Topgolf Callaway Brands Corp (MODG) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Callaway Golf fourth quarter 2006 financial results. [OPERATOR INSTRUCTIONS]

I would like to turn the conference over to Chief Financial Officer, Brad Holiday.

Please go ahead.

Thank you, and welcome everyone to Callaway Golf Company's fourth quarter 2006 earnings conference call.

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

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

During today's conference call, George will provide some opening remarks and I will provide an overview of the Company 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 future inventory levels; estimated sales; gross margins; operating expenses and earnings per share; estimated charges for employee incentive compensation expenses; the estimated cost to implement future gross margin initiatives or the amount or timing of the savings to be realized from such initiatives; future product releases or the timing of such releases; as well as the Company's estimated 2007 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 our earnings release issued today, as well as part 1, item 1A of our most recent Form 10-K filed with the SEC, together with 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 Top-Flite operations; the cost reduction initiatives announced in September, 2005; employee long-term incentive compensation; and gross margin initiatives.

This information may include non-GAAP financial measures within the meaning of Regulation G. The earnings release we issued today includes 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 call over to George for a few opening remarks.

Thanks, Brad, and thank you all for joining us.

I'd like to review some of the major highlights of 2006 and outline key objectives that we see for 2007 and beyond.

I'd also like to note 2007 is the Company's 25th anniversary.

Now, 2006 we believe was a year of much progress toward restoring Callaway to a position of strength and profitability, but not without some disappointments.

First, many but not all of the process breakdowns that have plagued us over the last few years are well on their way to being positively resolved.

Product development process is now operating on a three-year planning cycle, thus providing appropriate lead time for meaningful technological innovation.

All but one major introduction in 2006 were -- and all in 2007 are on schedule with little disruption to customer service anticipated.

Supply chain lead times have been reduced from their traditional 90-day average to 60 and in some cases to 45 days, thereby enhancing our responsiveness to market fluctuations and contributing to significant improvement in customer service, and there are more improvements yet to come.

Our forecasting accuracy, however, remains an issue and must continue to be improved.

A new demand planning function is being created to provide the proper focus and resource against this very important area.

Secondly, the business is sound in growing, albeit not without some notable exceptions.

Callaway and Odyssey grew 9% in 2006, a very healthy rate in view of recent past performances.

Shares for 2006 rose in drivers, woods, fairway woods and balls and accessories, while maintaining dominant shares in irons and putters.

Top-Flite Hogan, however, fell substantially short of expectations and dissipated much of the revenue gain achieved by Callaway and Odyssey.

The major restage and introduction of Top-Flite through the D2 launch addresses this critical area in 2007, with early results supporting this expectation.

The consumer has yet to have the final word, however, so we're holding -- we're holding our judgment on this reintroduction at this point.

Trade reception and early consumer buzz on the 2007 new product lineup portends a very positive outlook for 2007 and a continuation of the momentum that we started in 2006.

Third, the profitability is returning to respectable levels but with lots more work to be done.

OpEx savings committed to in September of '05 have been over-delivered with $44 million dropped to the bottom line versus the $30 million to $35 million promised for the first 12 months.

Margin improvement initiatives targeting on going savings of $50 million to $60 million over the next two years have been initiated and now are proceeding apace with more projects in development.

Overall performance against the three-year guidance is consistent with the commitments, albeit at the lower end of the ranges in some measures due to Top-Flite issues mentioned earlier.

As promised, Brad will spell out our first annual guidance for 2007 later and we will be updating the three-year outlook at our upcoming investor day next Monday.

New initiatives will be targeted against a reduction in working capital that also will be detailed at our investor day presentation on Monday.

Communications with our investor community has been stepped up and we're listening more attentively and hopefully responding more directly to your needs.

And, fourth, we've largely completed our organizational upgrading by bringing aboard some outstanding new talent and restructuring some of our existing organization to enable us to sustain the new directions and initiatives necessary for our continued growth.

Now, while the path to our recovery has not necessarily been as smooth as we'd have liked the progress is palpable and the morale of the organization, we believe, speaks volumes about how confident we are that it will continue.

Let me turn it back to Brad to give you some details.

Thanks, George.

I would like to cover a few highlights of the financial results for the quarter and full year.

In reviewing the results for the quarter, we achieved consolidated net sales of $180 million compared to $154 million last year, an increase of 17%.

We reported a net loss for the quarter of $10 million, compared to a loss of $19 million last year, and a loss per share of $0.15 versus a loss of $0.27 per share in the prior year.

On a pro forma basis, excluding 2006 after-tax charges of $0.02 from employee equity-based compensation associated with FAS 123(R), $0.01 for restructuring charges and $0.01 for gross margin improvement initiatives and 2005 after-tax charges of $0.03 for Top-Flite integration charges and $0.02 for restructuring charges, our pro forma loss per share for 2006 was $0.11 compared to a loss per share of $0.22 in 2005.

