Callaway Golf Company — 2011 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; filed November 2, 2011. Figures below are in millions of dollars except per-share amounts. The business is seasonal, with most sales and profitability generally in the first half of the year.
Financial performance and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $173.2 | $175.6 | $732.7 | $782.1 |
| Gross profit | $47.4 | $49.1 | $273.7 | $310.0 |
| Gross margin | 27% | 28% | 37% | 40% |
| Operating income (loss) | $(44.2) | $(38.0) | $(31.3) | $15.5 |
| Net income (loss) | $(62.6) | $(18.3) | $(108.8) | $13.5 |
| Basic and diluted EPS | $(1.01) | $(0.33) | $(1.81) | $0.09 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $21.9 | $55.9 |
- Revenue and segments: Nine-month golf-club sales fell 6% to $600.6; golf-ball sales fell 9% to $132.1. Q3 club sales were nearly flat, while golf-ball sales declined 7%.
- Cash and liquidity: Cash was $64.3 at September 30, up from $55.0 at year-end 2010. Current assets were $454.2 and current liabilities $148.1. Operating cash flow of $21.9 was below the prior-year $55.9. Capital expenditures were $21.2; building-sale proceeds were $18.3; dividends paid were $9.8.
- Debt and facility: No ABL borrowings were outstanding at quarter-end; letters of credit totaled $0.5. The revolving facility provides up to $210.0, subject to borrowing-base availability; reported maximum funded indebtedness available at quarter-end was approximately $88.0. The company reported compliance with facility restrictions.
Material changes and notable items
- Nine-month sales declined 6%, and gross margin contracted 300 basis points. Management cited a challenging golf market, competitor product success, lower production volumes and fixed-cost absorption, and weaker Japan sales; favorable currency translation partly offset these pressures.
- The nine-month net loss included a $51.9 non-cash U.S. deferred-tax valuation allowance, $12.2 of tax expense from reversal of prepaid tax assets, $12.6 of reorganization charges, $17.6 of Global Operations Strategy charges, and a $5.4 non-cash impairment of Top-Flite trade names and trademarks. A $6.2 gain on building sales partly offset charges.
- The tax provision was $69.1 for the nine months, versus a $3.5 benefit in 2010. The company said it would recognize a negative annual effective tax rate for 2011 and expected another $9.3 of tax expense in Q4 as remaining prepaid taxes were charged. The valuation allowance was non-cash; its recognition does not itself prevent future use of tax attributes, subject to applicable limitations.
- A correction to the December 2010 balance sheet increased long-term deferred tax liabilities by approximately $9.0 and reduced retained earnings by $9.4; the company said it was not material to previously reported annual statements. It also identified a nonmaterial overstatement of the valuation allowance in the first-half 2011 statements and disclosed prospective corrections.
- Inventory fell to $204.2 from $268.6 at December 2010, which management attributed largely to seasonal patterns and the absence of a comparable prior-year product launch.
Outlook, risks and contingencies
- Management expected the June 2011 reorganization to produce about $50.0 in annualized pretax savings, with up to half reinvested in brand and demand creation. Expected total charges were $15.0–$20.0; most remaining charges were expected in Q4 2011.
- The company increased its estimated total Global Operations Strategy charges to approximately $40.0–$45.0, following an October sublease-related charge. It expected to complete the operational transition by year-end 2011; approximately $7.8 of future charges remained estimated as of September 30.
- Management anticipated a much-improved 2012 and a return to profitability, citing savings, brand investment, 2012 products, and supply and distribution efficiencies. This is forward-looking and depends on execution and market conditions.
- Risks include weak consumer demand and golf-market conditions, competitive and promotional pressure, foreign-exchange movements, execution delays or higher costs in restructuring, and potential further impairment if market conditions deteriorate. The company said its business recovery in Japan was uncertain.
- Material litigation includes ongoing patent disputes with Acushnet and a Corporate Trade Inc. claim seeking approximately $8.9; the ultimate outcomes and aggregate losses could not be estimated. Management did not expect pending matters, individually or in aggregate, to materially affect financial position, while acknowledging an adverse resolution could materially affect results or cash flow in a period.
- Minimum contractual commitments totaled $140.6, including $83.2 of unconditional purchase obligations, $40.1 of operating leases, $7.4 of preferred dividends under the stated conversion scenario, and $9.9 of uncertain tax contingencies. Management believed liquidity would be sufficient for at least 12 months, subject to economic, operating, currency, Japan-recovery, and covenant risks. Planned 2011 capital expenditures were approximately $30.0.
- The 7.50% convertible preferred stock carries cumulative dividends; approximately 19.9 million common shares could be issued upon conversion. Potential dilution was excluded from loss-period EPS as antidilutive.
Important facts for investors to verify
- Whether the company achieves its stated return to profitability in 2012 and realizes the planned savings while funding brand reinvestment.
- Actual restructuring charges, cash costs, completion timing, and whether the Monterrey and logistics transitions deliver the projected efficiencies.
- Sales trends, margins, product launches, competitive position, and recovery in Japan, particularly given lower year-to-date sales and golf-ball demand.
- Cash generation, borrowing-base availability and covenant compliance, and the effect of contractual commitments and preferred dividends on liquidity.
- Future tax expense, recoverability and possible use of deferred tax assets, ownership-change limitations, and the outcome of disclosed tax corrections.
- Developments in patent and other litigation, the uPro MX product withdrawal and warranty costs, and potential further impairment of goodwill or intangible assets.