Callaway 2002 Annual Report Download - page 27

24 CALLAWAY GOLF COMPANY
Drivers). While the Company believes it would have had an
additional competitive advantage in the United States and
Canada had the USGA adopted the May 9, 2002 proposal and
raised the COR limit to 0.860, it continues to believe that its
driver products that conform to the 0.830 limit have perform-
ance and other attributes that make many golfers prefer them
over the offerings of competitors.
Supply o f Ele c t ric it y and En e rg y Co ntrac t s
Beginning in the summer of 2000, the Company identified a
future risk to ongoing operations as a result of the deregulation
of the electricity market in California. In July 2000, the Company
entered into a one-year supply agreement with Idaho Power
Company (“Idaho Power”), a subsidiary of Idacorp, Inc., for the
supply of electricity at $64 per megawatt hour. During the
second quarter of 2001, Idaho Power advised the Company that
it was unwilling to renew the contract upon expiration in July
2001 due to concerns surrounding the volatility of the California
electricity market at that time.
As a result, in the second quarter of 2001, the Company entered
into an agreement with Pilot Power Group, Inc. (“Pilot Power”)
as the Company’s energy service provider and in connection
therewith entered into a long-term, fixed-priced, fixed-capacity,
energy supply contract (“Enron Contract”) with Enron Energy
Services, Inc. (“EESI”), a subsidiary of Enron Corporation, as part
of a comprehensive strategy to ensure the uninterrupted supply
of electricity while capping costs in the volatile California
electricity market. The Enron Contract provided, subject to the
other terms and conditions of the contract, for the Company to
purchase nine megawatts of energy per hour from June 1, 2001
through May 31, 2006 (394,416 megawatts over the term of the
contract). The total purchase price for such energy over the full
contract term would have been approximately $43.5 million.
At the time the Company entered into the Enron Contract,
nine megawatts per hour was in excess of the amount the
Company expected to be able to use in its operations. The
Company agreed to purchase this amount, however, in order
to obtain a more favorable price than the Company could have
obtained if the Company had purchased a lesser quantity. The
Company expected to be able to sell any excess supply
through Pilot Power.
Because the Enron Contract provided for the Company to
purchase an amount of energy in excess of what it expected to
be able to use in its operations, the Company accounted for the
Enron Contract as a derivative instrument in accordance with
Statement of Financial Accounting Standards (“SFAS”) No. 133,
“Accounting for Derivative Instruments and Hedging Activities.”
The Enron Contract did not qualify for hedge accounting under
SFAS No. 133. Therefore, the Company recognized changes in
the estimated fair value of the Enron Contract currently in earnings.
The estimated fair value of the Enron Contract was based upon
a present value determination of the net differential between the
contract price for electricity and the estimated future market
prices for electricity as applied to the remaining amount of
unpurchased electricity under the Enron Contract. Through
September 30, 2001, the Company had recorded unrealized
pre-tax losses of $19.9 million ($7.7 million in the second quarter
of 2001 and $12.2 million in the third quarter of 2001).
On November 29, 2001, the Company notified EESI that, among
other things, EESI was in default of the Enron Contract and that
based upon such default, and for other reasons, the Company
was terminating the Enron Contract effective immediately. At
the time of termination, the contract price for the remaining
energy to be purchased under the Enron Contract through May
2006 was approximately $39.1 million.
On November 30, 2001, EESI notified the Company that it
disagreed that it was in default of the Enron Contract and that
it was prepared to deliver energy pursuant to the Enron
Contract. However, on December 2, 2001, EESI, along with
Enron Corporation and numerous other related entities, filed for
bankruptcy. Since November 30, 2001, the parties have not
been operating under the Enron Contract and Pilot Power has
been providing energy to the Company from alternate suppliers.
As a result of the Company’s notice of termination to EESI, and
certain other automatic termination provisions under the Enron
Contract, the Company believes that the Enron Contract has
been terminated. As a result, the Company adjusted the
estimated value of the Enron Contract through the date of
termination, at which time the terminated Enron Contract
ceased to represent a derivative instrument in accordance with
SFAS No. 133. Because the Enron Contract is terminated and
neither party to the contract is performing pursuant to the terms