Callaway Golf Company (CALY) Q2 2015 Earnings Report, Transcript and Summary

Good afternoon. I would like to welcome everyone to the Q2 2015 Callaway Golf Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer session. [Operator Instructions] Thank you. Patrick Burke, Head of Investor Relations, you may now begin your conference.

Thank you, Ian, and good afternoon everyone. Welcome to Callaway's second quarter 2015 earnings conference call. I'm Patrick Burke, the company's Head of Investor Relations. Joining me on today's call are Chip Brewer, our President and Chief Executive Officer; and Robert Julian, our Chief Financial Officer. I would like to point out that any comments made during the call about future performance, events, prospects, or circumstances including statements related to estimated 2015 net sales, sales growth, gross margins, operating expenses, pre-tax income and earnings per share, future market conditions, foreign currency exchange rates, market share gains or brand momentum, the loss or success of the company's future products, long-term profitability or the creation of long-term shareholder value, the collectability of accounts receivable and salability of inventory, estimated 2015 capital expenditures and depreciation and amortization expenses and other statements referring to future periods and identified by words such as "believe", "will", "could", "would", "expect", or "anticipate" are forward-looking statements subject to safe harbor protection under the Federal Securities Laws. Such statements reflect our best judgment today based on current market trends and conditions. Actual results could differ materially from those projected in forward-looking statements as a result of certain risks and uncertainties applicable to the company and its businesses. For details concerning these and other risks and uncertainties, you should consult our earnings issued today as well as Part One Item 1A of our most recent Form 10-K for the year ended December 31, 2014, filed with the SEC together with the company's other reports subsequently filed with the SEC from time-to-time. Also during the call in order to provide a better understanding of the Company's underlying operational performance we will provide certain of the Company's results and projections on a constant currency basis, which essentially excludes all offsetting hedging gains and losses for quarter during the applicable period, and applies the prior period exchange rates to the adjusted current or future period financial information and so prior period rates, were in effect during the current or future period. We will also provide information on the company's earnings excluding interest, taxes, and depreciation and amortization expenses. This information may include non-GAAP financial measures within the meaning of Regulation G. The information provided on the call today and the earnings release and the latest schedules we issued today include reconciliation of such non-GAAP financial information to the most directly comparable financial information prepared in accordance with GAAP. The earnings release and related schedules are available on Investor Relations of the company's website at www.callawaygolf.com. I would now like to turn the call over to Chip.

