Apr 24, 2008
Executives
Kathryn Chieger - VP, Corporate and IR Dustan E. McCoy - Chairman and CEO Peter G.
Leemputte - Sr. VP and CFO
Analysts
Timothy Conder - Wachovia Capital Markets, Llc Edward Aaron - RBC Capital Markets Joseph Hovorka - Raymond James Chris Hussey - Goldman Sachs Hakan Ipekci - Merrill Lynch Laura Richardson - BB&T Capital Markets Steven Rees - JPMorgan Hayley Wolff - Rochdale Securities Eli Lapp - Morgan Stanley
Operator
Good morning and welcome to Brunswick Corporation's 2008 First Quarter Earnings Conference Call. All participants will be in a listen-only mode, until the question-and-answer period.
Today's meeting will be recorded. If you have any objections, you may disconnect at this time.
I would now like to introduce Kathryn Chieger, Vice President of Corporate and Investor Relations. Thank you.
You may begin.
Kathryn Chieger - Vice President, Corporate and Investor Relations
Good morning and thank you for joining us today. With me are Dustan McCoy, Brunswick's Chairman and CEO; and Pete Leemputte, our CFO.
Before we begin our remarks, let me remind everyone that during this call our comments will include certain forward-looking statements about our future results. Please keep in mind that our actual results could differ materially from expectations as of today.
For the details on the factors to consider, please look at our 10-K for 2007 which is available on request or by going to our website, at brunswick.com. We appreciate your taking time to be with us this morning, and given that we are in a busy earnings reporting season, we'll try to keep our remarks brief and wrap you the call in about 45 minutes.
Now I would like to turn the call over to Dusty.
Dustan E. McCoy - Chairman and Chief Executive Officer
Thank you Kathryn, and thanks to all who have joined this call today. As most of you have already seen, we have reported earnings of $0.15 per share for the first quarter and down 61% from the $0.38 we earned in the first quarter of 2007.
There are a few significant puts and takes in these figures that Pete will detail in a minute. As you will see, even excluding these items, this is a solid financial performance, given the difficult economic conditions impacting our consumers and the resulting very weak marine markets that we are facing.
Preliminary industry reports show the retail demand for boats fell by about 17% in the first quarter compared to 2007. As we've seen for the past year, the decline is more pronounced in the fiberglass segment at 20% than it is in the aluminum, which is down 13%.
I'll give some more color in a few minutes, but in any measure, the U.S marine industry is experiencing an unprecedented downturn, driven by adverse economic conditions. Against this setting, our financial performance is very good this quarter.
This is due to the remarkable work of my 26,000 fellow employees at Brunswick and I thank each of them for their outstanding performance. I will now turn the call over to Pete, after which I'll wrap up our prepared remarks for this morning with further details about markets, along with some comments about our continuing efforts to position the company for the ultimate marine recovery.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Thanks Dusty and good morning everyone. As Dusty just mentioned, our earnings for the past quarter showed $0.15 per share, down from $0.38 in 2007.
There are a number of factors outside of our usual operating performance that affected the year-over-year comparison, including two divestitures, restructuring charges and special tax items. Let me first review these briefly.
During the quarter, we sold our 50% interest in MBK our Japanese bowling joint venture through our partner Mitsui. MBK sell bowling products to the Japanese markets and operated 14 bowling centers there.
The inherent value of this business within retail real estate, not profits from ongoing operation; and as a result, we felt that it was to liquidate our investments by establishing new independent distribution for bowling products. The transaction resulted in a $0.10 per share gain during the quarter.
Most importantly, it brought in $40 million in gross cash proceeds, $37 million after all costs for the transaction and taxes. We will be able to mitigate most cash taxes on the sale using capital loss carry forwards associated with last year's divestiture of Brunswick's new technologies.
We also recorded a $0.07 per share loss in the first quarter from the planned sale of Baja, our performance boat brand to Fountain boats. The combination allows for boat brands to achieve greater scale advantages in production.
We have signed a Letter of Intent and expect to close in the second quarter, with a further $0.03 to $0.05 per share loss to cover severance in closing costs. Consideration from Fountain will be in the form of a new supply agreement, whereby Mercury will continue to sell engines to Baja.
These engine sales are profitable for Brunswick. Please note that almost all the Baja charges are non-cash.
Excluding the impact of the MBK and Baja transactions, earnings totaled $0.12 per diluted share in the first quarter. That compares to $0.35 last year, excluding $0.03 in special tax items.
Beyond the divestitures, we also recognized restructuring charges of over $13 million or $0.09 per share in the first quarter, compared to $0.06 last year. The $13 million is composed of severance costs, asset impairments and other planned closure costs.
In total, about two-thirds of these pretax restructuring charges are cash costs. Also note that roughly 40% of the $13 million was incurred by Boat Group and other 40% at Bowling & Billiards.
Both Mercury and corporate each accounted for about 10%. Overall sales in the first quarter fell by 3% to $1.35 billion.
Revenues from our domestic businesses were down 10%, led by a 13% drop at our marine operations. While we posted domestic sales growth of both Life Fitness and Bowling & Billiards, we saw sharp declines across most of our consumer-oriented businesses.
At Like Fitness, U.S consumer equipment sales to specialty retailers fell by 30%, while at Billiards sales were up 22%. It was commercial equipment at Life Fitness in our bowling retail and bowling product businesses that accounted for the U.S.
sales growth of the two non-marine segments. Partially offsetting the U.S decline was 11% top-line growth in markets outside the U.S.
The weak dollar was the biggest driver while higher shipments were also at work. Given increased exports from the U.S it is proving difficult to book boat containers and deck space for the shipment of our products overseas in recent months.
That will prove critical to maintain the international sales growth, as we move through 2008. In the first quarter, 39% of our sales were outside the U.S, as compared to 34% last year.
