Document
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2018
OR
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period                      to                     
Commission file number 001-10962  
 
 
 
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
(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  ý    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
 
Accelerated filer
 
o
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
o
 
 
 
 
Emerging growth company
 
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  ý
As of June 30, 2018, the number of shares outstanding of the Registrant’s common stock was 94,439,937.
 


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Important Notice to Investors Regarding Forward-Looking Statements: This report contains "forward-looking statements" as defined under the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as: "may," "should," "will," "could," "would," "anticipate," "plan," "believe," "project," "estimate," "expect," "strategy," "future," "likely," "on track," and similar references to future periods. Forward-looking statements include, among others, statements that relate to future plans, events, liquidity, financial results or performance including, but not limited to, statements relating to future stock repurchases, cash flows and liquidity, compliance with debt covenants, estimated unrecognized stock compensation expense, projected capital expenditures and depreciation and amortization expense, market conditions, future contractual obligations, the realization of deferred tax assets, including loss and credit carryforwards, future income tax expense, the future impact of new accounting standards, the related financial impact of the future business and prospects of the Company, TravisMathew, LLC ("TravisMathew") and OGIO International, Inc. ("OGIO"), the expected continued financial impact of the Company's joint venture in Japan and the impact of the 2017 Tax Cuts and Jobs Act (the "Tax Act"), which includes a broad range of provisions that could have a material impact on the Company's tax provision in future periods. These statements are based upon current information and the Company's current beliefs, expectations and assumptions regarding the future of the Company's business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of the Company's control. As a result of these uncertainties and because the information on which these forward-looking statements is based may ultimately prove to be incorrect, actual results may differ materially from those anticipated. Important factors that could cause actual results to differ include, among others, the following:
certain risks and uncertainties, including changes in capital market or economic conditions;
a material impact on the Company's tax provision as a result of the Tax Act;
consumer acceptance of and demand for the Company’s products;
future retailer purchasing activity, which can be significantly affected by adverse industry conditions and overall retail inventory levels;
any unfavorable changes in U.S. trade, tax or other policies, including restrictions on imports or an increase in import tariffs;
the level of promotional activity in the marketplace;
future consumer discretionary purchasing activity, which can be significantly adversely affected by unfavorable economic or market conditions;
significant fluctuations in foreign currency exchange rates and the degree of effectiveness of the Company’s hedging programs;
the ability of the Company to manage international business risks;
adverse changes in the credit markets or continued compliance with the terms of the Company’s credit facilities;
delays, difficulties or increased costs in the supply of components needed to manufacture the Company’s products or in manufacturing the Company’s products, including the Company's dependence on a limited number of suppliers for some of its products;
adverse weather conditions and seasonality;
any rule changes or other actions taken by the USGA or other golf association that could have an adverse impact upon demand or supply of the Company’s products;
the ability of the Company to protect its intellectual property rights;
a decrease in participation levels in golf;
the effect of terrorist activity, armed conflict, natural disasters or pandemic diseases on the economy generally, on the level of demand for the Company’s products or on the Company’s ability to manage its supply and delivery logistics in such an environment; and
the general risks and uncertainties applicable to the Company and its business.
Investors should not place undue reliance on these forward-looking statements, which are based on current information and speak only as of the date hereof. The Company undertakes no obligation to update any forward-looking statements to reflect new information or events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Investors should also 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


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Company has a policy against distributing or confirming financial forecasts or projections issued by 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. For details concerning these and other risks and uncertainties, see Part I, Item IA, “Risk Factors” contained in the Company's most recent Annual Report on Form 10-K, as well as the Company’s quarterly reports on Form 10-Q and current reports on Form 8-K subsequently filed with the Securities and Exchange Commission from time to time.

Callaway Golf Company Trademarks: The following marks and phrases, among others, are trademarks of Callaway Golf Company: Apex, Apex Tour, APW, Aqua Dry, Arm Lock, Backstryke, Big Bertha, Big Bertha Alpha, Big T, Black Series, Bounty Hunter, C, C Grind, Callaway, Callaway Golf, Callaway Media Productions, Callaway Supersoft, Chev, Chev 18, Chevron Device, Chrome Soft, Cirrus, Comfort Tech, CUATER, Cup 360, CXR, 360 Face Cup, D.A.R.T., Dawn Patrol, Demonstrably Superior And Pleasingly Different, Divine, Eagle, Engage, Epic, ERC, Exo, Cage, Fast Tech Mantle, FT Optiforce, FT Performance, FT Tour, FTiZ, Fusion, GBB, GBB Epic, Gems, Gravity Core, Great Big Bertha, Great Big Bertha Epic, Griptac, Grom, Groove, In, Groove Technology, Heavenwood, Hex Aerodynamics, Hex Chrome, Hex Solaire, HX, Hyper Dry, Hyper, Lite, Hyper Speed Face, I, MIX, Innovate or Die, Ion-X, Jailbird, Jailbreak, Kings of Distance, Legacy, Longer From Everywhere, Mack Daddy, Majestic, MarXman, MD3 Milled, MD4 Tactical, Metal-X, Microhinge Face Insert, Number One Putter in Golf, O OGIO, O Works, Odyssey, Odyssey Works, Ogio, OGIO ALPHA, OGIO ARORA, OGIO CLUB, OGIO FORGE, OGIO ME, OGIO MY EXPRESSION, OGIO RENEGADE, OGIO SAVAGE, OGIO SHADOW, Opti Flex, Opti Grip, Opti Shield, Opti Therm, OptiFit, ORG 14, ORG 15, PRESTIGE 7, ProType, ∙R∙, R-Moto, Renegade, Rig 9800, Rossie, RSX, S2H2, Sabertooth, Shredder, SLED, SoftFast, Solaire, Speed Regime, Speed Step, SR1, SR2, SR3, Steelhead XR, Steelhead, Strata, Strata Jet, Stronomic, Sub Zero, Superhot, T M, Tank, Tank Cruiser, Tech Series, Teron, TI, HOT, TMCA, Toe Up, Toulon, Toulon Garage, Tour Authentic, Trade In! Trade Up!, TRAVISMATHEW, Trionomer Cover, Tyro, udesign, Uptown, Versa, VFT, W Grind, Warbird, Weather Series, Wedgeducation, White Hot, White Hot Pro, White Hot Pro Havok, White Hot Tour, White Ice, World's Friendliest, X-12, X-14, X-16, X-18, X-20, X-22, X-24, X-ACT, X Hot, X Hot Pro, X² Hot, X Series, XR, XR 16, XSPANN, Xtra Traction Technology, Xtra Width Technology, XTT, 2-Ball, 3 Deep


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CALLAWAY GOLF COMPANY
INDEX

 
 
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.


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PART I. FINANCIAL INFORMATION
Item 1.    Financial Statements (Unaudited)
CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
 
June 30,
2018
 
December 31,
2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
57,748

 
$
85,674

Accounts receivable, net
242,023

 
94,725

Inventories
237,068

 
262,486

Income taxes receivable
11,033

 
542

Other current assets
21,927

 
22,557

Total current assets
569,799

 
465,984

Property, plant and equipment, net
77,604

 
70,227

Intangible assets, net
225,224

 
225,758

Goodwill
56,055

 
56,429

Deferred taxes, net
65,538

 
91,398

Investment in golf-related venture
70,777

 
70,495

Other assets
10,425

 
10,866

Total assets
$
1,075,422

 
$
991,157

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued expenses
$
162,217

 
$
176,127

Accrued employee compensation and benefits
30,754

 
40,173

Asset-based credit facilities
96,140

 
87,755

Accrued warranty expense
8,035

 
6,657

Equipment note, short-term
2,389

 
2,367

Income taxes payable
9,792

 
1,295

Total current liabilities
309,327

 
314,374

Long-term liabilities:
 
 
 
Income tax liability
4,118

 
4,602

Deferred taxes, net
1,807

 
1,822

Long-term other
2,091

 
1,536

Equipment note, long-term
8,343

 
9,448

Commitments and contingencies (Note 12)

 

Shareholders’ equity:
 
 
 
Preferred stock, $0.01 par value, 3,000,000 shares authorized, none issued and outstanding at June 30, 2018 and December 31, 2017

 

Common stock, $0.01 par value, 240,000,000 shares authorized, 95,648,648 and 95,042,557 shares issued at June 30, 2018 and December 31, 2017, respectively
956

 
950

Additional paid-in capital
335,025

 
335,222

Retained earnings
434,674

 
324,081

Accumulated other comprehensive loss
(11,176
)
 
(6,166
)
Less: Common stock held in treasury, at cost, 1,208,711 and 411,013 shares at June 30, 2018 and December 31, 2017, respectively
(18,797
)
 
(4,456
)
Total Callaway Golf Company shareholders’ equity
740,682

 
649,631

Non-controlling interest in consolidated entity (Note 8)
9,054

 
9,744

Total shareholders’ equity
749,736

 
659,375

Total liabilities and shareholders’ equity
$
1,075,422

 
$
991,157




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


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CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Net sales
$
396,311

 
$
304,548

 
$
799,502

 
$
613,475

Cost of sales
203,614

 
156,383

 
406,343

 
317,595

Gross profit
192,697

 
148,165

 
393,159

 
295,880

Operating expenses:
 
 
 
 
 
 
 
Selling expense
83,261

 
68,102

 
166,221

 
139,864

General and administrative expense
24,408

 
22,155

 
46,302

 
45,019

Research and development expense
10,708

 
8,863

 
20,332

 
17,745

Total operating expenses
118,377

 
99,120

 
232,855

 
202,628

Income from operations
74,320

 
49,045

 
160,304

 
93,252

Interest income
363

 
305

 
415

 
336

Interest expense
(2,024
)
 
(855
)
 
(3,604
)
 
(1,601
)
Other income (expense), net
5,522

 
(971
)
 
1,016

 
(5,377
)
Income before income taxes
78,181

 
47,524

 
158,131

 
86,610

Income tax provision
17,247

 
16,050

 
34,466

 
29,256

Net income
60,934

 
31,474

 
123,665

 
57,354

Less: Net income (loss) attributable to non-controlling interest
67

 
31

 
(57
)
 
