Topgolf Callaway Brands Corp (MODG) 2003 Q1 法說會逐字稿

Good afternoon.

My name is Wes (ph) and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Callaway Golf first quarter, 2003 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 period.

If you would like to ask a question during this time, simply press star then the number one on your telephone keypad.

If you would like to withdraw your question, press the pound key.

Thank you.

I would like to turn the conference over to Mr. Brad Holiday, Executive Vice President and Chief Financial Officer.

Mr. Holiday, you may begin.

Thank you and welcome everyone to Callaway Golf Company's first quarter 2003 conference call.

I am Brad Holiday, Executive Vice President, Chief Financial Officer of Callaway Golf Company.

Joining me today is Ron Drapeau, Chairman, President, and Chief Executive Officer of Callaway Golf Company.

During today's conference call, Ron will provide a brief overview of our first quarter results and current trends.

I will provide more detailed comments about our financial results and Ron will then conclude with some additional thoughts before we open the call for questions.

Before we begin I would like to point out that any comments made about future performance, events or circumstances, including estimates of net sales and earnings per share information for 2003 and beyond and statements concerning licensing revenue growth 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 and are subject to certain risks and uncertainties which could cause the actual results to differ materially from those projected in forward-looking statements.

For details concerning these and other risks and uncertainties, you should consult our most recent Form 10-K filed with the SEC, as well as the Company's other reports subsequently filed with the SEC from time to time.

With that I will turn the call over to Ron.

Thanks, Brad, and thanks to everyone for joining us today.

As you know, there has been a lot of uncertainty in the economy throughout last year and into 2003.

The crisis in Iraq only added to these concerns as the quarter unfolded, and specific to the golf industry, rounds played continued to decline.

We entered the year cautiously, not knowing for sure how those factors would impact the golf industry and our business.

While the industry in general was soft, today we are pleased to report that we achieved $272 million in net sales resulting in diluted earnings per share of 64 cents, beating our earnings per share guidance by 10 cents.

Brad will provide more details in a moment.

The highlights for the quarter include improved gross margins versus last year, reduced operating expenses in absolute dollars and as a percentage of net sales versus last year, improved operating income margins, reduced inventories year-over-year, and an increase in cash.

Another highlight is that we are ahead of our expectations regarding driver usage on tour.

In fact, weekly PGA tour usage for our Great Big Bertha II driver has increased our driver usage to 20 percent from 10 percent a year ago, ranking it as the top model on the combined tours several times this year.

So all in all we feel good about our performance, both financially and operationally, and feel we are executing all the initiatives we set for ourselves in 2003.

I will turn the call over to Brad now who will cover the details of our financial results.

After he has finished, I have a few more comments before we open the call to questions.

Thanks, Ron.

Net sales for the quarter were $272 million, an increase of six percent when compared to last year.

We benefited from improved year-over-year currency exchange rates during the quarter, especially for the pound, euro and yen.

In constant dollars, net sales grew one percent.

Sales of woods were 34 percent of total sales at $93 million, compared to $106 million last year.

Sales of titanium and other non-steel woods, including Great Big Bertha II drivers and Fairway woods, surpassed last year's sales of C4, VFT and ERC2 woods.

However, steel woods were down when compared to last year's successful launch of Steelhead III woods, accounting for the overall decline in wood sales.

Bear in mind that we started filling the pipeline with Great Big Bertha II drivers in late 2002.

Sales of irons were $96 million for the quarter, a very strong 15 percent increase versus last year, and represent 35 percent of total sales.

This increase is driven by the early success of the X-16 and X-16 Pro Series Irons launched in January of this year.

Sales of X-16 Irons have more than offset the decrease in sales of our prior X-14 line, which was still in the product line last year, and so far is our most popular iron ever.

Putter sales were $45 million for the quarter.

This is an increase of 75 percent versus last year, driven by the continued success of the Odyssey Two-Ball (ph) Putter.

Golf ball sales were $14 million versus 2002 sales of $23 million.

Last year's numbers included pipeline sale associated with the introduction of the HX ball.

This year's numbers did not include any new product launches and were further affected by continued declines in rounds played in the United States.

Sales of accessories and other products were $24 million, a 22 percent increase over last year.

