Escalade, Incorporated (ESCA) Q4 2022 Earnings Report, Transcript and Summary

Greetings, and welcome to Escalade Inc. Fourth Quarter and Full Year 2022 Earnings Results Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Patrick Griffin. Thank you. You may begin.

Thank you, operator. On behalf of the entire team at Escalade, I'd like to welcome you to our fourth quarter and full year 2022 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 vary -- 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 on the call. In 2022, Escalade continued to build leading market positions within our key indoor and outdoor recreation categories while navigating a challenging operating environment. Following 2 years of elevated pandemic-related consumer demand for sporting goods and recreational equipment, demand conditions for most of our categories began to return to more normalized levels in 2022 contributing to a 10% year-over-year decline in organic sales. From an operations perspective, supply chain-related congestion and elevated inventory levels led to higher logistics costs for our business throughout most of last year, negatively impacting our profitability. Demand softened as the year progressed given elevated channel inventory levels with many of our customers. Fourth quarter sales declined year-over-year across most outdoor categories, including archery, basketball, outdoor games, water sports and playground, partially offset by continued strength in pickleball, indoor games, table tennis and billiards. However, even during a period of weakening consumer demand, we continue to maintain our price discipline, underscoring the resilience of our brands, the loyalty of our customers and the generally affluent demographic we serve. Importantly, we delivered year-over-year growth in gross margin during the fourth quarter despite a seasonally promotional environment, which is an accomplishment for our entire team. As expected, our inventory declined during the fourth quarter due to planned reductions in inbound product flow, seasonal demand and selective promotional activities. We reduced our total inventory by more than $13 million during the fourth quarter, which enabled us to repay nearly $12 million in outstanding debt. Also during 2022, we continue to build leading positions within our growth categories guided by a continued focus on innovation and new product development. For example, within pickleball, our category-leading Onix and Dura brands have continued to garner rave reviews and gain additional distribution, capitalizing on rapid consumer adoption of America's fastest-growing sport. In more established categories such as billiards and indoor game room, we've worked to build a leading portfolio of brands serving every aspect of the consumer experience from tables and cues to a full suite of accessories. We acquired Brunswick Billiards in January 2022, our largest acquisition to date. Brunswick complements our portfolio of leaders brands and broader offering in the indoor recreation market, including table tennis, darting, game tables and licensed games. This past year, we successfully completed the integration of Brunswick, which was accretive to our full year earnings per share, consistent with our expectations for the acquisition. This year, we are capitalizing on the potential provided by Brunswick to leverage our larger presence in the billiard market and realize additional revenue opportunities as well as cost savings. To achieve this goal, we are combining our Brunswick Billiards, Cue & Case and American Heritage brands to create a market-leading billiards and game room platform. During the first quarter of 2023, we are preparing to launch patented innovative paddle technology to further support our market leadership in the fast-growing pickleball category, a suite of American Cornhole League licensed products together with accessory and ancillary products in our other leading categories. In summary, while last year brought its fair share of challenges, adding temporary yet sizable cost burdens to our business, we continue to advance our strategic priorities, driving both market share gains in key categories, together with continued operational execution across our sourcing, manufacturing, product development, e-commerce, compliance and manufacturing centers of excellence. Turning now to our outlook for the business. While we do not provide financial guidance, we want to highlight several noteworthy items that may prove helpful from a modeling perspective. First, based on consumer discussions and recent economic trends, we anticipate difficult year-over-year comparisons in both the first and second quarters of 2023 as we work through our high-cost inventory, manage through continued excess inventory levels in the channel and adjust to softening consumer discretionary spending. Please also note that we had an unusually strong first quarter last year that benefited from a favorable mix and sales pulled forward from the second quarter of 2022. Additionally, due to the change in our reporting calendar, our second quarter will span 91 days this year versus the 112 days in last year's 16-week Q2. Despite near-term demand softness and economic headwinds, we do expect our gross margins to improve in the second half of 2023, given lower ocean freight rates and reduced logistics expenses. These favorable trends could be partially offset by further inflationary pressures. Our capital allocation priority will continue to be debt reduction, consistent with our objective of achieving net leverage ratio in the range of 1.5 to 2.5x EBITDA while continuing to support internal growth initiatives and a stable quarterly cash dividend, the latter of which remains an important element of our focus on total shareholder return. We expect to further reduce inventory levels in 2023 as we seek to lower carrying costs and improve asset utilization. At this time, we expect retail inventory levels in the system to return closer to historical levels in the back half of the year, creating the potential for improved channel inventory replenishment later in 2023. Given the current macro environment, we believe operational discipline remains of paramount importance. The rate of inflation remains elevated, interest rates are at multiyear highs and consumer sentiment has hit a 10-year low. This will likely lead to continued difficult operating environment given the multiple headwinds facing consumers. To that end, we are taking a conservative approach, positioning our business to successfully weather the current environment. While we already run lean, we are actively evaluating opportunities to further control expenses and to improve our asset utilization without impacting the long-term growth of our business. Part of that evaluation process, we have made the decision to close our manufacturing facility in Rosarito, Mexico. While we expect some near-term expenses related to the closure of our facility, we believe this strategic action will drive improved organizational efficiency and enhanced asset utilization. As Escalade completes the celebration of its 100th-year anniversary, we are grateful for the ongoing support of our customers, employees and our investors and remain steadfast in our focus on delivering exceptional memorable consumer experiences that build brand loyalty while driving long-term value creation for our shareholders. I would particularly like to thank our talented employees who responded to the many challenges we faced in 2022. With that, I'll turn the call over to Stephen.

