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EXHIBIT 7.1
FINANCIAL STATEMENTS OF THE BUSINESS ACQUIRED
TABLE OF CONTENTS
FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2002
Independent Auditors' Report......................................................................................... 7
Consolidated Statement of Operations for the year ended December 31, 2002............................................ 8
Consolidated Balance Sheet as of December 31, 2002................................................................... 9
Consolidated Statement of Cash Flows for the year ended December 31, 2002............................................ 10
Consolidated Statement of Shareholders' Deficiency for the year ended December 31, 2002.............................. 11
Notes to Consolidated Financial Statements........................................................................... 12
UNAUDITED FINANCIAL STATEMENTS FOR THE EIGHT MONTHS ENDED AUGUST 24, 2003 AND AUGUST 23, 2002
Consolidated Condensed Statements of Operations for the eight months ended August 24, 2003 and August 23, 2002....... 26
Consolidated Condensed Balance Sheets as of August 24, 2003 and December 31, 2002.................................... 27
Consolidated Condensed Statements of Cash Flows for the eight months ended August 24, 2003 and August 23, 2002....... 28
Consolidated Condensed Statement of Shareholders' Deficiency for the eight months ended August 24, 2003.............. 29
Notes to Consolidated Condensed Financial Statements................................................................. 30
6
INDEPENDENT AUDITORS' REPORT
To the Audit Committee of Callaway Golf Company
Carlsbad, California
We have audited the accompanying consolidated balance sheet of SHC, Inc. and
subsidiaries (the "Company") as of December 31, 2002 and the related statements
of operations, changes in shareholders' deficiency and of cash flows for the
year ended December 31, 2002. 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 of America. 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 report.
In our opinion, the 2002 financial statements present fairly, in all material
respects, the financial position of SHC, Inc. and subsidiaries at December 31,
2002 and the results of its operations and its cash flows for the year then
ended in conformity with accounting principles generally accepted in the United
States of America.
As discussed in Note F to the financial statements, the Company changed its
method of accounting for goodwill and other intangible assets to adopt Statement
of Financial Accounting Standards No 142.
As discussed in Note A, the Company has filed for reorganization under Chapter
11 of the Federal Bankruptcy Code. The accompanying financial statements do not
purport to reflect or provide for the consequences of the bankruptcy
proceedings. In particular, such financial statements do not purport to show (a)
as to assets, their realizable value on a liquidation basis or their
availability to satisfy liabilities; (b) as to prepetition liabilities, the
amounts that may be allowed for claims or contingencies, or the status and
priority thereof; (c) as to stockholder accounts, the effect of any changes that
may be made in the capitalization of the Company; or (d) as to operations, the
effect of any changes that may be made in its business.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A, the Company's
recurring losses from operations, negative working capital, significant amount
of current outstanding debt, and shareholders' capital deficiency raise
substantial doubt about its ability to continue as a going concern. Management's
plans concerning these matters are also discussed in Note A. The financial
statements do not include adjustments that might result from the outcome of this
uncertainty.
/s/ Deloitte & Touche LLP
Hartford, Connecticut
November 19, 2003
7
SHC, INC. AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2002
(DOLLAR AMOUNTS IN THOUSANDS)
YEAR ENDED
DECEMBER 31,
2002
------------
Net sales ..................................................... $ 259,018
Cost of sales ............................................... 148,905
------------
Gross profit .................................................. 110,113
Selling, general and administrative
expenses ................................................. 126,336
Impairment charge on goodwill ............................... 18,431
Gain on early extinguishment of debt ........................ (35,090)
------------
Income from operations ........................................ 436
Interest expense, net ....................................... 37,852
Currency translation gain ................................... (2,849)
------------
Loss from continuing operations before income taxes ........... (34,567)
Income tax expense ......................................... 44,748
------------
Loss from continuing operations ............................... (79,315)
Discontinued operations:
Income from discontinued operations, net of tax
expense of $266 ............................................... 492
------------
Net loss ...................................................... $ (78,823)
============
See accompanying Notes to Consolidated Financial Statements.
8
SHC, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2002
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31,
2002
------------
ASSETS
CURRENT ASSETS
Cash .......................................................... $ 19,111
Receivables, less allowance of $3,296 ......................... 71,518
Inventories ................................................... 39,350
Deferred income taxes ......................................... --
Prepaid expenses .............................................. 2,770
Current assets of discontinued operations ..................... 14,686
------------
Total current assets ................................ 147,435
Property, plant and equipment, net ............................ 48,449
Intangible assets ............................................. 48,391
Deferred income taxes ......................................... --
Deferred financing costs ...................................... 3,301
Other ......................................................... 372
Long-term assets of discontinued operations ................... 21,846
------------
Total assets ........................................ $ 269,794
============
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES
Bank loans and other debt ..................................... $ 617,393
Accounts payable .............................................. 31,240
Accrued expenses .............................................. 43,809
Current liabilities of discontinued operations ................ 634
------------
Total current liabilities ........................... 693,076
Pension benefits .............................................. 18,419
Postretirement benefits ....................................... 8,400
Other ......................................................... 399
------------
Total liabilities ................................... 720,294
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' DEFICIENCY
Common stock, $.01 par value, 7,000,000 shares authorized,
4,763,594 shares outstanding .................................. 48
Additional paid-in capital .................................... 565,579
Accumulated deficit ........................................... (1,005,793)
Accumulated other comprehensive loss
-- currency translation adjustments .......................... (3,565)
-- additional minimum pension liability....................... (6,769)
------------
Total shareholders' deficiency ...................... (450,500)
------------
Total liabilities and shareholders' deficiency ...... $ 269,794
============
See accompanying Notes to Consolidated Financial Statements.
9
SHC, INC. AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2002
(DOLLARS AMOUNTS IN THOUSANDS)
YEAR ENDED
DECEMBER 31,
2002
------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ...................................................... $(78,823)
Adjustments to reconcile net loss to net cash used in
operating activities:
Gain on early extinguishment of debt ........................ (35,090)
Depreciation and amortization ............................... 12,132
Gain on disposal of fixed assets ............................ (91)
Deferred compensation expense ............................... 17
Impairment charge on goodwill ............................... 18,431
Bad debt expense ............................................ 901
Deferred income taxes ....................................... 44,222
Deferred financing cost amortization ........................ 2,961
Other ....................................................... (456)
Non-cash charge from discontinued operations ................ 12,387
Changes in assets and liabilities, net of discontinued
operations:
Receivables ................................................. 4,206
Inventories ................................................. 2,387
Prepaids .................................................... 1,155
Other assets ................................................ 3,690
Current liabilities, excluding bank loans ................... 2,132
Long term liabilities ....................................... 868
Other liabilities ........................................... (136)
Change in assets and liabilities of discontinued
operations ............................................... 3,782
--------
Net cash used in operating activities ..................... (5,325)
--------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .......................................... (10,982)
Proceeds from the sale of fixed assets ........................ 150
--------
Net cash flows used in investing activities ............... (10,832)
--------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments under term loans ................................. (118)
Net borrowings under revolving credit facility ................ 21,678
Net repayments of non U.S. bank loans ......................... (318)
Net borrowings other debt ..................................... 10,901
Payment of deferred financing costs ........................... (3,136)
--------
Net cash flows provided by financing activities ........... 29,007
--------
Net increase in cash ...................................... 12,850
Cash balance, beginning of year ........................... 6,261
--------
Cash balance, end of year ................................. $ 19,111
========
SUPPLEMENTAL CASH FLOW DATA:
Interest paid ................................................. $ 14,675
Income taxes paid ............................................. 100
NON-CASH TRANSACTIONS:
Capital expenditures financed under capital leases ............ 153
See accompanying Notes to Consolidated Financial Statements.
10
SHC, INC. AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED SHAREHOLDERS' DEFICIENCY
FOR THE YEAR ENDED DECEMBER 31, 2002
(DOLLAR AMOUNTS IN THOUSANDS)
ADDITIONAL
PREFERRED COMMON PAID-IN ACCUMULATED
STOCK STOCK CAPITAL DEFICIT
--------- ------ ---------- -----------
December 31, 2001 ............. $ 100,000 $ 987 $ 465,942 $ (926,970)
Net loss ...................... (78,823)
Minimum Pension Liability .....
Currency translation adjustment
Comprehensive loss ............
Amortization of deferred
compensation.................
Recapitalization .............. (100,000) (939) 99,637
--------- ------ ---------- -----------
December 31, 2002 ............. $ -- $ 48 $ 565,579 $(1,005,793)
========= ====== ========== ===========
ACCUMULATED
OTHER
TREASURY DEFERRED COMPREHENSIVE COMPREHENSIVE
STOCK COMPENSATION LOSS TOTAL LOSS
-------- ------------ ------------- --------- -------------
December 31, 2001 ............. $ (128) $ (100) $ (3,109) $(363,378)
Net loss ...................... (78,823) $ (78,823)
Minimum Pension Liability ..... (6,769) (6,769) (6,769)
Currency translation adjustment (456) (456) (456)
-------------
Comprehensive loss ............ $ (86,048)
=============
Amortization of deferred
compensation................. 17 17
Recapitalization .............. 128 83 (1,091)
-------- ------------ ------------- ---------
December 31, 2002 ............. $ -- $ -- $ (10,334) $(450,500)
======== ============ ============= =========
See accompanying Notes to Consolidated Financial Statements.
