Callaway Golf Company
Q4 2008 Earnings Call Transcript

Published: 28 Jan 2009

[Operator:]

At this time, I would like to welcome everyone to the Callaway Golf Fourth Quarter Earnings Call. (Operator Instructions). I would now like to turn the call over to Brad Holiday, Chief Financial Officer. Mr. Holiday, you may begin.

[Brad Holiday:]

Thank you and welcome everyone to Callaway Golf Company's fourth quarter 2008 Earnings Call. 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 relating to future growth, market share gains, estimated sales, gross margins, operating expenses, earnings per share and cash flow, estimated charges and benefits and the timing thereof related to the company's gross margin initiatives or future initiatives, and the estimated effect of foreign currency on the company's business, 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 needs and other risks and uncertainties, you should consult our earnings release issued today as well as Part 1, Item 1A of our most recent Form 10-K filed with the SEC, together with the company's other reports subsequently filed with the SEC from time to time. In addition, during the call, in order to assist interested parties with period-over-period comparisons on a consistent and comparable basis, we will provide certain pro forma information as to the company's performance, excluding the benefit associated with the reversal of an energy derivative valuation account and 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, and the reversal of a non-cash energy derivative valuation account. This pro forma 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 compared 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:]

Thank you, Brad, and thank you for joining us. The macroeconomic turmoil being faced on a global basis remains relatively unabated. Clearly, we've not seen the bottom as yet and we'll continue to face headwinds into 2009 as we have in the last quarter of 2008. Economic uncertainties have impacted discretionary spending globally and will likely continue to do so through at least some portion of 2009. Together with significant moves in foreign exchange, projecting and assessing business results becomes quite difficult. Now, having said all of that, none of which is news to any of you, I will try to present a realistic picture of Callaway Golf's performance in 2008 and our perspective on 2009 and beyond. These perspectives on '09 will not include specific financial guidance at this time, but we hope that color commentary will be of help to you in assessing our performance and modeling projected results. While we are disappointed that global economic conditions late in 2008 undermined our results in the first half, the underlying performance characteristics and conditions for the company are quite strong, and we believe they bode well for the longer term. And while for some it may be hard to look past the short term, we are both confident and optimistic that we will outperform our relevant peer group when macroeconomic headwinds subside. Now, our reasons for this are manifold. Our brands are strong and have a number one or two share in most categories throughout the world. Our trade relations, I believe, are the strongest in the industry, and we are looked to by most of the large retailers for guidance on structuring their golfing operations. Executionally, we are at the top of our game, having consistently improved our efficiency, reliability and customer service. Our drive for margin and spending efficiency has now institutionalized. We have delivered $56 million in margin initiatives over 2007 and 2008. We are tracking to deliver the next $20 million to $30 million committed to earlier this year for '09 and '10, and have now initiated additional projects that we believe will deliver another $20 million to $30 million over the '11 and '12 timeframe. These efforts have enabled us to largely offset the downward economic pressure in 2008 and will help us as well in 2009. These initiatives have allowed us to generate some of the highest profitability margins in the industry. The new product line for 2009 is one of the strongest in the company's history and was very well received in recent Golf Digest equipment issues. Our pre-books have progressed in accordance with our expectations and are a testament to trade confidence and reliance on Callaway, and support the view that priority is given to major proven brands versus secondary ones in times of economic uncertainty. Our long-term ability to generate cash is strong with a very conservative balance sheet that is free of any long-term debt. We maintain strong working capital and operating expense controls, allowing us to maintain support for our brands and the ability to spend on longer-term growth initiatives. Our solid financial footing has also allowed us to continue to search for appropriate acquisition opportunities that can provide incremental revenue streams within and without golf. A specific example is our recent acquisition of uPlay, a state-of-the-art electronics company with GPS technology for golf range finders and potential applications for other product categories as well. Our organization is stronger than it has ever been, made up of a solid cadre of golf industry experts and consumer products operations, marketing sales and financial professionals that are the best in the business. This talented management group gives us the wherewithal to navigate the difficult market conditions in which we find ourselves. Now, clearly, we can't control the short term economic trends, but we are focused on those elements we can affect, and will continue to manage our operations in a best-in-class manner for the longer term. As far as FX is concerned, we manage the business on a local currency basis also, so as not to make the wrong decisions for the long-term. This should be of some comfort to those with that broader view in mind. I'd like to now turn the call over to Brad to provide more detail after which we can go into the Q&A.

[Brad Holiday:]

