**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

(Mark One)

 

**ý****     ****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

For thequarterly period ended**November 26, 2005**

 

or

 

**o****     ****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES 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)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. **Yes ****ý****  No  ****o**

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). **Yes ****o****  No  ****ý**

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  **Yes ****o****  No  ****ý**

 

APPLICABLE ONLY TO CORPORATEISSUERS:

 

As of December 31, 2005, the Company had10,663,894 shares of common stock, par value $0.01 per share, outstanding.

 

 

----

 

**GOLFGALAXY, INC.**

**FORM 10-QFOR THE QUARTERLY PERIOD ENDED NOVEMBER 26, 2005**

**INDEX**

 
| PART I-FINANCIAL  INFORMATION                                                                                           | 3  |
|------------------------------------------------------------------------------------------------------------------------------|----|
| Item  1. Financial Statements.                                                                                               | 3  |
| Balance Sheets as of November 26, 2005  (unaudited), November 27, 2004 (unaudited) and February 26, 2005      | 3  |
| Statements of Operations for the Three  and Nine Months Ended November 26, 2005 and November 27, 2004  (unaudited) | 4  |
| Statements of Cash Flows for the Nine  Months Ended November 26, 2005 and November 27, 2004 (unaudited)            | 5  |
| Notes to Unaudited Financial  Statements                                                                                     | 6  |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations.                        | 10 |
| Item  3. Quantitative and Qualitative Disclosures About Market Risk.                                                         | 18 |
| Item  4. Controls and Procedures.                                                                                            | 18 |
| PART II-OTHER  INFORMATION                                                                                              | 18 |
| Item  2. Unregistered Sales of Equity Securities and Use of Proceeds.                                                        | 18 |
| Item 6.  Exhibits.                                                                                                           | 19 |
| SIGNATURES                                                                                                                   | 20 |

####  

#### **2**

#### ****

####  

#### **PART I—FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements.**

 

**GOLFGALAXY, INC.**

**BALANCE SHEETS**

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

 
| ** **                                                                                                                                       | ** ** | **November 26,  2005  (unaudited)** | ** ** | **November 27,  2004  (unaudited)** | ** ** | **February 26,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                       | ** ** | ** **                               | ** ** | ** **                               | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                       |       |                                     |       |                                     |       |                        |       |
| Current assets:                                                                                                                                  |       |                                     |       |                                     |       |                        |       |
| Cash and cash equivalents                                                                                                                        |       | $                                        | 15,465     |                                     | $          | 9,486                       |       | $ | 3,245 |   |
| Accounts receivable, net of allowances of  $70, $50 and $50, respectively                                                                        |       | 6,143                                    |       | 3,682                                    |       | 3,455                       |       |
| Inventories, net                                                                                                                                 |       | 43,305                                   |       | 29,268                                   |       | 30,415                      |       |
| Deferred tax assets                                                                                                                              |       | 2,219                                    |       | 3,574                                    |       | 2,219                       |       |
| Prepaid expenses and other current assets                                                                                                        |       | 2,459                                    |       | 1,038                                    |       | 1,291                       |       |
| Total current assets                                                                                                                             |       | 69,591                                   |       | 47,048                                   |       | 40,625                      |       |
| Property and equipment                                                                                                                           |       |                                     |       |                                     |       |                        |       |
| Property and equipment                                                                                                                           |       | 43,810                                   |       | 29,359                                   |       | 35,929                      |       |
| Accumulated depreciation                                                                                                                         |       | (17,767                                  | )          | (13,959                                  | )          | (14,097                     | )          |
| Property and equipment, net                                                                                                                      |       | 26,043                                   |       | 15,400                                   |       | 21,832                      |       |
| Deferred tax assets                                                                                                                              |       | 2,272                                    |       | 1,766                                    |       | 2,272                       |       |
| Other assets                                                                                                                                     |       | 236                                      |       | 380                                      |       | 408                         |       |
| Total assets                                                                                                                                     |       | $                                        | 98,142     |                                     | $          | 64,594                      |       | $ | 65,137 |   |
|                                                                                                                                             |       |                                     |       |                                     |       |                        |       |
| **Liabilities and shareholders’ equity  (deficit)**                                                                                         |       |                                     |       |                                     |       |                        |       |
| Current liabilities:                                                                                                                             |       |                                     |       |                                     |       |                        |       |
| Accounts payable                                                                                                                                 |       | $                                        | 21,923     |                                     | $          | 18,010                      |       | $ | 15,826 |   |
| Accrued liabilities                                                                                                                              |       | 9,987                                    |       | 9,091                                    |       | 11,675                      |       |
| Total current liabilities                                                                                                                        |       | 31,910                                   |       | 27,101                                   |       | 27,501                      |       |
|                                                                                                                                             |       |                                     |       |                                     |       |                        |       |
| Deferred rent credits and other                                                                                                                  |       | 11,403                                   |       | 6,368                                    |       | 6,831                       |       |
|                                                                                                                                             |       |                                     |       |                                     |       |                        |       |
| Redeemable convertible preferred stock,  including accumulated preferred stock dividends:                                                        |       |                                     |       |                                     |       |                        |       |
| Preferred Series A, par value $1.00,  Authorized shares – 80,000; Issued and outstanding – 0, 80,000 and 80,000,  respectively    |       | —                                   |       | 13,781                                   |       | 14,054                      |       |
| Preferred Series B, par value $1.00,  Authorized shares – 35,000; Issued and outstanding – 0, 35,000 and 35,000,  respectively    |       | —                                   |       | 5,638                                    |       | 5,746                       |       |
| Preferred Series C, par value $1.00,  Authorized shares – 100,000; Issued and outstanding – 0, 100,000 and 100,000,  respectively |       | —                                   |       | 15,320                                   |       | 15,623                      |       |
| Preferred Series D, par value $1.00,  Authorized shares – 150,000; Issued and outstanding – 0, 94,000 and 94,000,  respectively   |       | —                                   |       | 13,063                                   |       | 13,318                      |       |
|                                                                                                                                             |       | —                                   |       | 47,802                                   |       | 48,741                      |       |
| Shareholders’ equity (deficit):                                                                                                             |       |                                     |       |                                     |       |                        |       |
| Common stock, par value $0.01 per share:                                                                                                         |       |                                     |       |                                     |       |                        |       |
| Authorized shares – 40,000,000; Issued and  outstanding – 10,661,969, 1,863,212 and 1,883,969, respectively                            |       | 107                                      |       | 19                                       |       | 19                          |       |
| Additional paid-in capital                                                                                                                       |       | 68,832                                   |       | —                                   |       | —                      |       |
| Accumulated deficit                                                                                                                              |       | (14,110                                  | )          | (16,696                                  | )          | (17,955                     | )          |
| Total shareholders’ equity (deficit)                                                                                                        |       | 54,829                                   |       | (16,677                                  | )          | (17,936                     | )          |
| Total liabilities and shareholders’ equity  (deficit)                                                                                       |       | $                                        | 98,142     |                                     | $          | 64,594                      |       | $ | 65,137 |   |

 

NOTE: The Balance Sheet as of February 26, 2005,has been derived from the audited financial statements.

