Form 10-Q CALLAWAY GOLF CO For: Sep 30
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E-mailUNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q |
� | Quarterly Report Pursuant to Section�13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September�30, 2014
OR
o | Transition Report Pursuant to Section�13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period �������������������� to ��������������������
Commission file number 001-10962��
Callaway Golf Company | ||
(Exact name of registrant as specified in its charter) | ||
Delaware | � | 95-3797580 |
(State or other jurisdiction of incorporation or organization) | � | (I.R.S. Employer Identification No.) |
2180 Rutherford Road, Carlsbad, CA 92008
(760) 931-1771
(Address, including zip code, and telephone number, including area code, of principal executive offices)
Indicate by check mark whether the registrant (1)�has filed all reports required to be filed by Section�13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2)�has been subject to such filing requirements for the past 90 days.����Yes�������No��o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation�S-T (�232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).����Yes�������No��o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Large�accelerated�filer | o | Accelerated�filer | � | |||
Non-accelerated filer | o��(Do not check if a smaller reporting company) | Smaller�reporting�company | o | |||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).����Yes��o����No���
As of September 30, 2014, the number of shares outstanding of the Registrants common stock outstanding was 77,573,211.
Important Notice to Investors Regarding Forward-Looking Statements: This report contains "forward-looking statements" as defined under the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as: "may," "should," "will," "anticipate," "plan," "believe," "project," "estimate," "expect," "strategy," "future," "likely," "on track," and similar references to future periods. Forward-looking statements include, among others, statements that relate to future plans, events, liquidity, financial results or performance including, but not limited to, statements relating to future stock repurchases, cash flows and liquidity, compliance with debt covenants, estimated unrecognized stock compensation expense, projected capital expenditures and depreciation and amortization expense, market conditions, future contractual obligations, the realization of deferred tax assets, including loss and credit carryforwards, the reversal of the deferred tax valuation allowance in future periods, future income tax expense, and the continued success of the Company's turnaround plan and the Company's recovery, as well as improved financial results during 2014. These statements are based upon current information and our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. As a result of these uncertainties and because the information on which our forward-looking statements is based may ultimately prove to be incorrect, actual results may differ materially from those anticipated. Important factors that could cause actual results to differ include, among others, the following:
" | certain risks and uncertainties, including changes in capital market or economic conditions, delays, difficulties, changed strategies, or increased costs in implementing the Companys turnaround plans; |
" | consumer acceptance of and demand for the Companys products; |
" | future retailer purchasing activity, which can be significantly affected by adverse industry conditions and overall retail inventory levels; |
" | the level of promotional activity in the marketplace; |
" | future consumer discretionary purchasing activity, which can be significantly adversely affected by unfavorable economic or market conditions; |
" | future changes in foreign currency exchange rates and the degree of effectiveness of the Companys hedging programs; |
" | adverse changes in the credit markets or continued compliance with the terms of the Companys credit facilities; |
" | delays, difficulties or increased costs in the supply of components needed to manufacture the Companys products or in manufacturing the Companys products; |
" | adverse weather conditions and seasonality; |
" | any rule changes or other actions taken by the USGA or other golf association that could have an adverse impact upon demand or supply of the Companys products; |
" | the ability of the Company to protect its intellectual property rights; |
" | a decrease in participation levels in golf; |
" | the effect of terrorist activity, armed conflict, natural disasters or pandemic diseases on the economy generally, on the level of demand for the Companys products or on the Companys ability to manage its supply and delivery logistics in such an environment; and |
" | the general risks and uncertainties applicable to the Company and its business. |
For details concerning these and other risks and uncertainties, see Part I, Item IA, Risk Factors contained in the Companys most recent Annual Report on Form 10-K, as well as the Companys Quarterly Reports on Form 10-Q and Current Report on Form 8-K subsequently filed with the Commission from time to time. Investors should not to place undue reliance on these forward-looking statements, which are on current information and speak only as of the date hereof. The Company undertakes no obligation to update any forward-looking statements to reflect new information or events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Investors should also be aware that while the Company from time to time does communicate with securities analysts, it is against the Companys policy to disclose to them any material non-public information or other confidential commercial information. Furthermore, the Company has a policy against distributing or confirming financial forecasts or projections issued by analysts and any reports issued by such analysts are not the responsibility of the Company. Investors should not assume that the Company agrees with any report issued by any analyst or with any statements, projections, forecasts or opinions contained in any such report.
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Callaway Golf Company Trademarks: The following marks and phrases, among others, are trademarks of Callaway Golf Company: Anypoint-Backstryke-Big Bertha-Black Series Tour Designs-Callaway-Callaway Golf-C Grind-Chev-Chev 18-Chevron Device-D.A.R.T.-Demonstrably Superior and Pleasingly Different-Divine-Eagle-ERC-FTiZ-FT Optiforce-FT Performance-FT Tour-Fusion-Gems-Great Big Bertha-Heavenwood-HX-HX Diablo-Hex Aerodynamics-Hex Black Tour-Hex Chrome-Hex Hot-Hex Diablo-Hex Solaire-Hex Warbird-IMIX-Legacy-Legacy Aero-Legend-Mack Daddy 2-Marksman-Metal-X-Number One Putter in Golf-Odyssey-OptiFit-ORG.14-ProType-ProType Black-Rossie-S2H2-Sabertooth-Solaire-Steelhead-Strata-Stronomic-Sure-Out-Tank-Teron-Tech Series-Ti-Hot-Tour Authentic-Tour i-Tour i(S)-Tour iX-Tour i(Z)-Trade In! Trade Up!-Tru Bore-uDesign-uPro-Versa-VFT-Warbird-White Hot-White Hot Tour-White Hot Pro-White Ice-World's Friendliest-X-Act-X Forged-X Hot-X Hot Pro-XJ Series-X-SPANN-Xtra Traction Technology-XTT-Xtra Width Technology-XWT-2-Ball-3 Deep.
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CALLAWAY GOLF COMPANY
INDEX
Item�1. | ||
Item�2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | |
Item�3. | ||
Item�4. | ||
Item�1. | ||
Item�1A. | ||
Item�2. | ||
Item�3. | ||
Item�4. | ||
Item�5. | ||
Item�6. | ||
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PART I. FINANCIAL INFORMATION
Item�1.����Financial Statements (Unaudited)
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
(In thousands, except share and per share data)
September�30, 2014 | December�31, 2013 | ||||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 33,462 | $ | 36,793 | |||
Accounts receivable, net | 143,090 | 92,203 | |||||
Inventories | 185,583 | 263,492 | |||||
Deferred taxes, net | 5,925 | 6,419 | |||||
Other current assets | 23,559 | 22,696 | |||||
Total current assets | 391,619 | 421,603 | |||||
Property, plant and equipment, net | 61,881 | 71,341 | |||||
Intangible assets, net | 88,847 | 88,901 | |||||
Goodwill | 28,403 | 29,212 | |||||
Deferred taxes, net | 2,688 | 2,299 | |||||
Other assets | 54,106 | 50,507 | |||||
Total assets | $ | 627,544 | $ | 663,863 | |||
LIABILITIES AND SHAREHOLDERS EQUITY | |||||||
Current liabilities: | |||||||
Accounts payable and accrued expenses | $ | 98,914 | $ | 157,120 | |||
Accrued employee compensation and benefits | 29,212 | 31,585 | |||||
Asset-based credit facility | 25,660 | ||||||
Accrued warranty expense | 5,882 | 6,406 | |||||
Income tax liability | 3,577 | 5,425 | |||||
Total current liabilities | 137,585 | 226,196 | |||||
Long-term liabilities: | |||||||
Income tax payable | 4,243 | 4,387 | |||||
Deferred taxes, net | 35,101 | 35,271 | |||||
Convertible notes, net (Note 3) | 108,386 | 107,835 | |||||
Long-term incentive compensation and other | 2,020 | 5,555 | |||||
Commitments and contingencies (Note 12) | |||||||
Shareholders equity: | |||||||
Preferred stock, $0.01 par value, 3,000,000 shares authorized, none issued and outstanding at September 30, 2014 and December�31, 2013 | |||||||
Common stock, $0.01 par value, 240,000,000 shares authorized, 78,373,598 and 78,314,902 shares issued at September 30, 2014 and December�31, 2013, respectively | 784 | 783 | |||||
Additional paid-in capital | 208,477 | 205,712 | |||||
Retained earnings | 132,246 | 77,038 | |||||
Accumulated other comprehensive income | 7,369 | 12,177 | |||||
Less: Common stock held in treasury, at cost, 800,387 and 967,089 shares at September 30, 2014 and December�31, 2013, respectively | (8,667 | ) | (11,091 | ) | |||
Total shareholders equity | 340,209 | 284,619 | |||||
Total liabilities and shareholders equity | $ | 627,544 | $ | 663,863 | |||
The accompanying notes are an integral part of these financial statements.
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CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
�
� | Three Months Ended� �September 30, | Nine Months Ended� �September 30, | |||||||||||||
� | 2014 | 2013 | 2014 | 2013 | |||||||||||
Net sales | $ | 168,572 | $ | 178,229 | $ | 752,339 | $ | 715,631 | |||||||
Cost of sales | 103,265 | 118,820 | 431,329 | 430,134 | |||||||||||
Gross profit | 65,307 | 59,409 | 321,010 | 285,497 | |||||||||||
Operating expenses: | |||||||||||||||
Selling expense | 46,871 | 49,871 | 184,786 | 179,851 | |||||||||||
General and administrative expense | 12,918 | 18,870 | 43,459 | 48,626 | |||||||||||
Research and development expense | 8,144 | 7,689 | 22,903 | 22,435 | |||||||||||
Total operating expenses | 67,933 | 76,430 | 251,148 | 250,912 | |||||||||||
Income (loss) from operations | (2,626 | ) | (17,021 | ) | 69,862 | 34,585 | |||||||||
Interest income | 43 | 92 | 368 | 492 | |||||||||||
Interest expense | (2,080 | ) | (2,067 | ) | (7,665 | ) | (7,094 | ) | |||||||
Other income (expense), net | 3,833 | (1,120 | ) | (1,367 | ) | 7,536 | |||||||||
Income (loss) before income taxes | (830 | ) | (20,116 | ) | 61,198 | 35,519 | |||||||||
Income tax provision | 304 | 1,037 | 3,651 | 4,941 | |||||||||||
Net income (loss) | (1,134 | ) | (21,153 | ) | 57,547 | 30,578 | |||||||||
Dividends on convertible preferred stock | 1,766 | 3,332 | |||||||||||||
Net income (loss) allocable to common shareholders | $ | (1,134 | ) | $ | (22,919 | ) | $ | 57,547 | $ | 27,246 | |||||
Earnings (loss) per common share: | |||||||||||||||
Basic | $ | (0.01 | ) | $ | (0.32 | ) | $ | 0.74 | $ | 0.38 | |||||
Diluted | $ | (0.01 | ) | $ | (0.32 | ) | $ | 0.66 | $ | 0.36 | |||||
Weighted-average common shares outstanding: | |||||||||||||||
Basic | 77,646 | 72,649 | 77,551 | 71,613 | |||||||||||
Diluted | 77,646 | 72,649 | 93,384 | 86,870 | |||||||||||
The accompanying notes are an integral part of these financial statements.
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CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands)
�
� | Three Months Ended� �September 30, | Nine Months Ended� �September 30, | |||||||||||||
� | 2014 | 2013 | 2014 | 2013 | |||||||||||
Net income (loss) | $ | (1,134 | ) | $ | (21,153 | ) | $ | 57,547 | $ | 30,578 | |||||
Other comprehensive income (loss): | |||||||||||||||
Foreign currency translation adjustments | (9,495 | ) | 1,948 | (4,808 | ) | (11,886 | ) | ||||||||
Comprehensive income (loss) | $ | (10,629 | ) | $ | (19,205 | ) | $ | 52,739 | $ | 18,692 | |||||
The accompanying notes are an integral part of these financial statements.
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CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
� | Nine Months Ended� �September 30, | ||||||
� | 2014 | 2013 | |||||
Cash flows from operating activities: | |||||||
Net income | $ | 57,547 | $ | 30,578 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Depreciation and amortization | 16,379 | 19,693 | |||||
Deferred taxes | (179 | ) | 303 | ||||
Non-cash share-based compensation | 3,979 | 2,592 | |||||
(Gain) loss on disposal of long-lived assets | (1,097 | ) | 2,428 | ||||
Discount amortization on convertible notes | 551 | 523 | |||||
Change in assets and liabilities: | |||||||
Accounts receivable, net | (52,218 | ) | (69,122 | ) | |||
Inventories | 75,380 | 14,132 | |||||
Other assets | (150 | ) | 2,013 | ||||
Accounts payable and accrued expenses | (50,620 | ) | (151 | ) | |||
Accrued employee compensation and benefits | (2,195 | ) | 6,614 | ||||
Accrued warranty expense | (524 | ) | (773 | ) | |||
Income taxes receivable/payable | (4,936 | ) | 177 | ||||
Other liabilities | (3,575 | ) | (1,449 | ) | |||
Net cash provided by operating activities | 38,342 | 7,558 | |||||
Cash flows from investing activities: | |||||||
Capital expenditures | (8,803 | ) | (8,920 | ) | |||
Proceeds from sales of property and equipment | 458 | 4,025 | |||||
Investment in golf-related ventures | (4,712 | ) | (7,189 | ) | |||
Net cash used in investing activities | (13,057 | ) | (12,084 | ) | |||
Cash flows from financing activities: | |||||||
Repayment of credit facilities, net | (25,660 | ) | |||||
Exercise of stock options | 2,222 | ||||||
Dividends paid | (2,330 | ) | (4,882 | ) | |||
Acquisition of treasury stock | (1,006 | ) | |||||
Credit facility amendment costs | (608 | ) | |||||
Equity issuance costs | (7 | ) | (274 | ) | |||
Net cash used in financing activities | (27,389 | ) | (5,156 | ) | |||
Effect of exchange rate changes on cash and cash equivalents | (1,227 | ) | (4,922 | ) | |||
Net decrease in cash and cash equivalents | (3,331 | ) | (14,604 | ) | |||
Cash and cash equivalents at beginning of period | 36,793 | 52,003 | |||||
Cash and cash equivalents at end of period | $ | 33,462 | $ | 37,399 | |||
Supplemental disclosures: | |||||||
Cash paid for income taxes, net | $ | 8,349 | $ | 4,401 | |||
Cash paid for interest and fees | $ | 7,824 | $ | 4,336 | |||
Noncash investing and financing activities: | |||||||
Dividends payable | $ | $ | 57 | ||||
Issuance of common stock and treasury stock for compensatory stock awards released from restriction | $ | 87 | $ | 1,649 | |||
Acquisition of treasury stock for minimum statutory withholding taxes | $ | (7 | ) | $ | (364 | ) | |
Accrued capital expenditures at period-end | $ | 268 | $ | 1,936 | |||
The accompanying notes are an integral part of these financial statements.