I would also like to point out that licensing revenue is now included in net sales versus other income category last year.

Last year's results have been reclassified for comparative purposes, and the amounts are not significant in either year.

Our licensing arrangements for apparel and footwear are relatively new, and we have structured our agreements in ways which support the successful launch by reinvesting royalties in the first year back into the business.

Overall, we are encouraged by these initiatives and we expect royalties to grow nicely over time.

Ashworth's first year with Callaway Golf Apparel line was successful with revenues for their 2002 fiscal year at just under $17 million.

They're forecasting revenues to nearly double to $30 million for their 2003 fiscal year ending October.

Our apparel licensee in Japan and Korea, Sonya International (ph) , has had a successful first selling season.

Our footwear licensee, Tour Golf Group, has told us that initial orders have been encouraging with shipments of products to retail beginning in late March.

Turning to our international business, net sales for the quarter were $122 million, an increase of 16 percent when compared to last year, and represent 45 percent of our total net sales.

In constant dollars, net sales internationally would have increase five percent.

Sales trends by region were as follows.

Europe increased 23 percent to $50 million;

Japan increased six percent to $33 million; rest of Asia including Korea increased 14 percent to $18 million; and U.S. sales of $149 million decreased one percent compared to last year.

Moving on to the rest of the income statement, gross profits for the quarter increased seven percent to $138 million when compared to 2002.

Gross margins were 51 percent of net sales, an increase of one percentage point over last year and the result of stable year-over-year club margins and lower golf ball sales volumes, which have lower margins.

Selling, advertising, and tour expenses were $8 million less than last year, and as a percent of net sales improved from 22 percent last year to 18 percent this year.

This reduction was due in part to lower advertising in Q1 when compared to last year, some of which is due to a shift in our spending to later in the year.

Also contributing to the reduction was lower employee costs resulting from our November '02 reduction in force.

G&A expenses of $14 million were flat as a percent of sales and three percent higher in dollars.

R&D expenses of $7 million decreased $1 million and decreased at two percent of net sales versus three percent in 2002.

This decrease was due to a reduction in consulting fees, employee expense, and depreciation expense.

Operating income increased 36 percent to $68 million with margins increasing to 25 percent this year from 20 percent last year.

The other income line for the quarter showed a net loss of $1 million due to fees associated with the termination of a portion of our line of credit, lower interest income and losses on foreign exchange.

Regarding the line of credit, due to our strong cash position, our ability to generate cash and the fact that we have not used the line for over three years, we decided during the quarter to cancel our accounts receivable facility, leaving us with the GE syndicated revolving line of credit.

Golf ball net sales were $14 million and represent five percent of our total sales versus $23 million last year.

And as I noted earlier, the lower sales were largely the result of not having any new ball launches during the quarter, while last year we introduced our new HX (ph) technology.

Our market share has remained steady with about seven percent overall and 11 percent in the above $20 segment.

Gross margins were in the mid-single digit range versus the mid-double digits last year, due to the lower volumes.

Operating expenses were tightly controlled, resulting in an operating loss of $5 million, flat with losses incurred last year.

We ended the quarter with a strong balance sheet, which included $308 million of net working capital.

Cash increased 21 percent to $81 million while inventories decreased 17 percent from a year ago.

Receivables were up eight percent on the increase in sales with DSOs at 67 days versus 60 days last year.

The quality of our outstanding receivables remain very good.

Capital expenditures for the quarter were $2 million with depreciation and amortization of $10 million.

During the quarter, we purchased 276,000 shares of stock at an average price of $11.65 and have $16 million remaining in our May 2002 authorization of $50 million.

This concludes my remarks.

I would now like to turn the call back over to Ron.

Thanks, Brad.

There are some additional items I would like to comment on before we open the call to questions.

First, I want to address guidance for the remainder of the year.

We continue to reiterate our full-year guidance of essentially flat sales in the $790 million range and earnings per share of 88 cents plus or minus three percent.

We feel we have done a good job of developing great products, placing them at retail and capturing a representative share of inventory in stores.

We have made good progress on tour and gaining additional driver usage and we have developed a solid advertising message with our Great Shots campaign.

