ESCALADE INC 10-Q

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   Forward-Looking Statements   This report contains forward-looking statements relating to present or future trends or factors that are subject to risks and uncertainties. These risks include, but are not limited to: specific and overall impacts of the COVID-19 global pandemic on Escalade’s financial condition and results of operations; the impact of competitive products and pricing; product demand and market acceptance; new product development; Escalade’s ability to achieve its business objectives, especially with respect to its Sporting Goods business on which it has chosen to focus; Escalade’s ability to successfully achieve the anticipated results of strategic transactions, including the integration of the operations of acquired assets and businesses and of divestitures or discontinuances of certain operations, assets, brands, and products; the continuation and development of key customer, supplier, licensing and other business relationships; Escalade’s ability to develop and implement our own direct to consumer e-commerce distribution channel; Escalade’s ability to successfully negotiate the shifting retail environment and changes in consumer buying habits; the financial health of our customers; disruptions or delays in our business operations, including without limitation disruptions or delays in our supply chain, arising from political unrest, war, labor strikes, natural disasters, public health crises such as the coronavirus pandemic, and other events and circumstances beyond our control; Escalade’s ability to control costs; Escalade’s ability to successfully implement actions to lessen the potential impacts of tariffs and other trade restrictions applicable to our products and raw materials, including impacts on the costs of producing our goods, importing products and materials into our markets for sale, and on the pricing of our products; general economic conditions; fluctuation in operating results; changes in foreign currency exchange rates; changes in the securities markets; continued listing of the Company’s common stock on the NASDAQ Global Market; the Company’s inclusion or exclusion from certain market indices; Escalade’s ability to obtain financing and to maintain compliance with the terms of such financing; the availability, integration and effective operation of information systems and other technology, and the potential interruption of such systems or technology; risks related to data security of privacy breaches; the potential impact of actual or perceived defects in, or safety of, our products, including any impact of product recalls or legal or regulatory claims, proceedings or investigations involving our products; and other risks detailed from time to time in Escalade’s filings with the Securities and Exchange Commission. Escalade’s future financial performance could differ materially from the expectations of management contained herein. Escalade undertakes no obligation to release revisions to these forward-looking statements after the date of this report.   Overview   Escalade, Incorporated (Escalade, the Company, we, us or our) is focused on growing its Sporting Goods business through organic growth of existing categories, strategic acquisitions, and new product development. The Sporting Goods business competes in a variety of categories including basketball goals, archery, billiards, indoor and outdoor game recreation and fitness products. Strong brands and on-going investment in product development provide a solid foundation for building customer loyalty and continued growth.   Within the sporting goods industry, the Company has successfully built a robust market presence in several niche markets. This strategy is heavily dependent on expanding our customer base, barriers to entry, strong brands, excellent customer service and a commitment to innovation. A key strategic advantage is the Company’s established relationships with major customers that allow the Company to bring new products to market in a cost effective manner while maintaining a diversified portfolio of products to meet the demands of consumers. In addition to strategic customer relations, the Company has substantial manufacturing and import experience that enable it to be a low cost supplier.   To enhance growth opportunities, the Company has focused on promoting new product innovation and development and brand marketing. In addition, the Company has embarked on a strategy of acquiring companies or product lines that complement or expand the Company's existing product lines or provide expansion into new or emerging categories in sporting goods. A key objective is the acquisition of product lines with barriers to entry that the Company can take to market through its established distribution channels or through new market channels. Significant synergies are achieved through assimilation of acquired product lines into the existing Company structure. In January 2022, the Company completed its acquisition of the assets of the Brunswick Billiards® business, complementing its existing portfolio of billiards brands and other offerings in the Company’s indoor recreation market. The Company also sometimes divests or discontinues certain operations, assets, brands, and products that do not perform to the Company's expectations or no longer fit with the Company's strategic objectives.   