and Business Acceleration
Boating Services Network is our leading dealer finance and operations service that includes floor planning from Brunswick Acceptance Corporation (USA) and Brunswick Commercial Finance (Canada), retail finance from Blue Water Finance and Mercury Repower Finance, retail extended product protection from Passport and Passport Premier, private label limited warranties for leading boat and engine manufacturers, retail insurance from Boater's Choice Insurance, and close to 50 name brand marine dealer service providers from Brunswick Dealer Advantage.
In 2018, Boating Services Network launched OnBoard Boating Cluband Rentals, a state-of-the-art, turnkey business platform empowering marine dealers and marinas to expand their operations and serve the emerging and rapidly growing boat club and rental consumer market segments. The suite of boats, tools, and services available through OnBoard enables club and rental operators to provide club members and rental customers an exceptional boating experience with a diverse fleet of newer boats, an easy-to-use online reservation system, incentives for members to become boat owners as they become captivated by the boating lifestyle, and many more benefits over time. We also launched NAUTIC-ON, a smart technology and service system that helps boaters stay connected with their boats remotely, monitoring engine status, battery and bilge pump, and providing other advanced features, in 2018.
We provide financial services through Brunswick Product Protection Corporation, which provides marine dealers the opportunity to offer extended product warranties to retail customers, and through Blue Water Dealer Services, Inc., which provides retail financial services to marine dealers. Each company allows us to offer a more complete line of financial services to our boat and marine engine dealers and their customers.
Financing Joint Venture
Through our Brunswick Financial Services Corporation subsidiary, we own a 49 percent interest in a joint venture, Brunswick Acceptance Company, LLC (BAC). Under the terms of the joint venture agreement, BAC provides secured wholesale inventory floorplan financing to our boat and engine dealers. A subsidiary of Wells Fargo & Company owns the remaining 51 percent.
In February 2018, the parties entered into an amended and restated joint venture agreement (JV Agreement) to extend the term of their financial services through December 31, 2022. The JV Agreement contains a financial covenant that conforms to the maximum leverage ratio test in the Credit Facility described in Note 17 – Debt in the Notes to Consolidated Financial Statements. The joint venture agreement contains provisions allowing for the renewal of the agreement or the purchase of the other party’s interest in the joint venture at the end of its term. Alternatively, either partner may terminate the agreement at the end of its term.
Refer to Note 11 – Financing Joint Venture in the Notes to Consolidated Financial Statements for more information about our financial services.
Distribution
We utilize independent distributors, dealers, and retailers (Dealers) for the majority of our boat sales and significant portions of our sales of marine engine, fitness, and billiards products. We have over 16,000 Dealers serving our business segments worldwide. Our marine Dealers typically carry one or more of the following product categories: boats, engines, and related parts and accessories.
We own Land 'N' Sea, Kellogg Marine Supply, Payne's Marine Group, and Del City, which comprise the primary parts and accessories distribution platforms for our Marine Engine segment in North America. We believe that these businesses, collectively, are the leading distributors of marine parts and accessories throughout North America, with 21 distribution warehouses located throughout the United States and Canada offering same-day or next-day delivery service to a broad array of marine service facilities and Dealers. We also believe we are a leading parts and accessories distributor in the Asia-Pacific region.
Our Dealers are independent companies or proprietors that range in size from small, family-owned businesses to a large, publicly-traded corporation with substantial revenues and multiple locations. Some Dealers sell our products exclusively, while a majority also carry competitor and complementary products. We partner with our boat dealer network to improve quality, service,
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distribution, and delivery of parts and accessories to enhance the boating customer's experience.
Demand for a significant portion of our products is seasonal, and a number of our Dealers are relatively small and/or highly-leveraged. As a result, many Dealers secure floor plan financing from BAC or other third party finance companies, enabling them to provide stable channels for our products. In addition to the financing BAC offers, we may also provide our Dealers with incentive programs, loan guarantees, inventory repurchase commitments, and financing receivable arrangements, under which we are obligated to repurchase inventory or receivables from a finance company in the event of a Dealer's default. We believe that these arrangements are in our best interest; however, these arrangements expose us to credit and business risk. Our business units, along with BAC, maintain active credit operations to manage this financial exposure, and we continually seek opportunities to sustain and improve the financial health of our various distribution channel partners. Refer to Note 9 – Financing Receivables and Note 14 – Commitments and Contingencies in the Notes to Consolidated Financial Statements for further discussion of these arrangements.
Technology and Innovation
Upon the completion of the separation of our Fitness business, Brunswick will transition into a company concentrated on leading the global marine industry with a sharpened focus and clear vision, consistently innovating the future of recreational boating. To support this goal, we have established a strong foundation of cross functional and cross business investments and initiatives to further improve customer interaction with our products, including NAUTIC-ON and OnBoard Boating Club and Rentals. We continue to partner with TechNexus Holdings, LLC to identify and incubate innovative start-up ventures with strategic marine applications to help drive long-term growth.
For its part, Fitness continues to develop digital solutions focused on providing innovative solutions to meet the needs of fitness facilities and exercisers. In addition, Fitness is collaborating with a number of technology companies to accelerate the development of its technology portfolio to satisfy growing demand for digital fitness and connectivity solutions. For further details about Fitness, see Amendment No. 1 to the Registration Statement on Form 10, File No. 001-38741, filed on February 8, 2019 by Life Fitness Holdings, Inc.
International Operations
Non-U.S. sales are set forth in Note 7 – Segment Information and Note 2 – Revenue Recognition in the Notes to Consolidated Financial Statements and are also included in the table below, which details our non-U.S. sales by region:
(in millions) | 2018 | 2017 | 2016 | ||||||||
Europe | $ | 696.2 | $ | 610.1 | $ | 569.2 | |||||
Asia-Pacific | 437.0 | 407.9 | 363.1 | ||||||||
Canada | 317.3 | 320.3 | 284.6 | ||||||||
Rest-of-World | 256.8 | 265.8 | 240.1 | ||||||||
Total | $ | 1,707.3 | $ | 1,604.1 | $ | 1,457.0 | |||||
Total International Sales as a Percentage of Net Sales | 33 | % | 33 | % | 35 | % | |||||
We transact a portion of our sales in non-U.S. markets in local currencies, while a meaningful portion of our product costs are denominated in U.S. dollars as a result of our U.S. manufacturing operations. As a result, the strengthening or weakening of the U.S. dollar affects the financial results of our non-U.S. operations.
Marine Engine segment non-U.S. sales represented approximately 50 percent of our non-U.S. sales in 2018. The segment's principal non-U.S. operations include the following:
• | Distribution, sales, service, engineering, or representative offices in Australia, Belgium, Brazil, Canada, China, Dubai, Finland, France, Italy, Japan, the Netherlands, New Zealand, Norway, Russia, Singapore, Sweden, and Switzerland; |
• | Component, parts and accessories manufacturing, and light assembly facilities in Mexico, the Netherlands, New Zealand, and Northern Ireland; |
• | An outboard engine assembly plant in Suzhou, China; and |
• | An outboard engine assembly plant operated by a joint venture in Japan. |
Boat segment non-U.S. sales comprised approximately 21 percent of our non-U.S. sales in 2018. The Boat Group manufactures or assembles a portion of its products in Canada, Mexico, New Zealand, and Portugal, as well as in boat plants owned and operated
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by third parties in Poland that perform contract manufacturing for us, which are sold mostly in international markets through Dealers. The Boat Group has sales or import offices in Belgium, Canada, France, Italy, the Netherlands, New Zealand, Norway, Poland, and Sweden. Of our boat sales in Canada and Europe, approximately 38 percent and 91 percent, respectively, were produced in the region.
Fitness segment non-U.S. sales comprised approximately 29 percent of our non-U.S. sales in 2018. Fitness sells its products worldwide and has sales and distribution centers in Brazil, Germany, Hong Kong, Japan, the Netherlands, Spain, and the United Kingdom. The Fitness segment manufactures strength-training equipment and select lines of cardiovascular equipment in Hungary for its international markets, and has relationships with third-party contract manufacturing partners in Taiwan, China, Mexico, and Indonesia.
Raw Materials and Supplies
We purchase a wide variety of raw materials from our supplier base, including commodities such as aluminum, resins, oil, and steel, as well as product parts and components, such as engine blocks and boat windshields. The prices for these raw materials, parts, and components fluctuate depending on market conditions. Significant increases in the cost of such materials would raise our production costs, which could reduce profitability if we did not recoup the increased costs through higher product prices.
As our manufacturing operations continued to raise production levels in 2018, our need for raw materials and supplies also increased. During 2018, we experienced some shortages or delayed delivery of certain materials, parts, and supplies essential to our manufacturing operations, although such shortages did not materially impact operations. We have addressed and will continue to address this issue by identifying alternative suppliers, working to secure adequate inventories of critical supplies, and continually monitoring the capabilities of our supplier base. In 2019, we anticipate our suppliers will need to increase their manufacturing capacity and investments to meet the rising demand for their products and, in many cases, may need to hire additional workers in order to fulfill the orders placed by us and other customers.
Our global procurement operations continue to better leverage purchasing power across our divisions and to improve supply chain and cost efficiencies. We mitigate commodity price risk on certain raw material purchases by entering into fixed priced contracts or derivatives to mitigate exposure related to changes in commodity prices.
Intellectual Property
We have, and continue to obtain, patent rights covering certain features of our products and processes. By law, our patent rights, which consist of patents and patent licenses, have limited lives and expire periodically. We believe that our patent rights are important to our competitive position in all of our business segments. Our trademark rights have indefinite lives, and many are well known to the public and are considered to be valuable assets. Most of our intellectual property is owned by U.S. entities.
In the Marine Engine segment, patent rights principally relate to features of outboard engines and inboard-outboard drives, hybrid drives, and pod drives, including: die-cast powerheads; cooling and exhaust systems; drivetrain, clutch, and gearshift mechanisms; boat/engine mountings; shock-absorbing tilt mechanisms; ignition systems; propellers; marine vessel control systems; fuel and oil injection systems; supercharged engines; outboard mid-section structures; segmented cowls; hydraulic trim, tilt and steering; screw compressor charge air cooling systems; a range of proprietary metal alloys; and airflow silencers.
In the Boat segment, patent rights principally relate to processes for manufacturing fiberglass hulls, decks, and components for boat products, as well as patent rights related to boat features and components.
In the Fitness segment, patent rights principally relate to fitness equipment designs and components, including patents covering internal processes, programming functions, displays, design features and styling, as well as billiards table designs and components.
The following are our principal trademarks:
Marine Engine Segment: Ancor, Attwood, Axius, BEP, Blue Sea Systems, CZone, Del City, FulTyme RV, Garelick, Kellogg Marine Supply, Land 'N' Sea, Lenco Marine, Marinco, Mariner, Mastervolt, MerCruiser, Mercury, Mercury Marine, Mercury Precision Parts, Mercury Propellers, Mercury Racing, MotorGuide, OptiMax, Park Power, Progressive Industries, ProMariner, Quicksilver, Seachoice, SeaPro, SmartCraft, Sport-Jet, Swivl-Eze, Talamex, Valiant, Verado, Whale, and Zeus.
Boat Segment: Bayliner, Boston Whaler, Crestliner, Cypress Cay, Harris, Heyday, Lowe, Lund, Master Dealer, Meridian, Princecraft, Protector, Quicksilver, Rayglass, Sea Ray, Thunder Jet, and Uttern.
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Fitness Segment: Air Hockey, Brunswick, Contender, Cybex, Flex Deck, Gold Crown, Hammer Strength, Indoor Cycling Group, Lifecycle, Life Fitness, and SCIFIT.
Competitive Conditions and Position
We believe that we have a reputation for quality in each of our highly competitive lines of business. We compete in various markets by: utilizing efficient production techniques; developing and strengthening our leading brands; developing and promoting innovative technological advancements; undertaking effective marketing, advertising, and sales efforts; providing high-quality, innovative products at competitive prices; and offering extensive aftermarket products.
Strong competition exists in each of our product groups, but no single enterprise competes with us in all product groups. In each product area, competitors range in size from large, highly-diversified companies to small, single-product businesses. We also indirectly compete with businesses that offer alternative leisure products or activities.
The following summarizes our competitive position in each segment:
Marine Engine Segment: We believe the Marine Engine segment is a world leader in the manufacture and sale of recreational and commercial marine engines and marine parts and accessories. The marine engine market is highly competitive among several major international companies that comprise the majority of the market, including Japanese-based outboard engine manufacturers, as well as several smaller companies including Chinese manufacturers. Competitive advantage in this segment is a function of product features, technological leadership, quality, service, pricing, performance, manufacturing capabilities, depth of product portfolio, intuitive product controls, and durability, along with effective promotion and distribution.
Boat Segment: We believe that the Boat segment is a world leader in the manufacture and sale of pleasure motorboats. There are several major manufacturers of pleasure and offshore fishing boats, along with hundreds of smaller manufacturers. However, few major manufacturers compete in the breadth of categories or geographies in which our Boat segment competes. Consequently, this business is highly competitive by category but also highly fragmented. In all of our boat operations, we compete on the basis of product features, technology, quality, brand strength, dealer service, pricing, performance, value, durability and styling, along with effective promotion and distribution.
Fitness Segment: We believe we are the world's largest manufacturer of commercial fitness equipment and a leading manufacturer of high-quality consumer fitness equipment and billiards tables. The fitness equipment industry is highly competitive among several major international companies that comprise the majority of the market, as well as many smaller manufacturers, which creates a highly fragmented, competitive landscape. Many of our fitness equipment offerings include industry-leading product features, and we place significant emphasis on introducing innovative fitness equipment to the market. Competitive focus is also placed on product quality, technology, service, pricing, state-of-the-art biomechanics, connectivity and customer solutions, and effective promotional activities. The billiards industry continues to experience competitive pressure from low-cost billiards manufacturers outside the United States.
Research and Development
We strive to improve our competitive position in all of our segments by continuously investing in research and development to drive innovation in our products and manufacturing technologies. Our research and development investments support the introduction of new products and enhancements to existing products. Research and development expenses were 2.9 percent, 3.0 percent and 3.1 percent of net sales in 2018, 2017 and 2016, respectively. Research and development expenses by segment are discussed in Note 7 – Segment Information in the Notes to Consolidated Financial Statements.
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Number of Employees
The number of employees worldwide is shown below by segment:
December 31, 2018 | December 31, 2017 | ||||||||||
Total | Union (domestic) | Total | Union (domestic) | ||||||||
Marine Engine | 7,719 | 2,402 | 6,541 | 2,078 | |||||||
Boat | 4,996 | — | 5,365 | — | |||||||
Fitness | 2,956 | 170 | 2,854 | 166 | |||||||
Corporate (A) | 367 | — | 356 | — | |||||||
Total (B) | 16,038 | 2,572 | 15,116 | 2,244 | |||||||
(A) Corporate numbers include certain information technology employees and shared service employees.
(B) All employee numbers exclude temporary employees.
We believe that the relationships between our employees, applicable labor unions, and the Company remain stable. Mercury Marine and its largest union, the International Association of Machinists and Aerospace Workers (IAM) Lodge 1947, agreed to a new collective bargaining agreement in February 2018 which will remain in place through August 26, 2023.
Environmental Requirements
Refer to Note 14 – Commitments and Contingencies in the Notes to Consolidated Financial Statements for a description of certain environmental proceedings.
Available Information
Brunswick maintains an Internet website at http://www.brunswick.com that includes links to our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports, and Proxy Statements (SEC Filings). The SEC Filings are available without charge as soon as reasonably practicable following the time that they are filed with, or furnished to, the SEC. Shareholders and other interested parties may request email notification of the posting of these documents through the Investors section of our website. Brunswick’s SEC Filings are also available on the SEC’s website at http://www.sec.gov.
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Item 1A. Risk Factors
The Company's operations and financial results are subject to certain risks and uncertainties, including those described below, which could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.
Worldwide economic conditions significantly affect our industries and businesses, and economic decline can materially impact our financial results.
In times of economic uncertainty and contraction, consumers tend to have less discretionary income and to defer expenditures for discretionary items, which adversely affects our financial performance, especially in the marine businesses. Although we have expanded the portions of our portfolio that are dependent or substantially weighted toward the usage and maintenance of boats and engines versus the sale of new product and therefore less susceptible to economic cycles, a portion of the business remains cyclical and sensitive to personal spending levels.
Deterioration in general economic conditions that in turn diminishes consumer confidence or discretionary income may reduce our sales, or we may decide to lower pricing for our products, thus adversely affecting our financial results, including increasing the potential for future impairment charges. Further, most of our products are used for recreation, and consumers’ limited discretionary income in times of economic hardship may be diverted to other activities that occupy their time, such as other forms of recreation, religious, cultural, or community activities. We cannot predict the timing or continued strength of global economies, either worldwide or in the specific markets in which we compete.
Failure to successfully implement our strategic plan and growth initiatives could have a material adverse effect on our business and financial condition.
Our ability to continue generating strong cash flow and profits depends partly on the sustained successful execution of our strategic plan and growth initiatives, including optimizing our business portfolio, making acquisitions, and expanding into new adjacent markets and customers. To address risks associated with our plan and growth initiatives, we have established processes to regularly review, manage, and modify our plans, and we believe we have appropriate oversight to monitor initiatives and their impact. Our strategic plan and growth initiatives may require significant capital investment and management attention, however, which could result in the diversion of these resources from the core business and other business issues and opportunities. Additionally, any new initiative is subject to certain risks, including customer acceptance, competition, the ability to manufacture products on schedule and to specification, the ability to create the necessary supply chain, and/or the ability to attract and retain qualified management and other personnel. There is no assurance that we will be able to develop and successfully implement our strategic plan and growth initiatives in a manner that fully achieves our strategic objectives.
The inability to successfully integrate new acquisitions, including the Global Marine Business of Power Products, could negatively impact financial results.
