UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
-----
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
_____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-10962
CALLAWAY GOLF COMPANY
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-3797580
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2285 RUTHERFORD ROAD, CARLSBAD, CA 92008-8815
(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 X No___.
---
The number of shares outstanding of the Registrant's Common Stock, $.01 par
value, as of October 31, 1998 was 75,110,837.
CALLAWAY GOLF COMPANY
INDEX
Page
Part I. Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheet at September 30, 1998
and December 31, 1997 3
Consolidated Condensed Statement of Income for the three and nine
months ended September 30, 1998 and 1997 4
Consolidated Condensed Statement of Cash Flows for the nine
months ended September 30, 1998 and 1997 5
Consolidated Condensed Statement of Shareholders' Equity for
the nine months ended September 30, 1998 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk 20
Part II. Other Information 20
Item 1. Legal Proceedings 20
Item 2. Changes in Securities 20
Item 3. Defaults Upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
2
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED BALANCE SHEET
(In thousands, except share and per share data)
September 30, December 31,
1998 1997
===========================================================================================================
ASSETS (Unaudited)
- - ------
Current assets:
Cash and cash equivalents $ 31,012 $ 26,204
Accounts receivable, net 117,861 124,470
Inventories, net 162,271 97,094
Deferred taxes 27,376 23,810
Other current assets 9,663 10,208
- - -----------------------------------------------------------------------------------------------------------
Total current assets 348,183 281,786
Property, plant and equipment, net 183,370 142,503
Intangible assets, net 123,762 112,141
Other assets 23,455 25,284
- - -----------------------------------------------------------------------------------------------------------
$678,770 $ 561,714
===========================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
- - ------------------------------------
Current liabilities:
Accounts payable and accrued expenses $ 41,191 $ 30,063
Line of credit 50,000
Accrued employee compensation and benefits 12,632 14,262
Accrued warranty expense 34,576 28,059
Income taxes payable 11,581
- - -----------------------------------------------------------------------------------------------------------
Total current liabilities 149,980 72,384
Long-term liabilities 9,784 7,905
Commitments and contingencies (Note 7)
Shareholders' equity:
Preferred Stock, $.01 par value, 3,000,000 shares
authorized, none issued outstanding at September 30,
1998 and December 31, 1997, respectively
Common Stock, $.01 par value, 240,000,000 shares
authorized, 75,110,837 and 74,251,664 issued and
outstanding at September 30, 1998, and
December 31, 1997, respectively 751 743
Paid-in capital 259,859 337,403
Unearned compensation (7,110) (3,575)
Retained earnings 320,962 298,728
Accumulated other comprehensive income 516 (559)
Less: Grantor Stock Trust (5,300,000 shares) at market (55,972) (151,315)
- - -----------------------------------------------------------------------------------------------------------
Total shareholders' equity 519,006 481,425
- - -----------------------------------------------------------------------------------------------------------
$678,770 $ 561,714
===========================================================================================================
See accompanying notes to consolidated condensed financial statements.
3
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF INCOME (UNAUDITED)
(In thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
- - ---------------------------------------------------------------------------------------------------
1998 1997 1998 1997
- - ---------------------------------------------------------------------------------------------------
Net sales $172,944 100% $257,435 100% $583,104 100% $679,540 100%
Cost of goods sold 89,859 52% 118,666 46% 307,523 53% 319,026 47%
- - ---------------------------------------------------------------------------------------------------
Gross profit 83,085 48% 138,769 54% 275,581 47% 360,514 53%
Operating expenses:
Selling 40,285 23% 32,643 13% 118,314 20% 95,238 14%
General and administrative 24,534 14% 24,716 10% 68,718 12% 57,045 8%
Research and development 9,132 5% 10,640 4% 26,209 4% 24,682 4%
Litigation settlement 12,000 5% 12,000 2%
- - ---------------------------------------------------------------------------------------------------
Income from operations 9,134 5% 58,770 23% 62,340 11% 171,549 25%
Other income, net 343 1,146 303 3,561
- - ---------------------------------------------------------------------------------------------------
Income before income taxes 9,477 5% 59,916 23% 62,643 11% 175,110 26%
Provision for income taxes 3,641 22,867 24,509 66,773
- - ---------------------------------------------------------------------------------------------------
Net income $ 5,836 3% $ 37,049 14% $ 38,134 7% $108,337 16%
===================================================================================================
Earnings per common share:
Basic $ 0.08 $ 0.54 $ 0.55 $ 1.59
Diluted $ 0.08 $ 0.52 $ 0.53 $ 1.52
Common equivalent shares:
Basic 69,610 68,704 69,383 68,085
Diluted 71,199 71,648 71,323 71,382
Dividends paid per share $ 0.07 $ 0.07 $ 0.21 $ 0.21
See accompanying notes to consolidated condensed financial statements.
4
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED)
(In thousands)
Nine months ended
September 30,
- - ------------------------------------------------------------------------------------------------------------------------------------
1998 1997
- - ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 38,134 $ 108,337
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 21,267 12,797
Non-cash compensation 7,800 7,515
Tax benefit from exercise of stock options 2,036 25,946
Deferred taxes (4,514) (2,379)
Changes in assets and liabilities, net of effects from
acquisitions:
Accounts receivable, net 19,397 (73,431)
Inventories, net (56,371) 35,989
Other assets (5,387) (6,423)
Accounts payable and accrued expenses (1,022) 1,511
Accrued employee compensation and benefits 956 24,259
Accrued warranty expense 6,517 746
Income taxes payable 14,177 240
Other liabilities (13,744) 1,653
- - ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 29,246 136,760
- - ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Business acquisitions, net of cash acquired (10,973) (129,256)
Capital expenditures (52,139) (46,292)
Sale of fixed assets 13 72
- - ------------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (63,099) (175,476)
- - ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Issuance of Common Stock 4,437 19,103
Dividends paid (14,598) (14,264)
Retirement of Common Stock (1,303) (33,010)
Net proceeds from line of credit 50,000
- - ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 38,536 (28,171)
- - ------------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 125 (77)
- - ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 4,808 (66,964)
Cash and cash equivalents at beginning of period 26,204 108,457
- - ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 31,012 $ 41,493
====================================================================================================================================
See accompanying notes to consolidated condensed financial statements.
5
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
(In thousands)
ACCUMULATED
OTHER COMPREHENSIVE
COMMON STOCK PAID-IN UNEARNED RETAINED COMPREHENSIVE INCOME
SHARES AMOUNT CAPITAL COMPENSATION EARNINGS INCOME GST TOTAL TOTAL
====================================================================================================================================
- - ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 74,252 $743 $337,403 ($3,575) $298,728 ($559) ($151,315) $481,425
- - ------------------------------------------------------------------------------------------------------------------------------------
Exercise of stock options 384 4 4,433 4,437
Issuance of Restricted
Common Stock 130 1 4,029 (4,030)
Cancellation of Restricted
Common Stock 4 (108) 94 (14)
Tax benefit from exercise
of stock options 2,036 2,036
Compensatory stock and
stock options 1,507 401 1,908
Employee stock purchase plan 386 4 5,902 5,906
Stock retirement (45) (1) (1,302) (1,303)
Cash dividends (15,711) (15,711)
Dividends on shares held
by GST 1,113 1,113
Adjustment of GST shares
to market value (95,343) 95,343
Equity adjustment from foreign
currency translation 1,075 1,075 $ 1,075
Net income 38,134 38,134 38,134
- - ------------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1998 75,111 $751 $259,859 ($7,110) $320,962 $ 516 ($55,972) $519,006 $39,209
====================================================================================================================================
See accompanying notes to consolidated condensed financial statements.
