NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited consolidated condensed financial statements have been prepared by Callaway Golf Company (the “Company” or “Callaway Golf”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”). Accordingly, certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 filed with the Commission. These consolidated condensed financial statements, in the opinion of management, include all the normal and recurring adjustments necessary for the fair presentation of the financial position, results of operations and cash flows for the periods and dates presented. Interim operating results are not necessarily indicative of operating results for the full year.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates and assumptions.
Recent Accounting Standards
In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-09, "Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting." This amendment is intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The amendment is effective for annual periods beginning after December 15, 2016, and interim periods therein. Early application is permitted. The Company does not expect that the adoption of this amendment will have a material impact on the Company's consolidated condensed financial statements.
In March 2016, the FASB issued ASU No. 2016-04, "Liabilities—Extinguishment of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products." The amendment clarifies when it is acceptable to recognize the unredeemed portion of prepaid gift cards into income, and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the impact of this guidance on its consolidated condensed financial statements and disclosures. As of September 30, 2016, the Company had
$1,206,000
of deferred revenue related to unredeemed gift cards.
In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)."
Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date:
(i) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and
(ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.
Under the new guidance, lessor accounting is largely unchanged and lessees will no longer be provided with a source of off-balance sheet financing. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted.
Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently evaluating the impact this ASU will have on its consolidated condensed financial statements and disclosures.
In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments─Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." The amendment requires (i) equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, (ii) public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and (iii) separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables). This amendment eliminates the
requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. This amendment is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact this ASU will have on its consolidated condensed financial statements and disclosures.
In July 2015, the FASB issued ASU No. 2015-11, "Inventory (Topic 330): Simplifying the Measurement of Inventory." Topic 330, Inventory, currently requires an entity to measure inventory at the lower of cost or market. Market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin. The amendments apply to inventory that is measured using first-in, first-out (FIFO) or average cost. An entity should measure in-scope inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments in this update more closely align the measurement of inventory in GAAP with the measurement of inventory in International Financial Reporting Standards. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The amendments should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The Company does not expect that the adoption of this amendment will have a material impact on its consolidated condensed financial statements.
In August 2014, the FASB issued ASU No. 2014-15, "Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern." This ASU is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures, and provides guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations today in the financial statement footnotes. Until the issuance of this ASU, U.S. GAAP lacked guidance about management’s responsibility to evaluate whether there is substantial doubt about the organization’s ability to continue as a going concern or to provide related footnote disclosures. The amendments are effective for annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early application is permitted for annual or interim reporting periods for which the financial statements have not previously been issued. The Company does not expect that the adoption of this amendment will have a material impact on its consolidated condensed financial statements and disclosures.
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers: (Topic 606)." This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). This ASU will supersede the revenue recognition requirements in Topic 605, "Revenue Recognition," and most industry-specific guidance. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer (e.g., assets within the scope of Topic 360, "Property, Plant, and Equipment," and intangible assets within the scope of Topic 350, "Intangibles-Goodwill and Other") are amended to be consistent with the guidance on recognition and measurement (including the constraint on revenue) in this ASU. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted only for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company does not intend to early adopt the new guidance, and is currently evaluating the adoption method and the impact the adoption will have on its consolidated condensed financial statements and disclosures.
Note 2. Financing Arrangements
In addition to cash on hand, as well as cash generated from operations, the Company relies on its primary and Japan asset-based revolving credit facilities to manage seasonal fluctuations in liquidity and to provide additional liquidity when the Company’s operating cash flows are not sufficient to fund the Company’s requirements. As of
September 30, 2016
, the Company had
no
borrowings outstanding under either facility,
$933,000
in outstanding letters of credit, and
$124,628,000
in cash and cash equivalents. At September 30, 2015, the Company had
no
borrowings outstanding under either facility,
$1,117,000
in outstanding letters of credit, and
$41,592,000
in cash and cash equivalents. The combined maximum amount that could have been outstanding under both facilities on
September 30, 2016
, after letters of credit, was
$97,215,000
, resulting in total available liquidity including cash on hand of
$221,843,000
compared to the maximum amount that could have been outstanding under both facilities on
September 30, 2015
, after letters of credit, of
$106,187,000
, resulting in total available liquidity including cash on hand of
$147,779,000
.
Primary Asset-Based Revolving Credit Facility
The Company's primary credit facility is a Loan and Security Agreement with Bank of America N.A. and other lenders (as amended, the “ABL Facility”), which provides a senior secured asset-based revolving credit facility of up to
$230,000,000
, comprised of a
$160,000,000
U.S. facility, a
$25,000,000
Canadian facility and a
$45,000,000
United Kingdom facility, in each case subject to borrowing base availability under the applicable facility. The amounts outstanding under the ABL Facility are secured by certain assets, including cash (to the extent pledged by the Company), inventory and accounts receivable of the Company’s subsidiaries in the United States, Canada and the United Kingdom.
As of
September 30, 2016
, the Company had
no
borrowings outstanding under the ABL Facility and
$933,000
in outstanding letters of credit. The maximum amount of additional indebtedness (as defined by the ABL Facility) that could have been outstanding on
September 30, 2016
, after outstanding borrowings and letters of credit, was approximately
$83,060,000
. The maximum availability under the ABL Facility fluctuates with the general seasonality of the business and increases and decreases with changes in the Company’s inventory and accounts receivable balances. The maximum availability is at its highest during the first half of the year when the Company’s inventory and accounts receivable balances are higher and is lower during the second half of the year when the Company's inventory levels decrease and its accounts receivable decrease as a result of cash collections and lower sales. Average outstanding borrowings during the
nine
months ended
September 30, 2016
were
$25,105,000
, and the average amount available under the ABL Facility during the nine months ended
September 30, 2016
, after outstanding borrowings and letters of credit, was approximately
$104,896,000
. Amounts borrowed under the ABL Facility may be repaid and borrowed as needed. The entire outstanding principal amount (if any) is due and payable on
June 23, 2019
.
The ABL Facility includes certain restrictions including, among other things, restrictions on the incurrence of additional debt, liens, stock repurchases and other restricted payments, asset sales, investments, mergers, acquisitions and affiliate transactions.
In addition, the ABL Facility imposes restrictions on the amount the Company could pay in annual cash dividends. These restrictions do not materially limit the Company's ability to pay future dividends at the current dividend rate.
As of
September 30, 2016
, the maximum amount that the Company could have paid out in dividends was
$48,560,000
. As of
September 30, 2016
, the Company was in compliance with all financial covenants of the ABL Facility. Additionally, the Company is subject to compliance with a fixed charge coverage ratio covenant during, and continuing
30
days after, any period in which the Company’s borrowing base availability, as amended, falls below
$23,000,000
. The Company’s borrowing base availability was above
$23,000,000
during the
nine
months ended
September 30, 2016
, and the Company was in compliance with the fixed charge coverage ratio as of
September 30, 2016
. Had the Company not been in compliance with the fixed charge coverage ratio as of
September 30, 2016
, the Company's maximum amount of additional indebtedness that could have been outstanding on
September 30, 2016
would have been reduced by
$23,000,000
.
The interest rate applicable to outstanding loans under the ABL Facility fluctuates depending on the Company’s “availability ratio," which is expressed as a percentage of (i) the average daily availability under the ABL Facility to (ii) the sum of the Canadian, the U.K. and the U.S. borrowing bases, as adjusted.
