MasterCraft Boat Holdings, Inc. (MCFT) Q3 2019 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Q3 2019 MasterCraft Boat Holdings, Inc. Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Tim Oxley, Chief Financial Officer.

Thank you, operator, and welcome, everyone. Today's call is being webcast live and will also be archived on our website for future listening. Joining me on today's call is Terry McNew, MasterCraft Boat Holdings' President and Chief Executive Officer. Our agenda includes the strategic overview by Terry, followed by my analysis of financials. Then Terry will reiterate our expectations for fiscal 2019 followed by the Q&A session. Before we begin, we'd like to remind participants that the information contained in this call is current only as of today, May 9, 2019. The company assumes no obligation to update any statements, including forward-looking statements. Statements that are not historical facts are forward-looking statements and are subject to the safe harbor disclaimer in today's press release. Additionally, on this conference call, we will discuss non-GAAP measures that include or exclude special or onetime items not indicative of our ongoing operations. For each non-GAAP measure, we also provide the most directly comparable GAAP measure in our fiscal 2019 third quarter earnings release, which includes a reconciliation of these non-GAAP measures to our GAAP results. Before turning the call over to Terry, I'd like to remind listeners that there's a slide deck summarizing our financial results in the Investors section of our website. With that, I'll turn the call over to Terry.

Thanks, Tim. I'd also like to thank everyone for joining us today. As you saw from today's press release, during our fiscal third quarter, we continued our track record of delivering record-setting levels of net sales, adjusted EBITDA and adjusted net income, reflecting the successful execution of our growth strategy. For the quarter, net sales increased nearly 37% to $128.4 million. Adjusted EBITDA increased 25% to $21.9 million, and fully diluted adjusted net income per share grew slightly more than 32% to $0.78 per share. We continue to see strong retail and wholesale momentum in our core MasterCraft brand, driven by our strong product portfolio and the underlying strength in the broader performance sport boat segment. Internal warranty registrations are up significantly year-over-year, which is driving our wholesale demand. Dealer inventory turns are at levels above where they were exiting the boat show season last year, and we recently started seeing a pickup in retail demand as we entered the all-important April, May and June selling season. We attribute this strong retail performance to our best-in-class product development and continued U.S. economic growth. On the recognition front, our X24 was recently recognized by Boating Industry magazine as one of its top 50 products for 2019. This award is an addition to the NMMA's Innovation of the Year award the X24 won in February at the Miami Boat Show. Through our industry-leading product design and engineering, we will continue to elevate the riding experience for our consumers, which in turn drives retail demand for our products. As we anticipated, our third quarter gross margin at MasterCraft rebounded both sequentially and on a year-over-year basis. Recall that the change in the revenue recognition standard created a timing impact around how we booked our retail rebate accrual throughout the year, with the first half of the year creating a headwind compared to the prior year and the second half creating a slight tailwind, driven by the strong year-to-date retail activity we've experienced so far and the overall lack of aged inventory in our channel. We also benefited from lower retail rebates, resulting in a reduction in our retail rebate accrual. This gross margin improvement at MasterCraft was accomplished despite our continued strategy to offset a portion of the retaliatory import tariffs impacting our Canadian and European dealers during the quarter. Our decision to support our dealers during this trade dispute has not come without financial cost, but it was the right decision for the business, and we believe having tariff-free inventory on showroom floors during the boat show season will manifest itself in market share gains throughout the heavy retail season. In contrast, if we had not chosen to support our impacted dealers, we simply would not have been able to meet all of the pent-up demand coming out of Canada now that the retaliatory import tariffs in Canada have been rescinded. We applaud the Canadian government for taking a step and look forward to a swift resolution of the retaliatory import tariffs still impacting our European dealers. At NauticStar, we saw continued financial improvements this quarter, with a sequential increase in gross margins compared to our first -- our fiscal second quarter. Our product development strategy of pivoting NauticStar's portfolio to higher-margin, larger project -- product continues to be a primary focus and is validated by the current softness in retail demand being experienced across the midline smaller product category. We will more fully realize the financial benefits in this strategy as these larger products become a larger percentage of our mix over the next several years. In the meantime, our focus remains on driving efficiency and expanding our dealer footprint. We are also pleased to have Jay Povlin assume the role of NauticStar's President. He started in that capacity back in March. Jay brings over 25 years of industry experience to that role, most recently serving as Vice President of Global Sales and Marketing at MasterCraft. As NauticStar continues on its path for growth, finding a business leader skilled in building brands and expanding dealer networks was critical. Developing talented executives and being able to leverage this talent across our diversified portfolio is another example of how we can drive growth at new acquisitions. Jay has already settled in his new role, and we are excited for the things he and the rest of the NauticStar team will accomplish in the future. The integration of our newest brand, Crest, is ahead of plan and we are seeing the benefits of our industry-leading operational excellence through increased capacity and enhanced working capital efficiencies. Importantly, this additional capacity to support future long-term growth at Crest has come with virtually no capital expenditures. While there is still additional opportunity for operational and financial improvement, the Crest team has been very receptive to our operational improvement playbook and are driving results daily. We will continue to push for additional enhancements in quality, product development and innovation as well as safety at Crest, which will in turn allow us to expand our dealer network going forward. Within the first 6 months of our ownership, we have added more than 15 points of distribution, with nearly half of those being existing MasterCraft or NauticStar dealers. We're very excited about the dealer synergy opportunities that exist between all of our brands and believe this will lead to sustainable profitable market share growth over the long term. Throughout our fiscal third quarter, we saw retail activity slowly gain momentum, and we remain comfortable with inventory levels across all our brands despite challenging domestic weather conditions and their impact on retail demand. We believe the upcoming retail season will be solid driven by the resilience of the U.S. economy, the strength of our product portfolio and premier dealer partners. Lastly, regarding our new Aviara brand, we could not have been more pleased by the reception and feedback we've received from our exclusive dealer partner, MarineMax, as well as retail customers and industry experts about the AV32 models debuted at the Miami Boat Show in February. We recently began production of the AV32, with shipments anticipated to begin at the start of our fiscal 2020 year in July. The new AV36 and AV40 models are in the final stages of development and will debut at the Fort Lauderdale Boat Show later this calendar year. We will provide a high-level overview of our expectations for Aviara's financial contribution to our fiscal 2020 performance later on the call. Now I'd like to turn the call back over to Tim to go over our financials.

