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MARINE PRODUCTS CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

July 31, 2014

Marine Products Corporation, through our wholly owned subsidiaries Chaparral and Robalo, is a leading manufacturer of recreational fiberglass powerboats. Our sales and profits are generated by selling the products that we manufacture to a network of independent dealers who in turn sell the products to retail customers. These dealers are located throughout the continental United States and in several international markets. Many of these dealers finance their inventory through third-party floorplan lenders, who pay Marine Products generally within seven to ten days after delivery of the products to the dealers.

The discussion on business and financial strategies of the Company set forth under the heading "Overview" in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2013 is incorporated herein by reference. There have been no significant changes in the strategies since year-end.

In implementing these strategies and attempting to optimize our financial returns, management closely monitors dealer orders and inventories, the production mix and profitability of its various models, and indications of near term demand such as consumer confidence, interest rates, fuel costs, dealer orders placed at our annual dealer conferences, and retail attendance and orders at annual winter boat show exhibitions. We also consider trends related to certain key financial and other data, including our market share, unit sales of our products, average selling price per unit, and gross profit margins, among others, as indicators of the success of our strategies. Marine Products' financial results are specifically affected by consumer confidence, because pleasure boating is a discretionary expenditure. Our financial results are also affected by interest rates and credit availability, because many retail customers finance the purchase of their boats and our dealers finance the purchase of their inventory. In addition, our financial results are affected by other socioeconomic and environmental factors such as availability of leisure time, consumer preferences, demographics and the weather.

Our net sales were higher during the second quarter of 2014 compared to the first quarter of 2014 and the second quarter of 2013 because of strong dealer demand for our larger Robalo models, our larger Chaparral H2O models, and our new Vortex jet boats. In addition, industry indicators such as attendance at the recent winter boat shows, industry reports regarding 2014 retail boat sales, and the increased availability of floorplan financing for our dealers, have given us a favorable outlook for the near-term selling environment for our products.

Operating income increased by 66.2 percent during the second quarter of 2014 compared to the same period in the prior year due to higher gross profit, partially offset by higher selling, general and administrative expenses. Selling, general and administrative expenses increased due to costs that vary with sales and profitability, such as officer incentive compensation, warranty expense and sales commissions. Dealer inventory in units as of June 30, 2014 was lower than at the end of the first quarter of 2014 but higher than at the end of the second quarter of 2013.

19 MARINE PRODUCTS CORPORATION AND SUBSIDIARIES OUTLOOK



The discussion on the outlook for 2014 is incorporated herein by reference from the Company's annual report on Form 10-K for the fiscal year ended December 31, 2013.

We believe that recreational boating retail demand in many segments of the industry is improving. Attendance and sales during the recent winter boat shows have been moderately higher than the prior season, and residential real estate markets and consumer confidence have stabilized. We also believe that there is improved demand from consumers who have delayed purchasing a boat over the past few years due to economic uncertainty.

Although industry wide retail boat sales remain lower than they were prior to the financial crisis, sales volumes expanded in 2013 and the first six months of 2014, and we expect this to continue for the remainder of 2014. We believe improvements in retail boat sales will be modest due to the lack of strong economic improvement, which tends to discourage consumers from purchasing large discretionary goods such as pleasure boats. Fluctuations in fuel prices can impact our sales, and during the second quarter fuel prices increased compared to both the prior quarter and the prior year. In general, the overall cost of boat ownership has increased, especially in the sterndrive recreational boat market segment, which comprises the majority of the Company's sales. The higher cost of boat ownership also discourages consumers from purchasing recreational boats. For a number of years, Marine Products as well as other boat manufacturers have been improving their customer service capabilities, marketing strategies and sales promotions in order to attract more consumers to recreational boating as well as improve consumers' boating experiences. The Company provides financial incentives to its dealers for receiving favorable customer satisfaction surveys. In addition, the recreational boating industry conducts a promotional program which involves advertising and consumer targeting efforts, as well as other activities designed to increase the potential consumer market for pleasure boats. Many manufacturers, including Marine Products, participate in this program. Management believes that these efforts have incrementally benefited the industry and Marine Products. As in past years, Marine Products enhanced its selection of models for the 2015 model year which began on July 1, 2014. We are continuing to emphasize the value-priced Chaparral and Robalo models, as well as larger models in the Chaparral line-up including the SSX's, and new Robalo bay boat models. In addition, we produced and sold our first Vortex jet boats in the first and second quarters of 2014 and plan to introduce an additional larger model for the 2015 model year for production during the third quarter of 2014. We believe that these jet boat models will expand our customer base, and leverage our strong dealer network and reputation for quality and styling. We will continue to develop and produce additional new products for the 2015 model year.

