e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 |
For the quarterly period ended October 1, 2005
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 |
For the transition period from to
Commission file number 333-101117
GOLFSMITH INTERNATIONAL HOLDINGS, INC.
(Exact Name of Registrant as Specified in Its Charter)
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Delaware
(State or Other Jurisdiction of Incorporation or Organization)
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16-1634897
(I.R.S. Employer
Identification No.) |
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11000 N. IH-35, Austin, Texas
(Address of Principal Executive Offices)
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78753
(zip code) |
Registrants Telephone Number, Including Area Code: (512) 837-8810
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date.
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Class of Common Stock
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Outstanding at November 11, 2005 |
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$.001 par value
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21,594,597 Shares |
GOLFSMITH INTERNATIONAL HOLDINGS, INC.
QUARTERLY REPORT
FOR THE QUARTER ENDED OCTOBER 1, 2005
TABLE OF CONTENTS
2
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Golfsmith International Holdings, Inc.
Consolidated Balance Sheets
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October 1, |
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January 1, |
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2005 |
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2005 |
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(Unaudited) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
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$ |
8,574,966 |
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Receivables, net of allowances of $147,139 at October 1, 2005
and $161,838 at January 1, 2005 |
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1,349,955 |
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854,555 |
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Inventories, net of reserves of $3,048,706 at October 1, 2005
and $1,385,650 at January 1, 2005 |
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63,784,718 |
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54,197,532 |
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Prepaid and other current assets |
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6,458,149 |
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6,405,525 |
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Total current assets |
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71,592,822 |
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70,032,578 |
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Property and equipment: |
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Land and buildings |
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21,246,109 |
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21,133,430 |
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Equipment, furniture, fixtures and autos |
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18,231,807 |
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15,174,320 |
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Leasehold improvements and construction in progress |
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19,351,253 |
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15,247,612 |
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58,829,169 |
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51,555,362 |
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Less: accumulated depreciation |
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(13,713,421 |
) |
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(10,647,641 |
) |
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Net property and equipment |
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45,115,748 |
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40,907,721 |
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Goodwill |
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41,634,525 |
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41,634,525 |
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Tradename |
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11,158,000 |
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11,158,000 |
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Trademarks |
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14,483,175 |
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14,483,175 |
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Customer database, net of accumulated amortization of $1,133,068 at
October 1, 2005 and $849,801 at January 1, 2005 |
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2,266,137 |
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2,549,404 |
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Debt issuance costs, net of accumulated amortization of $2,851,208 at
October 1, 2005 and $2,062,104 at January 1, 2005 |
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5,006,507 |
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5,795,611 |
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Other long-term assets |
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429,186 |
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368,285 |
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Total assets |
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$ |
191,686,100 |
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$ |
186,929,299 |
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3
Golfsmith International Holdings, Inc.
Consolidated Balance Sheets (continued)
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October 1, |
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January 1, |
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2005 |
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2005 |
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(Unaudited) |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable bank |
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$ |
3,679,640 |
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$ |
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Accounts payable trade |
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26,092,249 |
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31,006,493 |
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Accrued expenses and other current liabilities |
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14,061,076 |
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18,717,115 |
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Line of credit |
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2,945,000 |
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Total current liabilities |
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46,777,965 |
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49,723,608 |
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Long-term debt |
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81,749,070 |
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79,808,033 |
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Deferred rent |
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3,735,989 |
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3,084,367 |
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Total liabilities |
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132,263,024 |
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132,616,008 |
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Stockholders equity: |
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Common stock $.001 par value; 40,000,000 shares authorized; 21,594,597 shares
issued and outstanding at October 1, 2005 and January 1, 2005, respectively |
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21,594 |
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21,594 |
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Restricted common stock units $.001 par value; 755,935 shares
issued and outstanding at October 1, 2005 and January 1, 2005, respectively |
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756 |
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756 |
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Additional capital |
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60,288,607 |
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60,288,607 |
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Other comprehensive income |
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176,722 |
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279,607 |
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Accumulated deficit |
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(1,064,603 |
) |
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(6,277,273 |
) |
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Total stockholders equity |
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59,423,076 |
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54,313,291 |
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Total liabilities and stockholders equity |
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$ |
191,686,100 |
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$ |
186,929,299 |
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See accompanying notes.
4
Golfsmith International Holdings, Inc.
Consolidated Statements of Operations
(Unaudited)
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Nine months Ended |
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Three Months Ended |
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October 1, |
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October 2, |
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October 1, |
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October 2, |
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2005 |
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2004 |
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2005 |
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2004 |
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Net revenues |
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$ |
251,972,974 |
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$ |
236,621,309 |
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$ |
85,521,081 |
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$ |
73,895,536 |
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Cost of products sold |
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161,494,699 |
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155,755,165 |
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55,638,319 |
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49,378,753 |
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Gross profit |
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90,478,275 |
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80,866,144 |
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29,882,762 |
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24,516,783 |
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Selling, general and administrative |
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74,803,234 |
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68,992,648 |
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25,438,975 |
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21,920,978 |
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Store pre-opening expenses |
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1,742,389 |
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396,580 |
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338,870 |
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14,382 |
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Total operating expenses |
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76,545,623 |
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69,389,228 |
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25,777,845 |
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21,953,360 |
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Operating income |
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13,932,652 |
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11,476,916 |
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4,104,917 |
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2,581,423 |
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Interest expense |
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(8,688,730 |
) |
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(8,393,503 |
) |
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(2,938,100 |
) |
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(2,796,936 |
) |
Interest income |
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66,678 |
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24,934 |
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3,718 |
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20,409 |
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Other income |
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65,769 |
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1,102,306 |
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34,679 |
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1,074,557 |
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Other expense |
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(87,718 |
) |
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(63,047 |
) |
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(15,740 |
) |
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(16,874 |
) |
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Income before income taxes |
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5,288,651 |
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4,147,606 |
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1,189,474 |
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862,579 |
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Income tax expense |
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(75,981 |
) |
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(1,549,718 |
) |
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21,121 |
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(326,924 |
) |
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Net income |
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$ |
5,212,670 |
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$ |
2,597,888 |
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$ |
1,210,595 |
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$ |
535,655 |
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See accompanying notes.
5
Golfsmith International Holdings, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
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Nine months Ended |
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October 1, |
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October 2, |
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2005 |
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2004 |
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Operating Activities |
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Net income |
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$ |
5,212,670 |
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$ |
2,597,888 |
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Adjustments to reconcile net income to net cash provided by (used in) operating
activities: |
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Depreciation |
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4,009,894 |
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|
3,995,053 |
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Amortization of intangible assets |
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283,267 |
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|
283,268 |
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Amortization of debt issue costs and debt discount |
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|
2,730,141 |
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2,430,367 |
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Non-cash loss on write-off of property and equipment |
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|
1,027,177 |
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387,902 |
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Gain on sale of assets |
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(11,500 |
) |
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(1,064,045 |
) |
Changes in operating assets and liabilities: |
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Accounts receivable |
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(495,400 |
) |
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(1,180,737 |
) |
Inventories |
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(9,587,186 |
) |
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4,720,731 |
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Prepaid and other assets |
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(113,525 |
) |
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(798,360 |
) |
Accounts payable bank |
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|
3,679,640 |
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Accounts payable trade |
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(4,914,244 |
) |
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(1,592,349 |
) |
Accrued expenses and other current liabilities |
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|
(4,653,797 |
) |
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(1,742,849 |
) |
Deferred rent |
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651,622 |
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333,600 |
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Net cash provided by (used in) operating activities |
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(2,181,241 |
) |
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8,370,469 |
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Investing Activities |
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Capital expenditures |
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(9,248,117 |
) |
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(4,973,719 |
) |
Proceeds from sale of assets |
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11,500 |
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2,105,000 |
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Net cash used in investing activities |
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(9,236,617 |
) |
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(2,868,719 |
) |
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Financing Activities |
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Principal payments on lines of credit |
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(22,891,589 |
) |
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(33,475,151 |
) |
Proceeds from lines of credit |
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25,836,589 |
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|
32,058,112 |
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Other |
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(2,244 |
) |
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(4,901 |
) |
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Net cash provided by (used in) financing activities |
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2,942,756 |
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(1,421,940 |
) |
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Effect of exchange rate changes on cash |
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(99,864 |
) |
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|
8,442 |
|
Change in cash and cash equivalents |
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|
(8,574,966 |
) |
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|
4,088,252 |
|
Cash and cash equivalents, beginning of period |
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|
8,574,966 |
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|
1,050,544 |
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Cash and cash equivalents, end of period |
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$ |
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$ |
5,138,796 |
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6
Golfsmith International Holdings, Inc.
Consolidated Statements of Cash Flows (continued)
(Unaudited)
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Nine months Ended |
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October 1, |
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October 2, |
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2005 |
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2004 |
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Supplemental cash flow information: |
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Interest payments |
|
$ |
7,914,814 |
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$ |
7,953,343 |
|
Tax payments |
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$ |
376,607 |
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|
$ |
266,704 |
|
See accompanying notes.
7
GOLFSMITH INTERNATIONAL HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
October 1, 2005
1. Nature of Business and Basis of Presentation
Description of Business
Golfsmith International Holdings, Inc. (Holdings or the Company), is a multi-channel,
specialty retailer of golf and tennis equipment and related apparel and accessories and a designer
and marketer of golf equipment. The Company offers golf equipment from leading manufacturers,
including Callaway®, Cobra®, FootJoy®, Nike®,
Ping®, Taylor Made® and Titleist®. In addition, the Company offers
its own proprietary brands, including Golfsmith®, Lynx®, Snake
Eyes®, Killer Bee®, Zevo®, GearForGolf TM and
GiftsForGolf TM. As of October 1, 2005, the company marketed its products through 52
superstores as well as through its direct-to-consumer channels, which include its clubmaking and
consumer catalogs and its Internet site. The Company also operates the Harvey Penick Golf Academy,
an instructional school incorporating the techniques of the well-known golf instructor, the late
Harvey Penick.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of Golfsmith
International Holdings, Inc. and its wholly owned subsidiary Golfsmith International, Inc.
(Golfsmith). Holdings has no operations nor does it have any assets or liabilities other than its
investment in its wholly owned subsidiary. Accordingly, these consolidated financial statements
represent the operations of Golfsmith and its subsidiaries. All significant inter-company accounts
and transactions have been eliminated in consolidation.
The accompanying unaudited interim consolidated financial statements have been prepared in
accordance with U.S. generally accepted accounting principles. As information in this report
relates to interim financial information, certain footnote disclosures have been condensed or
omitted. In the Companys opinion, the unaudited interim consolidated financial statements reflect
all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation
of the Companys financial position, results of operations and cash flows for the periods
presented. These consolidated financial statements should be read in conjunction with the
Companys audited consolidated financial statements and notes thereto for the year ended January 1,
2005, included in the Companys Annual Report on Form 10-K filed with the Securities and Exchange
Commission on April 1, 2005. The results of operations for the three and nine month periods ended
October 1, 2005 are not necessarily indicative of results that may be expected for any other
interim period or for the full fiscal year.
The balance sheet at January 1, 2005 has been derived from audited consolidated financial
statements at that date but does not include all of the information and footnotes required by
accounting principles generally accepted in the United States for complete financial statements.
For further information, refer to the audited consolidated financial statements and notes thereto
for the fiscal year ended January 1, 2005 included in the Companys Annual Report on Form 10-K
filed with the Securities and Exchange Commission on April 1, 2005.
