UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-10962
CALLAWAY GOLF COMPANY
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-3797580
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2285 RUTHERFORD ROAD, CARLSBAD, CA 92008-8815
(619) 931-1771
(Address, including zip code and telephone number, including area code, of
principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_].
The number of shares outstanding of the issuer's of Common Stock, $.01 par
value, as of October 31, 1996 was 72,734,222.
1
CALLAWAY GOLF COMPANY
INDEX
Page
Part I. Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheet at September
30, 1996 and December 31, 1995 3
Consolidated Condensed Statement of Income for
the three months and nine months ended September 30,
1996 and 1995 4
Consolidated Condensed Statement of Cash Flows
for the nine months ended September 30, 1996 and 1995 5
Consolidated Condensed Statement of Shareholders'
Equity for the nine months ended September 30, 1996 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Part II. Other Information 16
2
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED BALANCE SHEET
(In thousands, except share and per share data)
September 30, December 31,
1996 1995
-------------- -------------
(Unaudited)
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 140,331 $ 59,157
Accounts receivable, net 84,864 73,906
Inventories, net 82,169 51,584
Deferred taxes 25,623 22,688
Other current assets 7,496 2,370
--------- ---------
Total current assets 340,483 209,705
Property and equipment, net 80,983 69,034
Other assets 23,189 11,236
--------- ---------
$ 444,655 $ 289,975
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable and accrued
expenses $ 30,979 $ 26,894
Accrued employee compensation and
benefits 34,410 10,680
Accrued warranty expense 27,289 23,769
Income taxes payable 12,894 1,491
--------- ---------
Total current liabilities 105,572 62,834
Long-term liabilities 3,144 2,207
Commitments (Note 10)
Shareholders' equity:
Preferred Stock, $.01 par value
3,000,000 shares authorized, none
issued and outstanding at
September 30, 1996 and December
31, 1995, respectively 0 0
Common Stock, $.01 par value
240,000,000 shares authorized,
72,616,022 and 70,912,129 issued
and outstanding at September 30,
1996 and December 31, 1995,
respectively 726 709
Paid-in capital 302,270 214,846
Unearned compensation (2,283) (2,420)
Retained earnings 216,089 131,712
Less: Grantor Stock Trust
(5,300,000 shares) at market
(Note 9) (180,863) (119,913)
--------- ---------
Total shareholders' equity 335,939 224,934
--------- ---------
$ 444,655 $ 289,975
========= =========
See accompanying notes to consolidated condensed financial statements.
3
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF INCOME (UNAUDITED)
(In thousands, except per share data)
Three months ended Nine months ended
----------------------------------- ------------------------------------
September 30, September 30, September 30, September 30,
1996 1995 1996 1995
---------------- ---------------- --------------- ------------------
Net sales $194,545 100% $155,924 100% $539,685 100% $430,647 100%
Cost of goods sold 88,474 45% 75,130 48% 253,899 47% 209,541 49%
-------- -------- -------- --------
Gross profit 106,071 55% 80,794 52% 285,786 53% 221,106 51%
Selling expenses 21,728 11% 15,247 10% 61,727 11% 51,943 12%
General and administrative expenses 19,326 10% 15,896 10% 61,440 11% 43,790 10%
Research and development costs 5,245 3% 1,936 1% 11,653 2% 6,213 1%
-------- -------- -------- --------
Income from operations 59,772 31% 47,715 31% 150,966 28% 119,160 28%
Other income, net 1,619 1,361 3,952 3,008
-------- -------- -------- --------
Income before income taxes 61,391 32% 49,076 31% 154,918 29% 122,168 28%
Provision for income taxes 22,973 18,898 58,108 47,756
-------- -------- -------- --------
Net income $ 38,418 20% $ 30,178 19% $ 96,810 18% $ 74,412 17%
======== ======== ======== ========
Earnings per common share $ .54 $ .44 $ 1.38 $ 1.06
======== ======== ======== ========
Common equivalent shares 71,065 68,830 70,390 70,414
======== ======== ======== ========
Dividends paid per share $.06 $.05 $.18 $.15
======== ======== ======== ========
See accompanying notes to consolidated condensed financial statements.
