Callaway Golf Company (CALY) Q2 2019 Earnings Report, Transcript and Summary

Good afternoon. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Callaway Golf Company Second Quarter Earnings Release. [Operator Instructions] Thank you. Mr. Patrick Burke, company's Head of Investor Relations, you may begin your conference.

Thank you Rob and good afternoon everyone. Welcome to Callaway's Second Quarter 2019 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; Brian Lynch, our Chief Financial Officer; and Jennifer Thomas, our Chief Accounting Officer. Today the company issued a press release announcing its second quarter 2019 financial results. A copy of the press release and associated presentation are available on the Investor Relations section of the company's website at ir.callawaygolf.com. Most of the financial numbers reported and discussed on today's call are based on U.S. Generally Accepted Accounting Principles in the few instances where we report non-GAAP measures, we have reconciled the non-GAAP measures to the corresponding GAAP measures at the back of the presentation in accordance with Regulation G. Please note that this call will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from management's current expectations. We encourage you to review the safe harbor statements contained in the presentation and the press release for a more complete description. Please note that in connection with our prepared remarks there is an accompanying PowerPoint presentation that may make it easier for you to follow the call today. This earnings presentation is available for download on the Callaway Investor Relations website under the Webcasts and Presentations tab. Also on the same tab, you can choose to join the webcast to listen to the call and view the slides. As a webcast participant you are able to flip through the slides. I would now like to turn the call over to Chip.

