.

0

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

 

☑QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: October 1, 2017

OR

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                    to                                                  

 

Commission File Number 001-37502

MCBC HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

100 Cherokee Cove Drive, Vonore, TN 37885

(Address of Principal Executive Office) (Zip Code)

 

(423) 884-2221

(Registrant’s telephone number, including area code)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

☑     Yes          ☐     No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

☑     Yes          ☐     No

    

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☑

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

☐     Yes          ☑     No

As of November 6, 2017, there were 18,678,441 shares of the Registrant’s common stock, par value $0.01 per share, issued and outstanding.

 

 

 

 

 

TABLE OF CONTENTS

 

 

 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains certain “forward-looking statements” within the meaning of the federal securities laws. We use words such as “could,” “may,” “might,” “will,” “expect,” “likely,” “believe,” “continue,” “anticipate,” “estimate,” “intend,” “plan,” “project” and other similar expressions to identify some but not all forward-looking statements and include statements in this quarterly report on Form 10-Q concerning our pipeline of new models; 

our ability to continue our operating momentum, capture additional market share and deliver continued growth; expectations regarding driving margin expansion, sales increases and organic growth; the successful integration of NauticStar, LLC into our business; our fiscal 2018 outlook and key growth initiatives. Forward-looking statements involve estimates and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements.

 

The forward-looking statements contained in this quarterly report on Form 10-Q are based on assumptions that we have made in light of our industry experience and our perceptions of historical trends, current conditions, expected future developments and other important factors we believe are appropriate under the circumstances. As you read and consider this quarterly report on Form 10-Q, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties (many of which are beyond our control) and assumptions. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many important factors could affect our actual operating and financial performance and cause our performance to differ materially from the performance anticipated in the forward-looking statements, including but not limited to the following: general economic conditions, demand for our products, changes in consumer preferences, competition within our industry, our reliance on our network of independent dealers, our ability to manage our manufacturing levels and our large fixed cost base, the successful introduction of our new products, and the other important factors described under the caption "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017, filed with the Securities and Exchange Commission (the “SEC”) on September 7, 2017. Should one or more of these risks or uncertainties materialize, or should any of these assumptions prove incorrect, our actual operating and financial performance may vary in material respects from the performance projected in these forward-looking statements.

 

Further, any forward-looking statement speaks only as of the date on which it is made, and except as required by law, we undertake no obligation to update any forward-looking statement contained in this quarterly report on Form 10-Q to reflect events or circumstances after the date on which it is made or to reflect the occurrence of anticipated or unanticipated events or circumstances. New important factors that could cause our business not to develop as we expect emerge from time to time, and it is not possible for us to predict all of them.

 

 

MCBC HOLDINGS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except share and per share data)

 

 

The notes form an integral part of the condensed consolidated financial statements.

 

 

 

 

MCBC HOLDINGS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share and per share data)

 

 

The notes form an integral part of the condensed consolidated financial statements.

 

 

MCBC HOLDINGS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY 

(Dollars in thousands, except share and per share data)

 

 

The notes form an integral part of the condensed consolidated financial statements.

 

 

MCBC HOLDINGS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 (Dollars in thousands, except share and per share data)

 

 

The notes form an integral part of the condensed consolidated financial statements.

 

 

1.ORGANIZATION AND NATURE OF BUSINESS

 

MCBC Holdings, Inc. (the “Company”) was formed on January 28, 2000, as a Delaware holding company that operates primarily through its wholly owned subsidiaries, MasterCraft Boat Company, LLC; MasterCraft Services, Inc.; MasterCraft Parts, Ltd.; and MasterCraft International Sales Administration, Inc. The Company and its subsidiaries collectively are referred to herein as the “Company”.

 

The Company is a designer and manufacturer of premium inboard tournament ski boats and luxury performance V-drive runabouts under the MasterCraft brand. The Company also leases a parts warehouse in the United Kingdom to expedite service, primarily to dealers and customers in Europe.

2.BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

The Company's fiscal year begins July 1 and ends June 30, with the interim quarterly reporting periods consisting of 13 weeks. Therefore, the quarter end will not always coincide with the date of the end of the calendar month.