On August 9, 2018, Brunswick acquired the Global Marine & Mobile business of Power Products, which includes the global marine, specialty vehicle, mobile, industrial power, and transportation aftermarket products businesses. Acquisitions pose risks, such as our ability to project and evaluate market demand; maximize potential synergies and cost savings; make accurate accounting estimates; and achieve anticipated business objectives. The Power Products acquisition and other, future acquisitions, present these and other integration risks, including:
• | disruptions in core, adjacent, or acquired businesses that could make it more difficult to maintain business and operational relationships, including customer and supplier relationships; |
• | the possibility that the expected synergies and value creation will not be realized or will not be realized within the expected time period; |
• | the risk that unexpected costs will be incurred; |
• | diversion of management attention; and |
• | difficulties retaining employees. |
If we fail to timely and successfully integrate new businesses, including Power Products, into existing operations, we may see higher production costs, lost sales, or otherwise diminished earnings and financial results.
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The anticipated Fitness business separation could be disruptive to the business and our operations, and there can be no assurance that it will provide business benefits or that it will be consummated within the anticipated time period or at all.
The Fitness business separation, whether ultimately a spin-off or a sale, like any business separation, involves risks, including difficulties associated with the separation of operations, services, and personnel, disruption in our operations or businesses, the potential loss of key employees, and adverse effects on relationships with business partners. In addition, we will incur significant expense in connection with the separation, and completion of the proposed transaction will require significant amounts of management time and effort, which may divert management’s attention from other aspects of our business operations. If we do not successfully manage these risks, our business, financial condition, and results of operations could be adversely affected.
The proposed separation may not achieve the intended results, or results may take longer to realize than expected. Unanticipated developments could delay, prevent, or otherwise adversely affect the separation, including disruptions in general market conditions or other developments. The anticipated benefits of the separation are based on a number of assumptions, some of which may prove incorrect, and we cannot predict the prices at which our common stock, or the common stock of the Fitness stand-alone entity, may trade after the proposed separation. In addition, we cannot assure that we will be able to complete the business separation within the announced timeline, or at all. Delays or failure to consummate the separation could negatively affect our business and financial results.
In addition to these risks, we face other risks specific to a spin-off of the Fitness business, as opposed to a sale, including the risk that a spin-off could result in significant tax liability to the Company or our shareholders, despite the steps we have taken to avoid this result. Completion of the spin-off is conditioned on our receipt of a written legal opinion to the effect that the distribution of Life Fitness common stock will qualify for non-recognition of gain and loss for U.S. Federal income tax purposes.
The legal opinion will not address any U.S. state or local or foreign tax consequences of the spin-off, and will rely on the continuing effectiveness and validity of the favorable private letter ruling (the “IRS Ruling”) from the U.S. Internal Revenue Service (the “IRS”) regarding such U.S. Federal income tax consequences of the spin-off. The Company has received the IRS Ruling, which relies on certain facts, assumptions, representations, and undertakings from Fitness business and from Brunswick. If any of these facts, assumptions, representations, or undertakings is incorrect or not otherwise satisfied, we may not be able to rely on the IRS Ruling. In addition, the IRS ruling is not a comprehensive ruling from the IRS regarding all aspects of the U.S. Federal income tax consequences of the transactions. Accordingly, notwithstanding the legal opinion and the IRS Ruling, there can be no assurance that the IRS will not assert, or that a court would not sustain, a contrary position.
Further, the legal opinion will be based on certain representations as to factual matters from the Company and the Fitness business. The opinion cannot be relied on if any of the assumptions, representations, or covenants is incorrect, incomplete, or inaccurate, or is violated in any material respect. If the distribution of Life Fitness common stock were determined not to qualify for non-recognition of gain and loss for U.S. Federal income tax purposes, U.S. holders could be subject to significant tax consequences.
The final determination to proceed with a spin-off or sale is a decision of our Board of Directors, and this determination could have an adverse impact on the Company's financial results. There are many factors that could impact the structure or timing of, the anticipated benefits from, or determination to ultimately proceed with, the separation, including global economic conditions, tax considerations, market conditions, and changes in the regulatory or legal environment, any of which could adversely impact the value of the separation transaction to our shareholders. Additionally, the completion of the separation will be complex, costly, and time-consuming, and an inability to realize the full extent of the anticipated benefits, as well as delays encountered in the process, could have an adverse effect upon the revenues, costs, and operating results of the Company.
An impairment in the carrying value of goodwill, trade names, and other long-lived assets could negatively affect our consolidated results of operations and net worth.
Goodwill and indefinite-lived intangible assets, such as our trade names, are recorded at fair value at the time of acquisition and are not amortized, but are reviewed for impairment at least annually or more frequently if impairment indicators arise. In evaluating the potential for impairment of goodwill and trade names, we make assumptions regarding future operating performance, business trends, and market and economic conditions. Such analyses further require us to make certain assumptions about sales, operating margins, growth rates, and discount rates. Uncertainties are inherent in evaluating and applying these factors to the assessment of goodwill and trade name recoverability. We could be required to evaluate the recoverability of goodwill or trade names prior to the annual assessment if we experience business disruptions, unexpected significant declines in operating results, a divestiture of a significant component of our business, or declines in market capitalization.
As of the Company’s annual goodwill impairment testing date on October 1, 2018, the estimated fair value of the Fitness reporting unit was approximately 19 percent in excess of its carrying value, which included goodwill of $390.8 million. In making
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this determination, management made several significant assumptions that impact the estimated fair value of the Fitness reporting unit, including projected results, such as improvement of operating performance, particularly expanded gross margins, which are predicated upon the successful execution of cost reduction initiatives along with increased sales, in future years when compared with 2018 and the discount rate. While we believe current gross margin and sales projections are reasonable, the Fitness segment’s ability to expand gross margins or grow sales in line with projections could be negatively affected by its ability to execute the planned actions underlying the forecasted improvement in its performance as well as market conditions. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the impairment test will prove to be an accurate prediction of the future. To the extent future operating results differ from those in our current forecast, or if the assumptions underlying the discount rate change, it is possible that an impairment charge could be recorded.
We also continually evaluate whether events or circumstances have occurred that indicate the remaining estimated useful lives of our definite-lived intangible assets and other long-lived assets may warrant revision or whether the remaining balance of such assets may not be recoverable. We use an estimate of the related undiscounted cash flow over the remaining life of the asset in measuring whether the asset is recoverable.
As of December 31, 2018, goodwill was approximately 13 percent of total assets and included $391 million of goodwill related to the Fitness segment, $32 million of goodwill related to the Marine Engine segment, and $2 million of goodwill related to the Boat segment. If the future operating performance of the Company's reporting units is not sufficient, we could be required to record non-cash impairment charges. Impairment charges could substantially affect our reported earnings in the periods such charges are recorded. In addition, impairment charges could indicate a reduction in business value which could limit our ability to obtain adequate financing in the future.
Changes to U.S. trade policy, tariffs, and import/export regulations may have a material adverse effect on our business, financial condition, and results of operations.
Changes in laws and policies governing foreign trade could adversely affect our business. As a result of recent policy changes, there may be greater restrictions and economic disincentives on international trade. The new tariffs and other changes in U.S. trade policy could trigger retaliatory actions by affected countries, and certain foreign governments have instituted or are considering imposing trade sanctions on certain U.S. goods, such as aluminum and steel. Although we were recently granted exclusion from Section 301 tariffs for Mercury Marine 40, 50, and 60 horsepower engines, these exclusions are only in effect through the end of 2019, we continue to be subject to meaningful other tariffs, and there is no assurance that we will be granted similar exclusions for these or other products in the future, or that we will not be subject to additional tariffs. Like many other multinational corporations, we do a significant amount of business that would be affected by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs and international trade agreements). Such changes have the potential to adversely impact the U.S. economy, our industry, and global demand for our products and, as a result, could have a material adverse effect on our business, financial condition and results of operations.
An inability to identify and complete targeted acquisitions could negatively impact financial results.
Our growth initiatives include making strategic acquisitions, which depend on the availability of suitable targets at acceptable terms and our ability to complete the transactions. In managing our acquisition strategy, we conduct rigorous due diligence, involve various functions, and continually review target acquisitions, all of which we believe mitigates some of our acquisition risks. However, we cannot assure that suitable acquisitions will be identified or consummated or that, if consummated, they will be successful. Acquisitions include a number of risks, including our ability to project and evaluate market demand, potential synergies, and cost savings, and our ability to make accurate accounting estimates, as well as diversion of management attention. Uncertainties exist in assessing the value, risks, profitability, and liabilities associated with certain businesses or assets, negotiating acceptable terms, obtaining financing on acceptable terms, and receiving any necessary regulatory approvals. As we continue to grow, in part, through acquisitions, our success depends on our ability to anticipate and effectively manage these risks. Any failure to do so could have a material adverse effect on our financial condition and results of operations.
There can be no assurance that strategic divestitures will provide business benefits.
As part of our strategy, we continuously evaluate our portfolio of businesses. Recent results of this evaluation include the planned separation of the Fitness business, the discontinuation of Sea Ray Sport Yacht and Yacht models, and winding down yacht production. We have previously and may in the future make other changes to our portfolio as well, which may be material. Divestitures involve risks, including difficulties in the separation of operations, services, products and personnel, disruption in our operations or businesses, finding a suitable purchaser, the diversion of management's attention from our other businesses, the potential loss of key employees, adverse effects on relationships with our dealer or supplier partners or their businesses, the erosion
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of employee morale or customer confidence, and the retention of contingent liabilities related to the divested business. If we do not successfully manage the risks associated with divestitures, our business, financial condition, and results of operations could be adversely affected as the potential strategic benefits may not be realized or may take longer to realize than expected.
Changes in currency exchange rates can adversely affect our results.
Some of our sales are denominated in a currency other than the U.S. dollar. Consequently, a strong U.S. dollar may adversely affect reported revenues and our profitability. We have hedging programs in place to reduce our risk to currency fluctuations; however, we cannot hedge against all currency risks, especially over the long term. We maintain a portion of our cost structure in currencies other than the U.S. dollar, which partially mitigates the impact of a strengthening U.S. dollar. This includes manufacturing operations for boats in Europe and Canada, fitness equipment in Europe, and smaller outboard engines manufactured and purchased from our joint venture in Japan. We also continue to evaluate the supply chain and cost structure for opportunities to further mitigate foreign currency risks.
We sell products manufactured in the U.S. into certain international markets in U.S. dollars, including to Canada, Europe, and Latin America. Demand for our products in these markets may be diminished by a strengthening U.S. dollar, or we may need to lower prices to remain competitive. Some of our competitors with cost positions based outside the U.S., including Asian-based outboard engine and fitness equipment manufacturers, European-based large fiberglass boat manufacturers, and a European-based fitness equipment manufacturer, may have an improved cost position due to a strengthening U.S. dollar, which could result in pricing pressures on our products. Although these factors have existed for several years, we do not believe they have had a material adverse effect on our competitive position.
Fiscal concerns may negatively impact worldwide credit conditions and adversely affect our industries, businesses, and financial condition.
Fiscal policy could have a material adverse impact on worldwide economic conditions, the financial markets, and availability of credit and, consequently, may negatively affect our industries, businesses, and overall financial condition. Customers often finance purchases of our products, particularly boats, and as interest rates rise, the cost of financing the purchase also increases. Credit market conditions, while improved, are still less favorable overall than those in existence prior to the global recession in 2008. While credit availability is adequate to support demand and interest rates remain relatively low, they have recently increased, and there are fewer lenders, tighter underwriting and loan approval criteria, as well as greater down payment requirements. If credit conditions worsen, and adversely affect the ability of customers to finance potential purchases at acceptable terms and interest rates, it could result in a decrease in sales or delay improvement in sales.
Dealer or distributor inability to secure adequate access to capital could adversely affect our sales.
Our dealers require adequate liquidity to finance their operations, including purchasing our products. Dealers are subject to numerous risks and uncertainties that could unfavorably affect their liquidity positions, including, among other things, continued access to adequate financing sources on a timely basis on reasonable terms. These financing sources are vital to our ability to sell products through our distribution network, particularly to boat and engine dealers. Entities affiliated with Wells Fargo & Company, including BAC, the Company’s 49 percent owned joint venture, finance a significant portion of our boat and engine sales to dealers through floorplan financing to marine dealers.
Many factors continue to influence the availability and terms of financing that our dealer floorplan financing providers offer, including:
• | their ability to access certain capital markets, such as the securitization and the commercial paper markets, and to fund their operations in a cost effective manner; |
• | the performance of their overall credit portfolios; |
• | their willingness to accept the risks associated with lending to marine dealers; |
• | the overall creditworthiness of those dealers; and |
• | the overall aging and level of pipeline inventories. |
Our sales could be adversely affected if financing terms change unfavorably or if BAC were to be terminated. This could require dealers to find alternative sources of financing, including our direct financing to dealers, which could require additional capital to fund the associated receivables.
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Our financial results could be adversely affected if we are unable to maintain effective distribution.
We rely on third-party dealers and distributors to sell most of our products, particularly in the marine businesses. Maintaining a reliable network of dealers is essential to our success. We face competition from other manufacturers in attracting and retaining distributors and independent boat dealers. For example, in 2017, Bass Pro Shops acquired Cabela's, a meaningful channel for the Lowe boat brand, and Cabela's subsequent transition away from Lowe boats required Lowe enhance its sales and distribution network by identifying alternative dealers. However, a significant deterioration in the number or effectiveness of our dealers and distributors could have a material adverse effect on our financial results.
Although at present we believe dealer health to be generally favorable, weakening demand for marine products could hurt our dealers’ financial performance. In particular, reduced cash flow from decreases in sales and tightening credit markets may impair dealers' ability to fund operations. Inability to fund operations can force dealers to cease business, and we may be unable to obtain alternate distribution in the vacated market. An inability to obtain alternate distribution could unfavorably affect our net sales through reduced market presence. If economic conditions deteriorate, we anticipate that dealer failures or voluntary market exits would increase, especially if overall retail demand materially declines.
Adverse economic, credit, and capital market conditions could have a negative impact on our financial results.
We may rely on short-term capital markets to meet our working capital requirements, fund capital expenditures, pay dividends, or fund employee benefit programs and we maintain short-term borrowing facilities that can be used to meet these capital requirements. In addition, over the long term, we may determine that it is necessary to access the capital markets to refinance existing long-term indebtedness or for other initiatives.
Adverse global economic conditions, market volatility, and regulatory uncertainty could lead to volatility and disruptions in the capital and credit markets. This could adversely affect our ability to access capital and credit markets or increase the cost to do so, which could have a negative impact on our business, financial results and competitive position.
In addition, our variable rate indebtedness may use LIBOR as a benchmark for establishing the rate. As announced in July 2017, LIBOR is expected to be phased out by the end of 2021. Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely impact the availability and cost of borrowings.
Loss of key customers could harm our business.
In each segment, we have important relationships with key customers and, from time to time, contracts with these customers come up for renewal. We cannot be certain we will renew such contracts, or renew them on favorable terms. For example, in 2018, we were involved in a competitive request for proposal and contract negotiations with Planet Fitness, a significant customer of our Fitness business. The resulting new contract with Planet Fitness is not exclusive to Fitness, and allows Planet Fitness to purchase from Fitness or two of our competitors. If we lose a key customer, or a significant portion of its business, we could be adversely affected. In addition, certain customers could try to negotiate more favorable pricing of our products, which could depress earnings. In an effort to mitigate the risk associated with reliance on key customer accounts, we continually monitor such relationships and maintain a complete and competitive product lineup.
Our business and operations are dependent on the expertise of our key contributors, our successful implementation of succession plans, and our ability to attract and retain management employees and skilled labor.
The talents and efforts of our employees, particularly key managers, are vital to our success. Our management team has significant industry experience and would be difficult to replace. We may be unable to retain them or to attract other highly qualified employees. Failure to hire, develop, and retain highly qualified and diverse employee talent and to develop and implement an adequate succession plan for the management team could disrupt our operations and adversely affect our business and our future success. Although we cannot ensure that all transitions will be implemented successfully, we perform an annual review of management succession plans with the Board of Directors, including reviewing executive officer and other important positions to substantially mitigate the risk associated with key contributor transitions.
In October, 2018 we announced that our Chief Executive Officer, Mark Schwabero, would be retiring effective December 31, 2018, and his successor would be David Foulkes, our current CEO. In a separate action, we named a new President of the Fitness division. Our ability to continue to execute our growth strategy could potentially be adversely affected by uncertainty associated with these transitions or other, currently unanticipated, executive changes that may be disruptive to, or cause uncertainty in, our business and future strategic direction. Any such disruption or uncertainty could have a material adverse impact on our business, results of operations, and financial condition.
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Much of our future success depends on, among other factors, our ability to attract and retain skilled labor. If we are not successful in these efforts, we may be unable to meet our operating goals and plans, which may impact our financial results. We continually invest in automation and improve our efficiency, but with unemployment rates at low levels in many of the geographic areas in which we manufacture or distribute goods, availability of skilled hourly workers remains critical to our operations. In order to manage this risk, we regularly monitor and make improvements to wages and benefit programs, as well as develop and improve recruiting and training programs to attract and retain an experienced and skilled workforce.
Inventory reductions by major dealers, retailers, and independent boat builders could adversely affect our financial results.
The Company and our dealers, retailers, and other distributors could decide to reduce the number of units they hold, particularly if demand trails forecasted levels or if new product introductions are expected to replace existing products. Such efforts tend to result in wholesale sales reductions in excess of retail sales reductions and would likely result in lower production levels of certain of our products, potentially causing lower rates of absorption of fixed costs in our manufacturing facilities and lower margins. While we have processes in place to help manage dealer inventories at appropriate levels, potential inventory reductions remain a risk to our future sales and results of operations.
We may be required to repurchase inventory or accounts of certain dealers.
We have agreements with certain third-party finance companies to provide financing to our customers, enabling them to purchase our products. In connection with these agreements, we may either have obligations to repurchase our products from the finance company, or may have recourse obligations to the finance company on the dealer’s receivables. These obligations may be triggered if our dealers default on their payment or other obligations to the finance companies.