These initiatives should drive consumer interest in our brand, however given everything that is going on in world economies, including the war in Iraq and a very uncertain global health issue in SARS, continued confidence has been at its lowest - consumer confidence has been at its lowest levels since the Depression.

Because of these factors, we think there could be a shift in consumer purchasing behaviors from an especially high second quarter into the third and fourth quarters.

For that reason, we are not going to give specific second quarter guidance and do no think that normal year-over-year comparisons should be relied upon by those who feel the urge to make such predictions on their own.

If you must make quarterly predictions, I would encourage you to think about balancing your expectations from the first half of the year to the second half as we have done for the reasons I just mentioned.

The total sales guidance for the year, as I stated, remains the same.

Earnings guidance included - excludes any special charges or gains.

As for the earnings gains seen this quarter, I'm sure several of you would like to make them additive to your annual earnings forecast.

While this could be a possibility, let me caution you on doing that just yet.

First, some of the gains are due to favorable foreign exchange rates that may or may not hold over the balance of the year.

Second, some are due to the timing of expenditures such as advertising that we will incur during the balance of the year.

Third, our successful first quarter will no doubt drive our competition to respond in the marketplace.

We may need to reinvest some of our savings to maintain tour presence, for example, or otherwise protect our business.

Our commitment to our shareholders is two fold in that we will keep you updated as to how we are tracking towards our full year forecast as the year progresses and we will do everything possible to drive improved earnings here from a long-term perspective to make sense for our business.

The second item I want to discuss deals with the status of our golf ball business.

I'm sure many of you will be asking the question in a few moments as to where we are regarding our decision.

To save you the effort of asking the question, I would tell you that we continue to diligently work on options that will eliminate the losses in this segment.

We are not ready yet to share anything with you, but will do so as soon as we can.

I can say that I feel better now about finding a positive solution to our challenge than I have in the last 12 months.

By positive, I mean a solution that keeps us in the business without incurring the losses we have experienced to date.

When we have the solution finalized, we will share it.

That concludes our prepared remarks.

I would like to thank you for your participation in today's conference call and your continued interest in the company.

We will now open the call to questions.

At this time, I would like to remind everyone in order to ask a question, please press star then the number one on your telephone keypad.

We'll pause for a moment to compile the Q&A roster.

Your first question comes from Carole Buyers of RBC Capital Markets.

Hi and good afternoon, gentlemen.

Couple of questions, I was wondering could you comment on what the losses were in the ball business this quarter versus last quarter?

It was five million dollars operating.

Five million.

Flat with last year, Carole.

Flat with last year, thank you.

Yes.

And then, could you also comment on the retail environment, the initial sell through and, you know, how cautious are retailers today and what the inventory position looks like at retail?

Well we've seen Carole, that the number of units sold has been, if you kind of look at a moving average number, sort of flat with a year ago.

Prices have somewhat been depressed, particularly in the metal wood category.

We've seen the same thing in golf balls with more share moving into lower priced points.

But I think it's pretty early yet for us to get a read on how the season is going to develop.

This is the time of the year, the Masters sort of kicks off the golf season in a lot of the country, in the East and in the North, and we still have some weather problems.

So I think it's a little bit premature to really get a read on what the market is going to be.

The first few months have been selling for all of us in the industry and the next couple of months will start to indicate what the other year will unfold with the caveat that our personal feelings is that the market is going to develop slower than it has historically because of the uncertainties that we described in our call and the lower consumer confidence that exists out there.

OK.

And then, and one more question, then I'll open it up.

Brad, can I ask you to repeat the woods business again?

You mentioned that the woods business was impacted by the steel wood introduction, the Steelhead introduction last year...

Yes, we...

Could you give more specifics on that?

Well, no more than what I gave already other than sales of titanium woods and other non-steel were higher year-over-year, Steel woods we had a very successful launch last year of Steelhead III so it's in its second year.

So the downtrend that we see in woods is really driven by the steel products.

OK, but then is it fair to say that titanium woods business was up in the double-digit range?

I wouldn't comment on the percentage, but it's up year-over-year.

OK.

Great, thanks.

Yes, you bet.

Your next question comes from Tim Conder of A.G. Edwards.

A few questions, gentlemen.

First of all, could you give any comment on the R&D related to balls on a year-over-year basis and how that's looking for the whole year?

