Callaway 2003 Annual Report Download

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CALLAWAY GOLF COMPANY
2003 ANNUAL REPORT

Table of contents

  • Page 1
    CALLAWAY GOLF COMPANY 2003 ANNUAL REPORT

  • Page 2

  • Page 3
    ... products with noticeably superior customer service, and generates a C O M P A N Y return to our shareholders in excess of the cost of capital. We share every golfer's G O L F passion for the game, and commit our talents and our technology to increasing the satisfaction and enjoyment all golfers...

  • Page 4
    C A L L AWAY GOLF C O M PA N Y 1

  • Page 5
    ... saleable inventories; • $57 million in plant, property and equipment comprising one of the lowest cost production facilities in the United States, a key factor in eliminating more than $20 million in Callaway Golf ball losses annually starting January 1, 2004; • $49 million of intangible assets...

  • Page 6
    ... these setbacks in sales and woods market share, and while negotiating and concluding the Top-Flite transaction, we delivered these positive results for you in 2003: • The new Great Big Bertha II Driver and Fairway Woods • Reflecting the strength of our Callaway Golf business, we achieved net...

  • Page 7
    ... business through a license arrangement with Tour Golf Group, Inc., in 2003. This is another element in our strategy to be "head-to-toe" for golf. Tour Golf Group, Inc., experienced a promising start in the U.S. with sales of over $3.5 million, and will be expanding into Canada and Europe in 2004...

  • Page 8
    ... driver had been years in the making, but the new driver "COR" rules precluded U.S. golfers from using that technology. Second, our wood product line at the moderate price point, consisting of Steelhead stainless steel drivers and fairway woods, lagged behind a market shift to low-cost cast titanium...

  • Page 9
    ... technology in the new Big Bertha Red and Big Bertha Blue models. Moderately priced, these two-piece ionomer-covered balls still benefit from HX aerodynamics and integrated Callaway Golf and Top-Flite R&D. Rounding things out, we offer the Callaway Golf Warbird golf balls at the value range. If you...

  • Page 10
    ... winner Jim Furyk. The Hogan brand also plans to introduce several new club products, including the FTX-Forged Transition irons and CFT Hybrid irons and an expanded line of Ben Hogan Bettinardi putters, including the "Baby Ben" putter that was so successful on tour in 2003. The TopFlite brand will...

  • Page 11
    ...and generates a return to our shareholders in excess of the cost of capital.

  • Page 12
    ... with Accountants on Accounting and Financial Disclosure Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Corporate Data 77 73 78 Our Corporate Commitment 79 Board of Directors | Senior Management C A L L AWAY GOLF C O M PA...

  • Page 13
    ... Callaway Golf and Top-Flite golf ball and golf club manufacturing and research and development operations. These charges reduced the Company's gross profit by approximately $24.1 million, pre-tax (see Notes 2 and 3 to the Consolidated Financial Statements). (3) For 2002, the Company's gross profit...

  • Page 14
    ...the most directly comparable GAAP financial measures, provides useful information to investors by permitting additional relevant period-to-period comparisons of the historical operations of the Callaway Golf business, excluding the operations of the recently acquired Top-Flite Golf business, as well...

  • Page 15
    ... stated two-year warranty policy for its Callaway Golf clubs, although the Company's historical practice has been to honor warranty claims well after the two-year stated warranty period. The Company's policy is to accrue the estimated cost of satisfying future warranty claims at the time the sale is...

  • Page 16
    ... practice has been to honor warranty claims well after the two-year stated warranty period. Prior to the third quarter of 2002, the Company's method of estimating both its implicit and explicit warranty obligation was to utilize data and information based on the cumulative failure rate by product...

  • Page 17
    ... golf ball manufacturing facilities, the TopFlite, Strata and Ben Hogan brands, and all golf-related patents and trademarks. The Company acquired the Top-Flite assets because they provided a unique opportunity to increase significantly the size and profitability of the Company's golf ball business...

  • Page 18
    ... Drivers and Fairway Woods and Big Bertha C4 Drivers. The declines in sales of these products were expected as the Company's products generally sell better in their first year after introduction. Both Big Bertha Hawk Eye VFT Titanium Drivers and Fairway Woods and ERC II Forged C A L L AWAY GOLF...

  • Page 19
    ...in 2003 combined with the additional inventory obsolescence reserves established in 2002 on ERC II Drivers and Big Bertha C4 Drivers. These favorable impacts were offset by a decline in golf ball margins and overall lower average selling prices on golf club and ball products. 16 C A L L AWAY GOLF...

  • Page 20
    ... before taxes was 33% in 2003 as compared to 38% in 2002. The effective tax rate was lower in 2003 as compared to 2002, primarily as a result of the recognition of atypical tax benefits in the current year income tax provision related to the statutory U.S export sales incentive. Net income for the...

  • Page 21
    ... partially offset by the sales generated from the January 2002 introduction of Big Bertha Steelhead III Woods, the February 2002 introduction of Big Bertha C4 Drivers, and the September 2002 introduction of the Great Big Bertha II Titanium Drivers and Fairway Woods. 18 C A L L AWAY GOLF C O M PA...

  • Page 22
    ... to the Rule 35 golf ball. The $8.3 million (15%) increase in sales of accessories and other products was primarily attributable to increased sales resulting from the February 2002 launch of Callaway Golf gloves and the August 2002 launch of the Callaway Golf Forged Wedges. Net sales information by...

  • Page 23
    ...-out pricing for discontinued Rule 35 golf ball products and a price reduction on all golf ball products implemented in August 2002, additional inventory reserves established on ERC II Drivers and Big Bertha C4 Drivers, a customs and duty assessment in Korea, and the $2.3 million charge related to...

  • Page 24
    ...from efforts to consolidate the Callaway Golf and Top-Flite golf ball and golf club manufacturing and research and development operations (see above "Top-Flite Acquisition"). These decreases were partially offset by the addition of Top-Flite property, plant and equipment of $56.7 million and current...

  • Page 25
    ... exclude certain non-cash charges related to the restructuring of the Company's golf ball operations) for any four consecutive quarters may not be less than $50.0 million. The Credit Facility agreement also includes certain other restrictions, including restrictions limiting additional indebtedness...

  • Page 26
    ...Company's golf ball operations related to the Callaway Golf brand have not generated cash flows sufficient to fund these operations. In September 2003, the Company completed the Top-Flite Acquisition. The Company believes that the future combined Callaway Golf and Top-Flite golf ball operations will...

  • Page 27
    ...beyond November 2001. See below "Supply of Electricity and Energy Contracts." In addition to the obligations listed above, the Company has entered into contracts with professional golfers to evaluate and promote Callaway Golf, Odyssey, Top-Flite, Ben Hogan and Strata branded products. Many of these...

  • Page 28
    ...into a long-term, fixed-priced, fixed-capacity, energy supply contract ("Enron Contract") with Enron Energy Services, Inc. ("EESI"), a subsidiary of Enron Corporation, as part of a comprehensive strategy to ensure the uninterrupted supply of electricity while capping costs in the volatile California...

  • Page 29
    ...be able to use in its operations. The Company agreed to purchase this amount, however, in order to obtain a more favorable price than the Company could have obtained if the Company had purchased a lesser quantity. The Company expected to be able to sell any excess supply through Pilot Power. Because...

  • Page 30
    ... included golf ball manufacturing facilities, the Top-Flite, Strata and Ben Hogan brands, and all golf-related patents and trademarks. The Company faces certain challenges associated with this acquisition, including (i) reinvigorating the Top-Flite brand in the marketplace, (ii) the assimilation...

  • Page 31
    ... international operations. Adverse Global Economic Conditions The Company sells golf clubs, golf balls and golf accessories. These products are recreational in nature and are therefore discretionary purchases for consumers. Consumers are generally more willing to make discretionary purchases of golf...

  • Page 32
    ... or profitably integrate these brands or operations or maintain the combined market share previously enjoyed by The Top-Flite Golf Company and Callaway Golf Company. Golf Ball Costs The cost of entering the golf ball business has been significant. The cost of competing in the golf ball business has...

  • Page 33
    ... the Company could engage alternative suppliers to deliver its products in a timely and cost-efficient manner. In addition, many of the components the Company uses to build its golf clubs, including clubheads and shafts, are shipped to the Company via air carrier and ship services. Any significant...

  • Page 34
    ... tour and advertising support and product development. In order for its golf ball business to be successful, the Company will need to integrate the acquired Top-Flite assets with its golf ball manufacturing operations and must produce golf balls at prices and costs that are reasonable and must sell...

  • Page 35
    ... golfers in order to evaluate and promote Callaway Golf, Odyssey, TopFlite and Ben Hogan branded products. The Company has entered into endorsement arrangements with members of the various professional tours, including the Champions Tour, the PGA Tour, the LPGA Tour, the PGA European Tour, the Japan...

  • Page 36
    ... professional tours, and the Company has heavily advertised that fact. 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. The Company from time to time implements programs...

  • Page 37
    ... to these restrictions, the Company's brand could be damaged by the use or misuse of the Company's trademarks in connection with its licensees' products. Product Returns Golf Clubs. The Company supports all of its golf clubs with a limited two-year written warranty. Since the Company does not rely...

  • Page 38
    ... and financial condition. Information Systems All of the Company's major operations, including manufacturing, distribution, sales and accounting, are dependent upon the Company's information computer systems. The Callaway Golf business information systems and the acquired Top-Flite information...

  • Page 39
    ...the normal course of business, the Company is exposed to foreign currency exchange rate risks that could impact the Company's results of operations. The Company's risk management strategy includes the use of derivative financial instruments, including forwards and purchased options, to hedge certain...

  • Page 40
    ... or pricing models using current market rates, and records all derivatives on the balance sheet at fair value. At December 31, 2003, the fair values of foreign currency-related derivatives were recorded as current assets of $0.1 million and current liabilities of $0.8 million. At December 31, 2002...

  • Page 41
    ... its balance sheet, subject to periodic review, in accordance with SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." See above "Supply of Electricity and Energy Contracts." Interest Rate Fluctuations Additionally, the Company is exposed to...

  • Page 42
    CALLAWAY GOLF COMPANY CONSOLIDATED BALANCE SHEETS December 31, (In thousands, except share and per share data) 2003 2002 ASSETS Current assets: Cash and cash equivalents Accounts receivable, net Inventories, net Deferred taxes Other current assets Total current assets Property, plant and ...

  • Page 43
    CALLAWAY GOLF COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31, (In thousands, except per share data) Net sales Cost of sales Gross profit Selling expenses General and administrative expenses Research and development expenses Total operating expenses Income from operations ...

  • Page 44
    ...163 Loss on purchase of leased equipment - Tax benefit (reversal of benefit) from exercise of stock options (982) Non-cash compensation 15 Non-cash energy derivative losses - Net non-cash foreign currency hedging (gains) loss 2,619 Net (gain) loss from sale of marketable securities 98 Deferred taxes...

  • Page 45
    ... in unrealized loss on marketable securities, net of tax Net income Balance, December 31, 2003 78,959 3,484 - (32) - - 283 82,694 879 - - - 4 83,577 133 83,710 $ $ $ $ $ $ The accompanying notes are an integral part of these financial statements. 42 C A L L AWAY GOLF C O M PA N Y

  • Page 46
    ...,523 $ 589,383 Comprehensive Income $ $ (3,297) 4,994 58,375 $ 60,072 $ $ 5,602 (4,958) (92) 69,446 $ 69,998 $ $ 7,396 (751) 92 45,523 $ 52,260 C A L L AWAY GOLF C O M PA N Y 43

  • Page 47
    ... Hawk Eye VFT Tungsten Injected Titanium Irons, Steelhead X-16, Steelhead X-14 and Big Bertha Irons, Odyssey putters and wedges, Callaway Golf wedges, Top-Flite woods, Top-Flite irons and wedges, Ben Hogan irons and wedges, golf balls, golf bags and other golf accessories. The golf ball product line...

  • Page 48
    ... has a stated two-year warranty policy for its golf clubs, although the Company's historical practice has been to honor warranty claims well after the two-year stated warranty period. The Company's policy is to accrue the estimated cost of warranty coverage at the time the sale is recorded. In...

  • Page 49
    ...the time of acquisition and reevaluates such determination at each balance sheet date. Trading securities are carried at quoted fair value, with unrealized gains and losses included in earnings. Available-for-sale securities are carried at quoted fair value, with unrealized gains and losses reported...

  • Page 50
    ...The actual purchase price was dependent in part upon interest rates on the date of purchase. Due to a decline in interest rates, the actual purchase price exceeded the estimated fair value of the equipment. Therefore, in 2002, a charge of $2,300,000 was recorded in cost of sales. Normal repairs and...

  • Page 51
    ... to expense as the options vest and additional options may be granted in future years. The fair value of employee stock options was estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions: Years Ended December 31, 2001 Dividend yield 1.6% Expected...

  • Page 52
    ...Segment Information The Company's operating segments are organized on the basis of products and consist of Golf Clubs and Golf Balls. The Golf Clubs segment consists primarily of Callaway Golf, Top-Flite and Ben Hogan woods, irons, wedges and putters as well as Odyssey putters and other golf-related...

  • Page 53
    ... Callaway Golf, Top-Flite, Ben Hogan and Strata golf balls that are designed, manufactured and sold by the Company. The Company also discloses information about geographic areas. This information is presented in Note 14. Recent Accounting Pronouncements In December 2003, the Securities and Exchange...

  • Page 54
    ... it acquired before January 1, 2004. FIN No. 46(R) applies to public enterprises as of the beginning of the applicable interim or annual period. The Company believes that the adoption of FIN No. 46 and FIN No. 46(R) has not had and will not have a material impact on its financial position or results...

  • Page 55
    ...acquired golf assets, including the use of acquired assets in the manufacture of golf balls and golf clubs and the commercialization of existing Top-Flite, Strata and Ben Hogan brands, patents and trademarks. The Company's consolidated statement of operations include the Company's Top-Flite business...

  • Page 56
    ...2002 as if the acquisition of the Top-Flite golf operations had taken place at the beginning of the periods presented (in thousands, except per share data) . Year Ended December 31, (1) explicit warranty obligations was to utilize data and information based on the cumulative failure rate by product...

  • Page 57
    ...$ Property, plant and equipment, net: Land Buildings and improvements Machinery and equipment Furniture, computers and equipment Production molds Construction-in-process Accumulated depreciation $ Accounts payable and accrued expenses: Accounts payable Accrued expenses Accrued sales programs Accrued...

  • Page 58
    ... to an annual impairment test. The following sets forth the intangible assets by major asset class: December 31, 2003 December 31, 2002 (In thousands) Useful Life (Years) Gross Accumulated Amortization Net Book Value Gross Accumulated Amortization Net Book Value Non-Amortizing: Trade name...

  • Page 59
    ... the annual impairment tests and fair-value analysis for goodwill and other non-amortizing intangible assets, respectively, held throughout the year. There were no impairments or impairment indicators present and no loss was recorded during the year ended December 31, 2003. The value of the trade...

  • Page 60
    ...exclude certain non-cash charges related to the restructuring of the Company's golf ball operations) for any four consecutive quarters may not be less than $50,000,000. The new credit facility agreement also includes certain other restrictions, including restrictions limiting additional indebtedness...

  • Page 61
    ... 31, 2003, 2002 and 2001, the notional amounts of the Company's foreign exchange contracts were approximately $91,222,000, $134,782,000 and $156,961,000, respectively. The Company estimates the fair values of derivatives based on quoted market prices or pricing models using current market rates, and...

  • Page 62
    ... on contracts used to hedge balance sheet exposures. Energy Derivative In the second quarter of 2001, the Company entered into a long-term, fixed-price, fixed-capacity, energy supply contract as part of a comprehensive strategy to ensure the uninterrupted supply of electricity while capping costs in...

  • Page 63
    ... be reported as non-operating income. As of the date of termination of the energy supply contract, the derivative valuation account reflected $19,922,000 of unrealized losses resulting from changes in the estimated fair value of the contract. The fair value of the contract was estimated at the time...

  • Page 64
    ... for as a reduction to shareholders' equity until used in connection with the settlement of employee stock option exercises and employee stock plan purchases. Each period, the shares owned by the GST are valued at the closing market price, with corresponding changes in the GST balance reflected...

  • Page 65
    ... of stock options upon a non-employee Director's initial appointment to the Company's Board of Directors and annually on the anniversary of such appointment. All such grants are made at prices based on the market value of the stock at the date of grant. 2003 1,041 385 1,426 2002 197 439 636 2001...

  • Page 66
    ...entitles the holder, under certain circumstances, to purchase Common Stock of Callaway Golf Company or of the acquiring company at a substantially discounted price 10 days after a person or group publicly announces it has acquired or has tendered an offer for 15% or more of the Company's outstanding...

  • Page 67
    ...options to purchase shares of Common Stock granted to employees, officers, professional endorsers and consultants of the Company. The valuation of options granted to non-employees is estimated using the Black-Scholes option-pricing model. Unearned compensation has been charged for the value of stock...

  • Page 68
    ... 2003, 2002 and 2001, tax benefits related to stock option exercises were $1,784,000, $5,479,000 and $14,520,000, respectively. Such benefits were...management's assessment, it is more likely than not that all the net deferred tax assets will be realized through future earnings. C A L L AWAY GOLF...

  • Page 69
    ... 2002, Callaway Golf Sales Company was served with a complaint filed in the District Court of Sedgwick County, Kansas, Case No. 02C3607, seeking to assert an alleged class action on behalf of Kansas consumers who purchased select Callaway Golf products covered by the New Product Introduction Policy...

  • Page 70
    ... Illinois, Case No. 03-CV-4646. Saso Golf alleges that sales of Callaway Golf's metal woods, including but not limited to the original Callaway Golf Biggest Big Bertha, infringe U.S. Patent No. 5,645,495 and seeks compensatory damages, treble damages, attorney's fees, prejudgment interest, costs and...

  • Page 71
    ... of operations. The Company is also single-sourced or dependent on a limited number of suppliers for the materials it uses to make its golf balls. Many of the materials are customized for the Company. Any delay or interruption in such supplies could have a material 68 C A L L AWAY GOLF C O M PA...

  • Page 72
    ... Endorsement Contracts The Company establishes relationships with professional golfers in order to evaluate and promote Callaway Golf, Odyssey, Top-Flite, Ben Hogan and Strata branded products. The Company has entered into endorsement arrangements with members of the various professional tours...

  • Page 73
    ...consists primarily of Callaway Golf, Top-Flite and Ben Hogan woods, irons, wedges and putters as well as Odyssey putters and other golf-related accessories. The Golf Balls segment consists primarily of Callaway Golf, Top-Flite, Ben Hogan and Strata golf balls that are designed, manufactured and sold...

  • Page 74
    ... Top-Flite, Ben Hogan and Strata brands on apparel, souvenirs and gifts. 2003 2002 $ 309,972 243,454 111,523 66,023 62,247 $ 793,219 2001 $ 392,945 248,872 67,471 54,853 53,931 $ 818,072 Net sales Drivers and Fairway Woods $ 252,420 Irons 271,684 Putters 142,814 Golf Balls 78,378 (*) Accessories...

  • Page 75
    ...the newly acquired Top-Flite business. In order to assist this officer with his relocation across country on such short notice (and because under the Sarbanes-Oxley Act of 2002 the Company is prohibited from making a loan to him), the Company purchased his residence in California at a cost of $2,000...

  • Page 76
    ...opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Callaway Golf Company and subsidiaries as of December 31, 2003 and 2002 and the results of their operations and their cash flows for the years then ended, in conformity with accounting...

  • Page 77
    ..., California March 10, 2004 fairly, in all material respects, the financial position of Callaway Golf Company and Subsidiaries as of December 31, 2001, and the results of their operations and their cash flows for the year ended December 31, 2001 in conformity with accounting principles generally...

  • Page 78
    ... the warranty reserve based upon the best information available to the Company at the time those prior period financial statements were prepared. Despite lengthy discussions between management and KPMG, including consultation with the staff of the Securities and Exchange Commission, management and...

  • Page 79
    ... end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company...

  • Page 80
    ...• Callaway Golf Clubs and Golf Balls • Odyssey Putters • Callaway Golf and Odyssey accessories • Callaway Golf apparel • Callaway Golf tour player profiles, stats and news • Corporate information, financial reports & news releases • Customer Service • International locations and news...

  • Page 81
    ... that each year an amount equal to 1% of the Company's adjusted pre-tax earnings for the previous calendar year will be used for charitable purposes. Giving back to the communities where our employees live and work. It's another thing that sets Callaway Golf apart. 78 C A L L AWAY GOLF C O M PA...

  • Page 82
    ...President, Global Press and Public Relations Richard C. Helmstetter Senior Executive Vice President, Strategic Initiatives Bradley J. Holiday Senior Executive Vice President and Chief Financial Officer Patrice Hutin President and Chief Operating Officer, Callaway Golf Company Steven C. McCracken...

  • Page 83
    ...We share every golfer's passion for the game Photography REX GELERT Printing CONTINENTAL LITHO Art Direction/Design JEFF ADAMOFF | CALLAWAY GOLF

  • Page 84
    Left to right: Richard Helmstetter, Brad Holiday, Larry Dorman, Patrice Hutin, Ron Drapeau, Bob Penicka, Steve McCracken

  • Page 85
    enjoy the game

  • Page 86