Topgolf Callaway Brands Corp (MODG) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by.

We do appreciate your patience today while the conference is assembled and good afternoon.

Welcome to the Callaway Golf Second Quarter 2005 Results Conference Call. (OPERATOR INSTRUCTIONS) Here with our opening remarks is Callaway Golf's Chief Financial Officer, Mr. Brad Holiday.

Please go ahead, sir.

Thank you and welcome, everyone, to Callaway Golf Company's Second Quarter 2006 Earnings Conference Call.

I'm Brad Holiday, Chief Financial Officer of Callaway Golf Company.

Joining me today is George Fellows, President and CEO of Callaway Golf.

During today's conference call, George will provide a few opening remarks and I will provide an overview of the Company's financial results, and we will then open the call for questions.

I would like to point out that any comments made about future performance, events or circumstances including statements relating to momentum in revenue or market share, future gross margin improvement, restoration of the Top-Flite brand, future operating expense savings and reinvestment, and achievement of three-year targets, as well as the Company's estimated 2006 capital expenditures and depreciation and amortization expenses 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.

Actual results could differ materially from those projected in the forward-looking statements as a result of certain risks and uncertainties, applicable to the Company and its business.

For details concerning these and other risks and uncertainties, you should consult part 1, item 1A of our most recent Form 10-K filed with the SEC, as well as the Company's other reports subsequently filed with the SEC from time to time.

In addition, during the call, in order to assist interested parties with period-over-period comparisons, we will provide certain pro forma information as to the Company's performance excluding charges associated with the integration of the Top-Flite operations, the cost reduction initiatives announced in September 2005, and employee equity-based compensation.

This information may include non-GAAP financial measures within the meaning of Regulation G. The earnings release we issued today includes a reconciliation of such non-GAAP financial measures to the most directly comparable financial measures prepared in accordance with GAAP.

The earnings release is available on the Investor Relations section of the Company's website at www.callawaygolf.com.

I would now like to turn the time over to George for a few opening remarks.

Thanks, Brad, and thanks for joining us.

I'd like to make some overview statements before Brad details our second quarter and year-to-date results.

Shortly after I joined the Company, we detailed and committed to a number of important initiatives that we felt were key to improving the long-term performance of the Company.

First, the identification of $60 million to $70 million of OpEx reductions with a plan to drop a majority to the bottom line while reinvesting the balance in the business to promote top line growth.

Second, the need to remap and restructure the internal processes to create a more streamlined and cost-efficient operation.

Thirdly, it was felt that we needed to update the organization with additional skill sets in order to better execute against a challenging and more complex business.

Fourth, we needed to focus more aggressively on the international business to better capitalize on the major opportunities outside the United States.

Fifth, on a top priority basis, create a major initiative for margin improvement to have measurable effect against the 2007 plans, and perhaps if some of them proceeded apace, have some effect at the end of '06.

Finally, sort of summing it up, the creation of a three-year financial target to establish Callaway's best-in-class, which we would deliver in a ramp-up fashion.

I'm pleased to say that measurable progress has been made on virtually all fronts albeit not without some bumps along the way, and we clearly have some work yet to do.

The OpEx savings are tracking on schedule and we are confident that we will deliver them in full measure, and Brad will give you some more detail a little later.

The process remapping has significantly improved our customer service performance on most new products, delivering then when and where needed in the requested quantity.

I say most, but not all, because one major project this year could not get on the new system given its timing, leading to some delays and some cost-up charges.

This dramatizes the continuing importance of this initiative.

Additionally, issues relating to forecasting accuracy are not yet fully resolved and have resulted in some one-time unanticipated costs that have been impacted margins as well.

These problems are unacceptable and we must continue our improvement in these areas in order for our margin targets to be achieved.

Organizational upgrading is well underway, and we've been able to supplement our solid core competencies with some new skill sets.

We have a new head of U.S.

Marketing, Bill Knees, a new head of International, Thomas Yang, and a new head of Worldwide Operations, Dave Laverty, all joining us within a very short span.

Actually, Thomas Yang joined us last week, and Dave Laverty will be coming onboard next week.

Bill, on the other hand, is an old hand at this point, having joined us in February of this year.

Additionally, internationally, we are in process of opening our own office in China, and we'll start selling there directly, not through a distributor, in early 2007.

As for margin improvement, the major initiatives are coming along quite well, and will have the promised positive effect on the 2007 plans.

I hope to give you more specifics and dimensionalize the effects on our next call following the close of the third quarter.

Finally, the three-year targets outlined in February are quite alive and well despite the bumps in the road experienced so far.

But it's important to note that this is only the second quarter of a three-year plan, and we can and should expect some surprises at this early state.

Clearly, we still have work to do.

In no way are we satisfied that all things are where they should be.

Internal processes, while much better, are not fully working properly as demonstrated by some delivery issues that still affect us, and the one-time unanticipated costs we still incur.

Top-Flite stabilization has been a tougher objective than originally hoped and is costing us more than we would like.

Our ability to anticipate and correct for unexpected costs from flaws in our system is not at the level we would like, and will continue to be a top priority.

But having said all this, we're making significant progress against all controllable issues that affect our financial results, as our numbers do reflect.

Our earnings are up 22% year-to-date over last year, and we also recognize that we will continue to have dialogue about the slope of the ramp-up of our results, but we are confident that our commitment to be best-in-class within the relevant business universe will be delivered upon.

Now, I'd like to turn this back to Brad to give you some more details, and I'll join you again for Q&A.

Thanks, George.

In reviewing the financial results for the quarter, we achieved consolidated net sales of $342 million, an increase of 6% compared to last year sales of $323 million.

We reported net income for the quarter of $23 million, compared to $18 million last year, and earnings per share of $0.33 versus $0.27 per share in the prior year.

