SPORT CHALET INC - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2004

|__| 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: 0-20736

Sport Chalet, Inc.
(Exact name of registrant as specified in its charter)

Delaware	95-4390071
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

One Sport Chalet Drive, La Canada, CA 91011 (Address of principal executive offices)

(818) 949-5300 (Registrant’s telephone number, including area code)

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 |X| No |_|

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of Act). Yes |_| No |X|

Number of shares outstanding of the registrant’s Common Stock, $0.01 par value, as of February 8, 2005: 6,685,701

SPORT CHALET, INC.

Table of Contents to Form 10-Q

PART I – FINANCIAL INFORMATION

		Page
Item 1.	Financial Statements		3

Item 2.	Management’s Discussion and Analysis of Financial Condition
	and Results of Operations	8

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Item 4.

Controls and Procedures

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Item 3.

Defaults Upon Senior Securities

Item 4.

Submission of Matters to a Vote of Security Holders

Item 5.

Other Information

Item 6.

Exhibits

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

SPORT CHALET, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

	Three months ended December 31,				Nine months ended December 31,
	2004		2003		2004		2003

Net sales	$	95,913,947	$	79,704,678	$	229,917,247	$	194,832,656
Cost of goods sold, buying and
occupancy		64,743,377		53,743,477		158,572,017		135,585,117

Gross profit		31,170,570		25,961,201		71,345,230		59,247,539
Selling, general and administrative
expenses		24,697,260		20,807,415		61,353,517		52,109,629


Income from operations		6,473,310		5,153,786		9,991,713		7,137,910
Interest expense		145,842		72,314		236,749		162,070

Income before taxes		6,327,468		5,081,472		9,754,964		6,975,840
Income tax provision		2,529,000		1,997,000		3,908,000		2,757,000


Net income	$	3,798,468	$	3,084,472	$	5,846,964	$	4,218,840


Earnings per share:
Basic	$	0.57	$	0.46	$	0.88	$	0.64

Diluted	$	0.53	$	0.44	$	0.81	$	0.61


Weighted average number of common
shares outstanding:
Basic		6,675,534		6,650,801		6,679,631		6,635,730

Diluted		7,226,357		7,028,838		7,212,034		6,960,235

See accompanying notes.

SPORT CHALET, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

	December 31, 2004		March 31, 2004
	(Unaudited)
Assets
Current assets:
Cash	$	6,894,585	$	3,071,648
Accounts receivable, less allowance of $300,000
at December 31, 2004 and $30,000 at March 31, 2004		4,595,010		1,158,934
Merchandise inventories		75,407,922		54,172,055
Prepaid expenses and other current assets		3,180,961		2,202,036
Deferred income taxes		2,294,721		2,443,945

Total current assets		92,373,199		63,048,618
Furniture, equipment and leasehold improvements-net		35,183,824		29,467,976
Deferred income taxes		193,961		83,704
Other assets		81,780		101,036

Total assets	$	127,832,764	$	92,701,334


Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	33,642,637	$	11,131,473
Salaries and wages payable		3,856,777		3,354,368
Income taxes payable		1,837,090		35,631
Other accrued expenses		11,917,418		7,830,961

Total current liabilities		51,253,922		22,352,433

Deferred rent		6,082,486		5,818,026
Stockholders’ equity
Preferred stock, $.01 par value:
Authorized shares - 2,000,000
Issued and outstanding shares - none		—		—
Common stock, $.01 par value:
Authorized shares - 15,000,000 Issued and outstanding shares -
6,682,701 at December 31, 2004 and 6,673,534
at March 31, 2004		66,827		66,735
Additional paid-in capital		22,949,331		22,830,906
Retained earnings		47,480,198		41,633,234

Total stockholders’ equity		70,496,356		64,530,875

Total liabilities and stockholders’ equity	$	127,832,764	$	92,701,334

See accompanying notes.

SPORT CHALET, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Nine months ended December 31,
	2004			2003
Operating activities
Net income	$	5,846,964		$	4,218,840
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization		5,535,987			4,498,396
Loss on disposal of furniture, equipment and leasehold improvements		205,094			301,648
Deferred income taxes		38,967			(546,250	)
Tax benefit on employee stock options		69,244			29,951
Changes in operating assets and liabilities:
Accounts receivable		(3,436,076	)		(361,162	)
Merchandise inventories		(21,235,867	)		(20,012,117	)
Prepaid expenses and other current assets		(978,925	)		(561,007	)
Refundable income taxes		—			58,990
Accounts payable		22,511,164			13,263,385
Salaries and wages payable		502,409			2,202,365
Income taxes payable		1,801,459			2,334,309
Other accrued expenses		4,086,457			7,057,016
Deferred rent		264,460			413,807

Net cash provided by operating activities		15,211,337			12,898,171

Investing activities
Purchase of furniture, equipment and leasehold improvements		(11,456,929	)		(6,657,452	)
Other assets		19,256			7,106

Net cash used in investing activities		(11,437,673	)		(6,650,346	)

Financing activities
Proceeds from exercise of stock options		49,273			166,197

Net cash provided by financing activities		49,273			166,197


Increase in cash and cash equivalents		3,822,937			6,414,022
Cash and cash equivalents at beginning of period		3,071,648			4,230,003

Cash and cash equivalents at end of period	$	6,894,585		$	10,644,025


Supplemental Disclosure of Cash Flow Information
Cash paid during the period for:
Income taxes	$	1,998,000		$	880,000
Interest		101,512			64,288

See accompanying notes.

SPORT CHALET, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.	Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of the results of operations for the periods presented have been included.