Operating margins stood at 0.8%, down over 300 basis points versus the first quarter of 2007. Gross margins fell by 170 basis points, loss and disposals, restructuring and impairment costs added another 105 basis points to the margin drop and operating expenses measured on a percentage of sales basis, were up by about 25 basis points.
About half of the gross margin declines measured in percent of sales is attributable to lower fixed cost absorption at our marine businesses. Production was down in an excess of 20% on a unit basis for our key fiberglass boat brands and for stern-drive engines.
The remainder of the drop in gross margins is due to a number of factors. There is a mix shift towards lower margin outboard engines and outboard-powered boats along with higher freight costs and ever-increasing fuel prices.
You may recall that we saw a much sharper decline in the outboard boat and engine businesses, back in 2005 when the current marine downturn began. Stern-drive engines and the fiberglass boats with power have been on a steeper decline in the more recent past, as the recession kicked in for larger and more expensive boats.
Operating expenses, excluding restructuring charges, while up slightly on a percentage of sales basis, actually were down by $3 million in the first quarter. After taking into account a bad debt charge at our bowling products business and the impact of the weaker dollar, spending fell by about 4% versus 2007.
Excluding inflation, real spending was down over about 7%. Lower variable compensation accruals were one factor, but our cost-reduction efforts are also at work.
We will continue to take actions to reduce spending in the typical market environment. From an overall perspective, I should mention that price increases did not completely cover inflation in raw material, labor, medical and overhead costs, also contributing to the operating margin degradation.
Taking a quick look at our segment results; you can see that the Boat Group suffered a pretax loss of just under $15 million in the quarter. The Baja divestiture along with restructuring charges, reduced earnings by about $14 million.
Lower sales volumes and unfavorable fixed cost absorption also played a key role. Revenues fell by 9% as we continue to reduce production to drive down dealer pipeline inventories.
The industry decline in retail unit limited further progress however, as pipelines stood at 35 weeks up one week versus the prior year. Importantly though, dealers had [ph] 2,800 fewer boats at the end of March compared to last year.
Higher inflationary pressures also affected the Boats Group's profit as did higher R&D spending for new and larger models, although the impact was softened by reduced discounting at several brands compared to the prior year. Mercury saw operating margins drop by 60 basis points to 5.5% on a 1% drop in sales.
While domestic stern-drive revenues were down double-digits, international engine sales grew by 12% and now account for 43% of Mercury's total business. This factor, along with a greater concentration of parts and accessory sales drove the lower decline in Mercury's revenue versus the Boat Group.
In our Fitness segment, profits were flat on a 3% sales increase, a slower growth rate than we had posted over the last few years. As I mentioned earlier, the 30% drop in the U.S.
consumer equipment sales was the primary driver. Excluding the domestic consumer business, Life Fitness sales were up 9% led by U.S commercial equipment shipments.
We have seen great acceptance of new products, most notably the elevation treadmills and cross trainers and will be launching new bikes shortly to complete our new cardio line up. Finally, at Bowling & Billiards, sales were up 7%.
We saw double-digit growth on the timing of shipments at bowling products, and 9% growth at our retail bowling operations with the addition of two centers compared to the first quarter of 2007. As I mentioned earlier, lower billiard sales partially offset these sales gains.
Despite the growth in revenue, operating margins fell by 700 basis points to 0.8%. Restructuring expenses, which included impairment and other charges to close our bowling pin plant in Wisconsin, along with the bad debt charge for bowling product equipment, caused the drop.
Excluding these factors, operating margins would have been 8.4%. Turning our attention to the balance sheet and free cash flow, it's clear that we have retained our strong financial position and excellent liquidity.
We ended the first quarter with a cash balance of $267 million up from $204 million, a year ago. Meanwhile our debt-to-capital ratio of 27.6% remains at historic lows as seen over the last decade.
We saw a free cash outflow of about $60 million from continuing operations during the quarter, a normal seasonal trend, but a bit worse than the $53 million outflow in 2007. Reduced sales and earnings are obviously an important driver.
Including our free cash flow this year is $37 million in net proceeds from the sale of our interest in MBK. But let me point out that in the first quarter of 2007, we received a $30 million payments are not to be carried from the 2001 divestiture.
And a net tax refund of $20 million associated with other payments made in 2006. For the favorable cash flow impact from the MBK is largely offset by different non-recurring items from 2007.
Working capital increase by $137 million in the first quarter, compared to $132 million last year. The chief factor is the timing of the company contributions to employees' profit sharing account.
Effective as of January 1st, 2007. We changed our plan from funding on a continual basis throughout the year to making one annual contribution in the first quarter of the following year.
But we find incremental cash outflow of approximately $35 million in the first quarter of 2008, leading to unfavorable working capital performance year-over-year. Excluding this factor, the working capital build would have been $102 million, $30 million lower than in the first quarter of 2007.
Working capital builds are a normal seasonal trend at this time of the year, with receivables' growth from international marine sales and boat and engine inventory build in advance for the current season. Importantly, inventories and receivables for our marine operation actually grew at a lower rate versus 2007, producing a favorable variance in free cash flow of $32 million.
So we have made progress in spite of the weaker marine markets. That being said, we have more work to do with inventories, which stood at $984 million, an increase of $39 million versus March of 2007.
Network inventories are up over $20 million and all of that growth is attributed to operations outside the U.S. While some of them is result of the weaker dollar, we will need to work this down and we will be doing that in the coming quarters.
Also we have $20 million in higher inventories at Hatteras. Three large boat deliveries for international customers got delayed at the end of March, due to the difficulty in securing overseas shipment as I mentioned earlier.
You will also note that we have higher than desired inventories for consumer products at Life Fitness, which will come down as we've reduced orders from Asian suppliers. Inventory reduction remains a key focus for us this year.
