Callaway Golf Company
Q1 2009 Earnings Call Transcript

Published: 1 May 2009

[Operator:]

Good afternoon. My name is [Marcello] and I will be your conference operator today. At this time I would like to welcome everyone to the Callaway Golf first quarter 2009 earnings conference. (Operator Instructions) I would now like to turn the call over to Brad Holiday, Chief Financial Officer. Sir, you may begin.

[Brad Holiday:]

Thank you and welcome, everyone, to Callaway Golf Company's first quarter 2009 earnings conference call. Joining me today is George Fellows, President and CEO of Callaway Golf. During today's conference call George will provide a few opening remarks and I will provide an overview of the company's financial results, and we will then open the call for questions. I would like to point out that any comments made about future performance, events or circumstances, including statements relating to future growth or market share gains, the ability to manage costs or invest in future initiatives, future benefits from the gross margin initiatives, the estimated industry or company sales for 2009 or estimated 2009 gross profit, operating expenses, CapEx and depreciation and amortization expenses, prospective amendments to the credit facility and future inventory levels 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 and other information. 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, including changes in economic conditions, credit markets or foreign currency exchange rates. For details concerning these and other risks and uncertainties you should consult our earnings release issued today as well as Part 1, Item 1A of our most recent Form 10-K filed with the SEC, together with the company's other reports subsequently filed with the SEC from time to time. In addition, during the call we may provide certain pro forma information relating to the company's EBITDA. This information may include non-GAAP financial measures within the meaning of Regulation G. The earnings release and related schedules 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:]

Thanks, Brad, and thank you all for joining us. Going into this year it was evident that unfavorable global economic conditions, together with a dramatically negative shift in foreign exchange rates, would have a significant effect on both the industry and company performance in 2009. Also, given Callaway's record pace in the first quarter of 2008 and, indeed, through the first half of the year, comps for the first quarter of 2009 would be particularly difficult. Unfortunately, these estimations were borne out. The widespread global economic downturn accelerated from the fourth quarter of '08 into the first quarter of '09, resulting in reductions in retail traffic of greater magnitude than originally anticipated. This was compounded by heightened retailer reluctance to carry traditional beginning of season inventories. At the same time, foreign exchange rate movement has more negatively impacted the translation of the company's international results into U.S. dollars more than originally projected. These factors in the aggregate resulted in first quarter revenues falling 26% below the company's record 2008 results. While we expect global economic conditions and foreign currency to continue to negatively impact results in the short term, the severity of their impact should decrease as the year progresses. Furthermore, we have taken additional steps to help mitigate this impact, including the implementation of several cost reduction initiatives and the reduction of approximately 10% of the company's worldwide positions. These steps, together with continued benefit from the aggressive implementation of our gross margin initiatives, will provide some additional offset to macro conditions. Now we are clearly disappointed in the manner in which the year has started; however, we firmly believe that the golf industry will recover as the economy recovers. Rather than approach the balance of the year from a purely defensive posture, we not only will continue to aggressively manage costs and focus on liquidity but we will also concentrate on positioning Callaway to emerge this trying period in a stronger position when the industry does recover. In this regard, we will continue to invest in additional gross margin initiatives to further improve our cost structure as well as spend behind the strength of our 2009 product lineup in order to continue to gain market share. As expected, both the retail trade and consumers tend to focus on leading brands in tough times, and that has certainly been evident in the golf industry today. On a year-to-date basis, Callaway has increased share in most product categories worldwide and expects to continue to do so. Clearly, the short-term outlook remains unclear but there have been some glimmers that we may well have bottomed or have come close to doing so. But whatever your view may be on the broader economic issues, golf as an industry will recover as the economy does and those players who position themselves properly and focus on the longer term will benefit from the shakeout. We are quite confident Callaway will be one of those clear beneficiaries. With that I'd like to turn the meeting back over to Brad and we can go into Q&A afterward.