6
CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
---------------------
The accompanying financial information for the three and nine months ended
September 30, 1998 and 1997 has been prepared by Callaway Golf Company (the
"Company") and has not been audited. These financial statements, in the opinion
of management, include all adjustments (consisting only of normal recurring
accruals) necessary for a fair presentation of the financial position, results
of operations and cash flows for the periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K filed for the year ended December 31, 1997.
Interim operating results are not necessarily indicative of operating results
for the full year.
The preparation of financial statements in conformity with generally accepted
accounting principles 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 from those estimates.
Certain prior period amounts have been reclassified to conform with the current
period presentation.
2. CASH EQUIVALENTS
----------------
Cash equivalents are highly liquid investments purchased with maturities of
three months or less. Cash equivalents consist primarily of investments in
money market accounts.
3. INVENTORIES
-----------
September 30, December 31,
1998 1997
- - ------------------------------------------------------------------------------------
(Unaudited)
Inventories, net (in thousands):
Raw materials $ 89,040 $ 47,780
Work-in-process 2,497 3,083
Finished goods 76,418 51,905
167,955 102,768
- - ------------------------------------------------------------------------------------
Less reserve for obsolescence (5,684) (5,674)
- - ------------------------------------------------------------------------------------
$162,271 $ 97,094
====================================================================================
4. BANK LINE OF CREDIT
-------------------
The Company has a $150.0 million unsecured line of credit. At September 30,
1998, the amount available under the line of credit was $99.2 million and the
weighted-average interest rate of the outstanding borrowings was 5.8%. The line
of credit has been primarily utilized to support portions of the Company's
operations and the issuance of letters of credit, of which there were $0.8
million outstanding at September 30, 1998.
7
The line of credit requires the Company to maintain certain financial ratios,
including current and debt-to-equity ratios. The Company is also subject to
other restrictive covenants under the terms of the credit agreement. As of
September 30, 1998, the Company was in compliance with all such covenants.
5. COMPREHENSIVE INCOME
--------------------
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income." This statement
requires that all components of comprehensive income be reported in the
financial statements in the period in which they are recognized. The components
of comprehensive income for the Company include net income and foreign currency
translation adjustments. In accordance with the provisions of APB 23,
"Accounting for Income Taxes-- Special Areas," the Company has elected the
indefinite reversal criterion, and accordingly, does not accrue income taxes on
foreign currency translation adjustments. The financial statements of prior
periods presented have been reclassified for comparative purposes.
6. EARNINGS PER SHARE
------------------
A reconciliation of the numerators and denominators of the basic and diluted
earnings per common share calculations for the three and nine months ended
September 30, 1998, and 1997 is presented below.
(in thousands, except per share data)
Three months ended Nine months ended
September 30, September 30,
- - ------------------------------------------------------------------------------------------------------
1998 1997 1998 1997
- - ------------------------------------------------------------------------------------------------------
(Unaudited)
Net income $ 5,836 $37,049 $38,134 $108,337
======================================================================================================
Weighted-average shares outstanding:
Weighted-average shares outstanding - Basic 69,610 68,704 69,383 68,085
Dilutive Securities 1,589 2,944 1,940 3,297
- - ------------------------------------------------------------------------------------------------------
Weighted average shares outstanding - Diluted 71,199 71,648 71,323 71,382
======================================================================================================
Earnings per common share
Basic $ 0.08 $ 0.54 $ 0.55 $ 1.59
Diluted $ 0.08 $ 0.52 $ 0.53 $ 1.52
For the three months ended September 30, 1998 and 1997, 12,196,000 and 1,070,00,
respectively, options outstanding were excluded from the calculations, as their
effect would have been antidilutive.
7. COMMITMENTS AND CONTINGENCIES
-----------------------------
Subject to certain conditions, the Company has committed to purchase titanium
golf clubheads costing approximately $36.1 million from one of its vendors.
Under the current schedule, the clubheads are to be shipped to the Company in
1998 and 1999.
8
The Company and its subsidiaries, incident to their business activities, from
time to time are parties to a number of legal proceedings in various stages of
development. It is the opinion of the management of the Company that the
probable result of these matters individually and in the aggregate will not have
a material adverse effect upon the Company's financial position, results of
operations or cash flows.
8. RECENTLY ISSUED ACCOUNTING STANDARD
-----------------------------------
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which the
Company will be required to adopt beginning January 1, 2000. This statement
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. The Company is currently evaluating the impact the adoption of
SFAS No. 133 will have on its financial statements, if any.
9. SUBSEQUENT EVENT
----------------
On November 11, 1998, the Company announced that it had adopted, with the
approval of its Board of Directors, a business plan that includes a number of
cost reduction actions and operational improvements. The Company currently
estimates that it will incur charges in the fourth quarter of 1998 associated
with implementation of this business plan between $70 million and $85 million
related to employee severance costs, impairment of assets, excess lease costs,
losses on disposition of assets, other exit costs, as well as obsolete or excess
inventory charges. If the Company takes actions that vary from those currently
expected, actual charges recorded could differ significantly from those
estimated above.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Statements used in this discussion that relate to future plans, events,
financial results or performance are forward-looking statements as defined under
the Private Securities Litigation Reform Act of 1995. Such statements are
subject to certain risks and uncertainties which could cause actual results to
differ materially from those anticipated. Readers are cautioned not to place
undue reliance on these forward-looking statements which speak only as of the
date hereof. The Company undertakes no obligation to republish revised forward-
looking statements to reflect events or circumstances after the date hereof or
to reflect the occurrence of unanticipated events. Readers also are urged to
carefully review and consider the various disclosures made by the Company which
describe certain factors which affect the Company's business, including the
disclosures made under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Certain Factors Affecting
Callaway Golf Company" below, as well as the Company's other periodic reports on
Forms 10-K and 10-Q and Current Reports on Form 8-K filed with the Securities
and Exchange Commission.
Readers also should be aware that while the Company does, from time to time,
communicate with securities analysts, it is against the Company's policy to
disclose to them any material non-public information or other confidential
commercial information. Accordingly, shareholders should not assume that the
Company agrees with any statement or report issued by any analyst irrespective
of the content of the statement or report. Further, the Company has a policy
against issuing or confirming financial forecasts or projections issued by
others. Accordingly, to the extent that reports issued by securities analysts
contain any projections, forecasts or opinions, such reports are not the
responsibility of the Company.
