SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended April 30, 2004

OR

For the transition period from                     to                    

Commission file number: 0-18553

Ashworth, Inc.

2765 LOKER AVENUE WEST
CARLSBAD, CA 92008
(Address of Principal Executive Offices)

(760) 438-6610
(Telephone No. Including Area Code)

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 o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

INDEX

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PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

ASHWORTH, INC. AND SUBSIDIARIES

     See accompanying notes to condensed consolidated financial statements.

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ASHWORTH, INC. AND SUBSIDIARIES

See accompanying notes to condensed consolidated financial statements.

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ASHWORTH, INC. AND SUBSIDIARIES

See accompanying notes to condensed consolidated financial statements.

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ASHWORTH, INC. AND SUBSIDIARIES

NOTE 1 - Basis of Presentation.

In the opinion of management, the accompanying condensed consolidated balance sheets and related interim condensed consolidated statements of operations and cash flows include all adjustments (consisting only of normal recurring items) necessary for their fair presentation. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Interim results are not necessarily indicative of results to be expected for the full year.

Certain information in footnote disclosures normally included in financial statements has been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, and consolidated financial statements and notes thereto included in the annual report on Form 10K for the year ended October 31, 2003, filed with the SEC on January 29, 2004.

Shipping and Handling Revenue

The Company includes payments from its customers for shipping and handling in its net revenues line item in accordance with Emerging Issues Task Force (“EITF”) 00-10, Accounting of Shipping and Handling Fees and Costs.

Cost of Goods Sold

The Company includes F.O.B. purchase price, inbound freight charges, duty, buying commissions and overhead in its cost of goods sold line item. Overhead costs include purchasing and receiving costs, inspection costs, warehousing costs, internal transfers costs and other costs associated with the Company’s distribution. The Company does not exclude any of these costs from cost of goods sold.

Shipping and Handling Expenses

Shipping expenses, which consist primarily of payments made to freight companies, are reported in selling, general and administrative expenses. Shipping expenses for the quarters ended April 30, 2004 and 2003 were $618,000 and $520,000 respectively. For the six-month periods ended April 30, 2004 and 2003, shipping expenses were $932,000 and $832,000 respectively.

Reclassifications

Certain reclassifications have been made to the prior period’s condensed consolidated financial statements to conform to classifications used in the current period. These reclassifications had no impact on previously reported results.

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NOTE 2 - Inventories.

Inventories consist of the following at April 30, 2004 and October 31, 2003:

NOTE 3 – Disposal and Acquisition of Fixed Assets.

The Company owned land and two buildings located in Carlsbad, California that were purchased on December 9, 1993 for $3,500,000 and were reported in the domestic segment. On February 24, 2004 the Company completed the sale of the land, buildings and other assets for approximately $5,747,000 and paid off the $2,610,000 balance due on the existing mortgage. The property was sold as a unit on an “as is” basis for a price which exceeded its carrying value. The gain on the sale of the property was recorded in the second quarter of fiscal 2004. The Company has also entered into a lease agreement to lease the facility from the new owner commencing on February 24, 2004 and terminating on December 31, 2004, with an option to renew the term of the lease for a period of 60 days. Under the terms of the lease agreement, the Company pays monthly rent of approximately $47,000 plus taxes, insurance and utilities.

On October 25, 2002, the Company entered into an agreement to purchase the land and building, to be built to the Company’s specifications, in the Ocean Ranch Corporate Center in Oceanside, California. The building was constructed with approximately 200,000 square feet of useable office and warehouse space and will be used by the Company to warehouse, embroider, finish, package and distribute clothing products and related accessories. On April 2, 2004, the Company completed the purchase of the new distribution center in Oceanside, California for approximately $13,686,000 and entered into a secured loan agreement with a bank to finance $11,650,000 of the purchase price. The loan carries a fixed interest rate of 5% and will be amortized over 30 years, but is due and payable on May 1, 2014.

NOTE 4 - Net Income Per Share Information.