[Brad Holiday:]

Thanks, George. As mentioned by George in his comments, the golf industry was significantly impacted during the first quarter by the depressed global economic conditions. Callaway Golf's first quarter net sales declined to $272 million compared to a record $366 million last year, reflecting not only a reduction in traffic at retail but also a reluctance on the part of many retailers to load in normal inventory levels prior to the opening of the golf season. Also impacting the quarterly results were the negative effect of a stronger dollar, which accounted for approximately $22 million of the year-over-year variance. We reported net income for the quarter of $7 million compared to $40 million last year and earnings per share of $0.11 on 63.3 million shares compared to $0.61 on 64.8 million shares a year ago. Earnings per share include for each of 2009 and 2008 after-tax charges of $0.01 per share for the company's gross margin improvement initiatives. In looking at sales by product segments I would like to mention before we get into the details that the decline in sales across all categories was primarily due to the unfavorable economic conditions as well as foreign currency translation due to the stronger dollar this year. Specifically, our wood sales for the quarter were $80 million compared to $117 million in 2008. In addition to what I just mentioned, the decrease was also due to lower volumes, lower average selling prices as consumers continued to shift to lower price point products, as well as more competitive pricing in the marketplace versus a year ago. Sales of irons were $65 million compared to $96 million last year. The decrease was due to lower volumes as well as a shift in product mix from higher-priced Fusion irons to our lower-price X-Series irons this year. Golf ball sales were $47 million for the quarter compared to last year's sales of $58 million. The decline was due to lower volumes and a shift in product mix from premium Tour ix balls to more moderately priced Diablo, HX Hot, and Warbird models. Accessory sales were $52 million for the quarter compared to sales last year of $60 million. This decrease was driven primarily by a reduction in package club sets, lower golf bag and footwear sales offset partially by incremental sales associated with the uPlay acquisition. Putter sales were $28 million compared to $35 million in sales last year due primarily to fewer putter models launched during this year combined with a shift in product mix from higher-priced models last year to lower-priced models such as this year's Crimson Series putters. Turning to our regional breakout, U.S. sales were $141 million for the quarter compared to $184 million last year. International sales decreased to $131 million compared to $182 million in 2008. Foreign currency translation negatively impacted sales by $22 million. First quarter gross margins were 43% of net sales compared to 48% in 2008. Margins were negatively impacted by lower volumes, lower average selling prices, increased golf ball material costs, and unfavorable foreign currency translation offset partially by continued savings associated with our gross margin initiatives. Operating expenses for the quarter were $103 million compared to $111 million last year. This year-over-year reduction reflects a decrease primarily in employee compensation as well as the positive effect of currency translation on international expenses. The cost reduction actions taken during the quarter were partially offset by incremental spending associated with the uPlay acquisition made at the end of 2008, new market support in Asia, as well as incremental tour expense. Moving to the balance sheet, consolidated net receivables were $239 million, a decrease of $61 million compared to last year due primarily to the year-over-year decrease in sales. Consolidated days sales outstanding increased to 80 days compared to 75 days last year due to an increase in customer incentive programs. Collections on AR remain strong and the overall quality of our AR is good. Net inventories totaled $262 million, a decrease of $2 million compared to last year. Net inventories as a percent of trailing 12-month sales increased to 25.6% through the first quarter compared to 22.9% for the same period last year. This metric is higher than we had anticipated coming into the year but reasonable given the decline in sales and the lead times necessary to support a typical year's shipping seasonality, and we expect to be back in the low 20% range by the end of the year. EBITDA for the first quarter was impacted significantly compared to a record first quarter last year due to the factors already mentioned. On a trailing 12-months basis, EBITDA decreased to $68 million compared to a record level of $137 million for the same period last year. As you know, our business is seasonal with our peak borrowing occurring during the second quarter of the year. Because of the decline in EBITDA and the seasonal borrowings, we are in discussions with our banks to amend our credit facility to make sure we remain in compliance with the financial covenants under the facility. We believe we will have an amendment in place by the end of the quarter and will continue to proactively manage all spending and debt to preserve our liquidity. Capital expenditures for the quarter were $10 million. We estimate 2009 capital expenditures to be in the $40 to $45 million range, which includes approximately $15 million for our headquarters consolidation project. Depreciation and amortization was $10 million for the quarter and we estimate 2009 to range from $40 to $45 million. As George mentioned, the current environment makes it extremely difficult to forecast full year results. Based upon the most recent trends, along with the fact that comps for both sales and foreign currency ease up during the second half of the year, industrywide sales are estimated to decrease by approximately 15% to 20% compared to 2008 assuming reasonable retail inventory levels as the year progresses. Based on recent market share gains we estimate Callaway Golf's annual sales will decrease at a rate less than the industry. We estimate full year gross margins as a percentage of net sales to be in the range of 40% to 42% due to the lingering effects of economic and foreign currency headwinds combined with product mix and pricing trends. We anticipate operating expenses will decrease to a range of $375 million to $390 million compared to $403 million in 2008 as the benefit of cost reduction actions begin to take effect, including a reduction in employee costs related to the recent elimination of 10% of the company's worldwide position. While these economic conditions have adversely impacted our results to date and will continue to impact our balance of year results, we believe we are taking the appropriate actions at this time. The Callaway brand is strong and gaining momentum and market share in most categories around the world. We will continue to aggressively manage costs to mitigate these economic conditions while at the same time continue to invest in those initiatives that will drive long-term growth and ultimately shareholder value. We believe in the long-term potential of the golf industry and believe the actions we are taking will position Callaway Golf to emerge a stronger company as the economy and golf industry begin to recover. We would now like to open the call for questions.