CERTAIN FACTORS AFFECTING CALLAWAY GOLF COMPANY
BUSINESS PLAN
-------------
On November 11, 1998, the Company announced that it had adopted a business plan
that includes a number of cost reduction actions and operational improvements
which should better position the Company to achieve greater profitability and
shareholder value under difficult market conditions. These actions will
include: the consolidation of the operations of its wholly-owned subsidiary,
Odyssey Golf, Inc., into the operations of the Company while maintaining the
distinct and separate Odyssey brand image; the discontinuation, transfer or
suspension of certain initiatives not directly associated with the Company's
core businesses, such as the Company's involvement with
9
interactive golf sites, golf book publishing, and driving range ventures; and
the re-sizing of the Company's core business to reflect current and expected
business conditions. The implementation of the business plan will not impact the
current development of the Company's proposed golf ball business. See "Part I.
FINANCIAL INFORMATION - Item 2. Certain Factors Affecting Callaway Golf
Company - Golf Ball Development."
The Company anticipates that its work force will be reduced in connection with
implementation of the business plan. The Company expects that its work force
will be reduced by approximately 700 jobs or about 24% of its work force.
As a result of the implementation of this business plan, the Company expects to
accrue certain one-time charges in the fourth quarter of 1998. See "Part I.
FINANCIAL INFORMATION-Item 1. Financial Statements, Note 9." The Company
currently expects a diluted earnings per share loss for 1998 of between $0.25
and $0.40. The Company anticipates the implementation of the business plan will
generate savings going forward of approximately $40 million per year, beginning
in 1999, including a reduction in employee compensation expense of more than $28
million. In addition, the Company is implementing an ongoing process of
reviewing its manufacturing operations and its worldwide supplier network aimed
at reducing the cost of goods sold and generating significant savings. However,
no assurance can be given that the full amount of the anticipated savings will
be realized. See "Part II. OTHER INFORMATION - Item 5. Other Information."
SALES; GROSS MARGIN; SEASONALITY
The Company believes that the growth rate in the worldwide golf equipment market
has been declining and that it may continue to decline. The economic turmoil
in Southeast Asia and Japan continues to cause contraction in the retail golf
markets in these countries and continues to have an adverse effect on the
Company's sales and results of operations. The Company expects this situation
to continue at least until economic stability returns to these areas.
Sales of the Company's newly introduced Big Bertha(R) Steelhead(TM) Metal Woods
remained strong. While it is expected that demand for this new product will be
strong for the rest of 1998, sales have been and are expected to continue to be
limited by the availability of Big Bertha(R) Steelhead(TM) Metal Woods during
the initial ramp up of production. Further, Big Bertha(R) Steelhead(TM) Metal
Woods are directly competing with the Company's sale of Big Bertha(R) War
Bird(R) Metal Woods and competes with the sale of the Company's titanium metal
woods. No assurances can be given that the demand for the Company's existing
products or the introduction of new products will permit the Company to
experience growth in sales, or maintain historical levels of sales, in the
future.
Sales to Japan, which accounted for approximately 10% of the Company's total
sales in 1997 and 9% of total sales through September 30, 1998, are expected to
decrease in 1999, as the Company's distributor, Sumitomo Rubber Industries, Ltd.
("Sumitomo"), prepares for the transition of responsibility from it to ERC
International Company ("ERC"), a wholly-owned Japanese subsidiary of the
Company, in the year 2000. See "Certain Factors Affecting Callaway Golf Company
- - -- International distribution."
The Company experienced a decrease in its gross margin as a percentage of net
sales during the third quarter of 1998 compared to historical levels. In the
third quarter of 1998 this decrease was primarily due to increased sales of
irons as a percentage of net sales, which have lower margins than metal woods, a
metal woods wholesale price reduction implemented during May 1998, and an
increase in warranty expense. In the near term, the Company's gross margin will
continue to be affected by the metal woods price reduction implemented in May,
or if sales of irons as a percentage of the Company's net sales remain at
current levels or continue to rise. The Company also may experience further
pressure on its gross margin due to competitive market conditions. Additionally,
the Company expects that certain actions contemplated as a result of its current
business plan, including the write-down of obsolete and excess inventory, will
result in further decreased margins.
10
In the golf equipment industry, sales to retailers are generally seasonal due to
lower demand in the retail market in the cold weather months covered by the
fourth and first quarters. The Company's business generally follows this
seasonal trend and the Company expects this to continue. Unusual or severe
weather conditions such as the "El Nino" weather patterns experienced during the
winter of 1997-1998 may compound these seasonal effects. The Company believes
that seasonality will have a negative effect on the Company's future sales and
results of operations, unless overcome by other factors such as successful
product introductions.
COMPETITION
The market in which the Company does business is highly competitive, and is
served by a number of well-established and well-financed companies with
recognized brand names, as well as new companies with popular products. New
product introductions and/or price reductions by competitors continue to
generate increased market competition and the Company believes that such
competition has caused it to lose some unit market share and has negatively
affected sales. While the Company believes that its products and its marketing
efforts continue to be competitive, there can be no assurance that successful
marketing activities by competitors will not negatively impact the Company's
future sales.
A manufacturer's ability to compete is in part dependent upon its ability to
satisfy the various subjective requirements of golfers, including the golf
club's look and "feel," and the level of acceptance that the golf club has among
professional and other golfers. The subjective preferences of golf club
purchasers also may be subject to rapid and unanticipated changes. There can be
no assurance as to how long the Company's golf clubs will maintain market
acceptance. For example, consumer support for shallow-faced metal woods has
risen in 1998, to the benefit of competitors making such products.
NEW PRODUCT INTRODUCTION
The Company believes that the introduction of new, innovative golf equipment is
important to its future success. As a result, the Company faces certain risks
associated with such a strategy. For example, new models and basic design
changes in golf equipment are frequently met with consumer rejection. In
addition, prior successful designs may be rendered obsolete within a relatively
short period of time as new products are introduced into the marketplace.
Further, new products that retail at a lower price than prior products may
negatively impact the Company's revenues unless unit sales increase. New
designs should generally satisfy the standards established by the United States
Golf Association ("USGA") and the Royal and Ancient Golf Club of St. Andrews
("R&A") because these standards are generally followed by golfers within their
respective jurisdictions. While all of the Company's current products have been
found to conform to USGA and R&A rules, there is no assurance that new designs
will receive USGA and/or R&A approval, or that existing USGA and/or R&A
standards will not be altered in ways that adversely affect the sales of the
Company's products.
On November 2, 1998, the USGA announced the adoption of a test protocol to
measure the so-called "spring-like effect" in certain golf clubheads. The USGA
has previously advised the Company that none of the Company's current products
would be barred by this test, and the Company's own testing confirms that its
products comply. The USGA's limitation on future technological advancements,
however, may impede the Company's ability to introduce new products and could
have a material adverse effect on the Company's results of operations.