The applicable margin for any month could be reduced by 0.25% if the Company’s availability ratio is greater than or equal to 67% and the Company’s “leverage ratio” (as defined below) is less than 4.0 to 1.0 as of the last day of the month for which financial statements have been delivered, so long as no default or event of default exists.
The Company’s “leverage ratio” is the ratio of the amount of debt for borrowed money to the twelve-month trailing EBITDA (as defined in the ABL Facility), each determined on a consolidated basis. At
September 30, 2016
, the Company’s trailing 12 month average interest rate applicable to its outstanding loans under the ABL Facility, including the fees described below, was
2.59%
.
The ABL Facility provides for monthly fees ranging from
0.25%
to
0.375%
of the unused portion of the ABL Facility, depending on the prior month’s average daily balance of revolver loans and stated amount of letters of credit relative to lenders’ commitments.
The fees incurred in connection with the origination and amendment of the ABL Facility totaled
$4,987,000
, which are amortized into interest expense over the term of the ABL Facility agreement. Unamortized fees at
September 30, 2016
and December 31,
2015
totaled
$1,422,000
and
$1,781,000
, respectively, of which
$517,000
and
$509,000
were included in other current assets, respectively, and
$905,000
and
$1,272,000
were included in other assets, respectively, in the accompanying consolidated condensed balance sheets.
Japan ABL Facility
The Company has a separate asset-based loan and guarantee agreement between its subsidiary in Japan and The Bank of Tokyo-Mitsubishi UFG, Ltd and The Development Bank of Japan (as amended, the "Japan ABL Facility"), which provides a credit
facility of up to
2,000,000,000
Yen (or U.S.
$19,736,000
, using the exchange rate in effect as of
September 30, 2016
) over a
two
-year term, subject to borrowing base availability under the facility. The amounts outstanding are secured by certain assets, including eligible inventory. There were
no
borrowings outstanding under this facility as of September 30, 2016. The maximum amount that could have been outstanding at September 30, 2016 was
1,434,640,000
Yen (or U.S.
$14,155,000
).
The Japan ABL Facility is
subject to an effective interest rate equal to TIBOR plus 0.25%
. At
September 30, 2016
, the trailing 12 month average interest rate applicable to the Company's outstanding loans under the Japan ABL Facility together with fees was
0.35%
and includes certain restrictions including covenants related to certain pledged assets and financial performance metrics. As of
September 30, 2016
, the Company was in compliance with these covenants.
Convertible Senior Notes
In 2012, the Company issued
$112,500,000
of
3.75%
Convertible Senior Notes (the “convertible notes”). The convertible notes were convertible at the option of the note holder at any time on or prior to the close of business on the business day immediately preceding
August 15, 2019
, into shares of common stock at an initial conversion rate of 133.3333 shares per $1,000 principal amount of convertible notes, which is equal to an aggregate of
15,000,000
shares of common stock at a conversion price of approximately
$7.50
per share, subject to customary anti-dilution adjustments. In connection with these convertible notes, the Company incurred transactional fees of
$3,537,000
.
During the second half of 2015, the convertible notes were retired pursuant to certain exchange transactions and shareholder conversions, which resulted, among other things, in the issuance of
15,000,000
shares of the Company's common stock to the note holders. In connection with the retirement of the convertible notes, the Company recorded
$108,955,000
in shareholders' equity as of
December 31, 2015
, net of the outstanding discount of
$3,395,000
. There were
no
convertible notes outstanding as of
September 30, 2016
and
December 31, 2015
.
In connection with the elimination of the convertible notes, the Company accelerated the amortization of transaction fees during the second half of 2015. As a result, there were
no
transaction fees amortized during the three and nine months ended
September 30, 2016
. Total interest and amortization expense recognized in the three and nine months ended September 30, 2015 was
$767,000
and
$3,273,000
, respectively.
Note 3. Earnings (Loss) per Common Share
Basic earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period.
Diluted earnings per common share reflects the potential dilution that could occur if convertible securities, or other contracts to issue common stock, were exercised or converted into common stock. Dilutive securities are included in the calculation of diluted earnings per common share using the treasury stock method and the if-converted method in accordance with Accounting Standards Codification ("ASC") Topic 260, “Earnings per Share.” Dilutive securities include convertible notes, options granted pursuant to the Company’s stock option plans and outstanding restricted stock units and performance share units granted to employees and non-employee directors (see
Note 11
).
Weighted-average common shares outstanding—diluted is the same as weighted-average common shares outstanding—basic in periods when a net loss is reported or in periods when anti-dilution occurs.
The following table summarizes the computation of basic and diluted earnings per share (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Earnings (loss) per common share—basic
|
|
|
|
|
|
|
|
Net income (loss) attributable to Callaway Golf Company
|
$
|
(5,866
|
)
|
|
$
|
(3,617
|
)
|
|
$
|
66,629
|
|
|
$
|
45,020
|
|
Weighted-average common shares outstanding—basic
|
94,081
|
|
|
83,875
|
|
|
94,021
|
|
|
80,030
|
|
Basic earnings (loss) per common share
|
$
|
(0.06
|
)
|
|
$
|
(0.04
|
)
|
|
$
|
0.71
|
|
|
$
|
0.56
|
|
Earnings (loss) per common share—diluted
|
|
|
|
|
|
|
|
Net income (loss) attributable to Callaway Golf Company
|
$
|
(5,866
|
)
|
|
$
|
(3,617
|
)
|
|
$
|
66,629
|
|
|
$
|
45,020
|
|
Interest on convertible debt
|
—
|
|
|
—
|
|
|
—
|
|
|
5,329
|
|
Net income (loss) including assumed conversions
|
$
|
(5,866
|
)
|
|
$
|
(3,617
|
)
|
|
$
|
66,629
|
|
|
$
|
50,349
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding—basic
|
94,081
|
|
|
83,875
|
|
|
94,021
|
|
|
80,030
|
|
Convertible notes weighted-average shares outstanding
|
—
|
|
|
—
|
|
|
—
|
|
|
13,217
|
|
Options and restricted stock
|
—
|
|
|
—
|
|
|
1,666
|
|
|
1,367
|
|
Weighted-average common shares outstanding—diluted
|
94,081
|
|
|
83,875
|
|
|
95,687
|
|
|
94,614
|
|
Dilutive earnings (loss) per common share
|
$
|
(0.06
|
)
|
|
$
|
(0.04
|
)
|
|
$
|
0.70
|
|
|
$
|
0.53
|
|
For the three months ended
September 30, 2016
and 2015, securities outstanding totaling approximately
269,000
shares (comprised of stock options and restricted stock units), and
11,676,000
shares (comprised of stock options and common shares underlying convertible senior notes of
9,711,000
), respectively, have been excluded from the calculation of earnings per common share—diluted as their effect would be antidilutive. For the nine months ended
September 30, 2016
and 2015, securities outstanding totaling approximately
330,000
and
579,000
shares, respectively, comprised of stock options and restricted stock units, have been excluded from the calculation of earnings per common share—diluted as their effect would be antidilutive.
