Wednesday, August 13, 2008

Those Margins Are Gross!

Escalade Inc. (NASDAQ: ESCA) manufactures and distributes sporting goods and office equipment. Escalade has a P/E of 10, and sells on the market for $42 million, but has a book value of $87 million. Of course, as discussed here, the book value doesn't necessarily tell you much about the company's net worth. Nevertheless, this company warrants a closer look.

In the first half of this year, the company actually swung to a loss. A comparison of this year's 2nd quarter income statement to that of last year's suggests a revenue shortfall is the main culprit, as revenue dropped from $51 million to $46 million. Curiously, however, the company's cost of goods sold stayed the same, as follows ($ millions):

Had the company's COGS dropped at the same rate as its revenue, it would have managed a decent profit. So what could have happened? On the revenue side, it's possible competitors offered customers similarly perceived products at much lower prices, requiring Escalade to drop their prices to match. Another possibility is that inflation caused the company to have to manufacture the same number of products but at higher prices, and customers were unable/unwilling to allow these higher costs to be passed onto them.

So what's the answer in this case? The reader considering investing is challenged to find the the answer to this question (and more) in the "Management's Discussion and Analysis" section of the latest quarterly report. Investors are encouraged to read this section, as well as the notes to the financial statements (as discussed here) before making any investments!

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