Exhibit 13.1
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Portions of the Callaway Golf Company 1997 Annual Report to Shareholders
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FINANCIAL CONTENTS
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Selected Financial Data.............................................................................28
Management's Discussion and Analysis of Financial Condition and Results of Operations...............29
Consolidated Balance Sheet..........................................................................34
Consolidated Statement of Income....................................................................35
Consolidated Statement of Cash Flows................................................................36
Consolidated Statement of Shareholders' Equity......................................................37
Notes to Consolidated Financial Statements..........................................................38
Report of Independent Accountants...................................................................47
Summarized Quarterly Financial Data (unaudited).....................................................48
27
-------------------------------
SELECTED FINANCIAL DATA
-------------------------------
(in thousands, except per share data) Year ended December 31,
1997 1996 1995 1994 1993
---------------------------------------------------------------------
Statement of Income Data:
Net sales $ 842,927 $ 678,512 $ 553,287 $ 448,729 $ 254,645
Cost of goods sold 400,127 317,353 270,125 208,906 115,458
---------------------------------------------------------------------
Gross profit 442,800 361,159 283,162 239,823 139,187
Selling, general and administrative expenses 191,313 155,177 120,201 106,913 67,118
Research and development costs 30,298 16,154 8,577 6,380 3,653
Litigation settlement 12,000
---------------------------------------------------------------------
Income from operations 209,189 189,828 154,384 126,530 68,416
Other income, net 4,576 5,767 4,017 2,875 1,184
---------------------------------------------------------------------
Income before income taxes and cumulative
effect of accounting change 213,765 195,595 158,401 129,405 69,600
Provision for income taxes 81,061 73,258 60,665 51,383 28,396
---------------------------------------------------------------------
Income before cumulative effect
of accounting change 132,704 122,337 97,736 78,022 41,204
Cumulative effect of accounting change 1,658
---------------------------------------------------------------------
Net income $ 132,704 $122,337 $ 97,736 $ 78,022 $ 42,862
=====================================================================
Earnings per Common Share (Note 1):
Income before cumulative effect
of accounting change
Basic $1.94 $1.83 $1.47 $1.14 $0.65
Diluted $1.85 $1.73 $1.40 $1.07 $0.60
Cumulative effect of accounting change
Basic $0.03
Diluted $0.02
---------------------------------------------------------------------
Net income
Basic $1.94 $1.83 $1.47 $1.14 $0.68
Diluted $1.85 $1.73 $1.40 $1.07 $0.62
=====================================================================
Dividends paid per share $0.28 $0.24 $0.20 $0.10 $0.03
(in thousands) December 31,
1997 1996 1995 1994 1993
---------------------------------------------------------------------
Balance Sheet Data:
Cash and cash equivalents $26,204 $108,457 $59,157 $54,356 $48,996
Working capital $209,402 $250,461 $146,871 $130,792 $83,683
Total assets $561,714 $428,428 $289,975 $243,622 $144,360
Long-term liabilities $7,905 $5,109 $2,207 $610
Total shareholders' equity $481,425 $362,267 $224,934 $186,414 $116,577
=====================================================================
28
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
-----------------------------------------------------
Results of Operations
Years Ended December 31, 1997 and 1996
For the year ended December 31, 1997, net sales increased 24% to $842.9 million
compared to $678.5 million for the prior year. The growth in sales included
increases in the sales of metal woods, irons, and putters. Metal wood sales
increased $65.1 million primarily due to sales of Biggest Big Bertha(TM)
Titanium Drivers. Iron sales increased $65.4 million primarily due to sales of
Great Big Bertha(R) Tungsten.Titanium(TM) Irons, which generated revenues of
$59.3 million for the year ended December 31, 1997. Also contributing to the
increase in net sales was the acquisition of certain assets and liabilities of
Odyssey Sports, Inc. by the Company's wholly-owned subsidiary, Odyssey Golf,
Inc. ("Odyssey"), which contributed $20.5 million in net sales.
For the year ended December 31, 1997, gross profit increased to $442.8
million from $361.2 million in 1996 and cost of goods sold was relatively
unchanged as a percentage of sales from the prior year.
The Company accrues a provision for warranty expense at the time of sale
of its products. Based on the Company's warranty policies and historical rates
of product returns, the Company believes its accrual for warranty expense to be
adequate.
Selling expenses increased to $120.6 million in 1997 from $80.7 million in
1996. As a percentage of net sales, selling expenses increased to 14% from 12%.
The $39.9 million increase was primarily due to increased promotional and tour
expenses, higher costs related to the Company's performance centers and
additional selling expenses associated with the addition of Odyssey.
General and administrative expenses decreased to $70.7 million in 1997
from $74.5 million in 1996. The $3.8 million decrease was primarily due to
reduced employee bonus and profit sharing expenses, partially offset by
increased start-up costs associated with the Company's golf ball operations and
the addition of Odyssey.
Research and development expenses increased to $30.3 million in 1997 as
compared to $16.2 million in 1996. This $14.1 million increase resulted from
increased expenditures related to casting technologies, golf ball development
and product engineering efforts.
Litigation settlement expense of $12.0 million represents the Company's
third quarter settlement of certain litigation brought against it and certain
officers of the Company by a former officer of the Company.
During the fourth quarter of 1997, the Company reversed an accrual for
bonus compensation of approximately $8.0 million due to the fact that certain
operating targets were not met.
Years Ended December 31, 1996 and 1995
For the year ended December 31, 1996, net sales increased 23% to $678.5 million
compared to $553.3 million for the prior year. This increase was attributable
primarily to increased sales of Great Big Bertha(R) Titanium Drivers, and Great
Big Bertha(R) Fairway Woods which were introduced in January 1996, combined with
increased sales of Big Bertha(R) Irons. These sales increases were offset by a
decrease in net sales of Big Bertha(R) War Bird(R) Metal Woods.
For the year ended December 31, 1996, gross profit increased to $361.2
million from $283.2 million for the prior year and gross margin increased to 53%
from 51%. The increase in gross margin was primarily the result of decreases in
component costs and manufacturing labor and overhead costs associated with
increased production volume and improved labor efficiencies.
The Company accrues a provision for warranty expense at the time of sale
of its products. Based on the Company's warranty policies and historical rates
of product returns, the Company believes its accrual for warranty expense to be
adequate.
Selling expenses increased to $80.7 million in 1996 from $64.3 million in
1995. The $16.4 million increase was primarily due to increased tour
endorsement, TV advertising and employee compensation expenses. As a percentage
of net sales, selling expenses remained constant at 12%.
General and administrative expenses increased to $74.5 million in 1996
from $55.9 million in 1995. The $18.6 million increase was related primarily to
increased employee compensation and benefits, consulting costs associated with
the Company's business development initiatives and increases in computer
support, legal and other general and administrative expenses. As a percentage of
net sales, general and administrative expenses increased to 11% from 10%.
