Callaway Golf Company
Q2 2008 Earnings Call Transcript

Published: 31 Jul 2008

[Operator:]

Welcome to the Callaway Golf 2008 second quarter results conference call. (Operator Instructions) I’d now like to turn the conference over to Chief Financial Officer Brad Holiday.

[Bradley J. Holiday:]

Welcome to Callaway Golf Company’s second quarter 2008 earnings conference call. I’m Brad Holiday, Chief Financial Officer. 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 sales, gross margins, operating expenses and earnings per share, estimated charges relating to the company’s gross margin initiatives, future inventory levels, and the company’s estimated 2008 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 to date 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’s business. For details concerning these and other risks and uncertainties, you should consult our earnings release issued today as well as Part 1, Item 1-A of our most recent Form 10-K field 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 a period-over-period comparison on a consistent and comparable basis, we will provide certain proforma information as to the company’s performance excluding charges associated with the company’s gross margin initiatives. In order to evaluate the company’s core operating performance from a cash generation perspective, we will also provide information concerning the company’s earnings before interest taxes, depreciation and amortization. This proforma information may include non-GAAP financial measures within the meaning of Regulation G. The earnings release we issued today includes a reconciliation of such non-GAAP financial measures to the most directly comparable financial measures prepared in accordance with GAAP. The earnings release is available on the investor relations section of the company’s website at www.callawaygolf.com. I would now like to turn the call over to George for a few opening remarks.

[George Fellows:]

We are particularly pleased with the results of the second quarter given the rather difficult economic picture in the U.S. The first half of 2008 represents a record half of both revenue and earnings for the company following record sales in 2007. While the results speak for themselves, let me take a few minutes to add a little color to how these were achieved and our best view at this moment to the outlook for the rest of the year. The first half played out much as we had expected with weak economic conditions in the U.S. limiting sales but continued strength internationally offsetting the softness. The U.S. is down 7% in revenues for the half versus 2007 while international grew 14%. As expected, international represented over half the first six months’ revenues reaching 51%. This lead is expected to continue and likely expand going forward. Our gross margin initiatives are on track to deliver the $50-$60 million in savings as originally projected and are proving to be relatively insulated from overall economic conditions. Having said that, we are clearly facing headwinds with some commodity cost increases and more importantly mixed pressures as U.S. consumers trend toward lower priced products. Despite these issues, gross margins still project to increase at least 100 basis points versus 2007. While this is somewhat below our original expectations, it is still quite a positive picture in this year and a very good indicator for 2009. When comparing our overall results versus the consumer durable and the power peer group, we are substantially outperforming the averages in all the key performance metrics we shared with you in the past. It should be noted that the market has remained rational throughout this period and is expected to remain so for the balance of the year. Little extraordinary pricing activity is taking place beyond the normal markdowns to clear out end-of-life product. Trade inventories are within acceptable ranges and are not expected to be an inhibitor to 2009 selling later this year. As indicated in the pre-release, we are reiterating our full-year guidance. Our expectation is for continued softness in the U.S. being more than offset by the strong international business trends helped along by positive currency rates. We are anticipating a continued rational market and intend no extraordinary pricing or product activity that would in any way jeopardize 2009 performance. A continuation of benefits from the gross margin initiatives and maintenance of tight spending control will provide additional benefits to the bottom line thus enabling us to reach our annual EPS targets. Brad will give you further details on the first half results and the second half projections in a moment. Overall, we believe these are good results requiring more sweat and strain than originally planned but they do position the business well for the second half and the challenges that we’re going to face and very importantly, a strong 2009 recovery. With that, let me turn it back to Brad to give you some details.

[Bradley J. Holiday:]