 

*See accompanying notes.*

 

3

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**GOLFGALAXY, INC.**

**STATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                           | ** ** | **Three Months Ended**      | ** ** | **Nine Months Ended**       | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **November 26,  2005** | ** ** | **November 27,  2004** | ** ** | **November 26,  2005** | ** ** | **November 27,  2004** | ** ** |
| ** **                                           | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                            |       | $                           | 31,800     |                        | $          | 20,281 |   | $ | 160,005 |   | $ | 106,240 |   |
| Cost of sales                                        |       | 23,915                      |       | 15,192                      |       | 111,822 |   | 74,713 |   |
| Gross profit                                         |       | 7,885                       |       | 5,089                       |       | 48,183 |   | 31,527 |   |
|                                                 |       |                        |       |                        |       |   |   |   |   |
| Operating expenses:                                  |       |                        |       |                        |       |   |   |   |   |
| Store operating                                      |       | 7,594                       |       | 4,793                       |       | 29,299 |   | 18,892 |   |
| General and administrative                           |       | 2,527                       |       | 2,520                       |       | 7,784 |   | 6,509 |   |
| Preopening                                           |       | 662                         |       | 599                         |       | 2,012 |   | 1,163 |   |
| Total operating expenses                             |       | 10,783                      |       | 7,912                       |       | 39,095 |   | 26,564 |   |
| (Loss) income from operations                        |       | (2,898                      | )          | (2,823                      | )          | 9,088 |   | 4,963 |   |
| Other income                                         |       | —                      |       | 8,410                       |       | — |   | 8,410 |   |
| Interest income (expense), net                       |       | 172                         |       | 11                          |       | 287 |   | (21 | ) |
| (Loss) income before income taxes                    |       | (2,726                      | )          | 5,598                       |       | 9,375 |   | 13,352 |   |
| Income tax benefit (expense)                         |       | 1,117                       |       | (2,247                      | )          | (3,844 | ) | (5,363 | ) |
| Net (loss) income                                    |       | (1,609                      | )          | 3,351                       |       | 5,531 |   | 7,989 |   |
| Less preferred stock dividends                       |       | —                      |       | (937                        | )          | (1,721 | ) | (2,757 | ) |
| Net (loss) income applicable to common  shareholders |       | $                           | (1,609     | )                           | $          | 2,414 |   | $ | 3,810 |   | $ | 5,232 |   |
| Net (loss) income per share:                         |       |                        |       |                        |       |   |   |   |   |
| Basic                                                |       | $                           | (0.15      | )                           | $          | 1.30 |   | $ | 0.66 |   | $ | 2.81 |   |
| Diluted                                              |       | $                           | (0.15      | )                           | $          | 0.43 |   | $ | 0.58 |   | $ | 1.04 |   |
| Weighted average number of shares  outstanding:      |       |                        |       |                        |       |   |   |   |   |
| Basic                                                |       | 10,653,135                  |       | 1,862,778                   |       | 5,768,834 |   | 1,862,223 |   |
| Diluted                                              |       | 10,653,135                  |       | 7,704,345                   |       | 9,480,569 |   | 7,703,790 |   |

 

*See accompanying notes.*

 

4

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**GOLFGALAXY, INC.**

**STATEMENTS OF CASH FLOWS**

***(In Thousands)***

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Nine Months Ended**       | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                         | ** ** | **November 26,  2005** | ** ** | **November 27,  2004** | ** ** |
| **Operating activities**                                                           |       |                        |       |   |   |
| Net income                                                                         |       | $                           | 5,531      |   | $ | 7,989 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                        |       |   |   |
| Realized gain on Golf Town Canada Inc.  stock                                      |       | —                      |       | (8,410 | ) |
| Depreciation and amortization                                                      |       | 3,714                       |       | 2,303 |   |
| Disposal of property and equipment                                                 |       | 15                          |       | 6 |   |
| Amortization of debt issuance costs                                                |       | 10                          |       | 16 |   |
| Noncash compensation                                                               |       | 81                          |       | — |   |
| Change in operating assets and liabilities:                                        |       |                        |       |   |   |
| Accounts receivable                                                                |       | (2,688                      | )          | (1,977 | ) |
| Inventories                                                                        |       | (12,890                     | )          | (3,704 | ) |
| Prepaid expenses and other                                                         |       | (1,168                      | )          | (266 | ) |
| Accounts payable                                                                   |       | 6,097                       |       | 1,442 |   |
| Accrued liabilities and other                                                      |       | 3,048                       |       | 3,796 |   |
| Net cash provided by operating activities                                          |       | 1,750                       |       | 1,195 |   |
| **Investing activities**                                                           |       |                        |       |   |   |
| Additions to property and equipment                                                |       | (7,940                      | )          | (4,921 | ) |
| Proceeds from sale of Golf Town Canada Inc.  stock                                 |       | —                      |       | 8,304 |   |
| Net cash (used in) provided by investing  activities                               |       | (7,940                      | )          | 3,383 |   |
| **Financing activities**                                                           |       |                        |       |   |   |
| Proceeds from the issuance of common stock                                         |       | 69                          |       | 8 |   |
| Credit facility issuance costs                                                     |       | —                      |       | (43 | ) |
| Payment of preferred stock dividends                                               |       | (19,562                     | )          | — |   |
| Proceeds from initial public offering, net                                         |       | 37,903                      |       | — |   |
| Net cash provided by (used in) financing  activities                               |       | 18,410                      |       | (35 | ) |
| Net increase in cash and cash equivalents                                          |       | 12,220                      |       | 4,543 |   |
| Cash and cash equivalents, beginning of  year                                      |       | 3,245                       |       | 4,943 |   |
| Cash and cash equivalents, end of quarter                                          |       | $                           | 15,465     |   | $ | 9,486 |   |
| **Supplemental disclosure of cash flow  information**                              |       |                        |       |   |   |
| Cash paid during the year for:                                                     |       |                        |       |   |   |
| Interest                                                                           |       | $                           | 2          |   | $ | 2 |   |
| Taxes                                                                              |       | $                           | 4,618      |   | $ | 3,537 |   |
| **Supplemental disclosure of non-cash  financing activities**                      |       |                        |       |   |   |
| Conversion of preferred stock into common  stock                                   |       | $                           | 30,900     |   | $ | — |   |

 

*Seeaccompanying notes.*

 

5

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**GOLFGALAXY, INC.**

**NOTESTO 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 financial statements and therelated notes should be read in conjunction with the annual financialstatements and notes included in the final prospectus relating to the Company’sinitial public offering (“IPO”), as filed with the Securities and ExchangeCommission (the “SEC”), which includes audited financial statements for each ofthe three fiscal years in the period ended February 26, 2005.

