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 SEPTEMBER 30, 2004  OR |_|
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
(State or other jurisdiction of
incorporation or organization)
95-4390071
(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 November 2, 2004:  6,682,701 1   SPORT CHALET, INC.


Table of Contents to
Form 10-Q



PagePART
      I  FINANCIAL INFORMATIONItem
      1.     Financial Statements
    
    3Item
      2.     Managements Discussion
      and Analysis of Financial Condition
                      and
      Results of Operations
    
    8Item
      3.     Quantitative and Qualitative
      Disclosures About Market Risk
    
    17Item
      4.     Controls and Procedures
    
    17PART
      II  OTHER INFORMATIONItem
      1.    Legal Proceedings
    
    18Item
      2.     Unregistered Sales of Equity
      Securities and Use of Proceeds
    
    18Item
      3.     Defaults Upon Senior Securities
    
    18Item
      4.     Submission of Matters to
      a Vote of Security Holders
    
    18Item
      5.     Other Information
    
    19Item
      6.     Exhibits and Reports on Form
      8-K
    
    192


PART I  FINANCIAL
INFORMATION




Item
1.Financial Statements.


SPORT CHALET, INC.


CONDENSED CONSOLIDATED
STATEMENTS OF INCOME(UNAUDITED)





Three months
      ended
      September 30,
    
    Six months
      ended
      September 30,2004
    
    2003
    
    2004
    
    2003Net
      sales
    
    
    $
    72,465,181
    
    $
    61,818,702
    
    $
    134,003,300
    
    $
    115,127,978Cost of goods
      sold, buying and
         occupancy
    
    
    
    49,989,199
    
    
    43,305,377
    
    
    93,828,640
    
    
    81,841,640Gross
      profit
    
    
    
    22,475,982
    
    
    18,513,325
    
    
    40,174,660
    
    
    33,286,338Selling,
      general and administrative
         expenses
    
    
    
    19,419,902
    
    
    15,580,745
    
    
    36,656,257
    
    
    31,302,214Income from
      operations
    
    
    
    3,056,080
    
    
    2,932,580
    
    
    3,518,403
    
    
    1,984,124Interest
      expense
    
    
    
    47,616
    
    
    55,746
    
    
    90,907
    
    
    89,756Income before
      taxes
    
    
    
    3,008,464
    
    
    2,876,834
    
    
    3,427,496
    
    
    1,894,368Income tax
      provision
    
    
    
    1,205,000
    
    
    1,149,000
    
    
    1,379,000
    
    
    760,000Net income
    
    
    $
    1,803,464
    
    $
    1,727,834
    
    $
    2,048,496
    
    $
    1,134,368Earnings
      per share:Basic
    
    
    $
    0.27
    
    $
    0.26
    
    $
    0.31
    
    $
    0.17Diluted
    
    
    $
    0.25
    
    $
    0.25
    
    $
    0.28
    
    $
    0.16Weighted
      average number of
         common shares outstanding:Basic
    
    
    
    6,679,590
    
    
    6,633,667
    
    
    6,678,631
    
    
    6,631,667Diluted
    
    
    
    7,217,471
    
    
    6,944,024
    
    
    7,202,652
    
    
    6,937,438See accompanying
notes.



3


SPORT CHALET, INC.


CONDENSED CONSOLIDATED
BALANCE SHEETS


September
      30,
      2004
    
    March 31,
      2004(Unaudited)AssetsCurrent assets:Cash
    
    
    $
    1,371,215
    
    $
    3,071,648Accounts
      receivable, less allowance of $235,000
            at September 30, 2004 and $30,000 at
      March 31, 2004
    
    
    
    4,448,821
    
    
    1,158,934Merchandise
      inventories
    
    
    
    76,625,015
    
    
    54,172,055Prepaid
      expenses and other current assets
    
    
    
    2,443,198
    
    
    2,202,036Deferred
      income taxes
    
    
    
    2,326,380
    
    
    2,443,945Total
      current assets
    
    
    
    87,214,629
    
    
    63,048,618Furniture,
      equipment and leasehold improvements-net
    
    
    
    32,228,634
    
    
    29,467,976Deferred
      income taxes
    
    
    
    398,402
    
    
    83,704Other
      assets
    
    
    
    87,403
    
    
    101,036Total
      assets
    
    
    $
    119,929,068
    
    $
    92,701,334Liabilities
      and stockholders equityCurrent liabilities:Bank
      overdraft
    
    
    $
    7,543,711
    
    $
    Accounts
      payable
    
    
    