Note 4. Inventories
Inventories are summarized below (in thousands):
|
|
|
|
|
|
|
|
|
|
September 30,
2016
|
|
December 31,
2015
|
Inventories:
|
|
|
|
Raw materials
|
$
|
43,877
|
|
|
$
|
53,876
|
|
Work-in-process
|
1,005
|
|
|
703
|
|
Finished goods
|
112,120
|
|
|
154,304
|
|
|
$
|
157,002
|
|
|
$
|
208,883
|
|
Note 5. Goodwill and Intangible Assets
Goodwill and intangible assets, which consist of trade names, trademarks, trade dress, patents and other intangible assets, were acquired in connection with the acquisition of Odyssey Sports, Inc. in 1997, FrogTrader, Inc. in 2004, and certain foreign distributors. Internally developed intangible assets are expensed as incurred.
The Company’s goodwill and acquired intangible assets with indefinite lives are not amortized, but are subject to an annual impairment test. The Company performs an impairment analysis on its goodwill and intangible assets at least annually and whenever events or changes in circumstances indicate that the carrying value of such assets may not be fully recoverable. Acquired intangible assets with definite lives are amortized over their estimated useful lives and are tested for impairment only when impairment indicators are present.
Goodwill at
September 30, 2016
and December 31, 2015 was
$26,235,000
and
$26,500,000
, respectively. The decrease in goodwill during the
nine
months ended
September 30, 2016
of
$265,000
was due to foreign currency fluctuations.
The following sets forth the intangible assets by major asset class (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Useful
Life
(Years)
|
|
September 30, 2016
|
|
December 31, 2015
|
|
Gross
|
|
Accumulated
Amortization
|
|
Net Book
Value
|
|
Gross
|
|
Accumulated
Amortization
|
|
Net Book
Value
|
Non-Amortizing:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade name, trademark and trade dress and other
|
NA
|
|
$
|
88,590
|
|
|
|
$
|
—
|
|
|
|
$
|
88,590
|
|
|
$
|
88,590
|
|
|
|
$
|
—
|
|
|
|
$
|
88,590
|
|
Amortizing:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Patents
|
2-16
|
|
31,581
|
|
|
|
31,428
|
|
|
|
153
|
|
|
31,581
|
|
|
|
31,389
|
|
|
|
192
|
|
Developed technology and other
|
1-9
|
|
7,981
|
|
|
|
7,981
|
|
|
|
—
|
|
|
7,961
|
|
|
|
7,961
|
|
|
|
—
|
|
Total intangible assets
|
|
|
$
|
128,152
|
|
|
|
$
|
39,409
|
|
|
|
$
|
88,743
|
|
|
$
|
128,132
|
|
|
|
$
|
39,350
|
|
|
|
$
|
88,782
|
|
Aggregate amortization expense on intangible assets was approximately
$59,000
and
$38,000
for the
nine
months ended
September 30, 2016
and 2015, respectively.
Amortization expense related to intangible assets at
September 30, 2016
in each of the next five fiscal years and beyond is expected to be incurred as follows (in thousands):
|
|
|
|
|
Remainder of 2016
|
$
|
13
|
|
2017
|
51
|
|
2018
|
51
|
|
2019
|
38
|
|
|
$
|
153
|
|
Note 6. Joint Venture
Effective July 1, 2016, the Company completed the previously announced joint venture with its long-time apparel licensee, TSI Groove & Sports Co, Ltd., ("TSI"), a premier apparel manufacturer in Japan. The new venture is named Callaway Apparel K.K. and includes the design, manufacture and distribution of Callaway-branded apparel, footwear and headwear in Japan. The Company contributed
$10,333,000
, primarily in cash, for a
52%
ownership of the joint venture, and TSI contributed
$9,538,000
, primarily in inventory, for the remaining
48%
. The valuation of contributed assets is preliminary and subject to change upon completion of this process. Changes in final values are not expected to be material to the consolidated condensed financial statements. The Company has a majority voting percentage on matters pertaining to the business operations and significant management decisions of the joint venture, and as such, the Company is required to consolidate the financial results of the joint venture with the financial results of the Company. The joint venture was consolidated one month in arrears.
As a result of the consolidation, during the three and nine months ended September 30, 2016, the Company recognized
$11,452,000
in net sales from the joint venture and recorded net income attributable to the non-controlling interest of
$127,000
in its consolidated condensed statement of operations. At September 30, 2016, the Company recognized a non-controlling interest of
$9,589,000
in its consolidated condensed balance sheet and consolidated condensed statement of shareholders' equity.
Note 7. Investments
Investment in Topgolf International, Inc.
The Company owns a minority interest in Topgolf International, Inc., doing business as the Topgolf Entertainment Group (“Topgolf”), the owner and operator of Topgolf entertainment centers, which ownership consists of common stock and various classes of preferred stock. In connection with this investment, the Company has a preferred partner agreement with Topgolf in which the Company has preferred signage rights, rights as the preferred supplier of golf products used or offered for use at Topgolf facilities at prices no less than those paid by the Company’s customers, preferred retail positioning in the Topgolf retail stores, access to consumer information obtained by Topgolf, and other rights incidental to those listed above.
In January 2016, the Company invested an additional
$1,260,000
in preferred shares of Topgolf. In February 2016, Topgolf announced that Providence Equity Partners L.L.C. (“Providence Equity”) made a significant minority preferred stock investment in Topgolf (the “Providence Equity Investment”). As required by the terms of the Providence Equity Investment, Topgolf used a
portion of the proceeds it received to repurchase shares from its existing shareholders, other than Providence Equity (the “Topgolf Repurchase Program”). In April 2016, the Company sold approximately
10.0%
or
$5,767,000
(on a cost basis) of its preferred shares in Topgolf under the Topgolf Repurchase Program for
$23,429,000
, which reduced the Company's total investment to
$48,808,000
, and the Company's ownership percentage to approximately
15.0%
. In connection with this sale, during the second quarter of 2016, the Company recognized a gain of approximately
$17,662,000
in other income (expense).
Following the completion of the Providence Equity Investment and the Topgolf Repurchase Program, the Company estimated that the fair value of its Topgolf shares was within the range of
$207,000,000
to
$217,000,000
. This fair value estimate was based solely upon the valuations and pricing in the Providence Equity Investment and related Topgolf Repurchase Program. No discount was attributed to this fair value estimate for any preferred terms, including any shareholder, governance or other rights provided to Providence Equity that may differ from those held by the Company, and no premium was attributed to this fair value estimate for any incremental value that might otherwise apply in the case of a change in control transaction (e.g. an initial public offering or sale of Topgolf). The Company’s Topgolf shares are illiquid and there is no assurance that the Company could sell its shares for the estimated fair value, or at all. Further, this estimate represents the fair value as of a point in time immediately after the Providence Equity Investment and the Topgolf Repurchase Program. Since that time, Topgolf has continued with its new site development plans, including the opening of its flagship site in Las Vegas, Nevada. The value of the Company’s shares is significantly affected by the number of sites opened by Topgolf and, as a result, the range in fair value of the Company's Topgolf shares discussed above may not be indicative of the current fair value of the Company's investment in Topgolf. The current or future value of the Company’s shares may differ materially from the previously estimated fair value. In addition to the number of new Topgolf sites opened, the current or future fair value will be affected by many factors, including the availability of interested and willing buyers, the future performance of the Topgolf business, Topgolf’s future capital structure, potential future dilution, and private and public equity market valuations and market conditions. In the absence of the Providence Equity Investment, it would not have been practicable for the Company to estimate the fair value of its Topgolf shares. In the absence of another transaction indicative of fair market value, the Company does not anticipate that it will be practicable on a cost-benefit basis to estimate the fair value of its Topgolf shares in the future. As the fair value range was derived from the private placement transaction described above, it is categorized within Level 3 of the fair value hierarchy (see
Note 12
).
