Topgolf Callaway Brands 10Q 2001 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


	x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2001


	o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-10962

CALLAWAY GOLF COMPANY

(Exact name of registrant as specified in its charter)






Delaware		95-3797580
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

2180 Rutherford Road, Carlsbad, CA 92008-8815

(760) 931-1771

(Address, including zip code, and telephone number, including area code, of principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o.

The number of shares outstanding of the Registrant’s Common Stock, $.01 par value, as of July 31, 2001 was 82,397,373.

Important Notice:Statements made in this report that relate to future plans, events, financial results or performance, including statements relating to future liquidity, are forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. These statements are based upon current information and expectations. Actual results may differ materially from those anticipated as a result of certain risks and uncertainties. For details concerning these and other risks and uncertainties, see below — Certain Factors Affecting Callaway Golf Company, as well as the Company’s other periodic reports on Forms 10-K, 10-Q and 8-K subsequently filed with the Securities and Exchange Commission from time to time. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Investors also should be aware that while the Company from time to time does communicate with securities analysts, it is against the Company’s policy to disclose to them any material non-public information or other confidential commercial information. Furthermore, the Company has a policy against issuing or confirming financial forecasts or projections issued by securities analysts and any reports issued by such analysts are not the responsibility of the Company. Investors should not assume that the Company agrees with any report issued by any analyst or with any statements, projections, forecasts or opinions contained in any such report.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements
		CONSOLIDATED CONDENSED BALANCE SHEETS
		CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
		CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
		CONSOLIDATED CONDENSED STATEMENTS OF SHAREHOLDERS’ EQUITY
		NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures about Market Risk
PART II. OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 3. Defaults Upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits and Reports on Form 8-K
EXHIBIT 10.50
EXHIBIT 10.51
EXHIBIT 10.52
EXHIBIT 10.53

CALLAWAY GOLF COMPANY

INDEX


		Page

PART I FINANCIAL INFORMATION
Item 1.	Financial Statements




	Consolidated Condensed Balance Sheets at June 30, 2001 and December 31, 2000		1




	Consolidated Condensed Statements of Operations for the three and six months ended June 30, 2001 and 2000		2




	Consolidated Condensed Statements of Cash Flows for the six months ended June 30, 2001 and 2000		3




	Consolidated Condensed Statements of Shareholders’ Equity for the six months ended June 30, 2001		4




	Notes to Consolidated Condensed Financial Statements		5




Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		11




Item 3.	Quantitative and Qualitative Disclosures about Market Risk		23




PART II OTHER INFORMATION




Item 1.	Legal Proceedings		25




Item 2.	Changes in Securities and Use of Proceeds		26




Item 3.	Defaults Upon Senior Securities		26




Item 4.	Submission of Matters to a Vote of Security Holders		26




Item 5.	Other Information		26




Item 6.	Exhibits and Reports on Form 8-K		27

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CALLAWAY GOLF COMPANY

CONSOLIDATED CONDENSED BALANCE SHEETS

(In thousands, except share and per share data)


			June 30,			December 31,
			2001			2000

			(Unaudited)
ASSETS




Current assets:




	Cash and cash equivalents		$	131,831		$	102,596




	Accounts receivable, net (Note 5)			141,936			58,836




	Inventories, net			138,810			133,962




	Deferred taxes			24,773			29,354




	Other current assets			14,452			17,721

		Total current assets		451,802			342,469




Property, plant and equipment, net				132,611			134,712




Intangible assets, net				124,441			112,824




Other assets				37,402			40,929

			$	746,256		$	630,934


LIABILITIES AND SHAREHOLDERS’ EQUITY




Current liabilities:




	Accounts payable and accrued expenses		$	56,187		$	44,173




	Accrued employee compensation and benefits			29,709			22,574




	Accrued warranty expense			38,212			39,363




	Income taxes payable						3,196

		Total current liabilities		124,108			109,306




Long-term liabilities				21,520			9,884
Commitments and contingencies (Note 7)




Shareholders’ equity:
	Preferred Stock, $.01 par value, 3,000,000 shares authorized, none issued and outstanding at June 30, 2001 and December 31, 2000




	Common Stock, $.01 par value, 240,000,000 shares authorized, 82,407,373 and 78,958,963 issued at June 30, 2001 and December 31, 2000, respectively			824			790




	Paid-in capital			388,876			347,765




	Unearned compensation			(636	)		(1,214	)




	Retained earnings			400,780			349,681




	Accumulated other comprehensive income			(5,477	)		(6,096	)




	Less: Grantor Stock Trust (5,300,000 shares) at market value			(83,740	)		(98,713	)

				700,627			592,213




	Less: Common Stock held in treasury, at cost, 5,837,441 shares and 4,815,241 shares at June 30, 2001 and December 31, 2000, respectively			(99,999	)		(80,469	)

		Total shareholders’ equity		600,628			511,744

			$	746,256		$	630,934

The accompanying notes are an integral part of these financial statements.

CALLAWAY GOLF COMPANY

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)



				Three Months Ended									Six Months Ended
				June 30,									June 30,


				2001					2000				2001					2000






Net sales				$	253,655		100	%	$	289,922	100	%	$	515,021		100	%	$	487,328		100	%




Cost of goods sold					121,719		48	%		145,415	50	%		246,177		48	%		254,556		52	%

		Gross profit			131,936		52	%		144,507	50	%		268,844		52	%		232,772		48	%




Operating expenses:




	Selling				54,131		21	%		47,990	17	%		107,377		21	%		90,740		19	%




	General and administrative				20,586		8	%		17,614	6	%		40,436		8	%		35,121		7	%




	Research and development				8,444		4	%		8,132	3	%		17,378		3	%		16,349		3	%

Income from operations					48,775		19	%		70,771	24	%		103,653		20	%		90,562		19	%




Other (expense) income, net					(3,557	)				2,141				(2,627	)				3,726

Income before provision for income taxes and cumulative effect of accounting change					45,218		18	%		72,912	25	%		101,026		20	%		94,288		19	%




Provision for income taxes					18,243					28,723				39,976					37,001

Income before cumulative effect of accounting change					26,975		11	%		44,189	15	%		61,050		12	%		57,287		12	%




Cumulative effect of accounting change																			(957	)

Net income				$	26,975		11	%	$	44,189	15	%	$	61,050		12	%	$	56,330		12	%

Earnings per common share:
	Basic




		Income before cumulative effect of accounting change		$	0.38				$	0.63			$	0.86				$	0.80




		Cumulative effect of accounting change																	(0.01	)

			Net income	$	0.38				$	0.63			$	0.86				$	0.79

	Diluted




		Income before cumulative effect of accounting change		$	0.36				$	0.61			$	0.83				$	0.79




		Cumulative effect of accounting change																	(0.01	)

			Net income	$	0.36				$	0.61			$	0.83				$	0.78

Weighted average shares used in earnings per share computations:




	Basic				71,490					70,693				70,754					70,946




	Diluted				74,777					72,686				73,619					72,584





Dividends paid per share				$	0.07				$	0.07			$	0.14				$	0.14

The accompanying notes are an integral part of these financial statements.

CALLAWAY GOLF COMPANY

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)



				Six Months Ended
				June 30,

				2001			2000

Cash flows from operating activities:




	Net income			$	61,050		$	56,330




	Adjustments to reconcile net income to net cash provided by operating activities:




		Depreciation and amortization			18,303			19,739




		Loss on disposal of assets			1,686			332




		Non-cash compensation			348			1,381




		Tax benefit from exercise of stock options			13,845			4,475




		Net non-cash foreign currency and hedging gains			(2,965	)




		Deferred taxes			7,430			1,104




		Changes in assets and liabilities, net of effects from acquisitions:




			Accounts receivable, net		(85,401	)		(80,619	)




			Inventories, net		(7,427	)		(7,519	)




			Other assets		(4,579	)		294




			Accounts payable and accrued expenses		16,767			7,291




			Accrued employee compensation and benefits		7,289			4,106




			Accrued warranty expense		(1,151	)		4,098




			Income taxes payable		(2,789	)		21,771




			Accrued restructuring cost-long term					(1,056	)




			Other liabilities		11,636			(413	)

	Net cash provided by operating activities				34,042			31,314





Cash flows from investing activities:




	Business acquisitions, net of cash acquired				(1,529	)		(426	)




	Capital expenditures				(14,689	)		(16,168	)




	Sale of property and equipment				41			79

	Net cash used in investing activities				(16,177	)		(16,515	)





Cash flows from financing activities:




	Issuance of Common Stock				42,503			18,599




	Dividends paid				(9,951	)		(9,917	)




	Acquisition of Treasury Stock				(19,530	)		(50,000	)




	Proceeds from sale-leaseback of equipment							1,268

	Net cash provided by (used in) financing activities				13,022			(40,050	)





Effect of exchange rate changes on cash					(1,652	)		(171	)





Net increase (decrease) in cash and cash equivalents					29,235			(25,422	)




Cash and cash equivalents at beginning of period					102,596			112,602





Cash and cash equivalents at end of period				$	131,831		$	87,180

The accompanying notes are an integral part of these financial statements.

