Topgolf Callaway Brands Corp (MODG) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Callaway Golf First Quarter Financial Results Conference Call.

At this time, all phone lines are in a listen only mode.

After today's remarks, there will be an opportunity for questions instructions will be given at that time.

(OPERATOR INSTRUCTIONS) As a reminder, today's conference call is being recorded.

I would now like to turn the call over to your opening speaker, Chief Financial Officer, Brad Holiday.

Please go ahead.

Thank you and welcome everyone to Callaway Golf Company's first quarter 2007 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 estimates of future sales and earnings, future inventory levels, estimated charges for the Company's gross margin initiatives, future product releases and 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 uncertainties, you should consult our earnings release issued today, as well as Part 1, Item 1A of our most recent Form 10K filed with the SEC, together with the Company's other reports sequentially files 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 and the Company's gross margin initiatives.

This information may include non-GAAP financial measures within the meaning of Regulation G.

The earnings release we issued today, included 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 thanks for joining us.

We are pleased with the progress the Company continues to make as we enter into the 2007 golf season in the United States.

The numbers will be covered in great detail by Brad shortly, but I'd like to provide some backdrop before he does so.

Our results have exceeded expectations, partly due to timing issues -- we shipped some product earlier than originally planned -- but also due to strong early consumer response to our new product lineup.

Early consumer sell through sales worldwide are encouraging, with March results reflecting some of our highest shares in most categories in recent years.

Specificly, our March share in woods 22.9%, up a point from February, but up a full 6.2 points March this time last year.

Our iron share of 29.3 was up 2.5 share points from February, up a full 5.2 share points from March of '06.

In putters, our share was 42.7, 3.6 share points up from February and a full 10.3 share points up from March of a year ago.

In the U.K.

the story is pretty similar.

Our wood share was 23.5% in March, up 8.1 share points from the February figures and up 2.6 from a year ago.

Our iron share was 28.1, up 8.7 share points from February and up a full 4.4 share points from a year ago, and putters at 35.7 up from February and equal to the figures for March of '06.

On the other hand rounds played through March were down 2%, but it was a recovery from the 11.1% negative through February of this year.

While we certainly expect a continued strong recovery from these levels as weather improves, the slow start is somewhat concerning.

I'd also hoped to give you a more complete feel for the Top-Flite restage progress in this call beyond the fragmentary anecdotal feedback that has indicated early positive traction, but the slow start of the season will delay that until the next call.

Suffice it to say, however, we are feeling quite positive about the final outcome, based on the fact that the Top-Flite ball shares have been increasing each month since January.

As these early shares indicate, our new products well received and in some cases, specifically the FT5 and FT-i drivers, and the X20 irons, substantially beyond expectations.

While our supply chain responsiveness is markedly better and much more reliable, we have had problems keeping up with the very high demand.

Despite these relatively minor hiccups, our process and organization continues to perform extremely well and is living up to our much higher expectations.

Profitability and other financial metrics continue to ramp up according to our plan with Op Ex and margin improvement efforts delivering as anticipated, and Brad will give you more detail very shortly.

This is clearly a pro-dominantly good news story, but I would hasten to day that it is still very early in the golf season with most major consumer activity just beginning.

So I caution all of us not to get too far out ahead of ourselves.

The second quarter and beyond will ultimately spell out whether or not he the first quarter results are the full story.

While we are optimistic, we are cautiously so.

To reflect the generally positive tenor of the results to date, we are adjusting our annual guidance upward in what we would consider a prudent way, and I would to turn over the call to Brad at this time, to give you the details.

Thanks, George.

For the quarter, we achieved consolidated net sales of $335 million, the second highest first quarter for the Company's history and an increase of 11% compared to last year's sales of $302 million.

We reported a 43% increase in net income for the quarter to $33 million compared to $23 million last year.

And earnings per share increased 45% to $0.48 from $0.33 per share a year ago.

On a pro forma basis, excluding 2007 after tax after tax charges of $0.01 for gross margin improvement initiatives, and 2006 after tax charges of $0.01 for Top-Flite integration charges, our fully diluted earnings per share for 2007 increased 44% to $0.49 compared to $0.34 in 2006.

Please keep in mind that these earnings include charges associated with long term incentive compensation expense.

Looking at sales by product segments, our wood sales for the quarter were $103 million, an increase of $6 million, or 6% compared to 2006.

This was due to an increase our driver sales associated with our expanded driver line this year, offset partially by a reduction in fairway and hybrid sales compared to last year.

Sell in of our Fusion drivers, the FT-i and FT5 have been strong and early sell through data is trending positively.

Sales of irons were a $100 million, a 15% increase compared to the first quarter sales last year of $87 million.