Research and development expenses increased to $16.2 million in 1996 as
compared to $8.6 million in 1995. This increase resulted from increased staffing
and operational expenses consistent with the Company's efforts to pursue
potential new business opportunities and the continued focus on existing core
products.
Net interest income increased to $5.0 million in 1996 compared to $3.5
million in 1995. The increase in interest income was due to the investment of
higher average cash balances.
29
Liquidity and Capital Resources
At December 31, 1997, cash and cash equivalents decreased to $26.2 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 Sports, Inc. for $129.3 million and increases in capital
expenditures, which totaled $67.9 million and included building and land
improvements, computer equipment and software, and research and development
machinery and equipment. During 1997, the Company also spent $53.0 million to
repurchase and retire Common Stock and paid $19.1 million in dividends.
Offsetting these investing and financing activities were cash flows generated by
operations of $165.5 million and proceeds from Common Stock transactions
totaling $21.6 million.
The Company had available a $50.0 million line of credit at December 31,
1997. This credit facility was replaced with a new five year, $150.0 million
credit facility during February 1998. 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 new line of credit.
Certain Factors Affecting
Callaway Golf Company
Growth in Sales; Profit Margins; Seasonality
The Company believes that the growth rate, if any, 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 economic turmoil in Southeast Asia and
Korea has caused a significant contraction in the retail golf markets in these
countries and had an adverse effect on the Company's sales and results of
operations for the fourth quarter of 1997. The Company expects this situation to
continue until economic stability returns to these areas. Potential economic
disruption from this turmoil in other areas, such as Japan and elsewhere in
Asia, also could adversely impact the Company's future sales and results of
operations. Additionally, although demand for the Company's products has been
generally strong during 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 rates in sales. Given the
Company's current size and market position, it is likely that further market
penetration will prove more difficult.
The Company experienced an increase in its cost of goods sold during the
third and fourth quarters of 1997 compared to historical levels, primarily due
to a general increase in sales of irons, which have lower margins than metal
woods, and an increase in sales to Japan, an area which has the lowest margins
of all the areas in which the Company sells. In addition, the current operations
of Odyssey have lower margins than the Company has experienced historically. If
sales of irons in general, or Great Big Bertha(R) Tungsten.Titanium(TM) Irons in
particular, as a percentage of the Company's total sales remain at these levels
or continue to rise, the recent increases in cost of goods sold over historical
levels will continue. Similarly, if Odyssey's business continues to increase,
and its margins do not improve, the Company's margins could continue to
decrease.
In the golf equipment industry, sales to retailers are generally seasonal
due to lower demand in the retail market in the cold weather months covered by
the fourth and first quarters. The Company's business generally follows this
seasonal trend and the Company expects this to continue. Unusual or severe
weather conditions such as the "El Nino" weather patterns being experienced in
the winter of 1997-1998 will compound these seasonal affects and could have a
negative effect on the Company's sales and results of operations.
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 is
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
30
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.
The rapid introduction of new products by the Company can result in
close-outs of existing inventories, both at the Company and at retailers. So
far, the Company has managed such close-outs so as to avoid any material
negative impact on the Company's operations. There can be no assurance that the
Company will always be able to do so.
As the Company introduces new products, it plans its manufacturing
capacity based upon the forecasted demand for such new products. Actual demand
for such new products may exceed forecasted demand. The Company's unique product
designs often require sophisticated manufacturing techniques, which can limit
the Company's ability to quickly expand its manufacturing capacity to meet the
full demand for new products. If the Company is unable to produce sufficient
quantities of new products in time to fulfill actual demand, especially during
the Company's traditionally busy second and third quarters, it could limit the
Company's sales and adversely affect its financial performance.
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 production changes to assure its customers of the highest quality
available in the market. The Company's Biggest Big Bertha(TM) Drivers, because
of their large clubhead size and extra long graphite shafts, have experienced
shaft breakage at a rate higher than generally experienced with the Company's
other metal woods. Significant increases in the incidence of shaft 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 manufacturing techniques and processes which make it difficult to
identify and utilize alternative suppliers quickly. Consequently, if a
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 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. The Company is
considering alternative methods of ground shipping to reduce its reliance on
UPS, but no change has been made. Any interruption in UPS services could have a
material adverse effect on the company's sales and results of operations.
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 patents or other intellectual property
31
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 actions.
Despite its efforts to avoid such infringements, there can be no assurance that
Callaway Golf Ball Company will not infringe on the patents or other
intellectual property rights of third parties in its development efforts, or
that it will be able to obtain licenses to use any such rights, if necessary.
"Gray Market" Distribution
Some quantities of the Company's products find their way to unapproved outlets
or distribution channels. This "gray market" in the Company's products can
undermine authorized retailers and distributors who promote and support the
Company's products, and can injure the Company's image in the minds of its
customers and consumers. On the other hand, stopping such commerce could result
in a potential decrease in sales to those customers who are selling Callaway
Golf products to unauthorized distributors and/or an increase in sales returns
over historical levels. While the Company has taken some lawful steps to limit
commerce in its products in the "gray market" in both domestic and international
markets, it has not stopped such commerce. The Company's efforts to address gray
market issues could have an adverse impact on the Company's sales and financial
performance.
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
professional endorsers were to stop using the Company's products contrary to
their endorsement agreements, the Company's business could be adversely affected
in a material way by the negative publicity.
Many professional golfers throughout the world use the Company's golf
clubs even though they are not contractually bound to do so. The Company has
created cash "pools" that reward such usage. For the last several years, the
Company has experienced an exceptional level of driver penetration on the
world's five major professional tours, and the Company has heavily advertised
that fact. There is no assurance that the Company will be able to sustain this
level of professional usage. Many other companies are aggressively seeking the
patronage of these professionals, and are offering many inducements, including
specially designed products and significant cash rewards. While it is not clear
whether professional endorsements materially contribute to retail sales, it is
possible that a decline in the level of professional usage could have a material
adverse effect on the Company's business.
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. Investments in these ventures could have a negative impact
on the Company's future cash flows and results of operations. 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. The Company is actively pursuing a reorganization of its
international operations, including the acquisition of distribution rights in
certain key countries in Europe and Asia. These efforts have and will result in
additional investments in inventory, accounts receivable, corporate
infrastructure and facilities. The integration of foreign distributors into the
Company's international sales operations will require the dedication of
management resources which may temporarily detract from attention to the
day-to-day business of the Company, and also increase the Company's exposure to
fluctuations in exchange rates for various foreign currencies. International
reorganization also could result in disruptions in the distribution of the
Company's products in some areas. There can be no assurance that the acquisition
of some or all of the Company's foreign 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 does not intend to extend this
agreement.