The year-over-year increase in net sales was primarily due to an increase in demand for current 2006 products, and the impact of new products introduced during the quarter.

For example, in the fourth quarter of 2005, new products included the ERC Hot Fairway Wood and the Odyssey Dual Force 2 Putter.

This year's new products that were launched during the fourth quarter included the X Hybrid, the X Hot Fairway Wood, a new Callaway golf ball model designed only for the mass channel; as well as limited shipments of our new 2007 X-20 Irons, to a few markets to take advantage of holiday sales opportunities.

Pro forma fourth quarter gross margins, excluding restructuring charges, gross margin initiatives and employee equity-based compensation charges, were 34% of net sales compared to 32% in the prior year.

This increase was driven by the mix of new products introduced during the year, higher volume and margins of our Callaway Golf balls and accessories, as well as some positive manufacturing variances.

Partially offsetting these percentage increases were declines in our wood margins during the quarter, driven by lower year-over-year volumes on the Ft3 Driver as it comes to the end of its life cycle, lower Odyssey putter margins due to a shift in the mix of putters sold in the quarter, and lower Top-Flite margins due to the inventory reduction initiatives we had initiated earlier this year.

Pro forma operating expenses for the quarter, excluding FAS 123(R), restructuring charges and integration charges, were $77 million, flat compared to $76 million last year.

Please keep in mind that last year's results already included savings of approximately $8 million due to the restructuring initiatives we took in September of 2005.

We also had a $2 million passativ -- positive tax reserve adjustment associated with the resolution of an outstanding IRS audit that resulted in a very positive tax rate for the quarter.

Resolution of audits like this and the associated adjustments do occur on occasions, but for future planning purposes I would still recommend using a normalized tax rate of 38.5%.

Highlights for the full year of 2006 include an increase in consolidated sales of 2%, to a record high of $1.018 billion compared to $998 million in 2005.

This increase was driven by 9% growth in our Callaway and Odyssey brands, offset by 31% decline in the Top-Flite and Ben Hogan brands.

More specifically, the $20 million year-over-year sales increase was due to a significant increase in woods, including drivers, fairway woods and hybrids, as well as our wedge and accessories categories.

Partially offsetting these increases were declines in irons associated with the lower second-year volume of the X-18 model, a higher mix of our lower-priced Big Bertha '06 model and lower sales of Ben Hogan products due to steps taken in 2006 to rationalize product offerings.

Regionally sales increased across all regions compared to 2005, with the exception of Europe, which was impacted by the 2006 World Cup soccer tournaments in that region, along with some severe extremes in weather throughout the year.

Pro forma 2006 gross margins, excluding charges for FAS 123(R), restructuring, Top-Flite integration and gross margin initiatives, were 40% compared to 42% in 2005.

Gross margins were negatively impacted by the Top-Flite and Ben Hogan inventory reduction initiatives we undertook during the year, as well as lower iron margins associated with the expected end-of-life volume declines for our X-18 models.

Partially offsetting these declines were positive margin contributions from Callaway golf balls, wedges and accessories.

As you know, we have several initiatives currently under way that are targeted and improving gross margins over the next two years.

Pro forma 2006 operating expenses for the full year were $349 million compared to $384 million last year.

The reduction of $35 million is the result of the restructuring initiatives we took late last year and is in addition to the $8 million in savings we recognized in the fourth quarter last year as I already mentioned.

Moving to the balance sheet, net working capital decreased 10% compared to last year, driven by increase in our short-term borrowings and payables, partially offset by an increase in receivables and inventory.

Consolidated net receivables increased to $118 million compared to $98 million last year due to the year-over-year increase in sales during the quarter.

Consolidated DSO was 61 days compared to 59 days last year.

Collections remain good, as does the overall quality of our receivables.

Net inventories were $265 million compared to $242 million last year, a variance of $23 million but down compared to the third quarter variance of approximately $31 million and the first quarter variance of $75 million, and in line with our expectations discussed last quarter.

This year-over-year increase can be attributed generally to a couple of things.

First, there are three new drivers in the product line for 2007, two of which are premium priced -- the FT-i and FT-5 drivers -- compared to one new driver last year.

Both of these products are being launched into the market during the first quarter and have affected our year-end inventory balances.

Secondly, we have prelaunch inventory of our new higher cost X-20 line of irons as well as some higher levels of putters and accessories associated with 2007 products.

One of the targeted goals of our gross margin improvement initiatives will be to lower inventory levels over the course of the next two years, which we expect to result from shortened component lead times and improvements to our internal supply chain processes.

The overall quality of our inventory is good, with appropriate reserves in place for slower-moving products.

Capital expenditures for the year were $32 million, in line with previous estimates and equal to 2005.