Capital expenditures of $28 million year-to-date are down $12 million or nearly 30% versus the prior year. The reductions largely come from our marine businesses.
On a full year basis, we currently anticipate capital spending of $155 million. Although, we likely will increase funds available for land purchases for additional Brunswick Zone XL bowling centers.
Decision on these incremental investments will be made once we secure outside financing for new properties likely through sale we expect from existing bowling properties. Appreciation and amortization expense for 2008 is forecasted at about $190 million.
You will note that we did not repurchase any stock in the quarter. Given the current credit market volatility and the uncertainty in the overall economy, we will continue to build cash balances.
Before turning the call back over to Dusty, let me comment on the 48% effective tax rate seen in the quarter. This was largely influenced by the gain on the MBK transaction.
While there were minimal cash taxes with the deal as I mentioned earlier, we recognized a 54% tax rate for accounting purposes. Excluding the MBK and Baja divestitures and our restructuring action, the effective tax rate stood at 33% in the first quarter.
That will drop later in the year if Congress extends R&D tax credits. Now back to Dusty.
Dustan E. McCoy - Chairman and Chief Executive Officer
Thanks Pete. Let me begin by adding a bit more detail on trends that we are seeing in marine marketplace.
And in early year that fiberglass retail boat demand fell by 20% in the first quarter. This is based on preliminary industry boat registrations as the data for the month of March only includes 24 states, which hover about 55% in the market.
So the trends going into the retail selling seasons are established in our view by these statistics. Within the fiberglass category, the most important profitable segments for Brunswick is fiberglass boats powered by stern-drive engines.
The industry data shows that retail registrations in this segment were down 24% in the first quarter. While no region of the country was immune, the large volume states of Florida, California, and New York were down between 20%, 24% and 50%.
If there is a bright spot in any of this, it is the fact that we have gained significant market share in the important fiberglass category and have done so, without having a discount products at the levels that we were doing so last year. As Pete mentioned, our production of fiberglass boats was down over 20% in the first quarter.
Given these market conditions, we will continue to cut production versus 2007 in the second quarter. All this speaks to the need to continue pursuing efficiency gains that occur in Brunswick as a marine market leader, and as a result of our often-stated strategy.
We closed four boat plants last year and have announced the closure of mothballing of three more in the first quarter; further closures are unlikely. As we close plants, we consolidate boat production and fuel production facilities, an we are now manufacturing multiple brands in several of our plants.
While we would be doing this to obtain a smaller, more flexible manufacturing footprint, regardless of market conditions lower volumes permit us to accelerate implementation a little faster. Gaining greater efficiency by changing our manufacturing footprint has not been limited to our marine operations.
Earlier this year, we announced the closing of our bowling pin plant in Wisconsin. We are now outsourcing pins from another manufacturer.
As we mentioned earlier, we exited the performance boat market while maintaining our profitable supply of racing units. We are asking ourselves, does the steep decline in real disposable income, competition for leisure time and other factors means that demand in other bowling categories will be permanently altered.
We are also asking ourselves for the competitive structure in certain of our marine businesses for close attainment of acceptable profitability. The results included in our case, we will exit targeted brands in our marine portfolio and maximize profitability and shareholder value.
You will see us take further restructuring cost reduction actions as we move through the year. As Pete mentioned, restructuring cost is over $13 million in the first quarter, excluding the Baja divestiture.
Based on our announcements today, an activity already underway, the full year impact will approach $40 million. The new actions may drive restructuring charges even higher, of course will generate a leaner and more efficient organization.
Cost reductions from productivity improvements are important focuses for us. We have aggressive internal targets that we will achieve and exceed over the next several months.
However, we cannot cost cut our way to prosperity. There is potential for growth in segments of the recreational marine industry and in the fitness and entertainment industry, even in these difficult economic times.
It is important that we're also focused growth both in near and long-term. We are moving faster in the growth-oriented marine segments, and are redirecting our R&D dollars and talent to accelerate this activity.
And normal market conditions, new product is an important driver of growth. In the current market conditions, new products takes on an ever increasing performance...
importance. As those you who follow us know we focus significant resources on developing the new form of product development process across the company.
We continue to invest in new product development and with these investments and robust processes, we have best-ever new products coming out of our development pipeline. We continue to pursue growth outside the U.S.
and we'll build infrastructure and improve process for longer-term global growth. We continue to benefit from investments and leading-edge business equipments and Life Fitness' strong global market position.
We think there continues to be good opportunities in this segment as we grow this business. Our Brunswick Zone XL retail bowling centers provide excellent investment returns in this historical heart of company.
Our rate of Zone XL openings will continue to increase. So despite this unprecedented marine market downturn, we continue to execute on our strategy have positioned Brunswick to fully benefit when the economy recovers.
With that, we will be happy to take your questions. Question And Answer
Operator
Thank you. We will now begin the question-and-answer session.
[Operator Instructions]. Our question comes from Tim Conder with Wachovia.
Please go ahead.
Timothy Conder - Wachovia Capital Markets, Llc
Thank you operator. First of all guys, it's tough out there, but you are doing a good job.
So, just keep plugging away.
Dustan E. McCoy - Chairman and Chief Executive Officer
Thank you, Tim.
Timothy Conder - Wachovia Capital Markets, Llc
Couple of questions; Pete, and I apologize if I missed this in your commentary. Could you just state again what the ForEx benefit was in the quarter, both on sales and potentially the EBITDA lines?
And then also if I missed in your commentary I apologize but I did not see it in the pres release, so but... any comments on the weeks on your channel inventories on the engine side?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Yes, first with regards to FX impacts on sales. If you look at the 11% growth that we mentioned, a little more than half, not much was driven by FX, and the remainder was driven by performance.
