Topgolf Callaway Brands Corp (MODG) 2003 Q3 法說會逐字稿

Good afternoon, my name is April, and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Callaway Golf third quarter earnings conference call..

Mr. Holiday, you may begin your conference.

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

Joining us today is Ron Drapeau, chairman and chief executive officer of Callaway Golf Company.

During today's conference call, Ron will provide an overview of our year-to-date results and current trends.

I will provide more detailed comments about our financial results, Ron will then provide some commentary on the recently completed acquisitions of Top-Flite and our plans for growing the Callaway business, 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, plans, or circumstances including estimates of sales, capex, and earnings-per-share information for 2003, statements concerning the company's future woods business, and estimated potential changes to earnings are forward-looking statements subject to Safe Harbor protection under the federal security's laws.

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

For details concerning these and other risks and uncertainties, you should consult our most recent Form 10Q 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 for joining us this afternoon.

As Brad mentioned, I will cover two areas -- the Top-Flite acquisition and our plan for growth in our core business in 2004 and beyond in more detail toward the end of the call.

For now, I would like to share a few general comments about Callaway Golf Company's most recent results.

Today I'm seeing what appear to be some positive signs in the global economic picture.

The last job report in the United States showed 57,000 new jobs created -- the first time in many months that has happened.

The stock market has been rebounding some, and new housing continues to fuel the economy.

Clouding this good news is the continuing U.S. intervention and the Iraqi conflict and the imposing $87b funding requirement and the impact it might have on this recovering economy.

Additionally, there is some discussion of Japan addressing their bank debt, which could begin their recovery process in that country, and Europe has varying pockets of strength.

I think it is still too early to predict that we will see sufficient improvement in world economic conditions to drive more consumers to part with more of their hard-earned currency, but I don't see the situation getting any worse.

So I still plan to manage our business to protect shareholder returns in a challenging marketplace, and if things improve, then all the better.

In particular, the golf industry has yet to show signs of renewed strength.

Rounds played in the United States continue to trail prior years with cumulative results through August down 3.4%.

We continue to see aggressive discounting by some of our competitors, and yet the size of the market is not growing.

Many seem to be fighting for market share without concern for margins or brand value, making it a challenge to manage our business for maximum shareholder benefit.

It will take time for this market to correct.

Looking at our results for the nine months ended September 30th, consolidated net sales, including two weeks of Top-Flite domestic results were $667m -- basically flat with 2002 results.

At the same time, we improved our net income and earnings per share with our best nine months ended September 30th since 1997.

This is important, because 1997 was the last growth year for the company and the industry.

If you exclude the effects of the warranty reserve reversal that occurred last year, our improvement in earnings is even better.

I am pleased and proud of these results.

They reflect the diligence with which we manage our business, and they stack up positively as compared to our competitors.

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

Thanks, Ron.

First of all, as you know, we closed on the domestic portion of the Top-Flite acquisition on September 15th, so our reported P&L includes two weeks of their results.

That said, the impact of Top-Flite is immaterial to our cumulative results.

In presenting the financials today, I will give you a high-level summary of the consolidated P&L inclusive of Top-Flite results, and then I will review Callaway Golf results excluding the Top-Flite numbers and discuss the year-over-year comparisons as I normally do to make the comparison to earlier guidance less confusing.

We will break out Top-Flite results separately for the balance of this year, but going forward into 2004 we will discuss our business in terms of product categories such as woods, irons, balls, et cetera, rather than by brand, consistent with how we report our results today.

So having said that, total combined results through the first nine months were as follows: net sales were $667m including Top-Flite sales of $5m.

Gross profit was $335m, or 50% of net sales.

Top-Flite was $2m of this amount.

Operating income was $121m, or 18 % of net sales.

Top-Flite was breakeven.

Net income was $79m or 12% of net sales.

Top-Flite was breakeven.

Earnings per share was $1.19 with Top-Flite at breakeven.

We don't have restated results yet for Top-Flite for the same period last year, so I can't give you year-over-year comparisons at this time.

The historical information I can share on the Top-Flite financials is limited to net sales for 2002 year-to-date and a 2003 full-year forecast, which I will do in a few minutes.

As you know, the financials for Top-Flite for earlier years were intertwined with the Spalding and Etonic businesses.

We are in the process of separating the results of these businesses and developing pro forma financials for the golf segment, which is what we acquired.

This information will be included in our updated 8-K filing due in early December.

We hope you will understand the magnitude of this undertaking and will be patient until we can provide audited results for your use.

Also, as I give you our results this time, I will be starting with year-to-date results followed by third quarter results.

The reason for this is that we believe the focus on performance of Callaway Golf should be on longer-term results rather than quarterly, which can fluctuate for a variety of reasons.

This is fully consistent with what we have been saying for over a year now.

So looking at just the Callaway Golf results, excluding Top-Flite, year-to-date sales through September declined 1% to $662m with diluted earnings per share of $1.19, an increase of 7% compared to last year's $1.11.

In constant dollars, total net sales would have been $640m, a 5% decline from last year.

Net sales for the third quarter were $148m, a decline of 8% when compared to 2002.

In constant dollars, total net sales would have been $146m, a 10% decline from last year.

Year-to-date sales of woods declined 17% to $214m compared to $258m last year and comprised 32% of sales.

Solid sales of titanium woods, led by our GBB2 line were offset by lower year-over-year sales of steel products and C4 sales that we had in the line last year.

Yet for the eight months ending August for Golf DataTek [sp], Callaway metal woods remained number one in retail dollar share at 25%.

Third quarter sales of woods declined 22% to $44m.

Most of this decline was due to last year's international launch of our GBB2 drivers and price pressure on our steel products from competitors' titanium drivers.

