Share-Based Compensation

The Company accounts for its share-based compensation arrangements in accordance with ASC Topic 718, which requires the measurement and recognition of compensation expense for all share-based payment awards to employees and directors based on estimated fair values. ASC Topic 718 further requires a reduction in share-based compensation expense by an estimated forfeiture rate. The forfeiture rate used by the Company is based on historical forfeiture trends. If actual forfeiture rates are not consistent with the Company’s estimates, the Company may be required to increase or decrease compensation expenses in future periods.

The Company uses the alternative transition method for calculating the tax effects of share-based compensation pursuant to ASC Topic 718. The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC Pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC Pool and consolidated statements of cash flows of the tax effects of employee and director share-based awards that were outstanding upon adoption of ASC Topic 718.

Stock Plans

As of December 31, 2013, 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 Plan") and the 2013 Non-Employee Directors Stock Incentive Director Plan (the "2013 Directors Plan").

The 2004 Plan permits the granting of stock options, stock appreciation rights, restricted stock awards, restricted stock units and other equity-based awards to the Company’s officers, employees, consultants and certain other non-employees who provide services to the Company. All grants under the 2004 Plan are discretionary, although no participant may receive awards in any one year in excess of 2,000,000 shares. The maximum number of shares issuable over the term of the 2004 Plan is 24,000,000.

The 2013 Directors Plan permits the granting of stock options, restricted stock awards and restricted stock units to eligible directors serving on the Company's Board of Directors. The Directors may receive a one-time grant upon their initial appointment to the Board and thereafter an annual grant upon being re-elected at each annual meeting of shareholders, not to exceed 50,000 shares within any calendar year. The maximum number of shares issuable over the term of the 2013 Directors Plan is 1,000,000.

The following table presents shares authorized, available for future grant and outstanding under each of the Company’s plans as of December 31, 2013:



	Authorized	Available	Outstanding⁽²⁾
	(In thousands)
1995 Employee Stock Incentive Plan	10,800	—	234
1996 Stock Option Plan	9,000	—	100
2001 Directors Plan⁽¹⁾	500	10	144
2004 Plan	24,000	10,567	4,834
2013 Directors Plan	1,000	939	60
Total	45,300	11,516	5,372


(1)	The Company’s 2001 Non-Employee Directors Plan expired on December 31, 2011. The shares available for grant under this plan are only available to satisfy incremental dividend equivalent rights for outstanding awards.


(2)	Outstanding shares underlying restricted stock units granted under the 2001 Directors Plan, 2004 Plan and 2013 Directors Plan include accrued incremental dividend equivalent rights.

Stock Options

All stock option grants made under the 2004 Plan are made at exercise prices no less than the Company’s closing stock price on the date of grant. Outstanding stock options generally vest over a three-year period from the grant date and generally expire up to 10 years after the grant date. The Company recorded $1,839,000, $1,586,000 and $3,306,000 of compensation expense relating to outstanding stock options for the years ended December 31, 2013, 2012 and 2011, respectively.

The Company records compensation expense for employee stock options based on the estimated fair value of the options on the date of grant using the Black-Scholes option-pricing model. The model uses various assumptions, including a risk-free interest rate, the expected term of the options, the expected stock price volatility, and the expected dividend yield. Compensation expense for employee stock options is recognized over the vesting term and is reduced by an estimate for forfeitures, which is based on the Company’s historical forfeitures of unvested options and awards. For the years ended December 31, 2013, 2012 and 2011, the weighted average estimated forfeiture rate used was 6.6%, 5.7% and 4.5%, respectively. The table below summarizes the average fair value assumptions used in the valuation of stock options granted during the years ended December 31, 2013, 2012 and 2011.