Secondly, as it relates to Asia and Canada in particular, you gave the rest of Asia, Brad, but can you maybe comment on how Canada was first quarter year-over-year and then what trends are you seeing at retail year-to-date there?

And then one more question here; if you take out the gross--if you take out currency out of the gross margin, if we're doing this right, your gross margin is actually down year-over-year.

Any comments on that?

And then how currency could benefit or hurt you in the quarters going forward.

I'll take the first one, Tim.

As regards R&D related to balls, we are continuing to invest in R&D and we've not given specific guidance about the amount of spending that we put to various products, but so we continue those efforts.

How, I guess on the R&D run, how is that as a percentage or a dollar commitment?

I mean, are you de-emphasizing the R&D there or keeping it about the same, increasing it?

We continue to invest in the R&D and I really don't want to flag any relationships of R&D to specific products because of the competitors that listen to this call.

OK.

And Tim, I think--we've never given Canada in the past; it's just not that substantial to the whole business.

So I think I'll pass on that.

I think...

In relation to the SARS framing that you guys gave; that's why I'm asking the question.

It's too early to tell.

I mean, you know, first quarter is behind us and, of course, SARS has been really more recently in the past three or four weeks, so I would say it had little impact in Canada in the very first quarter.

With regards to foreign exchange and the impact it'll have on our business as we go forward, you know, yet to be seen.

I mean, if the dollar remains weak, it's obviously going to have a positive impact on our overall business when you factor in our international business.

And one of the caveats that Ron mentioned with regards to guidance is we don't know what FX is going to do for the balance of the year.

You know, depending on when the crisis ends in Iraq will certainly drive some of the impact around how strong the dollar gets, so we'll have to wait and see.

OK.

Now again, back to the--what are you seeing second quarter to date in Asia and in Canada in context of your SARS caveat.

Well, Tim, the second quarter is only two weeks old, so it's really too early.

Any trends, though, that you're detecting from SARS?

Not in the last two weeks.

OK, OK.

And then, Brad, on the currency side, again, did that--are calculations correct that if you exclude the currency benefit, your gross margins were actually down in the first quarter?

Oh I don't know if they'd be down; we were up a percent overall.

I haven't gone through and done the calculation top (ph) I had here, but it might be flat maybe.

OK.

I'd have to go through and do the calculation, Tim.

I don't have it at my fingertips.

And I guess where you're currently hedged then on currency as it stands now, assuming nothing changes, would that be a positive or a negative impact the balance of the year?

You mean how we're hedged relative to where currency's going to go?

Yes, how - I mean assuming ...

We're less hedged this year in general than we were last year.

OK.

And that's really due just to the volatility right now - we don't know which direction it's going to go, but we're less hedged than we were last year.

But the good news is the rates are better than they were last year.

OK.

And then, Ron, one question here and then I'll let somebody else ask a few.

Any tightening or update on the timetable as it relates to a decision on the ball ops?

No, not really.

We're working diligently on it.

More important to us is the right solution than the timing of it, but I'm feeling good about where we're headed.

OK.

Thank you.

Your next question comes from Casey Alexander of Gilford Securities.

Hi.

Good afternoon, guys.

Hi, Casey.

Hey, I promise not to try to trick you with any golf ball questions.

My only question is - it relates to the decrease in selling expenses.

Has there been a change in the composition of the sales force or a decrease in the headcount of the sales force or have you made a conscious effort to really restructure the sales force and keep your cost down there?

Casey, yes, we did.

Last fall we had a restructuring throughout the company, and there was an impact to that as regards the sales force, and we have restructured some of the territories and the coverage to get better utilization of our - of our skills there.

So that is part of the reduction, but also part of it, as Brad mentioned in his - in his discussion, is timing of advertising expenses, as well.

OK.

All right.

That's all I have.

Thank you.

Your next question comes from Joe Yurman of Bear, Stearns.

Hey, guys.

Hey, Joe.

Three questions - I realize there's been a lot of puts and takes and uncertainties regarding how you may have to invest depending on the actions of your competitors, but can you still say that on a year-over-year basis, Brad, that op ex will be lower versus last year?

That's the first question.

The second one is regarding the partnership event that you've held the last I believe two years in the late fall, given some change in the sales curve that you talk about here, can you comment on the way that you're thinking about that event and, you know, how we should think about any '04 product launch in latter '03?