In reviewing the financial results for the quarter, we reported consolidated net sales of $366 million, a 4% decrease compared to last year’s record sales of $380 million. Net income for the quarter increased to $37.1 million compared to $36.6 million last year and diluted earnings per share were $0.58, a 9% increase versus $0.53 per share the prior year. Excluding 2009 after-tax charges of $0.05 and 2007 after-tax charges of $0.02 associated with our gross margin initiatives, our proforma earnings per share for 2008 increased 15% to $0.63 compared to $0.55 in 2007. Through the first six months, we achieve record sales of $732 million, an increase of 2% compared to last year and record earnings per share of $1.19, an 18% increase compared to $1.01 last year. Excluding 2008 after-tax charges of $0.06 and 2007 after-tax charges of $0.03 for gross margin initiatives, our proforma earnings per share for 2008 increased 20% to $1.25 compared to $1.04 in 2007. Taking a quick look at overall sales by product category, our woods sales were down through the quarter against a record second quarter last year when the FPI and the FP5 drivers were at their peek in sales. For the quarter, woods decreased to $86 million compared to $113 million in 2007. Year-to-date, our woods category has decreased 6% to $203 million compared to $216 million last year. Sales of irons and wedges for the quarter were up 3% to $100 million, compared to second quarter sales last year of $97 million which included significant sales of the very successful X20 irons launched during the first quarter of 2007. This year’s increase was due to the introduction of our new FT hybrids, FT irons and new Big Bertha irons. Year-to-date sales in our irons category were $170 million, the same as 2007. Golf ball sales were $74 million for the quarter, an increase of 3% compared to last year’s sales of $72 million. The increase was driven by strong sales of Callaway-branded golf balls including several new products, but in particular, the strong introduction of the new HX Hot Bite model and the Callaway Tour i and Tour ix balls. Year-to-date, our golf ball sales were $133 million, an increase of 5% compared to last year, despite the U.S. rounds played being down 2% through June. Other sales for the quarter declined to $33 million versus $38 million last year with year-to-date putter sales up 1% compared to last year. Accessory sales were $73 million, an increase of 22% for the quarter driven by growth in nearly every category and are up 23% for the first six months. Turning to our regional breakout, U.S. sales declined to $176 million after the quarter compared to $204 million last year. International sales continued to be strong and were $190 million for the quarter, an increase of 8% compared to last year’s sales of $176 million. In constant dollars, international sales increased 3%. Through the first six months, U.S. sales were $360 million, a decrease of 7%. International more than offset this decline with sales of $372 million, an increase of 14% compared to last year’s sales of $326 million. Most regions have experience positive growth this year with Japan and Europe being particularly strong both in U.S. dollars and local currency. In constant dollars, international sales increased 8%. Gross margins improved for the quarter to 46.7% compared to 46.1% last year. Excluding charges for gross margin initiatives in both 2007 and 2008, proforma second quarter gross margins improved 140 basis points to 48% of net sales compared to 46.6% in the prior year. This increase in gross margin percentage is primarily due to the positive results of our gross margin initiatives and favorable effective foreign currency rates partially offset by product mix. Year-to-date gross margins were 47.3% compared to 47% last year. Adjusted for the gross margin initiatives, profroma gross margins improved 60 basis points to 48.1% compared to 47.5% last year. We estimated charges for the full year associated with these initiatives will be approximately $11 million. This increase in full-year expense is due to the acceleration of some projects associated with our next round of margin improvement initiatives that will impact 2009 and 2010. Operating expenses for the quarter were $111 million compared to $113 million last year, flat as a percentage of net sales at 30%. Year-to-date operating expenses were $221 million compared to $218 million last year, also flat as a percent of net sales at 30%. Currency translation and inflation has had a negative impact on OpEx for the year. The tight management of spending has partially offset this impact and we will continue to carefully manage OpEx spending over the balance of the year. Moving to the balance sheet, consolidated net receivables were $287 million compared to $282 million last year. The DSOs increased to 71 days compared to 67 days last year due to an increase in standard payment terms related to some current year sales programs. Collections on receivables remained good as is the overall quality of our outstanding balances. Net inventories were $236 million, an increase of $10 million compared to $226 million last year and a decline of $28 million compared to the end of the first quarter. Inventory as a percent of trending 12 month sales improved slightly to 20.6% compared to 20.8% in 2007 and we are still on track to achieve our year-end target of 20%. Trailing 12-month EBITDA to the second quarter was $135 million, an increase of 17% compared to the same period last year. Capital expenditures for the quarter were $13 million and we estimate 2008 capital expenditures to be approximately $50-$55 million consistent with our forecast last quarter. Depreciation and amortization was $11 million for the quarter. Our estimate for the full year remains at approximately $35-$40 million. During the second quarter, we repurchased 1.5 million shares of stock for $20 million at an average price of $13.59 per share. We have $80 million left on our November 2007 authorization of $100 million. As George mentioned, we are maintaining our original full-year guidance with sales ranging at the high end of our $1.145-$1.165 billion range and proforma fully diluted earnings per share at the lower end of our $1.08-$1.18 range based on 64.5 million shares outstanding and excluding $0.11 per share for our gross margin initiatives. Let me spend a couple of minutes providing a little more color on this balance of the year outlook. With regards to sales, we estimate that the second half of 2008 will be up year-over-year for a couple of reasons. First, we feel our international business will continue to outperform our last year’s results due to the current lift from positive currency rates along with the fact that in our Japan market which has been outperforming expectations all year, there is a second selling season in the fall that provides some additional upside. We do however expect to see continued weakness in the U.S. market combined with a rational but competitive pricing environment for the balance of the year. We feel our international business will harshly offset this weakness. We also feel we should get a year-over-year lift from limited new product introductions we are planning for the fourth quarter to capitalize on the holiday season. We typically do this every year. We feel the opportunity is larger than we have planned for in the past. In looking at sales by quarter, we estimate the third quarter to be down slightly compared to last year, with the offsetting sales growth falling into the fourth quarter. As George has already mentioned, our gross margin initiatives are on track to achieve our original guidance of $50-$60 million that we provided in 2006 for the two-year time period ending in 2008. Taking into consideration the impact of a shift in our product mix this year and to a lesser extent, the impact of higher oil prices, we currently estimate our annual proforma gross margins will improve by at least 100 basis points compared to last year. While this is lower than original expectations, we are still pleased with the results given the challenging environment we’ve been in this year. Third quarter margins should be up by a similar amount with the larger year-over-year improvement falling in the fourth quarter. We estimate our annual operating expense should be flat as a percent of sales compared to last year. Spending will be higher in 2008 due to the negative impact of foreign currency on our foreign subs, general inflation and some additional marketing investment which are being partially offset by tight spending controls we implemented earlier this year in anticipation of a weak U.S. economy. Please keep in mind that last year’s results included gains from the sale of two buildings from our Carlsbad campus during the third and fourth quarters of $3.8 million and $1.5 million respectively which are responsible for some of the year-over-year increase. Specifically, I would anticipate an increase of approximately $10 million in operating expense during the third quarter compared to 2007 with the balance of the full-year forecast falling into the fourth quarter. Overall, we’re pleased with our results to date. We’ve been able to overcome several challenges so far this year on post-record results. For the balance of the year, we are focused on leveraging all potential opportunities as well as tightly managing our costs both in the cost of goods as well as OpEx areas in order to deliver on our 2008 commitment and set the stage for a successful 2009. We would now like to open the call for questions.