The financial data at March 31, 2004 is derived from audited financial statements which are included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2004, and should be read in conjunction with the audited financial statements and notes thereto. Interim results are not necessarily indicative of results for the full year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Certain reclassifications were made to the prior year financial statements to conform to current year presentation with regard to the consolidated statement of cash flows.

On February 7, 2005, the Office of the Chief Accountant of the SEC (the “OCA”) issued a letter regarding lease accounting. The Company has historically treated construction allowances from landlords as a reduction of fixed assets on its balance sheet and a reduction of depreciation expense on its statement of cash flows. In the opinion of the OCA, Statement of Accounting Standards No. 13 and FASB Technical Bulletin No. 88-1 require such landlord reimbursements to be presented on the balance sheet as a deferred credit and the amortization to be a reduction of rent expense. The Company and its independent registered public accounting firm have not yet determined the effect of the OCA’s position on the Company’s financial statements. However, because the amortization period for the related leasehold improvements is generally the same as the life of the lease, the Company does not believe that the OCA’s position would have a material effect on the Company’s income from operations.

2.	Earnings per Share

Earnings per share, basic, is computed based on the weighted average number of common shares outstanding for the period. Earnings per share, diluted, is computed based on the weighted average number of common and potentially dilutive common equivalent shares outstanding for the period. A reconciliation is as follows:

	Three months ended December 31,				Nine months ended December 31,
	2004		2003		2004		2003
Net income	$	3,798,468	$	3,084,472	$	5,846,964	$	4,218,840

Weighted average number of common shares:
Basic		6,675,534		6,650,801		6,679,631		6,635,730
Effect of dilutive securities-
stock options		550,823		378,037		532,403		324,505

Diluted		7,226,357		7,028,838		7,212,034		6,960,235


Earnings per share:
Basic	$	0.57	$	0.46	$	0.88	$	0.64
Effect of dilutive securities-
stock options	$	0.04	$	0.02	$	0.07	$	0.03

Diluted	$	0.53	$	0.44	$	0.81	$	0.61

3.	Stock Compensation

Statement of Financial Accounting Standards (“SFAS”) No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in annual and interim financial statements about the method of accounting for stock-based compensation and its effects on reporting. In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share-Based Payment.” The standard requires all entities to recognize compensation expense for all share-based payments granted to employees in an amount equal to the fair value. The new standard is effective for the first period that begins after June 15, 2005, and allows two different methods of transition. The Company continues to apply the principles of APB Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans. Accordingly, no compensation expense has been recorded in conjunction with options issued to employees. Had compensation cost been determined based on the fair value of the options at the grant date and amortized over the option’s vesting period, consistent with the method prescribed by SFAS No. 123, the Company’s net income would have been:

	Three months ended December 31,				Nine months ended December 31,
	2004		2003		2004		2003

Net income as reported	$	3,798,468	$	3,084,472	$	5,846,964	$	4,218,840
Add:
Stock-based compensation expense
included in reported net income,
net of related tax effects		—		—		—		—
Deduct:
Total stock-based employee compensation
expense determined under fair market
value based method for all awards, net
of related tax effects		147,294		134,583		409,037		400,053

Pro forma net income	$	3,651,174	$	2,949,889	$	5,437,927	$	3,818,787


Earnings per share - basic and diluted
As reported - basic	$	0.57	$	0.46	$	0.88	$	0.64
As reported - diluted	$	0.53	$	0.44	$	0.81	$	0.61

Pro forma - basic	$	0.55	$	0.44	$	0.81	$	0.58
Pro forma - diluted	$	0.52	$	0.42	$	0.77	$	0.55

The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in fiscal 2004: expected volatility of 41%; risk-free interest rate of 4.0%; expected lives from one to four years; and expected dividends of 0%. The Black-Scholes model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

4.	New Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” The standard requires all entities to recognize compensation expense for all share-based payments granted to employees in an amount equal to the fair value. The new standard is effective for the first period that begins after June 15, 2005, and allows two different methods of transition. Note 3, Stock Compensation, of the Notes to Consolidated Financial Statements of this Quarterly Report on Form 10-Q, contains pro forma disclosures regarding the effect on net earnings and earnings per share as if the Company had applied the fair value method of accounting for stock-based compensation. Depending on the model used to calculate stock-based compensation expense in the future and other requirements of SFAS No. 123(R), the pro forma disclosure may not be indicative of the stock-based compensation expense that will be recognized in the Company’s future financial statements. The Company does not believe that the adoption of SFAS No. 123(R) will have a material impact on its results of operations or financial position. The Company expects to implement the new standard in the second quarter ending September 30, 2005 and is currently evaluating the new standard and models which may be used to calculate future stock-based compensation expense.

Item 2.

Management’s Discussion and Analysis of Financial Condition and

Results of Operations.

Except for the historical information contained herein, the matters addressed in this Item 2 constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements are subject to a variety of risks and uncertainties, including those discussed below under the heading “Factors That May Affect Future Results” and elsewhere in this Quarterly Report on Form 10-Q, that could cause actual results to differ materially from those anticipated by the Company’s management. The Private Securities Litigation Reform Act of 1995 (the “Act”) provides certain “safe harbor” provisions for forward-looking statements. All forward-looking statements made in this Quarterly Report on Form 10-Q are made pursuant to the Act.

The following should be read in conjunction with the Company’s financial statements and related notes thereto provided under “Item 1–Financial Statements” above.