Thanks Patrick. Good afternoon everybody and thank you for joining us for today's call. I'm pleased to announce another excellent quarter. These results reflect the strength of our strategy brands and operating availability. It also reinforces that we are on a path to creating substantial growth on the top and bottom line over the long term. Over the last several years we have realized strong results across our core metrics, including revenue growth, gross margin, adjusted EBITDA and EPS. We believe our strategy will allow us to continue this strength. In fact our results today reflect the strength of this long-term strategy as we're seeing key investments in other initiatives meaningfully impact the growth of the businesses. As is my custom, I'd like to take this chance to thank the Callaway Golf team for the hard work required in delivering these results across all of our brands and driving further change in growth at our company. Like me, I'm sure our team realizes that we have a lot more opportunity in front of us and remains motivated to continuously improve. In my comments today, let me quickly walk through the results of our segments and then spend more time on our growing soft goods business, hoping to provide more clarity on the outlook for that segment and the key drivers of value creation. Turning to slide four of the presentation. Our total company revenues were up 13% during the quarter and are up 20% year-to-date. For the first half on a currency-neutral basis, we delivered growth across all business units, regions and major product categories. For the quarter we ensured continued solid performance in our golf equipment business, continued double-digit growth in the TravisMathew's business, as well as positive results in our recently acquired Jack Wolfskin business which saw encouraging year-over-year growth, especially in its direct-to-consumer business where new product innovation along with new recent investments in marketing are beginning to bear fruit. Based on our brand momentum and strong operating performance and despite the negative FX headwinds, we are pleased to be able to raise our earnings guidance for the full year. In addition, we've begun the process of paying down our long-term debt, completing a $30 million payment in late July, while continuing to make what we believe are higher return and long-term investments in our business and returning cash to shareholders with $27 million in share repurchases year-to-date. In line with this strategy, we are announcing today that our Board of Directors has approved a new $100 million stock repurchase program. To avoid confusion though, investors should not think of this as a significant change in capital allocation strategy. We only had $22 million in availability remaining on the previous authorization and we want to make sure we had capacity to continue the capital allocation strategy we've had in place which generally includes the level of annual share repurchases, while also allowing us the flexibility to opportunistically respond, if circumstances warrant. Let's now take a look at our operating performance by business segment. Turning to Slide five of the presentation. Our equipment business had a solid quarter with revenues roughly flat on a constant currency basis, despite less product launches on the year-over-year basis. Market conditions varied widely by region, but met expectations overall. For the first half, we grew slightly faster than the market, which we believe was approximately flat on a global basis with the exception of short-term quarterly variations in launch timing, we are positioned to continue to do this. This should be especially true in the second half of this year where our growth rates will be aided by favorable golf product launch cadence versus last year. This year-to-date we are demonstrating strength across the breadth of our product lineup and proud to be able to claim the number one hard goods position in the U.S. and Europe and the number one sticks position in Japan. In the U.S. thanks to our new advancements using artificial intelligence technology our Epic Flash Woods are the number one selling driver and Fair Wood models year-to-date. And we remain the number one selling iron brand with Apex and Rogue irons the number one and number one selling iron models year-to-date respectively. Callaway is also the number one driver in global tours and Odyssey as the number one putter. Our golf ball business also continues to do extremely well with currency-neutral revenue growth of nearly 10% year-to-date. The market reaction to our Triple Track Technology and the new ERC Golf Balls has been excellent and our U.S. market shares continue to set records. Taking a step back and looking at the big picture we believe the golf equipment market remains in a healthy position with a significant and stable market, improved structural dynamics over the last several years, an exciting global tour creating interest in the game and potential upside demand drivers such as putt golf. We see a predictable and well-structured market where our leadership positions scale and operating acumen can continue to drive moderate growth and meaningful cash flows. Turning to slide six in our soft goods segment. Before reviewing the results of this segment, I'd like to talk about how we see soft goods as a growth opportunity that builds upon our core strengths. I believe over the last seven years we have consistently demonstrated a few core strengths across all of our businesses here at Callaway. This includes driving product innovation to capture market share growth, leveraging industry-leading marketing and consumer insights, creating and supporting highly appealing brands across geographies and last but not least prioritizing operational excellence and margin improvement. Over the last four years, we have methodically built a scale position in soft goods markets that plays to these strengths. Prior to Jack Wolfskin acquisition, we had approximately $300 million in revenues in this segment. With the Jack Wolfskin acquisition, we are closing in on $700 million. I'd like to add that there's a lot of synergies in the segment. These are businesses where we know the consumer whether that be in golf outdoors or active lifestyle. They are businesses where there is preference for premium style of performance. These are markets that had growth rates well above golf equipment and the successful businesses that establish scale deliver operating margins greater than most equipment businesses and trade at multiples higher than pure-play equipment companies. As we develop global scale in this segment, we see significant synergies and scale advantages via supply chain, sourcing, warehousing, logistics, marketing and global expansion. For example, Jack Wolfskin gives us a potential to have a large Central European warehouse that we can use across all of our businesses. We have also identified significant synergies in sourcing freight and logistics, all of which we now believe have higher potential than what we baked into our initial acquisition estimates. The significant scale and synergy potential here and a higher market growth rates will benefit our shareholders as we execute this strategy. Turning to slide seven and looking at the soft goods segment performance. Revenues year-to-date had surged due to the recent acquisition of Jack Wolfskin as well as strong performance across the majority of our branded business portfolio. TravisMathew is worthy of a special call out here as that business continues to deliver double-digit growth and we remain energized about its future. The Jack Wolfskin business grew 14% during the quarter thanks to excellent performance in its direct-to-consumer business where our e-commerce business was up double digits and our own retail was up low-single digits on a comp store basis and high-single digits overall. It's encouraging to see this business respond to the investments and change in initiatives we are putting in place as it again speaks to the core skills we have built and our ability to work in collaboration with like-minded brands to generate returns. We also completed the acquisition of minority balance in our Callaway Apparel Japan joint venture during the quarter thus giving us 100% control. This represents a strategic move that will set the stage for future improvements and profitability and synergy within the segment. These results speak to another key tenet of our soft goods business. Each of these brands has highly compelling stand-alone prospects as well as synergies through their combined scale. Our soft goods business are large and rapidly growing segment of our company. We are confident and excited about the long-term outlook and potential here. Turning back to the business as a whole on slide eight. Over the next several years, we anticipate further strengthening all the brands in our portfolio and we believe we are trending accordingly. We also continue to reinvest back in our business in both the golf equipment, soft goods with several key infrastructure projects underway, many of which will extend through mid-2021. These include the aforementioned Chicopee ball plant capital project which is now in its final year, multiple distribution center expansion projects all aimed at increased capacity and efficiency one of which is the 700,000 square-foot multi-brand facility in Dallas, Texas as well as several IT systems upgrades and convergence related to recent acquisitions and growth ambitions. These projects are progressing nicely. We believe our reinvestments in long-term management decisions are setting the stage for continued strength in revenue and earnings growth. Now, on Slide 9, a quick comment on the ever-evolving tariff conversations. The recently announced 10% U.S. tariffs of list four items from China if implemented would leave the company to experience a little higher tariff expense for the balance of the year, but without material impact to the business and our estimates here have been incorporated into our guidance. Our operations team has done an outstanding job over the last several years diversifying our supply chain outside of China. As a result we are not significantly impacted by this issue. I believe this gives us a competitive advantage both in hard goods and soft goods. Lastly as a reminder the Jack Wolfskin business is not really impacted by the China tariff issue at all and neither sources there nor sell much product in the U.S. As for the Brexit issue and the tariff risk between U.K. and Europe, we are in process of having our DCs in England certified as a bonded free trade zone, a process we expect to have completed by the end of this year. We believe that will allow us to avoid inter U.K. and Europe tariffs on our golf equipment business. We also now have the added flexibility of using the Jack Wolfskin distribution center in Hamburg, Germany. Ultimately, we are well-positioned from a global supply chain perspective and not particularly sensitive to tariffs. In fact I believe we have a bit of a competitive advantage with strength and scale of our diversified supply chain operations infrastructure. Now on Slide 10, we're pleased to be increasing our guidance this year. These projections set us overcoming a significant FX headwind and delivering substantial overall growth in terms of revenue and adjusted EBITDA. The growth is being driven by our recent strategic acquisitions as well as continued strength in our organic business which we project to be up approximately 8% on a constant currency basis for the full year. We are also pleased that the golf equipment industry remains healthy and we believe we are well-positioned to continue our leadership positions in the industry. Our TravisMathew brand continues to drive significant growth and we remain energized by the Jack Wolfskin acquisition which had a strong quarter and where we are increasingly confident for the long-term including increasingly positive view on long-term synergies. I believe we have very clear strategy. And as evidenced by our results over the last three years where we have seen our gross margin improve 250 basis points, adjusted EBITDA more than double, adjusted EBITDA margin increased 400 basis points, and $0.82 added to our EPS. I also believe we have a track record that would support our ability to deliver on our strategy. As we continue to execute our strategy, we are confident that we can further transform our business and continue to deliver long-term growth rates that can and will significantly exceed that of the golf business overall. As we demonstrate this to the market, we are optimistic our trading multiples will reflect our results. Brian over to you.

