2005: Callaway at a crossroads

At Sterling Farms Golf Course in Stamford, Conn., head pro Angela Aulenti recently ticked off the backlog of Callaway Golf product orders that were weeks from being filled.

Callaway’s 454 driver? “I’ve been told they don’t have the heads,” Aulenti says.

The X-18 irons? “The projection is three weeks,” she says.

Callaway clearly has regained some momentum lost in recent years, though its comeback has been slowed somewhat by the operational problems illustrated by Aulenti, a self-described “Callaway fan” who plays the company’s products.

“Last year they didn’t have a product people wanted, so it didn’t matter,” Aulenti says. “This year they have a strong lineup, but we can’t get the product.”

It’s been a year since Callaway stunned investors with news of business problems at its Top-Flite unit, in Japan and, most painfully, in its metalwoods business, which peaked at $544.3 million in 1997, but now generates less than half those revenues. Callaway ended 2004 with sales of $934.6 million and a $10.4 million loss – its first unprofitable year since 1998.

To turn around the company, Callaway first had to stop the bleeding, and it appears to have done that. It reasserted its dominance in the irons category, increasing its market share 50 percent in just the first four months of this year thanks to strong demand for its Fusion, X-18 and X-Tour models. Sales of Callaway-branded balls also are on the upswing, and the metalwoods business has stabilized, thanks in part to the company’s belated 2004 entry into the hybrid category with the popular Big Bertha Heavenwood.

And it can’t hurt that U.S. Open champion Michael Campbell, using all Callaway products, became the company’s first staff player to win a PGA Tour major championship.

But Callaway has only started down the path to full recovery. It needs to demonstrate that it has more must-have products in its pipeline. And Wall Street remains cool toward Callaway, in part because of uncertainty about the company, which is searching for a new chief executive while speculation persists that it might be sold or even go private (see sidebar).

Entering 2005, Callaway found itself in a position not unlike that of its arch nemesis, TaylorMade, six years ago. At the time, TaylorMade’s management was in transition, and its product pipeline had run dry. It recommitted itself to winning back market share in metalwoods, typically golf manufacturers’ most profitable product category and one that Callaway had owned for much of the 1990s.

Now Callaway appears to have a sense of urgency about winning back market share.

William C. Baker, Callaway’s chairman and CEO since predecessor Ron Drapeau was forced out in August 2004, seemed to acknowledge this in February, when he sent a memo to the entire Callaway staff announcing a reorganization. In the memo, Baker said the company needed to “be faster to market and quicker to respond to changing market conditions. With the golf equipment business fundamentally flat and with intense competition, we simply must streamline our decision-making process.”

(Baker and other Callaway executives declined to comment for this story.)

According to numerous sources, Baker, a board member since 1994, lobbied to succeed company founder Ely Callaway as CEO during the late 1990s. Now he’s cast more as a caretaker – waiting to turn over the company to a new leader – though Callaway has begun to prosper during his brief tenure.

“They’ve got as good a (product) lineup as they’ve ever had,” says Scott Peters, owner of Golf & Ski Warehouse, a three-store chain in New Hampshire. “Individual products like the Big Bertha and the Great Big Bertha might have been better, but from soup to nuts, their lineup has never been better.”

Nor, as Aulenti noted, has it ever been harder to get, the result of forecasting problems and a flawed “just-in-time” inventory initiative, according to some of the company’s retail accounts. Retailers who used to be awash in Callaway products now can’t get enough.

“How do you run out of your best-selling ball in mid-May?” wonders Jeff Caraway, vice president of merchandising at Austad’s Golf. “We’re selling the HX Tour ball almost 1-to-1 with the (Titleist) Pro V1, but we can’t get it. How does that happen?”

Those problems aside, Callaway’s accounts are happy to see the company churning out hit products again, and doing so with more humility – an adjective not often associated with Callaway under Drapeau.

“Arrogant would certainly fit the description,” Phil Upham, who operates four Edwin Watts franchised stores in Massachusetts, says of Callaway’s past attitude.

Now, Upham says, “They certainly are listening and working with their retailers and trying to be good partners. We’ve seen a major change in the company.”

Brad Bowen, buyer for the Golf USA chain, jokes that he liked to schedule vacations at the end of each quarter to avoid calls from salesmen eager to meet quarterly numbers.

But he, too, says Callaway recently has become more “dealer-friendly.”

Golf USA’s corporate and franchised stores typically are less than 4,000 square feet, but Bowen says Callaway’s retail programs usually required each store to buy more than $30,000 in Callaway products to qualify for a 5 percent discount – far too much product for stores of that size. Bowen says that after years of prodding, Callaway this year cut the purchase requirement in half, bringing the discount within reach.

Callaway’s next big product launch, scheduled for July 4, is the FT-3 driver, the company’s latest metalwood to incorporate a carbon composite body. Much of the company’s Tour staff, including lead endorsers Phil Mickelson and Annika Sorenstam, have been using the club,

and several competitors – including Adams, Mizuno and Wilson – believe strongly in the benefits of composite technology. But consumers haven’t yet voted for it with their wallets.

Plus, Callaway’s track record in this area is particularly troublesome.

“I’m kind of once-bitten, twice shy on that Fusion technology,” Bowen says. “We went through the C4 (driver), and it was pretty bloody, and we went through the ERC Fusion, and it was pretty bloody.”

Still, regardless of how the FT-3 fares, the widespread sentiment is that Callaway can’t be held down for long.

“They will be back,” Caraway says. “Whether 2005 turns out to be a good year for them is yet to be determined. But the consumer is still in love with the brand.”

Wall Street, for its part, hasn’t been in love with Callaway, or the golf industry in general, for several years. That stems from macro issues – weak participation and rounds-played numbers – as well as Callaway’s string of product misses and past problems in its ball business. And far from courting investors and analysts, Callaway often seemed dismissive of them.

“In the Drapeau regime, there was a hostile relationship between Callaway’s management and Wall Street,” says Casey Alexander, special situations analyst at Gilford Securities.

The chill of that relationship has begun to thaw, he says, though he still wouldn’t describe it as friendly, largely because Callaway appears to have adopted the position: “Let us fix our problems, and then we’ll fix our relationships with Wall Street.” Alexander has no gripe with that if the company underpromises and overdelivers. In fact, his hedge fund recently bought Callaway shares.

John Moran, an analyst with the brokerage firm Ryan Beck & Co., is “of the opinion that patience is likely to be rewarded with these guys.” He notes that Callaway’s inventory levels at retail are healthy, the company’s ball business turned a modest $1.7 million pre-tax profit in the first quarter, and the balance sheet remains solid. He says investors also would like to see the company display the “swagger” it had under founder Ely Callaway.

The company’s retail customers would like that as well – but not too much swagger. Callaway – a company that at one time could do no wrong, and later had trouble admitting its faults – clearly was humbled by its problems in 2004, which Baker, in his memo to the staff, termed “a trying year for our company.”

Like his counterparts around the industry, Bowen is hopeful that Callaway “remembers the lesson learned is that we all need each other.”

“It’s kind of like the story about the lion,” Bowen says. “You pull the splinter out of his paw, and you hope the lion remembers you pulled the splinter out so that he doesn’t eat you later.”

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