In addition, in December 2015, the Company and Topgolf entered into a shareholder loan agreement, which resulted in a note receivable from Topgolf for
$3,200,000
. The loan was subject to an annual interest rate of
10.0%
, and was due and payable on March 30, 2016. The loan was paid in full in February 2016.
The Company’s total ownership interest in Topgolf, including the Company's voting rights in the preferred shares of Topgolf, remains at less than 20.0% of the outstanding equity securities of Topgolf. As of
September 30, 2016
, the Company did not have the ability to significantly influence the operating and financing activities and policies of Topgolf, and accordingly, the Company’s investment in Topgolf is accounted for at cost in accordance with ASC Topic 325, “Investments—Other.”
Note 8. Product Warranty
The Company has a stated
two
-year warranty policy for its golf clubs. The Company’s policy is to accrue the estimated cost of satisfying future warranty claims at the time the sale is recorded. In estimating its future warranty obligations, the Company considers various relevant factors, including the Company’s stated warranty policies and practices, the historical frequency of claims, and the cost to replace or repair its products under warranty.
The following table provides a reconciliation of the activity related to the Company’s reserve for accrued warranty expense (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Beginning balance
|
$
|
6,172
|
|
|
$
|
6,447
|
|
|
$
|
5,706
|
|
|
$
|
5,607
|
|
Provision
|
1,163
|
|
|
1,052
|
|
|
4,403
|
|
|
4,321
|
|
Claims paid/costs incurred
|
(1,820
|
)
|
|
(1,484
|
)
|
|
(4,594
|
)
|
|
(3,913
|
)
|
Ending balance
|
$
|
5,515
|
|
|
$
|
6,015
|
|
|
$
|
5,515
|
|
|
$
|
6,015
|
|
Note 9. Income Taxes
The Company calculates its interim income tax provision in accordance with ASC 270, “Interim Reporting,” and ASC 740 “Accounting for Income Taxes” (together, “ASC 740”). At the end of each interim period, the Company estimates the annual effective tax rate for foreign operations and applies that rate to its ordinary foreign quarterly earnings. For the Company's U.S. operations, the Company uses the discrete method to calculate the U.S. interim tax expense as the annual effective rate is not considered a reliable estimate of year-to-date income tax expense. Under the discrete method, the Company determines its U.S. tax expense based upon actual results as if the interim period were an annual period. The Company's full U.S. valuation allowance position and the seasonality of the Company's business create results with significant variations in the customary relationship between income tax expense and pre-tax income for the interim periods. As a result, the Company believes that using the discrete method is more appropriate than the annual effective tax rate method to calculate the income tax provision related to its U.S. operations.
The realization of deferred tax assets, including loss and credit carry forwards, is subject to the Company generating sufficient taxable income during the periods in which the deferred tax assets become realizable. Due to the Company's cumulative pre-tax operating losses generated in the United States from 2009 to 2014, the Company recorded a valuation allowance against its U.S. deferred tax assets. As of
September 30, 2016
, the valuation allowance against the U.S. deferred tax assets was
$164,616,000
. So long as the valuation allowance exists, U.S. income tax expense related to deferred tax assets will be offset by the associated valuation allowance, resulting in an effective U.S. income tax rate substantially different than statutory rates. In evaluating its ability to realize the net deferred tax assets, the Company considered all available positive and negative evidence, including the U.S. business losses in periods prior to 2015, the U.S. business profits in 2015 and for the first nine months in 2016, and future projections of profitability which are subject to uncertainty. As of September 30, 2016, current evidence does not support the realization of these deferred tax assets. During the fourth quarter of 2016, the Company will conduct its 2017 planning and forecasting process as well as its periodic evaluation of deferred tax assets. As part of this process, the Company will evaluate all available evidence in determining the likelihood that it will be able to realize all or some portion of its deferred tax assets. If, upon completing this evaluation, the Company concludes that it is more likely than not that the Company will be able to realize its deferred tax assets, all or a significant portion of the valuation allowance may be reversed at or before the end of the current year. If the Company were to reverse all or a significant portion of the valuation allowance, the Company would realize a significant one-time, non-cash tax benefit in the period of reversal and the Company would then expect to report an effective U.S. income tax rate that is closer to its statutory rates.
The provision for income taxes is primarily comprised of taxes related to the Company's foreign operations. The income tax provision for the three months ended
September 30, 2016
and
2015
was
$1,294,000
and
$1,547,000
, respectively. The income tax provision for the nine months ended
September 30, 2016
and
2015
was
$4,632,000
and
$5,002,000
, respectively. The decrease in the income tax provision in the third quarter and the first nine months of 2016 was primarily due to a decrease in income from foreign jurisdictions compared to the same periods in the prior year.
At
September 30, 2016
, the gross liability for income taxes associated with uncertain tax positions was
$7,660,000
. Of this amount,
$920,000
would benefit the Company’s consolidated condensed financial statements and effective income tax rate, if favorably settled. The unrecognized tax benefit liabilities are expected to decrease by approximately
$181,000
during the next 12 months. The gross liability for uncertain tax positions increased by
$338,000
and
$570,000
for the three and
nine months ended September 30, 2016
, respectively. The increases were primarily due to increases in tax positions taken in the current year.
The Company recognizes interest and penalties related to income tax matters in income tax expense. For the three months ended
September 30, 2016
and
2015
, the Company's provision for income taxes includes expenses of
$54,000
and
$35,000
related to the recognition of interest and penalties, respectively. For the nine months ended
September 30, 2016
and
2015
, the Company's provision for income taxes includes expenses of
$83,000
and
$1,000
related to the recognition of interest and penalties, respectively. As of
September 30, 2016
and December 31,
2015
, the gross amount of accrued interest and penalties included in income taxes payable in the accompanying consolidated condensed balance sheets was
$1,143,000
and
$1,060,000
, respectively.
The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is generally no longer subject to income tax examinations by tax authorities in the following major jurisdictions:
|
|
|
|
Tax Jurisdiction
|
|
Years No Longer Subject to Audit
|
U.S. federal
|
|
2010 and prior
|
California (United States)
|
|
2008 and prior
|
Canada
|
|
2009 and prior
|
Japan
|
|
2009 and prior
|
South Korea
|
|
2011 and prior
|
United Kingdom
|
|
2011 and prior
|
Pursuant to Section 382 of the Internal Revenue Code, use of the Company's net operating losses and credit carry-forwards may be limited significantly if the Company were to experience a cumulative change in ownership of the Company's stock by “5-percent shareholders” that exceeds 50% over a rolling three-year period. The Company does not believe there has been a cumulative change in ownership in excess of 50% during that period. The Company continues to monitor changes in ownership. If such a cumulative change did occur in any three-year period and the Company were limited in the amount of losses it could use to offset taxable income, the Company's results of operations and cash flows could be adversely impacted.
