Adams Golf (ADGF)

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Founded in 1987 by Barney Adams, Adams Golf (NASDAQ: ADGF), Inc. designs, assembles, markets and distributes premium quality, technologically innovative golf clubs for golfers of all skill levels. ADGF has led the golf equipment industry in hybrid iron sales over the past six years. ADGF's Idea Hybrid Irons have also taken over the leadership position on the PGA, Champions and Nationwide Tours over the past four years – which includes claiming the #1 hybrid played at all four major championships in 2008. ^[1]

ADGF's Brief History

Once a golf equipment component supplier and contract manufacturer in West Texas, Barney Adams moved ADGF to Dallas in the 1990s to concentrate on custom fitting and new product development. In 1996, Barney Adams collected six patents for his Tight Lies fairway wood, a low center of gravity and upside-down club head design, and created an unprecedented phenomenon in the golf industry. ^[2] Sales skyrocketed beyond Mr. Adam's wildest expectation, and earned Adams Golf two placements on the "Inc. 500" Fastest Growing Small Companies list, and Industry Week Top 25 Award for Growing Manufacturing Companies, several golf industry awards, and led to the largest IPO (6 million shares at $16 per share) in the history of the golf industry in 1998.^[2]

Through the years, ADGF's Tight Lies fairway woods have received rave reviews and unprecedented loyalty. Even today, 10 years since it was first introduced, hundreds of thousands of golfers worldwide still have Tight Lies in their bags.

Contents 1 ADGF's Brief History 2 Key Trends and Forces 2.1 The Golf Industry's Recent Struggles 2.2 United States Golf Association (USGA) and Technology Reforms 2.3 A Decrease in the Golf Population 2.4 Some reasons for the decline the golfing population include: 2.5 Golf Demographics 2.6 A Sluggish Start for the 2011 Golf Season 2.6.1 Good News 2.6.2 Bad News 3 ADGF's Marketing: 3.1 Product Mix 3.2 ADGF's Marketing Mix 3.2.1 Place 3.2.2 Promotion 3.2.3 Price 4 Competitors: 4.1 Comparison of Business Segments 5 Porters Five Forces Analysis: 5.1 Competition in the industry 5.2 Potential of new entrants into industry 5.3 Power of suppliers 5.4 Power of Buyers 5.5 Threat of substitute products 6 SWOT Analysis: 6.1 The Increased Attention to Intellectual Property Protection 7 Financial Performance: 7.1 Research and Development 7.2 Profitability 7.3 Cash Conversion Cycle 8 Valuation Ratios 9 Human Resources 10 References

Players around the world have also put ADGF's hybrid irons in their bags over the past six years due to ADGF's and technology and innovation in the hybrid segment of the industry. Maintaining Mr. Adam's Tight Lies philosophy and design, ADGF has produced multiple hybrid irons-- integrating fairway wood design with the function of traditional irons-- that have appealed to, and satisfied, the needs of all players, from recreational to tour professional golfers.

Key Trends and Forces

The Golf Industry's Recent Struggles

Industry-wide equipment sales - as compiled by Golf Datatech - have declined by about 18% since 2007.^[3] ADGF's sales have declined 10% since the 2008 recession. ^[2] The economic downturn has also affected ADGF's chief rivals, Callaway Golf, TaylorMade and Titleist, equally badly. ^[3] Revenues from high-margin drivers and metal woods fell by nearly 30%, sales of iron sets declined by 20%, and putter revenues dropped 24% between 2007 and year-end 2010, according to Golf Datatech's 2010 study. ^[3]

Year-on-year sales declines first appeared in irons, golf balls, and bags which began selling fewer units in mid-2006. The 12-month rolling decline in golf ball sales coincides closely with the decline in rounds played, which according to the National Golf Foundation reached a peak of 532.3 million in 2006. Golf Datatech statistics show that mid-2009 marked the worst of the recession for the golf equipment industry. ^[3] In 2009, year-on-year sales declines hit 12% for golf balls, 16% for bags and footwear, 17% for drivers, irons, and putters, 22% for fairway woods, 24% for hybrids, and 4% for wedges.^[3] The trend suggests that golfers are spending their money on game improvement products, such as hybrids and putters, more so than drivers probably due to the lower prices and greater versatility.

However, since that mid-2009 point, the sizes of year-on-year sales declines have been gradually getting smaller. It appears that all of the equipment product categories have bottomed out and sales are now recovering” said of Tom Stine Golf Datatech. ^[3] In fact, some product categories were approaching an annual growth towards the end of 2010. Growing categories in late-2010 were, of course, wedges with a 24% year-on-year increase, and fairway woods with a 4% improvement. ^[3] By the turn of 2011 sales of irons, bags, footwear, balls, and gloves had stabilized, although sales of putters, hybrids, and drivers continued to fall by 5% to 10% below sales levels a year before.^[3] The stabilization of sales correlates to the stabilization and increase in number of rounds played since 2006 levels.

United States Golf Association (USGA) and Technology Reforms

The only equipment category to grow since 2007 has been wedges. Their sales enjoyed a boom after the USGA and R&A's (Royal & Ancient Golf Club) 2008 equipment ruling banning the production of wedges featuring squared grooves after 31 December, 2010 due to the amount of spin that they produced (which disadvantaged players who did not use squared grooved wedges). ^[3] Bans on certain golf clubs by the USGA have usually precipitated buying sprees. However, the ruling allowed high-spin generating wedges purchased before 2011 to be used in recreational play until 2024. "This generous accommodation for the 99-plus percent of golfers not involved in tournament play drove wedge sales up by 23% in 2010 alone," said John Gamble, a business professor at the University of South Alabama.^[3] Golfers rushed to stock up on Titleist Vokey Spin Milled wedges, Cleveland Golf Zip Groove wedges, and Callaway Golf Jaws Mack Daddy wedges before the ban went into effect.The rush to purchase squared groove wedges also allowed the average selling price for wedges to reach a record $97 in 2010. ^[3]

In 1998 the USGA also placed restrictions on driver performance in order to limit how far a golfer would hit a drive. What determines how far a golf driver hits is the Coefficient of Restitution (COR). In layman terms, COR is basically the amount of flexibility that a driver face possesses; the greater the flexibility, the greater the COR will be, which translates into greater distance on golf drives.