20 MARINE PRODUCTS CORPORATION AND SUBSIDIARIES



Our financial results for the full year of 2014 will depend on a number of factors, including interest rates, consumer confidence, the availability of credit to our dealers and consumers, fuel costs, the continued acceptance of our new products in the recreational boating market, our ability to compete in the competitive pleasure boating industry, and the costs of labor and certain of our raw materials and key components.

RESULTS OF OPERATIONS

Key operating and financial statistics for the three and six months ended June 30, 2014 and 2013 are as follows:

Three months ended Six months ended June 30, June 30, 2014 2013 2014 2013 Total number of boats sold 979 875 1,902 1,851 Average gross selling price per boat (in thousands) $ 44.3$ 44.0$ 46.2$ 43.3 Net sales (in thousands) $ 47,975$ 42,235$ 95,677$ 86,518 Percentage of cost of goods sold to net sales 80.3 % 82.7 % 80.9 % 83.3 % Gross profit margin percent 19.7 % 17.3 % 19.1 % 16.7 % Percentage of selling, general and administrative expenses to net sales 11.1 % 11.4 % 11.9 % 12.1 % Operating income (in thousands) $ 4,125$ 2,482$ 6,893$ 3,954 Warranty expense (in thousands) $ 745$ 689$ 1,546$ 1,438



THREE MONTHS ENDED JUNE 30, 2014 COMPARED TO THREE MONTHS ENDED JUNE 30, 2013

Net sales for the three months ended June 30, 2014 increased $5.7 million or 13.6 percent compared to the comparable period in 2013. The change in net sales during the quarter compared to the prior year was due primarily to an 11.9 percent increase in the number of units sold and lower incentives, although average gross selling price per boat was relatively flat. Unit sales increased due primarily to sales of our larger Robalo models and Bay Boats, coupled with our larger Chaparral H2O models, and our new Vortex jet boats. In the second quarter of 2014, sales outside of the United States accounted for 18.8 percent of net sales compared to 20.8 percent of net sales in the prior year second quarter. International net sales increased 2.8 percent during the second quarter of 2014 to $9.0 million while domestic net sales increased 16.4 percent to $38.9 million compared to the second quarter of prior year.

21 MARINE PRODUCTS CORPORATION AND SUBSIDIARIES



Cost of goods sold for the three months ended June 30, 2014 was $38.5 million compared to $34.9 million for the comparable period in 2013, an increase of $3.6 million or 10.4 percent. Cost of goods sold, as a percentage of net sales, decreased primarily due to a favorable model mix, lower incentives, improved margins on parts and accessories sales and efficiencies from higher production volumes.

Selling, general and administrative expenses for the three months ended June 30, 2014 were $5.3 million compared to $4.8 million for the comparable period in 2013, an increase of $0.5 million or 9.8 percent. This increase was due to expenses that vary with sales and profitability, such as sales commissions and incentive compensation. Selling, general and administrative expenses as a percentage of net sales, was approximately the same in the second quarter of 2014 and the second quarter of 2013.

Operating income for the three months ended June 30, 2014 increased $1.6 million compared to the comparable period in 2013 due to higher gross profit, partially offset by higher selling, general and administrative expenses.

Interest income was $121 thousand during the three months ended June 30, 2014 compared to $178 thousand for the comparable period in 2013. This decrease was primarily due to a decrease in realized gains, coupled with lower yields, partially offset by an increase in the average balance of our marketable securities portfolio.

Income tax provision for the three months ended June 30, 2014 was $1.2 million compared to $725 thousand for the comparable period in 2013. The income tax provision for the three months ended June 30, 2014 reflects an effective tax rate of 29.0 percent compared to an effective tax rate of 27.3 percent for the comparable period in the prior year. The 2014 rate is a result of continued beneficial permanent differences including tax-exempt interest income and a favorable U.S. manufacturing deduction. The 2013 effective tax rate benefited from the impact of the research and experimentation credit for the year.

