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ELY > SEC Filings for ELY > Form 10-Q on 29-Apr-2013All Recent SEC Filings

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Form 10-Q for CALLAWAY GOLF CO


29-Apr-2013

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 apparel, golf footwear, golf bags, gloves, eyewear and other golf-related accessories. 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 woods, hybrids, irons, wedges and putters 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 balls. 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 as well as weather conditions. 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.

More than 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 Company's reported net sales in regions outside the U.S. in 2013 were negatively affected by the translation of foreign currency sales into U.S. dollars based on 2013 exchange rates. If 2012 exchange rates were applied to 2013 reported sales in regions outside the U.S. and all other factors were held constant, net sales in such regions would have been $8.1 million higher than the net sales reported in the first quarter of 2013.


Table of Contents

Executive Summary

The Company's operating results for the first quarter of 2013 improved compared to the first quarter of 2012 due to increases in net sales and gross margin combined with a decrease in operating expenses. The strength of the Company's 2013 product line, including its new X Hot products and Versa line of putters, combined with the earlier timing of product launches in the first quarter of 2013 compared to the first quarter of 2012, resulted in a slight increase in net sales for the first quarter of 2013 to $287.8 million compared to net sales of $285.1 million in the first quarter of 2012. The Company achieved this increase in net sales despite (i) an $8.1 million negative impact on net sales resulting from unfavorable changes in foreign currency exchange rates during the first quarter of 2013 compared to the same period in 2012 and (ii) a $19.6 million negative impact on net sales in the first quarter of 2013 compared to the same period in 2012 resulting from the 2012 sale of the Top-Flite and Ben Hogan brands and the Company's transition to a third party model for other products, including U.S. apparel and footwear.

Gross margin increased by 170 basis points to 45.3% during the first quarter of 2013 compared to 43.6% during the comparable quarter of 2012. This improvement was primarily driven by the current year launch of the Razr Fit Extreme and X Hot family of woods, which have higher margins compared to the predecessor Razr Fit and Razr X family of woods launched in the first quarter of 2012. In addition, gross margin was favorably affected by improvements in the Company's cost structure resulting from the Company's 2012 restructuring initiatives (the "Cost Reduction Initiatives"). The Company continues to make progress on its Cost Reduction Initiatives, which resulted in a 6% or $6.2 million reduction in operating expenses in the first quarter of 2013 compared to the first quarter of 2012.

The increases in sales and gross margins and the decrease in operating expenses contributed to a $9.9 million increase in net income and a $0.10 increase in earnings per share for the first quarter of 2013 compared to the first quarter of 2012. Overall, the first quarter was an important first step in the Company's multi-year turnaround and management is pleased the recovery is on track. It is still early in the year, though, and the second quarter will have a big impact on the Company's ability to achieve its full year financial targets. Looking forward, the 2013 golf season is experiencing a delayed start in many geographical regions due to inclement weather, which could affect the Company's second quarter results, and the Company anticipates that the foreign currency headwinds experienced during the first quarter will continue through the balance of the year. Despite these challenges, management expects that its 2013 full year operating results will be significantly improved compared to 2012.

Three-Month Periods Ended March 31, 2013 and 2012

Net sales for the first quarter of 2013 increased $2.7 million to $287.8 million compared to $285.1 million in the first quarter of 2012. This increase was primarily due to increases in sales of woods and putters resulting from the successful launch of the Company's X Hot woods and Versa putters which were both introduced during the first quarter of 2013, combined with the earlier timing of product launches in the first quarter of 2013 compared to the first quarter of 2012. These increases were partially offset by a decline in sales of the Company's accessories and other products primarily due to the transition of the Company's apparel and footwear sales in the U.S. to a licensing arrangement during the second half of 2012. Additionally, the Company's net sales for the first quarter of 2013 were negatively impacted by $8.1 million resulting from unfavorable fluctuations in foreign currency rates. The Company's net sales by operating segment are presented below (dollars in millions):

                             Three Months Ended
                                  March 31,                    Growth
                              2013          2012        Dollars       Percent
              Net sales:
              Golf clubs   $    244.8      $ 242.6     $     2.2             1 %
              Golf balls         43.0         42.5           0.5             1 %

                           $    287.8      $ 285.1     $     2.7             1 %


Table of Contents

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
                                   March 31,                Growth/(Decline)
                               2013          2012        Dollars         Percent
          Net sales:
          United States     $    159.8      $ 149.7     $    10.1               7 %
          Europe                  38.3         42.7          (4.4 )           (10 )%
          Japan                   44.1         42.2           1.9               5 %
          Rest of Asia            20.1         18.0           2.1              12 %
          Other countries         25.5         32.5          (7.0 )           (22 )%