Thanks, Terry. From a top line perspective, net sales for the third quarter ended March 31, 2019, rose 36.9% or $34.6 million to $128.4 million compared to $93.8 million for the year ago third quarter. The inclusion of Crest represented $27.3 million of the overall increase. MasterCraft's net sales grew $10.2 million or 14.7%, driven by an 8% increase in unit volume, favorable product mix, a reduction of retail rebate expense due to strong year-to-date retail performance and the timing impact for the new revenue recognition standard adopted beginning in fiscal year 2019. MasterCraft's unit volume increased despite 1 week of production being shifted from the fiscal third quarter into the fiscal second quarter due to the timing of the planned annual holiday shutdown. The increase in net sales was partially offset by higher sales discounts given to Canadian and European dealers impacted by the retaliatory import tariffs. As Terry mentioned in his remarks, we made the strategic decision to partially offset the import tariffs for our Canadian and European dealers, which we believe provides us with a competitive advantage heading into the heavy retail selling season. Recall that through the first 6 months of our fiscal year, our tariff support impacted our financial results by $0.09 of EPS. For the full year, the total impact of our tariff support will be $0.12 to $0.13 of EPS. With the recent announcement of the Canadian retaliatory tariff being rescinded, we are hopeful that the European government will follow suit in the near future. Regardless, moving forward, we do not anticipate any additional tariff support impact on our financial results above this level in fiscal 2019, and tariff support in fiscal 2020, if any, will be significantly reduced compared to fiscal 2019 levels. NauticStar's net sales decreased 11.8% or $2.9 million due to lower wholesale units, driven by a slowdown in the retail demand for NauticStar small boats, partially offset by the organization's recently introduced larger models at higher price points. With the slowdown we are seeing to date in the small boat segment, we will be judicious in how we manage our retail pipeline at NauticStar to ensure the long-term success of the new larger boat models we are developing. Third quarter gross profit increased $7 million or 28.6% to $31.4 million compared to $24.4 million for the prior year period. The inclusion of Crest accounted for $4.7 million of the increase while MasterCraft contributed $3.8 million. NauticStar's gross profit declined by $1.5 million. On a consolidated basis, gross margin decreased to 24.4% for the fiscal third quarter compared to 26% for the prior year period. The decrease was primarily due to the dilutive effect from the inclusion of Crest. Excluding the impact of Crest, gross margin increased year-over-year to 26.4% from 26%, principally driven by growth in higher-margin MasterCraft unit sales, lower retail sales incentives due to the strong year-to-date retail performance and the timing impact from the new revenue recognition standard. The increase was partially offset by the strategic decision to offset a portion of the retaliatory import tariffs. On the expense front, operating expenses for the third quarter increased $3.7 million or 40.4% to $12.9 million compared to $9.2 million for the prior year period. This increase was mainly due to the inclusion of Crest and start-up costs associated with our new Aviara brand. Excluding the Aviara brand start-up costs, operating expenses as a percentage of net sales decreased for the third quarter compared to the prior year third quarter. Turning to the bottom line. Third quarter net income totaled $12.8 million versus $11.5 million for the year earlier period, principally driven by the inclusion of Crest. Adjusted net income of $14.6 million or $0.78 per share on a fully diluted weighted average share count of 18.8 million shares was computed using the company's estimated annual effective tax rate of approximately 22.5% versus 29% in the prior year period. This compares to adjusted net income of $11.1 million or $0.59 per fully diluted share in the prior year period. Adjusted EBITDA was $21.9 million for the fiscal third quarter compared to $17.5 million in the prior year period. Adjusted EBITDA margin was 17%, down from 18.7% in the fiscal 2018 third quarter, principally due to the inclusion of Crest. Lastly, given our ability to generate strong free cash flow, we've been able to reduce our pro forma net leverage ratio to 1.5x adjusted EBITDA. Recall that at the time of the Crest acquisition in October 2018, we had a pro forma net leverage ratio of 2.1x adjusted EBITDA. While we believe we have a healthy balance sheet, we will continue to emphasize the payment of debt in the near term. Please see the Non-GAAP Measures section of our press release and 10-Q for a reconciliation of adjusted EBITDA, adjusted EBITDA margin and adjusted net income to the most directly comparable financial measures presented in accordance with GAAP. In summary, we are very pleased with our results for the fiscal third quarter and look forward to carrying this momentum through the end of our fiscal year. With that, I would like to turn it back to Terry for outlook.