Sales of irons for the first nine months increased 10% to $233m and represented 35% of sales.

This growth was due to continued solid consumer demand for our X16 line as well as our Big Bertha irons.

For the third quarter, sales of irons increased 6% to $54m.

Our market share of irons in the United States, according to Golf DataTek, also remain number one in dollar share at retail with 27% through August.

Cumulative sales of putters increased 31% to $118m driven by continued strong demand for the various models of the Odyssey, White Hot, and Tour ball lines.

Quarterly sales of putters declined 4% to $27m.

We do not view this quarterly decline as significant but merely a reflection of the timing of product reaching the marketplace.

In fact, according to Golf DataTek, Odyssey putters have achieved a 51% dollar share at retail in the U.S. through eight months, another number-one market share position.

Sales of golf balls for the first nine months decreased 33% to $39m.

This decrease can be attributed to the decline in rounds played this year, the absence of any new product introductions, and the uncertainty surrounding our ball business earlier this year.

Third quarter golf ball sales decreased 16% to $10m.

U.S. sales were $365m for the first nine months of 2003, down 3% compared to last year, and international sales increased 1% to $297m and accounted for 45% of sales.

We benefited from currency exchange fluctuations and on a constant dollar basis, international net sales would have been $275m.

Sales by market were as follows.

Europe sales increased 5% to $124m through the first quarters and decreased 3% for Q3 to $30m.

In constant dollars, Europe was down 4% year-to-date and 7% for the quarter.

Japan sales declined 4% to $78m for the first nine months and are down 3% for the quarter to $23m.

In constant dollars, Japan declined 10% for nine months and 4% for the quarter.

Sales to the rest of Asia, including Korea, were up 2% to $49m during the first nine months and increased 9% to $15m for the quarter.

In constant dollars, the rest of Asia decreased 2% year-to-date and increased 8% for the quarter.

Turning to the rest of the income statement, gross profit for nine months decreased 4% to $332m and gross margins were 50% of sales compared to 52% last year.

Gross profit for the third quarter declined 15% to $68m with gross margin declining to 46% of sales.

When reconciling to last year, the major items impacting both the quarterly and cumulative results include last year's $17m warranty reserve reversal offset by the additional obsolescence reserve taken last year and subsequent adjustments hitting Q3 last year due to the late filing of our 10Q including the Korean customs charge.

We provided supplemental information in our press release to assist in making year-over-year comparisons.

We hope this helped.

Operating expenses for the year have totaled $211m, or 32% of net sales.

This is a reduction in operating expenses of 6% from last year's $225m.

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

For the third quarter, operating expenses declined 1% to $67m, or 46% of sales compared to 42% last year.

Operating income for the year was equal to last year at $121m and operating margin with 18% comparable to last year.

Cumulative net income for nine months benefited from a lower tax rate and with $79m an increase of 5% with diluted earnings per share of $1.19, which is 7% higher than last year, both the highest since 1997.

Third quarter net income decreased $5m to $2m with fully diluted earnings per share of three pennies.

This entire decline was due to the net effect of last year's warranty reversal and the subsequent adjustments reported in the third quarter due to the delay in filing our 10Q that I already mentioned.

Our balance sheet, including Top-Flite, remains solid.

We ended the third quarter with $73m in cash after paying $159m for the acquisition.

We have long-term debt of less than $5m and $269m of working capital.

Inventory, excluding Top-Flite, was $114m and decreased 11% year-over-year.

With Top-Flite included, inventory was $141m.

Accounts receivable increased 6% year-over-year to $109m, once again excluding Top-Flite.

The increase reflects the late second quarter sales and timing of payments on those sales.

Our current AR balances are still in good shape, and where there have been delays in payments, we are working with those accounts including Top-Flite accounts receivable total to $136m.

It should be noted that our write-offs of uncollectible AR through nine months is running less than one-tenth of 1% of net sales reflecting the high quality of our receivables.

Capital expenditures during the third quarter were $1m and depreciation and amortization totaled $10m.

Year-to-date, capital expenditures have totaled $5m and depreciation and amortization totaled $30m.

Our current full-year estimate of capex is in the $10m range, excluding any impact of the Top-Flite acquisition.

We are currently evaluating options surrounding the integration of the acquisition but do not expect significant capex requirements for the balance of this year.

Free cash flow for the past 12 months was approximately $97m.

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

Since May 2000 we have invested $234m 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.

Brad just covered a lot of numbers and results.

To summarize, I would reiterate that I am pleased with our results for the first nine months of the year.

We have had many challenges, but have worked hard and feel we have addressed them and generated good results for our shareholders.

Callaway net sales of $662m are down slightly for the year.

We maintained our number-one market share in woods, achieved a record number-one market share in our irons business, and continued to enjoy a strong a number-one market share with our putter franchise.

We have carefully managed our expenses all year resulting in the highest net income in earnings per share for the company during a comparable period since 1997.

We continue to generate cash, have a strong balance sheet, and successfully completed the acquisitions of the Top-Flite Golf Company.

Having said that, I would like to discuss with you our two most important areas of focus -- the first is the Top-Flite acquisition, and the second is our plans for growth in our core business in 2004 and beyond.

For more than two years now, we have told you that, given the right opportunity, we would leverage our strong balance sheet to take advantage of the inevitable industry consolidation.

We also pledged earlier this year that we would fix the profitability of our golf ball business by 2004.

This acquisition addresses both strategies and, as Brad said, even after completion of the deal, our balance sheet remains strong and essentially free of debt.

As reported in the 8-K at the end of September, the adjust cash portion of the acquisition was $159m plus the assumption of $5m of debt, bringing the total purchase price to $164m.

