Malibu Boats, Inc. (MBUU) Q3 2014 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to Malibu Boats conference call to discuss third quarter fiscal 2014 results. [Operator Instructions] Please be advised that reproduction of this call in whole or in part is not permitted without written authorization of Malibu Boats. As a reminder, this conference call is being recorded. From management on the call today are Mr. Jack Springer, Chief Executive Officer; and Mr. Wayne Wilson, Chief Financial Officer. I would now turn the call over to Mr. Wilson. Please go ahead, sir.

Thank you, and good afternoon, everyone. Welcome to Malibu's earnings call covering the fiscal third quarter ended March 31, 2014. Also here with us this afternoon is Ritchie Anderson, the company's Chief Operating Officer. Jack will provide commentary on the business, and I will discuss the fiscal third quarter results in greater detail. We will then open the call to questions. Before we get started, I want to remind everyone that a press release covering the company's fiscal third quarter financial results was issued this afternoon, and a copy of that press release can be found in the Investor Relations section of the company's website at www.malibuboats.com. I also want to remind everyone that management's remarks on this call may contain certain forward-looking statements, including predictions, expectations, estimates or other information that might be considered forward-looking and that actual results could differ materially from those projected on today's call. You should not place undue reliance on these forward-looking statements, which speak only as of today. And the company undertakes no obligation to update them for any new information or future events. Factors that might affect future results are discussed in our filings with the SEC, and we encourage you to review our SEC filings for a more detailed description of these risk factors. Please also note that we will be referring to certain non-GAAP financial measures on today's call, such as adjusted EBITDA, adjusted EBITDA margin and adjusted fully distributed net income. Reconciliations of these non-GAAP financial measures to GAAP financial measures are included in our earnings release. Now let me turn the call over to Jack Springer.

