EXHIBIT 13.1
Selected Financial Data
(in thousands, except per share data) Year ended December 31,
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1999 1998 1997 1996 1995
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Statement of Operations Data:
Net sales $714,471 $697,621 $842,927 $678,512 $553,287
Cost of goods sold 376,405 401,607 400,127 317,353 270,125
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Gross profit 338,066 296,014 442,800 361,159 283,162
Selling, general and administrative expenses 224,336 245,070 191,313 155,177 120,201
Research and development costs 34,002 36,848 30,298 16,154 8,577
Restructuring costs (Note 12) (5,894) 54,235
Sumitomo transition costs (Note 15) 5,713
Litigation settlement 12,000
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Income (loss) from operations 79,909 (40,139) 209,189 189,828 154,384
Interest and other income, net (Note 9) 9,182 3,911 4,586 5,804 4,038
Interest expense (3,594) (2,671) (10) (37) (21)
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Income (loss) before income taxes 85,497 (38,899) 213,765 195,595 158,401
Income tax provision (benefit) 30,175 (12,335) 81,061 73,258 60,665
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Net income (loss) $55,322 ($26,564) $132,704 $122,337 $97,736
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Earnings (loss) per common share:
Basic $0.79 ($0.38) $1.94 $1.83 $1.47
Diluted $0.78 ($0.38) $1.85 $1.73 $1.40
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Dividends paid per share $0.28 $0.28 $0.28 $0.24 $0.20
(in thousands) December 31,
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1999 1998 1997 1996 1995
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Balance Sheet Data:
Cash and cash equivalents $112,602 $ 45,618 $ 26,204 $108,457 $ 59,157
Working capital $205,198 $139,598 $209,402 $250,461 $146,871
Total assets $616,783 $655,827 $561,714 $428,428 $289,975
Long-term liabilities $ 11,575 $ 18,723 $ 7,905 $ 5,109 $ 2,207
Total shareholders' equity $499,934 $453,096 $481,425 $362,267 $224,934
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
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YEARS ENDED DECEMBER 31, 1999 AND 1998
For the year ended December 31, 1999, net sales increased $16.9 million, or
2%, to $714.5 million from $697.6 million in the prior year. The increase is
attributable to an increase in sales of metal woods, particularly titanium
metal woods, partially offset by a decrease in sales of irons and by sales of
non-current product through a managed close-out process at substantially
reduced prices. The increase in metal woods sales of $39.1 million (10%) is
largely attributable to the January 1999 introduction of Great Big Bertha(R)
Hawk Eye(R) Titanium Metal Woods and increases in sales of Big Bertha(R)
Steelhead(TM) Metal Woods, which were introduced in August 1998. Sales of
irons decreased $7.8 million, primarily as a result of a $27.6 million
decrease in sales of Big Bertha(R) X-12(R) Irons, which were introduced in
January 1998, partially offset by sales from the August 1999 introduction of
Hawk Eye(R) Tungsten Injected(TM) Titanium Irons of $27.7 million. Sales of
Odyssey(R) and Callaway Golf(R) putters decreased $7.5 million (14%). Sales
of other products decreased $6.9 million (30%).Also included in 1999 net
sales were $56.6 million in sales of non-current product, most of which were
sold at close-out prices.
In terms of net sales by region, sales in the United States decreased
$23.5 million (5%) to $414.1 million for the year ended December 31, 1999.
Net sales in Japan decreased $5.5 million (9%) to $55.9 million, as net
purchases by the Company's distributor declined in anticipation of the
transition of distribution of Callaway Golf(R) products from it to the
Company's wholly-owned Japanese subsidiary. Net sales to Europe remained
relatively constant at $115.7 million and net sales to the rest of Asia and
the rest of the world increased $38.9 million (114%) and $7.6 million (16%),
respectively. Sales to the rest of Asia increased in 1999 over 1998 due
largely to the economic recovery of the Korean market in 1999 and the
introduction of higher- margin products in Korea during 1999. The Company
does not expect that revenue in Korea will continue to increase at a rate
comparable to 1999.
For the year ended December 31, 1999, gross profit increased to $338.1
million from $296.0 million in the prior year, and as a percentage of net
sales increased to 47% from 42%. The increase is primarily due to lower
obsolescence charges in 1999 vs. a $30.0 million excess inventory charge
recorded in the fourth quarter of 1998, and an increase in sales of metal
woods (which carry higher margins). However, gross profit was unfavorably
affected by price reductions on the sales of non- current products through
the Company's managed close-out program and an increase in distribution costs
associated with the Company's foreign subsidiaries.
Selling expenses decreased to $131.9 million in 1999 from $147.0 million
in the prior year. As a percentage of net sales, selling expenses decreased
to 18% from 21%. This decrease is primarily attributable to planned
reductions in advertising, pro tour and other promotional expenses, partially
offset by an increase in employee compensation.
General and administrative expenses decreased to $92.5 million in 1999
from $98.0 million in 1998, or 13% and 14% of net sales, respectively. This
decrease is largely due to decreases in consulting, bad debt expense and
supplies expense, as well as a decrease in building-related costs associated
with the Company's 1998 restructuring program. These amounts were partially
offset by increases in costs associated with the ramp-up of the Company's
golf ball operations and increased depreciation and amortization expense
related to the Company's foreign operations.
Research and development expenses decreased to $34.0 million (5% of net
sales) in 1999 from $36.8 million (5% of net sales) in 1998. This decrease
was primarily the result of the shut-down of the Company's prototype foundry
and a decrease in consulting fees, partially offset by increases in employee
compensation and component prototype costs.
Restructuring income primarily relates to the reversal of a restructuring
reserve recorded in 1998 for a lease obligation in New York City that was
subsequently assigned to a third party. See Note 12 to the Consolidated
Financial Statements for a discussion of this and other restructuring
transactions.
Sumitomo Rubber Industries, Ltd. ("Sumitomo") transition costs represent
payments for non-current product which were associated with the transition of
the distribution of Callaway Golf(R) products from Sumitomo to a wholly-owned
subsidiary of the Company. See "Certain Factors Affecting Callaway Golf
Company - International Distribution" below and Note 15 to the Consolidated
Financial Statements for a discussion of this transaction.
Interest and other income increased to $9.2 million from $3.9 million for
the year ended December 31, 1999 as compared with the prior year. This
increase is primarily attributable to an increase in interest income
resulting from higher average cash and deferred compensation investment
balances during 1999 as compared with 1998, an increase in royalty income and
an increase in other income due to the receipt of insurance proceeds related
to the Company's deferred compensation plan.
Interest expense increased to $3.6 million in 1999 from $2.7 million in
1998. This increase is largely related to
interest on the Company's interim finance agreement for pre-lease financing
advances for the acquisition and installation costs of machinery and
equipment. Also contributing to the increase was an increase in interest
expense related to the Company's line of credit and accounts receivable
securitiza-tion facilities associated with higher interest and yield rates
and related fees.
During 1999, the Company recorded a tax provision of $30.2 million and
recognized a decrease in deferred taxes of $9.6 million. During 1999, the
Company realized tax benefits of $2.4 million related to the exercise of
stock options, $1.4 million related to non-taxable income from insurance
proceeds related to the Company's deferred compensation plan and $1.0 million
related to the reorganization of a foreign subsidiary.
YEARS ENDED DECEMBER 31, 1998 AND 1997
For the year ended December 31, 1998, net sales were $697.6 million, a 17%
decrease from the prior year. This decrease was primarily due to fewer metal
woods sales, particularly titanium metal woods, along with lower average
sales prices as a result of a metal wood wholesale price reduction on Big
Bertha(R) War Bird(R) Stainless Steel Metal Woods and Great Big Bertha(R) and
Biggest Big Bertha(R) Titanium Metal Woods, both domestically and in many
major international markets. In terms of product sales, the decrease was
attributable to decreases in metal woods sales of $154.4 million, iron sales
of $4.9 million and other product sales of $14.9 million, partially offset by
an increase in Odyssey(R) product sales of $28.9 million, as only five months
of Odyssey Golf, Inc.'s ("Odyssey") results were included in the prior year's
consolidated results (see Note 14 to the Consolidated Financial Statements).
The decrease in metal woods sales was composed of decreases in Great Big
Bertha(R) Metal Woods of $96.8 million, Big Bertha(R) War Bird(R) Metal Woods
of $77.7 million and Biggest Big Bertha(R) Drivers of $57.9 million, which
was partially offset by sales of Big Bertha(R) Steelhead(TM) Metal Woods,
which contributed $78.0 million to sales. The decrease in sales of irons was
attributable to decreases in Big Bertha(R) Irons of $137.6 million, Big
Bertha Gold(R) Irons of $28.3 million and Great Big Bertha(R) Irons of $31.1
million, which was partially offset by a $192.4 million increase in Big
Bertha(R) X-12(R) Irons.
In terms of net sales by region, United States sales decreased $109.6
million (20%) for the year ended December 31, 1998 as compared with 1997. Net
sales in Japan and the rest of Asia decreased $23.2 million (27%) and $19.8
million (37%), respectively, during 1998, while net sales in Europe and
Canada increased by $7.7 million (7%) and $7.7 million (44%), respectively,
during this period.
The Company believes the diversion of consumer purchases to the Company's
new Big Bertha(R) Steelhead(TM) Metal Woods and Big Bertha(R) X-12(R) Irons
from its higher priced titanium metal woods and irons, and marketplace
anticipation of the introduction of the Great Big Bertha(R) Hawk Eye(R)
Titanium Metal Woods in January 1999, also contributed to the decrease in
sales in 1998. Additionally, the Company believes that competition has caused
the Company to lose some market share domestically partly because of pricing
strategies implemented by certain competitors. In addition, the economic
turmoil in Southeast Asia and Japan had an adverse effect on the Company's
sales and results of operations. Sales earlier in the year also were
adversely affected by unusual "El Nino" weather conditions in the United
States. The Company also believes that certain actions by the United States
Golf Association in 1998 contributed to the drop in metal wood sales.
For the year ended December 31, 1998, gross profit decreased to $296.0
million from $442.8 million in the prior year, and gross margin decreased to
42% from 53%. This decrease was primarily attributable to additions to the
reserve for excess inventory of $30.0 million in the fourth quarter, lower
average sales prices as a result of a metal wood wholesale price reduction on
Big Bertha(R) War Bird(R) Stainless Steel Metal Woods and Great Big Bertha(R)
and Biggest Big Bertha(R) Titanium Metal Woods and the accompanying customer
compensation, an increase in warranty expense, and increased manufacturing
labor and overhead costs.
Selling expenses increased to $147.0 million in 1998 from $120.6 million
in 1997. This increase was primarily attributable to costs associated with
Odyssey's putter operations, which the Company acquired in August 1997, and
foreign and domestic subsidiaries acquired during 1998, as well as an
increase in international advertising and other marketing expenses. This
increase was partially offset by a decrease in domestic promotional and
endorsement expenses.
General and administrative expenses increased to $98.0 million in 1998
from $70.7 million in 1997. This increase was due to pre-production and non-
capitalized construction costs of the new golf ball facility, expenses
associated with foreign and domestic subsidiaries acquired during 1998,
expenses associated with the consolidation of the Company's European
operations, expenses associated with Odyssey's putter operations, including
amortization of goodwill, and an increase in the reserve for uncollectable
accounts receivable.
Research and development expenses increased to $36.8 million in 1998 from
$30.3 million in 1997. This increase was primarily attributable to increased
product design costs related to increased employee compensation, consulting
and other
overhead expenses, including those associated with Callaway Golf Ball Company
and Odyssey's putter operations.
Charges of $54.2 million were recorded in the fourth quarter of 1998
related to the Company's cost reduction actions (see "Restructuring" below).
These charges were primarily composed of $28.7 million for asset impairments,
excess lease costs, and costs to exit various non-core business activities,
including venues, new player development, interactive golf and publishing,
$13.8 million for impairment of assets due to the consolidation of continuing
operations and $11.7 million for employee separation costs.
Other income decreased to $3.9 million in 1998 from $4.6 million in 1997.
This decrease was due to a decrease in interest income resulting from lower
cash balances during 1998 versus 1997 and losses on dispositions of assets in
1998. This decrease was partially offset by net gains on foreign currency
transactions in 1998 of $1.6 million, as compared with net losses in 1997 of
$0.9 million.
Interest expense increased to $2.7 million in 1998 resulting from draws on
the Company's line of credit. The line of credit was not used during 1997.
