Callaway Golf Company — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Unaudited results cover Callaway’s golf clubs, golf balls, and gear, accessories and other businesses. Operations are seasonal, with much of golf-equipment sales and profit typically generated in the first half. OGIO was acquired in January 2017; Japan apparel joint-venture results were included from July 2016.
Key financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $304.5 million | $245.6 million | $613.5 million | $519.6 million |
| Gross profit | $148.2 million | $110.6 million | $295.9 million | $243.0 million |
| Gross margin | 48.7% | 45.0% | 48.2% | 46.8% |
| Operating income | $49.0 million | $20.9 million | $93.3 million | $66.2 million |
| Net income attributable to Callaway | $31.4 million | $34.1 million | $57.1 million | $72.5 million |
| Diluted EPS | $0.33 | $0.36 | $0.59 | $0.76 |
| Operating cash flow | Not separately stated for the quarter | Not separately stated for the quarter | $26.3 million | $17.8 million |
- Revenue drivers: Q2 sales rose 24.0%; first-half sales rose 18.1%. Golf clubs grew 19.3% in Q2 and 8.5% in the first half, led by the Epic woods line. Golf balls grew 3.8% and 9.7%, respectively. Gear, accessories and other grew 74.5% and 76.6%, substantially reflecting OGIO and the Japan apparel joint venture.
- Profit and margins: Higher average selling prices, favorable product mix, less discounting and foreign-currency translation improved gross margin. Higher air-freight and component costs, and lower-margin acquired businesses, partly offset the gains. Operating expenses increased with the acquired businesses and OGIO-related costs.
- Cash and liquidity: Cash was $62.0 million at June 30, down from $126.0 million at year-end. Current assets were $482.0 million and current liabilities $188.0 million. The company reported $6.2 million of borrowings, all under Japan facilities, and $61.959 million of cash; available facility borrowing capacity after letters of credit was approximately $174.3 million, or $236.3 million including cash. It reported compliance with applicable covenants.
- Cash uses: First-half investing cash outflow was $69.5 million, including $57.9 million net for OGIO and $12.2 million in capital expenditures. Financing cash outflow was $21.9 million, including $16.4 million of treasury-stock purchases and $1.9 million of dividends. Management expects 2017 capital expenditures of approximately $35 million.
- Debt and obligations: In July, Callaway amended its ABL facility and added a $60 million stretch term-loan facility. The filing describes additional leverage and fixed-charge coverage requirements when specified term-loan balances are outstanding. Minimum unconditional purchase obligations were $69.7 million over six years.
Material changes and comparability
- GAAP net income and EPS declined year over year despite sales and operating-income growth. Comparisons are affected by the $17.7 million pre-tax Topgolf investment-sale gain recorded in Q2 2016 and by minimal U.S. income-tax expense in 2016, when a valuation allowance was in place. Callaway began recognizing U.S. tax expense again in 2017 after reversing much of that allowance in late 2016.
- Q2 2017 included $2.3 million of OGIO transaction and transition costs; first-half results included $6.2 million. On Callaway’s non-GAAP basis, which excludes those costs and the 2016 Topgolf gain and normalizes 2016 taxes, Q2 net income was $32.9 million and diluted EPS $0.34, versus $11.3 million and $0.12 in Q2 2016. First-half non-GAAP net income was $61.2 million and diluted EPS $0.64, versus $35.8 million and $0.37. These company-defined measures are not GAAP and may not be comparable with other issuers’ measures.
- Segment reporting was reorganized in 2017 to separately show gear, accessories and other; prior-year segment figures were reclassified.
Outlook, risks and unusual items
- Management said available cash, expected operating cash flow and credit facilities should fund operating needs, capital expenditures and obligations for at least the next 12 months. No full-year revenue or earnings guidance is provided in the supplied filing text.
- On August 3, 2017, after quarter-end, Callaway announced an agreement to acquire TravisMathew for $125.5 million cash, subject to customary adjustments and closing conditions; closing was expected in Q3 2017. The company planned to use cash and the new stretch facility as needed.
- Approximately 80% of cash was held outside the United States. Repatriation for domestic needs could incur incremental U.S. federal and state taxes; management said it did not intend to repatriate foreign funds for ordinary domestic liquidity needs.
- Key risks include seasonal demand and weather, consumer and retailer demand, product acceptance and promotional activity, foreign-exchange movements, supplier and manufacturing constraints, golf participation, and acquisition integration. The filing estimates a $17.5 million maximum one-day loss from a hypothetical 10% adverse currency move in its forward contracts; management notes underlying transactions may partly offset this sensitivity.
- Routine legal claims and intellectual-property matters are described; management did not expect pending matters to have a material adverse effect but could not estimate aggregate potential losses. No material off-balance-sheet arrangements were reported.
- Callaway’s $49.0 million Topgolf investment remained carried at cost; the company said fair value could not practicably be estimated at June 30 and that future fair-value accounting could materially affect results or financial position.
Investor verification points
- Track whether Epic-product demand and pricing sustain the margin improvement, and whether freight and component costs continue to offset it.
- Separate organic growth from OGIO and Japan joint-venture contributions; check integration costs and profitability of the lower-margin soft-goods businesses.
- Verify TravisMathew closing, funding mix, purchase accounting and subsequent leverage and covenant headroom.
- Monitor seasonal working-capital needs, cash conversion, offshore cash availability, and compliance with the ABL and stretch-facility covenants.
- Assess the effect of U.S. taxes, foreign-exchange movements and the Topgolf investment’s eventual fair-value measurement on reported earnings and liquidity.