Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis provides information that we believe is
relevant to an assessment and understanding of our results of operation and
financial condition. You should read this analysis in conjunction with the
attached consolidated condensed financial statements and related notes thereto,
and with the audited consolidated financial statements and notes thereto for the
year ended November 30, 2003 included in our Annual Report on Form 10-KSB.
INITIAL PUBLIC OFFERING DURING FIRST QUARTER OF FISCAL 2004
On December 17, 2003, we completed an IPO of 2.5 million shares of common stock.
The proceeds received in the first quarter of fiscal 2004 from the stock
offering were $10.9 million, net of offering expenses; additional offering
expenses of $0.5 million relating to this IPO were incurred and paid in fiscal
2003. Proceeds have been or will be used to pay off outstanding obligations,
develop new infomercials, fund advertising and promotion campaigns, implement a
total enterprise information and financial system and for working capital and
other general corporate purposes. The implementation and related impact of the
advertising campaigns will begin in the third quarter of fiscal 2004. Due to a
lack of adequate capital during the past couple of years, we had to curtail our
advertising and marketing activities. Additionally, in order to continue
operations in the past couple of years we needed to utilize certain financial
instruments that were extremely costly and dilutive. Given the capital infusion
from the IPO and its effect on our ability to run our operations, we believe
that our past performance is not necessarily indicative of future operations.
OVERVIEW
We are a golf instruction and equipment company focused on delivering a total
system for improving the play of golfers of all abilities. We produce and sell
instructional video tapes explaining our Natural Golf swing system, offer golf
schools through a network of instructors certified to teach the Natural Golf
system, and manufacture and sell golf equipment specifically developed for the
golfer using the Natural Golf swing system.
Profitability of our operations has been and will continue to be determined by
our ability to acquire customers in a cost-effective manner through infomercials
and the use of other media, and to generate sufficient follow-on sales of our
products and services through the use of various direct marketing techniques.
LIQUIDITY AND CAPITAL RESOURCES
Our financing activities resulted in net cash of $7.5 million in the first six
months of fiscal 2004 as we completed an IPO in December 2003. During the past
few years, a significant portion of management's time has been expended to raise
funds. Additionally, due to the limited financing available to us, we were
required to incur debt with expensive rates of interest and dilutive warrant
features. As contemplated in the prospectus, substantially all of this debt has
been repaid, using cash of $3.6 million during the first six months of fiscal
2004, plus another $0.4 million subsequent to May 31, 2004. Also in the first
six months of fiscal 2004, we paid approximately $1.6 million to satisfy past
due obligations to vendors. As such, these transactions significantly changed
our financial position. Our working capital deficit was $6.3 million as of
November 30, 2003. We had a working capital surplus of $1.4 million as of May
31, 2004. Our cash balance increased from $400 at November 30, 2003 to $989,000
as of May 31, 2004.
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NATURAL GOLF CORPORATION AND SUBSIDIARIES
We incurred net losses of $4.5 million and $2.5 million for the first six months
of fiscal 2004 and 2003, respectively, and negative cash flow from operations of
$6.4 million for the first six months of fiscal 2004 and $0.2 million for the
first six months of fiscal 2003. Prior to our IPO, a substantial portion of our
operations was financed by the issuance of equity instruments attached to debt
financing that resulted in significant interest charges. While these were
non-cash charges, they still resulted in significant expenses being reported in
our Statements of Operations. The cash used in operations for the first six
months of fiscal 2004 and 2003 reflects $1.0 million and $0.5 million,
respectively, of non-cash interest expense resulting from the amortization of
debt discount and deferred financing costs related to these financing
transactions. The cash used in operations for the first six months of fiscal
2004 also includes $0.5 million of non-cash expenses related to the issuance of
warrants to purchase 175,000 shares of common stock at an exercise price of
$4.00 per share to holders of certain investor notes during the first quarter.
