EXHIBIT 13.1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Results Of Operations
Years Ended December 31, 1998 and 1997
For the year ended December 31, 1998, net sales were $697.6 million, a 17%
decrease from the prior year. This decrease was primarily due to fewer metal
woods sales, particularly titanium metal woods, along with lower average sales
prices as a result of a metal wood wholesale price reduction on Big Bertha(R)
War Bird(R) stainless steel metal woods and Great Big Bertha(R) and Biggest
Big Bertha(R) titanium metal woods, both domestically and in many major
international markets. In terms of product sales, the decrease was attributable
to decreases in metal woods sales of $154.4 million, iron sales of $4.9 million
and other product sales of $14.9 million, partially offset by an increase in
Odyssey(R) product sales of $28.9 million, as only five months of Odyssey Golf,
Inc.'s ("Odyssey") results were included in the prior year's consolidated
results (see Note 13 to the Consolidated Financial Statements). The decrease in
metal woods sales was composed of decreases in Great Big Bertha(R) metal woods
of $96.8 million, Big Bertha(R) War Bird(R) metal woods of $77.7 million and
Biggest Big Bertha(R) metal woods of $57.9 million, which was partially offset
by sales of Big Bertha(R) Steelhead(TM) metal woods, which contributed $78.0
million to sales. The decrease in sales of irons was attributable to decreases
in Big Bertha(R) irons of $137.6 million, Big Bertha(R) Gold irons of $28.3
million and Great Big Bertha(R) irons of $31.1 million, which was partially
offset by a $192.4 million increase in Big Bertha(R) X-12(TM) irons.
In terms of net sales by region, domestic sales decreased $109.6 million
(20%) for the year ended December 31,1998 as compared with 1997. Net sales in
Japan and the rest of Asia decreased $23.2 million (27%) and $19.8 million
(37%), respectively, during 1998, while net sales in Europe and Canada
increased by $7.7 million (7%) and $7.7 million (44%), respectively, during
this period.
The Company believes the diversion of consumer purchases to the Company's
new Big Bertha(R) Steelhead(TM) metal woods and Big Bertha(R) X-12(TM) irons
from its higher priced titanium metal woods and irons, and marketplace
anticipation of the introduction of the Great Big Bertha(R) Hawk Eye(R)
titanium metal woods in January 1999, also contributed to the decrease in sales
in 1998. Additionally, the Company believes that competition has caused the
Company to lose some market share domestically partly because of pricing
strategies implemented by certain competitors. In addition, the economic
turmoil in Southeast Asia and Japan had an adverse effect on the Company's
sales and results of operations. Sales earlier in the year also were adversely
affected by unusual "El Nino" weather conditions in the United States. The
Company also believes that certain actions by the USGA in 1998 contributed to
the drop in metal wood sales.
For the year ended December 31, 1998, gross profit decreased to $296.0
million from $442.8 million in the prior year, and gross margin decreased to
42% from 53%. This decrease was primarily attributable to additions to the
reserve for excess inventory of $30.0 million in the fourth quarter, lower
average sales prices as a result of a metal wood wholesale price reduction on
Big Bertha(R) War Bird(R) stainless steel metal woods and Great Big Bertha(R)
and Biggest Big Bertha(R) titanium metal woods and the accompanying customer
compensation, an increase in warranty expense, and increased manufacturing
labor and overhead costs.
Selling expenses increased to $147.0 million in 1998 from $120.6 million in
1997. This increase was primarily attributable to costs associated with
Odyssey's putter operations, which the Company acquired in August 1997, and
foreign and domestic subsidiaries acquired during 1998, as well as an increase
in international advertising and other marketing expenses. This increase was
partially offset by a decrease in domestic promotional and endorsement
expenses.
General and administrative expenses increased to $98.0 million in 1998 from
$70.7 million in 1997. This increase was due to pre-production and non-
capitalized construction costs of the new golf ball facility, expenses
associated with foreign and domestic subsidiaries acquired during 1998,
expenses associated with the consolidation of the Company's European
operations, expenses associated with Odyssey's putter operations, including
amortization of goodwill, and an increase in the reserve for uncollectable
accounts receivable.
Research and development expenses increased to $36.8 million in 1998 from
$30.3 million in 1997. This increase was primarily attributable to increased
product design costs related to increased employee compensation, consulting and
other overhead expenses, including those associated with Callaway Golf Ball
Company and Odyssey's putter operations.
Charges of $54.2 million were recorded in the fourth quarter of 1998 related
to the Company's cost reduction actions (see "Restructuring"). These charges
were primarily composed of $28.7 million for asset impairments, excess lease
costs, and costs to exit various non-core business activities, including
venues, new player development, interactive golf and publishing, $13.8 million
for impairment of assets due to the consolidation of continuing operations and
$11.7 million for employee separation costs.
Other income decreased to $3.9 million in 1998 from $4.6 million in 1997.
This decrease was due to a decrease in interest income resulting from lower
cash balances during 1998 versus 1997 and losses on dispositions of assets in
1998. This decrease was partially offset by net gains on foreign currency
transactions in 1998 of $1.6 million, as compared with net losses in 1997 of
$0.9 million.
Interest expense increased to $2.7 million in 1998 resulting from draws on
the Company's line of credit. The line of credit was not used during 1997.
YEARS ENDED DECEMBER 31, 1997 AND 1996
For the year ended December 31, 1997, net sales increased 24% to $842.9 million
compared to $678.5 million for the prior year. The growth in sales included
increases in the sales of metal woods, irons, and putters. Metal wood sales
increased $65.1 million primarily due to sales of Biggest Big Bertha(R)
Titanium Drivers. Iron sales increased $65.4 million primarily due to sales of
Great Big Bertha(R) Tungsten-Titanium(TM) Irons, which generated revenues of
$59.3 million for the year ended December 31, 1997. Also contributing to the
increase in net sales was the acquisition of certain assets and liabilities of
Odyssey Sports, Inc. by the Company's wholly-owned subsidiary, Odyssey Golf,
Inc., which contributed $20.5 million in net sales.
For the year ended December 31, 1997, gross profit increased to $442.8
million from $361.2 million in 1996 and cost of goods sold was relatively
unchanged as a percentage of sales from the prior year.
Selling expenses increased to $120.6 million in 1997 from $80.7 million in
1996. As a percentage of net sales, selling expenses increased to 14% from 12%.
The $39.9 million increase was primarily due to increased promotional and tour
expenses, higher costs related to the Company's performance centers and
additional selling expenses associated with the addition of Odyssey.
General and administrative expenses decreased to $70.7 million in 1997 from
$74.5 million in 1996. The $3.8 million decrease was primarily due to reduced
employee bonus and profit sharing expenses, partially offset by increased
start-up costs associated with the Company's golf ball operations and the
addition of Odyssey.
Research and development expenses increased to $30.3 million in 1997 as
compared to $16.2 million in 1996. This $14.1 million increase resulted from
increased expenditures related to casting technologies, golf ball development
and product engineering efforts.
Litigation settlement expense of $12.0 million represents the Company's
third quarter settlement of certain litigation brought against it and certain
officers of the Company by a former officer of the Company.
During the fourth quarter of 1997, the Company reversed an accrual for bonus
compensation of approximately $8.0 million due to the fact that certain
operating targets were not met.
Liquidity And Capital Resources
At December 31, 1998, cash and cash equivalents increased to $45.6 million from
$26.2 million at December 31, 1997, primarily as a result of $30.4 million
provided by operations and $63.5 million provided by financing activities,
partially offset by cash flows used in investing activities of $75.1 million.
After adding back non-cash expenses, the Company's operations generated
positive cash flows. Cash provided by financing activities was primarily due to
net proceeds from the Company's revolving line of credit and note payable, and
from the issuance of Common Stock, partially offset by dividends paid and
short-term debt retirements.
Cash used in investing activities totaled $75.1 million and resulted
primarily from capital expenditures for building improvements, production and
research and development machinery and computer equipment. Of these capital
expenditures, $47.7 million related to Callaway Golf Ball Company. The
acquisition of the Company's distributors in Korea, Belgium, Denmark, Canada,
France and Norway, the purchase of the remaining 80% interest in All-American
Golf LLC and the remaining 20% interest in Callaway Golf Trading GmbH also
contributed to cash used in investing activities.
The Company's principal source of liquidity, both on a short-term and long-
term basis, has been cash flow provided by operations and the Company's line of
credit facility. Even though sales declined in 1998 and the Company does not
foresee any significant improvement
in sales during 1999, the Company expects this trend to continue. The Company
replaced its $150.0 million line of credit facility in December 1998 with a
$75.0 million credit facility in conjunction with a two-staged loan funding
(see Note 4 to the Consolidated Financial Statements). On February 12, 1999,
the Company consummated the amendment of its line of credit to increase the
revolving credit facility to up to $120.0 million and entered into an $80.0
million accounts receivable securitization facility (see Note 16 to the
Consolidated Financial Statements). During 1998, the Company borrowed against
its line of credit to fund operations and finance capital expenditures. At
December 31, 1998, the Company had $3.0 million available on its line of
credit. The Company intends to repay its borrowings on its line of credit with
cash flow from operations.
As a result of the implementation of a business plan to improve operating
efficiencies (see "Restructuring"), the Company incurred charges of $54.2
million in the fourth quarter of 1998. Of these charges, $25.5 million are non-
cash. Cash outlays during 1998 for employee termination costs, contract
cancellation fees and other expenses were $10.2 million. Future material cash
outlays for employee termination costs, excess lease costs and other expenses
are estimated at $18.5 million. Of this amount, $5.3 million is anticipated to
occur during the first quarter of 1999, while the remainder, which primarily
relates to excess lease costs, will be paid through February 2013. These cash
outlays will be funded by cash flows from operations and the Company's line of
credit. If the actual actions taken by the Company differ from the plans on
which these estimates are based, actual losses recorded and resulting cash
outlays made by the Company could differ significantly.
The Company believes that, based upon its current operating plan, analysis
of its consolidated financial position and projected future results of
operations, it will be able to maintain its current level of operations,
including purchase commitments and planned capital expenditures for the
foreseeable future, through operating cash flows and available borrowings under
its credit facilities. There can be no assurance, however, that future industry
specific or other developments, or general economic trends will not adversely
affect the Company's operations or its ability to meet its future cash
requirements.
Restructuring
On November 11, 1998, the Company announced that it had adopted a business plan
that included a number of cost reduction actions and operational improvements.
These actions include: the consolidation of the operations of the Company's
wholly-owned subsidiary, Odyssey, into the operations of the Company while
maintaining the distinct and separate Odyssey(R) brand image; the
discontinuation, transfer or suspension of certain initiatives not directly
associated with the Company's core business, such as the Company's involvement
with interactive golf sites, golf book publishing, new player development and a
golf venue in Las Vegas; and the re-sizing of the Company's core business to
reflect current and expected business conditions. These initiatives are
expected to be largely completed during 1999. As a result of these actions, the
Company recorded one-time charges of $54.2 million during the fourth quarter of
1998. These charges (shown below in tabular format) primarily relate to: 1) the
elimination of job responsibilities, resulting in costs incurred for employee
severance; 2) the decision to exit certain non-core business activities,
resulting in losses on disposition of the Company's 80% interest in Callaway
Golf Media Ventures (see Note 15 of the Consolidated Financial Statements), a
loss on the sale of All-American Golf (See Note 13 of the Consolidated
Financial Statements), as well as excess lease costs; and 3) consolidation of
the Company's continuing operations resulting in impairment of assets, losses
on disposition of assets and excess lease costs. Without these charges, the
Company's earnings per diluted share would have been $0.13 for the year ended
December 31, 1998.
Employee reductions occurred in almost all areas of the Company, including
manufacturing, marketing, sales, and administrative areas. At December 31,
1998, the Company had reduced its non-temporary work force by approximately 750
positions. Although substantially all reductions occurred prior to December 31,
1998, a small number of reductions will occur in the first quarter of 1999.
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Details of the one-time charges are as follows:
One-Time Reserve Balance
(in thousands) Cash/Non-Cash Charge Activity at 12/31/98
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Elimination of Job Responsibilities $11,664 $ 8,473 $ 3,191
Severance packages Cash 11,603 8,412 3,191
Other Non-cash 61 61
Exiting Certain Non-core Business Activities $28,788 $12,015 $16,773
Loss on disposition of subsidiaries Non-cash 13,072 10,341 2,731
Excess lease costs Cash 12,660 146 12,514
Contract cancellation fees Cash 2,700 1,504 1,196
Other Cash 356 24 332
Consolidation of Operations $13,783 $ 2,846 $10,937
Loss on disposition/impairment of assets Non-cash 12,364 2,730 9,634
Excess lease costs Cash 806 4 802
Other Cash 613 112 501
Future cash outlays are anticipated to be completed by the end of 1999,
excluding certain lease commitments that continue through February 2013.