Thanks, George. Consolidated net sales for 2008 were $1.117 billion, basically flat compared to a record of $1.125 billion set in 2007 and the second highest sales year in the history of the company. On a pro forma basis, we reported net income of $60 or fully diluted earnings per share of $0.94, an increase of 6% compared to $0.89 in 2007 and in line with the guidance provided at our last earnings call. These pro forma results exclude from 2008 a non-cash, non-operational after-tax benefit of $0.22 per share related to the reversal of a $19.9 million energy derivative account that was established in 2001, associated with the termination of a long-term energy supply contract. Excluded from both 2008 and 2007 results were charges associated with our gross margin initiatives of $0.12 per share and $0.08 per share respectively. Including these items, reported earnings for 2008 were $1.04 per share compared to $0.81 per share for 2007. Consolidated net sales for the fourth quarter of 2008 were $171 million compared to $174 million last year. Pro forma net loss for the quarter was the same as last year at $15 million or $0.24 per share in both 2008 and 2007. Excluded from the '08 pro forma results was the $0.22 per share benefit for the long-term energy supply contract I just mentioned, and from '08 and '07 charges associated with the gross margin initiatives of $0.03 and $0.01 per share respectively. Including these items the reported loss for the fourth quarter of 2008 was $0.05 per share compared to a loss of $0.25 per share in 2007. Taking a quick look at our overall sales by product category, our wood sales for the year were $268 million compared to $306 million in 2007. The year-over-year decline was the result of both lower volume and pricing of our Fusion drivers, which were in their second year in the market, as well as a consumer shift to lower price points driven by recent economic conditions. Fairway and Utility Woods increased in both units and dollars year-over-year. For the quarter, wood sales were $31 million compared to $32 million last year. Sales of irons and wedges were essentially flat at $309 million compared to $310 million last year, due to lower second year sales of the X-20 Irons, partially offset by the introduction of the new Fusion Technology Irons and the X-22 Irons. For the quarter, iron sales were $48 million or 5% higher than last year. Golf ball sales increased to $223 million or 5% for the year, despite a decline in the number of rounds played for the year. This increase was the result of strong sales of the new HX Hot Bite model and Callaway premium golf balls. For the quarter, golf ball sales were $42 million, an increase of 11% compared to last year. Putter sales for the year were $102 million versus $109 million last year, while our accessory business achieved sales of $216 million, an increase of 15% compared to last year's sales of $187 million. The growth in accessories business was driven by increases in package sets, gloves, apparel and golf bags. For the quarter, accessory sales were $37 million, essentially flat compared to $38 million last year. Turning to our regional breakout, US sales declined 7% to $554 million for the year compared to $598 million. For the quarter, US sales were $89 million, an increase of 5% compared to 2007. International sales have been impacted by both the strengthening US dollar and a weak global economy in the second half of the year, similar to what we have experienced throughout the year in the United States. International sales for the full year were $563 million, an increase of 7% compared to last year's sales of $527 million. In constant dollars, international sales increased 5%. Japan had a particularly strong year with sales increasing 39% in US dollars and 21% on a currency neutral basis. China also generated strong growth albeit on a small base, but our investment there is beginning to generate some positive momentum. For the quarter, international sales declined 8% to $82 due to the strengthening US dollar, but on a currency neutral basis showed growth of 1% year-over-year. Full year gross margins were flat at 44% when compared to last year. Excluding charges for gross margin initiatives in both '07 and '08, pro forma full year gross margins were 45% of net sales, the same as last year. Gross margins were negatively impacted throughout the year by negative pricing and mix as consumers shifted their purchase to lower price products in light of the economy. Offsetting this negative trend were improvements in margins due to our gross margins initiatives and the positive impact of currency translation on gross margins. If you recall, in 2006, we announced our gross margin initiatives project with a targeted savings of $50 million to $60 million over 2007 and 2008. The total savings achieved for these two years totaled $56 million on an investment of $21 million, resulting in a very quick payback. Fourth quarter gross margins were 35% in '08 compared to 36% in '07. Excluding charges for gross margin initiatives in both of these years, pro forma fourth quarter gross margins were flat at 37%. Operating expenses for the year were flat at $403 million compared to last year. As a percentage of net sales, operating expenses were 36%, also flat compared to last year, which included a $5.4 million gain on the sale of two buildings here in Carlsbad. Currency translation and general inflation have had a negative impact on operating expenses for the year, but tight management of spending and lower incentive compensation expenses offset this impact. Fourth quarter operating expenses declined slightly to $89 million compared to $92 million last year. As George mentioned, our balance sheet remains strong with no long-term debt. In fact, we've always maintained a conservative balance, and in an environment where liquidity is at the top of the list of importance, that philosophy has certainly paid off. Our consolidated net receivables were $120 million at the end of the year compared to $112 million last year. Consolidated DSO was 65 days compared to 59 days last year. DSO was flat year-over-year in the US with the increase coming from our international business, where we had some term extensions in support of sales programs. We are actively working with our customers, and despite this challenging economic environment, we believe the overall quality of our receivables is good. Net inventories were $257 million at the end of the year, and as a percent of trailing 12-month sales was 23%, flat as compared to the same time last year and down compared to recent historical levels. While the results were slightly higher than our 20% target, we feel this is a reasonable level of inventory, given the amount of time we had to react to the decline in demand that we experienced during the second half of the year and are comfortable with the quality of the inventory we currently hold. Trailing 12-month EBITDA through December was $122 million or 11% of net sales compared to $127 million or 11% of net sales last year. Capital expenditures for the quarter were $18 million with full year spending of $51 million, which is in line with our previous estimate. Depreciation and amortization was $9 million for the quarter and $38 million for the year, also in line with our last estimate. As you know, we completed the acquisition of uPlay at the end of 2008. This is a small, local company that has developed some unique technology around handheld GPS devices used to help improve your game by providing accurate, on course measurements utilizing aerial imagery of each golf hole. We are very excited about this acquisition because it meets our criteria of being accretive albeit immaterial in 2009 in both margins and EPS. Also in addition to the synergies from co-branding these products with the Callaway Golf brand and immediate global expansion of distribution through our existing sales force, it is an extension to our core golf business and provides a technology platform for future growth and future products. As George mentioned, because of the uncertainties surrounding the global economy and currencies for 2009, we are going to defer providing annual guidance at this time. However, I would like to share some of our current assumptions for the year that might help you in modeling out 2009. First of all, we're not sure how the regional economies where we do business will play out in 2009, but in general, we feel there will continue to be a headwind until at least the middle of the year and feel the industry as a whole may be down by 5 to 10% for the year depending on when the economy begins to improve. However, we feel that our 2009 product line, which was clearly a leader in the recent Golf Digest equipment issue, is one of the strongest that we've ever had and believe it will generate market share gains to somewhat offset this decline in the industry. Also we believe that in an effort to manage inventory, our customers will leverage their open-to-buy dollars with fewer and stronger brands, which would bode well for our brand. Secondly, we are assuming that foreign currency translation will negatively impact our 2009 results, given the recent strengthening of the dollar that we have seen, especially in the back half of last year. Current spot rates would indicate that the dollar has strengthened on an average of 10% across the regions where we do business compared to 2008, even with the dollar weakening against the Japanese yen. To help you size the impact of this currency translation on our business, if you were simply to apply these current spot rates to our 2008 level of international revenues of $563 million, the revenue translation impact is approximately $56 million. This unfavorable revenue translation would be partially offset by the positive translation impact on local costs with roughly 65% to 75% of this top-line impact flowing through to pre-tax income. Therefore, the net EPS impact under the scenario would be a reduction of approximately $0.35 to $0.40 per share. Obviously, we can't control the swings in currency. However, we can control our spending, and we have taken several initiatives to reduce our costs in 2009 to help offset a portion of this impact. This includes reducing discretionary spending, while still supporting key brand initiatives and continuing to invest in longer-term projects that will provide high returns on our investments. The bottom-line is that we would expect our reported year-over-year revenues and earnings to be down when compared to 2008, primarily due to the negative effect of currency translation. However, on a currency neutral basis, which we believe is a more appropriate way to judge our operational performance; we estimate our earnings will be approximately flat with 2008 levels. Given the unprecedented economic conditions we are now facing, we would be very pleased with these results. Additionally, I would assume that for the first half of 2009 we'll be more heavily impacted by currency translation due to the fact that the dollar was the weakest during this period last year. Also, since we are coming out of what was a very weak fourth quarter in retail sales and the economy has not yet recovered, we believe the first quarter sales will be more heavily impacted than the second quarter along with the fact that first quarter comps compared to last year will be more challenging given the timing of when the economy began to slow down. I think it's important to point out that despite the impact of currency translation on our results, our core business remains strong. Our brands are global and we are either number one or number two in the major product categories around the world. We continue to improve our supply chain and customer service levels while at the same time reducing our product costs. These initiatives have delivered significant results to-date, and we believe there is a lot of runway left in our ability to further reduce costs. While this volatility in global currencies is unprecedented and will impact year-over-year comps, we remain focused on long-term growth. Ultimately, we are in a period of time now where we believe the strong will get stronger and due to the strength of our brands, our balance sheet and our long-term ability to generate cash, we have a unique opportunity to gain market share and position our company to make strategic financial progress over the next several years. We would now like to open the call for questions.

