Callaway Golf Company — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Unaudited results; the business is seasonal, with most sales and profitability generally in the first half of the year.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $249.6 million | $281.1 million | $537.4 million | $566.2 million |
| Gross profit | $95.7 million | $110.7 million | $226.1 million | $235.0 million |
| Gross margin | 38.3% | 39.4% | 42.1% | 41.5% |
| Operating income | $11.5 million | $9.6 million | $51.6 million | $37.4 million |
| Net income | $10.1 million | $2.8 million | $51.7 million | $34.6 million |
| Diluted EPS | $0.12 | $0.00 | $0.59 | $0.41 |
| Cash from operations | Not presented by quarter | $(67.0) million | $(91.3) million |
Balance sheet and liquidity
- At June 30, cash and cash equivalents were $30.0 million, versus $52.0 million at year-end 2012. Accounts receivable was $229.3 million and inventory was $187.2 million.
- Current assets were $478.7 million and current liabilities were $205.4 million.
- Debt included $38.5 million drawn on the asset-based revolving credit facility and convertible notes with a $107.5 million net carrying value ($112.5 million principal). The revolver had $48.1 million of additional borrowing availability; cash plus unused availability was approximately $78.0 million at period-end.
- The ABL rate was 6.25%; the facility matures June 30, 2016. The convertible notes bear 3.75% interest, mature August 15, 2019, and are convertible at approximately $7.50 per share. Approximately 15 million shares are issuable upon conversion.
- Operating cash use reflected seasonal working-capital needs, particularly increased receivables. Capital expenditures were $6.0 million for the half-year; management expected full-year 2013 capital expenditures of $15–$20 million.
Changes and operating drivers
- Reported sales fell 11% in Q2 and 5% for the first half. Management said current-business sales grew 6% on a constant-currency basis in the first half; reported sales were reduced by about $44.7 million from brands sold or businesses transitioned to third-party arrangements and by about $17.8 million from currency translation.
- Golf-club sales declined 11% in Q2 and 5% for the half. X Hot woods performed strongly, with first-half woods sales up 15%; lower putter and accessories sales partly offset this growth.
- Golf-ball sales declined 13% in Q2 and 6% for the half, reflecting the Top-Flite brand sale, softer volume and, for the half, a less favorable product mix.
- First-half gross margin improved 60 basis points, attributed mainly to product mix and manufacturing efficiencies. Q2 margin declined 110 basis points, affected by currency, restructuring charges and a $3.4 million write-off of golf-ball manufacturing equipment and inventory.
- First-half operating expenses declined $23.1 million, or 12%, year over year, primarily due to cost reductions and lower marketing expense. Q2 operating income improved despite lower sales.
Outlook, risks and unusual items
- Management expected full-year 2013 operating results to be significantly improved versus 2012, while anticipating continuing foreign-exchange headwinds and retail promotional activity. No numeric earnings or sales guidance was provided.
- The July 2012 cost-reduction program had incurred $62.6 million of cumulative charges through June 30, 2013; total pre-tax charges were estimated at approximately $65 million, with annualized savings of approximately $60 million. About $2.4 million of additional charges were expected over the next six months.
- In July 2013, Callaway terminated its golf-ball manufacturing and supply agreements with Suntech. In Q2 it recorded $3.4 million of non-cash charges to write off equipment and inventory at the facility. A $1.8 million loan to Suntech’s parent remained outstanding.
- Management considered cash, expected operating cash flows and the ABL facility sufficient for at least 12 months. However, the company had experienced operating losses and negative operating cash flow in prior years; liquidity depends on turnaround execution, product demand, seasonality, currency and credit availability.
- The company was in compliance with ABL covenants at June 30. A fixed-charge coverage covenant would apply if borrowing-base availability fell below $25 million; Callaway said it would not have met that ratio at period-end, although the trigger was not reached.
- Other exposures include foreign currency movements, weather and golf participation, consumer demand, promotional pricing, supply/manufacturing disruption, tax-asset valuation allowances and legal/IP claims. Unconditional purchase obligations were $56.8 million; operating lease commitments were $34.6 million.
- First-half net income benefited from $4.0 million of other income, primarily foreign-currency gains. Foreign-currency contracts had $132.0 million notional value; the filing estimated a $13.9 million maximum one-day loss under a hypothetical 10% adverse currency move, partly offset by underlying exposures.
Important facts for investors to verify
- Whether growth in the current product portfolio, particularly X Hot products, can continue to offset divested or transitioned businesses and currency headwinds.
- Whether cost-reduction savings are realized as expected and whether the remaining restructuring charges stay near management’s estimate.
- Seasonal cash collections, revolver availability and covenant headroom as receivables decline in the second half.
- Convertible-note dilution and the company’s ability to service debt, preferred dividends and contractual commitments.
- The effect of Suntech’s termination on golf-ball supply, costs and recovery of the outstanding loan.