CONDITION AND RESULTS OF OPERATIONS

The following section should be read in conjunction with Item 1: Business; Item 1A: Risk Factors; Item 6: Selected Financial Data; and Item 8: Financial Statements and Supplementary Data.

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, the impact of competitive products and pricing, product demand and market acceptance, new product development, the continuation and development of key customer and supplier relationships, Escalade's ability to control costs, general economic conditions, fluctuation in operating results, changes in the securities market, Escalade's ability to obtain financing and to maintain compliance with the terms of such financing 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" or "Company") manufactures and distributes products for two industries: Sporting Goods and Information Security and Print Finishing. Sporting Goods has expanded its product offerings to include team training products. Information Security and Print Finishing has increasingly focused its strategy on expanding the security segment of its business to assist businesses and governments with their high security needs for handling sensitive customer, employee and business documents and information, in addition to Martin Yale's traditional product offerings.

Within these industries the Company has successfully built a market presence in niche markets. This strategy is heavily dependent on expanding the customer base, barriers to entry, brand recognition and excellent customer service. 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 product line and wide customer base. In addition to strategic customer relations, the Company has substantial manufacturing and import experience that enable it to be a low cost supplier.

A majority of the Company's products are in markets that are currently experiencing low growth rates. Where the Company enjoys a commanding market position, such as table tennis tables in the Sporting Goods segment and paper folding machines in the Information Security and Print Finishing segment, revenue growth is expected to be roughly equal to general growth/decline in the economy. However, in markets that are fragmented and where the Company is not the dominant leader, such as archery in the Sporting Goods segment and data security shredders in the Information Security and Print Finishing segment, the Company anticipates growth. To enhance internal growth, the Company has a strategy of acquiring companies or product lines that complement or expand the Company's existing product lines. 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. Management believes that key indicators in measuring the success of this strategy are revenue growth, earnings growth and the expansion of channels of distribution. The following table sets forth the annual percentage change in revenues and net income (loss) over the past three years:

                                                   2012         2011         2010

      Net revenue
      Sporting Goods                                 16.1 %       13.0 %       11.7 %
      Information Security and Print Finishing       (6.1 %)       7.0 %      (11.1 %)
      Total                                           9.9 %       11.3 %        4.0 %

      Net income (loss)                            (211.0 %)     (26.7 %)     265.6 %

Excluding the impact of goodwill and intangible asset impairment in 2012 and accelerated depreciation in 2011, the annual percentage of change in net income would have been an increase of 23.6% in 2012 and 18.0% in 2011.

Results of Operations

The following schedule sets forth certain consolidated statement of operations data as a percentage of net revenue for the periods indicated:

                                                       2012         2011        2010
   Net revenue                                          100.0 %      100.0 %     100.0 %
   Cost of products sold                                 69.9 %       68.9 %      69.2 %
   Gross margin                                          30.1 %       31.1 %      30.8 %
   Selling, administrative and general expenses          21.3 %       26.8 %      22.9 %
   Amortization                                           1.5 %        1.2 %       1.1 %
   Goodwill and intangible asset impairment charges       9.1 %         .0 %        .0 %
   Operating income (loss)                               (1.8 %)       3.1 %       6.8 %

In 2012, without the goodwill and intangible asset impairment, operating income would have been 7.3%. In 2011, without the accelerated depreciation expense on the replaced ERP system, selling, administrative and general expenses would have been 23.5% and operating income would have been 6.4%.

Consolidated Revenue and Gross Margin

Sales growth across most sales channels of the Sporting Goods segment resulted in an overall increase of 16.1% in Sporting Goods net revenues for 2012 compared to 2011. Revenues from the Information Security and Print Finishing business decreased 6.1% in 2012 compared to 2011. Approximately 2.7% of the decrease in Information Security and Print Finishing revenue is due to changes in foreign exchange rates.

The overall gross margin percentage in 2012 was slightly lower than 2011. The gross margin percentage was up approximately 0.9% in the Sporting Goods segment and down approximately 5.1% in the Information Security and Print Finishing segment. Decreases in gross margin in the Information Security and Print Finishing segment were due mainly to legacy quality problems in certain product lines and increased competition and lower market demand in the certain categories.