In addition, the company assumed current liabilities of $16m consisting of employee and tour-related expenses, selected vendor obligations, and customer rebate obligations, bringing the total to $180m.

For this $180m, we acquired $80m of accounts receivable in inventory, $65m of property plant and equipment for a total of $145m in hard assets.

For the remaining $35m, we purchased a business that in 2002 generated $232m in worldwide revenues, strong brands represented by Top-Flite, Strata, and Ben Hogan, one of the largest golf-ball patent and trademark portfolios in the industry, and an extremely value asset in the human capital represented by the strong management team and employees.

From an economic point of view, we believe this was and will be a very positive acquisition for our company.

Our preliminary independent appraisal indicates we paid $15m less than the fair value of the net assets, which will result in negative goodwill.

When we file our 10-Q, this negative goodwill will be netted against the property and intangible assets resulting in lower carrying costs on our balance sheet.

I fully expect that this acquisition will be accretive in 2004 with significant longer-term benefits.

The purchase of Top-Flite fits well with Callaway Golf for several reasons.

First, they are one of the lowest-cost producers of golf balls in the world, and we believe the low-cost producer in the United States.

The manufacturing that we ship from Carlsbad will take advantage of this low-cost position, making us profitable in the golf ball business in 2004 as pledged.

Our opportunity to build on this base was solidified last Thursday with the ratification of a new five-year collective bargaining agreement in the main golf ball facility in Chicopee, Massachusetts, partnering us with a workforce to aggressively pursue market opportunities worldwide.

The combined golf ball share of Top-Flite, Strata, Hogan, and Callaway in all channels makes us a clear number-two in market share in the mid-20% range, more than twice as big as our next biggest competitor.

Second, Top-Flite has an extensive golf ball patent portfolio and time-proven ball research and development.

Combine this with our own patents and R&D, and we are positioned to continue to lead the marketplace with technological innovations that will limit our competitors' abilities to develop competing products.

Third, their brands are strong and complement our brands.

Top-Flite is a global brand recognized by golfers seeking quality at a reasonable cost.

Strata has appealed to a younger segment of golfers looking to improve their game with technology.

Ben Hogan is a premium brand valued by elite and highly skilled golfers seeking traditional equipment.

Combining them with the conference and Odyssey brands gives us the strongest and deepest equipment brand portfolio and sets us up to be the number-one golf company in the world in revenues and earnings.

Fourth, Top-Flite gives us a significant leadership position in distribution channels where the Callaway Golf and Odyssey brands currently do not participate in a meaningful way.

In particular, Top-Flite is a channel leader in the sporting goods and mass-merchant channels.

From an operating perspective, our goal is to maintain a separate public identity and image for the Top-Flite golf brands distinct from Callaway Golf.

In order to accomplish this in the United States, we have established a Top-Flite Golf Company as a wholly owned subsidiary and appointed Bob Penicka as president and chief operating officer.

As many of you know, Bob is a seasoned executive most recently leading supply chain efforts for Callaway Golf.

Bob and his team will be responsible for the Top-Flite, Strata, and Ben Hogan brands.

With the exception of our casting operations in Carlsbad, Top-Flite will be the center of our golf ball manufacturing and research and development for the entire company.

Bob and his team will be charged with growing the revenues and profits of that business while operating as a supplier of Callaway Golf branded balls to the parent at significantly reduced costs as compared to our own fledgling operations.

While Top-Flite will lose between a nickel and 10 cents per share in the fourth quarter, it is important that you understand this is the state of the company we purchased and the low point of the seasonality in golf.

It is not reflective of our plans for this company, going forward.

As recently announced, Patrice Hutin has been appointed as president and chief operating officer of Callaway Golf.

All golf club manufacturing and research and development will be coordinated under Callaway Golf providing efficiencies and increased opportunities for new products at all price points, going forward.

In addition, Callaway Golf's international distribution channels, including its wholly owned subsidiaries in Europe, Japan, Canada, Korea, and Australia will take over responsibility for selling the Top-Flite, Strata, and Ben Hogan products abroad.

We will start the 2004 season keeping much of the former Top-Flite organization in place under our ownership.

This should make the transition transparent to the customer so we do not miss sales in the critical part of the season.

As the year progresses, we will be integrating operations to build an even stronger organization for 2005.

As you can see, the acquisition does much more than fix the profit drain we have experienced in our own startup ball business.

We are certainly excited to execute against the plans we have made.

Turning back now to our core Callaway Golf business -- I know there have been questions raised about our woods decline.

Let me tell you what has been happening and what we plan to do about it.

Several factors have caused us to see a decline in our woods market share in the United States.

Some occurred in 2003, and some occurred earlier.

Let me list them for you.

First, the best club we ever brought to market in our flagship at the super premium price point, the ERC II, was banned by the United States Golf Association back in 2000.

In fact, it was not only banned, it was vilified.

This cost us our leadership advantage in technology and, as a result, allowed others to offer products that were closer in performance to ours.

We did not have a driver or fairway wood product in the super premium price point in 2003.

Nobody did.

At the premium price point, we offered the Great Big Bertha II line in 2003.

We launched it at a premium price point and maintained its number-one market share for all 2003 titanium model introductions, even though it competed against the premium products of other brands that were discounted in an effort to gain market share at any cost.

We think our strategy was better as shown in our earnings year-to-date.

Our Great Big Bertha II product line has done very well without relying upon discounting.

Its sales have exceeded our titanium wood sales in 2002, which included both ERC II and Hawkeye VFT.

We believe 2003 has been a success for us thus far at the premium price point category.

At the moderate price point, our competitive product has been the Steelhead III line introduced in 2001.

It has had to go head-to-head with discounted premium titanium products and new models that have offered a cast titanium driver at steel pricing.

