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Executives

Halina Balys - Corporate Secretary and Compliance Officer

Allan H. Fletcher - Chief Executive Officer

Edward (“Eddie”) J. Fadel - President

Greg W. Slack - Chief Financial Officer and Treasurer

Analysts

Ian Corydon - B. Riley & Company

Casey Alexander - Gilford Securities

Ashworth Incorporated (ASHW) F2Q08 Earnings Call June 9, 2008 4:30 PM ET

Operator

Welcome to the Ashworth, Inc. second quarter 2008 earnings release conference call. (Operator Instructions) I would now like the turn the conference over to Halina Balys.

Halina Balys

Welcome to Ashworth’s conference call for its second quarter 2008 financial results.

Before we begin, I would like to point out that any comments made during today’s conference call regarding the company’s future performance, events, or circumstances, including estimates of sales, gross margins, pre-book orders, product and sales channel synergies, and earnings per share are forward-looking statements subject to the Private Securities Litigation Reform Act Safe Harbor under the federal securities laws.

Such statements reflect the company’s current expectations based on present market trends and conditions and are subject to certain risks and uncertainties which could cause actual results to differ materially from those projected in the forward-looking statement.

For details concerning these and other risks and uncertainties, you should consult Ashworth’s most recent Forms 10-K and 10-Q filed with the SEC, as well as other reports by the company filed with the SEC from time to time. These disclosures are also included or referenced in today’s press release, which is available on our website at www.ashworthinc.com.

Joining us on today’s call are Allan Fletcher, Ashworth’s Chief Executive Officer; Eddie Fadel, Ashworth’s President; and Greg Slack, Ashworth’s Chief Financial Officer. Allan will provide a brief overview of the company’s strategic direction, Eddie will provide an overview of the product direction, and Greg will then cover the financial highlights of the second quarter 2008. And then we’ll open up the call for your questions.

With that, I would now like to turn over the call to Allan.

Allan H. Fletcher

We are pleased to report a profit of $0.06 per diluted share for the second quarter as well as the third consecutive quarter of revenue growth in our core golf channel. In the seven months since I joined the company, our management team has been implementing the strategic initiatives we believe will eventually turn the company to profitable growth.

We’ll continue to take necessary steps designed to improve the company’s operational efficiency and inventory productivity. We are continuing to establish channel-specific product strategies and sales programs to better serve our customers and improve our profitability.

Although we continue to see improvement in our domestic core golf distribution channel, we still believe a complete turnaround will take more time, sharp focus, and strong execution. We’re optimistic about the future of Ashworth, and we believe the plans we’ve started to implement will in time return the company to sustainable profitability.

Before we ask Greg to reflect on the financial results, I would like to ask Eddie to give you a brief overview of our product direction.

Edward (“Eddie”) J. Fadel - President

Products initiatives that we started a year ago are starting to show some results. We have improved distribution today, reduced liquidation, and part of our product strategies were better management of our inventory levels were down 19% in company, one. They’re also down in our Gekko affiliate, but they were increased in the UK and Canada.

The other side to it is our simplified pricing strategies, which have given us improved product margins. But most importantly is improved product mixes between core product and fashion product. We are beginning to ship our fall ‘08 product, which just started the 15th of May, and it’s too early to really have all of the retail indicators. But the early indicators are very positive for us in that we’re getting better sell-through at retail. And we’ve already had some reorder activity, which is really early for us in that area.

The strategy to move more towards performance cottons away from polyester has also proven to benefit us, both in our maintain margins and our sell-through at retail. Our Third Groove Performance cottons, with cotton where it counts, that have wicking and easy care, and our Hi-Def cotton have both proven to be great products.

Obviously it’s a very difficult market out there in the retail environment. But we believe with better products that we have an opportunity, even in a difficult market. You don’t have to be in a great market to have great results. So we’re very optimistic about the direction we’re headed.

Now I want to turn it over to Greg Slack.

Greg W. Slack

I would like to start with consolidated net revenues for the second quarter of fiscal 2008, decreased 3.4% to $57.8 million from $59.9 million for the same period of the prior fiscal year. Revenues decreased in all distribution channels except for the company’s core golf and the Collegiate/Race and distribution channels as well as Ashworth UK and the other international segments.

Second quarter net revenues for the company’s core golf channel of distribution, consisting of both on-course and off-course golf specialty shops, increased 2.3% to $22.3 million from $21.8 million for the same period of the prior year. This represents the third consecutive quarter that the company’s experienced year-over-year growth within its core golf channel.

However, the company continues to experience significant competitive pressure and market consolidation within the off-course channel of distribution. As part of the company’s effort to restore sales growth, management is implementing new sales management processes in both the on-course and off-course channels of distribution, including reviewing our sales territories and adding additional sales representatives in under-represented territories. We are also establishing a number of new programs with key off-course accounts.