The Company anticipates that this business plan will generate savings going
forward in excess of $40.0 million per year, beginning in 1999. In addition,
the Company is continuing to implement an ongoing process of reviewing its
manufacturing operations and its worldwide supplier network aimed at reducing
the cost of goods sold and generating significant savings. However, no
assurances can be given that the full amount of the anticipated savings will be
realized.
Certain Factors Affecting Callaway Golf Company
IMPLEMENTATION OF BUSINESS PLAN
During the fourth quarter of 1998, the Company began implementing its recently
adopted business plan. See "Liquidity and Capital Resources" and
"Restructuring" sections immediately above.
SALES; GROSS MARGIN; SEASONALITY
The Company believes that, although interest in golf appears to be growing, the
worldwide premium golf equipment market has been declining and that it may
continue to decline during the foreseeable future. Demand in the United States
for premium golf equipment also has declined in 1998, and the Company
experienced a decline in domestic sales in 1998. The economic turmoil in
Southeast Asia and Japan continues to cause contraction in the retail golf
markets in these countries and elsewhere around the world, and has had an
adverse effect on the Company's sales and results of operations. The Company
expects this situation to continue in 1999.
While sales of the Company's newly introduced Big Bertha(R) Steelhead(TM)
and Great Big Bertha(R) Hawk Eye(R) Titanium Metal Woods have been strong to
date, no assurances can be given that the demand for these products or the
Company's other existing products, or the introduction of new products, will
permit the Company to experience growth in sales, or maintain historical levels
of sales, in the future.
Sales to Japan, which accounted for approximately 9% of the Company's total
sales in 1998 and 10% of total sales in 1997, are expected to decrease in 1999
as the Company's distributor, Sumitomo Rubber Industries, Ltd. ("Sumitomo"),
prepares for the transition of responsibility from it to ERC International
Company ("ERC"), a wholly-owned Japanese subsidiary of the Company, by January
1, 2000. See "Certain Factors Affecting Callaway Golf Company International
distribution."
The Company experienced a decrease in its gross margin as a percentage of
net sales during 1998 compared to historical levels. This decrease was
primarily due to additions to the reserve for excess inventory, lower sales
revenue associated with a metal wood wholesale price reduction on Big Bertha(R)
War Bird(R) Stainless Steel Metal Woods, and Great Big Bertha(R) and Biggest
Big Bertha(R) Titanium Metal Woods and accompanying customer compensation, an
increase in warranty expense, and increased manufacturing labor and overhead
costs. For the first three quarters of 1998, the Company's gross margin was
impacted negatively by increased sales of irons as a percentage of net sales,
which
have lower margins than metal woods. However, this negative impact was offset
by a shift in product sales mix to a higher percentage of metal woods during
the fourth quarter of 1998. During 1999, the Company anticipates its gross
margin percentage to exceed its 1998 levels as a result of a shift in product
sales mix and decreased inventory obsolescence and manufacturing labor and
overhead costs. However, consumer acceptance of current and new product
introductions as well as continuing pricing pressure from competitive market
conditions may have an adverse effect on the Company's future sales and gross
margin.
In the golf equipment industry, sales to retailers are generally seasonal
due to lower demand in the retail market in the cold weather months covered by
the fourth and first quarters. The Company's business generally follows this
seasonal trend and the Company expects this to continue. Unusual or severe
weather conditions such as the "El Nino" weather patterns experienced during
the winter of 1997-1998 may compound these seasonal effects.
COMPETITION
The market in which the Company does business is highly competitive, and is
served by a number of well-established and well-financed companies with
recognized brand names, as well as new companies with popular products. New
product introductions and/or price reductions by competitors continue to
generate increased market competition and the Company believes that such
competition has caused it to lose some unit market share and has negatively
affected sales. While the Company believes that its products and its marketing
efforts continue to be competitive, there can be no assurance that successful
marketing activities by competitors will not negatively impact the Company's
future sales.
A manufacturer's ability to compete is in part dependent upon its ability to
satisfy the various subjective requirements of golfers, including the golf
club's look and "feel," and the level of acceptance that the golf club has
among professional and other golfers. The subjective preferences of golf club
purchasers also may be subject to rapid and unanticipated changes. There can be
no assurance as to how long the Company's golf clubs will maintain market
acceptance. For example, consumer support for shallow-faced metal woods
increased in 1998, and many of the Company's competitors are making such
products. The Company does not currently make a "shallow-faced" wood, and does
not believe that the designs currently in the market are superior to its
deeper-faced offerings. However, if "shallow-faced" products continue to gain
consumer acceptance, the Company's sales could be negatively affected.
NEW PRODUCT INTRODUCTION
The Company believes that the introduction of new, innovative golf equipment is
increasingly important to its future success. The Company faces certain risks
associated with such a strategy. For example, new models and basic design
changes in golf equipment are frequently met with consumer rejection. In
addition, prior successful designs may be rendered obsolete within a relatively
short period of time as new products are introduced into the marketplace.
Further, new products that retail at a lower price than prior products may
negatively impact the Company's revenues unless unit sales increase. New
designs generally should satisfy the standards established by the United States
Golf Association ("USGA") and the Royal and Ancient Golf Club of St. Andrews
("R&A") because these standards are generally followed by golfers within their
respective jurisdictions. While all of the Company's current products have been
found to conform to USGA and R&A rules, there is no assurance that new designs
will receive USGA and/or R&A approval, or that existing USGA and/or R&A
standards will not be altered in ways that adversely affect the sales of the
Company's products.
On November 2, 1998, the USGA announced the adoption of a test protocol to
measure the so-called "spring-like effect" in certain golf clubheads. The USGA
has advised the Company that none of the Company's current products are barred
by this test. The R&A is considering the adoption of a similar or related test.
Future actions by the USGA or the R&A may impede the Company's ability to
introduce new products and therefore could have a material adverse effect on
the Company's results of operations.
The Company's new products have tended to incorporate significant
innovations in design and manufacture, which have resulted in higher prices for
the Company's products relative to other products in the marketplace. There can
be no assurance that a significant percentage of the public will always be
willing to pay such prices for golf equipment. Thus, although the Company has
achieved certain successes in the introduction of its golf clubs in the past,
no assurances can be given that the Company will be able to continue to design
and manufacture golf clubs that achieve market acceptance in the future.
The rapid introduction of new products by the Company can result in
closeouts of existing inventories at both the wholesale and retail levels. Such
closeouts can result in reduced margins on the sale of older
products, as well as reduced sales of new products, given the availability of
older products at lower prices. Historically, the Company has managed such
closeouts so as to avoid any material negative impact on the Company's
operations, but there can be no assurance that the Company will always be able
to do so.
The Company plans its manufacturing capacity based upon the forecasted
demand for its products. Actual demand for such products may exceed or be less
than forecasted demand. The Company's unique product designs often require
sophisticated manufacturing techniques, which can limit the Company's ability
to quickly expand its manufacturing capacity to meet the full demand for its
products. If the Company is unable to produce sufficient quantities of new
products in time to fulfill actual demand, especially during the Company's
traditionally busy second and third quarters, it could limit the Company's
sales and adversely affect its financial performance. On the other hand, the
Company commits to components and other manufacturing inputs for varying
periods of time, which can limit the Company's ability to quickly react if
actual demand is less than forecast. As in 1998, this could result in excess
inventories and related obsolescence charges that could adversely affect the
Company's financial performance.
PRODUCT BREAKAGE
The Company supports all of its golf clubs with a limited two year written
warranty. Since the Company does not rely upon traditional designs in the
development of its golf clubs, its products may be more likely to develop
unanticipated problems than those of many of its competitors which use
traditional designs. For example, clubs have been returned with cracked
clubheads, broken graphite shafts and loose medallions. In addition, the
Company's Biggest Big Bertha(R) Drivers, because of their large clubhead size
and extra long, lightweight graphite shafts, have experienced shaft breakage at
a rate higher than generally experienced with the Company's other metal woods,
even though these shafts are among the most expensive to manufacture in the
industry. While any breakage or warranty problems are deemed significant to the
Company, the incidence of clubs returned as a result of cracked clubheads,
broken graphite shafts, loose medallions and other product problems to date has
not been material in relation to the volume of Callaway Golf clubs which have
been sold. The Company monitors closely the level and nature of any product
breakage and, where appropriate, seeks to incorporate design and production
changes to assure its customers of the highest quality available in the market.
Significant increases in the incidence of breakage or other product problems
may adversely affect the Company's sales and image with golfers. While the
Company believes that it has sufficient reserves for warranty claims, there can
be no assurance that these reserves will be sufficient if the Company were to
experience an unusually high incidence of breakage or other product problems.
CREDIT RISK
The Company primarily sells its products to golf equipment retailers and
foreign distributors. The Company performs ongoing credit evaluations of its
customers' financial condition and generally requires no collateral from these
customers. The Company believes it has adequate reserves for potential credit
losses. Historically, the Company's bad debt expense has been low. However, the
recent downturn in the retail golf equipment market has resulted in delinquent
or uncollectible accounts for some of the Company's significant customers. As a
result, during 1998 the Company increased its reserve for credit losses.
Management does not foresee any significant improvement in the golf equipment
market during 1999, and therefore expects this trend to continue. Accordingly,
there can be no assurance that the Company's results of operations or cash
flows will not be adversely impacted by the failure of its customers to meet
their obligations to the Company.
DEPENDENCE ON CERTAIN VENDORS AND MATERIALS
The Company is dependent on a limited number of suppliers for its clubheads and
shafts. In addition, some of the Company's products require specifically
developed manufacturing techniques and processes which make it difficult to
identify and utilize alternative suppliers quickly. The Company believes that
suitable clubheads and shafts could be obtained from other manufacturers in the
event its regular suppliers are unable to provide components. However, any
significant production delay or disruption caused by the inability of current
suppliers to deliver or the transition to other suppliers could have a material
adverse impact on the Company's results of operations.
The Company uses United Parcel Service ("UPS") for substantially all ground
shipments of products to its domestic customers. The Company is continually
reviewing alternative methods of ground shipping to supplement its use and
reduce its reliance on UPS. To date, a limited source of alternative vendors
have been identified and adopted by the Company. Nevertheless, any interruption
in UPS services could
have a material adverse effect on the Company's sales and results of
operations.
The Company's size has made it a large consumer of certain materials,
including titanium and carbon fiber. Callaway Golf does not make these
materials itself, and must rely on its ability to obtain adequate supplies in
the world marketplace in competition with other users of such materials. While
the Company has been successful in obtaining its requirements for such
materials thus far, there can be no assurance that it will always be able to do
so. An interruption in the supply of such materials or a significant change in
costs could have a material adverse effect on the Company.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The golf club industry, in general, has been characterized by widespread
imitation of popular club designs. The Company has an active program of
enforcing its proprietary rights against companies and individuals who market
or manufacture counterfeits and "knock off" products, and aggressively asserts
its rights against infringers of its copyrights, patents, trademarks, and trade
dress. However, there is no assurance that these efforts will reduce the level
of acceptance obtained by these infringers. Additionally, there can be no
assurance that other golf club manufacturers will not be able to produce
successful golf clubs which imitate the Company's designs without infringing
any of the Company's copyrights, patents, trademarks, or trade dress.
An increasing number of the Company's competitors have, like the Company
itself, sought to obtain patent, trademark, copyright or other protection of
their proprietary rights and designs. From time to time others have or may
contact the Company to claim that they have proprietary rights that have been
infringed by the Company and/or its products. The Company evaluates any such
claims and, where appropriate, has obtained or sought to obtain licenses or
other business arrangements. To date, there have been no interruptions in the
Company's business as a result of any claims of infringement. No assurance can
be given, however, that the Company will not be adversely affected in the
future by the assertion of intellectual property rights belonging to others.
This effect could include alteration of existing products, withdrawal of
existing products and delayed introduction of new products.
Various patents have been issued to the Company's competitors in the golf
ball industry. As Callaway Golf Ball Company develops a new golf ball product,
it must avoid infringing these patents or other intellectual property rights,
or it must obtain licenses to use them lawfully. If any new golf ball product
is found to infringe on protected technology, the Company could incur
substantial costs to redesign its golf ball product or to defend legal actions.
Despite its efforts to avoid such infringements, there can be no assurance that
Callaway Golf Ball Company will not infringe on the patents or other
intellectual property rights of third parties in its development efforts, or
that it will be able to obtain licenses to use any such rights, if necessary.
The Company has stringent procedures to maintain the secrecy of its
confidential business information. These procedures include criteria for
dissemination of information and written confidentiality agreements with
employees and vendors. Suppliers, when engaged in joint research projects, are
required to enter into additional confidentiality agreements. There can be no
assurance that these measures will prove adequate in all instances to protect
the Company's confidential information.