These results reflect strong performance of our new X20 line of irons as well as the introduction of our new X-Forged irons.

This compares to last year's introduction of our lower priced Big Bertha '06 line of irons.

Golf ball sales $54 million for the quarter, compared to last year sales of $56 million.

As you know, rounds played are down in the first quarter due to bad weather across much of the country.

The good news is that our combined U.S.

ball market share or retail sell-through has increased each month of the first quarter driven primarily by our Top-Flite brand.

Initial feedback on the new D-2 ball has been very positive with some good initial sell through, but we are still early in the season.

We will have a much better read on th re-launch of Top-Flite after the second quarter and we'll update you at that time.

Also, our Callaway golf ball sales are up year over year, reflecting the continued momentum around these products, in particular the HX Hot which has gotten off to a very strong start in year.

Accessories continue to perform well with sales of $49 million for the quarter, an increase of 29% compared to sales in 2006 of $38 million.

A majority of this increase can be attributed to footwear which was included partially as royalties in the first quarter results last year, before we entered the U.S.

footwear business directly.

Also contributing to this increase in accessories was positive sales growth in both Callaway Bags and Gloves.

Putter sales were $29 million, an increase of 16% compared to $25 million in sales last year.

This increase reflects the successful launch of our XG and Black series lines of putters.

Turning to our regional breakout, U.S.

sales were $184 million for the quarter compared to $181 million last year, an increase of 2%.

International sales increased 25% to $151 million compared to $121 million in 2006, with increases in all regions.

Foreign currency gains positively impacted sales by $6 million, so on a currency neutral basis, our international sales increased 20% compared to last year.

Pro forma first quarter gross margins, excluding pre-tax gross margin improvement initiative charges of approximately $1 million were 48% of net sales, compared to 44% in the prior year, which excludes Top-Flite integration charges of approximately a million dollars.

This increase as a percent of sales was driven primarily by positive product mix trends in irons, woods, and accessories, as well as improved manufacturing efficiencies, and progress against the gross margin improvement initiatives we announced last year.

Pro forma operating expenses for the quarter wer $105 million compared to $95 million last year.

This year over year increase reflects higher marketing expense associated with new product launches during the quarter, as well as increased selling expense associated with higher sales, consistent with our expectations.

Now I'll like to move on to the balance sheet.

Consolidated net receivables were $279 million, an increase of $34 million compared to last year, due to the year over year increase in sales.

Consolidated DSO increased slightly to 76 days compared to 74 days last year.

Collection on A/R remains strong and the overall quality of our A/R is good.

Net inventories totaled $271million compared to $247 million last year.

This increase was due to the increased mix of higher value products, such as drivers and irons, in our 2007 product line compared to last year along with the incremental footwear inventory associated with our U.S.

footwear business.

Looking forward, inventories will start to trend down as the season progresses and as we continue to execute against our gross margin initiatives, which are targeted to reduce overall levels throughout the balance of the year.

From a cash generation perspective, trailing 12 month EBITDA to the first quarter was $91 million, a 63% increase compared to the same period last year.

Capital expenditures were $8 million.

We still estimate 2007 capital expenditures to be in the 45 to $50 million range, consistent with our last estimate.

This represents 35 to $40 million for normal operations and gross margin initiatives, as well as approximately $10 million associated with the consolidation of some of our office buildings here in Carlsbad.

Depreciation and amortization was $9 million for the quarter.

Our estimate for 2007 is still expected to range from 30 to $35 million, consistent with your previous guidance.

As you know, last year our Board of Directors authorized $100 million for share repurchases.

During the first quarter, we repurchased 1 million shares at an average price of $15.16 and our remaining balance on the authorization is $32 million.

Now I would like to review our estimates for the year.

Our previous guidance was for sales to range from 1.035 to $1.055 billion with fully diluted earnings per share of $0.56 to $0.76, which include charges associated with long term compensation expense and excludes charges associated with our gross margin improvement initiatives.

In evaluating how to adjust that guidance, I would reiterate what George said in his opening remarks, that is, it's still early in the year with the season just opening in many geographic areas of the country.

First quarter sales are related to retail sell-in with limited sell-through data, so as much as we're pleased with our performance, it's not necessarily a reliable predictor of the full year.

Having said this, we are increasing our full year guidance, with sales increasing to 1.045 to 1.065 billion.

We are also increasing our corresponding pro forma, fully diluted earnings per share guidance to $0.72 to $0.82, based on a share count of 70 million shares, versus the 68 million we used in our last estimate.

This pro forma earnings estimate excludes an estimated $0.08 in charges associated with our gross margin improvement initiatives, currently underway, but does include charges associated with long term compensation expense.

There's a couple of things to keep in mind regarding this estimate.