11
SHC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
NOTE A -- ORGANIZATION
BUSINESS - SHC, Inc. (formerly Spalding Holdings Corporation) and
subsidiaries (together, the "Company") is a global manufacturer and marketer of
branded consumer products serving the sporting goods markets under the primary
trade names SPALDING(R), TOP-FLITE(R), ETONIC(R), STRATA(R), BEN HOGAN(R) and
DUDLEY(R). The sole subsidiary of the Company at December 31, 2002 is Spalding,
Inc., n/k/a TF Estate Inc. The sole subsidiary of Spalding, Inc. is Spalding
Sports Worldwide, Inc., n/k/a TFGC Estate Inc. ("Spalding") which markets and
licenses a variety of recreational and athletic products such as golf balls,
golf clubs, golf shoes, golf bags and accessories, basketballs, volleyballs,
footballs, soccer balls, softballs and clothing, shoes and equipment for many
other sports.
GOING CONCERN - For the year ended December 31, 2002, the Company reported
a net loss totaling $78,823, and at December 31, 2002, had a working capital
deficiency of $545,641, $617,393 in total current outstanding debt, and a
stockholders' deficit of $450,500. The Company has experienced significant
liquidity issues and has defaulted on its debt obligations. Without the benefit
of a recapitalization of the Company's debt structure or a material infusion of
cash it is unlikely the Company will meet its debt obligations in 2003.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed above
and as shown in the accompanying financial statements, the Company has defaulted
on its debt obligations, has substantial operating and liquidity issues, and on
June 30, 2003 the Company filed for voluntary bankruptcy protection and
reorganization under Chapter 11 of the United States Bankruptcy Code, all of
which raise substantial doubt about the Company's ability to continue as a going
concern. There can be no assurance that the Company will be able to restructure
successfully its indebtedness or that its liquidity and capital resources will
be sufficient to maintain its normal operations. These financial statements do
not include any adjustments relating to the recoverability and classification of
asset carrying amounts or the amount and classification of liabilities that
might result should the Company be unable to continue as a going concern. The
accompanying financial statements do not purport to reflect or provide for the
consequences of the bankruptcy proceedings. In particular, such financial
statements do not purport to show (a) as to assets, their realizable value on a
liquidation basis or their availability to satisfy liabilities; (b) as to
prepetition liabilities, the amounts that may be allowed for claims or
contingencies, or the status and priority thereof; (c) as to stockholder
accounts, the effect of any changes that may be made in the capitalization of
the Company; or (d) as to operations, the effect of any changes that may be made
in its business.
RECENT DEVELOPMENTS - In December 2002, the Company adopted a plan to sell
certain assets related to the Sporting Goods and Etonic shoe and glove
businesses, the proceeds of which would be used to repay outstanding
indebtedness. On April 8, 2003, the Company completed the sale of the Etonic
shoe and glove business to Etonic Worldwide LLC and on May 16, 2003, the Company
completed the sale of the Sporting Goods business to Russell Corporation. The
Company received proceeds of $61,647 in conjunction with these transactions and
recognized a gain of $20,457 (net of tax expense of $6,519). The Company used
approximately $47,000 of the proceeds to pay down a portion of its outstanding
debt and accrued interest. After the transaction with Russell Corporation, the
Company changed the name of Spalding to The Top-Flite Golf Company.
On June 30, 2003, the Company filed a voluntary petition for
reorganization under Chapter 11 of the U.S. Bankruptcy Code, together with a
prepackaged plan to sell substantially all of the assets of The Top-Flite Golf
Company to the Callaway Golf Company, with the U.S. Bankruptcy Court for the
District of Delaware. The Top-Flite Golf Company's international operations were
part of the sale, but were not part of the bankruptcy process. The court-ordered
auction was held on September 3, 2003, and on September 4, 2003, the Bankruptcy
Court approved Callaway Golf Company's offer to purchase substantially all the
assets of The Top-Flite Golf Company for approximately $169,294 in cash, and the
assumption of approximately $5,069 debt and the assumption of certain operating
liabilities. The cash portion of the purchase price was subject to adjustments
for the amount of inventory and accounts receivable delivered. The sold assets
included working capital (inventory and accounts receivable), fixed assets and
all golf patents, trademarks and intellectual property. On September 15, 2003,
the Company completed the sale of the assets of The Top-Flite Golf Company U.S.
operations and on October 1, 2003 completed the sale of certain additional
assets related to The Top-Flite Golf Company's international operations. Based
on the actual amount of inventories and accounts receivable delivered, and
certain other adjustments, the cash portion of the purchase price was adjusted
downward by approximately
12
$10,149. Accordingly, the adjusted cash portion of the purchase price was
approximately $159,145.
NOTE B -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of SHC, Inc. and its subsidiaries, all of which are
wholly-owned. All inter-company accounts and transactions have been eliminated
in consolidation.
REVENUE RECOGNITION - Sales are recognized when both title and risk of
loss transfer to the customer. Sales are recorded net of an allowance for sales
returns and sales programs. Sales returns are estimated based upon historical
returns, current economic trends, changes in customer demands and sell through
of products. The Company also records estimated reductions to revenue for sales
programs such as customer sales programs and incentive offerings. Sales program
accruals are estimated based upon the attributes of the sales program,
management's forecast of future product demand, and historical customer
participation in similar programs. Royalty income is recorded as underlying
product sales occur, subject to certain minimums, in accordance with the related
licensing agreements.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The estimated fair value of amounts
reported in the consolidated financial statements has been determined by using
available market information and appropriate valuation methodologies. The
carrying value of all current assets and current liabilities approximates fair
value because of their short-term nature.
INVENTORIES are stated at the lower of cost or market (First-in,
First-out). Reserves to adjust slow-moving inventory and obsolete inventory to
lower of cost or market are provided based on historical experience and current
product demand.
PROPERTY, PLANT AND EQUIPMENT - These assets are stated at cost and are
depreciated principally using the straight-line method over estimated useful
lives, which range from 3 to 20 years. Certain assets are depreciated for income
tax purposes using accelerated methods.
GOODWILL AND INTANGIBLE ASSETS - Amortization of goodwill and intangible
assets ceased with the adoption of SFAS No. 142. Intangible assets are tested
for impairment consistent with the provisions of SFAS No. 142. As a result of
the economic uncertainty, decrease in rounds played, combined with increased
competitive pressures, at year-end the Company performed its impairment test and
recognized an impairment charge related to the goodwill associated with its Golf
and Etonic shoe and glove businesses. See Note F.
IMPAIRMENT OF LONG-LIVED ASSETS - The Company evaluates its long-lived
assets for impairment annually or whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. The Company compares
the carrying value of its long-lived assets to an estimate of their expected
future cash flows (undiscounted and without interest charges) to evaluate the
reasonableness of the carrying value and remaining depreciation or amortization
period. If the sum of the expected future cash flows is less than the carrying
amount of the asset, an impairment is recognized.
DEFERRED FINANCING COSTS - The costs incurred to obtain financing
agreements have been capitalized and are amortized using the interest method
over the term of the related debt. In connection with the recapitalization on
April 23, 2002, the Company wrote off deferred financing costs of $3,962. See
Note H.
INCOME TAXES - Income tax expense/benefit is based on reported
earnings/loss before income taxes. Deferred income taxes reflect the impact of
temporary differences between the amounts of assets and liabilities recognized
for financial reporting purposes and such amounts recognized for tax purposes.
In accordance with Statement of Financial Accounting Standards No. 109 ("SFAS
109"), deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years the temporary differences are
expected to reverse. The effect on deferred taxes of a change in tax rates is
recognized in income in the period that the change in rate is enacted. The
Company provides a valuation allowance for its deferred tax asset when, in the
opinion of management, it is more likely than not that such assets will not be
realized.
RETIREMENT PLANS AND POSTRETIREMENT BENEFITS - Current service costs of
retirement plans and post-retirement healthcare and life insurance benefits are
accrued annually. Prior service costs resulting from amendments to the plans are
amortized over the average remaining service period of employees expected to
receive benefits.
13
EMPLOYEE STOCK OWNERSHIP PLANS - Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"),
encourages, but does not require companies to record compensation cost for
stock-based employee compensation plans at fair value. The Company has chosen to
continue to account for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB No. 25"), and related interpretations.
Accordingly, compensation cost for the stock options included under the
Company's 2002 Stock Award Plan for Key Employees of SHC, Inc. and Subsidiaries
(the "2002 Employee Stock Ownership Plan") is measured as the excess, if any, of
the fair value of the Company's stock at the date of the grant over the amount
an employee must pay to acquire the stock. As of April 23, 2002, the Company's
1996 Stock Purchase and Option Plan for Key Employees of Spalding Holdings
Corporation and Subsidiaries (the "1996 Employee Stock Ownership Plan") was
terminated and all shares and options cancelled.
ADVERTISING - Advertising costs (other than production media) are expensed
as incurred. Costs associated with production media (television commercials) are
expensed in the year when the advertising first takes place. Advertising and
promotion expenses amounted to $50,331 in 2002.
CURRENCY TRANSLATION - Non-U.S. currency-denominated assets and
liabilities are translated into U.S. dollars at the exchange rates existing at
the balance sheet dates. Income and expense items are translated at the average
exchange rates during the respective periods. Translation adjustments resulting
from fluctuations in the exchange rates are recorded as a separate component of
shareholders' deficiency as accumulated other comprehensive loss.
CURRENCY EXCHANGE CONTRACTS - Open forward currency exchange contracts are
marked-to-market using the forward rates at each balance sheet date and the
change in market value is recorded by the Company as a currency gain or loss. As
of December 31, 2002, the Company had no foreign exchange forward contracts
outstanding.
