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ELY > SEC Filings for ELY > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for CALLAWAY GOLF CO

Form 10-Q for CALLAWAY GOLF CO


7-Aug-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 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 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. 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 in nature and will fluctuate with sales volumes. With respect to the Company's operating segments, variable costs for golf clubs represent approximately 85% to 95% of cost of sales, and for golf balls, approximately 75% to 85%. Of these variable costs, material and component costs represent approximately 85% to 95% for golf clubs and approximately 75% to 85% for golf balls. On a consolidated basis, over 85% of total cost of sales is variable in nature, and of this amount, over 85% is comprised of material and component costs. Generally, the relative significance of the components of costs of sales does not vary materially from these percentages.
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 half of 2014 were negatively affected by the translation of foreign currency sales into U.S. dollars based on 2014 exchange rates. If exchange rates for the first half of 2013 were applied to 2014 reported sales in


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regions outside the U.S. and all other factors were held constant, net sales in such regions would have been $4.7 million higher than the net sales reported in the first half of 2014.
Executive Summary
The Company's net sales for the first six months of 2014 increased to $583.8 million or 9%, as compared to $537.4 million for the same period in 2013. This year-to-date increase was driven by the Company's continued brand momentum and the strength of its 2014 product line, which resulted in a significant increase in all product categories and market share gains in each of the Company's key markets around the world. The first half sales reflect both a 22% increase in net sales in the first quarter as well as a 7% decrease in sales in the second quarter. The second quarter net sales were adversely affected by challenging market conditions, including a late start to the 2014 golf season, high retail inventory industrywide and increased promotional activity compared to the second quarter of 2013.
The Company's gross profit as a percentage of sales increased 170 basis points during the first half of 2014 and by 90 basis points for the second quarter of 2014, both as compared to the same periods in the prior year. These increases were primarily the result of the improved manufacturing and distribution efficiencies resulting from the Company's prior cost-reduction initiatives. Also contributing to the increase for the first six months of 2014 was an increase in sales of higher margin products compared to 2013. In addition, there were no charges related to the Cost Reduction Initiatives in 2014 compared to charges incurred in 2013 of $4.1 million in the second quarter and $6.4 million in the first six months.
During the first six months of 2014, the Company continued to manage operating expenses while also increasing its investment in its marketing and tour programs. As a result, as planned, operating expenses increased by $8.7 million for the first six months of 2014 compared to the first six months of 2013. Operating expenses for the second quarter of 2014 decreased by $4.2 million, primarily as a result of a decrease in stock compensation resulting from the remeasurement of cash-settled awards.
For the first six months of 2014, the Company's other income/expense decreased to other expense of $5.2 million compared to other income of $8.7 million in the first six months of 2013. For the second quarter of 2014, the Company's other income/expense decreased by $5.5 million to other expense of $3.0 million compared to other income of $2.5 million in the second quarter of 2013. The decreases for both periods were primarily attributable to unfavorable changes in foreign currency rates related to the remeasurement of outstanding foreign currency hedging contracts.
For the first six months of 2014, net income increased by $7.0 million or 13%, and earnings per share increased by $0.07 or 12%, as compared to the same period in 2013. For the second quarter of 2014, net income decreased by $6.7 million or 67%, and earnings per share decreased by $0.08 or 67%, as compared to the second quarter of 2013. Management anticipates that market conditions will remain challenging for the second half of the year, but also believes that the Company's brand momentum and continually improving operational efficiencies should mitigate these headwinds and permit the Company to return to profitability for the full year.
Three-Month Periods Ended June 30, 2014 and 2013 Net sales for the second quarter of 2014 decreased by $17.7 million to $231.9 million compared to $249.6 million in the second quarter of 2013. This decrease was due to the late start to the 2014 golf season, high retail inventory industry-wide and increased promotional activity compared to the same period in 2013. Despite the softer than expected market conditions, the Company managed to gain market share due to continued brand momentum and the strong performance of the Big Bertha drivers, APEX irons and Speed Regime and Supersoft golf balls launched during the current year. Additionally, sales were positively impacted by favorable fluctuations in foreign currency rates during the second quarter of 2014. If 2013 rates were applied to 2014 sales in regions outside the U.S., net sales would have been $1.7 million lower.