Depreciation and amortization was also $32 million for the year, also in line with previous estimates.

We did not purchase any stock during the quarter; however, for the full year we repurchased 3.5 million shares of stock for $53 million at average price of $15.29 per share.

Those are a few highlights for the fourth quarter and full year.

As George mentioned we feel like we've made significant progress over the past year in many areas and have some positive momentum as we begin 2007.

So let me shift gears now to discuss how we think our business will shape up for 2007.

This is the first time we have provided annual guidance for a few years, but given the fact that we are the only stand-alone public golf company in the marketplace, we recognize how difficult it is to model our business each year.

Before I get into the details of the forecast, let me first share with you that on average over 50% of our annual sales are the result of new products introduced during the year.

This compares to larger consumer products companies where that number is much lower.

This high percentage of new products make forecasting sales more challenging in that we don't receive any meaningful retail sell-through or consumer response data on these products until the April-May time frame.

Having said all of that, we estimates sales for 2007 will range from $1.035 billion to $1.055 billion.

Pro forma fully diluted earnings per share are estimated to range from $0.75 to $0.85, compared to the $0.51 we just announced for 2006.

Both the forecast and prior period results exclude, among other things, charges associated with long term incentive compensation expense, which we excluded throughout 2006, to make comparisons to 2005 more meaningful.

Since we now have a base year which includes long term incentive compensation charges we will report our 2007 results inclusive of these charges.

So, including approximately $0.09 for these compensation charges, our 2007 fully-diluted earnings per share are estimated to be $0.66 to $0.76, compared to our 2006 results of $0.43, which includes $0.08 in compensation charges.

The year-over-year growth is generally the same, but now both years include these compensation charges.

We will still be providing pro forma results in 2007, excluding our gross margin improvement initiatives, but would encourage analysts to include these long-term compensation charges in your earnings forecast so that in 2007, First Call consensus will be uniform among all analysts and consistent with how we will report our results.

The 2007 estimate is based on an assumption of 68 million shares outstanding.

A couple of additional things to keep in mind as you model your forecast, we ended 2006 with pro forma gross margins of 40% and would estimate improvement on these results in the year associated with improved product margins due to a forecasted increased sales mix of higher margin products and the positive results we expect from our gross margin improvement initiatives currently under way.

When modeling full year operating expenses you should assume 3% inflation for the year, consistent with general market inflation trends.

Also, as you know, we exceeded the targeted savings generated by the restructuring initiatives taken in 2005 and 2006.

As we have previously discussed we will reinvest some of these savings in 2007, where appropriate, to drive consumer demand.

The relaunch of the Top-Flite brand is a good example of this reinvestment opportunity.

Also while the Company did not pay annual bonuses in 2006 due to the disappointing performance of our Top-Flite and Ben Hogan brands, we're including a charge for this in our 2007 forecast.

So, taking these three factors into consideration, annual OpEx is estimated to increase by $20 million to $30 million for the year.

Now, as you know, we will launch most of our new products for 2007 during the first four or five months of the year as the golf season opens up.

Actual shipments of our products may shift by a few weeks between the first and second quarter for a variety of reasons.

In addition, reorders are driven by the sell-through of our products to consumers, which is extremely difficult to forecast at this time.

This is one of the reasons for not providing quarterly guidance.

However, to provide some additional color on the first half of the year, we are currently estimating sales to range from $670 million to $690 million.

In addition, included with our earnings release we provided a schedule that summarizes the timing of new product introductions for both 2006 and 2007.

As you model the quarters, I would take into consideration that the second quarter is on average slightly higher in sales than the first quarter, due to the seasonality of the golf industry, but once again dependent on the actual shipments of new products that might ship between quarters.

Pro forma fully-diluted earnings per share, including long-term incentive compensation expense, is estimated at $0.05 -- excuse me, which is estimated at $0.05 but excluding gross margin initiatives, are estimated to range from $0.82 to $0.89.

Also keep in mind that savings from our gross margin initiatives will ramp up as the year progresses, so the second quarter gross margin should be higher as compared to the first quarter.

Additionally, because of the shift in the timing of our launch of our new drivers and associated marketing spending, operating expenses will be pretty equally balanced between the two quarters as compared to last year.

Taking all of this into consideration, second quarter pro forma earnings per share should be slightly higher as compared to the first quarter.

We estimate annual CapEx to be between $45 million and $50 million in 2007.

This includes approximately $35 million to $40 million to support our normal operations and our gross margin improvement initiatives.

It also includes approximately $10 million associated with the consolidation of some buildings we own on our business campus here in Carlsbad.

Our current plan calls for transforming the space in our headquarters building that was previously used for golf ball manufacturing into additional office space.

This will allow us to sell two buildings we currently own and generate some savings in association -- and associated operating expenses.

