Escalade Inc Q2 FY2023 Earnings Call

Greetings, and welcome to the Escalade Second Quarter 2023 Results Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Patrick Griffin, Vice President of Investor Relations. Thank you, sir. You may begin.

Thank you, operator. On behalf of the entire team at Escalade, I'd like to welcome you to our second quarter 2023 results conference call. Leading the call with me today are President and CEO, Walt Glazer; and Stephen Wawrin, our 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 lines for questions. With that, I would like to turn the call over to Walt.

Thank you, Patrick, and welcome to those joining us on the call today. I'm pleased to report that our team did a fantastic job recovering from a difficult first quarter and delivered strong second quarter results, highlighted by substantial growth in cash flow from operations, significant inventory and long-term debt reductions, EBITDA margin expansion, and thoughtful expense reductions. These accomplishments made by our team enabled us to beat the plan in the second quarter. Sales volumes improved significantly during the second quarter. Importantly, our results were substantially impacted by 21 fewer days within our reporting calendar as we moved to a traditional reporting calendar on January 1, 2023. Previously, our second quarter included four 4-week periods. This year and going forward, we will report results for the traditional 3-month April through June calendar quarter. Excluding the impact of the change in our reporting calendar, sales declined 9.5% on a year-over-year basis, which was an improvement over the prior quarter's sales decline of 28.5%. During the second quarter, our direct-to-consumer sales accelerated meaningfully, with non-licensed DTC sales up more than 60% versus the year-ago April through June period, driven by a combination of effective marketing campaigns and recent new product launches. While U.S. retail sales and sporting goods remained soft and channel inventories are still elevated, we are cautiously optimistic about recent increases in housing starts and somewhat improved consumer sentiment, driven by stability in the labor markets and a slowdown in inflation. We believe our diverse portfolio of leading recreational brands will continue to resonate with consumers in this changing environment. Operationally, the supply chain challenges that we faced last year have continued to lessen, particularly with respect to freight expenses. Improved operating leverage, lower-cost inventory, price discipline, expense reductions, and a more favorable product mix resulted in a 515 basis point sequential gross margin improvement between the first and second quarter of 2023. We anticipate further normalization in wholesale channel inventories as we move into the second half of this year, which should position us to capitalize on restocking opportunities entering the holiday season. As before, we remain highly focused on a combination of cost control, improved working capital management, and balance sheet optimization. Strategically, we continue to focus on investing in innovative product development to build market-leading positions in key growth categories. For example, during the second quarter, we launched a range of new carbon-based pickleball paddles that improve performance and playability for the fast-growing market of pickleball enthusiasts. This launch included our Evoke Premier Raw Carbon range as well as the Malice and Mayhem paddles, which utilize our patented ThermoFused Technology. Consumer acceptance of these exciting new paddles has exceeded our expectations and quickly sold through initial production runs. We are accelerating manufacturing to meet the strong demand. This successful launch also contributed to a significant double-digit year-over-year sales growth in our pickleball category despite the shorter second quarter of this year. We are also pleased to announce that our Goalrilla basketball brand has collaborated with Johnny Stephene, the founder of Handle Life and an NBA Skills Coach, to launch a range of weighted basketballs designed to improve ball handling efficiency and playmaking ability. Johnny's social media accounts have gained over 2 million followers who are interested in his unique story and amazing ball-handling skills. We are excited about this new Handle Life collaboration, which provides consumers with effective training tools to improve their game. We're also launching new products in several other key categories over the coming quarters, particularly an innovative assortment of American Cornhole League licensed cornhole boards and bags, which will launch initially at Academy Sports + Outdoors. For some thrilling cornhole competition, please tune in to the American Cornhole League World Championships, which will be held in Rock Hill, South Carolina from July 29 through August 6 and will air on ESPN and the CBS Sports Network. As we navigate the challenging demand environment, we know the importance of maintaining an appropriate cost structure and a fortified balance sheet. We continue to focus on optimizing our cost structure and maximizing cash flow. As highlighted by our second quarter results, we have already made great strides in improving our gross margins by reducing fixed costs and through lowering our operational expenses. We remain on track to achieve $2.3 million in annual cost savings and expect our costs to continue to trend lower through the remainder of the year. We continue to carry the ongoing expense of our Mexico operations and remain focused on divesting this facility by the end of 2023. We have spent approximately $900,000 year-to-date on professional services and severance expenses related to this divestiture. As previously mentioned, we continue to be sharply focused on cash flow. Cash conversion during the second quarter exceeded 100%, primarily due to improved working capital management, including the more optimal use of our cash on hand. As we continue through the end of the year, our inventory levels should drive additional cash generation, which we will utilize to further reduce our debt. At the end of the second quarter, our net leverage was 4.0x. However, we remain committed to reducing our leverage to our targeted range between 1.5 and 2.5x. While we have built our business over the years with a number of value-creating acquisitions, our current capital allocation priorities remain long-term debt reduction and payment of our dividend. Along with our focus on lowering net leverage, we continue to tightly control discretionary spending, including capital expenditures. Entering the third quarter, our team continues to do a great job navigating the current macro environment while also ensuring that we remain competitively positioned to support our retail partners and consumers loyal to our brands. I'm proud of the hard work and dedication of our team in responding to a disappointing first quarter by delivering a good second quarter with improved performance across most key metrics. We will continue to focus on creating exceptional consumer experiences that build brand loyalty, all while creating long-term shareholder value. We look forward to updating you with all our progress next quarter. With that, I'll turn over the call to Stephen for his prepared remarks.