CONCENTRATION OF CREDIT RISK - The Company sells a broad range of consumer
products in North America, Europe and the Pacific Rim. Concentrations of credit
risk with respect to trade receivables are limited due to the large number of
customers comprising the Company's customer base. Ongoing credit evaluations of
customers' financial condition are performed and, generally no collateral is
required. The Company maintains reserves for potential credit losses and such
losses, in the aggregate, have not exceeded management's expectations. During
2002, the Company's sales to one U.S. customer amounted to 13% of net sales. No
other customer exceeded 10% of net sales in 2002.
USE OF ESTIMATES - The preparation of the accompanying consolidated
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosures of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of sales and expenses during the
reported period. Actual results could differ from these estimates.
CASH AND CASH EQUIVALENTS - For purposes of the statements of consolidated
cash flows, the Company considers all highly liquid debt instruments purchased
with an original maturity of three months or less to be cash equivalents.
NEW ACCOUNTING PRONOUNCEMENTS - In May 2003, the Financial Accounting
Standards Board (the "FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 150, "Accounting for Certain Instruments with Characteristics of
Both Liabilities and Equity." SFAS No. 150 clarifies the accounting for certain
financial instruments with characteristics of both liabilities and equity and
requires that those instruments be classified as liabilities in statements of
financial position. Previously, many of those financial instruments were
classified as equity. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003 and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The Company
does not believe that the adoption of SFAS No. 150 will have a significant
impact on its financial statements.
In January 2003, the FASB issued Interpretation ("FIN") No. 46,
"Consolidation of Variable Interest Entities." In general, a variable interest
entity is a corporation, partnership, trust, or any other legal entity used for
business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. FIN No. 46 requires certain
variable interest entities to be consolidated by the primary beneficiary of the
entity if the investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. The consolidation requirements of FIN No. 46 apply
immediately to variable interest entities created after January 31, 2003. The
consolidation requirements apply to older entities in the first fiscal year or
interim period ending after December 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The adoption of
FIN No. 46 has not had, and is not expected to have, a material impact on the
Company's financial position or results of operations.
14
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure -- an Amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require in both annual and interim financial
statements prominent disclosures about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
Company is required to follow the prescribed disclosure format and has provided
the additional disclosures required by SFAS No. 148 for the annual period ended
December 31, 2002 (see Note L).
In November 2002, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," an interpretation of FASB Statements No. 5, 57 and 107,
and rescission of FASB Interpretation No. 34, "Disclosure of Indirect Guarantees
of Indebtedness of Others." FIN No. 45 elaborates on the disclosures to be made
by the guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also requires that a
guarantor recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of this interpretation are applicable on
a prospective basis to guarantees issued or modified after December 31, 2002,
while the provisions of the disclosure requirements are effective for financial
statements for interim or annual periods ending after December 15, 2002. The
adoption of FIN No. 45 has not had a material impact on the Company's results of
operations or financial position.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of such costs covered by the standard include lease termination costs
and certain employee severance costs associated with a restructuring,
discontinued operation, plant closing or other exit or disposal activity. SFAS
No. 146 is effective prospectively for exit and disposal activities initiated
after December 31, 2002. As the provisions of SFAS No. 146 are to be applied
prospectively after its adoption date, the Company cannot determine the
potential effects that the adoption of SFAS No. 146 will have on its results of
operations or financial position.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt," and an amendment of that Statement, SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS No.
145 also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor
Carriers." SFAS No. 145 amends SFAS No. 13, "Accounting for Leases," to
eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback transactions. SFAS No.
145 also amends other existing authoritative pronouncements to make various
technical corrections, clarify meanings, or describe their applicability under
changed conditions. The provisions of SFAS No. 145 related to the rescission of
SFAS No. 4 were adopted on January 1, 2003. The provisions related to SFAS No.
13 are effective for transactions occurring after May 15, 2002. All other
provisions of SFAS No. 145 are effective for financial statements issued after
May 15, 2002. The adoption of SFAS No. 145 required the Company to reclassify
debt extinguishment costs that do not meet the criteria of an extraordinary item
under APB 30, "Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" from an extraordinary item to income from
operations (see Note H).
The Company adopted Emerging Issues Task Force No. 01-9, "Accounting for
Considerations Given by a Vendor to a Customer" as of January 1, 2002. This
authoritative accounting guidance requires the treatment of certain vendor
considerations (i.e., volume discounts) as reductions of revenue instead of
selling and marketing expenses.
NOTE C -- DISCONTINUED OPERATIONS
In December 2002, the Company adopted a plan to sell the assets related to
the Sporting Goods and Etonic shoe and glove businesses. This plan was devised
in reaction to the Company's significant liquidity issues and the need to
generate cash to repay its bank debt. Based on these events, these businesses
were classified as discontinued operations as of December 31, 2002. On April 8,
2003, the Company completed the sale of its Etonic shoe and glove business, and
trademark name to Etonic Worldwide LLC, and on May 16, 2003, the Company
completed the sale of its Sporting Goods business and trademark name to Russell
Corporation. The Company received proceeds of $61,647 in conjunction with these
transactions and recognized a gain of $20,457 (net of tax expense of $6,519).
The Company used approximately $47,000 of the proceeds to pay down a portion of
its outstanding debt and accrued interest.
15
The assets and liabilities of the Sporting Goods and Etonic shoe and glove
discontinued operations have been separately classified in the Consolidated
Balance Sheet as of December 31, 2002. The assets and liabilities of the
discontinued operations consisted of the following:
SPORTING
ETONIC GOODS TOTAL
-------- -------- -------
Inventories.......................................... $ 4,847 $ 9,644 $14,491
Other current assets ................................ -- 195 195
-------- -------- -------
Total current assets of discontinued operations ..... 4,847 9,839 14,686
======== ======== =======
Property, plant and equipment, net .................. 525 231 756
Goodwill and intangible assets, net ................. -- 21,090 21,090
-------- -------- -------
Total noncurrent assets of discontinued operations .. 525 21,321 21,846
======== ======== =======
Other current liabilities ........................... 104 530 634
-------- -------- -------
Total current liabilities of discontinued operations 104 530 634
======== ======== =======
Net sales of the Sporting Goods and Etonic shoe and glove businesses were
$85,895 for the year ended December 31, 2002. Net interest expense allocated to
the Sporting Goods and Etonic shoe and glove discontinued operations was $762
for the year ended December 31, 2002. This amount represents interest expense
related to $10,467 of debt that was required to be repaid as a result of the
disposal transaction. The operations of the Sporting Goods and Etonic shoe and
glove businesses have been separately classified in the Consolidated Statement
of Operations as of December 31, 2002, as income from discontinued operations,
and exclude general corporate overhead charges and other expenses previously
allocated to the businesses. The operations of the Sporting Goods and Etonic
shoe and glove businesses are comprised of the following:
SPORTING
ETONIC GOODS TOTAL
-------- -------- -------
Net sales................................................ $ 15,301 $ 70,594 $85,895
======== ======== =======
Pre-tax (loss) income from discontinued operations....... $(12,816) $ 13,574 $ 758
Income tax benefit (expense)............................. 4,485 (4,751) (266)
-------- -------- -------
(Loss) income from discontinued operations............... $ (8,331) $ 8,823 $ 492
======== ======== =======
NOTE D -- INVENTORIES
DECEMBER 31,
2002
------------
Finished goods ........................... $ 24,073
Work in process .......................... 4,171
Raw materials ............................ 11,106
------------
Total inventories ........................ $ 39,350
============
NOTE E -- PROPERTY, PLANT AND EQUIPMENT, NET
DECEMBER 31,
2002
------------
Land ..................................... $ 2,541
Buildings and building improvements ...... 37,186
Machinery and equipment .................. 82,096
Construction in progress ................. 5,202
------------
127,025
Accumulated depreciation ................. (78,576)
------------
Property, plant and equipment, net ..... $ 48,449
============
16
NOTE F - GOODWILL AND INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." As a result of adopting SFAS No. 142, the Company's
goodwill and intangible assets are no longer amortized, but are subject to an
annual impairment test. The following sets forth the intangible assets by major
asset class:
DECEMBER 31,
2002
------------
Non-Amortizing
U.S. Trademark......................... $ 39,649
Non-U.S. Trademark..................... 7,607
Pension................................ 1,135
------------
Total intangible assets $ 48,391
============
The goodwill test for impairment consists of a two-step process that
begins with an estimation of the fair value of a reporting unit. The first step
is a screen for potential impairment and the second step measures the amount of
impairment, if any. SFAS No. 142 requires an entity to complete the first step
of the transitional goodwill impairment test within six months of adopting the
Statement. The Company has completed the first step of the test as of January 1,
2002 and no impairment was present. In accordance with SFAS No. 142, the Company
has completed the fair value analysis for goodwill and other intangible assets
as of December 31, 2002, and concluded that an impairment existed in its Etonic
shoe and glove and Golf businesses. The Company recorded an impairment charge on
goodwill and intangibles assets based on the fair market value of those
businesses which was determined using a discounted cash flow model and
consideration of the actual proceeds from the sales of those businesses in 2003.
The Company recorded an impairment charge of $18,431 relating to the golf
business which has been recorded within continuing operations. In addition, an
impairment charge of $12,387 to goodwill and intangible assets was recorded
within discontinued operations as it relates to the Etonic shoe and glove
business. Changes in goodwill and intangible assets during the year ended
December 31, 2002 were due to the impairment charges, reclassification of
$21,090 to non-current assets of discontinued operations and an additional
pension intangible asset of $277.