SIX MONTHS ENDED JUNE 30, 2014 COMPARED TO SIX MONTHS ENDED JUNE 30, 2013

Net sales for the six months ended June 30, 2014 increased $9.2 million or 10.6 percent compared to the comparable period in 2013. The change in net sales was due to a 6.8 percent increase in the average gross selling price per boat, coupled with a 2.8 percent increase in the number of boats sold. Unit sales increased primarily due to higher sales of our larger Robalo boats, larger Chaparrral H2O models and new Vortex jet boats, partially offset by lower unit sales of our SSI models. Average selling prices increased due to a favorable model mix and lower incentives that included higher sales of our larger Chaparral H2O models and larger Robalo models and also a significant number of our large SSX Sportsboats, introduced in the 2014 model year. In the first six months of 2014, sales outside of the United States accounted for 18.6 percent of net sales compared to 21.4 percent of net sales for the comparable period in 2013. International net sales decreased 3.8 percent to $17.8 million and domestic net sales increased 10.6 percent to $77.9 million compared to the comparable periods in the prior year.

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Cost of goods sold for the six months ended June 30, 2014 was $77.4 million compared to $72.1 million for the comparable period in 2013, an increase of $5.3 million or 7.4 percent. Cost of goods sold, as a percentage of net sales, decreased primarily due to a favorable model mix, lower incentives, improved margins on parts and accessories sales and enhanced operating efficiencies.

Selling, general and administrative expenses for the six months ended June 30, 2014 were $11.4 million compared to $10.5 million for the comparable period in 2013, an increase of $0.9 million or 8.6 percent. This increase was due to expenses that vary with sales and profitability, such as incentive compensation, sales commissions and warranty expense. Warranty expense was 1.6 percent of net sales for the six months ended June 30, 2014 compared to 1.7 percent in the prior year.

Operating income for the six months ended June 30, 2014 increased $2.9 million compared to the comparable period in 2013 due to higher gross profit, partially offset by higher selling, general and administrative expenses.

Interest income was $243 thousand during the six months ended June 30, 2014 compared to $327 thousand for the comparable period in 2013. This decrease was primarily due to a decrease in realized gains, coupled with lower yields, partially offset by an increase in the average balance of our marketable securities portfolio.

Income tax provision for the six months ended June 30, 2014 was $2.1 million compared to $0.9 million for the comparable period in 2013. The income tax provision for the six months ended June 30, 2014 reflects an effective tax rate of 30.1 percent compared to an effective tax rate of 21.0 percent for the prior year. The 2014 rate is a result of continued beneficial permanent differences including tax-exempt interest income and a favorable U.S. manufacturing deduction. The 2013 effective tax rate benefited from the impact of research and experimentation credits for both 2013 and the full year of 2012 when the credit was retroactively enacted into law in the first quarter of 2013.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

The Company's cash and cash equivalents at June 30, 2014 were $2.5 million compared to $5.1 million at December 31, 2013. In addition, the aggregate of short-term and long-term marketable securities was $44.4 million at June 30, 2014 compared to $36.6 million at December 31, 2013.

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The following table sets forth the cash flows for the applicable periods:

Six months ended June 30, (in thousands) 2014 2013 Net cash provided by operating activities $ 8,951$ 5,525 Net cash (used for) provided by investing activities (7,998 ) 218 Net cash used for financing activities $ (3,614 )$ (2,764 )



Cash provided by operating activities for the six months ended June 30, 2014 increased approximately $3.4 million compared to the comparable period in 2013. This increase is primarily due to an increase in net income, coupled with a favorable change in working capital. The major components of the net favorable change in working capital were as follows: a favorable change of $4.8 million in inventories due to inventory management and timing of shipments; $1.6 million favorable change in accrued expenses and other long-term liabilities, largely attributable to timing of payments related to warranties and retail incentives; and a $5.5 million unfavorable change in accounts payable, due primarily to timing of payments.

Cash used for investing activities for the six months ended June 30, 2014 was approximately $8.0 million compared to $0.2 million provided by investing activities for the same period in 2013. The increase in cash used for investing activities is primarily due to increased purchases of marketable securities in the current period because of increases in cash provided by operations.