LIQUIDITY AND CAPITAL RESOURCES
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At December 31, 1999, cash and cash equivalents increased to $112.6 million
from $45.6 million at December 31, 1998. For the year ended December 31,
1999, cash provided by operations of $166.3 million was partially offset by
cash used in investing activities of $53.5 million and cash used in financing
activities of $45.9 million. Cash flows used in investing activities resulted
from capital expenditures, primarily associated with the ramp-up of golf ball
operations and deferred purchase acquisition payments, partially offset by
proceeds from the sale of fixed assets. Of the capital expenditures for 1999,
$50.0 million were sold and leased back pursuant to terms of an equipment
financing and lease agreement (see Note 4 to the Consolidated Financial
Statements). Cash flows used in financing activities are primarily due to the
repayment of loan advances and dividends paid, partially offset by proceeds
from an equipment financing agreement (see Note 4 to the Consolidated
Financial Statements) and the issuance of Common Stock.
The Company's principal source of liquidity, both on a short-term and
long-term basis, has been cash flow provided by operations and the Company's
credit facilities. The Company expects this trend to continue even though
sales increased only slightly in 1999 and the Company does not foresee any
significant improvement in sales during the near term. On February 12, 1999,
the Company consummated the amendment of its line of credit to increase the
revolving credit facility to up to $120.0 million (the "Amended Credit
Agreement") and entered into an $80.0 million accounts receivable
securitization facility (the "Accounts Receivable Facility") (see Notes 4 and
5 to the Consolidated Financial Statements). During the first quarter of
1999, the Company utilized its Accounts Receivable Facility and borrowed
against its line of credit under the Amended Credit Agreement to fund
operations and finance capital expenditures. At December 31, 1999, the
Company had repaid the outstanding balance of the Amended Credit Agreement
with cash flow from operations and had $115.7 million available, net of
outstanding letters of credit, under this credit facility, subject to meeting
certain availability requirements under a borrowing base formula and other
limitations. Also at December 31, 1999, there were no advances under the
Accounts Receivable Facility, leaving up to $80.0 million available under
this facility. Further, in the third and fourth quarters of 1999, the Company
converted its note payable under the Finance Agreement to an operating lease
(see Note 4 to the Consolidated Financial Statements).
As a result of the implementation of its plan to improve operating
efficiencies (see "Restructuring" below), the Company incurred charges of
$54.2 million in the fourth quarter of 1998. Of these charges, $25.5 million
were estimated to be non-cash. Since the adoption of this restructuring plan
in the fourth quarter of 1998, the Company has made cash outlays for employee
termination costs, contract cancellation fees, excess lease costs and other
expenses totaling $18.8 million, of which $8.5 million occurred in 1999. As a
result of the reversal of a portion of certain restructuring reserves
totaling $8.6 million during 1999, due primarily to the assignment of a lease
and the sale of certain of the Company's buildings at terms more favorable
than estimated, expected future cash outlays for restructuring activities
have been reduced and are estimated to be $1.4 million (see Note 12 to the
Consolidated Financial Statements). This amount is expected to be paid by
July 2000. These cash outlays will be funded by cash flows from operations
and, if necessary, the Company's credit facilities. If the actual actions
taken by the Company differ from the plans on which these estimates are
based, actual losses recorded and resulting cash outlays made by the Company
could differ significantly.
Although the Company's golf club operations are mature and historically
have generated cash from operations, the Company's golf ball operations are
in a developmental stage. Therefore, the Company does not expect that its
golf ball operations will generate sufficient cash to fund its operations in
2000. However, 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 its consolidated operations including purchase commitments
and planned capital expenditures for the foreseeable future, through
operating cash flows and its credit facilities. There can be no assurance,
however, that future industry specific or other developments, or general
economic trends, will not adversely affect the Company's operations or its
ability to meet its future cash requirements.
RESTRUCTURING
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During the fourth quarter of 1998, the Company recorded a restructuring
charge of $54.2 million resulting from a number of cost reduction actions and
operational improvements. These actions included: the consolidation of the
operations of the Company's wholly-owned subsidiary, Odyssey, into the
operations of the Company while maintaining the distinct and separate
Odyssey(R) brand; the discontinuation, transfer or suspension of certain
initiatives not directly associated with the Company's core business, such as
the Company's involvement with interactive golf sites, golf book publishing,
new player development and a golf venue in Las Vegas; and the re-sizing of
the Company's core business to reflect current and expected business
conditions. These initiatives were completed during 1999, with the exception
of cash outlays related to the assignment of a lease obligation for a
facility in New York City that will continue through July 2000. The
restructuring charges (shown below in tabular format) primarily related to:
1) the elimination of job responsibilities, resulting in costs incurred for
employee severance; 2) the decision to exit certain non-core business
activities, resulting in losses on disposition of the Company's 80% interest
in Callaway Golf Media Ventures (See Note 14 to the Consolidated Financial
Statements), a loss on the sale of the business of All-American (See Note 14
to the Consolidated Financial Statements), as well as excess lease costs; and
3) consolidation of the Company's continuing operations resulting in
impairment of assets, losses on disposition of assets and excess lease costs.
Employee reductions occurred in almost all areas of the Company, including
manufacturing, marketing, sales, and administrative areas. At December 31,
1998, the Company had reduced its non-temporary work force by approximately
750 positions. Although substantially all reductions occurred prior to
December 31, 1998, a small number of reductions occurred in the first quarter
of 1999.
Details of the one-time charge are as follows:
(in thousands) Reserve Reserve
Cash/ One-Time Balance Balance
Non-Cash Charge Activity at 12/31/98 Activity(1) at 12/31/99
-------- ------ -------- ----------- ----------- -----------
ELIMINATION OF JOB RESPONSIBILITIES $11,664 $ 8,473 $ 3,191 $ 3,191
Severance packages Cash 11,603 8,412 3,191 3,191
Other Non-cash 61 61
EXITING CERTAIN NON-CORE BUSINESS ACTIVITIES $28,788 $12,015 $16,773 $15,394 $ 1,379
Loss on disposition of subsidiaries Non-cash 13,072 10,341 2,731 2,731
Excess lease costs Cash 12,660 146 12,514 11,135(2) 1,379
Contract cancellation fees Cash 2,700 1,504 1,196 1,196
Other Cash 356 24 332 332
CONSOLIDATION OF OPERATIONS $13,783 $ 2,846 $10,937 $10,937
Loss on impairment/disposition of assets Non-cash 12,364 2,730 9,634 9,634(3)
Excess lease costs Cash 806 4 802 802(4)
Other Cash 613 112 501 501
(1) Includes reversal of reserve totaling $8.6 million, as actual amounts
differed from estimates. Significant reversals are noted below in (2)
through (4).
(2) Includes reversal of $6.1 million of reserve due to the assignment of lease
obligation at terms significantly more favorable than estimated at the
establishment of the reserve.
(3) Includes reversal of $1.5 million of reserve related to disposition of two
buildings at higher sales prices than estimated.
(4) Includes reversal of $491,000 of reserve due to the sublease of a facility
at terms more favorable than estimated at the establishment of the reserve.
During 1999, the Company incurred charges of $1.3 million on the disposition
of building improvements eliminated during the consolidation of manufacturing
operations, as well as other charges of $671,000. These charges did not meet
the criteria for accru- al in 1998. Additionally, the Company incurred
charges of $749,000 related to asset dispositions and other restructuring
activities for which reserves were not established in 1998. Future cash
outlays are anticipated to be completed by July 2000.
CERTAIN FACTORS AFFECTING CALLAWAY GOLF COMPANY
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RESTRUCTURING
During 1999, as planned, the Company completed the restructuring of its
operations that it announced during the fourth quarter of 1998. See
"Restructuring" under "Results of Operations" discussed above. Although the
Company was pleased with the restructuring results in 1999, there can be no
assurance that the Company will continue to realize the benefits of the
restructuring.
SALES
Golf Clubs. The Company previously reported that it believed that the dollar
volume of the premium golf club market had been declining in certain major
markets, including the United States.Although the Company believes that
market conditions may have stabilized, there is no assurance that the overall
dollar volume of the premium golf club market in the U.S. will grow
significantly, or that it will not decline, in the near future. During 1999,
the Company's United States revenues decreased 5% while international
revenues increased 16% compared to 1998. The Company believes that this
decrease in United States revenue was due in part to softness in the United
States market, lower revenue per club from sales of golf equipment at low or
close-out prices, and declines in iron and putter sales due to the maturity
of those product lines. The Company believes that the increase in
international revenue is largely attributable to a significant increase in
revenue from sales in Korea as a result of the economic recovery of the
Korean market and the introduction of higher margin products in Korea in
1999. The Company does not expect that revenue in Korea will continue to
increase at a rate comparable to 1999. The Company further believes that some
portion of sales to international customers recorded in 1999 as direct
international sales may have formerly been made to the same international
customers indirectly through the United States distribution channel. See also
"Certain Factors Affecting Callaway Golf Company - Gray Market Distribution."
The Company's brands remained number one in the U.S. and the worldwide
market for woods, irons and putters in 1999. See also "Certain Factors
Affecting Callaway Golf Company - Competition."
Sales of the Company's Great Big Bertha(R) Hawk Eye(R) Titanium Metal
Woods, Big Bertha(R) Steelhead(TM) Metal Woods and Big Bertha(R) X-12(R)
Irons were strong in 1999. Hawk Eye(R) Tungsten Injected(TM) Titanium Irons
were introduced in September 1999, and Big Bertha(R) Steelhead Plus(TM)
Drivers and Fairway Woods, Big Bertha(R) Steelhead(TM) X- 14(TM) Irons and
Odyssey(R) White Hot(TM) Putters were released in January 2000. The initial
acceptance of these products has also been strong to date. No assurances can
be given, however, that the demand for these products or the Company's other
existing products, or the introduction of new products, will permit the
Company to experience growth in sales, or maintain historical levels of
sales, in the future.
The Company formerly reported that golf club sales to Japan might be lower
overall for 1999 as compared to 1998 as the Company's distributor, Sumitomo
Rubber Industries, Ltd. ("Sumitomo"), prepared for the transition of
responsibility from it to the Company's wholly-owned Japanese subsidiary,
Callaway Golf Kabushiki Kaisha ("Callaway Golf K. K."), formerly named ERC
International Company. Although the Company subsequently reported that sales
were not lower through the first nine months of 1999, sales in Japan for all
of 1999 were down 9% compared with 1998, with the reduction largely because
net purchases by Sumitomo, as expected, declined in anticipation of the
transition. In 1999, 1998 and 1997, sales to Sumitomo accounted for 7%, 8%
and 10%, respectively, of the Company's total net sales. The Sumitomo
distribution agreement required that Sumitomo purchase specific minimum
quantities from the Company. As a direct distributor, the Company will not
have the benefit of these guaranteed minimum purchases going forward.
Furthermore, there is no assurance that the Company will be able to transcend
the cultural and other barriers to successful distribution in Japan or that
its sales in Japan will be comparable to or exceed its prior sales to
Sumitomo. There also will be a delay in the recording of revenues for sales
in Japan as compared to previous years because revenue will now be recorded
upon sale to retailers and not upon sale to a distributor. See also "Certain
Factors Affecting Callaway Golf Company - International Distribution."
Golf Balls. 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 had previously licensed the
manufacture and distribution of a golf ball in Japan and Korea. The Company
also had distributed a golf ball under the trademark "Bobby Jones(R)." These
previous golf ball ventures were introduced primarily as promotional efforts
and were not commercially successful.
In February 2000, the Company released its new Rule 35(TM) Golf Balls.
These golf balls are the product of more than three years of research and
development and are manufactured in a new facility built by the Company for
that purpose. To date, the Company's investment in its golf ball business has
exceeded $170 million. The development of the Company's golf ball business,
by plan, has had a significant negative impact on the Company's cash flows,
financial position and results of
operations and will continue to affect the Company's performance in 2000. The
success of the Company's new golf ball business could be adversely affected
by various risks, including, among others, delays or difficulties in
manufacturing or distribution and unanticipated costs. Although initial
demand for the Company's golf balls is promising, there is no assurance that
such demand will result in a proportionate amount of actual sales or that
consumers will enjoy the balls sufficiently to sustain future sales.