In terms of the impact on EPS quarter-over-quarter, it was about $0.02 favorable from foreign exchange impact. And I am sorry, Tim your second question?
Timothy Conder - Wachovia Capital Markets, Llc
Relating to the weeks of inventory... on the unit inventory on the engine side?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Yes, we are not reporting that anymore. And really the reason why is it's difficult to track engine pipeline.
Unlike boats where we are selling to dealers, and we actually keep records of how many boats are still sitting in our dealers hands, on the engine side, we sell to OEMs and they export products in many cases and since engine pipelines are based on warranty registrations, they come and they are outside the U.S, we never see that. So, particularly over the last couple of years of export activity has grown across the industry, it's more difficult for us to track it.
But the best data we would have says that we are in okay shape overall and we are probably up one or two weeks to roughly 29 weeks or so, versus last year on that adjusted basis.
Timothy Conder - Wachovia Capital Markets, Llc
Okay and Dusty, I think you mentioned that again we will see further cuts and probably likely continuing to what we have seen in the... sort of that 25 to 45 foot segment, which entails more of the in-board engines.
Dustan E. McCoy - Chairman and Chief Executive Officer
Currently there Tim, but we may see it in other places. We are trying to be very...
on top of the markets, we are staying in close contact with our dealers. And frankly, Tim, if we begin to feel softness anywhere we are trying to slow production down rather quickly.
As we go into the selling season, it's important that we have enough products there for consumers, but we also don't want to end the selling season with too much. So we're on a knife-edge here and doing the best we can.
Timothy Conder - Wachovia Capital Markets, Llc
Okay. And then two other questions here; any comment on how things are going with Cummins.
Talk how that the joint venture operations performed during the quarter, and then I have one other follow up.
Dustan E. McCoy - Chairman and Chief Executive Officer
Cummins joint venture is performing magnificently. Clearly one of the best joint ventures we have ever entered.
You know in my comments Tim, I alluded to redirecting of both resources and talent in growing segments of the marine market. That's one place we are in conjunction with Cummings, we are very focused.
We believe there is great opportunity for us in smaller and larger product drives and for instance new diesel stern-drives et cetera, et cetera all which are really growing segments in the market. Cummins has been a great partner and the joint venture and doing very, very well for us.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
And good double digit growth and process in the quarter that shows up in other income.
Timothy Conder - Wachovia Capital Markets, Llc
Okay, okay. And then finally are we sort of at the point or not to where additional incentives are promotions to dealers to help move current and non-current inventories.
Is that effective or is it just more effective to cut back the production? I mean again what's already in the field is what's in the field, but I mean is throwing more dollars after is helping to move it or really not?
Dustan E. McCoy - Chairman and Chief Executive Officer
It frankly depends on the marketing types of products. We do this on a dealer-by-dealer basis and work with dealers in a particular market to understand what will help this product.
If discounting will, we would, but if you notice our numbers we are growing any abnormal or out of ordinary discounting right now. Because it doesn't help in those markets; the bar is just not there.
Timothy Conder - Wachovia Capital Markets, Llc
Okay.
Dustan E. McCoy - Chairman and Chief Executive Officer
So the best governor here is not getting the boats into the dealership.
Timothy Conder - Wachovia Capital Markets, Llc
Okay, okay. Thank you all.
Dustan E. McCoy - Chairman and Chief Executive Officer
Welcome.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Thank you, Tim.
Operator
Thank you our next question comes from Ed Aaron with RBC Capital Markets. Please go ahead.
Edward Aaron - RBC Capital Markets
Thanks. Good morning, guys
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Good morning, Ed.
Edward Aaron - RBC Capital Markets
Couple questions for you. First, did I hear you correctly, that you are planning, is it 40 million of restructuring this year?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Yes, excluding the Baja divestiture, it should be about $40 million based on actions that we've taken to-date and the activity that we've already planned. It's very possible and I would say probably likely it's going to go even higher than that.
Edward Aaron - RBC Capital Markets
And that's not net of the one-time gain that you had this quarter. Right?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
No, that is not net of that. That excludes any of the divestitures.
Edward Aaron - RBC Capital Markets
Okay, thanks for clearing that up. I wanted to ask a little bit on the timing of any additional changes in production.
In a typical year, I think dealers often wait till the model year change over to adjust their order activity, if they're uncomfortable with their inventory levels. This is obviously not a particularly normal year, as you know.
So just wondering, just thinking about the second quarter. I know you're not...
you don't give quarterly guidance. But would you expect the rate of decline in your year-over-year production to accelerate for the next quarter, just kind of given the unusual dynamics that are in place this year?
Dustan E. McCoy - Chairman and Chief Executive Officer
The way we're seeing it, Ed, is we were down... our production was down slightly over 20% for stern-drive engines and inboard/outboard...
I'm sorry, inboard, beetle-drive boats. We think that will be lower in the second quarter, for both.
As I've said, we've seen the market be down around 24% through those segments, and we want to get down under market performance, so yes, it is going to be in excess of 20% in the second quarter. And then we'll have to see for the rest of the year, as we'll see what happens with the Cummins.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
We're taking more outages in the second quarter than we normally would.
Edward Aaron - RBC Capital Markets
Okay, thanks. And then the...
obviously earnings are down significantly just given the environment, but the negative call it incremental margins I guess, in the marine business were actually quite a bit improved in Q1 versus what you had reported in the second half of last year, if I back out the restructuring charges. Would you just chalk that up to execution and some of the cost-cutting initiatives kind of coming to fruition, or are there other factors that might be involved that I am not catching there?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
There certainly is an impact from the cost-reduction activity pretty much across the board in our marine businesses. The other factor though, too, Ed, is, we are comparing of a base that was down in terms of production versus the prior year.
You have first quarter of 07 versus fourth quarter of 06 has been a steady sort of decline. So that also played as work up to a small extent.