222

Net income attributable to Callaway Golf Company
$
60,867

 
$
31,443

 
$
123,722

 
$
57,132

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic
$
0.65

 
$
0.33

 
$
1.31

 
$
0.61

Diluted
$
0.63

 
$
0.33

 
$
1.28

 
$
0.59

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
94,367

 
94,213

 
94,670

 
94,142

Diluted
96,928

 
96,197

 
96,981

 
96,073

 
 
 
 
 
 
 
 
Dividends declared per common share
$
0.01

 
$
0.01

 
$
0.02

 
$
0.02
















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


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CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
60,934

 
$
31,474

 
$
123,665

 
$
57,354

Other comprehensive income:
 
 
 
 
 
 
 
Change in derivative instruments
1,894

 
(462
)
 
338

 
(3,618
)
Foreign currency translation adjustments
(9,711
)
 
2,583

 
(4,990
)
 
8,571

Comprehensive income, before income tax on other comprehensive income items
53,117

 
33,595

 
119,013

 
62,307

Income tax expense (benefit) on derivative instruments
79

 
364

 
(170
)
 
798

Comprehensive income
53,196

 
33,959

 
118,843

 
63,105

Less: Comprehensive income (loss) attributable to non-controlling interests
(401
)
 
(79
)
 
188

 
190

Comprehensive income attributable to Callaway Golf Company
$
53,597

 
$
34,038

 
$
118,655

 
$
62,915




 





























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


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CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Six Months Ended
June 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
123,665

 
$
57,354

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
   Depreciation and amortization
9,766

 
8,497

   Deferred taxes, net
30,273

 
33,028

   Non-cash share-based compensation
6,464

 
5,402

   (Gain)/loss on disposal of long-lived assets
(3
)
 
1,035

   Unrealized (gain)/loss on foreign currency hedges
(1,021
)
 
1,550

Change in assets and liabilities, net of effect from acquisitions:
 
 
 
   Accounts receivable, net
(166,354
)
 
(84,368
)
   Inventories
23,415

 
28,022

   Other assets
2,476

 
(5,901
)
   Accounts payable and accrued expenses
(13,761
)
 
(10,335
)
   Accrued employee compensation and benefits
(9,323
)
 
(5,695
)
   Accrued warranty expense
1,378

 
574

   Income taxes receivable/payable, net
(1,972
)
 
(2,941
)
   Other liabilities
84

 
102

Net cash provided by operating activities
5,087

 
26,324

Cash flows from investing activities:
 
 
 
Capital expenditures
(17,107
)
 
(12,186
)
Investments in golf related ventures
(282
)
 

Acquisitions, net of cash acquired

 
(57,890
)
Proceeds from sales of property and equipment

 
560

Net cash used in investing activities
(17,389
)
 
(69,516
)
Cash flows from financing activities:
 
 
 
Proceeds from (repayments of) credit facilities, net
8,385

 
(5,735
)
Exercise of stock options
1,258

 
3,085

Repayments of long-term debt
(1,083
)
 

Dividends paid, net
(1,897
)
 
(1,882
)
Acquisition of treasury stock
(22,301
)
 
(16,410
)
Distributions to non-controlling interests
(821
)
 
(974
)
Net cash used in financing activities
(16,459
)
 
(21,916
)
Effect of exchange rate changes on cash and cash equivalents
835

 
1,092

Net decrease in cash and cash equivalents
(27,926
)
 
(64,016
)
Cash and cash equivalents at beginning of period
85,674

 
125,975

Cash and cash equivalents at end of period
$
57,748

 
$
61,959

Supplemental disclosures:
 
 
 
Cash paid for income taxes, net
$
5,329

 
$
6,217

Cash paid for interest and fees
$
3,288

 
$
1,179

Non-cash investing and financing activities:
 
 
 
Issuance of treasury stock and common stock for compensatory stock awards released from restriction
$
5,461

 
$
5,414

Accrued capital expenditures at period-end
$
1,729

 
$
1,661

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


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CALLAWAY GOLF COMPANY
CONSOLIDATED CONDENSED STATEMENT OF SHAREHOLDERS’ EQUITY
(Unaudited)
(In thousands)
 
 
Shareholders' Equity Callaway Golf Company
 
 
 
 
 
Common Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Treasury Stock
 
Total Callaway Golf Company Shareholders' Equity
 
Non-
Controlling Interest
 
 

 
Shares
 
Amount
 
 
 
 
Shares
 
Amount
 
 
 
Total
Balance at December 31, 2017
95,043

 
$
950

 
$
335,222

 
$
324,081

 
 
$
(6,166
)
 
 
(411
)
 
$
(4,456
)
 
 
$
649,631

 
 
$
9,744

 
$
659,375

Adoption of accounting standard

 

 

 
(11,185
)
 
 

 
 

 

 
 
(11,185
)
 
 

 
(11,185
)
Acquisition of treasury stock

 

 

 

 
 

 
 
(1,404
)
 
(22,301
)
 
 
(22,301
)
 
 

 
(22,301
)
Exercise of stock options

 

 
(1,241
)
 

 
 

 
 
175

 
2,499

 
 
1,258

 
 

 
1,258

Compensatory awards released from restriction
606

 
6

 
(5,420
)
 
(47
)
 
 

 
 
431

 
5,461

 
 

 
 

 

Share-based compensation

 

 
6,464

 

 
 

 
 

 

 
 
6,464

 
 

 
6,464

Cash dividends

 

 

 
(1,897
)
 
 

 
 

 

 
 
(1,897
)
 
 

 
(1,897
)
Equity adjustment from foreign currency translation

 

 

 

 
 
(5,178
)
 
 

 

 
 
(5,178
)
 
 
188

 
(4,990
)
Change in fair value of derivative instruments, net of tax

 

 

 

 
 
168

 
 

 

 
 
168

 
 

 
168

Distribution to non-controlling interest

 

 

 

 
 

 
 

 

 
 

 
 
(821
)
 
(821
)
Net income

 

 

 
123,722

 
 

 
 

 

 
 
123,722

 
 
(57
)
 
123,665

Balance at June 30, 2018
95,649

 
$
956

 
$
335,025

 
$
434,674

 
 
$
(11,176
)
 
 
(1,209
)
 
$
(18,797
)
 
 
$
740,682

 
 
$
9,054

 
$
749,736






























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


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CALLAWAY GOLF COMPANY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited consolidated condensed financial statements have been prepared by Callaway Golf Company (the “Company” or “Callaway Golf”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”). Accordingly, certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Commission. These consolidated condensed financial statements, in the opinion of management, include all the normal and recurring adjustments necessary for the fair presentation of the financial position, results of operations and cash flows for the periods and dates presented. Interim operating results are not necessarily indicative of operating results for the full year.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Examples of such estimates include provisions for warranty, uncollectible accounts receivable, inventory obsolescence, estimates for variable consideration related to sales returns and promotional programs, tax contingencies and provisional estimates due to the Tax Act enacted in December 2017, estimates on the valuation of share-based awards and recoverability of long-lived assets and investments. Actual results may materially differ from these estimates. On an ongoing basis, the Company reviews its estimates to ensure that these estimates appropriately reflect changes in its business or as new information becomes available.
Recent Accounting Standards
In August 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." The new standard is designed to refine and expand hedge accounting for both financial (e.g., interest rate) and commodity risks. Its provisions create more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes. It also makes certain targeted improvements to simplify the application of hedge accounting guidance. The new standard is effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption, including adoption in an interim period, is permitted. If early adoption is elected in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period (i.e., the initial application date). The Company is currently evaluating the impact this ASU will have on its consolidated condensed financial statements and disclosures.
In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)." Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged and lessees will no longer be provided with a source of off-balance sheet financing. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company plans to adopt this ASU on the effective date of January 1, 2019. The Company has a significant amount of operating leases that are classified as off-balance sheet commitments under the current accounting rules. The adoption of this ASU will require the Company to record right-of-use assets and lease liabilities related to these lease commitments, which will result in a significant increase in assets and liabilities on the Company's consolidated balance sheet. The Company is still completing its analysis of this ASU and the impact it will have on its consolidated financial statements.


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Adoption of New Accounting Standards
On January 1, 2018, the Company adopted ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" using the modified retrospective approach, and applied this guidance to all contracts as of the adoption date as discussed in Note 2 below. This new standard requires companies to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time based on when control of goods and services transfers to a customer. In addition, it requires companies to determine the transaction price for a contract, which is the price used to recognize revenue as well as the amount of consideration companies expect to collect from its customers in exchange for the promised goods or services in the contract. Because the transaction price can vary as a result of variable consideration for items such as sales returns, discounts, rebates, price concessions and incentives, companies are required to include an estimate of variable consideration in the transaction price. The adoption of this new standard accelerated the timing of when the Company recognizes variable consideration for certain sales promotions and price concessions that it offers to its customers. As a result, the Company now estimates the variable consideration related to these sales programs at the time of the sale based on a historical rate, as opposed to when these programs are approved and announced. Upon the adoption of Topic 606, the Company recorded a cumulative adjustment to beginning retained earnings of $11,185,000, as noted in the table below, to reflect the estimated amount of variable consideration related to future sales programs for revenue recognized in prior periods. Prior period information that is presented for comparative purposes has not been restated and continues to be reported under the accounting standards that were in effect in those periods.
Balance Sheet
Balance at
December 31, 2017
 
Adjustments Due To
Topic 606
 
Balance at
January 1, 2018
Accounts receivable, net
$
94,725

 
$
(16,156
)
 
$
78,569

Deferred taxes, net
$
91,398

 
$
4,971

 
$
96,369

Retained earnings
$
324,081

 
$
(11,185
)
 
$
312,896

The impact of adopting the new revenue standard on the Company's consolidated condensed statements of operations for the three and six month periods ended June 30, 2018 was as follows:
 
Three Months Ended June 30, 2018
 
As Reported
 
Balances Without Adoption of Topic 606
 
Effect of Change
Increase/(Decrease)
Net Sales
$
396,311

 
$
396,937

 
$
(626
)
Income tax provision
$
17,247

 
$
17,406

 
$
(159
)
Net income
$
60,934

 
$
61,401

 
$
(467
)
 
 
 
 
 
 
 
Six Months Ended June 30, 2018
 
As Reported
 
Balances Without Adoption of Topic 606
 
Effect of Change
Increase/(Decrease)
Net Sales
$
799,502

 
$
808,571

 
$
(9,069
)
Income tax provision
$
34,466

 
$
36,443

 
$
(1,977
)
Net income
$
123,665

 
$
130,757

 
$
(7,092
)


