EXHIBIT 13.1
SELECTED FINANCIAL DATA(1)
(IN THOUSANDS, EXCEPT PER SHARE DATA) YEAR ENDED DECEMBER 31,
2001 2000 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
Statement of Operations Data:
Net sales $ 816,163 $ 837,627 $ 719,038 $ 703,060 $ 848,941
Cost of sales 411,585 440,119 384,265 410,341 408,345
- -----------------------------------------------------------------------------------------------------------------------
Gross profit 404,578 397,508 334,773 292,719 440,596
Selling, general and administrative expenses 259,364 240,874 221,043 241,775 189,109
Research and development expenses 32,697 34,579 34,002 36,848 30,298
Restructuring (credits) expenses -- -- (5,894) 54,235 --
Sumitomo transition expenses -- -- 5,713 -- --
Litigation settlement -- -- -- -- 12,000
- -----------------------------------------------------------------------------------------------------------------------
Income (loss) from operations 112,517 122,055 79,909 (40,139) 209,189
Interest and other income, net 7,149 8,791 9,182 3,911 4,586
Interest expense (1,552) (1,524) (3,594) (2,671) (10)
Unrealized energy derivative losses (19,922) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and
cumulative effect of accounting change 98,192 129,322 85,497 (38,899) 213,765
Income tax provision (benefit) 39,817 47,366 30,175 (12,335) 81,061
- -----------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect
of accounting change 58,375 81,956 55,322 (26,564) 132,704
Cumulative effect of accounting change -- (957) -- -- --
- -----------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 58,375 $ 80,999 $ 55,322 $ (26,564) $ 132,704
=======================================================================================================================
Earnings (loss) per common share:
Basic
Income (loss) before cumulative effect
of accounting change $ 0.84 $ 1.17 $ 0.79 $ (0.38) $ 1.94
Cumulative effect of accounting change -- (0.01) -- -- --
- -----------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 0.84 $ 1.16 $ 0.79 $ (0.38) $ 1.94
=======================================================================================================================
Diluted
Income (loss) before cumulative effect
of accounting change $ 0.82 $ 1.14 $ 0.78 $ (0.38) $ 1.85
Cumulative effect of accounting change -- (0.01) -- -- --
- -----------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 0.82 $ 1.13 $ 0.78 $ (0.38) $ 1.85
=======================================================================================================================
Dividends paid per share $ 0.28 $ 0.28 $ 0.28 $ 0.28 $ 0.28
=======================================================================================================================
(IN THOUSANDS) DECEMBER 31,
2001 2000 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
Balance Sheet Data:
Cash and cash equivalents $ 84,263 $ 102,596 $ 112,602 $ 45,618 $ 26,204
Marketable securities $ 6,422 $ -- $ -- $ -- $ --
Working capital $ 252,817 $ 233,163 $ 205,198 $ 139,598 $ 209,402
Total assets $ 647,602 $ 630,934 $ 616,783 $ 655,827 $ 561,714
Long-term liabilities $ 31,379 $ 9,884 $ 11,575 $ 18,723 $ 7,905
Total shareholders' equity $ 514,349 $ 511,744 $ 499,934 $ 453,096 $ 481,425
(1) This information should be read in conjunction with the information set
forth below in "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the "Notes to Consolidated Financial
Statements."
28
Callaway Golf Company
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires the
Company to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, the Company evaluates its
estimates, including those related to provisions for warranty, uncollectible
accounts receivable, inventory obsolescence, restructuring costs and market
value estimates of derivative instruments. The Company bases its estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
YEARS ENDED DECEMBER 31, 2001 AND 2000
For the year ended December 31, 2001, net sales decreased $21.4 million (3%) to
$816.2 million from $837.6 million in the prior year. The decrease is due to a
decline in the sales of irons and metal woods, partially offset by an increase
in sales of golf balls, putters and accessories. This decline was also the
result of the timing of the launch of the Company's new products. The Company
did not begin selling its 2002 products in significant quantities in 2001 and
thus did not repeat the late-season launch of new products that occurred in
2000.
The decline in iron sales of $51.0 million (17%) to $248.9 million represents a
decrease in both unit and dollar sales. A decline was expected as the Company's
products generally sell better in their first year after introduction and 2001
was the second year in the life cycle of the Big Bertha Steelhead X-14 Stainless
Steel Irons. Declines in other older iron models such as the Hawk Eye Tungsten
Injected irons were partially offset by the introduction of the Hawk Eye VFT
Irons in the second half of the year.
The sales of metal woods decreased $10.1 million (2%) to $392.9 million. Similar
to the decline in iron sales, this decline represents a decrease in both unit
and dollars sales and is primarily attributable to a decline in sales of Big
Bertha Steelhead Plus Stainless Steel Metal Woods, which were introduced in
January 2000. The decline in metal woods was partially offset by net increases
generated by the introduction of the Big Bertha Hawk Eye VFT Metal Woods and ERC
II Forged Titanium Drivers which more than offset the decrease in sales of their
predecessors, Great Big Bertha Hawk Eye Metal Woods and ERC Forged Titanium
Drivers, respectively.
The increase in golf ball sales of $20.9 million (62%) to $54.9 million was
primarily due to the introduction of the CB1 and CTU 30 golf balls during 2001.
Sales of putters, accessories and other products increased $18.8 million (18%)
to $119.5 million in 2001 due primarily to increased sales of Odyssey putters
and golf bags in 2001.
The Company believes the overall decline in net sales is primarily due to poor
weather conditions, a general decline in the number of golf rounds played during
the year, aggressive competitive pricing strategies in the industry, economic
concerns among retailers and customers in many of the Company's key markets
around the world, the disruption in consumer spending following the September
11th tragedy, and the United States Golf Association's actions in the United
States against the Big Bertha ERC II Forged Titanium Driver. The strength of the
U.S. dollar in relation to other foreign currencies also had a significant
adverse effect upon the Company's net sales during 2001 as compared to 2000. As
compared to the year ended December 31, 2000, a decline in foreign currency
exchange rates adversely impacted net sales for the year ended December 31, 2001
by approximately $32.9 million, as measured by applying 2000 exchange rates to
2001 net sales.
During 2001, net sales in the United States decreased $7.1 million (2%) to
$444.1 million as compared to net sales during 2000. Overall, the Company's net
sales in regions outside the United States decreased $14.3 million (4%) to
$372.1 million during 2001 as compared to 2000. Had exchange rates during 2001
been the same as exchange rates during 2000, overall net sales in regions
outside of the United States would have been approximately 9% higher than
reported in 2001. Net sales by regions outside of the United States in 2001 are
as follows:
IN MILLIONS, EXCEPT PERCENT DATA
Percent
Net Sales Dollar Growth Growth
- --------------------------------------------------------------------------------
Japan $130.7 $ 8.7 7%
Europe 118.4 (7.1) (6%)
Rest of Asia including Korea 63.9 (18.5) (22%)
Rest of World 59.1 2.6 5%
- --------------------------------------------------------------------------------
$372.1 $(14.3)
================================================================================
The Company acquired certain of its distribution rights in the Europe and Rest
of World regions in the first quarter of 2001 and therefore began selling
directly to retailers rather than to a third party distributor.
For the year ended December 31, 2001, gross profits increased to $404.6 million
from $397.5 million in 2000 and as a percentage of net sales increased to 50% in
2001 from 47% in 2000. This improvement in gross profit is a result of a shift
in club product mix away from lower yielding iron products to higher yielding
wood products. Golf ball product profit margins improved during 2001 as compared
to 2000, as a result of increased sales volume, plant utilization and production
yields. The profit margin was also favorably affected by an $8.1 million
reduction in the Company's warranty expense during 2001 as compared to 2000. The
Company has observed a downward trend in actual costs over the past two years
associated with warranty claims due to improved product engineering and
manufacturing processes combined with a reduction of costs associated with
resolving claims. Accordingly, the Company reduced its warranty accrual rate
during 2001. The Company believes that its warranty accrual is adequate to cover
future claims and will continue to monitor the warranty accrual rate. The
Company may adjust the warranty accrual rate from time to time based on various
relevant factors, including the Company's stated warranty policies and
practices, the historical frequency of claims, and the cost to replace or repair
its products under warranty.
Selling expenses in 2001 increased to $188.3 million from $170.5 million in
2000. As a percentage of net sales, these expenses increased to 23% in 2001 from
20% in 2000. The increase is primarily due to increases in advertising costs and
promotional expenses of $9.6 million and $5.8 million, respectively, associated
with the Company's new product launches, the rollout of new fitting cart systems
and store-in-store project, and other demand creation initiatives.
29
Callaway Golf Company
General and administrative expenses increased to $71.1 million in 2001 from
$70.3 million in 2000. As a percentage of net sales, these expenses increased to
9% in 2001 from 8% in 2000. The increase is primarily attributed to $4.0 million
of higher employee compensation costs including severance charges, $3.7 million
of increased costs due primarily to the consolidation of facilities and $2.9
million of increased legal expenses, partially offset by decreases in
depreciation and bad debt expenses of $3.5 million and $5.1 million,
respectively.
Research and development expenses in 2001 decreased to $32.7 million from $34.6
million in 2000. As a percentage of net sales, these expenses remained constant
at 4% of net sales. The dollar decrease is due to a decrease in depreciation
expense and employee costs.
Interest and other income decreased to $7.1 million in 2001 from $8.8 million in
2000. This decrease is primarily attributable to a decrease in interest income
of $4.7 million associated with lower average cash balances, and lower interest
rates, in 2001 as compared with 2000, and realized losses of $2.1 million
generated from the sale of the Company's excess energy supply, partially offset
by a $2.7 million increase in foreign currency transaction gains, a $1.5 million
increase in realized marketable securities gains, and a $0.6 million increase in
royalty income. Interest expense remained relatively constant in 2001 at $1.6
million compared to $1.5 million in 2000.
Unrealized energy derivative losses totaled $19.9 million in 2001 as a result of
the Company's long-term energy supply contract which was entered into during
2001. The unrealized losses were generated by the decline in electricity rates
through November, 2001. The Company did not have a similar contract in 2000. See
"Supply of Electricity and Energy Contracts" below.
During 2001, the Company recorded a provision for income taxes of $39.8 million
and recognized a decrease in deferred taxes of $5.1 million. During 2001, the
Company realized $14.5 million in tax benefits related to the exercise of stock
options. The provision for income tax as a percentage of income before taxes was
41% in 2001 as compared with 37% in 2000. The effective tax rate was higher in
2001 as compared to 2000 primarily as a result of the increased utilization of
tax credits in 2000 and the unrealized energy derivative losses recognized
during 2001.
Net income for 2001 decreased 28% to $58.4 million from $81.0 million in 2000.
Earnings per diluted share during the year decreased 27% to $0.82 in 2001 as
compared to $1.13 in 2000. During 2001, the Company recorded a non-cash charge
of $14.2 million after-tax or $0.20 per diluted share, as a result of the change
in estimated market value of the Company's energy supply contract. Excluding
this non-cash energy supply contract charge, the Company's net income for 2001
as compared to 2000 would have decreased 10% to $72.6 million and diluted
earnings per share would have decreased 10% to $1.02.
YEARS ENDED DECEMBER 31, 2000 AND 1999
For the year ended December 31, 2000, net sales increased $118.6 million, or
16%, to $837.6 million from $719.0 million in the prior year. The increase is
attributable to an increase in sales of irons, golf balls and other products,
including putters and accessories, partially offset by a decrease in sales of
metal woods. The increase in sales of irons of 40% to $299.9 million represents
an increase in both unit and dollar sales and is primarily attributable to sales
of Great Big Bertha Hawk Eye Tungsten Injected Titanium Irons, which were not
sold in significant quantities during 1999. Also contributing to the increase in
sales of irons were sales of Big Bertha Steelhead X-14 Stainless Steel Irons,
which were introduced in January 2000, and which generated higher revenues
during 2000 than its predecessor, Big Bertha X-12 Stainless Steel Irons, did in
1999. This increase includes sales of $34.0 million of its Rule 35 golf balls
during 2000. This product was not sold during 1999. The overall decrease in
sales of metal woods of 3% to $403.0 million represents a decrease in both unit
and dollar sales of titanium and non-current metal woods, partially offset by an
increase in unit and dollar sales of stainless steel metal woods. The overall
decrease in sales of metal woods is primarily attributable to sales of
non-current products during 1999, which did not occur in significant quantities
during the comparable period of 2000, and to a decrease in sales of Great Big
Bertha Hawk Eye Titanium Metal Woods during 2000 as compared with 1999, the year
in which they were introduced. However, sales of ERC Forged Titanium Drivers,
which began shipping in significant quantities in the second quarter of 2000,
and initial shipments of the Company's newly-introduced ERC II Forged Titanium
Drivers and Big Bertha Hawk Eye VFT Titanium Metal Woods, which began shipping
in limited quantities in December 2000, partially offset the decrease in sales
of titanium metal woods. Also partially offsetting the decrease in sales of
titanium metal woods was an increase in sales of stainless steel metal woods
attributable to the January 2000 introduction of Big Bertha Steelhead Plus
Stainless Steel Metal Woods, which generated higher revenue in 2000 than their
predecessor, Big Bertha Steelhead Stainless Steel Metal Woods, did in 1999.
Net sales reflect the effect of a reclassification of shipping revenues from
selling expenses. This reclassification, which added $5.5 million to net sales
in 2000 and $4.6 million in 1999 was required by Emerging Issues Task Force
Issue No. 00-10 ("EITF 00-10"), and did not result in a change in the Company's
earnings or earnings per share for any period.
During 2000, sales in the United States increased $32.8 million (8%) to $451.2
million as compared to net sales during 1999. Overall, the Company's sales in
regions outside the United States increased $85.8 million (29%) to $386.4
million during 2000 as compared to 1999. Overall sales in regions outside of the
U.S. in 2000 as compared to 1999 were not significantly impacted by fluctuations
in foreign currency exchange rates. Net sales by regions outside of the United
States are as follows:
IN MILLIONS, EXCEPT PERCENT DATA
Percent
Net Sales Dollar Growth Growth
- --------------------------------------------------------------------------------
Japan $122.0 $ 66.1 118%
Europe 125.5 9.8 9%
Rest of Asia including Korea 82.4 9.3 13%
Rest of World 56.5 0.6 1%
- --------------------------------------------------------------------------------
$386.4 $ 85.8
================================================================================
Net sales in Japan increased significantly because the Company began selling
directly to customers in 2000 rather than through a distributor, as in prior
years.
For the year ended December 31, 2000, gross profits increased to $397.5 million
from $334.8 million in 2000 and as a percentage of net sales remained constant
at 47%. Overall gross profit was adversely affected in 2000 by lower margins
associated with manufacturing the Company's new golf balls which resulted
primarily from low plant utilization and production yields. This effect was
offset by improvements in golf club product margins. This improvement is
primarily attributable to reductions in manufacturing labor and overhead
expenses, favorable product mix primarily related to sales of ERC Forged
Titanium Drivers and the negative effect on 1999 gross profits that resulted
from close-out sales at substantially reduced prices.
Selling expense in 2000 increased to $170.5 million from $128.6 million in 1999,
and as a percentage of net sales increased to 20% from 18%. These amounts
include the reclassification of shipping revenue and expense, which
30
Callaway Golf Company
were previously recorded in selling expense. The effect of this reclassification
reduced selling expense by $5.7 million in 2000 and $3.3 million in 1999. The
overall increase in selling expense was primarily attributable to incremental
expenses associated with the launch of the Company's Rule 35 golf balls and with
expanded golf club sales activity in the Company's Japanese subsidiary. Prior to
2000, Callaway Golf products were sold in Japan through a third party
distributor. Expenses related to product endorsement also contributed to the
increase.
General and administrative expense decreased to $70.3 million in 2000 from $92.5
million in 1999, and as a percentage of net sales decreased to 8% from 13%. This
decrease is primarily attributable to the shifting of $18.4 million of costs
associated with the Company's golf ball pre-production period from general and
administrative expense in 1999 to cost of goods sold in 2000, as these costs
were related to production of golf balls in 2000. Also contributing to the
decrease were reductions in legal and consulting fees and in depreciation
expense of $3.2 million and $1.0 million, respectively. The overall decrease was
partially offset by an increase in bad debt expense of $4.4 million associated
with the write-off of uncollectible accounts.
Research and development expense was $34.6 million in 2000 as compared with
$34.0 million in 1999, and as a percentage of net sales decreased to 4% from 5%.
The nominal dollar increase was primarily attributable to an increase in
employee compensation and benefits.
Interest and other income decreased to $8.8 million in 2000 from $9.2 million in
1999. This decrease is primarily attributable to the 1999 receipt of $3.6
million of insurance proceeds related to the Company's deferred compensation
plan. This decrease was partially offset by a $1.6 million increase in royalty
income, a $0.6 million decrease in foreign currency transaction losses and a
$0.7 million increase in interest income associated with higher average cash
balances in 2000 as compared with 1999.
Interest expense decreased to $1.5 million in 2000 from $3.6 million in 1999.
This decrease reflects a decline in interest expense in the amounts of $1.4
million associated with the interim finance agreement for pre-lease financing
advances for the acquisition and installation costs of machinery and equipment
and $0.7 million associated with debt balances on the Company's line of credit
and accounts receivable securitization facilities. The line of credit and
accounts receivable securitization facilities were not utilized in 2000 and the
interim finance agreement was terminated in 1999.
During 2000, the Company recorded a provision for income taxes of $47.4 million
and recognized a decrease in deferred taxes of $4.4 million. During 2000, the
Company realized $6.8 million in tax benefits related to the exercise of stock
options. The provision for income tax as a percentage of income before taxes was
37% in 2000 as compared with 35% in 1999. The Company's effective tax rate for
2000 reflects a benefit from the consolidation of Callaway Golf Ball Company
with the Company.
The Company adopted Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" ("SAB No. 101") in the fourth quarter of 2000 with an
effective date of January 1, 2000. SAB No. 101 summarizes the Securities and
Exchange Commission's ("SEC") Division of Corporation Finance Staff's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. As a result of the adoption of SAB No. 101, the Company
recognized a cumulative effect adjustment of $1.0 million in the Consolidated
Statement of Operations for the year ended December 31, 2000.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2001, cash and cash equivalents decreased to $84.3 million from
$102.6 million at December 31, 2000. The decrease primarily resulted from cash
used in financing and investing activities of $74.0 million and $42.8 million,
respectively, partially offset by cash provided by operating activities of
$100.2 million. Cash flows used in financing activities are primarily
attributable to the acquisition of treasury stock ($104.0 million) and the
payment of dividends ($19.4 million), partially offset by proceeds from the
exercise of employee stock options ($45.0 million) and purchases under the
employee stock purchase plan ($5.7 million). Cash flows used in investing
activities are primarily attributable to capital expenditures ($35.3 million).