Furthermore, although the Company expects production of the golf balls to
increase as the year 2000 progresses, there is no assurance that the Company
will be able to manufacture enough balls to meet demand or be able to achieve
the operational or sales efficiencies necessary to make its golf ball
business profitable. Consequently, there can be no assurance as to whether
the golf ball will be commercially successful or that a return on the
Company's investment will ultimately be realized.
GROSS MARGIN
The Company's gross margin as a percentage of net sales increased to 47% in
1999 from 42% in 1998. This increase primarily resulted from lower
obsolescence charges in 1999 (vs. a $30.0 million excess inventory charge
recorded in the fourth quarter of 1998), higher metal wood sales (which carry
higher margins) as a percentage of total net sales, as compared to 1998, and
from reductions in manufacturing labor and overhead costs realized through
the Company's 1998 restructuring, along with reductions in certain component
costs. Gross margin as a percentage of net sales would have improved to 49%
but for close-out sales of Great Big Bertha(R) Tungsten.Titanium(TM) Irons,
Great Big Bertha(R) and Biggest Big Bertha(R) Titanium Metal Woods, and Big
Bertha(R) War Bird(R) Metal Woods, which had much lower margins. However,
consumer acceptance of current and new product introductions, the sale and
disposal of non-current products at reduced sales prices and continuing
pricing pressure from competitive market conditions may have an adverse
effect on the Company's future sales and gross margin. Furthermore, the
Company expects that in 2000 the Company's sales of irons as a percentage of
total net sales will increase. This would negatively impact the Company's
gross margin as a percentage of net sales because irons generally sell at
lower margins than woods.
The Company's margins also could be affected by its golf ball business.
During the year 2000, the Company expects that its margins in the golf ball
business will be less than the levels it expects to achieve when the Company
attains a level of operational and sales efficiency that allows it to benefit
from certain economies of scale. There is no assurance, however, that the
Company will achieve the economies of scale necessary to maintain or improve
its current overall sales margins.
SEASONALITY
In the golf club and golf ball industries, 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 golf club business
has generally followed this seasonal trend and the Company expects this to
continue for both its golf club and golf ball businesses. Unusual or severe
weather conditions such as the "El Nino" weather patterns experienced during
the winter of 1997-1998 may compound or otherwise distort these seasonal
effects.
COMPETITION
The worldwide market for premium golf clubs is highly competitive, and is
served by a number of well-established and well-financed companies with
recognized brand names, as well as new companies with popular products. New
product introductions and/or price reductions by competitors continue to
generate increased market competition. However, the Company believes that it
has gained unit and dollar market share for woods in the United States during
1999 as compared to 1998. 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.
A golf club 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 be subject to rapid and unanticipated
changes. There can be no assurance as to how long the Company's golf clubs
will maintain market acceptance.
The premium golf ball business is also highly competitive with a number of
well-established and well-financed competitors, including one competitor with
an estimated market share in excess of 50% of the premium golf ball business.
These competitors have established market share in the golf ball business,
which the Company will need to penetrate for its golf ball business to be
successful. There can be no assurance that the Company's golf balls will
obtain the market acceptance necessary to penetrate this established market.
NEW PRODUCT INTRODUCTION
The Company believes that the introduction of new, innovative golf clubs and
golf balls is important to its future success. 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. Further, any new products
that retail at a lower price than prior products may negatively impact the
Company's revenues unless unit sales increase.
New golf club and golf ball products generally seek to 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.
While all of the Company's current golf clubs and golf balls have been found
to conform to the Rules of Golf as applied in the jurisdictions where they
are sold, 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. For example,
on November 2, 1998, the USGA announced the adoption of a test protocol to
measure the so-called "spring-like effect" in certain golf clubheads. The
USGA has advised the Company that none of the Company's current clubs sold in
the U.S. are barred by this test. The R&A is considering the adoption of a
similar or related test, but has not yet done so. Both the USGA and the R&A
are reviewing the current regulations of golf, and one or both may change
those regulations in the future. Future actions by the USGA or the R&A may
impede the Company's ability to introduce new products and therefore could
have a material adverse effect on the Company's results of operations and
cash flows.
The Company's new products have tended to incorporate significant
innovations in design and manufacture, which have often resulted in higher
prices for the Company's products relative to other products in the
marketplace. For example, the Company's golf balls are premium golf balls and
there are many lower priced non-premium golf balls sold by others. There can
be no assurance that a significant percentage of the public will always be
willing to pay such premium prices for golf equipment or that the Company
will be able to continue to design and manufacture premium products that
achieve market acceptance in the future.
The rapid introduction of new golf club or golf ball products by the
Company could result in close-outs of existing inventories at both the
wholesale and retail levels. Such close-outs can result in reduced margins on
the sale of older products, as well as reduced sales of new products, given
the availability of older products at lower prices. The Company experienced
some of these effects in 1999 with respect to golf clubs and could experience
similar effects in future years as the Company from time to time introduces
new products or misjudges demand.
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. 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. 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. As in 1998, this could result
in excess inventories and related obsolescence charges that could adversely
affect the Company's financial performance.
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. In addition, the
Company's Biggest Big Bertha(R) Drivers, because of their large club head
size and extra long, lightweight graphite shafts, have experienced shaft
breakage at a rate higher than generally experienced with the Company's other
metal woods, even though these shafts were among the most expensive to
manufacture in the industry. This product was discontinued in 1999. 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(R) clubs that have been
sold.
The Company monitors the level and nature of any golf club breakage and,
where appropriate, seeks to incorporate design and production changes to
assure its customers of the highest quality available in the market.
Significant increases in the incidence of breakage or other product problems
may adversely affect the Company's sales and image with golfers. While the
Company believes that it has sufficient reserves for warranty claims, there
can be no assurance that these reserves will be sufficient if the Company
were to experience an unusually high incidence of breakage or other product
problems.
CREDIT RISK
The Company primarily sells its products to golf equipment retailers, wholly-
owned domestic and foreign subsidiaries and foreign distributors. The Company
performs ongoing credit evaluations of its customers' financial condition and
generally
requires no collateral from these customers. Historically, the Company's bad
debt expense has been low. However, the recent downturn in the retail golf
equipment market, primarily in the United States, has resulted in delinquent
or uncollectible accounts for some of the Company's significant customers. As
a result, during 1999 the Company wrote off approximately $5.3 million of
past due trade accounts receivable against the Company's reserve for
uncollectible accounts receivable. Management does not foresee any
significant improvement in the U.S. retail golf equipment market during 2000.
In addition, the Company's transition in Japan from selling to one
distributor to selling directly to many retailers could increase the
Company's delinquent or uncollectible accounts. There can be no assurance
that failure of the Company's customers to meet their obligations to the
Company will not adversely impact the Company's results of operations or cash
flows.
DEPENDENCE ON CERTAIN VENDORS AND MATERIALS
The Company is dependent on a limited number of suppliers for its club heads
and shafts. In addition, some of the Company's products require specifically
developed manufacturing techniques and processes which make it difficult to
identify and utilize alternative suppliers quickly. The Company believes that
suitable club heads and shafts could be obtained from other manufacturers in
the event its regular suppliers are unable to provide components. However,
any significant production delay or disruption caused by the inability of
current suppliers to deliver or the transition to other suppliers could have
a material adverse impact on the Company's results of operations.
The Company is also dependent on a limited number of suppliers for the
materials it uses to make its golf balls. Many of the materials, including
the golf ball cover, are customized for the Company. Any delay or
interruption in such supplies could have a material adverse impact upon the
Company's golf ball business. If the Company did experience any such delays
or interruptions, there is no assurance that the Company would be able to
find adequate alternative suppliers at a reasonable cost or without
significant disruption to its business.
The Company uses United Parcel Service ("UPS") for substantially all
ground shipments of products to its U.S. customers. The Company is
continually reviewing alternative methods of ground shipping to supplement
its use and reduce its reliance on UPS. To date, a limited number of
alternative vendors have been identified and are being used by the Company.
Nevertheless, 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 alloys and carbon fiber. The Company 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 always will 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 golf club industry, in general, has been characterized by widespread
imitation of popular club designs. 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 copyrights, 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 copyrights, patents, trademarks, or trade
dress.
An increasing number of the Company's competitors have, like the Company
itself, sought to obtain patent, trademark, copyright or other protection of
their proprietary rights and designs for golf clubs. From time to time others
have or may contact the Company to claim that they have proprietary rights
that 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 a 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 developed its new golf ball
product, it attempted to avoid infringing valid patents or other intellectual
property rights. Despite these attempts, it cannot be guaranteed that a
competitor will not assert and/or a court will not find that the Company's
new golf ball products infringe any patent or other rights of competitors. If
the Company's new golf ball product is found to infringe on protected
technology, there is no assurance that the Company would be able to obtain a
license to use such technology, and the Company could incur
substantial costs to redesign its golf ball product and/or defend legal
actions.
The Company has 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. While these efforts are
taken seriously, 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" for the Company's
products can undermine authorized retailers and foreign wholesale
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(R) products to unauthorized
distributors and/or an increase in sales returns over historical levels. For
example, the Company experienced a decline in sales in the United States in
1998, and believes the decline was due, in part, to a decline in "gray
market" shipments to Asia and Europe. While the Company has taken some lawful
steps to limit commerce in its products in the "gray market" in both the U.S.
and abroad, it has not stopped such commerce.
GOLF PROFESSIONAL ENDORSEMENTS
The Company establishes relationships with professional golfers in order to
evaluate and promote Callaway Golf(R) and Odyssey(R) branded products. The
Company has entered into endorsement arrangements with members of the various
professional tours, including the Senior PGA Tour, the PGA Tour, the LPGA
Tour and the PGA European Tour. While most professional golfers fulfill their
contractual obligations, some have been known to stop using a sponsor's
products despite contractual commitments. If certain of the Company'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 and do not grant
any endorsement to the Company. In addition, the Company has created cash
pools ("Pools") that reward such usage. However, in 1999, as compared to
1998, the Company significantly reduced these Pools for both Callaway Golf(R)
and Odyssey(R) brand products for the PGA and the Senior PGA Tours, and has
significantly reduced the Pools for Odyssey(R) brand products and eliminated
the Pools for Callaway Golf(R) brand products for the LPGA and buy.com
(formerly Nike) tours. The Company expects that the Pools for 2000 will be
comparable to 1999. In addition, many other companies are aggressively
seeking the patronage of these professionals, and are offering many
inducements, including specially designed products and significant cash
rewards. As a result, in 1999, usage of the Company's drivers on the PGA,
Senior PGA, LPGA and buy.com tours was substantially reduced compared to
1998. This trend may continue in the year 2000.
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. While it is not clear to what
extent professional usage contributes to retail sales, it is possible that
the recent decline in the level of professional usage of the Company's
products could have a material adverse effect on the Company's business.
Many golf ball manufacturers, including the leading U.S. manufacturer of
premium golf balls, have focused a great deal of their marketing efforts on
promoting the fact that tour professionals use their balls. Some of these
golf ball competitors spend large amounts of money to secure professional
endorsements, and the market leader has obtained a very high degree of tour
penetration. While several of the Company's staff professionals have decided
to use the Company's golf balls in play, there are others who are already
under contract with other golf ball manufacturers or, for other reasons, may
not choose to play the Company's products. In addition, several professionals
who are not on the Company's staff have expressed an interest in playing the
Company's ball, but it is too early to predict if a significant number will
actually do so. The Company does not plan to match the endorsement spending
levels of the leading manufacturer in 2000, and will instead rely more
heavily upon the performance of the ball and other factors to attract
professionals to the product. In the future the Company may or may not
increase its tour spending in support of the golf ball. It is not clear to
what extent use by professionals is important to the commercial success of
the Company's golf ball, but it is possible that the results of the Company's
golf ball business could be significantly affected by its success or lack of
success in securing acceptance on the professional tours.
INTERNATIONAL DISTRIBUTION
The Company's management believes that controlling the distribution of its
products in certain major markets in the world
has been and will be an element in the future growth and success of the
Company. The Company has been 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
resulted and will continue to result in additional investments in inventory,
accounts receivable, corporate infrastructure and facilities. The integration
of foreign distribution into the Company's international sales operations
will continue to require the dedication of management and other Company
resources.
Additionally, the Company's plan to integrate foreign distribution
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. 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. The
integration of foreign distribution 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
distribution will be successful, and it is possible that an attempt to do so
will adversely affect the Company's business.