[Operator:]

(Operator Instructions) Your first question comes from Tom Shaw - Stifel Nicolaus.

[Tom Shaw:]

First question for George, can you talk a little bit about the success of the new two for one or buy one, get one for $1 promotion? I guess I'm a little surprised that some of your major competitors haven't really followed suit in the first two or three weeks this promotion has been out there.

[George Fellows:]

Well, very specifically the response has been extraordinarily strong. In the first week of the promotion, for example, we achieved a lift in the normal movement during that period of time of anywhere from 200% to 400% and that has pretty much sustained itself through a good portion of the program to date. I would fully expect that our competition will indeed - and, in fact, some already have - come out with comparable programs of their own, but so far they haven't really impacted the effect that we've had in the marketplace. In addition to that, we've had particularly good success in all of our demo days throughout the areas where the golf season has opened and we're seeing very dramatic sales increases there as well. And in fact in many instances where multiple manufacturers are present at these demo days, we're fairly well dominating the sell through at that point. So I think the lesson to be learned is that with the economic conditions being what they are, there are still golfers out there; they're willing to spend money on new product. They perhaps need a somewhat stronger incentive in these conditions than they might normally need, but the fact is that the golf industry is, while somewhat hurt by this economic downturn, it is certainly positioned for a recovery when the economy recovers.

[Tom Shaw:]

Second question for Brad, if you look at the GMI initiative, it looks like a $7 million benefit which, if I'm looking at my notes right, it seems maybe a little quicker than the annual benefits if you start looking at it throughout the year. Is there some upside to that relative to - obviously you gave the overall gross margin guidance of $0.40 to $0.42, but what do you see there? And then kind of a tagalong to that on the gross margins, could you kind of order the magnitude of the pressure, the four factors you mentioned, and are there any opportunities there, such as higher material costs, as the year progresses?

[Brad Holiday:]

Well, a couple things on that. First of all, I think - by the way, the forecast I gave was on a pro forma basis excluding all of the GMI initiatives. I think what you're seeing is on the $7 million, as we talked about, we had an initial target of $50 to $60 million. We delivered $57 million in those two years that we had identified. Some of this is carryover from those initiatives, so we didn't have them all implemented last year, so some of what you're seeing now is just kind of carryover from some of the initiatives that we were continuing to implement towards the latter part of the year. All of the upside that you would maybe kind of bake or assume might be in there is built into our forecast right now, Tom. As you know, we've got another couple of initiatives that are coming, as George mentioned in the call last time, another $20 to $30 million in the next two years, '09 and '10, and then another $20 to $30 million beyond that. And so we'll probably refer to that as something different going forward, which is more kind of an operational strategy, but we haven't really started to even see the benefits of that as we go forward.

