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

Show all filings for CALLAWAY GOLF CO

Form 10-Q for CALLAWAY GOLF CO


29-Jul-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 a result of the sale of the Top-Flite brand during the first quarter of 2012. 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 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 $17.8 million higher than the net sales reported in the first half of 2013.

Executive Summary
During the first half of 2013, the Company continued to make progress on its turnaround with sales growth in its current business on a constant currency basis and improvements in operating efficiencies and cost management. The Company's first half 2013 sales of its current business grew 6% on a constant currency basis compared to 2012. Its reported net sales, however, were adversely affected by (i) the impact of its businesses that in 2012 were sold or transitioned to a third party model, which negatively affected sales by approximately $45 million for the first half of 2013 compared to 2012 and (ii) the impact of changes in foreign


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currency rates in 2013 as compared to 2012, which adversely affected sales by approximately $18 million for the first half of 2013. As a result of these factors, and despite increases in constant currency sales of the Company's current business, the Company's reported sales decreased by 5% for the first half of 2013 compared to the same period in the prior year.

In addition to improved sales of its current business on a constant currency basis, the Company's gross margins and operating expenses improved. Gross margin increased by 60 basis points to 42.1% during the first half of 2013 compared to 41.5% during the same period in 2012. This improvement was primarily driven by a favorable shift in sales mix as a result of increased sales of higher margin woods products in 2013, primarily due to the current year success of the X Hot line of woods. Gross margin was also favorably affected by improved manufacturing efficiencies and lower costs associated with the Company's cost structure resulting from the Company's 2012 restructuring initiatives (the "Cost Reduction Initiatives"). Additionally, as a result of these cost savings initiatives, as well as a continued focus on cost management, the Company's operating expenses improved by $23.1 million or 12% in the first half of 2013 compared to the same period in 2012.
These improvements enabled the Company to overcome softer than expected market conditions, the adverse effects of changes in foreign currency rates, and the impact of the sold or transitioned businesses. As a result, the Company's operating income and earnings per share increased to $51.6 million and $0.59 for the first half of 2013 compared to $37.4 million and $0.41 for the same period in 2012. Looking forward to the balance of 2013, the Company anticipates continued foreign currency headwinds and promotional activity at retail. However, despite these challenges, management expects that its 2013 full year operating results will be significantly improved compared to 2012.

Three-Month Periods Ended June 30, 2013 and 2012 Net sales for the second quarter of 2013 decreased $31.5 million to $249.6 million compared to $281.1 million in the second quarter of 2012. This decrease was primarily due to the sale of the Top-Flite and Ben Hogan brands in 2012 combined with a decline in sales of the Company's accessories and other products 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. Combined, the sale/transition of these businesses negatively affected sales by approximately $24.8 million in the second quarter of 2013 compared to 2012. Additionally, the Company's net sales for the second quarter of 2013 were negatively impacted by $9.7 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
                      June 30,                   Decline
                  2013            2012      Dollars    Percent
Net sales:
Golf clubs $     206.2          $ 231.3    $ (25.1 )     (11 )%
Golf balls        43.4             49.8       (6.4 )     (13 )%
           $     249.6          $ 281.1    $ (31.5 )     (11 )%

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
                           June 30,                   Decline
                       2013            2012      Dollars    Percent
Net sales:
United States   $     124.4          $ 142.3    $ (17.9 )     (13 )%
Europe                 40.2             43.4       (3.2 )      (7 )%
Japan                  36.7             37.0       (0.3 )      (1 )%
Rest of Asia           22.9             26.6       (3.7 )     (14 )%
Other countries        25.4             31.8       (6.4 )     (20 )%
                $     249.6          $ 281.1    $ (31.5 )     (11 )%

Net sales in the United States decreased $17.9 million (13%) to $124.4 million during the second quarter of 2013 compared to the same period in the prior year. As mentioned above, this decrease was primarily due to the sale of the Top-Flite and Ben Hogan brands in 2012 combined with the transition of the Company's apparel and footwear sales in the U.S. to a licensing