"GRAY MARKET" DISTRIBUTION
Some quantities of the Company's products find their way to unapproved outlets
or distribution channels. This "gray market" in the Company's products can
undermine authorized retailers and foreign wholesale distributors who promote
and support the Company's products, and can injure the Company's image in the
minds of its customers and consumers. On the other hand, stopping such commerce
could result in a potential decrease in sales to those customers who are
selling Callaway Golf products to unauthorized distributors and/or an increase
in sales returns over historical levels. For example, the Company experienced a
decline in sales in the United States in 1998, and believes the decline was
due, in part, to a decline in "gray market" shipments to Asia and Europe. While
the Company has taken some lawful steps to limit commerce in its products in
the "gray market" in both domestic and international markets, it has not
stopped such commerce.
GOLF PROFESSIONAL ENDORSEMENTS
The Company establishes relationships with professional golfers in order to
evaluate and promote Callaway Golf branded golf clubs. The Company has entered
into endorsement arrangements with members of the various professional tours,
including the Senior PGA Tour, the PGA Tour, the LPGA Tour, the PGA European
Tour and the Nike Tour. While most professional golfers fulfill their
contractual obligations, some have been known to stop using a sponsor's
products despite contractual commitments. To date, the Company believes that
the cessation of use by professional endorsers of Callaway(R) brand products
has not resulted in a significant amount of negative publicity.
However, if certain of Callaway Golf's professional endorsers were to stop
using the Company's products contrary to their endorsement agreements, the
Company's business could be adversely affected in a material way by the
negative publicity.
Many professional golfers throughout the world use the Company's golf clubs
even though they are not contractually bound to do so. The Company has created
cash "pools" that reward such usage. For the last several years, the Company
has experienced an exceptional level of driver penetration on the world's five
major professional tours, and the Company has heavily advertised that fact. It
is unlikely that the Company will be able to sustain this level of professional
usage in 1999. Many other companies are aggressively seeking the patronage of
these professionals, and are offering many inducements, including specially
designed products and significant cash rewards.
As in past years, during 1998, the Company continued its Big Bertha(R)
Players' Pools ("Pools") for the PGA, Senior PGA, LPGA and Nike Tours. Those
professional players participating in the Pools received cash for using
Callaway Golf products in professional tournaments, but were not bound to use
the products or grant any endorsement to the Company. The Company believes that
its professional endorsements and its Pools contributed to its usage on the
professional tours in 1998. However, in connection with its new business plan
for 1999 the Company has significantly reduced these Pools for the PGA and the
Senior PGA Tours, and has eliminated the Pools for the LPGA and Nike Tours. As
a result, the Company anticipates that the level of professional usage of the
Company's products will be lower in 1999 than 1998. Further, while it is not
clear whether professional endorsements materially contribute to retail sales,
it is possible that a decline in the level of professional usage of the
Company's products could have a material adverse effect on the Company's
business.
NEW BUSINESS VENTURES
The Company has invested significant capital in new business ventures. However,
in connection with the Company's review of its business, the Company has
determined to discontinue, transfer or suspend certain business ventures not
directly associated with the Company's core business. See "Restructuring."
However, the Company continues development of its golf ball business. See
"Certain Factors Affecting Callaway Golf Company - Golf Ball Development."
INTERNATIONAL DISTRIBUTION
The Company's management believes that controlling the distribution of its
products throughout the world will be an element in the future growth and
success of the Company. The Company has been actively pursuing a reorganization
of its international operations, including the acquisition of distribution
rights in certain key countries in Europe, Asia and North America. These
efforts have resulted and will continue to result in additional investments in
inventory, accounts receivable, corporate infrastructure and facilities. The
integration of foreign distribution into the Company's international sales
operations will require the dedication of management resources which may
temporarily detract from attention to the day-to-day business of the Company.
Additionally, the Company's plan of integration of foreign distribution
increases the Company's exposure to fluctuations in exchange rates for various
foreign currencies which could result in losses and, in turn, could adversely
impact the Company's results of operations. There can be no assurance that the
Company will be able to mitigate this exposure in the future through its
management of foreign currency transactions. International reorganization also
could result in disruptions in the distribution of the Company's products in
some areas. There can be no assurance that the acquisition of some or all of
the Company's foreign distribution will be successful, and it is possible that
an attempt to do so will adversely affect the Company's business.
In 1993, the Company, through a distributor agreement, appointed Sumitomo
Rubber Industries, Ltd. as the sole distributor, and Sumitomo Corporation as
the sole importer, of Callaway(R) golf clubs in Japan. This distributor
agreement runs through December 31, 1999. The Company does not intend to extend
it.
The Company has established ERC, a wholly owned Japanese corporation, for
the purpose of distributing Odyssey(R) products. ERC also will distribute
Callaway Golf balls when ready and Callaway Golf clubs beginning January 1,
2000. There will be significant costs and capital expenditures invested in ERC
before there will be sales sufficient to support such costs. However, these
costs have not been material to date. Furthermore, there are significant risks
associated with the Company's intention to effectuate distribution in Japan
through ERC, and it is possible that doing so will have a material adverse
effect on the Company's operations and financial performance.
GOLF BALL DEVELOPMENT
In 1996, the Company formed Callaway Golf Ball Company, a wholly owned
subsidiary of the Company, for the purpose of designing, manufacturing and
selling golf balls. The Company has previously licensed the manufacture and
distribution of a golf ball product in Japan and Korea. The Company also
distributed a golf ball under the trademark "Bobby Jones." These golf ball
ventures were introduced primarily as promotional efforts and were not
commercially successful.
The Company has determined that Callaway Golf Ball Company will enter the
golf ball business by creating, developing and manufacturing golf balls in a
new plant constructed just for this purpose. The successful implementation of
the Company's strategy could be adversely affected by various risks, including,
among others, delays in product development, construction delays and
unanticipated costs. There can be no assurance as to if and when a successful
golf ball product will be developed or that the Company's investments will
ultimately be realized.
The Company's golf ball business is still in the developmental stage and, by
plan, has had a significant negative impact on the Company's cash flows and
results of operations and will continue to do so during 1999. The Company
believes that many of the same factors that affect the golf equipment industry,
including growth rate in the golf equipment industry, intellectual property
rights of others, seasonality and new product introductions, also apply to the
golf ball business. In addition, the golf ball business is highly competitive
with a number of well-established and well-financed competitors. These
competitors have established market share in the golf ball business, which the
Company will need to penetrate for its golf ball business to be successful.
YEAR 2000 ISSUE
Historically, many computer programs have been written using two digits rather
than four to define the applicable year, which could result in the program
failing to properly recognize a year that begins with "20" instead of "19."
This, in turn, could result in major system failures or miscalculations, and is
generally referred to as the "Year 2000" or "Y2K" issue.
While the Company's own products do not contain date-based functionality and
are not susceptible to the Y2K issue, much of the Company's operations
incorporate or are affected by systems which may contain date-based
functionality. Therefore, the Company has formulated a Year 2000 Plan to
address the Company's Y2K issue. The Company's Year 2000 Plan contemplates four
phases -- assessment, remediation, testing and release/installation -- which
will overlap to a significant degree. The Company's own internal critical
systems and key suppliers are the primary areas of focus. The Company believes
critical systems and key suppliers are those systems or suppliers, which, if
they are not Y2K compliant, may disrupt the Company's manufacturing, sales or
distribution capabilities in a material manner.
The assessment phase involves an inventory, prioritization and preliminary
evaluation of the Y2K compliance of the Company's key systems (e.g., hardware,
software and embedded systems) and critical suppliers and customers (e.g.,
component suppliers, vendors, customers, utilities and other service providers)
on which the Company relies to operate its business. The Company estimates the
assessment phase to be approximately 90% complete.
During the assessment phase it was determined that over 450 of the Company's
key systems were considered critical to the ongoing operations of the Company.
Of these critical systems, the manufacturer certifies that approximately 60%
are Y2K compliant, and the compliance of approximately 33% of the systems is
undeterminable until they can be tested. Those systems tested and found not to
be Y2K compliant, as well as the remaining 7% which are not Y2K compliant, will
be fixed on the schedule discussed below.
Also in connection with the assessment phase, the Company has been assessing
the compliance of its critical suppliers and customers. The Company relies on
suppliers for timely delivery of a broad range of goods and services worldwide,
including components for its golf clubs. Moreover, the Company's suppliers rely
on countless other suppliers, over which the Company has little or no influence
regarding Y2K compliance. The level of preparedness of critical suppliers and
customers can vary greatly from country to country. The Company believes that
critical suppliers and customers present an area of significant risk to the
Company in part because of the Company's limited ability to influence actions
of third parties, and in part because of the Company's inability to estimate
the level and impact of noncompliance of third parties throughout the extended
supply chain.
The Company has received information concerning the Y2K compliance status of
critical suppliers and customers in response to extensive inquiries initiated
in the Fall of 1998 to determine the extent to which the Company is vulnerable
to those third parties' failure to remediate their own Y2K issues. The process
of evaluating these suppliers and selected customers is continuing and is
expected to be completed by the fourth quarter of 1999.
The Company has commenced the remediation phase and begun to identify and
implement remediation options for its critical systems. The Company expects to
complete this phase by mid-1999. Remediation for key systems will primarily
include altering the product or software code, upgrading or replacing the
product, recommending changes in how the product is used or retiring the
product.
In October 1997, the Company implemented a new business computer system,
which runs most of the Company's data processing and financial reporting
software applications and has in part addressed remediation issues Company-
wide. The manufacturer of the application software used on the new computer
system has represented that the software addresses the Y2K issue, although
recent testing of the software indicates that some level of remediation may be
required. The information systems of the majority of the Company's subsidiaries
have now been converted to the new system, and the Company anticipates
converting the remaining material subsidiaries by mid-year 1999.
The Company presently plans to have completed the four phases with respect
to those systems which are critical to its operations no later than the end of
the third quarter of 1999. Some non-critical systems may not be addressed until
after January 2000.
The total cost associated with assessment and required modifications to
implement the Company's Year 2000 Plan is not expected to be material to the
Company's financial position. The Company currently estimates that the total
cost of implementing its Year 2000 Plan will not exceed $6.0 million. This
preliminary estimate is based on presently available information and will be
updated as the Company continues its assessment and proceeds with
implementation. In particular, the estimate may need to be increased once the
Company has formulated its contingency plan. The total amount expended on the
Year 2000 Plan through December 1998 was $633,000, of which approximately
$414,000 related to repair or replacing of software and related hardware
problems and approximately $219,000 related to internal and external labor
costs.
If the Company's new business computer system fails due to the Y2K issue, or
if any computer hardware or software applications or embedded systems critical
to the Company's manufacturing, shipping or other processes are overlooked, or
if the remaining subsidiary conversions are not made or are not completed
timely, there could be a material adverse impact on the business operations and
financial performance of the Company. Additionally, there can be no assurance
that the Company's critical suppliers and customers will not experience a Y2K-
related failure that could have a material adverse effect on the business
operations or financial performance of the Company. In particular, if third
party suppliers, due to the Y2K issue, fail to provide the Company with
components or materials which are necessary to manufacture its products, with
sufficient electric power and other utilities to sustain its manufacturing
process, or with adequate, reliable means of transporting its products to its
customers worldwide, then any such failure could have a material adverse effect
on the business operations and financial performance of the Company.
The Company has not yet established a contingency plan, but intends to
formulate one to address unavoided or unavoidable risks and expects to have the
contingency plan formulated by July 1999. In particular, with respect to third
party component suppliers, the Company will develop contingency plans for
suppliers determined to be at high risk of noncompliance or business
disruption. The contingency plans are being developed on a case-by-case basis,
and may include booking orders and producing products before anticipated
business disruptions. Even so, judgments regarding contingency plans -- such as
how to develop them and to what extent -- are themselves subject to many
variables and uncertainties. There can be no assurance that the Company will
correctly anticipate the level, impact or duration of noncompliance by
suppliers that provide inadequate information. As a result, there is no
certainty that the Company's contingency plans will be sufficient to mitigate
the impact of noncompliance by suppliers, and some material adverse effect to
the Company may result from one or more third parties regardless of defensive
contingency plans.
Estimates of time, cost, and risk are based on currently available
information. Developments that could affect estimates include, but are not
limited to, the availability and cost of trained personnel; the ability to
locate and correct all relevant computer software code and systems; cooperation
and remediation success of the Company's suppliers and customers (and their
suppliers and customers); and the ability to correctly anticipate risks and
implement suitable contingency plans in the event of system failures at the
Company or its suppliers and customers (and their suppliers and customers).