On a pro forma basis, excluding 2006 after-tax charges of $0.03 for employee equity-based compensation expense associated with FAS 123-R, $0.01 for cost reduction initiatives, and $0.01 for Top-Flite integration charges, and in 2005, an after-tax charge of $0.03 for Top-Flite integration charges, our pro forma fully diluted earnings per share for 2006 increased 27%, to $0.38 compared to $0.30 in 2005.

The net sales increase of 6% includes strong growth in our Callaway Odyssey business compared to last year.

This year-over-year growth was across all product categories reflecting the strength of these two brands and the positive reception by our customers and consumers of our 2006 product line.

This gain was partially offset by declines in the Top-Flite and Ben Hogan brands.

Hogan sales were down relative to last year due in part to the fact that last year's results included a new driver, Fairway Woods, and moderately priced line of irons in the line versus no comparable new products being introduced this year.

The Top-Flite brand is also down year-over-year.

Balls represent a majority of Top-Flite sales, and while some of the golf ball models are performing well at retail, our higher price point products did not perform at expected levels.

We are focused on restoring the Top-Flite business, and over the balance of the year we'll be taking initiatives to clear some of the slower moving inventory at retail while implementing several initiatives to stabilize the brand and set the stage for a major re-launch of the brand in 2007.

Taking a quick look at overall sales by product segments, our wood sales for the quarter were $86 million, an increase of $17 million, or 24% compared to 2005.

All of this growth was due to our Callaway brand, which had a sales increase of 28% due to the success of our expanded line of woods including our FT-3 driver, X Series of drivers and fairway woods, and our new Fusion Hybrid clubs.

Sales of FT-3 experienced solid growth as a result of our second quarter re-launch efforts, higher product awareness due to Phil Mickelson's early season success, and the positive response to our Optifit system now at retail, which was developed to support our retailers in their custom fitting business.

The Top-Flite Ben Hogan brands were down year-over-year in net sales due to no new model introductions this year compared to the CS-3 driver and fairway woods introduced last year.

Total sales of irons were $107 million, a decrease of 4% compared to second quarter sales of last year of $112 million.

The decline was due to the Hogan line and the fact that we introduced the BH-5 irons last year compared with no comparable product introduction this year.

Callaway irons experienced positive growth of 3% year-over-year due to the introduction of the Fusion White Sole Model, higher year 2 sales of our X18 irons, and the increase in sales of the BB06 compared to comparable sales of the older BB04 model last year.

Golf ball sales were $69 million for the quarter, a 2% decline compared to last year's sales of $71 million.

This decrease was due to lower Top-Flite sales mostly offset by continued growth in our Callaway line of golf balls, which grew 15% compared to last year.

Putter sales were $37 million compared to $34 million last year.

This increase reflects the launch of our White Hot XG line of putters, as well as some shipments of our two- and three-ball SRT putters compared to our White Steel line of putters in 2005.

Turning to our regional breakout, U.S. sales were $186 million for the quarter, an increase of 3% compared to $181 million last year.

International sales were $156 million compared to $142 million last year, an increase of 10%.

Foreign currency positively impacted the second quarter by $1 million, so in constant dollars the international segment had sales growth of 9%.

Pro forma first quarter gross margins excluding integration, cost reduction and employee charges were 42% of net sales compared to 46% in the prior year.

Included in the results is an adjustment of $3.3 million due to inventory adjustments at our golf ball manufacturing plant.

Last November we integrated the plant onto our SAP Enterprise system.

Doing so required changes in how we track and account for WIP inventory in the plant, and how data is entered into the cost accounting system.

During our annual inventory count in early July, a discrepancy was noted that upon detailed review required an adjustment to our book inventory resulting in this charge.

We have identified the procedural issues and have implemented the appropriate controls to correct these issues.

This adjustment represents approximately one percentage point of the overall variance.

The balance of the margin decline falls across both the club and golf ball product categories.

The golf club impact can be attributed to a higher mix of older product models at slightly lower margins, higher costs on certain wood and putter models, higher labor costs to protect assembly capacity, and increased distribution costs associated with freight due to higher oil prices.

The impact from the ball category excluding the inventory adjustment I just mentioned is due to higher raw materials, a shift in product mix to lower priced and lower margin Top-Flite models, in addition to some price reductions and higher freight-related expenses.

We were unable to recoup these cost increases in the middle of the season, but will address in our 2007 planning.

Pro forma operating expenses for the quarter excluding FAS-123R, cost reduction and integration charges were $98 million, compared to $117 million last year.

Of the $19 million decrease, a majority is the result of the cost reduction initiatives taken in September of last year.

Approximately $7 million is due to reduction in accrued employee incentive compensation compared to last year.

This incentive compensation is based upon performance against annual targets approved by our board and accrued quarterly.

Adjustments are made on performance, and in this quarter despite the growth year-over-year targets -- excuse me -- year-over-year earnings, the accrual was reduced because we did not achieve our internal financial targets.

Included in our reported 2006 operating expenses are integration, cost reduction, and FAS 123-R pre-tax charges of $3.2 million in 2006, and integration charges of $2.1 million in 2005.

Moving to the balance sheet, networking capital decreased 3% compared to last year, driven by decreases in inventory and increases in payables due to higher utilization of our line of credit partially offset by increases in accounts receivable due to higher sales.

Consolidated net receivables were $258 million compared to $238 million last year.

Consolidated DSO increased marginally to 69 days, compared to 67 days last year.

Collections on AR remain good, and the overall quality of our AR is good.

Net inventories declined to $232 million compared to $193 million last year.

If you recall, last quarter our inventory was $75 million higher than the prior year due primarily to the lower inventory in 2005 related to supply issues.

This year-over-year variance has decreased to $39 million, or about half of last quarter's variance consistent with our expectation last quarter with further normalization expected over the balance of the year.

