Topgolf Callaway Brands Corp (MODG) 2010 Q3 法說會逐字稿

Good afternoon.

My name is Marcello and it will be your conference operator today.

At this time, I would like to welcome everyone to the Q3 2010 Callaway Golf earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a Q&A session.

(Operator Instructions) Thank you.

I will now turn the call over to Mr.

Brad Holiday, Chief Financial Officer.

Mr.

Holiday, you may begin your conference.

Thanks.

I would like to welcome everyone to Callaway Golf Company's third quarter 2010 earnings conference call.

I'm Brad Holiday.

Joining me today 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'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 related to estimated 2010 gross margins, operating expenses, and earnings, estimated benefits, and charges related to the Company's global operations strategy, the Company's estimated 2010 capital expenditures and depreciation and amortization expenses, and comments regarding a golf industry recovery, future pricing and the return of profitability in 2011 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 the Company's annual report on Form 10-K for the year ended December 31, 2009 filed with the 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 on a consistent and comparable basis, we will provide certain pro forma information as to the Company's performance excluding charges associated with the Company's gross margin initiatives and on a currency neutral basis.

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

The information provided during the call and earnings release we issued today include a reconciliation of such non-GAAP financial measures to the most directly comparable financial measures prepared in accordance with GAAP.

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

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

Thanks Brad, and thank you all for joining us.

The sluggish rate of economic recovery continues to plague the golf industry.

As a result the expected rebound in category sales in the US and other major markets throughout the world has not materialized during the 2010 seasonal period.

While some sectors of the US economy have sporadically begun to show some increased vitality, discretionary consumer durables spending, of which the golf equipment category is a prime example, has not done so.

Following double-digit declines in golf equipment in 2009 versus 2008, results in 2010 year-to-date are very disappointing.

Golf equipment category sales in 2010 year-to-date while less severe, are nonetheless showing further decreases of 3% in the US.

Clearly, the heavy, negative impact on the economic decline -- of the economic decline against two of the strongest of golf supporting industries, financial services and automotive, has delayed the recovery.

Following the first quarter period of some tempered optimism, subsequent uncertainty about the economic recovery and double-dipping in the US, Euro-zone turmoil and Japanese political and economic unrest combined to upset recovering trends in consumer confidence and leading economic indicators and materially impacted in a negative way consumer sell through during the key seasonal buying months in the second and third quarters.

As a consequence, the anticipated category recovery appears to have been deferred to the 2011 season.

Further exacerbating the market conditions have been widespread weather disruptions resulting in a 4% decline in playable hours in the US and a 4% reduction in rounds played.

Anecdotal feedback from many major markets around the world indicate similar conditions existed globally.

Additionally the third quarter reflects some other temporary effects on margin that distort the picture short-term.

And Brad will cover those in more detail shortly.

Despite all of the above we continue strongly in the view that the recovery to a more normalized market is a question of when not if.

Let me review a few objective facts underlying this belief.

Our promotional activity has declined as promised resulting in an almost 300 basis point pro forma gross margin improvement year-to-date.

This is expected to continue through the balance of the year and further improve into 2011.

A concern regarding consumers unwillingness to buy products not on deal following the heavy promotional activity in 2009 has not been fully redressed, but clearly the path back to normal pricing has been initiated successfully.

Price is still disproportionately important to many consumers but it as not as dominant as it was last year.

We will continue our emphasis on full price merchandise into 2011.

Our worldwide share has been maintained and even grown nominally despite this reduction in promotional frequency and level, further supporting the position that the consumer can and will come closer to normalized pricing over time.

Clearly the pace of this return is economy related.

Foreign exchange while less improved than originally expected has moved in the right direction and recovered a significant amount lost in 2009.

Unfortunately, the dollar remains strong in the early part of the year, our biggest volume period.

And therefore mitigated the gains achieved as the dollar weakens.

In response to the economic decline, we have made significant operating expense cuts.

As indicated in previous calls, we have taken a balanced approach to the economic downturn making selective investments in certain growth initiatives and continuing to drive our global operations strategy in order to better position the Company to take advantage of the economic recovery when it does gain momentum.

The payout for these investments is beginning to take shape.

Margin improvement initiatives as part of our global operations strategy continue to deliver meaningful savings despite the difficult economic climate.

Full year savings are expected to reach $16 million this year.

The total benefit from these initiatives will reach between $115 million and $125 million by 2013.

While these savings are being masked by the overall category declines, they are quite real and ongoing and will become more evident as the category recovers.

The investments in growth initiatives are also beginning to payoff with emerging markets like China showing 35% growth this year and our accessories business up 12% year-to-date.

While these businesses can't overcome current category weakness alone they together with other growth initiatives such as India, southeast Asia, and GPS devices will become quite important when the overall business normalizes.

The 2011 line up of new products has garnered significant positive response from our trade partners and is selling in quite successfully.

And finally our recently announced joint development program with the Lamborghini automobile company and the development of another Callaway breakthrough material towards composite reflects recognition of our continued innovative leadership in golf club development and our commitment to excellence in technology.