 

The preparation of financial statements in conformity withGAAP requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of net sales and expenses during the period. Ultimate results coulddiffer from those estimates.

 

**2. Initial Public Offering**

 

The Company completed its IPO, as of 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.

 

6

----

 

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.

 

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

 
| ** **                                                                                                 | ** ** | **Three Months Ended  (Unaudited)** | ** ** | **Nine Months Ended  (Unaudited)** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                 | ** ** | **November 26,  2005**         | ** ** | **November 27,  2004**        | ** ** | **November 26,  2005** | ** ** | **November 27,  2004** | ** ** |
| Net (loss) income applicable to common  shareholders                                                       |       | $                                   | (1,609     | )                                  | $          | 2,414 |   | $ | 3,810 |   | $ | 5,232 |   |
| Add stock-based compensation expense, net  of tax                                                          |       | 20                                  |       | —                             |       | 48 |   | — |   |
| Deduct total stock-based compensation  determined under fair-value-based method for all awards, net of tax |       | (96                                 | )          | (35                                | )          | (200 | ) | (107 | ) |
| Pro forma net (loss) income applicable to  common shareholders                                             |       | $                                   | (1,685     | )                                  | $          | 2,379 |   | $ | 3,658 |   | $ | 5,125 |   |
|                                                                                                       |       |                                |       |                               |       |   |   |   |   |
| Net (loss) income per share:                                                                               |       |                                |       |                               |       |   |   |   |   |
| Basic—as reported                                                                                     |       | $                                   | (0.15      | )                                  | $          | 1.30 |   | $ | 0.66 |   | $ | 2.81 |   |
| Basic—pro forma                                                                                       |       | $                                   | (0.16      | )                                  | $          | 1.28 |   | $ | 0.63 |   | $ | 2.75 |   |
| Diluted—as reported                                                                                   |       | $                                   | (0.15      | )                                  | $          | 0.43 |   | $ | 0.58 |   | $ | 1.04 |   |
| Diluted—pro forma                                                                                     |       | $                                   | (0.16      | )                                  | $          | 0.43 |   | $ | 0.57 |   | $ | 1.02 |   |
|                                                                                                       |       |                                |       |                               |       |   |   |   |   |
| Weighted Average Assumptions:                                                                              |       |                                |       |                               |       |   |   |   |   |
| Risk-free interest rate                                                                                    |       | 4.2                                 | %          | 3.4                                | %          |   |   |   |   |
| Expected dividends                                                                                         |       | —                              |       | —                             |       |   |   |   |   |
| Estimated average life                                                                                     |       | 5 years                             |       | 6 years                            |       |   |   |   |   |
| Volatility                                                                                                 |       | 50                                  | %          | —                             |       |   |   |   |   |

 

Thefair value of each option was estimated on the date of grant using the weightedaverage assumptions provided above. Prior to the Company’s IPO, fair value was estimated using the minimumvalue method. Subsequent to the IPO, the Company estimates the fair value ofeach option on the grant date using the Black-Scholes option-pricing model.Based on these assumptions, the estimated weighted average fair value of theoptions granted in the third quarter of fiscal 2006 and 2005 was $7.70 and$1.14, respectively.  Because of thelimited history of market trading in the Company’s common stock, estimatedvolatility for the third quarter of fiscal 2006 was based on an average of thevolatility reported by a peer group of publicly traded companies.

 

7

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### *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 tenyears after the date of grant.

 

Asof November 26, 2005 and February 26, 2005, there were 2,000,000common shares authorized for issuance under the Plans. Stock option activityunder the Plans was as follows:

 
| ** **                                      | ** ** | **Nine Months Ended  November 26, 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                                          |       | 351,000                                                    |       | 11.74                                         |       | 252,900 |   | 6.30 |   |
| Forfeited                                       |       | (24,050                                                    | )          | 7.21                                          |       | (32,075 | ) | 6.28 |   |
| Exercised                                       |       | (15,597                                                    | )          | 4.40                                          |       | (3,650 | ) | 5.91 |   |
| Outstanding, end of period                      |       | 1,226,628                                                  |       | 7.25                                          |       | 915,275 |   | 5.47 |   |
| Exercisable, end of period                      |       | 618,978                                                    |       | 5.25                                          |       | 525,706 |   | 4.86 |   |
| Weighted average fair value of options  granted |       | $                                                          | 4.68       |                                          |       |   | $ | 1.14 |   |   |   |
|                                                 |            |                                                            |            |                                               |            |  |  |  |  |  |  |  |  |

 

**4. Net (Loss) Income Per Share**

 

Basicnet (loss) income per share is computed based on the weighted average number ofcommon shares outstanding. Diluted net (loss) income per share is computedbased on the weighted average number of common shares outstanding adjusted bythe number of additional shares that would have been outstanding had allpotentially dilutive common shares been issued. Potentially dilutive shares ofcommon stock include certain common stock options, warrants and convertiblepreferred stock, depending on the estimated fair market value of the commonstock and amount of net income for the period measured.

 

Thefollowing table presents a reconciliation of the numerators and denominators ofbasic and diluted net (loss) income per share (in thousands, except share andper share amounts):

 
| ** **                                            | ** ** | **Three Months Ended  (Unaudited)** | ** ** | **Nine Months Ended  (Unaudited)** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                            | ** ** | **November 26,  2005**         | ** ** | **November 27,  2004**        | ** ** | **November 26,  2005** | ** ** | **November 27,  2004** | ** ** |
| Numerator:                                            |       |                                |       |                               |       |   |   |   |   |
| Net (loss) income applicable to common  shareholders  |       | $                                   | (1,609     | )                                  | $          | 2,414 |   | $ | 3,810 |   | $ | 5,232 |   |
| Add preferred stock dividends                         |       | —                              |       | 937                                |       | 1,721 |   | 2,757 |   |
| Numerator for diluted net (loss) income per  share    |       | $                                   | (1,609     | )                                  | $          | 3,351 |   | $ | 5,531 |   | $ | 7,989 |   |
| Denominator:                                          |       |                                |       |                               |       |   |   |   |   |
| Weighted average number of common shares  outstanding |       | 10,653,135                          |       | 1,862,778                          |       | 5,768,834 |   | 1,862,223 |   |
| Effect of dilutive securities:                        |       |                                |       |                               |       |   |   |   |   |
| Outstanding stock options and warrants                |       | —                              |       | 89,100                             |       | 508,896 |   | 89,100 |   |
| Convertible preferred stock                           |       | —                              |       | 5,752,467                          |       | 3,202,839 |   | 5,752,467 |   |
| Denominator for diluted net (loss) income  per share  |       | 10,653,135                          |       | 7,704,345                          |       | 9,480,569 |   | 7,703,790 |   |
| Net (loss) income per share:                          |       |                                |       |                               |       |   |   |   |   |
| Basic                                                 |       | $                                   | (0.15      | )                                  | $          | 1.30 |   | $ | 0.66 |   | $ | 2.81 |   |
| Diluted                                               |       | $                                   | (0.15      | )                                  | $          | 0.43 |   | $ | 0.58 |   | $ | 1.04 |   |

 

8

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**5. Employee Benefit Plan**

 

The Company has a defined contribution 401(k) profitsharing plan (the “Plan”) for eligible employees, which is qualified underSections 401(a) and 401(k) of the Internal Revenue Code of 1986. Employeesare entitled to make tax-deferred contributions of up to 75% of their eligiblecompensation. Effective July 1, 2005, the Company began matching 50% of thefirst 4% of eligible compensation contributed to the Plan by each participant.The Company’s matching contributions vest after four years of service, at age59 1/2 regardless of service or upon the death of the employee. The Company’smatching contributions to the Plan for the third quarter and first nine monthsof fiscal 2006 were $24,000 and $40,000, respectively. The Company did not makeany matching contributions to the Plan during either of the correspondingperiods of fiscal 2005. Future matching contributions to the Plan are at theCompany’s sole discretion.

 

**6. Golf Town Canada Inc.**

 

In 1998, the Company entered into a consultingagreement to assist in the development of Golf Town Canada Inc. (Golf TownCanada), a golf retailer based in Canada. Under the agreement, the Companyreceived payments in certain years related to consulting services and the useof certain advertising resources. The payments were not material to thefinancial results of the Company. In addition, the consulting agreement providedthe Company with a minority equity interest in Golf Town Canada and a positionon its Board of Directors. The equity interest was accounted for on a costbasis and was not material to the Company’s financial statements.

 

During the Company’s third quarter of fiscal 2005,Golf Town Canada sold all of its assets to the newly formed Golf Town CanadaIncome Fund as part of its initial public offering as a Canadian income fund.As part of the transaction, the Company surrendered its entire equity interest inGolf Town Canada for cash, resulting in a net realized gain before income taxesof $8.4 million. The Company has no further service obligations with regards toGolf Town Canada and no longer holds a position on its Board of Directors. Aspart of an agreement between the companies, there are restrictions on theCompany’s ability to open retail stores in Canada until 2008 and Golf TownCanada’s ability to open retail stores in the United States until 2013.

 

**7. NewAccounting Pronouncements**

 

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued a revision to SFAS No. 123,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.The Company will be required to implement the provisions of SFAS No. 123(R)beginning in the first quarter of fiscal 2007. The Company is currentlyevaluating option valuation methodologies and assumptions. The Company expectsto record substantial non-cash compensation expense in future periods as aresult of the adoption of SFAS No. 123(R), which will have a significantadverse impact on our results of operations.

 

In June 2005, the FASB’sEmerging Issues Task Force (“EITF”) reached a consensus on Issue No. 05-6,*Determining the Amortization Period forLeasehold Improvements Purchased after Lease Inception or Acquired in aBusiness Combination* (EITF No. 05-6). EITF No. 05-6requires leasehold improvements in operating leases that are either acquiredafter the beginning of the initial lease term or acquired as the result of abusiness combination to be amortized over the shorter of the assets’ usefullife or a term that includes the original lease term plus any renewals that arereasonably assured at the date the leasehold improvements are purchased. EITF No. 05-6 was effective for reporting periods beginning after June 29,2005. The adoption of EITF No. 05-6 did not have a material impact onthe Company’s net income, cash flows or financial position.

 

On October 6, 2005, theFASB issued FASB Staff Position (“FSP”) 13-1, *Accountingfor Rental Costs Incurred During a Construction Period*. FSP 13-1requires that rental costs associated with ground or building operating leasesthat are incurred during a construction period be recognized as rental expense.FSP 13-1 is effective for the first reporting period after December 15,2005. The Company has historically expensed rental costs incurred during aconstruction period; therefore, the adoption of this FSP will not have animpact on the Company’s net income, cash flows or financial position.

 

9

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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. In the current fiscal year, we have opened 15new stores, including four stores opened late in the fiscal third quarter. Asof November 26, 2005, we operated 49 superstores, generally ranging from13,000 to 18,000 selling square feet, located in 23 primarily northern andmidwestern states. Our “*Everything for theGame.®*” core strategy is to provide avid and casual golfers, as wellas gift purchasers, a category dominant selection of leading national brandproducts, expert sales assistance and professional services, the combination ofwhich is generally not available elsewhere. We offer our customers an exciting,interactive environment that compares favorably with the shopping experience atsmaller independent golf stores, on-course pro shops and the golf departmentsof general sporting goods retailers.

 

Wecompleted an initial public offering of our common stock on August 3,2005, selling 3,000,000 shares at an offering price of $14.00 per shareresulting in gross proceeds of $42.0 million. Our stock trades on the NasdaqNational Market under the ticker symbol “GGXY.” As part of the offering, all ofthe outstanding preferred stock converted into 5,752,467 shares of our commonstock, of which 1,542,500 were sold in the initial public offering, resultingin a total offering of 4,542,500 shares. After deducting the underwritingdiscounts and commissions, and other offering expenses, we received netproceeds from our initial public offering of $37.9 million. We used $19.6million of the net proceeds to pay our preferred shareholders all of the accruedand unpaid dividends due upon conversion of their shares of preferred stockinto shares of our common stock. We expect to use the remaining net proceedsfrom the offering to continue to open new retail stores and for generalcorporate 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.

 

We believe the interim financial statements filed inthis Form 10-Q and the discussions contained herein should be read inconjunction with the annual financial statements and notes included in thefinal prospectus relating to our initial public offering, as filed with SEC, whichincludes audited financial statements for each of the three fiscal years in theperiod 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**      | ** ** | **Nine Months Ended**       | ** ** |
|-------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                          | ** ** | **November 26,  2005** | ** ** | **November 27,  2004** | ** ** | **November 26,  2005** | ** ** | **November 27,  2004** | ** ** |
| **Statements of Operations Data**   |       |                        |       |                        |       |   |   |   |   |
| Net sales                           |       | 100.0                       | %          | 100.0                       | %          | 100.0 | % | 100.0 | % |
| Cost of sales                       |       | 75.2                        | %          | 74.9                        | %          | 69.9 | % | 70.3 | % |
| Gross profit                        |       | 24.8                        | %          | 25.1                        | %          | 30.1 | % | 29.7 | % |
| Store operating expenses            |       | 23.9                        | %          | 23.6                        | %          | 18.3 | % | 17.8 | % |
| General and administrative expenses |       | 7.9                         | %          | 12.4                        | %          | 4.9 | % | 6.1 | % |
| Preopening expenses                 |       | 2.1                         | %          | 3.0                         | %          | 1.2 | % | 1.1 | % |
| (Loss) income from operations       |       | (9.1                        | )%         | (13.9                       | )%         | 5.7 | % | 4.7 | % |
| Other income                        |       | 0.0                         | %          | 41.5                        | %          | 0.0 | % | 7.9 | % |
| Interest income (expense), net      |       | 0.5                         | %          | 0.0                         | %          | 0.2 | % | 0.0 | % |
| (Loss) income before income taxes   |       | (8.6                        | )%         | 27.6                        | %          | 5.9 | % | 12.6 | % |
| Income tax benefit (expense)        |       | 3.5                         | %          | (11.1                       | )%         | (2.4 | )% | (5.1 | )% |
| Net (loss) income                   |       | (5.1                        | )%         | 16.5                        | %          | 3.5 | % | 7.5 | % |

 

Net sales consist of sales, net of returns, from comparablestores and new stores, as well as sales from our eCommerce operations, which welaunched in March 2004. A new or relocated store is included in comparablestore results after it has been in operation for 12 full fiscal monthsfollowing the month of the store’s grand opening weekend, typically a store’s13th full month of operations. Sales from our eCommerce operations are notincluded in comparable store results. New store sales include all sales fromstores that have not yet become comparable stores.

 

10

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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 Nine Months Ended November 26, 2005compared with Three and Nine Months Ended November 27, 2004**

 

***Net Sales.***  Net sales for the third quarter of fiscal2006 were $31.8 million, an increase of $11.5 million, or 56.7%, comparedwith net sales of $20.3 million for the third quarter of fiscal 2005. Theincrease in net sales for the fiscal third quarter resulted primarily from$9.7 million in sales from new stores opened in the current or priorfiscal year, before becoming comparable stores, and a comparable store salesgain of $1.3 million, or 6.7%. Net sales for the first nine months offiscal 2006 were $160.0 million, an increase of $53.8 million, or50.7%, compared with net sales of $106.2 million for the first nine monthsof the prior fiscal year. The increase in net sales for the nine-month periodresulted primarily from $43.0 million in net sales from new stores openedin the current or prior fiscal year, before becoming comparable stores, and acomparable store sales gain of $8.6 million, or 8.4%. The increase incomparable store sales for both the third quarter and first nine months offiscal 2006 was attributable primarily to increased sales of golf clubs, whichwas driven by several new product introductions. Increased sales of golf ballsand apparel, resulting from merchandising focus on these product groups, alsocontributed to the comparable store sales gains.

 

***Gross Profit.***  Grossprofit increased by $2.8 million, or 54.9%, to $7.9 million for the thirdquarter of fiscal 2006, up from $5.1 million for the third quarter offiscal 2005. The gross profit rate decreased by 0.3% of net sales to 24.8% ofnet sales for the third quarter of fiscal 2006, compared with 25.1% of netsales for the third quarter of the prior fiscal year. For the first nine monthsof fiscal 2006 gross profit increased by $16.7 million, or 53.0%, to$48.2 million, up from $31.5 million for the same period of fiscal2005. The gross profit rate for the first nine months of fiscal 2006 increasedby 0.4% of net sales to 30.1% of net sales, compared with 29.7% of net salesfor the first nine months of the prior fiscal year. The decrease in our grossprofit rate for the fiscal third quarter was due to increased promotionalactivity, the timing of clearance inventory markdowns and higher freight costs,partially offset by increases in vendor allowances and a more profitable salesmix. The increase in our gross profit rate for the first nine months of fiscal2006 was due primarily to increases in vendor allowances and higher retailmargins, and was partially offset by higher freight costs.

 

***Store Operating Expenses.***  Storeoperating expenses for the third quarter of fiscal 2006 were $7.6 million,an increase of $2.8 million, or 58.3%, compared with store operating expensesof $4.8 million for the third quarter of fiscal 2005. The store operatingexpenses rate for the third quarter of fiscal 2006 increased to 23.9% of netsales, up from 23.6% of net sales for the third quarter of fiscal 2005. For thefirst nine months of fiscal 2006, store operating expenses increased by$10.4 million, or 55.0%, to $29.3 million, up from $18.9 millionfor the first nine months of fiscal 2005. The store operating expenses rate forthe nine-month period ended November 26, 2005, increased by 0.5% of netsales to 18.3% of net sales, compared with 17.8% of net sales for thenine-month period ended November 27, 2004. The increase in store operatingexpenses as a percentage of net sales for the third quarter of fiscal 2006,compared with the same period of the prior fiscal year, related primarily tothe timing of certain holiday season advertising expenses. The increase for thenine-month period was due primarily to new stores opened in the current orprior fiscal year. New stores generally have higher operating expenses as apercentage of net sales in comparison to mature stores due to the impact of apartial year of net sales in the year opened and because mature storesgenerally have higher sales volumes. Due to our anticipated store growth andthe high percentage of new stores in our store base, we expect store operatingexpenses as a percentage of net sales to continue to grow modestly through thenext year when compared with prior periods.

 

11

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***General and Administrative Expenses.*** General and administrative expenses were $2.5 million for the thirdquarter of fiscal 2006, essentially flat when compared with the third quarterof fiscal 2005. As a percentage of net sales, general and administrativeexpenses decreased to 7.9% for the third quarter of fiscal 2006, down from12.4% of net sales for the third quarter of fiscal 2005. For the first ninemonths of fiscal 2006, general and administrative expenses were$7.8 million, an increase of $1.3 million, or 20.0%, compared with$6.5 million for the same period of fiscal 2005. General andadministrative expenses as a percentage of net sales decreased to 4.9% for thefirst nine months of fiscal 2006, down from 6.1% of net sales for the firstnine months of the prior fiscal year. For both the third quarter and first ninemonths of fiscal 2006, compared with the corresponding periods of fiscal 2005,general and administrative expenses as a percentage of net sales benefited fromleverage achieved through net sales increasing at a faster rate than the growthof our payroll and payroll-related costs. The leverage of our payroll andpayroll-related costs in the current year was partially offset by additionaloperating costs related to becoming a public company. In addition, anonrecurring discretionary bonus awarded during the third quarter of fiscal2005 as a result of completing the sale of our investment in Golf Town CanadaInc. stock increased general and administrative expenses as a percentage of netsales for the third quarter of fiscal 2005.

 

***Preopening Expenses.*** Preopening expenses were $662,000 for the third quarter of fiscal 2006,an increase of $63,000, compared with $599,000 for the same period of fiscal2005. Preopening expenses increased by $0.8 million to $2.0 millionfor the first nine months of fiscal 2006, up from $1.2 million for the firstnine months of the prior fiscal year. The increase was related primarily toopening 15 new stores during the first nine months of fiscal 2006, comparedwith eight new store openings during the corresponding period of fiscal 2005.

 

***Other income.***Other income of $8.4 million for the threeand nine months ended November 27, 2004 represents the pre-tax gainrealized on the sale of our entire equity investment in Golf Town Canada Inc.

 

***Net Interest Income (Expense).***  Netinterest income was $172,000 for the third quarter of fiscal 2006, comparedwith $11,000 for the third quarter of fiscal 2005. For the first nine months offiscal 2006, we reported net interest income of $287,000, compared with netinterest expense of $21,000 for the same period of fiscal 2005. The change forboth the fiscal third quarter and nine-month period was due primarily tointerest income earned on the net proceeds from our initial public offering.

 

***Income Tax Benefit (Expense).***  Werecorded an income tax benefit of $1.1 million for the third quarter offiscal 2006, compared with an income tax provision of $2.2 million for thethird quarter of fiscal 2005. The income tax benefit for the third quarter offiscal 2006 was based on an estimated effective income tax rate of 41.0%, whilethe income tax provision for the third quarter of fiscal 2005 was based on anestimated effective income tax rate of 40.1%. We recorded income tax provisionsof $3.8 million and $5.4 million, respectively, for the first nine months offiscal 2006 and fiscal 2005, respectively. The income tax provisions for thefirst nine months of fiscal 2006 and fiscal 2005 were based on estimatedeffective annual income tax rates of 41.0% and 40.2%, respectively. The changein the effective income tax rates for both the third quarter and first ninemonths of fiscal 2006 was due primarily to fluctuations in the impact of stateincome taxes.

 

***Net (Loss) Income.***  We reported a net loss of $1.6 million forthe third quarter of fiscal 2006, compared with net income of $3.4 million forthe third quarter of fiscal 2005. Net income for the first nine months offiscal 2006 was $5.5 million, compared with $8.0 million for the first ninemonths of the prior fiscal year. As noted above, our results for the three andnine month periods ended November 27, 2004, included a nonrecurring pre-taxgain of $8.4 million, or $5.0 million after-tax, realized on the sale of ourequity investment in Golf Town Canada Inc. stock.

 

***Pro-Forma Net (Loss) Income PerShare.*** Pro-forma net (loss) income per share ispresented as if our initial public offering had occurred immediately prior tothe beginning of each period presented. In addition, pro-forma results for thethree and nine months ended November 27, 2004, exclude a nonrecurringafter-tax gain of $5.0 million realized on the sale of our equity investment inGolf Town Canada Inc. stock. We believe the use of pro-forma net (loss) incomeper share provides a consistent measure of profitability as well as importantsupplemental information due to the significant increase in common sharesoutstanding resulting from the completion of our initial public offering andthe conversion of the convertible preferred stock into shares of common stockas of August 3, 2005.  Pro-forma net(loss) income per share is considered a non-GAAP financial measure and is not inaccordance with, or preferable to, the ratio determined in accordance withGAAP. Pro-forma net (loss) income per share is intended to be a supplement, butnot as a substitute for financial information prepared in accordance with GAAP.Further, pro-forma net (loss) income per share, as we define it, may not becomparable to a similarly titled measure used by other companies. The mostdirectly comparable GAAP financial measure to pro-forma net (loss) income pershare is net (loss) income per share.

 

12

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The following table presents areconciliation of the numerator and denominator used in the calculation ofpro-forma net (loss) income per share (in thousands, except share and per shareamounts):

 
| ** **                                                       | ** ** | **Three Months Ended  (Unaudited)** | ** ** | **Nine Months Ended  (Unaudited)** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                       | ** ** | **November 26,  2005**         | ** ** | **November 27,  2004**        | ** ** | **November 26,  2005** | ** ** | **November 27,  2004** | ** ** |
| **Pro-Forma Information**                                        |       |                                |       |                               |       |   |   |   |   |
| Pro-forma net (loss) income applicable to  common shareholders   |       | $                                   | (1,609     | )                                  | $          | (1,683 | ) | $ | 5,531 |   | $ | 2,955 |   |
| Pro-forma net  (loss) income per share:                          |       |                                |       |                               |       |   |   |   |   |
| Basic                                                            |       | $                                   | (0.15      | )                                  | $          | (0.16 | ) | $ | 0.52 |   | $ | 0.28 |   |
| Diluted                                                          |       | $                                   | (0.15      | )                                  | $          | (0.16 | ) | $ | 0.50 |   | $ | 0.28 |   |
| Pro-forma weighted average number of shares  outstanding:        |       |                                |       |                               |       |   |   |   |   |
| Basic                                                            |       | 10,653,135                          |       | 10,615,245                         |       | 10,642,003 |   | 10,614,690 |   |
| Diluted                                                          |       | 10,653,135                          |       | 10,615,245                         |       | 11,150,899 |   | 10,703,790 |   |
|                                                             |       |                                |       |                               |       |   |   |   |   |
| **Reconciliation of pro-forma information to  GAAP**             |       |                                |       |                               |       |   |   |   |   |
| Net (loss) income applicable to common  shareholders (GAAP)      |       | $                                   | (1,609     | )                                  | $          | 2,414 |   | $ | 3,810 |   | $ | 5,232 |   |
| Gain on sale of Golf Town Canada Inc.  stock, net of tax         |       | —                              |       | (5,034                             | )          | — |   | (5,034 | ) |
| Preferred stock dividends                                        |       | —                              |       | 937                                |       | 1,721 |   | 2,757 |   |
| Net (loss) income applicable to common  shareholders (pro-forma) |       | $                                   | (1,609     | )                                  | $          | (1,683 | ) | $ | 5,531 |   | $ | 2,955 |   |
| ***Basic***                                                      | * *   | * *                            | * *   | * *                           | * *   | * * | * * | * * | * * |
| Weighted average number of shares  outstanding (GAAP)            |       | 10,653,135                          |       | 1,862,778                          |       | 5,768,834 |   | 1,862,223 |   |
| Conversion of preferred stock to common                          |       | —                              |       | 5,752,467                          |       | 3,202,839 |   | 5,752,467 |   |
| Weighted average additional shares issued  in IPO                |       | —                              |       | 3,000,000                          |       | 1,670,330 |   | 3,000,000 |   |
| Weighted average number of shares  outstanding (pro-forma)       |       | 10,653,135                          |       | 10,615,245                         |       | 10,642,003 |   | 10,614,690 |   |
| ***Diluted***                                                    |       |                                |       |                               |       |   |   |   |   |
| Weighted average number of shares  outstanding (GAAP)            |       | 10,653,135                          |       | 7,704,345                          |       | 9,480,569 |   | 7,703,790 |   |
| Weighted average additional shares issued  in IPO                |       | —                              |       | 3,000,000                          |       | 1,670,330 |   | 3,000,000 |   |
| Weighted average shares deemed antidilutive  (1)                 |       | —                              |       | (89,100                            | )          | — |   | — |   |
| Weighted average number of shares  outstanding (pro-forma)       |       | 10,653,135                          |       | 10,615,245                         |       | 11,150,899 |   | 10,703,790 |   |

 

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(1)     The computation of pro-forma diluted net (loss) income per share forthe third quarter of fiscal 2005 excludes the impact of potentially dilutivesecurities that were includedin the computation of diluted earnings per share in accordance with GAAP forthe same period. The potentially dilutive securities were excluded from thecomputation of pro-forma diluted net(loss) income per share sincethe effect would be antidilutive (i.e., including potentially dilutivesecurities would reduce the pro-forma loss per share).