The USGA's 1998 limitation on driver performance set off a 32% decline in the average selling price of drivers and fairway woods since 1997, so 2010 could also well mark the high point for wedge prices. New $400 drivers are easily-identifiable as "discretionary expenditure" for golfers more concerned with solidifying their personal financial situation than gaining three-to-five yards off the tee, thus, the decline in driver sales may continue to decrease.

A Decrease in the Golf Population

ADGF faces pressures from a shrinking market. As the Baby Boomer generation that fueled the sport's popularity ages and a younger, less active generation finds its entertainment elsewhere, fewer people are playing fewer rounds of golf. ^[5] The number of golfers in the U.S. has declined steadily since 2000, reaching 26 million in 2008, down from 30 million in 2000. ^[5] Furthermore, the amount of golfers that play at least 25 times a year has dropped about 33% since 2000.^[5]

Some reasons for the decline the golfing population include:

• Golfers married with children have limited time to play golf because of job responsibilities, lack of free time, and family responsibilities.^[4]

• Golfers married without children or single have experienced an increase in job responsibilities and lack of free time. ^[4]

• Retired or older golfers increasingly become sidelined with health concerns and related injuries.^[4]

• 30 percent of a 2007 National Golf Foundation survey claimed that they have not played as much golf as they would like because of the high greens fees at golf courses.^[4]

• Golfers are finding other alternative activities to occupy their time with due to their time constraints.

Golf Demographics

The participation of “core golfers” and rounds of golf played yearly drive the golf equipment sales. Core golfers are adult golfers who play eight or more rounds of golf per year and account for 87% of total domestic participation and 87% of total golf expenditures. ^[6] The majority of core golfers are located in the Atlantic (35% of core golfers) and Northeastern (24% of golfers) regions of the United States, with a strong presence of core golfers on the Pacific Coast (13% of core golfers). ^[6] On average, core golfers have an annual household income of $86,000 ^[6]. Another driver of golf industry growth is the number of 18-hole rounds of golf played within a year. With respect to core golfers, 47% of golfers played 8-24 rounds of golf in 2006, in contrast to only 2% of golfers who played more than 200 rounds during that same period. Individuals 70+ years of age playing on average 48 rounds of golf. ^[6].

A Sluggish Start for the 2011 Golf Season

Good News

From February 2010 to February 2011, the number of rounds increased in several regions in the United States; the country experienced a 13.6% increase in overall rounds played. The East North Central region experienced a 270% increase in rounds played. This is good news for Michigan since it is home to 1,047 golf courses, the most of any state in the nation. ^[7] However, as of 4/29/11, Michigan golf course rounds played are down almost 30% since last year at the same time ^[7].

Bad News

Warm weather is the ideal condition for golf, and consequently ADGF generates approximately 65% of its revenue during the spring and summer. ^[2] In addition, golf companies experience financial success when their players perform particularly well in the Majors (Masters in April, U.S. Open in June, British Open in July, PGA Championship in August), which coincides with prime golf season in America. An abundant quantity of golfers hang their clubs during the cold months of fall and winter, resulting in a decrease of rounds played in the second half of the year. In the short term, a lot of the mid-west states are still experiencing dismal weather conditions and are not expecting and increase the number of rounds played in the spring months of March, April, and May.

ADGF's Marketing:

Product Mix

ADGF operates solely in the golf club and accessory segment of the golf industry. Specifically, ADGF offers an arrangement of drivers, fairway woods, irons, wedges, and recently, putters.

Drivers (13.3% of FY 2010 Sales)

ADGF currently offers a variety of driver models "based on the shape, size, and material used in the club head."^[2] ADGF generally builds its drivers with graphite shafts. ^[2] During the summer of 2010, ADGF launched its Speedline 9064 drivers, and in January 2011, ADGF launched its Speedline Fast 11 drivers both featuring Velocity Slot Technology. The Speedline family is offered in standard and draw variations (left and right-handed) with a variety of loft and shaft flexes. Since its introduction in 2009, the Speedline family of drivers have been in the winners' bag at 21 different tour events.^[2]

Fairway woods and Hybrids (16.7% of FY 2010 Sales)

During January of 2011, ADGF launched the Speedline Fast 11 fairway woods. Offered in both stainless steel and titanium models, the Speedline fairway woods feature Velocity Slot Technology, resulting in an easy-to-hit fairway wood that, when compared to previous generations of fairway woods, has a 21 percent improvement in forgiveness accuracy, and 12 yards of increased distance.^[2] In 2009, ADGF's woods comprised 9 percent of the total woods market share. ^[8]

In December 2010, ADGF introduced three new individual hybrid product lines: the Idea Tech V3 hybirds, Idea a7 and Idea a7 over-sized (OS), Idea Pro Black , and Idea Tech a4 and a4 OS. Hybrid clubs are designed to be easier hit than conventional long irons.

The V3 hybrid won Gold designation in the 2011 Golf Digest Hot List (the leading golf club review) and was the category leader in "Innovation" in the hybrid category.^[2] The Idea a7 and a7 OS won Gold designation in the 2010 Golf Digest Hot Hist and were also the category leader in "Innovation" for hybrids.^[2] ADGF's largest testament to its hybrid performance is the fact that ADGF's hybrids were the most played hybrids on the 2011 PGA, Nationwide, and Champions tours combined.^[2]

Irons (68.3% of FY 2010 Sales)

In August 2010, ADGF launched its Idea V3 line of hybrid iron sets (4-pitching wedge).