Dustan E. McCoy - Chairman and Chief Executive Officer
But Ed, and I think we could say with great confidence, that many of our plants are performing significantly better than they have performed in prior years. It's significantly better.
Edward Aaron - RBC Capital Markets
Okay. Helpful, thanks.
And then, just one last question if I could; from a much longer term, call it three to five-year perspective, and your efforts to reduce your footprint size over time. What is the best way to think about, in relation to the overall size of your company, what the footprint will look like in several years?
I know it's a tough question but... to answer at this point, but if I am thinking about it say for maybe like looking at your PP&E as a percentage of your sales, which is somewhere close to 20% right now, what do you think that as an example might look like much farther down the road?
Or is that not the right way to think about it?
Dustan E. McCoy - Chairman and Chief Executive Officer
Well, that is one way to think about it, and I couldn't argue with that way. I think it's just a bit premature for us to be telling you about that.
As we get further through this year and do a little more strategic work, I think we will be prepared to talk about that.
Edward Aaron - RBC Capital Markets
Okay. Good luck with the rest of the year, thanks.
Dustan E. McCoy - Chairman and Chief Executive Officer
Thanks, Ed.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Thanks, Ed.
Operator
Thank you. Our next question comes from Joe Hovorka with Raymond James.
Please go ahead.
Joseph Hovorka - Raymond James
Thanks guys. A few quick questions; first, the decline in corporate expense in the quarter, what was that and is that sustainable for the rest of the year?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Part of that was driven by the timing on incentive accrual. That was...
probably about half of that and the rest was driven by cost reduction activity.
Joseph Hovorka - Raymond James
And is that then... I am thinking that the cost reduction part is sustainable, and the other accruals were just timing?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
The cost reduction part of sustainable. You've got to be careful too, because there's always some noise that goes through it with specific items, because that also includes some activity that we do with old discontinued operations.
So I don't want you to move forward and say that it's going to be there every quarter. But certainly, you should see progress over time with even additional cost reductions.
Joseph Hovorka - Raymond James
Okay, and it may be too early to answer this yet, but production cuts into model year 09, is that... will we see them?
Dustan E. McCoy - Chairman and Chief Executive Officer
I think it's too early to call that one, Joe.
Joseph Hovorka - Raymond James
Okay. And then have you heard anything anecdotal coming out of the dealers regarding retail credit availability.
Has that changed at all in the last three months or six months, whether from... it actually just being available, or tightening or loosening credit standards?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Yes, it's still generally available, Joe. What we have seen is there's some trend for some of the banks that are out there.
If they would have taken a score of 740 in the past, they have kicked it up to 760. They are trying to, if you will, upgrade their portfolio and they might be raising rates on lower credit scores.
But it's still generally available out there to people that want to buy.
Joseph Hovorka - Raymond James
Okay. Any change in things like loan-to-value ratios as well, or no?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Slightly, there has been a slight increase in some foreclosures and when you look at the aging of receivables. For example, with Brunswick Acceptance, our joint venture with GE, there has been a slight increase, not massive but slight, when you look at boats that have been...
that are sitting out there for 12 months. The 12 to 18-month category has gone up a little bit.
So it is something we are watching closely.
Joseph Hovorka - Raymond James
The 12 to 18, I think you're talking about the inventory in the dealer lots?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Yes. Yes.
Joseph Hovorka - Raymond James
Okay. And then last question; you had been buying brands for many years in North America, and now from the press release it seems like you want to shed brands.
What's... can you comment on the change in strategy there?
What's driving it, and will we see any of the brands that were purchased in the last six or seven years be part of that portfolio brand rationalization?
Dustan E. McCoy - Chairman and Chief Executive Officer
First off, let me go on the change in strategy. I wouldn't call it a fundamental change in strategy.
I think it's more driven by a change in markets. It's clear that we entered some pieces of the market just before they began to significantly fall.
For instance, in the aluminum markets which we entered in 2004, we began to see in late 2005 a significant decline in those markets, all driven by economic conditions. And those markets are down fundamentally...
production for those markets down fundamentally about 50%. So I mean, I am not saying what we are going to do with those businesses, but I am using that as an example, Joe.
And that's the sort of businesses then we are looking at to say, on a long-term basis, will the consumer be back in those markets? If we make certain assumptions about cost of fuel, cost of food, cost of education, insurance, medical, whatever, all of which impacts disposable income.
We're asking ourselves the hard questions about the ability of those consumers going forward to continue to participate in that segment of boating. We also did some acquisitions in order to look for synergies across our marine businesses, I mean boats and engines.
And I think what we're finding is, our engine business, particularly our outboard business, is performing very well now. We have a great product line-up across the entire segment.
Fundamentally, perhaps we don't need to be in those sorts of businesses, because our engine business is very healthy and it performs very well on a standalone basis and we just don't need the transforms to support it. So it's that sort of analysis Joe, that we're going through.
As to whether some of the brands we've purchased in the last few years would be brands we could exit, the answer is clearly yes, we could exit them. And we are doing all that work right now.
Joseph Hovorka - Raymond James
Okay, so you are basically looking for places that you think that have structurally changed, as opposed to cyclically changed. If am --
Dustan E. McCoy - Chairman and Chief Executive Officer
Correct.
Joseph Hovorka - Raymond James
Okay. And that may or may not be some of the brands that you had purchased in the last several years?
Dustan E. McCoy - Chairman and Chief Executive Officer
We can work hard on cyclical changes and hunt [ph] down and take costs out, lower production, et cetera, et cetera. And you're exactly right, it's those structural changes that we're trying to make sure we understand and make good decisions on.
Joseph Hovorka - Raymond James
Okay, great. Thanks guys.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Okay, thank you, Joe.
