Callaway Golf Company (NYSE: ELY) — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020; unaudited. Amounts are in U.S. dollars. Callaway designs and sells golf equipment and apparel, gear and accessories, including products under the Callaway, Odyssey, TravisMathew, OGIO and Jack Wolfskin brands.
Financial results and liquidity
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $475.6m | $426.2m | $1,214.8m | $1,389.1m |
| Gross profit | $200.7m | $191.4m | $518.5m | $636.6m |
| Gross margin | 42.2% | 44.9% | 42.7% | 45.8% |
| Operating income (loss) | $63.5m | $40.5m | $(73.3)m | $155.3m |
| Net income (loss) | $52.4m | $31.0m | $(86.4)m | $108.4m |
| Diluted EPS | $0.54 | $0.32 | $(0.92) | $1.13 |
| Cash from operating activities | — | $122.6m | $63.9m |
- Q3 sales rose 11.6%; Golf Equipment sales increased 27.0% to $267.3m, while Apparel, Gear and Other fell 3.4% to $208.3m. Q3 net income improved despite gross-margin compression.
- Nine-month sales declined 12.5%, reflecting pandemic-related disruptions, particularly in the first half. The nine-month operating loss includes a $174.3m goodwill and trade-name impairment charge related to Jack Wolfskin.
- Cash and cash equivalents were $286.7m at September 30, 2020, versus $106.7m at year-end 2019. Reported available liquidity, including cash and borrowing availability under credit facilities, was $636.9m.
- At quarter-end, the balance sheet reported $651.0m of long-term debt, $14.6m of current long-term debt and $30.2m outstanding on asset-based credit facilities. This includes a $258.8m face-value convertible note issue; its net carrying amount was $180.5m.
- Current assets were $925.1m and current liabilities $371.4m. Inventory declined to $324.9m from $456.6m at December 31, 2019; accounts receivable increased to $239.7m from $140.5m.
Material changes and management commentary
- Management attributed the Q3 golf-equipment rebound to increased interest in golf as an outdoor activity compatible with social distancing, with stronger U.S. sales and improved e-commerce. Apparel and gear recovery was uneven; Jack Wolfskin retail and wholesale sales remained pressured, while TravisMathew and e-commerce improved.
- Q3 gross margin fell 270 basis points year over year, mainly due to weaker soft-goods retail sales and inventory-reduction actions; currency and e-commerce mix partially offset the decline. Nine-month margin fell 310 basis points, also reflecting lower fixed-cost absorption during facility closures and higher U.S. tariffs on China imports.
- The company reported $122.6m of operating cash flow for the first nine months and spent $30.9m on capital expenditures. It issued $258.8m of 2.75% convertible notes in May and paid $31.8m for capped calls. Open-market repurchases and the quarterly dividend were suspended; the company continued limited share withholding for employee awards.
- Management said it expected liquidity and operating cash generation to fund operating needs, capital spending, debt repayments and contractual obligations for at least 12 months from the filing. 2020 capital-expenditure expectations were reduced to approximately $35m–$40m from a prior $55m estimate. No earnings or sales guidance was provided.
- Management’s company-defined non-GAAP diluted EPS was $0.60 for Q3 2020 versus $0.36 for Q3 2019, and $0.98 for the first nine months of 2020 versus $1.35 for the comparable 2019 period. These measures exclude specified impairment, amortization and other items and are not GAAP results.
Outlook, transactions and risks
- On October 27, 2020, after quarter-end, Callaway agreed to acquire Topgolf in an all-stock merger, expected to close in Q1 2021 subject to shareholder, regulatory and other customary conditions. Callaway estimated issuing approximately 90m shares; former Topgolf holders were expected to own about 48.5% of the combined company. Callaway expected to assume approximately $555m of Topgolf long-term debt, net of cash. Specified termination circumstances may trigger a $75m fee.
- COVID-19’s duration and effects on demand, operations, supply chains, retail traffic, and customers remained uncertain. Management reported improved Q3 sales but warned that volatility and material adverse effects could continue.
- The Jack Wolfskin impairment reflects reduced projected revenue amid pandemic disruption. Valuations depend on uncertain recovery and other assumptions; further impairment may be possible if performance or outlook weakens.
- Other notable exposures include variable-rate debt, foreign-exchange movements, debt-covenant compliance, tariffs, seasonal working-capital needs, purchase and lease commitments, and uncertain tax positions. The company reported compliance with applicable debt covenants at September 30, 2020.
- The proposed Topgolf deal adds execution, integration, financing, dilution and approval risks. The company noted that the merger could affect relationships with employees and business partners and that expected benefits may not be realized.
Important facts for investors to verify
- Whether the Topgolf merger received required approvals and closed on the expected terms, and the resulting share issuance, debt and dilution.
- Whether Q3 golf demand and e-commerce gains persisted, and whether apparel, Jack Wolfskin and international sales recovered.
- The assumptions supporting the Jack Wolfskin impairment assessment and the risk of additional impairment.
- Cash conversion, seasonal working-capital requirements, available borrowing capacity and ongoing covenant compliance.
- The reconciliation and exclusions in company-defined non-GAAP results, alongside GAAP earnings and the effects of currency and hedging items.