 

The information furnished in the condensed consolidated financial statements includes normal recurring adjustments and reflects all adjustments, which are, in the opinion of management, necessary for a fair presentation of the results of operations and statements of financial position for the interim periods presented. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and the applicable rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for financial information have been condensed or omitted pursuant to such rules and regulations. The June 30, 2017 condensed consolidated balance sheet data was derived from the audited financial statements but does not include all disclosures required by U.S. GAAP for complete financial statements. However, management believes that the disclosures in these condensed consolidated financial statements are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the Company's consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017.  

 

The unaudited condensed consolidated financial statements have been prepared on the same basis as the Company's audited consolidated financial statements for the year ended June 30, 2017 and, in the opinion of management, reflect all adjustments considered necessary to present fairly the Company's financial position as of October 1, 2017 and results of its operations, and its cash flows for the three months ended October 1, 2017 and October 2, 2016 and statement of shareholders' equity for the three months ended October 1, 2017. All adjustments are of a normal recurring nature. Our interim operating results for the three months ended October 1, 2017 and October 2, 2016 are not necessarily indicative of the results to be expected in future operating quarters.

 

There have been no changes in the Company's significant accounting policies or critical accounting estimates for the three months ended October 1, 2017 as compared with the significant accounting policies described in the Company's audited consolidated financial statements for the financial year ended June 30, 2017.

 

 

New Accounting Pronouncements Issued But Not Yet Adopted—In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). This guidance establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact this new guidance is expected to have on its financial position or results of operations and related disclosures.

 

In May 2014, the FASB and International Accounting Standards Board jointly issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which includes new principles-based accounting guidance for revenue recognition that will supersede virtually all existing revenue guidance. The core principle of this guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. To achieve the core principle, the guidance establishes the following five steps: 1) identify the contract(s) with a customer, 2) identify the performance obligation in the contract, 3) determine the transaction price, 4) allocate the transaction price to the performance obligations in the contract, and 5) recognize revenue when (or as) the entity satisfies a performance obligation. The guidance also details the accounting treatment for costs to obtain or fulfill a contract. Lastly, disclosure requirements have been enhanced to provide sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In July 2015, the FASB announced that the implementation date would be delayed by one year. During 2016, the FASB issued certain amendments to clarify and improve the implementation of the guidance in ASU 2014-09. The effective date and transition requirements for these amendments and ASU 2014-09 are now for annual and interim periods beginning after December 15, 2017.  The Company will adopt this guidance for our fiscal year beginning July 1, 2018.  

 

The Company is continuing to assess the potential effects of ASU 2014-09 on its consolidated financial statements, business processes, systems and controls. The Company plans to use the modified retrospective approach in applying the new standard. Based on the Company’s progress, it expects an impact from the new standard for dealers who are offered retail promotions which are currently recorded at the later of when the program has been communicated to the dealer or at the time of sale. Under the new standard, the Company expects these retail promotions to be recognized at the time of sale. As a result, the Company expects a change in the timing of recording retail promotions and rebates; however, it does not expect a change in the total amount of cumulative revenue recognized for each transaction. Any potential effect of adoption of this ASU has not yet been quantified. Additionally, the Company’s expectations may change as its implementation progresses.

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The guidance clarifies the definition of a business that provides a two-step analysis in the determination of whether an acquisition or derecognition is a business or an asset. The update removes the evaluation of whether a market

participant could replace any missing elements and provides a framework to assist entities in evaluating whether both an input and a substantive process are present. This guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those annual reporting periods and early adoption is permitted for transactions that meet specified criteria. This guidance is to be applied on a prospective basis for transactions that occur after the effective date.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This guidance eliminates Step 2 from the goodwill impairment test. Instead, an entity should recognize an impairment charge for the amount by which the carrying value exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2019. The Company is currently evaluating the effect that the adoption of this new guidance is expected to have on our financial position or results of operations and related disclosures.

 

In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. This guidance provides clarity and reduces complexity when applying the guidance in Topic 718, Compensation—Stock Compensation to a change to the term or condition of a share-based payment. ASU 2017-09 is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2017. The Company is currently evaluating the effect that the adoption of this new guidance is expected to have on our financial position or results of operations and related disclosures.