Operator
Thank you. Our next comes from Chris Hussey with Goldman Sachs.
Please go ahead.
Chris Hussey - Goldman Sachs
Good morning, guys. A question, a follow up on that, I mean your engine business.
What's happened over the last couple or three years, would you say, that's maybe made your engine business able to stand on its own, more than what you thought back then when you were buying those brands to support it?
Dustan E. McCoy - Chairman and Chief Executive Officer
Full product line-up. We now have a four-stroke line-up that goes from a 2.5 horsepower to 300 horsepower.
We are the only manufacturer in the world now that has that complete line-up. We've got a great manufacturing footprint now in China and Japan and in our facility up in Wisconsin.
They are doing an absolutely magnificent job of getting costs out including in improving productivity. We've got a lot more to do and they know that, but they are clearly after it.
We have been gaining share nicely. Following the OMC bankruptcy in 2001, the market changed rather dramatically and we needed to get good in four-stroke and we have done so.
So we have got great share position in the U.S, we are very comfortable with that. And of course that's where we have been attempting to pursue this strategy of marrying transform with engines in order to make sure the engine business was healthy.
So, the business is a great business, it's going to perform well in the future. In fact it's going to perform better, as both the market improves and our folks out in facility [ph] continue to improve their productivity.
So we are very satisfied with that business.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
And I would add that even on the stern-drive side with MerCruiser, we are very optimistic as well about the Axius and Zeus products coming to market as we speak. We think those are going to be pretty game-changing products out in that piece of the market as well.
Chris Hussey - Goldman Sachs
If I would imagine that you embarked on that strategy to add transforms that, you had anticipated you were going to go out with a full product line and get the China and Japanese footprints in place. Has anything happened to your competition would you qualify that has sort of allowed you to be even better off today relative to your competition than you thought would be when you were buying the transforms?
Dustan E. McCoy - Chairman and Chief Executive Officer
You mean in our engine business?
Chris Hussey - Goldman Sachs
In the engine business, yes because again what you meant by... I hear you and I know about that, and the now retired Pat Mackey has done a great job there.
But the... you guys were telling us about that for awhile.
I mean you would have anticipated that, when you were buying those transforms, I would have thought.
Dustan E. McCoy - Chairman and Chief Executive Officer
Well, a couple of things went on. First, we needed to ensure we had volume to support the investment quickly.
Now, as against the engine competitors, I think that we just have a lot better engines right now. Our Verado engines are technological marvel.
No one has approached the technology and performance of those engines, and then our cost position in the Japan and China plants in the smaller engines is unequaled. So the competition just hasn't kept up with us right now.
Chris Hussey - Goldman Sachs
That's fair enough. Last question then, sticking with engines is that fuel is like $117 oil is $117 a barrel.
It just seems to keep going up, and what are you guys doing from a development standpoint at all to address a world in which may be marine fuel is sitting up $5, $6 a gallon on a sustained basis? Are you addressing that at all?
Is there a Prius [ph] in your line-up in the future? Why do you laugh, you always wanted to be the Toyota of the sea.
Dustan E. McCoy - Chairman and Chief Executive Officer
I don't want to tell our competition too much, that's why I hate to say. Let me answer your question this way, Chris.
Again in my prepared remarks, I talked about redirecting significant dollars and talent, and that is one of the places we are in the process of really up talenting and putting money on it. There is a lot of potential there for it.
And even today, with our existing engines, for instance, with our Verado engines, we've decreased fuel consumption by 30%, by doing some real great engineering work and tweaking those engines, and the engines that are out there now actually perform that better. So when we look at these product drives, that's a hidden attributes in product drives is they also are about 30% more fuel efficient than are normal stern-drive or the old V-drives as I call them, inboards.
But looking around the corner I guess we have some ideas and we've got a lot of work going on looking around the corner, and we want to be one of the industry leaders in doing that. So, you'll hear us talk about it more in time as it evolves.
Chris Hussey - Goldman Sachs
Thanks very much, fellows. Good luck.
Dustan E. McCoy - Chairman and Chief Executive Officer
You are welcome.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Thanks, Chris.
Operator
Thank you. Our next question comes from Hakan Ipekci with Merrill Lynch.
Please go ahead.
Hakan Ipekci - Merrill Lynch
Thank you. Two questions; one is, I know it's early in the retail season, but if the current trends persist into the most of the retail season, would you anticipate your shipments to be up or down in the back half of the year?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
I think the answer to that question is going to lie with what is the mood of the dealer if you will in the second half of the year. And it's difficult to predict that until you get through the season.
Retail activity in the second quarter is going to be key to the inventory that they are going to hold going into the second half.
Dustan E. McCoy - Chairman and Chief Executive Officer
Hakan, if I can add to that, here's the way we are thinking about it. If there is hesitation on the part of one of our dealers to take product, then they ought not take it.
And if we have any concern about building a product, we are not building it. And we think that's important for both our dealer network and ourselves, as we go through this sort of downturn.
Hakan Ipekci - Merrill Lynch
Okay. And the other question is again related to dealers.
What's the health of the dealership network at this point? I mean it's been a pretty rough time, and what's the rate...
has there been an uptick in the rate of exits, bankruptcies and what are you seeing out there?
Dustan E. McCoy - Chairman and Chief Executive Officer
No we are not seeing a pickup in the rate of bankruptcies and exits. Clearly, the entire industry is under stress; all of us who are OEMS are under stress, and many of our dealers are under stress.
We have very, very close contact with our entire dealer network, and for any dealer who is having difficulties... difficult in any particular market, we try to show up immediately with the dealer and work through a get-well plan and a get through the difficult economic time plan with that dealer.
We have a few... but I would say a very few, dealers with whom we are working through those sorts of conditions with.