Note 10. Commitments & Contingencies
Legal Matters
The Company is subject to routine legal claims, proceedings and investigations incident to its business activities, including claims, proceedings, and investigations relating to commercial disputes and employment matters. The Company also receives information from time to time claiming that products sold by the Company infringe or may infringe patent, trademark or other intellectual property rights of third parties. One or more such claims of potential infringement could lead to litigation, the need to obtain licenses, the need to alter a product to avoid infringement, a settlement or judgment or some other action or material loss by the Company, which also could adversely affect the Company’s overall ability to protect its product designs and ultimately limit its future success in the marketplace. In addition, the Company is occasionally subject to non-routine claims, proceedings or investigations.
The Company regularly assesses such matters to determine the degree of probability that the Company will incur a material loss as a result of such matters as well as the range of possible loss. An estimated loss contingency is accrued in the Company’s financial statements if it is probable the Company will incur a loss and the amount of the loss can be reasonably estimated. The Company reviews all claims, proceedings and investigations at least quarterly and establishes or adjusts any accruals for such matters to reflect the impact of negotiations, settlements, advice of legal counsel and other information and events pertaining to a particular matter. All legal costs associated with such matters are expensed as incurred.
Historically, the claims, proceedings and investigations brought against the Company, individually and in the aggregate, have not had a material adverse effect upon the consolidated results of operations or financial position of the Company. The Company believes that it has valid legal defenses to the matters currently pending against the Company and the Company intends to vigorously defend itself in such matters. The Company has accrued estimated amounts of liability, if any, where required, appropriate and determinable. Any such accruals may be revised as further information becomes available. The results of any such matters are inherently unpredictable and the resolutions of these matters are subject to many uncertainties and the outcomes are not predictable. Consequently, management is unable to estimate the ultimate aggregate amount of monetary loss, amounts covered by insurance or the financial impact that will result from such matters. In addition, the Company cannot assure that it will be able to successfully defend itself in those matters or that any amounts accrued are sufficient. The Company does not believe that the matters currently pending against the Company will have a material adverse effect on the Company’s consolidated business, financial condition, cash flows or results of operations on an annual basis.
Unconditional Purchase Obligations
During the normal course of its business, the Company enters into agreements to purchase goods and services, including purchase commitments for production materials, as well as endorsement agreements with professional golfers and other endorsers, employment and consulting agreements, and intellectual property licensing agreements pursuant to which the Company is required to pay royalty fees. It is not possible to determine the amounts the Company will ultimately be required to pay under these agreements
as they are subject to many variables including performance-based bonuses, severance arrangements, the Company’s sales levels, and reductions in payment obligations if designated minimum performance criteria are not achieved. As of
September 30, 2016
, the Company has entered into many of these contractual agreements with terms ranging from
one
to
six
years. The minimum obligation that the Company is required to pay under these agreements is
$62,085,000
over the next
six
years. In addition, the Company also enters into unconditional purchase obligations with various vendors and suppliers of goods and services in the normal course of operations through purchase orders or other documentation or that are undocumented except for an invoice. Such unconditional purchase obligations are generally outstanding for periods less than a year and are settled by cash payments upon delivery of goods and services and are not reflected in this total. Future minimum commitments as of
September 30, 2016
, are as follows (in thousands):
|
|
|
|
|
Remainder of 2016
|
$
|
35,867
|
|
2017
|
17,817
|
|
2018
|
5,223
|
|
2019
|
2,691
|
|
2020
|
459
|
|
Thereafter
|
28
|
|
|
$
|
62,085
|
|
Other Contingent Contractual Obligations
During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include (i) intellectual property indemnities to the Company’s customers and licensees in connection with the use, sale and/or license of Company product or trademarks, (ii) indemnities to various lessors in connection with facility leases for certain claims arising from such facilities or leases, (iii) indemnities to vendors and service providers pertaining to the goods and services provided to the Company or based on the negligence or willful misconduct of the Company and (iv) indemnities involving the accuracy of representations and warranties in certain contracts. In addition, the Company has consulting agreements that provide for payment of nominal fees upon the issuance of patents and/or the commercialization of research results. The Company has also issued guarantees in the form of standby letters of credit of
$933,000
as of
September 30, 2016
.
The duration of these indemnities, commitments and guarantees varies, and in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation on the maximum amount of future payments the Company could be obligated to make. Historically, costs incurred to settle claims related to indemnities have not been material to the Company’s financial position, results of operations or cash flows. In addition, the Company believes the likelihood is remote that payments under the commitments and guarantees described above will have a material effect on the Company’s financial condition. The fair value of indemnities, commitments and guarantees that the Company issued during the
nine
months ended
September 30, 2016
was not material to the Company’s financial position, results of operations or cash flows.
Employment Contracts
In addition, the Company has made contractual commitments to each of its officers and certain other employees providing for severance payments, including salary continuation, upon the termination of employment by the Company without substantial cause or by the officer for good reason or non-renewal. In addition, in order to assure that the officers would continue to provide independent leadership consistent with the Company’s best interest, the contracts also generally provide for certain protections in the event of a change in control of the Company. These protections include the payment of certain severance benefits, such as monetary payments and health benefits, upon the termination of employment following a change in control.
Note 11. Share-Based Employee Compensation
As of
September 30, 2016
, the Company had
two
shareholder approved stock plans under which shares were available for equity-based awards: the Callaway Golf Company Amended and Restated 2004 Incentive Plan (the "2004 Incentive Plan") and the 2013 Non-Employee Directors Stock Incentive Plan (the "2013 Directors Plan"). From time to time, the Company grants stock options, restricted stock units, phantom stock units, stock appreciation rights and other awards under these plans.
The table below summarizes the amounts recognized in the financial statements for the three and
nine months ended
September 30, 2016
and 2015 for share-based compensation, including expense for stock options, restricted stock units, phantom stock units, cash settled stock appreciation rights and performance share units.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
(In thousands)
|
Cost of sales
|
$
|
198
|
|
|
$
|
120
|
|
|
$
|
520
|
|
|
$
|
563
|
|
Operating expenses
|
2,067
|
|
|
1,350
|
|
|
6,280
|
|
|
7,574
|
|
Total cost of share-based compensation included in income, before income tax
|
$
|
2,265
|
|
|
$
|
1,470
|
|
|
$
|
6,800
|
|
|
$
|
8,137
|
|
Stock Options
Stock options granted under the 2004 Incentive Plan are valued using the Black-Scholes option-pricing model on the date of grant. The model uses various assumptions, including a risk-free interest rate, the estimated term of the options, the estimated stock price volatility, and the estimated dividend yield. Compensation expense for stock options is recognized over the vesting period and is reduced by an estimate for forfeitures, which is based on the Company’s historical forfeitures of unvested options and awards.
There were
no
stock options granted during the first nine months of 2016 or 2015. Total compensation expense recognized for stock options during the three months ended
September 30, 2016
and 2015 was
$8,000
and
$320,000
, respectively. Total compensation expense recognized for stock options during the
nine months ended
September 30, 2016
and 2015 was
$137,000
and
$1,064,000
, respectively. At
September 30, 2016
, the total amount of unamortized expense related to stock options was
$56,000
, which will be recognized over a weighted-average period of
1.7
years.