Cash flows provided by operating activities reflect decreases in accounts
receivable ($3.2 million) and other assets ($5.6 million), as well as increases
in accounts payable and accrued expenses ($3.9 million) and increases in accrued
employee compensation and benefits ($2.8 million), partially offset by an
increase in inventory ($37.1 million) and decreases in accrued warranty expense
($4.5 million) and income taxes payable ($1.6 million). The increase in
inventory is primarily attributable to the Company's expanded new product
introductions for 2002 and the timing of the launch of these new products. The
Company did not begin selling its 2002 products in significant quantities in
2001 and thus did not repeat the late-season launch of new products that
occurred in 2000.
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 credit
facilities. The Company currently expects this trend to continue. The Company
has a revolving credit facility for up to $120.0 million (the "Amended Credit
Agreement") and an $80.0 million accounts receivable securitization facility
(the "Accounts Receivable Facility"). During 2001, the Company did not utilize
either its Accounts Receivable Facility or its line of credit under the Amended
Credit Agreement. At December 31, 2001, the Company had $120.0 million available
under the Amended Credit Agreement, subject to meeting certain availability
requirements under a borrowing base formula and other limitations. Also at
December 31, 2001, there were no advances under the Accounts Receivable
Facility, leaving up to $80.0 million available under this facility. See Notes 4
and 5 to the Consolidated Financial Statements for further detail.
In May 2000, the Company announced that its Board of Directors authorized it to
repurchase its Common Stock in the open market or in private transactions,
subject to the Company's assessment of market conditions and buying
opportunities from time to time, up to a maximum cost to the Company of $100.0
million. The Company began its repurchase program in May 2000 and during the
second quarter of 2001 completed the program which resulted in the repurchase of
a total of 5.8 million shares of the Company's Common Stock at an average cost
of $17.13 per share.
In August 2001, the Company announced that its Board of Directors authorized it
to repurchase additional shares of its Common Stock in the open market or in
private transactions, subject to the Company's assessment of market conditions
and buying opportunities from time to time, up to a maximum cost to the Company
of $100.0 million. During the second half of 2001, the Company repurchased 5.0
million shares of its Common Stock at an average cost of $16.98 per share.
In December 1998, the Company entered into a master lease agreement for the
acquisition and lease of machinery and equipment utilized in the Company's golf
ball operations. By December 31, 1999, the Company had finalized its lease
program and leased $50.0 million of equipment under the
31
Callaway Golf Company
operating lease. On February 11, 2002, pursuant to the master lease agreement,
the Company notified the lessor of its election to purchase the leased equipment
in August 2002 for approximately $44.8 million plus the payment of approximately
$5.2 million of lease termination fees.
In April 2001, the Company entered into a note payable as part of a licensing
agreement for patent rights. The unsecured, interest-free note payable matures
on December 31, 2003 and is payable in quarterly installments. The total amounts
payable in 2002 and 2003 are $2.7 million and $3.3 million, respectively.
The Company has entered into long-term purchase agreements for various key raw
materials. The purchase commitments covered by these agreements aggregate
approximately $4.0 million per year for 2002 and 2003.
Although the Company's golf club operations are mature and historically have
generated cash from operations, the Company's golf ball operations are
relatively new and to date have not generated cash flows sufficient to fund
these operations. The Company does not expect that its golf ball operations will
generate sufficient cash to fund these operations in the next twelve months.
However, based upon its current operating plan, analysis of its consolidated
financial position and projected future results of operations, the Company
believes that its operating cash flows, together with its credit facilities,
will be sufficient to finance current operating requirements, including planned
capital expenditures and purchase commitments. There can be no assurance,
however, that future industry specific or other developments, general economic
trends or other matters, will not adversely affect the Company's operations or
its ability to meet its future cash requirements (see "Certain Factors Affecting
Callaway Golf Company" below).
Supply of Electricity and Energy Contracts
Beginning in the summer of 2000, the Company identified a future risk to ongoing
operations as a result of the deregulation of the electricity market in
California. In July 2000, the Company entered into a one-year supply agreement
with Idaho Power Company ("Idaho Power"), a subsidiary of Idacorp, Inc., for the
supply of electricity at $64 per megawatt hour. During the second quarter of
2001, Idaho Power advised the Company that it was unwilling to renew the
contract upon expiration in July 2001 due to concerns surrounding the volatility
of the California electricity market at that time.
As a result, in the second quarter of 2001, the Company entered into an
agreement with Pilot Power Group, Inc. ("Pilot Power") as the Company's energy
service provider and in connection therewith entered into a long-term,
fixed-priced, fixed-capacity, energy supply contract ("Enron Contract") with
Enron Energy Services, Inc. ("EESI"), a subsidiary of Enron Corporation, as part
of a comprehensive strategy to ensure the uninterrupted supply of electricity
while capping costs in the volatile California electricity market. The Enron
Contract provided, subject to the other terms and conditions of the contract,
for the Company to purchase nine megawatts of energy per hour from June 1, 2001
through May 31, 2006 (394,416 megawatts over the term of the contract). The
total purchase price for such energy over the full contract term was
approximately $43.5 million.
At the time the Company entered into the Enron Contract, nine megawatts per hour
was in excess of the amount the Company expected to be able to use in its
operations. The Company agreed to purchase this amount, however, in order to
obtain a more favorable price than the Company could have obtained if the
Company had purchased a lesser quantity. The Company expected to be able to sell
any excess supply through Pilot Power.
Because the Enron Contract provided for the Company to purchase an amount of
energy in excess of what it expected to be able to use in its operations, the
Company accounted for the Enron Contract as a derivative instrument in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The Enron
Contract did not qualify for hedge accounting under SFAS No. 133. Therefore, the
Company recognized changes in the estimated fair value of the Enron Contract
currently in earnings. The estimated fair value of the Enron Contract was based
upon a present value determination of the net differential between the contract
price for electricity and the estimated future market prices for electricity as
applied to the remaining amount of unpurchased electricity under the Enron
Contract. Through September 30, 2001, the Company recorded unrealized pre-tax
losses of $19.9 million ($7.7 million in the second quarter of 2001 and $12.2
million in the third quarter of 2001).
On November 29, 2001, the Company notified EESI that, among other things, EESI
was in default of the Enron Contract and that based upon such default, and for
other reasons, the Company was terminating the Enron Contract effective
immediately. At the time of termination, the contract price for the remaining
energy to be purchased under the Enron Contract through May 2006 was
approximately $39.1 million.
On November 30, 2001, EESI notified the Company that it disagreed that it was in
default of the Enron Contract and that it was prepared to deliver energy
pursuant to the Enron Contract. However, on December 2, 2001, EESI, along with
Enron Corporation and numerous other related entities, filed for bankruptcy.
Since November 30, 2001, the parties have not been operating under the Enron
Contract and Pilot Power has been providing energy to the Company from alternate
suppliers.
As a result of the Company's notice of termination to EESI, and certain other
automatic termination provisions under the Enron Contract, the Company believes
that the Enron Contract has been terminated. As a result, the Company adjusted
the estimated value of the Enron Contract through the date of termination, at
which time the terminated Enron Contract ceased to represent a derivative
instrument in accordance with SFAS No. 133. Because the Enron Contract is
terminated and neither party to the contract is performing pursuant to the terms
of the contract, the Company no longer records future valuation adjustments for
changes in electricity rates. The Company continues to reflect on its balance
sheet the derivative valuation account of $19.9 million at December 31, 2001,
subject to periodic review, in accordance with SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
In applying these accounting principles, the Company sought and received
guidance from its auditors and others.
The Company believes the Enron Contract has been terminated, and as of March 8,
2002, EESI has not asserted any claim against the Company. There can be no
assurance, however, that EESI or another party will not assert a future claim
against the Company or that a bankruptcy court or arbitrator will not ultimately
nullify the Company's termination of the Enron Contract. No provision has been
made for contingencies or obligations, if any, under the Enron Contract beyond
November 30, 2001.
Restructuring
In 1998, the Company recorded a restructuring charge of $54.2 million resulting
from a number of cost reduction actions and operational improvements. During
1999, the Company completed its restructuring initiatives. During 2000, the
Company paid $1.4 million related to its restructuring obligations, primarily
rents associated with its former New York City facility. At December 31, 2000,
there was no remaining reserve balance. The Company
32
Callaway Golf Company
has a contingent liability related to the New York City facility (see Notes 11
and 12 to the Consolidated Financial Statements).
Certain Factors Affecting Callaway Golf Company
The financial statements contained in this report and the related discussion
describe and analyze the Company's financial performance and condition for the
periods indicated. For the most part, this information is historical. The
Company's prior results, however, are not necessarily indicative of the
Company's future performance or financial condition. The Company therefore has
included the following discussion of certain factors which could affect the
Company's future performance or financial condition. These factors could cause
the Company's future performance or financial condition to differ materially
from its prior performance or financial condition or from management's
expectations or estimates of the Company's future performance or financial
condition. These factors, among others, should be considered in assessing the
Company's future prospects and prior to making an investment decision with
respect to the Company's stock.
TERRORIST ACTIVITY AND ARMED CONFLICT Terrorist activities and armed conflicts
(such as the attacks on the World Trade Center and the Pentagon, the incidents
of Anthrax poisoning and the military actions in Afghanistan) would likely have
a significant adverse effect upon the Company's business. Such events would
likely have an adverse effect upon an already fragile world economy (discussed
below) and would likely adversely affect the level of demand for the Company's
products as consumer's attention and interest are diverted from golf and become
focused on these events and the economic, political, and public safety issues
and concerns associated with such events. Also, such events could adversely
affect the Company's ability to manage its supply and delivery logistics. If
such events caused a significant disruption in domestic or international air,
ground or sea shipments, the Company's ability to obtain the materials necessary
to produce and sell its products and to deliver customer orders also could be
materially adversely affected. Furthermore, such events have negatively impacted
tourism. If this negative impact upon tourism continues, the Company's sales to
retailers at resorts and other vacation destinations would be materially
adversely affected.
ADVERSE GLOBAL ECONOMIC CONDITIONS The Company sells golf clubs, golf balls and
golf accessories. These products are recreational in nature and are therefore
discretionary purchases for consumers. Consumers are generally more willing to
make discretionary purchases of golf products during favorable economic
conditions. An adverse change in economic conditions in the United States or in
the Company's international markets (which represent almost half of the
Company's total sales), or even a decrease in consumer confidence as a result of
anticipated adverse changes in economic conditions, could cause consumers to
forgo or to postpone purchasing new golf products. Such forgone or postponed
purchases could have a material adverse effect upon the Company.
The economic conditions in many of the Company's key markets around the world
are currently viewed by many as uncertain or troubled. In the United States,
there have been many announcements by companies of large-scale reductions in
force and others are expected. Consumers are less likely to purchase new golf
equipment when they are unemployed. Furthermore, even if economic conditions
were to improve during the latter part of 2002, the Company's sales in 2002 may
not experience a corresponding improvement because the golf selling season would
largely be over.
FOREIGN CURRENCY RISKS Almost half of the Company's sales are international
sales. As a result, the Company conducts transactions in approximately 12
currencies worldwide. Conducting business in such various currencies increases
the Company's exposure to devaluations of foreign currencies relative to the
U.S. dollar which adversely impacts the Company's results of operations. The
Company's results in 2001 were significantly affected negatively by the strength
of the U.S. dollar versus other foreign currencies as compared to the prior
year. Continued weakness in such foreign currencies during 2002 would have a
significant negative effect upon the Company.
The Company tries to mitigate its exposure to foreign currency fluctuations by
engaging in certain hedging activities. The Company's hedges reduce, but do not
eliminate, the affects of such foreign currency fluctuations on the Company's
results of operations. For example, the Company successfully entered into hedges
for certain transactions it anticipated to occur during 2001. These hedging
activities mitigated, but did not eliminate, the negative effects of foreign
currency fluctuations on the hedged transactions that occurred during such
period. Despite the Company's successful hedge transactions, decreases in
foreign currency exchange rates adversely impacted net sales for the year ended
December 31, 2001 by approximately $32.9 million (as measured by applying 2000
exchange rates to 2001 net sales). If the Company does not successfully hedge
future transactions, the adverse effects of foreign currency devaluations would
increase. (See below Item 3, Quantitative and Qualitative Disclosures about
Market Risk -- Foreign Currency Fluctuations).
GROWTH OPPORTUNITIES Golf Clubs. In order for the Company to significantly grow
its sales of golf clubs, the Company must either increase its share of the
market for golf clubs or the market for golf clubs must grow. The Company
already has a significant share of the worldwide premium golf club market and
therefore opportunities for additional market share may be limited. The Company
does not believe there has been any material increase in participation or the
number of rounds played in 1999, 2000 or 2001. In fact, Golf Datatech reports
that the number of rounds played declined 9 out of 12 months in 2001.
Furthermore, the Company believes that since 1997 the overall worldwide premium
golf club market has generally not experienced substantial growth in dollar
volume from year to year. There is no assurance that the overall dollar volume
of the worldwide premium golf club market will grow, or that it will not
decline, in the future. The Company's future club sales growth therefore may be
limited unless there is growth in the worldwide premium golf club market or it
can grow its already significant market share.
Golf Balls. The Company began selling its golf balls in February 2000 and does
not have as significant of a market share as it does in the club business.
Although opportunities exist for the acquisition of additional market share in
the golf ball market, such market share is currently held by some
well-established and well-financed competitors. There is no assurance that the
Company will be able to obtain additional market share in this very competitive
golf ball market. If the Company is unable to obtain additional market share,
its golf ball sales growth may be limited.
GOLF BALL COSTS The cost of entering the golf ball business has been
significant. To date, the development of the Company's golf ball business has
had a significant negative impact on the Company's cash flows, financial
position and results of operations. The Company will need to produce and sell
golf balls in large volumes to cover its costs and become profitable in 2002.
Although the Company's golf ball operations have shown significant improvement
during 2001, there is no assurance that the Company will be able to achieve the
sales or production efficiencies necessary to make its golf ball business
profitable. Until the golf ball business becomes profitable, the Company's
results of operations, cash flows and financial position will continue to be
negatively affected.
33
Callaway Golf Company
MANUFACTURING CAPACITY 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 require
significant start-up expenses and/or 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
season, it could limit the Company's sales and adversely affect its financial
performance. On the other hand, the Company invests in manufacturing capacity
and 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 less than optimum capacity usage and/or
in excess inventories and related obsolescence charges that could adversely
affect the Company's financial performance. In addition, if the Company were to
experience delays, difficulties or increased costs in its production of golf
clubs or golf balls, including production of new products needed to replace
current products, the Company's future golf club or golf ball sales could be
adversely affected.
DEPENDENCE ON ENERGY RESOURCES The Company's golf club and golf ball
manufacturing facilities use, among other resources, significant quantities of
electricity to operate. Many companies in California have experienced periods of
blackouts during which electricity was not available. The Company has
experienced one blackout period to date, and it is possible the Company will
experience additional blackout periods. The Company has taken certain steps to
provide access to alternative power supplies for certain of its operations, and
believes that these measures could mitigate any impact resulting from possible
future blackouts.
During the second quarter of 2001, the Company entered into a long-term energy
supply contract as part of a comprehensive strategy to ensure the uninterrupted
supply of energy while capping electricity costs in the volatile California
energy market. To obtain a more favorable price and to assure adequate supplies
during times of peak loads, the Company agreed to purchase a significantly
greater supply of electricity than it expected to use in its business. The
Company had expected to be able to re-sell some or all of this excess supply and
thereby reduce the net price of the electricity it uses in its business.
However, due to cooler than normal weather, government intervention and market
and regulatory imperfections, the market price for electricity in California
dropped significantly. As a result, the Company was unable to re-sell the excess
supply of electricity at favorable rates and thus the net cost of the
electricity used in the Company's business was higher than expected. In November
2001, the Company terminated its long-term supply contract and is currently
purchasing wholesale energy through the Company's energy service provider under
short-term contracts. If energy rates were once again to increase significantly,
the Company's energy costs would increase significantly and adversely affect the
Company's results of operations.
DEPENDENCE ON CERTAIN SUPPLIERS AND MATERIALS The Company is dependent on a
limited number of suppliers for its clubheads and shafts, some of which are
single-sourced. 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 the Company's results of operations. The Company is also
single-sourced or dependent on a limited number of suppliers for the materials
it uses to make its golf balls. Many of the materials are customized for the
Company. Any delay or interruption in such supplies could have a material
adverse impact upon the Company's golf ball business. If the Company did
experience any such delays or interruptions, there is no assurance that the
Company would be able to find adequate alternative suppliers at a reasonable
cost or without significant disruption to its business.
The Company uses United Parcel Service ("UPS") for substantially all ground
shipments of products to its U.S. customers. The Company uses air carriers and
ships for most of its international shipments of products. Any significant
interruption in UPS, air carrier or ship services could have a material adverse
effect upon the Company's ability to deliver its products to its customers. If
there were any such interruption in its services, there is no assurance that the
Company could engage alternative suppliers to deliver its products in a timely
and cost-efficient manner. In addition, many of the components the Company uses
to build its golf clubs, including clubheads and shafts, are shipped to the
Company via air carrier. Any significant interruption in UPS services, air
carrier services or shipping services into or out of the United States could
have a material adverse effect upon the Company.
The Company's size has made it a large consumer of certain materials, including
titanium alloys and carbon fiber. The Company 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 always will be able to do so. An interruption
in the supply of the materials used by the Company or a significant change in
costs could have a material adverse effect on the Company.
COMPETITION Golf Clubs. The worldwide market for premium golf clubs 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. For example, in 2002 Nike began marketing and selling golf clubs that
will compete with the Company's products, and several manufacturers in Japan
have announced plans to expand their businesses in the United States. New
product introductions, price reductions, extended payment terms and "close-outs"
by competitors continue to generate increased market competition. While the
Company believes that its products and its marketing efforts continue to be
competitive, there can be no assurance that successful marketing activities,
discounted pricing, extended payment terms or new product introductions by
competitors will not negatively impact the Company's future sales.