Reclassification
Certain reclassifications have been made to the prior year financial statements to conform to
the current year presentation. A reclassification of $6.2 million was
made to the consolidated balance sheet as of January 1, 2005 to
decrease both cash and cash equivalents and accounts payable in
connection with outstanding checks written but not presented for
payment prior to the balance sheet date. Reclassifications of $5.8
million and $1.8 million were made to the consolidated balance sheets
as of October 2, 2004 and January 3, 2004, respectively, to decrease
both cash and cash equivalents and accounts payable in connection
with outstanding checks written but not presented for payment prior
to the balance sheet date. The reclassifications are the result of
the Company funding the related cash accounts at the time the
outstanding checks are presented for payment, which has historically
been after the date on which the reporting period ends, instead of
the date on which the checks are written. All reclassifications have
been appropriately recorded in the consolidated statements of cash
flows.
Revenue Subject to Seasonal Variations
The Companys business is seasonal. The Companys sales leading up to and during the warm
weather golf season and the Christmas holiday gift-giving season have historically contributed a
higher percentage of the Companys annual net revenues and annual net operating income than other
periods in its fiscal year.
8
GOLFSMITH INTERNATIONAL HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
October 1, 2005
Fiscal Year
The Companys fiscal year ends on the Saturday closest to December 31. The three months ended
October 1, 2005 and October 2, 2004 both consist of thirteen weeks. The nine months ended October
1, 2005 and October 2, 2004 both consist of thirty-nine weeks.
2. Stock-Based Compensation
The Company accounts for its stock-based compensation plans under Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The
following table illustrates the effect on net income, if the Company had applied the fair value
recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS
No. 148, Accounting for Stock-Based Compensation Transition and Disclosure, An Amendment of FASB
Statement No. 123:
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Nine months Ended |
|
|
Three Months Ended |
|
|
|
October 1, 2005 |
|
|
October 2, 2004 |
|
|
October 1, 2005 |
|
|
October 2, 2004 |
|
Net income as reported |
|
$ |
5,212,670 |
|
|
$ |
2,597,888 |
|
|
$ |
1,210,595 |
|
|
$ |
535,655 |
|
Total stock-based
compensation cost, net
of related tax effects
included in the
determination of net
income as reported |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The stock-based
employee compensation
cost, net of related
tax effects, that would
have been included in
the determination of
net income if the fair
value based method had
been applied to all
awards |
|
|
(155,071 |
) |
|
|
(114,440 |
) |
|
|
(38,530 |
) |
|
|
(27,025 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma net income |
|
$ |
5,057,599 |
|
|
$ |
2,483,448 |
|
|
$ |
1,172,065 |
|
|
$ |
508,630 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3. Long-Lived Assets
The Company accounts for the impairment or disposal of long-lived assets in accordance with
Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No.
144, Accounting for the Impairment of Long-Lived Assets, which requires long-lived assets, such as
property and equipment, to be evaluated for impairment whenever events or changes in circumstances
indicate the carrying value of an asset may not be recoverable. An impairment loss is recognized
when estimated future undiscounted cash flows expected to result from the use of the asset plus net
proceeds expected from disposition of the asset, if any, are less than the carrying value of the
asset. When an impairment loss is recognized, the carrying amount of the asset is reduced to its
estimated fair value in the period in which the determination is made. Included in selling, general
and administrative expenses for the three months ended October 1, 2005 is a $0.4 million non-cash
loss on the write-off of property and equipment. Included in selling, general and administrative
expenses for the nine months ended October 1, 2005 is a $1.0 million non-cash loss on the write-off
of property and equipment. The losses were primarily due to the anticipated remodeling of three
stores in the fourth fiscal quarter of 2005, the remodeling of five stores in the second fiscal
quarter of 2005 and the modification of one store to a smaller store layout in the second fiscal
quarter of 2005, which resulted in certain assets having little or no future economic value.
Included in selling, general and administrative expenses for the nine months ended October 2, 2004
is a $0.4 million non-cash loss on the write-off of property and equipment in the second fiscal
quarter of 2004. The loss was primarily due to an anticipated retail store relocation, which
resulted in certain assets having little or no future economic value.
9
GOLFSMITH INTERNATIONAL HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
October 1, 2005
4. Intangible Assets
The following is a summary of the Companys intangible assets that are subject to
amortization:
|
|
|
|
|
|
|
|
|
|
|
October 1, |
|
|
January 1, |
|
|
|
2005 |
|
|
2005 |
|
Customer database gross carrying amount |
|
$ |
3,399,205 |
|
|
$ |
3,399,205 |
|
Customer database accumulated amortization |
|
|
(1,133,068 |
) |
|
|
(849,801 |
) |
|
|
|
|
|
|
|
Customer database net carrying amount |
|
$ |
2,266,137 |
|
|
$ |
2,549,404 |
|
|
|
|
|
|
|
|
Amortization expense related to finite-lived intangible assets was approximately $94,000 and
$283,000 for each of the three and nine months ended October 1, 2005 and October 2, 2004,
respectively, and is recorded in selling, general, and administration expenses on the consolidated
statements of operations.
5. Debt
Senior Secured Notes
On October 15, 2002, Golfsmith completed an offering of $93.75 million aggregate principal
amount at maturity of 8.375% senior secured notes due in 2009 at a discount of 20%, or $18.75
million. The terms of the notes limit the ability of Golfsmith to, among other things, incur
additional indebtedness, dispose of assets, make acquisitions, make other investments, pay
dividends and make various other payments. The terms of the notes also contain certain other
covenants, including a restriction on capital expenditures. In March 2005, the indenture governing
the notes was amended to revise the definition of capital expenditure basket to increase by $5.0
million the limitation on capital expenditures that may be made by Golfsmith or the guarantors of
the notes during any given fiscal year. As of October 1, 2005, the Company believes it was in
compliance with the covenants imposed by the indenture governing the notes.
Credit Facility
Golfsmith has a revolving senior credit facility with $12.5 million availability, subject to a
required reserve of $500,000. Borrowings under the credit facility are secured by substantially all
of Golfsmiths assets, excluding real property, equipment and proceeds thereof owned by Golfsmith,
Holdings, or Golfsmiths subsidiaries, and all of Golfsmiths stock and equivalent equity interest
in any subsidiaries. Available amounts under the senior credit facility are based on a borrowing
base. The borrowing base is limited to 85% of the net amount of eligible receivables, as defined in
the credit agreement, plus the lesser of (i) 65% of the value of eligible inventory and (ii) 60% of
the net orderly liquidation value of eligible inventory, and minus $2.5 million, which is an
availability block used to calculate the borrowing base. At October 1, 2005, the Company had $2.9
million outstanding under the senior credit facility.
In March 2005, several financial covenants in the senior credit facility were amended. The
limit on capital expenditures in each fiscal year was increased to the greater of (a) one-third of
Holdings EBITDA (as defined in the senior credit facility) in the immediately preceding fiscal
year and (b) the sum of: (i) $12.0 million, (ii) the amount, if any, of the excess cash flow (as
defined in the indenture to the senior secured notes) offer made and not accepted by the holders of
the senior secured notes during the immediately preceding fiscal year, and (iii) any amounts, up to
an aggregate of $1,000,000, previously permitted to be made as capital expenditures that have not
previously been made as capital expenditures. In addition, the covenants regarding minimum interest
coverage ratios and minimum earnings levels were removed for the fiscal period ending on or about
September 30, 2004 and all fiscal periods thereafter. Finally, the definition of borrowing base in
the senior credit facility was amended to include an availability block of $2.5 million, as used to
calculate the borrowing base under the senior credit facility. As of October 1, 2005, the Company
believes it was in compliance with the covenants in the credit facility.
10
GOLFSMITH INTERNATIONAL HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
October 1, 2005
6. Guarantees
Holdings and all of Golfsmiths existing domestic subsidiaries fully and unconditionally
guarantee, and all of Golfsmiths future domestic subsidiaries will guarantee, both the senior
secured notes issued by Golfsmith in October 2002 and the senior credit facility. The senior
secured notes mature in October 2009 with certain mandatory redemption features. Interest payments
are required on a semi-annual basis on the senior secured notes at an annual interest rate of
8.375%. At October 1, 2005, there were $2.9 million in borrowings outstanding under the senior
credit facility and $81.7 million aggregate principal amount outstanding of the senior secured
notes.
Holdings has no operations nor any assets or liabilities other than its investment in its
wholly owned subsidiary Golfsmith. Golfsmith has no independent operations nor any assets or
liabilities other than its investments in its wholly owned subsidiaries. Domestic subsidiaries of
Golfsmith comprise all of Golfsmiths assets, liabilities and operations. There are no restrictions
on the transfer of funds between Holdings, Golfsmith and any of Golfsmiths domestic subsidiaries.
The guarantees of Holdings and all existing and future Golfsmith domestic subsidiaries of
Golfsmiths senior secured notes and senior credit facility are explicitly excluded from the
initial recognition and initial measurement requirements of FASB Interpretation No. 45 as it meets
the definition of an intercompany guarantee.
The Company offers warranties to its customers depending on the specific product and terms of
the goods purchased. A typical warranty program requires that the Company replace defective
products within a specified time period from the date of sale. The Company records warranty costs
as they are incurred and historically such costs have not been material. During the three and nine
months ended October 1, 2005 and October 2, 2004, respectively, no material amounts have been
accrued or paid relating to product warranties.
7. Accrued Expenses and Other Current Liabilities
The Companys accrued expenses and other current liabilities are comprised of the following at
October 1, 2005 and January 1, 2005, respectively:
|
|
|
|
|
|
|
|
|
|
|
October 1, 2005 |
|
|
January 1, 2005 |
|
Salaries and benefits |
|
$ |
2,286,518 |
|
|
$ |
1,791,931 |
|
Interest |
|
|
691,248 |
|
|
|
2,647,670 |
|
Allowance for returns reserve |
|
|
935,013 |
|
|
|
1,326,394 |
|
Gift certificates |
|
|
5,910,826 |
|
|
|
7,521,148 |
|
Taxes |
|
|
1,863,331 |
|
|
|
3,169,661 |
|
Other |
|
|
2,374,140 |
|
|
|
2,260,311 |
|
|
|
|
|
|
|
|
Total |
|
$ |
14,061,076 |
|
|
$ |
18,717,115 |
|
|
|
|
|
|
|
|
8. Comprehensive Income
The Companys comprehensive income is composed of net income and translation adjustments. The
following table presents the calculation of comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months Ended |
|
|
Three Months Ended |
|
|
|
October 1, |
|
|
October 2, |
|
|
October 1, |
|
|
October 2, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Net income |
|
$ |
5,212,670 |
|
|
$ |
2,597,888 |
|
|
$ |
1,210,595 |
|
|
$ |
535,655 |
|
Translation adjustments |
|
|
(102,885 |
) |
|
|
8,623 |
|
|
|
1,814 |
|
|
|
(31,735 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
$ |
5,109,785 |
|
|
$ |
2,606,511 |
|
|
$ |
1,212,409 |
|
|
$ |
503,920 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11
GOLFSMITH INTERNATIONAL HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
October 1, 2005
9. Recently Issued Accounting Standards
In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123
(Revised), Share-Based Payment (SFAS No. 123 (R)), which replaces SFAS No. 123 and supercedes
Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees. Under the new
standard, companies will no longer be able to account for share-based compensation transactions
using the intrinsic method in accordance with APB No. 25. Instead, companies will be required to
account for such transactions using a fair-value method and recognize the expense in the
consolidated statement of income. SFAS 123(R) is effective as of the beginning of the first interim
or annual reporting period that begins after December 15, 2005. SFAS 123(R) applies to all awards
granted after the required effective date, but does not apply to awards granted in periods before
the required effective date because the Company uses the minimum value method, except if prior
awards are modified, repurchased or cancelled after the effective date. The Company will adopt SFAS
No. 123(R) on January 1, 2006. The impact of the adoption of SFAS 123(R) cannot be predicted at
this time because it will be depend on levels of share-based payments granted in the future.