[George Fellows:]

Additionally, we're seeing many of the raw material costs coming down. In the case of the ball raw materials, we're still in the process of flushing that higher-priced ball material through our system and we'll begin to see some of the benefits of the lower ball costs later on in the year. But at this point in time I think we've seen a reduction in most of the costs that were escalating last year.

[Brad Holiday:]

And we'll start seeing that more towards the third quarter, Tom, in terms of ball costs being probably more in line with where they were last year. And then I think to answer your last question, which was kind of order of priority, mix and price, if you will, had the biggest impact on the margins, followed by foreign currency which was basically offset by the gross margin initiatives. So as much as we saved in GMIs we also lost because of just the translation of FX. But the biggest chunk was just sales volume and mix, which includes pricing.

[Operator:]

Your next question comes from Scott Hamann - Keybanc Capital Markets.

[Scott Hamann:]

How would you characterize the retail inventory at this point and how much leftover product, like FT-i, FT-5, is kind of left out there right now?

[George Fellows:]

I think the data that we have - and again, I caution us because a lot of it is unfortunately not as reliable as we'd like it to be - but we have a clear indication that overall inventories at the trade level are down rather substantially something in the neighborhood of 13% - 14%. So the trade has been very, very cautious of how they're spending their money. As far as leftover product from prior years, there are no particular gluts of any of that old stuff laying around, not any more so than would normally be the case at this time. As long as the trade continues to take - and not improperly so, I might add - a conservative view on their buying patterns, we don't really believe that inventories are going to be a problem going out of the year. The promotions that we've instituted if anything are going to drive those inventories even lower so, again, I would not expect inventories to be an issue.

[Scott Hamann:]

Okay, Brad, on the work force reduction, what level of cost savings do you expect to realize there and were there any severance charges that were buried in your operating expenses during the quarter for that?

[Brad Holiday:]

We're not going to give the total on that, but I would tell you this, that in Q2 it will probably be more of a cost to us because we will have severance costs, but we'll have more net savings towards the end of the year. But it's all built into our forecast. That's in that 375 to 400. But we didn't get into the details of the specific savings.

[Scott Hamann:]

And then finally maybe just talk to some of the underlying trends you're seeing ex currency in some of your international markets during the quarter and what your expectations might be for the year.

[Brad Holiday:]

Well, the international markets, as I'm sure you know, are suffering much of the same kind of effects from the economics as we are here in the States, but there are some relative high spots and some relative low spots. Right now, Japan would appear to be suffering the greatest of any of the international environments. They stayed relatively strong much longer than most of the rest of the world did, but when they hit the wall they hit it pretty hard, so the downturn in Japan, I think, was rather dramatic. However, we will say that even with the downturn in Japan our line, particularly our legacy line, in Japan is doing really relatively well, not enough to offset the overall decline, but we're gaining share quite dramatically there. Europe is a mixed bag. There are some strong areas there. Eastern Europe seems to be suffering a bit more as does Southern Europe. The U.K. seems to be doing alright and the Scandinavian countries, although it's rather earlier, appear to be doing alright all well. Canada, of course, is pretty much following the pattern of the United States as it normally does. The South Pacific - Australia and New Zealand, if you will - is beginning to show some upturn, but of course they're going out of their season at this point in time. So it would appear that as the U.S. begins to recover I think we'll start to see comparable kinds of trends in Europe, albeit somewhat delayed from what we're doing. The last area to recover will undoubtedly be Japan. I did leave out Korea and I didn't mean to, but Korea seems to be showing some strength actually. But if you'll recall, Korea was an area that had a great deal of difficulty last year, so they perhaps have gotten a lot of that out of their system and they're beginning to show some signs of life. Again, I don't want to over conclude from very early signs, but we may indeed have bottomed and we may in fact be seeing some early signs of a potential recovery, but frankly I'd reserve judgment on that until after the season gets a little further along and we see how sustainable these early signs appear to be.

[George Fellows:]

I think, Scott, one other thing that you might already be aware of, but in terms of just currency impact, Europe was impacted the most if you just kind of order of priority - Europe followed by Korea followed by Canada. So part of the down that you see in the reported results, a lot more is in those three countries than the others.