This will be a two-year project, which we will expect -- that we expect to begin later this year.

Depreciation and amortization for the year is forecast to be $30 million to $35 million.

We would now like to open the call for questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from the line of John Shanley from Susquehanna Financial Group.

Please go ahead.

Thank you and good afternoon, guys.

Hey, John.

George, can you give us some insight in terms of how the Flite D2 launch went in January?

Well, the D2 introduction, as I think we've indicated in the past, has gone very well.

We've regained a very substantial number of green grass distribution points that had been lost over the past several years.

At this point it's very difficult to give you any sell through, because the market really hasn't begun, but certainly the trade reception has been very positive, and the early consumer testing that we had done on the product on a blind basis, meaning unidentified, reflected a very positive response to the ball's performance characteristics.

All of the up front research and indications that we have have been quite good.

The distribution base is substantially improved over last year, so at least the stage is set.

Now ultimately obviously the consumer's got to speak and we're waiting for that.

How long will that take, George, normally for you to get a good read in terms of whether this is --

The market, depending upon how the weather breaks, which unfortunately none of us control, will start breaking in various parts of the country in the March, April period but I would think it would be into May before we have enough definitive data points to be able to conclude how well we're doing.

And, John, on that the marketing doesn't even kick in until March, so we haven't really gotten a read yet because the marketing hasn't kicked in.

Fair enough.

In terms of inventory, you gave us a good explanation in terms of the new drivers that are being launched.

If you exclude those new products in comparison to comparable items that you hadn't launched at this time last year, is the inventory level in balance with your expectations?

It's kind of hard for us to read [multiple speakers] inventory build how much of it may be new product launches based on the fact that your sales expectations for the full year are 2% to 4% growth.

I'm trying to get some clarity on how to interpret that inventory build.

Sure.

Let me step back to '05 a little bit.

If you recall, we were having fairly substantial supply issues in '05.

We consciously went into '06 with the understanding that we were going to elevate our inventory levels in order to try to improve the customer service issues that we were facing, but that we would try to normalize those as we went through the year.

The likelihood was that we were going to end the year at a somewhat higher level than we ended '05.

In fact, the year has tracked pretty much along those lines and the increment in inventory that we're looking at as we closed '06 is pretty much in line with what our expectations were.

Now, having said that -- and we are pretty satisfied with the way in which we brought down that increment in inventory -- we will be announcing on Monday our sort of third level of initiative directed specifically at overall inventories where we will be establishing a target for further inventory reductions.

We will talk to an inventory turns target as well as an overall level of inventory that we will be going for over the course of the next two years, which will ultimately improve the picture even further from what you're seeing right now.

But as it relates to just '06, we're not unhappy with the way it's gone.

A portion of that increment over '05 that we're looking at is, in fact, resulting from the issues that Brad indicated, the additional introductions and the premium price of those introductions.

But we would like even that to disappear and we'll be talking about that on Monday.

Okay, and that should be very helpful.

And in terms of the launch schedule that was-- we found very helpful in terms of getting a handle on when the products that are going to be introduced into the marketplace.

Is there any way you can clarify for us how much significance we should place on the product?

I know for competitive reasons you probably don't want to give us quantities or something, but maybe if there was a way of giving us percentage increase, in terms of either revenue, or the number of drivers or irons that are being introduced into the marketplace it may give us a way of -- a sense of how much it could move the needle as these new products come into the market?

John, I'd love to be able to do that for you.

The competitive issues, I think, are fairly important in that regard.

Suffice it to say that we have probably the strongest introductory calendar -- excuse me -- that the Company has had in quite some time.

And I think the real -- the ultimate measure of the effect of that calendar will come as we observe the share gains that we anticipate as we go through the year.

So I wish I could give you a little more clarity on that, but I'm afraid I can't right now.

All right.

Fair enough.

Last question I have is on the cash flow statement there is a [inaudible] about a golf-related venture for $10 million.

What is that?

I think we may have mentioned it earlier, but if we haven't, let me talk about it now.

We have a minority investment in a company called Top Golf.

The best way to describe that for you is picture a driving range set up much like a dart board with targeted holes at various distances away.

The golf ball that's hit has an embedded RFID chip in it, which when you register at the desk gets scanned and put into your name.

And then when you're in your hitting bay and you're now striking the ball out there, when the ball lands and goes into the holes out there, it gets read, and the score -- and I'll talk a little bit about that in a minute -- gets registered on a screen in your hitting bay.

So that fundamentally, if you're an individual just practicing accuracy, you will be able to get a score on how close you get to the various targets that you establish.

Or for that matter you can go out with a foursome with a bunch of buddies or your family and you can play competitively against one another.

It is a very interesting grass roots business building prospect that we thought that had a lot of merit and we decided to take a very serious position in it.

