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 March 31, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-10962
CALLAWAY GOLF COMPANY
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-3797580
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2285 RUTHERFORD ROAD, CARLSBAD, CA 92008-8815
(760) 931-1771
(Address, including zip code and telephone number, including area code, of
principal executive offices)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
The number of shares outstanding of the issuer's of Common Stock, $.01
par value, as of April 30, 1997 was 72,661,132
1
CALLAWAY GOLF COMPANY
INDEX
Page
Part I. Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheet at March 31, 1997 3
and December 31, 1996
Consolidated Condensed Statement of Income for the three 4
months ended March 31, 1997 and 1996
Consolidated Condensed Statement of Cash Flows for the three 5
months ended March 31, 1997 and 1996
Consolidated Condensed Statement of Shareholders' Equity for 6
the three months ended March 31, 1997
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition 9
and Results of Operations
Part II. Other Information 14
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED BALANCE SHEET
(In thousands, except share and per share data)
March 31, December 31,
1997 1996
----------- ------------
(Unaudited)
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 113,623 $ 108,457
Accounts receivable, net 97,309 74,477
Inventories, net 96,191 98,333
Deferred taxes 26,058 25,948
Other current assets 9,187 4,298
---------- ----------
Total current assets 342,368 311,513
Property and equipment, net 99,360 91,346
Other assets 24,502 25,569
---------- ----------
$ 466,230 $ 428,428
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable and accrued expenses $ 39,682 $ 14,996
Accrued employee compensation and benefits 13,112 16,195
Accrued warranty expense 27,280 27,303
Income taxes payable 9,134 2,558
---------- ----------
Total current liabilities 89,208 61,052
Long-term liabilities 5,749 5,109
Commitments and Contingencies (Note 6)
Shareholders' equity:
Preferred Stock, $.01 par value, 3,000,000 shares authorized, none issued
and outstanding at March 31, 1997 and December 31, 1996, respectively
Common Stock, $.01 par value, 240,000,000 shares authorized, 72,842,675 and
72,855,222 issued and outstanding at March 31, 1997 and December 31, 1996,
respectively 728 729
Paid-in capital 293,156 278,669
Unearned compensation (3,309) (3,105)
Retained earnings 232,411 238,349
Less: Grantor Stock Trust (5,300,000 shares) at market (151,713) (152,375)
---------- ----------
Total shareholders' equity 371,273 362,267
---------- ----------
$ 466,230 $ 428,428
========== ==========
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
--------------------------------------------
March 31, March 31,
1997 1996
---- ----
Net sales $169,073 100% $135,138 100%
Cost of goods sold 82,071 49% 66,506 49%
--------- ---------
Gross profit 87,002 51% 68,632 51%
Selling expenses 26,579 16% 18,145 13%
General and administrative expenses 16,254 10% 17,191 13%
Research and development costs 5,953 4% 3,162 2%
--------- ---------
Income from operations 38,216 23% 30,134 22%
Other income, net 1,383 863
--------- ---------
Income before income taxes 39,599 23% 30,997 23%
Provision for income taxes 15,133 11,542
--------- ---------
Net income $ 24,466 14% $ 19,455 14%
========= =========
Earnings per common share $.34 $.28
==== ====
Common equivalent shares 71,763 69,595
====== ======
Dividends paid per share $.07 $.06
==== ====
See accompanying notes to consolidated condensed financial statements.
4
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED)
(In thousands)
Three months ended
-----------------------------------------
March 31, March 31,
1997 1996
---------------- ------------
Cash flows from operating activities:
Net income $24,466 $19,455
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 3,460 2,939
Loss on disposal of fixed assets 0 11
Non-cash compensation 4,309 1,778
Increase (decrease) in cash resulting from changes in:
Accounts receivable, net (23,174) (11,017)
Inventories, net 1,489 (15,794)
Deferred taxes (380) (924)
Other assets (3,945) (1,627)
Accounts payable and accrued expenses 22,720 (1,339)
Accrued employee compensation and benefits (351) 1,147
Accrued warranty expense (23) 1,350
Income taxes payable 6,635 8,003
Other liabilities 640 221
---------- ---------
Net cash provided by operating activities 35,846 4,203
---------- ---------
Cash flows used in investing activities:
Capital expenditures (11,503) (6,104)
----------- ----------
Net cash used in investing activities (11,503) (6,104)
----------- ----------
Cash flows used in financing activities:
Issuance of Common Stock 4,359 5,942
Tax benefit from exercise of stock options 6,285 4,184
Dividends paid, net (4,773) (3,964)
Retirement of Common Stock (25,091) 0
----------- ---------
Net cash (used in) provided by financing activities (19,220) 6,162
----------- ---------
Effect of exchange rate changes on cash 43 (22)
---------- ----------
Net increase in cash and cash equivalents 5,166 4,239
Cash and cash equivalents at beginning of period 108,457 59,157
---------- ---------
Cash and cash equivalents at end of period $ 113,623 $63,396
========== =========
See accompanying notes to consolidated condensed financial statements.
