Callaway Golf Company — FY2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. This is an annual report, not a standalone fourth-quarter filing; the filing also presents unaudited quarterly results. Callaway designs and sells golf clubs, balls and accessories under brands including Callaway, Odyssey and Top-Flite, in the U.S. and more than 100 countries.
Financial performance and position
| Metric | FY2011 | FY2010 |
|---|---|---|
| Net sales | $886.5 million | $967.7 million |
| Gross profit / margin | $311.3 million / 35% | $365.5 million / 38% |
| Operating loss | $81.1 million | $26.6 million |
| Net loss | $171.8 million | $18.8 million |
| Diluted loss per common share | $2.82 | $0.46 |
| Cash from operating activities | $10.1 million | $9.6 million |
| Capital expenditures | $28.9 million | $22.2 million |
| Cash and cash equivalents at year-end | $43.0 million | $55.0 million |
| Working capital at year-end | $251.5 million | $368.6 million |
FY2011 sales fell 8%; golf clubs declined 8% to $726.1 million and golf balls declined 9% to $160.4 million. Both operating segments reported pre-tax losses: golf clubs $3.9 million and golf balls $12.7 million. The company generated positive operating cash flow but spent more on capital expenditures, paid $13.1 million in dividends and ended the year with less cash.
The $230 million secured asset-based revolving credit facility had no borrowings outstanding at year-end; letters of credit totaled $0.5 million. Average borrowings during the year were $25.1 million. The facility matures June 30, 2016, is subject to borrowing-base availability and includes financial and other covenants. The company reported covenant compliance at year-end. Preferred stock outstanding carries a 7.5% cumulative dividend; $10.5 million of preferred dividends were deducted in arriving at loss attributable to common shareholders.
Material changes versus prior period
- Sales weakened amid a challenging golf market, stronger competitor product launches, the absence of a fourth-quarter woods launch, and natural disasters affecting Japan, Australia and Southeast Asia. U.S. sales fell 10%; Europe grew 3% while Japan fell 9%.
- Gross margin declined three percentage points. Lower production volumes and related fixed-cost under-absorption, final Global Operations Strategy costs, and lower sales in higher-margin Japan were principal pressures; cost savings, less closeout activity and favorable currency effects partly offset them.
- Operating expenses were nearly flat overall, but selling expense increased as a percentage of sales. Net loss widened substantially, in large part because the company recorded significant tax expense despite a pre-tax loss.
- Year-end inventory decreased $35.5 million to $233.1 million, and receivables fell $28.9 million to $115.7 million, reflecting lower sales and inventory management/product-launch timing.
Outlook, management commentary, risks and unusual items
- Management expected “much improved” 2012 financial performance, citing new products, marketing investment, restructuring savings and more efficient supply and distribution operations. The June 2011 reorganization was expected to produce about $50 million of annualized pre-tax savings, with up to half reinvested in brand and demand creation; most savings and reinvestment were expected in 2012. These are forward-looking expectations, not guarantees.
- The company recorded $81.6 million of income tax provision in 2011, including a $52.5 million valuation allowance against U.S. deferred tax assets and $21.6 million of expense from recognition of prepaid tax related to intercompany profits. U.S. tax benefits on losses will not be recognized until realization is considered more likely than not. Future use of tax losses may also be limited by an ownership change under Section 382.
- Restructuring charges included $24.7 million for the Global Operations Strategy and $16.3 million for the Reorganization and Reinvestment Initiatives. Management reported the global operations restructuring substantially complete and no additional charges expected for that program; about $1.0 million of further reorganization charges was estimated for 2012.
- Other unusual items included $6.5 million of impairment charges, a $6.2 million recognized gain on building sales, and a $0.7 million gain on the February 2012 sale of the Ben Hogan brand. Australian goodwill impairment was $1.1 million.
- Key risks include discretionary consumer demand and golf participation, intense competition and short product cycles, seasonality and weather, foreign exchange exposure, supplier/manufacturing and shipping disruptions, customer credit risk, and ABL availability/covenants. The company’s U.S. sales and operating results remain important to its recovery; significant international sales expose it to currency and regional economic risks.
- Patent litigation with Acushnet over Pro V1 golf balls remained ongoing, including appeals and challenges to patent validity; separate 2009 cases were stayed. A commercial trade-credit dispute was settled in January 2012. Management said pending matters were not expected to materially affect consolidated financial position, while noting adverse resolution could materially affect results or cash flows in a period.
- The filing reports a correction to prior-period deferred-tax balances, reducing 2010 deferred tax assets and equity by about $9.0 million; management said it did not consider the correction material to prior financial statements. Deloitte issued unqualified opinions on the financial statements and internal controls; management also concluded controls were effective.
Management stated that operating cash flow and available credit were expected to cover operating needs, planned expenditures and obligations for at least the next 12 months, subject to economic, currency and covenant risks. Planned 2012 capital expenditures were estimated at $25 million to $30 million. Contractual obligations included $79.0 million of purchase commitments and $33.1 million of operating leases.
Investor verification priorities
- Verify whether 2012 sales, margins and segment profitability improved as management expected, and whether the roughly $50 million savings target was achieved after planned reinvestment.
- Review cash conversion, working-capital trends, capital spending and seasonal borrowing needs against the $230 million ABL facility’s borrowing-base limits and covenants.
- Assess the sustainability of the U.S. deferred-tax valuation allowance, the potential for reversal, tax-related cash obligations and Section 382 limitations on loss carryforwards.
- Track product launch performance, competitive pricing, inventory/closeout levels and the company’s ability to restore golf-ball and golf-club segment profitability.
- Monitor outcomes of Acushnet patent disputes, customer concentration in golf balls, and any other litigation or contingent liabilities.