Thank you, Wayne. I'd like to welcome everyone to our call. Malibu Boats had another very strong quarter. I will remind you that our third quarter a year ago was also an exceptional quarter, so this was a challenging comparison for us and we're very pleased with the results. Net sales increased 7% and was driven by growth in both unit volume and average selling price. Both our Malibu and Axis brands performed very well in the quarter, and our new product introductions continued to create a lot of excitement with our dealers and our customers. Our margins were also very robust in the quarter with an adjusted EBITDA margin of 20%. Of particular note, this is the highest third quarter margin in the company's history and we continue to drive profitable growth through a balanced approach to managing volume, inventory, productivity and expenses. Our third fiscal quarter runs from January through March, and as you know, that is a boat show season. This is a time where our dealers showcase boats at their shows and ramp up for the peak retail selling season. During the boat shows and the following weeks, our dealers are busy taking orders, getting perspective new buyers into their showrooms, out on the water, and closing new sales. For anyone who wants to have their boat custom-built and on the water by the all-important Memorial holiday, they generally need to place their order by mid-April. So for us, the end of the third quarter and through the fourth quarter is a very busy period fulfilling all of the new boat orders to our dealers. I now want to spend a few minutes on our business model, which may be different than other manufacturers. It's very important that everyone understands Malibu's business model, and I want to be clear on how this cycle works, both at Malibu and at our dealers level. Regarding production. We plan our production before each model year begins. It is directly aligned to our annual budget. We then build our capacity levels to that production plan. What we're seeing today is in line with our productions for retail demand and maintaining adequate dealer inventory levels. Unless there is a significant shift in demand over our projections and lower than optimal field inventories existing, we hold to our plan. This is critical to generating strong margins. Maximizing our productivity and efficiency through our business model is a key reason why we attained the level of margin that we do. Since 2011, we have lowered our hour a boat metric by 25%, and our business model related reduction is one of the key contributing factors for that. Again, the best way to do this is to plan and maintain a consistent systematic production schedule throughout the entire year. And we do this through intense data analysis and proactive projections versus reacting to demand. Since 2010, we have maintained this model in a very disciplined way, and have steadily moved from 8 boats per day to 10 boats to 12 boats to 14 boats, and now we are finishing the current year at 15 boats being produced per day. It makes no sense and would impact our productivity that we altered our production schedule from week-to-week or even month-to-month around the retail order flow. So Malibu plans our business around the stet number of production slots each fiscal year and generally looks to maintain that schedule throughout the entire year. Not only does this allow us to consistently achieve higher margins, it also allows us to assist our dealers and not over-inventory the channel. When a manufacturer has a business model of changing production based on periodic demand, it creates chaos, inefficiency, lower margins and a lack of inability to control the channel inventory. At the same time, we are also constantly evaluating demand trends and looking to balance our production schedule. From time to time, we'll add another set of tooling to a particular boat or step up our total production schedule across the entire manufacturing floor. This is normally planned in advance. We executed on both of these dynamics in the past year. In early February, we added another set of tooling based on a very strong demand for our new Malibu 23 LSV boat. You might recall that the 23 LSV has sold more units at retail in history, more than any other model in the performance sports boat segment. We launched the new 33 LSV in August of 2013, and the demand since that time has been better than we expected. When it became clear that we needed an additional set of tooling to satisfy the underlying demand trends for this boat, we added that tooling and put it into place in the first quarter. Secondly, in January of 2013, we increased our production levels across our manufacturing floor by approximately 15% and have maintained that level through today. Wayne spoke to this on our last earnings call and explained how this would impact our year-over-year productivity levels, and therefore, our gross margin rates in the second -- in the first and the second halves of the fiscal year. Now as I stated earlier, managing production this way is critical to driving optimal margins and cash flow. We're a growth company and we believe we have tremendous growth opportunities ahead of us, but we are interested in growing profitably and balancing this growth in a way that maximizes our return on capital and shareholder value. This is the way we manage the business, and we are very disciplined in this approach. In addition, we are focused in how we manage production to keep inventories level and the channel clean. This again helps our margins and benefits our dealers in the long run. The win of actually shipping those boats to dealers is a function of timing and is influenced by a lot of different factors. There may be some unit timing differences quarter-to-quarter. The third and fourth quarters of this year will be no different. Timing differences between the third and fourth fiscal quarters every year are simply driven by delivery schedules. All of our boats are built pursuant to a purchase order, but when they actually ship can vary. The result that you will see in Q3 is that we shipped more boats that what we've budgeted. In Q4, you will likely to see less boats shipped versus the Q4 budget by about the same amount. Between the 2 quarters, we will be very close to the combined budget for the second half of the year, and our actual production and shipping will be equivalent to the production plan that built the adjusted budget. Moving to our new product results. We saw a great dealer and customer response from our new products this year. And we will always look to generate that type of response each and every year by introducing new boats and features in the marketplace. In fiscal 2014, we launched 3 new boats, the Malibu WAKESETTER 23 LSV, the Axis A24 and the Axis T22. All of these boats have been very well received, and demand has been stronger than we expected on all 3. I talked a little bit about this on our last earnings call, so I don't want to spend a lot of time on them again. However, I do want to point out that the Axis T22 has been a pivotal product for many of our dealers. This boat is a 22-foot traditional bow, high-performance boat at an entry-level price. Our dealers have had a great reception to this boat and has given many of them a model to compete directly with some of their competition. For fiscal year 2015, we will be looking to generate that same level of excitement for our products through a number of new introductions, both new product and feature introductions. While it's still a little premature to discuss the details, we are planning to launch 3 new or completely remodeled boats and a number of features and innovations that are designed to deliver never-before-seen features in our segment and further expansion of our integrated surf package across our entire line of products. We are very excited about the new model here, and we believe that we're well positioned to further distance ourselves from the competition and continue to gain market share. I look very forward to discussing our new products in greater detail on our next earnings call. In summary, we're very pleased with our record-setting third quarter results and the outlook for the fourth quarter and the new model year. We continue to drive profitable growth through a disciplined strategy around new product introductions, inventory management and productivity enhancements. We look forward to telling you more about our new product introductions for fiscal 2015 on our next call. We also continue to have the best dealers in the performance sports boat segment, which further propel our objectives of being profitable in growth. I will now turn the call over to Wayne Wilson for a more detailed review of our fiscal quarter third quarter results.