The Company's new products have tended to incorporate significant innovations in
design and manufacture, which have resulted in increasingly higher prices for
the Company's products relative to products already in the marketplace. There
can be no assurance that a significant percentage of the public will always be
willing to pay such prices for golf equipment. Thus, although the Company has
achieved certain successes in the introduction of its golf clubs in the past, no
assurances can be given that the Company will be able to continue to design and
manufacture golf clubs that achieve market acceptance in the future.
11
The rapid introduction of new products by the Company can result in close-outs
of existing inventories, both at the Company and at retailers. Such close-outs
can result in reduced margins on the sale of older products, as well as reduced
sales of the new product, given the availability of older products at lower
prices. Historically, the Company has managed such close-outs so as to avoid
any material negative impact on the Company's operations, but there can be no
assurance that the Company will always be able to do so. Further, the Company
expects that certain actions contemplated as a result of its current business
plan, including the write-down of obsolete and excess inventory, will result in
decreased margins.
The Company plans its manufacturing capacity based upon the forecasted demand
for its products. Actual demand for such products may exceed or be less than
forecasted demand. The Company's unique product designs often require
sophisticated manufacturing techniques, which can limit the Company's ability to
quickly expand its manufacturing capacity to meet the full demand for its
products. If the Company is unable to produce sufficient quantities of new
products in time to fulfill actual demand, especially during the Company's
traditionally busy second and third quarters, it could limit the Company's sales
and adversely affect its financial performance. On the other hand, the Company
commits to components and other manufacturing inputs for varying periods of
time, which can limit the Company's ability to quickly react if actual demand is
less than forecast. This could result in excess inventories that could adversely
affect the Company's financial performance. During the current 1998 fiscal year,
the Company has experienced a build-up of excess inventory due to lower than
expected demand for its products. As a result, and as part of its current
business plan, the Company anticipates a write-down of obsolete and excess
inventory in the fourth quarter of 1998.
PRODUCT BREAKAGE
The Company supports all of its golf clubs with a limited two year written
warranty. Since the Company does not rely upon traditional designs in the
development of its golf clubs, its products may be more likely to develop
unanticipated problems than those of many of its competitors which use
traditional designs. For example, clubs have been returned with cracked
clubheads, broken graphite shafts and loose medallions. While any breakage or
warranty problems are deemed significant to the Company, the incidence of clubs
returned as a result of cracked clubheads, broken graphite shafts, loose
medallions and other product problems to date has not been material in relation
to the volume of Callaway Golf clubs which have been sold. The Company monitors
closely the level and nature of any product breakage and, where appropriate,
seeks to incorporate design and production changes to assure its customers of
the highest quality available in the market. The Company's Biggest Big
Bertha(R) Drivers, because of their large clubhead size and extra long,
lightweight graphite shafts, have experienced shaft breakage at a rate higher
than generally experienced with the Company's other metal woods. Significant
increases in the incidence of breakage or other product problems may adversely
affect the Company's sales and image with golfers. The Company believes that it
has sufficient reserves for warranty claims; however, there can be no assurance
that these reserves will be sufficient if the Company were to experience an
unusually high incidence of breakage or other product problems.
DEPENDENCE ON CERTAIN VENDORS AND MATERIALS
The Company is dependent on a limited number of suppliers for its clubheads and
shafts. In addition, some of the Company's products require specifically
developed manufacturing techniques and processes which make it difficult to
identify and utilize alternative suppliers quickly. The Company believes that
suitable clubheads and shafts could be obtained from other manufacturers in the
event its regular suppliers are unable to provide components. However, any
significant production delay or disruption caused by the inability of current
suppliers to deliver or the transition to other suppliers could have a material
adverse impact on results of operations.
The Company uses United Parcel Service ("UPS") for substantially all ground
shipments of products to its domestic customers. The Company has reviewed and
approved alternative methods of ground shipping which the Company anticipates
will supplement its use, and reduce its reliance, on UPS. Nevertheless, any
interruption in UPS services could have a material adverse effect on the
Company's sales and results of operations.
The Company's size has made it a large consumer of certain materials, including
titanium and carbon fiber. Callaway Golf does not make these materials itself,
and must rely on its ability to obtain adequate supplies in the world
marketplace in competition with other users of such materials. While the
Company has been successful in obtaining its requirements for such materials
thus far, there can be no assurance that it will always be able to do so. An
interruption in the supply of such materials or a significant change in costs
could have a material adverse effect on the Company.
12
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The golf club industry, in general, has been characterized by widespread
imitation of popular club designs. The Company has an active program of
enforcing its proprietary rights against companies and individuals who market or
manufacture counterfeits and "knock off" products, and aggressively asserts its
rights against infringers of its copyrights, patents, trademarks, and trade
dress. However, there is no assurance that these efforts will reduce the level
of acceptance obtained by these infringers. Additionally, there can be no
assurance that other golf club manufacturers will not be able to produce
successful golf clubs which imitate the Company's designs without infringing any
of the Company's copyrights, patents, trademarks, or trade dress.
An increasing number of the Company's competitors have, like the Company itself,
sought to obtain patent, trademark, copyright or other protection of their
proprietary rights and designs. From time to time others have or may contact
the Company to claim that they have proprietary rights which have been infringed
by the Company and/or its products. The Company evaluates any such claims and,
where appropriate, has obtained or sought to obtain licenses or other business
arrangements. To date, there have been no interruptions in the Company's
business as a result of any claims of infringement. No assurance can be given,
however, that the Company will not be adversely affected in the future by the
assertion of intellectual property rights belonging to others. This effect
could include alteration of existing products, withdrawal of existing products
and delayed introduction of new products.
Various patents have been issued to the Company's competitors in the golf ball
industry. As Callaway Golf Ball Company develops a new golf ball product, it
must avoid infringing these patents or other intellectual property rights, or it
must obtain licenses to use them lawfully. If any new golf ball product is
found to infringe on protected technology, the Company could incur substantial
costs to redesign its golf ball product or to defend legal actions. Despite its
efforts to avoid such infringements, there can be no assurance that Callaway
Golf Ball Company will not infringe on the patents or other intellectual
property rights of third parties in its development efforts, or that it will be
able to obtain licenses to use any such rights, if necessary.
The Company has stringent procedures to maintain the secrecy of its confidential
business information. These procedures include criteria for dissemination of
information and written confidentiality agreements with employees and vendors.
Suppliers, when engaged in joint research projects, are required to enter into
additional confidentiality agreements. There can be no assurance that these
measures will prove adequate in all instances to protect the Company's
confidential information.
"GRAY MARKET" DISTRIBUTION
Some quantities of the Company's products find their way to unapproved outlets
or distribution channels. This "gray market" in the Company's products can
undermine authorized retailers and distributors who promote and support the
Company's products, and can injure the Company's image in the minds of its
customers and consumers. On the other hand, stopping such commerce could result
in a potential decrease in sales to those customers who are selling Callaway
Golf products to unauthorized distributors and/or an increase in sales returns
over historical levels. For example, the Company is experiencing a decline in
sales in the United States in 1998, and believes that decline is due, in part,
to a decline in "gray market" shipments to Asia and Europe. While the Company
has taken some lawful steps to limit commerce in its products in the "gray
market" in both domestic and international markets, it has not stopped such
commerce.