And Brad, I was hoping that you could quantify how FX benefited EPS and specifically how the translation of expenses at a higher rate possibly offset some of the sales [Inaudible] .

Do you want to take the sales meeting [Inaudible] ...

Let me take - Joe, this is Ron - let me take the [Inaudible] question concerning the partnership events that we've had in the past and also maybe one you didn't ask - attendance at the PGA Show and the questions about 2004 product introductions and when you might expect those to happen.

Basically, we have not decided at this point in time if we will attend the PGA Show or whether or not there will be a partnership event in 2003.

That's a decision we will make at the latest possible time if we feel that there's merit in doing do.

And a lot of that will depend on the conditions that, right now, we just can't see.

And then, as regards the new product introductions, we don't talk about - never have disclosed when we will introduce new products and I wouldn't start that process at this time.

Sure.

But you can rest assured that we have been spending our R&D money wisely.

OK.

Joe, I think with regards to your question on overall op ex, I think to Ron's point, I mean, we will - one of our commitments to our shareholders is we will try to drive profitability as much as we can, if it makes sense in the long term.

So to his point of we have seen some nice favorability versus our - versus last year so far, we don't know yet what we're going to need to spend it on in the back half of the year.

I can tell you right now that there will be more advertising, probably, year over year, because we actually consciously shifted it from first quarter to the last three quarters.

Right.

So that'll eat up some of the gains.

We have worked hard and, as you know how we operate our business, we manage our operating expenses pretty tightly to give us the flexibility that if we have to spend to protect a brand, we can do so.

If we don't need to, then we will let it flow to the bottom line.

That's the commitment we have to the shareholders.

OK.

With regards to FX and the overall impact, I don't have it rolled up for the total company.

OK.

I can talk to you later on that.

We have it kind of by region.

You know, it's probably in that five, $6 million range pretax, roughly.

OK.

But I don't really have it rolled up to a consolidated number.

OK.

Thanks.

Yes.

Again, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad.

Your next question comes from Carole Buyers of RBC Capital Markets.

Hi.

Just two quick follow-up questions.

First, I wanted to know whether or not you are still accepting returns for the C4 (ph) and the ERC2 (ph) .

And then, second, I wanted to know, in the wood business, it seems like there are a number of companies with new drivers, based on our research.

And I was wondering, without mentioning competitors' names, of course, is - are any of them being irrational as we've seen sometimes in the past in pricing competition or is it - is it too early to see what it's going to be like this season?

Carole, while we ran the ERC2 (ph) return - consumer return program - last fall, after the USGA reversed their direction - is that the one you're talking about?

Yes.

Yes.

Sorry.

Yes.

That ...

...

C4 (ph) [Inaudible] .

OK.

That has terminated and, quite frankly, we didn't see very many returns.

So there are a lot of people out there still enjoying that product.

So that's not an issue for us.

And as regards to irrational competitors - they're irrational in our - in our view because of the way they elect to present their brand.

I'm sure it's rational to them.

But the same things continue with this - by the same companies.

So far, as you can see by our results and we're very pleased and delighted that they have not had the - an impact such that we have had to do anything that we didn't want to do for our brand.

So we feel good about our positioning and the way we're presenting our products and the consumers that we're attracting to them.

When you - when you look at the, you know, new product like the GVD2 (ph) , at what point, as far as market share goes - you know, we look at the data tech numbers as do you, but is there a certain market share goal that you want to get to on that particular driver?

No, actually, I have more of a profitability goal in mind.

OK.

OK.

I guess that's smart in this environment.

Thank you.

You bet.

OK.

Your next question comes from Bud Leedom of Wells Fargo Securities.

Good afternoon, guys.

Hey, Bud.

Hey, Bud.

Just a couple of quick questions here.

First off, I'm just trying to understand the shift, as you characterize it, a little bit more in terms of Q2 revenue potentially falling more into Q3 and Q4.

Is that more of a product launch type of dynamic here in the sense that maybe the retail inventories are such that they're not going to normally order during the summer selling season?

Because, you know, historically the second quarter has been large just by virtue of what is sold during that period.

So maybe you can just help me understand that a little bit better.