Overview

Sport Chalet, Inc. is a leading operator of 36 full service specialty sporting goods superstores in California and Nevada. In 1959, Norbert Olberz, the Company’s Chairman Emeritus and principal stockholder (the “Principal Stockholder”), purchased a small ski and tennis shop in La Canada, California. A focus on providing quality merchandise with outstanding customer service was the foundation of

Norbert’s vision. The Company continues this tradition and is focused on growth through a number of initiatives, including: continuing new store development; remodeling stores to conform to the prototype; and improving information systems to increase product flow-through, improve in-stock positions and optimize merchandise assortment.

The Company’s growth strategy had historically focused on Southern California, but now includes opening new stores throughout California and Nevada as suitable locations are found. In addition, the Company currently plans to expand into Arizona with an initial opening of three locations in the Phoenix area in fiscal 2005-2006. The Company has opened eight stores in the last 24 months. Future store openings are subject to availability of satisfactory store locations based on local competitive conditions,

site availability and cost and the ability to provide and maintain high service levels and quality brand merchandising at competitive prices. Store openings are expected to have a favorable impact on sales volume, but will negatively affect profit in the short term. New stores tend to have higher costs in the early years of operation, due primarily to increased promotional costs and lower sales on a per employee basis until the store matures. As the store matures, sales tend to level off and expenses decline as a percentage of sales. Stores generally require three to four years to attract a stable, mature customer base.

The Company’s prototype stores and over 70% of the total store base range in size from 40,000 to 45,000 square feet and showcase each product category with the feel of a specialty shop all contained under one roof. The full service approach to customer service and product knowledge is enhanced by fixtures which feature specific categories, and give the customer an enhanced shopping experience. Mature stores are evaluated for remodel based on each store’s age and competitive situation, as well as how much the landlord will contribute to the required improvements. Future store remodeling plans will depend upon several factors, including, but not limited to, general economic conditions, competition trends and the availability of adequate capital.

The Company believes that the overall growth of its business will allow it to maintain or increase its operating margins. Increased merchandise volumes should enable the Company to improve its purchasing leverage and achieve greater support throughout the supply chain. The Company’s overall growth should leverage its investments in infrastructure such as the distribution center and information systems. However, these improvements are partially offset by the operating costs of new and maturing stores.

Results of Operations

Three Months Ended December 31, 2004 Compared to Three Months Ended December 31, 2003.

The following tables set forth statements of income data and relative percentages of net sales for the three months ended December 31, 2004 and 2003 (dollar amounts in thousands, except per share amounts).

	Three months ended December 31,
	2004					2003					Dollar		Percentage Dollar
	Amount		Percent			Amount		Percent			Increase		Increase
Net sales	$	95,914		100.0	%	$	79,705		100.0	%	$	16,209		20.3	%
Gross profit		31,171		32.5	%		25,961		32.6	%		5,210		20.1	%
Selling, general and administrative expenses		24,697		25.7	%		20,807		26.1	%		3,890		18.7	%
Income from operations		6,473		6.7	%		5,154		6.5	%		1,319		25.6	%
Interest expense		146		0.2	%		72		0.1	%		74		102.8	%
Income before taxes		6,327		6.6	%		5,082		6.4	%		1,245		24.5	%
Net income		3,798		4.0	%		3,084		3.9	%		714		23.2	%

Earnings per share:
Basic	$	0.57				$	0.46				$	0.11		23.9	%
Diluted	$	0.53				$	0.44				$	0.09		20.5	%

Sales increased $16.2 million, or 20.3%, from $79.7 million for the three months ended December 31, 2003 to $95.9 million for the same period this year. The sales growth is the result of opening eight new stores which resulted in an $11.4 million increase in sales, or 14.3%, as well as a same store sales increase of 6.8%. Three new stores were opened in the third quarter of fiscal 2004, two new stores were opened in the second quarter of fiscal 2005 and three new stores were opened in the third quarter of fiscal 2005. The same store sales increase is due to colder weather early in the quarter this year compared to the same period last year that helped stimulate demand for winter apparel and equipment. Excluding sales of winter related merchandise, same store sales increased 3.4% for the three months ended December 31, 2004 compared to the same period last year. Same store sales are based upon stores opened throughout both periods presented and exclude team sales.

Gross profit increased $5.2 million, or 20.1%, primarily from increased sales. As a percent of sales, gross profit decreased slightly from 32.6% for the three months ended December 31, 2003 to 32.5% for the same period this year.

Selling, general and administrative expenses increased $3.9 million, or 18.7%, primarily from additional stores. As a percent of sales, these expenses decreased from 26.1% for the three months ended December 31, 2003, to 25.7% for the same period this year. The decrease is primarily a result of the efficiencies from the increase in same store sales by the mature stores offset in part by the new stores which take time to reach operating efficiency. In addition, a decrease in workers’ compensation expense resulted in a reduction equal to approximately 1% of sales, partially as the result of an increase in reserves required in the same period last year as well as significantly reduced claim activity this year. The reduction in claim activity this year is believed to be the result of a new safety program implemented at all store locations.

The effective income tax rate was 39.3% for the three months ended December 31, 2003 compared to 40.0% for the same period this year. These rates differ from the statutory rate of 39.8% primarily as a result of permanent differences between financial reporting and tax-basis income.

Net income increased $714,000, or 23.2%, from $3.1 million, or $0.44 per diluted share, for the three months ended December 31, 2003 to $3.8 million, or $0.53 per diluted share, for the same period this year, primarily as a result of increased sales and reduced workers’ compensation expense, partially offset by the expenses associated with the new stores.

Nine Months Ended December 31, 2004 Compared to Nine Months Ended December 31, 2003.

