**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

(Mark One)

**x****              ****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

For the quarterlyperiod ended**August 26, 2006**

or

**o****                 ****TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

For the transitionperiod from __________ to __________

Commission FileNumber:**000-51460**

**GOLFGALAXY, INC.******(Exact name of registrant as specified in its charter)

| **Minnesota**                                                   |   | **41-1831724**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **7275  Flying Cloud Drive**                                    |   | ** **                            |
| **Eden  Prairie, Minnesota**                                    |   | **55344**                             |
| (Address of  principal executive offices)                       |   | (Zip Code)                            |

 

**(952)941-8848**(Registrant’s telephone number, including area code)

**N/A**(Former name, former address and former fiscal year, ifchanged from last report)

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.                                                                      Yes x  No  o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):
| Large accelerated  filer o | Accelerated  filer o | Non-accelerated  filer ý |
|---------------------------------|---------------------------|------------------------------------|

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).Yes o  No  x

As ofSeptember 29, 2006, the Company had 11,023,814 shares of common stock, parvalue $0.01 per share, outstanding.

 

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**GOLFGALAXY, INC.FORM 10-Q FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2006INDEX**
| PART I-FINANCIAL  INFORMATION                                                                                        |
|---------------------------------------------------------------------------------------------------------------------------|
| Item  1. Financial Statements.                                                                                            |
| Consolidated  Balance Sheets as of August 26, 2006 (unaudited), August 27, 2005 (unaudited)  and February 25, 2006   |
| Consolidated Statements of Operations for the Three  and Six Months Ended August 26, 2006 and August 27, 2005 (unaudited) |
| Consolidated Statements of Cash Flows for the Six  Months Ended August 26, 2006 and August 27, 2005 (unaudited)           |
| Notes to Unaudited Consolidated Financial Statements                                                                      |
| Item 2. Management’s Discussion and Analysis of Financial  Condition and Results of Operations.                      |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk.                                                      |
| Item 4. Controls and Procedures.                                                                                          |
| PART II-OTHER  INFORMATION                                                                                           |
| Item 4. Submission of Matters to a Vote of Security  Holders.                                                             |
| Item  5. Other Information.                                                                                               |
| Item 6.  Exhibits.                                                                                                        |
| SIGNATURES                                                                                                                |

 

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#### **PART I—FINANCIALINFORMATION**

**Item1. Financial Statements.**

**GOLF GALAXY, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(*In Thousands, Except Share and Per Share Amounts*)**
| ** **                                                                                                               | ** ** | **August 26,  2006  (unaudited)** | ** ** | **August 27,  2005  (unaudited)** | ** ** | **February 25,  2006** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                               | ** ** | ** **                             | ** ** | ** **                             | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                          |       |                                   |       |                                   |       |                        |       |
| Cash and cash  equivalents                                                                                               |       | $                                      | 9,850      |                                   | $          | 26,387                      |       | $ | 11,075 |   |
| Accounts  receivable, net of allowances of $214, $90 and $70, respectively                                               |       | 9,794                                  |       | 8,118                                  |       | 4,523                       |       |
| Inventories, net                                                                                                         |       | 55,141                                 |       | 36,694                                 |       | 45,278                      |       |
| Deferred tax  assets                                                                                                     |       | 2,897                                  |       | 2,219                                  |       | 2,275                       |       |
| Prepaid expenses  and other current assets                                                                               |       | 832                                    |       | 1,748                                  |       | 2,921                       |       |
| Total current assets                                                                                                     |       | 78,514                                 |       | 75,166                                 |       | 66,072                      |       |
|                                                                                                                     |       |                                   |       |                                   |       |                        |       |
| Property and equipment,  net                                                                                             |       | 39,813                                 |       | 23,434                                 |       | 35,218                      |       |
| Intangibles, net                                                                                                         |       | 2,062                                  |       | —                                 |       | —                      |       |
| Goodwill                                                                                                                 |       | 7,450                                  |       | —                                 |       | —                      |       |
| Deferred tax assets                                                                                                      |       | 5,041                                  |       | 2,272                                  |       | 4,700                       |       |
| Other assets                                                                                                             |       | 251                                    |       | 290                                    |       | 557                         |       |
| Total assets                                                                                                             |       | $                                      | 133,131    |                                   | $          | 101,162                     |       | $ | 106,547 |   |
| **Liabilities and shareholders’  equity**                                                                           | ** ** | ** **                             | ** ** | ** **                             | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                     |       |                                   |       |                                   |       |                        |       |
| Accounts payable                                                                                                         |       | $                                      | 27,582     |                                   | $          | 21,984                      |       | $ | 23,224 |   |
| Accrued  liabilities                                                                                                     |       | 16,801                                 |       | 12,183                                 |       | 16,453                      |       |
| Total current  liabilities                                                                                               |       | 44,383                                 |       | 34,167                                 |       | 39,677                      |       |
|                                                                                                                     |       |                                   |       |                                   |       |                        |       |
| Deferred tax  liabilities                                                                                                |       | 1,836                                  |       | —                                 |       | —                      |       |
| Deferred rent credits  and other                                                                                         |       | 14,988                                 |       | 10,664                                 |       | 12,177                      |       |
|                                                                                                                     |       |                                   |       |                                   |       |                        |       |
| Shareholders’ equity:                                                                                               |       |                                   |       |                                   |       |                        |       |
| Common stock,  par value $0.01 per share:                                                                                |       |                                   |       |                                   |       |                        |       |
| Authorized  shares — 40,000,000; Issued and outstanding — 11,020,034, 10,636,436 and  10,671,803, respectively |       | 110                                    |       | 106                                    |       | 107                         |       |
| Additional  paid-in capital                                                                                              |       | 76,573                                 |       | 68,727                                 |       | 68,961                      |       |
| Accumulated  deficit                                                                                                     |       | (4,802                                 | )          | (12,502                                | )          | (14,375                     | )          |
| Accumulated  other comprehensive income                                                                                  |       | 43                                     |       | —                                 |       | —                      |       |
| Total shareholders’  equity                                                                                         |       | 71,924                                 |       | 56,331                                 |       | 54,693                      |       |
| Total liabilities and shareholders’ equity                                                                          |       | $                                      | 133,131    |                                   | $          | 101,162                     |       | $ | 106,547 |   |

NOTE: The Balance Sheetas of February 25, 2006, has been derived from the audited financialstatements.

*Seeaccompanying notes.*

3

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**GOLF GALAXY, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(*InThousands, Except Share and Per Share Amounts*)**

**(Unaudited)**
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                      | ** ** | **August 26,  2006**        | ** ** | **August 27,  2005**      | ** ** | **August 26,  2006** | ** ** | **August 27,  2005** | ** ** |
| ** **                                      | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                       |       | $                                | 95,646     |                           | $          | 69,635 |   | $ | 178,163 |   | $ | 128,205 |   |
| Cost of sales                                   |       | 64,322                           |       | 47,565                         |       | 120,541 |   | 87,907 |   |
| Gross profit                                    |       | 31,324                           |       | 22,070                         |       | 57,622 |   | 40,298 |   |
|                                            |       |                             |       |                           |       |   |   |   |   |
| Operating  expenses:                            |       |                             |       |                           |       |   |   |   |   |
| Retail operating                                |       | 14,895                           |       | 10,773                         |       | 30,712 |   | 21,705 |   |
| General and administrative                      |       | 4,457                            |       | 2,155                          |       | 8,939 |   | 5,257 |   |
| Preopening                                      |       | 126                              |       | 40                             |       | 1,774 |   | 1,350 |   |
| Total operating  expenses                       |       | 19,478                           |       | 12,968                         |       | 41,425 |   | 28,312 |   |
| Income from  operations                         |       | 11,846                           |       | 9,102                          |       | 16,197 |   | 11,986 |   |
| Interest income,  net                           |       | 75                               |       | 100                            |       | 83 |   | 115 |   |
| Income before  income taxes                     |       | 11,921                           |       | 9,202                          |       | 16,280 |   | 12,101 |   |
| Income tax  expense                             |       | (4,920                           | )          | (3,755                         | )          | (6,707 | ) | (4,961 | ) |
| Net income                                      |       | 7,001                            |       | 5,447                          |       | 9,573 |   | 7,140 |   |
| Less preferred  stock dividends                 |       | —                           |       | (723                           | )          | — |   | (1,721 | ) |
| Net income  applicable to common shareholders   |       | $                                | 7,001      |                           | $          | 4,724 |   | $ | 9,573 |   | $ | 5,419 |   |
| Net income per  share:                          |       |                             |       |                           |       |   |   |   |   |
| Basic                                           |       | $                                | 0.64       |                           | $          | 0.98 |   | $ | 0.87 |   | $ | 1.62 |   |
| Diluted                                         |       | $                                | 0.61       |                           | $          | 0.59 |   | $ | 0.83 |   | $ | 0.83 |   |
| Weighted average  number of shares outstanding: |       |                             |       |                           |       |   |   |   |   |
| Basic                                           |       | 10,999,356                       |       | 4,801,458                      |       | 10,945,096 |   | 3,342,714 |   |
| Diluted                                         |       | 11,432,419                       |       | 9,211,662                      |       | 11,487,023 |   | 8,634,726 |   |

 

*See accompanying notes.*

4

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**GOLF GALAXY, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

