Topgolf Callaway Brands Corp (MODG) 2005 Q1 法說會逐字稿

Good afternoon.

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

At this time I would like to welcome everyone to the Callaway Golf first quarter earnings 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 one on your telephone keypad.

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

I would now like to turn the conference over to Brad Holiday, CFO of Callaway Golf.

Thank you.

Mr. Holiday, you may begin your conference.

Thank you.

And welcome, everyone, to Callaway Golf Company’s first quarter 2005 earnings conference call.

I’m Brad Holiday, CFO of Callaway Golf Company.

Joining me today is William Baker, Chairman and CEO 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.

I would like to point out that unless we specifically state otherwise, any reference by us about Callaway Golf includes Callaway Golf, Odyssey, and Callaway Golf Interactive, formerly known as 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, retail inventory levels, new product launches, anticipated golf ball margin improvements, the collection of accounts receivable, estimated 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 2, Item 7 of our most recent Form 10K 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 proforma information as to the Company’s performance excluding charges associated with the integration of the Top-Flite operations.

This information includes 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.

First, touching on the financial results for the quarter, sales were $300 million, a decrease of 18% compared to last year.

As mentioned in our January call and later in our April pre-release, we’d expected sales to be lower than the record level set in 2004 due to a couple of reasons.

First, we are staggering our new product launches this year compared to last year’s first quarter where we introduced a majority of our new products.

Second, we have adopted a less aggressive inventory strategy at retail in 2005 which, in our view, will insure more appropriate levels and avoid a repeat of last year which required the discounting of some of our wood products in order to stimulate sell through.

We reported net income of $18 million compared to $41 million last year and income of $0.27 per share versus $0.59 in the prior year.

On a proforma basis, excluding after-tax integration charges of $2 million and $3 million respectively, our net income for the quarter was $21 million compared to $44 million last year.

Proforma fully diluted earnings per share, excluding the $0.03 integration charge, was $0.30 compared to $0.64 last year which excluded a $0.05 integration charge.

Looking at sales by product segments, our wood sales declined 47% for the quarter compared to last year.

This decline reflects fewer new product introductions during the quarter as well as lower average selling prices due to the product mix and the carryover of products associated with last year’s netting down of retail inventory aimed at accelerating sell through at retail.

New wood products introduced this year include the Big Bertha 454 driver, some initial shipments of the Hogan Big Ben driver and fairway woods, as well as our high bred heaven woods which were launched at the end of Q3 last year compared to the introduction of 5 new models of drivers and fairway woods during the first quarter of last year.

Sales of irons increased 12% when compared to the first quarter of last year, reflecting sales of new products which include Callaway Golf X18 Series, our big Bertha Fusion Irons introduced late last year, as well as the new BH5 model of Hogan Irons introduced this year.

Partially offsetting these gains were lower sales of our older X16 and X16Pro series models and reduced sales of our Big Bertha ’04 irons now in their second year.

Callaway Golf Irons achieved a record level 18.7% unit market share in the United States in February according to Golf DataTech.

The mix shift to X18s and Fusion Irons from lower priced Big Bertha ’04 Irons resulted in a 6% increase in the average selling price for Callaway Golf Irons.

This month, we began shipping into the marketplace the Callaway Golf X-Tour Irons, currently being used by Phil Michelson.

While the quantities aren’t expected to be huge, there has been a lot of consumer excitement around this product and we’re anxious to see how it does at retail and the halo effect it might have on our other products.

Putter sales were down 15% versus the first quarter of last year due to lower volumes on our older White Hot and DFX models.

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

U.S. market share remains strong at 37% and 42% in unit and revenue share respectively, more than double the nearest competitor.

We recently began shipping the I-Trax, a new Callaway Golf putter model, to our retailers in April.

Golf ball sales were $59 million for the quarter compared to last year’s sales of $72 million.

