UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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 April 30, 1998 was 74,753,314.
CALLAWAY GOLF COMPANY
INDEX
Page
Part I. Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheet at March 31, 1998
and December 31, 1997 3
Consolidated Condensed Statement of Income for the
three months ended March 31, 1998 and 1997 4
Consolidated Condensed Statement of Cash Flows for the
three months ended March 31, 1998 and 1997 5
Consolidated Condensed Statement of Shareholders' Equity
for the three months ended March 31, 1998 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Part II. Other Information 17
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED BALANCE SHEET
(In thousands, except share and per share data)
March 31, December 31,
1998 1997
----------- ------------
ASSETS (Unaudited)
- ------
Current assets:
Cash and cash equivalents $ 14,430 $ 26,204
Accounts receivable, net 147,352 124,470
Inventories, net 142,036 97,094
Deferred taxes 24,714 23,810
Other current assets 11,438 10,208
--------- ---------
Total current assets 339,970 281,786
Property, plant and equipment, net 147,803 142,503
Intangible assets, net 116,348 112,141
Other assets 28,745 25,284
--------- ---------
$ 632,866 $ 561,714
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable and accrued expenses $ 48,883 $ 30,063
Line of credit 30,000
Accrued employee compensation and benefits 15,569 14,262
Accrued warranty expense 30,158 28,059
Income taxes payable 4,129
--------- ---------
Total current liabilities 128,739 72,384
Long-term liabilities 8,405 7,905
Commitments and contingencies (Note 7)
Shareholders' equity:
Preferred Stock, $.01 par value, 3,000,000 shares
authorized, none issued and outstanding at March
31, 1998 and December 31, 1997, respectively
Common Stock, $.01 par value, 240,000,000 shares
authorized, 74,733,864 and 74,251,664 issued and
outstanding at March 31, 1998, and December 31,
1997, respectively 747 743
Paid-in capital 351,283 337,403
Unearned compensation (7,319) (3,575)
Retained earnings 304,416 298,728
Accumulated other comprehensive income 295 (559)
Less: Grantor Stock Trust (5,300,000 shares)
at market (153,700) (151,315)
--------- ---------
Total shareholders' equity 495,722 481,425
--------- ---------
$ 632,866 $ 561,714
========= =========
See accompanying notes to consolidated condensed financial statements.
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF INCOME (UNAUDITED)
(In thousands, except per share data)
Three Months Ended
---------------------------
March 31,
1998 1997
-------- --------
Net sales $176,908 100% $169,073 100%
Cost of goods sold 93,203 53% 82,071 49%
-------- --------
Gross profit 83,705 47% 87,002 51%
Operating expenses:
Selling 35,792 20% 26,579 16%
General and administrative 20,504 12% 16,254 10%
Research and development 8,665 5% 5,953 4%
-------- --------
Income from operations 18,744 11% 38,216 23%
Other (expense) income, net (337) 1,383
-------- --------
Income before income taxes 18,407 10% 39,599 23%
Provision for income taxes 7,247 15,133
--------
Net income $ 11,160 6% $ 24,466 14%
======== ========
Earnings per common share:
Basic $ 0.16 $ 0.36
Diluted $ 0.16 $ 0.34
Common equivalent shares:
Basic 69,184 68,016
Diluted 71,173 71,763
Dividends paid per share $ 0.07 $ 0.07
See accompanying notes to consolidated condensed financial statements.
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED)
(In thousands)
Three months ended
--------------------
March 31,
1998 1997
-------- --------
Cash flows from operating activities:
Net income $ 11,160 $ 24,466
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization 6,829 3,460
Non-cash compensation 4,298 4,309
Tax benefit from exercise of stock options 1,531 6,285
Deferred taxes (1,650) (380)
Increase (decrease) in cash resulting from
changes in:
Accounts receivable, net (22,747) (23,174)
Inventories, net (42,508) 1,489
Other assets (8,340) (3,945)
Accounts payable and accrued expenses 16,034 22,720
Accrued employee compensation and benefits 3,902 (351)
Accrued warranty expense 2,099 (23)
Income taxes payable 6,835 6,635
Other liabilities 499 640
-------- --------
Net cash (used in) provided by operating activities (22,058) 42,131
-------- --------
Cash flows from investing activities:
Business acquisitions, net of cash acquired (4,296)
Capital expenditures (12,104) (11,503)
-------- --------
Net cash used in investing activities (16,400) (11,503)
-------- --------
Cash flows from financing activities:
Issuance of Common Stock 1,927 4,359
Dividends paid (4,846) (4,773)
Retirement of Common Stock (627) (25,091)
Net proceeds from line of credit 30,000
-------- --------
Net cash provided by (used in) financing activities 26,454 (25,505)
-------- --------
Effect of exchange rate changes on cash 230 43
-------- --------
Net (decrease) increase in cash and cash equivalents (11,774) 5,166
Cash and cash equivalents at beginning of period 26,204 108,457
-------- --------
Cash and cash equivalents at end of period $ 14,430 $113,623
======== ========
See accompanying notes to consolidated condensed financial statements.