Golf Balls. The premium golf ball business is also highly competitive, and may
be becoming even more competitive. There are a number of well-established and
well-financed competitors, including one competitor with an estimated market
share in excess of 50% of the premium golf ball business. There are also several
other competitors, including Nike and Taylor Made, that have introduced or will
introduce golf ball designs that directly compete with the Company's products,
and several manufacturers in Japan have announced their plans to expand their
businesses in the United States. Furthermore, as competition in this business
increases, many of these competitors are discounting substantially the prices of
their products. In order for its golf ball business to be successful, the
Company will need to penetrate the market share held by existing competitors,
while competing with new entrants, and must do so at prices that are profitable.
There can be no assurance that the Company's golf balls will obtain the market
acceptance necessary to be commercially successful.
34
Callaway Golf Company
MARKET ACCEPTANCE OF PRODUCTS A golf manufacturer's ability to compete is in
part dependent upon its ability to satisfy the various subjective requirements
of golfers, including a golf club's and golf ball's look and "feel," and the
level of acceptance that a golf club and ball has among professional and
recreational golfers. The subjective preferences of golf club and ball
purchasers are difficult to predict and may be subject to rapid and
unanticipated changes. For example, the Company's new HX Golf Balls employ
revolutionary aerodynamic technology. This aerodynamic technology is reflected
in the Company's patented tubular lattice network (a criss-crossing network of
tube-like projections that form hexagonal and pentagonal patterns around the
golf ball, as opposed to the conventional dimple), which gives it a unique
appearance different from any other golf ball on the market. There is no
assurance that golfers will be willing to purchase golf balls with this unique
appearance, notwithstanding the performance advantages.
In addition, the Company's products have tended to incorporate significant
innovations in design and manufacture, which have often resulted in higher
prices for the Company's products relative to other products in the marketplace.
There can be no assurance that a significant percentage of the public will
always be willing to pay such premium prices for golf equipment or that the
Company will be able to continue to design and manufacture premium products that
achieve market acceptance in the future. For example, the Company's new Big
Bertha C4 Driver is made of a compression cured carbon composite. All current
leading drivers in the marketplace are made of metal, generally either steel or
titanium. Although the Company believes that its new C4 Drivers provide
exceptional performance, there is no assurance golfers will be willing to pay
premium prices for a non-metallic driver or that the C4 Driver will be
commercially successful.
In general, there can be no assurance as to how long the Company's golf clubs
and balls will maintain market acceptance and therefore no assurance that the
demand for the Company's products will permit the Company to experience growth
in sales, or maintain historical levels of sales, in the future.
NEW PRODUCT INTRODUCTION The Company believes that the introduction of new,
innovative golf clubs and golf balls is important to its future success. A major
portion of the Company's revenues is generated by products that are less than
two years old. The Company faces certain risks associated with such a strategy.
For example, in the golf industry, 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, any new
products that retail at a lower price than prior products may negatively impact
the Company's revenues unless unit sales increase.
The rapid introduction of new golf club or golf ball products by the Company
could result in close-outs of existing inventories at both the wholesale and
retail levels. Such close-outs can result in reduced margins on the sale of
older products, as well as reduced sales of new products, given the availability
of older products at lower prices. Furthermore, it previously was the Company's
practice to announce its new product line at the beginning of each calendar
year. The Company recently departed from that practice and now announces its new
product line in the fourth quarter to allow retailers to plan better. Such early
announcements of new products could cause golfers, and therefore the Company's
customers, to defer purchasing additional golf equipment until the Company's new
products are available. Such deferments could have a material adverse effect
upon sales of the Company's current products and/or result in close-out sales at
reduced prices.
CONFORMANCE WITH THE RULES OF GOLF New golf club and golf ball products
generally seek to 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. The USGA rules are generally followed in the United
States, Canada and Mexico, and the R&A rules are generally followed in most
other countries throughout the world.
Currently, the Rules of Golf as published by the R&A and the USGA are virtually
the same except with respect to the regulation of "driving clubs." In 1998, the
USGA adopted a so-called "spring-like effect test" that limits the coefficient
of restitution ("COR") of drivers. The R&A has announced that it does not
believe that such a limitation is needed or in the best interests of the game of
golf, and has not adopted such a test or other performance limitation on
drivers.
Some countries, such as Japan and Canada, have local golf associations that
exert some control over the game of golf within their jurisdictions. The Royal
Canadian Golf Association ("RCGA") has announced that it will generally follow
the USGA with respect to equipment rules. So far, no other local organization
within the R&A's general jurisdiction has deviated from the R&A's position with
respect to equipment rules.
Currently, all of the Company's products are believed to be "conforming" under
the Rules of Golf as published by the R&A. In addition, all of the Company's
products with the exception of the Company's ERC II (and ERC II Pro Spec) Forged
Titanium Driver are believed to be "conforming" under the Rules of Golf as
published by the USGA and RCGA (the Company's ERC Fairway Woods are conforming).
Although the ERC II Drivers conform to all existing R&A equipment rules, and
most existing USGA and RCGA equipment rules, they do not conform to the USGA's
so-called "spring-like effect" test protocol. There is no assurance that new
designs will satisfy USGA and/or R&A standards, 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. For example, if the R&A were to reverse its current position
and rule that ERC II Drivers are non-conforming under the Rules of Golf as
published by the R&A, then the Company believes its sales of ERC II Drivers in
the Company's international markets would be significantly adversely affected.
On October 18, 2000, the Company announced that it intended to sell its ERC II
Forged Titanium Driver in the U.S. despite the fact that it was ruled to be
non-conforming by the USGA. To the Company's knowledge, it was the first large,
premium brand golf equipment company to sell non-conforming equipment in the
U.S. By undertaking this approach, the Company hoped to expand participation in
the game of golf in the United States -- the source of more than half of the
Company's revenues -- by making the game more enjoyable and accessible for more
people, including those people who play the game primarily for fun, enjoyment
and recreation.
While the Company believed that this is the best strategy for the Company and
its shareholders, and one that is good for the game of golf as well, the
strategy proved to be risky. The USGA vigorously and openly opposed the sale or
use of the ERC II Driver. On December 8, 2000, the USGA announced that scores in
rounds played with clubs that do not conform to USGA rules, such as the ERC II
Forged Titanium Driver, may not be posted for USGA handicap purposes. That
position was reinforced by further announcements by the USGA. A significant
number of U.S. retailers declined to carry the ERC II Driver. It also appears at
this time that a significant number of U.S. golfers have decided that they do
not wish to purchase a driver that may not be used
35
Callaway Golf Company
in competitions in the U.S. played subject to USGA rules or that may not be used
for handicap purposes. Retailer and/or consumer backlash against the
introduction of a non-conforming product hurt sales of ERC II Drivers in the
U.S., and may have injured sales of other, conforming products, or otherwise
damaged the brand. These negative effects will materially limit U.S. sales of
ERC II Drivers in 2002 and in future years, and could even negatively affect in
a material way the strength of the brand and the Company's business overseas
despite the fact that the ERC II Drivers fully conform with the R&A's Rules. On
the other hand, if there is a change in attitude and a large number of American
golfers who do not play in tournaments subject to the USGA's Rules are prepared
to purchase an exceptional non-conforming driver for use in recreational play,
and/or the Company's strategy is successful over time in attracting more people
to the game of golf in the U.S., then the beneficial effects could be
significant.
GOLF PROFESSIONAL ENDORSEMENTS The Company establishes relationships with
professional golfers in order to evaluate and promote Callaway Golf and Odyssey
branded products. The Company has entered into endorsement arrangements with
members of the various professional tours, including the Senior PGA Tour, the
PGA Tour, the LPGA Tour, the PGA European Tour, the Japan Golf Tour and the
buy.com Tour. While most professional golfers fulfill their contractual
obligations, some have been known to stop using a sponsor's products despite
contractual commitments. If certain of the Company'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.
Golf Clubs. Many professional golfers throughout the world use the Company's
golf clubs even though they are not contractually bound to do so and do not
grant any endorsement to the Company. The Company previously created cash pools
that rewarded such usage. In 2001, the Company discontinued these pools and is
allocating these resources to other tour programs. In addition, many other
companies are aggressively seeking the patronage of these professionals, and are
offering many inducements, including specially designed products and significant
cash rewards. In the past, the Company has experienced an exceptional level of
club usage on the world's major professional tours, and the Company has heavily
advertised that fact. The Company's lack of cash inducements for non-staff
golfers resulted in a decrease in usage of the Company's clubs by professional
golfers in 2001 and could result in a further decrease in 2002. The Company
continues to evaluate from time to time whether to implement programs that
reward usage of the Company's products. While it is not clear to what extent
professional usage contributes 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 sales and business.
Golf Balls. Many golf ball manufacturers, including the leading U.S.
manufacturer of premium golf balls, have focused a great deal of their marketing
efforts on promoting the fact that tour professionals use their balls. Some of
these golf ball competitors spend large amounts of money to secure professional
endorsements, and the market leader has obtained a very high degree of tour
penetration. While almost all of the Company's staff professionals, as well as
other professionals who are not on the Company's staff, have decided to use the
Company's golf balls in play, there is no assurance they will continue to do so.
Furthermore, there are many other professionals who are already under contract
with other golf ball manufacturers or who, for other reasons, may not choose to
play the Company's golf ball products. The Company does not plan to match the
endorsement spending levels of the leading manufacturer, and will instead rely
more heavily upon the performance of the ball and other factors to attract
professionals to the product. In the future, the Company may or may not increase
its tour spending in support of its golf ball. It is not clear to what extent
use by professionals is important to the commercial success of the Company's
golf balls, but it is possible that the results of the Company's golf ball
business could be significantly affected by its success or lack of success in
securing acceptance on the professional tours.
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 for golf clubs and golf balls. From time to time,
others have contacted or may contact the Company to claim that they have
proprietary rights that 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 or 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 the Company develops its golf ball products, it attempts to avoid
infringing valid patents or other intellectual property rights. Despite these
attempts, it cannot be guaranteed that competitors will not assert and/or a
court will not find that the Company's golf balls infringe certain patent or
other rights of competitors. If the Company's golf balls are found to infringe
on protected technology, there is no assurance that the Company would be able to
obtain a license to use such technology, and it could incur substantial costs to
redesign them and/or defend legal actions.
The Company has 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 suppliers. Suppliers,
when engaged in joint research projects, are required to enter into additional
confidentiality agreements. While these efforts are taken seriously, there can
be no assurance that these measures will prove adequate in all instances to
protect the Company's confidential information.
SEASONALITY AND ADVERSE WEATHER CONDITIONS In the golf club and golf ball
industries, sales to retailers are generally seasonal due to lower demand in the
retail market during cold weather months. The Company's golf club business has
generally experienced these seasonal fluctuations and the Company expects this
to continue generally for both its golf club and golf ball businesses.
Furthermore, unusual or severe weather conditions generally result in less golf
rounds played, which generally results in less demand for golf clubs and golf
balls. Consequently, sustained adverse weather conditions, especially during the
warm weather months, could materially affect the Company's sales. The Company
believes that overall in the Company's principal markets during
36
Callaway Golf Company
the first half of 2001 there was unusually adverse weather, which affected
retail sales of the Company's products and made the Company's customers
reluctant to re-order in quantity.
PRODUCT RETURNS Golf Clubs. 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 that 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 to date has not been material in relation to the
volume of clubs that have been sold.
The Company monitors the level and nature of any golf club breakage and, where
appropriate, seeks to incorporate design and production changes to assure its
customers of the highest quality available in the market. Significant increases
in the incidence of breakage or other product problems may adversely affect the
Company's sales and image with golfers. While the Company believes that it has
sufficient reserves for warranty claims, 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.
Golf Balls. The Company has not experienced significant returns of defective
golf balls, and in light of the quality control procedures implemented in the
production of its golf balls, the Company does not expect a significant amount
of defective ball returns. However, if future returns of defective golf balls
were significant, it could have a material adverse effect upon the Company's
golf ball business.
"GRAY MARKET" DISTRIBUTION Some quantities of the Company's products find their
way to unapproved outlets or distribution channels. This "gray market" for the
Company's products can undermine authorized retailers and foreign wholesale
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. While the Company
has taken some lawful steps to limit commerce in its products in the "gray
market" in both the U.S. and abroad, it has not stopped such commerce.
INTERNATIONAL DISTRIBUTION The Company's management believes that controlling
the distribution of its products in certain major markets in the world has been
and will be an element in the future growth and success of the Company. The
Company has reorganized a substantial portion 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, employees,
corporate infrastructure and facilities. The operation of foreign distribution
in the Company's international markets will continue to require the dedication
of management and other Company resources.
CREDIT RISK The Company primarily sells its products to golf equipment retailers
directly and through wholly-owned domestic and foreign subsidiaries, and to
foreign distributors. The Company performs ongoing credit evaluations of its
customers' financial condition and generally requires no collateral from these
customers. Historically, the Company's bad debt expense has been low. However, a
downturn in the retail golf equipment market could result in increased
delinquent or uncollectible accounts for some of the Company's significant
customers. In addition, as the Company integrates its foreign distribution its
exposure to credit risks increases as it no longer sells to a few wholesalers
but rather directly to many retailers. A failure of a significant portion of the
Company's customers to meet their obligations to the Company would adversely
impact the Company's performance and financial condition.
INFORMATION SYSTEMS All of the Company's major operations, including
manufacturing, distribution, sales and accounting, are dependent upon the
Company's information computer systems. Any significant disruption in the
operation of such systems, either as a result of an internal system malfunction
or infection from an external computer virus, would have a significant adverse
effect upon the Company's ability to operate its business. Although the Company
has taken steps to mitigate the effect of any such disruptions, there is no
assurance that such steps would be adequate in a particular situation.
Consequently, a significant or extended disruption in the operation of the
Company's information systems could have a material adverse effect upon the
Company's operations and therefore financial performance and condition.
Quantitative and Qualitative Disclosures About Market Risk
The Company uses derivative financial instruments for hedging purposes to limit
its exposure to changes in foreign exchange rates. Transactions involving these
financial instruments are with credit-worthy 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 utilized a derivative commodity instrument, the Enron
Contract, to manage electricity costs in the volatile California energy market
during the period of June 2001 through November 2001. Pursuant to its terms, the
Enron Contract was terminated and the Company has not entered into another
long-term energy contract that would be considered a derivative commodity
instrument. The Company is also exposed to interest rate risk from its credit
facilities and accounts receivable securitization arrangement. (See above
Certain Factors Affecting Callaway Golf Company -- Foreign Currency Risks).
FOREIGN CURRENCY FLUCTUATIONS In the normal course of business, the Company is
exposed to foreign currency exchange rate risks that could impact the Company's
results of operations. The Company's risk management strategy includes the use
of derivative financial instruments, including forwards and purchased options to
hedge certain of these exposures. The Company's objective is to offset gains and
losses resulting from these exposures with gains and losses on the derivative
contracts used to hedge them, thereby reducing volatility of earnings. The
Company does not enter into any trading or speculative positions with regard to
derivative instruments.
The Company is exposed to foreign currency exchange rate risk inherent primarily
in its sales commitments, anticipated sales and assets and liabilities
denominated in currencies other than the U.S. dollar. The Company transacts
business in 12 currencies worldwide, of which the most significant to its
operations are the European currencies, Japanese yen, Korean won, Canadian
dollar, and Australian dollar. 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.
The Company enters into foreign exchange contracts to hedge against exposure to
changes in foreign currency exchange rates. Such contracts are designated at
inception to the related foreign currency exposures being hedged, which include
anticipated intercompany sales of inventory denominated in foreign currencies,
payments due on intercompany transactions from certain
37
Callaway Golf Company
wholly-owned foreign subsidiaries, and anticipated sales by the Company's
wholly-owned European subsidiary for certain euro-denominated transactions. To
achieve hedge accounting, contracts must reduce the foreign currency exchange
rate risk otherwise inherent in the amount and duration of the hedged exposures
and comply with established company risk management policies. Pursuant to its
foreign exchange hedging policy, the Company may hedge anticipated transactions
and certain firm commitments and the related receivables and payables
denominated in foreign currencies using forward foreign currency exchange rate
contracts and put or call options. Foreign currency derivatives are used only to
the extent considered necessary to meet the Company's objectives of minimizing
variability in the Company's operating results arising from foreign exchange
rate movements. Hedging contracts generally mature within twelve months.
At December 31, 2001 and 2000, the Company had approximately $157.0 million and
$118.2 million, respectively, of foreign exchange contracts outstanding. Of the
total contracts outstanding at December 31, 2001 and 2000, approximately $122.6
million and $107.8 million, respectively, were designated as cash flow hedges.
The Company estimates the fair values of derivatives based on quoted market
prices or pricing models using current market rates, and records all derivatives
on the balance sheet at fair value. At December 31, 2001 and 2000, the net fair
value of foreign currency-related derivatives designated as cash flow hedges or
fair value hedges were recorded as net current assets of $8.8 million and net
current liabilities of $1.6 million, respectively.
For derivative instruments that are designated and qualify as cash flow hedges,
the effective portion of the gain or loss on the derivative instrument is
initially recorded in accumulated other comprehensive income as a separate
component of shareholders' equity and subsequently reclassified into earnings in
the period during which the hedged transaction is recognized in earnings. The
Company began utilizing cash flow hedges in the fourth quarter of 2000. During
2001 and 2000, the Company reclassified $2.9 million and $0, respectively, of
gains into earnings related to the release of the effective portion of gains on
contracts designated as cash flow hedges. As of December 31, 2001, the Company
expects to reclassify $6.4 million of deferred net gains into earnings within
the next twelve months. During 2001 and 2000, no gains or losses were
reclassified into earnings as a result of the discontinuance of any cash flow
hedges.
The ineffective gain or loss for derivative instruments that are designated and
qualify as cash flow hedges is reported in "interest and other income, net"
immediately. For foreign currency contracts designated as cash flow hedges,
hedge effectiveness is measured using the spot rate. Changes in the spot-forward
differential are excluded from the test of hedging effectiveness and are
recorded currently in earnings as a component of interest and other income, net.
Assessments of hedge effectiveness are performed using the dollar offset method
and applying a hedge effectiveness ratio between 80% and 125%. Given that both
the hedging item and the hedging instrument are evaluated using the same spot
rate, the Company anticipates the hedges to be highly effective. The
effectiveness of each derivative is assessed monthly. During the years ended
December 31, 2001 and 2000, a net gain of $2.0 million and a net loss of $0.2
million, respectively, were recorded in interest and other income, net
representing the ineffective portion of the Company's derivative instruments.
