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ELY > SEC Filings for ELY > Form 10-Q on 28-Oct-2013All Recent SEC Filings

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Form 10-Q for CALLAWAY GOLF CO


28-Oct-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 Regarding Forward-Looking Statements" 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 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 $31.5 million higher than the net sales reported in the first nine months of 2013.


Executive Summary

The Company's results for the three and nine months ended September 30, 2013 include sales growth as well as significant improvements in gross margins, operating expenses, and operating income compared to the same periods in the prior year. These financial results reflect the continued success of the Company's turnaround plan, including continued improvement in the development of more performance-oriented products, brand momentum, operating efficiencies, and cost management.

The Company's net sales increased approximately 21% for the third quarter of 2013 and less than 1% for the first nine months of 2013 compared to the same periods in the prior year. The Company achieved these results despite adverse changes in foreign currency rates, the sale in 2012 of the Top-Flite and Ben Hogan Brands, and the transition to a licensing arrangement for apparel and footwear in North America. The sale of these brands and licensing arrangements negatively impacted sales by $53.4 million for the first nine months in 2013 and by $8.7 million for the third quarter of 2013 compared to the same periods in 2012. In addition, changes in foreign currency rates negatively affected net sales by $31.5 million for the first nine months of 2013, and by $13.7 million for the third quarter of 2013, as compared to the same periods in 2012. On a constant currency basis, the Company's current business, which excludes the sold or transitioned brands and businesses, achieved 13% sales growth for the first nine months of 2013, and 38% sales growth for the third quarter of 2013, compared to the same periods in 2012.

In addition to improved sales, the Company's gross margin and operating expenses improved and the charges related to the Cost Reduction Initiatives were significantly less during 2013 compared to 2012. Gross margin increased by 650 basis points to 39.9% during the first nine months of 2013 compared to 33.4% during the same period in 2012. This improvement was primarily driven by (i) a $20.9 million decline in charges associated with the Company's 2012 Cost Reduction Initiatives, (ii) increased sales of higher margin woods products in 2013, primarily due to the current year success of the X Hot line of woods and mid-year product launches, and (iii) less promotional activity by the Company in the current year. Gross margin was also favorably affected by improved manufacturing efficiencies and a lower cost structure resulting from the Company's Cost Reduction Initiatives. Additionally, as a result of these initiatives, as well as a continued focus on cost management, the Company's operating expenses improved by $33.2 million or 12% during the first nine months of 2013 compared to the same period in 2012. In total, the Company incurred charges of $10.4 million in connection with the Cost Reduction Initiatives during the first nine months of 2013 compared to $39.8 million during the same period in 2012.

These improvements, along with the Company's improved brand momentum resulting from the success of the Company's 2013 product line, enabled the Company to overcome the adverse effects of changes in foreign currency rates, and the impact of the sold or transitioned businesses. The Company also has been able to grow its hard goods market share and manage inventory levels both internally and at retail despite challenges this year due to adverse weather conditions and higher than normal competitor promotional activity at retail in both North America and Europe. As a result, the Company's income from operations and diluted earnings per share increased to $34.6 million and $0.36, respectively, for the first nine months of 2013 compared to a loss from operations of $45.3 million and diluted loss per share of $0.91 for the same period in 2012.

Three-Month Periods Ended September 30, 2013 and 2012 Net sales for the third quarter of 2013 increased $30.3 million to $178.2 million compared to $147.9 million in the third quarter of 2012. This increase was primarily due to the strong performance of the current year X Hot family of products combined with the current quarter launch of the FT Optiforce drivers and Mack Daddy 2 wedges with no comparable product launch in the third quarter of the prior year. This increase was offset by 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 $8.7 million in the third quarter of 2013 compared to 2012. Additionally, the Company's net sales for the third quarter of 2013 were negatively impacted by $13.7 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
                   September 30,               Growth/(Decline)
                  2013            2012       Dollars        Percent
Net sales:
Golf clubs $     152.6          $ 121.3    $    31.3         26  %
Golf balls        25.6             26.6         (1.0 )       (4 )%
           $     178.2          $ 147.9    $    30.3         20  %