The following tables set forth statements of income data and relative percentages of net sales for the nine months ended December 31, 2004 and 2003 (dollar amounts in thousands, except per share amounts).

	Nine months ended December 31,
	2004					2003					Dollar		Percentage Dollar
	Amount		Percent			Amount		Percent			Increase		Increase
Net sales	$	229,917		100.0	%	$	194,833		100.0	%	$	35,084		18.0	%
Gross profit		71,345		31.0	%		59,248		30.4	%		12,097		20.4	%
Selling, general and administrative expenses		61,354		26.7	%		52,110		26.7	%		9,244		17.7	%
Income from operations		9,992		4.3	%		7,138		3.7	%		2,854		40.0	%
Interest expense		237		0.1	%		162		0.1	%		75		46.3	%
Income before taxes		9,755		4.2	%		6,976		3.6	%		2,779		39.8	%
Net income		5,847		2.5	%		4,219		2.2	%		1,628		38.6	%

Earnings per share:
Basic	$	0.88				$	0.64				$	0.24		37.5	%
Diluted	$	0.81				$	0.61				$	0.20		32.8	%

Sales increased $35.1 million, or 18.0%, from $194.8 million for the nine months ended December 31, 2003 to $229.9 million for the same period this year. The increase is the result of opening eight new stores which resulted in a $23.1 million increase in sales, or 11.9%, as well as a same store sales increase of 6.1%. Three new stores were opened in the third quarter of fiscal 2004, two new stores were opened in the second quarter of fiscal 2005 and three new stores were opened in the third quarter of fiscal 2005. The same store sales increase is believed to be due to better inventory assortments compared to the same period last year. Same store sales are based upon stores opened throughout both periods presented and exclude team sales.

Gross profit increased $12.1 million, or 20.4%, primarily from increased sales. As a percent of sales, gross profit increased from 30.4% for the nine months ended December 31, 2003 to 31.0% for the same period this year. The increase in gross profit as a percent of sales is primarily due to reduced costs from more efficient inbound logistics and continued improvements in inventory procurement which lowered markdowns.

Selling, general and administrative expenses increased $9.2 million, or 17.7%, primarily from additional stores. As a percent of sales, these expenses remain unchanged at 26.7% for the nine months ended December 31, 2003, and 26.7% for the same period this year. Efficiencies from the increase in same store sales by the mature stores were offset by the new stores which take time to reach operating efficiency. In addition, a decrease in workers’ compensation expense resulted in a reduction equal to approximately 0.4% of sales, partially as the result of an increase in reserves required in the same period last year as well as significantly reduced claim activity this year. The reduction in claim activity this year is believed to be the result of a new safety program implemented at all store locations.

The effective income tax rate was 39.5% for the nine months ended December 31, 2003 compared to 40.1% for the same period this year. These rates differ from the statutory rate of 39.8% primarily as a result of permanent differences between financial reporting and tax-basis income.

Net income increased $1.6 million, or 38.6%, from $4.2 million, or $0.61 per diluted share, for the nine months ended December 31, 2003 to $5.8 million, or $0.81 per diluted share, for the same period this year, primarily as a result of increased sales, improved gross profit margin, and reduced workers’ compensation expense, partially offset by the expenses associated with the new stores.

Liquidity and Capital Resources

The Company’s primary capital requirements are for inventory and store expansion, relocation and remodeling. Historically, cash from operations, credit terms from vendors and bank borrowings have met the Company’s liquidity needs. Management believes that these sources will be sufficient to fund currently anticipated cash requirements for the foreseeable future.

Net cash provided by operating activities is primarily the result of net income, adjusted for depreciation and amortization, and increases in accounts payable partially offset by inventory purchases. For the nine months ended December 31, 2004, $15.2 million was generated by operating activities compared to $12.9 million for the same period last year.

Accounts receivable increased $3.4 million for the nine months ended December 31, 2004 compared to the year-end balance primarily from amounts due to the Company from the landlords of recently opened new stores. These amounts represent partial reimbursement of construction costs as required by the lease agreements.

Inventories increased by $21.2 million and $20.0 million for the nine months ended December 31, 2004 and 2003, respectively, compared to the respective year-end balances primarily due to the build-up of seasonal inventory. In addition, the Company opened two new stores in the second quarter of fiscal 2005 and three new stores in the third quarter of fiscal 2005. The average inventory per store decreased by 9.2%, at December 31, 2004 as compared to December 31, 2003, primarily due to the continuing improvements in inventory procurement.

Historically, accounts payable has increased as inventory increases. In the nine months ended December 31, 2004, accounts payable increased by $22.5 million as compared to an increase of $13.3 million for the nine months ended December 31, 2003. The relative change as compared to inventory levels is the result of the timing of vendor payments near the end of the period.

Net cash used in investing activities for the nine months ended December 31, 2004 was $11.4 million compared to $6.7 million for the same period ended December 31, 2003. In addition to routine capital spending, the Company remodeled two stores and opened three new stores during the nine months ended December 31, 2003. For the nine months ended December 31, 2004, the Company completed two store remodels and opened five new stores. The Southern California based team dealer acquired during the quarter ended September 30, 2004 had an immaterial effect on the Company’s cash flow.

