Callaway Golf Company

Ladies and gentlemen, thank you for standing by, and welcome to the second quarter 2020 Callaway Golf Earnings Conference Call. At this time, all participants are in the listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to Mr. Patrick Burke, head of investor relations. Thank you. Please go ahead, sir.

Thank you, Erica, and good afternoon, everyone. Welcome to Callaway's second quarter 2020 earnings conference call. I'm Patrick Burke, the company's head of investor relations. Joining me on today's call are Chip Brewer, our president and chief executive officer, Brian Lynch, our chief financial officer, and Jennifer Thomas, our chief accounting officer. Today, the company issued a press release announcing its second quarter 2020 financial results. A copy of the press release and associated presentation are available on the investor relations section of the company's website at ir.calwigoff.com. Most of the financial numbers reported and discussed on today's call are based on U.S. generally accepted accounting principles. In the few instances where we report non-GAAP measures, We've reconciled the non-GAAP measures to the corresponding GAAP measures at the back of the presentation in accordance with Regulation G. Please note that this call will include forward-looking statements that involve risks and uncertainties that could cause the actual results to differ material from management's current expectations. We encourage you to review the safe harbor statements contained in the presentation and the press release for a more complete description. Please note, That in connection with our prepared remarks, there is an accompanying PowerPoint presentation that may make it easier for you to follow the call today. This earnings presentation is available for download on the Company Investor Relations website under the Webcast and Presentations tab. Also in the same tab, you can choose to join the webcast to listen to the call and view the slides. As a webcast participant, you are able to flip through the slides. I would now like to turn the call over to Chip. Thank you, Patrick. Good afternoon and thank you, everybody, for joining us for today's call. Starting on page four of the presentation, we're pleased to be with you today to discuss our Q2 results, results that have exceeded our expectations over the last few months and strengthened our confidence in the future. As covered in our press release, although Q2 results were heavily impacted by the various global shutdowns and stay-at-home orders, By late May, nearly all of our principal markets, manufacturing facilities, and distribution centers were open to some degree or another. As the quarter progressed, it became clear our businesses were recovering faster than we initially projected. Our e-commerce business has been and continues to be a particularly strong performer, in many cases delivering year-over-year growth of 50% or higher since reopening. Looking at our principals, this business is benefiting from both pent-up demand as well as increases in participation. The National Golf Foundation is now projecting a 20% increase in participation of juniors and either new or returning golfers this year. To various degrees, this is a global phenomenon, but looking more specifically at the U.S. for the month of June, rounds were up 14% year over year, For those of us trying to book a last-minute tee time, it probably felt even stronger than this. Equipment industry stats all suggest a double-digit increase in sales for the month, with data tech reporting hard goods sell-through up 16% versus the same month one year ago. And golf retail outside of resort locations remains very strong at present, and barring a shutdown situation or an inability to play golf, has not been particularly and it is logical that this could be the case. However, we cannot be sure yet. We'll have to keep our fingers crossed and track it over the next year or so. Callaway's global market shares also show good progress, with nice growth trends during the quarter and continued strength on a global basis. According to Datatex, in the U.S. year-to-date, Callaway remains the number one club brand and the number two ball brand. Our U.S. market share increased steadily during Q2 as markets opened up. In Japan, we remain the number two hard goods brand year-to-date and had a strong quarter from a market share perspective with an exceptionally strong growth year so far in golf ball thanks to ChromeSoft and the TripleTrack technology, which is resonating across the globe. In Europe, we remain the number one hard goods brand through May, which is the latest date available. As for market conditions, we already spoke about the U.S.' 's nice recovery during a quarter which data tech called down 27% from a sell-through perspective, and the National Golf Foundation shipment data says it was down 37%. Looking elsewhere, Japan was also significantly impacted during Q2, but the market remains relatively sound, only down approximately 7% in the first half of the year, and also showed growth in June. As we mentioned, Korea has performed very well all year. Europe was heavily impacted with no golf being allowed during their lockdown in the important U.K. market. And as a result, data tech reports that market is down nearly 40% through May. But fortunately, this market is bouncing back very strongly as well. We have new product launches planned for the second half of this year, similar to our strategy most years. As you would hope and expect, I remain confident in our new product pipeline. Our soft goods and apparel segment has also recovered above expectations, but not to the same degree golf has. Our e-com business in this segment is very strong, while retail, both our own retail and wholesale, is still down double digits, and unlike in golf equipment, has shown volatility in markets where there's been upticks in COVID