Q3 2023 Escalade Inc Earnings Call
Participants
Patrick Griffin; VP, Corporate Development & IR; Escalade Incorporated
Walter Glazer; CEO & President; Escalade Incorporated
Stephen Wawrin; CFO; Escalade Incorporated
Rommel Dionisio; Analyst; Aegis Capital Corp.
Presentation
Operator
Good morning and welcome to the Escalade third-quarter 2023 results conference call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Patrick Griffin, VP, Corporate Development. Please go ahead.
Patrick Griffin
Thank you, operator. On behalf of the entire team at Escalade, I'd like to welcome you to our third-quarter 2023 results conference call. We begin the call with me today our President and CEO, Walt Glazer, and Stephen Warren, our Chief Financial Officer.
Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may vary 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'd like to turn the call over to Walt.
Walter Glazer
Thank you, Patrick, and welcome to those joining us on the call. Our team delivered strong third-quarter results, highlighted by significant year over year growth in gross margins, operating income and operating cash flow, resulting in nearly $12 million of debt reduction in the quarter.
We achieved these results as our team continued to execute diligently on maximizing margins and reducing expenses, amid eroding consumer confidence and ongoing softness in consumer discretionary spending for most goods. Sales declined versus prior year levels [or were in line] with the volume trend we experienced in the second quarter.
As a reminder, our third quarter results benefited from eight additional days within our new reporting cycle, as we move to our traditional calendar reporting framework on January 1, 2023. Excluding the impact of the change on our reporting calendar, sales declined 11.6% on a year over year basis in the third quarter compared to 28.4% sales decline in the first quarter, which followed a 9.5 -- which was followed by a 9.5% sales decline in the second quarter.
In recent months, we've seen an encouraging stabilization within our mass merchant channel, which includes our big box and sporting goods retailers has the destocking trend evidenced earlier this year, lessened for some of our categories, improved customer orders for our Basketball and Pickleball product categories highlighted our third-quarter sales.
Furthermore, we continued to see strong growth [and] direct to consumer sales with non-license DTC sales up more than 50% year to date, driven by a combination of effective marketing campaigns for transition to the Shopify platform to reach new product launches. We believe our DTC sales growth indicates the consumer demand remains reasonably healthy for our brand portfolio, amid a challenging macroeconomic and retail environment.
We are closely monitoring eroding consumer confidence considering higher interest rates, political turmoil and persistent inflation. We have seen wholesale inventories begin to normalize in several categories, retail sales are recreation products remain generally soft. We believe our retail partners will continue to closely manage their inventory levels and be more proportional in this uncertain environment.
It is incumbent upon us to continue driving innovation and consumer interest across our brand portfolio. We remain focused on strengthening our market-leading brands and positioning our company for long-term success. Operationally, we continue to see further normalization of supply chain, which has resulted in lower freight costs and reduced inventory handling and storage expenses.
Last year, these higher input costs impacted our gross margins. As we sell through this higher cost inventory, it has replaced with lower-cost inventory that generates higher margins. We expect this favorable restocking cycle to continue into next year, the most of our categories. Benefit of lower input cost when compared -- when combined with a more favorable sales mix drove more than 650 basis points in year-over-year gross margin improvement during the third quarter.
Looking ahead, we believe these favorable input costs combined with lower fixed costs will position us to expand margins in 2024. As we highlighted last quarter, our team has targeted approximately $2 million in fixed cost savings, so we are on track to achieve by year end. The wind-down expenses and estimated under absorption of our Mexico operations, which were divesting, represented a 110 basis point negative impact to EBITDA margin in the third quarter and 140 basis points year to date.
In combination, we see multiple catalysts for improved operating leverage, which leads us to believe that our gross margins may further expand in 2024. As previously mentioned, we have seen the inventory destocking trends normalize in some categories, but we still expect some destocking to continue into the next year and certain categories such as Archery, Water Sports and the Game Room for wholesale inventories remain high.
We also expect that our sales trend from the second and third quarters will continue into the fourth quarter, excluding the impact of the company's reporting calendar changes. Strategically, we continue to focus on investing in innovative product development to build market-leading positions in key growth categories.
We are very pleased with the launch of our American Cornhole League license, Cornhole Boards and Bags. With our exclusive launch partner, Academy Sports and Outdoors. We are expanding our ACL sales to several other retail and e-commerce partners. Based on strong consumer demand, we are growing our ACL assortment to include two additional pro and comp bags in several colorways as well as our new Elite Cornhole Board.
We recently launched several new Bear Archery Bones, including the new bear persist, compound bow, which has innovative features that create less vibration and noise. Our new Bear Alaskan XT ready to hunt compound bow features and integrated Arrow rest insight, bringing tremendous combination features and value to the market.
Our Little Bear used Recurve bow is a compelling new offering handcrafted from Maple in our Gainesville, Florida manufacturing facility. We also successfully launched a new Bear Vertical Bow in our ongoing collaboration with the hunting public, which is a team of archery influencers with over 500,000 subscribers for their videos, showcasing tips and strategies for hunters.
The team from hunting public built their dream bow and included several features from some of their favorite bear bows of the past as well as some new innovations. The latest result of our collaboration is the Bear Adapt Plus Compound Bow, which features exceptional performance, comfort, and durability. Sales of this new bow have exceeded our expectations.
As we navigate this uncertain demand environment. We know the importance of maintaining an appropriate cost structure and fortified balance sheet to continue to focus on optimizing our cost structure and maximizing cash flow to further reduce debt.