***(In Thousands)***

**(Unaudited)**
| ** **                                                                                             | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                             | ** ** | **August 26,  2006**      | ** ** | **August 27,  2005** | ** ** |
| **Operating  activities**                                                                              | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net income                                                                                             |       | $                              | 9,573      |   | $ | 7,140 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:                     |       |                           |       |   |   |
| Depreciation and amortization                                                                          |       | 3,941                          |       | 2,417 |   |
| Disposal of property and equipment                                                                     |       | 23                             |       | 9 |   |
| Stock-based compensation                                                                               |       | 583                            |       | 46 |   |
| Change in operating assets and liabilities:                                                            |       |                           |       |   |   |
| Accounts receivable                                                                                    |       | (3,671                         | )          | (4,663 | ) |
| Inventories                                                                                            |       | (4,367                         | )          | (6,279 | ) |
| Prepaid expenses and other                                                                             |       | 2,131                          |       | (457 | ) |
| Accounts payable                                                                                       |       | 887                            |       | 6,158 |   |
| Accrued liabilities and other                                                                          |       | 6,637                          |       | 6,793 |   |
| Net cash  provided by operating activities                                                             |       | 15,737                         |       | 11,164 |   |
| **Investing  activities**                                                                              | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Acquisition of  The GolfWorks, net of $501 cash acquired                                               |       | (3,589                         | )          | — |   |
| Additions to  property and equipment                                                                   |       | (8,837                         | )          | (6,363 | ) |
| Net cash used in  investing activities                                                                 |       | (12,426                        | )          | (6,363 | ) |
| **Financing  activities**                                                                              | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Proceeds from  initial public offering, net                                                            |       | —                         |       | 37,903 |   |
| Payment of  preferred stock dividends                                                                  |       | —                         |       | (19,562 | ) |
| Proceeds from  the exercise of stock options and warrants                                              |       | 409                            |       | — |   |
| Excess tax  benefits from stock-based compensation                                                     |       | 397                            |       | — |   |
| Repayment of  debt assumed from The GolfWorks                                                          |       | (5,403                         | )          | — |   |
| Net cash (used  in) provided by financing activities                                                   |       | (4,597                         | )          | 18,341 |   |
| Effect of  exchange rate changes on cash and cash equivalents                                          |       | 61                             |       | — |   |
| Net (decrease)  increase in cash and cash equivalents                                                  |       | (1,225                         | )          | 23,142 |   |
| Cash and cash  equivalents, beginning of year                                                          |       | 11,075                         |       | 3,245 |   |
| Cash and cash  equivalents, end of quarter                                                             |       | $                              | 9,850      |   | $ | 26,387 |   |
| **Supplemental  disclosure of cash flow information**                                                  | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Cash paid during  the year for:                                                                        |       |                           |       |   |   |
| Interest                                                                                               |       | $                              | 57         |   | $ | 2 |   |
| Income taxes                                                                                           |       | $                              | 3,420      |   | $ | 3,141 |   |
| **Supplemental  disclosure of non-cash investing and financing activities**                            | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Conversion of preferred stock into common stock                                                        |       | $                              | —     |   | $ | 30,900 |   |
| Common stock and common stock warrants issued in  connection with the acquisition of The GolfWorks     |       | $                              | 6,226      |   | $ | — |   |
| Purchases of  property and equipment awaiting processing for payment, included in accrued  liabilities |       | $                              | 883        |   | $ | 82 |   |

 

*Seeaccompanying notes.*

5

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**GOLF GALAXY, INC.**

**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

**1. Basis of Presentation**

Theaccompanying unaudited consolidated financial statements of GolfGalaxy, Inc. (“Company”) have been prepared in accordance with U.S.generally accepted accounting principles (“GAAP”) for interim financialinformation. In the opinion of management, all adjustments (consisting ofnormal recurring adjustments) considered necessary for a fair presentation havebeen included. Due to the seasonal nature of the Company’s business, interimresults are not necessarily indicative of results for the entire fiscal year.

Certain information and footnote disclosures normally included in theannual financial statements prepared in accordance with GAAP have beencondensed or omitted pursuant to the rules and regulations of the Securitiesand Exchange Commission (“SEC”) for interim financial reporting. These interim unaudited consolidated financialstatements and the related notes should be read in conjunction with the annualfinancial statements and notes included in the Company’s Annual Report onForm 10-K for the fiscal year ended February 25, 2006.

The preparation of financial statements inconformity with GAAP requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of net sales and expenses during the period. Ultimateresults could differ from those estimates.

The unaudited consolidated financial statementsinclude the accounts of Golf Galaxy and its wholly owned subsidiary from thedate of acquisition. All intercompany transactions have been eliminated inconsolidation.

The Company operates onereportable business segment - Retail. The Retail segment is engaged primarilyin specialty golf retail within the United States. The Retail segment includesall of the Company’s retail channels including stores, catalog and eCommercebusinesses. The Company identifies segments based on the nature of the businessactivities and the processes by which management makes strategic and operatingdecisions, assesses performance and allocates resources. No single customeraccounts for 10% or more of the Company’s net sales.

**2. Public Offerings of Common Stock**

### *InitialPublic Offering*

The Company completed its initial public offering (“IPO”)as of August 3, 2005, issuing 3,000,000 common shares at an offering priceof $14.00 per share. As part of the IPO, all of the then outstanding preferredstock was converted into 5,752,467 shares of common stock, of which 1,542,500were sold in the IPO, resulting in a total offering of 4,542,500 common shares.The Company’s common stock trades on the Nasdaq Global Select Market under thesymbol “GGXY.”

After issuance costs, the Company received net proceedsof $37.9 million, of which $19.6 million was used to pay preferred shareholdersall of the accrued and unpaid dividends due upon the conversion of their sharesof preferred stock into shares of the Company’s common stock. The remainder ofthe net proceeds was used primarily to fund capital expenditures to open newstores and for the March 2006 acquisition of Ralph MaltbyEnterprises, Inc., now known as Golf Galaxy GolfWorks, Inc. (“TheGolfWorks”).

*Withdrawn Follow-on Offering*

Certain holders of theunregistered shares of common stock remaining from the conversion of theirpreferred stock concurrent with the IPO exercised their demand registrationrights during the first quarter of fiscal 2007. In May 2006, the Companyinitially filed a Registration Statement on Form S-1 (the “RegistrationStatement”) for anunderwritten public offering by the Company, with the majority of the shares inthe offering provided by certain selling shareholders. The Registration Statement was laterwithdrawn due to a decline in the Company’s stock price. The related costs ofthe withdrawn offering of $327,000 were included in general and administrativeexpenses for the first six months of fiscal 2007. The former preferredshareholders retain their demand registration rights for the existingunregistered common shares.

6

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**3.Acquisition of The GolfWorks**

In the first quarter of fiscal 2007, Golf Galaxyacquired all of the outstanding shares of The GolfWorks for a combination ofcash, common stock and warrants to purchase common stock. The aggregatepurchase price, including direct acquisition costs of $345,000, consisted of$4.1 million in cash ($500,000 of which was deposited into an indemnificationescrow); 250,862 shares of the Company’s common stock valued at $4.8 millionand warrants to purchase 150,000 shares of the Company’s common stock with afair value of $1.4 million. The value of the common stock was based on theaverage closing price of the Company’s common stock during a five-day tradingperiod beginning three trading days prior to the announcement of theacquisition; the value of the warrants was determined using the Black-Scholesoption pricing model. The warrants are immediately exercisable at $17.94 pershare with a 10-year term expiring on March 16, 2016. The Companyalso assumed $5.4 million in existing debt from The GolfWorks. Following theacquisition, the Company repaid all outstanding debt of The GolfWorks with acombination of available cash and borrowings under Golf Galaxy’s creditfacility.

The GolfWorks primarily is a retailer of golf-relatedproducts including proprietary clubheads, components and tools for club-making,as well as golf accessories and name brand shafts and grips. In addition to itsretail catalogs and eCommerce website, The GolfWorks’ products and fittingsystems are featured in the Company’s stores. The Company believes TheGolfWorks brand provides an opportunity to expand its retail offerings to newand existing customers. The Company intends to grow The GolfWorks brand throughan expanded store-in-store service area combined with integrated marketing andproduct offerings. The expanded service area features The GolfWorks brand tohighlight the Company’s technical expertise in club repair and upgradeservices. The store-in-store also features a wide assortment of golf clubcomponents, tools, shafts and grips for customers interested in building orservicing their own equipment. The GolfWorks store-in-store concept currentlyis featured in nearly half of the Company’s stores and is expected to beincluded in all retail stores by the end of fiscal 2007. The acquisition alsofacilitates the continued growth of the Company’s direct-to-consumer channel ona cost efficient basis. The acquired GolfWorks facilities include a customercontact center; distribution center; research, design and light assemblyfacilities; and a school for club builders. In April 2006, the Companycombined its contact centers to create a more efficient and lower-costoperation.

The acquisition of The GolfWorks was accounted forunder the purchase method of accounting. Accordingly, the results of TheGolfWorks have been included in the Company’s consolidated financial statementsas a wholly owned subsidiary beginning March 16, 2006. The purchase pricehas been allocated to the acquired assets and liabilities of The GolfWorksbased on an estimate of their fair values. The Company considered a number offactors in developing an estimate of fair value, including historical operatingresults, expectations of future operations and strategies, and the use ofindependent appraisals. The excess of the purchase price over the estimatedfair value of the acquired assets and assumed liabilities has been assigned togoodwill.  The goodwill is not deductiblefor tax purposes and the acquired assets retain their original income taxbasis. The allocation of the purchase price is subject to revision as we obtainmore information regarding asset valuations, liabilities assumed and revisionsof preliminary estimates of fair values made at the date of purchase.

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The following summarizes the estimated fair values ofthe acquired assets and assumed liabilities of The GolfWorks at the date ofacquisition.
| **Purchase Price Allocation ($ in thousands)**             | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------|------------|------------|
|                                                                                |       |       |       |
| Cash                                                                                |       | $          | 3,745      |       |
| Golf  Galaxy, Inc. common stock                                                |       | 4,778      |       |
| Warrants to  purchase common stock                                                  |       | 1,448      |       |
| Direct  acquisition costs                                                           |       | 345        |       |
| Total purchase  price                                                               |       | $          | 10,316     |       |
|                                                                                |       |       |       |
| Allocation of  purchase price to the fair value of acquired assets and liabilities: |       |       |       |
| Cash and cash equivalents                                                           |       | $          | 501        |       |
| Accounts receivable, net of allowances                                              |       | 1,590      |       |
| Inventories, net                                                                    |       | 5,474      |       |
| Prepaid expenses and other                                                          |       | 44         |       |
| Property and equipment, net                                                         |       | 3,429      |       |
| Intangible assets                                                                   |       | 2,230      |       |
| Goodwill                                                                            |       | 7,450      |       |
| Deferred tax assets                                                                 |       | 791        |       |
| Accounts payable                                                                    |       | (3,424     | )          |
| Accrued liabilities and other                                                       |       | (702       | )          |
| Borrowings under credit facility and debt  outstanding                              |       | (5,403     | )          |
| Deferred tax liabilities                                                            |       | (1,664     | )          |
| Total purchase price                                                                |       | $          | 10,316     |       |

 

Theestimated fair values of the intangible assets as of the acquisition date weredetermined based on an independent third party appraisal, and are as follows:
| **Intangible asset description ($ in thousands)** | ** ** | ** ** | **Amount** | ** ** | **Estimated useful life** | ** ** |
|----------------------------------------------------------------------------|------------|------------|------------|------------|-------------------------------------|------------|
|                                                                       |       |       |       |       |                                |
| Trademarks                                                                 |       | $          | 1,000      |       | Indefinite                          |       |
| Customer lists                                                             |       | 800        |       | 4  years   |                                |
| Non-compete  agreements                                                    |       | 320        |       | 5  years   |                                |
| Copyrights                                                                 |       | 90         |       | Indefinite |                                |
| Patents                                                                    |       | 20         |       | 8  years   |                                |
| Total                                                                      |       | $          | 2,230      |       |                                |       |

 

Theintangible assets will be amortized over their estimated useful lives whereapplicable. Based on the results of the independent appraisal, the trademarksand copyrights were deemed to have indefinite lives and accordingly, will notbe amortized. Goodwill and the indefinite-lived intangible assets are subjectto periodic evaluation for impairment in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 142, *Goodwilland Other Intangible Assets*.