For the 3 months ended June 30, 2023, Escalade reported net income of $3.6 million or $0.26 per diluted share on net sales of $67.8 million. For the second quarter, the company reported a gross margin of 24.6% compared to 25.1% in the prior year period. The 50-basis-point decline was primarily the result of higher cost inventory, elevated inventory storage and handling costs, and lower operating leverage on a comparably lower revenue base, partially offset by improved margins in several categories and expense reductions implemented through the second quarter. Selling, general, and administrative expenses declined 33.5% compared to the prior-year period to $9.8 million. The decrease in SG&A expense year-over-year was caused by lower variable selling expenses and initiatives to reduce our fixed costs, which Walt mentioned earlier. Earnings before interest, taxes, depreciation, and amortization declined by $2.7 million to $7.7 million in the second quarter of 2023 versus $10.3 million in the prior year period. Total cash provided by operations was $8.4 million for the quarter compared to $2.5 million in the prior year period. The increase in cash flow from operations reflects cash generated from improvement to working capital as a result of a reduction of inventories through the second quarter of 2023. Additionally, capital expenditures during the quarter decreased to approximately $500,000 from the prior-year period as we carefully manage our capital spending. As of June 30, 2023, the company had total cash and equivalents of $577,000 together with $42.4 million of availability on our senior secured revolving credit facility maturing in 2027. At the end of the second quarter of 2023, net debt outstanding or total debt less cash was 4x trailing 12-month EBITDA. In addition, we announced this morning a quarterly dividend of $0.15 per share to be paid to all shareholders of record August 29, 2023, and disbursed on September 5, 2023. One last important thing to remember, effective on January 1, we transitioned to a conventional 12-month reporting calendar. As a result, the second quarter of 2023 had 91 operating days as opposed to 112 operating days in the prior year period. This dynamic will have an impact on the comparability of our results for the third quarter.

We announced this morning a quarterly dividend of $0.15 per share to be paid to all shareholders of record on August 29, 2023, and disbursed on September 5, 2023. Additionally, starting January 1, we switched to a standard 12-month reporting calendar. Consequently, the second quarter of 2023 had 91 operating days compared to 112 operating days in the same period last year. This change will affect the comparability of our results for the third quarter.

I understand you mentioned that you incurred some severance costs in the second quarter. Additionally, you've achieved some cost savings from your recent restructuring efforts. Did I get it right that most of the one-time costs were incurred in the second quarter, but you may not have received the full benefit of the cost savings in that quarter? Moving forward, it seems like things should improve with potentially lower severance expenses and greater cost savings, as well as realizing the full quarter's benefit. Am I interpreting that accurately?

Rommel, I think I understand your question. So we have an ongoing cost savings program, and these initiatives are generating opportunities that are coming in every week from our teams. And so they're being implemented as we receive them. At the same time, we are shutting down our Mexico operation. So we're incurring the cost to carry the facility, we're incurring severance costs as we reduce the payroll there. So both of these things will continue into the third quarter and the cost savings, most of those will continue to develop and will benefit us Q3, Q4 and into 2024. Does that answer your question?

Yes. No, it's very helpful. Maybe just as a follow-up, how should we think about the inventory levels now? I know you were trying to build some safety stock as you're shutting down Rosarito. But just how should we think about where that number in terms of benchmarking should be at the end of the third quarter and fourth quarter relative to where it was in the second quarter?

Sure, we're looking at inventory levels from both our perspective and our customers'. We've made significant progress this year and expect more improvements in the second half. Our customers are reducing their inventories, but they still need to decrease them further in some categories. I've noticed that they're being more cautious than before, so they may hold less inventory than needed as we approach the holiday season and into 2024. We're keeping an eye on this and are seeing positive changes. However, it's uncertain how low the inventory levels will go. In specific categories, like pickleball, we're experiencing low inventories as we strive to keep up with demand for our new paddles.

Our next question is a follow-up from Rommel Dionisio with Aegis Capital.

Great. Okay. So I'll just ask one more, if I could. I know when supply chain was kind of turning against the industry last year and the year before that. You guys were looking to engineer products a little bit differently to drive additional cost savings. I wonder if you could just update us on the progress you've made there, to what extent that's contributing to stronger margins than what we were looking for in 2Q anyway.

Yes, certainly. When container costs were over $20,000, it was essential to enhance our packaging and shipping methods to maximize space and increase the number of items per container. We've successfully implemented those changes. Now that freight rates for ocean shipping are quite low, the impact of our reengineering efforts isn't as pronounced, but we are still reaping benefits from them. We're experiencing lower freight costs, improved container packing efficiency, better currency exchange rates, and decreased raw material costs. These factors are all contributing to our increased margins, and we expect these benefits to persist.

There are no further questions at this time. I'd like to turn the call back over to Patrick Griffin for any closing remarks.

Once again, thank you for your interest in Escalade and joining our call. Should you have any questions, please feel free to contact us at ir@escaladeinc.com. This concludes our call today. You may now disconnect.