Topgolf Callaway Brands Corp (MODG) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Callaway Golf third quarter financial results.

At this time, all participants are in a listen-only mode and later we will conduct a question-and-answer session with instructions being given at that time.

(OPERATOR INSTRUCTIONS).

And as a reminder today's conference is being recorded.

I would now like to turn the conference over to the Company's Chief Financial Officer, Mr.

Brad Holiday.

Please go ahead, sir.

Thank you and welcome everyone to Callaway Company's third quarter 2007 earnings conference call.

I'm Brad Holiday, Chief Financial Officer of Callaway Golf Company.

Joining me today is George Fellows, President and CEO of the Company.

During today's conference call, George will provide some opening remarks and I will provide an overview of the Company's financial results and we will then open the call for questions.

I would like a point out that any comments made about future performance, events or circumstances including statements related to estimated 2007 sales, gross margins, operating expenses and earnings per share, the achievement of three year financial targets, new product shipments, and the Company's estimated 2007 CapEx and depreciation and amortization expenses are forward-looking statements subject to Safe Harbor protection under the federal securities laws.

Such statements reflect our best judgment today based on current market trends and conditions.

Actual results could differ materially from those projected in the forward-looking statements as a result of certain risks and uncertainties applicable to the Company and its business.

For details concerning these and other risks and uncertainties, you should consult our earnings release issued today as well as Part 1 Item 1A of our most recent Form 10-K filed with the SEC together with 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 on a consistent and comparable basis, we will provide certain pro forma information as to the Company's performance, excluding charges associated with the Company's gross margin initiatives, the integration of top flight operations, and the restructuring initiatives announced in September 2005.

In order to evaluate the Company's core operating performance from a cash generation perspective, we will also provide information concerning the Company's earnings before interest, taxes, depreciation and amortization.

This pro forma 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.

I would like to now turn the call over to George for a few opening remarks.

Thanks, Brad, and thank you all for joining us.

We continue to be pleased with the Company's progress on a broad range of fronts, both near and longer-term.

Consumer and trade acceptance of our 2007 lineup has been outstanding with significant share gains in almost all major categories.

Just to quote a few, in the U.S., our wood share on a year-to-date basis is up 2.4 share points and it's up 3.9 share points in the UK.

In irons in the U.S., we're up almost one share point and in the UK up 2.6 share points.

Revenue growth has been particularly strong, further reflecting the positive consumer and trade response to the product line, while progress on margin improvement is proceeding on plan with year-to-date margins at 45% versus 40% in 2006.

Customer service continues to improve while inventories are being materially reduced.

Inventories at the close of the quarter were down $28 million, somewhat more than the target communicated earlier this year.

Our international business is ramping up with year-to-date sales plus 19% versus 2006.

Our overall profitability is solidly growing with trailing 12 month EBITDA up 139% to $136 million.

We are particularly pleased also with progress on key longer-term issues.

Additions to our organization have further enhanced our great internal talent and enabled the organization to raise the bar with regard to our ability to compete effectively.

Our process improvements in product development and manufacturing in supply chain have improved not only our ongoing profitability but also our ability to reproduce our positive results longer-term.

Testament to this is the robust new products pipeline currently in place, extending to 2010 and beyond, as well as the very positive early reception to the 2008 product line currently being introduced.

Now as happy as we may be with our results to date, there's still lots to be done on a number of fronts.

Among the many key items, the drive for additional margin improvement and working capital reductions remain in full force with more detail and new higher targets to come early next year.

Restoring Top-Flite to health remains a top priority and while progress to date is gratifying, we are no way where we need to be.

Exploration of other growth opportunities that we've talked about briefly in the past continue, and we hope to provide some insights as to progress also early next year.

And obviously there are many more imperatives than just these.