[Operator:]

(Operator Instructions) Our first question will come from Paul Swinland from Stephens, Inc.

[Paul Swinland:]

My first question was on the woods business. Is it correct to say that the woods are one of the major drivers in Japan?

[Bradley J. Holiday:]

We have a particular successful woods business in Japan. We introduced a new brand called Legacy which in a very, very short time has gone to the top of the list there. That continues to be a very strong performer and certainly is at the core of some of the performance we’re seeing there.

[Paul Swinland:]

Are the irons and the putters up in Japan as well?

[George Fellows:]

The putter business is extraordinarily strong in Japan. As you may know, the Japanese tour, I think our share is something in the 60%-70% of professionals on that tour. So we have a very strong presence there.

[Bradley J. Holiday:]

Paul, also in just local currency, Japan as a market is up 22%. Of course, we are getting some uplift on the currency but just in general, their business is very strong.

[Paul Swinland:]

The woods products that are for sale in the U.S., those are for sale in Japan too. Are those actually up in Japan?

[George Fellows:]

The other woods products are second year products as you probably know. The dominant player as far as Japan is concerned is the Legacy launch that we had earlier in the year. That is by far leading the charge, if you will.

[Paul Swinland:]

Just a housekeeping question and if I missed it in the opening remarks, I apologize. On the tax rate, is there anything repeatable there, any color you could give it there?

[Bradley J. Holiday:]

I would still kind of hold at 38.5%, Paul. I think that’s pretty reasonable at this point in time.

[Paul Swinland:]

I know your accessories business has been trending up for awhile but is it kind of the usual suspects there, is there anything particular that you would like to call out that is driving the business?

[George Fellows:]

The accessories business has been pretty consistently strong straight throughout. We’re seeing a very significant uplift almost across the board.

[Bradley J. Holiday:]

Package sets have been very popular for us this year, too. We introduced package set products. This year, also, eyewear has been very strong for us.

[Operator:]

We’ll next go to the line of John Shanley from Susquehanna Financial. Please go ahead.

[John Shanley:]

George, while you mentioned in your prepared remarks that you’re not expecting any unusual promotional activity. Clearly, golf product sales in retail have slowed down with some of the major outlets particularly Dick’s noting in their recent conference call that golf products were off almost 9%. That clearly is going to be building some level of inventory, I would imagine. Are you getting any indications from your retail accounts that they are becoming more promotional and likewise putting more pressure on some of their wholesale components of the business to either lower prices or give some kind of incentives to help lower their excess inventory positions?

[George Fellows:]

Not extraordinarily. In one respect, I think the entire industry was sort of ahead of the curve. Everyone was anticipating a less than bountiful year in 2008 and the signals for that were really early. I think that the trade has been quite careful as far as inventories are concerned. So I think that the pressures that you normally expect because of this kind of a downturn are going to be substantially less. I think that there have been some promotions that also have been very effective. Our gas car promotion, for example, we found was quite successful in moving through a bunch of product. The kind of pricing activity you’re seeing now is atypical of prior years and I think the fact that it’s not extraordinary, it probably is representative of the fact that the overall inventories are not terribly out of line.

[John Shanley:]

Let’s turn to the woods product category. Are there some plans that the company has to try to stimulate that business going forward to try to reverse some of the falloff in sales that you encountered in the last two quarters?

[George Fellows:]

I think as we indicated in some earlier calls, this was an off-year for us in drivers and there was an extraordinary effort against fairway woods and hybrids. We said that we had about a year left to go to try to get the pacing of our new product activity particularly in the woods areas at a level and on a timing that may make some sense. I think you’ll see that we will get in sync certainly for the ’09 year that is clearly going to be a driver year for us and I think the pacing of our new products will finally have arrived at the, I guess at the right spacing would be the way to phrase it. Yes, of course, we’re clearly going to be addressing that and we think ’09 will be very representative of that.

[John Shanley:]

Lastly, just turning to Japan again. Is the growth that you’ve been encountering in Japan in the last couple of quarters, is that sustainable going forward, is the overall market demand for golf products in Japan growing at the same level of your sales increases in that country have been dwindling?

[George Fellows:]

No, we’ve clearly gained share in Japan because of a very successful launch of Legacy. I think it’s fair to say, not to be overly Pollyanna about it, Japan has had to follow the R&A guidelines in terms of clubs as the rest of the world has. I think there was probably some pent-up purchase demand with Japan because if you recall, they had a very difficult driver year before then. I think this is a little bit of catch-up so if anything, the growth as far as the category is concerned is probably higher than I think we should expect over the long course. In our particular instance, the success of the Legacy launch and that entire franchise and the share gains that we’re seeing over there has allowed us to grow even faster than the accelerated market. We certainly hope to continue the pressure on share growth but I would be surprised that the category would be able to sustain the level that they did in ’08.

[John Shanley:]

Can you give us any indication of what you think your market share is in Japan at the present time?

[George Fellows:]

I don’t have those figures here in front of me but we can get back to you on that fairly quickly. The Legacy brand alone, the Legacy driver alone, I know achieved a 9% share which for an individual product in extraordinarily high. As far as the overall share including the other pieces, I’m sorry; I don’t have that figure handy right now.

[Operator:]

Our next question will come from Jay Pardaman, FG & Midwest Securities.