[Operator:]

(Operator Instructions). Our first question is from the line of Scott Hamann with KeyBanc Capital Markets. Please go ahead with your question. Scott Hamann - KeyBanc Capital Markets Good afternoon. In the fourth quarter, could you give a little color in terms of how much of the sales was attributed to new products versus the old products?

[Brad Holiday:]

The new products that we shipped were right around $40 million. That compares, I believe, with last year's $10 million to $15 million, and I think the year before was more in that $33 million range, So more in line with 2006, Scott, and that was the year prior to 2007 when we had the record year. Scott Hamann - KeyBanc Capital Markets Okay. And then, specifically, what types of things can you do in terms of cost structure and how much flexibility do you have to offset a potential sales decline?

[George Fellows:]

As Brad mentioned, we're taking a very, very hard look at our cost structure, not just from a product point of view, but also various support levels and, generally speaking, have taken a very conservative view on spending categories that we believe are more flexible. We're trying not to cut heavily into support of the brands. Quite the contrary, we're trying to support the brands very strongly during this period of time. But things such as Travel and T&E and a lot of the administrative expenses that we think we have some flex in, we've taken pretty hard cuts at. We have frozen salaries for next year. We have suspended 401(k) matching programs. We've essentially, although not completely frozen hiring, to the extent that we don't have critical positions that we need to fill. There are many, many areas on a worldwide basis that we took a very hard look at and we believe the net combination of those things will allow us to function quite comfortably through the year and still allow us to support the businesses as we feel they need to be. And so, we're not giving you any specific numbers because we can't at this point. We think we've clawed back a reasonable amount to try to offset some of the FX issues. Scott Hamann - KeyBanc Capital Markets Okay. And then, just on the golf ball business, profitability continues to improve there. How far along are you in that process and how much more can you really squeeze out in terms of profitability and how are you going to do that?

[George Fellows:]

We've got a fair amount of runway there as well. Our profitability continues to improve. There are a number of areas that we're working on. I shouldn't really specify exactly what they are, but part of the increase in profitability will come from just improving volumes, part of it will be in terms of how we source, and part of it will be in terms of negotiations that we're conducting right now with a lot of our raw material vendors. As you know, a number of costs spiked last year. They have come way back down again, and we are in the process of renegotiating a good number of those contracts in order to be able to get them in line with what the current day costs are. So, I think we have certainly more runway ahead of us than we have behind us in terms of improving our overall structure. Scott Hamann - KeyBanc Capital Markets Okay. And just to follow-up on the golf ball business. In terms of the Pro V1 situation, as far as the legal implications there, how has the dislocation in that market kind of created an opportunity for you to potentially gain some share in that premium ball market this year?

[George Fellows:]

Well, as you know, the courts sustained the injunction on Pro V1, and they were required to recall all of the old Pro V1 balls from the market. That is ongoing at this point. I will not speak for the trade in terms of exactly what that represented either in disruption to the Pro V1 business, but we believe that it did provide a positive environment for us to expand distribution and potentially expand our user base. Of course, time will tell. We'll see when the marketplace opens up exactly how that plays out. Scott Hamann - KeyBanc Capital Markets Okay. Thank you.

[George Fellows:]

Thanks, Scott.