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CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF SHAREHOLDERS EQUITY
(Unaudited)
(In thousands)
�
� | Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income | Treasury Stock | � | |||||||||||||||||||||||||
� | Shares | Amount | Shares | Amount | Total | ||||||||||||||||||||||||||
Balance at December 31, 2013 | 78,315 | $ | 783 | $ | 205,712 | $ | 77,038 | $ | 12,177 | (967 | ) | $ | (11,091 | ) | $ | 284,619 | |||||||||||||||
Acquisition of treasury stock | (133 | ) | (1,013 | ) | (1,013 | ) | |||||||||||||||||||||||||
Compensatory awards released from restriction | 58 | 1 | (87 | ) | 8 | 86 | |||||||||||||||||||||||||
Exercise of stock options | (1,129 | ) | 292 | 3,351 | 2,222 | ||||||||||||||||||||||||||
Equity issuance costs | (7 | ) | (7 | ) | |||||||||||||||||||||||||||
Share-based compensation | 3,979 | 3,979 | |||||||||||||||||||||||||||||
Stock dividends | 1 | 9 | (9 | ) | |||||||||||||||||||||||||||
Cash dividends | (2,330 | ) | (2,330 | ) | |||||||||||||||||||||||||||
Equity adjustment from foreign currency translation | (4,808 | ) | (4,808 | ) | |||||||||||||||||||||||||||
Net income | 57,547 | 57,547 | |||||||||||||||||||||||||||||
Balance at September 30, 2014 | 78,374 | $ | 784 | $ | 208,477 | $ | 132,246 | $ | 7,369 | (800 | ) | $ | (8,667 | ) | $ | 340,209 | |||||||||||||||
The accompanying notes are an integral part of these financial statements.
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CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited consolidated condensed financial statements have been prepared by Callaway Golf Company (the Company or Callaway Golf ) pursuant to the rules and regulations of the Securities and Exchange Commission ( SEC ). Accordingly, certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States ( U.S. GAAP ) have been condensed or omitted. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the year ended December�31, 2013 filed with the SEC. These consolidated condensed financial statements, in the opinion of management, include all the normal and recurring adjustments necessary for the fair presentation of the financial position, results of operations and cash flows for the periods and dates presented. Interim operating results are not necessarily indicative of operating results for the full year.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates and assumptions.
Recent Accounting Standards
In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-15, "Presentation of Financial StatementsGoing Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entitys Ability to Continue as a Going Concern." This ASU is intended to define managements responsibility to evaluate whether there is substantial doubt about an organizations ability to continue as a going concern and to provide related footnote disclosures, and provides guidance to an organizations management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations today in the financial statement footnotes. Until the issuance of this ASU, U.S. GAAP lacked guidance about managements responsibility to evaluate whether there is substantial doubt about the organizations ability to continue as a going concern or to provide related footnote disclosures.The amendments are effective for annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early application is permitted for annual or interim reporting periods for which the financial statements have not previously been issued. The Company does not expect that the adoption of this amendment will have a material impact on the Companys consolidated condensed financial statements and disclosures.
In June 2014, the FASB issued ASU No. 2014-12, "Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period." This ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period, be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The Company is currently evaluating the impact this ASU will have on its consolidated condensed financial statements.
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers: (Topic 606)." This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). This ASU will supersede the revenue recognition requirements in Topic 605, "Revenue Recognition," and most industry-specific guidance. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer (e.g., assets within the scope of Topic 360, "Property, Plant, and Equipment," and intangible assets within the scope of Topic 350, "Intangibles-Goodwill and Other") are amended to be consistent with the guidance on
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recognition and measurement (including the constraint on revenue) in this ASU. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently evaluating the impact this ASU will have on its consolidated condensed financial statements.
In July 2013, the FASB issued ASU No. 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force)." This ASU states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except in certain situations. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. The adoption of this amendment did not have a material impact on the Companys consolidated condensed financial statements.
In March 2013, the FASB issued ASU No.�2013-05, Foreign Currency Matters (Topic 830): Parents Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity. This ASU provides guidance on releasing cumulative translation adjustments to net income when an entity ceases to have a controlling financial interest in a subsidiary or business within a foreign entity. The cumulative translation adjustments should be released only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets resides. This ASU is effective on a prospective basis for fiscal years and interim reporting periods within those years, beginning after December�15, 2013. The adoption of this amendment did not have a material impact on the Companys consolidated condensed financial statements.
Note 2. Cost Reduction Initiatives
In December 2013, the Company completed its cost reduction initiatives (the Cost Reduction Initiatives ), which streamlined and simplified the Companys organizational structure and changed the manner in which the Company approaches and operates its business. These initiatives included (i)�a reduction in workforce that impacted all regions and levels of the organization in addition to other transition costs; (ii)�greater focus on the Companys core product lines, which included the transition of the Company's certain apparel and footwear product lines to a licensing arrangement with third parties; (iii)�the transition of the Companys GPS device business to a third-party based model; and (iv)�the reorganization of the Companys golf ball manufacturing supply chain, including the sale and lease-back of the Companys ball manufacturing facility in Chicopee, Massachusetts (Note 6).
As of December 31, 2013, the Company completed the Cost Reduction Initiatives and will not incur future charges associated with these initiatives. In the aggregate through December 31, 2013, the Company recognized total charges of $70,600,000 in connection with these initiatives, of which approximately two-thirds resulted in non-cash charges.
During the three and nine months ended September�30, 2013, the Company recognized total cash and non-cash charges of $1,858,000 and $10,365,000, respectively, in connection with these initiatives. Amounts recognized in cost of sales during the three and nine months ended September�30, 2013 totaled $1,005,000 and $7,374,000, respectively, and the amounts recognized in operating expenses totaled $853,000 and $2,991,000, respectively. Non-cash charges recognized in the first nine months of 2013 included lower of cost or market adjustments to inventory as well as inventory write-offs related to the Company's golf apparel, golf footwear and GPS device businesses. The Company did not recognize any charges in connection with the Cost Reduction Initiatives during the three and nine months ended September�30, 2014. Amounts payable as of September�30, 2014 included ongoing severance payments and transition costs in connection with the restructuring of the Company's distribution facility in Canada. See Note 16 for charges recognized by the Companys operating segments.
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The table below depicts the activity and liability balances recorded as part of the Cost Reduction Initiatives (in thousands) as of September�30, 2014 and 2013. Amounts payable as of September�30, 2014 and December 31, 2013 are included in accrued employee compensation and benefits, and accounts payable and accrued expenses in the accompanying consolidated condensed balance sheets.
� | Cost Reduction Initiatives | ||||||||||||||
� | Workforce Reductions | Transition Costs | Asset Write-offs | Total | |||||||||||
Nine months ended September 30, 2013 | |||||||||||||||
Restructuring payable balance, December 31, 2012 | $ | 4,531 | $ | 591 | $ | $ | 5,122 | ||||||||
Charges to cost and expense | 1,091 | 2,418 | 3,509 | ||||||||||||
Non-cash items | (1,699 | ) | (1,699 | ) | |||||||||||
Cash payments | (3,547 | ) | (717 | ) | (4,264 | ) | |||||||||
Restructuring payable balance, March 31, 2013 | $ | 2,075 | $ | 593 | $ | $ | 2,668 | ||||||||
Charges to cost and expense | 677 | 997 | 3,324 | 4,998 | |||||||||||
Non-cash items | (412 | ) | (3,324 | ) | (3,736 | ) | |||||||||
Cash payments | (1,652 | ) | (1,071 | ) | (2,723 | ) | |||||||||
Restructuring payable balance, June 30, 2013 | $ | 1,100 | $ | 107 | $ | $ | 1,207 | ||||||||
Charges to cost and expense | 602 | 1,256 | 1,858 | ||||||||||||
Non-cash items | (675 | ) | (675 | ) | |||||||||||
Cash payments | (669 | ) | (45 | ) | (714 | ) | |||||||||
Restructuring payable balance, September 30, 2013 | $ | 1,033 | $ | 643 | $ | $ | 1,676 | ||||||||
Nine months ended September 30, 2014 | |||||||||||||||
Restructuring payable balance, December�31, 2013 | $ | 806 | $ | 2,501 | $ | $ | 3,307 | ||||||||
Cash payments | (476 | ) | (1,355 | ) | (1,831 | ) | |||||||||
Restructuring payable balance, March 31, 2014 | $ | 330 | $ | 1,146 | $ | $ | 1,476 | ||||||||
Cash payments | (209 | ) | (203 | ) | (412 | ) | |||||||||
Restructuring payable balance, June 30, 2014 | $ | 121 | $ | 943 | $ | $ | 1,064 | ||||||||
Cash payments | (97 | ) | (260 | ) | (357 | ) | |||||||||
Restructuring payable balance, September 30, 2014 | $ | 24 | $ | 683 | $ | $ | 707 | ||||||||
Note 3. Financing Arrangements
In addition to cash on hand, as well as cash generated from operations, the Company relies on its asset-based revolving credit facility to manage seasonal fluctuations in liquidity and to provide additional liquidity when the Companys operating cash flows are not sufficient to fund the Companys requirements. The Companys ability to generate sufficient positive cash flows from operations is subject to many risks and uncertainties, including future economic trends and conditions, the success of the Companys multi-year turnaround, demand for the Companys products, foreign currency exchange rates, and the other risks and uncertainties applicable to the Company and its business. If the Company is unable to generate sufficient cash flows to fund its business, and is unable to reduce its manufacturing costs and operating expenses to offset such shortfall, the Company will need to increase its reliance on its credit facility for needed liquidity. If the Companys current credit facility is not available or sufficient and the Company could not secure alternative financing arrangements, the Companys future operations would be significantly, adversely affected. The Company believes that its current credit facility, along with its cash on hand and cash flows expected to be generated from operations, is sufficient to meet the Companys liquidity requirements for at least the next 12 months.
Asset-Based Revolving Credit Facility
The Company has a Loan and Security Agreement with Bank of America N.A. (as last amended in June 2014, the ABL Facility ), which provides a senior secured asset-based revolving credit facility of up to $230,000,000, comprised of a $160,000,000 U.S. facility, a $25,000,000 Canadian facility, and a $45,000,000 United Kingdom facility, in each case subject to borrowing base availability under the applicable facility. The amounts outstanding under the ABL Facility are secured by certain assets, including
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cash (to the extent pledged by the Company), inventory and accounts receivable of the Companys U.S., Canadian and U.K. legal entities.
As of September�30, 2014, the Company had no borrowings outstanding under the ABL Facility, $1,278,000 in outstanding letters of credit, and $33,462,000 in cash and cash equivalents. The maximum amount of additional indebtedness (as defined by the ABL Facility) that could have been outstanding on September�30, 2014, after outstanding borrowings and letters of credit was approximately $72,188,000, resulting in total available liquidity of $105,650,000. The maximum availability under the ABL Facility fluctuates with the general seasonality of the business and increases and decreases with changes in the Companys inventory and accounts receivable balances. The maximum availability is at its highest during the first half of the year when the Companys inventory and accounts receivable balances are higher and then decreases during the second half of the year when the Companys accounts receivable balances are lower due to an increase in cash collections. Average outstanding borrowings during the nine months ended September�30, 2014 were $84,168,000, and average available liquidity, defined as cash on hand combined with amounts available under the ABL Facility after outstanding borrowings and letters of credit was approximately $77,625,000. Amounts borrowed under the ABL Facility may be repaid and reborrowed as needed. The entire outstanding principal amount (if any) is due and payable at the earlier of (a)�the date that is six months prior to the maturity of the Companys 3.75% Convertible Senior Notes maturing on August�15, 2019 or (b) June�23, 2019, if a qualifying refinancing of the Companys 3.75% Convertible Senior Notes due 2019 has occurred at least six months prior to their maturity.
The ABL Facility includes certain restrictions including, among other things, restrictions on incurrence of additional debt, liens, dividends, stock repurchases and other restricted payments, asset sales, investments, mergers, acquisitions and affiliate transactions. As of September�30, 2014, the Company was in compliance with all covenants of the ABL Facility. Additionally, the Company is subject to compliance with a fixed charge coverage ratio covenant during, and continuing 30 days after, any period in which the Companys borrowing base availability, as amended, falls below $23,000,000. The Companys borrowing base availability was above $23,000,000 during the nine months ended September�30, 2014, and the Company was in compliance with the fixed charge coverage ratio as of September�30, 2014. Had the Company not been in compliance with the fixed charge coverage ratio as of September 30, 2014, the Company's maximum amount of additional indebtedness that could have been outstanding on September 30, 2014 would have been reduced by $23,000,000.
The interest rate, as amended, applicable to outstanding loans under the ABL Facility fluctuates depending on the Companys availability ratio," which is expressed as a percentage of (a)�the average daily availability under the ABL Facility to (b)�the sum of the Canadian, the U.K. and the U.S. borrowing bases, as adjusted. The applicable margin for any month will be reduced by 0.25% if the Companys availability ratio is greater than or equal to 67% and the Companys leverage ratio (as defined below) is less than 4.0 to 1.0 as of the last day of the month for which financial statements have been delivered, so long as no default or event of default exists. The Companys leverage ratio is the ratio of the amount of debt for borrowed money to the twelve-month trailing EBITDA (as defined in the ABL Facility), each determined on a consolidated basis. At September�30, 2014, the Companys trailing twelve months average interest rate applicable to its outstanding loans under the ABL Facility, including fees, was 4.23%.
Origination and amendment fees of $4,913,000 incurred in connection with the ABL Facility are amortized into interest expense over the term of the ABL Facility agreement. Unamortized fees at September�30, 2014 and December�31, 2013 totaled $2,359,000 and $2,295,000, respectively, of which $497,000 and $918,000 were included in other current assets, respectively, and $1,862,000 and $1,377,000 were included in other assets, respectively, in the accompanying consolidated condensed balance sheets.
Convertible Senior Notes
In August 2012, the Company issued $112,500,000 of 3.75% Convertible Senior Notes (the convertible notes ). The convertible notes pay interest of 3.75%�per year on the principal amount, payable semiannually in arrears on February�15 and August�15 of each year. The convertible notes mature on August�15, 2019.
The Company incurred transactional fees of $3,537,000, which are being amortized into interest expense over the term of the convertible notes. Unamortized transaction fees as of September�30, 2014 and December�31, 2013 were $2,526,000 and $2,863,000, respectively, of which $505,000 was included in other current assets as of both September�30, 2014 and December 31, 2013, and $2,021,000 and $2,358,000 were included in other assets as of September�30, 2014 and December 31, 2013, respectively, in the accompanying consolidated condensed balance sheets.
