<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
-----
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
----- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-10962
CALLAWAY GOLF COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 95-3797580
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2285 RUTHERFORD ROAD, CARLSBAD, CA 92008-8815
(760) 931-1771
(Address, including zip code and telephone number, including area code, of
principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
The number of shares outstanding of the Registrant's Common Stock, $.01
par value, as of October 31, 1999 was 76,072,724.
<PAGE>
CALLAWAY GOLF COMPANY
INDEX
Page
Part I. Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheet at
September 30, 1999 and December 31, 1998 2
Consolidated Condensed Statement of Operations
for the three and nine months ended
September 30, 1999 and 1998 4
Consolidated Condensed Statement of Cash Flows for
the nine months ended September 30, 1999 and 1998 5
Consolidated Condensed Statement of Stockholders'
Equity for the nine months ended September 30, 1999 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial 12
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about 24
Market Risk
Part II. Other Information
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 26
2
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED BALANCE SHEET
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 75,490 $ 45,618
Accounts receivable, net (Note 4) 105,459 73,466
Inventories, net 76,057 149,192
Deferred taxes 48,603 51,029
Other current assets 4,651 4,301
------------- ------------
Total current assets 310,260 323,606
Property, plant and equipment, net 174,503 172,794
Intangible assets, net 122,276 127,779
Other assets 32,163 31,648
------------- ------------
$639,202 $655,827
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 28,676 $ 35,928
Line of credit (Note 3) 70,919
Note payable (Note 3) 13,562 12,971
Accrued employee compensation and benefits 28,512 11,083
Accrued warranty expense 37,583 35,815
Accrued restructuring costs 2,515 7,389
Income taxes payable 7,818 9,903
------------- ------------
Total current liabilities 118,666 184,008
Long-term liabilities:
Deferred compensation 9,855 7,606
Accrued restructuring costs 9,791 11,117
Commitments and contingencies (Note 6)
Stockholders' equity:
Preferred Stock, $.01 par value, 3,000,000 shares authorized, none
issued and outstanding at September 30, 1999 and December 31, 1998
Common Stock, $.01 par value, 240,000,000 shares authorized, 76,032,724
and 75,095,087 issued and outstanding at September 30, 1999, and
December 31, 1998, respectively 760 751
Paid-in capital 275,032 258,015
Unearned compensation (3,533) (5,653)
Retained earnings 292,890 252,528
Accumulated other comprehensive income 335 1,780
Less: Grantor Stock Trust (5,300,000 shares) at market (64,594) (54,325)
------------- ------------
Total stockholders' equity 500,890 453,096
------------- ------------
$639,202 $655,827
============= ============
</TABLE>
See accompanying notes to consolidated condensed financial statements.
3
<PAGE>
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- ----------------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales $183,335 100% $172,944 100% $598,788 100% $583,104 100%
Cost of goods sold 93,439 51% 89,859 52% 316,707 53% 307,523 53%
-------- --- -------- --- -------- --- -------- ---
Gross profit 89,896 49% 83,085 48% 282,081 47% 275,581 47%
Operating expenses:
Selling 32,687 18% 40,285 23% 98,929 17% 118,314 20%
General and administrative 22,911 12% 24,534 14% 67,358 11% 68,718 12%
Research and development 8,672 5% 9,132 5% 25,405 4% 26,209 4%
Restructuring (65) 431
-------- --- -------- --- -------- --- -------- ---
Income from operations 25,691 14% 9,134 5% 89,958 15% 62,340 11%
Other income, net 2,934 343 769 303
-------- --- -------- --- -------- --- -------- ---
Income before income taxes 28,625 16% 9,477 5% 90,727 15% 62,643 11%
Provision for income taxes 11,053 3,641 35,562 24,509
-------- --- -------- --- -------- --- -------- ---
Net income $ 17,572 10% $ 5,836 3% $ 55,165 9% $ 38,134 7%
======== === ======== === ======== === ======== ===
Earnings per common share:
Basic $ 0.25 $ 0.08 $ 0.78 $ 0.55
Diluted $ 0.25 $ 0.08 $ 0.78 $ 0.53
Common equivalent shares:
Basic 70,581 69,610 70,290 69,383
Diluted 71,094 71,199 71,026 71,323
Dividends paid per share $ 0.07 $ 0.07 $ 0.21 $ 0.21
</TABLE>
See accompanying notes to consolidated condensed financial statements.
4
<PAGE>
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Nine months ended
September 30,
-------------------------------------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 55,165 $ 38,134
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 29,172 21,267
Loss (gain) on disposal of assets 259 (2)
Non-cash compensation 1,145 7,800
Tax benefit from exercise of stock options 1,869 2,036
Deferred taxes 3,590 (4,514)
Non-cash restructuring 158
Changes in assets and liabilities, net of effects from
acquisitions:
Accounts receivable, net (31,553) 19,397
Inventories, net 72,798 (56,371)
Other assets (2,412) (5,385)
Accounts payable and accrued expenses (6,060) (1,022)
Accrued employee compensation and benefits 17,302 956
Accrued warranty expense 1,764 6,517
Income taxes payable (2,088) 14,177
Accrued restructuring costs (5,032)
Other liabilities 2,249 (13,744)
Accrued restructuring costs - long term (1,326)
-------- --------
Net cash provided by operating activities 137,000 29,246
-------- --------
Cash flows from investing activities:
Business acquisitions, net of cash acquired (1,998) (10,973)
Capital expenditures (47,411) (52,139)
Sale of assets 5,055 13
-------- --------
Net cash used in investing activities (44,354) (63,099)
-------- --------
Cash flows from financing activities:
Issuance of Common Stock 5,863 4,437
Dividends paid (14,803) (14,598)
Retirement of Common Stock (1,303)
Proceeds from note payable 17,247
Line of credit, net (70,919) 50,000
-------- --------
Net cash (used in) provided by financing activities (62,612) 38,536
-------- --------
Effect of exchange rate changes on cash (162) 125
-------- --------
Net increase in cash and cash equivalents 29,872 4,808
Cash and cash equivalents at beginning of period 45,618 26,204
-------- --------
Cash and cash equivalents at end of period $ 75,490 $ 31,012
======== ========
</TABLE>
See accompanying notes to consolidated condensed financial statements.
5
<PAGE>
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Accumulated
Other
Common Stock Paid-in Unearned Retained Comprehensive Comprehensive
Shares Amount Capital Compensation Earnings Income GST Total Income
------ ---- -------- ------- -------- ------ -------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 75,095 $751 $258,015 ($5,653) $252,528 $1,780 ($54,325) $453,096
------ ---- -------- ------- -------- ------ -------- -------- -------
Exercise of stock options 564 5 2,219 2,224
Cancellation of Restricted
Common Stock (4) (108) 110 2
Tax benefit from exercise
of stock options 1,869 1,869
Compensatory stock and
stock options (867) 2,010 1,143
Employee stock purchase
plan 378 4 3,635 3,639
Cash dividends (15,916) (15,916)
Dividends on shares held 1,113 1,113
by GST
Adjustment of GST shares
to market value 10,269 (10,269)
Equity adjustment from
foreign currency
translation (1,445) (1,445) $(1,445)
Net income 55,165 55,165 55,165
------ ---- -------- ------- -------- ------ -------- -------- -------
Balance, September 30, 1999 76,033 $760 $275,032 ($3,533) $292,890 $ 335 ($64,594) $500,890 $53,720
====== ==== ======== ======= ======== ====== ======== ======== =======
</TABLE>
See accompanying notes to consolidated condensed financial statements.
6
<PAGE>
CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
---------------------
The accompanying financial information for the three and nine months ended
September 30, 1999 and 1998 has been prepared by Callaway Golf Company (the
"Company") and has not been audited. These financial statements, in the opinion
of management, include all adjustments (consisting only of normal recurring
accruals) necessary for the fair presentation of the financial position, results
of operations and cash flows for the periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K filed for the year ended December 31, 1998.
Interim operating results are not necessarily indicative of operating results
for the full year.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Certain prior period amounts have been reclassified to conform with the current
presentation.
2. INVENTORIES
-----------
September 30, December 31,
1999 1998
------------- ------------
(Unaudited)
Inventories, net (in thousands):
Raw materials $ 45,505 $102,352
Work-in-process 3,735 1,820
Finished goods 49,324 81,868
-------- --------
98,564 186,040
Less reserve for obsolescence (22,507) (36,848)
-------- --------
$ 76,057 $149,192
======== ========
3. BANK LINE OF CREDIT AND NOTE PAYABLE
------------------------------------
On February 12, 1999, the Company consummated the amendment of its line of
credit to increase the revolving credit facility to $120.0 million (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 September 30, 1999, up to
$118.8 million of the credit facility remained available for borrowings
(including a reduction of $1.2 million for outstanding letters of credit),
subject to meeting certain availability requirements under a borrowing base
formula and other limitations.