 

New Accounting Pronouncements Issued And Adopted — In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory.  This ASU changes the measurement principle for inventories valued under the FIFO or weighted-average methods from the lower of cost or market to the lower of cost and net realizable value.  Net realizable value is defined by the FASB as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. This ASU is effective for annual reporting periods beginning after December 15, 2016, and interim periods within those annual periods with early adoption permitted. The Company adopted the provisions of ASU 2015-11 on a prospective basis during the first quarter of fiscal year 2018. The adoption of this ASU did not have an impact on our financial position or results of operations and related disclosures.

 

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This guidance identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. This ASU is effective for annual reporting periods beginning after December 15, 2016, and interim periods within those annual periods with early adoption permitted. The Company adopted the provisions of ASU 2016-1 on a prospective basis during the first quarter of fiscal year 2018. The adoption of this ASU did not have an impact on our financial position or results of operations and related disclosures.

 

There are no other recently issued accounting pronouncements that are expected to have a material impact on our financial position or results of operations and related disclosures.

3.INVENTORIES

 

Inventories consisted of the following:

 

 

4. PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

Prepaid expenses and other current assets consisted of the following:

 

 

5.ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

 

Accrued expenses and other current liabilities consisted of the following:

 

 

 

 

 

 

The following table provides a roll forward of the accrued warranty liability:

 

 

 

6. FAIR VALUE MEASUREMENTS

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

 

Level 1 — Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2 — Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3 — Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

When determining the fair value measurements for assets or liabilities required or permitted to be recorded at and/or marked to fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, the Company looks to active and observable markets to price identical assets. When identical assets are not traded in active markets, the Company looks to market observable data for similar assets.

 

The following tables summarize the basis used to measure certain financial assets and liabilities at fair value on a recurring basis in the consolidated balance sheets:

 

 

The interest rate cap is valued utilizing pricing models taking into account inputs such as interest rates and notional amounts. Fair value measurements for the Company’s interest rate cap are classified under Level 2 because such measurements are based on significant other observable inputs. There were no transfers of assets or liabilities between Level 1 and Level 2 during the three months ended October 1, 2017.

 

 

7. LONG-TERM DEBT

 

Long-term debt outstanding is as follows:

 

 

In May 2016, the Company entered into a Second Amended and Restated Credit and Guaranty Agreement with Fifth Third Bank, as the agent and letter of credit issuer, and the lenders party thereto (the “Amended Credit Agreement”). The Amended Credit Agreement provided the Company with an $80,000 senior secured credit facility, consisting of a $50,000 term loan (the “Term Loan”) and a $30,000 revolving credit facility (the “Revolving Credit Facility”) and matures on May 26, 2021.  

 

As of October 1, 2017 and June 30, 2017, the Company had no borrowings outstanding on its Revolving Credit Facility. Availability under the Revolving Credit Facility is reduced by letters of credit. There were specified letters of credit outstanding of $250 at October 1, 2017 and June 30, 2017. As of October 1, 2017 and June 30, 2017, availability under the Revolving Credit Facility was $29,750 and $29,750, respectively, and unamortized deferred financing costs were $451 and $481, respectively. 

 

As of October 1, 2017 and June 30, 2017, the Company's total unamortized deferred financing costs were $1,052 and $1,139 respectively. These costs are being amortized over the term of the Amended Credit Agreement. As of October 1, 2017 the Company was in compliance with all of its debt covenants under its Term Loan and Revolving Credit Facility.

8. INCOME TAXES

 

The Company’s provision for income taxes as a percentage of pretax earnings (“effective tax rate”) is based on a current estimate of the annual effective income tax rate adjusted to reflect the impact of discrete items.  During the three months ended October 1, 2017 the effective tax rate was 33.4%.  The rate was lower than the 35% statutory rate primarily due to a permanent benefit associated with the domestic production activities deduction, which was partially offset by the inclusion of the state tax rate in the overall effective rate.

 

9. EARNINGS PER SHARE

 

The following table sets forth the computation of the Company’s earnings per share:

 

 

For the three months ended October 1, 2017, there were no anti-dilutive weighted average shares to be excluded from the computation of diluted earnings per share. For the three months ended October 2, 2016, the weighted average shares that were anti-dilutive, and therefore excluded from the computation of diluted earnings per share included options to purchase 122,640 shares of common stock.