Thanks, Patrick. That was very thorough. Good afternoon everybody and thank you for joining us for today's call. Q2 2015 was another good quarter for Callaway Golf. I'd like to include strong performance in the U.S. market as well as continued improvements in overall operating efficiencies. Partially offsetting these improvements, we're softer than anticipated market conditions in our international markets especially Asia combined with the global currency movements over the last year. Overall, we remain pleased with our progress and outlook. With that said I'll jump into some specifics. Revenues for Q3 were approximately flat on a GAAP basis, but up 6.5% on a currency neutral basis. Our U.S. business was up 8% reflecting both market share gains and improved market conditions. The market has been less promotional and it shows signs of stabilization and participation as well as improvements in rounds played in retail softer [ph]. Europe performed roughly consistent with expectation reflecting continued challenging market conditions but continuing strengthening of our relative position. Asia was a challenge during Q2 with market conditions underperforming expectations on top of the continuing foreign exchange translation issues. Looking at Japan specifically the market was down 5%, 5.7% through Q2 and our business there is also down year-to-date but we were up 19% on a local currency basis in Q2. A portion of the challenges in Japan are due to an inventory correction at retail and we appreciate the necessity of this adjustment and believe it should mostly work through by the end of the year provided there is no further drop off in market conditions. Looking outside of Japan, China has become a challenging market primarily due to government policy decisions and we've been working through a change in business and distribution models in the South East Asia markets of Thailand, Singapore, and Malaysia. Fortunately, our brand position across Asia remains very strong and we remain optimistic for the balance of the year in the long-term. Turning to market share, in the U.S., our year-to-date hard goods dollar market share of 3 June was 21.4% up 230 basis point year-over-year. This third-party data has us regaining the number one position in total clubs, as well as being the top-selling brand in the irons, fairway woods, hybrids, and putters [ph] categories year-to-date. We've been the number one player in the putter category for some time. But the fairway wood, hybrid, and irons positions represent improvements in our relative positions that have been realized over the last year or so. In addition, our golf ball sales per share were increased to 11.1%, up 140 basis points and moving us to the number two brand in this important category. In Japan, our year-to-date hard goods share through June was 16.2%, up 110 basis points year-over-year. We remain number one U.S. brand in this market. In UK, our year-to-date hard goods market share through June was 18.5%, up 50 basis points year-over-year. In Europe through May which is our most recent data for that market, our share was 20.8%, up 220 basis points and sustaining our position as the number one hard goods brand in that market. Overall, we're very pleased with our market share growth and brand strength across the globe. We remain pleased with our exposure on tour and these results continue to be a positive catalyst for our brand in market share growth. Our product pipeline remains robust and we anticipate several new product launches during the second half of this year. The quality timing of these launches will be roughly equivalent to last year. However, [indiscernible] last year we've been transitioning to a new strategic launch cadence, splitting wood launches in the spring and fall and also moving to two year cycles on almost all other products. We are pleased to be through the transition period and are optimistic that new launch cadence will benefit us going forward. In addition, our golf ball business continues to strengthen and I view this as a category for future growth based primarily in the success of Chrome Soft and our SoftFast core technology. One way of measuring our potential in this category is the consumer reaction to our product. To this end, Chrome Soft's net promoter score of 75% is one of the highest ratings we've had ever seen for Callaway product. We believe this bodes very well for us going forward. Our cost management and overall operating efficiencies during Q2 where at expectations or better. In particular, our currency neutral gross margins have increased significantly over the last few years. We are encouraged by this trend and I believe that those will offer the long-term profitability of our business. Robert, will add more color on this during his comments. Foreign exchange continues to be a challenge. Encountered with new product launches we are starting to strategically raise prices in international markets. However, the adjustment processes is going to take some time, probably multiple years to fully adjusting recover. Turning now to balance of the year guidance. We are lowering our overall revenue targets for the full year, but more importantly, further increasing our earnings expectations. On the revenue side, I believe the market overall will be roughly flat for the second half of the year. Callaway should have roughly the same new product activity as last year and I believe we will be able to sustain our brand momentum. As a result for the balance of the year we're forecasting constant currency growth of 12%. On the earnings side, thanks to improvements in operating efficiencies and revenue quality we are raising our EPS estimates to a range of positive $0.01 to positive $0.06. In closing I'm confident the Callaway Golf is in a much stronger position today that it has been in quite some time. The changes we have implemented are being noticed and improving effective of driving increased consumer and just an improved operating efficiencies. International market conditions continue to be challenging but the overall fundamentals of the industry appear to be improvement, especially in the U.S. market with less promotional activity, less over production, lower field inventories as well as the general stabilization of participation and increased interest in the game is measured by TV ratings. As a result I remain confident that we are on track with our overall plan and the plan will lead to steadily improve performance in the long-term shareholder value. I look forward to continue and keep you update on our progress and appreciate your interest and support. Robert over to you.