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
(In thousands)
Accumulated
other
Common Stock Paid-in Unearned Retained Comprehensive Comprehensive
Shares Amount Capital Compensation Earnings Income GST Total Income
------ ------ -------- ------------ -------- ------------- --------- -------- -------------
Balance, December 31, 1997 74,252 $743 $337,403 $(3,575) $298,728 $(559) $(151,315) $481,425
Exercise of stock options 205 2 1,925 1,927
Issuance of Restricted
Common Stock 130 1 4,029 (4,030)
Tax benefit from exercise
of stock options 1,531 1,531
Compensatory stock and
stock options 345 286 631
Employee stock purchase plan 167 2 3,665 3,667
Stock retirement (20) (1) (626) (627)
Cash dividends, net (5,217) (5,217)
Dividends on shares held
by GST 371 371
Adjustment of GST shares
to market value 2,385 (2,385)
Equity adjustment from
foreign currency 854 854 $ 854
Net income 11,160 11,160 11,160
------ ---- -------- ------- -------- ----- --------- -------- -------
Balance, March 31, 1998 74,734 $747 $351,283 $(7,319) $304,416 $ 295 $(153,700) $495,722 $12,014
====== ==== ======== ======= ======== ===== ========= ======== =======
See accompanying notes to consolidated condensed financial statements.
CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of presentation
---------------------
The accompanying financial information for the three months ended March 31, 1998
and 1997 has been prepared by Callaway Golf Company (the "Company") and has
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 the 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, 1997.
Interim operating results are not necessarily indicative of operating results
for the full year.
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.
Certain prior period amounts have been reclassified to conform with the current
period presentation.
2. Inventories
-----------
Inventories at March 31, 1998 and December 31, 1997 (in thousands):
March 31, December 31,
1998 1997
----------- ------------
(Unaudited)
Inventories, net:
Raw materials $ 59,791 $ 47,780
Work-in-process 2,739 3,083
Finished goods 85,138 51,905
-------- --------
147,668 102,768
Less reserve for obsolescence (5,632) (5,674)
-------- --------
$142,036 $ 97,094
======== ========
3. Cash equivalents
----------------
Cash equivalents are highly liquid investments purchased with maturities of
three months or less. Cash equivalents consist primarily of investments in
money market accounts.
4. Bank line of credit
-------------------
The Company has a $150.0 million unsecured line of credit. At March 31, 1998,
the amount available under the line of credit was $117.2 million and the
weighted-average interest rate of the outstanding borrowings was 5.8%. The line
of credit has been primarily utilized to support portions of the Company's
operations and the issuance of letters of credit, of which there were $2.8
million outstanding at March 31, 1998.
The line of credit 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. As of
March 31, 1998, the Company was in compliance with all such covenants.
5. Comprehensive income
--------------------
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 130, "Reporting Comprehensive Income." This statement
requires that all components of comprehensive income be reported in the
financial statements in the period in which they are recognized. The components
of comprehensive income for the Company include net income and foreign currency
translation adjustments. In accordance with the provisions of APB 23,
"Accounting for Income Taxes--Special Areas," the Company has elected the
indefinite reversal criterion, and accordingly, does not accrue income taxes on
foreign currency translation adjustments. The financial statements of prior
periods presented have been reclassified for comparative purposes.
6. Earnings per share
------------------
Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings Per
Share." This statement requires presentation of basic and diluted earnings per
common share. 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 three months ended March 31, 1998 and 1997 is presented
below.