Consolidated Selling, General and Administrative Expenses

Consolidated selling, general and administrative expenses ("SG&A") were $31.4 million in 2012 compared to $35.9 million in 2011, a decrease of $4.5 million or 12.5%. SGA in 2011 included $4.4 million of accelerated depreciation expense related to the replacement of the Company's Oracle ERP system. Excluding accelerated depreciation in 2011, SGA for 2012 was $0.1 million less than prior year. SG&A as a percent of sales is 21.3% in 2012 compared with 26.8% in 2011. Without the effects of the accelerated depreciation, SG&A as a percent of sales would have been 23.5% in 2011.

Other Income

Other income decreased slightly in 2012 compared to 2011, from $3.4 million to $3.0 million, a decrease of 10.8%. Income from the non-marketable equity investments was $3.0 million in 2012 compared with $3.3 million in 2011.

Provision for Income Taxes

The effective income tax rate in 2012 was impacted by the goodwill and intangible asset impairment write-down which is not deductible for income tax purposes. Excluding the effect of the goodwill and intangible asset impairment, the effective tax rate for 2012 would be 33.2% compared with 35.4% for 2011 and 33.2% for 2010. The effective tax rate for 2011 was higher relative to 2010 due to valuation allowances on net operating losses generated in the European subsidiaries.

Sporting Goods



Net revenues, operating income, and net income for the Sporting Goods business
segment for the three years ended December 29, 2012 were as follows:



In Thousands            2012         2011         2010

Net revenue        $ 112,599     $ 96,971     $ 85,815
Operating income      13,758       10,802        9,171
Net income             8,189        5,817        4,601

Net revenue increased 16.1% in 2012 compared to 2011 with growth coming from most sales channels in the Sporting Goods segment. The Company continues to aggressively pursue opportunities to increase revenue through introduction of new products, expansion of product distribution, acquisitions, and increased investment in consumer marketing. Sales channels are predominately mass market retail customers, specialty retailers, and dealers. During the year, the Company expanded its product offerings with the acquisition of the assets of Cajun Archery and the patent rights for rigid air technology from BDZ Holdings.

Gross margin and profitability increased in 2012 compared with 2011. The gross margin ratio in 2012 improved to 29.0% compared to 28.2% in the prior year. The improvement is due to product mix, continued focus on production efficiencies and better factory absorption resulting from increased sales volume. As a result, operating income as a percentage of net revenue increased to 12.2% in 2012 compared to 11.1% in 2011. Management anticipates that with additional sales growth in 2013, improvements in operating income will continue. Net income for 2012 increased from 2011 due primarily to increased revenue.

Information Security and Print Finishing



Net revenue, operating income (loss) and net loss for the Information Security
and Print Finishing business segment for the three years ended December 29, 2012
were as follows:



In Thousands                   2012         2011         2010

Net revenue               $  34,990     $ 37,279     $ 34,841
Operating income (loss)     (14,628 )         71          926
Net loss                    (15,683 )       (921 )       (187 )

Sales in the Information Security and Print Finishing business decreased 6.1% in 2012 compared to 2011 due to significant declines in certain export and Asian countries. The Company continues to evaluate product offerings and markets to stabilize sales and increase profitability. Excluding the effect of changes in foreign exchange rates, 2012 sales were down 3.4% from 2011. Sales are direct to end users, including government agencies, as well as through office products retailers, wholesalers, specialty dealers, and business partners.

Operating income in the Information Security and Print Finishing segment was impacted by goodwill and intangible asset impairment charges of $13.4 million. Without this impact, the operating income for this segment was a loss of $1.2 million, or (3.6%) of revenue in 2012 compared to 0.2% of revenue in 2011. High organizational costs and legacy quality issues contributed to losses during the year. The Company is focusing on cost saving initiatives and quality improvements to bring profitability to this segment.

Financial Condition and Liquidity

The current ratio, a basic measure of liquidity (current assets divided by current liabilities), held steady at 1.9 in 2012 compared to 1.9 in 2011. Inventory levels increased to $30.9 million in 2012 compared with $29.0 million in 2011 to support sales growth in certain expanded Sporting Goods categories. Total current and long-term debt increased to $22.6 million up from $21.9 million in 2011.