For further discussion of each operating segment's results, see "Golf Clubs and Golf Balls Segments Results" below.
Net sales information by region is summarized as follows (dollars in millions):

Three Months Ended
                        September 30,              Growth/(Decline)
                       2013            2012       Dollars      Percent
Net sales:
United States   $      67.0          $  57.1    $     9.9         17  %
Europe                 26.5             19.2          7.3         38  %
Japan                  48.6             41.6          7.0         17  %
Rest of Asia           23.7             16.1          7.6         47  %
Other countries        12.4             13.9         (1.5 )      (11 )%
                $     178.2          $ 147.9    $    30.3         20  %

Net sales in the United States increased $9.9 million (17%) to $67.0 million during the third quarter of 2013 compared to the same period in the prior year. Despite the unfavorable impact of fluctuations in foreign currency rates, the Company's sales in regions outside of the United States increased $20.4 million to $111.2 million for the third quarter of 2013 compared to $90.8 million in the same quarter of 2012. As mentioned above, the increase in net sales in all regions resulted from the favorable consumer acceptance of the Company's current year products combined with the timing of current quarter product launches. This increase was partially offset by 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 $13.7 million higher than reported in the third quarter of 2013. The Company's cost of sales is comprised primarily of material and component costs, distribution and warehousing costs, and overhead. In general, on a consolidated basis, approximately 80% - 85% of total cost of sales is variable in nature and will fluctuate with sales volumes. Of this amount, approximately 80% - 85% is comprised of material and component costs. Generally, the relative significance of the components of costs of sales does not vary materially from period to period. See "Segment Profitability" below for further discussion of gross margins.
Gross profit increased $55.6 million to $59.4 million for the third quarter of 2013 compared to $3.8 million in the third quarter of 2012. Gross profit as a percentage of net sales ("gross margin") increased to 33.3% in the third quarter of 2013 compared to 2.6% in the third quarter of 2012. This improvement was primarily due to a $26.3 million decline in charges associated with the Company's Cost Reduction Initiatives. Gross margin in the third quarter of 2013 was also favorably impacted by increased sales of higher margin woods products in 2013, primarily due to the current year success of the X Hot line of woods, combined with less promotional activity and more full priced sales resulting from the current quarter launch of the premium FT Optiforce woods products and Mack Daddy 2 wedges. The Company also realized improved manufacturing efficiencies in 2013 as a result of its Cost Reduction Initiatives. These increases were partially offset by the unfavorable impact of changes in foreign currency rates.


Selling expenses decreased by $10.4 million to $49.9 million (28.0% of net sales) in the third quarter of 2013 compared to $60.3 million (40.8% of net sales) in the comparable period of 2012. This decrease was primarily due to a $6.1 million decline in employee costs, travel and entertainment, and expenses in connection with the Company's transition of its apparel and footwear businesses to a licensing model as a result of the Company's Cost Reduction Initiatives. In addition, marketing expenses decreased by $2.6 million. General and administrative expenses increased by $0.7 million to $18.9 million (10.6% of net sales) in the third quarter of 2013 compared to $18.2 million (12.3% of net sales) in the comparable period of 2012. This increase was primarily due to a $2.8 million increase in bad debt expense, partially offset by a $1.7 million decrease in costs associated with the Company's Cost Reduction Initiatives, mostly related to employee costs and expenses in connection with the Company's wind-down of its GPS device business.
Research and development expenses decreased by $0.3 million to $7.7 million (4.3% of net sales) in the third quarter of 2013 compared to $8.0 million (5.4% of net sales) in the comparable period of 2012. This decrease was primarily due to a decline in costs associated with the Company's Cost Reduction Initiatives, mostly related to the Company's wind-down of its GPS device business. Other income (expense), net decreased in the third quarter of 2013 to other expense of $3.1 million compared to other expense of $3.4 million in the comparable period of 2012. This improvement was primarily due to an increase in net foreign currency gains in the third 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 $1.0 million for the third quarter of 2013, compared to $0.8 million for the third quarter of 2012. The $0.2 million increase resulted primarily from the release of certain unrecognized tax liabilities during the third quarter of 2012 resulting from the lapse of certain statutes of limitation. 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 third quarter of 2013 is not comparable to the effective tax rate for the third quarter of 2012 as the Company's income tax amount is not directly correlated to the amount of its pretax income.
Net loss for the third quarter of 2013 decreased to $21.2 million compared to $86.8 million in the comparable quarter of 2012. Diluted losses per share improved to $0.32 in the third quarter of 2013 compared to $1.33 in the comparable period of 2012. The Company's net loss for the third quarter of 2013 and 2012 includes the following charges and gains (in millions):