The iron sets are intended for aspiring and recreational players. ADGF offers two configurations of the sets: forged or all-hybrid. In both configurations, the eight piece set consists of a 4,5, and 6 iron that progressively-sized hybrids and a 7 iron mid-hybrid.^[2] The V3 hybrid set won the Gold designation, the category leader in “innovation”, and the Editor’s Choice award of the 2011 Golf Digest Hot list.^[2] ADGF offers several other sets, such as the Idea a7 and a7 OS irons, which received a Golf designation in the 2010 Golf Digest Hot List and was the leader in the "Performance" category, the Idea Pro Black, Redline, Idea Pro Black MB, Idea Pro Black CB1, and the Idea Black CB2 which received Gold honors in the 2011 Golf Digest Hot List. ^[2] The Idea a7OS hybrid-iron set was the top selling model in combined on- and off-course unit sales for March 2010 according to Data Tech Golf. With a 6.4 percent unit share, the Idea a7OS line-up increased its stake in the market an impressive 113 percent since the beginning of 2010. ^[9] In 2009, ADGF's hybrids held 11 percent of the total hybrid market share. ^[8]

Wedges/Putters/Accessories (1.7% of FY 2010 Sales)

As a complement to the Idea irons, ADGF offers Tom Watson signature wedges and Puglielli wedges. None of ADGF's wedges made the Golf Digest Hot List from 2008-2011. During the first quarter of 2011, ADGF purchased the assets of YES! Golf Company, who is respected by tour professions and recreational golfers for their quality putters. In addition to wedges and putters, ADGF currently offers a limited line of golf bags, hats, and other apparel accessories.

ADGF's Marketing Mix

Place

Since ADGF does not have any standalone retail stores, ADGF's products are primarily sold to specialty retail stores, mass merchandise stores, sporting good stores, and on course accounts. Sales to these distributors accounted for 81% of ADGF's net sales in 2010. ^[2]ADGF has approximately 4,000 retail accounts throughout the United States which are managed by 62 sales representatives. ^[2] ADGF's international sales are made through a network of approximately 36 independent distributors. ^[2]

In 2010, international sales accounted for 19% of ADGF's net sales. ^[2] International growth continues to be a key initiative for ADGF due to its strong future growth potential. During 2010, international revenues increased 8% over the previous year and ADGF continues to devote more resources towards the development of this business, including but not limited to, establishing a third party distribution center to better service and develop the European market.

ADGF is dependent upon three customers, which collectively comprised 28.9% of net revenues in 2010. Looking at the landscape of golf retail outlets, Golf Smith and Dicks Sporting Goods appear to two potential customers that comprised 28.9% of ADGF's net revenues-- Dick's CEO Edward W. Stack was ranked number seven on Golf Digest's CEO Handicap list with a registered handicap of 4.1 (though irrelevant, it may influence Dick's golf sales). ^[10] Lastly, ADGF maintains a website at www.adamsgolf.com, which allows visitors to access information about products, heritage, retailer locations, and corporate information.

Due to the nature of the industry and lead times associated with purchasing components overseas technological developments, ADGF carries a substantial level of inventory; usually, a level that is sustainable for six to nine months of sales. ^[2] A significant portion of ADGF's inventory purchases are from one supplier in China; approximately 27% of total inventory purchased in 2010. This Chinese supplier also manufactures all of ADGF's driver, fairway wood, irons, and wedges. Geographical postponement forces ADGF to order in large quantities in order to meet forecasted demands. At the end of 2010, ADGF had an inventory balance of $28 million dollars. ^[2]

Promotion

ADGF promotes its products primarily through golf-specific advertising, which include advertising with television commercials (ADGF's last television commercial was March 4, 2010) that run during golf tournaments and advertising in golf-related magazines, sponsorships of developmental tours, and selected tournaments.

In Michigan, ADGF sponsors the "Adams Golf Junior Tour", a tournament series presented by the Game of Your Life Foundation, headquartered in Coldwater, MI. The tour has approximately 700 members, between the ages of 12-19, and offers 30+ tournaments each summer. ADGF engages in a variety of promotional activities on the tour, such as consumer sweepstakes and giveaways. In addition, each member receives one free polo shirt with ADGF's logo at the beginning of each season.

Professional endorsements are the lynch-pin to ADGF's promotional strategy and overall success. ADGF has entered into endorsement contracts with professional golfers on the PGA, Champions PGA, Nationwide, and LPGA tours and "believe that having a presence on these tours promotes the image of [their] product lines and builds brand awareness."^[2]

On the PGA Tour, ADGF has entered into endorsement agreements with professionals such as Ryan Moore, Chad Campbell, Aaron Baddeley, and several others. On the Champions Tour, ADGF has entered into endorsement agreements with Tom Watson, Bernard Langer, Tommy Armour III, Paul Azinger and several others. All of ADGF's endorsement contracts have various dates of expiration through 2013 and require the professionals use certain ADGF's products--- these professionals are known as staff professionals. While these golfers are by no means as iconic as Tiger Woods and Phil Mickelson, they represent a sort of prestige that is attractive to certain customers. In order to increase sales, ADGF should look to sign a young tour player that has "consumer hype". Using Tom Watson in television advertisements does not garner the same attention as a younger, more popular tour player.

The performances of the professional golfers sponsored by ADGF strongly relates to sales. When a pro golfer uses certain equipment to win a tournament, that company experiences tremendous exposure to the media and receives praise from its peers. Amateur golfers of all levels generally want to play with the same types of equipment (clubs, balls, gear) the successful professionals trust. ADGF does not spend nearly as much of its financial resources as its competitors on selling and marketing expenses in order to retain staff of highly talented golf professionals.

Companies compete on the quality/performance as well as overall image of their equipment by investing heavily in research and development (R&D) and marketing campaigns. Nike, for instance, offered a $100M 5-year endorsement to Tiger Woods and Callaway has spent $32M on R&D in 2007. As will be discussed later in the analysis, Callaway's large R&D expense didn't necessarily correlate as well to sales as ADGF's did. ^[6]

Price

ADGF sells it product to its distributors on a cumulative quantity discount basis, meaning that the larger the quantity sold, the lower the item price is, i.e. economies of scale.

ADGF's retailers price their products using a value-based pricing model with price penetration objectives. The market for golf clubs is highly competitive and highly sensitive to economic conditions. Retail locations use seasonal discounts in order to move inventory and make room for next season's products.

When shopping for ADGF's products at pro-shop or big-store retail locations, ADGF's products are usually priced very competitively. ADGF's drivers are usually priced below its main competitors: TaylorMade, Titleist, PING, Cleveland, and Callaway. For example, as of 4/20/11, ADGF's Speeline F-11 drivers are consistently priced $100 less ($299 vs. $399) than the leading drivers on the market at Dicks Sporting Goods, Golf Smith, and The Golf Warehouse. This could a strategy to gain market share.

For ADGF's hybrids and irons, it appears that retail locations place a premium on the price in comparison to other hybrid clubs. For example, as of 4/20/11, ADGF's Idea V3 hybrid is priced at $199 while comparable hybrids for 2011 with Gold ratings from Golf Digest are priced from $179-$189. Only one hybrid was priced higher than the V3, and that was the Taylor Made Rescue R11 Tour Preferred, priced at $219 at Dicks Sporting Goods. ADGF's price premium is indicative of ADGF's leadership in the hybrid market and its reputation as the most played hybrid brand in golf.

Competitors:

The golf equipment industry lies on a spectrum of low-end to high-end manufacturers. The low-end manufacturers include Spalding, MacGregor, and Dunlop that mainly sell equipment for amateur players. ADGF falls between the low to high end manufacturers. While ADGF sells equipment for various skills of amateur players, it also provides a selection of professional equipment, but not to the extent of the high-end manufacturers. The high-end manufacturers include Callaway (NYSE: ELY), TaylorMade (owned by Adidas (ETR:ADS) ), Ping, Mizuno (TYO:8022), Cleveland (owned by SRI Sports (TYO:7825) , Bridgestone Golf (owned by Bridgestone Corporation (BRDCY) , and Nike Golf (NYSE: NKE), and Titleist (owned by Fortune Brands (FO)).

These manufacturers sell professional equipment, usually at specialty golf-shops.Catering towards more seasoned players, who mostly fall into the “core” participant group, these companies are able to extract higher margins on their sales. One could argue that high end customer is less concerned with price, and more so with the quality of his purchase, and perhaps, the image/sense of prestige that comes along with the purchase. Therefore, the strongest decision-drivers in this segment are quality of the products and their marketing.

Comparison of Business Segments

ADGF's core competitors are Titleist Golf, Callaway Golf, TaylorMade Golf and Nike Golf. Adadias, Fortune Brands, and Nike are the three largest companies Adam's faces in the United States and also comprise the a major portion of golf market share. Recent reports indicate that TaylorMade has the largest market share in the industry.

• Adams Golf (ADGF): ADGF's 2010 sales were driven by hybrid irons and hybrid fairway woods more than any of its competitors. ADGF's hybrids were the most popular hybrids on professional tours in 2010 and are very popular for recreational golfers. ADGF has remained a slow reactor over the years to the trends of the innovators in the golf industry. It appears that there is only a mild sense of urgency to generate a profit at ADGF considering their small tour professional list and their dismal marketing campaigns, so long as their hybrid segments remain competitive, it appears that there is no urgency for them to divert their expenditures into other segments to hedge the risk of ADGF's hybrids losing market share. As of April 2011, TaylorMade has made a giant leap in hybrid market share and is on track to bounce out ADGF from their top stop. Compared to its competitors, ADGF targets consumers who are looking to purchase complete sets of golf clubs, more so than consumers who are looking for individual clubs. While this limits the ability of ADGF to sell fully customized clubs to all of its consumers, ADGF does maintain customization options for the high skilled player. Also, over the past five years, ADGF's R&D team has improved tremendously and has begun to be an industry crusader in technology, i.e its Velocity Slot technology. However, ADGF still faces financial disadvantages compared to its larger competitors when it comes to capital investments and R&D expenditures.

• Fortune Brands (FO): The Acushnet Company is Fortune Brand's golf division and runs the following companies: Titleist, Cobra Golf clubs, Pinnacle balls, FootJoy gear, and Scotty Cameron putters. The company was the first to produce golf equipment back in 1932 and has been the largest and leading golf ball seller since 1949. ^[12]Acushnet is the top U.S. selling golf product in balls (Titleist) and shoes (FootJoy). is the industry leader in the golf ball sales in part to its most popular balls the ProV1 and ProV1x. As the leader, Titleist relied on its golf ball segment to drive its sales in 2010-- Titleist golf balls have been the most used at all PGA tour events since 1992 ^[12]. Titleist sponsors tour professions like Nick Watney, Rory Mcllroy, Geoff Olgivy, and Adam Scott. Titleist has been a defender in the industry over the years and has not focused on bring the latest technology to the market. Rather, it has focused on cost efficiency and providing an expansive live of golf balls (from the ProV1 to DT Solo) to maintain its market share and attract golfers of all levels.^[12] In 2010, Titleist had the most number of tour staff professionals using its products.

• Taylor Made- Adidas Golf (ADDYY): Bought out by Adidas in 1997, TaylorMade manufactures golf clubs, balls, and accessories, while Adidas deals with apparel. It is ranked first in world club distribution and more PGA Tour professionals play with TaylorMade drivers than Callaway, Cleveland, Cobra, Nike, and Ping combined. ^[13] TaylorMade boasts the most preferred drivers for professional and recreational golfs, and as such, its sales were driven primarily by driver and fairway wood sales. It also sponsors professional players such as the World's number one player, Martin Kaymer, Justin Rose, Sergio Garcia, and Mike Wier. TaylorMade has the most number of wins by any golf club manufacturer in 2011 with 15, the most number of drivers played in professional golf (TTM 2,023), and the most number of fairway woods played (TTM 2,293) and hybrids (TTM 1,320). ^[13] TaylorMade's R11 driver is the most popular driver on the 2011 PGA Tour. Overall, TaylorMade is an innovator in industry-- its removal weight system was in industry first in 2003---, always updating its driver model every 7-18 months with new technological innovations. In 2010, TaylorMade's market share in the drivers, fairway woods, and hybrid segment was 30% larger than the closest competitor. ^[13]

• Nike (NKE): Nike competes in all departments of the golfing market: clubs, balls, and gear. Always a leader in athletic innovations, Nike's golf equipment is used by Tiger Woods. Nike has been a reactor in the industry since it brought its first golf equipment to the market. Nike has never been known to invest heavily R&D or bring new creativity and innovation to the market; Nike is known for sponsoring Tiger woods and driving revenues, mainly through apparel, through advertisements. While Nike's endorsement over innovation strategy has paid off in apparel and accessory sales, golfers perceive Nike to not be a serious golf club manufacturer with equipment that is sub par.^[12] For 2010, Nike Golf had $638M in sales which was larger than ADGF's $86M but smaller than Callaway's $1.1B.

