Callaway Golf Company — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. Unaudited results; dollar amounts below are in millions unless stated otherwise.
Business context and key financial metrics
Callaway designs and sells golf clubs, balls, and related products through its golf clubs and golf balls segments. The business is seasonal, with most sales and profitability generally occurring in the first half of the year.
- Q3 revenue: $175.8, up 4% from $168.6; management reported 12% growth on a constant-currency basis.
- Q3 gross profit and margin: $77.6 and 44.1%, versus $65.3 and 38.7% a year earlier. Operating income was $0.8, compared with an operating loss of $2.6.
- Q3 net result: Net loss of $3.6, or $0.04 per diluted share, versus a loss of $1.1, or $0.01 per diluted share.
- Nine-month revenue: $690.5, down 8% from $752.3; down 2% on a constant-currency basis. Foreign exchange reduced reported sales by $46.7.
- Nine-month gross profit and margin: $306.6 and 44.4%, versus $321.0 and 42.7%. Net income was $45.0, or $0.53 per diluted share, versus $57.5, or $0.66 per diluted share.
- Segments: Q3 sales were $146.5 for golf clubs and $29.3 for golf balls. Nine-month sales were $577.3 and $113.2, respectively. Segment pretax income was $6.6 and $3.5 in Q3, and $69.5 and $17.6 for nine months; these figures exclude corporate and other reconciling items.
- Cash flow: Nine-month operating cash flow was $28.4, down from $38.3. Capital expenditures were $8.5; operating cash flow less capital expenditures was $19.9 (calculated). Cash increased $4.0 to $41.6.
- Balance sheet and liquidity: Total assets were $638.6 and shareholders’ equity was $416.1 at September 30. No borrowings were outstanding under the asset-based facilities; cash plus stated available facility capacity totaled $147.8. Accounts receivable was $153.0 and inventory was $184.8.
- Debt: Convertible notes had $27.5 face value remaining ($26.7 net carrying amount); the company had no outstanding ABL borrowings. The notes bore 3.75% interest and were due in 2019 absent earlier repayment or conversion.
Material changes versus the prior comparable period
- Q3 reported sales grew, led by U.S. sales and stronger golf-ball sales; the company attributed product momentum to launches including Great Big Bertha, Mac Daddy 3, XR irons, and Chrome Soft balls. Currency effects muted reported growth.
- Nine-month reported sales and net income declined. Management cited unfavorable exchange rates, a planned shift in product-launch timing that weighed on first-quarter sales, and softer international markets, particularly Asia.
- Gross margin improved in both periods, which management attributed to higher-priced product mix, less promotional activity, and improved manufacturing efficiencies; currency movements partly offset those gains.
- Q3 selling, general and administrative, and R&D expenses rose year over year. For the nine-month period, total operating expenses were broadly flat, with lower selling expense offset by higher G&A and R&D costs.
- In August, Callaway exchanged $85.0 of convertible-note principal for 11.3 million shares and cash payments to holders. This increased issued shares and reduced note principal; debt-issuance-cost amortization added a $1.6 charge in Q3.
Outlook, management commentary, risks, and unusual items
- Management said operating performance, market share, and brand momentum continued to improve, while warning that foreign exchange and softer international demand adversely affected reported results. Constant-currency figures are non-GAAP measures and should not be treated as GAAP results.
- Management expected to fund operations from cash, operating cash flow, and facility borrowings as needed, and believed liquidity would cover operating needs, capital expenditures, contractual obligations, and commitments for at least 12 months. Expected 2015 capital expenditures were approximately $15.0. No formal numerical earnings or revenue guidance is provided in the supplied filing text.
- On October 15, 2015, after quarter-end, the company issued a redemption notice for the remaining $27.5 of convertible notes, scheduled for November 16. Holders could convert before the redemption date; otherwise, the company expected to pay cash. Management said retiring the remaining debt would eliminate long-term debt and provide approximately $5.0 of annual incremental cash flow.
- Foreign exchange remains a significant exposure. Management estimated that a hypothetical 10% unfavorable currency move could produce a $12.9 one-day loss on forward contracts, which it expected would be partly offset by underlying transactions. The company hedges only a portion of its international exposures.
- Other risks include seasonality, consumer and retailer demand, promotional conditions, supplier and manufacturing dependencies, and the company’s ability to sustain its turnaround and generate cash. Management reported compliance with facility covenants at quarter-end.
- Minimum unconditional purchase obligations were $58.4 over the next four years; total listed contractual obligations were $110.8. Routine legal claims and other proceedings were disclosed, but management could not estimate an aggregate loss range and did not expect current matters to materially affect financial position.
- The company maintained a valuation allowance against U.S. deferred tax assets; realization depends on generating sufficient taxable income. The filing also reported $6.5 of gross uncertain-tax-position liabilities, subject to stated offsets.
Important facts for investors to verify
- Whether the remaining convertible notes were converted or redeemed, and the resulting cash use, share count, and debt position.
- Whether Q3 product momentum and gross-margin gains persisted beyond the seasonal period, and how much was attributable to product mix, pricing, and efficiencies.
- The continuing impact of foreign exchange and international demand, including the assumptions behind management’s constant-currency comparisons and hedge disclosures.
- Whether operating cash generation and available borrowing capacity remained sufficient against seasonal working-capital needs and contractual commitments.
- The trajectory of share-based compensation, corporate expenses, and the U.S. deferred-tax valuation allowance.