While the case can certainly be made that economic recovery is in fact taking hold, and is likely to accelerate, we are chastened by our having believed it was going to take hold more aggressively in 2010.

That is obviously the case, and what we believe to be conservative planning assumptions turned out not to be nearly so.

As a result, we are looking to 2011 with an even more prudently-oriented crystal ball and will be taking all appropriate actions necessary against infrastructure and spending to assure that Callaway is profitable in 2011 even if the sluggishness in the market persists to the extent the recovery does accelerate as we hope, it will be a further tailwind to our 2011 planning.

Let me turn the call back to Brad for a more detailed discussion of our third quarter results.

Thanks George.

Our year-to-date financial results reflect the overall softness in the golf industry experienced this year, a result of the continued softness in economic conditions in many of our regions globally.

As George mentioned, our expectations coming into this year were that we would see an improvement in overall global economic conditions, the dollar would weaken relative to 2009 levels and we would see reduced promotional activity at retail compared to last year.

Today while global economic conditions have improved, albeit at a rate lower than we anticipated, the golf retail market has continued to contract compared to last year.

The dollar has weakened this year but with the exception of the Yen, at rates less than we anticipated and it remained fairly strong through the first half of 2010 which is typically our biggest sales period.

And finally we have seen a reduction in promotional activity this year as we expected.

The results of these factors is that we have seen an increase in sales, an improvement in our gross margins through the first nine months of this year.

While unit volumes have decreased this year as some consumers have deferred their equipment purchases, we have seen an increase in average selling prices which we see as a positive trend towards returning to a more normal pricing environment when golf retail sales recover.

We're also encouraged by the fact that our global market share remained flat to up slightly in spite of the fact that we significantly reduced our promotional activity this year.

While gross margins as a percent of sales have improved year-to-date, third quarter gross margins were temporarily affected compared to last year for several reasons.

These include increases in expense related to our global operations strategy, the unfavorable impact of lower sales on fixed cost absorption during the quarter, and increased non-cash inventory related charges.

These inventory charges were primarily the result of the write-off of older incomplete sets of irons that we decided not to incur additional expense to complete due to the impending (inaudible) and anticipated continued softness in the golf retail market at the higher price points as well as residual apparel from our prior licensee arrangement.

We believe that year-to-date gross margins are a more accurate reflection of our current business.

Now turning to the specific financial results for the quarter, we reported consolidated net sales of $176 million, an 8% decrease compared to last year's sales of $191 million due primarily to soft market conditions and fewer promotions this year versus last year.

On a currency neutral basis, sales decreased 10% compared to last year.

We incurred a net loss for the quarter of $18.3 million compared to a loss of $13.4 million last year and a loss per share of $0.33 compared to a loss of $0.25 per share in the prior year.

The loss per share includes after-tax charges associated with our global operations strategy of $0.05 in 2010 compared to $0.01 per share in 2009 as well is a favorable tax benefit due to a revision to the estimated annual tax rate.

Through the first nine months, our sales increased 2% to $782 million compared to sales last year of $765 million.

On a currency neutral basis, sales decreased 1% compared to last year.

We reported earnings per share of $0.09 compared to a loss per share of $0.04 last year.

2010 results were impacted by $0.12 associated with preferred equity issued last June and $0.07 for charges relating to our global operations initiatives.

2009 results were impacted by $0.05 for the preferred equity and $0.04 in charges relating to our global operations strategy.

Taking a quick look at our overall sales by product category, our wood sales for the quarter declined to $27 million compared to $36 million in 2009 and year-to-date wood sales have decreased 4% to $185 million compared to $192 million last year.

Both periods were adversely impacted by the lower level of promotions this year compared to last year.

Sales of irons for the quarter were $48 million, a slight decrease compared to third quarter sales last year of $49 million.

Year-to-date sales in our irons category have decreased 5% to $177 million compared to $187 million last year.

While we have seen a decrease in unit volume this year, we've also seen a slight uptick in average selling prices.

Prior sales for the quarter declined to $16 million versus $17 million last year with year-to-date sales of $87 million an increase of 23% compared to 2009.

We have seen low double-digit increases in both unit volumes and average selling prices for putters through the first nine months.

Golf ball sales were $35 million for the quarter compared to last year's sales of $41 million.

Year-to-date, our total golf ball sales were $144 million compared to $146 million last year.

Because golf balls are a consumable item, unit volume has dropped this year, consistent with a drop in rounds played but we have seen an increase in average selling price per unit.

Accessory sales for the quarter increased 4% to $49 million compared to $48 million last year with sales through the first nine months of $189 million, an increase of 12% compared to $169 million in 2009.

The increase through the first nine months was due to growth in our women's Solaire club sets, increases in sales of golf apparel as well as golf bags.

Turning to our regional breakout, US sales were $76 million for the quarter compared to $94 million last year.

International sales increased 3% to $99 million for the quarter compared to last year's sales of $97 million.

Foreign currency had a positive impact of $3 million on sales this quarter compared to last year so on a currency neutral basis, international sales would have been $96 million or a decrease of 1%.

Through the first nine months, US sales were $390 million compared to $399 million last year.

