Topgolf Callaway Brands Corp (MODG) 2003 Q2 法說會逐字稿

Good afternoon.

My name is Jeff and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Callaway Golf second quarter 2003 results 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 that time, simply press star, then the "1", on your telephone keypad.

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

Thank you.

I would now like to turn the conference over to Brad Holiday, Chief Financial Officer of Callaway Golf.

You may begin your conference.

Thank you, and welcome, everyone, to Callaway Golf Company's second quarter fiscal 2003 conference call.

Joining us today is Ron Drapeau, Chairman, President, and Chief Executive Officer 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 provide some commentary on the recently announced acquisition of Top Flite and we will then open the call for questions.

Before we begin, I would like to point out that any comments made about future performance, events, or circumstances, including estimates of sales, cap ex spending, and earnings per share information for 2003, as well as statements concerning the anticipated acquisition of Top Flight, including the estimated charges to be taken and the benefits in performance to be realized from such acquisition, are forward-looking statements subject to safe harbor protection under the federal securities laws.

Such statements reflect our best judgment today based on current market trends and conditions are subject to risks and uncertainties, including the risks and uncertainties inherent in acquiring another company.

These risks and uncertainties could cause actual results to differ materially from those projected in forward-looking statements.

For details concerning these and other risks and uncertainties, you should consult our most recent Form 10-Q 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.

Thank you, Brad, and thank you all for joining us this afternoon.

As Brad mentioned, I will be commenting on the Top Flite acquisition later in the call, after we review our results for the second quarter and the first six months.

As you know, we have been cautious about our expectations for 2003.

The weather has played a big role this past quarter, with unseasonally wet weather in the eastern part of the United States.

Rounds played have been impacted, down 3.8% for May and down 2.7% year to date.

We have felt that the economic situation in the United States has remained uncertain, hurting retail sales in general.

And unemployment in the U.S. is at a 9-year high, which definitely has an impact on discretionary spending.

So having said all of this, we are pleased that we have been able to achieve the results we have for the first half of this year.

Sales of $514 million are second only to 2001, which was only slightly higher.

We generated $264 million in gross profit, with a margin of 51%.

Operating expenses were 28% of net sales, the lowest since 1997, resulting in operating income margin of 24% with net income and earnings per share both at company records.

These results reflect the hard work of our Callaway Golf employees in managing our expenses and the many initiatives implemented over the past few years.

As Brad will cover in a few moments, second-quarter results are down slightly from last year, but it is important that these results are reviewed in the context of the entire first half of the year, given the many factors affecting the timing of sales.

We remain cautious for the remainder of the year and I will cover an update to full-year guidance after Brad is finished.

With that, I will turn the call back to Brad, who will cover in more detail our financial results.

Thanks, Ron.

Second-quarter sales declined 4% to $242 million, with diluted earnings per share of 52 cents, a decline of 5% compared to last year.

In constant dollars, total net sales would have been $235 million.

Year-to-date sales increased 1% to $514 million.

Sales of woods for the second quarter declined 20% to $77 million compared to $96 million last year and comprised 32% of sales.

Solid sales of our GBB II line of titanium woods were offset by lower year-over-year sales of Steelhead 3, C 4, VFT, and ERC 2 woods that were in the line last year.

Year-to-date sales of woods declined 16% to $170 million.

Sales of irons for the second quarter increased 6% to $83 million and represented 34% of sales.

The irons growth was due to solid consumer acceptance of our X 16 line, and the continuing demand for our Big Bertha irons.

Year-to-date iron sales have increased 11% to $179 million.

Sales of putters in the second quarter increased 27% to $46 million, driven by continued strong demand for the odyssey two-ball putter.

Year-to-date to date, sales of putters are up 47% to $91 million.

Sales of golf balls for the second quarter decreased 34% to $16 million, reflecting the launch of our HX line of golf balls in the second quarter last year.

Year-to-date golf ball sales decreased 37% to $29 million.

Domestic sales were flat at $143 million during the second quarter, and international sales slipped 9% to $99 million and accounted for 41% of sales.

We benefited from currency exchange fluctuations, and on a constant-dollar basis, international net sales during the quarter would have been $91 million.

Sales by markets were as follows: Europe decreased 5% to $44 million during the quarter and is up 8% year to date to $94 million; in constant dollars, Europe was down 15% for the quarter and 3% year to date.