Restricted Stock Units
Restricted stock units granted under the 2004 Incentive Plan and 2013 Directors Plan are valued at the Company’s closing stock price on the date of grant and generally vest within a
one
- to
three
-year period. Compensation expense for restricted stock units is recognized over the vesting period and is reduced by an estimate for forfeitures. During the three months ended
September 30, 2016
and 2015, the Company granted
126,000
and
8,000
shares underlying restricted stock units, respectively, at a weighted average grant-date fair value of
$11.49
and
$9.10
, respectively. During the
nine months ended
September 30, 2016
and 2015, the Company granted
665,000
and
556,000
shares underlying restricted stock units, respectively, at a weighted average grant-date fair value of
$9.20
and
$8.30
, respectively.
Total compensation expense, net of estimated forfeitures, recognized for restricted stock units during the three months ended
September 30, 2016
and
2015
was
$1,055,000
and
$865,000
, respectively, and
$3,157,000
and
$2,626,000
for the
nine months ended
September 30, 2016
and 2015, respectively. At
September 30, 2016
, the Company had
$7,466,000
of total unamortized compensation expense related to non-vested restricted stock units under the Company’s share-based payment plans. That cost is expected to be recognized over a weighted-average period of
2.1 years
.
Performance Share Units
Performance share units granted under the 2004 Incentive Plan are stock-based awards in which the number of shares ultimately received depends on the Company's performance against specified metrics over a
one
- to
three
-year performance period from the date of grant. These performance metrics are established by the Company at the beginning of the performance period. At the end of the performance period, the number of shares of stock that could be issued is fixed based upon the degree of achievement of the performance goals. The number of shares that could be issued can range from
0%
to
200%
of the participant's target award. Performance share units are initially valued at the Company's closing stock price on the date of grant. Compensation expense, net of estimated forfeitures, is recognized over the vesting period and will vary based on remeasurements during the performance period. If the performance metrics are not probable of achievement during the performance period, compensation expense would be reversed. The awards are forfeited if the threshold performance metrics are not achieved as of the end of the performance period. The performance units cliff-vest in full on the third anniversary of the date of grant.
The Company granted
420,000
and
509,000
shares underlying performance units during the
nine months ended
September 30, 2016
and 2015, respectively, at a weighted average grant-date fair value of
$8.61
and
$7.96
per share, respectively. There were
no
shares underlying performance units granted during the three months ended
September 30, 2016
or 2015.
During the three months ended
September 30, 2016
and 2015, the Company recognized total compensation expense, net of estimated forfeitures, for performance share units of
$1,073,000
and
$790,000
, respectively, and
$3,170,000
and
$1,846,000
during the
nine
months ended
September 30, 2016
and 2015, respectively. At
September 30, 2016
, unamortized compensation expense related to these awards was
$5,938,000
, which is expected to be recognized over a weighted-average period of
1.4
years.
Phantom Stock Units
Phantom stock units granted under the 2004 Incentive Plan are a form of share-based awards that are indexed to the Company’s stock and are settled in cash. Because phantom stock units are settled in cash, compensation expense recognized over the vesting period will vary based on changes in fair value. Fair value is remeasured at the end of each interim reporting period based on the closing price of the Company’s common stock.
There were
no
phantom stock units granted during the three and
nine
months ended
September 30, 2016
or 2015. The Company did not recognize expense related to phantom stock units as of
September 30, 2016
. The Company recognized
$0
and
$390,000
of compensation expense related to previously granted phantom stock units during the three and
nine
months ended September 30, 2015, respectively. All of the previously granted phantom stock units were fully vested and paid-out as of June 30, 2015.
Stock Appreciation Rights
Cash settled stock appreciation rights ("SARs") granted under the 2004 Incentive Plan are valued using the Black-Scholes option-pricing model on the date of grant. SARs are subsequently remeasured at each interim reporting period based on a revised Black-Scholes value until they are exercised. SARs vest over a
three
-year period. As of
September 30, 2016
, all outstanding SARs were fully vested.
There were
no
SARs granted during the first
nine
months of 2016 or 2015. The Company recognized
$129,000
and reversed
$505,000
of compensation expense related to previously granted SARs during the three months ended
September 30, 2016
and 2015, respectively, and recognized
$336,000
and
$2,211,000
of compensation expense related to previously granted SARs during the nine months ended
September 30, 2016
and 2015, respectively. Accrued compensation expense for these awards was
$427,000
and
$1,460,000
at
September 30, 2016
and December 31, 2015, respectively, which was recorded in accrued employee compensation and benefits in the accompanying consolidated condensed balance sheets.
Note 12. Fair Value of Financial Instruments
Certain of the Company’s financial assets and liabilities are measured at fair value on a recurring and nonrecurring basis. Fair value is defined as the price that would be received to sell an asset or the price paid to transfer a liability (the exit price) in the principal and most advantageous market for the asset or liability in an orderly transaction between market participants. Assets and liabilities carried at fair value are classified using the following three-tier hierarchy:
Level 1
: Quoted market prices in active markets for identical assets or liabilities;
Level 2
: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and
Level 3
: Fair value measurements derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
The following table summarizes the valuation of the Company’s foreign currency forward contracts (see
Note 13
) that are measured at fair value on a recurring basis by the above pricing levels at
September 30, 2016
and December 31,
2015
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
Value
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
September 30, 2016
|
|
|
|
|
|
|
|
Foreign currency forward contracts—asset position
|
$
|
1,408
|
|
|
$
|
—
|
|
|
$
|
1,408
|
|
|
$
|
—
|
|
Foreign currency forward contracts—liability position
|
(5,132
|
)
|
|
—
|
|
|
(5,132
|
)
|
|
—
|
|
|
$
|
(3,724
|
)
|
|
$
|
—
|
|
|
$
|
(3,724
|
)
|
|
$
|
—
|
|
December 31, 2015
|
|
|
|
|
|
|
|
Foreign currency forward contracts—asset position
|
$
|
680
|
|
|
$
|
—
|
|
|
$
|
680
|
|
|
$
|
—
|
|
Foreign currency forward contracts—liability position
|
(342
|
)
|
|
—
|
|
|
(342
|
)
|
|
—
|
|
|
$
|
338
|
|
|
$
|
—
|
|
|
$
|
338
|
|
|
$
|
—
|
|
The fair value of the Company’s foreign currency forward contracts is based on observable inputs that are corroborated by market data. Observable inputs include broker quotes, daily market foreign currency rates and forward pricing curves. Remeasurement gains and losses on foreign currency forward contracts designated as cash flow hedges are recorded in other comprehensive income, and in other income (expense) for non-designated foreign currency forward contracts (see Note 12) .