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The impact of adopting the new revenue standard on the Company's consolidated condensed balance sheet as of June 30, 2018 was as follows:
 
June 30, 2018
 
As Reported
 
Balances Without Adoption of Topic 606
 
Effect of Change
Increase/(Decrease)
Assets
 
 
 
 
 
Accounts receivable, net
$
242,023

 
$
267,248

 
$
(25,225
)
Deferred taxes, net
$
65,538

 
$
59,792

 
$
5,746

 
 
 
 
 
 
Liabilities and Equity
 
 
 
 
 
Income tax liability
$
9,792

 
$
10,993

 
$
(1,201
)
Retained earnings
$
434,674

 
$
452,952

 
$
(18,278
)
On January 1, 2018, the Company early adopted ASU No. 2018-02 “Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” which provides financial statement preparers with an option to reclassify stranded tax effects within accumulated other comprehensive income to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act (or portion thereof) resulted in a disproportionate tax effect. The amendments are effective for all organizations for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company adopted this policy using the specific identification method, and the adoption of this policy did not have a material impact on the Company’s consolidated condensed financial statements.
On January 1, 2018, the Company adopted ASU No. 2016-16 “Intra-Entity Asset Transfer of Assets other than Inventory,” which eliminates the requirement to defer the tax effects of intra-entity asset transfers until they are disposed or sold to a third party. The adoption of this ASU did not have a material impact on the Company’s consolidated condensed financial statements.
On January 1, 2018, the Company adopted ASU No. 2016-04, "Liabilities—Extinguishment of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products," which clarifies when it is acceptable to recognize the unredeemed portion of prepaid gift cards into income. The adoption of this ASU did not change the Company's accounting for gift cards, and therefore did not impact the Company's consolidated condensed financial statements. As of June 30, 2018, the Company had $992,000 of deferred revenue related to unredeemed gift cards.
On January 1, 2018, the Company adopted No. 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." The amendment requires (i) equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, (ii) public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, and (iii) separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables). This amendment eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. As of June 30, 2018, the Company had an investment in Topgolf International, Inc., doing business as the Topgolf Entertainment Group ("Topgolf") of $70,777,000, consisting of common stock and various classes of preferred stock. Because Topgolf is a privately held company, the Company's investment in Topgolf is accounted for at cost less impairments, if any, as this investment is without a readily determinable fair value. In accordance with ASU No. 2016-01, if there is an observable price change as a result of an orderly transaction for the identical or similar investment of the same issuer, the Company would be required to assess the fair value impact, if any, on each class of Topgolf stock held by the Company, and write such stock up or down to its estimated fair value. Based on prior observable market transactions, the Company believes that the fair value of its investment in Topgolf significantly exceeds its cost. If there are any observable price changes related to this investment, the adjustment to measure this investment at fair value could have a significant effect on the Company's financial position and results of operations (see Note 9). During the three and six months ended June 30, 2018, there were no transactions with observable price changes and as such, no adjustments to measure this investment at fair value were made as of June 30, 2018.


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Table of Contents

Note 2. Revenue Recognition
The Company recognizes revenue from the sale of its products, which include golf clubs, golf balls, golf bags and other lifestyle and golf-related apparel and accessories. The Company sells its products to customers, which include on- and off-course golf shops and national retail stores, as well as to consumers through its e-commerce business and at its apparel retail locations. In addition, the Company recognizes royalty income from the sale of certain soft goods products, as well as revenue from the sale of gift cards.
The Company's contracts with customers are generally in the form of a purchase order. In certain cases, the Company enters into sales agreements containing specific terms, discounts and allowances. In addition, the Company enters into licensing agreements with certain distributors.
The following table presents the Company's revenue disaggregated by major product category and operating segment (in thousands):
 
Three Months Ended June 30, 2018
 
Operating Segments
 
Golf Clubs
 
Golf Balls
 
Gear, Accessories & Other
 
Total
Major product category:
 
Woods
$
93,958

 
$

 
$

 
$
93,958

Irons
111,059

 

 

 
111,059

Putters
27,785

 

 

 
27,785

Golf Balls

 
65,882

 

 
65,882

Gear, Accessories and Other

 

 
97,627

 
97,627

 
$
232,802

 
$
65,882

 
$
97,627

 
$
396,311


 
Six Months Ended June 30, 2018
 
Operating Segments
 
Golf Clubs
 
Golf Balls
 
Gear, Accessories & Other
 
Total
Major product category:
 
Woods
$
222,760

 
$

 
$

 
$
222,760

Irons
206,268

 

 

 
206,268

Putters
61,215

 

 

 
61,215

Golf Balls

 
120,804

 

 
120,804

Gear, Accessories and Other

 

 
188,455

 
188,455

 
$
490,243

 
$
120,804

 
$
188,455

 
$
799,502

The Company sells its golf clubs and golf ball products as well as its gear and accessories in the United States and internationally, with its principal international markets being Japan and Europe. Sales of golf clubs, golf balls and gear and accessories in each region are generally proportional to the Company's consolidated net sales by operating segment as a percentage of total consolidated net sales. Sales of gear and accessories in Japan are proportionally higher relative to the size of that region due to sales from the Company's apparel joint venture in Japan.


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The following table presents information about the geographical areas in which the Company operates. Revenues are attributed to the location to which the product was shipped.
 
Three Months Ended June 30, 2018
Major Geographic Region:
(In thousands)
United States
$
233,373

Europe
46,325

Japan
59,666

Rest of Asia
33,059

Other foreign countries
23,888

 
$
396,311

 
Six Months Ended June 30, 2018
Major Geographic Region:
 
United States
$
468,534

Europe
97,527

Japan
128,941

Rest of Asia
57,834

Other foreign countries
46,666

 
$
799,502


Product Sales
The Company recognizes revenue from the sale of its products when it satisfies the terms of a sales order from a customer, and transfers control of the products ordered to the customer. Control transfers at a point in time when products are shipped, and in certain cases, when products are received by customers. In addition, the Company recognizes revenue at the point of sale on transactions with consumers at its retail locations.
Royalty Income
Royalty income is recognized over time in net sales as underlying product sales occur, subject to certain minimum royalties, in accordance with the related licensing arrangements and is included in the Company's Gear, Accessories and Other operating segment. Total royalty income for the three months ended June 30, 2018 and 2017 was $4,750,000 and $4,760,000, respectively. Total royalty income for the six months ended June 30, 2018 and 2017 was $9,594,000 and $9,884,000, respectively.
Gift Cards
Revenues from gift cards are deferred and recognized when the cards are redeemed. The Company’s gift cards have no expiration date. The Company recognizes revenue from unredeemed gift cards, otherwise known as breakage, when the likelihood of redemption becomes remote and under circumstances that comply with any applicable state escheatment laws. To determine when redemption is remote, the Company analyzes an aging of unredeemed cards (based on the date the card was last used or the activation date if the card has never been used) and compares that information with historical redemption trends. The Company uses this historical redemption rate to recognize breakage on unredeemed gift cards over the redemption period. The Company does not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions used to determine the timing of recognition of gift card revenues. As of June 30, 2018 and December 31, 2017, the total amount of deferred revenue on gift cards was $992,000 and $971,000, respectively. The Company recognized $435,000 and $390,000 of deferred gift card revenue during the three months ended June 30, 2018 and 2017, respectively, and $761,000 and $651,000 during the six months ended June 30, 2018 and 2017, respectively.


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Table of Contents

Variable Consideration
The amount of revenue the Company recognizes is based on the amount of consideration it expects to receive from customers. The amount of consideration is the sales price adjusted for estimates of variable consideration, including sales returns, discounts and allowances as well as sales programs, sales promotions and price concessions that are offered by the Company as described below. These estimates are based on the amounts earned or to be claimed by customers on the related sales, and are therefore recorded as reductions to sales and trade accounts receivable.
The Company’s primary sales program, the “Preferred Retailer Program,” offers longer payment terms during the initial sell-in period, as well as potential rebates and discounts, for participating retailers in exchange for providing certain benefits to the Company, including the maintenance of agreed upon inventory levels, prime product placement and retailer staff training. Under this program, qualifying retailers can earn either discounts or rebates based upon the amount of product purchased. Discounts are applied and recorded at the time of sale. For rebates, the Company estimates the amount of variable consideration related to the rebate at the time of sale based on the customer’s estimated qualifying current year product purchases. The estimate is based on the historical level of purchases, adjusted for any factors expected to affect the current year purchase levels. The estimated year-end rebate is adjusted quarterly based on actual purchase levels, as necessary. The Preferred Retailer Program is generally short-term in nature and the actual amount of rebate to be paid under this program is known as of the end of the year and paid to customers shortly after year-end. Historically, the Company's actual amount of variable consideration related to its Preferred Retailer Program has not been materially different from its estimates.
The Company also offers short-term sales program incentives, which include sell-through promotions and price concessions. The Company records the estimated variable consideration related to these types of programs at the time of the sale based on a historical average rate, which generally aligns with the Company's products' life cycles. The Company monitors this estimate and adjusts the promotional liability when it becomes evident that the amount of consideration it expects to receive changes. Historically, the Company’s actual amount of variable consideration related to these sales programs has not been materially different from its estimates.
The Company records an estimate for anticipated returns as a reduction of sales and cost of sales and accounts receivable in the period that the related sales are recorded. Sales returns are estimated based upon historical returns, current economic trends, changes in customer demands and sell-through of products. The Company also offers its customers sales programs that allow for specific returns. The Company records a return liability for anticipated returns related to these sales programs at the time of the sale based on the terms of the sales program. Historically, the Company’s actual sales returns have not been materially different from management’s original estimates.
Credit Losses
The Company's trade accounts receivable are recorded at net realizable value, which includes an appropriate allowance for estimated credit losses, as well as reserves related to product returns and sales programs as described above. The estimate of credit losses is based upon historical bad debts, current customer receivable balances, age of customer receivable balances, the customer’s financial condition and current economic trends, all of which are subject to change. Actual uncollected amounts have historically been consistent with the Company’s expectations. The Company's payment terms on its receivables from customers are generally 60 days or less.
The following table provides a reconciliation of the activity related to the Company’s allowance for credit losses (in thousands):
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Beginning balance
$
3,809

 
$
3,700

 
$
4,447

 
$
5,728

Increase (decrease) in the provision for credit losses
311

 
54

 
(284
)
 
791

Write-off of uncollectible amounts, net of recoveries
(445
)
 
(147
)
 
(488
)
 
(2,912
)
Ending balance
$
3,675

 
$
3,607

 
$
3,675

 
$
3,607

The Company has a two-year stated product warranty. The estimated cost associated with its product warranty continues to be recognized at the time of the sale. See Note 10 for further information.