However, valuation of employee stock options under SFAS 123(R) is similar to SFAS 123, with minor
exceptions. For information about what the Companys reported results of operations would have been
had the Company adopted SFAS 123, see Note 2, Stock-Based Compensation.
In June 2005, the FASBs Emerging Issues Task Force (EITF) reached a consensus on Issue No. 05-6,
Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or
Acquired in a Business Combination (EITF No. 05-6). EITF No. 05-6 provides guidance on the
amortization period for leasehold improvements in operating leases that are either acquired after
the beginning of the initial lease term or acquired as the result of a business combination. This
guidance requires leasehold improvements purchased after the beginning of the initial lease term to
be amortized over the shorter of the assets useful life or a term that includes the original lease
term plus any renewals that are reasonably assured at the date the leasehold improvements are
purchased. This guidance is effective for reporting periods beginning after June 29, 2005. The
adoption of this statement did not have a material impact on the Companys net income, cash flows
or financial position.
12
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are the parent company of Golfsmith International, Inc., or Golfsmith. We have no
operations nor any assets or liabilities other than our investment in our wholly owned subsidiary
Golfsmith. The following discussion and analysis of historical financial condition and results of
operations is based on our financial condition and results of operations for all periods presented.
We are a multi-channel, specialty retailer of golf and tennis equipment and related apparel
and accessories and a designer and marketer of golf equipment. We sell brand name golf equipment
from the industrys leading manufacturers including Callaway®, Cobra®,
FootJoy®, Ping®, Nike®, Taylor Made® and
Titleist® as well as our own proprietary brands, Golfsmith®,
Lynx®, Snake Eyes®, Killer Bee®, Zevo®,
GearForGolf TM and GiftsForGolf TM. We sell through multiple distribution
channels consisting of:
|
|
|
52 superstores; |
|
|
|
|
regular mailings of our clubmakers catalogs, which offer golf club components, and
our consumer catalogs, which offer golf accessories, apparel and equipment; and |
|
|
|
|
golfsmith.com, our online e-commerce website. |
We also operate a clubmaker training program and are the exclusive operator of the Harvey
Penick Golf Academy, an instructional school incorporating the techniques of the well-known golf
instructor, the late Harvey Penick.
Industry Trends
Sales of our products are affected by increases and declines within the golf industry as a
whole. According to national publications, the golf industry is a greater than $62 billion
industry. We believe that increases and declines in the golf industry result from changes in the
overall economy, the number of golf participants, the number of rounds of golf being played by
these participants and the weather. According to a recent industry publication, golf had a base of
over 27 million participants in the United States as of the end of calendar year 2004. We believe
that since 1998, the overall worldwide premium golf club market has experienced only limited growth
in dollar volume from year to year and that from 1999 to 2004 there was no material increase in the
number of rounds played. Golf Datatech has reported that the number of golf rounds played in the
United States declined 0.1% in 2004 as compared to 2003. In addition, Golf Datatech has reported
that the number of golf rounds played in the United States declined 0.1% during the nine months
ended September 30, 2005 as compared to the same period in 2004. However, the decline during the
nine months ended September 30, 2005 was driven largely by a decline during the first quarter of
calendar year 2005. Golf Datatech has reported that the rate of growth in the number of rounds
played decreased 7.6% in the three months ended March 31, 2005, but increased 1.0% in the three
months ended June 30, 2005, and 1.4% in the three months ended September 30, 2005, in each case
compared to the corresponding period in 2004. We cannot assure you that a decline in the U.S.
economy or a reduction in discretionary consumer spending would not impede growth in the worldwide
market for golf-related products, including our products.
Superstores
Our superstores range in size from 8,000 to 33,000 square feet and average approximately
17,000 square feet. Our superstores feature a wide selection of golf and tennis equipment, apparel
and accessories from major brand manufacturers and also serve as the primary outlet in the United
States for our proprietary branded products. Our superstores accounted for 75.3% and 72.1% of our
net revenues for the three and nine months ended October 1, 2005, respectively, and 71.4% and 68.7%
of our net revenues for the three and nine months ended October 2, 2004. Changes in the revenues
that we generate from our superstores are driven primarily by the number of stores in operation and
changes in comparable store sales. We had 52 and 42 superstores in operation as of October 1, 2005
and October 2, 2004, respectively. We consider sales of a new store to be comparable commencing in
the fourteenth month after the store was opened or acquired. We consider sales of a relocated store
to be comparable if the relocated store is expected to serve a comparable customer base. We
consider sales of superstores with modified layouts to be comparable. We consider sales of stores
that are closed to be comparable in the period leading up to closure if they have met the
qualifications of a comparable store and do not meet the qualifications to be classified as
discontinued operations under Statement of Financial Accounting Standards (SFAS) No. 144,
Accounting for the Impairment of Long-Lived Assets.
We intend to selectively expand our existing store base in existing as well as new markets
that fit our selection criteria. We opened eight superstores during the nine months ended October
1, 2005, which consisted of six new stores and two relocated
13
stores. There are no plans to open any superstores during the fourth quarter of fiscal 2005.
All of the new stores built during fiscal 2005 are in the mold of our smaller store layout and
average approximately 13,000 square feet. We closed two stores during the nine months ended October
1, 2005 due to the expiration of lease terms. In both instances where we closed a store, we
subsequently opened a new store in 2005 to serve the same customer base of the closed stores. One
of the two stores subsequently opened is considered a comparable store. We expect to spend
approximately $1.5 million to open each additional superstore, which includes pre-opening expenses,
capital expenditures and inventory costs.
We plan to modify select superstores to feature our fitting and training specialty services
that provide the customer with an experiential shopping experience that complements our product
assortment. As of October 1, 2005, seven of our superstores provided precision golf equipment
fitting through an arrangement with Hot Stix Technologies, or Hot Stix. During the remaining
quarter of fiscal 2005, we plan to add or modify indoor hitting ranges in 24 existing superstores
to feature this precision golf equipment-fitting technology. In addition, as of October 1, 2005, 24
of our superstores provided in-store golf lessons from a PGA professional through our relationship
with GolfTEC Learning Centers, or GolfTEC. During the remaining quarter of fiscal 2005, we plan to
modify three of our existing superstores to accommodate in-store golf lessons through GolfTEC.
We also plan to modify select superstores to feature expanded hitting bays, putting greens and
short game areas that provide the customer with an experiential shopping experience that
complements our product assortment. We updated three superstores to provide this enhanced customer
shopping experience during the nine months ended October 1, 2005. We further plan to continue to
update and remodel existing superstores to provide a more consistent shopping experience among our
superstores. In addition, during the nine months ended October 1, 2005, we updated 24 of our
existing and new stores to feature tennis equipment, apparel and accessories, which as of October
1, 2005, were featured in 30 of our 52 stores. During the fourth quarter of fiscal 2005, we plan to
modify three of our existing stores to feature tennis equipment, apparel and accessories. We
modified one superstore to our smaller store layout during the nine months ended October 1, 2005.
We do not have any current plans to modify any more of our superstores to the smaller store layout.
Specialty Services
Over the past few years we have implemented a number of new initiatives and product offerings
such as our Playability Guarantee program designed to ensure complete customer satisfaction with
our customers purchase of golf clubs; our Club Vantage program that provides the customer with
separately-priced repair service on any club purchase; the Golfsmith credit card which offers
flexible payment options on any purchase; as described above, the availability of in-store custom
golf equipment fitting through Hot Stix, which complements our existing custom fitting services and
the availability of in-store golf lessons from a PGA professional through GolfTEC. We believe our
continued market expansion combined with these new initiatives have contributed to increased market
presence and brand recognition, as evidenced by the increase in our net revenues during the nine
months ended October 1, 2005 compared to the nine months ended October 2, 2004. You should read the
discussion of our revenue growth below in Results of Operations.
Products
The majority of our sales are comprised of golf equipment, apparel and accessories from
leading manufacturers, including Callaway®, Cobra®, FootJoy®,
Nike®, Ping®, Taylor Made® and Titleist®. We also sell
proprietary brand equipment, component, apparel and accessory products under the
Golfsmith®, Lynx®, Snake Eyes®, Killer Bee®,
Zevo®, GearForGolf TM and GiftsForGolf TM product lines. These
private label lines are included in all of our sales distribution channels and generate higher
gross profit margins than products we sell that are produced by other manufacturers. Sales of our
proprietary brands constituted approximately 16.1% and 16.7% of our net revenues for the three and
nine months ended October 1, 2005, respectively, and approximately 19.0% and 19.7% of our net
revenues for the three and nine months ended October 2, 2004, respectively.
We recognize revenue for retail sales at the time the customer takes possession of the
merchandise and purchases are paid for, primarily with either cash or a credit card. Catalog and
e-commerce sales are recorded upon shipment of merchandise. Revenue from the Harvey Penick Golf
Academy instructional school is recognized at the time the services are performed. Revenues from
the sale of gift certificates are recorded upon the redemption of the gift certificate for the
purchase of tangible products at the time the customer takes possession of the merchandise.
Our business is seasonal. Our sales leading up to and during the warm weather golf season and
the Christmas holiday gift-giving season have historically contributed a higher percentage of our
annual net revenues and annual net operating income than other periods in our fiscal year. During
fiscal 2004, the fiscal months of March through September and December, which together comprised 36
weeks of our 52-week fiscal year, contributed over three-quarters of our annual net revenues and
substantially all of
14
our annual operating income. You should read the information set forth below under Additional
Factors That May Affect Future Results for a discussion of the effects and risks of the
seasonality of our business.
Our fiscal year ends on the Saturday closest to December 31 and generally consists of 52
weeks, though occasionally our fiscal years will consist of 53 weeks. Each quarter of each fiscal
year generally consists of 13 weeks. The three-month periods ended October 1, 2005 and October 2,
2004 each consisted of 13 weeks and the nine-month periods ended October 1, 2005 and October 2,
2004 each consisted of 39 weeks.
Critical Accounting Policies and Estimates
Managements discussion and analysis of financial condition and results of operations is based
on our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosures of contingent assets and liabilities.
The estimates and assumptions are evaluated on an ongoing basis and are based on historical
experience and other various factors that are believed to be reasonable under the circumstances.
Actual results may differ from these estimates.
We believe the following critical accounting policies, as have been discussed with our audit
committee, affect our more significant judgments and estimates used in the preparation of our
consolidated financial statements.
Inventory Valuation
Inventory value is presented as a current asset on our balance sheet and is a component of
cost of products sold in our statement of operations. It therefore has a significant impact on the
amount of net income reported in any period. Merchandise inventories are carried at the lower of
cost or market. Cost is the sum of expenditures, both direct and indirect, incurred to bring
inventory to its existing condition and location. Cost is determined using the weighted-average
method. We estimate a reserve for damaged, obsolete, excess and slow-moving inventory and for
inventory shrinkage due to anticipated book-to-physical adjustments. We periodically review these
reserves by comparing them to on-hand quantities, historical and projected rates of sale, changes
in selling price and inventory cycle counts. Based on our historical results, using various methods
of disposition, we estimate the price at which we expect to sell this inventory to determine the
potential loss if those items are later sold below cost. The carrying value for inventories that
are not expected to be sold at or above costs are then written down. A significant adjustment in
these estimates or in actual sales may have a material adverse impact on our net income. Shrink
reserves are booked on a monthly basis at 0.4% to 1.0% of net revenues depending on the
distribution channel (direct-to-consumer channel or retail channel) in which the sales occur.
