Topgolf Callaway Brands Corp (MODG) 2002 Q2 法說會逐字稿

Good afternoon.

My name is

and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Callaway Golf's second quarter 2002 earnings release conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period.

If you would like to ask a question, during this time, simply press star, then the number one on your telephone keypad.

If you would like to withdraw your question press the pound key.

Thank you.

At this time, I would like to introduce Mr. Brad Holiday, Executive Vice President and Chief Financial Officer.

Mr. Holiday, you may begin your conference.

Thank you, and welcome everyone to Callaway Golf Company's second quarter, fiscal 2002, conference call.

Joining us today is Ron Drapeau, Chairman, President and Chief Executive of Callaway Golf Company.

During today's conference call Ron will provide an overview of our second quarter results and current trends.

I will provide more detailed comments about our financial results.

Ron will then conclude our prepared remarks with some thoughts on the golf industry, and the current competitive environment.

We will then open the call for questions.

During the call we will comment on current results, compared to last year.

For the sake of simplicity, our comments regarding year-over-year comparison will be based on pro forma results for last year, which excludes the non-cash charge, related to our long-term electricity supply agreement, which has subsequently been terminated.

There is no adjustment to current year results.

Before we begin, I would like to point out that any comments made about future performance, events or circumstances, including estimates of sales and earnings per share information, for 2002, are forward-looking statements, subject to safe harbor protection, under the Federal Securities laws.

Such statements reflect our best judgment to date, based on current market trends and traditions, and are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected in the forward-looking statement.

For details concerning these, and other risks and uncertainties, you should consult our most recent form 10-K, filed with the SEC, as well as the Company's other reports, subsequently filed with the SEC, from time to time.

With that, I will turn the call over to Ron.

Thanks Brad.

Thank you for joining us this afternoon.

I'm pleased to report solid second quarter results.

Net income increased 12 percent, and earnings per share increased 25 percent, to 55 cents.

The earnings growth exceeded the high end of our expectation.

While our second quarter sales were essentially unchanged, year over year, last year's cost cutting

and our continual improvement effort, throughout our operation, resulted in a solid improvement in our profitability, and the higher than expected earnings.

These results are a testament to the ongoing hard work of the entire Callaway team, and I want to thank them.

For those listening, who are unable to attend our recent shareholder meeting, I want to reiterate and couple of key points I touched on during that meeting.

In light of the current environment, regarding corporate accountability, I want to clearly state that Callaway Golf has always been a fiscally responsible company, and I can assure you that we will remain so under my watch.

We have a straightforward business of designing,

, manufacturing and marketing golf equipment.

We record sales based on applicable accounting rules, and we have long relationships, with our customer base, that pays in standard terms, in cash.

More importantly, we're profitable.

We generate solid pre-cash flow, and are investing that free-cash flow to improve our business and enhance shareholder value.

The only off balance sheet item we have is an operating lease for our golf ball equipment, which we entered into in December of 1998, and will buyout during the current quarter, capitalizing the equipment.

Now lets discuss our results a little further.

Year-to-date sales are off one percent, compared to last year's record level, which I believe is notable, in light of economic and industry conditions.

The decline was expected, due to our natural product life cycles.

Let me explain -- for the last six years we have developed a product life cycle that, for the most part, approximates two years.

As regards to metal woods, we have introduced new and improved titanium wood and

woods, in alternate years.

While both categories carry our highest gross margin percentages, the titanium metal woods have enjoyed higher price points, and therefore have a direct impact to the overall sales and gross margin mix.

In 2002, we are in the second year of both our

titanium ERC II metal wood, and our

titanium, Hawk Eye VFT metal woods.

Alternatively, we introduced, this year, our newest line of steel metal woods, the

.

Therefore, we anticipated that sales in gross margins would naturally be lower than a year ago.

Compared to 2000, which had a comparable product cycle mix, year-to-date sales are up four percent, and gross margins are up 400-bases points.

In light of the slight sales decline, from a year ago, and an unfavorable product mix of lower margin steel woods, irons and golf balls, I am pleased that we increased our first-half earnings by one percent.

Again, compared to 2000, our earnings are up 20 percent.

Combining these increases in earnings, with our stock repurchase program, has resulted in earnings per share growth of nine percent over 2001, and 27 percent over 2000.

This improvement in profitability is a direct result of our ongoing focus to better manage our business by lowering costs, and improving quality, in both our golf ball and golf club operation, including product engineering and manufacturing processes.

One of these improvements has been in the methods of satisfying warrant claims.

With that, we are reviewing whether the warrant reserve remains appropriate, or whether it should be reduced.

Any reduction in the warrant reserve would likely be made in the third quarter, be a one-time adjustment, not be material to the Company's financial condition.

Any resulting non-cash accounting benefit, to our reported earnings, is not included in our full-year guidance.

I only mention this now, because in the current environment the reversal of any reserve is often viewed as suspicious.

In this case it would be earned.

Additionally, we have managed savings in both G&A and R&D expenses, allowing us to invest in additional selling and marketing activities, to defend and grow our market position, in clubs and develop a foothold in golf balls.

This activity is paying off.

We are maintaining our number one position in the United States marketplace, in woods, irons and putters.

In golf balls we have gained share from a year ago, with new product introductions and a strong number two position on the six major world tours.

We have a very strong balance sheet, and our leveraging it to offer competitive terms to our retailers, while maintaining the necessary inventories to support sporadic demand peaks.

We believe this is good business practice in the current environment, in which we find ourselves, and the environment we expect over the next year.

Internationally we are benefitting from our diversification.

We have challenges in Japan that start with the economic and banking problems that we cannot control, and so we managing that part of our business with an approach that maintains our strong brand presence, while investing for better times.

On a positive note, our sales in Europe increased 25 percent, which was more than expected, and possibly offsets weakness in some of our other international markets.

The current environment, both economically and in our industry, is challenging.

I can't tell you what will happen regarding overall industry demand this year, nor can I tell you what some of our competitors will do.

What I can tell you is that we remain focused on managing those things within our control, namely product development, manufacturing cost reduction and expense management, to increase profitability and generate shareholder value.

We have introduced great new products, across all categories, and look forward to competing in these unpredictable times.