The Company's decrease of cash was principally a result of increased profits in the Sporting Goods segment offset by increases in accounts receivable and inventory levels, payments for capital purchases and acquisitions, and the distribution of shareholder dividends. The Company paid $5.1 million in dividends in 2012. Total bank debt for the year increased by $0.6 million. Total bank debt as a percentage of stockholders equity increased to 28.1% in 2012, up from 25.1% in 2011.

In 2013, the Company expects capital expenditures to be approximately $5.5 million which includes $0.6 million to continue the implementation of its integrated information system at its Sporting Goods locations and $2.4 million to acquire currently leased property in Rosarito, Mexico. The Company fully depreciated the remaining book value of its Oracle ERP system in 2011. This acceleration of depreciation resulted in additional pre-tax expense of $4.4 million, ($2.7 million net of tax) in 2011.

The Company's working capital requirements are primarily funded through cash flows from operations and revolving credit agreements with its bank. During 2012, the Company's maximum borrowings under its primary revolving credit lines totaled $22.1 million compared to $26.4 million in 2011. Total notes payable as of the end of fiscal 2012 was $22.6 million compared with $21.9 million at the end of fiscal 2011. The overall effective interest rate in 2012 was 3.2% which was up slightly from the effective rate of 2.9% in 2011. The Company's Credit Agreement with JPMorgan Chase Bank, N.A. matures as of July 31, 2013 and the Company has begun preliminary discussion regarding renewal of this agreement. The Company also maintains a multicurrency overdraft facility with its bank. The total amount outstanding under the overdraft facility at the end of fiscal 2012 was $2.5 million compared with $2.2 million at the end of fiscal 2011.

The Company has a long standing relationship with its lender and has met all financial covenants under the new agreement which was last amended as of May 4, 2012. The amended terms of the agreement modified the loan covenants relating to capital expenditures, stock repurchases, and issuance of common stock. As mentioned above, the Company increased its bank debt in 2012 by approximately 3.1% to $22.6 million.

The Company expects improvements in its overall sales levels for fiscal year 2013 compared with 2012 as a result of new product offerings and expanded customer base. The Company believes that cash generated from its projected 2013 operations and the commitment of borrowings from its primary lender will provide it with sufficient cash flows for its operations.

It is possible that if the economic conditions deteriorate, this could have adverse effects on the Company's ability to operate profitably during fiscal year 2013. To the extent that occurs, management intends to pursue cost reductions and to continue realigning its infrastructure in an effort to match the Company's overhead and cost structure with the sales level dictated by current market conditions.

New Accounting Pronouncements

Refer to Note 1 to the consolidated financial statements under the sub-heading "New Accounting Pronouncements".

Off Balance Sheet Financing Arrangements

The Company has no financing arrangements that are not recorded on the Company's balance sheet.

Contractual Obligations



The following schedule summarizes the Company's contractual obligations as of
December 29, 2012:



Amounts in thousands                                                  Payments Due by Period
                                                        Less than 1                                          More than 5
Contractual Obligations                    Total           year           1 -3 years       3 - 5 years          years

Debt                                      $ 20,118     $      16,618     $      3,500     $           -     $           -
Overdraft facility                           2,452             2,452                -                 -                 -
Future interest payments (1)                   855               695              160                 -                 -
Operating leases                             2,425               915            1,188               322                 -
Minimum payments under royalty and
license agreements                           2,225               350              750               750               375
Total                                     $ 28,075     $      21,030     $      5,598     $       1,072     $         375

Notes:

(1) Assumes that the Company will not increase borrowings under its long-term credit agreements and that the effective interest rate experienced in 2012 of 3.2% will continue for the life of the agreements.

Critical Accounting Estimates

The methods, estimates and judgments used in applying the Company's accounting policies have a significant impact on the results reported in its financial statements. Some of these accounting policies require difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. The most critical accounting estimates are described below and in the Notes to the Consolidated Financial Statements.