Inventory shrink expense recorded in the statements of operations was 0.8% of net revenues during
each of the three and nine months ended October 1, 2005, and 0.6% and 0.7% during the three and
nine months ended October 2, 2004, respectively. Inventory shrink expense recorded is a result of
physical inventory counts made during these respective periods and reserve amounts recorded for
periods outside of the physical inventory count dates. These reserve amounts are based on
managements estimates of shrink expense using historical experience.
Long-lived Assets, Including Goodwill and Identifiable Intangible Assets
We account for the impairment or disposal of long-lived assets in accordance with SFAS No.
144, Accounting for the Impairment of Long-Lived Assets, which requires long-lived assets, such as
property and equipment, to be evaluated for impairment whenever events or changes in circumstances
indicate the carrying value of an asset may not be recoverable. An impairment loss is recognized
when estimated future undiscounted cash flows expected to result from the use of the asset plus net
proceeds expected from disposition of the asset, if any, are less than the carrying value of the
asset. When an impairment loss is recognized, the carrying amount of the asset is reduced to its
estimated fair value. Based on our analyses, included in selling, general and administrative
expenses for the three months ended October 1, 2005 is a $0.4 million non-cash loss on the
write-off of property and equipment. Included in selling, general and administrative expenses for
the nine months ended October 1, 2005 is a $1.0 million non-cash loss on the write-off of property
and equipment. The losses were primarily due to the anticipated remodeling of three stores in the
fourth fiscal quarter of 2005, the remodeling of five stores in the second fiscal quarter of 2005
and the modification of one store to a smaller store layout in the second fiscal quarter of 2005,
which resulted in certain assets having little or no future economic value. Included in selling,
general and administrative expenses for the nine months ended October 2, 2004 is a $0.4 million
non-cash loss on the write-off of property and equipment in the second fiscal quarter of 2004. The
loss was primarily due to an anticipated retail store relocation, which resulted in certain assets
having little or no future economic value.
Goodwill represents the excess purchase price over the fair value of net assets acquired, or
net liabilities assumed, in a business combination. In accordance with SFAS No. 142, Goodwill and
Other Intangible Assets, we assess the carrying value of our
15
goodwill for indications of impairment annually, or more frequently if events or changes in
circumstances indicate that the carrying amount of goodwill or intangible asset may be impaired.
The goodwill impairment test is a two-step process. The first step of the impairment analysis
compares the fair value of the company or reporting unit to the net book value of the company or
reporting unit. We allocate goodwill to one enterprise-level reporting unit for impairment testing.
In determining fair value, we utilize a blended approach and calculate fair value based on
discounted cash flow analysis and revenue and earnings multiples based on industry comparables.
Step two of the analysis compares the implied fair value of goodwill to its carrying amount. If the
carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal
to that excess. We perform our annual test for goodwill impairment on the first day of the fourth
fiscal quarter of each year.
We test for possible impairment of intangible assets whenever events or changes in
circumstances indicate that the carrying amount of the asset is not recoverable based on
managements projections of estimated future discounted cash flows and other valuation
methodologies. Factors that are considered by management in performing this assessment include, but
are not limited to, our performance relative to our projected or historical results, our intended
use of the assets and our strategy for our overall business, as well as industry and economic
trends. In the event that the book value of intangibles is determined to be impaired, such
impairments are measured using a combination of a discounted cash flow valuation, with a discount
rate determined to be commensurate with the risk inherent in our current business model, and other
valuation methodologies. To the extent these future projections or our strategies change, our
estimates regarding impairment may differ from our current estimates.
Product Return Reserves
We reserve for product returns based on estimates of future sales returns related to our
current period sales. We analyze historical returns, current economic trends, current returns
policies and changes in customer acceptance of our products when evaluating the adequacy of the
reserve for sales returns. Any significant increase in merchandise returns that exceeds our
estimates could adversely affect our operating results. In addition, we may be subject to risks
associated with defective products, including product liability. Our current and future products
may contain defects, which could subject us to higher defective product returns, product liability
claims and product recalls. Because our allowances are based on historical return rates, we cannot
assure you that the introduction of new merchandise in our stores or catalogs, the opening of new
stores, the introduction of new catalogs, increased sales over the Internet, changes in the
merchandise mix or other factors will not cause actual returns to exceed return allowances. We book
reserves on a monthly basis at 1.8% to 10.8% of net revenues depending on the distribution channel
in which the sales occur. We routinely compare actual experience to current reserves and make any
necessary adjustments.
Store Closure Costs
When we decide to close a store and meet the applicable accounting guidance criteria, we
recognize an expense related to the future net lease obligation and other expenses directly related
to the discontinuance of operations in accordance with SFAS No. 146, Accounting For Costs
Associated With Exit or Disposal Activities. These charges require us to make judgments about exit
costs to be incurred for employee severance, lease terminations, inventory to be disposed of, and
other liabilities. The ability to obtain agreements with lessors, to terminate leases or to assign
leases to third parties can materially affect the accuracy of these estimates.
We closed two stores during the nine months ended October 1, 2005 due to the expiration of
lease terms. There were not any expenses associated with either closed store recorded in accordance
with SFAS No. 146. In both instances where we closed a store, we subsequently opened a new store in
2005 to serve the same customer base of the closed stores. We did not close any stores in fiscal
2004. We do not currently have any plans to close any additional stores, although we regularly
evaluate our stores and the necessity to record expenses under SFAS No. 146.
Operating Leases
We lease stores under operating leases. Store lease agreements often include rent holidays,
rent escalation clauses and contingent rent provisions for percentage of sales in excess of
specified levels. Most of our lease agreements include renewal periods at our option. We recognize
rent holiday periods and scheduled rent increases on a straight-line basis over the lease term
beginning with the date we take possession of the leased space. We record tenant improvement
allowances and rent holidays as deferred rent liabilities on our consolidated balance sheets and
amortize the deferred rent over the term of the lease to rent expense on our consolidated
statements of operations. We record rent liabilities on our consolidated balance sheets for
contingent percentage of sales lease provisions when we determine that it is probable that the
specified levels will be reached during the fiscal year. We record direct costs incurred to affect
a lease in other long-term assets and amortize these costs on a straight-line basis over the lease
term beginning with the date we take possession of the leased space.
16
Deferred Tax Assets
A deferred income tax asset or liability is established for the expected future consequences
resulting from temporary differences in the financial reporting and tax bases of assets and
liabilities. As of October 1, 2005, we recorded a full valuation allowance against accumulated
deferred tax assets of $4.3 million due to the uncertainties regarding the realization of deferred
tax assets primarily based on our cumulative loss position over the past three years. If we begin
to generate taxable income in a future period or if the facts and circumstances on which our
estimates and assumptions are based were to change, thereby impacting the likelihood of realizing
the deferred tax assets, judgment would have to be applied in determining the amount of valuation
allowance no longer required. Reversal of all or a part of this valuation allowance could have a
significant positive impact on our net income in the period that it becomes more likely than not
that certain of our deferred tax assets will be realized.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123 (Revised), Share-Based Payment (SFAS No. 123
(R)), which replaces SFAS No. 123 and supercedes Accounting Principles Board (APB) No. 25,
Accounting for Stock Issued to Employees. Under the new standard, companies will no longer be able
to account for share-based compensation transactions using the intrinsic method in accordance with
APB No. 25. Instead, companies will be required to account for such transactions using a fair-value
method and recognize the expense in the consolidated statement of income. SFAS 123(R) is effective
as of the beginning of the first interim or annual reporting period that begins after December 15,
2005. SFAS 123(R) applies to all awards granted after the required effective date, but does not
apply to awards granted in periods before the required effective date because we use the minimum
value method, except if prior awards are modified, repurchased or cancelled after the effective
date. We will adopt SFAS No. 123(R) on January 1, 2006. The impact of the adoption of SFAS 123(R)
cannot be predicted at this time because it will depend on levels of share-based payments granted
in the future. However, valuation of employee stock options under SFAS 123(R) is similar to SFAS
123, with minor exceptions. For information about what our reported results of operations would
have been had we adopted SFAS 123, see the discussion in Note 2 to our unaudited consolidated
financial statements included in Part I, Item 1, Financial Statements.
In June 2005, the FASBs Emerging Issues Task Force (EITF) reached a consensus on Issue No.
05-6, Determining the Amortization Period for Leasehold Improvements Purchased after Lease
Inception or Acquired in a Business Combination (EITF No. 05-6). EITF No. 05-6 provides guidance on
the amortization period for leasehold improvements in operating leases that are either acquired
after the beginning of the initial lease term or acquired as the result of a business combination.
This guidance requires leasehold improvements purchased after the beginning of the initial lease
term to be amortized over the shorter of the assets useful life or a term that includes the
original lease term plus any renewals that are reasonably assured at the date the leasehold
improvements are purchased. This guidance is effective for reporting periods beginning after June
29, 2005. The adoption of this statement did not have a material
impact on our net
income, cash flows or financial position.
Results of Operations
Three Months Ended October 1, 2005 Compared to Three Months Ended October 2, 2004
We had net revenues of $85.5 million, operating income of $4.1 million and net income of $1.2
million in the three months ended October 1, 2005 compared to net revenues of $73.9 million,
operating income of $2.6 million and net income of $0.5 million in the three months ended October
2, 2004.
The $11.6 million increase in net revenues from the three months ended October 2, 2004 to the
three months ended October 1, 2005 was mostly comprised of a $8.4 million increase in
non-comparable store net revenues and a $3.2 million, or 6.2%, increase in comparable store net
revenues. In comparison, comparable store net revenues for the three months ended October 2, 2004
decreased by $3.5 million, or 7.9%. We believe the increase in comparable store net revenues from
the three months ended October 2, 2004 to the three months ended October 1, 2005 was due in part to
the negative comparable results reported during the three months ended October 2, 2004.
Additionally, we believe the comparable store net revenue increase is influenced by the increase in
the number of golf rounds played in the U.S. during the three months ended September 30, 2005 of
1.4%, as compared to the same period in 2004, as reported by Golf Datatech. Further, we believe
the comparable store increases were influenced by improvement in our post-sale product return
rates. Non-comparable store net revenues include revenues from eleven stores in operation that were
opened subsequent to October 2, 2004. Direct-to-consumer channel net revenues increased $0.3
million, or 1.4%, from the three months ended October 2, 2004 to the three months ended October 1,
2005. International net revenues decreased by $0.3 million, or 20.4%, from the three months ended
October 2, 2004 to the three months ended October 1, 2005 due
17
primarily to the sale of the rights to a trademark in fiscal 2004. Sales of products using
this trademark contributed approximately one-third of international net revenues during the three
months ended October 2, 2004 but did not contribute any international net revenues during the three
months ended October 1, 2005.
For the three months ended October 1, 2005, gross profit was $29.9 million, or 34.9% of net
revenues, compared to $24.5 million, or 33.2% of net revenues, for the three months ended October
2, 2004. Increased net revenues for the three months ended October 1, 2005 compared to the three
months ended October 2, 2004 led to higher gross profit for the three months ended October 1, 2005.
The increase in gross margin percentage was due to increases in vendor allowances, which resulted
in higher margins, and to us realizing economies of scale due to continued retail store growth,
which has allowed us to purchase products in higher volumes with more favorable pricing.
Selling, general and administrative expenses increased $3.5 million to $25.4 million for the
three months ended October 1, 2005 from $21.9 million for the three months ended October 2, 2004.
Increased selling, general and administrative expenses for the three months ended October 1, 2005
compared to the three months ended October 2, 2004 resulted from an increase in expenses of $3.1
million related to general operations for non-comparable retail stores, an increase of $1.0 million
related to general operations for existing retail stores, offset by a decrease of $0.6 million
related to general operations for corporate and international expenses.