Disclosures about the Fair Value of Financial Instruments
The carrying values of cash and cash equivalents at
September 30, 2016
and December 31,
2015
are categorized within Level 1 of the fair value hierarchy due to the short-term nature of these balances. The table below illustrates information about fair value relating to the Company’s financial assets and liabilities that are recognized in the accompanying consolidated balance sheets as of
September 30, 2016
and December 31,
2015
, as well as the fair value of contingent contracts that represent financial instruments (in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
December 31, 2015
|
|
Carrying
Value
|
|
Fair
Value
|
|
Carrying
Value
|
|
Fair
Value
|
Money market funds
(1)
|
$
|
73,229
|
|
|
$
|
73,229
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Japan ABL Facility
(2)
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
14,969
|
|
|
$
|
14,969
|
|
Standby letters of credit
(3)
|
$
|
933
|
|
|
$
|
933
|
|
|
$
|
1,030
|
|
|
$
|
1,030
|
|
|
|
(1)
|
The carrying value of the money market funds approximates fair value as the funds are highly liquid and short-term in nature. The funds seek to maintain a stable net asset value of $1.00 per share, and the market value per share of these funds are available in active markets. As such, they are categorized within Level 1 of the fair value hierarchy. The money market funds accrue dividends, which are reinvested and reflected in the carrying value as of September 30, 2016.
|
|
|
(2)
|
The carrying value of the amount outstanding under the Japan ABL Facility approximates the fair value due to the short-term nature of this obligation. The fair value of this debt is categorized within Level 2 of the fair value hierarchy. See Note 2 for information on the Company's credit facilities, including certain risks and uncertainties related thereto.
|
|
|
(3)
|
The carrying value of the Company's standby letters of credit approximates the fair value as they represent the Company’s contingent obligation to perform in accordance with the underlying contracts. There were no amounts outstanding under these letters of credit as of
September 30, 2016
and December 31,
2015
. The fair value of this contingent obligation is categorized within Level 2 of the fair value hierarchy.
|
Nonrecurring Fair Value Measurements
The Company measures certain assets at fair value on a nonrecurring basis at least annually or when certain indicators are present. These assets include long-lived assets, goodwill and non-amortizing intangible assets that are written down to fair value when they are held for sale or determined to be impaired. During each of the
nine months ended
September 30, 2016
and
2015
, the Company did not have any significant assets or liabilities that were measured at fair value on a nonrecurring basis in periods subsequent to initial recognition.
Note 13. Derivatives and Hedging
In the normal course of business, the Company is exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to transactions of its international subsidiaries. As part of its strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, the Company uses designated cash flow hedges and non-designated hedges in the form of foreign currency forward contracts to mitigate the impact of foreign currency translation on transactions that are denominated primarily in Japanese Yen, British Pounds, Euros, Canadian Dollars, Australian Dollars and Korean Won.
The Company accounts for its foreign currency forward contracts in accordance with ASC Topic 815, “Derivatives and Hedging” (“ASC Topic 815”). ASC Topic 815 requires the recognition of all derivative instruments as either assets or liabilities on the balance sheet, the measurement of those instruments at fair value and the recognition of changes in the fair value of derivatives in earnings in the period of change, unless the derivative qualifies as a designated cash flow hedge that offsets certain exposures. Certain criteria must be satisfied in order for derivative financial instruments to be classified and accounted for as a cash flow hedge. Gains and losses from the remeasurement of qualifying cash flow hedges are recorded as a component of other comprehensive income and released into earnings as a component of cost of goods sold or net sales during the period in which the hedged transaction takes place. Gains and losses on the ineffective portion of hedges (hedges that do not meet accounting requirements due to ineffectiveness) and derivatives that are not elected for hedge accounting treatment are immediately recorded in earnings as a component of other income (expense).
Foreign currency forward contracts are used only to meet the Company’s objectives of minimizing variability in the Company’s operating results arising from foreign exchange rate movements. The Company does not enter into foreign currency forward contracts for speculative purposes. The Company utilizes counterparties for its derivative instruments that it believes are credit-worthy at the time the transactions are entered into and the Company closely monitors the credit ratings of these counterparties.
The following table summarizes the fair value of the Company's foreign currency forward contracts as well as the location of the asset and/or liability on the consolidated condensed balance sheets at
September 30, 2016
and December 31,
2015
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Derivatives
|
September 30, 2016
|
|
December 31, 2015
|
Balance Sheet Location
|
|
Fair Value
|
|
Balance Sheet Location
|
|
Fair Value
|
Derivatives designated as cash flow hedging instruments:
|
|
|
|
|
|
|
|
Foreign currency forward contracts
|
Other current assets
|
|
$
|
215
|
|
|
Other current assets
|
|
$
|
520
|
|
|
|
|
|
|
|
|
|
Derivatives not designated as hedging instruments:
|
|
|
|
|
|
|
|
Foreign currency forward contracts
|
Other current assets
|
|
$
|
1,193
|
|
|
Other current assets
|
|
$
|
160
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liability Derivatives
|
September 30, 2016
|
|
December 31, 2015
|
Balance Sheet Location
|
|
Fair Value
|
|
Balance Sheet Location
|
|
Fair Value
|
Derivatives designated as cash flow hedging instruments:
|
|
|
|
|
|
|
|
Foreign currency forward contracts
|
Accounts payable and
accrued expenses
|
|
$
|
1,172
|
|
|
Accounts payable and
accrued expenses
|
|
$
|
296
|
|
|
|
|
|
|
|
|
|
Derivatives not designated as hedging instruments:
|
|
|
|
|
|
|
|
Foreign currency forward contracts
|
Accounts payable and
accrued expenses
|
|
$
|
3,960
|
|
|
Accounts payable and
accrued expenses
|
|
$
|
46
|
|
The Company's foreign currency forward contracts are subject to a master netting agreement with each respective counterparty bank and are therefore net settled at their maturity date. Although the Company has the legal right of offset under the master netting agreements, the Company elected not to present these contracts on a net settlement amount basis, and are therefore presented on a gross basis on the accompanying consolidated condensed balance sheets at
September 30, 2016
and December 31,
2015
.
Cash Flow Hedging Instruments
Beginning in January 2015, the Company entered into foreign currency forward contracts designated as qualifying cash flow hedges to help mitigate the Company's foreign currency exposure on intercompany sales of inventory to its foreign subsidiaries. These contracts generally mature within
12
to
15
months from their inception. At
September 30, 2016
and December 31,
2015
, the notional amounts of the Company's foreign currency forward contracts designated as cash flow hedge instruments were approximately
$34,278,000
and
$55,938,000
, respectively. The reporting of gains and losses on these cash flow hedging instruments depends on whether the gains or losses are effective at offsetting changes in the cash flows of the underlying hedged items. The Company uses the hypothetical derivative method to measure the effectiveness of the foreign currency forward contracts and evaluates the effectiveness on a quarterly basis. The effective portion of the gains and losses on the hedging instruments are recorded in other comprehensive income until recognized in earnings during the period that the hedged transactions take place. Any ineffective portion of the gains and losses from the hedging instruments is recognized in earnings immediately. The Company would discontinue hedge accounting prospectively if (i) it is determined that the derivative is no longer effective in offsetting changes in the cash flows of a hedged item, (ii) when the derivative expires or is sold, terminated, or exercised, (iii) if it becomes probable that the forecasted transaction being hedged by the derivative will not occur, (iv) if a hedged firm commitment no longer meets the definition of a firm commitment, or (v) if it is determined that designation of the derivative as a hedge instrument is no longer appropriate. The Company estimates the fair value of its foreign currency forward contracts based on pricing models using current market rates. These contracts are classified under Level 2 of the fair value hierarchy (see
Note 12
).
As of
September 30, 2016
, the Company recorded a net loss of
$3,345,000
in other comprehensive income (loss) related to its hedging activities. Of this amount, for the three and nine months ended
September 30, 2016
, net losses of
$607,000
and
$879,000
, respectively, were relieved from other comprehensive income and recognized in cost of goods sold for the underlying intercompany sales that were recognized, and net losses of
$202,000
and
$758,000
, respectively, were relieved from other comprehensive income and recognized in net sales for the underlying third party sales. There were
no
ineffective gains or losses recognized during the nine months ended
September 30, 2016
. Forward points of
$118,000
were expensed as incurred for the nine months ended September 30, 2016. Based on the current valuation, the Company expects to reclassify net losses of
$1,152,000
from accumulated other comprehensive income (loss) into net earnings during the next 12 months.