 

10.STOCK-BASED COMPENSATION

 

During fiscal year ended June 30, 2015 the Company adopted the Amended and Restated MCBC Holdings, Inc. 2015 Incentive Award Plan (“2015 Plan”) in order to facilitate the grant of cash and equity incentives to non-employee directors, employees, and consultants of the Company and certain of its affiliates and to enable the Company and certain of its affiliates to obtain and retain the services of these individuals, which is essential to our long-term success. In July 2015, the Board amended and restated the Company's 2015 Plan which became effective just prior to the closing of the Company’s initial public offering to increase the shares available for issuance under the 2015 Plan.

 

In July 2017, the Company granted to certain employees 23,932 shares of restricted stock awards (“RSAs”) under the 2015 Plan at a per share fair value of $19.34, which is the market value of the Company’s common stock on the grant date. The RSAs will vest in three equal annual installments. In addition, the Company granted 17,064 RSAs under the 2015 Plan to certain non-employee directors for their annual equity award at a per share fair value of $19.34. During the three months ended October 1, 2017 and October 1, 2016, the Company recognized $143 and $36, respectively in stock-based compensation expense from all outstanding RSAs.

 

In July 2017, the Company granted 23,929 performance stock units (“PSUs”) under its 2015 Plan to certain employees at a per share fair value of $19.34, which is the market value of the Company’s common stock on the grant date.  The awards will be earned based upon the Company’s attainment of certain performance criteria over a three-year period. The performance period for the awards are a three-year period commencing July 1, 2017 and ending June 30, 2020.  Following the determination of the Company’s achievement with respect to the performance criteria, the amount of shares awarded will be subject to adjustment based upon the application of a total shareholder return (“TSR”) modifier. During the three months ended October 1, 2017 and October 1, 2016, the Company recognized $60 and $18, respectively in stock-based compensation expense from PSUs.

 

In July 2015, the Company granted 137,786 non-qualified stock options (“NSOs”) to certain employees at an option price equal to the $15.00 per share of the Company’s common stock, which was the initial public offering price, which will vest in 25% increments annually on each of the first four anniversaries of the grant date. In June 2016, the Company reduced the exercise price of these options by $4.30 per share, which was the amount of the special cash dividend paid in June 2016. Therefore, the exercise price of the options is $10.70 per share. The other terms of the options remained unchanged. We estimated the grant date fair value of stock options using the Black-Scholes pricing model assuming a risk-free interest rate of 1.93%, an expected term of 6.25 years, no dividend yield and a volatility rate of 56.7%. The Company recognized from these NSOs $61 and $65 in stock-based compensation expense during the three months ended October 1, 2017 and October 1, 2016, respectively.

 

11.SUBSEQUENT EVENTS

 

NauticStar Acquisition

 

On October 2, 2017, the Company completed the acquisition of NauticStar, LLC (the “Acquisition”). The aggregate purchase price for the of $79,800. The aggregate purchase price was subject to certain adjustments, including customary adjustments for the amount of working capital in the business at the closing date. A portion of the purchase price was deposited into an escrow account in order to secure certain post-closing obligations of the existing members (the “Sellers”). Due to the timing of the acquisition, the Company has not completed the valuation of assets acquired or liabilities assumed.

 

Third Amended and Restated Credit Agreement

 

On October 2, 2017, the Company and its wholly-owned subsidiaries (the “Borrowers”) entered into a Third Amended and Restated Credit and Guaranty Agreement by and among the Borrowers, the Company, as a guarantor, Fifth Third Bank, as the agent and letter of credit issuer, and the lenders party thereto (the “Third Amended Credit Agreement”), to become effective upon the closing of the Acquisition. The Third Amended Credit Agreement replaced and paid off the Company’s Second Amended and Restated Credit Agreement, dated May 27, 2016. The Third Amended Credit Agreement provides the Company with an $145 million senior secured credit facility, consisting of a $115 million term loan (the “Third Term Loan”) and a $30 million revolving credit facility.