PROFESSIONAL ENDORSEMENTS
The Company establishes relationships with professional golfers in order to
promote the Callaway Golf brand among both professional and amateur golfers.
The Company has entered into endorsement arrangements with members of the
various professional tours, including the Senior Professional Golf Association's
Tour, the Professional Golf Association's Tour, the Ladies Professional Golf
Association's Tour, the European Professional Golf Association's Tour and the
Nike Tour. While most professional golfers fulfill their contractual
obligations,
13
some have been known to stop using a sponsor's products despite contractual
commitments. To date, the Company believes that the cessation of use by
professional endorsers of Callaway(R) brand products has not resulted in a
significant amount of negative publicity. However, if certain of Callaway
Golf's professional endorsers were to stop using the Company's products contrary
to their endorsement agreements, the Company's business could be adversely
affected in a material way by the negative publicity.
Many professional golfers throughout the world use the Company's golf clubs even
though they are not contractually bound to do so. The Company has created cash
"pools" that reward such usage. For the last several years, the Company has
experienced an exceptional level of driver penetration on the world's five major
professional tours, and the Company has heavily advertised that fact. There is
no assurance that the Company will be able to sustain this level of professional
usage. Many other companies are aggressively seeking the patronage of these
professionals, and are offering many inducements, including specially designed
products and significant cash rewards.
As in past years, during 1998, the Company continued its Big Bertha(R) Players'
Pools ("Pools") for the PGA, SPGA, LPGA and Nike Tours. Those professional
players participating in the Pools received cash for using Callaway Golf
products in professional tournaments, but were not bound to use the products or
grant any endorsement to the Company. The Company believes that its
professional endorsements and its Pools contributed to its usage on the
professional tours in 1998. There is no guarantee, however, that the Company
will be able to sustain this level of professional usage, and in some measures
this level of usage has been lower on the professional tours in 1998 than in
1997. Further, while it is not clear whether professional endorsements
materially contribute to retail sales, it is possible that a decline in the
level of professional usage of the Company's products could have a material
adverse effect on the Company's business.
NEW BUSINESS VENTURES
The Company has invested significant capital in new business ventures. However,
in connection with the Company's review of its business, both existing and
proposed new business ventures have been evaluated The Company has determined
to discontinue, transfer or suspend certain business ventures not directly
associated with the Company's core business. See "Part I. FINANCIAL
INFORMATION - Item 2. Certain Factors Affecting Callaway Golf Company -
Business Plan." The Company will continue development of its golf ball business.
See "Part I. FINANCIAL INFORMATION - Item 2. Certain Factors Affecting Callaway
Golf Company - Golf Ball Development."
INTERNATIONAL DISTRIBUTION
The Company's management believes that controlling the distribution of its
products throughout the world will be an element in the future growth and
success of the Company. The Company is actively pursuing a reorganization of
its international operations, including the acquisition of distribution rights
in certain key countries in Europe, Asia and North America. These efforts have
resulted and will continue to result in additional investments in inventory,
accounts receivable, corporate infrastructure and facilities. The integration
of foreign distribution into the Company's international sales operations will
require the dedication of management resources which may temporarily detract
from attention to the day-to-day business of the Company. Additionally, the
integration of foreign distribution increases the Company's exposure to
fluctuations in exchange rates for various foreign currencies which could result
in losses and, in turn, could adversely impact the Company's results of
operations. To date, losses resulting from exchange rate fluctuations have not
had a significant adverse impact on the Company's results of operations.
However, there can be no assurance that the Company will be able to mitigate
this exposure in the future through its management of foreign currency
transactions. International reorganization also could result in disruptions in
the distribution of the Company's products in some areas. There can be no
assurance that the acquisition of some or all of the Company's foreign
distribution will be successful, and it is possible that an attempt to do so
will adversely affect the Company's business.
The Company, through a distribution agreement, appointed Sumitomo as the sole
distributor of the Callaway(R) golf clubs in Japan. The current distribution
agreement began in February 1993 and runs through December 31, 1999. The
Company does not intend to extend this agreement.
14
The Company has established ERC, a wholly-owned Japanese corporation, for the
purpose of distributing Odyssey(R) products immediately, Callaway Golf balls
when ready and Callaway Golf clubs beginning January 1, 2000. There will be
significant costs and capital expenditures invested in ERC before there will be
sales sufficient to support such costs. However, these costs have not been
material to date. Furthermore, there are significant risks associated with the
Company's intention to effectuate distribution in Japan through ERC, and it is
possible that doing so will have a material adverse effect on the Company's
operations and financial performance.
GOLF BALL DEVELOPMENT
In 1996, the Company formed Callaway Golf Ball Company, a wholly-owned
subsidiary of the Company, for the purpose of designing, manufacturing and
selling golf balls. The Company has previously licensed the manufacture and
distribution of a golf ball product in Japan and Korea. The Company also
distributed a golf ball under the trademark "Bobby Jones." These golf ball
ventures were not commercially successful.
The Company has determined that Callaway Golf Ball Company will enter the golf
ball business by developing a new product in a new plant to be constructed just
for this purpose. The successful implementation of the Company's strategy could
be adversely affected by various risks, including, among others, delays in
product development, construction delays and unanticipated costs. There can be
no assurance as to if and when a successful golf ball product will be developed
or that the Company's investments will ultimately be realized.
The Company's golf ball business is in the early stages of development and has
had a negative impact on the Company's cash flows and results of operations and
will continue to do so for the next several years. The Company believes that
many of the same factors which affect the golf equipment industry, including
growth rate in the golf equipment industry, intellectual property rights of
others, seasonality and new product introductions, also apply to the golf ball
business. In addition, the golf ball business is highly competitive with a
number of well-established and well-financed competitors. These competitors
have established market share in the golf ball business which will need to be
challenged in order for the Company's golf ball business to be successful.
YEAR 2000 ISSUE
Historically, many computer programs have been written using two digits rather
than four to define the applicable year, which could result in the program
failing to properly recognize a year that begins with "20" instead of "19."
This, in turn, could result in major system failures or miscalculations, and is
generally referred to as the "Year 2000 issue."
While the Company's own products do not contain date-based functionality and are
not susceptible to the year 2000 issue, much of the Company's operations
incorporate or are affected by systems which may contain date-based
functionality. Therefore, the Company has formulated a Year 2000 Plan to
address the Company's Year 2000 issues. The Company's Year 2000 Plan
contemplates four phases -- assessment, remediation, testing and
release/installation -- which will overlap to a significant degree. The
Company's own internal critical systems and key suppliers will be the primary
areas of focus. The Company believes critical systems are those systems which,
if they are not Year 2000 compliant, may disrupt the Company's manufacturing,
sales or distribution capabilities in a material manner.
