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ELY > SEC Filings for ELY > Form 10-Q on 25-Apr-2014All Recent SEC Filings

Show all filings for CALLAWAY GOLF CO

Form 10-Q for CALLAWAY GOLF CO


25-Apr-2014

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 Golf woods, hybrids, irons and 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 that are designed, manufactured and sold by the Company. As discussed in Note 16 "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.
A significant portion 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 the first quarter of 2014 were negatively affected by the translation of foreign currency sales into U.S. dollars based on 2014 exchange rates. If 2013 exchange rates were applied to 2014 reported sales in regions outside the U.S. and all other factors were held constant, net sales in such regions would have been $6.4 million higher than the net sales reported in the first quarter of 2014. Executive Summary
The Company's net sales for the first quarter of 2014 increased to $351.9 million or up 22%, as compared to $287.8 million for the same period in 2013. This increase reflects the Company's renewed focus on more consumer-oriented products, which resulted in a significant increase in most product categories and market share gains in each of the Company's key markets around the world. This increase included a 33% increase in the woods category, a 29% increase in the irons category and a 24% increase


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in the golf ball category. The strength of the Company's 2014 product line more than offset the negative impact of foreign currency movements. As compared to 2013, the Company's first quarter 2014 net sales were adversely affected by $6.4 million due to changes in foreign currency exchange rates.
In addition to the increase in sales, gross margins improved 160 basis points compared to last year due to improved pricing and sales mix, the completion of the cost reduction initiatives in 2013, and improved manufacturing and distribution efficiencies as a result of several initiatives implemented last year. These improvements offset the negative impact of foreign currency exchange rates and increased product costs associated with additional technology in several new products.
Operating expenses increased $12.9 million due to increases in marketing support for new products launched during the quarter, an increase in stock compensation expense associated with a 54% increase in the Company's stock price compared to March 31, 2013, and planned incremental tour investment.
Other income/expense decreased $8.9 million to other expense of $4.9 million in the first quarter of 2014 compared to other income of $4.0 million in the first quarter of 2013. This decrease is primarily attributable to changes in foreign currency contract valuations. These contracts, which are used to hedge the Company's exposure to changes in foreign currency exchange rates, are required to be marked to market at the end of each quarter and changes in the contract values are reported in other income/expense. The Company recorded contract valuation losses of $2.9 million in the first quarter of 2014 compared to $7.8 million of contract valuation gains in the first quarter of 2013. As a result of the increase in net sales and improved gross margins, which offset the increase in operating expenses and foreign currency contract losses, earnings per share for the first quarter of 2014 increased 30% to $0.61 compared to $0.47 in 2013.
These results reflect the Company's continued brand momentum and the success of the first stage of its multi-year turnaround plan. Management believes that the Company's turnaround plan is on track and that the actions taken to date will serve as the foundation for a sustained recovery over the long-term. In the short term, however, management is anticipating challenging market conditions for the second quarter and possibly the balance of the year. The golf market has been slow to open in many regions where the Company conducts business, including the Company's largest region, the United States, which continues to have unfavorable weather in many parts of the country. In addition, overall retail inventory levels are high and management anticipates a heavy promotional environment while the industry works through the excess inventory. If the golf market does not open shortly or if the promotional activity is heavier than anticipated, the Company's financial results for the balance of the year will be negatively affected.
Three-Month Periods Ended March 31, 2014 and 2013 Net sales for the first quarter of 2014 increased by $64.1 million to $351.9 million compared to $287.8 million in the first quarter of 2013. This increase was due to increased sales in almost all product categories, most notably, woods, irons and golf balls, resulting from continued brand momentum combined with the strong performance of the current year Big Bertha drivers, Apex irons and Speed Regime and Supersoft golf balls. These increases were partially offset by the negative impact of unfavorable fluctuations in foreign currency rates during the first quarter of 2014. If 2013 rates were applied to 2014 sales in regions outside the U.S., net sales would have been $6.4 million higher. The Company's net sales by operating segment are presented below (dollars in millions):

Three Months Ended
                       March 31,                      Growth
                  2014           2013 (1)      Dollars      Percent
Net sales:
Golf clubs $     299.2          $    245.4    $    53.8       22 %
Golf balls        52.7                42.4         10.3       24 %
           $     351.9          $    287.8    $    64.1       22 %

(1) The prior year amounts have been restated to reflect the Company's current year allocation methodology related to freight revenue and costs, certain discounts and other reserves not specific to a product type. This resulted in an increase to net sales of $0.6 million in the golf club segment, and a corresponding decrease in net sales in the golf ball segment.