    29,351,024
    
    
    11,131,473Salaries
      and wages payable
    
    
    
    2,988,752
    
    
    3,354,368Income
      taxes payable
    
    
    
    574,512
    
    
    35,631Other
      accrued expenses
    
    
    
    6,781,965
    
    
    7,830,961Total
      current liabilities
    
    
    
    47,239,964
    
    
    22,352,433Deferred
      rent
    
    
    
    6,007,412
    
    
    5,818,026Stockholders
      equityPreferred
      stock, $.01 par value:Authorized
      shares  2,000,000Issued
      and outstanding shares  none
    
    
    
    
    
    
    Common
      stock, $.01 par value:Authorized
      shares  15,000,000Issued
      and outstanding shares  6,680,701
                            at
      September 30, 2004 and 6,673,534
                            at
      March 31, 2004
    
    
    
    66,807
    
    
    66,735Additional
      paid-in capital
    
    
    
    22,933,155
    
    
    22,830,906Retained
      earnings
    
    
    
    43,681,730
    
    
    41,633,234Total
      stockholders equity
    
    
    
    66,681,692
    
    
    64,530,875Total
      liabilities and stockholders equity
    
    
    $
    119,929,068
    
    $
    92,701,334See accompanying notes.


4



SPORT CHALET, INC.


CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED)




Six months
      ended September 30,2004
    
    2003Operating
      activitiesNet income
    
    
    $
    2,048,496
    
    $
    1,134,368Adjustments
      to reconcile net income to net cash provided
           by operating activities:Depreciation
      and amortization
    
    
    
    3,761,783
    
    
    2,986,396Loss
      on disposal of furniture, equipment and leasehold improvements
    
    
    
    
    
    
    244,821Deferred
      income taxes
    
    
    
    (197,133
    )
    
    (149,542
    )Tax
      benefit on employee stock options
    
    
    
    61,923
    
    
    4,134Changes
      in operating assets and liabilities:Accounts
      receivable
    
    
    
    (3,289,887
    )
    
    87,982Merchandise
      inventories
    
    
    
    (22,452,960
    )
    
    (10,838,835
    )Prepaid
      expenses and other current assets
    
    
    
    (241,162
    )
    
    (242,571
    )Refundable
      income taxes
    
    
    
    
    
    
    58,990Bank
      overdraft
    
    
    
    7,543,711
    
    
    (566,426
    )Accounts
      payable
    
    
    
    18,219,551
    
    
    9,586,711Salaries
      and wages payable
    
    
    
    (365,616
    )
    
    (264,144
    )Income
      taxes payable
    
    
    
    538,881
    
    
    746,488Other
      accrued expenses
    
    
    
    (1,048,996
    )
    
    (18,889
    )Deferred
      rent
    
    
    
    189,386
    
    
    295,261Net
      cash provided by operating activities
    
    
    
    4,767,977
    
    
    3,064,744Investing
      activitiesPurchase
      of furniture, equipment and leasehold improvements
    
    
    
    (6,522,441
    )
    
    (3,681,844
    )Other assets
    
    
    
    13,633
    
    
    13,464Net
      cash used in investing activities
    
    
    
    (6,508,808
    )
    
    (3,668,380
    )Financing
      activitiesProceeds
      from exercise of stock options
    
    
    
    40,398
    
    
    39,430Net cash
      provided by financing activities
    
    
    
    40,398
    
    
    39,430Decrease
      in cash and cash equivalents
    
    
    
    (1,700,433
    )
    
    (564,206
    )Cash and
      cash equivalents at beginning of period
    
    
    
    3,071,648
    
    
    4,230,003Cash
      and cash equivalents at end of period
    
    
    $
    1,371,215
    
    $
    3,665,797Supplemental
      Disclosure of Cash Flow InformationCash
      paid during the period for:Income
      taxes
    
    
    $
    975,000
    
    $
    100,000Interest
    
    
    
    
    
    
    See accompanying notes.