Store pre-opening costs include costs associated with hiring and training personnel, supplies
and occupancy and miscellaneous costs related to new store openings and are expensed as incurred.
During the three months ended October 1, 2005, we incurred $0.3 million in store pre-opening
expenses related to the opening of three new retail locations during the third fiscal quarter of
2005, consisting of two new stores and one relocated store. During the three months ended October
2, 2004, we incurred approximately $14,000 in store pre-opening expenses related to residual costs
from the opening of four new retail locations during the first quarter of fiscal 2004.
Interest expense consists of costs related to Golfsmiths 8.375% senior secured notes and our
senior credit facility with a financial institution. Interest expense was $2.9 million and $2.8
million for the three months ended October 1, 2005 and October 2, 2004, respectively. For further
discussion, see Liquidity and Capital Resources Senior Secured Notes and Liquidity and
Capital Resources Credit Facility below.
Other income for the three months ended October 2, 2004 was $1.1 million and related almost
entirely to the sale of certain trademarks for Lynx in Europe, Malaysia, Thailand and Singapore to
a third party in August 2004. We received proceeds of $2.1 million, net of direct costs associated
with the sale, and recorded a gain on the sale of approximately $1.1 million. Other income was not
material for the three months ended October 1, 2005.
We record income taxes, consisting of federal, state and foreign taxes, based on the effective
rate expected for the fiscal year. Actual results may differ from these estimates. We did not
record federal income tax expense for the three months ended October 1, 2005 due to a full
valuation allowance being recorded. Income tax benefit of $21,121 during the three months ended
October 1, 2005 represents foreign income tax benefit. Income tax expense was $0.3 million, or
37.9% of pre-tax net income, for the three months ended October 2, 2004.
Nine months Ended October 1, 2005 Compared to Nine months Ended October 2, 2004
We had net revenues of $252.0 million, operating income of $13.9 million and net income of
$5.2 million in the nine months ended October 1, 2005 compared to net revenues of $236.6 million,
operating income of $11.5 million and net income of $2.6 million in the nine months ended October
2, 2004.
The $15.4 million increase in net revenues from the nine months ended October 2, 2004 to the
nine months ended October 1, 2005 was mostly comprised of a $19.5 million increase in
non-comparable store net revenues offset by a decrease in comparable store net revenues of $0.3
million, or 0.2%, a decrease in direct-to-consumer channel net revenues of $2.4 million, or 3.5%,
and a decrease in international net revenues of $1.4 million, or 25.9%. In comparison, comparable
store net revenues for the nine months ended October 2, 2004 increased by $2.9 million, or 2.5%.
We believe the decrease in comparable store net revenues from the nine months ended October 2, 2004
to the nine months ended October 1, 2005 was due to the increased competition in select markets and
was influenced by the 0.1% decrease in the number of golf rounds played in the U.S. during the nine
months ended October 1, 2005 as compared to the same period in 2004, as reported by Golf Datatech.
Non-comparable store net revenues include revenues from eleven stores in operation that were opened
subsequent to October 2, 2004 and five stores that became comparable during the nine months ended
October 1, 2005, but which contributed $4.2 million in non-comparable store net revenues during the
nine months ended October 1, 2005. The decrease in direct-to-consumer channel net revenues was
primarily
18
due to planned reductions in catalog circulation intended to improve direct-to-consumer
channel profitability. The decrease in international net revenues was primarily due to the sale of
the rights to a trademark in fiscal 2004. Sales of products using this trademark contributed
approximately one-third of international net revenues during the nine months ended October 2, 2004
but did not contribute any international net revenues during the nine months ended October 1, 2005.
For the nine months ended October 1, 2005, gross profit was $90.5 million, or 35.9% of net
revenues, compared to $80.9 million, or 34.2% of net revenues, for the nine months ended October 2,
2004. Increased net revenues for the nine months ended October 1, 2005 compared to the nine months
ended October 2, 2004 led to higher gross profit for the nine months ended October 1, 2005. The
increase in gross margin percentage was due to increases in vendor allowances, which resulted in
higher margins, and to us realizing economies of scale due to continued retail store growth, which
has allowed us to purchase products in higher volumes with more favorable pricing.
Selling, general and administrative expenses increased $5.8 million to $74.8 million for the
nine months ended October 1, 2005 from $69.0 million for the nine months ended October 2, 2004.
Increased selling, general and administrative expenses for the nine months ended October 1, 2005
compared to the nine months ended October 2, 2004 resulted from an increase in expenses of $7.2
million related to general operations for non-comparable retail stores, offset by a decrease of
$1.0 million related to general operations for corporate and international expenses and a decrease
of $0.4 million related to general operations for existing retail stores.
Store pre-opening costs include costs associated with hiring and training personnel, supplies
and occupancy and miscellaneous costs related to new store openings and are expensed as incurred.
During the nine months ended October 1, 2005, we incurred $1.7 million in store pre-opening
expenses related to the opening of eight new retail locations during the nine months ended October
1, 2005, consisting of six new stores and two relocated stores. During the nine months ended
October 2, 2004, we incurred $0.4 million in store pre-opening expenses related to the opening of
four new retail locations.
Other income for the nine months ended October 2, 2004 was $1.1 million and related almost
entirely to the sale of certain trademarks for Lynx in Europe, Malaysia, Thailand and Singapore to
a third party in August 2004. We received proceeds of $2.1 million, net of direct costs associated
with the sale, and recorded a gain on the sale of approximately $1.1 million. Other income was not
material for the nine months ended October 1, 2005.
Interest expense consists of costs related to Golfsmiths 8.375% senior secured notes and our
senior credit facility with a financial institution. Interest expense was $8.7 million and $8.4
million for the nine months ended October 1, 2005 and October 2, 2004, respectively. For further
discussion, see Liquidity and Capital Resources Senior Secured Notes and Liquidity and
Capital Resources Credit Facility below.
We record income taxes, consisting of federal, state and foreign taxes, based on the effective
rate expected for the fiscal year. Actual results may differ from these estimates. We did not
record federal income tax expense for the nine months ended October 1, 2005 due to a full valuation
allowance being recorded. Income tax expense of $75,981 during the nine months ended October 1,
2005 represents foreign income tax expense. Income tax expense was $1.5 million, or 37.4% of
pre-tax net income, for the nine months ended October 2, 2004.
Liquidity and Capital Resources
Cash Flows
As of October 1, 2005, we had no recorded cash and cash equivalents on our consolidated
balance sheet due to outstanding checks written and not
presented for payment that are recorded as a
liability on our consolidated balance sheet, as discussed in
Note 1 to our unaudited consolidated financial statements
included in this report. As of October 1, 2005, we had working capital of $24.8
million and outstanding debt obligations of $84.7 million. We had $9.1 million in borrowing
availability under our credit facility as of October 1, 2005, after giving effect to required
reserves of $500,000.
Operating activities
Net cash used in operating activities was $2.2 million for the nine months ended October 1,
2005, compared to net cash provided by operating activities of $8.4 million for the nine months
ended October 2, 2004.
19
The increase in net cash used in operating activities of $10.6 million from the nine months
ended October 2, 2004 to the nine months ended October 1, 2005 was principally due to an increase
in cash outflow of $14.3 million for the purchase of inventory offset by an increase in net income
of $2.6 million for the nine months ended October 1, 2005. The increase in cash used in operating
activities of $14.3 million related to inventory was primarily the result of an increase in the
number of retail superstores, from 42 stores as of October 2, 2004 to 52 stores as of October 1,
2005, and the related increase in inventory stock. Additionally, strategic initiatives to optimize
inventory levels in our retail locations combined with additive inventory for tennis product and
apparel increased inventory levels and the cash requirements to fund the increased inventory
levels.
Investing activities
Net cash used in investing activities was $9.2 million for the nine months ended October 1,
2005, compared to net cash used in investing activities of $2.9 million for the nine months ended
October 2, 2004. Net cash used in investing activities for the nine months ended October 1, 2005
was almost entirely the result of capital expenditures for new and existing stores. Net cash used
in investing activities for the nine months ended October 2, 2004 of $2.9 million was the result of
$5.0 million in capital expenditures, offset by proceeds of $2.1 million from the sale of assets.
We sold our trademarks for Lynx® in certain jurisdictions outside the United States in August 2004
for gross proceeds of $2.1 million.
Financing activities
Net cash provided by financing activities was $2.9 million for the nine months ended October
1, 2005 and primarily consisted of proceeds from our senior credit facility, net of payments,
compared to net cash used in financing activities of $1.4 million for the nine months ended October
2, 2004, which primarily consisted of payments made on our senior credit facility, net of proceeds.
Senior Secured Notes
On October 15, 2002, Golfsmith completed a private placement of $93.75 million aggregate
principal amount at maturity of its 8.375% senior secured notes due 2009 for gross proceeds of
$75.0 million. In July 2003, Golfsmith conducted an exchange offer in which Golfsmith offered to
exchange new senior secured notes registered under the Securities Act of 1933 for all of its
eligible existing senior secured notes. The terms of the new notes are substantially identical as
those issued in the private placement, except the new notes are freely tradable. We fully and
unconditionally guarantee the notes. As a result of the covenants in the indenture governing the
notes, our ability to borrow under the credit facility described below is restricted to a maximum
of $12.5 million, our capital expenditures are limited and the payment of dividends or repurchases
of stock are limited. In March 2005, the indenture governing the senior secured notes was amended
to revise the definition of capital expenditure basket to increase by $5.0 million the capital
expenditures that we are permitted to make during any given fiscal year.
Within 120 days after the end of each fiscal year, Golfsmith is required by the indenture
governing the notes to offer to repurchase the maximum principal amount of notes that may be
purchased with 50% of its excess cash flow from our previous fiscal year at a purchase price of
100% of the accreted value of the notes to be purchased. The indenture governing the notes defines
excess cash flow as consolidated net income plus interest, amortization and depreciation expense,
income taxes, and net non-cash charges, less certain capital expenditures, increases in working
capital, cash interest expense and income taxes. As of the end of fiscal 2004, we determined that
we did not have any excess cash flow, as defined in the indenture, and were thus not required to
offer to repurchase any of the notes. We do not believe that the current fiscal year requirement
will have a material impact on our liquidity.
Golfsmith is required by the indenture governing the notes to make the first principal payment
on the senior secured notes of $18.75 million in fiscal 2007. Should cash flows from operations
and from our senior credit facility be insufficient, we will be required to seek additional funding
to make the principal payment. We cannot assure you that we will be able to obtain additional
financing in sufficient amounts and on acceptable terms.
20
Credit Facility
We have a revolving senior credit facility with borrowing availability of up to $12.5 million
(subject to required reserves of $500,000), subject to customary conditions, to fund our working
capital requirements and for general corporate purposes. The senior credit facility expires in
April 2007. Three of our subsidiaries are borrowers under the senior credit facility and we,
Golfsmith and our other subsidiaries fully and unconditionally guarantee the senior credit
facility. Borrowings under our credit facility are secured by a pledge of our inventory,
receivables, and certain other assets. The credit agreement provides for same-day funding of the
revolver, as well as letters of credit up to a maximum of $1 million. Borrowings under the credit
facility may be made, at our option, as either an index rate loan or a LIBOR rate loan. Index rate
loans bear interest at the higher of (1) the Wall Street Journal posted base rate on corporate
loans or (2) the federal funds rate, in each case plus 1%. LIBOR rate loans bear interest at a rate
based on LIBOR plus 2.5%. A fee of 2.5% per annum of the amount available under outstanding letters
of credit is due and payable monthly. We are also required to pay a monthly commitment fee equal to
0.5% of the undrawn availability, as calculated under the agreement.