Our maximum contingent obligation to repurchase inventory and our maximum contingent recourse obligations on customer receivables are less than the total balances of dealer financings outstanding under these programs, because our obligations under certain of these arrangements are subject to caps, or are limited based on the age of product. Our risk related to these arrangements is mitigated by the proceeds we receive on the resale of repurchased product to other dealers, or by recoveries on receivables purchased under the recourse obligations.
Our inventory repurchase obligations relate primarily to the inventory floorplan credit facilities of our boat and engine dealers. Our actual historical repurchase experience related to these arrangements has been substantially less than our maximum contractual obligations. If dealers default on their obligations, file for bankruptcy, or cease operations, however, we could incur losses associated with the repurchase of our products. As a result, our net sales and earnings may be unfavorably affected due to reduced market coverage and an associated decline in sales.
Declines in marine industry demand could cause an increase in future repurchase activity, or could require us to incur losses in excess of established reserves. In addition, our cash flow and loss experience could be adversely affected if repurchased inventory is not successfully distributed to other dealers in a timely manner, or if the recovery rate on the resale of the product declines. The finance companies could require changes in repurchase or recourse terms that would result in an increase in our contractual contingent obligations.
Our financial results may be adversely affected by our third party suppliers' increased costs or inability to meet required production levels due to tariff impacts or defects or disruption of supply of raw materials, parts, and product components.
We rely on third parties to supply raw materials used in the manufacturing process, including oil, aluminum, copper, steel, and resins, as well as product parts and components. The prices for these raw materials, parts, and components fluctuate depending on market conditions and, in some instances, commodity prices or trade policies. Substantial increases in the prices of raw materials, parts, and components would increase our operating costs, and could reduce our profitability if we are unable to recoup the increased costs through higher product prices. Similarly, if a critical supplier were to close its operations, cease manufacturing, or otherwise fail to deliver an essential component necessary to our manufacturing operations, that could detrimentally affect our ability to manufacture and sell our products, resulting in an interruption in business operations and/or a loss of sales.
In addition, some components used in our manufacturing processes, including certain engine components, furniture, upholstery, and boat windshields, are available from a sole supplier or a limited number of suppliers. Operational and financial difficulties that these or other suppliers may face in the future could adversely affect their ability to supply us with the parts and components we need, which could significantly disrupt our operations. It may be difficult to find a replacement supplier for a limited or sole source raw material, part, or component without significant delay or on commercially reasonable terms. In addition, an uncorrected defect or supplier's variation in a raw material, part, or component, either unknown to us or incompatible with our manufacturing process, could jeopardize our ability to manufacture products.
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Some additional supply risks that could disrupt our operations, impair our ability to deliver products to customers, and negatively affect our financial results include:
• | financial pressures on our suppliers due to a weakening economy or unfavorable conditions in other end markets; |
• | a deterioration of our relationships with suppliers; |
• | events such as natural disasters, power outages or labor strikes; |
• | supplier manufacturing constraints and investment requirements; or |
• | labor disruption at major global ports and shipping hubs. |
These risks are exacerbated in the case of single-source suppliers, and the exclusive supplier of a key component potentially could exert significant bargaining power over price, quality, warranty claims, or other terms.
We continue to increase production; consequently, our need for raw materials and supplies continues to increase. Our suppliers must be prepared to ramp up operations and, in many cases, hire additional workers and/or expand capacity in order to fulfill our orders and those of other customers. Cost increases, defects, or sustained interruptions in the supply of raw materials, parts, or components due to delayed start-up periods our suppliers experience as they increase production efforts create risks to our operations and financial results. The Company experienced periodic supply shortages and increases in costs to certain materials, such as aluminum, in 2018. We continue to address these issues by identifying alternative suppliers for key materials and components, working to secure adequate inventories of critical supplies, and continually monitoring the capabilities of our supplier base. In the future, however, we may experience shortages, delayed delivery, and/or increased prices for key materials, parts, and supplies that are essential to our manufacturing operations.
Higher energy and fuel costs can affect our results.
Higher energy and fuel costs increase operating expenses at our manufacturing facilities and the cost of shipping products to customers. In addition, increases in energy costs can adversely affect the pricing and availability of petroleum-based raw materials such as resins and foam that are used in many of our marine products. Higher fuel prices may also have an adverse effect on demand for our marine parts and accessories businesses, as they increase the cost of boat ownership and possibly affect product use.
Our success depends upon the continued strength of our brands.
We believe that our brands, particularly including Mercury Marine, Sea Ray, Boston Whaler, Lund, and Life Fitness, significantly contribute to our success, and that maintaining and enhancing these brands is important to expanding our customer base. A failure to adequately promote and protect our brands could adversely affect our business and results of operations. Further, in connection with the divestiture of the bowling businesses, we licensed certain trademarks and servicemarks, including use of the name “Brunswick,” to the acquiring companies. Our reputation may be adversely affected by the purchasers' inappropriate use of the marks or of the name Brunswick, including potential negative publicity, loss of confidence, or other damage to our image due to this licensed use.
Either inadequate intellectual property protection that could allow others to use our technologies and impair our ability to compete, or failure to successfully defend against patent infringement claims could have a material adverse effect on our financial condition and results of operations.
We regard much of the technology underlying our products as proprietary. We rely on a combination of patents, trademark, copyright, and trade secret laws; employee and third-party non-disclosure agreements; and other contracts to establish and protect our technology and other intellectual property rights. However, we remain subject to risks, including:
• | the steps we take to protect our proprietary technology may be inadequate to prevent misappropriation of our technology; |
• | third parties may independently develop similar technology; |
• | agreements containing protections may be breached or terminated; |
• | we may not have adequate remedies for breaches; |
• | existing patent, trademark, copyright, and trade secret laws may afford limited protection; |
• | a third party could copy or otherwise obtain and use our products or technology without authorization; or |
• | we may be required to litigate to enforce our intellectual property rights, and we may not be successful. |
Policing unauthorized use of our intellectual property is difficult, particularly outside the U.S., and litigating intellectual property claims may result in substantial cost and divert management’s attention.
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In addition, we may be required to defend our products against patent or other intellectual property infringement claims or litigation. In addition to defense expenses and costs, we may not prevail in such cases, forcing us to seek licenses or royalty arrangements from third parties, which we may not be able to obtain on reasonable terms, or subjecting us to an order or requirement to stop manufacturing, using, selling, or distributing products that included challenged intellectual property, which could harm our business and financial results.
We have a fixed cost base that can affect our profitability in a declining sales environment.
The fixed cost levels of operating production facilities can put pressure on profit margins when sales and production decline. We have maintained discipline over our fixed cost base during the economic recovery, and improvements in gross margin can help mitigate the risks related to a fixed cost base. However, our profitability is dependent, in part, on our ability to absorb fixed costs over an increasing number of products sold and shipped. Decreased demand or the need to reduce inventories can lower our production levels and impact our ability to absorb fixed costs, consequently materially impacting our results.
Successfully managing our manufacturing footprint is critical to our operating and financial results.
Over the past several years, we have made strategic capital investments in capacity expansion activities to successfully capture growth opportunities and enhance product offerings, including expansions at Boston Whaler in Edgewater, Florida and Mercury Marine in Fond du Lac, Wisconsin. We may also make decisions to reduce our manufacturing footprint in accordance with our business strategy. We must carefully manage these capital improvement projects, expansions, and any manufacturing consolidation efforts to ensure they meet cost targets, comply with applicable environmental, safety, and other regulations, and uphold high-quality workmanship.
Moving production to a different plant, expanding capacity at an existing facility, or ceasing production at a facility involves risks, including difficulties initiating production within the cost and timeframe estimated, supplying product to customers when expected, integrating new products, and attracting sufficient skilled workers to handle additional production demands. If we fail to meet these objectives, it could adversely affect our ability to meet customer demand for products and increase the cost of production versus projections, both of which could result in a significant adverse impact on operating and financial results. Additionally, plant consolidation or expansion can result in manufacturing inefficiencies, additional expenses, including higher wages or severance costs, and cost inefficiencies, which could exceed projections and negatively impact financial results.
Our business operations could be negatively impacted by an outage or breach of our information technology systems or a cybersecurity event.
We manage our global business operations through a variety of information technology (IT) systems which we continually enhance to increase efficiency and security. We depend on these systems for commercial transactions, customer interactions, manufacturing, branding, employee tracking, and other applications. Some of the systems are based on legacy technology and operate with a minimal level of available support, and recent acquisitions using other systems have added to the complexity of our IT infrastructure. In addition, the Fitness business separation will require separation of business and IT systems, and new systems implementations across the enterprise also pose risks of outages or disruptions, which could affect our suppliers, commercial operations, and customers. We are working to upgrade, streamline, and integrate these systems and have invested in strategies to prevent a failure or breach but, like those of other companies, our systems are susceptible to outages due to natural disasters, power loss, computer viruses, security breaches, hardware or software vulnerabilities, disruptions, and similar events. If a legacy system or another of the Company's key systems were to fail or if our IT systems were unable to communicate effectively, this could result in missed or delayed sales or lost opportunities for cost reduction or efficient cash management.
We exchange information with hundreds of trading partners across all aspects of our commercial operations through our IT systems. A breakdown, outage, malicious intrusion, breach, random attack, or other disruption of communications could result in erroneous or fraudulent transactions, disclosure of confidential information, loss of reputation and confidence, and may also result in legal claims or proceedings, penalties and remediation costs. We have numerous e-commerce and e-marketing portals and our systems may contain personal information of customers or employees; therefore, we must continue to be diligent in protecting against malicious cyber attacks. We have been the target of attempted cyber-attacks and other security threats and we may be subject to breaches of our IT systems. We have programs in place that are intended to detect, contain, and respond to data security incidents and that provide employee awareness training regarding phishing, malware and other cyber risks. However, because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and may be difficult to detect, we may be unable to anticipate these techniques or implement adequate preventive measures. If our security measures are breached or fail, unauthorized persons may be able to obtain access to or acquire personal data. Depending on the nature of the information compromised, we may also have obligations to notify consumers and/or employees about the incident, and we may need to provide some form of remedy, such as a subscription to a credit monitoring service, for the individuals
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affected by the incident. This could negatively affect our relationships with customers or trading partners, lead to potential claims against the Company, and damage our image and reputation.
Our pension funding requirements and expenses are affected by certain factors outside our control.
Our funding obligations and pension expense for our two U.S. qualified pension plans are largely driven by the performance of assets set aside in trusts for these plans, the discount rate used to value the plans’ liabilities, actuarial data and experience, and legal and regulatory funding requirements. Changes in these factors could have an adverse impact on our results of operations, liquidity, or shareholders’ equity. The level of the Company's funding of our qualified pension plan liabilities was approximately 102 percent as of December 31, 2018. We continue to minimize our risks through pension de-risking actions, including investing in almost entirely fixed income investments and recently initiating the termination of both remaining U.S. qualified pension plans in 2018, which will be completed in 2019. However, our future pension expense and funding requirements could increase due to the effect of adverse changes in the discount rate and asset levels along with a decline in the estimated return on plan assets. Changes to legal regulations could require us to make increased contributions to the pension plans in 2019. In addition, the settlement will require us to recognize a substantial part of our unamortized actuarial losses as well as certain income tax consequences.
The timing and amount of our share repurchases are subject to a number of uncertainties.
The Board of Directors has authorized the Company’s discretionary repurchase of outstanding common stock, to be systematically completed in the open market or through privately negotiated transactions. In 2018, we repurchased $75 million of shares, and we plan to revisit additional share repurchases in 2019 after the planned Fitness business separation is completed. The amount and timing of share repurchases are based on a variety of factors. Important considerations that could cause us to limit, suspend, or delay future stock repurchases include:
• | unfavorable market and economic conditions; |
• | the trading price of our common stock; |
• | the nature of other investment opportunities available to us from time to time; and |
• | the availability of cash. |
Delaying, limiting, or suspending our stock repurchase program may negatively affect our stock price and performance versus earnings per share targets.
Our profitability may suffer as a result of competitive pricing and other pressures.
The introduction of lower-priced alternative products or services by other companies can hurt our competitive position in all of our businesses. We are constantly subject to competitive pressures in which predominantly international manufacturers may pursue a strategy of aggressive pricing, particularly during periods when their local currency weakens versus the U.S. dollar. Such pricing pressure may limit our ability to increase prices for our products in response to raw material and other cost increases and negatively affect our profit margins.
In addition, our independent boat builder customers may react negatively to potential competition for their products from Brunswick’s own boat brands, which can lead them to purchase marine engines and marine engine supplies from competing marine engine manufacturers and may negatively affect demand for our products.
Our ability to remain competitive depends on successfully introducing new products and services that meet customer expectations.
We believe that our customers look for and expect quality, innovation, and advanced features when evaluating and making purchasing decisions about products and services in the marketplace. Our ability to remain competitive and meet our growth objectives may be adversely affected by difficulties or delays in product development, such as an inability to develop viable new products or customer solutions, gain market acceptance of new products, generate sufficient capital to fund new product development, or obtain adequate intellectual property protection for new products. To meet ever-changing consumer demands, both timing of market entry and pricing of new products are critical. As a result, we may not be able to introduce new products that are necessary to remain competitive in all markets that we serve. Furthermore, we must continue to meet or exceed customers' expectations regarding product quality and after-sales service.
We manufacture and sell products that create exposure to potential claims and litigation.
Our manufacturing operations and the products we produce could result in product quality, warranty, personal injury, property damage, and other issues, thereby increasing the risk of litigation and potential liability, as well as regulatory fines. To manage
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this risk, we have established a global, enterprise-wide program charged with the responsibility for addressing, reviewing, and reporting on product integrity issues. Historically, the resolution of such claims has not had a materially adverse effect on our business, and we maintain what we believe to be adequate insurance coverage to mitigate a portion of these risks. However, we may experience material losses in the future, incur significant costs to defend claims or issue product recalls, experience claims in excess of our insurance coverage or that are not covered by insurance, or be subjected to fines or penalties. For example, in the last two years we have reported certain Cybex products designed prior to the Cybex acquisition as well as a Life Fitness PowerMill product to the Consumer Product Safety Commission ("CPSC") and those matters remain open. Our reputation may be adversely affected by such claims, whether or not successful, including potential negative publicity about our products. We record accruals for known potential liabilities, but there is the possibility that actual losses may exceed these accruals and therefore negatively impact earnings.
Compliance with environmental, zoning, data protection, and other laws and regulations may increase costs and reduce demand for our products.
We are subject to federal, state, local, and foreign laws and regulations, including product safety, environmental, health and safety, privacy, and other regulations. While we believe that we maintain the requisite licenses and permits and that we are in material compliance with applicable laws and regulations, a failure to satisfy these and other regulatory requirements could result in fines or penalties, and compliance could increase the cost of operations. The adoption of additional laws, rules, and regulations, including stricter emissions standards, could increase our manufacturing costs, increase consumer pricing, and reduce consumer demand for our products.
Environmental restrictions, boat plant emission restrictions, and permitting and zoning requirements can limit production capacity, access to water for boating and marinas, and storage space. While future licensing requirements, including any licenses imposed on recreational boating, are not expected to be unduly restrictive, they may deter potential customers, thereby reducing our sales. Furthermore, regulations allowing the sale of fuel containing higher levels of ethanol for automobiles, which is not appropriate or intended for use in marine engines, may nonetheless result in increased warranty, service costs, customer dissatisfaction with products, and other claims against the Company if boaters mistakenly use this fuel in marine engines, causing damage to and the degradation of components in their marine engines.
Our manufacturing processes involve the use, handling, storage and contracting for recycling or disposal of hazardous or toxic substances or wastes. Accordingly, we are subject to regulations regarding these substances, and the misuse or mishandling of such substances could expose us to liabilities, including claims for property, personal injury, or natural resources damages, or fines. We are also subject to laws requiring the cleanup of contaminated property, including cleanup efforts currently underway. If a release of hazardous substances occurs at or from one of our current or former properties or another location where we have disposed of hazardous materials, we may be held liable for the contamination, regardless of knowledge or whether we were at fault, and the amount of such liability could be material.
We are subject to various data protection and privacy laws and regulations in the foreign countries where we operate because we collect, store, process, and use personal information, and we rely on third parties that are not directly under our control to do so as well. The General Data Protection Regulation (GDPR) in the European Union (EU) went into effect in May 2018 and, although we have implemented plans to comply with the law, it could impose an even greater compliance burden and risk with respect to privacy and data security than prior laws. The EU (through the GDPR) and a growing number of legislative and regulatory bodies elsewhere in the world have adopted consumer notification requirements in the event of unauthorized access to or acquisition of certain types of personal data. These breach notification laws continue to evolve and may be inconsistent from one jurisdiction to another. Complying with these obligations could cause us to incur substantial costs and could increase negative publicity surrounding any incident that compromises personal data.
Additionally, we are subject to laws governing our relationships with employees, including, but not limited to, employment obligations as a federal contractor and employee wage, hour, and benefits issues, such as pension funding and health care benefits. Compliance with these rules and regulations, and compliance with any changes to current regulations, could increase the cost of our operations.
Changes in income tax laws or enforcement could have a material adverse impact on our financial results.
Although domestic tax reform legislation in the form of the Tax Cuts and Jobs Act (TCJA), signed into law on December 22, 2017, has had an overall positive impact on our financial statements, the impact of the legislation could change as we analyze and apply additional regulations or guidance issued by the government. In addition, other changes in international and domestic tax laws, including the reaction by states to the corporate tax changes in the TCJA, and changes in tax law enforcement, could negatively impact our tax provision, cash flow, and/or tax related balance sheet amounts, including our deferred tax asset values. Changes in U.S. tax law will likely have broader implications, including impacts to the economy, currency markets, inflation environment,
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consumer behavior, and/or competitive dynamics, which are difficult to predict, and may positively or negatively impact the Company and our results.