4
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED)
(In thousands)
Nine months ended
-------------------------------
September 30, September 30,
1996 1995
-------------- --------------
Cash flows from operating activities:
Net income $ 96,810 $ 74,412
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation 9,377 7,721
(Gain) on disposal of fixed assets (11) 0
Non-cash compensation 3,576 1,424
Increase (decrease) in cash
resulting from changes in:
Accounts receivable, net (7,485) (42,301)
Inventories, net (28,794) 33,087
Deferred taxes (4,665) 2,062
Other assets (13,168) (584)
Accounts payable and accrued
expenses (1,524) 6,873
Accrued employee compensation and
benefits 23,162 12,694
Accrued warranty expense 3,520 4,488
Income taxes payable 11,017 3,534
Other liabilities 937 187
-------- --------
Net cash provided by operating
activities 92,752 103,597
-------- --------
Cash flows from investing activities:
Capital expenditures (21,156) (16,831)
Intangible assets (481) 0
Investment in subsidiary (610) 0
-------- --------
Net cash used in investing (22,247) (16,831)
activities -------- --------
Cash flows from financing activities:
Issuance of Common Stock 11,101 3,173
Tax benefit from exercise of stock
options 11,951 5,552
Dividends paid (12,303) (10,115)
Retirement of Common Stock 0 (59,039)
-------- --------
Net cash provided (used in)
financing activities 10,749 (60,429)
-------- --------
Effect of exchange rate changes on
cash (80) 5
-------- --------
Net increase in cash and cash
equivalents 81,174 26,342
Cash and cash equivalents at beginning
of period 59,157 54,356
-------- --------
Cash and cash equivalents at end of $140,331 $ 80,698
period ======== ========
See accompanying notes to consolidated condensed financial statements.
5
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
(In thousands)
Common Shares Paid-in Unearned Retained
Stock Amount Capital Compensation Earnings GST Total
------ ------ --------- ------------- ---------- ---------- ----------
Balance, December 31, 1995 70,912 $709 $214,846 ($2,420) $131,712 ($119,913) $224,934
Exercise of stock options 1,536 15 11,086 11,101
Tax benefit from exercise of
stock options 11,951 11,951
Compensatory stock options 1,165 137 1,302
Compensatory stock 168 2 2,272 2,274
Cash dividends (12,939) (12,939)
Dividends on shares held by GST 636 636
Equity adjustment from
foreign currency translation (130) (130)
Adjustment of GST shares to
market value 60,950 (60,950)
Net income 96,810 96,810
------ ---- -------- ------- -------- --------- --------
Balance, September 30, 1996 72,616 $726 $302,270 ($2,283) $216,089 ($180,863) $335,939
====== ==== ======== ======= ======== ========= ========
See accompanying notes to consolidated condensed financial statements.
6
CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
Note 1
The accompanying consolidated condensed balance sheet as of September 30, 1996
and the consolidated condensed statements of income, cash flows and
shareholders' equity for the nine month periods ended September 30, 1996 and
1995 have been prepared by Callaway Golf Company (the Company) and have not been
audited. These financial statements, in the opinion of management, include all
adjustments (consisting only of normal recurring accruals) necessary for a fair
presentation of the financial position, results of operations and cash flows for
all periods presented. These financial statements should be read in conjunction
with the financial statements and notes thereto included in the Company's Annual
Report on Form 10-K filed for the year ended December 31, 1995. Interim
operating results are not necessarily indicative of operating results for the
full year. The consolidated condensed financial statements include the accounts
of the Company and its wholly owned subsidiaries, Callaway Golf Sales Company,
Callaway Golf Ball Company, Callaway Golf (UK) Limited and Callaway Golf
(Germany) GmbH. All significant intercompany transactions and balances have
been eliminated.
Note 2
The preparation of financial statements, in conformity with generally accepted
accounting principles, requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Note 3
Earnings per common share are calculated by dividing net income by the weighted
average number of common shares outstanding during the period increased by
dilutive common stock equivalents using the treasury stock method. Fully
diluted earnings per share was substantially the same as primary earnings per
share for the periods ended September 30, 1996 and 1995, respectively. Shares
owned by the Callaway Golf Company Grantor Stock Trust are included in the
number of weighted average shares outstanding using the treasury stock method
with assumed proceeds from exercise equal to the aggregate closing price of
those shares at the end of the reporting period. The dilutive effect of rights
to purchase preferred or common shares under the Callaway Golf Shareholder
Rights Plan have not been included in weighted average share amounts as the
conditions necessary to cause these rights to be exercised were not met.
Note 4
Inventories at September 30, 1996 and December 31, 1995 consisted of:
September 30, December 31,
1996 1995
------------- ------------
(Unaudited)
(in thousands)
Inventories:
Raw materials $36,838 $23,980
Work-in-process 1,586 1,109
Finished goods 48,205 31,291
------- -------
86,629 56,380
Less reserve for obsolescence (4,460) (4,796)
------- -------
Net inventories $82,169 $51,584
======= =======
7
CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
Note 5
The provision for income taxes is as
follows:
Nine months ended Nine months ended
September 30, 1996 September 30, 1995
------------------ ------------------
(Unaudited) (Unaudited)
(in thousands)
Current tax provision:
Federal $52,309 $35,676
State 9,317 8,444
Foreign 1,208 1,574
Deferred tax (benefit) expense:
Federal (4,234) 1,403
State (446) 802
Foreign (46) (143)
------- -------
Provisions for income taxes $58,108 $47,756
======= =======
Deferred tax assets are comprised of
the following:
September 30, December 31,
1996 1995
------------- -----------
(Unaudited)
(in thousands)
Reserves and allowances $18,508 $16,381
Depreciation and amortization 6,086 4,297
Deferred compensation 2,420 2,019
Effect of inventory overhead adjustment 1,629 1,414
Compensatory stock options and rights 1,554 1,346
State taxes, net 877 972
Other 625 605
------- -------
Net deferred tax assets $31,699 $27,034
======= =======
8
CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
Note 6
On August 20, 1996, the Company paid a quarterly dividend of $.06 per share to
shareholders of record on July 30, 1996. Additionally, on October 16, 1996, the
Company declared a quarterly dividend of $.06 per share payable November 19,
1996 to shareholders of record on October 29, 1996.
Note 7
During the nine months ended September 30, 1996, the Company entered into
forward foreign currency exchange rate contracts to hedge payments due on
intercompany transactions from its wholly owned foreign subsidiary. 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 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 September 30, 1996, the Company had
approximately $5,219,000 of foreign exchange contracts outstanding. The
contracts mature between October and December of 1996. Realized and unrealized
losses on these contracts are recorded in net income. The net realized and
unrealized losses from foreign exchange contracts for the nine months ended
September 30, 1996 totaled approximately $48,000.
Note 8
At September 30, 1996, the Company held investments in U.S. Treasury bills with
maturities of three months or less in the aggregate amount of $124.2 million.
Management determines the appropriate classification of its U.S. Government and
other debt securities at the time of purchase and reevaluates such designation
as of each balance sheet date. The Company has included these securities, net
of amortization, in cash and cash equivalents and has designated them as "held-
to-maturity."
Note 9
The Company's Grantor Stock Trust (GST) holds 5,300,000 shares of Company stock
at September 30, 1996. 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. These shares have no
impact on the net amount of shareholders' equity.
In 1995, the Company implemented 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 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.