**4. Stock-Based Compensation**

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 123 (revised), *Share-BasedPayment* (“SFAS No. 123(R)”). SFAS No. 123(R) requirescompensation expense to be measured based on the grant-date fair value of theaward and recognized over the requisite service period for awards that vest.SFAS No. 123(R) also requires a change in the classification of thebenefits of tax deductions in excess of recognized compensation cost fromoperating cash flow to a financing cash flow in periods after adoption. TheCompany adopted SFAS No. 123(R) effective February 26, 2006. Werecognize compensation expense on a straight-line basis over the requisiteservice period of the award. Prior to February 26, 2006, the Companyaccounted for stock-based compensation using the intrinsic value methodprescribed in Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*,and related Interpretations. Compensation expense for stock options wasmeasured as the excess, if any, of the fair value of the Company’s common stockat the date of grant over the stock option exercise price. Prior to fiscal2006, all stock options had an exercise price equal to the estimated fair valueof the common stock at the time of grant, resulting in no compensation expenserecorded for the issuance of stock options.

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Pursuantto the transition requirements of SFAS No. 123(R) for a newly publicentity, the Company is applying the modified prospective method only tounvested awards that were granted on or after its IPO. The unrecognizedcompensation cost relating to those awards will be recognized in the financialstatements over the remaining requisite service period. The Company is applyingthe prospective transition method to unvested awards granted prior to its IPO.The unrecognized compensation cost relating to those awards will continue to berecognized in the financial statements using the intrinsic value method underAPB Opinion No. 25. Accordingly, other than the stock options granted inMay 2005, no compensation expense will be recognized on unvested stockoptions granted prior to the Company’s IPO unless such awards are subsequentlymodified.

InMay 2005, the Company’s Board of Directors granted options to purchase138,000 shares of common stock at an exercise price of $8.00 per share based onan independently appraised value as of the most recent fiscal year-end. Inaddition to the Company’s financial results and growth prospects, the appraisalconsidered other factors, including the Company’s capital structure as aprivate company and the relative subordination of the common stock in relationto the preferred stock at the date of the appraisal. Because the exercise priceof the stock options granted in May 2005 was below the then-anticipatedprice range of the Company’s proposed IPO, the Company is recognizingcompensation expense ratably over the four-year vesting period of the optionsbased on the difference between the mid-point of the anticipated IPO pricerange at the time of grant and the exercise price of the options.

Thefollowing table summarizes the impact adopting SFAS No. 123(R) had onthe Company’s income before income taxes, net income, as well as basic anddiluted net income per share, for the three and six month periods ended August26, 2006.
| ** **                                                                  | ** ** | **Three Months Ended  (Unaudited)** | ** ** | **Six Months Ended  (Unaudited)** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| **($ in thousands except per share amounts)** | ** ** | **August 26,  2006**                     | ** ** | **August 26,  2006**                   | ** ** |
| Income before  income taxes                                                 |       | $                                             | (310       | )                                           | $          | (525 | ) |
| Net income                                                                  |       | (192                                          | )          | (347                                        | )          |
| Net income per  share:                                                      |       |                                          |       |                                        |       |
| Basic                                                                       |       | $                                             | (0.02      | )                                           | $          | (0.03 | ) |
| Diluted                                                                     |       | $                                             | (0.02      | )                                           | $          | (0.03 | ) |

 

Priorto the adoption of SFAS No. 123(R), the Company reported all tax benefitsresulting from the exercise of stock options as operating cash flows in thestatement of cash flows. In accordance with SFAS No. 123(R), the statementof cash flows for the six months ended August 26, 2006, presents the excess taxbenefits from the exercise of stock options as financing cash flows. For thefirst six months of fiscal 2007, $397,000 of excess tax benefits were reportedas financing cash flows rather than operating cash flows.

Inaccordance with the transition methods described above, financial results forthe second quarter and first six months of fiscal 2006 have not been restated.If the Company had elected to apply the fair value recognition provisions underSFAS No. 123, *Accounting forStock-Based Compensation*, for the three and six month periods endedAugust 27, 2005, the Company’s net income and net income per share would havebeen adjusted to the following pro forma amounts:
| ** **                                                                                                  | ** ** | **Three Months Ended  (Unaudited)** | ** ** | **Six Months Ended  (Unaudited)** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| **($ in thousands except per share amounts)**                                 | ** ** | **August 27,  2005**                     | ** ** | **August 27,  2005**                   | ** ** |
| Net income  applicable to common shareholders                                                               |       | $                                             | 4,724      |                                        | $          | 5,419 |   |
| Add stock-based  compensation expense, net of tax                                                           |       | 28                                            |       | 28                                          |       |
| Deduct total  stock-based compensation determined under fair-value-based method for all  awards, net of tax |       | (70                                           | )          | (104                                        | )          |
| Pro forma net  income applicable to common shareholders                                                     |       | $                                             | 4,682      |                                        | $          | 5,343 |   |
|                                                                                                        |       |                                          |       |                                        |       |
| Net income per  share:                                                                                      |       |                                          |       |                                        |       |
| Basic—as reported                                                                                      |       | $                                             | 0.98       |                                        | $          | 1.62 |   |
| Basic—pro forma                                                                                        |       | $                                             | 0.98       |                                        | $          | 1.60 |   |
| Diluted—as reported                                                                                    |       | $                                             | 0.59       |                                        | $          | 0.83 |   |
| Diluted—pro  forma                                                                                     |       | $                                             | 0.59       |                                        | $          | 0.82 |   |

 

9

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### *Stock Options*

TheCompany’s 1996 Stock Option and Incentive Plan and 2004 Amended and RestatedStock Incentive Plan (together, “Plans”) provide for the issuance of incentiveand non-qualified stock options. Options are generally granted at the fairmarket value as of the grant date, are exercisable ratably over various periodsand expire up to ten years after the date of grant. As of August 26, 2006,there were 2,500,000 common shares authorized for issuance under the Plans.

Stockoption activity under the Plans for the six months ended August 26, 2006,was as follows:
| ** **                        | ** ** | **Options** | ** ** | **Weighted Average  Exercise Price  per Share** | ** ** | **Weighted Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-----------------------------------|------------|-------------|------------|----------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding,  beginning of period |       | 1,238,944   |       | $                                                              | 7.58       |                                                        |       |                                |       |   |
| Granted                           |       | 368,250     |       | 17.16                                                          |       |                                                        |       |                                |       |
| Forfeited                         |       | (99,895     | )          | 10.04                                                          |       |                                                        |       |                                |       |
| Exercised                         |       | (97,369     | )          | 4.20                                                           |       |                                                        |       |                                |       |
| Outstanding, end  of period       |       | 1,409,930   |       | $                                                              | 10.14      |                                                        | 7.1 years  |                                | $          | 3.92 |   |
| Exercisable, end of  period       |       | 713,540     |       | $                                                              | 6.51       |                                                        | 4.9 years  |                                | $          | 6.15 |   |

 

Thefair value of each option was estimated on the date of grant using the weightedaverage assumptions provided below. Prior to the Company’s IPO, fair value wasestimated using the minimum value method. Subsequent to the IPO, the Companyestimates the fair value of each option on the grant date using theBlack-Scholes option-pricing model. Because of the limited history of markettrading in the Company’s common stock, estimated volatility for fiscal 2007 wasbased on an average of the volatility reported by a peer group of publiclytraded companies. Beginning with stock options granted in the first quarter offiscal 2007, the expected term is presumed to be the mid-point between thevesting date and the end of the contractual term. According to SEC StaffAccounting Bulletin No. 107, this approach is permitted until December 31,2007, for a “plain vanilla” employee stock option for which the value isestimated using a Black-Scholes formula. 
| ** **                              | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **August 26,  2006**        | ** ** | **August 27,  2005** | ** ** |
| Weighted Average Assumptions: |       |                             |       |   |   |
| Risk-free interest rate                 |       | 4.95-5.18                        | %          | 4.0 | % |
| Expected dividends                      |       | —                           |       | — |   |
| Estimated average life                  |       | 5.25-6.25 years                  |       | 5.00 years |   |
| Volatility                              |       | 50                               | %          | 50 | % |

 

Basedon these assumptions, the estimated weighted average fair value of the optionsgranted in the second quarter of fiscal 2007 and 2006 was $7.14 and $6.72,respectively. The estimated weighted average fair value of the options grantedduring the first half of fiscal 2007 and 2006 was $9.36 and $6.20,respectively.

Duringthe second quarter of fiscal 2007 and 2006, the Company received proceeds of$167,000 and $0, respectively, from the exercise of stock options and warrants.The aggregate intrinsic value of options exercised (the amount by which themarket price of the stock on the date of exercise exceeded the exercise priceof the option) during the three months ended August 26, 2006, and August 27,2005, was $459,000 and $0, respectively. The Company received proceeds of$409,000 and $0, respectively, from the exercise of stock options and warrantsduring the first six months of fiscal 2007 and 2006. The aggregate intrinsicvalue of options exercised during the first six months of fiscal 2007 and 2006was $1.5 million and $0, respectively.

As ofAugust 26, 2006, there was $3.9 million of measured but unrecognized compensationexpense related to stock options that is expected to be recognized over aweighted average period of 3.2 years.

10

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**5. Net Income Per Share**

Basicnet income per share is computed based on the weighted average number of commonshares outstanding. Diluted net income per share is computed based on theweighted average number of common shares outstanding adjusted by the number ofadditional shares that would have been outstanding had all potentially dilutivecommon shares been issued. Potentially dilutive shares of common stock includecertain common stock options, warrants and convertible preferred stock,depending on the estimated fair market value of the common stock and amount ofnet income for the period measured. Net income per diluted share for the secondquarter and first six months of fiscal 2007 excludes 553,000 and 416,000outstanding common stock options, respectively, because they wereanti-dilutive.