NOTE G -- ACCRUED EXPENSES
DECEMBER 31,
2002
------------
Compensation and other employee benefits $ 4,373
Interest ................................ 20,154
Advertising and promotion ............... 5,032
Other, principally operating expenses ... 14,250
------------
Total accrued expenses ............. $ 43,809
============
NOTE H - RECAPITALIZATION
On April 23, 2002 the Company reached an agreement of debt exchange and
recapitalization with holders of the majority of its 10-3/8% Series B Senior
Subordinated Notes due 2006. As a result of the debt exchange, the holders
exchanged $189,375 of the Company's outstanding Subordinated Notes (the "Old
Notes") and all accrued but unpaid interest on the Old Notes, for $94,688 in
aggregate principal amount of new notes issued by Spalding, Inc., a newly-formed
wholly-owned subsidiary of the Company and the holder of 100% of the stock of
Spalding Sports Worldwide, Inc. (the "New Notes") and shares of common stock of
the Company representing 88% of the outstanding stock of the Company. The New
Notes bear interest at 9.5% and mature in 2008, unless the Company fails to
consummate a complete refinancing of its indebtedness under its outstanding
credit agreement, in which event the maturity of the New Notes will be
accelerated to 2006. Interest will initially be payable in kind through the
issuance of additional New Notes in aggregate principal amount equal to the
amount of interest payable. After May 1, 2005, the New Notes will pay interest
in cash if certain financial targets are met.
17
The Company also received approval of amendments to its senior credit
facility from a majority of the participating banks. The amendments provide for
an additional $10,000 of funding from the Company's majority equity holder and
modified certain compliance measurements, including the addition of a 2.75%
interest rate floor on "eurodollar" loans. The market rate of "eurodollar" loans
at December 31, 2001 was 1.82%. The covenant changes were effective as of
December 31, 2001 and the additional borrowing capacity became available on
April 24, 2002.
In connection with the recapitalization, all authorized issued and
outstanding common stock, preferred stock, options and warrants of the Company,
then known as "Spalding Holdings Corporation", were cancelled upon the written
consent of a majority of the holders of such securities. In addition, all shares
of common stock and stock options issued and outstanding under the 1996 Employee
Stock Option Plan, and all other options previously issued, were cancelled.
The former holder of Variable Rate Cumulative Preferred Stock and Stock
Purchase Warrants received 7.8% of the outstanding common stock of the Company
and was granted 10-year warrants to purchase 8.9% of the authorized stock of the
Company and tandem offsetting options to purchase common stock of the Company on
the closing date in exchange for its liquidation preference. The warrants are
exercisable at an increasing price that will provide the holders of the Old
Notes with a 100% pro forma recovery of the Old Notes plus 10 3/8% interest that
would have accrued through the exercise date.
As a result of the recapitalization, the Company recorded a pre-tax gain
of $35,090. The Company also recorded a liability of $165,583 related to the
issuance of the New Notes, which is comprised of $94,688 of aggregate principal
New Notes and $70,895 of future interest payments related to the New Notes.
NOTE I - DEBT
The Company's U.S. operations have long-term bank financing arrangements
to support working capital needs and other general corporate requirements. The
operations utilized these arrangements primarily by use of direct bank
borrowings, acceptances and letters of credit. The Company's non-U.S.
subsidiaries have short-term bank financing arrangements to support
international working capital requirements. The subsidiaries utilize these
arrangements by use of direct bank borrowings and letters of credit.
Long-term debt consists of the following:
INTEREST RATE AT
DECEMBER 31, 2002 MATURITY DECEMBER 31, 2002
----------------- --------- -----------------
Bank Agreement:
Term Loans (Tranches A-E) 8.25-9.75% 2003-2006 $ 182,219
Revolving Credit Facility 8.25% 2003 247,978
Senior Subordinated Notes (New Notes) 9.5% 2008 165,583
Senior Subordinated Notes (Old Notes) 10 3/8% 2006 10,625
Other Indebtedness (Mass Development) 7.57% 2018 6,000
Notes payable to foreign banks and other debt 5.10-16.95% 2003 4,988
-----------------
617,393
-----------------
Less current portion 617,393
-----------------
Total long-term debt $ --
=================
CREDIT FACILITY - On September 30, 1996, the Company entered into a
secured credit facility (the "Credit Facility") with a syndicate of banks and
other financial institutions, which has been subsequently amended. The Credit
Facility provided for a $695,000 maximum credit commitment, however, this
commitment has been reduced to $442,213 based on required prepaid amounts in
connection with receipt of proceeds from asset dispositions. The Company's
Credit Facility includes Term Loans, consisting of Tranches A through E, and a
$259,994 Revolving Credit Loan. The Revolving Credit Loan expired in September
2003; availability under the facility at December 31, 2002 was $440, after
reduction of $11,575 for outstanding letters of credit.
All Term Loans and Revolving Credit Loans incurred interest during 2002,
at the Company's option, at either: (A) a "base rate" equal to the higher of (i)
the federal funds rate plus 0.50% per annum or (ii) the administrative agent's
prime rate, plus (a) in the case of Term Loan A and Term Loan E, a debt to
EBITDA-dependent rate ranging from 0.50% to 2.00% per annum, (b) in the case of
Term Loan B, 2.25% to 2.50% per annum, (c) in the case of Term Loan C, 2.75% to
3.00% per annum, (d) in the case of Term Loan D, 3.25% to 3.50% per annum, (e)
in the case of the Revolving Credit Loans and the Swingline Loans included in
the Revolving Credit Facility, a debt to EBITDA-dependent rate ranging from
0.50% to 2.00% per annum or (B) a "eurodollar rate" plus (i) in the
18
case of Term Loan A and E, a debt to EBITDA-dependent rate ranging from 1.125%
to 3.00% per annum, (ii) in the case of Term Loan B, 3.25% to 3.50% per annum,
(iii) in the case of Term Loan C, 3.75% to 4.00% per annum, (iv) in the case of
Term Loan D, 4.25% to 4.50% per annum or (v) in the case of Revolving Credit
Loan, a debt to EBITDA-dependent rate ranging from 1.125% to 3.00% per annum.
Swingline Loans, included in the Revolving Credit Facility, may only be "base
rate" loans. In addition, the April 23, 2002 amendment included the addition of
a 2.75% interest rate floor on "eurodollar" loans.
The Company paid a commitment fee calculated during 2002 at a debt to
EBITDA-dependent rate ranging from 0.45% to 0.75% per annum of the available
unused commitment under the Revolving Credit Loan in effect on each day. Such
fee is payable quarterly in arrears and upon termination of the Revolving Credit
Loan. In addition, the Company pays a fee to the administrative agent of $100
per annum, payable quarterly in arrears.
The Company incurred a letter of credit fee calculated during 2002 at a
debt to EBITDA-dependent rate ranging from 1.00% to 2.875% per annum of the face
amount of each letter of credit and a fronting fee calculated at a rate equal to
0.125% per annum of the face amount of each letter of credit. Such fees, except
fronting fee, are payable quarterly in arrears and upon the termination of the
Revolving Credit Loan. In addition, the Company pays customary transaction
charges in connection with any letters of credit.
The Term Loans are subject to mandatory prepayments (i) with the proceeds
of certain asset sales and certain debt offerings (excluding the Senior
Subordinated Notes) and (ii) on an annual basis with 50% of the Company's excess
cash flow (as defined in the Credit Facility) for so long as the ratio of the
Company's total debt (as defined in the Credit Facility) to EBITDA (as defined
in the Credit Facility) is greater than 4.0 to 1.0.
The Credit Facility prohibits the Company from repurchasing any senior
subordinated notes subject to limited exceptions. The Company's obligations
under the Credit Facility are secured by a pledge of the stock of certain of its
subsidiaries and a security interest in substantially all other tangible and
intangible assets, including accounts receivable, inventory, equipment and
contracts.
The Credit Facility contains customary covenants and restrictions on the
Company's ability to engage in certain activities including (i) limitations on
liens, (ii) limitations on consolidations and mergers of the Company and sales
of the assets of the Company, (iii) restrictions on the purchase, redemption or
acquisition of any capital stock, equity interest or any other obligations or
other securities and restrictions on the advances, loans, extension of credit or
capital contributions to, or investments in, other entities, (iv) restrictions
on additional indebtedness to be incurred by the Company, (v) restrictions on
payments of dividends or other distribution of assets, and (vi) compliance with
certain financial covenants relating to certain interest coverage, fixed charge
ratios, and a leverage ratio. The Credit Facility includes customary events of
default.
The Company's financing agreements (covering the Credit Facility, Senior
Subordinated Notes (Old & New), other indebtedness and short-term borrowings)
contain financial covenants. Beginning in June 2002, the Company was in default
with respect to non-payment of interest and failure to comply with certain
financial performance covenants under these agreements. As a consequence, all of
the long-term indebtedness of the Company has been classified as debt due within
one year. The Company signed forbearance agreements (effective through September
30, 2003) with its lenders that provided the Company a period of time to arrange
alternative financing. As of September 30, 2003, the Company was in default of
all of its outstanding debt obligations. The forbearance agreements provided for
a deferral of all interest payments, and also provides a forbearance through the
same time frame on the Company's financial covenants. The agreement also
requires that the Company convert its existing eurodollar loans to base rate
loans as those loans mature, and adds 2.0% to the Company's effective interest
rate. The additional 2.0% interest rate will be retroactively cancelled if the
Company makes prepayments of principal of $100,000 or more prior to January 31,
2003. The agreements also provided for an additional $10,000 of funding and the
Company's principal owner has acquired a participation in the funding. The
agreements also established a plan of repayment on any and all interest and
principal in connection with any asset disposition.