outbreaks. Despite this near-term volatility, all of which is COVID or macroeconomic-based, we still feel very good about our long-term position here. We remain confident that we are invested in brands with strong prospects and that are positioned to outperform apparel as a whole, both in the COVID environment and afterwards. After a tough start to the quarter, we're pleased with the recovery of the Jack Wolfskin business in both Germany and China. noting that these are the largest markets for Jack Wolfkin and also two of the most attractive economies globally. As a primarily U.S. brand, Travis Matthew was significantly impacted during Q2, but is now bouncing back very quickly with excellent sell through at key retailers and resumed brand momentum. Ecom has been outstanding for both Travis Matthew and Jack Wolfkin. During the quarter, we also made good progress on key initiatives, including the initial phases of our transition to our new 800,000 square foot super hub DC, just outside of Fort Worth, Texas. We are now shipping all US revenue out of the facility and expect to have this conversion behind us by the end of Q3. As stated during our last call, We are pleased with our financial position and are confident we are not only going to get through this crisis, but also emerge in a position of relative financial strength. That was true then and is even more so now. As discussed in our last call, we were aggressive in taking initial actions to lower our operating expenses and conserve capital. This was an important initiative and we're still operating under this philosophy. However, As conditions continue to improve, we're also now fully able to invest in innovation, digital competencies, and strategic growth initiatives. We believe this ability to invest and our conviction to do so will pay off nicely in the years ahead. In addition, as global hotspots and opportunities transition across the globe, we believe our company will benefit from our global scale, our leadership position in the golf equipment business, as well as the diversity and attractive growth opportunities associated with our family of brands. Looking forward, although we are very pleased with the pace of our recovery, we are unfortunately not comfortable providing quantitative guidance yet. We believe we are in a strong position now, and barring a broad shelter-in-place initiative in key markets or other unforeseen setbacks, we expect our business to both continue to improve but also to remain at least moderately impacted through 2021. In closing, while we're pleased we are now in a position to fully operate our business, the safety and health of the company's employees, customers, and partners continues to be paramount in our minds. As we transition back to normal operations, we are careful to follow appropriate protocols for social distancing, in-office capacity management, personal protective equipment, and other safety precautions. In addition, our thoughts and prayers continue to go out to those directly impacted by the virus and those diligently working on the front lines to protect, serve, and care for the rest of us. Brian, over to you. Thank you, Chip. Given the extremely challenging operational environment in the second quarter, we are pleased we were able to achieve positive non-GAAP earnings and adjusted EBITDA, and are also pleased, if not somewhat surprised, with the pace of recovery in our golf equipment and soft goods businesses. both of which have exceeded our expectations. We are especially pleased with the golf equipment business recovery, which is benefiting from increase in participation from new and returning golfers, as well as pent-up demand to play golf. We feel fortunate that our golf and outdoor lifestyle businesses support an active and healthy way of life that is compatible with social distancing. Before proceeding with the usual discussion of our financial results, I will elucidate on a couple of the announcements today. First, during the second quarter, we incurred a $174 million pre-tax, non-cash impairment charge on the carrying value of the Jack Wolfskin Goodwill and trade name. This includes running off all the Goodwill and reducing the carrying value of the trade name by $26 million. Based on a conservative view of the impact of COVID-19, and with the euro being weaker than originally projected, we believe it is appropriate to take the non-cash charge. We remain positive on the ability of this business to contribute to our earnings and revenue growth in the future. Second, we also announced today the suspension of our one-cent quarterly dividend. Given the uncertain impact COVID-19 will continue to have on the economy and our businesses in the short term, we remain focused on stringent cost management and improving capital allocation. As we re-evaluated our capital allocation strategy, we determined that our dividend was not the most efficient use of capital at this time and that the capital could be just used elsewhere. Following our convertible note offering during the second quarter, we are confident that we have adequate liquidity with over $480 million in cash and availability under our credit facilities, which will allow us to weather these uncertain times and emerge in a position of relative strength. In evaluating our results for the second quarter, you should keep in mind some specific factors that affect year-over-year comparisons. First, as a result of the Jack Wolfskin acquisition in January 2019, we incurred nine recovering transaction and transition-related expenses in 2019. Second, as a result of the OGO Travis Matthew and Jack Wolfskin acquisition, we incurred nine cash amortization and purchase accounting adjustments in 2020 and 2019, including the inventory step-up in the first quarter of 2019. Third, we also incurred other non-recurring charges, including costs related to the transition to our new North American