                                                             Three Months Ended
                                                                September 30,
                                                              2013          2012
Pre-tax charges related to the Cost Reduction Initiatives $    (1.9 )     $ (35.1 )
Income tax provision(1)                                        (1.0 )        (0.8 )
Total charges                                             $    (2.9 )     $ (35.9 )

(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.


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

                           Three Months Ended
                              September 30,              Growth/(Decline)
                             2013            2012      Dollars    Percent
Net sales:
Woods                 $      56.5          $  31.2    $  25.3          81  %
Irons                        39.5             31.0        8.5          27  %
Putters                      20.4             15.7        4.7          30  %
Accessories and other        36.2             43.4       (7.2 )       (16 )%
                      $     152.6          $ 121.3    $  31.3          26  %

The $25.3 million (81%) increase in net sales of woods to $56.5 million for the quarter ended September 30, 2013 resulted from an increase in both sales volume and average selling prices. The increase in sales volume was primarily due to the strong performance of the X Hot woods, which performed better at retail than the prior year Razr X woods, in addition to the midyear launch of FT Optiforce 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, as well as the midyear launch of FT Optiforce woods. In addition, there was less promotional activity during the third quarter of 2013 compared to the third quarter in 2012.
The $8.5 million (27%) increase in net sales of irons to $39.5 million for the quarter ended September 30, 2013 was primarily attributable to an increase in average selling prices as well as sales volumes. The increase in average selling prices was due to the introduction of the Mack Daddy 2 wedges and X Hot irons at higher average selling prices than many of the iron and wedge models launched in the prior year. The increase in sales volumes was primarily due to the current quarter launch of the Company's Mack Daddy 2 wedges with no comparable wedge launch in the third quarter of the prior year.
The $4.7 million (30%) increase in net sales of putters to $20.4 million for the quarter ended September 30, 2013 was primarily attributable to an increase in both sales volume and average selling prices. The increase in sales volumes was due to an increase in sales of the Company's current year Versa, White Hot Pro and Tank putter models compared to the Metal X and White Ice putters in the prior year. The increase in average selling prices was due to a decline in promotional activity in the third quarter of 2013 compared to the prior year. The $7.2 million (16%) decrease in net sales of accessories and other products to $36.2 million for the quarter ended September 30, 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 combined with a decline in sales of 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
                  2013            2012      Dollars     Percent
Net sales:
Golf balls $     25.6            $ 26.6    $  (1.0 )     (4 )%

The $1.0 million (4%) decrease in net sales of golf balls to $25.6 million for the quarter ended September 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 $2.9 million decline in sales of Top-Flite golf balls due to the sale of the Top-Flite brand during the first quarter of 2012 partially offset by an 8% increase in sales of Callaway golf balls during the third 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 of lower priced Top-Flite balls in 2012 to increased sales of higher priced Callaway branded golf balls in 2013.