The fair value of the Company's Credit Facility is estimated based on the
quoted market price for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturities. At December
31, 2002, based on market quotes for the same or similar securities it is
estimated that the Credit Facility was approximately 40% of the original face
value based on dealer quotes.
SENIOR SUBORDINATED NOTES - On September 30, 1996, the Company issued 10
3/8% Senior Subordinated Notes. In January 1997, the Company completed a public
debt offering which resulted in the Company exchanging its 10 3/8% Senior
Subordinated Notes for new 10 3/8% Series B Senior Subordinated Notes (the "Old
Notes"). The Old Notes will mature on October 1, 2006 and are unsecured senior
subordinated obligations of the Company. Interest on the Old Notes is payable
semiannually April 1 and October 1 of each year. The Old Notes are redeemable at
the option of the Company, in whole or in part, at any time on or after October
1, 2001.
19
The 9.5% Senior Subordinated Notes due 2008, issued as a result of the
recapitalization ("New Notes"), are general unsecured obligations of Spalding,
Inc. The Notes are subject to redemption at the option of Spalding, Inc., in
whole or in part, at a redemption price equal to 100% of the aggregated
principal amount, plus any accrued and unpaid interest.
At December 31, 2002, the estimated fair value of the Old Notes and New
Notes was indeterminable due to lack of trading activity.
OTHER INDEBTEDNESS - At December 31, 2002 other indebtedness consists of
a 7.57% note in the amount of $6,000, incurred in 1998 in connection with the
construction of a new warehouse located in Chicopee, MA., due in monthly
installments through February 2018. The interest rate on the $6,000 loan will
convert after five years to 300 basis points over the one-year U.S. Treasury
rate. There are no amortization requirements for the first five years of the
loan followed by principal payments of $33 per month until maturity. The Lender
has been granted a security interest in the warehouse.
NOTE J -- INCOME TAXES
Net loss from continuing operations before income taxes and extraordinary
loss in the United States and outside the United States, along with the
components of the income tax provision (benefit), are as follows:
YEAR
ENDED
DECEMBER 31,
2002
------------
Loss from continuing operations before income taxes:
United States..................................... $ (31,052)
Other nations..................................... (3,515)
-------------
Total..................................... $ (34,567)
=============
Income tax provision (benefit):
Current taxes:
Federal taxes.................................. $ 0
State taxes.................................... 133
Other nations' taxes........................... 658
------------
Total..................................... $ 791
------------
Deferred taxes:
Federal taxes.................................. $ 43,957
Other nations' taxes........................... 0
------------
Total..................................... 43,957
------------
Total income taxes expense................ $ 44,748
============
The differences between the effective income tax rate and the U.S.
statutory rate are as follows:
YEAR
ENDED
DECEMBER 31,
2002
------------
U.S. statutory rate (benefit)....................... (35)%
State income taxes, net of federal benefit 0
Net U.S. valuation allowance........................ 157
Non-U.S. losses with no taxes recorded and
other international differences................... 5
Other............................................... 2
------------
Effective tax rate................................ 129%
============
Under the asset and liability method prescribed by SFAS 109, deferred
income taxes, net of appropriate valuation allowances, are provided for the
temporary differences between the financial reporting and tax basis of assets
and liabilities using enacted tax rates expected to apply to taxable income in
the years the temporary differences are expected to reverse. The tax effects of
temporary differences that give rise to significant portions of the deferred tax
assets and liabilities at December 31, 2002 are as follows:
20
2002
------------
Deferred tax assets:
Net operating loss carryforwards $ 118,870
Acquired non-U.S. trademarks...................... 22,984
Accrued interest.................................. 25,559
Postretirement benefits........................... 3,374
Pension........................................... 2,910
Accrued liabilities............................... 4,705
Depreciation...................................... 1,157
Other............................................. 3,031
------------
Gross deferred tax assets...................... $ 182,590
------------
Deferred tax liabilities:
Intangibles Amortization.......................... $ (9,798)
Other............................................. --
------------
Gross deferred tax liabilities $ (9,798)
------------
Net deferred tax asset before
valuation allowance $ 172,792
Valuation allowance (172,792)
------------
Net deferred tax asset after
valuation allowance $ --
============
On December 31, 2002, the Company had net operating loss carryforwards of
$308,364 consisting of $278,726 from U.S. operations that expire between 2011
and 2021, and $29,638 in non-U.S. operations, some of which begin to expire in
2003 and others which are carried forward indefinitely. The U.S. net operating
losses are subject to limitations under Internal Revenue Code Section 382 which
will limit the amount by which existing federal net operating losses can offset
income in future years. As a result of this limitation and uncertainties
regarding the realization of future tax benefits, deferred tax assets have been
offset by valuation allowances of $172,792 at December 31, 2002.
NOTE K -- PENSION PLANS AND POSTRETIREMENT BENEFITS
The Company's United States operations have noncontributory, defined
benefit pension plans covering substantially all employees. These plans provide
employees with pension benefits that either are based on age and compensation or
are based on stated amounts for each year of service. The Company's funding
policy is to contribute annually the minimum amounts permitted by the Internal
Revenue Code. Plan assets are invested in a broadly diversified portfolio
consisting primarily of common stock and fixed income securities.
The Company also provides certain postretirement health care and life
insurance benefits for its domestic retired employees and their dependents.
Substantially all of the Company's United States employees may become eligible
for those benefits if they reach normal retirement age while working for the
Company. Most international employees are covered by government sponsored
programs and the cost to the Company is not significant. The Company does not
fund retiree health care benefits in advance and has the right to modify these
plans in the future.
The December 31, 2002 funded status of the Company's United States defined
benefit pension and post retirement plans consists of the following:
PENSION POSTRETIREMENT
BENEFITS BENEFITS
DECEMBER 31, DECEMBER 31,
2002 2002
------------ --------------
CHANGES IN BENEFIT OBLIGATION
Benefit obligation at beginning of period..... $ (43,465) $ (7,594)
Service cost.................................. (1,946) (226)
Interest cost................................. (2,943) (503)
Actuarial loss ............................... (1,878) (20)
Benefits paid................................. 4,868 461
------------ --------------
Benefit obligation at end of period........... $ (45,364) (7,882)
CHANGE IN PLAN ASSETS
Market value of assets at beginning of period $ 35,954
Actual return on assets....................... (6,120)
Employer contributions received during period. 1,350
Benefits paid during period................... (4,868)
------------
Market value of assets as end of period....... 26,316
------------
Unfunded status............................... (19,048) $ (7,882)
Unrecognized net transition asset............ (39) --
Unrecognized prior service cost............... (193) 81
Unrecognized net (gain)/loss.................. 8,765 (599)
Additional minimum pension liability.......... (7,904) --
------------ -------------
Accrued benefit costs......................... $ (18,419) $ (8,400)
============ ==============
21
In accordance with the provisions of SFAS No. 87, the Company recorded a
minimum pension liability at December 31, 2002 of $7,046, for circumstances in
which a pension plan's accumulated benefit obligation exceeded the fair value of
the plan's assets and accrued pension liability. Such liability in 2002 was
offset by a charge to accumulated other comprehensive income of $6,769 and the
recognition of an intangible asset of $277 related to unrecognized prior service
cost.
Assumptions used in accounting for United States defined benefit pension
plans as of December 31, 2002:
WEIGHTED-AVERAGE ASSUMPTIONS AT END OF YEAR
DECEMBER 31,
2002
--------------
Discount rate................. 6.50%
Expected return on plan assets 9.00%
Rate of compensation increase. 4.25%
PENSION
BENEFITS FOR
THE YEAR ENDED
DECEMBER 31,
2002
--------------
COMPONENTS OF NET PERIODIC
BENEFIT COSTS
Service costs................... $ 1,946
Interest costs.................. 2,943
Expected return on assets....... (3,025)
Amortization of unrecognized
transition asset.............. (15)
Amortization of unrecognized
prior service costs........... (3)
Amortization of unrecognized
net gain...................... (21)
--------------
Net periodic cost............... $ 1,825
==============
POST-RETIREMENT
BENEFITS FOR
THE YEAR ENDED
DECEMBER 31,
2002
---------------
COMPONENTS OF NET PERIODIC
BENEFIT COSTS
Service costs................... $ 227
Interest costs.................. 503
Amortization of unrecognized
prior service costs........... 14
Amortization of unrecognized
net gain...................... (144)
---------------
Net periodic costs.............. $ 600
==============
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage-point change in
assumed health care cost trend rates would have the following effects:
1-PERCENTAGE 1-PERCENTAGE
POINT INCREASE POINT DECREASE
-------------- --------------
EFFECT ON TOTAL OF SERVICE AND INTEREST COST COMPONENTS $ 74 $ (68)
EFFECT ON POSTRETIREMENT BENEFIT OBLIGATION............ $ 565 $ (537)
The Company's United States operations and most non-U.S. subsidiaries have
separate defined contribution plans. The purpose of these defined contribution
plans is generally to provide additional financial security during retirement by
providing employees with an incentive to make regular savings. Company
contributions to the plans are based on employee contributions or compensation.
The non-U.S. plans are integrated with the benefits required by the laws of the
various countries. The Company's defined contribution
22
plans' expenses totaled $433 in 2002.
In October 2003, the Board of Directors of the Company expressed their
intent to terminate the pension plans, subject to the U.S. Bankruptcy Court
approval. Effective September 30, 2003, the Company decided to terminate the
401(k) plans and has the intention to transfer existing account balances into
successor plans.
NOTE L -- SHAREHOLDERS' EQUITY
PREFERRED STOCK - On September 27, 1996 the Company's certificate of
incorporation was amended to establish and authorize 50,000,000 shares of
preferred stock, $.01 par value, with other preferences and attributes to be
determined by the Board of Directors at the time of each issuance of preferred
stock.