Management believes that key indicators in measuring the success of these strategies are revenue growth, earnings growth, new product introductions, and the expansion of channels of distribution.   14     As the impact of the COVID-19 pandemic evolves, the Company continues to respond to the challenges and opportunities arising from the COVID-19 pandemic. Even though the pandemic may not have had a material adverse direct effect on the Company, the pandemic’s effects on the global supply chain, higher freight and materials costs, supplier product delays, workforce availability and labor costs have caused operational challenges for the Company. The ultimate extent of the effects of the COVID-19 pandemic on the Company is highly uncertain and will depend on future developments, and such effects could exist for an extended period of time even after the pandemic ends. Consumer demand for the Company’s products may be slowing due to additional factors such as general economic conditions, inflation, recessionary fears, rising interest rates, changes in the housing market and declining consumer confidence. Management cannot predict the full impact of these factors on the Company. Due to the above circumstances and as described generally in this Form 10-Q, the Company’s results of operations for the period ended October 1, 2022 are not necessarily indicative of the results to be expected for fiscal year 2022.   Results of Operations The following schedule sets forth certain consolidated statement of operations data as a percentage of net revenue:       Three Months Ended     Nine Months Ended       October 1, 2022     October 2, 2021     October 1, 2022     October 2, 2021   Net revenue     100.0 %     100.0 %     100.0 %     100.0 % Cost of products sold     81.8 %     77.5 %     76.2 %     74.7 % Gross margin     18.2 %     22.5 %     23.8 %     25.3 % Selling, administrative and general expenses     11.7 %     12.6 %     14.0 %     14.1 % Amortization     0.9 %     0.5 %     0.9 %     0.6 % Operating income     5.6 %     9.4 %     8.9 %     10.6 %   Revenue and Gross Margin Sales decreased by 7.9% for the third quarter of 2022, compared with the same period in the prior year. Sales declined due to softening consumer demand and excess inventories in the retail channel. During the third quarter of 2022, increases in billiards and pickleball sales, together with the contribution from the Brunswick Billiards® acquisition completed January 21, 2022, were more than offset by lower sales in outdoor categories including archery, games, water sports, and playground. For the first nine months of 2022, sales were up 0.6% compared to prior year.   Gross margin declined to 18.2% for the third quarter of 2022 compared to 22.5% for the same period in 2021 due to lower sales, unfavorable product mix, global supply chain constraints, and nonrecurring product recall expenses.   Gross margin percentage decreased to 23.8% for the first nine months of 2022, compared to 25.3% for the same period in the prior year.   Selling, General and Administrative Expenses Selling, general and administrative expenses (SG&A) were $8.8 million for the third quarter of 2022 compared to $10.2 million for the same period in the prior year, a decrease of $1.4 million or 14.0%. SG&A as a percent of sales is 11.7% for the third quarter of 2022 compared with 12.6% for the same period in the prior year. For the first nine months of 2022, SG&A were $34.0 million compared to $33.9 million for the same period in 2021, an increase of $0.1 million or 0.3%. As a percent of sales, SG&A is 14.0% for the first nine months of 2022 compared with 14.1% for the same period in the prior year.   Provision for Income Taxes The effective tax rate for the first nine months of 2022 was 19.6% compared to 20.5% for the same period last year.   15     Financial Condition and Liquidity   Total debt at the end of the first nine months of 2022 was $106.7 million, an increase of $49.2 million from December 25, 2021. The increase in debt was largely driven by the funding of the Brunswick Billiards acquisition completed in January of 2022. The following schedule summarizes the Company’s total debt:   In thousands   October 1, 2022     December 25, 2021     October 2, 2021                             Current portion of long-term debt   $ 7,143     $ 7,143     $ 7,143   Long term debt     99,568       50,396       51,874   Total Debt   $ 106,711     $ 57,539     $ 59,017     As a percentage of stockholders’ equity, total debt was 67.8%, 39.2% and 40.8% at October 1, 2022, December 25, 2021, and October 2, 2021, respectively.   On January 21, 2022, the Company entered into an Amended and Restated Credit Agreement (“Restated Credit Agreement”) with its issuing bank, JP Morgan Chase Bank, N.A. (“Chase”), and the other lenders identified in the Restated Credit Agreement (collectively, the “Lender”). Under the terms of the Restated Credit Agreement, Old National Bank has been added as a Lender. The Lenders have now made available to the Company a senior revolving credit facility with increased maximum availability of $65.0 million (the “Revolving Facility”), up from $50.0 million, plus an accordion feature that would allow borrowings up to $90.0 million under the Revolving Facility subject to certain terms and conditions. The maturity date of the revolving credit facility was extended to January 21, 2027. The Company may prepay the Revolving Facility, in whole or in part, and reborrow prior to the revolving loan maturity date. The Restated Credit Agreement further extended the maturity date for the term loan facility to January 21, 2027.   