• Callaway Golf (ELY): While Callaway sells golf clubs in all of the available segments, its sales in 2010 were driven primarily by its putter segment. As they say in golf, "drive for show, putt for dough". Callaway is known for developing its product and creating new innovative clubs in the industry. It hired a team of aerospace and metallurgical engineers to design and produce the most technologically advanced golf clubs.^[12] And in 1991, it introduced the first stainless-steel driver-Big Bertha to the industry. ^[12] Phil Mickelson and Ernie Els have promoted the Callaway brand on the PGA tour for the past three years and have used Callaway's new RAZR-Hawk drivers. Callaway tries to differentiate itself from its competitors by offering a certified pre-owned online store for its customers with the intent of maintaining brand loyalty. Overall, so long as Callaway can remain fiscally fit, it is certain that it will continue to be an innovator in the industry.

Porters Five Forces Analysis:

Competition in the industry

Although the golf club industry is highly fragmented between big box retail brands and small boutique brands, the industry is extremely competitive due to improvements in golf club technology. It is difficult to determine a dominate brand in the industry since there is intense competition for market share. However, based on the fact that drivers are the most frequently purchased golf club and the most technologically advanced pieces of golf equipment, industry experts would argue that Taylor Made has a slight advantage over the rest of the competition since they are the leaders in driver sales. ^[2]

While there is intense competition, companies have found unique ways to differentiate their products aesthetically more so than technologically. For example, there are three basic materials for today's drivers by most golf club manufacturers: titanium, carbon fiber, and various lightweight steels. Since the USGA has implemented strict regulations on the C.O.R limits on the face of drivers and the size of the club head (a maximum of 460cc), manufacturers are restricted to how they can "build" driver club heads. In a sense, golf club manufacturers are limited to a template for club head design, just like how NASCAR requires its drivers to use "approved" car bodies for their race cars in order to ensure fairness across the field. Golf club manufacturers, such as ADGF, have utilized wind-tunnels to design the most aerodynamic driver club head possible in order to gain market share. Taylor Made has utilized a perimeter weight system and a white color scheme on its drivers to aesthetically appear to its consumers.

Since the golf club industry is rather mature, it is difficult for companies to generate new sales without attempting to woe customers from rival companies. For example, in effort to garner new customers for its products, PING Golf company was the first company to offer potential customers free custom fittings with launch monitor testing, persuading customers that customization is essential to shaving strokes. Similarly, there have been many mergers and acquisitions in the golf industry in order to capture as many customers as possible and instill brand loyalty. For example, ADGF recently acquired YES! Golf Putters in order to compete in the putter segment of the industry since ADGF's main competitors offer a line of putters. ADGF hopes that purchasers of ADGF clubs will buy YES! putters and vice a versa because of the reputation behind the Adams Golf name.

Potential of new entrants into industry

Low: Today, it is not easy for new companies to enter into the golf industry. Over the past 50 years, the industry has determined its major brands: Taylor Made, Titleist, and Callaway. The largest barrier to entry for new entrants is the existing loyalty to major brands. The second largest barrier to entry for new entrants would be the large capital investments for design facilities and manufacturing facilities that incorporate flexible manufacturing systems. Overall, the golf industry is well defined with many solid barriers to entry for new entrants.

Power of suppliers

Medium: There are four main component suppliers in the golf industry: grip manufacturers, shaft manufacturers, club head manufacturers, and build supply manufacturers. None of these suppliers necessarily exert more impact over another to affect a company's margins and volumes in the golf industry. For example, golf shaft manufacturer Aldila (ALDA) is the world's largest manufacturer of generic and premium grade graphite shafts and supplies all golf club manufacturers. For some professional golfers, there are no substitutes for Aldila shafts, leaving golf club manufacturers in a bind if Aldila is unable to product shafts. The same holds true for TrueTemper, the world's largest supplier (and most popular) of steel shafts and Golf Pride, the world's largest manufacturer of golf grips. While Aldila, TrueTemper, and Golf Pride are not the only manufacturers of their respective shafts and grips, there are few substitutes for their proven performance.

Power of Buyers

High: Buyers have a significant amount of power in the golf industry. Some customers, such as sporting goods retail giant Dicks Sporting Goods, have tremendous power over its suppliers since Dick's large volume purchases and sales provide the golf club companies with handsome returns. The distributors of golf clubs have power over the manufacturers mainly because there are a small number of large-scale buyers who aim to purchase the volumes that stores such as Dick's and Golf Smith International buy on an annual basis. In addition, it is very easy for distributors to switch to another golf club manufacturer since the products in the market offer similar performance and technological attributes. Price is not necessarily a concern for the distributors since the volume of their purchases ensures a low price per unit. Price does become a determinant for certain levels of golfers though. Also, big-box retailers are not necessarily purchasing the most advanced, or niche, products, thus allowing them to have leverage over prices. The highly customized and niche golf products are sold to pro-shops and boutique golf stores around the world that service specific target markets; these products are naturally more expensive than their basic versions.

High-end golf equipment manufacturers sell through on-course golf-shops, off-course golf shops, and online venues. Since most of these distributors are not large, and usually do not account for more than 3% of a manufacturer’s sales, they have rather low buyer power. ^[6] This would have been very different, had the high-end manufacturers chosen to use the same channels as low-end ones: large department stores a la Walmart that would exert much greater power over producers by increasing the size of the orders.

Golfers have some buyer power because they usually have the information about the features of the products they’re buying. Many golf magazines feature comparisons of various golf clubs and their performance characteristics, and this information is easy to find, making golf equipment, essentially, a “search good”; i.e Golf Digest's Hot List. Also, end users have relatively low switching costs between rival products, adding to their power.