7
<PAGE>
Effective as of 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 approximately $56.0 million of machinery and equipment.
This lease program includes an 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 quarter of 1999, the Company converted a portion
of Callaway Golf Ball Company's note payable to an operating lease. The Company
expects the remaining balance of $13.6 million to be converted to an operating
lease before the end of 1999.
4. 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
Corporation ("Golf Funding"). Pursuant to an agreement 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 September
30, 1999, no amount was outstanding under the Accounts Receivable Facility.
Fees incurred in connection with the sale of accounts receivable for the three
and nine months ended September 30, 1999 were $77,000 and $749,000,
respectively. These fees were recorded as other expense.
5. EARNINGS PER SHARE
------------------
A reconciliation of the numerators and denominators of the basic and diluted
earnings per common share calculations for the three and nine months ended
September 30, 1999, and 1998 is presented below.
<TABLE>
<CAPTION>
(in thousands, except per share data)
Three months ended Nine months ended
September 30, September 30,
(Unaudited)
-------------------------------------------------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income $17,572 $ 5,836 $55,165 $38,134
------- ------- ------- -------
Weighted-average shares outstanding:
Weighted-average shares outstanding - Basic 70,581 69,610 70,290 69,383
Dilutive securities 513 1,589 736 1,940
------- ------- ------- -------
Weighted average shares outstanding - Diluted 71,094 71,199 71,026 71,323
------- ------- ------- -------
Earnings per common share
Basic $ 0.25 $ 0.08 $ 0.78 $ 0.55
Diluted $ 0.25 $ 0.08 $ 0.78 $ 0.53
</TABLE>
For the three months ended September 30, 1999 and 1998, 12,024,000 and
12,196,000, respectively, options outstanding were excluded from the
calculations, as their effect would have been antidilutive.
8
<PAGE>
6. COMMITMENTS AND CONTINGENCIES
-----------------------------
Subject to certain conditions, the Company has committed to purchase titanium
golf clubheads costing approximately $6.3 million from one of its vendors.
Under the current schedule, the clubheads are expected to be shipped to the
Company during the remainder of 1999.
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 September
30, 1999. Management believes, however, 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.
7. RESTRUCTURING
-------------
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 Golf, Inc.
("Odyssey"), into the operations of the Company while maintaining the distinct
and separate Odyssey(R) brand image; 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 are expected to be completed largely during 1999.
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 assets, 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.
During the first nine months of 1999, the Company incurred charges of $1.2
million on the disposition of building improvements eliminated during the
consolidation of manufacturing operations, as well as other charges. These
charges did not meet the criteria for accrual in 1998. Additionally, the
Company incurred a charge of $0.5 million related to asset dispositions for
which a reserve was not established in 1998. These charges were partially
offset by gains of $1.5 million on the disposition of two of the Company's
buildings included in the restructuring plan, for which an impairment charge was
taken in 1998. A total of $0.5 million of the restructuring reserve related to
excess lease costs was not required as the facility to which the reserve related
was subleased at rates higher than estimated. Other activity during 1999
primarily related to cash payments for severance, disposition of assets,
contract cancellation and other items. During the first quarter of 1999,
substantially all of the approximately 750 non-temporary work force reductions
occurred.
9
<PAGE>
Details of the one-time charge are as follows (in thousands):
<TABLE>
<CAPTION>
Reserve Reserve
Cash/ One-Time Balance Balance
Non-Cash Charge Activity at 12/31/98 Activity at 9/30/99
-------- -------- -------- ----------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
ELIMINATION OF JOB RESPONSIBILITIES $11,664 $ 8,473 $ 3,191 $ 2,930 $ 261
Severance packages Cash 11,603 8,412 3,191 2,930 261
Other Non-cash 61 61
EXITING CERTAIN NON-CORE BUSINESS ACTIVITIES $28,788 $12,015 $16,773 $ 4,779 $11,994
Loss on disposition of subsidiaries Non-cash 13,072 10,341 2,731 2,426 305
Excess lease costs Cash 12,660 146 12,514 973 11,541
Contract cancellation fees Cash 2,700 1,504 1,196 1,092 104
Other Cash 356 24 332 288 44
CONSOLIDATION OF OPERATIONS $13,783 $ 2,846 $10,937 $10,684 $ 253
Loss on impairment/disposition of assets Non-cash 12,364 2,730 9,634 9,609 25
Excess lease costs Cash 806 4 802 802
Other Cash 613 112 501 273 228
-------- ------- ------- ------- ------- -------
</TABLE>
Future cash outlays are anticipated to be completed by the end of 1999,
excluding certain lease commitments that continue through February 2013 (see
also Note 10).
8. 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 steel metal woods and irons, Callaway Golf(R) and
Odyssey(R) putters and wedges, and related accessories. The Golf Balls segment
consists of golf balls that are to be designed, manufactured, marketed and
distributed by the Company. In accordance with its restructuring plan, the
Company is no longer pursuing the initiatives previously included in its All
Other segment, which included interactive golf sites, golf book publishing, new
player development and a driving range venture (Note 7). There are no
significant intersegment transactions. The tables below contain information
utilized by management to evaluate its operating segments for the interim
periods presented.
<TABLE>
<CAPTION>
Three Months Ended
September 30,
1999 1998
------------------------------------------------------------------------------------------------
Additions to Additions to
Income (loss) long-lived Income (loss) long-lived
Net Sales before tax assets Net Sales before tax assets
--------- ------------- ------------ --------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Golf Clubs $183,335 $37,833 $ 370 $172,944 $18,963 $ 7,723
Golf Balls (9,208) 5,585 (6,289) 15,988
All Other (3,197) 658
-------- ------- ------ -------- ------- -------
Consolidated $183,335 $28,625 $5,955 $172,944 $ 9,477 $24,369
======== ======= ====== ======== ======= =======
</TABLE>
10
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1999 1998
------------------------------------------------------------------------------------------------
Additions to Additions to
Income (loss) long-lived Income (loss) long-lived
Net Sales before tax assets Net Sales before tax assets
--------- ------------- ------------ --------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Golf Clubs $598,788 $115,584 $ 4,804 $583,104 $84,817 $24,573
Golf Balls (24,857) 43,485 (15,811) 26,674
All Other (6,363) 14,598
-------- -------- ------- -------- ------- -------
Consolidated $598,788 $ 90,727 $48,289 $583,104 $62,643 $65,845
======== ======== ======= ======== ======= =======
</TABLE>
9. ADOPTION OF NEW ACCOUNTING STANDARD
-----------------------------------
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, as amended by SFAS No.
137, "Deferral of the Effective Date of FAS 133," is effective for all periods
beginning after June 15, 2000; the Company elected to early adopt SFAS No. 133
on January 1, 1999.
In the first nine months of 1999, 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 and on payments
due from 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 intercompany transactions being hedged,
and the Company does not engage in hedging contracts which exceed the amount of
the intercompany transactions. Transaction gains recorded during the nine
months ended September 30, 1999 and 1998 were not material At September 30,
1999, the Company had approximately $26.0 million of foreign exchange contracts
outstanding. The contracts outstanding at September 30, 1999 mature between
October 1999 and June 2000. The Company's net unrealized gains and losses on
foreign exchange contracts included in net income for the nine months ended
September 30, 1999 and 1998 were not material.
Adoption of this statement did not significantly affect the way in which the
Company accounts for derivatives to hedge payments due on intercompany
transactions. Accordingly, no cumulative-effect-type 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.
11
<PAGE>
10. SUBSEQUENT EVENTS
-----------------
On October 5, 1999, the Company entered into an agreement with Sumitomo Rubber
Industries Ltd. ("Sumitomo"), its Japanese golf club distributor, providing for
the transition of the Company's business from Sumitomo to the Company's wholly-
owned Japanese subsidiary. This subsidiary will be directly and solely
responsible for the sale of Callaway Golf(R) and Odyssey(R) golf clubs and
Callaway Golf(R) balls in Japan beginning January 1, 2000. As a result of this
transition agreement, the Company expects a fourth quarter charge of not more
than $8.0 million.