EURO CURRENCY
Many of the countries in which the Company sells its products are Member States
of the Economic and Monetary Union ("EMU"). Beginning January 1, 1999 Member
States of the EMU have the option of trading
in either their local currencies or the euro, the official currency of EMU
participating Member States. Parties are free to choose the unit they prefer in
contractual relationships during the transitional period, beginning January
1999 and ending June 2002. The Company has installed a new computer system that
supports sales throughout Europe. This new system runs substantially all of the
principal data processing and financial reporting software for such sales. The
Company anticipates that, after the implementation of an upgrade, the new
system will contain the functionality to process transactions in either a
country's local currency or euro. The implementation of this upgrade, which is
part of a larger plan to update the Company's enterprise-wide software to the
manufacturer's current version, is planned to take place during 2000. Until
such time as the upgrade has occurred, transactions denominated in euro will be
processed manually. The Company does not anticipate a large demand from its
customers to transact in euros. Additionally, the Company does not believe that
it will incur material costs specifically associated with manually processing
data or preparing its business systems to operate in either the transitional
period or beyond. However, there can be no assurance that the conversion of EMU
Member States to euro will not have a material adverse effect on the Company
and its operations.
MARKET RISK
The Company is exposed to the impact of foreign currency fluctuations due to
its international operations and certain export sales. The Company is exposed
to both transactional currency/functional currency and functional
currency/reporting currency exchange rate risks. In the normal course of
business, the Company employs established policies and procedures to manage its
exposure to fluctuations in the value of foreign currencies. During 1998, the
Company entered into forward foreign currency exchange rate contracts to hedge
payments due on intercompany transactions by one of its wholly-owned foreign
subsidiaries, Callaway Golf Europe Ltd. The effect of this practice is to
minimize variability in the Company's operating results arising from foreign
exchange rate movements. These foreign exchange contracts generally do not
subject the Company to risk due to exchange rate movements because gains and
losses on these contracts offset losses and gains on the intercompany
transactions being hedged, and the Company does not engage in hedging contracts
which exceed the amounts of the intercompany transactions.
However, pursuant to its new foreign exchange hedging policy, beginning in
January 1999, the Company also may use forward foreign currency exchange rate
contracts to hedge certain firm commitments and the related receivables and
payables with other foreign subsidiaries. Additionally, the Company expects
that it also may hedge anticipated transactions denominated in foreign
currencies using forward foreign currency exchange rate contracts and put or
call options, which may be combined to form range forwards. Foreign currency
derivatives will be used only to the extent considered necessary to meet the
Company's objectives and the Company does not enter into forward contracts for
speculative purposes. The Company's foreign currency exposures include most
European currencies, Japanese yen, Canadian dollar and Korean won.
Additionally, the Company is exposed to interest rate risk from its Credit
Facilities (see Notes 4 and 16 to the Company's Consolidated Financial
Statements) which are indexed to the London Interbank Offering Rate ("LIBOR").
Sensitivity analysis is the measurement of potential loss in future earnings
of market sensitive instruments resulting from one or more selected
hypothetical changes in interest rates or foreign currency values. The Company
used a sensitivity analysis model to quantify the estimated potential effect of
unfavorable movements of 10% in foreign currencies to which the Company was
exposed at December 31, 1998 under its derivative financial instruments.
The sensitivity analysis model is a risk analysis tool and does not purport
to represent actual losses in earnings that will be incurred by the Company,
nor does it consider the potential effect of favorable changes in market rates.
It also does not represent the maximum possible loss that may occur. Actual
future gains and losses will differ from those estimated because of changes or
differences in market rates and interrelationships, hedging instruments and
hedge percentages, timing and other factors.
The estimated maximum one-day loss in earnings from the Company's foreign-
currency derivative financial instruments, calculated using the sensitivity
analysis model described above, is $1.2 million at December 31, 1998. The
Company believes that such a hypothetical loss from its derivatives would be
offset by increases in the value of the underlying transactions being hedged.
Notes 2 and 4 to the Consolidated Financial Statements outline the principal
amounts, weighted-average interest rates, fair values and other terms required
to evaluate the expected cash flows and sensitivity to interest rate changes.
CONSOLIDATED BALANCE SHEET
(in thousands, except share and per share data) December 31,
1998 1997
- ------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 45,618 $ 26,204
Accounts receivable, net 73,466 124,470
Inventories, net 149,192 97,094
Deferred taxes 51,029 23,810
Other current assets 4,301 10,208
- ------------------------------------------------------------------------------------------------------------------------------
Total current assets 323,606 281,786
Property, plant and equipment, net 172,794 142,503
Intangible assets, net 127,779 112,141
Other assets 31,648 25,284
- ------------------------------------------------------------------------------------------------------------------------------
$ 655,827 $ 561,714
==============================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 35,928 $ 30,063
Accrued employee compensation and benefits 11,083 14,262
Accrued warranty expense 35,815 28,059
Line of credit 70,919
Note payable 12,971
Accrued restructuring costs 7,389
Income taxes payable 9,903
- ------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 184,008 72,384
Long-term liabilities:
Deferred compensation 7,606 7,905
Accrued restructuring costs 11,117
Commitments and contingencies (Note 10)
Shareholders' equity:
Preferred Stock, $.01 par value, 3,000,000 shares
authorized, none issued
and outstanding at December 31, 1998 and 1997
Common Stock, $.01 par value, 240,000,000 shares
authorized, 75,095,087
and 74,251,664 issued and outstanding at December 31, 1998 and 1997 751 743
Paid-in capital 258,015 337,403
Unearned compensation (5,653) (3,575)
Retained earnings 252,528 298,728
Accumulated other comprehensive income 1,780 (559)
Less: Grantor Stock Trust (5,300,000 shares at December
31, 1998
and 1997) at market (Note 5) (54,325) (151,315)
- ------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 453,096 481,425
- ------------------------------------------------------------------------------------------------------------------------------
$ 655,827 $ 561,714
==============================================================================================================================
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data) Year ended December 31,
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------------
Net sales $697,621 100% $842,927 100% $678,512 100%
Cost of goods sold 401,607 58% 400,127 47% 317,353 47%
- ----------------------------------------------------------------------------------------------------------------------------------
Gross profit 296,014 42% 442,800 53% 361,159 53%
Selling expenses 147,022 21% 120,589 14% 80,701 12%
General and administrative expenses 98,048 14% 70,724 8% 74,476 11%
Research and development costs 36,848 5% 30,298 4% 16,154 2%
Restructuring costs 54,235 8%
Litigation settlement 12,000 1%
- ----------------------------------------------------------------------------------------------------------------------------------
(Loss) income from operations (40,139) (6%) 209,189 25% 189,828 28%
Interest and other income, net 3,911 4,586 5,804
Interest expense (2,671) (10) (37)
- ----------------------------------------------------------------------------------------------------------------------------------
(Loss) income before income taxes (38,899) (6%) 213,765 25% 195,595 29%
Income tax (benefit) provision (12,335) 81,061 73,258
- ----------------------------------------------------------------------------------------------------------------------------------
Net (loss) income $(26,564) (4%) $132,704 16% $122,337 18%
==================================================================================================================================
(Loss) earnings per common share
Basic $ (0.38) $ 1.94 $ 1.83
Diluted $ (0.38) $ 1.85 $ 1.73
Common equivalent shares
Basic 69,463 68,407 66,832
Diluted 69,463 71,698 70,661
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands) Year ended December 31,
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net (loss) income $(26,564) $ 132,704 $122,337
Adjustments to reconcile net (loss) income to net cash provided
by operating activities:
Depreciation and amortization 35,885 19,408 12,691
Non-cash compensation 2,887 2,041 1,919
Tax benefit from exercise of stock options 3,068 29,786 14,244
Deferred taxes (36,235) 1,030 (4,420)
Non-cash restructuring costs 25,497
Loss (gain) on disposal of assets 1,298 2 (17)
Changes in assets and liabilities, net of effects from acquisitions:
Accounts receivable, net 51,575 (36,936) 3,510
Inventories, net (42,665) 6,271 (44,383)
Other assets (12,149) (6,818) (12,872)
Accounts payable and accrued expenses (4,357) 13,529 (15,395)
Accrued employee compensation and benefits (3,411) (2,437) 2,031
Accrued warranty expense 7,760 756 3,534
Income taxes payable 9,652 (2,636) 626
Accrued restructuring costs 7,389
Other liabilities (299) 2,796 2,902
Accrued restructuring costs - long-term 11,117
- ---------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 30,448 159,496 86,707
- ---------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (67,859) (67,938) (35,352)
Acquisitions, net of cash acquired (10,672) (129,256) (610)
Proceeds from sale of assets 3,417 72 72
- ---------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (75,114) (197,122) (35,890)
- ---------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net proceeds from line of credit 70,919
Proceeds from note payable 12,971
Short-term debt retirement (10,373)
Issuance of Common Stock 10,343 27,530 14,533
Retirement of Common Stock (917) (52,985)
Dividends paid, net (19,485) (19,123) (16,025)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 63,458 (44,578) (1,492)
- ---------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 622 (49) (25)
- ---------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 19,414 (82,253) 49,300
Cash and cash equivalents at beginning of year 26,204 108,457 59,157
- ---------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 45,618 $ 26,204 $108,457
- ---------------------------------------------------------------------------------------------------------------------------
Supplemental disclosures:
Cash paid for interest $ 2,162 $ 10 $ 37
Cash paid for income taxes $ 8,165 $ 54,358 $ 62,938
===========================================================================================================================
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands) Accumulated Current
Other Year's
Common Stock Paid-In Unearned Retained Comprehensive Comprehensive
--------------
Shares Amount Capital Compensation Earnings Income GST Total Income
- --------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 70,912 $ 709 $214,846 $ (2,420) $131,801 $ (89) $ (119,913) $224,934
- --------------------------------------------------------------------------------------------------------------------------------
Exercise of stock options 1,775 18 12,240 12,258
Tax benefit from exercise of
stock options 14,244 14,244
Compensatory stock and stock
options 2,604 (685) 1,919
Employee stock purchase plan 168 2 2,273 2,275
Cash dividends (17,297) (17,297)
Dividends on shares held by GST 1,272 1,272
Adjustment of GST shares to
market value 32,462 (32,462)
Equity adjustment from foreign
currency translation 325 325 $ 325
Net income 122,337 122,337 122,337
- --------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 72,855 729 278,669 (3,105) 238,113 236 (152,375) 362,267 $ 122,662
- --------------------------------------------------------------------------------------------------------------------------------
Exercise of stock options 2,877 29 21,529 21,558
Tax benefit from exercise of
stock options 29,786 29,786
Compensatory stock and stock
options 2,511 (470) 2,041
Employee stock purchase plan 372 4 5,968 5,972
Stock retirement (1,852) (19) (52,966) (52,985)
Cash dividends (20,607) (20,607)
Dividends on shares held by GST 1,484 1,484
Adjustment of GST shares to
market value (1,060) 1,060
Equity adjustment from
foreign currency translation (795) (795) $ (795)
Net income 132,704 132,704 132,704
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 74,252 743 337,403 (3,575) 298,728 (559) (151,315) 481,425 $ 131,909
- -------------------------------------------------------------------------------------------------------------------------------
Exercise of stock options 391 4 4,433 4,437
Tax benefit from exercise
of stock options 3,068 3,068
Issuance of Restricted
Common Stock 130 1 4,029 (4,030)
Cancellation of Restricted
Common Stock (19) (597) 597
Compensatory stock and stock
options 1,532 1,355 2,887
Employee stock purchase plan 386 4 5,902 5,906
Stock retirement (45) (1) (765) (151) (917)
Cash dividends (20,969) (20,969)
Dividends on shares held
by GST 1,484 1,484
Adjustment of GST shares to
market value (96,990) 96,990
Equity adjustment from
foreign currency
translation 2,339 2,339 $ 2,339
Net loss (26,564) (26,564) (26,564)
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 75,095 $ 751 $258,015 $ (5,653) $252,528 $ 1,780 $ (54,325) $453,096 $ (24,225)
===============================================================================================================================
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1
THE COMPANY
- --------------------------------------------------------------------------------
Callaway Golf Company ("Callaway Golf" or the "Company") is a California
corporation formed in 1982. The Company designs, develops, manufactures and
markets high-quality, innovative golf clubs. Callaway Golf's primary products
include Big Bertha(R) metal woods with the War Bird(R) soleplate, Great Big
Bertha(R) titanium metal woods, Biggest Big Bertha(R) titanium drivers, Big
Bertha(R) Steelhead(TM) metal woods, Big Bertha(R) irons, Great Big Bertha(R)
Tungsten(R) Titanium(TM) irons, Big Bertha(R) X-12(TM) irons, Odyssey(R)
putters and wedges and various other putters.
NOTE 2
SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its subsidiaries, Callaway Golf Sales Company, Callaway Golf Ball Company,
Odyssey Golf, Inc. ("Odyssey"), CGV, Inc., All-American Golf LLC ("All-
American"), Callaway Golf Media Ventures ("CGMV"), Callaway Golf Europe Ltd.,
ERC International Company, Callaway Golf (Germany) GmbH, Callaway Golf Canada
Ltd., Callaway Golf Korea Ltd. and Callaway Golf Europe, S.A. All significant
intercompany transactions and balances have been eliminated.