Since ADGF annual success focuses on the dependence of new product introductions, it is key that the new products produced are widely accepted. Historically and more so than its competitors, a large portion of new golf club technologies and product designs badged under ADGF have been met with consumer rejection ^[2] Certain products that have been previously introduced have no been met with the level of acceptance anticipated by management, such as ADGF's line of wedges. Although no assurance can be given that ADGF's current or future products will be met with consumer acceptance, failure by ADGF to timely identify and develop innovative new products that yield widespread acceptance is only a result of poor development strategies-- it takes ADGF six to twelve months to bring a product to market from market evaluation through development, compared to TaylorMade's 4-8 month process ^[2] . Additionally, successful technologies and product concepts are likely to be copied by competitors. Therefore, if ADGF were to copy TaylorMade's R11 driver, they would probably not achieve the same profits simply due to the brand name.

Threat of substitute products

Medium: The likelihood that someone will switch from one product to another is high in the golf club industry, mainly because the cost of switching is rather low. However, the threat of a golfer changing from one brand to another is usually lower, since players usually stick to a brand that they are familiar with. Golf clubs from all manufacturers are typically all priced competitively, with the exception of professional versions of retail off-the-shelf products. Golfers of all skill levels are unlikely to switch golf clubs frequently because the initial costs or purchasing a quality set are somewhat significant for the average consumer. However, there are little to no barriers prohibiting customers from changing brands if they are unsatisfied with the product or would like to purchase a club with cutting edge technology. Plus, since the product life cycles of golf clubs are extremely short, the shortest being drivers, there are always opportunities to upgrade. Having said that, some high-end manufacturer's prices will be significantly higher than others due to the costs they incur for research and development, promotion via tour player sponsorships, and the value of brand name.

Golf club company's retain customers by providing quality golf clubs that perform well under all conditions and by continuously improving their products to sustain the desired level of satisfaction by the customer. Fortunately, for the larger golf club manufacturers such as Taylor Made and Titleist, the financial and marketing resources to do so are more available and abundant than for smaller golf club manufacturers, such as ADGF.

Furthermore, there are no viable substitutes for the product categories that are currently available on the market. The most recent substitute brought into the market was the hybrid golf club. Otherwise, the product categories that are represented in the market today are surely the ones that will remain for the years to come. The main issue is the similarity of substitutes. For example, if the price of coffee rises substantially, a coffee drinker may switch over to a beverage like tea.If substitutes are similar, it can be viewed in the same light as a new entrant.

SWOT Analysis:

The Increased Attention to Intellectual Property Protection

Imitation of popular club design is widespread in the golf industry. There are numerous patents held by third parties that relate to products competitive to ADGF. ADGF needs to ensure that it defends against competitors infringing upon its patents and product designs. Since ADGF does not have the luxury of excess cash to spend on costly litigation, especially in foreign countries such as China where 70-80% of counterfeit golf equipment is built,it is imperative that ADGF implement the necessary protections in its supply chain to ensure that its internal designs and information are not released. ^[14] In 2009, counterfeit golf equipment reached $200 million in sales. ^[14] It usually takes 60 days from counterfeit clubs to be produced and brought to market. ^[14]

Why does ADGF still produce golf equipment in China if there is a large risk of IP theft? "If we didn't, your $400 driver would cost $1,000," said Barney Adams in 2009 ^[8]. "Making a golf club is still very labor intensive. We understand the risks of doing business over there. We do the best we can to minimize them, and we move on."^[8]

Financial Performance:

Adams Golf reported net sales of $86.3 million for the year ended December 31, 2010, as compared to $76.1 million for the year ended December 31, 2009, an increase of 12% year-over-year. $69.8M of the $86.3M came from U.S. sales and $16.5 came from international sales. ^[2] International sales are made primarily in Canada, Europe, South Africa, Japan and other Asian regions. For the years ended December 31, 2010, 2009 and 2008, international sales accounted for approximately 19%, 20% and 20%, respectively, of ADGF's net sales. ^[2]

Adams Golf had a net profit of $5.0 million in 2010 as well, as compared to a loss of $12.2 million in 2009. ^[2] "2010 was a successful year for Adams Golf and we are pleased with our financial performance," said Mr. Chip Brewer, CEO and President of Adams Golf. ^[2] According to Golf Datatech LLC, ADGF's full year 2010 U.S. iron dollar share in the combined On and Off Course Channels was 10.2%, up 17% year-over-year.^[2] ADGF's full year 2010 wood dollar share in the same channels was 5.5%, up 6% year-over-year.^[2] These same market shares for the month of January 2011 were 12.4% and 7.0% respectively. ^[2]

When compared to its competitors, ADGF is clearly the smallest company in the golf industry, in terms of market cap, number of employees, revenues, and income.

Research and Development

Over the past three years, ADGF has also been out spent in research and development expenses by its competitors. Although exact figures for all its competitors are unavailable at the time of this report, when compared to Callaway Golf, it is easy to see that ADGF does not have the financial resources or capability to divest more than $4M per year in R&D expenses. In 2010, ADGF spent $3.7M on R&D while Callaway spent $36.4M. This suggests a few things about ADGF's operations.

First, it represents a longer product life cycle strategy. Being unable to spend over $3M per year in R&D expenses forces ADGF to diligently design and develop a product with the intention of it lasting in the market place for a longer period of time than its competitors products. This puts ADGF at a disadvantage since the golf club market place has a high turnover and short product life cycle because of new technologies.

Second, it suggests that ADGF focuses on short term "refreshes" of its products instead of extensive overhauls. Refreshing a product, whether it be cosmetically or physically, is not nearly as expensive as starting from scratch and minimizes huge increases in fixed and variable costs. Refreshing a product allows ADGF to stay as current as possible while spending as little as possible on R&D expenses, that is, however until the industry leaders decides to introduce a product that is a first of its kind. Some investors may argue that in order to remain competitive in the market ADGF must allocate more of its resources towards R&D since golf consumers often view Callway's products as "one step behind" the rest.