The overall dollar increase can be attributed generally to an increase in the number of product models this year, including additional models of higher value wood products, additional shaft inventory associated with our custom club business and OptiFit program introduced this year, and planned higher levels of inventory to avoid the supply issues experienced last year.

We constantly monitor our inventory levels in an effort to balance our desire to protect upside consumer demands with overall working capital management, but key to lowering the inventory levels is a reduction of club lead times with our overseas suppliers.

We have made some progress in this area and continue to work on projects to reduce these lead times.

The quality of our inventory is good, and all slow-moving items have been adequately reserved for.

Capital expenditures for the quarter were $14.

We estimate 2006 capital expenditures to be in the $35 million range, consistent with our forecast last quarter.

Depreciation and amortization was $8 million for the quarter.

Our estimate for 2006 was approximately $30 million, consistent with our previous guidance.

During the quarter we repurchased 1.8 million shares of stock for $28 million, at an average price of $15.97 per share.

Those are the highlights for the quarter.

We would now like to open the call for questions.

Thank you very much, Mr. Holiday and Mr. Fellows. (OPERATOR INSTRUCTIONS) Representing Gilford Securities, we go to the line of Casey Alexander.

Please go ahead.

Good afternoon.

You know, I mean, I'm sorry if I don't sound excited about these results, but I sit here and look at record gross margin for the quarter, and record high inventories, and a promotional environment out there where you guys are giving clubs away, and Top-Flite sales that are collapsing, it just seems to me like there's a lot of headwinds out there particularly with the promotional environment, is there any way to keep margins up there the way the promotional environment is shaping out?

Yes, absolutely.

One, I think you're misunderstanding what's going on out there.

There is a promotional environment, but the reality is the effect of the promotional environment on the margins is a relatively small part of the overall picture.

The issues we talked about related to that inventory adjustment that we had to take, which is -- well, we presume it's a one-time problem that I think we've resolved -- it represents some additional costs that we've incurred because our system is not fixed, it still has some issues associated with it.

All of those things are under our control, Casey.

The fact is that we were not able to recoup some of the unexpected cost increases that we've incurred in the early part of the quarter -- in the early part of the year, I should say, but we will indeed be able to make those adjustments as far as our 2007 planning is concerned.

So, the reality is that the margin issues that you're talking about are in fact largely under our control and largely addressable by some actions that we're already taking to fix the one-time situations, and will be addressed as far as some pricing and some cost reduction programs as we go into 2007.

So, I'm sorry that you're not enthusiastic about the results, also, but I can assure that we are.

Well, you know, discuss the fact that you're going to have a major re-launch of Top-Flite in 2007, and that comes on the heels of the major re-launch of Top-Flite 2006, and a major re-launch in 2005, so why should we have any belief that 2007 is going to be any better than '06 or '05?

I mean, this appears to be a brand that is in a long-term decline.

Well, it is a brand that has been in long-term decline.

It's one that was a very troubled brand when we picked it up.

As far as a major re-launch in '05 and '04, as you claim, I don't think that is exactly true.

The fact is that we were -- as we were incorporating the Top-Flite brand into the Callaway system, trying to do some bandaids to fix it.

Those bandaids were insufficient given the condition of the brand.

The major re-launch that we're planning for '07 is in fact a major re-launch and will encompass a great deal more than any of the previous activities.

Whether or not we can convince you to believe it or not is secondary to what the brand actually does in the marketplace, and I think that while we have very positive feelings about what will happen in '07, we'll let the numbers speak for themselves and you can make that determination yourself next year.

Well, would you concede at least that the manner in which the sales force was restructured has been the root of some of the cause of Top-Flite's problems this year?

No, categorically not.

I know this is something that you've been very [inaudible], but the reality is that has nothing whatever to do with it.

In fact, if you really want to look at it from a professional sales point of view, the reality is by consolidating the sales organizations, we put significantly better attention behind it and are able to accomplish certain things in the marketplace that would not have been accomplishable had we left the organizations separate.

So, again, listen, you are clearly entitled to your perspective on how a sales organization should be run, but the reality is the consolidation was in fact the right thing to do.

It has materially benefited the brand, and I think will put us into a good position in terms of the re-launch that we're planning in '07.

Like I said, Casey, the reality is the numbers will speak for themselves in '07.

If we're right, I'm sure you will be more than apologetic, and if we're wrong, we will.

Okay.

Well, I look forward to seeing what's up next.

I do, too.

All right.

Have a great day.

You, too.

And thank you, sir.

Next representing Susquehanna Financial we go to the line of John Shanley.

Please go ahead, sir.

Good afternoon, guys.

George, the 2-for-1 driver promotion that seem to be pretty emblematic of the industry right now with TSA and Dick's, and a lot of the other guys in the golf specialty chains getting on the bandwagon, can you give us an idea whether this is a greater magnitude of promotional efforts than you originally anticipated, and any indications in terms of how long you think this promotional activity may last?

Sure.

Look, let no one be misled.

That was not of our choice.

The fact is, that is not a desirable thing to do in the marketplace as a general rule.

It was initiated by one of our competitors due to whatever their internal reasons might have been.

We thought it appropriate to send a signal that we would not sit still for them doing things of that sort.

Clearly, it is not something that we would like to initiate or continue.

Our program in response to theirs ends at the end of this month.

I believe that they have adjusted their timing to end the end of the month as well, and frankly, as well as the trade, by the way, all hopes that this is not something that continues.

We certainly have no intention of continuing it, and I would suspect that based on the results that we'll see in the marketplace, it hopefully is unlikely that anyone else will initiate more of it.

Do you think that could be some impact of third quarter results if the promotion does in fact extend beyond the end of the month?

In our case it will not extend beyond the end of the month.

Ours ends on July 31.

I think, again, to not overstate it, the impact from an overall promotional cost point of view is not that significant.

It's not insignificant, obviously, but it really is not a controlling factor and should not be a material effect on our overall margins or earnings going forward.

Hey, John, this is Brad.