Thanks, Jack. Good afternoon, everyone. As you know, we completed our IPO in our fiscal third quarter and used the proceeds to eliminate our long-term debt and purchase stock from existing owners. The IPO offering transactions created an Up-C structure that consists of the C corporation holding company that sits above and hold the partial ownership interest in the limited liability operating company. Our financial results are consolidated for financial reporting purposes and our GAAP tax expense and share count are lower than they would be as a full C corporation. To help provide clear, consistent and comparable communication around our financials, we supplement our GAAP financials with the presentation of earnings using a non-GAAP metric, adjusted fully distributed net income. Adjusted fully distributed net income is calculated using a normalized tax structure and tax rate. We believe adjusted fully distributed net income will assist our Board of Directors, management and investors in comparing our net income on a consistent basis from period-to-period because it removes noncash and nonrecurring items and eliminates the variability in tax rates and noncontrolling interest as a result of the C structure. In addition, we provide a fully diluted share count that assumes all LLC units are exchanged for Class A common shares to be used in conjunction with the adjusted fully distributed net income. We believe dividing adjusted fully distributed net income by the share count is the most comparable metric to other companies' earnings per share. Turning to our results. We had a very strong fiscal third quarter and we are very pleased with the way the business performed. As Jack discussed, we managed the business around annual production target and delivered on every operating financial metric for the quarter. Net sales in the quarter increased 6.9% to $50.3 million. The increase was again driven by solid increases in both unit volume and net sales per unit. Unit volume increased 2.9% to 788 units, and net sales per unit increased 3.9% to nearly $64,000. Unit volumes continue to be driven by strong continued consumer demand for our boats, which was bolstered by the introduction of our new models and features. Net sales per unit were driven primarily by strong sales of new boat models and larger boats, including the WAKESETTER 23 LSV and Axis A24, as well as SURF GATE sales on Axis models. Both Malibu and Axis performed well in the quarter and the volume mix was in line with our expectations. As we indicated on our last earnings call, we expected strong Axis sales to result in 28% to 30% mix of Axis units in the second half of the year. This is exactly what we saw in the third quarter, with Axis units increasing 52% to 224 units and accounting for 28.4% of the volume mix. Strong demand for our 2 new Axis models and the introduction of SURF GATE as an optional feature to the Axis line continues to propel the Axis brand. Gross profit in the quarter increased 7.2% to $13.4 million and gross margin remained very strong at 26.6%, slightly up from third quarter last year. Higher volumes and higher average selling prices driven by the mix of larger boats and additional features offset a higher mix of Axis units in the quarter. Selling and marketing expense decreased slightly to $1.5 million in the third quarter, as the percentage of sales, selling and marketing declined 20 basis points to 3%. General and administrative expenses, excluding amortization, increased $6.1 million to $10.3 million on a GAAP basis. Onetime charges related to the termination of the management agreement modifications to certain profit interest awards and strategic financial restructuring expenses-related IPO accounted for all of the increase in general and administrative expenses. Excluding these onetime expenses, G&A expenses decreased 4.8% to $4 million in the quarter. Amortization expense remained flat with last year's 3 -- third quarter at $1.3 million. Adjusted EBITDA increased 12.9% to $10.1 million from $8.9 million in the fiscal third quarter last year. Higher volumes and lower operating expenses as a percentage of sales drove the increase. Adjusted EBITDA margins was 20% in the third quarter. And as Jack mentioned, this was the highest third quarter margin in the company's history. Non-GAAP pro forma adjusted fully distributed net income totaled $4.4 million, or $0.20 per share. This is calculated using normalized C corp tax rate of 37.6% and a fully distributed diluted share count of 22.4 million shares. Comparisons to year-ago results are not meaningful since we had no comparable share outstanding nor are we a corporate taxpayer under the historical business model. For a reconciliation of adjusted EBITDA and adjusted fully distributed net income to GAAP metrics, please see the tables in our earnings release. Turning to the balance sheet. Cash and equivalents were $5.3 million at the end of the third quarter. Accounts receivable increased to $9 million from $6.1 million in the comparable quarter, and the increase was driven primarily by increased shipments in the last week of the quarter. Inventories increased 28.6% to $17.3 million as a result of investment in raw materials driven by 3 factors: one, advantage purchases of engines headed into our model year change; two, increased trailers from strong Axis sales where trailers are standard; and three, increased parts inventory related to the opening of a new customer service warehouse. We now have 2 customer service warehouses that should allow us to better service our customers and get them back on the waters as quickly as possible. As you know, we use part of the proceeds from last year to pay down debt and ended the quarter with no long-term debt. Our balance sheet also contains a long-term deferred tax asset and deferred tax payable related to tax benefits derived from our Up-C structure. Our strong performance in the fiscal third quarter was partially driven by volume outperformance and partially margin outperformance, both of which are largely timing differentials between the final 2 quarters. On the volume side, we were over 20 units ahead of our expectations as a result of a few extra boats being shipped at the end of the quarter. This continued the pattern we saw in the second fiscal quarter where we shipped an extra 10 units approximately. As Jack discussed, we managed our boat production around the annual budgeted shipment number and there are always going to be some timing differences there driven by delivery schedules. We have not modified our original volume projections and continue to manage the business to this number. As Jack indicated, this means extra unit shipments in the third quarter will likely result in a similar number of fewer shipments in the fourth quarter. As a reminder, we continue to expect Axis units to make up 28% to 30% of the volume mix in the second half of the fiscal year. This shift in mix toward Axis will be most pronounced in the fourth quarter where Axis accounted for just 13% of the mix in last year's fourth quarter. Last year, we purposely limited shipment volumes on Axis in order to reduce channel inventories prior to the introduction of Surf Gate on the Axis line. This expected mix shift will likely keep our fourth quarter gross margin relatively flat on a sequential basis for the third quarter and down on a year-over-year basis. Also, as a reminder, we stepped up our production levels by approximately 15% in January of 2013 and expect to maintain those levels through the remainder of this fiscal year. On a year-over-year standpoint, this means the first half of fiscal 2014 benefited from higher production rates relative to the first half of fiscal 2013. In the back half of fiscal 2014, the year-over-year production comparison is more flat than we had planned the business around less benefit to gross margin in the second half. Both of these factors were fully built into our expectations at the start of the fiscal year. And aside from the few extra shipments in the third quarter and the timing of some expenses moving from earlier periods in the fourth quarter, we have not changed the way we are thinking about the business for the remainder of fiscal year. In conclusion, we are very pleased with our third quarter results and the positioning of the business into the fourth quarter and the next fiscal year. Our new products have been very well received and we have another full slate of introductions planned for the 2015 model year that should continue to drive demand and market share. With that, we would like to open the call to your questions. Operator?