15

Table of Contents

Note 3. Business Combinations
During 2017, the Company completed the acquisitions of OGIO International, Inc. ("OGIO") and TravisMathew, LLC ("TravisMathew"). The purchase price of each acquisition was allocated to the underlying assets acquired and liabilities assumed based upon their estimated fair values as of the date of acquisition in accordance with ASC Topic 820, "Fair Value Measurement." The excess between the purchase price and the fair value of the net identifiable tangible and intangible assets acquired and liabilities assumed was allocated to goodwill. The Company determined the estimated fair values after review and consideration of relevant information, including discounted cash flows, quoted market prices and estimates made by management. The Company may retrospectively adjust the fair value of the identifiable assets acquired and the liabilities assumed, as necessary, during the measurement period of up to one year from the acquisition date, to reflect new information existing at the acquisition date affecting the measurement of those amounts at that date, and any additional assets or liabilities existing at that date.
Valuations of acquired intangible assets and inventory are subject to fair value measurements that were based primarily on significant inputs not observable in the market and thus represent Level 3 measurements (see Note 14).
Both acquisitions were treated as asset purchases for income tax purposes and, as such, the Company expects to deduct all of the intangible assets, including goodwill, from taxable income over time.
Acquisition of OGIO International, Inc.
In January 2017, the Company acquired all of the outstanding shares of capital stock of OGIO, a leading manufacturer of high quality bags, accessories and apparel in the golf and lifestyle categories, in a cash transaction pursuant to the terms of a Share Purchase Agreement, by and among the Company, OGIO, and each of the shareholders and option holders of OGIO.
The acquired furniture, fixtures, office equipment, leasehold improvements, computer equipment and warehouse equipment were all valued at their estimated replacement cost, which the Company determined approximated the net book value of the assets on the date of the acquisition. Inventory was valued using the net realizable value approach, which was based on the estimated selling price in the ordinary course of business less reasonable disposal costs. The customer and distributor relationships were valued under the income approach based on the present value of future earnings. The trade name was valued under the royalty savings income approach method, which is equal to the present value of the after-tax royalty savings attributable to owning the trade name as opposed to paying a third party for its use. For this valuation, the Company used a royalty rate of 7.5%, which is reflective of royalty rates paid in market transactions, and a discount rate of 14.0% on the future cash flows generated by the net after-tax savings. Goodwill arising from the acquisition consists largely of the synergies expected from combining the operations of the Company and OGIO. For segment reporting purposes, goodwill is reported in the Gear, Accessories and Other operating segment.
The total purchase price was valued at $65,951,000. The Company recognized transaction costs of $1,805,000 in general and administrative expenses during the six months ended June 30, 2017.


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Table of Contents

The following table summarizes the fair values of the assets acquired and liabilities assumed as of the acquisition date based on the purchase price allocation (in thousands):
 
At January 11, 2017
Assets Acquired
 
 
Cash
 
$
8,061

Accounts receivable
 
7,696

Inventory
 
7,092

Other current assets
 
328

Property and equipment
 
2,369

Intangibles - trade name
 
49,700

Intangibles - customer & distributor relationships
 
1,500

Intangibles - non-compete agreements
 
150

Goodwill
 
5,885

Total assets acquired
 
82,781

Liabilities Assumed
 
 
Accounts Payable and accrued liabilities
 
16,830

Net assets acquired
 
$
65,951

Acquisition of TravisMathew, LLC
In August 2017, the Company acquired TravisMathew, a golf and lifestyle apparel company in an all-cash transaction pursuant to the terms of an Agreement and Plan of Merger, by and among the Company, TravisMathew, OTP LLC, a California limited liability company and wholly-owned subsidiary of the Company (“Merger Sub”), and a representative of the equity holders of TravisMathew. The Company acquired TravisMathew by way of a merger of Merger Sub with and into TravisMathew, with TravisMathew surviving as a wholly-owned subsidiary of the Company. The primary reason for this acquisition was to enhance the Company's presence in golf while also providing a platform for future growth in the lifestyle category.
The acquired furniture, fixtures, office equipment, leasehold improvements, computer equipment and warehouse equipment were all valued at their estimated replacement cost, which the Company determined approximated the net book value of the assets on the date of the acquisition. Inventory was valued using the net realizable value approach, which was based on the estimated selling price in the ordinary course of business less reasonable disposal costs. The licensing agreement was valued under the income approach based on the projected royalty income from the distributors. The customer and distributor relationships were valued under the income approach based on the present value of future earnings. The trade name was valued under the royalty savings income approach method, which is equal to the present value of the after-tax royalty savings attributable to owning the trade name as opposed to paying a third party for its use. For this valuation, the Company used a royalty rate of 8.0%, which is reflective of royalty rates paid in market transactions, and a discount rate of 11.0% on the future cash flows generated by the net after-tax savings. Goodwill arising from the acquisition consists largely of the synergies expected from combining the operations of the Company and TravisMathew. For segment reporting purposes, goodwill is reported in the Gear, Accessories and Other operating segment.
The total purchase price was valued at $124,578,000. In connection with the acquisition, during the second half of 2017, the Company recognized transaction costs of approximately $2,521,000 in general and administrative expenses.


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Table of Contents

The following table summarizes the fair values of the assets acquired and liabilities assumed as of the acquisition date based on the purchase price allocation (in thousands):
 
At August 17, 2017
Assets Acquired
 
 
Cash
 
$
663

Accounts receivable
 
9,715

Inventory
 
11,909

Other current assets
 
549

Property and equipment
 
4,327

Other assets
 
117

Intangibles - trade name
 
78,400

Intangibles - licensing agreement
 
1,100

Intangibles - customer & distributor relationships
 
4,450

Intangibles - non-compete agreements
 
600

Goodwill
 
23,640

Total assets acquired
 
135,470

Liabilities Assumed
 
 
Accounts Payable and accrued liabilities
 
10,892

Net assets acquired
 
$
124,578

Note 4. Financing Arrangements
In addition to cash on hand, as well as cash generated from operations, the Company relies on its primary and Japan asset-based revolving credit facilities to manage seasonal fluctuations in liquidity and to provide additional liquidity when the Company’s operating cash flows are not sufficient to fund the Company’s requirements. As of June 30, 2018, the Company had $96,140,000 outstanding under these facilities, $1,231,000 in outstanding letters of credit, and $57,748,000 in cash and cash equivalents. As of June 30, 2018, the Company's available liquidity, which is comprised of cash on hand and amounts available under both facilities, after letters of credit and outstanding borrowings was $301,266,000. As of June 30, 2017, the Company had $6,231,000 outstanding under these facilities, $854,000 in outstanding letters of credit, and $61,959,000 in cash and cash equivalents. As of June 30, 2017, the Company's available liquidity, which is comprised of cash on hand and amounts available under both facilities, after letters of credit and outstanding borrowings, was $246,736,000.
Primary Asset-Based Revolving Credit Facility
In November 2017, the Company amended and restated its primary credit facility (the Third Amended and Restated Loan and Security Agreement) with Bank of America N.A. and other lenders (the “ABL Facility”), which provides a senior secured asset-based revolving credit facility of up to $330,000,000, comprised of a $260,000,000 U.S. facility, a $25,000,000 Canadian facility and a $45,000,000 United Kingdom facility, in each case subject to borrowing base availability under the applicable facility. The amounts outstanding under the ABL Facility are secured by certain assets, including cash (to the extent pledged by the Company), the Company's intellectual property, certain eligible real estate, inventory and accounts receivable of the Company’s subsidiaries in the United States, Canada and the United Kingdom. The real estate and intellectual property components of the borrowing base under the ABL Facility are both amortizing. The amount available for the real estate portion is reduced quarterly over a 15-year period, and the amount available for the intellectual property portion is reduced quarterly over a 3-year period.
As of June 30, 2018, the Company had $94,875,000 in borrowings outstanding under the ABL Facility and $1,231,000 in outstanding letters of credit. Amounts available under the ABL Facility fluctuate with the general seasonality of the business and increase and decrease with changes in the Company’s inventory and accounts receivable balances. Amounts available are highest during the first half of the year when the Company’s inventory and accounts receivable balances are higher and lower during the second half of the year when the Company's inventory levels decrease and its accounts receivable decrease as a result of cash collections and lower sales. Average outstanding borrowings during the six months ended June 30, 2018 were $125,296,000, and average amounts available under the ABL Facility during the six months ended June 30, 2018, after outstanding borrowings and


