Callaway Golf shares got hammered yesterday (falling more than 18%) after the golf-club maker said it was cutting its dividend to 1 cent a share from 7 cents and that it would raise $125 million from a convertible preferred stock offering that will be dilutive by ultimately creating 26% more shares outstanding. But in the longer-term, the company avoided what could have been a liquidity issue by taking these painful steps.
Callaway has a $250 million line of credit with eight banks (led by Bank of America) but because of certain tests in the line’s covenants, it can only tap $209 million (as of the end of March). It had drawn down $144 million of that amount, according to a 10Q filing Callaway made with the SEC in May.
In that same filing, Callaway noted that the weak economy and adverse foreign exchange translations that hurt it in the first quarter were expected to continue in 2Q. (Sales fell by $22.5 million in Europe because of the adverse forex). And if that was the case, the EBITDA (earnings before interest, taxes, depreciation and amoratization) test in its covenants would not be met. Callaway doesn;t break out those EBITDA numbers but its operating income (which is about as close as you get on an income statement) fell 70% in the first quarter versus the year ago quarter. So, if it didn;t meet the covenants, it could have been forced to renegotiate with the banks to borrow at a much higher rate than it currently pays.
So, by cutting the common stock dividend and using the $119 million in proceeds it raised from the preferred offering to pay down a big chunk of the bank loan, it was able to keep the favorable borrowing terms on the facility in the event it needs to tap it.