We have always been, and will always be, a product-driven company, which at the end of the day is key to successfully competing in our industry.

We will continue utilizing our strong cash position, and lack of debt, to defend our market share and work with our retail partners.

Finally, the proposed compromise, between the United States Golf Association and the Royal & Acient Golf Club, to allow high

drivers, in the United States, should benefit us directly.

After all, we invented this category, with the most notorious driver in the world, which became the most popular driver outside the United States.

We will now be able to make this great product available to golfers in this country, which leads me to an announcement, we will officially make tomorrow, to our customers.

As a celebration of this proposed compromise, we are offering, on a limited time basis, the opportunity for consumers to purchase an ERC II, at $299, a receive a dozen of our new

two-piece golf balls, at no charge.

This is the longest combination of club and ball available, to every golfer that likes to hit it long, which is every golfer.

We are very excited about this promotion, and believe our consumers will take this opportunity to get the best technology ever developed, both in a driver and ball aerodynamics.

Finally, we are introducing a new brand of golf ball.

It will called the

, and positioned as a

ball, in a price-point category, and in some channels where we do not compete with other Callaway golf products.

Now I will turn this call back to Brad, before we take questions.

Thanks Ron.

Second quarter sales declined slightly to $252 million, and diluted earnings per share increased 25 percent to 55 cents.

We realized a slight benefit, during the quarter, from foreign currency fluctuations, most significantly in Europe.

In constant dollars, total net sales would have been $251 million.

Sales benefitted during the quarter, from our diversified product offering, as lower wood sales were almost entirely offset by a 22-percent growth in other

.

Sales of woods, for the second quarter, declined 23 percent, to $97 million, compared to $126 million last year, and comprised 38 percent of sales.

As Ron mentioned, this is the second year of sales for our Big Bertha Hawk Eye VFT titanium driver and fairway woods, and ERC II

titanium driver.

As such, we expected a decline in our titanium wood sales that would not be completely offset by the introduction of the lower priced

woods.

Year-to-date, sales of woods declined 28 percent, to $202 million.

Sales of irons, for the second quarter, increased 10 percent, to $78 million, and represented 31 percent of sales.

The irons growth was due to solid consumer acceptance of our Big Bertha iron, and the continuing demand for

iron.

The X14's are in their third year of sales, which is longer than the usual two-year product life cycle, and are the best selling irons in our history.

Year-to-date, iron sales have increased 19 percent, to $162 million.

Sales of golf balls, for the second quarter, increased 13 percent to $24 million.

The second quarter growth was attributable to doubling our golf ball offering to four models, from two models last year.

We benefitted from continued sell in of our

three-piece golf balls, and the late quarter launch of our

two-piece golf balls.

Year-to-date golf ball sales increased 42 percent to $46 million.

Sales of putters, accessories and other products, in the second quarter, increased 51 percent, to $54 million, or 21 percent of sales.

This growth was driven by Odyssey putters, and our new Callaway golf clubs.

Demand for our

ball putter remains strong, and has far exceeded our original expectation.

Year-to-date sales of putters, and accessories and other products, are up 45 percent to $99 million.

U.S. sales increased three percent, to $144 million, during the second quarter, and international sales slipped five percent, to $109 million, and accounted for 43 percent of sales.

We benefitted from currency exchange fluctuations, and on a constant dollar basis, international net sales, during the quarter, would have been $108 million.

Weakness in Japan and certain other markets continue, but gains in Europe are offsetting most of that weakness.

Sales by markets were as follows: Europe increased 25 percent to $46 million, during the quarter, and is up 17 percent, year-to-date, to $87 million.

In constant dollars, Europe was up 22 percent for the quarter, and 17 percent year-to-date.

Japan declined 31 percent to $25 million, and is down 27 percent, for the first half of the year, to $57 million.

In constant dollars, Japan declined 29 percent, for the quarter, and 21 percent year-to-date.

Sales to the rest of Asia, including Korea, declined eight percent, to $18 million, during the quarter, and year-to-date is down 10 percent to $34 million.

In constant dollars, the rest of Asia declined 11 percent for the quarter, and 10 percent year-to-date.

One of the reasons for this decline is our efforts to curtail

marketing of our product, by some of our distributors.

Turning to the rest of the income statement, gross profit increased four percent, to $137 million, and gross margins increased to 55 percent of sales, from 52 percent last year, contributing to the higher than expected earnings for the quarter.

This strong growth margin improvement is particularly notable, given the planned product mix shift, to lower margin iron and steel products, in a lower average per unit selling price.

The improvement was the result of higher golf ball gross margins and lower club manufacturing costs.

Since implementing the continuous improvement program in 1999, and augmenting that with our

effort, beginning last year, we have reduced our per unit cost, to manufacture our clubs, by more than 30 percent.

Year-to-date gross profit declined one percent, to $266 million, consistent with sales trends, as gross margin was unchanged at 52 percent of sales.

Operating expense for the quarter totaled $78 million, or 31 percent of net sales.

This is a decline of six percent from last year's $83 million, or 33 percent of net sales.

The reduction was the result of lower employee expenses, from the initiatives we put in place the second half of last year, reductions in our facilities' costs and lower goodwill amortization, due to FASB 142 implementation, which represents about a third of the savings.

These gains were partially offset by increased investments in marketing and selling activities.

Year-to-date operating expenses declined five percent, to $157 million, or 31 percent of sales.

Operating income during the second quarter increased 21 percent, to $59 million, and operating margin increased to 23 percent, from 19 percent last year.

The operating margin expansion was directly attributable to a combination of higher gross margins and lower operating expenses.

First half operating income increased five percent, to $109 million, or 21 percent of sales, compared to 20 percent last year.

Second quarter net income increased 12 percent, to $37 million, with diluted earnings per share of 55 cents, which is 25 percent higher than last year, and well above the high end of our guidance, given on our last conference call.

Year-to-date net income increased one percent, to $68 million, while EPS increased nine percent, to 99 cents per share.

Compared to 2000 year-to-date, net income has increased 20 percent, and earnings per share 27 percent.

Our golf ball business continues improving.

Second quarter golf ball sales increased 13 percent, driven by continued momentum of our new

golf balls.

Gross margins improved from the low 20-percent range last year, to the high 30 -percent range during the second quarter.