The net carrying amount of the convertible notes as of September�30, 2014 and December�31, 2013 was $108,386,000 and $107,835,000, respectively. The unamortized discount of $4,114,000 as of September�30, 2014 will be amortized to interest expense over the remaining term of approximately 4.9 years. Total interest and amortization expense recognized during the three and nine
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months ended September�30, 2014 was $1,241,000 and $3,715,000, respectively, and $1,233,000 and $3,673,000 for the three and nine months ended September�30, 2013, respectively.
The notes are convertible, at the option of the note holder, at any time on or prior to the close of business on the business day immediately preceding August�15, 2019, into shares of common stock at an initial conversion rate of 133.3333 shares per $1,000 principal amount of convertible notes, which is equal to 15,000,000 shares of common stock at a conversion price of approximately $7.50 per share, subject to customary anti-dilution adjustments. Upon the occurrence of certain change of control events of the Company, the Company will pay a premium on the convertible notes converted in connection with such change of control events by increasing the conversion rate on such convertible notes.
Under certain circumstances, the Company has the right to terminate the right of note holders to convert their convertible notes. If the Company exercises such termination right prior to August�15, 2015, each note holder who converts its convertible notes after receiving notice of such exercise will receive a make-whole payment in cash or common stock, as the Company may elect, with respect to the convertible notes converted.
Upon the occurrence of a change of control of the Company or a termination of trading of the common stock of the Company, note holders will have the option to require the Company to repurchase for cash all or any portion of such note holders convertible notes at a price equal to 100% of the principal amount of the repurchased convertible notes, plus accrued and unpaid interest thereon to the repurchase date.
The convertible notes are not redeemable by the Company prior to August�15, 2015. On or after August�15, 2015, the convertible notes are redeemable in whole or in part at the option of the Company at a redemption price equal to 100% of the principal amount of the convertible notes to be redeemed, plus accrued and unpaid interest thereon to the redemption date.
The convertible notes contain certain covenants including payment of principal, certain repurchase obligations and interest, obligations of the Company to convert the convertible notes, and other customary terms as defined in the Indenture. The Company remained in compliance with these covenants as of September�30, 2014.
Note 4. Preferred Stock
In August 2013, the Company exchanged 233,843 shares of its 7.50% Series B Cumulative Perpetual Convertible Preferred Stock, $0.01 par value, (the preferred stock ) for 3,316,922 shares of the Company's common stock at the stated conversion rate of 14.1844, plus an additional 75,342 common shares as an inducement. The Company also paid the exchanging holders cash dividends through December 15, 2013 on their shares of preferred stock surrendered in the exchange. During the fourth quarter of 2013, the Company issued a notice of redemption and holders of 183,496 shares of preferred stock converted their holdings for 2,602,770 shares of common stock at the conversion rate of 14.1844. The Company redeemed the remaining 300 shares for $30,000 in cash. At December 31, 2013 and September 30, 2014, there were no shares outstanding of the Company's Series B Cumulative Perpetual Convertible Preferred Stock.
Note 5. Earnings per Common Share
Earnings per common sharebasic, is computed by dividing net income allocable to common shareholders (net income less preferred stock dividends) by the weighted-average number of common shares outstanding for the period.
Earnings per common sharediluted, is computed by dividing the sum of net income allocable to common shareholders and interest expense on the Company's convertible notes, by the weighted-average number of common sharesdiluted. Dilutive securities are included in the calculation of diluted earnings per common share using the treasury stock method and the if-converted method in accordance with Accounting Standards Codification ( ASC ) Topic 260, Earnings per Share. Dilutive securities include the common stock equivalents of convertible preferred stock and convertible notes, options granted pursuant to the Companys stock option plans and outstanding restricted stock units and performance share units granted to employees and non-employee directors (see Note 13). There were no shares outstanding of the Company's Series B Cumulative Perpetual Convertible Preferred Stock as of September�30, 2014 (see Note 4).
Weighted-average common shares outstandingdiluted is the same as weighted-average common shares outstandingbasic in periods when a net loss is reported or in periods when diluted earnings per share is higher than basic earnings per share. �
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The following table summarizes the computation of basic and diluted earnings per share (in thousands, except per share data):
� | Three Months Ended� �September 30, | Nine Months Ended� �September 30, | |||||||||||||
� | 2014 | 2013 | 2014 | 2013 | |||||||||||
Earnings (loss) per common sharebasic | |||||||||||||||
Net income (loss) | $ | (1,134 | ) | $ | (21,153 | ) | $ | 57,547 | $ | 30,578 | |||||
Less: Preferred stock dividends | 1,766 | 3,332 | |||||||||||||
Net income (loss) allocable to common shareholders | $ | (1,134 | ) | $ | (22,919 | ) | $ | 57,547 | $ | 27,246 | |||||
Weighted-average common shares outstandingbasic | 77,646 | 72,649 | 77,551 | 71,613 | |||||||||||
Basic earnings (loss) per common share | $ | (0.01 | ) | $ | (0.32 | ) | $ | 0.74 | $ | 0.38 | |||||
Earnings (loss) per common sharediluted | |||||||||||||||
Net income (loss) | $ | (1,134 | ) | $ | (21,153 | ) | $ | 57,547 | $ | 30,578 | |||||
Less: Preferred stock dividends | 1,766 | 3,332 | |||||||||||||
Add: Interest on convertible debt, net of tax | 3,715 | 3,673 | |||||||||||||
Net income (loss) including assumed conversions | $ | (1,134 | ) | $ | (22,919 | ) | $ | 61,262 | $ | 30,919 | |||||
Weighted-average common shares outstandingbasic | 77,646 | 72,649 | 77,551 | 71,613 | |||||||||||
Convertible notes weighted-average shares outstanding | 15,000 | 15,000 | |||||||||||||
Options and restricted stock | 833 | 257 | |||||||||||||
Weighted-average common shares outstandingdiluted | 77,646 | 72,649 | 93,384 | 86,870 | |||||||||||
Dilutive earnings (loss) per common share | $ | (0.01 | ) | $ | (0.32 | ) | $ | 0.66 | $ | 0.36 | |||||
Earnings per sharedilutive, reflects the potential dilution that could occur if securities, or other contracts to issue common stock, were exercised or converted into common stock. Options with an exercise price in excess of the average market value of the Company's common stock during the period have been excluded from the calculation as their effect would be antidilutive.
For the three months ended September�30, 2014 and 2013, securities outstanding totaling approximately 16,753,000 (including common shares underlying convertible senior notes of 15,000,000) and 24,716,000 shares (including common shares underlying convertible senior notes of 15,000,000, and common shares underlying 4,446,000 preferred shares), respectively, have been excluded from the calculation of earnings per common sharediluted, as their effect would be antidilutive. For the nine months ended September�30, 2014 and 2013, securities totaling approximately 2,717,000 and 11,117,000 (including common shares underlying 5,426,000 preferred shares), respectively, have been excluded from the calculation of earnings per common sharediluted, as their effect would be antidilutive.
Note 6. Sale of Buildings
On February�28, 2013, the Company completed the sale of its manufacturing facility in Chicopee, Massachusetts for proceeds of $3,496,000, net of closing costs and commissions, and recorded a loss on the sale of $31,000. The Company has $102,000 and $785,000 accrued in accounts payable and accrued expenses as of September�30, 2014 and December�31, 2013, respectively, for certain environmental remediation costs related to the sale of this facility. The Company has leased back a reduced portion of the square footage for ongoing golf ball operations.
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Note 7. Inventories
Inventories are summarized below (in thousands):
September�30, 2014 | December�31, 2013 | ||||||
Inventories: | |||||||
Raw materials | $ | 44,609 | $ | 56,104 | |||
Work-in-process | 528 | 328 | |||||
Finished goods | 140,446 | 207,060 | |||||
$ | 185,583 | $ | 263,492 | ||||
Note 8. Goodwill and Intangibles Assets
Goodwill at September�30, 2014 and December�31, 2013 was $28,403,000 and $29,212,000, respectively. The decrease in goodwill during the nine months ended September�30, 2014 of $809,000 was due to foreign currency fluctuations. Gross goodwill before impairments at September�30, 2014 and December�31, 2013 was $30,152,000 and $30,961,000, respectively.
The Companys goodwill and acquired intangible assets with indefinite lives are not amortized, but are subject to an annual impairment test. The Company performs an impairment analysis on its goodwill and intangible assets at least annually and whenever events or changes in circumstances indicate that the carrying value of such assets may not be fully recoverable. Acquired intangible assets with definite lives are amortized over their estimated useful lives and are tested for impairment only when impairment indicators are present.
The following sets forth the intangible assets by major asset class (dollars in thousands):
� | Useful Life (Years) | September�30, 2014 | December�31, 2013 | ||||||||||||||||||||||||||
� | Gross | Accumulated Amortization | Net�Book Value | Gross | Accumulated Amortization | Net Book Value | |||||||||||||||||||||||
Non-Amortizing: | |||||||||||||||||||||||||||||
Trade name, trademark and trade dress and other | NA | $ | 88,590 | $ | $ | 88,590 | $ | 88,590 | $ | $ | 88,590 | ||||||||||||||||||
Amortizing: | |||||||||||||||||||||||||||||
Patents | 2-16 | 31,581 | 31,326 | 255 | 31,581 | 31,287 | 294 | ||||||||||||||||||||||
Developed technology and other | 1-9 | 7,961 | 7,959 | 2 | 7,961 | 7,944 | 17 | ||||||||||||||||||||||
Total intangible assets | $ | 128,132 | $ | 39,285 | $ | 88,847 | $ | 128,132 | $ | 39,231 | $ | 88,901 | |||||||||||||||||
Aggregate amortization expense on intangible assets was approximately $54,000 and $267,000 for the nine months ended September�30, 2014 and 2013, respectively.
Amortization expense related to intangible assets at September�30, 2014 in each of the next five fiscal years and beyond is expected to be incurred as follows (in thousands):
Remainder of 2014 | $ | 14 | |
2015 | 51 | ||
2016 | 51 | ||
2017 | 51 | ||
2018 | 51 | ||
2019 | 39 | ||
$ | 257 | ||
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Note 9. Investments
Investment in TopGolf International, Inc.
The Company owns preferred shares of TopGolf International, Inc. ( TopGolf ), the owner and operator of TopGolf entertainment centers. In connection with this investment, the Company has a preferred partner agreement with TopGolf in which the Company has preferred signage rights, rights as the preferred supplier of golf products used or offered for use at TopGolf facilities at prices no less than those paid by the Companys customers, preferred retail positioning in the TopGolf retail stores, access to consumer information obtained by TopGolf, and other rights incidental to those listed.
During the three and nine months ended September 30, 2014, the Company invested an additional $190,000 and $4,712,000 in preferred shares, respectively, of TopGolf, thereby increasing the Company's total investment as of September�30, 2014 to $42,317,000. The Companys total ownership interest in TopGolf, including the incremental investments completed in 2014, remains at less than 20%. In addition, the Company does not have the ability to significantly influence the operating and financing activities and policies of TopGolf. Accordingly, the Companys investment in TopGolf is accounted for at cost in accordance with ASC Topic 325, InvestmentsOther, and is included in other assets in the accompanying consolidated condensed balance sheets as of September�30, 2014 and December�31, 2013.
Note 10. Product Warranty
The Company has a stated two-year warranty policy for its golf clubs. The Companys policy is to accrue the estimated cost of satisfying future warranty claims at the time the sale is recorded. In estimating its future warranty obligations, the Company considers various relevant factors, including the Companys stated warranty policies and practices, the historical frequency of claims, and the cost to replace or repair its products under warranty.
The following table provides a reconciliation of the activity related to the Companys reserve for accrued warranty expense (in thousands):
� | Three Months Ended� �September 30, | Nine Months Ended� �September 30, | |||||||||||||
� | 2014 | 2013 | 2014 | 2013 | |||||||||||
Beginning balance | $ | 7,396 | $ | 8,241 | $ | 6,406 | $ | 7,539 | |||||||
Provision | (15 | ) | 190 | 3,895 | 4,335 | ||||||||||
Claims paid/costs incurred | (1,499 | ) | (1,665 | ) | (4,419 | ) | (5,108 | ) | |||||||
Ending balance | $ | 5,882 | $ | 6,766 | $ | 5,882 | $ | 6,766 | |||||||
Note 11. Income Taxes
The Company calculates its interim income tax provision in accordance with ASC 270, Interim Reporting, and ASC 740 Accounting for Income Taxes (together, ASC 740 ). In general, at the end of each interim period, the Company estimates the annual effective tax rate for foreign operations and applies that rate to its ordinary foreign quarterly earnings. For the nine months ended September�30, 2014, and consistent with prior quarters, the discrete method was used to calculate the Company's U.S. interim tax expense as the annual effective rate was not considered a reliable estimate of year-to-date income tax expense. Under the discrete method, the Company determines its U.S. tax expense based upon actual results as if the interim period were an annual period. The Company's full U.S. valuation allowance position and the seasonality of the Company's business create results with significant variations in the customary relationship between income tax expense and pre-tax income for the interim periods. As a result, the use of the discrete method is more appropriate than the annual effective tax rate method.
The realization of deferred tax assets, including loss and credit carry forwards, is subject to the Company generating sufficient taxable income during the periods in which the temporary differences become realizable. Due to the Company's taxable losses in the United States over the last few years, the Company has recorded a valuation allowance against its U.S. deferred tax assets. At each quarter end that a valuation allowance is maintained, as the U.S. deferred tax assets are adjusted upwards or downwards, the associated valuation allowance and income tax expense will be adjusted. If sufficient positive evidence arises in the future, such as a sustained return to profitability in the U.S. business, any existing valuation allowance could be reversed as appropriate, decreasing income tax expense in the period that such conclusion is reached.
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The provision for income taxes is primarily comprised of taxes related to the Company's foreign operations. The income tax provision for the three months ended September�30, 2014 and 2013 was $304,000 and $1,037,000, respectively, and was $3,651,000 and $4,941,000 for the nine months ended September�30, 2014 and 2013, respectively. The decrease in the income tax provision was primarily due to the release of certain unrecognized tax benefits in the three and nine months ended September 30, 2014 due to the lapse of statutes of limitation in various jurisdictions.
At September�30, 2014, the gross liability for income taxes associated with uncertain tax positions was $6,321,000. The liability for uncertain tax positions could be reduced by $2,024,000 of offsetting tax benefits associated with the correlative effects of potential transfer pricing adjustments as well as $3,176,000 of deferred taxes. The net amount of $1,121,000, if recognized, would favorably affect the Companys consolidated condensed financial statements and effective income tax rate. The unrecognized tax benefit liabilities are expected to decrease approximately $426,000 during the next 12 months. The gross liability for uncertain tax positions decreased by $4,838,000 for the three months ended September 30, 2014. This decrease was primarily due to a change in tax position related to an unrecognized tax benefit in the United States and the release of certain unrecognized tax benefits due to lapse of statutes of limitation in various jurisdictions.