 

The Third Amended Credit Agreement bears interest, at the Company’s option, at either the prime rate plus an applicable margin ranging from 0.75% to 1.75% or at an adjusted London Interbank Offered Rate (“LIBOR”) plus an applicable margin ranging from 1.75% to 2.75%, in each case based on the Company’s senior leverage ratio. Based on the Company’s current senior leverage ratio, the applicable margin for loans accruing interest at the prime rate is 1.25% and the applicable margin for loans accruing interest at LIBOR is 2.25%. In connection with the third Amended Credit Agreement, the Company paid $1,322 of related fees. The Third Term Loan will mature and all remaining amounts outstanding thereunder will be due and payable on October 2, 2022. On October 17, 2017, the Company made a voluntary $10.0 million Third Term Loan payment out of excess cash.

 

 

 

 

 

 

 

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 industry outlook, our expectations regarding 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 Annual Report on Form 10-K for the fiscal year ended June 30, 2017. Our actual results may differ materially from those contained in or implied by any forward-looking statements.

 

Overview

 

We are a world-renowned innovator, designer, manufacturer, and marketer of premium recreational sport boats, with a leading market position in the U.S., a strong international presence, and dealers around the world. Our boats are used for water skiing, wakeboarding, and wake surfing, as well as general recreational boating. Our robust product portfolio of performance sport boats are manufactured to the highest standards of quality, performance, and styling. With our recent acquisition of NauticStar in October 2017, we now have a presence in the salt water fishing and outboard propulsion markets.

 

We sell our boats through an extensive network of independent dealers in North America and internationally. We partner with 97 North American dealers with 157 locations and 48 international dealers with 81 locations throughout the rest of the world. For the three months ended October 1, 2017, 88.3% of our net sales were generated from North America and 11.7% of our net sales were generated from outside of North America. Our acquisition of NauticStar has allowed us to expand into NauticStar’s network.

 

Outlook

 

Our sales are impacted by general economic conditions, which affect the demand for our products, the demand for optional features, the availability of credit for our dealers and retail consumers, and overall consumer confidence. While the performance sport boat, salt water fishing and outboard propulsion categories have grown in recent years, new unit sales remain significantly below historical peaks. While there is no guarantee that our market will continue to grow, we believe that increased consumer demand, limited used boat inventory and the superior quality, performance, styling, and value proposition of our recently released boats present a long runway for future growth. Our revamped manufacturing and product development processes have led to operational efficiencies which we expect will continue to drive margin expansion.

 

Recent Transactions

 

Agreement to Acquire Nautic Star, LLC

 

On October 2, 2017, the Company completed the acquisition of NauticStar. The aggregate purchase price for the of $79,800. The aggregate purchase price was subject to certain adjustments, including customary adjustments for the amount of working capital in the business at the closing date. A portion of the purchase price was deposited into escrow

accounts in order to secure certain post-closing obligations of the existing members (the “Sellers”). Due to the timing of the acquisition, the Company has not completed the valuation of assets acquired or liabilities assumed.

 

Third Amended and Restated Credit Agreement

 

On October 2, 2017, the Company and its wholly-owned subsidiaries (the “Borrowers”) entered into the Third Amended Credit Agreement, to become effective upon the closing of the Acquisition. The Third Amended Credit Agreement replaced and paid off the Company’s Second Amended and Restated Credit Agreement, dated May 27, 2016. The Third Amended Credit Agreement provides the Company with an $145 million senior secured credit facility, consisting of a $115 million term loan (the “Third Term Loan”) and a $30 million revolving credit facility.

 

The Third Amended Credit Agreement bears interest, at the Company’s option, at either the prime rate plus an applicable margin ranging from 0.75% to 1.75% or at an adjusted rate of LIBOR plus an applicable margin ranging from 1.75% to 2.75%, in each case based on the Company’s senior leverage ratio. Based on the Company’s current senior leverage ratio, the applicable margin for loans accruing interest at the prime rate is 1.25% and the applicable margin for loans accruing interest at LIBOR is 2.25%. In connection with the third Amended Credit Agreement, the Company paid $1,322 of related fees. The Third Term Loan will mature and all remaining amounts outstanding thereunder will be due and payable on October 2, 2022. On October 17, 2017, the Company made a voluntary $10.0 million Third Term Loan payment out of excess cash.