First, as we have said in the past, estimating sales by quarter is challenging and movement between quarters can occur based on factors which include product availability and the magnitude and timing of orders from our customers.

It is safe to say that in the first quarter, we were able to ship additional products to retail, which positively impacted results, some of which was a timing shift from the second quarter.

Second, as mentioned, it is still early in the year, and we have no idea what competitive actions may occur over the balance of the year.

Both of these factors were considered as part of our full year estimate.

The good news, however, is that we'll be in a much better position to comment on these issues on our next call, and as always, we are committed to updating our projections at quarterly earnings calls.

Finally, although in the past, we've had some product launches late in the year, we currently do not plan to do so in 2007.

While we may introduce a small number of products on a limited basis for Holiday sales opportunities, our product development process targets a great majority of our new product launches at the beginning of the golf season.

Said another way, we had more sales in the second half of 2006 associated with new product launches than we are currently estimating for this year.

Those are the highlights for the quarter.

We would now like to open the call for questions.

(OPERATOR INSTRUCTIONS) Our first question is from James Hardimon FTN Midwest Securities.

Good afternoon, guys.

Couple of brief questions here.

First in terms of the guidance.

The change in share count from 68 million to 70 million.

Obviously, at least a part of that is due to the share appreciation over the last three months.

Is that all that was or was there sort of a revision in cash flow or maybe a diversion towards something else?

It's a combination of really exercises of options with the share price spiking up a little bit during the first quarter, as well as just the impact of the higher share price on the dilution calculation.

Second question.

Obviously, the new product schedule helped but it doesn't seem of the helped nearly as much in the U.S.

as internationally.

It looks like the U.S.

business was actually flat.

What's the difference there.

Why such a big discrepancy?

The sales figures that we quoted were sell-in figures, obviously.

We'd had a fairly extensive sell in last year as well.

So the year on year in the U.S.

is not necessarily reflective of the success of the products.

If you recall from a couple of calls ago, Europe had just an outrageously bad start of the season because of very severe weather conditions, the World Cup etc.

And in the case of another very big market of ours, Japan, we indicated that there was a fair amount of confusion among the consumers as it related to Japan going to conforming product as of the start of '08.

We felt that, very substantially, that would restrict at least among a significant portion their willingness to buy a product because they weren't sure whether or not to go the conforming or nonconforming products.

If you take a look at what seems to have happened, particularly in Japan, a lot of that pent up consumer response has let go and they are in fact out there buying quite extensively.

In fact, our ERC driver in Japan, our new product, has achieved the number one driver position after being in the marketplace only a couple of weeks.

A lot of that was just pent up purchase intent, if you will, on the part of people holding back for quite some period of time.

I don't really think there's a marked difference in, at least at this early, early stage, from a consumer point of view, domestically versus internationally.

It's more the base, I think that the international markets were starting from, given the way they started last year.

I would just add a couple color commentary.

I think, obviously, FX had a positive impact and if you back it out, I think it was up around 20%.

Europe was actually flat, year over year, because they had a strong first quarter.

It wasn't until the second quarter that the reorders were impacted by the weather.

They are really up against a strong introduction that they had last year.

And to George's point, also in the Asia countries, we've done a little bit more regionally specific products that seem to be resonating with the consumers over there.

If I think about the benefit you got just from the product release schedule in the first quarter, was that purely an international phenomenon -- I mean, obviously the comparisons in general were easier internationally, but did you get any benefit from the new product schedule domestically?

We did in effect, the Fusion drivers were not intended to be released to the marketplace until a month or so later than they actually were, and by doing so we proportionally made the product available on a worldwide basis so that virtually all regions benefited, if you will, by the early release.

Okay.

But again, only in a relatively nominal sense in that the quantities that we had available to release early were in fact conditioned by the fact that we were really building up the introductory quantities at the time, and didn't have the full launch quantities available.

And just related to that, what type of feedback have you gotten from some of your customers in terms of the current -- you called it a relatively minor shortage.

When do you think that's going to be remedied?

What's the timetable at which you think your going to be at full inventory, so to speak, in terms of those new drivers?

That's actually a very good question and one I wish I had a perfect answer for.

At this particular point in time, the demand seems to be accelerating as we try to accelerate the production quantities.

Originally we thought we were clearly going to be caught up before this.

That catch up date has been pushed out somewhat.

But again, very distinctly different from the condition that faced in '05 and '06, where the supply chain, if you will, was undergoing some serious changes and some mending.

At this particular juncture the supply chain is operating extremely well, and in fact are the ramping up their capabilities at a remarkable rate.

The good news, or bad news, depending on which side of the story you're looking at, is that the consumer demand is outstripping even their ability to ramp up the production.

So at this point we're quoting June as our catch up date.