Basic net income per share has been computed based on the weighted average number of common shares outstanding during the period. Diluted net income per share has been computed based on the weighted average number of common shares outstanding plus the dilutive effects of common shares potentially issuable from the exercise of common stock options. Common stock options are excluded from the computation of net income per share if their effect is anti-dilutive. The following table sets forth the computation of basic and diluted net income per share based on the requirements of Statement of Accounting Standards (“SFAS”) No. 128, Earnings Per Share:

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For the quarters ended April 30, 2004 and 2003, the diluted weighted average shares outstanding computation excludes 324,000 and 1,867,000 options, respectively, whose impact would have an anti-dilutive effect. For the six-month periods ended April 30, 2004 and 2003, the diluted weighted average shares outstanding computation excludes 320,000 and 1,847,000 options, respectively, whose impact would have an anti-dilutive effect.

NOTE 5 – Stock Option Compensation.

The Company has elected to follow Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its employee stock options. Under APB No. 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The interim information regarding pro forma net income and earnings per share is required by SFAS No. 123, Accounting for Stock Based Compensation, and SFAS No. 148, Accounting for Stock Based Compensation – Transition and Disclosure. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the vesting period of the options.

Compensation expense for options issued to non-employees is based on the fair value of each option estimated at date of grant using the Black-Scholes option-pricing model. The Company made no such grants to non-employees during the first six months of either fiscal year 2004 or fiscal year 2003.

For purposes of the following pro forma disclosures required by SFAS No. 123, the fair value of each option granted after fiscal 1995 has been estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants during the second quarter of fiscal 2004: risk-free interest rate of 3.73%; expected volatility of

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57.0%; and expected life of 10 years. The Company did not grant any options during the second quarter of fiscal 2003. The following weighted-average assumptions were used for grants during the first six months of fiscal 2004 and first six months of fiscal 2003, respectively: risk-free interest rates of 3.73% to 4.49% in fiscal 2004 and 3.98% to 4.01% in fiscal 2003; expected volatility of 57.0% to 58.3% in fiscal 2004 and 58.3% in fiscal 2003; and expected life of 10 years in fiscal 2004 and fiscal 2003. The Company has not paid any cash or other dividends and does not anticipate paying dividends in the foreseeable future; therefore, the expected dividend yield is zero. The Company’s pro forma information is as follows:

The Company did not reflect any stock-based employee compensation expense in the consolidated financial statements for the periods presented in the above table.

NOTE 6 – Issuance of Common Stock.

Common stock and capital in excess of par value increased by $914,000 in the six months ended April 30, 2004, of which $775,000 is due to the issuance of 142,000 shares of common stock on exercise of options and $139,000 is the tax benefit related to the exercise of those options.

NOTE 7 – Comprehensive Income.

The Company includes the cumulative foreign currency translation adjustment as well as the net unrealized gains and loss on cash flow hedges as components of the comprehensive income in addition to net income for the period. The following table sets forth the components of other comprehensive income for the periods presented:

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NOTE 8 – Legal Proceedings.

		On January 22, 1999, Milberg Weiss Bershad Hynes & Lerach LLP filed a class action in the United States District Court for the Southern District of California (“U.S. District Court”) on behalf of purchasers of the Company’s common stock during the period between September 4, 1997 and July 15, 1998. The action was subsequently consolidated with two similar suits and plaintiffs filed their Amended and Consolidated Complaint on December 17, 1999. Upon the Company’s motion, the U.S. District Court dismissed the Complaint with leave to amend on July 18, 2000. On September 18, 2000, plaintiffs served their Second Consolidated Amended Complaint (“Second Amended Complaint”). On November 6, 2000, the Company filed its motion to dismiss the Second Amended Complaint, which the U.S. District Court granted, in part, and denied, in part. The remaining portions of the Second Amended Complaint allege that, among other things, during the class period and in violation of the Securities Exchange Act of 1934, the Company’s financial statements, as reported, did not conform to generally accepted accounting principles with respect to revenues and inventory levels. It further alleges that certain Company executives made false or misleading statements or omissions concerning product demand and that two former executives engaged in insider trading. The plaintiffs seek unspecified damages. The parties are currently in the discovery process. The Company has not to date booked any provision for settlement charges.
		The Company is party to other claims and litigation proceedings arising in the normal course of business. Although the legal responsibility and financial impact with respect to such other claims and litigation cannot currently be ascertained, the Company does not believe that these other matters will result in payment by the Company of monetary damages, net of any applicable insurance proceeds, that, in the aggregate, would be material in relation to the consolidated financial position, liquidity or results of operations of the Company.

NOTE 9 – Segment Information.