Cash used for financing activities for the six months ended June 30, 2014 increased approximately $0.9 million compared to the six months ended June 30, 2013 primarily due to an increase in share repurchases, coupled with an increase in shares purchased for withholding taxes on the vesting of restricted shares.

Financial Condition and Liquidity

The Company believes that the liquidity provided by existing cash, cash equivalents and marketable securities, its overall strong capitalization and cash generated by operations will provide sufficient capital to meet the Company's requirements for at least the next twelve months. The Company's decisions about the amount of cash to be used for investing and financing purposes are influenced by its capital position and the expected amount of cash to be provided by operations.

24 MARINE PRODUCTS CORPORATION AND SUBSIDIARIES



Cash Requirements

The Company currently expects that capital expenditures during 2014 will be approximately $1.4 million of which $258 thousand has been spent through June 30, 2014.

The Company participates in a multiple employer Retirement Income Plan, sponsored by RPC, Inc. ("RPC"). The Company made a $135 thousand cash contribution to this plan during the first six months of 2014 and does not expect to make any additional contributions for the remainder of 2014.

As of June 30, 2014, the Company has purchased a total of 5,133,785 shares in the open market under the Company stock repurchase program and there are 3,116,215 shares that remain available for repurchase under the current authorization. The Company repurchased 100,000 shares under this program during the six months ended June 30, 2014.

The Company warrants components of the boat, excluding the engine, against defects in materials and workmanship for a period of one year. Cockpit upholstery is warranted for 2 years. The Company also warrants the structural hull, including its bulkhead and supporting stringer system, against defects in materials and workmanship for as long as the original purchaser owns the boat. The structural deck is warranted for a period of 5 years to the original purchaser. See Note 6 to the Consolidated Financial Statements for a detail of activity in the warranty accruals during the six months ended June 30, 2014 and 2013.

OFF BALANCE SHEET ARRANGEMENTS

To assist dealers in obtaining financing for the purchase of its boats for inventory, the Company has entered into agreements with various third-party floor plan lenders whereby the Company guarantees varying amounts of debt for qualifying dealers on boats in inventory. The Company's obligation under these guarantees becomes effective in the case of a default under the financing arrangement between the dealer and the third-party lender. The agreements provide for the return of all repossessed boats to the Company in a new and unused condition as defined, in exchange for the Company's assumption of specified percentages of the debt obligation on those boats, up to certain contractually determined dollar limits which vary by lender. The Company had no material repurchases of inventory during the year ended December 31, 2013 or the six months ended June 30, 2014.

Management continues to monitor the risk of defaults and resulting repurchase obligations based in part on information provided by the third-party floor plan lenders and will adjust the guarantee liability at the end of each reporting period based on information reasonably available at that time.

The Company currently has an agreement with one of the floor plan lenders whereby the contractual repurchase limit is to not exceed 16 percent of the amount of the average net receivables financed by the floor plan lender for dealers during the prior 12 month period, which was $7.8 million as of June 30, 2014. The Company has contractual repurchase agreements with additional lenders with an aggregate maximum repurchase obligation of approximately $5.4 million with various expiration and cancellation terms of less than one year, for an aggregate repurchase obligation with all financing institutions of approximately $13.2 million as of June 30, 2014.

25 MARINE PRODUCTS CORPORATION AND SUBSIDIARIES



RELATED PARTY TRANSACTIONS

In conjunction with its spin-off from RPC in 2001, the Company and RPC entered into various agreements that define their relationship after the spin-off. RPC charged the Company for its allocable share of administrative costs incurred for services rendered on behalf of Marine Products totaling approximately $339 thousand in the six months ended June 30, 2014 and $268 thousand in the six months ended June 30, 2013.

During the quarter ended June 30, 2014, the Company purchased 100,000 shares for total consideration of $775,000, from one of its directors who is also an executive officer. The purchase was completed under the stock buyback program approved by the Board of Directors that is currently in effect.

CRITICAL ACCOUNTING POLICIES

The discussion of Critical Accounting Policies is incorporated herein by reference from the Company's annual report on Form 10-K for the fiscal year ended December 31, 2013. There have been no significant changes in the critical accounting policies since year-end.

IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS

See Note 2 of the Consolidated Financial Statements for a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition.

SEASONALITY

Marine Products' quarterly operating results are affected by weather and general economic conditions. Quarterly operating results for the second quarter historically have reflected the highest quarterly sales volume during the year with the first quarter being the next highest sales quarter. However, the results for any quarter are not necessarily indicative of results to be expected in any future period.

