Callaway Golf Company woke up to the reality last week that the market may have passed them by with their Big Bertha series of drivers and that the Top-Flite Golf Company contains some other landmines that will see it continue to be a drag on the bottom line for the near future. The profit upside realized in Callaways own golf ball business is not nearly enough to offset the negatives with the other two businesses or the continuing decline in business in Japan, forcing the company last week to lower sales and earnings expectations for the balance of the year.
Wall Street quickly pulled the plug on Callaway, sending ELY shares down 22.4% for the week to close at $11.83 on Friday. The bad news also affected shaft-maker Aldila, which saw shares fall nearly 30% for the week, and Adams Golf, which declined almost 14% for the week.
The primary issue here is that Callaway finally woke up to the fact that the consumer was buying drivers with bigger heads and that the Big Bertha just wasnt, well, “Big” enough anymore and was priced against comparable models that were $50 to $100 less than the Big Berthas $249 price tag.
“They missed the idea that the big heads were the big sellers,” said analyst Dennis McAlpine. “They're facing tougher-than-expected business, and on top of that, they screwed up.” He said that most of the golf business had improved significantly this year. Another analyst watching the golf market said Callaway should have seen the super-size golf head trend coming. “The preference for these heads has gone up pretty sharply, but it didn't happen overnight,” said analyst Alexander Paris of Barrington Research.
The Big Bertha driver, with its 360cc head, may now fit into the mid-size category as other drivers push past the 400cc mark and start pushing the 460cc envelope, the largest allowed under USGA rules.
The issue with the overall titanium driver business, led by the BB, is seen as particularly worrisome as it represented some of the highest margin sales for the company and was expected to generate more than half the annual volume in the Woods business.
Callaway noted that Q1 Woods sales were up 32% versus last year and they were expecting sell through at a similar rate. It never happened. Margins will now evaporate quickly as ELY moves to cut prices to compete and move inventory at retail. ELY is now estimating that gross margin in the Callaway brand will be down 600 basis points from earlier projections to come in at approximately 45% of sales.
Chairman and CEO Ron Drapeau said that the price compression on titanium drivers “may be permanent” and they will need to get aggressive to “proactively fight” for their share of the market.
While ELY has lost share in its overall Woods category, it did point out some bright spots. They said that ERC Fusion wood sales “remain on track” and captured nearly 4.5% revenue market share in April. They also pointed to their 24% share of the Irons market that is “almost double” their nearest competitor, and its dominant 43% share of the Putter market. Callaway has also seen some upside in its own Golf Ball business as it gets profitable after moving operations to Top-Flites facilities. They even saw Callaway balls jump to over 10% of the ball market in April, with the new HX Tour ball capturing a 5% share.
Top-Flite poses the other key issue for ELY, as they start to uncover the stuff they didnt know about when they made the buy. Management said that as they learn more about “past business practices” at T-F they have found a larger amount of golf ball inventory at retail that was supported by high discounts and “aggressive programs”. They said that some new products were also positioned at “unsupportable” price points and sell through has been “well below plan”.
Drapeau said that “some products in the line were priced purely to generate revenues while generating an operating loss.” He said it will take longer than expected to move those goods through the marketplace, impacting annual forecasts.
As for Japan, Drapeau said that there was “no growth in Japan in any of the segments at this time.” He said product cycles there had gotten “fairly short” in the last 12 to 18 months. Sales in Japan are expected to be as much as 20% to 25% below 2003 levels.
Looking to a strategy to regain share, Drapeau sees a mix of aggressive promotional tactics to help short-term and a realignment of the product teams to ensure that the Big miss doesnt happen again. Drapeau said they are “going on the offensive” and will utilize their strong margins, which are seen as “some of the strongest in the business”, to take back their lost share. In the opinion of many, that can only mean only one thing — a major price war will soon commence at retail if it hasnt already. On the product side, Callaway will re-structure its research and technology resources more closely with its product management teams in an effort to stay closer to consumer trends.
The company will also be making some reductions in operating expenses which will certainly mean a number of job cuts. Management said they would be taking a “hard look” across the entire organization.
The company now expects Q2 net sales to be in the $290 million to $295 million range, generating diluted EPS of between 10 cents and 14 cents a share. Callaway also does not expect to hit its previous forecast for full year 2004, now estimating diluted EPS in the 15 cents to 25 cents per share range on sales between $975 million and $990 million for the year. At the end of Q1 the company had given earnings guidance in the range of 82 cents to 97 cents per diluted share on sales in the $1.00 to $1.06 billion range.