CALLAWAY GOLF COMPANY

CONSOLIDATED CONDENSED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited)

(In thousands)


																Accumulated
		Common Stock														Other						Treasury Stock
							Paid-in			Unearned			Retained			Comprehensive															Comprehensive
		Shares			Amount		Capital			Compensation			Earnings			Income			GST			Shares			Amount			Total			Income

Balance, December 31, 2000			78,959		$	790	$	347,765		$	(1,214	)	$	349,681		$	(6,096	)	$	(98,713	)		(4,815	)	$	(80,469	)	$	511,744

	Exercise of stock options		3,175			31		39,337																					39,368




	Cancellation of Restricted Common Stock		(10	)				(310	)		310




	Tax benefit from exercise of stock options							13,845																					13,845




	Acquisition of Treasury Stock																						(1,022	)		(19,530	)		(19,530	)




	Compensatory stock and stock options							80			268																		348




	Employee stock purchase plan		283			3		3,132																					3,135




	Cash dividends paid													(9,951	)														(9,951	)




	Adjustment of GST shares to market value							(14,973	)											14,973




	Foreign currency translation																(3,184	)											(3,184	)	$	(3,184	)




	Unrealized gain on cash flow hedges, net of tax																3,803												3,803			3,803




	Net income													61,050															61,050			61,050

Balance, June 30, 2001			82,407		$	824	$	388,876		$	(636	)	$	400,780		$	(5,477	)	$	(83,740	)		(5,837	)	$	(99,999	)	$	600,628		$	61,669

The accompanying notes are an integral part of these financial statements.

CALLAWAY GOLF COMPANY

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying financial information for the three and six months ended June 30, 2001 and 2000 has been prepared by Callaway Golf Company (the “Company”) and has not been audited. These financial statements, in the opinion of management, include all adjustments (consisting only of normal recurring accruals) necessary for the fair presentation of the financial position, results of operations and cash flows for the periods presented.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K filed for the year ended December 31, 2000. Interim operating results are not necessarily indicative of operating results for the full year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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.

2. Reclassifications and Recent Accounting Pronouncements

In the fourth quarter of 2000, the Company adopted Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB No. 101”) with an effective date of January 1, 2000. SAB No. 101 summarizes the Securities and Exchange Commission’s (“SEC”) Division of Corporation Finance Staff’s views in applying accounting principles generally accepted in the United States to revenue recognition in financial statements. The Company’s Consolidated Condensed Statements of Operations for the three and six months ended June 30, 2000 have been adjusted from amounts previously reported in the prior year Form 10-Q filed with the SEC to reflect the application of SAB 101. Accordingly, net sales and provision for income taxes have been reduced by $1,037,000 and $510,000, respectively, and cost of goods sold was increased by $254,000, for the three months ended June 30, 2000 from amounts previously reported. For the six months ended June 30, 2000, net sales, cost of goods sold and provision for income taxes have been reduced by $11,520,000, $5,117,000 and $2,515,000, respectively, from amounts previously reported. The cumulative effect of accounting change on periods prior to 2000 was $957,000 and is included in the Consolidated Condensed Statements of Operations for the six months ended June 30, 2000.

In July 2000, the Emerging Issues Task Force (“EITF”) finalized its consensus on Issue No. 00-10, “Accounting for Shipping and Handling Revenues and Costs.” Pursuant to EITF Issue No. 00-10 and the SEC’s position on this issue, all amounts billed to customers for shipping and handling should be included in “net sales” and costs incurred related to shipping and handling should be included in “cost of goods sold.” The Company had previously included shipping and handling revenues and costs in “selling” costs. The Company’s Consolidated Condensed Statements of Operations for the three and six months ended June 30, 2000 have been reclassified from the prior year Form 10-Q filed with the SEC to include an increase in net sales of $1,925,000 and $3,206,000, respectively, and an increase in cost of goods sold of $3,654,000 and $5,986,000, respectively, to reflect the classification required by EITF Issue No. 00-10. There was no effect on operating results as a result of the adoption of EITF Issue No. 00-10.

In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statements of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations”, and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. SFAS No. 142 requires the use of a non-amortization approach to

CALLAWAY GOLF COMPANY

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

account for purchased goodwill. Goodwill acquired on or prior to June 30, 2001 will no longer be amortized effective January 1, 2002. Goodwill acquired on or after July 1, 2001 will follow the non-amortization approach under SFAS No. 142. Under the non-amortization approach, goodwill would be tested for impairment, rather than being amortized to earnings, as originally proposed. In addition, SFAS No. 142 requires that acquired intangible assets be separately identified and amortized over their individual useful lives. The Company will be required to adopt these statements beginning January 1, 2002. Based on the Company’s current carrying value of goodwill and intangible assets at June 30, 2001, unamortized goodwill and intangible asset balances are expected to be approximately $16.9 million and $104.1 million, respectively, at December 31, 2001. In accordance with SFAS No. 142, the goodwill balance that was being amortized over periods ranging from five to 40 years will follow the non-amortization approach after January 1, 2002.

3. Inventories

			��
		June 30,			December 31,
		2001			2000

		(Unaudited)




Inventories, net (in thousands):




	Raw materials	$	58,284		$	56,936




	Work-in-process		1,916			1,293




	Finished goods		86,865			83,453

			147,065			141,682




Less reserve for obsolescence			(8,255	)		(7,720	)

		$	138,810		$	133,962

4. Bank Lines of Credit

The Company has a revolving credit facility of up to $120.0 million (the “Amended Credit Agreement”). The Amended Credit Agreement is secured by substantially all of the assets of the Company and expires in February 2004. The Amended Credit Agreement bears interest at the Company’s election at the London Interbank Offering Rate (“LIBOR”) plus a margin or the higher of the base rate on corporate loans at large U.S. money center commercial banks (prime rate) or the Federal Funds Rate plus 50 basis points. The Amended Credit Agreement requires the Company to maintain certain minimum financial ratios including a fixed charge coverage ratio, as well as other restrictive covenants. As of June 30, 2001, up to $119.3 million of the credit facility remained available for borrowings (including a reduction of $0.7 million for outstanding letters of credit), subject to meeting certain availability requirements under a borrowing base formula and other limitations.

The Company’s Japanese subsidiary has two separate credit facilities with an aggregate commitment of 2.5 billion yen (approximately $20.0 million at June 30, 2001). These credit facilities do not expire and are cancelable at the Company’s discretion without penalty. Borrowings under these agreements bear interest equal to the Tokyo Interbank Offering Rate (“TIBOR”) plus a margin. As of June 30, 2001, the Company had no borrowings under these credit facilities.

5. Accounts Receivable Securitization

The Company’s wholly-owned subsidiary, Callaway Golf Sales Company, sells trade receivables on an ongoing basis to its wholly-owned subsidiary, Golf Funding Corporation (“Golf Funding”). Pursuant to an agreement with a securitization company (the “Accounts Receivable Facility”), Golf Funding, in turn, can sell such receivables to the securitization company on an ongoing basis, which could yield proceeds of up to $80.0 million, subject to meeting certain availability requirements under a borrowing base formula and other

CALLAWAY GOLF COMPANY

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

limitations. Golf Funding’s sole business is the purchase of trade receivables from Callaway Golf Sales Company. Golf Funding is a separate corporate entity with its own separate creditors, which in the event of its liquidation would be entitled to be satisfied out of Golf Funding’s assets prior to any value in Golf Funding becoming available to the Company. The Accounts Receivable Facility expires in February 2004.

Under the Accounts Receivable Facility, the receivables are sold at face value with payment of a portion of the purchase price being deferred. As of June 30, 2001, no amount was outstanding under the Accounts Receivable Facility. Fees incurred in connection with this facility for each of the three and six month periods ended June 30, 2001 and 2000 were $76,000 and $152,000, respectively. These fees were recorded in “other (expense) income, net.”

6. Earnings Per Share

A reconciliation of the weighted average shares used in the basic and diluted earnings per common share computations for the three and six months ended June 30, 2001 and 2000 is presented below.



		Three Months Ended				Six Months Ended
		June 30,				June 30,

		2001		2000		2001		2000


		(Unaudited)




Weighted-average shares outstanding (in thousands):




	Weighted-average shares outstanding — Basic		71,490		70,693		70,754		70,946




	Dilutive securities		3,287		1,993		2,865		1,638

	Weighted-average shares outstanding — Diluted		74,777		72,686		73,619		72,584

For the three months ended June 30, 2001 and 2000, 6,111,000, and 8,482,000, respectively, options outstanding were excluded from the calculations, as their effect would have been antidilutive. For the six months ended June 30, 2001 and 2000, 6,002,000 and 8,986,000, respectively, options outstanding were excluded from the calculations, as their effect would have been antidilutive.

7. Commitments and Contingencies

To manage its electricity costs in light of uncertainty in the California energy market, the Company entered into a long-term energy supply contract at a fixed rate for a delivery term defined as June 1, 2001 through May 31, 2006 (see Note 10). To obtain a more favorable price and to assure adequate supplies during times of peak loads, the Company agreed to purchase a greater supply of electricity than it expects to use in its business. The Company expects to sell some or all of this excess supply based on energy market conditions. The total purchase price over the contract term is approximately $43.5 million.

At June 30, 2001, the Company was contingently liable for lease payments relating to a facility in New York City totaling $4.4 million. This contingency is the result of the assignment of an operating lease to a third party and expires in February 2003.

On July 24, 2000, Bridgestone Sports Co., Ltd. (“Bridgestone”) filed a complaint for patent infringement in the United States District Court for the Northern District of Georgia, Civil Action No. 100-CV-1871, against Callaway Golf Company, Callaway Golf Ball Company (collectively “Callaway Golf”), and a golf retailer located in Georgia (the “U.S. Action”). Bridgestone alleges in the U.S. Action that the manufacture and sale of the Company’s Rule 35® golf ball infringes four U.S. golf ball patents owned by Bridgestone. Bridgestone is seeking unspecified damages and injunctive relief. On September 12, 2000, Callaway Golf answered the Complaint, and asserted affirmative counterclaims against Bridgestone seeking a judicial declaration that Callaway Golf does not infringe the Bridgestone patents, that the patents are invalid, and that Bridgestone engaged in inequitable conduct in the United States Patent and Trademark Office. On

CALLAWAY GOLF COMPANY

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

October 13, 2000, Bridgestone and the retailer defendant entered into a consent judgment discontinuing the action against the retailer. The parties are engaged in discovery. No trial date has been set by the District Court.