26 MARINE PRODUCTS CORPORATION AND SUBSIDIARIES INFLATION



The market prices of certain material and component costs used in manufacturing the Company's products, especially resins that are made with hydrocarbon feedstocks, copper and stainless steel, were very volatile as a result of the financial crisis of 2008, the ensuing global recession and the subsequent economic recovery. During the second quarter of 2014, the prices of many of these commodities were constant. Although the potential exists for these costs to remain volatile, we believe that the Company's material costs will remain relatively stable in 2014. In the event that the prices of these commodities increase in the future and result in higher raw materials costs, we cannot be confident that the Company will be able to institute sufficient price increases to its dealers to compensate for these increased materials costs, or that the Company will be able to implement manufacturing strategies that will significantly reduce usage of raw materials that will compensate for any increased materials costs.

New boat buyers typically finance their purchases. Higher inflation typically results in higher interest rates that could translate into an increased cost of boat ownership. Should higher inflation and increased interest rates occur, prospective buyers may choose to forego or delay their purchases or buy a less expensive boat in the event that interest rates rise or credit is not available to finance their boat purchases.

FORWARD-LOOKING STATEMENTS

Certain statements made in this report that are not historical facts are "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may include, without limitation, the expected effect of recent accounting pronouncements on the Company's consolidated financial statements; the Company's estimate for warranty accruals; our favorable outlook for the near-term selling environment for our products; our belief that recreational boating retail demand in many segments of the industry is improving; our belief that there is improved demand from consumers who have delayed purchasing a boat over the past few years due to economic uncertainty; our belief that the recent expansion of sales volumes will continue for the remainder of 2014; our belief that improvements in retail boat sales will be modest due to the lack of economic improvement; the Company's belief that the recreational boating industry promotional program has incrementally benefited the industry and Marine Products; our plans to continue to emphasize the value-priced Chaparral and Robalo models as well as larger models in the Chaparral line-up including the SSX's and new Robalo bay boat models; our plans to introduce a larger Vortex jet boat model for the 2015 model year and the anticipated timing for production of those models; our belief that these jet boat models will expand our customer base and leverage our strong dealer network and reputation for quality and styling; the Company's belief that its liquidity, capitalization and cash expected to be generated from operations, will provide sufficient capital to meet the Company's requirements for at least the next twelve months; the Company's expectations about capital expenditures during 2014; the Company's expectation about contributions to its pension plan in 2014; the Company's belief that material costs will remain relatively stable in 2014; the Company's belief that it may not be able to institute sufficient price increases to compensate for increased material costs or implement manufacturing strategies that will significantly reduce usage of raw materials to compensate for any increased material costs; the Company's expectation regarding market risk of its investment portfolio; and the Company's expectations about the effect of litigation on the Company's financial position or results of operations.

27 MARINE PRODUCTS CORPORATION AND SUBSIDIARIES



The words "may," "should," "will," "expect," "believe," "anticipate," "intend," "plan," "believe," "seek," "project," "estimate," and similar expressions used in this document that do not relate to historical facts are intended to identify forward-looking statements. Such statements are based on certain assumptions and analyses made by our management in light of its experience and its perception of historical trends, current conditions, expected future developments and other factors it believes to be appropriate. We caution you that such statements are only predictions and not guarantees of future performance and that actual results, developments and business decisions may differ from those envisioned by the forward-looking statements. Risk factors that could cause such future events not to occur as expected include the following: economic conditions, unavailability of credit and possible decreases in the level of consumer confidence impacting discretionary spending, business interruptions due to adverse weather conditions, increased interest rates, unanticipated changes in consumer demand and preferences, deterioration in the quality of Marine Products' network of independent boat dealers or availability of financing of their inventory, our ability to insulate financial results against increasing commodity prices, the impact of rising gasoline prices and a weak housing market on consumer demand for our products, competition from other boat manufacturers and dealers, and insurance companies that insure a number of Marine Products' marketable securities have been downgraded, which may cause volatility in the market price of Marine Products' marketable securities. Additional discussion of factors that could cause actual results to differ from management's projections, forecasts, estimates and expectations is contained in Marine Products Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2013. The Company does not undertake to update its forward-looking statements.


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