9
CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
Note 10
In the normal course of business, the Company enters into certain long term
purchase commitments with various vendors. The Company has agreements with one
of its suppliers which require the Company to purchase, under certain
conditions, a minimum of 2,000,000 graphite shafts, or 25% of all graphite
shafts required in the manufacture of its golf clubs, whichever is greater,
through December 31, 1997, and 25% of all graphite shaft requirements from
January 1998 through May 1998.
In April 1996, the Company entered into a clubhead supply agreement with one of
its suppliers to purchase, under certain conditions, titanium club heads costing
up to a maximum of $97,500,000 for the remainder of 1996 through December 1997.
This agreement is cancelable by the Company at any time by giving six months
notice.
Effective June 1995, the Company agreed to form a joint venture with Sturm,
Ruger & Company, Inc. (Sturm, Ruger), its main supplier of Great Big Bertha(R)
titanium heads, to construct a foundry that would significantly increase Sturm,
Ruger's capacity to produce heads. Under the terms of the joint venture
agreements, the Company shall have a 50% equity interest in the new foundry and
is required to contribute up to $7,000,000 in capital contributions for
developing, designing, equipping and operating the new facility. The Company
accounts for its investment in the joint venture pursuant to the equity method.
As of September 30, 1996, the Company had made capital contributions of
$6,454,000 to the joint venture, which had not commenced operations. It was
contemplated in 1995 that the Company would purchase from Sturm, Ruger and the
joint venture at competitive prices a minimum quantity of 500,000 club heads per
year in 1996, 1997 and 1998. The Company has placed orders that meet or exceed
this minimum for 1996 and 1997. However, delays and cost overruns in the joint
venture project, improved production at Sturm, Ruger and the development of new
alternative sources for quality titanium castings at significantly lower prices
than those originally contemplated for the joint venture have prompted the
parties to enter into discussions about the continuing need for the joint
venture.
Note 11
Effective January 1, 1996, the Company adopted Statement of Financial Accounting
Standard (SFAS) No. 123, "Accounting for Stock-Based Compensation." The Company
will continue to measure compensation expense for its stock-based employee
compensation plans using the intrinsic value method prescribed by APB Opinion
No. 25, "Accounting for Stock Issued to Employees." Adoption of SFAS 123 will
not have a material impact on the Company's financial position or results of
operations for the year ending December 31, 1996.
Note 12
Effective January 1, 1996, the Company adopted Statement of Financial Accounting
Standard (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of." The new standard requires that the
Company investigate potential impairments of long-lived assets, certain
identifiable intangibles, and associated goodwill, on an exception basis, when
events or changes in circumstances indicate that the carrying value of an asset
may not be recoverable. 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. Adoption of SFAS 121 did not have a material impact on the Company's
financial position or results of operations.
10
CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
Note 13
On May 30, 1996, a lawsuit was filed against Callaway Golf Company and two of
its officers by a former officer of the Company. The lawsuit asserts claims for
breach of oral contract, fraud, negligent misrepresentation, declaratory
judgment, rescission, restitution and accounting, arising out of an alleged oral
promise in connection with the assignment of a patent for certain tooling
designs and alleges facts which may be asserted by the plaintiff as an
additional claim for wrongful termination of employment. The complaint seeks
damages of $290,000,000, a royalty of $27,000,000 or compensatory damages for
breach of alleged oral contract, as well as unspecified punitive damages and
costs. The Company is vigorously defending the suit, and believes based on the
information available to it at this time that it has good and valid defenses to
the claims and that the suit will not have a material adverse effect upon the
Company's financial position, results of operations or cash flows.
Note 14
On July 1, 1996 the Company acquired a majority ownership interest in its German
distributor, Golf Trading GmbH. This acquisition was made through the formation
of Callaway Golf (Germany) GmbH (a wholly owned subsidiary).