Available amounts under the senior credit facility are based on a borrowing base. The
borrowing base is limited to 85% of the net amount of eligible receivables, as defined in the
credit agreement, plus the lesser of (i) 65% of the value of eligible inventory and (ii) 60% of the
net orderly liquidation value of eligible inventory, and minus $2.5 million, which is an
availability block used to calculate the borrowing base.
In March 2005, several financial covenants in the senior credit facility were amended. The
limit on capital expenditures in each fiscal year was increased to the greater of (a) one-third of
our EBITDA (as defined in the senior credit facility) in the immediately preceding fiscal year and
(b) the sum of: (i) $12.0 million, (ii) the amount, if any, of the excess cash flow offer (as
described above under Liquidity and Capital Resources Senior Secured Notes) made and not
accepted by the holders of the senior secured notes during the immediately preceding fiscal year,
and (iii) any amounts, up to an aggregate of $1,000,000, previously permitted to be made as capital
expenditures that have not previously been made as capital expenditures. In addition, the covenants
regarding minimum interest coverage ratios and minimum earnings levels were removed for the fiscal
period ending on or about September 30, 2004 and all fiscal periods thereafter. Finally, the
definition of borrowing base in the senior credit facility was amended to include an availability
block of $2.5 million, as used to calculate the borrowing base under the senior credit facility.
Due to our accelerated growth plans, we believe that the modification of the capital
expenditure limit better matches our currently projected cash needs. We do not believe that the
addition of the availability block described above will materially impact our borrowing
availability in fiscal 2005. As of October 1, 2005, we had $2.9 million in borrowings outstanding,
and $9.1 million of borrowing availability after giving effect to required reserves of $500,000
under the credit agreement and we believe we were in compliance with the covenants contained in the
senior credit facility.
Borrowings under our senior credit facility typically increase as working capital increases in
anticipation of the important selling periods in late spring and in advance of the Christmas
holiday, and then decline following these periods. In the event sales results are less than
anticipated and our working capital requirements remain constant, the amount available under the
credit facility may not be adequate to satisfy our needs. If this occurs, we may not succeed in
obtaining additional financing in sufficient amounts and on acceptable terms.
Capital Expenditures
Subject to our ability to generate sufficient cash flow, in fiscal year 2005 we currently plan
to spend $11.0 million to $13.0 million on corporate projects, to open additional stores and/or to
retrofit, update or remodel existing stores, of which $9.2 million was expended during the nine
months ended October 1, 2005.
21
Contractual Obligations
Our future contractual obligations related to long-term debt, noncancellable operating leases
and purchase obligations at October 1, 2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
Contractual |
|
|
|
|
|
Less than |
|
|
|
|
|
|
|
|
|
|
After 5 |
|
Obligations |
|
Total |
|
|
1 Year |
|
|
1-3 Years |
|
|
4-5 Years |
|
|
Years |
|
|
|
(in thousands) |
|
Long-term debt (1) |
|
$ |
93,750 |
|
|
$ |
|
|
|
$ |
18,750 |
|
|
$ |
75,000 |
|
|
$ |
|
|
Operating leases |
|
$ |
125,619 |
|
|
$ |
15,946 |
|
|
$ |
30,727 |
|
|
$ |
27,088 |
|
|
$ |
51,858 |
|
Purchase obligations (2) |
|
$ |
4,505 |
|
|
$ |
3,326 |
|
|
$ |
786 |
|
|
$ |
393 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
223,874 |
|
|
$ |
19,272 |
|
|
$ |
50,263 |
|
|
$ |
102,481 |
|
|
$ |
51,858 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Long-term debt represents principal payments required to be made on the senior
secured notes. Interest payments on the notes are required semi-annually and are
calculated at 8.375% of the aggregate principal amount at maturity of notes then
outstanding. |
|
(2) |
|
Purchase obligations consist of minimum royalty payments and services and goods we
are committed to purchase in the ordinary course of business. Purchase obligations do not
include contracts we can terminate without cause with little or no penalty to us. |
We expect that our principal uses of cash for the next several years will be interest payments
on the senior secured notes and our senior credit facility, capital expenditures, primarily for new
store openings and existing store updates and remodels, possible acquisitions (to the extent
permitted by the lenders under our senior credit facility and under the indenture governing the
notes), working capital requirements and our contractually obligated operating lease payments. We
expect to spend approximately $1.5 million to open each additional superstore, which includes
pre-opening expenses, capital expenditures and inventory costs. Additionally, Golfsmith is required
to (1) offer to repurchase a portion of the senior secured notes at 100% of their accreted value
within 120 days after the end of each fiscal year with 50% of our excess cash flow, as defined in
the indenture governing the senior secured notes, and (2) under certain circumstances, purchase
senior secured notes at 101% of their accreted value plus accrued and unpaid interest, if any, to
the date of purchase. As of the end of fiscal 2004, we determined that we did not have any excess
cash flow, as defined in the indenture, and we were thus not required to offer to repurchase any of
the notes. We believe that cash from operations combined with borrowing availability under our
senior credit facility will be sufficient to meet our expected debt service requirements, planned
capital expenditures and operating needs. However, we have limited ability to obtain additional
debt financing to fund working capital needs and capital expenditures should cash from operations
and from our senior credit facility be insufficient. As of October 1, 2005, we had $9.1 million of
borrowing availability under the senior credit facility after giving effect to required reserves of
$500,000. We believe that the financial support of our principal stockholder and the use of our
senior credit facility offer us potential funding avenues to meet working capital requirements.
Further, we believe discretionary cash outflows related to new store openings, store retrofittings,
advertising and capital expenditures can be adjusted accordingly if needed to meet working capital
requirements. If cash from operations and from our senior credit facility is not sufficient to meet
our needs, we cannot assure you that we will be able to obtain additional financing in sufficient
amounts and on acceptable terms. You should read the information set forth below under Additional
Factors That May Affect Future Results for a discussion of the risks affecting our operations.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, as defined by the rules and regulations of
the Securities and Exchange Commission.
22
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risks, which include changes in U.S. interest rates and, to a lesser
extent, foreign exchange rates. We do not engage in financial transactions for trading or
speculative purposes.
Interest Rate Risk
The interest payable on our senior credit facility is based on variable interest rates and is
therefore affected by changes in market interest rates. As of October 1, 2005, if the maximum
available under the credit facility of $12.5 million had been drawn and the variable interest rate
applicable to our variable rate debt had increased by ten percentage points, our interest expense
would have increased by $1.25 million on an annual basis, thereby materially affecting our results
from operations and cash flows. Our interest rate risk objectives are to limit the impact of
interest rate fluctuations on earnings and cash flows and to lower our overall borrowing costs. To
achieve these objectives, we manage our exposure to fluctuations in market interest rate for a
portion of our borrowings through the use of fixed rate debt instruments to the extent that
reasonably favorable rates are obtainable with such arrangements. We may enter into derivative
financial instruments such as interest rate swaps or caps and treasury options or locks to mitigate
our interest rate risk on a related financial instrument or to effectively fix the interest rate on
a portion of our variable rate debt. Currently, we are not a party to any derivative financial
instruments. We do not enter into derivative or interest rate transactions for speculative
purposes. We regularly review interest rate exposure on our outstanding borrowings in an effort to
minimize the risk of interest rate fluctuations.
Foreign Currency Risks
We purchase a significant amount of products from outside of the U.S. However, these purchases
are primarily made in U.S. dollars and only a small percentage of our international purchase
transactions are in currencies other than the U.S. dollar. Any currency risks related to these
transactions are deemed to be immaterial to us as a whole.
We operate a fulfillment center in Toronto, Canada and a sales, marketing and fulfillment
center near London, England, which exposes us to market risk associated with foreign currency
exchange rate fluctuations. At this time, we do not manage the risk through the use of derivative
instruments. A 10% adverse change in foreign currency exchange rates would not have a significant
impact on our results of operations or financial position.
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FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning
of the federal securities laws. Statements that are not historical facts, including statements
about our beliefs and expectations, are forward-looking statements. Forward-looking statements
include statements preceded by, followed by or that include the words may, could, would,
should, believe, expect, anticipate, plan, estimate, target, project, intend, or
similar expressions. These statements include, among others, statements regarding our expected
business outlook, anticipated financial and operating results, our business strategy and means to
implement the strategy, our objectives, the amount and timing of future store openings, store
retrofits and capital expenditures, the likelihood of our success in expanding our business,
financing plans, working capital needs and sources of liquidity.
Forward-looking statements are only predictions and are not guarantees of performance. These
statements are based on our managements beliefs and assumptions, which in turn are based on
currently available information. Important assumptions relating to the forward-looking statements
include, among others, assumptions regarding demand for our products, the introduction of new
product offerings, store opening costs, our ability to lease new sites on a timely basis, expected
pricing levels, the timing and cost of planned capital expenditures, competitive conditions and
general economic conditions. These assumptions could prove inaccurate. Forward-looking statements
also involve risks and uncertainties, which could cause actual results that differ materially from
those contained in any forward-looking statement. Many of these factors are beyond our ability to
control or predict. Such factors include, but are not limited to, the factors set forth below under
Additional Factors That May Affect Future Results.
We believe our forward-looking statements are reasonable; however, undue reliance should not
be placed on any forward-looking statements, which are based on current expectations. Further,
forward-looking statements speak only as of the date they are made, and we undertake no obligation
to update publicly any of them in light of new information or future events.
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Additional Factors That May Affect Future Results
Our success depends on the continued popularity of golf and the growth of the market for
golf-related products. If golf declines in popularity, our sales could materially decline.
We generate substantially all of our net revenues from the sale of golf-related equipment,
apparel and accessories. The demand for our golf products is directly related to the popularity of
golf, the number of golf participants and the number of rounds of golf being played by these
participants. If golf participation decreases, sales of our products would be adversely affected.
In addition, the popularity of golf organizations, such as the Professional Golfers Association,
also affects the sales of our golf equipment and golf-related apparel and accessories. We depend on
the exposure of our brands to increase brand recognition and reinforce the quality of our products.
Any significant reduction in television coverage of PGA or other golf tournaments, or any other
significant decreases in either attendance at golf tournaments or viewership of golf tournaments,
will reduce the visibility of our brand and could adversely affect our sales.
In addition, we do not believe there has been any material increase in golf participation or
the number of golf rounds played since 1999. The number of rounds played in the U.S. dropped to 495
million in 2003 from 518 million in 2000, perhaps reflecting the general decline in the U.S.
economy. We believe that the golf industry did not experience growth in 2004. Golf Datatech has
reported that the number of golf rounds played in the United States declined 0.1% in 2004 as
compared to 2003. Additionally, Golf Datatech has reported that the number of golf rounds played in
the United States declined 0.1% in the nine months ended September 30, 2005 as compared to the same
period in 2004. We cannot assure you that the overall dollar volume of the worldwide market for
golf-related products will grow, or that it will not decline, in the future.
We may not be able to borrow additional funds, if needed, to expand our business or compete
effectively and, as a result, our net revenues and profitability may be materially adversely
affected.
The indenture governing the senior secured notes and our senior credit facility limit almost
completely our ability to borrow additional funds. We believe that the terms of the liens securing
our senior credit facility and the senior secured notes effectively preclude us from borrowing
additional funds, other than under our senior credit facility. As a result, to the extent that we
do not have borrowing availability under our senior credit facility, we will have to fund our
operations, including new store openings and capital expenditures as well as any future
acquisitions, with cash flow from operations. If we do not generate sufficient cash flow from our
operations to fund these expenditures, we may not be able to compete effectively and our sales and
profitability would likely be materially adversely affected.
