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ELY AT A GLANCE

P/E ► -152   EV/EBITDA ► 16.2 AVG ROA ► 0% AVG ROE ► -0.8% AVG Debt to Equity ► 0.234 VERY LOW Current Ratio ► 3.54 HIGH Interest Coverage Ratio ► -1.32 AVG

 

 

 

 

 

 

Callaway Golf Company (NYSE: ELY) makes golf equipment. The company sold $1.1 billion in equipment for FY 2008,^[1] with 50.4% of sales arising outside of the US ^[2] In 2008, Callway's net sales were divided between woods (24%), irons (27.6%), putters (9.1%), balls (20%), and other accessories (19.3%).^[3] Sales in woods, a product that carries high for the company, decreased $37.6 million (12%) to $268.3 million from 2007 as a result of declines in both average selling prices and sales volume, as well as a decreased number of new driver models. ^[3] In Q3 2009, Callaway reported revenue of $191 million, a decrease of 11% from Q3 2008,^[4] while its net income was approximately -$13.43 million, a decrease of 80.5% from net income in Q3 2008.^[5] Callaway attributed its struggles, in which it expects revenue for 2009 to ultimately be 16% lower than 2008 revenue, to unfavorable exchange rates and a challenging economic and market condition.^[6]

Callaway 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.^[7] The number of golfers in the U.S. has declined steadily since 2000, reaching 26 million in 2008, down from 30 million in 2000.^[7] Furthermore, the amount of golfers that play at least 25 times a year has dropped about 33% since 2000.^[7] However, Callaway's sales have maintained strong as of 2007, increasing 38% since 2003.^[8] In addition, experts predict that the golf club market will see a growth rate of over 25% annually in China and India as golf continues to expand worldwide, a trend that benefits Callaway.^[9] Callaway did start to feel the slowing consumer spending following the 2007 Credit Crunch in Q3 2008 as its sales declined over 9% during the quarter, although the company believes its popular 2009 line of products will boost Callaway's overall year performance.^[10]

Callaway depends on continual new product launches for its success, as customers come back to buy the latest technology. In 2007, the company's product launches had mixed results - sales of a new line of Top Flight balls called the Xtreme flopped, but the popular release of the Big Bertha 460 driver spurred a 15% increase in driver sales.^[11] In June 2009, Callaway Golf announced it had completed its $140 million private offering of series B preferred stock. ^[12]

Business Overview

Callaway manufactures clubs, including drivers, woods, irons, wedges, and putters, under their brands Callaway and Ben Hogan, while developing golf balls under the names Callaway, Ben Hogan, and Top Flite. In addition, the company produces putters through their Callaway and Odyssey lines, and retail apparel (hats to shoes) and accessories (bags, umbrellas, other forms of gear) primarily through its Callaway logo.^[13] Callaway, Ben Hogan, Top Flite, and Odyssey are all well known to the golfing community because of endorsements by top professional golfers, like Phil Mickelson, Arnold Palmer, and Annika Sorenstam. The company retails goods worldwide, with international sales of 50.4%.^[2]

ELY 3 Year Financial Performance^[8]

Business Segments

ELY Revenue Breakdown by Business Segment^[14]

ELY Revenue Breakdown by Geographic Region^[15]

The company's business segments are organized into the Golf Clubs segment and the Golf Balls segment.

Golf Clubs Segment (80% of sales, 95.1% of operating income)^[16]

• Irons (27.6% of sales): The company sells irons and wedges under the Callaway Golf, Top-Flite, and Ben Hogan names. Callaway earned $309.6 million in revenue from iron sales in 2007, which represented a 8% increase from a year earlier.^[11] The company attributes several new successful product launches, including the X-20 series irons, for the rise in sales.

• Drivers and Fairway Woods (24% of sales): Callaway designs and sells drivers and fairway woods under the Callaway Golf, Top-Flite, and Ben Hogan brand names. The company earned $268.3 million in revenue from the sales of drivers and fairway woods, or 24% of its total 2008 revenue.^[17] Woods sales decreased $37.6 million (12%) to $268.3 million from 2007 as a result of declines in both average selling prices and sales volume, as well as a decreased number of new driver models. ^[3] As a result of said decline, Callaway announced that it would get rid of its FT IQ driver line in September 2009, after only one year on the market.^[18]

• Accessories and Other (17% of Revenue): This segment includes Callaway's sales of golf-related accessories like golf bags, footwear, gloves and umbrellas as well as royalties earned through licensing of the company's logo on apparel, watches, and travel gear. Together, accessories sales reached $186.9 million in 2007, or 17% of the company's revenue.^[11] This represents a 17% increase from 2006 which was mainly due to higher sales of Callaway footwear.^[11]

