MasterCraft Boat Holdings, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis should be read together with the unaudited condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q. In addition, the statements in this discussion and analysis regarding our expectations concerning the performance of our business, anticipated financial results, liquidity and the other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in “Cautionary Note Regarding Forward-Looking Statements” above and in “Risk Factors” set forth in our 2021 Annual Report on Form 10-K. Our actual results may differ materially from those contained in or implied by any forward-looking statements. Certain statements in the following discussions are based on non-GAAP financial measures. 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 U.S. GAAP in the 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, as the Company’s management believes that these measures and the information they provide are useful to users of the financial statements, including investors, because they permit users of the financial statements to view the Company’s performance using the same tools that management utilizes and to better evaluate the Company’s ongoing business performance. In order to better align the Company’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 business acquisitions. Overview The COVID-19 pandemic has facilitated strong marine retail demand as consumers have taken advantage of more flexible work schedules allowing for more leisure time and marine product usage. This strong retail demand has created historically low dealer inventory levels which, in turn, has increased wholesale demand for our products. Despite the rise in demand for our products, which led to a 38.8 percent increase in net sales year over year, supply chain disruption, production inefficiencies, and inflationary pressures impacted first quarter 2022 results. Supply Chain Disruptions. Demand for raw materials and components used in the production of our products has surged. As a result, some of the materials and components that we use are in short supply. To reduce the impact of supply chain disruptions on production, we have increased our raw materials safety stock where possible. Additionally, work in process has increased as a result of supply chain shortages delaying our ability to finish production units. Production Inefficiencies . Business processes have been altered to address completion of boats waiting on parts while maintaining normal production lines, resulting in increased labor costs. Absenteeism and implementing COVID-19 mitigating procedures also burdened our work force as we continue to focus on ramp-up of production to meet unprecedented demand. Inflationary Pressures. Inflationary pressures have increased the costs of raw materials and components used to build our products, negatively impacting our margins during the first quarter of 2022. New model year price increases took effect for fiscal 2022; however, these price increases did not fully offset the increased material costs caused by inflation. In response to worsening inflationary pressures, we announced additional mid-cycle price increases that will be implemented during the second quarter and expect the price increases to offset the impact of inflation for the full year. As we continue to navigate the unprecedented confluence of demand and disruption precipitated by the COVID-19 pandemic, our production rates and results going forward will depend, in large part, on our and our suppliers’ capacity and ability to alleviate ongoing and changing risks. 17 We will continue to actively monitor the impact of the COVID-19 pandemic and may take further actions to alter business operations as may be required by government authorities, or that are determined to be in the best interest of our employees, dealers, suppliers, and stakeholders. The full extent of the impact of the COVID-19 pandemic on our business, operations, and financial results will depend on evolving factors that we cannot predict. See “Risk Factors — Risks Relating to Our Business — Actual or potential public health emergencies, epidemics, or pandemics, such as the current coronavirus (“COVID-19”) pandemic, could have a material adverse effect on our business, results of operations, or financial condition” set forth in our 2021 Annual Report on Form 10-K. Results of Operations The table below presents our consolidated results of operations for the three months ended: Three Months Ended October 3, October 4, 2022 vs. 2021 2021 2020 Change % Change Consolidated statements of operations : NET SALES $ 144,010 $ 103,745 $ 40,265 38.8 % COST OF SALES 113,888 77,515 36,373 46.9 % GROSS PROFIT 30,122 26,230 3,892 14.8 % OPERATING EXPENSES: Selling and marketing 4,282 2,907 1,375 47.3 % General and administrative 9,670 8,932 738 8.3 % Amortization of other intangible assets 1,026 