**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

(MarkOne)

 

**ý****                   ****QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

For the quarterly period ended**August 27, 2005**

 

or

 

**o****                   ****TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

For the transition periodfrom                to               

 

Commission File Number: **000-51460**

 

 

**GOLFGALAXY, INC.**

(Exact name of registrant asspecified 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 telephonenumber, including area code)

 

**N/A**

(Former name, former addressand former fiscal year, if changed from last report)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. **Yes ****o****  No  ****ý**

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Securities Exchange Act of 1934). **Yes ****o****  No  ****ý**

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act.)  **Yes ****o****  No  ****ý**

 

Asof October 1, 2005, the Company had 10,658,997 shares of common stock, parvalue $0.01 per share, outstanding.

 

 

----

 

**GOLFGALAXY, INC.**

**FORM 10-QFOR THE QUARTERLY PERIOD ENDED AUGUST 27, 2005**

**INDEX**

 
| PART I-FINANCIAL INFORMATION |    |
|-----------------------------------|---------|
|                              | Item 1. | Financial Statements. |   |
|                              |    |   | Balance Sheets as of August 27, 2005  (unaudited), August 28, 2004 (unaudited) and February 26, 2005 |   |
|                              |    |   | Statements of Operations for the Three  and Six Months Ended August 27, 2005 and August 28, 2004  (unaudited) |   |
|                              |    |   | Statements of Cash Flows for the Six  Months Ended August 27, 2005 and August 28, 2004 (unaudited) |   |
|                              |    |   | Notes to Unaudited 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 2. | Unregistered Sales of Equity  Securities and Use of Proceeds. |   |
|                              | Item 6. | Exhibits. |   |
| SIGNATURES                        |    |

 

2

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**PART I**—**FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements.**

 

**GOLF GALAXY, INC.**

**BALANCESHEETS**

**(*In Thousands, ExceptShare and Per Share Amounts*)**

 
| ** **                                                                                                            | ** ** | **August 27,  2005  (unaudited)** | ** ** | **August 28,  2004  (unaudited)** | ** ** | **February 26,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                            | ** ** | ** **                             | ** ** | ** **                             | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                            |       |                                   |       |                                   |       |                        |       |
| Current assets:                                                                                                       |       |                                   |       |                                   |       |                        |       |
| Cash and cash equivalents                                                                                             |       | $                                      | 26,387     |                                   | $          | 14,084                      |       | $ | 3,245 |   |
| Accounts receivable, net of allowances of  $90, $50 and $50, respectively                                             |       | 8,118                                  |       | 3,845                                  |       | 3,455                       |       |
| Inventories, net                                                                                                      |       | 36,694                                 |       | 21,774                                 |       | 30,415                      |       |
| Deferred tax assets                                                                                                   |       | 2,219                                  |       | 3,574                                  |       | 2,219                       |       |
| Prepaid expenses and other current assets                                                                             |       | 1,748                                  |       | 1,099                                  |       | 1,291                       |       |
| Total current assets                                                                                                  |       | 75,166                                 |       | 44,376                                 |       | 40,625                      |       |
| Property and equipment                                                                                                |       |                                   |       |                                   |       |                        |       |
| Property and equipment                                                                                                |       | 39,928                                 |       | 26,802                                 |       | 35,929                      |       |
| Accumulated depreciation                                                                                              |       | (16,494                                | )          | (13,226                                | )          | (14,097                     | )          |
| Property and equipment, net                                                                                           |       | 23,434                                 |       | 13,576                                 |       | 21,832                      |       |
| Deferred tax assets                                                                                                   |       | 2,272                                  |       | 1,766                                  |       | 2,272                       |       |
| Other assets                                                                                                          |       | 290                                    |       | 375                                    |       | 408                         |       |
| Total assets                                                                                                          |       | $                                      | 101,162    |                                   | $          | 60,093                      |       | $ | 65,137 |   |
|                                                                                                                  |       |                                   |       |                                   |       |                        |       |
| **Liabilities and shareholders’ equity  (deficit)**                                                              |       |                                   |       |                                   |       |                        |       |
| Current liabilities:                                                                                                  |       |                                   |       |                                   |       |                        |       |
| Accounts payable                                                                                                      |       | $                                      | 21,984     |                                   | $          | 16,877                      |       | $ | 15,826 |   |
| Accrued liabilities                                                                                                   |       | 12,183                                 |       | 10,151                                 |       | 11,675                      |       |
| Total current liabilities                                                                                             |       | 34,167                                 |       | 27,028                                 |       | 27,501                      |       |
|                                                                                                                  |       |                                   |       |                                   |       |                        |       |
| Deferred rent credits and other                                                                                       |       | 10,664                                 |       | 5,299                                  |       | 6,831                       |       |
|                                                                                                                  |       |                                   |       |                                   |       |                        |       |
| Redeemable convertible preferred stock,  including accumulated preferred stock dividends:                             |       |                                   |       |                                   |       |                        |       |
| Preferred Series A, par value $1.00,  80,000 shares authorized, issued and outstanding                           |       | —                                 |       | 13,511                                 |       | 14,054                      |       |
| Preferred Series B, par value $1.00,  35,000 shares authorized, issued and outstanding                           |       | —                                 |       | 5,528                                  |       | 5,746                       |       |
| Preferred Series C, par value $1.00,  100,000 shares authorized, issued and outstanding                          |       | —                                 |       | 15,019                                 |       | 15,623                      |       |
| Preferred Series D, par value $1.00,  150,000 shares authorized, 94,000 issued and outstanding                   |       | —                                 |       | 12,807                                 |       | 13,318                      |       |
|                                                                                                                  |       | —                                 |       | 46,865                                 |       | 48,741                      |       |
| Shareholders’ equity (deficit):                                                                                  |       |                                   |       |                                   |       |                        |       |
| Common stock, par value $0.01 per share:                                                                              |       |                                   |       |                                   |       |                        |       |
| Authorized shares – 40,000,000; Issued and  outstanding – 10,636,436, 1,861,945 and 1,883,969, respectively |       | 106                                    |       | 19                                     |       | 19                          |       |
| Additional paid-in capital                                                                                            |       | 68,727                                 |       | —                                 |       | —                      |       |
| Accumulated deficit                                                                                                   |       | (12,502                                | )          | (19,118                                | )          | (17,955                     | )          |
| Total shareholders’ equity (deficit)                                                                             |       | 56,331                                 |       | (19,099                                | )          | (17,936                     | )          |
| Total liabilities and shareholders’ equity  (deficit)                                                            |       | $                                      | 101,162    |                                   | $          | 60,093                      |       | $ | 65,137 |   |

*See accompanying notes.*

 

