The following discussion should be read in conjunction with the Consolidated Condensed Financial Statements and the related notes that appear elsewhere in this report. See also "Important Notice to Investors" on page 2 of this report.

Results of Operations

Overview of Business and Seasonality

The Company designs, manufactures and sells high quality golf clubs and golf balls and also sells golf and lifestyle apparel, golf footwear, golf bags, gloves, eyewear and other golf-related accessories, including uPro GPS on-course measurement devices. The Company designs its products to be technologically advanced and in this regard invests a considerable amount in research and development each year. The Company's golf products are designed for golfers of all skill levels, both amateur and professional.

The Company has two operating segments that are organized on the basis of products, namely the golf clubs segment and golf balls segment. The golf clubs segment consists primarily of Callaway Golf, Top-Flite and Ben Hogan woods, hybrids, irons, wedges and putters as well as Odyssey putters. This segment also includes other golf-related accessories described above and royalties from licensing of the Company's trademarks and service marks as well as sales of pre-owned golf clubs. The golf balls segment consists primarily of Callaway Golf and Top-Flite golf balls. As discussed in Note 16 "Segment Information" to the Notes to Consolidated Condensed Financial Statements, the Company's operating segments exclude a significant amount of corporate general administrative expenses and other income (expense) not utilized by management in determining segment profitability.

In most of the Company's key markets, the game of golf is played primarily on a seasonal basis. Weather conditions generally restrict golf from being played year-round, except in a few markets, with many of the Company's on-course customers closing for the cold weather months. The Company's business is therefore also subject to seasonal fluctuations. In general, during the first quarter, the Company begins selling its products into the golf retail channel for the new golf season. This initial sell-in generally continues into the second quarter. The Company's second quarter sales are also significantly affected by the amount of reorder business of the products sold during the first quarter. The Company's third quarter sales are generally dependent on reorder business but are generally less than the second quarter as many retailers begin decreasing their inventory levels in anticipation of the end of the golf season. The Company's fourth quarter sales are generally less than the other quarters due to the end of the golf season in many of the Company's key markets. However, fourth quarter sales can be affected from time to time by the early launch of product introductions related to the new golf season of the subsequent year. This seasonality, and therefore quarter to quarter fluctuations, can be affected by many factors, including the timing of new product introductions. In general, however, because of this seasonality, a majority of the Company's sales and most, if not all, of its profitability generally occurs during the first half of the year.

Approximately half of the Company's business is conducted outside of the United States and is conducted in currencies other than the U.S. dollar. For reporting purposes, transactions conducted in foreign currencies must be translated into U.S. dollars based upon applicable foreign currency exchange rates. Fluctuations in foreign currency rates therefore can have a significant effect on the Company's reported financial results. In general, the Company's financial results are affected positively by a weaker U.S. dollar and are affected negatively by a stronger U.S. dollar as compared to the foreign currencies in which the Company conducts its business. The Company's hedging activities can mitigate but do not eliminate the effects of the foreign currency fluctuations. As a result of the strengthening of the U.S. dollar in 2009 as compared to 2008, the translation of foreign currency exchange rates had a negative impact on the Company's financial results during the first nine months in 2009. If the dollar continues to strengthen as compared to the currencies in which the Company conducts business, the Company's future reported financial results would continue to be adversely affected.

Executive Summary

The unfavorable global economic conditions, including changes in foreign currency exchange rates that persisted in 2009 have had a significant adverse effect on our business this year. Consumers demonstrated a reluctance to purchase golf equipment in this uncertain environment and those limited number of consumers who made such purchases shifted to lower price point products. Competition for this limited pool of consumer dollars resulted in a very competitive marketplace and an aggressive pricing and promotional environment. Furthermore, retailers were cautious throughout the year as to the amount of inventory they carried and the amount of products they were willing to re-order. As a result of these conditions, the Company's sales for the third quarter of 2009 declined 11% compared to the third quarter of 2008.