At December 31, 2001 and 2000, the Company had approximately $34.4 million and
$10.4 million of foreign contracts used to hedge balance sheet exposures
outstanding. The gains and losses on foreign currency contracts used to hedge
balance sheet exposures are recognized in interest and other income, net in the
same period as the remeasurement gain and loss of the related foreign currency
denominated assets and liabilities and thus offset these gains and losses.
During 2001 and 2000, the Company recorded net realized and unrealized gains on
contracts used to hedge balance sheet exposures of $4.5 million and $5.3
million, respectively.
Sensitivity analysis is the measurement of 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 Company used a
sensitivity analysis model to quantify the estimated potential effect of
unfavorable movements of 10% in foreign currencies to which the Company was
exposed at December 31, 2001 through its derivative financial instruments.
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.
The estimated maximum one-day loss in earnings from the Company's
foreign-currency derivative financial instruments, calculated using the
sensitivity analysis model described above, is $15.3 million at December 31,
2001. The Company believes that such a hypothetical loss from its derivatives
would be offset by increases in the value of the underlying transactions being
hedged.
ELECTRICITY PRICE FLUCTUATIONS During the second quarter of 2001, the Company
entered into the Enron Contract to manage electricity costs in the volatile
California energy market. This derivative did not qualify for hedge accounting
treatment under SFAS No. 133. Therefore, the Company recognized the changes in
the estimated fair value of the contract based on current market rates as
unrealized energy derivative losses. During the fourth quarter of 2001, the
Company notified the energy supplier that, among other things, the energy
supplier was in default of the energy supply contract and that based upon such
default, and for other reasons, the Company was terminating the energy supply
contract. As a result, the Company adjusted the estimated value of this contract
through the date of termination, at which time the terminated contract ceased to
represent a derivative instrument in accordance with SFAS No. 133. Because the
contract is terminated and neither party to the contract is performing pursuant
to the terms of the contract, the Company no longer records future valuation
adjustments for changes in electricity rates. The Company continues to reflect
the derivative valuation account on its balance sheet, subject to periodic
review, in accordance with SFAS No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities." See "Supply of
Electricity and Energy Contracts" above.
INTEREST RATE FLUCTUATIONS Additionally, the Company is exposed to interest rate
risk from its Amended Credit Agreement and Accounts Receivable Facility (see
Notes 4 and 5 to the Company's Consolidated Financial Statements) which are
indexed to the London Interbank Offering Rate and Redwood Receivables
Corporation Commercial Paper Rate. No amounts were advanced or outstanding under
these facilities at December 31, 2001.
Notes 4 and 5 to the Company's Consolidated Financial Statements outline the
principal amounts, if any, and other terms required to evaluate the expected
cash flows and sensitivity to interest rate changes.
38
Callaway Golf Company
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) DECEMBER 31,
2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 84,263 $ 102,596
Marketable securities 6,422 --
Accounts receivable, net 48,653 58,836
Inventories, net 167,760 133,962
Current deferred taxes 27,266 29,354
Other current assets 20,327 17,721
- ------------------------------------------------------------------------------------------------------------------------------------
Total current assets 354,691 342,469
Property, plant and equipment, net 133,250 134,712
Intangible assets, net 121,313 113,760
Deferred taxes 20,282 23,332
Other assets 18,066 16,661
- ------------------------------------------------------------------------------------------------------------------------------------
$ 647,602 $ 630,934
====================================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 38,261 $ 44,173
Accrued employee compensation and benefits 25,301 22,574
Accrued warranty expense 34,864 39,363
Note payable, current portion 2,374 --
Income taxes payable 1,074 3,196
- ------------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 101,874 109,306
Long-term liabilities:
Deferred compensation 8,297 9,884
Energy derivative valuation account 19,922 --
Note payable, net of current portion 3,160 --
Commitments and contingencies (Note 11)
Shareholders' equity:
Preferred Stock, $.01 par value, 3,000,000 shares authorized, none
issued and outstanding at December 31, 2001 and 2000 -- --
Common Stock, $.01 par value, 240,000,000 shares authorized,
82,694,173 shares and 78,958,963 shares issued at December 31, 2001 and 2000, respectively 827 790
Paid-in capital 419,541 347,765
Unearned compensation (211) (1,214)
Retained earnings 388,609 349,681
Accumulated other comprehensive loss (4,399) (6,096)
Less: Grantor Stock Trust held at market value, 10,764,690 shares and
5,300,000 shares at December 31, 2001 and 2000, respectively (206,144) (98,713)
- ------------------------------------------------------------------------------------------------------------------------------------
598,223 592,213
Less: Common Stock held in treasury, at cost, 4,939,000 shares and
4,815,241 shares at December 31, 2001 and 2000, respectively (83,874) (80,469)
- ------------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 514,349 511,744
- ------------------------------------------------------------------------------------------------------------------------------------
$ 647,602 $ 630,934
====================================================================================================================================
The accompanying notes are an integral part of these financial statements.
39
Callaway Golf Company
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA) YEAR ENDED DECEMBER 31,
2001 2000 1999
- -------------------------------------------------------------------------- ------------------- -------------------
Net sales $ 816,163 100% $ 837,627 100% $ 719,038 100%
Cost of sales 411,585 50% 440,119 53% 384,265 53%
- -------------------------------------------------------------------------- ------------------- -------------------
Gross profit 404,578 50% 397,508 47% 334,773 47%
Selling expenses 188,306 23% 170,541 20% 128,565 18%
General and administrative expenses 71,058 9% 70,333 8% 92,478 13%
Research and development expenses 32,697 4% 34,579 4% 34,002 5%
Restructuring credits -- -- -- -- (5,894) (1%)
Sumitomo transition expenses -- -- -- -- 5,713 1%
- -------------------------------------------------------------------------- ------------------- -------------------
Income from operations 112,517 14% 122,055 15% 79,909 11%
Interest and other income, net 7,149 8,791 9,182
Interest expense (1,552) (1,524) (3,594)
Unrealized energy derivative losses (19,922) -- --
- -------------------------------------------------------------------------- ------------------- -------------------
Income before income taxes and cumulative
effect of accounting change 98,192 12% 129,322 16% 85,497 12%
Income taxes 39,817 47,366 30,175
- -------------------------------------------------------------------------- ------------------- -------------------
Income before cumulative effect
of accounting change 58,375 81,956 55,322
Cumulative effect of accounting change -- (957) --
- -------------------------------------------------------------------------- ------------------- -------------------
Net income $ 58,375 7% $ 80,999 10% $ 55,322 8%
========================================================================== =================== ===================
Earnings per common share:
Basic
Income before cumulative effect of
accounting change $ 0.84 $ 1.17 $ 0.79
Cumulative effect of
accounting change -- (0.01) --
- -------------------------------------------------------------------------- ------------------- -------------------
$ 0.84 $ 1.16 $ 0.79
- -------------------------------------------------------------------------- ------------------- -------------------
Diluted
Income before cumulative effect of
accounting change $ 0.82 $ 1.14 $ 0.78
Cumulative effect of
accounting change -- (0.01) --
- -------------------------------------------------------------------------- ------------------- -------------------
$ 0.82 $ 1.13 $ 0.78
========================================================================== =================== ===================
Common equivalent shares:
Basic 69,809 69,946 70,397
Diluted 71,314 71,412 71,214
The accompanying notes are an integral part of these financial statements.
40
Callaway Golf Company
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS) YEAR ENDED DECEMBER 31,
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 58,375 $ 80,999 $ 55,322
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 37,467 40,249 39,877
Non-cash compensation 342 2,157 1,390
Tax benefit from exercise of stock options 14,520 6,806 2,377
Non-cash energy derivative losses 19,922 -- --
Net non-cash foreign currency hedging gains (4,748) (1,410) --
Deferred taxes 1,732 4,906 9,971
Non-cash restructuring costs -- -- (8,609)
Loss on disposal of assets 1,824 342 315
Changes in assets and liabilities, net of effects from acquisitions:
Accounts receivable, net 3,182 (9,047) 19,690
Inventories, net (37,147) (39,402) 51,092
Other assets 5,630 (3,074) (12,966)
Accounts payable and accrued expenses 3,936 2,638 12,225
Accrued employee compensation and benefits 2,848 1,623 9,875
Accrued warranty expense (4,499) 3,258 286
Income taxes payable (1,644) 4,088 (10,001)
Accrued restructuring costs -- (1,379) (8,517)
Deferred compensation (1,587) (1,691) 3,969
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 100,153 91,063 166,296
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (35,274) (28,386) (56,244)
Acquisitions, net of cash acquired (5,758) (444) (2,389)
Investment in marketable securities (6,422) -- --
Proceeds from sale of capital assets 4,629 244 5,095
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (42,825) (28,586) (53,538)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net payments on line of credit -- -- (70,919)
(Payments on) proceeds from note payable (1,168) -- 35,761
Issuance of Common Stock 50,651 28,233 9,009
Acquisition of Treasury Stock (104,049) (80,469) --
Dividends paid, net (19,447) (19,538) (19,760)
Proceeds from sale-leaseback of equipment -- 1,268 --
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (74,013) (70,506) (45,909)
- ------------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (1,648) (1,977) 135
- ------------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (18,333) (10,006) 66,984
Cash and cash equivalents at beginning of year 102,596 112,602 45,618
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 84,263 $ 102,596 $ 112,602
====================================================================================================================================
Supplemental disclosures:
Issuance of note payable for acquisition of intangible assets $ 6,702 $ -- $ --
Cancellation of restricted Common Stock $ 992 $ 217 $ 684
Common Stock issued for acquisition of intangible assets $ 516 $ -- $ --
Non-cash financing $ -- $ -- $ 48,732
Cash paid for interest and fees $ 977 $ 805 $ 3,637
Cash paid for income taxes $ 25,738 $ 29,245 $ 30,670
The accompanying notes are an integral part of these financial statements.
41
CALLAWAY GOLF COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Common Stock Paid-in
Shares Amount Capital
- ----------------------------------------------------------------------------------------------
Balance, December 31, 1998 75,095 $ 751 $ 258,015
Exercise of stock options 851 8 5,362
Tax benefit from exercise of stock options -- -- 2,377
Cancellation of Restricted Common Stock (22) -- (684)
Compensatory stock and stock options -- -- (795)
Employee stock purchase plan 378 4 3,635
Cash dividends -- -- --
Dividends on shares held by GST -- -- --
Adjustment of GST shares to market value -- -- 39,419
Equity adjustment from foreign currency translation -- -- --
Net income -- -- --
Balance, December 31, 1999 76,302 763 307,329
- ----------------------------------------------------------------------------------------------
Exercise of stock options 2,252 23 23,932
Tax benefit from exercise of stock options -- -- 6,806
Cancellation of Restricted Common Stock (7) -- (217)
Acquisition of Treasury Stock -- -- --
Compensatory stock and stock options -- -- 804
Employee stock purchase plan 412 4 4,274
Cash dividends -- -- --
Dividends on shares held by GST -- -- --
Adjustment of GST shares to market value -- -- 4,969
Equity adjustment from foreign currency translation -- -- --
Unrealized loss on cash flow hedges, net of tax -- -- --
Other -- -- (132)
Net income -- -- --
Balance, December 31, 2000 78,959 790 347,765
- ----------------------------------------------------------------------------------------------
Exercise of stock options 3,484 34 42,621
Tax benefit from exercise of stock options -- -- 14,520
Cancellation of Restricted Common Stock (32) -- (992)
Acquisition of Treasury Stock -- -- --
Compensatory stock and stock options -- -- 331
Employee stock purchase plan 283 3 2,244
Shares issued for intangible assets -- -- (129)
Cash dividends -- -- --
Dividends on shares held by GST -- -- --
Addition to GST -- -- (9,717)
Adjustment of GST shares to market value -- -- 22,898
Equity adjustment from foreign currency translation -- -- --
Unrealized gain on cash flow hedges, net of tax -- -- --
Net income -- -- --
Balance, December 31, 2001 82,694 $ 827 $419,541
- ----------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
42
Callaway Golf Company
Accumulated
Other Treasury Stock Total
Unearned Retained Comprehensive ------------------------ Shareholders' Comprehensive
Compensation Earnings Income (Loss) GST Shares Amount Equity Income
- ------------------------------------------------------------------------------------------------------------------------------------
$ (5,653) $ 252,528 $ 1,780 $ (54,325) -- $ -- $ 453,096
-- -- -- -- -- -- 5,370
-- -- -- -- -- -- 2,377
684 -- -- -- -- -- --
2,185 -- -- -- -- -- 1,390
-- -- -- -- -- -- 3,639
-- (21,244) -- -- -- -- (21,244)
-- 1,484 -- -- -- -- 1,484
-- -- -- (39,419) -- -- --
-- -- (1,500) -- -- -- (1,500) $ (1,500)
-- 55,322 -- -- -- -- 55,322 55,322
- ------------------------------------------------------------------------------------------------------------------------------------
(2,784) 288,090 280 (93,744) -- -- 499,934 $ 53,822
====================================================================================================================================
-- -- -- -- -- -- 23,955
-- -- -- -- -- -- 6,806
217 -- -- -- -- -- --
-- -- -- -- (4,815) (80,469) (80,469)
1,353 -- -- -- -- -- 2,157
-- -- -- -- -- -- 4,278
-- (21,022) -- -- -- -- (21,022)
-- 1,484 -- -- -- -- 1,484
-- -- -- (4,969) -- -- --
-- -- (5,422) -- -- -- (5,422) $ (5,422)
-- -- (954) -- -- -- (954) (954)
-- 130 -- -- -- -- (2)
-- 80,999 -- -- -- -- 80,999 80,999
- ------------------------------------------------------------------------------------------------------------------------------------
(1,214) 349,681 (6,096) (98,713) (4,815) (80,469) 511,744 $ 74,623
====================================================================================================================================
-- -- -- 2,375 -- -- 45,030
-- -- -- -- -- -- 14,520
992 -- -- -- -- -- --
-- -- -- -- (6,001) (104,049) (104,049)
11 -- -- -- -- -- 342
-- -- -- 3,374 -- -- 5,621
-- -- -- -- 40 645 516
-- (21,717) -- -- -- -- (21,717)
-- 2,270 -- -- -- -- 2,270
-- -- -- (90,282) 5,837 99,999 --
-- -- -- (22,898) -- -- --
-- -- (3,297) -- -- -- (3,297) $ (3,297)
-- -- 4,994 -- -- -- 4,994 4,994
-- 58,375 -- -- -- -- 58,375 58,375
- ------------------------------------------------------------------------------------------------------------------------------------
$ (211) $ 388,609 $ (4,399) $(206,144) (4,939) $ (83,874) $ 514,349 $ 60,072
====================================================================================================================================
43
Callaway Golf Company
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1
The Company
Callaway Golf Company ("Callaway Golf" or the "Company") was incorporated in
California in 1982 and was reincorporated in Delaware in 1999. The Company
designs, develops, manufactures and markets high-quality, innovative golf clubs,
golf balls and golf accessories. Callaway Golf's primary products for the
periods presented include Great Big Bertha Hawk Eye and Big Bertha Hawk Eye VFT
Titanium Metal Woods, ERC and ERC II Forged Titanium Drivers, Big Bertha
Steelhead Plus and Big Bertha Steelhead Metal Woods, Great Big Bertha Hawk Eye
and Great Big Bertha Hawk Eye VFT Tungsten Injected Titanium Irons, Steelhead
X-14 and Big Bertha X-12 Irons, Odyssey putters and wedges, Rule 35 and CB1 golf
balls, golf bags and other golf accessories.
NOTE 2
Significant Accounting Policies
PRINCIPLES OF CONSOLIDATION The consolidated financial statements for the
periods presented include the accounts of the Company and its subsidiaries,
Callaway Golf Sales Company, Golf Funding Corporation ("Golf Funding"), Callaway
Golf Ball Company, Odyssey Golf, Inc. ("Odyssey"), CGV, Inc., Callaway Golf
Media Ventures ("CGMV"), Callaway Golf Europe Ltd., Callaway Golf Europe, S.A.,
Callaway Golf K.K. (formerly named ERC International Company), Callaway Golf
(Germany) GmbH, Callaway Golf Canada Ltd., Callaway Golf Korea, Ltd., Callaway
Golf South Pacific PTY Ltd. and Callaway Golf Company Grantor Stock Trust. All
significant intercompany transactions and balances have been eliminated.
Callaway Golf Ball Company and Odyssey were merged with the Company as of
December 29, 2000 and December 22, 1999, respectively. The Company sold its
interest in CGMV in March 1999 in an effort to discontinue certain initiatives
not directly associated with the Company's core business (Note 12). Callaway
Golf Europe, S.A. was merged with Callaway Golf Europe Ltd. in 1999 (Note 13).
USE OF ESTIMATES The preparation of financial statements in conformity with
accounting principles generally accepted in the United States 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. Examples of such estimates include
provisions for warranty, uncollectible accounts receivable, inventory
obsolescence, restructuring costs and market value estimates of derivative
instruments. Actual amounts could differ from those estimates.
REVENUE RECOGNITION Sales are recognized net of an allowance for sales returns
when both title and risk of loss transfer to the customer. The Company adopted
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB No. 101") in the fourth quarter of 2000 with an effective date of January
1, 2000. SAB No. 101 summarizes the Securities and Exchange Commission ("SEC")
Staff's views in applying generally accepted accounting principles to revenue
recognition in financial statements. As a result of the adoption of SAB No. 101,
the Company recognized a cumulative effect adjustment of $957,000 in the
Consolidated Statement of Operations for the year ended December 31, 2000 to
reflect the change in the Company's revenue recognition policy from shipping
point to the time both legal and practical risk of loss transfers to the
customer.
Amounts billed to customers for shipping and handling are included in net sales
and costs incurred related to shipping and handling are included in cost of
sales.
