Escalade - Q2 2023

Transcript

Operator (participant)

Greetings, and welcome to the Escalade second quarter 2023 results conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.

Patrick Griffin (VP of Corporate Development and Investor Relation)

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 discussions 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.

Walt Glazer (President and CEO)

Thank you, Patrick. 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 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, four-week periods. This year, going forward, we will report results for the traditional three months, 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 of sporting goods remain 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 points 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 significant double-digit year-over-year sales growth in our pickleball category, despite the shorter second quarter this year. We are also pleased to announce that our Goalrilla Basketball brand has collaborated with Johnny Stephen, the founder of HandleLife 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 HandleLife collaboration, which provides consumers with effective training tools to improve their game. We are 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 29th through August 6th, 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 fortified balance sheet. We continue to focus on optimizing our cost structure 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 4.0 times. However, we remain committed to reducing our leverage to our targeted range between 1.5 and 2.5 times. 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, 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.

Stephen Wawrin (CFO)

For the three 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 gross margin of 24.6%, compared to 25.1% in the prior year period. The 50 basis points 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-$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 30th, 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 four times trailing twelve-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 29th, 2023, and dispersed on September 5th, 2023. One last important thing to remember, effective on January 1st, 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. With that operator, we will open the call for questions.

Operator (participant)

Thank you. We'll now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for your question. Our first question comes from the line of Rommel Dionisio with Aegis Capital. Please proceed with your question.

Rommel Dionisio (Head of Research)

Good morning. Thanks very much for taking my question. I think you had talked about incurring some severance costs in second quarter, and also obviously you realized some cost savings as a result of your recent restructuring efforts. Did I understand correctly that most of the one-time costs were incurred in 2Q, but maybe didn't get a full quarter of benefit cost savings in 2Q? Going forward, things should look even better with regards to maybe lower severance expense and higher cost savings? as a result of getting the full quarter's benefit. Am I reading that correctly? Thanks.

Walt Glazer (President and CEO)

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

Rommel Dionisio (Head of Research)

It does. Yeah. 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, just how should we think about where that number, in terms of benchmarking, should be at the end of third quarter and fourth quarter relative to where it was in second quarter? Thanks.

Walt Glazer (President and CEO)

Sure. Sure. Of course, we're, we're looking at inventory on, on two levels, both at our customers and, and on ours. You know, we've made great progress so far this year. We anticipate further progress in the second half of the year. What we're seeing with our customers is a reduction in inventories. They're coming down. They still need to come down further in certain categories. What I've observed is that our customers are more conservative than they have been, and so they're probably gonna carry less inventory, perhaps maybe even than they need, going into the holiday season and into 2024. You know, we're monitoring that. We're seeing improvement, but, you know, as to where how low it goes, that remains to be seen. In certain categories, like pickleball, inventories are short. You know, we're chasing to keep up with these hot new paddles that we've just introduced.

Rommel Dionisio (Head of Research)

Great. Okay, I'll jump back in the queue. Thank you very much.

Operator (participant)

Thank you. Once again, if you'd like to ask a question, please press star one on your telephone keypad. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment please, while we poll for more questions. Our next question is a follow-up from Rommel Dionisio with Aegis Capital. Please proceed with your question.

Rommel Dionisio (Head of Research)

Oh, great. Okay, thanks. I'll just ask one more, if I could. The, you know, I know when, 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, your stronger margins than what we were looking for in Q2, anyway. Thank you.

Walt Glazer (President and CEO)

Yeah, sure. We, you know, when containers were, you know, $20,000+, you know, it was imperative to improve the packaging and the way that we ship the product to take less space and get more items on the container. We've done that. What we've seen is that freight rates, ocean freight rates are, you know, quite low now. The impact is not as strong, you know, from those re-engineering efforts, but we are continuing to, you know, benefit from those. You know, we're seeing lower freight rates, we're seeing better efficiency of the container packing, we're seeing better currency exchange, and we're seeing lower raw material costs. Those are the things, Rommel, that are contributing to these higher margins, and we anticipate those effects to continue.

Rommel Dionisio (Head of Research)

Great. All right, thanks very much.

Walt Glazer (President and CEO)

Thank you.

Operator (participant)

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

Patrick Griffin (VP of Corporate Development and Investor Relation)

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 [email protected]. This concludes our call today. You may now disconnect.