International sales increased 7% to $393 million compared to last year's sales of $366 million.

Foreign currency had a positive impact of $24 million on sales through the first nine months of the year so on a currency neutral basis, international sales increased 1%.

Gross margins were 27.9% for the quarter compared to 31.2% last year.

As I already mentioned, this decrease in gross margin percentage is due to increased charges associated with our global operations initiatives, negative fixed cost absorption due to lower volumes, and the non-cash inventory charges I've already mentioned.

Excluding charges for our global operations initiatives, third quarter pro forma gross margins were 30.8% compared to 31.7% last year.

Year-to-date gross margins improved to 39.6% compared to 37.3% in 2009.

Adjusted for the charges associated with our global operations initiatives, year-to-date pro forma gross margins were 40.6%, an improvement of 270 basis points compared to 37.9% last year.

Operating expenses for the quarter were $87 million compared to $85 million last year.

Year-to-date, they were up slightly to $294 million compared to $287 million last year due primarily to the negative impact of foreign currency, incremental investment in growth initiatives, and restoration of some employee benefits partially offset by expense reductions in several other areas.

As George mentioned in his comments, we have reduced our core OpEx spending over the past few years and we have reinvested these savings to fund the various growth initiatives associated with emerging markets, expansion of our apparel category and the entry into the GPS category.

Other expenses for the quarter were $2.4 million in expense compared to income of $800,000 in the third quarter of 2009.

Year-to-date other expenses was $5.6 million compared to expense last year of $1 million.

[Those] periods were adversely impacted by the weak dollar and the mark-to-market losses on our forward hedge contracts this year.

Now moving on to the balance sheet, our consolidated net receivables were $152 million at quarter-end compared to $155 million at the end of the third quarter last year.

Consolidated days outstanding increased to 79 days compared to 74 days last year due to an increase in consumer -- excuse me, in customer incentive programs.

Collections on receivables remain good as is the overall quality of our outstanding balances.

Net inventories increased to $230 million compared to $199 million last year due to weak market conditions and the unfavorable impact of FX.

Inventory, as a percent of trailing 12 months, sales was 23.7% compared to 21.2% in 2009.

We ended the quarter with $111 million in cash and no debt and we are in compliance with all the covenants of our credit facilities.

Capital expenditures for the quarter were $8 million and for the first nine months were $15 million.

We are lowering our estimate for 2010 capital expenditures to be approximately $25 million for the year from our previous estimate of $30 million to $35 million.

Depreciation and amortization was $10 million for the quarter and for the first nine months was $30 million and our estimate for the full year remains at approximately $40 million.

The outlook for the year continues to be very difficult to predict due to the uncertainty surrounding consumers' confidence and willingness to buy products as well as the level and timing of the recovery in the golf industry.

We do have a planned new product launch in November of our Octane line of woods albeit at a lower level of sales than new products launched during the fourth quarter of last year.

We continue to estimate that our gross margins as a percent of sales and pro forma earnings will improve compared to last year but we expect operating expenses to increase approximately 2% compared to 2009 due to the negative effect of foreign currency translation, the restoration of some employee benefits suspended last year and incremental investments in some key growth initiatives.

We would now like to open the call for questions.

(Operator Instructions) Our first question is from the line of Scott Hamann with KeyBanc Capital Markets.

Please go ahead with your question.

Good afternoon guys.

Just in terms of retail sell-through, can you differentiate between what you're seeing at the green grass location versus the specialty locations?

I think at the early part of the year green grass sell-through was actually better than anticipated and in fact, from a pricing point of view they tend to sell the more expensive merchandise.

As the off-course kicked in, I think we begin to see the weakness in the overall equipment market and the off-course people, virtually without exception, have had a difficult year from the point of view of hard goods.

Okay and then just on -- with respect to realigning the cost base to be profitable next year, how should we think about the opportunities that you have and maybe the magnitude of what you can do in operating expenses?

We are currently in the midst of finalizing a number of different actions that we will be taking before the end of the year so I really can't and won't go into any specific detail with you at this point.

But I guess you're -- you will have to base your judgments on our past performance when we make statements like that, that we will indeed be able to bring our cost base in line with the level of business that we are currently experiencing so that profitability will indeed return next year.

We feel pretty comfortable that we were going to be able to do that to the extent that the market does improve and I'm being very careful about my presumptions there.

Because I was a bit more positive about that going into 2010.

To the extent that it does indeed improve and there are, of course, signs that indicate that it might -- that will become a tailwind to our business and should actually help us quite a bit.

Okay and then just finally in terms of market share gains, can you run through what numbers you might have and if -- those maintaining are gaining in what's consistent across all the categories?

Well I can.

It's going to be a little complicated and probably better off doing it one-on-one because what we have done is we have tried to take into account what's going on internationally with the data is not directly comparable to the data that we use in the US and also try to take into account, the sporting goods and mass merchandiser categories -- plus as a trade that are not reported on at all in the US.

Overall, on a weighted basis and we are using essentially blended US shares, Europe, Japan, Korea and Canada where we do have data of various sorts.

We believe that the weighted average share in 2010 is approximately 18.9% using the exact same methodology against 2009, the share at that point was 18.5%.