Certain activist shareholder actions could cause us to incur expense and hinder execution of our strategy.
We actively engage in discussions with our shareholders regarding further strengthening our Company and creating long-term shareholder value. This ongoing dialogue can include certain divisive activist tactics, which can take many forms. Some shareholder activism, including potential proxy contests, could result in substantial costs, such as legal fees and expenses, and divert management’s and our Board’s attention and resources from our businesses and strategic plans. Additionally, public shareholder activism could give rise to perceived uncertainties as to our future, adversely affect our relationships with dealers, distributors, or customers, make it more difficult to attract and retain qualified personnel, and cause our stock price to fluctuate based on temporary or speculative market perceptions or other factors that do not necessarily reflect the underlying fundamentals and prospects of our business. These risks could adversely affect our business and operating results.
Some of our operations are conducted by joint ventures that are not operated solely for our benefit.
We share ownership and management responsibilities with jointly owned companies such as BAC and Tohatsu Marine Corporation. These joint ventures may not have the same goals, strategies, priorities, or resources as the Company because they are intended to be operated for the benefit of all co-owners, rather than for our exclusive benefit. If such a conflict occurred, it could negatively impact our sales or financial results.
A significant portion of our revenue is derived from international sources, which creates additional uncertainty.
We intend to continue to expand our international operations and customer base as part of our growth strategy. Sales outside the United States, especially in emerging markets, are subject to various risks, including government embargoes or foreign trade restrictions, foreign currency effects, tariffs, customs duties, inflation, difficulties in enforcing agreements and collecting receivables through foreign legal systems, compliance with international laws, treaties, and regulations, and unexpected changes in regulatory environments, disruptions in distribution, and dependence on foreign personnel and unions, as well as economic and social instability. In addition, there may be tax inefficiencies in repatriating cash from non-U.S. subsidiaries, or tax laws that affect this process may change.
Instability, including, but not limited to, political events, civil unrest, and an increase in criminal activity, in locations where we maintain a significant presence could adversely impact our manufacturing and business operations. Decreased stability poses a risk of business interruption and delays in shipments of materials, components, and finished goods, as well as a risk of decreased local retail demand for our products.
In addition, global political and economic uncertainty and shifts, such as the ongoing negotiations to determine the future terms of the U.K.’s relationship with the EU (Brexit), pose risks of volatility in global markets, which could affect our operations and financial results. Changes in U.S. policy regarding foreign trade or manufacturing may create negative sentiment about the U.S. among non-U.S. customers, employees, or prospective employees, which could adversely affect our business, sales, hiring, and employee retention. If we continue to expand our business globally, our success will depend, in part, on our ability to anticipate and effectively manage these and other risks, which could materially impact international operations or the business as a whole.
Adverse weather conditions and climate events can have a negative effect on marine revenues.
Changes in seasonal weather conditions can have a significant effect on our operating and financial results, especially in the marine businesses. Sales of our marine products are typically stronger just before and during spring and summer, and favorable weather during these months generally has had a positive effect on consumer demand. Conversely, unseasonably cool weather, excessive rainfall, or drought conditions during these periods can reduce or change the timing of demand. Additionally, climate changes, regardless of the cause, resulting in environmental changes including, but not limited to, severe weather, changing sea levels, poor water conditions, or reduced access to water, could disrupt or negatively affect our business.
Catastrophic events, including natural and environmental disasters, could have a negative effect on our operations and financial results.
Hurricanes, floods, earthquakes, storms, and catastrophic natural or environmental disasters could disrupt our distribution channel, operations, or supply chain and decrease consumer demand. If a catastrophic event takes place in one of our major sales markets, our sales could be diminished. Additionally, if such an event occurs near our business locations, manufacturing facilities or key suppliers' facilities, business operations and/or operating systems could be interrupted. We could be uniquely affected by a catastrophic event due to the location of certain of our boat facilities in coastal Florida and the size of the manufacturing operation in Fond du Lac, Wisconsin.
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Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our headquarters are in Mettawa, Illinois. We have numerous manufacturing plants, distribution warehouses, sales offices, and product test sites around the world. Research and development facilities are primarily located at manufacturing sites.
We believe our facilities are suitable and adequate for our current needs and are well maintained and in good operating condition. Most plants and warehouses are of modern, single-story construction, providing efficient manufacturing and distribution operations. We believe our manufacturing facilities have the capacity, or we are investing to increase capacity, to meet current and anticipated demand. We own most of our principal plants.
The principal facilities used in our operations are in the following locations:
Marine Engine Segment
Leased facilities include: Fresno, California; Old Lyme, Connecticut; Largo, Miramar, and Pompano Beach, Florida; Lowell, Michigan; St. Paul Park, Minnesota; Brisbane and Melbourne, Australia; Toronto, Ontario, Canada; Auckland, New Zealand; Bangor, Northern Ireland; Amsterdam and Heerenveen, Netherlands; and Singapore.
Owned facilities include: Panama City and St. Cloud, Florida; Atlanta, Georgia; Brookfield, Fond du Lac, and Oshkosh, Wisconsin; Petit Rechain, Belgium; Victoria and Burnaby, British Columbia, Canada; Milton and Oakville, Ontario, Canada; Suzhou, China; and Juarez, Mexico.
Boat Segment
Leased facilities include: Greeneville, Tennessee and Auckland, New Zealand.
Owned facilities include: Edgewater and Merritt Island (Sykes Creek), Florida; Fort Wayne, Indiana; New York Mills, Minnesota; Lebanon, Missouri; Vonore, Tennessee; Clarkston, Washington; Petit Rechain, Belgium; Princeville, Quebec, Canada; Reynosa, Mexico; and Vila Nova de Cerveira, Portugal.
Fitness Segment
Leased facilities include: Rosemont, Illinois; a portion of the Franklin Park, Illinois facility; Tulsa, Oklahoma; Nuremberg, Germany.
Owned facilities include: a portion of the Franklin Park, Illinois facility; Falmouth, Kentucky; Owatonna and Ramsey, Minnesota; Bristol and Delavan, Wisconsin; and Kiskoros, Hungary.
Item 3. Legal Proceedings
Refer to Note 14 – Commitments and Contingencies in the Notes to Consolidated Financial Statements for information about the Company's legal proceedings.
Item 4. Mine Safety Disclosures
Not applicable.
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Executive Officers of the Registrant
Brunswick's Executive Officers are listed in the following table:
Officer | Present Position | Age | ||
David M. Foulkes | Chief Executive Officer | 57 | ||
William L. Metzger | Senior Vice President and Chief Financial Officer | 57 | ||
Huw S. Bower | Vice President and President - Brunswick Boat Group | 44 | ||
Christopher F. Dekker | Vice President, General Counsel and Secretary | 50 | ||
John C. Pfeifer | Senior Vice President and President - Mercury Marine | 53 | ||
Brenna Preisser | Vice President and Chief Human Resources Officer and President, Business Acceleration | 41 | ||
Daniel J. Tanner | Vice President and Controller | 61 | ||
David M. Foulkes was named Chief Executive Officer of Brunswick in January 2019. He served as Chief Technology Officer and President, Brunswick Marine Consumer Solutions, from May 2018 to 2019, as Vice President and Brunswick Chief Technology Officer from 2014 to 2018, as Vice President of Product Development and Engineering, Mercury Marine, from 2010 to 2018 and as President of Mercury Racing from 2012 to 2018. Previously, Mr. Foulkes was Vice President for Research & Development at Mercury Marine from the start of his employment in 2007.
William L. Metzger was named Senior Vice President and Chief Financial Officer of Brunswick in March 2013. Previously, he served as Vice President and Treasurer of Brunswick from 2001 to 2013 and in a number of positions of increasing responsibility since his employment with Brunswick began in 1987.
Huw S. Bower was named Vice President and President - Brunswick Boat Group in April 2016. Previously, he served as President - Boston Whaler Group from 2013 to 2016, as President - Lowe Boats from 2010 to 2013, and in positions of increasing responsibility since he started with Brunswick in 2006.
Christopher F. Dekker was named Vice President, General Counsel and Secretary of Brunswick in October 2014. Prior to his appointment, Mr. Dekker served as Brunswick's Associate General Counsel, with responsibilities for litigation, employment, and compliance matters, from 2010 to 2014.
John C. Pfeifer was named Senior Vice President and President - Mercury Marine in October 2018. Prior to his appointment, he was Vice President and President - Mercury Marine from 2014 to 2018 and Vice President - Global Operations for Mercury Marine from 2012 to 2014. He had previously been President of Brunswick Marine in EMEA (Europe, Middle East and Africa) from 2008 to 2014 after joining Brunswick in 2006 as President of the Brunswick Asia Pacific Group.
Brenna Preisser was named Vice President and Chief Human Resources Officer and President, Business Acceleration in December 2018. Prior to this appointment, Ms. Preisser served as Vice President and Chief Human Resources Officer of Brunswick from 2016 to 2018. Ms. Preisser previously served as Senior Director – Human Resources for Brunswick from 2015 to 2016 and as Vice President – Human Resources for Life Fitness from 2013 to 2015. Ms. Preisser held a number of positions of increasing responsibility since she began her employment with Brunswick in 2004.
Daniel J. Tanner was named Vice President and Controller of Brunswick in February 2016. Previously, he served as Assistant Vice President - Finance from 2015 to 2016, as Group Financial Officer for Life Fitness from 2003 to 2015, and as Director – Financial Planning and Analysis for Brunswick from 2001 to 2003.
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PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Brunswick's common stock is traded on the New York and Chicago Stock Exchanges under the symbol "BC". As of February 15, 2019, there were 7,789 shareholders of record of the Company's common stock.
In the first, second, third and fourth quarters of 2018, Brunswick paid quarterly dividends on its common stock of $0.19, $0.19, $0.19 and $0.21 per share, respectively. In the first, second, third and fourth quarters of 2017, Brunswick paid quarterly dividends on its common stock of $0.165, $0.165, $0.165 and $0.19 per share, respectively. Brunswick expects to continue to pay quarterly dividends at the discretion of the Board of Directors, subject to continued capital availability and a determination that cash dividends continue to be in the best interest of the Company's shareholders.
Brunswick's dividend and share repurchase policies may be affected by, among other things, the Company's views on future liquidity, potential future capital requirements and restrictions contained in certain credit agreements.
Performance Graph
Comparison of Five-Year Cumulative Total Shareholder Return among Brunswick, S&P 500 Index and S&P 500 Global Industry Classification Standard (GICS) Consumer Discretionary Index
2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |||||||
Brunswick | 100.00 | 112.32 | 111.82 | 122.15 | 125.22 | 106.95 | ||||||
S&P 500 GICS Consumer Discretionary Index | 100.00 | 113.56 | 115.16 | 128.78 | 156.69 | 150.08 | ||||||
S&P 500 Index | 100.00 | 109.61 | 120.70 | 127.90 | 157.11 | 158.62 | ||||||
The basis of comparison is a $100 investment at December 31, 2013 in each of: (i) Brunswick, (ii) the S&P 500 GICS Consumer Discretionary Index and (iii) the S&P 500 Index. All dividends are assumed to be reinvested. The S&P 500 GICS Consumer Discretionary Index encompasses industries including automotive, household durable goods, textiles and apparel and leisure equipment. Brunswick believes the companies included in this index provide the most representative sample of enterprises that are in primary lines of business that are similar to Brunswick's.
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Issuer Purchases of Equity Securities
The Company has executed share repurchases against authorizations approved by the Board of Directors in 2014 and 2016. In 2018, the Company repurchased $75.0 million of stock under these authorizations and as of December 31, 2018, the remaining authorization was $34.8 million.
The Company did not repurchase any shares of its common stock during the three months ended December 31, 2018.
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Item 6. Selected Financial Data
The selected historical financial data presented below as of and for the years ended December 31, 2018, 2017 and 2016 has been derived from, and should be read in conjunction with, the historical consolidated financial statements of the Company, including the notes thereto, and Item 7 of this report, including the Matters Affecting Comparability section. The selected historical financial data presented below as of and for the years ended December 31, 2015 and 2014 has been derived from the consolidated financial statements of the Company for those years and are not included in this Annual Report Form 10-K.
(in millions, except per share data) | 2018 (A) (B) | 2017 (A) | 2016 | 2015 | 2014 (C) | ||||||||||||||
Results of operations data | |||||||||||||||||||
Net sales | $ | 5,159.2 | $ | 4,835.9 | $ | 4,488.5 | $ | 4,105.7 | $ | 3,838.7 | |||||||||
Restructuring, exit, integration and impairment charges | 80.9 | 81.3 | 15.6 | 12.4 | 4.2 | ||||||||||||||
Operating earnings | 367.0 | 398.3 | 479.5 | 414.0 | 356.4 | ||||||||||||||
Pension settlement charge | — | 96.6 | 55.1 | 82.3 | 27.9 | ||||||||||||||
Earnings before interest and income taxes | 370.4 | 305.0 | 415.4 | 340.8 | 316.6 | ||||||||||||||
Earnings before income taxes | 322.2 | 281.2 | 389.7 | 315.2 | 287.9 | ||||||||||||||
Net earnings from continuing operations | 263.1 | 146.4 | 274.4 | 227.4 | 194.9 | ||||||||||||||
Net earnings from discontinued operations, net of tax | 2.2 | — | 1.6 | 14.0 | 50.8 | ||||||||||||||
Net earnings | $ | 265.3 | $ | 146.4 | $ | 276.0 | $ | 241.4 | $ | 245.7 | |||||||||
Basic earnings per common share | |||||||||||||||||||
Earnings from continuing operations | $ | 3.00 | $ | 1.64 | $ | 3.01 | $ | 2.45 | $ | 2.08 | |||||||||
Net earnings from discontinued operations, net of tax | 0.03 | — | 0.02 | 0.15 | 0.55 | ||||||||||||||
Net earnings | $ | 3.03 | $ | 1.64 | $ | 3.03 | $ | 2.60 | $ | 2.63 | |||||||||
Average shares used for computation of basic earnings per share | 87.6 | 89.4 | 91.2 | 93.0 | 93.6 | ||||||||||||||
Diluted earnings per common share | |||||||||||||||||||
Earnings from continuing operations | $ | 2.98 | $ | 1.62 | $ | 2.98 | $ | 2.41 | $ | 2.05 | |||||||||
Net earnings from discontinued operations, net of tax | 0.03 | — | 0.02 | 0.15 | 0.53 | ||||||||||||||
Net earnings | $ | 3.01 | $ | 1.62 | $ | 3.00 | $ | 2.56 | $ | 2.58 | |||||||||
Average shares used for computation of diluted earnings per share | 88.2 | 90.1 | 92.0 | 94.3 | 95.1 | ||||||||||||||
(A) | Refer to Note 23 – Quarterly Data (unaudited), for further details on certain unusual items which impacted 2018 and 2017 results. |
(B) | 2018 Earnings before income taxes includes transaction financing charges of $5.1 million. |
(C) | 2014 Earnings before interest and income taxes includes a $20.2 million impairment charge related to an equity investment. |
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(in millions, except per share and other data) | 2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||
Balance sheet data | |||||||||||||||||||
Total assets of continuing operations | $ | 4,285.7 | $ | 3,358.2 | $ | 3,284.7 | $ | 3,152.5 | $ | 3,087.9 | |||||||||
Debt | |||||||||||||||||||
Short-term | $ | 41.3 | $ | 5.6 | $ | 5.9 | $ | 6.0 | $ | 5.5 | |||||||||
Long-term | 1,179.5 | 431.8 | 436.5 | 442.5 | 446.3 | ||||||||||||||
Total debt | 1,220.8 | 437.4 | 442.4 | 448.5 | 451.8 | ||||||||||||||
Common shareholders' equity | 1,582.6 | 1,482.9 | 1,440.1 | 1,281.3 | 1,171.5 | ||||||||||||||
Total capitalization | $ | 2,803.4 | $ | 1,920.3 | $ | 1,882.5 | $ | 1,729.8 | $ | 1,623.3 | |||||||||
Cash flow data | |||||||||||||||||||
Net cash provided by operating activities of continuing operations | $ | 337.0 | $ | 401.6 | $ | 439.1 | $ | 345.3 | $ | 255.3 | |||||||||
Depreciation and amortization | 149.6 | 110.8 | 103.9 | 88.9 | 81.2 | ||||||||||||||
Capital expenditures | 193.4 | 203.2 | 193.9 | 132.5 | 124.8 | ||||||||||||||
Investments | (10.8 | ) | (3.2 | ) | 5.1 | 0.9 | 0.2 | ||||||||||||
Cash dividends paid | 67.8 | 60.6 | 55.4 | 48.3 | 41.7 | ||||||||||||||
Other data | |||||||||||||||||||
Dividends declared per share | $ | 0.78 | $ | 0.685 | $ | 0.615 | $ | 0.525 | $ | 0.45 | |||||||||
Book value per share | 18.23 | 16.95 | 15.77 | 14.11 | 12.64 | ||||||||||||||
Return on beginning shareholders' equity | 17.9 | % | 10.2 | % | 21.5 | % | 20.6 | % | 23.7 | % | |||||||||
Effective tax rate from continuing operations | 18.3 | % | 47.9 | % | 29.6 | % | 27.9 | % | 32.3 | % | |||||||||
Debt-to-capitalization rate | 43.5 | % | 22.8 | % | 23.5 | % | 25.9 | % | 27.8 | % | |||||||||
Number of employees | 16,038 | 15,116 | 14,415 | 12,745 | 12,165 | ||||||||||||||
Number of shareholders of record | 7,823 | 8,247 | 8,683 | 9,009 | 9,488 | ||||||||||||||
Common stock price (NYSE) | |||||||||||||||||||
High | $ | 69.82 | $ | 63.82 | $ | 56.30 | $ | 56.63 | $ | 51.94 | |||||||||
Low | 41.92 | 48.04 | 36.05 | 46.08 | 38.95 | ||||||||||||||
Close (last trading day) | 46.45 | 55.22 | 54.54 | 50.51 | 51.26 | ||||||||||||||
The Notes to Consolidated Financial Statements should be read in conjunction with the above summary.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Certain statements in Management’s Discussion and Analysis are based on non-GAAP financial measures. GAAP refers to generally accepted accounting principles in the United States. For example, the discussion of the Company’s cash flows includes an analysis of free cash flows and total liquidity; the discussion of the Company's net sales includes a discussion of net sales on a constant currency basis and excluding acquisitions and Sport Yacht and Yacht operations; the discussion of the Company's earnings includes a presentation of operating earnings and operating margin excluding restructuring, exit, integration and impairment charges, Sport Yacht and Yacht operations, purchase accounting amortization, costs related to the planned Fitness business separation, acquisition-related costs and certain non-recurring charges in the Fitness segment; gross margin excluding Sport Yacht and Yacht operations, purchase accounting amortization and certain non-recurring charges in the Fitness segment; and diluted earnings per common share, as adjusted. A “non-GAAP financial measure” is a numerical measure of a registrant’s historical or future financial performance, financial position or cash flows that excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the consolidated statements of operations, balance sheets or statements of cash flows of the issuer; or includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented. Non-GAAP financial measures do not include operating and statistical measures.