32
The Company has established ERC International Company ("ERC"), a
wholly-owned Japanese corporation, for the purpose of distributing Odyssey(R)
products immediately, Callaway Golf balls when ready and Callaway Golf clubs
beginning January 1, 2000. There will be significant costs and capital
expenditures invested in ERC before there will be sales sufficient to support
such product costs. Furthermore, there are significant risks associated with the
Company's intention to effectuate distribution in Japan through ERC, and it is
possible that doing so will have a material adverse effect on the Company's
operations and financial performance.
Golf Ball Development
In 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 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 flows and results of 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 introductions, also apply to the
golf ball business. In addition, the golf ball business is highly competitive
with a number of well-established and well-financed competitors. These
competitors have established market share in the golf ball business which will
need to be penetrated in order for the Company's golf ball business to be
successful.
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 implemented a new computer system which runs
most 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 is in the
process of implementing such conversion. 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 is currently assessing the extent of the
Year 2000 impact on its suppliers, distributors, customers and other vendors.
Presently, the Company does not believe that Year 2000 compliance will result in
additional 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.
Management Information Systems
As noted above, in October 1997, the Company converted to a new integrated
computer system which runs substantially all of the Company's principal data
processing and financial reporting software applications. As the Company enters
its traditional busy selling season in the second and third quarters, the
demands on the Company's information systems will increase substantially. Any
significant disruptions or delays in the Company's information systems during
this period could negatively impact the Company's ability to process sales
orders and compile other management information, which in turn could have
material adverse effects on the Company's sales and results of operations.
33
--------------------------
CONSOLIDATED BALANCE SHEET
--------------------------
December 31,
(in thousands, except share and per share data) 1997 1996
-------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 26,204 $ 108,457
Accounts receivable, net 124,470 74,477
Inventories, net 97,094 98,333
Deferred taxes 23,810 25,948
Other current assets 10,208 4,298
-------------------------
Total current assets 281,786 311,513
Property, plant and equipment, net 142,503 91,346
Intangible assets, net 112,141 4,277
Other assets 25,284 21,292
-------------------------
$ 561,714 $ 428,428
=========================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 30,063 $ 14,996
Accrued employee compensation and benefits 14,262 16,195
Accrued warranty expense 28,059 27,303
Income taxes payable 2,558
-------------------------
Total current liabilities 72,384 61,052
Long-term liabilities (Note 7) 7,905 5,109
Commitments and contingencies (Note 9)
Shareholders' equity:
Preferred Stock, $.01 par value, 3,000,000 shares authorized,
none issued and outstanding at December 31, 1997 and 1996
Common Stock, $.01 par value, 240,000,000 shares authorized,
74,251,664 and 72,855,222 issued and outstanding at
December 31, 1997 and 1996 (Note 4) 743 729
Paid-in capital 337,403 278,669
Unearned compensation (3,575) (3,105)
Retained earnings 298,169 238,349
Less: Grantor Stock Trust (5,300,000 shares at December 31, 1997
and 1996) at market (Note 4) (151,315) (152,375)
-------------------------
Total shareholders' equity 481,425 362,267
-------------------------
$ 561,714 $ 428,428
=========================
See accompanying notes to consolidated financial statements.
34
--------------------------------
CONSOLIDATED STATEMENT OF INCOME
--------------------------------
(in thousands, except per share data) Year ended December 31,
1997 1996 1995
---------------------------------------------------------------------------------
Net sales $842,927 100% $678,512 100% $553,287 100%
Cost of goods sold 400,127 47% 317,353 47% 270,125 49%
---------------------------------------------------------------------------------
Gross profit 442,800 53% 361,159 53% 283,162 51%
Selling expenses 120,589 14% 80,701 12% 64,310 12%
General and administrative expenses 70,724 8% 74,476 11% 55,891 10%
Research and development costs 30,298 4% 16,154 2% 8,577 2%
Litigation settlement 12,000 1%
---------------------------------------------------------------------------------
Income from operations 209,189 25% 189,828 28% 154,384 28%
Interest and other income, net 4,576 5,767 4,017
---------------------------------------------------------------------------------
Income before income taxes 213,765 25% 195,595 29% 158,401 29%
Provision for income taxes 81,061 73,258 60,665
---------------------------------------------------------------------------------
Net income $132,704 16% $122,337 18% $ 97,736 18%
=================================================================================
Earnings per common share
Basic $1.94 $1.83 $1.47
Diluted $1.85 $1.73 $1.40
Common equivalent shares
Basic 68,407 66,832 66,641
Diluted 71,698 70,661 69,855
See accompanying notes to consolidated financial statements.
35
------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
------------------------------------
(in thousands) Year ended December 31,
1997 1996 1995
--------------------------------------------------------
Cash flows from operating activities:
Net income $ 132,704 $ 122,337 $ 97,736
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 19,408 12,691 10,778
Non-cash compensation 8,013 4,194 2,027
Tax benefit from exercise of stock options 29,786 14,244 11,236
Deferred taxes 1,030 (4,420) 4,978
Increase (decrease) in cash resulting from changes in:
Accounts receivable, net (36,936) 3,510 (43,923)
Inventories, net 6,271 (44,383) 22,516
Other assets (6,744) (12,817) (6,518)
Accounts payable and accrued expenses 13,529 (15,395) 9,227
Accrued employee compensation and benefits (2,437) 2,031 1,322
Accrued warranty expense 756 3,534 5,587
Income taxes payable (2,636) 626 (9,845)
Other liabilities 2,796 2,902 1,597
--------------------------------------------------------
Net cash provided by operating activities 165,540 89,054 106,718
--------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (67,938) (35,352) (29,510)
Acquisition of a business, net of cash acquired (129,256) (610)
--------------------------------------------------------
Net cash used in investing activities (197,194) (35,962) (29,510)
--------------------------------------------------------
Cash flows from financing activities:
Issuance of Common Stock 21,558 12,258 7,991
Retirement of Common Stock (52,985) (67,022)
Dividends paid, net (19,123) (16,025) (13,350)
--------------------------------------------------------
Net cash used in financing activities (50,550) (3,767) (72,381)
--------------------------------------------------------
Effect of exchange rate changes on cash (49) (25) (26)
--------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (82,253) 49,300 4,801
Cash and cash equivalents at beginning of year 108,457 59,157 54,356
--------------------------------------------------------
Cash and cash equivalents at end of year $ 26,204 $ 108,457 $ 59,157
========================================================
Supplemental disclosure:
Cash paid for income taxes $ 54,358 $ 62,938 $ 58,543
--------------------------------------------------------
See accompanying notes to consolidated financial statements.