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
When used in this discussion, the words "believes," "anticipated" and
similar expressions are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties which could cause
actual results to differ materially from those projected. Readers are cautioned
not to place undue reliance on these forward-looking statements which speak only
as of the date hereof. The Company undertakes no obligation to republish
revised forward-looking statements to reflect events or circumstances after the
date hereof or to reflect the occurrence of unanticipated events. Readers are
also urged to carefully review and consider the various disclosures made by the
Company which attempt to advise interested parties of the factors which affect
the Company's business, including the disclosures made under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Factors Affecting the Golf Club Industry and Callaway
Golf" in this Report, as well as the Company's other periodic reports on Forms
10-K, 10-Q and 8-K filed with the Securities and Exchange Commission.
RESULTS OF OPERATIONS
THREE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1995:
Net sales increased 25% to $194.5 million for the three months ended September
30, 1996 compared to $155.9 million for the same period in the prior year. This
increase was primarily attributable to increased sales of Great Big Bertha(R)
Metal Woods, including the Great Big Bertha(R) Fairway Woods which were
introduced in January 1996, combined with increased sales of Big Bertha(R)
Irons. These sales increases were offset by a decrease in net sales of Big
Bertha(R) War Bird(R) Metal Woods.
For the three months ended September 30, 1996, gross profit increased to
$106.1 million from $80.8 million for the same period in the prior year and
gross margin increased to 55% from 52%. The increase in gross profit was
primarily the result of decreases in component costs and manufacturing labor and
overhead costs related to increased production volume and improved labor
efficiencies.
Selling expenses increased to $21.7 million in the third quarter of 1996
compared to $15.2 million in the third quarter of 1995. As a percentage of net
sales, selling expenses in the third quarter increased to 11% from 10% for the
same period in 1995. The $6.5 million increase was primarily a result of
increased sales representatives' salaries and commission expense in the quarter
due to a new compensation package under which such expenses are incurred more
evenly throughout the year, combined with increases in TV advertising and tour
endorsement expenses.
General and administrative expenses for the three months ended September 30,
1996 increased to $19.3 million from the $15.9 million incurred during the third
quarter of 1995. As a percentage of net sales, general and administrative
expenses remained constant at 10% for the third quarter of 1996 and 1995. The
$3.4 million increase in general and administrative expenses was primarily
attributable to increased employee compensation and benefits, costs associated
with the Company's business development initiatives and facility expenses.
These increases were partially offset by a decrease in charitable contributions.
Research and development expenses were $5.2 million for the three months ended
September 30, 1996 as compared to $1.9 million for the same period in the prior
year. The increase in research and development costs was attributable to
increased personnel and operating expenses associated with the Company's golf
club testing facility and shaft and tooling departments.
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1995:
For the nine months ended September 30, 1996, net sales increased 25% to
$539.7 million compared to $430.6 million for the same period in the prior year.
This increase was primarily attributable to increased sales of Great Big
Bertha(R) Metal Woods, including the Great Big Bertha(R) Fairway Woods.
12
For the nine months ended September 30, 1996, gross profit increased to $285.8
million from $221.1 million for the same period in the prior year and gross
margin increased to 53% from 51%. The increase in gross margin was primarily
the result of decreases in component costs and manufacturing labor and overhead
costs related to increased production volume and improved labor efficiencies.
Selling expenses increased to $61.7 million from $51.9 million for the nine
months ended September 30, 1996 compared to the same period in the prior year.
As a percentage of net sales, selling expenses in the first nine months of 1996
decreased to 11% from 12% for the same period in 1995. The decrease as a
percentage of net sales was primarily attributable to costs being spread over a
larger sales volume. The $9.8 million increase was primarily a result of
compensation, tour endorsement and TV advertising expenses.
General and administrative expenses for the nine months ended September 30,
1996 increased to $61.4 million from the $43.8 million incurred during the nine
months ended September 30, 1995. The $17.6 million increase was primarily
attributable to increased employee compensation and benefits, costs associated
with the Company's business development initiatives and increases in computer
support, legal, depreciation and other general and administrative expenses.