5
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
(In thousands)
Common Stock Paid-in Unearned Retained
Shares Amount Capital Compensation Earnings GST Total
------ ------ ------- ------------ -------- --- -----
Balance, December 31, 1996 72,855 $729 $278,669 ($3,105) $238,349 ($152,375) $362,267
Exercise of stock options 603 6 4,353 4,359
Tax benefit from exercise of
stock options 6,285 6,285
Compensatory stock options 822 (204) 618
Employee stock purchase plan 233 2 3,689 3,691
Stock retirement (848) (9) (25,082) (25,091)
Cash dividends (5,144) (5,144)
Dividends on shares held by
GST 371 371
Equity adjustment from
foreign currency translation (549) (549)
Adjustment of GST shares to
market value (662) 662
Net income 24,466 24,466
------ ------- ---------- -------- ----------- ---------- ----------
Balance, March 31, 1997 72,843 $728 $293,156 ($3,309) $232,411 ($151,713) $371,273
====== ==== ========= ======== =========== ========= ==========
See accompanying notes to consolidated condensed financial statements.
6
CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
---------------------
The accompanying consolidated condensed balance sheet as of March 31, 1997 and
the consolidated condensed statements of income, cash flows and shareholders'
equity for the three month periods ended March 31, 1997 and 1996 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.
Certain information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested that 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, 1996. Interim operating results are not necessarily indicative of
operating results for the full year.
2. INVENTORIES
-----------
Inventories at March 31, 1997 and December 31, 1996 (in thousands):
March 31, December 31,
1997 1996
----------- ------------
(Unaudited)
Inventories, net:
Raw materials $ 47,638 $ 50,012
Work-in-process 1,491 1,651
Finished goods 52,266 51,954
--------- ---------
101,395 103,617
Less reserve for obsolescence (5,204) (5,284)
--------- ---------
Net inventories $ 96,191 $ 98,333
========= =========
3. FOREIGN CURRENCY EXCHANGE CONTRACTS
-----------------------------------
During the three months ended March 31, 1997, the Company entered into forward
foreign currency exchange rate contracts to hedge payments due on intercompany
transactions from a 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 March 31, 1997, the Company had approximately
$3,843,000 of foreign exchange contracts outstanding. The contracts mature
between April and July of 1997. Realized and unrealized losses on these
contracts are recorded in net income. The net realized and unrealized gains from
foreign exchange contracts for the three months ended March 31, 1997 totaled
approximately $250,000.
7
4. CASH AND CASH EQUIVALENTS
-------------------------
At March 31, 1997, the Company held investments in U.S. Treasury bills with
maturities of three months or less in the aggregate amount of $99.5 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."
5. EARNINGS PER SHARE
------------------
Earnings per share are based upon the weighted average number of shares
outstanding during the period increased by the effect of dilutive stock options,
when applicable, using the treasury stock method. Earnings per common and common
equivalent share as presented on the face of the consolidated condensed
statement of income represent primary earnings per share. Dual presentation of
primary and fully diluted earnings per share has not been made because the
differences are insignificant.
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 128, "Earnings Per Share". SFAS No. 128
will be adopted by the Company as required in the fourth quarter of 1997. Upon
adoption of SFAS No. 128, the Company will present basic earnings per share and
diluted earnings per share. Basic earnings per share will be computed based on
the weighted average number of shares outstanding during the period. Diluted
earnings per share will be computed based on the weighted average number of
shares outstanding during the period increased by the effect of dilutive stock
options using the treasury stock method. Pro forma basic earnings per share for
the three months ended March 31, 1997 and 1996 are $.36 and $.29, respectively.
Pro forma diluted earnings per share for the three months ended March 31, 1997
and 1996 are $.34 and $.28, respectively.
6. COMMITMENTS AND CONTINGENCIES
-----------------------------
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 25% of all graphite shafts required in the manufacture
of its golf clubs through May 1998.