36
------------------------------------------------------
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
------------------------------------------------------
(in thousands) Common Stock
-----------------------------------------------------------------------------
Paid-In Unearned Retained
Shares Amount Capital Compensation Earnings GST Total
-----------------------------------------------------------------------------
Balance, December 31, 1994 68,095 $680 $ 75,002 $(3,670) $114,402 $186,414
Exercise of stock options 2,329 24 7,971 (4) 7,991
Tax benefit from exercise of stock options 11,236 11,236
Compensatory stock options 759 1,250 2,009
Compensatory stock 1 18 18
Stock retirement (4,813) (48) (66,974) (67,022)
Cash dividends (13,550) (13,550)
Dividends on shares held by GST 200 200
Equity adjustment from foreign currency (98) (98)
Establishment of GST 5,300 53 86,785 $ (86,838)
Adjustment of GST shares to market value 33,075 (33,075)
Net income 97,736 97,736
-----------------------------------------------------------------------------
Balance, December 31, 1995 70,912 709 214,846 (2,420) 131,712 (119,913) 224,934
Exercise of stock options 1,775 18 12,240 12,258
Tax benefit from exercise of stock options 14,244 14,244
Compensatory stock options 2,604 (685) 1,919
Employee stock purchase plan 168 2 2,273 2,275
Cash dividends (17,297) (17,297)
Dividends on shares held by GST 1,272 1,272
Equity adjustment from foreign currency 325 325
Adjustment of GST shares to market value 32,462 (32,462)
Net income 122,337 122,337
-----------------------------------------------------------------------------
Balance, December 31, 1996 72,855 729 278,669 (3,105) 238,349 (152,375) 362,267
Exercise of stock options 2,877 29 21,529 21,558
Tax benefit from exercise of stock options 29,786 29,786
Compensatory stock options 2,511 (470) 2,041
Employee stock purchase plan 372 4 5,968 5,972
Stock retirement (1,852) (19) (52,966) (52,985)
Cash dividends (20,607) (20,607)
Dividends on shares held by GST 1,484 1,484
Equity adjustment from foreign currency (795) (795)
Adjustment of GST shares to market value (1,060) 1,060
Net income 132,704 132,704
-----------------------------------------------------------------------------
Balance, December 31, 1997 74,252 $743 $337,403 $(3,575) $298,169 $(151,315) $481,425
=============================================================================
See accompanying notes to consolidated financial statements.
37
--------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------
Note 1
THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Callaway Golf Company ("Callaway Golf" or the "Company") is a California
corporation formed in 1982. The Company designs, develops, manufactures and
markets high-quality, innovative golf clubs. Callaway Golf's primary products
include Big Bertha(R) Metal Woods with the War Bird(R) soleplate, Great Big
Bertha(R) Titanium Metal Woods, Biggest Big Bertha(TM) Titanium Drivers, Big
Bertha(R) Irons, Great Big Bertha(R) Tungsten.Titanium(TM) Irons, Odyssey(R)
putters and wedges and various other putters. The consolidated financial
statements include the accounts of the Company and its subsidiaries, Callaway
Golf Sales Company, Callaway Golf Ball Company, Odyssey Golf, Inc., CGV, Inc.,
Callaway Golf (UK) Limited, ERC International Company and Callaway Golf
(Germany) GmbH. All significant intercompany transactions and balances have been
eliminated.
Revenue Recognition
Sales are recognized at the time goods are shipped, net of an allowance for
sales returns.
Advertising Costs
The Company advertises primarily through television and print media. The
Company's policy is to expense advertising costs, including production costs, as
incurred. Advertising expenses for 1997, 1996 and 1995 were $20,320,000,
$18,321,000 and $12,148,000, respectively.
Foreign Currency Translation and Transactions
The accounts of the Company's foreign subsidiaries have been translated into
United States dollars at appropriate rates of exchange. Cumulative translation
gains or losses are recorded as a separate component of shareholders' equity.
Gains or losses resulting from foreign currency transactions (transactions
denominated in a currency other than the entity's local currency) are included
in the consolidated statement of income. The Company recorded transaction losses
of $940,000 in 1997. The amounts recorded as a result of foreign currency
transactions in 1996 and 1995 were not material.
During 1997, 1996 and 1995, the Company entered into forward foreign
currency exchange rate contracts to hedge payments due on intercompany
transactions by one of its wholly-owned foreign subsidiaries, Callaway Golf (UK)
Limited. Realized and unrealized gains and losses on these contracts are
recorded in income. The effect of this practice is to minimize variability in
the Company's operating results arising from foreign exchange rate movements.
The Company does not engage in foreign currency speculation. These foreign
exchange contracts do not subject the Company to risk due to exchange rate
movements because gains and losses on these contracts offset losses and gains on
the intercompany transactions being hedged, and the Company does not engage in
hedging contracts which exceed the amount of the intercompany transactions. At
December 31, 1997, 1996 and 1995, the Company had approximately $2,575,000,
$5,774,000 and $446,000, respectively, of foreign exchange contracts
outstanding. The contracts outstanding at December 31, 1997 mature between
January and May of 1998. The Company had net realized and unrealized gains on
foreign exchange contracts of $261,000 in 1997, net realized and unrealized
losses of $521,000 in 1996 and net realized and unrealized gains of $106,000 in
1995.
Earnings per Common Share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standard ("SFAS") No. 128, "Earnings Per Share." This statement
requires presentation of basic and diluted earnings per common share. Basic
earnings per common share is calculated by dividing net income for the period by
the weighted-average number of common shares outstanding during the period.
Diluted earnings per common share is calculated by dividing net income for the
period by the weighted-average number of common shares outstanding during the
period, increased by dilutive potential common shares ("dilutive securities")
that were outstanding during the period. Dilutive securities include shares
owned by the Callaway Golf Company Grantor Stock Trust (Note 4), options issued
pursuant to the Company's stock option plans (Note 6), shares related to the
Employee Stock Purchase Plan (Note 6) and rights to purchase preferred shares
under the Callaway Golf Company Shareholder Rights Plan (Note 6). Dilutive
securities related to the Callaway Golf Company Grantor Stock Trust and the
Company's stock option plans are included in the calculation of diluted earnings
per common
38
share using the treasury stock method. Dilutive securities related to the
Employee Stock Purchase Plan are calculated by dividing the average withholdings
during the period by 85% of the lower of the offering period price or the market
value at the end of the period. The dilutive effect of rights to purchase
preferred shares under the Callaway Golf Shareholder Rights Plan have not been
included as dilutive securities because the conditions necessary to cause these
rights to be redeemed were not met. All earnings per common share data reported
in prior periods have been restated in accordance with SFAS No. 128. A
reconciliation of the numerators and denominators of the basic and diluted
earnings per common share calculations for the years ended December 31, 1997,
1996, and 1995 is presented in Note 5.
Financial Statement Preparation
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash Equivalents
Cash equivalents are highly liquid investments purchased with maturities of
three months or less. Cash equivalents consist of investments in money market
accounts and U.S. Treasury bills.
At December 31, 1996, the Company held investments in U.S. Treasury bills
with maturities of three months or less in the aggregate amount of $96,407,000.