On November 12, 1999, the Company entered into an assignment of a lease
obligation for a facility in New York for which a restructuring charge was taken
in 1998. As a result of this transaction, the Company anticipates it will record
as income in the fourth quarter of 1999 approximately $6.0 million due to the
reversal of a portion of the restructuring reserve established for this
facility.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Statements used in this discussion that relate to future plans, events,
financial results or performance are forward-looking statements as defined under
the Private Securities Litigation Reform Act of 1995. Such statements are
subject to certain risks and uncertainties which could cause actual results to
differ materially from those anticipated. Readers are cautioned not to place
undue reliance on these forward-looking statements which speak only as of the
date hereof. The Company undertakes no obligation to republish revised forward-
looking statements to reflect events or circumstances after the date hereof or
to reflect the occurrence of unanticipated events. Readers also are urged to
carefully review and consider the various disclosures made by the Company which
describe certain factors which affect the Company's business, including the
disclosures made under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Certain Factors Affecting
Callaway Golf Company" below, as well as the Company's other periodic reports on
Forms 10-K and 10-Q and Current Reports on Form 8-K filed with the Securities
and Exchange Commission.
Readers also should be aware that while the Company communicates with securities
analysts, the Company has a policy against issuing or confirming financial
forecasts or projections issued by others. Accordingly, to the extent that
reports issued by securities analysts contain any projections, forecasts or
opinions, such reports are not the responsibility of the Company, and
stockholders should not assume that the Company agrees with any statement or
report issued by any analyst.
CERTAIN FACTORS AFFECTING CALLAWAY GOLF COMPANY
- -----------------------------------------------
RESTRUCTURING
In the third quarter of 1999, the Company continued to implement its
restructuring in accordance with the plan adopted in the fourth quarter of 1998.
See "Restructuring" under "Results of Operations" section below.
SALES; GROSS MARGIN; SEASONALITY
The Company believes that the dollar volume of the premium golf equipment market
has been declining in certain major markets, including the United States, and
may continue to decline during the foreseeable future. During the first nine
months of 1999, the Company's United States revenues decreased 8% and
international revenues increased 21% compared to the same period in 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 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."
Despite the softness in the United States golf market, it is believed that the
Company's overall market share for woods increased in the first nine months of
1999 compared to the same period in 1998. See also "Certain Factors Affecting
Callaway Golf Company - Competition."
12
<PAGE>
While sales of the Company's Great Big Bertha Hawk Eye Titanium Metal Woods, Big
Bertha Steelhead Metal Woods and Big Bertha(R) X-12(R) Irons were strong through
the third quarter of 1999, no assurances can be given 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. Great Big Bertha Hawk Eye Tungsten
Injected Titanium Irons were introduced in September 1999 and initial acceptance
in the marketplace has also been strong to date.
The Company formerly reported that sales to Japan may be lower overall for 1999
as compared to 1998 as the Company's distributor, Sumitomo Rubber Industries,
Ltd. ("Sumitomo"), prepares for the transition of responsibility from it to ERC
International Company ("ERC"), a wholly-owned Japanese subsidiary of the
Company, by January 1, 2000. This has not been the case through the first nine
months of 1999. Sales to Sumitomo were 11% higher for the first nine months of
1999 as compared to the same period in 1998. Sales to Japan, which include
sales of Odyssey(R) product through ERC, accounted for approximately 10% of the
Company's total sales in 1997, 9% of total sales in 1998 and 10% of total sales
for the first nine months of 1999. The Company believes that primarily as a
result of amicable negotiations for a smooth transition resulting in the
execution of a transition agreement in October 1999, sales to Sumitomo were
higher than expected. See also "Certain Factors Affecting Callaway Golf Company
- - International Distribution."
The Company's gross margin as a percentage of net sales increased to 49% in the
third quarter of 1999 from 48% in the third quarter of 1998. This increase
primarily resulted from higher metal wood sales (which carry higher margins) as
a percentage of total net sales in the current quarter, as compared to 1998, and
continued reductions in manufacturing labor and overhead costs along with
reductions in certain component costs. Gross margin as a percentage of net
sales would have improved to 52% but for close-out sales of Great Big Bertha
Tungsten.Titanium Irons, Great Big Bertha and Biggest Big Bertha Titanium Metal
Woods, and Big Bertha War Bird Metal Woods, which have lower margins. For all
of 1999, the Company anticipates its gross margin percentage will exceed its
1998 levels. 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.
In the golf equipment industry, sales to retailers are generally seasonal due to
lower demand in the retail market in the cold weather months covered by the
fourth and first quarters. For several years, the Company's business has
generally followed this seasonal trend and the Company expects this to continue.
Unusual or severe weather conditions such as the "El Nino" weather patterns
experienced during the winter of 1997-1998 may compound these seasonal effects.
COMPETITION
The market in which the Company does business is highly competitive, and is
served by a number of well-established and well-financed companies with
recognized brand names, 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 the
first nine months of 1999 as compared to the same period in 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 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.
NEW PRODUCT INTRODUCTION
The Company believes that the introduction of new, innovative golf equipment is
important to its future success. The Company faces certain risks associated
with such a strategy. For example, new models and basic design
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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, new products that retail at a lower price than prior products may
negatively impact the Company's revenues unless unit sales increase. New designs
generally should 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 products have been
found to conform to USGA and R&A rules, 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.
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 products are barred
by this test. The R&A is considering the adoption of a similar or related test.
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 resulted in higher prices for the Company's
products relative to other products in the marketplace. There can be no
assurance that a significant percentage of the public will always be willing to
pay such prices for golf equipment. Thus, although the Company has achieved
certain successes in the introduction of its premium priced golf clubs in the
past, no assurances can be given that the Company will be able to continue to
design and manufacture golf clubs that achieve such market acceptance in the
future.
The rapid introduction of new products by the Company can 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.
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 Drivers, because of their large clubhead 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 are 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 clubs that have been sold. The Company monitors
the level and nature of any product breakage and, where appropriate, seeks to
incorporate design and production changes to assure its customers of the highest
quality available in the market. 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
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breakage or other product problems.
CREDIT RISK
The Company 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.
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 the first nine months of 1999, the
Company wrote off approximately $4.6 million of past due trade accounts
receivable against the Company's reserve for uncollectible accounts receivable.
The Company considers its remaining reserve for uncollectible accounts
receivable to be adequate. Management does not foresee any significant
improvement in the golf equipment market during 1999, and thus 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 clubheads and
shafts. In addition, some of the Company's products require specifically
developed manufacturing techniques and processes which make it difficult to
identify and utilize alternative suppliers quickly. The Company believes that
suitable clubheads 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 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. Callaway Golf does not make these materials
itself, and must rely on its ability to obtain adequate supplies in the world
marketplace in competition with other users of such materials. While the
Company has been successful in obtaining its requirements for such materials
thus far, there can be no assurance that it will always be able to do so. An
interruption in the supply of such materials or a significant change in costs
could have a material adverse effect on the Company.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The 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. 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.
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Various patents have been issued to the Company's competitors in the golf ball
industry. As Callaway Golf Ball Company develops a new golf ball product, it
attempts to avoid infringing valid patents or other intellectual property
rights. If any new golf ball product is found to infringe on protected
technology, the Company could incur substantial costs to redesign its golf ball
product, obtain a license and/or defend legal actions. Despite its efforts to
avoid such infringements, there can be no assurance that Callaway Golf Ball
Company will not be found to infringe on the valid patents or other intellectual
property rights of third parties in its development efforts, or that it will be
able to obtain licenses to use any such rights, if necessary.
The Company has stringent procedures to maintain the secrecy of its confidential
business information. These procedures include criteria for dissemination of
information and written confidentiality agreements with employees and vendors.
Suppliers, when engaged in joint research projects, are required to enter into
additional confidentiality agreements. 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" in 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 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 U.S. and international markets, it has not stopped such
commerce.
GOLF PROFESSIONAL ENDORSEMENTS
The Company establishes relationships with professional golfers in order to
evaluate and promote Callaway Golf and Odyssey branded golf clubs. 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 Callaway Golf's professional
endorsers were to stop using the Company's products contrary to their
endorsement agreements, the Company's business could be adversely affected in a
material way by the negative publicity.
Many professional golfers throughout the world use the Company's golf clubs even
though they are not contractually bound to do so and do not grant any
endorsement to the Company. In addition, the Company has created cash pools
("Pools") that reward such usage. During 1998, the Company continued its Pools
for the PGA, Senior PGA, LPGA and Nike Tours. The Company believes that its
professional endorsements and its Pools contributed to its usage on the
professional tours in 1998. However, in 1999, the Company has significantly
reduced these Pools for both Callaway Golf 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 brand
products for the LPGA and Nike Tours. 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 the first nine months of 1999, usage of the Company's drivers on
the PGA, Senior PGA, LPGA and Nike Tours was substantially reduced compared to
the first nine months of 1998.