3

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**GOLF GALAXY, INC.**

**STATEMENTS OF OPERATIONS**

**(*In Thousands,Except Share and Per Share Amounts*)**

**(Unaudited)**

 
| ** **                                      | ** ** | **Three Months Ended**    | ** ** | **Six Months Ended**      | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                      | ** ** | **August 27,  2005** | ** ** | **August 28,  2004** | ** ** | **August 27,  2005** | ** ** | **August 28,  2004** | ** ** |
| ** **                                      | ** ** | ** **                | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                       |       | $                         | 69,635     |                      | $          | 47,540 |   | $ | 128,205 |   | $ | 85,959 |   |
| Cost of sales                                   |       | 47,565                    |       | 32,665                    |       | 87,907 |   | 59,521 |   |
| Gross profit                                    |       | 22,070                    |       | 14,875                    |       | 40,298 |   | 26,438 |   |
|                                            |       |                      |       |                      |       |   |   |   |   |
| Operating expenses:                             |       |                      |       |                      |       |   |   |   |   |
| Store operating                                 |       | 10,773                    |       | 7,127                     |       | 21,705 |   | 14,099 |   |
| General and administrative                      |       | 2,155                     |       | 1,842                     |       | 5,257 |   | 3,989 |   |
| Preopening                                      |       | 40                        |       | 46                        |       | 1,350 |   | 564 |   |
| Total operating expenses                        |       | 12,968                    |       | 9,015                     |       | 28,312 |   | 18,652 |   |
| Income from operations                          |       | 9,102                     |       | 5,860                     |       | 11,986 |   | 7,786 |   |
| Interest income (expense), net                  |       | 100                       |       | 4                         |       | 115 |   | (32 | ) |
| Income before income taxes                      |       | 9,202                     |       | 5,864                     |       | 12,101 |   | 7,754 |   |
| Income tax expense                              |       | (3,755                    | )          | (2,351                    | )          | (4,961 | ) | (3,116 | ) |
| Net income                                      |       | 5,447                     |       | 3,513                     |       | 7,140 |   | 4,638 |   |
| Less preferred stock dividends                  |       | (723                      | )          | (919                      | )          | (1,721 | ) | (1,820 | ) |
| Net income applicable to common  shareholders   |       | $                         | 4,724      |                      | $          | 2,594 |   | $ | 5,419 |   | $ | 2,818 |   |
| Net income per share:                           |       |                      |       |                      |       |   |   |   |   |
| Basic                                           |       | $                         | 0.98       |                      | $          | 1.39 |   | $ | 1.62 |   | $ | 1.51 |   |
| Diluted                                         |       | $                         | 0.59       |                      | $          | 0.46 |   | $ | 0.83 |   | $ | 0.60 |   |
| Weighted average number of shares  outstanding: |       |                      |       |                      |       |   |   |   |   |
| Basic                                           |       | 4,801,458                 |       | 1,861,945                 |       | 3,342,714 |   | 1,861,945 |   |
| Diluted                                         |       | 9,211,662                 |       | 7,703,512                 |       | 8,634,726 |   | 7,703,512 |   |

*See accompanying notes.*

 

4

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**GOLF GALAXY, INC.**

**STATEMENTS OF CASH FLOWS**

***(In Thousands)***

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Six Months Ended**      | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                         | ** ** | **August 27,  2005** | ** ** | **August 28,  2004** | ** ** |
| **Operating activities**                                                           |       |                      |       |   |   |
| Net income                                                                         |       | $                         | 7,140      |   | $ | 4,638 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                      |       |   |   |
| Depreciation and amortization                                                      |       | 2,417                     |       | 1,486 |   |
| Disposal of property and equipment                                                 |       | 9                         |       | 5 |   |
| Amortization of debt issuance costs                                                |       | 7                         |       | 14 |   |
| Noncash compensation                                                               |       | 46                        |       | — |   |
| Change in operating assets and liabilities:                                        |       |                      |       |   |   |
| Accounts receivable                                                                |       | (4,663                    | )          | (2,140 | ) |
| Inventories                                                                        |       | (6,279                    | )          | 3,790 |   |
| Prepaid expenses and other                                                         |       | (457                      | )          | (327 | ) |
| Accounts payable                                                                   |       | 6,158                     |       | 309 |   |
| Accrued liabilities and other                                                      |       | 4,451                     |       | 3,645 |   |
| Net cash provided by operating activities                                          |       | 8,829                     |       | 11,420 |   |
| **Investing activities**                                                           |       |                      |       |   |   |
| Purchases of property and equipment                                                |       | (4,028                    | )          | (2,279 | ) |
| Net cash used in investing activities                                              |       | (4,028                    | )          | (2,279 | ) |
| **Financing activities**                                                           |       |                      |       |   |   |
| Payment of preferred stock dividends                                               |       | (19,562                   | )          | — |   |
| Proceeds from initial public offering, net                                         |       | 37,903                    |       | — |   |
| Net cash provided by financing activities                                          |       | 18,341                    |       | — |   |
| Net increase in cash and cash equivalents                                          |       | 23,142                    |       | 9,141 |   |
| Cash and cash equivalents, beginning of  year                                      |       | 3,245                     |       | 4,943 |   |
| Cash and cash equivalents, end of quarter                                          |       | $                         | 26,387     |   | $ | 14,084 |   |
| **Supplemental disclosure of cash flow  information**                              |       |                      |       |   |   |
| Cash paid during the year for:                                                     |       |                      |       |   |   |
| Interest                                                                           |       | $                         | 2          |   | $ | 2 |   |
| Taxes                                                                              |       | $                         | 3,141      |   | $ | 395 |   |
| **Supplemental disclosure of non-cash  financing activities**                      |       |                      |       |   |   |
| Conversion of preferred stock into common  stock                                   |       | $                         | 30,900     |   | $ | — |   |

*See accompanying notes.*

 

5

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**GOLF GALAXY, INC.**

**NOTES TO UNAUDITED FINANCIAL STATEMENTS**

 

**1. Basis of Presentation**

 

Theaccompanying unaudited financial statements of Golf Galaxy, Inc. (the “Company”)have been prepared in accordance with U.S. generally accepted accountingprinciples (“GAAP”) for interim financial information. In the opinion ofmanagement, all adjustments (consisting of normal recurring adjustments)considered necessary for a fair presentation have been included. Due to theseasonal nature of the Company’s business, interim results are not necessarilyindicative of results for the entire fiscal year.

 

These interim unaudited financialstatements and the related notes should be read in conjunction with the annualfinancial statements and notes included in the final prospectus relating to theCompany’s initial public offering (“IPO”), as filed with the Securities andExchange Commission (the “SEC”), which includes audited financial statementsfor each of the three fiscal years in the period ended February 26, 2005.

 

The preparation of financialstatements in conformity with GAAP requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of net sales and expenses during theperiod. Ultimate results could differ from those estimates.

 

**2. Initial Public Offering**

 

The Company completed its IPO, effective August 3,2005, issuing 3,000,000 common shares at an offering price of $14.00.  As part of the IPO, all of the outstandingpreferred stock was converted into 5,752,467 shares of common stock, of which1,542,500 were sold in the IPO, resulting in a total offering of 4,542,500common shares.  The Company’s commonstock trades on the Nasdaq National Market under the symbol “GGXY.”

 

After issuance costs, the Company received netproceeds of $37.9 million, of which $19.6 million was used to pay preferredshareholders all of the accrued and unpaid dividends due upon the conversion oftheir shares of preferred stock into shares of the Company’s common stock.  The remaining net proceeds are planned to beused to finance the Company’s store growth and for general corporate purposes.

 

The holders of the remaining unregistered shares ofcommon stock resulting from the conversion of the preferred stock have defineddemand registration rights, which may be exercised in the future.

 

**3. Stock-Based Compensation**

 

TheCompany has elected to apply the disclosure-only provisions of Statement ofFinancial Accounting Standards (“SFAS”) No. 123, *Accounting for Stock-Based Compensation,*as amended by SFAS No. 148, **Accounting for Stock-Based Compensation—Transition andDisclosure—an amendment of FASB Statement No. 123**.Accordingly, the Company accounts for stock-based compensation using theintrinsic value method prescribed in Accounting Principles Board (“APB”)Opinion No. 25, *Accounting for StockIssued to Employees*, and related interpretations. Compensationexpense for stock options is measured as the excess, if any, of the fair valueof the Company’s common stock at the date of grant over the stock optionexercise price.

 

Priorto fiscal 2006, all stock options had an exercise price equal to the estimatedfair value of the common stock at the time of grant, resulting in nocompensation expense recorded for the issuance of stock options.

 

InMay 2005, the Board of Directors granted options to purchase 138,000shares of common stock at an exercise price of $8.00 per share based on anindependently 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.

 

Becausethe exercise price of the stock options granted in May 2005 was below thethen-anticipated price range of the Company’s proposed IPO, the Company isrecognizing compensation expense ratably over the four-year vesting period ofthe options based on the difference between the mid-point of the anticipatedIPO price range at the time of grant and the exercise price of the options.