Golf Balls (20% of sales, 4.9% of operating income ^[16])

Callaway earns 20% of its revenue from sales of golf balls under the Callaway Golf and Top-Flite brand names.^[3] Golf ball sales increased 5% in 2008 to $223.1 million due to an increase of $17 million in Callaway Golf ball sales offset by a $6.2 million decrease in sales of Top-Flite balls. ^[3] Operating profit from golf balls increased from just $0.9 million in 2007 to $6.9 million in 2008. ^[16]

• Putters (9.1% of Revenue)^[3]:

Callaway also sells putters under the Odyssey, Callaway Golf, Top-Flite, and Ben Hogan brand names. Putter sales accounted for 9.1% of the company's revenue in 2008, reaching $101.7 million.^[3] Sales of putters increased 7% during 2008 resulted from a decrease in sales volumes partially offset by an increase in selling price.^[19]

Financial Analysis

Callaway reported $1.11 billion in revenue in 2008, a slight decrease from $1.12 billion in 2007.^{[1] [20][8]} Callaway's net income totaled $66.1 million in 2008, a 28% increase from $54 million in 2007.^[1] The company's growth in net income is attributed primarily to its increase in gross margin (5% increase) as well as increased sales worldwide. Furthermore, the company's SG&A and research and development expenses as a percentage of revenue remained constant during 2007, which added to Callaway's net income growth.^[21] The company's golf clubs segment (including all types of clubs and the accessories category) continues to be the most crucial aspect of the company's financial success as it operated at a 16.7% operating margin in 2007, compared to 0.42% for golf balls.^[22]

In the second quarter of 2009, the company reported net income fell 82% to $6.5 million, down from $37.1 million in the year ago period, disappointing analysts.^[23] Net sales fell 17 percent to $302.2 million, hurt by weak consumer spending and currency fluctuations. ^[23]

Key Trends and Forces

Declining Golf Industry Challenges Callaway's Sales

The number of yearly golf rounds is an effective indicator for the annual sales of golf equipment. In 2006, 501 million golfers rounds of golf were played in the U.S., down from its peak of 518 million in 2000. The population (golfers who play at least eight rounds a year) in 2006 was 15 million, down from the record of 17 million in 2000.^[7]

Number of Annual Rounds of Golf Played in the United States ^[24]

In 2006, for the first time in over half a century, the golf industry did not see any net increase of facilities from the previous year (119 new courses opened while 146 closed down). As a benchmark, 400 courses were introduced in 2000.^[25] However, Callaway continues to grow as of 2007, with a 10.5% increase in sales during 2007, mainly due to a 21% increase in European sales as the company continues to seek expansion opportunities abroad.^[20]

Economic downturns also reduce demand for ELY's products as many consumers forgo purchases on luxury items like new drivers. ELY has cited softening worldwide sales following the 2007 Credit Crunch and subprime lending crisis. For example, in Q3 2008, its sales dropped about 9.1% from a year earlier to $213.5 million^[10] Additionally, the company reported a net loss of $7.4 million, because of its decline in sales and costs associated with previous acquisitions.^[10]

One interesting factor that will help golf's popularity (along with Callaway's business) is the announcement that golf will make its return to the Olympic games in 2016, which will increase its exposure to the world and introduce it to a new generation of people.^[26]

Callaway's brand equity depends on the performance of its endorsed players

The performances of the professional golfers sponsored by Callaway 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. Callaway equipment is represented well on major tours:

Callaway Endorsement Players ^[27]

Due to the general trend of short product life cycles, Callaway's new releases must drive its revenue

New Callaway products have an average life of two years, with most of its sales occurring in the first, and generate about 55% of the company's annual sales.^[28] As a result, Callaway faces the challenge of having to release fresh products every year to accommodate its consumers. The company's struggles with inventing novel clubs can be seen by the decline in research and development expenses since 2004:

Callaway's Annual Research and Development Expenses ^[29]

Despite its downward trend of innovating profitable products, Callaway looks forward to a successful 2008 with the help of its strong brand equity and by introducing the following products to the market:

Seasonal fluctuations impact golf rounds played and Callaway’s sales

Warm weather is the ideal condition for golf, and consequently Callaway generates approximately 65% of its revenue during the spring and summer. 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, Callaway is expected to get a slight boost from the three week extension of daylight savings time starting in 2008, as this should increase the number of rounds played in some North American markets.