Thefollowing table presents a reconciliation of the numerators and denominators ofbasic and diluted net income per share (in thousands, except share and pershare amounts):
| ** **                                           | ** ** | **Three Months Ended  (Unaudited)** | ** ** | **Six Months Ended  (Unaudited)** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                           | ** ** | **August 26,  2006**                     | ** ** | **August 27,  2005**                   | ** ** | **August 26,  2006** | ** ** | **August 27,  2005** | ** ** |
| Numerator:                                           |       |                                          |       |                                        |       |   |   |   |   |
| Net income applicable to common shareholders         |       | $                                             | 7,001      |                                        | $          | 4,724 |   | $ | 9,573 |   | $ | 5,419 |   |
| Add preferred stock dividends                        |       | —                                        |       | 723                                         |       | — |   | 1,721 |   |
| Numerator for  diluted net income per share          |       | $                                             | 7,001      |                                        | $          | 5,447 |   | $ | 9,573 |   | $ | 7,140 |   |
| Denominator:                                         |       |                                          |       |                                        |       |   |   |   |   |
| Weighted average number of common shares outstanding |       | 10,999,356                                    |       | 4,801,458                                   |       | 10,945,096 |   | 3,342,714 |   |
| Effect of dilutive securities:                       |       |                                          |       |                                        |       |   |   |   |   |
| Outstanding stock options and warrants               |       | 433,063                                       |       | 575,226                                     |       | 541,927 |   | 498,290 |   |
| Convertible preferred stock                          |       | —                                        |       | 3,834,978                                   |       | — |   | 4,793,722 |   |
| Denominator for  diluted net income per share        |       | 11,432,419                                    |       | 9,211,662                                   |       | 11,487,023 |   | 8,634,726 |   |
| Net income per  share:                               |       |                                          |       |                                        |       |   |   |   |   |
| Basic                                                |       | $                                             | 0.64       |                                        | $          | 0.98 |   | $ | 0.87 |   | $ | 1.62 |   |
| Diluted                                              |       | $                                             | 0.61       |                                        | $          | 0.59 |   | $ | 0.83 |   | $ | 0.83 |   |

 

**6.Property and Equipment**

Major classes of depreciable assets are as follows (inthousands):
| ** **                                      | ** ** | **August 26,  2006  (unaudited)** | ** ** | **August 27,  2005  (unaudited)** | ** ** | **February 25,  2006** | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|
| Fixtures and  equipment                         |       | $                                      | 31,694     |                                   | $          | 21,799                      |       | $ | 24,755 |   |
| Leasehold  improvements                         |       | 26,373                                 |       | 17,746                                 |       | 19,831                      |       |
| Land and  buildings                             |       | 2,830                                  |       | —                                 |       | —                      |       |
| Construction in  process                        |       | 1,673                                  |       | 383                                    |       | 9,671                       |       |
|                                            |       | 62,570                                 |       | 39,928                                 |       | 54,257                      |       |
| Less accumulated  depreciation and amortization |       | (22,757                                | )          | (16,494                                | )          | (19,039                     | )          |
| Property and equipment,  net                    |       | $                                      | 39,813     |                                   | $          | 23,434                      |       | $ | 35,218 |   |

 

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**7.Intangibles**

Intangible assets consisted of the following (inthousands):
| ** **                     | ** ** | **August 26,  2006  (unaudited)** | ** ** |
|--------------------------------|------------|----------------------------------------|------------|
| Indefinite-lived  intangibles  |       |                                   |       |
| Trademarks                     |       | $                                      | 1,000      |   |
| Copyrights                     |       | 90                                     |       |
|                           |       | 1,090                                  |       |
| Amortized intangibles          |       |                                   |       |
| Customer lists                 |       | 800                                    |       |
| Non-compete agreements         |       | 320                                    |       |
| Patents                        |       | 20                                     |       |
|                           |       | 1,140                                  |       |
| Less accumulated  amortization |       | (168                                   | )          |
|                           |       | 972                                    |       |
|                           |       |                                   |       |
| Intangibles, net               |       | $                                      | 2,062      |   |

 

**8.Employee Benefit Plan**

The Company has a defined contribution401(k) profit sharing plan (“401(k) Plan”) for eligible employees,which is qualified under Sections 401(a) and 401(k) of the InternalRevenue Code of 1986, as amended. Employees are entitled to make tax-deferredcontributions of up to 75% of their eligible compensation. EffectiveJuly 1, 2005, the Company began a discretionary match of 50% of the first4% of eligible compensation contributed to the 401(k) Plan by eachparticipant. The Company’s matching contribution vests after four years ofservice, at age 591¤2 regardless of service, or upon thedeath of the employee. The Company’s matching contributions to the401(k) Plan for the second quarter and first six months of fiscal 2007were $48,000 and $88,000, respectively. The Company’s  matching contribution to the 401(k) Planfor the second quarter and first six months of fiscal 2006 was $16,000. Futurematching contributions to the 401(k) Plan are at the Company’s solediscretion.

**9.New Accounting Pronouncements**

In June 2006, the FASB issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109*. This Interpretationclarifies the accounting for uncertainty in income taxes recognized in thefinancial statements in accordance with FASB Statement No. 109, *Accounting for Income Taxes.* ThisInterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. This Interpretation also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition. This Interpretation iseffective for fiscal years beginning after December 15, 2006. The Company isstill evaluating the impact of adopting this Interpretation, but it is notexpected to have a material impact on its consolidated results of operations orfinancial position.

12

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**Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations.**

**Overview**

GolfGalaxy, Inc. is a multi-channel golf specialty retailer offering adistinctive combination of competitively priced merchandise from the leadingnational brands in golf equipment, apparel and accessories, along with golf services and golf instruction byon-staff certified PGA professionals. We opened 11 new stores during thefirst six months of fiscal 2007. As of August 26, 2006, we operated 61superstores in 24 states, e-Commerce websites and catalog operations. Our “*Everything for the Game.®*” core strategyis to provide avid and casual golfers, as well as gift purchasers, a categorydominant selection of leading national brand products, expert non-commissionedsales assistance and professional services, the combination of which isgenerally not available elsewhere. We offer our customers an exciting,interactive environment that compares favorably with the shopping experience atsmaller independent golf stores, on-course pro shops and the golf departmentsof general sporting goods retailers.

Wecompleted an initial public offering of our common stock on August 3,2005, selling 3,000,000 shares at an offering price of $14.00 per share. Ourstock is traded on the Nasdaq Global Select Market under the ticker symbol “GGXY.”As part of the offering, all of the then outstanding preferred stock convertedinto 5,752,467 shares of our common stock, of which 1,542,500 were sold in theinitial public offering, resulting in a total offering of 4,542,500 shares.After deducting the underwriting discounts and commissions, and other offeringexpenses, we received net proceeds from our initial public offering of $37.9million. We used $19.6 million of the net proceeds to pay our preferredshareholders all of the accrued and unpaid dividends due upon conversion oftheir shares of preferred stock into shares of our common stock. The remainderof the net proceeds was used primarily to fund capital expenditures to open newstores and for the March 2006 acquisition of Ralph MaltbyEnterprises, Inc. now known as Golf Galaxy GolfWorks, Inc. (“TheGolfWorks”).

In the first quarter of fiscal 2007, we acquired allof the outstanding shares of The GolfWorks for a combination of cash, commonstock and warrants to purchase common stock. The aggregate purchase price,including direct acquisition costs of $345,000, consisted of $4.1 million incash ($500,000 of which was deposited into an indemnification escrow); 250,862shares of our common stock valued at $4.8 million and warrants to purchase150,000 shares of our common stock with a fair value of $1.4 million. The valueof the common stock was based on the average closing price of our common stockduring a five-day trading period beginning three trading days prior to theannouncement of the acquisition; the value of the warrants was determined usingthe Black-Scholes option pricing model. The warrants are immediatelyexercisable at $17.94 per share with a 10-year term expiring onMarch 16, 2016. We also assumed $5.4 million in existing debt from TheGolfWorks. Following the acquisition, we repaid all outstanding debt of TheGolfWorks with a combination of available cash and borrowings under our creditfacility. The results of The GolfWorks have been included in our consolidatedfinancial statements as a wholly owned subsidiary beginning March 16,2006.

The GolfWorks primarily is a retailer of golf-relatedproducts including proprietary clubheads, components and tools for club-making,as well as golf accessories and name brand shafts and grips. In addition to itsretail catalogs and eCommerce website, The GolfWorks’ products and fittingsystems are featured in our stores. We believe The GolfWorks brand provides usan opportunity to expand our retail offerings to new and existing customers. Weintend to grow The GolfWorks brand through an expanded store-in-store servicearea combined with integrated marketing and product offerings. The expandedservice area features The GolfWorks brand to highlight our technical expertisein club repair and upgrade services. The store-in-store also features a wideassortment of golf club components, tools, shafts and grips for customersinterested in building or servicing their own equipment. The GolfWorksstore-in-store concept currently is featured in nearly half of our stores andis expected to be included in all of our retail stores by the end of fiscal2007. The acquisition also facilitates the continued growth of ourdirect-to-consumer channel on a cost efficient basis. The acquired GolfWorksfacilities include a customer contact center; distribution center; research,design and light assembly facilities; and a school for club builders. InApril 2006, we combined our contact centers to create a more efficient andlower-cost operation.

Due tothe seasonal nature of our business, interim results are not necessarilyindicative of results for the entire fiscal year. Our net sales and net incomeare generally greatest during the first and second quarters of our fiscal year.

The interim financial statements included in thisQuarterly Report on Form 10-Q (“Report”) and the related discussionscontained herein should be read in conjunction with the audited financialstatements and notes included in our Annual Report on Form 10-K forthe fiscal year ended February 25, 2006.

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**Results of Operations**

Thefollowing table presents selected items in the unaudited statements ofoperations as a percentage of our net sales.
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **August 26,  2006**   | ** ** | **August 27,  2005**      | ** ** | **August 26,  2006** | ** ** | **August 27,  2005** | ** ** |
| **Statements  of Operations Data**   | ** ** | ** **                  | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                            |       | 100.0                       | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Cost of sales                        |       | 67.3                        |       | 68.3                           |       | 67.7 |   | 68.6 |   |
| Gross profit                         |       | 32.7                        |       | 31.7                           |       | 32.3 |   | 31.4 |   |
| Retail operating  expenses           |       | 15.6                        |       | 15.5                           |       | 17.2 |   | 16.9 |   |
| General and  administrative expenses |       | 4.7                         |       | 3.1                            |       | 5.0 |   | 4.1 |   |
| Preopening  expenses                 |       | 0.1                         |       | 0.0                            |       | 1.0 |   | 1.0 |   |
| Income from  operations              |       | 12.3                        |       | 13.1                           |       | 9.1 |   | 9.4 |   |
| Interest income,  net                |       | 0.1                         |       | 0.1                            |       | 0.0 |   | 0.1 |   |
| Income before  income taxes          |       | 12.4                        |       | 13.2                           |       | 9.1 |   | 9.5 |   |
| Income tax  expense                  |       | (5.1                        | )          | (5.4                           | )          | (3.8 | ) | (3.9 | ) |
| Net income                           |       | 7.3                         | %          | 7.8                            | %          | 5.3 | % | 5.6 | % |

 

Net sales consist of sales, net of returns, fromcomparable stores and new stores, as well as sales from our eCommerce andcatalog operations. A store is included in comparable store results after ithas been in operation for 12 full fiscal months following the month of thestore’s grand opening weekend, typically a store’s 13th full month ofoperations. Sales from our eCommerce and catalog operations are not included incomparable store results. New store sales include net sales from stores thathave not yet become comparable.