Thank you, Chip. Today we are reporting consolidated Q2, 2015 net sales of $231 million compared to $232 million last year, a decrease of less than 1%. Foreign currency experiences negatively impacted revenues by $17 million. So on a constant currency basis year-over-year net sales increased by over 6%. Looking at Q2 revenue on a regional basis net sales in the U.S. increased 8% to $122 million. International sales were $109 million in the quarter, a decrease of 9% on a GAAP basis. However, on a currency neutral basis, Q2 international sales increased 5% year-over-year. Details by region are included in the attachment in today's press release. Gross margins were 44.1% in Q2 2015, compared to 39.2% last year and improvement of 490 basis points. This increase was driven by favorable price and mix variances associated with new product launches along with continued operational improvements. This favorability was partially offset by increased cost related to new product technology and negative foreign currency variances. On a constant currency basis gross margins would have improved 840 basis points to 47.6%. Operating expenses were $83 million in Q2 2015, a 4% increase compared to last year. This increase was due to continued investment in marketing and tour and increases in employee cost associated with stock price depreciation. On a constant currency basis operating expenses would have been $86 million, an increase of 8% compared to last year. These results generated operating income of $19 million in Q2 2015, compared to $11 million in last year. On a constant currency basis, operating income would have been $31 million, an improvement of 187% compared to last year. We have other expense of $4 million in Q2 2015 compared to $6 million last year. This change was primarily due to the impact of changes in currency rates on outstanding foreign currency hedging contracts. The company generated net income of $13 million in Q2 2015, compared to $3 million in 2014. Earnings per share were $0.15 or 95 million shares in Q2 2015, compared to $0.04 and 79 million shares in 2014. On a constant currency basis, Q2 2015 earnings per share would have been $0.30. Returning to net sales, I would like to provide some more details by product category, on a constant currency basis. Wood sales were $54 million in Q2 2015, an increase of 1% compared to last year. This was due to the success of our XR brand, particularly in the fairway woods and hybrids categories, which more than offset the drop off cost by a shift in our launch time. On a year-to-date basis, Callaway is the number one fairway woods and hybrid for dollar market share in the U.S. Iron sales were $63 million in Q2, an increase of 20% versus last year. This was driven by the successful launch of our XR Irons, as well as continued momentum in our Big Bertha and Apex Irons. On a year-to-date basis Callaway is the number one iron per dollar market share in the U.S. Putter sales were $26 million in Q2, a decrease of 2% compared to last year. We had continued success with our inline putters, driven by the success of our Odyssey Works Putter Line, offset by close out volumes of putters in Q2 of 2014, impacting the year-over-year comparison. On year-to-date basis, Odyssey is number one putter for dollar market share in the U.S. Golf ball sales were $43 million in Q2, an increase of 11% compared to last year. This was due to the successful launch of our new Chrome Soft golf ball and the continued success of our Supersoft line of balls. On a year-to-date basis, Callaway is the number two golf ball for dollar market share in the U.S. Accessories and other sales were $60 million in Q2, an increase of 1% compared to last year, mostly driven by our golf bag business. Turning now to the balance sheet, we ended Q2, 2015 with cash of $27 million, roughly equivalent to $29 million for Q2 of last year. We had $43 million of outstanding borrowings on our ABL credit facilities at the end of Q2 2015, compared to $60 million in Q2 of last year. Available liquidity including cash improved to $143 million compared to $71 million last year. Our consolidated net receivables were $220 million at the end of Q2 2015. An increase of 12% compared to Q2 of last year. DSO increased to 87 days compared to 78 days last year. Due to a change in our standard terms customer mix and new product launch timing. We remain comfortable with our overall quality of accounts receivables. Our inventory balance is $171 million at the end of Q2 2015, a decrease of 18% compared to Q2 of last year. This reduction was due to continued improvements in forecasting and inventory management as well as improved sell-through at retail. As a result, inventory as a percentage of trailing 12-month cost of sales improved to 35% compared to 38% in 2014. We remain comfortable with the quality of our inventory at this time. Capital expenditures for Q2 2015 were $4 million compared to $2 million last year. We estimate approximately $15 million to $18 million for the full year 2015. Depreciation and amortization expense was $4 million in the quarter compared to $5 million last year. We estimate approximately $20 million for the full year 2015. Our trailing 12-month EBITDA, at the end of Q2, was $39 million compared to $26 million last year, a 52% increase year-over-year. I'll now comment on our 2015 full year guidance. For the reason as Chip mentioned earlier we are lowering our 2015 net sales estimate on a GAAP basis to a range of $830 million to $840 million, a decline of 5% to 6% compared to last year. On a constant currency basis, this new estimate would equate to a range of $880 million to $890 million, essentially flat compared to last year. Due to launch timing, we expect Q3 reported sales growth to be relatively flat versus prior year with higher sales growth in Q4. Full year 2015 gross margins are estimated to be 42.0% and improvement of 100 basis points from our previous estimate, due to better than expected Q2 results continued improvements on our manufacturing operations and supply chain and improved sales mix over the balance of the year. Overall, this represents a 160 basis point improvement in gross margin compared to prior year on a GAAP basis. On a constant currency basis gross margin is 45.0%, an improvement of 460 basis points. Operating expenses are still estimated to be approximately $335 million for full year 2015, consistent with previous guidance. This compares to $327 million in 2014. The increase primarily relates to additional investment in marketing, and tour spending, as well as other employer related cost and normal annual cost increases. On a constant currency basis operating expenses are expected to be approximately $345 million, consistent with our previous plans and guidance. 2015 pre-tax income is estimated to range from $7 million to $12 million with a corresponding tax provision of $6.5 million, this compares to pre-tax income of $22 million and a corresponding tax provision of $5.6 million in 2014. On a constant currency basis 2015 pre-tax income is estimated to range from $45 million to $50 million or an increase of 105% to 127% compared to last year. Finally, we are raising our 2015 earnings per estimate on a fully diluted basis to a range of $0.01 to $0.06 per share on 80 million shares outstanding. This compares to our previous estimate of a range from negative $0.03 to positive $0.04 per share. On a constant currency basis, our updated EPS estimate would range from $0.45 to $0.50 per share, an increase of 125% to 150% compared to last year's $0.20 per share on 78 million shares. Before beginning the question and answer portion of the call, I would just like to add one personal note. This is my first earnings call as the new CFO at Callaway Golf. I would just like to say how excited and energized I'm about joining in the Callaway team. And then I'm really looking forward to the opportunity to contribute and build on the momentum and success that this team has created and enjoyed under Chip's leadership and guidance. I also look forward to engaging in a more active way with our investor and shareholder communities. Telling the Callaway story and driving shareholder value it is certainly no exaggeration to say that I'm absolutely thrilled to be here at Callaway Golf. With that, we will now open to call for questions.

