Callaway Golf Company — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012. Financial statements are unaudited. Callaway designs, manufactures and sells golf clubs, golf balls and related products. Results are seasonal, with most sales and profitability generally occurring in the first half of the year.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $147.9m | $173.2m | $714.1m | $732.7m |
| Gross profit / margin | $3.8m / 3% | $47.4m / 27% | $238.8m / 33% | $273.7m / 37% |
| Operating loss | $82.7m | $44.2m | $45.3m | $31.3m |
| Net loss | $86.8m | $62.6m | $52.2m | $108.8m |
| Loss per common share | $1.33 | $1.01 | $0.91 | $1.81 |
| Cash from operating activities | Not presented by quarter | $(29.3)m | $21.9m |
- Q3 sales fell 15%; golf clubs declined 14% and golf balls 19%. For the nine months, sales declined 3%, with clubs down 1% and balls down 10%.
- Nine-month net loss improved year over year, but pretax loss increased to $49.5m from $39.7m. The lower reported net loss partly reflects the prior-year $69.1m tax provision, including a $52.8m charge to establish a U.S. deferred-tax valuation allowance; tax expense is not directly proportional to pretax loss.
- Nine-month operating cash flow was negative $29.3m, versus positive $21.9m a year earlier. Investing activities provided $11.2m, including $26.9m of proceeds from brand sales; financing provided $33.8m. Cash increased $16.1m to $59.1m.
Financial position and liquidity
- At September 30, cash was $59.1m, current assets $422.8m, current liabilities $135.9m, and total assets $681.9m. Inventory was $189.1m, down from $233.1m at year-end 2011.
- The company recorded $106.9m of convertible notes, net of discount. It had no borrowings under its $230m asset-based revolving credit facility, although borrowing capacity is subject to borrowing-base limits; letters of credit totaled $3.3m. The company reported covenant compliance.
- On August 29, Callaway issued $112.5m of 3.75% convertible senior notes due 2019: $63.2m exchanged for preferred stock and $49.3m issued for cash, yielding $46.8m net proceeds. The notes are convertible at approximately $7.50 per share. Remaining preferred stock had a $41.9m liquidation preference.
- Cash dividends paid were $9.5m in the first nine months. The company reported $79.2m of minimum unconditional purchase obligations and $36.2m of operating lease commitments.
- Capital expenditures were $16.0m in the first nine months; management estimated full-year 2012 capital expenditures of $20m–$25m.
Material changes and unusual items
- Q3 gross margin was sharply reduced by $27.3m of Cost Reduction Initiative charges recorded in cost of sales, as well as promotional pricing. Total Cost Reduction Initiative charges were $35.1m for Q3 and $39.8m for the first nine months.
- The initiatives include workforce reductions, licensing certain non-core apparel and footwear lines, moving the integrated-device business to a third-party model, and reorganizing golf-ball manufacturing. The company recorded impairment/write-off charges related to uPro assets and inventory and wrote down its Chicopee golf-ball facility by $7.9m after agreeing in principle to sell and lease back a smaller portion.
- Callaway sold the Top-Flite and Ben Hogan brands in early 2012 for net proceeds totaling approximately $26.9m and recorded a $6.6m gain. The Top-Flite sale contributed to lower golf-ball sales.
- The company reported nine-month foreign-currency translation headwinds: at prior-year exchange rates, international sales would have been $4.1m higher. Foreign-currency derivatives had $197.1m notional value; a modeled 10% adverse currency move implied a maximum one-day derivative loss of $21.3m, which management said would be partly offset by underlying exposures.
Outlook, risks and contingencies
- Management estimated approximately $60m in gross annualized savings from the 2012 Cost Reduction Initiatives, with approximately $55m of total pretax charges expected, about two-thirds noncash. It expected to incur the estimated charges over the following 12 months; timing and amounts could vary.
- Management said it was optimistic that results would improve significantly in 2013. It also stated that cash on hand, operating cash flows and available financing were expected to fund operating needs, capital expenditures and commitments for at least 12 months.
- Key stated risks include weak consumer demand and economic conditions, promotional activity, product acceptance, foreign-exchange movements, execution delays or costs for the restructuring plan, and potential credit-facility covenant issues. U.S. deferred-tax assets remain subject to a valuation allowance pending sufficient evidence of sustained profitability; tax attributes may also be limited by ownership-change rules.
- Routine legal and intellectual-property matters are disclosed. Management could not estimate the aggregate possible loss, but did not expect current matters, individually or together, to materially affect financial position; an unfavorable outcome could affect results or cash flows in a particular period.
Investor verification priorities
- Separate recurring operating performance from the $35.1m Q3 and $39.8m nine-month restructuring charges, impairment write-offs and promotional effects.
- Track whether the promised approximately $60m annualized savings materialize, and compare realized savings with the expected approximately $55m of charges.
- Assess the drivers of negative nine-month operating cash flow and whether seasonal cash generation and borrowing availability support the stated 12-month liquidity outlook.
- Review convertible-note dilution and refinancing implications, remaining preferred-stock obligations, and ABL borrowing-base availability and covenants.
- Monitor sales, pricing and margins by product and region, particularly woods and irons, golf balls following the Top-Flite divestiture, and evidence supporting management’s 2013 outlook.