Also, from an accounting perspective, we accrue the estimated cost of the promotion when we launch it, so it would have been a Q2 event.

Oh, okay, great.

Now, if we miss that estimate and we have to true it up, there might be a small impact, but we did accrue the entire program in Q2.

Okay, that's helpful.

Thank you.

George, getting under the golf ball situation with the steep decline in the operating pre-tax margins that the golf ball business had between 2Q of this year versus the corresponding period a year ago, can you give us some indication of more precisely what you can do to be able to turn this business around and regain or recapture some of the market share?

I know it's still in a working phase, but it would certainly help investors to have a clear understanding what can be done, since that does seem to have such a material effect on your gross margin for the overall corporation.

Sure, absolutely.

First, the golf ball business really ought to be looked at in two different pieces, one the Callaway piece and the Top-Flite piece, the Callaway piece representing more of the up-market portion of the golf ball business.

Our business is extremely solid there and growing quite nicely.

It has entirely different technology in parts of that line than you would find in Top-Flite.

We anticipate that -- or we see that that business is going to go on in exactly -- or we would certainly hope that this is going to go on exactly in the fashion it has right now.

It's very solid, it's gaining additional tracking, it's gaining share in the marketplace, and I don't really feel that should represent any concern going forward.

The Top-Flite business, as we indicated, has been a difficult business.

It came onboard in a rather damaged state, and it has without question lost some share.

We are looking at doing a number of different things.

There are manufacturing options that we're looking at that will significantly impact the cost of manufacture for the Top-Flite ball.

Those activities are underway.

I can't report exactly the state that they're in, but I would anticipate that they should have some very positive impact on the margin for those balls going into next year.

The second thing is that we are restaging a major new Top-Flite ball for next year with a different technology and a very different consumer orientation that will be launching for next year as well, and the pricing will reflect that and the margin, therefore, will also reflect that.

So, we believe that will have a material effect on the overall ball margins as well.

Part of the problem this year, because we're trying to clean the channels of the old balls that we're trying to get rid of, is that we are and will continue to have to offer some promotional devices to get the channel clear of these products.

That is in the short-term going to effect the margin that the balls reflect.

It is not an ongoing margin.

It is, however, reflective of the fact that we're doing these activities.

Those are obviously not to be repeated next year, so I don't think that the sort of cleansing efforts that we're going through right now will really have an impact on the '07 and beyond margins that we're looking at in balls.

The reality is that we have some plans to address the margin issues as it relates to manufacturing costs.

We were hogtied to some degree in terms of pricing activity this year, because some of the unexpected cost increases that we face occurred midyear, and it is very difficult and sometimes very unwise to try to adjust prices midseason, so we'll be in a much better position as we plan ourselves going into '07 to take care of even those issues going forward.

So, again, I'm not trying to make light of the fact that we had these issues in this quarter, but, again, they are to a fairly significant extent under our control, and I think we can impact most of it.

Just to summarize, you think the inventory overhang of the old balls will be out of the market by sometime during fiscal '06 and will not affect fiscal '07, is that a correct assessment?

That is clearly our intent and plan, and we're working against that assumption.

Okay.

The last question I have is on the plans for placing more resources if you think it's warranted in the accessory side of your business with the acquisition of the Tour Golf group.

Is that likely to be a more material part of the overall corporation, and can you give us an idea of what you think it could represent in terms of overall corporate revenue?

No, it will not become a more significant factor.

The fact is there were some issues with regard to our security of supply, if you will, in the shoe business going forward.

It put us into a position of essentially taking over that business and having to assume the responsibility for sales for the '06 and '07 period of time.

It is not our intent long-term to continue to do that.

We will in fact be looking for an appropriate and effective licensee to take over that business.

We had to acquire the assets, which in part reflects some of the inventory issues we were talking about.

We had to acquire the assets fundamentally just to secure supply and make sure that we didn't interrupt what was developing into a reasonably attractive business for us.

So, going forward beyond the '07 period, I would anticipate we'll go back to a typical licensing structure with an appropriate licensee.

For '06 and '07, we've taken on the responsibility, we've structured ourselves such that it represents a minimal interruption to the normal flow of our sales organization, and in fact the reality is that the selling cycle for shoes is actually somewhat different than it is for golf equipment.

So the burden on the sales organization actually falls in a relatively slack period for them.

So, it really isn't that much of an interruption, if you will.

Okay, fair enough.

Thank you very much.

Appreciate it.

No problem.

Thank you, Mr. Shanley.

Next representing Wedbush Morgan Securities, we go to the line of Rommel Dionisio.

Please go ahead.

Good afternoon.

On the gross margin comments, Brad, I think you talked about higher labor among other factors.

I'm a little puzzled at that given the significant headcount reduction you took last November.

Could you help reconcile that?

Yes.

One of the issues, Rommel, that we had last year as we got into the peak season is, we didn't have enough capacity to build products for customs, etc., kind of at once club assembly capacity.

So, what we did this year is we went into the year with some additional people trained and on staff, so that as we got the increased demand during the peak season, especially on customs and especially with launching of custom programs and OptiFit, that we would have enough capacity.

So, our labor was up a little bit year-over-year just because of that protection of capacity, if you will.

This is manufacturing labor on a per-unit basis.

It's not a permanent addition of staff, if that was the concern.

Okay, so it's more of a temporary issue.

Yes, it is.

Fair enough.

And just one clarifying question.

George, I know you've mentioned several times that the two-for promotion is not that significant, but is it possible to quantify the extent of the accrual in Q2?

We don't usually give that level, but the only assurance I can give you is that relatively speaking it's really not as big a number as I think there seems to be concern.

It's well less than half a percent of margin, well less than that.

Fair enough.

Thanks very much.

And thank you very much.

Tim Conder with A.G.

Edwards has our next question.

Please go ahead, sir.

Thank you.