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The Company's net sales by operating segment are presented below (dollars in millions):

Three Months Ended
                       June 30,                     Decline
                  2014           2013 (1)      Dollars    Percent
Net sales:
Golf clubs $     193.2          $    206.8    $ (13.6 )      (7 )%
Golf balls        38.7                42.8       (4.1 )     (10 )%
           $     231.9          $    249.6    $ (17.7 )      (7 )%

(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 clubs segment, and a corresponding decrease in net sales in the golf balls segment.

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
                           June 30,                Growth/(Decline)
                       2014            2013       Dollars      Percent
Net sales:
United States   $     112.5          $ 124.4    $    (11.9 )     (10 )%
Europe                 39.3             40.2          (0.9 )      (2 )%
Japan                  32.5             36.7          (4.2 )     (11 )%
Rest of Asia           25.1             22.9           2.2        10  %
Other countries        22.5             25.4          (2.9 )     (11 )%
                $     231.9          $ 249.6    $    (17.7 )      (7 )%

Net sales in the United States decreased $11.9 million (10%) to $112.5 million during the second quarter of 2014 compared to the same period in the prior year. The Company's sales in regions outside of the United States decreased $5.9 million (5%) to $119.4 million for the second quarter of 2014 compared to $125.3 million in the same quarter of 2013. The 7% decrease in net sales in all regions primarily resulted from the challenging market conditions and high promotional activity mentioned above. This decrease was partially offset by the favorable 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 $1.7 million lower than reported in the second quarter of 2014.
Gross profit decreased $4.9 million (5%) to $90.8 million for the second quarter of 2014 compared to $95.7 million in the second quarter of 2013. Gross profit as a percentage of net sales ("gross margin") increased to 39.2% in the second quarter of 2014 compared to 38.3% in the second quarter of 2013. This increase was primarily due to cost savings from improved manufacturing and distribution efficiencies, and charges recognized during the second quarter of 2013 related to the Cost Reduction Initiatives. These increases were partially offset by (i) the net unfavorable impact of changes in foreign currency rates period over period; (ii) an increase in promotional activity in the second quarter of 2014 compared to the second quarter of 2013; (iii) and an increase in club component costs due to more expensive materials and technology incorporated into certain putters and woods products launched in the current year. See "Cost of Sales and Segment Profitability" below for further discussion of gross margin. Selling expenses decreased by $1.1 million to $60.6 million (26.1% of net sales) in the second quarter of 2014 compared to $61.7 million (24.7% of net sales) in the comparable period of 2013. This decrease was primarily due to a $0.5 million decrease in marketing expenses in addition to a $0.5 million decrease in employee costs.
General and administrative expenses decreased by $2.7 million to $12.5 million (5.4% of net sales) in the second quarter of 2014 compared to $15.2 million (6.1% of net sales) in the comparable period of 2013. This decrease was primarily due to a $2.6 million decrease in stock compensation expense as a result of a 19% decrease in the Company's stock in the second quarter of 2014, combined with a $1.0 million decrease in legal expenses, partially offset by a $0.7 million increase in bad debt expense.