These unfavorable macroeconomic conditions are temporary and we are already seeing some positive signs that they are subsiding. Because these conditions are temporary, we have taken a balanced approach in navigating this challenging environment. We have balanced managing our expenses closely (operating expenses decreased 8% for the third quarter of 2009 compared to the third quarter of 2008) while at the same time investing in growth initiatives such as the Company's acquisition of uPlay, LLC and expansion into and additional investments in emerging markets such as India and China. Similarly, the Company implemented several promotional programs, balancing the adverse effect on the Company's gross margins (gross margins were 31.2% for the third quarter of 2009 compared to 37.5% in the third quarter of 2008) with market share gains in all major golf club product categories. We believe that this balanced approach will best position the Company to emerge from this temporary downturn and take advantage of opportunities as the economy recovers.

Although the decline in sales and gross margins had a significant effect on our business in the third quarter (a loss of $0.25 per share as compared to a loss of $0.12 per share in the third quarter of 2008), we are cautiously optimistic that the golf industry market conditions will improve along with the global economy in 2010. Until market conditions do improve, we intend to continue our balanced approach of managing expenses and investing for the future.

Three-Month Periods Ended September 30, 2009 and 2008

The adverse effects of the weak global economy coupled with unfavorable changes in foreign currency exchange rates continued to negatively affect the Company's net sales throughout the third quarter of 2009, which contributed to a $22.6 million (11%) decrease in net sales to $190.9 million compared to $213.5 million in the third quarter of 2008. This decrease reflects a $15.1 million decline in net sales of the Company's golf clubs segment and a $7.5 million decline in net sales of the Company's golf balls segment as presented below (dollars in millions):

                             Three Months Ended
                                September 30,          Growth (Decline)
                              2009         2008      Dollars       Percent
              Net sales
              Golf clubs   $    150.0    $   165.1   $  (15.1 )         (9 )%
              Golf balls         40.9         48.4       (7.5 )        (16 )%

                           $    190.9    $   213.5   $  (22.6 )        (11 )%

For further discussion of each operating segment's results, see "Golf Club and Golf Ball Segments Results" below.

Net sales information by region is summarized as follows (dollars in millions):

                                    Three Months Ended
                                       September 30,          Growth/(Decline)
                                     2009         2008      Dollars       Percent
        Net sales:
        United States             $     93.9    $   104.6   $  (10.7 )        (10 )%
        Europe                          27.0         33.4       (6.4 )        (19 )%
        Japan                           29.1         32.8       (3.7 )        (11 )%
        Rest of Asia                    21.0         18.5        2.5           14 %
        Other foreign countries         19.9         24.2       (4.3 )        (18 )%

                                  $    190.9    $   213.5   $  (22.6 )        (11 )%

Net sales in the United States decreased $10.7 million to $93.9 million during the third quarter of 2009 compared to the same period in the prior year. The Company's sales in regions outside of the United States decreased $11.9 million (11%) to $97.0 million during the third quarter of 2009 compared to the same quarter in 2008. The decrease in net sales in the United States and internationally is primarily attributable to the unfavorable economic conditions, including a $3.4 million decline in net sales as a result of unfavorable changes in foreign currency rates, primarily in Europe.

For the third quarter of 2009, gross profit decreased $20.5 million to $59.6 million from $80.1 million in the third quarter of 2008. Gross profit as a percentage of net sales ("gross margin") decreased to 31% in the third quarter of 2009 compared to 38% in the third quarter of 2008. The decrease in gross margin is primarily attributable to the unfavorable economic conditions and the resulting reduction in sales volume during the third quarter of 2009, as well as the impact of sales promotions and price reductions taken on drivers and irons that were in the second year of their product lifecycles, and unfavorable changes in foreign currency rates. These declines were partially offset by cost reductions on golf club component costs combined with more cost efficient golf club designs, as well as an overall improvement in manufacturing efficiencies as a result of the Company's gross margin improvement initiatives. See "Segment Profitability" below for further discussion of gross margins. Gross profit for the third quarter of 2009 was negatively affected by charges of $0.9 million related to the Company's gross margin improvement initiatives compared to $3.6 million for the comparable period in 2008.

Selling expenses decreased $8.7 million (13%) to $57.0 million in the third quarter of 2009 compared to $65.7 million in the comparable period of 2008. As a percentage of net sales, selling expenses decreased to 30% in the third quarter of 2009 compared to 31% in the third quarter of 2008. The dollar decrease in selling expenses was primarily due to cost reductions taken by the Company during the third quarter of 2009, which included a decrease of $6.3 million in advertising and promotional activities as well as decreases in travel and entertainment and consulting expenses.