The Company has committed to purchase titanium golf club heads costing
approximately $40,880,000 from one of its vendors. These heads are to be shipped
to the Company in accord with a production schedule that runs through the middle
of 1998.
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. Pursuant to the joint venture
agreement, the Company has a 50% equity interest in the new foundry and has
contributed $7,000,000 in capital contributions for developing, designing and
equipping the new facility, which has not commenced operations. The Company
accounts for its investment in the joint venture pursuant to the equity method.
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. While the costs of a possible dissolution
of the joint venture are not known at this time, management does not believe
that such costs would have an adverse material impact on the financial position,
results of operations or cash flows of 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 (the "Schmidt Litigation"). 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
8
certain tooling designs. The plaintiff has also recently filed a first amended
complaint asserting claims for wrongful termination and termination in violation
of public policy. The first amended complaint seeks damages of $290,000,000, a
royalty of $27,000,000, or compensatory damages for breach of the alleged oral
contract and related claims; damages of approximately $10,000,000 for the
wrongful termination; and unspecified punitive damages and costs. Formal
discovery has commenced in preparation for trial. The trial is currently
scheduled to commence on October 20, 1997. Following the Company's tender of the
Schmidt Litigation to its insurers, the carriers denied coverage. On April 11,
1997, the Company initiated litigation against these carriers seeking a judicial
declaration that such coverage is afforded under the applicable insurance
policies (the "Insurance Litigation"). The Company believes there are
meritorious defenses to the Schmidt Litigation, and thus no provision for
liability has been made in the Company's financial statements. The Company also
believes it is entitled to coverage by its insurers for all or some of the costs
and claims asserted in the Schmidt Litigation. The ultimate resolution of the
Schmidt Litigation and the Insurance Litigation, however, could result in a
material liability and income statement charge.
The Company has certain additional contingent liabilities resulting from
litigation and claims incident to the ordinary course of business. Except as
noted above, 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 the probable result of
these matters individually and in the aggregate will not have a material adverse
effect upon the Company's financial position, results of operations or cash
flows.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
When used in this discussion, the words "expect(s)," "feel(s)," "believe(s),"
"will," "may," "anticipate(s)" 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 describe certain
factors which affect the Company's business, including the disclosures made
under the caption "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Certain Factors Affecting Callaway Golf Company"
below, as well as the Company's other periodic reports on Forms 10-K, 10-Q and
8-K filed with the Securities and Exchange Commission.
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 1997. Sales of all golf clubs in Japan, the world's
second largest consumer of golf clubs next to the United States, appeared to be
declining during 1996, but recent trends indicate the market may be stabilizing.
Although demand for the Company's products has been generally strong during the
quarter ended March 31, 1997, 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 Company's increasing sales volume in many years has
tended to mitigate the impact of seasonality on the Company's operating results.
However, in recent years, the Company's operating results have been more
significantly affected by seasonal buying trends, and the Company expects this
trend to continue.
9
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. New product introductions by competitors continue to
generate increased market competition. For example, in 1997 Taylor Made
introduced two new products, the "Ti Bubble 2" Metal Wood Driver and the "Ti
Bubble 2" Irons, and other competitors have increased their marketing activities
with respect to existing products. 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.
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 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 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.
The Company believes that the introduction of new, innovative golf equipment
will be important to its future success. As a result, the Company faces certain
risks associated with such a strategy. For example, new models and basic design
changes in golf equipment are frequently met with consumer rejection. In
addition, prior successful designs may be rendered obsolete within a relatively
short period of time as new products are introduced into the marketplace. New
designs must 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. 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.
Moreover, the Company's new products have tended to incorporate significant
innovations in design and manufacture, which have resulted in increasingly
higher prices for the Company's products relative to products already in the
marketplace. There can be no assurance that a significant percentage of the
public will always be willing to pay such prices for golf equipment. Thus,
although the Company has achieved certain successes in the introduction of its
golf clubs in the past, no assurances can be given that the Company will be able
to continue to design and manufacture golf clubs that achieve market acceptance
in the future.
Since the Company does not rely upon traditional designs in the development of
its golf clubs, its products may be more likely to develop unanticipated
problems than those of many of its competitors which use traditional designs.
For example, clubs have been returned with cracked clubheads, broken graphite
shafts and loose medallions. While any breakage or warranty problems are deemed
significant to the Company, the incidence of clubs returned as a result of
cracked clubheads, broken graphite shafts, loose medallions and other product
problems has not to date 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, incorporates design and
production changes to assure its customers of the highest quality available in
the market. If Callaway Golf clubs were to experience a significant increase in
the incidence of breakage or other product problems, the Company's sales and
image with golfers would be materially adversely affected.
