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ELY > SEC Filings for ELY > Form 10-Q on 30-Oct-2012All Recent SEC Filings

Show all filings for CALLAWAY GOLF CO

Form 10-Q for CALLAWAY GOLF CO


30-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Consolidated Condensed Financial Statements and the related notes that appear elsewhere in this report. See also "Important Notice to Investors" on page 2 of this report.

Results of Operations

Overview of Business and Seasonality

The Company designs, manufactures and sells high quality golf clubs and golf balls and also sells golf-related accessories, including golf bags, golf gloves and uPro GPS on-course measurement devices. The Company designs its products to be technologically advanced and in this regard invests a considerable amount in research and development each year. The Company's golf products are designed for golfers of all skill levels, both amateur and professional.

The Company has two operating segments that are organized on the basis of products, namely the golf clubs segment and golf balls segment. The golf clubs segment consists primarily of Callaway Golf woods, hybrids, irons, and wedges as well as Odyssey putters. This segment also includes other golf-related accessories described above and royalties from licensing of the Company's trademarks and service marks as well as sales of pre-owned golf clubs. The golf balls segment consists primarily of Callaway Golf and Top-Flite golf balls, until the sale of the Top-Flite brand in March 2012 (see Note 8). As discussed in Note 17 "Segment Information" to the Notes to Consolidated Condensed Financial Statements, the Company's operating segments exclude a significant amount of corporate general administrative expenses and other income (expense) not utilized by management in determining segment profitability.

In most of the regions where the Company does business, the game of golf is played primarily on a seasonal basis. Weather conditions generally restrict golf from being played year-round, except in a few markets, with many of the Company's on-course customers closing for the cold weather months. The Company's business is therefore also subject to seasonal fluctuations. In general, during the first quarter, the Company begins selling its products into the golf retail channel for the new golf season. This initial sell-in generally continues into the second quarter. The Company's second quarter sales are significantly affected by the amount of reorder business of the products sold during the first quarter. The Company's third quarter sales are generally dependent on reorder business but are generally less than the second quarter as many retailers begin decreasing their inventory levels in anticipation of the end of the golf season. The Company's fourth quarter sales are generally less than the other quarters due to the end of the golf season in many of the Company's key markets. However, fourth quarter sales can be affected from time to time by the early launch of product introductions related to the new golf season of the subsequent year. This seasonality, and therefore quarter to quarter fluctuations, can be affected by many factors, including the timing of new product introductions. In general, however, because of this seasonality, a majority of the Company's sales and most, if not all, of its profitability generally occurs during the first half of the year.

Approximately half of the Company's business is conducted outside of the United States and is conducted in currencies other than the U.S. dollar. As a result, changes in foreign currency rates can have a significant effect on the Company's financial results. The Company enters into foreign currency exchange contracts to mitigate the effects of changes in foreign currency rates. While these foreign currency exchange contracts can mitigate the effects of changes in foreign currency rates, they do not eliminate those effects, which can be significant. These effects include (i) the translation of results denominated in foreign currency into U.S. dollars for reporting purposes, (ii) the mark-to-market adjustments of certain intercompany balance sheet accounts denominated in foreign currencies, and (iii) the mark-to-market adjustments on the Company's foreign currency exchange contracts. In general, the Company's overall financial results are affected positively by a weaker U.S. dollar and are affected negatively by a stronger U.S. dollar as compared to the foreign currencies in which the Company conducts its business. The impact of the translation of sales denominated in foreign currencies into U.S. dollars had a net negative impact on the Company's financial results during the first nine months of 2012.


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Executive Summary

The Company experienced a 3% decline in sales and a 400 basis point decline in gross margins for the first nine months of 2012 compared to the same period in the prior year. This decline in sales and gross margins resulted from the sale of the Top-Flite and Ben Hogan brands earlier this year as well as sales promotions and other actions the Company took to enhance sell-through of 2012 product lines and prepare the business for a successful 2013. This decline in the Company's net sales and margins was partially offset by a $20.9 million (7%) decline in operating expenses for the first nine months of 2012 compared to the same period in 2011 primarily due to a reduction in employee costs as a result of the Company's Cost Reduction Initiatives. Although Management is not satisfied with the Company's financial results on an absolute basis, the results reflect many actions that should be beneficial in the long-term.