Japan declined 16% to $21 million during the quarter, and is down 4% for the first half of the year, to $55 million.

In constant dollars, Japan declined 21% for the quarter and 12% year to date.

Sales to rest of Asia, including Korea, declined 16% to $15 million during the quarter, and year to date is down 1% to $34 million.

In constant dollars rest of Asia declined 18% for the quarter and 6% year to date.

Turning to the rest of the income statement, gross profit for the second quarter decreased 8% to $126 million, and gross margins decreased to 52% of sales from 55% last year.

The lower gross profit percent was the result of a lower mix of woods, lower prices, lower golf ball gross margins, partially offset by increased putter volumes.

Year-to-date gross profit declined 1% to $264 million, with gross margin percent declining slightly to 51% of sales.

Operating expenses for the quarter totaled $74 million, or 31% of net sales.

This is a decline of 6% from last year's $78 million.

The reduction was the result of lower employee expenses from the initiatives we put in place the second half of last year, as well as general declines in most cost categories.

These gains were partially offset by higher advertising expense that we mentioned last quarter.

Year-to-date operating expenses declined 9% to $143 million, or 28% of sales compared to 31% last year.

Operating income during the second quarter decreased 12% to $52 million, and operating margin was 22% compared to 24% last year.

First-half operating income increased 10% to $121 million, or 24% of sales compared to 22% of sales last year.

Second-quarter net income decreased 8% to $34 million, with diluted earnings per share of 52 cents, which is 5% lower than last year.

First-half net income increased 13% to a record $77 million with diluted earnings per share of $1.16, a 17% increase versus last year.

Our balance sheet remains solid.

We ended the second quarter with $137 million in cash, no long-term debt, and $348 million of working capital.

Inventory decreased 18% year over year, accounts receivables increased 12% year over year to $197 million.

This increase reflects higher sales towards the end of the quarter, consistent with our comments last quarter that there could be a delay in sales towards the end of the second quarter and possibly into the third quarter.

Capital expenditures during the second quarter were $2 million, and depreciation and amortization totaled $10 million.

Year-to-date, capital expenditures have totaled $4 million and depreciation and amortization totaled $20 million.

Our current full-year estimate of CAPEX spending is approximately $15 million, excluding any impact of the Top Flite acquisition.

Free cash flow for the past 12 months was $105 million.

During the quarter, we did not repurchase any of our common stock.

Since May of 2000, we have invested $234 million to repurchase a total of 13.9 million shares.

This concludes my remarks.

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

Thanks, Brad.

With regards to guidance, we remain cautious for the remainder of the year.

The golf equipment marketplace, particularly in the United States, remains challenging and our competitors and their actions remain unpredictable.

The economy, while perhaps in the early stages of recovery, remains fragile, with unemployment as I mentioned in my opening comments at a 9-year high.

With these facts in mind, we still believe we will achieve essentially flat revenues year over year at approximately $780 million.

With regards to fully diluted earnings per share, we believe because of the favorable results of our cost control efforts, we should be able to achieve approximately 95 cents per share.

Now I would like to address our recent acquisition announcement.

As you all know, on June 30th, we announced that we had entered into an agreement to purchase substantially all of the assets, domestic and international, of the Top Flite Golf Company through our prepackaged bankruptcy procedure.

At that time, we indicated that we would provide more information about the transaction at today's conference call.

While it is still very early in the process, there is some additional information about the transaction that we can and will share at this time.

First, I can report that the process appears to be proceeding on schedule.

As I think most of you know, Section 363 transaction must go through various steps in the bankruptcy court that assures the creditors they are receiving a fair price.

The filing with the bankruptcy court was made on time, and on July 3rd the Court approved the timetable for approving the sale procedures.

The next scheduled hearing has been set for July 23rd.

Top-Flite has requested that the process for receiving any competing bids be completed in the second half of August, with a sale hearing on August 22nd.

At the same time, and in parallel with the bankruptcy process, we participated in a review of the transaction pursuant to the Hart-Scott-Rodino Pre-merger Notification Act.

That process is complete and the transaction has been cleared.

We hope to keep to this schedule so we can close the entire transaction as promptly as possible, thereby permitting us to get things ready for a good start in the 2004 golf season.

If things proceed as expected, we will close our transaction this year, perhaps as early as September.