So to sum up some of the key metrics through three quarters of 2007, our net sales are up 13% to $950 million, a record for the Company; our gross profit is up 27%; our trailing 12 month EBITDA, as I mentioned, is up from $57 million last year to $136 million this year; we have repurchased 6.2 million shares of stock for $104 million through nine months.

And now looking to the balance of the year, we will be raising our estimates for 2007 for the third time, and we feel we are well on track to achieving the three year guidance given earlier this year.

I'd like to now turn the call back over to Brad.

Thanks, George.

In reviewing the financial results for the quarter, we achieved consolidated net sales of $236 million, a 22% increase compared to last year sales of $194 million.

Net income for the quarter was $1 million compared to a loss of $12 million last year, and earnings per share was $0.02 versus a loss of $0.18 per share in the prior year.

On a pro forma basis excluding 2007, after-tax charges of $0.04 per gross margin initiatives that we announced last November, in 2006 after-tax charges of $0.01 for Top-Flite integration charges and $0.01 for restructuring charges, our pro forma earnings per share for 2007 increased to $0.06 compared to a loss of $0.16 in 2006.

Through the first nine months, we achieved record sales of $950 million; an increase of 13% compared to last year, and earnings per share of $1.03; an increase of 110% compared to $0.49 last year.

On a pro forma basis excluding 2007 after-tax charges of $0.07 per gross margin initiatives, and 2006 after-tax charges of $0.04 for Top-Flite integration charges, and $0.01 for restructuring charges, our pro forma earnings per share for 2007 increased 104% to $1.10 compared to $0.54 in 2006.

We are very pleased with these results, which reflect our strong 2007 product line as well as the initiatives we have been focused on this year to improve our gross margins and business processes.

Taking a quick look at overall sales by product category, our wood sales for the quarter increased 29% to $56 million compared to $44 million in 2006.

This increase was due to continued sales momentum of our Fusion platform of drivers offset by a slight decline in fairway woods.

Year-to-date, our woods category has increase 19% to $271 million compared to $227 million last year.

Sales of irons and wedges were $65 million compared to third quarter sales last year of $53 million; an increase of 23%.

A majority of this increase was driven by the success of our X-series irons offset slightly by a decline in our Fusion line of irons, which are in the latter part of their product life cycles.

Year-to-date, our irons category has increased 7% to $261 million compared to $243 million last year.

Golf ball sales were $49 million for the quarter; an increase of 50% compared to last year sales of $43 million.

This increase was driven by strong sales of Callaway-branded golf balls, including several new products but in particular, our HX Hot model along with increases in our Top-Flite business due to the success so our D2 golf ball, which has continued to gain momentum throughout the year.

Year-to-date, our total golf ball sales were $175 million; an increase of 4% compared to last year, despite a decline in rounds played in the U.S.

this year.

Putter sales for the quarter were $22 million compared to $23 million last year.

Year-to-date putter sales have increased 3% to $88 million, maintaining the number one position in marketshare.

Accessories and other sales have increased by 38% for the quarter driven by our gloves, bags, and footwear products.

Year-to-date accessories and other sales have increased by 34%.

Turning to our regional breakout, U.S.

sales were $124 million for the quarter compared to $103 million last year; an increase of 21%.

International sales were $111 million; an increase of 23% compared to $91 million last year.

All regions experienced sales growth with the strongest results in Europe and Canada.

Through the first nine months, U.S.

sales were $513 million; an increase of 9%, with international sales increasing 19% over last year to $438 million.

All regions have experienced positive sales growth through the first three quarters, both in U.S.

and local currencies.

Gross margins for the quarter were 40% compared to 35% last year.

Excluding charges for gross margin initiatives in 2007 and integration and restructuring charges in 2006, pro forma third quarter gross margins were 42% of net sales compared to 36% in the prior year.

A majority of this increasing gross margin percentage is due to our gross margin initiatives with the balance due to a favorable mix of higher margin products, primarily our X-series irons, Fusion drivers and our golf ball business.