General and administrative expenses increased $0.3 million (1%) to $20.5 million in the third quarter of 2009 compared to $20.2 million in the comparable period of 2008. As a percentage of net sales, general and administrative expenses increased to 11% in the third quarter of 2009 from 9% reported in the third quarter of 2008. The dollar increase was primarily due to a reduction in the employee incentive compensation accrual during the third quarter of 2008 in addition to an increase in deferred compensation expense in the third quarter of 2009. These increases were partially offset by a decrease in legal expenses.

Research and development expenses increased $1.0 million (16%) to $7.7 million in the third quarter of 2009 compared to $6.7 million in the comparable period of 2008. As a percentage of sales, research and development expenses increased to 4% in the third quarter of 2009 compared to 3% reported in the third quarter of 2008. The dollar increase was primarily due to increased costs, including salaries, wages and tooling as a result of the Company's entrance into the golf electronics market through the acquisition of uPlay, LLC, which was completed in December 2008.

Other income (expense) improved by $2.5 million in the third quarter of 2009 to other income of $0.8 million compared to other expense of $1.7 million in the comparable period of 2008. This improvement is primarily attributable to an increase of $1.2 million in the Company's deferred compensation plan asset value resulting from favorable changes in the market, and an increase of $0.9 million as a result of net foreign currency gains reported in the third quarter of 2009 compared to net foreign currency losses reported in the third quarter of 2008.

The effective tax rate for the third quarter of 2009 was 45.7% compared to 47.3% for the comparable period in 2008. The tax rate for the third quarter of 2009 was favorably impacted by certain discrete tax items, including the utilization of foreign losses, audit settlements and the lapse of certain state statutes of limitation. The tax rate for the third quarter of 2008 was favorably impacted by the utilization of state losses and credits. The relative impact of these discrete tax items on the effective tax rate was greater in 2008 as a result of a smaller loss before income taxes for that quarter.

Net loss for the third quarter of 2009 decreased to $13.4 million from $7.4 million in the comparable period of 2008. Diluted loss per share declined to $0.25 per share in the third quarter of 2009 compared to $0.12 per share in the third quarter of 2008. Net loss and loss per share for the third quarter of 2009 were negatively affected by after-tax charges of $0.6 million ($0.01 per share) related to costs incurred in connection with the Company's gross margin initiatives. In addition, net loss allocable to common shareholders and loss per share for the third quarter of 2009 were negatively affected by dividends on convertible preferred stock of $2.6 million ($0.04 per share). Net loss and loss per share for the third quarter of 2008 were negatively affected by $2.2 million ($0.04 per share) related to costs incurred in connection with the Company's gross margin initiatives.

Golf Clubs and Golf Balls Segments Results for the Three Months Ended September 30, 2009 and 2008

The decrease in net sales during the third quarter of 2009 was primarily due to the continued effects of a weak global economy as discussed above and its adverse effects on consumer spending and retailer demand, which negatively affected sales volumes and average selling prices as further discussed below. This decline in net sales was further exacerbated by an unfavorable shift in foreign currency rates due to the overall strengthening of the U.S. dollar against the foreign currencies in which the Company conducts its business during the third quarter of 2009 compared to the same period in 2008.

Golf Clubs Segment

Net sales information by product category is summarized as follows (dollars in
millions):



                                   Three Months Ended
                                      September 30,          Growth/(Decline)
                                    2009         2008      Dollars       Percent
         Net sales:
         Woods                   $     35.7    $    34.5   $    1.2            3 %
         Irons                         49.4         63.8      (14.4 )        (23 )%
         Putters                       17.1         21.3       (4.2 )        (20 )%
         Accessories and other         47.8         45.5        2.3            5 %

                                 $    150.0    $   165.1   $  (15.1 )         (9 )%

The $1.2 million (3%) increase in net sales of woods to $35.7 million for the quarter ended September 30, 2009 was primarily attributable to an increase in sales volume partially offset by a decrease in average selling prices. The increase in sales volume and decrease in average selling prices were primarily caused by a sales promotion where consumers could purchase selected fairway woods or hybrid club products for $1 dollar with the purchase of certain new 2009 driver products. In addition, average selling prices were negatively affected by

price reductions taken on second year drivers models as well as sales of the current year FT-9 and FT-iQ drivers, which were offered at lower prices than their predecessors, the FT-5 and FT-i drivers, respectively, during the comparable period in the prior year.