The Company includes non-GAAP financial measures in Management’s Discussion and Analysis and elsewhere in this Annual Report on Form 10-K, as Brunswick’s management believes that these measures and the information they provide are useful to investors because they permit investors to view Brunswick’s performance using the same tools that management uses and to better evaluate the Company’s ongoing business performance. In order to better align Brunswick's reported results with the internal metrics used by the Company's management to evaluate business performance as well as to provide better comparisons to prior periods and peer data, non-GAAP measures exclude the impact of purchase accounting amortization related to the Power Products acquisition.
Certain statements in Management’s Discussion and Analysis are forward-looking as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on current expectations, estimates, and projections about Brunswick’s business and by their nature address matters that are, to different degrees, uncertain. Words such as “may,” “could,” “expect,” “anticipate,” “intend,” “target,” “plan,” “seek,” “estimate,” “believe,” “predict,” “project,” “outlook,” “goal,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties that may cause actual results to differ materially from expectations as of the date of this Annual Report on Form 10-K. These risks include, but are not limited to, those set forth under Item 1A of this Annual Report on Form 10-K. Forward-looking statements speak only as of the date on which they are made and Brunswick does not undertake any obligation to update them to reflect events or circumstances after the date of this Annual Report.
Brunswick does not provide forward-looking guidance for certain financial measures on a GAAP basis because it is unable to predict certain items contained in the GAAP measures without unreasonable efforts. These items may include pension settlement charges, restructuring, exit, integration and impairment costs, special tax items, costs related to the planned Fitness business separation, acquisition-related costs, and certain other unusual adjustments.
Overview and Outlook
Presentation of Sea Ray Results
In December 2017, the Board of Directors authorized the Company to exit its Sea Ray business, including the Meridian brand, and as a result, reclassified the assets and liabilities as held for sale on the Consolidated Balance Sheets and presented the results of the business as discontinued operations on the Consolidated Statements of Operations in the 2017 Form 10-K. In June 2018, the Board of Directors authorized the Company to end the sale process for its Sea Ray business and once again report the results of the business within continuing operations beginning in the second quarter of 2018. Refer to the Form 8-K dated July 19, 2018 and Note 3 – Discontinued Operations in the Notes to Consolidated Financial Statements for further information.
Acquisition of Power Products
On August 9, 2018, the Company completed its acquisition of the Global Marine Business of Power Products Holdings, LLC (Power Products) for $909.6 million in cash, on a cash-free, debt-free basis. The net sales and operating earnings of Power Products included within Brunswick's financial statements since the date of acquisition were $82.8 million and $1.9 million, respectively, for the year ended December 31, 2018. Operating earnings included $21.2 million of purchase accounting amortization. For further discussion regarding the acquisition, refer to Note 5 – Acquisitions in the Notes to Consolidated Financial Statements for further details.
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Discontinued Operations
In the fourth quarter of 2018, the Company made adjustments to certain liabilities that were retained as part of the sale of the retail bowling business in 2014 and the bowling products business in 2015. Refer to Note 3 – Discontinued Operations in the Notes to Consolidated Financial Statements for further information.
Overview
The Company's 2018 results represent the ninth consecutive year of growth, resulting from strong operating performance from our marine businesses. The Company looked to achieve the following financial objectives in 2018:
• | Deliver revenue growth; |
• | Increase earnings before income taxes, as well as deliver improvements in both gross margin and operating margin percentages; and |
• | Continue to generate strong free cash flow and execute against the Company's capital strategy. |
Achievements against the Company's financial objectives in 2018 were as follows:
Deliver revenue growth:
• | Ended the year with a 7 percent increase in net sales when compared with 2017 on a GAAP basis as well as on a constant currency basis excluding the impact of acquisitions along with Sea Ray Sport Yacht and Yacht operations, due to the following: |
• | The Company's combined Marine segments reported strong growth in the Marine Engine segment and solid growth in the Boat segment; |
▪ | Marine Engine segment sales benefited from significant growth in propulsion, primarily as a result of organic growth in the outboard engine business, as well as steady growth in the marine parts and accessories businesses; |
▪ | Boat segment sales decreased slightly as a result of the winding down of Sport Yacht and Yacht operations during 2018. Excluding the impact of Sport Yacht and Yacht operations, sales increased across all three primary boat categories, with strong growth in the saltwater fishing category, primarily driven by Boston Whaler, and solid growth in the recreational fiberglass and aluminum fishing categories; |
• | The U.S. marine market, which comprised 71 percent of the Company's marine sales, performed in line with expectations in 2018, with industry unit volume growing 3 percent. Outboard boats and engines drove industry growth, with increases in aluminum fishing boats and pontoons outpacing overall industry performance; |
• | Fitness segment net sales were flat in 2018 compared with 2017 as growth in international markets was offset by declines in domestic sales, particularly of Cybex branded cardio product; and |
• | International sales for the Company increased 6 percent in 2018 when compared with 2017 on a GAAP basis and increased 4 percent on a constant currency basis, excluding the impact of acquisitions and Sport Yacht and Yacht operations; the increase was driven by Asia-Pacific, Europe and Canada, while Rest-of-World regions declined slightly. |
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Increase earnings before income taxes, as well as deliver improvements in both gross margin and operating margin percentages:
• | Reported earnings before income taxes of $322.2 million in 2018 compared with earnings before income taxes of $281.2 million in 2017; adjusted earnings before income taxes were $530.4 million in 2018 versus $504.5 million in 2017; |
• | Gross margin declined 50 basis points when compared with 2017, resulting from the wind-down of Sport Yacht and Yacht operations as well as purchase accounting amortization associated with the Power Products acquisition. Additionally, several unfavorable factors in the Fitness segment contributed to gross margin declines. Partially offsetting these factors were volume benefits and a favorable impact from changes in sales mix, including benefits from new products in the marine businesses. Gross margin, as adjusted, also declined 50 basis points from the prior year; and |
• | Operating margin declined by 110 basis points when compared with the prior year due to the factors affecting gross margin percentage discussed above, as well as costs associated with the planned Fitness business separation and acquisition-related costs. Operating margin, as adjusted, was flat versus 2017. |
Continue to generate strong free cash flow and execute against the Company's capital strategy:
• | Generated free cash flow of $208.8 million in 2018, enabling the Company to continue executing its capital strategy as follows: |
• | Funded investments in growth: |
• | Through the acquisition of Power Products for $909.6 million during 2018; and |
• | Organically through capital expenditures, which included investments in new products as well as capacity expansions, primarily within the Marine Engine segment. |
• | Contributed $163.8 million to the Company's qualified and nonqualified defined benefit pension plans; and |
• | Enhanced shareholder returns in 2018 by repurchasing $75.0 million of common stock under the Company’s share repurchase program and increased cash dividends paid to shareholders to $67.8 million. |
• | Ended the year with $304.2 million of cash and marketable securities. |
Net earnings from continuing operations increased to $263.1 million in 2018 from $146.4 million in 2017. The 2018 results include an income tax provision of $59.1 million, which was based on a U.S. federal statutory rate of 21 percent and included a net benefit of $4.1 million primarily related to 2017 U.S. tax reform updates. The 2017 results reflect an income tax provision of $134.8 million, which was based on a U.S. federal statutory rate of 35 percent and included net charges of $69.7 million mostly relating to the impact of U.S. tax reform, including the impact on deferred tax balances from the reduction in the statutory rate from 35 percent to 21 percent, along with an estimate of taxes payable on deemed unrepatriated foreign earnings.
Outlook for 2019
The Company is projecting 2019 to be another year of strong revenue and earnings growth with excellent free cash flow generation in excess of $320 million, with approximately $20 million attributable to the Company's Fitness segment. The Company is targeting growth in the combined marine segments in the range of 9 percent to 11 percent, including an approximate 4 percent benefit from completed acquisitions, and mid single-digit percent declines in the Fitness segment.
The marine segments are expected to benefit from a steady global marine market, ongoing benefits from customer migration to higher horsepower engines and boats with increased technology and content, and market share gains due in part to the continued strong demand and acceptance of new outboard products. The Company anticipates the Marine Engine segment will increase net sales at a rate of low-to-mid-teens percent including the Power Products acquisition as well as continued growth in market share in outboard engines, especially in the greater than 150 horsepower categories. Boat segment net sales are expected to grow low-to-mid-single digit percent including benefits from growth in premium brands in the U.S. The Company expects Fitness segment net sales to decline, reflecting lower sales to value-oriented health clubs and stable market demand.
The Company is planning to deliver higher earnings before income taxes in 2019 resulting from increased revenue and improvements in both gross margin and operating margin levels. Margin gains reflect strong improvement in the marine segments,
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partially offset by margins in the Fitness segment. The Company projects operating expenses to increase in 2019 as it continues to fund incremental investments to support growth and incur costs in connection with the Fitness business separation.
Gross margins for the Company's marine segments in 2019 are anticipated to benefit from new products, volume leverage and cost reduction activities; additionally, the Marine Engine segment will benefit from the Power Products acquisition. Partially offsetting these positive factors are the estimated impacts of tariffs and unfavorable movements in foreign exchange rates, which are expected to have an incremental negative impact on gross margins versus 2018. Operating expenses for both marine segments are estimated to decline slightly versus 2018 on a percentage of sales basis. Fitness segment gross margins in 2019 are anticipated to remain consistent with 2018 levels, including benefits from cost reduction initiatives. Operating margins are expected to decline due to planned investments in new products and modernizing information technology platforms which are intended to position the Fitness business to succeed as an independent entity.
The Company is planning for its effective tax rate in 2019 to be approximately 23 percent to 24 percent based on existing tax law.
Matters Affecting Comparability
Certain events occurred during 2018, 2017 and 2016 that the Company believes affect the comparability of the results of operations. The tables below summarize the impact of changes in currency exchange rates, the impact of recent acquisitions and the impact of Sport Yacht and Yacht operations on the Company's net sales:
Net Sales | 2018 vs. 2017 | ||||||||||||||
(in millions) | 2018 | 2017 | GAAP | Currency Impact | Acquisition Impact | Impact of Sport Yacht and Yacht | |||||||||
Marine Engine | $ | 2,993.6 | $ | 2,631.8 | 13.7% | 0.1% | 4.0% | — | |||||||
Boat | 1,471.3 | 1,490.6 | (1.3)% | 0.5% | — | (7.5)% | |||||||||
Marine eliminations | (344.0 | ) | (320.2 | ) | |||||||||||
Total Marine | 4,120.9 | 3,802.2 | 8.4% | 0.3% | 2.8% | (3.1)% | |||||||||
Fitness | 1,038.3 | 1,033.7 | 0.4% | 0.3% | — | — | |||||||||
Total | $ | 5,159.2 | $ | 4,835.9 | 6.7% | 0.3% | 2.2% | (2.3)% | |||||||
Net Sales | 2017 vs. 2016 | ||||||||||||||
(in millions) | 2017 | 2016 | GAAP | Currency Impact | Acquisition Impact | Impact of Sport Yacht and Yacht | |||||||||
Marine Engine | $ | 2,631.8 | $ | 2,441.1 | 7.8% | 0.2% | 1.0% | — | |||||||
Boat | 1,490.6 | 1,369.9 | 8.8% | 0.2% | 0.7% | (5.0)% | |||||||||
Marine eliminations | (320.2 | ) | (302.9 | ) | |||||||||||
Total Marine | 3,802.2 | 3,508.1 | 8.4% | 0.2% | 1.0% | (1.7)% | |||||||||
Fitness | 1,033.7 | 980.4 | 5.4% | (0.0)% | 3.1% | — | |||||||||
Total | $ | 4,835.9 | $ | 4,488.5 | 7.7% | 0.2% | 1.4% | (1.3)% | |||||||
Retention of the Sea Ray business and wind down of Sport Yacht and Yacht operations. As a result of the decision to retain and restructure the Sea Ray business and wind down Sport Yacht and Yacht operations as discussed in Note 3 – Discontinued Operations in the Notes to Consolidated Financial Statements, starting in the second quarter of 2018, the results of the Sea Ray business are reported in continuing operations. The results of Sport Yacht and Yacht operations are summarized in the table below.
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Year Ended | |||||||||||
(in millions) | 2018 | 2017 | 2016 | ||||||||
Net sales (A) | $ | 49.4 | $ | 151.6 | $ | 194.4 | |||||
Gross margin (A) | (39.7 | ) | (12.4 | ) | 12.6 | ||||||
Restructuring, exit, integration and impairment charges | 49.4 | 23.3 | — | ||||||||
Operating loss (A) | (107.8 | ) | (55.2 | ) | (9.5 | ) | |||||
(A) During 2018, Sport Yacht and Yacht results include $16.0 million of charges within Net sales related to estimated retail sales promotions to support the sale of sport yachts and yachts in the dealer pipeline. There were no comparable charges in 2017 or 2016.
Acquisitions. The Company completed acquisitions during 2018, 2017 and 2016 that affect the comparability of net sales. The impacts on consolidated and segment sales comparisons are reflected above. Refer to Note 5 – Acquisitions in the Notes to Consolidated Financial Statements for further information.
Changes in foreign currency rates. Percentage changes in net sales expressed in constant currency reflect the impact that changes in currency exchange rates had on comparisons of net sales. To determine this information, net sales transacted in currencies other than U.S. dollars have been translated to U.S. dollars using the average exchange rates that were in effect during the comparative period. The percentage change in net sales expressed on a constant currency basis better reflects the changes in the underlying business trends, excluding the impact of translation arising from foreign currency exchange rate fluctuations. Approximately 21 percent of the Company's annual net sales are transacted in a currency other than the U.S. dollar. The Company's most material exposures include sales in Euros, Canadian dollars, Australian dollars, Brazilian reais and British pounds.
Additionally, operating earnings comparisons were negatively affected by foreign exchange rates by approximately $2 million in 2018 when compared with 2017, and were positively affected by foreign exchange rates by approximately $1 million in 2017 when compared with 2016. These estimates include the impact of translation on all sales and costs transacted in a currency other than the U.S. dollar, the impact of hedging activities and pricing actions in certain international markets in response to the changes in the exchange rate between the local currency and the U.S. dollar.
Restructuring, exit, integration and impairment charges. The Company recorded restructuring, exit, integration and impairment charges during 2018, 2017 and 2016. The following table summarizes these charges by cash charges and non-cash charges.
(in millions) | 2018 | 2017 | 2016 | ||||||||
Cash charges: | |||||||||||
Boat (A) | $ | 27.5 | $ | 5.4 | $ | 0.6 | |||||
Fitness (B) | 3.5 | 13.7 | 12.7 | ||||||||
Corporate | 1.5 | 1.6 | — | ||||||||
Total cash charges | 32.5 | 20.7 | 13.3 | ||||||||
Non-cash charges: | |||||||||||
Boat (A) | 26.6 | 43.2 | — | ||||||||
Fitness (B) | 21.8 | 16.6 | — | ||||||||
Corporate | — | 0.8 | 2.3 | ||||||||
Total non-cash charges | 48.4 | 60.6 | 2.3 | ||||||||
Total restructuring, exit, integration and impairment charges | $ | 80.9 | $ | 81.3 | $ | 15.6 | |||||
_______________
(A) Restructuring, exit, integration and impairment activities within the Boat segment primarily related to the wind-down of Sport Yacht and Yacht operations. As the wind-down was largely completed during 2018, the operating losses and cash flows in excess of restructuring activities will no longer be incurred.
(B) As a result of Restructuring, exit, integration and impairment activities, the Company anticipates future cost savings of approximately $5 million in the Fitness segment, with the full impact realized in 2019. Future cost savings will primarily be reflected within Selling, general and administrative expense.
See Note 4 – Restructuring, Exit, Integration and Impairment Activities in the Notes to Consolidated Financial Statements for further details on charges and initiatives.
Purchase accounting amortization. As part of purchase accounting for the Power Products acquisition, the Company recognized definite-lived intangible assets as well as a fair value adjustment to inventory, both of which will be amortized over
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their useful lives. During 2018, the Company recorded $12.0 million and $9.2 million of purchase accounting amortization within Selling, general and administrative expense and Cost of sales, respectively. There was no purchase accounting amortization for Power Products during 2017 or 2016.
Fitness business separation charges. On March 1, 2018, the Company's Board of Directors authorized proceeding with separating its Fitness business from the Company portfolio. In connection with this action, the Company incurred $19.3 million of charges within Selling, general and administrative expense during 2018. There were no comparable charges in 2017 or 2016.
Acquisition-related costs. In connection with the Power Products acquisition, the Company recorded $13.8 million of costs within Selling, general and administrative expense during 2018. As part of the financing of the acquisition, the Company recorded $5.1 million of Transaction financing charges in 2018 to secure the 364-Day Senior Unsecured Bridge Facility as described in Note 17 – Debt in the Notes to Consolidated Financial Statements. There were no comparable charges in 2017 or 2016.