Second, I know that there has been speculation about whether there may be other bidders who will step forward during this process.

At this time it is premature to speculate on whether any other bids will be received or what we might do if a higher bid is submitted.

But that won't stop people from speculating, so we suggest you should consider the following facts.

Top-Flite's investment bankers have been aggressively marketing the company for sale or merger since 2002.

We believe that all potential bidders were contacted during that process, and all had an opportunity to submit an offer.

Top-Flite has reported to the Bankruptcy Court that ours was the only offer received.

We believe our bid is a fair offer that reflects a combination of the intrinsic value of the assets being purchased and the value of some synergies that are uniquely available to us, given our present situation in the golf ball business.

If other bidders emerge, they must satisfy the substantive and procedural requirements that will be set by the Court next week.

Both the bidder and the bid must be qualified.

Under the proposal pending before the Bankruptcy Court, this means, among other things, the bidder must fully disclose its identity and demonstrate the financial capability to consummate the deal.

The bid must exceed our proposed purchase price of $125 million by a meaningful amount.

The proposal before the Court is approximately $7.6 million.

The term of the bid must not be materially more burdensome or conditional than our offer.

The bid must not be conditioned on obtaining financing.

The bid must be based upon a markup of our purchase agreement and a good-faith deposit of at least 10% of the amount bid must accompany the bid.

If another bidder emerges, we will have the opportunity to increase our offer in an auction process run by the Court.

However, we are not required to increase our offer, and could choose to walk away.

If we are outbid, we are entitled, under most circumstances, to reimbursement of our expenses up to $1.25 million, and a breakup fee, which is currently set at 3.5% of the transaction price.

If a higher bid is submitted, we will evaluate our options at that time.

While the proposed transaction at the proposed price is our preferred solution to the problems with our golf ball business that we have discussed for some time, it is not the only solution.

Let me stress.

We believe that there are other viable ways of eliminating our losses in the golf ball business and we would evaluate any change in this transaction in comparison with those opportunities.

The key terms of our proposed transaction are as follows.

Purchase price is $125 million subject to some adjustments at and after closing.

There will be a holdback of 10%, $12.5 million, to cover certain post-closing shortfalls.

We will receive that at closing accounts receivable and inventory worth approximately $90 million, with a holdback of 10% on the accounts receivable to cover the risk of non-collection, and with inventory valued at 97% of standard cost, excluding capitalized variances and inter company transfer margins to cover obsolescence risks.

We will be taking no accounts receivable that is more than 90 days past due, and the bulk will be current.

We will be taking all inventories, including international inventory, but the valuation ascribed to inventory will not exceed $43.7 million.

We will be buying the golf brands including Top-Flite, Strada, and Ben Hogan.

We intend to support those brands going forward.

We will not be buying the Spalding brand.

It was already sold to Russell athletics. (inaudible) which has also been sold.

We will be buying all of Top-Flite's United States and foreign golf-related patents and trademark registrations.

We will be acquiring the golf ball manufacturing, warehousing, and office facilities in Chicopee, Massachusetts, which have three buildings with about 840,000 total square feet in Gloversville, New York, 65,000 square feet, and will be assuming the lease on the golf club operations in Fort Worth, Texas.

We will also be taking over the owned and leased facilities in England, Sweden, Australia, New Zealand, Taiwan, and Canada, as well as the equipment kept in those locations.

The transfer of international assets may be slightly later than the transfer of U.S. assets due to the foreign legal requirements.

We expect to make offers of employment to most of Top-Flite's current employees, including a number of its senior management team.

We will enter into negotiations with union representatives at those facilities, such as Chicopee, which are unionized.

We are only assuming a selected number of Top-Flite 's current obligations.

These include, for the most part, substantially all of Top-Flite's pro endorsement agreements and some leases.

We are not taking any of Top-Flite's bank debt and we will not be continuing the existing pension plan.

We will be taking most, but not all, of Top-Flite's agreements with foreign distributors.

While the bankruptcy process is being completed, Top-Flite will continue to operate its business as usual, paying its debts and collecting moneys owed.

The purchase agreement requires Top-Flite's current management to continue operations in the ordinary course, including the ongoing launch of the infinity product line.

While we have the right to monitor those operations to assure that there is no material adverse change, we do not control or guide them.

We think it is premature to announce how we intend to employ these assets or to provide guidance on the financial impact this transaction could have on future quarters once the deal is consummated.

We don't yet own these assets, and the financial information concerning these operations is the property of Top-Flite.

We are subject to a confidentiality agreement, and cannot provide you with Top-Flite's operational details.

Moreover, we see no positive value in telling our competitors what we are planning.

What we can say at this time is the following.

As reported by Top-Flite to the bankruptcy court, Top-Flite's net sales in 2002 for golf balls and golf clubs were $186 million and $40 million, respectively.

Any further information about the Top-Flite operations would have to come from Top-Flite at this time.

We expect to consolidate the golf ball and golf club manufacturing operations.

This will take some time, but should be completed in 2004.

In connection with such a consolidation, some assets and investments will be written off, with charges taken as incurred.

We have stated that total charges may be up to $70 million, the vast majority of which will be non-cash.

We expect that the efficiencies that can be achieved by a consolidated golf ball manufacturing will permit us to hit our target of solving the profit drain from that business in 2004.

The specific timing on when we might see the benefits of these efficiencies will depend upon when we can close the transaction and begin the process of consolidation.

Excluding the charges associated with the consolidation and integration of operations discussed above, we expect the Top-Flite business will be accretive to our earnings in 2004.

We think that this gives you all a little more visibility into the transaction.

As we progress, we will continue to evaluate the timing of further disclosures.

This concludes our prepared remarks.

We will now open the call to questions.

At this time, I would like to remind everyone in order to ask a question, please press star, then the number 1, on your telephone keypad.

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

Your first question comes from Carole Buyers of RBC Capital Markets.

Hi.

Good afternoon, gentlemen.

I just have three questions.

I was wondering if you can elaborate on the accounts receivable, why sales would come toward the end of the quarter.

And then number two, I was wondering what the ball business lost in the second quarter.

And then finally, the $70 million non-cash write-off, should we assume that you'll close the Carlsbad facility once -- if and when the transaction closes?

I'll take the first two, Carol.

With regards to receivables, we had mentioned in the last conference call that we felt that there might be a slight delay in terms of when the sales would start to pick up, due to kind of a slow start of the economy, and that's exactly what we saw happening in the quarter.

So relative to last year, we had more sales skewed towards the back half of the quarter.

The second question with regards to the golf ball, the income or loss from operations was $5 million.

And I'll let Ron address the last one with regards to the write-off of that we've talked about.

Hi, Carol.

In terms of the $70 million charge, if we are successful in completing the transaction to acquire Top-Flite we would at that point in time own three golf ball manufacturing facilities, and consolidation would be inevitable.

We have not made final decisions on whether those consolidations would happen.

OK.

And then going back just to the first question about the pickup toward the back end of the quarter, did you -- does it feel like the month of June -- so are you saying that the month of June, just from a demand standpoint at your retailers is obviously better than May?

I think that it's safe to say that it -- you know, we've talked about it picking up a little bit more towards the -- or being a little bit delayed versus last year.

I think the season, especially with the wet east coast season, started later in the season and that's what we felt.

So we saw a little bit more demand from our retailers, in terms of when their orders were placed with us.

And I guess that would probably follow the trend that their retail sales probably started picking up more later in the quarter.

OK.

Thank you.

You're welcome.

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

Good afternoon, guys.

Nice quarter.

Hi, Bud.

Thank you.

Thanks, Bud.

Just a couple of questions here.

I -- and thank you, Ron, for elaborating as much as you could on the Spalding situation, or Top-Flite.

I was just wondering, in terms of the patents maybe if you could just make a comment as it relates to the royalty situation with Titleist.

Are there patents within the portfolio of Spalding that may allow you to go a different direction with that?

Is that part of the value proposition that you see?

I really wouldn't want to comment at this time, Bud.

I think that would be playing our hand to our competitors of what we intend to do with the assets.

OK.

OK.

And also just on the golf ball situation, Brad, could you give me the gross margins of the ball?

We haven't given specifics, but it's single-digit.

OK.

OK.

And then just on the CAPEX for 2003, I missed what your guidance was for the full year on that.

Full year is around $15 million.

15.

OK.

OK.

And then just finally, if you could make a comment just on Japan.

You know, obviously the economic situation over there persists.

What's your outlook for Japan, and what are you seeing in terms of your -- you know, your forecast over there?