A reduction in discretionary consumer spending could reduce sales of our products.
Our products are recreational in nature and are therefore discretionary purchases for
consumers. Consumers are generally more willing to make discretionary purchases of golf and tennis
products during favorable economic conditions. Discretionary spending is affected by many factors,
including, among others, general business conditions, interest rates, the availability of consumer
credit, taxation, and consumer confidence in future economic conditions. Our customers purchases
of discretionary items, including our products, could decline during periods when disposable income
is lower, or periods of actual or perceived unfavorable economic conditions. Any significant
decline in these general economic conditions or uncertainties regarding future economic prospects
that adversely affect discretionary consumer spending could lead to reduced sales of our products.
In addition, our sales could be adversely affected by a downturn in the economic conditions in the
markets in which our superstores operate.
Our sales and profits may be adversely affected if we and our suppliers fail to successfully
develop and introduce new products.
Our future success will depend, in part, upon our and our suppliers continued ability to
develop and introduce innovative products in the golf equipment market. The success of new
products depends in part upon the various subjective preferences of golfers, including a golf
clubs look and feel, and the level of acceptance that a golf club has among professional and
recreational golfers. The subjective preferences of golf club purchasers are difficult to predict
and may be subject to rapid and unanticipated changes. If we or our suppliers fail to successfully
develop and introduce innovative products on a timely basis, then our sales and profits may suffer.
In addition, if we or our suppliers introduce new golf clubs too rapidly, it could result in
close-outs of existing inventories. Close-outs can result in reduced margins on the sale of older
products, as well as reduced sales of new products given the availability of older products at
lower prices. These reduced margins and sales may adversely affect our results of operations.
25
Our sales and profitability may be adversely affected if new competitors enter the golf products
industry.
Increased competition in our markets due to the entry of new competitors, including companies
that currently supply us with products that we sell, could reduce our net revenues. Our competitors
currently include other specialty retailers, mass merchandise retailers, conventional sporting
goods retailers, on-course pro shops, and online retailers of golf equipment. These businesses
compete with us in one or more product categories. In addition, traditional and specialty golf
retailers are expanding more aggressively in marketing brand-name golf equipment, thereby competing
directly with us for products, customers and locations. Some of these potential competitors have
been in business longer than we have and/or have greater financial or marketing resources than we
do and may be able to devote greater resources to sourcing, promoting and selling their products.
As a result of this competition, we may experience lower sales or greater operating costs, such as
marketing costs, which would have an adverse effect on our profitability.
New superstores that we may open may divert our limited capital resources away from other areas of
our business and may not be profitable, which could adversely affect the profitability of our
company as a whole.
Our strategy involves opening additional superstores in new and existing markets. During the
nine months ended October 1, 2005, we opened eight new stores, which consisted of six new stores
and two relocated stores, incurring $1.7 million in related pre-opening expenses and $4.1 million
in related capital expenditures. There are no plans to open any superstores during the fourth
quarter of fiscal 2005. We expect to spend $1.5 million to open each additional superstore, which
includes pre-opening expenses, capital expenditures and inventory costs. This amount is an estimate
and actual store opening costs may vary. We intend to fund new store openings through cash flow
from operations. Our senior credit facility and the indenture governing our senior secured notes
significantly restrict our ability to incur indebtedness and to make capital expenditures. We may
not have or be able to obtain sufficient funds to fund our planned expansion.
Our ability to open new stores on a timely and profitable basis is subject to various
contingencies, some of which are beyond our control. These contingencies include our ability to
locate suitable store sites, negotiate acceptable lease terms, build-out or refurbish sites on a
timely and cost-effective basis, hire, train and retain skilled managers and personnel, obtain
adequate capital resources and successfully integrate new stores into existing operations. We
cannot assure you that our new stores will be a profitable deployment of our limited capital
resources. If any of our new stores are not profitable, then the profitability of our company as a
whole may be adversely affected.
Our expansion in new and existing markets, if unsuccessful, could cause our operating income to
decrease.
Our expansion in new and existing markets may present competitive, distribution, and
merchandising challenges that differ from our current challenges, including competition among our
stores clustered in a single market, diminished novelty of our store design and concept, added
strain on our distribution center and management information systems and diversion of management
attention from existing operations. To the extent that we are not able to meet these new
challenges, our operating income could decrease.
If we do not accurately predict our sales during our peak seasons and they are lower than we
expect, our profitability may be materially adversely affected.
Our business is seasonal. Our sales leading up to and during the warm weather golf season and
the Christmas holiday gift-giving season have historically contributed a higher percentage of our
annual net revenues and annual net operating income than other periods in our fiscal year. During
fiscal 2004, the fiscal months of March through September and December, which together comprise 36
weeks of our 52-week fiscal year, contributed over three-quarters of our annual net revenues and
substantially all of our annual operating income. We make decisions regarding merchandise well in
advance of the season in which it will be sold. We incur significant additional expenses leading up
to and during these periods in anticipation of higher sales in these periods, including acquiring
additional inventory, preparing and mailing our catalogs, advertising, creating in-store promotions
and hiring additional employees. If our sales during our peak seasons are lower than we expect for
any reason, we may not be able to adjust our expenses in a timely fashion. As a result, our
profitability may be materially adversely affected.
If the products we sell do not satisfy the standards of the United States Golf Association and the
Royal and Ancient Golf Club of St. Andrews in the future, our net revenues attributable to those
products and our profitability may be reduced.
We and our suppliers generally seek to satisfy the standards established by the United States
Golf Association and the Royal and Ancient Golf Club of St. Andrews in the design of golf clubs
because these standards are generally followed by golfers within their respective geographic areas.
We believe that all of the products we sell conform to these standards, except where expressly
marketed as non-conforming. However, we cannot assure you that our products will satisfy these
standards in the future or that the
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standards of these organizations will not be changed in a way that makes our products
non-conforming. If our products that are intended to conform are determined to be non-conforming,
our net revenues attributable to those products and, as a result, our profitability may be reduced.
We lease most of our superstore locations. If we are unable to maintain those leases or locate
alternative sites for our superstores on terms that are acceptable to us, our net revenues and
profitability could be reduced.
We lease 51 of our 52 current superstores. In the nine months ended October 1, 2005, we closed
two stores when their leases expired. In both instances, we opened a new superstore in 2005 in
order to serve the same customer base of the closed stores. We cannot assure you that we will be
able to maintain our existing store locations as leases expire, or that we will be able to locate
alternative sites on favorable terms. If we cannot maintain our existing store locations or locate
alternative sites on favorable or acceptable terms, our net revenues and profitability could be
reduced.
Our comparable store sales may fluctuate, which could negatively impact our future operating
performance.
Our comparable store sales are affected by a variety of factors, including, among others:
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customer demand in different geographic regions; |
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our ability to efficiently source and distribute products; |
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changes in our product mix; |
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effects of competition; |
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our ability to effectively execute our business strategy; and |
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general economic conditions. |
Our comparable store sales have fluctuated significantly in the past and we believe that such
fluctuations may continue. Our historic results are not necessarily indicative of our future
results, and we cannot assure you that our comparable store sales will not decrease again in the
future. Any reduction in or failure to increase our comparable store sales could negatively impact
our future operating performance.
If we fail to accurately target the appropriate segment of the consumer catalog market or if we
fail to achieve adequate response rates to our catalogs, our results of operations may suffer.
Our results of operations depend in part on the success of our direct-to-consumer distribution
channels, which consist of our catalog and Internet operations. Our direct-to-consumer distribution
channels accounted for 26.1% and 28.8% of our net revenues for the nine-month periods ended October
1, 2005 and October 2, 2004, respectively. Within our direct-to-consumer distribution channels, the
success of our catalog operations also contributes to the success of our Internet operations, as
many of our customers who receive catalogs choose to purchase products through our website. We
believe that the success of our catalog and Internet operations depends on our ability to:
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achieve adequate response rates to our mailings; |
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continue to offer a merchandise mix that is attractive to our mail order customers; |
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cost-effectively add new customers; |
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cost-effectively design and produce appealing catalogs; and |
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timely deliver products ordered through our catalogs to our customers. |
We have historically experienced fluctuations in the response rates to our catalog mailings.
If we fail to achieve adequate response rates, we could experience lower sales, significant
markdowns or write-offs of inventory and lower margins, which would adversely affect our results of
operations, perhaps materially.
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If we are unable to meet our labor needs, our performance will suffer.
Many of our employees are in entry-level or part-time positions that historically have high
rates of turnover. We may be unable to meet our labor needs and control our costs due to external
factors such as unemployment levels, minimum wage legislation, and wage inflation. If we cannot
attract and retain quality employees, our performance will suffer and we may not be able to
successfully execute our strategy to open new superstores.
If we lose the services of our chief executive officer, we may not be able to manage our operations
and implement our growth strategy effectively.
Our future success depends, in large part, on the continued service of James Thompson, our
president and chief executive officer, who possesses significant expertise and knowledge of our
business and markets. We do not maintain key person insurance on any of our officers or managers.
We have entered into an employment agreement with Mr. Thompson that expires, subject to automatic
one-year extensions, in October 2006. Any loss or interruption of the services of Mr. Thompson
prior to or upon expiration of his employment agreement could significantly reduce our ability to
effectively manage our operations and implement our growth strategy because we cannot assure you
that we would be able to find an appropriate replacement should the need arise.
We are controlled by one stockholder, which may give rise to a conflict of interest.
As of October 1, 2005, Atlantic Equity Partners III, L.P. owned 74.3% of our common stock on a
fully diluted basis, including outstanding stock options. All of our stockholders are parties to a
stockholders agreement that contains voting arrangements that give Atlantic Equity Partners III
voting control over the election of all but one of our directors. As a result, Atlantic Equity
Partners III controls us and effectively has the power to approve any action requiring the approval
of the holders of our stock, including adopting certain amendments to our certificate of
incorporation and approving mergers or sales of all of our assets. In addition, as a result of
Atlantic Equity Partners IIIs ownership interest, conflicts of interest could arise with respect
to transactions involving business dealings between us and Atlantic Equity Partners III or First
Atlantic Capital Ltd., which operates Atlantic Equity Partners III, potential acquisitions of
businesses or properties, the issuance of additional securities, the payment of dividends by us and
other matters.
If we are unable to enforce our intellectual property rights, or if we are accused of infringing on
a third partys intellectual property rights, our net revenues and profits may decline.
We currently hold a substantial number of registrations, trademarks and servicemarks. The
exclusive right to use these registrations, trademarks and servicemarks has helped establish our
market share. Our registrations are valid as long as they are properly maintained and the
registered marks have not become generic or abandoned or the registrations obtained fraudulently.
Our trademarks and servicemarks are generally valid as long as they are properly in use in
commerce. The loss or reduction of any of our significant proprietary rights could hurt our ability
to distinguish our products from competitors products and retain our market share. In addition,
our proprietary products generate higher margins than products we sell that are produced by other
manufacturers. If we are unable to effectively protect our proprietary rights and less of our sales
come from our proprietary products, our net revenues and profits may decline.
Additionally, third parties may assert claims against us alleging infringement,
misappropriation or other violations of patent, trademark or other proprietary rights, whether or
not such claims have merit. Such claims can be time consuming and expensive to defend and could
require us to cease using and selling the allegedly infringing products, which may have a
significant impact on our net revenues and cause us to incur significant litigation costs and
expenses.
Self-insured benefits plan claims could materially impact our results of operations.