Are you there Scott?

Yes.

Thinking about drivers.

Drivers seemed they were a little bit weak this quarter.

I mean is it fair to say in that category you maintained or gained share?

The one thing you've got to understand about the share data on Drivers and Fairway Woods and Hybrids is last year we had a free Fairway Wood or Hybrid with the purchase of a driver.

So drivers, as far as the data, is -- as it's currently compiled, drivers were classified at full price and no credit was given for Fairway Woods so in essence the driver share was somewhat inflated last year and the Fairway Woods and Hybrid shares were depressed last year.

This year you have exactly the reverse situation, so the drivers' share as reported right now is understated from what it really should be and the Fairway Woods and the Hybrids are overstated.

If you put all of them together, essentially I'm speaking mostly in the US in this case, because that's where the heavy promotional activity occured, the overall wood share is approximately flat on a year-to-date basis.

Now the same conditions didn't exist in most of the international markets and there we did gain some share in the various components of woods.

So if you put that all together and you try to normalize it as best you can like I said it's a fairly complicated problem.

The share in woods overall ticked up slightly on a global basis.

Okay thanks a lot.

Our next question is from the line of Dan Wewer with Raymond James.

Please go ahead with your question.

Thanks.

So George, I wanted to talk about maybe an alternative scenario from what's happening with the golf industry.

That your customer perhaps is willing to spend but they are just simply not finding a new technology in the industry that's significantly different than from a year ago or two years ago.

So when I go to the Apple store, I see your customer lined up buying iPads all day long.

I think that they are willing to spend but there's again just because of the industry rules or what's happened with innovation, there is just nothing significantly different.

How do you go about addressing that, that type of challenge?

Dan, I understand your point and it's certainly something that we examine quite carefully.

The fact is that there are technological changes year-to-year, I think in a more robust economy, the willingness to buy the new technology however different it might be is significantly greater than it is in the kind of economy we are looking at right now.

When we go to our demo days and these are people that are serious about the golf industry and obviously are interested in new products, we are not finding that kind of reluctance as it relates to new technology.

I think the issues that we are facing over the last two years unfortunately is simply an economic one.

The fact is, that golf equipment doesn't wear out.

It's perfectly acceptable to defer the expense particularly when the economics are such that you are reluctant to spend the additional money.

So I think the issue really is more an economic one not a lack of technology.

And in fact if you take a look at the product line that we are introducing for 2011 with forged composite technology the response from almost every level of the business from consumers that we have shown this to, to the trade, et cetera, has been extremely positive.

Price points are compressed somewhat over the last few years obviously, and the overall purchases, both from a unit and dollar point of view, reflect the fact that people recognize that this is clearly a deferrable category.

And as such, is going to be very much victim to their overall confidence in their economic situation.

That unfortunately hasn't improved in 2010 anywhere nearly to the degree that we had anticipated coming into it.

And again like I said, if you're looking for the silver lining, there are clearly signs that it is in fact progressing albeit at a relatively slow rate but we think it's very prudent going into 2011 that we not count on that and we not build that into our planning.

Which again speaks to why we are going to take a very conservative point of view on how we structure and how we spend going into next year.

George I know that Dick's Sporting Goods and Golf Galaxy are your largest domestic customers.

When we visit Dick's, it looks like they are selling a lot of drivers at $149 price point.

I know historically you have wanted to avoid cheapening the brand by going after that end of the segment.

But do you think that we are at the point where Callaway has to reconsider that price point perhaps take advantage of the Hogan brand which I don't believe you've used for several years now -- perhaps as an idea as a way to go after that end of the segment that does seem to have some growth in it.

There are two fundamental issues that you're talking about.

One is the name and reputation of a brand and the other is the ability to make money irrespective of the brand name.

We have very consciously not chased share in the interest of profitability this year.

I think the fact that we have been able to sustain and/or slightly grow our share in view of that fact would seem to indicate that there are a very substantial segment of the golfing population out there that are willing to pay out even under the current circumstances.

We think that's going to continue to improve.

The simple fact of life is without cheapening the product very substantially you don't make money at $149.

This is not where we are going to go.

We can easily affect the revenue line and make some of those share numbers look a lot better.

Unfortunately, the consequence of that would reflect themselves in the bottom line and not particularly attractively.

We've gone through that as a matter of course in 2009.

We do not intend to go through that again.

We think that we can, in fact, structure ourselves to make money even under the current depressed circumstances.

And again, I am firmly of the belief that the marketplace is coming back from a pricing point of view and will continue to do so and as such, we will make even more money when that happens.

We are -- but to be fair to your point, we are clearly looking at that , and deciding whether or not there is another brand name under which we might be able to bring out a line that would address those price points but the key criterion as far as we are concerned is can we make money at it?

If we can, we will certainly address it and try to do that.

If we can't, no, we're not going to play down at that level and the extent to which other people might decide to do that they clearly don't have to talk to you about their

Right, then the last question I had, George.

Either for you or Brad.

Inventory is up 15% roughly year-over-year.

Obviously sales are -- remain tepid.