The $14.4 million (23%) decrease in net sales of irons to $49.4 million for the quarter ended September 30, 2009 was primarily attributable to a decrease in both sales volume and average selling prices. The decrease in sales volume was driven by a decline in retailer demand and consumer spending in addition to a decline in sales of second year Big Bertha and Fusion-Series irons models during the third quarter of 2009. The decrease in average selling prices was primarily due to price reductions taken on the Company's Big Bertha irons, which were in the second year of their product lifecycles, combined with an unfavorable shift in product mix from sales of the more premium Fusion irons during the third quarter of 2008 to sales of lower priced X-series irons during the third quarter of 2009.

The $4.2 million (20%) decrease in net sales of putters to $17.1 million for the quarter ended September 30, 2009 was primarily attributable to a reduction in sales volume and average selling prices. The decrease in sales volume was primarily driven by a decline in retailer demand and consumer spending in addition to fewer putter models launched during 2009 compared to 2008. The decrease in average selling prices was primarily attributable to an unfavorable shift in product mix from sales of the higher priced Black Series putters during the third quarter of 2008 to sales of the lower priced Crimson putters during the third quarter of 2009.

The $2.3 million (5%) increase in net sales of accessories and other products to $47.8 million for the quarter ended September 30, 2009 was primarily attributable to sales of the Company's new uPro GPS on-course measurement device introduced in 2009, partially offset by a decline in sales of golf bags and golf footwear.

Golf Balls Segment

Net sales information for the golf balls segment is summarized as follows
(dollars in millions):



                              Three Months Ended
                                September 30,           Growth/(Decline)
                              2009          2008      Dollars       Percent
              Net sales:
              Golf balls   $     40.9    $     48.4   $   (7.5 )        (16 )%

The $7.5 million (16%) decrease in net sales of golf balls to $40.9 million for the quarter ended September 30, 2009 consisted of decreases of $6.9 million in Callaway Golf ball sales and $0.6 million in Top-Flite golf ball sales. These decreases were primarily due to decreases in average selling prices for both the Callaway Golf and Top-Flite brands as well as a decline in sales volume for the Callaway Golf brand. The decrease in average selling prices for Callaway Golf balls resulted from increased promotional activity as well as an unfavorable shift in mix from the launch of moderately priced golf balls in 2009 compared to the launch of a more premium line of golf balls in 2008. The decline in sales volume for the Callaway Golf brand was principally due to the Company's premium golf balls being in their second year of their lifecycle compared to several new competitor offerings in 2009.

Segment Profitability

Profitability by operating segment is summarized as follows (dollars in
millions):



                                                 Three Months Ended
                                                   September 30,                      Growth (Decline)
                                             2009                 2008             Dollars         Percent
Income (loss) before income taxes
Golf clubs                                 $    (7.5 )         $      2.8          $  (10.3 )         (368 )%
Golf balls                                      (4.2 )               (2.7 )            (1.5 )          (56 )%

                                           $   (11.7 )(1)      $      0.1 (1)      $  (11.8 )         (118 )%

(1) Amounts shown are before the deduction of corporate general and administration expenses and other income (expenses) of $13.0 million and $14.3 million for the three months ended September 30, 2009 and 2008, respectively, which are not utilized by management in determining segment profitability. For further information on segment reporting see Note 16 to the Consolidated Condensed Financial Statements-"Segment Information" in this Form 10-Q.

Pre-tax income (loss) in the Company's golf clubs operating segment decreased to a pre-tax loss of $7.5 million for the third quarter of 2009 from pre-tax income of $2.8 million reported for the comparable period in the prior year. This decrease was primarily attributable to a decline in net sales as discussed above combined with a decline in gross margin. The decline in gross margin is primarily due to the aggressive pricing and promotional environment in 2009 and the impact of unfavorable changes in foreign currency rates during the third quarter of 2009 compared to the same period in the prior year. These decreases in gross margin were partially offset by cost savings provided by the Company's gross margin improvement initiatives, including cost reductions on club components as a result of improved product designs, a favorable shift in golf club production to more cost efficient regions outside the U.S and an increase in labor efficiencies.