Thank you, Chip. As Chip mentioned, we are pleased with our second quarter and first half results. The results reflect the strong performance of our 2019 golf product lineup as well as the strength in our TravisMathew and Jack Wolfskin businesses. This performance allow us to overcome the significant impact from changes in foreign currency exchange rates which negatively impacted second quarter first half sales by $9 million and $24 million respectively. Despite anticipated additional foreign currency headwinds, we expect strong year-over-year earnings comparisons in the second half of 2019 as a result of the continued success of our 2019 golf products a more favorable cadence for second half golf product launches for the continuing momentum of our TravisMathew business and our outlook for the seasonal Jack Wolfskin business which generally earns all of its profit in the second half of the year. We remain focused on executing our strategy of creating a premium golf equipment and active lifestyle company. We are excited by the long-term revenue growth and earnings potential this strategy presents. In evaluating our results for the second quarter of first half, you should keep in mind some specific factors that affect year-over-year comparisons. First, the Jack Wolfskin acquisition occurred in January 2019 and therefore that business is not included in our 2018 results. Second, when discussing our non-GAAP results today, we exclude noncash purchase accounting adjustments related to the OGIO TravisMathew and Jack Wolfskin acquisitions and we also exclude other non-recurring transaction and transition expenses related to the acquisitions and non-recurring advisory fees. We exclude these items because that is how we evaluate our performance. A reconciliation of this non-GAAP information to the corresponding GAAP information is included with the earnings release we issued today. With those factors in mind, I will now provide some specific financial results. Turning to slide 12, today we are reporting consolidated second quarter 2019 net sales of $447 million, compared to $396 million in 2018, an increase of $51 million or 13% and a record for net sales. The 13% growth was primarily driven by the Jack Wolfskin business, which contributed $48 million in the second quarter. Changes in foreign currency exchange rates negatively impacted second quarter of 2019 net sales by $9 million. On a constant currency basis and excluding the Jack Wolfskin business, second quarter 2019 net sales increased 2%. This increase is driven by increased sales in the golf ball business and continued double-digit growth in the TravisMathew business. Gross margin was 46.3% in the second quarter of 2019 compared to 48.6% in the second quarter of 2018, which was in line with our expectations. On a non-GAAP basis gross margins were 47.5%, a 110 basis points decrease compared to the second quarter of 2018. This decrease is primarily attributable to foreign currency headwinds and the current year golf equipment product mix of higher-priced products, which generally have lower gross margins due to more advanced technology, all of which was partially offset by the TravisMathew and Jack Wolfskin businesses, which were accretive on a gross margin basis. Operating expenses of $162 million in the second quarter of 2019, which is a $44 million increase compared to $118 million in the second quarter of 2018. Non-GAAP operating expenses were $159 million, an increase of $41 million in the quarter. This increase is primarily due to the addition of 2019 of operating expenses from the Jack Wolfskin business, which added an incremental $38 million of operating expense, excluding the non-recurring acquisition cost. Operating income was $45 million in the second quarter of 2019 compared to operating income of $74 million for the same period of 2018, a decrease of 39%. Non-GAAP operating income for 2019 was $53 million compared to non-GAAP operating income of $75 million in 2018, a decrease of $22 million or 29%, which is primarily related to the negative effect of foreign currency as well as the seasonality of Jack Wolfskin business, which generally reports an operating loss in the second quarter. Other expense was $9 million in the second quarter of 2019 compared to other income of $4 million in the same period the prior year. The higher other expense in 2019 resulted from a $9 million increase in interest expense, primarily related to the new term loan entered into January 2019 to fund the purchase of Jack Wolfskin as well as foreign exchange hedging losses as compared to hedging gains in the prior year. Fully diluted earnings per share was $0.30 or 95.9 million shares in the second quarter of 2019 compared to $0.63 in the second quarter of 2018. Non-GAAP fully diluted earnings per share was $0.37 versus non-GAAP diluted earnings per share of $0.63 in the second quarter of 2018. This non-GAAP decrease is primarily attributable to the increased interest expense, foreign exchange hedging losses and the seasonality of the Jack Wolfskin business, which generally has an operating loss in the second quarter. Adjusted EBITDA decreased $22 million to $66 million in the second quarter of 2019 compared to $88 million in the second quarter of 2018. We are particularly pleased with this result given the adverse headwinds from changes in foreign currency and the seasonality of the Jack Wolfskin business. Turning to slide 13, consolidated first half 2019 net sales were $963 million compared to $800 million in 2018, an increase of $163 million or 20% and another record for net sales. The 20% growth was primarily driven by the Jack Wolfskin business, which contributed $141 million in the first half. Changes in foreign currency exchange rates negatively impacted first half 2019 net sales by $24 million. On a constant currency basis and excluding the Jack Wolfskin business, first half 2019 net sales increased 4.5%. This increase in net sales was driven by the strengths in 2019 golf product line as well as continued double-digit growth in the TravisMathew business. Gross margins was 46.2% in the first half of 2019 compared to 49.2% in the first half of 2018, which was in line with expectations. Non-GAAP gross margins were 47.4%, a 180 basis point decrease compared to the first half of 2018. This decrease is primarily attributable to foreign currency headwinds and current year golf equipment product mix of higher-priced products, which typically have lower gross margins due to more advanced technology, all of which was partially offset by the TravisMathew business, which was accretive on a gross margin basis. Operating expense was $330 million in the first half of 2019, which is a $98 million increase compared to $233 million in the first half of 2018 and includes the first half operating expenses related to the new Jack Wolfskin business. On a non-GAAP basis, operating expenses were $322 million, an increase of $89 million in the quarter. This increase is primarily due to the addition in 2019 of operating expenses from the Jack Wolfskin business, which added an incremental $77 million of operating expense excluding the non-recurring acquisition cost and also reflects investments in the TravisMathew business and normal inflationary pressures. Operating income was $115 million in the first half of 2019, compared to operating income of $160 million from the same period in 2018, a decrease of 28%. Non-GAAP operating income for the first half of 2019 was $134 million, compared to non-GAAP operating income of $161 million in 2018, a decrease of $27 million or 17%, which is primarily related to the seasonality of the Jack Wolfskin business, which generally reports an operating loss in the first half as well as the negative effect of foreign currency. Other expense of $21 million in the first half of 2019, compared to other expense of $2 million in the same period of the prior year. The higher other expense in 2019 resulted from a $17 million increase in interest expense, primarily related to the new term loan. Fully diluted earnings per share was $0.81 or 96.2 million shares in the first half of 2019, compared to $1.28 in first half of 2018. Non-GAAP fully diluted earnings per share was $0.99 versus non-GAAP fully diluted earnings per share of $1.28 in the first half of 2018. This non-GAAP decrease is primarily attributable to the increased interest expense and the seasonality of Jack Wolfskin business, which generally has an operating loss in the first half. Adjusted EBITDA decreased $18 million to $159 million in the first half of 2019, compared to $178 million in the first half of 2018. Again we are pleased with this result given the adverse headwinds from changes in foreign currency and the seasonality in the Jack Wolfskin business. Turning to slide 14, I will now cover certain key balance sheet and cash flow items. First, I'd like to mention that with the strong 2019 first half results, we're able to pay