18

Table of Contents

letters of credit, was approximately $166,295,000. Amounts borrowed under the ABL Facility may be repaid and borrowed as needed. The entire outstanding principal amount (if any) is due and payable on November 20, 2022.
The ABL Facility includes certain restrictions including, among other things, restrictions on the incurrence of additional debt, liens, stock repurchases and other restricted payments, asset sales, investments, mergers, acquisitions and affiliate transactions. In addition, the ABL Facility imposes restrictions on the amount the Company could pay in annual cash dividends, including meeting certain restrictions on the amount of additional indebtedness and requirements to maintain a certain fixed charge coverage ratio under certain circumstances. As of June 30, 2018, the Company was in compliance with all financial covenants of the ABL Facility. Additionally, the Company is subject to compliance with a fixed charge coverage ratio covenant during, and continuing 30 days after, any period in which the Company’s borrowing base availability, as amended, falls below 10% of the maximum facility amount. The Company’s borrowing base availability was above $33,000,000 during the six months ended June 30, 2018, and the Company was in compliance with the fixed charge coverage ratio as of June 30, 2018. Had the Company not been in compliance with the fixed charge coverage ratio as of June 30, 2018, the Company's maximum amount of additional indebtedness that could have been outstanding on June 30, 2018 would have been reduced by $33,000,000.
The interest rate applicable to outstanding loans under the ABL Facility fluctuates depending on the Company’s “availability ratio," which is expressed as a percentage of (i) the average daily availability under the ABL Facility to (ii) the sum of the Canadian, the U.K. and the U.S. borrowing bases, as adjusted. At June 30, 2018 the Company’s trailing 12 month average interest rate applicable to its outstanding loans under the ABL Facility was 4.01%. Additionally, the ABL Facility provides for monthly fees of 0.25% of the unused portion of the ABL Facility.
The fees incurred in connection with the origination and amendment of the ABL Facility totaled $2,275,000, which will be amortized into interest expense over the term of the ABL Facility agreement. Unamortized origination fees at June 30, 2018 and December 31, 2017 were $1,998,000 and $2,197,000, respectively, of which $461,000 and $454,000, respectively, were included in other current assets and $1,537,000 and $1,743,000, respectively, were included in other long-term assets in the accompanying consolidated condensed balance sheets.
Japan ABL Facility
In January 2018, the Company refinanced the asset-based loan agreement between its subsidiary in Japan and The Bank of Tokyo-Mitsubishi UFJ, Ltd (the "Japan ABL Facility"), which provides a credit facility of up to 4,000,000,000 Yen (or U.S. $36,320,000, using the exchange rate in effect as of June 30, 2018) over a three-year term, subject to borrowing base availability under the facility. The amounts outstanding are secured by certain assets, including eligible inventory and eligible accounts receivable. The Japan ABL Facility also includes certain restrictions including covenants related to certain pledged assets and financial performance metrics. As of June 30, 2018, the Company was in compliance with these covenants. The Japan ABL Facility is subject to an effective interest rate equal to the Tokyo interbank offered rate plus 0.80%.
The Company had 140,000,000 Yen (or approximately U.S. $1,265,000) in borrowings outstanding under the Japan ABL Facility as of June 30, 2018, and the year to date average interest rate applicable to the Company's outstanding borrowings under this facility was 0.85%. The facility expires in January 2021.
Equipment Note
In December 2017, the Company entered into a long-term financing agreement (the "Equipment Note") secured by certain equipment at the Company's golf ball manufacturing facility. As of June 30, 2018 and December 31, 2017, the Company had $10,732,000 and $11,815,000, respectively, outstanding under this agreement, of which $2,389,000 and $2,367,000 were reported in current liabilities, respectively, and $8,343,000 and $9,448,000 were reported in long-term liabilities, respectively, in the accompanying consolidated condensed balance sheets. The Company's interest rate applicable to outstanding borrowings was 3.79%. Total interest expense recognized during the three and six months ended June 30, 2018 was $105,000 and $215,000, respectively. The equipment note amortizes over a 5-year term.
The Equipment Note is subject to compliance with a fixed charge coverage ratio covenant of 1.25 during each fiscal quarter in which the Company has outstanding borrowings, and a fixed charge coverage ratio of 1.0 during periods in which no borrowings are outstanding. As of June 30, 2018, the Company was in compliance with these covenants.


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Table of Contents

Note 5. Earnings per Common Share
Basic earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period.
Diluted earnings per common share takes into account the potential dilution that could occur if outstanding securities were exercised. Dilutive securities are included in the calculation of diluted earnings per common share using the treasury stock method in accordance with ASC Topic 260, “Earnings per Share.” Dilutive securities include outstanding options granted pursuant to the Company’s stock option plans and outstanding restricted stock units and performance share units granted to employees and non-employee directors (see Note 13).
Weighted-average common shares outstanding—diluted is the same as weighted-average common shares outstanding—basic in periods when a net loss is reported or in periods when anti-dilution occurs.  
The following table summarizes the computation of basic and diluted earnings per share (in thousands, except per share data):
 
Three Months Ended June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Earnings per common share—basic
 
 
 
 
 
 
 
Net income
$
60,934

 
$
31,474

 
$
123,665

 
$
57,354

Less: Net income (loss) attributable to non-controlling interests
67

 
31

 
(57
)
 
222

Net income attributable to Callaway Golf Company
$
60,867

 
$
31,443

 
$
123,722

 
$
57,132

Weighted-average common shares outstanding—basic
94,367

 
94,213

 
94,670

 
94,142

Basic earnings per common share
$
0.65

 
$
0.33

 
$
1.31

 
$
0.61

Earnings per common share—diluted
 
 
 
 
 
 
 
Net income attributable to Callaway Golf Company
$
60,867

 
$
31,443

 
$
123,722

 
$
57,132

Weighted-average common shares outstanding—basic
94,367

 
94,213

 
94,670

 
94,142

Outstanding options, restricted stock units and performance share units
2,561

 
1,984

 
2,311

 
1,931

Weighted-average common shares outstanding—diluted
96,928

 
96,197

 
96,981

 
96,073

Dilutive earnings per common share
$
0.63

 
$
0.33

 
$
1.28

 
$
0.59

For the three and six months ended June 30, 2017, securities outstanding totaling approximately 131,000 shares and 141,000 shares, respectively, comprised of stock options, have been excluded from the calculation of earnings per common share—diluted as their effect would be antidilutive. There were no securities excluded from the calculation of earnings per common share—diluted for the three and six months ended June 30, 2018.
Note 6. Inventories
Inventories are summarized below (in thousands):
 
June 30,
2018
 
December 31, 2017
Inventories:
 
 
 
Raw materials
$
67,177

 
$
67,785

Work-in-process
723

 
868

Finished goods
169,168

 
193,833

 
$
237,068

 
$
262,486

Note 7. Goodwill and Intangible Assets
Goodwill at June 30, 2018 decreased to $56,055,000 from $56,429,000 at December 31, 2017. This $374,000 decrease was due to foreign currency fluctuations. The Company's goodwill is reported in the Golf Clubs and Gear, Accessories and Other operating segments (see Note 17).


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In accordance with ASC Topic 350, “Intangibles—Goodwill and Other,” the Company’s goodwill and non-amortizing intangible assets are subject to an annual impairment test or more frequently when impairment indicators are present. There were no impairment charges recognized during the three and six months ended June 30, 2018. The following sets forth the intangible assets by major asset class (dollars in thousands):
 
Useful
Life
(Years)
 
June 30, 2018
 
December 31, 2017
 
Gross
 
Accumulated
Amortization
 
Net Book
Value
 
Gross
 
Accumulated
Amortization
 
Net Book
Value
Non-Amortizing:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trade name, trademark and trade dress and other
NA
 
$
218,364

 
 
$

 
 
$
218,364

 
$
218,364

 
 
$

 
 
$
218,364

Amortizing:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Patents
2-16
 
31,581

 
 
31,516

 
 
65

 
31,581

 
 
31,491

 
 
90

Other
1-9
 
15,780

 
 
8,985

 
 
6,795

 
15,780

 
 
8,476

 
 
7,304

Total intangible assets
 
 
$
265,725

 
 
$
40,501

 
 
$
225,224

 
$
265,725

 
 
$
39,967

 
 
$
225,758

Aggregate amortization expense on intangible assets was approximately $267,000 and $63,000 for the three months ended June 30, 2018 and 2017, respectively, and $534,000 and $121,000 for the six months ended June 30, 2018 and 2017, respectively.
Amortization expense related to intangible assets at June 30, 2018 in each of the next five fiscal years and beyond is expected to be incurred as follows (in thousands):
Remainder of 2018
$
533

2019
1,053

2020
966

2021
910

2022
734

2023
595

Thereafter
2,069

 
$
6,860

Note 8. Joint Venture
The Company has a joint venture in Japan, Callaway Apparel K.K., with its long-time apparel licensee, TSI Groove & Sports Co, Ltd., ("TSI") for the design, manufacture and distribution of Callaway-branded apparel, footwear and headwear in Japan. The Company contributed $10,556,000, primarily in cash, for a 52% ownership of the joint venture, and TSI contributed $9,744,000, primarily in inventory, for the remaining 48%. The Company has a majority voting percentage on matters pertaining to the business operations and significant management decisions of the joint venture, and as such, the Company is required to consolidate the financial results of the joint venture with the financial results of the Company. The Company consolidates the joint venture one month in arrears.
As a result of the consolidation, during the three and six months ended June 30, 2018, the Company recorded net income attributable to the non-controlling interest of $67,000 and net loss of $57,000, respectively, in its consolidated condensed statements of operations. Total non-controlling interests on the Company's consolidated condensed financial statements was $9,054,000 and $9,744,000 at June 30, 2018 and December 31, 2017, respectively.
Note 9. Investments
Investment in Topgolf International, Inc.
The Company owns a minority interest of approximately 14.0% in Topgolf, the owner and operator of Topgolf entertainment centers, which ownership consists of common stock and various classes of preferred stock. In connection with this investment, the Company has a preferred partner agreement with Topgolf in which the Company has preferred signage rights, rights as the preferred supplier of golf products used or offered for use at Topgolf facilities at prices no less than those paid by the Company’s customers, preferred retail positioning in the Topgolf retail stores, and other rights incidental to those listed above.


