Escalade Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
April 1, 2024

Key Takeaways

  • Strong cash generation and debt reduction: Q4 operating cash of $20.6M funded $21.1M in debt repayments, reducing net leverage by one turn and totaling $44M in debt paydown for 2023.
  • Margin expansion: Q4 gross margin improved by 190 basis points to 24.3% driven by lower freight costs, improved sales mix and price discipline, while SG&A fell 4% year-over-year.
  • Direct-to-consumer growth: Non-licensed DTC sales surged 39% in Q4, reflecting strong momentum across most product lines despite overall sales headwinds.
  • Sales decline and soft demand outlook: Net sales fell 9.2% in Q4 and management expects consumer discretionary spending to remain pressured into 2024, weighing on demand.
  • Material weaknesses were identified in IT general controls and year-end closing processes; while historical financial statements remain accurate, remediation efforts and higher audit costs are planned for 2024.
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Earnings Conference Call
Escalade Q4 2023
00:00 / 00:00

There are 5 speakers on the call.

Operator

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

Operator

Thank you. You may begin.

Speaker 1

Thank you, operator. On behalf of the entire team at Escalade, I'd like to welcome you to our Q4 and full year 2023 results conference call. Leading the call with me today are President and CEO, Walt Glaser and Stephen Warren, 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.

Speaker 1

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.

Speaker 2

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 $20,600,000 of cash from operations in the 4th quarter, which supported $21,100,000 in debt repayments and a one turn 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.

Speaker 2

Even so, our 4th quarter gross margin still improved by more than 190 basis points versus the prior year Q4 due to lower freight costs, improved sales mix and price discipline on our in line product assortment. While 4th 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 Q4 versus the prior year, driven by growth across most of our product lines.

Speaker 2

Looking ahead, we continue to closely monitor the relative health of household balance sheets, employment conditions and consumer discretionary spending. Changing 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 $2,000,000 annually as of the end of the Q4. These cost reductions are comprised of which resulted in a 4% reduction in our SG and A expenses during the Q4 of 2023.

Speaker 2

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 Q4 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 $100,000,000 at the end of 2023, we still see an opportunity for inventory reduction as we move through 2024, particularly in our billiards and water sports categories.

Speaker 2

That said, we don't expect these efforts to have the same unfavorable impact on margins as we had in the Q4 of 2023. Given the more normalized channel inventory levels, the key demand 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 $44,000,000 in debt during 2023.

Speaker 2

Cash conversion during the Q4 exceeded 100% for the 2nd straight quarter, primarily due to a $12,800,000 reduction in our inventory and a $13,400,000 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 4th quarter, our net debt leverage was 2.2 times, which is within our target range of 1.5 times to 2.5 times. 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 recreational 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.

Speaker 2

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

Speaker 3

call over to Stephen for his prepared remarks. Thank you, Walt. For the 3 months ended December 31, 2023, Escalade reported net income of $2,900,000 or $0.21 per diluted share on net sales of $65,500,000 For the Q4, 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 Q4 decreased by 4% compared to the prior year period to $10,400,000 As a percentage of net sales, SG and A increased 80 basis points year over year to 15.8% in the Q4 of 2023 compared to 15% in the Q4 of 2022.

Speaker 3

The decrease in SG and 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 $600,000 to $6,400,000 in the Q4 of 2023 versus $5,800,000 in the prior year period. Total cash provided by operations for the Q4 of 2023 was $20,600,000 for the quarter compared to $14,300,000 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 Q4 of 2023. For the full year, capital expenditures were similar to the prior year.

Speaker 3

As of December 31, 2023, the company had total cash and equivalents of $16,000 together with $66,800,000 of availability on our senior secured revolving credit facility maturing in 2027. At the end of the Q4 of 2023, net debt outstanding or total debt less cash was 2.2 times trailing 12 month EBITDA. As Walt mentioned earlier, we repaid $21,100,000 of debt during the Q4 of 2023, bringing our total debt repayment for the full year 2023 to $44,000,000 As of December 31, 2023, we had $50,900,000 of total debt outstanding, including 18 $200,000 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 $263,600,000 a decrease of 16% compared to the full year 2022.

Speaker 3

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 $41,500,000 in 2023 or 15.7 percent of net sales compared to $44,800,000 or 14.3 percent of net sales in 2022. The $3,300,000 decrease in our SG and 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, Forvis LLP, has identified certain 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.

Speaker 3

1st and most importantly, these material weaknesses did not impact the accuracy of our historical consolidated financial statements. 2nd, these material weaknesses did not impact Fortis' ability to issue an opinion on the consolidated financial statements for 2023 10 ks. 3rd, 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.

Speaker 3

There was a relatively minimal impact on our results for the Q4 because there were 92 operating days in the Q4 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

Thank you. We'll now conduct our question and answer Our first question comes from Rommel Dionisio with Aegis Capital Corp. Please state your question.

Speaker 4

Good morning. Thanks for taking my question. 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 sell and equal sell through or are we still maybe a few months or a couple of quarters away from that?

Speaker 4

Thanks very much.

Speaker 2

Hey, good morning, Rommel, and thank you for your question. 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.

Speaker 2

So I guess to answer your question, overall, I would say that retail inventories are pretty much in balance and POS should generally reflect the level of factory sales that we're seeing.

Speaker 4

Okay. And maybe a follow-up to that. As refill inventories normalize, 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 competitive promotions across categories?

Speaker 4

Thanks.

Speaker 2

Sure. Once again, it depends on the category. I would say that in certain 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.

Speaker 2

In others, no real change.

Speaker 4

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 that you would expect in 2024? Or is it more just maybe an allocate different allocation of current expenditures? Thanks.

Speaker 2

Sure. Yes, Rommel, we do expect that we're budgeting for some higher audit cost and some higher cost 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.

Speaker 2

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 were running our facilities below optimal levels, which that impacts margin 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 wouldn't 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.

Speaker 2

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.

Speaker 4

Great. Thanks so much for taking my questions.

Operator

Thank you. And there are no further questions at this time. I'll hand the floor back to Patrick Griffin for closing remarks.

Speaker 1

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 irescalade inc.com. That concludes our call today. You may now disconnect.

Operator

Thank you. All parties may disconnect.

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