Other non-recurring charges in the Fitness segment. The Company's Fitness segment recorded $11.8 million and $13.5 million of non-recurring charges in 2018 and 2017, respectively. The charges in 2018 consisted of $3.6 million within Selling, general and administrative expense related to a contract dispute, $3.1 million within Cost of sales related to the settlement of supplier obligations, $2.8 million within Selling, general and administrative expense associated with the delayed submission of import duty filings in a foreign jurisdiction and $2.3 million within Cost of sales for a product field campaign. For 2017, non-recurring charges consisted of $8.4 million and $5.1 million within Cost of sales and Selling, general and administrative expense, respectively, related to field campaigns pertaining to certain Cybex products designed prior to the acquisition. Refer to Note 14 – Commitments and Contingencies for further details.
Pension settlement charges. There were no pension settlement charges in 2018. In the fourth quarters of 2017 and 2016, the Company recognized $96.6 million and $55.1 million of charges, respectively, related to actions taken to settle a portion of its pension obligations. These actions included transferring certain plan obligations to a third party by purchasing annuities on behalf of plan participants and making lump-sum payments directly to certain plan participants, as applicable. These costs are reflected in Pension settlement charge on the Consolidated Statements of Operations. See Note 18 – Postretirement Benefits in the Notes to Consolidated Financial Statements for further details.
Adoption of new revenue standard. On January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers, (new revenue standard) using the modified retrospective method. As a result of applying the new revenue standard, the Company reported higher Net sales of $15.6 million and higher Operating earnings of $10.1 million during the year ended December 31, 2018 when compared with previous GAAP. Refer to Note 1 – Significant Accounting Policies in the Notes to Consolidated Financial Statements for further information on the impact of the new revenue standard on the Company's consolidated financial statements. Refer to Note 2 – Revenue Recognition in the Notes to Consolidated Financial Statements for further discussion of the Company's revenue recognition policies and a presentation of disaggregated revenue.
Tax items. As a result of U.S. tax reform, the Company's U.S. federal statutory rate decreased to 21 percent in 2018 versus 35 percent in 2017 and 2016. In addition, the 2018 income tax provision of $59.1 million included a net benefit of $4.1 million primarily related to 2017 U.S. tax reform updates. The 2017 results reflected an income tax provision of $134.8 million, which included net charges of $69.7 million mostly relating to the impact of U.S. tax reform, including the impact on deferred tax balances from the reduction in the statutory rate from 35 percent to 21 percent, along with an estimate of taxes payable on deemed unrepatriated foreign earnings. The 2016 results include an income tax provision of $115.3 million, which included a net tax charge of $1.1 million, primarily associated with the impact of changes in tax laws partially offset by the reassessment of tax reserves and favorable valuation allowance adjustments.
See Note 13 – Income Taxes in the Notes to Consolidated Financial Statements for further details.
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Results of Operations
Consolidated
The following table sets forth certain amounts, ratios and relationships calculated from the Consolidated Statements of Operations for 2018, 2017 and 2016:
2018 vs. 2017 | 2017 vs. 2016 | ||||||||||||||||||||||||
(in millions, except per share data) | 2018 | 2017 | 2016 | $ | % | $ | % | ||||||||||||||||||
Net sales | $ | 5,159.2 | $ | 4,835.9 | $ | 4,488.5 | $ | 323.3 | 6.7 | % | $ | 347.4 | 7.7 | % | |||||||||||
Gross margin (A) (B) | 1,321.0 | 1,262.1 | 1,232.4 | 58.9 | 4.7 | % | 29.7 | 2.4 | % | ||||||||||||||||
Restructuring, exit, integration and impairment charges | 80.9 | 81.3 | 15.6 | (0.4 | ) | (0.5 | )% | 65.7 | NM | ||||||||||||||||
Operating earnings (B) | 367.0 | 398.3 | 479.5 | (31.3 | ) | (7.9 | )% | (81.2 | ) | (16.9 | )% | ||||||||||||||
Pension settlement charge | — | 96.6 | 55.1 | (96.6 | ) | (100.0 | )% | 41.5 | 75.3 | % | |||||||||||||||
Transaction financing charges | 5.1 | — | — | 5.1 | NM | — | NM | ||||||||||||||||||
Net earnings from continuing operations (B) | 263.1 | 146.4 | 274.4 | 116.7 | 79.7 | % | (128.0 | ) | (46.6 | )% | |||||||||||||||
Diluted earnings per share from continuing operations | $ | 2.98 | $ | 1.62 | $ | 2.98 | $ | 1.36 | 84.0 | % | $ | (1.36 | ) | (45.6 | )% | ||||||||||
Expressed as a percentage of Net sales: | |||||||||||||||||||||||||
Gross margin | 25.6 | % | 26.1 | % | 27.5 | % | (50) bpts | (140) bpts | |||||||||||||||||
Selling, general and administrative expense | 14.0 | % | 13.2 | % | 13.3 | % | 80 bpts | (10) bpts | |||||||||||||||||
Research and development expense | 2.9 | % | 3.0 | % | 3.1 | % | (10) bpts | (10) bpts | |||||||||||||||||
Operating margin | 7.1 | % | 8.2 | % | 10.7 | % | (110) bpts | (250) bpts | |||||||||||||||||
NM = not meaningful
bpts = basis points
(A) | Gross margin is defined as Net sales less Cost of sales as presented in the Consolidated Statements of Operations. |
(B) | Refer to Note 23 – Quarterly Data (unaudited), for further details on certain unusual items which impacted 2018 and 2017 results. |
2018 vs. 2017
Net sales increased during 2018 when compared with 2017 driven by strong growth in the Marine Engine segment. Marine Engine segment sales benefited from significant growth in propulsion, primarily as a result of organic growth in the outboard engine business driven by high demand for new outboard products, as well as the marine parts and accessories businesses, which included contributions from the Power Products acquisition. Boat segment sales decreased slightly as a result of the winding down of Sport Yacht and Yacht operations during 2018. Excluding the impact of Sport Yacht and Yacht operations, sales increased across all three primary boat categories, with strong growth in the saltwater fishing category, primarily driven by Boston Whaler, and solid growth in the recreational fiberglass and aluminum fishing categories. Fitness segment net sales were flat in 2018 compared with 2017 as growth in international markets was offset by declines in domestic sales, particularly of Cybex branded cardio product. International net sales for the Company increased 6 percent in 2018 on a GAAP basis; on a constant currency basis and excluding the impact of acquisitions and Sport Yacht and Yacht operations, international sales increased 4 percent, driven by increases in Asia-Pacific, Europe and Canada, partially offset by declines in Rest-of-World.
Gross margin percent decreased in 2018 when compared with 2017, reflecting the wind-down of the Sport Yacht and Yacht operations as well as purchase accounting amortization. Additionally, several unfavorable factors drove lower gross margins in the Fitness segment including inventory cost adjustments primarily related to product transitions, higher freight costs, an unfavorable impact from changes in sales mix and cost inflation and inefficiencies. Partially offsetting these factors were favorable items in the marine businesses including volume benefits and a favorable impact from changes in sales mix, including benefits from new products.
Selling, general and administrative expense and Research and development expense increased during 2018 when compared with 2017. Selling, general and administrative expense in 2018 included purchase accounting amortization associated with the Power Products acquisition, costs associated with the planned Fitness business separation and acquisition-related costs. Both expenses reflected planned spending increases to support new product promotion and development, primarily in the Marine Engine segment.
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During 2018, the Company recorded restructuring, exit, integration and impairment charges of $80.9 million compared with $81.3 million in 2017. See Note 4 – Restructuring, Exit, Integration and Impairment Activities in the Notes to Consolidated Financial Statements for further details.
The Company recognized equity earnings of $7.7 million and $6.1 million in 2018 and 2017, respectively, which were mainly related to the Company's marine joint ventures. Equity earnings in 2018 included a $2.3 million gain on the sale of an equity investment as discussed in Note 10 – Investments in the Notes to Consolidated Financial Statements.
In 2017, the Company recorded $96.6 million, respectively, of charges related to pension settlement actions as discussed in Note 18 – Postretirement Benefits in the Notes to Consolidated Financial Statements. There were no pension settlement actions in 2018.
The Company recognized $4.3 million and $2.8 million in 2018 and 2017, respectively, in Other expense, net. Other expense, net primarily includes pension and other postretirement benefit costs, the amortization of deferred income related to a trademark licensing agreement with AMF Bowling Centers, Inc. as discussed in Note 1 – Significant Accounting Policies in the Notes to Consolidated Financial Statements, as well as remeasurement gains and losses resulting from changes in foreign currency rates.
Net interest expense increased $19.3 million in 2018 compared with 2017 primarily due to recent debt issuances as discussed in Note 17 – Debt in the Notes to Consolidated Financial Statements. Interest expense also included the mark-to-market impact of the Company's fixed-to-floating rate interest rate swaps.
Transaction financing charges of $5.1 million in 2018 related to the 364-Day Senior Unsecured Bridge Facility which was secured in connection with the Power Products acquisition as discussed in Note 17 – Debt in the Notes to Consolidated Financial Statements.
As a result of U.S. tax reform, the Company's U.S. federal statutory rate decreased to 21 percent in 2018 versus 35 percent in 2017. In addition, the 2018 income tax provision of $59.1 million included a net benefit of $4.1 million primarily related to 2017 U.S. tax reform updates. The 2017 results reflected an income tax provision of $134.8 million, which included net charges of $69.7 million mostly relating to the impact of U.S. tax reform, including the impact on deferred tax balances from the reduction in the statutory rate from 35 percent to 21 percent, along with an estimate of taxes payable on deemed unrepatriated foreign earnings. The effective tax rate for 2018 and 2017 was 18.3 percent and 47.9 percent, respectively.
The Company's effective tax rate also reflects the benefit of having earnings from foreign entities that are in jurisdictions that have lower statutory tax rates than the U.S. This includes entities in Hungary, China and Poland which have applicable statutory tax rates of 9 percent, 15 percent and 19 percent, respectively.
See Note 13 – Income Taxes in the Notes to Consolidated Financial Statements for further details on the impacts of the TCJA as well as a reconciliation of the Company's effective tax rate and statutory Federal income tax rate.
Operating earnings decreased, while Net earnings from continuing operations and Diluted earnings per common share from continuing operations increased in 2018 when compared with 2017, primarily due to the factors discussed in the preceding paragraphs. The increase in Diluted earnings per common share from continuing operations also included benefits from common stock repurchases.
Diluted earnings per common share, as adjusted, increased by $0.76 per share, or 19 percent, to $4.77 per share for 2018 when compared with 2017, and excluded the following items in 2018: restructuring, exit, integration and impairment charges of $0.71 per share, losses related to Sport Yacht and Yacht operations of $0.51 per share, costs associated with the planned Fitness business separation of $0.19 per share, purchase accounting amortization of $0.18 per share, acquisition-related costs of $0.17 per share, other non-recurring charges in the Fitness segment of $0.10 per share, a net benefit from special tax items of $0.05 per share and a gain on the sale of an equity investment of $0.02 per share. In 2017, Diluted earnings per common share, as adjusted excluded $0.62 per share of restructuring, exit, integration and impairment charges, a net charge from special tax items of $0.76 per share, a pension settlement charge of $0.69 per share, losses related to Sport Yacht and Yacht operations of $0.22 per share and $0.10 per share of other non-recurring charges in the Fitness segment.
2017 vs. 2016
Net sales increased during 2017 when compared with 2016 due to increases across all segments. Marine Engine segment net sales increased due to strong growth in both outboard engines as well as the marine parts and accessories businesses. Outboard engines benefited from a favorable market environment, particularly for higher horsepower engines, and continued benefits from
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new product launches and market share gains. The marine parts and accessories businesses benefited from several factors, including the successful execution of the Company's international growth strategy, recent acquisitions and new product launches. Boat segment net sales reflected strong growth in the saltwater fishing and aluminum freshwater categories, partially offset by slight declines in the recreational fiberglass category as a result of sales weakness in Sport Yacht and Yacht operations. Fitness segment net sales increased modestly reflecting growth in international markets while domestic demand was flat. International net sales for the Company increased 10 percent in 2017 on a GAAP basis; on a constant currency basis and excluding acquisitions and Sport Yacht and Yacht operations, international net sales increased 7 percent, driven by strong increases in Asia-Pacific as well as solid increases in other international markets.
Gross margin percent decreased in 2017 when compared with 2016, primarily driven by declines in the Fitness segment as a result of several factors, including higher costs, particularly costs for product field campaigns for certain Cybex products designed prior to the acquisition as well as higher freight costs, particularly in the fourth quarter, challenging pricing dynamics in certain international markets and unfavorable changes in sales mix. Gross margin declines also reflected increased warranty costs and manufacturing inefficiencies for Sport Yacht and Yacht operations.
Selling, general and administrative expense and Research and development expense line items increased during 2017 when compared with 2016, but decreased as a percentage of net sales. Both line items reflected increased funding to support investments in new products and growth initiatives, partially offset by cost reduction efforts.
During 2017, the Company recorded restructuring, integration and impairment charges of $81.3 million compared with $15.6 million in 2016. See Note 4 – Restructuring, Exit, Integration and Impairment Activities in the Notes to Consolidated Financial Statements for further details.
The Company recognized equity earnings of $6.1 million and $4.3 million in 2017 and 2016, respectively, which were mainly related to the Company's marine joint ventures.
In 2017 and 2016, the Company recorded $96.6 million and $55.1 million, respectively, of charges related to pension settlement payments as discussed in Note 18 – Postretirement Benefits in the Notes to Consolidated Financial Statements.
The Company recognized $(2.8) million and $(13.3) million in 2017 and 2016, respectively, in Other expense, net. The reduction of expense in 2017 primarily related to decreased pension expense as discussed in Note 18 – Postretirement Benefits in the Notes to Consolidated Financial Statements.
Net interest expense decreased slightly in 2017 compared with 2016.
The Company recognized an income tax provision of $134.8 million in 2017, which included net charges of $69.7 million mostly relating to the impact of U.S. tax reform, including the impact on deferred tax balances from the reduction in the statutory rate from 35 percent to 21 percent, along with an estimate of taxes payable on deemed unrepatriated foreign earnings. The 2016 results include an income tax provision of $115.3 million, which included a net tax charge of $1.1 million, primarily associated with the impact of changes in tax laws partially offset by the reassessment of tax reserves and favorable valuation allowance adjustments. The effective tax rate for 2017 and 2016 was 47.9 percent and 29.6 percent, respectively. See Note 13 – Income Taxes in the Notes to Consolidated Financial Statements for further details.
Operating earnings, Net earnings from continuing operations and Diluted earnings per common share from continuing operations decreased in 2017 when compared with 2016, primarily due to the factors discussed in the preceding paragraphs. The decrease in Diluted earnings per common share from continuing operations was partially offset by benefits from common stock repurchases.
Diluted earnings per common share, as adjusted, increased by $0.43 per share, or 12 percent, to $4.01 per share for 2017 when compared with 2016, and excluded the following items in 2017: $0.62 per share of restructuring, exit, integration and impairment charges, a net charge from special tax items of $0.76 per share, a pension settlement charge of $0.69 per share, losses related to Sport Yacht and Yacht operations of $0.22 per share and $0.10 per share of other non-recurring charges in the Fitness segment. In 2016, Diluted earnings per common share, as adjusted excluded a pension settlement charge of $0.38 per share, Restructuring, integration and impairment charges of $0.11 per share, losses related to Sport Yacht and Yacht operations of $0.10 per share and special tax items were a net charge of $0.01 per share.
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Segments
The Company operates in three operating and reportable segments: Marine Engine, Boat and Fitness. Refer to Note 7 – Segment Information in the Notes to Consolidated Financial Statements for details on the segment operations.
Marine Engine Segment
The following table sets forth Marine Engine segment results for the years ended December 31, 2018, 2017 and 2016:
2018 vs. 2017 | 2017 vs. 2016 | ||||||||||||||||||||||||
(in millions) | 2018 | 2017 | 2016 | $ | % | $ | % | ||||||||||||||||||
Net sales | $ | 2,993.6 | $ | 2,631.8 | $ | 2,441.1 | $ | 361.8 | 13.7 | % | $ | 190.7 | 7.8 | % | |||||||||||
Operating earnings (A) | 454.4 | 411.3 | 378.4 | 43.1 | 10.5 | % | 32.9 | 8.7 | % | ||||||||||||||||
Operating margin (A) | 15.2 | % | 15.6 | % | 15.5 | % | (40) bpts | 10 bpts | |||||||||||||||||
bpts = basis points
(A) Includes $21.2 million of purchase accounting amortization and $13.8 million of acquisition-related costs in 2018.
2018 vs. 2017
Marine Engine segment net sales benefited from significant growth in both the propulsion and marine parts and accessories businesses. Propulsion benefited from organic growth as a result of robust demand for new, higher horsepower outboard products. The marine parts and accessories business benefited from contributions from Power Products as well as steady organic growth in both the products and distribution businesses. Acquisitions completed in 2018 and 2017 accounted for approximately 4 percentage points of the Marine Engine segment's overall revenue growth rate in 2018. International net sales were 30 percent of the segment's net sales in 2018, and increased 13 percent from the prior year on a GAAP basis. On a constant currency basis and excluding acquisitions, international net sales increased 6 percent in 2018, which included gains in all international regions.
The Marine Engine segment reported increased operating earnings in 2018 when compared with the prior year as a result of strong operating performance including higher net sales, favorable impacts from changes in sales mix and contributions from the acquisition of Power Products. Partially offsetting these factors were the impacts of purchase accounting amortization and acquisition-related costs. Additionally, the first half of the year included unfavorable impacts of plant efficiencies associated with production ramp-up for new products and the integration of new warehouse management systems as well as planned spending increases for product promotion and development.