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 whether professional
usage materially 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.
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NEW BUSINESS VENTURES
The Company has, in the past, invested significant capital in new business
ventures. However, in connection with the Company's 1998 restructuring, the
Company discontinued, transferred or suspended certain business ventures not
directly associated with the Company's core business. See "Restructuring" under
"Results of Operations" section below. The Company continues development of its
golf ball business. See "Certain Factors Affecting Callaway Golf Company - Golf
Ball Development."
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 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.
In 1993, the Company appointed Sumitomo as the sole distributor, and Sumitomo
Corporation as the sole importer, of Callaway Golf golf clubs in Japan through a
distributor agreement. This distributor agreement runs through December 31,
1999. The Company notified Sumitomo and Sumitomo Corporation that it will be
concluding the distribution agreement on December 31, 1999. In October 1999,
the Company entered in an agreement with Sumitomo providing for the transition
of the Company's Japanese distribution from Sumitomo to the Company's wholly-
owned Japanese subsidiary. The Company anticipates that the fourth quarter 1999
charges resulting from the transition agreement will be not more than $8
million.
Effective November 1, 1999, the corporate name of the Company's wholly-owned
Japanese subsidiary was changed to Callaway Golf Kabushiki Kaisha ("Callaway
Golf K. K."). Callaway Golf K. K. currently distributes Odyssey products in
Japan and will distribute Callaway Golf clubs beginning January 1, 2000 and
Callaway Golf balls when ready. 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 products in Japan through
Callaway Golf K. K. beginning January 2000, and it is possible that doing so
will have a material adverse effect on the Company's operations and financial
performance.
GOLF BALL DEVELOPMENT
In 1996, the Company formed Callaway Golf Ball Company, a wholly-owned
subsidiary of the Company, for the purpose of designing, manufacturing and
selling golf balls. The Company has previously licensed the manufacture and
distribution of a golf ball in Japan and Korea. The Company also distributed a
golf ball under the trademark "Bobby Jones." These golf ball ventures were
introduced primarily as promotional efforts and were not commercially
successful.
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The Company has determined that Callaway Golf Ball Company will enter the golf
ball business by creating, developing and manufacturing golf balls in a new
plant constructed just for this purpose. The successful implementation of the
Company's strategy could be adversely affected by various risks, including,
among others, delays in product development, manufacturing delays and
unanticipated costs. The Company currently anticipates launching its golf ball
in early 2000. However, there can be no assurance as to whether the golf ball
developed will be ready by that time, that it will be commercially successful or
that a return on the Company's investments will ultimately be realized.
The development of the Company's golf ball business, by plan, has had a
significant negative impact on the Company's cash flows and results of
operations and will continue to do so through the end of 1999. The Company
believes that many of the same factors that affect the golf equipment industry,
including growth rate in the golf equipment industry, intellectual property
rights of others, seasonality and new product introductions, also apply to the
golf ball business. In addition, the golf ball business is highly competitive
with a number of well-established and well-financed competitors. These
competitors have established market share in the golf ball business, which the
Company will need to penetrate for its golf ball business to be successful.
YEAR 2000 ISSUE
Historically, many computer programs have been written using two digits rather
than four 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.
While the Company's own products do not contain date-based functionality and are
not susceptible to the Y2K issue, much of the Company's operations incorporate
or are affected by systems which may contain date-based functionality.
Therefore, the Company has formulated a Year 2000 Plan to address the Company's
Y2K issue. The Company's Year 2000 Plan contemplates four phases -- assessment,
remediation, testing and release/installation -- which will overlap to a
significant degree. The Company's own internal critical systems and key
suppliers are the primary areas of focus. The Company believes critical systems
and key suppliers are those systems or suppliers, which, if they are not Y2K
compliant, may disrupt the Company's manufacturing, sales or distribution
capabilities in a material manner.
The assessment phase, which has been completed, involved an inventory,
prioritization and preliminary evaluation of the Y2K compliance of the Company's
key systems (e.g., hardware, software and embedded systems) and critical
suppliers and customers (e.g., component suppliers, vendors, customers,
utilities and other service providers) on which the Company relies to operate
its business. During this phase it was determined that over 450 of the
Company's key systems were considered critical to the ongoing operations of the
Company.
The remediation phase primarily included or will include altering the product or
software code, upgrading or replacing the product, recommending changes in how
the product is used or retiring the product. The remediation phase has been
substantially completed for all systems.
In addition, the Company received information concerning the Y2K compliance
status of critical suppliers and customers in response to extensive inquiries
aimed at determining the extent to which the Company is vulnerable to those
third parties' failure to remediate their own Y2K issues. The Company relies on
suppliers for timely delivery of a broad range of goods and services worldwide,
including components for its golf clubs. Moreover, the Company's suppliers rely
on countless other suppliers, over which the Company has little or no influence
regarding Y2K compliance. The level of preparedness of critical suppliers and
customers can vary greatly from country to country. The Company believes that
critical suppliers and customers present an area of significant risk to the
Company in part because of the Company's limited ability to influence actions of
third parties, and in part because of the Company's inability to estimate the
level and impact of noncompliance of third parties throughout the extended
supply chain. The process of evaluating these suppliers and selected customers
is continuing and is expected to be completed by the fourth quarter of 1999.
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In October 1997, the Company implemented a new business computer system, which
runs most of the Company's data processing and financial reporting software
applications (including material subsidiaries) and has in part addressed
remediation issues Company-wide. The manufacturer of the application software
used on the new computer system has represented that the software addresses the
Y2K issue, and the Company's own testing of that representation has been
completed.
The Company has substantially completed four phases with respect to those
systems which are critical to its operations. Some non-critical systems may not
be addressed until after January 2000.
The total cost associated with assessment and required modifications to
implement the Company's Year 2000 Plan is not expected to be material to the
Company's financial position or results of operations. The Company currently
estimates that the total cost of implementing its Year 2000 Plan will not exceed
$4.0 million. The total amount expended on the Year 2000 Plan through September
1999 was $2,350,000, of which approximately $1,130,000 related to repair or
replacing of software and related hardware problems and approximately $1,220,000
related to internal and external labor costs.
If the Company's new business computer system fails due to the Y2K issue, or if
any computer hardware or software applications or embedded systems critical to
the Company's manufacturing, shipping or other processes are overlooked, there
could be a material adverse impact on the business operations and financial
performance of the Company. Additionally, there can be no assurance that the
Company's critical suppliers and customers will not experience a Y2K-related
failure that could have a material adverse effect on the business operations or
financial performance of the Company. In particular, if third party suppliers,
due to the Y2K issue, fail to provide the Company with components or materials
which are necessary to manufacture its products, with sufficient electric power
and other utilities to sustain its manufacturing process, or with adequate,
reliable means of transporting its products to its customers worldwide, then any
such failure could have a material adverse effect on the business operations and
financial performance of the Company.
The Company has established contingency plans to address unavoided or
unavoidable risks. In particular, with respect to third party component
suppliers, the Company has formulated contingency plans to guard against
disruptions in the supply of critical components. These plans include booking
orders and producing products before potential business disruptions. Even so,
judgments regarding contingency plans -- such as how to develop them and to what
extent -- are themselves subject to many variables and uncertainties. There can
be no assurance that the Company will correctly anticipate the level, impact or
duration of noncompliance by suppliers. As a result, there is no certainty that
the Company's contingency plans will be sufficient to mitigate the impact of
noncompliance by suppliers, and some material adverse effect to the Company may
result from one or more third parties regardless of defensive contingency plans.
Estimates of time, cost, and risk are based on currently available information.
Developments that could affect estimates include, but are not limited to, the
availability and cost of trained personnel; the ability to locate and correct
all relevant computer software code and systems; cooperation and remediation
success of the Company's suppliers and customers (and their suppliers and
customers); and the ability to correctly anticipate risks and implement suitable
contingency plans in the event of system failures at the Company or its
suppliers and customers (and their suppliers and customers).
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 during the
transitional period, beginning January 1999 and ending June 2002. The Company
has installed a new computer system that supports sales throughout Europe. This
new system runs substantially all of the principal data processing and financial
reporting software for such sales. The Company anticipates that, after the
implementation of an upgrade, the new system will contain the functionality to
process transactions in either a country's local currency or euro. The
implementation of this upgrade, which is part of a larger plan to update the
Company's enterprise-wide software to the manufacturer's current version, is
planned to take place during 2000. Until such time as the upgrade has occurred,
transactions denominated in euro will be
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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.