	2013		2012		2011
Dividend yield	0.6	%	1.2	%	1.4	%
Expected volatility	48.8	%	50.6	%	48.5	%
Risk-free interest rate	0.7	%	0.8	%	2.0	%
Expected life	4.3 years		4.9 years		5.0 years

The Company uses historical dividends to estimate the expected dividend yield. The expected volatility is based on the historical volatility of the Company’s stock. The risk-free interest rate is based on the U.S. Treasury yield curve at the date of grant with maturity dates approximately equal to the expected term of the options at the date of the grant. The expected life of the Company’s options is based on evaluations of historical employee exercise behavior, forfeitures, cancellations and other factors. The valuation model applied in this calculation utilizes highly subjective assumptions that could potentially change over time. Changes in the subjective input assumptions can materially affect the fair value estimates of an option. Furthermore, the estimated fair value of an option does not necessarily represent the value that will ultimately be realized by the employee holding the option.

The following table summarizes the Company’s stock option activities for the year ended December 31, 2013 (in thousands, except price per share and contractual term):



Options	Number of Shares		Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at January 1, 2013	5,167		$	11.08
Granted	1,842		$	6.53
Exercised	(216	)	$	7.66
Forfeited	(86	)	$	6.77
Expired	(2,215	)	$	11.15
Outstanding at December 31, 2013	4,492		$	9.42	5.66	$	4,446
Vested and expected to vest in the future at December 31, 2013	4,365		$	9.51	5.56	$	4,208
Exercisable at December 31, 2013	2,598		$	11.48	3.27	$	989

The weighted-average grant-date fair value of options granted during the years ended December 31, 2013, 2012 and 2011 was $2.47, $2.63 and $2.94 per share, respectively.

At December 31, 2013, there was $3,220,000 of total unrecognized compensation expense related to options granted to employees under the Company’s share-based payment plans. That cost is expected to be recognized over a weighted-average period of 2.0 years. The amount of unrecognized compensation expense noted above does not necessarily represent the amount that will ultimately be realized by the Company in its consolidated statement of operations.

The total intrinsic value for options exercised during the years ended December 31, 2013 and 2012 was $243,000 and $3,000, respectively. Cash received from the exercise of stock options for the years ended December 31, 2013 and 2012 was $1,652,000 and $19,000, respectively. There were no stock option exercises in 2011.

Restricted Stock Units

Restricted stock units awarded under the 2004 Plan and the 2013 Directors Plan are recorded at the Company’s closing stock price on the date of grant. Restricted stock units generally vest at the end of a three year period. At December 31, 2013, 2012 and 2011, the weighted average grant-date fair value of restricted stock units granted was $6.55, $6.36 and $7.01, respectively. The Company recorded $1,694,000, $1,556,000 and $1,799,000 of compensation expense related to restricted stock units, in 2013, 2012 and 2011, respectively. The table below is a roll-forward of the activity for restricted stock units during the 12 months ended December 31, 2013 (in thousands, except fair value amounts):



Restricted Stock Units	Units		Weighted- Average Grant-Date Fair Value
Nonvested at January 1, 2013	647		$	6.87
Granted	440		6.55
Vested	(193	)	7.86
Forfeited	(21	)	6.78
Nonvested at December 31, 2013	873		$	6.49

At December 31, 2013, there was $3,398,000 of total unrecognized compensation expense related to nonvested restricted stock units granted to employees under the Company’s share-based payment plans. That cost is expected to be recognized over a weighted-average period of 1.64 years.

Phantom Stock Units

PSUs awarded under the 2004 Plan are a form of share-based award that are indexed to the Company’s stock and are settled in cash. Because PSUs are settled in cash, compensation expense recognized over the vesting period will vary based on changes in fair value. Fair value is remeasured at the end of each interim reporting period based on the closing price of the Company’s stock. PSUs vest at the end of a three year period.

The weighted average grant-date fair value per share of PSUs granted to employees during the years ended December 31, 2012 and 2011 was $6.37 and $7.51, respectively. The Company did not grant PSUs in 2013.