Distribution Center in Texas, as we are incurring redundant costs during the transition, and including implementation costs related to the new Jack Wolfson IT system and severance costs related to our cost reduction initiative. Fourth, the $174 million impairment charge in the second quarter of 2020 is non-recovering and did not affect 2019 results. Fifth, we incurred and will continue to incur non-cash amortization of the debt discount on the notes issued during the second quarter of 2020. We have provided in the tables to this release a schedule breaking out the impact of these items on the second quarter and first half results, and these items are excluded from our non-GAAP results. With those factors in mind, I will now provide some specific financial results. Turning now to slide nine, today we are reporting consolidated second quarter 2020 net sales of $297 million compared to $447 million in 2019, a decrease of $150 million, or 34%. The decrease was primarily driven by the COVID-19 pandemic, partially offset by an increase in our e-commerce business. The decrease in net sales reflects a decrease in both our golf equipment segment, which decreased 28%, and our soft goods segment, which decreased 44%. This decrease also reflects a decrease in all major regions and private categories, period over period, all due to COVID-19. Changes in foreign currency rates also negatively impacted second quarter 2020 net sales by $2 million. Gross margin was 41.1% in the second quarter of 2020 compared to 46.3% in the second quarter of 2019, a decrease of 520 basis points. On a non-GAAP basis, gross margin was 42.2% in the second quarter compared to 47.5% in the second quarter of 2019, a decrease of 530 basis points. The decrease in gross margin is primarily due to the decreased sales and business challenges caused by COVID-19, costs associated with idle facilities for a significant portion of the second quarter, a change in mix of products sold, including a decrease in sales from higher market retail sales due to temporary store closures, and increased sales of package sets, entry-level golf balls, and pre-owned products due to the increase in new and returning golfers, combined with an increase in U.S. tariffs on imports from China. Operating expenses were $300 million in the second quarter of 2020, which is a $138 million increase compared to $162 million in the second quarter of 2019. This increase is primarily due to the $174 million non-cash impairment charge related to the Jack Wolfson Goodwill and Trade Game. Excluding the impairment charge and other items previously mentioned, non-GAAP operating expenses for the second quarter were $121 million a $38 million decrease compared to the second quarter of 2019. This decrease is due to the actions we undertook to reduce costs as well as a reduction of variable expenses associated with lower sales during the quarter. Other income was $2 million in the second quarter of 2020 compared to other expense of $9 million in the same period of the prior year. The $11 million increase was primarily related to a $13 million increase in foreign currency-related gains, period over period, primarily related to the settlement of a cross-currency swap arrangement. This $13 million increase was partially offset by a $2 million increase in interest expense, primarily related to our convertible notes. Pre-tax loss was $176 million in the second quarter of 2020, compared to pre-tax earnings of $36 million for the same period in 2019. including the impairment charge and other items previously mentioned, non-GAAP pre-tax income was $7 million in the second quarter of 2020, compared to non-GAAP pre-tax income of $44 million in the same period of 2019. Loss per share was $1.78 or 94.1 million shares in the second quarter of 2020, compared to earnings per share of 30 cents or 95.9 million shares in the second quarter of 2019. including the impairment charge and the other items previously mentioned. Non-GAAP fully diluted earnings per share was $0.06 in the second quarter of 2020, compared to fully diluted earnings per share of $0.37 for the second quarter of 2019. Adjusted EBITDA loss was $29 million in the second quarter of 2020, compared to $66 million in the second quarter of 2019. Now I'm turning to slide 10. First half 2020 net sales are $739 million, compared to $963 million in 2019, a decrease of $224 million, or 23%. The decrease is primarily driven by the COVID-19 pandemic, partially offset by an increase in our e-commerce business. The decrease in net sales reflects a decrease in both our golf equipment segment, which decreased 19%, and our soft goods segment, which decreased 32%. This decrease also reflects a decrease in all major regions and product categories period over period due to COVID-19. Changes in foreign currency rates also negatively impacted first half 2020 net sales by $6 million. Gross margin was 43% in the first half of 2020 compared to 46.2% in the first half of 2019, a decrease of 320 basis points. Gross margins in 2019 were negatively impacted by the non-recurring purchase price inventory step-up associated with the Jack Wolfskin acquisition. On a non-GAAP basis, gross margin was 43.6% in the first half of 2020 compared to 47.4% in the first half of 2019, a decrease of 380 basis points. A decrease in gross margin is primarily due to the decreased sales and business challenges caused by COVID-19, costs associated with idle facilities for a significant portion of the second quarter, a change in mix of products sold, including a decrease in sales from higher-margin retail sales due to temporary store closures, and increased sales of package sets, entry-level golf balls, and pre-owned products due to the increase in new and returning golfers, combined with an increase in U.S. tariffs on imports from China, all partially offset by an increase in e-commerce business. Operating expense was $454 million in