Topgolf Callaway Brands Corp (MODG) 2004 Q4 法說會逐字稿

Good afternoon.

My name is Tasha, and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Callaway Golf fourth quarter financial results conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' 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 1 on your telephone key pad.

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

I would now like to turn the call over to Mr. Brad Holiday, Chief Executive Officer of Callaway Golf.

Mr. Holiday, you may begin your conference.

It's Chief Financial Officer.

But, thank you, and welcome, everyone, to the Callaway Golf Company's fourth quarter 2004 earnings conference call.

I am Brad Holiday, the Chief Financial Officer of Callaway Golf.

Joining me today is William Baker, Chairman and Chief Executive Officer of Callaway Golf Company.

During today's conference call I will provide an overview of our financial results, and will then open the call for questions.

Before we begin, I would like to point out that unless we specifically state otherwise, any reference by us to Callaway Golf includes Callaway Golf, Odyssey, and FrogTrader.

And any reference to Top-Flite includes both Top-Flite and Ben Hogan.

Furthermore, any comments made about future performance, events, or circumstances, including the Company's success, prospects, or growth, the success of the Company's products, retail inventory levels, estimated effective tax rates, capital expenditures and depreciation and amortization expenses, the timing of the completion of the consolidation of the ball operations and estimated integration charges 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 actual results to differ materially from those projected in the forward-looking statements.

For details concerning these and other risks and uncertainties, you should consult Part 1, Item 2 of our most recent Form 10-Q filed with the SEC, as well as the Company's other reports subsequently filed with the SEC from time to time.

In addition, during the call, in order to assist interested parties with period-over-period comparisons, we will provide certain pro forma information as to the Company's performance, excluding charges associated with the integration of the Top-Flite operations, as well as information regarding the performance of the Callaway Golf operation and the Top-Flite operations on a stand-alone basis and excluding integration charges.

This information may include non-GAAP financial measures within the meaning of Regulation G. The earnings release we issued today includes a reconciliation of such non-GAAP financial measures to the most directly comparable financial measures prepared in accordance with GAAP.

The earnings release is available on the investor relations section of the Company's website at www.callawaygolf.com.

As you may have noticed, consistent with last quarter, we included additional financial detail with our press release this quarter.

Rather than reading the numbers on the conference call, we thought it was best to provide the numbers in our press release and reserve comments for discussing the details and trends associated with the numbers.

I will refer you to the tables in the press release for sales by product category and geographic region, and will focus my comments on the appropriate areas.

First, touching on the financial results for the fourth quarter, on a consolidated basis, which includes results for both Callaway Golf and Top-Flite, as well as integration charges, sales for the fourth quarter were $144 million, a decrease of 1 percent compared to last year.

Of the $144 million in reported sales, Top-Flite contributed $36 million, a 3 percent increase when compared to $35 million last year.

We reported a net loss of $28 million, compared to a net loss of $33 million last year, and a loss of $0.42 per share versus a loss of $0.50 a share in the prior year.

On a pro forma basis, excluding integration charges of 3 million and 16 million respectively, our net loss for the quarter was $25 million, compared to a net loss of $17 million last year.

Pro forma fully-diluted net loss per share was $0.37, compared to a net loss of $0.26 last year.

Looking at sales by product segments, our wood sales declined 35 percent for the quarter on lower volumes and prices.

This decline reflects the carryover of price reductions associated with the netting down of retail inventory we implemented last quarter to accelerate the sell through of inventory at retail.

The good news is that this action has been successful, and the inventory level of woods in the retail channel is back in line with our market share, putting us in a better position than 6 months ago for the sell in of our 2005 products.

Sales of irons increased 3 percent when compared to the fourth quarter of last year, reflecting higher sales of Big Bertha 04' Irons, and our newest product, the Big Bertha Fusion Irons, as well as incremental iron sales of the Hogan Hybrid clubs introduced in 2004.

Partially offsetting these gains were lower sales of our older X-16 and X-16 Pro Series models and reduced sales on our Big Bertha 02' Irons.

The mix shift from the X-16s to the Big Bertha 04' Irons resulted in lower average selling prices, due to the lower price point associated with the Big Bertha 04', but were partially offset by the higher price points associated with our new Fusion Irons.

Putter sales were down 26 percent versus the fourth quarter of last year due to lower volumes and prices on some White Hot closeout models and the DFX line.

Partially offsetting these declines were sales of our recently introduced White Steel line of putters.

While still early in the season, initial feedback on retail sell through for this new line of putters is very encouraging.

Golf ball sales were $44 million for the quarter, a 25 percent increase compared to last year's sales of $35 million.

Callaway branded ball sales totaled $15 million, compared with 5 million reported last year, driven by the success of the HX Tour, as well as increases across the entire line of products.

Top-Flite ball sales were $28 million for the quarter, compared with $30 million reported last year, a decrease of 7 percent.

For the quarter, the ball segment recorded an operating loss of $7 million.

Excluding integration charges of $4 million, the ball segment reported an operating loss of $3 million in the quarter, versus a loss of $12 million last year.

Callaway branded golf balls incurred an operating loss of $400,000 for the quarter, compared to a loss of $9 million last year.

Top-Flite lost $2 million, which is consistent with last year.

For the full year, the ball segment recorded an operating loss of $9 million.

Excluding integration charges of $14 million, the ball segment recorded an operating profit of $5 million, as compared to an operating loss of $29 million last year.

For the year, Callaway branded golf balls achieved a profit of $15 million, compared to a loss of $26 million in 2003, a turn around of $41 million year-over-year.

The significant turn around is primarily the result of the Top-Flite acquisition.

Turning to our regional breakout, U.S. sales increased 8 percent, including Top-Flite, and were higher by 14 percent excluding Top-Flite.

Our international sales were down 13 percent, including Top-Flite results, but declined 18 percent excluding Top-Flite.

The international declines were primarily due to Japan which recorded about half of last year's sales.

Part of this decline was the result of a product return program initiated in that market and the associated reserve taken against sales during the quarter.

Fourth quarter gross margins, excluding integration charges declined to 28 percent of net sales compared to 40 percent in the prior year.

Lower average selling prices, and the retailer net-down programs associated with our mid-summer inventory initiative, and lower Top-Flite gross margins accounted for the majority of the decline, offset partially by some favorable volume and mix.

Full year gross margins, excluding integration charges were 40 percent of net sales, compared to 48 percent in 2003.

Operating expenses for the quarter, excluding integration charges were $84 million, a decrease of $5 million compared to last year.

Operating expenses were lower for Callaway due to lower G&A and research and development expenses.

Operating loss for the quarter was $44 million, once again excluding integration charges, versus a loss of $31 million last year.

Our effective tax rate for the quarter was 40.9 percent.

In addition to our normalized rate of 38.9 percent, we have returned to income reserves for previously accrued taxes that are no longer required, associated with tax audits that reached completion during the quarter.

This resulted in a higher overall effective tax rate.

Our annual effective tax rate was 57.4 percent, the result of our normalized tax rate of 38.9 percent combined with the reversal of previously accrued taxes I just mentioned.

Based on our current worldwide mix of business, we expect our normal -- normalized effective tax rate for 2005 to be approximately 38.5 percent, excluding any unusual items.

The integration of Top-Flite is proceeding on plan.

We still expect total integration charges to be 60 to $65 million.

These charges total $25 million in 2003, $28 million in 2004, with approximately 7 to $12 million to be incurred in 2005.

To recap our integration progress to date, we have completed the consolidation of operations in Canada, Australia and Europe, reduced headcount across the organization, and moved a majority of our ball manufacturing to the Chicopee manufacturing facility.

Our goal is to complete the ball manufacturing consolidation to Chicopee during 2005.

Moving to the balance sheet, we finished the quarter with cash of $32 million, down 16 million compared to last year, and with outstanding borrowings on our line of credit of $13 million.

Net receivables were $105 million, an increase of $5 million compared to last year.

DSOs for the Callaway Golf business were 74 days, compared to 63 days last year, while Top-Flite DSOs equaled 65 days.

The increase in the Callaway Golf DSOs is due to the more aggressive terms we have offered in 2004 in response to market conditions.

Collections on AR remain strong, and the overall quality of our AR is good.

Net inventories totaled $181 million, a decrease of $4 million compared to last year.

Callaway inventory decreased by $24 million, and was offset partially by the acquisition of FrogTrader and increases at Top-Flite associated with the expanded 2005 Ben Hogan club line.

You will note that we have an income taxes receivable account of $32 million on our balance sheet this year, as compared to a payable balance of $12 million at the end of last year.

This balance represents the cash expected to be received in connection with the carry back of the 2004 tax loss to prior years and a refund of 2004 estimated tax payments made throughout the year.

CapEx for the quarter was $10 million, bringing the total for the year to $26 million, in line with our last estimate of $25 million.

CapEx for 2005 is estimated at approximately $25 million.

Depreciation and amortization for the year was $51 million, also in line with our last estimate of $50 million.

D&A for 2005 is estimated at approximately 40 to $45 million.

Our cash flow from operations was $9 million, compared to $119 million last year.

The key drivers for the variance were lower earnings and the changes in the tax accounts that I already mentioned.

As you know, we are no longer providing guidance for future periods.

The fact that over half of our annual sales come from new products each year makes forecasting with accuracy extremely difficult.

We are excited about the products we have introduced for the 2005 season, and the response so far from both retailers and consumers has been positive.

Included in the new product portfolio is the Big Bertha Titanium 454 Driver, which recently won the World Long Drive Championship; the Callaway Heavenwoods, White Steel putters;

X-18 and Fusion Irons; and the new HX Hot Golf Ball.

In addition, we also have several new Top-Flite ball models, several new Hogan products, which now includes a driver and fairway line, as well as a new line of irons and balls.

A word of caution I might throw out as you develop your quarterly models, is that last year was a record first quarter for our Company.

While we are excited about our new products this year, we are being cautious when dealing with our retailers to make sure that the appropriate level on inventory gets placed into the marketplace to avoid a repeat of what happened last year.

I would suggest you take this into consideration as you do your modeling.

I would now like to open the call for questions.

At this time, I would like to remind everyone, if you would like to ask a question, press the star, then number 1 on your telephone key pad.

We will pause for just a moment to compile the Q&A roster.

Your first question comes from Ed Aaron.

Hello, Ed, are you there?

Yes, can you hear me?

I can now.

I'm sorry.

Hi.

Good afternoon.

Couple of questions.

First, I was hoping you could maybe give a quick progress report on the CEO search.

This is Bill Baker.

We've retained the firm of Heidrick & Struggles, Ron Jarvis (ph), and he's studying in great depth the Company, its current management team, and the needs that need to be filled by the new CEO.

And so, he's moving steadily on that, started last Monday.

Any time line expected or -- ?

No, we don't have a time line set.

The thing we're going to do is be very, very careful.

Okay.

Fair enough.

And then, just with respect to the retail inventories, you mentioned that they have been worked down significantly over the past 6 months.

Do you think that they've come down to what you would consider to be appropriate or acceptable levels for this time of year?

Yes, I do, Ed.

I think that all the feedback we're getting from the retailers is that the general response is that inventories are in real good shape as we go into 2005.

There may be a couple of little spotty areas, maybe in the northern-tier states, where some of the shops are closed for the winter.

But I would say, generally, and if you look at Datatech, inventories are back in line with where we'd like them.

Okay.

That's on both sides of the business, both Top-Flite and Callaway.

Okay.

Great.

And then with respect to the new product introductions and your marketing or advertising efforts, are you making any changes this year from what you've done in the past?

In terms of vehicles and where we spend the money?

Yes.

Just the type of advertising and marketing that you're doing this year versus in the past.

You know, I think generally it's pretty much in line with what we've done in the past.

I think you're aware on the Top-Flite side of the business, they have taken some of their ad dollars and have actually directed them to, kind of, a relaunch of the brand that's associated with the Busch Series of NASCAR, which is kind of a unique way of marketing that product and the demographics associated with racing are very much in line with golf.

I would tell you that we will still advertise in most of the golf publications, we will have TV, and of course we have some new assets that we're going to utilize this year with our -- in our marketing campaigns.

But the level of spending, you think, is going to be pretty comparable?

You know, I'll say comparable.

We're not giving much direction going forward.

We balance all of our expenses, so we will look -- throughout the year, we will adjust as we go forward as we need to, but right now I'd say it's comparable.

Okay.

Great.

Just one last question, and then I'll open it up.

I kind of missed your commentary about Japan and the decline there.

I know you gave some explanation, but I didn't quite catch it.

Well, there's 2 things with Japan that I think have occurred in the past.

I think the first one is our product probably wasn't as well positioned for Japan as it needed to be plus the market's been a little bit soft over there.

I think we have some new products over there that seem to be getting off to a good start.

We have the ERC Fusion Irons as well as the ERC Golf Ball, which seem to be selling well over there.