I wish I had huge confidence that we could hold that date, but as the demand continues to increase, I'm not certain.

Thanks, guys.

Our next question is from Bill Chappelle with SunTrust Robinson Humphrey.

Can you talk about the market share gains on the driver side?

Maybe give us a little more color, how much of that was FT-i versus FT5 versus the new Big Bertha products.

Obviously, the bulk of it, at this stage, has been in the Fusion product.

We've gotten extraordinary response to it.

The FT-5 became the Golf Digest's Editor's Choice Award product.

The FT-i is really an extraordinary new technology that I think has captured the marketplace's imagination quite a bit.

So the initial consumer response has been very heavily against those.

The happen to be the higher priced drivers and typically are targeted at the better golfer.

The rest of us, if you will, basically come out and buy a little later in the season, more specifically starting right about now as the season opens up in most parts of the country.

We would expect the share gains to begin shifting to the more traditional titanium drivers as time passes.

And did you see any benefit from the short term recall of [SIMO-2] or is it more just people liked your product a little bit better?

Well, we certainly feel they liked our product a little bit better.

That was an unfortunate thing.

We don't like to see that happen, frankly, to anybody in our marketplace.

I think manufacturing hiccups occasionally occur.

I don't think, in long term, it's going to affect the marketplace as we get further into the season.

On the golf ball side, I was just a little bit surprised by the trends in the quarter.

Is that mainly because you're comping against the higher price version of Top-Flite, or did you still get the full distribution, I guess, it was 900 new green grass stores.

Again, the distribution was extensively larger than it was last year.

You'll recall also that at previous call, we indicated that we were simultaneously, to the relaunch of D2, We were going to clean up the marketplace and get out of the market a great number of the really old products that have been around for far too long and very fragmentary distribution.

So we're, versus a year ago, we're matching up against those numbers.

The important thing is that if you take a look at it from January on when the our new D2 product began showing up in distribution and the marketplace was substantially, but not completely, cleaned up of the old product the Top-Flite shares have on a month to month basis continued to increase.

We're very hopeful that in fact that's proceeding pretty much as planned.

And if it continues as we expect it will, the D2 launch, or the entire Top-Flite relaunch, will go as we hoped.

On the share count, just to make sure I'm clear, you're basically saying it's about a 3 million share increase with the price going up net, then taking off a million shares that you repurchased in the quarter?

That's right.

And the guidance assumes no further repurchases this year.

At this time it assumes no repurchases.

That's where we stand at this point in time.

And the share price is up fairly dramatically over what we've been estimating in our last conference call when we gave annual guidance.

Congratulations on the quarter.

Thank you very much.

Thank you.

Our next question is from the the line of John Shanley with Susquehanna Financial Group.

Please go ahead.

Thank you and good afternoon.

George, are the old inventory of Top-Flite balls pretty much out of the marketplace now?

I'd say substantially.

But there's still stuff around, and we'll probably be around in lessening quantities as we go into the year.

They're becoming much less of a factor as we go forward.

And in fact, all of the marketing thrust, and frankly, most of the trade thrust has been against the new stuff, out of of which is to the good.

We don't think that's going to get in the way of the balance of the relaunch.

Great too hear.

In terms of product margins with the new product, the D2, plus the Callaway ball growth, are you getting substantially better product margins now in the golf ball business than you had this time last year?

I would tell you, John, that the margins are healthy.

I would tell you that as the Top-Flite mix continues to grow, as we're getting the market share gains, those margins are lower than the Callaway line, so just the mix will tend to drag margins down a little bit.

The offset to that, of course, is the fact that a lot of the balls that we're getting out of the line were in fact very low margin stuff and that should help work it in the other direction.

Depending on how the mix ultimately shakes out and we are obviously hoping for continued growth in the Callaway line as well.

It's really hard to predict at this particular time, again, because it's very early in season, how the overall mix is going to affect the margin.

I guess, suffice to say that our production capabilities in balls and the margins that we're generating, are improving based on a lot of the margin improvement projects we talked about earlier.

So that, net of all of this, we should be in better shape.

Great to hear also.

You mentioned the pent up demand in Japan, which certainly registered a substantial improvement, up 45%, as well as the rest of Asia, which was also up strongly, year over year.

Do you expect this demand will continue into Q2 and beyond that point?

And also the strong demand for the product facilitating improved product margins in that market as well?

It would be hard for me to predict with any accuracy.

My presumption is that the season is just opening up there as well, and to the extent there's been a resurgence of consumer interest in buying products this early in the season, there's no reason to assume, short of disastrous weather coming afterward, that it would suddenly stop.

I guess it would be fair to assume that it's going to continue for a time.