[Operator Instructions] Your first question comes from Lee Giordano with Sterne Agee CRT. Your line is open.

Thanks. Good afternoon, everybody.

Hi, Lee.

Chip, it would be helpful so you can get some of your thoughts on the impact of the success of the younger players in the PGA Tour that we're seeing like Spieth, Rory and Fowler. How is that having any impact on consumer demand for golf equipment in the game itself, it sounds like we're seeing participation level out here and things soon to be getting better. And then secondly, can you update us on your efforts to strengthen the Callaway brand in the mind of younger players out there? Thanks.

Sure, Lee. Golf has been exciting over the last six months. It's not longer, really probably started last year and players such as Rory Mcilroy and now Jordan Spieth and others are really capturing the attention excitement of young and old golf fans are liking also casual participants have not been has fully engaged. So I can't really say I believe there is any immediate impact there. It probably helps but quantifying that is very difficult. But I do think it bodes very well for the long-term health of the store and the industry and we're all very excited about it. Callaway has had a lot of success on tour, over expenditure of the time, but certainly accentuated over the last three years. And we've really strengthened our positions with - on tour and with younger players. You see players such as Ryo Ishikawa and Kevin Kisner, and Patrick Reed, and Chris Kirk and many others showing up all the time now, playing Callaway products and showing off the brand on tour and that was clearly part of our goal. You'll also see a signing young exciting players like the Oliver Schniderjans that we just announced signing and Julien Brun two young First Team All-American players that have joined the Callaway team going forward. Our marketing efforts are young and energetic and vibrant. They've reached the traditional golfer, but we are also using digital and social media in an energetic and modern way that identifies with the young golfer so a lot of good things going on, on that front, I think for the industry as well as Callaway.

Great, thank you.

Our next question comes from the line of Michael Swartz with SunTrust. Your line is now open.

Hey, good afternoon guys.

Hey, Michael.

Just wanted to touch around, should I think you made the commentary about 12% growth in the back half of the year obviously constant FX, could you just give us a sense of how much of that is just the momentum you're seeing coming out of the first half versus some of the planned product launches in the second half?

We'll just give you a - our market share in the U.S. just so happens to be up 12% through the first half year-to-date. So, we're really seeing a good broad momentum in our business on a market share basis and optimistic that we'll be able to continue that momentum.

Okay. And then just on the ball side of the business, I mean, the profitability came - profitability there in the quarter came in better than I would have expected. So thinking about the back of the year, is that - was that just due to a shift in the timing of some of the investments around Chrome Soft, I saw the commentary in the press release about some incremental investments there. So I guess help us to understand that.

No, golf ball is just a significant upside opportunity for our business, both on revenue and on profitability. It's interesting because on a GAAP basis our dollar sales in golf ball are down and even constant currency not as high as you would expect given our strength of market share. On top of that, we've invested more in the golf ball business this year and we think this is going to payoff very nicely for us. The crown soft product and super soft product are resonating in the marketplace and the quality of our revenues and our market share are as high as I believe, they're certainly higher than they've been - since I've been with the company may be as high and as optimistic as we've been in the category for a long time. And we think the second half and going forward is one that strike with opportunity.

Okay, great. Thanks a lot for the color.

Your next question comes from the line of Casey Alexander with Gilford Securities. Your line is open.

Hi, good afternoon. As I look at your guidance and I think about the back half of the year, last year was when you sort of, as you say changed the cadence of new product introduction. And so Q3 came in, revenue significantly higher than Q4. As I think about how to cut off the rest of the year, should I be looking at it the same way or is it going to come in somewhat of a different balance?

It's going to coming in a little different balance. We're going to be closer to that level in Q3, and with the majority of the growth coming in Q4 the way we currently see it in our case.

Okay. That's very helpful. Secondly, are there any updates on top golf, I mean I know that you guys are intimately involved with them? Do you have any more on the top golf development pipeline - timeline, excuse me, and also has the company made any further investments in capital golf since we last talked?

