Topgolf Callaway Brands Corp. (NYSE:MODG) Q1 2023 Earnings Call Transcript

Topgolf Callaway Brands Corp. (NYSE:MODG) Q1 2023 Earnings Call Transcript May 11, 2023

Operator: Good day, and welcome to the Topgolf Callaway Brands First Quarter 2023. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Lauren Scott, Director of Investor Relations. Please go ahead.

Lauren Scott: Thank you, Dave, and good afternoon, everyone. Welcome to Topgolf Callaway Brands First Quarter 2023 Earnings Conference Call. I’m Lauren Scott, the Company’s Director of Investor Relations. Joining me as speakers on today’s call are Chip Brewer, our President and Chief Executive Officer; and Brian Lynch, our Chief Financial Officer and Chief Legal Officer. Earlier today, the Company issued a press release announcing its first quarter 2023 financial results. In addition, there is a presentation that accompanies today’s prepared remarks and may make it easier for you to follow the call. This earnings presentation as well as the earnings press release are both available on the Company’s Investor Relations website under the Financial Results tab.

Most of the financial numbers reported and discussed on today’s call are based on U.S. Generally Accepted Accounting Principles. In the instances where we report non-GAAP measures, we have 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 actual results to differ materially 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. And with that, I would now like to turn the call over to Chip Brewer.

Oliver Brewer: Thank you, Lauren. Good afternoon to everyone on our call, and thank you for joining us today. Our business is off to a strong start with first quarter revenue and adjusted EBITDA coming in ahead of our expectations. The outperformance was driven largely by continued operational momentum at the Topgolf venues as well as a strong launch of our Paradym family of clubs. Looking forward, there is certainly some macroeconomic uncertainty around the world. However, across all of our business segments, our core consumers remain engaged, and we continue to believe our portfolio of brands is positioned to drive further growth in both revenue and profitability. We believe we are uniquely positioned to do this by meeting our consumers in a diverse set of an environment that they are highly passionate about, be that on-course, off-course or in their active lifestyle.

This certainly includes leveraging the synergies inherent in our leadership position in both on and off-course golf, what we like to call Modern Golf. Turning to Topgolf specifically, and I believe this is perhaps the key point investors should take away from today’s call, the team’s various initiatives, combined with their brand momentum, have both made us increasingly confident in our ability to drive long-term same venue sales growth, and we are now pleased to be able to communicate even higher venue profitability expectations. This increased confidence and updated expectations have obvious and significant positive implications for the long-term value of our company. Shifting to our segment overview. I’ll first start with Topgolf’s results.

The Topgolf venues business had another great quarter, outperforming our expectations for both revenue and profitability. Owned venues delivered 11% same venue sales growth over Q1 last year, driven by continued brand momentum, increased digital access through PIE, our inventory management system, and our new marketing initiatives. Adjusted EBITDA exceeded expectations due to continued improvement in operational efficiencies. We will speak more on this operational efficiency improvement in a moment. From a development perspective, we opened one venue during Q1 in Charleston, South Carolina, and it opened very strongly. We remain on track to open 11 new owned and operated venues in 2023 with one scheduled to open in Q2 and the balance coming in the second half of the year.

And Toptracer also had a successful quarter with over 1,550 bays installed compared to approximately 1,160 last year. For the full-year, same venue sales is now forecast to be up mid to high-single digits, a little lower than we thought when we spoke with you in February due to corporate events trending lower starting late in Q1. Our corporate business was strong to start the quarter and is still expected to be at approximately 2019 levels for the full-year. However, with the March banking crisis and what we believe is a trend towards many companies further reducing corporate spend, we viewed it as prudent to lower our balance of year corporate sales expectations versus our original budget. We view this revision as a reflection of near-term volatility and not a long-term concern over the viability of our corporate sales channel.