And again because of the regionalized product that we've offered in greater quantity this year, and the fact that we've worked on the overall margin of our line entirely, I would expect the margin will continue to improve.

Turning to accessories for a minute, it had the best incremental sales gain year over year of all your product offerings.

Was it mostly footwear?

I know you had detailed that category specifically.

But is the footwear area the real growth vehicle in your accessories business, and will that likely continue as you go forward?

Keep in mind, John, what I tried to point ut in my comments, was the fact that last year, in the second quarter I believe, we purchased our footwear licensee.

So the sales of footwear in the U.S.

were really counted as royalties last year.

This year we got the full increment of the sales side of it.

So that's a portion of it.

The accessories line in total is extremely well.

As a matter of fact in the March share period, our bag business took over the Number 1 slot in the United States as having the largest share and I don't have a history that goes back that far, but this may in fact be the first time that's ever happened.

So in general, the overall accessories business continues to grow quite well and we're also doing pretty well as far as increasing the margin there, also.

In general, this is becoming a pretty important part of our business.

Are the margins and accessories for the most part below those of irons and woods?

Or are they comparable to it?

They tend to be slightly lower.

But as I said, we're taking some initiatives against that, utilizing a lot of what the operations group and supply chain group are doing in general, and we're hoping to improve that situation.

I think, long term, it would not be unfair to assume that accessories will always be somewhat lower than clubs if we're doing our yob right.

That's great to hear.

Lastly, turning to the guidance for the second quarter, can you give us a sense of how much incremental sales in the first quarter may have been generated by taking some business that normally would have been done in the second quarter where you got early --

I don't think we're going to get into that level of detail.

Essentially, the directional color that we had given you saying that the second quarter has typically been larger than the first quarter will continue to stand even though there has been some, you know, nominal shifting from second into first quarter.

That general color guidance, if you will, I think will still stand.

In telling you that we shipped some of the it earlier, we're just making sure no one gets ahead of themselves in terms of what the second quarter might have been if one assumed the first quarter was business as usual.

Can you give us an idea if shipments in April of this year ran ahead of what you shipped in April of '06?

I apologize.

We can't give you that much detail.

I will say that the second quarter is proceeding as planned.

So that there's nothing that's happening at this point that would change our point of view on how the year is coming out, nor, for that matter, would raise any questions about our guidance.

Thank you very much.

Appreciate it.

Okay.

and our next question is from the line of Haley Wolfe with Rockdale Securities.

Please go ahead.

A couple of questions.

First, you talked about the supply position in the FT-i.

Given the complexity of manufacturing is there any one particular area, is there a bottleneck, or is it just the demand was stronger than you anticipated?

Sheer demand, Haley.

The Operations guys have done an extraordinary job balancing out the various steps necessary to complete the club.

We're not finding any particular bottleneck.

We're not backing up at one phase of the production process versus the other.

Just the sheer volume that's being demanded by the marketplace is, unfortunately, right now outstripping our ability to catch up.

And then can you talk about your view on the ratio of FT-i to FT-5 sales?

Yes, I think our original expectation, because FT-i is so different, there were a whole variety of points of view in terms of exactly what proportion of our overall Fusion business that would represent.

And compounded of course, by the fact that it does sell for $100 more than the -- or almost $100 more the FT-5.

It would appear that it is selling in a higher proportion than we had anticipated and much closer to the FT-i in terms of total numbers.

But I will tell you that as the marketplace opens up and we get into the hotter portion of the season, those ratios may change.

So we're staying fairly alert to any shifts that we see coming in from the marketplace.

Right now, FT-i is selling at a much higher level than we'd originally expected.

Your sales, year over year, were up $32 million.

Your gross margin -- your gross profit was up $28 million.

Is that -- I mean you know is that a mix issue is there much cost saving in that number?

That's a pretty good incremental margin.

It's both, as I think Brad indicated in his earlier comments.

Mix certainly has a part to play in that.

We have much higher priced products going this first quarter versus last year, so that mix certainly had an affect on the overall margin.

But at the same time, the margin improvement projects that we talked about are in fact, moving along apace, and are contributing as we anticipated they would to the overall margin.

Last question, you gave the market share numbers.

Can you talk about the inventory share?

The inventory share in the market?

Yes.

The inventory share in the market at this point really doesn't mean much.

Just simply because the market hasn't really opened up.

It's more of a pre-sale that had gone in.

I think that would be a terrific question at the end of the second quarter call.

As I think Brad also indicated in his comments, our plan as we go through the year will clearly be to bring down the inventory, certainly in our warehouses.

Right now if you take a look at the inventory as far as the trade's concerned they're clamoring for more, rather than less, so that might tell you something.

I'll let something else ask questions.

Thanks, Haley.

