Escalade - Q3 2024

Transcript

Operator (participant)

After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mr. Patrick Griffin, Vice President of Corporate Development. Please go ahead, sir.

Patrick Griffin (VP of Corporate Development)

Thank you, operator. On behalf of the entire team at Escalade, I'd like to welcome you to our third quarter 2024 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 line for questions. With that, I would like to turn the call over to Walt.

Walt Glazer (CEO)

Thank you, Patrick, and welcome to those joining us on the call. During the third quarter, we made substantial progress optimizing our asset base and cost structure as we navigate a transitional period in consumer demand. While net sales declined 7.7% versus the prior year, we achieved modest gross margin expansion, even while absorbing $1.8 million of non-recurring business rationalization expense in our cost of goods sold. Excluding these non-recurring expenses, our gross margin would have been 27.4%, representing a 265 basis points improvement over the prior year. Our portfolio optimization efforts during the quarter included the sale of our Rosarito, Mexico facility, the cost rationalization at our Eagan, Minnesota facility, the wind down of operations in Orlando, Florida, and the consolidation of our high-end billiards accessory products into our Bristol, Wisconsin facility.

The optimization of our operational footprint will largely be complete by year-end. With the completion of this program, we will reduce our operational footprint by approximately 300,000 sq ft, or 20%. The team has done an outstanding job this year, rescaling our operations while still providing ample capacity to support a recovery in consumer demand. In addition, we remain focused on maximizing our cash flow and generated $10.5 million of cash from operations during the quarter. Along with proceeds from the sale of our Rosarito facility, we distributed over $2 million in dividends, made capital expenditures to support our operations, and repaid nearly $14 million of debt, taking our net leverage ratio to 1.1x.

Going forward, we expect these efforts to drive higher gross margins through the end of the year in 2025, despite near-term softness in consumer demand. As we move into the holiday season, we anticipate a higher level of promotional activity as we believe consumers will be price conscious given the economic environment. At the same time, we anticipate promotional activity will serve to accelerate the inventory destocking efforts already underway at many retailers. Despite soft consumer spending for consumer discretionary goods, we continue to see favorable demand in our archery, safety, and basketball categories, driven by new product introductions. Additionally, our own direct-to-consumer e-commerce volumes continue to increase, up 29% year over year during the quarter. We believe consumer loyalty to our market-leading, differentiated recreational brands continues to position us to deliver above market performance as we move through the next phase of the retail cycle.

As before, we continue to invest in connecting more deeply with consumers through our own e-commerce initiatives, marketing programs, and corporate partnerships, while continuing to deliver category-leading innovative brands that build loyalty across a diverse base of established and emerging recreational sports. Looking ahead, we are encouraged by the Federal Reserve's recent monetary easing, as well as a resilient job market. We continue to closely monitor household balance sheets and consumer sentiment. As interest rates likely move lower, we expect this will aid a recovery in consumer demand for discretionary, recreational goods. However, we recognize the cycle will take some time, and we do not expect to see materially stronger demand in the near term as we settle into consumer spending patterns more similar to the pre-pandemic economy. In the meantime, we are committed to improving our financial position through optimizing our cost structure and maximizing our operating leverage.

These efforts, along with ongoing inventory rationalization, will not only position us to navigate the ongoing trough in consumer demand, but also position us for profitable growth and outperformance through the next cycle. As we continue to generate strong cash flow, we are prioritizing the continued repayment of our higher cost variable rate debt, which we expect to pay off by the end of the year. In addition, we are continuing to invest in innovation, ensuring continued outperformance. A notable example is the Bear Archery team, which did an amazing job designing, manufacturing, and marketing a whole new lineup of compound bows. They've delivered substantial upgrades to five of our top six selling bows and have brought integrated riser capability to price points never seen before in the industry.

A highlight is the newest version of the Adapt bow, in partnership with The Hunting Public, an influencer group with online video series and podcasts for avid hunters, which has exceeded even our admittedly high expectations. We also launched the new Onix Supercell pickleball paddle, which introduces Cloud Control technology to the market. The 22 mm proprietary construction of the paddle creates an expansive sweet spot that provides outstanding control, touch, and power. As recently announced, we entered into an exciting new agreement to be the official U.S. distributor of Adidas fitness accessories. The Adidas brand is globally recognized and synonymous with high performance. This new partnership will expand our fitness offering, which today includes The Step, Lifeline, and US Weight brands. Our Adidas fitness accessory offering will be available online and in retail in early 2025.