Net revenues from the company’s corporate distribution channel decreased 18.1% to $5.4 million in the second quarter of fiscal 2008, as compared to $6.6 million for the same period of fiscal ‘07. The decrease was driven by certain customer event revenues that occurred in the comparable quarter of the prior year that did not reoccur, and our strategic decision to discontinue sales to certain customers.

In the past, the company has experienced missed sales opportunities in this channel due to out-of-stock positions in selected styles. The company believes that the narrowing of the corporate assortments will improve its inventory productivity and customer in-stock position.

Net revenue from the company’s retail distribution channel decreased to $3.1 million in the second quarter of 2008 from $6.4 million in the prior year. The retail channel experienced a decline in the second quarter, primarily due to account consolidation in the channel as well as a decision by management to strategically exit a number of underperforming doors.

The company will seek to continue to improve its brand positioning by focusing on premium retail accounts and doors within the channel. We are currently working carefully to open a number of new retail doors through specially-tailored assortments and sales programs.

Net revenue for Gekko increased 20% or $2 million to $11.8 million for the second quarter of fiscal ‘08 as compared to $9.8 million for the same period of the prior fiscal year. The increase was primarily driven by improved penetration of the Kudzu products and the NASCAR racing distribution channel, which was aided by our own exclusive vendor rights to the 50th running of the Daytona 500.

This increase was partially offset by the absence of certain corporate event revenue that occurred in the prior year quarter that did not reoccur in the second quarter of fiscal 2008, as well as a decline in the Outdoor Direct catalog sales.

Net revenues from the company’s owned outlet stores decreased 14.2% or $370,000 to $2.2 million for the second quarter of fiscal ‘08, as compared to $2.6 million for the same period of 2007. This decrease reflects a generally difficult retail environment and lower unit volumes as a result of fewer promotions and markdowns.

Net revenue for Ashworth U.K. Limited increased 4% or $341,000 to $8.9 million for the second quarter of fiscal 2008 from $8.5 million for the same period of the prior year. The increase was primarily due to the shipment of certain first quarter orders that were delayed until the second quarter, resulting from the closing of the United Kingdom’s distribution center over a two-week period, and the first quarter to accommodate the deployment of our new ERP system in the United Kingdom.

Net revenues from other international segment remained flat at $4.2 million for the second quarter of fiscal 2008 as compared to the same period of the prior year. We reported a consolidated net income of approximately $1 million for the second quarter or $0.06 per basic and diluted share compared to a net loss of $2.5 million or $0.17 per basic and diluted share for the same quarter of the prior year. The company’s consolidated gross margins increased 340 basis points to 42.2% for the second quarter of fiscal ‘08 as compared to 38.8% in the second quarter of last year.

The increase in consolidated gross margins were driven by an increase in the domestic average selling price outpacing a corresponding increase in the average cost per unit, resulting in a favorable margin impact; lower overhead costs within the domestic operations as reduced overhead expenses, primarily in labor; and a favorable impact of fewer off-price sales as compared to the prior year from our United Kingdom operation.

However, these favorable effects were somewhat offset by a larger concentration of revenue from our lower-margin NASCAR channel as compared to the prior year. Consolidated SG&A expenses increased 4.3% to $22.8 million from the second quarter of 2008 as compared to $21.8 million for the same period a year ago.

As a percentage of sales, SG&A expense increased to 39.4% from 36.5%. The increase in SG&A was largely due to an increase in consulting fees, primarily associated with athletic endorsements, design consultants, and a consulting agreement for the services of our CEO; higher royalty expense as a result of higher concentration of revenue from licensed products; an increase in commission expenses as a result of higher concentration of revenues from independent representatives; and expenses related to the employment of a non-compete agreement entered into with the principals of Gekko on June 4 of 2007.

These increases were somewhat offset by decreases in salaries and wages, primarily performance-based bonuses. Total net other expenses decreased 58.6% or $545,000 to $249,000 for the second quarter of 2008, compared to $794,000 for the second quarter of 2007. This decrease was primarily driven by a favorable currency effect.

The effective tax rate for income tax provision for the second quarter of 2008 was 32%, compared to 518% for the second quarter of 2007. This decrease in the effective tax rate was due primarily to a $2.9 million discrete charge in 2007 quarter to establish a valuation allowance against the company’s non-originating deferred tax asset and originating deductible temporary differences.

Now turning to the balance sheet, accounts receivable decreased $1.7 million, 3.7% from April 30, 2007, to April 30, 2008, primarily due to the 3.4% decrease in revenue during the second quarter. Consolidated inventory decreased 1.4% to $52.4 million as of April 30, as compared with the same period of last year and is in line with expected requirements.

