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 July 31, 2004

OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

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 [  ]

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

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

INDEX

-i-

PART I

FINANCIAL INFORMATION

ASHWORTH, INC. AND SUBSIDIARIES

See accompanying notes to condensed consolidated financial statements.

1

ASHWORTH, INC. AND SUBSIDIARIES

See accompanying notes to condensed consolidated financial statements.

2

ASHWORTH, INC. AND SUBSIDIARIES

See accompanying notes to condensed consolidated financial statements.

3

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 10-K for the year ended October 31, 2003, filed with the SEC on January 30, 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 July 31, 2004 and 2003 were $572,000 and $525,000, respectively. For the nine-month periods ended July 31, 2004 and 2003, shipping expenses were $1,504,000 and $1,357,000, 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.

NOTE 2 – Inventories.

Inventories consisted of the following at July 31, 2004 and October 31, 2003:

4

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 $14,023,000 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 – Acquisition of Membership Interests in Gekko Brands, LLC.

		At close of business on July 6, 2004, Ashworth, Inc. completed the acquisition of all of the membership interests in Gekko Brands, LLC (the “Acquisition”), a leading designer, producer and distributor of headwear and apparel under The Game® and Kudzu® brands, pursuant to the Membership Interests Purchase Agreement entered into on July 6, 2004, between Ashworth Acquisition Corp., a Delaware corporation and wholly owned subsidiary of Ashworth, Inc. and the selling members identified therein.
		The purchase price for the Acquisition was $24 million consisting of $23 million in cash, a $1 million promissory note and $0.7 million in acquisition costs. Up to an additional $6.5 million will be paid to the remaining members of Gekko Brands, LLC management if the subsidiary achieves specific EBIT and other operating targets over approximately the next four years or through Ashworth’s fiscal year 2008. Ashworth intends that the operations of the newly acquired subsidiary will continue to focus on designing, producing and distributing headwear and apparel. Gekko Brands, LLC will be included in the Company’s existing reportable domestic segment.
		In connection with the Acquisition, Ashworth entered into a new secured 5-year bank facility comprised of a $20 million term loan and a $35 million line of credit replacing its prior $55 million facility. To finance the cash purchase price of the Acquisition, Ashworth utilized the term loan together with part of the new line of credit.

5

		The operating results of Gekko Brands, LLC are included in the Company’s consolidated results from the date of acquisition.
		The acquisition has been accounted for using the purchase method in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations. The Company is obtaining a third party valuation of certain tangible and intangible assets acquired with the Gekko brands acquisition and expects to receive the final report prior to October 31, 2004. The following table presents the tentative allocation of the aggregate purchase price for Gekko Brands, LLC based on its estimated fair value of the assets and liabilities acquired:

The $12.3 million allocated to goodwill reflects the benefit the Company expects to realize from expanding its distribution into new channels.

The $10.4 million in other assets includes tradenames, customer lists and non-compete agreements.

Pro Forma Results of Operations

The results of Gekko Brand, LLC’s operations have been included in the consolidated financial statements since July 7, 2004. Had the acquisition been completed as of the beginning of the fiscal year, the Company would have reported pro forma net revenues, net income (loss) and basic and diluted net income (loss) per share amounts as follows (in millions, except per share data):

The pro forma results include interest expense on the Company’s term loan and line of credit that were used to finance the acquisition. The pro forma results also include adjustments for income taxes and deprecation and amortization of assets to give effect for purchase accounting adjustments in recording the acquisition. The pro forma amounts are not indicative of anticipated future results.

6

NOTE 5 – Intangible Assets.

The Company accounts for goodwill and intangible assets in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill and certain intangible assets are not amortized but are subject to an annual impairment test. Changes in goodwill and tradenames during the nine months ended July 31, 2004 were due to the acquisition of Gekko Brands, LLC. The following sets forth the intangible assets by major category:

Intangible assets with definite lives are amortized using the straight-line method over periods ranging from 2 to 10 years. During the three months ended July 31, 2004 and 2003, aggregate amortization expense was approximately $40,000 and $50,000, respectively. During the nine months ended July 31, 2004 and 2003, aggregate amortization expense was approximately $91,000 and $149,000, respectively. Amortization expense related to intangible assets at July 31, 2004 in each of the next five fiscal years and beyond is expected to be as follows:

NOTE 6 – Line of Credit Agreement.

On July 6, 2004, the Company entered into a new business loan agreement with Union Bank of California, N.A., as the administrative agent, and two other lenders. The new loan agreement is comprised of a $20,000,000 term loan and a $35,000,000 revolving credit facility, which expires on July 6, 2009 and is collateralized by substantially all of the assets of the Company other than the Company’s real estate.