On December 14, 2000, Bridgestone filed an action in the Tokyo, Japan District Court asserting patent infringement against Callaway Golf’s wholly-owned subsidiary, Callaway Golf K.K., based on its sale of Rule 35® Softfeel™ golf balls in Japan (the “Japan Action”). Only one of the Bridgestone patents at issue in the U.S. Action has issued in Japan. Callaway Golf has denied the claims asserted in the Japan Action and has filed an invalidity proceeding with the Japanese Patent Office to invalidate the Bridgestone Patent.

On April 6, 2001, a complaint was filed against Callaway Golf Company and Callaway Golf Sales Company (collectively, the “Company”), in the Circuit Court of Sevier County, Tennessee, Case No. 2001-241-IV. The complaint seeks to assert a class action by plaintiff on behalf of himself and on behalf of consumers in Tennessee and Kansas who purchased selected Callaway Golf products on or after March 30, 2000. Specifically, the complaint alleges that the Company adopted a New Product Introduction Policy governing the introduction of certain of the Company’s new products in violation of Tennessee and Kansas antitrust and consumer protection laws. The plaintiff is seeking damages, restitution and punitive damages.

The Company and its subsidiaries, incident to their business activities, are parties to a number of legal proceedings, lawsuits and other claims, including the matters specifically noted above. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. Consequently, management is unable to ascertain the ultimate aggregate amount of monetary liability, amounts which may be covered by insurance, or the financial impact with respect to these matters as of June 30, 2001. However, management believes at this time that the final resolution of these matters, individually and in the aggregate, will not have a material adverse effect upon the Company’s annual consolidated financial position, results of operations or cash flows.

8. Restructuring

In 1998, the Company recorded a restructuring charge of $54.2 million resulting from a number of cost reduction actions and operational improvements. During 1999, the Company completed its restructuring initiatives. During the three and six month periods ended June 30, 2000, the Company paid $0.6 million and $1.1 million, respectively, related to its restructuring obligations, primarily rents associated with its former New York City facility (see Note 7). At June 30, 2001, there was no remaining reserve balance.

CALLAWAY GOLF COMPANY

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

9. Segment Information

The Company’s operating segments are organized on the basis of products and include golf clubs and golf balls. The Golf Clubs segment consists of Callaway Golf® titanium and stainless steel metal woods and irons, Callaway Golf® and Odyssey® putters and wedges, and related accessories. The Golf Balls segment consists of golf balls that are designed, manufactured, marketed and distributed by the Company. The table below contains information utilized by management to evaluate its operating segments for the interim periods presented.



		Three Months Ended						Six Months Ended
		June 30,						June 30,

		2001			2000			2001			2000

(In thousands)
		(Unaudited)
Net sales




	Golf clubs	$	232,719		$	279,239		$	482,558		$	470,685




	Golf balls		20,936			10,683			32,463			16,643

		$	253,655		$	289,922		$	515,021		$	487,328

Income (loss) before provision for income taxes and cumulative effect of accounting change




	Golf clubs	$	68,135		$	95,470		$	142,591		$	141,730




	Golf balls		(3,842	)		(13,802	)		(9,909	)		(29,102	)




	Reconciling items⁽¹⁾		(19,075	)		(8,756	)		(31,656	)		(18,340	)

		$	45,218		$	72,912		$	101,026		$	94,288

Additions to long-lived assets




	Golf clubs	$	4,715		$	6,265		$	12,234		$	13,271




	Golf balls		12,033			1,075			13,078			2,897

		$	16,748		$	7,340		$	25,312		$	16,168


(1)	Represents corporate general and administrative expenses and other income (expense) not utilized by management in determining segment profitability.

10. Derivatives and Hedging

The Company uses derivative financial instruments to manage its exposures to electricity prices and foreign exchange rates. The derivative instruments are accounted for pursuant to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities.” As amended, SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position, measure those instruments at fair value and recognize changes in the fair value of derivatives in earnings in the period of change unless the derivative qualifies as an effective hedge that offsets certain exposures.

Energy Derivative

During the second quarter of 2001, the Company entered into a long-term, fixed-price, fixed-capacity, energy supply contract in order to manage its exposure to changes in energy prices which are subject to significant and often volatile fluctuation. The contract is effective through May 2006. As of June 30, 2001, this derivative did not qualify for hedge accounting treatment under SFAS No. 133. The Company recognized the changes in the fair value of the contract currently in earnings. The fair value of the contract as of June 30, 2001 was estimated based on market prices of electricity for the remaining period covered by the contract. The net differential between the contract price and market prices for future periods has been applied to the volume

CALLAWAY GOLF COMPANY

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

stipulated in the contract to arrive at an estimated future value. This estimated future value was discounted at rates commensurate with the Company’s estimation of contract performance risk. In addition, the contract extends beyond 18 months into the future and the market for electricity in California beyond the 18-month horizon is unpredictable and published market quotations are not available. The Company has relied upon near-term market quotations and other market information to determine fair value estimates. For the quarter ended June 30, 2001, the Company recorded $7.7 million of net realized and unrealized losses related to the energy derivative in “other (expense) income, net”.

Foreign Currency Exchange Contracts

During the three and six months ended June 30, 2001, the Company entered into forward foreign currency exchange rate contracts to hedge payments due on intercompany transactions from certain wholly-owned foreign subsidiaries and on certain euro-denominated accounts receivable. The effect of this practice is to minimize variability in the Company’s operating results arising from foreign exchange rate movements. The Company does not engage in foreign currency speculation. These foreign exchange contracts do not subject the Company to risk due to exchange rate movements because gains and losses on these contracts offset the losses and gains on the transactions being hedged, and the Company does not engage in hedging contracts which exceed the amount of the intercompany transactions. At June 30, 2001, the Company had approximately $52.5 million of foreign exchange contracts outstanding. The contracts mature between July and December of 2001. Gains and losses on the contracts are recorded in income. The net realized and unrealized gains from foreign exchange contracts for the three and six months ended June 30, 2001 totaled approximately $0.7 million and $6.0 million, respectively. For the three and six months ended June 30, 2000, net realized and unrealized gains totaled $2.3 million and $2.0 million, respectively.

During the fourth quarter of 2000, the Company utilized forward foreign currency exchange rate contracts to hedge cash flows associated with forecasted intercompany sales of inventory. These forward contracts are accounted for as cash flow hedges. The Company only hedges transactions that it deems to be more likely than not to occur. During 2000, the Company hedged only those transactions forecasted to occur by December 31, 2001. As of June 30, 2001, the Company had approximately $35.8 million of cash flow hedges outstanding. The Company assesses the effectiveness of these derivatives using the spot rate. Changes in the spot-forward differential are excluded from the test of hedging effectiveness and are recorded currently in earnings as a component of “other (expense) 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 hedges of anticipated intercompany inventory sales to be highly effective. The effectiveness of each derivative is assessed monthly. During the three and six months ended June 30, 2001, a gain of $178,000 and $682,000, respectively, was recorded in “other (expense) income, net” representing the ineffective portion of the Company’s derivative instruments.

The effective portion of the fair value of the derivatives is deferred on the balance sheet in other comprehensive income (“OCI”), a component of “Accumulative other comprehensive income.” Amounts recorded in OCI will be released to earnings in the same period that the hedged transaction will impact the Company’s consolidated earnings. This transaction date is assumed to occur when the underlying sale of product to a third party occurs. At June 30, 2001, $1,558,000 of deferred net gain is expected to be reclassified into earnings within the next six months. During the three and six months ended June 30, 2001, no gains or losses were reclassified into earnings as a result of discontinuance of any cash flow hedges.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Consolidated Condensed Financial Statements and the related notes that appear elsewhere in this report. See also Important Notice on inside cover of this report.

Results of Operations

Prior Period Financial Statements

Prior period amounts have been restated to reflect the Company’s current year presentation including the adoption of Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB No. 101”) and Emerging Issues Task Force Issue No. 00-10 (“EITF 00-10”). The Company adopted SAB No. 101 in the fourth quarter of 2000 with an effective date of January 1, 2000. As a result of the adoption of SAB No. 101, the Company adjusted amounts previously reported in the prior year Form 10-Q. Gross profit for the quarter ended June 30, 2000 also reflects the effect of a reclassification of shipping revenues and costs from selling expenses to net sales and costs of goods sold. This reclassification was required by EITF 00-10 and did not result in a change in the Company’s earnings or earnings per share for the period. See Note 2 to the Consolidated Condensed Financial Statements for further detail.

Three-month periods ended June 30, 2001 and 2000

Net sales decreased 13% to $253.7 million for the three months ended June 30, 2001 compared to $289.9 million for the comparable period in the prior year. Both unit and dollar sales of irons and metal woods decreased in the second quarter of 2001 as compared to the second quarter of 2000. Sales of the Company’s iron products were lower by $33.5 million (32%) in the second quarter of 2001 compared to the same quarter a year earlier. In total, sales of metal woods decreased by $15.6 million (11%) in the quarter ended June 30, 2001 compared to the same quarter of 2000. The decrease in sales of irons and woods primarily represents a decline in sales of Great Big Bertha® Hawk Eye® Tungsten Injected^TM Titanium Irons, Steelhead^TM X-14® Stainless Steel Irons and Steelhead Plus^TM Stainless Steel metal woods, all of which were introduced in January 2000. The decrease in sales of irons and metal woods was partially offset by the growth in the Company’s golf ball sales, which increased by $10.3 million (97%) in the current quarter compared to the second quarter of 2000. The Company believes that the overall decline in net sales was largely due to a shifting of some sales from the second quarter to the first quarter due to earlier availability of new products than has historically been the case, a decline in the number of golf rounds played as a result of unusually poor weather in the United States and Europe late into the season, aggressive competitive pricing, economic concerns among retailers and consumers, and the United States Golf Association’s actions in the United States against the Big Bertha® ERC® II Driver. The strength of the U.S. dollar in relation to other foreign currencies also had a significant adverse effect upon the Company’s net sales for the second quarter of 2001 as compared to the second quarter of 2000. As compared to the second quarter of 2000, fluctuations in foreign currency exchange rates adversely impacted second quarter 2001 net sales by approximately $11.8 million, as measured by applying second quarter 2000 exchange rates to second quarter 2001 net sales.