Year-to-date, gross margins were 45% compared to 40% in 2006.

Adjusted for gross margin initiatives in 2007 and integration and restructuring charges in '06, pro forma gross margins increased five percentage points to 46% compared to 41% last year.

Operating expenses for the quarter were $93 million compared to $85 million last year, but as a percentage of net sales, declined to 40% compared to 44% in 2006.

The dollar increase is due to increase marketing expenses, employee incentive compensation related to improved financial results, legal costs associated with enforcing our intellectual property rights, and higher selling costs associated with higher revenues.

These increases were partially offset by the gain recognized on the sale of the building here on campus.

Year-to-date operating expenses were $311 million compared to $281 million last year with a slight improvement as a percent of sales.

Moving to the balance sheet.

Net working capital increased 6% compared to last year.

This increase was driven by higher receivables associated with the higher net sales for the quarter and a decrease in our outstanding line of credit.

Excluding the balance on our credit facility, net working capital decreased 13% driven by a reduction in inventory.

Consolidated net receivable increased to $165 million compared to $138 million last year due to the higher net sales.

Consolidated day sales outstanding improved to 64 days compared to 66 days last year.

Collections on AR remained good and the overall quality of our AR is good.

Net inventories were $214 million compared to $242 million last year; a decline of $28 million.

This is a by-product of some of our gross margin initiatives and is in line with the $20 million to $25 million in targeted reductions that we communicated earlier this year.

From a cash generation perspective, as George mentioned, trailing 12 month EBITDA through September increased 139% to $136 million compared to $57 million for the same period last year.

This increase is a result of many top and bottom line initiatives we've implemented over the past two years.

CapEx for the quarter was $6 million and we estimate total 2007 capital expenditures to be approximately $35 million to $40 million, which is slightly lower than our forecast from last quarter due to a delay in our Carlsbad building consolidation project.

Depreciation and amortization was $10 million for the quarter.

Our estimate for the full year remains at approximately $35 million, consistent with our forecast last quarter.

During the third quarter, we repurchased 4.4 million shares of stock for $75 million at an average price of $16.87 per share.

Year-to-date through September, we have repurchased 6.2 million shares of stock for $104 million at an average price of $16.68 per share.

We have $22 million of the $100 million authorized by our Board in June of this year remaining at the end of the quarter.

As George mentioned, we are raising our full year guidance again with sales increasing to a range of $1.095 billion to $1.105 billion, and pro forma fully diluted earnings per share to $0.85 to $0.89 based on 68 million shares outstanding and excluding approximately $0.08 per share for our gross margin initiatives.

This is the third time we've raised our forecast this year, and in addition to this increase, we are also narrowing the range a bit, given the fact that we're now three quarters of the way through the year.

This new outlook compares to our last estimate from last quarter, of sales ranging from $1.07 million to $1.08 billion and pro forma fully diluted earnings per share of $0.78 to $0.84 based on 70 million shares outstanding.

Please keep in mind that the fourth quarter is typically the smallest revenue quarter of the year.

And net-net sales in 2006 included several new products that were introduced during the fourth quarter equaling approximately $30 million of sales.

Our forecast includes limited shipments of new products during the quarter with the exception of some products targeted at holiday sales opportunities.

Our full year forecast assumes that gross margins will continue to be approximately five percentage points better than last year.

It also assumes that annual operating expense will be approximately $45 million higher than last year, consistent with our last forecast, primarily due to higher employee incentive compensation associated with our improved financial results, higher marketing and advertising expense, higher legal expenses to enforce our intellectual property rights, and higher selling expenses due to increased revenues.

Fortunately, because we have been able to deliver higher gross margins than we originally had estimated, we have been able to invest in and fund many of these initiatives and still deliver much improved year-over-year financial results.

We would now like to open the call for questions.

(OPERATOR INSTRUCTIONS).

Bill Chappell, SunTrust.

It's actually Mark in for Bill here.