Top-Flite ball sales were down $10 million for the quarter, compared to $45 million reported last year with Callaway Golf balls down slightly due to the comparison to last year’s successful introduction of the X-Tour, as well as decline in rounds played this year.

Offsetting this decline somewhat was this year’s early success of the Hex Hot gold ball.

For the quarter, the ball segment recorded an operating profit of $2 million.

Excluding integration charges of approximately $3 million each year, the ball segment reported a profit of $5 million in the quarter versus a profit of $2 million last year.

Gross margins for the ball segment, excluding integration charges were in the low 40%, a nice improvement over the low 30% experienced last year.

Margins should continue to improve as we complete the transfer of all production to our Top-Flite manufacturing facility.

Callaway and Top-Flite combined revenue market share was nearly 17%, clearly number two on a combined basis, and more than double the next nearest competitor.

On a regional basis, U.S. sales decreased 15% with international sales down 21%.

Gross margins, excluding integration charges, were 45% of net sales compared to 47% in the prior year.

A lower mix of woods, along with lower average selling prices on carryover products from last year accounted for the majority of the decline which was partially offset by increases in our iron and ball margins.

Operating expenses for the quarter, excluding integration charges, were $100 million, the same level as last year.

G&A expenses were $3 million lower than last year due to reduced employee and legal costs.

R&D expenses were lower by $2 million due to lower employee expenses.

These lower expenses were offset by an increase in selling expenses due to higher advertising and marketing expenses.

Operating profit for the quarter was $35 million, once again excluding integration charges versus a profit of $69 million last year.

Our effective tax rate for the quarter was 39.5%.

The integration of Top-Flite is proceeding on plan and will be completed this year with the shut down of our Carlsbad Golf Ball manufacturing.

We still estimate expenses for the year to total between $7 and $12 million, bringing the total charges associated with the Top-Flite acquisition to a total of between $60 and $65 million, in line with our original estimate of $60 million.

Moving to the balance sheet, we finished the quarter with cash of $28 million, compared to $21 million last year, and with outstanding borrowings on our line of credit of $60 million compared to $53 million last year.

Net receivables were $228 million, a decrease of $70 million compared to last year on lower sales.

Consolidated DSOs were 69 days compared to 73 days last year due to more normalized credit terms being offered this year compared to last year Collection on A/R remains strong and the overall quality of our A/R is good.

Net inventories totaled $172 million, flat when compared to $170 million last year.

Callaway inventory decreased slightly and was offset by incremental inventory at Callaway Golf Interactive and increases at Top-Flite associated with the expanded 2005 Ben Hogan club line.

Cap ex for the quarter was $10 million and our 2005 estimate remains unchanged at $25 million.

Depreciation and amortization for the quarter was $12 million and our 2005 estimate remains unchanged at $40 to $45 million.

As we look at the quarter, I think there are some things, dynamics, to keep in mind.

Sales were down relative to last year for the reasons we’ve already discussed, those being the staggering of new product launches this year and working with our retailers to make sure that inventory at retail is maintained at the appropriate levels to avoid the situation we experienced last year.

We took price reductions last year on some products to help our retailers move the inventory and clear the channel for our new products we introduced this year.

I’m pleased to report that we accomplished this task and the retail channels for our products are in good shape.

We are still experiencing some of the pricing actions we took last summer when compared to first quarter this year because we carried over several of those products into 2005.

We have been fortunate in that our tour staff has performed very well this year and our brand, as well as some of our new and prototype products have received a lot of visibility in the press and on TV.

There’s a lot of positive buzz around our new products including the Titanium 454 driver used in winning the World’s Long Drive Championship last year, the new Hex Hot golf ball, Fusion and X18 Irons, as well as the Ben Hogan brand with the new driver and BH5 irons.

In terms of sell through at retail, we are pleased with early results thus far, but remember, it’s still early in the year.

That being said, we still believe these are positive signs as we enter the second quarter of the season and we believe that our strategy has been somewhat validated as evidenced by increases in market share which measures retail sell through.