The Company recognizes interest and penalties related to income tax matters in income tax expense. For the three months ended September�30, 2014 and 2013, the Company's provision for income taxes includes a benefit of $31,000 and expense of $58,000, respectively, related to interest and penalties. For the nine months ended September�30, 2014 and 2013, the Company's provision for income taxes includes benefits of $55,000 and $150,000, respectively, related to interest and penalties. As of September�30, 2014 and December�31, 2013, the gross amount of accrued interest and penalties included in income taxes payable in the accompanying consolidated condensed balance sheets was $1,108,000 and $1,163,000, respectively.
The Company files income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. The Company is generally no longer subject to income tax examinations by tax authorities in the following major jurisdictions:
Tax Jurisdiction | Years�No�Longer�Subject�to�Audit |
U.S. federal | 2009�and�prior |
California (United States) | 2008 and prior |
Canada | 2006 and prior |
Japan | 2007 and prior |
South Korea | 2008 and prior |
United Kingdom | 2009 and prior |
Pursuant to Section�382 of the Internal Revenue Code, use of the Company's NOL and credit carry-forwards may be limited significantly if the Company were to experience a cumulative change in ownership of the Company's stock by 5-percent shareholders that exceeds 50% over a rolling three-year period. The Company does not believe there has been a cumulative change in ownership in excess of 50% during that period. The Company continues to monitor changes in ownership. If such a cumulative change did occur in any three year period and the Company were limited in the amount of losses it could use to offset taxable income, the Company's results of operations and cash flows would be adversely impacted.
Note 12. Commitments & Contingencies
Legal Matters
The Company is subject to routine legal claims, proceedings, and investigations incident to its business activities, including claims, proceedings, and investigations relating to commercial disputes and employment matters. The Company also receives from time to time information claiming that products sold by the Company infringe or may infringe patent, trademark, or other intellectual property rights of third parties. One or more such claims of potential infringement could lead to litigation, the need to obtain licenses, the need to alter a product to avoid infringement, a settlement or judgment, or some other action or material loss by the Company, which also could adversely affect the Companys overall ability to protect its product designs and ultimately limit its future success in the marketplace. In addition, the Company is occasionally subject to non-routine claims, proceedings, or investigations.
The Company regularly assesses such matters to determine the degree of probability that the Company will incur a material loss as a result of such matters as well as the range of possible loss. An estimated loss contingency is accrued in the Companys
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financial statements if it is probable the Company will incur a loss and the amount of the loss can be reasonably estimated. The Company reviews all claims, proceedings, and investigations at least quarterly and establishes or adjusts any accruals for such matters to reflect the impact of negotiations, settlements, advice of legal counsel, and other information and events pertaining to a particular matter. All legal costs associated with such matters are expensed as incurred.
Historically, the claims, proceedings and investigations brought against the Company, individually, and in the aggregate, have not had a material adverse effect upon the consolidated results of operations, cash flows, or financial position of the Company. The Company believes that it has valid legal defenses to the matters currently pending against the Company. These matters are inherently unpredictable and the resolutions of these matters are subject to many uncertainties and the outcomes are not predictable with assurance. Consequently, management is unable to estimate the ultimate aggregate amount of monetary loss, amounts covered by insurance, or the financial impact that will result from such matters. Management believes that the final resolution of the current matters pending against the Company, individually and in the aggregate, will not have a material adverse effect upon the Companys consolidated financial position. The Companys results of operations or cash flows, however, could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies.
Unconditional Purchase Obligations
During the normal course of its business, the Company enters into agreements to purchase goods and services, including purchase commitments for production materials, endorsement agreements with professional golfers and other endorsers, employment and consulting agreements, and intellectual property licensing agreements pursuant to which the Company is required to pay royalty fees. It is not possible to determine the amounts the Company will ultimately be required to pay under these agreements as they are subject to many variables including performance-based bonuses, reductions in payment obligations if designated minimum performance criteria are not achieved, and severance arrangements. As of September�30, 2014, the Company has entered into many of these contractual agreements with terms ranging from one to four years. The minimum obligation that the Company is required to pay under these agreements is $48,763,000 over the next four years. In addition, the Company also enters into unconditional purchase obligations with various vendors and suppliers of goods and services in the normal course of operations through purchase orders or other documentation or that are undocumented except for an invoice. Such unconditional purchase obligations are generally outstanding for periods less than a year and are settled by cash payments upon delivery of goods and services and are not reflected in this total. Future minimum purchase commitments as of September�30, 2014, are as follows (in�thousands):
Remainder of 2014 | $ | 33,598 | |
2015 | 12,499 | ||
2016 | 2,472 | ||
2017 | 192 | ||
2018 | 2 | ||
$ | 48,763 | ||
Other Contingent Contractual Obligations
During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include (i)�intellectual property indemnities to the Companys customers and licensees in connection with the use, sale and/or license of Company product or trademarks, (ii)�indemnities to various lessors in connection with facility leases for certain claims arising from such facilities or leases, (iii)�indemnities to vendors and service providers pertaining to the goods and services provided to the Company or based on the negligence or willful misconduct of the Company, and (iv)�indemnities involving the accuracy of representations and warranties in certain contracts. In addition, the Company has consulting agreements that provide for payment of nominal fees upon the issuance of patents and/or the commercialization of research results. The Company has also issued guarantees in the form of standby letters of credit of $1,278,000 as of September�30, 2014.
The duration of these indemnities, commitments and guarantees varies, and in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation on the maximum amount of future payments the Company could be obligated to make. Historically, costs incurred to settle claims related to indemnities have not been material to the Companys financial position, results of operations or cash flows. In addition, the Company believes the likelihood is remote that material payments under the commitments and guarantees described above will have a material effect on the Companys
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financial condition. The fair value of indemnities, commitments and guarantees that the Company issued during the nine months ended September�30, 2014 was not material to the Companys financial position, results of operations or cash flows.
Employment Contracts
The Company has made contractual commitments to each of its officers and certain other employees providing for severance payments, including salary continuation, upon the termination of employment by the Company for convenience or by the officer for substantial cause. In addition, in order to assure that the officers would continue to provide independent leadership consistent with the Companys best interest, the contracts also generally provide for certain protections in the event of a change in control of the Company. These protections include the payment of certain severance benefits, such as salary continuation, upon the termination of employment following a change in control.
Note 13. Share-Based Employee Compensation
As of September�30, 2014, the Company had two shareholder approved stock plans under which shares were available for equity-based awards: the Callaway Golf Company Amended and Restated 2004 Incentive Plan and the 2013 Non-Employee Directors Stock Incentive Plan. From time to time, the Company grants stock options, restricted stock units, phantom stock units, stock appreciation rights and other awards under these plans. In 2014, the Company granted restricted stock units and performance share units under these plans, compared to stock options and restricted stock units in 2013.
The table below summarizes the amounts recognized in the financial statements for the three and nine months ended September�30, 2014 and 2013 for share-based compensation, including expense for stock options, restricted stock units, phantom stock units, cash settled stock appreciation rights and performance share units. The decrease in share-based compensation expense during the three and nine months ended September 30, 2014 compared to the same periods in the prior year was due to a decline in the stock price period over period. In addition, compensation expense during 2013 included expense from phantom stock units which vested in January 2014.
� | Three Months Ended� �September 30, | Nine Months Ended� �September 30, | |||||||||||||
(In thousands) | 2014 | 2013 | 2014 | 2013 | |||||||||||
Cost of sales | $ | (55 | ) | $ | 84 | $ | 71 | $ | 229 | ||||||
Operating expenses | (436 | ) | 1,804 | 2,519 | 4,028 | ||||||||||
Total cost of share-based compensation included in income, before income�tax | $ | (491 | ) | $ | 1,888 | $ | 2,590 | $ | 4,257 | ||||||
Stock Options
There were no stock options granted during the first nine months of 2014. During the nine months ended September�30, 2013, the Company granted 1,843,000 shares underlying stock options at a weighted average grant-date fair value of $2.47 per share based on the Black Scholes option-pricing model. There were no stock options granted during the third quarter of 2013. Total compensation expense recognized for stock options during the three and nine months ended September�30, 2014 was $358,000 and $1,081,000, respectively. Total compensation expense recognized for stock options during the three and nine months ended September�30, 2013 was $486,000 and $1,333,000, respectively.
The Company records compensation expense for employee stock options based on the estimated fair value of the options on the date of grant using the Black-Scholes option-pricing model. The model uses various assumptions, including a risk-free interest rate, the expected term of the options, the expected stock price volatility, and the expected dividend yield. Compensation expense for employee stock options is recognized over the vesting term and is reduced by an estimate for forfeitures, which is based on the Companys historical forfeitures of unvested options and awards.
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The table below summarizes the weighted average Black-Scholes fair value assumptions used in the valuation of stock options granted during the nine months ended September�30, 2013. There were no stock options granted during the third quarter of 2013, and the first nine months of 2014.
� | Nine Months Ended� �September 30, 2013 | |
Dividend yield | 0.6 | % |
Expected volatility | 48.8 | % |
Risk free interest rate | 0.7 | % |
Expected life | 4.3 years | |
Restricted Stock Units
Restricted stock units are valued at the Companys closing stock price on the date of grant and generally vest at the end of a three year period. Compensation expense for restricted stock units is recognized over the vesting period and is reduced by an estimate for forfeitures. During the three and nine months ended September�30, 2014, the Company granted 13,000 and 384,000 shares underlying restricted stock units, respectively, at a weighted average grant-date fair value of $7.61 and $8.18 per share, respectively. Total compensation expense, net of estimated forfeitures, recognized for restricted stock units during the three and nine months ended September�30, 2014 was $770,000 and $2,121,000, respectively.
During the nine months ended September�30, 2013, the Company granted 441,000 shares underlying restricted stock units at a weighted average grant-date fair value of $6.55 per share. There were no restricted stock units granted during the third quarter of 2013. Total compensation expense, net of estimated forfeitures, recognized for restricted stock units during the three and nine months ended September�30, 2013 was $436,000 and $1,258,000, respectively.
At September�30, 2014, the Company had $4,770,000 of total unrecognized compensation expense related to non-vested restricted stock units under the Companys share-based payment plans. That cost is expected to be recognized over a weighted-average period of 1.7 years.
Performance Share Units
Performance share units are stock-based awards in which the number of shares ultimately received depends on the Company's performance against specified metrics that are measured over a one year performance period from the date of grant. These performance metrics were established by the Company at the beginning of the performance period. At the end of the performance period, the number of shares of stock that could be issued will be fixed based upon the degree of achievement of the performance goals. The number of shares that could be issued can range from 50% to 150% of the participant's target award. Compensation expense for performance share units is recognized over the vesting period and is reduced by an estimate for forfeitures, and will vary based on remeasurements during the performance period. If the performance metrics are not met at the end of the performance period, compensation expense would be reversed and the awards would be forfeited. The performance units vest in full at the end of a three year period.
The Company granted 453,000 performance share units during the nine months ended September�30, 2014 at a weighted average grant-date fair value of $8.20 per share. The company did not grant performance share units during the third quarter of 2014 or during the three and nine months ended September 30, 2013. During the three and nine months ended September�30, 2014, the Company recognized total compensation expense, net of estimated forfeitures, of $310,000 and $777,000, respectively, for performance share units.
Phantom Stock Units
Phantom stock units ("PSUs") are cash-settled awards that are remeasured at the end of each interim reporting period based on the closing price of the Companys common stock. Compensation expense for PSUs is recognized over the vesting period and will vary based on changes in the Company's stock price. PSUs vest at the end of a three year period.
There were no PSUs granted in the first nine months of 2014 and 2013. The Company reversed $57,000 and recognized $374,000 of compensation expense related to previously granted PSUs during the three and nine months ended September 30, 2014, respectively, and recognized $430,000 and $947,000 in compensation expense during the three and nine months ended September 30, 2013, respectively.
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At September�30, 2014, accrued compensation expense for PSUs was $1,624,000, which was recorded in accrued employee compensation and benefits in the accompanying consolidated condensed balance sheets. At December�31,�2013, the Company accrued $2,830,000 of compensation expense for PSUs, of which $1,439,000 was included in accrued employee compensation and benefits and $1,391,000 was included in long-term incentive compensation and other in the accompanying consolidated condensed balance sheets.
Stock Appreciation Rights
Stock appreciation rights ("SARs") are cash-settled awards that are indexed to the Company's stock price and are remeasured at the end of each interim period based on the Black-Scholes option-pricing model. Compensation expense is recognized on a straight-line basis over a three year vesting period and fluctuates with changes in valuation. SARs continue to be remeasured subsequent to vesting until they are exercised.
There were no SARs granted during the three and nine months ended September 30, 2014 and 2013. Due to decreases in the Company's stock price during the three and nine months ended September 30, 2014, the Company reversed expense of $1,872,000 and $1,763,000, respectively, related to SARs. The Company recognized $536,000 and $719,000 of compensation expense related to SARs during the three and nine months ended September 30, 2013, respectively.
At September�30, 2014, the Company accrued compensation expense of $3,379,000 in accrued employee compensation and benefits in the accompanying consolidated condensed balance sheets. At December�31, 2013, the Company accrued compensation expense of $5,193,000, of which $4,200,000 and $993,000 was included in accrued employee compensation and benefits and long-term incentive compensation and other, respectively, in the accompanying consolidated condensed balance sheets.
Note 14. Fair Value of Financial Instruments
Certain of the Companys financial assets and liabilities are measured at fair value on a recurring and nonrecurring basis. Fair value is defined as the price that would be received to sell an asset or the price paid to transfer a liability (the exit price) in the principal and most advantageous market for the asset or liability in an orderly transaction between market participants. Assets and liabilities carried at fair value are classified using the following three-tier hierarchy:
Level 1: Quoted market prices in active markets for identical assets or liabilities;
Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and
Level 3: Fair value measurements derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
The following table summarizes the valuation of the Companys foreign currency exchange contracts (see�Note 15) that are measured at fair value on a recurring basis by the above pricing levels at September�30, 2014 and December 31, 2013 (in thousands):
Fair Value | Level�1 | Level 2 | Level�3 | ||||||||||||
September 30, 2014 | |||||||||||||||
Foreign currency derivative instrumentsasset position | $ | 2,556 | $ | $ | 2,556 | $ | |||||||||
Foreign currency derivative instrumentsliability position | (316 | ) | (316 | ) | |||||||||||
$ | 2,240 | $ | $ | 2,240 | $ | ||||||||||
December 31, 2013 | |||||||||||||||
Foreign currency derivative instrumentsasset position | $ | 557 | $ | $ | 557 | $ | |||||||||
Foreign currency derivative instrumentsliability position | (823 | ) | (823 | ) | |||||||||||
$ | (266 | ) | $ | $ | (266 | ) | $ | ||||||||
The fair value of the Companys foreign currency exchange contracts is based on observable inputs that are corroborated by market data. Foreign currency derivatives on the balance sheet are recorded at fair value with changes in fair value recorded in the statements of operations.