2017 vs. 2016
Marine Engine segment net sales increased in 2017 versus 2016 due to strong growth in both outboard engines and the marine parts and accessories businesses. Outboard engines benefited from a favorable market environment, particularly for higher horsepower engines, and continued benefits from market share gains, including benefits from newly launched products. The marine parts and accessories businesses benefited from the successful execution of the Company's international growth strategy, acquisitions and new product launches. Partially offsetting these factors was a decrease in sterndrive engine net sales due to the continuing shift to outboards which is contributing to unfavorable global retail demand trends. Acquisitions completed in 2017 and 2016 accounted for 1 percentage point of the Marine Engine segment's overall revenue growth rate in 2017. International net sales were 30 percent of the segment's net sales in 2017, and increased 10 percent from the prior year on a GAAP basis. On a constant currency basis, international net sales increased 9 percent in 2017, which included gains in all international markets, with the strongest increases in Canada, Europe and Asia-Pacific.
Marine Engine segment operating earnings increased in 2017 as a result of higher net sales and favorable changes in product mix, partially offset by planned increases in growth investments in advance of new product introductions and the resolution of litigation in the fourth quarter of 2017.
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Boat Segment
The following table sets forth Boat segment results for the years ended December 31, 2018, 2017 and 2016:
2018 vs. 2017 | 2017 vs. 2016 | ||||||||||||||||||||||||
(in millions) | 2018 | 2017 | 2016 | $ | % | $ | % | ||||||||||||||||||
Boat segment: | |||||||||||||||||||||||||
Net sales | $ | 1,471.3 | $ | 1,490.6 | $ | 1,369.9 | $ | (19.3 | ) | (1.3 | )% | $ | 120.7 | 8.8 | % | ||||||||||
Restructuring, exit, integration and impairment charges (A) | 54.1 | 48.6 | 0.6 | 5.5 | 11.3 | % | 48.0 | NM | |||||||||||||||||
Operating earnings (loss) | (12.5 | ) | 5.3 | 60.8 | (17.8 | ) | NM | (55.5 | ) | (91.3 | )% | ||||||||||||||
Operating margin | (0.8 | )% | 0.4 | % | 4.4 | % | (120) bpts | (400) bpts | |||||||||||||||||
Sport Yacht and Yacht operations: | |||||||||||||||||||||||||
Net sales | 49.4 | 151.6 | 194.4 | (102.2 | ) | (67.4 | )% | (42.8 | ) | (22.0 | )% | ||||||||||||||
Restructuring, exit, integration and impairment charges (A) | 49.4 | 23.3 | — | 26.1 | NM | 23.3 | NM | ||||||||||||||||||
Operating loss | (107.8 | ) | (55.2 | ) | (9.5 | ) | (52.6 | ) | (95.3 | )% | (45.7 | ) | NM | ||||||||||||
Operating margin | NM | (36.4 | )% | (4.9 | )% | NM | NM | ||||||||||||||||||
NM = not meaningful
bpts = basis points
(A) | Restructuring charges in 2018 and 2017 primarily relate to the wind-down of Sport Yacht and Yacht operations. See Note 4 – Restructuring, Exit, Integration and Impairment Activities in the Notes to Consolidated Financial Statements for further details. |
2018 vs. 2017
Boat segment net sales decreased slightly in 2018 compared with the same prior year period, primarily as a result of the winding down of Sport Yacht and Yacht operations during 2018. Sport Yacht and Yacht sales negatively affected sales comparisons by 7 percent. Net sales for the segment benefited from strong growth in the saltwater fishing category, due in part to the impact of new products and of hurricane activity on 2017 results. Net sales growth excluding Sport Yacht and Yacht operations was solid for the recreational fiberglass category, led by continued sales growth for Sea Ray Sport Boats and Cruisers. Aluminum freshwater reported solid growth as strong sales increases in pontoon boats were partially offset by continued weakness at Lowe due to the transition of distribution away from Cabela's and lower sales into Canada due to the impact of retaliatory tariffs on wholesale shipments. Global wholesale boat shipments were down, but sales increases were aided by higher average selling prices as customers continued to migrate to boats with more content and higher horsepower engines, as well as growth in premium brands, which outpaced the performance of value product lines. In addition, price increases were implemented in response to cost inflation, particularly in aluminum fishing boats and pontoons. International net sales were 24 percent of the segment's net sales in 2018, a decrease of 6 percent from the prior year on a GAAP basis. On a constant currency basis and excluding Sport Yacht and Yacht operations, international net sales decreased 3 percent when compared with the same prior year period, mainly due to declines in Rest-of-World regions.
Boat segment operating earnings decreased in 2018 when compared with the prior year, including positive timing benefits from the adoption and implementation of the new revenue standard. The decrease was the result of losses from Sport Yacht and Yacht operations which included wind-down activities and higher restructuring, exit, integration and impairment charges. The other businesses posted an overall increase in earnings, benefitting from increased sales and a favorable impact from changes in product mix.
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2017 vs. 2016
Boat segment net sales increased in 2017 versus 2016. The increase included the impact of Sport Yacht and Yacht operations, which negatively impacted sales comparisons by 5 percent. Excluding Sport Yacht and Yacht operations, Boat segment sales benefited from strong growth in all three primary boat categories and reflected growth in both domestic and international markets. Net sales benefited from increased global wholesale unit shipments as well as higher average selling prices, as customers continued to migrate to boats with more content and higher horsepower engines. An acquisition completed in 2016 accounted for 1 percentage point of the Boat segment's overall revenue growth rate in 2017. International net sales were 25 percent of the segment's net sales in 2017, an increase of 10 percent from the prior year on a GAAP basis. On a constant currency basis and excluding acquisitions and Sport Yacht and Yacht operations, international net sales increased 11 percent when compared with the same prior year period, mainly due to net sales increases in Canada and Europe.
Boat segment operating earnings decreased in 2017 when compared with 2016. The decrease was the result of losses from Sport Yacht and Yacht operations, reflecting higher restructuring, exit, integration and impairment charges and weaker operating performance. These factors more than offset earnings improvements from the rest of the businesses, which benefited from higher sales and margin gains, partially stemming from improved operating efficiencies.
Fitness Segment
The following table sets forth Fitness segment results for the years ended December 31, 2018, 2017 and 2016:
2018 vs. 2017 | 2017 vs. 2016 | ||||||||||||||||||||||||
(in millions) | 2018 | 2017 | 2016 | $ | % | $ | % | ||||||||||||||||||
Net sales | $ | 1,038.3 | $ | 1,033.7 | $ | 980.4 | $ | 4.6 | 0.4 | % | $ | 53.3 | 5.4 | % | |||||||||||
Restructuring, exit, integration and impairment charges (A) | 25.3 | 30.3 | 12.7 | (5.0 | ) | (16.5 | )% | 17.6 | NM | ||||||||||||||||
Operating earnings (B) | 22.4 | 64.1 | 117.3 | (41.7 | ) | (65.1 | )% | (53.2 | ) | (45.4 | )% | ||||||||||||||
Operating margin (B) | 2.2 | % | 6.2 | % | 12.0 | % | (400) bpts | (580) bpts | |||||||||||||||||
NM = not meaningful
bpts = basis points
(A) | Includes $22.1 million and $13.9 million in 2018 and 2017, respectively, related to Cybex trade name impairments. See Note 4 – Restructuring, Exit, Integration and Impairment Activities in the Notes to Consolidated Financial Statements for further details. |
(B) In 2018 and 2017, the Company's Fitness segment recorded $14.0 million and $13.5 million of non-recurring charges, respectively. The 2018 charges consisted of $3.6 million related to a contract dispute, $3.1 million related to the settlement of supplier obligations, $2.8 million associated with the delayed submission of foreign import duty filings, $2.3 million for a product field campaign and $2.2 million of charges related to the business separation. In 2017, the Fitness segment recorded a $13.5 million charge related to product field campaigns.
2018 vs. 2017
Fitness segment net sales were flat in 2018 compared with 2017 as growth in international markets was offset by declines in domestic sales, particularly of Cybex branded cardio product, and lower sales to value-oriented franchise clubs. This performance also included strong sales in the global commercial strength category due to increased demand resulting from a well-positioned product offering and evolving exerciser preferences. International net sales were 49 percent of the segment's net sales in 2018, and increased 6 percent from the prior year on a GAAP basis. On a constant currency basis, international net sales increased 5 percent, primarily driven by increases in Asia-Pacific and Europe, partially offset by slight declines in Canada.
Fitness segment operating earnings decreased in 2018 as a result of several factors affecting gross margins including inventory cost adjustments primarily related to product transitions, higher freight costs, an unfavorable impact from changes in sales mix and cost inflation and inefficiencies. These factors were partially offset by lower restructuring, exit, integration and impairment charges and higher sales, which included timing benefits from the adoption and implementation of the new revenue standard.
2017 vs. 2016
Fitness segment net sales increased in 2017 when compared with 2016 due primarily to growth in international markets including benefits from the ICG acquisition. Growth in sales to value-oriented franchise clubs continues to be offset by declines in sales to traditional clubs and certain vertical markets. Acquisitions completed in 2016 accounted for 3 percentage points of growth in 2017. International net sales were 46 percent of the segment's net sales in 2017 and increased 9 percent compared with
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the prior year on both a GAAP basis and on a constant currency basis due to strength across most international markets, especially Asia-Pacific and Europe, partially offset by slight declines in Canada.
Fitness segment operating earnings decreased in 2017 when compared with the prior year resulting from lower margins, reflecting several factors, including higher restructuring, exit, integration and impairment charges, costs associated with product field campaigns for certain Cybex products, higher costs including freight, particularly in the fourth quarter, the impact of planned costs associated with capacity expansions and new products, more challenging competitive dynamics in certain international markets and unfavorable changes in sales mix, partially offset by higher sales and cost reduction initiatives.
Corporate/Other
The following table sets forth Corporate/Other results for the years ended December 31, 2018, 2017 and 2016:
2018 vs. 2017 | 2017 vs. 2016 | ||||||||||||||||||||||||
(in millions) | 2018 | 2017 | 2016 | $ | % | $ | % | ||||||||||||||||||
Restructuring, exit, integration and impairment charges (A) | $ | 1.5 | $ | 2.4 | $ | 2.3 | $ | (0.9 | ) | (37.5 | )% | $ | 0.1 | 4.3 | % | ||||||||||
Operating loss (B) | (97.3 | ) | (82.4 | ) | (77.0 | ) | (14.9 | ) | (18.1 | )% | (5.4 | ) | (7.0 | )% | |||||||||||
(A) | See Note 4 – Restructuring, Exit, Integration and Impairment Activities in the Notes to Consolidated Financial Statements for further details. |
(B) | Includes $17.1 million of costs related to the planned Fitness business separation. |
Corporate operating expenses increased in 2018 compared with 2017 primarily due to costs related to the planned Fitness business separation. Comparisons also reflect lower restructuring, exit, integration and impairment charges. Corporate expenses increased in 2017 compared with 2016 primarily due to project and other growth initiative related spending, including investments in technology solutions and IT enhancements.
Cash Flow, Liquidity and Capital Resources
The following table sets forth an analysis of free cash flow for the years ended December 31, 2018, 2017 and 2016:
(in millions) | 2018 | 2017 | 2016 | ||||||||
Net cash provided by operating activities of continuing operations | $ | 337.0 | $ | 401.6 | $ | 439.1 | |||||
Net cash provided by (used for): | |||||||||||
Plus: Capital expenditures | (193.4 | ) | (203.2 | ) | (193.9 | ) | |||||
Plus: Proceeds from the sale of property, plant and equipment | 6.7 | 8.5 | 1.9 | ||||||||
Plus: Effect of exchange rate changes on cash and cash equivalents | (5.0 | ) | 6.9 | 0.1 | |||||||
Less: Cash paid for Fitness business separation costs, net of tax | (9.8 | ) | — | — | |||||||
Less: Cash impact of Sport Yacht and Yacht operations, net of tax | (53.7 | ) | (10.9 | ) | (20.6 | ) | |||||
Total free cash flow from continuing operations (A) | $ | 208.8 | $ | 224.7 | $ | 267.8 | |||||
(A) The Company defines “Free cash flow” as cash flow from operating and investing activities of continuing operations (excluding cash provided by or used for acquisitions, investments, purchases or sales/maturities of marketable securities and other investing activities, as well as cash paid for Fitness business separation costs, net of tax, and the cash impact of Sport Yacht and Yacht operations, net of tax) and the effect of exchange rate changes on cash and cash equivalents. Free cash flow is not intended as an alternative measure of cash flow from operations, as determined in accordance with GAAP in the United States. The Company uses this financial measure both in presenting its results to shareholders and the investment community and in its internal evaluation and management of its businesses. Management believes that this financial measure and the information it provides are useful to investors because it permits investors to view Brunswick’s performance using the same tool that management uses to gauge progress in achieving its goals. Management believes that the non-GAAP financial measure “Free cash flow” is also useful to investors because it is an indication of cash flow that may be available to fund investments in future growth initiatives.
Brunswick’s major sources of funds for capital investments, acquisitions, share repurchase programs and dividend payments are cash generated from operating activities, available cash and marketable securities balances and potential borrowings. The Company evaluates potential acquisitions, divestitures and joint ventures in the ordinary course of business.
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2018 Cash Flow
In 2018, net cash provided by operating activities of continuing operations totaled $337.0 million. The primary driver of the cash provided by operating activities was net earnings from continuing operations net of non-cash expense items. Additionally, the Company made discretionary pension contributions of $163.8 million to its qualified and nonqualified defined benefit plans. An increase in working capital had a negative effect on net cash provided by operating activities. Working capital is defined as Accounts and notes receivable, Inventories and Prepaid expenses and other, net of Accounts payable and Accrued expenses as presented in the Consolidated Balance Sheets excluding the impact of acquisitions. Net inventories increased by $84.2 million, primarily driven by increases in the Marine Engine segment due to increased production associated with new outboard products. Accounts receivable increased by $27.3 million as a result of strong year-over-year sales increases in the fourth quarter in the Company's Marine Engine segment. Partially offsetting these items were increases in Accounts payable of $49.3 million, mostly related to higher expenditures in the Marine Engine segment to support higher production, and Accrued expenses of $13.7 primarily due to customer rebates attributable to increased sales volume.
Net cash used for investing activities of continuing operations during 2018 totaled $1,107.3 million, which included cash paid for the acquisition of Power Products, net of cash acquired, of $909.6 million. See Note 5 – Acquisitions in the Notes to Consolidated Financial Statements for further details on the Power Products acquisition. In addition, capital expenditures totaled $193.4 million. The Company's capital spending focused on investments in new products as well as capacity expansion initiatives, mostly in the marine segments. Net cash used for investing activities also included $10.8 million of investments which primarily related to the Company's marine joint ventures.
Net cash provided by financing activities was $620.5 million during 2018. The cash inflow was mainly due to $793.5 million of net proceeds from debt activity in connection with the Power Products acquisition, partially offset by common stock repurchase activity and cash dividends paid to common shareholders. Refer to Note 17 – Debt in the Notes to Consolidated Financial Statements for further details on the Company's debt activity.
2017 Cash Flow
In 2017, net cash provided by operating activities of continuing operations totaled $401.6 million. The primary driver of the cash provided by operating activities was net earnings from continuing operations net of non-cash expense items. An increase in working capital had a negative effect on net cash provided by operating activities. Net inventories increased by $69.7 million to support higher sales volumes and Accounts receivable increased by $57.2 million as a result of strong year-over-year sales increases in the fourth quarter. Partially offsetting these items were increases in Accrued expenses of $47.1 million and Accounts payable of $31.0 due to higher expenditure levels and timing of payments.
Net cash used for investing activities of continuing operations during 2017 totaled $178.9 million, which included capital expenditures of $203.2 million. The Company's capital spending was focused on new product introductions, capacity expansion and other profit enhancing projects in all segments. Cash paid for the acquisition of Lankhorst Taselaar, net of cash acquired, was $15.5 million. Net cash used for investing activities also included $35.0 million of maturities of marketable securities and Proceeds from the sale of Property, plant and equipment of $8.5 million.
Cash flows used for financing activities of continuing operations were $203.7 million during 2017 and included common stock repurchases and cash dividends paid to common stock shareholders.
2016 Cash Flow
In 2016, net cash provided by operating activities of continuing operations totaled $439.1 million. The primary driver of the cash provided by operating activities was net earnings from continuing operations net of non-cash expense items. An increase in working capital had a negative effect on net cash provided by operating activities. Net inventories increased by $48.2 million due to increases in production to support higher sales volumes. Accrued expenses decreased $20.8 million which included the impact of the payments of deferred compensation in connection with executive management transitions. Partially offsetting these items was an increase in Accounts payable of $39.2 million, which was partially due to the timing of payments.
Net cash used for investing activities of continuing operations during 2016 totaled $486.0 million, which included capital expenditures of $193.9 million. The Company's capital spending was focused on new product introductions, capacity expansion projects in all segments and other high priority, profit-enhancing projects. Cash paid for acquisitions, net of cash acquired, totaled $276.1 million. Additionally, the Company had net purchases of marketable securities of $24.3 million during the year.
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Cash flows used for financing activities of continuing operations were $185.8 million during 2016 and included common stock repurchases and cash dividends paid to common stock shareholders.
Liquidity and Capital Resources
The Company views its highly liquid assets as of December 31, 2018 and 2017 as:
(in millions) | 2018 | 2017 | |||||
Cash and cash equivalents | $ | 294.4 | $ | 448.8 | |||
Short-term investments in marketable securities | 0.8 | 0.8 | |||||
Total cash, cash equivalents and marketable securities | $ | 295.2 | $ | 449.6 | |||
The following table sets forth an analysis of Total liquidity as of December 31, 2018 and 2017:
(in millions) | 2018 | 2017 | |||||
Cash, cash equivalents and marketable securities | $ | 295.2 | $ | 449.6 | |||
Amounts available under lending facilities(A) | 396.1 | 295.7 | |||||
Total liquidity (B) | $ | 691.3 | $ | 745.3 | |||
(A) See Note 17 – Debt in the Notes to Consolidated Financial Statements for further details on the Company's lending facility.