Cost of sales includes the cost of merchandise soldnet of certain vendor allowances, direct costs of services, freight, inventoryshrinkage, other inventory valuation adjustments and retail occupancy costs.Vendor allowances include promotional support, rebates and volume discounts.Retail occupancy costs include rent, real estate taxes and common areamaintenance charges.

Retail operating expenses primarily include storeassociate payroll and related employee benefits, advertising and depreciation.Retail operating expenses also include maintenance, utilities, insurance, bankand credit card charges, other store level expenses, as well as expensesassociated with the operation of our catalog and eCommerce Internet sites.

General and administrative expenses include allexpenses associated with operating our retail support offices.

Preopeningexpenses consist primarily of occupancy, payroll, recruiting and other costsincurred prior to a new store opening as well as incremental advertising inconnection with the store opening.

## **Three and Six Months Ended August 26, 2006 Compared withThree and Six Months Ended August 27, 2005**

***Net Sales.***Net salesfor the second quarter of fiscal 2007 were $95.6 million, an increase of 37.4%compared with $69.6 million for the second quarter of fiscal 2006. Netsales for the first six months of fiscal 2007 were $178.2 million, an increaseof 39.0%, compared with $128.2 million for the same period of the prior fiscalyear. The increase in net sales for both the fiscal second quarter and sixmonth period ended August 26, 2006, resulted primarily from sales at new storesopened in the current or prior fiscal year, before becoming comparable stores;sales through The GolfWorks, which we acquired on March 16, 2006; and, to alesser degree, an increase in comparable store sales. Our comparable storesales increased by 0.8% and 0.9%, respectively, for the second quarter andfirst half of fiscal 2007.

***Gross Profit.***Ourgross profit rate increased by 1.0% to 32.7% of net sales for the secondquarter of fiscal 2007, compared with 31.7% for the same quarter of the priorfiscal year. For the first six months of fiscal 2007, our gross profit rateincreased by 0.9% to 32.3% of net sales, compared with 31.4% for the first halfof fiscal 2006. The increase in our gross profit rate for both the second quarterand first six months of fiscal 2007 was due primarily to a more favorable salesmix, driven by increased sales of higher-margin categories such as services andaccessories, higher retail gross margins in certain product categories, and anincrease in vendor allowances. These increases were partially offset by anincrease in store occupancy and

14

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in-boundfreight costs as a percentage of net sales.

Weexpect that our continued focus on our strategic initiatives, includinginitiatives to drive sales of services and accessories, will have a positiveimpact on our gross profit rate over the remainder of fiscal 2007 relative tothe corresponding periods of fiscal 2006.

***Retail Operating Expenses.***Retailoperating expenses increased to 15.6% of net sales for the second quarter offiscal 2007, compared with 15.5% for the second quarter of fiscal 2006. For thefirst six months of fiscal 2007, retail operating expenses increased to 17.2%of net sales, compared with 16.9% for the same period of the prior fiscal year.The increase in retail operating expenses as a percentage of net sales was dueprimarily to the impact of new stores opened in the current and prior fiscalyear. New stores generally have higher operating expenses as a percentage ofnet sales in comparison to mature stores due to the impact of a partial year ofnet sales in the year opened and because mature stores generally have highersales volumes relative to their operating expenses. For the second fiscalquarter, the impact from new stores was substantially offset by activemanagement of certain controllable store operating expenses, includingadvertising and payroll.

Due toour store growth and the high percentage of new stores in our store base, weexpect retail operating expenses as a percentage of net sales to be modestlyhigher for fiscal 2007 when compared with the prior fiscal year.

***General and Administrative Expenses.***Generaland administrative expenses increased to 4.7% of net sales for the secondquarter of fiscal 2007, up from 3.1% for the second quarter of fiscal 2006. Forthe first half of fiscal 2007, general and administrative expenses as apercentage of net sales increased to 5.0%, compared with 4.1% for the sameperiod of the prior fiscal year. The increases in our general and administrativeexpenses rates for the second quarter and first half of fiscal 2007 were due toseveral factors, including incremental costs related to operating as a publiccompany, which had a limited impact in the same periods of the prior year, andstock-based compensation expense. As a result of adopting SFASNo. 123(R) at the beginning of fiscal 2007, our general andadministrative expenses for the second quarter and first six months of fiscal2007, were $310,000 and $525,000 higher, respectively, than if we had continuedto account for stock-based compensation under the intrinsic value methodprescribed in APB Opinion No. 25. In addition, our general andadministrative expenses rate for the second quarter of fiscal 2006 benefitedfrom the reversal of accrued performance-based incentive compensation, whichcontributed to the increase for the second quarter of fiscal 2007. General andadministrative expenses for the first six months of fiscal 2007 include a$327,000 charge from the first quarter related to our cancelled follow-oncommon stock offering. For the first six months of fiscal 2007, our general andadministrative expenses rate benefited from a reduction in performance-basedcompensation expense, compared with the corresponding period of fiscal 2006.

Forfiscal 2007, we expect general and administrative expenses to includeapproximately $1.2 million of expenses related to the expensing of stockoptions in accordance with SFAS No. 123(R).

***Preopening Expenses.***Preopeningexpenses were $126,000 for the second quarter of fiscal 2007, compared with$40,000 for the second quarter of fiscal 2006. For the first six months offiscal 2007, preopening expenses were $1.8 million compared with $1.4 millionfor the same period of fiscal 2006. We opened 11 new stores during the firstquarters of fiscal 2007 and 2006, respectively. The increase in preopeningexpenses for the second fiscal quarter was due primarily to an increase inpreopening occupancy costs, which can vary due to the location, lease terms andtiming of each new store opening. In addition to higher preopening occupancycosts, preopening expenses for the first half of fiscal 2007 increased due to ahigher level of advertising to establish certain new markets.

***Net Interest Income.***Net interest income for the second quarter of fiscal 2007 was $75,000, comparedwith $100,000 for the second quarter of the prior fiscal year. The decrease innet interest income for the second quarter was due primarily to interest earnedin the prior year on the net proceeds from our initial public offering, whichwas completed on August 3, 2005.  For thefirst six months of fiscal 2007, net interest income was $83,000, compared with$115,000 for the first half of fiscal 2006 due to the factor noted above, and ahigher level of borrowing in the first quarter of fiscal 2007.  For the remainder of fiscal 2007, we expectnet interest income to be lower, or net interest expense to be higher, than theprior year due to interest earned on the net proceeds from the IPO in the prioryear and the expectation of further utilization of our revolving creditfacility in the current fiscal year.

15

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***Income Tax Expense.***Werecorded income tax provisions of $4.9 million and $3.8 million,respectively, for the second quarters of fiscal 2007 and 2006. For the firstsix months of fiscal 2007, we recorded an income tax provision of $6.7 million,compared with $5.0 million for the first six months of the prior fiscal year.Our tax provision for interim periods is determined using an estimate of ourannual effective tax rate. The income tax provisions were based on estimatedannual effective income tax rates of 41.2% and 41.0% for fiscal 2007 and 2006,respectively. The change in the effective income tax rate was due primarily tothe impact of certain permanent book/tax differences and fluctuations in theimpact of state income taxes. The permanent book/tax differences primarilyrelate to the non-deductibility of stock option expense for incentive stockoptions, recognized for book purposes, following the adoption of SFAS No.123(R).

***Net Income.***Net income was $7.0 million, or $0.61per diluted share, for the second quarter of fiscal 2007, compared with $5.4million, or $0.59 per diluted share, for the second quarter of the prior fiscalyear, an increase of 29.6%. For the first six months of fiscal 2007, net incomeincreased by 35.2%, to $9.6 million, or $0.83 per diluted share, compared with$7.1 million, or $0.83 per diluted share, for the same period of the priorfiscal year.

***Pro-Forma Net Income Per Share.*** Pro-forma net income per share forthe second quarter and first six months of fiscal 2006 are presented as if ourinitial public offering had occurred immediately prior to the beginning offiscal 2006. We believe the use of pro-forma net income per share provides aconsistent measure of profitability as well as important supplementalinformation due to the significant increase in common shares outstandingresulting from the completion of our initial public offering and the conversionof the convertible preferred stock into shares of common stock as ofAugust 3, 2005. Pro-forma net income per share is considered a non-GAAPfinancial measure and is not in accordance with, or preferable to, net incomeper share determined in accordance with GAAP. The most directly comparable GAAPfinancial measure to pro-forma net income per share is net income per share.Pro-forma net income per share is intended to be a supplement to, but not asubstitute for, net income per share prepared in accordance with GAAP. Further,pro-forma net income per share, as we define it, may not be comparable to asimilarly titled measure used by other companies.

Thefollowing table presents a reconciliation of the numerator and denominator usedin the calculation of pro-forma net income per share (in thousands, exceptshare and per share amounts):
| ** **                                                 | ** **   | **Three Months  Ended  (Unaudited)** | ** **   | **Six Months  Ended  (Unaudited)** | ** **   |
|------------------------------------------------------------|--------------|-------------------------------------------|--------------|-----------------------------------------|--------------|
| ** **                                                 | ** **   | **August 27,  2005**                 | ** **   | **August 27,  2005**               | ** **   |
| **Pro-forma  Information**                                 | ** **   | ** **                                | ** **   | ** **                              | ** **   |
| Pro-forma net  income applicable to common shareholders    |         | $                                         | 5,447        |                                    | $            | 7,140 |   |
| Pro-forma net  income per share:                           |         |                                      |         |                                    |         |
| Basic                                                      |         | $                                         | 0.51         |                                    | $            | 0.67 |   |
| Diluted                                                    |         | $                                         | 0.49         |                                    | $            | 0.64 |   |
| Pro-forma  weighted average number of shares outstanding:  |         |                                      |         |                                    |         |
| Basic                                                      |         | 10,636,436                                |         | 10,636,436                              |         |
| Diluted                                                    |         | 11,211,662                                |         | 11,134,726                              |         |
|                                                       |         |                                      |         |                                    |         |
| **Reconciliation  of pro-forma information to GAAP**       | ** **   | ** **                                | ** **   | ** **                              | ** **   |
| Net income  applicable to common shareholders (GAAP)       |         | $                                         | 4,724        |                                    | $            | 5,419 |   |
| Preferred stock  dividends                                 |         | 723                                       |         | 1,721                                   |         |
| Net income  applicable to common shareholders (pro-forma)  |         | $                                         | 5,447        |                                    | $            | 7,140 |   |
| ***Basic***                                                | *** *** | *** ***                              | *** *** | *** ***                            | *** *** |
| Weighted average  number of shares outstanding (GAAP)      |         | 4,801,458                                 |         | 3,342,714                               |         |
| Conversion of  preferred stock to common                   |         | 3,834,978                                 |         | 4,793,722                               |         |
| Weighted average  additional shares issued in IPO          |         | 2,000,000                                 |         | 2,500,000                               |         |
| Weighted average  number of shares outstanding (pro-forma) |         | 10,636,436                                |         | 10,636,436                              |         |
| ***Diluted***                                              | *** *** | *** ***                              | *** *** | *** ***                            | *** *** |
| Weighted average  number of shares outstanding (GAAP)      |         | 9,211,662                                 |         | 8,634,726                               |         |
| Weighted average  additional shares issued in IPO          |         | 2,000,000                                 |         | 2,500,000                               |         |
| Weighted average number  of shares outstanding (pro-forma) |         | 11,211,662                                |         | 11,134,726                              |         |