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The Company invested an additional $282,000 in common and preferred shares of Topgolf through a private transaction with individual shareholders during the six months ended June 30, 2018. There were no additional investments during the second quarter of 2018.
In December 2017, Topgolf announced that it had completed a private placement led by Fidelity Management and Research Company (the "Fidelity Investment"), in which the Company invested $20,000,000 in series F preferred shares of Topgolf. Due to the nature and timing of this transaction, the Company believes the carrying value of its series F preferred shares that were purchased in this private placement approximates fair value as of December 31, 2017. The Company is unable to estimate the fair value of its other series of preferred stock or common stock due to the dissimilar nature of conversion rights, liquidation features and other preferred terms of these shares relative to the series F preferred shares. Further, it would not be practicable for the Company to determine the discount, if any, that would be applicable to any preferred terms, as well as any other rights provided to the holders of the various series of preferred stock, nor a premium, if any, for the incremental value that might apply in the case of a change in control transaction (e.g. an initial public offering or sale of Topgolf). The Company’s Topgolf shares are illiquid and there is no assurance that all classes of Topgolf shares would receive equivalent value upon a sale or other liquidation.
As of June 30, 2018 and December 31, 2017, the Company's total investment in Topgolf was $70,777,000 and $70,495,000, respectively.
As of June 30, 2018, there were no impairment indicators present with respect to this investment. Based on observable market transactions prior to December 31, 2017, the Company believes that the fair value of its investment in Topgolf significantly exceeds its cost. As of June 30, 2018, this investment was accounted for at cost less impairments (if any), as its fair value is not readily determinable. In accordance with ASU No. 2016-01 (see Note 1), if there is an observable price change as a result of an orderly transaction for the identical or similar investment of the same issuer, the Company would be required to assess the fair value impact, if any, on each class of Topgolf stock held by the Company, and write such stock up or down to its estimated fair value, which could have a significant effect on the Company's financial position and results of operations. During the three and six months ended June 30, 2018, there were no transactions with observable price changes and as such, no adjustments to measure this investment at fair value were made as of June 30, 2018.
Note 10. Product Warranty
The Company has a stated two-year warranty policy for its golf clubs. The Company’s policy is to accrue the estimated cost of satisfying future warranty claims at the time the sale is recorded. In estimating its future warranty obligations, the Company considers various relevant factors, including the Company’s stated warranty policies and practices, the historical frequency of claims, and the cost to replace or repair its products under warranty.
The following table provides a reconciliation of the activity related to the Company’s reserve for warranty expense (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Beginning balance
$
7,311

 
$
5,945

 
$
6,657

 
$
5,395

Provision
3,157

 
2,202

 
5,523

 
4,124

Claims paid/costs incurred
(2,433
)
 
(2,178
)
 
(4,145
)
 
(3,550
)
Ending balance
$
8,035

 
$
5,969

 
$
8,035

 
$
5,969

Note 11. Income Taxes
The Company calculates its interim income tax provision in accordance with ASC 270, “Interim Reporting,” and ASC 740 “Accounting for Income Taxes.” At the end of each interim period, the Company estimates its annual effective tax rate and applies that rate to its ordinary quarterly earnings to calculate the tax related to ordinary income. The tax effects for other items that are excluded from ordinary income are discretely calculated and recognized in the period in which they occur.
As of December 22, 2017, the Tax Act was enacted into legislation, which includes a broad range of provisions affecting businesses. The Tax Act significantly revises how companies compute their U.S corporate tax liability by, among other provisions, reducing the corporate tax rate from 35% to 21% for tax years beginning after December 31, 2017, implementing a territorial tax


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system, and requiring a mandatory one-time tax on U.S owned foreign held earnings and profits known as the toll charge or transition tax. For the six months ended June 30, 2018, the Company's consolidated effective tax rate was 21.8%.
As of December 31, 2017, the Company was able to reasonably estimate certain effects of the Tax Act and, therefore, recorded provisional adjustments associated with the deemed repatriation transition tax and rate change revaluation of the deferred tax assets. The Company has not made any additional measurement-period adjustments related to these items during the six months ended June 30, 2018, as the Company is still awaiting relevant guidance as to the provisions included in the Tax Act. However, the Company is continuing to gather additional information to complete the accounting for these items and expects to complete the accounting within the prescribed measurement period.
The realization of deferred tax assets, including loss and credit carryforwards, is subject to the Company generating sufficient taxable income during the periods in which the deferred tax assets become realizable. Due to the Company’s continued profitability, combined with future projections of profitability, the Company has determined that the majority of its U.S. deferred tax assets are more likely than not to be realized. The valuation allowance on the Company’s U.S. deferred tax assets as of June 30, 2018 primarily relates to state net operating loss carryforwards and credits that the Company estimates it may not be able to utilize in future periods. With respect to non-U.S. entities, there continues to be sufficient positive evidence to conclude that realization of its deferred tax assets is more likely than not under applicable accounting rules, and therefore no significant valuation allowances have been established.
The income tax provision was $17,247,000 and $16,050,000 for the three months ended June 30, 2018 and 2017, respectively, and $34,466,000 and $29,256,000 for the six months ended June 30, 2018 and 2017, respectively. The increase in the provision was primarily due to higher pre-tax income in the Company’s U.S. operations, which exceeded the impact of the reduction of the corporate tax rate with the Tax Act.
At June 30, 2018, the gross liability for income taxes associated with uncertain tax positions was $9,509,000. Of this amount, $1,405,000 would benefit the Company’s consolidated condensed financial statements and effective income tax rate if favorably settled. The unrecognized tax benefit liabilities are expected to decrease by approximately $102,000 during the next 12 months. The gross liability for uncertain tax positions decreased by $76,000 for the three months ended June 30, 2018. The decrease was primarily due to decreases in tax positions taken in the current quarter. The gross liability for uncertain tax positions increased by $209,000 for the six months ended June 30, 2018. The increase was primarily due to increases for tax positions expected to be taken in the current tax year.
The Company recognizes interest and penalties related to income tax matters in income tax expense. For the three months ended June 30, 2018 and 2017, the Company's provision for income taxes includes a benefit of $123,000 and an expense of $62,000, respectively, related to the recognition of interest and/or penalties. For the six months ended June 30, 2018 and 2017, the Company's provision for income taxes includes a benefit of $6,000 and an expense of $109,000, respectively. As of June 30, 2018 and December 31, 2017, the gross amount of accrued interest and penalties included in income taxes payable in the accompanying consolidated condensed balance sheets was $1,612,000 and $1,618,000, respectively.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is generally no longer subject to income tax examinations by tax authorities in the following major jurisdictions:
Tax Jurisdiction
 
Years No Longer Subject to Audit
U.S. federal
 
2010 and prior
California (United States)
 
2008 and prior
Canada
 
2010 and prior
Japan
 
2011 and prior
South Korea
 
2012 and prior
United Kingdom
 
2013 and prior
Pursuant to Section 382 of the Internal Revenue Code, use of the Company's net operating losses and credit carry-forwards may be limited significantly if the Company were to experience a cumulative change in ownership of the Company's stock by “5-percent shareholders” that exceeds 50% over a rolling three-year period. The Company does not believe there has been a cumulative change in ownership in excess of 50% during any rolling three-year period, and the Company continues to monitor changes in its


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ownership. If such a cumulative change did occur in any three-year period and the Company were limited in the amount of losses and credits it could use to offset its tax liabilities, the Company's results of operations and cash flows could be adversely impacted.
Note 12. Commitments & Contingencies
Legal Matters
The Company is subject to routine legal claims, proceedings and investigations incident to its business activities, including claims, proceedings, and investigations relating to commercial disputes and employment matters. The Company also receives from time to time information claiming that products sold by the Company infringe or may infringe patent, trademark or other intellectual property rights of third parties. One or more such claims of potential infringement could lead to litigation, the need to obtain licenses, the need to alter a product to avoid infringement, a settlement or judgment or some other action or material loss by the Company, which also could adversely affect the Company’s overall ability to protect its product designs and ultimately limit its future success in the marketplace. In addition, the Company is occasionally subject to non-routine claims, proceedings or investigations.
The Company regularly assesses such matters to determine the degree of probability that the Company will incur a material loss as a result of such matters as well as the range of possible loss. An estimated loss contingency is accrued in the Company’s consolidated financial statements if it is probable the Company will incur a loss and the amount of the loss can be reasonably estimated. The Company reviews all claims, proceedings and investigations at least quarterly and establishes or adjusts any accruals for such matters to reflect the impact of negotiations, settlements, advice of legal counsel and other information and events pertaining to a particular matter. All legal costs associated with such matters are expensed as incurred.
Historically, the claims, proceedings and investigations brought against the Company, individually and in the aggregate, have not had a material adverse effect on the consolidated condensed results of operations, cash flows or financial position of the Company. The Company believes that it has valid legal defenses to the matters currently pending against the Company. These matters are inherently unpredictable, and the resolutions of these matters are subject to many uncertainties and the outcomes are not predictable with assurance. Consequently, management is unable to estimate the ultimate aggregate amount of monetary loss, amounts covered by insurance or the financial impact that will result from such matters. In addition, the Company cannot assure that it will be able to successfully defend itself in those matters or that any amounts accrued are sufficient.  The Company does not believe that the matters currently pending against the Company will have a material adverse effect on the Company’s consolidated business, financial condition, cash flows or results of operations.
Unconditional Purchase Obligations
During the normal course of its business, the Company enters into agreements to purchase goods and services, including purchase commitments for production materials, as well as endorsement agreements with professional golfers and other endorsers, employment and consulting agreements, and intellectual property licensing agreements pursuant to which the Company is required to pay royalty fees. It is not possible to determine the amounts the Company will ultimately be required to pay under these agreements as they are subject to many variables including performance-based bonuses, severance arrangements, the Company’s sales levels, and reductions in payment obligations if designated minimum performance criteria are not achieved. As of June 30, 2018, the Company has entered into many of these contractual agreements with terms ranging from one to four years. The minimum obligation that the Company is required to pay under these agreements is $72,835,000 over the next four years. Future minimum commitments as of June 30, 2018, are as follows (in thousands):
Remainder of 2018
$
44,316

2019
16,806

2020
7,043

2021
3,532

2022
1,138

 
$
72,835

In addition, the Company also enters into unconditional purchase obligations with various vendors and suppliers of goods and services in the normal course of operations through purchase orders or other documentation or that are undocumented except for an invoice. Such unconditional purchase obligations are generally outstanding for periods less than a year and are settled by cash payments upon delivery of goods and services and are not reflected in this total.