We have exclusive marketing rights through all locations that this organization has currently, and also in terms of any expansion to have in the future.

Right now they have three locations operating in the UK, surrounding London.

We have one in Alexandria, Virginia.

There is another one opening up in Texas in a couple of months, and another one opening up in Chicago, also in a few months.

We think this is a very interesting developmental prospect, and we have some interesting hopes for it in terms of grass roots efforts to expand the game, and that's one of our major initiatives for '07.

Okay, fair enough.

Thanks a lot, I appreciate it.

No problem.

Our next question comes from the line of James Hardiman from FTN Midwest.

Please go ahead.

Good afternoon.

Couple questions for you guys.

You talked about supply chain lead times being reduced from, I believe you said 90 to - -what's today?

Around 45.

Well, 60 and in some cases in 45 in a few and we're hoping to push them further.

Okay.

I guess my question was, what inning are you in terms of that reduction and where do you think that number can get to and what's left to be done there?

Well, we're going to be giving a lot more color on that on Monday, so hopefully you'll be there to hear it.

I think we've made some very significant inroads already in getting probably the bulk of our lead times from 90 down to 60.

We're beginning now to push against that 60 to get it down even further.

But there are other initiatives that [Dave Laverty] will be getting into on Monday that will further improve our supply chain performance, if you will, in combination with the reduction in lead times.

So this is a very, very important area for us.

It not only has cost implications but certainly customer service implications, and that has been an area that we're quite concer -- we have been quite concerned about.

Great.

And can you give me an outlook on the international business?

Obviously you're not going to give guidance on growth in the different regions but just qualitatively if you can look at the different regions in comparison to your overall projected revenue growth.

What regions are you especially excited about and which ones are -- you think are going to be a challenge in 2007?

Well, I won't give you too much regional color, but let me give you a couple of broad comments.

Europe suffered dramatically last year from a combination of really extraordinary weather and the World Cup, so we would anticipate, short of a recurrence of the weather issues, that Europe should be an area that will face a very positive year.

Japan also was an area of some concern.

I think as we mentioned in prior calls, the Japanese market on January 1, 2008, will have to convert over to conforming product, pretty much in line with what the U.S. has.

Up until now they have not been required to do so.

I think '06 was impacted by the fact that it was sort of falling between two stools.

Should the consumer buy a new conforming driver in anticipation of having to convert over in a couple of years, and potentially be at a disadvantage to other playing partners of theirs who haven't done so?

Or should they, in fact, just stay with the non-conforming drivers and wait another year.

The net consequence of that uncertainty caused the driver market in the Japanese area to decline by 20%, and I think a lot of people deferred their purchases.

Assuming that we're going to get a lot more clarity on that in '07, because now we're literally on the verge of the conversion to conforming product, we would anticipate that Japan would also have a recovery.

Again, perhaps not as dramatic as we're anticipating in Europe, but nevertheless a positive year.

On an overall basis, the reception that our new products have received on a global basis -- not just in the U.S. but literally in every marketplace -- would seem to indicate that the product is right, is well received, and the response we're getting from the trade would seem to imply that it should be a positive year for us.

Great.

Just a quick follow-up, it sounds like, I guess in 2007 everything is going to be conforming, and when I look at your --

No, 2008 will be conforming in Asia. 2007, of course, is conforming here because we have been so for quite some time.

Okay.

I guess the question is, when I look at your product launch schedule, this hyper ERC driver that's slated to come out in Japan in February.

Should I expect that to be the last sort of country-specific product that you guys release?

No, again, the country-specific issues go beyond whether they're conforming or non-conforming.

They relate to the physicality of the people in the region, the swing speeds that are typical of the golfer, all sorts of other things.

So we will continue to be designing products very region-specific to the golfing public, if you will.

The conforming issue, as it relates to the rules set down by the R&A and the USGA, however, will be consistent with the rest of the world.

Great.

Thanks, guys.

No problem.

Our next question comes from the line of Tim Conder from A.G. Edwards.

Please go ahead.

Thank you.

First of all, the additional disclosure in your release as far as the table of product launches and that and everything, very helpful.

Thank you for that.

Couple of items here.

Brad, I think in some of your prepared comments you had some notes on Top-Flite and Hogan.

Just wanted clarity, was that for the year or for the fourth quarter?

And then in conjunction with that related question, given the preliminary launch here -- and again it's preliminary -- and the increased losses to clear the channel of Top-Flite in '04 -- I'm sorry, in '06 here, do you think Top-Flite we could be seeing a bottom here at least stabilization?

Tim, first of all, I'm not sure which comment.

I think the one thing I mentioned was that if you take a look at a full year that Top-Flite, Ben Hogan brands were down year-over-year 31% for sales.

Okay.

I think that was the specific, so that was for the full year.