While second quarter is typically a reorder time of year, and is difficult to forecast, we are encouraged by this energy and the positive signs we currently see in the market place.

One final comment with regards to the CEO search.

The board, along with the search firm of Heidrick & Struggles, are working diligently to fill the position with a qualified individual as quickly as is practical.

I would now like to open the call for questions.

[OPERATOR INSTRUCTIONS].

Your first question comes from Ed Aaron with RBC Capital Markets.

Thanks.

Good afternoon.

A couple of questions for you.

First, I was hoping you could elaborate a little bit on the international market.

The international sales were down it looks like more than the domestic sales were this quarter.

Is that because there was more inventory to work down internationally?

Or is that because international markets are just softer than U.S. markets from a sales perspective?

No, we really just didn’t - - if you look at the mix of the products that we had, Ed, it was just really the product mix this year versus last year.

And it just, you know, I think the difference between 20% and 15% is kind of in the same kind of category of down, so I don’t think there’s anything unique to the regions.

Okay.

And then the retail inventories are obviously a lot lower, down more than a year ago.

Last year was obviously though a very unusual year in terms of where the inventories were.

If you were to maybe take a look further back, going to say 2002/2003, could you give us some sense of where the retail inventories are today in relation to those periods?

Well, you know, we’ve always tried to manage our inventories at retail very judiciously in working with our retailers.

I think that certainly it’s comparable with prior years because we’ve always tried to keep them as reasonable as possible.

I think last year the unique situation was we had so many new products that we put out early in the quarter and when sales didn’t start to click through on the woods product, it backed up pretty quickly.

But I think that in terms of overall health of the retail channel, it’s probably similar to what we’ve seen in years past with last year being the exception.

Okay, great.

And then one other question and then I’ll open it up.

The R&D spending being lower than it was a year ago.

Is that something that we should read into in terms of a change in strategy?

Or is that just kind of the way it shook out this quarter?

Yeah, no change in strategy.

We’re still going to be focusing on new product and new technology.

Okay.

Great.

Thank you very much.

Your next question comes from Ramel Dianisio with Webb Bush Morgan.

Good afternoon.

A question on the selling expense.

You had fewer launches this year, at least in woods, and the selling expense is up as a percent of sales.

I wonder if you could just address that and talk about perhaps some mix between advertising as opposed to promotional expense and so forth?

You know, we don’t get into that level of detail.

We did have some advertising that hit towards the end of the quarter in preparation for some of the new launches that we will have coming out in second quarter.

I don’t have the details right in front of me, but we don’t share the details between promo and advertising and marketing.

Okay, that’s fair enough.

And just one follow up on Japan.

Japan was down 22% in the quarter.

Could you just update us, Brad, on how ERC Fusion Irons and the ERC ball are doing over there?

Actually doing very well in the first quarter.

They’ve been received very well on both fronts and we do have some other products that we will be brining into that marketplace later in the year, so we’re excited about that.

But so far, the reception to those 2 particular products has been very favorable.

Great.

Thanks very much.

Your next question comes from Casey Alexander with Guilford Securities.

Hi, good afternoon.

First of all, Mr. Baker, Callaway has always been a company that’s embraced technological change.

Could you kind of lay out the Company’s position in relation to the USGA’s thinly veiled invitation to provide prototypes for a rolled back golf ball?

Have you completed the question?

Yeah.

Well, I think the answer is I think they’re exploring something that has been suggested for a number of years.

And we’re perfectly willing to cooperate with them in exploration.

Okay.

You know, it seems as though the company looks like it’s taking a much more rational approach to managing its business and its inventories.

Is there some fear that perhaps the competition is not, especially given the weak rounds played in the first quarter, and that that may lead to pricing pressures later on this year?

Casey, this is Brad.

That’s hard for us to sit here and predict.

I’m not sure how they’re managing their business.

We focus really hard on ours and it would be our hopes that they’re also managing their business as judiciously as we are so we could avoid that.

But it’s hard for us to really comment on how they’re managing their inventory at retail.

Or how we would react to it.

Yeah, it’s a little hard to even anticipate, because I’m just not sure what they would do.

Okay, thanks.

Your next question comes from Michael Fox with JP Morgan.

Hi, good afternoon, guys.

I just have 2 quick questions.

Can you discuss the level of discounting that you’re seeing right now relative to past years?

And then also the new Fusion driver that some of the pros are using - - can you give us any update on that?

When that’s coming out and if that’s going to have any big advertising campaigns along with it?

Thanks a lot.

You know, Michael, re-ask the first question on discounting.

I’m not sure what kind of discounting you’re talking about.

Just kind of the competitive environment at retail.

I was wondering if you’re seeing a lot of discounting more or less than in previous years.

You know, I don’t think so.

I think that there are some products that have been in the marketplace for maybe up to a year that I’ve seen some discounting on.

But I don’t know that I see any unusual discounting at this kind of stage of the game for this time of the year.

And I think with regards to your second question, we have announced that Phil is playing a prototype Fusion driver.

We haven’t specifically said when that will be coming out.

But certainly sometime before probably summertime if you will.

In that timeframe, why we will probably be launching it.

It really depends on when we’re ready to bring the product and when our advertising campaigns and promotional events are all ready to be launched.

Okay.

And then also on the new Ben Hogan driver, was that originally planned to go out in the second quarter in a bigger way?

Are you getting good reception from retailers?

Can you just talk about how that’s going and then how big that could be if it does well?

Well, the reception at the PGA show was very favorable.

When they took it to Demo Day, it was a very positive response from those who tried it.

We launched it, got some shipments in towards the end of the first quarter.

Expect to get a lot more out here in the second quarter as a lot of the northern chair accounts start to open up.

I think it’s way too early to tell what kind of sell through we’re going to get at retail.

We’re going to watch it carefully.

But if the PGA show is any indication, then I would tell you that the response should be pretty positive.

But we’ll have to wait and see the actual sell throughs.

Okay.

Can you give us any type of indication on the number of stores that will carry it in relation to your Callaway driver?

Like a percentage or anything?

I believe it’s going to be pretty much normal distribution with those who would normally carry the Hogan line.

Keep in mind not everybody carries as broad of a venue of products but certainly wherever the Hogan line is currently carried, I would say a majority of those accounts would carry the driver and fairway woods.

Okay, can you give us an idea of what the percentage of stores that carry the Hogan line is relative to the Callaway?

You know, I don’t have that off the top of my head here, Michael.

Okay.

Thanks a lot.

I think a lot of them are pretty similar and a lot more probably associated with Green Grass.

Right, right.

Okay, thanks.

Your next question comes from John Moran with Ryan Beck.

Hi, guys.

Just a quick question circling back on one that was asked earlier there on R&D.

The decrease quarter over quarter I think Brad you had mentioned, was some of that due to cost saves from less personnel?

Some of that was, yes.

And then there was also lower depreciation year over year as we depreciate tool wings and some other things that we have over there.

Equipment.

But some of it was people because last year we did, there were some people that were let go over in that organization.

And that has a little bit of an impact.

Okay.

And then just real quick in terms of sort of the remaining 2005 products that are coming.

I take it from the answer that you gave to the last gentleman there, new product coming before summer.

Is it safe to read that then the bulk of it will be in Q2 with just a little bit then coming in third quarter?

I wouldn’t read into that, John.

It really depends.

We’re working hard and as soon as we are ready to bring it, we’ll bring it.

If it lands in Q2, fine, and if it Q3 is when it makes most sense, that’s when it will be.

Sounds good.

Thanks.

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

Hi.

Several questions here.

First of all, Brad, can you talk about, on the raw material side, just give us an update there?

Titanium steel, granite steel have been off a little bit.

But what type of overall raw materials or purchase component type of inflation are you guys looking at as a whole for the year or resins and everything?