The cash used in operations for the first six months of fiscal 2003 includes
$0.6 million of non-cash expenses related to the expected issuance of common
stock and options in payment of talent services related to an infomercial. In
addition to using proceeds from the IPO to pay off past due accounts payable and
accrued expenses mentioned earlier, we also used $1.2 million in fiscal 2004 to
prepay a commitment relating to a marketing agreement which will air subsequent
to May 31, 2004. We expect that an improvement in the effectiveness of our
marketing initiatives will yield enhanced cash flow results in the second half
of 2004. If there is delay in realizing these results, we may have to take other
steps to address our cash flow needs. These steps may include pursuing
additional financing. Although we incurred a net loss in the first six months of
fiscal 2003, the net change in assets and liabilities contributed positive cash
flow of $1.0 million in the first six months of fiscal 2003. The key reasons for
this change were an increase in accounts payable and accrued expenses and a
decrease in inventories in the first half of fiscal 2003, as we financed a
portion of our operations by extending payments to vendors and other service
providers and by reducing the level of inventory purchases due to our limited
access to cash during this period.
The profitability of future operations will be significantly affected by the
ability of the Company to profitably grow revenues and add new customers. The
primary drivers of any growth in second half of fiscal 2004 will be the response
by consumers to the television series on The Golf Channel which airs in the
third quarter and to our infomercial. The Company has no previous experience
with this type of television series. Additionally, the Company is expecting an
improvement in the effectiveness of its infomercial.
CONSOLIDATED RESULTS OF OPERATIONS
Comparison of Three Months Ended May 31, 2004 to Three Months Ended May 31, 2003
The following table sets forth operating results for the periods indicated. All
information is derived from the accompanying unaudited consolidated condensed
financial statements.
Three Months Ended May 31,
--------------------------------------------------------
% of % of
2004 Sales 2003 Sales
----------- ---------- ----------- ----------
Net sales $ 2,093,956 100.0 % $ 2,632,683 100.0 %
Gross profit 1,360,275 65.0 % 1,510,141 57.4 %
Operating expenses:
Selling expenses 1,592,803 76.1 % 1,606,692 61.0 %
General and administrative
expenses 1,110,866 53.1 % 662,365 25.2 %
Depreciation and amortization 95,172 4.5 % 72,654 2.8 %
----------- ---------- ----------- ----------
Total operating expenses $ 2,798,841 133.6 % $ 2,341,711 89.0 %
----------- ---------- ----------- ----------
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NATURAL GOLF CORPORATION AND SUBSIDIARIES
Net sales decreased $539,000, or approximately 20.5% for the second quarter of
fiscal 2004 compared to the second quarter of fiscal 2003. This decrease
resulted primarily from the follow-on sales of instruction services and
equipment after the promotion of our then new instruction package during the
first six months of fiscal 2003. In addition, just prior to the second quarter
of fiscal 2003 an extensive gift certificate program was initiated to drive
school and equipment sales. There was no such promotion during the first six
months of 2004, although a new instruction package and new equipment is
scheduled to be introduced in the third quarter of 2004. As a result, net sales
from instruction services declined by $243,000 in the second quarter of fiscal
2004 due to a 40% reduction in attending students. Additionally, equipment and
related accessory sales decreased $218,000 in the second quarter of fiscal 2004.
A significant portion of our equipment and related accessory sales are driven by
customer purchases of our golf instruction services. Media spending to acquire
new customers, although at comparable levels in the second quarter of 2004 and
the second quarter of fiscal 2003, generated about 15% less unit sales of
initial instruction packages in the second quarter of fiscal 2004. Net sales of
these instruction packages, however, were comparable due to a price promotion in
2003.
Gross profit percentage increased from 57.4% in the second quarter of fiscal
2003 to 65.0% in the second quarter of fiscal 2004. This increase was
attributable to an extensive gift certificate promotion in fiscal 2003 to drive
school and equipment sales. Overall gross profit declined only 10% in the second
quarter of fiscal 2004 compared to the 20.5% decline in sales due to the
aforementioned gift certificate promotion in 2003.