Management determines the appropriate classification of its U.S. Government and
debt securities at the time of purchase and reevaluates such designation as of
each balance sheet date. The Company recorded these securities at amortized
costs and designated them as "held-to-maturity." No investments in U.S. Treasury
bills were held at December 31, 1997.
The acquisition of substantially all of the assets and certain liabilities
of Odyssey Sports, Inc. (Note 11) and the repurchase and retirement of certain
of the Company's outstanding Common Stock necessitated the sale of certain
held-to-maturity debt securities with amortized costs of $115,428,000 and
$31,805,000, respectively, during 1997. These securities were purchased at a
discount and were sold within two weeks to two months of their respective stated
maturity dates. As such, the securities are considered to be sold at maturity
under the provisions of SFAS No. 115 "Accounting for Certain Investments in Debt
and Equity Securities." No realized or unrealized gain or loss resulted from the
sale of these securities.
Inventories
Inventories are valued at the lower of cost or market. Cost is determined using
the first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over estimated useful
lives of three to fifteen years. Repair and maintenance costs are charged to
expense as incurred.
Long-Lived Assets
The Company assesses potential impairments to its long-lived assets when there
is evidence that events or changes in circumstances have made recovery of the
asset's carrying value unlikely. An impairment loss would be recognized when the
sum of the expected future net cash flows is less than the carrying amount of
the asset. No impairment losses have been identified by the Company.
Intangible Assets
Intangible assets consist primarily of trade name, trademark, trade dress,
patents and goodwill resulting from the purchase of substantially all of the
assets and certain liabilities of Odyssey Sports, Inc. (Note 11). Intangible
assets are amortized using the straight-line method over periods ranging from
three to forty years. During 1997, amortization of intangible assets was
$1,778,000. Amortization expense for the years ended December 31, 1996 and 1995
was not material.
Stock-Based Compensation
Effective January 1, 1996, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation." The Company will continue to measure compensation
expense for its stock-based employee compensation plans using the intrinsic
value method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees." Pro forma disclosures of net income and earnings per share, as if
the fair value-based method prescribed by SFAS No. 123 had been applied in
measuring compensation expense, are presented in Note 6.
Income Taxes
Current income tax expense is the amount of income taxes expected to be payable
for the current year. A deferred income tax asset or liability is established
for the expected future consequences resulting from the differences in the
financial reporting and tax bases of assets and liabilities. Deferred income tax
expense (benefit) is the net change during the year in the deferred income tax
asset or liability.
39
Diversification of Credit Risk
The Company's financial instruments that are subject to concentrations of credit
risk consist primarily of cash equivalents and trade receivables.
The Company invests its excess cash in money market accounts and U.S.
Government securities and has established guidelines relative to diversification
and maturities in an effort to maintain safety and liquidity. These guidelines
are periodically reviewed and modified to take advantage of trends in yields and
interest rates.
The Company operates in the golf equipment industry and primarily sells its
products to golf equipment retailers. The Company performs ongoing credit
evaluations of its customers' financial condition and generally requires no
collateral from its customers. The Company maintains reserves for potential
credit losses.
Reclassifications
Certain prior period amounts have been reclassified to conform with the current
period presentation.
NOTE 2
SELECTED FINANCIAL STATEMENT INFORMATION
(in thousands) December 31,
1997 1996
----------------------
Cash and cash equivalents:
U.S. Treasury bills $ 96,407
Cash, interest bearing $ 24,438 11,415
Cash, non-interest bearing 1,766 635
----------------------
$ 26,204 $ 108,457
======================
Accounts receivable, net:
Trade accounts receivable $ 131,516 $ 80,814
Allowance for doubtful accounts (7,046) (6,337)
----------------------
$ 124,470 $ 74,477
======================
Inventories, net:
Raw materials $ 47,780 $ 50,012
Work-in-process 3,083 1,651
Finished goods 51,905 51,954
----------------------
102,768 103,617
Reserve for obsolescence (5,674) (5,284)
----------------------
$ 97,094 $ 98,333
======================
Property, plant and equipment, net:
Land $ 16,398 $ 9,589
Buildings and improvements 51,797 35,076
Machinery and equipment 45,332 29,778
Furniture, computers
and equipment 48,071 20,329
Production molds 13,690 9,399
Construction-in-process 19,361 21,003
----------------------
194,649 125,174
Accumulated depreciation (52,146) (33,828)
----------------------
$ 142,503 $ 91,346
======================
Intangible assets:
Trade name $ 69,629
Trademark and trade dress 29,841
Patents, goodwill and other 14,641 $ 4,502
----------------------
114,111 4,502
Accumulated amortization (1,970) (225)
----------------------
$ 112,141 $ 4,277
======================
Accounts payable and accrued expenses:
Accounts payable $ 18,379 $ 2,442
Accrued expenses 11,684 12,554
----------------------
$ 30,063 $ 14,996
======================
Accrued employee compensation and benefits:
Accrued payroll and taxes $ 9,729 $ 12,914
Accrued vacation and sick pay 4,092 3,017
Accrued commissions 441 264
----------------------
$ 14,262 $ 16,195
======================
Total rent expense was $1,760,000, $1,363,000, and $1,181,000 in 1997, 1996
and 1995, respectively.
NOTE 3
BANK LINE OF CREDIT
The Company had a $50,000,000 unsecured line of credit with an interest rate
equal to the bank's prime rate (8.5% at December 31, 1997). The line of credit
was renewed in February 1998 (Note 14). The line of credit has been primarily
utilized to support the issuance of letters of credit, of which there were
$4,046,000 outstanding at December 31, 1997, reducing the amount available under
the Company's line of credit to $45,954,000.
The line requires the Company to maintain certain financial ratios,
including current and debt-to-equity ratios. The Company is also subject to
other restrictive covenants under the terms of the credit agreement.
40
NOTE 4
COMMON AND PREFERRED STOCK
As of December 31, 1997, the Company had 240,000,000 authorized shares of Common
Stock, $.01 par value, of which 74,251,664 were issued and outstanding.
As of December 31, 1997, the Company was authorized to issue up to
3,000,000 shares of $.01 par value Preferred Stock. No Preferred Stock has been
issued.
In July 1995, the Company established the Callaway Golf Company Grantor
Stock Trust (GST). In conjunction with the formation of the GST, the Company
sold 4,000,000 shares of newly issued Common Stock to the GST at a purchase
price of $60,575,000 ($15.14 per share). In December 1995, the Company sold an
additional 1,300,000 shares of newly issued Common Stock to the GST at a
purchase price of $26,263,000 ($20.20 per share). The sale of these shares had
no net impact on shareholders' equity. During the term of the GST, shares in the
GST may be used to fund the Company's obligations with respect to one or more of
the Company's non-qualified or qualified employee benefit plans.