A couple of clarifications off the bat here.

Your saying, George that the Top-Flite, the new product and the Top-Flite ball margin in '07 should be improved, as well as this new ball, in particular, that you're talking about?

Yes.

Our anticipation is that with some sourcing opportunities that we're looking at right now, we should be able to sort of raise the tide, if you will, for all of the Top-Flite line.

And, again, the pricing and cost of the new ball will be structured such that the margin is significantly more acceptable than what we're looking at today.

So, unfortunately, we're going through a transition period.

It's not pretty, I'm not happy with it anymore than, I guess, you guys are, but it's something that we have to do in order to be able to clean the slate and start.

So, yeah, the margin from '07 forward will be markedly better than what we're looking at today.

Okay.

And, again, related to the ball adjustment, the Top-Flite inventory, you feel it's fully reserved now at this point?

Oh, it's 100% reserved, Tim, and we believe we put all the corrective measures in place to assure that it doesn't happen again.

We unfortunately had the physical inventory done and it hit us at the last minute, so we were really caught with a tough decision in terms of last minute adjustments.

Our desire was to just lay it out there and then fix it, so that's what we've done.

It's not something that we're particularly happy or proud about, but I think as we kick over various rocks and things crawl out from underneath and we have to kill them one at a time, but I can assure you, once killed, they're dead.

Okay.

And Callaway ball business, you've had some new products launched this year and everything.

We're hearing Titleist is basically going to come with a total revamp of the Pro-V1 line early, say, late in the first quarter of next year.

How are you planning to maybe approach that?

Will you have as significant of a Callaway branded ball offering, new product offering next year?

Well, you know, we have a very substantial IP portfolio in balls and, by the way, largely acquired through the Top-Flite acquisition, which is one of the major assets that we gained with that acquisition.

We are fairly confident that the technology that we have within our IP portfolio is in fact the best technology that exists in the ball business and, in fact, in many instances because of the patented nature of most of those technologies, really protect the performance area for balls for us quite well.

So, again, I don't know exactly what Titleist is going to bring out, we'll deal with it as it comes, but I don't have any particular concern that there's a technology out there that we don't have an answer to.

Okay.

Okay.

Also, you have the execution issues, George, year-to-date in the first half here, have they basically offset cost savings?

I don't know if you want to lump in the ball inventory adjustments in there or what, but overall, has that negated the cost savings year-to-date?

No, I think it's affected some of it, obviously.

Look, we're not very happy about those things.

The team has worked very long and hard at fixing some of the underlying problems that made these kinds of problems more the rule rather than the exception.

I think the silver lining of the problem is that this is now an exception rather than the rule.

I think we've gotten to the point where a significant portion of the systemic problems have been resolved, and as we, I guess, indicated last year, we expect it to be a lot better this year, but not perfect.

The unfortunate part is that was actually correct.

We are a lot better but we're not perfect, and we were nailed with several things that in the short-term offset some of the savings that we were able to generate with the OpEx plans we put forward.

Certainly not all of them, because they're far in excess, as you can tell, and our expectation is as we go further into '07 and overturn a few more of the rocks and kill some of the things that crawl out from those, we're going to be a whole lot better next year than we are this year.

So, again, this is something I think gets better.

It's the reason, in part, that we felt that the financial performance of the Company was going to ramp up rather than step function up.

It was a little naive on our part to think that we were going to solve it all in one shot, and the truth is we didn't.

But we have solved a great deal of it, and I would not expect that these exceptions are going to be particularly numerous in nature going forward.

Okay.

And at this point, given everything you've talked about, do you now anticipate breaking even the second half of the year?

Well, again, I'm constrained and have guns to my head saying that I'm not allowed to give forward-looking statements, so I'm afraid I'm going to have to duck that one.

Nice try though, I appreciate the effort.

Well, let me rephrase the question.

Will it be incrementally more challenging?

Incrementally more challenging?

What do you mean by that?

To reach break-even for the back half of the year?

Again, I can't give you forward-looking statements.

I can only tell you that a lot of the good things that we've done will obviously carry forward.

The OpEx affects the systems changes.

All of those things are ongoing.

They're not one-time things, and that's what makes them so important and so valuable to us.

So, again, the only thing that I'm concerned about going forward, which is really not under our control, is what happens in the retail environment.

That we can't do much about.

The one thing we can do -- the things we can affect, the margin improvement efforts, the OpEx savings, the improved marketing efforts behind our businesses, all of those things are under our control, and frankly I'm feeling pretty good about all of those and the way they're going.

I can't tell you what's going to happen in the rest of the world, however.

Okay.

And obviously you continue with the share repurchase, but given the levels you guys repurchased the stock in the second quarter and where the stock is and now somewhat running into what you've already described, what's the board's appetite for maybe a little more leverage to ratchet that up and/or has the board again been approached similar to like it was by any private equity groups, I think last summer somewhere in the mid-teens with proposed offers?

No.

No to which question?

You pick it.

I think he meant to say, Tim, was no comment.

Again, we're constrained about things we're saying, but I would not get terribly concerned about any of those things.

Okay.

Well, within the company, I mean, again, look to be maybe even more aggressive than it has been given the reloading of the share repurchase and the stock price and so forth?

Well, I can't tell you what we're going to do.

Obviously, that's always on the table to look at, but it would be inappropriate for me to tell you what our plans going forward on stock repurchase would be.

We'll continue to monitor it, Tim, and work with the board in terms of our actions.

Okay, okay.

Okay, thank you, gentlemen.

And our next question we go to the line of Robert Samuels representing JP Morgan.

Please go ahead, sir.

Hi, good afternoon.

Hey, George, you touched on it a little bit, but can you kind of talk a little bit more about the health of the consumer going forward?

Are you seeing any slowdown in orders?

If you can just kind of elaborate on that, that would be great.

You know, our share performance is starting to reflect the acceptance of our products and we're feeling pretty good about that.