The assessment phase involves an inventory, prioritization and preliminary
evaluation of the Year 2000 compliance of the key tools (e.g., hardware,
software, data and embedded systems) and relationships (e.g., with suppliers,
customers, utilities and other service providers) on which the Company relies to
operate its business. In connection with this phase, the Company has received
information concerning the Year 2000 compliance status of critical suppliers and
selected customers in response to extensive inquiries initiated in September and
October of 1998 to determine the extent to which the Company is vulnerable to
those third parties' failure to remediate their own Year 2000 issues. The
process of evaluating these suppliers and selected customers will continue
through the fourth quarter of 1998 and is scheduled for completion by mid-1999,
with follow-up reviews scheduled through the remainder of 1999. The Company
estimates the assessment phase to be approximately 75% complete.
15
The Company anticipates commencing the remediation phase during the fourth
quarter of 1998. During the remediation phase, the Company will begin to
identify remediation options for computer hardware and software and implement
such options. Examples of remediation options for computer hardware and
software products used by the Company include altering the product or code,
upgrading or replacing the product, recommending changes in how the product is
used or retiring the product. Examples of remediation options for suppliers,
customers and service providers include verifying compliance, developing
alternate suppliers, customers or service providers or stocking an additional
supply of product components.
In October 1997, the Company implemented a new business computer system which
runs most of the Company's data processing and financial reporting software
applications and has in part addressed remediation issues company-wide. The
manufacturer of the application software used on the new computer system has
represented that the software addresses the Year 2000 issue. The information
systems of some of the Company's subsidiaries have not yet been converted to the
new system, but the Company is in the process of implementing such conversions
as needed.
The Company presently plans to have completed the four phases with respect to
those systems which are critical to its operations no later than the end of the
third quarter of 1999. Some non-critical systems may not be addressed until
after January 2000.
The total cost associated with assessment and required modifications to
implement the Company's Year 2000 Plan is not expected to be material to the
Company's financial position. The Company currently estimates that the total
cost of implementing its Year 2000 Plan will not exceed $10.0 million. This
preliminary estimate is based on presently available information and will be
updated as the Company continues its assessment and proceeds with
implementation. In particular, the estimate may need to be increased once the
Company has received feedback from suppliers and formulated its contingency
plan. The total amount expended on the Year 2000 Plan through September 30,
1998, was $525,000, of which approximately $425,000 related to repair or
replacing of software and related hardware problems and approximately $100,000
related to internal and external labor costs.
If the Company's new business computer system fails with respect to the Year
2000 issue, or if any computer hardware or software applications or embedded
chips critical to the Company's manufacturing process are overlooked, or if the
subsidiary conversions are not made or are not completed timely, there could be
a material adverse impact on the business operations and financial performance
of the Company. Additionally, there can be no assurance that the systems of
other companies on which the Company's systems rely will be timely converted, or
that a failure to convert by another company, or a conversion that is
incompatible with the Company's systems, would not have a material adverse
effect on the business operations or financial performance of the Company. In
particular, if third party providers, due to the Year 2000 issue, fail to
provide the Company with components or materials which are necessary to
manufacture its products, with sufficient electric power and other utilities to
sustain its manufacturing process, or with adequate, reliable means of
transporting its products to its customers worldwide, then any such failure
could have a material adverse effect on the business operations and financial
performance of the Company.
The Company has not yet established a contingency plan, but intends to formulate
one to address unavoided or unavoidable risks and expects to have the
contingency plan formulated by July 1999.
EURO CURRENCY
Many of the countries in which the Company sells its products are Member States
of the Economic and Monetary Union ("EMU"). Beginning January 1, 1999 Member
States of the EMU may begin trading in either their local currencies or the
euro, the official currency of EMU participating Member States. Parties are
free to choose the unit they prefer in contractual relationships during the
transitional period, beginning January 1999 and ending June 2002. As noted
above, the Company is in the process of installing a new computer system at its
subsidiaries. This new
16
system will run substantially all of the principal data processing and financial
reporting software of the subsidiaries. The Company anticipates that, after the
implementation of an upgrade, the new system will contain the functionality to
process transactions in either a country's local currency or euro. Until such
time as the upgrade has occurred, transactions denominated in euro will be
processed manually. The Company does not anticipate a large demand from its
customers to transact in euros. Additionally, the Company does not believe that
it will incur material costs specifically associated with manually processing
data or preparing its business systems to operate in either the transitional
period or beyond. However, there can be no assurance that the conversion of EMU
Member States to euro will not have a material adverse effect on the Company and
its operations.
RESULTS OF OPERATIONS
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 1998 AND 1997:
Net sales decreased 33% to $172.9 million for the three months ended September
30, 1998 compared to $257.4 million for the comparable period in the prior year.
This decrease was largely attributable to a decrease in metal wood sales of
$94.8 million for the three months ended September 30, 1998 versus 1997. This
decrease was partially offset by sales of the Big Bertha (R) Steelhead (TM)
metal woods, which were introduced in the third quarter of 1998 and contributed
$33.1 million to sales. Also contributing to the decrease was an overall
decrease in sales of irons of $17.4 million during the third quarter of 1998
versus 1997. Soft metal woods sales, particularly titanium metal wood sales,
continued both domestically and abroad. Competition has caused the Company to
lose some unit market share domestically partly because of pricing strategies
implemented by certain large competitors. The Company also believes that certain
actions by the USGA earlier this year contributed to the drop in metal wood
sales. During the third quarter of 1998, sales to Japan and to the rest of Asia
(excluding Japan) decreased $14.3 million (53%) and $7.6 million (42%),
respectively over the same quarter of the prior year. Sales domestically and in
Europe also decreased $52.8 million (32%) and $5.3 million (16%), respectively
during the three months ended September 30, 1998 as compared to the same period
in the prior year.
For the three months ended September 30, 1998, gross profit decreased 40% to
$83.1 million from $138.8 million for the comparable period in the prior year.
As a percentage of net sales, gross profit decreased to 48% from 54% for the
quarter ended September 30, 1998 as compared to the same quarter of the prior
year, primarily as a result of higher cost of sales due to an increase in sales
of irons (which have lower margins than metal woods) as a percentage of total
dollar and unit sales, a metal wood wholesale price reduction implemented in May
1998 and an increase in warranty expense. These increases were partially offset
by a reduction in employee compensation expense during the quarter ended
September 30, 1998 over the comparable quarter in 1997.
Selling expenses increased to $40.3 million in the third quarter of 1998
compared to $32.6 million in the third quarter of 1997. As a percentage of net
sales, selling expenses increased to 23% from 13% during the third quarter of
1998 over the third quarter of 1997. The $7.7 million increase was primarily
the result of selling expenses related to Odyssey, which the Company purchased
in August 1997, and newly acquired foreign distribution and domestic
subsidiaries. Also contributing to the increase were increased advertising,
promotional, staffing and overhead expenses in certain foreign subsidiaries. The
increase was partially offset by a reduction in employee compensation expense
during the quarter ended September 30, 1998 over the quarter ended September 30,
1997.