WARRANTY POLICY The Company's warranty policy provides two-year limited coverage
for golf clubs following the date of purchase. The Company's policy is to accrue
the estimated cost of warranty coverage at the time the sale is recorded. In
estimating its future warranty obligations the Company considers various
relevant factors, including the Company's stated warranty policies and
practices, the historical frequency of claims, and the cost to replace or repair
its products under warranty. During 2001, 2000 and 1999, the Company recorded a
warranty provision of $9,527,000, $17,675,000 and $18,023,000, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments consist
of cash and cash equivalents, marketable securities, trade receivables and
payables, forward foreign currency exchange contracts (Note 6), its revolving
line of credit and note payable (Note 4) and its accounts receivable
securitization facility (Note 5). The carrying amounts of these instruments
approximate fair value because of their short-term maturities and variable
interest rates. During 2001, the Company also entered into an energy contract
accounted for as a derivative instrument that has been recorded based on
estimated fair values (see Notes 6 and 11).
ADVERTISING COSTS The Company advertises primarily through television and print
media. The Company's policy is to expense advertising costs, including
production costs, as incurred. Advertising expenses for 2001, 2000 and 1999 were
$44,707,000, $35,100,000 and $26,202,000, respectively.
RESEARCH AND DEVELOPMENT COSTS Research and development costs are expensed as
incurred.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS The Company's foreign subsidiaries
utilize their local currency as their functional currency. The accounts of these
foreign subsidiaries have been translated into United States dollars at
appropriate rates of exchange using the current rate method. Cumulative
translation gains or losses are recorded as accumulated other comprehensive
income in shareholders' equity. Gains or losses resulting from transactions that
are made in a currency different from the functional currency are recognized in
earnings as they occur or, for hedging contracts, when the underlying hedged
transaction affects earnings. The Company recorded transaction gains of
$2,533,000 in 2001 and transaction losses of $147,000 and $793,000 in 2000 and
1999, respectively, included in interest and other income, net.
DERIVATIVES AND HEDGING In June 1998, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities" as amended by
SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities." As amended, SFAS No. 133 establishes accounting and reporting
standards for derivative instruments and hedging activities and requires that an
entity recognize all derivatives as either assets or liabilities in the balance
sheet and measure those instruments at fair value. Changes in the fair value of
derivatives are recorded each period in income or other comprehensive income,
depending on whether the
44
Callaway Golf Company
derivatives are designated as hedges and, if so, the types and effectiveness of
hedges. SFAS No. 133 is effective for all periods beginning after June 15, 2000.
The Company elected to adopt SFAS No. 133 early on January 1, 1999.
Adoption of these statements did not significantly affect the way in which the
Company accounts for derivatives to hedge payments due on intercompany
transactions. Accordingly, no cumulative effect adjustments were made. In the
fourth quarter of 2000, the Company began hedging a portion of its anticipated
intercompany sales of inventory denominated in foreign currencies using forward
foreign currency exchange rate contracts. The purpose of these derivative
instruments is to minimize the variability of cash flows associated with the
anticipated transactions being hedged. As changes in foreign currency rates
impact the United States dollar value of anticipated transactions, the fair
value of the forward contracts also changes, providing a synthetic offset to
foreign currency rate fluctuations. During the second quarter of 2001, the
Company entered into a derivative commodity instrument as part of a
comprehensive strategy to ensure the uninterrupted supply of electricity while
capping electricity costs in the volatile California energy market. Additional
information about the Company's use of derivative instruments is presented in
Notes 6 and 11.
EARNINGS PER COMMON SHARE Basic earnings per common share is calculated by
dividing net income for the period by the weighted-average number of common
shares outstanding during the period. Diluted earnings per common share is
calculated by dividing net income for the period by the weighted-average number
of common shares outstanding during the period, increased by dilutive potential
common shares ("dilutive securities") that were outstanding during the period.
Dilutive securities include shares owned by the Callaway Golf Company Grantor
Stock Trust, options issued pursuant to the Company's stock option plans,
potential shares related to the Employee Stock Purchase Plan and rights to
purchase preferred shares under the Callaway Golf Company Shareholder Rights
Plan (Note 8). Dilutive securities related to the Callaway Golf Company Grantor
Stock Trust and the Company's stock option plans are included in the calculation
of diluted earnings per common share using the treasury stock method. Dilutive
securities related to the Employee Stock Purchase Plan are calculated by
dividing the average withholdings during the period by 85% of the lower of the
offering period price or the market value at the end of the period. The dilutive
effect of rights to purchase preferred shares under the Callaway Golf
Shareholder Rights Plan have not been included as dilutive securities because
the conditions necessary to cause these rights to be exercisable were not met. A
reconciliation of the numerators and denominators of the basic and diluted
earnings per common share calculations for the years ended December 31, 2001,
2000 and 1999 is presented in Note 7.
CASH AND CASH EQUIVALENTS Cash equivalents are highly liquid investments
purchased with maturities of three months or less.
MARKETABLE SECURITIES The Company classifies its marketable securities as
available-for-sale. These securities consist of equity securities and are
recorded at fair value based on quoted market prices, with unrealized gains and
losses reported in shareholders' equity as a component of accumulated other
comprehensive income. Proceeds from the sale of securities for the years ended
December 31, 2001, 2000 and 1999, were $253,565,000, $10,057,000 and $254,000,
respectively. Gains and losses on securities sold are determined based on the
specific identification method and are included in "interest and other income,
net." For the years ended December 31, 2001, 2000 and 1999, the Company recorded
$1,597,000, $57,000 and $36,000 of realized gains on securities sold in interest
and other income, net.
INVENTORIES Inventories are valued at the lower of cost or market. Cost is
determined using the first-in, first-out (FIFO) method. Inventories include
material, labor and manufacturing overhead costs.
PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are stated at cost
less accumulated depreciation. Depreciation is computed using the straight-line
method over estimated useful lives as follows:
Buildings and improvements 10-30 years
Machinery and equipment 5-15 years
Furniture, computers and equipment 3-5 years
Production molds 2 years
Normal repairs and maintenance costs are expensed as incurred. Expenditures that
materially increase values, change capacities or extend useful lives are
capitalized. Replacements are capitalized and the property, plant, and equipment
accounts are relieved of the items being replaced. The related costs and
accumulated depreciation of disposed assets are eliminated and any resulting
gain or loss on disposition is included in income. Construction in process
consists primarily of store display equipment not yet assembled and installed,
in-process internally developed software and unfinished molds that have not yet
been placed in service.
Effective January 1, 1999, the Company adopted Statement of Position ("SOP")
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." In accordance with SOP 98-1, the Company capitalizes certain
costs incurred in connection with developing or obtaining internal use software.
Costs incurred in the preliminary project stage are expensed. All direct
external costs incurred to develop internal-use software during the development
stage are capitalized and amortized using the straight-line method over the
remaining estimated useful lives. Costs such as maintenance and training are
expensed as incurred.
In September 2000, the Company completed an extensive upgrade of its
enterprise-wide business software system to a more current release. The upgrade
included improved functionalities and provides the Company the opportunity to
build upon its investment in the software. As a result of this upgrade, the
Company expects that this business system will have a greater useful life to the
Company than originally estimated. Therefore, in fiscal 2000, the Company
extended the estimated useful life of its business system by three years. For
the years ended December 31, 2001 and 2000, the effect of this change in
accounting estimate reduced depreciation expense by $3,892,000 and $1,319,000,
respectively, and increased net income by $2,314,000 and $791,000, respectively.
The resulting increase in net income increased the Company's earnings per
diluted share by $0.03 and $0.01 for the years ended December 31, 2001 and 2000,
respectively.
LONG-LIVED ASSETS The Company assesses potential impairments of its long-lived
assets whenever events or changes in circumstances indicate that the asset's
carrying value may not be recoverable. An impairment loss would be recognized
when the carrying amount of a long-lived asset (asset group) is not recoverable
and exceeds its fair value. The carrying amount of a long-lived asset (asset
group) is not recoverable if it exceeds the sum of the undiscounted cash flows
expected to result from the use and eventual disposition of the asset (asset
group).
INTANGIBLE ASSETS Intangible assets consist primarily of trade name, trademark,
trade dress, patents and goodwill resulting from the 1997 purchase of
substantially all of the assets and certain liabilities of Odyssey Sports, Inc.
and goodwill associated with the purchase of certain foreign distributors (Note
13). During 2001, 2000 and 1999, intangible assets were amortized using the
straight-line method over periods ranging from three to 40 years and
amortization of intangible assets was $7,569,000, $7,195,000 and $7,476,000,
respectively.
45
Callaway Golf Company
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 requires the use of a non-amortization approach to account
for goodwill and other intangible assets with indefinite lives. Goodwill and
other intangible assets with indefinite lives existing at June 30, 2001 are no
longer amortized effective January 1, 2002. Goodwill and other intangible assets
with indefinite lives acquired on or after July 1, 2001 follow the
non-amortization approach under SFAS No. 142. Under the non-amortization
approach, goodwill and other intangible assets with indefinite lives are tested
for impairment, rather than amortized to earnings. In addition, SFAS No. 142
requires that acquired intangible assets be separately identified and amortized
over their individual useful lives. The Company adopted the amortization
provisions of SFAS No. 142 effective January 1, 2002. At December 31, 2001, the
carrying value of unamortized goodwill, intangible assets with indefinite lives,
and other intangible assets was $16,846,000, $88,590,000 and $15,877,000,
respectively. Intangible assets with indefinite lives consist of trade name,
trademark and trade dress and goodwill. In accordance with SFAS No. 142, the
goodwill and other intangible assets with indefinite lives that were being
amortized over periods ranging from five to 40 years follow the non-amortization
approach effective January 1, 2002. Patents and other intangible assets are
amortized using the straight-line method over periods ranging from three to
sixteen years (Note 3).
STOCK-BASED COMPENSATION The Company measures compensation expense for its
stock-based employee compensation awards using the intrinsic value method. Pro
forma disclosures of net income and earnings per share, as if the fair
value-based method had been applied in measuring stock-based employee
compensation expense, are presented in Note 8. Compensation expense for
non-employee stock-based compensation awards is measured using the fair-value
method.
INCOME TAXES Current income tax expense is the amount of income taxes expected
to be payable for the current year. A deferred income tax asset or liability is
established for the expected future consequences resulting from temporary
differences in the financial reporting and tax bases of assets and liabilities.
Deferred income tax expense (benefit) is the net change during the year in the
deferred income tax asset or liability.
Deferred taxes have not been provided on the cumulative undistributed earnings
of foreign subsidiaries since such amounts are expected to be reinvested
indefinitely. The Company provides a valuation allowance for its deferred tax
assets when, in the opinion of management, it is more likely than not that such
assets will not be realized.
INTEREST AND OTHER INCOME, NET Interest and other income, net includes royalty
income, gains and losses on foreign currency transactions, interest income,
gains on the sale of marketable securities and losses generated from the sale of
the Company's excess energy supply. Gains and losses are presented as a net
amount for foreign currency and excess energy sales transactions. Also included
in other income during 1999 were net proceeds from an insurance policy related
to the deferred compensation plan of $3,622,000 (Note 9). The components of
interest and other income, net are as follows:
(IN THOUSANDS) YEAR ENDED DECEMBER 31,
2001 2000 1999
- --------------------------------------------------------------------------------
Royalty income $ 3,231 $ 2,669 $ 1,058
Net foreign currency gains (losses) 2,533 (147) (793)
Interest income 1,462 6,157 5,462
Gain on sale of securities 1,597 57 36
Net losses on excess energy sales (2,052) -- --
Net proceeds from insurance policy -- -- 3,622
Other 378 55 (203)
- --------------------------------------------------------------------------------
$ 7,149 $ 8,791 $ 9,182
================================================================================
COMPREHENSIVE INCOME SFAS No. 130, "Reporting Comprehensive Income," 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, unrealized gains or
losses on cash flow hedges and foreign currency translation adjustments. Since
the Company has met the indefinite reversal criteria, it does not accrue income
taxes on foreign currency translation adjustments. During 2001, the Company
recorded $4,994,000, net of tax expense of $3,055,000, related to net unrealized
gains on cash flow hedges. No amounts were reclassified to earnings during 2001
as a result of discontinuance of any cash flow hedges.
SEGMENT INFORMATION The Company utilizes the management approach to report
segment information. The Company's operating segments are organized on the basis
of products and include golf clubs and golf balls. The Company also discloses
information about geographic areas. This information is presented in Note 14.
DIVERSIFICATION OF CREDIT RISK The Company's financial instruments that are
subject to concentrations of credit risk consist primarily of cash equivalents,
marketable securities and trade receivables.
The Company may invest its excess cash in money market accounts and U.S.
Government securities and has established guidelines relative to diversification
and maturities in an effort to maintain safety and liquidity. These guidelines
are periodically reviewed and modified to take advantage of trends in yields and
interest rates.
The Company operates in the golf equipment industry and primarily sells its
products to golf equipment retailers, directly and through wholly-owned domestic
and foreign subsidiaries, and to foreign distributors. The Company performs
ongoing credit evaluations of its customers' financial condition and generally
requires no collateral from these customers. The Company maintains reserves for
potential credit losses, which it considers adequate to cover any such losses.
During 2001, 2000 and 1999, approximately 46%, 46% and 42%, respectively, of the
Company's net sales were made to foreign customers. An adverse change in either
economic conditions abroad or in the Company's relationship with significant
foreign retailers could negatively impact the volume of the Company's
international sales and the Company's results of operations, cash flows and
financial position.
The Company enters into forward exchange rate contracts and put or call options
for the purpose of hedging foreign exchange rate exposures on existing or
anticipated transactions. In the event of a failure to honor one of these
contracts by one of the banks with which the Company has contracted, management
believes any loss would be limited to the exchange rate differential from the
time the contract was made until the time it was compensated.
During the second quarter of 2001, the Company entered into a long-term,
fixed-price, fixed-capacity, energy supply contract as part of a comprehensive
strategy to ensure the uninterrupted supply of energy while capping electricity
costs in the volatile California energy market. During the fourth quarter of
2001, the energy supplier filed for bankruptcy protection and the Company
notified the energy supplier that, among other things, the energy supplier was
in default of the energy supply contract and that based upon such default, and
for other reasons, the Company was terminating the energy supply contract. As a
result, the Company began procuring energy from an alternative source at current
market rates.
46
Callaway Golf Company
RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires all business combinations initiated after June
30, 2001 to be accounted for using the purchase method. SFAS No. 142 requires
the use of a non-amortization approach to account for goodwill and other
intangible assets with indefinite lives. In addition, SFAS No. 142 requires that
acquired intangible assets be separately identified and amortized over their
individual useful lives. The Company was required to adopt these statements
beginning January 1, 2002. In accordance with SFAS No. 142, goodwill and other
intangible assets with indefinite lives that were being amortized over periods
ranging from five to 40 years follow the non-amortization approach effective
January 1, 2002. Other intangible assets with indefinite lives include
trademark, trade name and trade dress. At December 31, 2001, the carrying value
of unamortized goodwill and other intangible assets with indefinite lives was
$16,846,000 and $88,590,000, respectively. For the year ended December 31, 2001,
amortization expense of $3,588,000 and $2,487,000 was recorded for goodwill and
other intangible assets with indefinite lives, respectively.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 addresses the financial accounting
and reporting for the impairment or disposal of long-lived assets. SFAS No. 144
supersedes SFAS No. 121 but retains SFAS No. 121's fundamental provisions for
(a) recognition/measurement of impairment of long-lived assets to be held and
used and (b) measurement of long-lived assets to be disposed of by sale. SFAS
No. 144 also supersedes the accounting/reporting provisions of Accounting
Principles Board ("APB") Opinion No. 30 for segments of a business to be
disposed of but retains APB Opinion No. 30's requirement to report discontinued
operations separately from continuing operations and extends that reporting to a
component of an entity that either has been disposed of or is classified as held
for sale. SFAS No. 144 became effective for the Company beginning January 1,
2002. Adoption of SFAS No. 144 as of January 1, 2002 did not have a material
impact on the Company's results of operations and financial position.
RECLASSIFICATIONS Certain prior period amounts have been reclassified to conform
with the current period presentation.
NOTE 3
SELECTED FINANCIAL STATEMENT INFORMATION
(IN THOUSANDS) DECEMBER 31,
2001 2000
- --------------------------------------------------------------------------------
Accounts receivable, net:
Trade accounts receivable $ 53,810 $ 65,063
Allowance for doubtful accounts (5,157) (6,227)
- --------------------------------------------------------------------------------
$ 48,653 $ 58,836
================================================================================
Inventories, net:
Raw materials $ 67,336 $ 56,936
Work-in-process 2,179 1,293
Finished goods 105,381 83,453
- --------------------------------------------------------------------------------
174,896 141,682
Reserve for excess and obsolescence (7,136) (7,720)
- --------------------------------------------------------------------------------
$ 167,760 $ 133,962
================================================================================
Property, plant and equipment, net:
Land $ 10,533 $ 12,358
Buildings and improvements 84,687 90,301
Machinery and equipment 67,329 60,399
Furniture, computers and equipment 65,300 65,140
Production molds 31,371 25,610
Construction-in-process 7,025 5,766
- --------------------------------------------------------------------------------
266,245 259,574
Accumulated depreciation (132,995) (124,862)
- --------------------------------------------------------------------------------
$ 133,250 $ 134,712
================================================================================
Intangible assets, net:
Trade name $ 69,629 $ 69,629
Trademark and trade dress 29,841 29,841
Goodwill 29,313 24,761
Patents and other 22,067 10,970
- --------------------------------------------------------------------------------
150,850 135,201
Accumulated amortization (29,537) (21,441)
- --------------------------------------------------------------------------------
$ 121,313 $ 113,760
================================================================================
Accounts payable and accrued expenses:
Accounts payable $ 7,892 $ 5,552
Accrued expenses 30,369 38,621
- --------------------------------------------------------------------------------
$ 38,261 $ 44,173
================================================================================
Accrued employee compensation and benefits:
Accrued payroll and taxes $ 19,313 $ 16,178
Accrued vacation and sick pay 5,068 5,111
Accrued commissions 920 1,285
- --------------------------------------------------------------------------------
$ 25,301 $ 22,574
================================================================================
47
Callaway Golf Company
NOTE 4
DEBT
The Company has a revolving credit facility of up to $120,000,000 (the "Amended
Credit Agreement"). The Amended Credit Agreement is secured by substantially all
of the assets of the Company and expires in February 2004. The Amended Credit
Agreement bears interest at the Company's election at the London Interbank
Offering Rate ("LIBOR") plus a margin or the higher of the base rate on
corporate loans at large U.S. money center commercial banks (prime rate), or the
Federal Funds Rate plus 50 basis points. The Amended Credit Agreement requires
the Company to maintain certain minimum financial ratios, including a fixed
charge coverage ratio, as well as other restrictive covenants. As of December
31, 2001, up to $120,000,000 of the credit facility remained available for
borrowings, subject to meeting certain availability requirements under a
borrowing base formula and other limitations. Fees incurred in connection with
the credit facility for the years ended December 31, 2001, 2000 and 1999 were
$556,000 for each year and were recorded as interest expense.