Research and development expenses were $11.7 million for the nine months ended
September 30, 1996 as compared to $6.2 million for the same period in the prior
year. The increase in research and development costs is attributable to
increased personnel and operating expenses associated with the Company's golf
club testing facility and shaft and tooling departments.
CERTAIN FACTORS AFFECTING CALLAWAY GOLF COMPANY
The Company believes that the growth rate in the golf equipment industry in
the United States has been modest for the past several years, and this trend is
likely to continue through 1996. Sales of all golf clubs in Japan, the world's
second largest consumer of golf clubs next to the United States, appeared to be
stabilizing during early 1996, but recent trends indicate the market may be
declining. Although demand for the Company's products has been generally strong
during the three and nine months ended September 30, 1996, no assurances can be
given that the demand for the Company's existing products or the introduction of
new products will continue to permit the Company to experience its historical
growth or maintain its historical profit margin. Additionally, given the
Company's current size and market position, it is possible that further market
penetration will prove more difficult.
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. Although the Company's business generally follows
this seasonal trend, the success of the Company over the past several years has
tended to mitigate the impact of seasonality on the Company's operating results.
Beginning in the current year, the Company's operating results have been more
significantly affected by seasonal buying trends.
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. Several companies introduced new products in 1996 (e.g.
Ping "ISI" irons, Taylor Made "Burner Bubble Shaft" irons, Cobra "Ti" titanium
metal woods, "King Cobra II" irons and Armour "Ti 100" irons) that have
generated increased market competition. Others increased their marketing
activities with respect to existing products in 1996. While the Company
believes that its products and its marketing efforts continue to be competitive,
there can be no assurance that these actions by others will not negatively
impact the Company's future sales. Additionally, the golf club industry, in
general, has been characterized by widespread imitation of popular club designs.
A manufacturer's ability to compete is in part dependent upon its ability to
satisfy 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 may also 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.
13
The Company began shipping significant quantities of its Great Big Bertha(R)
Drivers in March 1995, and began shipping Great Big Bertha(R) Fairway Woods in
March of 1996. This product line is an important part of the Company's
business. Great Big Bertha(R) Metal Woods have a titanium club head and are
priced substantially higher than the Company's stainless steel product line.
The Company currently has three sources for its titanium club heads, but is
currently receiving the vast majority of its club heads from two vendors. While
the Company has been successful thus far in acquiring adequate quantities of
high quality titanium castings at acceptable prices, there is no guarantee that
its current suppliers will continue to meet those needs.
The Company believes that the introduction of new, innovative golf equipment
will be important to its future success. New models and basic design changes
are frequently introduced into the golf equipment market but are often met with
consumer rejection. Although the Company has achieved certain successes in the
introduction of its golf clubs, no assurances can be given that the Company will
be able to continue to design and manufacture golf clubs that achieve market
acceptance. In addition, prior successful designs may be rendered obsolete
within a relatively short period of time as new products are introduced into the
market. The design of new golf equipment is also greatly influenced by rules
and interpretations of the United States Golf Association ("USGA") and the Royal
and Ancient Golf Club of St. Andrews ("R&A"). The golf equipment standards
established by the USGA and R&A apply to competitive events sanctioned by each
organization and are generally followed in competitions within their respective
jurisdictions. Accordingly, it has become critical for designers of new clubs to
assure compliance with USGA and R&A standards. While the Company believes that
all of its clubs comply with USGA and R&A standards, no assurance can be given
that any new products will receive USGA and R&A approval or that existing USGA
and R&A standards will not be altered in ways that adversely affect the sales of
the Company's products.