General and administrative expenses decreased to $24.5 million for the three
months ended September 30, 1998 from $24.7 million for the comparable period in
the prior year. As a percentage of net sales, general and administrative
expenses in the third quarter of 1998 increased to 14% from 10%. The $0.2
million decrease was largely attributable to decreases in employee compensation
expense and outside legal fees. This decrease was partially offset by costs
associated with operations of Callaway Golf Ball Company, primarily non-
capitalized construction costs of its new facility, as well as depreciation and
other costs related to the implementation of the Company's new computer software
system. Costs also increasing in the third quarter of 1998 were those related to
Odyssey, including amortization of intangibles associated with the purchase of
substantially all of the assets and certain liabilities of Odyssey, costs
related to other subsidiaries which the Company did not own in the comparable
period of 1997, and costs related to golf development and new player programs
which were formed in the first quarter of 1998.
17
Research and development expenses decreased to $9.1 million in the third quarter
of 1998 compared to $10.6 million in the comparable period of the prior year.
As a percentage of net sales, research and development expenses in the third
quarter of 1998 increased to 5% from 4% in the third quarter of 1997. The $1.5
million decrease was primarily the result of a decrease in employee compensation
expense. This decrease was partially offset by increased costs associated with
development and testing of golf balls and costs related to Odyssey.
Other income decreased $0.8 million for the quarter ended September 30, 1998
over the comparable period of the prior year. This decrease was attributable to
a decrease of interest income resulting from lower cash balances during three
months ended September 30, 1998 versus 1997 as well as interest expense incurred
during the three months ended September 30, 1998 related to draws on the
Company's line of credit. This decrease was partially offset by net gains on
foreign currency transactions in the third quarter of 1998 as compared with a
net loss for the same period in 1997.
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1998 AND 1997:
Net sales decreased 96.4% to $583.1 million for the nine months ended September
30, 1998 compared to $679.5 million for the comparable period in the prior year.
This decrease was largely attributable to a decrease in sales of metal woods of
$165.1 million for the nine months ended September 30, 1998 versus 1997. This
decrease was partially offset by sales of the Big Bertha(R) Steelhead(TM) metal
woods, which were introduced in the third quarter of 1998 and contributed $33.1
million to sales. Soft metal woods sales, particularly, titanium metal woods
sales, continued both domestically and abroad. Competition has caused the
Company to lose some unit market share domestically partly because of pricing
strategies implemented by certain large competitors. In addition, sales earlier
in the year were adversely affected by unusual "El Nino" weather conditions in
the United States. The Company also believes that certain actions by the USGA
earlier this year contributed to the drop in metal wood sales. Soft metal woods
sales abroad may be attributed to continued economic problems in Asia. Sales to
Japan and to the rest of Asia (excluding Japan) decreased $14.5 million (22%)
and $21.5 million (47%), respectively, and domestic sales also decreased $71.5
million (16%) during the nine months ended September 30, 1998 as compared to the
same period in the prior year. These decreases were offset by increases in sales
to Europe of $10.1 million (11%) and Canada of $7.1 million (46%). Sales of
irons also showed an increase during the first nine months of 1998 ($16.9
million), primarily the result of sales of Big Bertha(R) X-12(TM) Irons, which
the Company introduced in January 1998. Sales of Odyssey(R) products contributed
an increase of $24.9 million to sales for the nine months ended September 1998.
For the nine months ended September 30, 1998, gross profit decreased 24% to
$275.6 million from $360.5 million for the comparable period in the prior year.
As a percentage of net sales, gross profit decreased to 47% from 53% for the
nine months ended September 30, 1998 as compared to the same period of the prior
year, primarily as a result of higher cost of sales due to an increase in sales
of irons, (which have lower margins than metal woods) as a percentage of total
dollar and unit sales, a metal wood wholesale price reduction implemented in May
1998 and an increase in warranty expense. These increases were partially offset
by a reduction in employee compensation expense during the nine months ended
September 30, 1998 over the nine months ended September 30, 1997.
Selling expenses increased to $118.3 million for the nine months ended September
30, 1998 compared to $95.2 million for the comparable period in the prior year.
As a percentage of net sales, selling expenses in the first nine months of 1998
increased to 20% from 14% for the comparable period in 1997. The $23.1 million
increase was primarily the result of selling expenses related to Odyssey, which
the Company acquired in August 1997 and newly acquired of foreign distribution
and domestic subsidiaries. Also contributing to the increase were increases in
advertising and promotional costs, as well as increased pro tour expenses
primarily resulting from tour signage contracts. The Company also experienced
increased advertising, promotional, staffing and overhead expenses in certain
foreign subsidiaries. The increase was partially offset by a reduction in
employee compensation expense during the nine months ended September 30, 1998
over the comparable period in 1997.
General and administrative expenses increased to $68.7 million for the nine
months ended September 30, 1998 from $57.0 million for the comparable period in
the prior year. As a percentage of net sales, general and administrative
expenses in the first nine months of 1998 increased to 12% from 8%. The $11.7
million increase was largely attributable to costs associated with operations of
Callaway Golf Ball Company, primarily non-capitalized
18
construction costs of its new facility, as well as depreciation and other costs
related to the implementation of the Company's new computer software system.
Also contributing to the increase were costs related to Odyssey, including
amortization of intangibles associated with the purchase of substantially all of
the assets and certain liabilities of Odyssey, costs related to other
subsidiaries which the Company did not own in the comparable period of 1997, and
costs related to golf development and new player programs which were formed in
the first quarter of 1998. This increase was partially offset by decreases in
employee compensation expense and outside legal fees.
Research and development expenses increased to $26.2 million in the first nine
months of 1998 compared to $24.7 million in the comparable period of the prior
year. As a percentage of net sales, research and development expenses in the
first nine months of 1998 remained constant at 4%. The $1.5 million increase
was primarily the result of costs associated with the development and testing of
golf balls, increased product design, engineering and casting technology costs
and costs related to Odyssey. This increase was partially offset by a decrease
in employee compensation expense.
Other income decreased $3.3 million for the nine months ended September 30, 1998
over the comparable period of the prior year. This decrease was attributable to
a decrease of interest income resulting from lower cash balances during nine
months ended September 30, 1998 versus 1997 as well as interest expense incurred
during the first nine months of 1998 related to draws on the Company's line of
credit. This decrease was partially offset by net gains on foreign currency
transactions in the first nine months of 1998 as compared with a net loss for
the same period in 1997.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, cash and cash equivalents increased to $31.0 million from
$26.2 million at December 31, 1997 primarily as a result of $29.2 million
provided by operations and $38.5 million provided by financing activities. Cash
flows from operations was primarily attributable to net income, increases in
income taxes payable and accrued warranty expense and a decrease in accounts
receivable, partially offset by an increase in inventories and a decrease in
other liabilities. Cash provided by financing activities was primarily due to
net proceeds from the Company's revolving line of credit as well as issuance of
Common Stock, partially offset by dividends paid.