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arrangement during the second half of 2012. The Company's sales in regions outside of the United States decreased $13.6 million to $125.2 million for the second quarter of 2013 compared to $138.8 million in the same quarter of 2012. This decrease was primarily due to the unfavorable impact of 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 $9.7 million higher than reported in the second quarter of 2013. Additionally, the Company experienced declines in sales in Europe and other countries due to adverse weather and softer market conditions during the current year.
Gross profit decreased $15.0 million to $95.7 million for the second quarter of 2013 compared to $110.7 million in the second quarter of 2012. Gross profit as a percentage of net sales ("gross margin") decreased to 38.3% in the second quarter of 2013 compared to 39.4% in the second quarter of 2012. The decrease in gross margin was primarily due to the unfavorable impact of changes in foreign currency rates combined with charges incurred during the second quarter of 2013 in connection with the Cost Reduction Initiatives announced in July 2012, primarily within the golf balls operating segment. This decrease in gross margin was partially offset by (i) a favorable shift in mix within the golf clubs operating segment as a result of sales of the higher margin X Hot family of irons in the second quarter of 2013 relative to sales of value priced irons in the second quarter of 2012, 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 White Hot Pro putters; and (ii) improved manufacturing efficiencies resulting from the Cost Reduction Initiatives. See "Segment Profitability" below for further discussion of gross margins.

Selling expenses decreased by $14.0 million to $61.7 million (24.7% of net sales) in the second quarter of 2013 compared to $75.7 million (26.9% of net sales) in the comparable period of 2012. This decrease was primarily due to an $8.9 million decrease in marketing expenses, combined with a $4.4 million decline in employee costs and travel and entertainment expenses resulting from the Cost Reduction Initiatives.
General and administrative expenses decreased by $3.3 million to $15.2 million (6.1% of net sales) in the second quarter of 2013 compared to $18.4 million (6.6% of net sales) in the comparable period of 2012. This decrease was primarily due to headcount reductions in connection with the Cost Reduction Initiatives, which resulted in a $2.4 million decrease in employee costs. Research and development expenses increased by $0.4 million to $7.3 million (2.9% of net sales) in the second quarter of 2013 compared to $6.9 million (2.5% of net sales) in the comparable period of 2012.
Other income, net was break-even in the second quarter of 2013 compared to other expense of $4.6 million in the comparable period of 2012. This improvement was primarily due to an increase in net foreign currency gains in the second 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 $1.4 million for the second quarter of 2013, compared to $2.2 million for the second quarter of 2012. The $0.8 million decrease resulted primarily from the release of certain unrecognized tax liabilities resulting from the lapse of certain statutes of limitations. 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 second quarter of 2013 is not comparable to the effective tax rate for the second 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 second quarter of 2013 increased to $10.1 million compared to $2.8 million in the comparable quarter of 2012. Diluted earnings per share increased to $0.12 in the second quarter of 2013 compared to break-even in the comparable period of 2012. The Company's net income for the second quarter of 2013 and 2012 includes the following charges and gains (in millions):

                                                             Three Months Ended
                                                                   June 30,
                                                              2013          2012
Pre-tax charges related to the Cost Reduction Initiatives $    (5.0 )     $  (4.6 )
Income tax provision(1)                                        (1.4 )        (2.2 )
Total charges                                             $    (6.4 )     $  (6.8 )

(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.