[Operator:]

Your next question comes from Dan Wewer - Raymond James.

[Dan Wewer:]

Brad, you noted that for the year you anticipate revenues declining less than the 15% to 20% projected for the industry and we're all mindful that your golf club business was down 27% during the first quarter so that would imply a nice acceleration in sales from the first quarter levels. Yet the quarters become seasonally less important beginning in the third and fourth quarter of the year, so I'm just trying to determine where do you see the opportunity quarters on the top line in 2009 to achieve that kind of revenue target?

[Brad Holiday:]

Well, you know, it really has a lot to do with the comps relative to - the business really started to turn south in the United States kind of middle of second quarter, late second quarter, and currency, the dollar started to strengthen more towards the August/September timeframe, so the year-over-year comps do get a lot easier towards the back half of the year and that's why.

[Dan Wewer:]

Okay, so even though those are smaller quarters for the company you think there's enough revenue opportunity so that you're down less than 15% for the year.

[George Fellows:]

Well, there's one other point. When we were talking 15% to 20%, on the one hand we were talking sell through numbers. The sell in numbers, certainly in the early part of the year, are affected not just by the sell through but also by the relatively conservative stance that the trade has taken in terms of inventories. So they cut back inventories 13% to 15%, which in turn compounded the 15% to 20% decline in sell through. The inventory issue should have stabilized, so hopefully we'll see that go away. And at this point in time - this is when the golf season opens up - we're going to find out just how strong the consumer response is going to be. Like I said, there are some early signs that it looks reasonable positive, but again, I would not over conclude from that. But given the fact that inventory should have stabilized and the comps are easier both from an FX point of view as well as sell through point of view, it makes the third and fourth quarter look a lot better than perhaps you might think.

[Brad Holiday:]

And, Dan, while it is lower, our mix is kind of in a 60/40 first half/second half so it's still significant enough that with the easy comps it can have that kind of an impact.

[Dan Wewer:]

And then this is a follow up question on the $1 fairway promotion. I know historically you guys have criticized some competitors for those type of promotions because it does maybe, to use the term, cheapen the brand. I'm curious as to why you thought it was proper for Callaway to initiate that kind of promotion this go around? And then also curious, once that promotion is complete, how do you go about incentivizing your customers to buy a Diablo or an iQ driver without getting that free fairway wood?

[Brad Holiday:]

Well, first you've got to start with the understanding that this is hardly a typical year. Under normal circumstances we're reluctant to do that kind of activity even though some of our competition does it as a matter of course. And in fact some of what we did was prompted by the fact that some of our competition has actually begun to do that kind of discounting in the fourth quarter and the first quarter earlier in the first quarter this year. But because it's not a typical year and because we think that this is really an opportunity for us to come out of this period stronger than perhaps we went in we decided to take a very aggressive stance to the marketplace and see whether or not we could kick off the season and kick off share gains early on. Early signs would seem to indicate that that is in fact happening. We think the worst posture one can take in this kind of environment is to run and hide and just allow the market to take its course, so we have deliberately gone out and become very aggressive and we'll continue to be so as we go through this rather difficult period. And I think we will come out much stronger in the end, both from a share point of view, from a consumer point of view. The trade in this particular instance, whereas they may have complained in the past about those kinds of activities by some of our competition, has been quite complimentary about what we've done because it has helped generate foot traffic into their doors, something that they were unable to do by themselves. And, you know, we're all in this game together, so between what we can do and what they can do perhaps we're able to kick the season off a bit more strongly than might ordinarily have been the case. Now when the promotion is done, again, if the marketplace picks back up again - and we're seeing signs that it will - we're going to return to more normalized buying patterns on the part of a lot of people. I'm not certain that we are bringing that many more people into the buying market at this stage of the season than we normally might, but I think we're bringing in more than would have been there given the state of the economy. When the back half of the year comes around, the buying patterns begin to ease off and I think we're going to start returning to a more normalized consumer buying pattern, at which point we're fundamentally budgeting accordingly.

[Operator:]

Your next question comes from [Eric Hollawaddie] - Stephens Inc.