The Company recognized net gains of
$1,018,000
and
$1,130,000
in cost of goods sold for the three and nine months ended September 30, 2015, respectively, and
$62,000
and
$683,000
in other income (expense) for the three and nine months ended September 30, 2015, respectively, as a result of hedge ineffectiveness.
The following tables summarize the net effect of all cash flow hedges on the consolidated condensed financial statements for the three and
nine
months ended
September 30, 2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain (Loss) Recognized in Other Comprehensive Income (Loss)
(Effective Portion)
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
Derivatives designated as cash flow hedging instruments
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Foreign currency forward contracts
|
|
$
|
331
|
|
|
$
|
(156
|
)
|
|
$
|
(3,345
|
)
|
|
$
|
1,999
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain (Loss) Reclassified from Other
Comprehensive Income into Earnings
(Effective Portion)
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
Derivatives designated as cash flow hedging instruments
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Foreign currency forward contracts
|
|
$
|
(809
|
)
|
|
$
|
1,018
|
|
|
$
|
(1,637
|
)
|
|
$
|
1,130
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain Recognized in Other Income (Expense)
(Ineffective Portion)
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
Derivatives designated as cash flow hedging instruments
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Foreign currency forward contracts
|
|
$
|
—
|
|
|
$
|
590
|
|
|
$
|
—
|
|
|
$
|
1,211
|
|
The following table details the amounts reclassified from accumulated other comprehensive loss to cost of goods sold, as well as changes in foreign currency translation for the nine months ended
September 30, 2016
. Amounts are in thousands.
|
|
|
|
|
|
Accumulated other comprehensive loss, December 31, 2015
|
|
$
|
(11,813
|
)
|
Change in fair value of derivative instruments
|
|
(3,345
|
)
|
Amounts reclassified from accumulated other comprehensive income to cost of goods sold
|
|
879
|
|
Amounts reclassified from accumulated other comprehensive income to net sales
|
|
758
|
|
Foreign currency translation adjustments
|
|
4,195
|
|
Accumulated other comprehensive loss, September 30, 2016, before tax
|
|
(9,326
|
)
|
Income tax expense related to items of other comprehensive income
|
|
31
|
|
Less: Comprehensive income attributable to non-controlling interest
|
|
76
|
|
Accumulated other comprehensive loss, September 30, 2016, after tax and non-controlling interest
|
|
$
|
(9,219
|
)
|
Foreign Currency Forward Contracts Not Designated as Hedging Instruments
The Company uses foreign currency forward contracts that are not designated as qualified hedging instruments to mitigate certain balance sheet exposures (payables and receivables denominated in foreign currencies), as well as gains and losses resulting from the translation of the operating results of the Company’s international subsidiaries into U.S. dollars for financial reporting purposes. These contracts generally mature within
12 months
from their inception. At
September 30, 2016
and December 31, 2015, the notional amounts of the Company’s foreign currency forward contracts not designated as hedging instruments used to help mitigate the exposures discussed above were approximately
$78,078,000
and
$43,098,000
, respectively. The increase in foreign currency forward contracts reflects the general timing of when the Company enters into these contracts. The Company estimates the fair values of foreign currency forward contracts based on pricing models using current market rates, and records all derivatives on the balance sheet at fair value with changes in fair value recorded in the statement of operations. The foreign currency contracts are classified under Level 2 of the fair value hierarchy (see
Note 12
).
The following table summarizes the location of net gains and losses in the consolidated condensed statements of operations that were recognized during the three and
nine months ended
September 30, 2016
and 2015, respectively (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Location of Net Gain (Loss) Recognized in Income on
Derivative Instruments
|
|
Amount of Net Gain (Loss) Recognized in Income on
Derivative Instruments
|
Derivatives not designated as hedging instruments
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Foreign currency forward contracts
|
|
Other income (expense), net
|
|
$
|
(50
|
)
|
|
$
|
637
|
|
|
$
|
(9,908
|
)
|
|
$
|
978
|
|
In addition, for the three and nine months ended
September 30, 2016
, the Company recognized net foreign currency gains related to transactions with its foreign subsidiaries of
$1,244,000
and
$3,909,000
, respectively. For the three and nine months ended September 30, 2015, the Company recognized net foreign currency losses related to transactions with its foreign subsidiaries of
$527,000
and
$1,254,000
, respectively.
Note 14. Segment Information
The Company has
two
operating segments that are organized on the basis of products, namely the golf clubs segment and golf balls segment. The golf clubs segment consists of Callaway Golf woods, hybrids, irons and wedges and Odyssey putters. This segment also includes golf apparel and footwear, golf bags, golf gloves, travel gear, headwear and other golf-related accessories, in addition to royalties from licensing of the Company’s trademarks and service marks and sales of pre-owned golf clubs. The golf balls segment consists of Callaway Golf and Strata balls that are designed, manufactured and sold by the Company. There are no significant intersegment transactions.
The table below contains information utilized by management to evaluate its operating segments for the interim periods presented (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Net sales:
|
|
|
|
|
|
|
|
Golf Clubs
|
$
|
155,210
|
|
|
$
|
146,522
|
|
|
$
|
586,445
|
|
|
$
|
577,294
|
|
Golf Balls
|
32,640
|
|
|
29,258
|
|
|
121,052
|
|
|
113,169
|
|
|
$
|
187,850
|
|
|
$
|
175,780
|
|
|
$
|
707,497
|
|
|
$
|
690,463
|
|
Income before income taxes:
|
|
|
|
|
|
|
|
Golf Clubs
|
$
|
2,818
|
|
|
$
|
6,564
|
|
|
$
|
71,166
|
|
|
$
|
69,555
|
|
Golf Balls
|
3,846
|
|
|
3,511
|
|
|
23,210
|
|
|
17,559
|
|
Reconciling items
(1)
|
(11,109
|
)
|
|
(12,145
|
)
|
|
(22,988
|
)
|
|
(37,092
|
)
|
|
$
|
(4,445
|
)
|
|
$
|
(2,070
|
)
|
|
$
|
71,388
|
|
|
$
|
50,022
|
|
Additions to long-lived assets:
|
|
|
|
|
|
|
|
Golf Clubs
|
$
|
5,675
|
|
|
$
|
3,087
|
|
|
$
|
9,587
|
|
|
$
|
7,906
|
|
Golf Balls
|
1,043
|
|
|
565
|
|
|
3,169
|
|
|
1,876
|
|
|
$
|
6,718
|
|
|
$
|
3,652
|
|
|
$
|
12,756
|
|
|
$
|
9,782
|
|
|
|
(1)
|
Reconciling items represent corporate general and administrative expenses and other income (expense) not included by management in determining segment profitability. The reconciling items for the nine months ended
September 30, 2016
include a
$17,662,000
gain that was recognized in the second quarter of 2016 in connection with the sale of approximately
10.0%
of the Company's investment in Topgolf (see
Note 7
), combined with decreases in interest expense and corporate stock compensation, partially offset by an increase in foreign currency exchange losses.
|