Let me defer to George a little bit on the status of Top-Flite and whether we're bottomed out.

I think what we said a bit in the past about Top-Flite is our expectations for '07 on Top-Flite we think are reasonable and they are only to see the brand stabilize.

We're not looking for a hockey stick at this point in time.

We have a lot to make up, if you will, in the marketplace and there's some credibility to rebuild as well.

So to have built in a very aggressive expectation for '07 I think would have been imprudent.

So our expectation for the D2 relaunch and its effect on the rest of the Top-Flite line we think is fairly moderate and prudent, which is stabilization, period.

Okay.

Okay.

And then your guidance includes obviously some additional charges related to the gross margin initiatives.

It would anticipate it also includes some of the anticipated early benefits?

Tim, we exclude the one-time charges associated with the gross margin initiatives because, truly, they're more just initial expense to get these programs off the ground.

So, in terms of comparability and being able to look at year over year, we're excluding the charges for that.

And if you recall, we had said it would range somewhere in the $5 million to $10 million range.

And if you look at the results for the year, we had about $2 million that impacted the 2006.

Okay.

So we would anticipate that there'll be some charges over the next two years associated with that.

We're going to exclude out those as we report our pro forma.

But on the other side of the coin would you -- built into some of your expectations, are there some initial benefits that you're going to --

Yes, absolutely.

Okay.

And so if you look at -- for example, as I mentioned in my comments, some of the gross margin improvements, are going to be the result of some of the gross margin initiatives that we had anticipated, which we said would be in the $20 million to $25 million range in '07.

And we began to feel some of it in the fourth quarter of '06, albeit at a fairly low level to start with.

Okay.

And then should we see any additional charges related to Top-Flite integration or the September '05 initiatives?

No.

I certainly hope not.

Okay, okay.

We're pretty well done with those, Tim.

Okay.

And just as a side note, the reason, once again -- I mean, you think in terms of reporting, putting the long-term compensation expense in to our reported numbers really allows us, then, just to address the gross margin initiatives as we try to get it back to operating results.

Okay.

That's the intent.

Any type of level of sales for Top-Flite alone or Hogan in '06, so we can sort of use that as a base benchmark?

We're not breaking out the numbers by brand.

But as we go from quarter to quarter, you'll -- believe me, you'll see it.

Okay.

Okay.

Back to a topic we've brought up-- and a few others a time before, I guess -- given your debt to cap, yes, you've got $80 million in sort of a short-term debt related to some of the working capital items that you've explained very well.

But given your current debt to cap of under 15%, why no share repo in the fourth quarter or why haven't you been more aggressive to this point?

Well, Tim, once again, we're always talking to our board with regards to the share repurchase.

We bought quite a bit of sha -- quite a few shares back this year.

But we typically end the year with a lot of working capital needs and we were into our line.

We could have taken a more aggressive approach, if we wanted to take on more debt, but it was our position that we would wait and hold off and continue to communicate with the board as we felt it was appropriate.

Okay.

Okay.

And by the way, again, on the guidance overall, versus what you guys have done in the past, thank you, again.

We appreciate it.

We hope it helps.

Is that it, Tim.

Yes, thank you.

Thank you.

Our next question comes from the line of Rommel Dionisio from Wedbush Morgan.

Please go ahead.

Good afternoon.

I wonder if you can anecdotally talk about the weather on the business, both for Q4 and Q1?

Obviously we had war -- a fairly warm winter up until the new year and now it's turned a lot colder.

To what extent did that warm weather benefit your fourth quarter business and to what extent is that impacting retail orders and so forth for the first quar --?

I don't think it's really affecting it that much.

As we talked before, we look at the business, really, from two different sides.

One, the ball business is pretty much a consumable business and I think tracks very closely or -- with rounds play, and that, of course, is heavily impacted by weather.

The equipment business, however, really is quite different and is more impacted by innovation and impulse, so that tends not to have much of an effect.

As it turned out, the rounds played in December were up quite substantially, reflective again of what you indicated, that we had a relatively warm period of time.

Overall for the year, rounds played were up only 0.7% and that follows on '06 where I think rounds played were up 0.4%.

So while we haven't changed the general trend of rounds played dramatically, it is edging up as opposed to down, which, I guess if you looked at it three years ago you might have concluded it was going the wrong way.

But I don't think that the warm weather had the particular impact in any serious way on any aspect of the business.

Certainly not from a selling point of view, because most people are really looking to the beginning of the season and don't pay that much attention to the -- to a short warm spell in December.

Sure.

And that's the clarification question.

If I could, Brad, in your prepared comments you talked about incentive compensation increasing, was the number $20 million to $30 million, did I hear that correctly?

I wish. [LAUGHTER]

No, Rommel, what I was saying is total OpEx is -- should be up about $20 million to $30 million for the year driven by three factors.