down $30 million on our outstanding term loan debt. This payment was made in July, and therefore, is not reflected in our second quarter balance sheet ending June 30th. We now have a principal outstanding balance of $450 million under our term loan B facility that was used to purchase the Jack Wolfskin business. Available liquidity, which represents additional availability under our credit facilities plus cash on hand was $273 million at the end of the second quarter of 2019 compared to $301 million at the end of the second quarter of 2018. Also on July 31st, we closed in a new one-year asset base loan facility with MUFG Bank in Japan for ¥2 billion or approximately $18 million based upon the exchange rate at the time of closing. Borrowings under this facility are subject to an interest rate of approximately 1%. This facility we use to fund the ¥2 billion purchase price for the remaining 48% interest in the company's joint venture in Japan, which manufactures and distributes Callaway-branded apparel, footwear and headwear. Callaway acquired the 48% interest in May 2018 and the purchase price is payable on August 2019. Acquiring a minority position gives us full control to improve profitability and provide a platform for multi-branded apparel strategy in Asia. Our consolidated net accounts receivable were $264 million, an increase of 9% compared to $242 million at the end of the second quarter of 2018, which is attributable to the addition of the Jack Wolfskin business in 2019. Days sales outstanding in the core business is generally consistent with the same period in 2018. We remain comfortable with the overall quality of our accounts receivable at this time. Our inventory balance increased by 52% to $360 million at the end of the second quarter of 2019. This increase was primarily due to the addition of the Jack Wolfskin business as well as an increase in golf equipment inventory in anticipation of upcoming new product launches and inventory needed to support an overall larger core business in 2019. We remain comfortable with the quality of our inventory at this time. Capital expenditures for the first half of 2019 were $23 million a year-over-year increase of $6 million, compared with first half 2018 due mainly to the addition of the Jack Wolfskin business and continued investment in our golf ball plant. Depreciation and amortization expense was $17 million in the first half of 2019, compared to $10 million in the first half of 2018. I'll now comment on our 2019 guidance. Turning to slide 15, I'd like to note that the non-GAAP guidance we are providing excludes the non-cash purchase accounting adjustments for Jack Wolfskin as well as OGIO and TravisMathew and the nonrecurring transactions and transition expenses related to the Jack Wolfskin transaction as well as nonrecurring advisory fees. We are raising our 2019 net sales range to $1.685 billion to $1.700 billion, an increase of $7.5 million at the midpoint of our prior guidance. The new guidance implies a 35% to 37% growth over the prior year. The growth versus previous guidance is expected to be driven by further strengthen in our non-Jack Wolfskin business, which is currently estimated to grow 7% to 9% on a constant currency basis when compared to 2018. These estimates assume changes in foreign currency exchange rates in 2019 will have a negative impact of $32 million on 2019 full year net sales, compared to 2018. We're slightly revising our guidance for full year gross margin to 46.7% which is 30 basis points lower than previous guidance. But still 20 basis points higher than 2018. We are also slightly revising our guidance for full year 2019 operating expenses, to $628 million as compared to previous guidance of $630 million. We are increasing our non-GAAP earnings per share to $1.03 to $1.09, compared to previous guidance of $0.96 to $1.06. This increase is being driven by projected increases in new sales, operating expense leverage and less interest expense. The estimated tax rate remains at 20.5% for 2019. The 2019 figures are based on 97 million shares outstanding. Consistent with our previous guidance, we estimate our capital expenditures in 2019, to be approximately $55 million to $60 million, which includes incremental capital expenditures, related to the Jack Wolfskin business, the ball plant and other infrastructure investments for the soft goods business. Capital expenditures were $37 million in 2018. Depreciation and amortization expense is estimated to be approximately $30 million, in 2019 which includes $9 million of the Jack Wolfskin business. Depreciation and amortization expense, for 2018 was $20 million. This estimate excludes approximately $4 million of noncash expense related to the purchase accounting for the acquisitions. We are increasing our adjusted EBITDA guidance to $208 million to $215 million. The adjusted EBITDA increase is driven by revenue increases and operating expense leverage. We estimate that noncash stock compensation expense will be approximately $14 million in 2019. We expect third quarter 2019 net sales of $412 million to $422 million which would represent, net sales growth of over 56% compared to 2018. This increase was driven by the addition of the Jack Wolfskin business which was acquired in January 2019. And an increase in the new product launches which include Epic Star Irons, Epic Flash Star hybrids and Epic Forged Irons, as well as continued growth in the TravisMathew business. This increase is expected to be offset by $7 million of negative foreign currency exchange compared to the same period in 2018. We expect third quarter 2019 non-GAAP earnings per share to increase approximately, $0.11 to $0.20 to $0.24 compared to $0.11 in the third quarter of 2018. We also expect adjusted EBITDA to increase to $48 million to $52 million, compared to $22 million in the third quarter of 2018. This decrease in profitability is expected to be driven primarily by the addition of the Jack Wolfskin business, to net sales increase in the core golf equipment business driven by new product launches. Growth in the apparel and the accessories businesses and for earnings per share by the lower estimated cap rate in the quarter, compared to the third quarter of 2018. Keep in mind these estimates for adjusted EBITDA for the third quarter. And full year 2019 exclude noncash stock compensation expense purchase accounting adjustment, nonrecurring transaction and transition expenses, related to the Jack Wolfskin acquisition and non-recurring advisory fees. One point worth noting is that, our guidance based upon the estimated impact of the China tariffs announced thus far, including the 25% tariff on headwear, bags and other soft goods also known as the list three tariffs and a 10% tariff on apparel, footwear and golf equipment also, knows as the list four tariffs. We currently estimate that the total impact from these tariffs in full year 2019 will be $3.5 million which is already included in our guidance. For full year 2020, the tariff impact is estimated to be $5 million. After 2020, we expect to be fully diversified with no material effect from such tariffs. Moving to slide 16, all things considered we are pleased with our first half results and the performance of our golf equipment and soft goods businesses. We expect to generate good free cash flow this year and as we grow our business. We intend to use that free cash flow for the benefit our shareholders, as we generally have in the past, though with some change in priorities. Then as we will first continue to invest in our business, we are confident we have identified clear opportunities, for further investment and unlock synergies, strengthen growth prospects and improve margin across the business. And as Chip mentioned earlier, we already have several key infrastructure projects underway, that are expected to continue through mid-2021. With regard to other investments and acquisitions, we will consider them at the right time it fits well with our overall strategy. Our current focus however, is on integrating and growing the brands we already have. Paying down our long-term debt and returning capital to shareholders. And as evidenced by our decision to pay down $30 million of our term loan B debt and repurchase approximately $27 million through our common stock this year. Consistent with this capital deployment strategy, important to authorize the company to repurchase up to $100 million, of the company's common stock in the open market or in private transactions. The new repurchase program replaces the prior repurchase program, which has been terminated by the Board of Directors. The remaining $22 million of authorization in the prior program was canceled. The repurchase program does not require the company to acquire specific number of shares and it will remain in effect until completed or terminated by the Board. That concludes our prepared remarks today. We'll now open the call for questions.