 

6

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Ifthe Company had elected to apply the fair value recognition provisions underSFAS No. 123, the Company’s net income would have been adjusted to thefollowing pro forma amounts (in thousands, except per share amounts):

 
| ** **                                                                                     | ** ** | **Three Months Ended  (Unaudited)** | ** ** | **Six Months Ended  (Unaudited)** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                     | ** ** | **August 27,  2005**           | ** ** | **August 28,  2004**         | ** ** | **August 27,  2005** | ** ** | **August 28,  2004** | ** ** |
| Net income applicable to common  shareholders                                                  |       | $                                   | 4,724      |                              | $          | 2,594 |   | $ | 5,419 |   | $ | 2,818 |   |
| Add stock-based compensation expense, net  of tax                                              |       | 28                                  |       | —                            |       | 28 |   | — |   |
| Deduct total stock-based compensation  determined under fair-value-based method for all awards |       | (70                                 | )          | (36                               | )          | (104 | ) | (72 | ) |
| Pro forma net income                                                                           |       | $                                   | 4,682      |                              | $          | 2,558 |   | $ | 5,343 |   | $ | 2,746 |   |
| Net income per share:                                                                          |       |                                |       |                              |       |   |   |   |   |
| Basic—as reported                                                                         |       | $                                   | 0.98       |                              | $          | 1.39 |   | $ | 1.62 |   | $ | 1.51 |   |
| Basic—pro forma                                                                           |       | $                                   | 0.98       |                              | $          | 1.37 |   | $ | 1.60 |   | $ | 1.47 |   |
| Diluted—as reported                                                                       |       | $                                   | 0.59       |                              | $          | 0.46 |   | $ | 0.83 |   | $ | 0.60 |   |
| Diluted—pro forma                                                                         |       | $                                   | 0.59       |                              | $          | 0.45 |   | $ | 0.82 |   | $ | 0.59 |   |
|                                                                                           |       |                                |       |                              |       |   |   |   |   |
| Weighted Average Assumptions:                                                                  |       |                                |       |                              |       |   |   |   |   |
| Risk-free interest rate                                                                        |       | 4.0                                 | %          | 3.3                               | %          |   |   |   |   |
| Expected dividends                                                                             |       | —                              |       | —                            |       |   |   |   |   |
| Estimated average life                                                                         |       | 5 years                             |       | 6 years                           |       |   |   |   |   |
| Volatility                                                                                     |       | 0.50                                |       | —                            |       |   |   |   |   |

 

Thefair value of each option is estimated on the date of grant using the minimumvalue method with the weighted average assumptions provided above.  Based on these assumptions, the estimatedweighted average fair value of the options granted in the second quarter offiscal 2006 and 2005 was $6.72 and $1.14, respectively.  Because of the limited history of markettrading in the Company’s common stock, estimated volatility for the secondquarter of fiscal 2006 was based on an average of the volatility reported by apeer group of publicly traded companies.

 

### *Stock Options*

### * *

TheCompany’s 1996 Stock Option and Incentive Plan and 2004 Stock Incentive Plan(together, the “Plans”) provide for the issuance of incentive and non-qualifiedstock options. Options are generally granted at the fair market value as of thegrant date, are exercisable ratably over various periods and expire up to ten yearsafter the date of grant.

 

Asof August 27, 2005 and February 26, 2005, there were 2,000,000 commonshares authorized for issuance under the Plans. Stock option activity under thePlans was as follows:

 
| ** **                                      | ** ** | **Six Months Ended  August 27, 2005  (Unaudited)** | ** ** | **Fiscal Year Ended  February 26, 2005** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                      | ** ** | **Shares**                                              | ** ** | **Weighted  Average  Exercise  Price**        | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding, beginning of period                |       | 915,275                                                 |       | $                                             | 5.47       |   | 698,100 |   | $ | 5.21 |   |
| Issued                                          |       | 327,000                                                 |       | 11.43                                         |       | 252,900 |   | 6.30 |   |
| Forfeited                                       |       | (20,450                                                 | )          | 6.48                                          |       | (32,075 | ) | 6.28 |   |
| Exercised                                       |       | —                                                  |       | —                                        |       | (3,650 | ) | 5.91 |   |
| Outstanding, end of period                      |       | 1,221,825                                               |       | 7.05                                          |       | 915,275 |   | 5.47 |   |
| Exercisable, end of period                      |       | 629,131                                                 |       | 5.22                                          |       | 525,706 |   | 4.86 |   |
| Weighted average fair value of options  granted |       | $                                                       | 4.46       |                                          |       |   | $ | 1.14 |   |   |   |
|                                                 |            |                                                         |            |                                               |            |  |  |  |  |  |  |  |  |

 

7

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**4. 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.

 

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 27,  2005**           | ** ** | **August 28,  2004**         | ** ** | **August 27,  2005** | ** ** | **August 28,  2004** | ** ** |
| Numerator:                                                 |       |                                |       |                              |       |   |   |   |   |
| Net income applicable to common  shareholders, as reported |       | $                                   | 4,724      |                              | $          | 2,594 |   | $ | 5,419 |   | $ | 2,818 |   |
| Add preferred stock dividends                              |       | 723                                 |       | 919                               |       | 1,721 |   | 1,820 |   |
| Numerator for diluted net income per share                 |       | $                                   | 5,447      |                              | $          | 3,513 |   | $ | 7,140 |   | $ | 4,638 |   |
| Denominator:                                               |       |                                |       |                              |       |   |   |   |   |
| Weighted average number of common shares  outstanding      |       | 4,801,458                           |       | 1,861,945                         |       | 3,342,714 |   | 1,861,945 |   |
| Effect of dilutive securities:                             |       |                                |       |                              |       |   |   |   |   |
| Outstanding stock options and warrants                     |       | 575,226                             |       | 89,100                            |       | 498,290 |   | 89,100 |   |
| Convertible preferred stock                                |       | 3,834,978                           |       | 5,752,467                         |       | 4,793,722 |   | 5,752,467 |   |
| Denominator for diluted net income per  share              |       | 9,211,662                           |       | 7,703,512                         |       | 8,634,726 |   | 7,703,512 |   |
| Net income per share:                                      |       |                                |       |                              |       |   |   |   |   |
| Basic                                                      |       | $                                   | 0.98       |                              | $          | 1.39 |   | $ | 1.62 |   | $ | 1.51 |   |
| Diluted                                                    |       | $                                   | 0.59       |                              | $          | 0.46 |   | $ | 0.83 |   | $ | 0.60 |   |

 

8

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*Pro-FormaNet Income Per Share*

 