The Company defines its operating segments as components of an enterprise for which separate financial information is available and regularly reviewed by the Company’s senior management. The Company has the following two reportable segments: domestic and international. Management evaluates segment performance based primarily on revenues and income from operations. Interest income and expense is evaluated on a consolidated basis and is not allocated to the Company’s business segments. Segment information is summarized (for the dates or periods presented) below:

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

     The Company operates in an industry that is highly competitive and must accurately anticipate fashion trends and consumer demand for its products. There are many factors that could cause actual results to differ materially from the projected results contained in certain forward-looking statements in this report. For additional information, see “Cautionary Statements and Risk Factors,” below.

     Because the Company’s business is seasonal, the current balance sheet balances at April 30, 2004 may more meaningfully be compared to the balances at April 30, 2003, rather than to the balances at October 31, 2003.

Critical Accounting Policies

     In response to the SEC’s Release Numbers 33-8040, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies” and 33-8056, “Commission Statement About Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the Company has identified the following critical accounting policies that affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

     Revenue Recognition. Based on its terms of F.O.B. shipping point, where risk of loss and title transfer to the buyer at the time of shipment, the Company recognizes revenue at the time products are shipped or, for Company stores, at the point of sale. The Company records sales in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition. Under these guidelines, revenue is recognized when all of the following exist: persuasive evidence of a sale arrangement exists, delivery of the product has occurred, the price is fixed or determinable and payment is reasonably assured. Provisions are made in the period of the sale for estimated product returns and sales allowances. The Company also includes payments from its customers for shipping and handling in its net revenues line item in accordance with Emerging Issues Task Force (“EITF”) 00-10, Accounting of Shipping and Handling Fees and Costs.

     Sales Returns and Other Allowances. Management must make estimates of potential future product returns related to current period product revenues. The Company also makes payments and/or grants credits to its customers as markdown (buydown) allowances and must make estimates of such

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potential future allowances. Management analyzes historical returns, current economic trends, changes in customer demand, and sell-through of our products when evaluating the adequacy of the sales returns and other allowances. Significant management judgments and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. Material differences may result in the amount and timing of our revenues for any period if management makes different judgments or utilizes different estimates. The reserves for sales returns and other allowances amounted to $1.1 million at April 30, 2004 compared to $728,000 at October 31, 2003 and $575,000 at April 30, 2003.

     Allowance for Doubtful Accounts. Management must also make estimates of the uncollectability of accounts receivable. The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments, which results in bad debt expense. Management determines the adequacy of this allowance by analyzing historical bad debts, continually evaluating individual customer receivables considering the customer’s financial condition and current economic conditions. During the second quarter of fiscal 2003 the Company wrote off the $2.5 million unpaid principal balance of an unsecured promissory note and approximately $2.0 million of receivables due from a national retail customer which had filed for protection under U.S. bankruptcy laws, against the $4.5 million previously reserved by the Company for these specific receivables. If the financial condition of other significant customers of ours were to deteriorate, resulting in the impairment of their ability to make payments, material additional allowances for doubtful accounts may be required. In October 2002, the Company acquired credit insurance to cover many of its major accounts. Our trade accounts receivable balance was $48.1 million, net of allowances for doubtful accounts of $1.1 million at April 30, 2004 as compared to the balance of $31.0 million, net of allowances for doubtful accounts of $1.3 million at October 31, 2003. At April 30, 2003, the trade accounts receivable balance was $48.5 million, net of allowances for doubtful accounts of $1.3 million.

     Inventory. The Company writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated net realizable value based on assumptions about age of the inventory, future demand and market conditions. This process provides for a new basis for the inventory until it is sold. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Our inventory balance was $43.5 million, net of inventory write-downs of $0.7 million at April 30, 2004 as compared to an inventory balance of $44.5 million, net of inventory write-downs of $1.0 million at October 31, 2003. At April 30, 2003, the inventory balance was $43.4 million, net of inventory write-downs of $0.8 million.