Shares owned by the GST are accounted for as a reduction to shareholders'
equity until used in connection with employee benefits. Each period the shares
owned by the GST are valued at the closing market price, with corresponding
changes in the GST balance reflected in capital in excess of par value.
NOTE 5
EARNINGS PER COMMON SHARE
The schedule below summarizes the elements included in the calculation of basic
and diluted earnings per common share for the years ended December 31, 1997,
1996 and 1995.
(in thousands, except per share data) Year ended December 31,
1997 1996 1995
----------------------------------------------------------------------------------------------------------
Net Per-Share Net Per-Share Net Per-Share
Income Shares Amount Income Shares Amount Income Shares Amount
----------------------------------------------------------------------------------------------------------
Net income $132,704 $122,337 $97,736
Basic EPS 68,407 $1.94 66,832 $1.83 66,641 $1.47
Dilutive Securities 3,291 3,829 3,214
------ ------ ------
Diluted EPS 71,698 $1.85 70,661 $1.73 69,855 $1.40
==========================================================================================================
For the years ended December 31, 1997, 1996 and 1995, 917,000, 269,000 and
1,329,000 options outstanding were excluded from the calculations, as their
effect would have been antidilutive.
NOTE 6
STOCK OPTIONS AND RIGHTS
Options
The Company had the following fixed stock option plans, under which shares were
available for grant at December 31, 1997: the 1991 Stock Incentive Plan (the
"Incentive Plan"), the Promotion, Marketing and Endorsement Stock Incentive Plan
(the "Promotion Plan"), the Non-Employee Directors Stock Option Plan, the 1995
Employee Stock Incentive Plan ("1995 Plan"), the 1996 Stock Option Plan ("1996
Plan") and two plans for certain key officers. The Incentive Plan and the 1996
Plan permit the granting of options to purchase Common Stock to the Company's
officers, consultants, employees, or Directors who are also employees, at option
prices which may be less than the market value of such stock at the date of
grant, while the 1995 Plan permits the granting of options to only employees and
consultants of the Company at option prices that may be less than market value
at the date of grant. The Company is authorized to grant options to acquire up
to 10,000,000 shares of Common Stock under the Incentive Plan and 146,000 shares
were available for grant at December 31, 1997. During 1997, the 1995 Plan and
the 1996 Plan were amended to increase the maximum number of options to acquire
shares of Common Stock to 3,600,000 and 3,000,000, respectively, while the
number of shares available for grant at December 31, 1997 was 209,000 and
1,280,000, respectively. Under the Promotion Plan, up to 3,560,000 shares of
Common Stock may be granted in the form of options or other stock awards to golf
professionals and other parties at prices which may be less than the market
value of the stock at the grant date.
41
Under the Promotion Plan, 774,000 shares were available for grant at December
31, 1997. The Non-Employee Directors Stock Option Plan permits the granting of
options to acquire up to 840,000 shares of Common Stock, of which 204,000 were
available for grant at December 31, 1997, to Directors of the Company who are
not employees, at prices based on a non-discretionary formula, which may be less
than the market value of the stock at the date of grant. During 1996 and 1995,
the Company granted options to purchase 600,000 and 500,000 shares,
respectively, to two key officers, under separate plans, in conjunction with
terms of their initial employment. At December 31, 1997, no shares were
available for grant under these plans. Additionally, under the 1990 Amended and
Restated Stock Option Plan ("1990 Plan"), 4,920,000 shares were authorized for
issuance at December 31, 1997, while no shares were available for future grant
at December 31, 1997.
Under the Company's stock option plans, outstanding options vest over
periods ranging from zero to five years from the grant date and expire up to ten
years after the grant date.
The following summarizes stock option transactions for the years ended
December 31, 1997, 1996, and 1995:
(in thousands, except per share data) Year ended December 31,
1997 1996 1995
--------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------------------------------------------------------------------------------------
Outstanding at beginning of year 10,800 $15.03 9,842 $ 9.87 10,652 $ 6.59
Granted 3,406 33.79 2,760 28.47 3,145 16.54
Exercised (2,877) 7.81 (1,775) 7.07 (2,329) 3.57
Canceled (72) 28.81 (27) 16.98 (1,626) 9.98
--------------------------------------------------------------------------------------
Outstanding at end of year 11,257 $22.41 10,800 $15.03 9,842 $ 9.87
Options exercisable at end of year 3,453 $12.17 3,939 $ 8.83 3,354 $ 6.05
--------------------------------------------------------------------------------------
Price range of outstanding options $0.44 -- $40.00 $0.44 -- $34.38 $.019 -- $18.06
======================================================================================
The following table summarizes additional information about outstanding stock
options at December 31, 1997:
Weighted-
Average
Number Remaining Weighted- Number Weighted-
Range of Outstanding Contractual Average Exercisable Average
Exercise Prices (in thousands) Life-Years Exercise Price (in thousands) Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
$ 0 -- $15 3,734 3.7 $ 9.69 2,594 $ 8.20
$15 -- $30 3,994 5.9 $23.63 693 $23.58
$30 -- $40 3,529 7.3 $34.98 166 $32.37
- ------------------------------------------------------------------------------------------------------------------------------------
$ 0 -- $40 11,257 5.6 $22.41 3,453 $12.17
====================================================================================================================================
42
During August 1995, the Company canceled 634,000 employee stock options,
exclusive of those held by Directors, with option prices in excess of the
then-current market price of the Company's stock. The Company then reissued an
equivalent number of options at the then-current market price.
Rights
The Company has granted officers, consultants, and employees rights to receive
an aggregate of 826,800 shares of Common Stock for services or other
consideration. At December 31, 1997, rights to receive 80,000 shares of Common
Stock remained outstanding. No rights were granted or exercised during 1997,
1996, or 1995.
In 1995, the Company implemented a plan to protect shareholders' rights in
the event of a proposed takeover of the Company. Under the plan, each share of
the Company's outstanding Common Stock carries one right to Purchase one
one-thousandth of a share of the Company's Series "A" Junior Participating
Preferred Stock (the "Right"). The Right entitles the holder, under certain
circumstances, to purchase Common Stock of Callaway Golf Company or of the
acquiring company at a substantially discounted price ten days after a person or
group publicly announces it has acquired or has tendered an offer for 15% or
more of the Company's outstanding Common Stock. The Rights are redeemable by the
Company at $.01 per Right and expire in 2005.
Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan ("ESPP") whereby eligible
employees may purchase shares of Common Stock at 85% of the lower of the fair
market value on the first day of a two year offering period or last day of each
six month exercise period. Employees may authorize the Company to withhold
compensation during any offering period, subject to certain limitations. During
1997, the ESPP was amended to increase the maximum number of shares of the
Company's Common Stock that employees may acquire under this plan to 1,500,000
shares. During 1997 and 1996, the ESPP purchased approximately 372,000 and
168,000 shares, respectively, of the Company's Common Stock. No shares were
purchased during 1995. As of December 31, 1997, 960,000 shares were reserved for
future issuance.