[Eric Hollawaddie:]

Hi, guys. I'm on the phone representing Rick Nelson as well. Your projection for the industry being down 15% to 20%, is that a U.S. retail number?

[Brad Holiday:]

It is essentially a combination. It is heavily influenced by the U.S. retail, which indeed, at least based on the data that we have at this point, was down that amount in the first quarter of this year. But we're seeing pretty comparable kinds of numbers in other markets where we get some fragmentary data - Europe, the U.K., etc. We're seeing the same kinds of numbers come out. So we don't think that's that far off the mark. Now, again, I don't see the market getting worse. We've been through a fairly rough period between the third and fourth quarter of last year and the first quarter of this year. It might get somewhat better than that, so we think that it might be - it might be - somewhat conservative to assume that the balance of the year will continue to be that low, but I wouldn't count on it.

[Eric Hollawaddie:]

How would you assess your product introduction pipeline for the rest of the year versus last year, both in terms of the number of product introductions that you've got planned as well as perhaps more qualitatively the strength of those introductions. Do you have products that you think may, from a qualitative sense, generate more buzz perhaps than ones you introduced in the balance of the year last year? We'd love your thoughts on that.

[George Fellows:]

Well, clearly I can't give you any detail on what we have planned for the balance of the year, but I would say our new product pipeline is relatively robust. We have, again, this is going to sound a little bit like hype and I don't mean it to be, but I think we have some outstanding products in the pipeline ready to come out. The exact timetable for those introductions obviously I can't to, but I think we're on a cadence of new product introduction that will be more representative of what we've done for '09 than what happened in the back end of '08. We have a very strong new product lineup that's really planned out for the next two to three years. We're finally on a cadence that we feel comfortable with, so I think that, whether or not everything gets as much buzz as we'd like, I think we've got a very solid program coming.

[Eric Hollawaddie:]

In terms of the first quarter, then, of '09, how did it compare versus the year ago quarter in terms of the number of introductions that you had?

[George Fellows:]

I think the number of introductions were quite comparable. I think the thing that we're very excited about as far as the '09 product line was concerned, we think the introductory program that we had for '09 in terms of products was about as strong as we've ever had in the company and was much stronger, I believe without doubt, was much stronger than the '08 products that we had introduced. And we see more of the '09 pattern as we go into '10 and beyond than the '08. Like I said, we're finally into a cadence of new product introduction on all of our product lines that will be quite robust and we feel very comfortable with.

[Brad Holiday:]

Eric, just to follow up on George's comment, it was basically kind of the same year-over-year. We had a couple of extra putter models last year and a few more ball models, but for all practical intents and purposes it was pretty flat year-over-year in terms of the number of the products.

[George Fellows:]

But the strength of the products were substantially greater, I think.

[Operator:]

Your next question comes from Hayley Wolff - Rochdale Securities LLC.

[Hayley Wolff:]

A couple questions. First, the amendment to your credit line, can you talk about what is that going to cost you and where you're looking to get extra room?

[Brad Holiday:]

No, we really can't discuss it right now, Hayley, other than we are in conversation with our banks and just want to make sure that we can maintain liquidity going forward. We'll announce it when we're done, but we really can't talk about it right now.

[Hayley Wolff:]

Second question on expense reduction. If I kind of do a little back of the envelope and add back the foreign currency savings, it doesn't look like there's a lot of expense reduction going on given all the efforts you've talked about over the past year or so and then the 10% headcount reduction. How do we think about OPEX in 2010?

[Brad Holiday:]

Well, first of all, we did take several initiatives earlier in this year where we actually got pretty good savings in the first quarter. You've got to keep in mind we have added some incremental headcount for the acquisition of uPlay, so there's incremental headcount year-over-year as well as we just opened up the markets in Thailand and Malaysia, which had a little bit. And we also added more recently a second sales force, if you will, that will handle soft goods and licensed products, so that has added a little bit kind of year-over-year. So we got savings, some of which is just incremental back into the business. Now, we will recognize more of those savings as the year progresses because some of this stuff we did last year. With regards to the reduction in force, that didn't happen until second quarter - or, excuse me, early second quarter - so we won't even see any benefits from that until we get past the severance charges in second quarter, but we'll start seeing some of the benefits in Q3 and Q4 and then of course we'll get the full year impact next year for the actions we took on that.