 

Seasonality and Other Factors That Affect Our Business

 

Our operating results are subject to annual and seasonal fluctuations resulting from a variety of factors, including:

 

 

 

 

 

 

 

Key Performance Measures

 

From time to time we use certain key performance measures in evaluating our business and results of operations and we may refer to one or more of these key performance measures in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These key performance measures include:

 

 

 

 

 

 

Components of Results of Operations

 

Net Sales

 

We generate sales from the sale of boats, trailers, and accessories to our dealers. The substantial majority of our net sales are derived from the sale of boats, including optional features included at the time of the initial wholesale purchase of the boat. Net sales consist of the following:

 

 

 

 

 

 

Cost of Sales

 

Our cost of sales includes all of the costs to manufacture our products, including raw materials, components, supplies, direct labor, and factory overhead. For components and accessories manufactured by third-party vendors, our costs are the amounts invoiced to us by the vendors. Cost of sales includes shipping and handling costs, depreciation expense related to manufacturing equipment and facilities, and warranty costs associated with the repair or replacement of our boats under warranty.

 

Operating Expenses

 

Our operating expenses include selling and marketing costs, general and administrative costs, impairment losses and amortization costs. These items include personnel and related expenses, non-manufacturing overhead, and various other operating expenses. Further, selling and marketing expenditures include the cost of advertising and marketing materials. General and administrative expenses include, among other things, salaries, benefits, and other personnel related expenses for employees engaged in product development, engineering, finance, information technology, human resources, and executive management. Other costs include outside legal and accounting fees, investor relations, risk management (insurance), and other administrative costs.

 

Other Expense

 

Other expense includes interest expense and change in common stock warrant fair value. Interest expense consists of interest charged under our credit facilities, including deferred financing fees and debt issuance costs written off in connection with the pay down of amounts owed on our credit facilities.

 

Income Tax Expense

 

Our accounting for income tax expense reflects management’s assessment of future tax assets and liabilities based on assumptions and estimates for timing, likelihood of realization, and tax laws existing at the time of evaluation. We record a valuation allowance, when appropriate, to reduce deferred tax assets to an amount that is more likely than not to be realized.

Results of Operations

 

The table below sets forth our results of operations for the periods presented. Our financial results for these periods are not necessarily indicative of the financial results that we will achieve in future periods.

 

Three months ended October 1, 2017 Compared to Three months ended October 2, 2016

 

Net Sales.  Net sales for the three months ended October 1, 2017, increased 7.2%, or $4.3 million to $65.0 million compared to $60.7 million for the three months ended October 2, 2016. The increase was primarily due to an increase in unit sales volume of 57 units, or 7.9% and favorable pricing, partially offset by unfavorable product mix.

 

Cost of Sales.  Our cost of sales increased $4.0 million, or 9.3%, to $46.9 million for the three months ended October 1, 2017 compared to $42.9 million for the three months ended October 2, 2016. The increase in cost of sales resulted primarily from a 7.9% increase in total unit volume and an increase in cost over the prior year due to our model year change over. Our cost of sales per unit increased slightly for the three months ended October 1, 2017 when compared to the three months ended October 2, 2016.

 

Gross Profit.  For the three months ended October 1, 2017, our gross profit increased $0.4 million, or 2.0%, to $18.2 million compared to $17.8 million for the three months ended October 1, 2016. Gross margin decreased to 27.9% for the three months ended October 1, 2017 compared to 29.3% for the three months ended October 2, 2016. The increase in gross profit resulted from an increase in unit volume, and was partially offset by unfavorable product mix and an increase in model-year changeover costs as we added significant new boat features to our 2018 models. This resulted in a decrease in gross margin when compared to the prior-year period.

 

Operating Expenses.  Selling and marketing expense increased $0.7 million, or 33.3%, to $2.7 million for the three months ended October 1, 2017 compared to $2.1 million for the three months ended October 2, 2016. This increase resulted mainly from increased dealer training costs and increased promotion activities with the introduction of the redesigned 2018 MasterCraft XStar. General and administrative expense increased by $0.2 million, or 5.9%, to $4.3 million for the three months ended October 1, 2017 compared to $4.1 million for the three months ended October 2, 2016. This increase resulted mainly from an increase of $0.9 million for legal and advisory fees related to our acquisition of NauticStar which was partially offset by a decrease of $0.7 million for legal and advisory fees related to our litigation with Malibu Boats, which was subsequently settled during the fourth quarter of fiscal 2017. Operating expenses as a percentage of net sales was 10.9% during the three months ended October 1, 2017 compared to 10.2% for the three months ended October 2, 2016. This increase was the result of the increases in selling and marketing expenses and general and administrative expenses described above.

