Escalade, Incorporated (ESCA) Q2 2022 Earnings Report, Transcript and Summary

Good day, and welcome to the Escalade, Incorporated Second Quarter 2022 Results Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Patrick Griffin, Vice President and Investor Relations. Please go ahead.

Thank you, operator. I'm Patrick Griffin, Vice President of Investor Relations and Corporate Development. On behalf of the entire team at Escalade, I'd like to welcome you to our second quarter 2022 results 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 would like to turn the call over to Walt.

Thank you, Patrick, and welcome to those joining us today. During a period of rising macroeconomic challenges and ongoing supply chain complexities, our team displayed the creativity and agility that has enabled Escalade to thrive throughout our 100-year history. During the second quarter, we continued to focus on delivering a unique customer experience with our diversified portfolio of niche sports games and outdoor products while leveraging the benefits afforded by our hybrid domestic manufacturing and global sourcing capabilities, decentralized organizational structure and lean operating model. Through the first 6 months of the year, we delivered year-over-year growth in revenue and EBITDA while continuing to support a stable quarterly cash dividend, which currently yields 4.6% on an annual basis. Before we move into a more detailed discussion of our second quarter results, I'd like to share our observations on the current macroeconomic environment and specifically how we are managing our business to effectively navigate the impacts of rising inflation, ongoing supply chain complexities and shifting consumer sentiment and behavior. Let's begin with the actions we are taking to mitigate cost pressures created by substantially higher inflation. The June Producer Price Index was up 11.2% year-over-year, which is near the March record of 11.6%. PPI represents the average input cost for producers like Escalade and has been notably higher than the CPI, which represents cost increases formed by consumers. We, like many of our peers, are grappling with the rising cost of labor, transportation and raw materials, including wood, steel, aluminum, plastic resin and packaging. In response to these cost pressures, we are accelerating our cost reduction initiatives throughout our organization. We are also optimizing our product assortment and introducing innovative new products to deliver great value to our consumers, while enhancing our margins. Some recent highlights include our Trophy Ridge Digital React archery site as well as the Silverback SB60 Ghost basketball system. Lastly, we have implemented a series of selective price increases, demonstrating the pricing power within our portfolio of strong brands and unique products. As has been widely documented, the global supply chain remains challenging. Deliveries that used to take weeks are now taking months due to longer factory and shipping lead times. On a positive note, ocean freight rates have declined from recent highs, but remain elevated from historical levels. The stronger U.S. dollar is also helping to relieve some of these inflationary cost pressures with our sourcing footprint outside the U.S.A. We're also starting to see some moderating of certain commodity prices. As discussed last quarter, we continued to utilize our hybrid sourcing model that leverages our domestic manufacturing and international sourcing capabilities to enhance our competitiveness. Additionally, we continue to diversify our international sourcing across multiple regions as we build a more durable and responsive supply chain. Finally, a word on the consumer. Anecdotally, during a period of rising inflation, low- to middle-income households are particularly impacted by higher food and fuel costs. Currently, real wage growth is in keeping up with the pace of inflation particularly for lower income households. These trends, coupled with reduced government stimulus are softening demand, particularly for opening price point products. Higher income households are currently being impacted by significantly lower asset prices, including equities from the recent stock market declines. Meanwhile, rapidly increasing interest rates are impacting the ability for many consumers to finance larger ticket items such as new homes and autos, while household savings rates are below pre-pandemic levels. Escalade's typical consumer profile generally skews toward a mid- to higher income household. While these households are better positioned, they are not immune to the economic challenges facing consumers. The U.S. Consumer Sentiment Index is down nearly 40% year-over-year, reaching its lowest level since 2011 and impacting consumer buying behavior. We are experiencing lower consumer demand in our outdoor categories, including archery and water sports as well as in our fitness category. As a result, we are also seeing higher retailer inventories and lower orders as retailers seek to appropriately manage their