During the second quarter of 2001, sales decreased in virtually all regions as compared with the second quarter of 2000. Sales in the United States decreased $15.1 million (10%) to $139.7 million during the second quarter of 2001 versus the second quarter of 2000. Overall, the Company’s sales in regions outside of the United States decreased $21.2 million (16%) to $114.0 million during the second quarter of 2001 versus the same quarter of 2000. Had exchange rates for the second quarter of 2001 been the same as the second quarter 2000 exchange rates, overall sales in regions outside of the United States would have been approximately 10% higher than reported. Sales in Japan decreased $2.3 million (6%) in the second quarter of 2001 to $37.1 million as compared to the same period in the prior year. Sales in Europe decreased $11.7 million (24%) to $37.1 million as compared to the second quarter of 2000, and sales in Canada decreased $0.9 million (7%) in the second quarter of 2001 to $12.5 million as compared to the same period in the prior year. Sales in Rest of Asia (including Korea) decreased $7.1 million (26%) to $20.0 million and sales in the regions comprising Rest of World decreased $0.3 million (6%) to $4.5 million in the second quarter of 2001 as compared with the

second quarter of 2000. Sales in Australia increased $1.2 million (71%) to $2.8 million during the second quarter of 2001. The Company acquired its distribution rights in Australia, Italy, Portugal, and Spain in the first quarter of 2001 and therefore began selling directly to retailers rather than a third party distributor.

For the second quarter of 2001, gross margin decreased to $131.9 million from $144.5 million in the second quarter of 2000, but increased as a percentage of net sales to 52% from 50%. This improvement in gross margin percentage is a result of a shift in club product mix away from lower yielding iron products to higher yielding wood products. The margin was also favorably affected by a reduction in the Company’s warranty expense as a percent of net sales in the second quarter of 2001 as compared to the second quarter of 2000. Golf ball product margins improved in the second quarter of 2001 as compared to the first quarter of 2000, associated with increased sales volume and an increase in plant utilization and production yields.

Selling expenses in the second quarter of 2001 increased to $54.1 million from $48.0 million in the comparable period of 2000, or 21% and 17% of net sales, respectively. This dollar increase was primarily due to increased advertising and promotional expenses related to the Company’s new product launches, the rollout of the new fitting cart systems and store-in-store project, and other demand creation initiatives.

General and administrative expenses increased to $20.6 million in the second quarter of 2001 from $17.6 million in the comparable period of 2000, or 8% and 6% of net sales, respectively. This dollar increase is mainly attributable to higher employee compensation and legal expenses, partially offset by a decrease in depreciation expense.

Research and development expenses increased to $8.4 million in the second quarter of 2001 from $8.1 million in the second quarter of 2000, or 4% and 3% of net sales, respectively. This dollar increase resulted primarily from increased employee costs.

Other expenses totaled $3.6 million in the second quarter of 2001 as compared to other income of $2.1 million in the second quarter of 2000. The $5.7 million of additional expense is primarily attributable to realized and unrealized losses of $7.7 million associated with the valuation of a long-term energy supply contract partially offset by a $1.3 million increase in licensing fees, a $0.5 million increase in foreign currency transaction gains, and a $0.2 million increase in net interest income.

For the second quarter of 2001, the Company recorded a provision for income taxes of $18.2 million and recognized a decrease in deferred taxes of $6.8 million. The provision for income taxes as a percentage of income before taxes increased slightly to 40% for the three months ended June 30, 2001 as compared to 39% for the comparable period of 2000. During the second quarter of 2001, the Company realized $5.3 million in tax benefits related to the exercise of employee stock options.

Second quarter 2001 net income declined 39% to $27.0 million from $44.2 million in the comparable period of the prior year. Second quarter 2001, diluted earnings per share decreased 41% to $0.36 from $0.61 in the same period last year. The Company entered into a long-term energy supply contract during the second quarter to manage its electricity costs in light of uncertainty in the California energy market. During the quarter ended June 30, 2001, the Company recorded a non-cash expense of $6.2 million after-tax or $0.08 per diluted share, as a result of the change in market value of the energy supply contract. Excluding this non-cash energy supply contract charge, the Company’s net income decreased 25% to $33.2 million and diluted earnings per share decreased 28% to $0.44.

Six-month periods ended June 30, 2001 and 2000

For the six months ended June 30, 2001, net sales increased $27.7 million, or 6%, to $515.0 million from $487.3 million in the comparable period of the prior year. The increase primarily represents an increase in sales of titanium metal woods, due to the worldwide launch of the new Big Bertha® ERC II Driver and the new Big Bertha® Hawk Eye® VFT™ Woods in October 2000. These products began shipping in significant quantities in the first quarter of 2001. In total, sales of metal woods increased by $43.8 million (19%) in the first half of 2001 compared to the first half of 2000. The increase in revenues was also the result of growth in the Company’s golf ball sales, which increased by $15.8 million (95%) in the first six months of 2001 compared to the same period of 2000. These increases were offset in part by lower sales of the Company’s iron

products. Sales of the Company’s irons declined by $46.0 million (25%) in the first half of 2001 compared to the same period a year earlier. The Company believes that net sales for the first half of 2001 were adversely affected by a decline in the number of golf rounds played as a result of unusually poor weather in the United States and Europe late into the season, aggressive competitive pricing, economic concerns among retailers and consumers, and the United States Golf Association’s actions in the United States against the Big Bertha ERC II driver. The strength of the U.S. dollar in relation to other foreign currencies also had a significant adverse effect upon the Company’s net sales for the first half of 2001 as compared to the first half of 2000. As compared to the first half of 2000, fluctuations in foreign currency exchange rates adversely impacted first half 2001 net sales by approximately $22.1 million, as measured by applying first half 2000 exchange rates to first half 2001 net sales.

Sales in the United States increased $19.1 million (7%) to $287.5 million during the first half of 2001 versus the first half of 2000. Overall, the Company’s sales in regions outside of the United States increased $8.6 million (4%) to $227.5 million during the first half of 2001 versus the same period of 2000. Had exchange rates for the first half of 2001 been the same as the first half 2000 exchange rates, overall sales in regions outside of the United States would have been approximately 10% higher. Sales in Japan increased $18.7 million (32%) in the first half of 2001 to $78.1 million as compared to the same period in the prior year. However, sales in Europe decreased $8.3 million (10%) to $74.5 million as compared to the first half of 2000 and sales in the Rest of Asia (including Korea) decreased $5.5 million (13%) to $37.6 million in the first half of 2001 as compared with the first half of 2000. Sales in Canada increased $0.6 million (3%) in the first six months of 2001 to $20.9 million as compared to the same period in 2000 and sales in the regions comprising the Rest of World increased $1.2 million (12%) to $11.0 million in the first half of 2001 versus the first half of 2000. Sales in Australia increased $1.9 million (53%) to $5.4 million during the first half of 2001. The Company acquired its distribution rights in Australia, Italy, Portugal, and Spain in the first quarter of 2001 and therefore began selling directly to retailers rather than a third party distributor.

For the six months ended June 30, 2001, gross margin increased to $268.8 million from $232.8 million in the comparable period of 2000, and as a percentage of net sales, increased to 52% from 48%. This improvement in gross margin is a result of a shift in club product mix away from lower yielding iron products to higher yielding wood products. The margin was also favorably affected by a reduction in the Company’s warranty expense as a percent of net sales during the six month period ended June 30, 2001 as compared to the same period in 2000. Golf ball product margins improved in the first half of 2001 as compared to the first half of 2000, associated with increased sales volume and an increase in plant utilization and production yields.

Selling expenses in the first half of 2001 increased to $107.4 million (21% of net sales) from $90.7 million (19% of net sales) in the first half of 2000. The dollar increase was primarily due to increased advertising and promotional expenses related to the Company’s new product launches, the rollout of the new fitting cart systems and store-in-store project, and other demand creation initiatives.

General and administrative expenses in the first half of 2001 increased to $40.4 million (8% of net sales) from $35.1 million (7% of net sales) in the comparable period of 2000. The dollar increase is mainly attributable to moving costs associated with the consolidation of operating facilities combined with higher employee compensation and legal expenses, partially offset by a decrease in depreciation expense.

Research and development expenses in the first half of 2001 increased to $17.4 million (3% of net sales) from $16.3 million (3% of net sales) in the first half of 2000. The dollar increase resulted primarily from increased employee costs.

Other expenses in the first half of 2001 totaled $2.6 million as compared to other income of $3.7 million in the comparable period of 2000. The $6.3 million of additional expense is primarily attributable to realized and unrealized losses of $7.7 million associated with the valuation of a long-term energy supply contract and a decrease in net interest income of $1.4 million partially offset by a $1.4 million increase in foreign currency transaction gains, a $1.1 million increase in licensing fees, and a $0.3 million increase in other income.

For the six months ended June 30, 2001, the Company recorded a provision for income taxes of $40.0 million and recognized a decrease in deferred taxes of $7.4 million. The provision for income taxes as a

percentage of income before taxes for the six months ended June 30, 2001 and 2000 was 40% and 39%, respectively. During the first half of 2001, the Company realized $13.8 million in tax benefits related to the exercise of employee stock options.

