Escalade Inc

NASDAQ:ESCA

Greetings, and welcome to the Escalade Fourth Quarter and Full Year 2023 Results Conference Call.

[Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Patrick Griffin, Vice President, Corporate Development.

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 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 financial 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. Our team delivered a strong finish to the year, a performance highlighted by improved gross margins, robust cash generation and a significant reduction in leverage. We generated $20.6 million of cash from operations in the fourth quarter, which supported $21.1 million in debt repayments and a [ 1x ] decline in our net leverage ratio at year-end. The strong cash generation during the quarter was driven by our continued emphasis on improved working capital efficiency, which included a strategic focus on inventory reduction. While our inventory reduction initiatives drove substantial cash flow in the quarter, our margins were pressured as a result of those efforts. Even so, our fourth quarter gross margin still improved by more than 190 basis points versus the prior year fourth quarter due to lower freight costs, improved sales mix and price discipline on our in-line product assortment. While fourth quarter sales declined by 9.2% versus prior year levels, our sales benefited from strong growth in our basketball and indoor games categories, offset by softness in most other categories.

Exiting the holiday selling season, we believe channel inventories have declined meaningfully as our retail partners successfully drove product sell-through. This has helped position us for a solid start to 2024 with most retail inventories in good shape. We continue to experience strong momentum in our direct-to-consumer sales with non-licensed DTC sales up 39% in the fourth quarter versus the prior year driven by growth across most of our product lines.

Looking ahead, we continue to closely monitor the relative health of household balance sheets, employment conditions and consumer discretionary spending. Change in consumer behavior has pressured discretionary spending in most of our categories. We expect consumer demand to remain relatively soft as these trends continue into 2024. Operationally, we realized our goal of reducing costs by $2 million annually as of the end of the fourth quarter. These cost reductions are comprised of lower inventory handling and storage costs, lower freight costs and operational improvements. We also focused on reducing our fixed and variable operating expenses, which resulted in a 4% reduction in our SG&A expenses during the fourth quarter of 2023.

In combination, these actions have positioned us to improve operating leverage and expand gross margins as we move through 2024. The planned divestiture of our Rosarito, Mexico operations continues to progress. We transitioned our manufacturing and warehousing in Rosarito to other facilities in the fourth quarter and reduced operating expenses. We also continue to actively market the facility to prospective buyers.

While we have successfully reduced our inventory to our goal of less than $100 million at the end of 2023, we still see an opportunity for further inventory reduction as we move through 2024, particularly in our Billiards and water sports categories. That said, we don't expect these efforts to have the same unfavorable impact on margins as we had in the fourth quarter of 2023. Given the more normalized channel inventory levels, the key demand in variable for 2024 will be the level of consumer spending in our categories.

Strategically, we remain committed to investing in innovative product development to build market-leading positions in key growth categories and best position our portfolio for above-market growth as we move through the economic cycle. As we continue to navigate the current demand environment, we're prioritizing a lean cost structure and further fortifying our balance sheet. Just as we have successfully reduced our fixed costs through the year, we also repaid more than $44 million in debt during 2023. Cash conversion during the fourth quarter exceeded 100% for the second straight quarter, [indiscernible] a reduction in our inventory and a $13.4 million reduction in accounts receivable.

In 2024, we will remain focused on maximizing cash generation and repaying our higher interest variable rate debt. At the end of the fourth quarter, our net debt leverage was 2.2x, which is within our target range of 1.5 to 2.5x. We believe our diverse portfolio of products continued focus on operational excellence and cost discipline, together with a well-capitalized balance sheet, position us to successfully navigate the transitional period for the consumer while continuing to build market-leading positions within our established portfolio of indoor and outdoor recreation brands. Our team has performed exceptionally well during a period of soft consumer spending on goods, positioning us to capitalize on a broader demand recovery. We believe that our collective focus on cost management and working capital efficiency will support further debt repayment over the coming year.

With channel inventories clearing and consumer demand poised to reaccelerate over time, I remain upbeat concerning the outlook for our business and opportunities for value creation in the years ahead. In the interim, 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 our progress next quarter.

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

Thank you, Walt. For the 3 months ended December 31, 2023, Escalade reported net income of $2.9 million or $0.21 per diluted share on net sales of $65.5 million. For the fourth quarter, the company reported gross margins of 24.3% compared to 22.4% in the prior year period. The 192 basis point improvement was primarily the result of more favorable product sales mix, lower freight costs, reduced inventory handling expenses and operating expense reductions, partially offset by the impact of our inventory reduction initiative and under-absorbed fixed costs associated with our facility in Mexico.

Selling, general and administrative expenses during the fourth quarter decreased by 4% compared to the prior year period to $10.4 million. As a percentage of net sales, SG&A increased 80 basis points year-over-year to 15.8% in the fourth quarter of 2023 compared to 15% in the fourth quarter of 2022. The decrease in SG&A expense year-over-year was a result of overhead cost reductions and lower variable spending, including incentive compensation.