[Operator:]

Our next question is from the line of David Wells with Avondale Partners. Please go ahead with your question. David Wells - Avondale Partners Yes, hi, thanks for taking my question.

[George Fellows:]

Hi, David. David Wells - Avondale Partners First I appreciate the additional color in terms of 2009 expectations. What are your thoughts regarding free cash flow and how should we be thinking about that?

[Brad Holiday:]

Well, David; we're not going to be getting into a lot of detail at this point in time. I think as we get towards the end of the second quarter, probably after the first quarter conference call, we'll give you some additional color on that. But I think that if you just take a look at what we've been able to accomplish in terms of just EBITDA improvement over the last several years, you can see we're on the track to being a positive cash generating type of a company. Certainly, we have directed some of that cash towards some of the initiatives around [GMIs] that we talked about in terms of gross margin improvement initiatives and as you know, we are doing a renovation of the building out here that will get everybody co-located. So, there has been a little bit of additional cash spend on the CapEx side of the business. And then we also bought over the last couple of years a fair amount of stock back. So, we have the ability to generate the cash. I don't want to give any details at this point in time until we get a better read on the year.

[Brad Holiday:]

And then, towards the end of the year, we bought uPro and our cash flow generation allowed us to be able to do that fairly comfortably. Again, we're going to rethink our priorities going into 2009, given the nature of the business, but certainly the cash generating capability of the business is pretty substantial. David Wells - Avondale Partners Great, and then secondly, in terms of the gross margin initiatives, that are in place and are being worked on for 2009, is there some sensitivity to those; will it be less effective due to decreases in the top line?

[George Fellows:]

Not really. Obviously, volume to some degree affects the overall savings, but in this particular or in these cases, that's not a controlling factor. Many of the initiatives that we're talking about are relatively independent to volume and we should be able to. As we said, we are quite comfortable that we are well on track to deliver the $20 million to $30 million in 2009 and 2010 that we promised last year. And in fact, we've identified a number of other projects that we believe will comfortably deliver another 20 to 30 in the 11 and 12 timeframe. So, these are largely volume independent. David Wells - Avondale Partners Okay. And then a balance sheet type question. In looking at your inventory up slightly from Q3, should we think about those levels being worked off as we go into 2009 and was there some product that was supposed to be shipped in Q4 that got pushed back from a retailer perspective?

[George Fellows:]

Little of both. Yes, you should certainly consider that we are going to be working, rather diligently, to work those inventories off. The 20% target that we had established is still one that we consider very important and would be able to get to. There is no real issue, certainly not in terms any inventories that we carry and as we look at the trade, again, of course depending on how the market opens up and develops later in the year, there doesn't appear to be anything overwhelming out there as well. David Wells - Avondale Partners All right, great. Thank you.

[Operator:]

Our next question is from the line of Tom Shaw with Stifel Nicolaus. Please go ahead with your question.

[Tom Shaw:]

Thanks. Hi, George, hi Brad.

[George Fellows:]

Hi, Tom.

[Tom Shaw:]

Couple of questions. First, could you give us an update on how the commodity prices are working their way into product cost and whether obviously with prices coming down we should see a lag effect and potentially some tailwind maybe in the next couple of quarters?

[Brad Holiday:]

That should in fact be correct. Now recognize that some of the commodities that we bought – we bought in the fourth quarter of last year – those will translate into our inventory cost in the first quarter of this year. The prices that our people are negotiating down and hopefully down rather potentially will begin to show up undoubtedly in the second quarter and beyond.

[Tom Shaw:]

Got you. And you gave a little color on what you expect the industry to look like at 5% to 10%. How are you looking at your retail partners in terms of, obviously, we're seeing a kind of bankruptcies and liquidations out in the industry. But what are you hearing or seeing from some of the bigger players or even the Mom-and-Pop?

[George Fellows:]

Well, I think everybody is cautious and correctly so, because everybody is facing the same uncertainties. The major players in our business are pretty solid and while they maybe planning at least at the early stages of the year, relatively [considers our] outlook. It always is going to depend on how the market breaks. I have to tell you, the reason it's very puzzling is, if we were to be getting only negative stories in, I'd feel somewhat differently, but depending on the day, you get some very interesting stories in of rather robust sales in our local area, and of course you get the [office] in some other areas. It's a very mixed picture at this point in time. And I think it's largely because depending on the news coming out at that particular moment, it either raises or lowers the expectations of both consumers and the trade. That's why we're reluctant to give any very specific guidance at this point, because it's just too fluid a situation. There is a good chance. I mean, I've seen a lot of economic reports that fundamentally say there's an expectation of some mild recovery in the second half of this year. Again, we haven't seen the effect of a lot of the programs that are supposedly going to be put in place rather shortly and how those affect the marketplace relative to the seasonality of our industry that is in question. And so we're just kind of holding our judgment until we see some real action and that will probably be in the April, May timeframe.

[Tom Shaw:]

Fair enough. And one regional question. Obviously you're seeing quite a bit of constant currency strength in Japan and I guess, some of that’s probably attributable to the legacy drivers that were launched.

[George Fellows:]

Yes.

[Tom Shaw:]

How do you lap against that in 2009 and also kind of finishing the Asia discussion, obviously it's a little bit of differing results for some of the weakness that's emerged in the last couple quarters. Could you kind of balance the Japan versus the rest of Asia?