The Company appointed Sumitomo as the sole distributor of Callaway Golf(R)
clubs in Japan, through a distribution agreement that ended December 31,
1999. In 1999, 1998 and 1997, sales to Sumitomo accounted for 7%, 8% and 10%,
respectively, of the Company's net sales. In the fourth quarter of 1999, the
Company successfully completed negotiations with Sumitomo to provide a smooth
transition of its business. As a result of the transition agreement, the
Company recorded a net charge of $8.6 million in the fourth quarter of 1999
for buying certain current inventory, payments for non-current inventory and
other transition expenses, including foreign currency transaction losses.
Effective January 1, 2000, the Company began distributing Callaway Golf(R)
brand products through Callaway Golf K. K., which also distributes Odyssey(R)
products and will also distribute Callaway Golf(TM) balls. In addition to the
fourth quarter 1999 charges noted above, there will be significant costs and
capital expenditures invested in Callaway Golf K. K. before there will be
sales sufficient to support such costs. Furthermore, there are significant
risks associated with the Company's intention to effectuate distribution of
Callaway Golf(R) products in Japan through Callaway Golf K. K. rather than
through Sumitomo. Some of these risks include increased delinquent and
uncollectible accounts now that the Company will be collecting its
receivables from many retailers as opposed to only one distributor.
Furthermore, the Company will no longer have the benefit of the minimum
purchases that Sumitomo was required to make. It is possible that these
circumstances could have a material adverse effect on the Company's
operations and financial performance. There also will be a delay in the
recording of revenues for sales in Japan as compared to previous years
because revenue now will be recorded upon sale to retailers and not upon sale
to a distributor.
YEAR 2000 ISSUE
The Y2K issue is the name given to the computer program problem whereby two
digits rather than four were used to define the applicable year, which could
result in the program failing to properly recognize a year that begins with
"20" instead of "19." This, in turn, could result in major system failures or
miscalculations, and is generally referred to as the "Year 2000" or "Y2K"
issue. A more detailed description of the risks associated with the Y2K issue
as applied to the Company and the Company's remedial actions and contingency
plans for the Y2K issue are contained in certain of the Company's prior
filings with the Securities and Exchange Commission, including its Quarterly
Report on Form 10-Q for the quarter ended September 30, 1999.
The Y2K issue has not had, and is not expected to have, any material
adverse effect on the Company. In 1998 and 1999 the Company formulated and
implemented a Year 2000 Plan to address the Company's Y2K issue. To date, the
Company's computer systems and manufacturing facilities have operated without
any significant Year 2000 problems and appear to be Year 2000 compliant. The
Company is not aware that any of its major third party suppliers have
experienced any significant Year 2000 problems. The Company currently does
not expect any significant future disruptions in its operations as a result
of the Y2K issue. Nevertheless, since it is impossible to predict all future
outcomes, there could be circumstances in which the Company could be
adversely affected.
The total cost associated with the assessment and required modifications
to implement the Company's Year 2000 Plan to date has not been material to
the Company's financial position or results of operations. The Company does
not expect to incur any significant future expenses related to the Y2K issue.
The total amount expended on the Year 2000 plan through December 1999 was
$2.7 million, of which approximately $1.2 million related to repair or
replacement of software and related hardware problems and approximately $1.5
million related to internal and external labor costs.
EURO CURRENCY
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 have the option
of 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 until 2002 when their local
currencies will be phased out. The current version of the Company's
enterprise-wide business system does not support transactions denominated in
euro. During 2000, the Company intends to upgrade its business system. The
upgraded version of this business system should support transactions
denominated in euro. The Company intends to enable the euro functionality of
its upgraded system no later than its third quarter in 2001. Until such time
as the upgrade has occurred and the euro functionality has been enabled,
transactions denominated in euro will be processed manually. To date, the
Company has not experienced, and does not anticipate in the near future, a
large demand from its customers to transact in euro. 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.
MARKET RISK
The Company is exposed to the impact of foreign currency fluctuations due to
its international operations and certain export sales. The Company is exposed
to both transactional currency/functional currency and functional
currency/reporting currency exchange rate risks. In the normal course of
business, the Company employs established policies and procedures to manage
its exposure to fluctuations in the value of foreign currencies. Pursuant to
its foreign exchange hedging policy, beginning in January 1999, the Company
may use forward foreign currency exchange rate contracts to hedge certain
firm commitments and the related receivables and payables with its foreign
subsidiaries. During 1999, the Company entered into such contracts on behalf
of two of its wholly-owned subsidiaries, Callaway Golf Europe Ltd. and
Callaway Golf Canada Ltd. The Company also hedged certain yen-denominated
transactions with its Japanese distributor. The effect of this practice is to
minimize variability in the Company's operating results arising from foreign
exchange rate movements. These foreign exchange contracts generally 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 transactions being
hedged, and the Company does not engage in hedging contracts which exceed the
amounts of these transactions.
Also pursuant to its foreign exchange hedging policy, the Company expects
that it also may hedge anticipated transactions denominated in foreign
currencies using forward foreign currency exchange rate contracts and put or
call options. Foreign currency derivatives will be used only to the extent
considered necessary to meet the Company's objectives and the Company does
not enter into forward contracts for speculative purposes. The Company's
foreign currency exposures include most European currencies, Japanese yen,
Canadian dollars and Korean won.
Additionally, the Company is exposed to interest rate risk from its
Accounts Receivable Facility and Amended Credit Agreement (see Notes 4 and 5
to the Company's Consolidated Financial Statements) which are indexed to the
London Interbank Offering Rate ("LIBOR") and Redwood Receivables Corporation
Commercial Paper Rate. No amounts were outstanding or advanced under these
facilities at December 31, 1999.
Sensitivity analysis is the measurement of potential loss in future
earnings of market sensitive instruments resulting from one or more selected
hypothetical changes in interest rates or foreign currency values. The
Company used a sensitivity analysis model to quantify the estimated potential
effect of unfavorable movements of 10% in foreign currencies to which the
Company was exposed at December 31, 1999 through its derivative financial
instruments.
The sensitivity analysis model is a risk analysis tool and does not
purport to represent actual losses in earnings that will be incurred by the
Company, nor does it consider the potential effect of favorable changes in
market rates. It also does not represent the maximum possible loss that may
occur. Actual future gains and losses will differ from those estimated
because of changes or differences in market rates and interrelationships,
hedging instruments and hedge percentages, timing and other factors.
The estimated maximum one-day loss in earnings from the Company's foreign-
currency derivative financial instruments, calculated using the sensitivity
analysis model described above, is $112,000 at December 31, 1999. The Company
believes that such a hypothetical loss from its derivatives would be offset
by increases in the value of the underlying transactions being hedged.
Notes 4 and 5 to the Consolidated Financial Statements outline the
principal amounts, and other terms required to evaluate the expected cash
flows and sensitivity to interest rate changes.
CONSOLIDATED BALANCE SHEET
(in thousands, except share and per share data) December 31,
1999 1998
- --------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 112,602 $ 45,618
Accounts receivable, net 54,252 73,466
Inventories, net 97,938 149,192
Deferred taxes 32,558 51,029
Other current assets 13,122 4,301
- --------------------------------------------------------------------------------------------------------
Total current assets 310,472 323,606
Property, plant and equipment, net 142,214 172,794
Intangible assets, net 120,143 127,779
Other assets 43,954 31,648
- --------------------------------------------------------------------------------------------------------
$ 616,783 $ 655,827
========================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 46,664 $ 35,928
Accrued employee compensation and benefits 21,126 11,083
Accrued warranty expense 36,105 35,815
Line of credit 70,919
Note payable 12,971
Accrued restructuring costs 1,379 7,389
Income taxes payable 9,903
- --------------------------------------------------------------------------------------------------------
Total current liabilities 105,274 184,008
Long-term liabilities:
Deferred compensation 11,575 7,606
Accrued restructuring costs 11,117
Commitments and contingencies (Note 11)
Shareholders' equity:
Preferred Stock, $.01 par value, 3,000,000 shares authorized, none issued and
outstanding at December 31, 1999 and 1998
Common Stock, $.01 par value, 240,000,000 shares authorized, 76,302,196 and
75,095,087 issued and outstanding
at December 31, 1999 and 1998 763 751
Paid-in capital 307,329 258,015
Unearned compensation (2,784) (5,653)
Retained earnings 288,090 252,528
Accumulated other comprehensive income 280 1,780
Less: Grantor Stock Trust (5,300,000 shares at December 31, 1999
and 1998) at market (Note 6) (93,744) (54,325)
- --------------------------------------------------------------------------------------------------------
Total shareholders' equity 499,934 453,096
- --------------------------------------------------------------------------------------------------------
$ 616,783 $ 655,827
========================================================================================================
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data) Year ended December 31,
1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
Net sales $ 714,471 100% $ 697,621 100% $ 842,927 100%
Cost of goods sold 376,405 53% 401,607 58% 400,127 47%
- ----------------------------------------------------------------------------------------------------------------------
Gross profit 338,066 47% 296,014 42% 442,800 53%
Selling expenses 131,858 18% 147,022 21% 120,589 14%
General and administrative expenses 92,478 13% 98,048 14% 70,724 8%
Research and development costs 34,002 5% 36,848 5% 30,298 4%
Restructuring costs (Note 12) (5,894) (1%) 54,235 8%
Sumitomo transition costs (Note 15) 5,713 1%
Litigation settlement 12,000 1%
- ----------------------------------------------------------------------------------------------------------------------
Income (loss) from operations 79,909 11% (40,139) (6%) 209,189 25%
Interest and other income, net (Note 9) 9,182 3,911 4,586
Interest expense (3,594) (2,671) (10)
- ----------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 85,497 12% (38,899) (6%) 213,765 25%
Income tax provision (benefit) 30,175 (12,335) 81,061
- ----------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 55,322 8% ($ 26,564) (4%) $ 132,704 16%
======================================================================================================================
Earnings (loss) per common share:
Basic $ 0.79 ($ 0.38) $ 1.94
Diluted $ 0.78 ($ 0.38) $ 1.85
Common equivalent shares:
Basic 70,397 69,463 68,407
Diluted 71,214 69,463 71,698
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands) Year ended December 31,
1999 1998 1997
- -------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $ 55,322 ($ 26,564) $ 132,704
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 39,877 35,885 19,408
Non-cash compensation 1,390 2,887 2,041
Tax benefit from exercise of stock options 2,377 3,068 29,786
Deferred taxes 9,971 (36,235) 1,030
Non-cash restructuring costs (8,609) 25,497
Loss on disposal of assets 315 1,298 2
Changes in assets and liabilities, net of effects
from acquisitions:
Accounts receivable, net 19,690 51,575 (36,936)
Inventories, net 51,092 (42,665) 6,271
Other assets (12,966) (12,149) (6,818)
Accounts payable and accrued expenses 12,225 (4,357) 13,529
Accrued employee compensation and benefits 9,875 (3,411) (2,437)
Accrued warranty expense 286 7,760 756
Income taxes payable (10,001) 9,652 (2,636)
Accrued restructuring costs (3,476) 7,389
Deferred compensation 3,969 (299) 2,796
Accrued restructuring costs - long-term (5,041) 11,117
- -------------------------------------------------------------------------------------------
Net cash provided by operating activities 166,296 30,448 159,496
- -------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (56,244) (67,859) (67,938)
Acquisitions, net of cash acquired (2,389) (10,672) (129,256)
Proceeds from sale of assets 5,095 3,417 72
- -------------------------------------------------------------------------------------------
Net cash used in investing activities (53,538) (75,114) (197,122)
- -------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net (payments on) proceeds from line of credit (70,919) 70,919
Proceeds from note payable 35,761 12,971
Short-term debt retirement (10,373)
Issuance of Common Stock 9,009 10,343 27,530
Retirement of Common Stock (917) (52,985)
Dividends paid, net (19,760) (19,485) (19,123)
- -------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (45,909) 63,458 (44,578)
- -------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 135 622 (49)
- -------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 66,984 19,414 (82,253)
Cash and cash equivalents at beginning of year 45,618 26,204 108,457
- -------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 112,602 $ 45,618 $ 26,204
===========================================================================================
Supplemental disclosures:
Non-cash financing (Note 4) $ 48,732
Cash paid for interest and fees $ 3,637 $ 2,162 $ 10
Cash paid for income taxes $ 30,670 $ 8,165 $ 54,358
- -------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands)
Accumulated Current
Common Stock Other Year's
------------------ Paid-In Unearned Retained Comprehensive Comprehensive
Shares Amount Capital Compensation Earnings Income GST Total Income
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 72,855 $729 $278,669 $(3,105) $ 238,113 $ 236 $(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
Adjustment of GSTshares to
market value (1,060) 1,060
Equity adjustment from foreign
currency translation (795) (795) $ (795)
Net income 132,704 132,704 132,704
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 74,252 743 337,403 (3,575) 298,728 (559) (151,315) 481,425 $ 131,909
- ----------------------------------------------------------------------------------------------------------------------------------
Exercise of stock options 391 4 4,433 4,437
Tax benefit from exercise of
stock options 3,068 3,068
Issuance of Restricted
Common Stock 130 1 4,029 (4,030)
Cancellation of Restricted
Common Stock (19) (597) 597
Compensatory stock and
stock options 1,532 1,355 2,887
Employee stock purchase plan 386 4 5,902 5,906
Stock retirement (45) (1) (765) (151) (917)
Cash dividends (20,969) (20,969)
Dividends on shares held by GST 1,484 1,484
Adjustment of GSTshares to
market value (96,990) 96,990
Equity adjustment from foreign
currency translation 2,339 2,339 $ 2,339
Net loss (26,564) (26,564) (26,564)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 75,095 751 258,015 (5,653) 252,528 1,780 (54,325) 453,096 $ (24,225)
- ----------------------------------------------------------------------------------------------------------------------------------
Exercise of stock options 851 8 5,362 5,370
Tax benefit from exercise of
stock options 2,377 2,377
Cancellation of Restricted
Common Stock (22) (684) 684
Compensatory stock and
stock options (795) 2,185 1,390
Employee stock purchase plan 378 4 3,635 3,639
Cash dividends (21,244) (21,244)
Dividends on shares held by GST 1,484 1,484
Adjustment of GSTshares to
market value 39,419 (39,419)
Equity adjustment from foreign
currency translation (1,500) (1,500) $ (1,500)
Net income 55,322 55,322 55,322
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 76,302 $763 $307,329 $(2,784) $288,090 $ 280 $(93,744) $499,934 $ 53,822
- ----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1
THE COMPANY
- --------------------------------------------------------------------------------
Callaway Golf Company ("Callaway Golf" or the "Company") was incorporated in
California in 1982 and was reincorporated in Delaware in 1999. The Company
designs, develops, manufactures and markets high-quality, innovative golf
clubs. Callaway Golf's primary products for the periods presented include
Great Big Bertha(R) Hawk Eye(R) Titanium Metal Woods, Big Bertha(R)
Steelhead(TM) Metal Woods, Biggest Big Bertha(R) Titanium Drivers, Great Big
Bertha(R) Titanium Metal Woods, Big Bertha(R) Metal Woods with the War
Bird(R) soleplate, Great Big Bertha(R) Tungsten Injected(TM) Titanium Irons,
Big Bertha(R) X-12(R) Irons, Great Big Bertha(R) Tungsten.Titanium(TM) Irons,
Big Bertha(R) Irons, Odyssey(R) putters and wedges and various other putters.