5


SPORT CHALET, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)


1.
Basis
of PresentationThe
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.


2.
Earnings
per ShareEarnings
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
      September 30,
    
    Six
      months ended
      September 30,2004
    
    2003
    
    2004
    
    2003Net
      income
    
    $
    1,803,464
    
    $
    1,727,834
    
    $
    2,048,496
    
    $
    1,134,368Weighted
      average number of common shares:Basic
    
    
    6,679,590
    
    
    6,633,667
    
    
    6,678,631
    
    
    6,631,667Effect
      of dilutive securities-
                      stock
      options
    
    
    537,881
    
    
    310,357
    
    
    524,021
    
    
    305,771Diluted
    
    
    7,217,471
    
    
    6,944,024
    
    
    7,202,652
    
    
    6,937,438Earnings
      per share:Basic
    
    $
    0.27
    
    $
    0.26
    
    $
    0.31
    
    $
    0.17Effect
      of dilutive securities-
                      stock
      options
    
    $
    0.02
    
    $
    0.01
    
    $
    0.03
    
    $
    0.01Diluted
    
    $
    0.25
    
    $
    0.25
    
    $
    0.28
    
    $
    0.166






3.
Stock
CompensationThe
Financial Accounting Standards Boards (FASB) SFAS No. 148, Accounting
for Stock-Based Compensation-Transition and Disclosure, and Amendment of FASB Statement
No. 123 (SFAS No.148) amends SFAS No. 123 Accounting for
Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to fair value based method of accounting for employee stock-based
compensation. In addition, 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. 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
      September 30,
    
    Six months
      ended
      September 30,2004
    
    2003
    
    2004
    
    2003Net
      income as reported
    
    
    $
    1,803,464
    
    $
    1,727,834
    
    $
    2,048,496
    
    $
    1,134,368Add: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
    
    
    
    145,193
    
    
    131,268
    
    
    279,840
    
    
    265,470Pro forma
      net income
    
    
    $
    1,658,271
    
    $
    1,596,566
    
    $
    1,768,656
    
    $
    868,898Earnings
      per share  basic and dilutedAs
      reported  basic
    
    
    $
    0.27
    
    $
    0.26
    
    $
    0.31
    
    $
    0.17As
      reported  diluted
    
    
    $
    0.25
    
    $
    0.25
    
    $
    0.28
    
    $
    0.16Pro forma
       basic
    
    
    $
    0.25
    
    $
    0.24
    
    $
    0.27
    
    $
    0.13Pro forma
       diluted
    
    
    $
    0.23
    
    $
    0.23
    
    $
    0.25
    
    $
    0.13The
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.


7



4.
New
Accounting PronouncementsOn
October 13, 2004, the Financial Accounting Standards Board (FASB) concluded
that the Proposed Statement of Financial Accounting Standards, Share-Based Payment, which
would require all companies to measure compensation cost for all share-based payments
(including employee stock options) at fair value, would be effective for public companies
for interim or annual periods beginning after June15, 2005. The Company could adopt the
new standard in one of two ways  the modified prospective transition method or the
modified retrospective transition method. The Company expects to adopt this new standard
in the second quarter ending September 30, 2005 and is currently evaluating the effect
that the adoption of this standard will have on its financial position and results of
operations.




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.


Results of Operations


The
following tables set forth statements of income data and relative percentages of net
sales for the periods indicated (dollar amounts in thousands, except per share amounts).





Three
      months ended September 30,
    
    Six
      months ended September 30,2004
    
    2003
    
    2004
    
    2003Amount
    
    
    Percent
    
    Amount
    
    
    Percent
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    PercentNet
      sales
    
    $
    72,465
    
    
    100.0
    %
    
    $
    61,819
    
    
    100.0
    %
    
    $
    134,003
    
    
    100.0
    %
    
    $
    115,128
    
    
    100.0
    %Gross
      profit
    
    
    22,476
    
    
    31.0
    %
    
    
    18,513
    
    
    29.9
    %
    
    
    40,175
    
    
    30.0
    %
    
    
    33,286
    
    
    28.9
    %Selling,
      general and administrative 
           expenses
    
    
    19,420
    
    
    26.8
    %
    
    
    15,581
    
    
    25.2
    %
    
    
    36,656
    
    
    27.4
    %
    
    
    31,302
    
    
    27.2
    %Income
      from operations
    
    
    3,056
    
    
    4.2
    %
    
    
    2,932
    
    
    4.7
    %
    
    
    3,519
    
    
    2.6
    %
    
    
    1,984
    
    
    1.7
    %Interest
      expense
    
    
    (48
    )
    
    (0.1
    %)
    
    
    (56
    )
    
    (0.1
    %)
    
    
    (91
    )
    
    (0.1
    %)
    
    
    (90
    )
    