(B) The Company defines Total liquidity as Cash and cash equivalents and Short-term investments in marketable securities as presented in the Condensed Consolidated Balance Sheets, plus amounts available for borrowing under its lending facilities. Total liquidity is not intended as an alternative measure to Cash and cash equivalents and Short-term investments in marketable securities as determined in accordance with GAAP in the United States. The Company uses this financial measure both in presenting its results to shareholders and the investment community and in its internal evaluation and management of its businesses. Management believes that this financial measure and the information it provides are useful to investors because it permits investors to view the Company’s performance using the same metric that management uses to gauge progress in achieving its goals. Management believes that the non-GAAP financial measure “Total liquidity” is also useful to investors because it is an indication of the Company’s available highly liquid assets and immediate sources of financing.
Cash, cash equivalents and marketable securities totaled $295.2 million as of December 31, 2018, a decrease of $154.4 million from $449.6 million as of December 31, 2017. Total debt as of December 31, 2018 and December 31, 2017 was $1,220.8 million and $437.4 million, respectively. The Company's debt-to-capitalization ratio increased to 43.5 percent as of December 31, 2018, from 22.8 percent as of December 31, 2017.
The Company secured short-term and long-term financing during 2018 in connection with the Power Products acquisition. Additionally, the Company amended and restated its existing credit agreement, increasing the borrowing capacity by $100 million and extending the credit agreement through September 2023. Management believes that the Company has adequate sources of liquidity to meet the Company's short-term and long-term needs. Refer to Note 17 – Debt in the Notes to Consolidated Financial Statements for further details on the Company's borrowing activity in 2018.
The Company has executed share repurchases against authorizations approved by the Board of Directors in 2014 and 2016. In 2018, the Company repurchased $75.0 million of stock under these authorizations and as of December 31, 2018, the remaining authorization was $34.8 million.
The Company contributed $160.0 million and $70.0 million to its qualified defined benefit pension plans in 2018 and 2017, respectively. The Company also contributed $3.8 million and $3.7 million to fund benefit payments from its nonqualified defined benefit pension plan in 2018 and 2017, respectively.
The aggregate funded status of the Company's qualified defined benefit pension plans, measured as a percentage of the projected benefit obligation, was approximately 103 percent at December 31, 2018 compared with approximately 80 percent at December 31, 2017. As of December 31, 2018, the Company's qualified defined benefit pension plans were over-funded on an aggregate projected benefit obligation basis by $18.4 million which represented a $156.0 million improvement from 2017. This improvement was mostly due to contributions of $160.0 million in 2018. As of December 31, 2018, the Company was left with a residual pre-tax funding requirement estimated to be between $15 million and $25 million to fully exit the plans. The Company plans to fully exit its defined benefit pension plans in 2019 and will incur charges in connection with this action, including the recognition of actuarial losses as well as certain income tax consequences.
See Note 18 – Postretirement Benefits in the Notes to Consolidated Financial Statements for more details.
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Capital Plan
The Company is projecting an increase in net earnings in 2019 when compared with 2018. Net activity in working capital is projected to reflect a usage of cash in 2019 in the range of $10 million to $30 million. Additionally, the Company is planning for capital expenditures of approximately $240 million to $260 million, including investments in capacity and new products, as well as certain cash payments in 2019 that relate to 2018 activities. Including these and other factors, the Company plans to generate free cash flow in 2018 in excess of $320 million, with approximately $20 million attributable to the Company's Fitness segment.
The Company plans on reducing debt by at least $150 million to $200 million primarily in the second half of 2019, with estimated interest expense in the range of $65 million to $70 million. Upon completion of the Fitness business separation, the Company will re-assess its debt retirement objectives and share repurchase activities. The 2019 capital plan does not incorporate the utilization of any net proceeds the Company may receive in connection with the Fitness business separation.
Including the previously described planned debt actions in 2019, the Company plans to substantially reduce all of its near-term maturity debt (maturities 2023 and prior) by the end of 2021. The reduction will be funded primarily through free cash flow, potentially augmented by proceeds from the Fitness business separation.
Quarterly dividend payments in the 2019 plan are anticipated to be $0.21 per share, consistent with current levels. However, the Company may adjust these levels as it evaluates opportunities to grow dividends.
The Company plans to fully exit its qualified defined benefit pension plans in 2019, which will require a residual pre-tax contribution of approximately $15 million to $25 million.
The Company expects its cash tax rate to be in the high-single digit percentage range in 2019.
Financial Services
Refer to Note 11 – Financing Joint Venture in the Notes to Consolidated Financial Statements for more information about the Company's financial services.
Off-Balance Sheet Arrangements
Guarantees. The Company has reserves to cover potential losses associated with guarantees and repurchase obligations based on historical experience and current facts and circumstances. Historical cash requirements and losses associated with these obligations have not been significant. See Note 14 – Commitments and Contingencies in the Notes to Consolidated Financial Statements for a description of these arrangements.
Contractual Obligations
The following table sets forth a summary of the Company's contractual cash obligations as of December 31, 2018:
Payments due by period | |||||||||||||||||||
(in millions) | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||||||
Contractual Obligations | |||||||||||||||||||
Debt (A) | $ | 1,240.5 | $ | 41.3 | $ | 383.4 | $ | 340.5 | $ | 475.3 | |||||||||
Interest payments on long-term debt | 163.5 | 26.2 | 52.3 | 38.5 | 46.5 | ||||||||||||||
Operating leases (B) | 153.4 | 40.3 | 58.8 | 31.4 | 22.9 | ||||||||||||||
Purchase obligations (C) | 211.6 | 209.1 | 2.4 | 0.1 | — | ||||||||||||||
Deferred management compensation (D) | 37.2 | 9.7 | 8.0 | 6.0 | 13.5 | ||||||||||||||
Other long-term liabilities (E) | 154.9 | 15.7 | 85.3 | 32.7 | 21.2 | ||||||||||||||
Total contractual obligations | $ | 1,961.1 | $ | 342.3 | $ | 590.2 | $ | 449.2 | $ | 579.4 | |||||||||
(A) | See Note 17 – Debt in the Notes to Consolidated Financial Statements for additional information on the Company's debt. “Debt” refers to future cash principal payments. Debt also includes the Company's capital leases as discussed in Note 22 – Leases in the Notes to Consolidated Financial Statements. |
(B) | See Note 22 – Leases in the Notes to Consolidated Financial Statements for additional information. |
(C) | Purchase obligations represent agreements with suppliers and vendors as part of the normal course of business. |
(D) | Amounts primarily represent long-term deferred compensation plans for Company management. |
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(E) | Other long-term liabilities primarily includes deferred revenue and future projected payments related to the Company's nonqualified pension plans. The Company is not required to make contributions to the qualified pension plan in 2019. |
Legal Proceedings
See Note 14 – Commitments and Contingencies in the Notes to Consolidated Financial Statements for disclosure related to certain legal and environmental proceedings.
Environmental Regulation
In its Marine Engine segment, Brunswick continues to develop engine technologies to reduce engine emissions to comply with current and future emissions requirements. The Boat segment continues to pursue fiberglass boat manufacturing technologies and techniques to reduce air emissions at its boat manufacturing facilities. The costs associated with these activities may have an adverse effect on segment operating margins and may affect short-term operating results. Environmental regulatory bodies in the United States and other countries may impose more stringent emissions standards and/or other environmental regulatory requirements than are currently in effect. Using its environmental management system processes, the Company complies with current regulations and expects to comply fully with any new regulations; compliance will most likely increase the cost of these products for the Company and the industry, but is not expected to have a material adverse effect on Brunswick's competitive position.
Critical Accounting Policies
The preparation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the amount of reported assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the periods reported. Actual results may differ from those estimates. If current estimates for the cost of resolving any specific matters are later determined to be inadequate, results of operations could be adversely affected in the period in which additional provisions are required. The Company has discussed the development and selection of the critical accounting policies with the Audit Committee of the Board of Directors and believes the following are the most critical accounting policies that could have an effect on Brunswick's reported results.
Revenue Recognition and Sales Incentives. Revenue is recognized as performance obligations under the terms of contracts with customers are satisfied; this occurs when control of promised goods (engines, engine parts and accessories, boats, and fitness equipment) is transferred to the customer. The Company recognizes revenue related to the sale of extended warranty contracts that extend the coverage period beyond the standard warranty period over the life of the extended warranty period.
Revenue is measured as the amount of consideration expected to be entitled in exchange for transferring goods or providing services. The Company has excluded sales, value add, and other taxes collected concurrent with revenue-producing activities from the determination of the transaction price for all contracts. The Company has elected to account for shipping and handling activities that occur after the customer has obtained control of a good as a fulfillment activity. For all contracts with customers, the Company has not adjusted the promised amount of consideration for the effects of a significant financing component as the period between the transfer of the promised goods and the customer's payment is expected to be one year or less.
See Note 2 – Revenue Recognition in the Notes to Consolidated Financial Statements for more information.
Warranty Reserves. The Company records an estimated liability for product warranties at the time revenue is recognized. The liability is estimated using historical warranty experience, projected claim rates and expected costs per claim. The Company adjusts its liability for specific warranty matters when they become known and the exposure can be estimated. The Company's warranty liabilities are affected by product failure rates as well as material usage and labor costs incurred in correcting a product failure. If actual costs differ from estimated costs, the Company must make a revision to the warranty liability.
Goodwill. Goodwill results from the excess of purchase price over the net assets of businesses acquired. All three of the Company's reporting units, which are also the Company's reportable segments, have a goodwill balance.
The Company reviews goodwill for impairment annually and whenever events or changes in circumstances indicate that the fair value of a reporting unit may be below its carrying value. As part of the annual test, the Company may perform a qualitative, rather than quantitative, assessment to determine whether the fair values of its reporting units are “more likely than not” to be greater than their carrying values. In performing this qualitative analysis, the Company considers various factors, including the effect of market or industry changes and the reporting units' actual results compared to projected results.
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If the fair value of a reporting unit does not meet the "more likely than not" criteria discussed above, the impairment test for goodwill is a quantitative, two-step process. The first step compares the fair value of the reporting unit with its carrying value. If the fair value exceeds the carrying value, goodwill is not considered impaired. If the carrying amount exceeds the fair value, the second step is performed to measure the amount of the impairment loss, if any. In this second step, the implied fair value goodwill is compared with the carrying amount of the goodwill. If the carrying amount of the goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill.
The Company calculates the fair value of its reporting units considering both the income approach and the guideline public company method. The income approach calculates the fair value of the reporting unit using a discounted cash flow approach utilizing a Gordon Growth model. Internally forecasted future cash flows, which the Company believes reasonably approximate market participant assumptions, are discounted using a weighted average cost of capital (Discount Rate) developed for each reporting unit. The Discount Rate is developed using market observable inputs, as well as considering whether or not there is a measure of risk related to the specific reporting unit’s forecasted performance. Fair value under the guideline public company method is determined for each unit by applying market multiples for comparable public companies to the unit’s financial results.
For 2018 and 2017, the goodwill impairment test for the Fitness reporting unit was a two-step process. As of the Company’s annual goodwill impairment testing date on October 1, 2018, the estimated fair value of the Fitness reporting unit was approximately 19 percent in excess of its carrying value, which included goodwill of $390.8 million. The fair value determination includes several inputs which require significant management assumptions. The most significant management assumptions that impact the estimated fair value of the reporting unit are the projected results and the Discount Rate assumption. The projected results include improvements in operating performance versus 2018, particularly expanded gross margins which are predicated upon several factors, including the successful execution of cost reduction initiatives, along with increased sales. A 100 basis point increase in the Discount Rate assumption would lower the excess spread over fair value by approximately 8.0 percent. While the Company believes the current projections and the discount rate assumption are reasonable, the Fitness business' ability to expand gross margins or grow sales in line with projections could be negatively affected by its ability to execute the planned actions underlying the forecasted improvement in its performance as well as market conditions. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the impairment test will prove to be an accurate prediction of the future. To the extent future operating results differ from those in our current forecast, or if the assumptions underlying the Discount Rate change, it is possible that an impairment charge could be recorded.
In addition, Brunswick is currently working to separate the Fitness business, which could involve either a spin-off or a sale transaction. It is possible that the public markets or potential buyers may value the standalone business differently upon a spin-off or in the event of a sale. It is not possible to predict what the valuation outcome will be and how the facts and circumstances at the time will influence the Brunswick Board of Directors’ final decision on the method of separation.
As of December 31, 2018, the goodwill balance for the Fitness reporting unit was $389.8 million, and represents the maximum potential goodwill impairment.
For 2018, 2017 and 2016, with the exception of the Fitness reporting unit in the two periods discussed above, the Company's reporting units met the "more likely than not" criteria; as a result, the Company was not required to perform the quantitative impairment test.
The Company did not record any goodwill impairments in 2018, 2017 or 2016.
Other intangible assets. The Company's primary intangible assets are customer relationships and trade names acquired in business combinations. Intangible assets are initially valued using a methodology commensurate with the intended use of the asset. The customer relationships including those acquired in the Power Products acquisition, which constitute the majority of the Company's customer relationships, were valued using the an income approach, specifically the multi-period excess earnings method (MPEEM). The fair value of trade names, including the Power Products trade names, is measured using a relief-from-royalty (RFR) approach, which assumes the value of the trade name is the discounted cash flows of the amount that would be paid to third parties had the Company not owned the trade name and instead licensed the trade name from another company. Higher royalty rates are assigned to premium brands within the marketplace based on name recognition and profitability, while other brands receive lower royalty rates. The basis for future sales projections for both the RFR and MPEEM are based on internal revenue forecasts by brand, which the Company believes represent reasonable market participant assumptions. The future cash flows are discounted using an applicable Discount Rate as well as any potential risk premium to reflect the inherent risk of holding a standalone intangible asset.
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The key uncertainties in the RFR and MPEEM calculations, as applicable, are: assumptions used in developing internal revenue growth and customer expense forecasts, assumed customer attrition rates, the selection of an appropriate royalty rate, as well as the perceived risk associated with those forecasts in determining the Discount Rate.
The costs of amortizable intangible assets are recognized over their expected useful lives, typically between three and sixteen years, using the straight-line method. Intangible assets that are subject to amortization are evaluated for impairment using a process similar to that used to evaluate long-lived assets described below. Intangible assets not subject to amortization are assessed for impairment at least annually and whenever events or changes in circumstances indicate that it is more likely than not that an asset may be impaired. The impairment test for indefinite-lived intangible assets consists of a comparison of the fair value of the intangible asset with its carrying amount. An impairment loss is recognized for the amount by which the carrying value exceeds the fair value of the asset.
For the years ended December 31, 2018 and 2017, the Company recorded $22.1 million and $13.9 million, respectively, of indefinite-lived intangible asset impairments related to the Cybex trade name. As a result of changes in operating strategy in 2018, the Cybex trade name was deemed to be a definite-lived intangible asset, with $2.6 million remaining within Other intangibles, net to be fully amortized by December 31, 2020. Refer to Note 4 – Restructuring, Exit, Integration and Impairment Activities for further details. The Company did not record impairments for indefinite-lived intangible assets in 2016.
Refer to Note 5 – Acquisitions and Note 12 – Goodwill and Other Intangibles in the Notes to Consolidated Financial Statements for more information.
Long-Lived Assets. The Company continually evaluates whether events and circumstances have occurred that indicate the remaining estimated useful lives of its definite-lived intangible assets--excluding goodwill and indefinite-lived trade names--and other long-lived assets may warrant revision or that the remaining balance of such assets may not be recoverable. Once an impairment indicator is identified, the Company tests for recoverability of the related asset group using an estimate of undiscounted cash flows over the remaining asset group's life. If an asset group's carrying value is not recoverable, the Company records an impairment loss based on the excess of the carrying value of the asset group over the long-lived asset group's fair value. Fair value is determined using observable inputs, including the use of appraisals from independent third parties, when available, and, when observable inputs are not available, fair value is based on the Company's assumptions of the data that market participants would use in pricing the asset or liability, based on the best information available in the circumstances. Specifically, the Company uses discounted cash flows to determine the fair value of the asset when observable inputs are unavailable. The Company tested its long-lived asset balances for impairment as indicators arose during 2018, 2017 or 2016, resulting in impairment charges of $13.1 million, $31.0 million and $2.4 million, respectively, which are recognized in either Restructuring, integration and impairment charges or Selling, general and administrative expense in the Consolidated Statements of Operations.
Income Taxes. Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting using tax rates in effect for the years in which the differences are expected to reverse. The Company evaluates the realizability of net deferred tax assets and, as necessary, records valuation allowances against them. The Company estimates its tax obligations based on historical experience and current tax laws and litigation. The judgments made at any point in time may change based on the outcome of tax audits and settlements of tax litigation, as well as changes due to new tax laws and regulations and the Company's application of those laws and regulations. These factors may cause the Company's tax rate and deferred tax balances to increase or decrease. See Note 13 – Income Taxes in Notes to Consolidated Financial Statements for further details.
Recent Accounting Pronouncements
See Note 1 – Significant Accounting Policies in the Notes to Consolidated Financial Statements for the recent accounting pronouncements that have been adopted during the year ended December 31, 2018, or will be adopted in future periods.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risk from changes in foreign currency exchange rates, commodity prices and interest rates. The Company enters into various hedging transactions to mitigate certain of these risks in accordance with guidelines established by the Company's management. The Company does not use financial instruments for trading or speculative purposes.
The Company uses foreign currency forward and option contracts to manage foreign exchange rate exposure related to anticipated transactions, and assets and liabilities that are subject to risk from foreign currency rate changes. The Company's principal currency exposures mainly relate to the Euro, Japanese Yen, Canadian dollar, Australian dollar, Brazilian Real, and the British Pound. The Company hedges certain anticipated transactions with financial instruments whose maturity date, along with the realized gain or loss, occurs on or near the execution of the anticipated transaction. The Company manages foreign currency