The Company’s amended credit facility with Bank of America, N.A. (the “Lender”) provides for advances up to $20 million, increasing to $35.0 million for the period October 1, through December 31, each year, less the amount of any outstanding draws, up to a $4.0 million maximum in authorized letters of credit. Interest accrues at the Lender’s prime rate plus 0.25% (5.50% at December 31, 2004) or can be fixed for a period of time at the then current rate established under one of several indices, all at the Company’s option. In addition, there is an unused commitment fee of 0.20% per year, based on a weighted average formula. This credit facility expires on September 30, 2005, and the Company expects to renegotiate and extend the term of this agreement or obtain another form of financing before that date. The Company’s obligation to the Lender is presently secured by a first priority lien on substantially all of the Company’s non-real estate assets, and the Company is subject to several restrictive covenants. The principal operating covenants require the Company to maintain certain minimum cash flow coverage and debt to equity ratios and restrict the level of capital expenditures, calculated on a quarterly basis. The Company currently is in compliance with the covenants. The Company believes its credit line with the Lender is sufficient to fund capital expenditures for the foreseeable future and to meet seasonal fluctuations in cash flow requirements. However, unexpected conditions could require the Company to request additional borrowing capacity from the Lender or alter its expansion plans or operations.

The Company’s primary contractual obligations and commitments as of December 31, 2004, are its store leases with initial terms expiring from 2005 through 2020, which typically provide for multiple five-year renewal options, and employment contracts:

Payments due by period:	Operating Leases		Employment Contracts
Within 1 year	$	21,392,206	$	319,500
2 - 3 years		42,055,034		639,000
4 - 5 years		37,970,135		639,000
After 5 years		73,490,723		1,357,875

Total	$	174,908,098	$	2,955,375

All retail store leases provide for base rent which may or may not be credited against percentage rent based upon gross sales from the premises. In some of the leases, base rental amounts increase as the lease term progresses although, in some cases, the Company expects that percentage rent will more than offset the base rental amounts. Generally, purchase obligations are cancelable 45 days prior to shipment from vendors. Letters of credit amounting to $2,309,000 relating to self-insurance reserves were outstanding as of December 31, 2004 and expire within one year.

No cash dividends were declared on Common Stock in the first three quarters of fiscal 2005. The Company intends to retain earnings for use in the operation and expansion of its business and, therefore, does not anticipate paying any cash dividends in the foreseeable future.

Critical Accounting Policies and Use of Estimates

The Company’s significant accounting policies are described in Note 2 of the Company’s Annual Report on Form 10-K for the year ended March 31, 2004, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the financial statements, the Company is required to make estimates and judgments which affect the results of its operations and the reported value of assets and liabilities. Actual results may differ from these estimates. The Company believes that the following summarizes critical accounting policies which require significant judgments and estimates in the preparation of its consolidated financial statements.

Accounting for Lease Incentives. On February 7, 2005, the Office of the Chief Accountant of the SEC (the “OCA”) issued a letter regarding lease accounting. The Company has historically treated construction allowances from landlords as a reduction of fixed assets on its balance sheet and a reduction of depreciation expense on its statement of cash flows. In the opinion of the OCA, Statement of Accounting Standards No. 13 and FASB Technical Bulletin No. 88-1 require such landlord reimbursements to be presented on the balance sheet as a deferred credit and the amortization to be a reduction of rent expense. The Company and its independent registered public accounting firm have not yet determined the effect of the OCA’s position on the Company’s financial statements. However, because the amortization period for the related leasehold improvements is generally the same as the life of the lease, the Company does not believe that the OCA’s position would have a material effect on the Company’s income from operations.

Inventory Valuation. Merchandise inventories are stated at the lower of cost (first-in, first-out determined by the retail method of accounting) or market. The Company considers cost to include direct cost of merchandise, plus internal costs associated with merchandise procurement, storage and handling. The Company regularly reviews aged and excess inventories to determine if the carrying value of such inventories exceeds market value. A reserve is recorded to reduce the carrying value to market value as necessary. A determination of market value requires estimates and judgment based on the Company’s historical markdown experience and anticipated markdowns based on future merchandising and advertising plans, seasonal considerations, expected business trends and other factors.

Revenue Recognition. Sales are recognized upon the purchase by customers at the Company’s retail store locations, less merchandise returned by customers. The Company provides a reserve for projected merchandise returns based on historical experience which is not material to the results of operations. As the reserve for merchandise returns is based on estimates, the actual returns could differ from the reserve, which could impact sales. Revenue from gift cards, gift certificates and store merchandise credits is recognized at the time of redemption. Revenues from services and licensing agreement are generally recorded on a cash basis, which approximates when the revenue is earned, and are not material.

Self-insurance. Property, general liability and workers’ compensation insurance coverage is self-insured for various levels. Self-insurance accruals include claims filed, as well as estimates of claims incurred but not yet reported based on historical trends. Projections of future loss are inherently uncertain because of the random nature of insurance claim occurrences and could be significantly affected if future occurrences and claims differ from historical trends.

Gift Card/Certificate Redemption. The Company offers its customers the option of purchasing gift cards and, in the past, gift certificates which may be used toward the future purchase of the Company’s product offerings. The gift cards and certificates have no expiration dates. The Company records unredeemed gift cards or certificates as a liability until the point of redemption. The Company’s historical experience indicates that not all issued gift cards or certificates get redeemed. Accordingly, the Company periodically adjusts the carrying value of the related liability and decreases cost of sales by a corresponding amount. Such adjustments have not been material to the Company’s results of operations to date. Pending legislation could impact the method in which the Company calculates the carrying value in the future. The Company monitors redemptions rates as a percent of issuances and uses this information to estimate probable redemption of all outstanding gift cards or certificates. This calculation is based on historical experience, and future redemption rates may vary if consumer purchasing practices change or if the pattern of redeeming gift cards is significantly different than the Company has experienced with gift certificates.