NOTE 2
SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements for the periods presented include the
accounts of the Company and its subsidiaries, Callaway Golf Sales Company,
Golf Funding Corporation ("Golf Funding"), Callaway Golf Ball Company,
Odyssey Golf, Inc. ("Odyssey"), CGV, Inc., All-American Golf LLC
("All-American"), Callaway Golf Media Ventures ("CGMV"), Callaway Golf Europe
Ltd., Callaway Golf Europe, S.A., Callaway Golf K.K. (formerly named ERC
International Company), Callaway Golf (Germany) GmbH, Callaway Golf Canada
Ltd. and Callaway Golf Korea, Ltd.. All significant intercompany transactions
and balances have been eliminated. The Company sold the business
ofAll-American in 1998 and its interest in CGMV in March 1999 (Note 14).
Callaway Golf Europe, S.A. was merged with Callaway Golf Europe Ltd. in 1999
(Note 14).
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.
Examples of such estimates include provisions for warranty, uncollectible
accounts receivable, inventory obsolescence and restructuring costs (Note
12). Actual results could differ from those estimates, which could materially
affect future results of operations.
REVENUE RECOGNITION
Sales are recognized at the time goods are shipped, net of an allowance for
sales returns.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist of cash and cash equivalents,
trade receivables and payables, forward foreign currency exchange contracts,
its revolving line of credit and note payable (Note 4) and its accounts
receivable securitiza-tion facility (Note 5). The carrying amounts of these
instruments approximate fair value because of their short maturities and
variable interest rates.
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 1999, 1998 and 1997 were $26,202,000,
$32,944,000 and $20,320,000 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 accumulated other comprehensive
income in 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
operations. The Company recorded transaction losses of $793,000 in 1999,
transaction gains of $1,598,000 in 1998 and transaction losses of $940,000 in
1997.
During 1999, 1998 and 1997, the Company entered into forward foreign
currency exchange rate contracts to hedge payments due on intercompany
transactions by certain of its wholly-owned foreign subsidiaries. The Company
also hedged certain yen-denominated transactions with its Japanese
distributor. 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 generally 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 intercom-pany transactions being hedged, and the
Company does not engage in hedging contracts which exceed the amount of the
intercompany transactions. At December 31, 1999, 1998 and 1997, the Company
had approximately $7,117,000, $11,543,000 and $2,575,000, respectively, of
foreign exchange contracts outstanding. The contracts outstanding at
December 31, 1999 mature between January and June of 2000. The Company had
net realized and unrealized gains on foreign exchange contracts of $358,000,
$57,000 and $261,000 in 1999, 1998 and 1997, respectively.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement establishes
accounting and reporting standards for derivative instruments and hedging
activities and requires that an entity recognize all derivatives as either
assets or liabilities in the balance sheet and measure those instruments at
fair value. Changes in the fair value of derivatives are recorded each period
in income or other comprehensive income, depending on whether the derivatives
are designated as hedges and, if so, the types of hedges. SFAS No. 133 is
effective for all periods beginning after June 15, 2000; the Company elected
to adopt early SFAS No. 133 on January 1, 1999.
Adoption of this statement did not significantly affect the way in which
the Company currently accounts for derivatives to hedge payments due on
intercompany transactions, as described above. Accordingly, no cumulative
effect adjustments were made. However, the Company expects that it also may
hedge anticipated transactions denominated in foreign currencies using
forward foreign currency exchange rate contracts and put or call options. The
forward contracts used to hedge anticipated transactions will be recorded as
either assets or liabilities in the balance sheet at fair value. Gains and
losses on such contracts will be recorded in other comprehensive income and
will be recorded in income when the anticipated transactions occur. The
ineffective portion of all hedges will be recognized in current period
earnings.
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 6), options issued pursuant to the Company's stock option plans
(Note 8), potential shares related to the Employee Stock Purchase Plan (Note
8) and rights to purchase preferred shares under the Callaway Golf Company
Shareholder Rights Plan (Note 8). 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 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. A reconciliation of the numerators and
denominators of the basic and diluted earnings per common share calculations
for the years ended December 31, 1999, 1998 and 1997 is presented in Note 7.
CASH EQUIVALENTS
Cash equivalents are highly liquid investments purchased with maturities of
three months or less.
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 two to 30 years. The Company's property, plant and
equipment generally are depreciated over the following periods:
------------------------------------------------------------
Buildings and improvements 10-30 years
Machinery and equipment 5-15 years
Furniture, computers and equipment 3-5 years
Production molds 2 years
------------------------------------------------------------
Normal repairs and maintenance are expensed as incurred. Expenditures that
materially increase values, change capacities or extend useful lives are
capitalized. Replacements are capitalized and the property, plant, and
equipment accounts are relieved of the items being replaced. The related
costs and accumulated depreciation of disposed assets are eliminated and any
resulting gain or loss on disposition is included in income.
The Company capitalizes certain software development and implementation
costs. Development and implementation costs are expensed until management has
determined that the software will result in probable future economic benefit
and management has committed to funding the project. Thereafter, all direct
external implementation costs, as well as purchased software costs, are
capitalized and amortized using the straight-line method over the remaining
estimated useful lives, not exceeding five years.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
LONG-LIVED ASSETS
The Company assesses potential impairments of 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. During the fourth quarter of 1998, the
Company implemented a restructuring plan that included a number of cost
reduction actions and operational improvements (Note 12). As a result of this
plan, impairment losses were recorded in 1998 for certain of the Company's
long-lived assets.
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. and goodwill
associated with the purchase of certain foreign distributors (Note 14).
Intangible assets are amortized using the straight-line method over periods
ranging from three to 40 years. During 1999, 1998 and 1997, amortization of
intangible assets was $7,476,000, $5,466,000 and $1,778,000 respectively.
STOCK-BASED COMPENSATION
The Company measures compensation expense for its stock-based employee
compensation awards using the intrinsic value method. Pro forma disclosures
of net income and earnings per share, as if the fair value-based method had
been applied in measuring compensation expense, are presented in Note 8.
Compensation expense for non-employee stock-based compensation awards is
measured using the fair-value method.
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 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.
Deferred taxes have not been provided on the cumulative undistributed
earnings of foreign subsidiaries since such amounts are expected to be
reinvested indefinitely. The Company provides a valuation allowance for its
deferred tax assets when, in the opinion of management, it is more likely
than not that such assets will not be realized.
COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income," 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.
Since the Company has met the indefinite reversal criterion, it does not
accrue income taxes on foreign currency translation adjustments.
SEGMENT INFORMATION
In 1998, the Company adopted SFAS No. 131, "Diclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise," replacing the
industry segment approach with the management approach. The management
approach designates the international organization that is used by management
for making operating decisions and assessing performance as the source of the
Company's reportable segments. SFAS No. 131 also requires disclosures about
products and services, geographic areas and major customers. The adoption of
this standard did not affect the Company's results of operations, financial
position or cash flows. This information is presented in Note 15.
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 may invest 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. During 1999 and 1998, no investments in
U.S. Government securities were held.
The Company operates in the golf equipment industry and primarily sells
its products to golf equipment retailers and foreign distributors. The
Company performs ongoing credit evaluations of its customers'financial
condition and generally requires no collateral from these customers. The
Company maintains reserves for potential credit losses, which it considers
adequate to cover any such losses.
During 1999, 1998, and 1997, approximately 42%, 38% and 35%, respectively,
of the Company's net sales were made to foreign customers. An adverse change
in either economic conditions abroad or the Company's relationship with
significant distributors could negatively impact the volume of the Company's
international sales and the Company's results of operations, cash flows and
financial position.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform with the
current period presentation.
NOTE 3
SELECTED FINANCIAL STATEMENT INFORMATION
- --------------------------------------------------------------------------------
(in thousands) December 31,
1999 1998
- --------------------------------------------------------------------------------
Cash and cash equivalents:
Cash, interest bearing $ 110,157 $ 41,689
Cash, non-interest bearing 2,445 3,929
- --------------------------------------------------------------------------------
$ 112,602 $ 45,618
================================================================================
Accounts receivable, net:
Trade accounts receivable $ 59,543 $ 83,405
Allowance for doubtful accounts (5,291) (9,939)
- --------------------------------------------------------------------------------
$ 54,252 $ 73,466
================================================================================
Inventories, net:
Raw materials $ 45,868 $ 102,352
Work-in-process 1,403 1,820
Finished goods 65,661 81,868
- --------------------------------------------------------------------------------
112,932 186,040
Reserve for obsolescence (14,994) (36,848)
- --------------------------------------------------------------------------------
$ 97,938 $ 149,192
================================================================================
Property, plant and equipment, net:
Land $ 12,358 $ 13,375
Buildings and improvements 87,910 55,307
Machinery and equipment 50,942 57,334
Furniture, computers and equipment 64,334 55,629
Production molds 22,714 17,472
Construction-in-process 5,032 52,920
- --------------------------------------------------------------------------------
243,290 252,037
Accumulated depreciation (101,076) (79,243)
- --------------------------------------------------------------------------------
$ 142,214 $ 172,794
================================================================================
Intangible assets:
Trade name $ 69,629 $ 69,629
Trademark and trade dress 29,841 29,841
Patents, goodwill and other 34,911 35,765
- --------------------------------------------------------------------------------
134,381 135,235
Accumulated amortization (14,238) (7,456)
- --------------------------------------------------------------------------------
$ 120,143 $ 127,779
================================================================================
Accounts payable and accrued expenses:
Accounts payable $ 11,297 $ 10,341
Note to related party (Note 16) 6,766
Accrued expenses 35,367 18,821
- --------------------------------------------------------------------------------
$ 46,664 $ 35,928
================================================================================
Accrued employee compensation and benefits:
Accrued payroll and taxes $ 15,303 $ 6,178
Accrued vacation and sick pay 4,571 4,423
Accrued commissions 1,252 482
- --------------------------------------------------------------------------------
$ 21,126 $ 11,083
================================================================================
NOTE 4
BANK LINE OF CREDIT AND NOTE PAYABLE
- --------------------------------------------------------------------------------
On February 12, 1999, the Company consummated the amendment of its credit
facility to increase the facility to up to $120,000,000 (the "Amended Credit
Agreement"). The Amended Credit Agreement has a five-year term and is secured
by substantially all of the assets of the Company. The Amended Credit
Agreement bears interest at the Company's election at the London Interbank
Offering Rate ("LIBOR") plus a margin or the higher of the base rate on
corporate loans at large U.S. money center commercial banks (prime rate) or
the Federal Funds Rate plus 50 basis points. The line of credit requires the
Company to maintain certain minimum financial ratios, including a fixed
charge coverage ratio, as well as other restrictive covenants. As of December
31, 1999, up to $115,739,000 of the credit facility remained available for
borrowings (including a reduction of $4,261,000 for outstanding letters of
credit), subject to meeting certain availability requirements under a
borrowing base formula and other limitations.