On August 20, 1998, the Company and KKR 1996 Fund entered into an
investment agreement whereby the Company agreed to sell to KKR 1996 Fund
1,000,000 shares of nonvoting, cumulative, variable rate preferred stock with a
face value and liquidation value of $100 a share (the "Cumulative Preferred
Stock") together with detachable stock purchase warrants (the "Warrants") for
$100,000. The Warrants allowed KKR 1996 Fund to purchase 44,100,000 shares of
the Company's common stock, par value $0.01 at an exercise price of $2.00 per
share. The term of the Warrants was eight years and the expiration date was
August 20, 2006.
On April 23, 2002, as part of the recapitalization, the Cumulative
Preferred Stock was cancelled, and the former holder of the Cumulative Preferred
Stock and stock purchase warrants, received 7.8% of the outstanding common stock
of the Company and was granted 10-year warrants to purchase 8.9% of the
authorized stock of the Company and tandem offsetting options to purchase common
stock of the Company on the closing date in exchange for its liquidation
preference. The warrants are exercisable at an increasing price that will
provide the holders of the Old Notes with a 100% pro forma recovery of the Old
Notes plus 10 3/8% interest that would have accrued through the exercise date.
STOCK OPTIONS - The 1996 Employee Stock Ownership Plan consists of an
aggregate of 16,300,000 shares of common stock, which may be sold or granted as
options to key employees of the Company. The share issuance price and the option
price must be at least 50% of the fair market value of the common shares on the
date of the sale or grant and an option's maximum term is ten years. All share
grants have been issued at market value. The options vest ratably over a
five-year period. Any outstanding options become immediately exercisable upon a
change in control of the Company. If an employee retires, any shares owned may
be put to the Company or the Company can call the shares based on a fair market
value formula, as defined. If an employee dies, becomes permanently disabled or
terminates employment, the Company can call the shares based on a fair market
value formula, as defined.
On April 23, 2002 all 8,087,720 outstanding shares and options issued
under the 1996 Employee Stock Ownership Plan and all other options issued prior
to 2002 were cancelled pursuant to the recapitalization as described in Note H.
The SHC, Inc. 2002 Employee Stock Ownership Plan consists of an aggregate
of 574,712 shares of common stock of the Company and 57,472 shares of common
stock of Spalding, which have been granted as options to key employees. The
share issuance price is $0.01 and the option's maximum term is ten years. The
options vest ratably over a four-year period. Any outstanding options become
immediately exercisable upon a change in control of the Company or Spalding or
the termination of the employee by the Company without cause or by the employee
with good reason, as defined. The 2002 Employee Stock Ownership Plan also
contemplated certain make-whole awards in the event that the sale of the Company
resulted in value to its subordinated debtholders in excess of the Company's
then senior debt. SFAS No. 123 proforma disclosures have not been provided for
the 2002 Employee Stock Ownership Plan because the fair value of those options
and make-whole awards is immaterial.
The 2002 Employee Stock Ownership Plan also consists of 124,350 shares of
restricted common stock of the Company, which have been granted to key
employees. The shares vest ratably over a four-year period. SFAS No. 123
proforma disclosures have not been provided for the 2002 Employee Stock
Ownership Plan because the fair value of those shares are immaterial.
The Company accounts for its stock-based employee compensation plans using
the intrinsic value recognition and measurement principles of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. All employee stock-based awards were
granted with an exercise price equal to the market value of the underlying
common stock on the date of grant and no compensation cost is reflected in net
loss for those awards.
23
PRO FORMA DISCLOSURES - The following table illustrates the effect on net
loss if the Company had applied the fair value recognition provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation" to stock-based employee
compensation.
YEAR ENDED
DECEMBER 31,
2002
------------
Net loss:
As reported $ (78,823)
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (15)
------------
Pro forma net loss $ (78,838)
============
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. No options were granted during 2001 and options granted during 2002 were
immaterial to the consolidated financial statements.
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 M - COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS - The Company is both a plaintiff and defendant in numerous
lawsuits incidental to its current and former operations, some alleging
substantial claims. In addition, the Company's operations are subject to
federal, state, and local environmental laws and regulations. The Company has
entered into settlement agreements with the U.S. Environmental Protection Agency
and other parties on several sites, and is still negotiating on other sites. The
settlement amount and estimated liabilities are not considered significant by
the Company based on present facts. Management is of the opinion that, after
taking into account the merits of defenses, insurance coverage and established
reserves, the ultimate resolution of these matters will not have a material
adverse effect on the Company's consolidated financial statements.
LEASE COMMITMENTS - The Company leases certain manufacturing, warehousing
and office facilities, and equipment under various operating lease arrangements
expiring periodically through 2007.
The Company also leases equipment under capital lease agreements that
expire in 2006. The short-term capital lease obligation of $280 is included in
accounts payable and the long-term portion of $399 is included in other
liabilities on the Company's consolidated balance sheet as of December 31, 2002.
In 2002, property, plant and equipment included $1,361 and accumulated
depreciation included $639 relating to the capital lease agreement.
The following is a schedule by year of future minimum lease payments
required under operating leases and capital leases that have initial or
remaining noncancelable lease terms in excess of one year at December 31, 2002:
OPERATING CAPITAL
LEASES LEASES
--------- -------
2003......................... $ 1,697 $ 358
2004......................... 1,282 287
2005......................... 866 143
2006......................... 504 23
2007......................... 376 --
Thereafter................... 1,862 --
--------- -------
Total minimum lease payments. $ 6,587 811
=========
Amounts representing interest (132)
-------
$ 679
=======
24
Rental expense under operating leases was $2,715 in 2002.
GOLF PROFESSIONAL ENDORSEMENT CONTRACTS - The Company establishes
relationships with professional golfers in order to evaluate and promote
TOP-FLITE(R), STRATA(R) and BEN HOGAN(R) branded products. The Company has
entered into endorsement arrangements with members of the various professional
tours, including the Champions Tour, the PGA Tour, the LPGA Tour, the PGA
European Tour, the Japan Golf Tour and the Nationwide Tour. Many of these
contracts provide incentives for successful performances using the Company's
products. For example, under these contracts, the Company could be obligated to
pay a cash bonus to a professional who wins a particular tournament while
playing the Company's golf balls. It is not possible to predict with any
certainty the amount of such performance awards the Company will be required to
pay in any given year. Such expenses, however, are an ordinary part of the
Company's business and the Company does not believe that the payment of these
performance awards will have a material adverse affect upon the Company.
OTHER CONTINGENT CONTRACTUAL OBLIGATIONS - During its normal course of
business, the Company has made certain indemnities, commitments and guarantees
under which it may be required to make payments in relation to certain
transactions. These include (i) intellectual property indemnities to the
Company's customers and licensees in connection with the use, sale and/or
license of Company products, (ii) indemnities to various lessors in connection
with facility leases for certain claims arising from such facility or lease,
(iii) indemnities to vendors and service providers pertaining to claims based on
the negligence or willful misconduct of the Company, and (iv) indemnities
involving the accuracy of representations and warranties in certain contracts.
In addition, the Company has made contractual commitments to several employees
providing for severance payments upon the occurrence of certain prescribed
events. The duration of these indemnities, commitments and guarantees varies,
and in certain cases, may be indefinite. The majority of these indemnities,
commitments and guarantees do not provide for any limitation of the maximum
potential for future payments the Company could be obligated to make. The
Company has not recorded any liability for these indemnities, commitments and
guarantees in the accompanying consolidated balance sheets.
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 good reason. 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.
NOTE N -- RELATED PARTY TRANSACTIONS
Effective with the reorganization on August 20, 1998, Spalding and Evenflo
Company, Inc. entered into an Indemnity Agreement whereby Spalding and Evenflo
Company, Inc. indemnified the other against liability or obligation related to
their respective operations or business whether arising prior to or after the
reorganization. Additionally, the Company indemnified Evenflo Company, Inc.
against damages, as defined in the agreement, incurred or sustained as a result
of any recall (voluntary or involuntary), safety advisory or other corrective
action relating to any products manufactured by Evenflo Company, Inc. prior to
the close of business on August 20, 1998.
Effective October 1, 1996, the Company and KKR, an affiliate of the
Company, entered into a management agreement providing for the performance by
KKR of certain management services for the Company. This agreement was
terminated on April 23, 2002, but no payments were made in 2002.
Oaktree Capital Management LLC, as general partner and/or investment
manager of certain funds and accounts it manages, is a significant holder of
Secured Credit Facility debt, the 9.5% Senior Subordinated Notes ("New Notes")
and common stock. As of December 31, 2002 it was one of the largest holders of
each of those debt and equity securities, with ownership percentages of 37%, 69%
and 61%, respectively.
Bronze, LLC, a KKR affiliate, also holds a small percentage of secured
credit facility debt.
25
SHC, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
(DOLLAR AMOUNTS IN THOUSANDS)
EIGHT MONTHS ENDED
----------------------
AUGUST 24, AUGUST 23,
2003 2002
--------- ---------
Net sales ............................................ $ 181,442 $ 185,350
Cost of goods sold ................................... 106,982 104,274
--------- ---------
Gross profit ..................................... 74,460 81,076
Operating expenses:
Selling, general and administrative expenses ..... 86,363 85,706
Gain on early extinguishment of debt ............. -- (35,090)
--------- ---------
(Loss) income from operations ........................ (11,903) 30,460
Interest expense, net ............................ 25,154 29,190
Currency gain, net ............................... (2,625) (2,362)
--------- ---------
(Loss) income before income taxes .................... (34,432) 3,632
Income tax (benefit) expense ..................... (6,767) 24,762
--------- ---------
Loss from continuing operations .................. (27,665) (21,130)
Income from discontinued operations, net of and
$7,293 and $3,859 of tax expense in
2003 and 2002 .................................... 21,896 7,167
--------- ---------
Net loss ............................................. $ (5,769) $ (13,963)
========= =========
The accompanying notes are an integral part of these consolidated condensed
financial statements.