[George Fellows:]

Sure, well, Japan of course has gone out of the year with a great deal of momentum. The legacy line, not just the legacy driver, had terrific success. We have a new legacy product going into Japan. Japan is a market that really requires news virtually every year, so that you don't really have second year product there, per say. And building on the momentum there we had on the legacy line in 2008, we're expecting that our line will do quite well. How the marketplace in general does, given some of the economic issues, I don't know, but the extent to which we can continue to gain share there, we obviously gained quite good in 2008. We will obviously dictate how that market does. We are in very, very strong shape in Japan. Korea is a recovering situation. They obviously face some of the same economic issues. Their currency was not nearly as strong and I think they lag behind the momentum. However, some of the products that we introduced in Japan are beginning to find some traction in Korea as well. And some of that success may indeed bleed into that marketplace. China, as you know, grew very substantially last year in the face of all of this. Again, it was off a small base so you can't over-conclude from it, but that is such a nascent market that I’d expect its growth, while it perhaps may slow somewhat would nevertheless still be there, given the fact that the marketplace is really quite hot. So, Asia in general, I think is still, even with the economic issues that we are facing, an area that potentially is a bright spot.

[Tom Shaw:]

All right. Thanks, best of luck this year.

[George Fellows:]

Thank you.

[Operator:]

(Operator Instructions). Our next question is from the line John Shanley with Susquehanna International Group. Please go ahead with your question.

[Tom Haggerty:]

This is actually Tom Haggerty in for John. Hi, guys.

[George Fellows:]

Hi, Tom.

[Tom Haggerty:]

I was wondering – you talked the last two quarters about a trade down affect you're seeing. Do you think it's substantially affecting any of your premium products in your new product area?

[Brad Holiday:]

That's really hard to tell. Recognize that, we dominate the premium product part of the market and that is not a huge segment of the overall business. So, the likelihood of that segment going to be particularly affected, I think is somewhat diminished because of that. I mean, it's not an insignificant part of the market, but it's certainly not a dominant piece and our position in that is really, really very strong. The early kind of sales figures we got on the holiday shipments of the FTiQ; the most expensive driver we make. We're actually stronger than I’d have anticipated, to be honest with you and it really reflects the unique nature of the golf market. The earlier doctor – the person that really is interested in technology and they are the people that fundamentally dominate that upper segment. Really golf is very high in their priority rankings, and as such the extra $100 for a driver just does not seem to be as important to them as it might be to others. We still think obviously that the $2.99 segment of the marketplace will continue to be the dominant piece. Clearly there has been some discounting by some of our competition of a good portion of their line, and they're certainly feeding off the bottom end of the marketplace. The real question is, how is the middle going to react to the economy, and that remains to be seen, I guess. As I said, I wait until the April-May timeframe before I have a really good picture on that.

[Tom Haggerty:]

Okay, thanks. Fair enough. And another, you were talking about the retail challenge in general, I was wondering, have you seen any particular weakness by channel, with green grass and specially in the big box, and how do you see that going forward?

[George Fellows:]

Well, it's really early to say. A lot of the conjecture about how retail is going to go right now is just because the marketplace really hasn’t opened up. Clearly, the off-course retailers are being cautious, and indeed they were pretty cautious through most of 2008 in order to make sure that their inventories were reasonably kept inline, as they have been going into the early part of 2009. But in virtually all cases, that still is an issue that remains to be seen. The green grass part of the business clearly hasn't opened up in the vast majority of the country. And while they may also be a little antsy and little concerned, we really haven't gotten any consumer feedback on what really the markets going to be like. So, a lot of overreacting to and I don't want to sound Pollyanna about this. But a lot of overreacting to is press hype, which I think has caused a fair amount of cautiousness on the part of all levels in this business. But the only important thing as far as any of us are concerned is what the consumer does when they finally come out of their houses and we don't know the answer to that at this point.

[Tom Haggerty:]

And moving forward, if there were some cancellations or some pushback from your retailers, what reaction time do you guys have to respond to that and keep your inventories in check?

[George Fellows:]

We've been spending the last several years building a great deal of flexibility into our supply chain. And as a consequence of that, we were able, case in point, the fourth quarter, where the retail world really got very conservative and yet while we ticked up a couple of points in inventory, it really didn't get out of line. So, our ability to react I think is quite good. I would be surprised, very surprised if the market changes were to cause us a problem in that area.

[Tom Haggerty:]

Okay, great. Well, good luck going forward, guys.

[George Fellows:]

Thank you very much.

[Operator:]

Our next question is from the line of Hayley Wolff with Rochdale Securities. Please go ahead with your question.

[Hayley Wolff:]

Hi, guys.

[Brad Holiday:]

Hi, Hayley.

[George Fellows:]

Hi, Hayley.

[Hayley Wolff:]

A couple of questions. First, the profitability in the club segment, can you be a little more specific about why it was down so much? And if you shipped $40 million of new product in the quarter, I'm just trying to understand just the gross margin trends?

[Brad Holiday:]

Well, the gross margin trend in the fourth quarter, as you know, is also always the quarter that you close out second year product and by definition the fourth quarter margin always goes down.

[Hayley Wolff:]

Right, sequentially, I know. Just year-over-year.

[Brad Holiday:]

That was the same. It was offset to some degree by the holiday shipments of the IQ product, but it wasn't, as we said; the fourth quarter margin was quite comparable to the year before. So, one sort of offset the other. But it wasn't atypical for the quarter.

[George Fellows:]

But for the year, Hayley, really mix drove a lot of that down, if you will, and just a little bit of lost leverage, if you will, on some of the volumes. It dropped a little bit for us. But mostly, it was just kind of the trade down and price mix, year-over-year profitability. You're comparing it to a much stronger 2007.

[Brad Holiday:]

The reason that we were able to sustain our overall margin levels was a direct reflection of the margin initiatives that we put in place the year before and they were able to essentially offset the downward pressure.

[Hayley Wolff:]

Okay. What was the FX contribution to sales, 2008 over 2007?

[Brad Holiday:]

It was $11 million.

[Hayley Wolff:]

Okay. That's for the year?

[Brad Holiday:]

For the year.