The table below is a roll-forward of the activity for phantom stock units during the 12 months ended December 31, 2013 (in thousands, except fair value amounts):



Phantom Stock Units	Units		Weighted- Average Grant-Date Fair Value
Nonvested at January 1, 2013	508		$	6.77
Granted	—		—
Vested	(17	)	7.51
Forfeited	(47	)	7.04
Nonvested at December 31, 2013	444		$	6.72

In connection with these awards, the Company recognized compensation expense of $1,635,000, $1,724,000 and $2,095,000 for the years ended December 31, 2013, 2012 and 2011, respectively. At December 31, 2013, the Company accrued compensation expense of $2,830,000 of which $1,439,000 was included in accrued employee compensation and benefits and $1,391,000 was included in long-term incentive compensation and other in the accompanying consolidated balance sheet. Accrued compensation expense for PSUs was $1,324,000 at December 31, 2012, which was included in long-term incentive compensation and other in the accompanying consolidated balance sheets.

Stock Appreciation Rights

The Company records compensation expense for SARs based on the estimated fair value on the date of grant using the Black Scholes option-pricing model. SARs are subsequently remeasured at each interim reporting period based on a revised Black Scholes value until they are exercised. SARs vest over a three year period. As of December 31, 2013, 2012 and 2011, the Company recognized $3,016,000, $2,285,000 and $321,000, respectively, in compensation expense related to these awards. At December 31, 2013 and 2012, the Company accrued compensation expense of $5,193,000 and $2,607,000, respectively, of which $4,200,000 and $1,819,000 was included in accrued employee compensation and benefits, respectively, and $993,000 and $788,000 was included in long-term incentive compensation and other, respectively, in the accompanying consolidated balance sheets.

The table below summarizes the total number of SARs granted to employees during the year ended December 31, 2013 (in thousands):



Stock Appreciation Rights	Units		Weighted- Average Exercise Price Per Share
Nonvested at January 1, 2013	2,995		$	6.42
Granted	—		—
Vested	(380	)	6.48
Forfeited	(140	)	6.69
Nonvested at December 31, 2013	2,475		$	6.39

Employee Stock Purchase Plan

The Company offered an employee stock purchase program in which participating employees authorized the Company to withhold compensation and use the withheld amounts to purchase shares of the Company’s common stock at 85% of the closing price on the last day of each six-month offering period. In 2011, the Company terminated this program. In 2011, the Company purchased approximately 376,000 shares of common stock under this program on behalf of participating employees and recorded compensation expense of $234,000.

Share-Based Compensation Expense

The table below summarizes the amounts recognized in the financial statements for the years ended December 31, 2013, 2012 and 2011 for share-based compensation, including expense for stock options, restricted stock units, phantom stock units and cash settled stock appreciation rights (in thousands):



	2013		2012		2011
Cost of sales	$	473	$	276	$	424
Operating expenses	7,711		6,874		10,882
Total cost of employee share-based compensation included in loss before income tax	$	8,184	$	7,150	$	11,306

In 2010, in connection with an employment agreement with a former executive officer of the Company, the Company was contractually obligated to grant $11,730,000 in the form of various share-based awards over the service period stipulated in the agreement. As a result, the total contractual obligation related to these equity awards was recognized on a straight-line basis over the contract term, which resulted in the recognition of compensation expense of $1,415,000 in 2011. Also in 2011, as a result of the resignation of the executive officer, the Company accelerated the vesting period of all outstanding equity awards granted under the employment agreement, which resulted in the recognition of additional compensation expense of $2,136,000.

In connection with the Cost Reduction Initiatives announced in July 2012 (see Note 3), the Company recognized $416,000 during the year ended December 31, 2012 in stock compensation expense as a result of the contractual acceleration of the vesting of certain stock options, restricted stock units and phantom stock units. In connection with the Reorganization and Reinvestment Initiatives announced in June 2011 (see Note 3), the Company recognized $3,539,000 during the year ended December 31, 2011 in stock compensation expense as a result of the contractual acceleration of the vesting of certain stock options, restricted stock units and phantom stock units.