(in thousands, except per share data) Three months ended March 31,
- -----------------------------------------------------------------------------------------------------
1998 1997
- -----------------------------------------------------------------------------------------------------
(Unaudited)
- -----------------------------------------------------------------------------------------------------
Net Per-Share Net Per-Share
Income Shares Amount Income Shares Amount
- -----------------------------------------------------------------------------------------------------
Net income $11,160 $24,466
Basic EPS 69,184 $0.16 68,016 $0.36
Dilutive Securities 1,989 3,747
------ ------
Diluted EPS 71,173 $0.16 71,763 $0.34
=====================================================================================================
For the three months ended March 31, 1998 and 1997, 3,980,000 and 183,900
options outstanding were excluded from the calculations as their effect would
have been antidilutive.
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.
The Company has committed to purchase titanium golf clubheads costing
approximately $54.8 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.
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. 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.
8. Subsequent event
----------------
On May 5, 1998, the Company purchased the remaining 80 percent equity interest
in All-American Golf LLC ("All-American") for approximately $4.5 million. Prior
to this event, the Company had a 20 percent equity interest in All-American,
which operates a nine-hole golf course, performance center, training facility
and driving range located in Las Vegas, Nevada.
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; Profit Margins; Seasonality
The Company believes that the growth rate in the world-wide golf equipment
market has been modest for the past several years and may now be declining.
In addition, recent economic turmoil in Southeast Asia and Korea has caused a
significant contraction in the retail golf markets in these countries and has
had an adverse effect on the Company's sales and results of operations for the
first quarter of 1998 and 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, sales in the U.S. of the Company's most
profitable products -- Biggest Big Bertha(TM), Great Big Bertha(R) and Big
Bertha(R) Metal Woods -- slowed in the first quarter of 1998, and may remain
soft. No assurances can be given that the demand for the Company's existing
products or the introduction of new products will permit the Company to
experience growth in sales.
The Company experienced an increase in its cost of goods sold during the first
quarter of 1998 and the third and fourth quarters of 1997 compared to historical
levels. In the first quarter of 1998 this increase was primarily due to an
increase in irons as a percentage of sales and credits, and discounts given on
remaining Big Bertha(R) Iron inventory at retail, while in the third and fourth
quarters of 1997 the increase was 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. If sales of irons as a percentage of the Company's total sales
remain at these levels or continue to rise, the recent increase in cost of goods
sold over historical levels will continue.
In the golf equipment industry, sales to retailers are generally seasonal due to
lower demand in the retail market in the cold weather months covered by the
fourth and first quarters. The Company's business generally follows this
seasonal trend and the Company expects this to continue. Unusual or severe
weather conditions such as the "El Nino" weather patterns experienced during the
winter of 1997-1998 have compounded these seasonal effects and had an adverse
effect on the Company's sales and results of operations for the first quarter of
1998. Such conditions could have a negative effect on the Company's future 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 and/or price reductions 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 should generally 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.
Reports have surfaced recently indicating that the USGA is evaluating steps that
might prohibit or restrict the use of modern, thin-faced metal woods under the
Rules of Golf. These reports predict that the USGA will promulgate by the year
2000 a rule establishing the maximum speed at which a golf ball can come off a
clubhead, similar to the USGA's existing "overall distance" standard applicable
to golf balls. The Company is aware of work ongoing at the USGA with regard to
the performance of thin-faced metal woods, but it has been advised by the USGA
that no decision has been made regarding new rules or rule interpretations
applicable to golf clubs. Although all of the Company's current products have
been approved by the USGA, it is possible that such reports and rumors about
possible action by the USGA against thin-faced metal woods are having or may
have a negative effect on the Company.
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.
The Company plans its manufacturing capacity based upon the forecasted demand
for its products. Actual demand for such products may exceed or be less than
forecasted demand. If the Company is unable to produce sufficient quantities of
new products in time to fulfill actual demand, especially during the Company's
traditionally busy second and third quarters, it could limit the Company's sales
and adversely affect its financial performance. On the other hand, the Company
commits to components and other manufacturing inputs for varying periods of
time, which can limit the Company's ability to quickly react if actual demand is
less than forecast. This could result in excess inventories that could adversely
affect the Company's financial performance. In addition, the Company's unique
product designs often require sophisticated manufacturing techniques, which can
limit the Company's ability to quickly expand its manufacturing capacity to meet
the full demand for its products.