Operating expenses increased by $457,000 in the second quarter of fiscal 2004,
and increased as a percentage of net sales from 89.0% in the second quarter of
fiscal 2003 to 133.6% in the second quarter of fiscal 2004. The primary reasons
for this increased percentage were the decline in sales in the second quarter of
fiscal 2004 and the $448,000 increase in general and administrative expenses. Of
this increase, $370,000 relates to the building of the management team and
increased fees for professional services and insurance, each necessary to carry
out the increased responsibilities since becoming a public company in December
2003. Selling expenses decreased slightly in the second quarter of fiscal 2004,
but increased as a percentage of net sales from 61.0% in the second quarter of
fiscal 2003 to 76.1% in the second quarter of fiscal 2004. The marketing
expenditures were more effective in 2003, primarily due to the addition of a
significant number of new customers in early 2003, as well as the rejuvenation
of a significant number of existing customers in 2003, both brought about as the
result of the introduction of our then new instruction package. These customers
were greater in number and more receptive to our marketing for follow-on sales
of schools and equipment, compared to 2004. The 2003 marketing activities also
included the gift certificate promotion that was required to be reflected as an
additional cost of sales, reducing the gross profit, but not affecting the
selling percentage. Until our new infomercial for 2004 was produced and
initially aired the last week of May, we ran the prior year's version, which was
less effective than it had been the previous year. The 2004 marketing plan is
primarily weighted toward the third quarter based on the new infomercial and
television series.
Interest expense decreased $357,000 during the second quarter of fiscal 2004. A
significant amount of this interest expense incurred in both periods is non-cash
and relates to the amortization of deferred financing costs and debt discount
associated with various notes issued to fund our working capital requirements
prior to the closing of our initial public offering. Since we had paid off such
a significant amount of notes during the first quarter of fiscal 2004, there was
significantly less debt discount and deferred financing costs remaining to
amortize during the second quarter of fiscal 2004.
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NATURAL GOLF CORPORATION AND SUBSIDIARIES
Comparison of Six Months Ended May 31, 2004 to Six Months Ended May 31, 2003
The following table sets forth operating results for the periods indicated. All
information is derived from the accompanying unaudited consolidated condensed
financial statements.
Six Months Ended May 31,
% of % of
2004 Sales 2003 Sales
Net sales $ 3,464,666 100.0 % $ 4,957,005 100.0 %
Gross profit 2,206,356 63.7 % 2,933,244 59.2 %
Operating expenses:
Selling expenses 2,641,218 76.2 % 3,173,826 64.0 %
General and administrative
expenses 2,364,291 68.2 % 1,435,434 29.0 %
Depreciation and amortization 154,611 4.5 % 130,044 2.6 %
Total operating expenses $ 5,160,120 148.8 % $ 4,739,304 95.6 %
Net sales decreased $1,492,000, or approximately 30.1%, for the first six months
of fiscal 2004 compared to the same period for fiscal 2003. This decrease
resulted from the major introduction of our new instruction package just prior
to fiscal 2003, and its impact on follow-on sales of instruction services and
equipment in the first six months of fiscal 2003. Of the decrease in
consolidated net sales, $473,000 was from a decline in net sales of initial
instruction packages. Unit sales of the initial instruction kits sold to newly
acquired customers dropped about 40% from the first six months of fiscal 2003 to
the same period for fiscal 2004. In addition, while this product is usually sold
to new customers, the new version, because it was the first major change in a
few years, was promoted and sold at a discount in the first half of fiscal 2003
to a significant number of existing customers. For these reasons, as well as the
initiation of an extensive gift certificate program just prior to the second
quarter of fiscal 2003, follow-on sales of instruction services and equipment
also dropped significantly in the first six months of fiscal 2004. Net sales
from instruction services declined by $405,000 for the first six months of
fiscal 2004, as our school attendees dropped by 41%. Due to the lower amount of
newly acquired customers and school attendees, sales of equipment and related
accessories also declined by $526,000 in the first six months of fiscal 2004.
Gross profit percentage increased from 59.2% in the first six months of fiscal
2003 to 63.7% in the first six months of fiscal 2004. This increase was
primarily attributable to an extensive gift certificate promotion that was
launched during the first quarter of fiscal 2003 in order to drive school and
equipment sales.
Operating expenses increased by $421,000 in the first six months of fiscal 2004,
and increased as a percentage of net sales from 95.6% in the first six months of
fiscal 2003 to 148.8% for the same period in fiscal 2004. The primarily reasons
for this increased percentage were the decreased sales and the $929,000 increase
in general and administrative expenses in the first six months of fiscal 2004.
