Callaway Golf Company — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited results. Callaway designs and sells golf clubs, balls, apparel, and related products; its reportable segments are golf clubs and golf balls. The business is seasonal, with most sales and profitability generally occurring in the first half of the year.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $187.9M | $175.8M | $707.5M | $690.5M |
| Gross profit / margin | $78.9M / 42.0% | $77.6M / 44.1% | $321.9M / 45.5% | $306.6M / 44.4% |
| Operating income (loss) | ($5.3M) | $0.8M | $60.9M | $56.3M |
| Net income (loss) attributable to Callaway | ($5.9M) | ($3.6M) | $66.6M | $45.0M |
| Diluted earnings (loss) per share | ($0.06) | ($0.04) | $0.70 | $0.53 |
- Q3 sales increased 6.9%; golf clubs sales rose 5.9% and golf balls sales rose 11.6%. Japan sales increased 22.8%, partly reflecting the newly consolidated apparel joint venture.
- Q3 gross margin fell 210 basis points, primarily due to product-launch timing, mix, and promotional activity. Nine-month margin improved 110 basis points, supported by manufacturing and supply-chain efficiencies and pricing, partly offset by promotions and foreign-currency effects.
- Nine-month net income included a $17.7M gain from selling part of the Topgolf investment, equal to approximately $0.18 per share. Without that gain, reported earnings would have been lower; the filing does not provide a pro forma adjusted earnings figure.
- Q3 operating expenses rose 9.5% to $84.1M, including higher marketing, Japan joint-venture costs, bad-debt reserves, and legal and professional fees. Nine-month expenses rose 4.3% to $261.0M.
Cash, debt, and liquidity
- Cash and cash equivalents were $124.6M at September 30, up from $49.8M at December 31, 2015. Nine-month operating cash flow was $85.6M, versus $28.4M a year earlier; investing cash flow was $12.8M provided and financing cash flow was $20.3M used.
- Cash flow included $23.4M of proceeds from the Topgolf share sale. Capital expenditures were $12.2M for the nine months; management expected approximately $18.4M for full-year 2016.
- No borrowings were outstanding under the credit facilities at quarter-end. After letters of credit, reported total available liquidity, including cash, was $221.8M. The company reported compliance with applicable credit-facility covenants.
- Current assets were $452.0M and current liabilities $155.8M. Inventory was $157.0M, down from $208.9M at year-end, principally due to seasonality and improved inventory management.
- Shareholders’ equity totaled $492.9M. The company declared dividends of $0.01 per share in Q3 and $0.03 per share for the nine months.
Material changes and management commentary
- Management attributed higher sales to brand momentum and hard-goods market-share gains despite softer-than-expected market conditions, with additional sales from Callaway Apparel K.K., consolidated beginning July 1, 2016. Callaway owns 52%; its Japanese partner owns 48%.
- Golf-club segment sales increased 1.6% for the nine months, with golf-ball sales up 7.0%. Within clubs, nine-month woods sales fell 8.0%, while irons rose 5.9% and accessories and other rose 9.8%.
- Interest expense declined substantially year over year following retirement of the convertible notes in 2015. Nine-month other expense was $5.8M, primarily reflecting foreign-currency hedge losses.
- The company sold approximately 10% of its Topgolf preferred shares for $23.4M and retained approximately 15% ownership. The filing’s estimated $207M–$217M fair-value range for the remaining shares was based on the 2016 private transaction and was not presented as a current guaranteed sale value; the investment is illiquid.
Outlook, risks, and contingencies
- Management stated that cash, expected operating cash flow, and available credit were expected to fund operations, planned capital expenditures, contractual obligations, and commercial commitments for at least the next 12 months. No specific sales or earnings guidance was provided in the supplied filing text.
- Management planned a fourth-quarter review of deferred tax assets. The company had a $164.6M U.S. deferred-tax valuation allowance and said then-current evidence did not support realization. A reversal could produce a significant one-time, non-cash tax benefit, but was uncertain.
- Key risks include consumer demand and retailer purchasing, promotional intensity, seasonality and weather, product acceptance, foreign-exchange volatility and hedging, supplier/manufacturing disruptions, golf participation, and credit availability and covenant compliance. A hypothetical 10% adverse currency move implied a modeled maximum one-day loss of $21.8M on forward contracts; management said underlying exposures could partly offset this sensitivity.
- Minimum contractual purchase obligations were $62.1M over the next six years. The company disclosed routine and intellectual-property-related legal matters, but did not expect pending matters to have a material adverse annual effect; ultimate outcomes remain uncertain. Management reported effective disclosure controls and no material change in internal control during the quarter.
Important facts for investors to verify
- How much of nine-month earnings and cash generation depended on the one-time Topgolf sale, and what is the present value and liquidity of the retained interest?
- Whether Q3 margin pressure, promotional activity, and the weaker golf-club segment profitability continued after the reporting period.
- Whether the apparel joint venture’s added revenue translates into sustainable profit after its incremental costs and non-controlling interest.
- Progress in U.S. profitability and the evidence supporting any deferred-tax valuation-allowance reversal.
- Foreign-currency exposure, hedge results, and continued access to borrowing-base availability as seasonal working-capital needs change.