Callaway Golf: Does It Have a Shot at the Green?

by: Alex Morris

Callaway (NYSE:ELY) released earnings for Q2 2010 after the close Wednesday, and the conference call was a mixed bag of both good and bad news. Here are the key points that I think should be taken away and watched as we head into the Fortune Brands (FO) call on July 30th.


  • Rest of Asia and Other Foreign Country Sales. Even though they only accounted for $76M of Callaway’s $606M in sales YTD (12.5%), it is nice to see one area of the business that is running smoothly and growing. Compared to the first six months of 2009, sales in the Rest of Asia and Other Foreign Countries are up 30% and 25%, respectively.
  • The Balance Sheet. Even though management made a lot of capital allocation errors (Di-worsification) in the past and was forced to issue preferred shares to remain in compliance with financial covenants, they seem to be getting things in order. As of the end of the quarter, the company had $54M in cash, and no debt, along with better inventory levels compared to the same point last year (very important when heading into the back half in this industry).
  • No guidance for the rest of the year! When Callaway said they were “cautiously optimistic” for 2010, the stock got killed when they came out and said that they had misjudged the recovery. For the balance of the year, the company did not provide outlook due to “an uncertain sales climate”. I think that they learned their lesson and realized that trying to predict sales/earnings during these unique set of economic conditions is a game best avoided.

Now for the rough spots…


  • Sales in U.S. and Europe. Both of these regions are still feeling the effects of the recession, so not much Callaway can do here. U.S. sales are up 3% YTD compared to last year, while sales in Europe are down 2% YTD last year. While that doesn’t sound too terrible, remember that sales in 2009 decreased 14% in the United States and 30% in Europe. These regions are killing Callaway and golf in general, and will continue to do so until spending starts to recover.
  • Japan Sales. 2009 sales in Japan were only down 2%, which helped them to pass Europe for the #2 region by sales in Callaway’s business. Throughout the first quarter of 2010, Japan was looking good: $53.4M in sales, compared to $41M in Europe. However, in Q2 2010, while Europe delivered comparable sales to Q2 2009 (flat at $42M), Japan plummeted to $30.1M, down 19% compared to the second quarter of last year. As management noted on the call, “the recovery from Japan in quarter one hit a wall in the second quarter”. Not only that, but they are thinking that Japan could be a “problem area” in the short run. With the U.S. and Europe struggling, the problems in Japan only compound the issues even further.
  • Preferred Shares. As I alluded to before, Callaway was forced to issue preferred shares last year. As a result, the company is paying out $10M a year in dividends to preferred shareholders and has 84 million diluted shares outstanding, compared to 65 million at the same point last year. This mistake is in the past, but is still killing shareholders every quarter to the tune of $2.5M for a company that needs to retain as much cash as possible for investments. Why they are still paying a $0.01 dividend every quarter to commons is completely irrational to me…

All in all, things are looking up. Management has made a commitment to avoiding a lot of the promotional activity that we saw at the end of 2009 that killed margins, and has done well to hold a gross profit margin of 41% YTD (compared to 36% last year). I was very happy to see cost of sales decrease by roughly $13M despite a sales increase, as well as a double digit percentage increase in putters and accessories sales year to date. The accessories growth, as discussed on the call, was partly attributed to their Solaire women’s club set, a niche market that Callaway has had success with over the past year. Maintaining positions at the top of the women’s and international market is extremely important to Callaway’s growth as we look further down the road. For the time being, I recommend listening to the Fortune Brands conference call on July 30th and the Adidas (OTCQX:ADDYY) conference call on August 4th. When these two companies release their results we will get a more complete picture of the industry and will be able to see where Callaway compares to the field. Only then can we decide whether it’s the whole industry, or just Callaway, that’s standing in a pot bunker with no shot at the green.

Disclosure: Long ELY