In December 1998, Callaway Golf Ball Company, then a wholly-owned subsidiary of
the Company, entered into a master lease agreement for the acquisition and lease
of up to $56,000,000 of machinery and equipment. By December 31, 1999, the
Company had finalized its lease program and leased $50,000,000 of equipment
pursuant to the master lease agreement. This lease program included an interim
finance agreement (the "Finance Agreement"). The Finance Agreement provided
pre-lease financing advances for the acquisition and installation costs of the
aforementioned machinery and equipment. The Finance Agreement bore interest at
LIBOR plus a margin and was secured by the underlying machinery and equipment
and a corporate guarantee from the Company. During the third and fourth quarters
of 1999, the Company converted the balance of this note payable into an
operating lease (Notes 11 and 17). As of December 31, 1999, no amount was
outstanding under this facility. On December 29, 2000, pursuant to an assumption
agreement, the Company assumed all of the rights, title, interest and
obligations of Callaway Golf Ball Company under the master lease agreement.
In April 2001, the Company entered into a note payable in the amount of
$7,500,000 as part of a licensing agreement for patent rights. The unsecured,
interest-free note payable matures on December 31, 2003 and is payable in
quarterly installments. The total amounts payable in 2002 and 2003 are
$2,700,000 and $3,300,000, respectively. During 2001, the Company recorded
imputed interest expense of $332,000. The present value of the note payable at
issuance totaled $6,702,000 using an imputed interest rate of approximately 7%.
NOTE 5
ACCOUNTS RECEIVABLE SECURITIZATION
The Company's wholly-owned subsidiary, Callaway Golf Sales Company, sells trade
receivables on an ongoing basis to its wholly-owned subsidiary, Golf Funding
Corporation ("Golf Funding"). Pursuant to an agreement with a securitization
company (the "Accounts Receivable Facility"), Golf Funding, in turn, can sell
such receivables to the securitization company on an ongoing basis, which could
yield proceeds of up to $80,000,000, subject to meeting certain availability
requirements under a borrowing base formula and other limitations. Golf
Funding's sole business is the purchase of trade receivables from Callaway Golf
Sales Company. Golf Funding is a separate corporate entity with its own separate
creditors, which in the event of its liquidation would be entitled to be
satisfied out of Golf Funding's assets prior to any value in Golf Funding
becoming available to the Company. The Accounts Receivable Facility expires in
February 2004.
Under the Accounts Receivable Facility, the receivables are sold at face value
with payment of a portion of the purchase price being deferred. As of December
31, 2001, no amount was outstanding under the Accounts Receivable Facility. Fees
incurred in connection with the facility for the years ended December 31, 2001,
2000 and 1999 were $305,000, $303,000 and $923,000, respectively, and were
recorded as interest expense.
NOTE 6
DERIVATIVES AND HEDGING
The Company uses derivative financial instruments to manage its exposures to
foreign exchange rates. The Company also utilized a derivative commodity
instrument to manage its exposure to electricity rates in the volatile
California energy market during the period of June 2001 through November 2001.
The derivative instruments are accounted for pursuant to SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" as amended by
SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities." As amended, SFAS No. 133 requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position, measure those instruments at fair value and recognize 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.
FOREIGN CURRENCY EXCHANGE CONTRACTS The Company enters into foreign exchange
contracts to hedge against exposure to changes in foreign currency exchange
rates. Such contracts are designated at inception to the related foreign
currency exposures being hedged, which include anticipated intercompany sales of
inventory denominated in foreign currencies, payments due on intercompany
transactions from certain wholly-owned foreign subsidiaries, and anticipated
sales by the Company's wholly-owned European subsidiary for certain
euro-denominated transactions. Hedged transactions are denominated primarily in
European currencies, Japanese Yen, Korean Won, Canadian Dollars and Australian
Dollars. To achieve hedge accounting, contracts must reduce the foreign currency
exchange rate risk otherwise inherent in the amount and duration of the hedged
exposures and comply with established company risk management policies. Pursuant
to its foreign exchange hedging policy, the Company may hedge anticipated
transactions and certain firm commitments and the related receivables and
payables denominated in foreign currencies using forward foreign currency
exchange rate contracts and put or call options. Foreign currency derivatives
are used only to the extent considered necessary to meet the Company's
objectives of minimizing variability in the Company's operating results arising
from foreign exchange rate movements. The Company does not enter into foreign
exchange contracts for speculative purposes. Hedging contracts generally mature
within twelve months.
At December 31, 2001, 2000 and 1999, the Company had approximately $156,961,000,
$118,236,000 and $7,117,000, respectively, of foreign exchange contracts
outstanding. Of the total contracts outstanding at December 31, 2001, 2000 and
1999, approximately $122,550,000, $107,779,000 and $0, respectively, were
designated as cash flow hedges. The Company estimates the fair values of
derivatives based on quoted market prices or pricing models using current market
rates, and records all derivatives on the balance sheet at fair value. At
December 31, 2001, 2000 and 1999, the net fair value of foreign currency-related
derivatives designated as cash flow hedges or fair value hedges were recorded as
net current assets of $8,762,000, net current liabilities of $1,551,000 and net
current assets of $74,000, respectively.
48
Callaway Golf Company
For derivative instruments that are designated and qualify as cash flow hedges,
the effective portion of the gain or loss on the derivative instrument is
initially recorded in accumulated other comprehensive income as a separate
component of shareholders' equity and subsequently reclassified into earnings in
the period during which the hedged transaction is recognized in earnings. The
Company began utilizing cash flow hedges in the fourth quarter of 2000. During
2001, the Company reclassified $2,927,000 of gains into earnings related to the
release of the effective portion of gains on contracts designated as cash flow
hedges. As of December 31, 2001, the Company expects to reclassify $6,424,000 of
deferred net gains into earnings within the next twelve months. During 2001 and
2000, no gains or losses were reclassified into earnings as a result of the
discontinuance of any cash flow hedges.
The ineffective gain or loss for derivative instruments that are designated and
qualify as cash flow hedges is reported in interest and other income, net
immediately. For foreign currency contracts designated as cash flow hedges,
hedge effectiveness is measured using the spot rate. Changes in the spot-forward
differential are excluded from the test of hedging effectiveness and are
recorded currently in earnings as a component of interest and other income, net.
Assessments of hedge effectiveness are performed using the dollar offset method
and applying a hedge effectiveness ratio between 80% and 125%. Given that both
the hedging item and the hedging instrument are evaluated using the same spot
rate, the Company anticipates the hedges to be highly effective. The
effectiveness of each derivative is assessed monthly. During the years ended
December 31, 2001 and 2000, a net gain of $1,988,000 and a net loss of $174,000,
respectively, was recorded in interest and other income, net representing the
ineffective portion of the Company's derivative instruments.
At December 31, 2001, 2000, and 1999, the Company had approximately $34,411,000,
$10,457,000 and $7,117,000 of foreign contracts used to hedge balance sheet
exposures outstanding. The gains and losses on foreign currency contracts used
to hedge balance sheet exposures are recognized in interest and other income,
net in the same period as the remeasurement gain and loss of the related foreign
currency denominated assets and liabilities and thus offset these gains and
losses. During 2001, 2000 and 1999, the Company recorded net realized and
unrealized gains on contracts used to hedge balance sheet exposures of
$4,473,000, $5,299,000 and $358,000, respectively.
ENERGY DERIVATIVE During the second quarter of 2001, the Company entered into a
long-term, fixed-price, fixed-capacity, energy supply contract as part of a
comprehensive strategy to ensure the uninterrupted supply of electricity while
capping costs in the volatile California electricity market. The contract was
originally effective through May 2006. This derivative did not qualify for hedge
accounting treatment under SFAS No. 133. Therefore, the Company recognized in
earnings the changes in the estimated fair value of the contract based on
current market rates as unrealized energy derivative losses. During the fourth
quarter of 2001, the Company notified the energy supplier that, among other
things, the energy supplier was in default of the energy supply contract and
that based upon such default, and for other reasons, the Company was terminating
the energy supply contract. As a result, the Company adjusted the estimated fair
value of this contract through the date of termination, at which time the
terminated contract ceased to represent a derivative instrument in accordance
with SFAS No. 133. As the contract is terminated and neither party to the
contract is performing pursuant to the terms of the contract, the Company no
longer records future valuation adjustments for changes in electricity rates.
The Company continues to reflect the derivative valuation account on its balance
sheet, subject to periodic review, in accordance with SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities." Any non-cash unrealized gains to be recognized upon extinguishment
of the derivative valuation account would be excluded from income from
operations.
As of the date of termination, the derivative valuation account reflected
$19,922,000 of unrealized losses resulting from changes in estimated fair value
of the contract. The fair value of the contract was estimated based on market
prices of electricity for the remaining period covered by the contract. The net
differential between the contract price and estimated market prices for future
periods was applied to the volume stipulated in the contract and discounted on a
present value basis to arrive at the estimated fair value of the contract. The
estimate of the fair value of the Company's energy derivative is highly
subjective and quoted market rates directly relevant to the Company's local
energy market and for periods extending beyond a 10 to 12-month horizon are not
quoted on a traded market. The Company has relied upon near-term market
quotations and other market information to determine fair value estimates. In
management's opinion, contract valuation models do not necessarily provide a
reliable single measure of the fair value of the energy derivative because there
are no quoted market rates directly relevant to the terms of the contract and
changes in subjective input assumptions can materially affect the fair value
estimates. See Note 11 for a discussion of contingencies related to the
termination of the Company's derivative energy contract.
NOTE 7
EARNINGS PER COMMON SHARE
The schedule below summarizes the elements included in the calculation of basic
and diluted earnings per common share for the years ended December 31, 2001,
2000 and 1999.
(IN THOUSANDS, EXCEPT PER SHARE DATA) YEAR ENDED DECEMBER 31,
2001 2000 1999
- --------------------------------------------------------------------------------
Net income $ 58,375 $ 80,999 $ 55,322
================================================================================
Weighted-average
shares outstanding:
Weighted-average shares
outstanding - Basic 69,809 69,946 70,397
Dilutive securities 1,505 1,466 817
- --------------------------------------------------------------------------------
Weighted-average
shares outstanding - Diluted 71,314 71,412 71,214
- --------------------------------------------------------------------------------
Earnings per common share:
Basic
Income before cumulative
effect of accounting
change $ 0.84 $ 1.17 $ 0.79
Cumulative effect of
accounting change -- (0.01) --
- --------------------------------------------------------------------------------
$ 0.84 $ 1.16 $ 0.79
================================================================================
Diluted
Income before cumulative
effect of accounting
change $ 0.82 $ 1.14 $ 0.78
Cumulative effect of
accounting change -- (0.01) --
- --------------------------------------------------------------------------------
$ 0.82 $ 1.13 $ 0.78
================================================================================
For the years ended December 31, 2001, 2000 and 1999, options outstanding
totaling 8,943,000, 8,931,000 and 10,979,000, respectively, were excluded from
the calculations of earnings per common share, as their effect would have been
antidilutive.
49
Callaway Golf Company
NOTE 8
STOCK, STOCK OPTIONS AND RIGHTS
COMMON STOCK AND PREFERRED STOCK The Company has an authorized capital of
243,000,000 shares, $.01 par value, of which 240,000,000 shares are designated
Common Stock, and 3,000,000 shares are designated Preferred Stock. Of the
Preferred Stock, 240,000 shares are designated Series A Junior Participating
Preferred Stock in connection with the Company's shareholders' rights plan (see
Shareholders' Rights Plan below). The remaining shares of Preferred Stock are
undesignated as to series, rights, preferences, privileges or restrictions.
The holders of Common Stock are entitled to one vote for each share of Common
Stock on all matters submitted to a vote of the Company's shareholders. Although
to date no shares of Series A Junior Participating Preferred Stock have been
issued, if such shares were issued, each share of Series A Junior Participating
Preferred Stock would entitle the holder thereof to 1,000 votes on all matters
submitted to a vote of the shareholders of the Company. The holders of Series A
Junior Participating Preferred Stock and the holders of Common Stock shall
generally vote together as one class on all matters submitted to a vote of the
Company's shareholders. Shareholders entitled to vote for the election of
directors are entitled to vote cumulatively for one or more nominees.
TREASURY STOCK In May 2000, the Company announced that its Board of Directors
authorized it to repurchase its Common Stock in the open market or in private
transactions, subject to the Company's assessment of market conditions and
buying opportunities from time to time, up to a maximum cost to the Company of
$100,000,000. The Company began its repurchase program in May 2000 and during
the second quarter of 2001 completed the program which resulted in the
repurchase of a total of 5,837,000 of the Company's Common Stock at an average
cost of $17.13 per share for a total of $100,000,000.
In August 2001, the Company announced that its Board of Directors authorized it
to repurchase its Common Stock in the open market or in private transactions,
subject to the Company's assessment of market conditions and buying
opportunities from time to time, up to a maximum cost to the Company of
$100,000,000. During the second half of 2001, the Company repurchased 4,979,000
shares of its Common Stock at an average cost of $16.98 per share for a total of
$84,518,000.
The Company's repurchases of shares of Common Stock are recorded at average cost
in Common Stock held in treasury and result in a reduction of shareholders'
equity. For the years ended December 31, 2001 and 2000, the Company repurchased
6,001,000 shares of Common Stock at an average cost of $17.34 and 4,815,000
shares of Common Stock at an average cost of $16.71, respectively.
In July 2001, the Company issued 5,837,000 shares of Common Stock held in
treasury to the Callaway Golf Grantor Stock Trust in exchange for a promissory
note in the amount of 90,282,000. The sale of these shares had no net impact on
shareholders' equity.
GRANTOR STOCK TRUST In July 1995, the Company established the Callaway Golf
Company Grantor Stock Trust (the "GST") for the purpose of funding the Company's
obligations with respect to one or more of the Company's non-qualified or
qualified employee benefit plans. The GST shares are used primarily for the
settlement of employee stock option exercises and employee stock plan purchases.
The existence of the GST will have no impact upon the amount of benefits or
compensation that will be paid under the Company's employee benefit plans. The
GST acquires, holds and distributes shares of the Company's Common Stock in
accordance with the terms of the trust. Shares held by the GST are voted in
accordance with voting directions from eligible employees of the Company as
specified in the GST.
In conjunction with the formation of the GST, the Company issued 4,000,000
shares of newly issued Common Stock to the GST in exchange for a promissory note
in the amount of $60,575,000 ($15.14 per share). In December 1995, the Company
issued an additional 1,300,000 shares of newly issued Common Stock to the GST in
exchange for a promissory note in the amount of $26,263,000 ($20.20 per share).
In July 2001, the Company issued 5,837,000 shares of Common Stock held in
treasury to the GST in exchange for a promissory note in the amount of
$90,282,000 ($15.47 per share). The issuance of these shares to the GST had no
net impact on shareholders' equity.
For financial reporting purposes, the GST is consolidated with the Company. The
value of shares owned by the GST are accounted for as a reduction to
shareholders' equity until used in connection with the settlement of employee
stock purchases. Each period, the shares owned by the GST are valued at the
closing market price, with corresponding changes in the GST balance reflected in
paid-in capital. The issuance of shares by the GST is accounted for by reducing
the GST and paid-in capital accounts proportionately as the shares are released.
The GST does not impact the determination or amount of compensation expense for
the benefit plans being settled. For the year ended December 31, 2001, 150,000
shares and 223,000 shares were released from the GST in connection with the
settlement of employee stock option exercises and employee stock plan purchases,
respectively, and no shares were released during the years ended December 31,
2000 and 1999.
OPTIONS The Company had the following fixed stock option plans, under which
shares were available for grant at December 31, 2001: the 1995 Employee Stock
Incentive Plan (the "1995 Plan"), the 1996 Stock Option Plan (the "1996 Plan"),
the 1998 Stock Incentive Plan (the "1998 Plan"), the Promotion, Marketing and
Endorsement Stock Incentive Plan (the "Promotion Plan") and the 2001
Non-Employee Directors Stock Option Plan (the "2001 Directors Plan").
The 1996 Plan and the 1998 Plan permit the granting of options or other stock
awards to the Company's officers, employees and consultants. Under the 1996 Plan
and the 1998 Plan, options may not be granted at option prices that are less
than fair market value at the date of grant. The 1995 Plan permits the granting
of options or other stock awards to only non-executive officer employees and
consultants of the Company at option prices that may be less than market value
at the date of grant. The 1995 Plan was amended in 2001 and the 1996 Plan was
amended in 2000 to increase the maximum number of shares of Common Stock to be
issued upon exercise of an option to 10,800,000 and 9,000,000 shares,
respectively.
During 1996 and 1995, the Company granted options to purchase shares to two key
officers, under separate plans, in conjunction with terms of their initial
employment (the "Key Officer Plans"). No shares are available for grant under
the Key Officer Plans as of December 31, 2001.
Under the Promotion Plan, shares of Common Stock may be granted in the form of
options or other stock awards to golf professionals and other endorsers at
prices that may be less than the market value of the stock at the grant date.
The 2001 Directors Plan permits the granting of options to purchase shares of
Common Stock to Directors of the Company who are not employees, at prices based
on the market value of the stock at the date of grant.
50
Callaway Golf Company
The following table presents shares authorized, available for future grant and
outstanding under each of the Company's plans as of December 31, 2001:
(IN THOUSANDS)
Authorized Available Outstanding
- --------------------------------------------------------------------------------
1991 Plan 10,000 -- 958
Promotion Plan 3,560 771 870
1995 Plan 10,800 2,683 6,050
1996 Plan 9,000 1,926 5,549
1998 Plan 500 300 166
Key Officer Plans 1,100 -- 720
2001 Directors Plan 500 456 44
Directors Plan 840 -- 396
- --------------------------------------------------------------------------------
Total 36,300 6,136 14,753
================================================================================
Under the Company's stock option plans, outstanding options vest over periods
ranging from zero to five years from the grant date and expire up to 12 years
after the grant date.