RESULTS OF OPERATIONS
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998:
Net sales increased 6% to $183.3 million for the three months ended September
30, 1999 compared to $172.9 million for the comparable period in the prior year.
Both unit and dollar sales of titanium metal woods increased in the third
quarter of 1999 over the third quarter of 1998 largely due to the January 1999
introduction of Great Big Bertha(R) Hawk Eye(R) Metal Woods. Unit and dollar
sales of irons also increased slightly during this period, due in part to the
September 1999 introduction of the Great Big Bertha(R) Hawk Eye(R) Tungsten
Injected(TM) Titanium Irons. Sales of the Company's stainless steel metal
woods decreased in the third quarter of 1999 as compared to the third quarter of
1998 in both units and dollars. This decrease may be attributed to both the
phase-out of Big Bertha(R) War Bird(R) Drivers, which sold at significantly
lower volume in both units and dollars in the third quarter of 1999 than in
1998, and the August 1998 introduction of Big Bertha(R) Steelhead(TM) Metal
Woods, which generated slightly higher revenues during this period in 1998.
During the third quarter of 1999 versus the third quarter of 1998, sales in the
United States decreased $8.2 million (7%). During this same period, sales in
Europe and in Japan increased $2.4 million (8%) and $7.9 million (64%),
respectively. Sales to the rest of Asia increased $8.1 million (78%) over the
same quarter of the prior year and sales to the rest of the world remained
relatively constant during this period.
For the three months ended September 30, 1999, gross profit was $89.9 million as
compared to $83.1 million for the same period in the prior year. As a
percentage of net sales, gross profit increased to 49% from 48% for the quarter
ended September 30, 1999 as compared to the same quarter of 1998. This increase
primarily resulted from a higher level of metal wood sales (which carry higher
margins), particularly titanium metal woods, as a percentage of total net sales
in the current quarter, as compared to 1998, and continued reductions in
manufacturing labor and overhead costs along with reductions in certain
component costs. Gross margin as a percentage of net sales would have improved
to 52% but for close-out sales during the current quarter 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 have
lower margins.
Selling expenses decreased to $32.7 million in the third quarter of 1999
compared to $40.3 million in the third quarter of 1998. As a percentage of net
sales, selling expenses decreased to 18% from 23% during the current quarter as
compared to the comparable quarter of 1998. The $7.6 million decrease was
primarily related to planned reductions in advertising, pro tour and other
promotional expenses. This decrease was partially offset by an increase in
employee compensation.
General and administrative expenses decreased to $22.9 million for the three
months ended September 30, 1999 from $24.5 million for the comparable period in
the 1998. As a percentage of net sales, general and administrative expenses in
the third quarter of 1999 decreased to 12% from 14% for the same period in 1998.
The $1.6 million decrease was primarily related to decreases in consulting, bad
debt expense and other general and administrative expenses. These decreases
were partially offset by costs associated with the ramp-up of the Company's golf
ball operations.
Research and development expenses decreased to $8.7 million in the third quarter
of 1999 compared to $9.1 million in the comparable period of the prior year. As
a percentage of net sales, research and development remained constant at 5% for
the three months ended September 30, 1999 and 1998. The $0.4 million decrease
was primarily
20
<PAGE>
the result of the shutdown of the Company's prototype foundry and a decrease in
consulting expense, partially offset by an increase in employee compensation.
Other income increased $2.6 million for the quarter ended September 30, 1999 as
compared to the same period in 1998. This increase was primarily attributable
to larger gains on foreign currency transactions in the third quarter of 1999 as
compared to this period in 1998, an increase in interest income due to higher
average cash balances during the third quarter of 1999 versus 1998 and a
decrease in interest expense as a result of reduced obligations under the
Company's credit facilities.
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998:
Net sales increased 3% to $598.8 million for the nine months ended September 30,
1999 compared to $583.1 million for the comparable period in the prior year.
Both unit and dollar sales of titanium and steel metal woods increased during
the current period largely due to sales of Big Bertha(R) Steelhead(TM) Metal
Woods, which were introduced in August 1998, and the January 1999 introduction
of Great Big Bertha(R) Hawk Eye(R) Metal Woods. Unit and dollar sales of irons
decreased during this same period. This decrease was due in part to the January
1998 introduction of the Big Bertha(R) X-12(TM) Irons, which experienced
significant retailer pipeline filling during 1998 and the close-out of Great Big
Bertha(R) Tungsten.Titanium(TM) Irons during the current year at substantially
discounted prices.
During the nine months ended September 30, 1999 versus 1998, sales in the United
States decreased $29.3 million (8%). During this same period, sales in Japan and
in the rest of Asia increased $8.2 million (16%) and $30.9 million (130%),
respectively. Sales to the rest of the world increased $5.5 million (14%) over
the same period of the prior year and sales in Europe remained relatively
constant during this period. See also "Sales; Gross Margin; Seasonality" under
"Certain Factors Affecting Callaway Golf Company" above.
For the nine months ended September 30, 1999, gross profit increased to $282.1
million from $275.6 million for the comparable period in the prior year. As a
percentage of net sales, gross profit remained constant at 47% for the nine
months ended September 30, 1999 and 1998. Gross margin was favorably affected
by an increase in sales of metal woods as a percentage of net sales, which have
higher margins than irons. This favorable effect was offset by 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. These products were sold at significantly lower prices, resulting in
lower margins.
Selling expenses decreased to $98.9 million in the first nine months of 1999
compared to $118.3 million in the comparable period of 1998. As a percentage of
net sales, selling expenses decreased to 17% from 20% during the first nine
months of 1999 over the comparable period of 1998. The $19.4 million decrease
was primarily related 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 $67.4 million for the nine
months ended September 30, 1999 from $68.7 million for the comparable period of
the prior year. As a percentage of net sales, general and administrative
expenses decreased to 11% from 12% in the nine months ended September 30, 1999
as compared with this same period in 1998. The $1.3 million decrease was
largely attributable to decreases in consulting, bad debt expense and other
general and administrative expenses. This decrease was partially offset by
costs associated with the ramp-up of the Company's golf ball operations and an
increase in employee compensation.
Research and development expenses decreased to $25.4 million for the nine months
ended September 30, 1999 compared to $26.2 million in the comparable period of
the prior year. As a percentage of net sales, research and development expenses
remained constant at 4% for the nine months ended September 30, 1999 and 1998.
The $0.8 million decrease was primarily the result of the shut-down of the
Company's prototype foundry and a decrease in consulting fees, partially offset
by an increase in employee compensation and an increase in component prototype
costs.
21
<PAGE>
Other income increased $0.5 million for the nine months ended September 30, 1999
over the comparable period of 1998. This increase was attributable to increases
in interest income due to higher average cash balances during the period and to
an increase in royalty income. This increase was partially offset by an
increase in interest expense incurred during the first nine months of 1999
related to the Company's credit facilities due primarily to higher interest and
yield rates and related fees.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, cash and cash equivalents increased to $75.5 million from
$45.6 million at December 31, 1998 primarily as a result of cash provided by
operations of $137.0 million, inclusive of a $41.0 million reduction in advances
under the Accounts Receivable facility, which was reflected as a reduction of
Accounts Receivable (see Note 4 to the Company's unaudited Consolidated
Condensed Financial Statements). This increase was partially offset by cash
used in investing activities of $44.4 million and cash used in financing
activities of $62.6 million, Cash flows used in investing activities resulted
from capital expenditures, primarily associated with the ramp-up of golf ball
operations, partially offset by proceeds from the sale of fixed assets, largely
those related to the Company's restructuring. Cash flows used in financing
activities are primarily attributed to the repayment of loan advances and
dividends paid, partially offset by proceeds from the Finance Agreement.
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
declined in 1998 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 and entered into an $80.0 million accounts receivable
securitization facility (the "Accounts Receivable Facility") (see Notes 3 and 4
to the unaudited Consolidated Condensed 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 September 30, 1999, the Company
had repaid the outstanding balance of the Amended Credit Agreement with cash
flow from operations and had $118.8 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 September 30, 1999, advances under the Accounts Receivable Facility had
been reduced, leaving up to $80.0 million available under this facility.
Further, in the third quarter of 1999, the Company converted a portion of its
note payable under the Finance Agreement to an operating lease, leaving a
remaining balance of $13.6 million. The Company anticipates the remainder of
this note payable to be converted to an operating lease before the end of 1999
(see Note 3 to the unaudited Consolidated Condensed Financial Statements).