Cost of Sales and Segment Profitability
The Company's cost of sales is comprised primarily of material and component costs, distribution and warehousing costs, and overhead. In general, approximately 65% - 70% and 85% - 90% of the Company's golf ball and golf club cost of sales, respectively, is variable in nature. Of these amounts, approximately 75% - 80% and 80% - 85%, respectively, is comprised of material and component costs. Generally, the relative significance of the components of costs of sales does not vary materially from period to period. Profitability by operating segment is summarized as follows (dollars in millions):

                             Three Months Ended
                                September 30,                 Growth
                              2013          2012       Dollars      Percent
Loss before income taxes:
Golf clubs(1)             $     (4.4 )    $ (57.8 )   $    53.4       92 %
Golf balls(1)                   (3.4 )      (13.8 )        10.4       75 %
Reconciling items(2)           (12.3 )      (14.4 )         2.1       15 %
                          $    (20.1 )    $ (86.0 )   $    65.9       77 %

(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 September 30, 2013 and 2012, the Company's golf clubs segment recognized pre-tax charges of $1.0 million and $23.6 million, respectively, and the golf balls segment recognized pre-tax charges of $0.5 million and $9.3 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 third quarter of 2013 and 2012, the reconciling items include pre-tax charges of $0.4 million and $2.2 million, respectively, related to the Cost Reduction Initiatives.

Pre-tax loss in the Company's golf clubs operating segment decreased to $4.4 million for the third quarter of 2013 from $57.8 million for the comparable period in the prior year. This decrease was primarily driven by an increase in gross margin from 4.8% for the third quarter of 2012 to 34.7% in the third quarter of 2013, combined with an increase in net sales as discussed above and a decrease in operating expenses as a result of net savings realized from the Cost Reduction Initiatives. The improvement in gross margin was primarily driven by charges recognized during the third quarter of 2012 in connection with the Company's Cost Reduction Initiatives, which negatively affected prior year gross margin by 19.5% within the golf clubs operating segment. In addition, gross margin was favorably impacted in 2013 by (i) a favorable shift in product mix to increased sales of woods products, primarily sales of the X Hot family of woods, which were introduced at a higher average selling price than the Razr X family of woods in 2012 as well as increased sales of the X Hot family of irons and Mack Daddy 2 wedges, both of which have higher margins relative to the value priced irons sold during the third quarter of 2012; (ii) an overall decrease in promotional activity combined with more full priced sales resulting from the current quarter launch of the premium FT Optiforce woods products and Mack Daddy 2 wedges; and (iii) improved manufacturing efficiencies and improvements to 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, as well as the impact of unfavorable foreign currency rates.


Pre-tax loss in the Company's golf balls operating segment decreased to $3.4 million for the third quarter of 2013 from $13.8 million for the comparable period in the prior year. This decrease was primarily attributable to a significant improvement in gross margin combined with a decrease in operating expenses as a result of net savings realized from the Cost Reduction Initiatives, partially offset by a decrease in net sales as discussed above. The increase in gross margin was primarily driven by charges recognized during the third quarter of 2012 in connection with the Company's Cost Reduction Initiatives, which negatively affected prior year gross margin by 35.0% within the golf balls operating segment. In addition, gross margin was positively impacted by improved manufacturing efficiencies and improvements to the Company's cost structure resulting from the Cost Reduction Initiatives. Gross margin was negatively impacted by a shift in sales in the third quarter of 2013 to more moderately priced and value priced golf balls compared to higher sales of premium golf balls in the comparable quarter of 2012, as well as the impact of unfavorable foreign currency rates.

Nine-Month Periods Ended September 30, 2013 and 2012 Net sales for the nine months ended September 30, 2013 increased $1.5 million to $715.6 million compared to $714.1 million for the same period in 2012. This increase was primarily due to an increase in sales of woods resulting from the successful performance of the Company's X Hot woods which were introduced during the current year. This increase was offset by 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 $53.4 million for the first nine months of 2013 compared to 2012. Additionally, the Company's net sales for the first nine months of 2013 were negatively impacted by $31.5 million resulting from unfavorable fluctuations in foreign currency rates. The Company's net sales by operating segment are presented below (dollars in millions):
Nine Months Ended . . .

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