26
SHC, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
AUGUST 24, DECEMBER 31,
2003 2002
----------- -----------
ASSETS
Current assets:
Cash ......................................................... $ 42,763 $ 19,111
Receivables, less allowance of $4,849 and $3,296, respectively 66,887 71,518
Inventories .................................................. 41,470 39,350
Prepaid expenses ............................................. 4,071 2,770
Current assets of discontinued operations .................... -- 14,686
----------- -----------
Total current assets ....................................... 155,191 147,435
Property, plant and equipment, net ............................. 42,928 48,449
Intangible assets .............................................. 48,391 48,391
Deferred financing costs ....................................... 3,335 3,301
Other assets ................................................... 136 372
Long-term assets of discontinued operations .................... -- 21,846
----------- -----------
Total assets .......................................... $ 249,981 $ 269,794
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
Current liabilities:
Bank Loans and other debt .................................... $ 605,310 $ 617,393
Accounts payable ............................................. 31,173 31,240
Accrued expenses ............................................. 41,588 43,815
Income taxes payable ......................................... 40 (6)
Current liabilities of discontinued operations ................ -- 634
----------- -----------
Total current liabilities ............................. 678,111 693,076
Long-term liabilities:
Pension benefits ............................................. 20,087 18,419
Postretirement benefits ...................................... 8,561 8,400
Other ........................................................ 230 399
----------- -----------
Total liabilities ..................................... 706,989 720,294
Commitments and contingencies
Shareholders' deficiency:
Common Stock, $.01 par value, 7,000,000 shares authorized,
4,763,594 issued and outstanding at August 24, 2003 and
December 31, 2002 ........................................... 48 48
Additional Paid-in capital ................................... 565,579 565,579
Accumulated deficit .......................................... (1,011,562) (1,005,793)
Accumulated other comprehensive loss
-- currency translation adjustments ........................ (4,304) (3,565)
-- additional minimum pension liability .................... (6,769) (6,769)
----------- -----------
Total shareholders' deficiency ......................... (457,008) (450,500)
----------- -----------
Total liabilities and shareholders' deficiency ......... $ 249,981 $ 269,794
=========== ===========
The accompanying notes are an integral part of these consolidated condensed
financial statements.
27
SHC, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLAR AMOUNTS IN THOUSANDS)
EIGHT MONTHS ENDED
--------------------
AUG. 24, AUG. 23,
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss ................................................................. $ (5,769) $(13,963)
Adjustments to reconcile net loss to net cash used in operating activities:
Gain on sale of discontinued operations ................................ (20,457) --
Gain from early extinguishment of debt ................................. -- (35,090)
Deferred compensation expense .......................................... -- 17
Depreciation ........................................................... 7,950 8,069
Gain on disposal of fixed assets ....................................... -- (46)
Deferred income taxes .................................................. -- 28,083
Deferred financing cost amortization ................................... 3,529 2,075
Other .................................................................. (737) (963)
Changes in assets and liabilities, net of discontinued operations:
Receivables, net ...................................................... 10,984 (75)
Inventories ........................................................... (2,120) (590)
Prepaids .............................................................. (2,502) (2,068)
Other assets .......................................................... 236 295
Current liabilities, excluding bank loans ............................. (13,313) 26,483
Long term liabilities ................................................. 1,659 838
Change in assets and liabilities of discontinued operations ........... 619 (1,331)
-------- --------
Net cash (used in) provided by operating activities ................. (19,921) 11,734
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ...................................................... (2,429) (5,661)
Proceeds from the sale of fixed assets .................................... -- 83
Net proceeds from sale of discontinued operations ......................... 61,647 --
-------- --------
Net cash provided by (used in) investing activities ................. 59,218 (5,578)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) .................................................. (12,082) 8,896
Payment of deferred financing costs ........................................ (3,563) (3,135)
-------- --------
Net cash (used in) provided by financing activities ................. (15,645) 5,761
-------- --------
Net increase in cash ....................................................... 23,652 11,917
Cash balance at beginning of period ......................................... 19,111 6,261
-------- --------
Cash balance at end of period ............................................... $ 42,763 $ 18,178
======== ========
SUPPLEMENTAL CASH FLOW DATA:
Interest paid ............................................................. $ 27,534 $ 14,093
Income taxes paid ......................................................... $ 199 $ 87
The accompanying notes are an integral part of these consolidated condensed
financial statements.
28
SHC, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENT OF SHAREHOLDERS' DEFICIENCY
(UNAUDITED)
(DOLLAR AMOUNTS IN THOUSANDS)
OTHER
ACCUMULATED
COMMON PAID-IN ACCUMULATED COMPREHENSIVE COMPREHENSIVE
STOCK CAPITAL DEFICIT LOSS TOTAL LOSS
-------- --------- ----------- ------------- --------- -------------
BALANCE, DECEMBER 31, 2002..........$ 48 $ 565,579 $(1,005,793) $ (10,334) $(450,500)
Net loss.......................... -- (5,769) -- (5,769) $ (5,769)
Currency translation adjustment... -- -- -- (739) (739) (739)
-------------
Comprehensive loss................ -- -- -- -- -- $ (6,508)
=============
-- -- -- -- --
-------- --------- ----------- ------------- ---------
BALANCE AUGUST 24, 2003.............$ 48 $ 565,579 $(1,011,562) $ (11,073) $(457,008)
======== ========= =========== ============= =========
The accompanying notes are an integral part of these consolidated condensed
financial statements.
29
SHC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The accompanying condensed consolidated balance sheet of SHC, Inc.
(formerly Spalding Holdings Corporation) and subsidiaries (the "Company") as of
August 24, 2003, and the related condensed statements of consolidated operations
and cash flows for the eight months ended August 24, 2003 and August 23, 2002
and of the statement of shareholders' deficiency for the eight months ended
August 24, 2003 and August 23, 2002 are unaudited. Accordingly, certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted. These consolidated condensed
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's Annual Report
for the year ended December 31, 2002. These consolidated condensed financial
statements, in the opinion of management, include all adjustments (consisting
only of normal recurring accruals) necessary for the fair presentation of the
financial position, results of operations and cash flows for the periods and
dates presented. Interim operating results are not necessarily indicative of
operating results for the full year.
GOING CONCERN For the eight months ended August 24, 2003, the Company
reported a net loss totaling $5,769, and at August 24, 2003, had a working
capital deficiency of $522,920, $605,310 in total current outstanding debt, and
a stockholders' deficit of $457,008. The Company experienced significant
liquidity issues and was in default of its senior secured credit facility.
Without the benefit of a recapitalization of the Company's debt structure or a
material infusion of cash it is unlikely the Company will meet its debt
obligations.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed above
and as shown in the accompanying financial statements, the Company has defaulted
on its debt obligations, has substantial operating and liquidity issues, and on
June 30, 2003 the Company filed for voluntary bankruptcy protection and
reorganization under Chapter 11 of the United States Bankruptcy Code, all of
which raise substantial doubt about the Company's ability to continue as a going
concern. There can be no assurance that the Company will be able to restructure
successfully its indebtedness or that its liquidity and capital resources will
be sufficient to maintain its normal operations. These financial statements do
not include any adjustments relating to the recoverability and classification of
asset carrying amounts or the amount and classification of liabilities that
might result should the Company be unable to continue as a going concern. The
accompanying financial statements do not purport to reflect or provide for the
consequences of the bankruptcy proceedings. In particular, such financial
statements do not purport to show (a) as to assets, their realizable value on a
liquidation basis or their availability to satisfy liabilities; (b) as to
prepetition liabilities, the amounts that may be allowed for claims or
contingencies, or the status and priority thereof; (c) as to stockholder
accounts, the effect of any changes that may be made in the capitalization of
the Company; or (d) as to operations, the effect of any changes that may be made
in its business.
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. Actual results could differ materially from those
estimates and assumptions.
NOTE B - BANKRUPTCY AND SALE OF GOLF BUSINESS
On June 30, 2003, the Company filed a voluntary petition for
reorganization under Chapter 11 of the U.S. Bankruptcy Code, together with a
prepackaged plan to sell substantially all of the assets of The Top-Flite Golf
Company to the Callaway Golf Company, with the U.S. Bankruptcy Court for the
District of Delaware. The Top-Flite Golf Company's international operations were
part of the sale, but were not part of the bankruptcy process. The court-ordered
auction was held on September 3, 2003 and on September 4, 2003, the Bankruptcy
Court approved Callaway Golf Company's offer to purchase substantially all the
assets of The Top-Flite Golf Company for approximately $169,294 in cash, and the
assumption of approximately $5,069 debt and the assumption of certain operating
liabilities. The cash portion of the purchase price was subject to adjustments
for the amount of inventory and accounts receivable delivered. The sold assets
included working capital (inventory and accounts receivable), fixed assets and
all golf patents, trademarks and intellectual property. On September 15, 2003,
the Company completed the sale of The Top-Flite Golf Company's U.S. operations
and on October 1, 2003 completed the sale of certain additional
30
assets related to The Top-Flite Golf Company's international operations. Based
on the actual amount of inventories and accounts receivable delivered, and
certain other adjustments, the cash portion of the purchase price was adjusted
downward by approximately $10,149. Accordingly, the adjusted cash portion of the
purchase price was approximately $159,145.