[Jay Pardaman:]

In terms of the new product releases that are going to move into the fourth quarter, what’s the rationale behind bringing that out a little bit early, does that impact ’09 numbers? Obviously you guys haven’t given any guidance for ’09 but how do I think about, how does that affect ’09? It sounds like for the fourth quarter; it helps sales and hurts earnings a little bit. What does that do for ’09? It seems that if you are the only guys out there doing this, screwing things up, this could be an incremental sales driver but are you hearing that anybody else might be moving up their release schedules as well that might sort of make it more necessary that you bring these out early?

[George Fellows:]

Let’s go back to the basic assumption. We’re not doing anything extraordinarily different than we’ve done in the prior years. The fact is that there is a holiday season and there’s a remarkable spike, if you will, in the November-December time frame for golf products and obviously, they’re gifts, etc. We’ve attacked that piece of the business in the last couple of years but we’re actually finding that it’s a bit bigger than we had originally anticipated. So we’ve stepped up a little of our activity as far as holidays are concerned but again, it’s not materially different. It’s slightly more volume than before but not materially different than it has been in the past. So the second part of the question, the role on impact in ’09, we believe that it won’t impact ’09 at all. We think that what we pick up in holiday is essentially incremental to what we’ve been able to get before. We are not taking any steps, and certainly intend to take any steps as we see it right now, that will impact the ’09 products in any way.

[Jay Pardaman:]

Shifting gears, it looks like you guys are accumulating a good bit of cash on the balance sheet. It doesn’t look like your guidance for the back half of the year doesn’t really assume any additional share repurchases. You talked about potentially using cash for acquisitions as we move forward. What’s the contingency there? If you guys don’t do a move from an acquisition standpoint, are you going to continue to accumulate cash or is the expectation that you’ll buy back additional shares if something doesn’t strike your fancy here over the next couple of quarters?

[George Fellows:]

I think our activity over the last couple of years should be a pretty good indicator. We’ve always said that buying back cash shares is clearly on the table all the time as a potential use of cash. We are, however, continuing to be very active in looking at the possible acquisition opportunities that might exist out there. One way or another, clearly, we’re going to sue the cash, if we don’t find an opportunity that makes sense for us from an acquisition point of view. The other alternatives are clearly going to be up for us to consider. Without telling you exactly what we’re going to do, because I’m not sure at this point, I think our actions in the past will pretty much predict what we’re going to do in the future.

[Jay Pardaman:]

It is safe to say that the guidance for the back half of the year does not assume any significant share repurchases? I think based on the numbers, is that a fair assumption?

[George Fellows:]

Yes, that’s a fair assumption, sure.

[Jay Pardaman:]

Last question, here real quick. Can you give us a little bit more color on the commodity costs increases? Which commodities are you getting beaten up on, how much of those prices are locked in going forward and do you think that’s going to have any impact on the incremental gross margin savings you guys talked about in ’09 and ’10?

[George Fellows:]

No, not significantly. Clearly, the biggest area are petrochemical based products which affect the ball and the ball business more. We’ve had prices pretty much locked in for the vast majority of this year. We mentioned it because it’s clearly on top of everybody’s mind but it has not a material effect in overall margins this year. We also see those costs are somewhat sliding backward. We don’t anticipate that they’re going to have any meaningful impact and certainly not an impact on the commitments we made as far a s margins.

[Jay Pardaman:]

Just so I understand, typically, you guys are able to lock in prices based on actual product. It seems like if it’s the ball business that’s getting beaten up the most on raw materials and you came out with your new balls this year, if it’s more of a shift towards drivers and irons next year, is it less of a concern?

[George Fellows:]

It’s not a huge concern to start with because it’s not enough of a move as far as the commodity costs are concerned to materially affect us. We also obviously have pricing options and more importantly a lot of the gross margin initiatives that have been taking costs out of the system, a good proportion of them happen to be in balls as well. So from a margin point of view, that’s not going to significantly going to affect us, certainly not as we see it right now. Then as you say, the emphasis will be going against clubs. We are finding very significant margin improvement initiatives in that areas so we expect those margins to be in pretty good shape as well. I say at this stage, the improvements in margin that we’ve committed to are alive and well.

[Operator:]

Let’s go to the line of Katherine Thompson from Aberdale Partners.

[Kathryn Thompson:]

Just for your fiscal year guidance. Can you confirm what your share count was projected to be for the previous guidance versus what you outlined in the release?

[Bradley J. Holiday:]

I think we had 66 in there originally, Katherine.

[Kathryn Thompson:]

Also, just looking at your cash flow statement, just saw a big swing in working capital. Can you talk through that and what can we expect for the remainder of the year and what can we expect from cash flow from operating activities?

[Bradley J. Holiday:]

I’m sorry, I missed that. What do you want?

[Kathryn Thompson:]

There’s a big swing in changes of assets and liabilities and your cash flow from operations.

[Bradley J. Holiday:]

Right, right. The big swing, if you just take a look at cash flow from operating activities is last year, one of the areas is inventory where last year we garnered a lot of the gains from our inventory reduction initiatives and we don’t have the same level of gains this year. We also actually paid our bonus this year versus last year, there was no bonus paid from a cash perspective. We just accrued it; we didn’t pay one in 2007. We had a little bit of a decline in cash collections due the longer payment terms that I talked about in A/R. That makes up the bulk majority, so three items.

[Kathryn Thompson:]

You talked a little bit about operating expenses in your prepared comments but they were a little bit higher than we were expecting. What was the main driver, particularly for the selling expense and for that line item, how should we think about that and how much discounting is included in that selling expense?