[Operator Instructions] And your first question comes from the line of Steven Zaccone from JPMorgan. Your line is open.

Great. Good afternoon, guys. Thanks for taking our questions. So first question just on the clubs business, we're halfway through the year and was just curious Chip for how you see the launches and the broader competitive backdrop performing versus initial expectations? First half club sales were about 1% constant currency. What's the best way to think about the underlying performance across woods irons and putters relative to that consolidated growth rate?

Hi, Steven. I'm pleased with our results. I think we continue to have solid or strong performance in our equipment categories. The – we had the issue this year of having less launches in the first half than last year. The markets are roughly flat. And I think we continue to show strength as a brand. If you look at the market share results, where we're number one model driver in fairway wood with the Epic Flash, number one irons overall, number one and number two models, number one hard goods in the U.S. and Europe number one sticks in Japan. I have to say that's a pretty solid performance and reflective of our technology and brand strength. And we're obviously expecting another excellent year where we're going to grow significantly faster than the markets overall when you look at the big picture.

Great. And then just second question just on gross margin. Could you talk about the decision to lower the full year guide? Is it primarily FX and tariffs or did something change fundamentally for the second half relative to your prior thinking? Thanks very much.

Sure, Steven. If you look at sort of our first half guidance, we over performed by about $22 million, and we are sort of giving that $7 million of that, the other $15 million for the most part represents earlier shipments in Q2 versus Q3. We received products in our facilities at different times and when they're ready, we ship them out. And so there's probably $50 million of that and just some customer orders toward the end that can fluctuate between quarters depending when a customer picks them up. So you probably have $50 million of earlier shipments than was expected, and the balance we are moving forward by taking our guidance up in the second half.

And if you look at just the gross margin elements for the full year, Steven, I think that is primarily just FX. It's a very minor change as you could tell 30 bps, so on a full year basis getting close to outside of our ability to forecast but it is indeed slightly down, but still up for the full year, so not a significant change. We still expect growth and continue to have some FX challenges.

Great. Best of luck in the rest of the year. Thank you.

Your next question comes from the line of Daniel Imbro from Stephens Inc. Your line is open.

Thanks. Good afternoon, guys. Congrats on the quarter.

Thanks, Daniel.

Wanted to follow-up on the gross margin question actually, you noted in the first half Brian that the launch of new high-tech products has weighed on gross margins. You have a pretty expensive product launch cadence coming up. So is the growth in Jack was going to more than offset that to drive what's implied to be pretty heavy gross margin expansion in the coming quarters?

Let me take that one, if I can Daniel real quick. So we do expect more new product launches in the second half of this year on the golf equipment side. And so that is margin-accretive versus last year so you're going to see improved performance in the second half. But the issue that Brian brought up is really in the odd number years of the golf equipment business where we're going to see newer products like Epic Flash and Apex. Those are higher technology products, but the cost of those products are also high and so the gross margin percentage is low. And that's going to be the case. It's just a normal expected outcome that we will experience on the odd number years. And we do expect improvement in the second half. So we have premium products launching in the second half, but they're really competing against no launches in the second half of last year. So we'll see margin improvement during the second half in that category as we will overall.

Got it. That's helpful, Chip. Thanks. And then to follow-up on one of your comments earlier, Chip around Jack Wolfskin's retail growth I think you said low single-digit organic but high single digit total. That seems to imply kind of mid-single digit retail unit growth. Should we expect that level of unit growth or unit store growth opportunity for Jack Wolfskin? Or how do you think about that opportunity? Thanks.