Could you discuss what type -- where you are seeing the inventory build-up, and how do you work that off without pressuring gross margin rates?

Sure, Scott or Dan, I'm sorry.

Where we are seeing the build-up right now, a couple of things.

We have consciously decided with some of our inventory that is going to be coming out of the catalog to build some opportunity, finish building out some of the clubs early so it doesn't interfere with normal production next year.

And we did a similar thing on some golf ball inventory so that is part of the reason.

Some of it is some new product launches that we are building obviously in anticipation of the Octane launch here in November.

And then lastly, part of it is just the fact that the conditions this year as we build our forecast and buy into inventory was softer than we anticipated so it's a little bit higher than we would have preferred but it's good inventory that we will be able to sell off as the year goes on next year.

So it's a little bit higher than what we would want but I think the quality is good and we made some conscious decisions to pre-build some inventory.

So I feel pretty good about it overall.

And just a little further on that.

Clearly the inventory situation as we go out of the year I think will be better than that because of the new products that Brad mentioned.

Very important issue however is the inventory situation at field level and the fact is that our situation at store level is the cleanest it's been, certainly in my memory in the five or five-and-a-half years that I've been in this business and reflected also in the reaction to, of our sales department as they go around selling in the 2011 line.

So the inventory we have is ongoing inventory which can easily be taken care of next year.

Inventory at the store level is quite controlled and in fact, a little on the light side, which should represent no impediment to the 2011 selling.

All things considered, inventory really is not one of the issues that we are concerned about at this point.

Okay great.

Thank you.

Our next question is from the line of James Hardiman with Longbow Research.

Please go ahead with your question.

Good afternoon.

Couple of questions.

I guess I will ask the retail question a slightly different way.

If we just focus on the third quarter, sales were down I think the number was 19%.

It doesn't seem like the retail numbers were nearly that bad.

Is there -- was there a discrepancy, was there an inventory sell-down, was there a timing issue that made retail diverge from wholesale?

How should I think about that?

There was a fairly heavy activity last year, if you recall, promotionally.

Like we said, we are not -- we are consciously not chasing share in the interest of profitability.

So a lot of the promotional activity that occurred in the third quarter of last year we're not anniversarying.

So to some extent that had obviously a measurable effect on the revenues this year.

Retail sales, as far as retail sales are concerned, may have been fairly soft as well.

Retail not just for us, but for the category in total.

So I think what you're seeing is a combination of our not chasing the very low price promotional stuff together with the fact that as we go out of the season, the number of people coming in to buy promotional merchandise I think is down.

If you talk to a lot of the retailers obviously you do and we do as well, it's very strange but there are other sporting goods categories that are doing rather nicely right now.

The clothing categories are doing rather nicely, golf equipment and I am talking about the hard goods part of golf equipment continues to lag the marketplace and I think clearly at this point in time the consumer has deferred 'til 2011 to come back in the marketplace.

So we don't anticipate the balance of this year as necessarily going to be markedly different.

There may be a bounce in holiday, and there typically is and I anticipate that there will be one this year as well, and the new product that we are introducing reflects that, but as Brad mentioned in his comments, our selling against that is smaller this year than last year in anticipation that the marketplace is still going to be somewhat reduced.

Great and a couple of quick questions on the gross margins.

Brad, you broke out the gross margin impacts, the factors that affected that this year.

Obviously you had the increased spending from the strategic initiatives but then -- which you quantified -- but then is there anyway you could quantify the other two?

Obviously you've got some fixed cost deleverage, but can you give us any numbers surrounding the inventory write-downs on the gross margins?

James, we're not going to go into that level of detail.

I would just tell you that the decision we made typically was irons, for example, as they come out of catalog, we will typically take longer if you will to liquidate them through the retail channel.

So we had a combination of several years' worth of programs, meaning, going back to our Fusion products.

Where with not a better retail environment out there, it is a little hard to sell high-priced irons going into the next year as we look at it conservatively.

So with the impending groove rule hanging over us and not willing to take and invest more money into those high-priced irons, we opted to take the write-down on those irons and that was a majority, the write-downs on those, in addition then also to the apparel front as we are transitioning to our new partner PEI.

We've gone through several rounds of liquidating inventory left over from our other licensees, so we have gone through everything we can and we've written that down to a level where we can liquidate it and get out of inventory but not going to go into details on the specifics within each one.

Let me ask it this way.

Would gross margins have been better than last year had it not been for those inventory charges, excluding the inventory charges as well as the strategic initiatives charges?

Yes, they probably would have been at to slightly above last year had we not had all of those moving parts and I think that's the point we were trying to make was that if you really look at year-to-date that's probably more normalized which shows we are up about 270 basis points compared to last year.

The third quarter because of the timing on some of these charges compared to last year.

It really has -- the timing really affected Q3 so I think it's a better way to look at it from a performance perspective would be on a year-to-date basis because it's reflective and takes out the timing of some of these incremental charges.

Great and just last question.

A bigger picture question.

From a gross margin perspective, if you can get back to, say the high watermark you guys had in 2007 and 2008 from a top line perspective, say $1.1 billion.