We administer self-insured, voluntary employee benefits plans that provide, among other
benefits, health care benefits to participating employees. The plans are designed to provide
specified levels of coverage up to $75,000 per covered employee, with excess insurance coverage
provided by a commercial insurer. Costs of health care have risen significantly in recent years,
and we expect this trend to continue. Our expenses and, consequently, our results of operations,
could be materially impacted by claims and other expenses related to such plans.
We rely on our management information systems for inventory management, distribution and other
functions. If our information systems fail to adequately perform these functions or if we
experience an interruption in their operation, our business and results of operations could be
adversely affected.
The efficient operation of our business is dependent on our management information systems. We
rely on our management
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information systems to effectively manage order entry, order fulfillment, point-of-sale, and
inventory replenishment processes. We experienced implementation problems with our current
management information system in 2000, when slowdowns in or lack of availability to the system
resulted in decreased sales, increased overhead costs, excess inventory and product shortages. The
failure of our management information systems to perform as we anticipate, as experienced when we
implemented our current system in 2000, could disrupt our business and could result in decreased
sales, increased overhead costs, excess inventory and product shortages, causing our business and
results of operations to suffer.
In addition, our management information systems are vulnerable to damage or interruption from:
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earthquake, fire, flood and other natural disasters; and |
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power loss, computer systems failure, Internet and telecommunications or data network failure. |
Any such interruption could have a material adverse effect on our business.
Our profitability would be adversely affected if the operation of our Austin call center or
distribution center were interrupted or shut down.
We operate a centralized call center and distribution center in Austin, Texas. We receive most
of our catalog orders and receive and ship a substantial portion of our merchandise at our Austin
facility. Any natural disaster or other serious disruption to this facility due to fire, tornado or
any other cause would substantially disrupt our sales and would damage a portion of our inventory,
impairing our ability to adequately stock our stores. In addition, we could incur significantly
higher costs and longer lead times associated with fulfilling our direct-to-consumer orders and
distributing our products to our stores during the time it takes for us to reopen or replace our
Austin facility. As a result, a disruption at our Austin facility would adversely affect our
profitability.
If our suppliers fail to deliver products on a timely basis and in sufficient quantities, such
failure could have a material adverse effect on our operations.
We depend on a limited number of suppliers for our clubheads and shafts. In addition, some of
our products require specifically developed manufacturing techniques and processes which make it
difficult to identify and utilize alternative suppliers quickly. Any significant production delay
or inability of current suppliers to timely deliver products including clubheads and shafts in
sufficient quantities, or the transition to other suppliers, could have a material adverse effect
on our results of operations. We do not have any long-term supply contracts with these suppliers.
We import substantially all of our proprietary products from Asia under short-term purchase
orders, and a significant amount of the products we buy from vendors to resell through our
distribution channels is shipped to us from Asia. If a disruption occurs in the operations of ports
through which our products are imported, we may begin to ship some of our products from Asia by air
freight, and many of our suppliers may also begin to ship their products by air freight. Shipping
by air freight is more expensive than shipping by boat, and if we cannot pass these increased
shipping costs on to our customers, our profitability will be reduced. A disruption at ports
through which our products are imported would have a material adverse effect on our results of
operations.
We may be subject to product warranty claims or product recalls which could harm our business,
results of operations, and reputation.
We may be subject to risks associated with our products, including product liability. Our
existing or future products may contain design or materials defects, which could subject us to
product liability claims and product recalls. Although we maintain limited product liability
insurance, if any successful product liability claim or product recall is not covered by or exceeds
our insurance coverage, our business, results of operations and financial condition would be
harmed. In addition, product recalls could adversely affect our reputation in the marketplace.
An increase in the costs of mailing, paper, and printing our catalogs would decrease our net
income.
Postal rate increases and paper and printing costs affect the cost of our catalog mailings. We
rely on discounts from the basic postal rate structure such as discounts for bulk mailings and
sorting by zip code and carrier routes for our catalogs. We are not a party to any long-term
contracts for the supply of paper. Our cost of paper has fluctuated significantly during the past
three fiscal years, and our future paper costs are subject to supply and demand forces external to
our business. A material increase in postal rates, such as the announced 2006 postal rate increase
of 5.4%, or printing or paper costs for our catalogs could materially decrease our net income.
29
A disruption in the service of our primary delivery service for our direct-to-consumer sales may
decrease our profitability.
During the nine-month periods ended October 1, 2005 and October 2, 2004, we generated 26.1%
and 28.8%, respectively, of our net revenues through our direct-to-consumer sales channels. We use
United Parcel Service, or UPS, for substantially all of our ground shipments of products sold
through our catalogs and Internet site to our customers in the United States. Any significant
interruption in UPSs services would impede our ability to deliver our products through our
direct-to-consumer channels, which could cause us to lose sales and/or customers. In the event of
an interruption in UPSs services, we may not be able to engage alternative carriers to deliver our
products in a timely manner on equally favorable terms. If we incur higher shipping costs, we may
be unable to pass these costs on to our customers, which could decrease our profitability.
Current and future tax regulations may adversely affect our direct-to-consumer business and
negatively impact our results of operations.
Our direct-to-consumer business may be adversely affected by state sales and use taxes as well
as the regulation of Internet commerce. We currently must collect taxes for approximately half of
our catalog and Internet sales. An unfavorable change in state sales and use taxes could adversely
affect our business and results of operations. In addition, future regulation of the Internet,
including the imposition of taxes on Internet commerce, could affect the development of our
Internet business and negatively affect our ability to increase our net revenues.
If we do not anticipate and respond to the changing preferences of our customers, our revenues
could significantly decline and we could be required to take significant markdowns in inventory.
Our success depends, in large part, on our ability to identify and anticipate the changing
preferences of our customers and stock our stores with a wide selection of quality merchandise that
appeals to their preferences. Our customers preferences for merchandise and particular brands vary
from location to location, and may vary significantly over time. We cannot guarantee that we will
accurately identify or anticipate the changing preferences of our customers or stock our stores
with merchandise that appeals to them. If we do not accurately identify and anticipate our
customers preferences, we may lose sales or we may overstock merchandise, which may require us to
take significant markdowns on our inventory. In either case, our revenues could significantly
decline and our business and financial results may suffer.
We may incur material costs or liabilities under environmental laws, which may materially adversely
affect our results of operations.
We are subject to various foreign, federal, state, and local environmental protection,
chemical control, and health and safety laws and regulations. We own and lease real property, and
some environmental laws hold current or previous owners or operators of businesses and real
property liable for contamination on or originating from that property, even if they did not know
of and were not responsible for the contamination. The presence of hazardous substances on any of
our properties or the failure to meet environmental regulatory requirements may materially
adversely affect our ability to use or to sell the property or to use the property as collateral
for borrowing, and may cause us to incur substantial remediation or compliance costs. If hazardous
substances are released from or located on any of our properties, we could incur substantial
liabilities through a private party personal injury or property damage claim or a claim by a
governmental entity for other damages.
In addition, some of the products we sell contain hazardous or regulated substances, such as
solvents and lead. Environmental laws may impose liability on any person who disposes of hazardous
substances, regardless of whether the disposal site is owned or operated by such person.
If we incur material costs or liabilities in the future under environmental laws for any
reason, our results of operations may be materially adversely affected.
Our sales could decline if we are unable to process increased traffic on our website or to prevent
unauthorized security breaches.
A key element of our strategy is to generate a high volume of traffic on, and use of, our
website. Accordingly, the satisfactory performance, reliability and availability of our website,
transaction processing systems and network infrastructure are critical to our reputation and our
ability to attract and retain customers, as well as maintain adequate customer service levels. Our
Internet revenues will depend on the number of visitors who shop on our website and the volume of
orders we can fill on a timely basis. Problems with our website or order fulfillment performance
would reduce the volume of goods sold and the attractiveness of our merchandise and could also
adversely affect consumer perception of our brand name. We may experience periodic system
interruptions from time to time. If there is a substantial increase in the volume of traffic on our
website or the number of orders
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placed by customers, we may be required to expand and upgrade further our technology,
transaction processing systems and network infrastructure. There can be no assurance that we will
be able to accurately project the rate or timing of increases, if any, in the use of our website,
or that we will be able to expand and upgrade our systems and infrastructure to accommodate such
increases on a timely basis.
The success of our website depends on the secure transmission of confidential information over
public networks. We rely on encryption and authentication technology licensed from third parties to
provide the security and authentication necessary to effect secure transmission of confidential
information, such as customer credit card numbers. In addition, we maintain an extensive
confidential database of customer profiles and transaction information. There can be no assurance
that advances in computer capabilities, new discoveries in the field of cryptography, or other
events or developments will not result in a compromise or breach of the algorithms we use to
protect customer transaction and personal data contained in our customer database. If any such
compromise of our security were to occur, it could have a material adverse effect on our
reputation, business, operating results and financial condition. A party who is able to circumvent
our security measures could misappropriate proprietary information or cause interruptions in our
operations. We may be required to expend significant capital and other resources to protect against
such security breaches or to alleviate problems caused by such breaches.
We may pursue strategic acquisitions, which could have an adverse impact on our business.
We intend to evaluate opportunities to acquire complementary companies or businesses in the
future. Acquisitions that we may make in the future entail a number of risks that could materially
and adversely affect our business and operating results, including:
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problems integrating operations that have different personnel, corporate culture,
financial systems, distribution, operations and general store operating procedures; |
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the diversion of capital and our managements time and attention from existing business operations; |
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risks associated with entering markets in which we lack prior experience; and |
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the need for financial resources above our planned investment levels. |
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Item 4. Controls and Procedures
Disclosure Controls and Procedures. Under the supervision and with the participation of our
management, including our principal executive officer and principal financial and accounting
officer, we conducted an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report
(the Evaluation Date). Based on this evaluation, our principal executive officer and principal
financial officer concluded as of the Evaluation Date that our disclosure controls and procedures
were effective such that the information relating to our company, including our consolidated
subsidiaries, required to be disclosed in our Securities and Exchange Commission (SEC) reports
(i) is recorded, processed, summarized and reported within the time periods specified in SEC rules
and forms, and (ii) is accumulated and communicated to our management, including our principal
executive officer and principal financial and accounting officer, as appropriate to allow timely
decisions regarding required disclosure.
Internal Control over Financial Reporting. During the nine months ended October 1, 2005, there
have been no changes in our internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, our internal control over financial
reporting.
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PART II: OTHER INFORMATION
Item 6. Exhibits
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10.1
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Golfsmith International, Inc. Annual Management Incentive Plan, effective as of
August 25, 2005 (incorporated by reference to Exhibit 10.1 to Golfsmith International
Holdings, Inc.s Current Report on Form 8-K (File No. 333-101117) filed on August 30,
2005) |
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10.2
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Golfsmith International, Inc.
Annual Management Incentive Plan Form of Individual Notice of Award,
effective as of August 25, 2005 (incorporated by reference to Exhibit
10.2 to Golfsmith International Holdings, Inc.s Current Report on Form
8-K (File No. 333-101117) filed on August 30, 2005) |
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31.1
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Rule 13a-14(a)/15d-14(a) Certification of James D. Thompson |
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31.2
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Rule 13a-14(a)/15d-14(a) Certification of Virginia Bunte |
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32.1
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Certification of James D. Thompson Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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32.2
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Certification of Virginia Bunte Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
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GOLFSMITH INTERNATIONAL HOLDINGS, INC. |
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By:
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/s/ James D. Thompson |
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James D. Thompson |
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Chief Executive Officer, President and Director |
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(Principal Executive Officer and Authorized Signatory) |
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Date: November 15, 2005 |
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By:
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/s/ Virginia Bunte |
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Virginia Bunte |
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Chief Financial Officer |
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(Principal Accounting Officer and Authorized Signatory) |
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Date: November 15, 2005 |
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