Yeah. Well, I'm not going to provide any forecast on that going forward. But I just think it was a very important metric for us when you look at their direct-to-consumer business. It's 30% of the total business and it's the segment of the business where we're going to see the fastest and most clear reaction to the changes that we're implementing there, whether that be from a product side or marketing initiatives, et cetera. And so being able to drive double-digit growth on that e-commerce side and then comp store growth as well as the overall growth in the retail side very encouraging sign. And obviously, our goal is to continue along those trends, but not providing specific guidance around that category itself.

Understood. Good luck in the back half guys.

Thank you.

And your next question comes from the line of Brett Andress from KeyBanc Capital Markets. Your line is open.

Hi. Good afternoon. Chip if you look across the international golf markets, how did those golf markets play out in the second quarter versus your expectations? And then when you look into the back half of the year what kind of growth are you underwriting for the industry?

Brett, it really was -- it varied kind of widely. And I'm going to comment really for the first half as opposed to the second quarter, because those numbers are clearer to me. The U.S. market is roughly flat. I think the Datatech numbers have it up ever so slightly high, but not in the full 1% rounds played, we're down 1%. So we're going to call the U.S. flat. The Asia markets varied, of course, as you'd expect. Japan struggling a little bit was done about 8%. But our Japan team has really performed beautifully this year. Our inventories have been in great shape and we continue to do a very good job there so we're growing faster than the market. And then Europe, it's had an excellent year. So that market is actually up 8% year-to-date. So as we look at the markets kind of broadly, I'd characterize them as roughly flat, which is roughly consistent with my expectations going into the year. And we see the markets remaining in good position going into the back half of the year. So, no real change in expectations. They're performing consistent with expectations and we anticipate that continuing.

Understood. Thank you. And then my follow-up, can you elaborate any more on the impacts of List 4 Tariffs? It sounds manageable for 2019, which is encouraging, but how should we start to think about the potential impacts on a full year basis in 2020?

As we stated -- so with everything -- so for 2019, it's really immaterial. It's in our guidance and it's roughly $1 million impact so as it's currently stated. Now as you project it going forward, and you project that as well with the List 3 for next year, if all of that was in place for the full year next year, we'd estimate that at about a $5 million impact for our current business. We're getting kind of used to this now, so we do expect all this to change. It seems to change fairly regularly sometimes without notice or a very limited notice. And we've got a very diversified and strong supply chain, so that any impact from the China tariffs is going to be nominal. And by the end of 2020, we believe it would be non-existent that we will have the ability to completely diversify. So, we're in a very good position there and as I tried to articulate. I think investment community needs to take into consideration that we're not sensitive to tariffs. I sometimes wonder that they're confused on that. But we are not particularly sensitive to this tariff issue.

Understood. Thank you for the clarification.

Thank you.

Your next question comes from the line of Dave King from Roth Capital. Your line is open.

Thanks. Afternoon. First on the full year guidance. What sort of contribution are you now expecting for Wolfskin versus I think it was $364 million or so last year? And then more importantly what's sort of driving the improvement in that business versus I think the guidance reduction you had last quarter?

Are you – sorry, so he's asking the revenue -- if we're changing our full year revenue estimates for Jack Wolfskin?

Correct. That's what I'm asking.

Yes. Dave we are not changing our full year revenue estimates for Jack Wolfskin at this time. So, they had a very good quarter. We're not -- on a high end of the range that we expected was some real clear positives. But at this point there is no change in the estimates that we have for that business for the full year.

Okay. Perfect. And then switching gears. In terms of the product launches that you have coming up for Q3 just give us some color to help size them up a little bit. Is Epic Star sort of the largest one in terms of versus some of the other two and how should we be thinking about that versus some of the prior similar launches?

Yes the Epic forged irons I believe are the largest single product category and how does it it's obviously more than last year but at or roughly consistent with what it would've been two years ago in terms of product gains. Last year was a little bit of an aberration in that we really had nothing launched or nothing substantial launched in the second half of the year. We usually do and this is a more normal cadence from that perspective. And the Epic forged irons that just shipped we're hearing good anecdotal feedback on them. We're very proud of them but too soon to get a read if this is going to be above or below expectations at this point but we're as you would expect very optimistic.

Okay. Great. Thanks for the color. Good luck for the rest of the year.

Thanks David.

Your next question comes from the line of Mike Swartz from SunTrust. Your line is open.

Hey, good evening guys. Just wanted to dig into Jack Wolfskin a little bit and something you said on the call. I think you said in the second quarter Wolfskin was accretive to corporate average gross margins meaning it would've been north of 47.5% I assume. Can we go back and look at the 8-K that was filed? I believe gross margin for that business was around 48%. So my question is how in what -- I think it's the smallest quarter for Jack Wolfskin, did they have margin that were in line with their full year average? And should we be thinking about that being north of 48% during the heaviest revenue quarters in the back half of the year?

Yes, Mike, this is Patrick. It is a small revenue quarter, but it's a from a direct-to-consumer perspective, it is a bigger mix of some of the quarters that are more fill-in quarters, especially in the wholesale markets. So that's what's driving the margins higher than the 47% to 48% that you were talking about.

Okay. That's helpful. And just second, clarification question. Chip, I think, you said that tariffs in 2019 will be -- did I hear, a $3 million headwind and in 2020, they're a $5 million headwind. And if so, is that on a net basis? Meaning is that after taking mitigating actions? Or is that gross before you would do anything?

That's net, Mike. So I think we said $3.5 million for this year all of which is in our earnings guidance estimates. And then if it was in its current position it would be $5 million and it is -- we've already forecasted what our mitigating factors would be, et cetera, so that is our best estimate at this point in time.

Okay, great.