Of this increase, approximately $198,000 relates to non-cash equity charges.
Approximately $235,000 related to non-recurring charges due to the IPO and the
severance for a former executive. Additionally, $383,000 relates to the cost to
build the management team, increased fees for professional services, additional
insurance for directors & officers and other expenses pertinent to operating a
public company. Selling expenses decreased $533,000 in the first six months of
fiscal 2004 due to significant costs incurred in the first six months of fiscal
2003 relating to talent used in a new infomercial at that time. We developed a
new infomercial in the first six months of fiscal 2004, but the costs incurred
were significantly less. Although selling expenses decreased in the first six
months of fiscal 2004, they increased as a percentage of net sales from 64.0% in
the first six months of 2003 to 76.2% in the same period in fiscal 2004. The
primary reason for the increase was the greater impact made through the
introduction of our new instruction package in late fiscal 2002. Marketing
dollars spent in late fiscal 2002 and in early fiscal 2003 to promote this
product created a significant amount of new customers. These new customers, plus
existing customers who purchased this revised product, made significant
follow-on purchases of our instruction services and equipment products during
the first six months of fiscal 2003. Additionally, a gift certificate promotion
in 2003 also generated significant sales. During the first six months of fiscal
2004, we have developed a new instructional package that began shipping in the
third quarter.
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NATURAL GOLF CORPORATION AND SUBSIDIARIES
Interest expense increased by $821,000 for the first six months of fiscal 2004
compared to the similar period of 2003. Most of this interest expense incurred
in both periods is non-cash and relates to the amortization of deferred
financing costs and debt discount associated with various notes issued to fund
our working capital requirements prior to the closing of our initial public
offering. The significant increase is partly due to the fact that approximately
$494,000 more of this amortization occurred in the first six months of fiscal
2004 than in the same period in 2003. This is primarily because the amortization
associated with the $1.3 million of unsecured convertible notes payable to
foreign investors occurred subsequent to the first six months of fiscal 2003, as
the notes were issued during the second half of fiscal 2003. The significant
increase in interest expense also resulted from recording non-cash interest
expense of $474,000 in the first quarter of fiscal 2004 which reflected the fair
value of warrants to purchase our common stock issued to holders of certain
investor notes. This was required in accordance with a note provision upon the
consummation of a "financing event" such as our IPO.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The policies below are critical to our business operations and the understanding
of our results of operations. In the ordinary course of business, we make a
number of estimates and assumptions relating to the reporting of our results of
operations and financial condition in the preparation of our financial
statements in conformity with accounting principles generally accepted in the
United States. Certain critical accounting assumptions affect the reported
amounts of assets, liabilities, revenues and expenses. As a result, changes in
these estimates or assumptions could significantly affect our financial position
or our results of operations. Actual results may differ from these estimates
under different assumptions or conditions as discussed below. We believe that of
the significant accounting policies used in the preparation of our consolidated
financial statements, the items discussed below involve critical accounting
estimates and high degree of judgment and complexity.
Revenue Recognition and Allowance for Sales Returns
We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements (SAB 101), as amended. SAB 101
requires that four basic criteria must be met before revenue can be recognized:
(1) persuasive evidence of an arrangement exists; (2) delivery has occurred or
services rendered; (3) the fee is fixed and determinable; and (4) collectibility
is reasonably assured.
Revenue is recognized from product sales when both title and risk of loss
transfer to the customer. Generally, both risk of loss and title pass to our
customers at the date of shipment via common carrier. Sales are recorded net of
an allowance for sales returns. We offer a money-back guarantee that allows the
customers to return most products, within 30 days of receipt, for a full refund
of their original product purchase price, or exchange them for other products.
We estimate product sale returns based upon sales levels, historical return
percentages and current economic trends. If the actual costs of sales returns
significantly exceed the recorded estimated allowance, our sales would be
significantly adversely affected. Revenue is recognized from sales of our golf
school instruction services when the customer has attended the instruction
program and our services have been rendered. We credit deferred revenue to the
extent we receive payment for products prior to shipment or prior to the
rendering of services.