NOTE C - DISCONTINUED OPERATIONS
On April 8, 2003, the Company completed the sale of the Etonic shoe and
glove business to Etonic Worldwide LLC and on May 16, 2003, the Company
completed the sale of the Sporting Goods Business to Russell Corporation. The
Company received proceeds of $61,647 in conjunction with these transactions and
recognized a gain of $20,457 net of tax expense of $6,519 and net of transaction
expenses. The Company used approximately $47,000 of the proceeds to pay down a
portion of its outstanding debt and accrued interest. The Company reported these
businesses as discontinued operations for all periods presented in the
accompanying financial statements, and operating results of Etonic through April
8, 2003 and Sporting Goods through May 18, 2003, the date of the sales, are
reflected separately from the results of continuing operations. Summarized
operating results and net loss of Etonic and Sporting Goods were as follows:
SPORTING
ETONIC GOODS TOTAL
------ -------- -------
Net sales........................................... $5,580 $23,129 $28,709
====== ======= =======
Pre-tax income from discontinued operations......... 70 2,144 2,214
Income tax expense.................................. 25 750 775
------ ------- -------
Income from discontinued operations................. 45 1,394 1,439
====== ======= =======
Gain on sale of discontinued operations (net of tax) -- 20,457 20,457
====== ======= =======
Total income from discontinued operations........... $ 45 $21,851 $21,896
====== ======= =======
NOTE D - RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 150, "Accounting for
Certain Instruments with Characteristics of Both Liabilities and Equity." SFAS
No. 150 clarifies the accounting for certain financial instruments with
characteristics of both liabilities and equity and requires that those
instruments be classified as liabilities in statements of financial position.
Previously, many of those financial instruments were classified as equity. SFAS
No. 150 is effective for financial instruments entered into or modified after
May 31, 2003 and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have
a significant impact on its financial statements.
In January 2003, the FASB issued Interpretation ("FIN") No. 46,
"Consolidation of Variable Interest Entities." In general, a variable interest
entity is a corporation, partnership, trust, or any other legal entity used for
business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. FIN No. 46 requires certain
variable interest entities to be consolidated by the primary beneficiary of the
entity if the investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. The consolidation requirements of FIN No. 46 apply
immediately to variable interest entities created after January 31, 2003. The
consolidation requirements apply to older entities in the first fiscal year or
interim period beginning after December 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The adoption of
FIN No. 46 has not had, and is not expected to have, a material impact on the
Company's financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure -- an Amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require in both annual and interim financial
statements prominent disclosures about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
Company is required to follow the prescribed disclosure format and has provided
the additional disclosures required by SFAS No. 148 for the period ended August
24, 2003 (see Note E).
31
In November 2002, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," an interpretation of FASB Statements No. 5, 57 and 107,
and rescission of FASB Interpretation No. 34, "Disclosure of Indirect Guarantees
of Indebtedness of Others." FIN No. 45 elaborates on the disclosures to be made
by the guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also requires that a
guarantor recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of this interpretation are applicable on
a prospective basis to guarantees issued or modified after December 31, 2002,
while the provisions of the disclosure requirements are effective for financial
statements for interim or annual periods ending after December 15, 2002. The
adoption of FIN No. 45 has not had a material impact on the Company's results of
operations or financial position.
NOTE E - ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for its stock-based employee compensation plans using
the intrinsic value recognition and measurement principles of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. All employee stock-based awards were
granted with an exercise price equal to the market value of the underlying
common stock on the date of grant and no compensation cost is reflected in net
income for those awards. Compensation expense for non-employee stock-based
compensation awards is measured using the fair-value method.
The following table illustrates the effect on net loss if the Company had
applied the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation" to stock-based employee compensation.
EIGHT MONTHS ENDED
--------------------
AUGUST 24, AUGUST 23,
2003 2002
-------- --------
Net loss:
As reported .................................................. $ (5,769) $(13,963)
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects
-- (15)
-------- --------
Pro forma net loss ........................................... $ (5,769) $(13,978)
======== ========
There were no new stock grants or other significant changes in the number
of grants outstanding, except for the cancellation of 43,103 shares.
NOTE F - INVENTORIES
Inventories are summarized below:
AUGUST 24, DECEMBER 31,
2003 2002
-------- --------
Raw materials................................................. $ 11,471 $ 24,073
Work-in-process............................................... 4,654 4,171
Finished goods................................................ 25,345 11,106
-------- --------
$ 41,470 $ 39,350
======== ========
NOTE G - GOODWILL AND INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." As a result of adopting SFAS No. 142, the Company's
goodwill and intangible assets are no longer amortized, but are subject to an
annual impairment test. The following sets forth the intangible assets by major
asset class (in thousands):
AUGUST 24, DECEMBER 31,
2003 2002
-------- --------
Non-amortizing:
U.S. Trademark.............................................. $ 39,649 $ 39,649
Non-U.S. Trademarks......................................... 7,607 7,607
Minimum Pension Liability................................... 1,135 1,135
-------- --------
Total intangible assets..................................... $ 48,391 $ 48,391
======== ========
32
There were no changes in goodwill during the eight months ended August 24,
2003.
NOTE H - DEBT
As discussed in Note A, the Company filed for bankruptcy on June 30, 2003.
The Company's financing agreements (covering the Credit Facility, Senior
Subordinated Notes (Old Notes & New Notes), other indebtedness and short-term
borrowings) contain financial covenants. The Company was in default with respect
to non-payment of interest and failure to comply with certain financial
performance covenants under these agreements. As a consequence, all of the
long-term indebtedness of the Company has been classified as debt due within one
year. The Company signed forbearance agreements (effective through September 30,
2003) with its lenders that provided the Company a period of time to arrange
alternative financing. As of September 30, 2003, the Company was in default of
all of its outstanding debt obligations. The forbearance agreement provides for
a deferral of all interest payments, and also provides a forbearance through the
same time frame on the Company's financial covenants. The agreement requires
that the Company convert its existing eurodollar loans to base rate loans as
those loans mature, and adds 2.0% to the Company's effective interest rate. The
additional 2.0% interest rate will be retroactively cancelled if the Company
makes prepayments of principal of $100,000 or more prior to January 31, 2003.
The agreement also provides for an additional $10,000 of funding and the
Company's principal owner has acquired a participation in the funding, and the
Company, in connection with any asset dispositions, was required to repay any
and all interest and principal in accordance with the agreement.
The Company is experiencing significant liquidity issues and is in default
of its senior secured credit facility. Without the benefit of a recapitalization
of the Company's debt structure or a material infusion of cash it is unlikely
the Company will meet its debt obligations.
NOTE I - COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS - The Company is both a plaintiff and defendant in numerous
lawsuits incidental to its current and former operations, some alleging
substantial claims. In addition, the Company's operations are subject to
federal, state and local environmental laws and regulations. The Company has
entered into settlement agreements with the U.S. Environmental Protection Agency
and other parties on several sites, and it still negotiating on other sites. The
settlement amount and estimated liabilities are not considered significant by
the Company based on present facts. Management is of the opinion that, after
taking into account the merits of defenses, insurance coverage and established
reserves, the ultimate resolution of these matters will not have a material
adverse effect on the Company's consolidated financial statements.
GOLF PROFESSIONAL ENDORSEMENT CONTRACTS - The Company establishes
relationships with professional golfers in order to evaluate and promote BEN
HOGAN(R), TOP-FLITE(R) and STRATA(R) branded products. The Company has entered
into endorsement arrangements with members of the various professional tours,
including the Champions Tour, the PGA Tour, the LPGA Tour, the PGA European
Tour, the Japan Golf Tour and the Nationwide Tour. Many of these contracts
provide incentives for successful performances using the Company's products. For
example, under these contracts, the Company could be obligated to pay a cash
bonus to a professional who wins a particular tournament while playing the
Company's golf clubs or golf balls. It is not possible to predict with any
certainty the amount of such performance awards the Company will be required to
pay in any given year. Such expenses, however, are an ordinary part of the
Company's business and the Company does not believe that the payment of these
performance awards will have a material adverse effect upon the Company.
OTHER CONTINGENT CONTRACTUAL OBLIGATIONS - During its normal course of
business, the Company has made certain indemnities, commitments and guarantees
under which it may be required to make payments in relation to certain
transactions. These include (i) intellectual property indemnities to the
Company's customers and licensees in connection with the use, sale and/or
license of Company products, (ii) indemnities to various lessors in connection
with facility leases for certain claims arising from such facilities or leases,
(iii) indemnities to vendors and service providers pertaining to claims based on
the negligence or willful misconduct of the Company and (iv) indemnities
involving the accuracy of representations and warranties in certain contracts.
In addition, the Company has made contractual commitments to several employees
providing for severance payments upon the occurrence of certain prescribed
events. The duration of these indemnities, commitments and guarantees varies,
and in certain cases, may be indefinite. The majority of these indemnities,
commitments and guarantees do not provide for any limitation on the maximum
amount of future payments the Company could be obligated to make. Historically,
costs incurred to settle claims related to indemnities have not been material to
the Company's financial position, results of operations or cash flows. In
addition, the Company believes the likelihood is remote that material payments
will be required under the commitments and guarantees described above. The fair
value of indemnities, commitments and guarantees that the Company issued during
the eight months ended August 24, 2003 was not material to the Company's
financial position, results of operations or cash flows.
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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 employment is terminated
by the Company for convenience or by the officer for good reason. 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.
34