And the $1 million Chip referred to before was just for the new 10% tariff on List 4. There's the other 2.5% from previous.

Okay. Thanks for the clarification.

Thank you, Mike.

Your next question comes from the line of Randy Konik from Jefferies. Your line is open.

Hi Good afternoon. This is Anna on for Randy. In terms of Truvis, are you still seeing some capacity constraints there? And when should we expect capacity to get closer to catching up with demand?

Hi Anna. It's Chip. No we are no longer capacity constrained on that product. That issue resolved probably earlier this year, so not an issue going forward.

Got it. Thanks. And then could you speak a little bit more on the rationale behind the new D.C. in Texas? And then anything to call out there in terms of start-up cost?

Nothing to call out on start-up costs yet. They're breaking ground now and just building that facility. So that will be a consolidated facility, multi-brand, where we'll be able to have Callaway brand, consolidate both our existing D.C. as well as some outsourced efforts to some degree the TravisMathew brand, and when we're ready the Jack Wolfskin North America brand into one facility. We'll be doing that all during the year next year. And long term, that gives us much more capacity and greater efficiency than where we're currently operating. It's one of the synergies of our scale and structure that we are able to do this and deliver the benefits for us in North America and we're doing similar projects really on a global basis.

Got. Thanks very much.

Thank you.

Your next question comes from the line of Susan Anderson from B. Riley FBR. Your line is open.

Hi. Good evening. Nice job on the quarter. Just to follow up on Jack Wolfskin. I guess, I'm kind of curious, I don't know if could talk about what products did well? It sounds like the growth is a little bit better than you guys expected. And then also the regions did you see similar performance within Europe as you did in Asia? And I guess looking out to the back half I think last quarter you had talked about you were expecting some lower orders for the second half I guess I was wondering if that's still the case? Thanks.

Sure, Susan. A couple of the hero products one was this pack and go product, which is really an interesting -- I know you specifically saw at the trade expo.

Yes.

But the -- that has done beautifully across their businesses so across the direct-to-consumer, e-com and both in China and in the Central Europe market. Great example of innovation that that team was able to invest in and we were able to by adding capital resources do a better job marketing communicating. So that would be the hero product that I would call out. The Europe market, I guess, on a relative basis did well really strong performance in the direct-to-consumer side. Direct-to-consumer is roughly 30% of the total business. China had a good quarter as well, but probably a little tougher market conditions there fairly competitive marketplace. We still love our position there. Encouraged by that management team et cetera, but they're fighting a little harder than the European team, which had a really nice quarter. And -- the reason we didn't change our expectations for the full year is still that lower pre-book order situation, which really will affect Q3. We have fairly high visibility on that as you'd expect. So that's one of the nice things about this type of business the soft goods business. You have pre-books and they're a considerable portion of the total revenue mix in the time when they ship. And so but that situation is still in front of us and part of our expectations for Q3.

[Technical Difficulty]

You broke up there, Susan.

And we've lost Susan. But your next question comes from the line of Casey Alexander from Compass Point. Your line is open.

I hope I -- don’t me ask me a question, its gets me drowned.

That was – for the record that was not ask anything do.

Well, I have asked questions before because they were going to response.

That was different management.

Well, okay. I have a couple of questions. One sort of I'm always anxious to look for low hanging fruit rather than 10 basis points somewhere. So in the Dallas super hub is it in the anticipation of your plans that that would be ready at some point in time next year? And seeing as how Jack Wolfskin is a second half product then it could be ready in time for broader distribution of Jack Wolfskin products in North America? And similarly was part of the point of the Japanese joint venture buyout also because maybe there were some terms or exclusions that prevented you from introducing other branded products that you own in that market?

So -- on the first one yes the Jack Wolfskin North America launch will be handled directly out of the new DC. So there is no DC servicing. We have very little business for Jack Wolfskin in North America and there's no DC so it basically ships from Germany, which is incredibly inefficient. And we plan to launch when we do launch for Jack Wolfskin out of this DC so correct on that. On Japan there were those firms that would -- impacted our ability to do anything with Jack Wolfskin or TravisMathew or the like. But we do see synergies now that we own 100% of that business of being able to share back offices, PCs, other structural and infrastructure that will create significant savings and operational efficiencies through the acquisition of it. And when we were able to do that and also finance it at approximately 1%. It seems like a good idea for shareholders.

Again, I'm not sure that you were specific to the point of was it in your expectation that Jack Wolfskin could be launching broader in North America by the second half of 2020?

Yes it is. Absolutely been our plan for that.

Okay. And then secondly, and if you don't want to comment on this, this is fine, but would you care to provide any insight with your and the Board's communication with JANA Partners?

Sure, Casey. I'm happy to do so. Of course, we have been in contact with JANA as we would with any significant shareholder who wants to engage with us. It's our policy not to comment on the specifics of any private conversations with those shareholders through so unless there's follow-up we'd leave it at that.

All right. Great. Thanks for taking my questions. I appreciate it.

Thank you, Casey.

Your next question comes from the line of George Kelly from Imperial Capital. Your line is open.

Hi, guys. Thanks for taking my questions. So just a few for you, Chip. I think I heard you say in your prepared remarks that the industry is a lot more rational this year. It's -- I think you're mostly speaking about the retail environment and pricing. So I'm just wondering if I heard you right, it's a lot different than it was eight years ago. And how does that change your thinking about your balance sheet? Does it give you more comfort taking risks with your balance sheet?