inventory levels. We believe longer-term behavioral shifts such as the increased trend toward hybrid work arrangements and healthy active lifestyles remain intact. We expect these trends, coupled with increased participation rates across many of our categories will benefit us over time. To that end, we continue to capitalize on our leadership positions in niche product categories where our customers tend to be brand loyalists who value the quality of a product experience. We are mindful of the potential downside risk that could materialize given the possibility of recession and continue to plan for a range of scenarios. As an example, we remain vigilant regarding expense control as evidenced by our lower absolute SG&A expenses in our legacy businesses during the second quarter. We also continue to optimize our promotional planning and product assortment to address changing consumer preferences. We are confident we will manage through this market cycle well as we have in the past. Turning now to a discussion of our second quarter performance. While net sales declined 5.4% on a year-over-year basis, we maintained our gross margin percentage equal to last year. We successfully navigated rising material, logistics and labor costs with the help of pricing, product and productivity initiatives that I mentioned earlier. Second quarter net sales, excluding acquisitions, declined 13% due to softness in fitness and select outdoor categories combined with the previously announced basketball revenue pull forward from the second -- into the first quarter of 2022. The integration of our recently completed Brunswick Billiards acquisition has progressed ahead of plan and is expected to be accretive to earnings in the second half of 2022. We completed Brunswick transition to Escalade's IT platform and ended our transition services agreement ahead of schedule in the second quarter. We believe this acquisition will allow for meaningful cross-selling synergies across our billiards and indoor recreation categories which have also outperformed in the recent market environment. Following our second quarter end, we exercised a portion of our accordion availability expanding our senior revolving credit facility maturing in 2027 by $10 million. As of July 9, we had total cash and availability of approximately $13.5 million excluding this additional $10 million granted under the accordion feature. Notably, we have an additional $15 million that could be exercised under the accordion, further increasing our availability should we choose to do so. Total inventories were $130 million at the end of second quarter, up from $86 million in the prior year period due to the addition of the Brunswick Billiards inventory as well as prior purchases of long lead time items in 2020 and 2021, exacerbated by slowing demand and retail order cancellations in recent months. At the beginning of 2022, we implemented a company-wide program to reduce inventory in anticipation of the normalization of consumer demand and supply chain conditions. As a result, our incoming order flow has been reduced, and we anticipate improved inventory turns by year-end with further improvements towards our historical turns of 2.5 to 3x in 2023, which will improve our cash conversion cycle. We continue to invest in our brands to position them for long-term category leadership. As an example, on Onix Pickleball, our leading pickleball brand is proud to be a sponsor of the PPA Tour, including the Skechers Invitational Summer Championship, which will be held August 12 through 14, in Pacific Palisades, California and featured live on the CBS Television Network. Further, several of our team ONIX sponsored players, including #1 rank players, Matt Wright and Lucy Kovalova, as well as #2 rank player, Callie Jo Smith, will be featured in live marquee matches on CBS. They will be playing with our ONIX Premier Pickleball paddles, be sure to tune in and catch the action. ONIX Pickleball was also the official paddle of the APP Open recently held in New York City, continuing with Pickleball, our Dura fast 40 Pickleball, the ball of choice for professional players and top tournaments is the official ball of all PPA Tour events. This year, the PPA tour is holding 20 events throughout the U.S. and Canada, which will be broadcast on multiple national TV networks. We continue to make appropriate investments to further enhance infinity for our pickleball brands as we consolidate our leadership position within a highly fragmented pickleball category. We've demonstrated a commitment to effective capital allocation and disciplined balance sheet management and approach that contributes to long-term value creation. Looking ahead, we are focusing our near-term capital allocation priorities on a targeted reduction in net leverage to a range of 1.5 to 2x trailing 12 months EBITDA, followed by continued investments in organic growth initiatives and a consistent payment of a quarterly cash dividend. With that, I'll turn the call over to Stephen for a review of our recent financial results.