Year-to-date golf ball gross margins are in the high 20-percent range, compared to the mid-upper teens last year.

Gross margins continue improving, as we lower our per ball production costs, and increase sales, to leverage facility expense.

Please keep in mind that our golf ball gross margins are largely impacted by volume, which is concentrated in the first half of the year.

Accordingly, we expect gross margins to continue improving year-over-year, but decline sequentially as the year progresses and the normal volume cycles decline.

We will now have five models of products in our line, and expect to continue improving our golf ball business, through expanded market share and improved profitability.

Our balance sheet remains solid.

We ended the second quarter with $92 million in cash, after investing $32 million to repurchase shares during the quarter.

We also ended the quarter with $294 million of working capital.

Inventory increased five percent year-over-year, but it declined 13 percent since the beginning of the year, following our typical seasonal pattern.

The year-over-year increase is due to several factors, including a broader product offering, launch quantities of our new

and

golf ball, and the fact that we took early receipt of some components, as a precautionary measure, in light of the potential longshoreman strike on the West Coast.

Accounts receivable increased 23 percent year-over-year, to $175 million, but declined four percent from the first quarter.

At first glance, the increase in receivables may raise a few eyebrows.

Let me clearly state that the quality of our receivables has actually improved, versus last year, and the increase is a direct result of our preferred retailer program we launched late last year.

This program is strategic and very straightforward.

We offer our best terms, which do not exceed 90 days, to the retailers who chose to join the plan, in exchange for the commitment to three key initiates.

One, minimum inventory levels, two, prime position in their store, and three, training their sales staff on the attributes of our product.

The response has exceeded our expectations, with more than half of our accounts joining the program.

We are very committed to this program, and have recently started auditing its participants, to assure compliance with the

terms.

We expect our receivable levels to decline as the year progresses, consistent with our typical seasonal pattern.

Capital expenditures during the quarter were $7 million, and depreciation and amortization totaled $9 million.

Free cash flow, for the past 12 months, was approximately $74 million.

During the quarter we repurchased 1.8-million shares of common stock, at an average price of $17.59 per share.

Since the original $100-million share repurchase was first authorized, in May of 2000, we have invested $218 million to repurchase a total of 12.7-million shares.

Finally, I would like to comment about guidance for the year.

Ron mentioned earlier that we have always tried to communicate as much as possible, regarding our Company's performance and future guidance.

We have typically been conservative, as demonstrated by this past quarter, because when this guidance is not received well by the investment community, especially in the current environment.

Many of you would like specific numbers, or a very narrow range by quarter, which for those of you who have run a business before know it's very difficult to achieve.

This is especially true for us, given our business

, or driven by reorders, after the first quarter.

We are also impacted by other factors, such as weather, economy, competition and sometimes governing body decisions.

So lets talk about what we know right now.

We know that the golf market is having a tough year.

played are down this year, in the United States.

Competition is aggressive and some are irrational in pricing, as they try to maintain or grow their market share.

Japan continues in its economic slump.

We also know that Callaway Golf has achieved stronger than expected results, in both quarters this year, manages cost very well, has the strongest brand in the industry, a strong balance sheet and drives new technology to the marketplace on a regular basis.

Things we don't know are what will happen with the economy and consumer confidence, when conditions in Japan will improve, competitive behavior, or the reaction to our just announced ERC II promotion.

We do believe, however, that given all of the companies in the golf industry, the Callaway Golf is best positioned to not only survive in this environment, but take advantage of any opportunities that exist.

We have many initiatives in the works that we believe will allow us to maximize our potential in the current marketplace, but need the flexibility as to when we implement them.

To give specific third quarter guidance, at this time, would hamper this flexibility, therefore we will not give specific quarterly guidance, but reiterate our full-year guidance of exceeding 2001 results, with sales estimated to be a range of 810 to $820 million, and fully diluted earnings per share of $1.02 to $1,07.

This will hopefully help you align your expectations with ours.

This concludes my remarks.

I would now like to turn the call back over to Ron.

Thank you.

I want to briefly address the current competitive environment, and the future of Callaway Golf, before we open the call for questions.

We have commented on and there has been considerable speculation about the behavior of some in our industry and the potential impact on our business.

We are closely monitoring these near-term factors and are responding strategically to defend our market share position.

We, like you, cannot predict with accuracy the future.

What I can tell you is that this management team is firmly committed to conducting our business ethically, with full disclosure and realistic expectations.

We are not content to merely react to changes in our industry.

We will fight for our market share.

We remain focused on developing products that are demonstratively superior, and pleasingly different, and on improving our operation.

We have faced and managed through these, and other industry conditions in the past, and as with any industry there will be future challenges, as well.

I believe we have considerable strengths that are often overlooked, namely we have a strong brand equity, solid management team, proven product development capability, financial strength and the best infrastructure worldwide in the industry.

We have new products in our pipeline that I believe are very exciting, and we're committed to leveraging the strengths I just mentioned, to drive long-term earnings growth and shareholder value.

That concludes are prepared remarks.

I would like to thank you for participating in today's conference call and your continued interest in the Company.

At this time, I would like to remind everyone, in order to ask a question please press star, then the number one, on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Carol Buyers, RBC Capital Markets.

Hi.

Good afternoon.

Just a few questions.

Sure.

First of all, with respect to the ball growth, versus the sell through, we have seen data that shows April and May ball growth growing at 75 percent, at the retail level, yet the gross for the quarter was 13 percent.

Is this just a function of the sell through that we saw in the first quarter?

, I would wonder where you're getting the information on retail sales growing at 75 percent.

Rounds are down this spring, due to severe weather throughout most of the country, and our information says that golf ball sales are not increasing.

No, no.

I -- no, I know the industry data.

I'm talking about Callaway balls specifically.

Maybe restate your question

, because I'm not sure I understood either.

What's the 75 percent you mentioned?

Golf Data Tech is -- has provided us the self-through data, for April and May.

And April, for Callaway -- and for April and May -- looked to come in about 75 percent.

Obviously that's new ball -- ball

is included in there, yet the growth for the balls that you reported was 13 percent.

We'd have to take this question offline and look at your hard data, because ...

OK.

... that's different than what we've seen.

OK.

Would you -- OK, I want to ask my next question then.