Finally, during the third quarter, we began consolidation of our cue and case accessories business into the Bristol, Wisconsin, headquarters for our Brunswick Billiards Group. This allows us to combine dealer shipments of Brunswick and American Heritage Billiards and game room tables, along with a wide range of high-quality cue and case billiards accessories. Dealers will benefit from the efficiency of the combined shipments, further building upon our competitive advantages in this category. The Bristol team did a fantastic job planning and preparing, while working hand in hand with our highly capable Evansville associates to execute this transition, which is now complete. Our vision is to build and strengthen our brand portfolio, centered on helping consumers create great memories while engaging in healthy activities with their family and friends. We look forward to updating you with our progress next quarter.

With that, I'll turn the call over to Stephen for his prepared remarks.

Stephen Wawrin (CFO)

Thank you, Walt. For the three months ended September 30th, 2024, Escalade reported net income of $5.7 million or $0.40 per diluted share on net sales of $67.7 million. For the third quarter, the company reported gross margins of 24.8% compared to 24.7% in the prior year period. The 10 basis point increase was primarily the result of lower inventory handling costs and a reduction in fixed costs associated with our facility in Mexico, partially offset by lower net sales and a $1.8 million in non-recurring optimization expenses. Selling, general, and administrative expenses during the third quarter increased by 6% or $0.6 million compared to the prior year period to $11.1 million. The third quarter SG&A increase was mainly driven by higher professional fees.

Earnings before interest, taxes, depreciation, and amortization increased by $2 million to $9.9 million in the third quarter of 2024, versus $7.9 million in the prior year period. I would also note that in conjunction with the divestiture of our Rosarito, Mexico, facility, we recognized a $3.9 million gain on the sale of assets, which is reflected in our third quarter of 2024 operating income. Total cash provided by operations for the third quarter of 2024 was $10.5 million for the quarter, compared to $14.8 million in the prior year period. The decrease in operating cash flow is driven by timing of inventory management initiatives in the prior year, which drove strong free cash flow generation in the third quarter of 2023.

As of September 30th, 2024, the company had total cash and equivalents of $426,000. At the end of the third quarter of 2024, net debt outstanding, or total debt less cash, was 1.1x trailing 12-month EBITDA. As of September 30th, 2024, we had $29.5 million of total debt outstanding, including $2.1 million of high-interest variable rate debt. We will continue to focus on repaying the remainder of this variable rate debt this year, while driving our total net leverage below our long-term target range of 1.5x to 2.5x EBITDA. On October 11th, we proactively entered into an amendment to our senior secured revolving credit facility, which reduced our borrowing capacity by $15 million or 20%.

As a result of this amendment, we had total availability of $58.3 million. Recognizing the significant improvement in our working capital position this past year, we believe this new amendment provides ample availability for our current sales level and for future growth. As part of the amendment, we also exchanged our fixed charge coverage ratio covenant with an interest coverage ratio, giving us additional operating flexibility. With that, operator, we will open the call for questions.

Operator (participant)

Thank you. We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two, and at this time, we'll pause momentarily to assemble our roster, and the first question will come from Rommel Dionisio with Aegis. Please go ahead.

Rommel Dionisio (Head of Research)

Good morning. A couple of questions on some of the newer restructuring initiatives. Maybe you could just touch base on the Minnesota rationalization. I believe that's water sports, so is that in the distribution? So is that gonna go elsewhere, or are you just kind of, you know, maybe trimming the product assortment and you're able to save some, you know, generate some cost savings that way? Could you just provide a little more detail on that, please?

Walt Glazer (CEO)

Sure. Good morning, Rommel, and thank you for your question. Yeah, so in Minnesota, in Eagan, we have our water sports business, and we've had excess inventory there, so we've reduced our square footage, our space. We've also recognized that the category is temporarily smaller than it was traditionally, and so we had to make some tough decisions around staffing and personnel. Those decisions have been made, and the cost structure has been corrected, and we are prepared to grow that business when and if the consumer is ready to buy water sports again.