Thanks, Tim. Our year-to-date performance gives us confidence in our ability to deliver a strong finish to fiscal 2019. We will be prudent in managing all of our brands during the key April, May and June selling season. Our goal is to maintain healthy dealer inventory levels through the end of fiscal 2019 to ensure we are well positioned to execute on the strong growth initiatives we have planned for fiscal 2020. With that in mind, we are reaffirming our previously provided full year fiscal 2019 guidance. For the full fiscal year-end June 30, 2019, we expect net sales percentage growth to be in the -- to be up in the low 40% range. Adjusted EBITDA margins are expected to be in the mid to high 16% range, reflecting the inclusion of Crest, which is dilutive to margins. Adjusted EPS percentage growth is expected to be in the low 30% range. Looking forward slightly, Aviara's financial results will be reported in our MasterCraft reporting segment starting in fiscal 2020, given Aviara will be manufactured out of the same award-winning facility using the same dedicated employees and proven management team as MasterCraft. With our track record of operational excellence and experience building larger product in the outboard and sterndrive luxury day boat market, we believe this new brand will generate strong returns on investment and drive incremental free cash flow for many years to come. Our preliminary expectation for Aviara's net sales contribution in our fiscal 2020 is between $10 million and $15 million, with additional runway in future years as we recognize the full benefit of future models to be released at the Fort Lauderdale Boat Show in late calendar 2019. Importantly, Aviara is expected to be slightly accretive to our MasterCraft reporting segment gross margin profile after integration is complete and we are at full run rate. As is our normal cadence, we will provide full consolidated fiscal 2020 guidance on our fourth quarter earnings call later this year. Now I'd like to turn it over to the operator for questions.