Each loan bears interest at the Adjusted LIBO Rate for the interest period in effect plus the Applicable Rate. Applicable Rate means the applicable rate per annum set forth below, based upon Escalade’s Funded Debt to Adjusted Ratio as of the most recent determination date:   Funded Debt to EBITDA Ratio   Revolving Commitment ABR Spread     Revolving Commitment Term Benchmark Spread     Letter of Credit Fee     Commitment Fee Rate   Category 1 Greater than or equal to 2.50 to 1.0     0.25 %       2.00 %       2.00 %       0.30 %   Category 2 Greater than or equal to 1.50 to 1.0 but less than 2.50 to 1.0     -0-       1.75 %     1.75 %     0.25 % Category 3 Less than 1.50 to 1.0     (0.25% )     1.50 %     1.50 %     0.20 %   The Applicable Rate is determined as of the end of each quarter based upon the Company’s annual or quarterly consolidated financial statements and shall be effective during the period commencing the date of delivery to the agent.   In addition to the increased revolving borrowing amount and extended maturity dates, other significant changes reflected in the Restated Credit Agreement included: specifying that Indian’s acquisition of the assets of the Brunswick Billiards business is a permitted acquisition; providing a $7.5 million swingline commitment by Chase; replacing LIBOR with the replacement benchmark secured overnight financing rate as previously contemplated; and adjustments to certain financial covenants relating to the fixed charge coverage ratio. Escalade’s indebtedness under the Restated Credit Agreement continues to be collateralized by liens on all of the present and future equity of each of Escalade’s domestic subsidiaries and substantially all of the assets of the Company (excluding real estate). Each direct and indirect domestic subsidiary of Escalade and Indian has secured its guaranty of indebtedness incurred under the Revolving Facility with a first priority security interest and lien on all of such subsidiary’s assets. Escalade, Indian and all of the domestic subsidiaries entered into an Amended and Restated Pledge and Security Agreement dated January 21, 2022 in favor of the Lender to continue the existing liens, previously existing under the original pledge and security agreements entered into on April 30, 2009, as amended, and thereafter for subsidiaries created or acquired after that date. The obligations, guarantees, liens and other interests granted by Escalade, Indian, and their domestic subsidiaries continue in full force and effect.   16     On July 18, 2022, the Company entered into the First Amendment to the Restated Credit Agreement. Under the terms of the First Amendment, the Lender increased the maximum availability under the senior revolving credit facility from $65.0 million to $75.0 million pursuant to the accordion feature in the Restated Credit Agreement. The First Amendment also adjusted the funded debt to EBITDA ratio financial covenant to 3:00 to 1:00 as of the end of the Company’s third and fourth fiscal quarters of 2022.   On October 26, 2022, the Company entered into the Second Amendment ("Second Amendment”) to the Restated Credit Agreement. Under the terms of the Second Amendment, the Lender increased the maximum availability under the senior revolving credit facility from $75.0 million to $90.0 million pursuant to the accordion feature in the Restated Credit Agreement. The Second Amendment adjusted the funded debt to EBITDA ratio financial covenant to 3:25 to 1:00 as of the end of the Company’s third and fourth fiscal quarters of 2022 and 3:00 to 1:00 as of the end of the Company’s first fiscal quarter of 2023. The Second Amendment also modified the EBITDA definition to permit add-backs of a) up to $2.0 million for disposition related expenses; and b) up to $2.0 million for unusual or non-recurring expenses which are incurred prior to the end of fiscal year 2023 and which are subject to the approval of the Administrative Agent.   As of October 1, 2022, the outstanding principal amount of the term loan was $41.7 million and total amount drawn under the Revolving Facility was $65.0 million.   The Company funds working capital requirements, shareholder dividends, and stock repurchases through operating cash flows and revolving credit agreements with its Lenders. The Company expects that cash generated from its 2022 operations and its access to adequate levels of revolving credit will provide it with sufficient cash flows for its operations and to meet growth needs.   Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK   Not Required.   Item 4. CONTROLS AND PROCEDURES   Evaluation of Disclosure Controls and Procedures   Escalade maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of “disclosure controls and procedures” in Rules 13a-15(e) and 15d-15(e). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, could provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.   The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.   Changes in Internal Control over Financial Reporting   Management of the Company has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the third quarter of 2022.   There have been no changes to the Company’s internal control over financial reporting that occurred since the beginning of the Company’s first quarter of 2022 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.   17     PART II. OTHER INFORMATION   Item 1. LEGAL PROCEEDINGS.   None.