 

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 three 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** | ** ** | **Quarter Ended  Nov. 26, 2005** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **($ in thousands, except per share data)** | ** ** | ** ** | ** ** |
| **Statement of Operations Data**          |       |                                             |       |   |   |   |   |   |   |
| Net sales                                 |       | $                                                | 58,570     |   | $ | 69,635 |   | $ | 31,800 |   |   |   |
| Gross profit                              |       | 18,228                                           |       | 22,070 |   | 7,885 |   |   |   |
| Gross profit as a percentage of net sales |       | 31.1                                             | %          | 31.7 | % | 24.8 | % |   |   |
| Store operating expenses                  |       | 10,932                                           |       | 10,773 |   | 7,594 |   |   |   |
| General and administrative expenses       |       | 3,102                                            |       | 2,155 |   | 2,527 |   |   |   |
| Preopening expenses                       |       | 1,310                                            |       | 40 |   | 662 |   |   |   |
| Income (loss) from operations             |       | 2,884                                            |       | 9,102 |   | (2,898 | ) |   |   |
| Other Income                              |       | —                                           |       | — |   | — |   |   |   |
| Income (loss) before income taxes         |       | 2,899                                            |       | 9,202 |   | (2,726 | ) |   |   |
| Net income (loss)                         |       | $                                                | 1,693      |   | $ | 5,447 |   | $ | (1,609 | ) |   |   |
| Basic net income (loss) per share         |       | $                                                | 0.37       |   | $ | 0.98 |   | $ | (0.15 | ) |   |   |
| Diluted net income (loss) per share       |       | $                                                | 0.21       |   | $ | 0.59 |   | $ | (0.15 | ) |   |   |
| Comparable store sales increase (2)       |       | 10.5                                             | %          | 7.4 | % | 6.7 | % |   |   |
| Stores opened during the period           |       | 11                                               |       | — |   | 4 |   |   |   |
| Number of stores at end of period         |       | 45                                               |       | 45 |   | 49 |   |   |   |
| Selling square feet at end of period      |       | 671,953                                          |       | 671,953 |   | 727,112 |   |   |   |

 

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

 

(2)     A new or relocated store is included in the comparable store base afterit has been in operation for 12 full fiscal months following the month of thestore’s grand opening weekend. A store that is closed for remodel or repair isexcluded from the comparable store sales calculation during the period ofclosure and the comparable period of the succeeding year. Sales from oureCommerce operations are not included in the comparable store salescalculation. Comparable store results for a 53-week fiscal year are presentedon 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 primary source of working capital liquidity is cash provided by operations.We also have availability for borrowing, if necessary, under our creditfacility. We plan to finance the capital requirements of our continued storeexpansion with the net proceeds from our initial public offering. Historically,our main source of capital for store growth has been the proceeds from ourequity financings.

 

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

 
| ** **                                           | ** ** | **Nine Months Ended**       | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **November 26,  2005** | ** ** | **November 27,  2004** | ** ** |
| Net cash provided by operating activities            |       | 1,750                       |       | 1,195 |   |
| Net cash (used in) provided by investing  activities |       | (7,940                      | )          | 3,383 |   |
| Net cash provided by (used in) financing  activities |       | 18,410                      |       | (35 | ) |
| Net increase in cash and cash equivalents            |       | $                           | 12,220     |   | $ | 4,543 |   |
|                                                      |            |                             |            |  |  |  |  |

 

Net cash provided by operating activities was $1.8 million for thefirst nine months of fiscal 2006, compared with $1.2 million for the first ninemonths of fiscal 2005. Excluding income taxes of $3.4 million in fiscal 2005from the gain on the sale of our equity investment in Golf Town Canada Inc., netcash provided by operating activities for the first nine months of fiscal 2006decreased $2.8 million compared with the same period of the prior fiscalyear.  The decrease in cash provided byoperating activities, excluding the tax effect of the Golf Town gain, was dueprimarily to increased inventory levels resulting from store growth, partiallyoffset by a related increase in accounts payable.

 

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Net cash used in investing activities was $7.9 million for the firstnine months of fiscal 2006, compared with net cash provided by investingactivities of $3.4 million for the same period of fiscal 2005. Net cash used ininvesting activities consists principally of investments in leaseholdimprovements and fixtures associated with new store openings. Net cash providedby investing activities for the first nine months of fiscal 2005 includedpre-tax proceeds of $8.3 million from our sale of Golf Town Canada Inc.stock.  Cash used to fund the additionsof property and equipment increased $3.0 million for the first nine months offiscal 2006 compared with the same period of fiscal 2005, reflecting theopening of 15 new stores in the current year compared with eight new storesopened during the same period of fiscal 2005.

 

Netcash provided by financing activities was $18.4 million for the first ninemonths of fiscal 2006 compared with net cash used in financing activities of$35,000 for the same period of the prior fiscal year. The change was dueprimarily to the net proceeds received upon the completion of our initialpublic offering during the second quarter of fiscal 2006, reduced by $19.6million used to pay preferred shareholders all of the accrued and unpaiddividend due upon the conversion of preferred stock into shares of our commonstock.

 

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 of credit. At ouroption, the credit facility can be expanded to $20.0 million. Borrowingsunder the credit facility are secured by our inventories, accounts receivable,and financial and intangible assets. Availability under the credit facility iscalculated on the basis of eligible inventory and accounts receivable, net ofspecified reserves, and less any outstanding letters of credit. Interest on anyoutstanding indebtedness under our credit facility accrues at the prime lendingrate or an adjusted LIBOR as defined in the agreement for the credit facility.There were no outstanding borrowings on our credit facility as of November 26,2005, November 27, 2004 or February 26, 2005.

 

Ourfuture capital requirements for store growth will primarily depend on thenumber of new stores we open and the timing of those openings within a givenfiscal year. These requirements will include investments and costs directlyrelated to opening new stores and may also include costs necessary to ensurethat our infrastructure is able to support a larger store base. Additionalcapital may also be needed in the future to remodel or relocate existingstores. Based on our current plans for store growth, we expect to fund ouranticipated capital requirements through cash provided by operations and thenet proceeds from our initial public offering.

 

**Off-Balance-Sheet Arrangements and ContractualObligations**

 

Welease our retail store locations, office space and certain office equipmentprimarily through operating leases. Our liquidity is not dependent on the useof off-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.

 

**Critical Accounting 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,estimates and judgments on historical experience, current trends and otherfactors that we believe to be relevant at the time the consolidated financialstatements are prepared. On a regular basis, we review our accounting policies,assumptions, estimates and judgments to ensure that our financial statementsare presented fairly and in accordance with GAAP. However, because futureevents and their effects cannot be determined with certainty, actual resultscould differ from our assumptions and estimates, and such differences could bematerial.