So, Casey, this is Robert and I'll take that question and I'll start with your second question, which is about the further investments. So there has been no further investments in top golf in this past quarter. And I'll preface my comments by saying as you know top golf is a private company in which we hold the minority interest, so...

Sure.

Hence we can't comment and a lot of detail about their financial results, but there are somethings that I can share with you. What I would tell you this is a very exciting business and they're doing very, very well. They just open three new sites more recently in San Antonio, Oklahoma City and Kansas City, which gives now total of 18, I believe that are open and they are planning six more sites this year. So they will lend you with about 24. Their normal cadence in terms of new sites there I think your plan is about 10 per year. And it seems that there is still on track for that. And next year will include sort of a flagship opening in Las Vegas at some point. But we are very excited about our top golf investment here at Callaway and what does mean to the Callaway shareholders.

Well. Thank you, Robert. That's very helpful and by the way welcome to the company and to the company's conference calls. My last question is looking at the balance sheet and comparing it to last year. I mean the improvement in the balance sheet on a year-to-year basis is terrific. I mean, inventories year-to-year are down. I understand you made some changes in terms of the accounts receivable, but I would imagine during the third quarter that's going to be cash coming in and your credit facilities down year-to-year. Given that and a quarter of a billion of working capital how does the company think about the outstanding convertible issue considering the fact that I think August 15th is a reasonably significant date coming up?

Yeah, Casey, this is Robert. I'll take that one too. And just to get us a little big grounded on the convertible debt as you know it is callable at par after August 15th of this year with a face value of $112.5 million. You may also be aware that it has a coupon of 3.75%. So our annual interest and expenses on net debt is about $5.5 million a year and the conversion prices are at $7.50. So what I can tell you about our strategy is this, we are well aware of our options relative to convertible debt and we're working with our bankers to divide the strategy. No final decision has been made at this time, but it certainly on our radar screen. I can't tell you that our current guidance assume status quo relative to the convert. So we haven't built any of that into the current guidance. But if and when anything changes relative to our approach to the convert we will let you guys know.

All right, great, thank you. That's very helpful. And that's all I have right now, thank you for taking my questions this afternoon.

Thanks Casey.

[Operator Instructions] And your next question comes from the line of Randal Konik with Jefferies. Your line is open.

Hi, can you hear me?

Yes, Randy.

All right, great. Thanks guys. I was just curious around Asia, how do you think about Asia and comparing it and contrasting of what the work you've done nicely in the U.S. market in terms of inventory control and then followed by the improvement in the actual market or the actual geography, kind of give us some color and how do you think the Asia market shakes out over the next couple of years it would be helpful, something and also top line, but also from a margin standpoint. Thanks.

Sure, Robert. Our improvements in the business that our market share are really global in extent. It's one of the things that really pleased with in proud of on the business. So we've seen momentum in the brand and improvements on the constant currency basis that have really stand the globe. So that really includes Asia. The FX movements have been quite acute in different markets particularly Japan. So that has a negative impact on the profitability in that market and just a little pressure on the market. And as I mentioned, the Japan market is down year-to-date or through June of about 5.7% that was down a little more than what we expected, not tragic by any means, but a softer market condition there than anticipated. Nothing really that we see to read into that. We're going to have work through the FX issue there, all brands will and other than that no fundamental change. China has been a little bit more problematic. There have been some government policy moves there that are contrary to the interest of golf. That has a significant negative impact on the business in China. However, our China business is relatively small for Callaway. So there is a fundamental change in the China business. But they will probably resolve itself, but only over a long period of time or at whatever time the government's policy decisions shift. And they do have a tendency to shift, but I certainly can't predict when that might occur. We're committed to the market. We have a nice business there and optimistic over the long run you will have a good business there. Southeast Asia has also been a challenge for us and that's really we've been transitioning business models there. And we're working through that. We will have that resolved sometime between now and the end of the year. And so that market should be back to normal for us. But we've had a little bit of headwinds from the Asian market first half of the year. The China one is the very small market for us. It's a significant for the long-term, there is a fundamental change there, the rest of it is not fundamentally much different or in Southeast Asia we'll have that works through and improvements are consistent with what we’re seeing elsewhere in the world other than the FX. Does that make sense?

That's very helpful.

Yeah, it's very helpful. Thank you.

Thank you.

And there are no further questions, now I will turn the call to CEO Chip Brewer.

Well, thank you very much everyone for calling in. We appreciate the interest and support in Callaway Golf and we'll look forward to speaking with you again at the end of Q3. Thanks again.

This concludes today's conference call. You may now disconnect.