FINANCIAL STATEMENT PREPARATION
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Examples of such estimates include provisions for warranty, uncollectible
accounts receivable, inventory obsolescence and restructuring costs (Note 11).
Actual results could differ from those estimates, which could materially affect
future results of operations.
REVENUE RECOGNITION
Sales are recognized at the time goods are shipped, net of an allowance for
sales returns.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist of cash and cash equivalents, trade
receivables and payables, forward foreign currency exchange contracts, its
revolving line of credit and note payable (Note 4). The carrying amounts of
these instruments approximate fair value because of their short maturities and
variable interest rates.
ADVERTISING COSTS
The Company advertises primarily through television and print media. The
Company's policy is to expense advertising costs, including production costs,
as incurred. Advertising expenses for 1998, 1997 and 1996 were $32,944,000,
$20,320,000 and $18,321,000, respectively.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The accounts of the Company's foreign subsidiaries have been translated into
United States dollars at appropriate rates of exchange. Cumulative translation
gains or losses are recorded as accumulated other comprehensive income in
shareholders' equity. Gains or losses resulting from foreign currency
transactions (transactions denominated in a currency other than the entity's
local currency) are included in the consolidated statement of operations. The
Company recorded transaction gains of $1,598,000 in 1998 and transaction losses
of $940,000 in 1997. The amounts recorded as a result of foreign currency
transactions in 1996 were not material.
During 1998, 1997 and 1996, the Company entered into forward foreign
currency exchange rate contracts to hedge payments due on intercompany
transactions by one of its wholly-owned foreign subsidiaries, Callaway Golf
Europe Ltd. Realized and unrealized gains and losses on these contracts are
recorded in income. The effect of this practice is to minimize variability in
the Company's operating results arising from foreign exchange rate movements.
The Company does not engage in foreign currency speculation. These foreign
exchange contracts generally do not subject the Company to risk due to exchange
rate movements because gains and losses on these contracts offset losses and
gains on the intercompany transactions being hedged, and the Company does not
engage in hedging contracts which exceed the amount of the intercompany
transactions. At December 31, 1998, 1997 and 1996,
the Company had approximately $11,543,000, $2,575,000 and $5,774,000,
respectively, of foreign exchange contracts outstanding. The contracts
outstanding at December 31, 1998 mature between January and June of 1999. The
Company had net realized and unrealized gains on foreign exchange contracts of
$57,000 and $261,000 in 1998 and 1997, respectively, and net realized and
unrealized losses of $521,000 in 1996.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement establishes
accounting and reporting standards for derivative instruments and hedging
activities and requires that an entity recognize all derivatives as either
assets or liabilities in the balance sheet and measure those instruments at
fair value. Changes in the fair value of derivatives are recorded each period
in income or other comprehensive income, depending on whether the derivatives
are designated as hedges and, if so, the types of hedges. SFAS No. 133 is
effective for all periods beginning after June 15, 1999; the Company has
elected to early adopt SFAS No. 133 on January 1, 1999.
Adoption of this statement does not significantly affect the way in which
the Company currently accounts for derivatives to hedge payments due on
intercompany transactions, as described above. Accordingly, no cumulative-
effect-type adjustments will be made. However, the Company expects that it also
may hedge anticipated transactions denominated in foreign currencies using
forward foreign currency exchange rate contracts and put or call options, which
may be combined to form range forwards. The forward contracts used to hedge
anticipated transactions will be recorded as either assets or liabilities in
the balance sheet at fair value. Gains and losses on such contracts will be
recorded in other comprehensive income and will be recorded in income when the
anticipated transaction occurs. The ineffective portion of all hedges will be
recognized in current period earnings. Due to its current and expected future
limited use of derivative instruments, the Company does not expect that the
adoption of SFAS No. 133 will have a material impact on its results of
operations or financial position.
EARNINGS PER COMMON SHARE
Basic earnings per common share is calculated by dividing net income for the
period by the weighted-average number of common shares outstanding during the
period. Diluted earnings per common share is calculated by dividing net income
for the period by the weighted-average number of common shares outstanding
during the period, increased by dilutive potential common shares ("dilutive
securities") that were outstanding during the period. Dilutive securities
include shares owned by the Callaway Golf Company Grantor Stock Trust (Note 5),
options issued pursuant to the Company's stock option plans (Note 7), potential
shares related to the Employee Stock Purchase Plan (Note 7) and rights to
purchase preferred shares under the Callaway Golf Company Shareholder Rights
Plan (Note 7). Dilutive securities related to the Callaway Golf Company Grantor
Stock Trust and the Company's stock option plans are included in the
calculation of diluted earnings per common share using the treasury stock
method. Dilutive securities related to the Employee Stock Purchase Plan are
calculated by dividing the average withholdings during the period by 85% of the
lower of the offering period price or the market value at the end of the
period. The dilutive effect of rights to purchase preferred shares under the
Callaway Golf Shareholder Rights Plan have not been included as dilutive
securities because the conditions necessary to cause these rights to be
redeemed were not met. A reconciliation of the numerators and denominators of
the basic and diluted earnings per common share calculations for the years
ended December 31, 1998, 1997 and 1996 is presented in Note 6.
CASH EQUIVALENTS
Cash equivalents are highly liquid investments purchased with maturities of
three months or less.
The acquisition of substantially all of the assets and certain liabilities
of Odyssey Sports, Inc. (Note 13) and the repurchase and retirement of certain
of the Company's outstanding Common Stock necessitated the sale of certain
held-to-maturity debt securities with amortized costs of $115,428,000 and
$31,805,000, respectively, during 1997. These securities were purchased at a
discount and were sold within two weeks to two months of their respective
stated maturity dates. As such, the securities are considered to be sold at
maturity under the provisions of SFAS No. 115 "Accounting for Certain
Investments in Debt and Equity Securities." No realized or unrealized gains or
losses resulted from the sales of these securities.
INVENTORIES
Inventories are valued at the lower of cost or market. Cost is determined using
the first-in, first-out (FIFO) method.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over estimated useful
lives of three to fifteen years. Repair and maintenance costs are charged to
expense as incurred. The Company's property, plant and equipment are
depreciated over the following periods:
----------------------------------------------------
Buildings and improvements 10-15 years
Machinery and equipment 5 years
Furniture, computers and equipment 3-5 years
Production molds 3 years
----------------------------------------------------
Normal repairs and maintenance are expensed as incurred. Expenditures that
materially increase values, change capacities or extend useful lives are
capitalized. Replacements are capitalized and the property, plant, and
equipment accounts are relieved of the items being replaced. The related costs
and accumulated depreciation of disposed assets are eliminated and any
resulting gain or loss on disposition is included in income.
LONG-LIVED ASSETS
The Company assesses potential impairments of its long-lived assets when there
is evidence that events or changes in circumstances have made recovery of the
asset's carrying value unlikely. An impairment loss would be recognized when
the sum of the expected future net cash flows is less than the carrying amount
of the asset. During the fourth quarter of 1998, the Company implemented a
restructuring plan that included a number of cost reduction actions and
operational improvements (Note 11). As a result of this plan, impairment losses
were recorded for certain of the Company's long-lived assets.
INTANGIBLE ASSETS
Intangible assets consist primarily of trade name, trademark, trade dress,
patents and goodwill resulting from the purchase of substantially all of the
assets and certain liabilities of Odyssey Sports, Inc. and goodwill associated
with the purchase of certain foreign distributors (Note 13). Intangible assets
are amortized using the straight-line method over periods ranging from three to
40 years. During 1998 and 1997, amortization of intangible assets was
$5,466,000 and $1,778,000 respectively. Amortization expense for the year ended
December 31, 1996 was not material.
STOCK-BASED COMPENSATION
The Company measures compensation expense for its stock-based employee
compensation plans using the intrinsic value method. Pro forma disclosures of
net income and earnings per share, as if the fair value-based method had been
applied in measuring compensation expense, are presented in Note 7.
INCOME TAXES
Current income tax expense is the amount of income taxes expected to be payable
for the current year. A deferred income tax asset or liability is established
for the expected future consequences resulting from differences in the
financial reporting and tax bases of assets and liabilities. Deferred income
tax expense (benefit) is the net change during the year in the deferred income
tax asset or liability.
Deferred taxes have not been provided on the cumulative undistributed
earnings of foreign subsidiaries since such amounts are expected to be
reinvested indefinitely. The Company provides a valuation allowance for its
deferred tax assets when, in the opinion of management, it is more likely than
not that such assets will not be realized.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." This statement requires that all components of
comprehensive income be reported in the financial statements in the period in
which they are recognized. The components of comprehensive income for the
Company include net income and foreign currency translation adjustments. Since
the Company has elected the indefinite reversal criterion, it does not accrue
income taxes on foreign currency translation adjustments. The financial
statements of prior periods presented have been reclassified for comparative
purposes.
SEGMENT INFORMATION
Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." This statement requires
disclosure of certain information about the Company's operating segments,
products, geographic areas in which it operates and its major customers. This
information is presented in Note 14.
DIVERSIFICATION OF CREDIT RISK
The Company's financial instruments that are subject to concentrations of
credit risk consist primarily of cash equivalents and trade receivables.
The Company may invest its excess cash in money market accounts and U.S.
Government securities and has established guidelines relative to
diversification and maturities in an effort to maintain safety and liquidity.
These guidelines are periodically reviewed and modified to take advantage of
trends in yields and interest rates. During 1998, no investments in U.S.
Government securities were held.
The Company operates in the golf equipment industry and primarily sells its
products to golf equipment retailers and foreign distributors. The Company
performs ongoing credit evaluations of its customers' financial condition and
generally requires no collateral from these customers. The Company maintains
reserves for potential credit losses, which it considers adequate to cover any
such losses.
During 1998, 1997, and 1996, approximately 38%, 35% and 32%, respectively,
of the Company's net sales were made to foreign customers. An adverse change in
either economic conditions abroad or the Company's relationship with
significant distributors could negatively impact the volume of the Company's
international sales and the Company's results of operations.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform with the current
period presentation.
NOTE 3
SELECTED FINANCIAL STATEMENT INFORMATION
- --------------------------------------------------------------------------------
(in thousands) December 31,
1998 1997
- -------------------------------------------------------------------------------------
Cash and cash equivalents:
Cash, interest bearing $ 41,689 $ 24,438
Cash, non-interest bearing 3,929 1,766
- -------------------------------------------------------------------------------------
$ 45,618 $ 26,204
=====================================================================================
Accounts receivable, net:
Trade accounts receivable $ 83,405 $131,516
Allowance for doubtful
accounts (9,939) (7,046)
- -------------------------------------------------------------------------------------
$ 73,466 $124,470
=====================================================================================
Inventories, net:
Raw materials $102,352 $ 47,780
Work-in-process 1,820 3,083
Finished goods 81,868 51,905
- -------------------------------------------------------------------------------------
186,040 102,768
Reserve for obsolescence (36,848) (5,674)
- -------------------------------------------------------------------------------------
$149,192 $ 97,094
=====================================================================================
Property, plant and equipment, net:
Land $ 13,375 $ 16,398
Buildings and improvements 55,307 51,797
Machinery and equipment 57,334 45,332
Furniture, computers and
equipment 55,629 48,071
Production molds 17,472 13,690
Construction-in-process 52,920 19,361
- -------------------------------------------------------------------------------------
252,037 194,649
Accumulated depreciation (79,243) (52,146)
- -------------------------------------------------------------------------------------
$172,794 $142,503
=====================================================================================
Intangible assets:
Trade name $ 69,629 $ 69,629
Trademark and trade dress 29,841 29,841
Patents, goodwill and other 35,765 14,641
- -------------------------------------------------------------------------------------
135,235 114,111
Accumulated amortization (7,456) (1,970)
- -------------------------------------------------------------------------------------
$127,779 $112,141
- -------------------------------------------------------------------------------------
Accounts payable and accrued
expenses:
Accounts payable $ 10,341 $ 18,379
Note to related party (Note 15) 6,766
Accrued expenses 18,821 11,684
- -------------------------------------------------------------------------------------
$ 35,928 $ 30,063
=====================================================================================
Accrued employee compensation and
benefits:
Accrued payroll and taxes $ 6,178 $ 9,729
Accrued vacation and sick pay 4,423 4,092
Accrued commissions 482 441
- -------------------------------------------------------------------------------------
$ 11,083 $ 14,262
=====================================================================================
- --------------------------------------------------------------------------------
NOTE 4
BANK LINE OF CREDIT AND NOTE PAYABLE
- --------------------------------------------------------------------------------
On December 30, 1998, the Company replaced its existing bank line of credit
with a $75,000,000 interim revolving credit facility. The credit facility is
secured by substantially all of the assets of the Company and bears interest
at the London Interbank Offering Rate ("LIBOR") plus a fixed interest margin.
Proceeds from the initial borrowing on the closing date were used to repay the
Company's existing indebtedness under a revolving loan agreement dated as of
February 4, 1998. The credit facility will be used to support working capital
and general corporate needs, including the issuance of letters of credit. As
of December 31, 1998, $2,951,000 of the credit facility remained available for
borrowings, including a reduction of $1,130,000 for outstanding letters of
credit. The credit facility requires the Company to maintain certain minimum
financial ratios including a fixed charge coverage ratio, as well as other
restrictive covenants.
On February 12, 1999, the Company consummated the amendment of its credit
facility to increase the facility to up to $120,000,000. Also effective on
February 12, 1999, the Company entered into an $80,000,000 accounts receivable
securitization (Note 16).
On December 30, 1998, Callaway Golf Ball Company, a wholly-owned subsidiary
of the Company, entered into a master lease agreement for the acquisition and
lease of approximately $56,000,000 of machinery and equipment. This lease
program is expected to commence during the second quarter of 1999 and includes
an interim finance agreement (the "Finance Agreement"). The Finance Agreement
provides pre-lease financing advances for the acquisition and installation
costs of the aforementioned machinery and equipment. The Finance Agreement
bears interest at LIBOR plus a fixed interest margin and is secured by the
underlying machinery and equipment and a corporate guarantee from the Company.
As of December 31, 1998, $12,971,000 was outstanding under this facility.
NOTE 5
GRANTOR STOCK TRUST
- --------------------------------------------------------------------------------
In July 1995, the Company established the Callaway Golf Company Grantor Stock
Trust (the "GST"). In conjunction with the formation of the GST, the Company
sold 4,000,000 shares of newly issued Common Stock to the GST at a purchase
price of $60,575,000 ($15.14 per share). In December 1995, the Company sold an
additional 1,300,000 shares of newly issued Common Stock to the GST at a
purchase price of $26,263,000 ($20.20 per share). The sale of these shares had
no net impact on shareholders' equity. During the term of the GST, shares in
the GST may be used to fund the Company's obligations with respect to one or
more of the Company's non-qualified or qualified employee benefit plans.
Shares owned by the GST are accounted for as a reduction to shareholders'
equity until used in connection with employee benefits. Each period, the
shares owned by the GST are valued at the closing market price, with
corresponding changes in the GST balance reflected in capital in excess of par
value.
- --------------------------------------------------------------------------------
NOTE 6
EARNINGS PER COMMON SHARE
- --------------------------------------------------------------------------------
The schedule below summarizes the elements included in the calculation of
basic and diluted (loss) earnings per common share for the years ended
December 31, 1998, 1997 and 1996.
For the year ended December 31, 1998, all dilutive securities were excluded
from the calculation of diluted loss per share, as their effect would have
been antidilutive. For the years ended December 31, 1997 and 1996, 917,000 and
269,000 options, respectively, were excluded from the calculations, as their
effect would have been antidilutive.
(in thousands, except per share data) Year ended December 31,
- --------------------------------------------------------------------------------------------------
1998 1997 1996
Net (loss) income $(26,564) $132,704 $122,337
- --------------------------------------------------------------------------------------------------
Weighted-average shares outstanding:
Weighted-average shares outstanding - Basic 69,463 68,407 66,832
Dilutive securities 3,291 3,829
- --------------------------------------------------------------------------------------------------
Weighted average shares outstanding - Diluted 69,463 71,698 70,661
==================================================================================================
(Loss) earnings per common share
Basic $ (0.38) $ 1.94 $ 1.83
Diluted $ (0.38) $ 1.85 $ 1.73
NOTE 7
STOCK OPTIONS AND RIGHTS
- --------------------------------------------------------------------------------
OPTIONS
The Company had the following fixed stock option plans, under which shares
were available for grant at December 31, 1998: the 1991 Stock Incentive Plan
(the "1991 Plan"), the 1995 Employee Stock Incentive Plan (the "1995 Plan"),
the 1996 Stock Option Plan (the "1996 Plan"), the 1998 Stock Incentive Plan
(the "1998 Plan"), the Promotion, Marketing and Endorsement Stock Incentive
Plan (the "Promotion Plan") and the Non-Employee Directors Stock Option Plan
(the "Directors Plan").
The 1991 Plan, the 1996 Plan and the 1998 Plan permit the granting of
options or other stock awards to the Company's officers, employees and
consultants. Under the 1991 Plan, option prices may be less than the market
value at the date of grant, while under the 1996 Plan and the 1998 Plan
options may not be granted at option prices that are less than fair market
value at the date of grant. The 1995 Plan permits the granting of options or
other stock awards to only employees and consultants of the Company at option
prices that may be less than market value at the date of grant. The 1995 Plan
and the 1996 Plan were amended in 1998 to increase the maximum number of
options to acquire shares of Common Stock to 4,600,000 and 6,000,000 shares,
respectively.
During 1996 and 1995, the Company granted options to purchase shares to two
key officers, under separate plans, in conjunction with terms of their initial
employment (the "Key Officer Plans"). The 1990 Amended and Restated Stock
Option Plan (the "1990 Plan") permitted the granting of options to officers,
employees and consultants. No shares are available for grant under the Key
Officer Plans or the 1990 Plan.
Under the Promotion Plan, shares of Common Stock may be granted in the form
of options or other stock awards to golf professionals and other endorsers at
prices that may be less than the market value of the stock at the grant date.
The Directors Plan permits the granting of options to purchase shares of
Common Stock to Directors of the Company who are not employees, at prices
based on a non-discretionary formula, which currently may not be less than the
market value of the stock at the date of grant.
The following table presents shares authorized, available for future grant and
outstanding under each of the Company's plans as of December 31, 1998:
(in thousands)
- ---------------------------------------------------------------------------------------------------------------
Plan Authorized Available Outstanding
- ---------------------------------------------------------------------------------------------------------------
1990 Plan 4,920 130
1991 Plan 10,000 38 3,447
Promotion Plan 3,560 738 1,211
1995 Plan 4,600 739 3,768
1996 Plan 6,000 2,195 3,805
1998 Plan 500 500
Key Officer Plans 1,100 820
Director Plan 840 92 456
- -------------------------------------------------------------------------------------------------------------
Total 31,520 4,302 13,637
=============================================================================================================
Under the Company's stock option plans, outstanding options vest over
periods ranging from zero to five years from the grant date and expire up to
ten years after the grant date.
The following summarizes stock option transactions for the years ended
December 31, 1998, 1997 and 1996:
(in thousands, except per share data) Year ended December 31,
1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- -----------------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 11,257 $22.41 10,800 $15.03 9,842 $ 9.87
Granted 4,020 25.04 3,406 33.79 2,760 28.47
Exercised (441) 10.16 (2,877) 7.81 (1,775) 7.07
Canceled (1,199) 34.86 (72) 28.81 (27) 16.98
- -----------------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 13,637 $22.62 11,257 $22.41 10,800 $15.03
Options exercisable at end of year 6,039 $17.78 3,453 $12.17 3,939 $ 8.83
- -----------------------------------------------------------------------------------------------------------------------------------
Price range of outstanding options $0.44 - $40.00 $0.44 - $40.00 $0.44 - $34.38
===================================================================================================================================
The following tables summarize additional information about outstanding
stock options at December 31, 1998 and options and other stock awards granted
during 1998:
OPTIONS OUTSTANDING AND EXERCISABLE BY PRICE RANGE AS OF DECEMBER 31, 1998
Weighted-
Average
Number Remaining Weighted- Number Weighted-
Range of Outstanding Contractual Average Exercisable Average
Exercise Prices (in thousands) Life-Years Exercise Price (in thousands) Exercise Price
- -------------------------------------------------------------------------------------------------------------
$ 0 - $10 1,327 3.4 $ 3.21 1,249 $ 2.83
$10 - $25 4,602 4.5 $16.37 2,841 $14.82
$25 - $40 7,708 6.9 $29.68 1,949 $31.63
- -------------------------------------------------------------------------------------------------------------
$ 0 - $40 13,637 5.8 $22.62 6,039 $17.78
=============================================================================================================
OPTIONS AND OTHER STOCK AWARDS GRANTED DURING 1998
Number Weighted-Average
(in thousands) Exercise Price
- -------------------------------------------------------------------------------------------------------------
Exercise price = market value 3,878 $25.88
Exercise price ** market value 5 $28.56
Exercise price * market value 137 $ 1.28
- -------------------------------------------------------------------------------------------------------------
4,020 $25.04
- -------------------------------------------------------------------------------------------------------------
** Greater than
* Less than
During 1998, the Company modified certain terms of 720,000 options held by
directors, certain officers and employees. These modifications, which largely
resulted from the Company's restructuring plan, included acceleration of
vesting and extension of expiration terms at the Company's discretion. At the
time of modification, the exercise prices of the options were in excess of the
then-current market price and accordingly, this action did not result in
compensation expense for the Company.
Also during 1998, the Company canceled 150,000 options held by non-employees
with option prices in excess of the then-current market price of the Company's
stock. The Company then reissued an equivalent number of options at the then-
current market price and extended certain expiration terms, and recorded the
related compensation expense of $71,000. An additional $195,000 was recorded in
unearned compensation, which will be amortized over the remaining vesting
periods.
RIGHTS
The Company has granted officers, consultants, and employees rights to receive
an aggregate of 826,800 shares of Common Stock for services or other
consideration. During 1998, 80,000 rights were exercised while none were
granted. At December 31, 1998, no rights to receive shares of Common Stock
remained outstanding. No rights were granted or exercised during 1997 or 1996.
The Company has a plan to protect shareholders' rights in the event of a
proposed takeover of the Company. Under the plan, each share of the Company's
outstanding Common Stock carries one right to purchase one one-thousandth of a
share of the Company's Series "A" Junior Participating Preferred Stock (the
"Right"). The Right entitles the holder, under certain circumstances, to
purchase Common Stock of Callaway Golf Company or of the acquiring company at a
substantially discounted price ten days after a person or group publicly
announces it has acquired or has tendered an offer for 15% or more of the
Company's outstanding Common Stock. The Rights are redeemable by the Company at
$.01 per Right and expire in 2005.
RESTRICTED COMMON STOCK
During 1998, the Company granted 130,000 shares of Restricted Common Stock to
26 officers of the Company. Of these shares, 19,250 shares have been canceled.
The shares, which are restricted as to sale or transfer until vesting, will
vest on January 1, 2003. The related net compensation expense of $3,433,000 is
being recognized ratably over the vesting period, based on the difference
between the exercise price and market value of the stock on the measurement
date.
EMPLOYEE STOCK PURCHASE PLAN
The Company has an Employee Stock Purchase Plan ("ESPP") whereby eligible
employees may purchase shares of Common Stock at 85% of the lower of the fair
market value on the first day of a two year offering period or the last day of
each six month exercise period. Employees may authorize the Company to withhold
compensation during any offering period, subject to certain limitations. During
1997, the ESPP was amended to increase the maximum number of shares of the
Company's Common Stock that employees may acquire under this plan to 1,500,000
shares. During 1998, 1997 and 1996, the ESPP purchased approximately 386,000,
372,000 and 168,000 shares, respectively, of the Company's Common Stock. As of
December 31, 1998, 574,000 shares were reserved for future issuance.
COMPENSATION EXPENSE
During 1998, 1997, and 1996, the Company recorded $2,321,000, $2,041,000 and
$1,919,000, respectively, in compensation expense for certain options and
rights to purchase shares of Common Stock granted to employees and consultants
of the Company. The valuation of options and rights granted to non-employees is
estimated using the Black-Scholes option pricing model.
Unearned compensation has been charged for the value of options granted to
both employees and non-employees on the measurement date based on the valuation
methods described above. These amounts are amortized over the vesting period.
The unamortized portion of unearned compensation is shown as a reduction of
shareholders' equity in the accompanying consolidated balance sheet.
- --------------------------------------------------------------------------------
PRO FORMA DISCLOSURES
If the Company had elected to recognize compensation expense based upon the
fair value at the grant date for employee awards under these plans, the
Company's net (loss) income and (loss) earnings per share would be changed to
the pro forma amounts indicated below:
(in thousands, Year ended December 31,
except per share data) 1998 1997 1996
- --------------------------------------------------------------------------------
Net (loss) income:
As reported $(26,564) $132,704 $122,337
Pro forma $(46,847) $124,978 $113,587
(Loss) earnings per
common share:
As reported
Basic $ (0.38) $ 1.94 $ 1.83
Diluted $ (0.38) $ 1.85 $ 1.73
Pro forma
Basic $ (0.67) $ 1.83 $ 1.70
Diluted $ (0.67) $ 1.77 $ 1.59
================================================================================
The pro forma amounts reflected above may not be representative of future
disclosures since the estimated fair value of stock options is amortized to
expense as the options vest and additional options may be granted in future
years. The fair value of employee stock options was estimated at the date of
grant using the Black-Scholes option pricing model with the following
assumptions for the years ended December 31, 1998, 1997, and 1996,
respectively:
Year ended December 31,
1998 1997 1996
- --------------------------------------------------------------------------------
Dividend yield 1.9% 0.9% 0.9%
Expected volatility 42.0% 31.5% 31.5%
Risk free interest rates 4.66 - 4.72% 5.64 - 5.89% 5.32 - 7.66%
Expected lives 3 - 6 years 3 - 6 years 2 - 6 years
================================================================================
The weighted-average grant-date fair value of options granted during 1998
was $9.88 per share. 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 8
EMPLOYEE BENEFIT PLANS
- --------------------------------------------------------------------------------
The Company has a voluntary deferred compensation plan under Section 401(k) of
the Internal Revenue Code (the "401(k) Plan") for all employees who satisfy the
age and service requirements under the 401(k) Plan. Each participant may elect
to contribute up to 10% of annual compensation, up to the maximum permitted
under federal law, and the Company is obligated to contribute annually an
amount equal to 100% of the participant's contribution up to 6% of that
participant's annual compensation. Additionally, the Company can make
discretionary contributions based on the profitability of the Company. No
discretionary contributions were made for the years ended December 31, 1998 and
1997. For the year ended December 31, 1996, the Company recorded compensation
expense for discretionary contributions of $6,390,000. Employees contributed to
the 401(k) Plan $5,601,000, $5,384,000 and $3,315,000 in 1998, 1997 and 1996,
respectively. In accordance with the provisions of the 401(k) Plan, the Company
matched employee contributions in the amount of $4,673,000, $4,495,000 and
$1,988,000 during 1998, 1997 and 1996, respectively.
The Company also has an unfunded, nonqualified deferred compensation plan.
The plan allows officers and certain other employees of the Company to defer
all or part of their compensation, to be paid to the participants or their
designated beneficiaries upon retirement, death or separation from the Company.
For the years ended December 31, 1998, 1997 and 1996, the total participant
deferrals, which are reflected in long-term liabilities, were $908,000,
$1,166,000 and $2,564,000, respectively.
- --------------------------------------------------------------------------------
NOTE 9
INCOME TAXES
- --------------------------------------------------------------------------------
The Company's (loss) income before income tax (benefit) provision was subject
to taxes in the following jurisdictions for the following periods:
(in thousands) Year ended December 31,
1998 1997 1996
- --------------------------------------------------------------------------------
Domestic $(34,555) $212,453 $193,170
Foreign (4,344) 1,312 2,425
- --------------------------------------------------------------------------------
$(38,899) $213,765 $195,595
================================================================================
The (benefit) provision for income taxes is as follows:
(in thousands) Year ended December 31,
1998 1997 1996
- --------------------------------------------------------------------------------------------------
Current tax provision:
United States $ 21,345 $ 66,462 $ 65,287
State 2,296 12,419 11,154
Foreign 250 1,150 1,244
Deferred tax (benefit) expense:
United States (31,173) 1,042 (3,911)
State (4,847) 50 (437)
Foreign (206) (62) (79)
- ---------------------------------------------------------------------------------------------------
Income tax (benefit)
provision $(12,335) $ 81,061 $ 73,258
===================================================================================================
During 1998, 1997 and 1996, the Company recognized certain tax benefits
related to stock option plans in the amount of $3,068,000, $29,786,000 and
$14,244,000, respectively. Such benefits were recorded as a reduction of income
taxes payable and an increase in additional paid-in capital.
Significant components of the Company's deferred tax assets and liabilities
as of December 31, 1998 and 1997 are as follows:
(in thousands) December 31,
1998 1997
- -----------------------------------------------------------------------------------
Deferred tax assets:
Reserves and allowances $36,229 $15,914
Depreciation and amortization 7,963 6,107
Deferred compensation 3,100 4,559
Effect of inventory overhead adjustment 4,062 1,555
Compensatory stock options and rights 2,327 1,589
State taxes, net 5
Foreign net operating loss carry forwards 1,074
Other 3,979 702
Restructuring charges
Long-lived asset impairment 1,755
Rental/lease arrangements 5,472
Estimated losses on assets held for disposal 4,335
Capital loss carryforward 685
Other 52
- -----------------------------------------------------------------------------------
Total deferred tax assets 71,033 30,431
Valuation allowance for deferred tax assets (1,759)
- -----------------------------------------------------------------------------------
Net deferred tax assets 69,274 30,431
Deferred tax liabilities:
State taxes, net of federal income tax benefit (2,608)
- -----------------------------------------------------------------------------------
Net deferred tax assets $66,666 $30,431
- -----------------------------------------------------------------------------------
In 1998, the Company established a valuation allowance of $1,759,000 against
certain deferred tax assets, as the Company believes it is more likely than not
that such assets will not be realized. The Company expects to generate pre-tax
income in future years and accordingly, considers the deferred tax asset to be
realizable. The Company did not require a deferred tax asset valuation
allowance at December 31, 1997 or 1996.
- --------------------------------------------------------------------------------
A reconciliation of income taxes computed by applying the statutory U.S.
income tax rate to the Company's (loss) income before income taxes to the
income tax (benefit) provision is as follows:
(in thousands) Year ended December 31,
1998 1997 1996
- ---------------------------------------------------------------------------------------
Amounts computed
at statutory U.S. tax rate $(13,615) $74,816 $68,458
State income taxes, net of
U.S. tax benefit (1,501) 8,105 6,966
Non-deductible foreign losses 1,226
Expenses with no tax benefit 1,064
Non-deductible capital losses 588
Other (97) (1,860) (2,166)
- ---------------------------------------------------------------------------------------
Income tax (benefit) provision $(12,335) $81,061 $73,258
=======================================================================================
U.S. tax return examinations have been completed for the years through 1993.
The Company believes adequate provisions for income tax have been recorded for
all years.
NOTE 10
COMMITMENTS AND CONTINGENCIES
- --------------------------------------------------------------------------------
In the normal course of business, the Company enters into certain long-term
purchase commitments with various vendors. As of December 31, 1998, the Company
has committed to purchase titanium golf clubheads costing approximately
$31,585,000, from one of its vendors. Under the current production schedule,
the clubheads are to be shipped to the Company during 1999.
The Company and its subsidiaries, incident to their business activities, are
parties to a number of legal proceedings, lawsuits and other claims. Such
matters are subject to many uncertainties and outcomes are not predictable with
assurance. Consequently, management is unable to ascertain the ultimate
aggregate amount of monetary liability, amounts which may be covered by
insurance, or the financial impact with respect to these matters as of December
31, 1998. However, management believes that the final resolution of these
matters, individually and in the aggregate, will not have a material adverse
effect upon the Company's annual consolidated financial position, results of
operations or cash flows.
The Company leases certain warehouse, distribution and office facilities
under operating leases. Lease terms range from one to 15 years with options to
renew at varying terms. Commitments for minimum lease payments under non-
cancelable operating leases having initial or remaining non-cancelable terms in
excess of one year as of December 31, 1998 are as follows:
(in thousands)
- ----------------------------------------------------------------------------
1999 $ 4,084
2000 3,748
2001 3,870
2002 4,615
2003 2,827
Thereafter 16,508
- ----------------------------------------------------------------------------
$35,652
============================================================================
Rent expense for the years ended December 31, 1998, 1997 and 1996 was
$17,654,000, $1,760,000 and $1,363,000, respectively. Rent expense for 1998
includes $13,466,000 in excess lease costs related to the Company's
restructuring activities (Note 11).
NOTE 11
RESTRUCTURING
- --------------------------------------------------------------------------------
On November 11, 1998, the Company announced that it had adopted a business plan
that included a number of cost reduction actions and operational improvements.
These actions include: the consolidation of the operations of the Company's
wholly-owned subsidiary, Odyssey, into the operations of the Company while
maintaining the distinct and separate Odyssey(R) brand image; the
discontinuation, transfer or suspension of certain initiatives not directly
associated with the Company's core business, such as the Company's involvement
with interactive golf sites, golf book publishing, new player development and a
golf venue in Las Vegas; and the re-sizing of the Company's core business to
reflect current and expected business conditions. These initiatives are
expected to be largely completed during 1999. As a result of these actions, the
Company recorded one-time charges of $54,235,000 during the fourth quarter of
1998. These charges (shown below in tabular format) primarily relate to: 1) the
elimination of job responsibilities, resulting in costs incurred for employee
severance; 2) the decision to exit certain non-core business activities,
resulting in losses on disposition of the Company's 80% interest in CGMV (Note
15), a loss on the sale of All-American (Note 13), as well as excess lease
costs; and 3) consolidation of the Company's continuing operations resulting in
impairment of assets, losses on disposition of assets and excess lease costs.
- --------------------------------------------------------------------------------
Employee reductions occurred in almost all areas of the Company, including
manufacturing, marketing, sales, and administrative areas. At December 31,
1998, the Company had reduced its non-temporary work force by approximately 750
positions. Although substantially all reductions occurred prior to December 31,
1998, a small number of reductions will occur in the first quarter of 1999.
As part of this plan, the Company elected to consolidate its operations and
to sell certain of its buildings, which housed a portion of its manufacturing
and research and development activities. Other write-downs were recorded during
1998 for idle assets, assets whose manner of use had changed significantly and
equipment replaced as a result of capital improvements. The impaired assets
include buildings, building improvements, and machinery and equipment used in
certain of the Company's manufacturing and research and development
activities .
The projected future cash flows from these assets were less than the
carrying values of the assets. The carrying values of the assets held for sale
and the assets to be held and used were reduced to their estimated fair values
based on independent appraisals of selling values and values of similar assets
sold, less costs to sell. In 1998, the Company recorded losses from impairment
of assets of $12,634,000, which were recorded as a restructuring costs. The
Company expects to complete the dispositions in 1999. At December 31, 1998,
subsequent to the write-down for impairments, the carrying amount of the assets
held for disposal and assets to be held and used was $13,678,000 and
$4,582,000, respectively. Pursuant to SFAS No. 121, "Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of,"
assets to be held and used will continue to be depreciated, while assets held
for disposition will not. The Company does not expect that the effect on
depreciation will materially impact future results of operations.
Details of the one-time charges are as follows:
Reserve
One-Time Balance
(in thousands) Cash/Non-Cash Charge Activity at 12/31/98
- -------------------------------------------------------------------------------------------------------------------------
Elimination of Job Responsibilities $11,664 $ 8,473 $ 3,191
Severance packages Cash 11,603 8,412 3,191
Other Non-cash 61 61
Exiting Certain Non-core Business Activities $28,788 $12,015 $16,773
Loss on disposition of subsidiaries Non-cash 13,072 10,341 2,731
Excess lease costs Cash 12,660 146 12,514
Contract cancellation fees Cash 2,700 1,504 1,196
Other Cash 356 24 332
Consolidation of Operations $13,783 $ 2,846 $10,937
Loss on impairment/disposition of assets Non-cash 12,364 2,730 9,634
Excess lease costs Cash 806 4 802
Other Cash 613 112 501
================================================================================================================================
Future cash outlays are anticipated to be completed by the end of 1999,
excluding certain lease commitments that continue through February 2013.
NOTE 12
LITIGATION SETTLEMENT
- --------------------------------------------------------------------------------
On September 23, 1997, the Company settled a lawsuit brought against it and
certain officers of the Company by a former officer of the Company with the
payment of $12,000,000.
The Company filed suit against certain of its insurers and an insurance
agent seeking coverage for the costs of defending and settling the above
lawsuit (the "coverage litigation"). The insurance agent and one of the
Company's insurers have settled with the Company for an amount that was not
material. This settlement was recorded in general and administrative expenses
as a reduction of legal fees. The coverage litigation against the remaining
insurers has been unsuccessful to date because of court rulings that the claim
was not covered by the applicable insurance policies. The Company is appealing
the adverse coverage decision by the trial court. Although the Company believes
its appeal has merit, no assurance can be given that any additional costs will
be recovered.
- -------------------------------------------------------------------------------
NOTE 13
ACQUISITIONS
- -------------------------------------------------------------------------------
During 1998, the Company acquired distribution rights and substantially all of
the assets from its distributors in Korea, Canada, France, Belgium, Norway and
Denmark, as well as the remaining 20% interest in Callaway Golf Trading GmbH
(Note 15), the results of which are consolidated in the results of Callaway
Golf (Germany) GmbH. The aggregate purchase price for these transactions was
$27,229,000, excluding the assumption and subsequent retirement of short-term
debt obligations of $10,373,000. The excess of the purchase price over net
assets acquired of $20,935,000 was allocated to goodwill and is being amortized
over estimated useful lives of three to 10 years. These acquisitions, along
with the acquisition of the remaining 80% interest in All-American (discussed
below) are not considered significant business combinations. Accordingly, pro
forma financial information is not presented.