And importantly, our walk-in and small events business, which is the consumer-driven portion and accounts for 80% of venue revenue, has remained robust. Like our underlying operating efficiencies, this walk-in and small event business will also benefit from the continued rollout of PIE, marketing and other key initiatives through the balance of this year and next. As a result, we remain confident in our Topgolf earnings forecast for this year and have increased confidence in our ability to continue to deliver sustained same venue sales growth throughout business cycles, something we recognize we must prove to the markets and we hope that our six consecutive quarters of delivered same venue sales growth is starting to do. Digging a little deeper into the digital access and marketing improvements of the venues.

I want to highlight some of the early success metrics, starting with Topgolf’s come play around marketing campaign. Our goal is to increase awareness, primarily in markets where we have existing venues, but also more broadly given our growing national footprint. We are happy to report that awareness in market has increased to 48%, up from 41% a year ago and 38% as recently as December 2021. PIE, our digital inventory management system, is also showing very promising results. As of the end of March, we had implemented PIE in 36 venues across the U.S. with the expectation of being in all U.S. venues by the end of 2023. Venues with PIE in place have seen increased bay utilization, same venue sales growth and profitability. With the help of PIE, the team grew the digital penetration of our venue business by a couple of points again last quarter, ending at just over 30%.

The opportunity to further drive awareness and our digital runway are clear priorities for the Topgolf team. The results are paying off and there is significant runway ahead to grow top and bottom line through these efforts. I’ll now turn to venue unit economics. To further underscore the progress we have made as well as our confidence in the Topgolf venue business going forward, we are now updating the target venue unit economics and return metrics. As you’ll see in today’s investor presentation, we are now targeting 35% four-wall adjusted EBITDAR margins, up from 32% previously, and a 2.5-year payback period, down from just over three years and a 20% return on gross investment, up from approximately 17.5%. With these changes, we also increased our cash-on-cash return projection from 40% to 50% to 50% to 60%.

In my opinion, the updated adjusted EBITDA margin target is the big headline this quarter. It shows an approximate 10% improvement in the venue four-wall profitability versus the targets we published in early 2021 and nearly a 21% improvement versus actual results prior to our merger. This new target reflects the progress we’ve made on a lot of fronts, including further improving our pricing and digital reservation strategies, pay inventory and labor management, cost of goods sold, and of course, our confidence in driving long-term same-venue sales growth. These are sustainable long-term changes that will benefit our long-term outlook. If you have been following our story, you know we strongly believe that our top capital allocation priority is investing in the profitable growth of our business and that the largest portion of this is the investments we make in our venues.

Given these newly disclosed targets, we have even more conviction that this investment strategy will generate outstanding shareholder returns. Moving to the Golf Equipment segment. I’m very proud of the performance of our new Paradym line of clubs. The entire line is doing extremely well and delivering rave reviews from consumers. We launched Paradym in late February, and in the very next month, the Callaway brand jumped to the number one U.S. brand position in the driver, fairway wood and irons categories according to Datatech. The Paradym driver in particular continues to outperform, both on tour and in the market with eight wins on the PGA Tour year-to-date, and finishing the month of March as the number one selling driver model in the U.S. From a brand perspective, Jon Rahm’s historic success at the Masters was an incredible and highly visible moment for our business with over 12 million viewers, making it the most watched golf telecast in five years.

We congratulate Jon and are thrilled to be partnering with him on what is a terrific run of great play. On the women’s side of the game, Rose Zhang has also had a phenomenal season so far. Recently winning the Augusta National Women’s Amateur Tournament and setting the record for the most weeks as the number one ranked women’s amateur. We are excited and honored to be a part of her already very promising career in golf. Looking at the overall market for golf and the health of the game, all major indicators continue to be solid. Rounds played through March in the U.S. were roughly flat year-over-year, but remain significantly up versus 2019 levels, and also up versus even last year on a weather-adjusted playable hour basis. And overall interest in the sport, as indicated by the Masters ratings, remains very high.