TheCompany believes the use of pro-forma net income per share provides importantsupplemental information due to the significant increase in common shares outstandingresulting from the IPO and the conversion of the convertible preferred stockinto shares of common stock effective on August 3, 2005.  The pro-forma net income per share ispresented as if the IPO had occurred immediately prior to the beginning of eachperiod presented. Pro-forma net income per share is considered a non-GAAPfinancial measure and is not in accordance with, or preferable to, the ratiodetermined in accordance with GAAP. Further, pro-forma net income per share, asthe Company defines it, may not be comparable to a similarly titled measureused by other companies. The most directly comparable GAAP financial measure topro-forma net income per share is net income per share. The following tablepresents a reconciliation of the numerator and denominator used in thecalculation of pro-forma net income per share (in thousands, except share andper share amounts):

 
| ** **                                                 | ** ** | **Three Months Ended  (Unaudited)** | ** ** | **Six Months Ended  (Unaudited)** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| ** **                                                 | ** ** | **August 27,  2005**           | ** ** | **August 28,  2004**         | ** ** | **August 27,  2005** | ** ** | **August 28,  2004** | ** ** |
| **Pro-Forma Information**                                  |       |                                |       |                              |       |   |   |   |   |
| Pro-forma net income applicable to common  shareholders    |       | $                                   | 5,447      |                              | $          | 3,513 |   | $ | 7,140 |   | $ | 4,638 |   |
| Pro-forma net  income per share:                           |       |                                |       |                              |       |   |   |   |   |
| Basic                                                      |       | $                                   | 0.51       |                              | $          | 0.33 |   | $ | 0.67 |   | $ | 0.44 |   |
| Diluted                                                    |       | $                                   | 0.49       |                              | $          | 0.33 |   | $ | 0.64 |   | $ | 0.43 |   |
| Pro-forma weighted average number of shares  outstanding:  |       |                                |       |                              |       |   |   |   |   |
| Basic                                                      |       | 10,636,436                          |       | 10,614,412                        |       | 10,636,436 |   | 10,614,412 |   |
| Diluted                                                    |       | 11,211,662                          |       | 10,703,512                        |       | 11,134,726 |   | 10,703,512 |   |
|                                                       |       |                                |       |                              |       |   |   |   |   |
| **Reconciliation of pro-forma information to  GAAP**       |       |                                |       |                              |       |   |   |   |   |
| Net income applicable to common  shareholders (GAAP)       |       | $                                   | 4,724      |                              | $          | 2,594 |   | $ | 5,419 |   | $ | 2,818 |   |
| Preferred Stock Dividends                                  |       | 723                                 |       | 919                               |       | 1,721 |   | 1,820 |   |
| Net income applicable to common  shareholders (Pro-forma)  |       | $                                   | 5,447      |                              | $          | 3,513 |   | $ | 7,140 |   | $ | 4,638 |   |
| ***Basic***                                                | * *   | * *                            | * *   | * *                          | * *   | * * | * * | * * | * * |
| Weighted average number of shares  outstanding (GAAP)      |       | 4,801,458                           |       | 1,861,945                         |       | 3,342,714 |   | 1,861,945 |   |
| Conversion of preferred stock to common                    |       | 3,834,978                           |       | 5,752,467                         |       | 4,793,722 |   | 5,752,467 |   |
| Weighted average additional shares issued  in IPO          |       | 2,000,000                           |       | 3,000,000                         |       | 2,500,000 |   | 3,000,000 |   |
| Weighted average number of shares  outstanding (Pro-forma) |       | 10,636,436                          |       | 10,614,412                        |       | 10,636,436 |   | 10,614,412 |   |
| ***Diluted***                                              |       |                                |       |                              |       |   |   |   |   |
| Weighted average number of shares outstanding  (GAAP)      |       | 9,211,662                           |       | 7,703,512                         |       | 8,634,726 |   | 7,703,512 |   |
| Weighted average additional shares issued  in IPO          |       | 2,000,000                           |       | 3,000,000                         |       | 2,500,000 |   | 3,000,000 |   |
| Weighted average number of shares  outstanding (Pro-forma) |       | 11,211,662                          |       | 10,703,512                        |       | 11,134,726 |   | 10,703,512 |   |

 

9

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**5. Employee Benefit Plan**

 

TheCompany has a defined contribution 401(k) profit sharing plan (the “Plan”) foreligible employees, which is qualified under Sections 401(a) and 401(k) ofthe Internal Revenue Code of 1986. Employees are entitled to make tax-deferredcontributions of up to 18% of their eligible compensation. The Company may, atits discretion, make matching contributions to the Plan for each plan year. TheCompany’s contributions vest after four years of service, at age 59 1/2regardless of service or upon the death of the employee. Effective July 1,2005, the Company began matching 50% of the first 4% of eligible compensationcontributed to the Plan by each participant. The Company’s matchingcontribution to the Plan for the second quarter and first six months of fiscal2006 was $16,000. The Company did not make any matching contributions to thePlan during either of the corresponding periods of fiscal 2005.

 

**6. New Accounting Pronouncements**

 

In December 2004, the Financial AccountingStandards Board (“FASB”) issued a revision to SFAS No. 123, which requiresthe calculation of the fair value of stock-based compensation, estimation offuture forfeitures and income taxes and recognition of the net value as anon-cash expense over the vesting period of the underlying instruments. Theimplementation of SFAS No. 123 (revised 2004), *Share-Based Payment* (SFAS No. 123(R)), can be made oneither a modified prospective or modified retrospective basis. Based on currentguidance, the Company will be required to implement the provisions of SFAS No. 123(R)beginning in fiscal 2007. The Company is currently evaluating option valuationmethodologies and assumptions. The Company expects to record substantialnon-cash compensation expenses in future periods as a result of the adoption ofSFAS No. 123(R), which will have a significant adverse impact on ourresults of operations.

 

In June 2005, the FASB’s Emerging Issues TaskForce (“EITF”) reached a consensus on Issue No. 05-6, *Determining the Amortization Period for LeaseholdImprovements Purchased after Lease Inception or Acquired in a BusinessCombination* (EITF No. 05-6). EITF No. 05-6 providesguidance on the amortization period for leasehold improvements in operatingleases that are either acquired after the beginning of the initial lease termor acquired as the result of a business combination. This guidancerequires leasehold improvements purchased after the beginning of the initial leaseterm to be amortized over the shorter of the assets’ useful life or a term thatincludes the original lease term plus any renewals that are reasonably assuredat the date the leasehold improvements are purchased.  This guidance iseffective for reporting periods beginning after June 29, 2005. Theadoption of this statement did not have a material impact on the Company’s netincome, cash flows or financial position.

 

On July 14, 2005, the FASB issued a proposedInterpretation, *Accounting for Uncertain TaxPositions, an Interpretation of FASB Statement No. 109*. This proposed Interpretation would clarify the accounting for uncertain taxpositions as described in SFAS No. 109, *Accountingfor Income Taxes*, and would require an enterprise to recognize, inits financial statements, the best estimate of the impact of a tax positiononly if that position is probable of being sustained on audit based solely onthe technical merits of the position. The proposed Interpretation is expectedto be effective as of the end of the first fiscal year ending after December 15,2005. The Company does not expect the adoption of this new guidance toimpact its net income, cash flows or financial position.

 

10

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

**Overview**

 

GolfGalaxy, Inc. is a leading golf specialty retailer offering a distinctivecombination of competitively priced merchandise from the leading nationalbrands in golf equipment and apparel, along with non-commissioned salesassistance and pro shop services. As of August 27, 2005, we operated 45superstores, generally ranging from 13,000 to 18,000 selling square feet,located in 19 primarily northern and midwestern states. 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 sales assistanceand professional services, the combination of which is generally not availableelsewhere. We offer our customers an exciting, interactive environment thatcompares favorably with the shopping experience at smaller independent golfstores, on-course pro shops and the golf departments of general sporting goodsretailers.

 

Wecompleted an initial public offering of our common stock on August 3,2005. Our stock trades on the Nasdaq National Market under the ticker symbol “GGXY.”The initial public offering consisted of 4,542,500 shares of common stock. Ofthe shares of common stock sold in the initial public offering, we sold3,000,000 shares, resulting in proceeds of $42.0 million. As part of theoffering, all of the outstanding preferred stock converted into 5,752,467shares of our common stock, of which 1,542,500 were sold in the initial publicoffering, resulting in a total offering of 4,542,500 shares of common stock.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. We expect touse the remaining net proceeds from the offering to continue to open new retailstores and for general corporate purposes.

 

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

 

Webelieve the interim financial statements filed in this Form 10-Q and thediscussions contained herein should be read in conjunction with the annualfinancial statements and notes included in the final prospectus relating to ourinitial public offering, as filed with SEC, which includes audited financialstatements for each of the three fiscal years in the period ended February 26,2005.