[Hayley Wolff:]

So is the 10% a net number or is it a gross number in headcount reduction?

[Brad Holiday:]

Well, it's gross. That's how many positions we eliminated.

[Hayley Wolff:]

So the additions to uPlay, Thailand, and Malaysia are included in that?

[Brad Holiday:]

Well, we added those towards the end of last year, so they were in the base. And so now we took 10% out of the base.

[Hayley Wolff:]

Can you kind of go through the impact of the buy one, get one free on margins, on profitability and how that program works at retail? And then George talked about a 200% to 400% lift with that program. I'm just trying to understand what the measurement is for that.

[Brad Holiday:]

Well, with regards to the gross margins in the first quarter and we hadn't really - remind me, George, when did we implement - we didn't do that until second quarter -

[Hayley Wolff:]

It's a 2Q program.

[Brad Holiday:]

Yes. So in terms of the first quarter, which we've already mentioned, if you take a look we're down about 500 basis points in gross margins. A majority of that is due to just what you would say is volume, mix and pricing. Part of it is the shift - most of it is the shift by consumers and just lower volumes for all the reasons we talked about. And then as I mentioned, foreign exchange impact was offset, if you will, by the savings we had in the GMI, so kind of the net-net is most of it was kind of a volume price issue in the first quarter. With regards to the second quarter, I mean, we're not talking about the quarter right now in terms of the overall impact, but baked into the 40% to 42% for the full year is the full year impact of that. And the way the program works is the retailers order the drivers and then they get the free product with it so that they can sell it or they get it for $1 and then they get to sell that.

[Hayley Wolff:]

Inventory that they have existing in the [inaudible] they get a credit for that?

[Brad Holiday:]

They will get a credit for whatever they sell in terms of drivers where they've had the promotion, yes. So at the end of the program we'll find out how many of the drivers they sold and then we'll give them a credit for the fairway wood.

[Hayley Wolff:]

And then in terms of thinking about the fourth quarter with the comps easing, last year in the fourth quarter you introduced the FT-iQ and then you introduced the X-22 irons. Am I to think that you're going to have new product introductions this year in the fourth quarter or would you prefer to wait for 2010? And then related, it sounds like you're thinking about product cycles being one year now as opposed to two years.

[George Fellows:]

Well, obviously, we can't really comment on what our introductory calendar is going to look like. I'm not trying to be cute about it, but all of our plans as we see them at this particular moment are played into the forecast that we're putting out there right now.

[Hayley Wolff:]

So for the fourth quarter to be better in terms of the rate of decline, you're coming up against tough comps in terms of products as well.

[George Fellows:]

Right.

[Hayley Wolff:]

And then can you just go through some of the market share data? I'm just trying to reconcile your commentary about market share gains.

[George Fellows:]

Well, our wood share year-to-date March is up 3 points, our irons share is up 3.2 points, our putter share is up 1.2 points. Those are U.S. data. I have much less reliable data coming out of the European markets, but they're pretty much comparable to that.

[Hayley Wolff:]

And that's DATATECH numbers?

[George Fellows:]

Correct.

[Hayley Wolff:]

For units or dollars?

[George Fellows:]

Dollars.

[Operator:]

Your next question comes from Jeff Blaeser - Morgan Joseph & Co., Inc..

[Jeff Blaeser:]

If the economy picks up, price points return to past levels, yet the dollar remains where it's out right now and we go back to your longer-term goal of 15% EBIT margins, what would the current dollar impact be in that type of scenario for that long-term goal at that time?

[George Fellows:]

Run that by me again one more time, Jeff? You asked a lot of questions. So assuming what?

[Jeff Blaeser:]

Before the economy kind of went down pretty dramatically, the long-term goal was about 15% EBIT margin. If we go back to that point and the dollar was where it's at today, would that target have changed all else being equal?

[George Fellows:]

I guess your question is do we think we can get back to mid teens in operating margins, is that your question?

[Jeff Blaeser:]

Yes, with the dollar at current levels.