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Disclosures about the Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, trade accounts receivable and trade accounts payable at September�30, 2014 and December�31, 2013 are reasonable estimates of fair value due to the short-term nature of these balances. The table below illustrates information about fair value relating to the Companys financial assets and liabilities that are recorded on the accompanying consolidated condensed balance sheets at their carrying values at September�30, 2014 and December�31, 2013, as well as the fair value of contingent contracts that represent financial instruments (in thousands).
� | September 30, 2014 | December 31, 2013 | |||||||||||||
� | Carrying Value | Fair Value | Carrying Value | Fair� Value | |||||||||||
Convertible notes(1) | $ | 108,386 | $ | 126,450 | $ | 107,835 | $ | 138,668 | |||||||
ABL Facility(2) | $ | $ | $ | 25,660 | $ | 25,660 | |||||||||
Standby letters of credit(3) | $ | 1,278 | $ | 1,278 | $ | 1,297 | $ | 1,297 | |||||||
(1) | The carrying value of the convertible notes at September�30, 2014 and December 31, 2013, is net of the unamortized discount of $4,114,000 and $4,665,000, respectively (see Note 3). The fair value of the convertible notes was determined based on secondary quoted market prices, and as such is classified as Level 2 in the fair value hierarchy. |
(2) | The carrying value of amounts outstanding under the Company's ABL Facility approximate the fair value due to the short term nature of this obligation. The fair value of this debt is categorized within Level 2 of the fair value hierarchy. |
(3) | The carrying value of the Company's standby letters of credit approximates the fair value as they represent the Companys contingent obligation to perform in accordance with the underlying contracts. There were no amounts outstanding under these letters of credit at September 30, 2014 and December 31, 2013. The fair value of this contingent obligation is categorized within Level 2 of the fair value hierarchy. |
Nonrecurring Fair Value Measurements
The Company measures certain assets at fair value on a nonrecurring basis when certain indicators are present. These assets include property, plant and equipment, goodwill and non-amortizing intangible assets that are written down to fair value when they are held for sale or determined to be impaired. During the nine months ended September�30, 2014 and 2013, the Company did not have any significant assets or liabilities that were measured at fair value on a nonrecurring basis in periods subsequent to initial recognition.
Note 15. Derivatives and Hedging
Foreign Currency Exchange Contracts
The Company accounts for its foreign currency exchange contracts in accordance with ASC Topic 815, Derivatives and Hedging ( ASC 815 ). ASC 815 requires the recognition of all derivatives as either assets or liabilities on the balance sheet, the measurement of those instruments at fair value and the recognition of changes in the fair value of derivatives in earnings in the period of change, unless the derivative qualifies as an effective hedge that offsets certain exposures.
In the normal course of business, the Company is exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to transactions of its international subsidiaries, including certain balance sheet exposures (payables and receivables denominated in foreign currencies). In addition, the Company is exposed to gains and losses resulting from the translation of the operating results of the Companys international subsidiaries into U.S. dollars for financial reporting purposes. As part of its strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, the Company uses derivative financial instruments in the form of foreign currency forward contracts and put and call option contracts ( foreign currency exchange contracts ) to help mitigate transactions that are denominated primarily in Japanese Yen, British Pounds, Euros, Canadian Dollars, Australian Dollars and Korean Won. Foreign currency exchange contracts are used only to meet the Companys objectives of minimizing variability in the Companys operating results arising from foreign exchange rate movements. The Company does not enter into foreign currency exchange contracts for speculative purposes. Foreign currency exchange contracts usually mature within twelve months from their inception.
The Company did not designate any foreign currency exchange contracts as derivatives that qualify for hedge accounting under ASC 815. At September�30, 2014 and December�31, 2013, the notional amounts of the Companys foreign currency exchange
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contracts used to help mitigate the exposures discussed above were approximately $113,201,000 and $42,264,000, respectively. The increase in foreign currency exchange contracts reflects the general timing of when the Company enters into these contracts. The Company estimates the fair values of foreign currency exchange contracts based on pricing models using current market rates, and records all derivatives on the balance sheet at fair value with changes in fair value recorded in the statements of operations. The foreign currency contracts are classified under Level 2 of the fair value hierarchy (see Note 14).
The following table summarizes the fair value of derivative instruments by contract type as well as the location of the asset and/or liability on the consolidated condensed balance sheets at September�30, 2014 and December�31, 2013 (in thousands):
Derivatives not designated as hedging instruments | Asset Derivatives | ||||||||||
September 30, 2014 | December�31, 2013 | ||||||||||
Balance�Sheet�Location | Fair�Value | Balance�Sheet�Location | Fair�Value | ||||||||
Foreign currency exchange contracts | Other�current�assets | $ | 2,556 | Other�current assets | $ | 557 | |||||
Derivatives not designated as hedging instruments | Liability Derivatives | ||||||||||
September 30, 2014 | December�31, 2013 | ||||||||||
Balance�Sheet�Location | Fair�Value | Balance�Sheet�Location | Fair�Value | ||||||||
Foreign currency exchange contracts | Accounts�payable�and accrued�expenses | $ | 316 | Accounts�payable�and accrued�expenses | $ | 823 | |||||
The following table summarizes the location of net gains and losses in the consolidated condensed statements of operations that were recognized during the three and nine months ended September�30, 2014 and 2013, respectively, in addition to the derivative contract type (in thousands):
�� | Location�of�net gain�(loss) recognized�in income�on� derivative instruments | Amount�of�Net Gain (Loss) Recognized�in Income�on�Derivative�Instruments | |||||||||||||||
Derivatives not designated as hedging instruments | Three Months Ended� �September 30, | Nine Months Ended� �September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||||
Foreign�currency�exchange�contracts | Other�income (expense),�net | $ | 8,766 | $ | (5,565 | ) | $ | 1,164 | $ | 7,238 | |||||||
The amounts shown in the table above represent a combination of realized and unrealized net gains and losses that were recognized by the Company on its foreign currency exchange contracts during the third quarter and first nine months of 2014 and 2013. Unrealized gains and losses represent the remeasurement of foreign currency exchange contracts that will mature in future periods. In addition, during the third quarter of 2014 and 2013, the Company recognized net foreign currency losses of $5,030,000 and net foreign currency gains of $4,455,000, respectively, related to transactions with foreign subsidiaries. During the first nine months of 2014 and 2013, the Company recognized net foreign currency losses of $2,662,000 and net foreign currency gains of $148,000, respectively, related to transactions with foreign subsidiaries.
Note 16. Segment Information
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 golf apparel and footwear, golf bags, golf gloves, travel gear, headwear and other golf-related accessories, in addition to royalties from licensing of the Companys trademarks and service marks and sales of pre-owned golf clubs. The golf balls segment consists of Callaway Golf balls that are designed, manufactured and sold by the Company. There are no significant intersegment transactions.
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The table below contains information utilized by management to evaluate its operating segments for the interim periods presented (in thousands):
� | Three Months Ended� �September 30, | Nine Months Ended� �September 30, | |||||||||||||
� | 2014 | 2013(1) | 2014 | 2013(1) | |||||||||||
Net sales: | |||||||||||||||
Golf Clubs | $ | 143,353 | $ | 152,207 | $ | 635,821 | $ | 604,433 | |||||||
Golf Balls | 25,219 | 26,022 | 116,518 | 111,198 | |||||||||||
$ | 168,572 | $ | 178,229 | $ | 752,339 | $ | 715,631 | ||||||||
Income before income taxes: | |||||||||||||||
Golf Clubs (2) | $ | 3,760 | $ | (5,060 | ) | $ | 77,922 | $ | 63,969 | ||||||
Golf Balls (2) | 543 | (2,770 | ) | 17,350 | (85 | ) | |||||||||
Reconciling items(3) | (5,133 | ) | (12,286 | ) | (34,074 | ) | (28,365 | ) | |||||||
$ | (830 | ) | $ | (20,116 | ) | $ | 61,198 | $ | 35,519 | ||||||
Additions to long-lived assets: | |||||||||||||||
Golf Clubs | $ | 2,169 | $ | 4,236 | $ | 7,401 | $ | 10,669 | |||||||
Golf Balls | 102 | 66 | 203 | 95 | |||||||||||
$ | 2,271 | $ | 4,302 | $ | 7,604 | $ | 10,764 | ||||||||
(1) | The prior year amounts have been reclassified 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. For the three months ended September 30, 2013, this resulted in a decrease to net sales and an increase to loss before income taxes of $403,000 and $650,000, respectively, in the golf clubs segment, and a corresponding increase to net sales and decrease to loss before income taxes in the golf balls segment. For the nine months ended September 30, 2013, this resulted in increases in net sales and income before income taxes of $834,000 and $3,559,000, respectively, in the golf clubs segment, and corresponding decreases in net sales and income before income taxes in the golf balls segment. |
(2) | In connection with the Cost Reduction Initiatives (see Note 2), the Companys golf clubs and golf balls segments recognized pre-tax charges of $990,000 and $454,000, respectively during the three months ended September 30, 2013, and $4,261,000 and $4,682,000, respectively, during the nine months ended September�30, 2013. |
(3) | Reconciling items represent corporate general and administrative expenses and other income (expense) not included by management in determining segment profitability. The change in reconciling items in the third quarter and first nine months of 2014 compared to the same periods in 2013 was primarily due to foreign currency transactions. During the three and nine months ended September�30, 2013, the reconciling items include pre-tax charges of $414,000 and $1,423,000, respectively, in connection with the Cost Reduction Initiatives. |
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Item�2.����Managements 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
Products
The Company designs, manufactures and sells high quality golf clubs, golf balls, golf bags 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 Companys golf products are designed for golfers of all skill levels, both amateur and professional.
Operating Segments
The Company has two reportable 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 Companys 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 Companys operating segments exclude a significant amount of corporate general administrative expenses and other income (expense) not utilized by management in determining segment profitability.
Cost of Sales
The Companys 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.
Seasonality
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 Companys on-course customers closing for the cold weather months. The Companys 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 Companys second quarter sales are significantly affected by the amount of reorder business of the products sold during the first quarter. The Companys 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 Companys fourth quarter sales are generally less than the other quarters due to the end of the golf season in many of the Companys 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, because of this seasonality, a majority of the Companys sales and most, if not all, of its profitability occurs during the first half of the year.
Foreign Currency
A significant portion of the Companys 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 Companys 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
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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 Companys foreign currency exchange contracts. In general, the Companys 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 Companys reported net sales in regions outside the U.S. in the first nine months 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 nine months of 2013 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 $4.3 million higher than the net sales reported in the first nine months of 2014. Additionally, in general, the U.S. dollar has recently strengthened against the foreign currencies in which the Company conducts its business, primarily the Japanese Yen. If this trend persists or if the U.S. dollar further strengthens against these currencies, it could significantly adversely impact the Company's future results of operations.
Executive Summary
The Companys net sales for the first nine months of 2014 increased to $752.3 million or 5%, as compared to $715.6 million for the same period in 2013.� Despite softer than expected market conditions, the Company continued to gain market share, driven by growth in sales of woods (+6%), irons (+9%), golf balls (+5%) and accessories and other (+3%). Net sales for the first nine months of 2014 were adversely affected by $4.3 million of unfavorable fluctuations in foreign currency rates. The Companys net sales for the third quarter of 2014 decreased 5% to $168.6 million due to the continued industry softness and the timing of new product launches compared to the same period in the prior year.
The Companys gross profit as a percentage of sales increased 280 basis points during the first nine months of 2014 and by 540 basis points for the third quarter of 2014, both as compared to the same periods in the prior year. These increases were primarily the result of favorable pricing on certain woods products combined with an increase in sales of higher margin products compared to 2013, as well as improved manufacturing and distribution efficiencies resulting from the Companys prior cost-reduction initiatives. Also contributing to the increase for the third quarter of 2014 was a decline in promotional activity, resulting in more full priced sales compared to 2013. In addition, there were no charges related to the cost-reduction initiatives in 2014 compared to charges incurred in 2013 of $7.4 million in the first nine months and $1.0 million in the third quarter (see Note 2 "Cost Reduction Initiatives" to the Notes to Consolidated Condensed Financial Statements in this Form 10-Q).
During the first nine months of 2014, the Company continued to manage operating expenses while also increasing its investment in its marketing and tour programs. As a result, operating expenses remained flat for the first nine months of 2014 compared to the same period in 2013. Operating expenses in the first nine months of 2013 included charges of $3.0 million related to the Company's cost-reduction initiatives, as well as incremental charges for bad debt. Operating expenses for the third quarter of 2014 decreased by $8.5 million, primarily as a result of a decline in bad debt expense, a decrease in stock compensation resulting from the remeasurement of cash-settled awards, as well as lower marketing expense due to a shift in new product launch timing.
For the first nine months of 2014, the Companys other income/expense decreased by $9.6 million to other expense of $8.7 million compared to other income of $0.9 million in the first nine months of 2013. For the third quarter of 2014, the Companys other income/expense improved by $4.9 million to other income of $1.8 million compared to other expense of $3.1 million in the third quarter of 2013. The changes in both periods are primarily attributable to the impact of changes in foreign currency rates on the Companys outstanding hedging contracts, which are remeasured at the end of each reporting period.
For the first nine months of 2014, net income increased by $27.0 million or 88% to $57.5 million, and diluted earnings per share increased by $0.30 or 83% to $0.66 per share, as compared to the same period in 2013.� For the third quarter of 2014, net loss improved by $20.0 million to $1.1 million, and diluted loss per share improved by $0.31 to $0.01 per share, as compared to the third quarter of 2013. These improvements reflect the Companys continued improvements in market share, tour success and operating efficiencies, as well as its anticipated return to profitability for the full year.
Three-Month Periods Ended September�30, 2014 and 2013
Net sales for the third quarter of 2014 decreased by $9.6 million to $168.6 million compared to $178.2 million in the third quarter of 2013. This decrease was due to a decline in golf club sales, with relatively flat golf ball sales. The decline in golf club sales was primarily due to continued industry softness combined with the timing of new product launches compared to the prior
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year. Despite the softer than expected market conditions, the Company gained market share due to continued brand momentum and the strong performance of the Big Bertha family of woods, APEX irons and Speed Regime and Supersoft golf balls launched during the current year.