 

**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 27,  2005**   | ** ** | **August 28,  2004** | ** ** | **August 27,  2005** | ** ** | **August 28,  2004** | ** ** |
| **Statements of Operations Data**   |       |                   |       |                 |       |   |   |   |   |
| Net sales                           |       | 100.0                  | %          | 100.0                | %          | 100.0 | % | 100.0 | % |
| Cost of sales                       |       | 68.3                   | %          | 68.7                 | %          | 68.6 | % | 69.2 | % |
| Gross profit                        |       | 31.7                   | %          | 31.3                 | %          | 31.4 | % | 30.8 | % |
| Store operating expenses            |       | 15.5                   | %          | 15.0                 | %          | 16.9 | % | 16.4 | % |
| General and administrative expenses |       | 3.1                    | %          | 3.9                  | %          | 4.1 | % | 4.6 | % |
| Preopening expenses                 |       | 0.0                    | %          | 0.1                  | %          | 1.0 | % | 0.7 | % |
| Income from operations              |       | 13.1                   | %          | 12.3                 | %          | 9.4 | % | 9.1 | % |
| Interest income (expense), net      |       | 0.1                    | %          | 0.0                  | %          | 0.1 | % | (0.1 | )% |
| Income before income taxes          |       | 13.2                   | %          | 12.3                 | %          | 9.5 | % | 9.0 | % |
| Income tax expense                  |       | (5.4                   | )%         | (4.9                 | )%         | (3.9 | )% | (3.6 | )% |
| Net income                          |       | 7.8                    | %          | 7.4                  | %          | 5.6 | % | 5.4 | % |

 

11

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Net sales consist of sales, netof returns, from comparable stores and new stores, as well as sales from oureCommerce operations, which we launched in March 2004. A new or relocatedstore is included in comparable store results after it has been in operationfor 12 full fiscal months following the month of the store’s grand openingweekend, typically a store’s 13th full month of operations. New store sales includeall sales from stores that have not yet become comparable stores.

 

Costof sales includes the cost of merchandise sold net of certain vendorallowances, direct costs of services, freight, inventory shrinkage, otherinventory valuation adjustments and store occupancy costs. Vendor allowancesinclude promotional support, rebates and volume discounts. Store occupancycosts include rent, real estate taxes and common area maintenance charges.

 

Storeoperating expenses primarily include store associate payroll and relatedemployee benefits, advertising and depreciation. Store operating expenses alsoinclude maintenance, utilities, insurance, bank and credit card charges, otherstore level expenses, as well as expenses associated with the operation of oureCommerce site.

 

Generaland administrative expenses include all expenses associated with operating ourcorporate headquarters.

 

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

 

**Three and Six Months Ended August 27, 2005 compared withThree and Six Months Ended August 28, 2004**

 

***Net Sales.***  Netsales for the second quarter of fiscal 2006 were $69.6 million, an increaseof $22.1 million, or 46.5%, compared with net sales of $47.5 million forthe second quarter of fiscal 2005. The increase in net sales for the fiscalsecond quarter resulted primarily from $17.8 million in sales from newstores opened in the current or prior fiscal year, before becoming comparablestores, and a comparable store sales gain of $3.4 million, or 7.4%. Netsales for the first six months of fiscal 2006 were $128.2 million, anincrease of $42.2 million, or 49.1%, compared with net sales of $86.0 millionfor the first six months of the prior fiscal year. The increase in net salesfor the six-month period resulted primarily from $33.2 million in netsales from new stores opened in the current or prior fiscal year, beforebecoming comparable stores, and a comparable store sales gain of$7.3 million, or 8.8%. The increase in comparable store sales for both thesecond quarter and first six months of fiscal 2006 was attributable primarilyto increased sales of golf clubs, which was driven by several new productintroductions. Increased sales of golf balls and apparel resulting frommerchandising focus on these product groups also contributed to the comparablestore sales gain.

 

***Gross Profit.***  Grossprofit increased by $7.2 million, or 48.3%, to $22.1 million for thesecond quarter of fiscal 2006, up from $14.9 million for the secondquarter of fiscal 2005. The gross profit rate increased by 0.4% of net sales to31.7% of net sales for the second quarter of fiscal 2006, compared with 31.3% ofnet sales for the second quarter of the prior fiscal year. For the first sixmonths of fiscal 2006 gross profit increased by $13.9 million, or 52.7%,to $40.3 million, up from $26.4 million for the same period of fiscal2005. The gross profit rate for the first six months of fiscal 2006 increasedby 0.6% of net sales to 31.4% of net sales, compared with 30.8% of net salesfor the first six months of the prior fiscal year. The increase in our grossprofit rate for both the second quarter and first six months of fiscal 2006 wasdue primarily to increases in vendor allowances resulting in higher retailmargins, and was partially offset by higher freight costs.

 

***Store Operating Expenses.***  Storeoperating expenses for the second quarter of fiscal 2006 were$10.8 million, an increase of $3.7 million, or 52.1%, compared with storeoperating expenses of $7.1 million for the second quarter of fiscal 2005.The store operating expenses rate for the second quarter of fiscal 2006increased to 15.5% of net sales, up from 15.0% of net sales for the secondquarter of fiscal 2005. For the first six months of fiscal 2006, storeoperating expenses increased by $7.6 million, or 53.9%, to$21.7 million, up from $14.1 million for the first six months offiscal 2005. The store operating expenses rate for the first half of fiscal2006 increased by 0.5% of net sales to 16.9% of net sales, compared with 16.4%of net sales for the same period of fiscal 2005. For both the second quarterand first half of fiscal 2006, the increase in store operating expenses as apercentage of net sales related primarily to new stores opened in the last 12months, including 11 new stores openings during the first six months of fiscal2006 and five new store openings during the second half of fiscal 2005. A totalof seven new stores were opened during the same periods of the prior fiscalyears. 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 and because mature stores generally have higher sales volumes. Due toour anticipated store growth and the high percentage of new stores in our storebase, we expect store operating expenses as a percentage of net sales tocontinue to grow modestly through the next year when compared with priorperiods.

 

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***General and Administrative Expenses.*** General and administrative expenses increased to $2.2 million forthe second quarter of fiscal 2006, up $0.4 million, or 22.2%, from$1.8 million for the second quarter of fiscal 2005. As a percentage of netsales, general and administrative expenses decreased to 3.1% for the secondquarter of fiscal 2006, down from 3.9% of net sales for the second quarter offiscal 2005. For the first six months of fiscal 2006, general andadministrative expenses were $5.3 million, an increase of$1.3 million, or 32.5%, compared with $4.0 million for the first sixmonths of fiscal 2005. General and administrative expenses as a percentage ofnet sales decreased to 4.1% for the first half of fiscal 2006, down from 4.6%of net sales for the same period of the prior fiscal year. The decrease ingeneral and administrative expenses as a percentage of net sales for the secondquarter and first six months of fiscal 2006, compared with the correspondingperiods of fiscal 2005, was due primarily to net sales increasing at a fasterrate than the growth of our payroll and payroll-related costs.

 

***Preopening Expenses.*** Preopening expenses were not significant in either the second quarter offiscal 2006 or the second quarter of fiscal 2005. Preopening expenses increasedby $0.8 million to $1.4 million for the first six months of fiscal2006, up from $0.6 million for the first six months of the prior fiscal year.The increase was related primarily to opening 11 new stores during the firsthalf of fiscal 2006, compared with five new store openings during the firsthalf of fiscal 2005.

 

***Net Interest Income (Expense).***  Netinterest income was $100,000 for the second quarter of fiscal 2006, comparedwith $4,000 for the second quarter of fiscal 2005. For the first six months offiscal 2006, we reported net interest income of $115,000, compared with netinterest expense of $32,000 for the first six months of fiscal 2005. The changefor both the fiscal second quarter and six-month period was due primarily to theeffect of higher interest rates on our cash investments in fiscal 2006 and interestincome earned on the net proceeds from our initial public offering.