Lastly, it suggests that ADGF is focused on providing "sets" of clubs instead of individual clubs. In order to remain lucrative in the individual club business, such as relying on driver sales for your main source of revenue, a company must be willing to put forth the capital to outspend and out innovate its competitors to capture the available market share and consumers. In ADGF's case, they are unable to outspend their competitors in R&D, so instead they focus on providing sets of golf clubs, which does not require strenuous capital expenses, is less affected by changes in technology, and usually has a more stable demand for new and amateur golfers since they are viewed as the best bang for the buck and do not chose to spend $300+ on a new driver. This could be a long term strategy for ADGF since a 2008 National Golf Foundation study found that the number of junior golfers increased between 2005 and 2008, from 4.4 million to 4.8 million kids ages 6 to 17--- the main target market for golf set sales. ^[15]

Looking at the efficiency/effectiveness of each company's R&D expenses in relation to sales, it is clear that ADGF's is efficient at using its R&D investments to produce approximately 4% of its sales revenue-- more efficient than Callaway in the past two years too. If ADGF can increase or sustain this effectiveness it should increase its R&D investments. However, a decrease in R&D expenses on the income statement will boost current earnings, but earnings in the long-term may suffer. ^[16] And an increase in current R&D expenses may lower current earnings but provide benefits in future years.^[16] Also, historical increases in R&D that don't result in increased future sales should be a red flag for investors. This could mean the company is becoming less efficient at using R&D investments to produce new products.

Profitability

From 2008 to 2010, ADGF has accrued the least amount of revenue compared to its competitors as well as the least amount of net income. Although ADGF has net losses in 2008 and 2009, ADGF earned a profit and a positive return on invested capital in 2010 and a 43.76% gross sales margin, suggesting that ADGF retains 44 cents on every dollar of revenue to use towards paying off other general expenses incurred. This figure is relatively low compared to the rest of the competition, which means that ADGF has less costs to pay after sales. In 2010 ADGF also recorded a positive return on asset (ROA) of 8.43%, up from a -19.61% return in 2009. ADGF may have changed operational techniques and strategy in 2010 to more efficiently use its assets to generate profits.

Looking at asset turnover ratios, it is important to understand that, like ROA, the ratio measures a firms efficiency at using its assets to generate sales, and the higher the ratio the better. Asset turnover also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins tend to have low asset turnover. From 2008 to 2010, ADGF has consistently had the highest asset turnover compared to its competitors. In 2010, ADGF's asset turnover was the highest its has been in three years, 1.44. Considering that ADGF's products to do not carry the brand value and curb appeal that brands such as TaylorMade and Titleist do, ADGF has a hard time adding a premium to its prices, and requires larger volumes of sales to earn significant sales margins. On the other hand, Titleist has consistently held the lowest asset turnover, which fits their premium pricing strategy.

Cash Conversion Cycle

A weakness of ADGF's financial performance is its cash conversion cycle (CCC). Compared to its competitors, ADGF's cycle is the second longest, 195 days. This is a product of ADGF's large days of inventory (177), payables receivable (45 days), and days sales outstanding (63). Decreasing the cycle time would allow ADGF to realize an increase in its bottom line because there would the less time for capital to be tied up in the golf club making process, thus producing and selling golf clubs faster. TaylorMade golf appears to be leading the industry in CCC with a total of 89 days.

Titleist, on the other hand, is leading the industry in receivables turnover, with a ratio of 7.53 times. This implies that Titleist operates either on a cash basis or that its extension of credit and collection of accounts receivable is efficient. ADGF has a low receivables turnover ratio of 5.8 which is blow the industry average of 6.8 times. Herein lay another area for improvement for ADGF's profitability. ADGF can increase its turnover by increasing its net credit sales or decreasing its average accounts receivable. ADGF should work with its suppliers to ensure that both parties are on the same page regarding credit policies and collection times.

Another area of improvement for ADGF is its inventory turnover. In 2010, ADGF turned over its inventory of golf equipment 2.07 times, while Nike turned over its inventory 4.64 times. Nike's figures may be distorted, however, since its golf apparel is included in its inventory (same for TaylorMade). While a low ratio indicates poor sales and excess inventory, a high ratio indicates high sales or ineffectve buying. ADGF did not have the lowest turnover though. Titleist had a turnover of only 1.8 times. With a premium price tag on its products, Titleist is still able to produce significant returns despite its low inventory turnover. Due to seasonal fluctuations technological improvements, ADGF should remain conscious of inventory levels and do its best to push sales in peak times.

Valuation Ratios

At first glance, it is clear that ADGF is disadvantaged by its size in market cap and sales in relation to the rest of the industry. With only $7M of cash on hand at the end of 2010, ADGF appears to be a mere grain of sand compared to its competitor, Titleist, with $865M of cash on hand at the end of 2010. However, unlike Titleist, ADGF is free of long term debt, which is helpful for boosting ADGF's short term bottom line. Looking long term, the absence of debt (financing) may place ADGF at a disadvantage since it does not have access to resources to acquire capital for future investments and thus increasing the value of the company.

Perhaps the most important valuation ratio to examine when analyzing the golf industry is the enterprise multiple (EV/EBITDA). The enterprise multiple is used for a couple reasons. First, the enterprise multiple is significant because it is an accurate determinant for identifying takeover candidates. In general, a low ratio indicates that a company might be undervalued and is a good takeover candidate and a high ratio indicates that a company might be overvalued and not a strong takeover candidate. Secondly, the enterprise multiple is useful for measuring the total value of a company, including its cash and debt interests.

ADGF's enterprise multiple is 5.8 , the lowest of its competitors, and below the industry average. Titleist has an enterprise multiple of 16.2, implying that it is highly valued or potentially over valued since a majority of its market value is derived from golf ball sales which are threatened by new substitutes from TaylorMade and Callaway. Callaway's enterprise multiple in 2010 was 17.4, while it realized a net loss of $19.3 million on the year, indicating that perhaps the company is overvalued.

Callaway's poor EBITA/Sales ratio would also suggest that the company is malled by inefficient processes and thus overvalued. On the other hand, ADGF's 7% EBITDA/Sales ratio would suggest that ADGF is capable generating sustainable earnings via efficient processes that have kept expenses relatively low. Titleist's 10% ratio implies that it has been able to use its processes the most efficiently in the industry to generate earnings after expenses.