(OPERATOR INSTRUCTIONS) Our next question is from the the line of Rommel Dionisio, Wedbush Morgan Securities.

Please go ahead.

Good afternoon.

At Analyst Day you talked about automating the production of putters in, I think you said spring or summer, completing the automation of woods and irons.

Can you give us an update and how the cost savings being realized from the automation of putters is coming along?

That process is going on very much as we indicated to you.

At this point in time, virtually all of our putter production is at least being affected by spot automation.

There are certain portions of the production process that were particularly quality related and/or labor related, and the the emphasize was to put automation into those as quickly as possible.

That's been done.

We're in the process of extending that spot automation into irons and both the irons and wood automation process is exactly on schedule.

Great.

Nice quarter.

Thanks a lot.

Our next question is from the line of Kathryn Thompson with Avondale Partners.

I just want to get some clarification on your shipping out of FT-i and FT5, and also your Big Bertha 460 drivers.

I understand that you introduced FT-i and FT5 a little bit earlier, but in essence, it appears you got one month's benefit of sales in Q1 from these new products.

Is that a correct assumption?

Not necessarily.

The presumption would be that we had sufficient quantities to send out to accommodate any and all consumer demand that might have existed at that point in time.

And the fact is that we did not have those full introductory quantities out there.

From a consumer point of view I'm sure we satisfied a portion of the demand, but clearly based on the unfulfilled orders that we currently have in place, clearly haven't fulfilled all of them.

So really Q1 doesn't scratch the surface much in terms of showing any type of benefit from those two product sales.

It does some.

It clearly does some because the products got off to a very good start.

But again, just as a cautionary note, the first quarter is still very largely a sell-in quarter.

It is not a sell through quarter because there are only certain portions in the United States that are actively in the consumer phase of their business.

That begins to open up now and obviously, depending on which part of the country you're in, you'll be seeing a lot of the golf courses opening up and that typically has a marked effect on the consumers coming out to buy new product for the year.

As we get into April and through the second quarter I think we'll see a very dramatic change in the pace of consumer purchases.

This is Brad.

I do think, as I mentioned in my comments, that fact that we were able to ship earlier from what we were looking at, kind of by quarter, we got a little bit more benefit than we originally anticipated.

That's what I was saying that the sum of the sales slid into the first quarter versus our expectations.

George is commenting that, from a consumer demand perspective, we got some benefit, but we certainly didn't meet the demand of all the consumers who had a desire for the product.

That's why we are kind of short in inventory at retail on some of the Fusion products.

Perfect.

Thanks for the clarification.

Also just moving to gross margins, I have to say I was surprised to see that even with what I think is a pretty modest increase in drivers, 6% increase, you were still able to get a 48% gross margin.

This would imply that you would have at at least that if not more going into Q2, assuming that you have a proportionally higher percentage of driver sales in the second quarter.

Are we thinking about that in the right way?

Again, remember the mix question we talked about.

The ball business, which has a lower margin than the sticks do, begins to open up and become a more important portion of the sales as we get into the second quarter.

So you have an offsetting margin affect because balls become more important.

Okay.

Again, obviously, the advances we've been able to make in terms of margin on the sticks will continue into the future quarters as well.

Right, right.

It still seems that on an overall dollars basis, the driver would somewhat outstrip the offsetting effect from the the balls, but that's a good point.

It's a mix issue.

Yes, yes.

Could you clarify a little bit more about what you're going in order to meet demand for lower inventories and stock outs for your driver products?

I think we mentioned at some of the previous calls, there are a number of different things that the supply chain guys are doing that are affecting that.

First and foremost, the responsiveness, the flexibility of our supply chain has materially improved.

We were looking at 90 day lead times in most cases for all clubs coming from the Far East.

In most instances those lead times are now down to as little as 45 days in some cases.

That's substantially changes the amount of in transit [whip] or finished goods that you need to have in the works.

Also there are some improvements, and again the focus right now are improvements in demand planning, which will materially affect the production planning process against the forecasting system that we currently have in place.

That in turn will also diminish the amount of safety stock that we're going to have in order to have a reasonable or acceptable level of customer service.

There was just so many projects along the way that we're working on.

We're quite comfortable with the commitment we made that we'll be able to reduce year ending inventory by 20 to $25 million.

I think we feel quite comfortable we'll be there.

We will be there.

I know it's a situation you haven't been in in a little while but is there any risk to upsetting retailers because you're not able to meet demand or losing sales or damaging relationships because you're not able to meet demand quickly enough?

There again, it's a glass is half empty or full.

Clearly we are not happy not being able to meet demand.

Anybody who likes to claim that being in this situation is a quality problem either doesn't understand or kidding himself.

We clearly do not like to be in a position where we can't meet demand.