The Companys net sales by operating segment are presented below (dollars in millions):
� | Three Months Ended� �September 30, | Decline | ||||||||||||
� | 2014 | 2013 (1) | Dollars | Percent | ||||||||||
Net sales: | ||||||||||||||
Golf clubs | $ | 143.4 | $ | 152.2 | $ | (8.8 | ) | (6 | )% | |||||
Golf balls | 25.2 | 26.0 | (0.8 | ) | (3 | )% | ||||||||
$ | 168.6 | $ | 178.2 | $ | (9.6 | ) | (5 | )% | ||||||
(1) The prior year amounts have been reclassified 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 a decrease to net sales of $0.4 million in the golf clubs segment, and a corresponding increase in net sales in the golf balls segment.
For further discussion of each operating segments 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) | ||||||||||||
� | 2014 | 2013 | Dollars | Percent | ||||||||||
Net sales: | ||||||||||||||
United States | $ | 74.5 | $ | 67.0 | $ | 7.5 | 11 | �% | ||||||
Europe | 24.5 | 26.5 | (2.0 | ) | (8 | )% | ||||||||
Japan | 35.1 | 48.6 | (13.5 | ) | (28 | )% | ||||||||
Rest of Asia | 21.8 | 23.7 | (1.9 | ) | (8 | )% | ||||||||
Other countries | 12.7 | 12.4 | 0.3 | 2 | �% | |||||||||
$ | 168.6 | $ | 178.2 | $ | (9.6 | ) | (5 | )% | ||||||
Net sales in the United States increased $7.5 million (11%)�to $74.5 million during the third quarter of 2014 compared to the same period in the prior year. The Companys sales in regions outside of the United States decreased $17.1 million (15%) to $94.1 million for the third quarter of 2014 compared to $111.2 million in the same quarter of 2013. The 5% decrease in net sales in all regions primarily resulted from the industry softness mentioned above, combined with later launch timing of certain products in Japan. 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 $0.4 million lower than reported in the third quarter of 2014.
Gross profit increased $5.9 million (10%) to $65.3 million for the third quarter of 2014 compared to $59.4 million in the third quarter of 2013. Gross profit as a percentage of net sales ( gross margin ) increased to 38.7% in the third quarter of 2014 compared to 33.3% in the third quarter of 2013. This increase was primarily due to (i) less promotional activity during the third quarter of 2014; (ii) a favorable shift in sales mix to higher margin Big Bertha woods and irons products in the third quarter of 2014 compared to the XHot woods and irons in the third quarter of 2013; (iii) a favorable shift in sales mix to premium Speed Regime golf balls in the third quarter of 2014; and (iv) cost savings from improved manufacturing and distribution efficiencies. These increases were partially offset by 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 $3.0 million to $46.9 million (27.8% of net sales) in the third quarter of 2014 compared to $49.9 million (28.0% of net sales) in the comparable period of 2013. This decrease was primarily due to a $2.3 million decrease in marketing expenses due to the timing of promotional activity, in addition to a $0.4 million decrease in employee costs.
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General and administrative expenses decreased by $6.0 million to $12.9 million (7.7% of net sales) in the third quarter of 2014 compared to $18.9 million (10.6% of net sales) in the comparable period of 2013. This decrease was primarily due to a $3.7 million decrease in bad debt expense as a result of additional reserves taken in the third quarter of 2013 related to a specific account, in addition to a $2.5 million decrease in employee costs primarily due to a $1.8 million decrease in stock compensation expense as a result of a 13% decrease in the Company's stock price during the third quarter of 2014, compared to an 8% increase in the Company's stock price in the third quarter of 2013.
Research and development expenses increased by $0.4 million to $8.1 million (4.8% of net sales) in the third quarter of 2014 compared to $7.7 million (4.3% of net sales) in the comparable period of 2013. This increase was primarily due to an increase in employee costs.
Other income (expense), net increased to other income of $3.8 million in the third quarter of 2014 compared to other expense of $1.1 million in the third quarter of 2013. This improvement was primarily due to a $4.8 million increase in net foreign currency gains in the third quarter of 2014 compared to the same period in 2013.
The Companys provision for income taxes decreased to $0.3 million in the third quarter of 2014, compared to $1.0 million in the third quarter of 2013. The $0.7 million decrease resulted primarily from the release of certain unrecognized tax benefits during the third quarter of 2014 resulting from the lapse of certain statutes of limitation. Due to the effects of the Companys valuation allowance against its U.S. deferred tax assets, the Companys effective tax rate for the third quarter of 2014 is not comparable to the effective tax rate for the third quarter of 2013 as the Companys provision for income taxes is not directly correlated to its pretax loss.
Net loss for the third quarter of 2014 decreased $20.1 million to $1.1 million compared to $21.2 million in the third quarter of 2013. Diluted losses per share improved to $(0.01) in the third quarter of 2014 compared to $(0.32) in the third quarter of 2013.
Golf Clubs and Golf Balls Segments Results for the Three Months Ended September 30, 2014 and 2013
Golf Clubs Segment
Golf club sales declined $8.8 million (6%) to $143.4 million in the third quarter of 2014 compared to the third quarter of 2013. This decline was primarily due to continued industry softness combined with the timing of new product launches compared to the prior year. Net sales information by product category is summarized as follows (dollars in millions):
� | Three Months Ended� �September 30, | Growth/(Decline) | ||||||||||||
� | 2014 | 2013 (1) | Dollars | Percent | ||||||||||
Net sales: | ||||||||||||||
Woods | $ | 52.2 | $ | 53.9 | $ | (1.7 | ) | (3 | )% | |||||
Irons | 36.7 | 38.6 | (1.9 | ) | (5 | )% | ||||||||
Putters | 13.7 | 19.8 | (6.1 | ) | (31 | )% | ||||||||
Accessories and other | 40.8 | 39.9 | 0.9 | 2 | �% | |||||||||
$ | 143.4 | $ | 152.2 | $ | (8.8 | ) | (6 | )% | ||||||
(1) The prior year amounts have been reclassified 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 a decrease to net sales of $0.4 million in the golf clubs segment, and a corresponding increase in net sales in the golf balls segment.
The $1.7 million (3%)�decrease in net sales of woods to $52.2 million for the quarter ended September�30, 2014 resulted from a decline in sales volume partially offset by an increase in average selling prices. The decrease in sales volume was primarily due to no new product launches during the third quarter of 2014 in Japan compared to two new products launched in the third quarter of 2013, combined with a decrease in sales of X2 Hot drivers and fairways due to the industry softness mentioned above, as well as a decrease in promotional activity in the third quarter of 2014 compared to the third quarter in the prior year. The increase in average selling prices was due to a favorable shift in product mix due to the success of the more premium Big Bertha woods products launched in the current year.
The $1.9 million (5%)�decrease in net sales of irons to $36.7 million for the quarter ended September�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
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primarily due to less promotional activity combined with a decline in wedge sales due to the launch of the Company's Mac Daddy 2 wedge in the third quarter of 2013 with no comparable wedge launch during the third quarter of 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 introduction of the APEX irons at higher average selling prices than the X Forged irons which were launched in the prior year.
The $6.1 million (31%) decrease in the net sales of putters to $13.7 million for the quarter ended September�30, 2014 was primarily due to a decline in sales volume partially offset by an increase in average selling prices. The decline in sales volume was due to a decrease in sales of closeout putter models in the third quarter of 2014 compared to the third quarter of 2013. The increase in average selling prices was due to a favorable shift in product mix to sales of the Company's counterbalanced technology putters (Tank and Tank Cruiser) as well as the introduction of the new elite Milled Collection putters during 2014 with no comparable elite putter launch during the prior year.
The $0.9 million (2%) increase in net sales of accessories and other to $40.8 million for the quarter ended September�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 Companys apparel 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� �September 30, | Decline | ||||||||||||
� | 2014 | 2013(1) | Dollars | Percent | ||||||||||
Net sales: | ||||||||||||||
Golf balls | $ | 25.2 | $ | 26.0 | $ | (0.8 | ) | (3 | )% | |||||
(1) The prior year amounts have been reclassified 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 a decrease to net sales of $0.4 million in the golf clubs segment, and a corresponding increase in net sales in the golf balls segment.
The $0.8 million (3%)�decrease in net sales of golf balls to $25.2 million for the quarter ended September�30, 2014 was primarily due 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 Company's HEX Chrome, X2 Hot and Practice balls partially offset by the success of the Company's Supersoft golf balls launched during the first quarter of 2014. The increase in average selling prices resulted from a decrease in promotional activity in the third quarter of 2014 compared to the third quarter of 2013, combined with 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� �September 30, | Growth | ||||||||||||
� | 2014 | 2013(1) | Dollars | Percent | ||||||||||
Income (loss) before income taxes: | ||||||||||||||
Golf clubs(2) | $ | 3.8 | $ | (5.1 | ) | $ | 8.9 | 175 | % | |||||
Golf balls(2) | 0.5 | (2.8 | ) | 3.3 | 118 | % | ||||||||
Reconciling items(3)� | (5.1 | ) | (12.2 | ) | 7.1 | 58 | % | |||||||
$ | (0.8 | ) | $ | (20.1 | ) | $ | 19.3 | 96 | % | |||||
(1) | The prior year amounts have been reclassified 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 loss before income taxes of $0.7 million in the golf clubs segment, and a corresponding decrease in loss before income taxes in the golf balls segment. |
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(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 September�30, 2013, the Companys golf clubs and golf balls segments recognized pre-tax charges of $1.0 million and $0.5 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 third quarter of 2013, the reconciling items include pre-tax charges of $0.4 million related to the Cost Reduction Initiatives. |
Pre-tax income in the Companys golf clubs operating segment increased to $3.8 million for the third quarter of 2014 from a pre-tax loss of $5.1 million for the comparable period in the prior year. This increase was driven by an increase in gross profit as a percentage of sales ("gross margin" or "margin") combined with a decrease in operating expenses, offset by a decrease in net sales as discussed above. The increase in gross margin was primarily due to (i) less promotional activity in the third quarter of 2014 compared to the third quarter in 2013; (ii) a favorable shift in sales mix to higher margin Big Bertha woods and irons products in the third quarter of 2014 compared to the XHot woods and irons in the third quarter of 2013; and (iii) cost savings from improved manufacturing and distribution efficiencies. These increases were partially offset by 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. The decrease in operating expenses in the third quarter of 2014 compared to the third quarter of 2013 was primarily due to decreases in bad debt expense and marketing expenses, as discussed above.
Pre-tax income in the Companys golf balls operating segment increased to $0.5 million for the third quarter of 2014 from a pre-tax loss of $2.8 million for the comparable period in the prior year. This increase was primarily attributable to an 11.1 percentage point improvement in gross margin combined with a decrease in operating expenses, partially offset by a decrease in net sales as discussed above. The improvement in gross margin was primarily due to (i) less promotional activity during the third quarter of 2014; (ii) the launch of the premium Speed Regime golf balls in 2014 with no comparable launch in the prior year; and (iii) cost savings from improved manufacturing and distribution efficiencies. The decrease in operating expenses in the third quarter of 2014 compared to the third quarter of 2013 was primarily due to decreases in bad debt expense and marketing expenses, as discussed above.
Nine-Month Periods Ended September�30, 2014 and 2013
Net sales for the nine months ended September 30, 2014 increased $36.7 million to $752.3 million compared to $715.6 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 family of woods, APEX irons, and Speed Regime and Supersoft golf balls launched during the current year resulting in market share gains across all product categories. These increases were partially offset by $4.3 million of unfavorable fluctuations in foreign currency rates.
The Companys net sales by operating segment are presented below (dollars in millions):
� | Nine Months Ended� �September 30, | Growth | ||||||||||||
� | 2014 | 2013(1) | Dollars | Percent | ||||||||||
Net sales: | ||||||||||||||
Golf clubs | $ | 635.8 | $ | 604.4 | $ | 31.4 | 5 | % | ||||||
Golf balls | 116.5 | 111.2 | 5.3 | 5 | % | |||||||||
$ | 752.3 | $ | 715.6 | $ | 36.7 | 5 | % | |||||||
(1) The prior year amounts have been reclassified 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 $0.8 million in the golf clubs segment, and a corresponding decrease in net sales in the golf balls segment.
For further discussion of each operating segments 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):
� | Nine Months Ended� �September 30, | Growth/(Decline) | ||||||||||||
� | 2014 | 2013 | Dollars | Percent | ||||||||||
Net sales: | ||||||||||||||
United States | $ | 371.7 | $ | 351.1 | $ | 20.6 | 6 | �% | ||||||
Europe | 115.0 | 104.9 | 10.1 | 10 | �% | |||||||||
Japan | 127.6 | 129.4 | (1.8 | ) | (1 | )% | ||||||||
Rest of Asia | 73.9 | 66.7 | 7.2 | 11 | �% | |||||||||
Other countries | 64.1 | 63.5 | 0.6 | 1 | �% | |||||||||
$ | 752.3 | $ | 715.6 | $ | 36.7 | 5 | �% | |||||||
Net sales in the United States increased $20.6 million (6%)�to $371.7 million during the nine months ended September 30, 2014 compared to $351.1 million in the same period in the prior year. The Companys sales in regions outside of the United States increased $16.1 million (4%) to $380.6 million for the nine months ended September 30, 2014 compared to $364.5 million in the same period in 2013. This overall 5% increase in net sales in all regions was due to the continued improvement in brand momentum as a result of the strong performance of the current year product introductions, which resulted in market share gains across all product categories primarily in the U.S. and Europe. This increase was partially offset by continued industry softness as well as 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 $4.3 million higher than reported in the first nine months of 2014.
Gross profit increased $35.5 million to $321.0 million for the nine months ended September 30, 2014 compared to $285.5 million in the comparable period of 2013. Gross profit as a percentage of net sales ( gross margin ) increased to 42.7% in the first nine months of 2014 compared to 39.9% in the first nine months of 2013. This increase in gross margin was primarily due to (i)� a favorable shift in sales mix to higher margin woods and golf balls products in 2014 compared to 2013, combined with an increase in average selling prices of certain drivers and irons products in 2014 compared to 2013; (ii) a decrease in promotional activity in 2014 compared to 2013; and (iii) cost savings from improved manufacturing and distribution efficiencies. These improvements were partially offset by (i) the net unfavorable impact of changes in foreign currency rates, and (ii) 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.
Selling expenses increased by $4.9 million to $184.8 million (24.6% of net sales) during the nine months ended September 30, 2014 compared to $179.9 million (25.1% of net sales) in the comparable period of 2013. This increase was primarily due to a $4.5 million increase in marketing expenses.