Product breakage
The Company supports all of its golf clubs with a limited two year written
warranty. Since the Company does not rely upon traditional designs in the
development of its golf clubs, its products may be more likely to develop
unanticipated problems than those of many of its competitors which use
traditional designs. For example, clubs have been returned with cracked
clubheads, broken graphite shafts and loose medallions. 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,
light weight 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. The Company
believes that it has sufficient reserves for warranty claims; however, there can
be no assurance that these reserves will be sufficient if the Company were to
experience an unusually high incidence of shaft breakage or other product
problems.
Dependence on certain vendors and materials
The Company is dependent on a limited number of suppliers for its clubheads and
shafts. In addition, some of the Company's products require specifically
developed manufacturing techniques and processes which make it difficult to
identify and utilize alternative suppliers quickly. 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.
The Company's size has made it a large consumer of certain materials, including
titanium and carbon fiber. Callaway Golf does not make these materials itself,
and must rely on its ability to obtain adequate supplies in the world
marketplace in competition with other users of such materials. While the
Company has been successful in obtaining its requirements for such materials
thus far, there can be no assurance that it will always be able to do so. An
interruption in the supply of such materials or a significant change in costs
could have a material adverse effect on the Company.
Intellectual property and proprietary rights
The 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 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.
The Company has stringent procedures to maintain the secrecy of its confidential
business information. These procedures include criteria for dissemination of
information and written confidentiality agreements with employees and vendors.
Suppliers, when engaged in joint research projects, are required to enter into
additional confidentiality agreements. There can be no assurance that these
measures will prove adequate in all instances to protect the Company's
confidential information.
"Gray market" distribution
Some quantities of the Company's products find their way to unapproved outlets
or distribution channels. This "gray market" in the Company's products can
undermine authorized retailers and 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.
Professional endorsements
The Company 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.
During 1997, Callaway Golf continued its Big Bertha(R) Players' Pools ("Pools")
for the PGA, SPGA, LPGA and Nike Tours. Those professional players participating
in the Pools received cash for using Callaway Golf products in professional
tournaments. The Company has established the 1998 Big Bertha(R) Players' Pools
similar to the 1997 Pools, in which professional players participating in the
Pools will receive cash for using certain Callaway Golf products in professional
tournaments. The Company believes that its professional endorsements and its
Pools contributed to its success on the professional tours in 1997. There is no
guarantee, however, that the Company will be able to sustain this level of
success.
New business ventures
The Company has invested, and expects to continue to invest, significant capital
in new business ventures. Investments in these ventures have had a negative
impact on the Company's cash flows and results of operations and will continue
to do so for the next several years. There can be no assurance that these 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, Asia and North America. 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. Additionally, the integration of
foreign distributors increases the Company's exposure to fluctuations in
exchange rates for various foreign currencies which could result in losses and,
in turn, could adversely impact the Company's results of operations. To date,
losses resulting from exchange rate fluctuations have not had a significant
adverse impact on the Company's results of operations. However, there can be no
assurance that the Company will be able to mitigate this exposure in the future
through its management of foreign currency transactions. International
reorganization also could result in disruptions in the distribution of the
Company's products in some areas. There can be no assurance that the
acquisition of some or all of the Company's foreign 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.
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 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 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 and has
had a negative impact on the Company's cash flows and results of operations and
will continue to do so for the next 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 and euro 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.
Many of the countries in which the Company sells its products are Member States
of the Economic and Monetary Union ("EMU"). Beginning January 1, 1999 Member
States of the EMU may begin trading in either their local currencies or the
euro, the official currency of EMU participating Member States. Parties are
free to choose the unit they prefer in contractual relationships during the
transitional period, beginning January 1999 and ending June 2002. As noted
above, the Company is in the process of installing a new computer system at its
subsidiaries. This new system, which will run substantially all of the
principal data processing and financial reporting software of these
subsidiaries, will contain the functionality to process transactions in either a
country's local currency or euro beginning in late 1999, after the
implementation of an upgrade. Until such time as the upgrade has occurred,
transactions denominated in euro will be processed manually. The Company does
not anticipate a large demand from its customers to transact in euros.
Additionally, the Company does not believe that it will incur material costs
specifically associated with manually processing data or preparing its business
systems to operate in either the transitional period or beyond. However, there
can be no assurance that the conversion of EMU Member States to euro will not
have a material adverse effect on the Company and its operations.
Results of Operations
Three-month periods ended March 31, 1998 and 1997:
Net sales increased 5% to $176.9 million for the three months ended March 31,
1998 compared to $169.1 million for the comparable period in the prior year.