On the other hand, our trade partners are extremely happy with the consumer demand they're facing for the product and they're moving out a whole lot of Callaway product in the process, so business is very good.

Also, we are delivering product far in excess of what the original orders were.

We are not only meeting their original expectations, but we're exceeding them by a fair margin.

The good news, bad news part is that the consumer demand is exceeding even that.

I guess depending on how you want to view that, nobody is happy about our inability to meet the full requirement, but we're all quite happy there's an extremely strong demand out there.

We are meeting the demand on many of our products.

We have a couple of spot shortages, but generally we are able to meet the demand on most of the products out there.

So it's a little spotty.

Sure, sure.

Great.

Thank you very much.

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

Edwards.

Please go ahead.

Thank you.

First of all may I offer the congratulations on a much better execution on the year over year basis.

And to circle back to a topic theme here in the Q&A, the gross margins.

First of all, Brad, again, you're mentioning that there's a shift obviously on the sales side with the purchase of the shoe business.

Can you break out for us, so we have a good comparable on the gross margin side, what the shoes contributed in royalties in the first and part of the second quarter and again, your margin performance is even more astounding this year, given that you're not getting that royalty benefit only.

If you could break that out that would be helpful.

Secondly, George, two things on the overall margins.

Can you rank your improvement between mix, your sourcing improvements -- which, again, congratulations on the great execution there, and also your ongoing projects that you're doing with gross margin.

Maybe rank which is the most important here in the quarter?

Let me see if I can handle all those for you.

The licensing fees on shoes are relatively diminimous.

They would not have been a big factor in the first quarter of last year and shouldn't necessarily influence your look at this year's results.

As far as the margin issues are concerned, I guess the best way for me to address that is the commitment we made of delivers 50 to $60 million of margin improvement is very healthy and well executed and is delivering exactly as planned.

So you can certainly continue to count on that pretty assuredly that it will take place.

I won't really break out the difference between mix and margin because I think the mix issue certainly as far as it relates to the first quarter will ultimately sort itself out as we get back through the year.

And to the extend that if we get to the end of the year, we've done disproportionally well in drivers versus some of the other products.

It may effect it to some degree, but I would not anticipate it would be that material.

So you're saying the mix issue overall won't be that material.

It's more collectively, for the full year, will be driven by the changes year over year in sourcing.

The mix issue is going to ultimately sort itself out to be pretty much along the lines that we had given you as far as guidance is concerned, and it would also appear that the margin improvement we also indicated for the year is coming in pretty close to plan.

So that if you put the combination together over the course of the year, I don't believe at this moment in time that there'll be a material variance from what we've given as guidance.

And on the gross margin savings, you're saying the dollar is on plan and the time frame or both or one or the other?

Pretty much both.

You can argue that there are some ups and some downs.

If your net them out right now, as we look at it, everything is proceeding almost frighteningly on plan.

Any time something happening exactly as you planned it, you should start worrying.

And in our particular case, they seem to be coming across exactly as we planned it, so we're quite pleased with it.

Percentages balance themselves out versus last year.

Exactly.

Very good.

Also given that you have a very good product pipeline and obviously exceptional response at retail on a very early basis as you pointed out, how does that pipeline potential look next year?

You guys always do a good job of coming up with decent products.

Should we anticipate such a robust pipeline year over year?

Realistically.

Again, you always hope all your products are going to be blockbusters.

But in reality, should we anticipate '08 as being quite as, from a probability perspective, as good as '07?

I guess without getting myself into too much detail I would tell you the three year guidance that we gave you the alive and well.

In that we have anticipated both the strength of '07 and whatever will follow.

I don't have anything in front of me at this point that would tell me that we're not going to be there.

So without getting into excruciating detail I would tell you that we're pretty much on the three year plan that we talked about and nothing at this point would suggest we get off that.

Clearly as we get further into the year and we give you some more color, and begin to give you some color on what's coming in '08, you'll be able to draw your own conclusions.

But at this point in time, I would not go off track.

And lastly, you alluded I think to part of this, but just to clarify, obviously, you get more benefit of D2 here with the relaunch official relaunch and everything and more product in the channel in the second quarter.

Should we anticipate golf ball sales, which were down on a year over year basis, should we anticipate that seeing a positive number looking into the second and third quarters as you look at your plans right now?

Again, I think we've talked in the past about the fact that our business really consists of two different pieces.

One, the semi-durable piece of clubs and the more consumable piece of balls.

And balls tend to be more related to rounds played.

At this point in time through the month of March, rounds played are down 2%.

But only as of last month.

In February, the rounds played were down 11.1%, so clearly the recovery is in place.

If that recovery continues, then I think you can make your own projections.

If rounds are up, you can expect balls to be up.

