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, 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 Registrant's Common Stock, $.01
par value, as of October 31, 1997 was 74,730,267.
CALLAWAY GOLF COMPANY
INDEX
Page
Part I. Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheet at September 30, 1997
and December 31, 1996 3
Consolidated Condensed Statement of Income for the three
and nine months ended September 30, 1997 and 1996 4
Consolidated Condensed Statement of Cash Flows for the nine
months ended September 30, 1997 and 1996 5
Consolidated Condensed Statement of Shareholders' Equity for
the nine months ended September 30, 1997 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Part II. Other Information 17
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,
1997 1996
-------------- -------------
(Unaudited)
ASSETS
- - ------
Current assets:
Cash and cash equivalents $ 41,493 $ 108,457
Accounts receivable, net 161,872 74,477
Inventories, net 67,369 98,333
Deferred taxes 26,483 25,948
Other current assets 11,084 4,298
--------- ---------
Total current assets 308,301 311,513
Property, plant and equipment, net 126,545 91,346
Other assets 136,276 25,569
--------- ---------
$ 571,122 $ 428,428
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- - ------------------------------------
Current liabilities:
Accounts payable and accrued expenses $ 20,473 $ 14,996
Accrued employee compensation and
benefits 38,114 16,195
Accrued warranty expense 28,049 27,303
Income taxes payable 2,701 2,558
--------- ---------
Total current liabilities 89,337 61,052
Long-term liabilities 6,762 5,109
Commitments and contingencies (Note 7)
Shareholders' equity:
Preferred Stock, $.01 par value,
3,000,000 shares authorized, none
issued and outstanding at September
30, 1997 and December 31, 1996,
respectively
Common Stock, $.01 par value,
240,000,000 shares authorized,
74,597,967 and 72,855,222 issued
and outstanding at September 30,
1997 and December 31, 1996,
respectively 746 729
Paid-in capital 364,424 278,669
Unearned compensation (3,862) (3,105)
Retained earnings 298,553 238,349
Less: Grantor Stock Trust
(5,300,000 shares) at market (184,838) (152,375)
--------- ---------
Total shareholders' equity 475,023 362,267
--------- ---------
$ 571,122 $ 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 Nine months ended
---------------------------------- ----------------------------------
September 30, September 30, September 30, September 30,
1997 1996 1997 1996
--------------- --------------- --------------- ---------------
Net sales $257,435 100% $194,545 100% $679,540 100% $539,685 100%
Cost of goods sold 118,666 46% 88,474 45% 319,026 47% 253,899 47%
-------- -------- -------- --------
Gross profit 138,769 54% 106,071 55% 360,514 53% 285,786 53%
Selling expenses 32,643 13% 21,728 11% 95,238 14% 61,727 11%
General and administrative
expenses 24,716 10% 19,326 10% 57,045 8% 61,440 11%
Research and development
costs 10,640 4% 5,245 3% 24,682 4% 11,653 2%
Litigation settlement (Note 8) 12,000 5% 12,000 2%
-------- -------- -------- --------
Income from operations 58,770 23% 59,772 31% 171,549 25% 150,966 28%
Other income, net 1,146 1,619 3,561 3,952
-------- -------- -------- --------
Income before income taxes 59,916 23% 61,391 32% 175,110 26% 154,918 29%
Provision for income taxes 22,867 22,973 66,773 58,108
-------- -------- -------- --------
Net income $ 37,049 14% $ 38,418 20% $108,337 16% $ 96,810 18%
======== ======== ======== ========
Earnings per common share $ .52 $ .54 $ 1.52 $ 1.38
======== ======== ======== ========
Common equivalent shares 71,648 71,065 71,382 70,390
======== ======== ======== ========
Dividends paid per share $ .07 $ .06 $ .21 $ .18
======== ======== ======== ========
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,
1997 1996
------------- -------------
Cash flows from operating activities:
Net income $ 108,337 $ 96,810
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization 12,797 9,377
Non-cash compensation 7,515 3,576
Increase (decrease) in cash resulting
from changes in:
Accounts receivable, net (73,431) (7,485)
Inventories, net 35,989 (28,794)
Deferred taxes (2,379) (4,665)
Other assets (6,351) (14,270)
Accounts payable and accrued
expenses 1,511 (1,524)
Accrued employee compensation and
benefits 24,259 23,162
Accrued warranty expense 746 3,520
Income taxes payable 240 11,017
Other liabilities 1,653 937
--------- --------
Net cash provided by operating 110,886 91,661
activities --------- --------
Cash flows from investing activities:
Acquisition of a business (129,256)
Capital expenditures (46,292) (21,156)