Rommel Dionisio (Head of Research)

Okay. Now maybe switching gears to the Orlando action. I think you mentioned you want to wind that down. You're targeting to wind that down by the year end. So that's, if I remember correctly, that's manufacturing and distribution for cornhole. Will that be shifted elsewhere, or are you thinking maybe, you know, downshifting on the business overall? Could you sort of walk us through your thoughts on that one? Thanks.

Walt Glazer (CEO)

Sure. Sure, Rommel. Yeah, and you're correct. That was the licensed cornhole business, and we've done a couple things. One is we're shifting to more of a pre-printed import model as opposed to print on demand in Orlando, so we've made that change. And then additionally, we're gonna consolidate that inventory into other facilities, primarily in Evansville, and some in Gainesville, Florida, as well. So just once again, adjusting the cost structure for the reality of the business today.

Rommel Dionisio (Head of Research)

Okay. No, that's, that's fair enough. That's great detail. So, there's no intention of kind of exiting that business or even kind of shrinking business? It's just more cost savings and relocation of other facilities and comes up some offshoring as well. Do I understand that correctly, Walt?

Walt Glazer (CEO)

Yes, we just wanna make sure that our cost structure is appropriate and that we're delivering great value to our consumers. And so that was very difficult to do with all the handling and the labor in Orlando.

Rommel Dionisio (Head of Research)

Great. Okay. And maybe just one last housekeeping question, if I could, maybe more for Steve. Stephen, the amortization expense was, you know, maybe about four, let's call $400,000, perhaps a little higher than would have been previous quarters. Is there something non-recurring there, or how should we think about that as a, kind of, an ongoing level for quarterly amortization? Thanks.

Stephen Wawrin (CFO)

No, you're correct, Rommel. That was actually part of the restructuring charges surrounding Orlando and writing off some of our intangible assets in that facility.

Rommel Dionisio (Head of Research)

Okay, so maybe a sixth from the, so the prior historical level seems like that should be more of an ongoing level. Is that kind of what I'm hearing?

Stephen Wawrin (CFO)

That's correct.

Rommel Dionisio (Head of Research)

Okay, perfect. Great. Thanks so much, gentlemen.

Stephen Wawrin (CFO)

Thank you.

Operator (participant)

The next question will come from David Cohen with Minerva. Please go ahead.

David Cohen (President and Chief Compliance Officer)

Thanks. Good morning, guys. As always, really good job of managing the balance sheet and paying down debt. As you alluded to, you're now sort of below your target debt range, and I'm wondering whether that occasions any reconsideration of capital allocation priorities, or whether you're not gonna make any decisions until there's a new CEO in place. Could you just give us whatever flavor you can of those conversations?

Walt Glazer (CEO)

Sure. Yeah, and good morning, David. Thank you for your question. Yeah, as you point out, we're below the range we've described, of 1.5x to 2.5x. We're at 1.1x, and it's likely gonna be lower than that by year end. So yeah, we are gonna continue to pay down the higher cost variable rate debt, which is costing us about 7.5%-8%. So that's a good use of capital, we think. You know, as far as the other capital allocation opportunities, you know, we pay a strong cash dividend. We have historically been a share repurchaser when the opportunity arose, and we've been an opportunistic acquirer as well.

I would say on the acquisition side, you know, we don't feel like we have to do anything now. We don't have any holes that we need to fill, but we are active in the flow of information. We're aware of businesses that, you know, are for sale or coming for sale. So, you know, we will continue to use all the levers of capital allocation, just depending on the opportunities that we're able to uncover. So that's where we stand today.

David Cohen (President and Chief Compliance Officer)

Okay, well, thanks, and best of luck, Walt.

Walt Glazer (CEO)

Thank you, David, very much. Appreciate it.

Operator (participant)

Again, if you have a question, please press star then one. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Patrick Griffin for any closing remarks. Please go ahead, sir.

Patrick Griffin (VP of Corporate Development)

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], and a member of our team will follow up with you. This concludes our call today. You may now disconnect.