I believe that, as an industry and our dealer network, as opposed to the early 90s when I wasn't here, and the early 2000s, our dealers are becoming much more savvy business people they are very focused on their inventories as a key gating item for the success of their business. And we've done a much better job in working with our dealers on controlling inventory.
Our programs, like our certification programs, the master dealer, ambassador, pro dealer, all the certification programs we've put out, help we and our dealers work together much better in order to keep them healthy. So I think the partnering is really paying off now.
And I'm, at a personal level, really proud of our dealer network, and I know life is tough, but I think will are being very good partners with all of our dealers, and we have surprisingly few dealers who are having issues..
Hakan Ipekci - Merrill Lynch
I see. Do you think, given the severity of the downturn in some of these...
because I would have expected, given what happened out there, that there would be more exits, and do you think, this is... some of the efforts have been delaying some of the weaker ones to exit?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Well I think, you have to be careful too, because there is the... they have seasonality of cash flow just like we do, and they are going into the prime selling season right now.
So, the fact is they are going into it with fewer boats than they had a year ago, so their inventory carrying costs are down, not to mention the fact that rates are down, to some extent as well, and it will depend how the next three... three, four months move in the marketplace, but at this point that's not the scenario, and it is pipeline management, that's why Dusty said earlier, if we think that dealers don't need it, we are not shipping it to them, not producing it.
Hakan Ipekci - Merrill Lynch
Okay, great. Thank you very much.
Dustan E. McCoy - Chairman and Chief Executive Officer
You're welcome.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Sure.
Operator
Thank you. Our next question comes from Laura Richardson with BB&T.
Please go ahead.
Laura Richardson - BB&T Capital Markets
Thanks. Couple questions here, because I am just trying to get a sense for how some of the restructuring is going to play out in the earnings eventually.
So Dusty, I apologize if you said this in the beginning, because I missed the first couple of things you said, but did you say what inning we are in terms of restructuring now?
Dustan E. McCoy - Chairman and Chief Executive Officer
No I didn't. Great question Laura; we are in the fourth innings.
Laura Richardson - BB&T Capital Markets
Fourth inning, okay. And that...
is that in terms of what you would want to change in manufacturing and sourcing, regardless of what was going on in the macro environment?
Dustan E. McCoy - Chairman and Chief Executive Officer
Yes.
Laura Richardson - BB&T Capital Markets
Okay.
Dustan E. McCoy - Chairman and Chief Executive Officer
As I have said, the macro environment permits us... or maybe put differently pushes us to move faster.
Laura Richardson - BB&T Capital Markets
Right.
Dustan E. McCoy - Chairman and Chief Executive Officer
So we are working through the process we always said we would... I think are dispatched a little faster.
Laura Richardson - BB&T Capital Markets
Yeah, okay, that was helpful to hear. Thank you for saying that.
Then, in terms of... and I am not trying to get into guidance at all.
I am just trying to understand how the economics are going to work for the business. Is it theoretically possible that once you stop having to cut production, then earnings can be kind of flat?
To whatever was the previous period? Or would they even be better because you...
of some of the restructuring you will have completed by that point, whenever it happens?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Well, Laura, this is Pete. For the last year or so, we have been saying how we have been producing at rates below retail demand.
In the first quarter, just because... we tend to steady-state produce, we produced a little bit higher, that's just a normal seasonal trend.
But yes, the retail market fell a lot more in the first quarter than I thought... I think we believed going into the quarter.
That's not exactly the case right now. But as we continue to cut production, you will come to the point when you get the retail pipeline, or the dealer pipeline, inventories to the level that you want, and you should be able to, in theory, raise production to the level of retail.
And if you look at our historical trends, that's what happened in 2002 and 2003. We actually had higher earnings in our marine businesses than we did in 2001, even though the market continued to drop a little, because of that...
that bounce effect that you get. But it's way too early to predict when that might occur.
Laura Richardson - BB&T Capital Markets
Yes, exactly, that's the million dollar question I guess, or multimillion dollar question. Okay, thanks guys.
Dustan E. McCoy - Chairman and Chief Executive Officer
This is the twelfth straight quarter, that's which... we have been producing under retail, or attempting to produce under the retail, and retail has been falling that entire time.
Laura Richardson - BB&T Capital Markets
Yes, pretty amazing. And I'm not going to ask you to predict when that's going to stop.
So, okay thanks guys.
Dustan E. McCoy - Chairman and Chief Executive Officer
Thank you.
Laura Richardson - BB&T Capital Markets
Okay, thank you.
Operator
Thank you. Our next question comes from Steven Rees of JPMorgan.
Please go ahead.
Steven Rees - JPMorgan
Hi, thank you. Just on the marine segments, it looks like the international business is still holding up quite well, and I think you said up double digits in engines.
Can you just talk about which markets are driving this growth and how this growth is trending relative to what you've seen over the last few years and if you've seen any volatility or slowing in any key international markets.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Sure.
Dustan E. McCoy - Chairman and Chief Executive Officer
Pete and I will double team this.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Go ahead.
Dustan E. McCoy - Chairman and Chief Executive Officer
Latin and South America, great growth engines for us right now. Russia and other of the far-eastern European countries are doing great, seeing a bit of weakness in Scandinavia, and Western and Central Europe are growing slightly.
And the Middle East continues to be growing well also. Is that helpful?
Steven Rees - JPMorgan
Yes, could you just talk about... in the boat segment, could you talk about what the international sales were up year-over-year?
I think you said double-digit for engines, but I am just curious --
Dustan E. McCoy - Chairman and Chief Executive Officer
They're both Mercury and Boat Group were probably up around that 11% average for the company, within a point or two of each other. So --
Steven Rees - JPMorgan
Okay.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
The company average.
Steven Rees - JPMorgan
But you haven't seen a significant slowing in any in the real key market. Okay, thank you.