                            $    287.8      $ 285.1     $     2.7               1 %

Net sales in the United States increased $10.1 million (7%) to $159.8 million during the first quarter of 2013 compared to the same period in the prior year. As mentioned above, this increase was primarily due to the successful launch of the Company's new 2013 woods and putter products combined with the earlier timing of product launches. The Company's sales in regions outside of the United States decreased $7.4 million to $128.0 million for the first quarter of 2013 compared to $135.4 million in the same quarter of 2012. This decrease was largely caused by a decline in sales in Canada and Europe due to unusually cold weather in those regions during the first quarter of 2013. This was partially offset by an increase in sales in Japan primarily due to favorable consumer acceptance of the Company's new products launched in that region during the current quarter. Additionally, the Company's reported net sales in regions outside the United States in 2013 were unfavorably affected by the translation of foreign currency sales into U.S. Dollars based upon 2013 exchange rates. If 2012 exchange rates were applied to 2013 reported sales in regions outside the U.S. and all other factors were held constant, net sales in such regions would have been $8.1 million higher than reported in the first quarter of 2013.

Gross profit increased $6.0 million to $130.4 million for the first quarter of 2013 compared to $124.4 million in the first quarter of 2012. Gross profit as a percentage of net sales ("gross margin") increased to 45.3% in the first quarter of 2013 compared to 43.6% in the first quarter of 2012. The increase in gross margin was primarily due to (i) improvements in the Company's cost structure as a result of the 2012 Cost Reduction Initiatives; (ii) a decrease in closeout activity in the putters category during the first quarter of 2013 combined with the successful launch of the Versa putter; and (iii) the current year launch of the Razr Fit Extreme family of woods and X Hot drivers, which have higher margins relative to the Razr Fit and Razr X woods that were launched in the first quarter of 2012. These increases were partially offset by an increase in club component costs due to more expensive materials and technology incorporated into the X Hot family of woods and Versa putters, in addition to charges incurred during the first quarter of 2013 in connection with the Cost Reduction Initiatives. See "Segment Profitability" below for further discussion of gross margins.


Table of Contents

Selling expenses decreased by $8.5 million to $68.3 million (24% of net sales) in the first quarter of 2013 compared to $76.8 million (27% of net sales) in the comparable period of 2012. This decrease was primarily due to the Company's Cost Reduction Initiatives, which resulted in a $5.1 million decline in employee costs and travel and entertainment expenses.

General and administrative expenses increased by $2.4 million to $14.6 million (5% of net sales) in the first quarter of 2013 compared to $12.2 million (4% of net sales) in the comparable period of 2012. This increase was primarily due to the recognition of a $6.6 million net gain in connection with the sale of the Company's Top-Flite and Ben Hogan brands during the first quarter of 2012. This increase was partially offset by headcount reductions due to the Company's Cost Reduction Initiatives, which resulted in a $1.7 million decrease in employee costs, in addition to decreases of $1.0 million in professional fees and $0.9 million in legal expenses.

Research and development expenses were relatively flat at $7.4 million (3% of net sales) in the first quarter of 2013 compared to $7.5 million (3% of net sales) in the comparable period of 2012.

Other income, net increased to $4.0 million in the first quarter of 2013 compared to $3.7 million in the comparable period of 2012. This improvement was primarily due to an increase in net foreign currency gains in the first quarter of 2013 compared to the same period in 2012, partially offset by an increase in interest expense.

The Company's provision for income taxes was $2.5 million for the first quarter of 2013, compared to a benefit of $0.3 million for the first quarter of 2012. The $2.8 million increase resulted from the sale of indefinite lived assets relating to the Top-Flite and Ben Hogan brands during the first quarter of 2012. Due to the effects of the Company's valuation allowance against its U.S. deferred tax assets, the Company's effective tax rate for the first quarter of 2013 is not comparable to the effective tax rate for the first quarter of 2012 as the Company's income tax amount is not directly correlated to the amount of its pretax income.

