Callaway Golf Company — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011. Unaudited results; amounts below are in U.S. dollars unless noted. Callaway designs, manufactures and sells golf clubs, golf balls and related products. Its business is seasonal, with most sales and profitability generally occurring in the first half.
Financial results
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $273.8m | $303.6m | $559.4m | $606.5m |
| Gross profit | $102.7m | $123.6m | $226.3m | $260.9m |
| Gross margin | 37% | 41% | 40% | 43% |
| Operating income (loss) | $(10.2)m | $25.1m | $12.8m | $53.5m |
| Net income (loss) | $(63.6)m | $11.5m | $(50.7)m | $31.8m |
| Basic and diluted EPS | $(1.03) | $0.14 | $(0.87) | $0.42 basic; $0.38 diluted |
- Q2 sales fell 10%; first-half sales fell 8%. Both golf clubs and golf balls sales declined in the first half: 7% and 9%, respectively.
- For the first half, cash used in operating activities was $25.4m, capital expenditures were $14.1m, and investing activities provided $4.1m, including proceeds from property sales. Financing activities provided $31.9m, including $37.1m of net ABL borrowings. Cash increased $11.5m to $66.5m.
- At June 30, cash was $66.5m and ABL borrowings were $37.1m. The June 30 facility was a secured, borrowing-base revolver of up to $75m, with a 4.75% stated rate at period end. On July 22, 2011, after quarter-end, the company amended the facility, increasing its stated size to $210m, subject to borrowing-base availability. The company reported compliance with facility restrictions at June 30.
- At June 30, accounts receivable was $253.5m and inventory was $215.3m, compared with $144.6m and $268.6m at December 31, 2010. The filing attributes much of the receivables increase to seasonal sales and notes inventory was 23.3% of trailing-twelve-month sales, versus 21.8% a year earlier.
Material changes and unusual items
- The company recorded a $57.2m non-cash tax expense to establish a valuation allowance against U.S. deferred tax assets. This drove the reported net losses; management said reversal would depend on sufficient evidence of a sustained return to U.S. profitability.
- Q2 included a $5.4m non-cash impairment of Top-Flite trade names and trademarks, reflecting lower estimated future cash flows amid competitive pressure in mass-market golf-ball channels.
- Global Operations Strategy restructuring charges were approximately $12.3m in the first half, including $5.8m in Q2. Estimated total program costs were $35m–$40m, with about $9.5m of future charges estimated as of June 30. The plan includes moving manufacturing and distribution operations, including production in Monterrey, Mexico.
- A separate reorganization and reinvestment plan announced June 29 is expected to generate approximately $50m of annualized pre-tax savings, with up to half reinvested in brand and demand-creation efforts. Estimated total charges are $15m–$20m, including $5.2m recognized in Q2.
- The first half included a $6.2m recognized gain related to the sale-and-leaseback of three Carlsbad buildings; total sale gain was $12.7m, with part deferred and recognized over the lease terms.
Management outlook, commentary and risks
- Management said the company’s recovery lagged the golf industry, citing insufficient prior brand investment, product-launch timing, reduced market share in several categories, competition and Japan’s March 2011 natural disaster. Foreign exchange translation added about $19m to first-half sales compared with 2010 exchange rates.
- Management expected to complete the North American manufacturing and distribution transition in 2011, Japan sales to recover toward more normal levels in 2012, and emerging markets to continue growing. It said these factors and the restructuring initiatives should support a return to profitability in 2012; these are forward-looking expectations, not assurances.
- The company expected 2011 capital expenditures of $25m–$30m and believed cash from operations and financing facilities would cover operating needs, capital expenditures and obligations for at least the next 12 months. It cautioned that economic conditions, foreign exchange, Japan’s recovery and covenant compliance could affect liquidity.
- Risks include weak consumer demand, promotional activity, competitors’ products, product acceptance, foreign-exchange volatility, execution and cost risks in restructuring and manufacturing transitions, and seasonality. A 10% adverse currency sensitivity scenario indicated an estimated maximum one-day loss of $24.6m on foreign-exchange contracts; management said underlying exposures could partly offset it.
- Legal matters include ongoing golf-ball patent disputes with Acushnet and a separate corporate-trade-credit case in which the counterparty seeks approximately $8.9m. Management could not estimate aggregate potential losses, though it did not expect current matters to materially affect financial position; adverse resolutions could affect results or cash flows in a particular period.
- Other notable obligations include $88.7m of minimum contractual purchase and other commitments over the next four years, $41.9m of operating lease commitments, and a $9.4m uncertain-tax-position liability. The preferred stock carries a 7.5% cumulative dividend; reported common EPS deducts preferred dividends.
Important facts for investors to verify
- Whether sales trends, gross margins and segment profitability improve, and whether the company achieves its stated 2012 return-to-profitability objective.
- Actual restructuring charges, timing and realized savings, including the amount reinvested in brand and demand creation and completion of the manufacturing transition.
- Whether U.S. operations return to sustained profitability sufficient to support realization or reversal of the deferred-tax valuation allowance.
- Borrowing-base availability and covenant headroom under the amended $210m ABL facility, alongside seasonal working-capital and operating cash-flow needs.
- Developments in Japan, competitive pressure—particularly in golf balls and putters—and the status and potential financial exposure of the patent and other legal disputes.
- Warranty costs: the reserve rose to $12.0m, with increased provision attributed primarily to inconsistent performance of certain GPS devices.