For further discussion of each operating segment's results, see golf clubs and golf balls segments results below.


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

Three Months Ended
                          March 31,                     Growth
                       2014            2013      Dollars      Percent
Net sales:
United States   $     184.7          $ 159.8    $    24.9       16 %
Europe                 51.2             38.3         12.9       34 %
Japan                  60.0             44.1         15.9       36 %
Rest of Asia           27.0             20.1          6.9       34 %
Other countries        29.0             25.5          3.5       14 %
                $     351.9          $ 287.8    $    64.1       22 %

Net sales in the United States increased $24.9 million (16%) to $184.7 million during the first quarter of 2014 compared to the same period in the prior year. The Company's sales in regions outside of the United States increased $39.2 million (31%) to $167.2 million for the first quarter of 2014 compared to $128.0 million in the same quarter of 2013. The 31% increase in net sales in all regions outside the United States resulted from the continued improvement in brand momentum combined with the strong performance of the current year product launches. This increase was partially offset by the unfavorable impact of the translation of foreign currency sales into U.S. Dollars based upon 2014 exchange rates. If 2013 exchange rates were applied to 2014 reported sales in regions outside the U.S. and all other factors were held constant, net sales in such regions would have been $6.4 million higher than reported in the first quarter of 2014.
The Company's cost of sales is comprised primarily of material and component costs, distribution and warehousing costs, and overhead. Due to the recent actions taken in connection with the cost reduction initiatives to improve manufacturing efficiencies, a greater percentage of the Company's manufacturing costs became variable. As a result, on a consolidated basis, over 85% of total cost of sales is now variable in nature and will fluctuate with sales volumes. Of this amount, over 85% is comprised of material and component costs. Generally, the relative significance of the components of costs of sales is not expected to vary materially from period to period. See "Cost of Sales and Segment Profitability" below for further discussion of gross margins. Gross profit increased $34.5 million (26%) to $164.9 million for the first quarter of 2014 compared to $130.4 million in the first quarter of 2013. Gross profit as a percentage of net sales ("gross margin") increased to 47% in the first quarter of 2014 compared to 45% in the first quarter of 2013. This improvement was primarily due to (i) a favorable shift in sales mix to higher margin woods, irons and golf ball products in the first quarter of 2014 compared to the first quarter of 2013, (ii) charges recognized during the first quarter of 2013 related to the cost reduction initiatives, and (iii) improved manufacturing and distribution efficiencies. These increases were partially offset by the unfavorable impact of changes in foreign currency rates, and an increase in club component costs due to more expensive materials and technology incorporated into certain woods products launched in the current year. See "Cost of Sales and Segment Profitability" below for further discussion of gross margin.
Selling expenses increased by $9.0 million to $77.3 million (22.0% of net sales) in the first quarter of 2014 compared to $68.3 million (23.7% of net sales) in the comparable period of 2013. This increase was primarily due to a $7.2 million increase in marketing expenses in addition to a $1.2 million increase in stock compensation expense as a result of a significant increase in the Company's stock price period over period. These increases were partially offset by a $0.4 million decrease in salaries and wages.
General and administrative expenses increased by $3.4 million to $18.0 million (5.1% of net sales) in the first quarter of 2014 compared to $14.6 million (5.1% of net sales) in the comparable period of 2013. This increase was primarily due to a $2.4 million increase in stock compensation expense as a result of a significant increase in the Company's stock price period over period. Research and development expenses increased by $0.5 million to $7.9 million (2.2% of net sales) in the first quarter of 2014 compared to $7.4 million (2.6% of net sales) in the comparable period of 2013. This increase was primarily due to an increase in stock compensation expense as a result of a significant increase in the Company's stock price period over period.
Other income (expense), net decreased in the first quarter of 2014 to other expense of $4.9 million compared to other income of $4.0 million in the comparable period of 2013. This decrease was primarily due to an $8.3 million increase in net foreign currency losses in the first quarter of 2014 compared to the same period in 2013, combined with a $0.5 million increase in interest expense.


