Callaway Golf Company — Q3 2014 Form 10-Q
Business context and reporting period. Unaudited results cover the three and nine months ended September 30, 2014, compared with the same 2013 periods. Callaway designs, manufactures and sells golf clubs, balls and related products; it reports golf clubs and golf balls as its two operating segments. Results are seasonal, with most sales and profitability generally occurring in the first half of the year.
Key financial results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $168.6m | $178.2m | $752.3m | $715.6m |
| Gross profit | $65.3m | $59.4m | $321.0m | $285.5m |
| Gross margin | 38.7% | 33.3% | 42.7% | 39.9% |
| Operating income (loss) | ($2.6m) | ($17.0m) | $69.9m | $34.6m |
| Net income (loss) | ($1.1m) | ($21.2m) | $57.5m | $30.6m |
| Diluted EPS | ($0.01) | ($0.32) | $0.66 | $0.36 |
| Operating cash flow | Not presented quarterly | $38.3m | $7.6m |
- Q3 sales fell 5%, led by lower club sales (down 6%); ball sales declined 3%. U.S. sales rose 11%, while Japan declined 28%.
- Nine-month sales rose 5%, with both clubs and balls up 5%. Management attributed gains to market-share progress and new products, including Big Bertha woods, APEX irons, and Speed Regime and Supersoft balls.
- Gross-margin improvement reflected less discounting, stronger mix and manufacturing/distribution efficiencies. Q3 operating expenses fell $8.5m, including lower bad-debt expense, stock compensation and marketing; nine-month operating expenses were broadly flat.
- Other income/expense was volatile: the statements report $3.8m of other income in Q3 2014 versus $1.1m of expense a year earlier, and $1.4m of expense for the first nine months versus $7.5m of income. Foreign-exchange movements were a major factor.
Financial position, liquidity and capital
- At September 30, cash and equivalents were $33.5m; current assets were $391.6m and current liabilities $137.6m.
- There were no ABL borrowings outstanding at quarter-end; approximately $72.2m of additional borrowing availability plus cash resulted in stated total available liquidity of $105.7m. Average ABL borrowings for the first nine months were $84.2m. The company reported covenant compliance.
- Convertible notes had a $108.4m net carrying value ($112.5m principal), bear 3.75% interest and mature in August 2019. They are convertible into approximately 15.0m shares at an initial $7.50 conversion price.
- Operating cash flow was $38.3m; investing cash use was $13.1m, including $8.8m of capital expenditures and $4.7m invested in golf-related ventures. Financing cash use was $27.4m, including repayment of $25.7m of credit-facility borrowings and $2.3m of dividends. Cash decreased $3.3m from year-end.
- Inventory was $185.6m, down $77.9m from December 31, 2013, largely reflecting seasonality. Accounts receivable were $143.1m, up from $92.2m at year-end, also reflecting seasonal sales and collections.
- In August, the board authorized a $50m share-repurchase program. The company repurchased 132,206 shares in Q3 for $1.0m; $49.0m remained authorized at quarter-end.
Outlook, risks and contingencies
- Management said the turnaround and recovery were on track and cited an anticipated return to profitability for full-year 2014; the filing provides no numerical full-year earnings or sales guidance. Expected 2014 capital expenditures were approximately $14m.
- Management believed cash, expected operating cash flows and ABL availability would fund operating needs and commitments for at least 12 months. It cautioned that weak demand, turnaround execution, currency movements or reduced credit availability could impair cash generation and liquidity.
- Currency exposure is material. The company reported $113.2m of foreign-currency contract notional value and a modeled estimated maximum one-day loss of $12.3m under a hypothetical 10% adverse currency movement; management said underlying exposures could partially offset this modeled loss. Contracts were not designated for hedge accounting.
- A U.S. deferred-tax valuation allowance remains due to prior U.S. taxable losses. Future reversal depends on sufficient positive evidence, including sustained U.S. profitability. The company also reported $6.3m gross uncertain-tax-position liabilities; the net $1.1m potentially favorable amount is subject to recognition.
- Minimum purchase obligations were $48.8m over the next four years. Routine legal and other claims were disclosed; management could not estimate aggregate possible losses, though it did not expect current matters to materially affect financial position. The filing reports no material changes to previously disclosed risk factors.
- The completed cost-reduction program generated no new charges in 2014; 2013 comparisons included $10.4m of charges in the first nine months. The company stated it had no material off-balance-sheet arrangements.
Important facts for investors to verify
- Whether sales and market-share gains persist, particularly given Q3 softness and the decline in Japan.
- Whether margin gains from pricing, product mix and cost efficiencies can be sustained without relying on lower promotional activity.
- Actual full-year profitability and cash generation versus management’s qualitative outlook and the seasonal working-capital cycle.
- ABL borrowing-base availability, covenant headroom and compliance as seasonal liquidity changes; assess convertible-note maturity, conversion and potential dilution.
- Foreign-exchange impacts and derivative exposures, including the differing effects on reported operating results and cash flows.
- Progress toward evidence supporting realization of U.S. deferred tax assets, and developments in tax, legal and contractual contingencies.