[Operator Instructions] And your first question comes from the line of Craig Kennison with Baird.

Terry, could you comment on the impact of weather on retail? Specifically curious what you're seeing in April and May and then what you've seen in markets like California where maybe better water has been a positive?

Sure. Kind of breaking it down by segment, Craig, MasterCraft unit sales were up on a retail basis in April, low double digit. Crest was up as well. NauticStar, as we mentioned, is seeing mixed results. The weather, primarily the Upper Midwest floods, probably delayed retail sales for Crest more than any other brand. They're pretty concentrated in that area, but we're still very bullish about the season. And as the sun starts to come out now in May, we're starting to see retail sales pick up across the board. California, MasterCraft, as we've said before, we've added several points of distribution. It's clearly now separated itself as the #2 MTA in the performance sport boat category, and we've increased market share there. So overall, as you know, every year, there's some weather condition across the United States. This year is no different. But we're very bullish about the selling season, and we think the weather is more of a timing issue than it is a full year impact.

Terry, I'd like to add, MasterCraft's retail sales on a year-to-date basis through March were up in the mid to high teens. And our turns, as we mentioned during the call, are improved over the prior year.

Yes. And to that point, Craig, NauticStar's turns are even higher than MasterCraft, and Crest, as we develop their reporting mechanisms, are doing well also.

That's super helpful. And then on Crest itself, could you remind me how many Crest dealers you had when you bought the company and what your goals are to expand distribution and really just how that pitch is going?

Sure. So when we purchased Crest, we were in the low 100s. As we said in our prepared remarks, we've added 15 points of distribution since we purchased them on October 1, 2018, with about half of that being NauticStar or MasterCraft dealers. They're very excited about it. Great dealer synergies between those 2 brands, and both at NauticStar and Crest, we'll continue to add points of distribution. NauticStar, we've owned them a little over 1.5 years. We've probably added about 25 points of distribution since we purchased them. And so for both of those brands, as we optimize their portfolios, dealer expansion is critical. MasterCraft, we continue to do dealer upgrades. It's a much more evolved dealer network, as you know, where retail is sold at MasterCraft in 46 countries around the world.

And your next question comes from the line of Eric Wold with B. Riley.

A couple of questions. I guess, one, just a quick clarification around the tariff situation. Assuming that the benefit of the Canadian tariff coming off for Q4 is de minimis, sub couple of cents, is that correct?

That's correct. We had not anticipated doing the tariff support in Q4 even before the tariffs were rescinded.

Okay. Perfect. And then drilling in on NauticStar, with the shift in production towards more larger boats, kind of where do you see the opportunity internally with smaller NauticStar over the next couple of years? Do you still see as strong an opportunity on the smaller side as you did when you purchased it? Or is it -- do you see some of the recent choppiness around that maybe indicating that a move towards -- a fuller move towards larger boats is probably the right one?

Yes. Eric, this is Terry. We're not going to abandon the small end of the portfolio at all. That's still a major contributor to their sales. They've been 18 to 28 feet historically since their brand was introduced, not quite 20 years ago. So we still will put a lot of emphasis on the smaller boats. In fact, even the Q4 wholesale orders coming into NauticStar from dealers, we're surprisingly seeing the dealers ordering a little more weighted to the smaller boats, believe it or not. We think they're mitigating risk, any risk they may see for the selling season that way. But it -- to answer your question, it's still a very important part of the portfolio. We are growing it on the upper end. As you know, we released the XS 32 at the Miami Boat Show, and it's doing real well. We introduced the 251 Hybrid late last year, last calendar year, and it's doing well.

