Callaway 2002 Annual Report Download - page 38

CALLAWAY GOLF COMPANY 35
Sensitivity analysis is the measurement of potential loss in
future earnings of market sensitive instruments resulting from
one or more selected hypothetical changes in interest rates or
foreign currency values. The Company used a sensitivity analysis
model to quantify the estimated potential effect of unfavorable
movements of 10% in foreign currencies to which the Company
was exposed at December 31, 2002 through its derivative
financial instruments.
The sensitivity analysis model is a risk analysis tool and does
not purport to represent actual losses in earnings that will be
incurred by the Company, nor does it consider the potential
effect of favorable changes in market rates. It also does not
represent the maximum possible loss that may occur. Actual
future gains and losses will differ from those estimated because
of changes or differences in market rates and interrelation-
ships, hedging instruments and hedge percentages, timing
and other factors.
The estimated maximum one-day loss from the Company’s
foreign-currency derivative financial instruments, calculated
using the sensitivity analysis model described above, is $14.7
million at December 31, 2002. The portion of the estimated loss
associated with the foreign exchange contracts that offset the
remeasurement gain and loss of the related foreign currency
denominated assets and liabilities is $5.4 million at December
31, 2002 and would impact earnings. The remaining $9.3 million
of the estimated loss at December 31, 2002 is derived from out-
standing foreign exchange contracts designated as cash flow
hedges and would initially impact OCI. The Company believes
that such a hypothetical loss from its derivatives would be
offset by increases in the value of the underlying transactions
being hedged.
Electricity Price Fluctuations
During the second quarter of 2001, the Company entered into
the Enron Contract to manage electricity costs in the volatile
California energy market. This derivative did not qualify for
hedge accounting treatment under SFAS No. 133. Therefore,
the Company recognized 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
reasons, the Company was terminating the energy supply
contract. As a result, the Company adjusted the estimated
value of this contract through the date of termination. Because
the contract is terminated and neither party to the contract is
performing pursuant to the terms of the contract, the terminated
contract ceased to represent a derivative instrument in
accordance with SFAS No. 133. The Company, therefore, 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.” See above “Supply of
Electricity and Energy Contracts.”
Interest Rate Fluctuations
Additionally, the Company is exposed to interest rate risk
from its Amended Credit Agreement (see Note 6 to the
Company’s Consolidated Financial Statements) which is
indexed to the London Interbank Offering Rate. No amounts
were advanced or outstanding under this facility at December
31, 2002. The Accounts Receivable Facility was terminated in
February 2003.
Note 6 to the Company’s Consolidated Financial Statements
outlines the principal amounts, if any, and other terms required
to evaluate the expected cash flows and sensitivity to interest
rate changes.