Well, Bud, I look at Japan and I think they're in the 12th year of a 7 year recession, and that affects the emotional aspect of the people that are involved in the buying and selling of discretionary products.

And I don't expect to see any recovery in the Japan market until we see something happen in the macro environment and have it trickle down, and that starts with them addressing their bank problems.

Gotcha!

OK.

So we could probably continue to -- or you continue to expect more of the same, from what we're seeing here currently?

Yes.

OK.

Thanks a lot, guys.

Your next question comes from Tim Conder of AG Edwards.

Hello?

Tim, you might be on mute.

Tim, your line is open.

OK.

A few questions, gentlemen.

Brad, if you could -- or Ron, whoever wants to take this, address the upside in the quarter versus expectations.

You talked a little bit about the season starting later, but were there any changes in mix or geographic composition that maybe gave a little bit of upside?

And then based on my calculations, the FOREX benefit was about 2 cents in the quarter.

If you could just maybe confirm that or adjust that.

And then Ron specifically as it relates to the $70 million worth of charges, would all of those be taken in '03?

And then on top-flight also, anything that you could offer regarding top-flight business trends year to date?

OK.

I'll address a couple of these and Brad can talk to the foreign currency.

As regards the -- our performance in the second quarter, we did not give guidance for the second quarter, so it really would be inappropriate for me to comment on whether or not we beat expectations.

Well, in relation to that, do you have any internal criteria as to when you would do a prerelease given, I guess, that the quarter was 35% upside to the consensus estimate?

We do not have a predetermined proposition for when we would come to the street and tell you we're going to beat earnings.

We don't think that's our responsibility.

Except to the extent that we would beat the number that we would provide.

If we were going to come up short considerably in a number that's out there on the street, we would tell you, and we have done so in the past.

OK.

As regards the $70 million charges, that would not all happen in 2003.

It would take some time to integrate an acquisition of this magnitude and complexity into Callaway Golf.

And any comments regarding top-flight's business trends should come from top-flight.

We are under a confidentiality agreement as part of this acquisition.

And Tim, this is Brad with regards to the expenses.

As you know, accounting rules now require you -- you take them as you incur them, so you don't set up a big reserve anymore, so this will go out over the course of the next year or so.

And with regard to your FX, I think you said, what, 2 to 3 pennies, roughly?

That's kind of in the zone of what we've calculated.

OK.

And then Ron, I guess to the previous question, the ball plant there in Carlsbad, obviously you're in a higher-cost area there.

Any -- any -- any, I guess, additional detail as far as consolidating that back to Massachusetts?

And if so, would that plant be sold or used as consolidating in the club business there in Carlsbad?

No, I really don't have any further comments at this time on how we would combine the operations.

OK.

Your next question comes from Joe Yurman of Bear Stearns.

Hey, guys.

Hi, Joe.

Hi, Joe.

A couple questions.

Given the upside that we saw here in the second quarter, Ron I was hoping maybe you could comment on -- I guess, the comment you made during the last quarter, whether you thought that there might be a change in the sales pattern this year, and there was some ability to defer revenue to the back half and then maybe just comment upon that in light of the fact that you're taking down a revenue estimate while introducing some new products, albeit in limited quantity.

So, you know, just kind of have things gotten a lot worse, I guess, since the first quarter, would be the question?

And then the second question is in terms of how you would fund the pending acquisition of top-flight, whether it would just be cash on the balance sheet or would you look to draw down your facility a little bit and some cash?

Thanks.

OK.

Joe, on the -- regards to the sales activity, first half/last half, as Brad mentioned earlier we did see some activity at the end of June and we thought that that's how things would develop in regard to the second quarter and while we thought the second quarter might be down from historical trends.

As regarding the last half specifically, we believe that we probably will not benefit by as much foreign currency translation gains in the last half of the year as we have in the first half.

We think that's been very unusual and we think that the -- the dollar might strengthen.

To answer your second question, in terms of funding the acquisition, obviously we have the cash with which to do the transaction and, come September, we will have more cash.

So we have the ability to pay for it just out of operating funds.

That doesn't preclude us from taking a look at -- at the opportunity to put some long-term debt or some type of financing on the balance sheet, with the attractive rates that are available today.

So we just leave that as an option at this time.

Thanks, guys.

Your next question comes from Richard Kim of Kensington Management Group.

