Callaway Golf Company — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Unaudited consolidated results. Callaway designs, manufactures and sells golf clubs, balls and related products; its business is seasonal, with most sales and profitability generally occurring in the first half.
Financial results and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $245.6 million | $230.5 million | $519.6 million | $514.7 million |
| Gross profit / margin | $110.6 million / 45.0% | $101.7 million / 44.1% | $243.0 million / 46.8% | $229.0 million / 44.5% |
| Operating income | $20.9 million | $18.6 million | $66.2 million | $55.5 million |
| Net income | $34.1 million | $12.8 million | $72.5 million | $48.6 million |
| Diluted EPS | $0.36 | $0.15 | $0.76 | $0.54 |
- Q2 sales rose about 6.5%; golf clubs increased 4.7% and golf balls 14.9%. First-half sales rose 1.0%, with golf balls up 5.4% and golf clubs approximately flat.
- First-half operating cash flow was $17.8 million, versus cash used of $32.7 million in 2015. Investing activities provided $17.5 million, including $23.4 million of Topgolf share-sale proceeds; financing activities used $14.6 million. Cash increased to $67.6 million from $49.8 million at year-end 2015.
- At June 30, cash was $67.6 million and asset-based facility borrowings were $5.3 million, all under the Japan facility; no borrowings were outstanding under the primary ABL facility. Available facility capacity after letters of credit was $148.7 million, giving total available liquidity including cash of $216.3 million. The convertible notes had been retired in 2015.
- Total assets were $672.5 million, current liabilities $147.2 million and shareholders’ equity $486.3 million. Inventory was $151.4 million, down from $208.9 million at December 31, 2015, reflecting seasonality and improved inventory management.
Changes versus prior year
- Gross margin improved 0.9 percentage points in Q2 and 2.3 points in the first half, attributed mainly to sourcing savings, manufacturing and supply-chain efficiencies, and higher average selling prices; increased promotional activity partly offset gains.
- Q2 net income included a $17.7 million ($0.18 per share) gain on the sale of part of the Topgolf investment. Callaway received $23.4 million and retained an approximately 15% interest. The reported earnings increase therefore includes a significant non-recurring gain.
- Interest expense declined following the 2015 retirement of the convertible notes. Other expense for the first half was $7.1 million, versus $0.5 million of other income in 2015, primarily due to increased losses on non-designated foreign-exchange hedges.
- Weighted-average basic shares increased to 94.0 million from 78.1 million for the first half, reflecting the 2015 conversion of the notes into shares. Diluted shares were 95.7 million versus 94.4 million.
Outlook, commentary and risks
- Management said strong products and brand momentum supported sales and market-share gains despite softer-than-anticipated market conditions. Product-launch timing reduced first-half volumes in some woods, irons and hybrids categories; management described the timing shift and extended product life cycles as planned.
- Management expected to fund operations from cash, operating cash flow and credit facilities as needed, and believed available liquidity would cover operating needs, capital expenditures and commitments for at least 12 months. Planned 2016 capital expenditures were approximately $15 million; $7.5 million had been spent in the first half. No specific earnings guidance is provided in the supplied filing text.
- Effective July 1, Callaway formed a Japan apparel joint venture with TSI, owning 52%; it expects to consolidate the venture in future results.
- Key risks include seasonality and weather, consumer and retailer demand, promotional intensity, execution of turnaround plans, foreign exchange and hedge volatility, supplier and manufacturing disruptions, credit-facility availability and covenant compliance, and golf participation. The company reported compliance with facility covenants at quarter-end.
- The U.S. deferred-tax valuation allowance was $164.6 million. Continued U.S. profitability could support reversal of some or all of it and a significant one-time non-cash tax benefit, but reversal is not assured. The company also reported $69.4 million of minimum unconditional purchase commitments over six years and routine legal and intellectual-property matters; management could not estimate aggregate possible legal losses.
- Foreign-currency forward contracts had a net liability fair value of $7.3 million at June 30. The filing’s sensitivity model estimated a $33.3 million maximum one-day loss under a hypothetical 10% currency movement; management said underlying hedged transactions would partially offset such exposure.
Important facts for investors to verify
- How much of reported earnings growth is sustainable operating improvement versus the $17.7 million Topgolf gain and foreign-exchange effects.
- Whether the gross-margin improvement and planned product-launch schedule persist, particularly given promotional activity and softer market conditions.
- Cash conversion, seasonal receivables and inventory levels, and continued access to borrowing-base liquidity as the business moves into the second half.
- Future evidence supporting any U.S. deferred-tax valuation-allowance reversal, and the tax and liquidity implications of foreign cash balances.
- The Topgolf investment’s realizable value: the filing’s estimated $207–$217 million fair-value range was transaction-based, Level 3, and subject to illiquidity and valuation uncertainty.