987 39 4.0 % Goodwill impairment 1,100 — 1,100 — Total operating expenses 16,078 12,826 3,252 25.4 % OPERATING INCOME 14,044 13,404 640 4.8 % OTHER EXPENSE: Interest expense 382 1,019 (637 ) (62.5 %) INCOME BEFORE INCOME TAX EXPENSE 13,662 12,385 1,277 10.3 % INCOME TAX EXPENSE 3,276 2,818 458 16.3 % NET INCOME $ 10,386 $ 9,567 $ 819 8.6 % Additional financial and other data: Unit sales volume: MasterCraft 783 640 143 22.3 % Crest 716 453 263 58.1 % NauticStar 291 286 5 1.7 % Aviara 19 13 6 46.2 % Consolidated unit sales volume 1,809 1,392 417 30.0 % Net sales: MasterCraft $ 92,015 $ 69,591 $ 22,424 32.2 % Crest 32,780 18,039 14,741 81.7 % NauticStar 13,360 12,342 1,018 8.2 % Aviara 5,855 3,773 2,082 55.2 % Consolidated net sales $ 144,010 $ 103,745 $ 40,265 38.8 % Net sales per unit: MasterCraft $ 118 $ 109 $ 9 8.3 % Crest 46 40 6 15.0 % NauticStar 46 43 3 7.0 % Aviara 308 290 18 6.2 % Consolidated net sales per unit 80 75 5 6.7 % Gross margin 20.9 % 25.3 % (440) bps 18 Three Months Ended October 3, 2021 Compared to the Three Months Ended October 4, 2020 Consolidated Results Net sales were $144.0 million for first quarter 2022, which represented an increase of 38.8 percent as compared to first quarter 2021. Net sales in each segment benefited from increased volume as our dealers look to restock their inventories, which have been depleted by strong consumer demand for boats. Higher prices, favorable model mix, and higher option sales were also favorable compared to the prior period. Gross margin declined 440 basis points to 20.9 percent when compared to first quarter 2021 as supply chain disruption and inflationary pressures drove materials and labor costs higher, and overhead from the new Aviara facility created unfavorable overhead absorption. Higher prices from model year changeover partially offset these headwinds. Operating expenses were $16.1 million for the first quarter, up $3.3 million from the prior-year period. Selling and marketing expense increased due to the timing of prior year expenses being impacted by the COVID-19 pandemic, resulting in lower costs for the first quarter of fiscal 2021. General and administrative expense increased as we continued to make investments in research and development and information technology. Additionally, an impairment charge related to the allocated goodwill associated with the Aviara segment was recorded in the first quarter of fiscal 2022, as discussed in Note 4 to the Unaudited Condensed Consolidated Financial Statements. Interest expense decreased $0.6 million due to lower effective interest rates and lower average outstanding debt balances during the quarter compared to the prior-year period. Segment Results Beginning with the first quarter of fiscal 2022 and as discussed in Note 1, our CODM began to manage our business, allocate resources, and evaluate performance based on the reportable segments of MasterCraft, Crest, NauticStar, and Aviara. MasterCraft Segment The following table sets forth MasterCraft segment results for the three months ended: Three Months Ended October 3, October 4, 2022 vs. 2021 2021 2020 Change % Change Net sales $ 92,015 $ 69,591 $ 22,424 32.2 % Operating income 16,180 14,366 1,814 12.6 % Purchases of property, plant and equipment 2,064 1,726 338 19.6 % Unit sales volume 783 640 143 22.3 % Net sales per unit $ 118 $ 109 $ 9 8.3 % Net sales increased $22.4 million, or 32.2 percent, to $92.0 million for first quarter 2022 compared to $69.6 million for the prior year period, primarily driven by an increase in sales volume. Additionally, net sales benefited from higher prices, favorable model mix, and higher options sales. Operating income for first quarter 2022 was $16.2 million, an increase of $1.8 million, compared to $14.4 million for first quarter 2021 driven by higher net sales, partially offset by the production inefficiencies from supply chain disruption, inflationary pressures, and higher sales and marketing costs compared to the COVID-impacted first quarter 2021. 19 Crest Segment The following table sets forth Crest segment results for the three months ended: Three Months Ended October 3, October 4, 2022 vs. 2021 2021 2020 Change % Change Net sales $ 32,780 $ 18,039 $ 14,741 81.7 % Operating income 3,799 1,662 2,137 128.6 % Purchases of property, plant and equipment 371 — 371 — Unit sales volume 716 453 263 58.1 % Net sales per unit $ 46 $ 40 $ 6 15.0 % Net sales were $32.8 million for first quarter 2022, compared to $18.0 million for first quarter 2021, an increase of $14.7 million, or 81.7 percent as a result of higher sales volumes and higher prices. Operating income increased 128.6 percent as compared to the prior year primarily as a result of higher net sales, partially offset by higher costs from supply chain disruption and inflationary pressures. NauticStar Segment The following table sets forth NauticStar segment results for the three months