the first half of 2020, which is a $124 million increase compared to $330 million in the first half of 2019. This increase is due to the $174 million non-cash impairment charge related to the Jack Wolfson Goodwill and Trade Name. Including the impairment charge and other items previously mentioned, non-GAAP operating expenses for the first half were $275 million, a $47 million decrease compared to the first half of 2019. This decrease is due to our cost reduction initiative, as well as a reduction in variable expenses due to the lower sales. Other expense was approximately $1 million in the second quarter of 2020, compared to other expense of $21 million in the same period of the prior year. The $20 million decrease was primarily related to a $21 million increase and foreign currency-related gains, period over period, including the $11 million gain related to the settlement of a cross-currency swap arrangement. The $21 million improvement was partially offset by a $1 million increase in interest expense related to our convertible notes. Other expense in 2019 was also negatively impacted by $3 million related to hedging losses on the acquisition purchase price hedge. Pretext loss was $138 million in the first half of 2020, compared to pretext income of $94 million for the same period in 2019. Excluding the impairment charge and other items previously mentioned, non-GAAP pretext income was $48 million in the first half of 2020, compared to non-GAAP pretext income of $118 million in the same period of 2019. Wealth per share was $1.47 on 94.2 million shares in the first half of 2020, compared to earnings per share of $0.81 on 96.2 million shares in the first half of 2019. Excluding the impairment charts in the items previously mentioned, non-GAAP fully diluted earnings per share was $0.38 in the first half of 2020, compared to fully diluted earnings per share of $0.99 for the first half of 2019. Adjusted EBITDA was $89 million in the first half of 2020 compared to $159 in the first half of 2019. Turning now to slide 11, I will now cover certain key balance sheet and cash flow items. As of June 30, 2020, available liquidity, which represents additional availability under our credit facilities plus cash on hand, was $483 million compared to $273 million at the end of the second quarter of 2019. We had total net debt of $621 million, including $440 million of principal outstanding under our total loan fee facility that was used to purchase Jack Wolfson. A consolidated net sales receivable was $214 million, a decrease of 19% compared to $264 million at the end of the second quarter of 2019, which is attributable to lower sales in the quarter. State sales outstanding increased to 78 days on June 30, 2020, compared to 62 days as of June 30, 2019. Despite some of our customers taking a little longer to pay in this COVID environment, they are paying, and we remain comfortable with the overall quality of our accounts receivable at this time. Also displayed on slide 11, our inventory balance increased by 5% to $379 million at the end of the second quarter of 2020. This increase was primarily due to lower sales lines in the second quarter related to COVID-19. The teams continue to be highly focused on inventory on hand, as well as inventory in the field. Given the circumstances, we are very pleased with our overall inventory position and the inventory of retail, especially on the golf side of the business, which remains low at this time. Capital expenditures for the second quarter of 2020 were $25 million, a year-over-year increase of $2 million compared to the second quarter of 2019, due mainly to the implementation of our Super Hub distribution center in Texas. We do expect our capital expenditures in 2020 to be approximately $35 to $40 million, up slightly from the estimate we provided in May, but down substantially from our $55 million of planned capital expenditures at the beginning of the year due to our cost reduction actions. Depreciation and amortization expense was $18 million in the second quarter of 2020, compared to $17 million in the second quarter of 2019. Appreciation and amortization expense excluding the $174 million impairment charge is still estimated to be approximately $39 million, consistent with our estimate provided in May. I am now on slide 12. As we previously reported, we are no longer providing other specific financial guidance at this time, due to the continued uncertainty surrounding the duration and impact of COVID-19. It is just too difficult to project with any uncertainty. Amidst all this uncertainty, where does this leave us? There are some things we know for certain. We were on track for another record sales year when COVID-19 hit unexpectedly, and we had a significant negative impact on our business. Our team did a very good job of responding to the pandemic with cost cuts, managing our supply chain, and shoring up liquidity. The impact of COVID-19 will continue to negatively impact our sales and gross margins through 2021, but it is impossible to predict to what degree with any certainty, although we expect the impact to ameliorate as time passes. Both our golf equipment and soft goods businesses are recovering more quickly than we expected, especially in the golf equipment business. We are fortunate in that both our golf equipment and outdoor lifestyle businesses are ideally suited to an active and healthy way of life that is compatible with the world of social distancing. And finally, liquidity is not an issue. The convertible note offering provided us with ample cushion to weather the pandemic, continue to invest in our businesses where necessary, and to prepare us to emerge in a position of strength. That concludes our prepared remarks today. We will now open the call for questions.

As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. And your first question is from Brett Andrews with KeyBank Capital Markets.