Impairment of Long-Lived Assets. The Company accounts for long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is determined by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered impaired, the impairment recognized is measured by comparing projected individual store discounted cash flow to the asset carrying values. Declines in projected store cash flow could result in the impairment of assets.

Accounting for Income Taxes. As part of the process of preparing the financial statements, income taxes are estimated for each of the jurisdictions in which the Company operates. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the balance sheet. The likelihood that deferred tax assets will be recovered from future taxable income is assessed, recognizing that future taxable income may give rise to new deferred tax assets. To the extent that future recovery is not likely, a valuation allowance would be established. To the extent that a valuation allowance is established or increased, an expense will be included within the tax provision in the income statement.

Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. Based on the Company’s history of operating earnings, no valuation allowance has been recorded as of December 31, 2004. In the event that actual results differ from these estimates, or these estimates are adjusted in future periods, a valuation allowance may need to be established, which could impact the Company’s financial position and results of operations.

Provisions for income taxes for 2004, 2003 and 2002 are based on numerous factors that are subject to audit by the Internal Revenue Service and the tax authorities in the various jurisdictions in which the Company does business.

Factors That May Affect Future Results

The Company’s short- and long-term success is subject to many factors that are beyond the Company’s control. Stockholders and prospective stockholders in the Company should consider carefully the following risk factors, in addition to other information contained in this report. This Report on Form l0-Q contains forward-looking statements, which are subject to a variety of risks and uncertainties. The Company’s actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors including those set forth below.

Implementing Section 404 of the Sarbanes-Oxley Act of 2002. The regulations implementing Section 404 of the Sarbanes-Oxley Act of 2002 require the Company to provide an assessment of the effectiveness of its internal control over financial reporting beginning with the Annual Report on Form 10-K for the fiscal year ending March 31, 2006. The Company’s independent auditors will be required to confirm in writing whether the assessment of the effectiveness of its internal control over financial reporting is fairly stated in all material respects, and separately report on whether they believe the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2006.

This process will be expensive, time consuming and will require significant attention of management. The Company cannot assure that it will not discover material weaknesses in its internal controls. The Company also cannot assure that it will complete the process of its evaluation and the auditors’ attestation on time. If the Company discovers a material weakness, corrective action may be time consuming, costly and further divert the attention of management. The disclosure of a material weakness, even if quickly remedied, could reduce the market’s confidence in the Company’s financial statements, cause the delisting of its Common Stock from Nasdaq and harm its stock price, especially if a restatement of financial statements for past periods were to be necessary.

Economic Conditions. The retail industry historically has been subject to substantial cyclical variations. The merchandise sold by the Company is generally a discretionary expense for its customers. A recession in the general economy or uncertainties regarding future economic prospects that affect consumer spending habits has had, and may in the future have, a material adverse effect on the Company’s results of operations.

Terrorism/War. Terrorist attacks may cause damage or disruption to the Company’s employees, facilities, information systems, vendors and customers, which could significantly impact net sales, costs and expenses and financial condition. The potential for future terrorist attacks, the national and international responses to terrorist attacks, and other acts of war or hostility may cause greater uncertainty and cause the Company to suffer in ways that the Company currently cannot predict. The Company’s geographical focus in California and Nevada may make the Company more vulnerable to such uncertainties than other comparable retailers who may not have similar geographical concentration.

Competition. The sporting goods business and the retail environment are highly competitive, and the Company competes with national, regional and local full-line sporting goods chains, specialty stores, supplier owned stores, discount and department stores, and internet retailers. A number of the Company’s competitors are larger and have greater resources than the Company.

Regional Market Concentration. Currently, most of the Company’s stores are located in Southern California and the balance are located in Northern California and the Las Vegas area of Nevada. Accordingly, the Company is subject to regional risks, such as the economy, weather conditions, natural disasters and government regulations. For example, warm winter weather in the resorts frequented by Southern California residents has affected sales in the past. When the region suffers an economic

downturn or when other adverse events occur, historically there has been an adverse effect on the Company’s net sales and profitability and this could also affect the Company’s ability to implement its planned growth. Several of the Company’s competitors operate stores across the United States and, thus, are not as vulnerable as the Company to such regional risks.

Reliance on a Single Distribution Center. The Company currently relies on a single distribution center in Ontario, California. Any natural disaster or other serious disruption to this distribution center due to fire, earthquake or any other cause could damage a significant portion of the Company’s inventory and could materially impair both the Company’s ability to adequately stock its stores and the Company’s net sales and profitability.

Expansion Plan. The Company’s continued growth depends on a strategy of opening new, profitable stores in existing markets and in new regional markets. The ability to successfully implement this growth strategy could be negatively affected by any of the following:

•	suitable sites may not be available for leasing;
•	the Company may not be able to negotiate acceptable lease terms;
•	the Company might not be able to hire and retain qualified store personnel; and
•	the Company might not have the financial resources necessary to fund the Company’s expansion plans.

In addition, the Company’s expansion in new and existing markets may present competitive, distribution and merchandising challenges that differ from the current challenges. These potential new challenges include competition among the Company’s stores, added strain on the Company’s distribution center, additional information to be processed by the Company’s information systems and diversion of management attention from ongoing operations. The Company faces additional challenges in entering new markets, including consumers’ lack of awareness of the Company, difficulties in hiring personnel and problems due to the Company’s unfamiliarity with local real estate markets and demographics. New markets may also have different competitive conditions, consumer tastes and discretionary spending patterns than the Company’s existing markets. To the extent that the Company is not able t these new challenges, net sales could decrease and operating costs could increase. Furthermore, a decline in the Company’s overall financial performance, increased rents or any other adverse effects arising from the commercial real estate market in the Company’s markets may adversely affect the Company’s current growth plan. There can be no assurance that the Company will possess sufficient funds to finance the expenditures related to its planned growth, that new stores can be opened on a timely basis, that such new stores can be operated on a profitable basis, or that such growth will be manageable.