 

Other Expense.  Interest expense decreased for the three months ended October 1, 2017 compared to the three months ended October 2, 2016. The decrease is due to interest incurred during the three months ended October 1, 2017 on a reduced principal balance owed on our term loan of $14.9 million when compared to the principal balance owed as of October 2, 2017. Due to the increase in our term loan balance on October 2, 2017, as discussed in “Recent transactions” above, we expect our interest expense to increase in subsequent periods when compared to the three months ended October 1, 2017.

 

Income Tax Expense.  Our income tax expense was $3.5 million for the three months ended October 1, 2017, reflecting an effective tax rate of 33.4%.  Our effective tax rate during the three months ended October 1, 2017 was lower than the 35% statutory rate primarily due to a permanent benefit associated with the domestic production activities deduction, which was partially offset by the inclusion of the state tax rate in the overall effective rate.

 

Non-GAAP Measures

 

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 and unusual items that we do not consider to be indicative of our ongoing operations, including fees and expenses related to our follow-on offering, transaction expenses associated with the acquisition of NauticStar and our stock-based compensation expense. We define Adjusted net income as net income adjusted to eliminate certain non-cash charges and unusual items that we do not consider to be indicative of our ongoing operations, including fees and expenses related to our follow-on offering, transaction expenses associated with the acquisition of NauticStar, our stock-based compensation expense, and an adjustment for income tax expense at a normalized annual effective tax rate.  We define Adjusted EBITDA margin as Adjusted EBITDA expressed as a percentage of sales. Adjusted EBITDA, Adjusted net income and Adjusted EBITDA margin are not measures of net income or operating income as determined under accounting principles generally accepted in the United States, which we refer to as GAAP. Adjusted EBITDA and Adjusted net income are not measures of performance in accordance with GAAP and should not be considered

as an alternative to net income or operating cash flows determined in accordance with GAAP. Additionally, Adjusted EBITDA is not intended to be a measure of cash flow for management’s discretionary use. We believe that the inclusion of EBITDA, Adjusted EBITDA, Adjusted EBITDA margin and Adjusted net income is appropriate to provide additional information to investors because securities analysts, noteholders and other investors use these non GAAP financial 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 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 GAAP, provides a more complete understanding of factors and trends affecting our business than GAAP alone measures.  We believe Adjusted net income assists our board of directors, management and investors in comparing our net income on a consistent basis from period to period because it removes non-cash and non-recurring items.  Adjusted EBITDA and Adjusted net income 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 GAAP. Some of these limitations are:

 

 

In addition, because not all companies use identical calculations, our presentation of Adjusted EBITDA and Adjusted net income may not be comparable to similarly titled measures of other companies, including companies in our industry.

 

The following table sets forth a reconciliation of Adjusted EBITDA to net income as determined in accordance with GAAP for the periods indicated:

 

 

 

 

 

The following table sets forth a reconciliation of Adjusted net income to net income as determined in accordance with GAAP for the periods indicated:

 

 

 

 

 

The following table shows the reconciliation of earnings per diluted share to Adjusted net income per diluted pro-forma weighted average share for the periods presented:

 

 

 

 

 

Liquidity and Capital Resources

 

Our primary liquidity and capital resource needs are to finance working capital and fund capital expenditures. Our principal source of funds is cash generated from operating activities. As of October 1, 2017, we had borrowing availability of $29.8 million under our revolving credit facility. We believe our cash from operations, along with borrowings under our revolving credit facility, will be sufficient to provide for our working capital and capital expenditures for at least the next 12 months. The following table summarizes the cash flows from operating, investing, and financing activities:

 

 

Operating Activities

 

Our net cash provided by operating activities increased by $5.2 million, or 101.6%, for the three months ended October 1, 2017 compared to the three months ended October 2, 2016, to $10.2 million from $5.0 million. This increase was primarily