Compensation Expense
During 1997, 1996, and 1995, the Company recorded $2,041,000, $1,919,000, and
$2,009,000, respectively, in compensation expense as the value of certain
options and rights to purchase shares of Common Stock granted to employees and
consultants of the Company. The valuation of the options and rights granted to
employees is based on the difference between the exercise price and the market
value of the stock on the measurement date. The valuation of the options and
rights granted to non-employees is estimated using the Black-Scholes option
pricing model.
Unearned compensation has been charged for the value of options granted to
both employees and non-employees on the measurement date based on the valuation
methods described above. These amounts are amortized over the vesting period of
employee options and over the contract terms for non-employees. The unamortized
portion of unearned compensation is shown as a reduction of shareholders' equity
in the accompanying consolidated balance sheet.
Pro Forma Disclosures
If the Company had elected to recognize compensation expense based upon the fair
value at the grant date for awards under these plans consistent with the
methodology prescribed by SFAS No. 123, the Company's net income and earning per
share would be reduced to the pro forma amounts indicated below:
(in thousands, except per share data) Year ended December 31,
1997 1996 1995
------------------------------
Net income:
As reported $132,704 $122,337 $97,736
Pro forma $124,978 $113,587 $95,510
Earnings per common share:
As reported
Basic $1.94 $1.83 $1.47
Diluted $1.85 $1.73 $1.40
Pro forma
Basic $1.83 $1.70 $1.43
Diluted $1.77 $1.59 $1.36
The pro forma amounts reflected above may not be representative of future
disclosures since the estimated fair value of stock options is amortized to
expense over the vesting period and additional options may be granted in future
years. The fair value of employee stock options was estimated at the date of
grant using the Black-Scholes option
43
pricing model with the following assumptions for the years ended December 31,
1997, 1996, and 1995, respectively:
Year ended December 31,
1997 1996 1995
--------------------------------------------
Dividend yield 0.9% 0.9% 0.9%
Expected volatility 31.5% 31.5% 31.5%
Risk free
interest rates 5.64-5.89% 5.32-7.66% 5.32-7.66%
Expected lives 3-6 years 2-6 years 2-6 years
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
subjective input assumptions can materially affect the fair value estimates, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of grants under the Company's employee stock-
based compensation plans.
NOTE 7
EMPLOYEE BENEFIT PLANS
The Company has a voluntary deferred compensation plan under Section 401(k) of
the Internal Revenue Code (the "401(k) Plan") for all employees who satisfy the
age and service requirements under the 401(k) Plan. Each participant may elect
to contribute up to 10% of annual compensation, up to the maximum permitted
under federal law, and the Company is obligated to contribute annually an amount
equal to 100% of the participant's contribution up to 6% of that participant's
annual compensation. Additionally, the Company can make discretionary
contributions based on the profitability of the Company. For the years ended
December 31, 1996 and 1995, the Company recorded compensation expense for
discretionary contributions of $6,390,000 and $6,481,000, respectively.
Discretionary contributions related to 1997 will not be made and accordingly, no
compensation expense was recorded. Employees contributed to the 401(k) Plan
$5,384,000, $3,315,000 and $3,336,000 in 1997, 1996 and 1995, respectively. In
accordance with the provisions of the 401(k) Plan, the Company matched employee
contributions in the amount of $4,495,000, $1,988,000 and $1,458,000 during
1997, 1996 and 1995, respectively.
The Company also has an unfunded, nonqualified deferred compensation plan.
The plan allows officers and certain other employees of the Company to defer all
or part of their compensation, to be paid to the participants or their
designated beneficiaries upon retirement, death or separation from the Company.
For the years ended December 31, 1997, 1996 and 1995, the total participant
deferrals, which are reflected in long-term liabilities, were $1,166,000,
$2,564,000 and $1,460,000, respectively.
NOTE 8
INCOME TAXES
Income before income taxes was taxed under the following jurisdictions for the
following periods:
(in thousands) Year ended December 31,
1997 1996 1995
-------------------------------------
Domestic $212,453 $193,170 $154,054
Foreign 1,312 2,425 4,347
-------------------------------------
$213,765 $195,595 $158,401
=====================================
The provision for income taxes is as follows:
(in thousands) Year ended December 31,
1997 1996 1995
-------------------------------------
Current tax provision:
Federal $66,462 $65,287 $48,563
State 12,419 11,154 9,840
Foreign 1,150 1,244 1,626
Deferred tax expense (benefit):
Federal 1,042 (3,911) (317)
State 50 (437) 1,053
Foreign (62) (79) (100)
-------------------------------------
Provision for income taxes $81,061 $73,258 $60,665
=====================================
During 1997, 1996 and 1995, the Company recognized certain tax benefits
related to stock option plans in the amount of $29,786,000, $14,244,000, and
$11,236,000, respectively. Such benefits were recorded as a reduction of income
taxes payable and an increase in additional paid-in capital.
Deferred tax assets are comprised of the following:
(in thousands) December 31,
1997 1996
-----------------
Reserves and allowances $15,914 $15,056
Depreciation and amortization 6,107 5,585
Deferred compensation 4,559 3,088
Effect of inventory overhead adjustment 1,555 2,057
Compensatory stock options and rights 1,589 1,541
State taxes, net 5 697
Other 702 3,437
-----------------
Net deferred tax asset $30,431 $31,461
=================
44
The Company did not require a deferred tax asset valuation allowance at
December 31, 1997 or 1996.
A reconciliation of income taxes computed by applying the statutory federal
income tax rate to income before income taxes to the provision for income taxes
is as follows:
(in thousands) Year ended December 31,
1997 1996 1995
------------------------------------
Amounts computed at
statutory federal tax rate $74,816 $68,458 $55,440
State income taxes,
net of federal benefit 8,105 6,966 7,081
Other (1,860) (2,166) (1,856)
------------------------------------
Provision for income taxes $81,061 $73,258 $60,665
====================================
NOTE 9
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 clubheads costing
approximately $73,714,000 from one of its vendors. These clubheads are to be
shipped to the Company in accord with a production schedule that extends into
1999.
The Company and its subsidiaries, incident to their business activities,
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.
NOTE 10
LITIGATION SETTLEMENT
On September 23, 1997, the Company settled a lawsuit brought against it and
certain officers of the Company by a former officer of the Company with the
payment of $12,000,000. The Company 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. The Company entered into a six year employment agreement with
the former officer which included the issuance of 600,000 stock options at the
market price on the date of the grant.