Cash conversion during the third quarter exceeded a 100% during what is normally a quarter where we see working capital use. Strong cash generation in the third quarter was primarily due to a $6.4 million reduction in our inventory and improved working capital management.
As we continue to the end of the year, we are targeting inventory below $100 million, which will further drive cash generation. We are focused on continuing to utilize free cash flow to reduce our debt. The end of the third quarter, our net leverage was 3.1 times EBITDA. We remain committed to further reducing our leverage to our targeted range between 1.5 times, 2.5 times EBITDA.
While we have built our businesses over the years with a number of value-creating acquisitions, our current capital allocation priority remains long term debt reduction, along with our focus on lowering net leverage, we continue to tightly control discretionary spending, including capital expenditures.
Proud of the hard work and dedication of our team, focusing on disciplined cost management and operational excellence amid this period of challenging demand. We will continue to focus on creating exceptional customer 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.
Stephen Wawrin
Thank you all. For the three months ended September 30, 2023, Escalade reported net income of $4.3 million [or] $0.31 per diluted share on net sales of $73.4 million. For the third quarter, the company reported gross margins of 24.7% compared to 18.2% in the prior year period. The 652 basis point improvement was primarily the result of more favorable product sales mix, lower inventory storage and handling expenses, operating expense reduction, partially offset by the impact of nonrecurrent expenses and under-absorbed fixed costs associated with our facility in Mexico.
Selling, general and administrative expenses increased by 26.3% compared to the prior year period to $11.1 million. The increase in SG&A expense year over year was a result of adjustments to accruals for incentive compensation in both the current and prior period. In the third quarter of last year lower incentive compensation expense resulted in an SG&A reduction below our normal level.
Based on our current level of sales and profitability, we expect SG&A, excluding amortization to remain at a normalized level similar to our year to date SG&A percentage of approximately 16%. Earnings before interest, taxes, depreciation, and amortization increased by $2.1 million to $7.9 million in the third quarter of 2023, versus $5.8 million in the prior year period.
Total cash provided by operations was $14.8 million for the quarter, compared to total cash used in operations of $5.5 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 through the third quarter of 2023. Additionally, capital expenditures during the quarter increased modestly year over year, but remain below historical averages, average levels as we carefully managed our capital spending.
As of September 30, 2023, the company had total cash and equivalents of [$919,000]. Together, with $47.5 million of availability on our senior secured revolving credit facility maturing in 2027. At the end of the third quarter of 2023, net debt outstanding, our total debt less cash was 3.1 times trailing 12-month EBITDA.
One last important thing to remember, effective on January 1, we transitioned to a conventional 12-month reporting calendar. As a result, the third quarter of 2023, had 92 operating days as opposed to 84 in the prior year period. This dynamic will have less of an impact on our results for the fourth quarter.
With that, operator, we will open the call for questions.
Question and Answer Session
Operator
We will now begin the question-and-answer session. (Operator Instructions)
Rommel Dionisio, Aegis. Please go ahead.
Rommel Dionisio
Good morning. Thank you, question on gross margins, (inaudible) guys highlighted the lower input costs, freight, and others. Wonder if you could talk about labor. Are you still seeing a bit of cost pressure in that front, thanks.
Walter Glazer
Good morning, Rommel.
We are seeing certainly less pressure than we saw a year ago, and the environment is getting a little bit better. We're still seeing some upward movement in some areas. But overall, I would say it's much better than it was a year ago.
Rommel Dionisio
Okay, good. Any update you could provide us on the (inaudible) Mexico divestiture?
Walter Glazer
I can tell you that we're hard at work on getting it done, and we're working with a couple of potential buyers they're doing their due diligence and we're providing them the information that they need. So, I can't predict exactly when we will close, but I would say we're hard at work to bring this to a conclusion.
Rommel Dionisio
Okay. And maybe one last one. Stephen, I think you talked about having less of an impact from the number of days in Q4, [it's supposed to] quantify exactly what the number is? in terms of days business days for the fourth quarter
For fourth quarter. Yeah, please.
Walter Glazer
It�s Just one day difference from the fourth quarter.
Rommel Dionisio
Okay. Okay, great. Thanks very much.
Walter Glazer
Yes, we were all trying to find that page, but I believe, it's a one day difference. Last year, we had 53 weeks that ended on December 31. This year, we're doing that the monthly calendar. So, second and third quarter, [were below] were the ones, where we had the biggest impact of the change in the number of days, fourth quarter be more of an apple to apples.
Rommel Dionisio
Okay. Perfect. Thank you.
Operator
(Operator Instructions) There are no questions at this time. This concludes our question-and-answer session.
I'm sorry, Rommel has rejoined the queue. Please go ahead.
Rommel Dionisio
Thanks, maybe just one follow-up. Given the, obviously your commentary on a slower pace of retail offtake and conservative inventory management [on the part of retailers?] How do you guys think about the pace of new product introductions going into 2024, you want to maybe hold back, until the environment gets better. you still kind of going forward with the usual pace of new product intros?
Thank you.
Walter Glazer
Yeah, Rommel, new product development, as a key part of our strategy and we want to keep our product line fresh and exciting for consumers. I will say that there was a time, when we had a lot of inventory and we thought why would we introduce something new that would just cannibalize the old existing inventory, but we've moved through most of that.
And so our pace of new product development is moving along a pace. And we have, again, as we described in the commentary, we have a lot going on at bear. We have a lot going on in our game�s areas, I think you should expect to see more exciting new products launches in 2024.
Rommel Dionisio
Great. I appreciate it. Thank you again.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Patrick Griffin for closing remarks.
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 at escaladeinc.com. This concludes our call today. You may now disconnect.