Thanks, Walt, and welcome to those joining us on the call today. For the 3 months ended July 9, 2022, Escalade reported net income of $5.7 million or $0.42 per diluted share on net sales of $94.3 million. The company reported gross margin of 25.2%, flat to prior year period despite continued challenges related to the global supply chain, raw material cost inflation and labor constraints. Selling, general and administrative expense as a percentage of net sales increased to 15.6% in the second quarter of 2022 versus 13.9% in the prior year period due to lower sales volume and expenses related to the acquisition and integration of Brunswick Billiards. SG&A expenses for the legacy business units were down year-over-year on an absolute basis. Total operating cash flow less capital expenditures, was $1.7 million in the second quarter versus $6.9 million in the prior year period. Earnings before interest, taxes, depreciation and amortization declined 15.7% to $10.3 million in the second quarter of 2022 versus $12.3 million in the prior year period. For the 6 months year-to-date EBITDA increased 1.5% to $20.9 million versus $20.6 million in 2021. As of July 9, 2022, the company had total cash and equivalents of $6.2 million, together with $7.3 million of availability on our senior secured revolving credit to in 2027. As Walt indicated, this availability increased by $10 million in July following the close of our second quarter as we exercised a portion of our accordion on our senior secured credit facility. At the end of the second quarter 2022, net debt outstanding or total debt less cash was 2.55x trailing 12-month EBITDA. We announced a quarterly dividend of $0.15 per share to be paid to all shareholders of record on September 6, 2022, and dispersed on September 13, 2022. With that, we will turn the call over to the operator to begin our question-and-answer portion of the call.

[Operator Instructions] The first question comes from Rommel Dionisio with Aegis Capital.

Just a question on gross margins. You guys maintain them on a year-over-year basis, which -- not a lot of companies managing to do that these days. With all the cost pressures you're seeing, the -- I know you've obviously put through some significant initiatives and price increases, but is there a positive mix shift also taking place with regards to your product portfolio that's also helping drive that?

Sure. Thank you, Rommel. That's a great question. And I would say, primarily, it's an issue of careful purchasing and selective price increases. Our hope was to really match the prior year gross margin, match our margins to protect those, but also deliver as much value as possible to the consumer. But there is some mix shift going on. And as we discussed in the call, we're seeing the higher end products doing better than the lower-end products. And as an example, in our basketball business, the -- our goals with a 72-inch backboard are outperforming the 60-inch goals, which are outperforming the 54-inch goals, and those in turn are outperforming the 50-inch goals. So we see really a significant trend toward the higher-priced feature-rich items doing better than the lower-priced items in our portfolio.

Okay. And just a quick follow-up, if I may. The -- in terms of the macroeconomic outlook, there's some talk, obviously, that the other shoe that may drop is the housing market. Could you just maybe refresh our memory given the change in your product portfolio with acquisitions over the years since the last sort of housing market downturn. What -- how would you expect to see the impact play out on your various business units? Would that be billiards and basketball the most impacted if there were a weakness in the housing market?

Yes. Thank you. Of course, every recession is different, and every economic challenge is quite different. So after 9/11, we saw a significant increase in so were cocooning and people investing in their homes and the billiards business, for example, did quite well. Of course, as we all know, after the economic crisis of the 2008, 2009, a lot of people lost their homes and investments in homes declined quite significantly. We'll see how this 1 plays out. But we would note that -- there's a lot more household formation while prices and housing are coming off recent highs, there are still a lot of people who want to own a home, who are moving into more suburban locations with bigger yards and bigger homes. And so we think that those things will continue to benefit us. And I would note that our indoor game category is -- continues to do quite well.

[Operator Instructions] Ladies and gentlemen, this concludes our question-and-answer session. I would now like to turn the conference back over to Mr. 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, and a member of our team will follow up with you. This concludes our call today. You may now disconnect.