Callaway Golf Company — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. Unaudited consolidated results. Callaway designs and sells golf clubs, balls, apparel and related products. The business is seasonal, with most sales and profitability generally occurring in the first half of the year.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 / comparison |
|---|---|---|
| Net sales | $274.1 million | $284.2 million; down 3.6% |
| Gross profit / margin | $132.4 million / 48.3% | $127.3 million / 44.8% |
| Operating income | $45.3 million | $36.9 million |
| Net income | $38.4 million | $35.8 million |
| Diluted EPS | $0.40 | $0.39 |
| Basic EPS | $0.41 | $0.46 |
| Cash used in operations | $71.5 million | $90.3 million |
| Capital expenditures | $5.0 million | $2.4 million |
Gross margin improved 350 basis points. Selling, general and administrative expenses declined overall, while research and development expense increased. Interest expense fell to $0.8 million from $2.1 million following retirement of the convertible notes in 2015. Other expense was $4.9 million versus other income of $2.5 million, mainly reflecting higher foreign-currency losses, particularly on hedging contracts.
At March 31, cash was $35.1 million, accounts receivable $233.2 million, inventory $186.1 million, and total assets $711.9 million. Current liabilities were $220.4 million and shareholders’ equity was $452.7 million. Cash declined $14.7 million from year-end; operating cash outflow was partly funded by $64.0 million of net borrowings under asset-based facilities.
Borrowings under the U.S./Canada/U.K. ABL and Japan ABL facilities totaled $79.0 million; no convertible notes were outstanding. Including cash, reported available liquidity was $227.3 million. The company reported compliance with facility covenants. Management believed cash, operating cash flows and credit availability would fund requirements for at least 12 months.
Material changes and management commentary
- Sales declined mainly because of planned changes to product-launch timing and extended product life cycles, together with unfavorable foreign exchange. Golf-club sales fell 3.5% and golf-ball sales fell 3.7%.
- Management attributed improved margins to manufacturing and supply-chain efficiencies, higher average selling prices in selected categories and reduced promotional activity. The 2016 product line was described as well received; Callaway said it maintained the leading U.S. dollar market share position in total golf clubs.
- Sales fell in the U.S. by 5.0% and Europe by 9.3%; Japan sales increased 5.6%. Management estimated that applying 2015 exchange rates to international Q1 2016 sales would have added $2.2 million.
- In April 2016, Callaway sold Topgolf preferred shares for $23.4 million, recognizing an expected gain of approximately $17.7 million, and retained an approximately 15% interest. The filing cautions that the remaining investment is illiquid and its estimated value may not be realizable.
- The company announced an agreement in principle for a Japan apparel joint venture with TSI, expected to be finalized in the second half of 2016. Callaway expects to own 52% and consolidate the venture if completed; definitive agreements and closing conditions remained outstanding.
Outlook, risks and contingencies
- Management expected 2016 capital expenditures of approximately $15 million and said it had no material capital-expenditure commitments at quarter-end.
- Approximately 95% of cash was held outside the United States. Repatriation could trigger incremental U.S. taxes; management said it did not intend to repatriate funds for ordinary domestic liquidity needs.
- A $164.6 million valuation allowance remained against U.S. deferred tax assets. Continued U.S. profitability could support a future reversal and significant one-time, non-cash tax benefit, but timing and realization are uncertain.
- Risks include seasonal demand and weather, consumer and retailer demand, product acceptance, promotional activity, foreign exchange and hedging volatility, supplier/manufacturing disruptions, credit availability and covenant compliance, and golf participation trends.
- The company reported routine and other legal matters but could not estimate aggregate potential losses; it believed current matters were not expected to materially affect financial position, while acknowledging an unfavorable outcome could affect results or cash flows in a particular period.
- Minimum purchase obligations were $68.5 million over the next four years. The company disclosed $1.0 million in standby letters of credit and stated it had no material off-balance-sheet arrangements.
Investor verification points
- Confirm subsequent-period sales, product reorder trends and whether the shifted launch calendar supports revenue recovery.
- Track gross-margin durability and whether operating efficiencies and reduced promotions persist.
- Reconcile foreign-exchange and derivative impacts: Q1 other expense was $4.9 million, and the filing estimated a $35.7 million one-day loss under a hypothetical 10% adverse currency move; underlying exposures may partly offset it.
- Monitor seasonal operating cash use, ABL availability, borrowings, and covenant compliance.
- Verify completion and accounting for the Topgolf share sale and Japan joint venture, including proceeds, gain recognition, valuation and closing terms.
- Assess evidence supporting any reversal of the U.S. deferred-tax valuation allowance and the potential tax consequences of foreign cash repatriation.