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The Company's provision for income taxes decreased to $1.5 million in the first quarter of 2014, compared to $2.5 million in the first quarter of 2013. The $1.0 million decrease resulted primarily from the release of certain unrecognized tax liabilities during the first quarter of 2014 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 first quarter of 2014 is not comparable to the effective tax rate for the first quarter of 2013 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 2014 increased $13.6 million (33%) to $55.3 million compared to $41.7 million in the first quarter of 2013. Diluted earnings per share increased $0.14 (30%) to $0.61 in the first quarter of 2014 compared to $0.47 in the first quarter of 2013.

Golf Clubs and Golf Balls Segments Results for the Three Months Ended March 31, 2014 and 2013
Golf Clubs Segment
Net sales information by product category is summarized as follows (dollars in millions):

                            Three Months Ended
                                  March 31,                 Growth/(Decline)
                             2014           2013 (1)      Dollars    Percent
Net sales:
Woods                 $     129.7          $     97.9    $  31.8          33  %
Irons                        73.3                56.7       16.6          29  %
Putters                      31.8                32.1       (0.3 )        (1 )%
Accessories and other        64.4                58.7        5.7          10  %
                      $     299.2          $    245.4    $  53.8          22  %

(1) The prior year amounts have been restated to reflect the Company's current year allocation methodology related to freight revenue and costs, certain discounts and other reserves not specific to a product type. This resulted in an increase to net sales of $0.6 million in the golf club segment, and a corresponding decrease in net sales in the golf ball segment. The $31.8 million (33%) increase in net sales of woods to $129.7 million for the quarter ended March 31, 2014 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 current year product line, including the Company's Big Bertha drivers and X2 Hot fairway woods and Hybrids. The increase in average selling prices was due to the launch of two premium drivers during the first quarter of 2014 compared to only one premium driver in the same period of the prior year, combined with the introduction of the X2 Hot fairway woods and hybrids at higher average selling prices than their predecessor, sold during the same period in the prior year. The $16.6 million (29%) increase in net sales of irons to $73.3 million for the quarter ended March 31, 2014 was primarily attributable to an increase in both sales volume and average selling prices. The increase in sales volume was primarily due to the strong performance of the Company's Apex and X2 Hot irons launched during the current quarter. The increase in average selling prices was due to a favorable shift in product mix due to the success of the more premium APEX irons in the current year combined with the introduction of the Apex irons at higher average selling prices than the X Forged irons which were launched in the prior year. The $0.3 million (1%) decrease in the net sales of putters to $31.8 million for the quarter ended March 31, 2014 was primarily due to a decline in sales volume which was almost completely offset by an increase in average selling prices. The decline in sales volume was due to the introduction of two new putter lines during the first quarter of 2013 compared to one new putter line introduced during the first quarter of the current year. The increase in average selling prices was due to the introduction of the new elite Metal X Milled putter during the first quarter of 2014 with no comparable elite putter launch during the first quarter of 2013. The $5.7 million (10%) increase in net sales of accessories and other to $64.4 million for the quarter ended March 31, 2014 was primarily due to an increase in sales of packaged sets, golf bags, gloves and headwear, partially offset by a decline in apparel and footwear sales due to the transition of the Company's apparel and footwear sales in Europe to a licensing arrangement during the first quarter of 2014.


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Golf Balls Segment
Net sales information for the golf balls segment is summarized as follows
(dollars in millions):
                 Three Months Ended
                       March 31,                      Growth
                  2014            2013(1)      Dollars      Percent
Net sales:
Golf balls $     52.7            $    42.4    $    10.3       24 %