That concludes our prepared remarks.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ian Corydon - B. Riley & Company.

Ian Corydon - B. Riley & Company

Could you just talk about how you feel about your inventory position now? Are there any pockets of aging inventory or is it [inaudible]?

Edward (“Eddie”) J. Fadel - President

We feel the mix of our inventory is greatly improved. And so there still is some out of season inventory, but that’s greatly reduced. I think we came out approximately, it’s like a three-month supply, and it all went to our outlet stores. So we’re not overburdened with that. The inventory mix in these markets, the inventory mix changes, the reason I feel good about it is our improved products, more of an emphasis on core products that better serve us through retail and golf markets in the future and with less risk to the company.

Ian Corydon - B. Riley & Company

And gross margin has been pretty volatile. Have you reached a point in your sales and with your inventory that we should see gross margins above 40% here in the next few quarters?

Greg W. Slack

I would tell you that they have been volatile in the past, and part of it’s related to the EDC, the embroidery distribution center in Carlsbad. And we have implemented an initiative to look at that and make it more efficient as far as the cost structure that we’re dealing with today. In May we went to a single shift structure through our slower periods in order to accommodate the embroidery plans that we have for the rest of the year.

And so, when we look at our margin, where we see continued increased benefits, our decrease in our overhead costs related to the labor over there. We expect that to improve throughout the rest of this year and into the next part of the year. We also saw an improvement in our starting margins, our net sales increased as our average selling price per unit improved, and outpaced the increased cost that we were seeing.

Also when we’re moving from, as Eddie had talked about before, moving more to a cotton-based product from the technical side, or the polyester, you’re going to also see improved pricing there, whereas the polyester with the oil and everything else because it’s a petroleum-based product, is getting more expensive in the marketplace.

Edward (“Eddie”) J. Fadel - President

And I talk about blue water. We’ve separated ourselves again, which is positive. Where everybody else is having price wars in certain categories, we’re not. The other thing is that, our inventory management is a high priority here. Of course we’re starting to ship fall ‘08 just beginning now. We’ve already designed spring ‘09, which we’ll start to sell, but the new word in this building, its okay to sell out of fashion.

I’m happy to report, we’re selling out of some of our fashion inventory for fall ‘08, which is great. Because then that’s less of a markdown, less liquidation in the market. We have less margin erosion, as we’ve been having in the past. So I think that will also benefit us going forward.

Ian Corydon - B. Riley & Company

If you’ve just begun shipping fall, how do you sell out? And or have you just sold out your pre-book?

Edward (“Eddie”) J. Fadel - President

No, we’ve gotten re-orders, for now we’re sold out. We do at times. It is possible to have an item sell out in pre-book, of course. But the first delivery is always the toughest delivery because we don’t have any sales yet. You have to buy the first delivery first, obviously, and you’re buying it 120 to 150 days in advance of when you start shipping it.

So, we haven’t gone to market yet usually when we’re buying that first delivery. So we’re always very excited when the first delivery is sold out. That’s our highest risk delivery. We have a sales plan and we budget how much of everything we’re going to sell, and it’s turned out in this case we’re selling out of some fashion things, where we’ve gotten great reaction.

Ian Corydon - B. Riley & Company

And for the spring, when do you start that pre-book?

Edward (“Eddie”) J. Fadel - President

Our sales meetings happen the end of this month in June. We’re having our sales meetings in Carlsbad, at our headquarters, and so that will be the introduction to our entire sales force for all of our brands. And they really hit the road right after 4th of July. We do have key customers in this week, though, being a U.S. Open week, and we’re pre-lining with customers. We’re going after orders already. But really, it’s sometime in July that we start to get results on the pre-book for the spring ‘09 season.

Ian Corydon - B. Riley & Company

On the credit facility, have you passed your seasonal high need to draw on the line, and [inaudible] availability?

Greg W. Slack

Yes. Our typical peak periods for the line are between February and mid-May. So we have passed that seasonality impact, and it’s going to start coming down. And we’ll see our availability expand throughout the rest of the year.

Ian Corydon - B. Riley & Company

And where did you peak out?

Greg W. Slack

I think we peaked out around, as far as the borrowing it’s around $40 right now.

Operator

Your next question comes from Casey Alexander - Gilford Securities.

Casey Alexander - Gilford Securities

Can you tell me what percentage of your sales are Callaway branded versus non-Callaway branded?

Greg Slack

We typically don’t give out the mix between the two brands. It’s not in our filings, and we typically don’t disclose that mix.

Operator

We have no further questions at this time.

Allan H. Fletcher

I would like to thank everyone who participated on the call today, and we appreciate your support. And if there’s anything you want to call us on directly, by all means do so. Thank you.

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Source: Ashworth, Inc. F2Q08 (Qtr End 04/30/2008) Earnings Call Transcript

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