Callaway 2001 Annual Report Download - page 39

Callaway Golf Company
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the first half of 2001 there was unusually adverse weather, which affected retail
sales of the Company’s products and made the Company’s customers reluctant
to re-order in quantity.
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 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 that use traditional designs. For example, clubs have been
returned with cracked clubheads, broken graphite shafts and loose medal-
lions. While any breakage or warranty problems are deemed significant to the
Company, the incidence of clubs returned to date has not been material in
relation to the volume of clubs that have been sold.
The Company monitors the level and nature of any golf club 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 adverse-
ly 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 experi-
ence an unusually high incidence of breakage or other product problems.
Golf Balls. The Company has not experienced significant returns of defective
golf balls, and in light of the quality control procedures implemented in the
production of its golf balls, the Company does not expect a significant
amount of defective ball returns. However, if future returns of defective golf
balls were significant, it could have a material adverse effect upon the
Company’s golf ball business.
“Gray Market” Distribution Some quantities of the Company’s products
find their way to unapproved outlets or distribution channels. This “gray mar-
ket” for the Company’s products can undermine authorized retailers and for-
eign wholesale distributors who promote and support the Company’s prod-
ucts, 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. While the Company has taken some lawful steps to limit com-
merce in its products in the “gray market” in both the U.S. and abroad, it has
not stopped such commerce.
International Distribution The Company’s management believes that con-
trolling 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 reorganized a substantial portion of its interna-
tional 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, employees, corporate infrastructure and facilities. The operation of
foreign distribution in the Company’s international markets will continue to
require the dedication of management and other Company resources.
Credit Risk The Company primarily sells its products to golf equipment
retailers directly and through wholly-owned domestic and foreign sub-
sidiaries, and to foreign distributors. The Company performs ongoing cred-
it 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, a downturn in the retail golf equipment
market could result in increased delinquent or uncollectible accounts for
some of the Company’s significant customers. In addition, as the Company
integrates its foreign distribution its exposure to credit risks increases as it no
longer sells to a few wholesalers but rather directly to many retailers. A fail-
ure of a significant portion of the Company’s customers to meet their obli-
gations to the Company would adversely impact the Company’s performance
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. Any significant disruption in the
operation of such systems, either as a result of an internal system malfunction
or infection from an external computer virus, would have a significant adverse
effect upon the Company’s ability to operate its business. Although the
Company has taken steps to mitigate the effect of any such disruptions, there
is no assurance that such steps would be adequate in a particular situation.
Consequently, a significant or extended disruption in the operation of the
Company’s information systems could have a material adverse effect upon the
Company’s operations and therefore financial performance and condition.
Quantitative and Qualitative Disclosures about Market Risk
The Company uses derivative financial instruments for hedging purposes to
limit its exposure to changes in foreign exchange rates. Transactions involving
these financial instruments are with credit-worthy firms. The use of these
instruments exposes the Company to market and credit risk which may at
times be concentrated with certain counterparties, although counterparty
nonperformance is not anticipated. The Company utilized a derivative com-
modity instrument, the Enron Contract, to manage electricity costs in the
volatile California energy market during the period of June 2001 through
November 2001. Pursuant to its terms, the Enron Contract was terminated
and the Company has not entered into another long-term energy contract that
would be considered a derivative commodity instrument. The Company is also
exposed to interest rate risk from its credit facilities and accounts receivable
securitization arrangement. (See above Certain Factors Affecting Callaway
Golf Company — Foreign Currency Risks).
Foreign Currency Fluctuations In 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 manage-
ment strategy includes the use of derivative financial instruments, including
forwards and purchased options to hedge certain of these exposures. The
Company’s objective is to offset gains and losses resulting from these expo-
sures with gains and losses on the derivative contracts used to hedge them,
thereby reducing volatility of earnings. The Company does not enter into
any trading or speculative positions with regard to derivative instruments.
The Company is exposed to foreign currency exchange rate risk inherent pri-
marily in its sales commitments, anticipated sales and assets and liabilities
denominated in currencies other than the U.S. dollar. The Company trans-
acts business in 12 currencies worldwide, of which the most significant to its
operations are the European currencies, Japanese yen, Korean won, Canadian
dollar, and Australian dollar. For most currencies, the Company is a net
receiver of foreign currencies and, therefore, benefits from a weaker U.S. dol-
lar and is adversely affected by a stronger U.S. dollar relative to those foreign
currencies in which the Company transacts significant amounts of business.
The Company enters into foreign exchange contracts to hedge against expo-
sure to changes in foreign currency exchange rates. Such contracts are desig-
nated at inception to the related foreign currency exposures being hedged,
which include anticipated intercompany sales of inventory denominated in
foreign currencies, payments due on intercompany transactions from certain