And then, with respect to the ball business, last quarter I know that we broke even on a cash basis, and I think you reported that you lost 4.5 million, with a one-time charge of 1.3, if you net that out.

Could you let us know where you are this quarter with the ball business?

Yes.

Are loss, at operating level -- operating profit -- was a loss of $1.5 million.

OK.

And, once again, very close to cash breakeven.

OK.

OK, great.

And then with -- just going back to the gross margin improvement that we saw this quarter, did a lot of it come from the ball business?

I mean, you know, what other fronts did we see improvement on the ball business -- I mean on the gross margin business?

You know -- I mean certainly some of it was with the ball business, given the fact that we

at the upper 30-percent range certainly contributed.

But a lot of the increase, in the margin percentage, was due to the continued manufacturing savings that were recognized on the

side of the business.

OK.

Thanks.

You're welcome.

Your next question comes from the line of

of

Advisors.

Hi.

Thank you.

A couple of questions, with respect to guidance in the back half.

First off, what is your expectation year-over-year for research and development costs, for '02, versus '01 -- rough basis?

Roughly I think that research and development costs will be comparable to where they were a year ago.

We're spending a little bit under that in the first half, but roughly we're budgeted about the same level.

OK.

And with respect to the sales guidance, you mentioned that it was more of an at-once business.

So is it -- is the eight ten to eight twenty a level that you feel confident about, in this conservative attitude toward guidance, on the whole?

Well, what we've been saying all along,

, is that all things being equal, we thought we would do better in 2002, than we did in 2001.

OK.

What's happened is there's been a tremendous amount of change since we said that last January.

And we have managed through those dynamics in the first half, feel good about our results that we've delivered, and what we're saying is that while it's still very fluid, there are a number of things in the second half of the year, some of them outside of our control, some of them that we directly control that will impact that number.

Given every thing we now, we feel comfortable we'll be in that range.

OK.

So in light of that, and in light of the R&D

remaining relatively stable, what -- I mean just broad strokes here -- what are the items that you're having a harder time forecasting and/or are going to be more challenging year-over-year, to put the guidance at what appears to be a very conservative level?

Well, very conservatives is not our -- is not our term.

I would just point

out that historically, if you look back, the majority of our sales happen in the first half of the year.

It's a very seasonal business that the golf buyers tend to buy in late winter and through the spring, as the golf season starts up, so that the natural seasonality to the business.

Secondly, there are a number of issues going on in this particular marketplace, with consumer confidence, that would lead us to say that that seasonality pattern will not change.

We've done $500 plus million in the first half, and how that represents in the close to 60 percent of our mix, as we go through the year, is not unusual.

We're predicting nothing different really.

I think the one thing that I might add is that, you know, Ron talked a little bit about that we're going to, you know, assess the marketplace, and we will do what it takes to protect and grow our market share.

So we think that the second half of the year could be competitive, and there are going to be some things we need to do, on terms of continuing to drive demand creation.

So those are some of the initiatives that we're evaluating right now.

OK.

And then just lastly -- so if it's the sales piece of the projection that is the harder part, if you were to deliver this type of sales, is it the gross margin, or

that then becomes the harder piece to forecast?

And is that the challenge here?

No, I would say that if we can deliver the sales we'll have a pretty good estimate on what we can deliver in earnings, which is why we have been able to predict the range we think we can come into.

OK.

OK.

Thanks very much ...

OK.

Your next question comes from the line of Joe Yurman of Bear Stearns.

Hey, guys.

Hey, Joe.

...

Joe.

I'll apologize in advance -- I'm in a conference room, so I don't have the ability to pick up a handset.

Can you hear me OK?

Yes, you're fine,

OK.

I have about two questions.

The first one is maybe just to add a little more color to the accrued warranty expense sales ratio, because it's been a point of

.

And kind of as a percentage of sales it's been going down, from quarter to quarter, and if you're going to lower it again I think it's going to be a point that people are going to try to get their teeth around, when looking at this tomorrow.

So can you address that first, and then I'll ask my second question?

Sure.

I think what we're finding, if you go back in and historically, and look at just data.

About two years ago we started to serialize our golf clubs, first of all, so we could track where they're sold.

And we started collecting data that would allow us to take a look at actual warranty experience, versus when it actually hits the market.

So we've developed, over the last year and a half, two years, a much better ability to track actual warranty costs.

And what we're seeing is, in the initial information that we're going to be working on, during this quarter, is quite a dramatic drip.

Or I should say, better yet, a better history of when we get the warranty in.

And when comparing that to our overall warrant reserve it's becoming pretty clear to us that the actual warrant reserve is too high.

The actual percentage of accrual ...

Yes.

... probably won't change.

It's really what we have in reserve, compared to what our burn rate is on actual warrant expense.

OK.

And, so we should expect kind of a one-time drop in the third quarter, and then just a leveling out ...

Yes.

... on a percentage basis?

Yes.

It'll be a one-time non-cash adjustment, third quarter, and the provision then will be based on some of this history, which we will apply to -- frankly, we'll probably apply it to the different product categories, i.e., woods, irons, et cetera, because they really vary by product type.

OK.

And my second question is just maybe you can poke holes in this argument.

In the first half if the year, counting the first and second quarter, you've already earned a dollar.

And the guidance that you're giving is a range of $1.02 to $1.07.

And I completely acknowledge, and I applaud you for thinking about the uncertainties that apply to any business in this environment.

But just let me give you some of the things the way that I look at it.

You've got improving ball margins and, you know, soon to be introduction of what's probably going to be your greatest product, with some of the greatest viability you've ever had for a product, probably sometime introduced in the third quarter, and possibly if tracking a pattern in 2000, maybe even sold in during the fourth quarter.

Secondly, and this is an assumption on my part, lower selling expenses.

But given the comments that you made about defending share -- I don't know if I should assume that.

What I'd like to assume, however, is that you'll continue to repurchase shares, so the absolute share count should be lower.

Japan is coming up against the back-half

that's down six, and down 24, sequentially in third and fourth quarter,

I realize that you've talked about competition being a little tougher over there, but it seems like it should come somewhat easier.

Depreciation savings, once you buy out the

lease, and I guess in aggregate my question is are there parts of the risk that I just don't understand?