[George Fellows:]

Yes, but you've got to remember, it was wildly skewed, much stronger in the first half and then very negative in the second half.

[Brad Holiday:]

Right

[Hayley Wolff:]

Okay.

[George Fellows:]

The problem with FX, then as now, is that the level, the magnitude of the swings has been really quite extraordinary and nothing like we've seen in any recent year.

[Brad Holiday:]

Hayley, just to put in perspective, it was $11.5 million for the full year. It was a negative $8.5 million for the quarter, because the dollar gained so much strength in the fourth quarter.

[Hayley Wolff:]

And the fall-through formula that you gave us earlier sort of applies to that?

[Brad Holiday:]

Well, not as much in the fourth quarter, because you're having less of an impact on the top line, but you still have what you would call your operating expense at roughly the same level. So, it's got a bigger impact on the operating expense line.

[Hayley Wolff:]

Okay. For 2009 you’ve got three new drivers coming out, two premium price points, one going into that meat and potatoes kind of price point. Help me understand, given that the consumer has really moved in favor of mid-price point, how you intend on marketing the higher price, getting to that consumer to open his wallet, and what's the contingency plan in the event that he or she is not willing?

[George Fellows:]

Well, I don’t think it's a correct judgment to say that the premium buyer has moved down to the middle price point. The thing that they characterized 2008 was a lot of those middle price point people were drawn down by some heavy discounting on the part of some of our competition. So, I think it was the $299 buyer that was attracted down to close out at $199. The upper end – it wasn’t at all clear that they were attracted down. And as I indicated a little earlier, the sell-through of the FTiQ, which is 499, essentially 499 retail driver, was surprisingly solid for holiday. And in fact this year, they came after December just now reflected a very, very positive response to that price point. So, I really think that the market is segmented. I think that there is a little more insulation at the upper end because of the nature of that buyer. And the real question is whether the 299 price point will sustain itself based on any competitive activity that might go on. Hayley Wolff - Rochdale Securities Are these Golf Datatech market shares or are these different market shares?

[George Fellows:]

Datatech. Hayley Wolff - Rochdale Securities Can you share them with us?

[George Fellows:]

Again, I’d caution you – Golf Datatech is at best a directionally useful tool. It is not a particularly accurate one, but from a directional point of view, I think you can take a look at those.

[Brad Holiday:]

Hey Hayley, I’d just add one other point to what George said, is that, if you take a look at last year and the trade down, at least from our company's perspective, is the product we had out there and the FT-5 and FTi were second year products. Hayley Wolff - Rochdale Securities All right.

[Brad Holiday:]

Now, this year we do have new technology out there. So, if there is going to be a year when you would expect people to be back in the premium end of it is, they would go after the newer technology. Hayley Wolff - Rochdale Securities Okay. And then one last question, 2006 operating expense levels, given the outlook for the US economy and then the European economies, what would it take for you guys to ratchet back your spending to get back to the 2006 levels?

[George Fellows:]

2006 levels? Hayley Wolff - Rochdale Securities You were at $360ish million in total operating expenses and now you're at $400 million?

[Brad Holiday:]

FX is a big contributor to the increase.

[George Fellows:]

Yes, FX – it's not a very directly comparable measure, because FX is an important part of it. Whether or not we pay discretionary bonuses during a given year is very much a part of it. I mean, there are a lot of other big pieces to that.

[Brad Holiday:]

And I think Hayley, the other thing – if you just take a look at that level as a percent of sales back then, it was roughly right where we are now, mid-30% range. So, it's relative to the sales level. Obviously, with higher sales we have higher variable costs associated with sales, commissions, selling force, advertising to drive the sales.

[George Fellows:]

It's not vastly different from an overall percentage point of view. Hayley Wolff - Rochdale Securities Right. Let's assume that sales decline in 2009.

[George Fellows:]

Look, I can't conjecture what's going to happen. I can assure you of one thing, that we have our primary focus on the bottom line and depending on how the business develops, we're going to take every step necessary in order to protect that bottom line to the fullest extent possible, but to conjecture about what we would do at this moment, I couldn't even begin to do that.

[Hayley Wolff:]

Okay. Fair enough.

[Operator:]

Our next question is from the line of Derek Leckow with Barrington. Please go ahead with your question, sir.

[Derek Leckow:]

Thanks, good afternoon. Just two quick ones here. Do you guys anticipate, all things being equal – do you anticipate sales mix to be a positive or negative impact on gross margin?

[George Fellows:]

We certainly view it to be a positive this year.

[Derek Leckow:]

Okay. Thank you. And then your CapEx level of $51 million last year, what do you anticipate for 2009?

[Brad Holiday:]

We're not really providing that right now. We will, as we give full year guidance, but we do still have the completion of this building renovation, which will keep it a little bit higher than what we've averaged prior to this past year. But we'll give you more detail as we get into the – probably, post the first quarter.

[Derek Leckow:]

Okay. So, it should be heading down to your D&A level, is that about right, about $40 million?

[Brad Holiday:]

I wouldn't say that's true for this year. I think a year out perhaps, but we still have some stuff that is still in process right now.

[George Fellows:]

And also, I caution you to note that, when I identified the additional $20 million to $30 million worth of cost savings, if you will, there are some expenditures associated with that as well. Now, the payback on those kinds of investments is quite attractive and we're going to balance the speed with which we pursue those with the cash that we're generating based on how the business goes. So, there are too many moving parts at this particular point in time and we will be in a much better position to give you more specific guidance in another few months.

[Derek Leckow:]

Okay. And then just in terms of ranking your priorities, in terms of the free cash flow here, is it still going to be share buyback followed by acquisitions followed by your dividend, or will that change somewhat this year?