Net income for the six months ended June 30, 2001 increased 9% to $61.1 million, compared to $56.3 for the comparable period last year. Earnings per diluted share during the period, increased 6% to $0.83 from $0.78 for the comparable period last year. The Company entered into a long-term energy supply contract during the second quarter to manage its electricity costs in light of uncertainty in the California energy market. During the first half of 2001, the Company recorded a non-cash expense of $6.2 million after-tax or $0.08 per diluted share, as a result of the change in market value of the energy supply contract. Excluding this non-cash energy supply contract charge, the Company’s net income for the first six months increased 20% to $67.3 million and diluted earnings per share increased 17% to $0.91.

Liquidity and Capital Resources

At June 30, 2001, cash and cash equivalents increased to $131.8 million from $102.6 million at December 31, 2000. This increase for the six month period ended June 30, 2001 primarily resulted from cash provided by operating and financing activities of $34.0 million and $13.0 million, respectively, partially offset by cash used in investing activities of $16.2 million. Cash flows provided by financing activities are primarily attributable to the exercise of employee stock options ($42.5 million) partially offset by the acquisition of treasury stock ($19.5 million) and the payment of dividends ($10.0 million). Cash flows used in investing activities are primarily attributable to capital expenditures of $14.7 million.

The Company’s principal source of liquidity, both on a short-term and long-term basis, has been cash flow provided by operations and the Company’s credit facilities. The Company currently expects this to continue. The Company has a revolving credit facility for up to $120.0 million (the “Amended Credit Agreement”) and an $80.0 million accounts receivable securitization facility (the “Accounts Receivable Facility”). In addition, the Company’s Japanese subsidiary has two separate credit facilities with an aggregate commitment of 2.5 billion yen (approximately $20.0 million at June 30, 2001). During the first six months of 2001, the Company did not utilize either its Accounts Receivable Facility or its lines of credit under the Amended Credit Agreement and the Japanese credit facilities. At June 30, 2001, the Company had $119.3 million available, net of outstanding letters of credit, under the Amended Credit Agreement, subject to meeting certain availability requirements under a borrowing base formula and other limitations. Also at June 30, 2001, there were no advances under the Accounts Receivable Facility, leaving up to $80.0 million available under this facility and the Company had no borrowings under the Japanese credit facilities. See Notes 4 and 5 to the Consolidated Condensed Financial Statements for further detail.

In May 2000, the Company announced that its Board of Directors authorized it to repurchase its Common Stock in the open market or in private transactions, subject to the Company’s assessment of market conditions and buying opportunities from time to time, up to a maximum cost to the Company of $100.0 million. During the second quarter of 2001, the Company repurchased 1.0 million shares of the Company’s Common Stock at an average cost of $19.07 per share. The Company began its repurchase program in May 2000 and during the second quarter of 2001 completed the program which resulted in the repurchase of a total of 5.8 million shares of the Company’s Common Stock at an average cost of $17.13 per share.

Although the Company’s golf club operations are mature and historically have generated cash from operations, the Company’s golf ball operations are relatively new and to date have not generated cash flows sufficient to fund these operations. The Company does not expect that its golf ball operations will generate sufficient cash to fund these operations for the remainder of 2001. However, the Company believes that, based upon its current operating plan, analysis of consolidated financial position and projected future results of operations, it will be able to maintain its current level of consolidated operations, including purchase commitments and planned capital expenditures, for the foreseeable future through operating cash flows and its credit facilities. There can be no assurance, however, that future industry specific or other developments, or

general economic trends, will not adversely affect the Company’s operations or its ability to meet its future cash requirements.

Certain Factors Affecting Callaway Golf Company

The financial statements contained in this report and the related discussion describe and analyze the Company’s financial performance and condition for the periods indicated. For the most part, this information is historical. The Company’s prior results are not necessarily indicative of the Company’s future performance or financial condition. The Company therefore has included the following discussion of certain factors which could affect the Company’s future performance or financial condition. These factors could cause the Company’s future performance or financial condition to differ materially from its prior performance or financial condition or from management’s expectations or estimates of the Company’s future performance or financial condition. These factors, among others, should be considered in assessing the Company’s future prospects and prior to making an investment decision with respect to the Company’s stock.

Adverse Global Economic Conditions

The Company sells golf clubs, golf balls and golf accessories. These products are recreational in nature and are therefore discretionary purchases for consumers. Consumers are generally more willing to make discretionary purchases of golf products during favorable economic conditions. An adverse change in economic conditions in the United States or in the Company’s international markets (which represent almost half of the Company’s total sales), or even a decrease in consumer confidence as a result of anticipated adverse changes in economic conditions, could cause consumers to forgo or to postpone purchasing new golf products. Such forgone or postponed purchases could have a material adverse effect upon the Company. The economic conditions in the United States, Japan, Europe, Korea and other countries are currently viewed by many as uncertain or troubled.

Growth Opportunities

Golf Clubs.In order for the Company to grow significantly its sales of golf clubs, the Company must either increase its share of the market for golf clubs or the market for golf clubs must grow. The Company already has a significant share of the worldwide premium golf club market and therefore opportunities for additional market share may be limited. The Company does not believe there has been any material increase in participation or the number of rounds played in 1999 and 2000. Furthermore, the Company believes that since 1997 the overall worldwide premium golf club market has generally not experienced substantial growth in dollar volume from year to year. There is no assurance that the overall dollar volume of the worldwide premium golf club market will grow, or that it will not decline, in the future. The Company’s future club sales growth therefore may be limited unless there is growth in the worldwide premium golf club market.

Golf Balls.The Company only began selling its golf balls in February 2000 and therefore it does not have as significant of a market share as it does in the club business. Although opportunities exist for the acquisition of additional market share in the golf ball market, such market share is currently held by some well-established and well-financed competitors. There is no assurance that the Company will be able to increase its market share in this very competitive golf ball market. If the Company is unable to obtain additional market share, its golf ball sales growth may be limited.

Golf Ball Costs

The cost of entering the golf ball business has been higher than the Company first anticipated. Much of these higher costs are attributable to higher than expected production costs as a result of yield and other ramp-up issues. To date, the development of the Company’s golf ball business has had a significant negative impact on the Company’s cash flows, financial position and results of operations. Although the Company believes it generally has resolved these issues, there is no assurance that the Company will be able to achieve the sales or production efficiencies necessary to make its golf ball business profitable. Until the golf ball business becomes

profitable, the Company’s results of operations, cash flows and financial position will continue to be negatively affected.

Manufacturing Capacity

The Company plans its manufacturing capacity based upon the forecasted demand for its products. Actual demand for such products may exceed or be less than forecasted demand. The Company’s unique product designs often require sophisticated manufacturing techniques, which can require significant start-up expenses and/or limit the Company’s ability to quickly expand its manufacturing capacity to meet the full demand for its products. If the Company is unable to produce sufficient quantities of new products in time to fulfill actual demand, especially during the Company’s traditionally busy season, it could limit the Company’s sales and adversely affect its financial performance. On the other hand, the Company invests in manufacturing capacity and commits to components and other manufacturing inputs for varying periods of time, which can limit the Company’s ability to quickly react if actual demand is less than forecast. This could result in less than optimum capacity usage and/or in excess inventories and related obsolescence charges that could adversely affect the Company’s financial performance. In addition, if the Company were to experience delays, difficulties or increased costs in its production of golf clubs or golf balls, including production of new products needed to replace current products, the Company’s future golf club or golf ball sales could be adversely affected.

Dependence on Energy Resources

The Company’s golf club and golf ball manufacturing facilities use, among other resources, significant quantities of electricity to operate. The State of California is currently experiencing a shortage of electricity. Depending on weather conditions, the shortage may worsen during the late summer months when electricity usage and demand for electricity are at their peak. Many companies in California have experienced periods of blackouts during which electricity was not available. The Company has experienced one blackout period to date, and expects that it will experience additional blackout periods. The Company has taken certain steps to provide uninterruptible power supplies for its key operations, including the ball and club operations, and believes that these measures will mitigate any impact resulting from future blackouts. However, if the blackout periods are significant and the Company’s contingency plans are not effective, the Company could experience significant disruptions in its manufacturing operations because of blackout periods, which could have a material adverse effect upon the Company.

Furthermore, market and regulatory imperfections are also causing extreme volatility in electricity prices. The Company has tried to mitigate fluctuations in electricity prices and lower its costs by entering into long-term contracts at fixed rates. In April 2001, the Company entered into a new long-term contract for electricity. To obtain a more favorable price and to assure adequate supplies during times of peak loads, the Company agreed to purchase a significantly greater supply of electricity than it expects to use in its business. The Company expects to be able to re-sell some or all of this excess supply and thereby reduce the net price of the electricity it uses in its business. If the Company is unable to re-sell a significant portion of such excess supply at favorable rates, the net cost of the electricity used in the Company’s business could increase significantly. Moreover, if the market price for electricity were to drop significantly during the term of the contract, and the Company was unable to revise its commitment, then the Company’s costs for electricity could be higher than its competitors’. Either scenario could have a significant adverse effect upon the Company’s results of operations. Furthermore, under current applicable accounting rules, the Company must each quarter recognize in earnings the change in the fair value of the electricity contract. Although the changes in the value of the contract result in non-cash charges, they could significantly affect the Company’s reported earnings.

In addition to electricity, the Company also uses natural gas to run the golf club and golf ball manufacturing facilities. Until recently, there has been a shortage of natural gas which caused prices to increase significantly. Although the Company does not expect any interruptions in its supply of natural gas, if the prices continue to increase, such increased prices could have a significant adverse effect upon the Company’s cost of goods sold and results of operations.