 

Oursignificant accounting policies are discussed in the “Notes to UnauditedFinancial Statements” included in this Quarterly Report on Form 10-Q andshould be 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.

 

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**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. Companies are required to recognize an expense for compensationcost related to all stock-based payment arrangements, including stock options.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.We will be required to implement the provisions of SFAS No. 123(R)beginning in the first quarter of fiscal 2007. SFAS No. 123(R) eliminatesthe ability to account for stock-based compensation transactions using theintrinsic value method under Accounting 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. We currently account for stock-based payments toemployees using APB Opinion No. 25’s intrinsic value method and, as such,generally recognize no compensation cost for employee stock options.Accordingly, the adoption of SFAS No. 123(R)’s fair-value-based methodwill have a significant adverse impact on our results of operations, althoughit will have no impact on our overall cash flows. While we expect that we willrecord substantial non-cash compensation expense as a result of the adoption ofSFAS No. 123(R) and that our results of operations will be significantlyadversely affected, the impact of adoption of SFAS No. 123(R) cannot bepredicted with more specificity at this time because it will depend on theoption methodology adopted, the assumptions utilized and the levels of stockbased payments granted in the future.

 

In June 2005, the FASB’sEmerging Issues Task Force (“EITF”) reached a consensus on Issue No. 05-6,*Determining the Amortization Period forLeasehold Improvements Purchased after Lease Inception or Acquired in aBusiness Combination* (EITF No. 05-6). EITF No. 05-6requires leasehold improvements in operating leases that are either acquiredafter the beginning of the initial lease term or acquired as the result of abusiness combination to be amortized over the shorter of the assets’ usefullife or a term that includes the original lease term plus any renewals that arereasonably assured at the date the leasehold improvements are purchased. EITF No. 05-6 was effective for reporting periods beginning after June 29,2005. The adoption of EITF No. 05-6 did not have a material impact onour net income, cash flows or financial position.

 

OnOctober 6, 2005, the FASB issued FASB Staff Position (“FSP”) 13-1, *Accounting for Rental Costs Incurred During aConstruction Period*. FSP 13-1 requires that rental costs associatedwith ground or building operating leases that are incurred during a constructionperiod be recognized as rental expense. FSP 13-1 is effective for the firstreporting period after December 15, 2005. We have historically expensedrental costs incurred during a construction period; therefore, the adoption ofthis FSP will not have an impact on our net income, cash flows or financialposition.

 

**Outlook**

 

Inconjunction with our earnings announcement for the fiscal third quarter on December 20,2005, we provided an updated outlook for both the fourth quarter and the fiscalyear ending February 25, 2006. For our fiscal fourth quarter, we areexpecting net sales of $40 million to $42 million, an increase of 49% to 57%over the fourth quarter of fiscal 2005. We are anticipating a comparable storesales gain in the mid-single digits for the fiscal fourth quarter. Finally, weare projecting a net loss for the fiscal fourth quarter of $900,000 to$600,000. For the fiscal year, we anticipate net sales of $200 million to $202million, which would represent an increase of 50% to 52% over fiscal 2005.Comparable store sales are expected to increase 6% to 8% for the full fiscalyear, consistent with our previous guidance. Net income for the fiscal year isprojected to be $4.6 million to $4.9 million. We expect to open one more storeduring the fiscal fourth quarter, which would bring our total new storeopenings to 16 for fiscal 2006. We also reiterated our plan to open 14 to 16new stores during fiscal 2007.

 

**A Special Note RegardingForward-Looking Statements**

 

This Quarterly Report on Form 10-Q (the “Report”)contains forward-looking statements that are based on our beliefs, assumptionsand expectations of future events taking into account the information currentlyavailable to us. All statements other than statements of historical factcontained in this Report are forward-looking statements. These statementsinvolve known and unknown risks, uncertainties and other factors that may causeour actual results, performances, financial condition or achievements to differmaterially from the expected future results, performances, financial conditionor achievements as expressed or implied in any forward-looking statements. Insome cases 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.

 

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The following factors, among others, could cause ouractual financial performance to differ materially from that expressed in anyforward-looking statement: a decline in the popularity of golf or golf-relatedproducts and services; limitations imposed by suppliers on the amount orvariety of products; failure by suppliers to develop and introduce new productsor if new products result in excessive close-outs of existing inventories;seasonal fluctuation in demand for products; weather conditions; the ability toimplement successfully our growth plan; competition in the golf and sportinggoods industry; a decline in discretionary spending; availability of adequatecapital to fund growth; and loss of key management. The foregoing list shouldnot be construed as exhaustive. Additional information concerning these andother factors that could cause actual results to differ materially from thosein the forward-looking statements contained herein is included in theprospectus in our Form S-1 Registration Statement filed with theSecurities and Exchange Commission.

 

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

 

**Item 3. Quantitative and Qualitative Disclosures AboutMarket Risk.**

 

Historically, we have borrowed under our revolvingcredit facility for seasonal liquidity needs. We have had no borrowings underthe credit facility during fiscal 2006. 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 November 26, 2005 and November 27, 2004, we didnot have any borrowings outstanding under our credit facility, although anyborrowings would have had an interest rate of 7.0% and 5.0% per annum,respectively. As we did not have any outstanding borrowings at November 26,2005 and November 27, 2004, there would have been no effect on our (loss)income before income taxes if interest rates were to increase by 100 basispoints. We do not anticipate borrowing under the revolving credit facility inthe near-term. We are not a party to any derivative financial instruments.

 

**Item 4.  Controls and Procedures.**

 

As of the end of the period covered by this Report,we conducted an evaluation, under the supervision and with the participation ofour principal executive officer and principal financial and accounting officer,of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act).  Based on this evaluation, ourprincipal executive officer and principal financial and accounting officerconcluded that our disclosure controls and procedures are effective to ensurethat information required to be disclosed by us in reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in SEC rules and forms.

 

There have been no changes in internal control overfinancial reporting during the quarter ended November 26, 2005 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

#### **PART II—OTHERINFORMATION**

#### ** **

**Item 2. Unregistered Sales of Equity Securitiesand Use of Proceeds.**

 

OnAugust 3, 2005, we completed an initial public offering of our commonstock pursuant to a registration statement on Form S-1 (File No. 333-125007)that was declared effective by the Securities and Exchange Commission on July 28,2005 and resulted in net proceeds to the Company of $37.9 million.

 

#### **Since the completion of the offering, we haveused approximately $19.6 million of the net proceeds to pay our preferredshareholders all of the accrued and unpaid dividends due upon the conversion oftheir shares of preferred stock into shares of our common stock. An additional$4.4 million of the net proceeds has been used to fund capital investments atnew stores. The remaining net proceeds are expected to be used to open newretail stores and for general corporate purposes.**

 

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

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                   |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                        |
| 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**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                      | GOLF GALAXY, INC.                                  |
|---------------------------|----------------------------------------------------|
|                      | (Registrant)                                       |
|                      |                                               |
| Date January 9, 2006 | /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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