Callaway 2003 Annual Report Download - page 62

CALLAWAY GOLF COMPANY 59
At December 31, 2003, 2002 and 2001, the notional amounts of
the Company’s foreign exchange contracts designated as cash
flow hedges were approximately $44,443,000, $84,843,000 and
$122,550,000, respectively. For derivative instruments that are
designated and qualify as cash flow hedges, the effective portion
of the gain or loss on the derivative instrument is initially
recorded in accumulated other comprehensive income (“OCI”)
as a separate component of shareholders’ equity and subse-
quently reclassified into earnings in the period during which the
hedged transaction is recognized in earnings. During the years
ended December 31, 2003, 2002 and 2001, the Company
recorded the following hedging activity in OCI (in thousands):
During the years ended December 31, 2003 and 2001, no gains
or losses were reclassified into earnings as a result of the discon-
tinuance of cash flow hedges. During the year ended December
31, 2002, gains of $171,000 were reclassified into earnings as a
result of the discontinuance of cash flow hedges.
As of December 31, 2003, $2,519,000 of deferred net losses related
to derivative instruments designated as cash flow hedges were
included in OCI. These derivative instruments hedge transactions
that are expected to occur within the next 12 months. As the
hedged transactions are completed, the related deferred net gain
or loss is reclassified from OCI into earnings. The Company does
not expect that such reclassifications will have a material effect
on the Company’s earnings, as any gain or loss on the derivative
instruments generally would be offset by the opposite effect on
the related underlying transactions.
The ineffective portion of the gain or loss for derivative instru-
ments that are designated and qualify as cash flow hedges is
immediately reported as a component of interest and other
income. For foreign currency contracts designated as cash flow
hedges, hedge effectiveness is measured using the spot rate.
Changes in the spot-forward differential are excluded from the
test of hedging effectiveness and are recorded currently in earnings
as a component of interest and other income. During the years
ended December 31, 2003, 2002 and 2001, the Company record-
ed
net gains of $38,000, $376,000 and $1,988,000, respectively,
as a result of changes in the spot-forward differential.
Assessments of hedge effectiveness are performed using the
dollar offset method and applying a hedge effectiveness ratio
between 80% and 125%. Given that both the hedged item and
the hedging instrument are evaluated using the same spot rate,
the Company anticipates the hedges to be highly effective. The
effectiveness of each derivative is assessed quarterly.
At December 31, 2003, 2002 and 2001, the notional amounts
of the Company’s foreign exchange contracts used to hedge
out
standing balance sheet exposures were approximately
$46,779,000, $49,939,000 and $34,411,000, respectively. The
gains and losses on foreign currency contracts used to hedge
bal-
ance sheet exposures are recognized as a component of interest
and other income in the same period as the remeasurement gain
and loss of the related foreign currency denominated assets and
liabilities and thus offset these gains and losses. During the years
ended December 31, 2003, 2002 and 2001, the Company recorded
net losses of $6,838,000 and $8,148,000 and net gains of
$4,473,000, respectively, due to net realized and unrealized gains
and losses on contracts used to hedge balance sheet exposures.
Years Ended December 31,
(In thousands) 2003 2002 2001
Beginning OCI balance
related to cash flow hedges $ (1,362) $ 6,424 $ (1,599)
Add: Net gain (loss)
initially recorded in OCI (3,858) (3,923) 10,950
Deduct: Net gain (loss)
reclassified from OCI
into earnings (2,701) 3,863 2,927
Ending OCI balance related
to cash flow hedges $ (2,519) $ (1,362) $ 6,424
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 the volatile
California electricity market. The contract was originally effective
through May 2006. This derivative did not qualify for hedge
accounting treatment under SFAS No. 133. Therefore, the
Company recognized in earnings the changes in the estimated
fair value of the contract based on current market rates as
unrealized energy derivative losses. During the fourth quarter
of 2001, the Company notified the energy supplier that, among
other things, the energy supplier was in default of the energy
supply contract and that based upon such default, and
for other