And how much of that, if any, do you have hedged?

That’s question number one.

And then back to a previous question on international.

I kind of hear what you’re saying on the mix, but given that you expected to have positive currency, that doesn’t quite make sense why international would be down more than domestic.

So if you could maybe elaborate on that a little bit.

And then for first quarter you said Top-Flite was down $10 million year over year.

Can you give us a reference point in either what Top-Flite ball sales actually were in first quarter or what they were in first quarter last year?

Okay, there are a lot of questions there, Tim, so let me start with the first one.

I think if you look at raw materials, we’re seeing obviously some increases in rubber in the ball business as well as we had seen some initial spikes around titanium.

And I think those have eased off a little bit as of late.

And with regards to hedging, we really don’t hedge specifically on raw material commodities.

However, when we lock in supply quantities with our suppliers, we do lock in a price.

And they have either taken a position or hedged the materials, but it’s kind of built into the price that they guarantee us.

Okay?

So that’s kind of a - -

Well, in general, I mean directionally, what type of year over year inflation in general are you looking at?

You know, I don’t know off the top of my head here, Tim, I really don’t.

As I said, directionally though, rubber and titanium have been up.

Rubber probably as a percentage more than probably titanium.

And what about plastic resins related to the ball?

No, haven’t seen a lot there.

I think another question had to do with golf balls, and as I stated, the golf ball business was down $10 million from $45 million last year.

In Top-Flite specific?

Top-Flite specific.

I’m trying to think of your other questions, there were several there.

Looking at international, in a previous question you’d stated that the mix issues were kind of similar on the international front, too, impacting the quarter.

But if that’s the case, given that you would have positive foreign currency, you would expect that then the international sales would not have been down as much as the domestic.

So maybe you can kind of reconcile that a little bit?

Yeah, the only thing that would have been different product-wise, Tim, is we had some, you know the 415 Plus drivers last year which were a little bit hotter drivers in some of the markets like Europe and Japan.

And we don’t really have anything that we’ve introduced this years that’s really “hot”, if you will.

So probably maybe a little bit more just because we don’t have a hot driver out there this year.

But there’s nothing unique that I’m seeing.

I think the markets are kind of reacting similarly and nothing that I can really see kind of year over year.

Okay.

On - - could you maybe along the same line maybe give us an overall if you had any FX benefit on sales or gross margin line, however you want to talk about it, for the company as a whole?

And then another question is, in the second quarter, and this is just sort of directional, what’s reasonable here.

Given that you’ll probably have a little bit richer mix as you were hurt on reorders last year in the second quarter, and a richer mix with new wood introductions, would it be reasonable to assume that you should see a better quarter in terms of sales and earnings year over year?

Well, Tim, keep in mind last year we were still shipping a lot of woods and it wasn’t until late in the quarter that we started, very late in the quarter, that we started any discount net down programs on our products.

So I think last year was a pretty good quarter for us relative to we still had a lot of sales going out although we were starting to see it slow down.

But none of the discounting happened really until heavy into the third quarter.

So I’m not going to sit and forecast kind of quarter over quarter.

I would tell you that as I sit here today and look at kind of the vital signs in the marketplace, the market share gains, the buzz around the product, what we’re hearing back from retailers, I feel a whole lot better about our position that we’re sitting in today with good inventory levels at retail and what I would call good solid sell throughs at retail as we enter the second quarter.

And that’s quite a bit different than what we saw this time last year, so I feel good about that.

I think you asked a question about the impact of FX?

It was a positive of about $5 million, so - -

On the top line?

No on total, total sales.

So of the $300 million, there was about $5 million in there positive on FX.

Okay.

And if I may, just more of a blocking and tackling question here.

If you could just update us on your outlook for depreciation and cap ex for the year?

You know, nothing’s really changed from what we had talked about I think over the, from January, and I think we’re probably looking in the neighborhood of about $25 million for cap ex and $40 to $45 million for D&A.

Okay.

Great.

Thank you.

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

Your next question comes from Brett Hendrickson with Inancia Capital.

Hey, Brad, how are you?

Good, Brett, how are you?

Not too bad.

My question was kind of similar to Tim’s and I won’t ask it again, but I just wanted to - - I didn’t hear the answer.

His question about just the difference between the overseas revenue change year over year.

Did you say what driver was out last year overseas that wasn’t out domestically?

We had like the 415.

We had a 415 Hot Series, and we had Fusion, I’m sorry, yeah, we had Fusion Hot which did pretty well overseas.

So we just didn’t have the same mix of, I guess, product overseas.

But I don’t see it as a dramatic difference between international and domestic frankly.

Okay, thanks, Brad.

Your next question comes from Hardin Bathia with DePrince, Rice and Zollo.

Hey guys.

My question is related to Brad, something you said about the golf ball business.

Gross margin in the quarter was in the low 40% range versus low 30% last year and you think that’s going to improve as production transitions.

Is there kind of a longer term goal for that, something you should target or we should target, I guess, for profitability there?

Well, you know, we haven’t given any specifics, but what I’m saying is we achieved in the first quarter here, just the first quarter and keep in mind that’s high volume, so we’re utilizing the plants pretty well.

But we were in the low 40s which was up approximately 10 points from last year.

As we continue to transition and get out of the ball manufacturing here in Carlsbad, then certainly that will allow us to take advantage of the low cost manufacturing we have out at the Top-Flite facility.

We have some internal targets, Hardin, I would tell you, and certainly we want to improve that business, but I think I’ve always kind of said that gross margins for golf balls could be kind of in the low to mid 40s is what we’ve sort of said.

So I think we’re starting to get into that zone.

And the other question relative to your comments about the second quarter, and I know you don’t want to talk specifically about it, but when you talked about the first quarter on your fourth quarter conference call, you described the relative comparison qualitatively year over year as first quarter of ’04 was a really strong one, a lot of big sell through, so it was going to be really tough to get there.

And I think there was some misunderstanding of that comment.

So I’m just hoping to make sure that doesn’t happen again and if there’s anything else you can provide for the second quarter.

A little more clarity on how that looks would be helpful I think.

Well, you know, Hardin, on that, I appreciate your comment.

I would tell you that some people - - I think if you take a look at the mix of people who cover us, some actually kind of did hear first quarter and their estimates were fairly reasonable.

It was kind of all over the board, frankly, is where the estimates were.

Nothing specific in terms of the second quarter.

Keep in mind last year at this time we still had a mix of heavily into the woods, and they were not being discounted yet at that time.

As I said, we still are positive about what we’re seeing in the marketplace about where we are today.

But Q2 is typically one of the hardest quarters for us to predict because it’s all about reorders at that point in time.

Sure.

If rounds played were to pick up, and you know they’re down 3.5% in the first two months, then that would be a positive compared to last year.

But it’s hard for me to predict that at this point in time.

So I’m not really providing any further guidance for the second quarter other than to tell you that the vital signs of the things that we think drive the marketplace are more positive this year than what we saw going into second quarter last year.

Okay.

Well, the way that I look at estimates right now, I mean, there’s a pretty wide disparity.

In fact, it ranges for the second quarter from $0.28 to $0.45, so again, there’s this wide range of understanding among analysts that I’m hoping you can narrow.

Well, I don’t have any further comments on guidance at this point in time, Hardin.

Okay.

At this time, there are no further questions.

Mr. Holiday, are there any closing remarks?

Just to thank everybody for joining us today and just want to continue to let everybody know that we’re working hard on a lot of things here at the company.

We’ve got some exciting products to come and we’re excited about kind of the buzz around the brands out in the marketplace and we look forward to the balance of the year.

So thank you for joining us.

This concludes today’s Callaway Golf first quarter earnings conference call.

You may now disconnect.