 

16

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#### **QuarterlyResults of Operations and Seasonality**

Thefollowing table sets forth certain unaudited financial and operating data foreach quarter of fiscal 2006 and the first and second quarters of fiscal 2007.The accompanying unaudited financial and operating data has been prepared inaccordance with U.S. generally accepted accounting principles for interimfinancial information. In the opinion of management, the unaudited quarterlyinformation reflects all adjustments, which include only normal and recurringadjustments, considered necessary to present fairly the information shown.
| ** **                                 | ** ** | **Fiscal 2006**                                                      | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Quarter Ended  May 28, 2005**                            | ** ** | **Quarter Ended  August 27, 2005** | ** ** | **Quarter Ended  Nov. 26, 2005** | ** ** | **Quarter Ended  Feb. 25, 2006** | ** ** |
| ** **                                 | ** ** | **($ in thousands, except per share data)** | ** ** |
| Net sales                                  |       | $                                                                         | 58,570     |   | $ | 69,635 |   | $ | 31,800 |   | $ | 40,125 |   |
| Gross profit                               |       | 18,228                                                                    |       | 22,070 |   | 7,885 |   | 10,555 |   |
| Gross profit as  a percentage of net sales |       | 31.1                                                                      | %          | 31.7 | % | 24.8 | % | 26.3 | % |
| Retail operating  expenses                 |       | $                                                                         | 10,932     |   | $ | 10,773 |   | $ | 7,594 |   | $ | 8,213 |   |
| General and  administrative expenses       |       | 3,102                                                                     |       | 2,155 |   | 2,527 |   | 2,249 |   |
| Preopening  expenses                       |       | 1,310                                                                     |       | 40 |   | 662 |   | 911 |   |
| Income (loss)  from operations             |       | 2,884                                                                     |       | 9,102 |   | (2,898 | ) | (818 | ) |
| Income (loss)  before income taxes         |       | 2,899                                                                     |       | 9,202 |   | (2,726 | ) | (666 | ) |
| Net income  (loss)                         |       | $                                                                         | 1,693      |   | $ | 5,447 |   | $ | (1,609 | ) | $ | (265 | ) |
| Basic net income  (loss) per share         |       | $                                                                         | 0.37       |   | $ | 0.98 |   | $ | (0.15 | ) | $ | (0.02 | ) |
| Diluted net  income (loss) per share       |       | $                                                                         | 0.21       |   | $ | 0.59 |   | $ | (0.15 | ) | $ | (0.02 | ) |
| Weighted average  shares outstanding:      |       |                                                                      |       |   |   |   |   |   |   |
| Basic                                      |       | 1,883,969                                                                 |       | 4,801,458 |   | 10,653,135 |   | 10,665,848 |   |
| Diluted                                    |       | 8,042,819                                                                 |       | 9,211,662 |   | 10,653,135 |   | 10,665,848 |   |
| Comparable store  sales increase (1)       |       | 10.5                                                                      | %          | 7.4 | % | 6.7 | % | 2.5 | % |
| Stores opened  during the period           |       | 11                                                                        |       | — |   | 4 |   | 1 |   |
| Number of stores  at end of period         |       | 45                                                                        |       | 45 |   | 49 |   | 50 |   |
| Selling square  feet at end of period      |       | 671,953                                                                   |       | 671,953 |   | 727,112 |   | 738,615 |   |

 
| ** **                                 | ** ** | **Fiscal 2007**                                                 | ** ** | ** **                                        | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **                                 | ** ** | **Quarter Ended  May 27, 2006**                       | ** ** | **Quarter Ended  August 26, 2006** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **($ in thousands, except per share data)** | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net sales                                  |       | $                                                                    | 82,517     |                                              | $          | 95,646     |       |   |   |   |   |
| Gross profit                               |       | 26,298                                                               |       | 31,324                                            |       |       |       |   |   |
| Gross profit as  a percentage of net sales |       | 31.9                                                                 | %          | 32.7                                              | %          |       |       |   |   |
| Retail operating  expenses                 |       | $                                                                    | 15,817     |                                              | $          | 14,895     |       |   |   |   |   |
| General and  administrative expenses       |       | 4,482                                                                |       | 4,457                                             |       |       |       |   |   |
| Preopening  expenses                       |       | 1,648                                                                |       | 126                                               |       |       |       |   |   |
| Income from  operations                    |       | 4,351                                                                |       | 11,846                                            |       |       |       |   |   |
| Income before  income taxes                |       | 4,359                                                                |       | 11,921                                            |       |       |       |   |   |
| Net income                                 |       | $                                                                    | 2,572      |                                              | $          | 7,001      |       |   |   |   |   |
| Basic net income  per share                |       | $                                                                    | 0.24       |                                              | $          | 0.64       |       |   |   |   |   |
| Diluted net  income per share              |       | $                                                                    | 0.22       |                                              | $          | 0.61       |       |   |   |   |   |
| Weighted average  shares outstanding:      |       |                                                                 |       |                                              |       |       |       |   |   |
| Basic                                      |       | 10,890,837                                                           |       | 10,999,356                                        |       |       |       |   |   |
| Diluted                                    |       | 11,590,229                                                           |       | 11,432,419                                        |       |       |       |   |   |
| Comparable store  sales increase (1)       |       | 1.0                                                                  | %          | 0.8                                               | %          |       |       |   |   |
| Stores opened  during the period           |       | 11                                                                   |       | —                                            |       |       |       |   |   |
| Number of stores  at end of period         |       | 61                                                                   |       | 61                                                |       |       |       |   |   |
| Selling square feet at  end of period      |       | 884,146                                                              |       | 884,146                                           |       |       |       |   |   |

 

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(1)             A new or relocatedstore is included in the comparable store base after it has been in operationfor 12 full fiscal months following the month of the store’s grand openingweekend. A store that is closed for remodel or repair is excluded from thecomparable store sales calculation during the period of closure and thecomparable period of the succeeding year. Sales from our catalog and eCommerceoperations are not included in the comparable store sales calculation. Comparablestore results for a 53-week fiscal year are presented on a 52/52-weekbasis.

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Our business is subject to seasonal fluctuations, withthe highest sales activity and substantially all of our income from operationsoccurring during the first and second quarters of our fiscal year. Many of ourstores are located in midwestern and northeastern states where late spring andsummer represent the peak of the golf season. It is possible the impact ofseasonal fluctuations could change as we continue to expand into additionalgeographic regions. The Father’s Day holiday in June drives a significantseasonal sales increase, and sales also increase during theDecember holiday season, albeit to a lesser extent.

Ourquarterly operating results may also fluctuate significantly because of otherfactors. Customer demand for our products and services, and consequently oursales, also can be significantly impacted by weather. The timing of new storeopenings and related expenses; the profitability of new stores; the impact on storeresults during remodeling; changes in retail competition in our markets; andgeneral economic conditions, can affect our quarterly results. The fixed costsof our operations make our operating results sensitive to changes, favorableand unfavorable, in demand for our products and services. Due to these factors,results for any individual quarter may not be indicative of results to beexpected for any other quarter or for a full fiscal year.

Ourpreopening expenses have varied from quarter to quarter primarily due to thetiming of store openings. We have historically opened the majority of our newstores in the first and third quarters of the fiscal year, and expect tocontinue this pattern going forward. We typically incur most preopeningexpenses for a new store during the three months immediately preceding itsopening. In addition, our labor and operating costs for a newly opened storeare typically higher than a mature store. Accordingly, the volume and timing ofnew store openings is expected to continue to have a significant impact onquarterly preopening costs and store labor and operating expenses.

**Liquidity and Capital Resources**

**Summary**

Ourprimary capital requirements are related to the growth of the business. Newstores require capital for inventory, capital expenditures such as tenantimprovements and fixtures, and preopening expenses. In addition, capital may berequired for strategic growth opportunities, such as the acquisition of TheGolfWorks in the first quarter of fiscal 2007, and to remodel existing storesto updated formats. Periodically, capital resources may be needed for systemsor facility improvements to support our growth. Sources of capital to fund ourgrowth have included proceeds from our equity financings, cash generated from operationsand cash proceeds from the sale of our equity in Golf Town Canada Inc., a golfspecialty retailer operating stores across Canada.

Ourworking capital liquidity needs change significantly from quarter to quarterdue to the impact of seasonality, the timing of new store openings and thetiming of inventory payments. Our primary source of working capital liquidityis cash provided by operations. We also have available borrowing capacity underour revolving credit facility, if needed.

In thefirst quarter of fiscal 2007, we acquired The GolfWorks, with a combination ofavailable cash, common stock and warrants to purchase common stock. Inaddition, we assumed approximately $5.4 million of existing debt from TheGolfWorks, which we repaid with our remaining available cash and short-termborrowings under our revolving credit facility. We generated sufficientoperating cash flow to fully pay off the revolving debt by the end of thefiscal first quarter. There were no borrowings outstanding on the line of creditas of August 26, 2006.

**CashFlows**

***Operating Activities.*** Net cash provided by operating activities was$15.7 million through the first two quarters of fiscal 2007, compared with$11.2 million for the same period in fiscal 2006. The increase in cash providedfrom operations for the first half of fiscal 2007 resulted primarily from theincrease in net income after adjusting for the non-cash impact of depreciationand stock option expense.  A $3.4 milliondecrease in leverage from accounts payable relative to increased inventorylevels was substantially offset by changes in other working capital components.Net inventory increased year-over-year due to the increase in the number ofopen stores and the inventory held by The GolfWorks, which was acquired in thefirst quarter of fiscal 2007.

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***Investing Activities.*** Net cash used in investing activities was$12.4 million for the first two quarters of fiscal 2007, compared with $6.4million for the same period of fiscal 2006. Capital expenditures primarily relatedto new stores, including the purchase of leaseholds, fixtures and operatingequipment, utilized $8.8 million and $6.4 million, respectively, in thesequarters. The March 2006 acquisition of The GolfWorks reduced net cash by$3.6 million in the first quarter of fiscal 2007, net of cash acquired of$501,000.