And Eric, one thing I wanted to mention on the Canadian tariffs. Keep in mind, it represents approximately $0.08 a share this year that we will not have -- we will not be dealing with next year.

Okay. And then coming on the boat shows, you now have had a chance to digest everything from those. What was your overall view of promotional activity at the shows, given it kind of came in the midst of some choppiness and stock market volatility? Did you get a sense competitors were getting more aggressive on promotional activity that creepy and the market become more of a norm? Or did you get a sense they are staying more on the rational side?

Yes. By brand, Eric, MasterCraft, we had another really strong year of boat shows. Last year was a record year. This year was about equivalent to last year in terms of boat show sales at MasterCraft. Very positive promotional activity, it was fairly benign, not only amongst us but our competitors. Crest, similar. Their boat show results were actually up year-over-year and didn't see much aggressive promotional activity in the aluminum pontoon segment. The saltwater segment, especially the small, we've talked about it before, that whole segment, as we talk to other manufacturers, is seeing mixed results, especially at the small end. So boat show results at NauticStar were down in the single digits but rebounded towards the end of the boat show selling season. And I think really, promotional activity wasn't super aggressive during the boat show seasons for the NauticStar category. We're waiting to see what it is in the promotional Q4. And I kind of characterized Crest and NauticStar sunshine boats, so they're really warm weather-inspired sales. And June is the most important month generally for every boat company, and it's not here yet. So kind of wait-and-see activity. As you know, we actively manage dealer pipeline every week. We've said that for the nearly 4 years that we've been a public company, but we've been doing it for -- actively for the last 7 years. Tim and I have been in the industry a combined 60-plus years, and that's arguably the most important metric we look at in our business. We're very much a pool system, so we watch that. And you can see, and Tim talked about it in our prepared comments, our gross to nets were very much in line and very healthy. We did not increase discounts last year or this year.

Perfect. And then just final question on just for modeling purposes. As you look to next year, where does the holiday production week shift? Does it shift back to Q2? Does it stay in Q3?

It will remain in Q2. Because that's kind of our normal cadence. This year, it was a bit of an outlier just because of how the calendar fell.

Yes. You see that phenomenon, Eric, about every 6 to 7 years. Once every 6 or 7 years, the calendar just kind of happens to fall in that way, so we'll go back to our normal Q2, and it should stay that way for the next few years.

And your next question comes from the line of Tim Conder with Wells Fargo.

This is actually Marc Torrente on for Tim. Great job again this quarter. Just a few questions for us. So your channel inventories sound like they're in good shape. You've been supporting Canada and European dealers on tariffs to encourage steady ship-in. Could you maybe provide some additional color on inventories by region? And then with the broader marine industry, we've heard of some increasing inventory levels. Are there any areas of competitive concern from your standpoint in any of your key segments?

Marc, as you know, we look at each dealer by brand every single week. So we're -- it is not anything new for us. We actively manage that, and the result of that is we don't really have any specific area where we're concerned about it. If we happen to see in our weekly analysis a particular dealer or a region getting above our indicators, then we go in and we work with them and help them get that down. So we don't see particular issues in any particular region with any brand.

When I look at our dealer inventory turns between the U.S., Canada and rest of world, and really, I've got good data on that for MasterCraft, the turns were up in all 3 of those regions. So we're bullish. We're very glad that we supported our Canadian and European dealers, and we look forward to the European tariffs going away at some time in the future. So...

Yes. MasterCraft dealer turns in Q3 were higher than they were last year, and NauticStar's are even higher than MasterCraft. We're still trying to get good gauge readings for Crest. It takes a while to kind of get those processes in place. It did when we purchased NauticStar. But we feel good about our inventory in all regions.

Okay. But what about from a competitor standpoint? Are you seeing any access out there in the channel that could be of concern or that might lead to higher promotional activity?

We don't have good line of sight for what our competitors' inventories are. I suspect given some of the comments coming from Brunswick, there may be some issues in the sterndrive segment or with the smaller sterndrives. But I'm not sensing it really.