Dustan E. McCoy - Chairman and Chief Executive Officer
No and in fact as Pete mentioned, we're not getting some shipments we'd like to be making overseas, because we can't get space on the vessels.
Steven Rees - JPMorgan
Okay, great. Thank you very much.
Dustan E. McCoy - Chairman and Chief Executive Officer
You're welcome.
Operator
Thank you our next question comes from Hayley Wolff with Rochdale Securities. Please go ahead.
Hayley Wolff - Rochdale Securities
Hi guys. Just a couple questions; first, on the commercial fitness side, are you seeing any signs that health clubs are delaying upgrade cycles?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Generally no. I'd say at this point in time, it's probably driven Hayley by the fact that we've got great new products out there that Elevation series on the cardio side, and our strength line-up is doing extremely well in addition to the cardio.
Hayley Wolff - Rochdale Securities
Okay.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
It's a pretty... I would tell you too, when we talk commercial, it's a pretty diverse business, I think if you'd talk to us seven years ago, it would have been much more kind of clubs by themselves.
Today it's not only clubs, it's hotels, it's the military, it's universities and professional athletic teams, and so we have a bit more diversity there going on and you do see trends in some of these that are pretty positive, like with university health club construction, things like that. And the other thing, even within the clubs, you have got some brands like Lifetime Fitness, whose more on the high end, and you also have club growth on the low end as well that are doing reasonably well, there is a number of clubs of, club chains that have been established that sell memberships at reasonably low rates, $15, $19.
They may not have all the amenities like full locker rooms et cetera but they still carry excellent equipment, and we have done pretty well in that piece of the market too.
Hayley Wolff - Rochdale Securities
Okay, thanks. And then on...
can you just review the inventory, I think I missed some of the moving parts in the inventory, and where is Baja into that equation?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Overall inventories were up $39 million year-over-year, $20 million of that came from Mercury, all in the international marketplace, some of it's driven by the weaker dollar but more of it's driven just by performance, we do have more product sitting particularly in Europe than we want to have at this point in time. The other piece, another $20 million came from Hatteras, and there were three relatively large boats that did not, and expensive boats, that did not ship at the end of March because of difficulties securing ocean freight, and that was the main driver there.
So... and then the other factor, we did see an increase in Life Fitness that was higher than what we wanted it to be, particularly because of the consumer product.
With that fall off in market, it's a very long lead time, we don't manufacture it, we source it from Asian suppliers, and we've shut down the supply chain, but it's going to take a couple quarters to see the benefit of that roll through. But we would...
we are shooting to continue to post inventory declines as we move through the rest of the year, and we would expect that our free cash flow this year from working capital reductions is going to be significantly higher than what we reported last year.
Hayley Wolff - Rochdale Securities
Is Baja in the first quarter number inventory?
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
A small amount, it's not that big. It didn't move the needle at all in terms of what you see.
Hayley Wolff - Rochdale Securities
Okay. And then last question...
or actually, two more questions; one is, is there any opportunity to ship more production over to China in the engine segment? And just looking at your basket of costs in a vacuum, sort of what percentage increase are you seeing now year-over-year?
Dustan E. McCoy - Chairman and Chief Executive Officer
First shipping, more Asian production over to China; yes, it's always a possibility. Our plant over there is obviously very good, but we are quite pleased with our production facilities right now and the progress we are making Hayley.
Hayley Wolff - Rochdale Securities
Okay.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Yes, and in terms of our cost inflation, I'd say on the materials side, it's probably averaging out maybe 3% across the portfolio, with some of the benefits that we have from are global sourcing offsetting it and that 3% is probable a net number. Wage inflation has been running 3%; benefits are going up close to 8%, 9%, 10%.
I felt it probably is averaging out something around 4, I would say.
Hayley Wolff - Rochdale Securities
Okay. Okay.
Thanks a lot guys.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Thank you.
Operator
Thank you the next question comes from Eli Lapp with Morgan Stanley. Please go ahead.
Eli Lapp - Morgan Stanley
Thanks. You had mentioned briefly a sale lease-back transaction.
I was wondering if you could give us some more detail on that, maybe timing, magnitude, use of proceeds that sort.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Sure. Generally, just as background, if you look at our historical portfolio of roughly 100 to 110 bowling centers, it has usually been 50% owned and 50% leased.
For the majority, the vast majority of the new Brunswick Zone XL centers that are out there, we have nine right now, I believe, all but two of those are owned properties, and they are much more expensive to build. They might run $11 million, between land and construction and equipment cost.
So, the sale lease-backs that we are looking are going to be, probably include a couple of those, as well as some of the older centers, and really it's not so much... what drives what centers we will sell and do lease-backs on is really driven more by tax factors than anything else because there's a potential for taxable gains, we want to try to minimize that.
I think the proceeds that we are looking at bringing in could be in the 20 to $30 million range that we'd want to put back into that business. So I would say also we are looking at some other financing sources as well, just build to suit, and leasing new facilities moving forward.
Eli Lapp - Morgan Stanley
Okay, thanks. And I am sorry, one more question.
You had mentioned earlier that you expect your free cash flow to be significantly better than that last year.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
No, I didn't say that. I said that with regard to working capital.
Eli Lapp - Morgan Stanley
Okay.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
You should see a positive trend in 2008 versus 2007 in terms of cash brought in from working capital reduction.
Eli Lapp - Morgan Stanley
All right. Thank you.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Welcome.
Dustan E. McCoy - Chairman and Chief Executive Officer
Thank you. That's all the questions we have on our monitor.
As usual, all the questions were great. We thank everyone for participating with us and having an interest in us.
And we will go and get back to work.
Peter G. Leemputte - Senior Vice President and Chief Financial Officer
Thank you, take care.
Operator
Thank you. That does conclude today's conference.
Please disconnect at this time.