--------- --------
Net cash used in investing activities (175,548) (21,156)
--------- --------
Cash flows from financing activities:
Issuance of Common Stock 19,103 11,101
Tax benefit from exercise of stock
options 25,946 11,951
Dividends paid (14,264) (12,303)
Retirement of Common Stock (33,010)
--------- --------
Net cash (used in) provided by
financing activities (2,225) 10,749
-------- --------
Effect of exchange rate changes on cash (77) (80)
-------- --------
Net (decrease) increase in cash and
cash equivalents (66,964) 81,174
Cash and cash equivalents at beginning
of period 108,457 59,157
-------- --------
Cash and cash equivalents at end of
period $ 41,493 $140,331
======== ========
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 2,502 25 19,078 19,103
Tax benefit from exercise of
stock options 25,946 25,946
Compensatory stock options 2,300 (757) 1,543
Employee stock purchase plan 372 4 5,968 5,972
Stock retirement (1,131) (12) (32,998) (33,010)
Cash dividends (15,377) (15,377)
Dividends on shares held by GST 1,113 1,113
Equity adjustment from foreign
currency translation (871) (871)
Adjustment of GST shares to market
value 32,463 (32,463)
Net income 108,337 108,337
------ ---- -------- ------- -------- --------- --------
Balance, September 30, 1997 74,598 $746 $364,424 $(3,862) $298,553 $(184,838) $475,023
====== ==== ======== ======= ======== ========= ========
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 financial information for the three and nine months ended
September 30, 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. 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
and the Company's Current Report on Form 8-K dated August 8, 1997, as amended.
Interim operating results are not necessarily indicative of operating results
for the full year.
Certain prior period amounts have been reclassified to conform with the current
period presentation.
2. Inventories
-----------
Inventories at September 30, 1997 and December 31, 1996 (in thousands):
September 30, December 31,
1997 1996
--------------- --------------
(Unaudited)
Inventories, net:
Raw materials $36,244 $ 50,012
Work-in-process 2,270 1,651
Finished goods 34,502 51,954
------- --------
73,016 103,617
Less reserve for obsolescence (5,647) (5,284)
------- --------
Net inventories $67,369 $ 98,333
======= ========
3. Foreign currency exchange contracts
-----------------------------------
During the nine months ended September 30, 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 September 30, 1997, the Company had
approximately $5.2 million of foreign exchange contracts outstanding. The
contracts mature between October and December 1997. Gains and losses on these
contracts are recorded in net income. The net realized and unrealized gains from
foreign exchange contracts for the nine months ended September 30, 1997 totaled
approximately $357,000.
7
4. Cash and cash equivalents
-------------------------
At September 30, 1997, the Company held investments in U.S. Treasury bills with
maturities of three months or less in the aggregate amount of $34.9 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."
The acquisition of substantially all of the assets and certain liabilities of
Odyssey Sports, Inc. ("Odyssey") (Note 6) necessitated the sale of certain held-
to-maturity debt securities from two weeks to two months prior to their
respective stated maturity dates and as a result are considered to be sold at
maturity under the provisions of Statement of Financial Accounting Standard
(SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." These debt securities were purchased at a discount and had an
amortized cost of $115.4 million when sold. No realized or unrealized gain or
loss resulted from the sale of these securities.
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 share and
common equivalent shares 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 and diluted earnings
per share for the three and nine months ended September 30, 1997 and 1996 are
presented below:
Three months ended Nine months ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
Pro forma: 1997 1996 1997 1996
------------- ------------- ------------- -------------
Basic $.54 $.57 $1.59 $1.45
Diluted $.52 $.54 $1.52 $1.38
6. Acquisition
-----------
On August 8, 1997, Callaway Acquisition, a wholly-owned subsidiary of the
Company, consummated its acquisition of substantially all of the assets and
certain liabilities of Odyssey, subject to certain adjustments as of the time of
closing. Odyssey manufactured and marketed the Odyssey(R) line of putters and
wedges with Stronomic(R) face inserts.