All we do is, we monitor the same things you do in terms of the comp store stuff that most retailers in the United States are reporting.

We haven't necessarily seen that yet, but I don't really know what the consumer world is going to be like going forward.

We do know in the case of the UK, they've had -- or actually most of Europe, certainly the northern and central parts of Europe -- they've had a horrible start to the season.

They had terrible weather, which started their season about seven weeks late, then they went into the World Cup, which essentially shuts Europe down for another month, and then they went into a heat jag of some sort, not unlike what we had in the United States.

So, Europe is not having a great time.

We haven't seen any of that happen here, so, again, like I said, these are conditions that we are monitoring and we look at very carefully.

We can't control them, but at this point in time from all consumer data that we see, we're doing quite well.

That's great.

And then just a question on the product cycle for next year.

How do you follow-up on the success you've had with the FT-3, with the X series, kind of -- can you give us a sense of not what you've got going, but how do you follow-up on those kinds of big, big hits?

I think I mentioned one of the things I was particularly pleased about was the fact that we had a very, very full -- we're getting some feedback here.

Are we okay?

I've taken care of that.

Please continue.

We're very pleased with the fact that we had a very robust pipeline of new products.

The reality is that the lineup that we see for 2007, we believe is very, very strong.

We'll obviously be in a position to talk to you about them.

We have our sales meeting in September, when we'll be revealing them to the world at large, so certainly the next call we'll be able to go through it.

But I'm feeling particularly good if we thought 2006 was strong, I think '07 is going to look every bit as good if not better.

Are you there?

Now, why include hybrids in that, seeing that's been such a robust segment, not only for you guys, but for the industry as a whole?

I'm sorry, what's your question?

With regards to the current promotion you guys are running, why include hybrids there, given that has been a pretty robust segment, both for you guys and the industry as a whole?

Well, the thing that made this semi-palatable for us was the fact that we were able to offer up products that were in their end of life rather than things that were relatively new, so things in end of life are generally the ones that you end up marking down at the end of the season anyway, so we had an opportunity to make that the free item going forward.

So, in effect, we really offset the need to do that perhaps later on in the year.

So, the reason we included them was that these products were at the end of their lifecycle.

So, it really represented very little hardship to us.

Okay, thanks a lot.

And, thank you very much, sir.

And our next participant in queue is Ward Davis with Trivium Capital.

Please go ahead.

Hey, guys.

Most of my questions have been answered.

Brad, just one point of clarification.

On the 2-for-1 promo, did you in responding to, I think John's question earlier, did you say that you essentially reserved for, or taken the full hit in terms what the margin impact you would have experienced all in the second quarter, so we shouldn’t see whatever sales and volumes were in July, we shouldn't see any gross margin hit from that in the third quarter?

That's correct, Ward.

The only difference would be if there was a true-up.

We tried to estimate it conservatively.

We don't have a lot of history with this, because we've not done many of them, but we tried to look at a lot of different ways to estimate it.

We then reserved for that estimate.

If in the event it exceeds that estimate, there would be a small true-up, but generally it was accrued for in the second quarter and would not impact third quarter.

From my checks, the promotion as you pointed out was unexpected and not something that you would have otherwise planned to do, but nonetheless from a consumer standpoint, I believe was a pretty widespread success and retailers that I talked to said it was a big traffic driver.

If we look at the sales in the wood category, I believe you said Callaway wood sales were up 28%.

If you strip away the promotion, can you provide some quantification in terms of how it impacted at least June for one month of the quarter?

And then as kind of a follow-up to that question, given what seems to be success in terms of driving a lot of traffic and volume on the promotion, how would you characterize inventory in the channel specifically at retail as you kind of go into the slower third-quarter period?

The inventory is quite good.

In fact, the sell-through effect is going on now.

Any buy-back in to restore inventory levels is likely to recur July going forward.

That kind of promotion basically draws down inventories.

We did not sell in against it again, not to any significant degree, anyway, because of the timing.

So, fundamentally, it really didn't have any effect on the sales reported through the June period.

Hey, Ward, one other thing just in regards to inventory retail.

We already talked about Top-Flite, there is some ball inventory that we're taking some initiatives on, but from a Callaway perspective, everything we're hearing is that inventory is in really good shape at retail.

Okay.

I guess just as a last question, it was brought up earlier, but to the extent that in June of '05, there were pretty heavy rumors if not outright press releases indicating that Tom Lee had bid around $16 a share for the Company.

Based on kind of where things are indicating going into tomorrow, the stock is trading at 25% or 30% below that price.

I mean, George, the question is, obviously, there are some metrics that we could point to that show that you are making progress particularly below the gross margin line, gross profit line in terms of cost savings and reduction, and the top line obviously is looking reasonably good.

But on the cost of goods side, it's pretty clear there's a lot of work to be done, and I guess it would be nice to hear something from the board in terms of what really is the time horizon we're looking at in terms of getting to some more specific goals, giving a little bit better guidance so that we can measure you and have metrics to measure you by, because it is sort of disconcerting to be sitting here with stock trading now kind of with an eleven handle on it, and the board having turned down a bid considerably higher within the past year.

Let's see.

There are several answers I can give you.

Number one, it's not trading with an eleven handle, it's trading with a twelve handle, but other than that, there was no specific bid, or there may have been rumors, but there was no specific bid.

Number two, the condition of the company at that time, last June, was significantly different than it is today, and the $60 million to $70 million of OpEx costs that were primarily OpEx cost savings that were generated I'm sure was an enticing target for some people that might have considered doing those things.

That's off the table, so it's hard for me to relate the condition of the Company today to the one that it was in back last June.

Two, as we indicated in February, we offered up some three-year metrics that we believe were appropriate and very achievable, and certainly within the territory that the Company has operated in in the past, that we felt were appropriate objectives for us to shoot for.