    (0.1
    %)Income
      before taxes
    
    
    3,008
    
    
    4.2
    %
    
    
    2,876
    
    
    4.7
    %
    
    
    3,428
    
    
    2.6
    %
    
    
    1,894
    
    
    1.6
    %Net
      income
    
    
    1,803
    
    
    2.5
    %
    
    
    1,727
    
    
    2.8
    %
    
    
    2,048
    
    
    1.5
    %
    
    
    1,134
    
    
    1.0
    %Earnings
      per share:Basic
    
    $
    0.27
    
    
    
    
    
    $
    0.26
    
    
    
    
    
    $
    0.31
    
    
    
    
    
    $
    0.17Diluted
    
    $
    0.25
    
    
    
    
    
    $
    0.25
    
    
    
    
    
    $
    0.28
    
    
    
    
    
    $
    0.168






Three
Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003. Sales
increased $10.7 million, or 17.2%, from $61.8 million for the three months ended
September 30, 2003 to $72.5 million for the same period this year. The increase is the
result of opening five new stores which contributed $6.7 million in sales, or 10.9% of
total sales, as well as a same store sales increase of 5.2%. Three new stores were opened
in the third quarter of fiscal 2004 and two new stores opened in the second quarter of
fiscal 2005. The same store sales increase is due to stronger end of summer sales
resulting from better inventory assortment compared to the same period last year. In
addition, the Company acquired a Southern California based team dealer and consolidated
the team business during the quarter. Same store sales are based upon stores opened
throughout both periods and exclude team sales.


Gross
profit increased $4.0 million, or 21.4%, primarily from increased sales. As a percent of
sales, gross profit increased from 29.9% for the three months ended September 30, 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 as well as
continued improvements in inventory procurement, which lowered markdowns as a percent of
sales.


Selling,
general and administrative expenses increased $3.8 million, or 24.6%, primarily from
additional stores. As a percent of sales, these expenses increased from 25.2% for the
three months ended September 30, 2003, to 26.8% for the same period this year. The
increase is primarily a result of the additional labor and advertising expense required
to open three new stores, partially offset by the leverage created by an increase in same
store sales.


The
effective income tax rate was 39.9% for the three months ended September 30, 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 $76,000, from $1.7 million, or $0.25 per diluted share, for the three
months ended September 30, 2003 to $1.8 million, or $0.25 per diluted share, for the same
period this year, primarily as a result of increased sales and improved gross profit
partially offset by the expenses required to open three new stores.


Six
Months Ended September 30, 2004 Compared to Six Months Ended September 30, 2003.Sales
increased $18.9 million, or 16.4%, from $115.1 million for the six months ended September
30, 2003 to $134.0 million for the same period this year. The increase is the result of
opening five new stores which contributed $11.8 million in sales, or 10.2% of total
sales, as well as a same store sales increase of 5.7%. Three new stores were opened in
the third quarter of fiscal 2004 and two new stores opened in the second quarter of
fiscal 2005. The same store sales increase is due to stronger sales resulting from better
inventory assortment compared to the same period last year. In addition, the Company
acquired a Southern California based team dealer and consolidated the team business
during the period. Same store sales are based upon stores opened throughout both periods
and exclude team sales.


Gross
profit increased $6.9 million, or 20.7%, primarily from increased sales. As a percent of
sales, gross profit increased from 28.9% for the six months ended September 30, 2003 to
30.0% 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 as well as
continued improvements in inventory procurement, which lowered markdowns as a percent of
sales.


Selling,
general and administrative expenses increased $5.4 million, or 17.1%, primarily from
additional stores. As a percent of sales, these expenses increased from 27.2% for the six
months ended September 30, 2003, to 27.4% for the same period this year. The increase is
primarily a result of the additional labor and advertising expense required to open three
new stores, partially offset by the leverage created by an increase in same store sales.




9



The
effective income tax rate was 40.1% for the six months ended September 30, 2003 compared
to 40.2% 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 $914,000, from $1.1 million, or $0.16 per diluted share, for the six
months ended September 30, 2003 to $2.0 million, or $0.28 per diluted share, for the same
period this year, primarily as a result of increased sales and improved gross profit
partially offset by the expenses required to open three 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 six months ended September 30, 2004, $4.8 million was
generated by operating activities compared to $3.1 million for the same period last year.


Inventories
increased by $22.5 million and $10.8 million for the six months ended September 30, 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 three new stores in the
third quarter of fiscal 2004 and two new stores in the second quarter of fiscal 2005. The
average inventory per store increased by 2.2%, at September 30, 2004 as compared to
September 30, 2003, primarily from the planned early receipt of winter related product,
without which the average inventory per store decreased 5.4%. The decrease is due to
continuing improvements in inventory procurement. Winter related product was received
earlier to improve efficiencies of overall merchandise flow.