The cost to acquire substantially all of the assets and certain liabilities of
Odyssey, including professional fees directly related to the acquisition, was
approximately $129.3 million and has been accounted for using the purchase
method of accounting. The allocations of the acquisition cost amounts to assets
acquired and liabilities assumed are presented in the table that follows. The
amounts therein are estimates and are subject to revision once appraisals and
other studies of fair value are completed. Amounts allocated to trade name,
trademark, trade dress and goodwill are being amortized over 40 years. The
amount allocated to the process patent is being amortized over 16 years and the
covenant not to compete is being amortized over 3 years.
8
Assets acquired/liabilities assumed August 8, 1997
- - ----------------------------------- --------------
(in thousands)
Accounts receivable $ 14,643
Inventories 6,000
--------
Total current assets 20,643
Property and equipment 1,360
Other assets 410
Trade name 69,629
Trademark and trade dress 29,841
Goodwill 2,036
Process patent 6,763
Covenant not to compete 1,641
--------
Total assets acquired 132,323
--------
Accounts payable and accrued liabilities (2,602)
Accrued compensation and related
benefits (465)
--------
Total liabilities assumed (3,067)
--------
Net assets acquired $129,256
========
The following unaudited pro forma net sales, net income and earnings per share
data for the nine months ended September 30, 1997 and 1996 are based on the
respective historical financial statements of the Company and Odyssey. The pro
forma data presented for the nine months ended September 30, 1997 combines the
results of operations of the Company for the nine months ended September 30,
1997 with the results of operations of Odyssey for the nine months ended June
30, 1997 and assumes that the acquisition of substantially all of the assets and
certain liabilities of Odyssey had occurred on January 1, 1997. The pro forma
data presented for the nine months ended September 30, 1996 combines the results
of operations of the Company for the nine months ended September 30, 1996 with
the results of operations of Odyssey for the nine months ended June 30, 1996 and
assumes that the acquisition of substantially all the assets and certain
liabilities of Odyssey had 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.
Nine months ended
-----------------------------
September 30, September 30,
1997 1996
------------- -------------
Net sales (in thousands) $723,586 $559,681
======== ========
Net income (in thousands) $110,169 $ 93,791
======== ========
Earnings per common share $ 1.54 $ 1.33
======== ========
7. 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.
9
The Company has committed to purchase titanium golf clubheads costing
approximately $53.2 million from one of its vendors. These clubheads are to be
shipped to the Company in accord with a production schedule that extends into
1999.
During June 1997, the Company entered into an agreement with Saint Andrews Golf
Corporation to form All-American Golf LLC ("All-American") whereby the Company
is a 20% equity owner in All-American, which operates a nine-hole golf course,
performance center, training facility and driving range (the "Center") located
in Las Vegas, Nevada. As of September 30, 1997, the Company had made capital
contributions to All-American of $750,000. Additionally, the Company has agreed
to loan All-American up to $5.3 million, pursuant to a secured promissory note,
for purposes of construction and various other start-up costs. The note, which
is secured by certain assets of All-American, bears interest of 10% per annum
and is payable in monthly installments. Commencing on the fifth anniversary of
the Center's opening, the principal shall be repaid in 60 equal monthly
installments. As of September 30, 1997 the Company has advanced All-American
approximately $3.9 million under the secured promissory note. The balance of the
note will be advanced upon the completion of the final milestone.
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. The Company believes that the majority of these proceedings involve
matters as to which liability, if any, will be adequately covered by insurance.
Management believes 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.
8. 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. Pursuant to
the settlement, the Company agreed to a six year employment agreement with the
officer, the payment of $12.0 million and the issuance of 600,000 stock options
at the market price on the date of grant. The Company is seeking coverage for
the costs of defending and settling this lawsuit with certain of its insurance
carriers and an insurance agent; however, no assurance can be given that any of
the costs will be recovered.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Statements used in this discussion that relate to future plans, events,
financial results or performance are forward-looking statements as defined under
the Private Securities Litigation Reform Act of 1995. Such statements are
subject to certain risks and uncertainties which could cause actual results to
differ materially from those anticipated. 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 and 10-Q and Current Reports on Form 8-K filed with the Securities
and Exchange Commission.