We also indicated at that point in time that while we potentially saw that we could get to maybe annual guidance, that we were not going to get into any shorter term guidance than that simply because it was neither productive for us as a Company in terms of operating it, nor, I think, particularly helpful to people that have a longer term investment horizon for the money that they put to work.

So, I guess the only thing I can refer you to is to measure us against the targets that we've established and make a determination as to whether or not you think we're making progress in that direction.

We did indicate that while the first effort that we put forward was going to be against the OpEx line, the next most important priority was to work against the margin line.

I would hope at the end of the third quarter, we will have some dimension to give you with regard to that, but we are very strongly working in that area and we'll have some, I think, material benefits to show you at that point in time.

So, again, some people may be impatient, some may not be, I don't know, but I can assure you that we're making very material progress against literally every one of the commitments that we made, including the financial metrics, and I guess you're just going to have to judge for yourself whether or not that's appropriate or adequate to your investment horizon.

I can't speak to that.

Mr. Davis, we still have your line open.

Did you have any follow-up question?

No, I'm done.

Thank you.

All right, you're welcome, sir.

Representing McAlpine Associates, we go to the line of Dennis McAlpine.

Please go ahead, sir.

Thank you and good afternoon.

Can you talk about where you stand with regard to your major product lines in market share, not specifically what they are, but how are they comparing now versus last year?

And then, secondly, your neighbor down the road that makes golf shafts just reported down earnings and talked about a dreadful market, backlog down, lack of new golf programs, generally a very -- I think they called it a lackluster golf equipment market.

Can you sort of reconcile what they're saying about how bad the market is versus what you're seeing?

Well, one of the problems with the golf industry is that the data and the sources of the data are not terribly consistent or in many instances not terribly good.

I can certainly talk to our experiences.

As you noted, our sales were up, our profitability is up, our shares are up.

I can only speak to our experiences, I can't tell you what their conditions are necessarily.

The fact is that if we look at the May share period, which is the first period in which some of our new products can really begin to be reflected in the marketplace, we are up 1.4% -- percentage points overall since January, up 1.4 percentage points since January.

That was -- I'm sorry, that was the golf ball market.

In the iron market, we're up 4.6 percentage points since January.

In the wood market, we're up 3.2 percentage points since January.

Again, I can't tell you that this is the most robust marketplace in the world.

I can only tell you that our performance this year, certainly from a consumer point of view, has been very satisfactory from our perspective.

We're making inroads in all the places we expected and wanted to make inroads.

So, even Golf Datatech, and I can't speak to the reliability of their numbers on a May year-to-date basis, they say that the woods business is up 19%, the iron business is up 9.5%, ball business is up 1.7%, putter business is up 5.1%, wedges are up 11.9%, shoes are up 5.7%, bags are up 5.3%, and gloves are up 3.0%.

So, all of that added up says that the market as defined by those subcategories is up 9.8% in dollars.

Hey, Dennis, this is Brad.

By the way, what George was giving you was Callaway shares, and it's in the U.S. only with Datatech, and that typically just touches the golf specialty, so the on-course, off-course, it doesn't touch the mass merchants or sporting goods, just to clarify.

But I will also say that we tend to do better in the mass merchants and sporting goods generally, so, again, I'm not taking shots at somebody else's sense of the market, but speaking for us, it isn't quite as dramatically negative as it would appear it is to them.

Very good.

Thank you.

We have a question now from the line of Hardin Bethea of DePrince, Race and Zollo.

Please go ahead.

Most of my questions were answered.

One clarification from Brad, if he's willing.

Again, the accruals taken in the second quarter related to the promotional event, you said well less than a half percent of margin.

Right.

Someone was asking for quantification, and I said it was significantly less than half of a margin point.

Okay.

And I guess when we get to half margin points, what is significant?

What is significant in terms of less than?

Yeah.

As George said, George said it was fairly insignificant.

I was just trying to quantify it by saying it was less than --

Less than half a margin point.

Yes, if you look at the overall decline year-over-year, it was certainly not anywhere in the zone of significant relative to the decline.

Okay, fair enough.

As it relates to the -- maybe you can give some details on the ball inventory, older ball inventory at Top-Flite that you'll be merging, for lack of a better word.

I'd like a better word, if you would.

Making way for a new product.

Thank you.

Can you help me understand what that looks like?

Again, you have your normal pipeline of product out there and if you're going to be bringing in a new product you want to flush through the old stuff as quickly as possible in order to make room.

This is not an extraordinary event in the world of retail, it's just something that one does in order to pave the way for the new product, and that's what we're talking about.

This is not a monumental exercise.

Again, I apologize if we're burdening you with too much detail, but part of what we're trying to do is give you as straight a scoop on the good and the bad of what's going on in general.

We're very pleased with the things that are happening.

We're very pleased with the progress of the Company.

I throw out the problems only to put in perspective for you and give you a better sense of what we're going through.

The fact that I mention them doesn't mean that we are quaking in our shoes about them, it's just in the interest of trying to be open and clear with you guys on the pluses and minuses.

So, the ball inventory or the one-time charges, or any of the other things that we're looking at are all very containable and very handleable things and we are dealing with them on an ongoing basis.

The only thing we'd like people to keep in mind is, hey, we're doing pretty good.

Our earnings are up substantially on a year-to-date basis.

We're making the progress that we said we were going to make, and yeah, we stumble and trip on things every now and then, but the general message is, we're exactly where we said we wanted to be.

Okay.

Right.

Well, one further question and a comment.

The question is, well, the comment first is, I think there continues to be a disconnect between expectations -- your expectations and market's expectations for what kind of earnings the Company can produce in what time frame.

Right.

I think that's a hindrance to realizing the value you think you can create with your three-year plan.

Understood.

The question then is something that Tim Conder, I think, tried to get at, which was not necessarily an earnings number for the second half, but the cost savings that you've realized to date, is there anything that would cause those cost savings to change seasonally or otherwise the first half versus the second half?