***Financing Activities.*** Net cash used in financing activities was $4.6million in the first two quarters of fiscal 2007 resulting primarily fromextinguishing the $5.4 million in debt acquired from The GolfWorks, partiallyoffset by $806,000 generated from the exercise of outstanding stock options,and related tax benefits. For the first half of fiscal 2006, net cash providedby financing activities was $18.3 million, resulting from $37.9 million in netproceeds from our initial public offering in the second quarter of fiscal 2006.The net proceeds from our IPO were partially offset by the payment of $19.6million of preferred stock dividends resulting from the conversion of thepreferred stock to common stock concurrent with our IPO.

***Sources of Liquidity*.** In addition to cash provided by operations, wemaintain a revolving credit facility as an additional source of short-termliquidity and working capital, if needed. The credit facility has a term endingOctober 2008 and provides for revolving loans in the aggregate of up to$15.0 million, of which up to $5.0 million may be in the form ofletters of credit. At our option, the credit facility can be expanded to$20.0 million. Borrowings under the credit facility are secured by ourinventories, accounts receivable, and financial and intangible assets.Availability under the credit facility is calculated on the basis of eligibleinventory and certain accounts receivable, net of specified reserves, and lessany outstanding letters of credit. Interest on any outstanding indebtednessunder our credit facility accrues at the prime lending rate or an adjustedLIBOR as defined in the agreement for the credit facility. There were nooutstanding borrowings on our credit facility as of August 26, 2006 or August27, 2005.

**CapitalResources**

Ourfuture capital requirements will primarily depend on the number and timing ofnew stores opened and capital needed for strategic growth opportunities, suchas the acquisition of The GolfWorks in the first quarter of fiscal 2007. Infiscal 2007, we expect capital expenditures related to new store growth ofapproximately $20 million to $22 million, including stores opened inthis fiscal year and planned for the first quarter of fiscal 2008. We currentlyplan to open an additional four to five stores in fiscal 2007 and 16 to 18 newstores in fiscal 2008. The growth of our business also may require capitalinvestments in our infrastructure to support a larger store base. Capital also maybe needed in the future to remodel or relocate existing stores. Based on ourcurrent plans, we expect to fund our capital requirements through cash providedby operations, our revolving credit facility and additional equity or debtfinancing, if necessary.

**Off-Balance-SheetArrangements and Contractual Obligations**

Welease our retail store locations, office space and certain office equipmentprimarily through operating leases and, to a much lesser degree, capital leasesfor certain technology equipment. Our liquidity is not dependent on the use ofoff-balance sheet financing arrangements other than in connection with ouroperating leases. There has been no material change in our contractualobligations other than in the ordinary course of business since the end offiscal 2006.

**CriticalAccounting Policies and Use of Estimates**

Ourconsolidated financial statements are prepared in accordance with GAAP. Inconnection with the preparation of the financial statements, we are required tomake assumptions, estimates and judgments that affect the reported amounts ofassets, liabilities, net sales, cost of sales, expenses and the relateddisclosures. We base our assumptions, estimates and judgments on historicalexperience, current trends and other factors that we believe to be relevant atthe time the consolidated financial statements are prepared. On a regularbasis, we review our accounting policies, assumptions, estimates and judgmentsto ensure that our financial statements are presented fairly and in accordance withGAAP. However, because future events and their effects cannot be determinedwith certainty, actual results could differ from our assumptions and estimates,and such differences could be material.

Oursignificant accounting policies are discussed in the “Notes to UnauditedConsolidated Financial Statements” included in this Report and should be readin conjunction with Note 2 of the “Notes to Financial Statements” includedin our Annual Report on Form 10-K for the fiscal year endedFebruary 25, 2006.

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**Impact of Recent Accounting Pronouncements**

In June 2006, theFASB issued Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109*.This Interpretation clarifies the accounting for uncertainty in income taxesrecognized in the financial statements in accordance with FASB Statement No.109, *Accounting for Income Taxes.*This Interpretation prescribes a recognition threshold and measurementattribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return. This Interpretationalso provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition. ThisInterpretation is effective for fiscal years beginning after December 15, 2006.We are still evaluating the impact of adopting this Interpretation, but it isnot expected to have a material impact on our consolidated results ofoperations or financial position.

**ASpecial Note Regarding Forward-Looking Statements**

This Report contains forward-looking statements thatare based on our beliefs, assumptions and expectations of future events takinginto account the information currently available to us. All statements otherthan statements of historical fact contained in this Report are forward-lookingstatements. These statements involve known and unknown risks, uncertainties andother factors that may cause our actual results, performances, financialcondition or achievements to differ materially from the expected futureresults, performances, financial condition or achievements as expressed orimplied in any forward-looking statements. In some cases forward-lookingstatements can be identified by terms such as “anticipates,” “believes,” “estimates,”“expects,” “intends,” “plans,” “seeks,” “predicts,” “projects,” “strives,” “potential,”“objective,” “may,” “could,” “should,” “would,” “will” and similar expressionsintended to identify forward-looking statements.

The following factors, among others, could cause ouractual financial performance to differ materially from that expressed in anyforward-looking statement: a decline in the popularity of golf or golf-relatedproducts and services; limitations imposed by suppliers on the amount or varietyof products; failure by suppliers to develop and introduce new products or ifnew products result in excessive close-outs of existing inventories; seasonalfluctuation in demand for products; weather conditions; the ability toimplement our growth plan successfully; competition in the golf and sportinggoods industry; a decline in discretionary spending; availability of adequatecapital to fund growth; loss of key management; and the ability to integrateacquired companies successfully, including The GolfWorks. The foregoing listshould not be construed as exhaustive. Additional information concerning theseand other factors that could cause actual results to differ materially fromthose in the forward-looking statements is included in our Annual Report onForm 10-K for the fiscal year ended February 25, 2006.

Forward-looking statements reflect our current viewswith respect to future events, are based on our assumptions and are subject torisks and uncertainties. Given these uncertainties, readers should not placeundue reliance on these forward-looking statements. Our forward-lookingstatements speak only as of the date of this Report. We assume no obligation toupdate or revise any forward-looking statements publicly, or to update thereasons actual results could differ materially from those anticipated in anyforward-looking statements, even if new information becomes available in thefuture.

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**Item3. Quantitative and Qualitative Disclosures About Market Risk.**

Historically, we have borrowed under our revolvingcredit facility for seasonal liquidity needs. Borrowings under the revolvingcredit facility incur interest at floating rates based either on the prime rateor an adjusted LIBOR, and to the extent there are outstanding borrowings, weare exposed to market risk related to changes in interest rates. During thefirst quarter of fiscal 2007, we assumed $5.4 million of existing debt from TheGolfWorks, which we repaid with available cash and short-term borrowings underour revolving credit facility. We generated sufficient operating cash flowduring our fiscal first quarter to fully pay off the revolving debt byMay 27, 2006. At August 26, 2006, and August 27, 2005, we did not have anyborrowings outstanding under our credit facility, although any prime-basedborrowings would have had an interest rate of 8.25% and 6.50% per annum,respectively. Given the amount of borrowings during the three and six monthperiods ended August 26, 2006, and August 27, 2005, there would have been nomaterial effect on our income before income taxes if interest rates would haveincreased by 100 basis points. We are not a party to any derivative financialinstruments.

**Item4. Controls and Procedures.**

As of the end of the period covered by this Report, weconducted an evaluation, under the supervision and with the participation ofour principal executive officer and our principal financial and accountingofficer, of our disclosure controls and procedures, as defined inRules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (“Exchange Act”). Based on this evaluation,our principal executive officer and our principal financial and accountingofficer concluded that our disclosure controls and procedures are effective toensure that information required to be disclosed by us in reports that we fileor submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the rules and forms of theSecurities and Exchange Commission.

There have been no changes in internal control overfinancial reporting during the quarter ended August 26, 2006, that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

#### **PART II—OTHER INFORMATION**

#### **Item 4. Submission of Matters to a Vote ofSecurity Holders.**

Our Annual Meeting of Shareholders was held on August9, 2006.

a.                  Shareholders re-elected Mr. David E.Bloom, Mr. Thomas C. Healy and Mr. William C. Mulligan as Class I directors,each to serve for a term of three years expiring at the 2009 annual meeting ofshareholders. Shareholders also elected Mr. Douglas C. Neve as a Class IIIdirector, to serve for a term of two years expiring at the 2008 annual meetingof shareholders. Shares voted were as follows:
| David E. Bloom       |   |       |   |
|----------------------|--------|------------|--------|
| For:                 |   | 10,566,252 |   |
| Withheld:            |   | 42,684     |   |
|                 |   |       |   |
| Thomas C. Healy      |   |       |   |
| For:                 |   | 10,571,219 |   |
| Withheld:            |   | 37,717     |   |
|                 |   |       |   |
| William C.  Mulligan |   |       |   |
| For:                 |   | 10,392,911 |   |
| Withheld:            |   | 216,025    |   |
|                 |   |       |   |
| Douglas C. Neve      |   |       |   |
| For:                 |   | 10,557,497 |   |
| Withheld:            |   | 51,439     |   |

 

21

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b.              Shareholders approved a proposal toamend the Golf Galaxy, Inc. 2004 Amended and Restated Stock Incentive Plan toincrease the number of shares reserved for issuance under the plan from1,000,000 shares of common stock, par value $0.01 per share, to 1,500,000shares.  Shares voted were as follows:
| For:        |   | 6,969,322 |   |
|-------------|--------|-----------|--------|
| Against:    |   | 2,078,408 |   |
| Abstention: |   | 835       |   |
| Non-votes:  |   | 1,560,371 |   |

 

#### **Item 5. Other Information.**

#### **Entry into Amended and Restated Employment Agreementsand Termination of Prior Employment Agreements****.** On October 9, 2006, we entered into anAmended and Restated Employment Agreement with each of Randall K. Zanatta, ourPresident, Chief Executive Officer and Chairman; Gregory B. Maanum, our ChiefOperating Officer; Richard C. Nordvold, our Chief Financial Officer; and RonaldG. Hornbaker, our Senior Vice President – Sales and Operations (each an“Executive” and collectively the “Executives”).

#### ** **

#### Each Amended and Restated Employment Agreement will continue in effectuntil either party terminates it. The Amended and Restated EmploymentAgreements for Messrs. Zanatta and Maanum provide that in the event weterminate his employment without cause or he terminates his employment with usfor good reason, we must pay his then-current annual base salary for theeighteen (18) - month period immediately following his termination ofemployment, plus the prorated portion (based on the number of days worked inthe fiscal year of termination) of the lesser of (i) the amount that theExecutive would have received pursuant to any bonus plan in effect during thefiscal year and (ii) such amounts as the Executive would have received based onour achieving 100% of our financial targets as reflected in such bonus plan.Each of Messrs. Zanatta and Maanum has agreed, for the period of his employmentwith us and for a period of eighteen (18) months thereafter, that he will notcompete with us. We also must continue for such eighteen (18) - month period toprovide benefits to Messrs. Zanatta and Maanum at the same levels and with theexpenses allocated as they were immediately before the Executive’s termination.The Amended and Restated Employment Agreements for Messrs. Nordvold andHornbaker also provide the above severance benefits and non-competerestrictions but, in all cases, for a six (6) month – period rather than aneighteen (18) – month period. Each of the Amended and Restated EmploymentAgreements also provide that the Executive will not solicit our employees toterminate their employment with us for the period of the Executive’s employmentwith us and for a period of two (2) years thereafter.