Certain Factors Affecting Callaway Golf Company
Growth in sales; seasonality
The Company believes that the growth rate in the world-wide golf equipment
market has been modest for the past several years, and this trend is likely to
continue. In addition, recent turmoil in the Southeast Asian financial markets
and its potential effect on Korea, Japan and the rest of Asia, combined with any
economic disruptions resulting from such turmoil, may have an adverse effect on
the Company's sales and results of operations. Although demand for the Company's
products has been generally strong during the quarter ended September 30, 1997,
no assurances can be given that the demand for the Company's
10
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. The Company's business generally follows this
seasonal trend and the Company expects this to continue.
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. New product introductions by competitors continue to
generate increased market competition. While the Company believes that its
products and its marketing efforts continue to be competitive, there can be no
assurance that successful marketing activities 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.
New product introduction
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. In
addition, the materials and unique clubhead designs incorporated in the
Company's Great Big Bertha(R) Tungsten.Titanium Irons require more sophisticated
and lengthy manufacturing processes than the Company's existing products. To
date, the Company has been unable to supply the Great Big Bertha(R)
Tungsten.Titanium Irons in sufficient quantities to meet fully the demand for
this new product. 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.
Product breakage
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 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
11
production changes to assure its customers of the highest quality available in
the market. The Company's recently introduced Biggest Big Bertha(TM) Drivers,
because of their large clubhead size and extra long graphite shafts, have
experienced breakage at a rate higher than generally experienced with the
Company's other metal woods. Significant increases in the incidence of breakage
or other product problems may adversely affect the Company's sales and image
with golfers.
Dependence on certain vendors
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 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 clubheads and shafts could be
obtained from other manufacturers, although the transition to other suppliers,
particularly with respect to the Great Big Bertha(R) Tungsten.Titanium(TM)
Irons, could result in significant production delays and an adverse impact on
results of operations during the transition.
The Company uses United Parcel Service ("UPS") for substantially all ground
shipments of products to its domestic customers. While the Company is seeking to
arrange alternative methods of ground shipping to reduce its reliance on UPS,
there can be no assurance that the Company will be successful in doing so.
Intellectual property and proprietary rights
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 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.
"Gray market" distribution
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
12
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.
Professional endorsements
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.
New business ventures
Beginning in 1995, the Company began to evaluate and pursue new business
ventures which it believes constitute potential growth opportunities in and
outside of the golf equipment industry. The Company has invested, and expects to
continue to invest, significant capital resources in these new ventures in the
form of research and development, capital expenditures and the hiring of
additional personnel. There can be no assurance that new ventures will lead to
new product offerings or otherwise increase the revenues and profits of the
Company. Like all new businesses, these ventures require significant management
time, involve a high degree of risk and will present many new challenges for the
Company. There can be no assurance that these activities will be successful, or
that the Company will realize appropriate returns on its investments in these
new ventures.
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. 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 some or all of the Company's foreign
distributors will be successful, and it is possible that an attempt to do so
will adversely affect the Company's business.
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 current distribution agreement began in February 1993 and
runs through December 31, 1999. 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.
Golf ball development
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.
The Company has determined that 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. The successful implementation of the
13
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 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 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. 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.
Acquisition of Odyssey
On August 8, 1997, the Company consummated its acquisition of substantially all
of the assets and certain liabilities of Odyssey Sports, Inc., a leading
manufacturer of premium putters. The integration of Odyssey's operations into
Odyssey Golf, a wholly-owned subsidiary of the Company, will require the
dedication of management resources which may temporarily detract from attention
to the day-to-day business of the Company. There can be no assurance that the
Company's integration of Odyssey's operations will not result in a loss of key
personnel, a decrease in revenues and profitability, or other material adverse
effects on the financial performance and business operations of Odyssey Golf
and/or the Company.
Odyssey(R) products previously were manufactured and shipped on behalf of
Odyssey by Tommy Armour Golf Company. In October 1997, Odyssey Golf began
manufacturing and shipping Odyssey(R) products at its own plant in Carlsbad,
California. There can be no assurance that the Company's ability to deliver
Odyssey(R) products to the marketplace in sufficient quantities and quality will
not be adversely affected by this manufacturing transition. Odyssey Golf is in
the process of restructuring its international distribution in certain
countries. There can be no assurance that this restructuring will not adversely
affect Odyssey Golf's international business.
Year 2000 Compliance
Historically, certain computer programs have been written using two digits
rather than four to define the applicable year, which could result in the
computer recognizing a date using "00" as the year 1900 rather than the year
2000. This, in turn, could result in major system failures or miscalculations,
and is generally referred to as the "Year 2000" problem.