In June 1996, the Company formed Callaway Golf Ball Company ("CGB"), a wholly
owned subsidiary of Callaway Golf 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". Both
previous golf ball ventures were not commercially successful. At this time, it
has not been determined whether CGB will enter the golf ball business by
developing a new product, by acquiring an existing golf ball manufacturer, by
participating in a joint venture with another company, or by a combination of
these factors. This business is in early stages of development, the impact of
this new business on the Company's future cash flow and income from operations
is uncertain. The Company believes that factors affecting the golf equipment
industry described above, including growth rate in the golf equipment industry,
seasonality and new product introduction will also apply to the golf ball
business. There can be no assurance if and when a successful golf ball product
will be developed or that the Company's investment will ultimately be realized.
In addition, the golf ball business is highly competitive with a number of well
established and well financed competitors including Titleist, Spalding, Maxfli,
Bridgestone and others. These competitors have established market share in the
golf ball business which will need to be penetrated in order for the Company's
golf ball business to be successful.
The Company is dependent on a limited number of suppliers for its club heads
and shafts. In addition, some of the Company's products require specifically
developed techniques and processes which make it difficult to identify and
utilize alternative suppliers quickly. Consequently, if any significant delay
or disruption in the supply of these component parts occurs, it may have a
material adverse effect on the Company's business.
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 it 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 patents, trademarks, or trade dress.
During 1995, there was an increase in unauthorized distribution of the
Company's products (i.e. product sold by the Company to authorized distributors
being ultimately sold at retail by unauthorized distributors). The
14
Company is making further efforts to reduce this unauthorized distribution of
its products in both domestic and international markets. While efforts to reduce
unauthorized distribution have had only limited success to date, these efforts
could result in an increase in sales returns over historical levels, and/or a
potential decrease in sales to those customers who are selling Callaway(R)
products to unauthorized distributors.
An increasing number of the Company's competitors have, like the Company
itself, sought to obtain patent, trademark or other protection of their
proprietary rights and designs. From time to time others have or may contact
the Company to claim that they have proprietary rights which have been infringed
by the Company and/or its products. The Company evaluates any such claims and,
where appropriate, has obtained or sought to obtain licenses or other business
arrangements. To date, there have been no interruptions in the Company's
business as the result of any claims of infringement. However, no assurance can
be given that the Company will not be adversely affected 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. Such effect may have a material adverse impact on
the Company.
During 1995, the Company established a department to evaluate opportunities in
and outside of the golf equipment industry. Such ventures will present new
challenges for the Company and there can be no assurance that this activity will
be successful. One of the opportunities identified by this department relates
to the Company's acquisition of selected foreign distributors. The Company's
management believes that controlling the distribution of its products in these
areas will be a key element in the future growth and success of the Company.
Executing this business strategy has and will result in additional investments
in inventory, accounts receivable, corporate infrastructure and facilities.
There can be no assurance that the acquisition of the Company's foreign
distributors will achieve these stated goals.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1996, cash and cash equivalents increased to $140.3 million
from $59.2 million at December 31, 1995, due to $92.7 million provided by
operating activities and $10.7 million provided by financing activities. These
increases were offset by $22.2 million used in investing activities associated
primarily with capital expenditures. The Company has available a $50.0 million
line of credit and anticipates that its existing capital resources and cash flow
generated from future operations will enable it to maintain its current level of
operations and its planned operations for the foreseeable future.
The Company's net accounts receivable increased to $84.9 million at September
30, 1996 from $73.9 million at December 31, 1995 and $72.3 million at September
30, 1995, primarily as a result of the increase in net sales. The 1996 third
quarter sales included certain sales with extended payment terms to qualified
customers. These terms are comparable to those traditionally offered by our
competitors. Net inventory was $82.2 million at September 30, 1996 compared to
$51.6 million at December 31, 1995 and $41.1 million at September 30, 1995. The
increase in inventory levels at September 30, 1996 is consistent with historical
seasonality trends. Component costs related to the Great Big Bertha(R) product
line which are higher in relation to other product lines also contributed to the
increase in inventory.
15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings:
The Company, incident to its business activities, is the plaintiff in
several legal proceedings, both domestically and abroad, in various stages of
development. In conjunction with the Company's program of enforcing its
proprietary rights, the Company has initiated a number of actions against
alleged infringers under the Lanham Act, 15 USCA Sections 1051-1127, the U.S.