The following summarizes stock option transactions for the years ended December
31, 2001, 2000 and 1999:
(IN THOUSANDS, EXCEPT PER SHARE DATA) YEAR ENDED DECEMBER 31,
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 16,758 $ 19.66 15,747 $ 20.46 13,637 $ 22.62
Granted 3,475 $ 19.72 4,461 $ 13.71 4,012 $ 11.30
Exercised (3,634) $ 12.39 (2,252) $ 10.64 (851) $ 6.40
Canceled (1,846) $ 26.77 (1,198) $ 25.01 (1,051) $ 24.95
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 14,753 $ 20.57 16,758 $ 19.66 15,747 $ 20.46
Options exercisable at end of year 11,484 $ 21.20 12,394 $ 19.99 11,066 $ 18.64
- ------------------------------------------------------------------------------------------------------------------------------------
Price range of outstanding options $ 5.00 - $ 40.00 $ 2.50 - $ 40.00 $ 0.44 - $ 40.00
====================================================================================================================================
The exercise price of all options granted during 2001 was equal to the market
value on the date of grant. The following table summarizes additional
information about outstanding stock options at December 31, 2001:
Weighted-Average
Number Remaining Number
Range of Outstanding Contractual Weighted-Average Exercisable Weighted-Average
Exercise Price (in thousands) Life-Years Exercise Price (in thousands) Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
$ 5- $ 10 86 1.81 $ 5.95 78 $ 5.57
$ 10- $ 15 4,897 5.20 $ 12.63 3,940 $ 12.44
$ 15- $ 25 4,595 6.72 $ 18.63 2,723 $ 18.63
$ 25- $ 40 5,175 3.12 $ 30.05 4,743 $ 30.22
- ------------------------------------------------------------------------------------------------------------------------------------
$ 5- $ 40 14,753 4.93 $ 20.57 11,484 $ 21.20
====================================================================================================================================
51
Callaway Golf Company
During 2001 and 2000, the Company, at its discretion, extended the expiration
terms or accelerated the vesting of 1,422,000 and 622,000 options, respectively,
held by certain employees and officers. Also, during 1999, the Company, at its
discretion, extended the expiration terms of 1,532,000 options held by certain
employees and officers. At the time of the modifications, the exercise prices of
the options were in excess of the then-current market price and accordingly
these actions did not result in compensation expense for the Company. Also
during 2001, the Company, at its discretion, indirectly re-priced 17,000 options
and recognizes compensation expense related to these options in accordance with
variable plan accounting.
SHAREHOLDERS' RIGHTS PLAN The Company has a plan to protect shareholders' rights
in the event of a proposed takeover of the Company. Under the plan, each share
of the Company's outstanding Common Stock carries one right to purchase one
one-thousandth of a share of the Company's Series "A" Junior Participating
Preferred Stock (the "Right"). The Right entitles the holder, under certain
circumstances, to purchase Common Stock of Callaway Golf Company or of the
acquiring company at a substantially discounted price ten days after a person or
group publicly announces it has acquired or has tendered an offer for 15% or
more of the Company's outstanding Common Stock. The Rights are redeemable by the
Company at $.01 per Right and expire in 2005.
RESTRICTED COMMON STOCK During 1998, the Company granted 130,000 shares of
Restricted Common Stock with a fair value of $31 per share to 26 officers of the
Company. Of these shares, 80,250 shares have been canceled due to the service
requirement not being met. During 1998, the Company, at its discretion,
accelerated the vesting of 20,000 shares and recorded related compensation
expense of $618,000. The remaining 29,750 shares, which are restricted as to
sale or transfer until vesting, will vest on January 1, 2003. The net
compensation expense of $922,000 related to the remaining shares is being
recognized ratably over the vesting period, based on the difference between the
exercise price and market value of the stock on the measurement date.
EMPLOYEE STOCK PURCHASE PLAN The Company had an Employee Stock Purchase Plan
("ESPP") whereby eligible employees purchased shares of Common Stock at 85% of
the lower of the fair market value on the first day of a two year offering
period or the last day of each six month exercise period. Eligible employees
authorized the Company to withhold compensation during an offering period,
subject to certain limitations. In May 1999, the Company's shareholders approved
a new ESPP (the "1999 ESPP") with substantially the same terms as the ESPP. This
plan was effective February 1, 2000 upon the termination of the ESPP.
During 2001, 2000 and 1999, approximately 506,000, 412,000 and 378,000 shares,
respectively, of the Company's Common Stock were purchased under the 1999 ESPP
or the ESPP. As of December 31, 2001, 1,277,000 shares were reserved for future
issuance under the 1999 ESPP.
COMPENSATION EXPENSE During 2001, 2000 and 1999, the Company recorded $342,000,
$2,157,000 and $1,390,000, respectively, in compensation expense for Restricted
Common Stock and certain options to purchase shares of Common Stock granted to
employees, officers, professional endorsers and consultants of the Company. The
valuation of options granted to non-employees is estimated using the
Black-Scholes option-pricing model.
Unearned compensation has been charged for the value of options granted to both
employees and non-employees on the measurement date based on the valuation
methods described above. These amounts are amortized over the vesting period.
The unamortized portion of unearned compensation is shown as a reduction of
shareholders' equity in the accompanying consolidated balance sheet.
PRO FORMA DISCLOSURES If the Company had elected to recognize compensation
expense based upon the fair value at the grant date for employee awards under
these plans, the Company's net income and earnings per share would be changed to
the pro forma amounts indicated below:
(IN THOUSANDS, EXCEPT PER SHARE DATA) YEAR ENDED DECEMBER 31,
2001 2000 1999
- --------------------------------------------------------------------------------
Net income:
As reported $ 58,375 $ 80,999 $ 55,322
Pro forma $ 43,948 $ 58,761 $ 34,422
Earnings per Common Share:
As reported
Basic $ 0.84 $ 1.16 $ 0.79
Diluted $ 0.82 $ 1.13 $ 0.78
Pro forma
Basic $ 0.63 $ 0.84 $ 0.49
Diluted $ 0.62 $ 0.83 $ 0.48
The pro forma amounts reflected above may not be representative of future
disclosures since the estimated fair value of stock options is amortized to
expense as the options vest and additional options may be granted in future
years. The fair value of employee stock options was estimated at the date of
grant using the Black-Scholes option-pricing model with the following
assumptions:
YEAR ENDED DECEMBER 31,
2001 2000 1999
- --------------------------------------------------------------------------------
Dividend yield 1.6% 1.1% 1.4%
Expected volatility 53.9% 53.0% 45.6%
Risk free interest rates 3.81% - 4.22% 5.18% - 5.56% 5.36% - 6.24%
Expected lives 3 - 4 years 3 - 4 years 3 - 4 years
The weighted-average grant-date fair value of options granted during 2001, 2000
and 1999 was $6.98, $6.91 and $3.57 per share, respectively. The Black-Scholes
option valuation model was developed for use in estimating the fair value of
traded options which have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective
assumptions including the expected stock price volatility. Because the Company's
employee stock options have characteristics significantly different from those
of traded options, and because changes in subjective input assumptions can
materially affect the fair value estimates, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of grants under the Company's employee stock-based compensation plans.
NOTE 9
Employee Benefit Plans
The Company has a voluntary deferred compensation plan under Section 401(k) of
the Internal Revenue Code (the "401(k) Plan") for all employees who satisfy the
age and service requirements under the 401(k) Plan. Each participant may elect
to contribute up to 15% of annual compensation, up to the maximum permitted
under Federal law, and the Company is obligated to contribute annually an amount
equal to 100% of the participant's contribution up to 6% of that participant's
annual compensation. Employees contributed
52
Callaway Golf Company
$6,353,000, $6,119,000 and $5,486,000 to the 401(k) Plan in 2001, 2000 and 1999,
respectively. In accordance with the provisions of the 401(k) Plan, the Company
matched employee contributions in the amount of $4,474,000, $4,706,000 and
$4,510,000 during 2001, 2000 and 1999, respectively. Additionally, the Company
can make discretionary contributions based on the profitability of the Company.
For the years ended December 31, 2001, 2000 and 1999, the Company recorded
compensation expense for discretionary contributions of $3,786,000, $3,799,000
and $3,605,000, respectively.
The Company also has an unfunded, non-qualified deferred compensation plan. The
plan allows officers, certain other employees and directors of the Company to
defer all or part of their compensation, to be paid to the participants or their
designated beneficiaries upon retirement, death or separation from the Company.
To support the deferred compensation plan, the Company has elected to purchase
Company-owned life insurance. The cash surrender value of the Company-owned
insurance related to deferred compensation is included in other assets and was
$10,556,000 and $8,310,000 at December 31, 2001 and 2000, respectively. The
liability for the deferred compensation is included in long-term liabilities and
was $8,297,000 and $9,884,000 at December 31, 2001 and 2000, respectively. For
the years ended December 31, 2001, 2000 and 1999, the total participant
deferrals, which are reflected in long-term liabilities, were $836,000, $843,000
and $997,000, respectively. Included in other income during 1999 were net
proceeds from an insurance policy related to the deferred compensation plan of
$3,622,000.
NOTE 10
INCOME TAXES
The Company's income before income tax provision was subject to taxes in the
following jurisdictions for the following periods:
(IN THOUSANDS) YEAR ENDED DECEMBER 31,
2001 2000 1999
- --------------------------------------------------------------------------------
United States $ 75,872 $ 101,890 $ 75,799
Foreign 22,320 27,432 9,698
- --------------------------------------------------------------------------------
$ 98,192 $ 129,322 $ 85,497
================================================================================
The provision for income taxes is as follows:
(IN THOUSANDS) YEAR ENDED DECEMBER 31,
2001 2000 1999
- --------------------------------------------------------------------------------
Current tax provision:
Federal $ 23,056 $ 26,616 $ 14,779
State 3,350 5,130 2,774
Foreign 8,273 10,623 3,044
Deferred tax expense (benefit):
Federal 3,595 7,463 8,956
State 1,526 (1,596) 1,162
Foreign 17 (870) (540)
- --------------------------------------------------------------------------------
Income tax provision $ 39,817 $ 47,366 $ 30,175
================================================================================
During 2001, 2000 and 1999, the Company recognized certain tax benefits related
to stock option exercises in the amount of $14,520,000, $6,806,000 and
$2,377,000, respectively. Such benefits were recorded as a reduction of income
taxes payable and an increase in paid-in capital.
Deferred tax assets and liabilities are classified as current or noncurrent
according to the classification of the related asset or liability. Significant
components of the Company's deferred tax assets and liabilities as of December
31, 2001 and 2000 are as follows:
(IN THOUSANDS) DECEMBER 31,
2001 2000
- --------------------------------------------------------------------------------
Deferred tax assets:
Reserves and allowances $ 20,032 $ 22,365
Depreciation and amortization 2,962 12,225
Compensation and benefits 5,506 7,208
Effect of inventory overhead adjustment 3,571 1,934
Compensatory stock options and rights 2,344 3,473
Foreign net operating loss carryforwards -- 107
Revenue recognition 8,433 1,320
Long-lived asset impairment 1,738 1,738
Capital loss carryforward 283 834
Tax credit carryforwards 2,192 3,200
Other 5,612 1,793
- --------------------------------------------------------------------------------
Total deferred tax assets 52,673 56,197
Valuation allowance for deferred tax assets (2,764) (1,354)
- --------------------------------------------------------------------------------
Deferred tax assets, net of valuation allowance 49,909 54,843
Deferred tax liabilities:
State taxes, net of federal income tax benefit (2,361) (2,157)
- --------------------------------------------------------------------------------
Net deferred tax assets $ 47,548 $ 52,686
================================================================================
At December 31, 2001, the Company had $2,192,000 of credit carryforwards
primarily relating to state investment tax credits which expire at various dates
between December 31, 2007 and 2009.
A valuation allowance has been established due to the uncertainty of realizing
certain tax attribute carryforwards, and a portion of other deferred tax assets.
Based on management's assessment, it is more likely than not that all the net
deferred tax assets will be realized through future earnings.
A reconciliation of income taxes computed by applying the statutory U.S. income
tax rate to the Company's income before income taxes to the income tax provision
is as follows:
(IN THOUSANDS) YEAR ENDED DECEMBER 31,
2001 2000 1999
- --------------------------------------------------------------------------------
Amounts computed at statutory
U.S. tax rate $ 34,367 $ 45,263 $ 29,924
State income taxes, net of
U.S. tax benefit 4,047 4,112 3,046
State tax credits, net of
U.S. tax benefit (878) (325) (2,075)
Nondeductible foreign losses -- 65 (476)
Expenses with no tax benefit 693 931 814
Nondeductible capital losses -- -- 130
Foreign sales corporation
tax benefits (1,406) (1,487) (1,471)
Nontaxable insurance proceeds -- -- (1,408)
Change in deferred tax
valuation allowance 1,410 (2,836) 2,431
Other 1,584 1,643 (740)
- --------------------------------------------------------------------------------
Income tax provision $ 39,817 $ 47,366 $ 30,175
================================================================================
U.S. tax return examinations have been completed for the years through 1994.
Management believes adequate provisions for income tax have been recorded for
all years.
53
Callaway Golf Company
NOTE 11
COMMITMENTS AND CONTINGENCIES
SUPPLY OF ELECTRICITY AND ENERGY CONTRACTS In the second quarter of 2001, the
Company entered into an agreement with Pilot Power Group, Inc. ("Pilot Power")
as the Company's energy service provider and in connection therewith entered
into a long-term, fixed-priced, fixed-capacity, energy supply contract ("Enron
Contract") with Enron Energy Services, Inc. ("EESI"), a subsidiary of Enron
Corporation, as part of a comprehensive strategy to ensure the uninterrupted
supply of energy while capping electricity costs in the volatile California
energy market. The Enron Contract provided, subject to the other terms and
conditions of the contract, for the Company to purchase nine megawatts of energy
per hour from June 1, 2001 through May 31, 2006 (394,416 megawatts over the term
of the contract). The total purchase price for such energy over the full
contract term was approximately $43,484,000.
At the time the Company entered into the Enron Contract, nine megawatts per hour
was in excess of the amount the Company expected to be able to use in its
operations. The Company agreed to purchase this amount, however, in order to
obtain a more favorable price than the Company could have obtained if the
Company had purchased a lesser quantity. The Company expected to be able to sell
any excess supply through Pilot Power.
On November 29, 2001, the Company notified EESI that, among other things, EESI
was in default of the Enron Contract and that based upon such default, and for
other reasons, the Company was terminating the Enron Contract effective
immediately. At the time of termination, the contract price for the remaining
energy to be purchased under the Enron Contract through May 2006 was
approximately $39,126,000.
On November 30, 2001, EESI notified the Company that it disagreed that it was in
default of the Enron Contract and that it was prepared to deliver energy
pursuant to the Enron Contract. On December 2, 2001, EESI, along with Enron
Corporation and numerous other related entities, filed for bankruptcy. Since
November 30, 2001, the parties have not been operating under the Enron Contract
and Pilot Power has been providing energy to the Company from alternate
suppliers.
As a result of the Company's notice of termination to EESI, and certain other
automatic termination provisions under the Enron Contract, the Company believes
that the Enron Contract has been effectively and appropriately terminated. There
can be no assurance that EESI or another party will not assert a future claim
against the Company or that a bankruptcy court or arbitrator will not ultimately
nullify the Company's termination of the Enron Contract. No provision has been
made for contingencies or obligations, if any, under the Enron Contract beyond
November 30, 2001.
LEGAL MATTERS On July 24, 2000, Bridgestone Sports Co., Ltd. ("Bridgestone")
filed a complaint for patent infringement in the United States District Court
for the Northern District of Georgia, Civil Action No. 100-CV-1871, against
Callaway Golf Company, Callaway Golf Ball Company (collectively "Callaway
Golf"), and a golf retailer located in Georgia (the "U.S. Action"). On October
13, 2000, Bridgestone and the retailer defendant entered into a consent judgment
discontinuing the action against the retailer. On December 14, 2000, Bridgestone
filed an action in the Tokyo, Japan District Court asserting patent infringement
against Callaway Golf's wholly-owned subsidiary, Callaway Golf K.K., based on
its sale of Rule 35 Softfeel golf balls in Japan (the "Japan Action"). On
October 9, 2001, the Company and Bridgestone announced that they signed a golf
ball patent license agreement permitting the Company to use a number of
Bridgestone's three piece golf ball patents worldwide. As a result of the
license agreement, the U.S. Action and Japan Action were dismissed.
On April 6, 2001, a complaint was filed against Callaway Golf Company and
Callaway Golf Sales Company (collectively, the "Company"), in the Circuit Court
of Sevier County, Tennessee, Case No. 2001-241-IV. The complaint seeks to assert
a class action by plaintiff on behalf of himself and on behalf of consumers in
Tennessee and Kansas who purchased selected Callaway Golf products on or after
March 30, 2000. Specifically, the complaint alleges that the Company adopted a
New Product Introduction Policy governing the introduction of certain of the
Company's new products in violation of Tennessee and Kansas antitrust and
consumer protection laws. The plaintiff is seeking damages, restitution and
punitive damages.
On October 3, 2001, the Company filed suit in the United States District Court
for the District of Delaware, Civil Action No. 01-669, against Dunlop Slazenger
Group Americas, Inc., d/b/a MaxFli ("MaxFli"), for infringement of a golf ball
aerodynamics patent owned by the Company. On October 15, 2001, MaxFli filed an
answer to the complaint denying any infringement, and also filed a counterclaim
against the Company asserting that a former MaxFli employee now working for the
Company had disclosed confidential MaxFli trade secrets to the Company, and that
the Company had used that information to enter the golf ball business. Among
other remedies, MaxFli is seeking damages in an unspecified amount and
injunctive relief.
The Company and its subsidiaries, incident to their business activities, are
parties to a number of legal proceedings, lawsuits and other claims, including
the matters specifically noted above. Such matters are subject to many
uncertainties and outcomes are not predictable with assurance. Consequently,
management is unable to ascertain the ultimate aggregate amount of monetary
liability, amounts which may be covered by insurance, or the financial impact
with respect to these matters as of December 31, 2001. However, management
believes at this time that the final resolution of these matters, individually
and in the aggregate, will not have a material adverse effect upon the Company's
consolidated financial position, results of operations or cash flows.
VENDOR ARRANGEMENTS The Company is dependent on a limited number of suppliers
for its clubheads and shafts, some of which are single-sourced. 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 the
Company's results of operations. The Company is also single-sourced or dependent
on a limited number of suppliers for the materials it uses to make its golf
balls. Many of the materials are customized for the Company. Any delay or
interruption in such supplies could have a material adverse impact upon the
Company's golf ball business. If the Company did experience any such delays or
interruptions, there is no assurance that the Company would be able to find
adequate alternative suppliers at a reasonable cost or without significant
disruption to its business.