Turning to equipment sales specifically. The market started the year a little behind our initial expectations of flat to slightly down for the full-year. But we view this as totally understandable given the economic climate and how many entry-level sets were purchased over the last few years. Fortunately, our product performance is at or slightly ahead of our expectations. We see these factors essentially balancing each other out. Overall, we feel good about the health of our core golf consumer. And despite macroeconomic uncertainty, we don’t see meaningful risk given both our brand heat and how passionate the consumer is about both us and golf in general. As previously mentioned, based on past data, golf has not been particularly sensitive to mild recessions.

And for those out there that have been looking for a post-COVID reversion in golf participation, I think that we would all have to agree that there is no sign of one in the current data as the game continues to be top of mind for what appears to be a sustainably larger audience with the resulting play levels remaining elevated. And as we look into the future, we have to keep in mind the positive long-term impact of the new structural growth now embedded in the modern golf ecosystem where our new venues alone should add 3 million to 4 million new off-course golf participants each year. Turning now to our Active Lifestyle segment. This business met our high expectations in Q1 and is forecast to do so for the full-year. We are seeing continued strong e-commerce sales growth both from TravisMathew and Jack Wolfskin.

TravisMathew continued to successfully expand its women’s launch during Q1 and also recently introduced active apparel. Despite more challenging market conditions this year, this brand is on track for another strong year of both bottom and top line growth. For Jack Wolfskin, performance in China outperformed expectations during the quarter and continues to trend positively. Our business in Europe was challenged by difficult business conditions and high customer inventories, but still delivered a nice quarter of growth. Overall, we are pleased with the brand’s direction, the quality of the products, and despite uncertainty on market conditions in Europe for the balance of this year, we remain confident in the long-term outlook. Lastly, turning to financial items.

In addition to the success of the business segments over the quarter, I want to commend our finance team on the completion of our debt refinancing. The new capital structure provides increased flexibility and a lower long-term cost of capital. It also simplifies and strengthens our capital structure, while maintaining modest net leverage and increasing our liquidity by over $300 million. I’m no financial expert, but I’m certain the combination of less financial risk, increased flexibility, and a lower cost of capital has to be a good thing. In conclusion, we remain confident that the modern golf ecosystem will grow again this year, and we remain excited about the direction of our business. In the near-term, we are increasingly confident in our ability to hit our 2023 expectations, including transitioning to positive free cash flow this year and then further EBITDA as well as EPS growth going forward.

With this increased confidence in 2023 and the higher venue economic expectations announced today, our confidence in delivering on or exceeding our previously announced long-term economic targets has, of course, also increased. And now I’ll turn the call to Brian to provide more detail on our financials and outlook.

Brian Lynch: Thank you, Chip, and good afternoon, everyone. As Chip mentioned, 2023 is off to a strong start, and we are very pleased with our first quarter results. Demand remains healthy, inventories are receding, and our debt refinancing was very successful, putting us in a good liquidity position with funded debt levels at approximately 2.3x. And even more importantly, the long-term profitability of and the corresponding shareholder value creation opportunity related to the Topgolf business is turning out to be even more successful than we expected. Let’s now turn to our results. Our first quarter results include net revenue of $1.16 billion, a year-over-year increase of 12% or 15% on a constant currency basis, led by 11% same venue sales growth at Topgolf and a 28% increase in Active Lifestyle revenue.

We achieved this sales growth despite a $29 million negative impact from changes in foreign currency exchange rates and an $80 million to $100 million fill in, in retail in the golf equipment business that occurred during the first half of 2022. The first quarter non-GAAP operating income was $91 million, increasing over 2% on a constant currency basis, or down 14% currency impacted. We are pleased with this performance given the tough year-over-year comparison for the golf equipment business as we anniversary the post-COVID retail channel fill in during the first half of 2022 and the investments in labor and marketing we made in the Topgolf business, which I will touch on further in a minute. Net income decreased $37.7 million on a non-GAAP basis, which is ahead of plan.