Future Capital Requirements. The Company may not be able to fund its future growth or react to competitive pressures if it lacks sufficient funds. Unexpected conditions could cause the Company to be in violation of its Lender’s operating covenants. Currently, the Company feels it has sufficient cash available through its bank credit facilities and cash from operations to fund existing operations for the foreseeable future. The Company cannot be certain that additional financing will be available in the future if necessary.

Management of Growth. Since its inception, the Company has experienced periods of rapid growth. No assurance can be given that the Company will be successful in maintaining or increasing its sales in the future. Any future growth in sales will require additional working capital and may place a significant strain on the Company’s management, information systems, inventory management and distribution facilities. Any failure to timely enhance the Company’s operating systems, or unexpected

difficulties in implementing such enhancements, could have a material adverse effect on the Company’s results of operations.

Dependence on Key Personnel. The Company depends on the continued service of its senior management. The loss of the services of any key employee could hurt the business. Also, the future success of the Company depends on its ability to identify, attract, hire, train and motivate other highly skilled personnel. Failure to do so may adversely affect future results.

Seasonality. The Company’s sales volume increases significantly during the Holiday season as is typical with other sporting goods retailers. In addition, the Company’s product mix has historically emphasized cold weather sporting goods increasing the seasonality of the Company’s business. In recent years the months of November, December and January represent between 30% and 34% of the Company’s total net sales, while winter-related products ranged from 15% to 19% of total net sales. The operating results historically have been influenced by the amount and timing of snowfall at the resorts frequented by those living in Southern California. An early snowfall often has influenced sales because it generally extends the demand for winter apparel and equipment, while a late snowfall may have the opposite effect. Suppliers in the ski and snowboard industry require the Company to make commitments for purchases of apparel and equipment by April for fall delivery, and only limited quantities of merchandise can be reordered during the fall. Consequently, the Company places its orders in the spring anticipating snowfall in the winter. If the snowfall does not at least provide an adequate base or occurs late in the season, or if sales do not meet projections, the Company may be required to mark down its winter apparel and equipment.

Variability of Quarterly Results. The Company has experienced, and expects to continue to experience, a substantial variation in its net sales and operating results from quarter to quarter. The Company believes that the factors which influence this variability of quarterly results include general economic and industry conditions that affect consumer spending, changing consumer demands, the timing of the Company’s introduction of new products, the level of consumer acceptance of each new product, the seasonality of the markets in which the Company participates, the weather and actions of competitors. Accordingly, a comparison of the Company’s results of operations from period to period is not necessarily meaningful, and the Company’s results of operations for any period are not necessarily indicative of future performance.

Closely Controlled Stock. At February 8 2005, Norbert Olberz, the Company’s founder, Chairman Emeritus, director and principal stockholder, owned approximately 65% of the Company’s outstanding Common Stock. Mr. Olberz effectively has the ability to control the outcome on all matters requiring stockholder approval, including, but not limited to, the election and removal of directors, and any merger, consolidation or sale of all or substantially all of the Company’s assets, and to control the Company’s management and affairs.

Information Systems are Vulnerable. The Company’s success, in particular the Company’s ability to successfully manage inventory levels and its centralized distribution system, largely depends upon the efficient operation of the Company’s computer hardware and software systems. The Company uses information systems to track inventory information at the store level, replenish inventory from the Company’s warehouse, and aggregate daily sales information among other things. These systems and the Company’s operations are vulnerable to damage or interruption from:

•	earthquake, fire, flood and other natural disasters;

•	power loss, computer systems failures, internet and telecommunications or data network failure, operator negligence, improper operation by or supervision of employees, physical and electronic loss of data and similar events; and
•	computer viruses, penetration by hackers seeking to disrupt operations or misappropriate information and other breaches of security.

The Company seeks to minimize these risks by the use of backup facilities and redundant systems. Nevertheless any failure that causes an interruption in the Company’s operations or a decrease in inventory tracking could result in reduced net sales.

Business Depends on Anticipating Consumer Tastes. If the Company fails to anticipate changes in consumer preferences, it may experience lower net sales, higher inventory markdowns and lower margins. Products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty. These preferences are also subject to change. Sporting goods are often subject to short-lived trends, such as the short-lived popularity of in-line scooters. Outdoor wear is significantly influenced by fashion. The Company’s success depends upon the ability to anticipate and respond in a timely manner to trends in sporting goods merchandise and consumers’ participation in sports. Failure to identify and respond to these changes may cause net sales to decline. In addition, because the Company generally makes commitments to purchase products from vendors up to nine months in advance of the proposed delivery, misjudging the market may over-stock unpopular products and force inventory markdowns that could have a negative impact on profitability, or have insufficient inventory of a popular item that can be sold at full markup.

Stock Price. The Company’s Common Stock is thinly traded making it difficult to sell large amounts. The market price of the Company’s Common Stock is likely to be volatile and could be subject to significant fluctuations in response to factors such as quarterly variations in operating results, operating results which vary from the expectations of securities analysts and investors, changes in financial estimates, changes in market valuations of competitors, announcements by the Company or its competitors of a material nature, additions or departures of key personnel, future sales of Common Stock and stock volume fluctuations. Also, general political and economic conditions such as a recession or interest rate fluctuations may adversely affect the market price of the Company’s Common Stock.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The Company’s exposure to interest rate risk consists primarily of borrowings under its credit facility, which bears interest at floating rates. The impact on earnings or cash flow during the next fiscal year from a change of 100 basis points in the interest rate would not be significant.