Cash used in investing activities totaled $63.1 million and resulted primarily
from capital expenditures for building improvements, production and research and
development machinery and computer equipment. Of these capital expenditures,
$26.7 million related to Callaway Golf Ball Company. The acquisition of the
Company's distributors in Korea, Belgium, Denmark, Canada and France and the
purchase of the remaining 80% interest of All-American Golf LLC also contributed
to cash used in investing activities.
The Company's principal source of liquidity, both on a short-term and long-term
basis, has been cash flow provided by operations and the Company's line of
credit facility. The Company expects this trend to continue although sales in
1998 have declined from those in the prior year and the Company does not foresee
any significant improvement in sales over the next several quarters. The
Company increased its line of credit facility from $50.0 million to $150.0
million in February 1998. The Company has borrowed against its line of credit
to supplement cash flow used in operations based upon the Company's need to
increase its inventory levels and finance additional operational activities as
well as finance capital expenditures during the nine months ended September 30,
1998. At September 30, 1998, the Company had available $99.2 million on its
line of credit. The Company intends to repay its borrowings on its existing line
of credit with cash flow from operations.
The implementation of the business plan discussed in Note 9 of the financial
statements and in Management's Discussion and Analysis above contemplates the
Company renegotiating certain loan covenants under its existing line of credit
or securing a new line of credit or other loan facility by December 31, 1998.
If the Company is unsuccessful in these efforts, and is otherwise unable to
modify its business plan to avoid violating certain loan covenants in its
existing line of credit, there could be a material adverse affect on the
Company's operations.
As a result of the implementation of the business plan, the Company currently
estimates that it will incur charges in the fourth quarter of 1998 of between
$70 million and $85 million related to
19
employee severance costs, impairment of assets, excess lease costs, losses on
disposition of assets, other exit costs, as well as obsolete or excess inventory
charges. If the Company takes actions that vary from those currently expected,
actual charges recorded could differ significantly from those estimated above.
The Company believes that, based upon its current operating plan, analysis of
its consolidated financial position and projected future results of operations,
it will be able to maintain its current level of operations, including purchase
commitments and planned capital expenditures for the foreseeable future, through
operating cash flows and available borrowings under its line of credit. There
can be no assurance, however, that future industry specific developments or
general economic trends will not adversely affect the Company's operations or
its ability to meet its cash requirements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company, incident to its business activities, is the plaintiff in several
legal proceedings, both domestically and abroad, in various stages of
development. In conjunction with the Company's program of enforcing its
proprietary rights, the Company has initiated a number of actions against
alleged infringers under the intellectual property laws of various countries,
including, for example, the United States Lanham Act, the U.S. Patent Act, and
other pertinent laws. Some defendants in these actions have, among other
things, contested the validity and/or the enforceability of some of the
Company's patents and/or trademarks. Others have asserted counterclaims against
the Company. The Company believes that the outcome of these matters
individually and in the aggregate will not have a material adverse effect upon
the financial position or results of operations of the Company. It is possible,
however, that in the future one or more defenses or claims asserted by
defendants in one or more of those actions may succeed, resulting in the loss of
all or part of the rights under one or more patents, loss of a trademark, a
monetary award against the Company, or some other loss to the Company. One or
more of these results could adversely affect the Company's overall ability to
protect its product designs and ultimately limit its future success in the
marketplace.
In addition, the Company from time to time receives information claiming that
products sold by the Company infringe or may infringe patent or other
intellectual property rights of third parties. To date, the Company has not
experienced any material expense or disruption associated with any such
potential infringement matters. It is possible, however, that in the future one
or more claims of potential infringement could lead to litigation, the need to
obtain additional licenses, the need to alter a product to avoid infringement,
or some other action or loss by the Company.
The Company and its subsidiaries, incident to their business activities, from
time to time are parties to a number of other legal proceedings in various
stages of development. It is the opinion of the management of the Company that
the probable result of these other matters individually and in the aggregate
will not have a material adverse effect upon the Company's financial position,
results of operations or cash flows.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION:
October and November 1998 Press Releases
- - ----------------------------------------
The Company issued three press releases, the first of which reported its third
quarter 1998 sales and earnings and the anticipation of continued adverse impact
of market conditions on its sales and earnings in the fourth quarter of 1998,
the second of which announced the consolidation of Odyssey Golf, Inc. with the
Company and the third of which reported the plan adopted by the Company pursuant
to its review of business elements. Copies of these press releases are attached
hereto as Exhibits 99.1, 99.2 and 99.3, respectively, and are incorporated
herein by reference.
Shareholder Proposal Notice Deadline
- - ------------------------------------
Shareholders who wish to bring proposals for action at the Company's 1999 Annual
Meeting of Shareholders must give written notice of such proposal to the
Company's Secretary no later than March 5, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
a. Exhibits:
--------
3.1 Articles of Incorporation (filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-8 (No. 33-85692), as filed with
the Securities and Exchange Commission (the "Commission") on
October 28, 1994, and incorporated herein by this reference.)
3.2 Certificate of Amendment of Articles of Incorporation of the
Company (filed as Exhibit 3.1.2 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1994, as filed with
the Commission on March 31, 1995, and incorporated herein by
this reference.)
3.3 By-laws (as amended through May 10, 1996) (filed as Exhibit 4.3
to the Company's Registration Statement on Form S-8 (No. 333-
5719), as filed with the Commission on June 11, 1996, and
incorporated herein by this reference.)
27 Financial Data Schedule/(+)/
99.1 Press Release dated October 21, 1998/(+)/
99.2 Press Release dated October 27, 1998/(+)/
99.3 Press Release dated November 11, 1998/(+)/
______________________________
/(+)/ Included with this Report.
b. Reports on Form 8-K:
-------------------
None
21
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
Date: November 16, 1998 /s/ ELY CALLAWAY
-------------------------
Ely Callaway
Chairman, President and
Chief Executive Officer
/s/ DAVID A. RANE
-------------------------
David A. Rane
Executive Vice President, Planning
and Administration and Chief Financial Officer
22
EXHIBIT INDEX
-------------
EXHIBIT NUMBER DESCRIPTION
-----------
3.1 Articles of Incorporation (filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-8 (No. 33-85692), as filed with
the Securities and Exchange Commission (the "Commission") on
October 28, 1994, and incorporated herein by this reference.)
3.2 Certificate of Amendment of Articles of Incorporation of the
Company (filed as Exhibit 3.1.2 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1994, as filed with the
Commission on March 31, 1995, and incorporated herein by this
reference.)
3.3 By-laws (as amended through May 10, 1996) (filed as Exhibit 4.3
to the Company's Registration Statement on Form S-8 (No. 333-
5719), as filed with the Commission on June 11, 1996, and
incorporated herein by this reference.)
27 Financial Data Schedule/(+)/
99.1 Press Release dated October 21, 1998/(+)/
99.2 Press Release dated October 27, 1998/(+)/
99.3 Press Release dated November 11, 1998/(+)/
______________________________
/(+)/ Included with this Report.
23