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. In the event of a significant delay or
disruption, the Company believes that suitable heads and shafts could be
obtained from other manufacturers, although the transition to another supplier,
particularly with respect to the Biggest Big Bertha(TM) Titanium Driver and
Great Big Bertha(R) Tungsten.Titanium(TM) Irons, could result in significant
production delays and would likely have an adverse impact on results of
operations during the transition.
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
10
infringers of its 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.
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. 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 on these patent or other intellectual property rights, or
it must obtain licenses to use them lawfully. If any new golf ball product was
found to infringe on protected technology, the Company could incur substantial
costs to redesign its golf ball product or to defend legal action taken against
it. Despite its efforts to avoid such infringements, there can be no assurance
that Callaway Golf Ball Company will not infringe on the patents and 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.
While the Company seeks to control the distribution of its products to the
extent permitted by law, it is still the case that 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 approved retailers and
distributors who promote and support the Company's products, and can injure the
Company's image in the minds of its customers and consumers. On the other hand,
stopping such commerce could result in an increase in sales returns over
historical levels, and/or a potential decrease in sales to those customers who
are selling Callaway Golf products to unauthorized distributors. 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 been
successful in stopping such commerce to date.
The Company also establishes relationships with professional golfers in order to
promote the Callaway Golf brand among both professional and amateur golfers. The
Company has entered into endorsement arrangements with members of the Senior
Professional Golf Association's Tour, the Professional Golf Association's Tour,
the Ladies Professional Golf Association's Tour, the European Professional Golf
Association's Tour and the Nike Tour. While most professional golfers fulfill
their contractual obligations, some have been known to stop using a sponsor's
products despite contractual commitments. If one or more of Callaway Golf's pro
endorsers were to stop using Callaway Golf's products contrary to their
endorsement agreements, the Company's business could be adversely affected in a
material way by the negative publicity.
During 1995, the Company began to evaluate growth 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 these activities will be
successful. Two of these opportunities identified by the Company relate to the
Company's acquisition of selected foreign distributors and the golf ball
business. The Company's management believes that controlling the distribution of
its products throughout the world will be a key element in the future growth and
success of the Company. Executing a business strategy to achieve this has and
will result in additional investments in inventory, accounts receivable,
corporate infrastructure and facilities. It could also result in disruptions in
the distribution of the Company's products in some areas. There can be no
assurance that the acquisition of the Company's foreign distributors will be
successful, and it is possible that the attempt to do so will adversely affect
the Company's business.
11
The Company, through a distribution agreement, appointed Sumitomo Rubber
Industries, Ltd. ("Sumitomo") as the sole distributor of the Company's golf
clubs in Japan. The distribution agreement requires Sumitomo to purchase
specified minimum quantities. The current distribution agreement began in
February 1993 and has an initial term of seven years. The Company has been
engaged in discussions regarding a possible restructuring of the Company's
distribution arrangements with Sumitomo, which is intended to streamline the
distribution of the Company's products in Japan. There can be no assurance,
however, that such a restructuring will occur, or if consummated, that the
proposed restructuring will achieve its intended goals. It is possible that the
attempt to restructure the Company's distribution arrangements in Japan, or the
failure to succeed in that attempt, will adversely affect the Company's business
in Japan.
In June 1996, the Company formed Callaway Golf Ball Company, a wholly-owned
subsidiary of the Company, for the purpose of designing, manufacturing and
selling golf balls. The Company has previously licensed the manufacture and
distribution of a golf ball product in Japan and Korea. The Company also
distributed a golf ball under the trademark "Bobby Jones." These golf ball
ventures were not commercially successful. At this time, it has not been finally
determined whether Callaway Golf Ball Company will enter the golf ball business
by developing a new product in a new plant to be constructed just for this
purpose; 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 the early stages of development. It is expected, however, that it
will have a negative impact on the Company's future cash flow and income from
operations for several years. The Company believes that many of the same factors
which affect the golf equipment industry, including growth rate in the golf
equipment industry, intellectual property rights of others, seasonality and new
product introduction, 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, Sumitomo Rubber Industries,
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.
