Can Callaway Get Out of the Rough?

Below-par earnings and hard-hitting rivals have left the maker of the Big Bertha titanium woods with some tough shots to make

On a recent golf outing, Frank Malena watched his teammate play 18 holes with a beloved old club, a 1995 Callaway Big Bertha driver. An avid player and the manager at a World of Golf retail store in New York City, Malena knew his friend's driver was no match for his own Callaway VFT, the latest model. But his friend "had grown so fond of his club, even though it was obsolete, that he just didn't want to give it up," Malena says.

This reluctance to upgrade to the VFT could be a big problem for Callaway Golf -- one of several dilemmas that are vexing the pioneering golf-equipment company. As the $3.7 billion-a-year industry grows more fractured, Callaway's premium line of Big Bertha oversized woods still commands top prices. But half a decade after the "titanium boom" in 1996 and 1997, when the new technology lured golfers to upgrade to expensive titanium equipment, many golfers are starting to balk at once again replacing their gear with the latest generation of Callaway clubs.

With a flood of rivals now touting their own new golf technologies and with the price of some premium drivers retailing at around $600, it's no wonder customers are hesitant. "The older products are selling well, but it's hard to convince people to buy the new stuff", says William Donald, an analyst with Standard & Poor's.


  Any trouble at Callaway, one of golf's few public, stand-alone designers and manufacturers, could be a sign of difficulties in the entire premium golf-equipment industry. Its prime competitors in the sector are TaylorMade, a subsidiary of France's Salomon; Titleist, a unit of Fortune Brands (FO ); and privately held Karsten Manufacturing, which makes PING clubs. Until very recently, business was booming. Callaway's sales hit $261.4 million in the first quarter, up 27% vs. the same quarter last year -- no small feat, given the slowing U.S. economy.

It's clear that Callaway has reached a turning point in recent weeks. In May, the company chose Ronald Drapeau, 54, a five-year company veteran, to succeed founder and CEO Ely Callaway, 81, who retains the chairman's title but retired from active involvement because of medical problems.

Just two weeks later, Senior Executive Vice-President Chuck Yash, who had been in line for the CEO job, resigned. Yash had been expected to get the top position after spending three years developing a new golf-ball business for the company, but analysts say that project stumbled. Titleist dominates golf-ball sales worldwide and remains the brand of choice for most pros.


  Now, Callaway Golf has an untested CEO at its helm. And the withdrawal of Callaway, who founded the company back in 1982 and is so closely identified with it that his first name is its stock symbol (ELY ), may leave a big vacuum. He's still recovering from gall-bladder and tumor surgery in April.

Drapeau faced his first big test almost immediately. In early June, the company warned analysts that it would probably miss earnings estimates for both the second quarter and the year. Its stock ended up shooting a triple bogey, as shares plunged about 40%, to around $11. It's now trading around $15 -- still way off its 52-week high.

Callaway expects earnings per share for the second quarter to come in at $0.35 to $0.38 on lower revenues, vs. $0.70 during the same quarter a year ago. For all of 2001, it expects earnings per share of $1.11, down slightly from $1.14 last year. "The other shoe finally dropped, and the market speculation [of problems developing at Callaway] was confirmed," says Joseph Yurman, a leisure-industry analyst at Bear Stearns.


  Callaway is still king for many die-hard golfers. The most avid players, 6.5 million in the U.S. alone, play 25-plus games annually, and spend more than $1,400 a year upgrading their clubs, according to the National Golf Foundation, a research group in Jupiter, Fla.

To continue nabbing these players, Callaway launched two innovative new clubs last year -- the ERC II Forged Titanium Driver and the Hawk Eye VFT Titanium Pro Series Driver. These and other Callaway drivers feature a "sweet spot" that aficionados say drives the ball farther. But these clubs don't come cheap. The company charges between $400 and $625 apiece for them.

Callaway blames heavy golf-ball discounting from rival Titleist, as well as the slowing economy, for its weakening earnings. In 2000, Callaway's golf-ball division took a $46 million pretax charge. Drapeau, who did a stint as Callaway's manufacturing chief right before getting the top job, has said in the past that the company has no intention of discounting its balls.


  However, over at World of Golf, Malena says Callaway just ordered drastic price reductions -- a box of 12 balls now sells for $32. "We're kind of disappointed about that. We were selling them just fine last week for $38," Malena says.

A deeper look at the company reveals other obstacles. The main one is that marketing experts agree there's still a stigma on the ERC II, which the U.S. Golf Assn. (USGA) has banned from tournaments. With the USGA saying the driver makes the game too easy, most top recreational golfers won't use it. "Golf is a sport based on honesty and integrity, and I think golfers will wait for the ERC II to become legitimized," says Todd Barrett, an independent golf consultant in Boston.

Although the company is actively working to get the ban removed, Barrett thinks it may have made a major miscalculation by not redesigning the club right away: "I believe that Callaway had a window of opportunity to create a compliant club, and they didn't," he says. The company continues to back the driver's legitimacy.


  Adding to the pressure, over the past four years many rival golf-club makers have been attacking the driver-and-woods market through aggressive promotions at pro tournaments. Callaway's competitors also have signed up the golf world's biggest stars. Titleist has Tiger Woods using its driver, and that alone has an enormous impact on the buying mindset of just about everyone who picks up a club.

Out on the PGA Tour, Callaway equipment is used by hardly any star players, most of whom favor clubs designed by Titleist, TaylorMade, Mizuno, and Orlimar. Drapeau, however, insists that a great golfer's name alone does not sell golf clubs. And he notes that, in addition to five-time Ladies' PGA Winner Annika Sorenstam, the company's clubs are used by 67 touring professionals around the world.

At a Golf World retail store in Trumbull, Conn., sales manager Joe Manna has another explanation for why Callaway may be coming under pressure: expense. "Callaway has been overpriced for the last seven years," he says. But with other powerful clubs, such as Titleist's new 975J driver, coming into play for around $450, Callaway clubs are a harder sell.


  What can Callaway do to get earnings back on track? Basic "blocking and tackling," Drapeau says. For instance, while the ERC II is banned in the U.S. tournaments, Europe has approved the club, and the Japanese market is strong, says S&P's Donald. With international sales climbing 29%, to $386 million in 2000, Callaway could benefit a lot from a sharper focus overseas. Analysts also applaud the company's impressive record of inventory management. "This puts them in a very good position for when sales come back," Donald says.

Callaway also could get a big boost if it lines up some five-star golfers to plug its clubs. "I really believe Callaway should go out and both get the game's best on board and market the hell out of them," Barrett says. Already, a new agreement with golf-clothing maker Ashworth for a complete line of men's and women's Callaway Golf Apparel is slated to debut in the fall of 2002, helping the company diversify its product mix. That should help gain a lot more shelf space for Callaway clothes, which are now available mainly at Nordstrom's.

All this isn't enough for S&P's Donald, who's pessimistic for the near term. But Bear Stearn's Yurman urges investors not to sweat it. "Callaway threw in the kitchen sink on everything that could go wrong," he says of the company's lowered guidance. "This was classic 'worst-case scenario' discounting, and Callaway is worth more than the market reflects right now," he says.

Yurman believes the stock will eventually rebound. The underlying business -- selling to the premium golf market -- is what Callaway has been good at all along, he figures. Whatever glitches have hurt that market recently, Callaway's name and brand are likely to hold up well over the long haul. But that hasn't allayed many investors' concerns about the company's subpar performance in the here and now.

By Suzanne Robitaille in New York

Edited by Thane Peterson