General and administrative expenses decreased by $5.1 million to $43.5 million (5.8% of net sales) during the nine months ended September 30, 2014 compared to $48.6 million (6.8% of net sales) in the comparable period of 2013. This decrease was primarily due to a decrease of $2.2 million in bad debt expense as a result of additional reserves taken in the third quarter of 2013 related to a specific account, as well as a $2.0 million decrease in stock compensation expense as a result of a 14% decrease in the Company's stock price in 2014. These decreases were partially offset by a $1.2 million increase in accrued employee bonus and compensation.
Research and development expenses increased slightly to $22.9 million (3.0% of net sales) during the nine months ended September 30, 2014 compared to $22.4 million (3.1% of net sales) in the comparable period of 2013 primarily due to an increase in employee costs.
Interest expense increased by $0.6 million to $7.7 million during the nine months ended September 30, 2014 compared to $7.1 million in the comparable period of 2013 as a result of higher average outstanding borrowings period over period.
Other income (expense), net decreased to other expense of $1.4 million during the nine months ended September 30, 2014 compared to other income of $7.5 million in the comparable period of 2013. This decrease was primarily due to an $8.9 million increase in net foreign currency losses in the first nine months of 2014 compared to the same period in 2013.
The Companys provision for income taxes decreased to $3.7 million for the nine months ended September 30, 2014, compared to $4.9 million in the comparable period of 2013. The $1.2 million decrease resulted primarily from the release of certain
32
unrecognized tax benefits in 2014 resulting from the lapse of certain statutes of limitation. Due to the effects of the Companys valuation allowance against its U.S. deferred tax assets, the Companys effective tax rate for 2014 is not comparable to the effective tax rate for 2013 as the Companys provision for income taxes is not directly correlated to pretax income.
Net income for the nine months ended September 30, 2014 improved by $26.9 million to $57.5 million compared to $30.6 million in the comparable period of 2013. Diluted earnings per share increased to $0.66 in the first nine months of 2014 compared to $0.36 in the comparable period of 2013.
Golf Clubs and Golf Balls Segments Results for the Nine Months Ended September 30, 2014 and 2013
Golf Clubs Segment
Net sales information by product category is summarized as follows (dollars in millions):
� | Nine Months Ended� �September 30, | Growth/(Decline) | ||||||||||||
� | 2014 | 2013(1) | Dollars | Percent | ||||||||||
Net sales: | ||||||||||||||
Woods | $ | 233.6 | $ | 219.4 | $ | 14.2 | 6 | �% | ||||||
Irons | 162.2 | 148.7 | 13.5 | 9 | �% | |||||||||
Putters | 72.3 | 73.5 | (1.2 | ) | (2 | )% | ||||||||
Accessories and other | 167.7 | 162.8 | 4.9 | 3 | �% | |||||||||
$ | 635.8 | $ | 604.4 | $ | 31.4 | 5 | �% | |||||||
(1) The prior year amounts have been reclassified 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 $0.8 million in the golf clubs segment, and a corresponding decrease in net sales in the golf balls segment.
The $14.2 million (6%)�increase in net sales of woods to $233.6 million for the nine months ended September 30, 2014 resulted from an increase in average selling prices with relatively flat sales volume. The increase in average selling prices was primarily due to the strong performance of the current year product line, including the more premium Big Bertha family of woods and X2 Hot Hybrids combined with less promotional activity compared to the same period in the prior year.
The $13.5 million (9%)�increase in net sales of irons to $162.2 million for the nine months ended September 30, 2014 was primarily attributable to an increase in both average selling prices and sales volume due to the success of the more premium APEX irons during the current year combined with the introduction of the APEX irons at a higher average selling price than the X Forged irons introduced in the prior year.
The $1.2 million (2%)�decrease in net sales of putters to $72.3 million for the nine months ended September 30, 2014 was primarily attributable to a decline in sales volume partially offset by an increase in average selling prices. The decline in sales volume was due to a shift in product launches to more premium models compared to the prior year core (higher volume) putter model launches. The increase in average selling prices was primarily 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 Company's new elite Metal X Milled putter during 2014, with no comparable elite putter launch in 2013.
The $4.9 million (3%)�increase in net sales of accessories and other products to $167.7 million for the nine months ended September 30, 2014 was primarily due to an increase in net sales of packaged sets, headwear and golf bags. These increases were partially offset by a decline in apparel sales due to the transition of the Company's European apparel business to a licensing model at the beginning of the current year.
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Golf Balls Segment
Net sales information for the golf balls segment is summarized as follows (dollars in millions):
� | Nine Months Ended� �September 30, | Growth | ||||||||||||
� | 2014 | 2013(1) | Dollars | Percent | ||||||||||
Net sales: | ||||||||||||||
Golf balls | $ | 116.5 | $ | 111.2 | $ | 5.3 | 5 | % | ||||||
(1) The prior year amounts have been reclassified 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 $0.8 million in the golf clubs segment, and a corresponding decrease in net sales in the golf balls segment.
The $5.3 million (5%)�increase in net sales of golf balls to $116.5 million for the nine months ended September�30, 2014 was driven by an increase in average selling prices with relatively flat sales volume. 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 the prior year.
Segment Profitability
Profitability by operating segment is summarized as follows (dollars in millions):
� | Nine Months Ended� �September 30, | Growth | ||||||||||||
� | 2014 | 2013(1) | Dollars | Percent | ||||||||||
Income before income taxes: | ||||||||||||||
Golf clubs(2) | $ | 77.9 | $ | 64.0 | $ | 13.9 | 22 | % | ||||||
Golf balls(2) | 17.4 | (0.1 | ) | 17.5 | NM | |||||||||
Reconciling items(3)� | (34.1 | ) | (28.4 | ) | (5.7 | ) | 20 | % | ||||||
$ | 61.2 | $ | 35.5 | $ | 25.7 | 72 | % | |||||||
(1) | The prior year amounts have been reclassified 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 $3.6 million in the golf clubs segment, and a corresponding decrease in the 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 nine months ended September 30, 2013, the Companys golf clubs and golf balls segments recognized $4.3 million and $4.7 million, respectively, in pre-tax charges related to these initiatives. |
(3) | Reconciling items represent corporate general and administrative expenses and other income (expense) not included by management in determining segment profitability. The increase in reconciling items in the first nine months of 2014 compared to the first nine months of 2013 was due to the recognition of net losses on foreign currency transactions in 2014 compared to the recognition of net gains in 2013. For the nine months ended September 30, 2013, the reconciling items include pre-tax charges of $1.4 million related to the Cost Reduction Initiatives. |
Pre-tax income in the Companys golf clubs operating segment increased to $77.9 million for the nine months ended September 30, 2014 from $64.0 million for the comparable period in the prior year. This increase was driven by an increase in net sales as discussed above combined with an increase in gross margin, offset by an increase in operating expenses. The increase in gross margin was primarily driven by (i)�a favorable shift in sales mix to the higher margin Big Bertha family of drivers in 2014 compared to the X Hot family of drivers in 2013; (ii) an increase in average selling prices on the X2 Hot family of drivers, fairways and irons in 2014 compared to the X Hot golf club products in 2013; (iii) a decrease in promotional activity in 2014 compared to 2013; and (iv) cost savings from improved manufacturing and distribution efficiencies. These increases were partially offset by (i) the net unfavorable impact of changes in foreign currency rates year over year, and (ii) 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. The increase in operating expenses during the first nine months of 2014 compared to the same period in 2013 was primarily due to increases
34
in marketing expenses and accrued employee bonus and compensation, partially offset by decreases in bad debt expense and stock compensation expense, as discussed above.
Pre-tax income in the Companys golf balls operating segment increased to $17.4 million for the nine months ended September 30, 2014 from a pre-tax loss of $0.1 million for the comparable period in the prior year. This increase was attributable to an increase in gross margin as well as an increase in net sales as discussed above, combined with a slight decrease in operating expenses. The increase in gross margin was primarily driven by (i) cost savings from improved manufacturing and distribution efficiencies; and (ii) 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 of changes in foreign currency rates year over year.
Financial Condition
The Companys cash and cash equivalents decreased $3.3 million to $33.5 million at September�30, 2014 from $36.8 million at December 31, 2013. Cash generated from operating activities increased by $30.7 million to $38.3 million during the nine months ended September�30, 2014 compared to $7.6 million in the comparable period of 2013. During the first nine months in 2014 and 2013, the Company used its cash and cash equivalents as well as cash generated from operating activities to pay down outstanding borrowings on its credit facilities (there were no repayments in 2013), and fund $8.8 million and $8.9 million in capital expenditures, respectively, as well as $4.7 million and $7.2 million in investments in golf-related ventures, respectively. The increase in cash provided by operating activities was primarily due to an increase in net income combined with a decline in inventory purchases during the period. Management expects to fund the Companys 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 Companys accounts receivable balance fluctuates throughout the year as a result of the general seasonality of the Companys business. The Companys 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 September�30, 2014, the Companys net accounts receivable increased $50.9 million to $143.1 million from $92.2 million as of December�31, 2013. The increase in accounts receivable reflects the general seasonality of the business and was primarily attributable to net sales of $168.6 million during the third quarter of 2014 compared to net sales of $127.2 million during the fourth quarter of 2013. The Companys net accounts receivable as of September�30, 2014 decreased by $14.3 million compared to the Companys net accounts receivable as of September�30, 2013. This decrease was primarily attributable to the $9.7 million decrease in net sales during the third quarter of 2014 compared to the third quarter of 2013, combined with cash collections as a result of shorter payment terms period over period.
The Companys inventory balance also fluctuates throughout the year as a result of the general seasonality of the Companys business. Generally, the Companys buildup of inventory levels begins during the fourth quarter and continues heavily into the first quarter as well as into the beginning of the second quarter in order to meet demand during the height of the golf season. Inventory levels start to decline toward the end of the second quarter and are at their lowest during the third quarter. Inventory levels are also impacted by the timing of new product launches. The Companys inventory decreased $77.9 million to $185.6 million as of September�30, 2014 compared to $263.5 million as of December�31, 2013. This decrease in inventory reflects the general seasonality of the business. The Companys inventory as of September�30, 2014 decreased by $5.3 million compared to the Company's inventory as of September�30, 2013 primarily due to a decline in woods and irons inventory due to the Company's close-out of its Razr product inventory combined with a decline in apparel inventory in Europe due to the Company's transition to a licensing model. Inventory as a percentage of the trailing 12�months net sales decreased to 21.1% as of September�30, 2014 compared to 22.8% as of September�30, 2013.
Liquidity and Capital Resources
The information set forth in Note 3 Financing Arrangements to the Notes to Consolidated Condensed Financial Statements included in Part I, Item 1, of this Quarterly Report, is incorporated herein by this reference.
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Liquidity
The Companys principal sources of liquidity consist of its existing cash balances, funds expected to be generated from operations and the ABL Facility. The Company experienced negative cash flows from operations in 2012 and 2013. During the second half of 2012, the Company implemented significant changes to its business, including among other things, steps designed to increase product sales as well as initiatives designed to reduce the Companys manufacturing costs and operating expenses. (For further discussion of the Cost Reduction Initiatives (see Note 2 "Cost Reduction Initiatives" to the Notes to Consolidated Condensed Financial Statements). As a result of these initiatives, in the first nine months of 2014, the Company realized an increase in net sales and gross margin, and improved its cash flows from operations. Based upon the Companys current cash balances, its estimates of funds expected to be generated from operations in 2014, and current and projected availability under the ABL Facility, the Company believes that it will be able to finance current and planned operating requirements, capital expenditures, contractual obligations and commercial commitments for at least the next 12 months.
The Companys ability to generate sufficient positive cash flows from operations is subject to many risks and uncertainties, including future economic trends and conditions, the success of the Companys multi-year turnaround, demand for the Companys products, foreign currency exchange rates, and other risks and uncertainties applicable to the Company and its business (see Risk Factors contained in Part I, Item�1A of the Company's Annual Report on Form 10-K for the year ended December�31, 2013). While management believes the Company's recovery is on track, as mentioned above, no assurance can be given that the Company will be able to generate sufficient operating cash flows in the future or maintain or grow its existing cash balances. If the Company is unable to generate sufficient cash flows to fund its business due to a decline in sales or otherwise and is unable to reduce its manufacturing costs and operating expenses to offset such decline, the Company will need to increase its reliance on the ABL Facility for needed liquidity.�If the ABL Facility is not then available or sufficient and the Company could not secure alternative financing arrangements, the Companys future operations would be significantly, adversely affected.
As of September�30, 2014, a significant portion of the Companys total cash is held in regions outside of the U.S. If the Company were to repatriate such cash, outside of settling intercompany balances during the normal course of operations, it would need to accrue and pay incremental U.S. federal and state income taxes, reduced by the current amount of available U.S. federal and state net operating loss and tax credit carryforwards. The Company has not, nor does it intend to, repatriate funds to the U.S. to satisfy domestic liquidity needs arising in the ordinary course of business, including liquidity needs associated with its domestic debt service requirements. As such, the Company considers the undistributed earnings of its foreign subsidiaries to be indefinitely reinvested and, accordingly, no U.S. income taxes have been provided thereon.
Other Significant Cash and Contractual Obligations
The table set forth below summarizes certain significant cash obligations as of September�30, 2014 that could affect the Companys future liquidity (in millions). Based upon the Companys cash balances as of September�30, 2014, its estimates of funds expected to be generated from operations in 2014, and current and projected availability under the ABL Facility, the Company believes that it will be able to finance current and planned operating requirements, capital expenditures, contractual obligations and commercial commitments for at least the next 12 months.