On December 30, 1998, Callaway Golf Ball Company, a wholly-owned
subsidiary of the Company, entered into a master lease agreement for the
acquisition and lease of up to $56,000,000 of machinery and equipment. As of
December 31, 1999, the Company had finalized its lease program and leased
$50,000,000 of equipment pursuant to the master lease agreement. This lease
program includes a interim finance agreement (the "Finance Agreement"). The
Finance Agreement provides pre-lease financing advances for the acquisition
and installation costs of the aforementioned machinery and equipment. The
Finance Agreement bears interest at LIBOR plus a margin and is secured by the
underlying machinery and equipment and a corporate guarantee from the
Company. During the third and fourth quarters of 1999, the Company converted
the balance of this note payable to the operating lease discussed above. As
of December 31, 1999, no amount was outstanding under this facility.
NOTE 5
ACCOUNTS RECEIVABLE SECURITIZATION
- --------------------------------------------------------------------------------
The Company's wholly-owned subsidiary, Callaway Golf Sales Company, sells
trade receivables on an ongoing basis to its wholly-owned subsidiary, Golf
Funding. Pursuant to an agreement effective February 12, 1999 with a
securitization company (the "Accounts Receivable Facility"), Golf Funding, in
turn, sells such receivables to the securitization company on an ongoing
basis, which yields proceeds of up to $80.0 million at any point in time.
Golf Funding's sole business is the purchase of trade receivables from
Callaway Golf Sales Company. Golf Funding is a separate corporate entity with
its own separate creditors, which in the event of its liquidation will be
entitled to be satisfied out of Golf Funding's assets prior to any value in
Golf Funding becoming available to the Company. The Accounts Receivable
Facility expires in February 2004.
Under the Accounts Receivable Facility, the receivables are sold at face
value with payment of a portion of the purchase price being deferred. As of
December 31, 1999, no amount was outstanding under the Accounts Receivable
Facility. Fees incurred in connection with the sale of accounts receivable
for year ended December 31, 1999 were $923,000 and were recorded as interest
expense.
NOTE 6
GRANTOR STOCK TRUST
- --------------------------------------------------------------------------------
In July 1995, the Company established the Callaway Golf Company Grantor Stock
Trust (the "GST"). In conjunction with the formation of the GST, the Company
sold 4,000,000 shares of newly issued Common Stock to the GSTat 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 GSTat 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 GSTmay 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 GSTbalance reflected in capital in excess
of par value.
NOTE 7
EARNINGS PER COMMON SHARE
- --------------------------------------------------------------------------------
The schedule below summarizes the elements included in the calculation of
basic and diluted earnings (loss) per common share for the years ended
December 31, 1999, 1998 and 1997.
For the years ended December 31, 1999 and 1997, 10,979,000 and 917,000
options, respectively, were excluded from the calculations, as their effect
would have been antidilutive. For the year ended December 31, 1998, all
dilutive securities were excluded from the calculation of diluted loss per
share, as their effect would have been antidulutive.
(in thousands, except per share data) Year ended December 31,
1999 1998 1997
- --------------------------------------------------------------------------------
Net income (loss) $55,322 ($26,564) $132,704
================================================================================
Weighted-average shares outstanding:
Weighted-average shares outstanding - Basic 70,397 69,463 68,407
Dilutive securities 817 3,291
- --------------------------------------------------------------------------------
Weighted-average shares outstanding - Diluted 71,214 69,463 71,698
================================================================================
Earnings (loss) per common share:
Basic $ 0.79 ($ 0.38) $ 1.94
Diluted $ 0.78 ($ 0.38) $ 1.85
- --------------------------------------------------------------------------------
NOTE 8
STOCK OPTIONS AND RIGHTS
- --------------------------------------------------------------------------------
The Company had the following fixed stock option plans, under which shares
were available for grant at December 31, 1999: the 1991 Stock Incentive Plan
(the "1991 Plan"), the 1995 Employee Stock Incentive Plan (the "1995 Plan"),
the 1996 Stock Option Plan (the "1996 Plan"), the 1998 Stock Incentive Plan
(the "1998 Plan"), the Promotion, Marketing and Endorsement Stock Incentive
Plan (the "Promotion Plan") and the Non-Employee Directors Stock Option Plan
(the "Directors Plan").
The 1991 Plan, the 1996 Plan and the 1998 Plan permit the granting of
options or other stock awards to the Company's officers, employees and
consultants. Under the 1991 Plan, option prices may be less than the market
value at the date of grant, while under the 1996 Plan and the 1998 Plan
options may not be granted at option prices that are less than fair market
value at the date of grant. The 1995 Plan permits the granting of options or
other stock awards to only employees and consultants of the Company at option
prices that may be less than market value at the date of grant. The 1995 Plan
was amended in 1999 to increase the maximum number of shares of Common Stock
to be issued upon exercise of an option to 7,100,000 shares.
During 1996 and 1995, the Company granted options to purchase shares to
two key officers, under separate plans, in conjunction with terms of their
initial employment (the "Key Officer Plans"). The 1990 Amended and Restated
Stock Option Plan (the "1990 Plan") permitted the granting of options to
officers, employees and consultants. No shares are available for grant under
the Key Officer Plans or the 1990 Plan.
Under the Promotion Plan, shares of Common Stock may be granted in the
form of options or other stock awards to golf professionals and other
endorsers at prices that may be less than the market value of the stock at
the grant date. The Directors Plan permits the granting of options to
purchase shares of Common Stock to Directors of the Company who are not
employees, at prices based on a non-discretionary formula, which may not be
less than the market value of the stock at the date of grant.
The following table presents shares authorized, available for future grant
and outstanding under each of the Company's plans as of December 31, 1999:
(in thousands)
Plan Authorized Available Outstanding
- --------------------------------------------------------------------------------
1990 Plan 4,920 100
1991 Plan 10,000 188 2,693
Promotion Plan 3,560 879 1,006
1995 Plan 7,100 1,647 5,249
1996 Plan 6,000 575 5,395
1998 Plan 500 500
Key Officer Plans 1,100 820
Directors Plan 840 64 484
- --------------------------------------------------------------------------------
Total 34,020 3,853 15,747
================================================================================
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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following summarizes stock option transactions for the years ended
December 31, 1999, 1998 and 1997:
(in thousands, except per share data) Year ended December 31,
1999 1998 1997
-----------------------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-----------------------------------------------------------------------------------------------------
Outstanding at beginning of year 13,637 $22.62 11,257 $22.41 10,800 $15.03
Granted 4,012 $11.30 4,020 $25.04 3,406 $33.79
Exercised (851) $ 6.40 (441) $10.16 (2,877) $ 7.81
Canceled (1,051) $24.95 (1,199) $34.86 (72) $28.81
-----------------------------------------------------------------------------------------------------
Outstanding at end of year 15,747 $20.46 13,637 $22.62 11,257 $22.41
Options exercisable at end of year 11,066 $18.64 6,039 $17.78 3,453 $12.17
-----------------------------------------------------------------------------------------------------
Price range of outstanding options $0.44-$40.00 $0.44-$40 $0.44-$40.00
=====================================================================================================
The following tables summarize additional information about outstanding
stock options at December 31, 1999 and options and other stock awards granted
during 1999:
OPTIONS OUTSTANDING AND EXERCISABLE BY PRICE RANGE AS OF DECEMBER 31, 1999:
Weighted-
Average Weighted-
Number Remaining Weighted- Average
Range of Outstanding Contractual Average Number Exercise Price
Exercise Prices (in thousands) Life-Years Exercise Price Exercisable (in thousands)
- ----------------------------------------------------------------------------------------
$0 - $10 762 2.21 $ 3.17 742 $ 3.01
$10 - $15 5,294 3.92 $11.54 4,841 $10.54
$15 - $25 2,642 4.75 $18.52 1,643 $18.75
$25 - $40 7,049 5.41 $29.75 3,840 $30.57
- ----------------------------------------------------------------------------------------
$0 - $40 15,747 4.64 $20.46 11,066 $18.64
========================================================================================
OPTIONS AND OTHER STOCK AWARDS GRANTED DURING 1999:
Weighted-
Number Average
(in thousands) Exercise Price
- -----------------------------------------------------------------------------
Exercise price = market value 3,921 $ 11.16
Exercise price (greater than) market value 80 $ 18.88
Exercise price (less than) market value 11 $ 8.56
- -----------------------------------------------------------------------------
4,012 $ 11.30
=============================================================================
During 1999, the Company, at its discretion, extended the expiration terms
of 1,532,000 options held by certain employees and officers. At the time of
modification, the exercise prices of the options were in excess of the then-
current market price and accordingly this action did not result in
compensation expense for the Company.
During 1998, the Company modified certain terms of 720,000 options held by
directors, certain officers and employees. These modifications, which largely
resulted from the Company's restructuring plan, included acceleration of
vesting and extension of expiration terms at the Company's discretion. At the
time of modification, the exercise prices of the options were in excess of
the then- current market price and accordingly this action did not result in
compensation expense for the Company.
Also during 1998, the Company canceled 150,000 options held by
non-employees 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 to these non- employees at the then-current market price and extended
certain expiration terms, and recorded the related compensation expense of
$71,000. An additional $195,000 was recorded in unearned compensation, and is
being amortized over the remaining vesting periods.
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. During 1998, 80,000 rights were exercised while none were
granted. No rights were granted or exercised during 1999 or 1997. At December
31, 1999, no rights to receive shares of Common Stock remained outstanding.
The Company has 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.
RESTRICTED COMMON STOCK
During 1998, the Company granted 130,000 shares of Restricted Common Stock to
26 officers of the Company. Of these shares, 41,250 shares have been canceled
due to the service requirement not being met. The shares, which are
restricted as to sale or transfer until vesting, will vest on January 1,
2003. The related net compensation expense of $2,751,000 is being recognized
ratably over the vesting period, based on the difference between the exercise
price and market value of the stock on the measurement date.
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 the 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 1999, 1998 and 1997, the ESPP purchased
approximately 378,000, 386,000 and 372,000 shares, respectively, of the
Company's Common Stock. As of December 31, 1999, 195,000 shares were reserved
for future issuance and will be purchased on the January 31, 2000 exercise
period, resulting in the termination of the ESPP.
In May 1999, the Company's shareholders approved a new ESPP(the "1999
ESPP") with substantially the same terms as the ESPP. There are 2,000,000
shares reserved for issuance under the 1999 ESPP. This plan will be effective
February 1, 2000 upon the termination of the ESPP.