Hi.

I had to get off for a moment but I -- I don't think this has been asked.

Number one is, are you unionized at your -- at your golf ball facility?

No, we are not.

OK.

And so I -- I assume that you're going to have to - you're going to have to be unionized if you're taking over a unionized company.

Is that fair or --

I wouldn't make any assumptions at this point in time in terms of employment agreements.

Or arrangements.

But it seems pretty logical to have to if you're in the golf ball business and one plant is unionized and one wouldn't be?

I wouldn't make that assumption.

OK.

Let's talk about your plants for a second, if we could.

Like you had mentioned that you have -- top-flight has three buildings, 840,000 square feet developed for -- or devoted to golf balls, is that correct?

Yes.

And how -- and how big is your plant, again?

Our golf ball plant in total is -- including the corporate offices, warehouse space, and a variety of other things, is about 200,000 square feet.

If you -- one of your problems has been that your golf ball -- that you haven't had enough volume in golf balls, is that correct?

Yes, that's right.

If you took the -- how much could you produce in your -- in your -- your 200,000 square feet?

We don't discuss our capacities.

Well, you have in the past.

I don't think so.

Sure.

You came out when you were -- you originally when you made expectation -- when you talked about going into the golf ball business, you talked about the plant, you said you were going to have a capacity of X. I just don't remember it.

I don't recall we've ever discussed capacities.

Well, if you look back in your records, you will.

I'm sure you have.

OK.

Thank you.

You're welcome.

Your next question comes from John Schwartz (ph) of Flatbush Watermill (ph)

Hello?

Hello?

Hey, Josh.

Hey guys, how are you?

Good.

Good.

I had two quick questions for you.

First, I don't want you to get into any details, but I'm curious if -- do you think that top-flight can help you increase sales of Callaway Golf balls?

Not top-flight golf balls.

No.

I think they're separate brands.

OK.

So any issue -- so this is -- in terms of the Callaway business of golf ball -- selling golf balls, this is only -- it can only help you lower your costs?

That's correct.

OK.

And then the other issue, Ron, once you -- this thing is done, one way or the other, if you get the deal done, you're -- obviously there's going to be a hundred some odd million left on the balance sheet, in some combination.

Either that or more debt.

If it doesn't get done, I don't know what your alternatives that you're thinking are, but you'll have more cash, I'm guessing.

But have you guys given any thought to your dividend policy and both with this transaction happening and without it, in terms of increasing it and -- I'm just curious of your thoughts.

Yeah, we have given thought.

We discuss it periodically with the finance committee and the board, but we're not at a point in time where we're ready to disclose anything.

I mean, so is there - all right.

I guess so it's -- if this deal gets done, I mean is it safe to say that you're -- you do this deal, you're not going to be interested in increasing the dividend within a six-month time or anything like that?

Well, I -- I --

I'm just -- I'm not trying to --

I think you can virtually be certain that if we get this deal done, we're going to be pretty busy consolidating and combining the operations and being very, very careful with our cash in the short period of time.

OK.

All right.

Thanks, guys.

Thanks, Josh.

Your next question comes from Alexander Paris of Barrington Research.

Thank you.

When you mentioned that in 2004, if this deal goes through, it would be accretive.

Are you talking about -- if you had 20 cents or so loss in balls and you were going to reduce there -- eliminate this loss, which I presume you hope to do by consolidating this added volume, do you just mean reduction of that 20 cents as being accretive, or do you see by -- from your acquisition cost and doing all the consolidations that there will be some extra accretion after all that, aside from just eliminating the ball loss?

Alexander, I'm specifically talking about the accretion we would get by eliminating the extra costs in our golf ball operations.

OK.

As I said earlier, we're under a confidentiality agreement --

Right.

-- in regards to top-flight, so I'm really not in a position to comment on their profitability and what contribution that might make to Callaway Golf.

Looking at -- when you first started in the ball business, I think you had an idea -- in fact, you used to throw numbers around at one -- what level you would be break-even on that, on the ball manufacturing.

Now there's been changes, I'm sure, in the industry and prices and so forth that maybe changed that.

But just looking at the volume that you have and the volume that you would have from -- from the acquisition, is that more than enough to make you break even or even profitable on balls?

Yes, this acquisition would eliminate the cost strain on our golf ball business that would allow us to make it accretive and would eliminate the losses, which is the commitment we made that we would address -- that we made to our shareholders, we would address this by 2004.