Obviously, you have taken a lot of cost out of the business.

If you can get back there from a top line perspective, would you expect to -- would you expect the margins to get back to where they were, that mid-40% level?

Would you expect them to be higher, lower, obviously there are some other factors, presumably your mix would be different.

It's probably a more competitive market, I don't know if you think that longer-term it's going to be more promotional but how should I think about that?

If you can get the top line to work, how should I think about longer-term gross margins?

I think if I could just step in here, the point that we have been trying to make about a lot of the gross margin initiatives and the global operations strategy, the savings there are real.

The unfortunate fact for us right now is that they are being terribly shrouded by the overall economic situation and the category decline.

The fact is that they are real and they are ongoing and they will obviously begin to surface as the marketplace comes back.

So to answer your question, yes, we certainly would expect the margins to get back up to those levels and importantly, I think free up some resources to make further investments in the overall business to make it grow more quickly.

So I don't think we have any doubts about that.

Now whether or not it gets back to that level in 2011 is obviously in question but we have no real concern beyond that, that we will be unable to get to those levels.

Great.

Thanks guys.

Our next question is from the line of Tim Conder with Wells Fargo.

Please go ahead with your question.

Thank you.

A few here.

Brad, just a clarification on your FX comments.

Did you say that it was a $3 million impact to the third quarter?

The top line, that's right.

Okay.

And just in general rule of thumb was that 65% flow-through, roughly, is that still in play?

Well, on an annual basis that's probably a fair assessment Tim, but towards the end of the year when sales become a lower percent of your overall P&L for the quarter, that number will not.

It will vary based on quarter.

But I think on an annual basis, we have said that whatever you see top line probably 65%, 70% would be the amount that would flow-through.

Okay, okay.

That's helpful.

And then staying on the FX theme, could you remind us for your European-based business, could you break it out in geographic sales?

How much of that is exposed to the Euro versus the Pound because I know is tilted pretty heavily skewed one way or the other just the way I think you guys use one as a more functional currency?

It's probably about 40% of our European businesses is in the UK, 60% is continent.

And so we -- everything we report is in Pounds so there is some risk obviously between the Pound and the Euro.

Right, right.

But that has been of a lesser concern, obviously, versus the dollar on both.

And then another point of clarification here.

You mentioned in the press release and I think in a prior release also you have given us an impact of the initiative charges on an EPS basis.

Should we think about that using a diluted share base of the 84 some odd million shares or more of the basic share base which is again, there's a difference of about, I think, $3 million or so.

Yes I would do it on basic shares because if you recall -- I mean, you do -- the way the methodology works is you do your earnings and you do it less dividends on your basic shares, or you take your earnings and you divide it by the fully diluted and you take the lesser of the two, if you will.

So really if you exclude the dividends, you would take it on your basic shares.

Okay.

Okay.

And then finally, I guess this was asked -- parts of a couple previous questions, but looking at what you're doing with -- you have had the close-outs, the inventory write-downs, you're taking the charges here as it relates to what you are doing with lowering the broad Company's cost structure.

If, once we do that and you then hopefully will be able to elevate the earnings power of the Company which you have alluded to.

How much do think you can hold given what TaylorMade is doing in taking their product cycle basically to 12 months across their whole product portfolio?

I mean it would seem like that would put pressure on -- key pressure on pricing overall from the manufacturers regardless of who TaylorMade's competitors are and then potentially have to bring back incremental promotions.

I mean how should we think about that given that strategic decision that TaylorMade is starting to implement?

Well, TaylorMade's been implementing that for some years now so it really doesn't represent much of a change.

I think that they are going to do what they are going to do.

We obviously have no control over that nor do we want to have any control over that.

I think at the end of the day, you have to make your own judgment as to whether or not one enhances or depreciates the value of one's equity -- brand equity when you do that over an extended period of time.

Our choice has been not to do that and to try to maintain as much of a high road as possible.

We do have promotional activity, we do have close-outs so that there is a limited amount of our franchise that does get down into that level.

We do have pre-owned clubs that we do sell that allow some people to get into our products perhaps not with new merchandise but year or two old products, so we have our way of dealing with that.

It has not over the last five years changed our approach to the business and were it not for this downturn that we have now suffered through for a couple of years if you will recall the 2007 results were record-breaking for the Company both in revenue and earnings.

The first half of 2008 was beating the 2007 rate.

We were facing fundamentally the exact same philosophy on the part of some of our competition at that period of time doing quite well with it.

The difference over the last couple of years, unfortunately has been the overall decline in the economy.

Now if you believe that the economy will in fact restore itself and I'm not talking about the timing because that obviously is in question, but will restore itself reasonably to the condition that it was before the decline, then I think you'd have to believe that we are going to prosper in that environment as we did before the downturn.

That is certainly our philosophy and belief and at the same time, we have taken a great number of steps from a cost containment, cost cutting point of view to enhance our business model and the profitability that we generate out of a dollar sales.

So again, I think as the economy recovers, as the golf industry recovers, we are in very, very solid shape to be able to take advantage of that recovery and I don't really see the competitive environment being any more difficult than it has been for the last five years that I've been here.