COMPENSATION EXPENSE
During 1999, 1998, and 1997, the Company recorded $1,370,000, $2,321,000 and
$2,041,000, respectively, in compensation expense for Restricted Common Stock
and certain options to purchase shares of Common Stock granted to employees,
officers and consultants of the Company. The valuation of options 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. The unamortized portion of unearned compensation is shown as
a reduction of shareholders' equity in the accompanying consolidated balance
sheet.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PRO FORMA DISCLOSURES
If the Company had elected to recognize compensation expense based upon the
fair value at the grant date for employee awards under these plans, the
Company's net income (loss) and earnings (loss) per share would be changed to
the pro forma amounts indicated below:
(in thousands, except Year ended December 31,
per share data) 1999 1998 1997
------------------------------------------------------------------------------
Net income (loss):
As reported $ 55,322 ($26,564) $ 132,704
Pro forma $ 34,422 ($46,847) $ 124,978
Earnings (loss) per
common share:
As reported
Basic $ 0.79 ($0.38) $ 1.94
Diluted $ 0.78 ($0.38) $ 1.85
Pro forma
Basic $ 0.49 ($0.67) $ 1.83
Diluted $ 0.48 ($0.67) $ 1.77
==============================================================================
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 as the options vest 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 pricing model with the following
assumptions for the years ended December 31, 1999, 1998, and 1997,
respectively:
Year ended December 31,
1999 1998 1997
------------------------------------------------------------------------------
Dividend yield 1.4% 1.9% 0.9%
Expected volatility 45.6% 42.0% 31.5%
Risk free interest rates 5.36%-6.24% 4.66-4.72% 5.64-5.89%
Expected lives 3-4 years 3-6 years 3-6 years
==============================================================================
The weighted-average grant-date fair value of options granted during 1999
was $3.57 per share. 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 9
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. Employees contributed to
the 401(k) Plan $5,486,000, $5,601,000 and $5,384,000 in 1999, 1998 and 1997,
respectively. In accordance with the provisions of the 401(k) Plan, the
Company matched employee contributions in the amount of $4,510,000,
$4,673,000 and $4,495,000 during 1999, 1998 and 1997, respectively.
Additionally, the Company can make discretionary contributions based on the
profitability of the Company. For the year ended December 31, 1999, the
Company recorded compensation expense for discretionary contributions of
$3,605,000. No discretionary contributions were made for the years ended
December 31, 1998 and 1997.
The Company also has an unfunded, nonqualified deferred compensation plan.
The plan allows officers, certain other employees and directors 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, 1999, 1998 and
1997, the total participant deferrals, which are reflected in long-term
liabilities, were $997,000, $908,000 and $1,166,000, respectively. Included
in other income during 1999 were net proceeds from an insurance policy
related to the deferred compensation plan of $3,622,000.
NOTE 10
INCOME TAXES
- --------------------------------------------------------------------------------
The Company's income (loss) before income tax provision (benefit) was subject
to taxes in the following jurisdictions for the following periods:
(in thousands) Year ended December 31,
1999 1998 1997
------------------------------------------------------------------------------
Domestic $ 75,799 ($ 34,555) $ 212,453
Foreign 9,698 (4,344) 1,312
------------------------------------------------------------------------------
$ 85,497 ($ 38,899) $ 213,765
==============================================================================
The provision (benefit) for income taxes is as follows:
(in thousands) Year ended December 31,
1999 1998 1997
- --------------------------------------------------------------------------------
Current tax provision (benefit):
United States $ 14,779 $ 21,345 $ 66,462
State 2,774 2,296 12,419
Foreign 3,044 250 1,150
Deferred tax expense (benefit):
United States 8,956 (31,173) 1,042
State 1,162 (4,847) 50
Foreign (540) (206) (62)
- --------------------------------------------------------------------------------
Income tax provision (benefit) $ 30,175 ($12,335) $ 81,061
================================================================================
During 1999, 1998 and 1997, the Company recognized certain tax benefits
related to stock option plans in the amount of $2,377,000, $3,068,000 and
$29,786,000 respectively. Such benefits were recorded as a reduction of
income taxes payable and an increase in additional paid-in capital.
Significant components of the Company's deferred tax assets and
liabilities as of December 31, 1999 and 1998 are as follows:
(in thousands) December 31,
1999 1998
- --------------------------------------------------------------------------------
Deferred tax assets:
Reserves and allowances $ 28,052 $ 36,229
Depreciation and amortization 16,601 7,963
Deferred compensation 4,678 3,100
Effect of inventory overhead adjustment 1,977 4,062
Compensatory stock options and rights 2,573 2,327
Foreign net operating loss carryforwards 798 1,074
Other 2,773 3,979
Restructuring charges
Long-lived asset impairment 1,740 1,755
Rental/lease arrangements 557 5,472
Estimated losses on assets held
for disposal 4,335
Capital loss carryforward 829 685
Other 52
Tax credit carryforwards 2,827
- --------------------------------------------------------------------------------
Total deferred tax assets 63,405 71,033
Valuation allowance for deferred
tax assets (4,190) (1,759)
- --------------------------------------------------------------------------------
Deferred tax assets, net of valuation
allowance 59,215 69,274
Deferred tax liabilities:
State taxes, net of federal income
tax benefit (2,128) (2,608)
- -------------------------------------------------------------------------------
Net deferred tax assets $ 57,087 $ 66,666
===============================================================================
At December 31, 1999, the Company had tax credit carry-forwards primarily
relating to state investment tax credits which have expiration dates
beginning with December 31, 2006.
A valuation allowance has been established due to the uncertainty of
realizing certain tax credits, carryforwards, and a portion of other deferred
tax assets. The valuation allowance was increased by $2,431,000 during 1999,
of which $2,073,000 was attributable to state research and investment tax
credits. Based on management's assessment, it is more likely than not that
all the net deferred tax assets will be realized through future earnings or
implementation of tax planning strategies.
A reconciliation of income taxes computed by applying the statutory U.S.
income tax rate to the Company's income (loss) before income taxes to the
income tax provision (benefit) is as follows:
(in thousands) Year ended December 31,
1999 1998 1997
------------------------------------------------------------------------------
Amounts computed at
statutory U.S. tax rate $ 29,924 ($13,615) $ 74,816
State income taxes, net
U.S. tax benefit 3,046 (1,501) 8,105
State tax credits, net of
U.S. tax benefit (2,075)
Nondeductible foreign losses (476) 1,226
Expenses with no tax benefit 814 1,064
Nondeductible capital losses 130 588
Foreign sales corporation
tax benefits (1,471) (236) (2,519)
Nontaxable insurance proceeds (1,408)
Change in tax valuation allowance 2,431
Other (740) 139 659
------------------------------------------------------------------------------
Income tax provision (benefit) $ 30,175 ($12,335) $ 81,061
==============================================================================
U.S. tax return examinations have been completed for the years through
1994. Management believes adequate provisions for income tax have been
recorded for all years.
NOTE 11
COMMITMENTS AND CONTINGENCIES
- --------------------------------------------------------------------------------
The Company and its subsidiaries, incident to their business activities, are
parties to a number of legal proceedings, lawsuits and other claims. Such
matters are subject to many uncertainties and outcomes are not predictable
with assurance. Consequently, management is unable to ascertain the ultimate
aggregate amount of monetary liability, amounts which may be covered by
insurance, or the financial impact with respect to these matters as of
December 31, 1999. However, management believes that the final resolution of
these matters, individually and in the aggregate, will not have
a material adverse effect upon the Company's annual consolidated financial
position, results of operations or cash flows.
The Company leases certain warehouse, distribution and office facilities,
as well as office and manufacturing equipment under operating leases. Lease
terms range from one to 10 years with options to renew at varying terms.
Callaway Golf Ball Company has guaranteed the residual value of equipment
leased pursuant to an operating lease which is subject to renewal. The
residual value guarantee, which approximates estimated fair market value of
the equipment at each option period, is reduced over time. Commitments for
minimum lease payments under non- cancelable operating leases having initial
or remaining non-cancelable terms in excess of one year as of December 31,
1999 are as follows:
(in thousands)
------------------------------------------------------------------------------
2000 $11,128
2001 9,755
2002 6,612
2003 1,972
2004 1,904
Thereafter 7,926
------------------------------------------------------------------------------
$39,297
==============================================================================
Future minimum lease payments have not been reduced by future minimum
sublease rentals of $2,207,000 under an operating lease. At December 31,
1999, the Company is contingently liable for $6,563,000 through February 2003
under an operating lease that was assigned to a third party (Note 12 ). Rent
expense for the years ended December 31, 1999, 1998 and 1997 was $2,315,000,
$17,654,000 and $1,760,000, respectively. Rent expense for 1999 does not
include a credit of $6,076,000 related to the reversal of a restructuring
reserve for excess lease costs (Note 12). Rent expense for 1998 includes
$13,466,000 in excess lease costs related to the Company's restructuring
activities (Note 12). The Company had no capital leases at December 31, 1999.
NOTE 12
RESTRUCTURING
- --------------------------------------------------------------------------------
During the fourth quarter of 1998, the Company recorded a restructuring
charge of $54,235,000 resulting from a number of cost reduction actions and
operational improvements. These actions included: the consolidation of the
operations of the Company's wholly-owned subsidiary, Odyssey, into the
operations of the Company while maintaining the distinct and separate
Odyssey(R) brand; the discontinuation, transfer or suspension of certain
initiatives not directly associated with the Company's core business, such as
the Company's involvement with interactive golf sites, golf book publishing,
new player development and a golf venue in Las Vegas; and the re-sizing of
the Company's core business to reflect current and expected business
conditions. These initiatives were completed during 1999, with the exception
of cash outlays related to the assignment of a lease obligation for a
facility in New York City that will continue through July 2000. The
restructuring charges (shown below in tabular format) primarily related to:
1) the elimination of job responsibilities, resulting in costs incurred for
employee severance; 2) the decision to exit certain non-core business
activities, resulting in losses on disposition of the Company's 80% interest
in CGMV (Note 14), a loss on the sale of the business of All-American (Note
14), as well as excess lease costs; and 3) consolidation of the Company's
continuing operations resulting in impairment of assets, losses on
disposition of assets and excess lease costs.
Employee reductions occurred in almost all areas of the Company, including
manufacturing, marketing, sales, and administrative areas. At December 31,
1998, the Company had reduced its non-temporary work force by approximately
750 positions. Although substantially all reductions occurred prior to
December 31, 1998, a small number of reductions occurred in the first quarter
of 1999.
During the restructuring, the Company consolidated its operations and sold
certain of its buildings, which housed a portion of its manufacturing and
research and development activities. Other write-downs were recorded during
1998 for idle assets, assets whose manner of use had changed significantly
and equipment replaced as a result of capital improvements. The impaired
assets included buildings, building improvements, and machinery and equipment
used in certain of the Company's manufacturing and research and development
activities.
The projected future cash flows from these assets were less than the
carrying values of the assets. The carrying values of the assets held for
sale and the assets to be held and used were reduced to their estimated fair
values based on independent appraisals of selling values and values of
similar assets sold, less costs to sell. In 1998, the Company recorded losses
from impairment of assets of $12,634,000, which were recorded as
restructuring costs. The Company completed the dispositions in 1999. At
December 31, 1998, subsequent to the write-down for impairments, the carrying
amount of the assets held for disposal and assets to be held and used was
$13,678,000 and $4,582,000, respectively. The Company continued to depreciate
the assets that were held and used but did not further depreciate the assets
held for disposition. The effect on depreciation for the year ended December
31, 1999 did not materially impact the Company's results of operations and
management does not expect this effect to materially impact future results of
operations.
Details of the one-time charge are as follows (in thousands):
Reserve Reserve
Cash/ One-Time Balance Balance
Non-Cash Charge Activity at 12/31/98 Activity(1) at 12/31/99
- ------------------------------------------------------------------------------------------------------------------------------------
ELIMINATION OF JOB RESPONSIBILITIES $11,664 $ 8,473 $ 3,191 $ 3,191
Severance packages Cash 11,603 8,412 3,191 3,191
Other Non-cash 61 61
EXITING CERTAIN NON-CORE BUSINESS ACTIVITIES $28,788 $12,015 $16,773 $15,394 $ 1,379
Loss on disposition of subsidiaries Non-cash 13,072 10,341 2,731 2,731(2)
Excess lease costs Cash 12,660 146 12,514 11,135 1,379
Contract cancellation fees Cash 2,700 1,504 1,196 1,196
Other Cash 356 24 332 332
CONSOLIDATION OF OPERATIONS $13,783 $ 2,846 $10,937 $10,937
Loss on impairment/disposition of assets Non-cash 12,364 2,730 9,634 9,634(3)
Excess lease costs Cash 806 4 802 802(4)
Other Cash 613 112 501 501
==================================================================================================================================
(1) Includes reversal of reserve totaling $8,609,000, as actual amounts
differed from estimates. Significant reversals are noted below in (2)
through(4)
(2) Includes reversal of $6,076,000 of reserve due to the assignment of lease
obligation at terms significantly more favorable than estimated at the
establishment of the reserve.
(3) Includes reversal of $1,470,000 of reserve related to disposition of two
buildings at higher sales prices than estimated. (4) Includes reversal of
$491,000 of reserve due to the sublease of a facility at terms more
favorable than estimated at the establishment of the reserve.
During 1999, the Company incurred charges of $1,295,000 on the disposition
of building improvements eliminated during the consolidation of manufacturing
operations, as well as other charges of $671,000. These charges did not meet
the criteria for accrual in 1998. Additionally, the Company incurred charges
of $749,000 related to asset dispositions and other restructuring activities
for which reserves were not established in 1998. Future cash outlays are
anticipated to be completed by July 2000.
NOTE 13
LITIGATION SETTLEMENT
- --------------------------------------------------------------------------------
In 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 filed suit against certain of its insurers and an insurance
agent seeking coverage for the costs of defending and settling the above
lawsuit (the "coverage litigation"). The insurers and the insurance agent
settled with the Company in 1998 for an amount that was not material. This
settlement was recorded in general and administrative expenses as a reduction
of legal fees.
NOTE 14
AQUISITIONS AND REORGANIZATIONS
- --------------------------------------------------------------------------------
During 1999, the Company acquired distribution rights and substantially all
of the assets from its distributor in Ireland for $810,000. Also in 1999, the
Company merged its subsidiary, Callaway Golf Europe, S.A., with another of
its subsidiaries, Callaway Golf Europe, Ltd. and now operates in France
through a satellite office. During 1998, the Company acquired distribution
rights and substantially all of the assets from its distributors in Korea,
Canada, France, Belgium, Norway and Denmark, as well as the remaining 20%
interest in Callaway Golf Trading GmbH (Note 16), the results of which are
consolidated in the results of Callaway Golf (Germany) GmbH. The aggregate
purchase price for these transactions was $27,229,000, excluding the
assumption and subsequent retirement of short-term debt
obligations of $10,373,000. The excess of the purchase price over net assets
acquired of $20,935,000 was allocated to goodwill and is being amortized over
estimated useful lives of three to 10 years. These acquisitions, along with
the acquisition of the remaining 80% interest in All-American (discussed
below) are not considered significant business combinations. Accordingly, pro
forma financial information is not presented.
In May 1998, the Company acquired for $4,526,000 the remaining 80%
interest in All-American, which operates a nine-hole golf course, performance
center, training facility and driving range located in Las Vegas, Nevada. On
December 30, 1998, as part of its business plan to discontinue certain
non-core business activities, the Company sold the business of All-American
in exchange for barter trade credits, which were recorded at the fair market
value of the asset exchanged. The Company recorded a loss on the disposition
of this business of $10,341,000 in December 1998 (Note 12).
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, 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 manufactured and marketed the Odyssey(R) line of putters and wedges
with Stronomic(R) and Lyconite(R) face inserts. During 1998, as part of its
restructuring plan, the operations of Odyssey were consolidated into that of
the Company, while maintaining the distinct and separate Odyssey(R) brand. In
1999, Odyssey was dissolved as a corporate entity and as a subsidiary.
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. Amounts allocated to
trade name, trademark, trade dress and goodwill are being amortized on the
straight-line basis over 40 years. The amounts allocated to the process
patent and covenant not to compete are being amortized on the straight- line
basis over 16 and three years, respectively.
The following unaudited pro forma net sales, net income and earnings per
share data for the year ended December 31, 1997 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 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 period specified, and do
not purport to represent what the Company's consolidated results of
operations might be for any future period.
(in thousands, except per share data) Year Ended
December 31,
1997
(unaudited)
----------------------------------------------------------------------
Net sales $884,840
----------------------------------------------------------------------
Net income $134,512
----------------------------------------------------------------------
Earnings per common share:
Basic $ 1.97
Diluted $ 1.88
======================================================================
NOTE 15
SEGMENT INFORMATION
- --------------------------------------------------------------------------------
The Company's operating segments are organized on the basis of products and
include golf clubs and golf balls. The Golf Clubs segment consists of
Callaway Golf(R) titanium and stainless steel metal woods and irons, Callaway
Golf(R) and Odyssey(R) putters and wedges, and sales of related accessories.
The Golf Balls segment consists of golf balls that are designed and
manufactured, and will be marketed and distributed by the Company's
wholly-owned subsidiary, Callaway Golf Ball Company. All Other segments,
including interactive golf sites, golf book publishing, new player
development and a driving range venture, are aggregated as they do not meet
requirements for separate disclosure set forth in SFAS No. 131. In accordance
with its restructuring plan, the Company is no longer pursuing these
initiatives (Note 12). There are no significant intersegment transactions.
The table below contains information utilized by management to evaluate its
operating segments.
(in thousands)
1999 Golf Clubs Golf Balls All Other Consolidated
-----------------------------------------------------------------------------------------------------------------
Net sales $ 714,471 $ 714,471
Income (loss) before tax 123,922 ($ 38,425) 85,497
Interest income 5,463 5,463
Interest expense (2,222) (1,372) (3,594)
Depreciation and amortization 36,151 3,726 39,877
Additions to long-lived assets 10,210 46,912(1) 57,122
=================================================================================================================
1998 Golf Clubs Golf Balls All Other Consolidated
-----------------------------------------------------------------------------------------------------------------
Net sales $ 697,621 $ 697,621
Income (loss) before tax 9,182 ($ 22,426) ($ 25,655) (38,899)
Interest income 1,564 7 1,571
Interest expense (2,252) (419) (2,671)
Depreciation and amortization 34,121 1,072 692 35,885
Additions to long-lived assets 39,854 47,721(1) 1,408 88,983
=================================================================================================================
1997 Golf Clubs Golf Balls All Other Consolidated
-----------------------------------------------------------------------------------------------------------------
Net sales $ 842,927 $ 842,927
Income (loss) before tax 222,771 ($ 9,013) $ 7 213,765
Interest income 4,703 4,703
Interest expense (10) (10)
Depreciation and amortization 19,219 84 105 19,408
Additions to long-lived assets 166,461 10,263 823 177,547
=================================================================================================================
(1) Includes an aggregate of $50,000,000 converted to an operating lease in
1999 (Note 4).
The Company markets its products domestically and internationally, with
its principal international markets being Asia and Europe. The table below
contains information about the geographical areas in which the Company
operates. Revenues are attributed to the location to which the product was
shipped. Long-lived assets are based on location of domicile.
The Company, through a distribution agreement, had appointed Sumitomo as
the sole distributor of Callaway Golf(R) clubs in Japan. The distribution
agreement, which began in February 1993 and ended on December 31, 1999,
required Sumitomo to purchase specified minimum quantities. In 1999, 1998,
and 1997, sales to Sumitomo accounted for 7%, 8% and 10%, respectively, of
the Company's net sales. In the fourth quarter of 1999, the Company
successfully completed negotiations with Sumitomo to provide a smooth
transition of its business. As a result of this transition agreement, the
Company recorded a net charge of $8.6 million in the fourth quarter of 1999
for buying certain current inventory, payments for non-current inventory and
other transition expenses, including foreign currency transaction losses.
Odyssey(R) brand products are sold through the Company's wholly-owned
Japanese subsidiary, Callaway Golf K.K., and beginning January 1, 2000,
Callaway Golf(R) brand products also will be sold through this subsidiary.
(In thousands)
1999 Sales Long-Lived Assets
------------------------------------------------------------------------------
United States $414,136 $241,241
Europe 115,673 14,027
Japan 55,928 2,634
Rest of Asia 73,121 974
Other foreign countries 55,613 3,481
------------------------------------------------------------------------------
Total $714,471 $262,357
==============================================================================
1998 Sales Long-Lived Assets
------------------------------------------------------------------------------
United States $437,627 $277,611
Europe 116,354 17,789
Japan 61,460 857
Rest of Asia 34,189 1,194
Other foreign countries 47,991 3,122
------------------------------------------------------------------------------
Total $697,621 $300,573
==============================================================================
1997 Sales Long-Lived Assets
------------------------------------------------------------------------------
United States $547,256 $250,548
Europe 108,659 4,035
Japan 84,634 61
Rest of Asia 54,029
Other foreign countries 48,349
------------------------------------------------------------------------------
Total $842,927 $254,644
==============================================================================
NOTE 16
TRANSACTIONS WITH RELATED PARTIES
- --------------------------------------------------------------------------------
During 1998, the Company entered into an agreement with Callaway Editions,
Inc. to form CGMV, a limited liability company that was owned 80% by the
Company and 20% by Callaway Editions, Inc. ("Callaway Editions"). Callaway
Editions is a publishing and media company which is owned 9% by Ely Callaway,
Chairman and Chief Executive Officer of the Company, and 81% by his son,
Nicholas Callaway. CGMV was formed to produce print and other media products
that relate to the game of golf. Pursuant to the agreement, the Company
agreed to loan CGMV up to $20,000,000 for working capital, subject to CGMV's
achievement of certain milestones to the satisfaction of the Company in its
sole discretion. Also pursuant to the agreement, CGMV was obligated to pay an
annual management fee of $450,000 to Callaway Editions. In conjunction with
the Company's restructuring plan, the Company committed to sell or assign its
interest in CGMV to Callaway Editions. Accordingly, the Company recorded a
charge in operations to December 1998 based on the December 31, 1998 book
value of CGMV (Note 12).
During 1999, the Company forgave the existing loan balance from CGMV of
approximately $2,142,000, sold its interest to Callaway Editions for a
nominal amount and paid $1,000,000 as consideration for release from its
obligation to loan CGMV up to $20,000,000. These transactions did not result
in a charge in 1999, as they were adequately accrued in the 1998
restructuring reserve (Note 12).
In December 1998, the Company purchased the remaining 20% interest in
Callaway Golf Trading GmbH, the Company's former German distributor, for
$6,766,000. The purchase price was in the form of a note payable bearing
interest at 7%, due in June 1999 to the seller, who is an officer of a
wholly-owned subsidiary of Company. The note payable was included in accounts
payable and accrued expenses at December 31, 1998 and was paid in February
1999.
REPORT OF INDEPENDENT ACCOUNTANTS
[LOGO 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 operations, 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, 1999 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States. 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 auditing standards generally
accepted in the United States, 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/ PRICEWATERHOUSECOOPERS LLP
San Diego, California
January 26, 2000
SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)
(in thousands, except per share data) Fiscal Year 1999 Quarters
1st 2nd 3rd 4th Total
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Net sales $185,744 $229,708 $183,335 $115,684 $714,471
Gross profit $ 83,520 $108,664 $ 89,896 $ 55,986 $338,066
Net income $ 12,823 $ 24,771 $ 17,572 $ 156 $ 55,322
Earnings per common share*
Basic $ 0.18 $ 0.35 $ 0.25 $ 0.00 $ 0.79
Diluted $ 0.18 $ 0.35 $ 0.25 $ 0.00 $ 0.78
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Fiscal Year 1998 Quarters
1st 2nd 3rd 4th Total
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Net sales $ 176,908 $ 233,251 $ 172,944 $ 114,518 $ 697,621
Gross profit $ 83,705 $ 108,790 $ 83,085 $ 20,434 $ 296,014
Net income(loss) $ 11,160 $ 21,137 $ 5,836 ($ 64,697) ($ 26,564)
Earnings(loss) per common share*
Basic $ 0.16 $ 0.30 $ 0.08 ($ 0.93) ($ 0.38)
Diluted $ 0.16 $ 0.30 $ 0.08 ($ 0.93) ($ 0.38)
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* Earnings per share is computed individually for each of the quarters
presented; therefore, the sum of the quarterly earnings per share may 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 March 6, 2000, the approximate number of holders of record of the
Company's Common Stock was 9,415.
STOCK PRICE INFORMATION
Year ended December 31,
1999 1998
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Period: High Low Dividend High Low Dividend
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First Quarter $11.44 $10.00 $0.07 $33.25 $26.50 $0.07
Second Quarter $16.69 $12.19 $0.07 $29.44 $17.94 $0.07
Third Quarter $14.63 $ 9.31 $0.07 $20.50 $ 9.56 $0.07
Fourth Quarter $18.00 $11.69 $0.07 $13.56 $ 9.81 $0.07
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