OK.

Did -- can you have any general idea of anybody running at -- at a sufficient volume?

What is -- what would be an ongoing gross margin in the ball business, say relative to the clubs, everything being equal?

It's a higher-margin business than the clubs, isn't it?

I really, again -- we're a very small player in the golf ball business and I'm not at liberty to discuss top-flight's side of it.

OK.

I'm just talking in general, but all right.

Thank you.

Your next question comes from Thomas (inaudible) of Michaels Miller.

Good afternoon, gentlemen.

Hi.

I was wondering if you would be first willing to touch on the European market like you did with Japan.

You don't see anything good happening in Japan.

How about Europe?

Well, Europe -- Europe continues to move along I think at a very steady state.

It has for the last couple of years.

It doesn't seem to go through the emotional swings that we see in the Japanese market.

The product life cycles are more stable in Europe.

They're very much akin to the United States market and it behaves very similarly to North America, I should say, United States and Canada.

And kind of touching on the last gentleman's question, are you willing to elaborate on the profit margins through each of your lines?

You mentioned low single digits for golf balls but what about woods, irons, putters, et cetera?

Well, you can do the math just by taking the single digits on our golf ball business and subtracting them from our total reported results and you can tell what our golf club business margins are.

Great.

Thank you very much.

Your next question comes from Casey Alexander of Gilford Securities.

Hi.

Good afternoon.

Hey, Casey.

Hi, Casey.

Hi, Ron, I just want to review what you went through on the details of the transaction itself.

The $125 million with subject to adjustment and holdback, we understand.

But let me get this straight.

You are receiving accounts receivable and inventory valued at approximately 90 million?

That's correct.

With no, and the inventory cannot be more than $43 million of that $90 million?

That's correct.

And no A/Rs past 930 days?

That's right.

OK.

It seems to me that at one point in time -- and, you know, you may not wish to discuss this but, that the top-flight golf company had an outstanding bill due from Kmart, which has emerged from bankruptcy.

Do you have any clue as to the status of that?

Actually, I do not.

OK.

But if it's past due, we wouldn't take it.

Right.

OK.

I understand.

I'm just trying to figure out if there -- you know, potential future business partner or not.

I don't believe -- do you do business with the Callaway Golf ball with Kmart at this point in time?

No, we don't.

OK.

All right.

That's all I have for right now.

All right, Casey.

Thanks, Casey.

Your next question comes from Carole Buyers of RBC Capital Markets.

Hi, just one more follow-up question.

I want us to revisit the second-half guidance.

If you go back and look at fiscal -- the second half of '02 and you net out the customs, the custom duties and the warranty reserves, you lost 6 cents per share.

And if you look at the guidance for the second half, you had a loss of -- you're assuming a loss of 21 cents there.

I mean, for the back half of the year.

Why are we assuming such deterioration in the business?

I know -- I understand some of it will be related to the GBB II launch but what else is going on.

Well, Carol, as I said earlier, we believe that the dollar may strengthen and we won't benefit from currency gains as we have in the first half of the year, or we got last year.

We also do not expect to have revenues as a result of the introduction we had a year ago, so if you compare the history, this is a very different year.

And Carole, this is Brad.

I mean we did launch the GBB II line late third quarter and all of fourth quarter and titanium woods.

What about new products for this year because you said in the release that you do plan to have some new products, right?

We expect to introduce some limited products in Japan.

OK.

In late September, in line with their second selling season.

OK.

I guess I was just trying to figure out why -- why the outlook seems to be much more gloomier when last year it felt like things couldn't get worse.

And year-over-year you've improved at least in the first half.

Well, we have sales are down -- this is Brad again, Carole.

I mean, we have sales down year over year, too.

Sure.

So, I mean it's a combination of sales and the gross margins associated with not having a titanium launch.

Gotcha.

Thanks.

OK.

Your next question comes from Doug Ruth of Lenox Financial.

Hi, guys.

I have a few questions.

Could you explain your commitment to having some of the clubs made in America and how you feel about that?

Well, I'm not sure what you mean "commitment."

We have, for most of the history of our company, had the vast majority of our products made here in Carlsbad.