[George Fellows:]

Well, again, all three of those things are obviously the primary uses for our cash. We found a very attractive and interesting acquisition this year, albeit a small one, and we decided that was a very good place to put cash. Last year of course we were a significant buyer of our own stock again, because we thought that was a good use of cash. Depending on how the business develops this year, all three of those things are obviously in the mix, but I can't conjecture at this point how we'd go.

[Derek Leckow:]

Okay. Fair enough. Thanks guys. Good luck next year.

[George Fellows:]

Thank you.

[Brad Holiday:]

Thank you.

[Operator:]

Our next question is from the line of Kristine Koerber with JMP Securities. Please go ahead with your question.

[Kristine Koerber:]

Yes, hi. A couple of questions. First, can you just talk about retail pricing overseas, in particular Japan? I know your premium price. Is pricing holding up fairly well?

[Brad Holiday:]

Yes, pretty much so. We have a pricing strategy by region of the world relative to US pricing. The internet has made it into a global marketplace, and so that we're not only constrained by the pricing within market, but we're also constrained to some degree by the pricing across regions. But we will continue to maintain a premium price in the Asian markets as appropriate and we have made adjustments in '08, to ensure that difference did not get out of hand and FX movement does impact that quite substantially. We also made pricing adjustments in Europe last year as a reflection of FX moves and have continue to do that based on the new FX benchmarks that we have. So, we are typically premium priced in international markets relative to the US price based on whatever the spot rates are at that moment. Kristine Koerber - JMP Securities Okay, thanks. And then with regard to the additional $20 million to $30 million in gross margin savings that you identified for 2011 and 2012. Can you just give us a little more color, I mean, are these new areas or maybe elaborate on that?

[Brad Holiday:]

They are new areas, largely. I guess, the only thing I can suggest at this point, because we really shouldn't and can't give you specifics, is I hope at this point in time we've generated enough credibility out there to accept the fact that if we commit to a savings number based on some changes that we're making in the business, we have in fact delivered every single one of them and over delivered in some cases. So, we're very comfortable with the $20 million to $30 million for 2009 and 2010 and we're quite comfortable with the $20 million to $30 million that we're projecting 2011 and 2012. We have specific projects in mind. They’re on the table. We’re working out the details on them right now. And as we get further into this year and those projects become a lot more fleshed out than they are right now, we'll be very happy to share that with you. Kristine Koerber - JMP Securities Thank you.

[Operator:]

Our next question is from the line of Jeff Blaeser with Morgan Joseph. Please go ahead with your question. Jeff Blaeser - Morgan Joseph Thanks for taking my question. Did the early product launches give you any added insight into the buying patterns that you're seeing at the retailers, pre-books translating to actual orders?

[George Fellows:]

Well, the holiday shipments that we made last year actually led to, again, if you take a look at the Datatech numbers, actually led to some fairly measurable and interesting share increases. So, that our presumption, that there is indeed a holiday market out there has been borne out now two years in a row, because we had seen some benefits associated with this limited shipment of holiday product. That is one of the positives that makes us feel that potentially this marketplace is not going to be as constrained as I think a lot of people are suggesting. But the fact is that, we don't know and until the marketplace opens up, i.e. people start playing golf and you really see what their appetite for a new product is, I’d not over conclude from the fact that holiday seemed to be okay for us. Jeff Blaeser - Morgan Joseph Okay. And then you mentioned, do you expect the industry to be down about 5% to 10%. By comparison, what was 2008 down in the back half of 2008?

[George Fellows:]

2008 as a total year was down 5%, in the US was down 5%. And by the way, our presumption on 5% to 10% for next year is solely based on the uncertainties that we're hearing about. I have no very hard data that would necessarily support that, but I think it's prudent, both from our point of view, as well as from the feedback that we're getting from a great deal of the trade, that is their expectation or at least their planning assumption. Clearly, we have, as do they, the ability to chase the market if indeed it does better than that. So, in this kind of a marketplace, you're better off chasing volume rather than overproducing and then having a problem at the other end. Jeff Blaeser - Morgan Joseph Okay. Would be fair to assume similar rates overseas, FX excluded?

[George Fellows:]

I don't think that would be unfair. Again, you're talking category now. We think certain markets, potentially Japan for example, where our momentum is quite substantial, our performance might exceed the marketplace more dramatically than we expected to in some other places. And we feel pretty good based on the acceptance of our product line that we hope to do better than the market. Jeff Blaeser - Morgan Joseph Okay. Thank you very much.

[George Fellows:]

You're welcome.

[Operator:]

Our next question is from the line of Tim Conder with Wachovia. Please go ahead with your question.

[Tim Conder:]

Thank you. A couple of clarifications, gentlemen, and thank you for all the details so far. Could you just clarify for us the percent of your sales that went to Canada and Korea during 2008?

[George Fellows:]

No, Tim. We don't usually give that level of detail. We usually give international and then the major markets.

[Tim Conder:]

Okay. And then Pro V1, to circle back to that topic, any upcoming court dates or additional hearing dates or anything that we should keep our eyes peeled for?

[George Fellows:]

The court system operates at its own speed. All I can tell you is that, all challenges to the jury decision we've essentially been sustained. Their last appeal was in fact before the courts now and we'll have to see how it comes out, but there is no way for us to predict exactly when the courts are going to act.

[Tim Conder:]

Okay. And on that front George, granted that they've ruled out a so called new and improved, probably one product, do not infringe over the court ruling, but two questions I guess. Would there still be the potential in your opinion of a settlement on the product that has been ruled to be infringed? And then, is there anything that you are looking at from the standpoint of the new product that they’re going to introduce in the market?

[George Fellows:]

I appreciate the question and I also appreciate the fact that you have no chance of my answering it.