 

***Income Tax Expense.***  Werecorded an income tax provision of $3.8 million for the second quarter offiscal 2006, compared with an income tax provision of $2.4 million for thesecond quarter of fiscal 2005. The income tax provision for the second quartersof fiscal 2006 and fiscal 2005 were based on estimated effective income taxrates of 40.8% and 40.1%, respectively. For the first six months of fiscal2006, we recorded an income tax provision of $5.0 million compared with anincome tax provision of $3.1 million for the first six months of the priorfiscal year. The income tax provision for the first six months of fiscal 2006and fiscal 2005 were based on estimated effective annual income tax rates of41.0% and 40.2%, respectively.

 

***Net Income.***  Net income was $5.4 million for the secondquarter of fiscal 2006, compared with $3.5 million for the second quarter offiscal 2005, an increase of $1.9 million, or 54.3%.  For the first six months of fiscal 2006 netincome was $7.1 million, compared with $4.6 million for the first six months ofthe prior fiscal year, an increase of $2.5 million, or 54.3%.

 

13

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**Quarterly Results of Operations and Seasonality**

 

Thefollowing table sets forth certain unaudited financial and operating data foreach quarter of fiscal 2005 and the first two quarters of fiscal 2006. Theunaudited quarterly information reflects all adjustments, which include onlynormal and recurring adjustments, necessary to present fairly the informationshown.

 
| ** **                                | ** ** | **Fiscal 2005**                                  | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                | ** ** | **Quarter Ended  May 29, 2004**             | ** ** | **Quarter Ended  August 28, 2004** | ** ** | **Quarter Ended  Nov. 27, 2004** | ** ** | **Quarter Ended  Feb. 26, 2005** | ** ** |
| ** **                                | ** ** | **($ in thousands, except per share data)** | ** ** |
| **Statement of Operations Data**          |       |                                             |       |   |   |   |   |   |   |
| Net sales                                 |       | $                                                | 38,419     |   | $ | 47,540 |   | $ | 20,281 |   | $ | 26,840 |   |
| Gross profit                              |       | 11,563                                           |       | 14,875 |   | 5,089 |   | 7,589 |   |
| Gross profit as a percentage of net sales |       | 30.1                                             | %          | 31.3 | % | 25.1 | % | 28.3 | % |
| Store operating expenses                  |       | 6,972                                            |       | 7,127 |   | 4,793 |   | 5,490 |   |
| General and administrative expenses       |       | 2,147                                            |       | 1,842 |   | 2,520 |   | 1,863 |   |
| Preopening expenses                       |       | 518                                              |       | 46 |   | 599 |   | 932 |   |
| Income (loss) from operations             |       | 1,926                                            |       | 5,860 |   | (2,823 | ) | (696 | ) |
| Other Income (1)                          |       | —                                           |       | — |   | 8,410 |   | — |   |
| Income (loss) before income taxes         |       | 1,890                                            |       | 5,864 |   | 5,598 |   | (679 | ) |
| Net income (loss)                         |       | $                                                | 1,125      |   | $ | 3,513 |   | $ | 3,351 |   | $ | (451 | ) |
| Basic net income (loss) per share         |       | $                                                | 0.12       |   | $ | 1.39 |   | $ | 1.30 |   | $ | (0.74 | ) |
| Diluted net income (loss) per share       |       | $                                                | 0.11       |   | $ | 0.46 |   | $ | 0.43 |   | $ | (0.74 | ) |
| Comparable store sales increase (2)       |       | 7.4                                              | %          | 5.9 | % | 9.9 | % | 4.8 | % |
| Stores opened during the period           |       | 5                                                |       | — |   | 3 |   | 2 |   |
| Number of stores at end of period         |       | 29                                               |       | 29 |   | 32 |   | 34 |   |
| Selling square feet at end of period      |       | 450,370                                          |       | 450,370 |   | 486,737 |   | 516,551 |   |

 
| ** **                                | ** ** | **Fiscal 2006**                                  | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                | ** ** | **Quarter Ended  May 28, 2005**             | ** ** | **Quarter Ended  August 27, 2005** | ** ** |
| ** **                                | ** ** | **($ in thousands, except per share data)** | ** ** |
| **Statement of Operations Data**          |       |                                             |       |   |   |
| Net sales                                 |       | $                                                | 58,570     |   | $ | 69,635 |   |
| Gross profit                              |       | 18,228                                           |       | 22,070 |   |
| Gross profit as a percentage of net sales |       | 31.1                                             | %          | 31.7 | % |
| Store operating expenses                  |       | 10,932                                           |       | 10,773 |   |
| General and administrative expenses       |       | 3,102                                            |       | 2,155 |   |
| Preopening expenses                       |       | 1,310                                            |       | 40 |   |
| Income from operations                    |       | 2,884                                            |       | 9,102 |   |
| Income before income taxes                |       | 2,899                                            |       | 9,202 |   |
| Net income                                |       | $                                                | 1,693      |   | $ | 5,447 |   |
| Basic net income per share                |       | $                                                | 0.37       |   | $ | 0.98 |   |
| Diluted net income per share              |       | $                                                | 0.21       |   | $ | 0.59 |   |
| Comparable store sales increase (2)       |       | 10.5                                             | %          | 7.4 | % |
| Stores opened during the period           |       | 11                                               |       | — |   |
| Number of stores at end of period         |       | 45                                               |       | 45 |   |
| Selling square feet at end of period      |       | 671,953                                          |       | 671,953 |   |

 

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(1)              We sold our equity investment in Golf TownCanada Inc. during the third quarter of fiscal 2005 for a pre-tax gain of$8.4 million.

 

(2)              A new or relocated store is included in thecomparable store base after it has been in operation for 12 full fiscal monthsfollowing the month of the store’s grand opening weekend. A store that isclosed for remodel or repair is excluded from the comparable store salescalculation during the period of closure and the comparable period of thesucceeding year. Sales from our eCommerce operations are not included in thecomparable store sales calculation. Comparable store results for a 53-weekfiscal year are presented on a 52/52-week basis.

 

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Ourbusiness is subject to seasonal fluctuations, with the highest sales activityand all income from operations occurring during the first and second quartersof our fiscal year. Most of our stores are located in northern and midwesternstates where late spring and summer represent the peak of the golf season. Itis possible the impact of seasonal fluctuation could change as we enteradditional geographic regions. The Father’s Day holiday in June drives asignificant seasonal sales increase, and sales also increase during theyear-end holiday season, albeit to a lesser extent.

 

Ourquarterly operating results may also fluctuate significantly because of otherfactors. Our customers’ demand for our products and services, and consequentlyour sales, can also be significantly impacted by weather conditions that affectoutdoor activities like golf and the demand for golf-related apparel,accessories, equipment and services. The timing of new store openings andrelated expenses; the profitability of new stores; the impact on store resultsduring remodeling; changes in competitors in our markets, such as new storeopenings or store closings by our competitors; and general economic conditions,also affect our quarterly results. The fixed costs of our operations make ouroperating results sensitive to changes, favorable and unfavorable, in demandfor our products and services. Due to these factors, results for any particularquarter may not be indicative of results to be expected for any other quarteror 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 either the first or third quarters of the fiscal year. Going forward,we anticipate that store openings will occur predominantly in the first, thirdand fourth quarters of the fiscal year. 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 greater than a mature store. Accordingly, the volume and timing of newstore openings in any quarter has had and is expected to continue to have asignificant impact on quarterly preopening costs and store labor and operatingexpenses.