[Operator Instructions] Our first question comes from the line of Joe Hovorka of Raymond James.

A couple of questions. One, can you give the retail -- your retail growth in the first quarter or rather the March quarter?

Our retail growth in the March quarter for about 20 -- 20 states reporting was about flat, but that's because we see a lot of volatility in the reporting on both calendar Q4 and calendar Q1 numbers. If you look at the historical volatility for those early reporting states, that's where you see all the volatility. When we look at April, which is an even bigger month, we have a few -- 5 of the largest states that we've gotten information for were mid teens year-over-year in April.

And just a little bit further commentary. That first quarter was only about 600 boats, so well less than 10% of the overall year. The latest numbers that we had for the quarter, of course, February and March, we're a little bit more -- or excuse me, January and February were a little bit more complete. But March had only about 25 states reporting. We had a couple of larger states who were not reporting. Kind of in contrast to that, in the month of April, in looking at our registrations, we had a little bit over 200 boats that were registered, which is 1/3 of the entire first quarter. So we believe that, that second quarter for us, the way that we operate the business, is going to be very strong from a retail point of view.

Okay. So delayed sales, basically, given the weather?

Delayed registrations.

Right, right. And...

Our market size, Joe, is pretty small, so you'd see a lot of lumpiness in the numbers from month-to-month, that's why we've gone out and pulled any of the April data, because 16% of year-over-year on the 5 largest reporting states that are available to me right now is pretty large.

And how do you put that -- I think the SSI data was up 9-ish percent for the month of March -- I'm sorry not for the month, for the quarter of March. How do you flip the 2 numbers, your flat number versus the 9%?

Well, we will get it -- I mean, we've looked at it on an annualized basis to try and see what that meant from a market share perspective. And really, when you're talking -- the small numbers that we're talking about, it's literally less than 2 dozen boats. And so on an annualized basis, from a market share perspective, we look at it and say 35 basis points. And that's why we go up and look at April and say, "Are we seeing a trend here or are we -- or is this just the small sample sizes that we're seeing with discrete date cutoffs?" And we think that's what we're seeing.

Our next question comes from the line of Tim Conder of Wells Fargo Security (sic) [Securities].

We'll continue along the retail line, but maybe look at it a little bit differently. Where you are, Jack or Wayne, at this point in the fiscal year, the channel inventories versus your expectations, how are those? And then, let's just fast forward? You're saying the timing difference should be a little bit between third and fourth quarter on your shipments. What you basically overshipped a little in the third, you'll undership in the fourth. I guess, is that much of a change from what you thought 90 days ago? And if so, why? Why would that be a change there?

To answer the latter question, no, it's not a change from 90 days ago. It's -- as we go back to our discussions, it's really timing differences and how we put our loads together. So as we're talking about 10 boats that could be a couple of different dealers that we're shipping boats too early. I think a more important stat to look at is from that wholesale side. We are -- we continue to meet or exceed what we said we're going to do from that wholesale, or from our standpoint, on a unit revenue EBITDA basis. And on the channel inventory question, we believe that, that channel inventory is exactly where it should be. And as we go towards that end of modeling year, we're positioned very well to have that channel inventory exactly where it needs to be to receive the model year 2015 product.

If you overlay, Tim, our estimates of that channel inventories relative to historical years, it's right on top of the prior couple years.

Okay, great. That's very helpful, gentlemen. And one other question then. Any update on where you are internationally versus domestic on the mix here in the quarter? And then, maybe any developments or changes that we've seen regarding your distribution looking out here in the new model year in fiscal year at this point in converting to more direct or any other changes you've made here in the last couple of months.

