Callaway Golf Company — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Unaudited results; amounts below are in U.S. dollars. The business designs, manufactures, and sells golf clubs, balls, and related products. Sales and profitability are seasonal, with most sales and substantially all profitability generally occurring in the first half.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $281.1 million | $273.8 million | $566.2 million | $559.4 million |
| Gross profit / margin | $110.7 million / 39% | $102.7 million / 37% | $235.0 million / 42% | $226.3 million / 40% |
| Operating income (loss) | $9.6 million | $(10.2) million | $37.4 million | $12.8 million |
| Net income (loss) | $2.8 million | $(59.1) million | $34.6 million | $(46.2) million |
| Diluted EPS | $0.00 | $(0.96) | $0.41 | $(0.80) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $(91.3) million | $(25.4) million |
Balance sheet and liquidity at June 30, 2012: Cash was $28.0 million; accounts receivable $254.9 million; inventory $215.8 million; total current assets $523.1 million and current liabilities $220.5 million. The company had $70.2 million drawn on its asset-based revolving credit facility, implying approximately $42.2 million of net debt before considering preferred stock. The facility limit was $230 million, subject to borrowing-base availability; the interest rate was 4.75%, maturity June 30, 2016. The company reported compliance with covenants and borrowing-base availability above the $25 million threshold that triggers a fixed-charge coverage covenant. Outstanding preferred stock carries a 7.5% cumulative dividend; its June 30 liquidation preference was about $140.4 million.
Changes versus comparable periods
- Q2 sales rose 3%; first-half sales rose about 1%. Golf-club sales grew 6% in Q2 and 3% in the first half, while golf-ball sales fell 9% and 7%, respectively.
- Gross margin improved by about 2 percentage points in both comparisons, largely because the Global Operations Strategy restructuring was completed in 2011. Higher component costs and closeout discounting partly offset the benefit.
- Operating expenses declined year over year in the first half, despite increased marketing investment. Lower headcount and restructuring-related savings helped; the 2012 period also included a $6.6 million gain on brand sales and $4.7 million of cost-reduction charges.
- Net income improved substantially, but comparisons are heavily affected by the $52.8 million noncash U.S. deferred-tax valuation allowance established in Q2 2011. The 2012 tax provision is not directly comparable to pretax income because the company maintains a U.S. valuation allowance.
Management outlook, risks, and unusual items
- Cost Reduction Initiatives: A 12% workforce reduction and other changes are expected to produce about $52 million in annualized savings. Estimated pretax charges are $36–$42 million over the following 12 months, with less than half expected to be cash expenditures. Charges of $4.7 million had been recorded through June 30. Management said the initiatives and a renewed focus on Callaway and Odyssey are intended to support sales growth and improved profitability in 2013 and beyond.
- Other restructuring: The 2011 Reorganization and Reinvestment Initiatives were expected to deliver about $50 million in annualized savings, with up to half reinvested in brands and demand creation. The company expected $183,000 of remaining charges in 2012.
- Capital and liquidity outlook: Management expected operating cash flows and financing facilities to fund operations, capital needs, and contractual commitments for at least 12 months, subject to business and market conditions. Estimated 2012 capital expenditures were $25–$30 million. First-half operating cash use reflected, in part, a $141.1 million increase in receivables, consistent with seasonality and sales timing.
- Portfolio changes: The company sold the Top-Flite and Ben Hogan brands in early 2012 for net proceeds of $26.9 million and recorded a $6.6 million pretax gain. Top-Flite and Ben Hogan balls had represented approximately 25% of annual golf-ball sales in recent years; management intended to replace some of that business with more profitable products. The company was also licensing apparel and footwear and evaluating a possible sale of its Chicopee golf-ball facilities, which could result in an impairment charge.
- Market and operating risks: Management cited loss of iron-category market share and weaker acceptance of current iron models. Results are exposed to seasonal demand, consumer discretionary spending, promotional activity, product launches, foreign exchange movements, and higher product costs. Currency translation reduced first-half sales outside the U.S.; hedges mitigate but do not eliminate currency exposure.
- Cash commitments and contingencies: Minimum unconditional purchase obligations were $84.2 million over six years; operating lease commitments were $30.4 million. Uncertain tax-position liabilities were $9.3 million. The company described routine and other legal matters but could not estimate aggregate potential losses; it did not expect current matters to materially affect financial position, while acknowledging an unfavorable resolution could affect results or cash flow in a period.
- Reporting item: Comparative 2011 tax figures were corrected for an overstated deferred-tax valuation allowance of $4.5 million. The company stated the correction was not material and did not affect reported operating cash flow.
Important facts for investors to verify
- Whether cost reductions deliver the projected $52 million annualized savings and how much of the $36–$42 million charge estimate is ultimately cash versus noncash.
- Whether the company can restore iron-category market share and offset lost golf-ball sales following the brand divestitures.
- Seasonal working-capital and cash conversion trends, including collections of the $254.9 million receivables balance and future reliance on the ABL facility.
- The effect of the U.S. deferred-tax valuation allowance on future reported earnings, and whether sustained profitability could support its reversal.
- Progress and potential costs of the Chicopee facility review, as well as any material developments in legal or tax contingencies.