We do have some limited offshore assembly for some offshore markets, and some -- sometimes in seasonal -- high seasonal needs, we've had some second-year products or some limited versions of putters assembled offshore, but the vast majority of our products are assembled here in California.

Well, for example, like coast cast is a supplier.

Are you committed to continuing to do business with them?

Coast cast is a North American supplier.

Yes.

And are you -- they are a major supplier to you.

Do you seek that business relationship continuing?

Well, to the extent that they deliver on the competitive issues of price, quality, and service, we will continue to do business with them.

OK.

My next question is about apparel and your commitment to apparel.

There's speculation, there's articles out on various web sites talking about how inexpensive some of the golf apparel companies are.

Specifically like Ashworth was mentioned, cutter and box, support Haley.

Do you see the company expanding the apparel offerings and --

Well, Doug, we're very comfortable with our licensing arrangement with the two apparel partners we have, Ashworth and (inaudible).

That's their business.

They understand it.

And they're doing a very good job for our brand, so we're -- we're happy with the arrangements, as they exist.

Would the company consider making acquisitions and owning apparel companies themselves?

Oh, I think we would consider any number of investments that would prove to be -- have a return that would be attractive to us, but we have nothing that we're looking at now.

OK.

All right.

Thank you for your time.

Sure.

Your next question comes from Joe Yurman of Bear Stearns.

Hey, guys there, back for a quick follow-up.

Assuming the acquisition does take place, I mean you're going to have a different customer.

You know, kind of the Wal-Mart of the world and Brad, you know, kind of how should we think about receivables and maybe kind of some of the terms that you have to offer a Wal-Mart or a big box, you know, versus a golf retailer?

Well, I think it -- Joe, I think it's -- it's really too early to speculate on that.

We're not doing business with those retailers today at Callaway Golf, and I think if -- if we continue to do business with them under the top-flight brand, we will assess at that point in time what the returns are, and we'll guide you accordingly.

OK.

And just maybe one quick one here, Brad, the tax rate, looks like it's ticked down, and the effective tax rate, the last two quarters, kind of from the traditional 39 to kind of, you know, 36-and-a-half, 37.

Is that a better run rate or is that just something that's going on with DTAs?

You know what, we've been looking at some of our foreign tax returns over the past couple of years, and have found some credits out there just through some of the diligence that we've been doing, so those are kind of one-timers.

I would assume kind of that 38 to 39% for the balance of the year, Joe.

Great.

Thanks.

Once again, if you would like to ask a question, please press star, then the number 1, on your telephone keypad.

Your next question comes from Tim Conder of AG Edwards.

Thank you.

Just a couple of others, gentlemen.

Ex-Topflight, what do you see inventories and receivables relative -- at year-end to what they were a year ago?

And then, somewhat of a derivative question to Joe's.

Let's assume that Topflight does get closed, and maybe a year, year-and-a-half down the road you're sitting across the table with Wal-Mart and they say, "Look, either you give us some of the Callaway brand also or we're walking away from the whole works."

How has that entered into your consideration of this transaction?

Well, Tim, I think you can expect that receivables and inventories will tend to follow seasonal patterns.

You know, as we move through the year, we tend to liquidate receivables and we build inventories for the oncoming season.

That's a normal pattern.

And we would expect to continue that.

In regard to your second question, quite frankly, I haven't given it any thought.

That's a bit far out.

OK.

But I mean given that customers such that are significant, an integral part of Top-Flite's business, I mean wouldn't that be a significant consideration in the whole scheme of things?

Well, I would only -- I would only come back to you and say I think we've been pretty good custodians of the brand, Callaway, and the brand, odyssey, thus far, and I think we understand what brand value is, and we're not going to jeopardize the brands that we would own -- that we already own or the new ones we would acquire.

So these are business decisions you make in the -- at the times that they're presented, but I think you -- you know enough about our industry to know how we have behaved during these last two difficult selling seasons, that we've protected the brand.

We believe that the long-term value to shareholders is to have a strong brand.

And a good custodian is a very fair term, Ron and I commend you guys for that.

Thank you.

At this time, there are no further questions.

Well, thank you, everyone.

We appreciate your interest in continuing to stay with us through the interesting times we're in.

As we move forward over the next few months with top-flight, we will keep you informed as things develop and there's something to talk about.

In the meantime, we wish you well and we look forward to talking to you next quarter.

This concludes today's conference call.

You may now disconnect.