Callaway Golf Company — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited consolidated results; comparative periods are 2017. Amounts below are USD unless noted.
Business context and reporting period
Callaway designs, manufactures and sells golf clubs, balls, apparel, bags, gear and accessories. Its three reporting segments are Golf Clubs, Golf Balls, and Gear, Accessories and Other. The business is seasonal, with most golf-club and golf-ball sales and profitability typically in the first half. Results include TravisMathew, acquired in August 2017, and OGIO, acquired in January 2017.
Financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $396.3m | $304.5m | $799.5m | $613.5m |
| Gross profit / margin | $192.7m / 48.6% | $148.2m / 48.7% | $393.2m / 49.2% | $295.9m / 48.2% |
| Operating income | $74.3m | $49.0m | $160.3m | $93.3m |
| Net income | $60.9m | $31.5m | $123.7m | $57.4m |
| Net income attributable to Callaway | $60.9m | $31.4m | $123.7m | $57.1m |
| Diluted EPS | $0.63 | $0.33 | $1.28 | $0.59 |
| Operating cash flow | Not separately stated | Not separately stated | $5.1m | $26.3m |
- Q2 sales rose 30.1%; six-month sales rose 30.3%. Growth was reported across all segments and major regions. Management cited the Rogue clubs and 2018 Chrome Soft balls, favorable market conditions, a first-half-weighted product launch schedule, TravisMathew sales and favorable currency effects.
- Q2 net sales by segment: Golf Clubs $232.8m (+18.6%), Golf Balls $65.9m (+35.0%), and Gear, Accessories and Other $97.6m (+64.0%). Six-month segment sales increased 25.7%, 24.5% and 48.9%, respectively.
- Gross margin was nearly flat year over year in Q2, as higher product costs and technology were largely offset by pricing and product mix. First-half margin improved 100 basis points, with price/mix and TravisMathew contribution partly offset by higher product costs. Golf Balls segment margin declined 280 basis points in Q2 and 300 basis points for the half, primarily from higher manufacturing costs.
- The six-month effective tax rate was 21.8%, versus 33.8% in 2017, primarily reflecting the Tax Act’s reduction in the U.S. corporate tax rate. The company said its Tax Act accounting remained subject to further guidance and completion of its measurement-period analysis.
Cash, debt and liquidity
- Cash and cash equivalents were $57.7m at June 30, 2018, down from $85.7m at year-end. Operating cash flow was $5.1m for the first half, compared with $26.3m a year earlier; the company attributed the decline mainly to higher receivables from increased sales and the timing of collections.
- Capital expenditures were $17.1m in the first half. The company expected approximately $40m of capital expenditures for full-year 2018.
- Borrowings under the U.S. and Japan asset-based facilities totaled $96.1m; the equipment note added $10.7m of debt. The ABL facilities had a combined stated maximum of $366.3m, subject to borrowing-base availability. Reported available liquidity, including cash and facility availability after borrowings and letters of credit, was $301.3m.
- Callaway reported compliance with applicable credit-facility covenants at June 30. Management believed available cash, operating cash flow and facility availability would fund operating needs and commitments for at least the next 12 months. Borrowing availability and working capital fluctuate seasonally.
- First-half financing included $22.3m of treasury-stock purchases and $1.9m of dividends paid. In May, the company replaced its prior authorization with a new $50m repurchase program; $49.9m remained available at June 30.
Material changes, outlook and risks
- Revenue recognition: Callaway adopted Topic 606 on January 1, 2018, using the modified retrospective method. Adoption reduced opening retained earnings by $11.2m and accelerates recognition of estimated promotions and price concessions. Reported first-half 2018 sales were $9.1m lower than they would have been without adoption; prior-period figures were not restated, limiting direct comparability.
- Foreign currency: Currency movements added $5.8m to Q2 sales and $16.7m to first-half sales versus the prior year. Q2 other income was $5.5m, compared with $1.0m of other expense a year earlier; management attributed the change primarily to foreign-currency gains. Results remain exposed to currency movements despite hedging.
- Guidance and commentary: The filing provides a 2018 capital-expenditure estimate and a liquidity outlook, but no specific sales or earnings guidance. Management described brand momentum, product launches and market conditions as favorable contributors, while noting that weather, seasonality, retailer activity, demand and currency can affect results.
- Commitments and contingencies: Minimum unconditional purchase obligations were $72.8m over the next four years. Routine legal and intellectual-property matters were disclosed; management did not expect pending matters to have a material adverse effect but said outcomes and aggregate losses could not be estimated with assurance.
- Other items to monitor: The $70.8m Topgolf investment is illiquid and carried at cost less impairment because fair value is not readily determinable; observable price changes could materially affect reported results. Adoption of lease accounting in 2019 was expected to significantly increase balance-sheet assets and liabilities due to operating leases.
- Risk factors were reported as unchanged from the company’s 2017 Form 10-K. Disclosed risks include product demand and retailer inventory, promotional intensity, tariffs and trade policy, supplier dependence, weather, seasonality, foreign exchange and credit-facility compliance.
Investor verification checklist
- Assess how much sales growth reflects underlying demand versus acquisitions, launch timing and favorable currency, and whether sales momentum persists beyond the first-half-heavy launch schedule.
- Review the Topic 606 adjustment and its effect on revenue timing and comparability; reported first-half sales were $9.1m below the no-adoption presentation.
- Track receivable collections and operating cash flow, given the $242.0m receivables balance and low first-half operating cash generation.
- Monitor seasonal borrowing needs, availability under the borrowing base, covenant compliance and the $72.8m of purchase obligations.
- Evaluate the sensitivity of earnings to foreign-currency movements and the unusually favorable Q2 hedge-related and other currency results.
- Review the carrying value and liquidity of the Topgolf investment, the remaining Tax Act accounting, and the expected balance-sheet effect of lease-standard adoption.