Product Warranty

The Company provides limited warranties on certain of its products for varying periods. Generally, the warranty periods range from 90 days to one year. However, some products carry extended warranties of seven-year, ten-year, and lifetime warranties. The Company records an accrued liability and expense for estimated future warranty claims based upon historical experience and management's estimate of the level of future claims. Changes in the estimated amounts recognized in prior years are recorded as an adjustment to the accrued liability and expensed in the current year. To the extent there are product defects in current products that are unknown to management and do not fall within historical defect rates, the product warranty reserve could be understated and the Company could be required to accrue additional product warranty costs thus negatively affecting gross margin.

Inventory Valuation Reserves

The Company evaluates inventory for obsolescence and excess quantities based on demand forecasts over specified time frames, usually one year. The demand forecast is based on historical usage, sales forecasts and current as well as anticipated market conditions. All amounts in excess of the demand forecast are deemed to be potentially excess or obsolete and a reserve is established based on the anticipated net realizable value. To the extent that demand forecasts are greater than actual demand and the Company fails to reduce manufacturing output accordingly, the Company could be required to record additional inventory reserves which would have a negative impact on gross margin.

Allowance for Doubtful Accounts

The Company provides an allowance for doubtful accounts based upon a review of outstanding receivables, historical collection information and existing economic conditions. Accounts receivable are ordinarily due between 30 and 60 days after the issuance of the invoice. Accounts are considered delinquent when more than 90 days past due. Delinquent receivables are reserved or written off based on individual credit evaluation and specific circumstances of the customer. To the extent that actual bad debt losses exceed the allowance recorded by the Company, additional reserves would be required which would increase selling, general and administrative costs.

Customer Allowances

Customer allowances are common practice in the industries in which the Company operates. These agreements are typically in the form of advertising subsidies, volume rebates and catalog allowances and are accounted for as a reduction to gross sales. The Company reviews such allowances on an ongoing basis and accruals are adjusted, if necessary, as additional information becomes available.

Impairment of Goodwill

The Company reviews goodwill for impairment annually and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable, in accordance with guidance in FASB ASC 350, Intangibles - Goodwill and Other. Management determined the assumptions and inputs utilized in the evaluation of the fair value of the Company's two separate reporting units, discussed below. The first phase of the goodwill impairment test requires that the fair value of the applicable reporting unit be compared with its recorded value. The Company establishes fair value by using an income approach or a combination of a market approach and an income approach. The market approach uses the guideline-companies method to estimate the fair value of a reporting unit based on reported sales of publicly-held entities engaged in the same or a similar business as the reporting unit. The income approach uses the discounted cash flow method to estimate the fair value of a reporting unit by calculating the present value of the expected future cash flows of the reporting unit. The discount rate is based on a weighted average cost of capital determined using publicly-available interest rate information on the valuation date and data regarding equity, size and country-specific risk premiums/decrements compiled and published by a commercial source. The Company uses assumptions about expected future operating performance in determining estimates of those cash flows, which may differ from actual cash flows.

If the implied fair value of a reporting unit is less than the recorded value of net assets, management performs a phase-two analysis that allocates the fair value of the reporting unit calculated in phase one to the specific tangible and intangible assets and liabilities of the reporting unit and results in an implied fair value of goodwill. Goodwill is reduced by any shortfall of implied goodwill to its current carrying value.

Beginning in late 2009, and continuing going forward, two of the Company's reporting units; Martin Yale North America and Martin Yale Europe, which comprise the Information Security and Print Finishing segment, have migrated to one reporting unit as a result of consolidation of management and internal reporting. During 2012, the Company had two reporting units that required separate goodwill impairment analysis. Those reporting units are Escalade Sports and Martin Yale Group. These reporting units are identical to the operating segments; Sporting Goods and Information Security and Print Finishing, respectively. Significant assumptions and inputs used in each of the reporting units goodwill impairment testing are as follows:

Escalade Sports - The Company appraised the fair value of the invested capital of the Escalade Sports reporting unit using an income approach. The discount rate used in the 2012 discounted cash flow calculation was 11.2% compared to 12.5% for 2011. The decrease in the discount rate is a result of decreases in the cost of debt capital and the size risk premium in 2012 compared with 2011. Projected revenues and costs for 2013 and beyond reflected the Company's best estimate of the current global economic situation, demand for existing products, the status of new products and product improvements, and the projected cost of raw materials and manufacturing that are deemed material in projecting future outcomes.