 

**Liquidity and Capital Resources**

 

Ourprimary capital requirements are for inventory, capital expenditures such astenant improvements and fixtures, and preopening expenses to support our newstore growth. Our working capital needs change significantly from quarter toquarter due to the impact of seasonality and the timing of new store openings.Our main source of liquidity is cash provided by operations. However, we planto finance our continued store expansion with the net proceeds from our initialpublic offering. We also have availability for borrowing, if necessary, underour credit facility. Historically, our main source of liquidity has been theproceeds from our equity financings.

 

Thefollowing table summarizes our cash flows from operating, investing andfinancing activities for the first six months of fiscal 2006 and fiscal 2005 ($in thousands):

 
| ** **                                 | ** ** | **Six Months Ended**      | ** ** |
|--------------------------------------------|------------|---------------------------|------------|
| ** **                                 | ** ** | **August 27,  2005** | ** ** | **August 28,  2004** | ** ** |
| Net cash  provided by operating activities |       | $                         | 8,829      |   | $ | 11,420 |   |
| Net cash  used in investing activities     |       | (4,028                    | )          | (2,279 | ) |
| Net cash  provided by financing activities |       | 18,341                    |       | — |   |
| Net increase  in cash and cash equivalents |       | $                         | 23,142     |   | $ | 9,141 |   |

 

Netcash provided by operating activities was $8.8 million for the first sixmonths of fiscal 2006, compared with $11.4 million for the first six monthsof fiscal 2005. The decrease in net cash provided by operating activities forthe first half of fiscal 2006 compared with the first half of the prior fiscalyear was due substantially to increased inventory levels, reflecting storegrowth, the timing of payments to vendors and an increase in constructionallowance accounts receivable.  Thesefactors were partially offset by an increase in net income.

 

Netcash used in investing activities was $4.0 million for the first half offiscal 2006, compared with $2.3 million for the first half of fiscal 2005.Net cash used in investing activities consists principally of investments in leaseholdimprovements and fixtures associated with new store openings. The increase innet cash used in investing activities for the first six months of fiscal 2006compared with the same period of the prior fiscal year is attributable to theincreased level of new store openings. We opened 11 new stores during the firstsix months of fiscal 2006 compared with five new store openings during thefirst six months of fiscal 2005.

 

Netcash provided by financing activities was $18.3 million for the first sixmonths of fiscal 2006 compared with $0 for the same period of the prior fiscalyear. The increase was due to the net proceeds from completing our initialpublic offering.

 

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Wemaintain a revolving credit facility as an additional source of short-termliquidity and working capital, if needed. The credit facility has a term offour years and provides for revolving loans in an aggregate up to$15.0 million, of which $5.0 million may be in the form of letters ofcredit. 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, net of specified reserves, and less any outstanding letters ofcredit. Interest on any outstanding indebtedness under our credit facilityaccrues at the prime lending rate or an adjusted LIBOR as defined in theagreement for the credit facility. There were no outstanding borrowings on ourcredit facilities as of August 27, 2005, August 28, 2004 or February 26,2005.

 

Ourfuture capital requirements will primarily depend on the number of new storeswe open and the timing of those openings within a given fiscal year. Theserequirements will include costs directly related to opening new stores and may alsoinclude costs necessary to ensure that our infrastructure is able to support alarger store base. Additional capital may also be needed in the future toremodel or relocate existing stores. Based on our current plans for storegrowth, we expect to fund our anticipated capital requirements through cashprovided by operations and the net proceeds from our initial public offering.

 

**Off-Balance-Sheet Arrangements and Contractual Obligations**

 

Welease our retail store locations, office space and certain office equipment primarilythrough operating leases. 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 2005.

 

**CriticalAccounting Policies and Use of Estimates**

 

Ourfinancial statements are prepared in accordance with U.S. generally acceptedaccounting principles (“GAAP”). In connection with the preparation of thefinancial statements, we are required to make assumptions, estimates andjudgments that affect the reported amounts of assets, liabilities, net sales,cost of sales, expenses and the related disclosures. We base our assumptions, estimatesand judgments on historical experience, current trends and other factors thatwe believe to be relevant at the time the consolidated financial statements areprepared. On a regular basis, we review our accounting policies, assumptions,estimates and judgments to ensure that our financial statements are presentedfairly and in accordance with GAAP. However, because future events and theireffects cannot be determined with certainty, actual results could differ fromour assumptions and estimates, and such differences could be material.

 

Oursignificant accounting policies are discussed in the “Notes to UnauditedFinancial Statements” included in this Quarterly Report on Form 10-Q and shouldbe read in conjunction with Note 2 of “Notes to Financial Statements”included in the final prospectus relating to our initial public offering, asfiled with the SEC.

 

**Impact of Recent Accounting Pronouncements**

 

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issued arevision to Statement of Financial Accounting Standards (“SFAS”) No. 123, *Accounting for Stock-Based Compensation*,which requires the calculation of the fair value of stock-based compensation,estimation of future forfeitures and income taxes, and recognition of the fairvalue as a non-cash expense over the vesting period of the underlyinginstruments. The implementation of SFAS No. 123 (revised 2004), *Share-Based Payment*(SFAS No. 123(R)),can be made on either a modified prospective or modified retrospective basis.Based on current guidance, we will be required to implement the provisions ofSFAS No. 123(R) beginning in fiscal 2007. SFAS No. 123(R) eliminatesthe ability to account for stock-based compensation transactions usingAccounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*,and generally requires instead that such transactions be accounted for using afair-value-based method. Companies are required to recognize an expense forcompensation cost related to stock-based payment arrangements, including stockoptions and employee stock purchase plans. We currently account for stock-basedpayments to our employees using APB Opinion No. 25’s intrinsic valuemethod and, as such, generally recognize no compensation cost for employeestock options. Accordingly, the adoption of SFAS No. 123(R)’s fair-value-basedmethod will have a significant adverse impact on our results of operations,although it will have no impact on our overall cash flows. We are currentlyevaluating option valuation methodologies and assumptions. While we expect thatwe will record substantial non-cash compensation expenses as a result of theadoption of SFAS No. 123(R) and that our results of operations will besignificantly adversely affected, the impact of adoption of SFAS No. 123(R)cannot be predicted with more specificity at this time because it will dependon the option methodology adopted, the assumptions utilized and the levels ofstock based payments granted in the future.

 

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In June 2005, the FASB’s Emerging Issues TaskForce (“EITF”) reached a consensus on Issue No. 05-6, *Determining the Amortization Period for LeaseholdImprovements Purchased after Lease Inception or Acquired in a BusinessCombination* (EITF No. 05-6). EITF No. 05-6 providesguidance on the amortization period for leasehold improvements in operatingleases that are either acquired after the beginning of the initial lease termor acquired as the result of a business combination. This guidancerequires leasehold improvements purchased after the beginning of the initiallease term to be amortized over the shorter of the assets’ useful life or aterm that includes the original lease term plus any renewals that arereasonably assured at the date the leasehold improvements are purchased. This guidance is effective for reporting periods beginning after June 29,2005. The adoption of this statement did not have a material impact on theCompany’s net income, cash flows or financial position.

 

OnJuly 14, 2005, the FASB issued a proposed Interpretation, *Accounting for Uncertain Tax Positions, anInterpretation of FASB Statement No. 109*.  This proposedInterpretation would clarify the accounting for uncertain tax positions asdescribed in SFAS No. 109, *Accountingfor Income Taxes*, and would require an enterprise to recognize, inits financial statements, the best estimate of the impact of a tax positiononly if that position is probable of being sustained on audit based solely onthe technical merits of the position. The proposed Interpretation is expectedto be effective as of the end of the first fiscal year ending after December 15,2005. The Company does not expect the adoption of this new guidance willimpact its net income, cash flows or financial position.