[Bradley J. Holiday:]

You know what, I’m just trying to look at the details here, Katherine, hold on a second. Overall, I think we were flat as a percent of sales. We were up kind of commensurately with sales. We did have OpEx was a negative impact on our business so it would have impacted 50% of our business across all categories, selling G&A, and that certainly had a negative impact year-to-date and will have for the full year. We see that as a negative. We’ve actually been cutting costs from what we had originally considered, plus you have general inflation in there if you just assume a base of about $400 million time 3%, if you assume that as inflation. There’s certainly upward pressure. We actually cut spending this year well against the last year on a dollar for dollar basis.

[Kathryn Thompson:]

I see that OpEx was the main one.

[Bradley J. Holiday:]

I’m sure it was. That’s worth a fairly significant amount.

[Kathryn Thompson:]

Can you just remind us, I think you said in the prepared comments or on the Q&A earlier but I missed it, your tax rate guidance for the back half of ’08?

[Bradley J. Holiday:]

I just gave full year. It was 38.5% which is what you should use for full year. I think that’s sill a good annual number at this point in time.

[Operator:]

We’ll next go to Alexander Paris from Barrington Research.

[Alexander Paris:]

Can you refresh my memory on the gross margin initiatives, the original program was for 2007 and 2008, and now it’s in 2006 for $50-$60 million savings. Now you’re on target for that, so that presumes through 2008 that you will have gotten those savings, right?

[Bradley J. Holiday:]

Correct.

[Alexander Paris:]

Now, you’re talking about margin improvements in 2009 and 2010.

[George Fellows:]

Another 20-30, yes.

[Alexander Paris:]

Is that just the after effects of this program?

[George Fellows:]

No, it’s more initiatives that it’s on top of.

[Bradley J. Holiday:]

As a mater of fact, we’ve taken some recent initiatives that, you know, some of our expenses went up this year that we’re taking a little bit earlier than we originally planned. As you know, we just shut down our Gloversville, New York ball facility. We got some other initiatives that we’re working on right now that will impact ’09 and ’10.

[Alexander Paris:]

So that’s 20-30 million over those two years.

[George Fellows:]

That’s correct, yes.

[Alexander Paris:]

Just looking at the balls, where are you in terms of the Callaway brand balls plus your goal of having Callaway-designed Top-Flite balls? Where are you in terms of having the full list of balls, covering all price points and so forth? Do you still have some Top-Flite balls you want to redesign?

[George Fellows:]

As you know, we’ve been operating over the last couple of years to try and get rid of a lot of the old low-margin Top-Flite balls and significantly upgrade them. That’s been done fairly substantially. The D2 introduction last year and then we had the Gamer and the three introduced this past year. There will be some continued upgrading of the Top-Flite balls going forward. We’re actually gaining some nice traction there and increasing share with Top-Flite and we continue to get rid of sort of the remaining low-end that represent a reasonable number of units but not very much in term so profitability as a consequence. We substantially changed the profitability profile of the ball business for us where we’re now quite comfortably in the black and growing. Just in terms of the ball business as a whole, you should expect a continued influx of new and upgraded balls as the business progresses. That’s just the cost of doing business.

[Alexander Paris:]

Nothing is forever but is this; the closing of this plant is that pretty much it for now or the near term in terms of moving manufacturing around in balls?

[George Fellows:]

We’re constantly in the process of reevaluating that. As I think we’ve mentioned, we’re undergoing a very complete and substantial review of our entire manufacturing and distribution network, if you will. That together with the changes in process and the automation that are being brought to the party by our supply chain and manufacturing group, I think we’ll continue to change our manufacturing footprint. That together with offshore sourcing, it’s going to remain a pretty fluid situation probably for the next several years.

[Alexander Paris:]

Speaking of international outsourcing, you haven’t talked much about, in terms of India and China, at least, those two big countries, can you give just a quick statement of your plans, progress and what opportunities you see there over the next year or two?

[George Fellows:]

Are you talking from a sourcing point of view or a business point of view?

[Alexander Paris:]

No, just overall, from breaking into that market or the market growing or your penetration growing.

[George Fellows:]

As you know, about a year ago, we put a on the ground subsidiary in China which is growing very substantially. Again it is just a very small base obviously, but it’s growing at quite a healthy pace. We see that continuing for quite some period of time. The brick countries in general are clearly very large opportunities for us going forward so we are taking a very close look at the remaining brick countries, that we’re not extraordinarily well-represented in. So Brazil, India, clearly are very important to us. Russia, we have a foothold, but clearly no where near where it’s going to be. Chin is in fact of the brick countries, the first that we’ve put a on the ground sub in. I think over the next several years, I think you will see us expanding more aggressively in the remaining countries as well. Just on top of that, it’s one of the reasons we’re so bullish about our entire international operation, we’re seeing some very substantial growth in Eastern Europe. Again, a lot of the developing countries or countries that are from an economic point of view are playing catch-up; golf is becoming a greater and greater factor. We’re seeing very substantial growth opportunity in those as well. At this point in time, we have lots of geography to deal with and all of which looks pretty good right now.

[Alexander Paris:]

I would guess given the long period of British rule that they would tend to be already more golfers in India than China. Would that be true?

[George Fellows:]

No, not necessarily. As a matter of fact, one would think. I frankly share that point of view until I am so proven otherwise. India is certainly a fertile ground for us but you have to remember, income distribution is a very important part of the development of the golf business and income distribution is moving at quite a pace in China. I think there needs to be a little more of that happening first in India before you see that happening quite at the same pace. Having said that you’re still dealing with a country with a billion people so the opportunity is there even if the income distribution hasn’t caught up with it yet.

[Operator:]

We’ll go to Hailey Wolf from Rockvale Securities.