Martin Yale Group - During the third quarter of fiscal 2012, the Company determined that sufficient indicators of potential impairment existed to require an interim goodwill impairment analysis for the Martin Yale Group reporting unit. These indicators included lower than expected operating profits and cash flows for the first nine months of 2012, coupled with continued economic weakness in the European and Asian markets.

The Company appraised the fair value of the combined total invested capital of Martin Yale North America and Martin Yale Europe, as a combined reporting unit. The appraisal study utilized a combination income and market approach. The market approach was weighted 50% and the income approach was weighted 50% to arrive at the final fair value determination. The discount rate used in the 2012 discounted cash flow calculation was 11.2% compared to 12.0% for 2011. The discount rate was developed in accordance with the riskiness of the future revenues and expenses of Martin Yale and also reflects market participant rates of return. The methodology used in 2012 is consistent with that used previously. Projected revenues and costs for 2013 and beyond reflect the Company's best estimate of the current global economic situation, demand for existing products, the status of new products and product improvements, and the projected cost of raw materials and manufacturing that are deemed material in projecting future outcomes.

The Company's testing determined that goodwill of the Escalade Sports reporting unit was not impaired. The testing of the Martin Yale Group reporting unit resulted in a goodwill impairment loss of $13.2 million in the third quarter of 2012. In addition, the Company recorded an intangible asset impairment for this segment related to other intangibles for Martin Yale Group of $0.2 million. The goodwill impairment loss reduces to zero the carrying value of goodwill recorded as part of various acquisitions in the Information Security and Print Finishing segment for purchases from 2003 through 2008.

Of the total recorded goodwill of $12.0 million at December 29, 2012, the entire amount was allocated to the Escalade Sports reporting unit. The results of the impairment test for the Escalade Sports reporting unit indicated that the fair value of invested capital exceeded the carrying value of invested capital by a significant margin as of December 29, 2012.

Long Lived Assets

The Company evaluates the recoverability of certain long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Estimates of future cash flows used to test recoverability of long-lived assets include separately identifiable undiscounted cash flows expected to arise from the use and eventual disposition of the assets. Where estimated future cash flows are less than the carrying value of the assets, impairment losses are recognized based on the amount by which the carrying value exceeds the fair value of the assets.

The Company consolidated its Mexico operations into its Rosarito, Mexico facility during 2008 and ceased operations at its Reynosa, Mexico facility in February 2009. During 2008, the Company recorded an impairment loss of $2.6 million related to the Reynosa facility and since 2009 this facility had been listed as idle. During 2011, the Company sold the Reynosa facility and recorded a pre-tax gain of $380 thousand and a combined Mexico and U.S. tax liability of $474 thousand for a net loss of $94 thousand.

Non-Marketable Equity Method Investments

The Company has minority equity positions in companies strategically related to the Company's business, but does not have control over these companies. The accounting method employed is dependent on the level of ownership and degree of influence the Company can exert on operations. Where the equity interest is less than 20% and the degree of influence is not significant, the cost method of accounting is employed. Where the equity interest is greater than 20% but not more than 50%, the equity method of accounting is utilized. Under the equity method, the Company's proportionate share of net income (loss) is recorded in other income on the consolidated statements of operations. The proportionate share of net income was $3.0 million, $3.3 million and $2.0 million in 2012, 2011 and 2010, respectively. Total cash dividends received from these equity investments amounted to $444 thousand, $323 thousand, and $0 in 2012, 2011 and 2010, respectively. The Company considers whether the fair values of any of its equity investments have declined below their carrying value whenever adverse events or changes in circumstances indicate that recorded values may not be recoverable. If the Company considers any such decline to be other than temporary (based on various factors, including historical financial results, product development activities and overall health of the investments' industry), a write-down is recorded to estimated fair value.

During 2012 one equity method investment, Escalade International, Ltd. performed below expectations, and this entity encountered unexpected attrition of certain significant customers as of the end of the third quarter 2012. Due to these . . .