One is 3% inflation, which is kind of in line with general inflation.

The fact that we had talked about reinvesting some of the OpEx savings back towards consumer demand initiatives like the Top-Flite reintroduction.

And then the fact that, in our base year, 2006, if you will, we did not pay a bonus, which, frankly, from a investor point of view, you should be pleased with, because we didn't deliver the results and we didn't pay because the performance wasn't there.

However, a year-over-year comparison would tell you that there are some funds in there for bonuses in 2007.

All combined, those three items should be in that $20 million to $30 million range.

Great, thanks for clearing that up.

You bet.

Our next question comes from the line of Beth Lilly from Woodland Partners.

Please go ahead.

Good afternoon, George and Brad.

I have two questions.

My first question is, George, could you talk about the golf ball business.

It's flat revenues year over year and it clearly is disappointing, and can you help us understand is it a critical mass issue?

Is it a product issue?

And as you look at the business, and you're very returns focused and return on invested capital focused, I can't imagine that you're very tolerant of many more years of losses?

Well, I think to your point, it's very important to look at the constituent pieces.

I think if you take a look at the pieces, you'll realize that the Callaway golf ball business was, in fact, up and profitable at a pretty decent level.

The issue we had was in Top-Flite, and as we indicated -- and Top-Flite is fundamentally a ball business.

There is some club and some accessories pieces to it, but fundamentally it's a ball business.

And because of the difficulties there, we gave back -- we dissipated, if you will, a lot of the progress made on the Callaway ball business.

The restage of Top-Flite with the D2 launch we believe will address that issue and sort of return the overall ball business to a much more positive picture.

But in terms of the progress that we've made in balls, if you were to focus strictly on the Callaway, which is the upper-end ball business, I think you'd be pleased.

So can you give us a sense of where -- if you look at Titleist margins and they have very signif -- they have very high margins in their ball business.

Right.

Where do you think your ball margins should be?

Well, again, I think our ball margins over ti -- again you have to take a look at the mix, but our ball margins over time there is absolutely no reason why they shouldn't approach those levels in general.

Now, remember, the Top-Flite fundamentally is a lower-priced ball and the margins would tend to be a little lower on that.

But I would think that ball margins should be able to get into the 45% to 50% range.

And if in fact we've corrected the Top-Flite issue, I would see us getting there in a shorter rather than longer time frame.

So is that something that's possible maybe in '08?

Anything is possible.

I can't predict that.

But, again, depending on the rapidity of recovery on Top-Flite, it could very well be much sooner rather than later, yes.

Okay, so it's -- just so I can understand this.

It's not -- it's a Top-Flite issue, so it is not a critical mass issue, it's -- you're producing enough balls, it's just a matter of the sell-through of the balls?

Let me split that up with you.

The capacity -- we have two different kinds of -- you've got two-piece balls, which are fundamentally the Top-Flite balls.

They are -- that's the area that is suffering.

And to the extent that the volume there isn't what we would like it to be, there is a capacity issue -- an overcapacity issue.

We are looking to alternatives to that in order to alleviate that as a problem, in addition to trying to relaunch that brand in order to get the volumes back up again.

The more expensive balls, which are the Callaway balls, some are two-piece and many of them are three-piece.

There it's not really a critical mass issue at this stage.

There it's just a matter of continuing to grow the business.

To put it in perspective for you, the Callaway balls were very substantially up in '06 versus '05.

So, in essence, the Callaway ball piece is profitable but Top-Flite isn't?

Yes, I think that is a fair characterization.

And, again, Top-Flite isn't because of the difficulties that we've had over the last several years.

It's not that they -- it can't be.

It's a matter of having to address the other questions, mostly marketing and product issues.

Okay.

And so you think those -- those issues have been addressed and so in '07 we'll see progress and then in '08 most likely the ball business should be profitable?

The overall -- well, certainly.

If the Top-Flite ball issue is addressed in '07 as we hope, very clearly so.

Because, as I said, the Callaway ball business is, in fact, profitable and it's just a matter of getting the drain of the Top-Flite business out from under us.

Yes.

And so, just to take that a step further, supposing the things -- the relaunch and this new Top-Flite ball is not successful, then what do you do?

Well, we're committed to making it successful.

And I believe that we have the right elements in place in order to be able to do that.

It's hard to address hypothetical questions.

Trust me, that if for some reason it doesn't do as well as we expect it will, we're going to find some other alternatives to fix the problem.

Our commitment is to the overall profitability to the Company and we're going to get there.

Because this is a significant drag on your profitability.

It's a measurable one, yes, and we clearly need to fix it.

Yes.

Okay.

My other question had to do with the $10 million investment.

So is it your goal to expand that across the country, and would that take a lot of capital?