Dependence on Certain Suppliers and Materials

The Company is dependent on a limited number of suppliers for its clubheads and shafts, some of which are single-sourced. In addition, some of the Company’s products require specifically developed manufacturing techniques and processes which make it difficult to identify and utilize alternative suppliers quickly. The Company believes that suitable clubheads and shafts could be obtained from other manufacturers in the event its regular suppliers are unable to provide components. However, any significant production delay or disruption caused by the inability of current suppliers to deliver or the transition to other suppliers could have a material adverse impact on the Company’s results of operations. The Company is also single-sourced or dependent on a limited number of suppliers for the materials it uses to make its golf balls. Many of the materials, including the golf ball cover, are customized for the Company. Any delay or interruption in such supplies could have a material adverse impact upon the Company’s golf ball business. If the Company did experience any such delays or interruptions, there is no assurance that the Company would be able to find adequate alternative suppliers at a reasonable cost or without significant disruption to its business.

The Company uses United Parcel Service (“UPS”) for substantially all ground shipments of products to its U.S. customers. Any significant interruption in UPS services could have a material adverse effect upon the Company’s ability to ship its products to its customers. If there were any such interruption in its services, there is no assurance that the Company could engage alternative suppliers to ship its products in a timely and cost-efficient manner. Any significant interruption in UPS Services could have a material adverse effect upon the Company.

The Company’s size has made it a large consumer of certain materials, including titanium alloys and carbon fiber. The Company does not make these materials itself, and must rely on its ability to obtain adequate supplies in the world marketplace in competition with other users of such materials. While the Company has been successful in obtaining its requirements for such materials thus far, there can be no assurance that it always will be able to do so. An interruption in the supply of such materials or a significant change in costs could have a material adverse effect on the Company.

Competition

Golf Clubs.The worldwide market for premium golf clubs is highly competitive, and is served by a number of well-established and well-financed companies with recognized brand names, as well as new companies with popular products. New product introductions, price reductions and “close-outs” by competitors continue to generate increased market competition. While the Company believes that its products and its marketing efforts continue to be competitive, there can be no assurance that successful marketing activities, discounted pricing or new product introductions by competitors will not negatively impact the Company’s future sales.

Golf Balls.The premium golf ball business is also highly competitive, and may be becoming even more competitive. There are a number of well-established and well-financed competitors, including one competitor with an estimated market share in excess of 50% of the premium golf ball business. There are also several recent entrants into the golf ball business, including Nike and Taylor Made. Many of these competitors have introduced or will introduce golf ball designs that directly compete with the Company’s products. Furthermore, as competition in this business increases, many of these competitors are discounting substantially the prices of their products. In order for its golf ball business to be successful, the Company will need to penetrate the market share held by existing competitors, while competing with the other new entrants, and must do so at prices that are profitable. There can be no assurance that the Company’s golf balls will obtain the market acceptance necessary to be commercially successful.

Market Acceptance of Products

A golf manufacturer’s ability to compete is in part dependent upon its ability to satisfy the various subjective requirements of golfers, including a golf club’s and golf ball’s look and “feel,” and the level of acceptance that a golf club and ball has among professional and recreational golfers. The subjective preferences of golf club and ball purchasers may be subject to rapid and unanticipated changes. There can be

no assurance as to how long the Company’s golf clubs and balls will maintain market acceptance and therefore no assurance that the demand for the Company’s products will permit the Company to experience growth in sales, or maintain historical levels of sales, in the future.

New Product Introduction

The Company believes that the introduction of new, innovative golf clubs and golf balls is important to its future success. A major portion of the Company’s revenues is generated by products that are less than two years old. The Company faces certain risks associated with such a strategy. For example, in the golf industry, new models and basic design changes in golf equipment are frequently met with consumer rejection. In addition, prior successful designs may be rendered obsolete within a relatively short period of time as new products are introduced into the marketplace. Further, any new products that retail at a lower price than prior products may negatively impact the Company’s revenues unless unit sales increase.

The Company’s new products have tended to incorporate significant innovations in design and manufacture, which have often resulted in higher prices for the Company’s products relative to other products in the marketplace. For example, the Company’s Rule 35® golf balls are premium golf balls and there are many lower priced non-premium golf balls sold by others. There can be no assurance that a significant percentage of the public will always be willing to pay such premium prices for golf equipment or that the Company will be able to continue to design and manufacture premium products that achieve market acceptance in the future.

The rapid introduction of new golf club or golf ball products by the Company could result in close-outs of existing inventories at both the wholesale and retail levels. Such close-outs can result in reduced margins on the sale of older products, as well as reduced sales of new products, given the availability of older products at lower prices. The Company experienced some of these effects in 1999 with respect to golf clubs and could experience similar effects in future years as the Company from time to time introduces new golf club or golf ball products or misjudges demand.

It previously was the Company’s practice to announce its new product line at the beginning of each calendar year. The Company recently departed from that practice and now announces its new product line in the fourth quarter to allow retailers to plan better. Such early announcements of new products could cause golfers, and therefore the Company’s customers, to defer purchasing additional golf equipment until the Company’s new products are available. Such deferments could have a material adverse effect upon sales of the Company’s current products and/or result in close-out sales at reduced prices.

Conformance with the Rules of Golf

New golf club and golf ball products generally seek to satisfy the standards established by the United States Golf Association (“USGA”) and the Royal and Ancient Golf Club of St. Andrews (“R&A”) because these standards are generally followed by golfers within their respective jurisdictions. The USGA rules are generally followed in the United States, Canada and Mexico, and the R&A rules are generally followed in most other countries throughout the world.

Currently, the Rules of Golf as published by the R&A and the USGA are virtually the same except with respect to the regulation of “driving clubs.” In 1998, the USGA adopted a so-called “spring-like effect test” that limits the coefficient of restitution (“COR”) of drivers. The R&A has announced that it does not believe that such a limitation is needed or in the best interests of the game of golf, and has not adopted such a test or other performance limitation on drivers.

Some countries, such as Japan and Canada, have local golf associations that exert some control over the game of golf within their jurisdictions. The Royal Canadian Golf Association (“RCGA”) has announced that it will generally follow the USGA with respect to equipment rules. So far, no other local organization within the R&A’s general jurisdiction has deviated from the R&A’s position with respect to equipment rules.

Currently, all of the Company’s products are believed to be “conforming” under the Rules of Golf as published by the R&A. In addition, all of the Company’s products with the exception of the Company’s ERC II (and ERC II Pro Series) Forged Titanium Driver are believed to be “conforming” under the Rules of

Golf as published by the USGA and RCGA. Although the ERC II Drivers conform to all existing R&A equipment rules, and most existing USGA and RCGA equipment rules, they do not conform to the USGA’s so-called “spring-like effect” test protocol. There is no assurance that new designs will satisfy USGA and/or R&A standards, or that existing USGA and/or R&A standards will not be altered in ways that adversely affect the sales of the Company’s products. For example, if the R&A were to reverse its current position and rule that the ERC II Drivers are non-conforming under the Rules of Golf as published by the R&A, then the Company believes its sales of the ERC II Drivers in the Company’s international markets would be significantly adversely affected.

On October 18, 2000, the Company announced that it intended to sell its ERC II Forged Titanium Driver in the U.S. despite the fact that it has been ruled to be non-conforming by the USGA. To the Company’s knowledge, it is the first large, premium brand golf equipment company to sell non-conforming equipment in the U.S. By undertaking this approach, the Company hopes to expand participation in the game of golf in the United States — the source of more than half of the Company’s revenues — by making the game more enjoyable and accessible for more people, including those people who play the game primarily for fun, enjoyment and recreation.

While the Company believes that this is the best strategy for the Company and its shareholders, and one that is good for the game of golf as well, the strategy has proven to be risky. The USGA has vigorously and openly opposed the sale or use of the ERC II Driver. On December 8, 2000, the USGA announced that scores in rounds played with clubs that do not conform to USGA rules, such as the ERC II Forged Titanium Driver, may not be posted for USGA handicap purposes. That position has been reinforced by further announcements by the USGA. A significant number of U.S. retailers have declined to carry the ERC II Driver, and that number could grow. It also appears at this time that a significant number of U.S. golfers may decide that they do not wish to purchase a driver that may not be used in competitions in the U.S. played subject to USGA rules or that may not be used for handicap purposes. Retailer and/or consumer backlash against the introduction of a non-conforming product has hurt sales of ERC II Drivers in the U.S., and may injure sales of other, conforming products, or otherwise damage the brand. These negative effects will materially reduce U.S. sales of ERC II Drivers and other products in 2001 and in future years, and could even negatively affect in a material way the strength of the brand and the Company’s business overseas despite the fact that the ERC II Drivers fully conform with the R&A’s Rules. On the other hand, if the Company is correct in its belief that there are a large number of American golfers who do not play in tournaments subject to the USGA’s Rules and who are prepared to purchase an exceptional non-conforming driver for use in recreational play, and/or the Company’s strategy is successful over time in attracting more people to the game of golf in the U.S., then the beneficial effects could be significant.

Golf Professional Endorsements

The Company establishes relationships with professional golfers in order to evaluate and promote Callaway Golf® and Odyssey® branded products. The Company has entered into endorsement arrangements with members of the various professional tours, including the Senior PGA Tour, the PGA Tour, the LPGA Tour, the PGA European Tour, the Japan Golf Tour and the buy.com Tour. While most professional golfers fulfill their contractual obligations, some have been known to stop using a sponsor’s products despite contractual commitments. If certain of the Company’s professional endorsers were to stop using the Company’s products contrary to their endorsement agreements, the Company’s business could be adversely affected in a material way by the negative publicity.

Golf Clubs.Many professional golfers throughout the world use the Company’s golf clubs even though they are not contractually bound to do so and do not grant any endorsement to the Company. The Company previously created cash pools that rewarded such usage. In 2001, the Company discontinued these pools, as it believes it is better to allocate these resources to other tour programs. In addition, many other companies are aggressively seeking the patronage of these professionals, and are offering many inducements, including specially designed products and significant cash rewards. In the past, the Company has experienced an exceptional level of club usage on the world’s major professional tours, and the Company has heavily advertised that fact. The Company’s lack of cash inducements for non-staff golfers could result in a decrease

in usage of the Company’s clubs by professional golfers. While it is not clear to what extent professional usage contributes to retail sales, it is possible that a decline in the level of professional usage of the Company’s products could have a material adverse effect on the Company’s sales and business.