This moderate price point, once occupied by stainless steel products, has been a big part of our total woods business for years, but it has declined in 2003 for the reasons stated.

So what are we going to do about this?

First, you should know that this is not a surprise to us.

We recognized the trends earlier.

The launch of Great Big Bertha II was only a first step in our strategy to gain back our historical share and, as I said, it was a good one.

It has done what we intended, which was to solidify our position at the premium price point in drivers and fairway woods without relying upon discounting to drive sales.

But as a result of the USJ limitations, the Great Big Bertha II was not a differentiated product.

We needed to develop a way to differentiate other than COR.

In 2001 and 2002, we tasked our research and development group with delivering new wood products for the super premium category for introduction in 2004, and they have done this.

We have announced ERC Fusion for 2004, a breakthrough platform for drivers.

A combination of a forged titanium face and carbon composite body with maximized customized weighting for optimal center of gravity and moment-of-inertia properties.

We are the only United States producer to have such a product.

With five tour wins and 80 to 90 drivers in play each week on the professional tours, it is the hottest new driver in a long time.

I am confident it will reestablish the super premium price point as well as Callaway Golf's technological leadership in 2004.

This product will not compete against lower-priced products because there is nothing else like it.

In 2004, we will continue the Great Big Bertha II forged titanium line, but with some freshening that will add to its appeal at retail and with new line extensions in both the United States and Japan.

This should reinforce the position we have regained at the premium price point.

Finally, those of you who follow us have probably already penciled in the replacement for Steelhead III, which is two years old in 2004.

You would be correct, but we have modified that strategy.

Our new introduction brings back the Big Bertha name on woods.

We will have a product line that includes cast titanium in the drivers and steel in the fairway woods, Callaway Golf technology in everything, and prices that may surprise you.

This line will offer a strong alternative against competitor cast titanium products.

Why buy another brand cast titanium driver when you can buy a Big Bertha?

I believe this new lineup of three wood segments and prices for products for 2004 will help us reverse the downward trend we've experienced in this very profitable segment of our business.

We intend to recapture share next year as part of a multi-year plan to move us to historical levels.

Moreover, I think these new products are exciting enough that they could even bring some consumers who have been sitting on the sidelines during these bad economic times, back into the marketplace, growing the size of the pie.

While the recent trends will start to reverse in 2004, I cannot assure you that we will recapture all of our lost woods business in 2004.

This will be a gradual process.

We need to not only recapture lost market share, but we need to grow the market back to historical levels.

This will take some time, given the state of the golf market, but we are committed to the goal of restoring our woods business to historic levels by 2006 -- a goal that offers us some great opportunity for growth above current sales levels.

I would now like to turn the call back over to Brad, who will talk a bit more about our expectations for the rest of 2003.

Thanks, Ron.

Looking at the full-year forecast, let me first talk about our stand-alone Callaway Golf business.

Full-year guidance from last quarter for net sales and earnings per share was approximately $780m and 95 cents, respectively.

Given what we know today, we estimate we will be able to achieve slightly higher earnings per share of approximately 97 cents on slightly lower sales of approximately $770m.

This new guidance reflects a bit of a slowdown in sales in the third quarter over our original estimate that carries through into our full-year forecast.

What has changed on the earnings line is reflective of slightly higher gross margins in the fourth quarter, a lower third quarter tax rate that will carry through, and continued tight management of our operating expenses.

When compared to last year's results, this would equate to an 11% increase in earnings per share on a 3% decline in net sales, excluding the impact of last year's warranty adjustment.

Looking at Top-Flite, historical P&Ls are limited at this time.

We are in the process of separating the golf results from what used to be the Spalding Company and included inflatables and the Etonic shoe businesses.

As you can imagine, this not only requires a lot of work but must also be audited for inclusion in our revised 8-K filing due in early December.

What I can share with you at this time is that full-year net sales for 2002 were $232m with year-to-date sales for nine months ended September 30th of $170m.

Sales for the fourth quarter are estimated at approximately $35m resulting in full-year 2003 net sales of $205m.

While we are still very early in the process of understanding all of their costs, we estimate the earnings-per-share impact for the full year is a loss of approximately 5 to 10 cents, consistent with the normal seasonality associated with golf.

As Ron indicated, this is the company we purchased, burdened by debt and under-invested in brand.

We plan on changing that equation to grow this business back to historical levels or better.

Our consolidated forecast for sales of approximately $810m with earnings per share of 87 cents to 92 cents.

This excludes any one-time manufacturing consolidation charges.

We are currently evaluating several options and timing surrounding the consolidation of the Callaway and Top-Flite golf ball manufacturing operations.

Top-Flite is a low-cost producer of golf balls, and we want to leverage its capability as quickly as possible.

They have technology that will allow them to make our two-piece golf balls almost immediately, but we must prove that they can achieve our performance requirements before we actually move production into their facility.

We believe we can do this fairly quickly.

Top-Flite currently does not have the casting technology that we have developed for our premium cast urethane balls.

So for the short term we will continue to finish these balls in our facility here in Carlsbad.

Once we can assure their manufacturing process can meet our performance requirements, we will continue to consolidate manufacturing operations.

As a result of this ongoing review of manufacturing, we are fine-tuning our estimate of potential charges resulting from the acquisition.

Our best estimate at this time is that these charges could total approximately $60m over the next 12 months, most of which will be noncash.

Accounting rules require that you record the charges as they happen, rather than recognizing a reserve for the entire estimate.

Because timing is so critical, I cannot give you a firm estimate of how much will impact 2003 versus 2004.

As we report our financial results for this year as well as 2004, we will break out these charges separately to make our true operating results more clear.

Once again, we will be filing an amended 8-K in early December that will include historical and pro forma results related to the Top-Flite golf business.

We would now like to open the call for any questions you might have.

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

Hi, good afternoon, gentlemen.

I want you to know that I'm at a conference and actually played with Callaway's Big Bertha this morning.

A couple of things -- one, I wanted to know if you can quantify the FX benefit for the quarter; two, I wanted you to break out the loss of the ball business; three, DSOs for the quarter; and, four, an explanation on the lower tax rate.

The first one -- you want to know what the FX impact was on sales, Carole?

Yes.

$22m year-to-date and $3m for the quarter.

$3m to the quarter -- and what was the gross margin benefit?

I don't have that right in front of me here.

Okay.

On the DSOs, our DSOs were, I believe, 73 days, and the last question, I'm sorry, again, was what?

I had two other questions -- the breakout of the loss of the ball business and the explanation for the lower tax rate.

The lower tax rate had to do with some work we've been doing on foreign taxes that we, over the past three years, so 2000, 2001, and 2002, and those are permanent, but we're pretty well through all of those.

So assuming, going forward, our tax rate should be in the 38% range on a go-forward basis.

And the losses, operating losses, on the Callaway Golf ball through the first nine months is approximately $17m.

What about for the quarter?

For the quarter, $7m.

Okay, and then, actually, one more question -- the ERC Fusion -- you mentioned this is in the super premium price point.

So are you saying that even at the premium level there's almost two different levels?

Yes, that's right.

This product will be priced at a higher level than the current forged titanium products in the marketplace led by Great Big Bertha II.

Okay, thanks.

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

Good afternoon, gentlemen.

Hey, Bud.

Hi, Bud.

Let's see, Brad, maybe you could just get into the gross margins for Q3.

Were those a little lower due to a larger mix of irons?

Maybe you can just break that out a little bit.

Well, a couple of things -- I mean, if you're going to do year-over-year comparisons, you know, last year we had the warranty reversal, the gross margin line, as well as some subsequent events that, because of the late filing of our Q, we tried to break that out on the press release, Bud.

In addition, last year we had a higher mix of titanium woods, because we were shipping internationally.

Some of the new GBB II line, so it is mix related.

This year we have a higher mix of irons, as we talked about.

Okay, and then I was just wondering, too, in terms of just your initial efforts with Top-Flite, can you explain some of the consolidation that we may see?

Are we going to see all of the golf balls consolidated into one facility eventually?

Or is there still going to be some production in the Carlsbad facility?

As we said in the call, Bud, it's our plan to center all the golf ball activity around Top-Flite excluding the cast cover finishing piece of our high-end balls on the Callaway line until we can get that process moved to Chicopee, but that will be ongoing in Carlsbad for some time.

Okay, so eventually we'll see it all in one facility?

Yes.

Okay, and then I was just wondering, in addition, in terms of a patent portfolio of Spalding and also of Ben Hogan, are there any relevant patents in there that may be able to obviate the payments that are made to Titleist?

Is there anything that you see in there that's relevant to the Callaway Golf ball there?

Absolutely, there are patents that are relative to the Callaway Golf ball and the rest of the industry, where -- that's a real hidden asset in this deal.

Okay, so in terms of some of these patents, would that eventually lead to a potential exit from the royalty payment to Titleist?

No, they're not related to what Titleist has patented.

Right, well, I guess what my question centered on -- is there any slight production changes that would utilize those patents that would still be somewhat similar to the CBU 30 and -- or CTU 30 and also the HX ball?

No, the patents are in different areas.

Okay, okay.

Hey, thanks very much.

Okay.

Your next question comes from Bret Jordan with Advest.

I have one going back to Carole's question on the driver -- what's the early feedback you have on the Fusion pricing.

Is that one of the first clubs to break the $600 retail price point mark?

Do you have any retailer feedback on that number?

The retailers are loving it.

The various brands you're going to carry now in Top-Flite, do you have a feeling for what your marketing spend to support that is going to be as a percentage of sales, going forward?

Not at this time.

We expect sometime in mid to late December to give guidance for 2004, and we'll be prepared in detail at that time to talk about the various brands and the support.

In the third quarter, what the Callaway market share was for balls, and then what Top-Flite was, and where that was relative to the prior year?

Well, the Callaway ball business basically only competes in the on-course and off-course specialty golf retail, whereas the Top-Flite competes in those channels as well as sporting goods and mass merchant.

So they're not really apples-to-apples, but as you combine them all together in all channels, we come up into the mid-20% market share for the combined brands.

Where would that have been a year ago?

A year ago it would have been a little higher than that.

Probably the high 20s, Bret, and that's across all channels.

You just look at DataTek, just for the Callaway line, we were just about 5.5% to 6%, but that's just in the traditional golf specialty channels.

But I think, as Ron just mentioned, I think we need to start looking across the entire industry, which includes mass merchants and sporting goods as well as golf specialty.

Okay.

Capex for '04 expectations, now that you've got property plans in the Top-Flite deal, do you have a feeling for what that number might be?

Not at this time.

When we talk in December, we'll give you a little bit more guidance on that, but it's a little early right now.

[audio break] play compressing and driving a relatively competitive environment from a manufacturer's standpoint -- is there a number, is there a level at which you think the pricing environment becomes less competitive, or is this just a state of the world in perpetuity?

I think there are going to be continued pressures, going forward, to bring better and better products and very competitive prices.

I think that's a natural trend as industries mature, but I think that the ERC Fusion platform, which is a whole new style and product differentiation gives us the opportunity to bring price back into the equation in terms of our total mix.

Where are the other graphite titanium clubs priced?

There's a couple of other non-U.S. manufacturers -- where are they selling those items?