Pre-tax loss in the Company's golf balls operating segment increased to $4.2 million for the third quarter of 2009 from $2.7 million reported for the comparable period in the prior year. The increase in the golf balls operating segment pre-tax loss is primarily due to a decline in net sales as discussed above as well as a decline in gross margin. The decline in gross margin was primarily due to various sales promotions in 2009, partially offset by a favorable shift in golf ball production to more cost efficient regions outside the U.S.

Operating expenses related to both the golf club and golf ball segments decreased during the third quarter of 2009 compared to the same period in 2008 as a result of cost reductions taken by the Company, primarily related to advertising and promotional activities.

The Company has continued to actively implement the gross margin improvement initiatives, which were announced during the fourth quarter of 2006. As a result of these initiatives, the Company's golf clubs and golf balls operating segments absorbed pre-tax charges of $0.7 million and $0.2 million, respectively, during the third quarter of 2009 and $1.9 million and $1.7 million, respectively, during the comparable period in 2008.

Nine-Month Periods Ended September 30, 2009 and 2008

The weak global economy and its continued adverse effects on the golf industry in general, in addition to unfavorable foreign currency exchange rates, contributed to a decline in net sales of $181.0 million (19%) to $764.9 million for the nine months ended September 30, 2009 compared to $945.9 million for the comparable period in the prior year. This decrease reflects a $146.4 million decline in net sales of the Company's golf clubs segment and a $34.6 million decline in net sales of the Company's golf balls segment as indicated below (dollars in millions):

                              Nine Months Ended
                                September 30,         Growth (Decline)
                               2009        2008     Dollars       Percent
               Net sales
               Golf clubs   $    618.4    $ 764.8   $ (146.4 )        (19 )%
               Golf balls        146.5      181.1      (34.6 )        (19 )%

                            $    764.9    $ 945.9   $ (181.0 )        (19 )%

For further discussion of each operating segment's results, see "Golf Club and Golf Ball Segments Results" below.

Net sales information by region is summarized as follows (dollars in millions):

                                     Nine Months Ended
                                       September 30,         Growth/(Decline)
                                      2009        2008     Dollars       Percent
         Net sales:
         United States             $    398.9    $ 465.1   $  (66.2 )        (14 )%
         Europe                         112.5      171.3      (58.8 )        (34 )%
         Japan                          113.6      132.7      (19.1 )        (14 )%
         Rest of Asia                    58.8       67.0       (8.2 )        (12 )%
         Other foreign countries         81.1      109.8      (28.7 )        (26 )%

                                   $    764.9    $ 945.9   $ (181.0 )        (19 )%

Net sales in the United States decreased $66.2 million (14%) to $398.9 million during the nine months ended September 30, 2009 compared to the same period in the prior year. The Company's sales in regions outside of the United States decreased $114.8 million (24%) to $366.0 million during the first nine months of 2009 compared to the same period in 2008. This decrease in net sales in the United States and internationally is primarily attributable to the adverse effects of the weak global economy, including a $44.9 million decline in net sales as a result of unfavorable changes in foreign currency rates, primarily in Europe.

For the nine months ended September 30, 2009, gross profit decreased $141.1 million to $285.6 million from $426.7 million in the comparable period of 2008. Gross margin decreased to 37% in the first nine months of 2009 compared to 45% in the comparable period in 2008. The decrease in gross margin is primarily attributable to the unfavorable economic conditions and the resulting reduction in sales volume as well as the impact of unfavorable changes in foreign currency rates. In addition, gross margin was affected by various golf club promotions, price reductions taken on older golf clubs products combined with a shift in consumer spending to lower priced and lower margin products in 2009 compared to the prior year. These declines were partially offset by cost reductions on golf club component costs combined with more cost efficient golf club designs, as well as an overall improvement in manufacturing efficiencies as a result of the Company's gross margin improvement initiatives. See "Segment Profitability" below for further discussion of gross margins. Gross profit for the nine months ended September 30, 2009 was negatively affected by charges of $4.3 million related to the Company's gross margin improvement initiatives compared to $9.4 million for the comparable period in 2008.

. . .