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Research and development expenses decreased by $0.5 million to $6.8 million (3.0% of net sales) in the second quarter of 2014 compared to $7.3 million (2.9% of net sales) in the comparable period of 2013. This decrease was primarily due to a decrease in employee costs.
Interest expense increased slightly to $2.9 million in the second quarter of 2014 compared to $2.8 million in the second quarter of 2013.
Other income (expense), net decreased to other expense of $3.0 million in the second quarter of 2014 compared to other income of $2.5 million in the second quarter of 2013. This decrease was primarily due to a $5.5 million increase in net foreign currency losses in the second quarter of 2014 compared to the same period in 2013.
The Company's provision for income taxes increased to $1.9 million in the second quarter of 2014, compared to $1.4 million in the second quarter of 2013. The $0.5 million increase resulted primarily from the release of certain unrecognized tax benefits during the second quarter of 2013 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 second quarter of 2014 is not comparable to the effective tax rate for the second quarter of 2013 as the Company's provision for income taxes is not directly correlated to the amount of its pretax income. Net income for the second quarter of 2014 decreased $6.7 million to $3.4 million compared to $10.1 million in the second quarter of 2013. Diluted earnings per share decreased $0.08 to $0.04 in the second quarter of 2014 compared to $0.12 in the second quarter of 2013.
Golf Clubs and Golf Balls Segments Results for the Three Months Ended June 30, 2014 and 2013
Golf Clubs Segment
Net sales information by product category is summarized as follows (dollars in millions):

                            Three Months Ended
                                  June 30,                  Growth/(Decline)
                             2014           2013 (1)      Dollars    Percent
Net sales:
Woods                 $      52.5          $     70.2    $ (17.7 )       (25 )%
Irons                        52.5                53.8       (1.3 )        (2 )%
Putters                      26.8                21.7        5.1          24  %
Accessories and other        61.4                61.1        0.3           -  %
                      $     193.2          $    206.8    $ (13.6 )        (7 )%

(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 clubs segment, and a corresponding decrease in net sales in the golf balls segment. The $17.7 million (25%) decrease in net sales of woods to $52.5 million for the quarter ended June 30, 2014 resulted from a decline in both sales volume and average selling prices. The decrease in sales volume was primarily due to a decline in sales of the Company's X2 Hot fairway woods in the second quarter of 2014 compared to the X Hot fairway woods in the second quarter of 2013 (fairway woods were up 57% in the second quarter of 2013 compared to the same period of 2012). The decrease in average selling prices was due to an increase in promotional activity at retail during the second quarter of 2014 compared to the same quarter in the prior year. The $1.3 million (2%) decrease in net sales of irons to $52.5 million for the quarter ended June 30, 2014 was primarily attributable to a decline in sales volume partially offset by an increase in average selling prices. The decrease in sales volume was primarily due to a decline in sales of the X2 Hot irons compared to the prior year X Hot irons resulting from challenging market conditions in the current year. This was partially offset by the strong performance of the Company's APEX irons launched during the current year. 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.


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The $5.1 million (24%) increase in the net sales of putters to $26.8 million for the quarter ended June 30, 2014 was primarily due to an increase in average selling prices combined with a slight increase in sales volumes. The increase in average selling prices was due to a favorable shift in product mix due to increased sales of the Company's new counterbalanced technology putters (Tank and Tank Cruiser) as well as the introduction of the new elite Metal X Milled putter during 2014 with no comparable elite putter launch during the prior year. The increase in sales volume was due to the launch of the new Tank Cruiser adjustable counterbalance line of putters during the second quarter of 2014. The $0.3 million (0%) increase in net sales of accessories and other to $61.4 million for the quarter ended June 30, 2014 was primarily due to an increase in sales of packaged sets, 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. Golf Balls Segment
Net sales information for the golf balls segment is summarized as follows (dollars in millions):

Three Months Ended
                       June 30,                     Decline
                  2014            2013(1)      Dollars    Percent
Net sales:
Golf balls $     38.7            $    42.8    $  (4.1 )     (10 )%

(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 clubs segment, and a corresponding decrease in net sales in the golf balls segment. The $4.1 million (10%) decrease in net sales of golf balls to $38.7 million for the quarter ended June 30, 2014 was primarily due to a decline in sales volume with a slight increase in average selling prices. The decrease in sales volume was primarily due to a decline in sales of Special Make-Up ("SMU") balls partially offset by 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 in 2013. Segment Profitability
Profitability by operating segment is summarized as follows (dollars in millions):