Considering that also, on top of that, we have 9/11 last year, and God willing that will not be an aspect of this year's market.

Joe this is Ron.

Let me start with your last point, and sort of then address the other ones that I think maybe we differ on.

OK.

Personally, in this room, we believe that the current environment, with the meltdown of the market, and the loss of our consumer's retirements, is a more negative effect than 9/11.

The people that are buying our golf clubs, the announced 4,000 layoffs yesterday, these type of things are dramatically affecting our consumer base.

And, so we would say to you that we think that is just as negative as September 11, if not more.

As regard to the other points you made, we believe we are going to have to invest in the second half of the year, in additional spending, to protect the gains we've been able to make in our golf ball business -- that foothold we've gotten.

We think we're going to have to fight for share there, against a very strong competitor, and we're going to have to continue to invest in our golf club business, against a competitor that has different drivers -- a new product for one, and secondly has a different behavior, than those

.

So we think we're going to have to invest in the second half of the year.

Thirdly, you've mentioned a product introduction that we have not announced.

And, so I don't know

you get that information, but ...

I'm assuming you're going to have a

driver.

Well that

remains to be determined.

OK.

OK.

Right now we're announcing what we think is a fantastic opportunity for consumers, in this country, to buy and play the ERC II driver, which they have been denied until now.

OK.

The other -- I guess the last point, Joe, is that ...

Yes.

... gross margins on golf balls, due to the seasonality ...

Right.

... will probably be lower in the second half of the year, as a result of not requiring the inventory build we had in the first half of the year, to support launches and sell in.

And, so out golf ball production will definitely be lower in the second half, in the first, and that will affect margins from an unabsorbed manufacturing overhead point of view.

OK.

So given that point, and what I'll call kind of flat

if you consider eight -- 816 last year, and the ten to 820 range, it's down to it's an operating margin issue, to defend shares.

So, with that said, can you provide us any guidance on what operating expenses might be for the back half?

Well, they'll be -- with regard to how specific, Joe.

I mean short of a number, what we have built into our forecast right now is that we will spend, in the second half of the year, around some of the promotions and some of the things that we're thinking about doing in the second half of the year.

OK.

You know, it's going to be up year over year, even despite, you know, some of the savings that we've incorporated.

But we -- you know, the one thing -- takeaway from this -- is we're not going to site idly by and, you know, let competition steal the share that we've worked hard to earn.

So we're going to -- we're going to be out there fighting.

OK.

Thank you.

Your next question comes from the line of Bud Leedom of Wells Fargo Securities.

Hi guys.

Let me be the first to say terrific quarter in Q2 there.

Let see, I just have a couple of questions.

Just in terms of the guidance that you -- that you had put out.

I mean obviously in Q1 you had slightly lowered the low end of the guidance, and then you -- you know, you really came in and blew out the numbers here.

What -- I mean what changed in your thinking, or what changed business wise, that sort of altered what your sentiments were going into Q2?

I missed a little bit of that, but are you talking about the guidance we gave in Q2?

Your Q1 guidance, pertaining to Q2, of the range of 38 to 48 cents.

And what changed with regards to the

of that, versus what we're giving you for full year?

Yes.

I mean obviously something precipitously changed at that point, you know of leading to the 55 cents you reported here.

And I was just wondering what had changed guidance to reality here?

What changed, Bud, was when we gave you the second guidance there was a tremendous uncertainty, on our part, as to what impact the slowdown in Japan would have.

As we moved through the quarter we found that Europe was able to offset the Japan shortfalls.

And, then second, we had the contributions coming out of our cost improvement activity that are quite frankly are not predictable, as to when you're going to start benefitting on those improvements.

OK.

And

the share repurchase too.

That was pretty hard to predict at the time, but we did buy 1.8-million shares back, and that contributed also.

OK.

So, just overall -- I mean, you know, clearly I understand your need for conservatism.

Are you finding -- you know, given competitive conditions, and everything we have out there, that the business, at this point, is maybe the hardest you've seen it to predict, or is this maybe sort of a change that we're going to see in guidance, in future quarters?

Well, I think that, you know, the market is changing all time, and I think that there's so many different factors involved with this that it does get to be a little bit

this year.

It's a little tougher to predict.

I mean, even going into last quarter, it was pretty tough to predict what the market was going to do.

It's tough to predict where Japan was going to be in the economy, and tough to predict what our competitors were going to do.

And we've got some pretty low pricing out there that goes head to head with some of our higher priced products.

So I think depending on what those variables are, and how well we can predict them, we will always try to give you the best guidance we can, and if there are a lot of variables we'll probably broaden that guidance.

But what we did do last quarter, to Ron's point, is we gave you a sales guidance, and we pretty much hit it right on in the middle.

And to reiterate what Ron said is, you know, we were pleasantly surprised with some of the manufacturing variances that came through that demonstrates the hard work that we put into it, and continued focused, by this management team, to control costs and the ability to do that.

OK.

Given the success you're having

Odyssey, are there any plans to maybe separate that business, in your breakout from what's going on, on the accessory side?

We'll have to wait and see how the full year looks, and talk about it before we decide if we're going to

it out.

OK.

Could you -- could you give me any sort of read on what you saw for

in Q2?

Is the club performing within your expectations, or -- you know, kind of what's your outlook for that club, and how did Q2 shape up for it?

Well, the

driver is a golf club that we have promoted as being light in weight, and so it's not a golf club that has been designed for use across all styles, and all sizes and ranges of players.

And, so it's success has been spotty.

In some markets it's doing very well, with some particular type of players it's doing very well.

The surprise on

, to us, has been the success it's had on tour.

That, quite frankly, we didn't expect, and the fact that some of the professionals have put this golf club in play and have been very successful with it, is really the highlight of it.

Is it meeting our expectations?

We set expectations pretty high.

I think if you asked any of our competitors if the

driver would meet their expectations they'd all say yes.

But we have hopes for the

that probably are higher than anybody else would put out there for it.

So maybe it's not at our expectation, but I think it's done well, as a new technology, that is very different than what we have conditioned the marketplace to understand, and it may take a while for the that product to catch on.

OK, great.

Thank you.

Your next question comes from the line of Timothy Conder of A.G. Edwards.

Yes, gentlemen, a couple of questions.

Ron, just to continue on, on that very last question that was asked, what didn't you see ass the curve and acceptance of

, or titanium, and how

that, I guess is the first question.

The second question, and I apologize if this was addressed already -- I did get on the call a little late.

Were there any type of special recapture -- the

of the reserve, or anything, in the second quarter?

I know you were talking about a

and a one-time thing for the third quarter.

Third question, how much is remaining on your share repurchase authorization.

And then fourth question

inventory, do you have a number there?

And then -- and by the way,

on the inventory control there?

And of that

inventories if you could maybe breakout what would be balls versus clubs and

, just on a percentage basis?

OK, Tim.

Well, I'll take the first couple of questions here.

regard to the level of acceptance of the

introduction, versus

, or some of our titanium drivers, we do not have a comparison.

As you will recall,

and

Big Bertha were all a full line of clubs, not just a driver.

And this is a very different product.

As I mentioned, it does not, and was not designed to appeal to every player in the marketplace, whereas

and

Big Bertha were.

So I don't think that's a direct comparison.

OK.

Secondly, there were no recapture reserves in the second quarter.

And then I'll let Brad talk about the share repurchase and then the finished goods inventory.

Hi Tim.

We have $32 million left on share repurchase, and the inventory breakdown -- 61 million in raw material -- one million in work in process -- and 91 million in finished goods.

Well, I guess my question, Brad, is of the finished goods, do you have any color maybe on the mix between balls and other, or maybe current year products, that being '02 products

new, versus non-older products? holiday: You know, Tim, we don't usually go into that level of detail.

You know, suffices to say that one of the things that we mentioned, in the conference call, was the fact that we do have

quantities of

, and our

is built into that, but we won't give ...

OK.

... the breakdown.

OK, that's

.

One last question, if I may.

and again, I apologize if you covered this in your -- part of your earlier comments.

Can you maybe just remind us on

or however you want to answer the question, on the

and the

, how you are, where you stand for the full year '02 versus '01?

And then have you hedged anything yet for '03?

We are -- well, I won't five you specifics, because it really varies and there's a lot of detail.

But we are better

this year, than we were last year.

Our activity has -- we've pulled back a little bit, because of the weakening dollar.

We've been watching -- it's been rather volatile.

And I guess the good news it's going the right direction, relative to the international market.

So we have not, you know, gone too far out into next year, because we're really waiting to see what goes on with the currency.

But we'll act, if it makes sense for us.

How are you

, I guess, as a whole for this year versus last year

currency?

I mean are you relatively level with your

, or ...

We're better this year, than last year, Tim.

OK.

OK.

Thank you gentlemen.

Your next question comes from the line of Brett Hendrickson of B. Riley & Company.

Hey, good afternoon guys.

Hi Brett.

Hi Brett.

Hey, Brad, since we're kind of on the subject of foreign income -- other income -- is that what was driving the consequential change in the other income line?

Yes, sequentially it is.

It was the gain on foreign exchange.

OK.

And can you tell us -- are you going to have an official press release, regarding this promotion with the ERC II?

Yes

today. hendrickson: I'm sorry Brad?

I think it goes out at three o'clock today.

OK.

Well, I won't get too into that then.

The ...

Are you talking about -- on which one, the ERC II?

The one where you're giving away the

two-piece ball, and it's all

for 299.

Yes, three o'clock today.

OK.

Are there any retailers, outside of the preferred retailer program, who are getting longer terms than they were, say this time last year, or just, you know, compared to historically?

No.

No, not at all.

The preferred retailer program, which I mentioned in the call, was -- the participation has been very strong.

They're the ones who get the terms.

And that's for

and

-- that's right, Brad?

It's for account, both

and

.

OK.

And domestic and foreign?

No, it's really pretty much U.S.

There are some restrictions, if you will, in some countries, but predominately it's the U.S.

.

... similar type of a program in Europe, but the one that we introduced last year was specifically in the U.S., and that's the one we've been talking about.

And that's probably what's driving the DSOs -- right?

Oh, yes, definitely.

What percent of the accounts

, because I know guys are going to get hung up on it?

Well, about 50 percent.

Oh, OK.

Fifty percent have participated.

OK.

Probably 50 percent of the dollars,

50 percent of the accounts, but a higher percentage of our dollar base.

Probably 80 or 90 percent of our dollar

...

And, you're obviously counting -- you account a chain as one account, even though it might have 50 stores -- right?

Right.

OK, so that explains that.

And I don't want to search for negatives, but I too am trying to rationalize the EPS guidance with -- you know, with -- with the revenue guidance and with the strong

first half.

On the -- Brad, you kind of somewhat vaguely referred to things you might have to implement to defend share, and I think the previous question

it sort of zeroed in.

We're talking about, you know,

, this morning, vowed to keep up the advertising expense there involved.

Are we talking about advertising expense?

Are we talking about potential rebates, or so-called markdown money, for maybe the VFT, or other drivers that have become somewhat obsolete by the new rules?

Well, Brett, if I were to sit here and tell you what we were going to do, I would be telling all my competitors what we're going to do.

Yes, I thought I'd try asking ...

So I'd like to not answer that question.

That's fair.

That's fair.

I know

was pretty public in vowing their advertising expense today.

OK ...

...

I think -- you know, I congratulate

on the first half they had.

both operate in the same market, and since you opened it up, let me suggest to you how I keep score.

Acushnet is out biggest competitor, and they're our best competitor.

So if you just sort of go down the report card, and market share, in woods, we're number one.

Market share in irons we're number one.

Market share in putters we're number one.

In golf ball share they're number one, and that's their strength.

They also are number one share in shoes and footwear, with

, in a market we don't participate in.

And they're very strong in number one position for golf clubs.

So we kind of carve the market up.

We're the equipment leader, they're the shoe and ball leader, and we're both trying to get into the other's business.

If you look at the first half year, year on year, they did $601 million, up eight percent, compared to our 509.

And so they had a better increase year over year, than we did, in sales volume.

But being a predominant golf ball company, being up eight percent, our golf ball business was up 42 percent.

So I think we did pretty well, compared to the leader in that segment of the industry.

On an operating income basis, on their 600 million, they earned $95 million.

We earned $109 million, so we beat them there.