Patent Act, 35 USCA Sections 1-376, and other pertinent laws. Some defendants
in these actions have, among other things, contested the validity and/or the
enforceability of some of the Company's patents and/or trademarks. Others have
asserted counterclaims against the Company. The Company believes that the
outcome of these matters individually and in the aggregate will not have a
material adverse effect upon the financial position or results of operations of
the Company. It is possible, however, that in the future one or more defenses
or claims asserted by defendants in those actions may succeed, resulting in the
loss of all or part of the rights under one or more patents, loss of a
trademark, a monetary award against the Company, or some other loss to the
Company. One or more of these results could adversely affect the Company's
overall ability to protect its product designs and ultimately limit its future
success in the market place.
In addition, the Company from time to time receives information
claiming that products sold by the Company infringe or may infringe patent or
other intellectual property rights of third parties. To date, the Company has
not experienced any material expense or disruption associated with any such
potential infringement matters. It is possible, however, that in the future one
or more claims of potential infringement could lead to litigation, the need to
obtain additional licenses, the need to alter a product to avoid infringement,
or some other action or loss by the Company.
On May 30, 1996, a lawsuit was filed against Callaway Golf Company
and two of its officers by a former officer of the Company, captioned Glenn
-----
Schmidt v. Callaway Golf Company, et al., Case No. N 71548, in the Superior
- ----------------------------------------
Court for the State of California, County of San Diego. On July 10, 1996, the
defendants removed the case to the United States District Court for the Southern
District of California, Case No. 961235 B AJB. On September 12, 1996, the
District Court entered an order returning the case to state court, holding that
the plaintiff's claims arose under state law. The lawsuit asserts claims for
breach of oral contract, fraud, negligent misrepresentation, declaratory
judgment, rescission, restitution and accounting, arising out of an alleged oral
promise in connection with the assignment of a patent for certain tooling
designs and alleges facts which may be asserted by the plaintiff as an
additional claim for wrongful termination of employment. The complaint seeks
damages of $290,000,000, a royalty of $27,000,000, or compensatory damages for
breach of the alleged oral contract, as well as unspecified punitive damages and
costs. The Company believes based on the information available to it at this
time that it has good and valid defenses to the claims, is vigorously defending
the suit, and has asserted its own counterclaims for breach of fiduciary duty,
fraud and negligent misrepresentation. Formal discovery has commenced in
preparation for trial.
The Company and its subsidiaries, incident to their business
activities, from time to time are parties to a number of legal proceedings in
various stages of development, including but not limited to those described
above. The Company believes that the majority of these proceedings involve
matters as to which liability, if any, will be adequately covered by insurance.
With respect to litigation outside the scope of applicable insurance coverage
and to the extent insured claims may exceed liability limits, it is the opinion
of the management of the Company that these matters individually and in the
aggregate will not have a material adverse effect upon the Company's financial
position, results of operations or cash flows.
Item 2. Changes in Securities:
None
Item 3. Defaults Upon Senior Securities:
None
16
Item 4. Submission of Matters to a Vote of Security Holders:
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
a. Exhibits:
10.9.2 Amendment No. 1 to Form of Tax Indemnification
Agreement
10.16.2 Indemnification Agreement by and between the
Company and Aulana L. Peters dated as of July
18, 1996
10.18 Employment agreement by and between the
Company and Elmer L. Ward Jr. dated July 1,
1996
11.1 Statement re: Computation of Earnings Per
Common Share
27 Financial Data Schedule
b. Reports on Form 8-K:
None
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CALLAWAY GOLF COMPANY
Date: November 13, 1996 /s/ DONALD H. DYE
------------------------
DONALD H. DYE
President
Chief Executive Officer
/s/ DAVID A. RANE
------------------------
DAVID A. RANE
Executive Vice President
Chief Financial Officer
18