Good morning, and welcome to the Escalade Inc. Third Quarter 2022 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Patrick Griffin, Vice President, Corporate Development. Please go ahead.

Good morning, and welcome to the Escalade Incorporated third quarter 2022 earnings conference call. Leading the call with me today are President and CEO, Walt Glazer; and Stephen Wawrin, Chief Financial Officer. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in our periodic reports filed with the SEC. Except as required by law, we undertake no obligation to update our forward-looking statements. At the conclusion of our prepared remarks, we will open the line for questions. With that, I'd like to turn the call over to Walt.

Thank you, Patrick, and welcome to those joining us today. During a period of broad-based inflationary pressures and rising interest rates, our third quarter results were impacted by lower customer demand across most product categories as our mass merchant channel partners seek to align elevated inventory levels with a near-term deceleration in consumer discretionary spending. In speaking with our retail partners, we believe the consumer is in a transitional period where households are seeking to recalibrate how much they have to spend on discretionary categories like ours as the cost to maintain their standard of living continues to rise. Importantly, demand hasn't grown to a halt, but it has slowed. Mass merchants have slowed purchasing in our categories to reduce their total inventory. Importantly, outside of the mass merchant channel, all other sales channels generated year-over-year sales growth in the third quarter. Over the last two years, we've had to do very little in the way of promotional pricing as demand for our products has grown. This year, as we enter the holiday season, we do expect to introduce selective promotions as we seek to reduce our finished goods inventory toward historical levels over the next several quarters. We believe this inventory reduction will also reduce our carrying cost and improve asset utilization to more acceptable levels in the future. In summary, while the near-term decline in sales growth is disappointing, we believe that the strength and diversity of our brands, diverse sourcing capabilities, and lean operating model position us to successfully navigate the current macroeconomic environment. We also believe that our end consumer, which often includes a higher earnings, more affluent demographic, is more resilient through economic cycles, which should benefit us. Given the slowing demand environment, we stayed very disciplined in managing controllable expenses and addressing supply chain and logistics challenges while continuing to deliver superior value to our customers. Looking forward, we also believe a potential economic downturn may create additional market share opportunities for the company. Turning now to a discussion of our third quarter performance. Net sales declined 7.9% year-over-year and gross margin dropped by 432 basis points. The decline in both sales and margin was primarily driven by softness in demand for our outdoor categories led by archery. This softness was partially offset by sales of our billiards and pickleball products. Elevated freight and logistic expenses more than offset some lower material costs in the third quarter, contributing to the gross profit margin decline. We are beginning to see lower ocean freight rates and improved turnaround times, but inland freight remains challenging due to labor and equipment shortages. Our gross profit margin during the quarter was also adversely impacted by a $1 million accrual related to projected expenses for a product recall. We continue to see sustained demand in some of our categories. Pickleball, in particular, is a category where demand remains strong as broad-based adoption of the sport continues at an accelerated pace. As discussed last quarter, we continue to expand our product assortment of paddles, balls, and accessories with our leading brands, ONIX and Dura. Our selection of pickleball gear is perfect for any level of player from beginner to professional. ONIX is a leading equipment brand in the sport and remains one of the most visible sponsors of the Professional Pickleball Association and top professionals in the sport. Outside of pickleball, we continue to build our strength in other growing outdoor lifestyle categories. Last month, we announced an exciting new partnership with the American Cornhole League which provides us the license to make, sell, and distribute American Cornhole League products to our expansive list of retail partners. The ACL is the leading worldwide governing body for professional, competitive, and recreational cornhole. The ACL is also the recognized leader in popularizing cornhole with its pro and amateur events around the country as well as broadcast deals on ESPN and CBS. With pickleball, cornhole, and other categories, we continue to build strong niche lifestyle brands that, in any economic environment, tend to have a loyal following of repeat customers that will continue to benefit us over the longer term. While we are not satisfied with the 2022 year-to-date results, we are taking steps to right-size our cost structure and asset base to weather the economic headwinds and position our company for continued growth in the years ahead. Following the end of our third quarter, we exercised an additional $15 million accordion feature under our senior revolving credit facility. We now have nearly $30 million of available liquidity. At the end of the third quarter, net debt outstanding, or total debt less cash, was three times trailing 12 months EBITDA. Total inventories were $135 million at the end of the third quarter, up from $130 million at the end of the second quarter. The sequential increase in inventory was primarily the result of softening consumer demand and some order cancellations by our customers due to elevated inventory levels in the retail channel. Vendor deposits and inventory in transit were both down meaningfully in the quarter. As we move through the seasonally strong fourth quarter, we expect to see inventory levels begin to decline, which should benefit our cash and liquidity position going into the new year. As before, we remain committed to our capital allocation strategy and disciplined balance sheet management. We continue to target long-term net leverage of 1.5 to 2 times EBITDA, along with funding internal growth initiatives and the consistent payment of our quarterly cash dividend.