[George Fellows:]

You know what? TBD. I mean, certainly the economy's had a big impact and we've got to rethink it. I think our goal is always to get back to the mid teens. I think with the economy where it is and the dollar the question is, is the timing shifted out? And the answer to that is obviously that it will be shifted out. But we're always going to try to hit the goal of trying to get back to those mid teens. That's how we're looking at our business, anyway, now.

[Jeff Blaeser:]

And then on the FX impact on the EPS, is it still, what, 65% - 70% flows down?

[George Fellows:]

You know, that's a very complicated number to figure out, but I think for just back of the envelope to kind of that 65% to 75%, it really depends on the time of year because you know it can have a bigger impact when your sales are smaller towards the second half of the year versus the impact it might have on your expenses. But on an annualized basis I think that's a rule of thumb you can use, 65% to 75% flow through.

[Jeff Blaeser:]

And then on the credit facility are you currently in compliance with the covenants or is that something that may occur in the second quarter probably on the EBITDA factor?

[George Fellows:]

We were compliant at the end of the first quarter and yes, it's a math exercise with the denominator as dropping.

[Operator:]

Your next question comes from Rommel Dionisio - Wedbush Morgan Securities Inc..

[Rommel Dionisio:]

In the various categories, I think, Brad, you mentioned that you saw a lot of negative mix shift in woods and irons and balls and some other categories as well. Does that mean units were actually relatively flat, not just for Callaway but for the industry, and people were just shifting to lower price points?

[Brad Holiday:]

No. No, volume was down in terms of units, but people also shifted to lower price points just based on kind of the economy and they were trying to buy down in terms of price point.

[Rommel Dionisio:]

Just as an offshoot of that question, do you guys get the sense that there's a long-term implication there? I mean, is it just people not golfing as much because times are tough or do you get the sense that maybe some people have given up their country club memberships and have left the sport for awhile even if the economy does come back?

[George Fellows:]

No, I really don't believe so. Yes, there are some issues with people being about to afford country club memberships, but I don't think, you know, again, you can tote this up to being parochial about this, but I really believe that the golf industry has gone through or is going through a fairly short-term hiccup because of the economy. The fact is that people are out there buying product, they're out there playing golf. Yes, it has had a short-term impact, but frankly, if you take a look at any other short-term impacts the golf industry has suffered through, it's always come back. I don't really think you can look at this as a permanent impairment of the golf industry. There are no signs to indicate that that's the case.

[Operator:]

(Operator Instructions)

[George Fellows:]

If there aren't anymore questions, I think it's very, very important to look at this from more than just a very short-term perspective. You know, clearly we, along with many other industries and/or pastimes have been impacted by the negative economy. The important thing to recognize is that the economy is going to come back, albeit certainly not as fast as any of us would like, and when it comes back golf shows every indication of coming back with it and coming back with it pretty much in the same condition it was before it all happened. I know that there are some concerns about the long-term effects of this kind of a downturn, but I will tell you that there are no signs in the marketplace that would indicate that this is a long-term effect. We are quite bullish about it. We've taken a very aggressive stance as it relates to the marketplace to ensure that we come out of this thing better off. I think the long-term effect that we will see is that there is going to be shakeout in the industry, that some of the secondary players are, in fact, going to be gone when this is all over. I could argue very clearly that that is a benefit to those that remain and those that remain strong. I think all of the major brands are going to be in that kind of condition. It is not unhealthy to go through a shakeout as we are going through, as many other industries have in the past. So we feel that as long as we keep our eye on the longer-term goal as opposed to reacting to the short-term issues that we face right now, we are in fact going to come out of this thing better and stronger than before and certainly early indications reflect the fact that that's true. So for those of you that worry about quarter-to-quarter variations, I'm afraid I can't help you. But for those of you that are at all interested in the medium to long term, I feel very strongly and can tell you that we all feel very strongly that this company is very solid, the industry is very solid, and we're going to come out of this just fine. So thank you all very much and we'll see you next quarter.

[Operator:]

And, ladies and gentlemen, this does conclude today's conference call. We'd like to thank you for your participation. You may now disconnect.