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Golf Clubs and Golf Balls Segments Results for the Three Months Ended June 30, 2013 and 2012
Golf Clubs Segment
Net sales information by product category is summarized as follows (dollars in millions):

                           Three Months Ended
                                 June 30,                Growth/(Decline)
                             2013            2012      Dollars    Percent
Net sales:
Woods                 $      71.9          $  58.6    $  13.3          23  %
Irons                        55.5             57.8       (2.3 )        (4 )%
Putters                      22.9             38.9      (16.0 )       (41 )%
Accessories and other        55.9             76.0      (20.1 )       (26 )%
                      $     206.2          $ 231.3    $ (25.1 )       (11 )%

The $13.3 million (23%) increase in net sales of woods to $71.9 million for the quarter ended June 30, 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 performed better at retail than the prior year Razr X woods. 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 during the same period in the prior year.
The $2.3 million (4%) decrease in net sales of irons to $55.5 million for the quarter ended June 30, 2013 was primarily attributable to a decline in sales volume resulting from fewer new irons models introduced in the current year compared to the same period in the prior year. This was partially offset by an increase in average selling prices due to the introduction of the X Hot irons at higher average selling prices than many of the Razr X irons models launched in the prior year.
The $16.0 million (41%) decrease in net sales of putters to $22.9 million for the quarter ended June 30, 2013 was primarily attributable to a decline in both sales volume and average selling prices. The decline 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 with Metal X putters launched during the second quarter of 2012. The decline in average selling prices was due to an unfavorable shift in product mix with fewer sales of the Company's higher priced progressive (Metal X and White Ice putters) and elite (Prototype IX and Tour Series) putter models to sales of more moderately priced core (Versa and White Hot Pro) putter models. The $20.1 million (26%) decrease in net sales of accessories and other products to $55.9 million for the quarter ended June 30, 2013 was primarily due to a decline in net sales of approximately $8.0 million 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 combined with a decline in sales of packaged sets, GPS devices and gloves.
Golf Balls Segment
Net sales information for the golf balls segment is summarized as follows (dollars in millions):

Three Months Ended
                      June 30,                   Decline
                  2013            2012      Dollars    Percent
Net sales:
Golf balls $     43.4            $ 49.8    $  (6.4 )     (13 )%

The $6.4 million (13%) decrease in net sales of golf balls to $43.4 million for the quarter ended June 30, 2013 was primarily due to a decline in sales volume slightly offset by an increase in average selling prices. The decrease in sales volume was primarily due to an $8.7 million decline in sales of Top-Flite golf balls due to the sale of the Top-Flite brand in 2012 partially offset by an increase in sales of Callaway golf balls during the second quarter of 2013 compared to the same period in the prior year. The increase in average selling prices resulted from a shift in product mix from sales lower priced Top-Flite balls in 2012 to increased sales of higher priced Callaway branded golf balls in 2013. In addition, golf ball sales in the second quarter of 2013 were negatively impacted by a decline in rounds played compared to rounds played in the comparative period of 2012.


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Segment Profitability
Profitability by operating segment is summarized as follows (dollars in
millions):
                               Three Months Ended
                                     June 30,              Growth/(Decline)
                                2013          2012        Dollars      Percent
Income before income taxes:
Golf clubs(1)               $    20.8       $  18.0     $    2.8          16  %
Golf balls(1)                     0.7           4.2         (3.5 )       (83 )%
Reconciling items(2)            (10.0 )       (17.2 )        7.2          42  %
                            $    11.5       $   5.0     $    6.5         130  %

(1) In connection with the Cost Reduction Initiatives (see Note 2 "Cost Reduction Initiatives" to the Notes to Consolidated Condensed Financial Statements), during the three months ended June 30, 2013 and 2012, the Company's golf clubs segment recognized pre-tax charges of $0.6 million and $1.7 million, respectively, and golf balls segment recognized pre-tax charges of $4.1 million and $0.3 million, respectively, 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 second quarter of 2013 and 2012, the reconciling items include pre-tax charges of $0.3 million and $2.7 million, respectively, related to the Cost Reduction Initiatives.