And then just on the overseas market in general, just the strength that you saw in Japan sort of what led that and maybe some of the trends that you're seeing there.

Thanks.

Well, Bud, the - our expectation that the sales seasonality is going to shift somewhat this year from the second quarter into the latter part of the year is entirely based on our guess at what the consumers are going to do.

It has nothing to do with product introductions or retail inventories.

It's our feeling that, with the uncertainty that exists right now and consumer confidence at depression levels, that it's going to take some time for that to unwind.

And we just think the season is going to develop later rather than sooner.

We've been through these cycles in the past, nothing quite like what we have presently with the - with the consumer environment, but golfers are very resilient buyers.

And eventually they come back to the market because golf is part of their life and equipment is part of their life and though we have seen ups and downs in the economy, there's a stable of golfers out there, the core and avid players that continue to buy product.

So we're not concerned over the long-term of them buying product, but we think the seasonality and the timing of it this year may be affected by the current state of mind.

OK.

And then in regards overseas in general, we've just had a very nice reception to our products including great Big Bertha II, which as you probably are aware, represents in Japan more popular, the driver category is more popular towards Titanium products than they are steel.

And so we've had a good offering and also our X-16 and X-16 Pro Series have been very well received there as well as the 2-Ball Putter, which is a run away share leader in the Japan market.

And we've had very favorable effect with the yen.

So a lot of good things going on for us in Japan right now.

OK.

And could you possibly comment on Korea in general?

Is that still sort of a up and down market for you or is there any stabilization there?

North or South?

Exactly.

South Korea has been very stable for us.

You know we purchased that distributor rights back in 1998 and it's been a very nice environment for us and continues to be.

We are - we are the leading U.S. brand of golf clubs in that market.

Great.

Well thanks very much and nice quarter.

Thank you.

Your next question comes from Tim Conder of AG Edwards.

First of all I wanted to apologize for not commending you on your receivables and inventory management; job well done there.

A couple of additional questions here.

Share repo, with only 16 million left, Ron, do you anticipate the Board will likely reload that at the next meeting?

And then, Brad, if you could give us an update on D&A cap ex outlook for the balance of the year.

And then of the 792 in sales, return to the ball issue here, how much of that are you budgeting in for balls?

On the stock repurchase, Tim, we view stock repurchase in light of what the other alternative uses are for cash and that's something that we review with the Finance Committee and the Board in total, really at every quarterly meeting.

And so we will--it will be on the agenda.

I can't at this time anticipate what direction the Board may want to go and that, I think, will depend a lot on where we are with the ball business, what our alternatives are at that point in time, and other uses for cash that we may or may not have.

And right now, with the economy the way it is and our concern over maybe the delay in startup of the season, I like sitting on some cash, I think that's a nice asset to hold.

So I feel good about our balance sheet presently.

Brad, you can talk about the cap ex.

Yes, cap ex, you know, our target is about $25 million for the year, Tim, and we're going to stick to that right now.

I think what we're seeing is a shift from Q1 more towards the latter part of the year, so I would still use about 25 million.

And D&A should be around 40.

OK.

And in terms of--and in terms of projections of sales, I don't believe that we actually every provide product detail in the forecast.

OK.

One last question, Ron, as it relates to Spaulding out there.

Any comment on industry talk that Tailormade (ph) and Mr. King over there may have a 30-day exclusive in which to evaluate purchase of Spaulding?

No, I really don't have any comment, Tim.

OK.

At this time there are no further questions.

Mr. Drapeau, do you have any closing remarks?

Yes, thank you.

Well, everyone that participated and listened to the conference call, we want to thank you very much for participating today and for your continued support of the Company.

We're looking for--just to reiterate our strategic thoughts, we're looking for a long term single-digit growth in sales and double-digit growth in earnings and we think this year may be a bit of a tough year as the remainder unfolds, but as you can see, we also had that same caution for the first quarter and we're very delighted that the results are better than we expected and better than we projected to you.

So going forward I would just ask you to stay with us.

We will keep communicating to you as we have further announcements to make, specifically on the golf ball business, and we're going to continue to drive shareholder value.

So thank you.

That concludes the Callaway Golf first quarter 2003 results conference call.

You may now disconnect.