This decrease includes an $18.6 million increase in interest expense related to higher interest rates and increased interest related to new Topgolf venues and $17.3 million of negative foreign currency translation as well as a $7.2 million decrease in other income net hedge gains. Lastly, Q1 adjusted EBITDA was $157 million, up 3% on a constant currency basis or down 7% currency impacted. The result was ahead of guidance we provided with our Q4 earnings with the outperformance largely attributable to the successful Paradym launch, improved supply and increased venue profitability at Topgolf. Now turning to our segment performance. In Q1 2023, Topgolf contributed $404 million in revenue, a year-over-year increase of 25% or 26% on a constant currency basis, driven by both strong same venue sales growth and better-than-expected performance in the non-comp newly opened venues.

Topgolf’s segment operating income decreased $3.7 million or 132 basis points of operating margin due to the planned increase in expenses we discussed last quarter, including marketing expenses related to Topgolf’s new marketing awareness campaign and the full impact of the investments in labor in the second half of 2022. Combined, these investments added over 300 basis points of headwind in the quarter. The underlying profitability of this business remains strong without the impact of these targeted investments on the seasonally low first quarter, operating margin would have increased nicely. Adjusted EBITDA for Topgolf was $48 million, up approximately $6 million compared to Q1 2022, and our guidance due to outperformance in the venue business.

Golf Equipment generated $444 million in revenue, down 5% over Q1 2022, or just over 1% on a constant currency basis. This was a better-than-planned result given the retail channel fill in I previously mentioned. Segment operating income decreased 19% to $82 million versus Q1 2022, primarily due to foreign exchange rate impacts. Constant currency gross margin also grew, up 140 basis points in the quarter with pricing and decreased freight expenses more than offsetting other inflationary pressures. Lastly, our Active Lifestyle segment revenue for the quarter was $320 million, up 28% or 32% on a constant currency basis year-over-year. Segment operating income increased 40% to $37 million. This increase was led by strong performance of the TravisMathew and Jack Wolfskin brands and favorable freight costs, which more than offset unfavorable foreign exchange rate impacts and inflation.

As we turn to the balance sheet, I’d like to highlight the debt refinancing we completed in March. Overall, the transactions added over $300 million of additional liquidity, reduced our cost of debt, and extended maturities of our credit facilities, thereby simplifying and strengthening our capital structure. While we have some increased debt and interest expense in the short-term related to the upsizing of the term loan, the additional liquidity gives us flexibility on how to finance Topgolf venues, and therefore, over the long-term, the amount of incremental debt and interest expense should be the same or lower than if we had not upsized the term loan. More specifically, we entered into a new $1.25 billion seven-year senior secured Term Loan B.

A large portion of the proceeds were used to refinance both the Callaway and Topgolf Term Loan B, and the Topgolf revolving credit facility, all of which have been paid off and no longer exist. We used the balance of the proceeds to pay down our ABL facility. We also upsized and extended the existing Topgolf Callaway Brands $400 million ABL with a new five-year $525 million senior secured ABL revolving credit facility. For the debt we replaced as part of the refinance, the payback was under two years and generated go-forward cash savings of over $12 million per year. Those savings are being offset by the additional liquidity we added, causing interest expense to be higher in 2023 than what we assumed for guidance in our Q4 earnings call. Moving to the balance sheet.

As of March 31, 2023, available liquidity, which is comprised of cash on hand and availability under our credit facilities, was $626 million compared to $576 million at March 31, 2022, and $415 million at December 31, 2022. At quarter end, we had total net debt of $2.210 billion, excluding the convertible debt of approximately $258 million compared to $1.457 billion at the end of Q1 2022. This increase relates primarily to incremental new venue financing and replenishment of working capital for the non-Topgolf business. Our net debt leverage, which excludes the convertible note, was a better-than-expected 4.1x at March 31, 2023, compared to 3.0x the prior year. The year-over-year increase was due to the new venue development and increases in working capital.