Or can you just provide a little more insight into how you want to grow that?

I think at this point in time we're learning a great deal.

We're experimenting with various ways in which we can leverage that presence, and that marketing involvement.

I don't think that we're prepared to talk to expansion opportunities, although we're clearly looking at them.

And we are also, at this point, a minority shareholder.

We're a 19% shareholder in it, so we're really not the guy that's going to call that shot.

We can influence it, obviously, but we can't call it.

I'd be in a better position to address that question probably a year from now after we've had some experience under our belt.

Who owns the other 81%?

Private investors.

Okay.

And what is the name of the investment?

It's called --

The name of the organization is Top Golf.

Top Golf.

That's the brand, anyway.

The brand.

Okay, great.

All right, that's very helpful, thank you.

I think it's called -- Golf Entertainment International is the corporate name.

Top Golf is the brand.

Okay, Golf Entertainment.

International.

Okay, wonderful.

Great.

Thank you very much.

Pleasure.

Our next question comes from the line of [Haley Wolfe] from [inaudible] Securities.

Please go ahead.

Hi, guys.

Hi, Haley.

Just a few questions.

One is can you comment on raw material pricing, any particular areas where you're seeing pressure year over year?

Second, would you comment on the targets in the current long-term compensation plan, vis-a-vis the prior plan?

And then, lastly, I got a little confused on some of the forward guidance numbers that Brad gave out.

The $0.82 to $0.89 number, can you clarify on what that one -- what that is?

That was the first six months, Haley, and that was inclusive of the long-term compensation charges.

Okay?

Yes.

Okay.

The cost issues that you were talking about obviously are continuing in the ball area.

And as we've mentioned, we've raised some prices on balls to offset some of that.

We're also looking at some manufacturing alternatives that will offset them even further.

At this point in time it's not a controlling issue.

Okay.

What was the -- I'm sorry, the second one was on the --

Some of the -- the earnings -- some of the targets that you have in the compensation plan that was approved in mid-January?

What's the question?

Will you disclose the targets that you have to achieve to get --?

The targets are consistent with our three-year plan, the ones that we indicated to you last February, I guess.

Okay.

And are there any changes in any short-term targets?

Well, we have annual targets for part of the plan every year and those are consistent with the guidance that we've given you as well.

But that is separate from the long-term incentive, Haley.

The long-term is tied more in line with our three-year goals that we have given last year and that we'll update Monday.

The annual ones are tied to more just annual targets that we have to grow the business.

But in all cases they're consistent with the guidance we've given to the Street.

Okay.

Thanks.

You bet.

No problem.

Our next question comes from the line of Casey Alexander from Gilford Securities.

Please go ahead.

Hi, good afternoon.

Hey, Brad, you went through a lot of adjustments to the 2007 numbers.

Are you going to go through that again on Monday so that those of us who can't write that fast will be able to get our spread sheets together?

Sure, I can do that, Casey.

I mean, generally for 2007, what I really gave was our forecast and then what I took out was the long-term employee compensation year over year, so we took what was normally our pro forma, which excluded that and all the gross margin initiatives, et cetera, which was the $0.51 is what we included this year.

What I gave you in the $0.75 to $0.85 was comparable to the $0.51.

The only thing I pulled out of there was long-term compensation, which was $0.08 in 2006 and is anticipated $0.09 in 2007.

Okay.

Well--

I tell you what, we can -- if anybody asks questions, they can follow up with me on Monday and I'll walk you through it.

That would be great.

I'm a little slow.

In the fourth quarter there was a really significant bump in accessories and other.

Does that have to do with your taking in the shoe business during the course of the year or is there something else in there I don't get?

It is a combination of shoes were included now and they weren't in the prior year, because we did acquire that business from the supplier.

And also just some of our accessory business -- gloves, bags, et cetera -- were up year over year.

Well, it's becoming a pretty significant part of the business.

It was 20% of the quarter.

It's 14% of the year.

How are the margins in that business compared to the rest of the business?

They're very good.

They're quite comparable and in a couple of instances even better than the basic business?

All right.

Great.

Well, then let's hope it keeps going the way it's going.

Well, listen, I hope you guys earn every penny of your bonuses in 2007.

We're trying.

I'm all done.

I'll see you on Monday.

Good deal.

We have no additional questions, please continue.

Well, thank you all very much for joining us.

We hope many of you can join us on Monday where we're going to give you an opportunity to see a lot of our new team in operation.

We're going to give you a lot more color on various aspects of our business that I hope will help you position Callaway as an investment opportunity in your overall portfolio.

And also give you an opportunity to ask some additional questions, not just of us but of the key management team here.

So until Monday, I wish you a good weekend and look forward to seeing you soon.

That does conclude our conference for today.

Thank you for your participation, and for using AT&T executive teleconference.

You may now disconnect.