First of all, I guess, on the gross margin initiative, it appears you're possibly seeing some of that ahead of schedule.

Is that goal still the $50 million to $60 million in savings you originally set out?

Or is it possible you see some upside to that?

It is recently consistent with what we originally had projected.

We are, as we indicated before, continuing to look at additional projects.

And as I indicated in my brief comments, we believe we will be coming out with higher targets in the early part of next year.

Right.

And then I guess as far as the $30 million in new product launches, can you remind us exactly which products those are in?

Yes, we did the HX Hot fairway woods was one of them.

I'm just trying to find a schedule that I had.

The X hybrids were last year.

There was some X-20 irons shipped in order to meet some of the early January shipments to some of our key accounts.

And then there was a new SMU ball for the mass channel that was launched in December.

Those were the bigger ones.

Okay, thanks a lot.

Congrats on a great quarter.

John Shanley, Susquehanna International Group.

George, staying on this movement of products out of the fourth quarter, new product development, would it be fair for us to assume in our models that we could add a fairly substantial additional amount to our first quarter models if you're moving products that normally -- or had in the past and developed and initiated in the fourth quarter into the more profitable first quarter?

What kind of an impact would that normally --

No, not really, if you -- actually '07 reflected exactly what you're discussing.

We've been striving to change the entire new product schedule so that more of the product was shipped early enough to catch the entire season.

In '07, we were largely successful at doing that.

And what essentially that has done is it's shifted a good deal of the new product shipment as well as the consumer takeaway into the earlier periods of the year.

So, this year by not shipping a great deal in the fourth quarter will actually be the second time that we're -- I mean, in '08 would be the second time that we'd be doing exactly that.

Okay.

I didn't understand that.

The other question is when are most of the new products likely to be introduced into the marketplace?

Well, the new products as we're currently scheduled right now begin shipment, a few of them, in January but mostly the February/March period.

And some will slip into April as well.

Again, we've spread them out in order to get the maximum effect in terms of sell-in and get the appropriate attention at retail to make sure they're merchandised properly.

John, we've already said that if we can get them shipped out and plan to ship them into the marketplace prior to the Masters -- which is kind of the kickoff for the season -- that's kind of the sweet spot for us in terms of introducing them to the marketplace.

Right.

Makes sense.

Can you give us an idea of the magnitude of the new product introductions for next year versus what you introduced this year?

Most of them are the same standard size.

About the same number of --?

Only kidding, John.

Sorry, that was a week attempt at humor.

No, we have really a rather full schedule of new product activity, albeit somewhat different than this year.

As you recall in '07, we had three new drivers.

This year we have essentially one with some updates on some others.

We have a rather full schedule of fairway woods and hybrids.

Last year we had the X-20 launch and the BB07 irons.

This year we have Fusion irons.

So, essentially we have touched all of the categories with some new products, albeit a different mix than they were in '07.

And of course we have a fairly large -- a very large new ball introduction, both on the Callaway side as well as on the Top-Flite side.

Great to hear.

And the other question I had is on Europe.

Business there seems to be doing extremely well.

You're up 40% year-to-date in sales.

Can you give us an insight in terms of are there specific countries that are particularly doing well for you?

And are the grounds played and the retailer interest in golf equipment growing in terms of the importance of the overall market?

Or are you just gaining share from other brands that are in the market?

Well, we're gaining substantial share as -- I think I quoted a couple of numbers early on from the data sources that we have.

But the increases in Europe are pretty much across the board.

Their weather situation is just a little different than it was last year.

Last year they started off terribly with a very wet and cold early part of the season.

And then a very hot middle part of the season.

This year, the bad weather came at a different point.

So the weather has somewhat improved as far as Europe is concerned this year, but not materially.

There, it's just that we're doing extraordinarily well.

The products have been very well received literally across the board.

Are there certain countries that are outperforming others in the marketplace?