We're number one in operating income, and

operating income return they had 15.9 percent, and we had 21.4.

We beat them by 500-bases points, again number one.

So in my report card I like the way we come out.

We're fighting hard to go after share of golf ball, and we're going to invest, to defend where we have the number one position, and we're going to invest for a stronger position where we're not number one.

OK.

Well, those comments actually help me kind of rationalize some of the expenses I put in my model, so thanks Ron.

Can you comment on the VFT, in terms of any rebate money that might have to be given out, as we get closer to the

going into effect?

No.

Again, we're not going to play our hand ...

That's fine.

and that's fine, Ron.

... on that.

I mean, inventories in VFT -- I mean the product has run its cycle, and the inventories are well under control, both with us and with the retailers, so it's really kind of a nonevent, from that perspective.

Today, as we sit here, Brett, we have less inventory, relative to sales turns in the marketplace, in golf clubs, than any of our competitors -- that includes VFT.

Yes.

Yes, that's all information I know.

I just see

and

and these other guys having legacy clubs out there, and wondering what's going to happen.

Last question ...

Well, there's a big difference, though, between somebody bringing a golf -- or reducing prices six months into the season.

We're four months into the season.

March/April time frame -- May time frame, before there's ever a new product on the horizon, versus us bringing a new product, at some point in time, and then addressing what's left in the marketplace.

Big difference in the discipline

talking about adjusting prices for the inventory that's in the marketplace.

Yes, I concur, and I think retailers are pretty happy with you guys, for what you've done.

Last question is what are your guys' assumptions, based on your revenue guidance, on when the competitors will come out with new

drivers?

I are you thinking it'll be right around January first, or do you think it'll come out with like

like

maybe in the fall?

Two have already come out --

and

.

So what are your guys thoughts, so that Nike and everyone else will have them out by October?

I thought we had the best one.

It was the first one, and we will be the company that will have that value accrued to us, and we're going to take the opportunity of gaining that momentum, for all the investment we've made the last two years, and the flax we've taken from certain segments of the industry, for developing this great product.

I think it's safe to assume, Brett, kind of a tag along with what's Ron's saying, is that we would anticipate a lot of activity, in the market, in the second half of the year with new products.

We don't know when they're going to come.

But, just to reiterate what Ron says is that, you know, we are not going to be afraid to go spend money, if that's what it's going to take for us to defend/grow our brand.

So that's part of what's built into our guidance.

Yes, and that's what I'll build in my model.

You guys reminded me of one other question ...

If I could just respond to your question on Nike first, they have not yet proven themselves a factor, in the metal, wood or iron business.

And, so I don't know if they'll bring a high

driver, but they don't have the credibility yet of having a driver.

Yes, they don't have a driver that can

out the original price.

OK, here's the question Ron -- given that Nike and I think Mr.

, from

, have come out publically -- at least those two guys have come out publically and kind of really given the U.S.

some flack, for how this changeover

six has gone.

Do you view that January first proposed date as being at anyway at

right now?

Well, there's no way for us to predict when the implementation will happen.

I would tell you this, we have not been investing that four percent of sales in R&D for nothing.

The fact that we're out there, with these products, and the fact that some of our competitors are complaining about it, maybe tells you there's an

on that R&D investment.

OK.

Well good, thanks guys.

Thanks Brett.

Your next question comes from the line of (Michael Gross) of

Capital.

Hi guys. unid: Hey,

.

I just wanted to make sure that we were correct in hearing some of the comments that you made, with respect to how pleased you guys are with the consumer response to the new products, the balls, the irons, two-ball putter, to name a few, the balance sheet improvement, with the inventories and receivables, and I guess the leadership that you've shown in the marketplace, and your ability to perform, you know, better than an earnings number this quarter.

And I just want to make sure we're hearing that correctly, and that the concern is one of what's going to happen with the consumer, in the back half, or maybe even throughout 2003?

Well, I mean, yes, just to reiterate everything you just said.

We are extremely pleased with a great second quarter, and a good first half of the year, given some of the environments that we've had to deal with.

You know, we -- as I mentioned in the conference call, we've done I think an exceptional job of managing costs, driving efficiencies in our operations.

And in a fairly competitive marketplace, continuing to drive new products.

We are pleased with the performance of our products.

I mean, as I mentioned, Big Bertha irons are being well received.

The balls are being well received.

The one issue, on balls, that Ron mentioned, and

even --

mentioned this morning is rounds played are down, and generally I would tell you that the ball business, at retail, is a little

this year, than I think any of us would like to see.

But, we've had good acceptance.

First of all, we've had good sell and acceptance of our balls, at retail, and for those who have tried the ball, we've had good repeat from people who've tried the ball -- they like the product.

So we have a good product, and we're dealing with just kind of a marketplace, right now, that's there's just not a lot of golf -- as much golf played as we'd like to see.

I think for the second half of the year, just to reiterate, we don't know what competition is going to do.

We are concerned about what's going on with the -- with people's investments, and the whole thing with the marketplace right now.

And we are not going to be afraid to invest more money, in our business, to make sure we maintain and/or grow our number one position, or grow our positions in certain product categories, where we are not number one right now.

But we feel pretty good about -- we feel really good about our performance and out outlook, but we are also realistic in seeing that there are still some uncertainties on the horizon, and that is built into our forecast.

Right.

So to just, I guess, balance all those comments, with respect to the value of the business, or the value of the Company, can we read into anything about the fact that you've been buying back stock, or

buying back stock at higher prices, than where the stock is today, that you guys, you know, despite what the balance of the year might bring, with respect to a consumer, and competitive activity, that there's a value in the business, and it's something that you're going to take advantage of, or continue to take advantage of, through buying back stock?

Well, we are what at $14.10 today, and we bought at 17.

There's more value today, than there was on the average, so I think it's safe to assume it's -- we believe that at $17 and change it was a great value, so it's even a greater value today, in our opinion.

Does that help?

That helps.

Thank you.

Gentlemen, we do have time for one more question, which comes from the line of

of

.

?

Hello.

Hey,

, how are ...

Hey guys, how are you?

Sorry about that.

Great quarter ...

Thank you.

... seriously.

I had just a couple of questions.

First, how's the

doing?