Yes. As we've described before, the international front and our attack of that market is more of a longer-term objective. Based on the export data that we have, we've held #1 market share in that international theater. And I'm excepting North America from that for 7 out of the last 8 quarters. Worldwide with North America we have a significant #1 position. So what we've seen since our last call in the last quarter is Europe continues to be slow, somewhat depressed. It's not begun to come back yet, although we're seeing a couple of countries that are improving. And then, some of the strategic decisions and strides that we've made in our emerging markets are starting to be executed, and we believe that they'll pay intermediate and long-term dividends, and then those are in the primary markets of Asia and South America.

[Operator Instructions] Our next question comes from the line of Michael Swartz of SunTrust.

I wanted to touch on just the margins in the quarter. I guess I was impressed with the growth you posted despite some of the tough comps year-over-year but understanding that a good portion of that is just due to the timing of shipments. But I guess going forward and just longer term, how do you think about or how should we think about the incremental flow through of margins maybe not on a quarter-to-quarter basis, but maybe how you think about it on a 12-month basis?

So in terms of the incremental flow-through, we think that incremental volume flows through pretty well the high variable rate of the cost of goods sold, call it 90% variable rate of cost of goods sold. Below that, you get pretty good flow-through. We have been obviously investing in the current year for public company expenses, as well as investing in some sales and marketing that have, at some level, variability. But you're going to get a bunch of leverage out of the G&A expenses. And so in that mid-20s range, you're going to see that incremental flow-through on the incremental sale.

Okay, that's helpful. And then just in terms of the timing of shipments, I guess, impact -- or for the pull forward to third quarter from fourth quarter. I mean, it looks like you'd probably be around $1 million. Is that the way to think about it?

If it's -- yes, I mean, if it's 20 units, it's going to be 20 units times the ASP, so it's going to be pretty close.

$1 million to $2 million, maybe? Okay.

[Operator Instructions] And our next question comes from the line of Jimmy Baker of B. Riley & Co.

Just as a follow-up to the retail sales commentary on the March quarter. Understanding that the March quarter is so small. In terms of retail deliveries, it's just a very small sample size. Maybe it'd be better if you could speak to boat show order activity in the March quarter and how that metric compared to, let's say, last year.

The -- our overall boat shows were up about -- if we compare our programs and boat shows for that season, we were up about 22%. So we had very, very strong growth in that first quarter, extending all the way into March. Some shows were just over the top in terms of number of orders, and others were in that 5% growth category. But we're very pleased with that boat show season.

Great. So then just regarding your annual production plan. Can you give us some context what would you say has been, let's say, the average variance from your initial annual plan in terms of what you've actually produced in recent years?

That's a great question. I would have to say that, that production variance, we -- I'd have to get back to you on that. We have been actually pretty good at targeting that, taking it up -- I think to Jack's point that he was making earlier on the call. We set a plan and we work that plan, and we -- it takes really meaningful deviations in the underlying retail demand market or inventory levels for us to vary from that plan because we have a production team that's planning for certain amount of units on certain number of days. And so if you look historically, you've probably seen a range of variations where in the past couple of years, we moved that production plan up 100 units and it's always been up because we plan for a more conservative. We plan relatively conservatively.

Okay, that's helpful. And then lastly, for me, maybe you could just speak to -- within your annual production plan, how granular you plan in terms of mix or maybe how flexible you can be in terms of mix and in terms of what retail demand or what dealer demand actually comes through from a mix standpoint relative to that initial plan, even if it doesn't require absolute number adjustments.

That's a good question. We're very flexible in that regard. We'll go into that year with our production plan. We break that down to the model level. So one of the things that we try to do is to make certain that based upon our plan, we have the adequate level of tooling going into it. In the case of the 23 LSV that I was talking about earlier, we -- that being that brand-new boat, we saw a spike in demand over and above what we had anticipated. So we added that, I think, it was a sixth set of tooling into the program in February, which would allow us to build more of that 23. So within our daily production schedule, what we will typically do is slot the number of models that we're going to spray and start on the build processes. But that's very adjustable and very flexible based upon our tooling and what our dealers actually need.

[Operator Instructions] And it appears we have no further questions in the queue. I would like to turn the call back to Mr. Jack Springer for closing remarks.

We're very pleased with this quarter. We're hitting or exceeding our numbers, and we are not moving what the performance that we expect to have in the future quarters. I appreciate and Wayne appreciates everybody who is on the call today. We look forward to a very good fourth quarter and being on the call with you again in 3 months. Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day.