NOTE 11
ACQUISITION
On August 8, 1997, the Company consummated its acquisition of substantially all
of the assets and certain liabilities of Odyssey Sports, Inc., by its
wholly-owned subsidiary, Odyssey Golf, Inc. ("Odyssey"), subject to certain
adjustments as of the time of closing. Odyssey's results of operations have been
included in the Company's consolidated results of operations since August 8,
1997. Odyssey manufactures and markets the Odyssey(R) line of putters and wedges
with Stronomic(R) and Lyconite(TM) face inserts.
The cost to acquire substantially all of the assets and certain liabilities
of Odyssey Sports, Inc., including professional fees directly related to the
acquisition, was approximately $129,256,000 and has been accounted for using the
purchase method of accounting. The allocation of the acquisition cost to assets
acquired and liabilities assumed is summarized in the table that follows.
Amounts allocated to trade name, trademark, trade dress and goodwill are being
amortized on the straight-line basis over forty years. The amounts allocated to
the process patent and covenant not to compete are being amortized on the
straight-line basis over sixteen and three years, respectively.
(in thousands) August 8, 1997
--------------
Assets acquired/liabilities assumed:
Total assets acquired $132,591
Total liabilities assumed (3,335)
--------
Net assets acquired $129,256
========
The following unaudited pro forma net sales, net income and earnings per
share data for the years ended December 31, 1997 and 1996 are based on the
respective historical financial statements of the Company and Odyssey Sports,
Inc. The pro forma data presented for the year ended December 31, 1997 combines
the results of operations of the Company for the year ended December 31, 1997
with the results of operations of Odyssey Sports, Inc. for the ten months ended
August 7, 1997 and the results of Odyssey for the two months ended September 30,
1997, and assumes that the acquisition of substantially all of the assets and
certain liabilities of Odyssey Sports, Inc. occurred on January 1, 1997. The pro
forma data presented for the year ended December 31, 1996 combines the results
of operations of the Company for the year ended December 31, 1996 with the
results of operations of Odyssey Sports, Inc. for the year ended September 30,
1996 and assumes that the acquisition of substantially all the assets and
certain liabilities of Odyssey Sports, Inc. occurred on January 1, 1996.
45
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.
Year ended December 31,
(in thousands, except per share data) (unaudited)
1997 1996
------------------------
Net sales $884,840 $711,715
------------------------
Net income $134,512 $119,385
------------------------
Earnings per common share
Basic $1.97 $1.79
Diluted $1.88 $1.69
NOTE 12
SALES INFORMATION
The Company is engaged in domestic and international sales through retail
customers and distributors located within the following geographic areas:
(in thousands) Year ended December 31,
1997 1996 1995
---------------------------------
United States $547,256 $460,611 $367,359
Japan 84,634 58,156 60,971
All others -- individually
less than 10% of
net sales 211,037 159,745 124,957
---------------------------------
$842,927 $678,512 $553,287
=================================
The Company, through a distribution agreement, appointed Sumitomo Rubber
Industries, Ltd. ("Sumitomo") as the sole distributor of Callaway(R) golf clubs
in Japan. The distribution agreement requires Sumitomo to purchase specified
minimum quantities. The current distribution agreement began in February 1993
and ends on December 31, 1999. In 1997, 1996 and 1995, sales to Sumitomo
accounted for 10%, 9% and 11%, respectively, of the Company's net sales.
NOTE 13
RELATED PARTY TRANSACTIONS
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 December 31, 1997, the Company had made capital
contributions to All-American of $750,000. Additionally, the Company loaned
All-American $5,250,000, 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 sixty equal monthly installments.
NOTE 14
SUBSEQUENT EVENTS
Dividend
On January 28, 1998, the Company declared a quarterly cash dividend of $.07 per
share payable on March 3, 1998, to shareholders of record on February 10, 1998.
Bank Line of Credit
On February 4, 1998, the Company renewed its line of credit, increasing it to
$150,000,000. The line of credit is unsecured and requires the Company to
maintain certain financial ratios, including current and debt-to-equity ratios.
The Company is also subject to other restrictive covenants under the terms of
the credit agreement.
Acquisition
On February 11, 1998, the Company purchased distribution rights and
substantially all of the assets of its Korean distributor, subject to certain
liabilities. The purchase price consisted of $3,696,000 in conversion of
accounts receivable and cash of approximately $3,137,000.
46
-----------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
-----------------------------------------
[LOGO OF PRICE WATERHOUSE APPEARS HERE]
To the Board of Directors and Shareholders of Callaway Golf Company
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of cash flows and of shareholders' equity
present fairly, in all material respects, the financial position of Callaway
Golf Company and its subsidiaries at December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ Price Waterhouse LLP
San Diego, California
January 28, 1998, except as to
Note 14, which is as of February 11, 1998
47
-------------------------------------------------------
SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)
-------------------------------------------------------
(in thousands, except per share data) Fiscal Year 1997 Quarters
- ----------------------------------------------------------------------------------------------------------------------------------
1st 2nd 3rd 4th Total
-------------------------------------------------------------------------------------------
Net Sales $169,073 $253,032 $257,435 $163,387 $842,927
Gross Profit $87,002 $134,742 $138,769 $82,287 $442,800
Net Income $24,466 $46,821 $37,049 $24,368 $132,704
Earnings per common share*
Basic $0.36 $0.69 $0.54 $0.35 $1.94
Diluted $0.34 $0.66 $0.52 $0.34 $1.85
Fiscal Year 1996 Quarters
- ----------------------------------------------------------------------------------------------------------------------------------
1st 2nd 3rd 4th Total
-------------------------------------------------------------------------------------------
Net Sales $135,138 $210,002 $194,545 $138,827 $678,512
Gross Profit $68,632 $111,083 $106,071 $75,373 $361,159
Net Income $19,455 $38,937 $38,418 $25,527 $122,337
Earnings per common share*
Basic $0.29 $0.58 $0.57 $0.38 $1.83
Diluted $0.28 $0.55 $0.54 $0.36 $1.73
*Earnings per share is computed individually for each of the quarters presented;
therefore, the sum of the quarterly earnings per share will not necessarily
equal the total for the year.
MARKET FOR COMMON SHARES AND RELATED SHAREHOLDER MATTERS
The Company's Common Shares are traded on the New York Stock Exchange (NYSE).
The Company's symbol for its Common Shares is "ELY."
As of February 24, 1998, the approximate number of holders of record of the
Company's Common Stock was 8,797.
STOCK PRICE INFORMATION
Year ended December 31,
1997 1996
-----------------------------------------------------------------------------
Period: High Low Dividend High Low Dividend
-----------------------------------------------------------------------------
First Quarter $33.63 $28.63 $.07 $28.13 $18.50 $.06
Second Quarter $38.13 $27.25 $.07 $33.88 $24.50 $.06
Third Quarter $38.38 $32.94 $.07 $36.63 $27.88 $.06
Fourth Quarter $36.38 $26.13 $.07 $36.63 $26.63 $.06
48