The only thing, Hardin, on that, you'll recall that we realized about 8 million of it in the fourth quarter of last year, so we'll be comping against an already reduced number in the fourth quarter.

But to the broader question, no, those were real legitimate, not one-time, but ongoing savings that we had generated, and even more importantly, frankly, are the margin improvement or production cost savings that we anticipate that we're going to be working into our plan in '07, which are also going to be ongoing savings.

There are no one timers here.

Okay.

I think, Brad, you said the first half realization was -- the majority was from new initiatives, the $19 million, I think, but you did call out 7 million of lower incentive comp, so is it fair to assume that basically the balance of that 19 was due to your cost savings initiatives?

Yes.

Fair enough.

Thanks, guys.

We have a question now from the line of Scott Scher representing Clovis Capital.

Please go ahead.

Quick question.

Have you guys made any progress on getting us some valuations on the land and buildings that you own in California?

I remember when we were out there at the Analyst Day, you did acknowledge that you own quite a bit of land and quite a number of buildings that have substantial value.

At the time you weren't ready to talk about the value.

You know, you hinted at $20 million, $30 million, $40 million.

Just curious now that it's four to five months later if you've done that and when we can expect to see you monetize that?

Are you a buyer?

I don't think that's funny, actually, but go ahead.

Just tell me what the numbers are.

No, I'm not prepared to tell you a number at this point.

Okay.

Because obviously in the context of buying back more stock and recognizing value, certainly that's an under-valued asset.

Do you think that's something we can expect to hear about sort of by the end of the year?

Well, we're continuing the process of building consolidation.

We're working on what we hope is our final plan at this point in time.

We haven't yet brought it to our board, but we do expect that we will be in a position to do that before the end of the year.

So, yes, I would think that we'd be able to give you our sense of that before the year is over.

And how much do you have left on the stock buy-back?

You bought back 2 million shares in the quarter.

How much is left that's been currently approved?

We have 7 million on the initial, and then the board approved another 50 million.

Okay, so there is 57 that's still outstanding?

That's correct.

Okay, great.

Thank you.

Our next question will go to the line of Mark Robins representing Grace and White.

Please go ahead.

Hi, good afternoon.

A couple of questions, a lot have been answered and some have even been answered.

Just looking at the gross profit for one more time.

So, if we look at it a year from now, you should pick up an easy 3.3 million just on the ball inventory error in the accounting system.

Is that correct?

Well, presuming --

No other errors, yeah.

Well, presuming that we fix the problem, yes.

Okay.

So, if we're going to even look at it on the pro forma basis, we're really looking at gross profit of 143.

It represented about one point for the quarter, Mark.

Right.

We don't give projections.

I guess I would just revert back to the statement I made, which we feel we have addressed the issues and put the proper controls in place to correct them.

Right, okay.

And I guess some of the comments have been made, it still looks like the three-year plan is going to take three years, not one quarter.

Yes.

Go figure that, huh?

It would make our conversation a lot easier if it would only take one quarter, unfortunately.

And the fact that the stock did sell significantly higher than any rumor bids.

Okay, I will let you go, because that kind of finishes that up.

Thank -- oh, actually, I do have one more question, I'm sorry.

In looking at the Top-Flite business, I know we've chatted about this in the past, do you see any possible impairment to the goodwill?

No, not at this time based on our current forecast and the way we look at the business, there are no impairment charges that are being considered at all.

Thank you very much.

And thank you very much, Mr. Robins.

Our final question today comes from the line of Tim Conder with A. G. Edwards.

Please go ahead.

Yes, gentlemen, just a follow-up on a previous question, somewhat mine, also.

I think, George, what the gentlemen was getting at earlier regarding where the stock is -- and, by the way, quoted on the Pacific Exchange at 1181 on the aft.

Okay.

You said that the improvements that maybe any potential people were looking at are now off the table.

That being said, at the point that they supposedly were looking at the company, that would imply the higher earnings power.

Now with some of the issues and that's on the table, they could theoretically come in at the price they were originally proposed to be looking at it, or a lower price and get all of that with these improvements for that price or a lower price.

So, I guess my point and I think some of the other points were, given that, and you're still very optimistic about the benefits that are going to roll through here over your three-year plan, why not be even more aggressive now where the stock is with the company's share repurchase?

I think that's the root of the question that I think myself and other people are sort of going at.

I hear you, I understand.

All I can tell you is that the stock repurchase issue is on the table, it always is on the table.

It's something for the board to make a determination about, and also for us to decide whether that's the appropriate way to spend the resources of the company.

I'm not taking a position one way or the other.

I hear your point, I understand it.

Obviously, I can't comment on it, but we do understand that view, for sure.

Tim Conder.

Okay.

Well, thank you very much.

Thank you very much, Mr. Conder, and with that, Mr. Fellows, Mr. Holiday, I'll turn the call back to you for any closing remarks.

Again, thank you all very much for joining us.

Just to reiterate, we believe that we're proceeding apace against the plan that we put forward.

We're trying to share with you all of the things that are going on both good and some of the things that perhaps are issues that we have to get over.

You have to make a determination as to whether or not we're gong to get by them.

We obviously know that we will.

I don't want anybody to walk away with any other impression other than the fact that we are pleased with the results, we think the plan that we put forward in February is very much in place, and we feel very much that we will be able to achieve that plan.

Once again, the numbers will speak for themselves and your determination as to how good those numbers are, obviously, is in your hands, but please understand that we are very much committed to achieving what we said we were going to do back in February.

So, again, thank you very much.

We will obviously talk to you again at the end of the third quarter, and hopefully have a lively debate then as well.

Ladies and gentlemen, that does conclude our call for this quarter.

Thank you very much for your participation, as well as for using AT&T's Executive Teleconference Service.

You may now disconnect.