Under this loan agreement, interest on the $20,000,000 term loan is fixed at 5.4% for the term of the loan. Interest on the revolving credit facility is charged at the bank’s reference rate. At July 31, 2004, the bank’s reference rate was 4.50%. The loan agreement also provides for optional interest rates based on London interbank offered rates (“LIBOR”) for periods of at least 30 days in increments of $500,000.

7

On September 3, 2004, the Company entered into the First Amendment to the loan agreement to amend Section 6.12(a). The loan agreement, as amended, contains certain financial covenants that include a requirement that the Company maintain (1) a minimum tangible net worth of $74,000,000 plus the net proceeds from any equity securities issued (including net proceeds from stock option exercises) after the date of the loan agreement for the period ending October 31, 2004, and a minimum tangible net worth of $74,000,000, plus 90% of net income after taxes (without subtracting losses) earned in each quarterly accounting period commencing after January 31, 2005, plus the net proceeds from any equity securities issued (including net proceeds from stock option exercises) after the date of the loan agreement, (2) a minimum EBITDA determined on a rolling four quarter basis ranging from $16,500,000 at July 6, 2004 and increasing over time to $27,000,000 at October 31, 2008 and thereafter, (3) a minimum ratio of cash and accounts receivable to current liabilities of 0.75:1.00 for fiscal quarters ending January 31 and April 30 and 1.00:1.00 for fiscal quarters ending July 31 and October 31, and (4) a minimum fixed charge coverage ratio of 1.10:1.00 at April 30, 2004 and 1.25:1.00 thereafter. The loan agreement limits annual lease and rental expense associated with the Company’s new distribution center in Oceanside, California as well as annual capital expenditures in any single fiscal year on a consolidated basis in excess of certain amounts allowed for the acquisition of real property and equipment in connection with the new distribution center. The loan agreement has an additional requirement where, for any period of 30 consecutive days, the total indebtedness under the revolving credit facility may not be more than $15,000,000. The loan agreement also limits the annual aggregate amount the Company may spend to acquire shares of its common stock. The Company is in compliance with, or has obtained waivers for, all of the loan agreement’s financial covenants as of July 31, 2004.

The line of credit under the loan agreement may also be used to finance commercial letters of credit and standby letters of credit. Commercial letters of credit outstanding under this loan agreement totaled $2,532,000 at July 31, 2004 as compared to $5,998,000 outstanding at July 31, 2003 under the prior loan agreement. The Company had $1,750,000 outstanding against the revolving credit facility under this loan agreement at July 31, 2004, compared to $6,000,000 outstanding at July 31, 2003 under the prior agreement. The decrease in outstanding letters of credit and borrowings is primarily due to converting several vendors from letters of credit to open credit terms. The Company had $20,000,000 outstanding on the term loan under this loan agreement at July 31, 2004. At July 31, 2004, $30,718,000 was available for borrowings against the revolving credit facility under this loan agreement.

NOTE 7 – 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 SFAS No. 128, Earnings Per Share:

8

For the quarters ended July 31, 2004 and 2003, the diluted weighted average shares outstanding computation excludes 327,000 and 916,000 options whose impact would have an anti-dilutive effect, respectively. For the nine-month periods ended July 31, 2004 and 2003, the diluted weighted average shares outstanding computation excludes 318,000 and 1,095,000 options whose impact would have an anti-dilutive effect, respectively.

NOTE 8 – Issuance of Common Stock.

Common stock and capital in excess of par value increased by $1,266,000 in the nine months ended July 31, 2004, of which $1,081,000 is due to the issuance of 194,000 shares of common stock on exercise of options and $185,000 is the tax benefit related to the exercise of those options.

NOTE 9 – 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 nine 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 third quarter of fiscal 2004 and the third quarter fiscal 2003, respectively: risk-free interest rate of

9

4.71% in 2004 and 3.34% to 3.43% in 2003; expected volatility of 56.4% in 2004 and 58.0% in 2003; and expected life of 10 years in 2004 and 2003. The following weighted-average assumptions were used for grants during the first nine months of fiscal 2004 and first nine months of fiscal 2003, respectively: risk-free interest rates of 3.73% to 4.71% in fiscal 2004 and 3.34% to 4.01% in fiscal 2003; expected volatility of 56.4% to 58.3% in fiscal 2004 and 58.0% to 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 for all periods.

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 10 – 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 computation of comprehensive income for the periods presented: