Callaway Golf Company — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; comparison is the three months ended March 31, 2011. Amounts are in U.S. dollars. The company designs, manufactures and sells golf clubs, golf balls and related products; results are seasonal, with sales and most profitability generally concentrated in the first half of the year.
Financial results and position
| Metric | Q1 2012 | Q1 2011 / prior date |
|---|---|---|
| Net sales | $285.1 million | $285.6 million |
| Gross profit / margin | $124.4 million / 44% | $123.7 million / 43% |
| Operating expenses | $96.5 million | $100.7 million |
| Operating income | $27.8 million | $23.0 million |
| Income before taxes | $31.5 million | $21.6 million |
| Income tax benefit (provision) | $0.3 million benefit | $8.8 million provision |
| Net income | $31.8 million | $12.8 million |
| Net income allocable to common shareholders | $29.2 million | $10.2 million |
| Basic / diluted EPS | $0.45 / $0.37 | $0.16 / $0.15 |
| Operating cash flow | $(92.4) million | $(39.4) million |
| Capital expenditures | $8.7 million | $6.9 million |
At March 31, 2012, cash was $51.7 million, current assets were $572.4 million and current liabilities were $272.8 million. Accounts receivable was $255.3 million and inventory was $236.2 million. The company had $85.9 million outstanding under its asset-backed revolving facility, at a stated interest rate of 4.75%; the facility allows up to $230 million subject to borrowing-base availability. The company reported compliance with facility covenants and availability above the $25 million threshold that triggers a fixed-charge coverage covenant. The facility matures June 30, 2016.
Material changes and drivers
- Sales were essentially flat. Golf-club sales rose 1% to $242.6 million; golf-ball sales fell 5% to $42.5 million. Woods and accessories grew, while irons and putters declined. Management cited weaker iron-market share and later product launches.
- Gross margin improved mainly because the Global Operations Strategy restructuring was completed in 2011; Q1 2011 included $6.5 million of related charges. Higher club component costs, putter closeouts and unfavorable iron mix partly offset the improvement.
- Operating expenses fell year over year despite increased advertising. Q1 2012 included a $6.6 million gain on sales of the Top-Flite and Ben Hogan brands; Q1 2011 included a $6.2 million gain on building sales. Lower employee costs also contributed to the expense decline.
- Other income was $3.7 million versus $1.4 million of expense in Q1 2011, primarily reflecting higher foreign-currency gains. The tax comparison is affected by the U.S. deferred-tax valuation allowance; management says interim tax expense is not directly correlated with pretax income.
- Cash used in operations increased, largely reflecting the seasonal receivables build. Receivables rose $139.6 million from year-end, which the company attributed to seasonality and first-quarter sales. Financing included $85.9 million of net credit-facility proceeds; investing cash inflows included $26.9 million from the brand sales.
Outlook, risks and unusual items
- Management expects operating cash flows and available financing to fund operating needs, capital spending, contractual obligations and commitments for at least the next 12 months, but cautions that economic conditions, foreign exchange, operations or covenant compliance could affect liquidity. Expected 2012 capital expenditures are $25–30 million.
- The 2011 Reorganization and Reinvestment Initiatives are expected to produce about $50 million of annualized pretax savings, with up to half reinvested in the Callaway and Odyssey brands and demand creation; most savings and reinvestment were expected in 2012. The company recorded $0.4 million of initiative charges in Q1 and estimated another $0.6 million for the balance of 2012.
- Management said it was dissatisfied with the pace of financial and market-share recovery and planned further operating changes to improve the efficiency of brand and demand-creation investments. It identified regaining iron share and replacing sales from divested brands as priorities. No formal earnings or revenue forecast is provided.
- In February and March 2012, the company sold the Ben Hogan and Top-Flite brands for net cash proceeds totaling approximately $26.9 million and recorded a $6.6 million pretax gain. Management said the proceeds would support investment in more profitable future products.
- On April 13, 2012, after quarter-end, Callaway and Acushnet announced settlement of pending litigation and other disputes. No money changed hands; the companies agreed to specified reciprocal patent rights, with remaining terms confidential. Dismissals were in process.
- Key risks include golf-market seasonality and discretionary demand, consumer acceptance of products, foreign-currency and interest-rate exposure, promotional activity, tax-asset realization and potential legal or intellectual-property claims. The company uses foreign-currency derivatives but does not designate them for hedge accounting. Its modeled maximum one-day loss under a hypothetical 10% adverse currency move was $21.3 million, which management said could be partly offset by the hedged transactions.
- Convertible preferred stock carries a 7.5% dividend and approximately 19.9 million potential common shares at the initial conversion rate. The company could elect mandatory conversion by June 15, 2012 subject to share-price conditions; preferred dividends were $2.6 million for the quarter.
Important facts for investors to verify
- Whether the company can restore iron-market share and sustain demand for new products, while managing the transition after the Top-Flite and Ben Hogan sales.
- Whether seasonal receivables convert to cash as expected and credit-facility borrowings decline; monitor borrowing-base availability and covenant headroom.
- How much of reported earnings growth reflects ongoing operations versus brand-sale gains, foreign-currency gains and the unusual tax comparison.
- Progress and realized net benefits from the $50 million restructuring savings plan after reinvestment, along with actual 2012 capital spending.
- Preferred-stock conversion, dividend and dilution outcomes; deferred-tax valuation allowance and potential Section 382 limits on tax attributes; and the final implementation of the Acushnet settlement.