Earnings before interest, taxes, depreciation and amortization increased by $0.6 million to $6.4 million in the fourth quarter of 2023 versus $5.8 million in the prior year period. Total cash provided by operations for the fourth quarter of 2023 was $20.6 million for the quarter compared to $14.3 million in the prior year period. The increase in cash flow from operations primarily reflects cash generated from improvements to working capital as a result of a reduction of inventories and accounts payable through the fourth quarter of 2023. For the full year, capital expenditures were similar to the prior year.

As of December 31, 2023, the company had total cash and equivalents of $16,000, together with $66.8 million of availability on our senior secured revolving credit facility maturing in 2027. At the end of the fourth quarter of 2023, net debt outstanding or total debt less cash was 2.2x trailing 12-month EBITDA. As Walt mentioned earlier, we repaid $21.1 million of debt during the fourth quarter of 2023, bringing our total debt repayment for the full year 2023 to $44 million. As of December 31, 2023, we had $50.9 million of total debt outstanding, including $18.2 million of high interest variable rate debt.

We will continue to prioritize the repayment of this variable rate debt during 2024 while managing our total net leverage within our long-term target range of 1.5x to 2.5x EBITDA. For the full year of 2023, our total net sales were $263.6 million, a decrease of 16% compared to the full year 2022. Our total gross margin for the year was 23.4% compared to 23.5% for the full year 2022. Selling, general and administrative expense was $41.5 million in 2023 or 15.7% of net sales compared to $44.8 million or 14.3% of net sales in 2022. The $3.3 million decrease in our SG&A expenses during 2023 reflects our efforts to intentionally manage our fixed and variable costs during a period of softening consumer demand. As we disclosed in early March, our public accounting firm, [ Forbis, LLP ] has identified certain material weaknesses in our internal financial reporting controls, specifically as it relates to our information technology general controls, controls over the year-end closing process, documentation and design controls related to financial statement accounts and assertions and the monitoring of the company's internal control framework.

There are several key takeaways from this disclosure worth noting. First and most importantly, these material weaknesses did not impact the accuracy of our historical consolidated financial statements. Second, these material weaknesses did not impact Forbis' ability to issue an opinion on the consolidated financial statements for the 2023 10-K.

Third, we intend to take decisive remedial action as we continue to develop strong internal controls across the organization. Our entire management team intends to resolve this process in a timely and compliant manner and expects the remedial process to conclude this year.

One last important thing to remember, effective on January 1, 2023, we transitioned to a conventional 12-month reporting calendar. There was a relatively minimal impact on our results for the fourth quarter because there were 92 operating days in the fourth quarter of 2023 as opposed to 91 in the prior year period. For the full year, our 2023 results now reflect a normal 365 operating days compared to 371 operating days during 2022. As we move into 2024, the year-over-year comparability of our results will no longer be impacted by this change.

With that, operator, we will open the call for questions.

[Operator Instructions]

Our first question comes from Rommel Dionisio with Aegis Capital Corp.

Just wanted to ask about the retail inventory situation, I think you mentioned that retail inventories have come down. Are we to a point now where solid equals sell-through? Or are we still maybe a few months or a couple of quarters away from that?

We are involved in a lot of different categories. And I would say that for the most part, retail inventories are balanced and in good shape. There are a couple of categories where there's still some excess inventory in the system. And actually, there are a few areas where retail inventories are sort of below normal. So I guess, to answer your question, overall, I would say, retail inventories are pretty much in balance and POS should generally reflect the level of factory sales that we're seeing.

Okay. And maybe a follow-up to that. As retail inventories normalized, are you seeing any sort of moderation in the competitive promotional environment or is that -- obviously, demand is a factor in that as well. I wonder if you could just comment on the competitors' promotions across categories?

Sure. Once again, it depends on the category. I would say that in certain [indiscernible] high growth categories, we're seeing just a tremendous amount of promotional activity, a lot of money being spent on all sort of programs. We will compete to maintain our market positions, but I'd say, in certain categories, it's been quite strong and others had no real change.

Okay. Maybe one last follow-up question, if I could. The financial controls that you alluded to in the prepared comments, will there be a meaningful cost impact you would expect in 2024? Is it more just maybe a different allocation of current expenditures?

Sure. Yes. Rommel, we do expect and we're budgeting for some higher audit costs and some higher costs in our IT systems and various controls. However, that doesn't -- we don't think it's significant enough to change our outlook. We are cautious about the consumer. We're cautious regarding top line sales. But we do believe that we have substantial margin enhancement opportunities, particularly relative to 2023 when we had some unusual costs around storage, inventory handling and so forth.

And then also, as I think we alluded to, as we were aggressively reducing our inventory and in some cases, we're running our facilities below optimal levels, which that impacts margins somewhat. And then also, we did do some discounting in some areas where we had some excess and some inventory that was moving towards obsolete. I would say it was obsolete, but it was things that we wanted to move. And so we were willing to discount those and sell those at a little bit lower margins. So I guess the message I'm trying to send is that we're cautious about the top line, but we feel good about the margin opportunities.

And there are no further questions at this time. I'll hand the floor back to Patrick Griffin for 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. That concludes our call today. You may now disconnect.

Thank you. All parties can disconnect.