[Hayley Wolfe:]

A couple questions. First on the conversation about raw material pricing for next year. I know you talked about pressure in the ball business but as you reload programs for products coming into ’09, are you saying you’re not seeing increase in costs of components?

[George Fellows:]

No, as a matter of fact, our component costs are coming down. You know, Hailey, we’ve been very heavily involved in reexamining the entire manufacturing process and supply chain, as you know of course. We have met with a great deal of success in bringing our unit costs down. In ’09, it’s going to be no different. We’re looking at some marked improvements in our overall unit costs. Hailey, keep in mind, one of the things that we’ve done with kind of linking together our product development process and manufacturing is designing efficiencies into the product which has really benefitted also.

[Hayley Wolfe:]

Japan, will you have a follow-on product for 2009?

[George Fellows:]

I don’t think we’re prepared to reveal our new product activity at this moment. You can be assured that we are being very aggressive as far as our new product activity is concerned but I’m careful not to mention specific –

[Hayley Wolfe:]

I’m just wondering about the sustainability of momentum.

[George Fellows:]

I think that the sustainability is certainly there. Clearly, we have a very robust pipeline of products for Asia as well as Europe and the United States. We’re not suffering from any lack of options.

[Hayley Wolfe:]

The fourth quarter product intros, should we think of those as being a niche product or should we think of that as being a new driver put into the market in the fourth quarter?

[George Fellows:]

You should think of them as being a wonderful example of managing one’s new products and P&L. I can’t tell you what it’s going to be but I think the important issue is that it is in terms of the overall volume we’re talking about for ’08, it is not substantially different from prior years. It will not certainly not based on any planning we’re looking at this point in time; it will not affect the ’09 calendar at all. You got to understand; some of the timing that we are doing our new products is really to balance our new products’ flow, if you will. The fact is that yes, there is a holiday season. Yes, there is some incremental volume to be associated with that and also depending on the remainder of the new product activity that we have planned; there is a certain amount of spacing that we have to provide in order to have each product have its day in the sun, if you will.

[Hayley Wolfe:]

You’re basically saying you don’t want to have a repeat of launching the 5 and the i at the same time.

[George Fellows:]

You got it. Thank you for that, by the way.

[Hayley Wolfe:]

You’re welcome. One last question, I remember a couple quarters back, you talked about how the FT3 had legs in year 2 and you thought that you could see that same type of performance from the FT5 and the FT-i. I’m just curious, what’s changed and what you’ve learned from that?

[George Fellows:]

I don’t think that point of view has changed too much. Let’s not forget what the market’s like in this country this year. Both of those products have done reasonably well. They really have. They would have done better have the overall woods business not been down 7% in the first half. So I don’t think I’d change my point of view. I think it’s very important for us to find a way to make sure that products have life in the second year. The new product activity base in this industry as in most other industries has accelerated and if we allow it to go unchecked, you know, it’s going to be a lot harder to manage and make money. We really have to make sure that there is a second year for most new products and we’re working very hard at doing that. I think the Fusion products, the 55 and i have in fact shown that. Unfortunately, ’08 is not the best example of it.

[Hayley Wolfe:]

Do you worry about the Hyper X now that it’s priced at parity to the F55?

[George Fellows:]

No, they’re really two entirely different products. Some products are at end of life and others are not. We’ve actually taken a very hard look at end of life processing of products in route to make sure that we were able to get out of the gracefully without having any undue costs associated with them. So far, that process is working very well for us. It will be refined as we go forward obviously but it’s doing very nicely. The movement through of our inventory appear to be going through quite well. Like I said, at this point, as we look at it, we don’t really see a trade or for that matter, our inventories being an obstacle for ’09.

[Operator:]

We’ll move to Bill Chapelle from SunTrust.

[Bill Chappell:]

Just one quick question, not to beat a dead horse on the holiday issue. Can you give us some color on what you do see for the holidays? I’m surprise that you would pull forward really anything what with what we’re hearing for the consumer going into the holidays. What are your expectations on the holidays this year versus last year, even?

[George Fellows:]

Relatively modest. You know, there are two things we’re doing as far as holiday. There’s some products associated with holiday and I think we have a very reasonable expectations as far as those are concerned. Clearly, we’re looking at the state of the economy and the expectations as far as consumers are concerned, and I think scaling our expectations appropriately. There’s no rosy pair of glasses over at this end of the table, anyway. I think the comparisons year-to-year I don’t think would shock anybody.

[Bill Chappell:]

The comment where you see opportunities where you want to pull forward some product, I would think if the holidays with everything going on, you would want to postpone things until the economic environment improves.

[George Fellows:]

No, there are two issues. Number one, there were certain holiday opportunities that we were not taking advantage of in prior years that we are now going to. So that’s just a matter of doing something that we should have been doing all along but hadn’t. As far as the other part of the question is concerned, there are timing issues for new product introductions that we feel we have to provide spacing in order to get the maximum value and we’re trying to do that spacing with the kind of introductions we’re doing right now. I know what your concern is. I know what everybody’s concern is. Are we sacrificing ’09 for ’08 and the answer to that is an unequivocal no. There’s no point in doing that. ’08 is what it’s going to be. We’re pretty comfortable that we’re okay with’08 so it makes no sense for us to take any chances with ’09.

[Operator:]

We’ll go to Tom Shaw with Steven Nicholas.

[Tom Shaw:]

Mainly clarification on questions at this point. You talked about the gas promo being successful but what did that do from a profitability standpoint in the quarter?