Item 4. Controls and Procedures.

The Company’s Chief Executive Officer, Craig Levra, and Chief Financial Officer, Howard Kaminsky, with the participation of the Company’s management, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer believe that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective at the “reasonable assurance” level in making known to them material information relating to the Company (including its consolidated subsidiaries) required to be included in this report.

Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such

objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures such as simple errors or mistakes or intentional circumvention of the established process.

There were no changes in the Company’s internal controls over financial reporting, known to the Chief Executive Officer or the Chief Financial Officer, that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II – OTHER INFORMATION

Item 1.

Legal Proceedings.

The Company is involved in various routine legal proceedings incidental to the conduct of its business. Management does not believe that any of these legal proceedings will have a material adverse impact on the business, financial condition, cash flows or results of operations of the Company, either due to the nature of the claims, or because management believes that such claims should not exceed the limits of the Company’s insurance coverage.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

Not Applicable.

Item 3.

Defaults Upon Senior Securities.

Not Applicable.

Item 4.

Submission of Matters to a Vote of Security Holders.

Not Applicable.

Item 5.

Other Information.

Stockholder Proposals

The proxy materials for the 2004 annual meeting of the stockholders held on August 2, 2004 were mailed to stockholders of the Company on June 21, 2004.

Under certain circumstances, stockholders are entitled to present proposals at stockholder meetings. The 2005 annual meeting of stockholders is presently expected to be held on or about August 1, 2005. Any such proposal to be included in the proxy statement for the Company’s 2005 annual meeting of stockholders must be received by the Secretary of the Company at the Company’s office at One Sport Chalet Drive, La Canada, California 91011 on or before February 21, 2005 in a form that complies with applicable regulations. If the date of the 2005 annual meeting is advanced or delayed more than 30 days from the date of the 2004 annual meeting, stockholder proposals intended to be included in the proxy statement for the 2005 annual meeting must be received by the Company within a reasonable time before the Company begins to print and mail the proxy statement for the 2005 annual meeting. Upon any determination that the date of the 2005 annual meeting will be advanced or delayed by more than 30 days from the date of the 2004 annual meeting, the Company will disclose the change in the earliest practicable Quarterly Report on Form 10-Q.

In the event a stockholder proposal is not submitted to the Company on or before May 6, 2005, the proxies solicited by the Board of Directors for the 2005 annual meeting of the stockholders will confer authority on the holders of the proxy to vote the shares in accordance with the recommendations of the Board of Directors if the proposal is presented at the 2005 annual meeting of stockholders without any discussion of the proposal in the proxy statement for such meeting.

Changes in Registrant’s Independent Registered Public Accounting Firm

(a) On November 15, 2004, the Company dismissed Ernst & Young LLP as the Company’s independent registered public accounting firm. Ernst & Young LLP had served as the Company’s independent registered public accounting firm since 1983. The decision to dismiss Ernst & Young LLP was made by the Audit Committee of the Board of Directors of the Company and, upon recommendation by that committee, was approved by the full Board of Directors.

The reports of Ernst & Young LLP on the Company’s financial statements for each of the last two completed fiscal years contained no adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles.

During the two most recent fiscal years and the subsequent interim period through the date of the dismissal, the Company had no disagreement with Ernst & Young LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreement, if not resolved to the satisfaction of Ernst & Young LLP, would have caused them to make reference to such disagreement in connection with their reports for such periods.

During the two most recent fiscal years and the subsequent interim period through the date of the dismissal, there have been no reportable events (as defined in Regulation S-K, Item 304(a)(1)(v)).

The Company provided Ernst & Young LLP with a copy of the above disclosures and requested that they furnish us with a letter addressed to the Securities and Exchange Commission stating whether they agree with the above statements and, if not, stating the respects in which they do not agree. A copy of the letter from Ernst & Young LLP is incorporated by reference to Exhibit 16.1 to the Company’s Form 8-K (File NO. 000-20736) filed on November 18, 2004.

(b) On November 15, 2004, the Company engaged Moss Adams LLP as the independent registered public accounting firm to audit the Company’s financial statements for the fiscal year ending March 31, 2005. The engagement of Moss Adams LLP was made by the Audit Committee of the Board of Directors of the Company and, upon recommendation by that committee, was approved by the full Board of Directors.

During the two most recent fiscal years of the Company and the subsequent interim period prior to engaging Moss Adams LLP, neither the Company, nor anyone on its behalf, has consulted with Moss Adams LLP regarding any of the matters set forth in Item 304(a)(2)(i)-(ii) of Regulation S-K.

Item 6.

Exhibits.

Exhibits:

3.1	Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s registration statement on Form S-1 (File No. 33-53120))
3.2	Bylaws of Sport Chalet, Inc. as amended (incorporated by reference to Exhibit 3.2 of the Company’s registration statement on Form S-8 (File No. 333-107683))
4.1	Form of Certificate for Common Stock (incorporated by reference to Exhibit 4.1 of the Company’s registration statement on Form S-1 (File No. 33-53120))
31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURE

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 thereunto duly authorized.

SPORT CHALET, INC.

DATE:	February 9, 2005	By: /s / HOWARD K. KAMINSKY
		Howard K. Kaminsky
		Executive Vice President-Finance,

Chief Financial Officer and Secretary

(On behalf of the Registrant and as

Principal Financial and Accounting Officer)