We expect the new debt leverage ratio will increase slightly in Q2 and then decrease in the second half as the business generates free cash flow. Consolidated net accounts receivable was $455 million as of March 31, 2023, compared to $413 million at the end of Q1 2022. Non-Topgolf DSOs were approximately flat year-over-year. Our inventory balance increased to $930 million at the end of the first quarter of 2023 compared to $552 million at March 31, 2022, but down from our December 31, 2022 balance of $959 million. We are still on track to be at more normal levels of inventory by the end of the year. The strong start to the golf equipment segment and continued momentum of the Active Lifestyle segment gives us increased confidence in this. The quality of the inventory is good as older inventory was generally cleaned up during the pandemic.

Capital expenditures for the first quarter were $70 million, net of venue financing reimbursements. This includes $51 million related to Topgolf. For full-year 2023, we expect total company CapEx of $270 million, including $190 million from Topgolf, which is net of venue financing reimbursements. Now turning to our balance of the year outlook. We are increasing the midpoint of our full-year 2023 revenue guidance, resulting in a new range of $4.42 billion to $4.47 billion, an increase in the midpoint of our adjusted EBITDA guidance, resulting in a new range of $625 million to $640 million. We are also increasing the Topgolf adjusted EBITDA outlook to $315 million to $325 million, to reflect the increased profitability at the venues, even with a slight decrease in same venue sales expectations.

For the second quarter of 2023, we estimate revenue to be within the range of $1.175 billion and $1.195 billion, up from Q2 2022’s reported $1.1 billion. We expect Topgolf segment revenue to be within the range of $475 million to $485 million, with same venue sales growth of flat to up 4%, and continued strong performance in the non-comp new venues. As a reminder, Q2 2022 was a strong quarter for Topgolf given the pent-up demand amid Omicron-related shutdowns in Q1 last year. We estimate Q2 adjusted EBITDA to be within the range of $195 million to $205 million, slightly down from Q2 2022, which assumes the Q2 adjusted EBITDA for the Topgolf segment to be within the range of $87 million to $93 million, up slightly compared to last year. Like the first quarter, second quarter year-over-year comparisons will be impacted by the 2022 retail channel fill in, in the golf equipment segment, and the investments in Topgolf labor and marketing expenses I mentioned earlier.

The skewed year-over-year comparison should moderate in the second half. Overall, we feel good about our business. While we are cognizant of the macroeconomic uncertainty around the world, the fundamentals of our business remain strong. Topgolf venue development and same venue sales growth remain robust. We are not seeing a reversion in golf. Our Active Lifestyle business was up significantly for the first quarter, and Topgolf and the total company are on track to be free cash flow positive well ahead of our forecast at the time of the merger. Finally, and most importantly, we are well on our way to achieving the increased venue profitability targets Chip mentioned earlier. Achieving these new targets should result in a higher enterprise valuation over the long-term.

That concludes our prepared remarks today, and we will now open the call for questions. Operator, over to you.

Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Daniel Imbro with Stephens. Please go ahead.

Operator: The next question comes from Randal Konik with Jefferies. Please go ahead.

Operator: The next question comes from Alex Perry with Bank of America. Please go ahead.

Operator: The next question comes from Michael Swartz with Truist Securities. Please go ahead.

Operator: The next question comes from Joe Altobello with Raymond James. Please go ahead.

Operator: The next question comes from George Kelly with ROTH MKM. Please go ahead.

Operator: Next question comes from Eric Wold with B. Riley Securities. Please go ahead.

Operator: Our next question comes from Noah Zatzkin with KeyBanc Capital Markets. Please go ahead.

Operator: The next question comes from John D. Kernan with TD Cowen. Please go ahead.

Operator: Our next question comes from Casey Alexander with Compass Point Research and Trading. Please go ahead.

Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Chip Brewer for any closing remarks.

Oliver Brewer: Yes. I want to thank everybody for tuning in today. And in particular, I want to thank the Topgolf Callaway Brands’ employees, associates, the playmakers and the venues, our advocates and customers for your support. Looking forward to a strong Q2 and look forward to speaking with everybody again in August.

Operator: The conference has now concluded. Thank you for attending today’s presentation.