Callaway Golf Company — Q1 2018 Form 10-Q
Business context and period. Unaudited results for the three months ended March 31, 2018, compared with Q1 2017. Callaway sells golf clubs, balls, bags, apparel and related products through three segments: Golf Clubs; Golf Balls; and Gear, Accessories and Other. Results include TravisMathew, acquired in August 2017, and reflect the seasonal buildup of sales and receivables ahead of the golf season.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $403.2 million | $308.9 million | +30.5% |
| Gross profit / margin | $200.5 million / 49.7% | $147.7 million / 47.8% | Margin +190 bps |
| Operating income | $86.0 million | $44.2 million | +94.5% |
| Net income attributable to Callaway | $62.9 million | $25.7 million | Up $37.2 million |
| Diluted EPS | $0.65 | $0.27 | +$0.38 |
| Operating cash flow | $(109.3) million | $(62.8) million | Greater cash use |
| Capital expenditures | $8.0 million | $6.3 million | — |
Sales increased across all segments. Golf Clubs generated $257.4 million (+33.0%), Golf Balls $54.9 million (+13.9%), and Gear, Accessories and Other $90.8 million (+35.3%). Segment pretax income was $65.8 million, $12.5 million and $20.3 million, respectively. Management attributed growth mainly to the Rogue clubs and Chrome Soft balls launches, TravisMathew sales, improved market conditions and favorable currency movements. Foreign exchange added $10.9 million to reported sales.
Higher selling prices and product mix, TravisMathew’s contribution and favorable currency supported gross margin; higher component costs for new products partly offset those benefits. Operating expenses rose 10.6% to $114.5 million, less than sales growth, with higher sales-related, marketing and TravisMathew costs partly offset by the absence of prior-year OGIO transaction and transition costs. The effective tax rate fell to 21.5% from 33.8%, principally reflecting the Tax Act’s reduction of the U.S. corporate rate.
Financial position, liquidity and cash flow
At March 31, 2018, cash and equivalents were $38.7 million, down from $85.7 million at year-end. Receivables were $265.2 million, up from $94.7 million at year-end, which management attributed mainly to seasonal sales and timing; inventory was $262.3 million, broadly flat with year-end. Operating cash use reflected the receivables increase and timing of inventory purchases. Financing provided $69.9 million, including $90.8 million of net credit-facility borrowings; the company also spent $20.1 million on treasury stock.
Borrowings were $178.5 million under asset-based revolving facilities and $11.3 million under an equipment note. Available liquidity, including cash and remaining facility availability after borrowings and letters of credit, was $220.1 million. The company reported compliance with applicable credit covenants and believes resources will cover operating needs, capital expenditures and obligations for at least 12 months. Approximately 92% of cash was held outside the United States. The company expects 2018 capital expenditures of $30–$40 million.
Material changes, outlook and risks
- Revenue accounting: Callaway adopted Topic 606 on January 1, 2018 using the modified retrospective method. Adoption reduced opening retained earnings by $11.2 million and accelerated recognition of promotional programs and price concessions. For Q1, reported sales were $8.4 million lower and net income $6.6 million lower than they would have been without adoption. Prior-year figures were not restated, limiting direct comparability.
- Outlook: No specific revenue or earnings forecast is stated in the supplied filing text. Management expects to fund operations through cash, operating cash flow and credit facilities; Q1 cash usage reflects seasonal working-capital needs.
- Commitments: Minimum unconditional purchase obligations were $81.1 million over the next four years. The filing also lists $54.2 million of operating lease commitments and other debt, lease and tax obligations. Routine legal matters are described; management did not expect pending matters to have a material adverse effect, but outcomes are uncertain.
- Key risks: Seasonal demand and weather; product acceptance and retailer purchasing/inventory; foreign exchange and hedging outcomes; consumer spending and promotional pressure; supply constraints and import tariffs; debt-facility availability and covenant compliance; and changes in tax law or interpretation. The company’s $70.8 million Topgolf investment is illiquid and carried at cost less impairment; observable price changes could materially affect reported results.
- Other notable items: The company repurchased $20.1 million of shares in Q1. In May 2018, after quarter-end, the board canceled the existing repurchase program and authorized a new program of up to $50 million. The company disclosed no material changes to risk factors from its 2017 Form 10-K.
Important facts for investors to verify
- How much of sales and earnings growth reflects new-product demand and organic performance versus TravisMathew, currency and launch timing.
- The ongoing and seasonal cash-conversion pattern, including collections of the sharp Q1 receivables increase and reliance on revolving facilities.
- The effects of Topic 606 on quarterly comparisons and the estimates for promotions, concessions and returns.
- Execution and profitability of the TravisMathew and OGIO businesses, and whether higher product costs or promotional activity pressure margins.
- Credit-facility availability, covenant headroom, foreign-cash accessibility and the company’s ability to meet its $30–$40 million capital-spending plan and contractual obligations.
- Tax Act measurement uncertainties, the valuation and liquidity of the Topgolf investment, and developments in legal or other contingencies.