I think that the -- I'm not sure if I said the industry is more rational in this call or not, but I think I had in previous. So I definitely believe the industry is more structurally sound. And that includes higher average selling prices, less excess inventory, a consolidated environment out there et cetera which does give us more confidence. So when I talk about the golf equipment business now you hear me talk about it as a large stable environment. And so I think yes, I guess it does give us more confidence. And as it relates to well how that impacts to our capital structure, it's not implicit as we think through that we would be more of as risk-averse. We're balancing needs there as you can see and growing the business with sometimes using outside capital. But we obviously want to be conservative in that and we believe we're managing that accordingly. We were pleased that we are able to repay $30 million of debt during the quarter and we feel confident in the outlook and positive cash flows of the business.

Okay. That's helpful. And then second question about Jack Wolfskin. So previous question last person was asking about some of the investments for U.S. distribution next year. And so my question is about you mentioned in your prepared remarks that you -- I think you said you're seeing more synergies than originally expected. So I'm just trying to patch the sort of margin outlook, as you make these investments and distribution in the new geographies and e-commerce and like as to -- how should that flow over the next couple of years, not looking for specific guidance?

Well. It will take us some -- we're going to be measured in these investments. These are going to be best of arms, nor that we think that these are central to the investment thesis in Callaway, nor is it a central point for our returns. But we do think there's upside there and we're going to be making measured investments in these key markets. If we're successful the markets are large and the categories are large, so the upside is significant. The investments will be such that there will be slower returns at the start. During the early stages, we're going to be spending some money with zero return during the stages. Immediately following that, we'll start to see some revenue. That revenue will be modest. And the returns it could be breakeven during those periods of time. But if our expectations follow then we're going to deliver attractive returns over the medium to long term. So there's a journey we're going to be going on here that I think has a lot of excitement for shareholders. You'll have to trust us and look at our track record that we're going to be measured in that, but the returns are certainly there. And if you look at any medium to long-term, it should be an exciting opportunity for all of us.

Thank you.

Thank you.

Your next question comes from the line of Joe Altobello from Raymond James. Your line is open.

Thanks, good afternoon. First question on the equipment margins side. It looks like profitability remains under pressure. Is that simply tough compares given the launch timing or is there a competitive dynamic at play? And maybe secondly to that how much does the second half launches improve margins for the equipment business?

Sure. Joe, I would agree with you that the equipment profitability is under pressure. It's down year-over-year due to FX and the fact that in the odd number years of the equipment business we launched higher value-added products such as Apex and the Epic Flash. And those have lower gross margins. So all of the equipment profitability is what we expected plus FX. And now, we are going to see improvement in that during the second half, but the characteristics that reflect itself in these odd number years is doing what we expected it to do and not really -- we're not viewing it as being under pressure per se.

Okay. Thanks. And then maybe secondly for Jack Wolfskin, you mentioned earlier that the outlook for sales is unchanged. I assume the EBITDA outlook is unchanged as well. And if so, what was the EBITDA drag for that business in 2Q?

Joe you're correct. It does not -- we're not changing our estimates nor -- and as we stated, we're not updating them on a quarterly basis for that specific segment. And then your question specifically what the EBITDA drag was in Q2 I think?

Correct. Yes.

And we really don't break out. We break out the revenues by quarter for you, but not the EBITDA contribution, although as we stated the whole time it is a quarter where they generally routinely do not make money.

Okay. Thank you, guys.

Thank you.

And your next question comes from the line of Alex Maroccia from Berenberg. Your line is open.

Good evening guys. Thanks for taking my questions. So earlier this year you said that Q3 for Jack is about 3 times or 4 times the size of Q2. Would you expect the light pre-books to affect the revenue mix between DTC and wholesale versus where it's been historically for the last two quarters?

Alex yes. I would think it would.

Okay. Are you able to provide a bit more info about the sales split? Is it going to be roughly the same as previous as well?

The sales split in Q3 between...

Between Q3 and 4?

In that particular business unit?

Yes.

I don't have that information. Patrick do you have anything?

Yes high level because there is a little bit more selling of wholesale there, Q3 is probably a little less DTC than Q4. It's probably very similar to Q1 versus Q2. But that's probably about all we have.

Yes I think he was asking it I don't know whether we have it is if you go after that 360 number and they know what they had in the first half now he's trying to divide it between the quarters Q3 and Q4 for his model.

And we have talked about that. I think 40% of the revenue is Q3. So we have talked about that before.

And 40% of the full year.

Yes.

And we're not saying any different than that right now?

No.

Okay.

All right. That's helpful.

Sure.

And then one more for me. So after seeing the weaker numbers and expected from a competitor on the golf ball numbers as well the poor weather, I was pretty impressed by you guys having growth year-over-year. Can you just provide a little more info on the market share at the moment and how you're driving those market share gains?

Alex thanks for noticing. We're -- and I think that in fairness we -- no comment on the competitors, which obviously we have a ton of respect for. But if you focus on our business, we have relatively consistently beaten the golf equipment markets. So this is what we expect from ourselves. And one of the confusing items is if you look at our market shares our market shares are down a little bit. But it's reflecting that market shares only measure a portion of the business now. So that's one of the reasons I don't report out on. They're still directionally important. They're still a metric that matters. But you can see in our actual revenues that we're driving results that are above that. We have really good strength of breadth of distribution and very broad product lines. As we stated, we were up every product segment, every region on a currency-neutral basis for the first half and pleased with that. We've invested aggressively over the last few years in technology, in marketing resources, et cetera that are all aimed at delivering these types of results and we're pleased that we're able to do it. We are optimistic for the second half as well.

All right. Great. Thanks a lot. Good luck for the quarter.

Thanks, Alex.

That is the all the time we have for questions. I will now turn the call back over to Mr. Chip Brewer, Chief Executive Officer for some closing remarks.

Well, thank you everybody for making the time for today's call. Our comments were longer than normal, and I apologize for that. I appreciate everybody's patience. We have a lot to talk about, and we look forward to speaking with you again in the end of Q3. Thanks so much.

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