In October 1997, the Company began implementing a new computer system which runs
substantially all of the Company's principal data processing and financial
reporting software applications. The application software used on this new
system is Year 2000 compliant. The information systems of certain of the
Company's subsidiaries, however, have not been converted to the new system, but
the Company expects that such conversion will be complete well in advance of the
Year 2000. Pursuant to the Company's Year 2000 Plan, the Company is currently
evaluating its computerized production equipment to assure that the transition
to the Year 2000 will not disrupt the Company's manufacturing capabilities. The
Company also intends to evaluate the systems of its key component suppliers,
distributors and other vendors. Presently, the Company does not believe that
Year 2000 compliance will result in material investments by the Company, nor
does the Company anticipate that the Year 2000 problem will have material
adverse effects on the business operations or financial performance of the
Company. There can be no assurance, however, that the Year 2000 problem will not
adversely affect the Company and its business.
14
Results of Operations
Three-month periods ended September 30, 1997 and 1996:
Net sales increased 32% to $257.4 million for the three months ended September
30, 1997 compared to $194.5 million for the comparable period in the prior year.
The increase was primarily attributable to sales generated by Biggest Big
Bertha(TM) Titanium Drivers and Great Big Bertha(R) Tungsten.Titanium(TM) Irons
as well as sales of the Odyssey(R) line of putters and wedges. Also contributing
to the increase were increased sales of Big Bertha Gold(TM) Irons and Big
Bertha(R) Tour Series Wedges. The increase was partially offset by a decrease in
sales of Great Big Bertha(R) Titanium Drivers, Big Bertha(R) War Bird(R) Metal
Woods and Big Bertha(R) Irons.
For the three months ended September 30, 1997, gross profit increased 31% to
$138.8 million from $106.1 million for the comparable period in the prior year.
As a percentage of net sales, gross profit decreased to 54% from 55%, primarily
as a result of slightly higher cost of sales associated with the product mix and
region sales during the quarter ended September 30, 1997 as compared to that
sold in the comparable quarter of the prior year.
Selling expenses increased to $32.6 million in the third quarter of 1997
compared to $21.7 million in the third quarter of 1996. As a percentage of net
sales, selling expenses increased to 13% from 11% during the third quarter of
1997 over the third quarter of 1996. The $10.9 million increase was primarily
the result of increased pro tour, promotional and compensation expenses.
General and administrative expenses increased to $24.7 million for the three
months ended September 30, 1997 from $19.3 million for the comparable period in
the prior year. As a percentage of net sales, general and administrative
expenses in the third quarter of 1997 remained constant at 10%. The $5.4 million
increase was primarily attributable to increases in legal fees, compensation
expenses and building construction costs.
Research and development expenses increased to $10.6 million in the third
quarter of 1997 compared to $5.2 million in the comparable period of the prior
year. As a percentage of net sales, research and development expenses in the
third quarter of 1997 increased to 4% from 3% in the third quarter of 1996. The
$5.4 million increase was primarily the result of increased product engineering
costs, the Company's interactive golf efforts and costs associated with golf
ball development.
Nine-month periods ended September 30, 1997 and 1996:
For the nine months ended September 30, 1997, net sales increased 26% to $679.5
million compared to $539.7 million for the comparable period of the prior year.
The increase was primarily attributable to sales generated by the introduction
of Biggest Big Bertha(TM) Titanium Drivers and Great Big Bertha(R)
Tungsten.Titanium(TM) Irons as well as sales of the Odyssey(R) line of putters
and wedges. Also contributing to the increase were increased sales of Big Bertha
Gold(TM) Irons and Big Bertha(R) Tour Series Wedges. This increase was partially
offset by a decrease in sales of Great Big Bertha(R) Titanium Drivers, Big
Bertha(R) War Bird(R) Metal Woods and Big Bertha(R) Irons.
For the nine months ended September 30, 1997, gross profit increased 26% to
$360.5 million from $285.8 million for the comparable period in the prior year,
while gross profit, as a percentage of net sales, remained constant at 53%.
Selling expenses increased to $95.2 million for the nine months ended September
30, 1997 from $61.7 million for the comparable period in the prior year. As a
percentage of net sales, selling expenses in the first nine months of 1997
increased to 14% from 11% for the comparable period in 1996. The $33.5 million
increase was primarily the result of increased compensation, pro tour,
promotional and advertising expenses.
