Mastercraft Boat Holdings, Inc. annual report, FY2017

Business Context and Reporting Period

MCBC Holdings, Inc. (now MasterCraft Boat Holdings, Inc.) designs, manufactures and markets premium recreational boats under the MasterCraft and NauticStar brands. This Form 10-K covers the fiscal year ended June 30, 2018; it is not a quarterly filing for 2017 Q4. NauticStar was acquired on October 2, 2017, creating two reportable segments and materially changing year-over-year comparability.

MasterCraft produces performance sport boats for skiing, wakeboarding and wake surfing. NauticStar produces outboard bay, deck and offshore center-console boats. Products are sold primarily through independent dealers in North America and internationally.

Financial Performance and Key Metrics

Metric	Fiscal 2018	Fiscal 2017	Change
Net sales	$332.7 million	$228.6 million	+45.5%
Gross profit	$90.4 million	$63.5 million	+42.4%
Gross margin	27.2%	27.8%	Down 0.6 percentage points
Operating income	$56.0 million	$33.5 million	+67.0%
Net income	$39.7 million	$19.6 million	+102.6%
Diluted EPS	$2.12	$1.05	+101.9%
Adjusted EBITDA	$64.0 million	$43.5 million	+47.3%
Adjusted EBITDA margin	19.2%	19.0%	Up 0.2 percentage points

• MasterCraft sales were $266.3 million, compared with $228.6 million in fiscal 2017. NauticStar contributed $66.4 million from the acquisition date through fiscal year-end.
• Unit volume was 3,068 MasterCraft boats, up from 2,790, and 1,687 NauticStar boats. Consolidated sales per unit declined to $70 thousand from $82 thousand because of the addition of NauticStar’s lower-priced product mix.
• MasterCraft operating income was $49.4 million; NauticStar operating income was $6.6 million.
• Cash provided by operating activities was $49.4 million, compared with $26.2 million in fiscal 2017. Capital expenditures were $5.3 million.
• Cash used in investing activities was $85.7 million, primarily reflecting the $80.5 million cash acquisition of NauticStar.
• Cash increased to $7.9 million from $4.0 million. The company reported $30.0 million of unused revolving-credit availability at June 30, 2018.
• Total debt was $75.2 million, including $76.7 million of gross senior secured term debt less $1.5 million of unamortized issuance costs. The term loan matures October 2, 2022.
• Total assets were $176.9 million and stockholders’ equity was $52.5 million at June 30, 2018, compared with $83.3 million and $11.8 million, respectively, at June 30, 2017.

Material Changes Versus the Prior Comparable Period

• The NauticStar acquisition expanded the business into the outboard-boat market and accounted for approximately 29.0% of fiscal 2018 consolidated sales.
• The company entered into a $145 million senior secured credit facility, consisting of a $115 million term loan and a $30 million revolver. It made $35.0 million of voluntary term-loan repayments during fiscal 2018.
• MasterCraft sales increased 16.5%, supported by higher unit volume, price increases, favorable product mix and reduced retail rebate activity.
• Gross margin declined because NauticStar had a lower margin profile, although operating expense leverage improved consolidated operating profitability.
• General and administrative expense declined 3.4%, primarily because fiscal 2017 included $5.9 million of patent-litigation costs. Fiscal 2018 included $1.7 million of acquisition-related legal and advisory costs and $0.6 million of new-brand startup costs.
• The effective tax rate declined to 24.5% from 37.5%, partly due to the Tax Cuts and Jobs Act and the resulting deferred-tax revaluation.
• Fiscal 2018 included a $1.033 million favorable out-of-period warranty adjustment. Management concluded the error was immaterial to current and prior periods.

Outlook, Risks, Contingencies and Unusual Items

Management expects continued growth from consumer demand, limited used-boat inventory, new products, and operational improvements. Management also expects NauticStar manufacturing and product-development improvements to support future margin expansion. No quantitative revenue or earnings guidance is provided.

• Results are seasonal and sensitive to weather, consumer confidence, discretionary spending, interest rates, credit availability and fuel prices.
• Substantially all sales depend on independent dealers; the top ten dealers represented approximately 33% of fiscal 2018 gross sales.
• Dealer floor-plan financing supports sales and working capital. The company may be required to repurchase repossessed inventory; the maximum potential obligation under floor-plan agreements was approximately $129.5 million at June 30, 2018, although no units were repurchased during fiscal 2018.
• The company relies heavily on key engine suppliers. Ilmor supplied all MasterCraft inboard engines, while Yamaha was the primary NauticStar outboard-engine supplier. Exclusive supply agreements generally run through June 30, 2023 and contain minimum-purchase requirements.
• Integration of NauticStar presents execution, cost and operational risks. NauticStar represented approximately 49.7% of consolidated assets at June 30, 2018 and was excluded from management’s internal-control assessment under the SEC’s acquisition transition provisions.
• Goodwill increased to $65.8 million, including $36.2 million related to NauticStar. No goodwill or intangible-asset impairment was recorded.
• The company had no off-balance-sheet financings and reported compliance with its debt covenants. It does not expect to pay dividends in the foreseeable future.
• The company expects fiscal 2019’s normalized effective tax rate to be approximately 24%. Adoption of the new revenue-recognition standard was expected to reduce retained earnings by approximately $2.5 million to $3.5 million after tax, subject to finalization.

Important Facts for Investors to Verify

• Separate the organic MasterCraft performance from the partial-year NauticStar contribution when assessing growth, margins and cash generation.
• Review the final purchase-price allocation, integration costs, goodwill and intangible-asset amortization associated with NauticStar.
• Monitor gross-margin trends as NauticStar becomes a larger portion of consolidated sales.
• Reconcile GAAP net income with Adjusted EBITDA and Adjusted Net Income, including acquisition, warranty, stock-compensation and startup adjustments.
• Assess debt repayment requirements, variable-rate exposure and compliance with credit-facility covenants.
• Evaluate dealer concentration, dealer liquidity and the potential exposure from floor-plan repurchase commitments.
• Confirm the final retained-earnings impact and disclosure changes from adoption of the new revenue-recognition standard.
• Monitor warranty accruals and the effect of the $1.033 million fiscal 2018 warranty correction on comparability.