(1) The prior year amounts have been restated to reflect the Company's current year allocation methodology related to freight revenue and costs, certain discounts and other reserves not specific to a product type. This resulted in an increase to net sales of $0.6 million in the golf club segment, and a corresponding decrease in net sales in the golf ball segment. The $10.3 million (24%) increase in net sales of golf balls to $52.7 million for the quarter ended March 31, 2014 was primarily due to an increase in both sales volume and average selling prices. The increase in sales volume was primarily due to the success of the Company's Supersoft and Speed regime golf balls launched during the first quarter of 2014. The increase in average selling prices resulted from a favorable shift in product mix to sales of higher priced Speed Regime golf balls with no comparable premium ball launch during the first quarter of 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. Due to the recent actions taken in connection with the cost reduction initiatives to improve manufacturing efficiencies, a greater percentage of the Company's manufacturing costs became variable. As a result, on a consolidated basis, over 80% and 85% of the Company's golf ball and golf club cost of sales, respectively, is now variable in nature and will fluctuate with sales volumes. Of these amounts, over 85% is comprised of material and component costs for both segments. Generally, the relative significance of the components of costs of sales is not expected to vary materially from period to period.
Profitability by operating segment is summarized as follows (dollars in millions):

                               Three Months Ended
                                    March 31,                  Growth
                                2014         2013(1)     Dollars    Percent
Income before income taxes:
Golf clubs(2)               $    62.7       $  44.8     $  17.9         40 %
Golf balls(2)                    11.7           5.4         6.3        117 %
Reconciling items(3)            (17.6 )        (6.1 )     (11.5 )      189 %
                            $    56.8       $  44.1     $  12.7         29 %

(1) The prior year amounts have been restated to reflect the Company's current year allocation methodology related to freight revenue and costs, certain discounts and other reserves not specific to a product type. This resulted in an increase to income before income taxes of $0.8 million in the golf club segment, and a corresponding decrease in income before income taxes in the golf ball segment.

(2) 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 March 31, 2013, the Company's golf clubs and golf balls segments recognized pre-tax charges of $2.7 million and $0.1 million, respectively.

(3) 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.

Pre-tax income in the Company's golf clubs operating segment increased to $62.7 million for the first quarter of 2014 from $44.8 million for the comparable period in the prior year. This increase was driven by a $53.8 million (22%) increase in net sales as discussed above combined with a slight increase in gross profit as a percentage of sales ("gross margin" or "margin"), offset by a $9.7 million increase in operating expenses. Gross margin was favorably impacted by (i) a favorable shift in sales mix to higher margin products in the first quarter of 2014, namely the Big Bertha family of drivers, Apex irons and Speed Regime golf balls,


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which have higher margins compared to the Razr Fit Extreme drivers, X Forged irons and HEX family of golf balls launched in the first quarter of 2013; (ii) an increase in margin on the 2014 X2 Hot family of drivers, fairway woods and irons, which were launched at higher prices compared to the X Hot product line launched in the prior year; (iii) cost savings from improved manufacturing and distribution efficiencies; and (iv) charges incurred during the first quarter of 2013 related to the Company's cost reduction initiatives. These increases were almost entirely offset by the impact of unfavorable changes in foreign currency rates combined with an increase in club component costs due to more expensive materials and technology incorporated into X2 Hot hybrids and Big Bertha Alpha drivers.
Pre-tax income in the Company's golf balls operating segment increased to $11.7 million for the first quarter of 2014 from $5.4 million for the comparable period in the prior year. This increase was primarily attributable to a $10.3 million (24%) increase in net sales as discussed above combined with a 580 basis point improvement in gross margin, offset by a $0.5 million increase in operating expenses. The improvement in gross margin was primarily due to the first quarter launch of the premium Speed Regime golf balls in 2014 with no comparable premium launch in first quarter last year, combined with cost savings from improved manufacturing efficiencies period over period. These increases were partially offset by the impact of unfavorable changes in foreign currency rates.
Financial Condition
The Company's cash and cash equivalents decreased $13.2 million to $23.6 million at March 31, 2014 from $36.8 million at December 31, 2013. The Company's 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, 2014 and 2013, the Company used its cash and cash equivalents and borrowings under its ABL facility to fund $124.8 million and $100.6 million, respectively, of cash used in operating activities, in addition to $4.0 million and $3.1 million in capital expenditures, respectively. The increase in cash used in operating activities was primarily due to an increase in net accounts receivable as a result of a $64.1 million increase in net sales period over period. Management expects to fund the Company's future operations from current cash balances and cash provided by its operating activities combined with borrowings under its ABL Facility, as deemed necessary (see further information on the ABL Facility 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, 2014, the Company's net accounts receivable increased $197.0 million to $289.2 million from $92.2 million as of December 31, 2013. The increase in accounts receivable reflects the general seasonality of the business and was . . .

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