[George Fellows:]

It didn’t affect it terribly. Again, it’s another form of promotion. We would have done something else in its place, and in fact we, in any kind of promotion like that, you insure. Our return on that promotion exceeded what we spent for insurance so it was actually quite a cost-effective promotion for us.

[Bradley J. Holiday:]

Tom, one other thing. It really was a value proposition for the consumer and protected our international pricing opportunities. So in countries like for example, Germany, the Fusion has sold through well all year. We were able to maintain full pricing on that product over there. That’s the reason we did it. One of the reasons we did it.

[Tom Shaw:]

Was there a time frame when both the gas promo and the price drop overlapped?

[Bradley J. Holiday:]

Yes, about two days.

[George Fellows:]

Yes, very short.

[Tom Shaw:]

With some of the GMI costs being pulled forward into ’08, are you expecting any of the benefits also to be pulled forward?

[Bradley J. Holiday:]

No, they should really start to impact us in ’09 but we wanted to get some of these actions taken care of so we can capitalize on them in ’09 as part of our $20-$30 million commitment.

[George Fellows:]

It may indeed pull forward more of it into ’09 because we started a little earlier but it won’t affect ’08.

[Tom Shaw:]

I hate to keep on the tax rate but it’s really, it probably helped the quarter by $0.02-$0.03. Can you give me more clarity on what happened there, you kind of gave guidance for the year but just a little more clarity on what happened in Q2?

[Bradley J. Holiday:]

In Q2, we had a couple of IRS audits that closed so we had a couple small gains but I think from an annual perspective, I still think 38.5% is probably the right number to target. It might be just a tenth or two lower than that but I think 38.5 is certainly in the zone, but for the second quarter, we had a couple of audits that had closed out. We reversed the provisions that we had on the balance sheet for those.

[George Fellows:]

This by the way, is a factor every year. Any company has a whole bunch of these things outstanding at any point in time. You know, they close out when they close out.

[Tom Shaw:]

Last one, it was answered earlier but I don’t know if it was a great answer. What are you carrying with competition in terms of bringing out new product this year?

[George Fellows:]

I thought our answer was great.

[Tom Shaw:]

Would you care to repeat it?

[George Fellows:]

No, as far as competition is concerned, you know, obviously I can’t predict or speak for what they’re going to do. It is not atypical for people to bring out some products for the end of the year. I believe some of our competition did that at the end of last year. Again, it’s a function of a), taking advantage of whatever holiday opportunity they believe exists and or any other thing they may be serving. Again, I don’t anticipate any dramatic differences year-to-year and we are certainly seeing no signs of that right now.

[Operator:]

We’ll go to Romo Diffanicio from Webush Morgan.

[Rommel Dionisio:]

From your earlier product, you had some supply chain issues initially. I wonder if you could just walk through operationally and strategically how assuming that you have some pretty successful launches, I expect you will, how the company has changed, how the supply chain has changed and your ability to meet demand for a hot product?

[George Fellows:]

It’s changed vastly, actually. We’ve changed our process throughout the entire supply chain. Our lead times, for example, when we were having our difficulties, our lead times were in the 4-6 month range. So you would have to put a forecast in 6 months in advance of the time you needed the product. We have reduced those lead times in many cases down to 45 days so that we have that many more forecasting cycles to go through before we have to commit to exact numbers. That reduction of lead time enormously affects your flexibility in terms of being able to adjust to the market. The process that we’ve gone through with many of our manufacturers has shortened their process time as well so that we’re substantially more nimble than ever before. That together with the fact that we now have a pretty robust demand planning function that ahs materially improved the forecasting accuracy that we’re dealing with, and by the way, it has a long way to go yet. It certainly has improved over the past. It essentially has taken us out of the problem area. We have had no difficult whatsoever in supplying virtually every single product this year. We are way ahead of the curve as far as the online products are concerned. I think the difficulties that we face as sort of a supply chain company are pretty much behind us. They are every much a result of the very hard work that the manufacturing and supply chain people have done over the last couple of years.

[Rommel Dionisio:]

A related question, maybe more for Brad. At the end of the December quarter, would we expect to see a roll in inventory billed above normal given the product launches for next year?

[Bradley J. Holiday:]

No, we’re still targeting roll to be down about 20% of trailing 12 months. This is our target. There might be a little bit of timing in there but our target is 20% but generally I would say no.

[George Fellows:]

The issue of overturned inventories is also materially affected by those reductions in lead times that I talked about. Clearly the build-up doesn’t have to be nearly as extreme today as it used to be in the past. So that materially affects the amount of inventory you have to have on hand for your launches and those will come down someday. The other part of it that you really have to take into account is just what is the introductory calendar, how many products are you bringing out and when are the in-market dates that you have established for them because that determines how and where you build your inventories. As far as going into ’09 is concerned, we don’t anticipate anything particularly different happening.

[Operator:]

We’ll next go to Jeff Blazer from Morgan Joseph.

[Jeff Blaeser:]

Have your ’09 growth margin expectations changed and should the difference this year kind of be added on for what you are looking for next year?

[Bradley J. Holiday:]

The gross margin initiatives have played out the way we thought they would. We’re still focused on the nine and ten commitments. Right now, we’ve seen some uptick in our costs because of the things we talked about, the shift in the product mix. If product mix comes back and we’re able to get out in front of, and hopefully oil prices are starting to stabilize, I would say we should be kind of back on track in terms of gross margins again in ’09.

[George Fellows:]

I think mix will become less of an issue based on the introductory calendar that we’re looking at. I wouldn’t expect any impact from ’08 carrying over.

[Jeff Blaeser:]

So it sounds like mix had more of an impact than product cost.

