Callaway Golf Company — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; unaudited. Callaway designs, manufactures and sells golf equipment and related products. Results are seasonal, with sales and profitability generally concentrated in the first half of the year.
Financial results
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $351.9 million | $287.8 million |
| Gross profit / margin | $164.9 million / 46.9% | $130.4 million / 45.3% |
| Operating income | $61.7 million | $40.1 million |
| Net income | $55.3 million | $41.7 million |
| Diluted EPS | $0.61 | $0.47 |
| Operating cash flow | $(124.8) million | $(100.6) million |
| Capital expenditures | $4.0 million | $3.1 million |
Sales increased 22%; diluted EPS rose 30%. Golf clubs contributed $299.2 million of sales, up 22%, and golf balls contributed $52.7 million, up 24%. Sales grew across all reported regions; foreign currency translation reduced international sales by an estimated $6.4 million. Gross margin improved about 160 basis points, reflecting product mix, pricing, cost-reduction benefits and manufacturing and distribution efficiencies. Operating expenses rose $12.9 million, including increased product marketing, stock-based compensation and tour investment. Other expense was $4.9 million, versus other income of $4.0 million a year earlier, primarily due to foreign-exchange contract valuation changes.
Liquidity, debt and balance sheet
- Cash was $23.6 million at March 31, down from $36.8 million at year-end. The company used $124.8 million in operating cash, largely reflecting seasonal receivables growth.
- Accounts receivable was $289.2 million, up from $92.2 million at year-end; inventory was $246.2 million, down from $263.5 million at year-end but $44.2 million above March 2013.
- Asset-based revolving credit borrowings were $140.6 million; convertible notes had a net carrying amount of $108.0 million. Total available liquidity, including cash, was reported as $76.1 million. ABL availability alone after borrowings and letters of credit was approximately $52.5 million.
- The ABL facility provides up to $230 million, matures June 30, 2016, and carried a trailing-12-month average interest rate of 5.15% at quarter-end. The company reported compliance with its debt covenants.
- Management said cash, expected operating cash flows and the ABL facility should fund requirements for at least the next 12 months. Planned 2014 capital expenditures were approximately $15 million.
Changes, outlook and risks
- Management said the turnaround plan remained on track and attributed growth to consumer-oriented product launches and market-share gains. Cost-reduction initiatives completed in 2013 were expected to generate approximately $60 million of annualized pretax savings; no related charges were recorded in Q1 2014, compared with $3.5 million in Q1 2013.
- No specific full-year earnings or sales guidance was provided. Management cautioned that Q2 and potentially the rest of 2014 could face difficult conditions: delayed golf-season openings and unfavorable weather, high retail inventories and heavy promotional activity. Worse-than-expected conditions could hurt results.
- Foreign-currency contract losses were $2.9 million in Q1 2014, compared with gains of $7.8 million a year earlier. Contracts are not designated for hedge accounting; reported fair-value changes affect earnings. A modeled 10% adverse currency move implied a $22.4 million estimated maximum one-day loss on contracts, which management expected to be partly offset by underlying exposures.
- The U.S. deferred-tax valuation allowance remained in place after recent U.S. taxable losses; future reversal depends on sufficient positive evidence, including sustained U.S. profitability. The Q1 tax provision was $1.5 million, primarily related to foreign operations.
- Pending Cleveland Golf litigation alleges trademark infringement over the phrase “Designed by Roger Cleveland”; plaintiffs seek unspecified damages and injunctive relief. Management said it could not estimate the ultimate loss, but did not expect pending matters to materially affect financial position.
- The company reported $61.3 million of minimum unconditional purchase obligations over the next three years. In February 2014, the board cancelled the $100 million share-repurchase authorization and required further board approval for open-market repurchases.
Key facts for investors to verify
- Whether strong product sell-through and market-share gains continued after Q1, and whether elevated retail and company inventory required more discounting.
- Subsequent operating cash flow, receivables collections and ABL borrowing-base availability, given substantial seasonal cash use and reliance on revolving credit.
- Actual gross-margin performance after currency effects, higher component costs and promotional activity.
- Progress toward the turnaround and cost savings, and evidence supporting any future release of the U.S. deferred-tax valuation allowance.
- Developments in the Cleveland Golf litigation and any material change in contingent obligations or debt-covenant compliance.