General and administrative expenses decreased to $57.0 million for the nine
months ended September 30, 1997 from $61.4 million for the comparable period in
the prior year. As a percentage of net sales, general and
15
administrative expenses in the first nine months of 1997 decreased to 8% from
11% in the first nine months of 1996. The $4.4 million decrease resulted
primarily from a decrease in compensation expenses, charitable contributions,
consulting fees and computer support expenses. These decreases were partially
offset by increases in legal fees and costs associated with the Company's
business development initiatives.
Research and development expenses increased to $24.7 million for the nine months
ended September 30, 1997 from $11.7 million for the comparable period in the
prior year. As a percentage of net sales, research and development expenses for
the first nine months of 1997 increased to 4% from 2% in the first nine months
of 1996. The $13.0 million increase was primarily attributable to increased
product engineering and design costs, the Company's interactive golf efforts and
costs associated with golf ball development.
Liquidity and Capital Resources
At September 30, 1997, cash and cash equivalents decreased to $41.5 million from
$108.5 million at December 31, 1996 primarily due to investing activities, which
included the acquisition of substantially all of the assets and certain
liabilities of Odyssey (Note 6), and increases in capital expenditures, which
totaled $46.3 million and included building and building improvements, computer
equipment and software, and research and development machinery and equipment.
These increases were partially offset by cash provided by operating activities
of $110.9 million.
The increase in cash flows from operations was primarily a result of net income
of $108.3 million, depreciation and amortization of $12.8 million, a decrease in
inventories of $36.0 million and an increase in accrued employee compensation
and benefits of $24.3 million, partially offset by increases in accounts
receivable of $73.4 million and other assets of $6.4 million.
The Company had available a $50.0 million line of credit at September 30, 1997.
At this time, the Company anticipates that it will be able to maintain its
current level of operations, including capital expenditures and planned
operations for the foreseeable future, through cash flow generated from future
operations and the existing line of credit.
16
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 marketplace.
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 the Company and two of its officers
by a former officer of the Company, captioned Glenn Schmidt v. Callaway Golf
------------------------------
Company, et al., case no. N71548, in the Superior Court for the State of
- - ---------------
California, County of San Diego (the "Schmidt Litigation"). On September 23,
1997, the Schmidt Litigation was dismissed pursuant to a settlement between
Schmidt, the Company and the other named defendants. The Company paid Mr.
Schmidt $12.0 million, obtained Mr. Schmidt's services for a six year term, and
issued options to Mr. Schmidt to purchase 600,000 shares of the Company's Common
Stock at the market price on the day of the option grant. After the Schmidt
Litigation was filed, the Company tendered the claim to its insurers. Certain
insurers denied coverage. On April 11, 1997, the Company initiated litigation
against certain of its carriers and an insurance agent, captioned Callaway Golf
-------------
v. National Union Fire Insurance Company of Pittsburgh, Federal Insurance
- - -------------------------------------------------------------------------
Company, and MDM Associates, Inc., case no. 709645, in the Superior Court for
- - ---------------------------------
the State of California, County of San Diego (the "Insurance Litigation"). In
the Insurance Litigation the Company is seeking a judicial declaration that
coverage is afforded for the Schmidt Litigation under the applicable insurance
policies. The Company believes it is entitled to coverage by its insurers for
all or some of the costs of defending and settling the claims asserted in the
Schmidt Litigation.
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 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. Changes in Securities:
None
Item 3. Defaults Upon Senior Securities:
None
17
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 Chief Executive Officer Employment Agreement by and
between Callaway Golf Company and Donald H. Dye entered
into as of January 1, 1997.
10.2 Asset Purchase Agreement dated July 20, 1997 by and
among Callaway Golf Company, Odyssey Sports, Inc. and
U.S. Industries, Inc. (filed as Exhibit 10.1 to the
Company's Current Report on Form 8-K dated August 8,
1997, as filed with the Securities and Exchange
Commission on August 22, 1997 and incorporated herein
by this reference).
10.3 Transitional Assembly Services Agreement dated as of
August 8, 1997 by and between Callaway Acquisition and
Tommy Armour Golf Company (filed as Exhibit 10.2 to the
Company's Current Report on Form 8-K dated August 8,
1997, as filed with the Securities and Exchange
Commission on August 22, 1997 and incorporated herein
by this reference).