As a result of the implementation of its plan to improve operating efficiencies
(see "Restructuring"), the Company incurred charges of $54.2 million in the
fourth quarter of 1998. Of these charges, $25.5 million were non-cash. Since
the adoption of this restructuring plan in the fourth quarter of 1998, cash
outlays for employee termination costs, contract cancellation fees, excess lease
costs and other expenses have been $16.3 million. Due to the assignment of a
lease obligation (see Note 10 to the Consolidated Condensed Financial
Statements), expected future cash outlays for such costs have been reduced and
are estimated to be $6.1 million. Of this amount, approximately $4.8 million is
anticipated to occur during the fourth quarter of 1999, while the remainder, is
expected to be paid during 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.
The Company believes that, based upon its current operating plan, analysis of
its consolidated financial position and projected future results of operations,
it will be able to maintain its current level of operations, including 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.
22
<PAGE>
RESTRUCTURING
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 Golf, Inc.
("Odyssey"), into the operations of the Company while maintaining the distinct
and separate Odyssey(R) brand image; 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 are expected to be completed largely during 1999.
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 assets, 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.
During the first nine months of 1999, the Company incurred charges of $1.2
million on the disposition of building improvements eliminated during the
consolidation of manufacturing operations, as well as other charges. These
charges did not meet the criteria for accrual in 1998. Additionally, the
Company incurred a charge of $0.5 million related to asset dispositions for
which a reserve was not established in 1998 These charges were partially offset
by gains of $1.5 million on the disposition of two of the Company's buildings
included in the restructuring plan, for which an impairment charge was taken in
1998. A total of $0.5 million of the restructuring reserve related to excess
lease costs was not required as the facility to which the reserve related was
subleased at rates higher than estimated. Other activity during 1999 primarily
related to cash payments for severance, disposition of assets, contract
cancellation and other items. During the first quarter of 1999, substantially
all of the approximately 750 non-temporary work force reductions occurred.
Details of the one-time charge are as follows (in thousands):
<TABLE>
<CAPTION>
Reserve Reserve
Cash/ One-Time Balance Balance
Non-Cash Charge Activity at 12/31/98 Activity at 9/30/99
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ELIMINATION OF JOB RESPONSIBILITIES $11,664 $ 8,473 $ 3,191 $ 2,930 $ 261
Severance packages Cash 11,603 8,412 3,191 2,930 261
Other Non-cash 61 61
EXITING CERTAIN NON-CORE BUSINESS ACTIVITIES $28,788 $12,015 $16,773 $ 4,779 $11,994
Loss on disposition of subsidiaries Non-cash 13,072 10,341 2,731 2,426 305
Excess lease costs Cash 12,660 146 12,514 973 11,541
Contract cancellation fees Cash 2,700 1,504 1,196 1,092 104
Other Cash 356 24 332 288 44
CONSOLIDATION OF OPERATIONS $13,783 $ 2,846 $10,937 $10,684 $ 253
Loss on impairment/disposition of assets Non-cash 12,364 2,730 9,634 9,609 25
Excess lease costs Cash 806 4 802 802
Other Cash 613 112 501 273 228
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
See "Liquidity on Capital Resources" section above for a discussion of future
cash outlays.
23
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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 new
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 the first nine months of 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 new 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 3 and 4 to the
Company's unaudited Consolidated Condensed Financial Statements) which are
indexed to the LIBOR and Redwood Receivables Corporation Commercial Paper Rate.
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 September 30, 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 $3.1 million at September 30, 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 3 and 4 to the unaudited Consolidated Condensed Financial Statements
outline the principal amounts, and other terms required to evaluate the expected
cash flows and sensitivity to interest rate changes.
24
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company, incident to its business activities, is often the plaintiff in
several legal proceedings, both domestically and abroad, in various stages of
development. For example, in conjunction with the Company's program of
enforcing its proprietary rights, the Company has initiated a number of actions
against alleged infringers under the intellectual property laws of various
countries, including, for example, the United States Lanham Act, the U.S.
Patent Act, and other pertinent laws. Historically, defendants in these actions
have, among other things, sometimes contested the validity and/or the
enforceability of some of the Company's patents and/or trademarks. Others have
asserted counterclaims against the Company. The Company believes that the
outcome of these matters individually and in the aggregate will not have a
material adverse effect upon the financial position or results of operations of
the Company. It is possible, however, that in the future one or more defenses
or claims asserted by defendants in one or more of those actions may succeed,
resulting in the loss of all or part of the rights under one or more patents,
loss of a trademark, a monetary award against the Company, or some other loss to
the Company. One or more of these results could adversely affect the Company's
overall ability to protect its product designs and may ultimately limit its
future success in the marketplace.
In addition, the Company from time to time receives information claiming that
products sold by the Company infringe or may infringe patent or other
intellectual property rights of third parties. To date, the Company has not
experienced any material expense or disruption associated with any such
potential infringement matters. It is possible, however, that in the future one
or more claims of potential infringement could lead to litigation, the need to
obtain additional licenses, the need to alter a product to avoid infringement,
or some other action or loss by the Company.
The Company and its subsidiaries, incident to their business activities, are
parties to a number of legal proceedings, lawsuits and other claims, including
those discussed above. 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 that
may be covered by insurance, or the financial impact with respect to these
matters. Management believes, however, 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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
25
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
a. Exhibits:
--------
3.1 Certificate of Incorporation (filed as Exhibit 3.1
to the Company's Current Report on Form 8-K, as
filed with the Securities and Exchange Commission
(the "Commission") on July 1, 1999, and incorporated
herein by this reference)
3.2 Bylaws (filed as Exhibit 3.2 to the Company's
Current Report on Form 8-K as filed with the
Commission on July 1, 1999, and incorporated herein
be this reference)
10.1 Callaway Golf Company Non-Employee Directors Stock
Option Plan (as amended and restated August 17,
1999)(+)
27 Financial Data Schedule(+)
b. Reports on Form 8-K:
-------------------
(1) On July 1, 1999, the Company filed a Current Report
on Form 8-K reporting that the Company had completed
its reincorporation from a California corporation to
a Delaware corporation.
(2) Effective on August 17, 1999, the Company filed a
Current Report on Form 8-K reporting that Chuck Yash
had been appointed as President of Callaway Golf
Company. The Company further reported that Mr. Yash
has been designated to succeed Ely Callaway as Chief
Executive Officer of the Company by December 31,
2000 or when Mr. Callaway ceases to be involved in
active management of the Company--whichever comes
earlier.
______________________________
(+)Included with this Report.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CALLAWAY GOLF COMPANY
Date: November 12, 1999 /s/ ELY CALLAWAY
------------
Ely Callaway
Chairman and
Chief Executive Officer
/s/ DAVID A. RANE
-------------
David A. Rane
Executive Vice President,
Administration and Planning
and Chief Financial Officer
27
<PAGE>
EXHIBIT INDEX
-------------
Exhibit Description
------- -----------
3.1 Certificate of Incorporation (filed as Exhibit 3.1
to the Company's Current Report on Form 8-K, as
filed with the Securities and Exchange Commission
(the "Commission") on July 1, 1999, and incorporated
herein by this reference)
3.2 Bylaws (filed as Exhibit 3.2 to the Company's
Current Report on Form 8-K as filed with the
Commission on July 1, 1999, and incorporated herein
be this reference)
10.1 Callaway Golf Company Non-Employee Directors Stock
Option Plan (as amended and restated August 17,
1999)(+)
27 Financial Data Schedule(+)
______________________________
(+)Included with this Report.
28
<PAGE>
CALLAWAY GOLF COMPANY
NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN
(AS AMENDED AND RESTATED AUGUST 17, 1999)
ARTICLE I
GENERAL
1. ADOPTION. This Callaway Golf Company Non-Employee Directors Stock
Option Plan (the "PLAN") is effective as of September 1, 1992, subject to
approval by the Board of Directors and shareholders of Callaway Golf Company
(the "COMPANY").
2. PURPOSE. The Plan is designed to promote the interests of the Company
and its shareholders by using investment interests in the Company to attract and
retain highly qualified independent directors.
3. ADMINISTRATION. The Plan shall be administered by the Company, which
shall have the power to construe the Plan, to determine all questions arising
under the Plan, to adopt and amend such rules and regulations for the
administration of the Plan as it may deem desirable, and otherwise to carry out
the terms of the Plan. The interpretation and construction by the administrator
of any provisions of the Plan or of any option granted under the Plan shall be
final. Notwithstanding the foregoing, the administrator shall have no authority
or discretion as to the selection of persons eligible to receive options granted
under the Plan, the number of shares covered by options granted under the Plan,
the timing of such grants, or the exercise price of options granted under the
Plan, which matters are specifically governed by the provisions of the Plan.