RESULTS OF OPERATIONS
THREE-MONTH PERIODS ENDED MARCH 31, 1997 AND 1996:
Net sales increased 25% to $169.1 million for the three months ended March 31,
1997 compared to $135.1 million for the same period in the prior year. The
increase was primarily attributable to the introduction of the Biggest Big
Bertha(TM) Titanium Driver and increased sales of the Great Big Bertha(R)
Titanium Metal Woods, Big Bertha Gold(TM) Irons and Big Bertha(R) Tour Series
Wedges. These sales increases were offset by a decrease in net sales of Big
Bertha War Bird(R) Metal Woods.
For the three months ended March 31, 1997, gross profit increased to $87.0
million from $68.6 million for the same period in the prior year and gross
margin remained constant at 51%.
Selling expenses increased to $26.6 million in the first quarter of 1997
compared to $18.1 million in the first quarter of 1996. As a percentage of net
sales, selling expenses in the first quarter of 1997 increased to 16% from 13%
for the same period in 1996. The $8.5 million increase was primarily a result of
increased profit sharing and bonus accruals, increased salaries, higher
promotional expenses associated with demonstrating new products at a trade show,
additional pro tour expenses with our staff players and increased print
advertising of the Company's new products.
General and administrative expenses for the three months ended March 31, 1997
decreased to $16.3 million from the $17.2 million incurred during the first
quarter of 1996. The $900,000 decrease in general and administrative expenses
was primarily attributable to decreased charitable contributions, lower computer
support expenses and decreased consulting fees in the first quarter of 1997.
12
Research and development expenses were $6.0 million for the three months
ended March 31, 1997 as compared to $3.2 million for the same period in the
prior year. The $2.8 million increase in research and development costs was
attributable to increased product engineering and testing of molds and shafts
with a continued focus on developing core products, increased spending on
developing potential new business opportunities and additional staffing and
overhead.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1997, cash and cash equivalents increased to $113.6 million from
$108.5 million at December 31, 1996 due to $35.8 million provided by operating
activities. This increase was offset by $19.2 million used in financing
activities associated primarily with retirement of the Company's Common Stock
and dividends paid. Also, the Company spent approximately $11.5 million in
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,
including capital expenditures and its planned operations for the foreseeable
future.
The Company's net accounts receivable increased to $97.3 million at March 31,
1997 from $74.5 million at December 31, 1996 and $84.9 million at March 31,
1996, primarily as a result of the increase in net sales. Net inventory was
$96.2 million at March 31, 1997 compared to $98.3 million at December 31, 1996
and $67.3 million at March 31, 1996. The inventory levels at March 31, 1997 are
consistent with historical seasonality trends.
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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 (the "Schmidt Litigation"). 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. The plaintiff has also recently filed a first amended complaint
asserting claims for wrongful termination and termination in violation of public
policy. The first amended complaint seeks damages of $290,000,000, a royalty of
$27,000,000, or compensatory damages for breach of the alleged oral contract and
related claims; damages of approximately $10,000,000 for the wrongful
termination; and unspecified punitive damages and costs. Formal discovery has
commenced in preparation for trial. The trial is currently scheduled to commence
on October 20, 1997. Following the Company's tender of the Schmidt Litigation to
its insurers, the carriers denied coverage. On April 11, 1997, the Company
initiated litigation against these carriers seeking a judicial declaration that
such coverage is afforded under the applicable insurance policies (the
"Insurance Litigation"). The Company believes there are meritorious defenses to
the Schmidt Litigation, and thus no provision for liability has been made in the
Company's financial statements. The Company also believes it is entitled to
coverage by its insurers for all or some of the costs and claims asserted in the
Schmidt Litigation. The ultimate resolution of the Schmidt Litigation and the
Insurance Litigation, however, could result in a material liability and income
statement charge.
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. Except as noted
above, 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 the probable result of these
matters individually and in the aggregate will not have a material adverse
effect upon the Company's financial position, results of operations or cash
flows.
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ITEM 2. CHANGES IN SECURITIES:
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES:
None
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:
10.1 Callaway Golf Company 1996 Stock Option Plan (as amended and restated through
April 17, 1997)
10.2 Callaway Golf Company Executive Deferred Compensation Plan (as amended
and restated through February 6, 1997)
10.3 Callaway Golf Company 1998 Executive Non-Discretionary Bonus Plan
11.1 Statement re: Computation of Earnings Per Share
27.1 Financial Data Schedule
b. Reports on Form 8-K:
None
15
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: May 13, 1997 /s/ Donald H. Dye
-------------------------------------
DONALD H. DYE
President and
Chief Executive Officer
/s/ David A. Rane
-------------------------------------
DAVID A. RANE
Executive Vice President, Golf Venues
and Chief Financial Officer
16