Net income for the first quarter of 2013 increased to $41.7 million compared to $31.8 million in the comparable quarter of 2012. Diluted earnings per share increased to $0.47 in the first quarter of 2013 compared to $0.37 in comparable period of 2012. The Company's net income for the first quarter of 2013 and 2012 includes the following charges and gains (in millions):

                                                               Three Months Ended
                                                                    March 31,
                                                               2013            2012
 Pre-tax charges related to the Cost Reduction Initiatives   $    (3.5 )      $   -
 Pre-tax gain on the sale of brands                                 -            6.6
 Income tax (provision) benefit(1)                                (2.5 )         0.3

 Total charges                                               $    (6.0 )      $  6.9

(1) The Company's income tax provision for 2013 and 2012 is affected by the establishment of a valuation allowance against the Company's U.S. deferred tax assets and is therefore not directly correlated to the amount of its pretax income. See Note 12 "Income Taxes" to the Notes to Consolidated Condensed Financial Statements included in this Form 10-Q.


Table of Contents

Golf Clubs and Golf Balls Segments Results for the Three Months Ended March 31, 2013 and 2012

Golf Clubs Segment

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



                                 Three Months Ended
                                      March 31,                Growth/(Decline)
                                  2013          2012        Dollars         Percent
       Net sales:
       Woods                   $     99.5      $  90.7     $      8.8             10 %
       Irons                         57.5         58.3           (0.8 )           (1 )%
       Putters                       32.6         24.1            8.5             35 %
       Accessories and other         55.2         69.5          (14.3 )          (21 )%

                               $    244.8      $ 242.6     $      2.2              1 %

The $8.8 million (10%) increase in net sales of woods to $99.5 million for the quarter ended March 31, 2013 resulted from an increase in both sales volume and average selling prices. The increase in sales volume was primarily due to the successful launch of the X Hot woods, which experienced better sell-in at retail than the prior year Razr X woods, combined with the earlier timing of product launches in the first quarter of 2013 compared to the first quarter of 2012. The increase in average selling prices was due to the introduction of the X Hot and Razr Fit Xtreme woods at higher average selling prices than their predecessors, the Razr X and Razr Fit woods sold in the same period of the prior year.

The $0.8 million (1%) decrease in net sales of irons to $57.5 million for the quarter ended March 31, 2013 was primarily attributable to a $4.7 million decline in sales of wedges almost completely offset by a $3.9 million increase in sales of irons. The decline in sales of wedges was primarily due to the timing of new product launches resulting from the introduction of the Forged wedges during the first quarter of 2012 with no comparable new wedge launch during the first quarter of the current year. The increase in sales of irons was due to an increase in sales volume resulting from the strong performance of the X Hot irons introduced during the first quarter of 2013 compared to the Razr X irons launched in the prior year.

The $8.5 million (35%) increase in net sales of putters to $32.6 million for the quarter ended March 31, 2013 was primarily attributable to an increase in sales volume and average selling prices. The increase in sales volume was due to the earlier timing of new product introductions with the launch of the Versa and White Hot Pro putters during the first quarter of 2013 compared to the prior year Metal X putters launched during the second quarter of 2012. The increase in average selling prices was attributable to a decline in promotional activity during the first quarter of 2013 compared to the same period in the prior year.

The $14.3 million (21%) decrease in net sales of accessories and other products to $55.2 million for the quarter ended March 31, 2013 was primarily due to the transition of the Company's apparel and footwear sales in the U.S. to a licensing arrangement during the second half of 2012.

Golf Balls Segment

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



                             Three Months Ended
                                  March 31,                    Growth
                             2013           2012        Dollars       Percent
              Net sales:
              Golf balls   $    43.0       $  42.5     $     0.5             1 %

The $0.5 million (1%) increase in net sales of golf balls to $43.0 million for the quarter ended March 31, 2013 was primarily due to an increase in sales volume partially offset by a decline in average selling prices. The increase in sales volume was primarily due to an increase in sales of lower priced golf ball models as well as an increase in the number of golf ball models launched during the first quarter of 2013 compared to the same quarter of the prior year. This increase more than offset the $7.2 million decline in sales of Top-Flite golf balls due to the sale of the Top-Flite brand in the first quarter of 2012. The decline in average selling prices resulted from a shift in product mix to sales of lower priced golf ball models combined with no premium ball launch during the first quarter of 2013.


Table of Contents

Segment Profitability

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



                                    Three Months Ended
                                         March 31,                 Growth/(Decline)
                                    2013            2012       Dollars         Percent
     Income before income taxes
     Golf clubs(1)                $    44.0        $ 32.6      $   11.4              35 %
     Golf balls(1)                      6.2           1.6           4.6             288 %
     Reconciling items(2)              (6.1 )        (2.7 )        (3.4 )          (126 )%

                                  $    44.1        $ 31.5      $   12.6              40 %

(1) In connection with the Cost Reduction Initiatives (see Note 2 to the Notes to Consolidated Condensed Financial Statements), during the three months ended March 31, 2013, the Company's golf clubs and golf balls segments absorbed $2.7 million and $0.1 million, respectively, in pre-tax charges related to these initiatives.