The increase was largely attributable to sales of Odyssey(R) product, which
contributed $10.1 million to net sales during the first quarter of 1998. This
increase was partially offset by a decrease in net sales of Callaway(R) product
during the first quarter of 1998 as compared with the comparable period of the
prior year. The decrease in Callaway(R) product sales is primarily attributable
to decreases in metal wood sales. Overall sales were affected by decreases in
sales in California and Florida, the markets most negatively affected by the
unusual "El Nino" weather conditions, and economic problems in the non-Japanese
Asian markets, partially offset by an increase in iron sales associated with the
introduction of Big Bertha(R) X-12 Irons.
For the three months ended March 31, 1998, gross profit decreased 4% to $83.7
million from $87.0 million for the comparable period in the prior year. As a
percentage of net sales, gross profit decreased to 47% from 51% for the quarter
ended March 31, 1998 as compared to the comparable quarter of the prior year,
primarily as a result of slightly higher cost of sales due to a general increase
in sales of irons, which have lower margins than metal woods, as a percentage of
the Company's total sales, and credits and discounts given to customers on
remaining Big Bertha(R) Iron inventory at retail. Additionally, the Company has
experienced a higher rate of return of metal woods over the past several
quarters as compared to that previously experienced. As a result, the Company
has increased the rate at which it reserves for warranty claims, further
reducing its gross margin for the three months ended March 31, 1998.
Selling expenses increased to $35.8 million in the first quarter of 1998
compared to $26.6 million in the first quarter of 1997. As a percentage of net
sales, selling expenses increased to 20% from 16% during the first quarter of
1998 over the first quarter of 1997. The $9.2 million increase is primarily the
result of selling expenses related to Odyssey, increased pro tour expenses
primarily resulting from tour signage, and increased advertising and promotional
costs.
General and administrative expenses increased to $20.5 million for the three
months ended March 31, 1998 from $16.3 million for the comparable period in the
prior year. As a percentage of net sales, general and administrative expenses
in the first quarter of 1998 increased to 12% from 10%. The $4.2 million
increase is primarily attributable to general and administrative costs related
to Odyssey, including amortization of intangibles associated with the purchase
of substantially all of the assets and certain liabilities of Odyssey Sports,
Inc., and costs associated with operations of Callaway Golf Ball Company.
Research and development expenses increased to $8.7 million in the first quarter
of 1998 compared to $6.0 million in the comparable period of the prior year. As
a percentage of net sales, research and development expenses in the first
quarter of 1998 increased to 5% from 4% in the first quarter of 1997. The $2.7
million increase is primarily the result of increased product engineering costs
associated with casting technology, and costs associated with golf ball
development.
Liquidity and Capital Resources
At March 31, 1998, cash and cash equivalents decreased to $14.4 million from
$26.2 million at December 31, 1997 primarily due to $22.1 million used in
operations. The decrease in cash flows from operations is primarily
attributable to an increases in accounts receivable and inventories, partially
offset by an increase in accounts payable and accrued expenses.
Also contributing to the decrease in cash during the period was cash used in
investing activities of $16.4 million, primarily resulting from capital
expenditures for building improvements, machinery and computer equipment as well
as the acquisition of the Company's distributors in Korea, Belgium and Denmark.
The decreases in cash flows from operations and investing activities were
partially offset by cash provided by financing activities, associated primarily
with net proceeds from the Company's revolving line of credit as well as
issuance of Common Stock, partially offset by dividends paid.
Historically, the Company's principal source of liquidity, both on a short-term
and long-term basis, has been cash flow provided by operations. The Company
increased its line of credit facility from $50.0 million to $150.0 million in
February 1998. The Company has borrowed against its line of credit to
supplement cash flow used in operations based upon the Company's need to
increase its inventory levels and finance additional operational activities
during the quarter ended March 31, 1998. At March 31, 1998, the Company had
available $117.2 million on this line of credit. The Company intends to repay
its borrowings on its line of credit with cash flow from operations. The
Company believes that, based upon its current operating plan, analysis of its
consolidated financial position and projected future results of operations, it
will be able to maintain its current level of operations, including planned
capital expenditures for the foreseeable future, through operating cash flows
and available borrowings under its line of credit. There can be no assurance,
however, that future industry specific developments or general economic trends
will not adversely affect the Company's operations or its ability to meet its
cash requirements.