     Asset Purchase Credits. In November 2000, the Company entered into an agreement with a third party whereby prior seasons’ slower selling inventory which was not damaged was exchanged for future asset purchase credits (“APCs”), which may be utilized by the Company to purchase future goods and services over a four-year period. The original value of the inventory exchanged (at cost) was $1.4 million resulting in $1.4 million in future APCs. In December 2003, the Company amended its agreement with the third party to exchange $0.9 million of additional prior seasons’ slower selling inventory (at cost) for an additional $0.9 million in future APCs and an extension of the original November 2000 agreement through December 2007. The Company has entered into contracts with several third party suppliers who have agreed to accept these APCs, in part, as payment for goods and services. The Company purchases products such as sales fixtures, office and packaging supplies, as well as temporary help, freight and printing services from such third party suppliers. From time to time the Company may enter into additional contracts with such third party suppliers to use the APCs. Management reviews and estimates the likelihood of fully utilizing the APCs on a periodic basis. If the Company is unable to find suppliers who agree to accept the APCs in quantities as projected by management, a write-down of the value of the APCs may be required. At April 30, 2004, the Company had $1.1 million of the APCs remaining and management expects to fully utilize them over the remaining life of the contract through December 2007.

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The Company recorded $0.3 million of the APC’s in its “Other Current Assets” line item and $0.8 million in its “Other Assets” line item.

Off-Balance Sheet Arrangements

     At April 30, 2004 and 2003, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, the Company does not engage in trading activities involving non-exchange traded contracts which rely on estimation techniques to calculate fair value. As such, the Company is not exposed to any financing, liquidity, market or credit risk that could arise if the Company had engaged in such relationships.

Overview

     The Company earns revenues and income and generates cash through the design, marketing and distribution of quality men’s and women’s sports apparel under the Ashworth^® and Callaway Golf apparel brands. The Company’s products are sold in the United States, Europe, Canada and various other international markets to selected golf pro shops, resorts, off-course specialty shops, upscale department stores, to top specialty-advertising firms for the corporate market as well as in the Company’s own stores. Nearly all of the Company’s production is through “full package” purchases of ready-made goods with approximately 85% of its products manufactured in Asian countries. The Company embroiders a majority of these garments with custom golf course, tournament and corporate logos for its customers.

     The Company includes F.O.B. purchase price, inbound freight charges, duty, buying commissions and overhead in its cost of goods sold line item. Overhead costs include purchasing and receiving costs, inspection costs, warehousing costs, internal transfers costs and other costs associated with the Company’s distribution. The Company does not exclude any of these costs from cost of goods sold.

     During the second quarter of fiscal 2004 the Company completed two transactions relating to its distribution facilities. In February 2004, the Company completed the sale and lease-back of its old distribution center located in Carlsbad, California. The Company sold the Carlsbad distribution center for $5,747,000 and realized a gain on sale of fixed assets of $1,589,000. In April 2004, the Company completed the purchase of the new distribution facility in Oceanside, California for $13,686,000. The Company applied the tax deferred gain on sale of the old facility to reduce the cost basis of the new facility, for tax purposes, utilizing a tax-deferred exchange under Internal Revenue Code section 1031.

     Second quarter fiscal 2004 net revenue increased 4.0% to $54,672,000 as compared to $52,595,000 for the same period of the prior year. The increase was primarily driven by net revenue increases in its retail, international and corporate channels, offset by a decrease in net revenues from the Company owned stores while net revenues in our domestic core golf and off-course specialty distribution channel were essentially flat. The net revenues growth, combined with improved gross margins and controlled expenses, and the $1.0 million after tax gain on sale of the Company’s facilities in Carlsbad, California, resulted in second quarter net income of $5,663,000 or $0.41 per diluted share, compared to net income of $4,282,000 or $0.33 per diluted share in the same quarter of last fiscal year.

Results of Operations

Second quarter 2004 compared to second quarter 2003

     Consolidated net revenues for the second quarter of fiscal 2004 increased 4.0% to $54,672,000

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from $52,595,000 for the same period in 2003 primarily due to higher revenues from the Company’s retail and corporate distribution channels as well as the international segment.

     Net revenues for the domestic segment increased 2.3% to $44,450,000 for the second quarter of fiscal 2004 from $43,440,000 in the second quarter of fiscal 2003. Net revenues from the Company’s retail distribution channel increased 24.3% or $973,000 as compared to the second quarter of fiscal 2003. The increase in the retail distribution channel in the second quarter of fiscal 2004 as compared to the same period of the prior fiscal year is primarily from the addition of retail-specific product offerings and the implementation of the resort shop concept in retail locations. Net revenues from the Company’s corporate distribution channel increased 5.1% or $273,000 in the current quarter as compared to the same quarter of the prior fiscal year. The increase in the corporate distribution channel in the current quarter was primarily due to the addition of the Callaway Golf apparel Sport line to the product lines offered by the corporate distribution channel, as well as the improving economy. These increases were partially offset by a decrease in the net revenues from the Company owned stores in the current quarter as compared to the same quarter in the prior fiscal year. Net revenues from the Company owned stores decreased 13.3% or $214,000 due to the closing of two of the nine Company owned stores. Net revenues from the Company’s golf related distribution channel were essentially flat as compared to the same quarter of the prior fiscal year.

     Net revenues for the international segment increased 11.7% to $10,222,000 from $9,155,000 for the same period of the prior fiscal year. The increase was primarily due to higher revenues in the Company’s U.K. subsidiary and Canadian divisions resulting from the fluctuations in currency exchange rates as well as a slight increase in net revenues from other international territories.

     Consolidated gross margin for the quarter increased 80 basis points to 42.6% as compared to 41.8% a year earlier. This increase was primarily due to reduced costs resulting from improved international product sourcing.

     Consolidated selling, general, and administrative (“SG&A”) expenses increased 2.6% to $15,087,000 for the second quarter of fiscal 2004 from $14,712,000 for the same period in fiscal 2003. This increase was primarily due to higher sales related variable expense resulting from the higher revenues. As a percentage of net revenues, SG&A expenses decreased slightly to 27.6% of net revenues for the second quarter of fiscal 2004 compared to 28.0% in the second quarter of fiscal 2003.

     Total other income increased to $1,218,000 for the second quarter of fiscal 2004 from an expense of $111,000 in the second quarter of fiscal 2003, due primarily to a $1,532,000 net gain on disposal of fixed assets offset by the currency transaction loss recorded in the second quarter of fiscal 2004 as compared to a currency transaction gain recorded by the Company’s U.K. subsidiary in the same period of the prior fiscal year.

     The effective income tax rate for the second quarter of fiscal 2004 remained unchanged form the same period of fiscal year 2003 at 40.0% of pre-tax income.

Six months ended April 30, 2004 compared to six months ended April 30, 2003

     Consolidated net revenues for the first half of fiscal 2004 increased 3.6% to $82,010,000 from $79,158,000 for the same period in fiscal 2003 primarily due to higher revenues from its retail and corporate distribution channels as well as the international segment, partially offset by a decrease in net revenues from the Company’s golf related distribution channel.

     Net revenues for the domestic segment increased 0.8% to $67,511,000 in the first six months of

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fiscal 2004 from $66,977,000 in the first half of fiscal 2003. Net revenues from the Company’s retail distribution channel increased 45.3% or $2,699,000 in the first six months of fiscal 2004 as compared to the same period of fiscal 2003. The increase in the retail distribution channel in the first half of fiscal 2004 as compared to the same period of the prior fiscal year is primarily due to increased number of doors as well as slightly higher comparable store sales resulting from retail-specific product offerings and the implementation of the resort shop concept in retail locations. Net revenues from the Company’s corporate distribution channel increased 5.4% or $536,000 in the first half of fiscal 2004 as compared to the same period of the prior fiscal year. The increase in the corporate distribution channel was primarily due to the addition of the Callaway Golf apparel Sport line to the product lines offered by the corporate distribution channel, as well as the improving economy. These increases were partially offset by a decrease in the net revenues from the Company’s golf related distribution channel as well as from the Company owned stores. Net revenues from the Company’s golf related distribution channel decreased 4.2% or $2,032,000 in the first half of fiscal 2004 as compared to the first half of fiscal 2003. This decrease was primarily due to continuing industry weakness resulting in a reduction in the average order size. Net revenues from the Company owned stores decreased 20.2% or $669,000 primarily due to the closing of two of the nine Company owned stores.

     Net revenues for the international segment increased 19.0% to $14,499,000 in the first half of fiscal 2004 from $12,181,000 for the same period of the prior fiscal year. The increase was primarily due to higher revenues in the Company’s U.K. subsidiary and Canadian divisions of which $1,549,000 was due to the weakening of the U.S. dollar against the British pound and Canadian dollar during the first half of fiscal 2004. Net revenues from the Company’s U.K. subsidiary in the first half of fiscal 2004 increased by $1,806,000 or 25.4% compared to the same period of the prior fiscal year, of which $1,094,000 was due to fluctuations in currency exchange rates. The balance of the increase was due to an increased number of accounts as well as an increased average order size. Net revenue from the Canadian divisions increased by $514,000 or 14.5% as compared to net