Callaway Golf Company — FY 2013 Form 10-K
Business context and reporting period: Annual report for the fiscal year ended December 31, 2013, filed February 27, 2014. Callaway designs and sells golf clubs, balls and accessories worldwide through the Callaway, Odyssey and Strata brands. The business is seasonal, with most sales and profitability typically in the first half of the year.
Financial performance
| Metric | FY 2013 | FY 2012 |
|---|---|---|
| Net sales | $842.8 million | $834.1 million |
| Gross profit / margin | $314.8 million / 37.3% | $248.2 million / 29.8% |
| Operating loss | $10.8 million | $116.2 million |
| Net loss | $18.9 million | $122.9 million |
| Loss per diluted share | $0.31 | $1.96 |
| Cash used in operating activities | $8.9 million | $28.8 million |
| Capital expenditures | $13.0 million | $18.4 million |
| Cash and cash equivalents at year-end | $36.8 million | $52.0 million |
- FY 2013 fourth-quarter net sales were $127.2 million and net loss was $49.5 million.
- Year-end inventory rose to $263.5 million from $211.7 million, primarily due to earlier purchases for planned product launches. Working capital was $195.4 million, down from $225.4 million.
- At year-end, borrowings under the asset-based revolving credit facility (ABL) were $25.7 million; the convertible notes had $112.5 million principal outstanding and a $107.8 million net carrying value. Total available liquidity, including cash and ABL availability, was reported as approximately $60.0 million.
Material changes and drivers
- Sales increased 1% despite a $39.8 million adverse foreign-currency translation impact and a $57.2 million impact from the prior sale of Top-Flite and Ben Hogan and the transition of apparel and footwear to licensing. On a constant-currency basis, excluding sold or transitioned businesses, management reported 14% growth.
- Woods sales rose 28% to $256.5 million, supported by the X Hot line; irons sales rose 6%. Golf-ball sales declined 5%, while accessories and other sales fell 20%, in part because of the licensing transition and lower sales of certain accessories.
- Gross margin improved by 7.5 percentage points, reflecting fewer restructuring-related charges, a richer product mix, less promotional activity and manufacturing efficiencies. Operating expenses declined 11% to $325.5 million.
- The company recorded $16.6 million of pre-tax charges related to its Cost Reduction Initiatives in 2013, compared with $54.1 million in 2012. It stated these initiatives were complete by year-end 2013.
- Callaway retired its remaining preferred stock during 2013 through exchanges and redemption, eliminating preferred shares outstanding at year-end.
Outlook, risks and unusual items
- Management said the turnaround was progressing and expected a return to profitability and positive operating cash flow in 2014. This is forward-looking, not a guarantee; results depend on sales growth, cost control, consumer demand, currency movements and other risks.
- The company reported negative operating cash flows in each year from 2009 through 2013. It believed cash, expected operating cash flow and ABL availability would fund requirements for at least 12 months, but warned that weaker sales or insufficient facility availability could adversely affect operations.
- The ABL facility is secured by specified assets, matures June 30, 2016 and includes restrictions on debt, dividends and other actions. Callaway reported covenant compliance at year-end; however, it said it would not have met the fixed-charge coverage ratio if that covenant had applied. The covenant is triggered when borrowing-base availability falls below $25 million.
- Convertible notes bear 3.75% interest and mature August 15, 2019. Their initial conversion price is approximately $7.50 per share. The filing reports a fair value of $138.7 million versus a $107.8 million carrying value at year-end.
- Other notable exposures include customer credit risk (a large customer filed for Chapter 11 in 2013), foreign-exchange exposure, seasonal demand, competition and product obsolescence, reliance on suppliers and logistics, and the potential limitations on U.S. tax-loss carryforwards following an ownership change.
- The company invested an additional $13.6 million in TopGolf during 2013, bringing its investment to $37.6 million; its ownership remained below 20% and was accounted for at cost. It also recorded $5.6 million of charges after ending a golf-ball manufacturing and supply arrangement with Suntech.
- A trademark-infringement lawsuit concerning the phrase “Designed by Roger Cleveland” was pending. Management said it could not reliably estimate the ultimate loss; an unfavorable resolution could materially affect results or cash flows in a particular period.
Important facts for investors to verify
- Whether the company achieved its stated 2014 targets for profitability and positive operating cash flow, and how much cash was consumed by inventory and other working-capital needs.
- Current ABL availability, covenant headroom and compliance, including the effect of seasonal borrowing-base changes and the facility’s 2016 maturity.
- Whether 2013 sales and margin improvements were sustained without restructuring charges, and the performance of core clubs and golf balls after excluding divested or licensed businesses and currency effects.
- Collectability of receivables, including exposure to the customer bankruptcy, and the quality and sell-through of the substantially higher year-end inventory.
- Developments in the Cleveland Golf litigation, environmental remediation obligations, and the realizability of deferred tax assets subject to a substantial valuation allowance.