Well, the only products that seem at all similar to this, and there really is nothing like this with the forged face carbon body -- there are some carbon-topped products that have been introduced in Japan, and they are super premium price categories.

Relatively in line with other sort of composite products?

Yes.

Your next question comes from the line of Tim Conder with AG Edwards.

Gentlemen, first of all, let me offer my congratulations in a difficult environment.

Thank you, Tim.

A couple of questions -- we'll start out with Brad on the receivables -- how is the aging, Brad, of the Callaway receivables?

I know you gave the stat with the losses, and then maybe break out the aging of the Top-Flite receivables.

Well, we don't usually give all the detail on aging, Tim.

What I stated was, you know, we had a DSO of 73 days, which was up about 10 days from where we were a year ago, which is consistent with where we've been all year, as we've had extended terms over what our past practice has been.

I think the important thing is, as I mentioned, the amount that we've actually written off as uncollectible on past dues is less than a tenth of a percent.

We work very closely with our accounts.

Obviously, it's been a difficult environment for a lot of people out at retail.

I think our percentage of those accounts that have not been able to come through and pay on our invoices have been very, very, very low -- less than a tenth of a percent, which is really quite good.

But we work with those that have problems, and I think Ron has talked a lot all year about what a difficult environment that it has been, and I think that you go talk to some of the golf retailers, and they've had some tough times, and we work very closely with them.

Let me tell you, the overall quality remains very good with our current receivables being a very strong percentage of the total, and we feel very comfortable with where our receivables are.

Okay, and then, Brad and Ron, thank you for the guidance on the sales on Top-Flite.

Any commentary year-to-date or for '03, as you see it at this point on Top-Flite as it relates to EBID or EBITDA percentage based on that sales guidance that you gave?

Well, the challenge we have, Tim, is that all the numbers that we have seen thus far have been comingled with the inflatables business of Spalding and Etonic, and while the investment bankers did their best to break out those numbers during the negotiation process, we prefer to wait until we have them audited to disclose them, and that will be in the Q that will be -- or -- yeah -- I guess in the 10-K that will be -- 8-K, my accountant --

Early December, we'll get that to you.

It means for guesstimate's sake, could -- well -- okay -- yeah, for an annual basis.

Okay, that's fine.

Well, we gave you the estimate of the earnings-per-share impact for the full year since we acquired them.

We just don't have any audited numbers we can give you for the full year of 2003.

We have to wait on that.

Okay, and as it relates to a tax rate or anything, Brad, should -- I mean -- just for ease of sake, should we assume a similar tax rate or are there some losses?

Yeah -- no -- a similar tax rate.

Okay, okay.

And then you've touched on this a little bit -- with Top-Flite how are you going to look with reversing the loss of share there?

Do you see additional marketing spends there?

I mean, obviously, they probably didn't spend as much as they should have, given the debt situation they were in.

How do you see that, looking forward, at this point?

Well, I think there are two things that we will be investigating, Tim.

One will be to invest more in total dollars than they have in the past couple of years, because they've been strapped for cash.

And then, secondly, of that mix, we plan on investing a higher percentage of that mix where the opportunity is, and that's in the Top-Flite brand.

We think that they have over-invested in Hogan, which is a niche market, and we intend to divert some of that funds towards Top-Flite.

Okay, okay.

And as it relates to Hogan, Ron, there are rumors out there in the industry as to how much in sales Hogan is, and rumors that their breakeven.

How do you see that brand, going forward?

Do you see an opportunity to grow it?

Do you see it being accretive in any way?

I guess, what's the future with Hogan?

Do you keep it?

Do you maybe look at selling it potentially?

I mean, what direction do you think at Hogan on this point?

Well, I think it fits nicely in this portfolio of brands and product offerings we have.

As you well know, it represents a forged iron product line, high-quality image after the man himself.

It fits a product segment that we don't have an offering in Callaway Golf, and so if you look at it as a pure add-on to our iron business, it gets a free ride with a little bit of investment spending behind it.

There's no infrastructure required to make it happen, and there's no reason why it shouldn't be a positive contributor.

I think the growth potential opportunity in that segment is somewhat limited.

There are not that many golfers in the world that can play those products, and there's a couple of other brands that have offerings there.

I think Hogan is probably the best name in that group of competitors in terms of what that product represents to those best-player category, and I see it as a nice, positive addition and plus to our whole portfolio.

So, again, you think it will be accretive, going forward, after maybe adjusting some marketing dollars over and then some other efficiencies?

Yes, I think so.

Okay, and then, I guess, to wrap up the line of questioning there -- you anticipated Top-Flite being accretive in '04.

Is that accretive on a stand-alone basis for Top-Flite or are you also factoring in the eliminations of your golf ball loss?

And if you could, maybe, somehow separate the two or however you want to comment along those lines?

We'll break out some of that detail in mid to late December but, in summary, accretive on its own as it looks today, without any of the consolidation.

Secondly, you get the benefit on the cost reduction that applies to Callaway's golf ball business.

Thirdly, you get an absorption of overhead contribution at Top-Flite as we put Callaway golf balls through that operation.

So there are three elements to it, but the number one is accretive just as it stands.

Okay, and then, again, eliminating the Callaway loss secondly, and then overhead absorption third?

Right.

Okay, thank you, gentlemen.

Thanks, Tim.

Your next question comes from Casey Alexander with Gilford Securities.

High, good afternoon.

Hi, Casey.

Maybe I'm just parsing the phrase, but what do you mean by relaunch the Callaway Golf ball line?

Well, what we plan on doing, and maybe you've read something about it, is we have a brand-new golf ball called the HX Tour.

It's been out on tour now for a couple of months.

It's done extremely well, and the players love it.

