Callaway 2003 Annual Report Download - page 41

38 CALLAWAY GOLF COMPANY
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, 2003 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 interre-
lationships, 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
$9.9 million at December 31, 2003. 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 $5.0 million at
December 31, 2003 and would impact earnings. The remaining
$4.9 million of the estimated loss at December 31, 2003 is
derived from outstanding 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 $100.0 million credit facility (see Note 7 to the Company’s
Consolidated Condensed Financial Statements). The Credit
Facility is indexed to, at the Company’s election, (i) the higher
of (a) the Federal Funds Rate plus 50.0 basis points or (b) Bank
of America’s prime rate, and in either case less a margin of 50.0
to 100.0 basis points depending upon the Company’s
Consolidated Leverage Ratio or (ii) the Eurodollar Rate (as
such term is defined in the Credit Facility agreement), plus a
margin of 75.0 to 125.0 basis points depending upon the
Company’s Consolidated Leverage Ratio.
In connection with the Top-Flite acquisition, the Company
assumed long-term debt, which was indexed to the U.S.
Treasury Note, plus 300 basis points. The rate on the outstanding
balance was 4.31% in 2003. In November 2003, the Company
paid the loan balance in full.
Note 7 to the Company’s Consolidated Condensed Financial
Statements outlines the principal amounts, if any, and other
terms required to evaluate the expected cash flows and sensitivity
to interest rate changes.