Well, that's always the case.

But again, our larger pieces of business are the UK, the Scandinavian countries, Germany, et cetera.

So, it's a very broad-based performance on the part of Europe this year.

Okay, great.

The last question I have is, are you evaluating further real estate consolidation in Carlsbad or is that just a one-shot deal?

You know, we're always looking at ways to try to make our operation a bit more efficient.

Right now as we currently sit, given our immediate plans, I would expect that this would be it.

But again, as additional things happen in the operations area, that might indeed lead to further consolidation down the road.

Fair enough.

Thank you very much.

Appreciate it.

Rommel Dionisio, Wedbush Morgan.

Just a question on inventories.

I think in your comments, George, you talked about how you're seeing somewhat of a timing shift in '07 and in '08 [with those] new product launches.

So should we use the year-end '06 inventory level as sort of a benchmark to track you to see how you do at year-end '07?

Because I remember on last year's conference call for the fourth quarter, you talked about how you had three new woods coming out and inventories were up a fair [call] at that point, so.

Well, we typically will have an increase in inventories as we get to the end of the year, building for the early next year shipments.

So you would expect the third quarter to fourth quarter inventory to rise.

You should use, however, the '06 ending inventory as a base to measure how much we've been able to reduce the overall inventory.

So, while the number will be up from the third quarter as it is typically because of the pattern that we have to follow for production, it will be down '07 to '06.

And Rommel, remember we had targeted to be down $20 million to $25 million by the end of the year.

So we're -- (multiple speakers) go ahead.

Yes, just one last question.

I think in your restructuring discussion last year you talked about completing the automation of production of putters and woods and irons by summer.

Could you just give us an update on the progress there?

No, we didn't say completed.

We'd say that we're continuing -- expanded across a broader portion of our line.

And that is indeed what has happened there.

There are design requirements in order to automate.

And that requires new lines.

So it takes a period of years until you ultimately redesign things so that they're all automatable.

But a larger percentage of our product is now at least partially assembled automatically than it was a year ago.

And next year, it will be even greater.

Fair enough.

Congrats on the quarter.

Jeff Blaeser, Morgan Joseph.

Thanks for taking my call.

Just a quick question on the three year plan.

Are you still comfortable?

Obviously you had some good progress this year with the three you put out earlier in the year.

And if so, do you expect it to be gradual over the next two years, particularly the mid-teens EBIT margin expectations?

At this point as we indicated, we're quite comfortable that we're well on our way toward achieving the objectives that we delineated earlier this year.

We will, in fact, be coming out with our revisions to the three year forecast early next year in addition to coming out with guidance for the year '08 in the early part of the year.

So I think I'll reserve the detail on that until that point.

Fair enough.

Didn't expect that one to get through.

It's a good try, though.

I appreciate it.

Yes, thanks.

And also on the -- looks like on the free cash flow or the cash from operations, you're a little bit over $100 million year-to-date.

Do you have any expectations for the year-end and could it be closer to the $100 million free cash by the end of this year?

Is that possible?

Well, we're obviously pacing slightly ahead of where we had projected for three years.

So, we haven't really given a forecast for the year.

But certainly, as we start to tie up more inventory here towards the end of the year, why, we're going to be close to the levels we're at now, Jeff, to be honest with you.

Ok, great.

Thank you very much.

(OPERATOR INSTRUCTIONS).

David Wells, Avondale Partners.

Just a couple of quick questions.

First off, just in terms of the operating margin improvement that you saw on a year-over-year basis in Q3, how should we think about that going into the fourth quarter?

Should that continue or should we see some expense deleverage?

You should feel very good about it.

No, we would expect that we're going to continue to keep pressure on the overall margin.

We are quite comfortable delivering exactly what we said we were going to deliver earlier in the year.

And as I indicated, I'd hold comment on what we think the future holds until the early part of next year.

But I would not be surprised if it's pretty much in line with what you've heard before.

All right.

Certainly.

And then just in terms of mix going into the fourth quarter, is there any color that you can give there about expectations?

Well, again, remember the fourth quarter is a relatively small quarter for the industry based on the seasonality.

And we are a higher priced line.

And the people that come in and buy -- other than the gift givers, if you will, at the end of the year -- are fundamentally looking for bargains and markdowns and things of that sort.

So -- and that's not an area that we participate in particularly heavily.

So, I don't know if that gives you enough color on it.

But we are not selling much in the way of closeouts at the end of the year.

Tim Conder, Wachovia.

My congratulations also, gentlemen, on a good execution.

A couple of things, maybe a little minutia here.

The tax -- what was it, different tax rate or not, Brad, on the sale of the building?

No different tax rate.

I think we had some -- well, we had some tax audits that cleared up during the quarter, Tim.

And [that's] just the low level of profitability during the quarter it ends up impacting the tax rate more than normal.

Okay.

And how should we think about that on a go-forward basis?

You know, I've always kind of just targeted around 38.5% is the number that I would continue to use.

I mean, there will be some fluctuations just based on how we close out audits and things that come through, but generally I would just use that.

Okay.

And then, again, a good recovery, gaining share in Europe.

Is that also fair in Japan?

And then between those major geographic areas, could you break out what's -- let's call it share gains versus the currency?

Well, to talk to the share gains, yes.

To the extent that we get data, share data, in the Asian markets and that, of course, is fairly limited, but our share gains had been marked in Japan as well.

So that the gains that we're seeing in the business in Asia are local currency gains for sure.

Clearly there have been FX effects on those numbers and I think Brad can give you some color on the FX.

Tim, I would just tell you that with marketshare -- I mean we get the marketshares, they don't really tie it back to U.S.

dollars -- but on the quarter, FX had a positive impact of $4.7 million.

And for the first nine months, about $16 million.

Okay.

All on the net line there?

On [Internet] -- well, that's net sales.

Net sales.

Okay.

And then what about -- anything, Brad, on the -- looking at it on the EBIT perspective?

Well, that gets a little bit tougher, but you've got to assume the favorability we get on the top line costs us more in operating expense.

So it has cost us more there.

I don't have a number that we've ever really shared with you guys because it's just a little hard to really fine-tune.

But generally a weaker dollar will have a positive impact on the bottom line until you reach the point where pricing becomes an issue.

And we have seen one case of that this year in our Korea market where we actually took some pricing down.

So that certainly had a negative impact on the bottom line.

Okay.

And then was there an investments made, an additional investment in an existing venture or a new venture during the quarter?

We invested some additional -- or actually provided some additional credit facility to the top golf entity to the tune of, I think, it was about $3 million -- $2.5 million.

So that was the additional investment.

Okay.

And kind of what's the plan going forward there?

Well, we're still a minority partner.

And they are continuing to expand the number of facilities that they have.

They opened one in roughly September, October in Dallas.

And they have another one scheduled to open up soon in Chicago.

And we are a minority interest.

We continue to work with them and try to take advantage of branding opportunities and really just seeing if we can bring more people into the game of golf.

Okay, great.

Thank you, gentlemen.

And gentlemen, there are no further questions in queue at this time.

I'll turn it back to you.

Well, again, I'd like to thank you all very much for joining us.

Clearly, we're pleased with the progress the Company has had to date.

Obviously, we are not at all satisfied that we've come anywhere close to our capabilities and the organization is working very, very hard to be able to raise that bar.

And again, just to remind you, the early part of the year I think we'll be setting some additional targets, higher targets for us in a number of different categories.

And we'll be looking forward to communicating them to you then.

In the meantime, enjoy the fourth quarter.

Thank you.

And ladies and gentlemen, that does conclude your conference for today.

Thank you for your participation and for using AT&T Executive Teleconference Service.

You may now disconnect.