We have not introduced that to the marketplace yet.

So that's going to be the lead flagship product for us under the Callaway brand, and then we will be bringing the HX Red and HX blue cast urethane products with a new appearance, a new logo on them.

We're going to be bringing in the two-piece category, a new golf ball called Big Bertha, and then, finally, we'll be rebranding the Warbird line of the Callaway product.

So it will be a very different look in terms of the marketplace.

There's a whole new presentation for all of these products.

Are there any Callaway balls coming out of Chicopee now?

No, not today.

But there will be by the end of the fourth quarter.

Okay.

How do you plan to rationalize the Top-Flite product line, particularly the golf ball line?

They seem to have a very large amount of SKUs.

And what are your plans for rationalizing that product line?

Well, the 2004 product line is pretty well set.

We're not going to make any changes to that.

During 2004 we will look at the competitive landscape and determine for all the brands on how we want to segment our products relative to price points and where we want to compete or stand alone with the three brands or four, if you include Strata.

Is there any reason to persist with the Infinity ball?

I mean, it hasn't captured much market share, and you're giving away sales to Infinity Golf.

Is there any reason to keep that going?

Infinity ball actually is doing pretty well at launch, according to our information.

Okay.

I didn't hear you say -- is Hogan going to continue to be run out of Texas, or is it going to be moved?

I didn't say.

Is it going to continue to be run out of Texas?

I'm not ready to say.

Okay.

You said that you do not believe that, given the profile of the player, that there's a tremendous amount of growth at Hogan, yet the Hogan management team projected that over the next three years they could grow their sales to $250m.

This was at last year's PGA merchandise show.

There seems to be a dichotomy there.

Was what they were discussing a pipe dream or what's the deal?

Well, we have a very different view of that.

The niche segment of forged blade, which is what Hogan stands for, is not a growth segment in this industry.

Now, that management team, I know, felt like they could grow Hogan to be a full line product company to compete with Callaway and Titleist and Ping and TaylorMade.

We don't see that, not in this marketplace.

I think it has a nice niche where it can make a profitable contribution, and I think, as I said earlier, they overspent on trying to make Hogan more than it can be.

Okay, I happen to agree with you that Hogan is one of the natural fits in this business, but how do you handle the internal cultural dichotomy when your chief designer of Callaway clubs has declared clubs with hozzles to be inferior?

You keep his hands off Hogan.

On the Fusion club, if it were priced at the premium category as opposed to the super premium category, are there manufacturing issues that would make the margins less than the Great Big Bertha II?

In startup there are.

Over time, those cost efficiencies will come in, but why give the product away?

Well, there haven't been a lot of successful $600 drivers in the marketplace for several years now.

ERC II was extremely successful, and in Japan there have been a lot of 70,000, 80,000, 90,000 yen drivers.

All right.

This is not just a U.S. business we run.

Yeah, I hear you, but I don't know how many years we're going to talk about ERC II as the reason that you're losing market share in woods.

Well, only until we turn it around and when the impact stops.

But there's definitely --

Well, this is 2003.

That was 2000.

Well, you may elect not to believe it.

I think it had a tremendous impact on where we were the last two years.

But, you know, I run the R&D operation here.

But you don't think that C4 had a tremendous impact on it?

No, not at all.

Okay, thank you.

Your next question comes from Rick [Shea] with [Barden] Capital.

Hi.

A couple of questions -- one, could you give me a little better snapshot of the state of the Top-Flite business?

What condition that sales organization is in?

What sort of programs exist?

What's in that R&D portfolio and maybe how they've approached the business by channel?

Well, I'll start with the latter first -- they are industry leaders in the major retailers in the channels in mass merchants and in some sporting goods, so they are a leader, a recognized leader in that segment.

In terms of the sales organization, as you can imagine, over the last five years, six years, since the acquisition by KKR, they have been drained of the investment they should have been putting behind their brands to grow their businesses or protect their shares in this challenging marketplace.

And so the sales organization has had a very, very tough time of it around the world.

I can tell you they are extremely excited about being part of Callaway, who has no debt and understands investing and brands and wants to grow their businesses.

So I think the sales organization has worked hard in a very challenging time, and I think, going forward, we will see them outperform what they have been able to do in the last couple of years.

What was the peak -- do you have a sense of what the peak sales number was at Top-Flite?

It's hard to say because of the sporting goods business.

I think it might have been north of $250m.

Okay.

Will you be giving guidance for '04 simultaneously with the filing of this 8-K or will it be in the 8-K or how are you doing that?

No, we'll have a conference call in mid to late December to give guidance.

Okay, and roughly speaking, is there any thought on the potential of the financial model of the combined companies?

I'm not sure I understand the question.

Your EBID margin has been a lot higher.

I'm just trying to get a sense of the leverage with the combined businesses.

Are you talking about pre- our entering the golf ball business?

Yes.

Well, I mean, obviously, the leverage is what Ron talked about when he talked about Top-Flite being accretive and then also being able to recognize the value of their lower-cost manufacturing and the impact it has on our ball business, but, you know, kind of post-1997 is when we got into the golf ball business, and that was where the drain occurred on our margins.

Do you have any sense as to what the cost advantages they have over your existing costs?

We do, but I really don't want to share costs.

Okay, okay.

Last question -- is there anything currently being done in Top-Flite apparel, or could there be anything done?

There is a current license agreement, and that has, I think, a couple of years to run on it.

Okay, thank you.

Your next question comes from the line of Josh Schwartz with Flatbush Water Mill.

Hey, guys, how are you?

Good, how are you doing?

I'm great, thanks.

I wanted to say, first and foremost, somebody should tell you, I think it looks like a tremendous deal, and I congratulate you on that decision.