Yes. We're not getting any reports in from salespeople concerned about competitors' inventory. But to Tim's point, Marc, we just don't have real accurate line of sight on their inventory, but we're not hearing any anecdotal comments or concerns.

Okay. Great. And then it seems like there's some upside in Q3 primarily on core MasterCraft. You guys held guidance. Was there any pull forward in the third quarter or any changes to turns in the fourth quarter to read into?

Yes. There was a little bit of pull forward. As we mentioned, our retail rebate activity was less than we expected. As is said another way, we had strong retail activity without having to juice those numbers with retail rebates. And so for that reason, we had to take care of -- reduce our accrual a bit in Q3 and anticipate some of that coming in Q4.

[Operator Instructions] And your next question comes from the line of Brett Andress with KeyBanc Capital Markets.

[Audio Gap] pacing of the unit volumes for Aviara play out in fiscal '20? And then can you remind us of what the wholesale ASPs look like for that product?

Hey, Brett, you -- the first part of your question cut out. Could you repeat, please?

Can you hear me now?

Yes.

Yes.

Yes, sorry. Just to the extent that you're willing to share, how should the pacing of unit volumes play out for Aviara as you're thinking about it right now in fiscal '20? And then can you remind us what the wholesale ASPs look like for that product?

Yes. It's going to be significantly back-end loaded because keep in mind that while we're introducing the AV32 in July, the AV36 won't start production until October, and then the AV40 won't be until April. So I would expect approximately 25% of the net sales to be in the first half and 75% in the second half. That's kind of how back-end loaded it is just because of the timing of the introduction of product. Terry, you want to address the kind of the estimated wholesale number?

Yes. If you will, we're not prepared to talk about the wholesale on the 36 and the 40 yet. But if you think about it from the 32 dealer net, this is a wholesale kind of an average of the low $200,000s AUP. That can vary depending on options that are selected. But also, I want to add to Tim's comments, think about although we'll start booking the AV32 in July, larger boats take about a quarter to work up and complete integration. So we won't realize the full run rate margins until a quarter after each of those are introduced. The example would be Q1's margins will -- in July will build from a lower base. They'll most likely be below the average of MasterCraft gross margin, and then they'll get up to full run rate by the beginning of the second quarter. And then when we introduce the 36, it'll have a -- and 40, they'll have a similar algorithm. First quarter is always integration, and you build your gross margins until you get to full run rate.

Yes. So we'll experience some labor variances as we have to speed in building these new models.

And your next question comes from the line of Joe Altobello with Raymond James.

So just a couple of follow-up questions on Aviara. How much are you expecting in terms of start-up costs in the fourth quarter? And I assume since you'll be shipping the 32-foot in July, the start-up costs will go away in fiscal 2020.

Yes. The start-up costs, as we mentioned on previous calls, will stop when we book the first revenue in July. So we are -- and we've communicated this before, have about $2.5 million of add-backs in '19, and they will conclude at the end of June. They will stop at the end of this fiscal year.

I'd say the start-up cost in Q4 would be fairly similar to what we saw in Q3.

Yes.

Okay. And you mentioned it's accretive to gross margin at a full run rate. Does that -- should we assume that it's immediately accretive to EBITDA margins this year? Or will that take some time as well?

I think probably not in Q1, but in the subsequent quarters, it will be accretive because keep in mind, these -- some of these costs that are start-up costs will be ongoing next year. And so they will not be added back.

Okay. And just 1 last balance sheet question. Cash receivable was up pretty significantly both year-over-year and sequentially. A little bit of insight into why that was?

Sure. Timing in particular at Crest. Keep in mind the flooding is up there in the Upper Midwest, and so that affected the timing. So nothing to read into that other than the timing was a little bit later in the quarter than we traditionally see certainly at MasterCraft.

I am showing no further questions at this time. I would now like to turn the conference back to Terry McNew, President and Chief Executive Officer.

Thank you, operator. Once again, I want to thank everyone for joining us this morning. Across our organization, we continue to be well positioned for the balance of fiscal 2019 and beyond. We look forward to updating you on our fourth quarter and full year results in September. Thanks, and have a great day.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.