And we have been able to cope with that quite well so I would expect and in fact, count on our doing so going forward.

What I guess the question is they have been very competitive but it seems like they have taken it to a notch higher in going across their whole product portfolio.

So what yourselves and maybe other people in the industry are doing very, very appropriately to lower your cost structure, is there structural risk to the industry from a manufacturer standpoint I guess is the question.

That a lot of those savings that you're trying to get to raise the profitability level may have to -- may be hard to hold given the additional moves that TaylorMade has outlined here over the last several months.

Listen, it's hard for me to comment on TaylorMade's philosophy and what Adidas expects or doesn't expect of them.

So I'm on ground that I don't feel confident to comment on.

I can only tell you that we are operating the business in a profitable manner.

We intend to continue to do so, we've exhibited the capability of doing that quite nicely before the economic downturn and fully expect that to be the case going forward.

If one believes that an individual in any marketplace can continue to operate in the fashion that you're describing, yes, I guess there are consequences.

I personally don't believe that, that is likely or sustainable over the long term, so I -- again we all go through short-term pain in the process, but we are riding that pain reasonably well.

And I would expect that when it stops, we're going to be in a very good position to take advantage of that.

And one thing I guess from a margin standpoint, also you pointed out and granted, this will ebb and flow over time, but you're -- you should get a pretty decent, if all phases as it is right now, an FX tailwind in your key first half of the season looking into next year, correct?

One would hope that.

Although, I have to say that predicting FX moves is a lot like predicting the weather.

But yes, based on everything that we see, the likelihood for the first half of next year with regard to FX [alone] should be a tailwind.

Great.

Thank you.

Our next question is from the line of Derek Leckow with Barrington Research.

Please go ahead with your question.

Thank you.

Good afternoon.

First question is on the unit volume decline.

As we reflect back here on the 2010 season in the US, how much do you guys think is attributable to permanent closures of either on-course or off-course retail outlets?

And have we seen the industry now finally reset itself to a new normal level, in other words, do we look ahead to next year and think that perhaps we are past a lot of that closure and consolidation?

I think the answer to that is yes but even beyond that, I think you really have to take into account the fact that the golf industry is never understored.

The number of retail outlets dealing in golf merchandise was never at a loss.

So the fact that a number of doors unfortunately closed, I don't think is in anyway going to impair a golfer's ability to find product when they want it.

So yes, I do believe that the majority of closings are behind us and while there may be some sporadic ones going forward, as are always are, that's not going to be a big factor.

But I will also tell you that once you have absorbed the inventory of the doors that are closed, I don't think it really has any lasting effect on the overall retail environment for golf.

So as far as you're concerned your sales in the US at 19% decline, how much of that would you attribute to that issue versus lower sales overall?

Again the 19% decline really had nothing to do with stores as I indicated.

The promotional activity that went on last year versus what we were doing this year, I think is partly the reflection of that decline.

And the fact that the market is even weaker this year than it was last year.

Now it turns out by the way, that there is certain segments of the market that are hurt more -- the driver market which was the most heavily promoted part of the business last year is the one showing the most severe declines this year.

And I think that influenced a lot of what goes on but no, the third quarter results are a function of all the things that we talked about before this.

The retail environment and number of doors really had very little if anything to do with that.

That was more of a factor in 2009 you're saying?

Yes, I think it was an element of 2009 because at that point in time, the doors that closed, they are in inventory that had to be absorbed by the marketplace.

But again the estimate was that there were approximately 250 doors that were closed in 2009 and if you really add that up and compare it to the overall universe, it really didn't represent a particularly large factor even then.

So as we look ahead then I guess some of this has to do with permanent inventory reductions at the existing stores, is that right?

That is correct.

There's not buying as much merchandise.

That is absolutely correct.

I think what clearly began in the latter part of 2008 but really through 2009 was a very concerted effort on the part of most retail to cut back on their inventories and at that point in time cash management was the key issue.

A great number of the retailers in our environment are private equity owned and cash is king in that kind of an environment, so the retail environment was clearly intent on getting their overall inventories down.

They have done that, they did a little more of that in 2010 to date to the point where the inventories are really remarkably clean, remarkably clean right now.

If you go around and take a look at it, and in fact, one could argue maybe a little too clean.

So I don't think any further inventory reduction is likely.

By the same token, I don't believe building back of inventory is likely either.

I think we've all learned some lessons about cash management and I believe that retailers have made that a part of their DNA now.

And so Callaway's response to this, quite correctly, by a number of initiatives to reduce costs over the last couple of years.

As I look ahead to the next two to three years, what -- have you guys quantified what your permanent cost savings goal is?

And could you remind us of what that is?

As I indicated, I think by 2013 based on the projects that we have currently on the table, the overall savings will be in the neighborhood of $115 million to $125 million.

I can't give you an overall target simply because it's really an ongoing process, even as we speak, projects are being added to the list and others that are on the list that are not necessarily living up to our expectations or falling off.

I think that the one number that we are very comfortable with is the one that we have stated which is $125 million -- $115 million to $125 million.

Whether it goes beyond I think will depend on the additional projects that we uncover and our people are working very diligently against that.