If rounds are relatively flat, you can expect -- Now, that's total.

If we gain share as we hope to, that obviously will work in our favor.

And then Brad, if I heard you right in the comment on some of the international breakdown in the Q&A, the majority of the ForEx benefit was through Europe, correct, not through Asia?

I think on a local currency basis, Tim, they were flat and once again they had a pretty good sell-in last year.

The weather hammered them in the second quarter when the golf season didn't really get opened up.

So they were flat.

A lot of the growth we saw was really in the Asian countries, Korea, Japan, and the rest of Asia.

We're actually probably seeing a little as far as FX is concerned in Asia, offsetting a little bit of the gain in the Europe.

Great.

Thank you.

Thank you.

Our next question is from Robert Samuels with JPMorgan.

Can you give us color on how the new Top-Flite marketing campaign is being received and what does sell through look like in those parts of the country where the golf season has started earlier?

As I sort of indicated to you, the D2 share has increased each month from January on when they first began appearing at retail.

That would tell you that it's being well received.

But again, we're dealing with such an early part of the season and the heavy usage period comes up starting from now.

So any conclusion you draw on share, good or bad at this early stage, could easily be reversed when you get into the heavy buying season.

Right now the shares of D2s the share of Top-Flite in total has increased each month for the last three months.

And just regards to the sell through in some of the warmer weather states?

That share increase obviously would be coming from the states where they're selling balls.

On the club side.

I'm sorry?

In terms of driver sales, consumer response to it in some of the warmer weather states like a Florida.

The club sales are terrific.

Remember that people buy clubs before they go out and play.

They generally don't buy that many balls before they go out and play.

The share increases on balls tend to wait for the market.

Some of share increases that we're getting in clubs are not limited just to the warm weather places.

Okay.

Thanks.

The next question is from Harvey Wolf.

Please go ahead.

Oh, Haley.

Excuse me.

I'm sorry about that.

I've heard worse.

Not from us, I hope.

The ball profitability in the quarter was down if I can look at those numbers at face value.

Is that just a function of volume?

Should we see ball profitability start to improve?

And second, the USGA issue with the X460 are your concerned that it spills over to any other metal woods in your product line.

Have you begun testing some of the other clubs to make certain that they are USGA compliant with the COR?

There's no rub-off on anything else.

We in fact have a very extensive testing program.

That one particular loft just had a hiccup and also, not to get too much into detail, but high trajectory lofts are much more difficult to test as it relates to the CT measurement.

So, no excuse.

That one particular loft from one particular manufacturer, there was a limited quantity that had an issue.

We isolated them, stopped, and that's really not a problem.

As far as all the other products are concerned, we regularly test those as we produce them.

So clearly there's no issue with any of them.

You haven't gone back and just assumed that the USGA going to be a little more strict?

We've been in extensive conversation with the USGA.

They understand exactly what happened and it's not been an issue and the remediation that we've taken to fix this minor issue and insure it never happens again was perfectly acceptable to them.

That's not on an ongoing problem for us.

Has that had any meaningful impact?

Not at all.

Virtually -- absolutely of no effect so far.

Okay.

And then on the ball profitability in the quarter sort of going through the year?

You know what, Haley, I would say that for the full year, I think profitability should improve because last year we were closing out a lot of the golf balls, just to get them through the channel.

This year that will not be the case, as we look at it.

As the Top-Flite business continues to grow, once again lower price point, lower margin so that mix could have a negative effect.

But I think, overall, we're kind of anticipating ball profitability to improve over the full year.

Okay.

But you still have a lot of sort of one-off charges last year in Top-Flite.

Yes.

Even as Top-Flite grows, the profitability in the ball business should grow, I would think.

There are a lot of moving parts.

I think it's going to be generally more positive than negative.

Alright, thanks.

Thank you, ma'am.

And the last question comes from Casey Alexander Gilford Securities.

Please go ahead.

Good afternoon.

Somewhere around Avondale's fifth question, I lost my train of thought and forgot my question.

That's quite all right.

Brad, I'll talk to you tomorrow.

Everything else is fine.

Good.

How's the family?

Terrific.

If there are no other questions in queue and we'll turn it back to you, Mr.

Fellows.

Thank you all very much for taking the time with us.

Again, I think our feeling at this particular moment in time is that things are progressing as we had projected.

The guidance we've given you we think is still quite good as amended by Brad just a short time ago.

Clearly, the second quarter is going to be a telling quarter for us.

And while we feel quite optimistic, we think it's appropriate to exercise a reasonable degree of patience and caution as we go into the balance of the season.

We hope to have a very positive call with you in another three months and until then we wish you well and stay tuned.

Thank you ladies and gentlemen.

That does conclude our conference for today.

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