Golf Balls.Many golf ball manufacturers, including the leading U.S. manufacturer of premium golf balls, have focused a great deal of their marketing efforts on promoting the fact that tour professionals use their balls. Some of these golf ball competitors spend large amounts of money to secure professional endorsements, and the market leader has obtained a very high degree of tour penetration. While almost all of the Company’s staff professionals, as well as other professionals who are not on the Company’s staff, have decided to use the Company’s golf balls in play, there is no assurance they will continue to do so. Furthermore, there are many other professionals who are already under contract with other golf ball manufacturers or who, for other reasons, may not choose to play the Company’s golf ball products. The Company does not plan to match the endorsement spending levels of the leading manufacturer, and will instead rely more heavily upon the performance of the ball and other factors to attract professionals to the product. In the future the Company may or may not increase its tour spending in support of its golf ball. It is not clear to what extent use by professionals is important to the commercial success of the Company’s golf balls, but it is possible that the results of the Company’s golf ball business could be significantly affected by its success or lack of success in securing acceptance on the professional tours.

Intellectual Property and Proprietary Rights

The golf club industry, in general, has been characterized by widespread imitation of popular club designs. The Company has an active program of enforcing its proprietary rights against companies and individuals who market or manufacture counterfeits and “knock off” products, and aggressively asserts its rights against infringers of its copyrights, patents, trademarks, and trade dress. However, there is no assurance that these efforts will reduce the level of acceptance obtained by these infringers. Additionally, there can be no assurance that other golf club manufacturers will not be able to produce successful golf clubs which imitate the Company’s designs without infringing any of the Company’s copyrights, patents, trademarks, or trade dress.

An increasing number of the Company’s competitors have, like the Company itself, sought to obtain patent, trademark, copyright or other protection of their proprietary rights and designs for golf clubs and golf balls. From time to time others have contacted or may contact the Company to claim that they have proprietary rights that have been infringed by the Company and/or its products. The Company evaluates any such claims and, where appropriate, has obtained or sought to obtain licenses or other business arrangements. To date, there have been no interruptions in the Company’s business as a result of any claims of infringement. No assurance can be given, however, that the Company will not be adversely affected in the future by the assertion of intellectual property rights belonging to others. This effect could include alteration or withdrawal of existing products and delayed introduction of new products.

Various patents have been issued to the Company’s competitors in the golf ball industry. As the Company develops its golf ball products, it attempts to avoid infringing valid patents or other intellectual property rights. Despite these attempts, it cannot be guaranteed that competitors will not assert and/or a court will not find that the Company’s golf balls infringe certain patent or other rights of competitors. If the Company’s golf balls are found to infringe on protected technology, there is no assurance that the Company would be able to obtain a license to use such technology, and it could incur substantial costs to redesign them and/or defend legal actions.

The Company has procedures to maintain the secrecy of its confidential business information. These procedures include criteria for dissemination of information and written confidentiality agreements with employees and suppliers. Suppliers, when engaged in joint research projects, are required to enter into additional confidentiality agreements. While these efforts are taken seriously, there can be no assurance that these measures will prove adequate in all instances to protect the Company’s confidential information.

Seasonality and Adverse Weather Conditions

In the golf club and golf ball industries, sales to retailers are generally seasonal due to lower demand in the retail market during cold weather months. The Company’s golf club business has generally experienced these seasonal fluctuations and the Company expects this to continue generally for both its golf club and golf ball businesses. Furthermore, unusual or severe weather conditions generally result in less golf rounds played, which generally results in less demand for golf clubs and golf balls. Consequently, sustained adverse weather conditions, especially during the warm weather months, could materially affect the Company’s sales. The Company believes that overall in the Company’s principal markets during the first half of 2001 there was unusually adverse weather, which may have affected retail sales of the Company’s products and made the Company’s customers reluctant to re-order in quantity. If such reluctance were to continue, the Company’s sales for the remainder of the year would be materially adversely affected.

Product Returns

Golf Clubs.The Company supports all of its golf clubs with a limited two year written warranty. Since the Company does not rely upon traditional designs in the development of its golf clubs, its products may be more likely to develop unanticipated problems than those of many of its competitors that use traditional designs. For example, clubs have been returned with cracked clubheads, broken graphite shafts and loose medallions. While any breakage or warranty problems are deemed significant to the Company, the incidence of clubs returned to date has not been material in relation to the volume of clubs that have been sold.

The Company monitors the level and nature of any golf club breakage and, where appropriate, seeks to incorporate design and production changes to assure its customers of the highest quality available in the market. Significant increases in the incidence of breakage or other product problems may adversely affect the Company’s sales and image with golfers. While the Company believes that it has sufficient reserves for warranty claims, there can be no assurance that these reserves will be sufficient if the Company were to experience an unusually high incidence of breakage or other product problems.

Golf Balls.The Company has not experienced significant returns of defective golf balls, and in light of the quality control procedures implemented in the production of its golf balls, the Company does not expect a significant amount of defective ball returns. However, if future returns of defective golf balls were significant, it could have a material adverse effect upon the Company’s golf ball business.

“Gray Market” Distribution

Some quantities of the Company’s products find their way to unapproved outlets or distribution channels. This “gray market” for the Company’s products can undermine authorized retailers and foreign wholesale distributors who promote and support the Company’s products, and can injure the Company’s image in the minds of its customers and consumers. On the other hand, stopping such commerce could result in a potential decrease in sales to those customers who are selling Callaway Golf products to unauthorized distributors and/or an increase in sales returns over historical levels. For example, the Company experienced a decline in sales in the U.S. in 1998, and believes the decline was due, in part, to a decline in “gray market” shipments to Asia and Europe. While the Company has taken some lawful steps to limit commerce in its products in the “gray market” in both the U.S. and abroad, it has not stopped such commerce.

International Distribution and Foreign Currency Fluctuations

The Company’s management believes that controlling the distribution of its products in certain major markets in the world has been and will be an element in the future growth and success of the Company. The Company has reorganized a substantial portion of its international operations, including the acquisition of distribution rights in certain key countries in Europe, Asia and North America. These efforts have resulted and will continue to result in additional investments in inventory, accounts receivable, employees, corporate infrastructure and facilities. The operation of foreign distribution in the Company’s international markets will continue to require the dedication of management and other Company resources.

Additionally, the Company’s operation of foreign distribution increases the Company’s exposure to fluctuations in exchange rates for various foreign currencies which could result in losses and, in turn, could adversely impact the Company’s results of operations. The Company’s results for the first half of 2001 were significantly affected negatively by the strength of the U.S. dollar versus other foreign currencies as compared to the prior year. Continued weakness in such foreign currencies during the remainder of 2001 would have a significant negative effect upon the Company.

The Company tries to mitigate its exposure to foreign currency fluctuations by engaging in certain hedging activities. The Company’s hedges reduce, but do not eliminate, the adverse affects of such foreign currency fluctuations on the Company’s results of operations. For example, the Company successfully entered into hedges for certain transactions it anticipated to occur during the first half of 2001. These hedging activities mitigated the negative effects of foreign currency fluctuations on the hedged transactions that occurred during such period. However, despite the Company’s hedging activities, as compared to the first half of 2000, fluctuations in foreign currency exchange rates adversely impacted first half 2001 net sales by approximately $22.1 million, as measured by applying first half 2000 exchange rates to first half 2001 net sales. If it were not for the Company’s hedging activities, the adverse foreign currency effects would have been greater. There can be no assurance to what extent the Company might be able to mitigate its future exposure to fluctuations in foreign currency through its management of foreign currency transactions.(See below Item 3, Quantitative and Qualitative Disclosures about Market Risk — Foreign Currency Fluctuations).

Credit Risk

The Company primarily sells its products to golf equipment retailers directly and through wholly-owned domestic and foreign subsidiaries, and to foreign distributors. The Company performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral from these customers. Historically, the Company’s bad debt expense has been low. However, a downturn in the retail golf equipment market could result in increased delinquent or uncollectible accounts for some of the Company’s significant customers. In addition, as the Company integrates its foreign distribution its exposure to credit risks increases as it no longer sells to a few wholesalers but rather directly to many retailers. A failure of a significant portion of the Company’s customers to meet their obligations to the Company would adversely impact the Company’s performance and financial condition.

Information Systems

All of the Company’s major operations, including manufacturing, distribution, sales and accounting, are dependent upon the Company’s information computer systems. Any significant disruption in the operation of such systems could have a significant adverse effect upon the Company’s ability to operate its business. Although the Company has taken steps to mitigate the effect of any such disruptions, there is no assurance that such steps would be adequate in a particular situation. Consequently, a significant or extended disruption in the operation of the Company’s information systems could have a material adverse effect upon the Company’s operations and therefore financial performance and condition.

Many of the countries in which the Company sells its products are Member States of the Economic and Monetary Union (“EMU”). Beginning January 1, 1999, Member States of the EMU have the option of trading in either their local currencies or the euro, the official currency of EMU participating Member States. Parties are free to choose the unit they prefer in contractual relationships until 2002 when their local currencies will be phased out. The current version of the Company’s enterprise-wide business system currently supports single transactions denominated in euro. At the end of 2001, the Company expects to convert the customers who are in the EMU groups from their national currency to the euro. Until such time as the conversion has occurred transactions denominated in euro will be processed manually. To date, the Company has not experienced, and does not anticipate in the near future, a large demand from its customers to transact in euro. Additionally, the Company does not believe that it will incur material costs specifically associated with manually processing data or preparing its business systems to operate in either the transitional period or beyond. However, there can be no assurance that the conversion of EMU Member States to euro will not have a material adverse effect on the Company and its operations.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company uses derivative financial instruments for hedging purposes and to manage its exposure to changes in foreign exchange rates and electricity prices. Transactions involving these financial instruments are with credit-worthy firms and major exchanges. The use of these instruments exposes the Company to market and credit risk which may at times be concentrated with certain counterparties, although counterparty nonperformance is not anticipated. The Company is also exposed to interest rate risk from its credit facilities and accounts receivable securitization arrangement.(See above Certain Factors Affecting Callaway Golf Company — International Distribution and Foreign Currency Fluctuations).