As you now, our operations and supply chain people have done an incredible job to date, and I have a fairly high level of degree of confidence in their ability to deliver.

But another benefit just beyond the cost of the efficiencies of the supply chain being able to meet demand more quickly and compressed the timelines down so this wasn't all about cost.

It was also about driving efficiencies through the supply chain, I think that's a very important element that gets lost sometimes.

And also, by the way it facilitates both our as well as our trade partners' ability to maintain low inventories.

Just to remind you that not that long ago, just a few years ago, the length of time between the ordering of a product and our ability to deliver it to our warehouse was in the neighborhood of 100, 135, 145 days.

The changes in the supply chain have gotten down essentially to 45 days on average.

So our ability to turn around on orders that much more quickly obviates the need to keep long inventories.

That not only positively affects your cash management but it also positively affects your close-out risk if you will because you get a lot closer to the marketplace and have to bet a lot less on what might happen.

So overall, these things have clearly reduced costs, but they've substantially changed the paradigm in terms of how the trade is being service.

So 45 days is where you are at today for 2011.

Does it get better than that; is that the targeted number now?

The targeted number is zero.

We are obviously trying to make it better.

And I won't speak for our operations here because they all get nervous when they commit them to a date but obviously they're trying to make it even better than that.

And if I could just ask one more quick one here.

I saw some growth in Asia or other Asia and I'm reminded of the Indian opportunity, you are starting to ship I guess in February, March of 2011, can you --?

No, we shipped in February, March of 2010.

I'm sorry, yes, but isn't it -- are you expecting anything material different next year versus this year in terms of those shipments?

I think they are clearly going to grow.

The model we used is essentially the model we used in going into China, which was a very conservative model that essentially allowed revenue to lead infrastructure and as a consequence, we broke even in China in less than three years.

We are using fundamentally the same approach in India and, given the early signs, there is no reason to believe that similar results won't occur there as it has in China.

As you know, 35% of China has grown this year is -- it follows on a comparable kind of growth in the year prior, and is an expectation going forward as well.

Let me stop there.

Congratulations.

Thank you.

Our next question is from the line of Todd Slater with Lazard Capital Markets.

Please go ahead with your question.

Thanks.

Just two real quick questions guys.

But first of all, if you could just -- a little more obsolescence in your products but in looking back, I'm just curious what is the biggest change in your view in the US market compared to the first half of the year, and then I was also wondering if you could update us a little bit on the apparel initiatives and where you stand there?

Thanks.

Sure.

Well, the biggest change we have seen in the US market, particularly this year I think is a reduction at some level of the promotional activity that went on in 2009.

Much to the good as reflected in the gross margin improvement that we have shown.

It's also reflected in the higher average selling prices that we are seeing going on in the marketplace now.

We think that this is the first step toward normalizing if you will, the pricing environment in the golf industry.

I think that's all very healthy and all to the good.

Clearly the major change that we are looking from the marketplace is a resurgence, if you will, of golfers coming back in the market now.

We have two years of built-up, pent-up buying urges on the part of golfers.

I would have thought that, that would have resolved itself in 2010 and I was wrong.

But the economy and this lackluster manner in which it's recovered I think is a major cause of that.

To the extent that, that begins to look better going into 2011, I would think that some of that purchase power should be coming back in the marketplace.

But at this point in time, we are playing it very cautiously.

As far as the apparel initiative is concerned, we are just in the process of the first line of product that PEI has designed and created for us.

It's done very nicely.

We are gaining additional distribution in places that we are not willing to take the (inaudible) product in the past.

We see a very positive trajectory for that part of the business and it is growing quite nicely.

In addition, PE I is doing quite nicely with it selling it into the trade that we are not responsible for that, specifically department stores and outlets.

We think while we have a long way to go, we think the potential for the apparel part of this business is quite good and it's one of our focuses if you will going into 2011.

Thank you.

Best of luck this quarter.

Thank you very much.

And ladies and gentlemen, we have reached the end of the allotted time for Q&A.

Mr.

Fellows, would you like to add anything further before adjourning the call?

Yes.

Again 2010 has been a very difficult year, and clearly when we came into 2010, we thought the planning assumptions that we had put in place were quite conservative and we were counting on a modest improvement in the overall economic situation both in the United States and throughout the globe.

Quite to the contrary, unfortunately, the recovery in the United States has stalled even though it looks like it might be breaking loose at this point, but it certainly stalled for the good portion of our selling season.

And totally unexpected activity both in Europe and Asia with political unrest in Japan and the whole European Euro-Zone meltdown.

Clearly, deferred what I think would have been a much better year into 2011 and that is certainly our expectation going forward but the one thing that you can be quite well assured of is that we are going into the 2011 period with a very cautious outlook and a very careful financial structure outlook in order to ensure that we do not overstate as we did in 2010.

So clearly keep your eye on the ball with us and we will be talking to you in another quarter and we'll give you some more detail and color on our planning for 2011.

So thank you all for joining us and we'll talk to you again in a quarter.

Ladies and gentlemen, this does conclude today's conference call.

You may now disconnect.