The other thing we've done, as I mentioned, the way they do business in the Japan market is we have set up a reserve for this year for sales returns.

And as product, kind of, ends the end of its life cycle, where in the United States we might net it down and they sell it at reduced prices.

In Japan most of the manufacturers take that product back in and replace it with their newest products.

So we're working with limited number of our retailers to try that program.

Okay.

Thanks.

You're welcome.

Your next question comes from John Moran of Ryan Beck.

Hey, guys.

Just a couple of quick questions.

First, I don't know if you mentioned it, and I just happened to miss it, but if -- if there was any foreign exchange effect on sales or margins, would you mind breaking that out?

On the revenue side, it was about $3 million -- $3.5 million for the quarter, John, and I don't have it on the margin side.

Okay.

And then, just to kind of go back and touch on retail inventory levels.

Domestically, I know that they -- they're in pretty good shape.

Does that hold true for international inventory levels as well?

Yes.

I think it's pretty consistent around the world, John.

We haven't really heard anything back from any of our regions concerned.

I think they're pretty much in sync with where the U.S. is.

Okay.

And then in terms of R&D spending, sort of going forward, would you expect that '05 would be fairly comparable to this past year?

You know, John, you're asking me to forecast, and I prefer not to comment on that.

But we will continue to look at all of our expenses and we will manage them appropriately.

We certainly will make the appropriate investment in research and development as we go forth and develop new products.

Okay.

Great.

Thanks, guys.

You bet, John.

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

Thank you.

Couple of questions, just to follow up on that previous one on R&D.

Again, I guess, the -- in a quest to regain market share, the best way to do it is through new products.

So is it fair to assume that as a percent of sales, we should not see R&D go down, and potentially could increase somewhat as you, kind of, rebuild that pipeline?

Well, Tim, I think historically our R&D has kind of been at 3 -- 3 to 4 percent, percentage of net sales.

I think that we will remain in that kind of a range.

Certainly we're committed to spending in research and development.

We recognize the importance of developing new products.

And, obviously, our intent is to continue to grow sales.

So as sales grow, why, you know, we will continue to invest as appropriate.

Okay.

Okay.

And then from what you're seeing at this point in the market at retail from your perspective, how would you see pricing overall on comparable products across, you know, yourselves and competitors?

How do you see that at this point on a year-over-year basis?

And, again, from your perspective, what's your read on pricing trends?

Do you anticipate the market, overall, to be less aggressive this year, comparable, as far as how things unfold throughout the year?

And I know there's a lot of variability in that as it relates to weather and so forth, but just as you see the world as it stands at this point in time.

Well, I can't comment on what our competition is going to do.

I would tell you that we've got a product mix out there right now that we feel very comfortable with, and it's going to have products at different price points.

I think an example of where pricing -- average selling price may go up a little bit is the mix of the iron business with our new Fusion Irons.

Those are premium priced irons and are selling through very briskly at retail.

And I think at the end of the year, you might see an increase in the average selling price of irons, which tells me that if you have good technology and good performing products, that the golf consumer is going to be willing to pay more for that product.

So I think that's encouraging.

I think another example where that is also true is if you take a look at the great success we had with the 2-Ball Putter, and the fact we actually grew the whole putter category through higher pricing and more volume.

So, you know, I'm not going to, as I say, make comments or speculate what our competition might do.

Our intent, as it always is, is to put our products into the marketplace and try to maintain pricing throughout the year.

I think that's the best for us, the best for our retailers.

And last year was one where we didn't do that because we had some inventory issues, but I think we did the right thing in partnership with our retailers to help clear the channels out.

Okay.

And then, Brad, in your internal modeling, and I guess to a point this is forecasting a little bit, but just what -- from our modeling standpoint, what should we be kind of looking at as a share base?

You know, I think you should probably be in that 68 to 69 million share base, Tim.

And then that's going to be assuming that the stock price goes up a little bit throughout the year so you'll have a little more dilution due to options.

Okay.

And then, another question here.

Bob Penicka, it appears that from some of the option grants that he has been given has been somewhat elevated to position within the Company.

What's his formal position at this point in time?

Well, he hasn't been elevated to a higher level than he was out at Top-Flite.

I mean, he was brought back here in addition to managing the Top-Flite operation to help out on the supply chain side of the business, which he used to run.

Okay.

Okay.

Bob -- to answer your question, Bob did an excellent job for us and is doing an excellent job for us in Top-Flite.

He still continues to be President of that subsidiary.

And he's working very heavily in the operations end of this -- of this Company here in Carlsbad.

Okay.

And final question, we've asked this several times before, just from a more of a strategy development standpoint, I know you guys are still kind of working on the marketing repositioning of several things there, and as the year unfolds we're seeing that.

But looking out, you're still generating -- even given the difficulty of the past year, here -- still generating positive operating cash flow.

Any update on as far as strategy as it relates to that as we look forward here?

In terms of use of cash?

Yes.

Tim, it would be as consistent as what we've said in the past.

And that is we would certainly look at all options.

I think that if you go back and look at the results of the balls on operating profits on Callaway, I think it supports the acquisition we did of Top-Flite that was a great strategic fit.

And if there were another Top-Flite-like acquisition we would seriously and thoughtfully consider it.

Certainly, share repurchase is an option that we would keep in mind.

Dividends is something that we will continue to do and pay back a certain amount or a percentage, whatever we decide to do going forward.

But that seems to be pretty consistent at this point in time.

But you know, we're just kind of coming off a year when we're trying to get the retail channel back in a comfortable position so we can have a successful 2005.

And as we start to get back to, hopefully, historical levels of cash generation, then we'll address some of those a little more closely.

Great.

Thank you, gentlemen.

You bet, Tim.

Your next question comes from Mike Fox of J.P. Morgan.

Good afternoon.

I just had a couple of questions.

As far as your wood product line, besides the 454, are you still producing and shipping the ERC Fusion and the Great Big Bertha 2?

Yes, we are on limited quantities, I mean, as needed in the marketplace.

But I think right now the newest, most exciting product, Mike, that we have in the lineup is the Titanium 454 Driver.

Okay.

And what about the Big Bertha product that you introduced last year, is that still being produced or is that finished?

I believe we're still making that and there's some demand, but, once again, I think that was --

The 415.

No, not the 415, you're talking about the Big Bertha Driver, right?

Yes.

Yes.

We still have that.

We can still produce it.

And as orders come in, we will fill those orders.

But, once again, I think if you look at the mix of products, it's going to skew away from that particular product more into the newer product, just because the head size of the 454 and the performance, et cetera, versus that product.

Okay.

And I remember last year you had talked about Top-Flite, that you didn't really have a lot of control over what was in the marketplace because you -- given the timing of when you made the acquisition.

Do you feel like this year you have a better handle on that and maybe you consolidated some of the SKUs?

Or is that going to be next year?

No, I -- this, frankly, will be the year that we've actually had a chance to have an impact on the product that's in the marketplace.

I think if you look at the Top-Flite business, the good news there is, as I mentioned on inventory for Callaway, the Top-Flite inventory situation at retail is much healthier now than it was when we -- after we made the acquisition, and in particular the Infinity Golf Ball product.

They have reduced the number of SKUs on the Top-Flite side of business by 30 to 40 percent.

And what that means is just the different configurations of types of balls and packaging where it -- for various channels of distribution has been reduced quite a bit and received pretty well by retail.

And then in addition to that, there's an expanded line on the Hogan side, which includes, as I mentioned driver, fairway woods, of course, we have the hybrid carryovers from last year.

We have a new golf ball for the Hogan line, and we've got some expanded putters within the line also.

So this is a year when we've really had a chance to get in and have an impact on the products.

In addition to that, I think when you go out to retail and you start looking at all the new product, you'll see the new, kind of, branding icon and logo associated with Top-Flite.

One of the things Bob and team tried to do when he took over out there was to try to freshen the brand and really get it back to more of a distance value kind of a brand.

They signed Hank Kuehne, who is all about distance, and he's quite excited to be on board.

So, I think 2005 will have more of a mark on it than we were able to generate in 2004.

Is Hank Kuehne going to be using one of your drivers now, as well?

He is, yes.

As a matter of fact, he is.

Okay.

Thanks a lot.

You bet.

At this time there are no further questions.

Mr. Holiday, are there any closing remarks?

Well, I would just like to thank everybody for joining us today.

And while 2004 was a tough year for us, we are very excited about the product lineup that we have going into 2005, and are looking forward to hopefully a much more successful year in 2005 than we had last year.

So thank you for supporting us, and we look forward to checking in with you again at the end of the first quarter.