[George Fellows:]

Yes. Yes, by far.

[Jeff Blaeser:]

Do you still have any free cash flow expectations for the year?

[Bradley J. Holiday:]

You mean in terms of targets, Jeff?

[Jeff Blaeser:]

Yes, I know you’ve given three year targets.

[Bradley J. Holiday:]

We haven’t really shared anything on an annual basis. I would just tell you given the way our business is running now, I’m certain that we are on track with what we talked about in our three-year plans. I wouldn’t say I would deviate from that at all at this point and time.

[Jeff Blaeser:]

How would you classify second year product inventory levels at retail?

[George Fellows:]

They’re all within acceptable ranges. We’re going through our normal process of selling through like product. We’re seeing no particular build-up that’s troubling at this point.

[Bradley J. Holiday:]

I think to George’s earlier point. I think the retailers were very cautious going into the year this year. We did just have the successful gas card promotion which moved product through retail so I think generally speaking, retail inventory is pretty good right now.

[George Fellows:]

I’ve got to throw some kudos in the way of the retailers. Sometimes we complain that they don’t want to take as much as we would like them to but I think they were all appropriately cautious going into this year knowing that there were some uncertainties that they were going to face. I think most of them have handled it quite well so I’d be surprised if any of them have any long-term difficulties.

[Operator:]

We’ll go to Casey Alexander from Gilford Securities.

[Casey Alexander:]

Are we characterizing this wrong to say pulling product forward? Is it perhaps was this always part of your plan for the year and it was just our misperception that we wouldn’t see any new product until ’09? Is that a part of why people are struggling with this so much?

[George Fellows:]

I don’t know if that’s the reason. I think when we finally settle on our calendar for our new product introductions for ’09, the timing is always uncertain until you finally decide on how it goes. When we finally decided on what the timing would be, I wouldn’t say it’s a pull forward, it really was just settling down of the schedule. No, there’s not a pull-forward that you were talking about. The products that were intended to ship in ’09 are shipping in ’09. If there’s any of it shipping toward the end of ’08, it was because that’s the way the plan sorted out.

[Casey Alexander:]

I heard five other people discuss this as pulling forward product and maybe that’s not the right way to characterize it.

[George Fellows:]

I would not characterize it that way and I would certainly chastise them if I were you.

[Casey Alexander:]

I don’t think it’s my place to chastise anybody. Another question, it seems to me from the Analyst Day that Thomas’ presentation about the international business was kind of suggesting, as I recall, that he sort of expected Japan to be flat to modestly a big pull form the rest of Asia during the course of this year. It looks like its going the other way. Is that a surprise to you guys?

[George Fellows:]

I think the enormous success of the Legacy introduction represented there was a surprise only in the respect that it was even bigger than we thought. Japan grew 17% last year so the performance of Japan being way up at the top like that shouldn’t come as a surprise. It certainly didn’t come as a surprise to Thomas. I don’t know. Maybe we mischaracterized something, I guess. No, we’re not surprised by how well Japan is doing, it’s even doing a little better than we expected, however.

[Casey Alexander:]

One other thing, Brad, and I know this is pressed digitation but do you want to take a shot at sort of a guesstimated share count for ’09? Obviously, there has been such a change what we working with in ’08, we’re clearly all going to have to move our share counts for ’09. Is there any range or area that you would feel comfortable with us working with right now?

[Bradley J. Holiday:]

Probably, if I were to venture a guess right now, it’s so dependent upon stock price and everything next year, Casey, but probably in that 65 million range right now roughly.

[Casey Alexander:]

So not much up from ’08.

[Bradley J. Holiday:]

I wouldn’t expect much, but it’s really dependent upon –

[George Fellows:]

Well, if you would recommend us Casey, probably the count would go up.

[Casey Alexander:]

And that would hurt the earnings per share if I did that. There’s one other question. At the end of the second quarter, you still have $135 million on the credit facility. Is management just more comfortable with carrying a little leverage on the balance sheet than they used to be 4 or 5 years ago, because 4 or 5 years ago by the time you got to Q3, you clearly had any leverage wiped off the balance sheet and it doesn’t look like it’s going to be that way this year. Are you guys just more comfortable carrying a little bit of leverage on the balance sheet now?

[Bradley J. Holiday:]

I think it is all timing, Casey, and I think during the third quarter, we should be down to zero in terms of the line of credit. I think you have to go back also and take a look at how much stock we repurchased over the last couple of years. The difference was we weren’t buying a lot of stock back in the years when we had $100 million on the balance sheet but we purchase a lot of stock back but I would expect this third quarter to be down to zero in the line of credit and then it will start to build as we start to have working capital again.

[Operator:]

We have no additional questions.

[George Fellows:]

Thank you all for joining us. I know this has been a very troubling year for a lot of people. We have been, we believe, quite successful in coping with it largely because the management team here has been out ahead of the problem. We anticipated that the year was going to be somewhat troublesome if we put in place a lot of controls and some smart planning that was ultimately able to deliver the commitments that we had made to the marketplace. We are focused on that very substantially and we’ll continue to do such. We think that there’s still a lot of very good things to happen in this category. I’m also a believer that we’re seeing far too much negative talk about the economy even beyond where it really happens to be and because of that, I think we’re somewhat optimistic that the recovery for ’09 is very much going to happen. Indeed, if that were to be the case, we’re looking forward to ’09 as being a nice year for us. We still have a very difficult second half to go. I would stay tuned but right now we continue to feel quite comfortable with our projections for the balance of the year and we hope to talk to you about them ion the next quarter. Thank you all very much.