10.4.1 Standard Industrial/Commercial Single-Tenant Lease
dated September 20, 1996 by and between Techplex, L.P.
and Putter Properties, Inc.
10.4.2 Assignment made as of August 8, 1997 by Putter
Properties, Inc. to Callaway Acquisition.
10.4.3 Guaranty of Lease entered into as of August 8, 1997 by
the Company in favor of Techplex, L.P.
10.5 Indemnification Agreement by and between the Company
and Vernon E. Jordan, Jr., dated July 16, 1997.
11.1 Statement re: Computation of Earnings Per Share.
27.1 Financial Data Schedule.
b. Reports on Form 8-K:
-------------------
The Company filed the following Current Reports on Form 8-K during
the three months ended September 30, 1997:
(1) Current Report on Form 8-K dated July 20, 1997, regarding
agreement to acquire substantially all of the assets of
Odyssey Sports, Inc., reported under Item 5.
(2) Current Report on Form 8-K dated August 8, 1997, regarding the
consummation of the acquisition of substantially all of the
assets of Odyssey Sports, Inc., reported under Item 2.
(3) Amendment No. 1 to Current Report on Form 8-K/A dated August
8, 1997, regarding the consummation of the acquisition of
substantially all of the assets of Odyssey Sports, Inc.,
reported under Items 2 and 7. The following financial
statements were filed under Item 7 with that Report:
(a) Financial Statements of Business Acquired.
Audited financial statements as of September 30, 1996 and
for the year then ended, as follows:
- Report of Independent Accountants;
- Balance Sheet as of September 30, 1996;
18
- Statement of Income for the year ended September 30,
1996;
- Statement of Changes in Invested Capital of Parent
for the year ended September 30, 1996;
- Statement of Cash Flows for the year ended September
30, 1996; and
- Notes to financial statements.
Unaudited financial statements as of June 30, 1997 and for
the nine months ended June 30, 1997 and 1996, as follows:
- Unaudited Balance Sheet as of June 30, 1997;
- Unaudited Statements of Income for the nine months
ended June 30, 1997 and 1996; and
- Unaudited Statements of Cash Flows for the nine
months ended June 30, 1997 and 1996.
(b) Pro Forma Financial Information.
- Unaudited Pro Forma Consolidated Condensed Balance
Sheet as of June 30, 1997;
- Unaudited Pro Forma Consolidated Condensed
Statements of Income for the six months ended June
30, 1997 and the year ended December 31, 1996; and
- Notes to Unaudited Pro Forma Consolidated Condensed
financial statements.
(4) Current Report on Form 8-K dated September 12, 1997, regarding
the Company's settlement of litigation with a former officer,
Mr. Glenn Schmidt, on behalf of the Company and the other
defendants, reported under Item 5.
19
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, 1997 /s/ DONALD H. DYE
-------------
Donald H. Dye
President and
Chief Executive Officer
/s/ DAVID A. RANE
-------------
David A. Rane
Executive Vice President, Planning and
Administration and Chief Financial Officer
20
EXHIBIT INDEX
-------------
Exhibit Number Description
- - -------------- -----------
10.1 Chief Executive Officer Employment Agreement by and between
Callaway Golf Company and Donald H. Dye entered into as of
January 1, 1997.
10.2* Asset Purchase Agreement dated July 20, 1997 by and among
Callaway Golf Company, Odyssey Sports, Inc. and U.S.
Industries, Inc.
10.3* Transitional Assembly Services Agreement dated as of August 8,
1997 by and between Callaway Acquisition and Tommy Armour Golf
Company.
10.4.1 Standard Industrial/Commercial Single-Tenant Lease dated
September 20, 1996 by and between Techplex, L.P. and Putter
Properties, Inc.
10.4.2 Assignment made as of August 8, 1997 by Putter Properties,
Inc. to Callaway Acquisition.
10.4.3 Guaranty of Lease entered into as of August 8, 1997 by the
Company in favor of Techplex, L.P.
10.5 Indemnification Agreement by and between the Company and
Vernon E. Jordan, Jr., dated July 16, 1997.
11.1 Statement re: Computation of Earnings Per Share.
27.1 Financial Data Schedule.
_______________
*Previously filed with the Registrant's Current Report on Form 8-K dated August
8, 1997 as filed with the Securities and Exchange Commission on August 22, 1997.
21