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.
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. 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
Item 4. Submission of Matters to a Vote of Security Holders:
None
Item 5. Other Information:
On May 12, 1998, the Company issued a press release announcing the continued
adverse impact of market conditions on its second quarter 1998 sales and
earnings, which press release is attached hereto as Exhibit 99 and incorporated
herein by reference.
The Company previously reported in a February 27, 1998 press release that it
expected first quarter 1998 sales and earnings to be lower than expected due to
unusual severe weather patterns related to "El Nino" and the "Asian Flu."
Although the Company believes that the "El Nino" weather patterns have now
largely dissipated, and should not be a continuing concern, the "Asian Flu"
appears to have worsened, and may be having a negative impact on business in
Japan, which accounted for about 10% of the Company's revenues in 1997.
Moreover, metal wood sales continue to be soft in the second quarter of 1998.
The Company believes this is largely the result of extensive and continuing
price reductions by competitors as well as competition from new competitors in
the metal woods market. Additionally, there is some indication that demand for
premium priced titanium metal woods in general has softened, affecting the
entire golf club industry. Retail sales reports also indicate that the domestic
putter market is down generally, and as a result, sales of Odyssey(R) putters by
the Company's wholly-owned subsidiary, Odyssey Golf, Inc., are also expected to
be below targets for the quarter ended June 30, 1998.
While sales of the Company's newly introduced Big Bertha(R) X-12(TM) Irons
continue to be strong, both domestically and internationally, sales of the
Company's other irons, Great Big Bertha(R) Tungsten.Titanium(TM) Irons in
particular, have softened. The Company makes smaller profit margins from sales
of its irons as compared to the margins earned on sales of its metal woods.
The Company also stated that reports have surfaced indicating that the USGA, the
governing body of golf in the United States, is evaluating steps that might
prohibit or restrict the use of modern, thin-faced metal woods under the Rules
of Golf. These reports predict that the USGA will promulgate by the Year 2000 a
rule establishing the maximum speed at which a golf ball can come off a
clubhead, similar to the USGA's existing "overall distance" standard applicable
to golf balls. The Company is aware of work ongoing at the USGA with regard to
the performance of thin-faced metal woods, but it has been advised by the USGA
that no decision has been made regarding new rules or rule interpretations
applicable to golf clubs. Although all of the Company's current products have
been approved by the USGA, it is possible that such reports and rumors about
possible action by the USGA against thin-faced metal woods are having or may
have a negative effect on the Company.
The foregoing summary does not purport to be complete and is qualified in its
entirety by reference to the full text of the press release, a copy of which is
attached hereto as Exhibit 99.
Item 6. Exhibits and Reports on Form 8-K:
a. Exhibits:
--------
10.12 Executive Deferred Compensation Plan (as amended and
restated, effective January 1, 1998).
10.20 Revolving Loan Agreement, dated February 4, 1998 among
Callaway Golf Company, certain lenders therein named and
Wells Fargo Bank, National Association as Administrative
Agent.
10.23 Operating Agreement for Callaway Golf Media Ventures, LLC, a
California Limited Liability Company, executed as of January
26, 1998, by and between Callaway Golf Company and Callaway
Editions, Inc.
27 Financial Data Schedule.
99 Callaway Golf Company Press Release entitled "Market
Conditions will Continue to Adversely Impact Callaway Golf
Company's Second Quarter 1998 Sales and Earnings," dated May
12, 1998.
____________________
b. Reports on Form 8-K:
-------------------
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CALLAWAY GOLF COMPANY
Date: May 14, 1998 /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
EXHIBIT INDEX
--------------
Exhibit Number Description
- -------------- -----------
10.12 Executive Deferred Compensation Plan (as amended and restated,
effective January 1, 1998).
10.20 Revolving Loan Agreement, dated February 4, 1998 among Callaway Golf
Company, certain lenders therein named and Wells Fargo Bank,
National Association, as Administrative Agent.
10.23 Operating Agreement for Callaway Golf Media Ventures, LLC, a
California Limited Liability Company, executed as of January 26,
1998, by and between Callaway Golf Company and Callaway Editions,
Inc.
27 Financial Data Schedule.
99 Callaway Golf Company Press Release entitled "Market Conditions will
Continue to Adversely Impact Callaway Golf Company's Second Quarter
1998 Sales and Earnings," dated May 12, 1998.
__________________________