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NATURAL GOLF CORPORATION AND SUBSIDIARIES
Prepaid Expenses
Airing of the Company's infomercials normally requires payment in advance. Such
advance payments are recorded as prepaid expenses, which are later expensed in
the period that the related infomercial airings occur. As of May 31, 2004,
$520,000 has been prepaid for infomercial airings to occur in the third quarter
of fiscal 2004. While the airing of infomercials has been part of the Company's
operations for many years, the Company has, for the first time, entered into an
agreement with a media company to have a television series produced and aired.
The agreement calls for total payment in advance of $1 million. In addition to
the production and airing of the television series, the prepayment also includes
$200,000 of media, of which the Company used and expensed $172,000 in the first
six months of fiscal 2004. The media company is producing the television series
at its sole expense and cost, and will own exclusive right to use and distribute
the series. Therefore, the remaining $800,000 that was prepaid with respect to
the television series will be expensed as the series is aired. The first of
eight episodes aired on June 21. The remaining episodes are expected to occur
within the third quarter of fiscal 2004. It is anticipated that the total value
to be received from the production and airing of the television series is in
excess of the recorded prepayment amount. As of May 31, 2004 the Company has
made prepayments for other marketing expenses, as well as various for other
expenses required by its operations, mainly for insurance, rent, and postage.
Inventories
Our inventories are valued at the lower of cost or market. Cost is determined
using the first-in, first-out (FIFO) method. Our inventory balances consist of
the material costs of unassembled golf club components and other products bought
and sold for resale without further processing or assembly. These balances are
written down periodically to adjust for any obsolete or unmarketable inventory
as impairment of such inventories is identified. If the actual amount of
obsolete or unmarketable inventory significantly exceeds the estimated amounts,
our cost of products sold and gross profit would be adversely affected.
Income Taxes
Deferred income taxes are recognized for the expected tax consequences in future
years for differences between the tax bases of assets and liabilities and their
financial reporting amounts, based upon enacted tax laws and statutory tax rates
applicable to the periods in which the differences are expected to affect
taxable income. Our significant deferred tax asset is related primarily to our
net operating loss carry-forward. We have had net losses from inception and have
concluded that it is more likely than not that all deferred income tax assets
generated from operating losses through May 31, 2004 will not be realized.
Accordingly, we have recognized a valuation allowance equal to the entire
deferred income tax asset. The estimates for deferred tax assets and the
corresponding valuation allowance require complex judgments. We periodically
review those estimates for reasonableness. However, because the recoverability
of deferred tax assets is directly dependent upon our future operating results,
actual recoverability of deferred tax assets may differ materially from our
estimates.
SEASONALITY AND ECONOMIC CONDITIONS
Our second and third quarters are generally favorably affected due to the peak
golf season in the United States and Canada, our primary markets. Since
consumers consider our products and services discretionary spending items, we
may be adversely affected by a sustained economic downturn in the economy.
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NATURAL GOLF CORPORATION AND SUBSIDIARIES
FORWARD-LOOKING STATEMENTS
This Report includes forward-looking statements that reflect our current
expectations about our future results, performance, prospects and opportunities.
We have tried to identify these forward-looking statements by using words such
as "may," "will," "expect," "anticipate," "believe," "intend," "could" and
"estimate" and similar expressions. These forward-looking statements are based
on information currently available to us and are subject to a number of risks,
uncertainties and other factors that could cause our actual results,
performance, prospects or opportunities in 2004 and beyond to differ materially
from those expressed in, or implied by, these forward-looking statements. These
risks, uncertainties and factors include general economic uncertainty,
conditions in the golf industry, the inability to become profitable or grow
revenues, the timing, cost and execution of new marketing initiatives that might
not be effective at generating new customers and revenues at a level sufficient
to fund operations, seasonal fluctuations in the business, the inability to
raise additional capital if needed and competitive conditions in the golf
industry. For a more comprehensive discussion of these and other risks,
uncertainties and factors relating to our business, please read the disclosure
included in the Company's Form 10-KSB for the fiscal year ended November 30,
2003 (www.sec.gov). You should not place undue reliance on any forward-looking
statements. Except as otherwise required by federal securities laws, the Company
undertakes no obligation to revise or update any forward-looking statements to
reflect events or circumstances after the date of this press release.
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