Note 13. Share-Based Employee Compensation

As of September 30, 2014, 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 and the 2013 Non-Employee Directors Stock Incentive Plan. From time to time, the Company grants stock options, restricted stock units, phantom stock units, stock appreciation rights and other awards under these plans. In 2014, the Company granted restricted stock units and performance share units under these plans, compared to stock options and restricted stock units in 2013.

The table below summarizes the amounts recognized in the financial statements for the three and nine months ended September 30, 2014 and 2013 for share-based compensation, including expense for stock options, restricted stock units, phantom stock units, cash settled stock appreciation rights and performance share units. The decrease in share-based compensation expense during the three and nine months ended September 30, 2014 compared to the same periods in the prior year was due to a decline in the stock price period over period. In addition, compensation expense during 2013 included expense from phantom stock units which vested in January 2014.



	Three Months Ended September 30,					Nine Months Ended September 30,
(In thousands)	2014			2013		2014		2013
Cost of sales	$	(55	)	$	84	$	71	$	229
Operating expenses	(436		)	1,804		2,519		4,028
Total cost of share-based compensation included in income, before income tax	$	(491	)	$	1,888	$	2,590	$	4,257

Stock Options

There were no stock options granted during the first nine months of 2014. During the nine months ended September 30, 2013, the Company granted 1,843,000 shares underlying stock options at a weighted average grant-date fair value of $2.47 per share based on the Black Scholes option-pricing model. There were no stock options granted during the third quarter of 2013. Total compensation expense recognized for stock options during the three and nine months ended September 30, 2014 was $358,000 and $1,081,000, respectively. Total compensation expense recognized for stock options during the three and nine months ended September 30, 2013 was $486,000 and $1,333,000, 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.

The table below summarizes the weighted average Black-Scholes fair value assumptions used in the valuation of stock options granted during the nine months ended September 30, 2013. There were no stock options granted during the third quarter of 2013, and the first nine months of 2014.



	Nine Months Ended September 30, 2013
Dividend yield	0.6	%
Expected volatility	48.8	%
Risk free interest rate	0.7	%
Expected life	4.3 years

Restricted Stock Units

Restricted stock units are valued at the Company’s closing stock price on the date of grant and generally vest at the end of a three year period. Compensation expense for restricted stock units is recognized over the vesting period and is reduced by an estimate for forfeitures. During the three and nine months ended September 30, 2014, the Company granted 13,000 and 384,000 shares underlying restricted stock units, respectively, at a weighted average grant-date fair value of $7.61 and $8.18 per share, respectively. Total compensation expense, net of estimated forfeitures, recognized for restricted stock units during the three and nine months ended September 30, 2014 was $770,000 and $2,121,000, respectively.

During the nine months ended September 30, 2013, the Company granted 441,000 shares underlying restricted stock units at a weighted average grant-date fair value of $6.55 per share. There were no restricted stock units granted during the third quarter of 2013. Total compensation expense, net of estimated forfeitures, recognized for restricted stock units during the three and nine months ended September 30, 2013 was $436,000 and $1,258,000, respectively.

At September 30, 2014, the Company had $4,770,000 of total unrecognized compensation expense related to non-vested restricted stock units under the Company’s share-based payment plans. That cost is expected to be recognized over a weighted-average period of 1.7 years.

Performance Share Units

Performance share units are stock-based awards in which the number of shares ultimately received depends on the Company's performance against specified metrics that are measured over a one year performance period from the date of grant. These performance metrics were 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 will be fixed based upon the degree of achievement of the performance goals. The number of shares that could be issued can range from 50% to 150% of the participant's target award. Compensation expense for performance share units is recognized over the vesting period and is reduced by an estimate for forfeitures, and will vary based on remeasurements during the performance period. If the performance metrics are not met at the end of the performance period, compensation expense would be reversed and the awards would be forfeited. The performance units vest in full at the end of a three year period.

The Company granted 453,000 performance share units during the nine months ended September 30, 2014 at a weighted average grant-date fair value of $8.20 per share. The company did not grant performance share units during the third quarter of 2014 or during the three and nine months ended September 30, 2013. During the three and nine months ended September 30, 2014, the Company recognized total compensation expense, net of estimated forfeitures, of $310,000 and $777,000, respectively, for performance share units.

Phantom Stock Units

Phantom stock units ("PSUs") are cash-settled awards that are remeasured at the end of each interim reporting period based on the closing price of the Company’s common stock. Compensation expense for PSUs is recognized over the vesting period and will vary based on changes in the Company's stock price. PSUs vest at the end of a three year period.

There were no PSUs granted in the first nine months of 2014 and 2013. The Company reversed $57,000 and recognized $374,000 of compensation expense related to previously granted PSUs during the three and nine months ended September 30, 2014, respectively, and recognized $430,000 and $947,000 in compensation expense during the three and nine months ended September 30, 2013, respectively.

At September 30, 2014, accrued compensation expense for PSUs was $1,624,000, which was recorded in accrued employee compensation and benefits in the accompanying consolidated condensed balance sheets. At December 31, 2013, the Company accrued $2,830,000 of compensation expense for PSUs, 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 condensed balance sheets.

Stock Appreciation Rights

Stock appreciation rights ("SARs") are cash-settled awards that are indexed to the Company's stock price and are remeasured at the end of each interim period based on the Black-Scholes option-pricing model. Compensation expense is recognized on a straight-line basis over a three year vesting period and fluctuates with changes in valuation. SARs continue to be remeasured subsequent to vesting until they are exercised.

There were no SARs granted during the three and nine months ended September 30, 2014 and 2013. Due to decreases in the Company's stock price during the three and nine months ended September 30, 2014, the Company reversed expense of $1,872,000 and $1,763,000, respectively, related to SARs. The Company recognized $536,000 and $719,000 of compensation expense related to SARs during the three and nine months ended September 30, 2013, respectively.

At September 30, 2014, the Company accrued compensation expense of $3,379,000 in accrued employee compensation and benefits in the accompanying consolidated condensed balance sheets. At December 31, 2013, the Company accrued compensation expense of $5,193,000, of which $4,200,000 and $993,000 was included in accrued employee compensation and benefits and long-term incentive compensation and other, respectively, in the accompanying consolidated condensed balance sheets.