                               Three Months Ended
                                     June 30,              Growth/(Decline)
                                2014         2013(1)      Dollars      Percent
Income before income taxes:
Golf clubs(2)               $    11.3       $  24.2     $    (12.9 )     (53 )%
Golf balls(2)                     5.2          (2.7 )          7.9       293  %
Reconciling items(3)            (11.3 )       (10.0 )         (1.3 )      13  %
                            $     5.2       $  11.5     $     (6.3 )     (55 )%

(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 $3.4 million in the golf clubs segment, and a corresponding decrease in income before income taxes in the golf balls 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 June 30, 2013, the Company's golf clubs and golf balls segments recognized pre-tax charges of $0.6 million and $4.1 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 second quarter of 2013, the reconciling items include pre-tax charges of $0.3 million related to the Cost Reduction Initiatives.


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Pre-tax income in the Company's golf clubs operating segment decreased to $11.3 million for the second quarter of 2014 from $24.3 million for the comparable period in the prior year. This decrease was driven by a decrease in net sales as discussed above combined with a decrease in gross profit as a percentage of sales ("gross margin" or "margin"). The decrease in gross margin was primarily due to (i) the net unfavorable impact of changes in foreign currency rates period over period; (ii) an increase in promotional activity in the second quarter of 2014 compared to the second quarter of 2013; (iii) and an increase in club component costs due to more expensive materials and technology incorporated into certain woods and putter products launched in the current year. These decreases were partially offset by cost savings from improved manufacturing and distribution efficiencies, and charges recognized during the second quarter of 2013 related to the Cost Reduction Initiatives.
Pre-tax income in the Company's golf balls operating segment increased to $5.2 million for the second quarter of 2014 from a loss of $2.7 million for the comparable period in the prior year. This increase was primarily attributable to a 22.8 percentage point improvement in gross margin, partially offset by a decrease in net sales as discussed above. The improvement in gross margin was primarily due to (i) cost savings from improved manufacturing and distribution efficiencies; (ii) charges recognized during the second quarter of 2013 related to the Cost Reduction Initiatives; and (iii) the launch of the premium Speed Regime golf balls in 2014 with no comparable premium launch in 2013. These increases were partially offset by the net unfavorable impact on gross margin resulting from changes in foreign currency rates. Six-Month Periods Ended June 30, 2014 and 2013 Net sales for the six months ended June 30, 2014 increased $46.4 million to $583.8 million compared to $537.4 million for the same period in 2013. This increase was due to increased sales in both the golf club and golf ball operating segments resulting from continued brand momentum and the strong performance of the Big Bertha drivers, APEX irons, and Speed Regime and Supersoft golf balls launched during the current year. These increases were partially offset by the late start to the 2014 golf season, high retail inventory industry-wide and increased promotional activity during the second quarter of 2014. Additionally, the Company's net sales for the first six months of 2014 were negatively impacted by $4.7 million resulting from unfavorable fluctuations in foreign currency rates.
The Company's net sales by operating segment are presented below (dollars in millions):

Six Months Ended
                     June 30,                    Growth
                2014          2013(1)     Dollars      Percent
Net sales:
Golf clubs $    492.4        $  452.2    $    40.2       9 %
Golf balls       91.4            85.2          6.2       7 %
           $    583.8           537.4         46.4       9 %

(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 $1.2 million in the golf clubs segment, and a corresponding decrease in net sales in the golf balls segment. 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):

Six Months Ended
                         June 30,                    Growth
                     2014           2013      Dollars      Percent
Net sales:
United States   $    297.2        $ 284.1    $    13.1        5 %
Europe                90.5           78.5         12.0       15 %
Japan                 92.5           80.8         11.7       14 %
Rest of Asia          52.1           43.0          9.1       21 %
Other countries       51.5           51.0          0.5        1 %
                $    583.8        $ 537.4    $    46.4        9 %


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Net sales in the United States increased $13.1 million (5%) to $297.2 million during the six months ended June 30, 2014 compared to the same period in the . . .

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