� | Payments Due By Period | ||||||||||||||||||
� | Total | Less�than 1 Year | 1-3�Years | 4-5�Years | More�than 5 Years | ||||||||||||||
Convertible notes(1) | $ | 112.5 | $ | $ | $ | 112.5 | $ | ||||||||||||
Interest on convertible notes(1) | 20.7 | 4.4 | 8.4 | 7.9 | |||||||||||||||
Capital leases (2) | 0.9 | 0.4 | 0.4 | 0.1 | |||||||||||||||
Operating leases(3) | 25.8 | 9.3 | 11.1 | 4.4 | 1.0 | ||||||||||||||
Unconditional purchase obligations(4) | 48.8 | 33.6 | 15.2 | ||||||||||||||||
Uncertain tax contingencies(5)� | 4.2 | 0.6 | 0.8 | 0.8 | 2.0 | ||||||||||||||
Total | $ | 212.9 | $ | 48.3 | $ | 35.9 | $ | 125.7 | $ | 3.0 | |||||||||
(1) | In August�2012, the Company issued $112.5 million of convertible notes due August�15, 2019. Interest of 3.75%�per year on the principal amount is payable semiannually in arrears on February�15 and August�15 of each year. |
36
(2) | The Company leases certain warehouse, distribution and office facilities, vehicles and office equipment under operating leases. The amounts presented in this line item represent commitments for minimum lease payments under non-cancelable operating leases. |
(3) | Amounts represent future minimum lease payments. Capital lease obligations are included in accounts payable and accrued expenses and other long-term liabilities in the accompanying consolidated condensed balance sheets. |
(4) | During the normal course of its business, the Company enters into agreements to purchase goods and services, including purchase commitments for production materials, endorsement agreements with professional golfers and other endorsers, employment and consulting agreements, and intellectual property licensing agreements pursuant to which the Company is required to pay royalty fees. It is not possible to determine the amounts the Company will ultimately be required to pay under these agreements as they are subject to many variables including performance-based bonuses, severance arrangements, the Companys sales levels, and reductions in payment obligations if designated minimum performance criteria are not achieved. The amounts listed approximate minimum purchase obligations, base compensation, and guaranteed minimum royalty payments the Company is obligated to pay under these agreements. The actual amounts paid under some of these agreements may be higher or lower than the amounts included. In the aggregate, the actual amount paid under these obligations is likely to be higher than the amounts listed as a result of the variable nature of these obligations. In addition, the Company also enters into unconditional purchase obligations with various vendors and suppliers of goods and services in the normal course of operations through purchase orders or other documentation or that are undocumented except for an invoice. Such unconditional purchase obligations are generally outstanding for periods less than a year and are settled by cash payments upon delivery of goods and services and are not reflected in this line item. |
(5) | Amount represents the current and non-current portions of uncertain income tax positions as recorded on the Company's consolidated condensed balance sheet as of September�30, 2014. Amount excludes uncertain income tax positions that the Company would be able to offset against deferred taxes. For further discussion see Note 11 Income Taxes to the Notes to Consolidated Condensed Financial Statements in this Form 10-Q. |
During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include (i)�intellectual property indemnities to the Companys customers and licensees in connection with the use, sale and/or license of Company products or trademarks, (ii)�indemnities to various lessors in connection with facility leases for certain claims arising from such facilities or leases, (iii)�indemnities to vendors and service providers pertaining to the goods or services provided to the Company or based on the negligence or willful misconduct of the Company, and (iv)�indemnities involving the accuracy of representations and warranties in certain contracts.
In addition, the Company has made contractual commitments to each of its officers and certain other employees providing for severance payments upon the termination of employment. The Company also has consulting agreements that provide for payment of nominal fees upon the issuance of patents and/or the commercialization of research results. The Company has also issued guarantees in the form of a standby letter of credit in the amount of $1.3 million as security for contingent liabilities under certain workers compensation insurance policies. The duration of these indemnities, commitments and guarantees varies, and in certain cases may be indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation on the maximum amount of future payments the Company could be obligated to make. Historically, costs incurred to settle claims related to indemnities have not been material to the Companys financial position, results of operations or cash flows. In addition, the Company believes the likelihood is remote that payments under the commitments and guarantees described above will have a material effect on the Companys financial condition. The fair value of indemnities, commitments and guarantees that the Company issued during the fiscal year ended December�31, 2013 was not material to the Companys financial position, results of operations or cash flows. The fair value of indemnities, commitments and guarantees that the Company issued during the nine months ended September�30, 2014 was not material to the Companys financial position, results of operations or cash flows.
In addition to the contractual obligations listed above, the Companys liquidity could also be adversely affected by an unfavorable outcome with respect to claims and litigation that the Company is subject to from time to time. See Note 12 Commitments & Contingencies to the Notes to Consolidated Condensed Financial Statements and Legal Proceedings in Item�1 of Part II in this Form 10-Q.
Capital Expenditures
The Company does not currently have any material commitments for capital expenditures. The Company expects to have capital expenditures of approximately $14.0 million for the year ending December 31, 2014.
37
Off-Balance Sheet Arrangements
The company has no material off-balance sheet arrangements as defined in Regulation S-K Item 303(a)(4)(ii).
Critical Accounting Policies and Estimates
There have been no material changes to our critical accounting policies and estimates from the information provided in Part II, Item�7, Managements Discussion and Analysis of Financial Condition and Results of Operations, included in our Form 10-K for the fiscal year ended December�31, 2013.
Item�3.����Quantitative and Qualitative Disclosures about Market Risk
The Company uses derivative financial instruments for hedging purposes to limit its exposure to changes in foreign currency exchange rates. Transactions involving these financial instruments are with nationally recognized financial services firms. The use of these instruments exposes the Company to market and credit risk which may at times be concentrated with certain counterparties, although counterparty nonperformance is not anticipated. The Company is also exposed to interest rate risk from the ABL Facility.
Foreign Currency Fluctuations
In the normal course of business, the Company is exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to transactions of its international subsidiaries, including certain balance sheet exposures (payables and receivables denominated in foreign currencies) (see Note 15 Derivatives and Hedging to the Notes to Consolidated Condensed Financial Statements). In addition, the Company is exposed to gains and losses resulting from the translation of the operating results of the Companys international subsidiaries into U.S. dollars for financial reporting purposes. As part of its strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, the Company uses derivative financial instruments in the form of foreign currency forward contracts and put and call option contracts ( foreign currency exchange contracts ) to hedge transactions that are denominated primarily in British Pounds, Euros, Japanese Yen, Canadian Dollars, Australian Dollars and Korean Won. For most currencies, the Company is a net receiver of foreign currencies and, therefore, benefits from a weaker U.S. dollar and is adversely affected by a stronger U.S. dollar relative to those foreign currencies in which the Company transacts significant amounts of business.
Foreign currency exchange contracts are used only to meet the Companys objectives of offsetting gains and losses from foreign currency exchange exposures with gains and losses from the contracts used to hedge them in order to reduce volatility of earnings. The extent to which the Companys hedging activities mitigate the effects of changes in foreign currency exchange rates varies based upon many factors, including the amount of transactions being hedged. The Company generally only hedges a limited portion of its international transactions. The Company does not enter into foreign currency exchange contracts for speculative purposes. Foreign currency exchange contracts generally mature within�twelve months from their inception.
The Company does not designate foreign currency exchange contracts as derivatives that qualify for hedge accounting under ASC 815, Derivatives and Hedging. As such, changes in the fair value of the contracts are recognized in earnings in the period of change. At September�30, 2014 and December�31, 2013, the notional amounts of the Companys foreign currency exchange contracts used to hedge the exposures discussed above were approximately $113.2 million and $42.3 million, respectively. The increase in foreign currency exchange contracts reflects the general timing of when the Company enters into these contracts.
As part of the Companys risk management procedure, a sensitivity analysis model is used to measure the potential loss in future earnings of market-sensitive instruments resulting from one or more selected hypothetical changes in interest rates or foreign currency values. The sensitivity analysis model quantifies the estimated potential effect of unfavorable movements of 10% in foreign currencies to which the Company was exposed at September�30, 2014 through its foreign currency exchange contracts.
The estimated maximum one-day loss from the Companys foreign currency exchange contracts, calculated using the sensitivity analysis model described above, is $12.3 million at September�30, 2014. The Company believes that such a hypothetical loss from its foreign currency exchange contracts would be partially offset by increases in the value of the underlying transactions being hedged.
The sensitivity analysis model is a risk analysis tool and does not purport to represent actual losses in earnings that will be incurred by the Company, nor does it consider the potential effect of favorable changes in market rates. It also does not represent the maximum possible loss that may occur. Actual future gains and losses will differ from those estimated because of changes or differences in market rates and interrelationships, hedging instruments and hedge percentages, timing and other factors.
38
Interest Rate Fluctuations
The Company is exposed to interest rate risk from its ABL Facility. Outstanding borrowings under the ABL Facility accrue interest as described in Note 3 "Financing Arrangements" to the Notes to Consolidated Condensed Financial Statements in Part I, Item 1 of this Form 10-Q and in Liquidity and Capital Resources in Part I, Item 2. As part of the Companys risk management procedures, a sensitivity analysis was performed to determine the impact of unfavorable changes in interest rates on the Companys cash flows. The sensitivity analysis quantified that the incremental expense incurred by an increase of 10% in interest rates is $0.3 million at September�30, 2014.
Item�4.����Controls and Procedures
Disclosure Controls and Procedures. The Company carried out an evaluation, under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness, as of September�30, 2014, of the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures are effective.
Changes in Internal Control over Financial Reporting. During the quarter ended September�30, 2014, there were no changes in the Companys internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
39
PART II. OTHER INFORMATION
Item�1.����Legal Proceedings
The information set forth in Note 12 Commitments & Contingencies, to the Notes to Consolidated Condensed Financial Statements included in Part I, Item�1, of this Quarterly Report, is incorporated herein by this reference.�
Item�1A. Risk Factors
Certain Factors Affecting Callaway Golf Company
The Company has included in Part I, Item�1A of its Annual Report on Form 10-K for the year ended December�31, 2013, a description of certain risks and uncertainties that could affect the Companys business, future performance or financial condition (the Risk Factors ). There are no material changes from the disclosure provided in the Form 10-K for the year ended December�31, 2013 with respect to the Risk Factors. Investors should consider the Risk Factors prior to making an investment decision with respect to the Companys stock.
Item�2.����Unregistered Sales of Equity Securities and Use of Proceeds
Stock Purchases
In August 2014, the Company's Board of Directors authorized a $50.0 million share repurchase program under which it was authorized to repurchase shares of its common stock in the open market or in private transactions, subject to the Companys assessment of market conditions and buying opportunities. The repurchases will be made consistent with the terms of the Company's credit facility which defines the amount of stock that can be repurchased. The repurchase program will remain in effect until completed or until terminated by the Board of Directors.
The following table summarizes the purchases by the Company during the third quarter of 2014:
Three Months Ended September 30, 2014 | |||||||||||||||||||||
Total�Number of Shares Purchased | Weighted Average�Price Paid�per�Share | Total�Number of Shares Purchased as Part of Publicly Announced Program | Maximum Dollar Value that May Yet�Be Purchased Under the Program | ||||||||||||||||||
July 1, 2014-July 31, 2014 | $ | $ | 50,000,000 | ||||||||||||||||||
August 1, 2014-August 31, 2014 | 101,206 | $ | 7.60 | 101,206 | $ | 49,230,855 | |||||||||||||||
September 1, 2014-September 30, 2014 | 31,000 | $ | 7.65 | 31,000 | $ | 48,993,699 | |||||||||||||||
Total | 132,206 | $ | 7.61 | 132,206 | $ | 48,993,699 | |||||||||||||||
Item�3.����Defaults upon Senior Securities
None.
Item�4.����Mine Safety Disclosures
None
Item�5.����Other Information
None.
40
Item�6.����Exhibits
3.1 | �� | Certificate of Incorporation, incorporated herein by this reference to Exhibit 3.1 to the Company's Current Report on Form�8-K, as filed with the Commission on July�1, 1999 (file no. 1-10962). | |
3.2 | �� | Fifth Amended and Restated Bylaws, as amended and restated as of November 18, 2008, incorporated herein by this reference to Exhibit 3.1 to the Company's Current Report on Form 8-K, as filed with the Commission on November 21, 2008 (file no. 1-10962). | |
3.3 | �� | Amended and Restated Certificate of Designation for 7.50% Series B Cumulative Perpetual Convertible Preferred Stock, incorporated herein by this reference to Exhibit 3.1 to the Company's Current Report on Form 8-K, as filed with the Commission on March 5, 2010 (file no. 1-10962). | |
4.1 | �� | Form of Specimen Stock Certificate for Common Stock, incorporated herein by this reference to Exhibit 4.1 to the Company's Current Report on Form 8-K, as filed with the Commission on June�15, 2009 (file no. 1-10962). | |
4.3 | Indenture, dated as of August 29, 2012 between Callaway Golf Company and Wilmington Trust, National Association, as Trustee, incorporated herein by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K, as filed with the Commission on September 4, 2012 (file No. 1-10962). | ||
31.1 | �� | Certification of Oliver G. Brewer III pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | �� | Certification of Bradley J. Holiday pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | �� | Certification of Oliver G. Brewer III and Bradley J. Holiday pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
101.1 | �� | XBRL Instance Document | |
101.2 | �� | XBRL Taxonomy Extension Schema Document | |
101.3 | �� | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.4 | �� | XBRL Taxonomy Extension Definition Linkbase Document | |
101.5 | �� | XBRL Taxonomy Extension Label Linkbase Document | |
101.6 | �� | XBRL Taxonomy Extension Presentation Linkbase Document | |
( ) Included with this Report.
41
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
�
CALLAWAY GOLF COMPANY | |
By: | /s/� Jennifer Thomas |
Jennifer Thomas | |
Vice President and Chief Accounting Officer | |
Date: November�4, 2014
42
EXHIBIT INDEX
�
Exhibit | �� | Description | |
31.1 | �� | Certification of Oliver G. Brewer III pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | �� | Certification of Bradley J. Holiday pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | �� | Certification of Oliver G. Brewer III and Bradley J. Holiday pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
101.1 | �� | XBRL Instance Document | |
101.2 | �� | XBRL Taxonomy Extension Schema Document | |
101.3 | �� | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.4 | �� | XBRL Taxonomy Extension Definition Linkbase Document | |
101.5 | �� | XBRL Taxonomy Extension Label Linkbase Document | |
101.6 | �� | XBRL Taxonomy Extension Presentation Linkbase Document | |
�
43
Exhibit 31.1
CERTIFICATION
I, Oliver G. Brewer III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Callaway Golf Company;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrants other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and
5. The registrants other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting.
�
/S/ OLIVER�G. BREWER�III |
Oliver G. Brewer III President and Chief Executive Officer |
Dated: November�4, 2014
Exhibit 31.2
CERTIFICATION
I, Bradley J. Holiday, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Callaway Golf Company;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrants other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and
5. The registrants other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting.
�
/S/ BRADLEY�J. HOLIDAY |
Bradley J. Holiday Senior Executive Vice President and Chief Financial Officer |
Dated: November�4, 2014
Exhibit 32.1
CERTIFICATION PURSUANT
TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
Pursuant to 18 U.S.C. Section�1350, as adopted pursuant to Section�906 of the Sarbanes-Oxley Act of 2002, each of the undersigned officers of Callaway Golf Company, a Delaware corporation (the Company ), does hereby certify with respect to the Quarterly Report of the Company on Form 10-Q for the quarterly period ended September�30, 2014, as filed with the Securities and Exchange Commission (the 10-Q Report ), that:
(1) the 10-Q Report fully complies with the requirements of Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2) the information contained in the 10-Q Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
The undersigned have executed this Certification effective as of November�4, 2014.
�
/S/ OLIVER�G. BREWER�III |
Oliver G. Brewer III President and Chief Executive Officer |
�
/S/ BRADLEY�J. HOLIDAY |
Bradley J. Holiday Senior Executive Vice President and Chief Financial Officer |
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