ADGF may be a attractive takeover candidate for a potential investor looking to invest in undervalued company with the intent of turning around the organization in order remain a competitive player in the golf equipment market. As discussed before, ADGF's hybrid business appears to be the core strength of its operations and could potentially prove to be a lucrative asset to a potential buyer. So long as the current management is in place at ADGF, it does not appear that a radical change in product offerings will take place. Therefore, looking long term, it appears unlikely for ADGF to increase its value by trying to become the leader in another golf segment.

Human Resources

While companies in the golf industry average 608 employees, ^[17] ADGF employs 129 employees and 65 sales representatives, led by the following key executives:

• Oliver G. Brewer- President and CEO

Age 47, a Director since October 2000. Mr. Brewer has served as the President and Chief Executive Officer of Adams Golf since January 2002. He was ADGF's President and Chief Operating Officer from August 2000 to January 2002 and Senior Vice President of Sales and Marketing from September 1998 to August 2000. ^[2]Mr. Oliver received a salary of $377,000 in 2010, as well as a $519,750 bonus.^[2] Mr. Brewer is known for supporting his business amidst the staunch competition: “I tell people, ‘We’re just a little fairway wood company in Texas. Don’t worry about us.’ We’ll just kick your ass and take some business” ^[8] That could be the motto of Plano-based Adams, which started out with the longest of odds with its Tight Lies Fairway Wood—sales now of 2 million units and counting—and has since evolved into one of the last remaining national golf companies, offering a full range of clubs.

• Pamela High- Chief Financial Officer

Ms. High, 36, has served as Interim Chief Financial Officer of ADGF since April 2009. She was ADGF's Controller from July 2002 to April 2009. On October 28, 2010, Pamela High was named Chief Financial Officer.Ms. High has been an employee of ADGF for 11 years. She served as the Company’s Interim Chief Financial Officer from April 2009 until her appointment as Chief Financial Officer.^[2] In 2010, Ms. High received a salary of $118,000, a bonus of $53,000, and a stock award of $149,950. ^[2]

• B.H. Barney Adams- Board Chairman and Founder

At age 72, Mr. Adams has been a Director since 1987. Mr. Adams founded Adams Golf in 1987 and has served as our Chairman of the Board since that time. Mr. Adams served as Chief Executive Officer from 1987 until January 2002, and as President from 1987 until August 2000. Mr. Adams is the inventor of the Tight Lies® Fairway Wood.^[2] Mr. Adams brings has a wealth of golf industry experience as a golf retailer and manufacturer.^[2] Adams book, The Wow Factor, is an insiders look at the golf industry and offers business advice to entrepreneurs. Adams continues to be an avid golfer, but now mainly pursues his hobby, saltwater fly fishing.

Adams began playing golfing at 14, caddying at Onondaga Country Club in Fayetteville, New York. ^[2]Adams attended Clarkson College on an athletic scholarship, graduating in 1962 with a Business Management (BBA) degree and also became a member of Sigma Delta, a local fraternity on the Clarkson campus. After graduation, Adams worked for Corning Glass in various engineering positions, and then entered the supermarket industry in Southern California as an independent sales representative. He then led a Silicon Valley startup making microprocessors to reduce retail energy usage.^[2]

In 1983 Adams joined Dave Pelz Golf in Abilene, Texas. When Dave Pelz Golf Golf Inc. went bankrupt, Adams bought the assets and started Adams Golf. Initially specializing in custom fitted golf clubs, the company rapidly expanded after the creation of the Adams Tight Lies fairway wood. ^[2] “Every single major golf company—TaylorMade, Callaway, Ping, Titleist—all started with a single project and grew,” says Adams Golf founder Barney Adams ^[8]. “That’s what we wanted to do at Adams. The naysayers called it a lucky fluke. Now our stuff is as good as anybody’s.” In 1998 Adams Golf went public on Wall Street, with an initial public offering underwritten by Lehman Brothers.^[2] In 1999, Adams was selected as Manufacturing Entrepreneur of the Year by Ernst & Young in 1999. Although semi-retired since 2000, Barney Adams retains the title Chairman of the Board.

One may argue that Mr. Adams is not interested in making year over year profits since he would like to maintain his legacy as "the guy who reinvented fairway woods" with the Tight Lies. Mr. Adams will forever be a steward of the golf industry but may not be the best Board Chairman for the company.

References

1. ↑ "ADGF Hybrids", ADGF, 4/19/11
2. ↑ ^{2.00 2.01 2.02 2.03 2.04 2.05 2.06 2.07 2.08 2.09 2.10 2.11 2.12 2.13 2.14 2.15 2.16 2.17 2.18 2.19 2.20 2.21 2.22 2.23 2.24 2.25 2.26 2.27 2.28 2.29 2.30 2.31 2.32 2.33 2.34 2.35 2.36 2.37 2.38 2.39 2.40} "ADGF FY 2010 Annual Report", ADGF, 4/19/11
3. ↑ ^{3.00 3.01 3.02 3.03 3.04 3.05 3.06 3.07 3.08 3.09 3.10} "Are Golf Sales Out of the Bunker?" BBC, 4/22/11
4. ↑ ^{4.0 4.1 4.2 4.3 4.4 4.5} "Competition in Golf Equipment Industry"
5. ↑ ^{5.0 5.1 5.2} "More Americans are Giving Up Golf", 4/23/11
6. ↑ ^{6.0 6.1 6.2 6.3 6.4 6.5} "Callaway Analysis" 2007
7. ↑ ^{7.0 7.1} "MI golf courses" 4/23/11]
8. ↑ ^{8.0 8.1 8.2 8.3 8.4 8.5} "CEO Barney"
9. ↑ " Press Release"
10. ↑ "CEO Handicaps"
11. ↑ "Tour Number One"
12. ↑ ^{12.0 12.1 12.2 12.3 12.4 12.5} "Titleist"
13. ↑ ^{13.0 13.1 13.2} "TaylorMade Most Wins"
14. ↑ ^{14.0 14.1 14.2} "IP"
15. ↑ "NGF"
16. ↑ ^{16.0 16.1} "Investopedia"
17. ↑ "ADGF Competitors"]