####  

The foregoing descriptionof the Amended and Restated Employment Agreements is not complete and isqualified in its entirety by reference to each Amended and Restated EmploymentAgreement, a copy of each which is filed as Exhibit 10.2, Exhibit 10.3, Exhibit10.4 and Exhibit 10.5 to this Form 10-Q and is incorporated herein byreference.

 

In connection with eachof the Amended and Restated Employment Agreements with the Executives, theformer employment agreements with each Executive were terminated.

 

#### **Entry into Amended and Restated Retention Agreements and newRetention Agreements; Termination of Prior Retention Agreements****.** On October 9, 2006, we entered into anAmended and Restated Retention Agreement with each of Messrs. Zanatta andMaanum (the “Amended Retention Agreements”) and a new Retention Agreement witheach of Messrs. Nordvold and Hornbaker (the “Retention Agreements”).

####  

#### TheAmended Retention Agreements change the severance period from six (6) months toeighteen (18) months. Pursuant to the Amended Retention Agreements, in theevent we terminate the Executive’s employment in connection with a change incontrol, within 90 days prior to a change in control or within one year after achange in control, and other than for cause or initiated by the Executive forother than good reason, we must pay his then-current annual

22

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#### basesalary for the eighteen (18) -month period immediately following his terminationof employment, plus the prorated portion (based on the number of days worked inthe fiscal year of termination) of the lesser of (i) the amount that theExecutive would have received pursuant to any bonus plan in effect during thefiscal year and (ii) such amounts as the Executive would have received based onour achieving 100% of our financial targets as reflected in such bonus plan.Each of Messrs. Zanatta and Maanum has agreed, for the period of his employmentwith us and for a period of eighteen (18) months thereafter, that he will notcompete with us. We also must continue for such period to provide benefits toMessrs. Zanatta and Maanum at the same levels and with the expenses allocatedas they were immediately before the Executive’s termination. Each of theRetention Agreements for Messrs. Nordvold and Hornbaker also provide the aboveseverance benefits and non-compete restrictions but, in all cases, for a twelve(12) month – period rather than an eighteen (18) – month period. Each of the AmendedRetention Agreements and Retention Agreements also provide that the Executivewill not solicit our employees to terminate their employment with us for theperiod of the Executive’s employment with us and for a period of two (2) yearsthereafter. In addition, upon termination all options granted to the Executivevest immediately and become exercisable.

####  

Each of the AmendedRetention Agreements and the Retention Agreements may be terminated on April1st of any year after 2007 by the affirmative vote of a majority of the Boardof Directors prior to January 1 of that year and prior to the occurrence oractive consideration of a change in control.

 

The foregoing descriptionof the Amended Retention Agreements and the Retention Agreements is notcomplete and is qualified in its entirety by reference to each retentionagreement, a copy of each which is filed as Exhibit 10.6, Exhibit 10.7, Exhibit10.8 and Exhibit 10.9 to this Form 10-Q and is incorporated herein byreference.

 

#### In connectionwith each of the Amended Retention Agreements, the former retention agreementswith Messrs. Zanatta and Maanum were terminated.

23

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#### **Item 6. Exhibits.**

| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                    |
|------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1              |       | Amended and Restated Articles of Incorporation  (incorporated by reference to Exhibit 3.1 to the Registrant’s  Registration Statement on Form S-1 (File No. 333-125007)  as declared effective by the Commission on July 28, 2005 (the “S-1”)). |
|             |       |                                                                                                                                                                                                                                                                               |
| 3.2              |       | Amended and Restated Bylaws (incorporated by  reference to Exhibit 3.2 to the S-1).                                                                                                                                                                                           |
|             |       |                                                                                                                                                                                                                                                                               |
| 4.1              |       | Specimen of common stock certificate (incorporated  by reference to Exhibit 4.1 to the S-1).                                                                                                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                               |
| 4.2              |       | Amended and Restated Registration Rights Agreement  dated as of October 3, 2000 among the holders of preferred stock,  Randall K. Zanatta, Gregory B. Maanum and the Registrant (incorporated by  reference to Exhibit 4.3 to the S-1).                                  |
|             |       |                                                                                                                                                                                                                                                                               |
| 4.3              |       | Conversion Agreement dated May 16, 2005 among  the holders of preferred stock and the Registrant (incorporated by reference  to Exhibit 4.4 to the S-1).                                                                                                                 |
|             |       |                                                                                                                                                                                                                                                                               |
| 10.1             |       | Golf Galaxy, Inc. 2004 Amended and Restated Stock  Incentive Plan (incorporated by reference to Exhibit 99.1 to the Registrant’s  Current Report on Form 8-K dated August 9, 2006).                                                                                           |
|             |       |                                                                                                                                                                                                                                                                               |
| 10.2             |       | Amended and Restated Employment Agreement between  the Registrant and Randall K. Zanatta, dated October 9, 2006                                                                                                                                                                    |
|             |       |                                                                                                                                                                                                                                                                               |
| 10.3             |       | Amended and Restated Employment Agreement between  the Registrant and Gregory B. Maanum, dated October 9, 2006                                                                                                                                                                     |
|             |       |                                                                                                                                                                                                                                                                               |
| 10.4             |       | Amended and Restated Employment Agreement between  the Registrant and Richard C. Nordvold, dated October 9, 2006                                                                                                                                                                   |
|             |       |                                                                                                                                                                                                                                                                               |
| 10.5             |       | Amended and Restated Employment Agreement between  the Registrant and Ronald G. Hornbaker, dated October 9, 2006                                                                                                                                                                   |
|             |       |                                                                                                                                                                                                                                                                               |
| 10.6             |       | Amended and Restated Retention Agreement between the  Registrant and Randall K. Zanatta, dated October 9, 2006                                                                                                                                                                     |
|             |       |                                                                                                                                                                                                                                                                               |
| 10.7             |       | Amended and Restated Retention Agreement between the  Registrant and Gregory B. Maanum, dated October 9, 2006                                                                                                                                                                      |
|             |       |                                                                                                                                                                                                                                                                               |
| 10.8             |       | Retention Agreement between the Registrant and  Richard C. Nordvold, dated October 9, 2006                                                                                                                                                                                         |
|             |       |                                                                                                                                                                                                                                                                               |
| 10.9             |       | Retention Agreement between the Registrant and  Ronald G. Hornbaker, dated October 9, 2006                                                                                                                                                                                         |
|             |       |                                                                                                                                                                                                                                                                               |
| 31.1             |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350).                                                                                                                                                   |
|             |       |                                                                                                                                                                                                                                                                               |
| 31.2             |       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350).                                                                                                                                                   |
|             |       |                                                                                                                                                                                                                                                                               |
| 32.1             |       | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350).                                                                                                                                                   |
|             |       |                                                                                                                                                                                                                                                                               |
| 32.2             |       | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350).                                                                                                                                                   |

 

24

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                       | GOLF GALAXY, INC.                                 |
|-----------------------|---------------------------------------------------|
|                  | (Registrant)                                      |
|                  |                                              |
| Date October 10, 2006 | /s/ RANDALL K. ZANATTA                            |   |
|                  | Randall K. Zanatta                                |
|                  | *President, Chief Executive Officer and Chairman* |
|                  | *(Principal Executive Officer)*                   |
|                  |                                              |
| Date October 10, 2006 | /s/ RICHARD C. NORDVOLD                           |   |
|                  | Richard C. Nordvold                               |
|                  | *Chief Financial Officer*                         |
|                  | *(Principal Financial and Accounting Officer)*    |

 

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# **EXHIBIT INDEX TOFORM 10-Q**

| 3.1  |   | Amended and Restated Articles of Incorporation  (incorporated by reference to Exhibit 3.1 to the Registrant’s  Registration Statement on Form S-1 (File No. 333-125007)  as declared effective by the Commission on July 28, 2005 (the “S-1”)). |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2  |   | Amended and Restated Bylaws (incorporated by  reference to Exhibit 3.2 to the S-1).                                                                                                                                                                                           |
| 4.1  |   | Specimen of common stock certificate (incorporated  by reference to Exhibit 4.1 to the S-1).                                                                                                                                                                                  |
| 4.2  |   | Amended and Restated Registration Rights Agreement  dated as of October 3, 2000 among the holders of preferred stock,  Randall K. Zanatta, Gregory B. Maanum and the Registrant (incorporated by  reference to Exhibit 4.3 to the S-1).                                  |
| 4.3  |   | Conversion Agreement dated May 16, 2005 among the  holders of preferred stock and the Registrant (incorporated by reference to  Exhibit 4.4 to the S-1).                                                                                                                 |
| 10.1 |   | Golf Galaxy, Inc. 2004 Amended and Restated Stock  Incentive Plan (incorporated by reference to Exhibit 99.1 to the Company’s  Current Report on Form 8-K dated August 9, 2006).                                                                                              |
| 10.2 |   | Amended and Restated Employment Agreement between  the Registrant and Randall K. Zanatta, dated October 9, 2006                                                                                                                                                                    |
| 10.3 |   | Amended and Restated Employment Agreement between  the Registrant and Gregory B. Maanum, dated October 9, 2006                                                                                                                                                                     |
| 10.4 |   | Amended and Restated Employment Agreement between  the Registrant and Richard C. Nordvold, dated October 9, 2006                                                                                                                                                                   |
| 10.5 |   | Amended and Restated Employment Agreement between  the Registrant and Ronald G. Hornbaker, dated October 9, 2006                                                                                                                                                                   |
| 10.6 |   | Amended and Restated Retention Agreement between the  Registrant and Randall K. Zanatta, dated October 9, 2006                                                                                                                                                                     |
| 10.7 |   | Amended and Restated Retention Agreement between the  Registrant and Gregory B. Maanum, dated October 9, 2006                                                                                                                                                                      |
| 10.8 |   | Retention Agreement between the Registrant and  Richard C. Nordvold, dated October 9, 2006                                                                                                                                                                                         |
| 10.9 |   | Retention Agreement between the Registrant and  Ronald G. Hornbaker, dated October 9, 2006                                                                                                                                                                                         |
| 31.1 |   | Certification of Chief Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350).                                                                                                                                                   |
| 31.2 |   | Certification of Chief Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350).                                                                                                                                                   |
| 32.1 |   | Certification of Chief Executive Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350).                                                                                                                                                   |
| 32.2 |   | Certification of Chief Financial Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350).                                                                                                                                                   |

 

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