Net loss for the first nine months of 2012 decreased to $52.2 million from a net loss of $108.8 million in the comparable period of 2011. Loss per share decreased to $0.91 in the first nine months of 2012 compared to $1.81 in the first nine months of 2011. The Company's net loss for the first nine months of 2012 and 2011 includes the following charges and gains (in millions):

                                                                   Nine Months Ended
                                                                     September 30,
                                                                2012              2011
Cost Reduction Initiatives
Workforce reductions                                          $    (9.8 )      $       -
Transition costs                                                   (1.3 )
Asset write-offs                                                  (28.6 )
Gain on the sale of Top-Flite and Ben Hogan brands                  6.6                -
GOS charges                                                          -              (17.6 )
Charges related to the 2011 Reorganization and
Reinvestment Initiatives                                           (1.0 )           (12.6 )
2011 impairment charges                                              -               (5.4 )
Gain on the sale of buildings                                        -                6.2
Income tax provision(1)                                            (2.7 )           (69.1 )

Total charges                                                 $   (36.8 )      $    (98.5 )

(1) The Company's income tax provision for 2012 and 2011 is affected by a valuation allowance against the Company's U.S. deferred tax assets and is therefore not directly correlated to the amount of its pretax loss. See Note
12 "Income Taxes" to the Notes to Consolidated Condensed Financial Statements included in this Form 10-Q.

The Company continues to make progress on its cost-reduction initiatives (the "Cost Reduction Initiatives") announced in July 2012. These initiatives are aimed to better align the Company's cost structure with its current business levels and change the manner in which the Company approaches and operates its business. The actions include, (i) a reduction in workforce that impacts all regions and levels of the organization, (ii) greater focus on the Company's core product lines including licensing to third parties the rights to develop, manufacture and distribute certain non-core product lines (e.g. apparel and footwear) as well as transitioning to a third party based model for its integrated device business, and (iii) the reorganization of the Company's golf ball manufacturing supply chain, which includes the planned sale and lease-back of a reduced portion of the square footage of the Company's ball manufacturing facility in Chicopee, Massachusetts. The Company expects to incur total pre-tax charges of approximately $55.0 million, in connection with these initiatives, of which approximately two-thirds is expected to result in non-cash expenditures. To-date, the Company has incurred total charges related to its Cost Reduction Initiatives of $39.8 million, of which $35.1 million was recorded during the third quarter of 2012. These initiatives are estimated to yield approximately $60.0 million in gross annualized savings.

The Company continues to make solid progress on its turnaround plan. In addition to the Cost Reduction Initiatives discussed above, and the actions taken earlier this year, including the sale of the Top-Flite and Ben Hogan brands, the licensing of the Company's apparel and footwear businesses, changes in senior management,


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and changes in the Company's approach to product design and the sales and marketing functions, during the third quarter the Company also replaced a majority of its outstanding preferred stock with much less expensive 3.75% convertible debt, reached an agreement in principle on a sale/leaseback of its Chicopee, Massachusetts ball factory for a much smaller footprint and lower costs, and began transitioning to a third party based model for its integrated device business. These key initiatives are all consistent with Management's efforts to simplify the business, focus the team on the Company's core business of golf clubs and golf balls, and reduce its cost structure. Management is confident in its turnaround plan and optimistic that the Company's results will improve significantly in 2013.

Three-Month Periods Ended September 30, 2012 and 2011

Net sales for the third quarter of 2012 decreased to $147.9 million compared to $173.2 million in the third quarter of 2011. This decrease was primarily driven by a decline in sales in both the golf club and golf ball operating segments. The decline in sales in the golf club segment was primarily due to a decline in sales of woods and irons. The decline in sales in the golf ball segment was primarily due to the Company's sale of its Top-Flite brand in March 2012. These decreases were offset by an increase in putter sales resulting from the successful current year launch of the Company's Metal X putter platform. The Company's net sales by operating segment are presented below (dollars in millions):

                         Three Months Ended
                           September 30,                        Decline
                        2012            2011           Dollars            Percent
        Net sales:
        Golf clubs   $    121.3      $    140.5     $       (19.2 )              (14 )%
        Golf balls         26.6            32.7              (6.1 )              (19 )%

                     $    147.9      $    173.2     $       (25.3 )              (15 )%

For further discussion of each operating segment's results, see "Golf Club and Golf Ball Segments Results" below.