Pre-tax income in the Company's golf clubs operating segment increased to $20.8 million for the second quarter of 2013 from $18.0 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 gross margin, offset by a decrease in net sales as discussed above. The increase in gross margin was primarily driven by (i) a favorable shift in mix within the irons category as a result of sales of the X Hot family of irons in the second quarter of 2013, which have higher margins relative to the value priced irons sold during the second quarter of 2012; and (ii) improved manufacturing efficiencies and lower costs associated with the Company's cost structure resulting from 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 White Hot Pro putters.
Pre-tax income in the Company's golf balls operating segment decreased to $0.7 million for the second quarter of 2013 from $4.2 million for the comparable period in the prior year. This decrease was primarily attributable to a decrease in net sales as discussed above combined with a decrease in gross margin, offset by a decrease in operating expenses as a result of net savings realized from the Cost Reduction Initiatives. The decrease in gross margin was primarily driven by a $3.4 million write-off of certain manufacturing equipment and inventory during the second quarter of 2013 in connection with the Cost Reduction Initiatives, partially offset by sales of discounted Top-Flite brand golf balls during the second quarter of 2012.


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Six-Month Periods Ended June 30, 2013 and 2012 Net sales for the six months ended June 30, 2013 decreased $28.8 million to $537.4 million compared to $566.2 million for the same period in 2012. This decrease was primarily due to the sale of the Top-Flite and Ben Hogan brands in 2012 combined with a decline in sales of the Company's accessories and other products 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. Combined, the sale/transition of these businesses negatively affected sales by approximately $44.7 million for the first half of 2013 compared to 2012. Additionally, the Company's net sales for the first half of 2013 were negatively impacted by $17.8 million resulting from unfavorable fluctuations in foreign currency rates. These decreases were partially offset by an increase in sales of woods resulting from the successful launch of the Company's X Hot woods which were introduced during the current year. The Company's net sales by operating segment are presented below (dollars in millions):

Six Months Ended

                    June 30,                   Decline
                2013           2012      Dollars     Percent
Net sales:
Golf clubs $    451.0        $ 473.8    $ (22.8 )     (5 )%
Golf balls       86.4           92.4       (6.0 )     (6 )%
           $    537.4        $ 566.2    $ (28.8 )     (5 )%

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):

Six Months Ended
                         June 30,               Growth/(Decline)
                     2013           2012       Dollars      Percent
Net sales:
United States   $    284.1        $ 292.0    $     (7.9 )      (3 )%
Europe                78.5           86.1          (7.6 )      (9 )%
Japan                 80.8           79.2           1.6         2  %
Rest of Asia          43.0           44.6          (1.6 )      (4 )%
Other countries       51.0           64.3         (13.3 )     (21 )%
                $    537.4        $ 566.2    $    (28.8 )      (5 )%

Net sales in the United States decreased $7.9 million (3%) to $284.1 million during the six months ended June 30, 2013 compared to the same period in the prior year. As mentioned above, this decrease was primarily due to the sale of the Top-Flite and Ben Hogan brands combined with the transition of the Company's apparel and footwear sales in the U.S. to a licensing arrangement during the second half of 2012. The Company's sales in regions outside of the United States decreased $20.9 million to $253.3 million for the six months ended June 30, 2013 compared to $274.2 million in the same period in 2012. 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 $17.8 million higher than reported in the first half of 2013. Additionally, the Company experienced declines in sales in Europe and other countries due to adverse weather and softer market conditions during the current year.
Gross profit decreased $8.9 million to $226.1 million for the six months ended June 30, 2013 compared to $235.0 million in the comparable period of 2012. Gross profit as a percentage of net sales ("gross margin") increased to 42.1% in the first six months of 2013 compared to 41.5% in the first six months of 2012. The increase in gross margin was primarily due to (i) a favorable shift in mix to sales of higher margin golf club products in 2013 compared to 2012; and (ii) improved manufacturing efficiencies resulting from the Cost Reduction Initiatives. These increases were partially offset by the unfavorable impact of changes in foreign currency rates combined with charges incurred during the first six months of 2013 in connection with the Cost Reduction Initiatives. See "Segment Profitability" below for further discussion of gross margins.

Selling expenses decreased by $22.6 million to $130.0 million (24.2% of net sales) during the six months ended June 30, 2013 compared to $152.5 million (26.9% of net sales) in the comparable period of 2012. This decrease was primarily due to the

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