[Tim Conder:]

We will try, okay. The circle back, Brad, on a clarification, I think you were giving some directional color. If I heard you right, again the first quarter of 2009 you're anticipating being down, given the tough comp, given the tough comp on currency and then also looking at some maybe backup in the channel. Was that fair?

[Brad Holiday:]

Well, I wouldn't call it backup in the channel. I think, Tim, what I was trying to point out is we're exiting a pretty poor retail environment in the fourth quarter. And the question, as George pointed out is, we don't know how quickly that will recover and at this time last year the economy was nowhere in the shape it is right now. So, the year-over-year it’s going to be worse. So, it didn't have anything to do with just backup in the channels. As a matter of fact, we have carefully worked with our retailers and to George's point, they have been very conservative about their purchases of inventory. And frankly, still looking at the inventory or the Datatech numbers we see, I think, we're still under-inventoried in several categories. So, I don't see it being any backup. Its more related to the fact that the economy has not begun to recover and I think that's going to make it a tougher year-over-year comp as well as FX was going to have a bigger impact in the first half of the year than in the second half.

[Tim Conder:]

Okay. And then along that line, gentlemen, and in respect to the previous question also, grant last year there wasn't as much of good product out there and now yourselves along with several of your competitors have some very good products out there. What's your comfort level or not that given that, and given the backdrop of the economy, that you won't see the similar type of discounting going on? It gets back to the trade down question that was asked earlier?

[George Fellows:]

Well, Tim, listen, we operate our business on a fairly simple presence principle and that is we want profitable business. We're not in the business of discounting for the sake of discounting. I can't speak for everyone else in the industry and to the extent that they want to conduct themselves in that fashion, I have no control over that, obviously. I think that if we see any of that, it won't be until the second half because we have to give the market a chance to develop and show what it's going to do.

[Tim Conder:]

Right.

[George Fellows:]

And I think that question may be more appropriately answered in about three or four months.

[Brad Holiday:]

Hey, Tim, I’d just add to George's comment, and kind of the nature of how we run our business. And if you take a look and just the results even cumulative through the third quarter last year. As we take a look at operating margins, I mean, ours are probably the highest, one of the highest in the industry and I think that speaks to George's point; we really do try to maintain price integrity in the marketplace. We're not out there to buy share. We’re out there to try to work with our retailers, to sell good product and try to generate a profit for our shareholders. We really try to focus on the operating margin line. And to George's point, I mean, if we get to the end of the year and which is more appropriate for us to discount that's when we would look at it.

[George Fellows:]

And frankly, most of the major players have a similar philosophy. Not all, but most. What the secondary players do, we certainly can't tell. But they certainly have less of an effect on the marketplace. So, I think we watch it very carefully. We respond in a way that we believe is appropriate. But again, we're in this business to make a profitable volume.

[Tim Conder:]

And good foresight and minimum good business practices that you've already had a lot of these gross margin initiatives, flexible manufacturing in place, this would not definitely be a very good environment to be operating in, but so congratulations from that standpoint.

[George Fellows:]

Thank you very much.

[Brad Holiday:]

Thanks, Tim.

[Operator:]

That we do have a follow-up question from the line of Scott Hamann with KeyBanc Capital Market. Please go ahead, sir.

[Scott Hamann:]

Just a follow-up on your international business. Is Tom working on any new, kind of going into new countries or what's the focus there to keep the ball rolling, in terms of penetrating new regions?

[George Fellows:]

Well, we are obviously; we are very aggressive in the international market. We said before, and certainly maintain that – that represents one of the biggest opportunities for us down the road. Clearly, it would not seem, not be a surprise to you if I told you that the BRIC countries, ex-Russia, would be the focus for further expansion. So, Brazil, India, China are clearly areas that we're looking at aggressively. However, having said that, I will tell you that we're seeing some sparks of some interesting life coming out of Latin America and South America beyond Brazil. Eastern Europe continues to develop in a very attractive way. And a very important decision is going to be made later on this year that could markedly accelerate the business overseas and that is the decision to put golf back in the Olympics. Were that to happen, I believe we'd see an acceleration of the activity internationally.

[Scott Hamann:]

Great. Thanks a lot.

[George Fellows:]

All right. Thank you all.

[Operator:]

And this, ladies and gentleman, we have reached the end of the allotted time for questions and answers. Mr. Fellows, do you have any final remarks you would like to make?

[George Fellows:]

Yes, Again I would like to repeat a couple of things that we said earlier. There's a lot that we don’t know and there's a lot that we can't control. Obviously, FX is that and the macroeconomics that the world happens to be suffering under right now, we can't control. What we can control and what we do know, we think are very compelling. We have very strong brands and one could argue that we have the strongest brands internationally of anyone in this business. We have a very strong product line for 2009. That case in point being the ratings that we were able to get in the equipment issues of recent golf magazines. And I think we've gotten to the point, where we are executing at really best-in-class manner in this business from an efficiency point of view, from a consumer, from a customer service point of view. If you put all of those things together and we're making the investments that are appropriate, to ensure that we are on a growth track in the longer term. One has to suffer the bumps, the slings and arrows if you will of short-term economic disruptions and FX moves, but if one were to look at this company and decide whether or not it is indeed a solid, well-performing one. I think you would have to look at the longer term one, and I believe that we are in a very, very good position to be able to outperform the marketplace in the long-term. That is obviously for you to judge and to consider, but if you have a viewpoint that goes beyond the very short-term, we believe this company is a very attractive one. So, again, thank you all very much and we look forward to talking to you in the next quarter.

[Operator:]

Ladies and gentlemen, this does conclude today's conference call. We would like to thank you for your participation and you are now free to disconnect.