Thanks, Walt, and welcome to those joining us on the call today. For the 3 months ended December 31, 2022, Escalade reported net income of $2.7 million or $0.20 per diluted share on net sales of $72.1 million. For the 12 months ended December 31, 2022, Escalade reported net income of $18 million or $1.31 per diluted share on net sales of $313.8 million. For the fourth quarter, the company reported gross margin of 22.4% compared to 22.2% in the prior year period. We realized the 19 basis point increase in margin despite increased logistics expenses mainly associated with ongoing inventory, handling and storage. For the full year 2022, our total gross margin was 23.5% compared to 24.6% for the full year 2020, '21. For the fourth quarter, selling, general and administrative expense as a percentage of net sales increased to 15% compared to 12.9% in the prior year period due to the addition of Brunswick Billiards. For the full year 2022, our SG&A as a percentage of sales was 14.3% compared to 13.8% for the full year 2021. Earnings before interest, taxes, depreciation and amortization declined 21.5% to $5.8 million in the fourth quarter of 2022 versus $7.4 million in the prior year period. For the full year 2022, EBITDA decreased 12% to $32.5 million compared to $36.9 million in 2021. For the full year 2022, the company generated net cash from operations of $8.5 million compared to $0.9 million of net cash from operations during 2021 due to favorable changes in working capital. For 2022, our capital expenditures were more normalized at $2.1 million compared to $9.7 million during 2021 when we purchased a manufacturing facility in warehouse in Olney, Illinois, and completed improvements to our Evansville, Indiana facility. As of December 31, 2022, the company had total cash and equivalents of $4 million, together with $35 million of availability on our senior secured revolving credit facility maturing in 2027. At the end of the fourth quarter of 2022, net debt outstanding or total debt less cash was 2.8x trailing 12-month EBITDA. One last important thing to note as we enter 2023, effective this quarter, we are transitioning our fiscal calendar to a traditional 12-month reporting calendar year. This will create some differences with days as we compare our quarterly results year-over-year during 2023 but will ultimately help the consistency of our reporting in the long term. Please see our recently filed 8-K with a press release announcing our fourth quarter and full year results for a helpful table that shows a quarterly comparison with the days. With that, operator, we will open the call for questions.

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

The plan to limit the production in Mexico, will there be any corresponding exits of particular business lines or products? And if so, I wonder if you could discuss how that might potentially impact the top line? Or do you just plan to outsource whatever is produced there to other third-party providers?

Yes, Rom, that's a great question. We are not exiting any product lines or dropping any categories. It really is a situation where we feel we can better produce these products in other facilities. And as you probably know, there's a lot of demand for facilities in Mexico. So we're able to find a buyer who's -- who finds it as more valuable for them than it is for us. So we're kind of taking advantage of the current environment and moving the production to other facilities.

And just to clarify, I noticed there was $2.8 million on the balance sheet for assets held for sale. Is that primarily Mexico -- that facility?

Yes, that's correct.

Okay. Great. And if I could ask one more follow-up, if I could. Just for competitive outlook. I mean you guys have cited some broad macroeconomic pressures. You're certainly not alone in the supply chain challenges and difficult consumer spending trends. But from a competitive standpoint, it sounds like you're obviously maintaining, if not continue to gain market share with some of the new products planned, it sounds pretty exciting. Are you seeing some real -- any unusual actions on behalf of your competitors who are obviously all in the same boat with regards to supply chain in a tough economy. With regards to -- are they being -- in certain categories, unusually aggressive on the competitive promotional front? Or are they seeing even more kind of a distressed situation, whether just trying to have this as far as to exhaust -- to push product as quickly as they can?

Yes. So first of all, yes, we do feel like we're gaining market share, and we believe that when times are more challenging, that's the time when you can do that if you're a strong company with a strong balance sheet and a great team. So we are pushing hard to gain market share. We believe we are gaining share across most, if not all of our categories. I can't point to any particular situations where competitors are being particularly promotional or have gotten desperate. But clearly, everybody is feeling the effects of the consumer, the interest rate environment, the return to more normal demand patterns after COVID.

We have reached the end of the question-and-answer session. At this time, I'd like to turn the call back over to Walt Glazer for closing comments.

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

This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.