Thanks, Walt, and good morning, everyone. For the three months ended October 1, 2022, Escalade reported net income of $3 million or $0.22 per diluted share on net sales of $74.9 million. The company reported gross margin of 18.2% compared to 22.5% in the prior year period. The 432 basis point decline in margin was a result of lower sales, unfavorable product mix, global supply chain constraints, and the nonrecurring product recall expense Walt mentioned earlier. This product recall expense adversely impacted our earnings per share by $0.06 per diluted share in the quarter. Selling, general, and administrative expense as a percentage of net sales declined 11.7% compared to 12.5% in the prior year period due to ongoing expense mitigation initiatives. Total cash used in operations was $5.5 million for the quarter compared to the use of $2.6 million in the prior year period. Total capital expenditures were approximately $0.3 million during the third quarter compared to $4 million in the third quarter of last year when we purchased manufacturing and warehouse facilities in Olney, Illinois. We expect to normalize the level of capital expenditures in the quarters ahead. Earnings before interest, taxes, depreciation, and amortization declined 35.3% to $5.8 million in the third quarter of 2022 versus $9 million in the prior year period. For the year-to-date period, EBITDA decreased 9.7% to $26.7 million compared to $29.5 million in 2021. As of October 1, 2022, the company had total cash and equivalents of $4 million, together with $10 million of availability on our senior secured revolving credit facility maturing in 2027. As Walt mentioned, this availability increased by $15 million in late October following the close of our third quarter as we exercise the remaining portion of our accordion on senior secured credit facilities. In conjunction with the execution of the accordion feature, we also amended our credit agreement to give us more cushion on our leverage ratio requirement. The amendment increased our maximum leverage ratio from three times to 3.25 times for the third and fourth quarters of 2022, three times for the first quarter of 2023, and back to 2.75 times starting the second quarter of 2023. In addition, we also announced this morning a quarterly dividend of $0.15 per share to be paid to all shareholders of record on December 5, 2022, and this first on December 12, 2022.

Thank you. At this time, we will be conducting our question-and-answer session. We have a first question from the line of Rommel Dionisio with Aegis Capital. Please go ahead.

Yeah, good morning. I wonder if you could just talk about the competitive promotional environment, pricing environment. Just because, I mean, when you have excess retail inventories, you usually see a lot of promotions to clear that inventory. But obviously, in an inflationary period at sort of a countervailing factor, I wonder if you could just kind of maybe discuss that. I know you talked about in the prepared comments on select promotions of your own as we're especially as we're entering the holiday season and Black Friday and all that, if you could just give us some color on the competitive promotional environment. Thanks.

Sure, Rommel. Thanks for your question. Yeah, certainly, there is inflation in the system, but the reality is that we, a lot of our competitors and our customers have excess inventory. And so, we are anticipating more promotional activity in the fourth quarter. Our customers have indicated they intend to do the same, and we're prepared for that. And our primary objective is to reduce the level of inventory that we're carrying currently, and we have plans in place to do that.

Okay. And I know one of the initiatives on cost control you guys have implemented over the last few quarters has been kind of reengineering some products as well. Could you just give us an update on that, if that's continuing and how that's going? Thanks.

Sure. Yeah. So cost reduction is always on our mind. It's something that we do. We focus on every day, both in our overhead and in our product design. So we are continuing to do that. I would say, Rommel, that we are seeing some decreases in raw material costs. We're seeing decreases in ocean freight rates. So we believe that costs will continue to come down. And here, again, that's another reason why we want to reduce the amount of inventory that we're carrying. We anticipate purchasing inventory in the year ahead at costs below what they were last year.

Okay. Thanks very much for the color.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session, and I'd like to turn the call back over to Patrick Griffin for closing remarks. Over to you, Patrick.

Once again, thank you for your interest in Escalade and joining our call. Should you have any questions, feel free to contact us at [email protected], and a member of our team will follow up with you. This concludes our call today. You may now disconnect.

Thank you. Ladies and gentlemen, this concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.