Competition

Callaway encounters fierce competition in each of its departments, but has climbed its way to become one of the top retailers in four of the main golf equipment categories.^[31]

Callaway Products by Market Share of Total Golf Equipment Industry ^[32]

Callaway's competitors include:

• 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. Acushnet is the top U.S. selling golf product in balls (Titleist) and shoes (FootJoy). The company earned $1.4 billion in revenue in 2007, a 7% increase from a year earlier which the company attributes to increases in international sales and new product introductions.^[33]

• TaylorMade/adidas golf : Bought out by Adidas in 1997, TaylorMade manufactures golf clubs, balls, and accessories, while Adidas deals with apparel. Although it is ranked second in world club distribution, more PGA Tour professionals play with TaylorMade drivers than Callaway, Cleveland, Cobra, Nike, and Ping combined.^[34][35]

• 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.

• Cleveland Golf: SRI Sports Limited, a Japan-based sporting goods company that sells tennis and golf equipment through their Dunlop and Srixon licenses, acquired Cleveland Golf in December of 2007. Their golf brands are number one in club sells and number two in ball sells in Japan.^[36] The company sells drivers through wedges and produces putters under their brand, Never Compromise.

• Ping Golf: Ping has proven to be a competitor in all categories of golf clubs. Their new products won awards in Golf Digest's 2008 Hot List for game-improvement irons and putters.^[37]

Fortune Brands, Adidas, and Nike are the three largest companies Callaway faces in the U.S.:

The following clubs are expected to compete with Callaway this year:

Notes

1. ↑ ^{1.0 1.1 1.2} ELY 2008 10-K, Item 6 "Selected Financial Data," page 26
2. ↑ ^{2.0 2.1} ELY 2008, Item 7 "Management's Discussion," page 35
3. ↑ ^{3.0 3.1 3.2 3.3 3.4 3.5 3.6} ELY 2008 10-K, Item 7 "Management's Discussion," page 37
4. ↑ Reuters: Callaway Q3 2009
5. ↑ Callaway Investor Relations
6. ↑ Callaway Key Developments
7. ↑ ^{7.0 7.1 7.2 7.3} The New York Times, "More Americans Are Giving Up Golf," 2/21/2008
8. ↑ ^{8.0 8.1 8.2} ELY 2007 10-K, Item 6, pg. 25
9. ↑ The Stock Masters: Is There Any Growth Left in Golf?
10. ↑ ^{10.0 10.1 10.2} "Callaway Swings to Quarterly Loss, Backs '08 View" Reuters.com 10/30/2008
11. ↑ ^{11.0 11.1 11.2 11.3} ELY 2007 10-K, Item 7, pg. 33
12. ↑ RTT News, "Callaway Golf completes offering of 1.25 mln shares of series B preferred stock"
13. ↑ ELY 2006 10K, Item 1:Business, pg. 1
14. ↑ ELY 2006 10k, Item 1:Business, pg. 2
15. ↑ ELY 2006 10k, Item 7:Management's Discussion and Analysis of Financial Condition and Results of Operations, pg. 30
16. ↑ ^{16.0 16.1 16.2} ELY 2008 10-K, Item 7 "Management's Discussion," page 39
17. ↑ ELY 2007 10-K, Item 1, pg. 2
18. ↑ Examiner.com: Callaway Golf lowering its IQ?
19. ↑ ELY 2008 10-K, Item 7 "Management's Discussion," page 38
20. ↑ ^{20.0 20.1}
21. ↑ ELY 2007 10-K, Item 7, pg. 32
22. ↑ ELY 2007 10-K, Item 7, pg. 34
23. ↑ ^{23.0 23.1} Reuters "Callaway Golf Q2 profit plunges 82 pct"
24. ↑ SunTrust Bank, "Initiating Coverage, 03/29/2007:ELY"
25. ↑ The New York Sun: Golf Industry Counts on Boomers to Drive Sales
26. ↑ CNBC: Callaway to be helped by new products, Olympics
27. ↑ Callaway Golf: Pro Tour
28. ↑ ELY 2006: 10k, Item 1:Risk Factors, pg.9
29. ↑ ELY 2006 10k, Item 6:Selected Financial Data, pg. 22
30. ↑ Golf Digest:Hot List 2008
31. ↑ Hoovers: TaylorMade-adidas Golf Company Overview
32. ↑ SunTrust Initiate 03/29/2007:ELY
33. ↑ FO 2007 10-K Item 7, pg. 35
34. ↑ Hoovers: TaylorMade-adidas Golf Company Overview
35. ↑ TaylorMade: TaylorMade on Tour
36. ↑ Cleveland Golf: About us
37. ↑ Golf Digest: Hot List 2008
38. ↑ ^{38.0 38.1 38.2} FO 2007 10-K, Item 8, pg. 49
39. ↑ ^{39.0 39.1 39.2} Adidas 2007 Annual Report-TaylorMade Adidas Golf Section
40. ↑ ^{40.0 40.1 40.2} NKE 2008 10-K, Item 6, pg. 20
41. ↑ Golf Digest:Hot List 2008