The

--

got off very well, and has continued to do extremely well, I think a little better than the store owners' expectations.

And from your -- do you know -- I mean in terms of the velocity of inventory

, maybe specifically in the ball business, out of that store, relative to maybe another great, you know, customer you have.

Is it much higher?

Are you able -- my question, directly, are you able to sell a lot more balls, distributing directly, than through a third party retailer?

You know, the stores only been open as couple of months,

.

It think it's too early for us to be able to say whether that particular location, and that style of marketing of product, is doing better than some other particular retailer.

We'll need more data.

OK.

But, hey

, on that point, we are not distributing directly ...

No, I understand.

I ...

... it is one of our retailers.

Right, that's my -- I understand your point.

The other question, just one other one, and directed to Ron, and it's basically just a philosophical questions.

I asked the same thing to

this morning, and I'll pose it to you.

I don't know if you were listening to the call or not.

But, there's a lot of discussion about the number one market share companies maintaining number one market share.

And you know I've been an owner of this Company for coming on three and half, four years now, and I think it's true of any company.

I would much prefer to see a company get the best share of profits, which you're doing, than get the best share of market share and lower share of profits, which is what

does.

Now, it's my belief that Callaway -- you guys are controlling every line item incredibly well.

I mean I want to make that clear.

The selling expenses -- you know, there's a decision being made to invest, to keep share, and I just want to know -- you know, Ron, have you -- you know, is there any thought of -- what happens if we sold, you now, three percentage

less than wood, but made, you know, 10 percent more, I'd prefer that.

I just want to know if you've thought about something like that?

Well, I'll be interested if you're going to share with me what

said.

Well, I'll tell you right now, and I have no problem telling you where my -- you know where my

lie.

said that he has no intention of lowering his ad spend.

It's my belief that, you know, he would rather get market share than get profit share.

I think that's not why anyone should be in business.

This is no a

, you know, we should try and maximize the earnings.

So he has no intention of doing that, which in my head makes it more difficult for us to gain share.

But whenever he -- whenever these other companies -- you know, if there's a problem in the home business, he's going to go to

and ask him to lower his expenses, and that's when Callaway will get four percentage points of profit.

But, I'm just curious -- I view it as the same thing going on with Callaway versus

, you know.

And I think there's a tremendous amount of profit that can flow to our bottom line, if we ramp down the selling expense a little bit.

OK.

Well, my philosophy is I personally, and my team, get paid to make dollars.

Right.

OK?

I understand.

Now there's a lot that goes into the equation, but I will not sit here and tell you we will spend just to get share.

OK.

... because that is of no interest to us.

Earning money is what is of interest to us.

However, in the context, we have a responsibility to do what is right for the long term, and there are certain things that we feel we need to protect.

We won't do it at as disadvantage to the Company, neither will be short term the business, to float a whole bunch of products out there, and compete with

, just to sell units.

And we would generate more dollars, quite frankly, in the quarter, but it would be a bad thing for the brand.

So, we're balancing that as best we know how to do,

.

OK.

Let me just -- one follow up on that.

In terms of the selling expense, what's the concentration of that in ad spend versus, you know, programs to the retailer, because it's tough?

I mean is there a shift taking place, towards the selling program?

Well, here again it's -- you know, once of the unfortunate parts of being publicly held is that we're the only true golf play that tells the public what we're doing.

Right.

And we just elect not to share that kind of detail.

I'm sure some of our competitors are listening today.

Right ...

...

I would just all also, just if you look at the whole selling and tour kind of line, which I know you're talking about -- I mean just trust -- as you said, we manage our costs pretty well.

I would just ask that you to trust that when we are putting programs out there, we are looking at each one of them, and trying to prioritize which ones are going to give us the best return.

I do trust that, and -- I mean I hope that you trust that I do, because it's clear you guys have -- that's

in your interest, and that the only thing that I'm trying to bring out, and it can't be done on one call here, but to let you know that there are owners of the Company that are -- you know, wouldn't care if the Company did 20 million less in sales, but earned 30 million more, or some, you know, equation of down sales, up profit.

So, just to give you the freedom to, you know, do that.

If, in the future, you wanted to, there are people out there that think like owners.

Well, just as another side note on that -- I mean one of the things that you've seen, over this last couple of years, that as a Company we're trying to work expenses out of our business, both ay the gross margin line, as well as at our

line, with the idea of investing some of those dollars back in the business.

So it's not like we're trying to spend incrementally, without funding it internally.

We're trying to do things internally and redirect dollars, where we think we can get the most value.

You know,

, if you look at the first half of the year, we've done just what Brad has indicated.

We've cut costs aggressively, without sacrificing anything.

We've been able to invest in selling and promotion costs, and support our line, and deliver more earnings, in a year, where product mix has not been good for us.

I know, and I think -- I mean I'm not coming on here trying to yell at you.

I'm trying to have a -- you know, a talk like partners.

The only thing, I think you're getting a lot of questions, because I'll just remind you of one thing.

You know, when I -- I looked at the numbers.

I think I know the business as well as anyone, on the outside, you know.

And at the end of the first quarter we had -- I asked you a question, you know, would you be surprised if you came it at, you know, above 48 cents, and you told me you would, so I guess you're surprised.

I understand that.

You know, it's -- the only thing I'll ask you is continue to buy back the stock at this price.

Because, you know, two years ago, before Brad was there, there was a situation where the Company made a purchase at 19, the stock got clobbered and the Company stopped buying when it went to 14.

And now is the time when you can create value, for the guys who are going to stay around and will be here in four

.

Duly noted,

.

OK, thanks.

... you bet.

Thanks

.

This concludes the allotted time for the Q&A session.

We'll now turn the call back to Mr. Drapeau, for closing remarks.

Well, again, it's been an hour and ten minutes.

We've covered a lot of ground today.

I hope that all of the listeners have a real appreciation for the challenges we have, and the ability the management team has to manage those challenges.

I believe we've done that, demonstrating our performance in the first half of the year.

We're committed to those same shareholder values that were expressed by

, at the end of this call.

Our intent is to make money, to increase shareholder value.

And with that, I would just say thanks for attending the call, and we look forward to next quarter.

This concludes today's Callaway call, second quarter 2002 earnings release call.

You may now disconnect.