Callaway 2001 Annual Report Download - page 51

Callaway Golf Company
49
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 as a sepa-
rate component of shareholders’ equity and subsequently reclassified into
earnings in the period during which the hedged transaction is recognized in
earnings. The Company began utilizing cash flow hedges in the fourth quar-
ter of 2000. During 2001, the Company reclassified $2,927,000 of gains into
earnings related to the release of the effective portion of gains on contracts
designated as cash flow hedges. As of December 31, 2001, the Company
expects to reclassify $6,424,000 of deferred net gains into earnings within the
next twelve months. During 2001 and 2000, no gains or losses were reclassi-
fied into earnings as a result of the discontinuance of any cash flow hedges.
The ineffective gain or loss for derivative instruments that are designated and
qualify as cash flow hedges is reported in interest and other income, net
immediately. For foreign currency contracts designated as cash flow hedges,
hedge effectiveness is measured using the spot rate. Changes in the spot-for-
ward differential are excluded from the test of hedging effectiveness and are
recorded currently in earnings as a component of interest and other income,
net. 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 hedging 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 monthly. During
the years ended December 31, 2001 and 2000, a net gain of $1,988,000 and
a net loss of $174,000, respectively, was recorded in interest and other
income, net representing the ineffective portion of the Company’s derivative
instruments.
At December 31, 2001, 2000, and 1999, the Company had approximately
$34,411,000, $10,457,000 and $7,117,000 of foreign contracts used to hedge
balance sheet exposures outstanding. The gains and losses on foreign curren-
cy contracts used to hedge balance sheet exposures are recognized in interest
and other income, net 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 2001, 2000 and 1999, the Company
recorded net realized and unrealized gains on contracts used to hedge bal-
ance sheet exposures of $4,473,000, $5,299,000 and $358,000, respectively.
Energy Derivative During 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 rea-
sons, the Company was terminating the energy supply contract. As a result,
the Company adjusted the estimated fair value of this contract through the
date of termination, at which time the terminated contract ceased to repre-
sent a derivative instrument in accordance with SFAS No. 133. As the con-
tract is terminated and neither party to the contract is performing pursuant
to the terms of the contract, the Company no longer records future valuation
adjustments for changes in electricity rates. The Company continues to reflect
the derivative valuation account on 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.” Any non-
cash unrealized gains to be recognized upon extinguishment of the derivative
valuation account would be excluded from income from operations.
As of the date of termination, the derivative valuation account reflected
$19,922,000 of unrealized losses resulting from changes in estimated fair value
of the contract. The fair value of the contract was estimated based on market
prices of electricity for the remaining period covered by the contract. The net
differential between the contract price and estimated market prices for future
periods was applied to the volume stipulated in the contract and discounted
on a present value basis to arrive at the estimated fair value of the contract.
The estimate of the fair value of the Company’s energy derivative is highly
subjective and quoted market rates directly relevant to the Company’s local
energy market and for periods extending beyond a 10 to 12-month horizon
are not quoted on a traded market. The Company has relied upon near-term
market quotations and other market information to determine fair value
estimates. In management’s opinion, contract valuation models do not nec-
essarily provide a reliable single measure of the fair value of the energy deriv-
ative because there are no quoted market rates directly relevant to the terms
of the contract and changes in subjective input assumptions can materially
affect the fair value estimates. See Note 11 for a discussion of contingencies
related to the termination of the Company’s derivative energy contract.
NOTE 7
Earnings Per Common Share
The schedule below summarizes the elements included in the calculation of
basic and diluted earnings per common share for the years ended December
31, 2001, 2000 and 1999.
(in thousands, except per share data) Year Ended December 31,
2001 2000 1999
Net income $ 58,375 $ 80,999 $ 55,322
Weighted-average
shares outstanding:
Weighted-average shares
outstanding – Basic 69,809 69,946 70,397
Dilutive securities 1,505 1,466 817
Weighted-average
shares outstanding – Diluted 71,314 71,412 71,214
Earnings per common share:
Basic
Income before cumulative
effect of accounting
change $ 0.84 $ 1.17 $ 0.79
Cumulative effect of
accounting change — (0.01) —
$ 0.84 $ 1.16 $ 0.79
Diluted
Income before cumulative
effect of accounting
change $ 0.82 $ 1.14 $ 0.78
Cumulative effect of
accounting change — (0.01) —
$ 0.82 $ 1.13 $ 0.78
For the years ended December 31, 2001, 2000 and 1999, options outstanding
totaling 8,943,000, 8,931,000 and 10,979,000, respectively, were excluded
from the calculations of earnings per common share, as their effect would
have been antidilutive.