ended: Three Months Ended October 3, October 4, 2022 vs. 2021 2021 2020 Change % Change Net sales $ 13,360 $ 12,342 $ 1,018 8.2 % Operating loss (2,336 ) (1,619 ) (717 ) 44.3 % Purchases of property, plant and equipment 1,068 243 825 339.5 % Unit sales volume 291 286 5 1.7 % Net sales per unit $ 46 $ 43 $ 3 7.0 % Net sales increased by $1.0 million, or 8.2 percent, to $13.4 million for first quarter 2022 compared to $12.3 million for first quarter 2021 due to higher option sales, higher prices, and increased volume. Operating loss was $2.3 million for first quarter 2022 compared to an operating loss of $1.6 million for the prior year period. Higher costs from inflationary pressures, supply chain disruptions, and labor challenges offset higher net sales. 20 Aviara Segment The following table sets forth Aviara segment results for the three months ended: Three Months Ended October 3, October 4, 2022 vs. 2021 2021 2020 Change % Change Net sales $ 5,855 $ 3,773 $ 2,082 55.2 % Operating loss (3,599 ) (1,005 ) (2,594 ) 258.1 % Purchases of property, plant and equipment 115 73 42 57.5 % Unit sales volume 19 13 6 46.2 % Net sales per unit $ 308 $ 290 $ 18 6.2 % Net sales increased $2.1 million, or 55.2 percent to $5.9 million for first quarter 2022 compared to $3.8 million for the prior year period due to an increase in unit sales volume attributed to increased capacity from the new Merritt Island facility. During first quarter 2022, all Aviara boats were manufactured in our 140,000 square foot Merritt Island, Florida facility, which we purchased in October 2020 for $14.2 million. During first quarter 2021, Aviara boats were produced in our MasterCraft facility in Vonore, Tennessee. As a result of this transition to Merritt Island, overhead costs attributable to Aviara increased significantly which creates a dilutive near-term impact on Aviara’s margins and profitability. Operating loss was $3.6 million for first quarter 2022 compared to an operating loss of $1.0 million for first quarter 2021 as a result of ramp up related inefficiencies in the Merritt Island facility, including higher overhead costs associated with the new facility and a goodwill impairment charge. See Note 4 in Notes to Unaudited Condensed Consolidated Financial Statements for more information on the impairment charge. Non-GAAP Measures EBITDA, Adjusted EBITDA, and Adjusted EBITDA Margin We define EBITDA as earnings before interest expense, income taxes, depreciation and amortization. We define Adjusted EBITDA as EBITDA further adjusted to eliminate certain non-cash charges or other items that we do not consider to be indicative of our core and/or ongoing operations. For the periods presented herein, these adjustments include Aviara transition costs and certain non-cash items including goodwill impairment and share-based compensation. We define Adjusted EBITDA margin as Adjusted EBITDA expressed as a percentage of Net sales. Adjusted Net Income and Adjusted Net Income Per Share We define Adjusted Net Income and Adjusted Net Income per share as net income adjusted to eliminate certain non-cash charges or other items that we do not consider to be indicative of our core and/or ongoing operations and adjusted for the impact to income tax expense related to non-GAAP adjustments. For the periods presented herein, these adjustments include Aviara transition costs and certain non-cash items including goodwill impairment, other intangible asset amortization, and share-based compensation. 21 EBITDA, Adjusted EBITDA, Adjusted EBITDA m argin, Adjusted Net Income, and Adjusted Net Income per share, which we refer to collectively as the Non-GAAP Measures, are not measures of net income or operating income as determined under accounting principles generally accepted in the United States, or U.S. GAAP. The Non-GAAP Measures are not measures of performance in accordance with U.S. GAAP and should not be considered as an alternative to net income, net income per share, or operating cash flows determined in accordance with U.S. GAAP. Additionally, Adjusted EBITDA is not intended to be a measure of cash flow. We believe that the inclusion of the Non-GAAP Measures is appropriate to provide additional information to investors because securities analysts and investors use the Non-GAAP Measures to assess our operating performance across periods on a consistent basis and to evaluate the relative risk of an investment in our securities. We use Adjusted Net Income and Adjusted Net Income per share to facilitate a comparison of our operating performance on a consistent basis from period to period that, when viewed in combination with our results prepared in accordance with U.S. GAAP, provides a more complete understanding of factors and trends affecting our business than does U.S. GAAP measures alone. We believe Adjusted Net Income and Adjusted Net Income per share assists our board of directors, management, investors, and other users of the financial statements in comparing our net income on a consistent basis from period to period because it removes certain non-cash items and other items that we do not consider to be indicative of our core and/or ongoing operations and adjust s for the impact to income tax expense related to non-GAAP adjustments . The Non-GAAP Measures have limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under U.S. GAAP. Some of these limitations are: • Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future and Adjusted EBITDA does not reflect any cash requirements for such replacements; • Adjusted EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments; • Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; • Adjusted EBITDA does not reflect our tax expense or any cash requirements to pay income taxes; • Adjusted EBITDA does not reflect interest expense, or the cash requirements necessary to service interest payments on our indebtedness; and • Adjusted Net Income, Adjusted Net Income per share, and Adjusted EBITDA do not reflect the impact of earnings or charges resulting from matters we do not consider to be indicative of our core and/or ongoing operations, but may nonetheless have a material impact on our results of operations. In addition, because not all companies use identical calculations, our presentation of the Non-GAAP Measures may not be comparable to similarly titled measures of other companies, including companies in our industry. 22 The following table presents a reconciliation of net income as determined in accordance with U.S. GAAP to EBITDA, and Adjusted EBITDA, and net income margin (expressed as a percentage of net sales) to Adjusted EBITDA Margin (expressed as a percentage of net sales) for the periods indicated: Three Months Ended October 3, % of Net October 4, % of Net 2021 sale 2020 sale Net income $ 10,386 7.2% $ 9,567 9.2% Income tax expense 3,276 2,818 Interest expense 382 1,019 Depreciation and amortization 3,354 2,739 EBITDA 17,398 12.1% 16,143 15.6% Goodwill impairment (a) 1,100 - Share-based compensation 896 640 Aviara transition costs (b) - 178 Adjusted EBITDA $ 19,394 13.5% $ 16,961 16.3% (a) Represents a non-cash charge recorded in the Aviara segment for impairment of goodwill. See Note 4 for more information on the goodwill impairment charge. (b) Represents costs to transition production of the Aviara brand from Vonore, Tennessee to Merritt Island, Florida. Costs include duplicative overhead costs and costs not indicative of ongoing operations (such as training and facility preparation). The following table presents a reconciliation of net income as determined in accordance with U.S. GAAP to Adjusted Net Income for the periods indicated: Three Months Ended October 3, October 4, 2021 2020 (Dollars in thousands, except per share data) Net income $ 10,386 $ 9,567 Income tax expense 3,276 2,818 Goodwill impairment (a) 1,100 - Amortization of acquisition intangibles 999 960 Share-based compensation 896 640 Aviara transition costs (b) - 178 Adjusted Net Income before income taxes 16,657 14,163 Adjusted income tax expense (c) 3,831 3,257 Adjusted Net Income $ 12,826 $ 10,906 Adjusted Net Income per share: Basic $ 0.68 $ 0.58 Diluted $ 0.67 $ 0.58 Weighted average shares used for the computation of: Basic Adjusted Net Income per share 18,850,301 18,774,336 Diluted Adjusted Net Income per share 19,004,119 18,866,826 (a) Represents a non-cash charge recorded in the Aviara segment for impairment of goodwill. See Note 4 for more information on the goodwill impairment charge. (b) Represents costs to transition production of the Aviara brand from Vonore, Tennessee to Merritt Island, Florida. Costs include duplicative overhead costs and costs not indicative of ongoing operations (such as training and facility preparation). (c) Reflects income tax expense at an income tax rate of 23.0% for each period presented. 23 The following table presents the reconciliation of net income per diluted share to Adjusted Net Income per diluted share for the periods presented: Three Months Ended October 3, October 4, 2021 2020 Net income per diluted share $ 0.55 $ 0.51 Impact of adjustments: Income tax expense 0.17 0.15 Goodwill impairment (a) 0.06 - Amortization of acquisition intangibles 0.05 0.05 Share-based compensation 0.05 0.03 Aviara transition costs (b) - 0.01 Adjusted Net Income per diluted share before income taxes $ 0.88 $ 0.75 Impact of adjusted income tax expense on net income per diluted share before income taxes (c) (0.21 ) (0.17 ) Adjusted Net Income per diluted share $ 0.67 $ 0.58 (a) Represents a non-cash charge recorded in the Aviara segment for impairment of goodwill. See Note 4 for more information on the goodwill impairment charge. (b) Represents costs to transition production of the Aviara brand from Vonore, Tennessee to Merritt Island, Florida. Costs include duplicative overhead costs and costs not indicative of ongoing operations (such as training and facility preparation). (c) Reflects income tax expense at an income tax rate of 23.0% for each period presented. Liquidity and Capital Resources Our primary liquidity and capital resource needs are to finance working capital, fund capital expenditures, service our debt, and fund our stock repurchase program. Our principal sources of liquidity are our cash balance, cash generated from operating activities, our revolving credit agreement and the refinancing and/or new issuance of long-term debt. Cash and cash equivalents totaled $11.7 million as of October 3, 2021, a decrease of $27.6 from $39.3 million as of June 30, 2021. Total debt as of October 3, 2021 and June 30, 2021 was $84.4 million and $93.1 million, respectively. Our working capital was impacted by the $22.1 million increase in inventory during the first quarter of fiscal 2022 mainly due to an increase in raw materials to support higher production volumes and to increase safety stock to manage supply chain risk. Work in process has increased due to supply chain disruptions. As of October 3, 2021, we had $25.7 million outstanding under the Revolving Credit Facility, leaving $74.3 of available borrowing capacity. Refer to Note 6—Long Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements for further details. On June 24, 2021, the board of directors of the Company authorized a stock repurchase program that allows for the repurchase of up to $50.0 million of our common stock during the three-year period ending June 24, 2024. During the quarter ending October 3, 2021, the Company repurchased 58,379 shares of common stock for $1.5 million in cash, including related fees and expenses. We are continuing to monitor the impact of supply chain disruptions, production inefficiencies, and inflationary pressures on our business. However, we believe our cash balance, cash from operations, and our ability to borrow will be sufficient to provide for our liquidity and capital resource needs, including authorized stock repurchases. 24 The following table summarizes our cash flows from operating, investing, and financing activities: Three Months Ended October 3, October 4, 2021 2020 (Dollars in thousands) Total cash provided by (used in): Operating activities $ (13,555 ) $ 7,372 Investing activities (3,618 ) (2,042 ) Financing activities (10,428 ) (12,791 ) Net change in cash $ (27,601 ) $ (7,461 ) First Quarter 2022 Cash Flow Net cash used in operating activities for first quarter 2022 was $13.6 million mainly due to working capital usage, partially offset by net income. Working capital usage primarily consisted of an increase in inventory, accounts receivable, and a decrease in accrued expenses and other current liabilities. Partially offsetting the working capital usage was an increase in accounts payable. As discussed above, inventory increased $22.1 million for first quarter 2022. Accounts receivables increased as a result of timing in customer payments. Accrued expenses and other current liabilities decreased because of continued strong retail demand without the need for rebates and higher payments related to variable compensation costs. Accounts payable increased mainly due to the increase in inventory safety stock. Net cash used for investing activities was $3.6 million, which included capital expenditures. Our capital spending was focused on expanding our capacity and maintenance capital. Net cash used for financing activities was $10.4 and related to net payments of long-term debt of $8.8 million and funding of the stock repurchase program totaling $1.5 million. First Quarter 2021 Cash Flow Net cash provided by operating activities in first quarter 2021 totaled $7.3 million primarily due to net income and an increase in accounts payable, partially offset by an increase in inventory and accounts receivable. Accounts payables and inventory increased due to increased production. Accounts receivables increased due to an increase in sales. Net cash used for investing activities was $2.0 million, which consisted of capital expenditures. Net cash used for financing activities was $12.8 million and related primarily to payments of long-term debt. Off Balance Sheet Arrangements The Company did not have any off balance sheet financing arrangements as of October 3, 2021. Critical Accounting Policies As of October 3, 2021 there were no significant changes in or changes in the application of our critical accounting policies or estimation procedures from those presented in our Annual Report on Form 10-K for the fiscal year ended June 30, 2021, which was filed with the SEC on September 2, 2021 . ITEM 3. QUANTITATIVE AND QUALITATI VE DISCLOSURES ABOUT MARKET RISK. Refer to our 2021 Annual Report for a complete discussion of the Company’s market risk. There have been no material changes in market risk from those disclosed therein. 25