In May 1998, the Company acquired for $4,526,000 the remaining 80% interest
in All-American, which operates a nine-hole golf course, performance center,
training facility and driving range located in Las Vegas, Nevada. On December
30, 1998, as part of its business plan to discontinue certain non-core business
activities, the Company sold its interest in All-American in exchange for
barter trade credits, which were recorded at the fair market value of the asset
exchanged. The Company recorded a loss on the disposition of this subsidiary of
$10,341,000 in December 1998 (Note 11).
On August 8, 1997, the Company consummated its acquisition of substantially
all of the assets and certain liabilities of Odyssey Sports, Inc., by its
wholly-owned subsidiary, Odyssey, subject to certain adjustments as of the time
of closing. Odyssey's results of operations have been included in the Company's
consolidated results of operations since August 8, 1997. Odyssey manufactures
and markets the Odyssey(R) line of putters and wedges with Stronomic(R) and
Lyconite(R) face inserts.
The cost to acquire substantially all of the assets and certain liabilities
of Odyssey Sports, Inc., including professional fees directly related to the
acquisition, was approximately $129,256,000 and has been accounted for using
the purchase method of accounting. The allocation of the acquisition cost to
assets acquired and liabilities assumed are summarized in the table that
follows. Amounts allocated to trade name, trademark, trade dress and goodwill
are being amortized on the straight-line basis over 40 years. The amounts
allocated to the process patent and covenant not to compete are being amortized
on the straight-line basis over 16 and three years, respectively.
(in thousands) August 8, 1997
- -----------------------------------------------------------------
Assets acquired/liabilities assumed:
Total assets acquired $132,591
Total liabilities assumed (3,335)
- -----------------------------------------------------------------
Net assets acquired $129,256
=================================================================
The following unaudited pro forma net sales, net income and earnings per
share data for the years ended December 31, 1997 and 1996 are based on the
respective historical financial statements of the Company and Odyssey Sports,
Inc. The pro forma data presented for the year ended December 31, 1997 combines
the results of operations of the Company for the year ended December 31, 1997
with the results of operations of Odyssey Sports, Inc. for the ten months ended
August 7, 1997 and the results of Odyssey for the two months ended September
30, 1997 and assumes that the acquisition of substantially all of the assets
and certain liabilities of Odyssey Sports, Inc. occurred on January 1, 1997.
The pro forma data presented for the year ended December 31, 1996 combines the
results of operations of the Company for the year ended December 31, 1996 with
the results of operations of Odyssey Sports, Inc. for the year ended September
30, 1996 and assumes that the acquisition of substantially all the assets and
certain liabilities of Odyssey Sports, Inc. occurred on January 1, 1996.
The pro forma financial data presented are not necessarily indicative of the
Company's results of operations that might have occurred had the transaction
been completed at the beginning of the periods specified, and do not purport to
represent what the Company's consolidated results of operations might be for
any future period.
(in thousands, Year ended December 31,
except per share data) (unaudited)
1997 1996
- --------------------------------------------------------------------------------
Net sales $884,840 $711,715
- --------------------------------------------------------------------------------
Net income $134,512 $119,385
- --------------------------------------------------------------------------------
Earnings per common share
Basic $ 1.97 $ 1.79
Diluted $ 1.88 $ 1.69
================================================================================
- -------------------------------------------------------------------------------
NOTE 14
SEGMENT INFORMATION
- -------------------------------------------------------------------------------
The Company's operating segments are organized on the basis of products and
include golf clubs and golf balls. The golf clubs segment consists of
Callaway(R) titanium and steel metal woods and irons, Callaway(R) and
Odyssey(R) putters and wedges, and sales of related accessories. The golf balls
segment consists of golf balls that are to be designed, manufactured, marketed
and distributed by the Company's wholly-owned subsidiary, Callaway Golf Ball
Company. All Other segments, including interactive golf sites, golf book
publishing, new player development and a driving range venture, are aggregated
as they do not meet requirements for separate disclosure as set forth in SFAS
No. 131. In accordance with its restructuring plan, the Company is no longer
pursuing these initiatives (Note 11). There are no significant intersegment
transactions. The table below contains information utilized by management to
evaluate its operating segments.
(in thousands)
1998 Golf Clubs Golf Balls All Other Consolidated
- ------------------------------------------------------------------------------------
Net sales $697,621 $697,621
Income (loss) before tax 9,182 $(22,426) $(25,655) (38,899)
Interest income 1,564 7 1,571
Interest expense (2,252) (419) (2,671)
Depreciation and amortization 34,121 1,072 692 35,885
Additions to long-lived assets 39,854 47,721 1,408 88,983
====================================================================================
1997 Golf Clubs Golf Balls All Other Consolidated
- ------------------------------------------------------------------------------------
Net sales $842,927 $842,927
Income (loss) before tax 222,771 $ (9,013) $ 7 213,765
Interest income 4,703 4,703
Interest expense (10) (10)
Depreciation and amortization 19,219 84 105 19,408
Additions to long-lived assets 166,461 10,263 823 177,547
====================================================================================
The 1996 results for the Company's Golf Ball and All Other segments were not
material.
The Company markets its products domestically and internationally, with its
principal international markets being Asia and Europe. The table below contains
information about the geographical areas in which the Company operates.
Revenues are attributed to countries based on location in which the sale
originated, except as indicated below. Long-lived assets are based on the
country of domicile.
The Company, through a distribution agreement, appointed Sumitomo Rubber
Industries, Ltd. ("Sumitomo") as the sole distributor of Callaway(R) golf clubs
in Japan. Odyssey(R) brand products are sold through the Company's wholly-owned
Japanese subsidiary, ERC International Company. The distribution agreement
requires Sumitomo to purchase specified minimum quantities. The current
distribution agreement began in February 1993 and ends on December 31, 1999. In
1998, 1997, and 1996, sales to Sumitomo accounted for 8%, 10% and 9%,
respectively, of the Company's net sales.
(in thousands)
1998 Sales Long-Lives Assets
- -----------------------------------------------------------------------------
United States (excluding exports) $ 437,628 $ 277,611
Japan* 61,460 857
United Kingdom 64,077 3,998
Other foreign countries 134,456 18,107
- -----------------------------------------------------------------------------
Total $ 697,621 $ 300,573
=============================================================================
1997 Sales Long-Lived Assets
- -----------------------------------------------------------------------------
United States (excluding exports) $ 547,256 $ 250,548
Japan* 84,634 61
United Kingdom 56,194 478
Other foreign countries 154,843 3,557
- -----------------------------------------------------------------------------
Total $ 842,927 $ 254,644
=============================================================================
1996 Sales Long-Lived Assets
- -----------------------------------------------------------------------------
United States (excluding exports) $ 460,611 $ 90,840
Japan (includes direct U.S. shipments) 58,156
United Kingdom 37,668 324
Other foreign countries 122,077 4,459
- -----------------------------------------------------------------------------
Total $ 678,512 $ 95,623
=============================================================================
*Includes both sales from the Company's wholly-owned Japanese subsidiary, ERC
International, and direct U.S. shipments to Japan.
- -------------------------------------------------------------------------------
NOTE 15
TRANSACTIONS WITH RELATED PARTIES
- -------------------------------------------------------------------------------
During 1998, the Company entered into an agreement with Callaway Editions, Inc.
to form CGMV, a limited liability company that is owned 80% by the Company and
20% by Callaway Editions, Inc. ("Callaway Editions"). Callaway Editions is a
publishing and media company which is owned 9% by Ely Callaway, Chairman and
Chief Executive Officer of the Company, and 81% by his son, Nicholas Callaway.
CGMV was formed to produce print and other media products that relate to the
game of golf. Pursuant to the agreement, the Company agreed to loan CGMV up to
$20,000,000 for working capital, subject to CGMV's achievement of certain
milestones to the satisfaction of the Company in its sole discretion. As of
December 31, 1998, the Company has loaned $2,034,000 to CGMV. Also pursuant to
the agreement, CGMV is obligated to pay an annual management fee of $450,000 to
Callaway Editions. In conjunction with the Company's implementation of its
business plan to reduce costs and exit certain non-core business activities,
the Company is currently in negotiations to sell or assign its interest in CGMV
to Callaway Editions. Accordingly, the Company recorded a charge in operations
to December 1998 based on the December 31, 1998 book value of CGMV (Note 11).
In December 1998, the Company purchased the remaining 20% interest in
Callaway Golf Trading GmbH, the Company's former German distributor, for
$6,766,000. The purchase price is in the form of a note payable bearing
interest at 7%, due in June 1999 to the seller, who is an officer of a wholly-
owned subsidiary of Company. The note payable is included in accounts payable
and accrued expenses at December 31, 1998.
- -------------------------------------------------------------------------------
NOTE 16
SUBSEQUENT EVENTS
- -------------------------------------------------------------------------------
DIVIDEND
On January 27, 1999, the Company declared a quarterly cash dividend of $0.07
per share payable on March 3, 1999, to shareholders of record on February 10,
1999.
BANK LINE OF CREDIT
On February 12, 1999, the Company consummated the amendment of its line of
credit to increase the revolving credit facility to up to $120,000,000 (the
"Amended Credit Agreement"). The Amended Credit Agreement has a five-year term
and is secured by substantially all of the assets of the Company, except
domestic accounts receivable. The line of credit requires the Company to
maintain certain minimum financial ratios including a fixed charge coverage
ratio, as well as other restrictive covenants. Also effective on February 12,
1999, the Company entered into an $80,000,000 accounts receivable
securitization facility (the "Accounts Receivable Facility"). The Accounts
Receivable Facility provides loan advances through the sale of substantially
all of the Company's eligible domestic accounts receivable. The Accounts
Receivable Facility includes a corporate guarantee by the Company and requires
the Company to meet the same financial covenants set forth in the Amended
Credit Agreement.
Report of Independent Accountants
[LOGO APPEARS HERE]
To the Board of Directors and Shareholders of Callaway Golf Company
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of cash flows and of shareholders' equity
present fairly, in all material respects, the financial position of Callaway
Golf Company and its subsidiaries at December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PricewaterhouseCoopers LLP
San Diego, California
January 26, 1999, except as to
Note 16, which is as of February 12, 1999
SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)
(in thousands, except per share data) Fiscal Year 1998 Quarters
- ----------------------------------------------------------------------------------------------------------------
1st 2nd 3rd 4th Total
- ----------------------------------------------------------------------------------------------------------------
Net sales $176,908 $233,251 $172,944 $114,518 $697,621
Gross profit $ 83,705 $108,790 $ 83,085 $ 20,434 $296,014
Net income (loss) $ 11,160 $ 21,137 $ 5,836 $(64,697) $(26,564)
Earnings (loss) per common share*
Basic $ 0.16 $ 0.30 $ 0.08 $ (0.93) $ (0.38)
Diluted $ 0.16 $ 0.30 $ 0.08 $ (0.93) $ (0.38)
================================================================================================================
Fiscal Year 1997 Quarters
- ----------------------------------------------------------------------------------------------------------------
1st 2nd 3rd 4th Total
- ----------------------------------------------------------------------------------------------------------------
Net sales $169,073 $253,032 $257,435 $163,387 $842,927
Gross profit $ 87,002 $134,742 $138,769 $ 82,287 $442,800
Net income $ 24,466 $ 46,821 $ 37,049 $ 24,368 $132,704
Earnings per common share*
Basic $ 0.36 $ 0.69 $ 0.54 $ 0.35 $ 1.94
Diluted $ 0.34 $ 0.66 $ 0.52 $ 0.34 $ 1.85
================================================================================================================
*Earnings per share is computed individually for each of the quarters presented;
therefore, the sum of the quarterly earnings per share will not necessarily
equal the total for the year.
MARKET FOR COMMON SHARES AND RELATED SHAREHOLDER MATTERS
The Company's Common Shares are traded on the New York Stock Exchange (NYSE).
The Company's symbol for its Common Shares is "ELY."
As of March 8, 1999, the approximate number of holders of record of the
Company's Common Stock was 9,645.
STOCK PRICE INFORMATION
Year ended December 31,
1998 1997
- ---------------------------------------------------------------------------------------------
Period: High Low Dividend High Low Dividend
- ---------------------------------------------------------------------------------------------
First Quarter $33.25 $26.50 $0.07 $33.63 $28.63 $0.07
Second Quarter $29.44 $17.94 $0.07 $38.13 $27.25 $0.07
Third Quarter $20.50 $ 9.56 $0.07 $38.38 $32.94 $0.07
Fourth Quarter $13.56 $ 9.81 $0.07 $36.38 $26.13 $0.07
=============================================================================================