Net sales information by region is summarized as follows (dollars in millions):

                           Three Months Ended
                             September 30,                        Decline
                          2012            2011           Dollars            Percent
     Net sales:
     United States     $     57.1      $     73.9     $       (16.8 )              (23 )%
     Europe                  19.2            25.4              (6.2 )              (24 )%
     Japan                   41.6            41.8              (0.2 )                0 %
     Rest of Asia            16.1            17.5              (1.4 )               (8 )%
     Other countries         13.9            14.6              (0.7 )               (5 )%

                       $    147.9      $    173.2     $       (25.3 )              (14 )%

Net sales in the United States decreased $16.8 million (23%) to $57.1 million during the third quarter of 2012 compared to the same period in the prior year. The Company's sales in regions outside of the United States decreased $8.5 million to $90.8 million for the third quarter of 2012 compared to $99.3 million in the same quarter of 2011. This decrease was largely due to a decline in sales in Europe due to unfavorable market conditions in that region during the period. The Company's reported net sales in regions outside the United States in 2012 were unfavorably affected by the translation of foreign currency sales into U.S. dollars based upon 2012 exchange rates. If 2011 exchange rates were applied to 2012 reported sales in regions outside the U.S. and all other factors were held constant, net sales in such regions would have been $1.4 million higher than reported in the third quarter of 2012.


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For the third quarter of 2012, gross profit decreased by $43.6 million to $3.8 million from $47.4 million in the third quarter of 2011. Gross profit as a percentage of net sales ("gross margin") decreased to 3% in the third quarter of 2012 compared to 27% in the third quarter of 2011. The decrease in gross margin was primarily attributable to charges that were recognized in connection with the Company's Cost Reduction Initiatives that were announced in July 2012. These initiatives are targeted to streamline and simplify the Company's organizational structure as well as change the manner in which the Company approaches and operates its business. During the third quarter of 2012, the Company's gross margin was negatively affected by charges of $27.3 million (18.5 margin points) that include (i) the write-off of inventory, property, plant and equipment, and intangible assets in connection with the Company's decision to transition its integrated device business to a third party based model; (ii) the write-down of the Company's ball manufacturing facility in Chicopee, Massachusetts to its estimated net selling price as a result of the Company's decision to sell the building and lease back a reduced portion of the square footage to eliminate unused space at this facility; (iii) charges to write-down inventory related to the Company's decision to license to third parties the rights to develop, manufacture and distribute the Company's apparel and footwear product lines; and
(iv) charges related to reductions in workforce that impacted all regions and levels of the Company's business. In addition, gross margin was negatively affected by sales promotions offered during the third quarter of 2012 in the woods and irons product categories. These decreases were partially offset by the Company's completion of its global operations strategy initiatives ("GOS") in December 2011, which resulted in lower club conversion costs. During the third quarter of 2011, gross margin was negatively affected by $5.2 million of costs (or 3.0 margin points) in connection with these initiatives. See "Segment Profitability" below for further discussion of gross margins.

Selling expenses decreased by $2.0 million to $60.3 million (41% of net sales) in the third quarter of 2012 compared to $62.3 million (36% of net sales) in the comparable period of 2011. The dollar decrease was primarily due to a $3.0 million decrease in employee costs primarily as a result of a decline in headcount period over period, combined with a $0.9 million decline in travel and consulting. These decreases were partially offset by charges of $1.1 million in connection with the apparel and footwear licensing transition discussed above, in addition to a $1.6 million increase in advertising and promotional expenses, which is consistent with the Company's Reorganization and Reinvestment Initiatives announced in June 2011.

General and administrative expenses decreased by $2.6 million to $18.2 million (12% of net sales) in the third quarter of 2012 compared to $20.8 million (12% of net sales) in the comparable period of 2011. The dollar decrease was primarily due to a $2.2 million decrease in employee costs primarily due to a decline in headcount period over period as well as a $1.2 million decrease in legal expenses, partially offset by charges of $0.8 million in connection with the decision to transition in the Company's integrated device business to a third party based model.

Research and development expenses decreased by $0.5 million to $8.0 million (5% of net sales) in the third quarter of 2012 compared to $8.5 million (5% of net sales) in the comparable period of 2011 primarily due to reductions in employee headcount period over period partially offset by charges in connection with the Company's decision to transition in the Company's integrated device business to a third party based model.

Other expense, net decreased to $3.4 million in the third quarter of 2012 compared to $3.6 million in the comparable period of 2011 due to an increase in net foreign currency gains offset by an increase in interest expense in the third quarter of 2012 compared to the same period in 2011.

The Company's provision for income taxes decreased to $0.8 million for the third quarter of 2012 compared to $14.9 million for the comparable period of 2011. During the second quarter of 2011, the Company established a valuation allowance against its U.S. deferred tax assets. Due to the effects of this deferred tax asset valuation allowance, the Company's effective tax rate for the third quarter of 2012 is not comparable to the effective tax rate for the third quarter of 2011 as the Company's income tax amount is not directly correlated to the amount of its pretax loss.


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Net loss for the third quarter of 2012 increased to $86.8 million compared to a net loss of $62.6 million in the comparable quarter of 2011. Loss per share increased to $1.33 in the third quarter of 2012 compared to $1.01 in the comparable period of 2011. The Company's net loss for the third quarter of 2012 and 2011 includes the following charges (in millions):

                                                                 Three Months Ended
                                                                   September 30,
                                                              2012               2011
Pre-tax charges related to the Cost Reduction
Initiatives                                                 $   (35.1 )       $       -
Pre-tax charges related to the Reorganization and
Reinvestment Initiatives                                         (0.3 )             (7.4 )
Pre-tax GOS charges                                                -                (5.2 )
Income tax provision(1)                                          (0.8 )            (14.9 )

Total charges                                               $   (36.2 )       $    (27.5 )

(1) The Company's income tax provision for 2012 and 2011 is affected by a valuation allowance against the Company's U.S. deferred tax assets and is therefore not directly correlated to the amount of its pretax loss. See Note
12 "Income Taxes" to the Notes to Consolidated Condensed Financial Statements included in this Form 10-Q.

Golf Clubs and Golf Balls Segments Results for the Three Months Ended
September 30, 2012 and 2011

Golf Clubs Segment

Net sales information by product category is summarized as follows (dollars in
millions):



                              Three Months Ended
                                September 30,                    Growth/(Decline)
                             2012            2011           Dollars            Percent
  Net sales:
  Woods                   $     31.2      $     41.5     $       (10.3 )              (25 )%
  Irons                         31.0            38.2              (7.2 )              (19 )%
  Putters                       15.7            15.1               0.6                  4 %
  Accessories and other         43.4            45.7              (2.3 )               (5 )%

                          $    121.3      $    140.5     $       (19.2 )              (14 )%

The $10.3 million (25%) decrease in net sales of woods to $31.2 million for the quarter ended September 30, 2012 was primarily due to a decrease in both average selling prices and sales volume. The decrease in average selling prices was primarily due to sales promotions experienced during the quarter on certain in-line drivers and fairway woods. This decrease was partially offset by an increase in sales of the more premium Legacy 12 drivers launched during the third quarter compared to sales of the Legacy Black driver which was launched during the second quarter of 2011. The decrease in sales volume was primarily due to a decline in hybrid club sales combined with a decrease in closeout activity of older woods products in the second and third years of their product lifecycles.

The $7.2 million (19%) decrease in net sales of irons to $31.0 million for the quarter ended September 30, 2012 was primarily attributable to a decline in average selling prices partially offset by an increase in sales volume. The decline in average selling prices was primarily due to increased sales promotions on certain irons products during the third quarter of 2012 compared to the same quarter in the prior year combined with an unfavorable shift in product mix from sales of higher priced RAZR X irons during the third quarter of 2011 to sales of more moderately priced irons products during the third quarter of 2012. The increase in sales volumes was primarily due to increased sales of the Company's value priced irons.

The $0.6 million (4%) increase in net sales of putters to $15.7 million for the quarter ended September 30, 2012 was primarily attributable to an increase in sales volume partially offset by a decline in average selling


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prices. The increase in sales volume was due to the successful current year launch of the Metal X platform of putters. The decline in average selling prices was largely attributable to increased closeout activity in preparation for the Metal X product launch.

The $2.3 million (5%) decrease in net sales of accessories and other products to $43.4 million for the quarter ended September 30, 2012 was primarily driven by a decline in sales of accessories, packaged sets and golf bags. These decreases were partially offset by increased sales of pre-owned products, apparel due to increased sales in Europe and South Pacific and GPS devices due to the current year launch of the Company's new MX+ GPS devices.

Golf Balls Segment

Net sales information for the golf balls segment is summarized as follows
(dollars in millions):



                         Three Months Ended
                           September 30,                        Decline
                       2012             2011           Dollars            Percent
        Net sales:
        Golf balls   $    26.6       $     32.7     $        (6.1 )              (19 )%

The $6.1 million (19%) decrease in net sales of golf balls to $26.6 million for the quarter ended September 30, 2012 was primarily due to a decrease in sales volume partially offset by an increase in average selling prices. The decrease in sales volume was primarily due to a decline in sales of Top-Flite balls primarily resulting from the sale of the Top-Flite brand in March 2012. In recent years, sales of Top-Flite and Ben Hogan branded golf balls have represented approximately 25% of the Company's total golf ball annual sales. The increase in average selling prices was due to a favorable shift in sales mix from lower priced Top-Flite balls to higher priced Callaway golf balls combined with the successful current year launch of the HX Chrome and HX Black Tour balls.

Segment Profitability

Profitability by operating segment is summarized as follows (dollars in
millions):



                                            Three Months Ended
                                               September 30,                          Growth/(Decline)
                                        2012               2011(1)              Dollars              Percent
Loss before income taxes:
Golf clubs(2)                         $   (57.8 )       $       (23.8 )      $       (34.0 )               (143 )%
Golf balls(2)                             (13.8 )                (6.7 )               (7.1 )               (106 )%
Reconciling items(3)                      (14.4 )               (17.2 )                2.8                   16 %

                                      $   (86.0 )       $       (47.7 )      $       (38.3 )                (80 )%

(1) Certain prior period amounts were reclassified to conform with the current year presentation.

(2) The Company's golf clubs and golf balls operating segments include the following pre-tax charges:

$23.6 million and $9.3 million, respectively, in connection with the Company's Cost Reduction Initiatives during the third quarter of 2012;

$3.9 million and $1.3 million, respectively, in connection with the final phase of the Company's GOS Initiatives during the third quarter of 2011. The Company completed the final phase of the GOS initiatives in December 2011;

$4.2 million and $1.0 million, respectively, in connection with the Company's Reorganization and Reinvestment Initiatives during the third quarter of 2011; and

$0.3 million and $0.1 million, in connection with the Company's Reorganization and Reinvestment Initiatives during the third quarter of 2012.


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(3) Reconciling items represent corporate general and administrative expenses and other income (expense) not included by management in determining segment profitability. The reconciling items include pre-tax charges of:

$2.2 million in connection with the Cost Reduction Initiatives during the third quarter of 2012.

$2.3 million in connection with the Company's Reorganization and Reinvestment Initiatives during the third quarter of 2011.

See Note 2 "Restructuring Initiatives" to the Notes to Consolidated Condensed Financial Statements for details regarding the initiatives referenced herein.

Pre-tax loss in the Company's golf clubs operating segment increased to $57.8 million for the third quarter of 2012 from $23.8 million for the comparable period in the prior year. This increase in pre-tax loss was primarily driven by a $35.5 million decrease in gross margin combined with a decrease in net sales as discussed above. The decrease in gross margin was primarily driven by $23.6 million of charges incurred in connection with the Company's Cost Reduction Initiatives announced in July 2012, compared to $8.0 million of Restructuring and GOS charges incurred in 2011. In addition, club margins were negatively affected by sales promotions, closeout activity and increases in club component costs as compared to the third quarter in 2011.

Pre-tax loss in the Company's golf balls operating segment increased to $13.8 . . .

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