I had a question -- if we go back and kind of look at the thoughts when we first entered the ball market, I think the belief was that the Callaway brand could probably take some of the share of Top-Flite and all those people at the lower end, and maybe get -- there was a trend towards higher-priced ball usage.

I'm curious, Ron, what your thoughts are in terms of the Callaway brand -- that golf ball, number one, going forward?

Has the loss contributed to you not being able to do certain things to gain share?

I mean, more specifically, do you think that the Callaway brand can gain share and just what are your goals, because you used to talk about moving towards 20% to 30%.

Just kind of broadly, I wanted to hear what you thought.

Well, definitely, the struggle we had in delivering acceptable financial results in the golf business hampered what we could do.

Our ball today and for the last couple of years has been the number-two ball on tour.

We've gotten there through performance.

In order to go after number one, there is a fairly substantial cost for professional tour endorsement money, and we have not been able to put that money behind our ball, even though we have substantial interest from players who would play our ball in preference to the market leader.

So one of our challenges is we haven't been able to invest in our ball business, because we haven't delivered the earnings that we expected to deliver.

But if we take a step back, right now there's a situation where you're saying the market is not growing, so you're going to have to take share to grow the business, that's true of Callaway and Top-Flite.

And there's only two ways to do that in terms of having a competitive advantage.

You either have to differentiate your product, or you have to have the lowest-cost product.

And I guess -- so what you're saying is you've -- on the paying for tour usage -- that is still an attempt -- the goal there is to differentiate the product using the pros as the way to do that, is that right?

Well, I'll tell you, as I sit here right now, Josh, we are the low-cost producer in this country, and we have the most differentiated product.

So why wouldn't -- can you drop price on that product now?

Oh, I don't want to drop price.

What I want to do is to grow that segment -- we can take a significant piece of that segment in pricing as we see that consumers have been willing to pay for a product at that level, and we've got a very, very good product.

Okay.

So just to sum up on that -- I mean, broadly speaking, you're in the mid-20s right now -- combined ball share -- what are your thoughts in two or three years?

What are your goals that you think are reasonable?

Well, two or three years, I'd be very disappointed if we weren't able to grow that by five points or more.

Okay, and then one other question I had -- I didn't understand exactly what the strategy is with the intermediate price level on the woods?

You talked about the Steelhead and, you know, changing it slightly.

Yeah, what we're doing is we're reacting to what's going on in the marketplace, and we're bringing a cast titanium driver to compete with -- steel ferry [sp] woods to compete with similar products at a price point that will go after them.

We've been competing with a forged product in GBB II, and they're very different in terms of their performance and in terms of their price.

So we have three segments in woods for next year -- the super premium category, premium category, and then what is actually a commodity product now.

And that's -- okay, that's a steel -- the one that you're referring to?

Right.

Okay, thanks very much and good luck with everything.

Thanks, Josh.

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

Hi, just a quick follow-up -- in terms of the ERC Fusion, the rollout of that, obviously, you're going to launch in December -- is there going to be a limited initial launch or just specific accounts and then maybe similar to what you've done in the past -- a full rollout in January?

Maybe if you can just sort of go over the rollout plan there.

Well, it's a 2004 product.

We haven't decided yet whether we would bring some early for the Christmas season, but we may.

Great, thank you.

Your next question comes from Tim Conder with AG Edwards.

Just two follow-up, gentlemen.

Your integration timetable -- how much would you anticipate of the full integration process would you anticipate being completed in '04?

And then when would you anticipate that being fully completed?

And then, secondly, let's look out here now a couple of years.

You've purchased Top-Flite, you've gone through a difficult overall environment here, and it's a favorite question many people ask on this call, but you've still got a decent cash balance, and you're most likely going to continue generating even more cash as you get integration efficiencies.

What do you do with it and when, I guess?

Well, in terms of the consolidation question, we expect it will all be completed in 2004, Tim.

Okay.

And so 2005 forward, we should be getting annualized benefits that start from day one.

In terms of the cash, going forward, I think there's going to be opportunities.

I think there's going to be more consolidation in the industry.

There could be some of the same type of activity in Japan, where there are some strong brands, local brands.

There are going to be other opportunities in the marketplace as consumer behaviors change, and we're watching those, and there's a developing market in China.

There's going to be opportunities for us to invest our cash.

At what point, Ron or Brad, would you consider restarting the share repo?

Well, when we can't find other uses that will generate returns.

Okay, okay.

Your next question comes from Mark [Gravitz] with [Grace and White].

Hi, good afternoon and evening.

Hi, Mark.

Hi, a couple of questions -- actually, the first -- if you could reiterate the amount of the negative goodwill.

$15m.

One-five?

Yes.

Okay, and on the Top-Flite purchase, did you also purchase Bob Bettinardi and the putter line?

No.

Bob Bettinardi is a stand-alone company.

He had a license agreement with Top-Flite for the distribution of Bettinardi putters in the United States and Europe.

He had different distinct distribution for Japan and Asia, and we did not acquire that contract in the assignment with the other assets, but we have discussions ongoing with Bob.

Okay.

So it doesn't look like you're going to be entering the milled market anytime soon then?

Well, we entered the mill market with Callaway putters for 2004.

We've introduced to the marketplace and to our sales force and retailers.

Okay, I was unaware of that, thank you.

Okay, thank you very much.

At this time, there are no further questions.

Mr. Drapeau, are there any closing remarks?

Yes, thank you, everyone, for joining us today and for your ongoing interest in our company.

We are excited about our opportunities, going forward, and we're working hard to increase the value of your investment.

Thanks again for joining us today.

This concludes today's Callaway Golf third quarter earnings conference call.

You may now disconnect.