 

**Outlook**

 

OnSeptember 22, 2005, in conjunction with our earnings announcement for thefiscal second quarter, we provided our preliminary outlook for both the thirdquarter ending November 26, 2005, and the fiscal year ending February 25,2006. For our fiscal third quarter, we are expecting net sales of $30 millionto $32 million, an increase of 48% to 58% over the third quarter of fiscal2005. We anticipate a comparable store sales gain of 2% to 6% for the fiscalthird quarter. Finally, we are projecting a net loss for the fiscal thirdquarter of $1.8 million to $2.2 million. For the fiscal year, we anticipate netsales of $197 million to $202 million, which would represent an increase of 48%to 52% over fiscal 2005. Comparable store sales are expected to increase 6% to8% for the full fiscal year. Net income for the fiscal year is projected to be$4.5 million to $5.1 million.

 

Theoutlook provided above reflected our best estimate as of September 22,2005 of the anticipated impact of certain macro-economic factors, includingHurricane Katrina, higher gasoline and energy prices, and consumer spending patterns,on our future results. In anticipation of Hurricane Rita, we were forced toclose three stores as part of the larger-scale mandatory evacuation of thegreater Houston area. All three stores were reopened within 5 days of closing.The outlook provided on September 22, 2005 did not contemplate these storeclosings or its impact on our future financial results, which are not expectedto be material.

 

**A Special Note Regarding Forward-Looking Statements**

 

ThisQuarterly Report on Form 10-Q (the “Report”) contains forward-lookingstatements that are based on our beliefs, assumptions and expectations offuture events taking into account the information currently available to us.All statements other than statements of historical fact contained in thisReport are forward-looking statements. These statements involve known andunknown risks, uncertainties and other factors that may cause our actualresults, performances, financial condition or achievements to differ materiallyfrom the expected future results, performances, financial condition orachievements as expressed or implied in any forward-looking statements. In somecases forward-looking statements 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 expressions intended to identify forward-looking statements.

 

Thefollowing factors, among others, could cause our actual financial performanceto differ materially from that expressed in any forward-looking statement: adecline in the popularity of golf or golf-related products and services; limitationsimposed by suppliers on the amount or variety of products; failure by suppliersto develop and introduce new products or if new products result in excessiveclose-outs of existing inventories; seasonal fluctuation in demand forproducts; weather conditions; the ability to implement successfully our growthplan; competition in the golf and sporting goods industry; a decline indiscretionary spending; availability of adequate capital to fund growth; andloss of key management. The foregoing list should not be construed asexhaustive. Additional information concerning these and other factors thatcould cause actual results to differ materially from those in theforward-looking statements contained herein is included in the prospectus inour Form S-1 Registration Statement filed with the Securities and ExchangeCommission.

 

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Forward-lookingstatements reflect our current views with respect to future events, are basedon our assumptions and are subject to risks and uncertainties. Given theseuncertainties, readers should not place undue reliance on these forward-lookingstatements. Our forward-looking statements speak only as of the date of thisReport. We assume no obligation to update or revise any forward-lookingstatements publicly, or to update the reasons actual results could differmaterially from those anticipated in any forward-looking statements, even ifnew information becomes available in the future.

 

**Item 3. Quantitative and Qualitative Disclosures About MarketRisk.**

 

Duringdifferent times of the year, due to the seasonality of our business, we haveborrowed under our revolving credit facility. To the extent we borrow under ourrevolving credit facility, which bears interest at floating rates based eitheron the prime rate or LIBOR, we are exposed to market risk related to changes ininterest rates. At August 27, 2005 and August 28, 2004, we did nothave any borrowings outstanding under our credit facility, although anyborrowings would have had an interest rate of 6.5% and 4.5% per annum,respectively. As we did not have any outstanding borrowings at August 27,2005 and August 28, 2004, there would have been no effect on our incomebefore income taxes if interest rates were to increase by 100 basis points. Wedo not anticipate borrowing under the revolving credit facility in thenear-term. We are not a party to any derivative financial instruments.

 

**Item 4.  Controls and Procedures.**

 

Asof the end of the period covered by this report, we conducted an evaluation,under the supervision and with the participation of our principal executiveofficer and principal financial and accounting officer, of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act).  Based on this evaluation, our principal executiveofficer and principal financial and accounting officer concluded that ourdisclosure controls and procedures are effective to ensure that informationrequired to be disclosed by us in reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in SEC rules and forms.

 

Therehave been no changes in internal control over financial reporting during thequarter ended August 27, 2005 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

#### **PART II—OTHERINFORMATION**

#### ** **

**Item 2. Unregistered Sales of Equity Securities and Useof Proceeds.**

 

On August 3, 2005, wecompleted an initial public offering of our common stock pursuant to aregistration statement on Form S-1 (File No. 333-125007) that wasdeclared effective by the Securities and Exchange Commission on July 28,2005 (“Effective Date”). The managing underwriters of our offering were PiperJaffray & Co., William Blair & Company, L.L.C., WedbushMorgan Securities Inc. and A.G. Edwards & Sons, Inc. Our commonstock began trading on the Nasdaq National Market under the ticker symbol “GGXY”on July 29, 2005. The initial public offering consisted of 4,542,500shares of common stock, including the underwriters’ over-allotment option of592,500 common shares, all of which were sold at an offering price of $14.00per share. Of the shares of common stock sold in the initial public offering,we sold 3,000,000 shares and selling shareholders sold 1,542,500 shares.Concurrent with the completion of our offering, all of the outstandingpreferred stock converted into 5,752,467 shares of our common stock.

 

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The aggregate gross proceedsof the shares offered and sold by us totaled $42.0 million and theaggregate gross proceeds to the selling shareholders totaled$21.6 million. We did not receive any proceeds from the sale of shares bythe selling shareholders. In connection with the offering, we paid $2.9 millionin underwriting discounts and commissions. Expenses in connection with theissuance and distribution of shares of our common stock, other thanunderwriting discounts and commissions, are set forth below.

 
| SEC  registration fees              |   | $       | 7,036     |   |
|-------------------------------------|--------|---------|-----------|--------|
| NASD filing  fee                    |   | 6,860   |      |
| Nasdaq  National Market listing fee |   | 100,000 |      |
| Legal fees  and expenses            |   | 578,482 |      |
| Accounting  fees and expenses       |   | 178,800 |      |
| Printing and  engraving expenses    |   | 199,966 |      |
| Blue sky  fees and expenses         |   | 14,730  |      |
| Transfer  agent fees and expenses   |   | 7,300   |      |
| Miscellaneous  expenses             |   | 63,638  |      |
| Total                               |   | $       | 1,156,812 |   |

 

Afterdeducting the underwriting discounts and commissions and the offering expensesdescribed above, we received net proceeds from our initial public offering of$37.9 million, of which $19.6 million was used 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. We expect touse the remaining $18.3 million of net proceeds from the offering to continueto open new retail stores and for general corporate purposes.

 

**Item6. Exhibits.**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                            |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                                                                                                                                 |
| 3.1                  |       | Articles  of Incorporation (incorporated by reference to Exhibit 3.1 to the  Company’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                  |       | Bylaws  (incorporated by reference to Exhibit 3.2 to the S-1).                                                                                                                                                                                        |
|                 |       |                                                                                                                                                                                                                                                       |
| 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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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                        | GOLF  GALAXY, INC.                                |
|-----------------------------|---------------------------------------------------|
|                        | (Registrant)                                      |
|                        |                                              |
| Date  October 11, 2005 | /s/  RANDALL K. ZANATTA                           |   |
|                        | Randall  K. Zanatta                               |
| * *                    | *President, Chief Executive Officer and Chairman* |
| * *                    | *(Principal Executive Officer)*                   |
|                        |                                              |
|                        | /s/  RICHARD C. NORDVOLD                          |   |
|                        | Richard  C. Nordvold                              |
| * *                    | *Chief Financial Officer*                         |
| * *                    | *(Principal Financial and Accounting Officer)*    |

 

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# **EXHIBIT INDEX TO FORM 10-Q**

 
| 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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