Bank
overdraft represents the total of checks in transit in excess of cash on hand. The bank
overdraft at September 30, 2004 was $7.5 million and the overdraft is expected to
continue and fluctuate due to the timing of vendor payments in the future. Historically,
accounts payable has increased as inventory increases. In the six months ended September
30, 2004, accounts payable combined with the bank overdraft, increased by $25.8 million
as compared to an increase of $9.0 million for the six months ended September 30, 2003.
The relative change as compared to inventory levels is primarily the result of the timing
of inventory receipts during the period.


Net
cash used in investing activities for the six months ended September 30, 2004 was $6.5
million compared to $3.7 million for the same period ended September 30, 2003. In
addition to routine capital spending, the Company remodeled two stores during the six
months ended September 30, 2003. For the six months ended September 30, 2004, the Company
started two store remodels, opened three new stores and incurred additional expenditures
for two new stores scheduled to open later this fiscal year. The Southern California
based team dealer acquired during the quarter ended September 30, 2004 had an immaterial
effect on the Companys cash flow.


10






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% (5.0% at September 30, 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.
Due to improved inventory management the Company did not borrow on this facility during
the period ended September 30, 2004.


The
Companys primary contractual obligations and commitments as of September 30, 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
      
      ContractsWithin
      1 year
    
    $
    20,435,934
    
    $
    319,5002 - 3 years
    
    
    41,343,437
    
    
    639,0004
      - 5 years
    
    
    37,565,815
    
    
    639,000After 5 years
    
    
    76,616,276
    
    
    1,437,750Total
    
    $
    175,961,462
    
    $
    3,035,250All
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
September 30, 2004 and expire within one year.


No
cash dividends were declared on Common Stock in the first two 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.



11






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. 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.


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. Pending
legislation could impact the method in which the Company calculates 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.



12



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 September 30, 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 and
harm its stock price, especially if a restatement of financial statements for past
periods were to be necessary.


Until
the Company completes the review and any necessary remedial action, and secures the
written attestation of its independent auditors that its internal controls are adequate,
the Company will not be able to file its Annual Report on Form 10-K for fiscal year 2006
as required by the Securities Exchange Act of 1934. If the Companys Form 10-K is
delayed, its stock price could fall. If the delay is significant, the Company could be
subject to a variety of administrative sanctions, including the delisting of its Common
Stock from Nasdaq and the inability of registered broker-dealers to make a market in its
Common Stock, which would further reduce its stock price.


13






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.14






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 to meet 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.


15






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 November 2, 2004, 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.


Our
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.


16






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 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.


17


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.


On
August 2, 2004, we held our 2004 annual meeting of stockholders. At the annual meeting,
there were 6,679,115 shares entitled to vote, and 6,338,480 shares were represented at
the meeting in person or by proxy.


The
following summarizes the results for those matters submitted to our stockholders for
action at the annual meeting:


1.
Election
of Directors. To elect three Class 3 directors to hold office until the
annual meeting of stockholders to be held in 2007, or until their respective
successors have been elected and qualified.Director
    
    
    
    For
    
    
    WithheldDonald
      J. Howard
    
    
    
    6,321,347
    
    
    17,133Norbert
      Olberz
    
    
    
    6,228,447
    
    
    110,033Kenneth
      Olsen
    
    
    
    6,322,919
    
    
    15,5612.
Approval
of the 2004 Equity Incentive Plan.To approve the Companys 2004
Equity Incentive Plan.For
    
    
    Against
    
    
    Abstain
    
    Broker Non-Voter5,326,746
    
    
    304,795
    
    
    106,364
    
    
    660,5753.
Ratification
of Appointment of Independent Auditors.To ratify the appointment of Ernst
& Young LLP as the Companys independent auditors for the fiscal year
ending March 31, 2005.For
    
    
    Against
    
    
    Abstain6,328,070
    
    
    10,146
    
    
    26418






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.




Item
6.  Exhibits and Reports on Form 8-K.


(a)
Exhibits:31.1
Certification
Pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
Certification
Pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1
Certification
Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002(b)
Reports
on Form 8-K:None19






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.


DATE: November 3, 2004
    
    SPORT CHALET,
      INC.
      By:  /s/ HOWARD K. KAMINSKY
             
      Howard K. Kaminsk
      Executive Vice President-Finance,
      Chief Financial Officer and Secretary
      (On behalf of the Registrant and as
      Principal Financial and Accounting Officer)20