The Company has entered into long-term purchase agreements for various key raw
materials. The purchase commitments covered by these agreements aggregate
approximately $4,000,000 per year for 2002 and 2003.
LEASE COMMITMENTS The Company leases certain warehouse, distribution and office
facilities, as well as office and manufacturing equipment under operating
leases. Lease terms range from one to ten years expiring at various dates
through December 2008, with options to renew at varying terms. Commitments for
minimum lease payments under non-cancelable operating
54
Callaway Golf Company
leases as of December 31, 2001 are as follows:
(IN THOUSANDS)
- ------------------------------------------------
2002 $ 7,598
2003 2,792
2004 2,039
2005 1,929
2006 1,974
Thereafter 1,922
- ------------------------------------------------
$18,254
================================================
Future minimum lease payments have not been reduced by future minimum sublease
rentals of $1,882,000 under an operating lease. At December 31, 2001, the
Company is contingently liable for $3,167,000 through February 2003 under an
operating lease that was assigned to a third party (Note 12). Rent expense for
the years ended December 31, 2001, 2000, and 1999 was $3,759,000, $3,197,000 and
$2,315,000, respectively. Rent expense for 1999 does not include a credit of
$6,076,000 related to the reversal of a restructuring reserve for excess lease
costs (Note 12).
EMPLOYMENT CONTRACTS The Company has entered into employment contracts with each
of the Company's officers. These contracts generally provide for severance
benefits, including salary continuation, if the officer is terminated 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 Company's best interests in the event of an
actual or threatened change in control of the Company, the contracts also
generally provide for certain protections in the event of such a change in
control. These protections include the extension of employment contracts and the
payment of certain severance benefits, including salary continuation, upon the
termination of employment following a change in control. The Company is also
generally obligated to reimburse such officers for the amount of any excise
taxes associated with such benefits.
NOTE 12
RESTRUCTURING
In 1998, the Company recorded a restructuring charge of $54,235,000 resulting
from a number of cost reduction actions and operational improvements. These
actions included: the consolidation of the operations of the Company's
wholly-owned subsidiary, Odyssey, into the operations of the Company while
maintaining the distinct and separate Odyssey brand; the discontinuation,
transfer or suspension of certain initiatives not directly associated with the
Company's core business, such as the Company's involvement with interactive golf
sites, golf book publishing, new player development and a golf venue in Las
Vegas; and the re-sizing of the Company's core business to reflect current and
expected business conditions. These initiatives were completed during 1999, with
the exception of cash outlays related to the assignment of a lease obligation
for a facility in New York City that continued through July 2000. During 1999,
the Company incurred charges of $1,295,000 on the disposition of building
improvements eliminated during the consolidation of manufacturing operations, as
well as other charges of $671,000. These charges did not meet the criteria for
accrual in 1998. The Company also incurred charges of $749,000 during 1999
related to asset dispositions and other restructuring activities for which
reserves were not established in 1998. Additionally, in 1999, the Company
reversed $8,609,000 of the reserve as actual amounts differed from estimates
established in 1998. The reversal was primarily attributable to the $6,076,000
reversed as a result of the assignment of a lease obligation at terms
significantly more favorable than estimated at the establishment of the reserve
combined with the $1,470,000 reversal related to the disposition of two
buildings at higher sales prices than estimated. No charges were incurred during
2000 and during the third quarter of 2000, the restructuring reserve balance was
fully depleted.
NOTE 13
ACQUISITIONS AND REORGANIZATIONS
During the first quarter of 2001, the Company acquired distribution rights and
substantially all of the assets from its distributors in Spain and Australia for
$4,400,000 and $1,400,000, respectively. These acquisitions were accounted for
using the purchase method. On December 29, 2000, the Company consolidated a
wholly-owned subsidiary, Callaway Golf Ball Company, with the Company. During
1999, the Company acquired distribution rights and substantially all of the
assets from its distributor in Ireland for $810,000. Also in 1999, the Company
merged its subsidiary, Callaway Golf Europe, S.A., with another of its
subsidiaries, Callaway Golf Europe, Ltd. and now operates in France through a
satellite office. These acquisitions are not considered significant business
combinations. Accordingly, pro forma financial information is not presented.
NOTE 14
SEGMENT INFORMATION
The Company's operating segments are organized on the basis of products and
include golf clubs and golf balls. The Golf Clubs segment consists of Callaway
Golf titanium and stainless steel metal woods and irons, Callaway Golf and
Odyssey putters and wedges and related accessories. The Golf Balls segment
consists of golf balls that are designed, manufactured, marketed and distributed
by the Company. There are no significant intersegment transactions. The tables
below contain information utilized by management to evaluate its operating
segments.
(IN THOUSANDS)
2001 2000 1999
- --------------------------------------------------------------------------------
Net sales
Golf Clubs $ 761,310 $ 803,663 $ 719,038
Golf Balls 54,853 33,964 --
- --------------------------------------------------------------------------------
$ 816,163 $ 837,627 $ 719,038
================================================================================
Income (loss) before tax
Golf Clubs $ 184,770 $ 213,786 $ 175,794
Golf Balls (17,868) (45,918) (36,097)
Reconciling items(1) (68,710) (38,546) (54,200)
- --------------------------------------------------------------------------------
$ 98,192 $ 129,322 $ 85,497
================================================================================
Identifiable assets(2)
Golf Clubs $ 343,741 $ 317,036 $ 303,905
Golf Balls 60,166 52,255 42,293
- --------------------------------------------------------------------------------
$ 403,907 $ 369,291 $ 346,198
================================================================================
(1) Represents corporate general and administrative expenses and other income
(expense) not utilized by management in determining segment profitability.
(2) Identifiable assets are comprised of net inventory, property, plant and
equipment and intangible assets. Total identifiable assets differ from total
assets as a result of unidentified corporate assets not segregated between
the two segments.
The Company markets its products domestically and internationally, with its
principal international markets being Japan and Europe. The tables below contain
information about the geographical areas in which the Company operates. Revenues
are attributed to the location to which the product was shipped. Long-lived
assets are based on location of domicile.
55
Callaway Golf Company
(IN THOUSANDS)
Long-Lived
Sales Assets
- --------------------------------------------------------------------------------
2001
United States $ 444,091 $ 234,281
Japan 130,706 3,415
Europe 118,417 13,261
Rest of Asia 63,928 729
Other foreign countries 59,021 2,877
- --------------------------------------------------------------------------------
$ 816,163 $ 254,563
================================================================================
2000
United States $ 451,264 $ 228,920
Japan 122,003 3,229
Europe 125,511 11,229
Rest of Asia 82,371 994
Other foreign countries 56,478 3,164
- --------------------------------------------------------------------------------
$ 837,627 $ 247,536
================================================================================
1999
United States $ 418,397 $ 241,241
Japan 55,927 2,634
Europe 115,673 14,027
Rest of Asia 73,121 974
Other foreign countries 55,920 3,481
- --------------------------------------------------------------------------------
$ 719,038 $ 262,357
================================================================================
The Company, through a distribution agreement, had appointed Sumitomo as the
sole distributor of Callaway Golf clubs in Japan. The distribution agreement,
which began in February 1993 and ended on December 31, 1999, required Sumitomo
to purchase specified minimum quantities. In 1999, sales to Sumitomo accounted
for 7% of the Company's net sales. In the fourth quarter of 1999, the Company
successfully completed negotiations with Sumitomo to provide a transition of its
business. As a result of this transition agreement, the Company purchased all
undamaged, unopened inventory products in the possession of the distributor and
paid a transition fee to the distributor. The Company recorded a net charge of
$8,600,000 in the fourth quarter of 1999 for transition expenses, excess and
obsolete inventory purchased, and foreign currency transaction losses. The
transition expenses, excess and obsolete inventory charge, and foreign currency
transaction losses were included in income from operations, gross profits, and
other income, respectively. The Company also purchased saleable products and
accordingly increased its inventory balance by $3,600,000. Odyssey brand
products are sold through the Company's wholly-owned Japanese subsidiary,
Callaway Golf K.K., and beginning January 1, 2000, Callaway Golf brand products
were sold through this subsidiary.
NOTE 15
LICENSING ARRANGEMENTS
In 2001, the Company and Nordstrom, Inc. mutually terminated their prior
licensing arrangement, which included men's and women's golf apparel, men's
footwear and sun and skin care products. Also in 2001, the Company entered into
an exclusive licensing arrangement with Ashworth, Inc. for the creation of a
complete line of men's and women's apparel for distribution in the United
States, Canada, Europe, Australia, New Zealand and South Africa. In addition,
the Company also entered into a long-term licensing agreement with Sanei
International Co., Ltd. to create and sell Callaway Golf apparel in Japan. The
Company's golf apparel products will be available at retail beginning in 2002.
The first full year for which the Company will receive royalty revenue under
these licensing arrangements is 2003.
NOTE 16
TRANSACTIONS WITH RELATED PARTIES
A director of the Company is also a senior managing director of an investment
bank which performed services for the Company. Investment banking fees incurred
with this investment bank totaled $557,000 in 2001 and no fees were paid in 2000
and 1999. Another director of the Company is also an advisory partner of a law
firm which performs legal services for the Company. Legal fees incurred with
this law firm totaled $351,000, $469,000 and $1,063,000 in 2001, 2000, and 1999,
respectively.
The Callaway Golf Company Foundation (the "Foundation") oversees and administers
charitable giving for the Company and makes grants to carefully selected
organizations. Directors and executive officers of the Company also serve as
directors of the Foundation and the Company's employees provide accounting and
administrative services for the Foundation. In 2001, the Company recognized a
charitable contribution expense of $1,000,000 as a result of its unconditional
promise to contribute such amount to the Foundation. As of December 31, 2001,
the Company had paid $584,000 of the contribution. The remaining $416,000 was to
be paid in 2002. In 2000 and 1999, the Company donated $288,000 and $232,000,
respectively, to the Foundation.
During 1998, the Company entered into an agreement with Callaway Editions, Inc.
to form CGMV, a limited liability company that was owned 80% by the Company and
20% by Callaway Editions, Inc. ("Callaway Editions"). Callaway Editions is a
publishing and media company which was owned 9% by Ely Callaway, Chairman,
President and Chief Executive Officer of the Company, and 81% by his son,
Nicholas Callaway. During 1999, in connection with the termination of its
relationship with CGMV, the Company forgave the existing loan balance from CGMV
of approximately $2,142,000, sold its interest to Callaway Editions for a
nominal amount and paid $1,000,000 as consideration for release from its
obligation to loan CGMV up to $20,000,000. These transactions did not result in
a charge in 1999, as they were adequately accrued in the 1998 restructuring
reserve (Note 12).
In December 1998, the Company purchased the remaining 20% interest in Callaway
Golf Trading GmbH, the Company's former German distributor, for $6,766,000. The
purchase price was in the form of a note payable bearing interest at 7%, due in
June 1999 to the seller, who was then an officer of a wholly-owned subsidiary of
the Company. The note payable was included in accounts payable and accrued
expenses at December 31, 1998 and was paid in February 1999.
NOTE 17
SUBSEQUENT EVENT
In December 1998, the Company entered into a master lease agreement for the
acquisition and lease of machinery and equipment utilized in the Company's golf
ball operations. By December 31, 1999, the Company had finalized its lease
program and leased $50,000,000 of equipment under the operating lease. On
February 11, 2002, pursuant to the master lease agreement, the Company notified
the lessor of its election to purchase the leased equipment in August 2002 for
approximately $44,834,000 plus the payment of approximately $5,200,000 of lease
termination fees
56
Callaway Golf Company
REPORTS OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Callaway Golf Company:
We have audited the accompanying consolidated balance sheet of Callaway Golf
Company (a Delaware corporation) and Subsidiaries as of December 31, 2001, and
the related consolidated statements of operations, shareholders' equity, and
cash flows for the year ended December 31, 2001. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Callaway Golf Company and
Subsidiaries as of December 31, 2001, and the results of their operations and
their cash flows for the year ended December 31, 2001 in conformity with
accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
San Diego, California
January 15, 2002 (except with respect to
the matter discussed in Note 17, as to
which the date is February 11, 2002)
To the Board of Directors and Shareholders of Callaway Golf Company:
In our opinion, the accompanying consolidated balance sheet as of December 31,
2000 and the related consolidated statements of operations, of cash flows and of
shareholders' equity for each of the two years in the period ended December 31,
2000 present fairly, in all material respects, the financial position, results
of operations and cash flows of Callaway Golf Company and its subsidiaries at
December 31, 2000 and for each of the two years in the period ended December 31,
2000, in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
San Diego, California
March 19, 2001
57
Callaway Golf Company
CHANGE IN INDEPENDENT PUBLIC ACCOUNTANTS
In early 2001, the Company's Audit Committee requested that the Company evaluate
proposals from other firms in addition to its then current outside auditor,
PricewaterhouseCoopers ("PwC"). Management solicited proposals from likely
candidates, and during the second quarter of 2001 the Audit Committee reviewed a
number of candidates that had been pre-screened by management. At the conclusion
of this review process, the Audit Committee recommended to the Board of
Directors, and the Board of Directors approved, the appointment, effective as of
June 18, 2001, of Arthur Andersen LLP ("Arthur Andersen") as the Company's new
outside auditor for fiscal year 2001 (PwC's engagement officially ended on June
15, 2001). The Audit Committee recommended the change because, among other
things, it believed that a change in outside auditor could help assure an
independent and rigorous review of the Company's practices. (PwC had been the
Company's outside auditor for over ten years). In addition, the Committee felt
that Arthur Andersen offered a very high level of audit services at a
competitive cost to the Company.
The report of Arthur Andersen in connection with its audit of the Company's
consolidated financial statements for the year ended December 31, 2001 does not
contain an adverse opinion or a disclaimer of opinion, nor was it qualified or
modified as to uncertainty, audit scope or accounting principles.
PwC's reports in connection with its audits of the Company's consolidated
financial statements for the years ended December 31, 2000 and December 31,
1999, do not contain an adverse opinion or a disclaimer of opinion, nor were
they qualified or modified as to uncertainty, audit scope or accounting
principles. In addition, during the Company's fiscal years ended December 31,
2000 and December 31, 1999 and through the subsequent interim period through the
date PwC ceased to be the Company's auditor, there were no disagreements with
PwC on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which disagreements if not resolved
to PwC's satisfaction would have caused PwC to make reference to the subject
matter of the disagreement in connection with its reports.
SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA) FISCAL YEAR 2001 QUARTERS
1st 2nd(2) 3rd(2) 4th Total
- ------------------------------------------------------------------------------------------------------------------------------------
Net sales $ 261,365 $ 253,655 $ 195,848 $ 105,295 $ 816,163
Gross profit $ 136,907 $ 131,936 $ 95,024 $ 40,711 $ 404,578
Net income (loss) $ 34,075 $ 26,975 $ 6,519 $ (9,194) $ 58,375
Earnings (loss) per common share(1)
Basic $ 0.49 $ 0.38 $ 0.09 $ (0.14) $ 0.84
Diluted $ 0.47 $ 0.36 $ 0.09 $ (0.14) $ 0.82
- ------------------------------------------------------------------------------------------------------------------------------------
FISCAL YEAR 2000 QUARTERS
1st 2nd 3rd 4th Total
- ------------------------------------------------------------------------------------------------------------------------------------
Net sales $ 197,406 $ 289,922 $ 208,081 $ 142,218 $ 837,627
Gross profit $ 88,265 $ 144,507 $ 102,031 $ 62,705 $ 397,508
Income before cumulative effect of accounting change $ 13,098 $ 44,189 $ 20,055 $ 4,614 $ 81,956
Cumulative effect of accounting change $ (957) $ -- $ -- $ -- $ (957)
Net income $ 12,141 $ 44,189 $ 20,055 $ 4,614 $ 80,999
Earnings per common share(1)
Basic
Income before cumulative effect of accounting change $ 0.18 $ 0.63 $ 0.29 $ 0.07 $ 1.17
Cumulative effect of accounting change $ (0.01) $ -- $ -- $ -- $ (0.01)
---------------------------------------------------------------------
$ 0.17 $ 0.63 $ 0.29 $ 0.07 $ 1.16
Diluted
Income before cumulative effect of accounting change $ 0.18 $ 0.61 $ 0.29 $ 0.07 $ 1.14
Cumulative effect of accounting change $ (0.01) $ -- $ -- $ -- $ (0.01)
---------------------------------------------------------------------
$ 0.17 $ 0.61 $ 0.29 $ 0.07 $ 1.13
- ------------------------------------------------------------------------------------------------------------------------------------
(1) Earnings per share is computed individually for each of the quarters
presented; therefore, the sum of the quarterly earnings per share may not
necessarily equal the total for the year.
(2) The Company's net income and earnings per common share includes the
recognition of unrealized energy contract losses due to changes in the
estimated fair value of the energy contract based on market rates. During
the second and third quarters of 2001, the Company recorded $6,400,000 and
$7,800,000, respectively, of after-tax unrealized losses. During the fourth
quarter of 2001, the Company terminated the energy contract. As a result,
the Company will continue to reflect the derivative valuation account on its
balance sheet with no future valuation adjustments for changes in market
rates, subject to periodic review (Notes 6 and 11).
58
Callaway Golf Company
MARKET FOR COMMON SHARES AND RELATED SHAREHOLDER MATTERS
The Company's Common Shares are traded on the New York Stock Exchange (NYSE).
The Company's symbol for its Common Shares is "ELY." As of March 8, 2002, the
approximate number of holders of record of the Company's Common Stock was 9,000.
STOCK PRICE INFORMATION
YEAR ENDED DECEMBER 31,
2001 2000
- --------------------------------------------------------------------------------
Period: High Low Dividend High Low Dividend
First Quarter $ 27.01 $ 17.25 $ 0.07 $ 17.75 $ 11.00 $ 0.07
Second Quarter $ 26.34 $ 14.60 $ 0.07 $ 20.56 $ 14.81 $ 0.07
Third Quarter $ 18.12 $ 12.21 $ 0.07 $ 16.69 $ 12.44 $ 0.07
Fourth Quarter $ 19.83 $ 12.87 $ 0.07 $ 19.56 $ 14.50 $ 0.07
- --------------------------------------------------------------------------------
59