Foreign Currency Fluctuations

The Company is exposed to the impact of foreign currency fluctuations due to its international operations and certain export sales. The Company is exposed to both transactional currency/ functional currency and functional currency/ reporting currency exchange rate risks. In the normal course of business, the Company employs established policies and procedures to manage its exposure to fluctuations in the value of foreign currencies. Pursuant to its foreign exchange hedging policy, the Company may use forward foreign currency exchange rate contracts to hedge certain firm commitments and the related receivables and payables. During the six months ended June 30, 2001, the Company entered into such contracts on behalf of two of its wholly-owned subsidiaries, Callaway Golf Europe Ltd. and Callaway Golf K.K. The effect of this practice is to minimize variability in the Company’s operating results arising from foreign exchange rate movements. These foreign exchange contracts generally do not subject the Company to risk due to exchange rate movements because gains and losses on these contracts offset losses and gains on the transactions being hedged, and the Company does not engage in hedging contracts which exceed the amounts of these transactions.

Also pursuant to its foreign exchange hedging policy, the Company may hedge anticipated transactions denominated in foreign currencies using forward foreign currency exchange rate contracts and put or call options. Foreign currency derivatives are used only to the extent considered necessary to meet the Company’s objectives. The Company does not enter into forward contracts for speculative purposes. The Company’s foreign currency exposures include most European currencies, Japanese yen, Canadian dollars, Korean won, Australian dollars, and New Zealand dollars.

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 June 30, 2001 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 interrelationships, hedging instruments and hedge percentages, timing and other factors.

The estimated maximum one-day loss in earnings from the Company’s foreign-currency derivative financial instruments, calculated using the sensitivity analysis model described above, is $3.9 million at June 30, 2001. 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

The Company entered into a derivative commodity instrument to manage its exposure to the impact of electricity price fluctuations. The contract is a long-term fixed price physical delivery contract, which allows the Company greater predictability of energy costs and security in the supply of electricity in a volatile California energy market. This derivative commodity instrument is carried at fair value pursuant to requirements of SFAS No. 133. Therefore, fluctuations in the market price of electricity will directly affect the

carrying value of the contract. At June 30, 2001, the change in fair value of the outstanding derivative commodity instrument that would be expected from a ten percent adverse price change is $3.0 million. The fair value of the derivative commodity instrument is estimated based on present value adjusted quoted market prices as further discussed in Note 10 to the Consolidated Condensed Financial Statements. Price changes were calculated by assuming a ten percent adverse price change regardless of term or historical relationship between the contract price of the instrument and the underlying commodity price.

Interest Rate Fluctuations

Additionally, the Company is exposed to interest rate risk from its Amended Credit Agreement, Japanese credit facilities and Accounts Receivable Facility (see Notes 4 and 5 to the Company’s Consolidated Condensed Financial Statements) which are indexed to the LIBOR, TIBOR and Redwood Receivables Corporation Commercial Paper Rate. No amounts were advanced or outstanding under these facilities at June 30, 2001.

Notes 4 and 5 to the Consolidated Condensed Financial Statements outline the principal amounts, if any, and other terms required to evaluate the expected cash flows and sensitivity to interest rate changes.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The Company, incident to its business activities, is often the plaintiff in legal proceedings, both domestically and abroad, in various stages of development. In conjunction with the Company’s program of enforcing its proprietary rights, the Company has initiated or may initiate actions against alleged infringers under the intellectual property laws of various countries, including, for example, the U.S. Lanham Act, the U.S. Patent Act, and other pertinent laws. Defendants in these actions may, among other things, contest the validity and/or the enforceability of some of the Company’s patents and/or trademarks. Others may assert counterclaims against the Company. Based upon the Company’s experience, the Company believes that the outcome of these matters individually and in the aggregate will not have a material adverse effect upon the financial position or results of operations of the Company. It is possible, however, that in the future one or more defenses or claims asserted by defendants in one or more of those actions may succeed, resulting in the loss of all or part of the rights under one or more patents, loss of a trademark, a monetary award against the Company or some other loss to the Company. One or more of these results 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 from time to time receives information claiming that products sold by the Company infringe or may infringe patent or other intellectual property rights of third parties. To date, the Company has not experienced any material expense or disruption associated with any such potential infringement matters. It is possible, however, that one or more claims of potential infringement could lead to litigation, the need to obtain additional licenses, the need to alter a product to avoid infringement, or some other action or loss by the Company.

unable to ascertain the ultimate aggregate amount of monetary liability, amounts which may be covered by insurance, or the financial impact with respect to these matters as of June 30, 2001. However, management believes at this time that the final resolution of these matters, individually and in the aggregate, will not have a material adverse effect upon the Company’s annual consolidated financial position, results of operations or cash flows.

Item 2. Changes in Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

On May 2, 2001, the Company held its 2001 Annual Meeting of Shareholders. Ely Callaway, William C. Baker, Vernon E. Jordan, Jr., Yotaro Kobayashi, Aulana L. Peters, Richard L. Rosenfield and Charles J. Yash were elected to the Board of Directors.

The voting results for the election of directors are as follows:


Name	Votes For		Votes Withheld

Ely Callaway		65,632,902		1,607,833




William C. Baker		65,628,716		1,612,019




Vernon E. Jordan, Jr.		65,399,144		1,841,591




Yotaro Kobayashi		65,629,681		1,611,054




Aulana L. Peters		65,003,016		2,237,719




Richard L. Rosenfield		65,634,618		1,606,117




Charles J. Yash		65,612,409		1,628,326

On May 31, 2001, Mr. Yash left the Company and in connection with his departure resigned from the Board of Directors. Mrs. Peters resigned from the Board of Directors on June 6, 2001. Mr. Callaway passed away on July 5, 2001. Ronald A. Drapeau, who is Mr. Callaway’s successor as President and Chief Executive Officer of the Company, was appointed to the Board of Directors effective as of June 7, 2001. Also effective as of June 7, 2001, Ronald S. Beard was appointed to the Company’s Board of Directors.

Item 5. Other Information

None

Item 6. Exhibits and Reports on Form 8-K

a.Exhibits


3.1		Certificate of Incorporation, incorporated herein by this reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, as filed with the Securities and Exchange Commission (the “Commission”) on July 1, 1999 (file no. 1-10962).
3.2		Bylaws, incorporated herein by this reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K, as filed with the Commission on July 1, 1999 (file no. 1-10962).
4.1		Dividend Reinvestment and Stock Purchase Plan, incorporated herein by this reference to the Prospectus in the Company’s Registration Statement on Form S-3, as filed with the Commission on March 29, 1994 (file no. 33-77024).
10.50		Master Energy Purchase and Sale Agreement, and related Confirmation Letter, each entered into as of April 12, 2001, by and between Enron Energy Services, Inc. and the Company.(†)
10.51		Resignation and Consulting Agreement with Mutual Releases, entered into as of May 31, 2001, by and between the Company and Charles J. Yash.(†)
10.52		Release by Charles J. Yash effective May 31, 2001.(†)
10.53		Executive Officer Employment Agreement, entered into as of June 1, 2001, by and between the Company and Robert Penicka.(†)


(†)	Included with this Report.

b.Reports on Form 8-K

Form 8-K, dated May 15, 2001, reporting the issuance of a press release of even date therewith, which press release was captioned, “Ron Drapeau Appointed President and CEO of Callaway Golf as Ely Callaway Announces Retirement; Founder Remains as Chairman of the Board.”

Form 8-K, dated June 6, 2001, reporting the issuance of a press release of even date therewith, which press release was captioned, “Callaway Golf Announces Resignation of Chuck Yash.” The Form 8-K also reported the issuance of separate press releases dated June 8, 2001 captioned, “Callaway Golf See Revised Revenue Growth of 5% in First Half of 2001” and “Callaway Golf Appoints Two New Directors.”

Form 8-K, dated June 15, 2001, reporting that the Company notified PricewaterhouseCoopers LLP (“PwC”) that the Board of Directors, upon recommendation of the Audit Committee, approved the dismissal of PwC as the Company’s independent auditors effective June 18, 2001. The Current Report on Form 8-K also reported that the Board of Directors approved the appointment effective as of June 18, 2001 of the firm Arthur Andersen LLP to serve as the Company’s independent auditors for fiscal year 2001.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: August 14, 2001


	CALLAWAY GOLF COMPANY


	By:	/s/ BRADLEY J. HOLIDAY



	Bradley J. Holiday
	Executive Vice President and
	Chief Financial Officer

EXHIBIT INDEX


Exhibit		Description

	10.50	Master Energy Purchase and Sale Agreement, and related Confirmation Letter, each entered into as of April 12, 2001, by and between Enron Energy Services, Inc. and the Company.(†)
	10.51	Resignation and Consulting Agreement with Mutual Releases, entered into as of May 31, 2001, by and between the Company and Charles J. Yash.(†)
	10.52	Release by Charles J. Yash effective May 31, 2001.(†)
	10.53	Executive Officer Employment Agreement, entered into as of June 1, 2001, by and between the Company and Robert Penicka.(†)


(†)	Included with this Report.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. sophomore Avg

Topgolf Callaway Brands (MODG) 10-Q2001 Q2 Quarterly report

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