4. ELIGIBLE DIRECTORS. A person shall be eligible to receive grants of
options under this Plan (an "ELIGIBLE DIRECTOR") if, at the time of the option's
grant, he or she is a duly elected or appointed member of the Company's Board of
Directors, but is not then otherwise an employee of the Company or any of its
subsidiaries or affiliates and has not been an employee of the Company or any of
its subsidiaries or affiliates since the beginning of the Company's preceding
fiscal year.
5. SHARES OF COMMON STOCK SUBJECT TO THE PLAN AND GRANT LIMIT. The shares
that may be issued upon exercise of options granted under the Plan shall be
authorized and unissued shares of the Company's Common Stock. The aggregate
number of shares that may be issued upon exercise of options granted under the
Plan shall not exceed 840,000 shares of Common Stock, subject to adjustment in
accordance with Article III, and no individual may receive options under the
Plan to purchase more than 120,000 shares of the Company's Common Stock, subject
to adjustment in accordance with Article III.
1
<PAGE>
6. AMENDMENT OF THE PLAN. The Company's Board of Directors may, insofar
as permitted by law, from time to time suspend or discontinue the Plan or revise
or amend it in any respect whatsoever, except that no such amendment shall alter
or impair or diminish any rights or obligations under any option theretofore
granted under the Plan without the consent of the person to whom such option was
granted. In addition, without further shareholder approval, the Plan may not be
amended so as to increase the number of shares subject to the Plan (as adjusted
under Article III), increase the number of shares for which an option or options
may be granted to any optionee (as adjusted under Article III), change the class
of persons eligible to receive options under the Plan, provide for the grant of
options having an exercise price per option share less than the exercise price
specified in the Plan, or extend the final date upon which options may be
granted under the Plan. Under no circumstances may the provisions of the Plan
that provide for the amounts, price, and timing of option grants be amended more
than once every six months, other than to comport with changes in the Internal
Revenue Code, ERISA, or the rules thereunder.
7. TERM OF PLAN. Options may be granted under the Plan until September 1,
2002, whereupon the Plan will terminate. Notwithstanding the foregoing, each
option granted under the Plan shall remain in effect until such option has been
exercised or terminated in accordance with its terms and the terms of the Plan.
8. GRANTS BEFORE SHAREHOLDER APPROVAL. Option grants made before this
Plan has been approved by the Company's shareholders shall be made subject to
and effective only upon such approval.
9. RESTRICTIONS. All options granted under the Plan shall be subject to
the requirement that, if at any time the Company shall determine, in its
discretion, that the listing, registration or qualification of the shares
subject to options granted under the Plan upon any securities exchange or under
any state or federal law, or the consent or approval of any government
regulatory body, is necessary or desirable as a condition of, or in connection
with, the granting of such an option or the issuance, if any, or purchase of
shares in connection therewith, such option may not be exercised in whole or in
part unless such listing, registration, qualification, consent or approval shall
have been effected or obtained free of any conditions not acceptable to the
Company.
10. NONASSIGNABILITY. No option granted under the Plan shall be
assignable or transferable by the grantee except by will or by the laws of
descent and distribution or pursuant to a qualified domestic relations order (as
defined by the Internal Revenue Code of 1986, as amended). During the lifetime
of the optionee, the option shall be exercisable only by the optionee, and no
other person shall acquire any rights therein.
2
<PAGE>
11. WITHHOLDING TAXES. Whenever shares of Common Stock are to be issued
upon exercise of an option granted under the Plan, the administrator shall have
the right to require the optionee to remit to the Company an amount sufficient
to satisfy any federal, state and local withholding tax requirements prior to
the delivery of any certificate or certificates for such shares. The
administrator may, in the exercise of its discretion, allow satisfaction of tax
withholding requirements by accepting delivery of stock of the Company or by
withholding a portion of the Common Stock otherwise issuable upon exercise of an
option.
12. DEFINITION OF "FAIR MARKET VALUE." For purposes of the Plan, the term
"FAIR MARKET VALUE," when used in reference to the value of a share of the
Company's Common Stock on the date an option is granted under the Plan, shall
be: (a) if the Common Stock is listed on an established stock exchange or
exchanges, the mean between the highest and lowest sale prices of the Common
Stock quoted in the Transactions Index of each such exchange as averaged with
such mean price as reported on any and all other exchanges, as published in "The
Wall Street Journal" and determined by the Company, or, if no sale price was
quoted in any such Index for such date, then as of the next preceding date on
which such a sale price was quoted, provided that the mean on such preceding
date is not less than 100% of the fair market value of the Common Stock on the
date the option is granted; or, (b) if the Common Stock is not then listed on an
exchange, the average of the closing bid and asked prices per share for the
Common Stock in the over-the-counter market as quoted on NASDAQ on such date;
or, (c) if the Common Stock is not then listed on an exchange or quoted on
NASDAQ, an amount determined in good faith by the Company.
13. RIGHTS AS A SHAREHOLDER. An optionee or a transferee of an option
shall have no rights as a shareholder with respect to any shares issuable or
issued upon exercise of the option until the date of the receipt by the Company
of all amounts payable in connection with exercise of the option, including the
exercise price and any amounts required by the Company pursuant to Section 11 of
Article I.
14. PURCHASE FOR INVESTMENT. Unless the shares of Common Stock to be
issued upon exercise of an option granted under the Plan have been effectively
registered under the Securities Act of 1933 as now in force or hereafter
amended, the Company shall be under no obligation to issue any shares of Common
Stock covered by any option unless the person who exercises such option, in
whole or in part, shall give a written representation and undertaking to the
Company which is satisfactory in form and scope to counsel to the Company and
upon which, in the opinion of such counsel, the Company may reasonably rely,
that he or she is acquiring the shares of Common Stock issued to him or her
pursuant to such exercise of the option for his or her own
3
<PAGE>
account as an investment and not with a view to, or for sale in connection with,
the distribution of any such shares of Common Stock, and that he or she will
make no transfer of the same except in compliance with any rules and regulations
in force at the time of such transfer under the Securities Act of 1933, or any
other applicable law, and that if shares of Common Stock are issued without such
registration, a legend to this effect may be endorsed upon the securities so
issued.
ARTICLE II
STOCK OPTIONS
1. GRANTS OF INITIAL OPTIONS.
(a) Each Eligible Director who becomes an Eligible Director in 1992
shall, upon first becoming an Eligible Director, receive a one-time grant of an
option to purchase up to 80,000 shares of the Company's Common Stock at an
exercise price of $2.50 per share, subject to (i) vesting as set forth in
Section 4 of Article II, and (ii) adjustment as set forth in Article III.
(b) Each Eligible Director who becomes an Eligible Director from
January 1, 1993 through April 17, 1996 shall, upon first becoming an Eligible
Director, receive a one-time grant of an option to purchase up to 80,000 shares
of the Company's Common Stock at an exercise price per share equal to 75% of the
fair market value of the Company's Common Stock on the date of his or her
election to the Board, subject to (i) vesting as set forth in Section 4 of
Article II, and (ii) adjustment as set forth in Article III.
(c) Each Eligible Director who becomes an Eligible Director from
April 18, 1996 through August 17, 1999 shall, upon first becoming an Eligible
Director, receive a one-time grant of an option to purchase up to 80,000 shares
of the Company's Common Stock at an exercise price per share equal to the fair
market value of the Company's Common Stock on the date of his or her election to
the Board, subject to (i) vesting as set forth in Section 4 of Article II, and
(ii) adjustment as set forth in Article III.
(d) Each Eligible Director who becomes an Eligible Director after
August 17, 1999 shall, upon first becoming an Eligible Director, receive a one-
time grant of an option to purchase up to 20,000 shares of the Company's Common
Stock at an exercise price per share equal to the fair market value of the
Company's Common Stock on the date of his or her election to the Board, subject
to (i) vesting as set forth in Section 4 of Article II, and (ii) adjustment as
set forth in Article III.
(e) Options granted under Sections 1(a) through 1(d) of this Article
II are "INITIAL OPTIONS" for purposes hereof.
4
<PAGE>
2. GRANTS OF ADDITIONAL AND SPECIAL OPTIONS.
(a) Prior to January 1, 2000, on each even-numbered (i.e. 2nd, 4th,
6th, 8th, 10th) anniversary of an Eligible Director's election to the Board, if
the Eligible Director has served as a director since his or her election and is
continuing as a director for at least another year, such Eligible Director shall
automatically be granted an "ADDITIONAL OPTION" to purchase up to 8,000 shares
of the Company's Common Stock at an exercise price equal to the fair market
value of the Company's Common Stock on the date of grant, subject to (i) vesting
as set forth in Section 4 of Article II, and (ii) adjustment as set forth in
Article III.
(b) Beginning January 1, 2000, on each anniversary of an Eligible
Director's election to the Board, if the Eligible Director has served as a
director since his or her election and is continuing as a director for at least
another year, such Eligible Director shall automatically be granted an
"ADDITIONAL OPTION" to purchase up to 4,000 shares of the Company's Common Stock
at an exercise price equal to the fair market value of the Company's Common
Stock on the date of grant, subject to (i) vesting as set forth in Section 4 of
Article II and (ii) adjustment as set forth in Article III.
(c) Each Eligible Director who has an odd-numbered (i.e. 1st, 3rd,
5th, 7th) anniversary in 1999 shall receive a "SPECIAL OPTION" on August 17,
1999 to purchase up to 4,000 shares of the Company's Common Stock at an exercise
price equal to the fair market value of the Company's Common Stock on the date
of grant, subject to (i) vesting as set forth in Section 4 of Article II, and
(ii) adjustment as set forth in Article III.
(d) No individual may receive aggregate Additional Options and
Special Options to purchase more than 40,000 shares of the Company's Common
Stock pursuant to this Section.
3. EXERCISE PRICE. The option exercise price shall be payable upon the
exercise of an option in legal tender of the United States or such other
consideration as the administrator may deem acceptable, including without
limitation stock of the Company (delivered by or on behalf of the person
exercising the option or retained by the Company from the Common Stock otherwise
issuable upon exercise), provided, however, that the administrator may, in the
exercise of its discretion, (i) allow exercise of an option in a broker-assisted
or similar transaction in which the exercise price is not received by the
Company until immediately after exercise, and/or (ii) allow the Company to loan
the exercise price to the person entitled to exercise the option, if the
exercise will be followed by an immediate sale of some or all of the underlying
shares and a portion of the sales proceeds is dedicated to full payment of the
exercise price. Upon proper exercise, the Company shall deliver to the person
entitled to
5
<PAGE>
exercise the option or his or her designee a certificate or certificates for the
shares of Common Stock to which the option pertains.
4. VESTING AND EXERCISE.
(a) Initial Options shall vest and become exercisable 50% upon the
first anniversary of the grant date, if the optionee has remained an Eligible
Director for the entire period from the date of grant to the first anniversary
thereof, and 50% upon the second anniversary of the grant date, if the optionee
has remained an Eligible Director for the entire period from the date of grant
to the second anniversary thereof.
(b) Prior to January 1, 2000, Additional Options shall vest and
become exercisable 50% upon the first anniversary of the grant date, if the
optionee has remained an Eligible Director for the entire period from the date
of grant to the first anniversary thereof, and 50% upon the second anniversary
of the grant date, if the optionee has remained an Eligible Director for the
entire period from the date of grant to the second anniversary thereof.
Beginning January 1, 2000, Additional Options shall vest and become exercisable
100% two years from the grant date if the optionee has remained an Eligible
Director for the entire period from the date of grant to the vesting date.
(c) Each Special Option shall vest and become exercisable 100% on the
second anniversary date of the Eligible Director's election to the Board that
occurs following the grant date if the optionee has remained an Eligible
Director for the entire period from the date of grant to the vesting date.
5. OPTION AGREEMENTS. Each option granted under the Plan shall be
evidenced by an option agreement duly executed on behalf of the Company and by
the Eligible Director to whom such option is granted and stating the number of
shares of Common Stock issuable upon exercise of the option, the exercise price,
the time during which the option is exercisable, and the times at which the
options vest and become exercisable. Such option agreements may but need not be
identical and shall comply with and be subject to the terms and conditions of
the Plan, a copy of which shall be provided to each option recipient and
incorporated by reference into each option agreement. Each option agreement may
contain such other terms, provisions and conditions not inconsistent with the
Plan as may be determined by the administrator.
6. TERM OF OPTIONS AND EFFECT OF TERMINATION. Notwithstanding any other
provision of the Plan, no Initial Options, Additional Options or Special Options
shall be exercisable after the expiration of ten years from the effective date
of their grant. In the event that any outstanding option under the Plan expires
by reason of lapse of time or is otherwise terminated without exercise for any
reason, then the shares of Common Stock subject to
6
<PAGE>
any such option which have not been issued pursuant to the exercise of the
option shall again become available in the pool of shares of Common Stock for
which options may be granted under the Plan. In the event that the holder of any
option granted under this Plan shall cease to be a director of the Company for
any reason, all options granted under this Plan to such holder shall be
exercisable, to the extent already exercisable at the date such holder ceases to
be a director, for a period of one year after that date (or, if sooner, until
the expiration of the option according to its terms), and shall then terminate.
In the event of the death of an optionee while such optionee is a director of
the Company or within the period after termination of such status during which
he or she is permitted to exercise an option, such option may be exercised by
any person or persons designated by the optionee on a Beneficiary Designation
Form adopted by the administrator for such purpose or, if there is no effective
Beneficiary Designation Form on file with the Company, by the executors or
administrators of the optionee's estate or by any person or persons who shall
have acquired the option directly from the optionee by his or her will or the
applicable laws of descent and distribution.
ARTICLE III
RECAPITALIZATIONS AND REORGANIZATIONS
1. ANTI-DILUTION ADJUSTMENTS. The number of shares of Common Stock
available for issuance upon exercise of options granted under the Plan, the
maximum number of shares for which options granted under the Plan may be
exercised by any individual, the number of shares for which each option (issued
and unissued) can be exercised, and the exercise price per share of options
(issued and unissued) shall be proportionately adjusted for any increase or
decrease in the number of issued and outstanding shares of Common Stock
resulting from a subdivision or consolidation of shares or the payment of a
stock dividend or any other increase or decrease in the number of issued and
outstanding shares of Common Stock effected without receipt of consideration by
the Company. All share amounts and exercise prices set forth in this amended
plan document have been restated to take into account, and give full effect to,
any and all stock splits implemented since the adoption and approval of the Plan
by shareholders on April 29, 1993 and before April 17, 1996.
2. CORPORATE TRANSACTIONS. If the Company shall be the surviving
corporation in any merger or consolidation, each outstanding option shall
pertain to and apply to the securities to which a holder of the same number of
shares of Common Stock that are subject to that option would have been entitled.
A dissolution or liquidation or change in control of the Company, or a merger or
consolidation in which the Company is not the surviving corporation, shall cause
each outstanding option to terminate, unless the agreement of merger or
consolidation shall otherwise provide; provided that, in the event such
7
<PAGE>
dissolution, liquidation, change in control, merger or consolidation will cause
outstanding options to terminate, each optionee shall have the right immediately
prior to such dissolution, liquidation, merger or consolidation or upon such
change in control to exercise his or her option or options in whole or in part
without regard to any vesting requirements. For purposes hereof, a "change in
control" shall be the acquisition by any person or entity of beneficial
ownership of 50% or more of the Company's outstanding voting securities.
3. DETERMINATION BY THE COMPANY. To the extent that the foregoing
adjustments relate to stock or securities of the Company, such adjustments shall
be made by the administrator, whose determination in that respect shall be
final, binding and conclusive. The grant of an option pursuant to the Plan
shall not affect in any way the right or power of the Company to make
adjustments, reclassifications, reorganizations or changes of its capital or
business structure or to merge or to consolidate or to dissolve, liquidate or
sell, or transfer all of any part of its business or assets.
8
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CALLAWAY
GOLF COMPANY UNAUDITED CONSOLIDATED CONDENSED BALANCE SHEET AND UNAUDITED
CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS AT SEPTEMBER 30, 1999 AND FOR THE
NINE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 75,490
<SECURITIES> 0
<RECEIVABLES> 111,299
<ALLOWANCES> 5,840
<INVENTORY> 98,564
<CURRENT-ASSETS> 310,260
<PP&E> 267,128
<DEPRECIATION> 92,625
<TOTAL-ASSETS> 639,202
<CURRENT-LIABILITIES> 118,666
<BONDS> 0
0
0
<COMMON> 760
<OTHER-SE> 500,130
<TOTAL-LIABILITY-AND-EQUITY> 639,202
<SALES> 598,788
<TOTAL-REVENUES> 598,788
<CGS> 316,707
<TOTAL-COSTS> 316,707
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 513
<INTEREST-EXPENSE> 2,855
<INCOME-PRETAX> 90,727
<INCOME-TAX> 35,562
<INCOME-CONTINUING> 55,165
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 55,165
<EPS-BASIC> $0.78
<EPS-DILUTED> $0.78
</TABLE>