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Other Contingent Contractual Obligations
During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include (i) intellectual property indemnities to the Company’s customers and licensees in connection with the use, sale and/or license of Company product or trademarks, (ii) indemnities to various lessors in connection with facility leases for certain claims arising from such facilities or leases, (iii) indemnities to vendors and service providers pertaining to the goods and services provided to the Company or based on the negligence or willful misconduct of the Company and (iv) indemnities involving the accuracy of representations and warranties in certain contracts. In addition, the Company has consulting agreements that provide for payment of nominal fees upon the issuance of patents and/or the commercialization of research results. The Company has also issued guarantees in the form of standby letters of credit of $1,231,000 as of June 30, 2018.
The duration of these indemnities, commitments and guarantees varies, and in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation on the maximum amount of future payments the Company could be obligated to make. Historically, costs incurred to settle claims related to indemnities have not been material to the Company’s financial position, results of operations or cash flows. In addition, the Company believes the likelihood is remote that payments under the commitments and guarantees described above will have a material effect on the Company’s consolidated condensed financial statements. The fair value of indemnities, commitments and guarantees that the Company issued as of June 30, 2018 was not material to the Company’s financial position, results of operations or cash flows.
Employment Contracts
In addition, the Company has made contractual commitments to each of its officers and certain other employees providing for severance payments, including salary continuation, upon the termination of employment by the Company without substantial cause or by the officer for good reason or non-renewal. In addition, in order to assure that the officers would continue to provide independent leadership consistent with the Company’s best interest, the contracts also generally provide for certain protections in the event of a change in control of the Company. These protections include the payment of certain severance benefits, such as salary continuation, upon the termination of employment following a change in control.
Note 13. Share-Based Employee Compensation
As of June 30, 2018, the Company had two shareholder approved stock plans under which shares were available for equity-based awards: the Callaway Golf Company Amended and Restated 2004 Incentive Plan (the "2004 Incentive Plan") and the 2013 Non-Employee Directors Stock Incentive Plan (the "2013 Directors Plan"). From time to time, the Company grants stock options, restricted stock units, performance share units, phantom stock units, stock appreciation rights and other awards under these plans.
The table below summarizes the amounts recognized in the financial statements for the three and six months ended June 30, 2018 and 2017 for share-based compensation, including expense for restricted stock units, performance share units, stock options and cash settled stock appreciation rights.
 
Three Months Ended June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
 
 
Cost of sales
$
256

 
$
146

 
$
470

 
$
363

Operating expenses
3,208

 
2,039

 
5,994

 
5,007

Total cost of share-based compensation included in income, before income tax
$
3,464

 
$
2,185

 
$
6,464

 
$
5,370

Restricted Stock Units
Restricted stock units awarded under the 2004 Incentive Plan and the 2013 Directors Plan are valued at the Company’s closing stock price on the date of grant. Restricted stock units generally vest over a one- to three-year period. Compensation expense for restricted stock units is recognized on a straight-line basis over the vesting period and is reduced by an estimate for forfeitures. During the three months ended June 30, 2018 and 2017, the Company granted 59,000 and 60,000 shares underlying restricted stock units, respectively, at a weighted average grant-date fair value of $17.72 and $12.04, respectively. During the six months ended June 30, 2018 and 2017, the Company granted 419,000 and 526,000 shares underlying restricted stock units, respectively, at a weighted average grant-date fair value of $15.22 and $10.35, respectively.


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Total compensation expense, net of estimated forfeitures, recognized for restricted stock units during the three months ended June 30, 2018 and 2017 was $1,463,000 and $1,439,000, respectively, and $2,850,000 and $2,660,000, for the six months ended June 30, 2018 and 2017, respectively. At June 30, 2018, the Company had $12,642,000 of total unamortized compensation expense related to non-vested restricted stock units. That cost is expected to be recognized over a weighted-average period of 2.7 years.
Performance Share Units
Performance share units granted under the 2004 Incentive Plan are stock-based awards in which the number of shares ultimately received depends on the Company's performance against specified metrics over a one- to three-year performance period from the date of grant. These performance metrics are established by the Company at the beginning of the performance period. At the end of the performance period, the number of shares of stock that could be issued is fixed based upon the degree of achievement of the performance goals. The number of shares that could be issued can range from 0% to 200% of the participant's target award. Performance share units are initially valued at the Company's closing stock price on the date of grant. Stock compensation expense, net of estimated forfeitures, is recognized on a straight-line basis over the vesting period. The expense recognized over the vesting period is adjusted up or down based on the anticipated performance level during the performance period. If the performance metrics are not probable of achievement during the performance period, compensation expense would be reversed. The awards are forfeited if the threshold performance metrics are not achieved as of the end of the performance period. The performance share units cliff-vest in full three years from the date of grant.
The Company granted 307,000 and 370,000 shares underlying performance share units during the six months ended June 30, 2018 and 2017, respectively, at a weighted average grant-date fair value of $14.80 and $10.10 per share, respectively. There were no shares underlying performance share units granted during the three months ended June 30, 2018 and 2017. The awards granted during 2018, 2017 and 2016 are subject to a three-year performance period provided that (i) if certain first year performance goals are achieved, the participant could earn up to 50% of the three-year target award shares, subject to continued service through the vesting date, and (ii) if certain cumulative first- and second-year performance goals are achieved, the participant could earn up to an aggregate of 80% of the three-year target award shares (which includes any shares earned during the first year), subject to continued service through the vesting date. Based on the Company’s performance, participants earned a minimum of 50% of the target award shares granted in 2017, and 80% of the target award shares granted in 2016, in each case subject to continued service through the vesting date.
During the three months ended June 30, 2018 and 2017, the Company recognized total compensation expense, net of estimated forfeitures, for performance share units of $1,995,000 and $737,000, respectively, and $3,599,000 and $2,725,000, for the six months ended June 30, 2018 and 2017, respectively. At June 30, 2018, unamortized compensation expense related to these awards was $14,087,000, which is expected to be recognized over a weighted-average period of 1.6 years.
Note 14. Fair Value of Financial Instruments
Certain of the Company’s financial assets and liabilities are measured at fair value on a recurring and nonrecurring basis. Fair value is defined as the price that would be received to sell an asset or the price paid to transfer a liability (the exit price) in the principal and most advantageous market for the asset or liability in an orderly transaction between market participants. Assets and liabilities carried at fair value are classified using the following three-tier hierarchy:
Level 1: Quoted market prices in active markets for identical assets or liabilities;
Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and
Level 3: Fair value measurements derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.


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The following table summarizes the valuation of the Company’s foreign currency forward contracts (see Note 15) that are measured at fair value on a recurring basis by the above pricing levels at June 30, 2018 and December 31, 2017 (in thousands):
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
June 30, 2018
 
 
 
 
 
 
 
Foreign currency forward contracts—asset position
$
2,100

 
$

 
$
2,100

 
$

Foreign currency forward contracts—liability position
(435
)
 

 
(435
)
 

 
$
1,665

 
$

 
$
1,665

 
$

December 31, 2017
 
 
 
 
 
 
 
Foreign currency forward contracts—asset position
$
179

 
$

 
$
179

 
$

Foreign currency forward contracts—liability position
(239
)
 

 
(239
)
 

 
$
(60
)
 
$

 
$
(60
)
 
$

The fair value of the Company’s foreign currency forward contracts is based on observable inputs that are corroborated by market data. Observable inputs include broker quotes, daily market foreign currency rates and forward pricing curves. Remeasurement gains and losses on foreign currency forward contracts designated as cash flow hedges are recorded in other comprehensive income, and in other income (expense) for non-designated foreign currency forward contracts (see Note 15).
Disclosures about the Fair Value of Financial Instruments
The carrying values of cash and cash equivalents at June 30, 2018 and December 31, 2017 are categorized within Level 1 of the fair value hierarchy. The table below summarizes information about fair value relating to the Company’s financial assets and liabilities that are recognized in the accompanying consolidated condensed balance sheets as of June 30, 2018 and December 31, 2017, as well as the fair value of contingent contracts that represent financial instruments (in thousands).
 
June 30, 2018
 
December 31, 2017
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair 
Value
Primary Asset-Based Revolving Credit Facility(1)
$
94,875

 
$
94,875

 
$
74,000

 
$
74,000

Japan ABL Facility(1)
$
1,265

 
$
1,265

 
$
13,755

 
$
13,755

Equipment Note(2)
$
10,732

 
$
10,732

 
$
11,815

 
$
11,815

Standby letters of credit(3)
$
1,231

 
$
1,231

 
$
887

 
$
887

 
(1)
The carrying value of the amounts outstanding under the Company's primary asset-based revolving credit facility and Japan ABL Facility approximates the fair value due to the short-term nature of these obligations. The fair value of this debt is categorized within Level 2 of the fair value hierarchy. See Note 4 for information on the Company's credit facilities, including certain risks and uncertainties related thereto.
(2)
In December 2017, the Company entered into the Equipment Note secured by certain equipment at the Company's golf ball manufacturing facility. The fair value of this debt is categorized within Level 2 of the fair value hierarchy. See Note 4 for further information.
(3)
The carrying value of the Company's standby letters of credit approximates the fair value as they represent the Company’s contingent obligation to perform in accordance with the underlying contracts. The fair value of this contingent obligation is categorized within Level 2 of the fair value hierarchy.
Nonrecurring Fair Value Measurements
The Company measures certain assets at fair value on a nonrecurring basis at least annually or more frequently if certain indicators are present. These assets include long-lived assets, goodwill, non-amortizing intangible assets and investments that are written down to fair value when they are held for sale or determined to be impaired. During each of the six months ended June 30, 2018 and 2017, there were no impairment indicators related to the Company's assets that are measured at fair value on a nonrecurring basis. Assets purchased in connection with the acquisitions of OGIO and TravisMathew were valued at their fair value on the date of purchase (see Note 3).