(2) Reconciling items represent corporate general and administrative expenses and other income (expense) not included by management in determining segment profitability. For the first quarter of 2013, the reconciling items include pre-tax charges of $0.7 million related to the Cost Reduction Initiatives, and for the first quarter of 2012, the reconciling items include a pre-tax gain of $6.6 million in connection with the sale of the Top-Flite and Ben Hogan brands.

Pre-tax income in the Company's golf clubs operating segment increased to $44.0 million for the first quarter of 2013 from $32.6 million for the comparable period in the prior year. This increase was primarily driven by a decrease in operating expenses as a result of net savings realized from the Cost Reduction Initiatives, combined with an increase in net sales as discussed above and an increase in gross margin. The increase in gross margin was primarily driven by
(i) the current year launch of the Razr Fit Extreme and X Hot family of woods, which have higher margins relative to the Razr Fit and Razr X family of woods that were launched in the first quarter of 2012; (ii) a decrease in closeout activity in the putters category during the first quarter of 2013, combined with the successful launch of the Versa putter; and (iii) improvements in the Company's cost structure as a result of the Cost Reduction Initiatives. These increases were partially offset by an increase in club component costs due to more expensive materials and technology incorporated into the X Hot family of woods and Versa putters. In addition, during the first quarter of 2013, the golf clubs operating segment absorbed pre-tax charges of $2.7 million in connection with the Cost Reduction Initiatives, of which $2.2 million was included in gross profit.

Pre-tax income in the Company's golf balls operating segment increased to $6.2 million for the first quarter of 2013 from $1.6 million for the comparable period in the prior year. This increase was primarily attributable to a decrease in operating expenses as a result of net savings realized from the Cost Reduction Initiatives, combined with a slight increase in net sales as discussed above and an increase in gross margin. The increase in gross margin was primarily driven by improvements in the Company's cost structure as a result of the Cost Reduction Initiatives.


Table of Contents

Financial Condition

The Company's cash and cash equivalents decreased $23.9 million to $28.1 million at March 31, 2013, from $52.0 million at March 31, 2012. The levels of cash and cash equivalents fluctuate with the seasonality of the Company's business and are affected by the timing of product launches. Generally, during the first quarter, the Company will rely more heavily on its credit facility to fund operations as cash inflows from operations begin to increase during the second quarter as a result of cash collections from customers. During the three months ended March 31, 2013 and 2012, the Company used its cash and cash equivalents and borrowings from its credit facility to fund $100.6 million and $92.4 million, respectively, of cash used in operating activities, in addition to $3.1 million and $8.7 million, respectively, in capital expenditures. The increase in cash used in operating activities was primarily driven by a decrease in cash collected from the Company's net accounts receivable during the first quarter of 2013 relative to the first quarter of 2012 as a result of lower sales during the fourth quarter of 2012 compared to the fourth quarter of 2011. Management expects to fund the Company's future operations from cash provided by its operating activities combined with borrowings from its credit facility, as deemed necessary (see further information on the Company's credit line below).

The Company's accounts receivable balance fluctuates throughout the year as a result of the general seasonality of the Company's business. The Company's accounts receivable balance will generally be at its highest during the first and second quarters and decline significantly during the third and fourth quarters as a result of an increase in cash collections and lower sales. As of March 31, 2013, the Company's net accounts receivable increased $164.6 million to $255.7 million from $91.1 million as of December 31, 2012. The increase in accounts receivable reflects the general seasonality of the business and was primarily attributable to net sales of $287.8 million during the first quarter of 2013 compared to net sales of $119.9 million during the fourth quarter of 2012. The Company's net accounts receivable as of March 31, 2013 was flat compared to the Company's net accounts receivable as of March 31, 2012.

The Company's inventory balance also fluctuates throughout the year as a result of the general seasonality of the Company's business. Generally, the Company's buildup of inventory levels begins during the fourth quarter and continues heavily into the first quarter as well as into the beginning of the second quarter in order to meet demand during the height of the golf season. Inventory levels start to decline toward the end of the second quarter and are at their lowest during the third quarter. Inventory levels are also impacted by the timing of new product launches. The Company's net inventory decreased $9.8 million to $201.9 million as of March 31, 2013 compared to $211.7 million as of December 31, 2012. The Company's net inventory decreased by $34.3 million as of March 31, 2013 compared to the Company's net inventory as of March 31, 2012. Net . . .

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