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Note 15. Derivatives and Hedging
In the normal course of business, the Company is exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to transactions of its international subsidiaries. As part of its strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, the Company uses designated cash flow hedges and non-designated hedges in the form of foreign currency forward contracts to mitigate the impact of foreign currency translation on transactions that are denominated primarily in Japanese Yen, British Pounds, Euros, Canadian Dollars, Australian Dollars and Korean Won.
The Company accounts for its foreign currency forward contracts in accordance with ASC Topic 815, "Derivatives and Hedging ("ASC Topic 815"). ASC Topic 815 requires the recognition of all derivative instruments as either assets or liabilities on the balance sheet, the measurement of those instruments at fair value and the recognition of changes in the fair value of derivatives in earnings in the period of change, unless the derivative qualifies as a designated cash flow hedge that offsets certain exposures. Certain criteria must be satisfied in order for derivative financial instruments to be classified and accounted for as a cash flow hedge. Gains and losses from the remeasurement of qualifying cash flow hedges are recorded as a component of other comprehensive income and released into earnings as a component of cost of goods sold or net sales during the period in which the hedged transaction takes place. Gains and losses on the ineffective portion of hedges (hedges that do not meet accounting requirements due to ineffectiveness) and derivatives that are not elected for hedge accounting treatment are immediately recorded in earnings as a component of other income (expense).
Foreign currency forward contracts are used only to meet the Company’s objectives of minimizing variability in the Company’s operating results arising from foreign exchange rate movements. The Company does not enter into foreign currency forward contracts for speculative purposes. The Company utilizes counterparties for its derivative instruments that it believes are credit-worthy at the time the transactions are entered into and the Company closely monitors the credit ratings of these counterparties.
The following table summarizes the fair value of the Company's foreign currency forward contracts as well as the location of the asset and/or liability on the consolidated condensed balance sheets at June 30, 2018 and December 31, 2017 (in thousands):
 
Asset Derivatives
June 30, 2018
 
December 31, 2017
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
Derivatives designated as cash flow hedging instruments:
 
 
 
 
 
 
 
Foreign currency forward contracts
Other current assets
 
$
586

 
Other current assets
 
$
168

 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
Foreign currency forward contracts
Other current assets
 
$
1,514

 
Other current assets
 
$
11

 
Liability Derivatives
June 30, 2018
 
December 31, 2017
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
Derivatives designated as cash flow hedging instruments:
 
 
 
 
 
 
 
Foreign currency forward contracts
Accounts payable and
accrued expenses
 
$
126

 
Accounts payable and
accrued expenses
 
$
194

 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
Foreign currency forward contracts
Accounts payable and
accrued expenses
 
$
309

 
Accounts payable and
accrued expenses
 
$
45

The Company's foreign currency forward contracts are subject to a master netting agreement with each respective counterparty bank and are therefore net settled at their maturity date. Although the Company has the legal right of offset under the master netting agreements, the Company has elected not to present these contracts on a net settlement amount basis, and therefore present these contracts on a gross basis on the accompanying consolidated condensed balance sheets at June 30, 2018 and December 31, 2017.
Cash Flow Hedging Instruments
The Company uses foreign currency forward contracts designated as qualifying cash flow hedging instruments to help mitigate the Company's foreign currency exposure on intercompany sales of inventory to its foreign subsidiaries. These contracts


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generally mature within 12 to 15 months from their inception. At June 30, 2018 and December 31, 2017, the notional amounts of the Company's foreign currency forward contracts designated as cash flow hedge instruments were approximately $28,957,000 and $14,210,000, respectively. The reporting of gains and losses on these cash flow hedging instruments depends on whether the gains or losses are effective at offsetting changes in the cash flows of the underlying hedged items. The Company uses the critical terms method to measure the effectiveness of the foreign currency forward contracts and evaluates the effectiveness on a quarterly basis. The effective portion of the gains and losses on the hedging instruments are recorded in other comprehensive income until recognized in earnings during the period that the hedged transactions take place. Any ineffective portion of the gains and losses from the hedging instruments is recognized in earnings immediately. The Company would discontinue hedge accounting prospectively (i) if it is determined that the derivative is no longer effective in offsetting changes in the cash flows of a hedged item, (ii) when the derivative expires or is sold, terminated, or exercised, (iii) if it becomes probable that the forecasted transaction being hedged by the derivative will not occur, (iv) if a hedged firm commitment no longer meets the definition of a firm commitment, or (v) if it is determined that designation of the derivative as a hedge instrument is no longer appropriate. The Company estimates the fair value of its foreign currency forward contracts based on pricing models using current market rates. These contracts are classified under Level 2 of the fair value hierarchy (see Note 14).
As of June 30, 2018, the Company recorded a net gain of $138,000 in other comprehensive income (loss) related to its hedging activities. Of this amount, net losses of $155,000 and $200,000 for the three and six months ended June 30, 2018 were relieved from other comprehensive income and recognized in cost of goods sold for the underlying intercompany sales that were recognized. There were no ineffective hedge gains or losses recognized during the three and six months ended June 30, 2018. Gains on forward points of $158,000 and $219,000 were recognized as incurred for the three and six months ended June 30, 2018, respectively. Based on the current valuation, the Company expects to reclassify net gains of $319,000 from accumulated other comprehensive income into net earnings during the next 12 months.
The Company recognized net gains of $414,000 and $1,316,000 in cost of goods sold for the three and six months ended June 30, 2017, respectively.
The following tables summarize the net effect of all cash flow hedges on the consolidated condensed financial statements for the six months ended June 30, 2018 (in thousands):
 
 
Gain/(Loss) Recognized in Other Comprehensive Income
(Effective Portion)
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
Derivatives designated as cash flow hedging instruments
 
2018
 
2017
 
2018
 
2017
Foreign currency forward contracts
 
$
1,739

 
$
(48
)
 
$
138

 
$
(2,302
)
 
 
Gain/(Loss) Reclassified from Other Comprehensive Income into Earnings
(Effective Portion)
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
Derivatives designated as cash flow hedging instruments
 
2018
 
2017
 
2018
 
2017
Foreign currency forward contracts
 
$
(155
)
 
$
414

 
$
(200
)
 
$
1,316

 
 
 
 
 
 
 
 
 
Foreign Currency Forward Contracts Not Designated as Hedging Instruments
The Company uses foreign currency forward contracts that are not designated as qualifying cash flow hedging instruments to mitigate certain balance sheet exposures (payables and receivables denominated in foreign currencies), as well as gains and losses resulting from the translation of the operating results of the Company’s international subsidiaries into U.S. dollars for financial reporting purposes. These contracts generally mature within 12 months from their inception. At June 30, 2018 and December 31, 2017, the notional amounts of the Company’s foreign currency forward contracts used to mitigate the exposures discussed above were approximately $82,712,000 and $4,821,000, respectively. The increase in foreign currency forward contracts reflects the general timing of when the Company enters into these contracts. The Company estimates the fair values of foreign currency forward contracts based on pricing models using current market rates, and records all derivatives on the balance sheet at fair value with changes in fair value recorded in the consolidated condensed statements of operations. The foreign currency contracts are classified under Level 2 of the fair value hierarchy (see Note 14).


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The following table summarizes the location of net gains and losses in the consolidated condensed statements of operations that were recognized during the six months ended June 30, 2018 and 2017, respectively (in thousands):
  
 
Location of Net Gain/(Loss) Recognized in Income on Derivative Instruments
 
Amount of Net Gain/(Loss) Recognized in Income on 
Derivative Instruments
Derivatives not designated as hedging instruments
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Foreign currency forward contracts
 
Other expense, net
 
$
7,220

 
$
(1,128
)
 
$
3,360

 
$
(6,303
)
In addition, for the three and six months ended June 30, 2018 the Company recognized net foreign currency losses related to transactions with its foreign subsidiaries of $1,873,000 and $2,508,000, respectively, and net foreign currency gains related to transactions with its foreign subsidiaries of $24,000 and $699,000, respectively, for the three and six months ended June 30, 2017.
Note 16. Accumulated Other Comprehensive Loss
The following table details the amounts reclassified from accumulated other comprehensive loss to cost of goods sold, as well as changes in foreign currency translation for the six months ended June 30, 2018. Amounts are in thousands.
 
 
Derivative Instruments
 
Foreign Currency Translation
 
Total
Accumulated other comprehensive loss, December 31, 2017, after tax
 
$
(328
)
 
$
(5,838
)
 
$
(6,166
)
Change in derivative instruments
 
138

 

 
138

Net losses reclassified to cost of goods sold
 
200

 

 
200

Foreign currency translation adjustments
 

 
(5,178
)
 
(5,178
)
Income tax benefit
 
(170
)
 

 
(170
)
Accumulated other comprehensive loss, June 30, 2018, after tax
 
$
(160
)
 
$
(11,016
)
 
$
(11,176
)
Note 17. Segment Information
The Company has three operating segments that are organized on the basis of products, namely (i) Golf Clubs, (ii) Golf Balls and (iii) Gear, Accessories and Other. The Golf Clubs segment consists of Callaway Golf drivers and fairway woods, hybrids, irons and wedges, Odyssey putters, including Toulon Design putters by Odyssey, packaged sets and sales of pre-owned golf clubs. At the product category level, sales of packaged sets are included within irons, and sales of pre-owned golf clubs are included in the respective woods, irons and putters product categories. The Golf Balls segment consists of Callaway Golf and Strata golf balls that are designed, manufactured and sold by the Company. The Gear, Accessories and Other segment consists of golf apparel and footwear, golf bags, golf gloves, travel gear, headwear and other lifestyle and golf-related apparel, gear and accessories, OGIO branded gear and accessories, sales of apparel and accessories from the Company's joint venture in Japan, TravisMathew branded apparel, and royalties from licensing of the Company’s trademarks and service marks for various soft goods products. There are no significant intersegment transactions.


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The table below contains information utilized by management to evaluate its operating segments for the interim periods presented (in thousands).
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Net sales:
 
 
 
 
 
 
 
Golf Clubs
$
232,802

 
$
196,291

 
$
490,243

 
$
389,882

Golf Balls
65,882

 
48,767

 
120,804

 
96,991

Gear, Accessories and Other
97,627

 
59,490

 
188,455

 
126,602

 
$
396,311

 
$
304,548

 
$
799,502

 
$
613,475

Income before income taxes:
 
 
 
 
 
 
 
Golf Clubs
$
50,751

 
$
38,445

 
$
117,338

 
$
73,398

Golf Balls
13,288

 
10,939

 
25,813

 
22,460

Gear, Accessories and Other
24,069

 
11,877

 
44,406

 
21,496

Reconciling items(1)
(9,927
)
 
(13,737
)
 
(29,426
)
 
(30,744
)
 
$
78,181

 
$
47,524

 
$
158,131

 
$
86,610

Additions to long-lived assets:
 
 
 
 
 
 
 
Golf Clubs
$
3,291

 
$
2,817

 
$
6,189

 
$
6,612

Golf Balls
5,546

 
2,553

 
8,081

 
5,088

Gear, Accessories and Other
1,176

 
1,024

 
2,558

 
1,526

 
$
10,013

 
$
6,394

 
$
16,828

 
$
13,226

 
(1)
Reconciling items represent corporate general and administrative expenses and other income (expense) not included by management in determining segment profitability.
 
June 30, 2018
 
December 31, 2017
Total Assets:
 
 
 
Golf Clubs
$
299,938

 
$
321,265

Golf Balls
59,050

 
57,120

Gear, Accessories and Other
236,961

 
236,515

Reconciling items(1)
479,473

 
376,257

 
$
1,075,422

 
$
991,157

Goodwill: